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Section 1: 10-Q (10-Q)

bsrr-10q_20190331.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2019

Commission file number:  000-33063

 

Sierra Bancorp

(Exact name of Registrant as specified in its charter)

 

California

33-0937517

(State of Incorporation)

(IRS Employer Identification No)

 

86 North Main Street, Porterville, California 93257

(Address of principal executive offices)                  (Zip Code)

 

(559) 782-4900

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

 

Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).    Yes      No  

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer

 

  

Accelerated Filer:

 

Non‑accelerated Filer:

 

  

Smaller Reporting Company:

 

Emerging Growth Company:

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section7(a)(2)(B) of the Securities Act. 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

As of May 1, 2019, the registrant had 15,328,430 shares of common stock outstanding.

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

 

Trading

Symbol(s)

 

Name of each exchange on which registered

Common Stock, no par value

 

BSRR

 

The NASDAQ Stock Market LLC

 

 


FORM 10-Q

Table of Contents

 

 

Page

Part I - Financial Information

1

 

Item 1. Financial Statements (Unaudited)

1

 

 

Consolidated Balance Sheets

1

 

 

Consolidated Statements of Income

2

 

 

Consolidated Statements of Comprehensive Income

3

 

 

Consolidated Statements of Changes In Stockholder’s Equity

4

 

 

Consolidated Statements of Cash Flows

5

 

 

Notes to Consolidated Financial Statements (Unaudited)

6

 

 

 

 

 

 

Item 2. Management’s Discussion & Analysis of Financial Condition & Results of Operations

30

 

 

Forward-Looking Statements

30

 

 

Critical Accounting Policies

30

 

 

Overview of the Results of Operations and Financial Condition

31

 

 

Earnings Performance

32

 

 

 

Net Interest Income and Net Interest Margin

32

 

 

 

Provision for Loan and Lease Losses

35

 

 

 

Non-Interest Income and Non-Interest Expense

36

 

 

 

Provision for Income Taxes

38

 

 

Balance Sheet Analysis

38

 

 

 

Earning Assets

38

 

 

 

 

Investments

38

 

 

 

 

Loan and Lease Portfolio

40

 

 

 

 

Nonperforming Assets

41

 

 

 

 

Allowance for Loan and Lease Losses

42

 

 

 

 

Off-Balance Sheet Arrangements

44

 

 

 

Other Assets

44

 

 

 

Deposits and Interest-Bearing Liabilities

45

 

 

 

 

Deposits

45

 

 

 

 

Other Interest-Bearing Liabilities

46

 

 

 

Non-Interest Bearing Liabilities

46

 

 

Liquidity and Market Risk Management

46

 

 

Capital Resources

48

 

 

 

 

 

 

Item 3. Qualitative & Quantitative Disclosures about Market Risk

50

 

 

 

 

 

 

Item 4. Controls and Procedures

50

 

 

Part II - Other Information

51

 

Item 1. - Legal Proceedings

51

 

Item 1A. - Risk Factors

51

 

Item 2. - Unregistered Sales of Equity Securities and Use of Proceeds

51

 

Item 3. - Defaults upon Senior Securities

51

 

Item 4. - Mine Safety Disclosures

51

 

Item 5. - Other Information

51

 

Item 6. - Exhibits

52

 

 

Signatures

53

 

 


PART I - FINANCIAL INFORMATION

Item 1 – Financial Statements

SIERRA BANCORP

CONSOLIDATED BALANCE SHEETS

(dollars in thousands)

 

 

 

March 31, 2019

 

 

December 31, 2018

 

ASSETS

 

(unaudited)

 

 

(audited)

 

Cash and due from banks

 

$

58,940

 

 

$

72,439

 

Interest-bearing deposits in banks

 

 

9,123

 

 

 

1,693

 

Total cash & cash equivalents

 

 

68,063

 

 

 

74,132

 

Securities available-for-sale

 

 

563,628

 

 

 

560,479

 

Loans and leases:

 

 

 

 

 

 

 

 

Gross loans and leases

 

 

1,750,989

 

 

 

1,731,928

 

Allowance for loan and lease losses

 

 

(9,438

)

 

 

(9,750

)

Deferred loan and lease costs, net

 

 

2,787

 

 

 

2,602

 

Net loans and leases

 

 

1,744,338

 

 

 

1,724,780

 

Foreclosed assets

 

 

806

 

 

 

1,082

 

Premises and equipment, net

 

 

28,855

 

 

 

29,500

 

Goodwill

 

 

27,357

 

 

 

27,357

 

Other intangible assets, net

 

 

6,187

 

 

 

6,455

 

Bank-owned life insurance

 

