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WESTAMERICA BANCORPORATION - Quarter Report: 2016 June (Form 10-Q)

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2016

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 Registrant as Specified in Its Charter)

 

CALIFORNIA 94-2156203
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)

 

 

1108 FIFTH AVENUE, SAN RAFAEL, CALIFORNIA 94901

(Address of Principal Executive Offices) (Zip Code)

 

Registrant's Telephone Number, Including Area Code (707) 863-6000

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically 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 (§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 whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ☒ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☐
  (Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes ☐ No ☒

 

Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date:

 

Title of Class Shares outstanding as of July 25, 2016
   
Common Stock, 25,631,709
No Par Value  

 

 

 

TABLE OF CONTENTS

 

 

     Page 
Forward Looking Statements  3
PART I - FINANCIAL INFORMATION  
Item 1 Financial Statements  4
Notes to Unaudited Consolidated Financial Statements   9
Financial Summary  29
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations  30
Item 3 Quantitative and Qualitative Disclosures about Market Risk  51
Item 4 Controls and Procedures  51
PART II - OTHER INFORMATION  
Item 1 Legal Proceedings  52
Item 1A Risk Factors  52
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds  52
Item 3 Defaults upon Senior Securities   53
Item 4 Mine Safety Disclosures    53
Item 5 Other Information  53
Item 6 Exhibits  53
Signatures  54
Exhibit Index  55
Exhibit 31.1 - Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a)  56
Exhibit 31.2 - Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a)  57
Exhibit 32.1 - Certification of Chief Executive Officer Required by 18 U.S.C. Section 1350  58
Exhibit 32.2 - Certification of Chief Financial Officer Required by 18 U.S.C. Section 1350  59

 

 

 

 

 

 

-2

 

FORWARD-LOOKING STATEMENTS

 

This report on Form 10-Q contains forward-looking statements about Westamerica Bancorporation (the “Company”) 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 the reduction, mitigation of risk in the Company’s loan and investment 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, fire, flood, drought, and other disasters, on the uninsured value 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. The reader is directed to the Company's annual report on Form 10-K for the year ended December 31, 2015, for further discussion of factors which could affect the Company's business and cause actual results to differ materially from those expressed in any forward-looking statement made in this report. However, the reader should not consider these 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.

 

 

 

-3

 

PART I - FINANCIAL INFORMATION

Item 1 Financial Statements

 

WESTAMERICA BANCORPORATION

CONSOLIDATED BALANCE SHEETS

(unaudited)

 

   At June 30,
2016
  At December 31,
2015
   (In thousands)
Assets:          
Cash and due from banks  $441,785   $433,044 
Investment securities available for sale   1,531,035    1,570,216 
Investment securities held to maturity, with fair values of: $1,507,177 at June 30, 2016 and $1,325,699 at December 31, 2015   1,473,357    1,316,075 
Loans   1,429,560    1,533,396 
Allowance for loan losses   (28,910)   (29,771)
Loans, net of allowance for loan losses   1,400,650    1,503,625 
Other real estate owned   4,162    9,264 
Premises and equipment, net   37,759    38,693 
Identifiable intangibles, net   8,656    10,431 
Goodwill   121,673    121,673 
Other assets   160,008    165,854 
Total Assets  $5,179,085   $5,168,875 
           
Liabilities:          
Noninterest bearing deposits  $1,978,947   $2,026,049 
Interest bearing deposits   2,506,367    2,514,610 
Total deposits   4,485,314    4,540,659 
Short-term borrowed funds   67,852    53,028 
Other liabilities   67,592    42,983 
Total Liabilities   4,620,758    4,636,670 
           
Shareholders' Equity:          
Common stock (no par value), authorized - 150,000 shares Issued and outstanding: 25,632 at June 30, 2016 and 25,528 at December 31, 2015   389,680    378,858 
Deferred compensation   1,533    2,578 
Accumulated other comprehensive income   11,885    675 
Retained earnings   155,229    150,094 
Total Shareholders' Equity   558,327    532,205 
Total Liabilities and Shareholders' Equity  $5,179,085   $5,168,875 

 

See accompanying notes to unaudited consolidated financial statements.

 

-4

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

 

   For the Three Months  For the Six Months
   Ended June 30,
   2016  2015  2016  2015
   (In thousands, except per share data)
Interest and Fee Income:                    
Loans  $17,583   $20,035   $35,936   $40,265 
Investment securities available for sale   8,091    7,999    16,058    15,468 
Investment securities held to maturity   8,053    6,391    15,380    12,609 
Total Interest and Fee Income   33,727    34,425    67,374    68,342 
Interest Expense:                    
Deposits   531    601    1,074    1,243 
Short-term borrowed funds   10    16    19    32 
Federal Home Loan Bank advances   -    -    -    1 
Total Interest Expense   541    617    1,093    1,276 
Net Interest and Fee Income   33,186    33,808    66,281    67,066 
Provision for Loan Losses   -    -    -    - 
Net Interest and Fee Income After Provision For Loan Losses   33,186    33,808    66,281    67,066 
Noninterest Income:                    
Service charges on deposit accounts   5,239    5,694    10,487    11,401 
Merchant processing services   1,638    1,783    3,167    3,486 
Debit card fees   1,621    1,534    3,137    2,990 
Trust fees   657    672    1,318    1,378 
Other service fees   650    683    1,279    1,348 
ATM processing fees   603    627    1,261    1,212 
Financial services commissions   137    198    293    351 
Other noninterest income   1,157    1,078    2,489    2,403 
Total Noninterest Income   11,702    12,269    23,431    24,569 
Noninterest Expense:                    
Salaries and related benefits   12,887    13,696    26,004    27,034 
Occupancy   3,400    3,726    6,798    7,453 
Outsourced data processing services   2,130    2,111    4,260    4,219 
Furniture and equipment   1,187    1,158    2,400    2,277 
Amortization of identifiable intangibles   870    955    1,775    1,956 
Professional fees   758    582    1,490    1,130 
Courier service   462    598    1,007    1,141 
Other real estate owned   (392)   52    (281)   367 
Other noninterest expense   3,927    4,018    7,634    8,046 
Total Noninterest Expense   25,229    26,896    51,087    53,623 
Income Before Income Taxes   19,659    19,181    38,625    38,012 
Provision for income taxes   5,113    4,420    9,853    8,694 
Net Income  $14,546   $14,761   $28,772   $29,318 
                     
Average Common Shares Outstanding   25,586    25,514    25,516    25,582 
Average Diluted Common Shares Outstanding   25,630    25,536    25,549    25,595 
Per Common Share Data:                    
Basic earnings  $0.57   $0.58   $1.13   $1.15 
Diluted earnings   0.57    0.58    1.13    1.15 
Dividends paid   0.39    0.38    0.78    0.76 

 

See accompanying notes to unaudited consolidated financial statements.

 

-5

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

 

   For the Three Months  For the Six Months
   Ended June 30,
   2016  2015  2016  2015
   (In thousands)   
Net income  $14,546   $14,761   $28,772   $29,318 
Other comprehensive income:                    
Increase (decrease) in net unrealized gains on securities available for sale   9,070    (9,698)   19,311    (2,280)
Deferred tax (expense) benefit   (3,813)   4,078    (8,119)   958 
Increase (decrease) in net unrealized gains on securities available for sale, net of tax   5,257    (5,620)   11,192    (1,322)
Post-retirement benefit transition obligation amortization   15    15    30    30 
Deferred tax expense   (6)   (6)   (12)   (12)
Post-retirement benefit transition obligation amortization, net of tax   9    9    18    18 
Total other comprehensive income (loss)   5,266    (5,611)   11,210    (1,304)
Total comprehensive income  $19,812   $9,150   $39,982   $28,014 

 

See accompanying notes to unaudited consolidated financial statements.              

 

-6

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

(unaudited)

 

   Common
Shares
Outstanding
  Common
Stock
  Deferred
Compensation
  Accumulated
Other
Comprehensive
Income
  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 period                       29,318    29,318 
Other comprehensive loss                  (1,304)        (1,304)
Exercise of stock options   81    3,602                   3,602 
Tax benefit decrease upon exercise and expiration of stock options        (1,206)                  (1,206)
Restricted stock activity   17    741                   741 
Stock based compensation        672                   672 
Stock awarded to employees   2    69                   69 
Retirement of common stock including repurchases   (316)   (4,671)             (9,019)   (13,690)
Dividends                       (19,467)   (19,467)
Balance, June 30, 2015   25,529   $377,339   $2,711   $3,988   $141,300   $525,338 
                               
Balance, December 31, 2015   25,528   $378,858   $2,578   $675   $150,094   $532,205 
Net income for the period                       28,772    28,772 
Other comprehensive income                  11,210         11,210 
Exercise of stock options   225    10,060                   10,060 
Tax benefit increase upon exercise and expiration of stock options        211                   211 
Restricted stock activity   15    1,798    (1,045)             753 
Stock based compensation        752                   752 
Stock awarded to employees   1    60                   60 
Retirement of common stock including repurchases   (137)   (2,059)             (3,721)   (5,780)
Dividends                       (19,916)   (19,916)
Balance, June 30, 2016   25,632   $389,680   $1,533   $11,885   $155,229   $558,327 

 

See accompanying notes to unaudited consolidated financial statements.

 

-7

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

   For the Six Months
Ended June 30,
   2016  2015
   (In thousands)
Operating Activities:          
Net income  $28,772   $29,318 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   8,618    7,957 
Loan loss provision   -    - 
Net amortization of deferred loan fees   (157)   (149)
Decrease in interest income receivable   171    54 
Decrease (increase) in net deferred tax asset   2,066    (166)
Increase in other assets   (4,337)   (1,064)
Stock option compensation expense   752    672 
Tax benefit (increase) decrease upon exercise and expiration of stock options   (211)   1,206 
Decrease in income taxes payable   (1,469)   (640)
Increase in interest expense payable   46    25 
Increase (decrease) in other liabilities   1,849    (2,939)
Net writedown of/loss on sale of premises and equipment   7    11 
Net gain on sale of foreclosed assets   (1,017)   - 
Writedown of foreclosed assets   758    243 
Net Cash Provided by Operating Activities   35,848    34,528 
           
Investing Activities:          
Net repayments of loans   104,975    66,820 
Change in payable to FDIC(1)   98    - 
Purchases of investment securities available for sale   (260,587)   (627,164)
Proceeds from sale/maturity/calls of securities available for sale   344,393    604,708 
Purchases of investment securities held to maturity   (246,956)   (189,632)
Proceeds from maturity/calls of securities held to maturity   82,059    72,440 
Purchases of premises and equipment   (991)   (1,833)
Net change in FRB(2)/FHLB(3) securities   -    940 
Proceeds from sale of foreclosed assets   5,848    100 
Net Cash Provided by (Used in) Investing Activities   28,839    (73,621)
           
Financing Activities:          
Net change in deposits   (55,345)   5,661 
Net change in short-term borrowings and FHLB(3) advances   14,824    (27,037)
Exercise of stock options/issuance of shares   10,060    3,602 
Tax benefit increase (decrease) upon exercise and expiration of stock options   211    (1,206)
Retirement of common stock including repurchases   (5,780)   (13,690)
Common stock dividends paid   (19,916)   (19,467)
Net Cash Used in Financing Activities   (55,946)   (52,137)
Net Change In Cash and Due from Banks   8,741    (91,230)
Cash and Due from Banks at Beginning of Period   433,044    380,836 
Cash and Due from Banks at End of Period  $441,785   $289,606 
           
Supplemental Cash Flow Disclosures:          
Supplemental disclosure of non cash activities:          
Loan collateral transferred to other real estate owned  $488   $3,229 
Securities purchases pending settlement   26,488    24,952 
Supplemental disclosure of cash flow activities:          
Interest paid for the period   1,046    1,274 
Income tax payments for the period   9,922    9,500 

 

(1) Federal Deposit Insurance Corporation ("FDIC")

(2) Federal Reserve Bank ("FRB")

(3) Federal Home Loan Bank ("FHLB")

See accompanying notes to unaudited consolidated financial statements.

