First National Corporation (NASDAQ: FXNC) — Q1 2020 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, mortgage, and wealth management services through 14 branches and digital channels in Virginia. The unaudited filing covers the three months ended March 31, 2020, with comparisons to the three months ended March 31, 2019 and the December 31, 2019 balance sheet. The quarter was materially affected by the emerging COVID-19 pandemic.
Key financial metrics
| Metric | Q1 2020 | Comparable period / change |
|---|---|---|
| Total interest and dividend income | $8.2 million | $8.0 million in Q1 2019 |
| Net interest income | $7.0 million | Up 2% from $6.9 million |
| Provision for loan losses | $0.9 million | None in Q1 2019 |
| Noninterest income | $2.1 million | Up 6% from $2.0 million |
| Noninterest expense | $6.1 million | Up 1% from $6.1 million |
| Income before taxes | $2.1 million | Down from $2.8 million |
| Net income | $1.7 million | Down 25% from $2.3 million |
| Basic and diluted EPS | $0.34 | Down from $0.46 |
| Net interest margin | 3.77% | Down 20 basis points from 3.97% |
| Efficiency ratio | 66.50% | Improved from 67.23% |
| Return on average assets | 0.85% | Down from 1.21% |
| Return on average equity | 8.72% | Down from 13.47% |
| Net cash provided by operating activities | $3.4 million | $3.1 million in Q1 2019 |
At March 31, 2020, total assets were $816.4 million, up 2% from December 31, 2019. Net loans were $576.3 million, up 1%, and total deposits were $720.6 million, up 2%. Shareholders’ equity was $78.5 million, up 2%. Cash and cash equivalents ended at $48.1 million, compared with $45.8 million at year-end 2019.
The allowance for loan losses was $5.6 million, or 0.96% of total loans, compared with $4.9 million, or 0.86%, at December 31, 2019. Net charge-offs were $250 thousand, compared with $63 thousand in Q1 2019. Nonaccrual loans were $1.5 million, and nonperforming assets were approximately 0.19% of total assets. The investment portfolio totaled $147.6 million and was entirely investment grade.
Debt consisted of approximately $5.0 million of subordinated debt and $9.3 million of junior subordinated debt. The Company had no borrowings outstanding under its $5.0 million unsecured line of credit, and the Bank had $237.9 million of unused borrowing capacity, including $146.7 million from the Federal Home Loan Bank of Atlanta.
The Bank remained well capitalized at March 31, 2020. Regulatory ratios included total capital to risk-weighted assets of 14.98%, Tier 1 capital of 14.02%, common equity Tier 1 capital of 14.02%, and Tier 1 leverage of 10.08%.
Material changes versus the prior comparable period
- Net income declined $556 thousand, primarily because of the $900 thousand COVID-related provision for loan losses and higher operating expenses.
- Net interest income increased $127 thousand despite a 20-basis-point decline in net interest margin, as average earning assets increased 6% and average loans increased approximately $30.2 million.
- Noninterest income increased $114 thousand, led by higher wealth management fees and fees for other customer services.
- Noninterest expense increased $46 thousand, mainly from higher salaries and employee benefits.
- The allowance for loan losses increased $650 thousand from year-end 2019. Approximately $700 thousand of the quarterly provision reflected qualitative reserve adjustments related to worsening economic indicators.
- Loans, deposits, and assets increased from year-end, while time deposits declined $2.2 million.
- The Company repurchased 129,035 shares for $2.1 million at an average price of $16.05 per share before suspending future repurchases in March because of pandemic-related uncertainty.
- Accumulated other comprehensive income increased to $2.8 million from $724 thousand, primarily from unrealized gains on available-for-sale securities.
Guidance, outlook, risks, contingencies, and unusual items
The filing provides no formal earnings or revenue guidance. Management stated that Q1 results are not necessarily indicative of full-year 2020 performance and could not quantify the ultimate effects of COVID-19.
- As of April 30, 2020, the Company had executed 464 payment deferrals on $171.0 million of outstanding loans. The filing separately states that approximately 22% or 27% of loan balances were included in the deferral program; this discrepancy should be reconciled.
- As of April 30, 2020, the Bank had closed or obtained SBA approval for 575 PPP loans totaling $74.9 million. Management expected total PPP originations of as much as $80.0 million. First-round applications were expected to generate approximately $1.6 million of origination fee income, recognized over the loan lives.
- Management expects elevated credit pressure in hospitality, retail/shopping, and health care. These sectors represented approximately $45.0 million, $26.6 million, and $23.2 million of loans, respectively, or 16.29% combined of total loans.
- Future net interest income may be reduced by nonaccrual loans, reversals of accrued interest, lower loan demand, and the shift toward lower-yielding securities or bank deposits.
- Future noninterest income may be affected by suspended overdraft fees, reduced customer spending and ATM activity, lower wealth management asset values, and weaker mortgage activity.
- Future expenses may increase from collateral appraisals, loan workouts, legal and professional fees, and other credit-related activities.
- Management believes liquidity is sufficient, citing $133.4 million of cash and unencumbered securities and $176.9 million of overnight secured funding availability at March 31, 2020. Wholesale funding costs and deposit withdrawals remain risks.
- On April 21, 2020, the Company entered into two cash-flow-hedging interest-rate swaps with total notional value of $9.0 million, converting junior subordinated debt from floating to fixed rates of 0.79% and 0.82%.
- The Company invoked its pandemic continuity plan, including remote work and modified branch operations. Management reported no material control or business-continuity issues as of the filing date.
- Commitments to extend credit, standby letters of credit, and mortgage rate-lock commitments totaled approximately $105.9 million at March 31, 2020.
- The Company is assessing the future impact of the current expected credit loss standard, which could materially change credit-loss accounting when adopted.
Most important facts for investors to verify
- Whether loan deferrals convert into higher delinquency, nonaccrual loans, charge-offs, or additional reserve provisions after the deferral periods end.
- The reconciliation between the reported 22% and 27% loan-deferral percentages and the $171.0 million of deferrals reported as of April 30, 2020.
- Actual PPP loan volume, fee income, forgiveness rates, SBA reimbursement timing, and any associated credit or legal exposure.
- Whether the $5.6 million allowance for loan losses adequately reflects COVID-19 exposure, particularly in hospitality, retail, health care, and commercial real estate.
- Trends in net interest margin, loan demand, deposit costs, and noninterest income following the rapid decline in market interest rates.
- Liquidity utilization, deposit stability, borrowing costs, and pledged collateral as the pandemic develops.
- The impact of the April 2020 interest-rate swaps, LIBOR transition, and future derivative fair-value changes on earnings and accumulated other comprehensive income.