Auburn National Bancorporation, Inc. — Q2 2017 Form 10-Q
Business context and period: The company provides banking services through AuburnBank, primarily in East Alabama. This unaudited filing covers the quarter and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods unless noted. Dollar figures below are in millions unless otherwise stated.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Total revenue | $6.894 | $6.685 | $13.619 | $13.216 |
| Net interest income, GAAP | $6.101 | $5.692 | $11.990 | $11.389 |
| Net earnings | $1.995 | $1.931 | $3.885 | $4.122 |
| Basic and diluted EPS | $0.55 | $0.53 | $1.07 | $1.13 |
| Net interest margin, tax-equivalent | 3.28% | 3.10% | 3.23% | 3.11% |
| Efficiency ratio | 55.80% | 57.39% | 57.19% | 58.66% |
- Q2 net earnings rose about 3% year over year; first-half net earnings declined about 6%. First-half returns on average assets and equity were 0.93% and 9.26%, respectively, versus 1.00% and 9.99% in 2016.
- Net interest income improved as securities income increased, funding costs fell, and higher-cost wholesale funding was repaid. First-half tax-equivalent net interest income was $12.591 million versus $12.033 million.
- Noninterest income declined to $0.793 million in Q2 and $1.629 million in the first half, mainly because of lower mortgage lending income as mortgage production fell. Noninterest expense was broadly unchanged: $4.015 million for Q2 and $8.133 million for the half.
- The loan-loss provision was $0.100 million in both Q2 and the first half of 2017. The first half of 2016 included a $0.600 million provision credit, chiefly reflecting a $1.2 million recovery on a nonperforming construction loan.
- Six-month operating cash flow was $3.692 million versus $4.405 million. Investing activities used $40.410 million, largely reflecting $51.334 million of securities purchases; cash and cash equivalents fell $34.978 million to $86.299 million.
- At June 30, total assets were $836.311 million, loans net of allowance were $432.322 million, and securities available-for-sale were $277.363 million. Loans net of unearned income grew 1% from year-end 2016; securities rose 14%.
- Deposits were $742.456 million, up from $739.143 million at year-end. Long-term debt was $3.217 million, consisting of junior subordinated debentures; repurchase-agreement borrowings were $3.469 million. No federal funds lines were drawn.
- Stockholders’ equity was $85.099 million. The company reported a 10.56% Tier 1 leverage ratio, 16.22% CET1 ratio, 16.79% Tier 1 risk-based ratio, and 17.77% total risk-based ratio; management stated capital exceeded well-capitalized requirements.
Material changes and credit quality
- The allowance for loan losses increased to $4.965 million, or 1.14% of loans, from $4.643 million, or 1.08%, at year-end. Q2 included net recoveries of $0.277 million.
- Nonperforming assets were $2.358 million, or 0.54% of loans and other real estate owned, down from $2.522 million at year-end. Nonaccrual loans were $2.255 million. Accruing loans at least 90 days past due totaled $42,000.
- Potential problem loans increased to $6.936 million, or 1.6% of loans, from $5.843 million at year-end. Real estate-secured loans represented approximately 86.2% of the loan portfolio, including commercial real estate equal to about 51% of loans.
- Management refined its allowance methodology by extending the historical loss look-back period to 33 quarters and widening the permitted qualitative-factor adjustment range. It estimated that without the methodology changes, the calculated allowance at year-end 2016 would have been about $0.9 million lower.
- Available-for-sale securities had $2.551 million of gross unrealized losses. Management attributed these primarily to interest-rate changes, stated it did not intend to sell and was not likely to be required to sell before recovery, and reported no credit-impaired debt securities.
Outlook, risks, and contingencies
- Management expected 2017 net interest income to increase from 2016, based on anticipated growth in average earning assets, asset mix, and the possibility that asset yields would rise faster than funding costs. It cautioned that competition, low rates, and rising funding costs could pressure margins.
- Management expected mortgage lending income and volume to decline until plans to increase production capacity are implemented.
- Key risks include local and broader economic conditions, borrower credit quality, real estate values and concentrations, interest-rate movements, competition, regulatory and accounting changes, liquidity, cybersecurity, and uncertainty in allowance and fair-value estimates. The filing provides no earnings-per-share or other numerical full-year guidance.
- At June 30, the Bank had $65.4 million of unfunded loan commitments and $7.4 million of standby letters of credit. Available liquidity included a $249.7 million FHLB line and $41.0 million of federal funds lines; management believed liquidity was adequate for known obligations and reasonable needs over the next 12 months.
- The company repurchased three mortgage loans totaling $0.6 million during the first half under investor representation-and-warranty provisions; the loans were current when repurchased, and no requests were pending at quarter-end. Management did not consider the exposure material, noting 99% of serviced Fannie Mae loans were current.
- Management reported no material subsequent events, no material pending or threatened legal proceedings, and effective disclosure controls. Forward-looking statements are subject to the risks described in the filing.
Important facts for investors to verify
- Whether loan growth and securities reinvestment continue to support net interest income and margin as rates and competition change.
- Trends in mortgage originations, production-capacity plans, and mortgage-related income.
- Whether the rise in potential problem loans leads to higher nonperforming loans, charge-offs, or allowance needs; review real estate concentration and allowance assumptions.
- Deposit mix, funding costs, securities liquidity, and the availability and terms of contingent borrowing facilities.
- Future mortgage repurchase or make-whole requests, and the impact of upcoming accounting standards, particularly the expected-credit-loss standard.