CNB Financial Corporation — Q1 2018 Form 10-Q
Business context and reporting period
Regional bank holding company with CNB Bank and other subsidiaries serving markets in Pennsylvania, Ohio, and New York. This unaudited report covers the three months ended March 31, 2018; income and cash-flow comparisons are against Q1 2017, while balance-sheet comparisons are against December 31, 2017. Dollar amounts below are in millions unless noted.
Financial performance and position
| Metric | Q1 2018 / March 31, 2018 | Prior comparable |
|---|---|---|
| Interest and dividend income | $29.4 | $25.1 in Q1 2017 |
| Net interest income | $24.1 | $21.2 in Q1 2017 |
| Net interest margin, fully taxable equivalent | 3.72% | 3.67% in Q1 2017 |
| Non-interest income | $4.8 | $5.8 in Q1 2017 |
| Non-interest expense | $19.0 | $17.0 in Q1 2017 |
| Provision for loan losses | $1.6 | $1.0 in Q1 2017 |
| Net income / diluted EPS | $7.1 / $0.46 | $6.5 / $0.43 in Q1 2017 |
| Return on average assets / equity | 1.00% / 11.61% | 1.00% / 11.39% in Q1 2017 |
| Loans, net of unearned discount | $2,276.1 | $2,146.0 at year-end 2017 |
| Total deposits | $2,210.1 | $2,167.8 at year-end 2017 |
| Cash and cash equivalents | $28.6 | $35.3 at year-end 2017 |
| Total assets / shareholders’ equity | $2,908.9 / $244.8 | $2,768.8 / $243.9 at year-end 2017 |
| Allowance for loan losses | $20.8; 0.91% of loans | $19.7; 0.92% at year-end 2017 |
| Nonperforming assets | $20.4; 0.70% of assets | $20.4; 0.71% at year-end 2017 |
| Total risk-based capital / CET1 ratio | 13.69% / 9.58% | 14.32% / 10.00% at year-end 2017 |
Operating cash flow was $4.1 million, investing cash flow was negative $149.2 million, and financing cash flow was positive $138.3 million. The investing outflow chiefly reflected $130.1 million of net loan originations and payments; financing included $50.0 million of long-term borrowing proceeds and a $56.6 million increase in short-term borrowings. Cash declined $6.7 million during the quarter.
Material changes versus prior period
- Net income increased about 9.5% year over year as net interest income rose 13.7%. Average earning assets grew and their yield rose 21 basis points to 4.53%; the cost of interest-bearing liabilities rose 18 basis points to 0.94%.
- Total non-interest income fell about $1.0 million, primarily because Q1 2017 included $1.4 million of realized securities gains; Q1 2018 had no such gains. Excluding securities transactions, management said non-interest income increased from $4.2 million to $4.7 million.
- Non-interest expense rose $2.0 million. Management cited business growth, a larger customer base, staffing growth, and $698,000 of costs related to immediately vested stock compensation, deferred-compensation account value changes, and the sales-tax assessment.
- Income-tax expense declined to $1.1 million from $2.4 million; the effective tax rate fell to 13.7% from 27.4%, principally reflecting the 2017 Tax Cuts and Jobs Act and tax-exempt income.
- Loans grew 6.1% from year-end, led by commercial mortgages, which increased to $694.5 million from $600.1 million. Borrowings also increased: short-term borrowings rose to $91.0 million from $34.4 million, and FHLB and other long-term borrowings to $265.4 million from $222.9 million.
- Unrealized losses on available-for-sale securities increased to $7.6 million from $4.2 million at year-end; the quarter recorded a $3.9 million other comprehensive loss, largely from securities valuation changes. Management said it did not intend, and was not more likely than not required, to sell the securities before recovery.
Outlook, risks, and unusual items
- Management expected solid loan demand and loan growth through the rest of 2018, and said growth strategies were expected to increase earning assets and non-interest income sufficiently to more than offset higher non-interest costs. Management believed the company was positioned to sustain core earnings in 2018; these are expectations, not guarantees.
- Management considered liquidity acceptable, citing cash, traditional funding sources, FHLB financing, and loans and securities maturing within one year. It also reported compliance with regulatory capital-adequacy standards.
- Credit risk warrants attention: one impaired commercial real-estate loan deteriorated, prompting an additional $623,000 provision. Commercial mortgages rose to 31% of the loan portfolio from 28% at year-end. Management nevertheless stated the allowance was adequate. Net charge-offs were $568,000 versus $800,000 in Q1 2017.
- A Pennsylvania sales-tax assessment covering 2013 through July 2016 totaled $1.163 million, including interest and penalties. The company accrued $96,000; management and counsel disputed much of the remaining assessment. Resolution could take more than a year and could result in additional expense up to the assessed amount.
- Interest-rate risk is a key exposure. The filing’s model, based on December 31, 2017 data, estimated net interest income changes of +6.4% for a 400-basis-point rise, +5.1% for 300 basis points, +1.9% for 100 basis points, and −2.4% for a 100-basis-point decline. Management cautioned that actual results could differ significantly; falling-rate scenarios of 300 and 400 basis points were excluded.
- The company identified expected future accounting changes, including credit-loss and lease standards; the impact of the credit-loss standard remained undetermined, and lease adoption was expected to increase assets and liabilities, with amounts not yet determined.
- No legal proceedings were reported, no material changes to the prior annual report’s risk factors were disclosed, and management concluded disclosure controls were effective with no material internal-control changes during the quarter.
Important facts for investors to verify
- Whether commercial loan and commercial real-estate growth is matched by stable credit quality, particularly given the impaired loan provision and higher commercial mortgage concentration.
- Whether deposit funding, borrowing levels, and cash liquidity remain sufficient as loan growth continues and funding costs rise.
- Whether securities valuation losses remain unrealized and recover, and how any further rate changes affect accumulated other comprehensive loss and capital.
- The ultimate outcome and potential additional cost of the Pennsylvania sales-tax assessment beyond the $96,000 accrued.
- Whether management’s 2018 loan-growth and core-earnings expectations are achieved despite expense growth, credit costs, and changing interest rates.