 

-8

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1: Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission and follow general practices within the banking industry. The results of operations reflect interim adjustments, all of which are of a normal recurring nature and which, in the opinion of Management, are necessary for a fair presentation of the results for the interim periods presented. The interim results for the three and six months ended June 30, 2016 are not necessarily indicative of the results expected for the full year. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes as well as other information included in the Company's Annual Report on Form 10-K for the year ended December 31, 2015.

 

Note 2: Accounting Policies

 

The most significant accounting policies followed by the Company are presented in Note 1 to the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. 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.

 

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.

 

Recently Issued Accounting Standards

 

FASB Accounting Standards Update (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 will be required to adopt the ASU provisions on January 1, 2018. Management is evaluating the impact that the ASU will have on the Company’s financial statements.

 

-9

 

FASB Accounting Standards Update (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, utilizing the modified retrospective transition approach. Management is evaluating the impact that the ASU will have on the Company’s financial statements.

 

FASB ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, was issued March 30, 2016. The provisions of the new standard changes 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 will be required to adopt the ASU provisions January 1, 2017. Management is evaluating the impact that the ASU will have on the Company’s financial statements.

 

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 financial statements.

 

Note 3: 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 June 30, 2016
   Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
   (In thousands)
Securities of U.S. Government sponsored entities  $338,542   $805   $(8)  $339,339 
Agency residential mortgage-backed securities (MBS)   187,719    1,488    (1,461)   187,746 
Non-agency residential MBS   311    3    -    314 
Non-agency commercial MBS   2,213    7    (6)   2,214 
Obligations of states and political subdivisions   139,627    9,290    (67)   148,850 
Asset-backed securities   1,329    -    (12)   1,317 
FHLMC(1) and FNMA(2) stock   775    5,459    -    6,234 
Corporate securities   837,885    6,324    (1,595)   842,614 
Other securities   2,034    509    (136)   2,407 
Total  $1,510,435   $23,885   $(3,285)  $1,531,035 

 

(1) Federal Home Loan Mortgage Corporation

(2) Federal National Mortgage Association

 

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-10

 

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 June 30, 2016
   Amortized
Cost
  Gross
Unrecognized
Gains
  Gross
Unrecognized
Losses
  Fair
Value
   (In thousands)
Securities of U.S. government sponsored entities  $666   $9   $-   $675 
Agency residential MBS   752,173    11,129    (175)   763,127 
Non-agency residential MBS   6,004    58    (1)   6,061 
Agency commercial MBS   16,012    38    (323)   15,727 
Obligations of states and political subdivisions   698,502    23,233    (148)   721,587 
Total  $1,473,357   $34,467   $(647)  $1,507,177 

 

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, 2015
   Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
  Fair
Value
   (In thousands)
Securities of U.S. Government sponsored entities  $302,292   $255   $(665)  $301,882 
Agency residential MBS   208,046    1,407    (6,909)   202,544 
Non-agency residential MBS   354    16    -    370 
Non-agency commercial MBS   2,383    5    (9)   2,379 
Obligations of states and political subdivisions   148,705    8,861    (57)   157,509 
Asset-backed securities   2,025    -    (22)   2,003 
FHLMC(1) and FNMA(2) stock   775    3,554    -    4,329 
Corporate securities   902,308    882    (6,821)   896,369 
Other securities   2,039    952    (160)   2,831 
Total  $1,568,927   $15,932   $(14,643)  $1,570,216 

 

(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, 2015
   Amortized
Cost
  Gross
Unrecognized
Gains
  Gross
Unrecognized
Losses
  Fair
Value
   (In thousands)
Securities of U.S. government sponsored entities  $764   $-   $-   $764 
Agency residential MBS   595,503    1,810    (4,966)   592,347 
Non-agency residential MBS   9,667    185    -    9,852 
Agency commercial MBS   16,258    20    (274)   16,004 
Obligations of states and political subdivisions   693,883    13,638    (789)   706,732 
Total  $1,316,075   $15,653   $(6,029)  $1,325,699 

 

-11

 

The amortized cost and fair value of investment securities by contractual maturity are shown in the following table s at the dates indicated:

 

   At June 30, 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  $172,012   $172,481   $22,671   $23,259 
Over 1 to 5 years   808,374    813,891    276,940    282,552 
Over 5 to 10 years   335,816    344,373    301,645    313,958 
Over 10 years   1,181    1,375    97,912    102,493 
Subtotal   1,317,383    1,332,120    699,168    722,262 
MBS   190,243    190,274    774,189    784,915 
Other securities   2,809    8,641    -    - 
Total  $1,510,435   $1,531,035   $1,473,357   $1,507,177 

 

Securities available for sale at June 30, 2016 with maturity dates over one to five years include $128,405  thousand (fair value) of securities of U.S. Government sponsored entities with call options on dates within one year or less.

 

   At December 31, 2015
   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  $136,717   $136,976   $20,709   $21,354 
Over 1 to 5 years   1,049,786    1,044,453    259,556    262,163 
Over 5 to 10 years   166,352    173,585    289,568    296,352 
Over 10 years   2,475    2,749    124,814    127,627 
Subtotal   1,355,330    1,357,763    694,647    707,496 
MBS   210,783    205,293    621,428    618,203 
Other securities   2,814    7,160    -    - 
Total  $1,568,927   $1,570,216   $1,316,075   $1,325,699 

 

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 June 30, 2016 and December 31, 2015, the Company had no high-risk collateralized mortgage obligations as defined by regulatory guidelines.

 

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-12

 

An analysis of the gross unrealized losses of the available for sale investment securities portfolio follows:

 

 
 
 
 
Investment Securities Available for Sale
At June 30, 2016
   No. of  Less than 12 months  No. of  12 months or longer  No. of  Total
   Investment     Unrealized  Investment     Unrealized  Investment     Unrealized
   Positions  Fair Value  Losses  Positions  Fair Value  Losses  Positions  Fair Value  Losses
   ($ in thousands)
Securities of U.S. Government sponsored entities   1   $9,992   $(8)   -   $-   $-    1   $9,992   $(8)
Agency residential MBS   1    109    -    28    141,639    (1,461)   29    141,748    (1,461)
Non-agency residential MBS   1    37    -    -    -    -    1    37    - 
Non-agency commercial MBS   -    -    -    1    816    (6)   1    816    (6)
Obligations of states and political subdivisions   6    5,280    (28)   4    1,573    (39)   10    6,853    (67)
Asset-backed securities   -    -    -    1    1,317    (12)   1    1,317    (12)
Corporate securities   10    36,304    (211)   34    156,558    (1,384)   44    192,862    (1,595)
Other securities   -    -    -    1    1,864    (136)   1    1,864    (136)
Total   19   $51,722   $(247)   69   $303,767   $(3,038)   88   $355,489   $(3,285)

 

An analysis of gross unrecognized losses of the held to maturity investment securities portfolio follows:

 

 
 
 
 
Investment Securities Held to Maturity
At June 30, 2016
   No. of  Less than 12 months  No. of  12 months or longer  No. of  Total
   Investment     Unrecognized  Investment     Unrecognized  Investment     Unrecognized
   Positions  Fair Value  Losses  Positions  Fair Value  Losses  Positions  Fair Value  Losses
   ($ in thousands)
Agency residential MBS   3   $4,539   $(38)   3   $12,222   $(137)   6   $16,761   $(175)
Non-agency residential MBS   1    1,318    (1)   -    -    -    1    1,318    (1)
Agency commercial MBS   -    -    -    2    13,685    (323)   2    13,685    (323)
Obligations of states and political subdivisions   16    11,355    (32)   11    7,082    (116)   27    18,437    (148)
Total   20   $17,212   $(71)   16   $32,989   $(576)   36   $50,201   $(647)

 

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 ratings 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 June 30, 2016.

 

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 June 30, 2016, $744,632  thousand of investment securities were pledged to secure public deposits and short-term borrowed funds. As of December 31, 2015, $738,865  thousand of investment securities were pledged to secure public deposits and short-term borrowed funds.

 

-13

 

An analysis of gross unrealized losses  of investment securities available for sale follows:

 

 
 
 
 
Investment Securities Available for Sale
At December 31, 2015
   No. of  Less than 12 months  No. of  12 months or longer  No. of  Total
   Investment     Unrealized  Investment     Unrealized  Investment     Unrealized
   Positions  Fair Value  Losses  Positions  Fair Value  Losses  Positions  Fair Value  Losses
   ($ in thousands)
Securities of U.S. Government sponsored entities   8   $121,392   $(665)   -   $-   $-    8   $121,392   $(665)
Agency residential MBS   2    12,491    (366)   31    161,296    (6,543)   33    173,787    (6,909)
Non-agency commercial MBS   1    1,071    -    1    855    (9)   2    1,926    (9)
Obligations of states and political subdivisions   3    2,728    (18)   4    1,644    (39)   7    4,372    (57)
Asset-backed securities   -    -    -    1    2,003    (22)   1    2,003    (22)
Corporate securities   97    548,177    (5,442)   25    86,762    (1,379)   122    634,939    (6,821)
Other securities   -    -    -    1    1,840    (160)   1    1,840    (160)
Total   111   $685,859   $(6,491)   63   $254,400   $(8,152)   174   $940,259   $(14,643)

 

An analysis of gross unrecognized losses  of investment securities held to maturity follows:

 

 
 
 
 
Investment Securities Held to Maturity
At December 31, 2015
   No. of  Less than 12 months  No. of  12 months or longer  No. of  Total
   Investment     Unrecognized  Investment     Unrecognized  Investment     Unrecognized
   Positions  Fair Value  Losses  Positions  Fair Value  Losses  Positions  Fair Value  Losses
   ($ in thousands)
Agency residential MBS   41   $426,317   $(3,490)   13   $62,041   $(1,476)   54   $488,358   $(4,966)
Agency commercial MBS   -    -    -    2    13,951    (274)   2    13,951    (274)
Obligations of states and political subdivisions   55    44,585    (249)   54    42,081    (540)   109    86,666    (789)
Total   96   $470,902   $(3,739)   69   $118,073   $(2,290)   165   $588,975   $(6,029)

 

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 Three Months  For the Six Months
   Ended June 30,
   2016  2015  2016  2015
   (In thousands)
             
Taxable  $10,558   $8,393   $20,231   $15,946 
Tax-exempt from regular federal income tax   5,586    5,997    11,207    12,131 
Total interest income from investment securities  $16,144   $14,390   $31,438   $28,077 

  

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-14

 

Note 4: Loans and Allowance for Loan Losses

 

A summary of the major categories of loans outstanding is shown in the following tables.