 

49,270

 

 

 

48,153

 

Other assets

 

 

50,583

 

 

 

50,564

 

Total assets

 

$

2,539,087

 

 

$

2,522,502

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND SHAREHOLDERS' EQUITY

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

Non-interest bearing

 

$

658,524

 

 

$

662,527

 

Interest bearing

 

 

1,502,224

 

 

 

1,453,813

 

Total deposits

 

 

2,160,748

 

 

 

2,116,340

 

Repurchase agreements

 

 

19,360

 

 

 

16,359

 

Short-term borrowings

 

 

 

 

 

56,100

 

Subordinated debentures, net

 

 

34,811

 

 

 

34,767

 

Other liabilities

 

 

40,100

 

 

 

25,912

 

Total liabilities

 

 

2,255,019

 

 

 

2,249,478

 

 

 

 

 

 

 

 

 

 

Commitments and contingent liabilities (Note 8)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Shareholders' equity

 

 

 

 

 

 

 

 

Common stock, no par value; 24,000,000 shares authorized; 15,328,030 and 15,300,460 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively

 

 

113,001

 

 

 

112,507

 

Additional paid-in capital

 

 

3,135

 

 

 

3,066

 

Retained earnings

 

 

170,258

 

 

 

164,117

 

Accumulated other comprehensive loss, net

 

 

(2,326

)

 

 

(6,666

)

Total shareholders' equity

 

 

284,068

 

 

 

273,024

 

Total liabilities and shareholder's equity

 

$

2,539,087

 

 

$

2,522,502

 

 

The accompanying notes are an integral part of these consolidated financial statements

 

1


SIERRA BANCORP

CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2019 AND 2018

(dollars in thousands, except per share data, unaudited)

 

Interest and dividend income

 

2019

 

 

2018

 

Loans and leases, including fees

 

$

23,748

 

 

$

20,004

 

Taxable securities

 

 

2,617

 

 

 

2,338

 

Tax-exempt securities

 

 

1,045

 

 

 

1,016

 

Federal funds sold and other

 

 

73

 

 

 

118

 

Total interest income

 

 

27,483

 

 

 

23,476

 

Interest expense

 

 

 

 

 

 

 

 

Deposits

 

 

2,955

 

 

 

1,318

 

Short-term borrowings

 

 

72

 

 

 

13

 

Subordinated debentures

 

 

483

 

 

 

385

 

Total interest expense

 

 

3,510

 

 

 

1,716

 

Net interest income

 

 

23,973

 

 

 

21,760

 

Provision for loan losses

 

 

300

 

 

 

200

 

Net interest income after provision for loan losses

 

 

23,673

 

 

 

21,560

 

Non-interest income

 

 

 

 

 

 

 

 

Service charges on deposits

 

 

2,943

 

 

 

2,946

 

Other income

 

 

2,963

 

 

 

2,187

 

Total non-interest income

 

 

5,906

 

 

 

5,133

 

Other operating expense

 

 

 

 

 

 

 

 

Salaries and employee benefits

 

 

9,243

 

 

 

9,183

 

Occupancy and equipment

 

 

2,361

 

 

 

2,348

 

Other

 

 

6,248

 

 

 

6,356

 

Total other operating expense

 

 

17,852

 

 

 

17,887

 

Income before taxes

 

 

11,727

 

 

 

8,806

 

Provision for income taxes

 

 

2,832

 

 

 

2,096

 

Net income

 

$

8,895

 

 

$

6,710

 

 

 

 

 

 

 

 

 

 

PER SHARE DATA

 

 

 

 

 

 

 

 

Book value

 

$

18.53

 

 

$

16.75

 

Cash dividends

 

$

0.18

 

 

$

0.16

 

Earnings per share basic

 

$

0.58

 

 

$

0.44

 

Earnings per share diluted

 

$

0.58

 

 

$

0.44

 

Average shares outstanding, basic

 

 

15,311,154

 

 

 

15,232,696

 

Average shares outstanding, diluted

 

 

15,447,747

 

 

 

15,412,168

 

 

 

 

 

 

 

 

 

 

Total shareholder equity (in thousands)

 

$

284,068

 

 

$

255,320

 

Shares outstanding

 

 

15,328,030

 

 

 

15,246,780

 

Dividends paid (in thousands)

 

$

2,754

 

 

$

2,437

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

2


SIERRA BANCORP

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2019 AND 2018

(dollars in thousands, unaudited)

 

 

 

2019

 

 

2018

 

Net income

 

$

8,895

 

 

$

6,710

 

Other comprehensive income, before tax:

 

 

 

 

 

 

 

 

