First National Corporation — Q2 2022 Form 10-Q Summary
Business context and reporting period
First National Corporation is a Virginia bank holding company for First Bank, which provides commercial, real estate, consumer, deposit, mortgage, and wealth management services through 20 branches, a loan production office, customer service centers, digital channels, and ATMs. The filing covers the three and six months ended June 30, 2022; financial statements are unaudited.
Results include the July 2021 acquisition of The Bank of Fincastle and the September 2021 acquisition of the SmartBank Richmond-area loan portfolio. The Fincastle acquisition added approximately $267.9 million of assets, six branches, and $236.3 million of deposits at closing. The SmartBank transaction added an $82.6 million loan portfolio.
Key financial metrics
| Metric | Q2 2022 | Q2 2021 | Change |
|---|---|---|---|
| Total interest and dividend income | $11.8 million | $8.0 million | +47% |
| Net interest income | $11.3 million | $7.5 million | +51% |
| Provision for loan losses | $0.4 million | $(1.0) million recovery | Unfavorable $1.4 million |
| Noninterest income | $2.8 million | $2.4 million | +14% |
| Noninterest expense | $8.9 million | $6.6 million | +35% |
| Net income | $3.8 million | $3.3 million | +15% |
| Diluted earnings per share | $0.61 | $0.69 | Down from share dilution and higher shares outstanding |
| Net interest margin | 3.42% | 3.10% | +32 basis points |
| Efficiency ratio | 62.69% | 63.65% | Improved |
| Return on average assets | 1.08% | 1.31% | Declined |
| Return on average equity | 15.04% | 15.33% | Declined |
For the six months ended June 30, 2022, net income was $7.6 million, or $1.21 diluted EPS, versus $5.8 million, or $1.19 diluted EPS, in the prior-year period. Net interest income increased 46% to $21.8 million, noninterest income increased 20% to $5.5 million, and noninterest expense increased 32% to $17.6 million. The six-month net interest margin was 3.39%, compared with 3.19%.
Balance sheet, debt, liquidity, and capital
- Total assets were $1.415 billion at June 30, 2022, up $25.3 million from December 31, 2021.
- Loans, net of allowance, were $873.9 million, up $54.5 million, or 7.0%. Total loans were $880.1 million, with the largest balances in other real estate loans of $401.0 million and 1-4 family residential loans of $312.1 million.
- Total deposits were $1.296 billion, up $47.4 million from year-end. Noninterest-bearing demand deposits were $431.3 million, savings and interest-bearing demand deposits were $731.1 million, and time deposits were $133.7 million.
- Cash and cash equivalents were $124.4 million at June 30, 2022, compared with $176.0 million at year-end.
- Subordinated debt declined to $5.0 million from $10.0 million after a $5.0 million repayment on January 1, 2022. Junior subordinated debt remained $9.3 million.
- Shareholders’ equity declined to $100.3 million from $117.0 million, primarily because accumulated other comprehensive loss increased by $23.0 million from unrealized securities losses.
- Management reported available liquidity of $210.8 million from cash, bank deposits, securities, and loans maturing within one year. Additional non-deposit funding availability was $385.0 million, including $287.8 million from the Federal Home Loan Bank, $46.2 million through the Federal Reserve Discount Window, and $51.0 million of unsecured correspondent-bank lines.
- First Bank remained well capitalized. At June 30, 2022, total capital to risk-weighted assets was 14.23%, common equity Tier 1 capital was 13.56%, and Tier 1 leverage was 8.87%.
Cash flow and securities
- Six-month operating cash flow was $12.3 million, compared with $(0.6) million in the prior-year period.
- Investing activities used $104.6 million, including $54.2 million of net loan growth and $70.2 million of net purchases of available-for-sale and held-to-maturity securities.
- Financing activities provided $40.7 million, primarily from deposit growth, partially offset by the subordinated-debt repayment and dividends.
- Available-for-sale securities were $264.8 million and held-to-maturity securities were $77.2 million at June 30, 2022.
- Total unrealized losses on securities were $37.8 million, compared with $2.7 million at year-end, primarily due to higher market interest rates. Management characterized the losses as temporary and related to interest-rate movements rather than issuer credit concerns.
Material changes versus the prior comparable period
- Higher interest rates, substantially larger earning assets, and the Fincastle acquisition drove a 51% quarterly increase in net interest income. Average earning assets increased 37%, and the net interest margin expanded by 32 basis points.
- Loan interest income benefited from purchased-loan discount accretion of $351 thousand in Q2 2022, while PPP income accretion declined to $35 thousand from $509 thousand.
- Noninterest income growth reflected higher deposit service charges, ATM and check-card fees, wealth management fees, and other customer-service fees. Brokered mortgage fees declined.
- Expense growth reflected additional employees, branches, customers, and operations from the Fincastle and SmartBank transactions. Salaries and employee benefits increased $1.4 million in the quarter.
- Credit trends improved in several areas: nonperforming assets declined to $2.1 million from $4.2 million at year-end, impaired loans declined to $586 thousand from $2.3 million, and net charge-offs were $26 thousand in Q2 2022 versus $1.0 million in Q2 2021. However, the provision increased because of loan growth.
Guidance, outlook, risks, contingencies, and unusual items
- The filing provides no formal earnings or revenue guidance. Management cautions that interim results are not necessarily indicative of full-year results.
- Management stated that expected Fincastle cost savings had been substantially achieved by June 30, 2022. Merger-related expense was $20 thousand in the first six months of 2022 versus $682 thousand in the prior-year period.
- The company is preparing for adoption of the current expected credit loss model under ASU 2016-13, required for smaller reporting companies for fiscal years and interim periods beginning after December 15, 2022. Management expects the standard could materially change credit-loss accounting but has not quantified the impact.
- Loans modified under COVID-19 relief provisions totaled $4.7 million and were performing at quarter-end. PPP loans totaled $845 thousand, with $8 thousand of deferred PPP income remaining.
- At June 30, 2022, commitments to extend credit were $161.3 million and standby letters of credit were $18.1 million. These commitments may create future funding and credit exposure but do not necessarily represent future cash requirements.
- The company has $9.0 million of interest-rate swaps designated as cash-flow hedges for junior subordinated debt. The related fair value asset was $2.2 million. The debt is expected to transition from LIBOR to SOFR by June 30, 2023.
- Principal risks include interest-rate changes, deposit outflows, liquidity availability, real estate concentration, credit losses, collateral values, inflation and economic slowdown, competition, cybersecurity, reliance on third parties, regulatory changes, and the continuing effects of COVID-19.
- The filing reports no material changes to previously disclosed risk factors, no material pending legal proceedings, and effective disclosure controls and procedures.
Most important facts for investors to verify
- Whether loan growth and higher rates can sustain net interest margin expansion as deposit pricing pressure increases.
- The scale and timing of the CECL adoption impact on the allowance, capital, and earnings.
- Whether the $37.8 million securities unrealized loss remains temporary and does not require sales or impairment charges.
- Credit performance in the real estate-heavy loan portfolio, including nonperforming assets, past-due loans, TDRs, and the $4.7 million of COVID-related modifications.
- Liquidity and deposit stability relative to the $385.0 million of available non-deposit funding.
- The ongoing expense base and realization of remaining merger-related operating benefits.