First National Corporation 2014 Form 10-K Summary
Business context and reporting period
First National Corporation is a Virginia bank holding company whose principal subsidiary, First Bank, provides lending, deposits, wealth management, mortgage, and related financial services in Virginia’s Shenandoah Valley. The filing covers the fiscal year ended December 31, 2014; the filing was signed March 27, 2015. The company operated 10 branches, one customer service center, two loan-production offices, and 25 ATMs, with 156 full-time-equivalent employees.
First Mortgage launched in the second quarter of 2014 and began originating residential mortgage loans in the third quarter. A pending acquisition of six Bank of America branch locations was expected to close in the second quarter of 2015.
Key financial metrics
| Metric | 2014 | 2013 | Change |
|---|---|---|---|
| Net income | $7.6 million | $9.9 million | Down 23% |
| Net income available to common shareholders | $6.5 million | $9.0 million | Down 28% |
| Basic and diluted EPS | $1.32 | $1.83 | Down $0.51 |
| Net interest income | $18.6 million | $18.4 million | Up 1% |
| Net interest margin | 3.86% | 3.72% | Up 14 basis points |
| Noninterest income | $7.4 million | $6.9 million | Up 7% |
| Noninterest expense | $18.8 million | $20.8 million | Down 9% |
| Return on average assets | 1.45% | 1.85% | Down 40 basis points |
| Return on average equity | 13.49% | 21.87% | Down 838 basis points |
| Efficiency ratio | 74.03% | 74.86% | Improved |
Income before taxes was $11.1 million versus $5.1 million in 2013. The 2013 result benefited from a $4.8 million favorable tax impact from eliminating the valuation allowance on deferred tax assets; 2014 included a $3.5 million tax provision.
| Balance-sheet metric | December 31, 2014 | December 31, 2013 |
|---|---|---|
| Total assets | $518.2 million | $522.9 million |
| Gross loans | $378.4 million | $357.1 million |
| Loans, net | $371.7 million | $346.4 million |
| Securities | $83.3 million | $103.3 million |
| Total deposits | $444.3 million | $450.7 million |
| Shareholders’ equity | $59.6 million | $53.6 million |
| Cash and cash equivalents | $24.8 million | $31.5 million |
Operating cash flow was $7.0 million, compared with $8.7 million in 2013. Investing activities provided $55 thousand, primarily reflecting securities sales and loan growth. Financing activities used $13.7 million, including reductions in time deposits and borrowings, common dividends, and preferred dividends. Total cash decreased by $6.7 million during 2014.
At year-end, the company had $9.3 million of trust preferred capital notes and only $26 thousand of other borrowings. Available non-deposit funding totaled $88.7 million, including $42.9 million from the Federal Home Loan Bank, $41.9 million of unsecured federal funds lines, and $3.9 million through the Federal Reserve Discount Window.
Material changes versus the prior comparable period
- Loan balances increased 6% to $378.4 million, driven by improved demand, employee efforts, and fewer loan payoffs.
- Deposits declined modestly, but noninterest-bearing demand deposits increased 13% to $105.0 million; time deposits declined 18% to $101.7 million.
- The allowance for loan losses declined to $6.7 million, or 1.77% of loans, from $10.6 million, or 2.98%. The company recorded a $3.9 million recovery of loan losses versus a $425 thousand recovery in 2013.
- Net charge-offs fell sharply to $76 thousand from $2.0 million, while nonperforming assets declined to $9.9 million, or 1.91% of assets, from $14.7 million, or 2.81%.
- Noninterest expense benefited from lower OREO costs, FDIC assessments, property-disposal losses, and lease-termination losses. Excluding unusual categories, management stated that pretax income was approximately $6.8 million in both years.
- The securities portfolio decreased 19% to $83.3 million as funds were redeployed toward loans. The company recognized $696 thousand of net securities gains in 2014.
- Common dividends resumed in the second quarter of 2014 at $0.025 per share quarterly, for $0.075 per share for the year. Preferred dividends remained current.
Outlook, commentary, risks, and unusual items
Management stated that local economic conditions improved during 2014 and expected growth from the new mortgage division, additional loan-production offices, and the planned branch acquisition. The acquisition was expected to add approximately $308 million of deposits, $1.7 million of premises and equipment, and bring total assets to approximately $750 million after closing. The bank agreed to pay a deposit premium of 2.25% at closing.
Management believed liquidity was sufficient to meet depositor requirements and customer borrowing needs and believed the company and bank had adequate capital. At December 31, 2014, the company’s total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios were 19.93%, 18.67%, and 13.47%; the bank’s corresponding ratios were 19.14%, 17.88%, and 12.90%. The bank was categorized as well capitalized.
- Principal credit risks are concentrations in residential and commercial real estate, construction and land-development loans, and lending to small and medium-sized businesses in a geographically concentrated market.
- Future loan losses could exceed the allowance, particularly if real estate values or local economic conditions deteriorate.
- Mortgage income is cyclical and sensitive to interest rates, housing activity, underwriting requirements, and potential repurchase or settlement obligations on loans sold to investors.
- Net interest income remains exposed to changes in interest rates, deposit pricing, loan yields, competition, and the shape of the yield curve.
- The company faces competition from larger banks, regional institutions, credit unions, mortgage companies, and alternative financial-service providers.
- Cybersecurity, technology, third-party service-provider, operational, regulatory, litigation, reputation, and key-person risks could adversely affect earnings and liquidity.
- Basel III capital requirements began taking effect January 1, 2015. Management expected the company and bank to remain above well-capitalized requirements.
- Common dividends are subordinate to preferred dividends and trust-preferred interest and remain subject to regulatory, capital, liquidity, and earnings constraints.
- The filing reports no material pending legal proceedings, no unresolved SEC staff comments, and no material weakness in internal control over financial reporting.
Unusual or nonrecurring items included the large loan-loss recovery, $696 thousand of securities gains, lower OREO costs, and the absence of 2013 losses on property disposal and lease termination. The 2013 results also included a $543 thousand gain from terminating a post-retirement benefit and the $4.8 million deferred-tax valuation allowance reversal.
Most important facts an investor should verify
- Whether the planned six-branch acquisition closed on the expected timetable and whether the projected $750 million asset base and $308 million deposit addition were achieved.
- Whether the reduced allowance for loan losses remains adequate as the loan portfolio grows and as real-estate and construction exposures evolve.
- The sustainability of earnings excluding the 2014 loan-loss recovery and securities gains and excluding the 2013 tax benefit.
- Mortgage division origination volumes, gain-on-sale income, secondary-market execution, and any investor repurchase or indemnification exposure.
- Deposit trends, funding availability, interest-rate sensitivity, and the effect of Basel III implementation on capital ratios.
- The company’s ability to maintain common dividends while servicing preferred stock and trust-preferred obligations.
- The limited liquidity of the OTC-traded common stock and the potential dilution or funding effects of future acquisition-related share issuance.