Unrealized gains (losses) on securities:

 

 

 

 

 

 

 

 

Unrealized holding gain (loss) arising during period

 

 

6,167

 

 

 

(7,592

)

Less: reclassification adjustment for gains included in net income (1)

 

 

(6

)

 

 

 

Other comprehensive income (loss), before tax

 

 

6,161

 

 

 

(7,592

)

Income tax expense related to items of other comprehensive income (loss), net of tax

 

 

(1,821

)

 

 

2,245

 

Other comprehensive income (loss)

 

 

4,340

 

 

 

(5,347

)

 

 

 

 

 

 

 

 

 

Comprehensive income

 

$

13,235

 

 

$

1,363

 

 

(1)

Amounts are included in net gains on investment securities available-for-sale on the Consolidated Statements of Income in non-interest revenue.  Income tax expense associated with the reclassification adjustment for the three months ended March 31, 2019 and 2018 was $2 thousand and $0 thousand respectively.  

The accompanying notes are an integral part of these consolidated financial statements.

3


SIERRA BANCORP

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER’S EQUITY

FOR THE THREE MONTHS ENDED MARCH 31, 2019 AND 2018

(dollars in thousands, except per share data, unaudited)

 

 

 

Common Stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Paid In

 

 

Retained

 

 

Comprehensive

 

 

Shareholders'

 

 

 

Shares

 

 

Amount

 

 

Capital

 

 

Earnings

 

 

Income (Loss)

 

 

Equity

 

Balance, December 31, 2017

 

 

15,223,360

 

 

$

111,138

 

 

$

2,937

 

 

$

144,197

 

 

$

(2,330

)

 

$

255,942

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

6,710

 

 

 

 

 

 

 

6,710

 

Other comprehensive income, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(5,347

)

 

 

(5,347

)

Exercise of stock options

 

 

23,420

 

 

 

460

 

 

 

(78

)

 

 

 

 

 

 

 

 

 

 

382

 

Stock compensation costs

 

 

 

 

 

 

 

 

 

 

76

 

 

 

 

 

 

 

 

 

 

 

76

 

Stock issued-acquisition

 

 

 

 

 

 

 

 

 

 

(6

)

 

 

 

 

 

 

 

 

 

 

(6

)

Cash dividends - $.16 per share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,437

)

 

 

 

 

 

 

(2,437

)

Balance, March 31, 2018

 

 

15,246,780

 

 

$

111,598

 

 

$

2,929

 

 

$

148,470

 

 

$

(7,677

)

 

$

255,320

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2018

 

 

15,300,460

 

 

$

112,507

 

 

$

3,066

 

 

$

164,117

 

 

$

(6,666

)

 

$

273,024

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

8,895

 

 

 

 

 

 

 

8,895

 

Other comprehensive loss, net of tax

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

4,340

 

 

 

4,340

 

Exercise of stock options

 

 

27,570

 

 

 

494

 

 

 

(82

)

 

 

 

 

 

 

 

 

 

 

412

 

Stock compensation costs

 

 

 

 

 

 

 

 

 

 

151

 

 

 

 

 

 

 

 

 

 

 

151

 

Stock issued-acquisition

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash dividends - $.18 per share

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2,754

)

 

 

 

 

 

 

(2,754

)

Balance, March 31, 2019

 

 

15,328,030

 

 

$

113,001

 

 

$

3,135

 

 

$

170,258

 

 

$

(2,326

)

 

$

284,068

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

4


SIERRA BANCORP

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2019 AND 2018

(dollars in thousands, unaudited)

 

 

 

2019

 

 

2018

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net income

 

$

8,895

 

 

$

6,710

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain on sales of securities

 

 

(6

)

 

 

 

Loss on disposal of fixed assets

 

 

12

 

 

 

 

Gain on sale on foreclosed assets

 

 

(16

)

 

 

 

Writedowns on foreclosed assets

 

 

20

 

 

 

110

 

Share-based compensation expense

 

 

151

 

 

 

76

 

Provision for loan losses

 

 

300

 

 

 

200

 

Depreciation and amortization

 

 

754

 

 

 

785

 

Net amortization on securities premiums and discounts

 

 

1,030

 

 

 

1,423

 

Accretion of discounts for loans acquired and net deferred loan fees

 

 

(266

)

 

 

(356

)

Increase in cash surrender value of life insurance policies

 

 

(900

)

 

 

(204

)

Amortization of core deposit intangible

 

 

269

 

 

 

230

 

(Increase) decrease in interest receivable and other assets

 

 

(203

)

 

 

2,633

 

Increase (decrease) in other liabilities

 

 

4,476

 

