FARMERS NATIONAL BANC CORP /OH/ - Quarter Report: 2021 March (Form 10-Q)

UNITED STATES  

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

For the Quarterly period ended March 31, 2021

Commission file number 001-35296

FARMERS NATIONAL BANC CORP.

(Exact name of registrant as specified in its charter)

(330) 533-3341

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

Securities registered pursuant to Section 12(b) of the Act:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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CONSOLIDATED BALANCE SHEETS

FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES

See accompanying notes

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CONSOLIDATED STATEMENTS OF INCOME

FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES

See accompanying notes

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES

See accompanying notes

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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES

See accompanying notes.

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CONSOLIDATED STATEMENTS OF CASH FLOWS

FARMERS NATIONAL BANC CORP. AND SUBSIDIARIES

See accompanying notes

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Principles of Consolidation:

Farmers National Banc Corp. (“Company”) is a Financial Holding Company registered under the Bank Holding Company Act of 1956, as amended.  The Company provides full banking services through its nationally chartered subsidiary, The Farmers National Bank of Canfield (“Bank”).  The consolidated financial statements also include the accounts of the Bank’s subsidiaries; Farmers National Insurance, LLC (“Insurance”) and Farmers of Canfield Investment Co. (“Investments”).  The Company provides trust and retirement consulting services through its subsidiary, Farmers Trust Company (“Trust”), and insurance services through the Bank’s subsidiary, Insurance.  Farmers National Captive, Inc. (“Captive”) is a wholly-owned insurance subsidiary of the Company that provides property and casualty insurance coverage to the Company and its subsidiaries.  The Captive pools resources with eleven other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves and to provide insurance where not currently available or economically feasible in today’s insurance market place.  The consolidated financial statements include the accounts of the Company, the Bank and its subsidiaries, along with the Trust and Captive.  All significant intercompany balances and transactions have been eliminated in the consolidation.

Basis of Presentation:

The unaudited condensed consolidated financial statements have been prepared in conformity with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“U.S. GAAP”) for complete financial statements.  The financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2020 Annual Report to Shareholders included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.  The interim consolidated financial statements include all adjustments (consisting of only normal recurring items) that, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods presented.  The results of operations for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year.  Certain items included in the prior period financial statements were reclassified to conform to the current period presentation. There was no effect on net income or total stockholders’ equity.

Estimates:

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Segments:

The Company provides a broad range of financial services to individuals and companies in northeastern Ohio and western Pennsylvania.  Operations are managed and financial performance is primarily aggregated and reported in two lines of business, the Bank segment and the Trust segment.

Equity:

There are 50,000,000 shares authorized and available for issuance as of March 31, 2021.  Outstanding shares at March 31, 2021 were 28,236,691.

Comprehensive Income:

Comprehensive income consists of net income and other comprehensive income.  Other comprehensive income consists of unrealized gains and losses on securities available for sale (“AFS”), which are recognized as components of stockholders’ equity, net of tax effect.

Updates to Significant Accounting Policies:

Allowance for Credit Losses – Available-for-Sale Securities:  

Securities classified as AFS are those securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity.  Any decision to sell a security classified as AFS would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company’s assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors.

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The Company evaluates securities AFS in unrealized loss positions on a quarterly basis to determine whether the decline in fair value below the amortized costs basis is due to credit-related factors or noncredit-related factors.  In making this evaluation, management considers the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.  Any impairment that is not credit-related is recognized in other comprehensive income, net of related deferred income taxes.  Credit-related impairment is recognized as an allowance for credit losses (“ACL”) on the balance sheet based on the amount by which the amortized cost basis exceeds the fair value, with a corresponding charge to net income.  Both the ACL and the charge to net income may be reversed if conditions change.  However, if the Company intends to sell an impaired AFS security or more likely than not will be required to sell such a security before recovering its amortized cost basis, the entire impairment amount must be recognized in net income with a corresponding adjustment to the security’s amortized cost basis rather than through the establishment of an ACL.  The Company has recorded no ACL related to the investment portfolio as of March 31, 2021.

