First National Corporation — Q3 2021 Form 10-Q Summary
Business context and reporting period
First National Corporation is a Virginia bank holding company whose principal subsidiary, First Bank, provides commercial, residential, consumer, deposit, mortgage, and wealth-management services across Virginia. This unaudited Form 10-Q covers the three and nine months ended September 30, 2021, compared primarily with the corresponding 2020 periods and December 31, 2020 balance-sheet data.
The quarter included the July 1, 2021 acquisition of The Bank of Fincastle and the September 30, 2021 acquisition of $82.0 million of loans and certain fixed assets from SmartBank.
Key financial metrics
| Metric | Q3 2021 | Q3 2020 | 9M 2021 | 9M 2020 |
|---|---|---|---|---|
| Net interest income | $9.7 million | $7.6 million | $24.7 million | $22.0 million |
| Provision for loan losses | $0 | $1.5 million | ($1.0 million) recovery | $3.2 million |
| Noninterest income | $2.6 million | $2.2 million | $7.2 million | $6.1 million |
| Noninterest expense | $9.4 million | $6.1 million | $22.7 million | $17.9 million |
| Net income | $2.4 million | $1.8 million | $8.2 million | $5.7 million |
| Diluted EPS | $0.38 | $0.36 | $1.53 | $1.17 |
| Net interest margin | 3.06% | 3.41% | 3.13% | 3.58% |
| Efficiency ratio | 64.86% | 62.35% | 64.39% | 63.04% |
Q3 return on average assets was 0.71% and return on average equity was 8.64%, compared with 0.74% and 8.52%, respectively, in Q3 2020.
Financial condition, liquidity, and capital
- Total assets were $1.36 billion at September 30, 2021, up from $950.9 million at December 31, 2020, primarily due to the Fincastle acquisition and the SmartBank loan transaction.
- Loans, net of the allowance, were $817.0 million, up 31% from $622.4 million at year-end 2020. Total loans were $822.4 million, including $22.8 million of PPP loans.
- Total deposits were $1.21 billion, up from $842.5 million at year-end 2020. Noninterest-bearing demand deposits were $411.5 million, savings and interest-bearing demand deposits were $652.6 million, and time deposits were $148.4 million.
- Cash and cash equivalents ended at $114.6 million. Management reported $274.5 million of liquid assets, $239.0 million of available non-deposit funding, and $229.0 million of unused bank credit lines.
- Subordinated debt was $10.0 million and junior subordinated debt was $9.3 million. The Company also had a $5.0 million unsecured line of credit with no outstanding borrowings.
- Shareholders’ equity was $116.9 million, compared with $84.9 million at December 31, 2020. The increase primarily reflected shares issued in the Fincastle acquisition and retained earnings.
- First Bank remained well capitalized. September 30, 2021 regulatory ratios were 14.42% total capital, 13.81% Tier 1 capital, 13.81% common equity Tier 1 capital, and 9.22% Tier 1 leverage.
Material changes versus comparable periods
- Q3 net income increased $644,000, or 37%, as higher net interest income, the absence of a loan-loss provision, and stronger fee income more than offset higher operating costs.
- Net interest income increased 29% in Q3 and 12% for the first nine months, driven by substantially higher earning assets, lower deposit costs, PPP fee accretion, and acquired-loan discount accretion. The net interest margin declined 35 basis points in Q3 and 45 basis points year to date because lower-yielding securities, federal funds sold, and bank deposits grew faster than loans.
- Noninterest income increased 20% in Q3 and 19% year to date, led by service charges, ATM and card fees, wealth-management fees, and other customer-service fees.
- Noninterest expense increased 54% in Q3 and 27% year to date. The increase reflected Fincastle personnel and operating costs plus $1.3 million of Q3 merger expenses and $2.0 million year to date.
- The allowance for loan losses declined to $5.4 million, or 0.66% of total loans, from $7.5 million, or 1.19%, at year-end 2020. Net charge-offs were $31,000 in Q3.
- Nonaccrual loans declined to $2.2 million from $6.7 million at December 31, 2020. Nonperforming assets were $4.0 million, or 0.30% of total assets, including $1.8 million of other real estate owned.
- Accumulated other comprehensive income declined to $1.7 million from $3.4 million at year-end, primarily due to unrealized losses on available-for-sale securities.
Acquisitions, outlook, risks, and unusual items
- Fincastle was acquired for $33.8 million, consisting of $6.8 million cash and 1,348,065 First National shares. The transaction added six branches, approximately $267.9 million of assets, $194.5 million of loans, and $236.3 million of deposits as of June 30, 2021.
- SmartBank’s Richmond-area transaction involved $83.7 million of cash consideration for $82.0 million of loans and certain fixed assets. No deposits were assumed.
- Total estimated Fincastle merger costs are $3.4 million; management expected the remaining $1.4 million to be recorded during Q4 2021 and Q1 2022. Management also expects future cost savings and revenue benefits from integration, but cautions that they may not be realized within the expected timeframe.
- COVID-19 remains a material uncertainty. No loans remained in the original 90-day deferral program at September 30, 2021, but $13.3 million of commercial real estate and commercial and industrial loans had interest-only modifications, principally involving lodging and leisure borrowers. All were performing under modified terms or had resumed regular payments at quarter-end.
- PPP loans were $22.8 million, with $652,000 of deferred PPP income remaining to be accreted. A change in SBA forgiveness or guarantee assumptions could require additional allowance expense.
- The Company may experience future pressure from credit deterioration, lower loan demand, deposit outflows, higher funding costs, interest-rate changes, real-estate concentrations, merger integration challenges, cybersecurity events, and regulatory or accounting changes.
- The Company is preparing for adoption of the current expected credit loss standard, ASU 2016-13, required for the Company beginning in fiscal years after December 15, 2022. Management states that adoption could materially change credit-loss accounting.
- There were no material changes to previously disclosed risk factors, no material pending legal proceedings, and management concluded that disclosure controls and procedures were effective.
Most important facts for investors to verify
- Whether Fincastle integration produces the projected cost savings and revenue synergies and whether the remaining merger expenses remain near the $1.4 million estimate.
- Whether the $13.3 million of pandemic-related modified loans continue to perform after interest-only periods expire, particularly lodging and leisure exposures.
- Whether the lower allowance ratio remains adequate as acquired loans season and as the Company transitions to CECL accounting.
- Whether the lower net interest margin persists as securities and short-term liquidity balances remain elevated relative to higher-yielding loans.
- Whether deposit growth and available borrowing capacity remain sufficient to support loan growth and customer liquidity needs.
- Whether First Bank maintains its well-capitalized status after acquisition integration, continued dividends, and any future credit losses.