United Bankshares, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. The interim financial statements are unaudited. Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions where appropriate.
Business context and period
United is a bank holding company. On April 21, 2017, it acquired Cardinal Financial Corporation for approximately $975 million, primarily in United common shares. Cardinal added roughly $4.14 billion in assets, including George Mason Mortgage, and expanded United’s Washington, D.C. area presence. Results include Cardinal only from the acquisition date, making year-over-year comparisons materially affected by acquisition-related changes in scale, revenue and expenses. United now reports community banking and mortgage banking segments.
Financial performance and position
- Q3 earnings: Net income was $56.7 million, up from $41.5 million a year earlier; diluted EPS was $0.54 in both periods. Nine-month net income was $132.6 million versus $108.0 million; diluted EPS was $1.39 versus $1.48, reflecting a substantially larger share count following the stock-funded Cardinal acquisition.
- Revenue and interest: Q3 net interest income was $150.3 million, up 35.3%; total other income was $38.2 million, up 101.0%. For nine months, net interest income was $394.1 million, up 26.3%, and other income was $98.9 million, up 85.2%. Mortgage banking income drove much of the increase in other income. Tax-equivalent net interest margin was 3.65% in Q3, up from 3.56% a year earlier; the nine-month margin was 3.52%, down from 3.62%.
- Expenses and returns: Q3 noninterest expense increased 54.0% to $96.7 million; nine-month expense rose 46.3% to $271.6 million, mainly reflecting Cardinal’s operations and integration costs. Cardinal-related merger expenses were $25.0 million for the first nine months, including $12.8 million in severance charges. Q3 return on average assets was 1.19% and return on average equity 6.89%; nine-month figures were 1.03% and 6.22%, respectively.
- Assets, loans and deposits: Total assets were $19.13 billion at September 30, up 31.9% from year-end 2016, primarily due to Cardinal. Gross portfolio loans were $13.16 billion, up 27.0%; deposits were $13.88 billion, up 28.5%. Excluding Cardinal, management reported portfolio loans declined $369.2 million and deposits declined $269.7 million from year-end.
- Credit quality: The allowance for loan losses was $74.9 million, or 0.57% of loans, compared with 0.70% at year-end; coverage of nonperforming loans was 44.49%, down from 64.25%. Provision expense was $7.3 million in Q3 and $21.4 million for nine months. Nonperforming loans totaled $168.4 million, or 1.28% of loans, versus $113.3 million and 1.10% at year-end. Management cited increases in impaired loans and exposures to oil, gas and coal borrowers. Troubled debt restructurings rose to $46.1 million from $21.2 million at year-end.
- Liquidity and funding: Cash and cash equivalents were $1.75 billion, up $312.5 million from year-end. Nine-month operating cash flow was $125.2 million; investing activities provided $384.5 million and financing activities used $197.1 million. Deposits remain the primary funding source. Total borrowings were approximately $1.86 billion. United reported $3.72 billion of available FHLB borrowing capacity, subject to collateral, and $264 million in correspondent-bank lines.
- Capital and dividends: Shareholders’ equity was $3.26 billion. Regulatory ratios were 14.26% risk-based capital, 11.99% Common Equity Tier 1 and Tier 1 capital, and 10.09% leverage; each exceeded the stated well-capitalized thresholds. The quarterly dividend was $0.33 per share; nine-month dividends were $0.99 per share.
Material changes, outlook and risks
- Cardinal expanded the balance sheet and added mortgage banking, but acquisition-related costs and increased operating expenses offset some revenue growth. The mortgage banking segment reported a Q3 net loss of $2.8 million and a nine-month net loss of $0.3 million. Management attributed quarter-to-quarter mortgage income variability partly to fair-value accounting for locked mortgage commitments.
- No earnings or revenue guidance is provided in the supplied filing text. Management stated it expected to meet obligations over the next 12 months, had no material capital expenditure commitments, and knew of no material liquidity trends; these are management assessments, not guarantees.
- Interest-rate sensitivity modeling estimated a 0.02% decline in one-year net interest income for an immediate, sustained 100-basis-point rate increase and a 0.22% decline for a 200-basis-point increase. The filing cautions that modeled outcomes rely on uncertain assumptions. Mortgage securities also carry prepayment and extension risk.
- Available-for-sale trust-preferred collateralized debt obligations had a $31.7 million fair value and $6.5 million unrealized loss. Management concluded the losses were not other-than-temporary, citing expected cash flows and illiquid markets. These securities use Level 3 valuation inputs; a modeled 200-basis-point increase in discount rates would reduce their fair value by about 18%, or $5.7 million.
- Other material judgment areas include acquired-loan valuation, the allowance for credit losses, securities fair values and taxes. The Cardinal purchase-price allocation remained preliminary. The company disclosed approximately $4.12 billion of loan commitments and $148.7 million of standby letters of credit; many commitments may expire undrawn. Management said routine litigation was not expected to have a material financial effect. No material changes to the 2016 Form 10-K risk factors were reported.
Important facts for investors to verify
- How much of reported growth and future earnings reflects Cardinal, and whether expected cost savings and integration benefits materialize.
- Credit trends behind higher nonperforming loans, impaired loans and restructurings, particularly commercial and energy-related exposures, and whether the allowance remains adequate.
- The sustainability and volatility of George Mason’s mortgage banking results, including fair-value effects and loan production and sale volumes.
- Valuation assumptions and potential losses in Level 3 trust-preferred securities, and the sensitivity of net interest income and mortgage assets to market-rate changes.
- Funding mix, deposit retention, borrowing costs and capital ratios after the acquisition and the associated change in regulatory treatment of trust-preferred securities.