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EX-32.2 - EXHIBIT 32.2 - WESTAMERICA BANCORPORATIONexh_322.htm
EX-32.1 - EXHIBIT 32.1 - WESTAMERICA BANCORPORATIONexh_321.htm
EX-31.2 - EXHIBIT 31.2 - WESTAMERICA BANCORPORATIONexh_312.htm
EX-31.1 - EXHIBIT 31.1 - WESTAMERICA BANCORPORATIONexh_311.htm

 

 

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 March 31, 2018

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, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

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

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

Yes ☐   No ☒

 

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 April 26, 2018
     
Common Stock,   26,626,524
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
     
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 29
     
Item 3 Quantitative and Qualitative Disclosures about Market Risk 49
     
Item 4 Controls and Procedures 50
     
PART II - OTHER INFORMATION  
   
Item 1 Legal Proceedings 50
     
Item 1A Risk Factors 50
     
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds 50
     
Item 3 Defaults upon Senior Securities 51
     
Item 4 Mine Safety Disclosures 51
     
Item 5 Other Information 51
     
Item 6 Exhibits 51
     
Signatures 52
   
Exhibit Index 53
   
Exhibit 31.1 - Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a) 54
   
Exhibit 31.2 - Certification of Chief Financial Officer pursuant to Securities Exchange Act Rule 13a-14(a)/15d-14(a) 55
   
Exhibit 32.1 - Certification of Chief Executive Officer Required by 18 U.S.C. Section 1350 56
   
Exhibit 32.2 - Certification of Chief Financial Officer Required by 18 U.S.C. Section 1350 57

 

 

- 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 reduction, mitigation of risk in the Company’s loan and investment securities portfolios, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or board of directors, including those relating to products or services; (iii) statements of future economic performance; and (iv) statements of assumptions underlying such statements. Words such as "believes", "anticipates", "expects", “estimates”, "intends", "targeted", "projected", “forecast”, "continue", "remain", "will", "should", "may" and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

 

These forward-looking statements are based on Management’s current knowledge and belief and include information concerning the Company’s possible or assumed future financial condition and results of operations. A number of factors, some of which are beyond the Company’s ability to predict or control, could cause future results to differ materially from those contemplated. These factors include but are not limited to (1) the length and severity of difficulties in the global, national and California economies and the effects of government efforts to address those difficulties; (2) liquidity levels in capital markets; (3) fluctuations in asset prices including, but not limited to stocks, bonds, real estate, and commodities; (4) the effect of acquisitions and integration of acquired businesses; (5) economic uncertainty created by terrorist threats and attacks on the United States, the actions taken in response, and the uncertain effect of these events on the national and regional economies; (6) changes in the interest rate environment; (7) changes in the regulatory environment; (8) competitive pressure in the banking industry; (9) operational risks including a failure or breach in data processing or security systems or those of third party vendors and other service providers, including as a result of cyber attacks or fraud; (10) volatility of interest rate sensitive loans, deposits and investments; (11) asset/liability management risks and liquidity risks; (12) the effect of natural disasters, including earthquakes, fire, flood, drought, and other disasters, on the uninsured value of the Company’s assets and of loan collateral, the financial condition of debtors and issuers of investment securities, the economic conditions affecting the Company’s market place, and commodities and asset values; (13) changes in the securities markets and (14) the outcome of contingencies, such as legal proceedings. However, the reader should not consider the above-mentioned factors to be a complete set of all potential risks or uncertainties.

 

Forward-looking statements speak only as of the date they are made. The Company undertakes no obligation to update any forward-looking statements in this Report to reflect circumstances or events that occur after the date forward looking statements are made, except as may be required by law. The reader is directed to the Company's annual report on Form 10-K for the year ended December 31, 2017, 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.

 

- 3 -

 

PART I - FINANCIAL INFORMATION

Item 1      Financial Statements

 

WESTAMERICA BANCORPORATION

CONSOLIDATED BALANCE SHEETS

(unaudited)

 

   At March 31,  At December 31,
   2018  2017
   (In thousands)
Assets:          
Cash and due from banks  $555,607   $575,002 
Equity securities   1,764    1,800 
Debt securities available for sale   2,351,970    2,191,707 
Debt securities held to maturity, with fair values of: $1,098,895 at March 31, 2018 and $1,155,342 at December 31, 2017   1,114,287    1,158,864 
Loans   1,228,584    1,287,982 
Allowance for loan losses   (23,081)   (23,009)
Loans, net of allowance for loan losses   1,205,503    1,264,973 
Other real estate owned   1,376    1,426 
Premises and equipment, net   35,790    35,301 
Identifiable intangibles, net   3,280    3,850 
Goodwill   121,673    121,673 
Other assets   159,786    158,450 
Total Assets  $5,551,036   $5,513,046 
           
Liabilities:          
Noninterest-bearing deposits  $2,179,157   $2,197,526 
Interest-bearing deposits   2,688,710    2,630,087 
Total deposits   4,867,867    4,827,613 
Short-term borrowed funds   65,356    58,471 
Other liabilities   35,730    36,723 
Total Liabilities   4,968,953    4,922,807 
           
Contingencies (Note 10)          
           
Shareholders' Equity:          
Common stock (no par value), authorized - 150,000 shares Issued and outstanding: 26,591 at March 31, 2018 and 26,425 at December 31, 2017   439,817    431,734 
Deferred compensation   1,533    1,533 
Accumulated other comprehensive loss   (43,452)   (16,832)
Retained earnings   184,185    173,804 
Total Shareholders' Equity   582,083    590,239 
Total Liabilities and  Shareholders' Equity  $5,551,036   $5,513,046 

 

See accompanying notes to unaudited consolidated financial statements.

 

- 4 -

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

 

   For the
Three Months Ended
March 31,
   2018  2017
   (In thousands,
except per share data)
Interest and Fee Income:          
Loans  $14,697   $15,780 
Equity securities   85    74 
Debt securities available for sale   13,551    10,175 
Debt securities held to maturity   6,174    7,295 
Total Interest and Fee Income   34,507    33,324 
Interest Expense:          
Deposits   450    469 
Short-term borrowed funds   9    11 
Total Interest Expense   459    480 
Net Interest and Fee Income   34,048    32,844 
Provision for Loan Losses   -    - 
Net Interest and Fee Income After Provision For Loan Losses   34,048    32,844 
Noninterest Income:          
Service charges on deposit accounts   4,752    4,923 
Merchant processing services   2,420    1,875 
Debit card fees   1,605    1,481 
Trust fees   743    702 
ATM processing fees   664    575 
Other service fees   631    650 
Financial services commissions   114    195 
Equity securities losses   (36)   - 
Other noninterest income   1,062    1,256 
Total Noninterest Income   11,955    11,657 
Noninterest Expense:          
Salaries and related benefits   13,351    13,070 
Occupancy and equipment   4,691    4,887 
Outsourced data processing services   2,340    2,139 
Professional fees   785    611 
Amortization of identifiable intangibles   570    800 
Courier service   463    421 
Other noninterest expense   2,014    2,687 
Total Noninterest Expense   24,214    24,615 
Income Before Income Taxes   21,789    19,886 
Provision for income taxes   4,283    4,837 
Net Income  $17,506   $15,049 
           
Average Common Shares Outstanding   26,532    26,171 
Average Diluted Common Shares Outstanding   26,665    26,329 
Per Common Share Data:          
Basic earnings  $0.66   $0.58 
Diluted earnings   0.66    0.57 
Dividends paid   0.40    0.39 

 

See accompanying notes to unaudited consolidated financial statements.      

 

- 5 -

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

(unaudited)

 

   For the Three Months Ended
   March 31,
   2018  2017
   (In thousands)
Net income  $17,506   $15,049 
Other comprehensive (loss) income:          
Changes in net unrealized gains on debt securities available for sale   (32,846)   1,074 
Deferred tax benefit (expense)   9,709    (452)
Changes in net unrealized gains on debt securities available for sale, net of tax   (23,137)   622 
Post-retirement benefit transition obligation amortization   -    15 
Deferred tax expense   -    (6)
Post-retirement benefit transition obligation amortization, net of tax   -    9 
Total other comprehensive (loss) income   (23,137)   631 
Total comprehensive (loss) income  $(5,631)  $15,680 

 

See accompanying notes to unaudited consolidated financial statements.      

