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WESTAMERICA BANCORPORATION - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 1, 2014

The Federal Reserve's Federal Open Market Committee has maintained highly accommodative monetary policies to influence interest rates to low levels in order to provide stimulus to the economy following the "financial crisis" recession. The Company's principal source of revenue is net interest and fee income, which represents interest earned on loans and investment securities ("earning assets") reduced by interest paid on deposits and other borrowings ("interest-bearing liabilities"). The relatively low level of market interest rates has reduced the spread between interest rates on earning assets and interest bearing liabilities. The Company's net interest margin and net interest income declined as market interest rates on newly originated loans remain below the yields earned on older-dated loans and on the overall loan portfolio. The Company is reducing its exposure to rising interest rates by purchasing shorter-duration investment securities with lower yields than longer-duration securities. The Company's noninterest income was lower in the second quarter 2014 and in the first half of 2014 relative to the comparable periods in 2013 due to lower service charges on deposit accounts and lower merchant processing service fees. The Company incurs noninterest expenses to deliver products and services to its customers. The Company's credit quality continued to improve, as nonperforming assets and loan charge-offs declined in the second quarter and in the first half of 2014 compared with corresponding periods in 2013 and contributed to reducing expenses for nonperforming assets. Management is focused on controlling all noninterest expense levels, particularly due to market interest rate pressure on net interest income. Westamerica Bancorporation and subsidiaries (the "Company") reported net income of $15.2 million or $0.58 diluted earnings per common share for the second quarter 2014 and net income of $30.5 million or $1.15 diluted earnings per common share for the six months ended June 30, 2014. These results compare to net income of $17.1 million or $0.64 diluted earnings per common share for the second quarter 2013 and net income of $34.4 million or $1.27 diluted earnings per common share for the six months ended June 30, 2013.



Net Income

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

For the Three Months For the Six Months Ended June 30, 2014 2013 2014 2013 (In thousands, except per share data) Net interest income (FTE) $ 38,582$ 42,628$ 77,446$ 86,463 Provision for loan losses 1,000 1,800 2,000 4,600 Noninterest income 13,198 14,284 26,188 28,562 Noninterest expense 26,957 28,192 53,830 56,869 Income before taxes (FTE) 23,823 26,920 47,804 53,556 Income tax provision (FTE) 8,666 9,808 17,340 19,173 Net income $ 15,157$ 17,112$ 30,464$ 34,383 Average diluted common shares 26,238 26,898 26,387 27,027 Diluted earnings per common share $ 0.58 $



0.64 $ 1.15$ 1.27

Average total assets $ 4,908,467$ 4,840,319$ 4,899,255$ 4,874,212 Net income to average total assets (annualized) 1.24 % 1.42 % 1.25 % 1.42 % Net income to average common stockholders' equity (annualized) 11.57 % 12.74 % 11.61 % 12.84 % Net income for the second quarter of 2014 was $2.0 million less than the same quarter of 2013, the net result of declines in net interest and fee income (fully taxable equivalent or "FTE") and noninterest income, partially offset by decreases in the provision for loan losses, noninterest expense and income tax provision (FTE). A decrease in net interest and fee income (FTE) was mostly attributed to lower average balances of loans and lower yields on interest-earning assets, partially offset by higher average balances of investments and lower average balances of interest-bearing liabilities. The provision for loan losses was reduced, reflecting Management's evaluation of losses inherent in the loan portfolio; net losses and nonperforming loan volumes have declined relative to earlier periods. Lower noninterest income was mostly attributable to lower service charges on deposit accounts and lower merchant processing service fees. Noninterest expense decreased primarily due to reduced other real estate owned ("OREO") expense net of disposition gains, loan administration expenses, and professional fees. Comparing the first half of 2014 with the first half of 2013, net income decreased $3.9 million primarily due to lower net interest and fee income (FTE) and lower noninterest income, partially offset by decreases in the provision for loan losses, noninterest expense and income tax provision (FTE). The lower net interest and fee income (FTE) was primarily caused by a lower average volume of loans and lower yields on interest earning assets, partially offset by higher average balances of investments and lower average balances of interest-bearing liabilities. The provision for loan losses was reduced, reflecting Management's evaluation of losses inherent in the loan portfolio. Lower noninterest income was mostly attributable to lower service charges on deposit accounts and lower merchant processing service fees. Noninterest expense decreased mostly due to reduced OREO expense net of disposition gains, personnel costs, loan administration expenses, intangible amortization and professional fees. -30- --------------------------------------------------------------------------------



Net Interest and Fee Income (FTE)

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

For the Three Months For the Six Months Ended June 30, 2014 2013 2014 2013 (In thousands) Interest and fee income $ 35,403 $ 39,269$ 70,967$ 79,734 Interest expense 900 1,219 1,798 2,471 FTE adjustment 4,079 4,578 8,277 9,200 Net interest income (FTE) $ 38,582 $ 42,628$ 77,446$ 86,463 Average earning assets $ 4,114,811$ 4,147,096$ 4,104,009$ 4,141,510 Net interest margin (FTE) (annualized) 3.76 %



