Farmers National Banc Corp. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; balance sheet compared with December 31, 2022. Income and cash flow comparisons are against Q1 2022. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Business context and results
Farmers provides banking and trust services, primarily in northeastern Ohio and western Pennsylvania. Results and balance-sheet growth were materially affected by the January 1, 2023 acquisition of Emclaire Financial Corp., which expanded the company into additional Pennsylvania markets.
| Metric | Q1 2023 | Q1 2022 / prior balance |
|---|---|---|
| Net interest income | $36.6 million | $31.2 million |
| Net interest margin | 3.07% | 3.27% |
| Noninterest income | $10.4 million | $17.7 million |
| Noninterest expense | $30.7 million | $30.5 million |
| Provision for credit losses and unfunded loans | $8.6 million | Credit of $0.4 million |
| Net income / diluted EPS | $7.1 million / $0.19 | $15.8 million / $0.47 |
| Total assets | $5.11 billion | $4.08 billion at Dec. 31, 2022 |
| Loans, net | $3.12 billion | $2.38 billion at Dec. 31, 2022 |
| Total deposits | $4.40 billion | $3.56 billion at Dec. 31, 2022 |
| Cash and cash equivalents | $128.0 million | $75.6 million at Dec. 31, 2022 |
| Short-term / long-term borrowings | $204.0 million / $88.3 million | $95.0 million / $88.2 million at Dec. 31, 2022 |
Material changes and financial position
- Net interest income rose 17% year over year, principally due to a larger earning-asset base after the acquisition. Net interest margin nevertheless fell 20 basis points: asset yields increased 80 basis points while the cost of interest-bearing liabilities rose 134 basis points amid deposit competition, higher rates and greater use of wholesale funding.
- Net income declined 55%. Q1 2023 included $4.3 million of merger costs and approximately $7.7 million of acquisition-related Day 1 credit-loss provisions. Q1 2022 included an $8.4 million legal settlement gain and a $6.0 million charitable contribution; these nonrecurring items affect the comparison.
- Noninterest income declined mainly because the prior-year legal settlement did not recur. Mortgage loan-sale gains also decreased, from $1.1 million to $0.3 million, which management attributed to lower mortgage production as rates rose.
- The Emclaire merger consideration was approximately $92.6 million, including $33.4 million cash and $59.2 million in stock. It added approximately $740.7 million of loans and $875.8 million of deposits; acquisition accounting recorded $73.4 million of goodwill. Certain acquired-asset valuations remain preliminary, with completion expected by December 31, 2023.
- Cash from operating activities was $13.7 million, versus $13.2 million in Q1 2022. Investing activities provided $64.1 million, including $69.9 million of securities-sale proceeds, and financing activities used $25.4 million. Cash increased $52.5 million during the quarter; management said it intentionally held more cash amid banking-sector turmoil.
- Stockholders’ equity was $374.6 million, up from $292.3 million, mainly reflecting acquisition shares and a $33.8 million improvement in accumulated other comprehensive loss. The company repurchased 850,799 shares under publicly announced programs for approximately $11.5 million and paid $0.17 per share in dividends.
Credit, liquidity, capital and risks
- The allowance for credit losses was $36.0 million, or 1.14% of loans, compared with $27.0 million, or 1.12%, at year-end. Nonperforming loans were 0.57% of loans; annualized net charge-offs were 0.03%. Management considered the allowance adequate, while noting estimates may change with economic conditions.
- Available-for-sale securities had fair value of $1.36 billion and gross unrealized losses of $227.5 million at quarter-end. Management attributed losses to noncredit factors, principally interest rates and market conditions, and reported no credit-loss allowance on these securities. The company stated it had the ability and intent to hold them long enough to allow for recovery.
- Deposits increased mainly due to the acquisition, while the quarter’s cash-flow statement showed a $41.4 million net decrease in deposits. Short-term FHLB advances increased to $204.0 million; the Bank reported approximately $656.1 million of additional FHLB borrowing capacity, plus other available lines and the Federal Reserve discount window. Management described liquidity as adequate.
- The Bank was categorized as well capitalized. At March 31, consolidated common equity tier 1, total risk-based capital, tier 1 risk-based capital and tier 1 leverage ratios were 10.04%, 13.60%, 10.54% and 7.43%, respectively.
- Interest-rate simulations showed a 9.1% decline in net interest income and a 30.6% decline in economic value of equity under a 400-basis-point increase. Management said the EVE result exceeded policy limits and described actions including prioritizing loan growth and shrinking the investment portfolio.
- No specific earnings or financial guidance was provided. Forward-looking risks include economic and credit conditions, interest rates, deposit competition and funding availability, banking-industry instability, regulation, competition and employee retention. The company disclosed a pending class-action lawsuit concerning certain overdraft/NSF fees; it could not determine whether an adverse result was reasonably possible or estimate any loss.
Important facts for investors to verify
- Whether Emclaire integration, expected synergies and preliminary purchase-accounting valuations develop as management anticipates, and how recurring merger-related costs evolve.
- Deposit trends excluding acquired balances, deposit pricing and mix, and reliance on FHLB or other wholesale funding.
- Net interest margin sensitivity to further rate changes and the implications of the disclosed EVE policy-limit exceedance.
- Credit performance of acquired loans, future allowance needs, and the duration and potential effects of unrealized securities losses.
- Updates on the overdraft/NSF-fee litigation and any resulting contingency or financial impact.