Business Context and Reporting Period
The First Bancorp, Inc., a Maine financial holding company and parent of First National Bank, filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2019. Comparisons are primarily with June 30, 2018, and year-end December 31, 2018. The interim financial statements were reviewed, but not audited, by Berry Dunn McNeil & Parker, LLC.
Key Financial Metrics
| Metric | Six Months 2019 | Six Months 2018 | Q2 2019 | Q2 2018 |
|---|---|---|---|---|
| Interest income | $39.1 million | $33.7 million | $19.8 million | $17.2 million |
| Interest expense | $13.2 million | $9.0 million | $6.9 million | $4.9 million |
| Net interest income | $25.8 million | $24.7 million | $13.0 million | $12.3 million |
| Provision for loan losses | $625,000 | $1.0 million | $250,000 | $500,000 |
| Non-interest income | $6.7 million | $6.3 million | $3.6 million | $3.2 million |
| Non-interest expense | $17.1 million | $16.8 million | $8.7 million | $8.2 million |
| Net income | $12.6 million | $11.2 million | $6.4 million | $5.7 million |
| Diluted EPS | $1.15 | $1.04 | $0.59 | $0.53 |
| Tax-equivalent net interest margin | 2.90% | 2.94% | 2.88% | 2.88% |
| Non-GAAP efficiency ratio | 50.63% | 52.39% | 50.80% | 51.02% |
At June 30, 2019, total assets were $2.00 billion, total loans were $1.25 billion, investment securities were $634.1 million, deposits were $1.59 billion, and shareholders’ equity was $204.6 million. Cash and cash equivalents were $16.9 million.
The allowance for loan losses was $11.5 million, or 0.92% of total loans. Net charge-offs for the six months were $386,000, or 0.06% of average loans on an annualized basis. Return on average assets was 1.27% for the six months and return on average equity was 12.76%.
Six-month operating cash flow was $6.4 million, compared with $18.2 million in the prior-year period. Investing activities used $39.9 million, principally reflecting net loan growth and purchases of investment securities. Financing activities provided $31.3 million, primarily from increased certificates of deposit. Cash and cash equivalents declined by $2.2 million during the period.
Borrowed funds totaled $181.9 million at June 30, 2019, consisting of $171.7 million of short-term borrowings and $10.1 million of long-term borrowings. Management reported primary liquidity sources of $630.7 million and additional contingent liquidity of $366.8 million.
Material Changes Versus Prior Comparable Period
- Six-month net income increased 11.7% to $12.6 million; second-quarter net income increased 11.5% to $6.4 million.
- Tax-equivalent net interest income increased 5.0% for the six months and 5.8% for the quarter, primarily due to growth in earning assets. The six-month net interest margin declined modestly from 2.94% to 2.90%, while the quarterly margin was unchanged at 2.88%.
- Interest expense rose substantially, particularly on deposits, increasing 47.5% for the six months. This offset part of the growth in interest income.
- Non-interest income increased 6.9% for the six months, led by loan swap fees, wealth management income, and other operating income. No net securities gains were recorded in 2019 versus $136,000 in the prior-year six-month period.
- Non-interest expense increased 2.2% for the six months. Higher employee, furniture and equipment, and other operating costs were partly offset by lower FDIC insurance expense.
- Total assets increased $54.1 million, or 2.8%, from December 31, 2018. Loans increased $10.8 million, or 0.9%, while investment securities increased $49.4 million.
- Commercial loans increased $21.3 million from year-end, residential term loans increased $12.2 million, and municipal loans declined $15.0 million due to expected payoffs.
- Total deposits increased $65.9 million, or 4.3%, from year-end. Low-cost deposits declined $35.9 million, while certificates of deposit increased $125.6 million, indicating greater reliance on term funding.
- Borrowed funds declined $28.5 million from year-end and $115.6 million year over year.
- Shareholders’ equity increased from $191.5 million at year-end to $204.6 million. The accumulated unrealized position on available-for-sale securities improved from a $5.1 million loss to a $2.8 million gain.
Outlook, Risks, Contingencies, and Unusual Items
Management described the 2019 start as strong and stated that margins remained stable, operating expenses were controlled, and credit quality remained solid. A quarterly dividend of $0.30 per share was declared, representing a payout ratio of approximately 50.85% for the quarter.
The company reported total risk-based capital of 15.43% at the holding-company level and 15.35% at the Bank, both above applicable well-capitalized thresholds. Management identified remaining well-capitalized status as a priority.
- Nonperforming loans were $15.4 million, or 1.23% of total loans, compared with 1.17% at June 30, 2018 and 1.19% at December 31, 2018. Nonperforming assets were 0.83% of total assets.
- Total past-due loans were $12.3 million, or 0.98% of total loans, compared with 0.61% a year earlier. Loans 90 days or more past due and accruing increased to $672,000 from $351,000 at year-end.
- There were 83 troubled debt restructured loans totaling $24.5 million. Of that balance, 35.4% was on nonaccrual status, including $8.7 million across 23 loans. Nine TDR loans totaling $1.0 million were involved in bankruptcy.
- Impaired loans totaled $31.2 million, including $11.0 million with specific reserves of $1.8 million. The unallocated allowance increased to $1.8 million, or 16.0% of the total allowance, from $1.2 million at year-end.
- Investment securities with temporary impairment had a fair value of $84.7 million and unrealized losses of $1.3 million. Management concluded the losses were not other-than-temporary and stated it had the intent and ability to hold the securities until recovery or maturity. One municipal issuer was downgraded below investment grade and is being monitored.
- Management expects short-term interest rates to decline over the next one to three quarters. Interest-rate modeling indicated a projected first-year net interest income decline of 4.10% if rates rise 2 percentage points and a decline of 0.24% if rates fall 1 percentage point.
- The company uses interest-rate swaps for risk management. Six cash-flow hedges had aggregate notional amounts of $150.0 million at June 30, 2019. Customer loan swap contracts had total notional value of $25.8 million.
- The company is evaluating the current expected credit loss standard, ASU 2016-13, and anticipates that adoption may have a material impact. Implementation software was in the late stages of deployment; the company may qualify for a proposed delayed effective date for smaller reporting companies.
- The company is monitoring the potential discontinuation of LIBOR after December 31, 2021 and reviewing the related contracts. Management believes LIBOR exposure is modest.
- Management identified economic conditions, interest-rate volatility, deposit runoff, wholesale funding availability, loan demand and collectability, securities values, regulatory changes, and competition as principal forward-looking risks. No material changes were reported to the risk factors in the 2018 Form 10-K, and no reportable legal proceedings were disclosed.
Investor Verification Priorities
- Verify the sustainability of earnings growth given the substantial increase in deposit interest expense and the modest decline in the six-month net interest margin.
- Monitor deposit mix, certificate-of-deposit pricing and maturities, wholesale funding needs, and the company’s stated liquidity capacity.
- Reconcile changes in nonperforming loans, delinquencies, TDRs, impaired loans, charge-offs, and the growing unallocated allowance.
- Assess potential effects of CECL adoption on the allowance, capital, earnings, and dividend capacity.
- Review the investment portfolio for interest-rate, municipal credit, prepayment, and unrealized-loss exposure, including the downgraded issuer.
- Evaluate the sensitivity of net interest income to changing rates, deposit behavior, loan prepayments, and the company’s LIBOR transition plans.
- Confirm capital ratios, regulatory buffers, dividend capacity, and the continued ability of the Bank to upstream dividends to the holding company.
- Distinguish GAAP results from tax-equivalent and other non-GAAP measures when comparing performance with peers.