First National Corporation 10-Q Summary
Business context and reporting period
First National Corporation is a Virginia bank holding company for First Bank, serving individuals, businesses, governmental entities, nonprofits, and estates through 14 banking offices and digital channels in Virginia. This unaudited Form 10-Q covers the three and nine months ended September 30, 2020, compared with the same periods in 2019; balance-sheet comparisons are to December 31, 2019. The company identified COVID-19 as the principal operating and credit-risk factor during the period.
Financial performance and condition
Amounts below are in thousands except per-share data and percentages.
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net interest income | $7,574 | $7,071 | $22,011 | $20,935 |
| Provision for loan losses | $1,500 | $0 | $3,200 | $200 |
| Noninterest income | $2,201 | $2,191 | $6,073 | $6,211 |
| Noninterest expense | $6,135 | $6,186 | $17,892 | $18,514 |
| Net income | $1,754 | $2,493 | $5,702 | $6,840 |
| Diluted EPS | $0.36 | $0.50 | $1.17 | $1.38 |
| Net interest margin | 3.41% | 3.87% | 3.58% | 3.91% |
| Efficiency ratio | 62.35% | 65.65% | 63.04% | 66.93% |
At September 30, 2020, total assets were $942.7 million, up $142.7 million from year-end 2019. Net loans were $640.6 million, including $73.7 million of PPP loans, and deposits were $838.4 million. Shareholders’ equity was $82.3 million. Cash and cash equivalents were $122.2 million at quarter-end, compared with $45.8 million at December 31, 2019.
Nine-month operating cash flow was $9.1 million. Investing activities used $66.0 million, principally from a $74.4 million net increase in loans. Financing activities provided $133.3 million, primarily from deposit growth and the $5.0 million subordinated debt issuance. The company paid $1.5 million in dividends and repurchased $2.1 million of stock during the first nine months, although the repurchase program was suspended during the second and third quarters.
The allowance for loan losses was $7.8 million, or 1.20% of total loans, compared with $4.9 million, or 0.86%, at December 31, 2019. Nonaccrual loans and nonperforming assets were $7.0 million, or 0.74% of total assets, compared with $1.5 million, or 0.18%, at year-end 2019. The bank reported no other real estate owned.
Liquidity included $226.3 million of unused borrowing capacity, including $146.3 million from the Federal Home Loan Bank of Atlanta, $29.0 million through the Federal Reserve Discount Window, and $51.0 million of unsecured correspondent-bank lines. The bank was categorized as well capitalized, with a total risk-based capital ratio of 15.34%, common equity Tier 1 ratio of 14.09%, and Tier 1 leverage ratio of 8.67% at September 30, 2020.
Material changes versus comparable periods
- Third-quarter net income declined 30% to $1.8 million, while nine-month net income declined 17% to $5.7 million, primarily because of higher loan-loss provisions.
- Net interest income increased 7% in the quarter and 5% year to date as lower deposit funding costs and significant asset growth more than offset lower asset yields.
- Net interest margin declined 46 basis points in the quarter and 33 basis points year to date. PPP loans yielding 1.00% and increased balances of low-yielding bank deposits pressured asset yields.
- Third-quarter noninterest income was broadly stable, but nine-month noninterest income declined 2%, mainly because deposit service charges fell 32% year to date following lower overdraft activity and temporary fee relief.
- Noninterest expense declined 1% in the quarter and 3% year to date, aided by lower personnel, marketing, and other operating costs; $535 thousand of PPP origination salary costs was deferred and netted against PPP fees.
- Total loans increased $74.0 million, or approximately 13%, from year-end 2019, driven principally by $73.7 million of PPP loans and a $75.1 million increase in commercial and industrial loans.
- Deposits increased $132.0 million, with noninterest-bearing demand deposits up $67.1 million and savings and interest-bearing demand deposits up $80.8 million; time deposits declined $15.9 million.
- Impaired loans increased to $7.0 million from $1.5 million at year-end 2019. Troubled debt restructurings increased to $6.0 million from $360 thousand, and all such loans were nonperforming at September 30, 2020.
- Accumulated other comprehensive income increased to $3.4 million, largely from unrealized securities gains and the fair value of cash-flow hedges.
Guidance, outlook, risks, contingencies, and unusual items
- Management provided no quantitative earnings or revenue guidance. It stated that COVID-19 could reduce net interest income, noninterest income, and liquidity, and could increase credit-related and other operating expenses.
- At September 30, loans under payment deferral totaled $22.6 million, or 3% of loans, down sharply from $182.6 million, or 28%, at June 30. Management noted that deferrals could delay recognition of asset-quality deterioration; additional modifications could be considered in the fourth quarter.
- The bank originated $76.6 million of PPP loans, recognized $2.5 million of fees, and incurred $535 thousand of origination costs. Customers had requested forgiveness on $11.3 million of PPP balances, but SBA decisions were pending. Changes to the expected government guarantee could require additional reserves.
- Management expects continued pressure in retail/shopping, lodging, and leisure. These sectors represented approximately 4.17%, 4.13%, and 1.95% of total loans, respectively, or 10.25% combined, excluding the stated PPP presentation.
- The company issued $5.0 million of subordinated debt in June 2020 to strengthen holding-company liquidity and support the bank. Its existing $5.0 million subordinated note becomes callable in January 2021, subject to regulatory approval.
- The company entered into two interest-rate swaps with aggregate notional value of $9.0 million to convert variable-rate junior subordinated debt to fixed rates. The swaps had a $134 thousand fair-value asset at quarter-end.
- Commitments to extend credit, standby letters of credit, and mortgage rate-lock commitments totaled $138.0 million. Commitments to extend credit were $112.2 million, standby letters of credit were $10.6 million, and mortgage rate-lock commitments were $15.2 million.
- Management stated that disclosure controls were effective, no material internal-control changes were identified, and there were no material pending legal proceedings.
Most important facts for investors to verify
- Whether deferred borrowers resume scheduled payments and whether nonaccrual loans, TDRs, charge-offs, and required provisions increase after relief periods end.
- The ultimate forgiveness, repayment, and guarantee treatment of the $73.7 million PPP loan balance and the timing of SBA decisions.
- Whether commercial real estate exposure to retail, lodging, and leisure produces further collateral or credit losses.
- Whether the lower net interest margin persists as PPP balances, cash deposits, market rates, and loan demand change.
- The sustainability of deposit growth and the availability and cost of wholesale liquidity if customers withdraw funds.
- The effect of the $5.0 million subordinated note, the January 2021 call opportunity on existing debt, and continued suspension of stock repurchases on capital and shareholder returns.
- The eventual impact of COVID-19 on earnings, liquidity, capital ratios, and the allowance for loan losses, which management stated could not yet be quantified.