Business context and reporting period
Farmers National Banc Corp. filed this Form 10-K for the fiscal year ended December 31, 2015. The Ohio-based bank holding company operates banking, trust, retirement-consulting and insurance businesses, primarily in Ohio, with one Pennsylvania location. The company completed two bank acquisitions during 2015: National Bancshares Corporation (closed June 19) and Tri-State 1st Banc (closed October 1). Comparisons with 2014 are affected substantially by these acquisitions and the related integration costs.
Financial performance and position
Unless otherwise noted, amounts are in millions of dollars.
| Metric | 2015 | 2014 |
|---|---|---|
| Interest and dividend income | $53.8 | $40.9 |
| Net interest income | $49.7 | $36.3 |
| Provision for loan losses | $3.5 | $1.9 |
| Noninterest income | $18.3 | $15.3 |
| Noninterest expense | $54.0 | $38.2 |
| Net income | $8.1 | $9.0 |
| Diluted earnings per share | $0.36 | $0.48 |
| Return on average assets / equity | 0.54% / 4.97% | 0.79% / 7.45% |
| Net interest margin (tax-equivalent) | 3.81% | 3.59% |
| Efficiency ratio (tax-equivalent) | 75.26% | 70.24% |
Management said that excluding acquisition-related expenses, 2015 net income would have been $12.9 million, or $0.57 per share, and the efficiency ratio 66.2%. These are management-adjusted figures; the filing’s reported results include the costs.
At year-end, total assets were $1.870 billion, net loans $1.288 billion, deposits $1.409 billion, and stockholders’ equity $198.0 million. Short- and long-term borrowings totaled $248.0 million ($225.8 million and $22.2 million, respectively). The loan-to-deposit ratio was 92.04%. Cash and cash equivalents were $56.0 million; available-for-sale securities were $394.3 million, of which management reported $176 million unpledged. Core deposits were 96.8% of deposits. The Bank had $63.4 million of additional FHLB borrowing capacity.
Cash flow for 2015 was $6.3 million provided by operations, $23.1 million used in investing, and $45.4 million provided by financing; cash and cash equivalents increased $28.6 million to $56.0 million. Financing cash flow included increased short-term borrowing, while investing reflected loan growth and acquisition-related cash receipts.
Loan quality measures included an allowance for loan losses of $9.0 million, net charge-offs of $2.2 million, and nonperforming loans of $10.4 million (0.81% of loans), versus $8.5 million (1.28%) in 2014. The allowance covered 85.96% of nonperforming loans. Real-estate-secured loans represented about 68% of the portfolio; commercial real estate alone was 37.5%.
At year-end, the Bank’s regulatory capital ratios included 11.08% common equity Tier 1, 11.71% total risk-based capital and 8.65% leverage; regulators classified it as well capitalized. The company paid $0.12 per share in dividends during 2015.
Material changes versus 2014
- Assets grew 64% to $1.870 billion and loans nearly doubled to $1.297 billion, reflecting the acquisitions and reported 20% organic loan growth. Deposits rose to $1.409 billion, also primarily reflecting acquired balances.
- Net interest income increased $13.4 million, supported by a larger earning-asset base and a lower cost of interest-bearing liabilities. Tax-equivalent net interest margin rose 22 basis points to 3.81%; loan yield, however, fell from 4.97% to 4.74%.
- Noninterest income rose $3.0 million, including higher mortgage-loan sale gains, deposit service charges and transaction-related income.
- Noninterest expense increased $15.8 million. The filing reports $6.4 million of merger-related costs and a $5.8 million increase in salaries and benefits, largely associated with acquired staff; headcount increased by 105.
- Despite higher net interest income and noninterest income, net income fell $0.9 million and diluted EPS fell $0.12. The allowance ratio to total loans declined to 0.69%, in part because acquired loans were recorded at fair value without a carryover allowance; the ratio to non-acquired loans was 1.08%.
- Tangible book value per share declined to $5.76 from $6.23, while reported book value per share increased to $7.35 from $6.71. Goodwill and other intangibles rose to $42.9 million following acquisitions.
Outlook, risks and unusual items
Management identified continued profitable growth, core-deposit growth, revenue diversification and integration of the acquired banks as priorities. It expected merger-related transaction volumes and associated income to benefit from a full year of activity in 2016, but provided no quantified earnings or revenue guidance. Management stated that acquisition accretion would continue over several years.
- Integration and earnings: The acquired businesses added substantial assets and operating complexity. Integration costs, realization of anticipated synergies, employee retention and acquired-asset valuations remain important uncertainties. The 2015 NBOH and Tri-State acquisitions generated approximately $29.5 million of goodwill and $5.6 million of core-deposit intangibles; some acquisition valuations were preliminary.
- Credit concentration: The portfolio has significant real-estate exposure, and management cited higher commercial real estate charge-offs and increased nonperforming loan balances in dollars. Indirect auto lending had experienced higher delinquencies, repossessions and charge-offs. The lower year-end NPL ratio partly reflects the much larger acquired portfolio.
- Liquidity and funding: Management considered liquidity more than adequate and reported no draws on its two $25 million bank lines. However, short-term borrowings rose materially, and deposits decreased during 2015 on a cash-flow basis. Deposit retention, wholesale funding access and loan growth require monitoring.
- Interest-rate risk: The company identified interest rates as its primary market risk. Its simulation showed net interest income declining 1.3% under a sudden, sustained 300-basis-point rise and 2.8% under a 100-basis-point decline; management said results were within policy limits.
- Other exposures: Risks include local economic conditions, competition, regulatory and capital changes, deposit-insurance costs, cybersecurity and operational disruptions, and possible litigation or mortgage repurchase claims. Ordinary-course legal matters were not expected by management to materially affect results overall, although an unfavorable resolution could affect a particular future period.
- Unusual acquisition-related item: The filing reports $1.3 million of expense in 2015 associated with the NAI contingent consideration clause and states that the final $1.5 million payment was made in September 2015. Verify the accounting presentation and its relationship to the reported acquisition-cost and adjusted-earnings disclosures.
The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting. Management’s and the auditor’s control assessments excluded NBOH and Tri-State, which together represented 36% of consolidated assets and 23% of 2015 net interest income.
Important facts for investors to verify
- Reconcile reported 2015 earnings with management’s acquisition-cost-adjusted net income and EPS, including the definition and treatment of acquisition-related items.
- Review the acquired loan portfolios, purchase-accounting marks, preliminary valuations, goodwill, and the basis for the allowance—especially because the reported allowance-to-loans ratio is reduced by acquired loans recorded at fair value.
- Track subsequent nonperforming loans, delinquencies, charge-offs, troubled debt restructurings and commercial real estate exposures; distinguish organic credit trends from acquisition-related denominator effects.
- Assess integration progress, realized cost savings, staff and customer retention, and whether expected revenue and acquisition accretion materialize.
- Monitor deposit trends, short-term borrowings, FHLB capacity, liquidity, regulatory capital buffers and the sustainability of dividends as the company grows.
- Confirm the exact period label and comparative figures when consulting the original filing: the filing identifies fiscal 2015, although its extracted contents page contains a 2014 label.