 

   At June 30, 2016
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment
& Other
  Total
   (In thousands)   
Originated loans  $337,619   $502,493   $2,103   $102,292   $335,687   $1,280,194 
Purchased covered loans:                              
Gross purchased covered loans   -    -    -    2,280    10,497    12,777 
Purchased loan discount   -    -    -    -    -    - 
Purchased non-covered loans:                              
Gross purchased non-covered loans   13,072    98,553    160    228    29,987    142,000 
Purchased loan discount   (819)   (3,453)   -    (23)   (1,116)   (5,411)
Total  $349,872   $597,593   $2,263   $104,777   $375,055   $1,429,560 

 

   At December 31, 2015
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment
& Other
  Total
   (In thousands)   
Originated loans  $368,117   $517,070   $2,978   $117,631   $346,043   $1,351,839 
Purchased covered loans:                              
Gross purchased covered loans   -    -    -    2,385    11,828    14,213 
Purchased loan discount   -    -    -    (133)   (19)   (152)
Purchased non-covered loans:                              
Gross purchased non-covered loans   15,620    124,650    973    231    32,454    173,928 
Purchased loan discount   (989)   (4,264)   -    (23)   (1,156)   (6,432)
Total  $382,748   $637,456   $3,951   $120,091   $389,150   $1,533,396 

 

Changes in the carrying amount of impaired purchased loans were as follows:

 

   For the
Six Months Ended
June 30, 2016
  For the Year Ended
December 31, 2015
Impaired purchased loans  (In thousands)
Carrying amount at the beginning of the period  $3,887   $4,672 
Reductions during the period   (2,646)   (785)
Carrying amount at the end of the period  $1,241   $3,887 

 

Changes in the accretable yield for purchased loans were as follows:

 

   For the
Six Months Ended
June 30, 2016
  For the
Year Ended
December 31, 2015
Accretable yield:  (In thousands)
Balance at the beginning of the period  $1,259   $2,261 
Reclassification from nonaccretable difference   1,637    3,051 
Accretion   (2,338)   (4,053)
Balance at the end of the period  $558   $1,259 
           
Accretion  $(2,338)  $(4,053)
Change in FDIC indemnification   942    698 
(Increase) in interest income  $(1,396)  $(3,355)

 

-15

 

The following summarizes activity in the allowance for loan losses:

 

   Allowance for Loan Losses
For the Three Months Ended June 30, 2016
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment
and Other
  Purchased
Non-covered
Loans
  Purchased
Covered
Loans
  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                             
Balance at beginning of period  $9,847   $4,237   $130   $1,707   $6,683   $950   $-   $5,933   $29,487 
Additions:                                             
Provision   782    (340)   (3)   (106)   271    121    66    (791)   - 
Deductions:                                             
Chargeoffs   (764)   -    -    -    (677)   (38)   -    -    (1,479)
Recoveries   537    15    -    -    339    11    -    -    902 
Net loan (losses) recoveries   (227)   15    -    -    (338)   (27)   -    -    (577)
Total allowance for loan losses  $10,402   $3,912   $127   $1,601   $6,616   $1,044   $66   $5,142   $28,910 

 

   Allowance for Loan Losses
For the Six Months Ended June 30, 2016
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment
and Other
  Purchased
Non-covered
Loans
  Purchased
Covered
Loans
  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                             
Balance at beginning of period  $9,559   $4,224   $177   $1,801   $7,080   $967   $-   $5,963   $29,771 
Additions:                                             
Provision   1,996    (342)   (50)   (200)   423    (1,072)   66    (821)   - 
Deductions:                                             
Chargeoffs   (1,935)   -    -    -    (1,682)   (38)   -    -    (3,655)
Recoveries   782    30    -    -    795    1,187    -    -    2,794 
Net loan (losses) recoveries   (1,153)   30    -    -    (887)   1,149    -    -    (861)
Total allowance for loan losses  $10,402   $3,912   $127   $1,601   $6,616   $1,044   $66   $5,142   $28,910 

 

   Allowance for Loan Losses
For the Three Months Ended June 30, 2015
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment
and Other
  Purchased
Non-covered
Loans
  Purchased
Covered
Loans
  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                             
Balance at beginning of period  $5,470   $4,123   $730   $2,140   $7,031   $2,339   $-   $9,354   $31,187 
Additions:                                             
Provision   1,704    758    (327)   (82)   350    (921)   -    (1,482)   - 
Deductions:                                             
Chargeoffs   (401)   -    -    -    (576)   (396)   -    -    (1,373)
Recoveries   334    15    -    -    443    222    -    -    1,014 
Net loan (losses) recoveries   (67)   15    -    -    (133)   (174)   -    -    (359)
Total allowance for loan losses  $7,107   $4,896   $403   $2,058   $7,248   $1,244   $-   $7,872   $30,828 

 

   Allowance for Loan Losses
For the Six Months Ended June 30, 2015
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment
and Other
  Purchased
Non-covered
Loans
  Purchased
Covered
Loans
  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                             
Balance at beginning of period  $5,460   $4,245   $644   $2,241   $7,717   $2,120   $-   $9,058   $31,485 
Additions:                                             
Provision   1,594    621    (241)   (183)   69    (674)   -    (1,186)   - 
Deductions:                                             
Chargeoffs   (461)   -    -    -    (1,571)   (431)   -    -    (2,463)
Recoveries   514    30    -    -    1,033    229    -    -    1,806 
Net loan recoveries (losses)   53    30    -    -    (538)   (202)   -    -    (657)
Total allowance for loan losses  $7,107   $4,896   $403   $2,058   $7,248   $1,244   $-   $7,872   $30,828 

 

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-16

 

The allowance for loan losses and recorded investment in loans were evaluated for impairment as follows:

 

   Allowance for Loan Losses and Recorded Investment in Loans Evaluated for Impairment
   At June 30, 2016
   Commercial  Commercial Real Estate  Construction  Residential Real Estate  Consumer Installment and Other  Purchased Non-covered Loans  Purchased Covered Loans  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                             
Individually evaluated for impairment  $5,283   $316   $-   $-   $-   $-   $-   $-   $5,599 
Collectively evaluated for impairment   5,119    3,596    127    1,601    6,616    1,044    66    5,142    23,311 
Purchased loans with evidence of credit deterioration   -    -    -    -    -    -    -    -    - 
Total  $10,402   $3,912   $127   $1,601   $6,616   $1,044   $66   $5,142   $28,910 
Carrying value of loans:                                             
Individually evaluated for impairment  $14,035   $5,375   $-   $-   $-   $10,198   $-   $-   $29,608 
Collectively evaluated for impairment   323,584    497,118    2,103    102,292    335,687    125,346    12,581    -    1,398,711 
Purchased loans with evidence of credit deterioration   -    -    -    -    -    1,045    196    -    1,241 
Total  $337,619   $502,493   $2,103   $102,292   $335,687   $136,589   $12,777   $-   $1,429,560 

 

   Allowance for Loan Losses and Recorded Investment in Loans Evaluated for Impairment
   At December 31, 2015
   Commercial  Commercial Real Estate  Construction  Residential Real Estate  Consumer Installment and Other  Purchased Non-covered Loans  Purchased Covered Loans  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                             
Individually evaluated for impairment  $4,942   $585   $-   $-   $-   $-   $-   $-   $5,527 
Collectively evaluated for impairment   4,617    3,639    177    1,801    7,080    967    -    5,963    24,244 
Purchased loans with evidence of credit deterioration   -    -    -    -    -    -    -    -    - 
Total  $9,559   $4,224   $177   $1,801   $7,080   $967   $-   $5,963   $29,771 
Carrying value of loans:                                             
Individually evaluated for impairment  $12,587   $5,541   $-   $-   $-   $11,777   $-   $-   $29,905 
Collectively evaluated for impairment   355,530    511,529    2,978    117,631    346,043    152,038    13,855    -    1,499,604 
Purchased loans with evidence of credit deterioration   -    -    -    -    -    3,681    206    -    3,887 
Total  $368,117   $517,070   $2,978   $117,631   $346,043   $167,496   $14,061   $-   $1,533,396 

 

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 the Board of Directors. The Loan Review Department performs independent evaluations of loans and assigns credit risk grades to 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 the Loan Review Department are subject to review by the Bank’s regulatory authorities during regulatory examinations.

 

The following summarizes the credit risk profile by internally assigned grade:

  

   Credit Risk Profile by Internally Assigned Grade
   At June 30, 2016
   Commercial  Commercial Real Estate  Construction  Residential Real Estate  Consumer Installment and Other  Purchased Non-covered Loans  Purchased Covered Loans (1)  Total
   (In thousands)
Grade:                                        
Pass  $320,298   $483,433   $2,103   $99,248   $334,394   $120,779   $11,053   $1,371,308 
Substandard   16,899    19,060    -    3,044    1,006    21,169    1,724    62,902 
Doubtful   422    -    -    -    17    -    -    439 
Loss   -    -    -    -    270    52    -    322 
Purchased loan discount   -    -    -    -    -    (5,411)   -    (5,411)
Total  $337,619   $502,493   $2,103   $102,292   $335,687   $136,589   $12,777   $1,429,560 

 

(1) Credit risk profile reflects internally assigned grade of purchased covered loans without regard to FDIC indemnification.

 

-17

 

   Credit Risk Profile by Internally Assigned Grade
   At December 31, 2015
   Commercial  Commercial Real Estate  Construction  Residential Real Estate  Consumer Installment and Other  Purchased Non-covered Loans  Purchased Covered Loans (1)  Total
   (In thousands)
Grade:                                        
Pass  $353,474   $496,744   $2,978   $114,525   $344,876   $149,100   $12,563   $1,474,260 
Substandard   14,643    20,326    -    3,106    781    24,810    1,650    65,316 
Doubtful   -    -    -    -    12    18    -    30 
Loss   -    -    -    -    374    -    -    374 
Purchased loan discount   -    -    -    -    -    (6,432)   (152)   (6,584)
Total  $368,117   $517,070   $2,978   $117,631   $346,043   $167,496   $14,061   $1,533,396 

 

(1) 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 June 30, 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  $333,544   $941   $498   $-   $2,636   $337,619 
Commercial real estate   495,851    903    208    -    5,531    502,493 
Construction   2,103    -    -    -    -    2,103 
Residential real estate   99,990    1,683    315    -    304    102,292 
Consumer installment and other   331,904    2,596    772    303    112    335,687 
Total originated loans   1,263,392    6,123    1,793    303    8,583    1,280,194 
Purchased non-covered loans   129,939    388    1,256    53    4,953    136,589 
Purchased covered loans   12,727    21    -    -    29    12,777 
Total  $1,406,058   $6,532   $3,049   $356   $13,565   $1,429,560 

 

   Summary of Loans by Delinquency and Nonaccrual Status
At December 31, 2015
   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  $365,450   $1,777   $122   $-   $768   $368,117 
Commercial real estate   504,970    5,930    726    -    5,444    517,070 
Construction   2,978    -    -    -    -    2,978 
Residential real estate   115,575    1,202    414    -    440    117,631 
Consumer installment and other   341,566    3,263    919    295    -    346,043 
Total originated loans   1,330,539    12,172    2,181    295    6,652    1,351,839 
Purchased non-covered loans   158,554    589    7    -    8,346    167,496 
Purchased covered loans   13,929    132    -    -    -    14,061 
Total  $1,503,022   $12,893   $2,188   $295   $14,998   $1,533,396 

 

The following is a summary of the effect of nonaccrual loans on interest income:

 

   For the Three Months Ended  For the Six Months Ended
   June 30,
   2016  2015  2016  2015
   (In thousands)
Interest income that would have been recognized had the loans performed in accordance with their original terms  $284   $342   $563   $654 
Less: Interest income recognized on nonaccrual loans   (271)   (118)   (533)   (324)
Total reduction of interest income  $13   $224   $30   $330 

 

-18

 

There were no commitments to lend additional funds to borrowers whose loans were on nonaccrual status at June 30, 2016 and December 31, 2015.

