First United Corporation — Q3 2013 Form 10-Q
Business context and period. First United is a Maryland financial holding company whose primary business is community banking through First United Bank & Trust. This unaudited report covers the quarter and nine months ended September 30, 2013; balance-sheet comparisons are with December 31, 2012. Dollar figures below are in millions unless stated otherwise.
Key financial metrics
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net interest income | $11.0 | $9.8 | $29.5 | $29.6 |
| Provision for loan losses | $(1.1) | $0.04 | $(0.2) | $9.3 |
| Net income | $1.8 | $2.9 | $5.6 | $1.9 |
| Net income available to common shareholders | $1.4 | $2.5 | $4.3 | $0.6 |
| EPS, basic and diluted | $0.22 | $0.40 | $0.69 | $0.10 |
| Net interest margin, fully tax-equivalent | 3.77% | 3.28% | 3.37% | 3.31% |
Balance sheet at September 30, 2013: Total assets were $1,342.1; gross loans $836.2 and net loans $821.1; deposits $974.4; total liabilities $1,242.6; shareholders’ equity $99.5. Cash and cash equivalents were $71.5. Available-for-sale securities were $297.0 fair value, against $326.4 amortized cost; held-to-maturity securities were $3.9 at cost.
Cash flow and funding: Nine-month operating cash flow was $15.9; investing activities used $44.8, largely reflecting securities purchases; financing activities provided $17.3. Cash and cash equivalents declined $11.5 to $71.5. Short-term borrowings were $59.1 and long-term borrowings $182.7. Deposits were down $2.5 from year-end, while repurchase-agreement borrowings rose $19.8.
Credit and liquidity: The allowance for loan losses was $15.2, or 1.81% of loans, versus $16.0 and 1.84% at year-end. Nine-month net charge-offs were $0.7, an annualized 0.12% of average loans. Non-accrual loans fell to $14.8 from $19.9; total non-accrual and 90-days-past-due accruing loans were $15.8, down from $22.1. Other real estate owned (OREO) was $17.0. Management reported available funding capacity of $20.0 in unsecured correspondent lines, $32.2 at the Federal Reserve Discount Window, and approximately $16.6 at the FHLB.
Capital: At September 30, the consolidated total risk-based capital ratio was 15.18%, Tier 1 risk-based ratio 13.52%, and Tier 1 leverage ratio 11.02%; the Bank’s respective ratios were 16.02%, 14.74%, and 12.00%. Regulators categorized the Corporation and Bank as well capitalized. The filing says the Corporation expected to comply with forthcoming Basel III requirements.
Material changes versus comparable periods
- Nine-month common earnings increased to $4.3 from $0.6, primarily because the loan-loss provision fell by $9.4, from $9.3 expense to a $0.2 recovery. Management cited lower charge-offs, improved delinquency trends, lower loan balances, and a $0.8 recovery on a commercial real-estate credit.
- Q3 common earnings declined to $1.4 from $2.5. A $2.2 increase in OREO-related expense, mainly write-downs, outweighed stronger net interest income and interest recognized on two non-accrual loan payoffs.
- Net interest margin improved year over year in both periods. Nine-month net interest income was broadly flat as lower interest income was mostly offset by lower funding costs; Q3 net interest income rose $1.3.
- Operating expenses increased $2.9 over the first nine months, including a $2.5 increase in OREO expenses. OREO fair-value write-downs totaled $2.9 for the nine months and $2.9 in Q3; the OREO valuation allowance rose to $4.6.
- Gross loans fell $38.6, or 4.4%, from year-end, while the investment portfolio increased $73.7. Non-interest-bearing deposits grew $20.6, but total deposits edged down.
- Accumulated other comprehensive loss widened to $25.6 from $21.8 at year-end, chiefly reflecting unrealized losses on available-for-sale securities. The portfolio’s net unrealized loss was $29.4 at September 30.
Outlook, commentary, risks, and unusual items
- No specific earnings or financial guidance was provided. Management said the interim results are not necessarily indicative of full-year or future results.
- Management described credit quality as stabilizing, with fewer downgrades and improved delinquency levels, and said the allowance was adequate. Actual future provision needs depend on loan mix, credit performance, recoveries, and economic conditions.
- Management is emphasizing core deposits and lower-cost transaction and money-market accounts, and limiting special deposit pricing to full-relationship customers. It said liquidity was adequate and identified no known material liquidity pressures.
- The bank was described as asset-sensitive to interest rates. Management stated that investment portfolio restructuring better positioned the Corporation for a rising-rate environment; interest-rate changes, deposit costs, loan demand, and security valuations remain risks.
- The $16.3 fair value of the Level 3 collateralized debt obligation portfolio is based on significant unobservable inputs. It had $37.0 amortized cost and $21.1 in unrealized losses; management reported no credit-related OTTI charges in the first nine months of 2013. Market inactivity, illiquidity, and underlying issuer credit stress remain material valuation risks.
- At regulators’ request, the Corporation continued deferring interest on trust preferred debentures; cumulative deferred interest was approximately $6.1. It also continued suspending Series A preferred dividends, with approximately $4.8 accrued. Common dividends remained suspended, and resumption timing was uncertain. The Series A preferred dividend rate was scheduled to increase from 5% to 9% on February 15, 2014.
- Commitments to extend credit were $96.2 and standby letters of credit $1.1 at September 30. Management said the guarantees were collateralized and their associated liability was not material. The filing reported no legal proceedings and no material changes in risk factors since year-end.
- Disclosure controls were assessed as effective at a reasonable-assurance level; no material change in internal control over financial reporting was reported.
Most important facts for investors to verify
- Whether the sharp improvement in nine-month earnings is sustainable given that it was driven substantially by a provision recovery, while Q3 earnings fell year over year.
- Whether OREO valuations and sales support the substantial 2013 write-downs and the remaining $17.0 OREO balance.
- Credit performance in commercial real estate and acquisition-and-development loans, and whether non-accruals, criticized credits, and the allowance continue to improve.
- The assumptions and sensitivity behind Level 3 CDO valuations, the portfolio’s underlying deferrals/defaults, and the risk of further unrealized or credit losses.
- Funding, capital, and regulatory conditions required to resume deferred trust-preferred interest and preferred dividends, and the implications for any future common dividends.
- Whether deposit trends, borrowing growth, available liquidity sources, and interest-rate sensitivity remain consistent with management’s stated outlook.