Business context and reporting period
Farmers National Banc Corp. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2019. The Ohio-based financial holding company provides banking, trust, retirement consulting and insurance services, primarily in northeastern Ohio and western Pennsylvania. Unless stated otherwise, dollar amounts below are in millions.
Financial results and key metrics
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $20.8 | $19.9 | $61.2 | $58.4 |
| Provision for loan losses | $0.6 | $1.0 | $1.9 | $2.5 |
| Noninterest income | $7.4 | $6.5 | $21.0 | $18.8 |
| Noninterest expense | $16.4 | $16.2 | $49.1 | $46.7 |
| Net income | $9.2 | $8.1 | $26.1 | $23.9 |
| Diluted earnings per share | $0.33 | $0.29 | $0.94 | $0.85 |
- Quarterly net income rose about 13% year over year; nine-month net income rose about 9%. Q3 return on average assets was 1.51% (1.42% prior year) and return on average equity was 12.49% (12.80%). Nine-month returns were 1.47% and 12.52%, compared with 1.45% and 13.00%.
- Net interest margin, on a fully taxable-equivalent basis, was 3.79% for Q3 versus 3.86%; for nine months it was 3.81% versus 3.90%. Management attributed the margin decline mainly to deposit-rate competition: interest-bearing liability costs rose faster than earning-asset yields.
- Q3 efficiency ratio improved to 55.9% from 58.7%; the nine-month ratio was 57.3% versus 58.0%. Effective tax rates increased to 18.4% for Q3 from 12.8%, and to 16.4% for nine months from 14.7%, due to income-tax liability adjustments.
- Operating cash flow was $26.1; investing cash flow was negative $54.2 and financing cash flow was positive $55.8 for the nine months. Cash and cash equivalents increased $27.7 to $85.7.
Financial position, liquidity and asset quality
- At September 30, 2019, total assets were $2,433.2, up from $2,328.9 at year-end 2018. Gross loans were $1,784.1, up $48.3; management reported annualized loan growth of 3.7%. Available-for-sale securities were $423.2.
- Deposits were $2,040.7, up $240.9 from year-end. Brokered time deposits increased from $25.0 to $111.9. Short-term borrowings fell to $31.0 from $244.8, while long-term borrowings rose to $45.3 from $6.0. The company said additional deposits, including brokered time deposits, funded repayment of short-term FHLB advances and new longer-term advances.
- Management reported $35.0 of unused credit-line capacity and approximately $519.1 of additional FHLB borrowing capacity. Loans-to-deposits were 87.43%, compared with 96.18% in the reported prior-year comparison.
- Stockholders’ equity was $293.2, up 11.8% from year-end, supported by earnings and a $15.0 after-tax gain in other comprehensive income from securities. The Bank was classified as well capitalized; company common equity tier 1, total risk-based capital, tier 1 risk-based capital and tier 1 leverage ratios were 12.70%, 13.58%, 12.83% and 10.42%, respectively.
- Nonperforming loans were $6.7, or 0.38% of loans, versus 0.55% at September 30, 2018; nonperforming assets were 0.28% of assets. Loans 30–89 days past due totaled $9.1, or 0.51% of loans. The allowance was $14.3, equal to 0.80% of loans and 211.31% of nonperforming loans. Q3 net charge-offs were $0.5, or an annualized 0.12% of average net loans.
Material changes, outlook and risks
- Q3 interest and dividend income increased, led by loan growth and higher loan yields; deposit and other funding costs also rose. Noninterest income increased 14.9% in Q3, including higher mortgage-loan sale gains, insurance commissions, investment commissions and trust fees. Nine-month noninterest expense rose 5.1%.
- On August 30, 2019, the company agreed to acquire Maple Leaf Financial, parent of Geauga Savings Bank. Maple Leaf had $277.8 of assets, $186.4 of gross loans and $191.0 of deposits at June 30, 2019. Closing was expected in Q1 2020, subject to shareholder and regulatory approvals. Consideration is structured for a targeted 50% cash and 50% company shares, subject to election and proration provisions.
- Effective January 1, 2020, the company planned to adopt the expected-credit-loss standard (CECL). Its preliminary estimate was a 10%–20% increase in the loan-loss reserve, subject to further testing and model refinement.
- Interest-rate simulations showed that a 100-basis-point rate decrease would reduce modeled net interest income by 4.4% and net present value of equity by 30.0%. The latter exceeded the company’s internal policy limit; management said it would continue monitoring the exception. The filing also describes the balance sheet as slightly asset sensitive.
- A $0.505 legal-contingency charge was accrued in Q2. The company expected insurance reimbursement but had not recorded a recovery by September 30. It also reported ordinary-course litigation; the filing does not quantify other potential exposure.
- The company announced a new authorization to repurchase up to 1.5 million shares. During Q3 it bought 100,697 shares at an average $14.44 under the prior authorization; no shares were bought under the new program through quarter-end. The Q3 dividend was $0.10 per share. Management said cash was expected to decline toward year-end 2018 levels as it was used for loan growth and securities purchases. No earnings or revenue guidance was provided.
- Other notable items: securities available for sale had $14.5 of gross unrealized gains and $0.6 of gross unrealized losses; management considered the losses temporary. The trust and retirement consulting businesses were combined into one reporting segment during Q3. Management stated disclosure controls were effective and there were no material changes in internal control over financial reporting.
Important facts for investors to verify
- Progress, approvals, financing, consideration mix and expected timing of the Maple Leaf acquisition, including integration costs and resulting capital needs.
- CECL implementation assumptions and whether the preliminary 10%–20% reserve increase changes before adoption.
- Deposit pricing, brokered-deposit reliance and funding mix, and their effects on net interest margin and liquidity.
- Credit trends, charge-offs, delinquencies and reserve adequacy as the loan portfolio grows.
- Resolution and insurance recovery of the $0.505 legal accrual, and any developments in other litigation.
- Interest-rate exposure and management’s response to the policy exception for modeled equity value under falling rates.