UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
| ☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2017
or
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ______________ to______________.
Commission File Number: 001-09383
WESTAMERICA BANCORPORATION
(Exact name of the registrant as specified in its charter)
| CALIFORNIA | 94-2156203 |
| (State or Other Jurisdiction | (I.R.S. Employer |
| of Incorporation or Organization) | Identification Number) |
1108 FIFTH AVENUE, SAN RAFAEL, CALIFORNIA 94901
(Address of principal executive offices) (zip code)
Registrant’s telephone number, including area code: (707) 863-6000
Securities registered pursuant to Section 12(b) of the Act:
| Title of class: | Name of each exchange on which registered: |
Common Stock, no par value
|
The NASDAQ Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ☒ NO ☐
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ☐ NO ☒
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 if whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this chapter during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.) YES ☒ NO ☐
Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K (section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐
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 ☐ (Do not check if a smaller reporting company) | |
| 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 Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO ☒
The aggregate market value of the Common Stock held by non-affiliates of the registrant as of June 30, 2017 as reported on the NASDAQ Global Select Market, was $1,081,997,447.44 . Shares of Common Stock held by each executive officer and director and by each person who owns 10% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.
Number of shares outstanding of each of the registrant’s classes of common stock, as of the close of business on February 13, 2018 26,567,573 Shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement relating to registrant’s Annual Meeting of Shareholders, to be held on April 26, 2018, are incorporated by reference in Items 10, 11, 12, 13 and 14 of Part III to the extent described therein.
TABLE OF CONTENTS
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FORWARD-LOOKING STATEMENTS
This Report on Form 10-K contains forward-looking statements about Westamerica Bancorporation for which it claims the protection of the safe harbor provisions contained in the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, future credit quality and performance, the appropriateness of the allowance for loan losses, loan growth or reduction, mitigation of risk in the Company’s loan and investment securities portfolios, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or board of directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as "believes", "anticipates", "expects", “estimates”, "intends", "targeted", "projected", “forecast”, "continue", "remain", "will", "should", "may" and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
These forward-looking statements are based on Management’s current knowledge and belief and include information concerning the Company’s possible or assumed future financial condition and results of operations. A number of factors, some of which are beyond the Company’s ability to predict or control, could cause future results to differ materially from those contemplated. These factors include but are not limited to (1) the length and severity of difficulties in the global, national and California economies and the effects of government efforts to address those difficulties; (2) liquidity levels in capital markets; (3) fluctuations in asset prices including, but not limited to stocks, bonds, real estate, and commodities; (4) the effect of acquisitions and integration of acquired businesses; (5) economic uncertainty created by terrorist threats and attacks on the United States, the actions taken in response, and the uncertain effect of these events on the national and regional economies; (6) changes in the interest rate environment; (7) changes in the regulatory environment; (8) competitive pressure in the banking industry; (9) operational risks including a failure or breach in data processing or security systems or those of third party vendors and other service providers, including as a result of cyber attacks or fraud; (10) volatility of interest rate sensitive loans, deposits and investments; (11) asset/liability management risks and liquidity risks; (12) the effect of natural disasters, including earthquakes, hurricanes, fire, flood, drought, and other disasters, on the uninsured value of the Company’s assets and of loan collateral, the financial condition of debtors and issuers of investment securities, the economic conditions affecting the Company’s market place, and commodities and asset values; (13) changes in the securities markets and (14) the outcome of contingencies, such as legal proceedings. However, the reader should not consider the above-mentioned factors to be a complete set of all potential risks or uncertainties.
Forward-looking statements speak only as of the date they are made. The Company undertakes no obligation to update any forward-looking statements in this Report to reflect circumstances or events that occur after the date forward looking statements are made, except as may be required by law. See also “Risk Factors” in Item 1A and other risk factors discussed elsewhere in this Report.
Westamerica Bancorporation (the “Company”) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (“BHCA”). Its legal headquarters are located at 1108 Fifth Avenue, San Rafael, California 94901. Principal administrative offices are located at 4550 Mangels Boulevard, Fairfield, California 94534 and its telephone number is (707) 863-6000. The Company provides a full range of banking services to individual and commercial customers in Northern and Central California through its subsidiary bank, Westamerica Bank (“WAB” or the “Bank”). The principal communities served are located in Northern and Central California, from Mendocino, Lake and Nevada Counties in the north to Kern County in the south. The Company’s strategic focus is on the banking needs of small businesses. In addition, the Bank owns 100% of the capital stock of Community Banker Services Corporation (“CBSC”), a company engaged in providing the Company and its subsidiaries with data processing services and other support functions.
The Company was incorporated under the laws of the State of California in 1972 as “Independent Bankshares Corporation” pursuant to a plan of reorganization among three previously unaffiliated Northern California banks. The Company operated as a multi-bank holding company until mid-1983, at which time the then six subsidiary banks were merged into a single bank named Westamerica Bank and the name of the holding company was changed to Westamerica Bancorporation.
The Company acquired five banks within its immediate market area during the early to mid 1990’s. In April 1997, the Company acquired ValliCorp Holdings, Inc., parent company of ValliWide Bank, the largest independent bank holding company headquartered in Central California. Under the terms of all of the merger agreements, the Company issued shares of its common stock in exchange for all of the outstanding shares of the acquired institutions. The subsidiary banks acquired were merged with and into WAB. These six aforementioned business combinations were accounted for as poolings-of-interests.
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During the period 2000 through 2005, the Company acquired three additional banks. These acquisitions were accounted for using the purchase accounting method.
On February 6, 2009, Westamerica Bank acquired the banking operations of County Bank (“County”) from the Federal Deposit Insurance Corporation (“FDIC”). On August 20, 2010, Westamerica Bank acquired assets and assumed liabilities of the former Sonoma Valley Bank (“Sonoma”) from the FDIC. The County and Sonoma acquired assets and assumed liabilities were measured at estimated fair values, as required by FASB ASC 805, Business Combinations.
At December 31, 2017, the Company had consolidated assets of approximately $5.5 billion, deposits of approximately $4.8 billion and shareholders’ equity of approximately $590 million. The Company and its subsidiaries employed 785 full-time equivalent staff as of December 31, 2017.
The Company’s Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports as well as beneficial ownership reports on Forms 3, 4 and 5 are available through the SEC’s website (https://www.sec.gov). Such documents as well as the Company’s director, officer and employee Code of Conduct and Ethics are also available free of charge from the Company by request to:
Westamerica Bancorporation
Corporate Secretary A-2M
Post Office Box 1200
Suisun City, California 94585-1200
Supervision and Regulation
The following is not intended to be an exhaustive description of the statutes and regulations applicable to the Company’s or the Bank’s business. The description of statutory and regulatory provisions is qualified in its entirety by reference to the particular statutory or regulatory provisions. Moreover, major new legislation and other regulatory changes affecting the Company, the Bank, and the financial services industry in general have occurred in the last several years and can be expected to occur in the future. The nature, timing and impact of new and amended laws and regulations cannot be accurately predicted.
Regulation and Supervision of Bank Holding Companies
The Company is a bank holding company subject to the BHCA. The Company reports to, is registered with, and may be examined by, the Board of Governors of the Federal Reserve System (“FRB”). The FRB also has the authority to examine the Company’s subsidiaries. The Company is a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Company and the Bank are subject to examination by, and may be required to file reports with, the Commissioner of the California Department of Business Oversight (the “Commissioner”).
The FRB has significant supervisory and regulatory authority over the Company and its affiliates. The FRB requires the Company to maintain certain levels of capital. See “Capital Standards.” The FRB also has the authority to take enforcement action against any bank holding company that commits any unsafe or unsound practice, or violates certain laws, regulations or conditions imposed in writing by the FRB. Under the BHCA, the Company is required to obtain the prior approval of the FRB before it acquires, merges or consolidates with any bank or bank holding company. Any company seeking to acquire, merge or consolidate with the Company also would be required to obtain the prior approval of the FRB.
The Company is generally prohibited under the BHCA from acquiring ownership or control of more than 5% of any class of voting shares of any company that is not a bank or bank holding company and from engaging directly or indirectly in activities other than banking, managing banks, or providing services to affiliates of the holding company. However, a bank holding company, with the approval of the FRB, may engage, or acquire the voting shares of companies engaged, in activities that the FRB has determined to be closely related to banking or managing or controlling banks. A bank holding company must demonstrate that the benefits to the public of the proposed activity will outweigh the possible adverse effects associated with such activity.
The FRB generally prohibits a bank holding company from declaring or paying a cash dividend that would impose undue pressure on the capital of subsidiary banks or would be funded only through borrowing or other arrangements which might adversely affect a bank holding company’s financial position. Under the FRB policy, a bank holding company should not continue its existing rate of cash dividends on its common stock unless its net income is sufficient to fully fund each dividend and its prospective rate of earnings retention appears consistent with its capital needs, asset quality and overall financial condition. See the section entitled “Restrictions on Dividends and Other Distributions” for additional restrictions on the ability of the Company and the Bank to pay dividends.
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Transactions between the Company and the Bank are restricted under Regulation W. The regulation codifies prior interpretations of the FRB and its staff under Sections 23A and 23B of the Federal Reserve Act. In general, subject to certain specified exemptions, a bank or its subsidiaries are limited in their ability to engage in “covered transactions” with affiliates: (a) to an amount equal to 10% of the bank’s capital and surplus, in the case of covered transactions with any one affiliate; and (b) to an amount equal to 20% of the bank’s capital and surplus, in the case of covered transactions with all affiliates. The Company is considered to be an affiliate of the Bank. A “covered transaction” includes, among other things, a loan or extension of credit to an affiliate; a purchase of securities issued by an affiliate; a purchase of assets from an affiliate, with some exceptions; and the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.
Federal regulations governing bank holding companies and change in bank control (Regulation Y) provide for a streamlined and expedited review process for bank acquisition proposals submitted by well-run bank holding companies. These provisions of Regulation Y are subject to numerous qualifications, limitations and restrictions. In order for a bank holding company to qualify as “well-run,” both it and the insured depository institutions which it controls must meet the “well capitalized” and “well managed” criteria set forth in Regulation Y.
The Gramm-Leach-Bliley Act (the “GLBA”), or the Financial Services Act of 1999, repealed provisions of the Glass-Steagall Act, which had prohibited commercial banks and securities firms from affiliating with each other and engaging in each other’s businesses. Thus, many of the barriers prohibiting affiliations between commercial banks and securities firms have been eliminated.
The BHCA was also amended by the GLBA to allow new “financial holding companies” (“FHCs”) to offer banking, insurance, securities and other financial products to consumers. Specifically, the GLBA amended section 4 of the BHCA in order to provide for a framework for the engagement in new financial activities. A bank holding company (“BHC”) may elect to become an FHC if all its subsidiary depository institutions are well capitalized and well managed. If these requirements are met, a BHC may file a certification to that effect with the FRB and declare that it elects to become an FHC. After the certification and declaration is filed, the FHC may engage either de novo or through an acquisition in any activity that has been determined by the FRB to be financial in nature or incidental to such financial activity. BHCs may engage in financial activities without prior notice to the FRB if those activities qualify under the list of permissible activities in section 4(k) of the BHCA. However, notice must be given to the FRB within 30 days after an FHC has commenced one or more of the financial activities. The Company has not elected to become an FHC.
Regulation and Supervision of Banks
The Bank is a California state-chartered Federal Reserve member bank and its deposits are insured by the FDIC. The Bank is subject to regulation, supervision and regular examination by the California Department of Business Oversight (“DBO”), and the FRB. The regulations of these agencies affect most aspects of the Bank’s business and prescribe permissible types of loans and investments, the amount of required reserves, requirements for branch offices, the permissible scope of its activities and various other requirements.
In addition to federal banking law, the Bank is also subject to applicable provisions of California law. Under California law, the Bank is subject to various restrictions on, and requirements regarding, its operations and administration including the maintenance of branch offices and automated teller machines, capital requirements, deposits and borrowings, shareholder rights and duties, and investment and lending activities.
In addition, the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) imposes limitations on the activities and equity investments of state chartered, federally insured banks. FDICIA also prohibits a state bank from making an investment or engaging in any activity as a principal that is not permissible for a national bank, unless the Bank is adequately capitalized and the FDIC approves the investment or activity after determining that such investment or activity does not pose a significant risk to the deposit insurance fund.
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On July 21, 2010, financial regulatory reform legislation entitled the "Dodd-Frank Wall Street Reform and Consumer Protection Act" (the "Dodd-Frank Act") was signed into law. The Dodd-Frank Act implemented far-reaching changes across the financial regulatory landscape, including provisions that, among other things:
| • | Centralized responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing, examining and (as to banks with $10 billion or more in assets) enforcing compliance with federal consumer financial laws. |
| • | Restricted the preemption of state law by federal law and disallowed subsidiaries and affiliates of national banks from availing themselves of such preemption. |
| • | Applied the same leverage and risk-based capital requirements that would apply to insured depository institutions to most bank holding companies. |
| • | Required bank regulatory agencies to seek to make their capital requirements for banks countercyclical so that capital requirements increase in times of economic expansion and decrease in times of economic contraction. |
| • | Changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminated the ceiling on the size of the Deposit Insurance Fund ("DIF") and increased the floor of the size of the DIF. |
| • | Imposed comprehensive regulation of the over-the-counter derivatives market, which would include certain provisions that would effectively prohibit insured depository institutions from conducting certain derivatives businesses in the institution itself. |
| • | Required large, publicly traded bank holding companies to create a risk committee responsible for the oversight of enterprise risk management. |
| • | Implemented corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, that would apply to all public companies, not just financial institutions. |
| • | Made permanent the $250 thousand limit for federal deposit insurance. |
| • | Repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts. |
| • | Amended the Electronic Fund Transfer Act ("EFTA") to, among other things, give the FRB the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. While the Company’s assets are currently less than $10 billion, interchange fees charged by larger institutions may dictate the level of fees smaller institutions will be able to charge to remain competitive. |
Provisions in the legislation that affect the payment of interest on demand deposits and interchange fees may increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate.
Capital Standards
The federal banking agencies have risk-based capital adequacy guidelines intended to provide a measure of capital adequacy that reflects the degree of risk associated with a banking organization’s operations for both transactions resulting in assets being recognized on the balance sheet as assets, and the extension of credit facilities such as letters of credit and recourse arrangements, which are recorded as off balance sheet items. Under these guidelines, nominal dollar amounts of assets and credit equivalent amounts of off balance sheet items are multiplied by one of several risk adjustment percentages, which range from 0% for assets with low credit risk, such as certain U.S. government securities, to 1250% for assets with relatively higher credit risk, such as certain securitizations. A banking organization’s risk-based capital ratios are obtained by dividing its qualifying capital by its total risk-adjusted assets and off balance sheet items.
The federal banking agencies take into consideration concentrations of credit risk and risks from nontraditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation is made as a part of the institution’s regular safety and soundness examination. The federal banking agencies also consider interest rate risk (related to the interest rate sensitivity of an institution’s assets and liabilities, and its off balance sheet financial instruments) in the evaluation of a bank’s capital adequacy.
As of December 31, 2017, the Company’s and the Bank’s respective ratios exceeded applicable regulatory requirements. See Note 9 to the consolidated financial statements for capital ratios of the Company and the Bank, compared to minimum capital requirements and for the Bank the standards for well capitalized depository institutions.
On July 2, 2013, the Federal Reserve Board approved a final rule that implements changes to the regulatory capital framework for all banking organizations over a transitional period 2015 through 2018.
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See the sections entitled “Capital Resources and Capital to Risk-Adjusted Assets” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations for additional information.
Prompt Corrective Action and Other Enforcement Mechanisms
FDICIA requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios.
An institution that, based upon its capital levels, is classified as “well capitalized,” “adequately capitalized” or “undercapitalized” may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions. In addition to measures taken under the prompt corrective action provisions, commercial banking organizations may be subject to potential enforcement actions by the federal banking agencies for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency.
Safety and Soundness Standards
FDICIA has implemented certain specific restrictions on transactions and required federal banking regulators to adopt overall safety and soundness standards for depository institutions related to internal control, loan underwriting and documentation, and asset growth. Among other things, FDICIA limits the interest rates paid on deposits by undercapitalized institutions, restricts the use of brokered deposits, limits the aggregate extensions of credit by a depository institution to an executive officer, director, principal shareholder or related interest, and reduces deposit insurance coverage for deposits offered by undercapitalized institutions for deposits by certain employee benefits accounts. The federal banking agencies may require an institution to submit an acceptable compliance plan as well as have the flexibility to pursue other more appropriate or effective courses of action given the specific circumstances and severity of an institution’s noncompliance with one or more standards.
Federal banking agencies require banks to maintain adequate valuation allowances for potential credit losses. The Company has an internal staff that continually reviews loan quality and reports to the Board of Directors. This analysis includes a detailed review of the classification and categorization of problem loans, assessment of the overall quality and collectability of the loan portfolio, consideration of loan loss experience, trends in problem loans, concentration of credit risk, and current economic conditions, particularly in the Bank’s market areas. Based on this analysis, Management, with the review and approval of the Board, determines the adequate level of allowance required. The allowance is allocated to different segments of the loan portfolio, but the entire allowance is available for the loan portfolio in its entirety.
Restrictions on Dividends and Other Distributions
The Company’s ability to pay dividends to its shareholders is subject to the restrictions set forth in the California General Corporation Law (“CGCL”). The CGCL provides that a corporation may make a distribution to its shareholders if (i) the corporation’s retained earnings equal or exceed the amount of the proposed distribution plus unpaid accrued dividends (if any) on securities with a dividend preference, or (ii) immediately after the dividend, the corporation’s total assets equal or exceed total liabilities plus unpaid accrued dividends (if any) on securities with a dividend preference.
The power of the board of directors of an insured depository institution to declare a cash dividend or other distribution with respect to capital is subject to statutory and regulatory restrictions which limit the amount available for such distribution depending upon the earnings, financial condition and cash needs of the institution, as well as general business conditions. FDICIA prohibits insured depository institutions from paying management fees to any controlling persons or, with certain limited exceptions, making capital distributions, including dividends, if, after such transaction, the institution would be undercapitalized.
In addition to the restrictions imposed under federal law, banks chartered under California law generally may only pay cash dividends to the extent such payments do not exceed the lesser of retained earnings of the bank or the bank’s net income for its last three fiscal years (less any distributions to shareholders during this period). In the event a bank desires to pay cash dividends in excess of such amount, the bank may pay a cash dividend with the prior approval of the Commissioner in an amount not exceeding the greatest of the bank’s retained earnings, the bank’s net income for its last fiscal year or the bank’s net income for its current fiscal year.
The federal banking agencies also have the authority to prohibit a depository institution or its holding company from engaging in business practices which are considered to be unsafe or unsound, possibly including payment of dividends or other payments under certain circumstances even if such payments are not expressly prohibited by statute. The Federal reserve Board has issued guidance indicating its expectations that a bank holding company will inform and consult with Federal Reserve supervisory staff sufficiently in advance of (i) declaring and paying a dividend that could raise safety and soundness concerns (e.g., declaring and paying a dividend that exceeds earnings for the period for which the dividend is being paid); (ii) redeeming or repurchasing regulatory capital instruments when the bank holding company is experiencing financial weaknesses; or (iii) redeeming or repurchasing common stock or perpetual preferred stock that would result in a net reduction as of the end of the quarter in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred.
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Premiums for Deposit Insurance
Substantially all of the deposits of the Bank are insured up to applicable limits by the DIF of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank's capital level, asset quality and supervisory rating ("CAMELS rating").
In July 2010, Congress in the Dodd-Frank Act increased the minimum for the DIF reserve ratio, the ratio of the amount in the fund to insured deposits, from 1.15% to 1.35% and required that the ratio reach that level by September 30, 2020. Further, the Dodd-Frank Act made banks with $10 billion or more in assets responsible for the increase from 1.15% to 1.35%, among other provisions.
In October 2010, the FDIC adopted a new DIF restoration plan to ensure the DIF reaching 1.35% by September 30, 2020. In assessing its progress in restoring the reserves, at least semi-annually, the FDIC updates its loss and income projections for the fund and, if needed, increases or decreases assessment rates, following notice-and-comment rulemaking, if required.
In February 2011, the FDIC adopted a final rule effective April 1, 2011 to:
| (1) | Redefine the deposit insurance assessment base from total domestic deposits to average total assets minus average tangible equity as required by the Dodd-Frank Act; |
| (2) | Change the deposit insurance assessment rates (which sets forth progressively lower assessment rate schedules that will take effect when the reserve ratio exceeds 1.15%, 2%, and 2.5%) ; |
| (3) | Implement the Dodd-Frank Act DIF dividend provisions; and |
| (4) | Revise the risk-based assessment system for all “large” and “highly complex” insured depository institutions. “Large” depository institutions are defined generally as having more than $10 billion in assets and "highly complex" institutions have over $50 billion in assets and are fully owned by a parent with over $500 billion in assets. The Bank is neither a “large” nor “highly complex” institution. |
In March, 2016, the FDIC issued a final rule to increase the DIF reserve ratio to the statutory minimum level of 1.35%, effective July 1, 2016, if the reserve ratio reached 1.15% before that date.
In August, 2016, the FDIC announced the DIF reserve ratio surpassed the 1.15% reserve ratio target, triggering three major changes:
| (1) | The decline in the range of initial assessment rates for all banks from 5-35 basis points to 3-30 basis points; |
| (2) | The assessment of a quarterly surcharge on large banks equal to an annual rate of 4.5 basis points in addition to regular assessments; and |
| (3) | A revised method to calculate risk-based assessment rates for established small banks (under $1 billion in assets) pursuant to an FDIC final rule issued April, 2016. |
The Company cannot provide any assurance as to the effect of any future changes in its deposit insurance premium rates.
Community Reinvestment Act and Fair Lending Developments
The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and Community Reinvestment Act (“CRA”) activities. The CRA generally requires the federal banking agencies to evaluate the record of financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods. In addition to substantive penalties and corrective measures that may be required for a violation of certain fair lending laws, the federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities including merger applications.
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Financial Privacy Legislation and Customer Information Security
The GLBA, in addition to the previously described changes in permissible nonbanking activities permitted to banks, BHCs and FHCs, also required the federal banking agencies, among other federal regulatory agencies, to adopt regulations governing the privacy of consumer financial information. The Bank is subject to the FRB’s regulations in this area. The federal bank regulatory agencies have established standards for safeguarding nonpublic personal information about customers that implement provisions of the GLBA (the “Guidelines”). Among other things, the Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against any anticipated threats or hazards to the security or integrity of such information, and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.
U.S.A. PATRIOT Act
Title III of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”) is the International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001. It includes numerous provisions for fighting international money laundering and blocking terrorist access to the U.S. financial system. The goal of Title III is to prevent the U.S. financial system and the U.S. clearing mechanisms from being used by parties suspected of terrorism, terrorist financing and money laundering. The provisions of Title III of the USA Patriot Act which affect the Bank are generally set forth as amendments to the Bank Secrecy Act. These provisions relate principally to U.S. banking organizations’ relationships with foreign banks and with persons who are resident outside the United States. The USA Patriot Act does not impose any filing or reporting obligations for banking organizations, but does require certain additional due diligence and recordkeeping practices.
Sarbanes-Oxley Act of 2002
The stated goals of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. Sarbanes-Oxley generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports under the Securities Exchange Act of 1934 (the “Exchange Act”).
Sarbanes-Oxley includes very specific additional disclosure requirements and corporate governance rules, required the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues. Sarbanes-Oxley represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees and public company shareholders. Sarbanes-Oxley addresses, among other matters: (i) independent audit committees for reporting companies whose securities are listed on national exchanges or automated quotation systems (the “Exchanges”) and expanded duties and responsibilities for audit committees; (ii) certification of financial statements by the chief executive officer and the chief financial officer; (iii) the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; (iv) a prohibition on insider trading during pension plan blackout periods; (v) disclosure of off-balance sheet transactions; (vi) a prohibition on personal loans to directors and officers under most circumstances with exceptions for certain normal course transactions by regulated financial institutions; (vii) expedited electronic filing requirements related to trading by insiders in an issuer’s securities on Form 4; (viii) disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; (ix) accelerated filing of periodic reports; (x) the formation of the Public Company Accounting Oversight Board (“PCAOB”) to regulate public accounting firms and the audit of public companies that are subject to the securities laws; (xi) auditor independence; (xii) internal control evaluation and reporting; and (xiii) various increased criminal penalties for violations of securities laws.
Programs To Mitigate Identity Theft
In November 2007, federal banking agencies together with the National Credit Union Administration and Federal Trade Commission adopted regulations under the Fair and Accurate Credit Transactions Act of 2003 to require financial institutions and other creditors to develop and implement a written identity theft prevention program to detect, prevent and mitigate identity theft in connection with certain new and existing accounts. Covered accounts generally include consumer accounts and other accounts that present a reasonably foreseeable risk of identity theft. Each institution’s program must include policies and procedures designed to: (i) identify indicators, or “red flags,” of possible risk of identity theft; (ii) detect the occurrence of red flags; (iii) respond appropriately to red flags that are detected; and (iv) ensure that the program is updated periodically as appropriate to address changing circumstances. The regulations include guidelines that each institution must consider and, to the extent appropriate, include in its program.
| -8- |
Pending Legislation
Changes to state laws and regulations (including changes in interpretation or enforcement) can affect the operating environment of BHCs and their subsidiaries in substantial and unpredictable ways. From time to time, various legislative and regulatory proposals are introduced. These proposals, if codified, may change banking statutes and regulations and the Company’s operating environment in substantial and unpredictable ways. If codified, these proposals could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance among banks, savings associations, credit unions and other financial institutions. The Company cannot accurately predict whether those changes in laws and regulations will occur, and, if those changes occur, the ultimate effect they would have upon our financial condition or results of operations. It is likely, however, that the current level of enforcement and compliance-related activities of federal and state authorities will continue and potentially increase.
Competition
In the past, the Bank’s principal competitors for deposits and loans have been major banks and smaller community banks, savings and loan associations and credit unions. To a lesser extent, competition was also provided by thrift and loans, mortgage brokerage companies and insurance companies. Other institutions, such as brokerage houses, mutual fund companies, credit card companies, and certain retail establishments have offered investment vehicles that also compete with banks for deposit business. Federal legislation in recent years has encouraged competition between different types of financial institutions and fostered new entrants into the financial services market.
Legislative changes, as well as technological and economic factors, can be expected to have an ongoing impact on competitive conditions within the financial services industry. While the future impact of regulatory and legislative changes cannot be predicted with certainty, the business of banking will remain highly competitive.
Readers and prospective investors in the Company’s securities should carefully consider the following risk factors as well as the other information contained or incorporated by reference in this Report.
The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties that Management is not aware of or focused on or that Management currently deems immaterial may also impair the Company’s business operations. This Report is qualified in its entirety by these risk factors.
If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of the company’s securities could decline significantly, and investors could lose all or part of their investment in the Company’s common stock.
Market and Interest Rate Risk
Changes in interest rates could reduce income and cash flow.
The discussion in this Report under “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset, Liability and Market Risk Management” and “- Liquidity and Funding” and “Item 7A Quantitative and Qualitative Disclosures About Market Risk” is incorporated by reference in this paragraph. The Company’s income and cash flow depend to a great extent on the difference between the interest earned on loans and investment securities and the interest paid on deposits and other borrowings, and the Company’s success in competing for loans and deposits. The Company cannot control or prevent changes in the level of interest rates which fluctuate in response to general economic conditions, the policies of various governmental and regulatory agencies, in particular, the Federal Open Market Committee of the FRB, and pricing practices of the Company’s competitors. Changes in monetary policy, including changes in interest rates, will influence the origination of loans, the purchase of investments, the generation of deposits and other borrowings, and the rates received on loans and investment securities and paid on deposits and other liabilities.
| -9- |
Changes in capital market conditions could reduce asset valuations.
Capital market conditions, including liquidity, investor confidence, bond issuer credit worthiness, perceived counter-party risk, the supply of and demand for financial instruments, the financial strength of market participants, and other factors can materially impact the value of the Company’s assets. An impairment in the value of the Company’s assets could result in asset write-downs, reducing the Company’s asset values, earnings, and equity.
The value of securities in the Company’s investment securities portfolio may be negatively affected by disruptions in securities markets
The market for some of the investment securities held in the Company’s portfolio can be extremely volatile. Volatile market conditions may detrimentally affect the value of these securities, such as through reduced valuations due to the perception of heightened credit and liquidity risks. There can be no assurance that the declines in market value will not result in other than temporary impairments of these assets, which would lead to loss recognition that could have a material adverse effect on the Company’s net income and capital levels.
The weakness of other financial institutions could adversely affect the Company.
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. The Company routinely executes transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, and other institutional clients. Many of these transactions expose the Company to credit risk in the event of default of the Company’s counterparty or client. In addition, the Company’s credit risk may be increased when the collateral the Company holds cannot be realized or is liquidated at prices not sufficient to recover the full amount of the secured obligation. There is no assurance that any such losses would not materially and adversely affect the Company’s results of operations or earnings.
Shares of Company common stock eligible for future sale or grant of stock options could have a dilutive effect on the market for Company common stock and could adversely affect the market price.
The Articles of Incorporation of the Company authorize the issuance of 150 million shares of common stock (and two additional classes of 1 million shares each, denominated “Class B Common Stock” and “Preferred Stock”, respectively) of which approximately 26.4 million shares of common stock were outstanding at December 31, 2017. Pursuant to its stock option plans, at December 31, 2017, the Company had outstanding options for 1.0 million shares of common stock, of which 469 thousand were currently exercisable. As of December 31, 2017, 930 thousand shares of Company common stock remained available for grants under the Company’s stock option plans. Sales of substantial amounts of Company common stock in the public market could adversely affect the market price of its common stock.
The Company’s payment of dividends on common stock could be eliminated or reduced.
Holders of the Company’s common stock are entitled to receive dividends only when, as and if declared by the Company’s Board of Directors. Although the Company has historically paid cash dividends on the Company’s common stock, the Company is not required to do so and the Company’s Board of Directors could reduce or eliminate the Company’s common stock dividend in the future.
The Company could repurchase shares of its common stock at price levels considered excessive.
The Company repurchases and retires its common stock in accordance with Board of Directors-approved share repurchase programs. At December 31, 2017, approximately 1.8 million shares remained available to repurchase under such plans. The Company has been active in repurchasing and retiring shares of its common stock when alternative uses of excess capital, such as acquisitions, have been limited. The Company could repurchase shares of its common stock at price levels considered excessive, thereby spending more cash on such repurchases as deemed reasonable and effectively retiring fewer shares than would be retired if repurchases were effected at lower prices.
Risks Related to the Nature and Geographical Location of the Company’s Business
The Company invests in loans that contain inherent credit risks that may cause the Company to incur losses.
The Company can provide no assurance that the credit quality of the loan portfolio will not deteriorate in the future and that such deterioration will not adversely affect the Company.
| -10- |
The Company’s operations are concentrated geographically in California, and poor economic conditions may cause the Company to incur losses.
Substantially all of the Company’s business is located in California. A portion of the loan portfolio of the Company is dependent on real estate. At December 31, 2017, real estate served as the principal source of collateral with respect to approximately 53% of the Company’s loan portfolio. The Company’s financial condition and operating results will be subject to changes in economic conditions in California. The California economy was severely affected by the recessionary period of 2008 to 2009. Much of the California real estate market experienced a decline in values of varying degrees. This decline had an adverse impact on the business of some of the Company’s borrowers and on the value of the collateral for many of the Company’s loans. Generally, the counties surrounding and near San Francisco Bay have recovered more soundly from the recent recession than counties in the California “Central Valley,” from Sacramento in the north to Bakersfield in the south. Approximately 22% of the Company’s loans are to borrowers in the California “Central Valley.” Economic conditions in California’s diverse geographic markets can be vastly different and are subject to various uncertainties, including the condition of the construction and real estate sectors, the effect of drought on the agricultural sector and its infrastructure, and the California state government’s budgetary and fiscal condition. The Company can provide no assurance that conditions in any sector or geographic market of the California economy will not deteriorate in the future and that such deterioration will not adversely affect the Company.
The markets in which the Company operates are subject to the risk of earthquakes, fire storms and other natural disasters.
All of the properties of the Company are located in California. Also, most of the real and personal properties which currently secure a majority of the Company’s loans are located in California. Further, the Company invests in securities issued by companies and municipalities operating throughout the United States, and in mortgage-backed securities collateralized by real property located throughout the United States. California and other regions of the United States are prone to earthquakes, brush and forest fires, flooding, drought and other natural disasters. In addition to possibly sustaining uninsured damage to its own properties, if there is a major earthquake, flood, drought, fire or other natural disaster, the Company faces the risk that many of its debtors may experience uninsured property losses, or sustained business or employment interruption and/or loss which may materially impair their ability to meet the terms of their debt obligations. A major earthquake, flood, prolonged drought, fire or other natural disaster in California or other regions of the United States could have a material adverse effect on the Company’s business, financial condition, results of operations and cash flows.
Adverse changes in general business or economic conditions could have a material adverse effect on the Company’s financial condition and results of operations.
A sustained or continuing weakness or weakening in business and economic conditions generally or specifically in the principal markets in which the Company does business could have one or more of the following adverse impacts on the Company’s business:
| · | a decrease in the demand for loans and other products and services offered by the Company; |
| · | an increase or decrease in the usage of unfunded credit commitments; |
| · | an increase or decrease in the amount of deposits; |
| · | a decrease in non-depository funding available to the Company; |
| · | an impairment of certain intangible assets, including goodwill; |
| · | an increase in the number of clients and counterparties who become delinquent, file for protection under bankruptcy laws or default on their loans or other obligations to the Company, which could result in a higher level of nonperforming assets, net charge-offs, provision for loan losses, reduced interest revenue and cash flows, and valuation adjustments on assets; |
| · | an impairment in the value of investment securities; |
| · | an impairment in the value of life insurance policies owned by the Company; |
| · | an impairment in the value of real estate owned by the Company. |
The 2008 - 2009 financial crisis led to the failure or merger of a number of financial institutions. Financial institution failures can result in further losses as a consequence of defaults on securities issued by them and defaults under contracts entered into with such entities as counterparties. The failure of institutions with FDIC insured deposits can cause the DIF reserve ratio to decline, resulting in increased deposit insurance assessments on surviving FDIC insured institutions. Weak economic conditions can significantly weaken the strength and liquidity of financial institutions.
| -11- |
The Company’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, are highly dependent upon the business environment in the markets where the Company operates, in the State of California and in the United States as a whole. A favorable business environment is generally characterized by, among other factors, economic growth, healthy labor markets, efficient capital markets, low inflation, high business and investor confidence, and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by: declines in economic growth, high rates of unemployment, deflation, declines in business activity or consumer, investor or business confidence; limitations on the availability of or increases in the cost of credit and capital; increases in inflation; natural disasters; or a combination of these or other factors.
Such business conditions could adversely affect the credit quality of the Company’s loans, the demand for loans, loan volumes and related revenue, securities valuations, amounts of deposits, availability of funding, results of operations and financial condition.
Regulatory Risks
Restrictions on dividends and other distributions could limit amounts payable to the Company.
As a holding company, a substantial portion of the Company’s cash flow typically comes from dividends paid by the Bank. Various statutory provisions restrict the amount of dividends the Company’s subsidiaries can pay to the Company without regulatory approval. The Bank obtained regulatory approval for dividends paid to the Company in 2017. A reduction in subsidiary dividends paid to the Company could limit the capacity of the Company to pay dividends. In addition, if any of the Company’s subsidiaries were to liquidate, that subsidiary’s creditors will be entitled to receive distributions from the assets of that subsidiary to satisfy their claims against it before the Company, as a holder of an equity interest in the subsidiary, will be entitled to receive any of the assets of the subsidiary.
Adverse effects of changes in banking or other laws and regulations or governmental fiscal or monetary policies could adversely affect the Company.
The Company is subject to significant federal and state regulation and supervision, which is primarily for the benefit and protection of the Company’s customers and not for the benefit of investors. In the past, the Company’s business has been materially affected by these regulations.
Laws, regulations or policies, including accounting standards and interpretations currently affecting the Company and the Company’s subsidiaries, may change at any time. Regulatory authorities may also change their interpretation of these statutes and regulations. Therefore, the Company’s business may be adversely affected by any future changes in laws, regulations, policies or interpretations or regulatory approaches to compliance and enforcement including future acts of terrorism, major U.S. corporate bankruptcies and reports of accounting irregularities at U.S. public companies.
