Auburn National Bancorporation, Inc. — 2017 Q3 Form 10-Q
Business context and period. Auburn National Bancorporation is a bank holding company operating through AuburnBank, primarily in Lee County and surrounding East Alabama communities. This unaudited filing covers the quarter and nine months ended September 30, 2017; comparative results are for 2016. Dollar amounts below are in millions unless noted.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net interest income, GAAP | $6.261 | $5.608 | $18.251 | $16.997 |
| Net interest income, tax-equivalent | $6.565 | $5.924 | $19.156 | $17.957 |
| Noninterest income | $0.968 | $1.063 | $2.597 | $2.890 |
| Net earnings | $2.136 | $1.951 | $6.021 | $6.073 |
| Diluted earnings per share | $0.59 | $0.54 | $1.65 | $1.67 |
| Tax-equivalent net interest margin | 3.32% | 2.94% | 3.26% | 3.05% |
| Efficiency ratio | 56.09% | 56.96% | 56.81% | 58.09% |
Tax-equivalent figures are non-GAAP measures. Q3 total revenue was $7.229 million on the company’s tax-equivalent presentation; GAAP net interest income was $6.261 million.
- Balance sheet at September 30: assets $828.5 million; loans, net of unearned income, $449.4 million; securities available-for-sale $265.2 million; deposits $732.6 million; total liabilities $742.0 million; stockholders’ equity $86.5 million.
- Liquidity and cash flow: cash and cash equivalents were $78.1 million, down from $121.3 million at year-end 2016. For the first nine months, operating cash flow was $7.4 million, investing cash outflow $41.8 million, and financing cash outflow $8.8 million. Investing outflow primarily reflected securities purchases and loan growth.
- Debt and funding: long-term debt was $3.2 million, consisting of junior subordinated debentures; short-term borrowings and repurchase agreements totaled $3.6 million. The Bank had $246.8 million of available FHLB capacity and $41.0 million in federal funds lines, with none outstanding on those lines.
- Capital: regulatory ratios were 10.70% tier 1 leverage, 16.15% CET1, 16.71% tier 1 risk-based, and 17.62% total risk-based. Management reported ratios above well-capitalized requirements and sufficient to meet the fully phased-in capital conservation buffer.
Material changes versus comparable periods
- Q3 net earnings rose 9.5% year over year; nine-month earnings declined 0.9%. Nine-month EPS was $1.65 versus $1.67.
- Nine-month tax-equivalent net interest income increased 6.7%, and margin rose 21 basis points. Management attributed the improvement to a larger securities portfolio, lower deposit costs, and repayment of higher-cost funding. Average earning-asset yield improved, while loan and securities yields faced competitive and reinvestment-rate pressure.
- Nine-month noninterest income fell 10.1%, primarily as mortgage lending income declined with lower mortgage origination and sale volume; securities gains also decreased. Noninterest expense increased 2.0%, partly because 2016 included gains on OREO sales.
- Loans grew 4% from year-end to $449.4 million, driven mainly by commercial real estate. Deposits declined 0.9% to $732.6 million as interest-bearing balances fell, partly offset by growth in noninterest-bearing deposits. Securities rose 9% to $265.2 million.
- Nonperforming assets rose to $3.0 million from $2.5 million at year-end; nonaccrual loans increased to $2.9 million, including $2.5 million in commercial real estate. The allowance was $4.7 million, or 1.04% of loans, versus 1.08% at year-end. Nine-month net charge-offs were $73,000, compared with net recoveries of $889,000 in 2016, when a $1.2 million recovery followed payoff of a nonperforming construction loan.
Outlook, risks, and unusual items
- Management expected 2017 net interest income to continue increasing versus 2016, based on asset-mix changes and its expectation that asset yields could rise faster than funding costs, subject to competitive pressures. This is forward-looking, not a quantified earnings forecast.
- Management said mortgage lending income and volume were expected to decline versus prior periods until planned production-capacity improvements are implemented; no timing or quantified outlook was provided.
- Key risks include interest-rate movements and competition for loans and deposits; borrower credit deterioration and real-estate concentration; valuation and allowance-estimation uncertainty; economic and regulatory changes; cybersecurity and data breaches; and mortgage repurchase or make-whole claims.
- Real-estate-secured loans were 86.7% of the portfolio. Commercial real estate was 53% of loans, and one borrower relationship exceeded the Bank’s internal exposure limit. Potential problem loans were $5.8 million; 14% were 30–89 days past due.
- The allowance methodology uses a longer loss-history look-back period and a wider range for qualitative adjustments. Management stated the refinements were intended to better reflect economic-cycle losses and that the allowance was adequate; the estimate remains judgmental.
- The Bank repurchased three Fannie Mae loans during the first nine months, with aggregate principal of $0.6 million; one request was pending at quarter-end. Management did not consider exposure material and reported 99% of Fannie Mae-serviced loans current.
- No material subsequent events were identified. Management reported no pending or threatened legal proceedings expected to have a material adverse effect, and disclosure controls were deemed effective. No new accounting guidance was adopted during the first nine months; the company was evaluating forthcoming standards, including expected credit-loss accounting.
Important facts for investors to verify
- Whether commercial real estate nonaccruals and potential problem loans continue to rise, and whether the allowance remains adequate as loan growth continues.
- Whether planned mortgage production-capacity changes occur and reverse the expected decline in mortgage volume and income; monitor repurchase requests and related losses.
- Whether net interest income and margin gains persist as rates, loan pricing competition, deposit costs, and securities reinvestment yields change.
- How the company funds loan growth and dividends if deposits remain flat or decline; verify liquidity availability and capital ratios.
- Reconcile the reported tax-equivalent net interest figures with GAAP results when comparing performance, and track the effect of future accounting-standard adoption.