First National Corporation Form 10-K Summary
Business context and reporting period
First National Corporation is a Virginia bank holding company whose principal subsidiary, First Bank, provides commercial and consumer lending, deposit, and wealth management services through 14 branches and digital channels in Virginia. The filing covers the fiscal year ended December 31, 2020, including fourth-quarter results, and was filed March 31, 2021. The company is a non-accelerated smaller reporting company; its common stock trades on Nasdaq under FXNC.
Financial performance and condition
| Metric | 2020 | 2019 | Change |
|---|---|---|---|
| Net interest income | $29.5 million | $28.0 million | Up 5% |
| Provision for loan losses | $3.0 million | $450 thousand | Up $2.6 million |
| Noninterest income | $8.2 million | $8.6 million | Down 4% |
| Noninterest expense | $23.8 million | $24.3 million | Down 2% |
| Net income | $8.9 million | $9.6 million | Down 7% |
| Diluted EPS | $1.82 | $1.92 | Down 5% |
| Net interest margin | 3.50% | 3.88% | Down 38 basis points |
| Return on average assets | 0.98% | 1.23% | Down 25 basis points |
| Return on average equity | 10.92% | 13.19% | Down 227 basis points |
- Total assets increased 19% to $950.9 million. Net loans increased to $622.4 million, including $64.7 million of PPP loans, while securities increased to $156.3 million.
- Deposits increased 19% to $842.5 million, driven partly by PPP proceeds and government stimulus payments. Shareholders’ equity increased 10% to $84.9 million.
- Net cash provided by operating activities was $15.1 million, compared with $11.9 million in 2019. Investing activities used $70.5 million, principally from loan growth and securities purchases, while financing activities provided $136.9 million, principally from deposit growth and subordinated debt issuance. Cash and cash equivalents increased to $127.3 million.
- The company issued $5.0 million of 5.50% fixed-to-floating subordinated debt due 2030. Total subordinated debt was $10.0 million and junior subordinated debt was $9.3 million at year-end.
- Liquidity included $177.0 million of liquid assets and $237.7 million of available non-deposit funding, including $160.3 million from the Federal Home Loan Bank, $51.0 million of unsecured correspondent lines, and $26.4 million from the Federal Reserve Discount Window.
- The Bank remained well capitalized: common equity Tier 1 and Tier 1 ratios were 14.57%, total capital was 15.82%, and the Tier 1 leverage ratio was 8.80%.
Material changes versus the prior comparable period
- Profitability declined despite higher net interest income because the provision for loan losses increased substantially in response to COVID-19-related credit risks.
- Net interest income benefited from lower deposit funding costs and 16% growth in average earning assets, but asset yields declined and PPP loans carried a 1.00% rate, reducing the net interest margin.
- Noninterest income declined primarily because service charges on deposit accounts fell $898 thousand, partly offset by higher wealth management and other customer-service fees.
- Noninterest expense declined $532 thousand, partly because $535 thousand of PPP loan origination salary costs were deferred and netted against PPP loan fees.
- Asset quality weakened: nonperforming assets increased to $6.7 million from $1.5 million, impaired loans increased to $6.7 million from $1.5 million, and troubled debt restructurings increased to $6.0 million from $360 thousand.
- The allowance for loan losses increased to $7.5 million, or 1.19% of total loans, from $4.9 million, or 0.86%. Net charge-offs were $449 thousand, compared with $525 thousand in 2019.
- The company repurchased 129,035 shares for $2.1 million during 2020. The repurchase plan expired on December 31, 2020, and no replacement plan was authorized because of pandemic uncertainty.
Guidance, outlook, risks, contingencies, and unusual items
- Management did not provide formal earnings guidance. It expects continued pressure on retail, lodging, and leisure borrowers; these exposures totaled $64.6 million, or 10.27% of total loans, at year-end.
- Approximately 99% of loans in the 2020 payment-deferral program returned to regular payments; $1.2 million remained deferred at year-end. Separately, $14.3 million of commercial real estate loans were modified to interest-only payments for six to 24 months, including $12.8 million in lodging and $1.5 million in leisure.
- The Bank originated $76.6 million of 2020 PPP loans and received $2.5 million of fees, offset by $535 thousand of origination costs. The Bank originated an additional $18.9 million under the renewed PPP through February 28, 2021.
- On February 18, 2021, the company agreed to acquire The Bank of Fincastle for approximately $31.6 million in cash and stock. The transaction is expected to close in the third quarter of 2021, subject to shareholder and regulatory approvals. Expected 2021 merger-related costs are approximately $4.2 million pretax, and approximately 1.3 million shares are expected to be issued.
- Management expects the Fincastle transaction to increase the combined company to approximately $1.2 billion of assets, $868.0 million of gross loans, and $1.0 billion of deposits based on December 31, 2020 balances. Integration and goodwill could reduce regulatory capital ratios.
- Key risks include further COVID-19-related credit deterioration, concentration in commercial and other real estate loans, interest-rate and net-interest-margin pressure, deposit outflows, liquidity access, cybersecurity and third-party service disruptions, regulatory changes, and the transition away from LIBOR.
- The company has $114.9 million of commitments to extend credit and unfunded lines, $10.7 million of standby letters of credit, and $10.4 million of locked-rate mortgage commitments. It also has $9.0 million of interest-rate swaps hedging junior subordinated debt.
- Management reported effective disclosure controls and internal control over financial reporting, with no material weaknesses. The independent auditor issued an unqualified opinion; the allowance for loan losses and related qualitative factors were identified as the critical audit matter.
Most important facts an investor should verify
- Whether COVID-19 modifications, particularly the $14.3 million of interest-only commercial real estate loans, lead to additional nonaccrual loans, charge-offs, or provisions.
- The collectability and forgiveness status of PPP loans and the timing of recognition of remaining net PPP fees.
- Execution, regulatory approval, funding, dilution, goodwill, capital impact, and actual cost of the Fincastle acquisition.
- Future deposit trends, liquidity utilization, funding costs, and compliance with well-capitalized requirements.
- The adequacy of the $7.5 million allowance for loan losses under continuing pandemic effects and the future adoption of the current expected credit loss standard.
- The company’s dividend capacity, given reliance on Bank dividends and contractual restrictions associated with subordinated and junior subordinated debt.