Finward Bancorp — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023; comparisons are primarily with the corresponding 2022 periods. Finward is a bank holding company whose results depend mainly on Peoples Bank. Dollar amounts below are in millions unless stated otherwise.
Financial performance
- Q2: Net income was $2.44 million, down 45.0% from $4.43 million; diluted EPS was $0.57 versus $1.04. Return on average assets was 0.46% and return on average equity was 7.05%, compared with 0.85% and 12.45%, respectively.
- First half: Net income was $4.68 million, down 28.8% from $6.57 million; diluted EPS was $1.10 versus $1.59. ROA was 0.45% versus 0.65%, and ROE was 6.74% versus 8.40%.
- Q2 revenue and interest margins: Interest income was $21.61 million, up from $17.74 million, but interest expense rose to $7.57 million from $0.44 million. Net interest income declined 18.8% to $14.04 million. GAAP net interest margin was 2.88% versus 3.59%; tax-adjusted margin, a non-GAAP measure, was 3.03% versus 3.78%.
- First-half revenue and interest margins: Interest income was $41.75 million versus $33.63 million, while interest expense increased to $13.04 million from $0.80 million. Net interest income declined 12.6% to $28.71 million. GAAP net interest margin was 2.98% versus 3.50%; tax-adjusted margin was 3.13% versus 3.70%.
- Q2 noninterest income was $3.01 million, up 3.8%; first-half noninterest income was $5.61 million, down 7.1%. First-half noninterest expense fell 10.2% to $28.22 million, partly reflecting lower personnel and prior-year acquisition-related costs.
- The income statement reports provision for credit losses of $0.51 million for Q2 and $1.00 million for the first half. The allowance for credit losses was $19.51 million at June 30, or 1.27% of loans, versus $12.90 million and 0.85% at year-end. Adoption of CECL on January 1 reduced retained earnings by $6.12 million after tax.
Financial position, cash flow and liquidity
- Total assets were $2.16 billion at June 30, up 4.4% from December 31, 2022. Loans receivable, net of allowance, were $1.51 billion versus $1.50 billion; total deposits were $1.80 billion versus $1.78 billion.
- Deposit mix shifted toward higher-yielding products: certificates of deposit increased $141.6 million (39.0%) and money market balances rose $30.2 million, while checking declined $88.8 million and savings declined $62.9 million. Core deposits, as defined by management, were down 8.6% from year-end. Estimated uninsured deposits fell to $351.1 million, or 19.6% of deposits, from $516.1 million, or 29.1%.
- At June 30, cash and cash equivalents were $115.7 million. First-half operating cash flow was $17.1 million, investing cash flow was negative $10.9 million, and financing cash flow was positive $78.2 million; cash increased $84.4 million from year-end.
- Borrowed funds were $150.0 million, including $100.0 million from the Federal Reserve’s Bank Term Funding Program (BTFP) and $50.0 million of FHLB advances. Repurchase agreements were $46.4 million, bringing these two funding categories to $196.4 million combined. The filing reports $693.3 million of additional borrowing capacity and separately cites $809.0 million in total liquidity sources, including cash and other facilities.
- Management described liquidity as strong and believes available resources will meet operating needs for the next 12 months. The Bank’s CET1, Tier 1, total capital and leverage ratios were 10.0%, 10.0%, 11.0% and 7.6%, respectively; the filing states the Bank exceeded applicable well-capitalized thresholds.
- Stockholders’ equity was $136.8 million, or 6.3% of assets; book value per share was $31.77. The available-for-sale securities portfolio was $368.1 million and had $79.2 million of gross unrealized losses; accumulated other comprehensive loss was $60.2 million after tax.
Material changes and management commentary
- Higher asset yields did not offset sharply higher funding costs: Q2 average yield on earning assets rose to 4.43% from 3.68%, while average cost of interest-bearing liabilities increased to 1.57% from 0.09%. Management expects net interest margin compression to continue unless target rates decline enough to permit liability repricing.
- Nonperforming loans declined to $12.33 million, or 0.80% of loans, from $18.38 million, or 1.21%, at year-end. Special-mention loans increased to $12.93 million from $11.59 million; substandard loans declined to $14.83 million from $23.01 million. Management said it did not expect classified or nonperforming loans to materially affect future operations, liquidity or capital.
- Commercial real estate loans were $501.8 million, about 32.8% of loans. Management said it is monitoring the portfolio for risks including higher rates, reduced occupancy and lower property valuations.
- Management attributed the decline in Q2 earnings principally to funding-cost pressure. Cost reductions included a reported 12 full-time-equivalent reduction since March 31; the first-half reduction was 21 since December 31, 2022. First-half expenses also benefited from the absence of certain 2022 Royal Financial acquisition costs.
- The company declared a quarterly dividend of $0.31 per share, paid July 6, 2023. It reported no share repurchases under its formal repurchase program during the first half.
Outlook, risks and contingencies
- No specific earnings or full-year financial guidance is provided. Management’s stated outlook is for continued margin compression unless interest rates decline and deposit and other funding costs can be repriced lower. Six-month results are not necessarily indicative of full-year results.
- The filing discusses industry liquidity and deposit volatility, interest-rate and securities valuation exposure, deposit mix and pricing, and uncertainty in economic forecasts used in the new CECL allowance model. Management states it does not currently anticipate needing to sell securities at a loss before recovery of amortized cost, but securities values remain sensitive to rates and market conditions.
- Interest-rate modeling indicates that an immediate +200-basis-point shock would increase modeled next-12-month net interest income 1.9% but reduce economic value of equity 11.5%; a -200-basis-point shock would reduce modeled net interest income 9.4%. These are model estimates, not forecasts.
- Outstanding loan-funding commitments were $269.5 million, 54.9% variable-rate, and standby letters of credit were $14.2 million. Management believes cash flow and borrowing capacity are sufficient to fund them.
- Management stated that ordinary-course legal proceedings are not expected to have a material adverse effect. Disclosure controls were assessed as effective, and no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Reconcile the provision figures: the consolidated income statement reports $0.51 million for Q2 and $1.00 million for the first half, while MD&A loan-segment tables show $0.49 million and $0.97 million, respectively. Confirm the treatment of the unfunded-commitment provision and any presentation differences.
- Track deposit stability and repricing: core deposits declined despite modest overall deposit growth, certificates increased substantially, and the average cost of funds rose sharply.
- Assess the sustainability of net interest income and the sensitivity assumptions behind management’s margin and interest-rate scenarios.
- Monitor commercial real estate, construction and land-development exposures, criticized loans, charge-offs and the adequacy of the CECL allowance as economic forecasts change.
- Review liquidity capacity, collateral pledged for borrowings, uninsured-deposit estimates and the maturity schedule for $150 million of borrowed funds, including $50 million due in 2023 and $100 million in 2024.
- Consider the $79.2 million gross unrealized securities loss and the risks associated with holding securities until recovery or maturity.