Additionally, the Company’s business is affected significantly by the fiscal and monetary policies of the federal government and its agencies. The Company is particularly affected by the policies of the FRB, which regulates the supply of money and credit in the United States of America. Among the instruments of monetary policy available to the FRB are (a) conducting open market operations in U.S. government securities, (b) changing the discount rates of borrowings by depository institutions, (c) changing interest rates paid on balances financial institutions deposit with the FRB, and (d) imposing or changing reserve requirements against certain borrowings by banks and their affiliates. These methods are used in varying degrees and combinations to directly affect the availability of bank loans and deposits, as well as the interest rates charged on loans and paid on deposits. The policies of the FRB may have a material effect on the Company’s business, results of operations and financial condition. Under long- standing policy of the FRB, a BHC is expected to act as a source of financial strength for its subsidiary banks. As a result of that policy, the Company may be required to commit financial and other resources to its subsidiary bank in circumstances where the Company might not otherwise do so.
Following the most recent recession, the FRB has been providing vast amounts of liquidity into the banking system. The FRB has been purchasing large quantities of U.S. government securities, including agency-backed mortgage securities, increasing the demand for such securities thereby reducing interest rates. The FRB began reducing these asset purchase activities in the fourth quarter 2013 and the Federal Open Market Committee (“FOMC”) has been increasing the target range for the federal funds rate. On December 13, 2017, the FOMC raised the target range for the federal funds rate to 1¼ to 1½ percent, which could reduce liquidity in the markets and cause interest rates to rise, thereby increasing funding costs to the Bank, reducing the availability of funds to the Bank to finance its existing operations, and causing fixed-rate investment securities and loans to decline in value.
Federal and state governments could pass legislation detrimental to the Company’s performance.
As an example, the Company could experience higher credit losses because of federal or state legislation or regulatory action that reduces the amount the Bank's borrowers are otherwise contractually required to pay under existing loan contracts. Also, the Company could experience higher credit losses because of federal or state legislation or regulatory action that limits or delays the Bank's ability to foreclose on property or other collateral or makes foreclosure less economically feasible. Federal, state and local governments could pass tax legislation causing the Company to pay higher levels of taxes.
| -12- |
The FDIC insures deposits at insured financial institutions up to certain limits. The FDIC charges insured financial institutions premiums to maintain the Deposit Insurance Fund. The FDIC may increase premium assessments to maintain adequate funding of the Deposit Insurance Fund.
The behavior of depositors in regard to the level of FDIC insurance could cause our existing customers to reduce the amount of deposits held at the Bank, and could cause new customers to open deposit accounts at the Bank. The level and composition of the Bank's deposit portfolio directly impacts the Bank's funding cost and net interest margin.
Systems, Accounting and Internal Control Risks
The accuracy of the Company’s judgments and estimates about financial and accounting matters will impact operating results and financial condition.
The discussion under “Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies” in this Report and the information referred to in that discussion is incorporated by reference in this paragraph. The Company makes certain estimates and judgments in preparing its financial statements. The quality and accuracy of those estimates and judgments will have an impact on the Company’s operating results and financial condition.
The Company’s information systems may experience an interruption or breach in security.
The Company relies heavily on communications and information systems, including those of third party vendors and other service providers, to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Company’s data processing, accounting, customer relationship management and other systems. Communication and information systems failures can result from a variety of risks including, but not limited to, events that are wholly or partially out of the Company’s control, such as telecommunication line integrity, weather, terrorist acts, natural disasters, accidental disasters, unauthorized breaches of security systems, energy delivery systems, cyber attacks, and other events. Although the Company devotes significant resources to maintain and regularly upgrade its systems and processes that are designed to protect the security of the Company’s computer systems, software, networks and other technology assets and the confidentiality, integrity and availability of information belonging to the Company and its customers, there is no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately corrected by the Company or its vendors. The occurrence of any such failures, interruptions or security breaches could damage the Company’s reputation, result in a loss of customer business, subject the Company to additional regulatory scrutiny, or expose the Company to litigation and possible financial liability, any of which could have a material adverse effect on the Company’s financial condition and results of operations.
The Company’s controls and procedures may fail or be circumvented.
Management regularly reviews and updates the Company’s internal control over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures. The Company maintains controls and procedures to mitigate against risks such as processing system failures and errors, and customer or employee fraud, and maintains insurance coverage for certain of these risks. Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Events could occur which are not prevented or detected by the Company’s internal controls or are not insured against or are in excess of the Company’s insurance limits or insurance underwriters’ financial capacity. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None
| -13- |
Branch Offices and Facilities
Westamerica Bank is engaged in the banking business through 82 branch offices in 21 counties in Northern and Central California. WAB believes all of its offices are constructed and equipped to meet prescribed security requirements.
The Company owns 29 banking office locations and one centralized administrative service center facility and leases 58 facilities. Most of the leases contain renewal options and provisions for rental increases, principally for changes in the cost of living index, and for changes in other operating costs such as property taxes and maintenance.
Neither the Company nor any of its subsidiaries is a party to any material pending legal proceeding, nor is their property the subject of any material pending legal proceeding, other than ordinary routine legal proceedings arising in the ordinary course of the Company’s business. None of these proceedings is expected to have a material adverse impact upon the Company’s business, financial position or results of operations.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s common stock is traded on the NASDAQ Stock Market (“NASDAQ”) under the symbol “WABC”. The following table shows the high and the low sales prices for the common stock, for each quarter, as reported by NASDAQ:
| High | Low | |||||||
| 2017: | ||||||||
| First quarter | $ | 64.07 | $ | 54.12 | ||||
| Second quarter | 57.78 | 51.31 | ||||||
| Third quarter | 59.54 | 49.54 | ||||||
| Fourth quarter | 63.03 | 53.96 | ||||||
| 2016: | ||||||||
| First quarter | $ | 49.63 | $ | 40.72 | ||||
| Second quarter | 51.53 | 45.86 | ||||||
| Third quarter | 50.96 | 46.61 | ||||||
| Fourth quarter | 65.34 | 48.20 | ||||||
As of January 31, 2018, there were approximately 5,700 shareholders of record of the Company’s common stock.
The Company has paid cash dividends on its common stock in every quarter since its formation in 1972. See Item 8, Financial Statements and Supplementary Data, Note 20 to the consolidated financial statements for recent quarterly dividend information. It is currently the intention of the Board of Directors of the Company to continue payment of cash dividends on a quarterly basis. There is no assurance, however, that any dividends will be paid since they are dependent upon earnings, cash balances, financial condition and capital requirements of the Company and its subsidiaries as well as policies of the FRB pursuant to the BHCA. See Item 1, “Business - Supervision and Regulation.”
The notes to the consolidated financial statements included in this Report contain additional information regarding the Company’s capital levels, capital structure, regulations affecting subsidiary bank dividends paid to the Company, the Company’s earnings, financial condition and cash flows, and cash dividends declared and paid on common stock.
| -14- |
Stock performance
The following chart compares the cumulative return on the Company’s stock during the ten years ended December 31, 2017 with the cumulative return on the S&P 500 composite stock index and NASDAQ’S Bank Index. The comparison assumes $100 invested in each on December 31, 2007 and reinvestment of all dividends.
| December 31, | ||||||||||||||||||||||||
| 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | |||||||||||||||||||
| Westamerica Bancorporation (WABC) | $ | 100.00 | $ | 117.83 | $ | 131.29 | $ | 135.08 | $ | 110.22 | $ | 110.48 | ||||||||||||
| S&P 500 (SPX) | 100.00 | 63.01 | 79.69 | 91.71 | 93.62 | 108.59 | ||||||||||||||||||
| NASDAQ Bank Index (CBNK) | 100.00 | 78.47 | 65.69 | 75.00 | 67.12 | 79.69 | ||||||||||||||||||
| December 31, | ||||||||||||||||||||
| 2013 | 2014 | 2015 | 2016 | 2017 | ||||||||||||||||
| Westamerica Bancorporation (WABC) | $ | 151.16 | $ | 135.34 | $ | 129.56 | $ | 179.56 | $ | 169.70 | ||||||||||
| S&P 500 (SPX) | 143.73 | 163.36 | 162.32 | 181.53 | 216.54 | |||||||||||||||
| NASDAQ Bank Index (CBNK) | 112.92 | 118.46 | 126.39 | 174.06 | 179.77 | |||||||||||||||
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| -15- |
The following chart compares the cumulative return on the Company’s stock during the five years ended December 31, 2017 with the cumulative return on the S&P 500 composite stock index and NASDAQ’S Bank Index. The comparison assumes $100 invested in each on December 31, 2012 and reinvestment of all dividends.
| December 31, | ||||||||||||||||||||||||
| 2012 | 2013 | 2014 | 2015 | 2016 | 2017 | |||||||||||||||||||
| Westamerica Bancorporation (WABC) | $ | 100.00 | $ | 136.83 | $ | 122.50 | $ | 117.28 | $ | 162.54 | $ | 153.61 | ||||||||||||
| S&P 500 (SPX) | 100.00 | 132.36 | 150.43 | 149.48 | 167.16 | 199.41 | ||||||||||||||||||
| NASDAQ Bank Index (CBNK) | 100.00 | 141.69 | 148.65 | 158.61 | 218.42 | 225.59 | ||||||||||||||||||
ISSUER PURCHASES OF EQUITY SECURITIES
The table below sets forth the information with respect to purchases made by or on behalf of Westamerica Bancorporation or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of common stock during the quarter ended December 31, 2017 (in thousands, except per share data).
| 2017 | ||||||||||||||||
| Period | (a) Total Number of shares Purchased | (b) Average Price Paid per Share | (c) Number of Shares Purchased as Part of Publicly Announced Plans or Programs | (d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs | ||||||||||||
| (In thousands, except exercise price) | ||||||||||||||||
| October 1 through October 31 | - | $ | - | - | 1,750 | |||||||||||
| November 1 through November 30 | - | - | - | 1,750 | ||||||||||||
| December 1 through December 31 | - | - | - | 1,750 | ||||||||||||
| Total | - | $ | - | - | 1,750 | |||||||||||
The Company repurchases shares of its common stock in the open market to optimize the Company’s use of equity capital and enhance shareholder value and with the intention of lessening the dilutive impact of issuing new shares under stock option plans, and other ongoing requirements.
| -16- |
No shares were repurchased during the period from October 1, 2017 through December 31, 2017. A program approved by the Board of Directors on July 27, 2017 authorizes the purchase of up to 1,750 thousand shares of the Company’s common stock from time to time prior to September 1, 2018.
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| -17- |
ITEM 6. SELECTED FINANCIAL DATA
The following financial information for the five years ended December 31, 2017 has been derived from the Company’s audited consolidated financial statements. This information should be read in conjunction with those statements, notes and other information included elsewhere herein.
WESTAMERICA BANCORPORATION
FINANCIAL SUMMARY
| For the Years Ended December 31, | ||||||||||||||||||||
| 2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||
| (In thousands, except per share data and ratios) | ||||||||||||||||||||
| Interest and loan fee income | $ | 133,836 | $ | 134,051 | $ | 136,529 | $ | 140,209 | $ | 154,396 | ||||||||||
| Interest expense | 1,900 | 2,116 | 2,424 | 3,444 | 4,671 | |||||||||||||||
| Net interest and loan fee income | 131,936 | 131,935 | 134,105 | 136,765 | 149,725 | |||||||||||||||
| (Reversal of) provision for loan losses | (1,900 | ) | (3,200 | ) | - | 2,800 | 8,000 | |||||||||||||
| Noninterest income: | ||||||||||||||||||||
| Securities gains | 7,955 | - | - | - | - | |||||||||||||||
| Other noninterest income | 48,673 | 46,574 | 47,867 | 51,787 | 57,011 | |||||||||||||||
| Total noninterest income | 56,628 | 46,574 | 47,867 | 51,787 | 57,011 | |||||||||||||||
| Noninterest expense | 103,292 | 101,752 | 105,300 | 106,799 | 112,614 | |||||||||||||||
| Income before income taxes | 87,172 | 79,957 | 76,672 | 78,953 | 86,122 | |||||||||||||||
| Income tax provision | 37,147 | 21,104 | 17,919 | 18,307 | 18,945 | |||||||||||||||
| Net income | $ | 50,025 | $ | 58,853 | $ | 58,753 | $ | 60,646 | $ | 67,177 | ||||||||||
| Average common shares outstanding | 26,291 | 25,612 | 25,555 | 26,099 | 26,826 | |||||||||||||||
| Average diluted common shares outstanding | 26,419 | 25,678 | 25,577 | 26,160 | 26,877 | |||||||||||||||
| Common shares outstanding at December 31, | 26,425 | 25,907 | 25,528 | 25,745 | 26,510 | |||||||||||||||
| Per common share: | ||||||||||||||||||||
| Basic earnings | $ | 1.90 | $ | 2.30 | $ | 2.30 | $ | 2.32 | $ | 2.50 | ||||||||||
| Diluted earnings | 1.89 | 2.29 | 2.30 | 2.32 | 2.50 | |||||||||||||||
| Book value at December 31, | 22.34 | 21.67 | 20.85 | 20.45 | 20.48 | |||||||||||||||
| Financial ratios: | ||||||||||||||||||||
| Return on assets | 0.92 | % | 1.12 | % | 1.16 | % | 1.22 | % | 1.38 | % | ||||||||||
| Return on common equity | 8.39 | % | 10.85 | % | 11.32 | % | 11.57 | % | 12.48 | % | ||||||||||
| Net interest margin (FTE)(1) | 3.12 | % | 3.24 | % | 3.36 | % | 3.70 | % | 4.08 | % | ||||||||||
| Net loan losses to average loans | 0.08 | % | 0.04 | % | 0.11 | % | 0.17 | % | 0.33 | % | ||||||||||
| Efficiency ratio(2) | 51.45 | % | 53.09 | % | 53.69 | % | 52.24 | % | 50.11 | % | ||||||||||
| Equity to assets | 10.71 | % | 10.46 | % | 10.30 | % | 10.46 | % | 11.20 | % | ||||||||||
| Period end balances: | ||||||||||||||||||||
| Assets | $ | 5,513,046 | $ | 5,366,083 | $ | 5,168,875 | $ | 5,035,724 | $ | 4,847,055 | ||||||||||
| Loans | 1,287,982 | 1,352,711 | 1,533,396 | 1,700,290 | 1,827,744 | |||||||||||||||
| Allowance for loan losses | 23,009 | 25,954 | 29,771 | 31,485 | 31,693 | |||||||||||||||
| Investment securities | 3,352,371 | 3,237,070 | 2,886,291 | 2,639,439 | 2,211,680 | |||||||||||||||
| Deposits | 4,827,613 | 4,704,741 | 4,540,659 | 4,349,191 | 4,163,781 | |||||||||||||||
| Identifiable intangible assets and goodwill | 125,523 | 128,600 | 132,104 | 135,960 | 140,230 | |||||||||||||||
| Short-term borrowed funds | 58,471 | 59,078 | 53,028 | 89,784 | 62,668 | |||||||||||||||
| Federal Home Loan Bank advances | - | - | - | 20,015 | 20,577 | |||||||||||||||
| Term repurchase agreement | - | - | - | - | 10,000 | |||||||||||||||
| Shareholders' equity | 590,239 | 561,367 | 532,205 | 526,603 | 542,934 | |||||||||||||||
| Capital ratios at period end: | ||||||||||||||||||||
| Total risk based capital | 16.17 | % | 15.95 | % | 13.39 | % | 14.54 | % | 16.18 | % | ||||||||||
| Tangible equity to tangible assets | 8.63 | % | 8.26 | % | 7.94 | % | 7.97 | % | 8.56 | % | ||||||||||
| Dividends paid per common share | $ | 1.57 | $ | 1.56 | $ | 1.53 | $ | 1.52 | $ | 1.49 | ||||||||||
| Common dividend payout ratio | 83 | % | 68 | % | 67 | % | 66 | % | 60 | % | ||||||||||
| (1) | Yields on securities and certain loans have been adjusted upward to a "fully taxable equivalent" ("FTE") basis in order to reflect the effect of income which is exempt from federal income taxation at the current statutory tax rate. |
| (2) | The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income on an FTE basis and noninterest income). |
| -18- |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion addresses information pertaining to the financial condition and results of operations of Westamerica Bancorporation and subsidiaries (the “Company”) that may not be otherwise apparent from a review of the consolidated financial statements and related footnotes. It should be read in conjunction with those statements and notes found on pages 47 through 88, as well as with the other information presented throughout this Report.
Critical Accounting Policies
The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the banking industry. Application of these principles requires the Company to make certain estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain accounting policies inherently have a greater reliance on the use of estimates, assumptions and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment writedown or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available.
The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, Management has identified the allowance for loan losses accounting to be the accounting area requiring the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available. A discussion of the factors affecting accounting for the allowance for loan losses and purchased loans is included in the “Loan Portfolio Credit Risk” discussion below.
Net Income
The Company reported net income of $50.0 million and diluted earnings per common share (“EPS”) of $1.89 in 2017. The 2017 results include adjustments to net deferred tax asset values triggered by enactment of the Tax Cuts and Jobs Act of 2017 which reduced EPS $0.48, recognition of a loss contingency which reduced EPS $0.12, and securities gains which increased EPS $0.18. The 2017 results compare to net income of $58.9 million or $2.29 EPS for the year ended December 31, 2016 and net income of $58.8 million or $2.30 EPS for the year ended December 31, 2015.
The Company’s principal source of revenue is net interest and loan fee income, which represents interest and fees earned on loans and investment securities (“earning assets”) reduced by interest paid on deposits and other borrowings (“interest-bearing liabilities”). Market interest rates declined considerably following the recession of 2008 and 2009. Interest rates remained historically low through 2016 as the Federal Open Market Committee’s (“FOMC”) monetary policy was highly accommodative. During this period, Management avoided originating long-dated, low-yielding loans given the potential impact of such assets on forward earning potential; as a result, loans declined and investment securities increased. The changing composition of the earning assets and low market interest rates has pressured the net interest margin to lower levels. The FOMC’s first post-recession increase in the federal funds rate occurred in December 2015, although longer-term rates declined. The FOMC’s successive post-recession increases in the federal funds rate occurred between December 2016 and December 2017, although longer-term rates have not increased by a similar magnitude. The more recent increase in rates has resulted in competitive loan yields which are more appealing from a profitability perspective, in Management’s opinion.
The funding of the Company’s earning assets is primarily customer deposits. The Company’s long-term strategy includes maximizing checking and savings deposits as these types of deposits are lower-cost and less sensitive to changes in interest rates compared to time deposits. The 2017 average volume of checking and savings deposits was 95 percent of average total deposits.
| -19- |
The Company recognized a reversal of the provision for loan losses of $1.9 million in 2017. Credit quality improved during 2017 with nonperforming assets declining $4 million to $8 million at December 31, 2017. The Company’s net losses in 2017 were 0.08% of average loan balances. These developments were reflected in Management’s evaluation of credit quality, the level of the provision for loan losses, and the adequacy of the allowance for loan losses at December 31, 2017.
The Company presents its net interest margin and net interest income on an FTE basis using the current statutory federal tax rate. Management believes the FTE basis is valuable to the reader because the Company’s loan and investment securities portfolios contain a relatively large portion of municipal loans and securities that are federally tax exempt. The Company’s tax exempt loans and securities composition may not be similar to that of other banks. Therefore in order to reflect the impact of the federally tax exempt loans and securities on the net interest margin and net interest income for comparability with other banks, the Company presents its net interest margin and net interest income on an FTE basis.
The Company’s significant accounting policies (see Note 1 (“Summary of Significant Accounting Policies”) to Financial Statements in the Company’s 2017 Form 10-K) are fundamental to understanding the Company’s results of operations and financial condition. The Company adopted the FASB ASU 2016-09, Improvements to Employee Share-Based Payment Accounting effective January 1, 2017. The 2017 results reflect the Company’s prospective adoption of ASU 2016-09; The 2017 income tax provision was $698 thousand lower than would have been under accounting standards prior to the adoption of ASU 2016-09.
Components of Net Income
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| ($ in thousands, except per share data) | ||||||||||||
| Net interest and loan fee income (FTE) | $ | 144,118 | $ | 145,077 | $ | 148,258 | ||||||
| Reversal of (provision for) loan losses | 1,900 | 3,200 | - | |||||||||
| Noninterest income | 56,628 | 46,574 | 47,867 | |||||||||
| Noninterest expense | (103,292 | ) | (101,752 | ) | (105,300 | ) | ||||||
| Income before income taxes (FTE) | 99,354 | 93,099 | 90,825 | |||||||||
| Income taxes (FTE) | (49,329 | ) | (34,246 | ) | (32,072 | ) | ||||||
| Net income | $ | 50,025 | $ | 58,853 | $ | 58,753 | ||||||
| Net income per average fully-diluted common share | $ | 1.89 | $ | 2.29 | $ | 2.30 | ||||||
| Net income as a percentage of average shareholders' equity | 8.39 | % | 10.85 | % | 11.32 | % | ||||||
| Net income as a percentage of average total assets | 0.92 | % | 1.12 | % | 1.16 | % | ||||||
Comparing 2017 with 2016, net income decreased $8.8 million. Net interest and loan fee income (FTE) decreased in 2017 compared with 2016 mostly attributable to lower average balances of loans and lower net yield on those loans, partially offset by higher average balances of investments. The Company recorded a $1.9 million reversal of provision for loan losses in 2017 and a $3.2 million reversal of provision for loan losses in 2016, reflecting Management's evaluation of losses inherent in the loan portfolio. Noninterest income increased primarily due to gains on sale of securities of $8.0 million and higher merchant processing services fees, partially offset by lower service charges on deposit accounts. Noninterest expense increased due to a $5.5 million loss contingency and an impairment charge of tax credit investments, partially offset by reductions in professional fees and correspondent service charges. The tax provision (FTE) for 2017 was higher than in 2016 primarily due to a $12.3 million charge to re-measure the Company’s net deferred tax asset triggered by enactment of the Tax Cuts and Jobs Act of 2017. The 2017 income tax provision was $698 thousand lower than it would have been under accounting standards prior to the adoption of ASU 2016-09.
Comparing 2016 with 2015, net income increased $100 thousand due to a reversal of provision for loan losses and lower noninterest expense, partially offset by lower net interest and fee income (FTE), lower noninterest income and higher income tax provision (FTE). The lower net interest and fee income (FTE) was primarily caused by lower average balances of loans, partially offset by higher average balances of investments and lower average balances of higher-costing time deposits. The Company recorded a reversal of the provision for loan losses of $3.2 million, reflecting Management's evaluation of losses inherent in the loan portfolio. Noninterest income decreased primarily due to reduced levels of service charges on deposit accounts, financial services commissions and other service fees, partially offset by higher debit card fees. Noninterest expense decreased mostly due to lower personnel expense, lower occupancy expense, and lower other operating expense, offset in part by higher legal fees. Income tax provision (FTE) increased in 2016 due to higher pretax income, declining tax preference items and lower tax credits.
| -20- |
Net Interest and Loan Fee Income (FTE)
The Company's primary source of revenue is net interest income, or the difference between interest income earned on loans and investment securities and interest expense paid on interest-bearing deposits and other borrowings.
Components of Net Interest and Loan Fee Income (FTE)
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| ($ in thousands) | ||||||||||||
| Interest and loan fee income | $ | 133,836 | $ | 134,051 | $ | 136,529 | ||||||
| Interest expense | (1,900 | ) | (2,116 | ) | (2,424 | ) | ||||||
| FTE adjustment | 12,182 | 13,142 | 14,153 | |||||||||
| Net interest and loan fee income (FTE) | $ | 144,118 | $ | 145,077 | $ | 148,258 | ||||||
| Net interest margin (FTE) | 3.12 | % | 3.24 | % | 3.36 | % | ||||||
Comparing 2017 with 2016, net interest and loan fee income (FTE) decreased $959 thousand mostly due to lower average balances of loans (down $109 million) and lower net yield on those loans (down 0.16%), partially offset by higher average balances of investments (up $255 million).
Comparing 2016 with 2015, net interest and loan fee income (FTE) decreased $3.2 million due to lower average balances of loans (down $194 million), partially offset by higher average balances of investments (up $255 million) and lower average balances of higher-costing time deposits (down $62 million).
Loan volumes have declined due to payoffs and problem loan workout activities (such as chargeoffs, collateral repossessions and principal payments), particularly with purchased loans, and reduced volumes of loan originations. The Company did not take an aggressive posture relative to loan portfolio growth during the post-recession period of historically low interest rates. Management increased investment securities as loan volumes declined. The average balance of the investment securities portfolio increased from $2.8 billion in 2015 to $3.1 billion in 2016 and $3.3 billion in 2017. The Company has been purchasing shorter-duration investment securities with lower yields than longer-duration securities to increase liquidity. The Company’s high levels of liquidity will provide an opportunity to obtain higher yielding assets as market interest rates rise.
Yields on interest-earning assets declined due to historically low interest rates prevailing in the market. The net interest margin (FTE) was 3.12% in 2017, 3.24% in 2016 and 3.36% in 2015. The volume of older-dated higher-yielding loans and securities declined due to principal maturities and paydowns. As the investment securities portfolio grew during the three years ended December 31, 2017, the investment securities portfolio generated an increasing portion of the interest income (FTE). Interest income (FTE) generated from investments represented 47.0% of total interest income (FTE) in 2015, 52.2% in 2016 and 57.0% in 2017. During the three years ended December 31, 2017, the net interest margin (FTE) was affected by low market interest rates and the changing composition of interest-earning assets.
The Company has been replacing higher-cost funding sources with low-cost deposits and interest expense has declined to offset some of the decline in interest income. Interest expense has been reduced by lowering rates paid on interest-bearing deposits and borrowings by reducing the volume of higher-cost funding sources. Federal Home Loan Bank (“FHLB”) advances were repaid in January 2015. Average balances of time deposits declined $27 million in 2017 compared with 2016 while lower-cost checking and savings deposits grew 4% in the same period. Lower-cost checking and savings deposits accounted for 94.8% of total average deposits in 2017 compared with 94.1% in 2016 and 92.5% in 2015.
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| -21- |
Summary of Average Balances, Yields/Rates and Interest Differential
The following tables present information regarding the consolidated average assets, liabilities and shareholders’ equity, the amounts of interest income earned from average interest earning assets and the resulting yields, and the amounts of interest expense incurred on average interest-bearing liabilities and the resulting rates. Average loan balances include nonperforming loans. Interest income includes reversal of previously accrued interest on loans placed on non-accrual status during the period and proceeds from loans on nonaccrual status only to the extent cash payments have been received and applied as interest income and accretion of purchased loan discounts. Yields on tax-exempt securities and loans have been adjusted upward to reflect the effect of income exempt from federal income taxation at the federal statutory tax rate of 35 percent for 2015, 2016 and 2017. Due to the Tax Cuts and Jobs Act of 2017, the federal tax rate will be 21 percent for 2018; as such, the upward adjustment to reflect the effect of income exempt from federal taxation will be lower in 2018.
Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin
| For the Year Ended December 31, 2017 | ||||||||||||
| Interest | ||||||||||||
| Average | Income/ | Yields/ | ||||||||||
| Balance | Expense | Rates | ||||||||||
| ($ in thousands) | ||||||||||||
| Assets | ||||||||||||
| Investment securities: | ||||||||||||
| Taxable | $ | 2,498,001 | $ | 51,445 | 2.06 | % | ||||||
| Tax-exempt (1) | 809,136 | 31,737 | 3.92 | % | ||||||||
| Total investments (1) | 3,307,137 | 83,182 | 2.52 | % | ||||||||
| Loans: | ||||||||||||
| Taxable | 1,252,474 | 59,700 | 4.77 | % | ||||||||
| Tax-exempt (1) | 62,728 | 3,136 | 5.00 | % | ||||||||
| Total loans (1) | 1,315,202 | 62,836 | 4.78 | % | ||||||||
| Total interest-earning assets (1) | 4,622,339 | 146,018 | 3.16 | % | ||||||||
| Other assets | 817,343 | |||||||||||
| Total assets | $ | 5,439,682 | ||||||||||
| Liabilities and shareholders' equity | ||||||||||||
| Noninterest-bearing demand | $ | 2,095,522 | $ | - | - | % | ||||||
| Savings and interest-bearing transaction | 2,380,841 | 1,123 | 0.05 | % | ||||||||
| Time less than $100,000 | 136,324 | 318 | 0.23 | % | ||||||||
| Time $100,000 or more | 109,563 | 415 | 0.38 | % | ||||||||
| Total interest-bearing deposits | 2,626,728 | 1,856 | 0.07 | % | ||||||||
| Short-term borrowed funds | 69,671 | 44 | 0.06 | % | ||||||||
| Total interest-bearing liabilities | 2,696,399 | 1,900 | 0.07 | % | ||||||||
| Other liabilities | 51,405 | |||||||||||
| Shareholders' equity | 596,356 | |||||||||||
| Total liabilities and shareholders' equity | $ | 5,439,682 | ||||||||||
| Net interest spread (1) (2) | 3.09 | % | ||||||||||
| Net interest and fee income and interest margin (1) (3) | $ | 144,118 | 3.12 | % | ||||||||
| (1) | Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate. |
| (2) | Net interest spread represents the average yield earned on interest-earning assets less the average rate incurred on interest-bearing liabilities. |
| (3) | Net interest margin is computed by calculating the difference between interest income and expense, divided by the average balance of interest-earning assets. The net interest margin is greater than the net interest spread due to the benefit of noninterest-bearing demand deposits. |
| -22- |
Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin
| For the Year Ended December 31, 2016 | ||||||||||||
| Interest | ||||||||||||
| Average | Income/ | Yields/ | ||||||||||
| Balance | Expense | Rates | ||||||||||
| ($ in thousands) | ||||||||||||
| Assets | ||||||||||||
| Investment securities: | ||||||||||||
| Taxable | $ | 2,212,234 | $ | 42,718 | 1.93 | % | ||||||
| Tax-exempt (1) | 840,262 | 34,103 | 4.06 | % | ||||||||
| Total investments (1) | 3,052,496 | 76,821 | 2.52 | % | ||||||||
| Loans: | ||||||||||||
| Taxable | 1,356,417 | 66,842 | 4.93 | % | ||||||||
| Tax-exempt (1) | 67,842 | 3,530 | 5.20 | % | ||||||||
| Total loans (1) | 1,424,259 | 70,372 | 4.94 | % | ||||||||
| Total interest-earning assets (1) | 4,476,755 | 147,193 | 3.29 | % | ||||||||
| Other assets | 769,389 | |||||||||||
| Total assets | $ | 5,246,144 | ||||||||||
| Liabilities and shareholders' equity | ||||||||||||
| Noninterest-bearing demand | $ | 2,026,939 | $ | - | - | % | ||||||
| Savings and interest-bearing transaction | 2,290,640 | 1,166 | 0.05 | % | ||||||||
| Time less than $100,000 | 154,022 | 402 | 0.26 | % | ||||||||
| Time $100,000 or more | 118,750 | 509 | 0.43 | % | ||||||||
| Total interest-bearing deposits | 2,563,412 | 2,077 | 0.08 | % | ||||||||
| Short-term borrowed funds | 61,276 | 39 | 0.06 | % | ||||||||
| Total interest-bearing liabilities | 2,624,688 | 2,116 | 0.08 | % | ||||||||
| Other liabilities | 52,216 | |||||||||||
| Shareholders' equity | 542,301 | |||||||||||
| Total liabilities and shareholders' equity | $ | 5,246,144 | ||||||||||
| Net interest spread (1) (2) | 3.21 | % | ||||||||||
| Net interest and fee income and interest margin (1) (3) | $ | 145,077 | 3.24 | % | ||||||||
| (1) | Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate. |
| (2) | Net interest spread represents the average yield earned on interest-earning assets less the average rate incurred on interest-bearing liabilities. |
| (3) | Net interest margin is computed by calculating the difference between interest income and expense, divided by the average balance of interest-earning assets. The net interest margin is greater than the net interest spread due to the benefit of noninterest-bearing demand deposits. |
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| -23- |
Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin
| For the Year Ended December 31, 2015 | ||||||||||||
| Interest | ||||||||||||
| Average | Income/ | Yields/ | ||||||||||
| Balance | Expense | Rates | ||||||||||
| ($ in thousands) | ||||||||||||
| Assets | ||||||||||||
| Investment securities: | ||||||||||||
| Taxable | $ | 1,947,835 | $ | 34,472 | 1.77 | % | ||||||
| Tax-exempt (1) | 849,618 | 36,284 | 4.27 | % | ||||||||
| Total investments (1) | 2,797,453 | 70,756 | 2.53 | % | ||||||||
| Loans: | ||||||||||||
| Taxable | 1,542,264 | 75,677 | 4.91 | % | ||||||||
| Tax-exempt (1) | 76,007 | 4,249 | 5.59 | % | ||||||||
| Total loans (1) | 1,618,271 | 79,926 | 4.94 | % | ||||||||
| Total interest-earning assets (1) | 4,415,724 | 150,682 | 3.41 | % | ||||||||
| Other assets | 668,276 | |||||||||||
| Total assets | $ | 5,084,000 | ||||||||||
| Liabilities and shareholders' equity | ||||||||||||
| Noninterest-bearing demand | $ | 1,968,817 | $ | - | - | % | ||||||
| Savings and interest-bearing transaction | 2,134,256 | 1,112 | 0.05 | % | ||||||||
| Time less than $100,000 | 172,836 | 571 | 0.33 | % | ||||||||
| Time $100,000 or more | 161,710 | 687 | 0.42 | % | ||||||||
| Total interest-bearing deposits | 2,468,802 | 2,370 | 0.10 | % | ||||||||
| Short-term borrowed funds | 75,054 | 53 | 0.07 | % | ||||||||
| Federal Home Loan Bank advances | 494 | 1 | 0.20 | % | ||||||||
| Total interest-bearing liabilities | 2,544,350 | 2,424 | 0.10 | % | ||||||||
| Other liabilities | 51,707 | |||||||||||
| Shareholders' equity | 519,126 | |||||||||||
| Total liabilities and shareholders' equity | $ | 5,084,000 | ||||||||||
| Net interest spread (1) (2) | 3.31 | % | ||||||||||
| Net interest and fee income and interest margin (1) (3) | $ | 148,258 | 3.36 | % | ||||||||
| (1) | Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate. |
| (2) | Net interest spread represents the average yield earned on interest-earning assets less the average rate incurred on interest-bearing liabilities. |
| (3) | Net interest margin is computed by calculating the difference between interest income and expense, divided by the average balance of interest-earning assets. The net interest margin is greater than the net interest spread due to the benefit of noninterest-bearing demand deposits. |
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| -24- |
Summary of Changes in Interest Income and Expense due to Changes in Average Asset & Liability Balances and Yields Earned & Rates Paid
The following tables set forth a summary of the changes in interest income and interest expense due to changes in average assets and liability balances (volume) and changes in average interest yields/rates for the periods indicated. Changes not solely attributable to volume or yields/rates have been allocated in proportion to the respective volume and yield/rate components.