 

 

 

 

 

- 6 -

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

(unaudited)

 

            Accumulated      
   Common        Other      
   Shares  Common  Deferred  Comprehensive  Retained   
   Outstanding  Stock  Compensation  (Loss) Income  Earnings  Total
   (In thousands)
                   
Balance, December 31, 2016   25,907   $404,606   $1,533   $(10,074)  $165,302   $561,367 
Net income for the period                       15,049    15,049 
Other comprehensive income                  631         631 
Exercise of stock options   376    17,593                   17,593 
Stock based compensation        456                   456 
Stock awarded to employees   -    15                   15 
Dividends                       (10,223)   (10,223)
Balance, March 31, 2017   26,283   $422,670   $1,533   $(9,443)  $170,128   $584,888 
                               
Balance, December 31, 2017   26,425   $431,734   $1,533   $(16,832)  $173,804   $590,239 
Cumulative effect of equity securities losses reclassified                  142    (142)   - 
Adjusted Balance, January 1, 2018   26,425    431,734    1,533    (16,690)   173,662    590,239 
Reclass stranded tax effects resulting from the Tax Cuts and Jobs Act                  (3,625)   3,625    - 
Net income for the period                       17,506    17,506 
Other comprehensive loss                  (23,137)        (23,137)
Exercise of stock options   166    7,534                   7,534 
Stock based compensation        525                   525 
Stock awarded to employees   -    24                   24 
Dividends                       (10,608)   (10,608)
Balance, March 31, 2018   26,591   $439,817   $1,533   $(43,452)  $184,185   $582,083 

 

See accompanying notes to unaudited consolidated financial statements.

 

 

- 7 -

 

WESTAMERICA BANCORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

 

   For the Three Months
Ended March 31,
   2018  2017
   (In thousands)
Operating Activities:          
Net income  $17,506   $15,049 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization/accretion   1,643    5,754 
Net amortization of deferred net loan (fees) cost   (40)   26 
Decrease in interest income receivable   1,019    1,744 
Life insurance premiums paid   (203)   (126)
Increase in income taxes payable   4,302    2,896 
(Increase) decrease in deferred tax asset   (20)   1,441 
Decrease in other assets   2,676    895 
Stock option compensation expense   525    456 
Increase in interest expense payable   15    8 
Decrease in other liabilities   (984)   (2,864)
Equity securities losses   36    - 
Writedown of premises and equipment   1    50 
Net gain on sale of foreclosed assets   -    (55)
Net Cash Provided by Operating Activities   26,476    25,274 
           
Investing Activities:          
Net repayments of loans   59,959    1,526 
Net receipts under FDIC(1) indemnification agreements   -    129 
Purchases of debt securities available for sale   (279,327)   (51,297)
Proceeds from sale/maturity/calls of debt securities available for sale   86,218    47,600 
Proceeds from maturity/calls of debt securities held to maturity   44,577    45,640 
Purchases of premises and equipment   (1,413)   (501)
Proceeds from sale of FRB(2) stock   -    24 
Proceeds from sale of foreclosed assets   50    1,014 
Net Cash (Used in) Provided by Investing Activities   (89,936)   44,135 
           
Financing Activities:          
Net change in deposits   40,254    (6,768)
Net change in short-term borrowings   6,885    14,533 
Exercise of stock options/issuance of shares   7,534    17,593 
Common stock dividends paid   (10,608)   (10,223)
Net Cash Provided by Financing Activities   44,065    15,135 
Net Change In Cash and Due from Banks   (19,395)   84,544 
Cash and Due from Banks at Beginning of Period   575,002    462,271 
Cash and Due from Banks at End of Period  $555,607   $546,815 
           
Supplemental Cash Flow Disclosures:          
Supplemental disclosure of noncash activities:          
Loan collateral transferred to other real estate owned  $-   $- 
Securities purchases pending settlement   -    - 
Supplemental disclosure of cash flow activities:          
Interest paid for the period   444    504 
Income tax payments for the period   -    500 

 

See accompanying notes to unaudited consolidated financial statements.

 

(1)Federal Deposit Insurance Corporation ("FDIC")
(2)Federal Reserve Bank ("FRB")

 

- 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 months ended March 31, 2018 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, 2017.

 

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, 2017. 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, it is reasonably possible conditions could change materially affecting results of operations and financial conditions.

 

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.

 

Certain amounts in prior periods have been reclassified to conform to the current presentation.

 

Recently Adopted Accounting Standards

 

In the three months ended March 31, 2018, the Company adopted the following new accounting guidance:

 

FASB Accounting Standard Update (ASU) 2014-09, Revenue (Topic 606): Revenue from Contracts with Customers, was issued May 2014. The ASU specifies a standardized approach for revenue recognition across industries and transactions. The ASU also requires additional disclosures. The scope of the ASU does not include revenue streams covered by other ASU topics; thus, Topic 606 does not apply to revenue related to financial instruments, guarantees and leases, such as the Company’s net interest income.

 

Approximately 73% of our revenue, including all of our net interest income and a portion of our noninterest income, is out of scope of the guidance. The contracts that are in scope of the guidance are primarily related to service charges and fees on deposit accounts, merchant processing fees, debit card fees, ATM processing fees, trust fees and other service charges, commissions and fees. We have completed analyzing the individual contracts in scope and determined our revenue recognition practices within the scope of the ASU as described below did not change in any material regard upon adoption of the ASU.

 

- 9 -

 

Service Charges on Deposit Accounts: The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn from the customer’s account balance.

 

Merchant Processing Services and Debit Card Fees: The Company earns interchange fees from cardholder transactions conducted through the payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder.

 

Trust Fees: The Company earns trust fees from its contracts with customers to manage assets for investment or custody services. These fees are primarily earned over time as the Company provides the contracted monthly or quarterly services and are generally assessed based on a tiered scale of the market value of assets under management (AUM) at month-end. Other related services provided, which are based on a fixed fee schedule, are recognized when the services are rendered.

 

Gains/Losses on Sales of OREO: The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. The Company does not finance the sale of OREO.

 

The Company adopted the ASU on January 1, 2018 and no cumulative adjustment was required.

 

FASB ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, was issued January 2016. The ASU addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Most notably, the ASU changes the income statement impact of equity investments held by the Company and the requirement for the Company to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes (Note 9).

 

The Company was required to adopt the ASU provisions on January 1, 2018, and for those equity securities with readily determinable fair values, the Company elected the retrospective transition approach with a cumulative effect adjustment to the balance sheet and for those equity securities that do not have readily determinable fair values, the Company elected the prospective transition approach. The impact of the adoption of this accounting standard on the Company’s consolidated financial statements will be subject to the price volatility of the equity investments. As a result of implementing the ASU provisions, effective January 1, 2018, the Company recorded a cumulative effect adjustment to retained earnings of $142 thousand.

 

FASB ASU 2018-02, Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, was issued February 2018. The ASU eliminates the stranded tax effects resulting from the Tax Cuts and Jobs Act by allowing a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. The Company early adopted the provisions of the ASU effective January 1, 2018, by reclassifying the Company’s $3,625 thousand stranded tax effect.

 

Recently Issued Accounting Standards

 

FASB ASU 2016-02, Leases (Topic 842), was issued February 25, 2016. The provisions of the new standard require lessees to recognize most leases on-balance sheet, increasing reported assets and liabilities. Lessor accounting remains substantially similar to current U.S. GAAP.

 

The Company will be required to adopt the ASU provisions January 1, 2019, and plans to elect the modified retrospective transition approach. Management is evaluating the impact that the ASU will have on the Company’s financial statements. As of December 31, 2017, the Company leased 58 of its operating facilities; the remaining minimum lease payments were $17.5 million. The Company does not expect a material change in noninterest expenses upon adoption of the new standard.

 

FASB ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, was issued on June 16, 2016. The ASU significantly changes estimates for credit losses related to financial assets measured at amortized cost and certain other contracts. For estimating credit losses, the FASB is replacing the incurred loss model with the current expected credit loss (CECL) model, which will accelerate recognition of credit losses. Additionally, credit losses relating to debt securities available-for-sale 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.

 

- 10 -

 

The Company will be required to adopt the ASU provisions on January 1, 2020. Management is evaluating the impact that the ASU will have on the Company’s consolidated financial statements. The ultimate adjustment to the allowance for loan losses will be accomplished through an offsetting after-tax adjustment to shareholders’ equity. Economic conditions and the composition of the Company’s loan portfolio at the time of adoption will influence the extent of the adopting accounting adjustment.

 

FASB ASU 2017-08, Receivables – Non-Refundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities, was issued March 2017. The ASU will shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity.

 

The Company will be required to adopt the ASU provisions on January 1, 2019. Management is evaluating the impact the ASU will have on the Company’s financial statements.