 

 

(3,020

)

Deferred income tax benefit (provision)

 

 

2

 

 

 

(953

)

Net amortization of partnership investment

 

 

450

 

 

 

405

 

Net cash provided by operating activities

 

 

14,968

 

 

 

8,039

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Maturities and calls of securities available for sale

 

 

1,150

 

 

 

200

 

Proceeds from sales of securities available for sale

 

 

15,504

 

 

 

 

Purchases of securities available for sale

 

 

(34,469

)

 

 

(36,750

)

Principal pay downs on securities available for sale

 

 

19,803

 

 

 

22,282

 

Loan originations and payments, net

 

 

(19,618

)

 

 

(34,471

)

Purchases of premises and equipment

 

 

(87

)

 

 

(412

)

Proceeds from sale premises and equipment

 

 

10

 

 

 

 

Proceeds from sales of foreclosed assets

 

 

7,920

 

 

 

 

Purchase of bank-owned life insurance

 

 

(217

)

 

 

(278

)

Net cash from bank acquisition

 

 

 

 

 

(6

)

Net cash used in investing activities

 

 

(10,004

)

 

 

(49,435

)

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Increase in deposits

 

 

44,408

 

 

 

48,244

 

Decrease in borrowed funds

 

 

(56,100

)

 

 

(16,100

)

Increase in Fed funds purchased

 

 

 

 

 

300

 

Increase in repurchase agreements

 

 

3,001

 

 

 

4,379

 

Cash dividends paid

 

 

(2,754

)

 

 

(2,437

)

Stock options exercised

 

 

412

 

 

 

382

 

Net cash (used in) provided by financing activities

 

 

(11,033

)

 

 

34,768

 

 

 

 

 

 

 

 

 

 

Decrease in cash and due from banks

 

 

(6,069

)

 

 

(6,628

)

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

 

 

 

 

 

 

Beginning of period

 

 

74,132

 

 

 

70,137

 

End of period

 

$

68,063

 

 

$

63,509

 

The accompanying notes are an integral part of these consolidated financial statements.

 

5


Sierra Bancorp

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

March 31, 2019

(Unaudited)

Note 1 – The Business of Sierra Bancorp

Sierra Bancorp (the “Company”) is a California corporation headquartered in Porterville, California, and is a registered bank holding company under federal banking laws.  The Company was formed to serve as the holding company for Bank of the Sierra (the “Bank”), and has been the Bank’s sole shareholder since August 2001.  The Company exists primarily for the purpose of holding the stock of the Bank and of such other subsidiaries it may acquire or establish.  As of March 31, 2019, the Company’s only other subsidiaries were Sierra Statutory Trust II, Sierra Capital Trust III, and Coast Bancorp Statutory Trust II, which were formed solely to facilitate the issuance of capital trust pass-through securities (“TRUPS”).  Pursuant to the Financial Accounting Standards Board (“FASB”) standard on the consolidation of variable interest entities, these trusts are not reflected on a consolidated basis in the Company’s financial statements.  References herein to the “Company” include Sierra Bancorp and its consolidated subsidiary, the Bank, unless the context indicates otherwise.

 

Bank of the Sierra, a California state-chartered bank headquartered in Porterville, California, offers a wide range of retail and commercial banking services via branch offices located throughout California’s South San Joaquin Valley, the Central Coast, Ventura County, and neighboring communities.  The Bank was incorporated in September 1977, and opened for business in January 1978 as a one-branch bank with $1.5 million in capital.  Our growth in the ensuing years has largely been organic in nature, but includes four whole-bank acquisitions:  Sierra National Bank in 2000, Santa Clara Valley Bank in 2014, Coast National Bank in 2016, and Ojai Community Bank in October 2017.  We also acquired a branch located in Lompoc, California from Community Bank of Santa Maria in May 2018, and we opened a new branch on Palm Avenue in Fresno in September 2018.  As of the filing date of this report the Bank operates 40 full service branches and an online branch, and maintains ATMs at all but one of our branch locations as well as seven non-branch locations.  Moreover, the Bank has specialized lending units which focus on agricultural borrowers, SBA loans, and mortgage warehouse lending.  The Company had total assets of $2.5 billion at March 31, 2019, and for a number of years we have claimed the distinction of being the largest bank headquartered in the South San Joaquin Valley.  The Bank’s deposit accounts, which totaled $2.2 billion at March 31, 2019, are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to maximum insurable amounts.