 

The following summarizes impaired loans:

 

   Impaired Loans
At June 30, 2016
   Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
   (In thousands)
Impaired loans with no related allowance recorded:               
    Commercial  $3,953   $4,042   $- 
    Commercial real estate   12,039    16,691    - 
    Construction   -    -    - 
    Residential real estate   527    557    - 
    Consumer installment and other   479    586    - 
                
Impaired loans with an allowance recorded:               
    Commercial   10,501    12,009    5,283 
    Commercial real estate   4,510    5,527    316 
    Construction   -    -    - 
    Residential real estate   -    -    - 
    Consumer installment and other   -    -    - 
                
Total:               
    Commercial  $14,454   $16,051   $5,283 
    Commercial real estate   16,549    22,218    316 
    Construction   -    -    - 
    Residential real estate   527    557    - 
    Consumer installment and other   479    586    - 

 

   Impaired Loans
At December 31, 2015
   Recorded
Investment
  Unpaid
Principal
Balance
  Related
Allowance
   (In thousands)
Impaired loans with no related allowance recorded:               
    Commercial  $2,917   $2,979   $- 
    Commercial real estate   16,309    21,168    - 
    Construction   271    271    - 
    Residential real estate   666    697    - 
    Consumer installment and other   350    456    - 
                
Impaired loans with an allowance recorded:               
    Commercial   10,170    10,170    4,942 
    Commercial real estate   4,660    5,109    585 
    Construction   -    -    - 
    Residential real estate   -    -    - 
    Consumer installment and other   -    -    - 
                
Total:               
    Commercial  $13,087   $13,149   $4,942 
    Commercial real estate   20,969    26,277    585 
    Construction   271    271    - 
    Residential real estate   666    697    - 
    Consumer installment and other   350    456    - 

 

-19

 

Impaired loans include troubled debt restructured loans. Impaired loans at June 30, 2016, included $17,962 thousand of restructured loans, $10,255 thousand of which were on nonaccrual status. Impaired loans at December 31, 2015, included $15,712 thousand of restructured loans, $7,464 thousand of which were on nonaccrual status.

 

   Impaired Loans
   For the Three Months Ended June 30,  For the Six Months Ended June 30,
   2016  2015  2016  2015
   Average
Recorded
Investment
  Recognized
Interest
Income
  Average
Recorded
Investment
  Recognized
Interest
Income
  Average
Recorded
Investment
  Recognized
Interest
Income
  Average
Recorded
Investment
  Recognized
Interest
Income
   (In thousands)
Commercial  $14,094   $135   $12,564   $147   $13,752   $268   $12,395   $293 
Commercial real estate   18,639    202    19,715    147    19,744    361    19,017    404 
Construction   136    -    -    -    203    -    459    - 
Residential real estate   740    5    693    8    775    9    776    14 
Consumer installment and other   412    6    797    7    379    12    1,026    13 
Total  $34,021   $348   $33,769   $309   $34,853   $650   $33,673   $724 

 

The following table provides information on troubled debt restructurings:

 

   Troubled Debt Restructurings
At June 30, 2016
   Number of
Contracts
  Pre-Modification
Carrying Value
  Period-End
Carrying Value
  Period-End
Individual
Impairment
Allowance
   ($ in thousands)
Commercial   8   $2,817   $2,171   $174 
Commercial real estate   11    17,587    15,568    316 
Residential real estate   1    241    223    - 
Total   20   $20,645   $17,962   $490 

 

   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 three and six months ended June 30, 2016, the Company modified one loan with a carrying value of $242 thousand and four loans with a total carrying value of $4,843 thousand, respectively, that were considered troubled debt restructurings. The concessions granted in the four restructurings completed in the first six months of 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 three and six months ended June 30, 2015, the Company modified one loan with a carrying value of $100 thousand and six loans with an aggregate carrying value of $1,830 thousand, respectively, that were considered troubled debt restructurings. The concessions granted in the six restructurings completed in the first six months of 2015 consisted of modification of payment terms to extend the maturity date to allow for deferred principal repayment and under-market terms. During the three and six months ended June 30, 2016 and 2015, no troubled debt restructured loans defaulted. 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 June 30, 2016 and December 31, 2015.

 

There were no loans held for sale at June 30, 2016 and December 31, 2015.

 

-20

 

At June 30, 2016 and December 31, 2015, the Company held total other real estate owned (OREO) of $4,162 thousand net of reserve of $2,534 thousand and $9,264 thousand net of reserve of $1,986 thousand, respectively, of which $-0-  thousand was foreclosed residential real estate properties. The amount of consumer mortgage loans outstanding secured by residential real estate properties for which formal foreclosure proceedings were in process was $29  thousand at June 30, 2016 and $-0- thousand at December 31, 2015.

  

Note 5: 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 June 30, 2016, Westamerica Bank did not have credit extended to any one entity exceeding these limits. At June 30, 2016, Westamerica Bank had 36 lending relationships with aggregate loans 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 4, the Company had loan commitments related to real estate loans of $59,171 thousand and $61,190 thousand at June 30, 2016 and December 31, 2015, 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 June 30, 2016, Westamerica Bank held corporate bonds in 48 issuing entities which exceeded $5 million of each issuer.

  

Note 6: Other Assets

 

Other assets consisted of the following:

 

   At June 30,
2016
  At December 31,
2015
   (In thousands)
Cost method equity investments:          
    Federal Reserve Bank stock (1)  $14,069   $14,069 
    Other investments   201    201 
        Total cost method equity investments   14,270    14,270 
Life insurance cash surrender value   50,245    48,972 
Net deferred tax asset   41,617    51,748 
Limited partnership investments   13,863    15,259 
Interest receivable   20,003    20,174 
Prepaid assets   3,984    4,771 
Other assets   16,026    10,660 
    Total other assets  $160,008   $165,854 

 

(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 June 30, 2016, this investment totaled $13,863 thousand and $2,299  thousand of this amount represents outstanding equity capital commitments that are included in other liabilities. At December 31, 2015, this investment totaled $15,259 thousand and $2,299  thousand of this amount represents outstanding equity capital commitments. At June 30, 2016, the $2,299 thousand of outstanding equity capital commitments are expected to be paid as follows, $453 thousand in 2016, $763 thousand in 2017, and $1,083 thousand in 2018 or thereafter.

 

-21

 

The amounts recognized in net income for these investments include:

 

   For the Three Months Ended  For the Six Months Ended
   June 30,
   2016  2015  2016  2015
   (In thousands)
Investment loss included in pre-tax income  $675   $750   $1,350   $1,425 
Tax credits recognized in provision for income taxes   511    658    1,109    1,316 

 

Note 7: 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 three and six months ended June 30, 2016 and year ended December 31, 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 three and six months ended June 30, 2016 and year ended December 31, 2015, no such adjustments were recorded.

 

The carrying values of goodwill were:

 

   At June 30,
2016
  At December 31,
2015
   (In thousands)
Goodwill  $121,673   $121,673 

 

The gross carrying amount of identifiable intangible assets and accumulated amortization was:

 

   At June 30, 2016  At December 31, 2015
   Gross
Carrying
Amount
  Accumulated
Amortization
  Gross
Carrying
Amount
  Accumulated
Amortization
   (In thousands)
Core Deposit Intangibles  $56,808   $(48,447)  $56,808   $(46,782)
Merchant Draft Processing Intangible   10,300    (10,005)   10,300    (9,895)
    Total Identifiable Intangible Assets  $67,108   $(58,452)  $67,108   $(56,677)

 

As of June 30, 2016, 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 Six Months ended June 30, 2016 (actual)  $1,665   $110   $1,775 
Estimate for year ended December 31, 2016   3,292    212    3,504 
   2017   2,913    164    3,077 
   2018   1,892    29    1,921 
   2019   538    -    538 
   2020   287    -    287 

 

-22

 

Note 8: Deposits and Borrowed Funds

 

The following table provides additional detail regarding deposits.

 

   Deposits
   At June 30,
2016
  At December 31,
2015
   (In thousands)
Noninterest-bearing  $1,978,947   $2,026,049 
Interest-bearing:          
    Transaction   827,857    860,706 
    Savings   1,404,840    1,366,936 
    Time deposits less than $100 thousand   142,863    150,780 
    Time deposits $100 thousand through $250 thousand   92,477    96,971 
    Time deposits more than $250 thousand   38,330    39,217 
        Total deposits  $4,485,314   $4,540,659 

 

Demand deposit overdrafts of $2,979  thousand and $3,038  thousand were included as loan balances at June 30, 2016 and December 31, 2015, respectively. Interest expense for aggregate time deposits with individual account balances in excess of $100 thousand was $135 thousand and $271 thousand for the three months and six months ended June 30, 2016, respectively and $182 thousand and $379 thousand for the three months and six months ended June 30, 2015, respectively.

 

The following table provides additional detail regarding short-term borrowed funds.

 

   Repurchase Agreements (Sweep)
Accounted for as Secured Borrowings
   At June 30, 2016  At December 31, 2015
   Remaining Contractual Maturity of the Agreements
   Overnight and Continuous
Repurchase agreements:  (In thousands)
Collateral securing borrowings:          
Securities of U.S. Government sponsored entities  $101,131   $98,969 
Obligations of states and political subdivisions   1,015    3,975 
Corporate securities   49,846    54,681 
Total collateral carrying value  $151,992   $157,625 
Total short-term borrowed funds  $67,852   $53,028 

 

The $35,000 thousand unsecured line of credit expired, with no outstanding balance, March 18, 2016 and was not renewed. There was no outstanding balance at December 31, 2015.

 

Note 9: 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:

 

-23

 

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 or with a market to book ratio below 95:100. 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 six months ended June 30, 2016, and three months ended March 31, 2015, there were no transfers in or out of levels 1, 2 or 3. During the three months ended June 30, 2015, the Company reevaluated the valuation techniques and assumptions used by its vendors in valuing the Company’s available for sale securities, and based on the evaluation, transferred $437,715 thousand out of level 1 and transferred $437,715 thousand into level 2. There were no transfers into level 1 or into or out of level 3 during this same period. Subsequent to June 30, 2015 and through the year ended December 31, 2015, there were no transfers into or out of levels 1, 2 or 3.

 

 

 

 

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-24

 

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 June 30, 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  $339,339   $-   $339,339   $- 
Agency residential MBS   187,746    -    187,746    - 
Non-agency residential MBS   314         314    - 
Non-agency commercial MBS   2,214    -    2,214    - 
Obligations of states and political subdivisions   148,850    -    148,850    - 
Asset-backed securities   1,317    -    1,317    - 
FHLMC and FNMA stock   6,234    9    6,225    - 
Corporate securities   842,614    -    842,614    - 
Other securities   2,407    543    1,864    - 
    Total securities available for sale  $1,531,035   $552   $1,530,483   $- 

 

   At December 31, 2015
   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  $301,882   $-   $301,882   $- 
Agency residential MBS   202,544    -    202,544    - 
Non-agency residential MBS   370         370    - 
Non-agency commercial MBS   2,379    -    2,379    - 
Obligations of states and political subdivisions   157,509    -    157,509    - 
Asset-backed securities   2,003    -    2,003    - 
FHLMC and FNMA stock   4,329    7    4,322    - 
Corporate securities   896,369    -    896,369    - 
Other securities   2,831    991    1,840    - 
    Total securities available for sale  $1,570,216   $998   $1,569,218   $- 

 

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-25

 

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 June 30, 2016 and December 31, 2015, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related assets at period end.

 

   At June 30, 2016  For the
Six Months Ended
June 30, 2016
   Carrying Value  Level 1  Level 2  Level 3  Total Losses
   (In thousands)
Other real estate owned  $4,162   $-   $-   $4,162   $(759)
Impaired loans   14,217    -    -    14,217    (1,499)
Total assets measured at fair value on a nonrecurring basis  $18,379   $-   $-   $18,379   $(2,258)

 

   At December 31, 2015  For the
Year Ended
December 31, 2015
   Carrying Value  Level 1  Level 2  Level 3  Total Losses
   (In thousands)
Other real estate owned  $9,264   $-   $-   $9,264   $(320)
Impaired loans   15,633    -    -    15,633    (449)
Total assets measured at fair value on a nonrecurring basis  $24,897   $-   $-   $24,897   $(769)

 

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 due to the unavailability from third party evaluators.

 

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 $28,910 thousand at June 30, 2016 and $29,771 thousand at December 31, 2015 and the purchased loan discount associated with purchased covered and purchased non-covered loans of $-0- thousand and $5,411 thousand, respectively at June 30, 2016 and $152 thousand and $6,432 thousand, respectively at December 31, 2015 were applied against the estimated fair values to recognize estimated future defaults of contractual cash flows. The Company does not consider these values to be a liquidation price for the loans.

