OHIO VALLEY BANC CORP quarterly report, Q2 FY2014

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Ohio Valley Banc Corp. — Q2 2014 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2014. Financial statements are unaudited. Unless stated otherwise, dollar amounts are in thousands.

Business context and reporting period

Ohio Valley Banc Corp. provides commercial and retail banking, consumer finance, and related services primarily in southeastern Ohio and western West Virginia. Banking generated 88.6% of consolidated revenue in Q2 2014. The filing cautions that first-half results are not necessarily indicative of full-year results.

Financial results and condition

  • Q2 earnings: Net income was $1,344, down 30.8% from $1,942 a year earlier; diluted and basic earnings per share were $0.33 versus $0.48.
  • First-half earnings: Net income was $4,908, down 5.0% from $5,165; earnings per share were $1.20 versus $1.27.
  • Net interest income and margin: Q2 net interest income increased 4.4% to $8,187; first-half net interest income increased 4.3% to $16,969. Net interest margin was 4.46% for Q2 and 4.49% for the first half, compared with 4.33% and 4.37%, respectively, in 2013.
  • Credit costs: Provision for loan losses was $1,386 in Q2 and $1,880 in the first half, versus provision reversals of $189 and $158 in the comparable 2013 periods. First-half net charge-offs were $107, compared with $279 in 2013.
  • Other income and expenses: Q2 noninterest income declined 2.7% to $1,912; first-half noninterest income increased 2.1% to $6,030. Noninterest expense declined 4.4% in Q2 to $6,997 and 6.4% in the first half to $14,292.
  • Margins and returns: Reported annualized return on assets was 1.20%, versus 1.28% at June 30, 2013; return on equity was 12.03%, versus 13.45%.
  • Balance sheet: Total assets were $763,813, up 2.2% from year-end 2013. Gross loans grew 3.8% to $587,918; deposits grew 1.4% to $637,657. Shareholders’ equity increased 4.9% to $84,373.
  • Credit quality: Allowance for loan losses rose 28.8% from year-end to $7,928, or 1.35% of loans (1.09% at year-end). Nonperforming loans were 0.63% of loans; nonperforming assets were 0.71% of assets. Impaired loans increased 24.3% from year-end. Total TDRs rose 30.5% to $16,445; 98% were performing to modified terms.
  • Cash flow and liquidity: First-half operating cash flow was $6,606, compared with $7,212 in 2013. Cash and cash equivalents declined $5,700 to $22,644, largely as seasonal tax-processing funds were deployed to support loan growth and certificate maturities. Cash, specified securities and short-term securities totaled $108,524, or 14.2% of assets. Additional stated borrowing availability was $154,920 at the FHLB and $40,495 at the Federal Reserve.
  • Debt and capital: Other borrowed funds were $21,901, up from $18,748 at year-end; subordinated debentures were $8,500. Regulatory capital ratios were 15.6% Tier 1 risk-based, 16.9% total risk-based and 11.4% leverage, all above stated minimums. First-half dividends were $0.42 per share.

Material changes versus comparable periods

  • Despite improved net interest income and lower expenses, earnings fell as the loan-loss provision shifted from a 2013 reversal to substantial expense in 2014.
  • Management cited two impaired commercial credits totaling $12,000 that were downgraded in Q2 as a key factor in increased classified assets and general loan-loss reserves. Classified commercial loans rose to $20,805 from $10,957 at year-end; criticized loans declined to $8,227 from $16,498.
  • Loan growth was led by commercial and industrial loans, up 21.8% from year-end. Commercial real estate loans increased 4.2%, while residential real estate loans declined 0.6%.
  • Deposit balances increased, including seasonal tax-processing balances and public funds; time deposits decreased $4,123 as the company emphasized lower-cost core deposits.
  • The first-half 2013 comparison included $452 of income from settlement of two bank-owned life insurance policies and a $212 trust-preferred redemption fee. These items did not recur in 2014. First-half 2014 included a $135 ProAlliance-related gain.

Outlook, commentary, risks and unusual items

  • No specific earnings or financial guidance was provided. Management said it would pursue commercial lending while maintaining underwriting discipline, grow and retain core deposits, and redeploy excess low-yielding cash into higher-yielding assets as opportunities arise.
  • Management expects seasonal ERC/ERD tax-processing income to be concentrated in the first half, with minimal income expected in the second half. Management also expected the lower Ohio financial-institutions tax expense to continue for the remainder of 2014.
  • Management considered the allowance adequate but noted that borrower circumstances and economic conditions could require future adjustments. It identified loan quality and underwriting as continuing priorities.
  • Interest-rate modeling showed a liability-sensitive position: modeled net interest income declined 0.76%, 1.71% and 2.85% under +100, +200 and +300 basis-point shocks, respectively, and declined 2.71% under a -100 basis-point shock. Management said results were within board limits.
  • Key risks include changes in economic conditions, competition, interest rates, loan defaults and prepayments, funding costs, litigation and regulatory changes. The filing reports no applicable legal proceedings and no material change in internal control over financial reporting.
  • After quarter-end, the company received $675 on August 1 related to the sale of its 9% ProAlliance interest. Together with the $135 first installment, stated total proceeds were $810, with a stated 2014 after-tax net-income impact of $535; reduced future dividend income will partly offset the transaction benefit. A wholly owned captive insurer began operations in July 2014.

Important facts for investors to verify

  • Whether the higher allowance and commercial-credit downgrades adequately reflect borrower cash-flow deterioration, collateral values and potential further classification changes.
  • The performance and loss exposure of the $16,445 TDR portfolio, including the $1,975 in commitments to lend to TDR customers.
  • Whether commercial loan growth can be sustained without weakening underwriting or increasing concentration and credit risk.
  • The quality and sustainability of earnings after seasonal tax-processing revenue and the ProAlliance gain, and against the prior-year BOLI settlement comparison.
  • Funding and liquidity trends as seasonal deposits normalize, including use of FHLB and Federal Reserve borrowing capacity and sensitivity to interest-rate changes.
  • The final accounting and timing of the ProAlliance sale benefit and the financial, tax and insurance implications of the newly operational captive.