Unity Bancorp, Inc. — 2013 Third-Quarter Form 10-Q
Business context and reporting period. Unity Bancorp is a New Jersey bank holding company whose subsidiary, Unity Bank, operates 15 branches in New Jersey and Pennsylvania. This unaudited filing covers the quarter and nine months ended September 30, 2013; balance-sheet comparisons are to December 31, 2012. Amounts below are in millions unless stated otherwise.
Financial results and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net interest income | $6.87 | $7.03 | $20.36 | $20.69 |
| Provision for loan losses | $0.60 | $1.00 | $1.55 | $3.20 |
| Noninterest income | $1.65 | $1.77 | $5.13 | $5.33 |
| Noninterest expense | $5.94 | $6.00 | $18.13 | $18.16 |
| Net income | $1.30 | $1.20 | $3.85 | $3.08 |
| Income available to common shareholders | $1.18 | $0.80 | $2.86 | $1.88 |
| Diluted EPS | $0.15 | $0.10 | $0.36 | $0.24 |
Margins and returns: Q3 net interest margin was 3.53%, down from 3.72%; nine-month margin was 3.57%, down from 3.65%. Q3 return on average assets was 0.62% versus 0.60%, and return on average common equity was 8.25% versus 5.74%. The efficiency ratio was 69.93% for Q3 versus 68.22%, and 72.17% year to date versus 71.20%.
September 30 balance sheet: Assets were $876.1, up 6.9% from year-end; loans were $660.6, up 12.5%, led by commercial loans ($348.6) and residential mortgages ($173.1). Deposits were $727.1, up $78.4. Cash and cash equivalents were $74.7, down $19.5. Securities totaled $106.9. Borrowed funds and subordinated debentures totaled $90.5, unchanged from year-end. Shareholders’ equity was $55.9, down from $77.5.
Cash flow and liquidity: For the nine months, operating activities provided $9.7; investing activities used $83.5, including $78.2 of net loan growth; financing activities provided $54.3. Cash and cash equivalents declined $19.5 to $74.7. The Bank reported $48.7 of additional FHLB borrowing capacity. Outstanding lending commitments were approximately $119.8, and management stated it believed liquidity was sufficient to meet them.
Credit quality and capital: The allowance for loan losses was $13.6, or 2.05% of total loans, versus $14.8 and 2.51% at year-end. Nine-month net charge-offs were $2.8 versus $4.3. Nonperforming loans were $16.7, or 2.52% of loans, compared with $17.5 and 2.98% at year-end; nonperforming assets were $17.9. The Bank’s September 30 capital ratios were 7.21% leverage, 9.35% Tier 1 risk-based, and 11.94% total risk-based; it exceeded the then-applicable “well-capitalized” thresholds.
Material changes versus comparable periods
- Q3 net income increased 8.9% and income available to common shareholders increased 48.1%; nine-month net income increased from $3.1 to $3.8. The lower preferred-stock burden contributed to the larger increase in common earnings.
- Net interest income declined in both periods as asset yields fell faster than funding costs. Management reported Q3 net interest margin down 19 basis points; lower interest expense and a reduced loan-loss provision partly offset weaker interest income.
- Loan balances grew substantially, particularly commercial loans (up $47.1 from year-end) and residential mortgages (up $41.0). Deposit growth included $36.0 of short-term funds received in September, which the company expected to leave after 90 days.
- Asset quality improved on several measures: nonperforming loans, the allowance balance, and year-to-date net charge-offs were lower than at year-end or in the comparable prior-year period. However, consumer nonperforming loans rose to $1.7 from $0.3 at year-end, and potential problem loans increased to $6.5 from $3.5.
- Shareholders’ equity fell mainly because Unity redeemed its remaining Treasury CPP preferred stock and repurchased the Treasury warrant for $2.7; lower securities valuations also reduced equity. The company completed redemption of all $20.6 of CPP preferred stock during 2013.
Outlook, commentary, risks, and unusual items
- Management identified growth in in-market loans and deposits, improving credit quality, expense control, and lower funding costs as strategic priorities. The filing provides no specific earnings or revenue guidance.
- Management expected the low interest-rate environment to continue and warned that further asset-yield declines could exceed the benefit of additional funding-cost reductions, putting pressure on net interest margin.
- Credit risks include real-estate collateral exposure: approximately 95% of loans were secured by real estate. Management cited economic and property-market conditions as factors that could increase delinquencies, defaults, and collateral losses. SBA lending was described as a higher-risk product than other loan categories.
- Unrealized losses on securities increased: available-for-sale securities had net unrealized losses of $0.68 at September 30, compared with net unrealized gains of $2.2 at year-end. Management attributed losses primarily to rate spreads and other market factors and did not consider the securities other-than-temporarily impaired.
- The company redeemed the remaining CPP preferred shares for approximately $10.4 in July and repurchased the Treasury warrant for $2.7 in August. A $0.01-per-share common dividend was paid in September; the company said the CPP dividend restriction no longer applied.
- Legal proceedings in the ordinary course were not expected by management to materially affect financial position or results. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether deposit growth is durable, particularly after the expected departure of $36.0 in short-term funds, and how municipal and brokered deposits affect funding stability.
- Whether loan growth can sustain returns as yields and net interest margin decline; monitor commercial real-estate exposure, potential problem loans, consumer delinquencies, and charge-offs.
- Whether the $13.6 allowance remains adequate as the loan portfolio expands and credit conditions or collateral values change.
- How securities-market movements affect accumulated other comprehensive income, equity, and the valuation of securities with less observable inputs.
- The effect of CPP redemption and warrant repurchase on capital and liquidity, and the Bank’s capacity to meet future regulatory capital requirements.
- Commitment funding needs, including the approximately $119.8 in lending commitments and the $8.2 brokered CD maturity reported for October 2013.