California First Leasing Corp

What they do

California First National Bancorp, through its bank subsidiary CalFirst Bank and leasing subsidiary CalFirst Leasing, provides secured financing via equipment leasing, syndicated commercial loan participations, non-recourse loans secured by leases and equipment, and direct commercial loans. CalFirst Bank originates substantially all leases and loans, gathers deposits via the Internet, and operates from one central location in Orange County, California.

Revenue drivers

• Commercial loans — Historically the largest asset class, accounting for 53% of bookings in fiscal 2017 and 68% in fiscal 2016; originations ceased in January 2017 due to regulatory restrictions, and the portfolio declined to $219.5 million at September 30, 2017.
• Lease portfolio — Leases accounted for 38% of the lease and loan portfolio at June 30, 2017; new lease bookings in fiscal 2017 included manufacturing equipment ($32.7M), computer hardware/software ($28.9M), and transportation equipment ($15.6M).
• Investment securities — Yield on average investment securities was 2.21% in Q1 FY2018; average balance was $101.5 million, providing a stable source of interest income.
• Deposit spreads and net interest margin — The company earns net interest income on the spread between yields on leases, loans, and securities, and rates paid on internet deposits and borrowings; net interest margin improved to 3.11% in Q1 FY2018 from 2.53% in the prior-year quarter.

Recent performance

For fiscal 2017, net income rose to $11.1 million from $8.6 million in fiscal 2016, with diluted EPS of $1.08. Operating cash flow surged to $44.3 million in fiscal 2017 from $9.7 million the prior year. In Q1 FY2018 (quarter ended September 30, 2017), net earnings were $2.3 million, up 17.2% year-over-year, and diluted EPS was $0.22. Total assets fell to $629.5 million at September 30, 2017 from $715.6 million at June 30, 2017, and commercial loans declined 28% during the quarter to $219.5 million.

Strategy

Management is refocusing on the traditional leasing business and reducing funding and other expenses, while working to lift regulatory restrictions on commercial loan origination. The company has been managing deposit runoff to align with loan payoffs, reducing excess liquidity. Management does not believe the costs of regulatory burden on commercial lending will justify returning to the prior growth strategy. The board continues to evaluate all options available to serve shareholder interests.

Risks

• Regulatory restrictions on lending — The OCC directed CalFirst Bank to cease originating syndicated commercial loans and to substantially reduce leveraged loan concentration; these restrictions remain in place and have halted new loan origination since January 2017.
• Portfolio contraction — The loan portfolio declined 45% from December 31, 2016 to August 31, 2017, and management projects continued declines in fiscal 2018, reducing net interest income and earning-asset capacity.
• Asset runoff without replacement — Commercial loan payoffs are not being timely replaced with alternative earning assets, which could lower future earnings and leave the bank significantly overcapitalized with limited profitable deployment.
• Interest rate mismatch — Many leases, loans, and liquid investments are tied to U.S. Treasury rates and Libor, which may not move in step with deposit rates, causing volatility in net interest income.

Outlook

Management projects the loan portfolio will continue to decline in fiscal 2018, and this will adversely affect net interest income and the ability to deploy capital profitably. While some loan restrictions may be lifted in the next quarter, management is not optimistic about returning to the syndicated commercial loan strategy. The company plans to continue refocusing on leasing and expense reduction, and the board is evaluating strategic options.