Norwood Financial Corp. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; unaudited consolidated results. Norwood is a Pennsylvania-based bank holding company whose principal subsidiary is Wayne Bank, serving northeastern Pennsylvania and parts of New York.
Key financial metrics
| Metric | Q1 2018 | Comparable period / date |
|---|---|---|
| Net interest income | $8.807 million | $8.497 million, Q1 2017 |
| Net income | $3.129 million | $2.376 million, Q1 2017 |
| Basic and diluted EPS | $0.50 | $0.38, Q1 2017; adjusted for 2017 50% stock dividend |
| Net interest margin, fully taxable-equivalent | 3.46% | 3.51%, Q1 2017 |
| Return on average assets / equity | 1.13% / 11.00% | 0.87% / 8.54%, Q1 2017 |
| Net cash from operating activities | $2.044 million | $3.241 million, Q1 2017 |
Amounts below are in U.S. dollars. Total interest income was $10.029 million (up from $9.434 million); interest expense was $1.222 million (up from $0.937 million). The loan-loss provision was $0.550 million versus $0.600 million. Other income was $1.694 million versus $1.643 million, and other expenses were $6.248 million versus $6.614 million. Income tax expense was $0.574 million, with a 15.5% effective rate, compared with $0.550 million and 18.8%.
Financial condition, liquidity and credit
- Total assets were $1.127 billion at March 31, down from $1.133 billion at year-end 2017. Loans were $775.7 million, up from $764.1 million; available-for-sale securities were $265.9 million, down from $281.1 million.
- Deposits totaled $940.1 million, up $10.8 million from year-end, primarily reflecting seasonal municipal savings balances. Short-term borrowings fell $12.6 million to $29.9 million; other borrowings declined to $33.1 million from $35.9 million.
- Cash and cash equivalents were $12.1 million. Cash plus available-for-sale securities totaled $278.0 million, or 24.7% of assets, versus $297.8 million, or 26.3%, at year-end. Management said liquidity was adequate. Cash declined $4.6 million during the quarter; investing activities used $0.4 million and financing activities used $6.2 million.
- Stockholders’ equity was $113.8 million, down from $115.7 million. Net income and $1.4 million of declared dividends were more than offset by a $3.7 million after-tax decline in securities’ fair value recorded in other comprehensive income. The quarterly dividend was $0.22 per share.
- The allowance for loan losses was $8.1 million, or 1.04% of loans, versus $7.6 million, or 1.00%, at year-end. Net charge-offs were $85,000, compared with $162,000 in Q1 2017. Nonperforming loans were $1.7 million (0.22% of loans), down from $2.5 million (0.32%); nonperforming assets were $3.1 million (0.28% of assets), down from $4.1 million (0.37%). Management considered the allowance adequate but cautioned that future losses could exceed it.
- Regulatory capital ratios at March 31 included Tier 1 leverage of 9.63%, Common Equity Tier 1 of 13.17%, and total capital of 14.16%. The Company said it and the Bank met applicable capital requirements, including the capital conservation buffer.
Changes and management commentary
- Net income rose $753,000 year over year, primarily due to a $310,000 increase in GAAP net interest income and a $591,000 reduction in foreclosed-real-estate expense. Lower foreclosed-real-estate costs were partly offset by higher salaries and other operating expenses.
- Loan growth increased average loan interest income, while securities balances declined as portfolio runoff helped fund loans. Rising rates increased deposit and borrowing costs: the average cost of interest-bearing liabilities rose to 0.61% from 0.47%, and time-deposit cost rose to 1.10% from 0.88%.
- Fully taxable-equivalent net interest income increased $40,000 to $9.083 million, but the margin declined five basis points. Management attributed pressure in part to the lower tax-equivalent adjustment after the federal corporate tax rate fell from 34% to 21%.
- Available-for-sale securities had $9.1 million of gross unrealized losses at quarter-end, compared with $5.4 million at year-end. Management attributed the losses to interest-rate changes, considered them temporary, and reported no other-than-temporary impairment charge.
Outlook, risks and unusual items
The filing provides no specific earnings, revenue or growth guidance. Management cautioned that quarterly results are not necessarily indicative of full-year results. The Company reported a negative 90-day interest-sensitivity gap of $17.6 million, compared with a positive $20.3 million at year-end; it warned that, over that interval, funding costs could rise faster than asset yields if rates increase. Simulations for a 200-basis-point rate change remained within the Company’s policy limit of a 10% net-interest-income decline.
Key stated risks include commercial-credit and real-estate collateral exposure, loan losses exceeding the allowance, interest-rate and liquidity risk, regional economic conditions, deposit competition, cybersecurity, regulatory costs, and risks related to realizing acquisition benefits and goodwill. Commercial rental and hospitality/lodging loans were $68.5 million (8.8% of loans) and $58.6 million (7.6%), respectively. Off-balance-sheet commitments to grant loans, unfunded credit lines and standby letters of credit totaled $115.8 million; not all are expected to be drawn. Standby-letter-of-credit liability was reported as immaterial.
On January 1, 2018, the Company adopted revenue-recognition guidance with no material impact. The Tax Cuts and Jobs Act reduced the corporate rate to 21%; the resulting deferred-tax-asset remeasurement had already reduced its value by $3.06 million in Q4 2017. The Company also adopted guidance allowing tax effects stranded in accumulated other comprehensive income to be reclassified, recording a $434,000 reclassification between accumulated other comprehensive income and retained earnings. The Company expects the forthcoming credit-loss standard to result in a one-time adjustment to the allowance and opening retained earnings, but could not estimate its size. Lease guidance was expected to increase assets and liabilities by less than 1% based on preliminary analysis.
In litigation referenced from the prior annual report, the court on April 5, 2018 denied the plaintiff’s motions for summary judgment on its claims, dismissed one of Delaware’s counterclaims, and directed discovery to continue. Management reported no material changes to previously disclosed risk factors and said disclosure controls were effective.
Important facts for investors to verify
- Whether loan growth and improved credit metrics persist, and whether the allowance remains sufficient as the portfolio and regional economy evolve.
- How deposit pricing and other funding costs respond to rate changes, given the negative short-term gap and lower reported net interest margin.
- Whether securities’ unrealized losses remain temporary and how further market-value changes affect equity and regulatory capital.
- The eventual retained-earnings and allowance impact, adoption timing, and implementation assumptions for the expected-credit-loss standard.
- Developments in the ongoing litigation and the extent to which the $115.8 million of credit commitments are funded.