First Community Bankshares, Inc. — Q2 2020 Form 10-Q
Reporting period: Three and six months ended June 30, 2020. First Community is a community-banking holding company operating 58 branches across Virginia, West Virginia, North Carolina, and Tennessee. Comparisons are affected by the December 31, 2019 Highlands acquisition.
Financial performance and condition
Amounts below are in millions of dollars unless otherwise noted.
| Metric | Q2 2020 / June 30, 2020 | Comparable period / change |
|---|---|---|
| Total revenue (net interest income plus noninterest income) | $33.25 | $31.64 in Q2 2019 |
| Net interest income | $26.34 | Up 14.6% from $22.99 |
| Net income | $8.24 | Down 21.2% from $10.45 |
| Diluted earnings per share | $0.46 | $0.66 in Q2 2019 |
| Net interest margin, fully taxable equivalent | 4.22% | 4.72% in Q2 2019 |
| Return on average assets | 1.15% | 1.89% in Q2 2019 |
| Provision for credit losses | $3.83 | $1.59 in Q2 2019 |
| Total assets | $2,949.1 | Up 5.4% from year-end 2019 |
| Total loans, before allowance | $2,136.8 | Up 1.1% from year-end 2019 |
| Total deposits | $2,497.8 | Up 7.2% from year-end 2019 |
| Cash and cash equivalents | $421.5 | $217.0 at year-end 2019 |
| Allowance for loan losses | $23.8 | $18.4 at year-end 2019 |
| Total nonperforming assets | $27.8 | $21.2 at year-end 2019 |
| Total stockholders’ equity | $415.8 | $428.8 at year-end 2019 |
For the six months ended June 30, revenue was $68.48 million, net income was $16.11 million, and diluted EPS was $0.90; net income and diluted EPS were down 19.8% and 29.1%, respectively, from the first half of 2019. Six-month net interest income increased 19.6%, while the FTE net interest margin declined to 4.46% from 4.66%.
Six-month cash flow: operating activities provided $18.21 million, investing activities provided $49.77 million, and financing activities provided $136.50 million, resulting in a $204.48 million increase in cash. The company reported no long-term borrowings and $1.10 million in repurchase-agreement borrowings at June 30. Available liquidity included $365.67 million of unused FHLB capacity, $85.00 million of correspondent-bank lines, and $6.08 million at the Federal Reserve Discount Window. The company reported capital ratios above regulatory well-capitalized requirements; at June 30, its total risk-based capital ratio was 15.07% and Tier 1 leverage ratio was 10.18%.
Material changes and drivers
- Q2 earnings fell despite higher net interest income, principally because the credit-loss provision rose $2.25 million year over year and Q2 2019 included $2.03 million in litigation settlements. Pandemic-related declines in deposit service charges also reduced revenue.
- For the first half, the provision for credit losses was $7.33 million, up $4.53 million year over year. Management attributed the reserve build to COVID-19 uncertainty. The allowance increased 28.9% from year-end.
- Net interest margin declined amid historically low rates. Loan growth and deposit growth also reflect the Highlands acquisition; the company said the acquisition contributed $8.85 million to the year-over-year increase in first-half net interest income.
- Noninterest expense rose 21.4% in the first half, including $4.08 million higher salaries and benefits, largely related to Highlands, and $1.89 million in residual merger expenses.
- Noninterest-bearing deposits increased $125.03 million from year-end, which management attributed in significant part to federal stimulus. Available-for-sale securities declined $71.21 million, primarily following $51.03 million of sales in Q1.
Outlook, risks, and unusual items
- Management expects COVID-19 to materially affect provisions for loan losses in periods after June 30, 2020, but could not estimate the ultimate effect of the pandemic. It identified hotel/motel and retail lending as among the portfolios at greatest risk.
- By June 30, the company had modified or deferred payments on 3,097 loans totaling $436.11 million in principal. Accrued interest on these loans was $702,000; if losses ultimately occur, accrued interest and fees may need to be reversed. COVID-related commercial modifications were generally classified as Special Mention.
- The bank originated 758 PPP loans totaling $60.23 million. PPP loans are SBA-guaranteed and potentially forgivable, but the filing highlights possible borrower litigation and risk that SBA guarantees could be reduced or denied if origination, funding, or servicing deficiencies are found.
- The company elected CARES Act relief from applying the CECL standard during the permitted period. It anticipates an approximately $5.61 million cumulative-effect retained-earnings adjustment upon adoption, and separately describes an approximately $7.04 million opening allowance adjustment for purchased credit-deteriorated Highlands loans.
- In view of economic uncertainty, management temporarily delayed consideration of a new share-repurchase authorization. The prior program had been completed in Q1; 734,653 shares were repurchased for $21.87 million during the first half, with none repurchased in Q2.
- COVID-19, low interest rates, borrower repayment capacity, collateral values, and reduced demand for loans and fee-based services are key risks. Management reported no material unmitigated operational or internal-control challenges. It expects liquidity and capital to support the company, while cautioning that pandemic effects remain uncertain.
- The company disclosed ordinary-course legal claims but said their resolution is not expected to materially adversely affect financial condition, results, or cash flows. No formal earnings guidance was provided.
Important facts for investors to verify
- Track payment performance and credit quality of the $436.11 million modified-loan portfolio, particularly hotel/motel and retail exposures, and the direction of nonaccrual loans and the allowance.
- Assess subsequent credit-loss provisions against management’s warning that future periods may be materially affected by COVID-19.
- Verify PPP forgiveness, servicing compliance, and any SBA guarantee disputes or related litigation.
- Clarify the timing and accounting impact of CECL adoption, including the separately stated $5.61 million retained-earnings estimate and $7.04 million purchased-credit-deteriorated-loan adjustment.
- Monitor net interest margin under sustained low rates, deposit trends, and capital ratios after the repurchases and dividend payments.
- Separate Highlands acquisition effects and prior-year litigation settlements from underlying operating trends when comparing results.