Eagle Bancorp Montana, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; unaudited consolidated results. Comparisons are with the corresponding 2017 periods, except balance-sheet comparisons, which are with December 31, 2017. Amounts are in U.S. dollars.
Business context and reporting period
The company operates Opportunity Bank of Montana, a Montana community bank focused on consumer and commercial lending, deposits, securities, and mortgage lending and servicing. On January 31, 2018, it completed the acquisition of TwinCo, Inc. and Ruby Valley Bank for $18.93 million ($9.90 million cash and $9.03 million in stock). Acquired assets included $55.1 million of loans and $82.2 million of deposits; the transaction added $5.1 million of goodwill. TwinCo’s operations are included from February 1, 2018, and the company says it cannot practicably isolate TwinCo’s post-acquisition revenue or net income.
Financial performance and position
- Q2 earnings: Net income was $1.33 million, up 25.0% from $1.07 million. Diluted EPS was $0.24 versus $0.27; basic EPS was $0.24 versus $0.28, reflecting a materially larger share count after the 2017 public offering and TwinCo stock issuance.
- First-half earnings: Net income was $1.91 million, up 4.2% from $1.83 million. Diluted EPS was $0.35 versus $0.47.
- Interest income and margins: Q2 net interest income increased 32.8% to $7.81 million; first-half net interest income rose 29.0% to $14.66 million. Net interest margin was 4.18% in Q2 (3.66% a year earlier) and 3.91% for the first half (3.66% a year earlier). Higher loan balances and yields contributed; deposit and borrowing interest expense also increased.
- Noninterest income and expenses: Q2 noninterest income fell 13.6% to $3.08 million, and first-half income fell 15.0% to $5.76 million, mainly because mortgage loan sale gains declined. Noninterest expense rose 21.3% to $9.24 million in Q2 and 16.7% to $17.57 million for the first half, including higher compensation and TwinCo-related costs. First-half acquisition costs were $365,000.
- Credit costs and asset quality: Loan-loss provision was $24,000 in Q2 and $526,000 for the first half. The allowance was $6.15 million, or 1.06% of gross loans. Nonperforming assets rose to $2.12 million from $1.50 million at year-end; nonperforming loans were $1.66 million, up from $977,000. Management said the allowance was adequate. The filing attributes the $527,000 commercial real estate nonaccrual balance to TwinCo.
- Balance sheet: Total assets rose 15.4% to $826.83 million from year-end. Net loans increased 13.4% to $575.58 million, and securities available-for-sale increased 16.8% to $154.27 million. Total deposits grew 17.8% to $613.18 million, primarily reflecting TwinCo; FHLB advances and other borrowings rose to $91.47 million.
- Debt and equity: FHLB advances and other borrowings plus other long-term debt totaled $116.31 million. Long-term debt included $10 million of 5.75% senior notes due 2022, $10 million of 6.75% subordinated notes due 2025, and $5.16 million of variable-rate subordinated debentures due 2035. Shareholders’ equity was $91.81 million, up 9.8% from year-end.
- Cash flow: First-half operating cash flow was $2.73 million, compared with $7.44 million in 2017. Investing activities used $19.12 million, including the TwinCo cash payment and premises and equipment additions; financing activities provided $17.94 million. Cash and cash equivalents increased $1.54 million to $8.98 million.
- Capital and liquidity: The Bank exceeded applicable regulatory capital requirements. At June 30, its total risk-based capital ratio was 15.654%, Tier 1 and common equity Tier 1 ratios were 14.647%, and Tier 1 leverage ratio was 11.261%. The Bank also exceeded its stated internal liquidity minimums; exact liquidity ratios are not provided in the filing text excerpt.
- Other comprehensive income: First-half comprehensive loss was $26,000 despite net income of $1.91 million, primarily reflecting a $2.80 million pretax decline in the fair value of available-for-sale securities. Accumulated other comprehensive loss reached $1.62 million.
Material changes versus comparable periods
- Q2 net interest income and net income grew, but EPS declined year over year as weighted-average shares increased to 5.52 million diluted from 3.87 million.
- For the first half, net interest income growth was largely offset by lower mortgage-sale gains and higher operating expenses; net income rose only modestly and EPS decreased.
- Balance-sheet growth reflects both TwinCo and organic lending. Gross loans increased $68.5 million from year-end, including $55.1 million of acquired loans; deposits increased $92.6 million.
- Net interest margin improved year over year, while the cost of interest-bearing liabilities increased modestly. The federal funds target rate rose from 1.50% to 2.00% during the first half of 2018.
- Nonperforming loans and assets increased from year-end, although they remained low relative to total assets; the allowance coverage of nonperforming loans declined from 588.54% to 370.71%.
Outlook, management commentary, risks and contingencies
No numerical earnings or growth guidance is provided. Management says it intends to focus on growing net interest margin and fee income while controlling operating expenses. It identifies efficient funding of balance-sheet growth as a challenge, amid competition for deposits and possible changes in customer demand. Mortgage-sale income is vulnerable to lower mortgage activity, rate movements, and competitive pressure.
Key risks cited include interest-rate changes that could reduce margins or securities values, real-estate price and economic weakness, competition, borrower repayment and collateral risks, deposit funding pressure, acquisition integration and growth execution, cybersecurity, regulatory changes, and the uncertainty of loan-loss estimates. Management expects the future expected-credit-loss standard (CECL) to affect the financial statements and says adoption may increase the allowance; the amount was not yet reasonably estimable. The company reported no material change in previously disclosed risk factors, no material pending legal proceedings, and effective disclosure controls as of June 30, 2018.
After quarter-end, the board declared a $0.0925-per-share dividend payable September 7, 2018 and authorized repurchases of up to 100,000 shares through July 19, 2019. These are subsequent events, not completed second-quarter transactions.
Important facts for investors to verify
- How much of loan, deposit, and earnings growth is sustainable organically versus attributable to TwinCo, and how integration costs and acquired-loan performance develop.
- Whether the increase in nonperforming loans, particularly acquired commercial real estate exposure, persists and whether the allowance remains adequate.
- Trends in net interest margin and funding costs as rates rise, including deposit pricing, borrowing needs, and liquidity.
- Mortgage origination volumes and sale margins, which drove the decline in noninterest income, and the resulting effect on earnings.
- The effect of the larger share count on per-share earnings and returns, as well as the impact of securities valuation changes on equity.
- Management’s CECL implementation work and the eventual allowance and capital effects; the filing does not provide a clear estimate.