Allowance for Credit Losses – Loans:  

The ACL represents management’s estimate of expected credit losses in the Company’s loan portfolio at the balance sheet date.  The Company estimates the ACL based on the amortized cost basis of the underlying loan and has made an accounting policy election to exclude accrued interest from the loan’s amortized cost basis and the related measurement of the ACL.  Estimating the amount of the ACL is a function of a number of factors, including but not limited to changes in the loan portfolio, net charge-offs, trends in past due and nonaccrual loans, and the level of potential problem loans, all of which may be susceptible to significant change.

Prior to January 1, 2021, as described in further detail in the Company’s 2020 Annual Report on Form 10-K, the Company used an incurred loss impairment model.  This methodology assessed the overall appropriateness of the allowance for credit losses and included allocations for specifically identified impaired loans and loss factors for all remaining loans, with a component primarily based on historical loss rates and another component primarily based on other qualitative factors.  Impaired loans were individually assessed and measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral if the loan was collateral dependent.  Loans that were determined not to be impaired were collectively evaluated for impairment, stratified by type and allocated loss ranges based on the Company’s actual historical loss ratios for each strata, and adjustments were also provided for certain environmental and other qualitative factors.

On January 1, 2021, the Company adopted the current expected credit loss model (“CECL”).  This methodology for calculating the allowance for credit losses considers the possibility of loss over the life of the loan.  It also considers historical loss rates and other qualitative adjustments, as well as a new forward-looking component that considers reasonable and supportable forecasts over the expected life of each loan.  To develop the ACL estimate under the current expected loss model, the Company segments the loan portfolio into loan pools based on loan type and similar credit risk elements.  The Company uses the cohort (“cohort”) and the probability of default/loss given default (“PD/LGD”) methodologies as described in the Credit Quality Indicators section of the loan footnote.      

Risks and Uncertainties:

The outbreak of COVID-19 has adversely impacted a broad range of industries in which the Company’s customers operate and could impair their ability to fulfill their financial obligations to the Company.  The spread of the outbreak has caused disruptions in the economy and has disrupted banking and other financial activity in the areas in which the Company operates.  While there has been no material impact to the Company’s business continuity or financial condition the possible of future challenges continues to exist.  

Congress, the President, and the Federal Reserve have taken several actions designed to cushion the economic fallout.  Most notably, the Coronavirus Aid, Relief and Economic Security Act (“CARES”) the Health and Economic Recovery Omnibus Emergency Solutions Act (“HEROES”), both signed into law during 2020, and the American Rescue Plan Act as multi trillion dollar legislative packages, and the American Rescue Plan Act signed into law on March 11, 2021, as a $1.9 trillion COVID-19 relief bill.  The goal of these acts was to provide economic stability during the pandemic through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors.  The packages also included extensive emergency funding for hospitals and providers. The American Rescue Plan continued these measures by funding increases in vaccine distribution, additional cash payments to millions of Americans, extended unemployment benefits, and support for caregiving, nutrition programs, health care and pensions.  In addition to the general impact of COVID-19, certain provisions of the these legislative acts as well as other recent legislative and regulatory relief efforts have had a material impact on the Company’s operations.

The Company’s business is dependent upon the willingness and ability of its employees and customers to conduct banking and other financial transactions.  If the global response to contain COVID-19 continues for a further extended period or is ultimately unsuccessful, the Company could experience a material adverse effect on its business, financial condition, results of operations and cash flows.  While it is not possible to know the full universe or extent that the impact of COVID-19 will have on the Company’s operations, the Company will disclose potentially material items of which it becomes aware.

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Financial position and results of operations:

The Company’s fee income declined and could be reduced further due to lingering COVID-19 affects.  In keeping with guidance from regulators, the Company worked with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc.  From the beginning of the pandemic in 2020 through the quarter ended March 31, 2021, the Company has waived $780 thousand in fees.  The Company recognizes the breadth of the economic impact is likely to continue impacting its fee income in future periods.

The Company’s interest income improved slightly in the quarter ended March 31, 2021 compared to the same period in 2020 and yet the net interest margin decreased by 17 basis points.  The margin could be reduced further due to COVID-19 and the continued low interest rate environment.  In keeping with guidance from regulators, the Company is working with COVID-19 affected borrowers to defer their payments.  Currently the Bank has five loans remaining that are deferring their loan payments.  While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed.  In such a scenario, interest income in future periods could be negatively impacted.  At this time, the Company is unable to project the materiality of such an impact, but recognizes the breadth of the economic impact may affect its borrowers’ ability to repay in future periods.

