FIRST UNITED CORP quarterly report, Q2 FY2016

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First United Corporation — Q2 2016 Form 10-Q

Business context and period: First United Corporation is a bank holding company whose principal subsidiary is First United Bank & Trust. This unaudited report covers the quarter and six months ended June 30, 2016; balance-sheet comparisons are to December 31, 2015. Dollar figures below are in millions unless stated otherwise.

Financial performance and position

  • Q2 earnings: Net income was $1.704 million versus $1.175 million a year earlier; net income available to common shareholders was $1.254 million versus $0.500 million. Diluted EPS was $0.20 versus $0.08.
  • First-half earnings: Net income was $3.575 million versus $2.543 million; income available to common shareholders was $2.450 million versus $1.193 million. Diluted EPS was $0.39 versus $0.19.
  • Interest income and margin: First-half net interest income was $18.788 million, up from $17.669 million. Fully tax-equivalent net interest margin was 3.22% versus 3.04%; Q2 margin was 3.20% versus 3.00%.
  • Credit costs and expenses: First-half provision for loan losses rose to $1.914 million from $0.126 million. Operating expenses fell to $19.436 million from $20.559 million. First-half effective tax rate was 26.5%, compared with 22.9%.
  • Assets and funding at June 30: Total assets were $1,307.4 million, down from $1,323.5 million at year-end. Gross loans were $919.3 million, up $40.2 million; deposits were $1,005.3 million, up $6.5 million. Net loans were $906.6 million.
  • Liquidity and cash flow: Cash and cash equivalents were $22.7 million, down from $52.1 million at year-end. First-half operating cash flow was $4.5 million versus $5.8 million; investing activities used $13.0 million versus providing $12.8 million; financing activities used $20.9 million versus providing $3.8 million. Management said available liquidity was adequate. At June 30, the Bank reported $70.0 million in correspondent-bank lines, $10.9 million at the Fed Discount Window, and approximately $137.3 million available from the FHLB.
  • Borrowings and capital: Short-term borrowings fell to $20.4 million from $35.8 million; long-term borrowings were $146.8 million versus $147.5 million. Consolidated total capital, Tier 1 capital, common equity Tier 1, and leverage ratios were 16.42%, 14.14%, 10.13%, and 10.69%, respectively. The Bank’s corresponding ratios were 16.36%, 15.11%, 15.11%, and 10.93%.
  • Equity: Shareholders’ equity was $113.2 million, down from $120.8 million, primarily reflecting the $10.0 million preferred-stock redemption, partly offset by earnings. The company had 6,269,004 common shares outstanding on July 31, 2016.

Material changes and management commentary

  • Management attributed higher first-half earnings mainly to improved net interest income, higher other income, and lower expenses, partly offset by the substantially higher loan-loss provision and increased taxes. Lower funding costs followed repayment of a $30 million FHLB advance in July 2015; management also continued shifting deposits toward lower-cost core accounts.
  • Loan growth was concentrated in commercial real estate and acquisition-and-development lending. Commercial real estate loans increased $23.3 million from year-end, and acquisition-and-development loans increased $8.5 million.
  • Non-accrual loans declined to $11.3 million from $15.5 million, while OREO increased to $9.4 million from $6.9 million. Loans past due 30 days or more were 0.47% of the portfolio, down from 0.76% at year-end.
  • The allowance for loan losses was $12.7 million, or 1.38% of loans. First-half net charge-offs were $1.2 million versus $0.4 million; management said the allowance was adequate. A $1.7 million charge-off on one commercial real estate loan was cited, and a $1.6 million specific allocation related to a Pennsylvania mall participation loan contributed to the provision increase.
  • Available-for-sale securities declined to $147.2 million from $170.2 million, with sales and calls used in part to fund loan growth. The $20.2 million pooled trust-preferred CDO portfolio was valued using Level 3 inputs; management reported no credit-related OTTI charges in the first half, but the securities had limited market activity and significant valuation uncertainty.

Outlook, risks, contingencies, and unusual items

  • The filing provides no quantified earnings or revenue guidance. Management said the investment portfolio restructuring had better positioned the Corporation for a rising-rate environment and described it as asset-sensitive at June 30. Interest-rate movements, deposit costs and flows, loan demand, portfolio quality, competition, economic conditions, and regulatory changes were identified as risks.
  • First United must obtain Federal Reserve approval before future interest payments on trust-preferred debt and dividends on Series A preferred stock. The filing says approval had been received for third-quarter 2016 payments; future payments also depend on Bank dividends and applicable restrictions.
  • First United redeemed $10.0 million of Series A preferred stock in February 2016. Four new interest-rate swaps totaling $30 million were entered into in March to hedge floating-rate trust-preferred debt; their June 30 fair value was a $1.1 million liability. The filing reports no hedge ineffectiveness.
  • Other notable items included a reported one-time BOLI death benefit in Q2 and a $0.4 million reduction in tax expense from low-income housing tax credits and related tax losses. Loan commitments were $116.2 million and standby letters of credit were $1.7 million at June 30.
  • Management reported no material change in risk factors since the 2015 Form 10-K, no legal proceedings, and effective disclosure controls. It also noted that interim results are not necessarily indicative of full-year results.

Important facts for investors to verify

  • Track whether credit costs, impaired loans, commercial real estate exposure, OREO, and the allowance change as the loan book grows; review the mall participation loan and the large commercial real estate charge-off.
  • Assess the CDO portfolio’s Level 3 valuation assumptions, collateral performance, and sensitivity to market liquidity and credit conditions.
  • Confirm cash and liquidity trends, funding mix, deposit pricing, and availability of borrowing facilities alongside continued loan growth.
  • Monitor regulatory approvals and cash capacity for trust-preferred interest and preferred dividends, as well as capital ratios and the effects of preferred-stock redemption.
  • Reconcile the reported BOLI death benefit and related proceeds, and distinguish recurring operating performance from one-time income and other unusual items.