EAGLE FINANCIAL SERVICES INC quarterly report, Q3 FY2012

Eagle Financial Services, Inc. — Q3 2012 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2012. Dollar amounts are in millions unless otherwise noted. Eagle is a bank holding company whose principal subsidiary, Bank of Clarke County, takes deposits and makes commercial, consumer, and real estate loans.

Financial performance

Metric	Q3 2012	Q3 2011	Nine months 2012	Nine months 2011
Net interest income	$5.77	$5.73	$17.52	$16.91
Provision for loan losses	$1.05	$1.05	$1.65	$2.85
Noninterest income	$1.55	$1.47	$4.60	$4.60
Noninterest expenses	$4.58	$4.65	$13.56	$13.77
Net income	$1.25	$1.14	$4.97	$3.63
Diluted earnings per share	$0.37	$0.34	$1.49	$1.10

Net income rose 10.0% year over year in Q3 and 36.9% for the first nine months. Nine-month return on average assets was 1.18% (0.85% in 2011); return on average equity was 10.97% (8.75%).
Net interest margin was 4.40% in Q3 (4.34% a year earlier) and 4.52% year to date (4.33%). Nine-month net interest income increased 3.6%, as lower funding costs more than offset reduced interest income. Average interest-bearing liability cost fell to 0.89% from 1.21%.
The nine-month efficiency ratio was 59.21%, compared with 57.90% in 2011. The filing defines this non-GAAP ratio as noninterest expense divided by tax-equivalent net interest income plus noninterest income, excluding securities gains and losses.

Financial position, cash flow and liquidity

At September 30, 2012, total assets were $574.2 million, net loans $419.5 million, deposits $457.2 million, and shareholders’ equity $62.8 million. Assets increased $6.1 million from year-end 2011.
Gross loans increased 4.2% to $427.5 million; deposits increased 1.9% to $457.2 million. Noninterest-bearing demand deposits rose $14.9 million, while time deposits fell $16.0 million. Loans-to-deposits increased to 93.51% from 91.52%.
Available-for-sale securities declined $12.9 million to $101.2 million, primarily due to maturities and principal repayments. Their reported unrealized gain was $6.2 million at quarter-end.
Borrowings included $10.0 million of federal funds/repurchase agreements, $32.3 million of Federal Home Loan Bank advances, and $7.2 million of trust preferred capital notes. FHLB advances declined $10.0 million from year-end; total liabilities were $511.4 million.
For the first nine months, operating cash flow was $8.8 million, investing cash flow was negative $6.4 million, and financing cash flow was negative $2.5 million. Cash and cash equivalents ended at $21.8 million, down $0.1 million from year-end.
Management reported liquid assets of $215.5 million, or 42.14% of total liabilities, versus $246.6 million, or 48.37%, at year-end.

Credit quality, capital and material changes

Nonaccrual loans increased to $5.1 million from $2.4 million at year-end, largely due to three large loans placed on nonaccrual in Q3. Nonperforming assets were 1.73% of loans and OREO, up from 1.18% at year-end.
Past-due loans totaled $7.6 million, including $1.3 million 90 or more days past due; $10,000 of the latter remained accruing. OREO was $2.4 million.
The allowance for loan losses was $8.0 million, or 1.86% of loans, versus $8.7 million and 2.13% at year-end. Nine-month net charge-offs were $2.4 million, compared with $2.1 million in 2011. Allowance coverage of nonperforming assets declined to 106.79% from 179.45%.
There were 24 troubled debt restructurings totaling $8.4 million at September 30, versus 25 totaling $10.7 million at year-end. The company reported no commitments to lend additional amounts to TDR borrowers. Five TDRs totaling $963,000 were modified during the first nine months; five TDR loans totaling $963,000 had a payment default during that period.
Shareholders’ equity was 10.94% of assets, versus 10.23% at year-end. The Tier 1 risk-based, total risk-based, and Tier 1 leverage ratios were 16.24%, 17.50%, and 11.74%, respectively. Management stated the company remained well capitalized.

Outlook, risks and unusual items

No earnings or growth guidance was provided. Management expected to pay $0.73 per share in dividends during 2012; dividends declared for the first nine months were $0.54 per share.
The company contracted for $1.2 million to build its twelfth retail branch in Purcellville, Virginia, expected to be completed in early 2013.
Management cited credit risk, real-estate collateral values, local economic conditions, competition, interest-rate risk, growth execution, capital adequacy, regulation, and technology as risks. It noted that real estate loans represented 91.40% of total loans.
Lower loan-loss provision reflected a lower specific allowance requirement. FDIC assessment expense also fell; a $174,000 second-quarter 2012 adjustment increased prepaid FDIC insurance and reduced expense. Mortgage origination fees rose with higher volume, while deposit-account service charges were affected by regulatory changes.
The company uses a swap to convert floating-rate trust preferred debt to fixed-rate payments; the swap liability was $672,000 at quarter-end. Management said it did not expect to exercise the notes’ call provisions in the foreseeable future.
Management reported effective disclosure controls, no material change in internal control over financial reporting, no material pending legal proceedings, and no subsequent events requiring adjustment or disclosure.

Important facts for investors to verify

Whether the rise in nonaccrual loans and nonperforming assets continues, and how the affected large loans are collateralized and resolved.
Whether the lower allowance balance remains adequate given higher net charge-offs, lower allowance coverage, and the real-estate concentration.
Payment performance and subsequent status of restructured and past-due loans, including the reported TDR defaults.
Sustainability of margin and earnings gains as asset yields fall, deposits reprice, and the company funds loan growth.
Liquidity trends, deposit mix, borrowing needs, and the cost and execution of the new branch project.