First United Corporation — Q3 2017 Form 10-Q
Business context and reporting period. First United Corporation is a bank holding company whose primary subsidiary is First United Bank & Trust. This unaudited quarterly report covers the three and nine months ended September 30, 2017; balance-sheet comparisons are with December 31, 2016. Amounts below are in U.S. dollars. Financial results are not necessarily indicative of full-year results.
Financial performance and position
- Third quarter: Net income was $2.0 million, down from $2.3 million in Q3 2016. Net income available to common shareholders was $1.8 million versus $1.8 million; diluted EPS was $0.25 versus $0.29.
- Nine months: Net income was $6.3 million versus $5.9 million; net income available to common shareholders was $5.3 million versus $4.3 million. Diluted EPS was $0.77 versus $0.68.
- Revenue and margins: Nine-month net interest income was $29.4 million, up $1.1 million year over year. Fully tax-equivalent net interest margin improved to 3.36% from 3.21%; Q3 margin was 3.37% versus 3.22%. Nine-month total other operating income was $10.6 million, down from $11.2 million.
- Expenses and credit costs: Nine-month operating expenses were $29.3 million, compared with $29.2 million. Loan-loss provision was $1.8 million versus $2.2 million for the first nine months, but rose to $0.9 million in Q3 from $0.3 million, primarily due to a $1.3 million specific allocation for a deteriorating impaired credit.
- Cash flow: Operating activities provided $4.0 million for the first nine months, versus $7.9 million in 2016. Investing activities used $6.7 million; financing activities provided $24.4 million. Cash and cash equivalents ended the period at $85.0 million, up from $63.3 million at year-end.
- Balance sheet: Total assets were $1.352 billion, up from $1.318 billion at year-end. Gross loans were $889.9 million, slightly below $891.9 million; deposits were $1.041 billion, up from $1.014 billion. Shareholders’ equity was $120.8 million, versus $113.7 million.
- Credit quality: Allowance for loan losses was $10.8 million, or 1.21% of gross loans, versus $9.9 million at year-end. Net charge-offs for the nine months were $1.0 million, down from $2.1 million. Non-accrual loans declined to $11.6 million from $13.9 million; accruing loans at least 90 days past due increased to $1.0 million from $0.4 million.
- Debt and liquidity: Short-term borrowings were $45.8 million, up from $36.0 million; long-term borrowings were $120.9 million, down from $131.7 million, including repayment of $10.8 million of junior subordinated debt. Management stated liquidity was adequate. Available funding included $70.0 million in unsecured correspondent lines, $7.1 million at the Fed Discount Window and approximately $86.2 million through the FHLB.
- Capital: At September 30, consolidated total risk-based capital was 16.88%, Tier 1 risk-based capital 15.77%, common equity Tier 1 12.36%, and Tier 1 leverage 11.46%. Each exceeded the filing’s stated well-capitalized thresholds.
Material changes and notable items
- Nine-month common earnings improved chiefly from higher net interest income, lower loan-loss provision and reduced preferred dividends. Those gains were partly offset by lower securities gains, service-charge income and BOLI income, and higher salaries and data-processing costs.
- Q3 common earnings per share declined despite higher net interest income, as the larger loan-loss provision and operating expenses weighed on results. The filing attributes much of the provision increase to the identified impaired credit.
- A March 2017 rights offering issued 783,626 common shares and generated approximately $9.2 million in net proceeds. The proceeds partly funded a $10.0 million Series A preferred-stock redemption and repayment of $10.8 million of Trust III debentures.
- After quarter-end, on October 3, the company announced its intention to redeem the remaining $10.0 million of Series A preferred stock on or about November 15, 2017.
- Available-for-sale securities had a $6.3 million net unrealized loss at September 30. The $14.7 million Level 3 collateralized debt obligation portfolio had a $5.0 million unrealized loss and is valued using discounted cash flows and significant unobservable inputs. Management reported no credit-related OTTI on these securities during the first nine months.
Outlook, risks and contingencies
- The filing provides no earnings or revenue guidance. Management says future loan-loss provisions depend on loan balances and mix, credit quality, loss experience, recoveries and qualitative factors.
- Management identified interest-rate exposure as its primary market risk and reported the company was asset-sensitive at September 30. Results may be affected by rate changes, deposit flows and funding costs, loan demand, competition, economic conditions and portfolio quality.
- The company reported a $17.7 million net deferred tax asset measured using a 35% federal tax rate. Proposed tax legislation could reduce the corporate rate; management warned that enactment could require an initial charge to lower the asset’s carrying value, although later tax provisions could also be lower. The outcome and timing were uncertain.
- Loan commitments totaled $123.6 million and standby letters of credit $1.9 million. Management expected most commitments to expire undrawn and considered the letter-of-credit liability immaterial. No legal proceedings were reported.
- Management stated disclosure controls were effective at a reasonable-assurance level and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the specific impaired commercial credit worsens further and leads to additional provisions, charge-offs or collateral losses.
- Progress and recoverability assumptions for the Level 3 CDO portfolio, including its valuation inputs and the extent of non-credit unrealized losses.
- Completion and effects of the planned November 2017 preferred-stock redemption, including the resulting capital and dividend implications.
- Any enacted tax-law changes and their effect on the $17.7 million deferred tax asset and future effective tax rate.
- Whether deposit growth, borrowing levels and interest-rate changes sustain liquidity and net interest margin.