Unity Bancorp, Inc. — Q2 2011 Form 10-Q
Business context and reporting period. Unity Bancorp is a New Jersey bank holding company whose subsidiary, Unity Bank, provides commercial and retail banking services through branches in New Jersey and Pennsylvania. This unaudited filing covers the quarter and six months ended June 30, 2011; balance-sheet comparisons are primarily to December 31, 2010.
Key financial metrics
Amounts below are in millions, except per-share data and ratios.
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net interest income | $7.47 | $7.26 | $14.95 | $14.73 |
| Provision for loan losses | $1.75 | $1.50 | $4.25 | $3.00 |
| Noninterest income | $1.45 | $1.17 | $2.70 | $2.08 |
| Noninterest expense | $6.25 | $6.04 | $12.41 | $11.98 |
| Net income | $0.64 | $0.68 | $0.86 | $1.43 |
| Income available to common shareholders | $0.25 | $0.30 | $0.09 | $0.68 |
| Diluted EPS | $0.03 | $0.04 | $0.01 | $0.09 |
- Margins: Net interest margin was 3.88% in Q2 versus 3.51% a year earlier; the six-month margin was 3.90% versus 3.54%. Management attributed the improvement mainly to lower funding costs and a shift toward lower-cost deposits.
- Balance sheet at June 30: Assets were $806.2 million; loans $615.1 million; deposits $641.2 million; cash and cash equivalents $46.3 million; and shareholders’ equity $72.2 million. The allowance for loan losses was $16.0 million, or 2.60% of loans.
- Credit quality: Nonperforming loans were $25.1 million, or 4.08% of loans; nonperforming assets were $27.8 million, or 3.45% of assets. Six-month net charge-offs were $2.6 million. OREO was $2.7 million.
- Debt and liquidity: Borrowed funds and subordinated debentures totaled $90.5 million, unchanged from year-end. The company reported $66.7 million of additional FHLB borrowing capacity. Six-month operating cash flow was $1.6 million; cash increased $2.4 million to $46.3 million.
- Capital: At June 30, the company reported a 10.40% leverage ratio, 13.41% Tier 1 risk-based capital ratio and 14.67% total risk-based capital ratio. The Bank’s corresponding ratios were 8.89%, 11.46% and 14.07%.
Material changes versus comparable periods
- Q2 net income declined to $0.64 million from $0.68 million; six-month net income fell to $0.86 million from $1.43 million. Common earnings were further reduced by preferred dividends and discount accretion.
- Interest income declined as average earning assets and loan balances contracted, but interest expense fell more quickly. Six-month net interest income increased modestly despite lower interest income.
- The six-month loan-loss provision rose to $4.25 million from $3.00 million. Nonperforming loans increased $3.4 million from year-end, while the allowance-to-loan ratio rose from 2.33% at year-end to 2.60%.
- Deposits declined $13.6 million from year-end, largely reflecting planned runoff of higher-rate time deposits and lower interest-bearing demand balances. Savings and noninterest-bearing demand deposits increased.
- Total assets fell $12.2 million from year-end. Loans were nearly flat; securities declined $13.1 million. Shareholders’ equity increased $2.1 million.
Outlook, commentary, risks and unusual items
- Management said the recession and real-estate weakness continued to pressure borrowers and collateral values. It reported rising nonperforming assets, higher provision expense and elevated OREO costs, while citing improved net interest margin, core deposit growth and a well-capitalized position.
- The company decided to close underperforming Colonia and Springfield, New Jersey branches, with closures planned for July and September 2011. The decision resulted in $215,000 of Q2 residual lease and fixed-asset disposal costs. Excluding these costs, management stated common income would have been $399,000 for Q2 and $236,000 for the first half.
- The six-month tax provision included a $150,000 reversal of a deferred-tax valuation reserve. Management said the effective tax rate would have been 28.1% without that adjustment, versus the reported 13.0% rate.
- Management provided no specific earnings or revenue guidance. It said the company was preserving capital and would resume common dividends when earnings and credit quality improved. Treasury CPP preferred stock carries a 5% dividend rate through its fifth anniversary and 9% thereafter; CPP restrictions limit capital distributions.
- Key risks include loan losses and collateral deterioration, particularly in real estate and the hotel/motel sector. Hotel/motel loans represented 11.1% of total loans; the company said it was no longer financing those properties. Management also identified interest-rate, economic, regulatory and market risks. It noted the August 5, 2011 U.S. sovereign credit-rating downgrade could disrupt markets, raise rates and adversely affect liquidity and net interest income.
- At June 30, 16 troubled debt restructurings totaled $17.5 million. The company also reported $2.0 million in standby letters of credit and approximately $67.9 million in borrower commitments to advance, and said it believed it had sufficient liquidity to meet commitments.
- The company reported no known legal proceedings expected to have a material adverse effect. Disclosure controls were assessed as effective, with no significant quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether nonperforming loans, OREO and charge-offs stabilize, and whether the $16.0 million allowance remains adequate as credit conditions and collateral values change.
- How much of the reported earnings improvement in net interest margin can persist as assets and loans reprice, given historically low rates and declining average earning assets.
- Whether branch closures deliver lasting cost savings beyond the $215,000 one-time Q2 charge, and how the planned closures affect deposits and customer retention.
- The quality and trend of the $17.5 million TDR balance, hotel/motel exposure and commercial real-estate concentrations.
- The effect of deposit runoff, government-deposit sensitivity, CPP restrictions and the U.S. credit-rating downgrade on liquidity, capital distributions and funding costs.