First National Corporation: 2019 Q3 Form 10-Q Summary
Business Context and Reporting Period
First National Corporation is a Virginia-based bank holding company for First Bank, which provides commercial, residential, consumer, deposit, and wealth management services through 14 banking offices, a loan production office, a customer service center, digital channels, and ATMs in Virginia’s Shenandoah Valley and central regions.
This unaudited Form 10-Q covers the three and nine months ended September 30, 2019, with comparisons to the corresponding 2018 periods and balance-sheet comparisons to December 31, 2018. The company reported 4,968,277 common shares outstanding as of November 8, 2019.
Financial Performance and Key Metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Net interest income | $7.1 million, versus $7.1 million | $20.9 million, versus $20.5 million |
| Net interest margin | 3.87%, versus 4.02% | 3.91%, versus 3.89% |
| Noninterest income | $2.2 million, versus $2.2 million | $6.2 million, versus $6.9 million |
| Noninterest expense | $6.2 million, versus $6.0 million | $18.5 million, versus $17.7 million |
| Provision for loan losses | None in either period | $200 thousand, versus $100 thousand |
| Net income | $2.5 million, versus $2.7 million | $6.8 million, versus $7.8 million |
| Diluted earnings per share | $0.50, versus $0.54 | $1.38, versus $1.58 |
| Return on average assets | 1.27%, versus 1.41% | 1.19%, versus 1.38% |
| Return on average equity | 13.31%, versus 16.89% | 12.85%, versus 17.17% |
| Efficiency ratio | 65.65%, versus 62.68% | 66.93%, versus 63.07% |
Quarterly net interest income was essentially unchanged because 4% growth in average earning assets was offset by a 15-basis-point decline in net interest margin. Deposit pricing increased materially, particularly for money market and time deposits. Year-to-date net interest income increased 2%, supported by loan growth and a two-basis-point improvement in net interest margin.
Balance Sheet, Cash Flow, Debt, and Liquidity
- Total assets were $777.2 million at September 30, 2019, up $24.2 million, or 3%, from December 31, 2018.
- Total loans were $571.3 million, up $28.4 million, or 5%; loans net of the allowance were $566.3 million.
- Loan growth was led by other real estate loans, up $13.5 million; 1-4 family residential loans, up $10.9 million; and commercial and industrial loans, up $6.0 million.
- Total deposits were $685.6 million, up $15.1 million, or 2%, primarily from higher noninterest-bearing demand and savings and interest-bearing deposits.
- Shareholders’ equity was $75.3 million, up $8.6 million. Accumulated other comprehensive income improved from a loss of $1.8 million to income of $1.1 million, primarily because of unrealized securities gains.
- Cash and cash equivalents increased to $30.4 million from $28.6 million at year-end. Nine-month operating cash flow was $6.9 million, compared with $10.3 million in 2018; investing cash flow was negative $18.9 million, and financing cash flow was positive $13.8 million.
- Securities totaled $134.6 million, down $10.4 million. The company purchased $3.0 million of bank-owned life insurance during the nine months.
- Subordinated debt was $5.0 million and junior subordinated debt was $9.3 million. The company had no borrowings outstanding on its $5.0 million unsecured line of credit, and the Bank had $212.4 million of unused borrowing capacity, including $138.9 million from the Federal Home Loan Bank of Atlanta.
- Management reported liquidity sufficient to meet depositor and customer borrowing needs. Liquid assets and loans maturing within one year totaled $113.6 million; 14% of loans, or $80.8 million, matured within one year.
- The Bank was classified as well capitalized. September 30 ratios included total capital to risk-weighted assets of 14.57%, Tier 1 capital of 13.71%, common equity Tier 1 capital of 13.71%, and Tier 1 leverage of 10.09%.
Material Changes Versus Prior Comparable Period
- Third-quarter net income declined $183 thousand, or 7%, primarily because of higher operating expenses and a lower net interest margin.
- Nine-month net income declined $974 thousand, or 12%, as higher noninterest expense, lower noninterest income, and a larger loan-loss provision more than offset higher net interest income.
- Nine-month noninterest income fell $667 thousand, or 10%. The primary drivers were lower bank-owned life insurance income, lower service charges, and the absence of prior-year settlement and pension-related income.
- Nine-month noninterest expense increased $834 thousand, or 5%, driven by salaries and benefits, marketing, legal and professional fees, and other operating expenses.
- Net charge-offs declined to $297 thousand for the nine months from $625 thousand in 2018. The allowance for loan losses was $4.9 million, or 0.86% of total loans, versus $5.0 million, or 0.92%, at year-end 2018.
- Nonperforming assets declined to $1.6 million, or 0.20% of total assets, from $3.2 million, or 0.42%. There was no other real estate owned at either date.
- On January 1, 2019, the company reclassified approximately $23.4 million of eligible securities from held to maturity to available for sale, recording a $431 thousand unrealized loss in accumulated other comprehensive income.
Outlook, Risks, Contingencies, and Unusual Items
The filing provides no specific earnings or revenue guidance. Management states that quarterly and year-to-date results are not necessarily indicative of full-year results.
- Key risks include economic and employment conditions, interest-rate changes, deposit pricing pressure, competition from banks and financial technology companies, real estate concentration, credit losses, nonperforming assets, liquidity and funding availability, cybersecurity, regulatory changes, and reliance on third-party providers.
- Management believes the allowance is adequate, but notes that additional provisions could be required because of economic deterioration, loan growth, changes in qualitative factors, accounting changes, or borrower-specific developments.
- At September 30, 2019, total commitments to extend credit, standby letters of credit, and rate-lock commitments were $113.4 million. Commitments to extend credit were $93.8 million, standby letters of credit were $10.4 million, and locked-rate mortgage commitments were $9.2 million.
- Other potential problem loans totaled $3.8 million, compared with $3.5 million at December 31, 2018. Troubled debt restructurings totaled $371 thousand, and none were performing under restructured terms.
- The company adopted new lease accounting in 2019, recognizing a $390 thousand right-of-use asset and lease liability at adoption; management reported no material effect on the consolidated financial statements. The September 30 operating lease liability was $296 thousand.
- The company is evaluating the future credit-loss standard, ASU 2016-13. Management states that it may materially change credit-loss accounting, but the filing does not provide a quantified impact.
- The company entered into supplemental executive retirement plans with three employees in March 2019; related contribution expense was $155 thousand for the nine months.
- There were no material pending legal proceedings, no material changes to previously disclosed risk factors, and no material changes to contractual obligations outside the ordinary course of business. Disclosure controls and internal control over financial reporting were reported effective.
Important Facts for Investors to Verify
- Whether deposit-cost increases continue to pressure net interest margin and earnings.
- The sustainability and composition of loan growth, particularly the concentration in commercial and other real estate loans.
- Future credit-loss provisions under ASU 2016-13 and whether the allowance remains adequate as the portfolio expands.
- Trends in noninterest income after the absence of prior-year bank-owned life insurance, settlement, and pension-related benefits.
- Changes in nonperforming assets, troubled debt restructurings, potential problem loans, and net charge-offs.
- The company’s decision regarding adoption of the community bank leverage ratio framework.
- Availability and terms of secondary funding sources, including the Federal Home Loan Bank facility, during stressed liquidity conditions.