Norwood Financial Corp. — Q2 2018 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2018. Norwood is a bank holding company whose primary business is conducted through Wayne Bank, serving northeastern Pennsylvania and parts of New York. Amounts below are in millions of dollars unless otherwise noted.
Financial performance and position
- Q2 earnings: Net income was $3.51 million, up 29% from $2.72 million in Q2 2017. Basic and diluted EPS were $0.57 and $0.56, respectively, versus $0.44 and $0.43. Annualized return on average assets was 1.23% and return on average equity was 12.25%.
- Six-month earnings: Net income was $6.64 million, up 30% from $5.10 million. Basic and diluted EPS were $1.07 and $1.06, versus $0.82 and $0.81. Annualized return on average assets was 1.18% and return on average equity was 11.63%.
- Revenue and margins: Q2 net interest income was $9.22 million, up from $8.66 million; other income was $1.77 million, up from $1.66 million. For the first six months, net interest income was $18.02 million versus $17.15 million, and other income was $3.47 million versus $3.30 million. Tax-equivalent net interest margin was 3.54% in Q2, unchanged year over year, and 3.50% for six months versus 3.53%.
- Costs and taxes: Q2 noninterest expense increased 3.6% to $6.35 million, largely from higher salaries and benefits. Six-month noninterest expense declined to $12.60 million from $12.74 million, primarily because foreclosed-real-estate expense fell. Effective tax rates were 16.6% for Q2 and 16.1% for six months; management attributed the lower rates principally to the federal corporate tax-rate reduction.
- Assets and lending: Total assets were $1.151 billion, up from $1.133 billion at year-end. Loans were $803.8 million, up from $764.1 million; growth included $26.1 million in commercial loans and $13.5 million in retail loans. The allowance for loan losses was $8.33 million, or 1.04% of loans, compared with $7.63 million, or 1.00%.
- Credit quality: Nonperforming loans fell to $1.27 million, or 0.16% of loans, from $2.48 million, or 0.32%, at year-end. Nonperforming assets were $2.66 million, or 0.23% of assets, versus $4.14 million, or 0.37%. Six-month net charge-offs were $0.28 million, compared with $0.24 million a year earlier.
- Deposits, debt, and liquidity: Deposits rose $21.5 million to $950.9 million, with management citing seasonal municipal savings-account activity. Short-term borrowings were $43.3 million and other borrowings $30.3 million, for total borrowings of $73.6 million, down from $78.5 million at year-end. Cash and cash equivalents were $16.1 million. Cash plus available-for-sale securities totaled $275.5 million, or 23.9% of assets, versus $297.8 million, or 26.3%, at year-end; management said liquidity remained adequate.
- Cash flow and capital: Six-month operating cash flow was $9.21 million; investing activities used $23.74 million, including $40.39 million of net loan growth; financing activities provided $13.94 million. Cash and cash equivalents decreased $0.59 million. Stockholders’ equity was $115.5 million. The company reported Tier 1 leverage of 9.61%, Tier 1 and Common Equity Tier 1 risk-based capital ratios of 13.06%, and total risk-based capital of 14.06%; it said it complied with applicable capital requirements.
Material changes and management commentary
- Earnings growth reflected higher net interest income, lower loan-loss provision, and a substantial reduction in foreclosed-real-estate expense for the six-month comparison. Loan growth contributed to interest income, while runoff in securities helped fund lending.
- Funding costs rose: the six-month average cost of interest-bearing liabilities increased to 0.61% from 0.46%, and the average cost of time deposits rose to 1.13% from 0.91%. Management also noted that rising rates on deposits and overnight borrowings increased interest expense.
- Available-for-sale securities declined to $259.4 million from $281.1 million at year-end. Accumulated other comprehensive loss widened to $7.04 million from $2.67 million, reflecting unrealized securities losses associated, in management’s view, with interest-rate and spread changes. The company recorded no other-than-temporary impairment and said it did not intend, and was not likely required, to sell the securities before recovery.
- The company reported a positive 90-day interest-sensitivity gap of $9.8 million, down from $20.3 million at year-end. Its modeled net-interest-income exposure to a plus or minus 200-basis-point rate shift was within policy limits, which allow no more than a 10% decline.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific earnings or revenue guidance. Management cautioned that interim results are not necessarily indicative of full-year or future results.
- Risks highlighted include loan losses exceeding the allowance, commercial-lending and real-estate exposure, regional economic conditions, interest-rate and liquidity risks, deposit competition, acquisition integration, cybersecurity, regulation, capital availability, and potential impairment of goodwill or other assets.
- Credit concentrations included commercial rentals of $79.2 million (9.8% of loans) and hospitality/lodging of $61.2 million (7.6%). Management reported no losses in these named concentrations during the first half of 2018.
- Off-balance-sheet commitments totaled $121.4 million: $43.3 million to grant loans, $72.4 million of unfunded credit lines, and $5.7 million of standby letters of credit. The filing says some commitments may expire undrawn and the recorded liability for standby-letter guarantees was not material.
- A lawsuit referenced in the prior annual report was settled, with all claims dismissed by agreement on July 18, 2018. Norwood Settlement Services, LLC’s existence terminated on May 29, 2018. The company adopted the new revenue-recognition standard in January 2018, with no material impact; it estimated the future lease-accounting adoption would increase assets and liabilities by less than 1%. The expected effect of the upcoming credit-loss standard could not yet be quantified.
- The company declared cash dividends of $0.44 per share for the first half. It reported no share repurchases during Q2; 129,500 shares remained available under its repurchase authorization.
Important facts for investors to verify
- Whether loan growth and improving nonperforming-asset ratios continue, and whether allowance coverage remains appropriate as consumer and commercial lending expand.
- How deposit pricing and funding costs respond to further rate changes, and whether net interest margin holds up as securities run off and loan balances grow.
- Whether securities valuation losses and the decline in available liquidity materially affect equity, liquidity management, or future earnings.
- The eventual allowance and retained-earnings effects of adopting the expected-credit-loss standard, which management said it could not yet estimate.
- Actual utilization and credit quality of the $121.4 million in lending commitments, along with exposure to commercial rentals, hospitality, and the regional economy.