Note 2 – Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in a condensed format, and therefore do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements.  The information furnished in these interim statements reflects all adjustments that are, in the opinion of Management, necessary for a fair statement of the results for such periods.  Such adjustments can generally be considered as normal and recurring unless otherwise disclosed in this Form 10-Q.  In preparing the accompanying financial statements, Management has taken subsequent events into consideration and recognized them where appropriate.  The results of operations in the interim statements are not necessarily indicative of the results that may be expected for any other quarter, or for the full year.  Certain amounts reported for 2018 have been reclassified to be consistent with the reporting for 2019.  The interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2018, as filed with the Securities and Exchange Commission (the “SEC”).

Note 3 – Current Accounting Developments

 

In February 2016 the FASB issued ASU 2016-02, Leases (Topic 842).  The intention of this standard is to increase the transparency and comparability around lease obligations.  Previously unrecorded off-balance sheet obligations will now be brought more prominently to light by presenting lease liabilities on the face of the balance sheet, accompanied by enhanced qualitative and quantitative disclosures in the notes to the financial statements.  ASU 2016-02 is generally effective for public business entities in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.  The Company has leases on 21 branch locations, an administrative office building, and three offsite ATM locations which are considered operating leases and are not currently reflected in our financial statements.  Pursuant to ASU 2016-02, on January 1, 2019 these lease agreements were recognized on our consolidated statement of condition as right-of-use assets totaling approximately $10 million, and corresponding lease liabilities. Please see Note 13 to the consolidated financial statements for more detailed disclosure information.

6


 

In September 2016 the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which eliminates the probable initial recognition threshold for credit losses in current U.S. GAAP, and instead requires an organization to record a current estimate of all expected credit losses over the contractual term for financial assets carried at amortized cost.  This is commonly referred to as the current expected credit losses (“CECL”) methodology.  Expected credit losses for financial assets held at the reporting date will be measured based on historical experience, current conditions, and reasonable and supportable forecasts.  Another change from existing U.S. GAAP involves the treatment of purchased credit deteriorated assets, which are more broadly defined than purchased credit impaired assets in current accounting standards.  When such assets are purchased, institutions will estimate and record an allowance for credit losses that is added to the purchase price rather than being reported as a credit loss expense.  Furthermore, ASU 2016-13 updates the measurement of credit losses on available-for-sale debt securities, by mandating that institutions record credit losses on available-for-sale debt securities through an allowance for credit losses rather than the current practice of writing down securities for other-than-temporary impairment.  ASU 2016-13 will also require the enhancement of financial statement disclosures regarding estimates used in calculating credit losses.  ASU 2016-13 does not change the existing write-off principle in U.S. GAAP or current nonaccrual practices, nor does it change accounting requirements for loans held for sale or certain other financial assets which are measured at the lower of amortized cost or fair value.  As a public business entity that is an SEC filer, ASU 2016-13 becomes effective for the Company on January 1, 2020, although early application is permitted for 2019.  On the effective date, institutions will apply the new accounting standard as follows:  for financial assets carried at amortized cost, a cumulative-effect adjustment will be recognized on the balance sheet for any change in the related allowance for loan and lease losses generated by the adoption of the new standard; financial assets classified as purchased credit impaired assets prior to the effective date will be reclassified as purchased credit deteriorated assets as of the effective date, and will be grossed up for the related allowance for expected credit losses created as of the effective date; and, debt securities on which other-than-temporary impairment had been recognized prior to the effective date will transition to the new guidance prospectively with no change in their amortized cost basis.  The Company is well under way with transition efforts.  We have established an implementation team which is chaired by our Chief Credit Officer and includes the Company’s other executive officers, along with certain members of our credit administration and finance departments.  Furthermore, after extensive discussion and due diligence, we engaged a third-party vendor and purchased a specialized application to assist in our calculation of potential required reserves utilizing the CECL methodology and to help validate our current reserving methodology.  A preliminary evaluation indicates that the provisions of ASU 2016-13 will likely have a material impact on our consolidated financial statements, particularly the level of our allowance for credit losses and shareholders’ equity.  While the potential extent of that impact has not yet been definitively determined, initial estimates indicate that our allowance for loan and lease losses could increase by 100% or more relative to current levels if we utilize the discounted cash flow methodology with forecasting.

 

In January 2017 the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business.  Currently, Topic 805 specifies three elements of a business – inputs, processes, and outputs.  While an integrated set of assets and activities (collectively referred to as a “set”) that is a business usually has outputs, outputs are not required. In addition, all the inputs and processes that a seller uses in operating a set are not required if market participants can acquire the set and continue to produce outputs, for example, by integrating the acquired set with their own inputs and processes.  This led many transactions to be accounted for as business combinations rather than asset purchases under legacy GAAP.  The primary goal of ASU 2017-01 is to narrow the definition of a business, and the guidance in this update provides a screen to determine when a set is not a business.  The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business.  This reduces the number of transactions that need to be further evaluated.  The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, and we implemented ASU 2017-01 on a prospective basis effective January 1, 2018.  This update affected the accounting treatment used for our branch deposit purchase in the second quarter of 2018, and we expect that it will also impact the way we account for certain branch acquisitions in future periods, if the opportunity for such arises.

