Unity Bancorp, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Unaudited consolidated results for Unity Bancorp and Unity Bank. The company operates 17 branches in New Jersey and Pennsylvania and provides commercial and retail banking services.
Financial performance and position
- Second-quarter earnings: Net income was $3.44 million, up from $2.82 million a year earlier; diluted EPS was $0.32 versus $0.30. Return on average assets was 1.11% and return on average equity was 12.47%.
- First-half earnings: Net income was $6.64 million and diluted EPS was $0.62, compared with $7.03 million and $0.74 in 2016. The prior-year period included a $2.3 million pretax gain on subordinated-debt repurchases; excluding that gain, 2016 first-half net income was $5.6 million and diluted EPS was $0.59.
- Net interest income and margin: Q2 net interest income was $11.15 million, up 19.4%; net interest margin rose to 3.79% from 3.61%. First-half net interest income was $21.54 million, up 17.5%, and margin was 3.75% versus 3.55%. Management attributed growth mainly to loan and earning-asset expansion and improved yields.
- Other income and expenses: Q2 noninterest income was $2.02 million, down from $2.23 million, reflecting lower mortgage and SBA loan-sale activity. First-half noninterest income was $4.23 million versus $6.51 million, primarily because 2016 included the debt-repurchase gain. Noninterest expense increased to $7.42 million in Q2 and $14.86 million for the first half, mainly due to higher compensation, staffing, branch expansion, and technology costs. The efficiency ratio was 56.41% for Q2 and 57.71% for the first half.
- Credit costs and asset quality: Loan-loss provision was $0.40 million in Q2 and $0.65 million for the first half. Net charge-offs were $0.43 million for the first half, down from $0.60 million. Nonperforming loans were $5.68 million, or 0.54% of loans, versus $7.24 million and 0.74% at year-end 2016. Nonperforming assets were $6.26 million, or 0.49% of assets. Potential problem loans rose to $4.0 million from $1.1 million at year-end.
- Balance-sheet growth: Total assets were $1.276 billion, up 7.2% from year-end 2016. Total loans were $1.047 billion, up 7.5%; notable growth included consumer loans (+15.4%), residential mortgages (+9.1%), and commercial loans (+7.1%). Deposits were $1.004 billion, up 6.2%, while borrowed funds were $142 million, up $21 million. Shareholders’ equity was $112.4 million.
- Cash flow and liquidity: First-half operating activities provided $10.7 million; investing activities used $90.1 million, primarily for loan growth and securities purchases; financing activities provided $78.3 million, principally from deposit growth and new borrowings. Cash and cash equivalents ended at $104.8 million, down $1.1 million from year-end. The company reported $223.1 million of additional FHLB borrowing capacity.
- Capital: At June 30, the company’s leverage, CET1, Tier 1 risk-based, and total risk-based capital ratios were 9.66%, 11.32%, 12.34%, and 13.59%, respectively. The bank’s respective ratios were 9.35%, 11.94%, 11.94%, and 13.20%; each exceeded the stated well-capitalized thresholds.
Material changes and management commentary
- Growth in loans and deposits expanded the balance sheet; management cited stronger loan growth and the rising-rate environment as contributors to increased net interest income and margin.
- Management elected to retain more residential mortgages in portfolio for long-term investment. First-half mortgage sales were $42.3 million, down from $51.1 million in 2016; SBA sales were $11.3 million versus $10.6 million.
- Savings deposits increased substantially, partly from promotional products; noninterest-bearing demand deposits also grew with commercial relationships. Management said time-deposit balances declined as municipal and institutional deposits were reduced.
- There is no specific earnings or financial guidance in the supplied filing text. Management cautioned that interim results are not necessarily indicative of full-year results.
Risks, contingencies, and unusual items
- Credit risk is concentrated geographically in the bank’s service area, and approximately 95% of loans were secured by real estate. Changes in local economic conditions or property values could affect collateral and credit losses. SBA 7(a) loans are identified by management as riskier than other loan products.
- Government deposits are short-duration and price-sensitive. The company reported $79.1 million of government deposits and $219.2 million in loan commitments, of which $131.4 million expire within one year; management believed liquidity was sufficient to honor commitments.
- Interest-rate changes affect asset yields, funding costs, and securities values. The company uses swaps to hedge some variable-rate debt payments; its disclosed 200-basis-point economic-value-of-equity sensitivities were within board limits.
- Four OREO properties were sold in the first half, generating a $253,000 net loss; OREO was $581,000 at quarter-end. The allowance for loan losses was $12.8 million, or 1.22% of loans, and management considered it adequate, while noting future provisions may be needed as conditions change.
- Management stated that pending ordinary-course legal matters were not expected to materially affect the company. The filing reported no material change in market-risk assessment and no significant change in internal control over financial reporting.
Most important facts for investors to verify
- Whether loan growth and improved net interest margin can continue without materially higher deposit costs or credit losses.
- The composition and performance of the $4.0 million in potential problem loans, and subsequent trends in nonperforming loans, charge-offs, and the allowance.
- The sustainability of deposit growth, dependence on rate-sensitive deposits and borrowings, and availability of liquidity as commitments fund or deposits leave.
- The effect of retaining more residential mortgages and the portfolio’s exposure to interest rates, prepayments, and real-estate collateral values.
- Comparability of year-over-year earnings, including the 2016 debt-repurchase gain and the effect of higher compensation and expansion-related expenses.