Summary of Changes in Interest Income and Expense
| For the Year Ended December 31, 2017 | ||||||||||||
| Compared with | ||||||||||||
| For the Year Ended December 31, 2016 | ||||||||||||
| Volume | Yield/Rate | Total | ||||||||||
| (In thousands) | ||||||||||||
| Increase (decrease) in interest and loan fee income: | ||||||||||||
| Investment securities: | ||||||||||||
| Taxable | $ | 5,518 | $ | 3,209 | $ | 8,727 | ||||||
| Tax-exempt (1) | (1,263 | ) | (1,103 | ) | (2,366 | ) | ||||||
| Total investments (1) | 4,255 | 2,106 | 6,361 | |||||||||
| Loans: | ||||||||||||
| Taxable | (5,118 | ) | (2,024 | ) | (7,142 | ) | ||||||
| Tax-exempt (1) | (266 | ) | (128 | ) | (394 | ) | ||||||
| Total loans (1) | (5,384 | ) | (2,152 | ) | (7,536 | ) | ||||||
| Total decrease in interest and loan fee income (1) | (1,129 | ) | (46 | ) | (1,175 | ) | ||||||
| Increase (decrease) in interest expense: | ||||||||||||
| Deposits: | ||||||||||||
| Savings and interest-bearing transaction | 45 | (88 | ) | (43 | ) | |||||||
| Time less than $100,000 | (46 | ) | (38 | ) | (84 | ) | ||||||
| Time $100,000 or more | (39 | ) | (55 | ) | (94 | ) | ||||||
| Total interest-bearing deposits | (40 | ) | (181 | ) | (221 | ) | ||||||
| Short-term borrowed funds | 5 | - | 5 | |||||||||
| Total decrease in interest expense | (35 | ) | (181 | ) | (216 | ) | ||||||
| (Decrease) increase in net interest and loan fee income (1) | $ | (1,094 | ) | $ | 135 | $ | (959 | ) | ||||
| (1) | Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate. |
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| -25- |
Summary of Changes in Interest Income and Expense
| For the Year Ended December 31, 2016 | ||||||||||||
| Compared with | ||||||||||||
| For the Year Ended December 31, 2015 | ||||||||||||
| Volume | Yield/Rate | Total | ||||||||||
| (In thousands) | ||||||||||||
| Increase (decrease) in interest and loan fee income: | ||||||||||||
| Investment securities: | ||||||||||||
| Taxable | $ | 4,679 | $ | 3,567 | $ | 8,246 | ||||||
| Tax-exempt (1) | (400 | ) | (1,781 | ) | (2,181 | ) | ||||||
| Total investments (1) | 4,279 | 1,786 | 6,065 | |||||||||
| Loans: | ||||||||||||
| Taxable | (9,119 | ) | 284 | (8,835 | ) | |||||||
| Tax-exempt (1) | (456 | ) | (263 | ) | (719 | ) | ||||||
| Total loans (1) | (9,575 | ) | 21 | (9,554 | ) | |||||||
| Total (decrease) increase in interest and loan fee income (1) | (5,296 | ) | 1,807 | (3,489 | ) | |||||||
| Increase (decrease) in interest expense: | ||||||||||||
| Deposits: | ||||||||||||
| Savings and interest-bearing transaction | 81 | (27 | ) | 54 | ||||||||
| Time less than $100,000 | (62 | ) | (107 | ) | (169 | ) | ||||||
| Time $100,000 or more | (183 | ) | 5 | (178 | ) | |||||||
| Total interest-bearing deposits | (164 | ) | (129 | ) | (293 | ) | ||||||
| Short-term borrowed funds | (10 | ) | (4 | ) | (14 | ) | ||||||
| Federal Home Loan Bank advances | (1 | ) | - | (1 | ) | |||||||
| Total decrease in interest expense | (175 | ) | (133 | ) | (308 | ) | ||||||
| (Decrease) increase in net interest and loan fee income (1) | $ | (5,121 | ) | $ | 1,940 | $ | (3,181 | ) | ||||
| (1) | Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate. |
Provision for Loan Losses
The Company manages credit costs by consistently enforcing conservative underwriting and administration procedures and aggressively pursuing collection efforts with debtors experiencing financial difficulties. The provision for loan losses reflects Management's assessment of credit risk in the loan portfolio during each of the periods presented.
The Company recorded a reversal of the provision for loan losses of $1.9 million in 2017 and $3.2 million in 2016. The Company provided no provision for loan losses in 2015. Classified loans declined $10.5 million (which included nonperforming loans of $5.9 million) in 2017. The Company’s net loan losses decreased from $1.7 million in 2015 to $617 thousand in 2016 and $1.0 million in 2017; these developments were reflected in Management’s evaluation of credit quality, the level of the provision for loan losses, and the adequacy of the allowance for loan losses at December 31, 2017. At December 31, 2017, the Company had $7.8 million in residential real estate secured loans which are indemnified from loss by the FDIC up to eighty percent of principal; the indemnification expires February 6, 2019. For further information regarding credit risk, the FDIC loss-sharing agreements, net credit losses and the allowance for loan losses, see the “Loan Portfolio Credit Risk” and “Allowance for Loan Losses” sections of this Report.
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| -26- |
Noninterest Income
Components of Noninterest Income
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Service charges on deposit accounts | $ | 19,612 | $ | 20,854 | $ | 22,241 | ||||||
| Merchant processing services | 8,426 | 6,377 | 6,339 | |||||||||
| Securities gains | 7,955 | - | - | |||||||||
| Debit card fees | 6,421 | 6,290 | 6,084 | |||||||||
| Trust fees | 2,875 | 2,686 | 2,732 | |||||||||
| ATM processing fees | 2,610 | 2,411 | 2,397 | |||||||||
| Other service fees | 2,584 | 2,571 | 2,689 | |||||||||
| Financial services commissions | 639 | 568 | 695 | |||||||||
| Other noninterest income | 5,506 | 4,817 | 4,690 | |||||||||
| Total Noninterest Income | $ | 56,628 | $ | 46,574 | $ | 47,867 | ||||||
In 2017, noninterest income increased $10.1 million compared with 2016 mainly due to $8.0 million in gains on sale of securities. Merchant processing services fees increased $2.0 million due to successful sales efforts and higher transaction volumes. ATM processing fees and debit card fees increased $199 thousand and $131 thousand, respectively, primarily due to increased transaction volumes. Trust fees increased $189 thousand due to successful sales efforts. Offsetting the increase were service charges on deposits which decreased $1.2 million due to declines in fees charged on overdrawn and insufficient funds accounts (down $1.0 million) and lower fees on analyzed accounts (down $220 thousand).
In 2016, noninterest income decreased $1.3 million or 2.7% compared with 2015. Service charges on deposits decreased $1.4 million due to declines in fees charged on overdrawn and insufficient funds accounts (down $1.1 million) and lower fees on analyzed accounts (down $393 thousand). The decrease was partially offset by increased debit card fees of $206 thousand as a result of increased transaction volumes.
Noninterest Expense
Components of Noninterest Expense
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Salaries and related benefits | $ | 51,519 | $ | 51,507 | $ | 52,192 | ||||||
| Occupancy and equipment | 19,430 | 19,017 | 19,394 | |||||||||
| Outsourced data processing services | 9,035 | 8,505 | 8,441 | |||||||||
| Loss contingency | 5,542 | 3 | - | |||||||||
| Amortization of identifiable intangibles | 3,077 | 3,504 | 3,856 | |||||||||
| Professional fees | 2,161 | 3,980 | 2,490 | |||||||||
| Courier service | 1,732 | 1,952 | 2,329 | |||||||||
| Impairment of tax credit investments | 625 | - | - | |||||||||
| Other noninterest expense | 10,171 | 13,284 | 16,598 | |||||||||
| Total Noninterest Expense | $ | 103,292 | $ | 101,752 | $ | 105,300 | ||||||
In 2017, noninterest expense increased $1.5 million compared with 2016. The 2017 noninterest expense included a $5.5 million loss contingency and a $625 thousand impairment of low income housing limited partnership investments due to enactment of the Tax Cuts and Jobs Act of 2017. The loss contingency represents the Company’s estimated refunds to customers of revenue recognized in prior years. Outsourced data processing services expense increased $530 thousand primarily due to additional processing services. Expenses for occupancy and equipment increased $413 thousand due to technology upgrades. Other noninterest expense decreased $3.1 million primarily due to decreases in correspondent bank service charges and insurance premiums. Professional fees decreased $1.8 million due to lower legal fees associated with nonperforming assets. Amortization of intangibles decreased $427 thousand as assets are amortized on a declining balance method.
| -27- |
In 2016, noninterest expense decreased $3.5 million or 3.4% compared with 2015. Salaries and related benefits decreased $685 thousand primarily due to employee attrition, offset in part by higher expenses for stock based compensation. Occupancy and equipment expense decreased $377 thousand in 2016 compared with 2015 mostly due to branch closures and a lease expiration related to a non-branch building, partially offset by higher depreciation costs for technology. Courier expense decreased $377 thousand primarily due to logistical changes and switching to new vendors. Amortization of identifiable intangibles decreased $352 thousand as assets are amortized on a declining balance method. Other operating expense decreased $3.3 million primarily due to lower expenses for correspondent service charges, insurance premiums, operating losses on limited partnership investments and higher net gains on foreclosed properties. Professional fees increased $1.5 million due to higher legal fees associated with loan administration and collection activities.
Provision for Income Tax
The income tax provision (FTE) was $49.3 million in 2017 compared with $34.2 million in 2016 and $32.1 million in 2015. The 2017 income tax provision (FTE) included a $12.3 million charge to re-measure the Company’s net deferred tax asset triggered by enactment of the Tax Cuts and Jobs Act of 2017. Effective January 1, 2017, the Company adopted ASU 2016-09 which has the potential to create volatility in the book tax provision at the time nonqualified stock options are exercised or expire. During 2017, 509 thousand shares were issued due to the exercise of nonqualified stock options resulting in a tax deduction exceeding related share based compensation by $1.7 million. The 2017 income tax provision was $698 thousand lower than it would have been under accounting standards prior to the adoption of ASU 2016-09. The 2017 effective tax rate (FTE) was 49.6% compared with 36.8% in 2016 and 35.3% in 2015. The effective tax rates without FTE adjustments were 42.6% for 2017, 26.4% for 2016 and 23.4% for 2015. The effective tax rates for 2017 were higher than the effective tax rates for 2016 due to the 2017 $12.3 million charge to re-measure the Company’s net deferred tax asset, higher pre-tax income, and declining tax preference items. The effective tax rates for 2016 were higher than the effective tax rates for 2015 due to higher pre-tax income and declining tax preference items. Interest income earned on municipal securities and loans which are exempt from federal income taxes and the tax credits earned from investments in limited partnerships have each declined in 2017 and 2016.
Investment Securities Portfolio
The Company maintains an investment securities portfolio consisting of securities issued by U.S. Government sponsored entities, agency and non-agency mortgage backed securities, state and political subdivisions, corporations, and other securities.
Management has increased the investment securities portfolio in response to deposit growth and loan volume declines. The carrying value of the Company’s investment securities portfolio was $3.4 billion as of December 31, 2017 and $3.2 billion as of December 31, 2016.
Management continually evaluates the Company’s investment securities portfolio in response to established asset/liability management objectives, changing market conditions that could affect profitability, liquidity, and the level of interest rate risk to which the Company is exposed. These evaluations may cause Management to change the level of funds the Company deploys into investment securities and change the composition of the Company’s investment securities portfolio. In 2016 Management reduced securities of U.S. Government sponsored entities to reduce call optionality and increased agency residential MBS to develop more reliable cash flows. In 2017 corporate securities increased in order to improve yields without extending the duration of the bond portfolio.
As of December 31, 2017, substantially all of the Company’s investment securities continue to be investment grade rated by one or more major rating agencies. In addition to monitoring credit rating agency evaluations, Management performs its own evaluations regarding the credit worthiness of the issuer or the securitized assets underlying asset-backed securities. The Company’s procedures for evaluating investments in securities are in accordance with guidance issued by the Board of Governors of the Federal Reserve System, “Investing in Securities without Reliance on Nationally Recognized Statistical Rating Agencies” (SR 12-15) and other regulatory guidance. There have been no significant differences in our internal analyses compared with the ratings assigned by the third party credit rating agencies.
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| -28- |
The following table shows the fair value carrying amount of the Company’s investment securities available for sale as of the dates indicated:
Available for Sale Portfolio
| At December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Securities of U.S. Government sponsored entities | $ | 119,319 | $ | 138,660 | $ | 301,882 | ||||||
| Agency residential mortgage-backed securities (MBS) | 767,706 | 691,499 | 202,544 | |||||||||
| Non-agency residential MBS | 154 | 271 | 370 | |||||||||
| Agency commercial MBS | 2,219 | - | - | |||||||||
| Securities of U.S. Government entities | 1,590 | 2,025 | 2,379 | |||||||||
| Obligations of states and political subdivisions | 185,221 | 183,411 | 157,509 | |||||||||
| Asset-backed securities | - | 695 | 2,003 | |||||||||
| FHLMC(1) and FNMA(2) stock | - | 10,869 | 4,329 | |||||||||
| Corporate securities | 1,115,498 | 860,857 | 896,369 | |||||||||
| Other securities | 1,800 | 2,471 | 2,831 | |||||||||
| Total | $ | 2,193,507 | $ | 1,890,758 | $ | 1,570,216 | ||||||
(1) Federal Home Loan Mortgage Corporation
(2) Federal National Mortgage Association
The following table sets forth the relative maturities and contractual yields of the Company’s available for sale securities (stated at fair value) at December 31, 2017. Yields on state and political subdivision securities have been calculated on a fully taxable equivalent basis using the current federal statutory rate. Mortgage-backed securities are shown separately because they are typically paid in monthly installments over a number of years.
Available for Sale Portfolio Maturity Distribution
| At December 31, 2017 | ||||||||||||||||||||||||||||
| Within one year | After one but within five years | After five but within ten years | After ten years | Mortgage- backed | Other | Total | ||||||||||||||||||||||
| ($ in thousands) | ||||||||||||||||||||||||||||
| Securities of U.S. Government sponsored entities | $ | 80 | $ | 66,635 | $ | 52,604 | $ | - | $ | - | $ | - | $ | 119,319 | ||||||||||||||
| Interest rate | 5.84 | % | 1.90 | % | 1.97 | % | - | % | - | % | - | % | 1.94 | % | ||||||||||||||
| Securities of U.S. Government entities | 124 | - | 1,466 | - | - | - | 1,590 | |||||||||||||||||||||
| Interest rate | 2.15 | % | - | % | 2.67 | % | - | % | - | % | - | % | 2.63 | % | ||||||||||||||
| Obligations of states and political subdivisions | 11,256 | 27,948 | 100,863 | 45,154 | - | - | 185,221 | |||||||||||||||||||||
| Interest rate | 3.04 | % | 5.23 | % | 5.51 | % | 3.49 | % | - | % | - | % | 4.56 | % | ||||||||||||||
| Corporate securities | 181,925 | 928,464 | 5,109 | - | - | - | 1,115,498 | |||||||||||||||||||||
| Interest rate | 1.86 | % | 2.32 | % | 2.73 | % | - | % | - | % | - | % | 2.24 | % | ||||||||||||||
| Subtotal | 193,385 | 1,023,047 | 160,042 | 45,154 | - | - | 1,421,628 | |||||||||||||||||||||
| Interest rate | 1.93 | % | 2.37 | % | 4.23 | % | 3.49 | % | - | % | - | % | 2.52 | % | ||||||||||||||
| MBS | - | - | - | - | 770,079 | - | 770,079 | |||||||||||||||||||||
| Interest rate | - | % | - | % | - | % | - | % | 2.05 | % | - | % | 2.05 | % | ||||||||||||||
| Other securities without set maturities | - | - | - | - | - | 1,800 | 1,800 | |||||||||||||||||||||
| Interest rate | - | % | - | % | - | % | - | % | - | % | 2.39 | % | 2.39 | % | ||||||||||||||
| Total | $ | 193,385 | $ | 1,023,047 | $ | 160,042 | $ | 45,154 | $ | 770,079 | $ | 1,800 | $ | 2,193,507 | ||||||||||||||
| Interest rate | 1.93 | % | 2.37 | % | 4.23 | % | 3.49 | % | 2.05 | % | 2.39 | % | 2.35 | % | ||||||||||||||
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| -29- |
The following table shows the amortized cost carrying amount and fair value of the Company’s investment securities held to maturity as of the dates indicated:
Held to Maturity Portfolio
| At December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Securities of U.S. Government sponsored entities | $ | - | $ | 581 | $ | 764 | ||||||
| Agency residential MBS | 545,883 | 668,235 | 595,503 | |||||||||
| Non-agency residential MBS | 4,462 | 5,370 | 9,667 | |||||||||
| Agency commercial MBS | 9,041 | 9,332 | 16,258 | |||||||||
| Obligations of states and political subdivisions | 599,478 | 662,794 | 693,883 | |||||||||
| Total | $ | 1,158,864 | $ | 1,346,312 | $ | 1,316,075 | ||||||
| Fair value | $ | 1,155,342 | $ | 1,340,741 | $ | 1,325,699 | ||||||
The following table sets forth the relative maturities and contractual yields of the Company’s held to maturity securities at December 31, 2017. Yields on state and political subdivision securities have been calculated on a fully taxable equivalent basis using the current federal statutory rate. Mortgage-backed securities are shown separately because they are typically paid in monthly installments over a number of years.
Held to Maturity Portfolio Maturity Distribution
| At December 31, 2017 | ||||||||||||||||||||||||
| Within one year | After one but within five years | After five but within ten years | After ten years | Mortgage- backed | Total | |||||||||||||||||||
| ($ in thousands) | ||||||||||||||||||||||||
| Obligations of states and political subdivisions | $ | 50,295 | $ | 269,050 | $ | 277,170 | $ | 2,963 | $ | - | $ | 599,478 | ||||||||||||
| Interest rate | 2.99 | % | 2.95 | % | 4.38 | % | 4.23 | % | - | % | 3.54 | % | ||||||||||||
| MBS | - | - | - | - | 559,386 | 559,386 | ||||||||||||||||||
| Interest rate | - | % | - | % | - | % | - | % | 2.03 | % | 2.03 | % | ||||||||||||
| Total | $ | 50,295 | $ | 269,050 | $ | 277,170 | $ | 2,963 | $ | 559,386 | $ | 1,158,864 | ||||||||||||
| Interest rate | 2.99 | % | 2.95 | % | 4.38 | % | 4.23 | % | 2.03 | % | 2.81 | % | ||||||||||||
The following table summarizes total corporate securities by the industry sector in which the issuing companies operate:
| At December 31, | ||||||||||||||||
| 2017 | 2016 | |||||||||||||||
| Market value | As percent of total corporate securities | Market value | As percent of total corporate securities | |||||||||||||
| ($ in thousands) | ||||||||||||||||
| Basic materials | $ | 35,219 | 3 | % | $ | 14,083 | 2 | % | ||||||||
| Communications | 50,763 | 5 | % | 40,744 | 5 | % | ||||||||||
| Consumer, cyclical | 12,592 | 1 | % | 44,491 | 5 | % | ||||||||||
| Consumer, non-cyclical | 133,476 | 12 | % | 56,543 | 6 | % | ||||||||||
| Financial | 525,932 | 47 | % | 583,658 | 68 | % | ||||||||||
| Industrial | 129,989 | 12 | % | 39,455 | 4 | % | ||||||||||
| Technology | 71,708 | 6 | % | 41,251 | 5 | % | ||||||||||
| Utilities | 155,819 | 14 | % | 40,632 | 5 | % | ||||||||||
| Total corporate securities | $ | 1,115,498 | 100 | % | $ | 860,857 | 100 | % | ||||||||
During the third quarter 2017, the Atlantic hurricane season caused severe damage within many US States and Territories. Management has evaluated investment security exposures within the counties receiving disaster designations. The Company’s exposures are limited to municipal and corporate bond investment securities from issuers within Texas, Florida and Georgia counties. The Company holds municipal bonds of $19 million issued by 17 municipalities within Texas counties, $8 million issued by eight municipalities within Florida counties and $6 million issued by four municipalities within Georgia counties. The market value of the bonds at December 31, 2017 was $20 million, $9 million and $7 million, respectively. The bonds mature as follows:
| -30- |
| 2018 | 2019 | 2020 | 2021 and 2022 | 2023 | 2024 | 2025 | 2026 | 2027 | Total | |||||||||||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||||||||||||||
| Texas | $ | 280 | $ | 4,285 | $ | 3,220 | $ | - | $ | 4,460 | $ | 710 | $ | 4,435 | $ | 1,625 | $ | 350 | $ | 19,365 | ||||||||||||||||||||
| Florida | 1,000 | 2,185 | - | - | 1,755 | 600 | 340 | 635 | 1,405 | 7,920 | ||||||||||||||||||||||||||||||
| Georgia | - | - | - | - | - | - | 1,325 | 4,880 | - | 6,205 | ||||||||||||||||||||||||||||||
| $ | 1,280 | $ | 6,470 | $ | 3,220 | $ | - | $ | 6,215 | $ | 1,310 | $ | 6,100 | $ | 7,140 | $ | 1,755 | $ | 33,490 | |||||||||||||||||||||
In Management’s judgment, each municipality’s financial resources and the availability of federal and state disaster funds mitigate the risk exposure of the bonds, particularly for intermediate-term and longer-term bonds.
In addition, the Company holds one $12.0 million (market value) corporate bond maturing in 2021 issued by a regulated utility in a Texas county which can recapture capital expenditures through rates charged customers; the market value of this corporate bond at December 31, 2017 was 119.0% of its par value, which reflects the bond’s 9.15% coupon rate.
Based on currently available information, Management does not expect any of the bonds affected by the hurricanes to become impaired; Management will continue to monitor the value of these bonds for impairment.
The following tables summarize the total general obligation and revenue bonds issued by states and political subdivisions held in the Company’s investment securities portfolios as of the dates indicated, identifying the state in which the issuing government municipality or agency operates.
At December 31, 2017, the Company’s investment securities portfolios included securities issued by 647 state and local government municipalities and agencies located within 44 states. None of the Company’s investment securities were issued by Puerto Rican government entities. The largest exposure to any one municipality or agency was $10.0 million (fair value) represented by nine general obligation bonds.
| At December 31, 2017 | ||||||||
| Amortized | Fair | |||||||
| Cost | Value | |||||||
| (In thousands) | ||||||||
| Obligations of states and political subdivisions: | ||||||||
| General obligation bonds: | ||||||||
| California | $ | 104,330 | $ | 106,311 | ||||
| Texas | 66,636 | 66,699 | ||||||
| New Jersey | 39,387 | 39,612 | ||||||
| Minnesota | 30,485 | 30,707 | ||||||
| Other (36 states) | 292,102 | 294,779 | ||||||
| Total general obligation bonds | $ | 532,940 | $ | 538,108 | ||||
| Revenue bonds: | ||||||||
| California | $ | 38,838 | $ | 39,660 | ||||
| Kentucky | 21,731 | 21,958 | ||||||
| Iowa | 17,304 | 17,287 | ||||||
| Colorado | 14,956 | 15,086 | ||||||
| Washington | 13,506 | 13,963 | ||||||
| Indiana | 12,914 | 13,054 | ||||||
| Other (29 states) | 130,196 | 131,301 | ||||||
| Total revenue bonds | $ | 249,445 | $ | 252,309 | ||||
| Total obligations of states and political subdivisions | $ | 782,385 | $ | 790,417 | ||||
| -31- |
At December 31, 2016, the Company’s investment securities portfolios included securities issued by 698 state and local government municipalities and agencies located within 44 states. None of the Company’s investment securities were issued by Puerto Rican government entities. The largest exposure to any one municipality or agency was $10.0 million (fair value) represented by nine general obligation bonds.
| At December 31, 2016 | ||||||||
| Amortized | Fair | |||||||
| Cost | Value | |||||||
| (In thousands) | ||||||||
| Obligations of states and political subdivisions: | ||||||||
| General obligation bonds: | ||||||||
| California | $ | 105,129 | $ | 106,391 | ||||
| Texas | 69,017 | 68,671 | ||||||
| New Jersey | 40,111 | 40,102 | ||||||
| Pennsylvania | 37,384 | 37,543 | ||||||
| Minnesota | 32,946 | 32,847 | ||||||
| Other (36 states) | 280,488 | 279,571 | ||||||
| Total general obligation bonds | $ | 565,075 | $ | 565,125 | ||||
| Revenue bonds: | ||||||||
| California | $ | 47,415 | $ | 48,429 | ||||
| Kentucky | 22,854 | 22,902 | ||||||
| Pennsylvania | 18,568 | 18,683 | ||||||
| Iowa | 18,086 | 18,302 | ||||||
| Colorado | 15,574 | 15,674 | ||||||
| Other (30 states) | 157,452 | 159,054 | ||||||
| Total revenue bonds | $ | 279,949 | $ | 283,044 | ||||
| Total obligations of states and political subdivisions | $ | 845,024 | $ | 848,169 | ||||
At December 31, 2017 and 2016, the revenue bonds in the Company’s investment securities portfolios were issued by state and local government municipalities and agencies to fund public services such as water utility, sewer utility, recreational and school facilities, and general public and economic improvements. The revenue bonds were payable from 22 revenue sources at December 31, 2017 and 23 revenue sources at December 31, 2016. The revenue sources that represent 5% or more individually of the total revenue bonds are summarized in the following tables.
| At December 31, 2017 | ||||||||
| Amortized | Fair | |||||||
| Cost | Value | |||||||
| (In thousands) | ||||||||
| Revenue bonds by revenue source: | ||||||||
| Water | $ | 50,737 | $ | 51,854 | ||||
| Sewer | 30,427 | 31,030 | ||||||
| Sales tax | 30,233 | 30,777 | ||||||
| Lease (renewal) | 20,007 | 20,235 | ||||||
| College & University | 17,230 | 17,087 | ||||||
| Other (17 sources) | 100,811 | 101,326 | ||||||
| Total revenue bonds by revenue source | $ | 249,445 | $ | 252,309 | ||||
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| -32- |
| At December 31, 2016 | ||||||||
| Amortized | Fair | |||||||
| Cost | Value | |||||||
| (In thousands) | ||||||||
| Revenue bonds by revenue source: | ||||||||
| Water | $ | 55,401 | $ | 56,826 | ||||
| Sewer | 37,996 | 38,497 | ||||||
| Sales tax | 31,146 | 31,835 | ||||||
| Lease (renewal) | 24,242 | 24,235 | ||||||
| College & University | 17,856 | 17,762 | ||||||
| Other (18 sources) | 113,308 | 113,889 | ||||||
| Total revenue bonds by revenue source | $ | 279,949 | $ | 283,044 | ||||
See Note 2 to the consolidated financial statements for additional information related to the investment securities.
Loan Portfolio
The Company originates loans with the intent to hold such assets until principal is repaid. Management follows written loan underwriting policies and procedures which are approved by the Bank’s Board of Directors. Loans are underwritten following approved underwriting standards and lending authorities within a formalized organizational structure. The Board of Directors also approves independent real estate appraisers to be used in obtaining estimated values for real property serving as loan collateral. Prevailing economic trends and conditions are also taken into consideration in loan underwriting practices.
All loan applications must be for clearly defined legitimate purposes with a determinable primary source of repayment, and as appropriate, secondary sources of repayment. All loans are supported by appropriate documentation such as current financial statements, tax returns, credit reports, collateral information, guarantor asset verification, title reports, appraisals, and other relevant documentation.
Commercial loans represent term loans used to acquire durable business assets or revolving lines of credit used to finance working capital. Underwriting practices evaluate each borrower’s cash flow as the principal source of loan repayment. Commercial loans are generally secured by the borrower’s business assets as a secondary source of repayment. Commercial loans are evaluated for credit-worthiness based on prior loan performance and borrower financial information including cash flow, borrower net worth and aggregate debt.
Commercial real estate loans represent term loans used to acquire or refinance real estate to be operated by the borrower in a commercial capacity. Underwriting practices evaluate each borrower’s global cash flow as the principal source of loan repayment, independent appraisal of value of the property, and other relevant factors. Commercial real estate loans are generally secured by a first lien on the property as a secondary source of repayment.
Real estate construction loans represent the financing of real estate development. Loan principal disbursements are controlled through the use of project budgets, and disbursements are approved based on construction progress, which is validated by project site inspections. A first lien on the real estate serves as collateral to secure the loan.
Residential real estate loans generally represent first lien mortgages used by the borrower to purchase or refinance a principal residence. For interest-rate risk purposes, the Company offers only fully-amortizing, adjustable-rate mortgages. In underwriting first lien mortgages, the Company evaluates each borrower’s ability to repay the loan, an independent appraisal of the value of the property, and other relevant factors. The Company does not offer riskier mortgage products, such as non-amortizing “interest-only” mortgages and “negative amortization” mortgages.
For loans secured by real estate, the Bank requires title insurance to insure the status of its lien and each borrower is obligated to insure the real estate collateral, naming the Company as loss payee, in an amount sufficient to repay the principal amount outstanding in the event of a property casualty loss.
Consumer installment and other loans are predominantly comprised of indirect automobile loans with underwriting based on credit history and scores, personal income, debt service capacity, and collateral values.
For management purposes, the Company segregates its loan portfolio into two segments. Loans originated by the Company following its loan underwriting policies and procedures are separated from loans purchased from the FDIC. Loan volumes have declined due to payoffs and problem loan workout activities, particularly with purchased loans, and reduced volumes of loan originations. The Company did not take an aggressive posture relative to loan portfolio growth during the post-recession period of historically low interest rates. Management increased investment securities as loan volumes declined.
| -33- |
The following table shows the composition of the loan portfolio of the Company by type of loan and type of borrower, on the dates indicated:
Loan Portfolio
| At December 31, | ||||||||||||||||||||
| 2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Commercial | $ | 335,996 | $ | 354,697 | $ | 382,748 | $ | 391,815 | $ | 364,159 | ||||||||||
| Commercial real estate | 568,584 | 542,171 | 637,456 | 718,604 | 799,019 | |||||||||||||||
| Construction | 5,649 | 2,555 | 3,951 | 13,872 | 13,896 | |||||||||||||||
| Residential real estate | 65,183 | 87,724 | 120,091 | 149,827 | 185,057 | |||||||||||||||
| Consumer installment and other | 312,570 | 365,564 | 389,150 | 426,172 | 465,613 | |||||||||||||||
| Total loans | $ | 1,287,982 | $ | 1,352,711 | $ | 1,533,396 | $ | 1,700,290 | $ | 1,827,744 | ||||||||||
The following table shows the maturity distribution and interest rate sensitivity of commercial, commercial real estate, and construction loans at December 31, 2017. Balances exclude residential real estate loans and consumer loans totaling $377.8 million. These types of loans are typically paid in monthly installments over a number of years.
Loan Maturity Distribution
| At December 31, 2017 | ||||||||||||||||
| Within One Year | One to Five Years | After Five Years | Total | |||||||||||||
| (In thousands) | ||||||||||||||||
| Commercial and Commercial real estate | $ | 151,661 | $ | 195,110 | $ | 557,809 | $ | 904,580 | ||||||||
| Construction | 5,649 | - | - | 5,649 | ||||||||||||
| Total | $ | 157,310 | $ | 195,110 | $ | 557,809 | $ | 910,229 | ||||||||
| Loans with fixed interest rates | $ | 49,271 | $ | 85,095 | $ | 61,134 | $ | 195,500 | ||||||||
| Loans with floating or adjustable interest rates | 108,039 | 110,015 | 496,675 | 714,729 | ||||||||||||
| Total | $ | 157,310 | $ | 195,110 | $ | 557,809 | $ | 910,229 | ||||||||
Commitments and Letters of Credit
The Company issues formal commitments on lines of credit to well-established and financially responsible commercial enterprises. Such commitments can be either secured or unsecured and are typically in the form of revolving lines of credit for seasonal working capital needs. Occasionally, such commitments are in the form of letters of credit to facilitate the customers’ particular business transactions. Commitment fees are generally charged for commitments and letters of credit. Commitments on lines of credit and letters of credit typically mature within one year. For further information, see the accompanying notes to the consolidated financial statements.
Loan Portfolio Credit Risk
The Company extends loans to commercial and consumer customers which expose the Company to the risk borrowers will default, causing loan losses. The Company’s lending activities are exposed to various qualitative risks. All loan segments are exposed to risks inherent in the economy and market conditions. Significant risk characteristics related to the commercial loan segment include the borrowers’ business performance and financial condition, and the value of collateral for secured loans. Significant risk characteristics related to the commercial real estate segment include the borrowers’ business performance and the value of properties collateralizing the loans. Significant risk characteristics related to the construction loan segment include the borrowers’ performance in successfully developing the real estate into the intended purpose and the value of the property collateralizing the loans. Significant risk characteristics related to the residential real estate segment include the borrowers’ financial wherewithal to service the mortgages and the value of the property collateralizing the loans. Significant risk characteristics related to the consumer loan segment include the financial condition of the borrowers and the value of collateral securing the loans.
| -34- |
The preparation of the financial statements requires Management to estimate the amount of losses inherent in the loan portfolio and establish an allowance for credit losses. The allowance for credit losses is maintained by assessing or reversing a provision for loan losses through the Company’s earnings. In estimating credit losses, Management must exercise judgment in evaluating information deemed relevant, such as financial information regarding individual borrowers, overall credit loss experience, the amount of past due, nonperforming and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other information. The amount of ultimate losses on the loan portfolio can vary from the estimated amounts. Management follows a systematic methodology to estimate loss potential in an effort to reduce the differences between estimated and actual losses.
The Company closely monitors the markets in which it conducts its lending operations and follows a strategy to control exposure to loans with high credit risk. The Bank’s organization structure separates the functions of business development and loan underwriting; Management believes this segregation of duties avoids inherent conflicts of combining business development and loan approval functions. In measuring and managing credit risk, the Company adheres to the following practices.
| · | The Bank maintains a Loan Review Department which reports directly to the audit committee of the Board of Directors. The Loan Review Department performs independent evaluations of loans to challenge the credit risk grades assigned by Management using grading standards employed by bank regulatory agencies. Those loans judged to carry higher risk attributes are referred to as “classified loans.” Classified loans receive elevated Management attention to maximize collection. |
| · | The Bank maintains two loan administration offices whose sole responsibility is to manage and collect classified loans. |
Classified loans with higher levels of credit risk are further designated as “nonaccrual loans.” Management places classified loans on nonaccrual status when full collection of contractual interest and principal payments is in doubt. Uncollected interest previously accrued on loans placed on nonaccrual status is reversed as a charge against interest income. The Company does not accrue interest income on loans following placement on nonaccrual status. Interest payments received on nonaccrual loans are applied to reduce the carrying amount of the loan unless the carrying amount is well secured by loan collateral. “Nonperforming assets” include nonaccrual loans, loans 90 or more days past due and still accruing, and repossessed loan collateral (commonly referred to as “Other Real Estate Owned”).
Nonperforming Assets
| At December 31, | ||||||||||||||||||||
| 2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Nonperforming nonaccrual loans | $ | 1,641 | $ | 3,956 | $ | 14,648 | $ | 17,494 | $ | 19,893 | ||||||||||
| Performing nonaccrual loans | 4,285 | 4,429 | 350 | 110 | 1,409 | |||||||||||||||
| Total nonaccrual loans | 5,926 | 8,385 | 14,998 | 17,604 | 21,302 | |||||||||||||||
| Accruing loans 90 or more days past due | 531 | 497 | 295 | 502 | 410 | |||||||||||||||
| Total nonperforming loans | 6,457 | 8,882 | 15,293 | 18,106 | 21,712 | |||||||||||||||
| Other real estate owned | 1,426 | 3,095 | 9,264 | 6,374 | 13,320 | |||||||||||||||
| Total nonperforming assets | $ | 7,883 | $ | 11,977 | $ | 24,557 | $ | 24,480 | $ | 35,032 | ||||||||||
Nonperforming assets have declined during 2016 and 2017 due to payoffs, chargeoffs and sale of Other Real Estate Owned. At December 31, 2017, one loan secured by commercial real estate with a balance of $4.3 million was on nonaccrual status. The remaining five nonaccrual loans held at December 31, 2017 had an average carrying value of $328 thousand and the largest carrying value was $1.0 million.
Management believes the overall credit quality of the loan portfolio is reasonably stable; however, classified and nonperforming assets could fluctuate from period to period. The performance of any individual loan can be affected by external factors such as the interest rate environment, economic conditions, and collateral values or factors particular to the borrower. No assurance can be given that additional increases in nonaccrual and delinquent loans will not occur in the future.
| -35- |
Allowance for Credit Losses
The Company’s allowance for loan losses represents Management’s estimate of loan losses inherent in the loan portfolio. In evaluating credit risk for loans, Management measures loss potential of the carrying value of loans. As described above, payments received on nonaccrual loans may be applied against the principal balance of the loans until such time as full collection of the remaining recorded balance is expected.
