FIRST CAPITAL INC quarterly report, Q1 FY2018

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First Capital, Inc. — Q1 2018 Form 10-Q

Business context and period. First Capital is the savings and loan holding company for First Harrison Bank and related subsidiaries. This unaudited filing covers the three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. Amounts below are in millions unless otherwise indicated.

Financial performance and position

  • Earnings: Net income attributable to First Capital was $2.133 million, or $0.64 per diluted share, versus $1.553 million, or $0.46, in Q1 2017. Income before taxes rose to $2.497 million from $2.071 million.
  • Interest income and margins: Interest income increased to $6.764 million from $6.343 million; interest expense declined to $0.342 million from $0.359 million. Net interest income rose 7% to $6.422 million. The tax-equivalent interest-rate spread increased to 3.62% from 3.44%; average earning-asset yield was 3.87% versus 3.70%.
  • Other income and expenses: Noninterest income was $1.526 million versus $1.453 million. Noninterest expense rose to $5.254 million from $5.155 million. Provision for loan losses was $0.197 million, down from $0.211 million.
  • Taxes: Income tax expense declined to $0.361 million from $0.515 million; the effective tax rate was 14.5% versus 24.9%, reflecting the Tax Cuts and Jobs Act, tax-credit investment benefits, and increased nontaxable income.
  • Cash flow: Operating cash flow was $3.358 million, compared with $4.825 million. Investing activities provided $3.975 million, versus using $19.311 million; financing activities provided $6.237 million. Cash and cash equivalents increased $13.570 million during the quarter to $39.485 million.
  • Balance sheet and liquidity: Total assets were $767.324 million, up from $758.956 million. Deposits increased to $681.571 million from $664.562 million. Net loans were $407.279 million, down from $409.618 million; available-for-sale securities were $264.843 million, down from $271.172 million.
  • Debt and capital: The Bank repaid its $10.0 million Federal Home Loan Bank advance; no such advances remained at quarter-end. Total equity was $79.446 million, down from $81.050 million, largely due to securities-related other comprehensive loss. The Bank reported regulatory capital ratios of 9.7% Tier 1 leverage, 13.8% common equity Tier 1, 13.8% Tier 1 risk-based, and 14.5% total risk-based, and was classified as well-capitalized.
  • Credit quality: The allowance for loan losses was $3.631 million, essentially unchanged from year-end. Nonperforming loans were $2.854 million versus $2.827 million; nonaccrual loans were $2.675 million versus $2.536 million. Net charge-offs were $0.200 million, compared with $0.179 million.

Material changes versus comparable periods

  • Net income attributable to the Company increased about 37% year over year, principally due to higher net interest income after provision and lower income tax expense.
  • Net interest income rose $0.438 million; management attributed the increase to higher average balances and tax-equivalent yields on earning assets and lower average interest-bearing liabilities.
  • Noninterest expense increased $0.099 million. Higher compensation and data-processing costs were partly offset by lower losses on foreclosed real estate.
  • Available-for-sale securities incurred a $4.015 million unrealized holding loss before tax in Q1 2018, versus an unrealized gain in Q1 2017. After tax and reclassification, other comprehensive loss was $3.017 million; comprehensive loss attributable to First Capital was $0.884 million.
  • Within the loan portfolio, construction and land loans increased, while commercial real estate, residential mortgage, and consumer loans declined during the quarter.

Outlook, commentary, risks, and unusual items

  • Outlook: The filing provides no specific earnings or operating guidance. Management notes interim results are not necessarily indicative of full-year results.
  • Regulatory conversion: The Bank’s approved conversion from a federal savings association to an Indiana-chartered commercial bank, and the Company’s approved change to a financial holding company, were expected to occur simultaneously in June 2018. Management said the conversion was not expected to affect clients or eligible deposit insurance.
  • Affordable-housing investment: The Bank invested $3.9 million in a qualified affordable-housing entity and had a further $3.5 million unfunded commitment, expected to be funded through capital calls to 2029. Q1 included $0.082 million of amortization expense and $0.098 million of tax credits and other tax benefits.
  • Interest-rate exposure: The Company’s simulation estimated that a 100-basis-point rate increase would raise one-year net interest income by 0.40%, while a 100-basis-point decrease would lower it by 2.34%, relative to the base case. The filing cautions that model assumptions and borrower or depositor behavior limit the reliability of these estimates.
  • Key risks: Management identifies economic conditions, interest rates and monetary policy, loan and securities quality, loan demand, deposit flows, competition, regulatory changes, and accounting changes as factors that could affect results. The loan portfolio has meaningful exposure to the Louisville, Kentucky area. Management’s allowance estimates are judgmental and may require revision.
  • Securities valuation: Gross unrealized losses on available-for-sale securities were $7.403 million at March 31, 2018, compared with $3.981 million at year-end. Management attributed losses principally to interest rates, did not consider them other-than-temporary, and said it had the ability to hold the securities. Further market or economic deterioration could adversely affect credit quality.
  • Accounting and legal matters: Adoption of the new revenue-recognition standard had no material impact. The Company was assessing the expected-credit-loss standard and anticipated a one-time cumulative adjustment upon adoption. The filing reports no legal proceedings and no material changes to previously disclosed risk factors.

Most important facts for investors to verify

  1. Whether improved earnings persist, especially given the reduction in the effective tax rate and the role of tax-credit benefits.
  2. Whether securities market-value declines stabilize or further reduce equity through accumulated other comprehensive loss.
  3. Trends in nonperforming loans, charge-offs, foreclosures, and the adequacy of the allowance, particularly in the Company’s regional real-estate exposure.
  4. Deposit growth, funding costs, loan growth, and liquidity following repayment of the FHLB advance.
  5. Completion and effects of the planned regulatory conversion, and the funding and returns associated with the affordable-housing commitment.
  6. Implementation timing and eventual allowance impact of the expected-credit-loss accounting standard; the filing does not provide a clear quantified estimate.