 

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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 June 30, 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  $441,785   $441,785   $441,785   $-   $- 
    Investment securities held to maturity   1,473,357    1,507,177    -    1,507,177    - 
    Loans   1,400,650    1,423,629    -    -    1,423,629 
                          
Financial Liabilities:                         
    Deposits  $4,485,314   $4,484,269   $-   $4,211,644   $272,625 
    Short-term borrowed funds   67,852    67,852    -    67,852    - 

 

   At December 31, 2015
   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  $433,044   $433,044   $433,044   $-   $- 
    Investment securities held to maturity   1,316,075    1,325,699    -    1,325,699    - 
    Loans   1,503,625    1,517,394    -    -    1,517,394 
                          
Financial Liabilities:                         
    Deposits  $4,540,659   $4,539,455   $-   $4,253,691   $285,764 
    Short-term borrowed funds   53,028    53,028    -    53,028    - 

 

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.

 

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Note 10: 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 $299,744 thousand and $299,884 thousand at June 30, 2016 and December 31, 2015, 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 $23,567 thousand and $26,149 thousand at June 30, 2016 and December 31, 2015, respectively. The Company also had commitments for commercial and similar letters of credit of $-0- thousand at June 30, 2016 and $40 thousand at December 31, 2015. At June 30, 2016 and December 31, 2015, the Company had a reserve for unfunded commitments of $2,593 thousand, 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 is reasonably estimable.

 

Note 11: 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 Three Months  For the Six Months
   Ended June 30,
   2016  2015  2016  2015
   (In thousands, except per share data)
Net income applicable to common equity (numerator)  $14,546   $14,761   $28,772   $29,318 
Basic earnings per common share                    
Weighted average number of common shares outstanding - basic (denominator)   25,586    25,514    25,516    25,582 
Basic earnings per common share  $0.57   $0.58   $1.13   $1.15 
Diluted earnings per common share                    
Weighted average number of common shares outstanding - basic   25,586    25,514    25,516    25,582 
Add common stock equivalents for options   44    22    33    13 
Weighted average number of common shares outstanding - diluted (denominator)   25,630    25,536    25,549    25,595 
Diluted earnings per common share  $0.57   $0.58   $1.13   $1.15 

 

For the three and six months ended June 30, 2016, options to purchase 779 thousand and 1,038 thousand shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per share because the option exercise price exceeded the fair value of the stock such that their inclusion would have had an anti-dilutive effect.

 

For the three and six months ended June 30, 2015, options to purchase 1,376 thousand and 1,575 thousand shares of common stock, respectively, were outstanding but not included in the computation of diluted net income per share because the option exercise price exceeded the fair value of the stock such that their inclusion would have had an anti-dilutive effect.

 

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WESTAMERICA BANCORPORATION

FINANCIAL SUMMARY

 

   For the Three Months  For the Six Months
   Ended June 30,
   2016  2015  2016  2015
   (In thousands, except per share data)
Net Interest and Fee Income (FTE)(1)  $36,495   $37,415   $72,942   $74,345 
Provision for Loan Losses   -    -    -    - 
Noninterest Income   11,702    12,269    23,431    24,569 
Noninterest Expense   25,229    26,896    51,087    53,623 
Income Before Income Taxes (FTE)(1)   22,968    22,788    45,286    45,291 
Income Tax Provision (FTE)(1)   8,422    8,027    16,514    15,973 
Net Income  $14,546   $14,761   $28,772   $29,318 
                     
Average Common Shares Outstanding   25,586    25,514    25,516    25,582 
Average Diluted Common Shares Outstanding   25,630    25,536    25,549    25,595 
Common Shares Outstanding at Period End   25,632    25,529           
                     
Per Common Share:                    
  Basic Earnings  $0.57   $0.58   $1.13   $1.15 
  Diluted Earnings   0.57    0.58    1.13    1.15 
  Book Value  $21.78   $20.58           
                     
Financial Ratios:                    
  Return on Assets   1.13%   1.17%   1.12%   1.17%
  Return on Common Equity   10.87%   11.50%   10.86%   11.47%
  Net Interest Margin (FTE)(1)   3.27%   3.37%   3.30%   3.40%
  Net Loan Losses to Average Loans   0.16%   0.09%   0.12%   0.08%
  Efficiency Ratio(2)   52.3%   54.1%   53.0%   54.2%
                     
Average Balances:                    
  Assets  $5,184,409   $5,044,361   $5,179,607   $5,051,907 
  Earning Assets   4,473,700    4,436,196    4,427,507    4,389,374 
  Loans   1,455,050    1,655,779    1,477,833    1,669,686 
  Deposits   4,531,751    4,395,351    4,534,650    4,399,127 
  Shareholders' Equity   537,987    514,768    532,582    515,423 
                     
Period End Balances:                    
  Assets  $5,179,085   $5,031,230           
  Earning Assets   4,433,952    4,425,730           
  Loans   1,429,560    1,631,271           
  Deposits   4,485,314    4,354,844           
  Shareholders' Equity   558,327    525,338           
                     
Capital Ratios at Period End:                    
  Total Risk Based Capital   14.76%   13.08%          
  Tangible Equity to Tangible Assets   8.48%   7.99%          
                     
Dividends Paid Per Common Share  $0.39   $0.38   $0.78   $0.76 
Common Dividend Payout Ratio   68%   66%   69%   66%

 

The above financial summary has been derived from the Company's unaudited consolidated financial statements. This information should be read in conjunction with those statements, notes and the other information included elsewhere herein. Percentages under the heading "Financial Ratios" are annualized with the exception of the efficiency ratio.

               

(1) Yields on securities and certain loans have been adjusted upward to a "fully taxable equivalent" ("FTE") basis, which is a non-GAAP financial measure, 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, which is a non-GAAP financial measure, and noninterest income).

 

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

Westamerica Bancorporation and subsidiaries’ (the “Company”) principal source of revenue is net interest and fee income, which represents interest earned on loans and investment securities (“interest-earning assets”) reduced by interest paid on deposits and other borrowings (“interest-bearing liabilities”). The relatively low level of market interest rates has reduced the spread between interest rates on earning assets and interest bearing liabilities. The Company’s net interest margin and net interest income declined as market interest rates on newly originated loans remain below the yields earned on older-dated loans and on the overall loan portfolio. The Company’s loan portfolio has declined from the second quarter 2015 through the second quarter 2016; Management has been avoiding long-dated, low-yielding loans given historically low interest rates. Management has also maintained, in their opinion, conservative loan underwriting, terms and conditions. During this period, the investment portfolio has grown. The Company has been reducing its exposure to rising interest rates by purchasing shorter-duration investment securities, which have lower yields than longer-duration securities. The changing composition of interest earning assets and low market interest rates has pressured the net interest margin on a fully taxable equivalent (“FTE”) basis. In the second quarter 2016 the Company’s average checking and savings deposits were 5 percent higher than in the second quarter 2015. The growth in lower-costing deposit products contributed to lowering the funding cost from 0.06 percent in the second quarter 2015 to 0.05 percent in the second quarter 2016. Credit quality improved with nonperforming assets declining to $18.1 million at June 30, 2016 from $25.7 million at June 30, 2015. Management is focused on controlling all noninterest expense levels, particularly due to market interest rate pressure on net interest income.

 

The Company presents its net interest margin and net interest income on a FTE basis using the current statutory federal tax rate, which is a non-generally accepted accounting principles (GAAP) financial measure. 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 a FTE basis.

 

The Company’s significant accounting policies are presented in Note 1 to the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, and are fundamental to understanding the Company’s results of operations and financial condition. There have been no changes to the Company’s significant accounting policies during the first half of 2016.

 

The Company reported net income of $14.5 million or $0.57 diluted earnings per common share for the second quarter 2016 and net income of $28.8 million or $1.13 diluted earnings per common share for the six months ended June 30, 2016. These results compare to net income of $14.8 million or $0.58 diluted earnings per common share for the second quarter 2015 and net income of $29.3 million or $1.15 diluted earnings per common share for the six months ended June 30, 2015.

 

 

 

 

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Net Income

 

Following is a summary of the components of net income for the periods indicated:

 

   For the Three Months  For the Six Months
   Ended June 30,
   2016  2015  2016  2015
   (In thousands, except per share data)
Net interest and fee income (FTE)  $36,495   $37,415   $72,942   $74,345 
Provision for loan losses   -    -    -    - 
Noninterest income   11,702    12,269    23,431    24,569 
Noninterest expense   25,229    26,896    51,087    53,623 
Income  before taxes (FTE)   22,968    22,788    45,286    45,291 
Income tax provision (FTE)   8,422    8,027    16,514    15,973 
Net income  $14,546   $14,761   $28,772   $29,318 
                     
Average diluted common shares   25,630    25,536    25,549    25,595 
Diluted earnings per common share  $0.57   $0.58   $1.13   $1.15 
                     
Average total assets  $5,184,409   $5,044,361   $5,179,607   $5,051,907 
Net income to average total assets (annualized)   1.13%   1.17%   1.12%   1.17%
Net income to average common shareholders' equity (annualized)   10.87%   11.50%   10.86%   11.47%

 

Net income for the second quarter of 2016 was $215 thousand less than the same quarter of 2015, the net result of lower net interest and fee income (FTE), lower noninterest income and higher income tax provision (FTE), partially offset by lower noninterest expense. A decrease in net interest and fee income (FTE) was mostly attributed to lower average balances of loans, partially offset by higher average balances of investments and lower average balances of higher-costing time deposits. The provision for loan losses remained zero, 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 and lower merchant credit card fees. Noninterest expense decreased mostly due to lower insurance related costs and lower salaries resulting from employee attrition, occupancy cost reductions from branch closures, and gains on sale of foreclosed properties. The income tax provision (FTE) was higher in the second quarter 2016 due to reduced levels of federally tax-exempt income on interest-earning assets relative to pre-tax income, and lower tax credits.

 

Comparing the first half of 2016 with the first half of 2015, net income decreased $546 thousand due to lower net interest and fee income (FTE), lower noninterest income and higher income tax provision (FTE), partially offset by lower noninterest expense. 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, the effect of one additional accrual day and lower average balances of higher-costing time deposits. The provision for loan losses remained zero, 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 and lower merchant credit card fees, partially offset by higher debit card fees. Noninterest expense decreased mostly due to lower insurance related costs and lower salaries resulting from employee attrition, occupancy cost savings from branch closures, and gains on sale of foreclosed properties. Income tax provision (FTE) increased in the first half of 2016 due to reduced levels of federally tax-exempt income on interest-earning assets relative to pre-tax income, and lower tax credits.

 

 

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Net Interest and Fee Income (FTE)

 

Following is a summary of the components of net interest and fee income (FTE) for the periods indicated:

 

   For the Three Months  For the Six Months
   Ended June 30,
   2016  2015  2016  2015
   ($ in thousands)
Interest and fee income  $33,727   $34,425   $67,374   $68,342 
Interest expense   541    617    1,093    1,276 
FTE adjustment   3,309    3,607    6,661    7,279 
Net interest and fee income (FTE)  $36,495   $37,415   $72,942   $74,345 
                     
Average earning assets  $4,473,700   $4,436,196   $4,427,507   $4,389,374 
Net interest margin (FTE) (annualized)   3.27%   3.37%   3.30%   3.40%

 

Net interest and fee income (FTE) decreased during the second quarter 2016 by $920 thousand from the same period in 2015, mainly due to lower average balances of loans (down $201 million), partially offset by higher average balances of investments (up $238 million) and lower average balances of higher-costing time deposits (down $72 million).

 

Comparing the first half of 2016 with the first half of 2015, net interest and fee income (FTE) decreased $1.4 million due to lower average balances of loans (down $192 million), partially offset by higher average balances of investments (up $230 million), the effect of one additional accrual day and lower average balances of higher-costing time deposits (down $84 million).