4.12 % 3.79 % 4.19 %

Net interest and fee income (FTE) decreased during the second quarter 2014 by $4.0 million from the same period in 2013 to $38.6 million, mainly due to lower average balances of loans (down $192 million) and lower yields on interest-earning assets (down 39 basis points "bp"), partially offset by higher average balances of investments (up $160 million) and lower average balances of interest-bearing liabilities (down $84 million). Comparing the first six months of 2014 with the first six months of 2013, net interest and fee income (FTE) decreased $9.0 million primarily due to a lower average volume of loans (down $224 million) and lower yields on interest-earning assets (down 43 bp), partially offset by higher average balances of investments (up $186 million) and lower average balances of interest-bearing liabilities (down $107 million). Loan volumes have declined due to problem loan workout activities (such as chargeoffs, collateral repossessions and principal payments), particularly with purchased loans, and reduced volumes of loan originations. In Management's opinion, current levels of competitive loan pricing do not provide adequate forward earnings potential. As a result, the Company has not currently taken an aggressive posture relative to loan portfolio growth. Management has maintained relatively stable interest-earning asset volumes by increasing investment securities as loan volumes have declined. Yields on interest-earning assets have declined due to relatively low interest rates prevailing in the market. In the first half of 2014, the Company purchased shorter-duration investment securities with lower yields than longer-duration securities in order to reduce its exposure to rising interest rates. The Company's high levels of liquidity will provide an opportunity to obtain higher yielding assets once market interest rates start rising. The Company has been replacing higher-cost funding sources with low-cost deposits and interest expense has declined to offset some of the decline in asset yields.



Interest and Fee Income (FTE)

Interest and fee income (FTE) for the second quarter of 2014 decreased $4.4 million or 10.0% from the same period in 2013. The decrease was caused by lower average balances of loans and lower yields on interest-earning assets, partially offset by higher average balances of investments. The total average balances of loans declined due to decreases in the average balances of commercial real estate loans (down $105 million), consumer loans (down $58 million), residential real estate loans (down $44 million) and tax-exempt commercial loans (down $20 million), partially offset by a $37 million increase in the average balance of taxable commercial loans. The average investment portfolio increased largely due to higher average balances of securities of U.S. Government sponsored entities (up $269 million), partially offset by a $113 million decrease in average balances of collateralized mortgage obligations and mortgage-backed securities. -31- -------------------------------------------------------------------------------- The average yield on the Company's earning assets decreased from 4.24% in the second quarter 2013 to 3.85% in the corresponding period of 2014. The composite yield on loans declined 20 bp to 5.18% mostly due to lower yields on consumer loans (down 36 bp), taxable commercial loans (down 46 bp), commercial real estate loans (down 10 bp) and construction loans (down 313 bp). Nonperforming loans are included in average loan volumes used to compute loan yields; fluctuations in nonaccrual loan volumes impact loan yields. The investment yields in general declined due to market rates. The investment portfolio yield decreased 38 bp to 2.80% primarily due to lower yields on municipal securities (down 50 bp) and corporate securities (down 28 bp), partially offset by a 39 bp increase in yields on securities of U.S. Government sponsored entities. The yield on securities of U.S. government sponsored entities rose as securities added to the portfolio in the second quarter 2014 were higher yielding than securities held in the prior period. Comparing the first half of 2014 with the first half of 2013, interest and fee income (FTE) was down $9.7 million or 10.9%. The decrease resulted from a lower average volume of loans and lower yields on interest-earning assets, partially offset by higher average balances of investments. Average interest earning assets decreased $38 million or 0.9% in the first half of 2014 compared with the first half of 2013, net result of a $224 million decrease in average loans and a $186 million increase in average investments. The decrease in the average balance of the loan portfolio was attributable to decreases in average balances of commercial real estate loans (down $111 million), consumer loans (down $67 million), residential real estate loans (down $46 million) and tax-exempt commercial loans (down $20 million), partially offset by a $22 million increase in the average balance of taxable commercial loans. The average investment portfolio increased mostly due to higher average balances of U.S. government sponsored entities (up $218 million) and corporate securities (up $65 million), partially offset by a $105 million decrease in average balances of collateralized mortgage obligations and mortgage-backed securities. The average yield on earning assets for the first half of 2014 was 3.88% compared with 4.31% in the first half of 2013. The loan portfolio yield for the first half of 2014 was 5.19% compared with 5.42% for the first half of 2013 mostly due to lower yields on consumer loans (down 38 bp), commercial real estate loans (down 15 bp), taxable commercial loans (down 46 bp), residential real estate loans (down 15 bp), construction loans (down 216 bp) and tax-exempt commercial loans (down 17 bp). Nonperforming loans are included in average loan volumes used to compute loan yields; fluctuations in nonaccrual loan volumes impact loan yields. The yield on construction loans in the first half of 2013 was elevated due to interest received on nonaccrual loans and discount accretion on purchased loans. The investment portfolio yield decreased 41 bp to 2.84% primarily due to lower yields on municipal securities (down 56 bp) and corporate securities (down 32 bp), partially offset by higher yields on securities of U.S. government sponsored entities (up 34 bp). The yield on securities of U.S. government sponsored entities rose as securities added to the portfolio in the first half of 2014 were higher yielding than securities held in the prior period.