The following table summarizes the allowance for loan losses, chargeoffs and recoveries for the periods indicated:
| For the Years Ended December 31, | ||||||||||||||||||||
| 2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||
| ($ in thousands) | ||||||||||||||||||||
| Analysis of the Allowance for Loan Losses | ||||||||||||||||||||
| Balance, beginning of period | $ | 25,954 | $ | 29,771 | $ | 31,485 | $ | 31,693 | $ | 30,234 | ||||||||||
| Provision for loan losses | (1,900 | ) | (3,200 | ) | - | 2,800 | 8,000 | |||||||||||||
| Loans charged off: | ||||||||||||||||||||
| Commercial | (961 | ) | (2,023 | ) | (756 | ) | (2,152 | ) | (4,472 | ) | ||||||||||
| Commercial real estate | - | - | (449 | ) | (1,022 | ) | (1,816 | ) | ||||||||||||
| Construction | - | - | (431 | ) | - | (237 | ) | |||||||||||||
| Residential real estate | - | - | - | (30 | ) | (109 | ) | |||||||||||||
| Consumer and other installment | (4,957 | ) | (4,749 | ) | (3,493 | ) | (4,214 | ) | (4,097 | ) | ||||||||||
| Total chargeoffs | (5,918 | ) | (6,772 | ) | (5,129 | ) | (7,418 | ) | (10,731 | ) | ||||||||||
| Recoveries of loans previously charged off: | ||||||||||||||||||||
| Commercial | 762 | 4,028 | 1,174 | 2,275 | 1,765 | |||||||||||||||
| Commercial real estate | 88 | 554 | 290 | 213 | 273 | |||||||||||||||
| Construction | 1,899 | - | 45 | 53 | - | |||||||||||||||
| Consumer and other installment | 2,124 | 1,573 | 1,906 | 1,869 | 2,152 | |||||||||||||||
| Total recoveries | 4,873 | 6,155 | 3,415 | 4,410 | 4,190 | |||||||||||||||
| Net loan losses | (1,045 | ) | (617 | ) | (1,714 | ) | (3,008 | ) | (6,541 | ) | ||||||||||
| Balance, end of period | $ | 23,009 | $ | 25,954 | $ | 29,771 | $ | 31,485 | $ | 31,693 | ||||||||||
| Net loan losses as a percentage of average loans | 0.08 | % | 0.04 | % | 0.11 | % | 0.17 | % | 0.33 | % | ||||||||||
The Company's allowance for loan losses is maintained at a level considered appropriate to provide for losses that can be estimated based upon specific and general conditions. These include conditions unique to individual borrowers, as well as overall loan loss experience, the amount of past due, nonperforming and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other factors. A portion of the allowance is individually allocated to impaired loans whose full collectability of principal is uncertain. Such allocations are determined by Management based on loan-by-loan analyses. The Company evaluates for impairment all loans with outstanding principal balances in excess of $500 thousand which are classified or on nonaccrual status and all “troubled debt restructured” loans. The remainder of the loan portfolio is collectively evaluated for impairment based in part on quantitative analyses of historical loan loss experience of loan portfolio segments to determine standard loss rates for each segment. The loss rate for each loan portfolio segment reflects both the historical loss experience during a look-back period and a loss emergence period. Liquidating purchased consumer installment loans are evaluated separately by applying historical loss rates to forecasted liquidating principal balances to measure losses inherent in this portfolio segment. The loss rates are applied to segmented loan balances to allocate the allowance to the segments of the loan portfolio.
The remainder of the allowance is considered to be unallocated. The unallocated allowance is established to provide for probable losses that have been incurred as of the reporting date but not reflected in the allocated allowance. The unallocated allowance addresses additional qualitative factors consistent with Management's analysis of the level of risks inherent in the loan portfolio, which are related to the risks of the Company's general lending activity. Included in the unallocated allowance is the risk of losses that are attributable to national or local economic or industry trends which have occurred but have not yet been recognized in loan chargeoff history (external factors). The primary external factor evaluated by the Company and the judgmental amount of unallocated reserve assigned by Management as of December 31, 2017 is economic and business conditions $0.5 million. Also included in the unallocated allowance is the risk of losses attributable to general attributes of the Company's loan portfolio and credit administration (internal factors). The internal factors evaluated by the Company and the judgmental amount of unallocated reserve assigned by Management are: loan review system $1.1 million, adequacy of lending Management and staff $0.5 million and concentrations of credit $1.3 million.
| -36- |
The following table presents the allocation of the allowance for loan losses as of December 31 for the years indicated:
| At December 31, | ||||||||||||||||||||||||||||||||||||||||
| 2017 | 2016 | 2015 | 2014 | 2013 | ||||||||||||||||||||||||||||||||||||
| Allocation of the Allowance Balance | Loans as Percent of Total Loans | Allocation of the Allowance Balance | Loans as Percent of Total Loans | Allocation of the Allowance Balance | Loans as Percent of Total Loans | Allocation of the Allowance Balance | Loans as Percent of Total Loans | Allocation of the Allowance Balance | Loans as Percent of Total Loans | |||||||||||||||||||||||||||||||
| ($ in thousands) | ||||||||||||||||||||||||||||||||||||||||
| Commercial | $ | 7,746 | 26 | % | $ | 8,327 | 26 | % | $ | 9,559 | 25 | % | $ | 5,460 | 23 | % | $ | 4,005 | 20 | % | ||||||||||||||||||||
| Commercial real estate | 3,849 | 44 | % | 3,330 | 40 | % | 4,212 | 42 | % | 4,245 | 42 | % | 12,223 | 44 | % | |||||||||||||||||||||||||
| Construction | 335 | 1 | % | 152 | - | % | 235 | - | % | 654 | 1 | % | 617 | 1 | % | |||||||||||||||||||||||||
| Residential real estate | 995 | 5 | % | 1,330 | 7 | % | 1,801 | 8 | % | 2,241 | 9 | % | 405 | 10 | % | |||||||||||||||||||||||||
| Consumer installment and other | 6,418 | 24 | % | 7,980 | 27 | % | 8,001 | 25 | % | 9,827 | 25 | % | 4,591 | 25 | % | |||||||||||||||||||||||||
| Unallocated portion | 3,666 | - | % | 4,835 | - | % | 5,963 | - | % | 9,058 | - | % | 9,852 | - | % | |||||||||||||||||||||||||
| Total | $ | 23,009 | 100 | % | $ | 25,954 | 100 | % | $ | 29,771 | 100 | % | $ | 31,485 | 100 | % | $ | 31,693 | 100 | % | ||||||||||||||||||||
The 2017 decline in the allowance for loan losses was due to declines in classified loans, delinquent loans, and the overall loan portfolio. The increase in the allocation of the allowance for loan losses to commercial real estate and construction loans is due to increased loan volumes outstanding. The decline in the unallocated portion was due to improved economic conditions within the Company’s geographic markets.
| Allowance for Loan Losses | ||||||||||||||||||||||||||||
| For the Year Ended December 31, 2017 | ||||||||||||||||||||||||||||
| Consumer | ||||||||||||||||||||||||||||
| Commercial | Residential | Installment | ||||||||||||||||||||||||||
| Commercial | Real Estate | Construction | Real Estate | and Other | Unallocated | Total | ||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||
| Balance at beginning of period | $ | 8,327 | $ | 3,330 | $ | 152 | $ | 1,330 | $ | 7,980 | $ | 4,835 | $ | 25,954 | ||||||||||||||
| Additions: | ||||||||||||||||||||||||||||
| (Reversal) provision | (382 | ) | 431 | (1,716 | ) | (335 | ) | 1,271 | (1,169 | ) | (1,900 | ) | ||||||||||||||||
| Deductions: | ||||||||||||||||||||||||||||
| Chargeoffs | (961 | ) | - | - | - | (4,957 | ) | - | (5,918 | ) | ||||||||||||||||||
| Recoveries | 762 | 88 | 1,899 | - | 2,124 | - | 4,873 | |||||||||||||||||||||
| Net loan (losses) recoveries | (199 | ) | 88 | 1,899 | - | (2,833 | ) | - | (1,045 | ) | ||||||||||||||||||
| Total allowance for loan losses | $ | 7,746 | $ | 3,849 | $ | 335 | $ | 995 | $ | 6,418 | $ | 3,666 | $ | 23,009 | ||||||||||||||
| Allowance for Loan Losses and Recorded Investment in Loans Evaluated for Impairment | ||||||||||||||||||||||||||||
| At December 31, 2017 | ||||||||||||||||||||||||||||
| Commercial | Commercial Real Estate | Construction | Residential Real Estate | Consumer Installment and Other | Unallocated | Total | ||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | 4,814 | $ | 171 | $ | - | $ | - | $ | - | $ | - | $ | 4,985 | ||||||||||||||
| Collectively evaluated for impairment | 2,932 | 3,678 | 335 | 995 | 6,418 | 3,666 | 18,024 | |||||||||||||||||||||
| Purchased loans with evidence of credit deterioration | - | - | - | - | - | - | - | |||||||||||||||||||||
| Total | $ | 7,746 | $ | 3,849 | $ | 335 | $ | 995 | $ | 6,418 | $ | 3,666 | $ | 23,009 | ||||||||||||||
| Carrying value of loans: | ||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | 10,675 | $ | 14,234 | $ | - | $ | 208 | $ | - | $ | - | $ | 25,117 | ||||||||||||||
| Collectively evaluated for impairment | 325,291 | 553,769 | 5,649 | 64,975 | 312,406 | - | 1,262,090 | |||||||||||||||||||||
| Purchased loans with evidence of credit deterioration | 30 | 581 | - | - | 164 | - | 775 | |||||||||||||||||||||
| Total | $ | 335,996 | $ | 568,584 | $ | 5,649 | $ | 65,183 | $ | 312,570 | $ | - | $ | 1,287,982 | ||||||||||||||
Management considers the $23.0 million allowance for loan losses to be adequate as a reserve against loan losses inherent in the loan portfolio as of December 31, 2017.
See Note 3 to the consolidated financial statements for additional information related to the loan portfolio, loan portfolio credit risk, and allowance for loan losses.
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| -37- |
Asset/Liability and Market Risk Management
Asset/liability management involves the evaluation, monitoring and management of interest rate risk, market risk, liquidity and funding. The fundamental objective of the Company's management of assets and liabilities is to maximize its economic value while maintaining adequate liquidity and a conservative level of interest rate risk.
Interest Rate Risk
Interest rate risk is a significant market risk affecting the Company. Many factors affect the Company’s exposure to interest rates, such as general economic and financial conditions, customer preferences, historical pricing relationships, and re-pricing characteristics of financial instruments. Assets and liabilities may mature or re-price at different times. Assets and liabilities may re-price at the same time but by different amounts. Short-term and long-term market interest rates may change by different amounts. The timing and amount of cash flows of various assets or liabilities may shorten or lengthen as interest rates change. In addition, the changing levels of interest rates may have an impact on loan demand, demand for various deposit products, credit losses, and other elements of earnings such as account analysis fees on commercial deposit accounts and correspondent bank service charges.
The Company’s earnings are affected not only by general economic conditions, but also by the monetary and fiscal policies of the United States government and its agencies, particularly the Federal Open Market Committee (the “FOMC”). The monetary policies of the FOMC can influence the overall growth of loans, investment securities, and deposits and the level of interest rates earned on assets and paid for liabilities. The nature and impact of future changes in monetary policies are generally not predictable.
Management expects a high level of uncertainty in regard to interest rate levels in the immediate term, and Management’s most likely earnings forecast for the twelve months ending December 31, 2018 assumes market interest rates will gradually rise, with short-term rates rising more than long-term rates.
In adjusting the Company's asset/liability position, Management attempts to manage interest rate risk while enhancing the net interest margin and net interest income. At times, depending on expected increases or decreases in general interest rates, the relationship between long and short-term interest rates, market conditions and competitive factors, Management may adjust the Company's interest rate risk position in order to manage its net interest margin and net interest income. The Company's results of operations and net portfolio values remain subject to changes in interest rates and to fluctuations in the difference between long and short-term interest rates.
The Company’s asset and liability position was slightly “asset sensitive” at December 31, 2017, depending on the interest rate assumptions applied to the simulation model employed by Management to measure interest rate risk. An “asset sensitive” position results in a slightly larger change in interest income than in interest expense resulting from application of assumed interest rate changes. Simulation estimates depend on, and will change with, the size and mix of the actual and projected balance sheet at the time of each simulation. Management continues to monitor the interest rate environment as well as economic conditions and other factors it deems relevant in managing the Company's exposure to interest rate risk.
The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk, even though such activities may be permitted with the approval of the Company's Board of Directors.
Market Risk - Equity Markets
Equity price risk can affect the Company. As an example, any preferred or common stock holdings, as permitted by banking regulations, can fluctuate in value. Management regularly assesses the extent and duration of any declines in market value, the causes of such declines, the likelihood of a recovery in market value, and its intent to hold securities until a recovery in value occurs. Declines in value of preferred or common stock holdings that are deemed “other than temporary” could result in loss recognition in the Company's income statement.
Fluctuations in the Company's common stock price can impact the Company's financial results in several ways. First, the Company has regularly repurchased and retired its common stock; the market price paid to retire the Company's common stock affects the level of the Company's shareholders' equity, cash flows and shares outstanding. Second, the Company's common stock price impacts the number of dilutive equivalent shares used to compute diluted earnings per share. Third, fluctuations in the Company's common stock price can motivate holders of options to purchase Company common stock through the exercise of such options thereby increasing the number of shares outstanding and potentially adding volatility to the book tax provision. Finally, the amount of compensation expense associated with share based compensation fluctuates with changes in and the volatility of the Company's common stock price.
| -38- |
Market Risk - Other
Market values of loan collateral can directly impact the level of loan chargeoffs and the provision for loan losses. The financial condition and liquidity of debtors issuing bonds and debtors whose mortgages or other obligations are securitized can directly impact the credit quality of the Company’s investment securities portfolio requiring the Company to recognize other than temporary impairment charges. Other types of market risk, such as foreign currency exchange risk, are not significant in the normal course of the Company's business activities.
Liquidity and Funding
The objective of liquidity management is to manage cash flow and liquidity reserves so that they are adequate to fund the Company's operations and meet obligations and other commitments on a timely basis and at a reasonable cost. The Company achieves this objective through the selection of asset and liability maturity mixes that it believes best meet its needs. The Company's liquidity position is enhanced by its ability to raise additional funds as needed in the wholesale markets.
In recent years, the Company's deposit base has provided the majority of the Company's funding requirements. This relatively stable and low-cost source of funds, along with shareholders' equity, provided 98 percent of funding for average total assets in 2017 and in 2016. The stability of the Company’s funding from customer deposits is in part reliant on the confidence clients have in the Company. The Company places a very high priority in maintaining this confidence through conservative credit and capital management practices and by maintaining an appropriate level of liquidity reserves.
Liquidity is further provided by assets such as balances held at the Federal Reserve Bank, investment securities, and amortizing loans. The Company's investment securities portfolio provides a substantial secondary liquidity reserve. The Company held $3.4 billion in total investment securities at December 31, 2017. Under certain deposit, borrowing and other arrangements, the Company must hold and pledge investment securities as collateral. At December 31, 2017, such collateral requirements totaled approximately $716 million.
Liquidity risk can result from the mismatching of asset and liability cash flows, or from disruptions in the financial markets. The Company performs liquidity stress tests on a periodic basis to evaluate the sustainability of its liquidity. Under the stress testing, the Company assumes outflows of funds increase beyond expected levels. Measurement of such heightened outflows considers the composition of the Company’s deposit base, including any concentration of deposits, non-deposit funding such as short-term borrowings, and unfunded lending commitments. The Company evaluates its stock of highly liquid assets to meet the assumed higher levels of outflows. Highly liquid assets include cash and amounts due from other banks from daily transaction settlements, reduced by branch cash needs and Federal Reserve Bank reserve requirements, and investment securities based on regulatory risk-weighting guidelines. Based on the results of the most recent liquidity stress test, Management is satisfied with the liquidity condition of the Bank and the Company. However, no assurance can be given the Bank or Company will not experience a period of reduced liquidity.
Management continually monitors the Company’s cash levels. Loan demand from credit worthy borrowers will be dictated by economic and competitive conditions. The Company aggressively solicits non-interest bearing demand deposits and money market checking deposits, which are the least sensitive to changes in interest rates. The growth of these deposit balances is subject to heightened competition, the success of the Company's sales efforts, delivery of superior customer service, new regulations and market conditions. The Company does not aggressively solicit higher-costing time deposits; as a result, Management anticipates such deposits will decline. Changes in interest rates, most notably rising interest rates, could impact deposit volumes. Depending on economic conditions, interest rate levels, liquidity management and a variety of other conditions, deposit growth may be used to fund loans or purchase investment securities. However, due to possible volatility in economic conditions, competition and political uncertainty, loan demand and levels of customer deposits are not certain. Shareholder dividends are expected to continue subject to the Board's discretion and continuing evaluation of capital levels, earnings, asset quality and other factors.
Westamerica Bancorporation ("Parent Company") is a separate entity apart from Westamerica Bank (“Bank”) and must provide for its own liquidity. In addition to its operating expenses, the Parent Company is responsible for the payment of dividends declared for its shareholders, and interest and principal on any outstanding debt. The Parent Company currently has no debt. Substantially all of the Parent Company's revenues are obtained from subsidiary dividends and service fees.
| - 39 - |
The Bank’s dividends paid to the Parent Company, proceeds from the exercise of stock options, and Parent Company cash balances provided adequate cash for the Parent Company to pay shareholder dividends of $41 million in 2017, $40 million in 2016 and $39 million in 2015, and retire common stock in the amount of $314 thousand in 2017, $6 million in 2016 and $15 million in 2015. Payment of dividends to the Parent Company by the Bank is limited under California and Federal laws. The Company believes these regulatory dividend restrictions will not have an impact on the Parent Company's ability to meet its ongoing cash obligations.
Contractual Obligations
The following table sets forth the known contractual obligations, except deposits, short-term borrowing arrangements and post-retirement benefit plans, of the Company:
| At December 31, 2017 | ||||||||||||||||||||
Within One Year | Over One to Three Years | Over Three to Five Years | After Five Years | Total | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Operating Lease Obligations | $ | 6,481 | $ | 8,025 | $ | 2,194 | $ | 825 | $ | 17,525 | ||||||||||
| Purchase Obligations | 8,138 | 16,652 | 8,518 | - | 33,308 | |||||||||||||||
| Total | $ | 14,619 | $ | 24,677 | $ | 10,712 | $ | 825 | $ | 50,833 | ||||||||||
Operating lease obligations have not been reduced by minimum sublease rentals of $2 million due in the future under noncancelable subleases. Operating lease obligations may be retired prior to the contractual maturity as discussed in the notes to the consolidated financial statements. The purchase obligation consists of the Company’s minimum liabilities under contracts with third-party automation services providers .
Capital Resources
The Company has historically generated high levels of earnings, which provide a means of accumulating capital. The Company's net income as a percentage of average shareholders' equity (“return on equity” or “ROE”) has been 8.4% in 2017, 10.9% in 2016 and 11.3% in 2015. The Company also raises capital as employees exercise stock options. Capital raised through the exercise of stock options was $25 million in 2017, $24 million in 2016 and $5 million in 2015.
The Company paid common dividends totaling $41 million in 2017, $40 million in 2016 and $39 million in 2015, which represent dividends per common share of $1.57, $1.56 and $1.53, respectively. The Company's earnings have historically exceeded dividends paid to shareholders. The amount of earnings in excess of dividends provides the Company resources to finance growth and maintain appropriate levels of shareholders' equity. In the absence of profitable growth opportunities, the Company has repurchased and retired its common stock as another means to return earnings to shareholders. The Company repurchased and retired 6 thousand shares valued at $314 thousand in 2017, 137 thousand shares valued at $6 million in 2016 and 344 thousand shares valued at $15 million in 2015.
The Company's primary capital resource is shareholders' equity, which was $590 million at December 31, 2017 compared with $561 million at December 31, 2016. The Company's ratio of equity to total assets was 10.71% at December 31, 2017 and 10.46% at December 31, 2016.
The Company performs capital stress tests on a periodic basis to evaluate the sustainability of its capital. Under the stress testing, the Company assumes various scenarios such as deteriorating economic and operating conditions, unanticipated asset devaluations, and significant operational lapses. The Company measures the impact of these scenarios on its earnings and capital. Based on the results of the most recent stress tests, Management is satisfied with the capital condition of the Bank and the Company. However, no assurance can be given the Bank or Company will not experience a period of reduced earnings or a reduction in capital from unanticipated events and circumstances.
| - 40 - |
Capital to Risk-Adjusted Assets
On July 2, 2013, the Federal Reserve Board approved a final rule that implements changes to the regulatory capital framework for all banking organizations. The rule’s provisions which most affected the regulatory capital requirements of the Company and the Bank:
| · | Introduced a new “Common Equity Tier 1” capital measurement, |
| · | Established higher minimum levels of capital, |
| · | Introduced a “capital conservation buffer,” |
| · | Increased the risk-weighting of certain assets, and |
| · | Established limits on the amount of deferred tax assets with any excess treated as a deduction from Tier 1 capital. |
Under the final rule, a banking organization that is not subject to the “advanced approaches rule” may make a one-time election not to include most elements of Accumulated Other Comprehensive Income, including net-of-tax unrealized gains and losses on available for sale investment securities, in regulatory capital. Neither the Company nor the Bank is subject to the “advanced approaches rule” and both made the election not to include most elements of Accumulated Other Comprehensive Income in regulatory capital.
Banking organizations that are not subject to the “advanced approaches rule” began complying with the final rule on January 1, 2015; on such date, the Company and the Bank became subject to the revised definitions of regulatory capital, the new minimum regulatory capital ratios, and various regulatory capital adjustments and deductions according to transition provisions and timelines. All banking organizations began calculating standardized total risk-weighted assets on January 1, 2015. The transition period for the capital conservation buffer for all banking organizations began on January 1, 2016 and will end January 1, 2019. Any bank subject to the rule which is unable to maintain its “capital conservation buffer” will be restricted in the payment of discretionary executive compensation and shareholder distributions, such as dividends and share repurchases.
The final rule did not supersede provisions of the Federal Deposit Insurance Corporation Improvement Act (FDICIA) requiring federal banking agencies to take prompt corrective action (PCA) to resolve problems of insured depository institutions. The final rule revised the PCA thresholds to incorporate the higher minimum levels of capital, including the “common equity tier 1” ratio.
The capital ratios for the Company and the Bank under the new capital framework are presented in the table below, on the dates indicated.
| To Be | ||||||||||||||||||||
| Required for | Well-capitalized | |||||||||||||||||||
| Capital Adequacy Purposes | Under Prompt | |||||||||||||||||||
| At December 31, 2017 | Effective | Effective | Corrective Action | |||||||||||||||||
| Company | Bank | January 1, 2017 | January 1, 2019 | Regulations (Bank) | ||||||||||||||||
| Common Equity Tier I Capital | 15.36 | % | 12.50 | % | 5.75 | %(1) | 7.00 | %(2) | 6.50 | % | ||||||||||
| Tier I Capital | 15.36 | % | 12.50 | % | 7.25 | %(1) | 8.50 | %(2) | 8.00 | % | ||||||||||
| Total Capital | 16.17 | % | 13.52 | % | 9.25 | %(1) | 10.50 | %(2) | 10.00 | % | ||||||||||
| Leverage Ratio | 8.86 | % | 7.16 | % | 4.00 | % | 4.00 | % | 5.00 | % | ||||||||||
(1) Includes 1.25% capital conservation buffer.
(2) Includes 2.5% capital conservation buffer.
| To Be | ||||||||||||||||||||
| Required for | Well-capitalized | |||||||||||||||||||
| Capital Adequacy Purposes | Under Prompt | |||||||||||||||||||
| At December 31, 2016 | Effective | Effective | Corrective Action | |||||||||||||||||
| Company | Bank | January 1, 2016 | January 1, 2019 | Regulations (Bank) | ||||||||||||||||
| Common Equity Tier I Capital | 14.85 | % | 11.70 | % | 5.125 | %(3) | 7.00 | %(4) | 6.50 | % | ||||||||||
| Tier I Capital | 14.85 | % | 11.70 | % | 6.625 | %(3) | 8.50 | %(4) | 8.00 | % | ||||||||||
| Total Capital | 15.95 | % | 13.02 | % | 8.625 | %(3) | 10.50 | %(4) | 10.00 | % | ||||||||||
| Leverage Ratio | 8.46 | % | 6.63 | % | 4.000 | % | 4.00 | % | 5.00 | % | ||||||||||
(3) Includes 0.625% capital conservation buffer.
(4) Includes 2.5% capital conservation buffer.
| - 41 - |
The Company and the Bank routinely project capital levels by analyzing forecasted earnings, credit quality, securities valuations, shareholder dividends, asset volumes, share repurchase activity, stock option exercise proceeds, and other factors. Based on current capital projections, the Company and the Bank expect to maintain regulatory capital levels exceeding the highest effective regulatory standard and pay quarterly dividends to shareholders. No assurance can be given that changes in capital management plans will not occur.
Deposit Categories
The Company primarily attracts deposits from local businesses and professionals, as well as through retail savings and checking accounts, and, to a more limited extent, certificates of deposit.
The following table summarizes the Company’s average daily amount of deposits and the rates paid for the periods indicated:
Deposit Distribution and Average Rates Paid
| For the Years Ended December 31, | ||||||||||||||||||||||||||||||||||||
| 2017 | 2016 | 2015 | ||||||||||||||||||||||||||||||||||
| Average Balance | Percentage of Total Deposits | Rate | Average Balance | Percentage of Total Deposits | Rate | Average Balance | Percentage of Total Deposits | Rate | ||||||||||||||||||||||||||||
| ($ In thousands) | ||||||||||||||||||||||||||||||||||||
| Noninterest-bearing demand | $ | 2,095,522 | 44.4 | % | - | % | $ | 2,026,939 | 44.1 | % | - | % | $ | 1,968,817 | 44.4 | % | - | % | ||||||||||||||||||
| Interest bearing: | ||||||||||||||||||||||||||||||||||||
| Transaction | 888,116 | 18.8 | % | 0.03 | % | 862,581 | 18.8 | % | 0.03 | % | 822,156 | 18.5 | % | 0.03 | % | |||||||||||||||||||||
| Savings | 1,492,725 | 31.6 | % | 0.02 | % | 1,428,059 | 31.1 | % | 0.06 | % | 1,312,100 | 29.6 | % | 0.06 | % | |||||||||||||||||||||
| Time less than $100 thousand | 136,324 | 2.9 | % | 0.17 | % | 154,022 | 3.4 | % | 0.26 | % | 172,836 | 3.9 | % | 0.33 | % | |||||||||||||||||||||
| Time $100 thousand or more | 109,563 | 2.3 | % | 0.38 | % | 118,750 | 2.6 | % | 0.43 | % | 161,710 | 3.6 | % | 0.42 | % | |||||||||||||||||||||
| Total (1) | $ | 4,722,250 | 100.0 | % | 0.07 | % | $ | 4,590,351 | 100.0 | % | 0.08 | % | $ | 4,437,619 | 100.0 | % | 0.10 | % | ||||||||||||||||||
(1) The rates for total deposits reflect value of noninterest-bearing deposits.
The Company’s strategy includes building the value of its deposit base by building balances of lower-costing deposits and avoiding reliance on higher-costing time deposits. From 2015 to 2017 higher costing time deposits declined from 7% to 5% of total deposits. The Company’s average balances of checking and savings accounts represented 95% of average balances of total deposits in 2017 compared with 94% in 2016 and 93% in 2015.
Total time deposits were $232 million and $256 million at December 31, 2017 and 2016, respectively. The following table sets forth, by time remaining to maturity, the Company’s total domestic time deposits. The Company has no foreign time deposits.
Time Deposits Maturity Distribution
| At December 31, 2017 | ||||
| (In thousands) | ||||
| 2018 | $ | 179,421 | ||
| 2019 | 23,096 | |||
| 2020 | 11,990 | |||
| 2021 | 11,329 | |||
| 2022 | 5,979 | |||
| Thereafter | 3 | |||
| Total | $ | 231,818 | ||
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| - 42 - |
The following sets forth, by time remaining to maturity, the Company’s domestic time deposits in amounts of $100 thousand or more:
Time Deposits $100,000 or more Maturity Distribution
| At December 31, 2017 | ||||
| (In thousands) | ||||
| Three months or less | $ | 41,560 | ||
| Over three through six months | 21,336 | |||
| Over six through twelve months | 25,415 | |||
| Over twelve months | 25,659 | |||
| Total | $ | 113,970 | ||
Short-term Borrowings
The following table sets forth the short-term borrowings of the Company:
Short-Term Borrowings Distribution
| At December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Securities sold under agreements to repurchase the securities | $ | 58,471 | $ | 59,078 | $ | 53,028 | ||||||
| Total short-term borrowings | $ | 58,471 | $ | 59,078 | $ | 53,028 | ||||||
Further detail of federal funds purchased and other borrowed funds is as follows:
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| ($ in thousands) | ||||||||||||
| Federal funds purchased balances and rates paid on outstanding amount: | ||||||||||||
| Average balance for the year | $ | 5 | $ | 5 | $ | 8 | ||||||
| Maximum month-end balance during the year | - | - | - | |||||||||
| Average interest rate for the year | 1.53 | % | 0.77 | % | 0.48 | % | ||||||
| Average interest rate at period end | - | % | - | % | - | % | ||||||
| Securities sold under agreements to repurchase the securities balances and rates paid on outstanding amount: | ||||||||||||
| Average balance for the year | $ | 69,666 | $ | 61,271 | $ | 75,046 | ||||||
| Maximum month-end balance during the year | 82,126 | 74,815 | 89,484 | |||||||||
| Average interest rate for the year | 0.06 | % | 0.06 | % | 0.07 | % | ||||||
| Average interest rate at period end | 0.06 | % | 0.06 | % | 0.06 | % | ||||||
| FHLB advances balances and rates paid on outstanding amount: | ||||||||||||
| Average balance for the year | $ | - | $ | - | $ | 494 | ||||||
| Maximum month-end balance during the year | - | - | - | |||||||||
| Average interest rate for the year | - | % | - | % | 0.20 | % | ||||||
| Average interest rate at period end | - | % | - | % | - | % | ||||||
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| - 43 - |
Financial Ratios
The following table shows key financial ratios for the periods indicated:
| At and For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| Return on average total assets | 0.92 | % | 1.12 | % | 1.16 | % | ||||||
| Return on average common shareholders' equity | 8.39 | % | 10.85 | % | 11.32 | % | ||||||
| Average shareholders' equity as a percentage of: | ||||||||||||
| Average total assets | 10.96 | % | 10.34 | % | 10.21 | % | ||||||
| Average total loans | 45.34 | % | 38.08 | % | 32.08 | % | ||||||
| Average total deposits | 12.63 | % | 11.81 | % | 11.70 | % | ||||||
| Common dividend payout ratio | 83 | % | 68 | % | 67 | % | ||||||
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| - 44 - |
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk, even though such activities may be permitted with the approval of the Company’s Board of Directors.
Credit risk and interest rate risk are the most significant market risks affecting the Company, and equity price risk can also affect the Company’s financial results. These risks are described in the preceding sections regarding “Loan Portfolio Credit Risk,” and “Asset/Liability and Market Risk Management.” Other types of market risk, such as foreign currency exchange risk and commodity price risk, are not significant in the normal course of the Company’s business activities.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS
| - 45 - |
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of Westamerica Bancorporation and subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting, and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2017. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Company’s system of internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of Management and Directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Management performed an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017 based upon criteria in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this assessment, Management determined that the Company’s internal control over financial reporting was effective as of December 31, 2017 based on the criteria in Internal Control - Integrated Framework (2013) issued by COSO.
The Company’s independent registered public accounting firm has issued an attestation report on Management’s assessment of the Company’s internal control over financial reporting. Their opinion and attestation on internal control over financial reporting appear on page 89.
