FIRST CAPITAL INC annual report, FY2018

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First Capital, Inc. — 2018 Form 10-K Summary

Business context and reporting period

First Capital is a bank holding company operating through First Harrison Bank, a community bank with 18 locations in Indiana and Kentucky. Its primary markets are five counties in southern Indiana and Kentucky. The Bank gathers deposits and makes residential mortgage, commercial real estate, commercial business, construction and consumer loans. This filing covers the fiscal year ended December 31, 2018; comparisons are primarily with 2017.

Financial performance and condition

  • Earnings: Net income attributable to First Capital was $9.253 million, or $2.77 diluted EPS, versus $7.439 million, or $2.23, in 2017. Fourth-quarter attributable net income was $2.496 million ($0.75 diluted EPS), compared with $1.587 million ($0.48) in fourth-quarter 2017.
  • Interest income and margins: Net interest income rose 9.0% to $27.275 million. Net interest margin increased to 3.79% from 3.64%; interest-rate spread rose to 3.72% from 3.58%. Higher average loan balances and yields drove much of the increase.
  • Other income and expenses: Noninterest income fell to $6.168 million from $6.698 million, while noninterest expense rose to $21.615 million from $20.258 million. The efficiency ratio increased to 64.6% from 63.8%.
  • Taxes and profitability: Income tax expense declined to $1.394 million from $3.103 million, and the effective tax rate fell to 13.1% from 29.4%. Management attributed the reduction mainly to the lower federal corporate tax rate and tax-credit investments. Return on average assets was 1.19% and return on average equity was 11.46%.
  • Balance sheet: Total assets increased 4.6% to $794.2 million. Net loans grew 6.0% to $434.3 million; deposits rose 5.6% to $701.6 million. Available-for-sale securities were $261.8 million, down from $271.2 million. Stockholders’ equity attributable to the Company was $85.8 million.
  • Credit quality: The allowance for loan losses was $4.065 million, or 0.93% of gross loans, compared with $3.634 million, or 0.88%, in 2017. Net charge-offs were $737,000 (0.17% of average loans). Nonperforming assets declined to $6.199 million, or 0.78% of assets, from $6.798 million, or 0.90%; nonperforming loans were $3.057 million.
  • Cash flow: Operating activities provided $13.348 million; investing activities used $22.100 million; financing activities provided $23.949 million. Cash and cash equivalents increased $15.197 million to $41.112 million.
  • Debt and liquidity: The Bank had no FHLB advances outstanding at year-end, compared with $10.0 million a year earlier, and no borrowings under its $7.0 million combined external credit lines. Liquidity included $48.8 million of cash and interest-bearing deposits and $261.8 million of available-for-sale securities. Total stockholders’ equity was $85.956 million, including noncontrolling interest.
  • Capital: The Bank was reported as well capitalized. Its year-end total risk-based capital ratio was 14.62%, common equity Tier 1 ratio 13.87%, and leverage ratio 9.57%.

Material changes versus 2017

  • Net income attributable to the Company increased about 24%, supported by higher net interest income and lower income tax expense.
  • Loan growth was concentrated in commercial real estate, construction, land and consumer lending. Residential mortgage loans were broadly unchanged; the Bank originated $54.3 million for secondary-market sale, down from $63.4 million in 2017.
  • Deposits increased by $37.1 million, led by demand and savings accounts; time deposits declined. The Bank repaid its $10.0 million year-end 2017 FHLB borrowing.
  • Nonperforming assets improved overall, although nonperforming loans increased from $2.827 million to $3.057 million and the provision for loan losses rose from $915,000 to $1.168 million.
  • Noninterest income included a $207,000 unrealized loss on an equity investment and a $270,000 impairment loss on a tax-credit investment. Net unrealized losses on available-for-sale securities also increased, contributing to a $1.417 million after-tax other comprehensive loss.

Outlook, commentary, risks and unusual items

  • Management did not provide numerical earnings or growth guidance. Its stated priorities for 2019 include loan and secondary-market mortgage growth, deposit-account growth, reducing nonperforming assets through collections and foreclosed-property sales, investing in technology, controlling costs and evaluating expansion opportunities.
  • The Bank’s risk profile includes meaningful exposure to real estate and construction lending, commercial credit, local economic conditions, and interest-rate changes. Management specifically noted that fixed-rate loans can pressure earnings if funding costs rise; 40.9% of loans were fixed-rate at year-end.
  • Interest-rate simulations projected that a parallel 100-basis-point increase would raise one-year net interest income by 0.65%, while a 100-basis-point decrease would raise it by 3.23%. These are model estimates, not forecasts or guarantees. The filing also cautions that assumptions about repricing, prepayments and deposit behavior may differ from actual outcomes.
  • Credit-loss estimates depend on management judgments and collateral valuations. Qualitative adjustments increased the estimated allowance by approximately $3.1 million; classified-loan adjustments added $333,000. A new expected-credit-loss standard (CECL) was expected to increase the allowance through an adoption adjustment, but the amount was not yet known.
  • The Bank reported immaterial cyber-attacks or breaches during the year and continued investment in security controls. Other disclosed risks include competition, regulatory change, vendor and operational disruptions, and volatility in securities values.
  • The 2018 effective tax rate benefited from the Tax Cuts and Jobs Act and tax-credit investments. The affordable-housing investment had a $3.6 million balance and a further $2.9 million unfunded commitment; recognized tax credits and other tax benefits were $393,000.
  • The independent auditor gave an unqualified opinion on the financial statements and internal control over financial reporting. Management also concluded that disclosure controls and internal controls were effective as of year-end. No material pending legal proceeding was identified.

Important facts for investors to verify

  • Whether loan growth—especially commercial real estate, construction and consumer lending—remains consistent with underwriting standards, and how nonperforming loans and charge-offs trend.
  • The adequacy of the $4.065 million allowance given the $3.1 million qualitative-factor component, collateral discounts and planned CECL adoption.
  • Whether the 13.1% effective tax rate and earnings benefit from tax-credit investments are sustainable; review the investment’s remaining funding obligations and returns.
  • Deposit mix, pricing and retention, along with the liquidity impact of $114.4 million in total credit commitments and upcoming time-deposit maturities.
  • Interest-rate sensitivity and whether actual asset yields and funding costs track the filing’s modeled scenarios.
  • Quarterly trends in mortgage-sale gains, operating expenses, securities marks and foreclosed-real-estate write-downs, which affected reported results.