Business context and reporting period
Farmers National Banc Corp. (NASDAQ: FMNB) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2023. The Ohio-based financial holding company provides banking, trust, investment and insurance services in northeastern Ohio and western Pennsylvania.
Results reflect the January 1, 2023 acquisition of Emclaire Financial Corp. (Emlenton), which expanded the company into western Pennsylvania and the Pittsburgh market. Unless otherwise noted, dollar amounts below are in millions.
Financial performance and condition
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Net interest income | $34.6 | $31.7 | $71.2 | $63.0 |
| Net interest margin | 2.92% | 3.25% | 3.00% | 3.25% |
| Net income | $15.0 | $16.0 | $22.0 | $31.8 |
| Diluted EPS | $0.40 | $0.47 | $0.59 | $0.94 |
| Noninterest income | $9.4 | $9.5 | $19.9 | $27.2 |
| Noninterest expense | $26.4 | $21.5 | $57.1 | $51.9 |
At June 30, 2023, total assets were $5.07 billion, net loans $3.12 billion, deposits $4.27 billion, and stockholders’ equity $367.0 million. Cash and cash equivalents were $116.1 million. Short-term borrowings were $300.0 million, primarily FHLB advances; long-term borrowings were $88.4 million. The bank reported $707.8 million of additional FHLB borrowing capacity, alongside unused bank credit lines.
Six-month operating cash flow was $28.9 million, compared with $40.2 million in 2022. Investing cash flow was positive $72.7 million and financing cash flow was negative $61.1 million. Cash increased $40.5 million to $116.1 million.
The allowance for credit losses was $35.0 million, or 1.11% of loans; nonperforming loans were $18.0 million, or 0.57% of loans, and the allowance covered 194.7% of nonperforming loans. Annualized second-quarter net charge-offs were 0.10% of average loans. Regulatory capital ratios included 10.25% common equity tier 1 and 13.76% total risk-based capital at the consolidated level; the Bank remained classified as well capitalized.
Material changes versus comparable periods
- Q2 net income fell about 6% year over year and diluted EPS declined from $0.47 to $0.40, despite higher net interest income. Six-month net income fell to $22.0 million from $31.8 million.
- Net interest margin contracted 33 basis points in Q2 and 25 basis points for the six-month period. Management attributed pressure to funding costs rising faster than asset yields amid deposit competition, Federal Reserve rate increases and deposit outflows.
- Six-month net interest income increased about $8.2 million, primarily reflecting a larger earning-asset base following Emlenton. Loan balances grew by approximately $750 million from year-end, including about $742 million of acquired loans; deposits rose about $709 million, including $876 million acquired, partly offset by deposit runoff.
- Six-month provision for credit losses and unfunded commitments totaled $8.6 million, including approximately $7.7 million of acquisition-related Day 1 provision. The reported credit-loss allowance also reflects acquired loans.
- Six-month noninterest income was lower largely because the 2022 comparison included an $8.4 million legal settlement. 2022 expenses also included a $6.0 million charitable contribution and legal costs related to that settlement. 2023 included $4.8 million of Emlenton merger costs.
- Unrealized losses on available-for-sale securities were $246.2 million at June 30, compared with $266.8 million at year-end 2022. Accumulated other comprehensive loss was $193.5 million. Management attributed securities losses primarily to interest rates and market conditions, not credit deterioration, and recorded no credit-loss allowance on the portfolio.
Outlook, risks and unusual items
The filing provides no specific earnings or financial guidance. Management said further rate increases were possible, while describing increases beyond 50 basis points as doubtful for its interest-rate risk assumptions. It identified high rates and an inverted yield curve as continuing earnings headwinds. The company is prioritizing loan growth, shrinking the securities portfolio and using wholesale funding in response to deposit trends.
Interest-rate simulations show potential net interest income declines of 5.6% under a +200-basis-point shock and 10.8% under +400 basis points. Estimated economic value of equity declines were 14.1% and 30.0%, respectively; the up-rate EVE results exceed internal policy limits. Management cited the speed and scale of recent rate changes and the mismatch between funding and asset repricing.
The Emclaire transaction involved $92.6 million of consideration, including $59.2 million in stock and $33.4 million in cash, and generated $73.4 million of goodwill. Preliminary acquisition fair-value estimates remained subject to finalization, expected by December 31, 2023. The company paid quarterly dividends of $0.17 per share and repurchased 850,799 shares during the first half.
A pending putative class action alleges improper NSF fees. The company considers an adverse result reasonably possible, with exposure estimated up to $600,000, and is defending the matter. The filing also notes industry-wide uncertainty following failures of several U.S. banks, which could affect depositor confidence, funding, liquidity and regulatory costs. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether acquired-bank integration and cost savings support earnings, and how preliminary acquisition valuations and goodwill develop.
- Deposit retention, deposit pricing, reliance on FHLB and other wholesale funding, and the resulting effect on net interest margin and liquidity.
- Credit performance in the expanded loan portfolio, including nonperforming loans, charge-offs, commercial real estate exposure and the adequacy of the allowance.
- Potential capital and earnings effects of securities valuation losses and the disclosed interest-rate sensitivity, particularly EVE results outside policy limits.
- Updates on the NSF-fee litigation, share repurchases, and any change to dividend policy or capital ratios.