 

Loan volumes have declined due to problem loan workout activities (such as chargeoffs, collateral repossessions and principal payments), particularly with purchased loans, and reduced volumes of loan originations. In Management’s opinion, current levels of competitive loan pricing do not provide adequate forward earnings potential. As a result, the Company has not currently taken an aggressive posture relative to loan portfolio growth. Management has maintained relatively stable interest-earning asset volumes by increasing investment securities as loan volumes have declined.

 

Yields on interest-earning assets declined due to relatively low interest rates prevailing in the market. The annualized net interest margin (FTE) was 3.27% in the second quarter 2016 and 3.30% in the first half of 2016 compared with 3.37% in the second quarter 2015 and 3.40% in the first half of 2015. The volume of older-dated higher-yielding loans declined due to principal maturities and paydowns. The Company, in anticipation of rising interest rates, 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 invest in higher yielding assets assuming market interest rates start rising.

 

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. Average balances of time deposits declined $72 million from the second quarter 2015 to second quarter 2016 while lower-cost checking and savings deposits grew 5% in the same period. Average balances of checking and saving deposits accounted for 93.9% of average total deposits in the second quarter 2016 and 93.8% in the first half of 2016 compared with 92.1% and 91.7% in the second quarter 2015 and first half of 2015, respectively.

 

 

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Net Interest Margin (FTE)

 

The following summarizes the components of the Company's net interest margin for the periods indicated (percentages are annualized.):

 

   For the Three Months  For the Six Months
   Ended June 30,
   2016  2015  2016  2015
             
Yield on earning assets (FTE)   3.32%   3.43%   3.35%   3.46%
Rate paid on interest-bearing liabilities   0.08%   0.10%   0.08%   0.10%
Net interest spread (FTE)   3.24%   3.33%   3.27%   3.36%
Impact of noninterest-bearing demand deposits   0.03%   0.04%   0.03%   0.04%
Net interest margin (FTE)   3.27%   3.37%   3.30%   3.40%

 

During 2015 and 2016, the net interest margin (FTE) was affected by low market interest rates. The volume of older-dated higher-yielding loans and securities declined due to principal maturities and paydowns. Management has been avoiding long-dated, low-yielding loans given historically low interest rates. Management has also maintained conservative loan underwriting, terms and conditions. During this period, the investment portfolio has grown. The changing composition of interest-earning assets and low market rates has pressured the net interest margin. Rates on interest-bearing liabilities were kept low by reducing the volume of higher-cost time deposits.

 

 

 

 

 

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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 current statutory tax rate. Yields, rates and interest margins are annualized.

 

Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin

 

   For the Three Months Ended June 30, 2016
      Interest   
   Average  Income/  Yields/
   Balance  Expense  Rates
   ($ in thousands)
Assets               
Investment securities:               
Taxable  $2,182,962   $10,558    1.93%
Tax-exempt (1)   835,688    8,581    4.11%
Total investments (1)   3,018,650    19,139    2.53%
Loans:               
Taxable   1,386,677    16,999    4.93%
Tax-exempt (1)   68,373    898    5.28%
Total loans (1)   1,455,050    17,897    4.95%
Total Interest-earning assets (1)   4,473,700    37,036    3.32%
Other assets   710,709           
Total assets  $5,184,409           
                
Liabilities and shareholders' equity               
Noninterest-bearing demand  $1,994,803   $-    -%
Savings and interest-bearing transaction   2,260,054    292    0.05%
Time less than $100,000   157,419    104    0.27%
Time $100,000 or more   119,475    135    0.45%
Total interest-bearing deposits   2,536,948    531    0.08%
Short-term borrowed funds   61,920    10    0.07%
Total interest-bearing liabilities   2,598,868    541    0.08%
Other liabilities   52,751           
Shareholders' equity   537,987           
Total liabilities and shareholders' equity  $5,184,409           
Net interest spread (1) (2)             3.24%
Net interest and fee income and interest margin (1) (3)       $36,495    3.27%

 

(1)Amounts calculated on an FTE 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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Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin

 

   For the Three Months Ended June 30, 2015
      Interest   
   Average  Income/  Yields/
   Balance  Expense  Rates
   ($ in thousands)
Assets               
Investment securities:               
Taxable  $1,920,459   $8,393    1.75%
Tax-exempt (1)   859,958    9,215    4.29%
Total investments (1)   2,780,417    17,608    2.53%
Loans:               
Taxable   1,578,185    19,310    4.91%
Tax-exempt (1)   77,594    1,114    5.76%
Total loans (1)   1,655,779    20,424    4.95%
Total Interest-earning assets (1)   4,436,196   $38,032    3.43%
Other assets   608,165           
Total assets  $5,044,361           
                
Liabilities and shareholders' equity               
Deposits:               
Noninterest-bearing demand  $1,942,124   $-    -%
Savings and interest-bearing transaction   2,104,570    269    0.05%
Time less than $100,000   176,052    150    0.34%
Time $100,000 or more   172,605    182    0.42%
Total interest-bearing deposits   2,453,227    601    0.10%
Short-term borrowed funds   86,967    16    0.07%
Total interest-bearing liabilities   2,540,194   $617    0.10%
Other liabilities   47,275           
Shareholders' equity   514,768           
Total liabilities and shareholders' equity  $5,044,361           
Net interest spread (1) (2)             3.33%
Net interest and fee income and interest margin (1) (3)       $37,415    3.37%

 

(1)Amounts calculated on an FTE 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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Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin

 

   For the Six Months Ended June 30, 2016
      Interest   
   Average  Income/  Yields/
   Balance  Expense  Rates
   ($ in thousands)
Assets               
Investment securities:               
  Taxable  $2,114,700   $20,231    1.91%
  Tax-exempt (1)   834,974    17,218    4.12%
    Total investments (1)   2,949,674    37,449    2.54%
Loans:               
  Taxable   1,407,891    34,725    4.96%
  Tax-exempt (1)   69,942    1,861    5.35%
    Total loans (1)   1,477,833    36,586    4.98%
        Total Interest-earning assets (1)   4,427,507    74,035    3.35%
Other assets   752,100           
    Total assets  $5,179,607           
                
Liabilities and shareholders' equity               
  Noninterest-bearing demand  $1,994,395   $-    -%
  Savings and interest-bearing transaction   2,259,867    585    0.05%
  Time less than $100,000   158,805    218    0.28%
  Time $100,000 or more   121,583    271    0.45%
     Total interest-bearing deposits   2,540,255    1,074    0.08%
Short-term borrowed funds   59,883    19    0.07%
    Total interest-bearing liabilities   2,600,138    1,093    0.08%
Other liabilities   52,492           
Shareholders' equity   532,582           
    Total liabilities and shareholders' equity  $5,179,607           
Net interest spread (1) (2)             3.27%
Net interest and fee income and interest margin (1) (3)       $72,942    3.30%

 

(1) Amounts calculated on an FTE 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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Distribution of Assets, Liabilities & Shareholders’ Equity and Yields, Rates & Interest Margin

 

   For the Six Months Ended June 30, 2015
      Interest   
   Average  Income/  Yields/
   Balance  Expense  Rates
   ($ in thousands)
Assets               
Investment securities:               
  Taxable  $1,854,706   $15,946    1.72%
  Tax-exempt (1)   864,982    18,638    4.31%
    Total investments (1)   2,719,688    34,584    2.54%
Loans:               
  Taxable   1,591,440    38,827    4.92%
  Tax-exempt (1)   78,246    2,210    5.70%
    Total loans (1)   1,669,686    41,037    4.96%
        Total Interest-earning assets (1)   4,389,374   $75,621    3.46%
Other assets   662,533           
    Total assets  $5,051,907           
                
Liabilities and shareholders' equity               
Deposits:               
  Noninterest-bearing demand  $1,931,034   $-    -%
  Savings and interest-bearing transaction   2,103,846    548    0.05%
  Time less than $100,000   178,393    316    0.36%
  Time $100,000 or more   185,854    379    0.41%
     Total interest-bearing deposits   2,468,093    1,243    0.10%
Short-term borrowed funds   86,662    32    0.07%
Federal Home Loan Bank advances   997    1    0.20%
    Total interest-bearing liabilities   2,555,752   $1,276    0.10%
Other liabilities   49,698           
Shareholders' equity   515,423           
    Total liabilities and shareholders' equity  $5,051,907           
Net interest spread (1) (2)             3.36%
Net interest and fee income and interest margin (1) (3)       $74,345    3.40%

 

(1) Amounts calculated on an FTE 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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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 Three Months Ended June 30, 2016
   Compared with
   For the Three Months Ended June 30, 2015
   Volume  Yield/Rate  Total
   (In thousands)
Increase (decrease) in interest and loan fee income:               
Investment securities:               
  Taxable  $1,147   $1,018   $2,165 
  Tax-exempt (1)   (260)   (374)   (634)
    Total investments (1)   887    644    1,531 
Loans:               
  Taxable   (2,355)   44    (2,311)
  Tax-exempt (1)   (134)   (82)   (216)
    Total loans (1)   (2,489)   (38)   (2,527)
      Total (decrease) increase in interest and loan fee income (1)   (1,602)   606    (996)
Increase (decrease) in interest expense:               
Deposits:               
  Savings and interest-bearing transaction   19    4    23 
  Time less than $100,000   (16)   (30)   (46)
  Time $100,000 or more   (56)   9    (47)
     Total interest-bearing deposits   (53)   (17)   (70)
Short-term borrowed funds   (5)   (1)   (6)
   Total decrease in interest expense   (58)   (18)   (76)
(Decrease) increase in net interest and loan fee income (1)  $(1,544)  $624   $(920)

 

(1) Amounts calculated on an FTE basis using the current statutory federal tax rate.        

 

 

 

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Summary of Changes in Interest Income and Expense

 

   For the Six Months Ended June 30, 2016
   Compared with
   For the Six Months Ended June 30, 2015
   Volume  Yield/Rate  Total
   (In thousands)
Increase (decrease) in interest and loan fee income:               
Investment securities:               
  Taxable  $2,235   $2,050   $4,285 
  Tax-exempt (1)   (647)   (773)   (1,420)
    Total investments (1)   1,588    1,277    2,865 
Loans:               
  Taxable   (4,388)   286    (4,102)
  Tax-exempt (1)   (231)   (118)   (349)
    Total loans (1)   (4,619)   168    (4,451)
    Total (decrease) increase in interest and loan fee income (1)   (3,031)   1,445    (1,586)
Increase (decrease) in interest expense:               
Deposits:               
  Savings and interest-bearing transaction   42    (5)   37 
  Time less than $100,000   (35)   (63)   (98)
  Time $100,000 or more   (130)   22    (108)
     Total interest-bearing deposits   (123)   (46)   (169)
Short-term borrowed funds   (13)   -    (13)
Federal Home Loan Bank advances   (1)   -    (1)
   Total decrease in interest expense   (137)   (46)   (183)
(Decrease) increase in net interest and loan fee income (1)  $(2,894)  $1,491   $(1,403)

 

(1) Amounts calculated on an FTE basis using the current statutory federal tax rate.        

 

Provision for Loan Losses

 

The Company manages credit costs by consistently enforcing, in Management’s opinion, 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 provided no provision for loan losses in the three months and six months ended June 30, 2016 and 2015. The provision for loan losses is determined based on Management’s evaluation of credit quality for originated and purchased loans. The Company recorded purchased loans at estimated fair value upon the acquisition dates. Such estimated fair values were recognized for individual loans, although small balance homogenous loans were pooled for valuation purposes. The valuation discounts recorded for purchased loans included Management’s assessment of the risk of principal loss under economic and borrower conditions prevailing on the dates of purchase. The purchased County Bank loans secured by single-family residential real estate are “covered” through February 6, 2019 by loss-sharing agreements the Company entered with the FDIC which mitigates losses during the term of the agreements. Any deterioration in estimated value related to principal loss subsequent to the acquisition dates requires additional loss recognition through a provision for loan losses. No assurance can be given future provisions for loan losses related to purchased loans will not be necessary. 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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Noninterest Income

 

The following table summarizes the components of noninterest income for the periods indicated.

