Farmers National Banc Corp. — Q2 2017 Form 10-Q
Business context and reporting period. The Ohio-based financial holding company provides banking, trust, retirement consulting and insurance services. This unaudited report covers the quarter and six months ended June 30, 2017; balance-sheet comparisons are to December 31, 2016. Dollar amounts below are in millions unless otherwise stated.
Financial performance and condition
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net interest income | $18.4 | $16.9 | $35.9 | $33.6 |
| Provision for loan losses | $1.0 | $1.0 | $2.0 | $1.8 |
| Noninterest income | $6.1 | $5.7 | $11.9 | $10.7 |
| Noninterest expense | $15.8 | $14.8 | $30.4 | $29.2 |
| Net income | $5.7 | $5.0 | $11.5 | $9.8 |
| Diluted earnings per share | $0.21 | $0.19 | $0.42 | $0.36 |
| Net interest margin | 4.05% | 4.06% | 4.03% | 4.07% |
| Efficiency ratio, tax-equivalent basis | 60.79% | 62.60% | 59.81% | 62.63% |
- Second-quarter annualized return on average assets was 1.11% and return on average equity was 10.25%; six-month figures were 1.14% and 10.52%, respectively.
- At June 30, assets were $2,085.7, up from $1,966.1 at year-end. Gross loans were $1,505.3, up $77.6 since year-end (10.9% annualized growth); available-for-sale securities were $391.6, up $21.6.
- Deposits were $1,541.0, up $16.2 since year-end. Total borrowings were approximately $298.8, up 40.0%; short-term borrowings rose $90.7 during the half, largely from FHLB advances. Stockholders’ equity was $226.7, up $13.5.
- Cash and cash equivalents were $64.6, up $22.9 since year-end. For the first half, operating cash flow was $14.0, investing cash use was $90.1, and financing cash flow was $99.0; the net increase in cash was $22.9.
- Regulatory capital ratios at June 30: consolidated common equity tier 1 11.80%, total risk-based capital 12.67%, tier 1 risk-based capital 11.93%, and tier 1 leverage 9.47%. The Bank was categorized as well capitalized.
Material changes and management commentary
- Year-over-year quarterly net income increased $0.7, while first-half net income increased $1.7. Management attributed stronger net interest income principally to loan growth and higher earning assets. Higher liability costs partly offset improved asset yields; management cited rising deposit-rate pressure.
- Noninterest income grew, supported by mortgage loan-sale gains, debit-card and EFT fees, and insurance commissions following the Bowers Insurance Agency acquisition. Expense growth was driven mainly by salaries and employee benefits, with Bowers-related operating costs also contributing. The efficiency ratio improved as revenue growth and lower merger costs helped offset expense increases.
- Management’s non-GAAP adjusted net income, excluding acquisition costs, was $5.8 for Q2 and $11.6 for the first half, versus $5.2 and $10.2, respectively, in 2016. These measures are supplemental, not substitutes for GAAP results.
- Asset quality indicators improved from June 2016: nonperforming loans were $6.4, or 0.42% of loans, versus $8.4 and 0.62%; loans delinquent 30–89 days were $7.1, or 0.47%, versus $11.4 and 0.84%. The allowance was $11.7, 0.78% of loans and 184.83% of nonperforming loans. Quarterly net charge-offs were $0.5, or 0.14% annualized of average net loans. Management considers the allowance adequate.
- Management described the balance sheet as slightly asset-sensitive and said the net interest margin should remain relatively stable in the then-current rising-rate environment. However, its rate simulation showed net interest income declining 2.1% under a sudden, sustained 300-basis-point increase and 2.8% under a 100-basis-point decrease; all modeled results were within internal limits.
Outlook, transactions, risks and contingencies
- The proposed Monitor Bancorp merger, announced in March 2017, was expected to close in Q3 2017, subject to Monitor shareholder approval. Regulatory approval had been received. Estimated transaction value was approximately $7.8, including expected goodwill of $1.4; consideration is subject to the agreed tangible-book-value calculation and shareholder cash-or-stock elections.
- Management intended to maintain the securities portfolio at its current proportion of assets and expected cash levels to remain relatively steady after $7.0 of security purchases settled in early July. No formal earnings guidance was provided.
- Liquidity sources included $25 of unused bank lines, approximately $63.8 of additional FHLB borrowing capacity, and access to the Federal Reserve Discount Window. The company reported $313.7 of unused loan commitments and up to $8.0 of commitments to SBIC investment funds, of which $3.8 had been invested.
- Key stated risks include local economic and credit conditions, interest-rate movements, loan demand, competition, technology change and regulatory developments. Management reported no material change in the risk factors disclosed in the 2016 Form 10-K, no material adverse outstanding legal actions, and effective disclosure controls.
- Among pending accounting standards, management had not yet determined the impact of the expected-credit-loss standard (ASU 2016-13). It estimated the lease standard could add about $2.6 of assets and liabilities, with no material income-statement effect.
Important facts for investors to verify
- Progress and final economics of the Monitor merger, including shareholder approval, closing timing, consideration and goodwill.
- Whether loan growth remains sound and whether delinquencies, nonperforming loans, charge-offs and allowance coverage continue to track favorably.
- Funding mix and borrowing costs: short-term borrowings increased materially while loans-to-deposits reached 97.68%.
- Net interest margin sensitivity to further rate changes, especially the effects of deposit repricing and acquired-loan discount accretion.
- Drivers and sustainability of earnings growth, including Bowers-related commission income, mortgage gains, compensation expense and management’s non-GAAP adjustments.
- Liquidity availability, off-balance-sheet commitments, and eventual implementation effects of the expected-credit-loss accounting standard.