First National Corporation 10-Q Summary
Business Context and Reporting Period
First National Corporation is the bank holding company for First Bank, serving individuals, small and medium-sized businesses, governmental entities and nonprofit organizations in Virginia’s Shenandoah Valley. The unaudited filing covers the three and nine months ended September 30, 2014, with balance-sheet comparisons to December 31, 2013 and operating comparisons to September 30, 2013. The Bank launched its First Mortgage division in the second quarter; residential mortgage originations began in the third quarter and are generally expected to be sold into the secondary market.
Financial Condition and Key Metrics
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Total interest and dividend income | $5.2 million | $5.3 million | $15.2 million | $16.1 million |
| Net interest income | $4.8 million | $4.6 million | $13.8 million | $13.9 million |
| Provision/(recovery) for loan losses | $(0.1) million | $0.3 million | $(0.7) million | $2.5 million |
| Noninterest income | $1.7 million | $1.6 million | $5.0 million | $5.2 million |
| Noninterest expense | $4.8 million | $4.6 million | $13.9 million | $14.5 million |
| Net income | $1.2 million | $1.2 million | $3.9 million | $2.5 million |
| Net income available to common shareholders | $0.9 million | $1.0 million | $3.1 million | $1.8 million |
| Basic and diluted EPS | $0.19 | $0.21 | $0.64 | $0.37 |
Q3 net interest margin was 3.92%, compared with 3.68% in the prior-year quarter; nine-month margin was 3.82%, compared with 3.73%. Return on average assets was 0.95% for Q3 and 1.00% for nine months, versus 0.92% and 0.62%, respectively, in the comparable periods. Return on average equity was 8.64% for Q3 and 9.41% for nine months, versus 11.44% and 7.48%.
- At September 30, total assets were $519.4 million, compared with $522.9 million at December 31, 2013.
- Gross loans increased 5% to $374.7 million; loans net of allowance were $365.0 million, up from $346.4 million.
- Securities available for sale were $104.7 million, compared with $103.3 million at year-end.
- Total deposits declined 3% to $438.9 million. Noninterest-bearing demand deposits increased 11% to $103.0 million, while time deposits declined 10% to $111.2 million.
- Shareholders’ equity increased to $57.6 million from $53.6 million, aided by net income and a $1.1 million improvement in accumulated other comprehensive income.
- Cash and cash equivalents declined to $10.7 million from $31.5 million at year-end.
- Nine-month operating cash flow was $5.0 million, compared with $7.7 million in 2013. Investing activities used $18.4 million, principally reflecting a $19.4 million net increase in loans; financing activities used $7.4 million.
- Borrowings included $5.3 million of federal funds purchased, $6.0 million of other borrowings and $9.3 million of trust preferred capital notes.
- Unused non-deposit funding sources totaled $98.0 million, including $62.6 million from the Federal Home Loan Bank, $31.7 million of unsecured correspondent-bank federal funds lines and $3.7 million through the Federal Reserve Discount Window.
- Regulatory capital remained strong. First Bank’s total risk-based capital ratio was 17.71%, Tier 1 risk-based ratio was 16.44% and Tier 1 leverage ratio was 11.85%, all above well-capitalized thresholds.
Material Changes Versus Prior Comparable Period
- Q3 net income was broadly unchanged, but earnings available to common shareholders and EPS declined because preferred-stock dividends and accretion increased to $329 thousand from $229 thousand.
- Nine-month net income increased 58% to $3.9 million, and EPS increased to $0.64 from $0.37, primarily because the loan-loss provision became a $700 thousand recovery from a $2.5 million provision.
- Net charge-offs fell to $228 thousand for nine months from $3.7 million; the allowance declined to $9.7 million, or 2.59% of total loans, from $10.6 million, or 2.98%, at year-end.
- Nonperforming assets declined to $10.5 million, or 2.02% of assets, from $14.7 million, or 2.81%, at year-end. Nonaccrual loans were $8.7 million and OREO was $1.8 million.
- Impaired loans declined to $16.8 million from $21.7 million at year-end. Troubled debt restructurings remained $1.9 million, including $796 thousand performing under restructured terms.
- Noninterest income declined year to date because 2013 included a $543 thousand one-time gain from terminating a directors’ post-retirement obligation. Excluding that item, 2014 noninterest income increased 8%.
- Q3 noninterest expense increased 2%, reflecting higher salaries, recruiting and mortgage-division costs, partly offset by lower OREO and FDIC expenses. The nine-month expense decline was 4%.
- Efficiency ratio was 72.74% in Q3 and 73.15% for nine months, compared with 69.60% and 72.62%, respectively.
- Other real estate owned, net, declined from $3.0 million to $1.8 million, while the related valuation allowance declined from $1.7 million to $456 thousand.
Outlook, Risks, Contingencies and Unusual Items
The filing provides no formal earnings or revenue guidance. Management states that loan demand remained relatively low, although originations increased, and expects the new mortgage division’s future originations to be substantially sold to investors. Management believes liquidity is sufficient to meet depositor and borrowing needs and expects capital ratios to remain sufficient under Basel III requirements taking effect January 1, 2015.
- Primary risks include local economic weakness, real-estate and construction exposure, borrower repayment risk, collateral-value declines, additional nonperforming assets and the adequacy of loan-loss and OREO valuation allowances.
- Interest-rate changes may affect net interest income, deposit behavior, securities values and borrowers’ repayment capacity.
- The Company relies partly on secondary liquidity sources, including FHLB advances, securities and loan sales, correspondent-bank lines and out-of-market time deposits.
- Commitments to extend credit totaled $58.3 million and standby letters of credit totaled $6.1 million at September 30, 2014. Total commitments, standby letters of credit and rate-lock commitments were $65.3 million.
- Investment securities had $1.4 million of gross unrealized losses, which management considered temporary and attributable to interest-rate movements rather than issuer credit concerns. The portfolio was entirely investment grade.
- Preferred Stock Series A began accruing dividends at 9% after May 14, 2014, compared with 5% previously, increasing the burden on common earnings.
- The Board declared a $0.025 per common share dividend payable December 19, 2014.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting. No material legal proceedings or material changes to previously disclosed risk factors were reported.
Important Facts for Investors to Verify
- Whether the reduction in loan-loss expense and nonperforming assets is sustainable or primarily reflects recoveries, resolutions and improved historical loss assumptions.
- Credit quality trends in commercial real estate, construction and land-development loans, including the $20.1 million of other potential problem loans.
- Liquidity following the decline in cash and deposits, including the composition, availability and collateral requirements of the $98.0 million in unused funding sources.
- The effect of the 9% Series A preferred dividend rate on future earnings available to common shareholders and capital planning.
- Execution, profitability and loan-sale economics of the newly launched First Mortgage division.
- Sensitivity of net interest margin, securities valuations and borrower performance to changes in market interest rates and local economic conditions.