Dated: February 27, 2018
| - 46 - |
WESTAMERICA BANCORPORATION
| At December 31, | ||||||||
| 2017 | 2016 | |||||||
| Assets: | ||||||||
| Cash and due from banks | $ | 575,002 | $ | 462,271 | ||||
| Investment securities available for sale | 2,193,507 | 1,890,758 | ||||||
| Investment securities held to maturity, with fair values of: $1,155,342 at December 31, 2017 and $1,340,741 at December 31, 2016 | 1,158,864 | 1,346,312 | ||||||
| Loans | 1,287,982 | 1,352,711 | ||||||
| Allowance for loan losses | (23,009 | ) | (25,954 | ) | ||||
| Loans, net of allowance for loan losses | 1,264,973 | 1,326,757 | ||||||
| Other real estate owned | 1,426 | 3,095 | ||||||
| Premises and equipment, net | 35,301 | 36,566 | ||||||
| Identifiable intangibles, net | 3,850 | 6,927 | ||||||
| Goodwill | 121,673 | 121,673 | ||||||
| Other assets | 158,450 | 171,724 | ||||||
| Total Assets | $ | 5,513,046 | $ | 5,366,083 | ||||
| Liabilities: | ||||||||
| Noninterest-bearing deposits | $ | 2,197,526 | $ | 2,089,443 | ||||
| Interest-bearing deposits | 2,630,087 | 2,615,298 | ||||||
| Total deposits | 4,827,613 | 4,704,741 | ||||||
| Short-term borrowed funds | 58,471 | 59,078 | ||||||
| Other liabilities | 36,723 | 40,897 | ||||||
| Total Liabilities | 4,922,807 | 4,804,716 | ||||||
| Contingencies (Note 13) | ||||||||
| Shareholders' Equity: | ||||||||
| Common stock (no par value), authorized - 150,000 shares Issued and outstanding: 26,425 at December 31, 2017 and 25,907 at December 31, 2016 | 431,734 | 404,606 | ||||||
| Deferred compensation | 1,533 | 1,533 | ||||||
| Accumulated other comprehensive loss | (16,832 | ) | (10,074 | ) | ||||
| Retained earnings | 173,804 | 165,302 | ||||||
| Total Shareholders' Equity | 590,239 | 561,367 | ||||||
| Total Liabilities and Shareholders' Equity | $ | 5,513,046 | $ | 5,366,083 | ||||
See accompanying notes to consolidated financial statements.
| - 47 - |
WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF INCOME
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands, except per share data) | ||||||||||||
| Interest and Loan Fee Income: | ||||||||||||
| Loans | $ | 61,740 | $ | 69,139 | $ | 78,441 | ||||||
| Investment securities available for sale | 44,664 | 34,276 | 31,263 | |||||||||
| Investment securities held to maturity | 27,432 | 30,636 | 26,825 | |||||||||
| Total Interest and Loan Fee Income | 133,836 | 134,051 | 136,529 | |||||||||
| Interest Expense: | ||||||||||||
| Deposits | 1,856 | 2,077 | 2,370 | |||||||||
| Short-term borrowed funds | 44 | 39 | 53 | |||||||||
| Federal Home Loan Bank advances | - | - | 1 | |||||||||
| Total Interest Expense | 1,900 | 2,116 | 2,424 | |||||||||
| Net Interest and Loan Fee Income | 131,936 | 131,935 | 134,105 | |||||||||
| Reversal of Provision for Loan Losses | (1,900 | ) | (3,200 | ) | - | |||||||
| Net Interest and Loan Fee Income After Reversal of Provision For Loan Losses | 133,836 | 135,135 | 134,105 | |||||||||
| Noninterest Income: | ||||||||||||
| Service charges on deposit accounts | 19,612 | 20,854 | 22,241 | |||||||||
| Merchant processing services | 8,426 | 6,377 | 6,339 | |||||||||
| Securities gains | 7,955 | - | - | |||||||||
| Debit card fees | 6,421 | 6,290 | 6,084 | |||||||||
| Trust fees | 2,875 | 2,686 | 2,732 | |||||||||
| ATM processing fees | 2,610 | 2,411 | 2,397 | |||||||||
| Other service fees | 2,584 | 2,571 | 2,689 | |||||||||
| Financial services commissions | 639 | 568 | 695 | |||||||||
| Other noninterest income | 5,506 | 4,817 | 4,690 | |||||||||
| Total Noninterest Income | 56,628 | 46,574 | 47,867 | |||||||||
| Noninterest Expense: | ||||||||||||
| Salaries and related benefits | 51,519 | 51,507 | 52,192 | |||||||||
| Occupancy and equipment | 19,430 | 19,017 | 19,394 | |||||||||
| Outsourced data processing services | 9,035 | 8,505 | 8,441 | |||||||||
| Loss contingency | 5,542 | 3 | - | |||||||||
| Amortization of identifiable intangibles | 3,077 | 3,504 | 3,856 | |||||||||
| Professional fees | 2,161 | 3,980 | 2,490 | |||||||||
| Courier service | 1,732 | 1,952 | 2,329 | |||||||||
| Impairment of tax credit investments | 625 | - | - | |||||||||
| Other noninterest expense | 10,171 | 13,284 | 16,598 | |||||||||
| Total Noninterest Expense | 103,292 | 101,752 | 105,300 | |||||||||
| Income Before Income Taxes | 87,172 | 79,957 | 76,672 | |||||||||
| Provision for income taxes | 37,147 | 21,104 | 17,919 | |||||||||
| Net Income | $ | 50,025 | $ | 58,853 | $ | 58,753 | ||||||
| Average Common Shares Outstanding | 26,291 | 25,612 | 25,555 | |||||||||
| Diluted Average Common Shares Outstanding | 26,419 | 25,678 | 25,577 | |||||||||
| Per Common Share Data: | ||||||||||||
| Basic earnings | $ | 1.90 | $ | 2.30 | $ | 2.30 | ||||||
| Diluted earnings | 1.89 | 2.29 | 2.30 | |||||||||
| Dividends paid | 1.57 | 1.56 | 1.53 | |||||||||
See accompanying notes to consolidated financial statements.
| - 48 - |
WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Net Income | $ | 50,025 | $ | 58,853 | $ | 58,753 | ||||||
| Other comprehensive loss: | ||||||||||||
| Changes in net unrealized gains on securities available for sale | (3,767 | ) | (18,610 | ) | (8,028 | ) | ||||||
| Deferred tax benefit | 1,585 | 7,825 | 3,375 | |||||||||
| Reclassification of gains included in net income | (7,955 | ) | - | - | ||||||||
| Deferred tax expense on gains included in net income | 3,345 | - | - | |||||||||
| Changes in unrealized gains and losses on securities available for sale, net of tax | (6,792 | ) | (10,785 | ) | (4,653 | ) | ||||||
| Post-retirement benefit transition obligation amortization | 59 | 61 | 61 | |||||||||
| Deferred tax expense | (25 | ) | (25 | ) | (25 | ) | ||||||
| Post-retirement benefit transition obligation amortization, net of tax | 34 | 36 | 36 | |||||||||
| Total Other Comprehensive Loss | (6,758 | ) | (10,749 | ) | (4,617 | ) | ||||||
| Total Comprehensive Income | $ | 43,267 | $ | 48,104 | $ | 54,136 | ||||||
See accompanying notes to consolidated financial statements.
| - 49 - |
WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
| Common Shares Outstanding | Common Stock | Deferred Compensation | Accumulated Other Comprehensive Income (loss) | Retained Earnings | Total | |||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||
| Balance, December 31, 2014 | 25,745 | $ | 378,132 | $ | 2,711 | $ | 5,292 | $ | 140,468 | $ | 526,603 | |||||||||||||
| Net income for the year 2015 | 58,753 | 58,753 | ||||||||||||||||||||||
| Other comprehensive loss | (4,617 | ) | (4,617 | ) | ||||||||||||||||||||
| Exercise of stock options | 108 | 4,848 | 4,848 | |||||||||||||||||||||
| Tax benefit decrease upon exercise and expiration of stock options | (1,284 | ) | (1,284 | ) | ||||||||||||||||||||
| Restricted stock activity | 17 | 874 | (133 | ) | 741 | |||||||||||||||||||
| Stock based compensation | 1,272 | 1,272 | ||||||||||||||||||||||
| Stock awarded to employees | 2 | 105 | 105 | |||||||||||||||||||||
| Retirement of common stock | (344 | ) | (5,089 | ) | (10,003 | ) | (15,092 | ) | ||||||||||||||||
| Dividends | (39,124 | ) | (39,124 | ) | ||||||||||||||||||||
| Balance, December 31, 2015 | 25,528 | 378,858 | 2,578 | 675 | 150,094 | 532,205 | ||||||||||||||||||
| Net income for the year 2016 | 58,853 | 58,853 | ||||||||||||||||||||||
| Other comprehensive loss | (10,749 | ) | (10,749 | ) | ||||||||||||||||||||
| Exercise of stock options | 499 | 24,031 | 24,031 | |||||||||||||||||||||
| Tax benefit increase upon exercise and expiration of stock options | 394 | 394 | ||||||||||||||||||||||
| Restricted stock activity | 15 | 1,798 | (1,045 | ) | 753 | |||||||||||||||||||
| Stock based compensation | 1,494 | 1,494 | ||||||||||||||||||||||
| Stock awarded to employees | 2 | 90 | 90 | |||||||||||||||||||||
| Retirement of common stock | (137 | ) | (2,059 | ) | (3,721 | ) | (5,780 | ) | ||||||||||||||||
| Dividends | (39,924 | ) | (39,924 | ) | ||||||||||||||||||||
| Balance, December 31, 2016 | 25,907 | 404,606 | 1,533 | (10,074 | ) | 165,302 | 561,367 | |||||||||||||||||
| Net income for the year 2017 | 50,025 | 50,025 | ||||||||||||||||||||||
| Other comprehensive loss | (6,758 | ) | (6,758 | ) | ||||||||||||||||||||
| Exercise of stock options | 509 | 24,583 | 24,583 | |||||||||||||||||||||
| Restricted stock activity | 13 | 707 | 707 | |||||||||||||||||||||
| Stock based compensation | 1,824 | 1,824 | ||||||||||||||||||||||
| Stock awarded to employees | 2 | 104 | 104 | |||||||||||||||||||||
| Retirement of common stock | (6 | ) | (90 | ) | (224 | ) | (314 | ) | ||||||||||||||||
| Dividends | (41,299 | ) | (41,299 | ) | ||||||||||||||||||||
| Balance, December 31, 2017 | 26,425 | $ | 431,734 | $ | 1,533 | $ | (16,832 | ) | $ | 173,804 | $ | 590,239 | ||||||||||||
See accompanying notes to consolidated financial statements.
| - 50 - |
WESTAMERICA BANCORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| Operating Activities: | (In thousands) | |||||||||||
| Net income | $ | 50,025 | $ | 58,853 | $ | 58,753 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Depreciation and amortization/accretion | 26,082 | 19,939 | 16,402 | |||||||||
| (Reversal of) provision for loan losses | (1,900 | ) | (3,200 | ) | - | |||||||
| Net amortization of deferred loan fees | (46 | ) | (340 | ) | (310 | ) | ||||||
| Increase in interest income receivable | (2,068 | ) | (1,316 | ) | (780 | ) | ||||||
| Life insurance premiums paid | (842 | ) | (828 | ) | (782 | ) | ||||||
| Decrease in net deferred tax asset | 27,018 | 4,380 | 830 | |||||||||
| Increase in other assets | (890 | ) | (2,493 | ) | (1,046 | ) | ||||||
| Stock option compensation expense | 1,824 | 1,494 | 1,272 | |||||||||
| Tax benefit (increase) decrease upon exercise and expiration of stock options | - | (394 | ) | 1,284 | ||||||||
| (Decrease) increase in income taxes payable | (6,650 | ) | (40 | ) | 265 | |||||||
| Decrease in interest expense payable | (31 | ) | (52 | ) | (86 | ) | ||||||
| (Decrease) increase in other liabilities | (3,016 | ) | 2,026 | (5,754 | ) | |||||||
| Gain on sale of other assets | (1,004 | ) | - | - | ||||||||
| Gain on sale of securities | (7,955 | ) | - | - | ||||||||
| Write-down/net loss on sale of premises and equipment | 60 | 30 | 109 | |||||||||
| Net loss/write-down (gain) on sale of foreclosed assets | 147 | (422 | ) | 247 | ||||||||
| Net Cash Provided by Operating Activities | 80,754 | 77,637 | 70,404 | |||||||||
| Investing Activities: | ||||||||||||
| Net repayments of loans | 66,065 | 183,506 | 164,093 | |||||||||
| Change in payable to FDIC1 | (63 | ) | (127 | ) | - | |||||||
| Purchases of investment securities available for sale | (635,814 | ) | (1,080,959 | ) | (946,794 | ) | ||||||
| Proceeds from sale/maturity/calls of securities available for sale | 319,324 | 737,625 | 967,118 | |||||||||
| Purchases of investment securities held to maturity | - | (246,956 | ) | (437,935 | ) | |||||||
| Proceeds from maturity/calls of securities held to maturity | 178,429 | 204,054 | 153,014 | |||||||||
| Purchases of premises and equipment | (2,720 | ) | (1,818 | ) | (4,474 | ) | ||||||
| Net change in FHLB2 securities | - | - | 940 | |||||||||
| Proceeds from sale of foreclosed assets | 1,521 | 7,412 | 1,774 | |||||||||
| Net Cash Used in Investing Activities | (73,258 | ) | (197,263 | ) | (102,264 | ) | ||||||
| Financing Activities: | ||||||||||||
| Net change in deposits | 122,872 | 164,082 | 191,476 | |||||||||
| Net change in short-term borrowings and FHLB2 advances | (607 | ) | 6,050 | (56,756 | ) | |||||||
| Exercise of stock options/issuance of shares | 24,583 | 24,031 | 4,848 | |||||||||
| Taxes paid by withholding shares for tax purposes | - | (356 | ) | (357 | ) | |||||||
| Tax benefit increase (decrease) upon expiration/exercise of stock options | - | 394 | (1,284 | ) | ||||||||
| Retirement of common stock | (314 | ) | (5,424 | ) | (14,735 | ) | ||||||
| Common stock dividends paid | (41,299 | ) | (39,924 | ) | (39,124 | ) | ||||||
| Net Cash Provided by Financing Activities | 105,235 | 148,853 | 84,068 | |||||||||
| Net Change In Cash and Due from Banks | 112,731 | 29,227 | 52,208 | |||||||||
| Cash and Due from Banks at Beginning of Period | 462,271 | 433,044 | 380,836 | |||||||||
| Cash and Due from Banks at End of Period | $ | 575,002 | $ | 462,271 | $ | 433,044 | ||||||
| Supplemental Cash Flow Disclosures: | ||||||||||||
| Supplemental disclosure of noncash activities: | ||||||||||||
| Loan collateral transferred to other real estate owned | $ | - | $ | 821 | $ | 4,911 | ||||||
| Securities purchases pending settlement | - | - | 2,885 | |||||||||
| Supplemental disclosure of cash flow activities: | ||||||||||||
| Interest paid for the period | 1,931 | 2,202 | 2,533 | |||||||||
| Income tax payments for the period | 17,351 | 19,264 | 17,666 | |||||||||
See accompanying notes to consolidated financial statements.
1 Federal Deposit Insurance Corporation ("FDIC")
2 Federal Home Loan Bank ("FHLB")
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WESTAMERICA BANCORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Business and Accounting Policies
Westamerica Bancorporation, a registered bank holding company (the “Company”), provides a full range of banking services to corporate and individual customers in Northern and Central California through its wholly-owned subsidiary bank, Westamerica Bank (the “Bank”). The Bank is subject to competition from both financial and nonfinancial institutions and to the regulations of certain agencies and undergoes periodic examinations by those regulatory authorities. All of the financial service operations are considered by management to be aggregated in one reportable operating segment.
The Company has evaluated events and transactions subsequent to the balance sheet date. Based on this evaluation, the Company is not aware of any events or transactions that occurred subsequent to the balance sheet date but prior to filing that would require recognition or disclosure in its consolidated financial statements. Certain amounts in prior periods have been reclassified to conform to the current presentation.
Summary of Significant Accounting Policies
The consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States of America. The following is a summary of significant policies used in the preparation of the accompanying financial statements.
Accounting Estimates. Certain accounting policies underlying the preparation of these financial statements require Management to make estimates and judgments about future economic and market conditions. These estimates and judgments may affect reported amounts of assets and liabilities, revenues and expenses, and disclosures of contingent assets and liabilities. Although the estimates contemplate current conditions and how Management expects them to change in the future, it is reasonably possible that in 2018 actual conditions could be worse than anticipated in those estimates, which could materially affect our results of operations and financial conditions.
Principles of Consolidation. The consolidated financial statements include the accounts of the Company and all the Company’s subsidiaries. Significant intercompany transactions have been eliminated in consolidation. The Company does not maintain or conduct transactions with any unconsolidated special purpose entities.
Cash. Cash includes Due From Banks balances which are readily convertible to known amounts of cash and are generally 90 days or less from maturity at the time of initiation, presenting insignificant risk of changes in value due to interest rate changes.
Securities. Investment securities consist of debt securities of the U.S. Treasury, government sponsored entities, states, counties, municipalities, corporations, agency and non-agency mortgage-backed securities, asset-backed securities and equity securities. Securities transactions are recorded on a trade date basis. The Company classifies its debt and marketable equity securities in one of three categories: trading, available for sale or held to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Trading securities are recorded at fair value with unrealized gains and losses included in earnings. Held to maturity securities are those debt securities which the Company has the ability and intent to hold until maturity. Held to maturity securities are recorded at cost, adjusted for the amortization of premiums or accretion of discounts. Securities not included in trading or held to maturity are classified as available for sale. Available for sale securities are recorded at fair value. Unrealized gains and losses, net of the related tax effect, on available for sale securities are included in accumulated other comprehensive income.
The Company utilizes third-party sources to value its investment securities; securities individually valued using quoted prices in active markets are classified as Level 1 assets in the fair value hierarchy, and securities valued using quoted prices in active markets for similar securities (commonly referred to as “matrix” pricing) are classified as Level 2 assets in the fair value hierarchy. The Company validates the reliability of third-party provided values by comparing individual security pricing for securities between more than one third-party source. When third-party information is not available, valuation adjustments are estimated in good faith by Management and classified as Level 3 in the fair value hierarchy.
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A decline in the market value of any available for sale or held to maturity security below amortized cost that is deemed other than temporary results in a charge to earnings and the establishment of a new cost basis for the security. Unrealized investment securities losses are evaluated at least quarterly to determine whether such declines in value should be considered “other than temporary” and therefore be subject to immediate loss recognition in income. Although these evaluations involve significant judgment, an unrealized loss in the fair value of a debt security is generally deemed to be temporary when the fair value of the security is below the carrying value primarily due to changes in risk-free interest rates, there has not been significant deterioration in the financial condition of the issuer, and the Company does not intend to sell or be required to sell the securities before recovery of its amortized cost. An unrealized loss in the value of an equity security is generally considered temporary when the fair value of the security declined primarily due to current market conditions and not deterioration in the financial condition of the issuer, the Company expects the fair value of the security to recover in the near term and the Company does not intend to sell or be required to sell the securities before recovery of its cost basis. Other factors that may be considered in determining whether a decline in the value of either a debt or an equity security is “other than temporary” include ratings by recognized rating agencies, actions of commercial banks or other lenders relative to the continued extension of credit facilities to the issuer of the security, the financial condition, capital strength and near-term prospects of the issuer, and recommendations of investment advisors or market analysts.
The Company follows the guidance issued by the Board of Governors of the Federal Reserve System, “Investing in Securities without Reliance on Nationally Recognized Statistical Rating Agencies” (SR 12-15) and other regulatory guidance when performing investment security pre-purchase analysis or evaluating investment securities for impairment. Credit ratings issued by recognized rating agencies are considered in the Company’s analysis only as a guide to the historical default rate associated with similarly-rated bonds.
Purchase premiums are amortized and purchase discounts are accreted over the estimated life of the related investment security as an adjustment to yield using the effective interest method. Unamortized premiums, unaccreted discounts, and early payment premiums are recognized as a component of gain or loss on sale upon disposition of the related security. Interest and dividend income are recognized when earned. Realized gains and losses from the sale of available for sale securities are included in earnings using the specific identification method.
Nonmarketable Equity Securities. Nonmarketable equity securities include securities that are not publicly traded, such as Visa Class B common stock, and securities acquired to meet regulatory requirements, such as Federal Reserve Bank stock, which are restricted. These restricted securities are accounted for under the cost method and are included in other assets. The Company reviews those assets accounted for under the cost method at least quarterly for possible declines in value that are considered “other than temporary”. The Company’s review typically includes an analysis of the facts and circumstances of each investment, the expectations for the investment’s cash flows and capital needs, the viability of its business model and any exit strategy. The asset value is reduced when a decline in value is considered to be other than temporary. The Company recognizes the estimated loss in noninterest income.
Loans. Loans are stated at the principal amount outstanding, net of unearned discount and unamortized deferred fees and costs. Interest is accrued daily on the outstanding principal balances. Loans which are more than 90 days delinquent with respect to interest or principal, unless they are well secured and in the process of collection, and other loans on which full recovery of principal or interest is in doubt, are placed on nonaccrual status. Interest previously accrued on loans placed on nonaccrual status is charged against interest income. In addition, some loans secured by real estate with temporarily impaired values and commercial loans to borrowers experiencing financial difficulties are placed on nonaccrual status (“performing nonaccrual loans”) even though the borrowers continue to repay the loans as scheduled. When the ability to fully collect nonaccrual loan principal is in doubt, payments received are applied against the principal balance of the loans on a cost-recovery method until such time as full collection of the remaining recorded balance is expected. Any additional interest payments received after that time are recorded as interest income on a cash basis. Performing nonaccrual loans are reinstated to accrual status when improvements in credit quality eliminate the doubt as to the full collectability of both interest and principal. Certain consumer loans or auto receivables are charged off against the allowance for credit losses when they become 120 days past due.
The Company evaluates all classified loans and nonaccrual loans with outstanding principal balances in excess of $500 thousand, and all “troubled debt restructured” loans for impairment. The Company recognizes a loan as impaired when, based on current information and events, it is probable that it will be unable to collect both the contractual interest and principal payments as scheduled in the loan agreement. Income recognition on impaired loans conforms to that used on nonaccrual loans. In certain circumstances, the Company might agree to restructured loan terms with borrowers experiencing financial difficulties; such restructured loans are evaluated under ASC 310-40, “Troubled Debt Restructurings by Creditors.” In general, a restructuring constitutes a troubled debt restructuring when the Company, for reasons related to a borrower’s financial difficulties, grants a concession to the borrower it would not otherwise consider. Loans are evaluated on an individual basis. The Company follows its general nonaccrual policy for troubled debt restructurings. Performing troubled debt restructurings are reinstated to accrual status when improvements in credit quality eliminate the doubt as to full collectability of both principal and interest.
Nonrefundable fees and certain costs associated with originating or acquiring loans are deferred and amortized as an adjustment to interest income over the contractual loan lives. Upon prepayment, unamortized loan fees, net of costs, are immediately recognized in interest income. Other fees, including those collected upon principal prepayments, are included in interest income when received. Loans held for sale are identified upon origination and are reported at the lower of cost or market value on an aggregate loan basis.
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Purchased Loans. Purchased loans are recorded at estimated fair value on the date of purchase. Impaired purchased loans are accounted for under FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. Evidence of credit quality deterioration as of the purchase date may include attributes such as past due and nonaccural status. Generally, purchased loans that meet the Company’s definition for nonaccrual status fall within the scope of FASB ASC 310-30. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in cash flows result in a reversal of the provision for loan losses to the extent of prior charges, or a reclassification of the difference from nonaccretable to accretable with a positive impact on interest income on a prospective basis. Any excess of expected cash flows over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows. For covered purchased loans with an accretable difference, the corresponding FDIC receivable is amortized over the shorter of the contractual term of the indemnification asset or the remaining life of the loan. Further, the Company elected to analogize to ASC 310-30 and account for all other loans that had a discount due in part to credit not within the scope of ASC 310-30 using the same methodology.
Covered Loans. Loans covered under loss-sharing or similar credit protection agreements with the FDIC are reported in loans exclusive of the expected reimbursement cash flows from the FDIC. Covered loans are initially recorded at fair value at the acquisition date. Subsequent decreases in the amount expected to be collected results in a provision for loan losses and a corresponding increase in the estimated FDIC reimbursement, with the estimated net loss impacting earnings. Interest previously accrued on covered loans placed on nonaccrual status is charged against interest income, net of estimated FDIC reimbursements of such accrued interest. The FDIC reimburses the Company up to 80% of 90 days interest on covered loans.
Allowance for Credit Losses. The Company extends loans to commercial and consumer customers primarily in Northern and Central California. These lending activities expose the Company to the risk borrowers will default, causing loan losses. The Company’s lending activities are exposed to various qualitative risks. All loan segments are exposed to risks inherent in the economy and market conditions. Significant risk characteristics related to the commercial loan segment include the borrowers’ business performance and financial condition, and the value of collateral for secured loans. Significant risk characteristics related to the commercial real estate segment include the borrowers’ business performance and the value of properties collateralizing the loans. Significant risk characteristics related to the construction loan segment include the borrowers’ performance in successfully developing the real estate into the intended purpose and the value of the property collateralizing the loans. Significant risk characteristics related to the residential real estate segment include the borrowers’ financial wherewithal to service the mortgages and the value of the property collateralizing the loans. Significant risk characteristics related to the consumer loan segment include the financial condition of the borrowers and the value of collateral securing the loans.
The preparation of these financial statements requires Management to estimate the amount of probable incurred losses inherent in the loan portfolio and establish an allowance for credit losses. The allowance for credit losses is established by assessing a provision for loan losses against the Company’s earnings. In estimating credit losses, Management must exercise significant judgment in evaluating information deemed relevant, such as financial information regarding individual borrowers, overall credit loss experience, the amount of past due, nonperforming and classified loans, recommendations of regulatory authorities, prevailing economic conditions and other information. The amount of ultimate losses on the loan portfolio can vary from the estimated amounts. Management follows a systematic methodology to estimate loss potential in an effort to reduce the differences between estimated and actual losses.
The allowance for credit losses is established through provisions for credit losses charged to income. Losses on loans, including impaired loans, are charged to the allowance for loan losses when all or a portion of the recorded amount of a loan is deemed to be uncollectible. Recoveries of loans previously charged off are credited to the allowance when realized. The Company’s allowance for credit losses is maintained at a level considered adequate to provide for losses that can be estimated based upon specific and general conditions. These include conditions unique to individual borrowers, as well as overall credit loss experience, the amount of past due, nonperforming and classified loans, recommendations of regulatory authorities, prevailing economic conditions, FDIC loss-sharing or similar credit protection agreements and other factors. A portion of the allowance is specifically allocated to impaired loans whose full collectability is uncertain. Such allocations are determined by Management based on loan-by-loan analyses. The Company evaluates all classified loans and nonaccrual loans with outstanding principal balances in excess of $500 thousand, and all “troubled debt restructured” loans for impairment. A second allocation is based in part on quantitative analyses of historical credit loss experience. The results of this analysis are applied to current loan balances to allocate the reserve to the respective segments of the loan portfolio exclusive of loans individually evaluated for impairment. In addition, consumer installment loans which have similar characteristics and are not usually criticized using regulatory guidelines are analyzed and reserves established based on the historical loss rates and delinquency trends, grouped by the number of days the payments on these loans are delinquent. The remainder of the reserve is considered to be unallocated. The unallocated allowance is established to provide for probable losses that have been incurred as of the reporting date but not reflected in the allocated allowance. It addresses additional qualitative factors consistent with Management’s analysis of the level of risks inherent in the loan portfolio, which are related to the risks of the Company’s general lending activity. Included in the unallocated allowance is the risk of losses that are attributable to national or local economic or industry trends which have occurred but have not yet been recognized in past loan charge-off history (external factors). The external factors evaluated by the Company include: economic and business conditions, external competitive issues, and other factors. Also included in the unallocated allowance is the risk of losses that are attributable to general attributes of the Company’s loan portfolio and credit administration (internal factors). The internal factors evaluated by the Company include: loan review system, adequacy of lending Management and staff, loan policies and procedures, problem loan trends, concentrations of credit, and other factors. By their nature, these risks are not readily allocable to any specific segment of the loan portfolio in a statistically meaningful manner.
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Liability for Off-Balance Sheet Credit Exposures. A liability for off-balance sheet credit exposures is established through expense recognition. Off-balance sheet credit exposures relate to letters of credit and unfunded loan commitments for commercial, construction and consumer loans. Historical credit loss factors for commercial, construction and consumer loans are applied to the amount of these off-balance sheet credit exposures to estimate inherent losses.
Other Real Estate Owned. Other real estate owned is comprised of property acquired through foreclosure proceedings, acceptances of deeds-in-lieu of foreclosure and, if applicable, vacated bank properties. Losses recognized at the time of acquiring property in full or partial satisfaction of debt are charged against the allowance for credit losses. Other real estate owned is recorded at the fair value of the collateral, generally based upon an independent property appraisal, less estimated disposition costs. Losses incurred subsequent to acquisition due to any decline in annual independent property appraisals are recognized as noninterest expense. Routine holding costs, such as property taxes, insurance and maintenance, and losses from sales and dispositions, are recognized as noninterest expense.
Covered Other Real Estate Owned. Other real estate owned covered under loss-sharing agreements with the FDIC is reported exclusive of expected reimbursement cash flows from the FDIC. Upon transferring covered loan collateral to covered other real estate owned status, the covered loan collateral is recorded at fair value, generally based upon an independent property appraisal, less estimated disposition costs with losses charged against acquisition date fair value discounts; the amount of losses exceeding acquisition date fair value discounts are recognized as noninterest expense inclusive of expected reimbursement cash flows from the FDIC. Subsequent losses incurred due to any decline in annual independent property appraisal valuations are recognized as noninterest expense inclusive of expected reimbursement cash flows from the FDIC.
Premises and Equipment. Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is computed substantially on the straight-line method over the estimated useful life of each type of asset. Estimated useful lives of premises and equipment range from 20 to 50 years and from 3 to 20 years, respectively. Leasehold improvements are amortized over the terms of the lease or their estimated useful life, whichever is shorter.
Revenue Recognition. The Company recognizes revenue as it is earned based on contractual terms, as transactions occur, or as services are provided and collectability is reasonably assured. In certain circumstances, noninterest income is reported net of associated expenses that are directly related to variable volume-based sales or revenue sharing arrangements or when the Company acts on an agency basis for others.
Life Insurance Cash Surrender Value. The Company has purchased life insurance policies on certain directors and officers as well as acquired such assets as part of the acquisition of other banks. Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement. These assets are included in other assets on the consolidated balance sheets.
Intangible Assets. Intangible assets are comprised of goodwill, core deposit intangibles and other identifiable intangibles acquired in business combinations. Intangible assets with definite useful lives are amortized on an accelerated basis over their respective estimated useful lives not exceeding 15 years. If an event occurs that indicates the carrying amount of an intangible asset may not be recoverable, Management reviews the asset for impairment. Any goodwill and any intangible asset acquired in a purchase business combination determined to have an indefinite useful life is not amortized, but is evaluated for impairment annually. The Company has the option to first assess qualitative factors to determine the likelihood of impairment pursuant to FASB ASU 2011-08, Testing for Goodwill Impairment. Although the Company has the option to first assess qualitative factors when determining if impairment exists, the Company has opted to perform a quantitative analysis to determine if impairment exists.
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Impairment of Long-Lived Assets. The Company reviews its long-lived and certain intangible assets for impairment whenever events or changes indicate that the carrying amount of an asset may not be recoverable. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
Income Taxes. The Company and its subsidiaries file consolidated tax returns. The Company accounts for income taxes in accordance with FASB ASC 740, Income Taxes, resulting in two components of income tax expense: current and deferred. Current income tax expense approximates taxes to be paid or refunded for the current period. The Company determines deferred income taxes using the balance sheet method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and recognizes enacted changes in tax rates and laws in the period in which they occur. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized subject to Management’s judgment that realization is more likely than not. A tax position that meets the more likely than not recognition threshold is measured to determine the amount of benefit to recognize. The tax position is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon settlement. Interest and penalties are recognized as a component of income tax expense.
Stock Options. The Company applies FASB ASC 718 – Compensation – Stock Compensation, to account for stock based awards granted to employees using the fair value method. The Company recognizes compensation expense for restricted performance share grants over the relevant attribution period. Restricted performance share grants have no exercise price, therefore, the intrinsic value is measured using an estimated per share price at the vesting date for each restricted performance share. The estimated per share price is adjusted during the attribution period to reflect actual stock price performance. The Company’s obligation for unvested outstanding restricted performance share grants is classified as a liability until the vesting date due to a cash settlement feature, at which time the issued shares become classified as shareholders’ equity.
Extinguishment of Debt. Gains and losses, including fees, incurred in connection with the early extinguishment of debt are charged to current earnings as reductions in noninterest income.
Postretirement Benefits. The Company uses an actuarial-based accrual method of accounting for post-retirement benefits.
Other. Securities and other property held by the Bank in a fiduciary or agency capacity are not included in the financial statements since such items are not assets of the Company or its subsidiaries.
Recently Adopted Accounting Standards
In 2017, the Company adopted the following new accounting guidance:
FASB Accounting Standards Update (ASU) 2016-09, Improvements to Employee Share-Based Payment Accounting, was issued March 30, 2016. The provisions of the new standard changed several aspects of the accounting for share-based payment award transactions, including: (1) Accounting and Cash Flow Classification for Excess Tax Benefits, (2) Forfeitures, and (3) Tax Withholding Requirements and Cash Flow Classification. The Company adopted the ASU provisions effective January 1, 2017, which has the potential to create volatility in the book tax provision at the time nonqualified stock options are exercised or expire. During 2017, 509 thousand shares were issued due to the exercise of nonqualified stock options resulting in a tax deduction exceeding related share based compensation by $1,667 thousand. The 2017 income tax provision was $698 thousand lower than it would have been under accounting standards prior to the adoption of ASU 2016-09. The Company elected to account for forfeitures as they occur.
Recently Issued Accounting Standards
FASB ASU 2014-09, Revenue (Topic 606): Revenue from Contracts with Customers, was issued May 2014. The ASU specifies a standardized approach for revenue recognition across industries and transactions. The ASU also requires additional disclosures. The scope of the ASU does not include revenue streams covered by other ASU topics; thus, Topic 606 does not apply to revenue related to financial instruments, guarantees and leases, such as the Company’s net interest income.
Approximately 73% of our revenue, including all of our net interest income and a portion of our noninterest income, is out of scope of the guidance. The contracts that are in scope of the guidance are primarily related to service charges and fees on deposit accounts, merchant processing fees, trust fees and other service charges, commissions and fees. We have completed analyzing the individual contracts in scope and determined our revenue recognition will not change in any material regard upon adoption of the ASU. The Company adopted the ASU on January 1, 2018.
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FASB ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, was issued January 2016. The ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most notably, the ASU changes the income statement impact of equity investments held by the Company and the requirement for the Company to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes.
The Company was required to adopt the ASU provisions on January 1, 2018, and for those equity securities with readily determinable fair values, the Company elected the retrospective transition approach with a cumulative effect adjustment to the balance sheet and for those equity securities that do not have readily determinable fair values, the Company elected the prospective transition approach. The impact of the adoption of this accounting standard on the Company’s consolidated financial statements will be subject to the price volatility of the equity investments, which is immaterial. At December 31, 2017, the Company had $2000 thousand in equity investments with readily determinable fair value.
FASB ASU 2016-02, Leases (Topic 842), was issued February 25, 2016. The provisions of the new standard require lessees to recognize most leases on-balance sheet, increasing reported assets and liabilities. Lessor accounting remains substantially similar to current U.S. GAAP.
The Company will be required to adopt the ASU provisions January 1, 2019, and plans to elect the modified retrospective transition approach. Management is evaluating the impact that the ASU will have on the Company’s financial statements. As of December 31, 2017, the Company leased 58 of its operating facilities; the remaining minimum lease payments were $17.5 million. The Company does not expect a material change in noninterest expenses upon adoption of the new standard.
FASB ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, was issued on June 16, 2016. The ASU significantly changes estimates for credit losses related to financial assets measured at amortized cost and certain other contracts. For estimating credit losses, the FASB is replacing the incurred loss model with the current expected credit loss (CECL) model, which will accelerate recognition of credit losses. Additionally, credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses under the new standard. The Company will also be required to provide additional disclosures related to the financial assets within the scope of the new standard.
The Company will be required to adopt the ASU provisions on January 1, 2020. Management is evaluating the impact that the ASU will have on the Company’s consolidated financial statements. The ultimate adjustment to the allowance for loan losses will be accomplished through an offsetting after-tax adjustment to shareholders’ equity. Economic conditions and the composition of the Company’s loan portfolio at the time of adoption will influence the extent of the adopting accounting adjustment.
FASB ASU 2017-08, Receivables – Non-Refundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities, was issued March 2017. The ASU will shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity.
The Company will be required to adopt the ASU provisions on January 1, 2019. Management is evaluating the impact the ASU will have on the Company’s financial statements.
FASB ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, was issued August 2017. The ASU will expand and refine hedge accounting for both nonfinancial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. The ASU also provides for a one-time reclassification of prepayable assets from held-to-maturity (HTM) to available for sale (AFS) regardless of derivative use.
The Company will be required to adopt the ASU provisions January 1, 2019. The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk, even though such activities may be permitted with the approval of the Company’s Board of Directors. However, the Company is currently evaluating the prepayable assets in the HTM portfolio to determine if a one-time reclassification of prepayable assets from HTM to the AFS will occur upon implementation.
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Note 2: Investment Securities
An analysis of the amortized cost, gross unrealized gains and losses accumulated in other comprehensive income, and fair value of the available for sale investment securities portfolio follows:
| Investment Securities Available for Sale At December 31, 2017 | ||||||||||||||||
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | |||||||||||||
| (In thousands) | ||||||||||||||||
| Securities of U.S. Government sponsored entities | $ | 122,285 | $ | 1 | $ | (2,967 | ) | $ | 119,319 | |||||||
| Agency residential mortgage-backed securities (MBS) | 787,679 | 522 | (20,495 | ) | 767,706 | |||||||||||
| Non-agency residential MBS | 153 | 1 | - | 154 | ||||||||||||
| Agency commercial MBS | 2,244 | - | (25 | ) | 2,219 | |||||||||||
| Securities of U.S. Government entities | 1,612 | - | (22 | ) | 1,590 | |||||||||||
| Obligations of states and political subdivisions | 182,907 | 3,796 | (1,482 | ) | 185,221 | |||||||||||
| Corporate securities | 1,123,671 | 1,104 | (9,277 | ) | 1,115,498 | |||||||||||
| Other securities | 2,000 | - | (200 | ) | 1,800 | |||||||||||
| Total | $ | 2,222,551 | $ | 5,424 | $ | (34,468 | ) | $ | 2,193,507 | |||||||
An analysis of the amortized cost, gross unrecognized gains and losses, and fair value of the held to maturity investment securities portfolio follows:
| Investment Securities Held to Maturity At December 31, 2017 | ||||||||||||||||
| Amortized Cost | Gross Unrecognized Gains | Gross Unrecognized Losses | Fair Value | |||||||||||||
| (In thousands) | ||||||||||||||||
| Agency residential MBS | $ | 545,883 | $ | 606 | $ | (9,850 | ) | $ | 536,639 | |||||||
| Non-agency residential MBS | 4,462 | 70 | - | 4,532 | ||||||||||||
| Agency commercial MBS | 9,041 | - | (66 | ) | 8,975 | |||||||||||
| Obligations of states and political subdivisions | 599,478 | 7,736 | (2,018 | ) | 605,196 | |||||||||||
| Total | $ | 1,158,864 | $ | 8,412 | $ | (11,934 | ) | $ | 1,155,342 | |||||||
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An analysis of the amortized cost, gross unrealized gains and losses accumulated in other comprehensive income, and fair value of the available for sale investment securities portfolio follows:
| Investment Securities Available for Sale At December 31, 2016 | ||||||||||||||||
| Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Value | |||||||||||||
| (In thousands) | ||||||||||||||||
| Securities of U.S. Government sponsored entities | $ | 141,599 | $ | 35 | $ | (2,974 | ) | $ | 138,660 | |||||||
| Agency residential MBS | 711,623 | 921 | (21,045 | ) | 691,499 | |||||||||||
| Non-agency residential MBS | 272 | - | (1 | ) | 271 | |||||||||||
| Securities of U.S. Government entities | 2,041 | - | (16 | ) | 2,025 | |||||||||||
| Obligations of states and political subdivisions | 182,230 | 5,107 | (3,926 | ) | 183,411 | |||||||||||
| Asset-backed securities | 696 | - | (1 | ) | 695 | |||||||||||
| FHLMC(1) and FNMA(2) stock | 749 | 10,120 | - | 10,869 | ||||||||||||
| Corporate securities | 866,835 | 1,690 | (7,668 | ) | 860,857 | |||||||||||
| Other securities | 2,034 | 621 | (184 | ) | 2,471 | |||||||||||
| Total | $ | 1,908,079 | $ | 18,494 | $ | (35,815 | ) | $ | 1,890,758 | |||||||
(1) Federal Home Loan Mortgage Corporation
(2) Federal National Mortgage Association
An analysis of the amortized cost, gross unrecognized gains and losses, and fair value of the held to maturity investment securities portfolio follows:
| Investment Securities Held to Maturity At December 31, 2016 | ||||||||||||||||
| Amortized Cost | Gross Unrecognized Gains | Gross Unrecognized Losses | Fair Value | |||||||||||||
| (In thousands) | ||||||||||||||||
| Securities of U.S. Government sponsored entities | $ | 581 | $ | 1 | $ | - | $ | 582 | ||||||||
| Agency residential MBS | 668,235 | 1,122 | (8,602 | ) | 660,755 | |||||||||||
| Non-agency residential MBS | 5,370 | 76 | - | 5,446 | ||||||||||||
| Agency commercial MBS | 9,332 | 11 | (143 | ) | 9,200 | |||||||||||
| Obligations of states and political subdivisions | 662,794 | 6,031 | (4,067 | ) | 664,758 | |||||||||||
| Total | $ | 1,346,312 | $ | 7,241 | $ | (12,812 | ) | $ | 1,340,741 | |||||||
During the quarter ending December 31, 2017, the Company sold its shares of FHLMC and FNMA stock. Total proceeds from the sale were $8,704 thousand and the realized gain recorded in income was $7,955 thousand.
