Farmers National Banc Corp. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; balance-sheet figures are compared with December 31, 2017 unless otherwise noted. The Ohio-based financial holding company provides banking, trust, retirement consulting and insurance services. Amounts are in millions of dollars unless stated otherwise.
Financial performance
- Net income: $7.73 million, up from $5.78 million in Q1 2017; diluted EPS was $0.28 versus $0.21. Annualized return on assets was 1.45% (1.17%); return on equity was 13.03% (10.87%).
- Interest revenue and margin: Interest and dividend income was $21.28 million, up from $18.85 million. Net interest income was $18.95 million, up from $17.53 million. Tax-equivalent net interest margin was 3.92%, down 9 basis points from 4.01%; asset yields rose 10 basis points while interest-bearing liability costs rose 25 basis points.
- Other income and expenses: Noninterest income increased 2.1% to $6.01 million. Noninterest expense rose 3.3% to $15.10 million. The tax-equivalent efficiency ratio improved to 57.98% from 58.79%.
- Taxes: Income tax expense fell to $1.36 million from $1.97 million; the effective tax rate declined to 14.96% from 25.43%, primarily reflecting the federal corporate tax-rate reduction.
- Cash flow: Operating activities provided $9.98 million; investing activities used $24.19 million; financing activities provided $8.75 million. Cash and cash equivalents ended the quarter at $52.15 million, down $5.47 million from year-end.
Financial position, funding and credit
- Assets and loans: Total assets were $2.17 billion. Gross loans rose $22.0 million to $1.60 billion, a 5.6% annualized increase; growth was concentrated in commercial real estate, residential real estate and agricultural lending. Net loans were $1.59 billion.
- Deposits and borrowings: Deposits increased $32.4 million to $1.64 billion, as interest-bearing deposits rose and noninterest-bearing deposits declined. Total borrowings decreased $21.7 million to $274.8 million; short-term borrowings were $268.0 million and long-term borrowings $6.8 million. Loans were 97.69% of deposits.
- Liquidity: Management considered liquidity adequate. The Bank reported $35 million of unused credit lines, approximately $336.3 million of additional FHLB borrowing capacity and access to the Federal Reserve Discount Window. Core deposits were approximately 95.9% of total deposits.
- Capital: Consolidated common equity tier 1, total risk-based capital, tier 1 risk-based capital and tier 1 leverage ratios were 12.06%, 12.94%, 12.19% and 9.68%, respectively. Management said the Company and Bank met applicable capital requirements; the Bank was classified as well capitalized. Stockholders’ equity was $241.2 million, down $0.8 million, mainly due to securities valuation losses. The quarterly dividend was $0.07 per share.
- Credit quality: The allowance for loan losses was $12.55 million, or 0.78% of loans, versus $12.32 million, or 0.78%, at year-end. Q1 provision was $0.78 million, down from $1.05 million a year earlier. Nonperforming loans were $7.89 million (0.49% of loans), and nonperforming assets were 0.37% of assets. Net charge-offs were $0.54 million, or 0.14% annualized of average net loans.
Material changes and notable items
- Net income increased about 34% year over year, supported by higher net interest income, a lower loan-loss provision and the lower effective tax rate. The tax-rate benefit reflects the Tax Cuts and Jobs Act; the Company had reduced deferred tax assets by approximately $1.8 million in Q4 2017.
- Higher deposit and borrowing costs pressured margin despite increased asset yields. Debit-card interchange and trust fees grew, while retirement consulting fees and gains on mortgage-loan sales declined.
- Available-for-sale securities produced a $7.02 million after-tax other comprehensive loss, versus $0.23 million of income in Q1 2017. Unrealized securities losses totaled $10.11 million at quarter-end; management attributed most to interest rates and liquidity, and reported no other-than-temporary impairment.
- The Company acquired Monitor Bancorp in August 2017. The Q1 2017 comparison is not on a pro forma basis for that acquisition.
- Adoption of ASU 2016-01 resulted in a $169,000 cumulative adjustment between retained earnings and accumulated other comprehensive income; the Q1 income-statement impact from equity-security fair-value changes was not material. ASC 606 adoption did not change revenue recognition. The Company expects to adopt the current expected credit loss standard on January 1, 2020; its full impact had not been determined.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management expected cash levels to remain relatively constant over the following months as deposits funded loan growth and securities purchases, and intended to maintain the securities portfolio at approximately its current share of assets during the rest of 2018. Management described the balance sheet as slightly asset-sensitive, while interest-rate simulations showed modeled net interest income declines of 3.2% under a 300-basis-point increase and 2.1% under a 100-basis-point decrease; all modeled outcomes were within internal limits.
Key stated risks include local economic and credit conditions, banking-industry competition, regulation, interest-rate changes, loan demand and technology changes. Off-balance-sheet unused commitments totaled $343.3 million; the Company also had commitments of up to $8 million to SBIC funds, of which $5.6 million had been invested. Management reported no material legal proceedings and no material changes to the risk factors in its 2017 Form 10-K. The Company reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether loan growth can continue without worsening delinquencies, nonperforming loans or charge-offs, and whether the allowance remains adequate.
- How further deposit-rate competition and funding costs affect net interest margin and earnings.
- The durability of earnings growth after separating the tax-rate benefit from operating performance and considering the Monitor acquisition’s effect on comparisons.
- The effect of interest-rate-driven securities losses on tangible book value and capital, and the assumptions behind management’s rate-risk simulations.
- The eventual impact of the expected-credit-loss standard and the Company’s ability to maintain liquidity and capital as lending grows.