Virginia National Bankshares Corporation — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016; unaudited consolidated results. Comparisons are primarily with the corresponding 2015 periods. Balance-sheet comparisons are with December 31, 2015 unless otherwise noted. Dollar amounts are in millions except per-share data.
Business context and financial position
The company operates Virginia National Bank and VNB Wealth Management. At September 30, 2016, total assets were $569.5 million, loans were $430.9 million, deposits were $495.2 million, and shareholders’ equity was $59.3 million. Assets rose $2.0 million from year-end and $20.7 million year over year; loans increased $7.2 million from year-end and $40.8 million year over year.
- Cash and cash equivalents were $42.0 million, including $32.9 million in federal funds sold. Deposits increased $8.7 million from year-end; 77.3% were noninterest-bearing or interest-bearing transaction and money-market accounts.
- Available-for-sale and restricted securities totaled $72.2 million, down $4.3 million from year-end. Management said securities were reduced as funds were redeployed into higher-yielding loans.
- Repurchase-agreement balances were $13.5 million, down from $23.2 million at year-end. The filing does not identify other borrowings as a material funding source.
- Regulatory capital ratios were 12.33% for common equity Tier 1 and Tier 1, 13.02% total capital, and 10.24% leverage. Management reported these ratios exceeded applicable “well-capitalized” levels.
Revenue, earnings, margins, and cash flow
- Q3 2016: Net interest income was $4.54 million, noninterest income $1.41 million, pretax income $2.03 million, and net income $1.40 million, or $0.59 per diluted share. Net income rose 66% from $0.84 million, or $0.34 per diluted share, in Q3 2015.
- Nine months 2016: Net interest income was $13.48 million, noninterest income $3.79 million, pretax income $6.18 million, and net income $4.26 million, or $1.79 per diluted share. Net income increased 111% from $2.02 million, or $0.79 per diluted share, in the prior-year period.
- Net interest margin on a fully taxable-equivalent (FTE) basis was 3.41% for Q3 and 3.46% for the first nine months, compared with 3.22% and 3.12%, respectively, in 2015. The FTE efficiency ratio improved to 63.8% for Q3 and 65.4% year to date, from 76.0% and 78.9%.
- For the first nine months, noninterest expense declined 8.5% to $11.38 million, including a $0.99 million reduction in salaries and benefits. The effective tax rate was 31.1%, versus 26.5% for the first nine months of 2015.
- Operating cash flow was $4.54 million, investing activities used $3.27 million, and financing activities used $2.77 million. Cash and cash equivalents decreased $1.50 million to $42.03 million. Cash dividends paid were $0.78 million; share repurchases used $1.26 million.
Material changes versus prior periods
- Growth in loan balances and a shift from lower-yielding securities to loans lifted interest income and margins. Average loans were $45.3 million higher in Q3 year over year; for the first nine months, average loans represented 80.2% of earning assets versus 67.8% in 2015.
- The company recorded a $0.29 million recovery of loan-loss provision in the first nine months of 2016, versus a $0.41 million provision in 2015. The allowance declined to $3.28 million, or 0.76% of loans, from $3.57 million, or 0.84%, at year-end.
- Noninterest income increased $0.13 million year to date. Brokerage and insurance income benefited from the wealth-management book acquisition; securities gains were $0.19 million versus $0.07 million a year earlier. Lower trust and royalty income partly offset these increases.
- VNB Wealth purchased a client-relationship book effective February 1, 2016, with $31.5 million in associated assets under management. The purchase price was $1.2 million, payable over five years; the company recorded $0.37 million of goodwill and $0.71 million of net finite-lived intangibles. Remaining annual payments were reflected in a $0.45 million contingent liability at quarter-end.
- The stock repurchase program expired in September 2016. The company repurchased 55,062 shares during the first nine months of 2016 and none in Q3.
Outlook, management commentary, risks, and unusual items
- No quantified earnings or financial guidance was provided. Management said loan growth had moderated in the first three quarters after strong growth in prior periods and expected the higher-yielding asset mix to continue supporting 2016 earnings; it cautioned that interim results are not necessarily indicative of full-year results.
- Beginning in Q2 2016, management changed the allowance methodology to a loan-level migration-analysis model, expanded loan classifications, and separately considered “Watch” loans. Management said the change should better capture portfolio risk. The company estimated the change increased the nine-month recovery of provision by $129,000 versus the prior methodology.
- Credit indicators included $2.4 million of impaired loans, $173,000 of nonaccrual loans, and $389,000 of loans at least 90 days past due but still accruing. Fifty purchased student loans totaling $868,000 were classified as performing troubled debt restructurings under regulatory guidance; management said these loans were fully insured and no loss was expected.
- Management reported $77,000 of unrealized losses on securities and considered them temporary, citing its intent and ability to hold the securities and its view that the losses were not credit-related. The portfolio is exposed to interest-rate changes.
- The Loudoun Mall branch in Winchester closed on October 28, 2016, after the reporting date; accounts and staff were transferred to another office. The company said it was searching for at least one new Winchester branch location.
- Forward-looking risks cited include changes in interest rates and economic conditions, borrower credit quality, competition, technology adoption, and banking, tax, and other regulatory changes. Management identified loan-loss estimates, deferred tax assets, and other real estate owned as estimates subject to uncertainty. No legal proceedings were reported; management concluded disclosure controls were effective.
Most important facts for investors to verify
- Whether loan growth, asset mix, and net interest margin can be sustained as rates and competition change.
- Whether the lower allowance ratio and the revised loss-migration methodology adequately reflect credit risk, including student-loan delinquencies and TDR classifications.
- How much of reported earnings growth depends on expense reductions, securities gains, and the acquired wealth-management book, and whether those items recur.
- Liquidity and funding trends, including deposits, federal funds sold, and repurchase-agreement balances; confirm the company’s capacity to meet commitments under stressed conditions.
- The performance and payment terms of the wealth-book acquisition, and the effect of the Winchester branch closure and any replacement location.