OHIO VALLEY BANC CORP quarterly report, Q2 FY2018

Ohio Valley Banc Corp. — Q2 2018 Form 10-Q

Unaudited results for the three and six months ended June 30, 2018; balance-sheet comparisons are with December 31, 2017. Amounts are in thousands of dollars except per-share data and ratios. The company provides banking and consumer-finance services, primarily in southeastern Ohio and western West Virginia.

Financial performance and position

Second-quarter net income rose 70.9% year over year, and first-half net income rose 27.9%. Management attributed higher earnings mainly to loan and bank-deposit interest income and a lower effective tax rate; Q2 also benefited from lower loan-loss provision and noninterest expense. First-half provision expense increased to $733 from $320. The effective tax rate for the first half was 16.0%, compared with 24.8% in 2017, reflecting the federal corporate tax-rate reduction.

Net interest income increased 5.7% for Q2 and 5.8% for the first half. However, higher deposit costs and excess seasonal cash held at the Federal Reserve compressed the net interest margin. The efficiency ratio improved to 72.8% for Q2 and 69.6% year to date, from 79.8% and 72.5%, respectively.

First-half cash flows: operating activities provided $9,333; investing activities used $14,661; financing activities used $6,054. Cash and cash equivalents declined $11,382. Total other borrowed funds were $41,443, and subordinated debentures were $8,500. The company reported $149,521 of additional FHLB borrowing capacity and $54,146 available on its Federal Reserve borrowing line. Cash, qualifying short-term securities and available-for-sale securities totaled $165,484, or 16.1% of assets.

Material changes and credit quality

Gross loans grew 1.6% from year-end, with commercial loans up 5.3%; residential real estate and consumer loans declined slightly. Deposits fell 1.2%, including a $10,565 decline in noninterest-bearing deposits. Borrowed funds increased $5,494, partly reflecting $8,000 of new FHLB advances used to fund earning assets. Available-for-sale securities’ unrealized losses increased $1,974 during the first half as market rates rose; the resulting reduction in fair value contributed to accumulated other comprehensive loss.

The allowance for loan losses was $7,639, or 0.98% of gross loans, versus $7,499, or 0.97%, at year-end. Nonperforming loans were 1.45% of loans, up from 1.36%; nonperforming assets were 1.23% of assets, versus 1.17%. Nonaccrual loans increased to $10,844 from $10,112, while loans past due 90 days or more and still accruing were $471. Troubled debt restructurings totaled $14,788, down from $16,942 at year-end; $1,498 were not performing to modified terms. Management said the allowance was adequate but noted future adjustments may be necessary.

At June 30, the company and bank exceeded applicable “well capitalized” thresholds. The company’s total risk-based capital ratio was 17.1%; the bank’s was 15.6%. First-half dividends were $0.42 per share.

Outlook, risks and notable items

• Tax-refund services: A third-party provider intends to stop using the bank by the end of 2018, ahead of the contract’s December 2019 expiration. The company reported first-half ERC/ERD fees of $1,533 and related interest income of approximately $803. Unless a replacement arrangement is secured, management expects adverse effects on income and liquidity; temporary tax-related deposits are also seasonal.
• Ohio lending law: A law signed July 30, 2018 restricts certain short-term and small loans and applies to much of Loan Central’s lending. Management was evaluating the impact and possible exemptions or structural responses; it believed the consolidated effect would not be material, but the assessment was ongoing.
• Interest-rate and funding risks: Management identified the company as asset-sensitive; modeled net interest income rose 0.61% under a 100-basis-point rate increase and fell 1.66% under a 100-basis-point decrease. Margin pressure could persist if deposit costs rise or loan growth does not absorb lower-yielding cash.
• Unusual prior-year expense: Four fraudulent wire transfers in Q2 2017 resulted in $830 of net expense at June 30, 2017; insurance recovered the remaining amount in Q4 2017. This prior-year item helped lower reported Q2 2018 expenses comparatively.
• Accounting and contingencies: Early adoption of ASU 2018-02 reclassified $173 of stranded tax effects from accumulated other comprehensive income to retained earnings. The expected-credit-loss standard (CECL) was under implementation; its financial impact had not yet been determined. Off-balance-sheet credit commitments and guarantees totaled approximately $75,203; amounts drawn were not necessarily expected to equal contractual totals. No legal proceedings were reported as applicable.
• The filing provides no specific earnings or financial guidance. Management cautioned that interim results are not necessarily indicative of full-year results. Forward-looking outcomes are subject to economic, competitive, interest-rate, credit, funding, litigation and regulatory risks.

Important facts for investors to verify

• Whether the bank replaces the tax-refund provider, and the resulting impact on ERC/ERD fee income, interest income and seasonal liquidity.
• The effect of the Ohio law on Loan Central’s products, expenses and earnings as implementation details become clear.
• Trends in nonaccrual residential loans, net charge-offs, criticized/classified credits, TDR performance and adequacy of the allowance.
• Deposit retention and funding costs, loan growth, and whether higher deposit costs continue to constrain net interest margin.
• Potential earnings and capital effects of securities valuation changes, CECL implementation and the $75,203 of off-balance-sheet commitments.