CB Financial Services, Inc. — 2018 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2018; it is not a standalone fourth-quarter filing. CB Financial Services is a Pennsylvania bank holding company operating Community Bank and its insurance subsidiary, Exchange Underwriters, across southwestern Pennsylvania, West Virginia and eastern Ohio. The company completed its acquisition of First West Virginia Bancorp (FWVB) on April 30, 2018, expanding its network by eight branches. Because FWVB results are included only from the acquisition date, year-over-year comparisons are affected by the merger.
Financial results and condition
| Metric | 2018 | 2017 | Change / context |
|---|---|---|---|
| Total assets | $1.281 billion | $934.5 million | Up 37.0%, primarily reflecting FWVB |
| Deposits | $1.087 billion | $773.3 million | Up 40.5%; included about $281.6 million acquired in the merger |
| Net loans | $903.3 million | $735.6 million | Up 22.8%; net loan growth was $167.7 million |
| Net interest income | $37.7 million | $29.1 million | Up 29.7%; interest income growth exceeded higher funding costs |
| Net interest margin | 3.60% | 3.58% | Up 2 basis points |
| Provision for loan losses | $2.5 million | $1.9 million | Higher amid loan growth and commercial-loan charge-offs |
| Noninterest income | $8.3 million | $7.8 million | Up 6.9% |
| Noninterest expense | $34.9 million | $25.2 million | Up 38.7%, including acquisition-related costs and expanded operations |
| Income before taxes | $8.6 million | $9.8 million | Down $1.2 million |
| Net income | $7.1 million | $6.9 million | Up 1.6%; effective tax rate fell to 17.9% from 29.3% |
| Diluted EPS | $1.40 | $1.69 | Lower, with a larger weighted-average share count after merger issuance |
| Operating cash flow | $13.7 million | $11.6 million | Cash and due from banks ended at $53.4 million |
Profitability and costs. Return on average assets was 0.61% versus 0.78%, return on average equity was 5.91% versus 7.53%, and the efficiency ratio rose to 75.85% from 68.29%. Average funding costs increased as deposit and borrowing rates rose. Salaries and benefits, acquired core-deposit-intangible amortization, occupancy and equipment costs, and merger-related expenses contributed to expense growth. The Tax Cuts and Jobs Act reduced the federal corporate rate to 21%, contributing to the lower effective tax rate.
Asset quality. Nonperforming assets declined to $7.2 million from $7.6 million, or 0.56% of total assets versus 0.81%. Nonperforming loans were 0.69% of total loans versus 0.97%. The allowance for loan losses was $9.6 million, 1.05% of loans and 151.40% of nonperforming loans. Net charge-offs increased to $1.8 million from $877,000, including approximately $1.2 million charged off on three commercial and industrial relationships. Special-mention and classified loans together fell to $31.7 million from $41.6 million.
Capital, debt and liquidity. Shareholders’ equity was $137.6 million, up from $93.3 million, including approximately $41.5 million of net equity issuance related to the FWVB transaction. Community Bank was categorized as well capitalized; its year-end common equity Tier 1 ratio was 11.44%, total capital ratio 12.57%, and Tier 1 leverage ratio 7.82%. Deposits were the primary funding source. Year-end borrowings included $31.0 million in short-term repurchase agreements and $20.0 million in long-term FHLB advances. Cash was $53.4 million and unpledged securities were $67.6 million; management stated liquidity was sufficient. Available borrowing capacity included up to $373.4 million from the FHLB, subject to collateral and other terms. The company reported $206.2 million of funding commitments, including loan commitments and unused lines.
Fourth-quarter snapshot. For the three months ended December 31, 2018, net income was $2.43 million, compared with $1.38 million in the 2017 quarter. Net interest income was $10.73 million; provision for loan losses was $400,000; noninterest income was $2.04 million; and noninterest expense was $9.38 million. Quarterly diluted EPS was $0.46 versus $0.33.
Material changes versus the prior comparable period
- The FWVB merger materially expanded the balance sheet, deposit base, loan portfolio, securities portfolio, branch network and employee count. The company issued 1,317,647 shares and paid approximately $9.8 million cash; total consideration was about $51.3 million.
- Loan growth reflected acquired loans and organic originations. Commercial real estate represented 31.5% of total loans at year-end, up from 28.1%; residential real estate represented 35.6%, down from 36.7%.
- Net interest income rose substantially, but higher expenses and credit costs constrained earnings growth. Net income increased only modestly, while diluted EPS declined.
- Available-for-sale securities increased to $225.4 million from $123.6 million, largely due to acquired securities. Mortgage-backed securities rose to $97.8 million in fair value from $17.0 million.
- Average deposit cost increased to 0.52% from 0.38%; average cost of interest-bearing deposits increased to 0.69% from 0.50%.
Outlook, risks and unusual items
- Outlook: The filing gives no quantified earnings or revenue guidance. Management expects to pursue loan diversification, core-deposit growth and insurance commission growth, while maintaining conservative underwriting. It noted that return on equity may remain relatively low until merger-related capital is deployed.
- Merger execution: Management cited potential integration, employee-retention, cost-savings and revenue-synergy risks. FWVB contributed approximately $1.5 million of net income from May 1 through December 31, 2018. Unaudited pro forma net income, assuming the merger occurred January 1, 2017, was $8.0 million for 2018 and $8.4 million for 2017; these figures are not forecasts.
- Credit and regional risks: The loan book has significant real-estate exposure, and commercial real estate and business loans carry higher risks than residential mortgages. Local activity is exposed to natural-gas prices, drilling and related regulation, as well as regional employment and property values.
- Interest-rate and funding risks: Management identified rate changes as a key market risk. Its modeled economic value of equity fell 20.6% under an instantaneous +300-basis-point scenario; the filing cautions that model assumptions limit predictive value. Time deposits of $93.0 million matured within one year, and a significant share of deposits of $100,000 or more included public-entity funds.
- Control weakness: Management concluded disclosure controls and internal control over financial reporting were not effective at year-end due to a material weakness in the manual consolidation and review process. Reclassification errors in stockholders’ equity required post-closing adjustments. Management reported no material misstatement resulted and outlined remediation steps, but gave no assurance the weakness would be remediated by year-end 2019. The independent auditor gave an unqualified opinion on the financial statements but did not attest to internal-control effectiveness.
- Other unusual items: The company disclosed an immaterial prior-period loan-collateral error: 2018 pretax income was understated by $300,000 and net income by $237,000, with 2017 overstated by the same amounts. It also recorded a $300,000 provision related to the error. ATM fraud losses increased expenses; insurance recovery claims were pending, with no recovery amount stated. No material pending legal proceedings were reported.
Important facts for investors to verify
- Whether FWVB integration delivers anticipated revenue growth, cost savings and customer retention, and how recurring expenses compare with merger-related costs.
- Current trends in net interest margin, deposit pricing and deposit retention, particularly for large and public-entity deposits.
- Loan-level developments in commercial and industrial relationships, commercial real estate exposure, charge-offs, nonperforming assets and allowance adequacy.
- Remediation progress and independent scrutiny of the material weakness in consolidation and financial-reporting controls.
- Any insurance recoveries for ATM fraud, and the realized effect of rate movements on earnings, securities values and liquidity.
- Cash-flow comparability: the filing reports consolidated operating cash flow of $13.7 million and investing cash flow of $27.5 million in 2018, with acquisition and securities-sale proceeds affecting investing cash flow.