 

   For the Three Months  For the Six Months
   Ended June 30,
   2016  2015  2016  2015
   (In thousands)
             
Service charges on deposit accounts  $5,239   $5,694   $10,487   $11,401 
Merchant processing services   1,638    1,783    3,167    3,486 
Debit card fees   1,621    1,534    3,137    2,990 
Trust fees   657    672    1,318    1,378 
Other service charges   650    683    1,279    1,348 
ATM processing fees   603    627    1,261    1,212 
Financial services commissions   137    198    293    351 
Other noninterest income   1,157    1,078    2,489    2,403 
Total  $11,702   $12,269   $23,431   $24,569 

 

Noninterest income for the second quarter 2016 declined by $567 thousand or 4.6% from the same period in 2015. Service charges on deposits decreased $455 thousand due to declines in fees charged on overdrawn and insufficient funds accounts (down $302 thousand) and lower fees on analyzed accounts (down $184 thousand), partially offset by the effect of deposit fee increases effective February 2016. Merchant processing services fees decreased $145 thousand primarily due to lower transaction volumes and because larger sales relationships with low margins accounted for a significant portion of transaction volumes.

 

In the first half of 2016, noninterest income decreased $1.1 million or 4.6% compared with the first half of 2015. Service charges on deposits decreased $914 thousand due to declines in fees charged on overdrawn and insufficient funds accounts (down $534 thousand) and lower fees on analyzed accounts (down $389 thousand), partially offset by the effect of deposit fee increases effective February 2016. Merchant processing services fees decreased $319 thousand primarily due to lower transaction volumes and because larger sales relationships with low margins accounted for a significant portion of transaction volumes. Debit card fees increased $147 thousand due to increased transaction volumes.

 

Noninterest Expense

 

The following table summarizes the components of noninterest expense for the periods indicated.

 

   For the Three Months  For the Six Months
   Ended June 30,
   2016  2015  2016  2015
   (In thousands)
             
Salaries and related benefits  $12,887   $13,696   $26,004   $27,034 
Occupancy   3,400    3,726    6,798    7,453 
Outsourced data processing services   2,130    2,111    4,260    4,219 
Furniture and equipment   1,187    1,158    2,400    2,277 
Amortization of identifiable intangibles   870    955    1,775    1,956 
Professional services   758    582    1,490    1,130 
Courier service   462    598    1,007    1,141 
Other real estate owned   (392)   52    (281)   367 
Other noninterest expense   3,927    4,018    7,634    8,046 
Total  $25,229   $26,896   $51,087   $53,623 

 

Noninterest expense decreased $1.7 million 6.2% in the second quarter 2016 compared with the same period in 2015. Salaries and related benefits declined $809 thousand in the second quarter 2016 compared with the same period in 2015 mostly due to lower insurance costs and lower salaries resulting from employee attrition. Occupancy expense decreased $326 thousand in the second quarter 2016 compared with the same period in 2015 mostly due to branch closures and a lease expiration related to a non-branch building. Courier expense decreased $136 thousand primarily due to logistical changes. Expenses for other real estate owned in the second quarter 2016 were reduced by net gains from the sale of foreclosed properties. Professional fees increased $176 thousand due to higher legal fees associated with nonperforming assets.

 

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In the first half of 2016, noninterest expense decreased $2.5 million or 4.7% compared with the first half of 2015. Salaries and related benefits decreased $1.0 million primarily due to lower insurance costs and lower salaries resulting from employee attrition. Occupancy expense decreased $655 thousand in the first half of 2016 compared with the first half of 2015 mostly due to branch closures and a lease expiration related to a non-branch building. Courier expense decreased $134 thousand primarily due to logistical changes. Expenses for other real estate owned in the first half of 2016 were reduced by net gains from the sale of foreclosed properties. Professional fees increased $360 thousand due to higher legal fees associated with nonperforming assets. Furniture and equipment expense increased $123 thousand mainly due to increased depreciation costs for technology.

 

Provision for Income Tax

 

During the second quarter 2016, the Company recorded an income tax provision (FTE) of $8.4 million, compared with $8.0 million in the second quarter 2015. The second quarter 2016 provision represents an effective tax rate (FTE) of 36.7%, compared with 35.2% for the second quarter 2015. The income tax provision (FTE) was $16.5 million for the first half of 2016 compared with $16.0 million for the corresponding period of 2015. The first half of 2015 effective tax rate (FTE) was 36.5% compared to 35.3% for the same period of 2015. The effective tax rates (FTE) for the second quarter 2015 and the first half of 2015 were lower than in the respective periods of 2016 due to declining tax preference items. Interest income earned on municipal securities and loans which is exempt from federal income taxes has declined with both declining interest rates and lower volumes of municipal securities and loans. The Company’s investments in limited partnerships that qualify for tax credits have also declined.

 

 

Investment Portfolio

 

The Company maintains a 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 asset-backed and other securities. Investment securities are held in safekeeping by an independent custodian.

 

Management has increased the investment portfolio in response to deposit growth and loan volume declines. The carrying value of the Company’s investment securities portfolio was $3.0 billion as of June 30, 2016, an increase of $118 million compared to December 31, 2015.

 

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, change the composition of the Company’s investment securities portfolio, and change the proportion of investments allocated into the available for sale and held to maturity investment categories.

 

As of June 30, 2016, 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. Credit ratings are considered in our analysis only as a guide to the historical default rate associated with similarly-rated bonds. 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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The following tables summarize the total general obligation and revenue bonds 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 June 30, 2016, the Company’s investment securities portfolios included securities issued by 717 state and local government municipalities and agencies located within 43 states with a fair value of $870.4 million. None of the Company’s investment securities were issued by Puerto Rican government entities. The largest exposure to any one municipality or agency was $10.6 million (fair value) represented by nine general obligation bonds.

 

   At June 30, 2016
   Amortized  Fair
   Cost  Value
   (In thousands)
Obligations of states and political subdivisions:      
General obligation bonds:          
California  $117,263   $122,041 
Texas   61,945    63,859 
New Jersey   40,286    41,559 
Pennsylvania   40,584    41,271 
Minnesota   33,093    34,067 
Other (35 states)   253,435    263,899 
Total general obligation bonds  $546,606   $566,696 
           
Revenue bonds:          
California  $47,829   $50,130 
Pennsylvania   25,309    25,677 
Kentucky   23,955    24,858 
Iowa   18,121    18,789 
Colorado   16,120    16,866 
Other (30 states)   160,189    167,421 
Total revenue bonds  $291,523   $303,741 
Total obligations of states and political subdivisions  $838,129   $870,437 

 

At December 31, 2015, the Company’s investment securities portfolios included securities issued by 725 state and local government municipalities and agencies located within 44 states with a fair value of $864.2 million. None of the Company’s investment securities were issued by Puerto Rican government entities. The largest exposure to any one municipality or agency was $10.3 million (fair value) represented by nine general obligation bonds.

 

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   At December 31, 2015
   Amortized  Fair
   Cost  Value
   (In thousands)
Obligations of states and political subdivisions:      
General obligation bonds:          
California  $117,968   $121,096 
Texas   62,030    63,394 
Pennsylvania   51,547    52,115 
New Jersey   38,651    39,322 
Minnesota   32,588    33,133 
Other (34 states)   243,488    249,854 
Total general obligation bonds  $546,272   $558,914 
           
Revenue bonds:          
California  $49,095   $51,206 
Pennsylvania   29,446    29,841 
Kentucky   19,825    20,400 
Iowa   18,156    18,728 
Colorado   16,161    16,560 
Other (31 states)   163,633    168,592 
Total revenue bonds  $296,316   $305,327 
Total obligations of states and political subdivisions  $842,588   $864,241 

 

At June 30, 2016 and December 31, 2015, 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. The revenue sources that represent 5% or more individually of the total revenue bonds are summarized in the following tables.

 

   At June 30, 2016
   Amortized  Fair
   Cost  Value
   (In thousands)
Revenue bonds by revenue source:          
Water  $56,469   $59,909 
Sewer   43,357    45,101 
Sales tax   31,625    33,413 
Lease (renewal)   25,325    26,331 
College & University   18,362    18,781 
Lease (abatement)   16,771    17,609 
Other   99,614    102,597 
Total revenue bonds by revenue source  $291,523   $303,741 

 

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   At December 31, 2015
   Amortized  Fair
   Cost  Value
   (In thousands)
Revenue bonds by revenue source:          
Water  $62,661   $65,412 
Sewer   45,912    47,242 
Sales tax   31,680    32,945 
Lease (renewal)   21,673    22,227 
College & University   17,967    18,215 
Lease (abatement)   17,017    17,769 
Other   99,406    101,517 
Total revenue bonds by revenue source  $296,316   $305,327 

 

See Note 3 to the unaudited consolidated financial statements for additional information related to the investment securities.

 

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.

 

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 established by assessing a provision for loan losses against 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 Board of Directors. The Loan Review Department performs independent evaluations of loans and assigns credit risk grades to evaluated loans 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”).

 

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The former County Bank loans and repossessed loan collateral were purchased from the FDIC with indemnifying loss-sharing agreements. The loss-sharing agreement on single-family residential real estate assets expires February 6, 2019. The loss-sharing agreement on non-single-family residential real estate assets expired February 6, 2014 as to losses and expires February 6, 2017 as to loss recoveries.

 

Nonperforming Assets         
   At June 30,  At December 31,
   2016  2015  2015
   (In thousands)
Originated:               
Nonperforming nonaccrual loans  $1,693   $6,269   $6,302 
Performing nonaccrual loans   6,890    11    350 
Total nonaccrual loans   8,583    6,280    6,652 
Accruing loans 90 or more days past due   303    221    295 
Total nonperforming loans   8,886    6,501    6,947 
Other real estate owned   1,089    5,906    5,829 
Total nonperforming assets  $9,975   $12,407   $12,776 
                
Purchased covered:               
Nonperforming nonaccrual loans  $29   $3   $- 
Performing nonaccrual loans   -    -    - 
Total nonaccrual loans   29    3    - 
Accruing loans 90 or more days past due   -    -    - 
Total nonperforming loans   29    3    - 
Other real estate owned   -    486    - 
Total nonperforming assets  $29   $489   $- 
                
Purchased non-covered:               
Nonperforming nonaccrual loans  $4,805   $9,937   $8,346 
Performing nonaccrual loans   148    5    - 
Total nonaccrual loans   4,953    9,942    8,346 
Accruing loans 90 or more days past due   53    -    - 
Total nonperforming loans   5,006    9,942    8,346 
Other real estate owned   3,073    2,868    3,435 
Total nonperforming assets  $8,079   $12,810   $11,781 
                
Total nonperforming assets  $18,083   $25,706   $24,557 

 

At June 30, 2016, two loans secured by commercial real estate totaling $9.3 million were on nonaccrual status. The remaining fourteen nonaccrual loans held at June 30, 2016 had an average carrying value of $304 thousand and the largest carrying value was $1.9 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.

 

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. Further, the carrying value of purchased loans includes fair value discounts assigned at the time of purchase under the provisions of FASB ASC 805, Business Combinations, and FASB ASC 310-30, Loans or Debt Securities with Deteriorated Credit Quality. The allowance for loan losses represents Management’s estimate of loan losses in excess of these reductions to the carrying value of loans within the loan portfolio.