 

FASB ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, was issued August 2017. The ASU will expand and refine hedge accounting for both nonfinancial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. The ASU also provides for a one-time reclassification of prepayable assets from held-to-maturity (HTM) to available for sale (AFS) regardless of derivative use.

 

The Company will be required to adopt the ASU provisions January 1, 2019. The Company does not currently engage in trading activities or use derivative instruments to control interest rate risk, even though such activities may be permitted with the approval of the Company’s Board of Directors. However, the Company is currently evaluating the prepayable assets in the HTM portfolio to determine if a one-time reclassification of prepayable assets from HTM to the AFS will occur upon implementation.

 

 

 

 

 

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- 11 -

 

Note 3: Investment Securities

 

Effective January 1, 2018, upon adoption of ASU 2016-01, equity securities included in the Company’s available for sale portfolio of $1,800 thousand were reclassified to equity securities. The reclassification of equity securities resulted in recording a cumulative effect adjustment to retained earnings of $142 thousand, net of tax.

 

At March 31, 2018, the market value of equity securities was $1,764 thousand. During the three months ended March 31, 2018, the Company recognized gross unrealized holding losses of $36 thousand in earnings.

 

An analysis of the amortized cost and fair value by major categories of debt securities available for sale, which are carried at fair value with net unrealized gains (losses) reported on an after-tax basis as a component of cumulative other comprehensive income, and debt securities held to maturity, which are carried at amortized cost, follows:

 

      Gross  Gross   
   Amortized  Unrealized  Unrealized  Fair
   Cost  Gains  Losses  Value
At March 31, 2018  (In thousands)
Debt securities available for sale            
Securities of U.S. Government sponsored entities  $122,291   $1   $(4,345)  $117,947 
Agency residential mortgage-backed securities (MBS)   879,824    500    (32,684)   847,640 
Non-agency residential MBS   138    1    -    139 
Agency commercial MBS   2,229    -    (39)   2,190 
Securities of U.S. Government entities   1,526    -    (6)   1,520 
Obligations of states and political subdivisions   181,386    2,910    (3,661)   180,635 
Corporate securities   1,226,267    523    (24,891)   1,201,899 
Total debt securities available for sale   2,413,661    3,935    (65,626)   2,351,970 
Debt securities held to maturity                    
Agency residential MBS   520,105    325    (16,728)   503,702 
Non-agency residential MBS   4,179    77    -    4,256 
Agency commercial MBS   1,902    -    (9)   1,893 
Obligations of states and political subdivisions   588,101    4,419    (3,476)   589,044 
Total debt securities held to maturity   1,114,287    4,821    (20,213)   1,098,895 
Total  $3,527,948   $8,756   $(85,839)  $3,450,865 

 

 

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- 12 -

 

      Gross  Gross   
   Amortized  Unrealized  Unrealized  Fair
   Cost  Gains  Losses  Value
At December 31, 2017  (In thousands)
Debt securities available for sale                    
Securities of U.S. Government sponsored entities  $122,285   $1   $(2,967)  $119,319 
Agency residential MBS   787,679    522    (20,495)   767,706 
Non-agency residential MBS   153    1    -    154 
Agency commercial MBS   2,244    -    (25)   2,219 
Securities of U.S. Government entities   1,612    -    (22)   1,590 
Obligations of states and political subdivisions   182,907    3,796    (1,482)   185,221 
Corporate securities   1,123,671    1,104    (9,277)   1,115,498 
Total debt securities available for sale   2,220,551    5,424    (34,268)   2,191,707 
Debt securities held to maturity                    
Agency residential MBS   545,883    606    (9,850)   536,639 
Non-agency residential MBS   4,462    70    -    4,532 
Agency commercial MBS   9,041    -    (66)   8,975 
Obligations of states and political subdivisions   599,478    7,736    (2,018)   605,196 
Total debt securities held to maturity   1,158,864    8,412    (11,934)   1,155,342 
Total  $3,379,415   $13,836   $(46,202)  $3,347,049 

 

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

 

   At March 31, 2018
   Debt Securities Available  Debt Securities Held
   for Sale  to Maturity
   Amortized  Fair  Amortized  Fair
   Cost  Value  Cost  Value
   (In thousands)
Maturity in years:                    
1 year or less  $164,450   $162,099   $67,865   $68,636 
Over 1 to 5 years   1,098,360    1,075,777    248,126    247,858 
Over 5 to 10 years   225,690    223,481    269,159    269,527 
Over 10 years   42,970    40,644    2,951    3,023 
Subtotal   1,531,470    1,502,001    588,101    589,044 
MBS   882,191    849,969    526,186    509,851 
Total  $2,413,661   $2,351,970   $1,114,287   $1,098,895 

 

 

   At December 31, 2017
   Debt Securities Available  Debt Securities Held
   for Sale  to Maturity
   Amortized  Fair  Amortized  Fair
   Cost  Value  Cost  Value
   (In thousands)
Maturity in years:                    
1 year or less  $193,337   $193,385   $50,295   $51,105 
Over 1 to 5 years   1,031,807    1,023,047    269,050    269,471 
Over 5 to 10 years   159,266    160,042    277,170    281,546 
Over 10 years   46,065    45,154    2,963    3,074 
Subtotal   1,430,475    1,421,628    599,478    605,196 
MBS   790,076    770,079    559,386    550,146 
Total  $2,220,551   $2,191,707   $1,158,864   $1,155,342 

 

 

- 13 -

 

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 March 31, 2018 and December 31, 2017, the Company had no high-risk collateralized mortgage obligations as defined by regulatory guidelines.

 

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

 

   Debt Securities Available for Sale
   At March 31, 2018
   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   2   $1,977   $(12)   8   $115,889   $(4,333)   10   $117,866   $(4,345)
Agency residential MBS   11    280,804    (6,163)   52    492,453    (26,521)   63    773,257    (32,684)
Agency commercial MBS   2    2,190    (39)   -    -    -    2    2,190    (39)
Securities of U.S. Government entities   -    -    -    3    1,520    (6)   3    1,520    (6)
Obligations of states and political subdivisions   57    31,091    (636)   35    49,993    (3,025)   92    81,084    (3,661)
Corporate securities   82    781,714    (16,548)   34    258,551    (8,343)   116    1,040,265    (24,891)
Total   154   $1,097,776   $(23,398)   132   $918,406   $(42,228)   286   $2,016,182   $(65,626)

 

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

 

   Debt Securities Held to Maturity
   At March 31, 2018
   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   23   $33,919   $(578)   67   $451,597   $(16,150)   90   $485,516   $(16,728)
Agency commercial MBS   1    1,893    (9)   -    -    -    1    1,893    (9)
Obligations of states and political subdivisions   266    257,849    (1,557)   58    57,422    (1,919)   324    315,271    (3,476)
Total   290   $293,661   $(2,144)   125   $509,019   $(18,069)   415   $802,680   $(20,213)

 

The unrealized losses on the Company’s debt securities were caused by market conditions for these types of investments, particularly changes in risk-free interest rates. The Company evaluates debt securities on a quarterly basis including changes in security ratings issued by rating agencies, changes in the financial condition of the issuer, and, for mortgage-backed and asset-backed securities, delinquency and loss information with respect to the underlying collateral, changes in the levels of subordination for the Company’s particular position within the repayment structure and remaining credit enhancement as compared to expected credit losses of the security. Substantially all of these securities continue to be investment grade rated by a major rating agency. In addition to monitoring credit rating agency evaluations, Management performs its own evaluations regarding the credit worthiness of the issuer or the securitized assets underlying asset backed securities.

 

The Company does not intend to sell any debt securities and has concluded that it is more likely than not that it will not be required to sell the debt securities prior to recovery of the amortized cost basis. Therefore, the Company does not consider these debt securities to be other-than-temporarily impaired as of March 31, 2018.

 

The fair values of the debt 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 debt securities declines. As a result, other than temporary impairments may occur in the future.

 

As of March 31, 2018 and December 31, 2017, the Company had debt securities pledged to secure public deposits and short-term borrowed funds of $696,058  thousand and $715,774 thousand, respectively.