Interest Expense

Interest expense has been reduced by lowering rates paid on interest-bearing deposits and borrowings and by reducing the volume of higher-cost funding sources. A $15 million long-term note was repaid in October 2013 and average balances of time deposits declined $148 million for the second quarter 2014 compared with second quarter 2013 and $156 million for the first half of 2014 compared with the first half of 2013. Lower-cost checking and savings deposits accounted for 89.3% of total average deposits in the second quarter 2014 compared with 85.5% in the second quarter 2013 and 89.1% in the first half of 2014 compared with 85.2% in the first half of 2013. Interest expense in the second quarter of 2014 decreased $319 thousand or 26.2% compared with the same period in 2013 due to lower average balances of interest-bearing liabilities. Interest-bearing liabilities declined due to lower average balances of time deposits $100 thousand or more (down $118 million), time deposits less than $100 thousand (down $30 million), preferred money market savings (down $19 million), debt financing (down $15 million) and Federal Home Loan Bank advances (down $5 million), partially offset by higher average balances of money market savings (up $58 million), money market checking accounts (up $31 million) and regular savings (up $15 million). The average rate paid on interest-bearing liabilities decreased from 0.19% in the second quarter of 2013 to 0.14% in the second quarter of 2014. Rates on interest-bearing deposits were 0.12% for the second quarter 2014 compared with 0.14% for the second quarter 2013. Comparing the first half of 2014 with the first half of 2013, interest expense declined $673 thousand or 27.2% due to lower average balances of interest-bearing liabilities. Average balances of debt financing and Federal Home Loan Bank advances declined $15 million and $5 million, respectively. Average balances of interest-bearing deposits decreased primarily due to lower average balances of time deposits $100 thousand or more (down $125 million), time deposits less than $100 thousand (down $31 million) and preferred money market savings (down $19 million), partially offset by higher average balances of money market checking accounts (up $23 million), money market savings (up $49 million) and regular savings (up $14 million). Rates paid on interest-bearing liabilities averaged 0.14% during the first half of 2014 compared with 0.19% for the first half of 2013. Rates paid on interest-bearing deposits were 0.12% in the first half of 2014 compared with 0.14% in the first half of 2013. -32- --------------------------------------------------------------------------------



Net Interest Margin (FTE)

The following summarizes the components of the Company's net interest margin for the periods indicated: For the Three Months For the Six Months Ended June 30, 2014 2013 2014 2013 Yield on earning assets (FTE) 3.85 % 4.24 % 3.88 % 4.31 % Rate paid on interest-bearing liabilities 0.14 % 0.19 % 0.14 % 0.19 % Net interest spread (FTE) 3.71 % 4.05 % 3.74 % 4.12 % Impact of noninterest bearing demand deposits 0.05 % 0.07 % 0.05 % 0.07 % Net interest margin (FTE) 3.76 % 4.12 % 3.79 % 4.19 % During the first half of 2014, the net interest margin (FTE) was affected by low market interest rates. The volume of older-dated higher-yielding loans and securities declined due to principal maturities and paydowns. Newly originated loans and purchased securities have lower yields. The Company is reducing its exposure to rising interest rates by purchasing shorter-duration investment securities, which carry lower yields than longer-duration securities. Rates on interest-bearing liabilities were kept low by reducing the volume of higher-cost funding sources. During the second quarter 2014 the net interest margin (FTE) decreased 36 bp compared with the same period in 2013. Lower yields on earning assets were partially offset by lower rates paid on interest-bearing liabilities and resulted in a 34 bp decrease in net interest spread (FTE). The 5 bp net interest margin contribution of noninterest-bearing demand deposits resulted in the net interest margin (FTE) of 3.76%. During the first half of 2014, the net interest margin (FTE) decreased 40 bp compared with the first half of 2013. The net interest spread (FTE) in the first half of 2014 was 3.74% compared with 4.12% in the fourth quarter of 2013, the net result of a 43 bp decrease in earning asset yields, partially offset by lower cost of interest-bearing liabilities (down 5 bp). [The remainder of this page intentionally left blank] -33-

-------------------------------------------------------------------------------- Summary of Average Balances, Yields/Rates and Interest Differential The following tables present information regarding the consolidated average assets, liabilities and shareholders' equity, the amounts of interest income earned from average interest earning assets and the resulting yields, and the amounts of interest expense incurred on average interest-bearing liabilities and the resulting rates. Average loan balances include nonperforming loans. Interest income includes reversal of previously accrued interest on loans placed on non-accrual status during the period and proceeds from loans on nonaccrual status only to the extent cash payments have been received and applied as interest income and accretion of purchased loan discounts. Yields on tax-exempt securities and loans have been adjusted upward to reflect the effect of income exempt from federal income taxation at the current statutory tax rate.



Distribution of Assets, Liabilities & Shareholders' Equity and Yields, Rates &


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Source: Edgar Glimpses


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