Capital and liquidity:

While the Company believes that it has sufficient capital to withstand an extended economic recession brought about by COVID-19, its reported and regulatory capital ratios could be adversely impacted by further credit losses.  The Company relies on cash on hand as well as dividends from its subsidiaries.  If the Company’s capital deteriorates such that its subsidiary bank is unable to pay dividends to it for an extended period of time, the Company may not be able to pay dividends to shareholders.

The Company maintains access to multiple sources of liquidity.  Wholesale funding markets have remained open.  Rates for short term funding have recently been low but if funding costs are elevated for an extended period of time, it could have an adverse effect on the Company’s net interest margin.  If an extended recession caused large numbers of the Company’s deposit customers to withdraw their funds, the Company might become more reliant on volatile or more expensive sources of funding.

New Accounting Standards:

Reacting to the global markets’ planned shift away from using major interbank reference rates, including the London Interbank Offered Rate (LIBOR), the FASB issued ASU 2020-04, Facilitation of the Effects of Reference Rate Reform on Financial Reporting, to ease the burden of accounting for contract modifications related to reference rate reform. The amendments in ASU 2020-04 create a new Topic in the Codification, ASC 848, Reference Rate Reform, which contains guidance that is designed to simplify how entities account for contracts that are modified to replace LIBOR or other benchmark interest rates with new rates. The amendments in ASU 2020-04 give entities the option to apply expedients and exceptions to contract modifications that are made until December 31, 2022, if certain criteria are met.  If adopted, these amendments and exceptions should be applied to all eligible modifications to contracts that are accounted for under an ASC Topic or industry Subtopic.  The guidance in ASC 848 will not apply to any contract modifications made after December 31, 2022.  Management is still evaluating the ASU and has not adopted it as of March 31, 2021.

In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. This ASU eliminates Step 2 from the goodwill impairment test.  Instead, under the new guidance, an entity is to perform its annual goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount.  An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value.  The new guidance is effective for annual reporting periods, and interim reporting periods within those annual periods, beginning after December 15, 2019.  Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.  The Company adopted this ASU on January 1, 2020.  The adoption of this guidance did not have an impact on the Company’s Consolidated Financial Statements.

In June 2016, the FASB issued ASU 2016-13: Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (modified by ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments Credit Losses).  The ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts.  Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates.  Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques changed to reflect the full amount of expected credit losses.  Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances.  Additionally, the ASU amends the accounting for credit losses on available for sale debt securities and purchased financial assets with credit deterioration.  ASU 2016-13 is effective for public companies for annual periods beginning after December 15, 2019.  Entities

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will apply the standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted.

In accordance with the accounting relief provisions of CARES and subsequent provisions of HEROES, the Bank postponed the adoption of the current expected credit losses (“CECL”) accounting standard from January 1, 2020 to January 1, 2021.  The Company adopted ASC 326 using the modified retrospective method for all financial assets measured at amortized cost and off-balance-sheet credit exposures.  Results for reporting periods beginning after January 1, 2021 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable GAAP.  The Company recorded the onetime adjustment to equity in the amount of $1.9 million, net of tax which increased the allowance for credit losses $2.5 million.

Business Combinations:

On January 7, 2020, the Company completed the acquisition of Maple Leaf Financial, Inc. (“Maple Leaf”), the parent company of Geauga Savings Bank, with branches located in Cuyahoga and Geauga Counties in Ohio.  The Company expects the acquisition to increase synergies and cost savings resulting from the combining of the two companies.  The transaction involved both cash and 1,398,229 shares of stock totaling $43.0 million.  Pursuant to the terms of the Merger Agreement, common shareholders of Maple Leaf had the right to receive $640.00 in cash or 45.5948 common shares, without par value, of the Company.  Holders of outstanding and unexercised warrants to purchase Maple Leaf Common Shares received an amount in cash equal to the excess of $640.00 over $370.00, the exercise price of such warrants.

