Union Bankshares, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unaudited consolidated financial statements; amounts below are in millions unless noted. Comparisons are with the corresponding 2010 period or December 31, 2010, as applicable.
Business context and reporting period
Union Bankshares is a Vermont bank holding company. On May 27, 2011, its bank subsidiary acquired three New Hampshire branches, adding approximately $67.0 million of deposits and $33.6 million of loans at acquisition. The transaction expanded the company’s footprint and materially affected period-end balances.
Key financial metrics
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net interest income | $4.732 | $4.685 | $9.269 | $9.273 |
| Provision for loan losses | $0.150 | $0.090 | $0.300 | $0.180 |
| Noninterest income | $1.647 | $1.475 | $3.048 | $2.640 |
| Noninterest expense | $5.009 | $4.069 | $9.589 | $8.154 |
| Net income | $1.031 | $1.526 | $2.059 | $2.745 |
| Diluted/basic EPS reported | $0.23 | $0.34 | $0.46 | $0.62 |
Q2 net interest margin was 4.29%, down 37 basis points year over year; net interest spread was 4.10%, down 34 basis points. The efficiency ratio rose to 77.11% from 65.31%. Q2 return on average assets was 0.86% (1.39% prior year) and return on average equity was 9.93% (14.64%).
At June 30, total assets were $513.6, net loans were $397.0, loans held for sale were $3.1, deposits were $433.0, borrowed funds were $32.6, and stockholders’ equity was $41.9. Cash and cash equivalents were $30.0, with a further $15.9 in interest-bearing bank deposits. Total assets increased 13.4% and deposits 14.9% from year-end, largely due to the branch acquisition. The allowance for loan losses was $4.06, approximately 1.01% of loans excluding loans held for sale.
For the six months, operating cash flow was $4.5 versus $11.2 in 2010; investing cash flow was $20.5, including $28.9 of net cash acquired in the branches; financing cash flow was negative $9.3. Cash and cash equivalents increased $15.7 to $30.0.
Material changes versus prior periods
- Net income declined 32.4% in Q2 and 25.0% for the first half. Management attributed the Q2 decrease principally to higher operating costs, including $0.307 of branch acquisition expenses, increased loan-loss provision, and other expense growth, partly offset by higher noninterest income and lower income taxes.
- For the first half, noninterest expense increased 17.6%, including $0.345 of acquisition expenses. Salaries, benefits, occupancy and other costs also increased; FDIC assessments declined following a change to a net-assets-based assessment measure.
- Lower asset yields offset growth in average earning assets. Six-month interest income fell 1.2%, while interest expense fell 6.2%; net interest income was nearly unchanged.
- Period-end loans increased from year-end, but excluding acquired loans the company reported a net decline, reflecting seasonal municipal loan paydowns. Deposits excluding the acquired balances also reflected seasonal municipal flows.
- Nonperforming assets rose to $7.24, or 1.41% of assets, from $5.21, or 1.15%, at year-end. Nonperforming loans increased to $6.38 from $3.60; the allowance covered 63.63% of nonperforming loans, down from 104.36%.
Outlook, risks and unusual items
- No specific earnings or revenue guidance was provided. Management described loan demand as cautiously improving but noted possible adverse effects from inflation and higher interest rates. It expected substantially all branch acquisition costs had been incurred by June 30, with further costs not expected to be material.
- Management identified a prolonged low-rate environment and competitive deposit pricing as risks to margins. Its simulations showed estimated 12-month net interest income changes of +21.5% under an immediate 300-basis-point rate increase and -5.6% under a 100-basis-point decrease; management cautioned that simulations are estimates and do not incorporate potential management actions. Return on assets under flat and falling-rate cases did not meet internal minimum guidelines.
- Credit risks include rising delinquencies and nonperforming loans, economic weakness, borrower performance, and real estate collateral values. Q2 provision increased to $0.150 from $0.090. The company recorded $0.147 of first-half OREO write-downs, including $0.105 in Q2.
- The branch acquisition generated $2.23 of goodwill and a $1.69 core deposit intangible, amortized over an estimated ten-year life. Acquired branches contributed a reported net loss of $0.121 in Q2 and $0.146 for the six-month period; pro forma comparative results were not provided because management said they were impracticable to estimate.
- Regulatory, legislative and operating risks include Dodd-Frank implementation, interchange-fee competition, compliance costs, healthcare costs and changes in deposit competition. The company reported that it remained well capitalized; its total risk-based capital ratio was 12.63%, down from 15.12% at year-end but above the 10% well-capitalized threshold.
- Off-balance-sheet commitments totaled $92.1, including $40.6 of commitments to originate loans and $48.3 of unused lines of credit. Management stated that many commitments may not be drawn. Legal proceedings were described as ordinary-course matters not expected to have a material adverse effect.
Important facts for investors to verify
- Whether the acquired branches meet management’s expectations for deposit retention, loan performance and profitability; confirm the final purchase-price allocation.
- Whether rising nonperforming loans, delinquencies and OREO values require additional provisions or write-downs.
- Whether net interest margin and earnings respond as expected to low rates, competition and rate changes, compared with management’s simulation assumptions.
- How much of reported balance-sheet growth reflects acquisition and seasonal municipal deposits and loans, rather than underlying organic growth.
- Capital, liquidity and funding trends, including the impact of large time-deposit maturities, repurchase sweeps and outstanding commitments.
- The sustainability of the $0.25 quarterly dividend relative to earnings; the first-half payout ratio was 108.70%. A further $0.25 dividend was declared July 20, 2011, payable August 11.