First National Corporation: FY2017 Form 10-K Summary
Business Context and Reporting Period
First National Corporation is a Virginia bank holding company whose primary subsidiary, First Bank, provides commercial and consumer lending, deposits, wealth management, mortgage, payment, and related services in the Shenandoah Valley and central Virginia. The filing covers the fiscal year ended December 31, 2017, including fourth-quarter results. First Bank entered the Richmond market by opening a branch during the fourth quarter. The Bank operated 15 branches, a loan production office, and a customer service center, with 160 full-time equivalent employees at year-end.
Financial Performance and Condition
| Metric | 2017 | 2016 |
|---|---|---|
| Net interest income | $25.3 million | $23.3 million |
| Net interest margin | 3.77% | 3.61% |
| Noninterest income | $8.3 million | $8.5 million |
| Noninterest expense | $23.3 million | $23.5 million |
| Provision for loan losses | $100 thousand | None |
| Income before taxes | $10.2 million | $8.3 million |
| Net income | $6.4 million | $5.9 million |
| Diluted earnings per share | $1.30 | $1.20 |
| Return on average assets | 0.89% | 0.84% |
| Return on average equity | 11.57% | 12.00% |
| Efficiency ratio | 66.42% | 71.05% |
Fourth-quarter 2017 net income was $1.3 million, or $0.27 diluted earnings per share, compared with $1.7 million, or $0.34 per share, in fourth-quarter 2016. Fourth-quarter results included $1.5 million of income tax expense, including the effect of the Tax Cuts and Jobs Act.
| Year-end balance-sheet metric | 2017 | 2016 |
|---|---|---|
| Total assets | $739.1 million | $716.0 million |
| Loans, net | $516.9 million | $480.7 million |
| Total deposits | $665.0 million | $645.6 million |
| Securities | $139.0 million | $149.7 million |
| Shareholders’ equity | $58.2 million | $52.2 million |
| Cash and cash equivalents | $40.0 million | $41.1 million |
Net cash provided by operating activities was $6.6 million, compared with $9.0 million in 2016. Investing activities used $26.5 million, principally because of a $36.2 million increase in loans. Financing activities provided $18.9 million, primarily from increases in demand and savings deposits. Cash and cash equivalents declined by $1.1 million during 2017.
The Bank had $134.1 million of available nondeposit funding at year-end, including $82.1 million from the Federal Home Loan Bank, $42.0 million of unsecured correspondent-bank lines, and $10.0 million through the Federal Reserve Discount Window. Liquid assets, including cash, bank deposits, securities, and loans maturing within one year, totaled $103.5 million.
Subordinated debt was $4.9 million and junior subordinated debt was $9.3 million. The Company was current on interest payments. The subordinated note has a 2025 maturity and a fixed 6.75% interest rate; the junior subordinated debt has mandatory redemption dates in 2034 and 2036 and floating rates.
Material Changes Versus the Prior Comparable Period
- Net income increased $541 thousand, or 9%, driven primarily by a $2.0 million increase in net interest income and a $204 thousand reduction in noninterest expense.
- Average earning assets increased 4%, while the net interest margin expanded 16 basis points to 3.77%. Loan balances represented 74% of average earning assets, compared with 71% in 2016.
- Loans, net, increased 8%, or $36.1 million. Commercial, residential real estate, other real estate, and consumer lending all contributed to growth.
- Deposits increased $19.4 million. Noninterest-bearing demand deposits increased $12.8 million, while savings and interest-bearing deposits increased $12.4 million; time deposits declined $5.8 million.
- Noninterest income declined $201 thousand, primarily because service charges on deposit accounts fell $484 thousand. ATM and check-card fees, wealth-management fees, and bank-owned life insurance income increased.
- The allowance for loan losses was $5.3 million, or 1.02% of total loans, versus 1.09% in 2016. Net charge-offs declined to $95 thousand from $203 thousand.
- Nonperforming assets declined to $1.3 million, or 0.17% of total assets, from $1.8 million, or 0.25%. Nonaccrual loans decreased to $937 thousand, while other real estate owned increased to $326 thousand.
- Bank regulatory capital ratios remained well above minimums, although they declined modestly as the Bank paid $5.5 million of dividends to the Company. The year-end total risk-based capital ratio was 13.12%, common equity Tier 1 ratio was 12.09%, and leverage ratio was 8.46%.
Guidance, Outlook, Management Commentary, Risks and Unusual Items
The filing does not provide formal earnings or revenue guidance. Management described improving economic conditions in the Company’s Virginia markets and continued implementation of its growth strategy, including the Richmond branch. Management expects growth initiatives to increase personnel, occupancy, and other expenses and may depress earnings in the short term while new deposits are deployed into loans and other earning assets.
The Tax Cuts and Jobs Act reduced the federal corporate tax rate from 34% to 21%. The Company recorded a $752 thousand 2017 income tax charge to remeasure net deferred tax assets. The filing also reflects a $158 thousand reclassification of stranded tax effects from accumulated other comprehensive income to retained earnings.
Credit quality improved overall, but management cautioned that the allowance may prove insufficient and that future provisions could increase because of loan growth, economic conditions, real estate values, borrower performance, or regulatory review. The loan portfolio is concentrated in real estate, including commercial real estate, construction, and land-development lending.
Other significant risks include interest-rate and funding risk, intense competition for loans and deposits, dependence on dividends from the Bank, cybersecurity and third-party technology risks, regulatory and compliance costs, limited trading liquidity of the common stock, potential litigation, and the effects of future accounting and capital requirements. The current expected credit loss standard was scheduled to become effective for the Company on January 1, 2020 and could materially affect credit reserves, earnings, and capital.
At December 31, 2017, commitments to extend credit and unfunded lines totaled $78.0 million, standby letters of credit totaled $10.4 million, and locked-rate mortgage commitments totaled $2.8 million. The filing states that no material legal proceedings were pending. Management reported effective internal control over financial reporting and no material weaknesses; the independent auditor audited the financial statements but was not engaged to attest to internal controls.
Most Important Facts an Investor Should Verify
- Whether loan growth, particularly in commercial real estate, construction, and purchased consumer loans, is accompanied by stable credit quality and an adequate allowance for losses.
- The sustainability of the 3.77% net interest margin as deposit costs rise and interest rates change.
- The effect of the Richmond expansion on deposits, expenses, profitability, and operating leverage.
- The impact of the Tax Cuts and Jobs Act on recurring tax expense and deferred tax assets after the one-time $752 thousand charge.
- Liquidity availability and the Company’s reliance on Bank dividends to service parent-level debt and pay common dividends.
- The effect of the current expected credit loss standard and other future regulatory or accounting changes on capital and earnings.
- The Company’s exposure to commercial real estate, nonperforming assets, potential problem loans of $8.9 million, and unfunded commitments.
- The limited OTC trading market for the common stock and the sustainability of the $0.14 per-share 2017 dividend.