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The amortized cost and fair value of investment securities by contractual maturity are shown in the following tables at the dates indicated:
| At December 31, 2017 | ||||||||||||||||
| Securities Available for Sale | Securities Held to Maturity | |||||||||||||||
| Amortized Cost | Fair Value | Amortized Cost | Fair Value | |||||||||||||
| (In thousands) | ||||||||||||||||
| Maturity in years: | ||||||||||||||||
| 1 year or less | $ | 193,337 | $ | 193,385 | $ | 50,295 | $ | 51,105 | ||||||||
| Over 1 to 5 years | 1,031,807 | 1,023,047 | 269,050 | 269,471 | ||||||||||||
| Over 5 to 10 years | 159,266 | 160,042 | 277,170 | 281,546 | ||||||||||||
| Over 10 years | 46,065 | 45,154 | 2,963 | 3,074 | ||||||||||||
| Subtotal | 1,430,475 | 1,421,628 | 599,478 | 605,196 | ||||||||||||
| MBS | 790,076 | 770,079 | 559,386 | 550,146 | ||||||||||||
| Other securities | 2,000 | 1,800 | - | - | ||||||||||||
| Total | $ | 2,222,551 | $ | 2,193,507 | $ | 1,158,864 | $ | 1,155,342 | ||||||||
| At December 31, 2016 | ||||||||||||||||
| Securities Available for Sale | Securities Held to Maturity | |||||||||||||||
| Amortized Cost | Fair Value | Amortized Cost | Fair Value | |||||||||||||
| (In thousands) | ||||||||||||||||
| Maturity in years: | ||||||||||||||||
| 1 year or less | $ | 154,693 | $ | 154,835 | $ | 14,961 | $ | 15,639 | ||||||||
| Over 1 to 5 years | 750,834 | 745,219 | 292,024 | 292,062 | ||||||||||||
| Over 5 to 10 years | 238,077 | 239,153 | 318,580 | 319,587 | ||||||||||||
| Over 10 years | 47,756 | 44,416 | 37,810 | 38,052 | ||||||||||||
| Subtotal | 1,191,360 | 1,183,623 | 663,375 | 665,340 | ||||||||||||
| MBS | 713,936 | 693,795 | 682,937 | 675,401 | ||||||||||||
| Other securities | 2,783 | 13,340 | - | - | ||||||||||||
| Total | $ | 1,908,079 | $ | 1,890,758 | $ | 1,346,312 | $ | 1,340,741 | ||||||||
Expected maturities of mortgage-related securities can differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties. In addition, such factors as prepayments and interest rates may affect the yield on the carrying value of mortgage-related securities. At December 31, 2017 and December 31, 2016, the Company had no high-risk collateralized mortgage obligations as defined by regulatory guidelines.
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| - 60 - |
An analysis of the gross unrealized losses of the available for sale investment securities portfolio follows:
| Investment Securities Available for Sale | ||||||||||||||||||||||||||||||||||||
| At December 31, 2017 | ||||||||||||||||||||||||||||||||||||
| No. of | Less than 12 months | No. of | 12 months or longer | No. of | Total | |||||||||||||||||||||||||||||||
| Investment Positions | Fair Value | Unrealized Losses | Investment Positions | Fair Value | Unrealized Losses | Investment Positions | Fair Value | Unrealized Losses | ||||||||||||||||||||||||||||
| ($ in thousands) | ||||||||||||||||||||||||||||||||||||
| Securities of U.S. Government sponsored entities | 1 | $ | 996 | $ | (2 | ) | 8 | $ | 117,252 | $ | (2,965 | ) | 9 | $ | 118,248 | $ | (2,967 | ) | ||||||||||||||||||
| Agency residential MBS | 7 | 238,554 | (1,501 | ) | 51 | 516,711 | (18,994 | ) | 58 | 755,265 | (20,495 | ) | ||||||||||||||||||||||||
| Non-agency residential MBS | 1 | 1 | - | - | - | - | 1 | 1 | - | |||||||||||||||||||||||||||
| Agency commercial MBS | 2 | 2,219 | (25 | ) | - | - | - | 2 | 2,219 | (25 | ) | |||||||||||||||||||||||||
| Securities of U.S. Government entities | - | - | - | 3 | 1,590 | (22 | ) | 3 | 1,590 | (22 | ) | |||||||||||||||||||||||||
| Obligations of states and political subdivisions | 50 | 21,453 | (228 | ) | 35 | 52,071 | (1,254 | ) | 85 | 73,524 | (1,482 | ) | ||||||||||||||||||||||||
| Corporate securities | 64 | 571,112 | (4,047 | ) | 38 | 282,924 | (5,230 | ) | 102 | 854,036 | (9,277 | ) | ||||||||||||||||||||||||
| Other securities | - | - | - | 1 | 1,800 | (200 | ) | 1 | 1,800 | (200 | ) | |||||||||||||||||||||||||
| Total | 125 | $ | 834,335 | $ | (5,803 | ) | 136 | $ | 972,348 | $ | (28,665 | ) | 261 | $ | 1,806,683 | $ | (34,468 | ) | ||||||||||||||||||
An analysis of gross unrecognized losses of the held to maturity investment securities portfolio follows:
| Investment Securities Held to Maturity | ||||||||||||||||||||||||||||||||||||
| At December 31, 2017 | ||||||||||||||||||||||||||||||||||||
| No. of | Less than 12 months | No. of | 12 months or longer | No. of | Total | |||||||||||||||||||||||||||||||
| Investment Positions | Fair Value | Unrecognized Losses | Investment Positions | Fair Value | Unrecognized Losses | Investment Positions | Fair Value | Unrecognized Losses | ||||||||||||||||||||||||||||
| ($ in thousands) | ||||||||||||||||||||||||||||||||||||
| Agency residential MBS | 15 | $ | 30,218 | $ | (201 | ) | 65 | $ | 479,775 | $ | (9,649 | ) | 80 | $ | 509,993 | $ | (9,850 | ) | ||||||||||||||||||
| Agency commercial MBS | 1 | 1,913 | (4 | ) | 1 | 7,062 | (62 | ) | 2 | 8,975 | (66 | ) | ||||||||||||||||||||||||
| Obligations of states and political subdivisions | 146 | 131,032 | (553 | ) | 59 | 58,979 | (1,465 | ) | 205 | 190,011 | (2,018 | ) | ||||||||||||||||||||||||
| Total | 162 | $ | 163,163 | $ | (758 | ) | 125 | $ | 545,816 | $ | (11,176 | ) | 287 | $ | 708,979 | $ | (11,934 | ) | ||||||||||||||||||
The unrealized losses on the Company’s investment securities were caused by market conditions for these types of investments, particularly changes in risk-free interest rates. The Company evaluates securities on a quarterly basis including changes in security ratings issued by rating agencies, changes in the financial condition of the issuer, and, for mortgage-backed and asset-backed securities, delinquency and loss information with respect to the underlying collateral, changes in the levels of subordination for the Company’s particular position within the repayment structure and remaining credit enhancement as compared to expected credit losses of the security. Substantially all of these securities continue to be investment grade rated by a major rating agency. In addition to monitoring credit rating agency evaluations, Management performs its own evaluations regarding the credit worthiness of the issuer or the securitized assets underlying asset backed securities.
The Company does not intend to sell any investments and has concluded that it is more likely than not that it will not be required to sell the investments prior to recovery of the amortized cost basis. Therefore, the Company does not consider these investments to be other-than-temporarily impaired as of December 31, 2017.
The fair values of the investment securities could decline in the future if the general economy deteriorates, inflation increases, credit ratings decline, the issuer’s financial condition deteriorates, or the liquidity for securities declines. As a result, other than temporary impairments may occur in the future.
As of December 31, 2017, $715,774 thousand of investment securities were pledged to secure public deposits and short-term borrowed funds. As of December 31, 2016, $768,845 thousand of investment securities were pledged to secure public deposits and short-term borrowed funds.
| - 61 - |
An analysis of gross unrealized losses of investment securities available for sale follows:
| Investment Securities Available for Sale | ||||||||||||||||||||||||||||||||||||
| At December 31, 2016 | ||||||||||||||||||||||||||||||||||||
| No. of | Less than 12 months | No. of | 12 months or longer | No. of | Total | |||||||||||||||||||||||||||||||
| Investment | Fair | Unrealized | Investment | Fair | Unrealized | Investment | Fair | Unrealized | ||||||||||||||||||||||||||||
| Positions | Value | Losses | Positions | Value | Losses | Positions | Value | Losses | ||||||||||||||||||||||||||||
| ($ in thousands) | ||||||||||||||||||||||||||||||||||||
| Securities of U.S. Government sponsored entities | 8 | $ | 117,227 | $ | (2,974 | ) | - | $ | - | $ | - | 8 | $ | 117,227 | $ | (2,974 | ) | |||||||||||||||||||
| Agency residential MBS | 21 | 524,269 | (16,494 | ) | 28 | 122,901 | (4,551 | ) | 49 | 647,170 | (21,045 | ) | ||||||||||||||||||||||||
| Non-agency residential MBS | 2 | 246 | (1 | ) | - | - | - | 2 | 246 | (1 | ) | |||||||||||||||||||||||||
| Securities of U.S. Government entities | 2 | 1,253 | (9 | ) | 1 | 772 | (7 | ) | 3 | 2,025 | (16 | ) | ||||||||||||||||||||||||
| Obligations of states and political subdivisions | 43 | 57,989 | (3,905 | ) | 3 | 1,117 | (21 | ) | 46 | 59,106 | (3,926 | ) | ||||||||||||||||||||||||
| Asset-backed securities | - | - | - | 1 | 695 | (1 | ) | 1 | 695 | (1 | ) | |||||||||||||||||||||||||
| Corporate securities | 53 | 385,175 | (6,551 | ) | 27 | 96,145 | (1,117 | ) | 80 | 481,320 | (7,668 | ) | ||||||||||||||||||||||||
| Other securities | - | - | - | 1 | 1,816 | (184 | ) | 1 | 1,816 | (184 | ) | |||||||||||||||||||||||||
| Total | 129 | $ | 1,086,159 | $ | (29,934 | ) | 61 | $ | 223,446 | $ | (5,881 | ) | 190 | $ | 1,309,605 | $ | (35,815 | ) | ||||||||||||||||||
An analysis of gross unrecognized losses of investment securities held to maturity follows:
| Investment Securities Held to Maturity | ||||||||||||||||||||||||||||||||||||
| At December 31, 2016 | ||||||||||||||||||||||||||||||||||||
| No. of | Less than 12 months | No. of | 12 months or longer | No. of | Total | |||||||||||||||||||||||||||||||
| Investment | Fair | Unrecognized | Investment | Fair | Unrecognized | Investment | Fair | Unrecognized | ||||||||||||||||||||||||||||
| Positions | Value | Losses | Positions | Value | Losses | Positions | Value | Losses | ||||||||||||||||||||||||||||
| ($ in thousands) | ||||||||||||||||||||||||||||||||||||
| Agency residential MBS | 66 | $ | 569,876 | $ | (8,285 | ) | 3 | $ | 10,480 | $ | (317 | ) | 69 | $ | 580,356 | $ | (8,602 | ) | ||||||||||||||||||
| Agency commercial MBS | - | - | - | 1 | 7,214 | (143 | ) | 1 | 7,214 | (143 | ) | |||||||||||||||||||||||||
| Obligations of states and political subdivisions | 295 | 272,496 | (3,710 | ) | 12 | 13,126 | (357 | ) | 307 | 285,622 | (4,067 | ) | ||||||||||||||||||||||||
| Total | 361 | $ | 842,372 | $ | (11,995 | ) | 16 | $ | 30,820 | $ | (817 | ) | 377 | $ | 873,192 | $ | (12,812 | ) | ||||||||||||||||||
The following table provides information about the amount of interest income earned on investment securities which is fully taxable and which is exempt from regular federal income tax:
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Taxable | $ | 51,445 | $ | 42,718 | $ | 34,472 | ||||||
| Tax-exempt from regular federal income tax | 20,651 | 22,194 | 23,616 | |||||||||
| Total interest income from investment securities | $ | 72,096 | $ | 64,912 | $ | 58,088 | ||||||
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| - 62 - |
Note 3: Loans and Allowance for Credit Losses
A summary of the major categories of loans outstanding is shown in the following tables at the dates indicated.
| At December 31, | ||||||||
| 2017 | 2016 | |||||||
| (In thousands) | ||||||||
| Commercial | $ | 335,996 | $ | 354,697 | ||||
| Commercial Real Estate | 568,584 | 542,171 | ||||||
| Construction | 5,649 | 2,555 | ||||||
| Residential Real Estate | 65,183 | 87,724 | ||||||
| Consumer Installment & Other | 312,570 | 365,564 | ||||||
| Total | $ | 1,287,982 | $ | 1,352,711 | ||||
Total loans outstanding reported above include loans purchased from the FDIC of $83,478 thousand and $121,210 thousand at December 31, 2017 and December 31, 2016, respectively. Loans purchased from the FDIC were separately reported in prior periods and have been reclassified into their respective categories in the current presentation.
Changes in the accretable yield for purchased loans were as follows:
| For the Years Ended December 31, | ||||||||
| 2017 | 2016 | |||||||
| Accretable yield: | (In thousands) | |||||||
| Balance at the beginning of the period | $ | 1,237 | $ | 1,259 | ||||
| Reclassification from nonaccretable difference | 1,852 | 3,912 | ||||||
| Accretion | (2,351 | ) | (3,934 | ) | ||||
| Balance at the end of the period | $ | 738 | $ | 1,237 | ||||
| Accretion | $ | (2,351 | ) | $ | (3,934 | ) | ||
| Change in FDIC indemnification | 192 | 1,053 | ||||||
| (Increase) in interest income | $ | (2,159 | ) | $ | (2,881 | ) | ||
The following summarizes activity in the allowance for loan losses:
| Allowance for Loan Losses For the Year Ended December 31, 2017 | ||||||||||||||||||||||||||||
| Commercial | Commercial Real Estate | Construction | Residential Real Estate | Consumer Installment and Other | Unallocated | Total | ||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||
| Balance at beginning of period | $ | 8,327 | $ | 3,330 | $ | 152 | $ | 1,330 | $ | 7,980 | $ | 4,835 | $ | 25,954 | ||||||||||||||
| Additions: | ||||||||||||||||||||||||||||
| (Reversal) provision | (382 | ) | 431 | (1,716 | ) | (335 | ) | 1,271 | (1,169 | ) | (1,900 | ) | ||||||||||||||||
| Deductions: | ||||||||||||||||||||||||||||
| Chargeoffs | (961 | ) | - | - | - | (4,957 | ) | - | (5,918 | ) | ||||||||||||||||||
| Recoveries | 762 | 88 | 1,899 | - | 2,124 | - | 4,873 | |||||||||||||||||||||
| Net loan (losses) recoveries | (199 | ) | 88 | 1,899 | - | (2,833 | ) | - | (1,045 | ) | ||||||||||||||||||
| Total allowance for loan losses | $ | 7,746 | $ | 3,849 | $ | 335 | $ | 995 | $ | 6,418 | $ | 3,666 | $ | 23,009 | ||||||||||||||
| Allowance for Credit Losses For the Twelve Months Ended December 31, 2016 | ||||||||||||||||||||||||||||
| Commercial | Commercial Real Estate | Construction | Residential Real Estate | Consumer Installment and Other | Unallocated | Total | ||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||
| Balance at beginning of period | $ | 9,559 | $ | 4,212 | $ | 235 | $ | 1,801 | $ | 8,001 | $ | 5,963 | $ | 29,771 | ||||||||||||||
| Additions: | ||||||||||||||||||||||||||||
| (Reversal) provision | (3,237 | ) | (1,436 | ) | (83 | ) | (471 | ) | 3,155 | (1,128 | ) | (3,200 | ) | |||||||||||||||
| Deductions: | ||||||||||||||||||||||||||||
| Chargeoffs | (2,023 | ) | - | - | - | (4,749 | ) | - | (6,772 | ) | ||||||||||||||||||
| Recoveries | 4,028 | 554 | - | - | 1,573 | - | 6,155 | |||||||||||||||||||||
| Net loan recoveries (losses) | 2,005 | 554 | - | - | (3,176 | ) | - | (617 | ) | |||||||||||||||||||
| Total allowance for loan losses | $ | 8,327 | $ | 3,330 | $ | 152 | $ | 1,330 | $ | 7,980 | $ | 4,835 | $ | 25,954 | ||||||||||||||
| - 63 - |
| Allowance for Loan Losses | ||||||||||||||||||||||||||||
| For the Year Ended December 31, 2015 | ||||||||||||||||||||||||||||
| Commercial | Commercial Real Estate | Construction | Residential Real Estate | Consumer Installment and Other | Unallocated | Total | ||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||
| Balance at beginning of period | $ | 5,460 | $ | 4,245 | $ | 654 | $ | 2,241 | $ | 9,827 | $ | 9,058 | $ | 31,485 | ||||||||||||||
| Additions: | ||||||||||||||||||||||||||||
| Provision (reversal) | 3,681 | 126 | (33 | ) | (440 | ) | (239 | ) | (3,095 | ) | - | |||||||||||||||||
| Deductions: | ||||||||||||||||||||||||||||
| Chargeoffs | (756 | ) | (449 | ) | (431 | ) | - | (3,493 | ) | - | (5,129 | ) | ||||||||||||||||
| Recoveries | 1,174 | 290 | 45 | - | 1,906 | - | 3,415 | |||||||||||||||||||||
| Net loan recoveries (losses) | 418 | (159 | ) | (386 | ) | - | (1,587 | ) | - | (1,714 | ) | |||||||||||||||||
| Total allowance for loan losses | $ | 9,559 | $ | 4,212 | $ | 235 | $ | 1,801 | $ | 8,001 | $ | 5,963 | $ | 29,771 | ||||||||||||||
The allowance for loan losses and recorded investment in loans evaluated for impairment were as follows:
| Allowance for Loan Losses and Recorded Investment in Loans Evaluated for Impairment | ||||||||||||||||||||||||||||
| At December 31, 2017 | ||||||||||||||||||||||||||||
| Commercial | Commercial Real Estate | Construction | Residential Real Estate | Consumer Installment and Other | Unallocated | Total | ||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | 4,814 | $ | 171 | $ | - | $ | - | $ | - | $ | - | $ | 4,985 | ||||||||||||||
| Collectively evaluated for impairment | 2,932 | 3,678 | 335 | 995 | 6,418 | 3,666 | 18,024 | |||||||||||||||||||||
| Purchased loans with evidence of credit deterioration | - | - | - | - | - | - | - | |||||||||||||||||||||
| Total | $ | 7,746 | $ | 3,849 | $ | 335 | $ | 995 | $ | 6,418 | $ | 3,666 | $ | 23,009 | ||||||||||||||
| Carrying value of loans: | ||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | 10,675 | $ | 14,234 | $ | - | $ | 208 | $ | - | $ | - | $ | 25,117 | ||||||||||||||
| Collectively evaluated for impairment | 325,291 | 553,769 | 5,649 | 64,975 | 312,406 | - | 1,262,090 | |||||||||||||||||||||
| Purchased loans with evidence of credit deterioration | 30 | 581 | - | - | 164 | - | 775 | |||||||||||||||||||||
| Total | $ | 335,996 | $ | 568,584 | $ | 5,649 | $ | 65,183 | $ | 312,570 | $ | - | $ | 1,287,982 | ||||||||||||||
| Allowance for Loan Losses and Recorded Investment in Loans Evaluated for Impairment | ||||||||||||||||||||||||||||
| At December 31, 2016 | ||||||||||||||||||||||||||||
| Commercial | Commercial Real Estate | Construction | Residential Real Estate | Consumer Installment and Other | Unallocated | Total | ||||||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||||||
| Allowance for loan losses: | ||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | 5,048 | $ | - | $ | - | $ | - | $ | - | $ | - | $ | 5,048 | ||||||||||||||
| Collectively evaluated for impairment | 3,279 | 3,330 | 152 | 1,330 | 7,980 | 4,835 | 20,906 | |||||||||||||||||||||
| Purchased loans with evidence of credit deterioration | - | - | - | - | - | - | - | |||||||||||||||||||||
| Total | $ | 8,327 | $ | 3,330 | $ | 152 | $ | 1,330 | $ | 7,980 | $ | 4,835 | $ | 25,954 | ||||||||||||||
| Carrying value of loans: | ||||||||||||||||||||||||||||
| Individually evaluated for impairment | $ | 11,174 | $ | 12,706 | $ | - | $ | 835 | $ | - | $ | - | $ | 24,715 | ||||||||||||||
| Collectively evaluated for impairment | 343,494 | 528,957 | 2,555 | 86,889 | 365,236 | - | 1,327,131 | |||||||||||||||||||||
| Purchased loans with evidence of credit deterioration | 29 | 508 | - | - | 328 | - | 865 | |||||||||||||||||||||
| Total | $ | 354,697 | $ | 542,171 | $ | 2,555 | $ | 87,724 | $ | 365,564 | $ | - | $ | 1,352,711 | ||||||||||||||
The Bank’s customers are small businesses, professionals and consumers. Given the scale of these borrowers, corporate credit rating agencies do not evaluate the borrowers’ financial condition. The Bank maintains a Loan Review Department which reports directly to Audit Committee of the Board of Directors. The Loan Review Department performs independent evaluations of loans and validates management assigned credit risk grades on evaluated loans using grading standards employed by bank regulatory agencies. Loans judged to carry lower-risk attributes are assigned a “pass” grade, with a minimal likelihood of loss. Loans judged to carry higher-risk attributes are referred to as “classified loans,” and are further disaggregated, with increasing expectations for loss recognition, as “substandard,” “doubtful,” and “loss.” Loan Review Department evaluations occur every calendar quarter. If the Bank becomes aware of deterioration in a borrower’s performance or financial condition between Loan Review Department examinations, assigned risk grades are re-evaluated promptly. Credit risk grades assigned by management and validated by the Loan Review Department are subject to review by the Bank’s regulatory authorities during regulatory examinations.
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| - 64 - |
The following summarizes the credit risk profile by internally assigned grade:
| Credit Risk Profile by Internally Assigned Grade | ||||||||||||||||||||||||
| At December 31, 2017 | ||||||||||||||||||||||||
| Commercial | Commercial Real Estate | Construction | Residential Real Estate | Consumer Installment and Other | Total | |||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||
| Grade: | ||||||||||||||||||||||||
| Pass | $ | 324,185 | $ | 548,853 | $ | 5,649 | $ | 62,253 | $ | 310,429 | $ | 1,251,369 | ||||||||||||
| Substandard | 11,811 | 19,731 | - | 2,930 | 1,370 | 35,842 | ||||||||||||||||||
| Doubtful | - | - | - | - | 1 | 1 | ||||||||||||||||||
| Loss | - | - | - | - | 770 | 770 | ||||||||||||||||||
| Total | $ | 335,996 | $ | 568,584 | $ | 5,649 | $ | 65,183 | $ | 312,570 | $ | 1,287,982 | ||||||||||||
Credit risk profile reflects internally assigned grade of purchased covered loans without regard to FDIC indemnification.
| Credit Risk Profile by Internally Assigned Grade | ||||||||||||||||||||||||
| At December 31, 2016 | ||||||||||||||||||||||||
| Commercial | Commercial Real Estate | Construction | Residential Real Estate | Consumer Installment and Other | Total | |||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||
| Grade: | ||||||||||||||||||||||||
| Pass | $ | 340,973 | $ | 515,045 | $ | 2,555 | $ | 84,384 | $ | 362,597 | $ | 1,305,554 | ||||||||||||
| Substandard | 13,724 | 25,830 | - | 3,340 | 2,477 | 45,371 | ||||||||||||||||||
| Doubtful | - | 1,296 | - | - | 10 | 1,306 | ||||||||||||||||||
| Loss | - | - | - | - | 480 | 480 | ||||||||||||||||||
| Total | $ | 354,697 | $ | 542,171 | $ | 2,555 | $ | 87,724 | $ | 365,564 | $ | 1,352,711 | ||||||||||||
Credit risk profile reflects internally assigned grade of purchased covered loans without regard to FDIC indemnification.
The following tables summarize loans by delinquency and nonaccrual status:
| Summary of Loans by Delinquency and Nonaccrual Status At December 31, 2017 | ||||||||||||||||||||||||
| Current and Accruing | 30-59 Days Past Due and Accruing | 60-89 Days Past Due and Accruing | Past Due 90 Days or More and Accruing | Nonaccrual | Total Loans | |||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||
| Commercial | $ | 334,908 | $ | 627 | $ | 164 | $ | - | $ | 297 | $ | 335,996 | ||||||||||||
| Commercial real estate | 561,883 | 1,143 | 125 | - | 5,433 | 568,584 | ||||||||||||||||||
| Construction | 5,649 | - | - | - | - | 5,649 | ||||||||||||||||||
| Residential real estate | 65,183 | - | - | - | - | 65,183 | ||||||||||||||||||
| Consumer installment and other | 307,445 | 3,321 | 1,077 | 531 | 196 | 312,570 | ||||||||||||||||||
| Total | $ | 1,275,068 | $ | 5,091 | $ | 1,366 | $ | 531 | $ | 5,926 | $ | 1,287,982 | ||||||||||||
| Summary of Loans by Delinquency and Nonaccrual Status At December 31, 2016 | ||||||||||||||||||||||||
| Current and Accruing | 30-59 Days Past Due and Accruing | 60-89 Days Past Due and Accruing | Past Due 90 Days or More and Accruing | Nonaccrual | Total Loans | |||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||
| Commercial | $ | 353,497 | $ | 966 | $ | 40 | $ | - | $ | 194 | $ | 354,697 | ||||||||||||
| Commercial real estate | 533,377 | 1,460 | 445 | - | 6,889 | 542,171 | ||||||||||||||||||
| Construction | 2,329 | 226 | - | - | - | 2,555 | ||||||||||||||||||
| Residential real estate | 86,098 | 528 | 37 | - | 1,061 | 87,724 | ||||||||||||||||||
| Consumer installment and other | 360,549 | 3,288 | 989 | 497 | 241 | 365,564 | ||||||||||||||||||
| Total | $ | 1,335,850 | $ | 6,468 | $ | 1,511 | $ | 497 | $ | 8,385 | $ | 1,352,711 | ||||||||||||
There were no commitments to lend additional funds to borrowers whose loans were on nonaccrual status at December 31, 2017 and December 31, 2016.
| - 65 - |
The following summarizes impaired loans:
| Impaired Loans At December 31, | ||||||||||||||||||||||||
| 2017 | 2016 | |||||||||||||||||||||||
| Recorded Investment | Unpaid Principal Balance | Related Allowance | Recorded Investment | Unpaid Principal Balance | Related Allowance | |||||||||||||||||||
| (In thousands) | ||||||||||||||||||||||||
| With no related allowance recorded: | ||||||||||||||||||||||||
| Commercial | $ | 1,212 | $ | 1,271 | $ | - | $ | 1,234 | $ | 1,303 | $ | - | ||||||||||||
| Commercial real estate | 13,169 | 14,985 | - | 13,233 | 15,610 | - | ||||||||||||||||||
| Residential real estate | 208 | 239 | - | 1,279 | 1,309 | - | ||||||||||||||||||
| Consumer installment and other | 360 | 466 | - | 569 | 675 | - | ||||||||||||||||||
| Total with no related allowance recorded | 14,949 | 16,961 | - | 16,315 | 18,897 | - | ||||||||||||||||||
| With an allowance recorded: | ||||||||||||||||||||||||
| Commercial | 9,764 | 9,764 | 4,814 | 10,163 | 10,172 | 5,048 | ||||||||||||||||||
| Commercial real estate | 1,790 | 1,792 | 171 | - | - | - | ||||||||||||||||||
| Total with an allowance recorded | 11,554 | 11,556 | 4,985 | 10,163 | 10,172 | 5,048 | ||||||||||||||||||
| Total | $ | 26,503 | $ | 28,517 | $ | 4,985 | $ | 26,478 | $ | 29,069 | $ | 5,048 | ||||||||||||
Impaired loans include troubled debt restructured loans. Impaired loans at December 31, 2017, included $12,081 thousand of restructured loans, $4,285 thousand of which were on nonaccrual status. Impaired loans at December 31, 2016, included $12,381 thousand of restructured loans, $5,302 thousand of which were on nonaccrual status.
| Impaired Loans For the Years Ended December 31, | ||||||||||||||||||||||||
| 2017 | 2016 | 2015 | ||||||||||||||||||||||
| |
|
Average Recorded Investment |
|
Recognized Interest Income |
|
Average Recorded Investment |
|
Recognized Interest Income |
|
Average Recorded Investment |
|
Recognized Interest Income |
||||||||||||
| (In thousands) | ||||||||||||||||||||||||
| Commercial | $ | 11,156 | $ | 508 | $ | 12,923 | $ | 512 | $ | 12,631 | $ | 584 | ||||||||||||
| Commercial real estate | 14,806 | 884 | 16,701 | 725 | 20,307 | 674 | ||||||||||||||||||
| Construction | - | - | 102 | - | 263 | - | ||||||||||||||||||
| Residential real estate | 423 | 17 | 746 | 19 | 643 | 31 | ||||||||||||||||||
| Consumer installment and other | 415 | 20 | 473 | 25 | 739 | 25 | ||||||||||||||||||
| Total | $ | 26,800 | $ | 1,429 | $ | 30,945 | $ | 1,281 | $ | 34,583 | $ | 1,314 | ||||||||||||
The following tables provide information on troubled debt restructurings:
| Troubled Debt Restructurings At December 31, 2017 | ||||||||||||||||
| |
|
Number of Contracts |
|
Pre-Modification Carrying Value |
|
Period-End Carrying Value |
|
Period-End Individual Impairment Allowance |
||||||||
| ($ in thousands) | ||||||||||||||||
| Commercial | 7 | $ | 2,393 | $ | 1,085 | $ | 43 | |||||||||
| Commercial real estate | 10 | 11,528 | 10,788 | - | ||||||||||||
| Residential real estate | 1 | 241 | 208 | - | ||||||||||||
| Total | 18 | $ | 14,162 | $ | 12,081 | $ | 43 | |||||||||
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| - 66 - |
| Troubled Debt Restructurings At December 31, 2016 | ||||||||||||||||
| |
|
Number of Contracts |
|
Pre-Modification Carrying Value |
|
Period-End Carrying Value |
|
Period-End Individual Impairment Allowance |
||||||||
| ($ in thousands) | ||||||||||||||||
| Commercial | 7 | $ | 2,719 | $ | 1,489 | $ | 113 | |||||||||
| Commercial real estate | 10 | 11,257 | 10,673 | - | ||||||||||||
| Residential real estate | 1 | 241 | 219 | - | ||||||||||||
| Total | 18 | $ | 14,217 | $ | 12,381 | $ | 113 | |||||||||
| Troubled Debt Restructurings At December 31, 2015 | ||||||||||||||||
| |
|
Number of Contracts |
|
Pre-Modification Carrying Value |
|
Period-End Carrying Value |
|
Period-End Individual Impairment Allowance |
||||||||
| ($ in thousands) | ||||||||||||||||
| Commercial | 6 | $ | 3,138 | $ | 2,802 | $ | 194 | |||||||||
| Commercial real estate | 10 | 12,927 | 12,684 | - | ||||||||||||
| Residential real estate | 1 | 242 | 226 | - | ||||||||||||
| Total | 17 | $ | 16,307 | $ | 15,712 | $ | 194 | |||||||||
During the year ended December 31, 2017, the Company modified four loans with a carrying value of $699 thousand that were considered troubled debt restructurings. The four concessions granted in 2017 consisted of modifications of payment terms to extend the maturity date to allow for deferred principal repayment and under-market terms.
During the year ended December 31, 2016, the Company modified four loans with a total carrying value of $4,731 thousand that were considered troubled debt restructurings. The concessions granted in the four restructurings completed in 2016 consisted of three modifications of payment terms to extend the maturity date to allow for deferred principal repayment and under-market terms and one court order requiring under-market terms.
During the year ended December 31, 2015, the Company modified ten loans with a carrying value of $11,026 thousand that were considered troubled debt restructurings. The concessions granted in the restructurings completed in 2015 consisted of four under-market terms and modification of payment terms to extend the maturity date to allow for deferred principal repayment and six court orders.
During the year ended December 31, 2017, one troubled debt restructured loan with a carrying value of $58 thousand was charged off. There were no chargeoffs related to troubled debt restructurings made during the year ended December 31, 2016 and 2015. During the years ended December 31, 2017, 2016 and 2015, no troubled debt restructured loans defaulted within 12 months of the modification date. A troubled debt restructuring is considered to be in default when payments are ninety days or more past due.
There were no loans restricted due to collateral requirements at December 31, 2017 and December 31, 2016.
There were no loans held for sale at December 31, 2017 and December 31, 2016.
At December 31, 2017 and 2016, the Company held total other real estate owned (OREO) of $1,426 thousand net of reserve of $1,905 thousand and $3,095 thousand net of reserve of $1,816 thousand, respectively, of which $-0- thousand was foreclosed residential real estate properties or covered OREO at both dates, respectively. The amount of consumer mortgage loans outstanding secured by residential real estate properties for which formal foreclosure proceedings were in process was $196 thousand at December 31, 2017. There were no consumer mortgage loans outstanding secured by residential real estate properties for which formal foreclosure proceedings were in process at December 31, 2016.
| - 67 - |
Note 4: Concentration of Credit Risk
Under the California Financial Code, credit extended to any one person owing to a commercial bank at any one time shall not exceed the following limitations: (a) unsecured loans shall not exceed 15 percent of the sum of the shareholders' equity, allowance for loan losses, capital notes, and debentures of the bank, or (b) secured and unsecured loans in all shall not exceed 25 percent of the sum of the shareholders' equity, allowance for loan losses, capital notes, and debentures of the bank. At December 31, 2017, Westamerica Bank did not have credit extended to any one entity exceeding these limits. At December 31, 2017, Westamerica Bank had 40 lending relationships each with aggregate amounts exceeding $5 million. The Company has significant credit arrangements that are secured by real estate collateral. In addition to real estate loans outstanding as disclosed in Note 3, the Company had loan commitments related to real estate loans of $53,874 thousand and $57,721 thousand at December 31, 2017 and December 31, 2016, respectively. The Company requires collateral on all real estate loans with loan-to-value ratios at origination generally no greater than 75% on commercial real estate loans and no greater than 80% on residential real estate loans. At December 31, 2017, Westamerica Bank held corporate bonds in 70 issuing entities that exceeded $5 million for each issuer.
Note 5: Premises, Equipment and Other Assets
Premises and equipment consisted of the following:
| At December 31, | ||||||||||||
| Cost | Accumulated Depreciation and Amortization | Net Book Value | ||||||||||
| (In thousands) | ||||||||||||
| 2017 | ||||||||||||
| Land | $ | 11,796 | $ | - | $ | 11,796 | ||||||
| Building and improvements | 41,641 | (26,249 | ) | 15,392 | ||||||||
| Leasehold improvements | 5,817 | (4,790 | ) | 1,027 | ||||||||
| Furniture and equipment | 22,284 | (15,198 | ) | 7,086 | ||||||||
| Total | $ | 81,538 | $ | (46,237 | ) | $ | 35,301 | |||||
| 2016 | ||||||||||||
| Land | $ | 11,896 | $ | - | $ | 11,896 | ||||||
| Building and improvements | 40,992 | (25,180 | ) | 15,812 | ||||||||
| Leasehold improvements | 5,922 | (4,599 | ) | 1,323 | ||||||||
| Furniture and equipment | 21,874 | (14,339 | ) | 7,535 | ||||||||
| Total | $ | 80,684 | $ | (44,118 | ) | $ | 36,566 | |||||
Depreciation and amortization of premises and equipment included in noninterest expense amounted to $3,925 thousand in 2017, $3,959 thousand in 2016 and $3,523 thousand in 2015.
