First National Corporation — 2019 Q2 Form 10-Q Summary
Business context and reporting period
First National Corporation is a Virginia bank holding company for First Bank, which provides commercial, residential, consumer, deposit, and wealth management services through 14 branches, a loan production office, a customer service center, digital banking, and ATMs in Virginia. This unaudited report covers the three and six months ended June 30, 2019, with comparisons to the same 2018 periods and to December 31, 2018.
Financial condition and key metrics
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net interest income | $7.0 million, up 2% | $13.9 million, up 4% |
| Provision for loan losses | $0.2 million, versus none | $0.2 million, versus $0.1 million |
| Noninterest income | $2.0 million, down 2% | $4.0 million, down 14% |
| Noninterest expense | $6.2 million, up 6% | $12.3 million, up 5% |
| Net income | $2.1 million, down 15%; diluted EPS $0.42 | $4.3 million, down 15%; diluted EPS $0.88 |
| Net interest margin | 3.88%, versus 3.86% | 3.93%, versus 3.83% |
| Efficiency ratio | 67.94%, versus 64.17% | 67.59%, versus 63.27% |
| Return on average assets | 1.08%, versus 1.29% | 1.14%, versus 1.37% |
| Return on average equity | 11.76%, versus 16.23% | 12.60%, versus 17.33% |
All dollar amounts in the table are as reported; financial statement amounts are generally in thousands.
- Total assets were $778.4 million at June 30, 2019, up $25.4 million, or 3%, from year-end 2018.
- Net loans increased $32.1 million to $570.0 million. Total loans grew primarily in commercial real estate, residential real estate, and commercial and industrial lending.
- Total deposits increased $19.2 million to $689.8 million, led by a $16.0 million increase in savings and interest-bearing demand deposits and a $4.6 million increase in noninterest-bearing demand deposits.
- Shareholders’ equity rose $6.1 million to $72.8 million, helped by earnings and a $2.6 million improvement in accumulated other comprehensive income from securities valuation changes.
- The allowance for loan losses was $5.0 million, or 0.87% of total loans, compared with 0.92% at December 31, 2018.
- Nonperforming assets were $1.8 million, or 0.23% of total assets, compared with $3.2 million, or 0.42%, at year-end 2018. There was no other real estate owned balance.
- Six-month operating cash flow was $4.2 million, compared with $5.8 million in 2018. Investing activities used $28.2 million, primarily because of $32.3 million of net loan growth. Financing activities provided $18.4 million, primarily from deposit growth.
- Cash and cash equivalents declined to $23.1 million from $28.6 million at year-end 2018.
- The Company had $4.97 million of subordinated debt and $9.28 million of junior subordinated debt. It had no outstanding borrowings under its $5.0 million unsecured line of credit or its Federal Home Loan Bank line.
- Available non-deposit funding totaled $164.7 million, including $99.1 million from the Federal Home Loan Bank, $53.0 million of correspondent-bank federal funds lines, and $12.6 million through the Federal Reserve Discount Window.
- First Bank remained well capitalized, with total risk-based capital of 14.24%, common equity Tier 1 capital of 13.37%, and Tier 1 leverage capital of 9.96% at June 30, 2019.
Material changes versus comparable periods
- Profitability weakened despite higher net interest income. Second-quarter and year-to-date net income each fell approximately 15%, primarily because of higher loan-loss provisions, lower noninterest income, and higher operating expenses.
- Net interest income benefited from loan growth, higher earning-asset yields, and improved net interest margins. These benefits were partly offset by higher deposit funding costs as competition and market rates increased.
- Noninterest income declined because of lower overdraft-related service charges and the absence of prior-year benefits, including life insurance proceeds, pension-plan distribution income, and a brokerage settlement-related payment. Wealth management fees increased.
- Noninterest expense increased due to higher salaries and benefits, marketing, occupancy, legal and professional fees, and other operating costs. The Company also incurred expenses related to strategic initiatives, branch consolidation, Nasdaq listing, compliance testing, and accounting-standard implementation.
- Credit quality improved on several measures: nonperforming assets, impaired loans, past-due loans, and net charge-offs were lower than in the prior comparable periods. However, loan growth and higher historical loss rates drove a $200 thousand provision in the second quarter.
- On January 1, 2019, the Company reclassified eligible held-to-maturity securities with amortized cost of $23.4 million and fair value of approximately $23.0 million to available-for-sale securities under updated hedging guidance.
Outlook, risks, contingencies, and unusual items
- No quantitative earnings or revenue guidance was provided. Management stated that interim results are not necessarily indicative of full-year 2019 results.
- The Company adopted the new lease standard in 2019, recognizing a right-of-use asset and lease liability of approximately $390 thousand at adoption; management reported no material overall effect. The June 30 balances were $329 thousand and $328 thousand, respectively.
- The Company is preparing for ASU 2016-13, the current expected credit loss standard. Management stated that adoption may materially change credit-loss accounting and is testing models, validating data, and assessing effects on capital and strategic plans.
- Loans are concentrated in real estate, exposing results to changes in local property values, construction conditions, borrower cash flows, and the broader economy. Management identified interest-rate changes, deposit competition, credit losses, liquidity, regulatory changes, cybersecurity, operational disruptions, litigation, and FDIC insurance costs as key risks.
- Off-balance-sheet commitments totaled $111.4 million, comprising $94.7 million of commitments to extend credit, $10.4 million of standby letters of credit, and $6.3 million of locked-rate mortgage commitments.
- At June 30, 2019, troubled debt restructurings totaled $381 thousand, and none were performing under the restructured terms. Formal foreclosure proceedings covered $149 thousand of residential mortgage loans.
- Management reported no material pending legal proceedings, no material changes to previously disclosed risk factors, effective disclosure controls, and no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether continued loan growth, particularly in commercial real estate, increases future provisions, charge-offs, or capital requirements.
- The sustainability of the improved net interest margin as deposit costs rise and interest rates change.
- The recurring level of noninterest income after the absence of prior-year life insurance, pension, and settlement-related items.
- The effect and implementation timing of the expected credit loss standard on reserves, earnings, capital, and strategic plans.
- The composition and performance of the $2.8 million of potential problem loans and the $381 thousand of nonperforming troubled debt restructurings.
- Liquidity and funding capacity as cash declined while loans expanded, including the availability and collateral requirements of the $164.7 million in non-deposit funding.
- The effect of higher operating expenses and the 67.59% year-to-date efficiency ratio on future profitability.