Business Context and Reporting Period
Meridian Corporation, a Pennsylvania bank holding company for Meridian Bank, filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2019. Its principal segments are Banking, Mortgage Banking, and Wealth Management. The company had 6,406,996 common shares outstanding as of August 14, 2019.
Financial Performance and Condition
| Metric | Three months ended June 30, 2019 | Three months ended June 30, 2018 | Six months ended June 30, 2019 | Six months ended June 30, 2018 |
|---|---|---|---|---|
| Net interest income | $8.9 million | $8.1 million | $17.4 million | $15.8 million |
| Non-interest income | $7.9 million | $8.7 million | $14.4 million | $15.7 million |
| Non-interest expense | $14.2 million | $14.1 million | $26.4 million | $26.6 million |
| Provision for loan losses | $14 thousand | $413 thousand | $233 thousand | $967 thousand |
| Net income | $2.0 million | $1.8 million | $4.0 million | $3.1 million |
| Diluted earnings per share | $0.31 | $0.28 | $0.63 | $0.48 |
| Net interest margin | 3.72% | 3.88% | 3.69% | 3.89% |
| Annualized ROA | 0.81% | 0.81% | 0.82% | 0.72% |
| Annualized ROE | 7.14% | 7.02% | 7.22% | 6.05% |
- Total assets were $1.056 billion at June 30, 2019, up 5.9% from December 31, 2018.
- Portfolio loans and leases, excluding mortgage loans held for sale, were $885.2 million, up 5.6% year to date. Commercial mortgage and construction lending were significant contributors to growth.
- Total deposits increased 11.8% to $840.7 million, while cash and cash equivalents increased to $30.6 million from $24.0 million at year-end.
- Stockholders’ equity increased to $114.4 million. Tangible book value per share was $17.09, compared with $16.31 at December 31, 2018.
- Loan quality remained relatively stable: nonperforming loans were $4.1 million, or 0.45% of total loans, and the allowance was $8.6 million, or 0.99% of loans held for investment.
- Cash flow from operating activities was $6.9 million, compared with an operating cash outflow of $5.9 million in the prior-year period. Investing activities used $52.1 million, primarily due to net loan growth, while financing activities provided $51.9 million, primarily from deposit growth.
- Debt included $75.0 million of short-term borrowings, $8.9 million of long-term debt, and $9.2 million of subordinated debentures. Short-term borrowings declined from $114.3 million at year-end.
- Primary liquidity was approximately $148.5 million. The company reported $477.6 million of maximum FHLB borrowing capacity, $39 million of unsecured federal funds lines, and other available CD-based funding arrangements.
- Regulatory capital ratios exceeded well-capitalized thresholds, including a 13.23% total risk-based capital ratio, 11.37% common equity tier 1 and Tier 1 risk-based capital ratios, and a 10.96% Tier 1 leverage ratio.
Material Changes Versus Prior Comparable Period
- Quarterly net income rose $220 thousand, or approximately 12%, while six-month net income rose $956 thousand, or approximately 31%.
- Net interest income increased 9.5% in the quarter and 9.9% year to date, driven by loan and earning-asset growth. Rising deposit and funding costs compressed net interest margin by 16 basis points in the quarter and 20 basis points year to date.
- Non-interest income declined 8.5% in the quarter and 8.6% year to date. Mortgage banking income declined 13.6% and 7.5%, respectively, due mainly to lower origination volume, despite higher loan-sale margins.
- Wealth management income declined, while the company recognized $515 thousand of SBA loan income and $139 thousand of gains on sales of investment securities that were not present in the prior-year comparable period.
- Non-interest expense increased slightly in the quarter but declined 1.0% year to date. Lower compensation expense, particularly in Mortgage Banking, was partly offset by higher professional fees and litigation-related costs.
- The Mortgage Banking segment shifted to operating losses of $197 thousand in the quarter and $91 thousand year to date, compared with operating profits in the prior-year periods. Banking segment operating margin increased to $2.7 million in the quarter and $5.2 million year to date.
Outlook, Risks, Contingencies, and Unusual Items
- The filing does not provide formal earnings or revenue guidance. Management expects results to remain sensitive to loan growth, deposit pricing, mortgage origination volume, market interest rates, credit performance, and regulatory and legal developments.
- Management described the balance sheet as asset-sensitive for interest-rate risk purposes. Its simulation indicated modestly positive projected effects on next-year net interest income from rate increases, but results depend on assumptions regarding repricing, deposit behavior, prepayments, and loan growth.
- The company identified a material weakness in internal control over financial reporting related to mortgage licensing compliance, monitoring, loan-transfer accounting, mortgage repurchase reserves, and related revenue recognition. Management concluded that disclosure controls were not effective as of June 30, 2019.
- Mortgage loans had been originated without a required license in a neighboring state since 2012. The company discontinued originations in that state, restricted system access, began an internal audit program, and was developing an ongoing licensing-compliance control.
- The licensing issue resulted in approximately $474 thousand of customer reimbursements and a $12 thousand fine. The filing also describes a $486 thousand total pre-tax impact, including a $407 thousand prior-period correction, with a $315 thousand net-of-tax reduction to retained earnings related to earlier periods.
- In July 2019, the Bank reached an agreement in principle to settle a former-employee wage-and-hour lawsuit for $990 thousand, subject to a definitive agreement and court approval. A $665 thousand additional expense was recorded in the second quarter, and the company reported a $325 thousand reserve at March 31, 2019.
- Off-balance-sheet commitments included $320.1 million of commitments to extend credit and $9.5 million of letters of credit. Loan-sale agreements may require repurchases if representations and warranties are breached, although no such repurchases occurred in the 2019 periods.
- The company is implementing or evaluating several accounting standards, including current expected credit losses, revenue recognition, financial instruments, and leases. The filing states that the potential impact of some standards remains under assessment.
Investor Verification Priorities
- Verify remediation and independent testing of the material weakness in mortgage licensing and financial reporting controls.
- Monitor the final settlement agreement and court approval for the $990 thousand wage-and-hour litigation settlement.
- Assess whether rapid commercial loan growth is accompanied by stable credit quality, particularly in commercial mortgage, construction, and commercial and industrial portfolios.
- Track net interest margin pressure from higher deposit costs and the company’s ability to maintain funding and liquidity as loans grow.
- Evaluate the sustainability of mortgage banking income, SBA loan gains, and other non-recurring or market-sensitive fee income.
- Confirm the eventual accounting impact of CECL and other pending accounting-standard adoptions.