EAGLE FINANCIAL SERVICES INC quarterly report, Q3 FY2011

Eagle Financial Services, Inc. — Q3 2011 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2011. The company is a bank holding company whose principal subsidiary, Bank of Clarke County, conducts commercial banking. Financial amounts below are in millions unless noted; balance-sheet comparisons are to December 31, 2010.

Financial performance

Metric	Q3 2011	Q3 2010	Nine months 2011	Nine months 2010
Net interest income	$5.732	$5.571	$16.910	$16.535
Provision for loan losses	$1.050	$2.850	$2.850	$4.150
Noninterest income	$1.394	$1.475	$4.341	$4.222
Noninterest expense	$4.567	$4.290	$13.514	$12.453
Income before taxes	$1.509	$(0.094)	$4.887	$4.154
Net income	$1.139	$0.081	$3.629	$3.144
Diluted earnings per share	$0.34	$0.02	$1.10	$0.97

Year-to-date net income rose 15.4%; Q3 earnings increased substantially from a very low prior-year quarter. Lower loan-loss provision was a major contributor: it declined $1.8 million year over year in Q3 and $1.3 million year to date.
Net interest margin was 4.34% in Q3 versus 4.31% a year earlier, but 4.33% year to date versus 4.37%. Year-to-date net interest income improved as interest expense fell 11.5%, despite a 0.5% decrease in interest income.
Year-to-date noninterest expense rose 8.5%, including higher salaries and benefits, software costs, and outside loan-review fees. The reported efficiency ratio improved to 57.90% from 62.26%.
Annualized year-to-date return on assets was 0.85% versus 0.76%; return on equity was 8.75% versus 7.85%.

Financial position, cash flow and liquidity

Total assets were $571.336 million, up 2.2% from year-end 2010. Net loans were $398.649 million, down 0.7%; gross loans were $406.540 million, down 0.5%. Available-for-sale securities were $119.996 million, up 9.3%.
Deposits increased 4.8% to $450.007 million. Shareholders’ equity rose to $57.923 million from $53.829 million; equity equaled 10.14% of assets.
Borrowings included $10.0 million of federal funds and repurchase-agreement balances, $42.25 million of Federal Home Loan Bank advances, and $7.217 million of trust preferred notes. FHLB advances were down $10 million from year-end.
For the first nine months, operating cash flow was $9.651 million, investing cash flow was $(9.867) million, and financing cash flow was $5.085 million. Cash and cash equivalents increased $4.869 million to $18.839 million.
Management reported liquid assets of $251.208 million, or 48.93% of liabilities, versus $227.394 million, or 45.03%, at year-end. The loan-to-deposit ratio fell to 90.34% from 95.14%.
Capital ratios at September 30 were 15.61% Tier 1 risk-based, 16.85% total risk-based, and 10.74% Tier 1 leverage. Each exceeded the company’s stated internal minimums.

Credit quality, changes and material items

The allowance for loan losses increased to $7.891 million from $7.111 million, equal to 1.94% of loans versus 1.74% at year-end. Nine-month net charge-offs were $2.070 million, compared with $2.287 million in 2010.
Nonaccrual loans declined to $2.635 million from $8.377 million, primarily due to charge-offs. However, other real estate owned and repossessed assets increased to $3.489 million from $1.805 million; other real estate owned alone was $3.437 million.
Nonperforming assets were 1.48% of loans and other real estate owned, down from 2.04%. Past-due loans 90 days or more and still accruing were $165,000 versus $10,000 at year-end. Management said further increases in past-due loans, nonperforming loans, and OREO were possible given economic conditions and real-estate exposure.
There were 23 troubled debt restructurings totaling $10.069 million at quarter-end, compared with 31 totaling $8.469 million at year-end. Seven loans modified as TDRs during the prior 12 months had payment defaults during the first nine months of 2011, with recorded investment of $2.517 million.
Available-for-sale securities carried an unrealized gain of $5.154 million, compared with $2.343 million at year-end. Management attributed unrealized losses on certain securities primarily to market interest-rate changes and considered them temporary; it also identified market, credit, and interest-rate risks.
Deposit-account service charges declined, with management citing regulatory changes affecting fees on certain transactions. Management also warned that Dodd-Frank debit-card interchange rules could reduce debit-card income in the future.

Outlook, risks and contingencies

The filing provides no numerical earnings or revenue guidance. Management stated that interim results are not necessarily indicative of full-year results.
The company’s stated strategy emphasizes local lending and core-deposit growth. Management identified credit quality, real-estate values, borrower repayment capacity, interest-rate movements, competition, funding, capital, regulatory change, and execution of growth plans among the forward-looking risks.
The pension plan was terminated effective September 30, 2010; a payout was expected in Q4 2011, subject to regulatory approval. The company projected approximately $581,000 of pension-plan expense for 2011 and none thereafter.
No material pending legal proceedings or subsequent events requiring adjustment or disclosure were reported. Management concluded disclosure controls were effective at September 30, 2011, with no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether lower provisions and reduced nonaccrual balances are sustainable, considering charge-offs, TDR defaults, delinquencies, and rising OREO.
Recent and subsequent trends in collateral values and loan performance, particularly in real-estate-related portfolios.
The effect of regulatory fee and interchange changes on service-charge and debit-card revenue.
Completion, timing, and final cost of the pension-plan payout, including regulatory approval.
Whether deposit growth, liquidity, capital ratios, and net interest margin remain adequate as rates, competition, and funding needs change.