CFB Bankshares / Central Federal Corporation — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. The filing registrant is Central Federal Corporation (NASDAQ: CFBK), parent of CFBank, N.A.; the filing describes a community bank concentrated in Ohio markets. Financial amounts below are in millions unless stated otherwise.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net interest income | $5.23 | $4.35 | $10.33 | $8.26 |
| Net interest margin | 3.08% | 3.43% | 3.14% | 3.42% |
| Noninterest income | $2.57 | $0.73 | $4.26 | $1.21 |
| Noninterest expense | $4.93 | $3.67 | $9.63 | $7.08 |
| Net income | $2.28 | $1.13 | $3.96 | $1.92 |
| Diluted EPS | $0.55 | $0.25 | $0.93 | $0.42 |
- Q2 pre-tax income was $2.86 million, versus $1.41 million a year earlier. For the first half, it was $4.96 million, versus $2.39 million.
- Growth in noninterest income was led by mortgage loan sale gains: $2.36 million in Q2 versus $0.51 million, and $3.87 million for the first half versus $0.82 million.
- Interest income and expense both rose with growth in earning assets and funding costs. Q2 net interest income increased 20%, but net interest margin declined 35 basis points year over year. First-half margin fell 28 basis points.
- No loan-loss provision was recorded in either comparative period. Net recoveries were $5,000 in Q2 and $17,000 for the first half of 2019.
Financial position, cash flow and capital
- Assets and lending: Total assets were $721.0 million at June 30, up 8.4% from year-end 2018. Net loans and leases rose 8.7% to $598.7 million; loans held for sale rose to $52.2 million from $17.4 million.
- Funding: Deposits increased 8.4% to $628.6 million. Interest-bearing deposits were $521.9 million. FHLB advances and other debt totaled $18.5 million; subordinated debentures totaled $14.8 million.
- Liquidity: Cash and cash equivalents declined to $34.3 million from $67.3 million. Management reported $178.4 million in cash, unpledged securities and available borrowing capacity, down from $189.2 million at year-end. This included $74.9 million of additional FHLB capacity, $61.6 million of FRB capacity and $8.0 million of unused commercial-bank line availability.
- Cash flow: First-half operating cash flow was negative $32.8 million, largely reflecting the expansion of mortgage originations held for sale; investing cash flow was negative $48.6 million, while financing cash flow was positive $48.4 million, principally from deposit growth. Cash ended the period at $34.3 million.
- Credit quality: Allowance for loan and lease losses was $7.0 million, or 1.16% of total loans, versus 1.26% at year-end. Nonperforming loans rose to $2.42 million (0.40% of loans) from $0.38 million (0.07%), primarily after a commercial real estate loan became nonaccrual. Criticized and classified loans also increased.
- Equity and regulatory capital: Stockholders’ equity rose to $50.9 million from $45.6 million. CFBank’s June 30 total capital ratio was 11.95%, common equity tier 1 ratio 10.79%, and leverage ratio 9.44%; each exceeded the filing’s stated fully phased-in minimums.
Material changes and management commentary
- Management attributed loan growth to new relationships and sales activity, particularly in commercial, commercial real estate and single-family residential lending. The bank opened a Blue Ash, Ohio branch in March 2019.
- Mortgage banking expansion drove higher loan-sale revenue as well as higher salaries, staffing and marketing expense. Management cited mortgage business growth, geographic expansion, infrastructure and risk management needs as expense drivers.
- Higher deposit and borrowing costs outpaced some of the benefit from asset growth: the average cost of interest-bearing liabilities increased, and net interest margin contracted despite higher net interest income.
- The company adopted lease accounting on January 1, 2019, recognizing operating lease right-of-use assets of approximately $2.4 million; lease liabilities were $2.16 million at June 30.
- Management said liquidity was sufficient for current operating needs and strategic plans and considered the allowance adequate, while warning that deteriorating borrower performance, economic conditions or real estate values could require additional reserves. The filing provides no specific earnings or revenue guidance.
Risks, contingencies and unusual items
- Credit exposure: Nonaccrual loans and substandard classifications increased, including a newly nonaccrual commercial real estate loan. Management’s allowance estimates depend on borrower performance, collateral values and economic assumptions.
- Mortgage banking: Mortgage originations held for sale and related fair-value and derivative activity expanded significantly. Mortgage rate-lock commitments had a notional amount of $242.6 million at quarter-end; associated market and execution risks may affect reported gains.
- Funding and debt: The parent had $5.0 million drawn on a $10 million revolving credit facility expiring in February 2020 unless extended or replaced. Subordinated debt carries interest-rate and payment obligations; the $10 million notes bear 7% through December 2023 before resetting to a floating rate.
- Dividends: Bank-to-parent distributions may require regulatory non-objection while CFBank has an accumulated deficit, and parent dividends are subject to regulatory, liquidity and debt-payment conditions.
- Accounting and tax: The company was evaluating the expected-credit-loss standard (CECL); management said the impact could not yet be reasonably determined and that adoption could increase the allowance. Certain pre-1988 thrift bad-debt reserves could generate tax recapture in specified circumstances.
- Management reported no material change in market risk, no material legal proceeding, no material change in risk factors, and effective disclosure controls. These statements do not eliminate ordinary-course litigation or other business risks.
Important facts for investors to verify
- Whether the higher mortgage-sale gains and loan-sale pipeline are sustainable, and how mortgage activity affects cash flow and quarterly earnings volatility.
- Whether credit deterioration continues: monitor nonperforming loans, criticized/classified loans, delinquencies, charge-offs and allowance coverage, especially commercial real estate exposures.
- Whether deposit pricing and funding costs continue to compress net interest margin, and whether loan growth earns returns sufficient to offset that pressure.
- How the company manages liquidity after the substantial decline in cash, including reliance on deposit growth and borrowing capacity, and the status of the parent’s credit line before its February 2020 expiry.
- The eventual CECL adoption impact and any changes to the allowance, capital ratios or dividend capacity.