First United Corporation — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. First United is a bank holding company whose principal subsidiary is First United Bank & Trust. Figures are unaudited; dollar amounts below are in millions unless otherwise noted.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income (GAAP) | $11.9 | $11.6 | $36.4 | $34.5 |
| Provision for loan losses | $0.2 | $(0.01) | $5.0 | $0.7 |
| Net income | $5.0 | $4.5 | $9.3 | $10.2 |
| Diluted earnings per share | $0.70 | $0.63 | $1.32 | $1.44 |
| Net interest margin, fully taxable equivalent | 3.12% | 3.62% | 3.43% | 3.67% |
For the nine months, the 8.3% decline in EPS reflected higher credit-loss provisioning, partly offset by higher net interest income and lower operating expenses. Q3 net income rose year over year despite lower margin, supported by lower funding costs, mortgage-related gains and reduced expenses. Nine-month other operating income, including gains, was $13.4 million versus $12.7 million; operating expenses were $33.0 million versus $33.7 million. Return on average assets was 0.79% and return on average equity was 9.87% for the nine months, compared with 0.97% and 10.96%, respectively, in 2019.
Financial condition, cash flow and capital
- At September 30, assets were $1.686 billion, up $243.9 million from year-end 2019. Gross loans were $1.192 billion, deposits $1.377 billion, and shareholders’ equity $130.2 million.
- Loans grew $142.0 million, including $148.9 million of SBA Paycheck Protection Program (PPP) loans; residential mortgage balances declined $39.7 million. Cash and cash equivalents rose to $155.6 million from $50.0 million at year-end.
- Deposits increased $235.3 million, with growth in non-interest-bearing deposits and other core accounts as well as PPP-related balances. Short-term borrowings were $52.6 million; long-term borrowings were $100.9 million, unchanged from year-end.
- Nine-month cash flows: $7.8 million provided by operations, $135.9 million used in investing, and $233.8 million provided by financing; cash and cash equivalents increased $105.6 million.
- The allowance for loan losses was $16.2 million, or 1.36% of loans including PPP loans and 1.55% excluding PPP loans. Nine-month net charge-offs were $1.3 million. Management considered the allowance adequate but noted estimates depend on uncertain economic and borrower conditions.
- Both the Corporation and Bank were reported well-capitalized. At September 30, the Corporation’s total risk-based capital ratio was 16.14% and its Tier 1 leverage ratio was 10.37%; the Bank’s corresponding ratios were 15.36% and 9.64%.
- Management reported $145.0 million of unsecured correspondent lines, $137.5 million of available FHLB borrowing capacity and $1.1 million at the Federal Reserve Discount Window. It said liquidity was adequate and the institutions’ capital ratios were strong.
Material changes, outlook and risks
- COVID-19 and credit: Management increased qualitative loan-loss factors amid uncertainty, attributing $4.4 million of the nine-month $5.0 million provision to qualitative adjustments and $0.6 million to loan growth and portfolio mix. Active COVID-related modifications had fallen to 42 loans totaling $19.3 million as of October 30, compared with 383 loans totaling $214.5 million reported through July 31. These are differently timed measures. Hotels and certain other borrowers remained exposed to reduced business activity.
- PPP: The Bank funded 1,174 PPP loans totaling $148.9 million. The loans are 100% SBA-guaranteed and carry a 1% rate; the company anticipated approximately $3.5 million of deferred fees. It had not accessed the Federal Reserve’s PPP Liquidity Facility. As of October 26, 51 applications had SBA approval, 123 were pending SBA validation and 76 were under Bank review.
- Interest rates and earnings: Lower market rates, PPP lending and elevated cash balances pressured asset yields and net interest margin; deposit-rate reductions helped reduce interest expense. Management reported the Bank was asset-sensitive and estimated that a 100-basis-point rate rise would increase net interest income by $2.0 million, while a 100-basis-point decline would reduce it by $1.8 million. These are model estimates, not forecasts.
- Credit and collateral items: Classified substandard loans increased $12.7 million from year-end, primarily due to two relationships; management said these loans were current and well collateralized. A $1.1 million specific allocation on a nonaccrual development loan was charged off and $1.3 million reallocated to the general allowance. The related property entered OREO after foreclosure in November, and management anticipated about $2.0 million of OREO reduction if a parcel sale closed as expected in December.
- Unusual expenses and gains: Nine-month professional-services and investor-relations expenses rose substantially in connection with the 2020 annual meeting and proxy contest. Mortgage refinancing and securities sales contributed to gains; Q3 gains included approximately $0.7 million from mortgage-loan sales and $0.6 million from investment sales. Lower salaries and benefits partly offset elevated legal and other costs.
- Goodwill and securities valuation: A COVID-related interim goodwill test found estimated fair value exceeded carrying value by approximately 3%, so no impairment was recorded. The $12.8 million CDO portfolio is Level 3 and valued using significant unobservable inputs; its $5.8 million unrealized loss was principally described as non-credit-related OTTI. Management said no credit-related OTTI was recognized in the first nine months.
- Litigation: Driver Opportunity Partners sued the Corporation, current directors and two former directors over the proxy contest and related events, seeking unspecified damages and, among other relief, a new director election. The company disputed the claims and intended to defend them; the outcome and related costs could not be assessed. Insurance may not cover all costs or damages, and indemnification obligations may apply.
- Outlook: The filing provides no specific earnings or revenue guidance. Management emphasized uncertainty around the pandemic’s duration, economic conditions, borrower repayment capacity, government support and further restrictions. It also noted that lower rates and changing credit conditions could affect margins and loan-loss estimates.
Investor verification priorities
- Track credit quality, subsequent charge-offs and allowance adequacy, particularly in hotel, commercial real estate and development exposures; distinguish PPP-guaranteed loans from other loans.
- Confirm PPP fee recognition, forgiveness progress and the impact of PPP balances and excess liquidity on future margin and earnings.
- Monitor deposit composition, liquidity usage, borrowing capacity and capital ratios as pandemic-related balances change.
- Review the assumptions behind Level 3 CDO valuations and the interim goodwill test, including sensitivity to market and economic conditions.
- Follow the Driver litigation, related legal expenses, insurance coverage and any effect on governance or the 2020 director election.
- Reconcile reported results with unusual gains, deferred PPP fees, proxy-related expenses and the timing of the anticipated OREO sale.