 

-45

 

The following table summarizes the allowance for loan losses, chargeoffs and recoveries of the Company for the periods indicated:

 

   For the Three Months  For the Six Months
   Ended June 30,
   2016  2015  2016  2015
   ($ in thousands)
Analysis of the Allowance for Loan Losses            
Balance, beginning of period  $29,487   $31,187   $29,771   $31,485 
  Provision for loan losses   -    -    -    - 
  Loans charged off                    
    Commercial   (764)   (401)   (1,935)   (461)
    Real estate residential   -    -    -    - 
    Consumer installment and other   (677)   (576)   (1,682)   (1,571)
    Purchased non-covered loans   (38)   (396)   (38)   (431)
  Total chargeoffs   (1,479)   (1,373)   (3,655)   (2,463)
  Recoveries of loans previously charged off                    
    Commercial   537    334    782    514 
    Commercial real estate   15    15    30    30 
    Real estate construction   -    -    -    - 
    Consumer installment and other   339    443    795    1,033 
    Purchased non-covered loans   11    222    1,187    229 
  Total recoveries   902    1,014    2,794    1,806 
  Net loan losses   (577)   (359)   (861)   (657)
Balance, end of period  $28,910   $30,828   $28,910   $30,828 
                     
Net loan (losses) recoveries:                    
  Originated loans  $(550)  $(185)  $(2,010)  $(455)
  Purchased non-covered loans   (27)   (174)   1,149    (202)
Net loan losses as a percentage of average total loans (annualized)   0.16%   0.09%   0.12%   0.08%

 

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, the amount of non-indemnified purchased 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 the loss emergence period. The loss rates are applied to segmented loan balances to allocate the allowance to the segments of the loan portfolio.

 

Purchased loans were recorded on the date of purchase at estimated fair value; fair value discounts include a component for estimated loan losses. The Company evaluates all nonaccrual purchased loans with outstanding principal balances in excess of $500 thousand for impairment; the impaired loan value is compared to the recorded investment in the loan, which has been reduced by the loan default discount estimated on the date of purchase. If Management’s impairment analysis determines the impaired loan value is less than the recorded investment in the purchased loan, an allocation of the allowance for loan losses is established for the deficiency. For all other purchased loan portfolio segments, Management applies loss rates to the purchased loan portfolio segments to determine initial allocations of the allowance. Further, liquidating purchased consumer installment loans are evaluated separately by applying historical loss rates to forecasted liquidating principal balances to initially measure losses inherent in this portfolio segment. The initial allocations of the allowance to purchased loan portfolio segments are compared to loan default discounts ascribed to each segment. Management establishes allocations of the allowance for loan losses for any estimated deficiency.

 

-46

 

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 June 30, 2016 is economic and business conditions $1.1 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 $0.9 million, and concentrations of credit $2.0 million.

 

   Allowance for Loan Losses
   For the Three Months Ended June 30, 2016
               Consumer  Purchased  Purchased      
      Commercial     Residential  Installment  Non-covered  Covered      
   Commercial  Real Estate  Construction  Real Estate  and Other  Loans  Loans  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                             
    Balance at beginning of period  $9,847   $4,237   $130   $1,707   $6,683   $950   $-   $5,933   $29,487 
    Additions:                                             
        Provision   782    (340)   (3)   (106)   271    121    66    (791)   - 
    Deductions:                                             
        Chargeoffs   (764)   -    -    -    (677)   (38)   -    -    (1,479)
        Recoveries   537    15    -    -    339    11    -    -    902 
            Net loan (losses) recoveries   (227)   15    -    -    (338)   (27)   -    -    (577)
Total allowance for loan losses  $10,402   $3,912   $127   $1,601   $6,616   $1,044   $66   $5,142   $28,910 

 

 

   Allowance for Loan Losses
   For the Six Months Ended June 30, 2016
               Consumer  Purchased  Purchased      
      Commercial     Residential  Installment  Non-covered  Covered      
   Commercial  Real Estate  Construction  Real Estate  and Other  Loans  Loans  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                             
    Balance at beginning of period  $9,559   $4,224   $177   $1,801   $7,080   $967   $-   $5,963   $29,771 
    Additions:                                             
        Provision   1,996    (342)   (50)   (200)   423    (1,072)   66    (821)   - 
    Deductions:                                             
        Chargeoffs   (1,935)   -    -    -    (1,682)   (38)   -    -    (3,655)
        Recoveries   782    30    -    -    795    1,187    -    -    2,794 
            Net loan (losses) recoveries   (1,153)   30    -    -    (887)   1,149    -    -    (861)
Total allowance for loan losses  $10,402   $3,912   $127   $1,601   $6,616   $1,044   $66   $5,142   $28,910 

 

 

   Allowance for Loan Losses and Recorded Investment in Loans Evaluated for Impairment
   At June 30, 2016
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment
and Other
  Purchased
Non-covered
Loans
  Purchased Covered Loans  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                             
Individually evaluated for impairment  $5,283   $316   $-   $-   $-   $-   $-   $-   $5,599 
Collectively evaluated for impairment   5,119    3,596    127    1,601    6,616    1,044    66    5,142    23,311 
Purchased loans with evidence of credit deterioration   -    -    -    -    -    -    -    -    - 
Total  $10,402   $3,912   $127   $1,601   $6,616   $1,044   $66   $5,142   $28,910 
Carrying value of loans:                                             
Individually evaluated for impairment  $14,035   $5,375   $-   $-   $-   $10,198   $-   $-   $29,608 
Collectively evaluated for impairment   323,584    497,118    2,103    102,292    335,687    125,346    12,581    -    1,398,711 
Purchased loans with evidence of credit deterioration   -    -    -    -    -    1,045    196    -    1,241 
Total  $337,619   $502,493   $2,103   $102,292   $335,687   $136,589   $12,777   $-   $1,429,560 

 

Management considers the $28.9 million allowance for loan losses to be adequate as a reserve against loan losses inherent in the loan portfolio as of June 30, 2016.

 

See Note 4 to the unaudited consolidated financial statements for additional information related to the loan portfolio, loan portfolio credit risk, and allowance for loan losses.

 

-47

 

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 Reserve Board (the “FRB”). The monetary policies of the FRB 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 June 30, 2017 assumes market interest rates will either remain at relatively low levels or short-term rates will rise gradually.

 

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 June 30, 2016, 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. 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.

-48

 

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 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 the first half of 2016 and 97 percent in 2015. 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 $3.0 billion in total investment securities at June 30, 2016. Under certain deposit, borrowing and other arrangements, the Company must hold and pledge investment securities as collateral. At June 30, 2016, such collateral requirements totaled approximately $745 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 will monitor the Company’s cash levels throughout 2016. 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. Substantially all of the Parent Company's revenues are obtained from subsidiary dividends and service fees.

 

The Bank’s dividends paid to the Parent Company and proceeds from the exercise of stock options provided adequate cash flow for the Parent Company to pay shareholder dividends of $20 million in the first half of 2016 and $39 million in 2015, and retire common stock in the amount of $6 million and $15 million, respectively. 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.

 

-49

 

Capital Resources

 

The Company has historically generated high levels of earnings, which provides a means of accumulating capital. The Company's net income as a percentage of average shareholders' equity (“return on equity” or “ROE”) has been 10.9% (annualized) in the first half of 2016, 11.3% in 2015 and 11.6% in 2014. The Company also raises capital as employees exercise stock options. Capital raised through the exercise of stock options was $10 million in the first half of 2016 compared with $5 million in 2015 and $12 million in 2014.

 

The Company paid common dividends totaling $20 million in the first half of 2016, $39 million in 2015 and $40 million in 2014, which represent dividends per common share of $0.78, $1.53 and $1.52, 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 137 thousand shares valued at $6 million in the first half of 2016, 344 thousand shares valued at $15 million in 2015 and 1.0 million shares valued at $53 million in 2014.

 

The Company's primary capital resource is shareholders' equity, which was $558 million at June 30, 2016 compared with $532 million at December 31, 2015. The Company's ratio of equity to total assets was 10.78% at June 30, 2016 and 10.30% at December 31, 2015.

 

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.

 

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 are subject to the “advanced approaches rule” and 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.

 

-50

 

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.

 

         Transitional     Well-capitalized
         Minimum  Minimum  by Regulatory
         Regulatory  Regulatory  Definition
         Requirement  Requirement  Under FDICIA
   At June 30, 2016  Effective  Effective  Effective
   Company  Bank  January 1, 2016  January 1, 2019  January 1, 2015
                
Common Equity Tier I Capital   14.11%   11.72%   5.125%(1)   7.00%(2)   6.50%
Tier I Capital   14.11%   11.72%   6.625%(1)   8.50%(2)   8.00%
Total Capital   14.76%   12.43%   8.625%(1)   10.50%(2)   10.00%
Leverage Ratio   8.26%   6.81%   4.000%   4.00%   5.00%

 

(1) Includes 0.625% capital conservation buffer.

(2) Includes 2.5% capital conservation buffer.

 

         Transitional     Well-capitalized
         Minimum  Minimum  by Regulatory
         Regulatory  Regulatory  Definition
         Requirement  Requirement  Under FDICIA
   At December 31, 2015  Effective  Effective  Effective
   Company  Bank  January 1, 2015  January 1, 2019  January 1, 2015
                
Common Equity Tier I Capital   12.82%   11.00%   4.50%   7.00%(3)   6.50%
Tier I Capital   12.82%   11.00%   6.00%   8.50%(3)   8.00%
Total Capital   13.39%   11.68%   8.00%   10.50%(3)   10.00%
Leverage Ratio   7.99%   6.82%   4.00%   4.00%   5.00%

 

(3) Includes 2.5% capital conservation buffer.

 

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.

 

 

Item 3. 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, are not significant in the normal course of the Company’s business activities.

 

Item 4. 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 June 30, 2016.

 

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 June 30, 2016 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

Neither the Company nor any of its subsidiaries is a party to any material pending legal proceeding, nor is its 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 1A. Risk Factors

 

The Company’s Form 10-K as of December 31, 2015 includes detailed disclosure about the risks faced by the Company’s business; such risks have not materially changed since the Form 10-K was filed.

 

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

 

(a) Previously reported on Form 8-K.

(b) None

(c) 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 June 30, 2016 (in thousands, except per share data).

 

   2016
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 price paid)
April 1 through April 30   7   $49.35    7    1,590 
May 1 through May 31   -    -    -    1,590 
June 1 through June 30   -    -    -    1,590 
Total   7    49.35    7    1,590 

 

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.

 

Shares were repurchased during the second quarter 2016 pursuant to a program approved by the Board of Directors on July 23, 2015 authorizing the purchase of up to 1,750 thousand shares of the Company’s common stock from time to time prior to September 1, 2016.

 

 

 

 

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Item 3. Defaults upon Senior Securities

 

None

 

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

 

Item 5. Other Information

 

None

 

 

Item 6. Exhibits

 

The exhibit list required by this item is incorporated by reference to the Exhibit Index filed with this report.

 

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.

 

WESTAMERICA BANCORPORATION

(Registrant)

 

 

/s/ JOHN "ROBERT" THORSON  

John "Robert" Thorson

Senior Vice President and Chief Financial Officer

(Chief Financial and Accounting Officer)

 

Date: August 2, 2016

 

 

 

 

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EXHIBIT INDEX

 

Exhibit 31.1: Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a)

 

Exhibit 31.2: Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a)

 

Exhibit 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

 

Exhibit 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

 

Exhibit 101: Pursuant to Rule 405 of Regulation S-T, the following financial information from the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2016, is formatted in XBRL interactive data files: (i) Consolidated Statements of Income for the three and six months ended June 30, 2016 and 2015; (ii) Consolidated Balance Sheets at June 30, 2016, and December 31, 2015; (iii) Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2016 and 2015, (iv) Consolidated Statements of Changes in Shareholders’ Equity for the six months ended June 30, 2016 and 2015; (v) Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and 2015 and (vi) Notes to the Unaudited Consolidated Financial Statements.

 

 

 

 

 

 

 

 

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