 

- 14 -

 

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

 

   Debt Securities Available for Sale
   At December 31, 2017
   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   $996   $(2)   8   $117,252   $(2,965)   9   $118,248   $(2,967)
Agency residential MBS   7    238,554    (1,501)   51    516,711    (18,994)   58    755,265    (20,495)
Non-agency residential MBS   1    1    -    -    -    -    1    1    - 
Agency commercial MBS   2    2,219    (25)   -    -    -    2    2,219    (25)
Securities of U.S. Government entities   -    -    -    3    1,590    (22)   3    1,590    (22)
Obligations of states and political subdivisions   50    21,453    (228)   35    52,071    (1,254)   85    73,524    (1,482)
Corporate securities   64    571,112    (4,047)   38    282,924    (5,230)   102    854,036    (9,277)
Total   125   $834,335   $(5,803)   135   $970,548   $(28,465)   260   $1,804,883   $(34,268)

 

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

 

   Debt Securities Held to Maturity
   At December 31, 2017
   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   15   $30,218   $(201)   65   $479,775   $(9,649)   80   $509,993   $(9,850)
Agency commercial MBS   1    1,913    (4)   1    7,062    (62)   2    8,975    (66)
Obligations of states and political subdivisions   146    131,032    (553)   59    58,979    (1,465)   205    190,011    (2,018)
Total   162   $163,163   $(758)   125   $545,816   $(11,176)   287   $708,979   $(11,934)

 

The 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
   Ended March 31,
   2018  2017
   (In thousands)
       
Taxable  $14,935   $12,147 
Tax-exempt from regular federal income tax   4,875    5,397 
Total interest income from investment securities  $19,810   $17,544 

 

 

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- 15 -

 

Note 4: Loans and Allowance for Loan Losses

 

A summary of the major categories of loans outstanding is shown in the following table at the dates indicated.

 

   At March 31,  At December 31,
   2018  2017
   (In thousands)
Commercial  $306,978   $335,996 
Commercial Real Estate   553,318    568,584 
Construction   2,941    5,649 
Residential Real Estate   59,484    65,183 
Consumer Installment & Other   305,863    312,570 
Total  $1,228,584   $1,287,982 

 

Total loans outstanding reported above include loans purchased from the FDIC of $75,476  thousand and $83,478 thousand at March 31, 2018 and December 31, 2017, respectively. Loans purchased from the FDIC were separately reported in prior periods and have been reclassified into their respective categories in the current presentation.

 

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

 

 

   For the  For the
   Three Months Ended  Year Ended
   March 31, 2018  December 31, 2017
Accretable yield:  (In thousands)
Balance at the beginning of the period  $738   $1,237 
Reclassification from nonaccretable difference   313    1,852 
Accretion   (452)   (2,351)
Balance at the end of the period  $599   $738 
           
Accretion  $(452)  $(2,351)
Change in FDIC indemnification   1    192 
(Increase) in interest income  $(451)  $(2,159)

 

The following summarizes activity in the allowance for loan losses:

 

   Allowance for Loan Losses
   For the Three Months Ended March 31, 2018
               Consumer      
      Commercial     Residential  Installment      
   Commercial  Real Estate  Construction  Real Estate  and Other  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                   
Balance at beginning of period  $7,746   $3,849   $335   $995   $6,418   $3,666   $23,009 
Additions:                                   
(Reversal) provision   (17)   (25)   (160)   (87)   37    252    - 
Deductions:                                   
Chargeoffs   (41)   -    -    -    (1,365)   -    (1,406)
Recoveries   829    -    -    -    649    -    1,478 
Net loan recoveries (losses)   788    -    -    -    (716)   -    72 
Total allowance for loan losses  $8,517   $3,824   $175   $908   $5,739   $3,918   $23,081 

 

 

   Allowance for Loan Losses
   For the Three Months Ended March 31, 2017
               Consumer      
      Commercial     Residential  Installment      
   Commercial  Real Estate  Construction  Real Estate  and Other  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                   
Balance at beginning of period  $8,327   $3,330   $152   $1,330   $7,980   $4,835   $25,954 
Additions:                                   
Provision (reversal)   209    182    (40)   (116)   106    (341)   - 
Deductions:                                   
Chargeoffs   (103)   -    -    -    (1,739)   -    (1,842)
Recoveries   160    10    -    -    637    -    807 
Net loan recoveries (losses)   57    10    -    -    (1,102)   -    (1,035)
Total allowance for loan losses  $8,593   $3,522   $112   $1,214   $6,984   $4,494   $24,919 

 

 

- 16 -

 

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

 

   Allowance for Loan Losses and Recorded Investment in Loans Evaluated for Impairment
   At March 31, 2018
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment and
Other
  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                   
Individually evaluated for impairment  $4,777   $214   $-   $-   $-   $-   $4,991 
Collectively evaluated for impairment   3,740    3,610    175    908    5,739    3,918    18,090 
Purchased loans with evidence of credit deterioration   -    -    -    -    -    -    - 
Total  $8,517   $3,824   $175   $908   $5,739   $3,918   $23,081 
Carrying value of loans:                                   
Individually evaluated for impairment  $10,513   $11,393   $-   $206   $-   $-   $22,112 
Collectively evaluated for impairment   296,432    541,327    2,941    59,278    305,705    -    1,205,683 
Purchased loans with evidence of credit deterioration   33    598    -    -    158    -    789 
Total  $306,978   $553,318   $2,941   $59,484   $305,863   $-   $1,228,584 

 

 

   Allowance for Loan Losses and Recorded Investment in Loans Evaluated for Impairment
   At December 31, 2017
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment and
Other
  Unallocated  Total
   (In thousands)
Allowance for loan losses:                                   
Individually evaluated for impairment  $4,814   $171   $-   $-   $-   $-   $4,985 
Collectively evaluated for impairment   2,932    3,678    335    995    6,418    3,666    18,024 
Purchased loans with evidence of credit deterioration   -    -    -    -    -    -    - 
Total  $7,746   $3,849   $335   $995   $6,418   $3,666   $23,009 
Carrying value of loans:                                   
Individually evaluated for impairment  $10,675   $14,234   $-   $208   $-   $-   $25,117 
Collectively evaluated for impairment   325,291    553,769    5,649    64,975    312,406    -    1,262,090 
Purchased loans with evidence of credit deterioration   30    581    -    -    164    -    775 
Total  $335,996   $568,584   $5,649   $65,183   $312,570   $-   $1,287,982 

 

The Bank’s customers are small businesses, professionals and consumers. Given the scale of these borrowers, corporate credit rating agencies do not evaluate the borrowers’ financial condition. The Bank maintains a Loan Review Department which reports directly to Audit Committee of the Board of Directors. The Loan Review Department performs independent evaluations of loans and validates management assigned credit risk grades on evaluated loans using grading standards employed by bank regulatory agencies. Loans judged to carry lower-risk attributes are assigned a “pass” grade, with a minimal likelihood of loss. Loans judged to carry higher-risk attributes are referred to as “classified loans,” and are further disaggregated, with increasing expectations for loss recognition, as “substandard,” “doubtful,” and “loss.” Loan Review Department evaluations occur every calendar quarter. If the Bank becomes aware of deterioration in a borrower’s performance or financial condition between Loan Review Department examinations, assigned risk grades are re-evaluated promptly. Credit risk grades assigned by management and validated by the Loan Review Department are subject to review by the Bank’s regulatory authorities during regulatory examinations.

 

 

 

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

 

   Credit Risk Profile by Internally Assigned Grade
   At March 31, 2018
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment and
Other
  Total
   (In thousands)
Grade:                              
Pass  $283,666   $547,740   $2,941   $59,202   $303,836   $1,197,385 
Substandard   23,312    5,578    -    282    1,523    30,695 
Doubtful   -    -    -    -    177    177 
Loss   -    -    -    -    327    327 
Total  $306,978   $553,318   $2,941   $59,484   $305,863   $1,228,584 

 

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

 

   Credit Risk Profile by Internally Assigned Grade
   At December 31, 2017
   Commercial  Commercial
Real Estate
  Construction  Residential
Real Estate
  Consumer
Installment and
Other
  Total
   (In thousands)
Grade:                              
Pass  $324,185   $548,853   $5,649   $62,253   $310,429   $1,251,369 
Substandard   11,811    19,731    -    2,930    1,370    35,842 
Doubtful   -    -    -    -    1    1 
Loss   -    -    -    -    770    770 
Total  $335,996   $568,584   $5,649   $65,183   $312,570   $1,287,982 

 

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

 

The following tables summarize loans by delinquency and nonaccrual status:

 

   Summary of Loans by Delinquency and Nonaccrual Status
   At March 31, 2018
   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  $306,396   $227   $84   $-   $271   $306,978 
Commercial real estate   544,476    2,809    360    -    5,673    553,318 
Construction   2,941    -    -    -    -    2,941 
Residential real estate   59,184    300    -    -    -    59,484 
Consumer installment and other   302,214    2,667    531    255    196    305,863 
Total  $1,215,211   $6,003   $975   $255   $6,140   $1,228,584 

 

 

   Summary of Loans by Delinquency and Nonaccrual Status
   At December 31, 2017
   Current and
Accruing
  30-59 Days
Past Due and
Accruing
  60-89 Days
Past Due and
Accruing
  Past Due 90
Days or More
and Accruing
  Nonaccrual  Total Loans
   (In thousands)
Commercial  $334,908   $627   $164   $-   $297   $335,996 
Commercial real estate   561,883    1,143    125    -    5,433    568,584 
Construction   5,649    -    -    -    -    5,649 
Residential real estate   65,183    -    -    -    -    65,183 
Consumer installment and other   307,445    3,321    1,077    531    196    312,570 
Total  $1,275,068   $5,091   $1,366   $531   $5,926   $1,287,982 

 

There were no commitments to lend additional funds to borrowers whose loans were on nonaccrual status at March 31, 2018 and December 31, 2017.

