FIRST UNITED CORP quarterly report, Q3 FY2016

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First United Corporation — Q3 2016 Form 10-Q

Business context and reporting period

First United Corporation is a bank holding company whose principal subsidiary is First United Bank & Trust. This unaudited filing covers the three and nine months ended September 30, 2016; balance-sheet comparisons are with December 31, 2015. Amounts below are in U.S. dollars.

Financial performance and condition

  • Third quarter: Net income was $2.285 million, versus $1.948 million in Q3 2015. Net income available to common shareholders was $1.835 million, or $0.29 per share, versus $1.273 million, or $0.20 per share.
  • First nine months: Net income was $5.860 million, versus $4.491 million in 2015. Net income available to common shareholders was $4.285 million, or $0.68 per share, versus $2.466 million, or $0.39 per share.
  • Interest income and margin: Nine-month net interest income was $28.282 million, up from $26.879 million; fully tax-equivalent net interest margin was 3.21%, versus 3.07%. Q3 net interest income was $9.494 million, versus $9.210 million; fully tax-equivalent margin was 3.22%, versus 3.13%.
  • Other income and expenses: Nine-month total other operating income was $11.221 million, up from $9.810 million, including $0.525 million in net gains. Operating expenses declined to $29.198 million from $30.221 million. Income tax expense rose to $2.237 million from $1.351 million; the effective tax rate was 27.6%, versus 23.1%.
  • Cash flow: Nine-month operating cash flow was $7.947 million, compared with $9.087 million. Investing activities used $1.987 million, versus providing $43.649 million; financing activities provided $7.983 million, versus using $23.398 million. Cash and cash equivalents increased $13.943 million to $66.084 million.
  • Balance sheet and funding: Total assets were $1.338 billion; loans were $902.489 million ($890.445 million net of allowance), deposits were $1.019 billion, and shareholders’ equity was $114.768 million. Total short- and long-term borrowings were $182.532 million. Compared with year-end 2015, loans rose $23.5 million and deposits rose $20.4 million; equity fell $6.0 million, principally reflecting the $10 million preferred-stock redemption, partly offset by earnings.
  • Capital and liquidity: At September 30, consolidated total risk-based capital was 16.93%, Tier 1 risk-based capital 14.69%, common equity Tier 1 10.51%, and Tier 1 leverage 10.77%. Management reported $70.0 million available on correspondent lines, $7.9 million at the Fed Discount Window, and approximately $149.3 million of FHLB availability.

Material changes and management commentary

  • Nine-month earnings improved primarily because net interest income rose $1.4 million, other operating income rose $1.4 million, and expenses fell $1.0 million. These gains were partly offset by a $1.6 million increase in loan-loss provision and higher taxes.
  • Management attributed lower funding costs to shifting deposits from higher-cost certificates of deposit toward lower-cost core accounts. Average interest expense fell $1.1 million year over year for the nine-month period.
  • The loan-loss provision increased to $2.208 million from $0.626 million, principally due to a specific allocation on a large Pennsylvania mall participation loan. Net charge-offs were $2.086 million, versus $0.480 million; the allowance was $12.044 million, or 1.33% of loans.
  • Non-accrual loans rose to $18.144 million from $15.498 million at year-end, primarily due to a large participation loan moving to non-accrual. Other real estate owned increased to $10.259 million from $6.883 million. Accruing loans past due 30 days or more were 0.69% of loans, down from 0.76%.
  • Available-for-sale securities totaled $148.037 million at fair value. The $19.927 million collateralized debt obligation portfolio is Level 3, with $4.794 million of unrealized losses; management reported no credit-related OTTI charges on securities in the first nine months of 2016 and relies on third-party valuation work.

Outlook, risks, contingencies, and unusual items

  • The filing provides no quantified earnings or revenue guidance. Management said it was asset-sensitive and believed its investment portfolio restructuring better positioned the Corporation for rising rates. It stated that liquidity was adequate and did not identify trends expected to materially impair liquidity.
  • Management identified interest-rate changes, deposit flows and funding costs, loan demand and credit quality, competition, economic conditions, regulatory changes, and valuation estimates as risks. The filing says risk factors had not materially changed from the 2015 Form 10-K.
  • The Corporation must obtain Federal Reserve approval for future interest payments on trust preferred debentures and dividends on Series A preferred stock; approval for fourth-quarter 2016 payments had been received. The preferred stock carries a 9% cumulative dividend. The February 2016 redemption reduced outstanding preferred stock by $10 million.
  • Outstanding loan commitments were $113.1 million and standby letters of credit were $1.7 million. The filing states that letters of credit are generally collateralized and their associated liability was not considered material. No legal proceedings were reported.
  • Other notable items include a one-time BOLI death benefit that contributed to income, a $3.0 million pension-plan contribution, and Q3 OREO valuation write-downs. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.

Important facts for investors to verify

  • Credit performance and the outlook for the large mall participation loan, non-accrual balances, CRE charge-offs, and rising OREO.
  • The assumptions and sensitivity of the $19.9 million Level 3 CDO valuation, including collateral performance, liquidity, and potential further losses.
  • Whether the higher provision and charge-offs indicate a continuing increase in credit costs, and how allowance coverage evolves as loans grow.
  • Whether deposit-mix improvements can sustain funding-cost reductions and margins if interest rates or competition change.
  • Regulatory approval requirements and capacity for preferred dividends and trust-preferred interest payments, alongside capital levels and planned funding needs.