First United Corporation — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017; comparisons are primarily with 2016. This is an annual report, not a standalone fourth-quarter results filing. First United is a community bank holding company serving western Maryland and northeastern West Virginia through First United Bank & Trust.
Business context and financial performance
At year-end, the company had $1.341 billion in assets, $882.5 million in net loans, $1.039 billion in deposits and $108.4 million in shareholders’ equity. Its primary income sources are loan and investment interest and fees for financial services, including trust and brokerage services.
| Metric | 2017 | 2016 |
|---|---|---|
| Interest income | $46.9 million | $45.9 million |
| Net interest income, GAAP | $39.6 million | $37.6 million |
| Net interest income, fully tax-equivalent | $40.2 million | $38.2 million |
| Net interest margin, fully tax-equivalent | 3.37% | 3.19% |
| Provision for loan losses | $2.5 million | $3.1 million |
| Income before taxes | $12.2 million | $10.1 million |
| Income tax expense | $6.9 million | $2.8 million |
| Net income | $5.3 million | $7.3 million |
| Net income available to common shareholders | $4.1 million | $5.3 million |
| Basic and diluted EPS | $0.58 | $0.84 |
Operating expenses were essentially flat at $39.1 million. Reported return on average assets was 0.40% and return on average equity was 4.52%, versus 0.55% and 6.38%, respectively, in 2016.
Financial position, liquidity and capital
- Loans and deposits: Gross loans were $892.5 million, up $0.6 million year over year; deposits increased $25.2 million. Growth in non-interest-bearing deposits was $30.4 million, while lower-cost core balances generally replaced certificates of deposit.
- Credit quality: Non-accrual loans declined to $7.1 million from $13.9 million; total non-accrual and 90-days-past-due accruing loans fell to $7.7 million from $14.4 million. The decline was partly associated with charge-offs, including $4.5 million on a large CRE relationship. The allowance for loan losses was $10.0 million, or 1.12% of loans, versus $9.9 million, or 1.11%, in 2016. Net charge-offs were $2.5 million, down from $5.1 million.
- Cash flow: Operating activities provided $12.9 million, investing activities used $7.7 million and financing activities provided $15.2 million. Cash and cash equivalents increased $20.4 million to $83.8 million.
- Borrowings: Total borrowings were $169.8 million, comprising $48.8 million of short-term repurchase agreements and $120.9 million of long-term borrowings. Long-term debt included $90.0 million of FHLB advances and $30.9 million of junior subordinated debentures. The company repaid $10.8 million of debentures during 2017.
- Available funding: The Bank reported $86.2 million of additional FHLB capacity, $75.0 million of unused correspondent-bank lines and a $7.0 million unused Federal Reserve line. Management said it believed liquidity was adequate.
- Capital: The Corporation’s total risk-based capital ratio was 15.98%, its common equity Tier 1 ratio was 12.54%, and the Bank’s total risk-based capital ratio was 15.58%. Both were categorized as well capitalized. Shareholders’ equity declined to $108.4 million from $113.7 million.
Material changes versus 2016
- Fully tax-equivalent net interest income rose 5.5%, and margin expanded from 3.19% to 3.37%, reflecting higher asset yields and lower interest expense. Interest expense benefited from debt repayment and a shift toward lower-cost deposits.
- Net income available to common shareholders declined $1.2 million, despite higher pre-tax income. The principal factor was a one-time $3.2 million tax expense from revaluing deferred tax balances after enactment of the Tax Cuts and Jobs Act; the reported effective tax rate rose to 56.8% from 27.6%.
- The Corporation completed a $9.2 million net-proceeds common-stock rights offering in March 2017 and redeemed the remaining $20.0 million of Series A preferred stock in two 2017 redemptions. It also repaid $10.8 million of Trust III junior subordinated debentures. No common dividends were declared in 2017 or 2016.
- Trust Department assets under supervision increased to approximately $824 million from $740 million. Trust income rose 7.0%; gains on investment-security sales fell to $29,000 from $526,000.
- Available-for-sale securities had a $7.1 million net unrealized loss at year-end, improved from $9.6 million in 2016. The $14.9 million fair value of the Level 3 pooled trust preferred CDO portfolio was below its $19.7 million amortized cost. Management recorded no additional credit-related impairment in 2017.
Outlook, risks and contingencies
- The filing gives no specific earnings, revenue, margin or loan-growth guidance. Management described liquidity as adequate and said it knew of no matters likely to materially impair future capital or liquidity needs.
- Management identified interest-rate exposure as a principal market risk. The Bank was asset-sensitive, but modeled effects varied by rate scenario: a 100-basis-point increase was estimated to raise net interest income by $387,000, while a 400-basis-point increase was estimated to reduce it by $371,000; a 100-basis-point decrease was estimated to reduce it by $3.0 million. These are model estimates dependent on assumptions, not forecasts.
- Credit risk is concentrated in the company’s regional markets and real-estate-related lending. CRE and acquisition-and-development exposures, local economic weakness, collateral values and loan-loss estimate uncertainty could affect results. The company expects the CECL standard, planned for adoption January 1, 2020, to require lifetime expected-loss estimates; its financial impact was still being assessed.
- Other cited risks include competition, deposit replacement and funding costs, changing banking and consumer-protection regulation, cybersecurity and third-party technology risks, investment valuation and impairment, and potential deferred-tax-asset realization. The CDO portfolio is illiquid and valued using significant unobservable inputs.
- Loan commitments and commercial letters of credit totaled $129.4 million at year-end. Management did not consider these arrangements materially adverse. The company said ordinary-course legal matters were not expected to have a material adverse effect.
- The independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls and internal controls were effective as of year-end.
Most important facts for investors to verify
- How much of the decline in common earnings was attributable to the one-time tax revaluation, and what tax rate and deferred-tax assumptions apply going forward?
- Whether the lower non-accrual balance reflects durable borrower improvement or, in material part, charge-offs and changes in loan composition; review large CRE credits and collateral support.
- The sensitivity of the CDO portfolio’s estimated value and credit performance to assumptions, given its $14.9 million Level 3 valuation and limited market liquidity.
- Whether the reported capital and liquidity buffers remain adequate after preferred-stock redemptions, planned lending, deposit changes and potential funding-cost increases.
- The company’s progress and estimated capital impact in preparing for CECL adoption, along with future common-dividend policy and any restrictions affecting distributions.