 

- 18 -

 

The following summarizes impaired loans:

 

   Impaired Loans
   At March 31,  At December 31,
   2018  2017
      Unpaid        Unpaid   
   Recorded  Principal  Related  Recorded  Principal  Related
   Investment  Balance  Allowance  Investment  Balance  Allowance
   (In thousands)
With no related allowance recorded:                              
Commercial  $1,183   $1,227   $-   $1,212   $1,271   $- 
Commercial real estate   9,766    11,752    -    13,169    14,985    - 
Residential real estate   206    237    -    208    239    - 
Consumer installment and other   354    461    -    360    466    - 
Total with no related allowance recorded   11,509    13,677    -    14,949    16,961    - 
                               
With an allowance recorded:                              
Commercial   9,634    9,634    4,777    9,764    9,764    4,814 
Commercial real estate   2,784    2,787    214    1,790    1,792    171 
Total with an allowance recorded   12,418    12,421    4,991    11,554    11,556    4,985 
Total  $23,927   $26,098   $4,991   $26,503   $28,517   $4,985 

 

Impaired loans include troubled debt restructured loans. Impaired loans at March 31, 2018, included $9,550 thousand of restructured loans, $4,110 thousand of which were on nonaccrual status. Impaired loans include troubled debt restructured loans. Impaired loans at December 31, 2017, included $12,081 thousand of restructured loans, $4,285 thousand of which were on nonaccrual status.

 

   Impaired Loans
   For the Three Months Ended March 31,
   2018  2017
   Average  Recognized  Average  Recognized
   Recorded  Interest  Recorded  Interest
   Investment  Income  Investment  Income
   (In thousands)
Commercial  $10,897   $175   $11,292   $118 
Commercial real estate   13,755    215    14,500    237 
Construction   -    -    -    - 
Residential real estate   207    4    748    4 
Consumer installment and other   357    3    543    7 
Total  $25,216   $397   $27,083   $366 

 

The following tables provide information on troubled debt restructurings:

 

   Troubled Debt Restructurings
   At March 31, 2018
            Period-End
            Individual
   Number of  Pre-Modification  Period-End  Impairment
   Contracts  Carrying Value  Carrying Value  Allowance
   ($ in thousands)
Commercial   7   $2,393   $1,043   $39 
Commercial real estate   9    9,537    8,301    - 
Residential real estate   1    241    206    - 
Total   17   $12,171   $9,550   $39 

 

 

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   Troubled Debt Restructurings
   At December 31, 2017
            Period-End
            Individual
   Number of  Pre-Modification  Period-End  Impairment
   Contracts  Carrying Value  Carrying Value  Allowance
   ($ in thousands)
Commercial   7   $2,393   $1,085   $43 
Commercial real estate   10    11,528    10,788    - 
Residential real estate   1    241    208    - 
Total   18   $14,162   $12,081   $43 

 

During the three months ended March 31, 2018, the Company did not modify any loans that were considered troubled debt restructurings. During the three months ended March 31, 2017, the Company modified two loans with a carrying value of $273 thousand that were considered troubled debt restructurings. The two concessions granted in the three months ended March 31, 2017 consisted of modifications of payment terms to extend the maturity date to allow for deferred principal repayment and under-market terms. There were no chargeoffs related to troubled debt restructurings made during the three months ended March 31, 2018 and March 31, 2017. During the three months ended March 31, 2018 and 2017, no troubled debt restructured loans defaulted within 12 months of the modification date. A troubled debt restructuring is considered to be in default when payments are ninety days or more past due.

 

There were no loans restricted due to collateral requirements at March 31, 2018 and December 31, 2017.

 

There were no loans held for sale at March 31, 2018 and December 31, 2017.

 

At March 31, 2018 and December 31, 2017, the Company held total other real estate owned (OREO) of $1,376 thousand net of reserve of $1,905 thousand and $1,426 thousand net of reserve of $1,905 thousand, respectively, of which $-0-  thousand was foreclosed residential real estate properties or covered OREO at both dates, respectively. The amount of consumer mortgage loans outstanding secured by residential real estate properties for which formal foreclosure proceedings were in process was $196 thousand at March 31, 2018 and December 31, 2017.

 

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 March 31, 2018, Westamerica Bank did not have credit extended to any one entity exceeding these limits. At March 31, 2018, Westamerica Bank had 36 lending relationships each with aggregate amounts exceeding $5 million. The Company has significant credit arrangements that are secured by real estate collateral. In addition to real estate loans outstanding as disclosed in Note 4, the Company had loan commitments related to real estate loans of $48,623 thousand and $53,874 thousand at March 31, 2018 and December 31, 2017, 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 March 31, 2018, Westamerica Bank held corporate bonds in 72 issuing entities that exceeded $5 million for each issuer.

 

 

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Note 6: Other Assets

 

Other assets consisted of the following:

 

   At March 31,  At December 31,
   2018  2017
   (In thousands)
Equity securities without readily determinable fair values:          
Federal Reserve Bank stock (1)  $14,069   $14,069 
Other investments   158    158 
Total equity securities without readily determinable fair values   14,227    14,227 
Life insurance cash surrender value   54,742    54,101 
Net deferred tax asset   42,842    33,112 
Limited partnership investments   9,519    10,119 
Interest receivable   22,538    23,557 
Prepaid assets   4,532    4,906 
Other assets   11,386    18,428 
Total other assets  $159,786   $158,450 

 

(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 March 31, 2018, this investment totaled $9,519 thousand and $2,299  thousand of this amount represents outstanding equity capital commitments that are included in other liabilities. At December 31, 2017, this investment totaled $10,119 thousand and $2,299  thousand of this amount represented outstanding equity capital commitments. At March 31, 2018, the $2,299 thousand of outstanding equity capital commitments are expected to be paid as follows, $722 thousand in 2020, $131 thousand in 2023, $90 thousand in 2024 and $1,356 thousand in 2025 or thereafter.

 

The amounts recognized in net income for these investments include:

 

   For the Three Months Ended
   March 31,
   2018  2017
   (In thousands)
Investment loss included in pre-tax income  $600   $450 
Tax credits recognized in provision for income taxes   336    463 

 

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 months ended March 31, 2018 and year ended December 31, 2017. 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 months ended March 31, 2018 and year ended December 31, 2017 no such adjustments were recorded.

 

The carrying values of goodwill were:

 

   At March 31, 2018  At December 31, 2017
   (In thousands)
Goodwill  $121,673   $121,673 

 

 

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

 

   At March 31,  At December 31,
   2018  2017
   Gross     Gross   
   Carrying  Accumulated  Carrying  Accumulated
   Amount  Amortization  Amount  Amortization
   (In thousands)
Core Deposit Intangibles  $56,808   $(53,528)  $56,808   $(52,987)
Merchant Draft Processing Intangible   10,300    (10,300)   10,300    (10,271)
Total Identifiable Intangible Assets  $67,108   $(63,828)  $67,108   $(63,258)

 

As of March 31, 2018, the current period and estimated future amortization expense for identifiable intangible assets was:

 

      Merchant   
   Core  Draft   
   Deposit  Processing   
   Intangibles  Intangible  Total
   (In thousands)
For the Three Months ended March 31, 2018 (actual)  $541   $29   $570 
Estimate for the remainder of year ending December 31, 2018   1,351    -    1,351 
Estimate for year ending December 31, 2019   538    -    538 
2020   287    -    287 
2021   269    -    269 
2022   252    -    252 
2023   236    -    236 

 

 

Note 8: Deposits and Borrowed Funds

 

The following table provides additional detail regarding deposits.