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| - 68 - |
Other assets consisted of the following:
| At December 31, | ||||||||
| 2017 | 2016 | |||||||
| (In thousands) | ||||||||
| Cost method equity investments: | ||||||||
| Federal Reserve Bank stock (1) | $ | 14,069 | $ | 14,069 | ||||
| Other investments | 158 | 201 | ||||||
| Total cost method equity investments | 14,227 | 14,270 | ||||||
| Life insurance cash surrender value | 54,101 | 51,535 | ||||||
| Net deferred tax asset | 33,112 | 55,417 | ||||||
| Limited partnership investments | 10,119 | 12,591 | ||||||
| Interest receivable | 23,557 | 21,489 | ||||||
| Prepaid assets | 4,906 | 4,825 | ||||||
| Other assets | 18,428 | 11,597 | ||||||
| Total other assets | $ | 158,450 | $ | 171,724 | ||||
(1) A bank applying for membership in the Federal Reserve System is required to subscribe to stock in the Federal Reserve Bank (FRB) in its district in a sum equal to six percent of the bank’s paid-up capital stock and surplus. One-half of the amount of the bank's subscription shall be paid to the FRB and the remaining half will be subject to call when deemed necessary by the Board of Governors of the Federal Reserve System.
The Company invests in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for low-income housing tax credits. At December 31, 2017, this investment totaled $10,119 thousand and $2,299 thousand of this amount represents outstanding equity capital commitments that are included in other liabilities. At December 31, 2016, this investment totaled $12,591 thousand and $2,299 thousand of this amount represented outstanding equity capital commitments. At December 31, 2017, the $2,299 thousand of outstanding equity capital commitments are expected to be paid as follows, $722 thousand in 2020, $131 thousand in 2023, $90 thousand in 2024 and $1,356 thousand in 2025 or thereafter.
The amounts recognized in net income for these investments include:
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Investment loss included in pre-tax income | $ | 1,800 | $ | 2,475 | $ | 2,850 | ||||||
| Valuation impairment included in pre-tax income | 625 | - | - | |||||||||
| Tax credits recognized in provision for income taxes | 1,850 | 2,286 | 2,650 | |||||||||
The $625 thousand valuation impairment recognized in 2017 was due to a decline in future expected federal tax benefits due to the reduction in the federal corporate tax rate upon enactment of the Tax Cuts and Jobs Act of 2017.
Note 6: Goodwill and Identifiable Intangible Assets
The Company has recorded goodwill and other identifiable intangibles associated with purchase business combinations. Goodwill is not amortized, but is evaluated for impairment at least annually. The Company did not recognize impairment during the years ended December 31, 2017, 2016 and 2015. Identifiable intangibles are amortized to their estimated residual values over their expected useful lives. Such lives and residual values are also periodically reassessed to determine if any amortization period adjustments are indicated. During the years ended December 31, 2017, 2016 and 2015 no such adjustments were recorded.
The carrying values of goodwill were:
| At December 31, | ||||||||
| 2017 | 2016 | |||||||
| (In thousands) | ||||||||
| Goodwill | $ | 121,673 | $ | 121,673 | ||||
| - 69 - |
The gross carrying amount of identifiable intangible assets and accumulated amortization was:
| At December 31, | ||||||||||||||||
| 2017 | 2016 | |||||||||||||||
| |
|
Gross Carrying Amount |
|
Accumulated Amortization |
|
Gross Carrying Amount |
|
Accumulated Amortization |
||||||||
| (In thousands) | ||||||||||||||||
| Core Deposit Intangibles | $ | 56,808 | $ | (52,987 | ) | $ | 56,808 | $ | (50,074 | ) | ||||||
| Merchant Draft Processing Intangible | 10,300 | (10,271 | ) | 10,300 | (10,107 | ) | ||||||||||
| Total Identifiable Intangible Assets | $ | 67,108 | $ | (63,258 | ) | $ | 67,108 | $ | (60,181 | ) | ||||||
As of December 31, 2017, the current period and estimated future amortization expense for identifiable intangible assets was:
| |
|
Core Deposit Intangibles |
|
Merchant Draft Processing Intangible |
|
Total |
||||||
| (In thousands) | ||||||||||||
| For the Year Ended December 31, 2017 (actual) | $ | 2,913 | $ | 164 | $ | 3,077 | ||||||
| Estimate for the Year Ended December 31, 2018 | 1,892 | 29 | 1,921 | |||||||||
| 2019 | 538 | - | 538 | |||||||||
| 2020 | 287 | - | 287 | |||||||||
| 2021 | 269 | - | 269 | |||||||||
| 2022 | 252 | - | 252 | |||||||||
Note 7: Deposits and Borrowed Funds
The following table provides additional detail regarding deposits.
| Deposits | ||||||||
| At December 31, | ||||||||
| 2017 | 2016 | |||||||
| (In thousands) | ||||||||
| Noninterest-bearing | $ | 2,197,526 | $ | 2,089,443 | ||||
| Interest-bearing: | ||||||||
| Transaction | 904,245 | 865,701 | ||||||
| Savings | 1,494,024 | 1,493,427 | ||||||
| Time deposits less than $100 thousand | 117,848 | 133,712 | ||||||
| Time deposits $100 thousand through $250 thousand | 76,578 | 84,925 | ||||||
| Time deposits more than $250 thousand | 37,392 | 37,533 | ||||||
| Total deposits | $ | 4,827,613 | $ | 4,704,741 | ||||
Demand deposit overdrafts of $2,786 thousand and $2,679 thousand were included as loan balances at December 31, 2017 and 2016, respectively. Interest expense for aggregate time deposits with individual account balances in excess of $100 thousand was $415 thousand in 2017, $509 thousand in 2016 and $687 thousand in 2015.
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| - 70 - |
The following table provides additional detail regarding short-term borrowed funds.
| Repurchase Agreements (Sweep) Accounted for as Secured Borrowings | ||||||||
| Remaining Contractual Maturity of the Agreements Overnight and Continuous | ||||||||
| At December 31, | ||||||||
| 2017 | 2016 | |||||||
| Repurchase agreements: | (In thousands) | |||||||
| Collateral securing borrowings: | ||||||||
| Securities of U.S. Government sponsored entities | $ | 74,173 | $ | 74,031 | ||||
| Agency residential MBS | 58,251 | 63,277 | ||||||
| Corporate securities | 105,113 | 90,554 | ||||||
| Total collateral carrying value | $ | 237,537 | $ | 227,862 | ||||
| Total short-term borrowed funds | $ | 58,471 | $ | 59,078 | ||||
| For the Years Ended December 31, | ||||||||
| 2017 | 2016 | |||||||
| Highest Balance at Any Month-end | ||||||||
| (In thousands) | ||||||||
| Securities sold under repurchase agreements | $ | 82,126 | $ | 74,815 | ||||
Note 8: Shareholders’ Equity
The Company grants stock options and restricted performance shares to employees in exchange for employee services, pursuant to the shareholder-approved 1995 Stock Option Plan, which was last amended and restated in 2012. Nonqualified stock option grants (“NQSO”) are granted with an exercise price equal to the fair market value of the related common stock on the grant date. NQSO generally become exercisable in equal annual installments over a three-year period with each installment vesting on the anniversary date of the grant. Each NQSO has a maximum ten-year term. A restricted performance share grant becomes vested after three years of being awarded, provided the Company has attained its performance goals for such three-year period.
The following table summarizes information about stock options granted under the Plan as of December 31, 2017. The intrinsic value is calculated as the difference between the market value as of December 31, 2017 and the exercise price of the shares. The market value as of December 31, 2017 was $59.55 as reported by the NASDAQ Global Select Market:
| Options Outstanding | Options Exercisable | |||||||||||||||||||||||||||||||||
| At December 31, 2017 | For the Year Ended December 31, 2017 | At December 31, 2017 | For the Year Ended December 31, 2017 | |||||||||||||||||||||||||||||||
Range of Exercise Price | Number Outstanding | Aggregate Intrinsic Value | Weighted Average Remaining Contractual Life | Weighted Average Exercise Price | Number Exercisable | Aggregate Intrinsic Value | Weighted Average Remaining Contractual Life | Weighted Average Exercise Price | ||||||||||||||||||||||||||
| (In thousands) | (Years) | (In thousands) | (Years) | |||||||||||||||||||||||||||||||
| $40 | - | 45 | 400 | $ | 6,798 | 7.5 | $ | 43 | 105 | $ | 1,751 | 6.9 | $ | 43 | ||||||||||||||||||||
| 45 | - | 50 | 22 | 305 | 4.1 | 46 | 22 | 305 | 4.1 | 46 | ||||||||||||||||||||||||
| 50 | - | 55 | 310 | 2,588 | 1.9 | 51 | 310 | 2,588 | 1.9 | 51 | ||||||||||||||||||||||||
| 55 | - | 60 | 298 | 725 | 8.3 | 57 | 32 | 94 | 2.1 | 57 | ||||||||||||||||||||||||
| $40 | - | 60 | 1,030 | $ | 10,416 | 6.0 | 49 | 469 | $ | 4,738 | 3.1 | 49 | ||||||||||||||||||||||
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| - 71 - |
The Company applies the Roll-Geske option pricing model (Modified Roll) to determine grant date fair value of stock option grants. This model modifies the Black-Scholes Model to take into account dividends and American options. During the twelve months ended December 31, 2017, 2016 and 2015, the Company granted 266 thousand, 325 thousand and 343 thousand stock options, respectively. The following weighted average assumptions were used in the option pricing to value stock options granted in the periods indicated:
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| Expected volatility (1) | 20 | % | 22 | % | 20 | % | ||||||
| Expected life in years (2) | 4.8 | 4.8 | 4.9 | |||||||||
| Risk-free interest rate (3) | 1.97 | % | 1.41 | % | 1.36 | % | ||||||
| Expected dividend yield | 3.28 | % | 4.49 | % | 3.64 | % | ||||||
| Fair value per award | $ | 8.27 | $ | 5.97 | $ | 5.46 | ||||||
| (1) | Measured using daily price changes of Company’s stock over respective expected term of the option and the implied volatility derived from the market prices of the Company’s stock and traded options. |
| (2) | The number of years that the Company estimates that the options will be outstanding prior to exercise. |
| (3) | The risk-free rate over the expected life based on the US Treasury yield curve in effect at the time of the grant. |
Employee stock option grants are being expensed by the Company over the grants’ three year vesting period. The Company issues new shares upon the exercise of options. The number of shares authorized to be issued for options at December 31, 2017 is 930 thousand.
A summary of option activity during the year ended December 31, 2017 is presented below:
| Shares | Weighted Average Exercise Price | Weighted Average Remaining Contractual Term | ||||||||||
| (In thousands) | (Years) | |||||||||||
| Outstanding at January 1, 2017 | 1,273 | $ | 47.36 | |||||||||
| Granted | 266 | 57.18 | ||||||||||
| Exercised | (509 | ) | 48.29 | |||||||||
| Forfeited or expired | - | N/A | ||||||||||
| Outstanding at December 31, 2017 | 1,030 | 49.44 | 6.0 | |||||||||
| Exercisable at December 31, 2017 | 469 | 49.45 | 3.1 | |||||||||
A summary of the Company’s nonvested option activity during the year ended December 31, 2017 is presented below:
| Shares | Weighted Average Grant Date Fair Value | |||||||
| (In thousands) | ||||||||
| Nonvested at January 1, 2017 | 553 | $ | 5.80 | |||||
| Granted | 266 | 8.27 | ||||||
| Vested | (258 | ) | 5.78 | |||||
| Forfeited | - | N/A | ||||||
| Nonvested at December 31, 2017 | 561 | $ | 6.98 | |||||
The weighted average estimated grant date fair value for options granted under the Company’s stock option plan during the twelve months ended December 31, 2017, 2016 and 2015 was $8.27, $5.97 and $5.46 per share, respectively. The total remaining unrecognized compensation cost related to nonvested awards as of December 31, 2017 is $2,012 thousand and the weighted average period over which the cost is expected to be recognized is 0.9 years.
| - 72 - |
The total intrinsic value of options exercised during the twelve months ended December 31, 2017, 2016 and 2015 was $4,642 thousand, $3,242 thousand and $504 thousand, respectively. The total fair value of Restricted Performance Shares (“RPSs”) that vested during the twelve months ended December 31, 2017, 2016 and 2015 was $708 thousand, $753 thousand and $741 thousand, respectively. The total fair value of options vested during the twelve months ended December 31, 2017, 2016 and 2015 was $1,493 thousand, $1,269 thousand and $1,321 thousand, respectively. The Company adopted the ASU provisions effective January 1, 2017, which has the potential to create volatility in the book tax provision at the time nonqualified stock options are exercised or expire. During the twelve months of 2017, 509 thousand shares were issued due to the exercise of nonqualified stock options resulting in a tax deduction exceeding related share based compensation by $1,667 thousand. The 2017 income tax provision was $698 thousand lower than would have been under accounting standards prior to the adoption of ASU 2016-09. The increase in tax benefits recognized for the tax deductions from the exercise of options totaled $394 thousand for the twelve months ended December 31, 2016. The decrease in tax benefits recognized for the tax deductions from the exercise of options totaled $1,284 thousand for the twelve months ended December 31, 2015.
A summary of the status of the Company’s restricted performance shares as of December 31, 2017 and 2016 and changes during the twelve months ended on those dates, follows:
| 2017 | 2016 | |||||||
| (In thousands) | ||||||||
| Outstanding at January 1, | 48 | 45 | ||||||
| Granted | 14 | 18 | ||||||
| Issued upon vesting | (13 | ) | (15 | ) | ||||
| Forfeited | - | - | ||||||
| Outstanding at December 31, | 49 | 48 | ||||||
As of December 31, 2017 and 2016, the restricted performance shares had a weighted-average contractual life of 1.2 years and 1.1 years, respectively. The compensation cost that was charged against income for the Company’s restricted performance shares granted was $827 thousand, $1,228 thousand and $535 thousand for the twelve months ended December 31, 2017, 2016 and 2015, respectively. There were no stock appreciation rights or incentive stock options granted in the twelve months ended December 31, 2017 and 2016.
On February 13, 2009, the Company issued a warrant to purchase 246,640 shares of the Company’s common stock at an exercise price of $50.92 per share. The warrants may be exercised in a manner wherein the Company withholds shares of common stock issuable upon exercise of the warrant equal in value to the aggregate exercise price, in which case the warrant holder would not deliver cash for the aggregate exercise price and the Company would issue a number of shares equal to the intrinsic value on the exercise date. The warrants remain outstanding at December 31, 2017.
The Company repurchases and retires its common stock in accordance with Board of Directors approved share repurchase programs. At December 31, 2017, approximately 1,750 thousand shares remained available to repurchase under such plans.
Shareholders have authorized two additional classes of stock of one million shares each, to be denominated “Class B Common Stock” and “Preferred Stock,” respectively, in addition to the 150 million shares of common stock presently authorized. At December 31, 2017, no shares of Class B Common Stock or Preferred Stock were outstanding.
Note 9: Regulatory Capital
Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can result in regulatory action. The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (Basel III rules) became effective for the Company on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule, and fully phased in by January 1, 2019. Under the Basel III rules, the Company must hold a capital conservation buffer above the adequately capitalized risk-based capital ratios. The capital conservation buffer is being phased in from 0.0% for 2015 to 2.50% by 2019. The capital conservation buffer for 2017 was 1.25% and 0.625% for 2016. The net unrealized gain or loss on available for sale securities is not included in computing regulatory capital. Management believes as of December 31, 2017, the Company and Bank met all capital adequacy requirements to which they are subject.
Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end 2017 and 2016, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution’s category.
| - 73 - |
The capital ratios for the Company and the Bank under the new capital framework as of the dates indicated are presented in the table below.
| At December 31, 2017 | Required for Capital Adequacy Purposes Effective January 1, 2017 | To Be Well-capitalized Under Prompt Corrective Action Regulations | ||||||||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
| ($ in thousands) | ||||||||||||||||||||||||
| Common Equity Tier 1 Capital | ||||||||||||||||||||||||
| Company | $ | 479,259 | 15.36 | % | $ | 179,377 | 5.75 | %(1) | N/A | N/A | ||||||||||||||
| Bank | 383,796 | 12.50 | % | 176,568 | 5.75 | %(1) | $ | 199,599 | 6.50 | % | ||||||||||||||
| Tier 1 Capital | ||||||||||||||||||||||||
| Company | 479,259 | 15.36 | % | 226,170 | 7.25 | %(1) | N/A | N/A | ||||||||||||||||
| Bank | 383,796 | 12.50 | % | 222,630 | 7.25 | %(1) | 245,660 | 8.00 | % | |||||||||||||||
| Total Capital | ||||||||||||||||||||||||
| Company | 504,576 | 16.17 | % | 288,562 | 9.25 | %(1) | N/A | N/A | ||||||||||||||||
| Bank | 415,113 | 13.52 | % | 284,045 | 9.25 | %(1) | 307,076 | 10.00 | % | |||||||||||||||
| Leverage Ratio (2) | ||||||||||||||||||||||||
| Company | 479,259 | 8.86 | % | 216,280 | 4.000 | % | N/A | N/A | ||||||||||||||||
| Bank | 383,796 | 7.16 | % | 214,468 | 4.000 | % | 268,085 | 5.00 | % | |||||||||||||||
(1) Includes 1.25% capital conservation buffer.
(2) The leverage ratio consists of Tier 1capital divided by the most recent quarterly average total assets, excluding certain intangible assets.
| At December 31, 2016 | Required for Capital Adequacy Purposes Effective January 1, 2016 | To Be Well-capitalized Under Prompt Corrective Action Regulations | ||||||||||||||||||||||
| Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
| ($ in thousands) | ||||||||||||||||||||||||
| Common Equity Tier 1 Capital | ||||||||||||||||||||||||
| Company | $ | 443,574 | 14.85 | % | $ | 153,126 | 5.125 | %(3) | N/A | N/A | ||||||||||||||
| Bank | 344,739 | 11.70 | % | 150,982 | 5.125 | %(3) | $ | 191,489 | 6.50 | % | ||||||||||||||
| Tier 1 Capital | ||||||||||||||||||||||||
| Company | 443,574 | 14.85 | % | 197,944 | 6.625 | %(3) | N/A | N/A | ||||||||||||||||
| Bank | 344,739 | 11.70 | % | 195,172 | 6.625 | %(3) | 235,680 | 8.00 | % | |||||||||||||||
| Total Capital | ||||||||||||||||||||||||
| Company | 476,595 | 15.95 | % | 257,700 | 8.625 | %(3) | N/A | N/A | ||||||||||||||||
| Bank | 383,572 | 13.02 | % | 254,092 | 8.625 | %(3) | 294,600 | 10.00 | % | |||||||||||||||
| Leverage Ratio (2) | ||||||||||||||||||||||||
| Company | 443,574 | 8.46 | % | 209,702 | 4.000 | % | N/A | N/A | ||||||||||||||||
| Bank | 344,739 | 6.63 | % | 208,005 | 4.000 | % | 260,006 | 5.00 | % | |||||||||||||||
(3) Includes 0.625% capital conservation buffer.
(2) The leverage ratio consists of Tier 1capital divided by the most recent quarterly average total assets, excluding certain intangible assets.
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| - 74 - |
Note 10: Income Taxes
Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the amounts reported in the financial statements of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Amounts for the current year are based upon estimates and assumptions as of the date of these financial statements and could vary significantly from amounts shown on the tax returns as filed.
The components of the net deferred tax asset are as follows:
| At December 31, | ||||||||
| 2017 | 2016 | |||||||
| (In thousands) | ||||||||
| Deferred tax asset | ||||||||
| Allowance for credit losses | $ | 7,349 | $ | 11,801 | ||||
| State franchise taxes | 1,871 | 2,679 | ||||||
| AMT carryforward | 1,752 | - | ||||||
| Securities available for sale | 8,586 | 7,283 | ||||||
| Deferred compensation | 5,279 | 8,043 | ||||||
| Real estate owned | 553 | 756 | ||||||
| Purchased assets and assumed liabilities | 1,111 | 3,026 | ||||||
| Post-retirement benefits | 526 | 903 | ||||||
| Employee benefit accruals | 2,066 | 3,399 | ||||||
| VISA Class B shares | 96 | 137 | ||||||
| Limited partnership investments | 57 | 86 | ||||||
| Impaired capital assets | 3,056 | 18,465 | ||||||
| Accrued liabilities | 1,609 | 967 | ||||||
| Premises and equipment | 299 | 577 | ||||||
| Other | 520 | 724 | ||||||
| Total deferred tax asset | 34,730 | 58,846 | ||||||
| Deferred tax liability | ||||||||
| Net deferred loan fees | 281 | 346 | ||||||
| Intangible assets | 1,247 | 2,955 | ||||||
| Other | 90 | 128 | ||||||
| Total deferred tax liability | 1,618 | 3,429 | ||||||
| Net deferred tax asset | $ | 33,112 | $ | 55,417 | ||||
Based on Management’s judgment, a valuation allowance is not needed to reduce the gross deferred tax asset because it is more likely than not that the gross deferred tax asset will be realized through recoverable taxes or future taxable income. Net deferred tax assets are included with other assets in the consolidated balance sheets.
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| - 75 - |
The provision for federal and state income taxes consists of amounts currently payable and amounts deferred are as follows:
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Current income tax expense: | ||||||||||||
| Federal | $ | 1,778 | $ | 16,258 | $ | 9,647 | ||||||
| State | 7,810 | 7,292 | 6,738 | |||||||||
| Total current | 9,588 | 23,550 | 16,385 | |||||||||
| Deferred income tax (benefit) expense: | ||||||||||||
| Federal | 14,461 | (2,604 | ) | 1,643 | ||||||||
| State | 783 | 158 | (109 | ) | ||||||||
| Total deferred | 15,244 | (2,446 | ) | 1,534 | ||||||||
| Adjustment of net deferred tax asset for enacted changes in tax rates: | ||||||||||||
| Federal | 12,315 | - | - | |||||||||
| State | - | - | - | |||||||||
| Total adjustments | 12,315 | $ | - | $ | - | |||||||
| Provision for income taxes | $ | 37,147 | $ | 21,104 | $ | 17,919 | ||||||
The provision for income taxes differs from the provision computed by applying the statutory federal income tax rate to income before taxes, as follows:
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Federal income taxes due at statutory rate | $ | 30,509 | $ | 27,985 | $ | 26,835 | ||||||
| Reductions in income taxes resulting from: | ||||||||||||
| Interest on state and municipal securities and loans not taxable for federal income tax purposes | (7,794 | ) | (8,382 | ) | (9,046 | ) | ||||||
| State franchise taxes, net of federal income tax benefit | 5,586 | 4,843 | 4,309 | |||||||||
| Re-measurement of net deferred tax asset due to enactment of new federal tax rate | 12,315 | - | - | |||||||||
| Stock compensation deduction in excess of book expense | (583 | ) | - | - | ||||||||
| Tax credits | (1,850 | ) | (2,286 | ) | (2,600 | ) | ||||||
| Dividend received deduction | (60 | ) | (52 | ) | (45 | ) | ||||||
| Cash value life insurance | (603 | ) | (607 | ) | (599 | ) | ||||||
| Other | (373 | ) | (397 | ) | (935 | ) | ||||||
| Provision for income taxes | $ | 37,147 | $ | 21,104 | $ | 17,919 | ||||||
The 2017 income tax provision includes a $12.3 million dollar charge to re-measure the Company’s net deferred tax asset as a result of the enactment of the Tax Cuts and Jobs Act of 2017. At December 31, 2017, the Company had no net operating loss and a $1,752 thousand AMT tax credit carryforward that under the Tax Cuts and Jobs Act of 2017 are fully refundable by 2022.
A reconciliation of the beginning and ending amounts of unrecognized tax benefits follow:
| 2017 | 2016 | |||||||
| (In thousands) | ||||||||
| Balance at January 1, | $ | 1,099 | $ | 1,243 | ||||
| Additions for tax positions taken in the current period | - | - | ||||||
| Reductions for tax positions taken in the current period | - | - | ||||||
| Additions for tax positions taken in prior years | - | - | ||||||
| Reductions for tax positions taken in prior years | - | (144 | ) | |||||
| Decrease related to settlements with taxing authorities | (190 | ) | - | |||||
| Decrease as a result of a lapse in statute of limitations | - | - | ||||||
| Balance at December 31, | $ | 909 | $ | 1,099 | ||||
| - 76 |
The deductibility of these tax positions will be determined through examination by the appropriate tax jurisdictions or the expiration of the tax statute of limitations. The Company does not anticipate any significant increase or decrease in unrecognized tax benefits during 2018. Unrecognized tax benefits at December 31, 2017 and 2016 include accrued interest and penalties of $13 thousand and $57 thousand, respectively. If recognized, the entire amount of the unrecognized tax benefits would affect the effective tax rate.
The Company classifies interest and penalties as a component of the provision for income taxes. At December 31, 2017, the tax years ended December 31, 2016, 2015 and 2014 remain subject to examination by the Internal Revenue Service and the tax years ended December 31, 2016, 2015, 2014, 2013, 2012 and 2011 remain subject to examination by the California Franchise Tax Board.
Note 11: Fair Value Measurements
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Available for sale investment securities are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as other real estate owned, impaired loans, certain loans held for investment, investment securities held to maturity, and other assets. These nonrecurring fair value adjustments typically involve the lower-of-cost or fair-value accounting of individual assets.
In accordance with the Fair Value Measurement and Disclosure topic of the Codification, the Company bases its fair values on the price that would be received to sell an asset or paid to transfer a liability in the principal market or most advantageous market for an asset or liability in an orderly transaction between market participants on the measurement date under current market conditions. A fair value measurement reflects all of the assumptions that market participants would use in pricing the asset or liability, including assumptions about the risk inherent in a particular valuation technique, the effect of a restriction on the sale or use of an asset, and the risk of nonperformance.
The Company groups its assets and liabilities measured at fair value into a three-level hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. When the valuation assumptions used to measure the fair value of the asset or liability are categorized within different levels of the fair value hierarchy, the asset or liability is categorized in its entirety within the lowest level of the hierarchy. These levels are:
Level 1 – Valuation is based upon quoted prices for identical instruments traded in active exchange markets, such as the New York Stock Exchange. Level 1 includes U.S. Treasury and equity securities, which are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 includes federal agency securities, mortgage-backed securities, corporate securities, asset-backed securities, and municipal bonds.
Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.
The Company relies on independent vendor pricing services to measure fair value for investment securities available for sale and investment securities held to maturity. The Company employs three pricing services. To validate the pricing of these vendors, the Company compares vendors’ pricing for each of the securities for consistency; significant pricing differences, if any, are evaluated using all available independent quotes with the quote closely affecting the market generally used as the fair value estimate. In addition, the Company conducts “other than temporary impairment (OTTI)” analysis on a quarterly basis; securities selected for OTTI analysis include all securities at a market price below 95 percent of par value. As with any valuation technique used to estimate fair value, changes in underlying assumptions used could significantly affect the results of current and future values. Accordingly, these fair value estimates may not be realized in an actual sale of the securities.
The Company regularly reviews the valuation techniques and assumptions used by its vendors and determines which valuation techniques are utilized based on observable market inputs for the type of securities being measured. The Company uses the information to determine the placement in the fair value hierarchy as level 1, 2 or 3. When the Company changes its valuation assumptions for measuring financial assets and financial liabilities at fair value, either due to changes in current market conditions or other factors, or reevaluates the valuation techniques and assumptions used by its vendors, it may need to transfer those assets or liabilities to another level in the hierarchy based on the new information. The Company recognizes these transfers at the end of the reporting period that the transfers occur. For the years ended December 31, 2017 and 2016, there were no transfers into or out of levels 1, 2 or 3.
| - 77 - |
Assets Recorded at Fair Value on a Recurring Basis
The tables below present assets measured at fair value on a recurring basis on the dates indicated.
| At December 31, 2017 | ||||||||||||||||
| Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
| (In thousands) | ||||||||||||||||
| Securities of U.S. Government sponsored entities | $ | 119,319 | $ | - | $ | 119,319 | $ | - | ||||||||
| Agency residential MBS | 767,706 | - | 767,706 | - | ||||||||||||
| Non-agency residential MBS | 154 | - | 154 | - | ||||||||||||
| Agency commercial MBS | 2,219 | - | 2,219 | - | ||||||||||||
| Securities of U.S. Government entities | 1,590 | - | 1,590 | - | ||||||||||||
| Obligations of states and political subdivisions | 185,221 | - | 185,221 | - | ||||||||||||
| Corporate securities | 1,115,498 | - | 1,115,498 | - | ||||||||||||
| Other securities | 1,800 | - | 1,800 | - | ||||||||||||
| Total securities available for sale | $ | 2,193,507 | $ | - | $ | 2,193,507 | $ | - | ||||||||
| At December 31, 2016 | ||||||||||||||||
| Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||||
| (In thousands) | ||||||||||||||||
| Securities of U.S. Government sponsored entities | $ | 138,660 | $ | - | $ | 138,660 | $ | - | ||||||||
| Agency residential MBS | 691,499 | - | 691,499 | - | ||||||||||||
| Non-agency residential MBS | 271 | - | 271 | - | ||||||||||||
| Securities of U.S. Government entities | 2,025 | - | 2,025 | - | ||||||||||||
| Obligations of states and political subdivisions | 183,411 | - | 183,411 | - | ||||||||||||
| Asset-backed securities | 695 | - | 695 | - | ||||||||||||
| FHLMC and FNMA stock | 10,869 | 17 | 10,852 | - | ||||||||||||
| Corporate securities | 860,857 | - | 860,857 | - | ||||||||||||
| Other securities | 2,471 | 656 | 1,815 | - | ||||||||||||
| Total securities available for sale | $ | 1,890,758 | $ | 673 | $ | 1,890,085 | $ | - | ||||||||
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| - 78 - |
Assets Recorded at Fair Value on a Nonrecurring Basis
The Company may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower of cost or fair value accounting of individual assets. For assets measured at fair value on a nonrecurring basis that were recorded in the balance sheet at December 31, 2017 and December 31, 2016, the following tables provide the level of valuation assumptions used to determine each adjustment and the carrying value of the related assets at period end.
| For the | ||||||||||||||||||||
| Year Ended | ||||||||||||||||||||
| At December 31, 2017 | December 31, 2017 | |||||||||||||||||||
| Carrying Value | Level 1 | Level 2 | Level 3 | Total Losses | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Other real estate owned | $ | 1,426 | $ | - | $ | - | $ | 1,426 | $ | (219 | ) | |||||||||
| Impaired loans: | ||||||||||||||||||||
| Commercial | 4,950 | - | - | 4,950 | - | |||||||||||||||
| Commercial real estate | 5,904 | - | - | 5,904 | - | |||||||||||||||
| Total assets measured at fair value on a nonrecurring basis | $ | 12,280 | $ | - | $ | - | $ | 12,280 | $ | (219 | ) | |||||||||
| For the | ||||||||||||||||||||
| Year Ended | ||||||||||||||||||||
| At December 31, 2016 | December 31, 2016 | |||||||||||||||||||
| Carrying Value | Level 1 | Level 2 | Level 3 | Total Losses | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Other real estate owned | $ | 3,095 | $ | - | $ | - | $ | 3,095 | $ | (705 | ) | |||||||||
| Impaired loans: | ||||||||||||||||||||
| Commercial | 5,115 | - | - | 5,115 | - | |||||||||||||||
| Commercial real estate | 4,410 | - | - | 4,410 | - | |||||||||||||||
| Total assets measured at fair value on a nonrecurring basis | $ | 12,620 | $ | - | $ | - | $ | 12,620 | $ | (705 | ) | |||||||||
Level 3 – Valuation is based upon present value of expected future cash flows, independent market prices, estimated liquidation values of loan collateral or appraised value of the collateral as determined by third-party independent appraisers, less 10% for selling costs, generally. Level 3 includes other real estate owned that has been measured at fair value upon transfer to foreclosed assets and impaired loans collateralized by real property and other business asset collateral where a specific reserve has been established or a chargeoff has been recorded. Losses on other real estate owned represent losses recognized in earnings during the period subsequent to its initial classification as foreclosed assets. The unobservable inputs and qualitative information about the unobservable inputs are not presented as the inputs were not developed by the Company.
Disclosures about Fair Value of Financial Instruments
The following section describes the valuation methodologies used by the Company for estimating fair value of financial instruments not recorded at fair value in the balance sheet.
Cash and Due from Banks Cash and due from banks represent U.S. dollar denominated coin and currency, deposits at the Federal Reserve Bank and correspondent banks, and amounts being settled with other banks to complete the processing of customers’ daily transactions. Collectively, the Federal Reserve Bank and financial institutions operate in a market in which cash and due from banks transactions are processed continuously in significant daily volumes honoring the face value of the U.S. dollar.
Investment Securities Held to Maturity The fair values of investment securities were estimated using quoted prices as described above for Level 2 valuation.
Loans Loans were separated into two groups for valuation. Variable rate loans, except for those described below, which reprice frequently with changes in market rates were valued using historical cost. Fixed rate loans and variable rate loans that have reached their minimum contractual interest rates were valued by discounting the future cash flows expected to be received from the loans using current interest rates charged on loans with similar characteristics. Additionally, the allowance for loan losses of $23,009 thousand at December 31, 2017 and $25,954 thousand at December 31, 2016 was applied against the estimated fair values to recognize estimated future defaults of contractual cash flows.
| - 79 - |
Deposit Liabilities Deposits with no stated maturity such as checking accounts, savings accounts and money market accounts can be readily converted to cash or used to settle transactions at face value through the broad financial system operated by the Federal Reserve Bank and financial institutions. The fair value of deposits with no stated maturity is equal to the amount payable on demand. The fair values of time deposits were estimated by discounting estimated future contractual cash flows using current market rates for financial instruments with similar characteristics.
Short-Term Borrowed Funds The carrying amount of securities sold under agreement to repurchase and other short-term borrowed funds approximate fair value due to the relatively short period of time between their origination and their expected realization.
The table below is a summary of fair value estimates for financial instruments and the level of the fair value hierarchy within which the fair value measurements are categorized, excluding financial instruments recorded at fair value on a recurring basis. The values assigned do not necessarily represent amounts which ultimately may be realized for assets or paid to settle liabilities. In addition, these values do not give effect to adjustments to fair value which may occur when financial instruments are sold or settled in larger quantities. The carrying amounts in the following table are recorded in the balance sheet under the indicated captions.
The Company has not included assets and liabilities that are not financial instruments, such as goodwill, long-term relationships with deposit, merchant processing and trust customers, other purchased intangibles, premises and equipment, deferred taxes and other assets and liabilities. The total estimated fair values do not represent, and should not be construed to represent, the underlying value of the Company.
| At December 31, 2017 | ||||||||||||||||||||
| Carrying Amount | Estimated Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2 ) | Significant Unobservable Inputs (Level 3 ) | ||||||||||||||||
| Financial Assets: | (In thousands) | |||||||||||||||||||
| Cash and due from banks | $ | 575,002 | $ | 575,002 | $ | 575,002 | $ | - | $ | - | ||||||||||
| Investment securities held to maturity | 1,158,864 | 1,155,342 | - | 1,155,342 | - | |||||||||||||||
| Loans | 1,264,973 | 1,257,811 | - | - | 1,257,811 | |||||||||||||||
| Financial Liabilities: | ||||||||||||||||||||
| Deposits | $ | 4,827,613 | $ | 4,824,586 | $ | - | $ | 4,595,795 | $ | 228,791 | ||||||||||
| Short-term borrowed funds | 58,471 | 58,471 | - | 58,471 | - | |||||||||||||||
| At December 31, 2016 | ||||||||||||||||||||
| Carrying Amount | Estimated Fair Value | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2 ) | Significant Unobservable Inputs (Level 3 ) | ||||||||||||||||
| Financial Assets: | (In thousands) | |||||||||||||||||||
| Cash and due from banks | $ | 462,271 | $ | 462,271 | $ | 462,271 | $ | - | $ | - | ||||||||||
| Investment securities held to maturity | 1,346,312 | 1,340,741 | - | 1,340,741 | - | |||||||||||||||
| Loans | 1,326,757 | 1,337,774 | - | - | 1,337,774 | |||||||||||||||
| Financial Liabilities: | ||||||||||||||||||||
| Deposits | $ | 4,704,741 | $ | 4,702,797 | $ | - | $ | 4,448,571 | $ | 254,226 | ||||||||||
| Short-term borrowed funds | 59,078 | 59,078 | - | 59,078 | - | |||||||||||||||
The majority of the Company’s standby letters of credit and other commitments to extend credit carry current market interest rates if converted to loans. No premium or discount was ascribed to these commitments because virtually all funding would be at current market rates.
| - 80 - |
Note 12: Lease Commitments
Twenty nine banking offices and a centralized administrative service center are owned and 58 facilities are leased. Substantially all the leases contain renewal options and provisions for rental increases, principally for cost of living index. The Company also leases certain pieces of equipment.
