Banc of California, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Banc of California is a California-focused community bank operating 32 branches. Management said it is transitioning toward a relationship-focused community bank, emphasizing core deposits, higher-margin lending and expense discipline.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $58.9 million | $71.3 million | $191.5 million | $215.9 million |
| Provision for loan losses | $38.5 million | $1.4 million | $39.1 million | $23.6 million |
| Noninterest income | $3.2 million | $4.8 million | $7.2 million | $21.5 million |
| Noninterest expense | $43.3 million | $60.9 million | $148.7 million | $183.2 million |
| Net income (loss), consolidated | $(14.1) million | $11.1 million | $9.5 million | $34.4 million |
| Net income (loss) available to common stockholders | $(22.7) million | $3.6 million | $(8.0) million | $16.3 million |
| Diluted EPS | $(0.45) | $0.07 | $(0.16) | $0.32 |
| Net interest margin | 2.86% | 2.93% | 2.84% | 2.97% |
Amounts are rounded. 2018 consolidated results include discontinued operations; 2019 discontinued operations were immaterial. The Q3 preferred-stock redemption also reduced income available to common stockholders by $5.1 million.
Financial position, cash flow and capital
- Balance sheet: Total assets were $8.63 billion, down $2.00 billion from December 31, 2018. Net loans were $6.32 billion, down 17.3%; available-for-sale securities were $775.7 million, down 61.1%.
- Deposits and borrowings: Deposits were $5.77 billion, down 27.1%, including a $1.49 billion reduction in higher-cost brokered certificates of deposit. Noninterest-bearing deposits rose $84.1 million. FHLB advances totaled $1.65 billion, compared with $1.52 billion at year-end; long-term debt was $173.3 million net ($175 million principal, 5.25% senior notes due 2025).
- Liquidity and cash flow: Cash and cash equivalents were $526.9 million. For the first nine months, operating cash flow was $60.1 million, investing cash flow was $2.16 billion, and financing cash flow was a use of $2.09 billion; cash increased $135.3 million. Available unused borrowing capacity included $874.6 million from FHLB, $21.0 million at the Federal Reserve Discount Window and $185.0 million in unsecured federal funds lines. The company also reported $711.1 million of unpledged securities.
- Credit: The allowance for loan losses was $62.9 million, or 0.99% of loans. Nonperforming loans were $45.2 million, or 0.71% of loans, versus $21.6 million and 0.29% at year-end. Nine-month net charge-offs were $38.3 million.
- Capital: At September 30, the company reported total risk-based capital of 14.37%, common equity Tier 1 of 10.34% and Tier 1 leverage of 9.84%. The bank subsidiary reported 15.65%, 14.60% and 10.75%, respectively. Management’s highlights separately cite a 14.31% company total risk-based ratio.
Material changes and unusual items
- A $35.1 million charge-off in Q3 related to a commercial line of credit originated in 2017 to a borrower purportedly involved in fraud. The charge-off drove most of the $38.5 million quarterly loan-loss provision; the bank also added $3.0 million to the C&I loss factor. The bank filed suit against two title companies seeking recovery, but stated recovery is uncertain.
- The bank reviewed 53 commercial lending relationships, representing $536 million in commitments, that were at least $5 million and not secured by real estate. It reported no other apparent fraud or collateral concerns identified in the reviewed credits to date, while cautioning the review may not detect every issue.
- The company sold approximately $1.16 billion of securities during the first nine months, including mortgage-backed securities and collateralized loan obligations. Q3 included a $5.1 million securities-sale loss and $731,000 impairment on remaining mortgage-backed securities. Management expected to sell the remaining mortgage-backed securities in Q4 and reinvest proceeds in a shorter-duration mix.
- A Freddie Mac multifamily securitization involved approximately $573.5 million of loans. The company recognized an $8.9 million gross gain on loan sales in Q3 and a $9.0 million swap loss in Q2; management said the swap was intended to offset changes in the loans’ fair value. The company disclosed a $4.4 million repurchase liability and maximum credit-loss exposure of $68.8 million under a guarantee.
- The company repurchased Series D and E preferred stock for $46.0 million, including premium and accrued dividends. The transaction reduced income available to common stockholders by $5.1 million. The quarterly common dividend was reduced from $0.13 to $0.06 per share in April 2019.
Outlook, risks and contingencies
- CECL: Management expected the January 1, 2020 adoption of the expected-credit-loss standard to increase the allowance by up to approximately 25% from September 30, 2019 levels, with much of the estimated increase attributable to C&I and CRE portfolios. The eventual impact remains dependent on portfolio conditions, economic forecasts and finalized models.
- Taxes: Management expected the 2019 effective tax rate to be closer to 11%, and said it expected a rate closer to 20% in 2020. These are tax-rate expectations, not earnings guidance.
- Legal matters: A proposed $19.75 million securities-litigation settlement would be paid by insurers, with no company cash contribution expected; court approval and other conditions remained outstanding. The company accrued $20.3 million for various litigation matters, including a matching insurance receivable for the proposed settlement. The filing also describes an ongoing SEC investigation, shareholder derivative suits and other litigation.
- Other risks: The filing highlights credit and fraud risk, loan-loss estimation, deposit and funding costs, interest-rate sensitivity, regulatory oversight, execution of the community-bank transition and the recent CEO transition. The company said there were no material changes to the risk factors in its 2018 Form 10-K. Disclosure controls were reported effective as of September 30, 2019.
Important facts for investors to verify
- Progress and recoveries, if any, related to the $35.1 million fraud-related charge-off and the completeness of the collateral review.
- Whether asset sales and deposit repricing improve net interest income and margin as the balance sheet contracts.
- Actual CECL adoption impact versus management’s estimate of an allowance increase of up to approximately 25%.
- Credit quality trends, including nonperforming loans, criticized loans, TDRs and future charge-offs.
- Final court approval and insurer funding of the proposed securities-litigation settlement, plus developments in the SEC investigation and other litigation.
- The reported 14.31% versus 14.37% company total risk-based capital ratio difference, and the effect of the OCC dividend-approval requirement on future capital distributions.
- Execution of the planned Q4 mortgage-backed securities sale and reinvestment, and the remaining exposure under the multifamily securitization guarantee.