Farmers National Banc Corp. — Q2 2018 Form 10-Q
Business context and reporting period. This unaudited quarterly filing covers the three and six months ended June 30, 2018. Farmers is an Ohio-based financial holding company serving northeastern Ohio and western Pennsylvania, with banking, trust, retirement consulting and insurance operations. The year-over-year results include Monitor Bancorp, acquired in August 2017, in the 2018 periods but not in the comparable 2017 periods.
Financial results and position
- Q2 earnings: Net income was $8.1 million, or $0.29 per diluted share, versus $5.7 million, or $0.21, in Q2 2017. For the first half, net income was $15.8 million, or $0.57 per diluted share, versus $11.5 million, or $0.42.
- Revenue and expenses: Q2 net interest income rose 6.5% to $19.6 million; noninterest income rose 4.2% to $6.3 million; and noninterest expense declined 1.9% to $15.5 million. First-half net interest income increased 7.3% to $38.5 million, noninterest income increased 3.1% to $12.3 million, and noninterest expense increased 0.6% to $30.6 million.
- Margins and returns: Net interest margin was 3.93% for Q2 and 3.92% for the first half, down 12 and 11 basis points, respectively, year over year. Q2 return on average assets was 1.47% and return on average equity was 13.28%; first-half figures were 1.46% and 13.13%. The Q2 efficiency ratio improved to 57.31% from 60.79%.
- Tax: The effective tax rate fell to 16.4% in Q2 from 26.0% a year earlier, and to 15.7% for the first half from 25.7%, primarily reflecting the federal corporate tax rate reduction. The 2017 tax law had also prompted a $1.8 million deferred-tax-asset reduction in Q4 2017.
- Balance sheet: At June 30, total assets were $2.238 billion; net loans were $1.626 billion; deposits were $1.650 billion; and stockholders’ equity was $247.5 million. Gross loans increased $61.8 million from December 31, 2017, while deposits increased $45.6 million. Cash and cash equivalents were $76.6 million, up $19.0 million since year-end.
- Cash flow, first half: Operating activities provided $16.0 million, investing activities used $64.7 million, and financing activities provided $67.7 million. Cash increased $19.0 million to $76.6 million.
- Funding and capital: Short-term borrowings were $316.0 million and long-term borrowings $6.6 million. The Company reported a 12.11% common equity tier 1 ratio, 12.97% total risk-based capital ratio and 9.81% tier 1 leverage ratio; the Bank was classified as well capitalized.
- Credit quality: Nonperforming loans were $8.4 million, or 0.51% of loans; nonperforming assets were 0.38% of assets. Loans 30–89 days delinquent totaled $10.6 million, or 0.65% of loans. The allowance for loan losses was $12.8 million, 0.78% of loans and 151.84% of nonperforming loans. Q2 net charge-offs were $536,000.
Material changes versus comparable periods
- Q2 and first-half net income increased substantially year over year, supported by higher net interest income, lower Q2 operating expenses and lower effective tax rates.
- Higher asset yields were more than offset in margin terms by rising funding costs: Q2 asset yields rose 9 basis points while the cost of interest-bearing liabilities rose 30 basis points. Management attributed funding-cost pressure mainly to short-term borrowings and time deposits.
- Loan growth was broad-based, especially in commercial real estate, residential real estate and agriculture. Management reported a 7.9% annualized loan growth rate for the first half.
- Trust fees and retirement consulting income increased, while gains on mortgage-loan sales declined: by $285,000 in Q2 and $405,000 for the first half versus 2017.
- Unrealized available-for-sale securities losses were $7.2 million after tax for the first half, compared with $4.1 million of gains in the prior-year period. Accumulated other comprehensive income moved from positive $596,000 at year-end 2017 to a loss of $6.8 million at June 30, 2018. Management attributed the fair-value decline principally to market expectations for long-term interest rates.
Outlook, risks and unusual items
- The filing provides no quantified earnings or revenue guidance. Management said it expected cash to trend back toward year-end 2017 levels over the next few months as funds supported loan growth and securities purchases, and intended to maintain the securities portfolio near its current share of assets.
- Management considered liquidity adequate. Available sources included an unused $35 million line of credit, approximately $302.4 million of additional FHLB borrowing capacity, and access to the Federal Reserve Discount Window. The Company also reported $376.2 million of unused customer commitments at June 30.
- Interest-rate risk is a key exposure. The company described its balance sheet as slightly asset-sensitive, but its simulation showed net interest income declining 4.1% under a sudden, sustained 300-basis-point rate increase. A 100-basis-point decrease produced a 10.8% decline in modeled net present value of equity, slightly exceeding the internal 10% policy guideline; management said it would continue monitoring this exception.
- Other stated risks include economic and credit conditions, banking-industry and regulatory changes, interest-rate movements, loan demand, technology, competition and pricing pressures. Management said there were no material changes to the risk factors disclosed in its 2017 Form 10-K.
- The Company is involved in lawsuits arising in the ordinary course of business; the filing does not state a clear quantified exposure. It reported no material impact from adopting ASC 606 or early adopting ASU 2017-08. The expected January 1, 2020 adoption of the credit-loss standard (ASU 2016-13) was being prepared for, but management had not determined its full impact.
Most important facts for investors to verify
- Whether loan growth continues without further deterioration in delinquencies, nonperforming loans or loss coverage.
- How rising deposit and borrowing costs affect net interest margin and earnings as funding competition continues.
- The effect of interest rates on securities fair values, accumulated other comprehensive income and the modeled policy exception for a 100-basis-point rate decline.
- Whether the reported liquidity sources and borrowing capacity remain available and adequate as loans expand.
- The eventual credit-loss accounting impact of ASU 2016-13, and any developments in ordinary-course litigation or off-balance-sheet commitments.