Business context and reporting period
Farmers National Banc Corp. is an Ohio-based bank holding company providing banking, trust, retirement consulting and insurance services. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2015; financial statement amounts below are in millions of dollars unless stated otherwise.
The June 19 acquisition of National Bancshares Corporation (NBOH), parent of First National Bank of Orrville, materially expanded the company. NBOH contributed approximately $545 million of assets and 14 branches. Its results were included only from the acquisition date, so reported year-over-year results are not directly comparable to a full-period combined-company comparison.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net interest income | $9.75 | $8.95 | $18.74 | $17.81 |
| Provision for loan losses | $0.85 | $0.30 | $1.30 | $0.63 |
| Noninterest income | $4.41 | $3.80 | $8.45 | $7.23 |
| Noninterest expense | $12.09 | $9.38 | $21.84 | $18.52 |
| Net income | $0.81 | $2.35 | $3.02 | $4.54 |
| Diluted earnings per share | $0.04 | $0.13 | $0.16 | $0.24 |
- Net interest margin was 3.66% for Q2 and 3.65% for the first half, compared with 3.54% and 3.55% in 2014, respectively. Management attributed the improvement to lower funding costs and a greater share of earning assets in loans.
- Quarterly annualized return on average assets and equity were 0.27% and 2.74%, versus 0.83% and 7.85% a year earlier. The quarterly tax-equivalent efficiency ratio was 81.03%, versus 69.68%.
- At June 30, total assets were $1.672 billion, gross loans $1.135 billion, deposits $1.321 billion and stockholders’ equity $182.6 million. At December 31, 2014, these were $1.137 billion, $663.9 million, $915.7 million and $123.6 million, respectively; much of the increase reflects NBOH.
- Cash and cash equivalents were $37.0 million at June 30, up $9.6 million since year-end. For the first half, operating cash flow was $3.2 million, investing cash flow $23.7 million and financing cash flow negative $17.4 million.
- Short-term and long-term borrowings were $85.7 million and $69.9 million, respectively, at June 30, compared with $59.1 million and $28.4 million at year-end. Management said the increase largely reflected borrowings assumed in the acquisition.
- The allowance for loan losses was $7.3 million, or 0.64% of loans; management cited 1.03% excluding acquired loans. Nonperforming loans were $8.0 million, or 0.70% of total loans, and nonperforming assets were 0.54% of assets. Second-quarter net charge-offs were $1.3 million, including losses associated with one commercial loan relationship.
- The Bank was categorized as well capitalized. At June 30, consolidated common equity Tier 1 and total risk-based capital ratios were 12.61% and 13.20%; the Tier 1 leverage ratio was 9.27%.
Material changes versus prior periods
- Q2 net income declined 65% year over year, and first-half net income declined 33%. Management attributed most of the decline to acquisition-related costs. Q2 included $1.9 million of merger-related expense, including $849,000 of estimated contingent consideration for the earlier NAI acquisition; first-half merger-related expense was $2.2 million.
- Loans increased $471.0 million from year-end, including approximately $430.5 million acquired with NBOH and $10.9 million of organic growth, according to management. Deposits rose $404.9 million, principally due to the acquisition; the company also reported deposit runoff during the first half.
- Noninterest income grew, notably retirement plan consulting fees, which increased to $1.3 million in the first half from $636,000. Noninterest expense increased $3.3 million, reflecting merger costs and higher salaries and benefits.
- Available-for-sale securities fell to $386.3 million from $389.8 million at year-end. First-half other comprehensive income included a $2.1 million after-tax loss, primarily from market interest-rate movements; Q2 after-tax OCI loss was $3.6 million.
- The acquisition issued 7.26 million shares valued at $59.0 million. NBOH consideration totaled $74.8 million, including $15.7 million cash; the preliminary purchase accounting recorded $26.7 million of goodwill and $4.4 million of core deposit intangible assets. Tangible book value per share declined to $5.57 from $6.23 at year-end, while reported book value per share rose to $7.11 from $6.71.
Outlook, commentary and risks
- No quantified earnings or financial guidance was provided. Management said it expected cash levels to remain steady over the next few months and described liquidity as adequate.
- A merger agreement with Tri-State 1st Banc was signed June 23, 2015. The transaction, including five First National Community Bank locations, was expected to close in Q4 2015, subject to regulatory and shareholder approvals and other customary conditions. Tri-State reported approximately $139 million of assets at March 31, 2015.
- Management identified interest-rate risk as the company’s primary market exposure and described the balance sheet as liability-sensitive. Its simulation estimated that a 100-basis-point rate increase would raise net interest income 2.2%, while a 100-basis-point decrease would reduce it 4.2%. The filing states these results were within internal limits.
- Key disclosed risks include economic and credit conditions, loan demand, interest-rate changes, competition, technology, and regulatory developments. Basel III requirements are being phased in through 2019. Management judged the loan-loss allowance adequate, but the acquired loan portfolio, higher charge-offs, acquisition integration and preliminary purchase valuations remain relevant considerations.
- Unused loan commitments were $240 million at June 30, up from $150 million at year-end, primarily because of NBOH. The company also had a $3 million commitment to an SBIC fund, of which $1.9 million had been invested.
- Management reported effective disclosure controls, no material change in internal control over financial reporting, no material change in risk factors from the 2014 Form 10-K, and no legal proceedings expected to have a material adverse effect.
Most important facts for investors to verify
- How much of the reported earnings decline and elevated efficiency ratio is temporary acquisition and contingent-consideration expense, and what are the remaining integration costs?
- Whether acquired loan quality, charge-offs and the allowance remain appropriate as NBOH loans are incorporated; review delinquency trends and credit marks on acquired loans.
- Whether acquired deposits remain stable and competitively priced, given disclosed first-half deposit runoff, and how the higher borrowing balance affects funding costs and liquidity.
- How the preliminary NBOH purchase accounting, $26.7 million goodwill balance and $4.4 million core deposit intangible may change, and the effect on tangible book value and future impairment risk.
- Whether the Tri-State transaction closes on the stated timetable and on the disclosed stock-and-cash terms, subject to approvals.
- Whether securities valuation changes and interest-rate sensitivity materially affect future earnings, accumulated other comprehensive income or capital.