First Bancorp — Q2 2017 Form 10-Q
Business context and period. First Bancorp is a North Carolina bank holding company. This unaudited filing covers the quarter and six months ended June 30, 2017. Results are materially affected by the March 3 acquisition of Carolina Bank; year-over-year comparisons are therefore not solely organic.
Financial performance and condition
- Q2 earnings: Net income was $11.2 million, versus $7.6 million; diluted EPS was $0.45, versus $0.37, up 21.6%. Net interest income was $39.9 million, up 26.6%, and noninterest income was $11.9 million, versus $5.9 million. Noninterest expense rose to $35.1 million from $26.1 million. No loan-loss provision was recorded in Q2 2017; Q2 2016 had a $0.3 million provision reversal.
- First-half earnings: Net income was $18.7 million versus $14.5 million; diluted EPS was $0.80 versus $0.70, up 14.3%. Net interest income was $74.2 million, noninterest income $21.7 million, and noninterest expense $67.2 million. The loan-loss provision was $0.7 million, compared with a $0.02 million reversal in first-half 2016.
- Margins and revenue drivers: Tax-equivalent net interest margin was 4.08% in Q2 and first-half 2017, versus 4.21% and 4.14%, respectively, in 2016. Management cited loan growth and Carolina Bank for higher net interest income, while higher borrowing costs and a relatively flat yield curve pressured margin. Loan discount accretion was $2.0 million in Q2 and $3.3 million in the first half.
- Balance sheet at June 30: Assets were $4.53 billion, loans $3.38 billion, deposits $3.64 billion, borrowings $355.4 million, and shareholders’ equity $500.7 million. Versus June 30, 2016, assets increased 30.6%, loans 29.9%, and deposits 26.9%; acquisition growth contributed significantly. First-half organic loan growth was $167.7 million and organic deposit growth $111.6 million.
- Cash flow and liquidity: First-half operating cash flow was $3.6 million, down from $30.9 million in 2016; investing cash use was $65.4 million and financing cash provided was $173.4 million. Cash and cash equivalents ended at $417.6 million. Available unused credit lines were $467 million. Liquid assets were 18.8% of deposits and borrowings, down from 19.8% a year earlier; management considered liquidity adequate.
- Capital: Total risk-based capital was 12.61%, down from 14.10% a year earlier; Common Equity Tier 1 was 10.44%, and Tier 1 leverage was 9.77%. Management said the company remained well-capitalized. Tangible common equity to tangible assets was 7.98%, down from 8.18%.
- Credit quality: Nonperforming assets were $55.0 million, or 1.21% of assets, versus $77.9 million and 2.25% a year earlier. Net charge-offs were 0.03% of average loans annualized for the first half, versus 0.20%. The allowance was $24.0 million, 0.71% of loans, compared with 1.00% a year earlier; acquired-loan discounts also provide a source of loss absorption, subject to loan-level accounting.
Material changes and notable items
- Carolina Bank added approximately $497.5 million of loans and $585.4 million of deposits at acquisition. First Bancorp issued 3.80 million shares and paid $25.3 million cash; $65.3 million of goodwill was recorded. Integration and acquisition-related expenses contributed to higher costs.
- Core noninterest income grew 42.1% in Q2, including higher mortgage fees, SBA consulting fees, and $0.9 million of SBA loan-sale gains. A $0.5 million Q2 gain primarily reflected sale of default judgments. First-half securities sales generated a $0.2 million loss.
- FDIC loss-share agreements had been terminated in September 2016. The company reported no FDIC indemnification-asset income or expense in 2017, unlike 2016.
- The company agreed to acquire ASB Bancorp for approximately $175 million, with consideration targeted at 90% stock and 10% cash, subject to approvals and other conditions. Closing was expected in Q4 2017. A purported ASB shareholder lawsuit filed July 19, 2017 challenges merger disclosures; the company said the outcome and potential loss could not be predicted.
Outlook, risks, and contingencies
- Management expected continued loan growth for the remainder of 2017. Based on modeling that assumed one further rate increase in 2017, it projected net interest margin would remain fairly stable; deposit rates were expected to rise gradually. These are expectations, not formal earnings guidance.
- Interest-rate exposure, a flat yield curve, competition for quality loans, and rising funding costs may pressure margins. Management noted that short-term repricing characteristics differ from the twelve-month position.
- Loan-loss estimates, acquired-loan fair values and discount accretion, and goodwill/intangible valuations rely on judgments and may change. Management cautioned that future credit conditions or regulatory reviews could require reserve adjustments.
- Loan growth has outpaced retail deposit growth, increasing use of brokered deposits and borrowings. Brokered deposits were $167.7 million, up 76% year over year; borrowings rose to $355.4 million from $206.4 million.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. It reported no legal proceedings expected to materially affect financial condition, while separately disclosing the ASB merger lawsuit.
Key facts for investors to verify
- How much of reported earnings and growth is sustainable organically after separating Carolina Bank’s contribution and acquisition-related costs?
- Whether loan quality, reserve coverage, and acquired-loan discount accretion remain consistent with management’s assumptions.
- Whether deposit growth can reduce reliance on brokered deposits and borrowings without materially increasing funding costs or weakening liquidity.
- Progress on Carolina Bank integration and the ASB Bancorp transaction, including regulatory and shareholder approvals and the effect of the lawsuit.
- Whether margin trends and capital ratios stabilize as rates, funding costs, and post-acquisition balance-sheet composition change.