 

In January 2017 the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350): Simplifying the Accounting for Goodwill Impairment.  This guidance removes Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation, and goodwill impairment will simply be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill.  All other goodwill impairment guidance will remain largely unchanged.  Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary.  The same one-step impairment test will be applied to goodwill at all reporting units, even those with zero or negative carrying amounts.  Entities will be required to disclose the amount of goodwill at reporting units with zero or negative carrying amounts.  The amendments in this update are effective for public business entities for fiscal years beginning after December 15, 2019.  We have not been required to record any goodwill impairment to date, and after a preliminary review do not expect that this guidance would require us to do so given current circumstances.  Nevertheless, we will continue to evaluate ASU 2017-04 to more definitely determine its potential impact on the Company’s consolidated financial position, results of operations and cash flows.

 

7


In March 2017 the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.  The amendments in this update will shorten the amortization period for certain callable debt securities held at a premium, by requiring the premium to be amortized to the earliest call date.  Under current guidance, the premium on a callable debt security is generally amortized as an adjustment to yield over the contractual life of the instrument, and any unamortized premium is recorded as a loss in earnings upon the debtor’s exercise of a call provision.  Under ASU 2017-08, because the premium will be amortized to the earliest call date, entities will no longer recognize a loss in earnings if a debt security is called prior to the contractual maturity date.  The amendments do not require an accounting change for securities held at a discount; discounts will continue to be amortized as an adjustment to yield over the contractual life of the debt instrument.  ASU 2017-08 is effective for public business entities, including the Company, for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.  Early adoption is permitted, including adoption in an interim period.  If an entity early adopts in an interim period, any adjustments must be reflected as of the beginning of the fiscal year that includes that interim period.  To apply ASU 2017-08, entities must use a modified retrospective approach, with the cumulative-effect adjustment recognized to retained earnings at the beginning of the period of adoption.  Entities are also required to provide disclosures about a change in accounting principle in the period of adoption.  The Company adopted ASU 2017-08 effective January 1, 2019 with no material impact on our financial statements or operations.

 

In August 2018 the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement, as part of its disclosure framework project.  Pursuant to this guidance, disclosures that will no longer be required include the following:  transfers between Level 1 and Level 2 of the fair value hierarchy; transfers in and out of Level 3 for nonpublic entities, as well as purchases and issuances and the Level 3 roll forward; a company’s policy for determining when transfers between any of the three levels have occurred; the valuation processes used for Level 3 measurements; and, the changes in unrealized gains or losses presented in earnings for Level 3 instruments held at the balance sheet date for nonpublic entities.  The following are additional disclosure requirements:  for public entities, the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 instruments held at the balance sheet date; for public entities, the range and weighted average of significant unobservable inputs used for Level 3 measurements, although for certain unobservable inputs the entity will be allowed to disclose other quantitative information in place of the weighted average to the extent that it would be a more reasonable and rational method to reflect the distribution of unobservable inputs; for nonpublic entities, some form of quantitative information about significant unobservable inputs used in Level 3 fair value measurements; and, for certain investments in entities that calculate the net asset value, disclosures will be required about the timing of liquidation and redemption restrictions lapsing if the latter has been communicated to the reporting entity.  The guidance also clarifies that the Level 3 measurement uncertainty disclosure should communicate information about the uncertainty at the balance sheet date.  ASU 2018-13 is effective for all entities in fiscal years beginning after December 15, 2019, including interim periods. Early adoption is permitted. In addition, an entity may early adopt any of the removed or modified disclosures immediately and delay adoption of the new disclosures until the effective date.

Note 4 – Supplemental Disclosure of Cash and Non-Cash Flow Information

During the three months ended March 31, 2019 and 2018, cash paid for interest due on interest-bearing liabilities was $3.409 million and $1.874 million, respectively.  There was no cash paid for income taxes during the three months ended March 31, 2019 or March 31, 2018.  There were assets totaling $26,000 that were acquired in settlement of loans for the three months ended March 31, 2019, but none during the three months ended March 31, 2018. Non-cash items which arose from the recording of an operating right-of-use asset and lease liability, pursuant to the adoption of ASU 2016-02, were $9.7 million and $10.3 million respectively during the first quarter of 2019.

