Business Context and Reporting Period
First National Corporation is a Virginia bank holding company whose primary subsidiary, First Bank, provides commercial, residential, consumer, deposit, and wealth-management services across the Shenandoah Valley, central Virginia, and Richmond markets. The Form 10-K covers the fiscal year ended December 31, 2019, with comparative information for 2018. The company operated 14 branches, a loan production office, and a customer service center, and had 154 full-time-equivalent employees at year-end.
Financial Performance and Condition
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Net interest income | $28.0 million | $27.6 million | Up 1% |
| Provision for loan losses | $450 thousand | $600 thousand | Down $150 thousand |
| Noninterest income | $8.6 million | $9.2 million | Down 7% |
| Noninterest expense | $24.3 million | $23.8 million | Up 2% |
| Income before taxes | $11.8 million | $12.4 million | Down 5% |
| Net income | $9.6 million | $10.1 million | Down 6% |
| Diluted earnings per share | $1.92 | $2.04 | Down 6% |
| Net interest margin | 3.88% | 3.93% | Down 5 basis points |
| Return on average assets | 1.23% | 1.34% | Down 11 basis points |
| Return on average equity | 13.19% | 16.36% | Down 317 basis points |
- Total assets increased 6% to $800.0 million. Net loans increased 6% to $569.4 million, while securities declined 3% to $140.4 million.
- Deposits increased 5% to $706.4 million, led by growth in savings and interest-bearing demand deposits. Shareholders’ equity increased 16% to $77.2 million, and equity-to-assets was 9.65%.
- Cash and cash equivalents increased to $45.8 million from $28.6 million. Operating activities provided $11.9 million of cash, investing activities used $28.9 million, and financing activities provided $34.2 million.
- Liquidity included $123.4 million of liquid assets and $218.1 million of available non-deposit funding, including $144.3 million from the Federal Home Loan Bank, $61.0 million of unsecured correspondent-bank lines, and $12.8 million from the Federal Reserve Discount Window.
- Subordinated debt was $5.0 million and junior subordinated debt was $9.3 million. The company was current on required interest payments.
- The Bank’s regulatory capital ratios were strong: common equity Tier 1 and Tier 1 ratios of 13.99%, total capital of 14.84%, and leverage of 10.13%. The Bank was categorized as well capitalized.
- Asset quality improved. Nonperforming assets declined to $1.5 million, or 0.18% of assets, from $3.2 million, or 0.42%. Net charge-offs declined to $525 thousand from $917 thousand, and the allowance for loan losses was $4.9 million, or 0.86% of total loans.
Material Changes Versus the Prior Comparable Period
- Net income declined primarily because noninterest income fell $605 thousand and noninterest expense increased $557 thousand. Higher net interest income and a lower loan-loss provision only partially offset those effects.
- Interest income increased with 3% growth in average earning assets and higher loan yields, but deposit-cost increases compressed the net interest margin. Average money-market deposits increased while lower-cost savings deposits declined.
- Noninterest income was pressured by lower deposit service charges, the absence of a prior-year bank-owned life insurance death benefit, and lower other operating income. Wealth-management fees, ATM and card fees, and loan-sale gains increased.
- Expense growth reflected higher salaries and benefits, marketing, legal and professional fees, card expenses, franchise taxes, and other operating costs. FDIC assessments and amortization expense declined.
- Commercial real estate loans increased $17.0 million, residential real estate loans increased $13.5 million, and commercial and industrial loans increased $5.5 million. Construction, consumer, and other loans declined.
- Accumulated other comprehensive income improved from a $1.8 million loss to $724 thousand of income, primarily due to unrealized gains on available-for-sale securities.
- The company adopted new lease accounting guidance in 2019, recognizing a $390 thousand right-of-use asset and lease liability at adoption; management stated that the adoption did not materially affect the financial statements.
- In January 2019, eligible securities with approximately $23.4 million of amortized cost were reclassified from held to maturity to available for sale, with a $431 thousand unrealized loss recorded in accumulated other comprehensive income.
Fourth-Quarter Results
Fourth-quarter 2019 net income was $2.7 million, or $0.55 diluted per share, compared with $2.3 million, or $0.47 diluted per share, in fourth-quarter 2018. Fourth-quarter net interest income was $7.1 million, noninterest income was $2.3 million, noninterest expense was $5.8 million, and the provision for loan losses was $250 thousand.
Guidance, Outlook, Commentary, Risks, and Unusual Items
The filing does not provide specific earnings or revenue guidance. Management stated that liquidity was sufficient for depositor requirements and customer borrowing needs and that capital levels exceeded regulatory requirements. The company plans to assess quarterly whether to adopt the community bank leverage ratio framework.
- Primary risks include economic deterioration in the company’s Virginia markets, interest-rate changes, deposit competition and higher funding costs, commercial real estate and construction-loan exposure, credit losses, and possible inadequacy of the allowance for loan losses.
- Other material risks include competition from banks, credit unions, mortgage companies, consumer lenders, and financial-technology firms; cyberattacks and technology failures; dependence on third-party service providers; regulatory and accounting changes; and limited trading liquidity in the company’s common stock.
- The company has variable-rate arrangements indexed to LIBOR and noted that the expected discontinuation of LIBOR after 2021 could create transition costs, disputes, repricing effects, or changes in market risk.
- Off-balance-sheet exposure included $92.5 million of commitments to extend credit and unfunded lines of credit, $11.0 million of standby letters of credit, and $2.2 million of locked-rate mortgage commitments.
- The company authorized a common-stock repurchase plan of up to $5.0 million through December 31, 2020, but made no open-market repurchases during 2019. Common dividends were $0.36 per share for 2019, compared with $0.20 in 2018.
- The company entered into supplemental executive retirement plans for three employees in 2019, recording $220 thousand of contribution expense.
- The company reported no material pending legal proceedings, no material loss contingencies, and no material weaknesses in internal control. The independent auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Investor Verification Checklist
- Verify the sustainability of loan growth, particularly the concentration in commercial real estate and other real-estate-secured loans.
- Monitor deposit mix, deposit pricing, funding costs, and the effect of interest-rate changes on the 3.88% net interest margin.
- Assess whether the $4.9 million allowance for loan losses remains adequate as the portfolio grows and as CECL implementation approaches.
- Review nonperforming assets, troubled debt restructurings, past-due loans, and future charge-offs; all $360 thousand of year-end TDRs were nonperforming.
- Evaluate liquidity availability and collateral requirements for the $218.1 million of non-deposit funding sources.
- Review the terms and maturity of the $5.0 million subordinated note and $9.3 million of LIBOR-indexed junior subordinated debt.
- Assess the impact of the 2019 decline in noninterest income and the company’s ability to control rising personnel, technology, compliance, and professional-service expenses.
- Track the LIBOR transition, CECL implementation, regulatory capital changes, and the potential effect of future economic or real estate-market deterioration.