FIRST NATIONAL CORP quarterly report, Q2 FY2021

First National Corporation 10-Q Summary

Business context and reporting period

First National Corporation, the holding company for First Bank, provides commercial, residential, consumer, deposit, and wealth management services in Virginia. This unaudited Form 10-Q covers the three and six months ended June 30, 2021, with comparisons to the corresponding 2020 periods. Amounts are in thousands except per-share data and ratios unless otherwise stated.

Key financial metrics

Metric	Q2 2021	Q2 2020	Six months 2021	Six months 2020
Net interest income	$7,495	$7,411	$15,007	$14,437
Net interest income after loan-loss provision/recovery	$8,495	$6,611	$16,007	$12,737
Noninterest income	$2,435	$1,773	$4,578	$3,872
Noninterest expense	$6,630	$5,613	$13,280	$11,757
Net income	$3,342	$2,243	$5,778	$3,948
Diluted EPS	$0.69	$0.46	$1.19	$0.81
Net interest margin	3.10%	3.59%	3.19%	3.67%
Efficiency ratio	63.65%	60.34%	64.09%	63.36%

Q2 net income increased $1.1 million, or approximately 49%, while six-month net income increased $1.8 million, or approximately 46%.
Return on average assets was 1.31% and return on average equity was 15.33% in Q2 2021, compared with 1.00% and 11.30%, respectively, in Q2 2020.
The Q2 loan-loss recovery was $1.0 million, compared with an $800 thousand provision in Q2 2020. Six-month results included a $1.0 million recovery versus a $1.7 million provision in 2020.
Net charge-offs were $1.0 million in Q2 2021 versus $88 thousand in Q2 2020.
Net interest margin declined 49 basis points in Q2 and 48 basis points year to date, reflecting lower asset yields, but earning-asset growth supported higher net interest income.

Balance sheet, cash flow, debt, and liquidity

Total assets increased to $1.025 billion at June 30, 2021 from $950.9 million at December 31, 2020, primarily from a $79.0 million increase in securities.
Net loans declined to $611.9 million from $622.4 million. Total loans were $617.3 million, including $5.5 million of allowance for loan losses.
Total deposits increased to $914.3 million from $842.5 million, driven by higher demand and savings deposits. Time deposits declined to $95.7 million from $100.2 million.
Shareholders’ equity increased to $88.7 million from $84.9 million. Accumulated other comprehensive income declined by $1.0 million, primarily reflecting securities and hedge valuation changes.
Cash and cash equivalents ended at $128.2 million, compared with $108.3 million at June 30, 2020. Six-month operating cash flow was negative $585 thousand, investing cash flow was negative $69.2 million, and financing cash flow was positive $70.7 million.
The Company had $19.3 million of subordinated and junior subordinated debt at June 30, 2021. It also maintained a $5.0 million unsecured holding-company line of credit with no borrowings outstanding.
The Bank had $268.3 million of unused borrowing capacity with non-affiliated banks, including $192.9 million from the Federal Home Loan Bank of Atlanta. Management reported total liquidity sources of approximately $249.4 million, excluding deposits.
First Bank remained well capitalized, with total risk-based capital of 16.25%, Tier 1 risk-based capital of 15.32%, common equity Tier 1 capital of 15.32%, and Tier 1 leverage of 8.78%.

Material changes versus prior comparable periods

Revenue benefited from lower deposit funding costs and higher noninterest income. Q2 noninterest income rose 37%, led by ATM and card fees, wealth management fees, deposit service charges, and other customer service fees.
Noninterest expense rose 18% in Q2 and 13% year to date. Salaries and benefits increased, and legal and professional fees included merger-related costs of $277 thousand in Q2 and $682 thousand year to date.
Nonperforming assets declined to $2.1 million, or approximately 0.21% of total assets, from $6.7 million, or approximately 0.71%, at December 31, 2020. Nonaccrual loans declined from $6.8 million at March 31, 2021 to $2.1 million at June 30, 2021.
The allowance for loan losses declined to $5.5 million, or 0.89% of total loans, from $7.5 million, or 1.19%, at year-end 2020. Excluding fully government-guaranteed PPP loans, the allowance ratio was 0.97%.
Total securities increased to $234.8 million from $156.3 million at year-end 2020. Available-for-sale securities had $1.0 million of unrealized losses at June 30, 2021, which management attributed to interest-rate movements rather than issuer credit concerns.

Outlook, unusual items, risks, and contingencies

No formal earnings guidance was provided. Management cautioned that interim results are not necessarily indicative of full-year results.
On July 1, 2021, the Company completed its acquisition of The Bank of Fincastle for $33.8 million, consisting of $6.8 million in cash and 1,348,356 shares of common stock. Fincastle reported $267.2 million of assets, $194.5 million of loans, and $236.3 million of deposits at June 30, 2021. Its results were not included in the June 30 financial statements.
The Company estimated total Fincastle merger-related costs of $4.2 million, with $3.5 million expected in the second half of 2021. Systems conversion was expected in October 2021. Management expected First Bank to remain well capitalized after including Fincastle.
COVID-19 remains a principal risk. No loans remained in the original 90-day payment-deferral program at June 30, 2021, but $13.4 million to $14.6 million of loans had pandemic-related interest-only modifications, depending on the disclosure basis used. The modified loans were concentrated in commercial real estate, particularly lodging and leisure.
Management identified retail/shopping, lodging, and leisure exposures totaling $62.0 million, or 9.72% of total loans, as sectors subject to continued pandemic-related pressure. Future losses could increase if borrower disruptions continue beyond modification periods.
PPP balances were $51.1 million at June 30, 2021, comprising $26.1 million originated in 2020 and $25.0 million originated in 2021. The Company expects substantial forgiveness and SBA repayment, but a change in government guarantees could require additional loan-loss provisions.
Other risks include declining net interest margins, interest-rate volatility, real-estate concentration, deposit outflows, credit deterioration, reliance on funding sources and third parties, cybersecurity, regulatory changes, and integration risks from the Fincastle acquisition.
Commitments to extend credit, standby letters of credit, and rate-lock commitments totaled approximately $133.3 million. Commitments to extend credit were $114.0 million, standby letters of credit were $9.9 million, and mortgage rate-lock commitments were $8.4 million.
A shareholder lawsuit concerning alleged disclosure deficiencies in Fincastle’s merger registration statement remained pending as of the filing date. A separate similar lawsuit was voluntarily dismissed on June 24, 2021. Management believes the pending lawsuit is without merit and intends to defend it vigorously.
Management concluded that disclosure controls were effective and reported no material changes to internal control over financial reporting.

Important facts for investors to verify

Whether the Fincastle acquisition produces the expected revenue synergies, cost savings, goodwill, capital-ratio impact, and remaining merger costs.
Whether lodging, leisure, retail, and other pandemic-sensitive borrowers continue to perform after interest-only modifications expire.
Whether the $5.5 million allowance for loan losses is adequate, particularly after adoption of the expected-credit-loss standard applicable to the Company in 2023.
Whether loan growth recovers or the balance sheet continues shifting toward lower-yielding securities and bank deposits, pressuring the net interest margin.
Whether deposit growth remains stable and available wholesale funding remains accessible at acceptable costs.
The outcome and potential cost of the pending Fincastle-related shareholder litigation.
Future common dividends and any reinstatement of a stock repurchase program, which was not authorized as of June 30, 2021.