Union Bankshares, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unaudited consolidated results include Union Bankshares and its subsidiary, Union Bank. Amounts are in U.S. dollars; financial statement figures below are generally in millions unless noted.
Business context and financial performance
The company is a community banking organization serving Vermont and New Hampshire. Its lending is concentrated in real estate, particularly commercial real estate. Management attributed year-over-year earnings growth primarily to higher net interest income and the lower federal corporate tax rate under the 2017 Tax Act.
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income | $7.21 | $6.59 | $14.14 | $12.89 |
| Provision for loan losses | $0.15 | $0 | $0.15 | $0 |
| Noninterest income | $2.15 | $2.33 | $4.62 | $4.57 |
| Noninterest expense | $6.32 | $5.87 | $12.45 | $11.81 |
| Net income | $2.45 | $2.23 | $5.20 | $4.16 |
| Diluted/basic EPS as reported | $0.54 | $0.50 | $1.16 | $0.93 |
| Net interest margin | 4.24% | 4.26% | 4.19% | 4.20% |
| Effective tax rate | 15.4% | 26.9% | 15.6% | 26.3% |
Q2 net income rose 10.0%; first-half net income rose 25.0%. First-half net interest income increased 9.7%, mainly from loan growth and higher earning-asset yields. In Q2, the average rate paid on interest-bearing liabilities increased 13 basis points, exceeding the 8-basis-point increase in average earning-asset yield; the net interest spread narrowed to 4.13% from 4.18%. Management said deposit competition and rising short-term rates could continue to pressure funding costs and margins.
Lower taxes materially supported earnings: the federal corporate rate fell from 34% to 21% effective January 1, 2018. Q2 noninterest income declined 7.8%, mainly because gains on residential loan sales fell; first-half noninterest income increased 1.2%, helped by a $252,000 life-insurance death benefit and a $191,000 gain on sale of a branch building. Expenses increased 7.6% in Q2 and 5.4% year to date, including higher pension and employee-benefit costs and electronic-banking expense.
Financial position, cash flow and credit
- Balance sheet at June 30: Assets were $717.6 million, down 3.8% from year-end 2017; deposits were $578.9 million, down $68.7 million; borrowed funds were $69.0 million, up $37.5 million; and equity was $60.1 million. Management said much of the deposit decline reflected municipalities’ and school districts’ seasonal June 30 loan repayments.
- Loans: Gross loans, including loans held for sale, totaled $580.5 million, down 2.4% from December 31, 2017 but up $38.9 million from June 30, 2017. Commercial real estate loans were $269.6 million, or 46.5% of gross loans. Management said increased FHLB borrowing helped fund loan demand as loan growth outpaced deposit growth.
- Cash flow and liquidity: First-half operating cash flow was $6.9 million, versus $8.5 million in 2017; investing activities provided $2.3 million versus using $2.5 million; financing activities used $33.9 million. Cash and cash equivalents fell $24.7 million to $13.8 million. The company reported $38.5 million of unused FHLB capacity, a $10 million federal funds line and other contingent liquidity sources. It also disclosed an agreement for $8 million of brokered deposits, settling July 13, at 2.07% and maturing October 12, to manage short-term liquidity needs.
- Credit quality: Nonperforming loans were $1.69 million, unchanged from year-end and down from $3.09 million a year earlier; nonperforming assets were 0.23% of assets. The allowance for loan losses was $5.55 million, 0.97% of loans not held for sale. First-half net charge-offs were $5,000, and the company recorded a $150,000 provision. Impaired loans were $4.0 million, including $3.4 million of troubled-debt restructurings.
- Capital and shareholder returns: Total capital to risk-weighted assets was 14.06% at the company and 14.01% at the bank; both met applicable capital requirements. The quarterly dividend was $0.30 per share, up $0.01 from 2017. First-half dividends declared were $0.60 per share.
- Other comprehensive loss: Accumulated other comprehensive loss increased to $6.26 million from $5.10 million, primarily reflecting unrealized losses on available-for-sale securities. Management said no security impairment was considered other-than-temporary.
Outlook, risks and unusual items
- The company expects to complete termination and settlement of its defined benefit pension plan by December 31, 2018. Management estimates a $3.2 million reduction in net income in Q4 2018 and approximately $1.1 million of company contributions in 2018; both estimates may change. After settlement, the company expects no remaining defined-benefit obligations or periodic pension expense.
- Interest-rate simulation showed estimated 12-month net-interest-income declines of 14% under a 200-basis-point increase and 21% under a 300-basis-point increase. The filing cautions that these are model outputs, not forecasts, and depend on assumptions about rates, deposits, prepayments and customer behavior.
- Key disclosed risks include competition for deposits and loans, interest-rate and margin pressure, borrower repayment and collateral-value deterioration, liquidity and deposit outflows, changing regulation and tax policy, cybersecurity, and uncertainty in the pension settlement and credit-loss estimates.
- Management described liquidity as sufficient for reasonable needs under current conditions, while cautioning that projected cash needs are uncertain. It also noted future expected credit losses under CECL accounting, effective for the company in 2020, and said implementation work was underway.
- Management stated that ordinary-course legal matters are not expected to have a material adverse effect. The filing reported no material changes to previously disclosed risk factors, no material change in internal control over financial reporting, and effective disclosure controls.
Important facts for investors to verify
- Whether seasonal municipal deposit movements reverse as expected, and how much reliance on higher-cost FHLB or brokered funding persists.
- Whether rising deposit costs continue to outpace asset repricing and weaken net interest margin; review the assumptions and limits underlying the rate-shock simulation.
- Progress and final cost of the pension-plan settlement, including the estimated $3.2 million Q4 earnings impact and $1.1 million contribution.
- Trends in commercial real estate exposure, past-due and impaired loans, the allowance, and the effects of adopting CECL.
- Whether securities’ unrealized losses remain temporary and how they affect equity and liquidity if securities must be sold.