Unity Bancorp, Inc. — Q1 2019 Form 10-Q
Business context and period. Unity Bancorp is a New Jersey bank holding company operating Unity Bank, with 19 branches in New Jersey and Pennsylvania. This unaudited report covers the three months ended March 31, 2019; balance-sheet comparisons are to December 31, 2018, and operating results are compared with Q1 2018. Unless stated otherwise, financial amounts below are in millions of dollars.
Key financial results
| Metric | Q1 2019 / March 31, 2019 | Comparable period / prior date |
|---|---|---|
| Net income | $5.74; diluted EPS $0.52 | $5.23; diluted EPS $0.48 in Q1 2018 |
| Interest income / net interest income | $18.50 / $14.22 | $15.64 / $12.87 in Q1 2018 |
| Net interest margin | 4.06% | 3.99% in Q1 2018 |
| Noninterest income / expense | $2.02 / $8.48 | $2.29 / $8.19 in Q1 2018 |
| Cash from operating activities | $11.21 | $7.61 in Q1 2018 |
| Total assets | $1,590.0 | $1,579.2 at December 31, 2018 |
| Total loans | $1,313.0 | $1,304.6 at December 31, 2018 |
| Total deposits | $1,226.6 | $1,207.7 at December 31, 2018 |
| Borrowed funds and subordinated debentures | $205.3 | $220.3 at December 31, 2018 |
| Cash and cash equivalents | $149.1 | $145.5 at December 31, 2018 |
| Shareholders’ equity | $143.7 | $138.5 at December 31, 2018 |
Material changes and operating performance
- Net income increased about 9.8% year over year. Net interest income rose 10.4%, primarily on loan growth and higher loan yields; average loans increased $131.0 million and the average loan yield rose 38 basis points to 5.45%.
- Higher funding costs partly offset asset growth: interest expense increased 54.8% to $4.28 million, and the average cost of interest-bearing liabilities rose to 1.60% from 1.12%. Net interest spread narrowed to 3.68% from 3.73%, although net interest margin improved.
- Noninterest income declined 11.6%, mainly due to lower loan payoff charges and reduced SBA loan-sale premiums. Noninterest expense rose 3.4%, with management citing software and equipment investment; the efficiency ratio improved to 52.53% from 54.00%.
- Return on average assets was 1.55% versus 1.53%; return on average equity was 16.52% versus 17.69%. The effective tax rate increased to 20.9% from 19.1%.
- Loans grew $8.4 million from year-end, led by commercial, residential mortgage and consumer lending; SBA loans declined. Deposits rose $18.9 million, principally from time deposits, while demand deposits declined. Management attributed demand-deposit outflows primarily to seasonal municipal activity.
Cash flow, liquidity, capital and credit
- Cash increased $3.62 million during the quarter. Investing activities used $10.93 million, while financing activities provided $3.34 million. Financing included $18.90 million of net deposit growth and $175 million of new borrowings, offset by $190 million of borrowing repayments.
- The allowance for loan losses was $15.68 million, or 1.19% of loans. The quarter included $304,000 of net charge-offs, compared with $140,000 of net recoveries in Q1 2018. Nonperforming loans were $7.27 million (0.55% of loans), up from $6.87 million at year-end and $4.28 million a year earlier. Nonperforming assets were $7.55 million, or 0.47% of assets.
- Approximately 94% of loans were secured by real estate. Management noted that real-estate values, local economic conditions and borrower performance can affect collateral and credit losses. Potential problem loans totaled $4.5 million. One performing commercial real-estate TDR was $738,000.
- The Bank reported a 9.71% leverage ratio, 12.14% CET1 ratio, 12.14% Tier 1 risk-based capital ratio and 13.39% total risk-based capital ratio; each exceeded the stated well-capitalized thresholds.
- Unfunded loan commitments were approximately $314.3 million, including $171.0 million expiring within one year. The Company said it believed it had adequate liquidity to honor commitments. It reported $259.9 million of additional FHLB borrowing capacity. Certain municipal deposits are short-duration and price-sensitive.
Outlook, commentary, risks and unusual items
- Management said net interest margin was expected to remain stable; the filing provides no specific earnings or revenue guidance. Results for the quarter are not necessarily indicative of full-year results.
- Management identified economic, market, regulatory and interest-rate changes as factors that could affect results, including the effect of rates on spreads and income. A 200-basis-point rate shock was estimated to change economic value of equity by a 0.67% decline in a rising-rate scenario and a 0.28% increase in a falling-rate scenario, within Board limits.
- The Company adopted lease accounting guidance on January 1, 2019, recognizing operating lease right-of-use assets and liabilities of approximately $2.7 million. It was evaluating the expected-credit-loss standard (ASU 2016-13), effective for the Company in 2020; it did not quantify the adoption impact. Management did not expect the cited goodwill standard to have a material effect.
- New Jersey tax changes include a temporary corporate surtax and mandatory unitary combined reporting; the reported effective tax rate rose year over year. Unrealized changes in equity securities were recognized in earnings under the applicable accounting standard.
- Management said pending ordinary-course legal matters were not expected to materially affect financial position or results. The filing reported no material change in market-risk assessment, effective disclosure controls, and no significant change in internal control over financial reporting.
Important facts for investors to verify
- Whether loan growth and higher yields can continue to offset deposit and borrowing cost increases, and whether the stated stable-margin outlook holds.
- Credit trends behind the increase in nonperforming loans, particularly residential mortgages, and the adequacy of the allowance given higher Q1 net charge-offs.
- Deposit mix, reliance on time and municipal deposits, and the cost and availability of alternative funding.
- Exposure to real-estate collateral and the scale, timing and funding of the $314.3 million in unfunded commitments.
- The eventual impact of ASU 2016-13 and the effect of New Jersey tax changes on future effective tax rates.