Minimum future rental payments under noncancelable operating leases as of December 31, 2017 are as follows:
| Minimum future rental payments | ||||
| (In thousands) | ||||
| 2018 | $ | 6,481 | ||
| 2019 | 4,882 | |||
| 2020 | 3,143 | |||
| 2021 | 1,462 | |||
| 2022 | 732 | |||
| Thereafter | 825 | |||
| Total minimum lease payments | $ | 17,525 | ||
The total minimum future rental payments have not been reduced by minimum sublease rentals of $2,088 thousand due in the future under noncancelable subleases. Total rentals for premises were $6,695 thousand in 2017, $6,823 thousand in 2016 and $8,359 thousand in 2015. Total sublease rentals were $406 thousand in 2017, $435 thousand in 2016 and $1,721 thousand in 2015. Total rentals for premises, net of sublease income, included in noninterest expense were $6,289 thousand in 2017, $6,388 thousand in 2016 and $6,638 thousand in 2015.
Note 13: Commitments and Contingent Liabilities
Loan commitments are agreements to lend to a customer provided there is no violation of any condition established in the agreement. Commitments generally have fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future funding requirements. Loan commitments are subject to the Company’s normal credit policies and collateral requirements. Unfunded loan commitments were $272,646 thousand and $304,508 thousand at December 31, 2017 and 2016, respectively. Standby letters of credit commit the Company to make payments on behalf of customers when certain specified future events occur. Standby letters of credit are primarily issued to support customers’ short-term financing requirements and must meet the Company’s normal credit policies and collateral requirements. Financial and performance standby letters of credit outstanding totaled $19,263 thousand and $21,732 thousand at December 31, 2017 and 2016, respectively. The Company had no commitments outstanding for commercial and similar letters of credit at December 31, 2017 and 2016. The Company had a reserve for unfunded commitments of $2,308 thousand at December 31, 2017 and $2,408 thousand at December 31, 2016, included in other liabilities.
Due to the nature of its business, the Company is subject to various threatened or filed legal cases. Based on the advice of legal counsel, the Company does not expect such cases will have a material, adverse effect on its financial position or results of operations. Legal liabilities are accrued when obligations become probable and the amount can be reasonably estimated.
The Company has determined that it will be obligated to provide refunds of revenue recognized in prior years to some customers. The Company estimates the probable amount of these obligations will be $5,542 thousand and has accrued a liability for such amount; the estimated liability is subject to revision.
The October 2017 California wildfires have disrupted operations in the Company's geographic footprint mainly due to temporary power outages, unhealthy air quality, and evacuations affecting some branches and an operations center. The Company maintains secondary power generation capability at its principal operations center. The Company maintains, and regularly tests, disaster recovery plans and protocols to be prepared for disasters such as these wildfires. The Company has not experienced a casualty loss as of the date of this report, but does carry customary casualty insurance to protect against such risk.
Management has performed an initial evaluation of loss exposure caused by the wildfires within the Company's loan portfolio and investment portfolio; Management has not identified any increased risk of loss, however, continuing Management evaluations and further wildfire developments could result in identification of losses which are not currently apparent.
| - 81 - |
Note 14: Retirement Benefit Plans
The Company sponsors a qualified defined contribution Deferred Profit-Sharing Plan covering substantially all of its salaried employees with one or more years of service. The costs charged to noninterest expense related to discretionary Company contributions to the Deferred Profit-Sharing Plan were $944 thousand in 2017, $1,000 thousand in 2016 and $734 thousand in 2015.
The Company also sponsors a qualified defined contribution Tax Deferred Savings/Retirement Plan (ESOP) covering salaried employees who become eligible to participate upon completion of a 90-day introductory period. The Tax Deferred Savings/ Retirement Plan (ESOP) allows employees to defer, on a pretax or after-tax basis, a portion of their salaries as contributions to this Plan. Participants may invest in several funds, including one fund that invests primarily in Westamerica Bancorporation common stock. The Company funds contributions to match participating employees’ contributions, subject to certain limits. The matching contributions charged to compensation expense were $1,098 thousand in 2017, $1,075 thousand in 2016 and $1,147 thousand in 2015.
The Company offers a continuation of group insurance coverage to eligible employees electing early retirement, for the period from the date of retirement until age 65. For eligible employees the Company pays a portion of these early retirees’ group insurance premiums. The Company also reimburses a portion of Medicare Part B premiums for all qualifying retirees over age 65 and, if eligible, their spouses. Eligibility for post-retirement medical benefits is based on age and years of service, and restricted to employees hired prior to February 1, 2006 who elect early retirement prior to January 1, 2019. The Company uses an actuarial-based accrual method of accounting for post-retirement benefits. The Company used a December 31 measurement date for determining post-retirement medical benefit calculations.
The following tables set forth the net periodic post-retirement benefit cost and the change in the benefit obligation for the years ended December 31 and the funded status of the post-retirement benefit plan as of December 31:
Net Periodic Benefit Cost
| At December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Service benefit | $ | (311 | ) | $ | (153 | ) | $ | (202 | ) | |||
| Interest cost | 95 | 108 | 106 | |||||||||
| Amortization of unrecognized transition obligation | 61 | 61 | 61 | |||||||||
| Net periodic (benefit) cost | $ | (155 | ) | $ | 16 | $ | (35 | ) | ||||
Other Changes in Benefit Obligations Recognized in Other Comprehensive Income
| Amortization of unrecognized transition obligation, net of tax | (34 | ) | (36 | ) | (36 | ) | ||||||
| Total recognized in net periodic (benefit) cost and accumulated other comprehensive income | $ | (189 | ) | $ | (20 | ) | $ | (71 | ) |
The transition obligation for this post-retirement benefit plan became fully amortized during the twelve months ended December, 2017.
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| - 82 - |
Obligation and Funded Status
| At December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| Change in benefit obligation | (In thousands) | |||||||||||
| Benefit obligation at beginning of year | $ | 2,319 | $ | 2,522 | $ | 2,782 | ||||||
| Service benefit | $ | (311 | ) | $ | (153 | ) | (202 | ) | ||||
| Interest cost | 95 | 108 | 106 | |||||||||
| Benefits paid | (145 | ) | (158 | ) | (164 | ) | ||||||
| Benefit obligation at end of year | $ | 1,958 | $ | 2,319 | $ | 2,522 | ||||||
| Accumulated post-retirement benefit obligation attributable to: | ||||||||||||
| Retirees | $ | 1,575 | $ | 1,705 | $ | 1,695 | ||||||
| Fully eligible participants | 382 | 606 | 809 | |||||||||
| Other | 1 | 8 | 18 | |||||||||
| Total | $ | 1,958 | $ | 2,319 | $ | 2,522 | ||||||
| Fair value of plan assets | - | - | - | |||||||||
| Accumulated post-retirement benefit obligation in excess of plan assets | $ | 1,958 | $ | 2,319 | $ | 2,522 | ||||||
Additional Information
Assumptions
| At December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| Weighted-average assumptions used to determine benefit obligations | ||||||||||||
| Discount rate | 3.70 | % | 4.10 | % | 4.30 | % | ||||||
| Weighted-average assumptions used to determine net periodic benefit cost | ||||||||||||
| Discount rate | 4.10 | % | 4.30 | % | 3.80 | % | ||||||
The above discount rate is based on the Corporate Aa 25-year rate, the term of which approximates the term of the benefit obligations. The Company reserves the right to terminate or alter post-employment health benefits. Post-retirement medical benefits are currently fixed amounts without provision for future increases; as a result, the assumed annual average rate of inflation used to measure the expected cost of benefits covered by this program is zero percent for 2017 and beyond.
Assumed benefit inflation rates are not applicable for this program.
| Estimated future benefit payments | ||||
| (In thousands) | ||||
| 2018 | $ | 138 | ||
| 2019 | 131 | |||
| 2020 | 124 | |||
| 2021 | 118 | |||
| 2022 | 112 | |||
| Years 2023-2027 | 482 | |||
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| - 83 - |
Note 15: Related Party Transactions
Certain of the Directors, executive officers and their associates have had banking transactions with subsidiaries of the Company in the ordinary course of business. In Management’s opinion, with the exception of the Company’s Employee Loan Program, all outstanding loans and commitments included in such transactions were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons, did not involve more than a normal risk of collectability, and did not present other favorable features. As part of the Employee Loan Program, all employees, including executive officers, are eligible to receive mortgage loans at one percent below Westamerica Bank’s prevailing interest rate at the time of loan origination. In Management’s opinion, all loans to executive officers under the Employee Loan Program are made by Westamerica Bank in compliance with the applicable restrictions of Section 22(h) of the Federal Reserve Act.
The table below reflects information concerning loans to certain directors and executive officers and/or family members during 2017 and 2016:
| 2017 | 2016 | |||||||
| (In thousands) | ||||||||
| Balance at January 1, | $ | 867 | $ | 911 | ||||
| Originations | - | - | ||||||
| Principal reductions | $ | (245 | ) | (44 | ) | |||
| Balance at December 31, | $ | 622 | $ | 867 | ||||
| Percent of total loans outstanding. | 0.05 | % | 0.06 | % | ||||
Note 16: Regulatory Matters
Payment of dividends to the Company by the Bank is limited under regulations for state chartered banks. The amount that can be paid in any calendar year, without prior approval from regulatory agencies, cannot exceed the net profits (as defined) for the preceding three calendar years less dividends paid. Under this regulation, the Bank obtained approval for dividends paid to the Company during 2017. The Company consistently has paid quarterly dividends to its shareholders since its formation in 1972.
The Bank is required to maintain reserves with the Federal Reserve Bank equal to a percentage of its reservable deposits. The Bank’s daily average on deposit at the Federal Reserve Bank was $458,186 thousand in 2017 and $365,880 thousand in 2016, which amounts exceed the Bank’s required reserves.
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| - 84 - |
Note 17: Other Comprehensive Income
The components of other comprehensive (loss) income and other related tax effects were:
| 2017 | ||||||||||||
| Before tax | Tax effect | Net of tax | ||||||||||
| (In thousands) | ||||||||||||
| Securities available for sale: | ||||||||||||
| Net unrealized losses arising during the year | $ | (3,767 | ) | $ | 1,585 | $ | (2,182 | ) | ||||
| Reclassification of gains included in net income | (7,955 | ) | 3,345 | (4,610 | ) | |||||||
| Net unrealized losses arising during the year | (11,722 | ) | 4,930 | (6,792 | ) | |||||||
| Post-retirement benefit obligation | 59 | (25 | ) | 34 | ||||||||
| Other comprehensive loss | $ | (11,663 | ) | $ | 4,905 | $ | (6,758 | ) | ||||
| 2016 | ||||||||||||
| Before tax | Tax effect | Net of tax | ||||||||||
| (In thousands) | ||||||||||||
| Securities available for sale: | ||||||||||||
| Net unrealized losses arising during the year | $ | (18,610 | ) | $ | 7,825 | $ | (10,785 | ) | ||||
| Reclassification of gains (losses) included in net income | - | - | - | |||||||||
| Net unrealized losses arising during the year | (18,610 | ) | 7,825 | (10,785 | ) | |||||||
| Post-retirement benefit obligation | 61 | (25 | ) | 36 | ||||||||
| Other comprehensive loss | $ | (18,549 | ) | $ | 7,800 | $ | (10,749 | ) | ||||
| 2015 | ||||||||||||
| Before tax | Tax effect | Net of tax | ||||||||||
| (In thousands) | ||||||||||||
| Securities available for sale: | ||||||||||||
| Net unrealized losses arising during the year | $ | (8,028 | ) | $ | 3,375 | $ | (4,653 | ) | ||||
| Reclassification of gains (losses) included in net income | - | - | - | |||||||||
| Net unrealized losses arising during the year | (8,028 | ) | 3,375 | (4,653 | ) | |||||||
| Post-retirement benefit obligation | 61 | (25 | ) | 36 | ||||||||
| Other comprehensive loss | $ | (7,967 | ) | $ | 3,350 | $ | (4,617 | ) | ||||
Accumulated other comprehensive income (loss) balances were:
| Post-retirement Benefit Obligation | Net Unrealized Gains (losses) on Securities | Accumulated Other Comprehensive Income (loss) | ||||||||||
| (In thousands) | ||||||||||||
| Balance, December 31, 2014 | $ | (106 | ) | $ | 5,398 | $ | 5,292 | |||||
| Net change | 36 | (4,653 | ) | (4,617 | ) | |||||||
| Balance, December 31, 2015 | (70 | ) | 745 | 675 | ||||||||
| Net change | 36 | (10,785 | ) | (10,749 | ) | |||||||
| Balance, December 31, 2016 | (34 | ) | (10,040 | ) | (10,074 | ) | ||||||
| Net change | 34 | (6,792 | ) | (6,758 | ) | |||||||
| Balance, December 31, 2017 | $ | - | $ | (16,832 | ) | $ | (16,832 | ) | ||||
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| - 85 - |
Note 18: Earnings Per Common Share
The table below shows earnings per common share and diluted earnings per common share. Basic earnings per common share are computed by dividing net income by the average number of common shares outstanding during the period. Diluted earnings per common share are computed by dividing net income by the average number of common shares outstanding during the period plus the impact of common stock equivalents.
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands, except per share data) | ||||||||||||
| Net income (numerator) | $ | 50,025 | $ | 58,853 | $ | 58,753 | ||||||
| Basic earnings per common share | ||||||||||||
| Weighted average number of common shares outstanding - basic (denominator) | 26,291 | 25,612 | 25,555 | |||||||||
| Basic earnings per common share | $ | 1.90 | $ | 2.30 | $ | 2.30 | ||||||
| Diluted earnings per common share | ||||||||||||
| Weighted average number of common shares outstanding - basic | 26,291 | 25,612 | 25,555 | |||||||||
| Add common stock equivalents for options | 128 | 66 | 22 | |||||||||
| Weighted average number of common shares outstanding - diluted (denominator) | 26,419 | 25,678 | 25,577 | |||||||||
| Diluted earnings per common share | $ | 1.89 | $ | 2.29 | $ | 2.30 | ||||||
For the years ended December 31, 2017, 2016 and 2015, options to purchase 323 thousand, 773 thousand and 1,313 thousand shares of common stock, respectively, were outstanding but not included in the computation of diluted earnings per common share because the option exercise price exceeded the fair value of the stock such that their inclusion would have had an anti-dilutive effect.
Note 19: Westamerica Bancorporation (Parent Company Only Condensed Financial Information)
Statements of Income and Comprehensive Loss
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Dividends from subsidiaries | $ | 12,728 | $ | 56,824 | $ | 68,981 | ||||||
| Interest income | 43 | 25 | 10 | |||||||||
| Other income | 8,590 | 8,315 | 8,411 | |||||||||
| Total income | 21,361 | 65,164 | 77,402 | |||||||||
| Interest on borrowings | - | - | 1 | |||||||||
| Salaries and benefits | 7,163 | 7,079 | 6,291 | |||||||||
| Other expense | 3,416 | 3,290 | 3,424 | |||||||||
| Total expense | 10,579 | 10,369 | 9,716 | |||||||||
| Income before taxes and equity in undistributed income of subsidiaries | 10,782 | 54,795 | 67,686 | |||||||||
| Income tax benefit | 241 | 1,025 | 803 | |||||||||
| Earnings of subsidiaries greater (less) than subsidiary dividends | 39,002 | 3,033 | (9,736 | ) | ||||||||
| Net income | 50,025 | 58,853 | 58,753 | |||||||||
| Other comprehensive loss, net of tax | (6,758 | ) | (10,749 | ) | (4,617 | ) | ||||||
| Comprehensive income | $ | 43,267 | $ | 48,104 | $ | 54,136 | ||||||
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| - 86 - |
Balance Sheets
| At December 31, | ||||||||
| 2017 | 2016 | |||||||
| (In thousands) | ||||||||
| Assets | ||||||||
| Cash | $ | 53,409 | $ | 64,054 | ||||
| Investment securities available for sale | - | 656 | ||||||
| Investment in Westamerica Bank | 500,776 | 468,172 | ||||||
| Investment in non-bank subsidiaries | 455 | 455 | ||||||
| Premises and equipment, net | 9,639 | 9,165 | ||||||
| Accounts receivable from Westamerica Bank | 538 | 522 | ||||||
| Other assets | 40,547 | 34,077 | ||||||
| Total assets | $ | 605,364 | $ | 577,101 | ||||
| Liabilities | ||||||||
| Accounts payable to Westamerica Bank | $ | 92 | $ | 705 | ||||
| Other liabilities | 15,033 | 15,029 | ||||||
| Total liabilities | 15,125 | 15,734 | ||||||
| Shareholders' equity | 590,239 | 561,367 | ||||||
| Total liabilities and shareholders' equity | $ | 605,364 | $ | 577,101 | ||||
Statements of Cash Flows
| For the Years Ended December 31, | ||||||||||||
| 2017 | 2016 | 2015 | ||||||||||
| (In thousands) | ||||||||||||
| Operating Activities | ||||||||||||
| Net income | $ | 50,025 | $ | 58,853 | $ | 58,753 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
| Depreciation and amortization | 319 | 305 | 326 | |||||||||
| Decrease (increase) in accounts receivable from affiliates | (16 | ) | 299 | (217 | ) | |||||||
| Insurance premiums paid | (704 | ) | (683 | ) | (637 | ) | ||||||
| Increase in other assets | (1,499 | ) | (1,257 | ) | (1,076 | ) | ||||||
| Stock option compensation expense | 1,824 | 1,494 | 1,272 | |||||||||
| Tax benefit (increase) decrease upon exercise of stock options and expiration of stock options | - | (394 | ) | 1,284 | ||||||||
| Provision (benefit) for deferred income tax | (3,971 | ) | 1,983 | (491 | ) | |||||||
| Increase in other liabilities | 202 | 1,392 | 743 | |||||||||
| Earnings of subsidiaries (greater) less than subsidiary dividends | (39,002 | ) | (3,033 | ) | 9,736 | |||||||
| Gain on sales of property and equipment | (793 | ) | (79 | ) | (39 | ) | ||||||
| Net Cash Provided by Operating Activities | 6,385 | 58,880 | 69,654 | |||||||||
| Investing Activities | ||||||||||||
| Purchases of premises and equipment | - | - | - | |||||||||
| Net Cash Provided by Investing Activities | - | - | - | |||||||||
| Financing Activities | ||||||||||||
| Exercise of stock options/issuance of shares | 24,583 | 24,031 | 4,848 | |||||||||
| Taxes paid by withholding shares for tax purposes | - | (356 | ) | (357 | ) | |||||||
| Tax benefit increase (decrease) upon exercise of stock options and expiration of stock options | - | 394 | (1,284 | ) | ||||||||
| Retirement of common stock | (314 | ) | (5,424 | ) | (14,735 | ) | ||||||
| Dividends | (41,299 | ) | (39,924 | ) | (39,124 | ) | ||||||
| Net Cash Used in Financing Activities | (17,030 | ) | (21,279 | ) | (50,652 | ) | ||||||
| Net change in cash | (10,645 | ) | 37,601 | 19,002 | ||||||||
| Cash at Beginning of Period | 64,054 | 26,453 | 7,451 | |||||||||
| Cash at End of Period | $ | 53,409 | $ | 64,054 | $ | 26,453 | ||||||
| Supplemental Cash Flow Disclosures: | ||||||||||||
| Supplemental disclosure of cash flow activities: | ||||||||||||
| Interest paid for the period | $ | - | $ | - | $ | 1 | ||||||
| Income tax payments for the period | 17,351 | 19,264 | 17,666 | |||||||||
| - 87 |
Note 20: Quarterly Financial Information
(Unaudited)
| For the Three Months Ended | ||||||||||||||||
| March 31, | June 30, | September 30, | December 31, | |||||||||||||
| (In thousands, expect per share data and price range of common stock) | ||||||||||||||||
| 2017 | ||||||||||||||||
| Interest and loan fee income | $ | 33,324 | $ | 33,163 | $ | 33,145 | $ | 34,204 | ||||||||
| Net interest income | 32,844 | 32,687 | 32,672 | 33,733 | ||||||||||||
| (Reversal of) provision for loan losses | - | (1,900 | ) | - | - | |||||||||||
| Noninterest income | 11,657 | 12,123 | 12,548 | 20,300 | ||||||||||||
| Noninterest expense | 24,615 | 24,396 | 24,114 | 30,167 | ||||||||||||
| Income before taxes | 19,886 | 22,314 | 21,106 | 23,866 | ||||||||||||
| Net income | 15,049 | 15,799 | 15,017 | 4,160 | ||||||||||||
| Basic earnings per common share | 0.58 | 0.60 | 0.57 | 0.16 | ||||||||||||
| Diluted earnings per common share | 0.57 | 0.60 | 0.57 | 0.16 | ||||||||||||
| Dividends paid per common share | 0.39 | 0.39 | 0.39 | 0.40 | ||||||||||||
| Price range, common stock | 54.12 - 64.07 | 51.31 - 57.78 | 49.54 - 59.54 | 53.96 - 63.03 | ||||||||||||
| 2016 | ||||||||||||||||
| Interest and loan fee income | $ | 33,647 | $ | 33,727 | $ | 33,468 | $ | 33,209 | ||||||||
| Net interest income | 33,095 | 33,186 | 32,945 | 32,709 | ||||||||||||
| (Reversal of) provision for loan losses | - | - | (3,200 | ) | - | |||||||||||
| Noninterest income | 11,729 | 11,702 | 11,598 | 11,545 | ||||||||||||
| Noninterest expense | 25,858 | 25,229 | 26,088 | 24,577 | ||||||||||||
| Income before taxes | 18,966 | 19,659 | 21,655 | 19,677 | ||||||||||||
| Net income | 14,226 | 14,546 | 15,628 | 14,453 | ||||||||||||
| Basic earnings per common share | 0.56 | 0.57 | 0.61 | 0.56 | ||||||||||||
| Diluted earnings per common share | 0.56 | 0.57 | 0.61 | 0.56 | ||||||||||||
| Dividends paid per common share | 0.39 | 0.39 | 0.39 | 0.39 | ||||||||||||
| Price range, common stock | 40.72 - 49.63 | 45.86 - 51.53 | 46.61 - 50.96 | 48.20 - 65.34 | ||||||||||||
| 2015 | ||||||||||||||||
| Interest and loan fee income | $ | 33,917 | $ | 34,425 | $ | 34,299 | $ | 33,888 | ||||||||
| Net interest income | 33,258 | 33,808 | 33,714 | 33,325 | ||||||||||||
| Provision for loan losses | - | - | - | - | ||||||||||||
| Noninterest income | 12,300 | 12,269 | 11,993 | 11,305 | ||||||||||||
| Noninterest expense | 26,727 | 26,896 | 26,173 | 25,504 | ||||||||||||
| Income before taxes | 18,831 | 19,181 | 19,534 | 19,126 | ||||||||||||
| Net income | 14,557 | 14,761 | 14,857 | 14,578 | ||||||||||||
| Basic earnings per common share | 0.57 | 0.58 | 0.58 | 0.57 | ||||||||||||
| Diluted earnings per common share | 0.57 | 0.58 | 0.58 | 0.57 | ||||||||||||
| Dividends paid per common share | 0.38 | 0.38 | 0.38 | 0.39 | ||||||||||||
| Price range, common stock | 40.68 - 48.44 | 42.70 - 51.69 | 43.00 - 51.90 | 42.96 - 49.64 | ||||||||||||
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| - 88 - |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and the Board of Directors of Westamerica Bancorporation
San Rafael, California
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Westamerica Bancorporation (the "Company") as of December 31, 2017 and 2016, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2017 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2017, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
| - 89 - |
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Crowe Horwath LLP
Crowe Horwath LLP
We have served as the Company's auditor since 2015.
Sacramento, California
February 27, 2018
| - 90 - |
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company’s principal executive officer and principal financial officer have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, as of December 31, 2017.
Based upon their evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective to ensure that material information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported as and when required and that such information is communicated to the Company’s management, including the principal executive officer and the principal financial officer, to allow for timely decisions regarding required disclosures. The evaluation did not identify any change in the Company’s internal control over financial reporting that occurred during the quarter ended December 31, 2017 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting. Management’s Report on Internal Control Over Financial Reporting and the attestation Report of Independent Registered Public Accounting Firm are found on pages 46 and 89, respectively.
None.
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| - 91 - |
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS OF THE REGISTRANT AND CORPORATE GOVERNANCE
The information regarding Directors of the Registrant and compliance with Section 16(a) of the Securities Exchange Act of 1934 required by this Item 10 of this Annual Report on Form 10-K is incorporated by reference from the information contained under the captions “Board of Directors and Committees”, “Proposal 1 — Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s Proxy Statement for its 2018 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.
Executive Officers
The executive officers of the Company and Westamerica Bank serve at the pleasure of the Board of Directors and are subject to annual appointment by the Board at its first meeting following the Annual Meeting of Shareholders. It is anticipated that each of the executive officers listed below will be reappointed to serve in such capacities at that meeting.
Name of Executive |
Position |
Held Since | ||
| David L. Payne | Mr. Payne, born in 1955, is the Chairman of the Board, President and Chief Executive Officer of the Company. Mr. Payne is President and Chief Executive Officer of Gibson Printing and Publishing Company and Gibson Radio and Publishing Company which are newspaper, commercial printing and real estate investment companies headquartered in Vallejo, California. | 1984 | ||
| John “Robert” Thorson | Mr. Thorson, born in 1960, is Senior Vice President and Chief Financial Officer for the Company. Mr. Thorson joined Westamerica Bancorporation in 1989, was Vice President and Manager of Human Resources from 1995 until 2001 and was Senior Vice President and Treasurer from 2002 until 2005. | 2005 | ||
| Dennis R. Hansen | Mr. Hansen, born in 1950, is Senior Vice President and Manager of the Operations and Systems Administration of Community Banker Services Corporation. Mr. Hansen joined Westamerica Bancorporation in 1978 and was Senior Vice President and Controller for the Company until 2005. | 2005 | ||
| Russell W. Rizzardi | Mr. Rizzardi, born in 1955, is Senior Vice President and Chief Credit Administrator of Westamerica Bank. Mr. Rizzardi joined Westamerica Bank in 2007. He has been in the banking industry since 1979 and was previously with Wells Fargo Bank and U.S. Bank. | 2008 |
The Company has adopted a Code of Ethics (as defined in Item 406 of Regulation S-K of the Securities Act of 1933) that is applicable to its senior financial officers including its chief executive officer, chief financial officer, and principal accounting officer.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item 11 of this Annual Report on Form 10-K is incorporated by reference from the information contained under the captions “Executive Compensation” in the Company’s Proxy Statement for its 2018 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.
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| - 92 - |
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item 12 of this Annual Report on Form 10-K is incorporated by reference from the information contained under the caption “Stock Ownership” in the Company’s Proxy Statement for its 2018 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.
Securities Authorized For Issuance Under Equity Compensation Plans
The following table summarizes the status of the Company’s equity compensation plans as of December 31, 2017:
| At December 31, 2017 | ||||||||||||
| Plan category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |||||||||
| (In thousands, except exercise price) | ||||||||||||
| (a) | (b) | (c) | ||||||||||
| Equity compensation plans approved by security holders | 1,030 | $ | 49 | 930 | ||||||||
| Equity compensation plans not approved by security holders | - | N/A | - | |||||||||
| Total | 1,030 | $ | 49 | 930 | ||||||||
ITEM 13. CERTAIN RELATIONSHIPS, RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information required by this Item 13 of this Annual Report on Form 10-K is incorporated by reference from the information contained under the caption “Certain Relationships and Related Party Transactions” in the Company’s Proxy Statement for its 2018 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item 14 of this Annual Report on Form 10-K is incorporated by reference from the information contained under the caption “Proposal 3 – Ratification of Independent Auditor” in the Company’s Proxy Statement for its 2018 Annual Meeting of Shareholders which will be filed pursuant to Regulation 14A of the Securities Exchange Act of 1934.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
| (a) | 1. | Financial Statements:
See Index to Financial Statements on page 45. The consolidated financial statements included in Item 8 are filed as part of this Report.
|
| (a) | 2. | Financial statement schedules required. No financial statement schedules are filed as part of this Report since the required information is included in the consolidated financial statements, including the notes thereto, or the circumstances requiring inclusion of such schedules are not present.
|
| (a) | 3. | Exhibits:
The exhibit list required by this item is incorporated by reference to the Exhibit Index filed with this Report. |
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
WESTAMERICA BANCORPORATION
/s/ John “Robert” Thorson
John “Robert” Thorson
Senior Vice President
and Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: February 27, 2018
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.
| Signature | Title | Date | ||
|
/s/ David L. Payne David L. Payne |
Chairman of the Board and Directors President and Chief Executive Officer (Principal Executive Officer)
|
February 27, 2018 | ||
/s/ John “Robert” Thorson John “Robert” Thorson |
Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)
|
February 27, 2018 | ||
/s/ Etta Allen Etta Allen |
Director
|
February 27, 2018 | ||
/s/ Louis E. Bartolini Louis E. Bartolini |
Director
|
February 27, 2018 | ||
/s/ E. Joseph Bowler E. Joseph Bowler |
Director
|
February 27, 2018 | ||
/s/ Arthur C. Latno, Jr. Arthur C. Latno, Jr. |
Director
|
February 27, 2018 | ||
/s/ Patrick D. Lynch Patrick D. Lynch |
Director
|
February 27, 2018 | ||
/s/ Catherine C. MacMillan Catherine C. MacMillan |
Director
|
February 27, 2018 | ||
/s/ Ronald A. Nelson Ronald A. Nelson |
Director
|
February 27, 2018 | ||
/s/ Edward B. Sylvester Edward B. Sylvester |
Lead Independent Director
|
February 27, 2018 |
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Exhibit Number |
|
| 3(a) | Restated Articles of Incorporation (composite copy), incorporated by reference to Exhibit 3(a) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1997, filed with the Securities and Exchange Commission on March 30, 1998. |
| 3(b) | By-laws, as amended (composite copy), incorporated by reference to Exhibit 3.2 to the Registrant’s Form 8-K, filed with the Securities and Exchange Commission on December 19, 2016. |
| 3(c) | Certificate of Determination of Fixed Rate Cumulative Perpetual Preferred Stock, Series A of Westamerica Bancorporation dated February 10, 2009, incorporated by reference to Exhibit 99.1 to the Registrant’s Form 8-K, filed with the Securities and Exchange Commission on February 13, 2009. |
| 4(c) | Warrant to Purchase Common Stock pursuant to the Letter Agreement between the Company and the United States Department of the Treasury dated February 13, 2009 incorporated by reference to Exhibit 4.2 to the Registrant’s Form 8-K, filed with the Securities and Exchange Commission on February 19, 2009. |
| 10(a)* | Amended and Restated Stock Option Plan of 1995, incorporated by reference to Exhibit A to the Registrant’s definitive Proxy Statement pursuant to Regulation 14(a) filed with the Securities and Exchange Commission on March 17, 2003. |
| 10(d)* | Westamerica Bancorporation Chief Executive Officer Deferred Compensation Agreement by and between Westamerica Bancorporation and David L. Payne, dated December 18, 1998 incorporated by reference to Exhibit 10(e) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 1999, filed with the Securities and Exchange Commission on March 29, 2000. |
| 10(e)* | Description of Executive Cash Bonus Program incorporated by reference to Exhibit 10(e) to Exhibit 2.1 of Registrant’s Form 8-K filed with the Securities and Exchange Commission on March 14, 2005. |
| 10(f)* | Non-Qualified Annuity Performance Agreement with David L. Payne dated November 19, 1997 incorporated by reference to Exhibit 10(f) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, filed with the Securities and Exchange Commission on March 15, 2005. |
| 10(g)* | Amended and Restated Westamerica Bancorporation Stock Option Plan of 1995 Nonstatutory Stock Option Agreement Form incorporated by reference to Exhibit 10(g) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, filed with the Securities and Exchange Commission on March 15, 2005. |
| 10(h)* | Amended and Restated Westamerica Bancorporation Stock Option Plan of 1995 Restricted Performance Share Grant Agreement Form incorporated by reference to Exhibit 10(h) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2004, filed with the Securities and Exchange Commission on March 15, 2005. |
| 10(i)* | Amended Westamerica Bancorporation and Subsidiaries Deferred Compensation Plan (As restated effective January 1, 2005) dated December 31, 2008 incorporated by reference to Exhibit 10(i) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008, filed with the Securities and Exchange Commission on February 27, 2009. |
| 10(j)* | Amended and Restated Westamerica Bancorporation Deferral Plan (Adopted October 26, 1995) dated December 31, 2008 incorporated by reference to Exhibit 10(j) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008, filed with the Securities and Exchange Commission on February 27, 2009. |
| 10(k)* | Form of Restricted Performance Share Deferral Election pursuant to the Westamerica Bancorporation Deferral Plan incorporated by reference to Exhibit 10(i) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005, filed with the Securities and Exchange Commission on March 10, 2006. |
| 10(l) | Purchase and Assumption Agreement by and between Federal Deposit Insurance Corporation and Westamerica Bank dated February 6, 2009, incorporated by reference to Exhibit 99.2 to the Registrant’s Form 8-K, filed with the Securities and Exchange Commission on February 11, 2009. |
| 10(m) | Letter Agreement between the Company and the United States Department of the Treasury dated February 13, 2009 incorporated by reference to Exhibit 10.1 to the Registrant’s Form 8-K, filed with the Securities and Exchange Commission on February 19, 2009. |
| 10(s)* | Amended and Restated Stock Option Plan of 1995, incorporated by reference to Exhibit A to the Registrant’s definitive Proxy Statement pursuant to Regulation 14(a) filed with the Securities and Exchange Commission on March 13, 2012. |
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|
Data Processing Agreement by and between Fidelity Information Services and Westamerica Bancorporation incorporated by reference to Exhibit 10(t) to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, filed with the Securities and Exchange Commission on February 28, 2017. |
| 11.1 | Statement re computation of per share earnings incorporated by reference to Note 18 of the notes to the consolidated financial statements of this Report. |
| 14 | Code of Ethics incorporated by reference to Exhibit 14 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, filed with the Securities and Exchange Commission on March 10, 2004. |
| 21 | Subsidiaries of the registrant. |
| 23.1 | Consent of Crowe Horwath LLP |
| 31.1 | Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a) |
| 31.2 | Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a) |
| 32.1 | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2 | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 101** | Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company’s Annual Report on Form 10-K for the period ended December 31, 2017, is formatted in XBRL interactive data files: (i) consolidated statements of income for each of the years in the three-year period ended December 31, 2017; (ii) consolidated balance sheets at December 31, 2017, and December 31, 2016; (iii) consolidated statements of comprehensive income for each of the years in the three-year period ended December 31, 2017, (iv) consolidated statements of changes in shareholders’ equity for each of the years in the three-year period ended December 31, 2017; (v) consolidated statements of cash flows for each of the years in the three-year period ended December 31, 2017 and (vi) notes to consolidated financial statements. |
____________
| * | Indicates management contract or compensatory plan or arrangement. |
| ** | As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934. |
The exhibits listed above are available through the SEC’s website (https://www.sec.gov). Alternatively, the Company will furnish to shareholders a copy of any exhibit listed above, but not contained herein, upon written request to the Office of the Corporate Secretary A-2M, Westamerica Bancorporation, P.O. Box 1200, Suisun City, California 94585-1200, and payment to the Company of $.25 per page.
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