First United Corporation — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012; balance-sheet comparisons are to December 31, 2011. First United is a Maryland financial holding company whose principal subsidiary is First United Bank & Trust, operating 28 offices and 29 ATMs. Unless noted, financial amounts below are in millions of dollars.
Financial performance and condition
- Q2 earnings: Net income was $1.649 million and net income available to common shareholders was $1.218 million, or $0.20 per share, compared with $1.133 million and $0.733 million, or $0.12 per share, in Q2 2011.
- First-half earnings: Net loss was $1.016 million; after preferred dividends and discount accretion, the loss attributable to common shareholders was $1.862 million, or $0.30 per share. The comparable 2011 period produced $2.090 million net income and $1.296 million available to common shareholders, or $0.21 per share.
- Revenue and margins: First-half net interest income was $19.781 million, up from $19.018 million. Fully tax-equivalent net interest margin rose to 3.33% from 2.85%; Q2 margin was 3.34% versus 2.95%. First-half total interest income declined to $27.269 million from $30.749 million, while interest expense fell to $7.488 million from $11.731 million. Total other operating income was $8.560 million versus $8.229 million.
- Credit costs and expenses: First-half provision for loan losses increased to $9.236 million from $4.605 million. Operating expenses declined to $19.949 million from $21.003 million. The company reported a first-half pretax loss of $0.844 million and income tax expense of $0.172 million.
- Cash flow: First-half operating cash flow was $5.353 million, investing cash flow was positive $36.418 million, and financing cash flow was negative $39.939 million. Cash and cash equivalents ended at $66.939 million, up $1.832 million since year-end.
- Balance sheet and liquidity: Total assets were $1.348 billion, down $42.4 million from year-end. Loans were $907.9 million gross and $891.1 million net; deposits were $996.3 million, down $31.4 million. Shareholders’ equity was $95.1 million. Short- and long-term borrowings totaled $235.4 million; long-term borrowings were $206.5 million.
- Credit quality: Allowance for loan losses was $16.770 million, or 1.85% of loans, versus $19.480 million, or 2.24%, at year-end. First-half net charge-offs were $11.946 million, an annualized 2.59% of average loans. Non-accrual loans declined to $27.017 million from $38.188 million; other real estate owned rose to $19.828 million from $16.676 million.
- Capital: At June 30, consolidated total risk-based capital was 13.40%, Tier 1 risk-based capital 11.68%, and Tier 1 leverage 9.84%. The Bank’s respective ratios were 13.67%, 12.40%, and 10.44%. The filing says both were categorized as well capitalized.
Material changes versus comparable periods
- The first-half common-shareholder result shifted from $1.296 million of income in 2011 to a $1.862 million loss in 2012, primarily because of increased loan-loss provision and charge-offs.
- A $9.0 million charge-off on a shared national credit for a Pennsylvania ethanol plant was the principal driver of the higher provision. The filing also cites a $1.1 million charge-off on a hotel participation loan and a $0.9 million charge-off on a Maryland motel loan.
- Lower deposit and borrowing costs supported higher net interest income and margin despite lower interest income. Management attributed the funding-cost reduction partly to balance-sheet repositioning and lower-cost deposit pricing.
- First United sold substantially all assets of its insurance agency effective January 1, 2012. Insurance commissions consequently fell; the sale also contributed to reduced goodwill. A one-time, tax-free bank-owned life insurance death benefit of approximately $0.7 million and first-half gains on securities and OREO partly offset lower recurring income and credit costs.
- Total loans fell $30.8 million from year-end, while deposits fell $31.4 million. Classified and non-accrual credit measures improved in some areas, but the allowance declined after substantial charge-offs.
Outlook, risks and unusual items
- Management anticipated a continued flat interest-rate environment during 2012 and expected net interest margin to continue improving. It described the balance sheet as asset sensitive and said portfolio restructuring better positioned the company for rising rates. These are forward-looking statements, not guarantees.
- Management stated it believed liquidity was adequate and the allowance was adequate, while noting future provision needs depend on loan balances, credit quality, loss trends, recoveries, and economic conditions.
- The securities portfolio included 18 pooled trust-preferred CDO securities with $36.6 million amortized cost and $9.3 million fair value. Their $27.2 million unrealized loss was largely associated with illiquidity and market conditions; management reported no credit-related OTTI charge in the first half. The CDOs are Level 3 valuations relying on significant unobservable inputs.
- At the Federal Reserve Bank of Richmond’s request, the parent continued deferring interest on trust preferred debentures; cumulative deferred interest was approximately $3.3 million. Series A preferred dividends remained suspended, with approximately $2.7 million accrued. Common dividends were also suspended. The filing provides no timing for resumption; payment capacity depends primarily on future earnings.
- Key risks include credit losses and collateral values, economic conditions, interest-rate changes, deposit flows and funding costs, investment valuation and liquidity, and regulatory changes. Loan commitments were $81.6 million and standby letters of credit $1.7 million at quarter-end.
- The filing reported no legal proceedings and no material change in risk factors since the 2011 Form 10-K. Management concluded disclosure controls were effective at a reasonable-assurance level and reported no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether credit performance remains stable after the large first-half charge-offs, especially in commercial and industrial and commercial real-estate exposures, and whether the $16.8 million allowance remains adequate.
- How much of the improved margin is sustainable, given lower funding costs, the reduced balance sheet, and management’s stated outlook for further margin improvement.
- The valuation assumptions, collateral performance, and potential future credit losses for the Level 3 CDO portfolio, which had $27.2 million of unrealized losses.
- The company’s earnings and regulatory constraints relevant to resuming trust-debt interest, preferred dividends, and common dividends; the filing gives no resumption date.
- The effects of continued deposit outflows, wholesale funding needs, and the increase in OREO on liquidity and future earnings.
- The period-specific results: the company was profitable in Q2 but reported a first-half loss, so quarter-only performance should not be treated as the year-to-date result.