First United Corporation — Q3 2015 Form 10-Q
Business context and period. First United Corporation is a bank holding company whose primary subsidiary is First United Bank & Trust. This unaudited report covers the three and nine months ended September 30, 2015; balance-sheet comparisons are with December 31, 2014. Unless indicated otherwise, figures below are in millions of dollars.
Financial results and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net interest income | $9.21 | $8.83 | $26.88 | $26.68 |
| Provision for loan losses | $0.50 | $0.69 | $0.63 | $1.63 |
| Total other operating income | $3.54 | $3.33 | $9.95 | $10.43 |
| Operating expenses | $9.71 | $9.91 | $30.36 | $30.57 |
| Net income | $1.95 | $1.34 | $4.49 | $3.94 |
| Net income available to common shareholders | $1.27 | $0.67 | $2.47 | $2.01 |
| Diluted earnings per common share | $0.20 | $0.10 | $0.39 | $0.32 |
- Margins and returns: Fully tax-equivalent net interest margin was 3.13% in Q3 2015 versus 2.96% a year earlier, and 3.07% for the first nine months versus 3.02%. Nine-month annualized return on average assets was 0.45%, return on average equity 5.34%, and average equity to average assets 9.23%.
- Balance sheet at September 30: Total assets were $1,320.3; loans $843.1 gross and $830.9 net; deposits $996.3; shareholders’ equity $114.6. Cash and cash equivalents were $64.8.
- Debt: Short-term borrowings were $38.5 and long-term borrowings $147.6, including $105.8 of FHLB advances and $41.7 of junior subordinated debt. Long-term borrowings fell $35.1 since year-end, principally from repayment of a $30.0 FHLB advance and $5.0 of subordinated debentures that matured.
- Cash flows: Nine-month operating cash flow was $9.1; investing activities provided $43.6 and financing activities used $23.4. Cash and cash equivalents increased $29.3 to $64.8. Investing cash flow included securities maturities and sales; cash flow is therefore not solely a measure of operating performance.
- Capital and liquidity: At September 30, consolidated total risk-based capital was 15.84%, Tier 1 risk-based capital 13.64%, common equity Tier 1 9.00%, and Tier 1 leverage 10.54%. The Bank’s corresponding ratios were 15.88%, 14.67%, 14.67%, and 11.29%. Management reported $70.0 available on unsecured correspondent lines, $20.1 at the Fed Discount Window, and approximately $98.0 available through the FHLB; management considered liquidity adequate.
Material changes versus comparable periods
- Common-shareholder earnings rose 91% in Q3 and 23% year to date, while diluted EPS increased to $0.20 and $0.39, respectively. Management attributed the improvement to higher net interest income, lower loan-loss provision, and lower operating expenses; quarterly other operating income also increased.
- Nine-month net interest income increased modestly as lower funding costs more than offset lower interest income. Interest expense declined $1.0, while interest income declined $0.8. Management cited lower average deposit costs, a lower average rate paid, and repayments of borrowings.
- Nine-month other operating income declined $0.5, mainly because prior-year gains included $1.1 from sales of previously impaired held-for-trading CDOs. Trust and brokerage income and bank-owned life insurance earnings increased.
- Operating expenses decreased $0.2 year over year. A $1.2 reduction in OREO expense was largely offset by a $1.1 increase in salaries and benefits, including pension administration and health-care costs.
- Total loans increased $3.1 from year-end, with residential mortgages up $11.3 and commercial real estate up $9.9, partly offset by an $18.5 reduction in commercial and industrial loans. Deposits increased $15.0; non-interest-bearing deposits increased $13.8 as the company emphasized core deposits and reduced certificates of deposit.
- OREO declined $5.5 to $7.5. Non-accrual loans were $11.8, slightly above $11.6 at year-end; total impaired loans declined to $24.0 from $24.8. Total TDRs rose to $17.9 from $13.7.
Outlook, risks, contingencies, and unusual items
- Management outlook: No specific earnings or revenue guidance was provided. Management said it would continue focusing on lower-cost core deposits and full-relationship customers, and considered the allowance and liquidity adequate. The company was asset-sensitive at quarter-end and said its investment portfolio restructuring better positioned it for rising rates.
- Credit and securities risks: The allowance for loan losses was $12.2, or 1.45% of gross loans, including a newly established $0.5 unallocated component. Nine-month net charge-offs were $0.5 versus $3.2 a year earlier. The allowance is based on estimates and actual losses may differ. The portfolio included $31.9 of Level 3 pooled trust preferred CDOs, with $7.3 of unrealized losses outstanding for at least 12 months; management used third-party cash-flow valuations and reported no credit-related OTTI charges in the first nine months of 2015. Fair value depends on significant unobservable assumptions and illiquid markets.
- Regulatory and shareholder distributions: Parent-company interest payments on trust preferred debt and dividends on Series A preferred stock remained subject to prior Federal Reserve approval; Bank dividends also require regulatory approval. The common-stock dividend had not resumed after suspension in 2010, and the filing gives no assurance about when it may resume. Preferred stock has a $30.0 liquidation preference; the filing reports $2.025 of accumulated preferred dividends and discount accretion for the nine-month period.
- Subsequent event: On October 30, 2015, a FINRA arbitration panel awarded First United $11.5 in compensatory damages in its dispute with FTN Financial Securities Corp. and two representatives concerning trust preferred securities. FTN paid the award on November 5. This occurred after the September 30 reporting date.
- Other exposures: Loan commitments were $107.7 and standby letters of credit $1.7 at quarter-end. Management said it expected most commitments to expire without being drawn. Interest-rate changes, deposit flows, credit quality, collateral values, and regulatory approvals are among the risks identified in the filing.
- Controls and legal matters: Management concluded disclosure controls were effective at the reasonable-assurance level and reported no material change in internal control over financial reporting during the quarter. The filing reported no legal proceedings as of its filing disclosures, apart from the separately described FINRA arbitration award.
Important facts for investors to verify
- How the $11.5 FINRA award is reflected in subsequent-period financial statements, cash, taxes, and any related accounting or legal disclosures.
- Current performance and valuation assumptions for the Level 3 CDO portfolio, especially the securities with long-standing unrealized losses and issuer deferrals or defaults.
- Whether loan quality trends, TDR growth, non-accrual balances, and OREO dispositions support the reported allowance adequacy.
- Regulatory approvals and terms governing preferred dividends and trust-preferred interest payments, and any effect on the possibility of restarting common dividends.
- Current capital and liquidity headroom under applicable regulatory requirements, including the phase-in of Basel III capital buffers and the availability of disclosed funding sources.
- Whether ongoing net interest margin performance can be sustained as rates, asset yields, deposit mix, and funding costs change; reported interim results are not necessarily indicative of full-year results.