SIERRA BANCORP quarterly report, Q3 FY2012

Sierra Bancorp — Q3 2012 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2012. Sierra Bancorp is a California bank holding company; its subsidiary, Bank of the Sierra, operates 25 full-service branches in the San Joaquin Valley. Dollar amounts below are in millions unless otherwise noted.

Financial performance and condition

MetricQ3 2012 / Sep. 30, 2012Comparable period / prior date
Net income$1.635; diluted EPS $0.12Q3 2011: $2.526; diluted EPS $0.18
Net interest income$13.129Q3 2011: $13.547
Net interest margin4.27%Q3 2011: 4.56%
Provision for loan losses$4.700Q3 2011: $3.000
Non-interest income / expense$3.896 / $11.011Q3 2011: $3.369 / $10.568
Assets$1,423.3Dec. 31, 2011: $1,335.4
Gross loans and leases$847.1Dec. 31, 2011: $757.6
Deposits$1,145.9Dec. 31, 2011: $1,086.3
Shareholders’ equity$174.5Dec. 31, 2011: $168.6
  • Nine-month results: Net income was $6.087 million versus $6.239 million in 2011; diluted EPS was $0.43 versus $0.44. Net interest income was $38.165 million versus $40.020 million, and the tax-equivalent net interest margin was 4.29% versus 4.64%.
  • Returns: Q3 annualized ROA and ROE were 0.46% and 3.74%, versus 0.74% and 6.00% in Q3 2011. Nine-month ROA and ROE were 0.59% and 4.73%, versus 0.63% and 5.09%.
  • Cash flow, nine months: Operating activities provided $28.9 million; investing activities used $125.4 million, principally reflecting $125.3 million of net loan growth; financing activities provided $78.5 million. Cash and cash equivalents declined $17.9 million to $45.1 million.
  • Credit and allowance: Nonperforming assets were $48.7 million, down from $71.5 million at year-end; nonperforming loans were $28.9 million and foreclosed assets were $19.8 million. The allowance was $12.8 million, or 1.51% of gross loans, versus $17.3 million, or 2.28%, at year-end. Nine-month net charge-offs were $15.1 million, compared with $10.2 million a year earlier.
  • Debt and liquidity: Total deposits were $1,145.9 million. Borrowings included $47.9 million of short-term borrowings, $5.0 million long-term borrowings, and $30.9 million of junior subordinated debentures. Management reported $196 million available on existing credit lines, with additional contingent FHLB and Federal Reserve borrowing capacity subject to collateral and other requirements.
  • Capital: Sierra Bancorp’s total risk-based capital, Tier 1 risk-based capital, and Tier 1 leverage ratios were 19.96%, 18.70%, and 13.50%, respectively. The Company and Bank were classified as well capitalized.

Material changes and management commentary

  • Q3 net income fell 35% year over year. Management attributed the decline primarily to lower net interest income and a $1.7 million increase in loan-loss provision, partly offset by higher non-interest revenue and a tax benefit.
  • Net interest margin contracted as yields on loans and investments fell, amid competition for quality loans and reinvestment at low rates. Lower-cost deposit mix and growth in earning assets partly offset the pressure.
  • Gross loans rose 12% from year-end, driven chiefly by a $126 million increase in mortgage warehouse line balances. Commercial and industrial loans grew to 27.29% of total loans from 13.12%; management cautioned that warehouse lending is rate-sensitive and its recent growth may not continue.
  • Asset quality improved by certain measures: nonperforming assets fell 32% from year-end, while performing troubled debt restructurings (TDRs) were $36.9 million. Total TDRs were $50.7 million, including $13.8 million on non-accrual status. Foreclosed assets nonetheless increased 29% from year-end.
  • Core non-maturity deposits increased $47 million, and total deposits rose 5%. Borrowings also increased to help fund loan growth. The allowance declined amid charge-offs and management’s assessment of improving risk in performing loans.
  • Q3 non-interest revenue benefited from bank-owned life insurance (BOLI) income, including variable returns tied to deferred compensation investments. It also included $90,000 of securities gains and $87,000 of non-recurring life-insurance proceeds; OREO sale losses were $555,000. Debit-card fraud losses increased, and the Bank reported implementing added fraud controls in October.

Outlook, risks, and contingencies

  • The filing provides no quantified earnings or revenue guidance. Management said it was pursuing high-quality lending growth and viewed current liquidity as sufficient for anticipated short-term needs, while cautioning that loan and deposit growth trends may not persist.
  • Interest-rate simulations indicate an asset-sensitive position: estimated next-12-month net interest income changes ranged from a 5.40% decline under an immediate 100-basis-point rate decrease to a 2.57% increase under a 100-basis-point increase. Some falling-rate scenarios slightly exceeded internal policy limits. Results depend on modeling assumptions, including deposit behavior and prepayments.
  • Proposed Basel III rules could affect capital ratios, including through the phase-out of approximately $30 million of trust-preferred securities from Tier 1 capital, treatment of accumulated other comprehensive income, and higher risk weights for certain loans. The ultimate impact was not yet determinable; management believed current capital should position the Company to absorb the changes, but gave no assurance.
  • Risks identified include economic weakness in the service area, interest-rate and liquidity changes, credit losses and nonperforming assets, ability to sell foreclosed properties, securities valuation declines, staffing and technology challenges, branch expansion, and regulation. Management said ordinary-course legal proceedings were not expected to have a material adverse effect; no material changes to previously disclosed risk factors were reported.

Investor facts to verify

  1. Whether mortgage warehouse lending growth is sustainable and whether the associated borrower, concentration, and funding risks are adequately controlled.
  2. Whether elevated charge-offs, new impairments, TDR performance, and growing foreclosed assets could require higher provisions or additional write-downs despite lower nonperforming loans.
  3. Whether the reduced allowance-to-loan ratio remains adequate given loan growth and nine-month net charge-offs.
  4. Whether margin pressure, rate sensitivity, and the tax benefit’s contribution to reported earnings persist or reverse.
  5. The eventual Basel III requirements and their effect on capital ratios, dividends, and growth capacity.