Note 5 – Share Based Compensation

On March 16, 2017 the Company’s Board of Directors approved and adopted the 2017 Stock Incentive Plan (the “2017 Plan”), which became effective May 24, 2017, the date approved by the Company’s shareholders.  The 2017 Plan replaced the Company’s 2007 Stock Incentive Plan (the “2007 Plan”), which expired by its own terms on March 15, 2017.  Options to purchase 341,450 shares that were granted under the 2007 Plan were still outstanding as of March 31, 2019 and remain unaffected by that plan’s expiration.  The 2017 Plan provides for the issuance of both “incentive” and “nonqualified” stock options to officers and employees, and of “nonqualified” stock options to non-employee directors and consultants of the Company.  The 2017 Plan also provides for the issuance of restricted stock awards to these same classes of eligible participants, although no restricted stock awards have ever been issued by the Company.  The total number of shares of the Company’s authorized but unissued stock reserved for issuance pursuant to awards under the 2017 Plan was initially 850,000 shares, and the number remaining available for grant as of March 31, 2019 was 690,800.  The potential dilutive impact of unexercised stock options is discussed below in Note 6, Earnings per Share.

 

8


Pursuant to FASB’s standards on stock compensation, the value of each stock option is reflected in our income statement as employee compensation or directors’ expense by amortizing its grant date fair value over the vesting period of the option.  The Company utilizes a Black-Scholes model to determine grant date fair values.  A pre-tax charge of $151,000 was reflected in the Company’s income statement during the first quarter of 2019 and $76,000 was charged during the first quarter of 2018, as expense related to stock options.

Note 6 – Earnings per Share

The computation of earnings per share, as presented in the Consolidated Statements of Income, is based on the weighted average number of shares outstanding during each period.  There were 15,311,154 weighted average shares outstanding during the first quarter of 2019, and 15,232,696 during the first quarter of 2018.

 

Diluted earnings per share calculations include the effect of the potential issuance of common shares, which for the Company is limited to shares that would be issued on the exercise of “in-the-money” stock options.  For the first quarter of 2019, calculations under the treasury stock method resulted in the equivalent of 136,593 shares being added to basic weighted average shares outstanding for purposes of determining diluted earnings per share, while a weighted average of 199,120 stock options were excluded from the calculation because they were underwater and thus anti-dilutive.  For the first quarter of 2018 the equivalent of 179,472 shares were added in calculating diluted earnings per share, while 169,000 anti-dilutive stock options were not factored into the computation.

Note 7 – Comprehensive Income

As presented in the Consolidated Statements of Comprehensive Income, comprehensive income includes net income and other comprehensive income.  The Company’s only source of other comprehensive income is unrealized gains and losses on available-for-sale investment securities.  Investment gains or losses that were realized and reflected in net income of the current period, which had previously been included in other comprehensive income as unrealized holding gains or losses in the period in which they arose, are considered to be reclassification adjustments that are excluded from other comprehensive income in the current period.

Note 8 – Financial Instruments with Off-Balance-Sheet Risk

The Company is a party to financial instruments with off‑balance‑sheet risk in the normal course of business.  Those financial instruments currently consist of unused commitments to extend credit and standby letters of credit.  They involve, to varying degrees, elements of risk in excess of the amount recognized in the balance sheet.  The Company’s exposure to credit loss in the event of nonperformance by counterparties for commitments to extend credit and letters of credit is represented by the contractual amount of those instruments.  The Company uses the same credit policies in making commitments and issuing letters of credit as it does for originating loans included on the balance sheet.  The following financial instruments represent off‑balance‑sheet credit risk (dollars in thousands):

 

 

 

March 31, 2019

 

 

December 31, 2018

 

Commitments to extend credit

 

$

715,163

 

 

$

781,987

 

Standby letters of credit

 

$

9,580

 

 

$

8,966

 

 

Commitments to extend credit consist primarily of the unused or unfunded portions of the following:  home equity lines of credit; commercial real estate construction loans, where disbursements are made over the course of construction; commercial revolving lines of credit; mortgage warehouse lines of credit; unsecured personal lines of credit; and formalized (disclosed) deposit account overdraft lines.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many commitments are expected to expire without being drawn upon, the unused portions of committed amounts do not necessarily represent future cash requirements.  Standby letters of credit are issued by the Company to guarantee the performance of a customer to a third party, and the credit risk involved in issuing letters of credit is essentially the same as the risk involved in extending loans to customers.

At March 31, 2019, the Company was also utilizing a letter of credit in the amount of $95 million issued by the Federal Home Loan Bank on the Company’s behalf as security for certain deposits and to facilitate certain credit arrangements with the Company’s customers.  That letter of credit is backed by loans which are pledged to the FHLB by the Company.

