Banc of California, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; balance-sheet comparisons are to December 31, 2018. The company is a California-focused bank operating 32 branches. Management is transitioning toward a core commercial banking model and reducing lower-margin mortgage lending and selected securities holdings. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Financial performance
- Net interest income: $67.8 million, down 5.3% from $71.6 million in Q1 2018. Net interest margin fell to 2.81% from 2.98%. Higher asset yields and loan balances were outweighed by higher funding costs.
- Net income and EPS: Continuing-operations net income was $7.0 million, approximately unchanged from $7.1 million. Net income available to common stockholders was $2.5 million versus $3.2 million; diluted EPS was $0.05 versus $0.06. Q1 2018 included $1.5 million of income from discontinued operations.
- Credit provision: $2.5 million, down from $19.5 million in Q1 2018, which included a large provision tied to a fraudulently obtained credit line and a separate loan downgrade. The 2019 provision reflected rising criticized loans, delinquencies and nonperforming loans, partly offset by lower pass-rated balances.
- Noninterest income and expense: Income was $6.3 million, down 26.6% year over year, primarily reflecting lower servicing income and securities gains. Expense was $61.8 million, up 3.4%; it included $2.8 million of restructuring costs and management identified $5.8 million of nonrecurring costs overall, including net legal and professional fees.
- Returns: Return on average assets was 0.28% versus 0.34%; return on average equity was 2.98% versus 3.40%.
- Cash flow: Operating activities provided $18.5 million; investing activities provided $682.3 million, substantially reflecting securities and loan sales; financing activities used $787.8 million, including deposit outflows and a $585.0 million reduction in FHLB advances. Cash and equivalents decreased $86.9 million to $304.7 million.
Financial position, liquidity and capital
- Assets and loans: Total assets were $9.89 billion, down $743.5 million (7.0%) from year-end. Loans and leases were $7.56 billion, down $143.7 million (1.9%); single-family residential loans declined $202.8 million, while multifamily loans increased $91.3 million.
- Deposits and borrowings: Deposits were $7.72 billion, down $191.7 million (2.4%). Noninterest-bearing deposits rose $97.3 million; brokered deposits fell $249.5 million to $1.46 billion. FHLB advances declined to $935.0 million from $1.52 billion. Long-term debt was $173.2 million net, consisting primarily of $175 million of 5.25% senior notes due 2025.
- Liquidity: The company reported $304.7 million of cash and cash equivalents and $1.36 billion of unpledged available-for-sale securities. It also cited $1.72 billion of unused FHLB capacity, a $21 million Federal Reserve line and $185 million of unsecured federal funds lines. Management stated liquidity was adequate for day-to-day needs.
- Capital: The Bank’s Common Equity Tier 1 ratio was 14.81%, compared with a 6.50% well-capitalized threshold; the company holding-company ratio was 9.72%. The Bank paid $36.0 million in dividends to the holding company in the quarter, and $37.9 million was available for dividends without prior OCC approval at quarter-end, subject to capital constraints.
- Credit quality: Nonperforming assets were $28.8 million, up 26.7% from year-end; nonperforming loans were 0.38% of loans versus 0.29%. Total delinquencies were 0.79% versus 0.53%. The allowance was $63.9 million, or 0.85% of loans, compared with $62.2 million, or 0.81%, at year-end.
Material changes, outlook and risks
- The company sold $243.4 million of single-family residential loans, recording a $1.6 million gain, and continued exiting third-party mortgage origination and brokered single-family lending. It sold its remaining $132.2 million commercial mortgage-backed securities and reduced collateralized loan obligations by $365.3 million. Proceeds helped repay brokered certificates of deposit and FHLB advances.
- Management described a strategy to expand core lending, strengthen core deposits and reduce reliance on higher-cost brokered deposits and FHLB funding. No quantified earnings or revenue guidance is provided in the supplied filing text.
- In April 2019, the Board approved reducing the quarterly common dividend from $0.13 to $0.06 per share. The Q1 dividend payout ratio was reported as 260%.
- Adoption of the expected-credit-loss standard (CECL) was scheduled for 2020. The company said the impact could be significant but could not yet be reasonably estimated; parallel calculations and testing were expected to begin in Q2 or Q3 2019.
- Key risks include the ongoing SEC investigation and related litigation, legal and reputational costs, the CEO transition, execution of the business transition and expense reductions, rising credit issues, deposit competition, and interest-rate and funding-cost sensitivity. A shareholder securities class action had trial set for February 2020; a separate action involving alleged access to confidential documents had trial set for September 2019. The company said it intended to contest the cases. Litigation accruals were $682,000 at quarter-end.
- Other notable items: alternative-energy partnership investments generated a $2.0 million loss in Q1 2019, compared with a small gain in Q1 2018; the 2018 period also included $7.3 million of related investment tax credits. The company adopted lease accounting and recognized operating lease right-of-use assets of $24.5 million and liabilities of $25.9 million at quarter-end.
Important facts for investors to verify
- Whether the dividend reduction and transition plan produce durable earnings improvement as the company reduces higher-cost funding and exits mortgage activities.
- Whether deposit trends, funding costs and net interest margin stabilize; Q1 deposit balances declined even as noninterest-bearing deposits increased.
- Whether the increase in delinquencies, criticized loans and nonperforming assets leads to further provisions or charge-offs.
- The eventual CECL allowance and capital impact, which management said may be significant but had not yet estimated.
- The progression, costs and potential outcomes of the SEC investigation and pending litigation, as well as the ongoing management transition.
- The risk and expected returns of the remaining CLO and alternative-energy partnership exposures, and the realization of planned expense savings.