FIRST UNITED CORP quarterly report, Q2 FY2013

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First United Corporation — Q2 2013 Form 10-Q

Business context and reporting period. First United is a bank holding company whose primary business is community banking through First United Bank & Trust. This unaudited filing covers the quarter and six months ended June 30, 2013; balance-sheet comparisons are with December 31, 2012. Amounts below are in millions unless stated otherwise.

Key financial results and position

  • Q2 earnings: Net income was $1.842 million, up from $1.649 million in Q2 2012. Net income available to common shareholders was $1.401 million, or $0.23 per diluted share, versus $1.218 million, or $0.20 per share.
  • First-half earnings: Net income was $3.764 million, compared with a $1.016 million net loss in the first half of 2012. Common-shareholder income was $2.886 million, or $0.47 per share, versus a $1.862 million loss, or $0.30 per share.
  • Interest income and margins: First-half net interest income was $18.476 million, down from $19.781 million. Fully tax-equivalent net interest margin declined to 3.17% from 3.33%; Q2 margin was 3.09%, versus 3.34% a year earlier. Management attributed the pressure chiefly to lower average loan balances and yields; lower funding costs partly offset the decline.
  • Credit costs: First-half provision for loan losses fell to $0.946 million from $9.236 million. Net charge-offs were $1.471 million, compared with $11.946 million. The 2012 comparison included large charge-offs on commercial credits. The allowance was $15.522 million, or 1.84% of loans, versus $16.047 million at year-end.
  • Noninterest items: First-half other operating income was $6.673 million, down from $7.752 million, including lower bank-owned life insurance income after a one-time $0.7 million death benefit in 2012. Operating expenses were $19.264 million, compared with $19.141 million.
  • Balance sheet: Total assets were $1.329 billion, up from $1.321 billion at year-end. Gross loans fell to $841.850 million from $874.829 million; deposits declined to $972.659 million from $976.884 million. Shareholders’ equity was $97.783 million, down from $98.905 million, primarily reflecting a $4.085 million increase in accumulated other comprehensive loss.
  • Cash flow and liquidity: First-half operating cash flow was $10.653 million; investing activities used $59.093 million, and financing activities provided $7.441 million. Cash and cash equivalents declined by $40.999 million to $42.069 million. Management stated it believed liquidity was adequate to meet anticipated needs.
  • Borrowings and capital: Short-term borrowings rose to $50.954 million from $39.257 million; long-term borrowings were essentially unchanged at $182.704 million. At June 30, consolidated total risk-based capital was 14.84%, Tier 1 risk-based capital 13.15%, and Tier 1 leverage 10.84%. The company and Bank were categorized as well capitalized under then-applicable rules.

Material changes versus comparable periods

  • The first-half return to profitability was driven principally by the $8.290 million lower loan-loss provision; it should not be read as equivalent growth in recurring operating revenue.
  • Average loans were $860.2 million in the first half, down from $922.7 million a year earlier. Lower loan income contributed to the decline in net interest income, while lower funding costs helped cushion it.
  • Loan quality indicators improved in several respects: nonaccrual loans were $19.377 million versus $19.915 million at year-end and $27.0 million at June 30, 2012; accruing loans past due 30 days or more were 0.75% of loans versus 2.39% at year-end. However, OREO increased to $19.344 million from $17.513 million.
  • Available-for-sale securities increased to $304.681 million in fair value from $223.273 million at year-end. The portfolio had a $29.1 million net unrealized loss at June 30, contributing to the decline in equity through other comprehensive loss.

Outlook, commentary, risks and unusual items

  • The filing provides no formal earnings or revenue guidance. Management said operating results for the interim period are not necessarily indicative of full-year or future results.
  • Management described credit quality as stabilizing, citing fewer downgrades and improved delinquencies, and considered the allowance adequate. Future provisioning remains dependent on loan balances, portfolio mix, credit quality, loss trends, recoveries and economic conditions.
  • The CDO portfolio included 18 pooled trust-preferred securities with $37.045 million amortized cost and $15.030 million fair value. Its $22.015 million unrealized loss was largely attributed by management to marketability, liquidity and economic conditions; no new credit-related OTTI was recorded in the first half. Valuation relies on significant unobservable inputs and third-party discounted-cash-flow analysis.
  • At the Reserve Bank’s request, the company continued to defer interest on trust-preferred debentures; cumulative deferred interest was approximately $5.5 million. Preferred-stock cash dividends also remained suspended, with approximately $4.4 million accrued. Common dividends remained suspended, and resumption depends primarily on future earnings and satisfaction of accrued obligations.
  • Interest-rate risk is the principal market risk. The company reported it was asset-sensitive and said the investment portfolio restructuring better positioned it for rising rates. Management also identified economic conditions, deposit flows and funding costs, loan and investment quality, competition, regulation and execution as risks to forward-looking results.
  • Basel III-related final capital rules were approved in July 2013. Management believed current capital levels and composition would comply if the rules were then effective; implementation was scheduled to phase in beginning in 2015.

Important facts for investors to verify

  • Whether earnings can remain positive as the benefit from sharply lower credit provisions moderates and net interest margin remains below prior-year levels.
  • Trends in criticized and nonaccrual credits, charge-offs, OREO, and the adequacy of the allowance—especially concentrations in commercial real estate and acquisition-and-development lending.
  • The valuation and credit performance of the Level 3 pooled trust-preferred CDO portfolio, including sensitivity to assumptions and further market-value declines.
  • The company’s capacity and timing to resume deferred trust-preferred interest, preferred dividends and common dividends, and the effect of accumulated arrears.
  • Liquidity and funding developments, including the increase in short-term borrowings, and the impact of securities unrealized losses on equity and capital.
  • Compliance with the phased-in Basel III capital standards and any related restrictions on distributions or other capital actions.