Business Context and Reporting Period
Company: First United Corporation (Maryland corporation, parent of First United Bank & Trust).
Filing Type: Form 10-Q (Unaudited Quarterly Report).
Reporting Period: Six months ended June 30, 2010.
Business Overview: The Corporation operates as a financial holding company providing retail and commercial banking services through 28 offices and 33 ATMs. It also includes an insurance subsidiary and statutory trusts for trust preferred securities.
Key Financial Metrics
| Metric (in thousands, except per share) | Six Months Ended June 30, 2010 | Six Months Ended June 30, 2009 |
|---|---|---|
| Net Interest Income | $22,830 | $27,189 |
| Provision for Loan Losses | $7,186 | $3,920 |
| Other Operating Income (Net of Losses) | $(3,332) | $5,018 |
| Total Operating Expenses | $22,405 | $23,399 |
| Net Loss | $(6,027) | $3,528 (Income) |
| Net Loss Attributable to Common Shareholders | $(6,806) | $2,876 (Income) |
| Basic Net Loss Per Common Share | $(1.11) | $0.47 (Income) |
| Total Assets | $1,775,998 | $1,743,796 |
| Total Loans (Gross) | $1,082,214 | $1,121,884 |
| Allowance for Loan Losses | $23,782 | $20,090 |
| Total Deposits | $1,373,722 | $1,304,166 |
| Total Borrowings (Short & Long Term) | $281,114 | $318,107 |
| Cash and Cash Equivalents | $316,232 | $189,671 |
| Shareholders' Equity | $100,078 | $100,566 |
Key Ratios:
- Net Interest Margin (FTE): 2.99% (vs. 3.76% in 2009).
- Return on Average Assets: -0.69% (vs. 0.43% in 2009).
- Return on Average Equity: -11.96% (vs. 7.07% in 2009).
- Non-accrual loans: $44.6 million (4.1% of total loans).
Material Changes vs. Prior Period
- Net Loss vs. Income: The Company reported a net loss of $6.0 million for the six months ended June 30, 2010, compared to net income of $3.5 million in the same period of 2009. This reversal was driven by a $4.4 million decline in net interest income, a $3.3 million increase in the provision for loan losses, and $8.1 million in credit-related other-than-temporary impairment (OTTI) charges on investment securities.
- Net Interest Income Decline: Net interest income dropped due to a shift in asset mix toward higher liquidity (cash and cash equivalents increased by $126.6 million) and a lower interest rate environment. The cost of maintaining this liquidity position reduced net interest margin by approximately 63 basis points.
- Investment Portfolio Restructuring: The Company restructured its investment portfolio, transferring $117.1 million of available-for-sale securities to trading and subsequently selling them. This resulted in net losses of $2.3 million related to the restructuring and $8.1 million in OTTI charges on Collateralized Debt Obligations (CDOs).
- Loan Portfolio: Gross loans decreased by $39.7 million due to runoff in the indirect installment portfolio and the decision to sell long-term fixed-rate mortgages into the secondary market rather than retaining them.
- Deposit Growth: Total deposits increased by $69.6 million, primarily driven by a $48 million increase in time deposits from a local municipality.
Guidance, Outlook, Risks, and Unusual Items
- Unusual Items: The primary driver of the loss was the $8.1 million credit-related OTTI charge on the CDO portfolio (18 pooled trust preferred securities). Management utilized an independent third party for valuation, classifying these as Level 3 assets due to market inactivity. Additionally, $2.3 million in net losses were recognized from the restructuring of the investment portfolio.
- Liquidity Strategy: Management explicitly elected to maintain an increased liquidity position in response to economic uncertainty and FDIC guidance. This strategy, while prudent, negatively impacted earnings by reducing yield on earning assets. Management does not anticipate reduced cash levels for the remainder of 2010.
- Capital Position: The Corporation remains "well capitalized" under federal regulatory requirements. Total Capital ratio was 12.01% and Tier 1 Capital ratio was 10.34% as of June 30, 2010.
- Risk Factors:
- Regulatory Changes: The Dodd-Frank Wall Street Reform and Consumer Protection Act (signed July 21, 2010) is expected to increase compliance burdens and costs, restrict certain products, and limit future capital raising strategies (e.g., prohibiting new trust preferred issuances from counting as Tier 1 capital).
- Overdraft Fees: New Regulation E amendments (effective July/August 2010) prohibiting fees on ATM and one-time debit card overdrafts without consumer consent may materially reduce non-interest income.
- Asset Quality: Continued economic distress has led to increased foreclosures and bankruptcies, necessitating higher provisions for loan losses and specific allocations for impaired loans.
- Outlook: Management anticipates purchasing replacement securities for the sold portfolio in the third quarter of 2010, focusing on shorter-term instruments to manage interest rate risk. No specific earnings guidance was provided for the full year.
Important Facts for Investor Verification
- CDO Portfolio Valuation: Verify the assumptions and third-party valuation methodology used for the $9.3 million fair value of the CDO portfolio, which carries $27.1 million in unrealized losses and $8.1 million in recognized OTTI charges.
- Liquidity Impact on Margins: Assess the sustainability of the high cash position ($316 million) and its continued drag on Net Interest Margin in a rising rate environment.
- Loan Loss Provision Adequacy: Review the specific allocations for impaired loans, particularly in the acquisition and development sector, given the $7.2 million provision and $44.6 million in non-accrual loans.
- Regulatory Compliance Costs: Monitor the financial impact of the Dodd-Frank Act and Regulation E changes on future non-interest income and operating expenses.
- Deposit Concentration: Note that a significant portion of deposit growth ($48 million) is from a single local municipality, with $23 million maturing within three months, creating potential liquidity volatility.