First National Corporation 10-Q Summary
Business context and reporting period
First National Corporation is a Virginia bank holding company for First Bank, serving consumers, businesses, government entities, estates, and nonprofits through 14 offices and digital channels in Virginia. The filing covers the quarter and six months ended June 30, 2020. Results were materially influenced by the COVID-19 pandemic, the SBA Paycheck Protection Program (PPP), lower interest rates, and borrower payment deferrals.
Key financial metrics
| Metric | Three months ended June 30, 2020 | Three months ended June 30, 2019 | Six months ended June 30, 2020 | Six months ended June 30, 2019 |
|---|---|---|---|---|
| Net interest income | $7.4 million | $7.0 million | $14.4 million | $13.9 million |
| Provision for loan losses | $0.8 million | $0.2 million | $1.7 million | $0.2 million |
| Noninterest income | $1.8 million | $2.0 million | $3.9 million | $4.0 million |
| Noninterest expense | $5.6 million | $6.2 million | $11.8 million | $12.3 million |
| Net income | $2.2 million | $2.1 million | $3.9 million | $4.3 million |
| Diluted EPS | $0.46 | $0.42 | $0.81 | $0.88 |
| Net interest margin | 3.59% | 3.88% | 3.67% | 3.93% |
| Efficiency ratio | 60.34% | 67.94% | 63.41% | 67.59% |
At June 30, 2020, total assets were $942.1 million versus $800.0 million at December 31, 2019. Net loans were $645.2 million, including a $6.3 million allowance for loan losses, compared with $569.4 million at year-end. Total deposits were $839.0 million versus $706.4 million, and shareholders’ equity was $80.8 million versus $77.2 million.
Six-month operating cash flow was $4.1 million, compared with $4.2 million in the prior-year period. Investing activities used $76.1 million, primarily from a $77.5 million net increase in loans. Financing activities provided $134.5 million, including deposit growth and $5.0 million of subordinated debt proceeds. Cash and cash equivalents increased to $108.3 million from $45.8 million at December 31, 2019.
The Bank remained well capitalized. At June 30, 2020, total capital to risk-weighted assets was 15.20%, common equity Tier 1 capital was 14.11%, and Tier 1 capital to average assets was 9.08%. Available nondeposit funding totaled $239.4 million, including $148.8 million from the Federal Home Loan Bank of Atlanta. No FHLB borrowings were outstanding.
Material changes versus prior comparable periods
- Second-quarter net income increased 8% to $2.2 million, while six-month net income decreased 9% to $3.9 million.
- Net interest income increased 6% in the quarter and 4% year to date because average earning assets grew 15% and 11%, respectively. Lower market rates and low-yielding PPP loans reduced the net interest margin by 29 basis points in the quarter and 26 basis points year to date.
- The provision for loan losses increased to $800 thousand in the quarter and $1.7 million year to date, reflecting pandemic-related economic factors, payment deferrals, and higher substandard loans.
- Noninterest income declined 13% in the quarter and 4% year to date, primarily because service charges on deposit accounts fell 51% and 27%, respectively, due largely to lower overdraft fee income.
- Noninterest expense declined 10% in the quarter and 5% year to date, partly because $520 thousand of employee costs associated with PPP loan origination were deferred and netted against PPP loan fees.
- Loans increased $77.2 million before the allowance, primarily from $73.3 million of PPP loans outstanding at June 30. Deposits increased $132.6 million, supported by PPP proceeds and government stimulus payments.
- The allowance for loan losses increased to 0.97% of total loans from 0.86% at December 31, 2019. Nonaccrual loans were $1.5 million, while impaired loans increased to $5.8 million from $1.5 million at year-end.
- The Company repurchased 129,035 shares for $2.1 million during the first six months, but suspended further repurchases during the second quarter because of pandemic-related uncertainty.
Guidance, outlook, commentary, risks, and unusual items
- Management did not provide formal earnings guidance and stated that the full financial impact of COVID-19 cannot be reasonably projected.
- Loans participating in the payment deferral program totaled $182.6 million, or 28% of Bank loan balances, at June 30. By July 31, participation had declined to $119.9 million, or 18%, although some loans received a second 90-day deferral.
- The Bank originated $76.2 million of PPP loans, received $2.5 million of related fees, incurred $520 thousand of origination costs, and had $73.3 million of PPP balances outstanding at June 30. Approximately 99% of PPP loans mature in 24 months, and management expects most to be forgiven and repaid by the SBA.
- Management identified hospitality, retail/shopping, and health care as sectors under significant pressure. These exposures totaled approximately $98.9 million, or 15.19% of total loans, excluding PPP loans.
- Future risks include higher credit losses, nonaccrual loans, additional provisions, reduced overdraft and transaction fee income, weaker wealth management or mortgage activity, higher problem-loan resolution costs, deposit outflows, funding cost volatility, cyber threats, and potential PPP-related liability or litigation.
- The Company issued a new $5.0 million subordinated note in June 2020, initially bearing 5.50% interest and maturing in 2030, primarily to strengthen holding-company liquidity and support the Bank during a severe downturn.
- Two interest-rate swaps with a combined notional amount of $9.0 million were entered into to convert variable-rate junior subordinated debt to fixed rates. The swaps had a $31 thousand liability at June 30.
- The Company adopted several accounting updates without a material effect. It is still assessing the future impact of the current expected credit loss standard, which may materially change credit-loss accounting when adopted.
- Management concluded that disclosure controls and procedures were effective, with no material changes to internal control over financial reporting. No material pending legal proceedings were reported.
Important facts for investors to verify
- Whether deferred borrowers resume contractual payments after the deferral periods and whether nonaccrual loans, impaired loans, charge-offs, and provisions increase.
- The ultimate forgiveness, SBA repayment, fee recognition, and credit-risk treatment of the PPP portfolio.
- Whether the net interest margin remains under pressure as low-rate assets and PPP loans affect earning-asset yields.
- Whether service-charge income, wealth management fees, mortgage activity, and other fee revenue recover or continue to decline.
- The adequacy of the $6.3 million allowance for loan losses under worsening economic conditions and the eventual adoption of expected-credit-loss accounting.
- The sustainability of the $0.11 quarterly dividend and the timing of any resumption of stock repurchases.
- Liquidity and capital trends, including deposit stability, use of the $239.4 million of available nondeposit funding, and the Company’s ability to manage subordinated debt obligations.