Business context and reporting period
Farmers National Banc Corp. filed this unaudited Form 10-Q for the quarter ended September 30, 2013. The Ohio-based bank holding company provides banking, trust, insurance, and—following its July 1 acquisition of National Associates, Inc. (NAI)—retirement-plan consulting services. Dollar amounts below are in millions unless otherwise stated.
Financial performance and condition
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net interest income | $8.85 | $9.10 | $26.86 | $27.64 |
| Provision for loan losses | $0.34 | $0.33 | $0.77 | $0.73 |
| Noninterest income | $4.17 | $3.37 | $10.27 | $8.95 |
| Noninterest expenses | $10.93 | $8.90 | $29.84 | $26.34 |
| Net income | $1.61 | $2.49 | $5.49 | $7.30 |
| Diluted earnings per share | $0.09 | $0.13 | $0.29 | $0.39 |
- Q3 return on average assets was 0.56% (0.88% prior year); return on average equity was 5.60% (8.22%). The tax-equivalent efficiency ratio rose to 81.64% from 70.12%. Nine-month efficiency ratio was 77.21%, versus 69.01%.
- Tax-equivalent net interest margin was 3.47% for Q3 and 3.59% for the first nine months, down from 3.67% and 3.80%, respectively. Management attributed the decline to lower asset yields and mortgage-backed security premium amortization following prepayments.
- At September 30, total assets were $1,148.1; net loans $604.0; available-for-sale securities $438.1; deposits $903.4; and stockholders’ equity $112.5. Loans increased $25.0 from year-end 2012, while deposits declined $15.6. Total borrowings rose $28.0 from year-end to $118.3, including $98.2 short-term and $20.1 long-term.
- Cash and cash equivalents were $40.3 at quarter-end. For the nine months, operating cash flow was $14.6, investing cash outflow $21.2, and financing cash inflow $9.1; cash increased $2.5.
- Regulatory capital ratios at September 30 were 16.28% total risk-based, 15.22% Tier 1 risk-based, and 9.29% Tier 1 leverage. Equity was 9.8% of assets; tangible common equity ratio was 8.96%.
Material changes versus comparable periods
- Net income declined 35% in Q3 and 25% for the nine months year over year. Management reported that excluding $1.3 million in Q3 severance costs, net income would have been $2.4 million, or $0.13 per share, for Q3 and $6.3 million, or $0.34 per share, year to date.
- Higher noninterest income partly offset weaker net interest income and higher expenses. Q3 income included $0.60 million of securities gains, $0.34 million of bank-owned life insurance income including death benefits, $0.21 million of NAI consulting fees, and a gain on sale of land within other operating income.
- Q3 salaries and benefits increased $1.67 million year over year, mainly because of severance. Nine-month expenses also included $0.27 million of merger-related costs.
- Net loans grew from $564.3 million at September 30, 2012 to $604.0 million at September 30, 2013. Nonperforming loans rose to $9.1 million from $8.7 million year over year and $8.2 million at December 31, 2012. The allowance was $7.4 million, or 1.21% of loans, versus 1.51% a year earlier; coverage of nonperforming loans was 80.77%.
- Available-for-sale securities recorded an after-tax unrealized loss of $11.9 million for the first nine months, compared with a $1.3 million gain in 2012. Accumulated other comprehensive income moved from $7.6 million at year-end 2012 to a $4.2 million accumulated loss at September 30, 2013, reflecting higher long-term interest rates.
Outlook, risks, and unusual items
- No earnings or revenue guidance is provided. Management said it was focused on growing noninterest income and reducing noninterest expenses. Two underutilized branches in Leetonia and Warren, Ohio, closed October 1, 2013; management expected any resulting losses to be immaterial and anticipated operating efficiencies.
- Management considered liquidity adequate. The bank had $24.5 million in unused bank credit lines and approximately $79.6 million of additional FHLB borrowing capacity; it also had access to the Federal Reserve Discount Window. A separate $1.5 million correspondent-bank revolver had $0.35 million outstanding.
- Interest-rate simulations showed net interest income declining 2.2% under a 300-basis-point rise and 2.7% under a 100-basis-point decline. Net present value of equity declined 13.8% under a 100-basis-point decline, exceeding internal policy limits; management said it did not consider that rate decline realistic in the current environment.
- The July 2013 NAI acquisition had $4.42 million of estimated consideration, including $0.92 million estimated contingent consideration. It added $2.63 million goodwill and $2.29 million identified intangible assets. NAI contributed $0.28 million revenue and a $0.10 million net loss in Q3.
- Management identified credit quality, economic and banking conditions, regulation, interest-rate movements, loan demand, technology, and competition as risks. Basel III requirements were scheduled to apply to the company and bank beginning January 1, 2015, with certain provisions phased in through 2019; management was evaluating the impact.
- The filing reported no material legal proceedings, no material change in previously disclosed risk factors, and effective disclosure controls. Management’s estimates for loan-loss allowance, deferred taxes, goodwill, and financial instrument fair values are subject to uncertainty.
Important facts for investors to verify
- Whether lower net interest margin and asset yields persist, and how asset repricing and deposit costs affect earnings.
- Whether the $1.3 million severance charge is nonrecurring and whether expense reductions, including branch closures, deliver expected savings.
- Credit trends behind rising nonperforming loans and the declining allowance-to-loan and allowance-to-nonperforming-loan ratios, including troubled debt restructurings.
- The effect of securities valuation changes on GAAP equity, tangible book value, and regulatory capital, and the eventual Basel III treatment.
- NAI’s ongoing contribution, contingent-payment performance conditions, and integration costs, as well as the remaining impact of the branch closures.