Farmers National Banc Corp. — Q3 2018 Form 10-Q
Business context and reporting period
Quarterly report for the three and nine months ended September 30, 2018. The Ohio-based financial holding company provides banking, trust, retirement consulting and insurance services, primarily in northeastern Ohio and western Pennsylvania. Comparisons below are with Q3 or the first nine months of 2017, or with December 31, 2017 for balance-sheet figures.
Financial performance and condition
- Profitability: Q3 net income was $8.1 million ($0.29 diluted EPS), up from $6.0 million ($0.22) a year earlier. Nine-month net income was $23.9 million ($0.85 diluted EPS), versus $17.5 million ($0.64). Q3 annualized ROA was 1.42% and ROE 12.80%; nine-month figures were 1.45% and 13.00%.
- Interest income and margin: Q3 net interest income rose to $19.9 million from $18.7 million; nine-month net interest income was $58.4 million versus $54.6 million. Net interest margin narrowed to 3.86% in Q3 from 3.96%, and to 3.90% for nine months from 4.01%, as funding costs rose faster than asset yields.
- Other revenue and expenses: Noninterest income increased 6.9% to $6.5 million in Q3 and 4.4% to $18.8 million year to date. Noninterest expense increased 2.5% to $16.2 million in Q3 and 1.2% to $46.7 million year to date. The tax-equivalent efficiency ratio improved to 58.7% in Q3 and 58.0% for nine months, from 59.9% in both prior-year periods.
- Taxes: Q3 effective tax rate fell to 12.8% from 25.1%; the nine-month rate was 14.7% versus 25.5%. Management attributed the decrease to the lower federal corporate tax rate and, for Q3, excess tax benefits from vested stock awards.
- Balance sheet and lending: Total assets were $2.293 billion, up from $2.159 billion at year-end 2017. Gross loans reached $1.692 billion, up $114.2 million (9.6% annualized); growth was concentrated in commercial real estate, residential real estate and agricultural loans. Deposits rose $154.0 million to $1.759 billion.
- Funding, liquidity and cash flow: Short- and long-term borrowings totaled $270.3 million, down from $296.6 million at year-end. Cash and cash equivalents were $75.6 million, up $18.0 million. Nine-month operating cash flow was $28.0 million, investing cash flow was negative $131.5 million, and financing cash flow was positive $121.6 million. The company reported $264 million of additional FHLB borrowing capacity, a $35 million Bank line of credit available, and $6.2 million in correspondent-bank revolving lines, of which $0.35 million was drawn.
- Capital: Stockholders’ equity was $248.8 million. Consolidated common equity tier 1, total risk-based capital, tier 1 risk-based capital and tier 1 leverage ratios were 12.13%, 13.00%, 12.26% and 9.87%, respectively. The Bank was classified as well capitalized.
Material changes and key developments
- Loan balances and interest income increased, but higher deposit and borrowing costs pressured margin: Q3 asset yields increased 21 basis points year over year while the cost of interest-bearing liabilities rose 41 basis points.
- Available-for-sale securities had a $14.2 million gross unrealized loss at September 30, 2018, compared with $3.5 million at year-end 2017. Nine-month other comprehensive loss, net of tax, was $11.1 million, versus income of $3.7 million in 2017. Management attributed the change primarily to market expectations for long-term interest rates and did not consider the identified losses other-than-temporary impairments.
- Credit indicators weakened modestly year over year: nonperforming loans were $9.2 million, or 0.55% of loans, versus $6.9 million and 0.44% at September 30, 2017. Nonperforming assets were 0.40% of assets. Q3 net charge-offs were $337,000 versus $592,000; the allowance was $13.4 million, or 0.79% of loans.
- Deposit growth included approximately $70 million reclassified from repurchase-agreement borrowings. Management reported repayment of $65.5 million in repurchase agreements during the first nine months.
- The company paid dividends of $0.08 per share in Q3, up from $0.07 in each of the first two quarters. Year-to-date declared dividends were $0.22 per share.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided. Management said it expects cash and cash equivalents to move back toward year-end 2017 levels over the following months as funds support loan growth and securities purchases, and intends to maintain the securities portfolio near its current proportion of assets.
- Management described the balance sheet as slightly asset-sensitive, but its modeled 100-basis-point rate decrease produced a 15.7% decline in net present value of equity, exceeding the stated policy limit. Management said it would continue monitoring the exception and may consider balance-sheet changes. A modeled 300-basis-point increase raised projected net interest income 6.4%.
- Off-balance-sheet unused commitments totaled $363.1 million. The company also had commitments of up to $8 million to invest in Small Business Investment Company funds; $6.5 million had been invested. Management stated the fair value of off-balance-sheet commitments was not material.
- The company is party to lawsuits arising in the ordinary course of business; the filing does not provide a clear quantified loss estimate. Management reported no material changes to previously disclosed risk factors.
- Expected adoption of lease accounting could add approximately $2.9 million of assets and an equal liability, with no material income-statement effect. Management has not determined the full impact of the expected-credit-loss standard, planned for adoption January 1, 2020.
Most important facts for investors to verify
- Whether loan growth can continue without further deterioration in nonperforming loans, delinquencies or allowance coverage.
- Whether deposit and borrowing cost increases continue to outpace asset-yield growth and compress net interest margin.
- The effect of securities valuation changes on accumulated other comprehensive income, capital and potential future realized losses.
- How management addresses the interest-rate-simulation policy exception and maintains liquidity as lending expands.
- The contribution of tax-law benefits and stock-award tax benefits to reported earnings, and the future impact of credit-loss and lease accounting adoption.