 

   Deposits
   At March 31,  At December 31,
   2018  2017
   (In thousands)
Noninterest-bearing  $2,179,157   $2,197,526 
Interest-bearing:          
Transaction   924,081    904,245 
Savings   1,540,192    1,494,024 
Time deposits less than $100 thousand   114,301    117,848 
Time deposits $100 thousand through $250 thousand   74,436    76,578 
Time deposits more than $250 thousand   35,700    37,392 
Total deposits  $4,867,867   $4,827,613 

 

Demand deposit overdrafts of $788  thousand and $2,786  thousand were included as loan balances at March 31, 2018 and December 31, 2017, respectively. Interest expense for aggregate time deposits with individual account balances in excess of $100 thousand was $97 thousand in the three months ended March 31, 2018 and $106 thousand in the three months ended March 31, 2017.

 

 

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

 

   Repurchase Agreements (Sweep)
Accounted for as Secured Borrowings
   Remaining Contractual Maturity of the Agreements
   Overnight and Continuous
   At March 31, 2018  At December 31, 2017
Repurchase agreements:  (In thousands)
Collateral securing borrowings:          
Securities of U.S. Government sponsored entities  $73,165   $74,173 
Agency residential MBS   64,266    58,251 
Corporate securities   104,210    105,113 
Total collateral carrying value  $241,641   $237,537 
Total short-term borrowed funds  $65,356   $58,471 

 

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. Equity securities and available for sale debt 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, debt securities held to maturity, and other assets. These nonrecurring fair value adjustments typically involve the lower-of-cost or fair-value accounting of individual assets.

 

In accordance with the Fair Value Measurement and Disclosure topic of the Codification, the Company bases its fair values on the price that would be received to sell an asset or paid to transfer a liability in the principal market or most advantageous market for an asset or liability in an orderly transaction between market participants on the measurement date under current market conditions. A fair value measurement reflects all of the assumptions that market participants would use in pricing the asset or liability, including assumptions about the risk inherent in a particular valuation technique, the effect of a restriction on the sale or use of an asset, and the risk of nonperformance.

 

The Company groups its assets and liabilities measured at fair value into a three-level hierarchy, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. When the valuation assumptions used to measure the fair value of the asset or liability are categorized within different levels of the fair value hierarchy, the asset or liability is categorized in its entirety within the lowest level of the hierarchy. These levels are:

 

Level 1 – Valuation is based upon quoted prices for identical instruments traded in active exchange markets, such as the New York Stock Exchange. Level 1 includes U.S. Treasury and equity securities, which are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

 

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 includes mutual funds, 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 equity securities, debt securities available for sale and debt 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 most closely reflecting the market generally used as the fair value estimate. In addition, the Company conducts “other than temporary impairment (OTTI)” analysis on a quarterly basis; debt securities selected for OTTI analysis include all debt securities at a market price below 95 percent of par value. As with any valuation technique used to estimate fair value, changes in underlying assumptions used could significantly affect the results of current and future values. Accordingly, these fair value estimates may not be realized in an actual sale of the securities.

 

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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 three months ended March 31, 2018 and year ended December 31, 2017, there were no transfers in to or out of levels 1, 2 or 3.

 

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 March 31, 2018
   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)
Equity securities                    
Mutual funds  $1,764   $-   $1,764   $- 
Total equity securities   1,764    -    1,764    - 
Debt securities available for sale                    
Securities of U.S. Government sponsored entities   117,947    -    117,947    - 
Agency residential MBS   847,640    -    847,640    - 
Non-agency residential MBS   139    -    139    - 
Agency commercial MBS   2,190    -    2,190    - 
Securities of U.S. Government entities   1,520    -    1,520    - 
Obligations of states and political subdivisions   180,635    -    180,635    - 
Corporate securities   1,201,899    -    1,201,899    - 
Total debt securities available for sale   2,351,970    -    2,351,970    - 
Total  $2,353,734   $-   $2,353,734   $- 

 

 

   At December 31, 2017
   Fair Value  Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2)
  Significant
Unobservable
Inputs
(Level 3)
   (In thousands)
Equity securities                    
Mutual funds  $1,800   $-   $1,800   $- 
Total equity securities   1,800    -    1,800    - 
Debt securities available for sale                    
Securities of U.S. Government sponsored entities   119,319    -    119,319    - 
Agency residential MBS   767,706    -    767,706    - 
Non-agency residential MBS   154    -    154    - 
Agency commercial MBS   2,219    -    2,219    - 
Securities of U.S. Government entities   1,590    -    1,590    - 
Obligations of states and political subdivisions   185,221    -    185,221    - 
Corporate securities   1,115,498    -    1,115,498    - 
Total debt securities available for sale   2,191,707    -    2,191,707    - 
Total  $2,193,507   $-   $2,193,507   $- 

 

 

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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 March 31, 2018 and December 31, 2017, the following tables provide the level of valuation assumptions used to determine each adjustment and the carrying value of the related assets at period end.

 

               For the
               Three Months Ended
   At March 31, 2018  March 31, 2018
   Carrying Value  Level 1  Level 2  Level 3  Total Losses
   (In thousands)   
Other real estate owned  $1,376   $-   $-   $1,376   $- 
Impaired loans:                         
Commercial   4,857    -    -    4,857    - 
Commercial real estate   6,680    -    -    6,680    - 
Total assets measured at fair value on a nonrecurring basis  $12,913   $-   $-   $12,913   $- 

 

 

               For the
               Year Ended
   At December 31, 2017  December 31, 2017
   Carrying Value  Level 1  Level 2  Level 3  Total Losses
   (In thousands)   
Other real estate owned  $1,426   $-   $-   $1,426   $(219)
Impaired loans:                         
Commercial   4,950    -    -    4,950    - 
Commercial real estate   5,904    -    -    5,904    - 
Total assets measured at fair value on a nonrecurring basis  $12,280   $-   $-   $12,280   $(219)

 

Level 3 – Valuation is based upon present value of expected future cash flows, independent market prices, estimated liquidation values of loan collateral or appraised value of the collateral as determined by third-party independent appraisers, less 10% for selling costs, generally. Level 3 includes other real estate owned that has been measured at fair value upon transfer to foreclosed assets and impaired loans collateralized by real property and other business asset collateral where a specific reserve has been established or a chargeoff has been recorded. Losses on other real estate owned represent losses recognized in earnings during the period subsequent to its initial classification as foreclosed assets. The unobservable inputs and qualitative information about the unobservable inputs are not presented as the inputs were not developed by the Company.

 

Disclosures about Fair Value of Financial Instruments

 

The following section describes the valuation methodologies used by the Company for estimating fair value of financial instruments not recorded at fair value in the balance sheet. The Company implemented the provisions of ASU 2016-01, Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, effective January 1, 2018. The provisions require the Company to use the “exit price notion” when measuring the fair value of financial instruments for disclosure purposes.

 

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.

 

Debt Securities Held to Maturity The fair values of debt securities were estimated using quoted prices as described above for Level 2 valuation.

 

Loans Loans are valued using the exit price notion. The Company uses a net present value of cash flows methodology that seeks to incorporate interest rate, credit, liquidity and prepayment risks in the fair market value estimation. Inputs to calculation include market rates for similarly offered products, market interest rate projections, credit spreads and prepayment assumptions.

 

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Prior to adoption of ASU 2016-01, loans were separated into two groups for valuation. Variable rate loans, except for those described below, which reprice frequently with changes in market rates were valued using historical cost. Fixed rate loans and variable rate loans that have reached their minimum contractual interest rates were valued by discounting the future cash flows expected to be received from the loans using current interest rates charged on loans with similar characteristics. Additionally, the allowance for loan losses of $23,009 thousand at December 31, 2017 was applied against the estimated fair values to recognize estimated future defaults of contractual cash flows.

 

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 Banks 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 using net present value of cash flows methodology that seeks to incorporate interest rate, credit, liquidity and prepayment risks in the fair market value estimation. Inputs to calculation include market rates for similarly offered products, market interest rate projections, credit spreads and prepayment assumptions. The resulting cash flows are compared against alternative funding sources.