Goodwill of $7.6 million, which is recorded on the balance sheet, arising from the acquisition consisted largely of synergies and the cost savings resulting from the combining of the entities.  The goodwill was determined not to be deductible for income tax purposes.  

The following table summarizes the consideration paid for Maple Leaf and the amounts of the assets acquired and liabilities assumed on the closing date of the acquisition.

The following table presents pro forma information as if the Maple Leaf acquisition that occurred during January 2020 actually took place at the beginning of 2020.  The pro forma information includes adjustments for merger related costs, amortization of intangibles arising from the transaction and the related income tax effects.  The pro forma financial information is not necessarily indicative of the results of operations that would have occurred had the transactions been effective on the assumed date.

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Securities:

The following table summarizes the amortized cost and fair value of the available for sale investment securities portfolio at March 31, 2021 and December 31, 2020 and the corresponding amounts of unrealized gains and losses recognized in accumulated other comprehensive income:

Proceeds from the sale of portfolio securities were $26.2 million during the three month period ended March 31, 2021.  Gross gains of $406.0 thousand along with gross losses of $22.6 thousand were realized on these sales during the three month period ended March 31, 2021.  $105 thousand of realized gains during the three month period were recognized in the income statement for equity securities as of March 31, 2021.  Proceeds from the sale of portfolio securities were $15.1 million during the three month period ended March 31, 2020.  Gross gains were $256 thousand along with gross losses of $0 during the same three month ended March 31, 2020.  $99 thousand of realized losses during the three month period ended March 31, 2020 were recognized in the income statement for equity securities.

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The amortized cost and fair value of the debt securities portfolio are shown by expected maturity.  Expected maturities may differ from contractual maturities if issuers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.

The following table summarizes the available for sale investment securities with unrealized losses at March 31, 2021 and December 31, 2020, aggregated by major security type and length of time in a continuous unrealized loss position.   

The Company has adopted ASU 2016-13 that makes improvements to the accounting for credit losses on securities available for sale.  The concept of other than-temporarily impaired securities has been replaced with the allowance for credit losses.  Securities available for sale are evaluated on an individual level and pooling of securities is no longer an option.  During this evaluation process, management considers the extent to which the fair value has been less than cost, the financial condition and near term prospects of the issuer, and the intent and ability of the Company to hold the security for a period of time sufficient to allow for any anticipated recovery in fair value.      

If the Company determines that a credit loss exists, the credit portion of the allowance will be measured using a discounted cash flow analysis using the effective interest rate as of the security’s purchase date.  As of March 31, 2021, the Company’s security portfolio consisted of 767 securities, 153 of which were in an unrealized loss position.  The majority of the unrealized losses on the Company’s securities are related to its holdings of state and political subdivisions and mortgage-backed securities.  The Company does not consider its AFS securities with unrealized losses to be attributable to credit-related factors, as the unrealized losses have occurred as a result of changes in noncredit related factors such as changes in interest rates, market spreads and market conditions subsequent to purchase, not credit deterioration.  As of March 31, 2021 no allowance for credit losses on AFS securities was recorded.

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Loans:

Loan balances were as follows:

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Purchased credit impaired loans under ASC 310

As part of past acquisitions, the Company acquired various loans that displayed evidence of deterioration of credit quality since origination and which it was probable that all contractually required payments would not be collected. The carrying amounts and contractually required payments of these purchase credit impaired loans under ASC 310, which are included in the loan balances above, are summarized in the following table:

The key assumptions considered include probability of default and the amount of actual prepayments after the acquisition date.  Prepayments affect the estimated life of the loans and could change the amount of interest income and principal expected to be collected.  In reforecasting future estimated cash flows, credit loss expectations are adjusted as necessary.  There were no adjustments to forecasted cash flows that impacted the allowance for credit losses for the three month periods ended March 31, 2021 and 2020.

Allowance for credit loss activity

The following tables present the activity in the allowance for credit losses by portfolio segment for the three month periods ended March 31, 2021 and 2020:

Three Months Ended March 31, 2021

Three Months Ended March 31, 2020

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The following table presents the allowance for loan losses under ASC 310.  The recorded investment in loans includes the unpaid principal balance and unamortized loan origination fees and costs, but excludes accrued interest receivable, which is not considered to be material:

December 31, 2020