FIRST NATIONAL CORP quarterly report, Q1 FY2017

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First National Corporation 10-Q Summary

Business Context and Reporting Period

First National Corporation is a Virginia bank holding company for First Bank, which provides lending, deposit, mortgage, wealth management, and related services in Virginia’s Shenandoah Valley and central regions. The filing covers the unaudited three months ended March 31, 2017, with comparisons to the three months ended March 31, 2016 and the December 31, 2016 balance sheet.

Key Financial Metrics

  • Net income: $1.543 million, or $0.31 basic and diluted earnings per share, versus $1.099 million, or $0.22 per share, in the prior-year quarter.
  • Revenue and margins: Net interest income increased 5% to $5.992 million. Noninterest income was $1.941 million, essentially unchanged. Net interest margin rose to 3.70% from 3.63%; the tax-equivalent interest rate spread was 3.58% versus 3.52%.
  • Profitability: Pretax income increased to $2.182 million from $1.525 million. Return on average assets was 0.88% versus 0.64%, and return on average equity was 11.78% versus 9.39%. The efficiency ratio improved to 69.52% from 77.32%.
  • Expenses: Noninterest expense declined 6% to $5.751 million, primarily reflecting lower salaries and employee benefits, legal and professional fees, and occupancy costs.
  • Credit costs and asset quality: No provision for loan losses was recorded in either quarter. The allowance for loan losses was $5.451 million, or 1.10% of total loans, compared with $5.520 million, or 1.22%, at March 31, 2016 and $5.321 million, or 1.09%, at December 31, 2016. First-quarter 2017 net recoveries were $130 thousand. Nonaccrual loans were $1.596 million, and total nonperforming assets were $1.846 million, or 0.25% of total assets.
  • Balance sheet: Total assets increased 2% to $727.296 million from $716.000 million at year-end. Net loans increased 2% to $492.319 million; total loans were $497.770 million. Deposits increased to $654.769 million from $645.570 million. Shareholders’ equity rose to $53.978 million from $52.151 million.
  • Cash flow: Operating activities provided $2.835 million, investing activities used $7.155 million, and financing activities provided $9.067 million. Cash and cash equivalents increased to $45.839 million from $41.092 million at year-end.
  • Debt and liquidity: Subordinated debt was $4.934 million and junior subordinated debt was $9.279 million. The Bank had no FHLB borrowings and reported $131.0 million of unused non-deposit funding capacity, including $80.4 million from the FHLB. Liquid assets and loans maturing within one year totaled $111.5 million.
  • Capital: First Bank was categorized as well capitalized. At March 31, 2017, total risk-based capital was 13.53%, Tier 1 risk-based capital was 12.43%, common equity Tier 1 capital was 12.43%, and Tier 1 leverage was 8.66%.

Material Changes Versus Prior Comparable Period

  • Net income increased $444 thousand, primarily because of higher net interest income and lower operating expenses; the benefit was partly offset by a $213 thousand increase in income tax expense.
  • Average earning assets increased 4%, while average loans represented 74% of earning assets versus 69% in the prior-year quarter. The shift away from securities toward loans supported the higher asset yield and net interest margin.
  • Loan balances increased $11.7 million during the quarter, led by residential real estate and other real estate loans. Securities decreased approximately $4.3 million as cash flows helped fund loan growth.
  • Nonperforming assets remained low but increased modestly from approximately $1.77 million at year-end, while nonaccrual loans increased from $1.520 million to $1.596 million.
  • Accumulated other comprehensive loss improved to $479 thousand from $860 thousand at year-end, primarily because of after-tax unrealized gains on available-for-sale securities.

Outlook, Commentary, Risks, and Unusual Items

  • The filing provides no formal earnings or financial guidance. Management cautions that first-quarter results are not necessarily indicative of full-year performance.
  • Management believes liquidity and capital are sufficient to support deposit requirements, customer borrowing needs, and anticipated asset growth.
  • Key risks include real estate and construction-loan concentrations, borrower credit deterioration, loan-loss-estimate uncertainty, interest-rate changes, competition for loans and deposits, regulatory changes, cybersecurity and operational risks, dependence on local economic conditions, and the limited trading market for the Company’s common stock.
  • At March 31, 2017, commitments to extend credit, standby letters of credit, and mortgage rate-lock commitments totaled $95.9 million. Commitments to extend credit were $78.3 million, standby letters of credit were $10.9 million, and locked-rate mortgage commitments were $6.7 million.
  • The Company is pursuing termination of its defined benefit pension plan, subject to Internal Revenue Service and Pension Benefit Guaranty Corporation approval. The filing previously anticipated a $2.1 million contribution upon termination, but the timing of approval remains unknown.
  • The Company adopted ASU 2016-09 for share-based compensation on January 1, 2017; management reported no material impact. The Company does not expect the other disclosed forthcoming accounting standards to have a material impact, although the effect of the expected-credit-loss standard remains under assessment.
  • Available-for-sale and held-to-maturity securities had aggregate unrealized losses of $1.581 million. Management considered the losses temporary and related to interest-rate changes rather than issuer credit concerns.
  • No material changes were reported in legal proceedings, risk factors, contractual obligations, or internal control effectiveness.

Important Facts for Investors to Verify

  • Whether loan growth, particularly in real estate and construction lending, remains consistent with underwriting standards and whether nonaccrual and potential problem loans continue to decline.
  • Whether the $5.451 million allowance for loan losses remains adequate as the loan portfolio expands and as the expected-credit-loss standard approaches adoption.
  • The timing, funding requirements, and final cost of terminating the defined benefit pension plan.
  • The sustainability of the improved efficiency ratio and lower personnel and professional-fee expenses.
  • The effect of changing interest rates on the net interest margin, deposit costs, securities valuations, and borrower repayment capacity.
  • The availability and terms of the $131.0 million in unused borrowing capacity and the potential funding needs associated with off-balance-sheet commitments.