 

Prior to adoption of ASU 2016-01, the fair value 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 tables below are 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 tables 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 March 31, 2018
   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  $555,607   $555,607   $555,607   $-   $- 
Debt securities held to maturity   1,114,287    1,098,895    -    1,098,895    - 
Loans   1,205,503    1,244,670    -    -    1,244,670 
                          
Financial Liabilities:                         
Deposits  $4,867,867   $4,864,792   $-   $4,643,430   $221,362 
Short-term borrowed funds   65,356    65,356    -    65,356    - 

 

 

 

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   At December 31, 2017
   Carrying
Amount
  Estimated Fair
Value
  Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
  Significant
Other
Observable
Inputs
(Level 2 )
  Significant
Unobservable
Inputs
(Level 3 )
Financial Assets:  (In thousands)
Cash and due from banks  $575,002   $575,002   $575,002   $-   $- 
Debt securities held to maturity   1,158,864    1,155,342    -    1,155,342    - 
Loans   1,264,973    1,257,811    -    -    1,257,811 
                          
Financial Liabilities:                         
Deposits  $4,827,613   $4,824,586   $-   $4,595,795   $228,791 
Short-term borrowed funds   58,471    58,471    -    58,471    - 

 

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.

 

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 $282,428 thousand and $272,646 thousand at March 31, 2018 and December 31, 2017, 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 $3,849 thousand and $19,263 thousand at March 31, 2018 and December 31, 2017, respectively. The Company had no commitments outstanding for commercial and similar letters of credit at March 31, 2018 and December 31, 2017. The Company had a reserve for unfunded commitments of $2,308 thousand at March 31, 2018 and $2,308 thousand at December 31, 2017, included in other liabilities.

 

Due to the nature of its business, the Company is subject to various threatened or filed legal cases. Based on the advice of legal counsel, the Company does not expect such cases will have a material, adverse effect on its financial position or results of operations. Legal liabilities are accrued when obligations become probable and the amount can be reasonably estimated.

 

The Company has determined that it will be obligated to provide refunds of revenue recognized in prior years to some customers. The Company estimates the probable amount of these obligations will be $5,542 thousand and has accrued a liability for such amount; the estimated liability is subject to revision.

 

 

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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 Ended
   March 31,
   2018  2017
   (In thousands, except per share data)
Net income (numerator)  $17,506   $15,049 
Basic earnings per common share          
Weighted average number of common shares outstanding - basic (denominator)   26,532    26,171 
Basic earnings per common share  $0.66   $0.58 
Diluted earnings per common share          
Weighted average number of common shares outstanding - basic   26,532    26,171 
Add common stock equivalents for options   133    158 
Weighted average number of common shares outstanding - diluted (denominator)   26,665    26,329 
Diluted earnings per common share  $0.66   $0.57 

 

For the three months ended March 31, 2018 and 2017, options to purchase 491 thousand and 299 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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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

 

WESTAMERICA BANCORPORATION

FINANCIAL SUMMARY

 

   For the Three Months Ended
   March 31,  December 31,
   2018  2017  2017
   (In thousands, except per share data)
Net Interest and Fee Income (FTE)(1)  $35,467   $36,030   $36,644 
Provision for Loan Losses   -    -    - 
Noninterest Income:               
Securities (Losses) Gains   (36)   -    7,955 
Other Noninterest Income   11,991    11,657    12,345 
Total Noninterest Income   11,955    11,657    20,300 
Noninterest Expense   24,214    24,615    30,167 
Income Before Income Taxes (FTE)(1)   23,208    23,072    26,777 
Provision for Income Taxes (FTE)(1)   5,702    8,023    22,617 
Net Income  $17,506   $15,049   $4,160 
                
Average Common Shares Outstanding   26,532    26,171    26,384 
Average Diluted Common Shares Outstanding   26,665    26,329    26,538 
Common Shares Outstanding at Period End   26,591    26,283    26,425 
                
Per Common Share:               
Basic Earnings  $0.66   $0.58   $0.16 
Diluted Earnings   0.66    0.57    0.16 
Book Value Per Common Share  $21.89   $22.25   $22.34 
                
Financial Ratios:               
Return On Assets   1.28%   1.13%   0.30%
Return On Common Equity   11.57%   10.48%   2.70%
Net Interest Margin (FTE)(1)   3.02%   3.14%   3.12%
Net Loan (Recoveries) Losses to Average Loans   (0.02)%   0.31%   0.19%
Efficiency Ratio(2)   51.1%   51.6%   53.0%
                
Average Balances:               
Assets  $5,564,705   $5,395,783   $5,534,700 
Earning Assets   4,723,213    4,620,001    4,682,897 
Loans   1,243,750    1,355,250    1,285,748 
Deposits   4,828,352    4,692,746    4,811,035 
Shareholders' Equity   613,860    582,384    610,200 
                
Period End Balances:               
Assets  $5,551,036   $5,395,947   $5,513,046 
Earning Assets   4,696,605    4,542,813    4,640,353 
Loans   1,228,584    1,351,090    1,287,982 
Deposits   4,867,867    4,697,973    4,827,613 
Shareholders' Equity   582,083    584,888    590,239 
                
Capital Ratios at Period End:               
Total Risk Based Capital   16.53%   16.91%   16.17%
Tangible Equity to Tangible Assets   8.42%   8.68%   8.63%
                
Dividends Paid Per Common Share  $0.40   $0.39   $0.40 
Common Dividend Payout Ratio   61%   68%   250%

 

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 an FTE basis in order to reflect the effect of income which is exempt from federal income taxation at the current statutory tax rate.

(2)The efficiency ratio is defined as noninterest expense divided by total revenue (net interest income on an FTE basis and noninterest income).

 


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Financial Overview

 

Westamerica Bancorporation and subsidiaries’ (the Company”) principal source of revenue is net interest and loan fee income, which represents interest and fees earned on loans and investment securities (“earning assets”) reduced by interest paid on deposits and other borrowings (“interest-bearing liabilities”). Market interest rates declined considerably following the recession of 2008 and 2009. Interest rates remained historically low through 2016 as the Federal Open Market Committee’s (“FOMC”) monetary policy was highly accommodative. During this period, Management avoided originating long-dated, low-yielding loans given the potential impact of such assets on forward earning potential; as a result, loans declined and investment securities increased. The changing composition of the earning assets and low market interest rates has pressured the net interest margin to lower levels. The FOMC’s increases in the federal funds rate occurred between December 2016 and March 2018, although longer-term rates have not increased by a similar magnitude. Net interest income was $34.0 million for the first quarter 2018, compared with $33.7 million for the fourth quarter 2017 and $32.8 million for the first quarter 2017. The increase in net interest income is due to higher asset yields and higher levels of average earning assets.

 

The funding source of the Company’s earning assets is primarily customer deposits. The Company’s long-term strategy includes maximizing checking and savings deposits as these types of deposits are lower-cost and less sensitive to changes in interest rates compared to time deposits. The first quarter 2018 average volume of checking and savings deposits was 95 percent of average total deposits.

 

Credit quality remained strong with nonperforming assets totaling $8 million at March 31, 2018 and net loan loss recoveries of $72 thousand for the first quarter 2018. The Company did not recognize a provision for loan losses in the first quarter 2018.

 

The Company presents its net interest margin and net interest income on an FTE basis using the current statutory federal tax rate. Management believes the FTE basis is valuable to the reader because the Company’s loan and investment securities portfolios contain a relatively large portion of municipal loans and securities that are federally tax exempt. The Company’s tax exempt loans and securities composition may not be similar to that of other banks, therefore in order to reflect the impact of the federally tax exempt loans and securities on the net interest margin and net interest income for comparability with other banks, the Company presents its net interest margin and net interest income on an FTE basis. Yields on tax-exempt securities and loans have been adjusted upward to reflect the effect of income exempt from federal income taxation at the federal statutory tax rate of 35% for 2017. Due to the Tax Cuts and Jobs Act of 2017 (“Act”), the federal tax rate became 21% for 2018; as such, the upward adjustment to reflect the effect of income exempt from federal taxation is lower in 2018.

 

The Company’s significant accounting policies (see Note 1, “Summary of Significant Accounting Policies,” to Financial Statements in the Company’s 2017 Form 10-K) are fundamental to understanding the Company’s results of operations and financial condition.

 

The Company reported first quarter 2018 net income of $17.5 million or $0.66 diluted earnings per common share. First quarter 2018 results compare to net income of $15.0 million or $0.57 diluted earnings per common share for the first quarter 2017 and $4.2 million or $0.16 diluted earnings per common share for the fourth quarter 2017. Fourth quarter 2017 results include adjustments to asset values triggered by enactment of the Act, recognition of a loss contingency, and securities gains which collectively reduced EPS $0.42.

