First National Corporation: FY2016 Form 10-K Summary
Business context and reporting period
First National Corporation is a Virginia bank holding company whose principal subsidiary, First Bank, provides lending, deposit, mortgage, wealth-management and related services in Virginia’s Shenandoah Valley and central regions. The filing covers the fiscal year ended December 31, 2016, with comparative information for 2015. First Bank operated 14 branches, two loan production offices and a customer service center, and employed 153 full-time-equivalent employees at year-end.
Key financial metrics
| Metric | 2016 | 2015 |
|---|---|---|
| Total assets | $716.0 million | $692.3 million |
| Gross loans | $486.1 million | $439.0 million |
| Loans, net | $480.7 million | $433.5 million |
| Deposits | $645.6 million | $627.1 million |
| Shareholders’ equity | $52.2 million | $46.0 million |
| Net interest income | $23.3 million | $20.7 million |
| Noninterest income | $8.5 million | $8.3 million |
| Noninterest expense | $23.5 million | $25.6 million |
| Net income | $5.9 million | $2.7 million |
| Net income available to common shareholders | $5.9 million | $1.5 million |
| Basic and diluted EPS | $1.20 | $0.31 |
| Net interest margin | 3.61% | 3.52% |
| Return on average assets | 0.84% | 0.41% |
| Return on average equity | 12.00% | 4.58% |
| Efficiency ratio | 71.05% | 80.92% |
Net cash provided by operating activities was $9.0 million, compared with $4.6 million in 2015. Investing activities used $25.3 million, primarily reflecting $47.3 million of net loan growth, while financing activities provided $18.1 million. Cash and cash equivalents increased to $41.1 million from $39.3 million.
Interest expense was $2.0 million, compared with $1.4 million in 2015. Subordinated debt totaled $4.9 million and junior subordinated debt totaled $9.3 million at year-end. The subordinated term note has a fixed 6.75% rate and matures in 2025. The junior subordinated debt carries LIBOR-indexed rates.
Liquidity sources included $114.9 million of cash, bank deposits, securities and loans maturing within one year, plus $125.6 million of available non-deposit funding, including $82.7 million from the Federal Home Loan Bank, $42.0 million of unsecured correspondent-bank lines and $893 thousand from the Federal Reserve Discount Window.
Material changes versus the prior comparable period
- Net income available to common shareholders increased by $4.4 million, driven by higher net interest income, lower operating expenses and the absence of preferred-stock dividends following the 2015 redemption.
- Net interest income increased 12% as average earning assets grew 10% and the net interest margin expanded by 9 basis points.
- Gross loans increased 11%, or $47.1 million, led by a $29.8 million increase in other real estate loans and a $9.5 million increase in residential real estate loans.
- Deposits increased $18.5 million. Noninterest-bearing demand deposits and savings and interest-bearing deposits grew, partly offset by a $12.7 million reduction in time deposits.
- Noninterest expense declined 8%, primarily due to lower salaries and benefits, supplies, legal and professional fees, and other real-estate-owned expenses. The 2015 period included $908 thousand of acquisition and integration expenses.
- The allowance for loan losses declined to $5.3 million, or 1.09% of loans, from $5.5 million, or 1.26%. No provision or recovery was recorded in 2016, versus a $100 thousand recovery in 2015.
- Nonperforming assets declined to $1.8 million, or 0.25% of assets, from $6.5 million, or 0.94%. Nonaccrual loans fell to $1.5 million from $3.9 million, and OREO declined to $250 thousand from $2.7 million.
- Securities declined 14% to $149.7 million as securities cash flows were used partly to fund loan growth. Unrealized securities losses increased, primarily because of market interest-rate changes; management did not identify credit-related impairment.
- The Company paid common dividends of $0.12 per share in 2016, compared with $0.10 per share in 2015, and did not repurchase common shares.
Fourth-quarter information
Fourth-quarter 2016 net income was $1.7 million, or $0.34 per basic and diluted share, compared with $941 thousand, or $0.17 per share, in the fourth quarter of 2015. Fourth-quarter net interest income was $5.9 million, noninterest income was $2.1 million, noninterest expense was $5.6 million and income before taxes was $2.4 million. No loan-loss provision was recorded in the quarter.
Guidance, outlook, risks and unusual items
The filing does not provide formal earnings or revenue guidance. Management reported that Virginia and U.S. economic conditions continued to improve during 2016, but highlighted continued sensitivity to interest rates, economic conditions, loan demand, deposit pricing and competition.
- The loan portfolio is concentrated in Virginia and has significant exposure to residential and commercial real estate, including construction and land-development lending. Declines in real-estate values or local economic activity could increase defaults, charge-offs and provision expense.
- Allowance adequacy depends on management estimates, historical loss rates, collateral values and economic conditions. Future provisions may be required despite the 2016 improvement in asset quality.
- Changes in interest rates may affect net interest income, loan repayment capacity, deposit costs, securities values and liquidity.
- Competition from larger banks, regional banks, credit unions, mortgage companies and alternative financial providers may pressure loan yields, deposit costs, fee income and market share.
- Cybersecurity incidents, technology failures, third-party service disruptions, fraud and reputational damage could result in losses, regulatory action and customer attrition.
- The Company is subject to extensive federal and state regulation, including phased-in Basel III capital requirements and changing consumer-protection, privacy and deposit-insurance rules.
- The Bank was categorized as well capitalized at December 31, 2016. Its total capital ratio was 13.47%, common equity Tier 1 ratio was 12.38%, Tier 1 leverage ratio was 8.48% and capital conservation buffer was 5.47%.
- The Company’s ability to pay common dividends depends on earnings, liquidity, capital requirements, regulatory restrictions and dividends from the Bank. Beginning January 1, 2017, the Bank could not transfer funds to the Company without prior regulatory approval under current supervisory practices.
- The defined-benefit pension plan was amended for termination, with benefit accruals ceasing November 30, 2016. The plan had a $2.1 million funded-status deficit at year-end, and the Company expected to contribute $2.1 million upon termination; regulatory approval timing remained uncertain.
- The Company had $71.4 million of commitments to extend credit, $9.0 million of standby letters of credit and $10.1 million of locked-rate mortgage commitments at year-end.
- Management stated that internal controls over financial reporting were effective and identified no material weakness. The independent auditor issued an unqualified opinion on the consolidated financial statements.
Most important facts for investors to verify
- Whether rapid loan growth, particularly in commercial and other real estate, remains consistent with underwriting standards and capital capacity.
- Whether the decline in nonperforming assets is sustained and whether the $5.3 million allowance remains adequate under changing real-estate and economic conditions.
- The sensitivity of the 3.61% net interest margin to further Federal Reserve rate changes, deposit repricing and competition for funding.
- The timing, cash cost and final funding requirements of the pension-plan termination.
- The Bank’s ability to upstream dividends to the holding company and support common-stock dividends while meeting regulatory capital requirements.
- The terms, interest-rate exposure and refinancing implications of the subordinated and junior subordinated debt.
- The impact of the forthcoming current expected credit-loss accounting model, which the filing states is expected to apply beginning January 1, 2020.