First Northern Community Bancorp — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unaudited consolidated results. Unless stated otherwise, dollar amounts are in millions.
Business context and financial performance
The company operates First Northern Bank of Dixon, a California state-chartered community bank serving the Sacramento Valley and surrounding Northern California communities. Its principal activities are lending and deposit-taking.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $10.738 | $9.594 | $21.250 | $18.907 |
| Net interest margin | 3.83% | 3.51% | 3.78% | 3.46% |
| Provision for loan losses | $0.525 | — | $1.050 | $0.600 |
| Non-interest income | $1.745 | $1.755 | $3.549 | $4.600 |
| Non-interest expense | $7.819 | $7.220 | $15.813 | $14.723 |
| Net income | $3.003 | $2.548 | $5.736 | $5.061 |
| Diluted EPS | $0.26 | $0.22 | $0.49 | $0.43 |
For the six months, return on average assets was 0.96% versus 0.87%; return on average equity was 11.29% versus 10.57%. Average equity to average assets was 8.51% versus 8.26%.
Financial position, cash flow and liquidity
- At June 30, 2018, assets were $1,186.5 million, down 2.6% from December 31, 2017. Deposits were $1,071.6 million, down 3.0%; total loans including loans held-for-sale were $732.3 million, down 1.1%; and available-for-sale securities were $285.9 million, up 1.8%.
- Cash and cash equivalents were $121.2 million, down $31.7 million from year-end. Stockholders’ equity was $103.6 million, up from $100.0 million. Accumulated other comprehensive loss widened to $6.8 million from $4.4 million, primarily reflecting unrealized securities losses.
- For the first six months, operating cash flow was $6.9 million, investing cash outflow was $5.5 million, and financing cash outflow was $33.1 million; cash declined by $31.7 million.
- The loan-to-deposit ratio was 68.3%, versus 67.0% at year-end. Management reported $80 million in unsecured short-term bank lines and $305.3 million of FHLB borrowing capacity, subject to collateral requirements. The filing reports no borrowings during the periods presented.
- The Bank’s June 30 capital ratios exceeded well-capitalized thresholds: leverage 9.06% (5.0% requirement), common equity Tier 1 and Tier 1 risk-based 12.66% each (6.5% and 8.0% thresholds), and total risk-based 13.92% (10.0% threshold).
Material changes versus comparable periods
- Q2 net income increased 17.9% and diluted EPS rose from $0.22 to $0.26. Six-month net income increased 13.3% and diluted EPS rose from $0.43 to $0.49.
- Net interest income grew 11.9% in Q2 and 12.4% year to date. Management attributed the improvement to higher average loan balances and yields, loan repricing and higher rates on interest-bearing bank balances; the Federal Funds rate increased 50 basis points during the first half.
- Six-month non-interest income fell 22.9%, mainly because the prior-year period included a $1.187 million gain on a real-estate sale-leaseback. Six-month non-interest expense increased 7.4%, largely from salaries and benefits and data processing.
- The effective tax burden declined: income tax provision was $2.2 million for the first half versus $3.1 million, primarily reflecting the federal corporate tax rate reduction.
- Non-accrual loans declined to $2.4 million from $3.8 million at year-end. Net non-performing assets were $2.0 million, or 0.2% of assets, compared with $3.7 million, or 0.3%. However, loans rated substandard or doubtful, excluding non-performing loans, increased to $16.2 million from $2.0 million.
Outlook, risks and unusual items
- The filing provides no specific earnings, revenue, margin or growth guidance. Management cautions that interim results are not necessarily indicative of full-year results. Its forward-looking discussion identifies interest rates, deposit retention, credit quality, regional economic conditions and regulatory changes as factors that may affect results. It also identifies an expectation of no cash dividend in the foreseeable future.
- Credit costs rose: the first-half loan-loss provision was $1.05 million, compared with $0.60 million. The allowance was $11.8 million, or 1.59% of loans, versus $11.1 million, or 1.49%, at year-end. Management cited charge-offs, loan balances and higher qualitative risk factors, especially in residential mortgages. Net charge-offs were $0.376 million for the first half.
- The portfolio is concentrated in real-estate-related lending: approximately 78% of loans excluding loans held-for-sale were secured by real estate, with substantial exposure to Northern California. Management warns that regional economic or property-market deterioration could increase defaults and reduce collateral values. Agricultural lending also carries weather and commodity-market risks.
- Available-for-sale securities had $7.8 million of gross unrealized losses at June 30, versus $4.5 million at year-end. Management attributed these losses primarily to interest-rate market conditions, reported no other-than-temporary impairment, and stated it did not expect to be required to sell the securities before recovery.
- Off-balance-sheet commitments totaled $217.1 million, including $212.2 million of undisbursed loan commitments and $3.1 million of performance standby letters of credit. These are contractual amounts, not expected cash outflows; an $0.85 million reserve for unfunded commitments was recorded. No material pending legal proceedings were reported.
- Accounting developments: the company adopted revenue-recognition and financial-instrument standards in 2018 without material reported impact. It was evaluating lease accounting changes expected to require recognition of lease assets and liabilities, and expected the forthcoming expected-credit-loss model to result in earlier loss recognition; the impacts had not been quantified.
Important facts for investors to verify
- Whether deposit declines are seasonal as management states, and whether deposits and cash stabilize or continue to contract.
- Trends in criticized loans, particularly the increase in substandard/doubtful balances, and whether higher residential-mortgage risk factors lead to additional provisions or charge-offs.
- Loan and securities exposure to Northern California real estate and the effect of interest-rate movements on securities values, funding costs and net interest margin.
- Whether earnings growth continues after excluding the prior-year sale-leaseback gain and accounting for higher operating costs and credit provisions.
- Progress and quantified effects of lease and expected-credit-loss accounting adoption, and any developments in liquidity, capital or dividend plans.