Union Bankshares, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Unaudited consolidated results; the company’s sole subsidiary is Union Bank. Unless noted otherwise, dollar amounts below are in millions.
Financial performance and condition
| Metric | Q3 2016 | Q3 2015 | First 9 months 2016 | First 9 months 2015 |
|---|---|---|---|---|
| Net interest income | $6.315 | $5.912 | $18.419 | $17.219 |
| Net income | $2.268 | $2.050 | $6.166 | $5.951 |
| Earnings per share | $0.51 | $0.45 | $1.38 | $1.33 |
| Net interest margin, tax-equivalent | 4.26% | 4.21% | 4.21% | 4.10% |
| Return on average assets | 1.40% | 1.33% | 1.28% | 1.28% |
| Return on average equity | 16.05% | 15.36% | 14.83% | 15.01% |
| Efficiency ratio | 66.73% | 65.97% | 67.59% | 66.00% |
For Q3, net interest income rose 6.8% and noninterest income rose 10.7%; no loan-loss provision was recorded, versus $150,000 in Q3 2015. These gains were partly offset by an 8.9% increase in noninterest expense and a 17.7% increase in income-tax expense. For the first nine months, net income increased 3.6%; higher net interest and noninterest income and a lower provision were partly offset by a 7.9% increase in noninterest expense.
- Revenue drivers: Loan interest income increased with loan growth; management also cited improved yields on earning assets and lower average funding costs. Q3 loan-sale gains were $921,000 versus $700,000 a year earlier; nine-month gains were $2.196 million versus $2.214 million.
- Expense and margins: Higher salaries, employee benefits and equipment costs contributed to expense growth. The efficiency ratio worsened year over year for both the quarter and year-to-date period, despite improved net interest margins.
- Cash flow: For the first nine months, operating activities provided $3.8 million, investing activities used $22.3 million and financing activities provided $36.1 million. Cash and cash equivalents increased $17.6 million to $35.6 million. Operating cash flow included a $750,000 pension-plan contribution.
- Balance sheet at September 30: Assets were $672.6 million, up 6.9% from year-end 2015; deposits were $572.2 million; gross loans were $522.4 million, plus $10.2 million held for sale; and stockholders’ equity was $56.8 million. Net loans and loans held for sale totaled $528.0 million.
- Funding and liquidity: Deposits increased $11.8 million from year-end, while time deposits declined $45.0 million and noninterest-bearing and other interest-bearing deposits grew. Borrowed funds rose $27.9 million to $37.5 million, principally reflecting FHLB advances used to fund loan demand. The company reported $15.1 million of unused FHLB credit capacity and $12.0 million of federal-funds lines; management stated liquidity was sufficient for reasonable needs.
- Capital: Union’s total risk-based capital ratio was 13.41%, and its Tier 1 leverage ratio was 8.64%. The filing states the company and bank met applicable capital requirements. The company’s equity-to-assets ratio was 8.45%.
Material changes and credit quality
- Loans grew 5.2% including loans held for sale. Commercial real estate loans were the largest portfolio category at $245.6 million; real-estate-secured lending represented 86.0% of total loans.
- Deposits shifted from time accounts toward non-time accounts, partly as municipal customers moved maturing funds into the new ICS money-market product. ICS exchanged deposits were $20.9 million at quarter-end, compared with $2.1 million at year-end 2015.
- Nonperforming loans were $3.4 million, or 0.64% of total loans, versus $3.4 million and 0.66% at year-end 2015. Accruing loans 90 or more days delinquent increased to $1.0 million from $836,000. The allowance was $5.2 million, or 1.00% of loans not held for sale; nine-month net charge-offs were $125,000.
- Impaired loans totaled $4.8 million, including $3.4 million of troubled-debt restructurings (TDRs). TDR balances increased from $2.7 million at year-end. No TDR loans modified in the prior 12 months subsequently defaulted during the reported periods.
- Investment securities totaled $60.7 million. Available-for-sale securities had $969,000 of net unrealized gains before tax; management considered no securities losses other-than-temporary.
Outlook, risks and unusual items
- Outlook: The filing gives no specific earnings or revenue guidance. Management described the bank as asset-sensitive and said it was positioned to benefit in 2017 from higher interest rates; it did not expect fourth-quarter 2016 rate movements to have a significant effect on 2016 results.
- Interest-rate sensitivity requires verification: Management’s narrative says rising rates produce positive results, but the disclosed sensitivity table reports net interest income changes of (14.00)% for a 200-basis-point increase and (21.00)% for a 300-basis-point increase. The table also lists limits of 5.2% and 7.8%. These figures appear inconsistent with the narrative and should be checked against the filed table.
- Key risks: Management cites economic and market conditions, competition, interest-rate changes, borrower repayment and collateral values, regulatory and tax changes, cybersecurity, technology costs, and changes in customer behavior. The loan portfolio is concentrated in real estate lending; management also monitors tourism-related borrower exposure following a weak prior winter season.
- Contingencies: Off-balance-sheet commitments and other listed credit-risk instruments totaled $114.9 million, including $80.7 million of unused lines of credit and $29.1 million of commitments to originate loans. Management did not expect ordinary-course legal proceedings to materially affect financial condition or results.
- Other items: The company declared a $0.28-per-share quarterly dividend payable November 8, 2016. It was evaluating the impact of several new accounting standards, including CECL, which was not yet effective for the company. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Reconcile the interest-rate sensitivity table’s negative projected changes with management’s stated expectation of benefits from rising rates, including the stated limits and assumptions.
- Assess whether the increase in borrowed funding and the evolving deposit mix can support loan growth at acceptable funding costs.
- Monitor the rise in 90-days-past-due accruing loans and TDR balances, real-estate concentration, and the adequacy of the $5.2 million loan-loss allowance.
- Track expense growth against revenue growth, particularly employee benefits and equipment costs, and the resulting efficiency ratio.
- Review the potential earnings and capital effects of CECL implementation and the $114.9 million of off-balance-sheet commitments.