 

 

 

 

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Net Income

 

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

 

   For the Three Months Ended
   March 31,  December 31,
   2018  2017  2017
   (In thousands, except per share data)
Net interest and loan fee income  $34,048   $32,844   $33,733 
FTE adjustment   1,419    3,186    2,911 
Net interest and loan fee income (FTE)   35,467    36,030    36,644 
Provision for loan losses   -    -    - 
Noninterest income   11,955    11,657    20,300 
Noninterest expense   24,214    24,615    30,167 
Income before taxes (FTE)   23,208    23,072    26,777 
Income tax provision (FTE)   5,702    8,023    22,617 
Net income  $17,506   $15,049   $4,160 
                
Average diluted common shares   26,665    26,329    26,538 
Diluted earnings per common share  $0.66   $0.57   $0.16 
                
Average total assets  $5,564,705   $5,395,783   $5,534,700 
Net income to average total assets (annualized)   1.28%   1.13%   0.30%
Net income to average common shareholders' equity (annualized)   11.57%   10.48%   2.70%

 

Net income for the first quarter of 2018 was $2.5 million more than the same quarter of 2017. Net interest and loan fee income increased $1.2 million in the first quarter 2018 compared with first quarter 2017 mostly attributable to higher average balances of investments and higher yield on earning assets as market interest rates rose. The increase was offset by lower average balances of loans. Net interest and loan fee income (FTE) in the first quarter 2018 included a lower FTE adjustment than in the first quarter 2017 due to the reduced federal corporate tax as a result of enactment of the Act. The provision for loan losses remained zero, reflecting Management's evaluation of losses inherent in the loan portfolio. The book tax provision for the first quarter 2018 was $4.3 million compared with $4.8 million for the first quarter 2017, representing effective tax rates of 19.7% and 24.3%, respectively. The book tax provisions for the first quarter 2018 and the first quarter 2017 include tax benefits of $451 thousand and $671 thousand, respectively, for tax deductions from the exercise of employee stock options which exceed related compensation expenses recognized in the financial statements; these benefits reduced the effective tax rate by 2.0% and 3.4%, respectively.

 

Comparing the first quarter of 2018 with the fourth quarter of 2017, net income increased $13.3 million. Net interest and loan fee income increased $315 thousand in the first quarter 2018 compared with fourth quarter 2017 mostly attributable to higher average balances of investments and higher yield on earning assets as market interest rates rose. The increase was offset by lower average balances of loans. Net interest and loan fee income (FTE) in the first quarter 2018 included a lower FTE adjustment than in the fourth quarter 2017 due to the reduced federal corporate tax as a result of enactment of the Act. The provision for loan losses remained zero, reflecting Management's evaluation of losses inherent in the loan portfolio. Noninterest income in the first quarter 2018 was $8.3 million lower than in the fourth quarter 2017 due to gains on sale of securities of $8.0 million in the fourth quarter 2017. Noninterest expense decreased $6.0 million primarily because the fourth quarter 2017 included a $5.5 million loss contingency accrual and a $625 thousand impairment charge on tax credit investments. The book tax provision for the first quarter 2018 was $4.3 million compared with $19.7 million for the fourth quarter 2017, representing effective tax rates of 19.7% and 82.6%, respectively. The book tax provision for the fourth quarter 2017 includes a $12.3 million charge resulting from re-measurement of the Company’s net deferred tax asset triggered by enactment of the Act.

 

 

 

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Net Interest and Loan Fee Income (FTE)

 

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

 

   For the Three Months Ended
   March 31,  December 31,
   2018  2017  2017
   (In thousands)
Interest and loan fee income  $34,507   $33,324   $34,204 
Interest expense   459    480    471 
Net interest and loan fee income   34,048    32,844    33,733 
FTE adjustment   1,419    3,186    2,911 
Net interest and loan fee income (FTE)  $35,467   $36,030   $36,644 
                
Average earning assets  $4,723,213   $4,620,001   $4,682,897 
Net interest margin (FTE) (annualized)   3.02%   3.14%   3.12%

 

Net interest and loan fee income increased $1.2 million in the first quarter 2018 compared with the first quarter 2017, mainly due to higher average balances of investments (up $215 million) and higher yield on earning assets (up 0.04%), partially offset by lower average balances of loans (down $111 million) The FTE adjustment was lower in the first quarter 2018 compared with the first quarter 2017 due to the reduced federal corporate tax rate as a result of enactment of the Act.

 

Comparing the first quarter 2018 with the fourth quarter 2017, net interest and loan fee income increased $315 thousand due to higher average balances of investments (up $82 million) and higher yield on interest earning assets (up 0.03%), offset by lower average balances of loans (down $42 million) The FTE adjustment was lower in the first quarter 2018 compared with the fourth quarter 2017 due to the reduced federal corporate tax rate as a result of enactment of the Act.

 

Yields on interest-earning assets increased in the first quarter 2018 as market interest rates rose. The annualized net interest margin (FTE) was 3.02% in the first quarter 2018 compared with 3.14% in the first quarter 2017 and 3.12% in the fourth quarter 2017. The first quarter net interest margin (FTE) was lower than in the first quarter 2017 and the fourth quarter 2017 due to the reduced federal corporate tax rate as a result of enactment of the Act.

 

The Company’s funding costs were 0.04% in the first quarter 2018, unchanged from the first quarter 2017. Average balances of time deposits declined $25 million from the first quarter 2017 to first quarter 2018 while lower-cost checking and savings deposits grew 4% in the same period. Average balances of checking and saving deposits accounted for 95.3% of average total deposits in the first quarter 2018 compared with 94.6% in the first quarter 2017 and 95.1% in the fourth quarter 2017; checking and savings deposits are less sensitive to rising interest rates than time deposits.

 

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 Ended
   March 31,  December 31,
   2018  2017  2017
          
Yield on earning assets   2.94%   2.90%   2.91%
Impact of FTE adjustment   0.12%   0.28%   0.25%
Yield on earning assets (FTE)   3.06%   3.18%   3.16%
Rate paid on interest-bearing liabilities   0.07%   0.07%   0.07%
Net interest spread (FTE)   2.99%   3.11%   3.09%
Impact of noninterest-bearing funds   0.03%   0.03%   0.03%
Net interest margin (FTE)   3.02%   3.14%   3.12%

 

 

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The FOMC increased the federal funds rate between December 2016 and March 2018. In the first quarter 2018 yield on earning assets increased with rising market interest rates. The net interest spread and net interest margin stated on an FTE basis are lower in the first quarter 2018 compared with the first quarter 2017 and the fourth quarter 2017 because the FTE adjustment to reflect the effect of income exempt from federal taxation is lower in 2018 compared with 2017. Rates on interest-bearing liabilities were kept low by reducing the volume of higher-cost time deposits and increasing balances of checking and savings deposits, which earn relatively low interest rates and are less volatile than time deposits during periods of rising market interest rates.

 

 

 

 

 

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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, rates and interest margins are annualized. Yields on tax-exempt securities and loans have been adjusted upward to reflect the effect of income exempt from federal income taxation at the federal statutory tax rate of 35 percent for 2017. Due to the Tax Cuts and Jobs Act of 2017, the federal tax rate became 21 percent for 2018; as such, the upward adjustment to reflect the effect of income exempt from federal taxation is lower in 2018.

 

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

 

   For the Three Months Ended March 31, 2018
      Interest   
   Average  Income/  Yields/
   Balance  Expense  Rates
   ($ in thousands)
Assets         
Investment securities:               
Taxable  $2,709,643   $14,935    2.20%
Tax-exempt (1)   769,820    6,169    3.21%
Total investments (1)   3,479,463    21,104    2.43%
Loans:               
Taxable   1,184,715    14,223    4.87%
Tax-exempt (1)   59,035    599    4.11%
Total loans (1)   1,243,750    14,822    4.83%
Total Interest-earning assets (1)   4,723,213    35,926    3.06%
Other assets   841,492           
Total assets  $5,564,705           
                
Liabilities and shareholders' equity               
Noninterest-bearing demand  $2,156,626   $-    -%
Savings and interest-bearing transaction   2,443,561    282    0.05%
Time less than $100,000   125,020    71    0.23%
Time $100,000 or more   103,145    97    0.38%
Total interest-bearing deposits   2,671,726    450    0.07%
Short-term borrowed funds   62,501    9    0.06%
Total interest-bearing liabilities   2,734,227    459    0.07%
Other liabilities   59,992           
Shareholders' equity   613,860           
Total liabilities and shareholders' equity  $5,564,705           
Net interest spread (1) (2)             2.99%
Net interest and fee income and interest margin (1) (3)       $35,467    3.02%

 

(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 March 31, 2017
      Interest   
   Average  Income/  Yields/
   Balance  Expense  Rates
   ($ in thousands)
Assets         
Investment securities:               
Taxable  $2,433,669   $12,147    2.00%
Tax-exempt (1)