CNB Financial Corporation — Q3 2016 Form 10-Q
Business context and reporting period. This unaudited filing covers the three and nine months ended September 30, 2016, with comparisons to 2015. CNB is a Pennsylvania-based bank holding company operating through CNB Bank and related businesses. It completed its acquisition of Lake National Bank on July 15, 2016; the acquired branches now operate within ERIEBANK. Amounts below are in millions unless noted.
Financial performance and condition
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Interest and dividend income | $25.0 | $22.2 | $69.5 | $65.2 |
| Net interest income | $21.9 | $19.0 | $60.3 | $55.8 |
| Non-interest income | $4.5 | $4.0 | $13.1 | $12.4 |
| Non-interest expense | $17.1 | $15.0 | $50.7 | $43.4 |
| Net income | $6.4 | $5.5 | $15.5 | $16.7 |
| Diluted earnings per share | $0.44 | $0.38 | $1.07 | $1.16 |
| Cash dividends per share | $0.165 | $0.165 | $0.495 | $0.495 |
Calculated interest income plus non-interest income was $29.4 million in Q3 2016 versus $26.2 million in Q3 2015, and $82.6 million for the first nine months versus $77.6 million. Net interest margin on a fully tax-equivalent basis was 3.88% in Q3 (3.75% prior year) and 3.76% for nine months (3.74% prior year). Q3 annualized return on assets and equity was 1.01% and 11.92%; the nine-month figures were 0.87% and 9.78%.
- Balance sheet at September 30: Assets were $2,539.9 million, net loans $1,785.2 million, deposits $2,023.8 million, and shareholders’ equity $215.5 million. Since December 31, 2015, net loans grew $224.1 million and deposits grew $208.7 million; growth includes the LNB acquisition.
- Liquidity and cash flow: Cash and cash equivalents were $36.9 million, up from $27.3 million at year-end. Nine-month operating cash flow was negative $21.1 million, investing cash flow negative $65.7 million, and financing cash flow positive $96.5 million; ending cash increased $9.6 million. Management considered liquidity acceptable, citing cash, traditional funding, FHLB access, and maturing securities and loans.
- Borrowings and capital: At quarter-end, FHLB and other long-term borrowings were $129.2 million, short-term borrowings $76.0 million, and subordinated debentures $70.6 million. CNB issued $50 million of subordinated notes in September, initially fixed at 5.75% through October 2021 and then floating at three-month LIBOR plus 455 basis points. Total risk-based capital ratio was 14.11%; Tier 1 capital ratio 10.52%; leverage ratio 7.71%. Tangible common equity to tangible assets was 6.94%.
- Credit quality: Allowance for loan losses was $15.7 million, or 0.87% of loans net of unearned discount, versus $16.7 million and 1.06% at year-end 2015. Nine-month net charge-offs were $3.1 million versus $2.0 million a year earlier; management attributed the increase mainly to Holiday consumer lending. Nonperforming assets were $16.5 million, or 0.65% of assets, versus $12.9 million and 0.57% at year-end.
Material changes versus comparable periods
- Q3 net income rose 16.2% year over year, while nine-month net income fell 7.1%. Nine-month operating expenses rose $7.3 million; net interest income increased $4.5 million.
- Loan growth reflected $122.0 million acquired from LNB and $101.1 million of organic growth. LNB consideration was $24.75 million; preliminary acquisition accounting recorded $11.8 million of goodwill and a $4.1 million combined yield and credit mark on acquired loans.
- Nine-month earnings included a $1.5 million prepayment penalty on repayment of $40 million of long-term borrowings, $1.6 million of core-processing conversion costs, $0.5 million of merger costs, and $1.0 million of realized securities gains. Management said the repayment is expected to save $1.9 million in interest expense in 2016 and 2017.
- Q3 expenses included $0.3 million of merger costs. The company completed a core processing system upgrade in May 2016; staffing increased to 471 full-time equivalents from 430 a year earlier, including 20 employees retained with LNB.
Outlook, commentary, risks, and unusual items
- Management expected solid loan demand and loan growth through the rest of 2016, and believed its growth strategy would support core earnings in 2016. It said expenses would rise with growth but expected earning assets and non-interest income to more than offset them. These are expectations, not guarantees; the filing provides no specific earnings guidance.
- Management identified interest rates as an important earnings factor. Its June 30 model estimated net interest income changes of +7.2% for a 400-basis-point rise, +6.0% for +300, +2.8% for +100, and -2.5% for -100 over one year. The filing cautions that actual outcomes may differ; -300 and -400 scenarios were excluded due to the low-rate environment.
- Risks cited include economic and competitive conditions, interest-rate and funding-cost changes, loan quality and reserve adequacy, deposit attrition, acquisition integration and expected benefits, regulatory or judicial proceedings, and technology change. Commercial and commercial real estate lending growth increases exposure to business and economic conditions.
- Management concluded the allowance was adequate for probable incurred losses. Unrealized securities losses were $2.1 million at quarter-end; management said it did not intend, and was not more likely than not required, to sell affected securities before recovery. Structured pooled trust preferred securities of $1.7 million are valued using significant unobservable inputs and are sensitive to assumptions and market volatility.
- The filing reports no material legal proceedings and no material changes to the risk factors in the 2015 Form 10-K. Disclosure controls were judged effective, with no material change to internal control over financial reporting reported.
Important facts for investors to verify
- How LNB integration, preliminary purchase accounting, and the new Ohio branch affect future expenses, loan growth, and returns.
- Whether organic loan and deposit growth continues, and how much reported growth is attributable to the acquisition.
- Credit trends, particularly Holiday charge-offs, commercial loan ratings, nonperforming assets, and allowance coverage as the portfolio expands.
- The realized and recurring effects of the debt prepayment, subordinated notes, conversion costs, and securities gains on future earnings and funding costs.
- Interest-rate sensitivity and liquidity assumptions, including execution of off-balance-sheet commitments and the valuation of Level 3 securities.