9


Note 9 – Fair Value Disclosures and Reporting, the Fair Value Option and Fair Value Measurements

FASB’s standards on financial instruments, and on fair value measurements and disclosures, require public business entities to disclose in their financial statement footnotes the estimated fair values of financial instruments.  In addition to disclosure requirements, FASB’s standard on investments requires that our debt securities that are classified as available for sale and any equity securities which have readily determinable fair values be measured and reported at fair value in our statement of financial position.  Certain impaired loans are also reported at fair value, as explained in greater detail below, and foreclosed assets are carried at the lower of cost or fair value.  FASB’s standard on financial instruments permits companies to report certain other financial assets and liabilities at fair value, but we have not elected the fair value option for any of those financial instruments.

Fair value measurement and disclosure standards also establish a framework for measuring fair values.  Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability, in an orderly transaction between market participants on the measurement date.  Further, the standards establish a fair value hierarchy that encourages an entity to maximize the use of observable inputs and limit the use of unobservable inputs when measuring fair values.  The standards describe three levels of inputs that may be used to measure fair values:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

 

Level 2: Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

 

Level 3: Significant unobservable inputs that reflect a company’s own assumptions about the factors that market participants would likely consider in pricing an asset or liability.

Fair value estimates are made at a specific point in time based on relevant market data and information about the financial instruments.  Fair value disclosures for deposits include demand deposits, which are by definition equal to the amount payable on demand at the reporting date.  Fair value calculations for loans and leases reflect exit pricing, and incorporate our assumptions with regard to the impact of prepayments on future cash flows and credit quality adjustments based on risk characteristics of various financial instruments, among other things.  Since the estimates are subjective and involve uncertainties and matters of significant judgment they cannot be determined with precision, and changes in assumptions could significantly alter the fair values presented.

Estimated fair values for the Company’s financial instruments are as follows, as of the dates noted:

 

Fair Value of Financial Instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(dollars in thousands, unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2019

 

 

 

 

 

 

 

Fair Value Measurements

 

 

 

Carrying

Amount

 

 

Quoted Prices in

Active Markets for

Identical Assets

(Level 1)

 

 

Significant

Observable

Inputs

(Level 2)

 

 

Significant

Unobservable

Inputs

(Level 3)

 

 

Total

 

Financial assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

68,063

 

 

$

68,063

 

 

$

 

 

$

 

 

$

68,063

 

Investment securities available for sale

 

 

563,628

 

 

 

 

 

 

563,628

 

 

 

 

 

 

563,628

 

Loans and leases, net held for investment

 

 

1,744,299

 

 

 

 

 

 

1,730,151

 

 

 

 

 

 

1,730,151

 

Collateral dependent impaired loans

 

 

39

 

 

 

 

 

 

39

 

 

 

 

 

 

39

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

2,160,748

 

 

 

658,524

 

 

 

1,501,824

 

 

 

 

 

 

2,160,348

 

Repurchase agreements

 

 

19,360

 

 

 

19,360

 

 

 

 

 

 

 

 

 

19,360

 

Short term borrowings

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Subordinated debentures

 

 

34,811

 

 

 

 

 

 

30,355

 

 

 

 

 

 

30,355

 

10


 

 

 

December 31, 2018

 

 

 

 

 

 

 

Fair Value Measurements

 

 

 

Carrying

Amount

 

 

Quoted Prices in

Active Markets for

Identical Assets

(Level 1)

 

 

Significant

Observable

Inputs

(Level 2)

 

 

Significant

Unobservable

Inputs

(Level 3)

 

 

Total

 

Financial assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

74,132

 

 

$

74,132

 

 

$

 

 

$

 

 

$

74,132

 

Investment securities available for sale

 

 

560,479

 

 

 

 

 

 

560,479

 

 

 

 

 

 

560,479

 

Loans and leases, net held for investment

 

 

1,724,575

 

 

 

 

 

 

1,707,463

 

 

 

 

 

 

1,707,463

 

Collateral dependent impaired loans

 

 

205

 

 

 

 

 

 

205

 

 

 

 

 

 

205

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits

 

 

2,116,340

 

 

 

662,527

 

 

 

1,453,048

 

 

 

 

 

 

2,115,575

 

Repurchase agreements

 

 

16,359

 

 

 

16,359

 

 

 

 

 

 

 

 

 

16,359

 

Short term borrowings

 

 

56,100

 

 

 

 

 

 

56,100

 

 

 

 

 

 

56,100

 

Subordinated debentures

 

 

34,767