United Bankshares, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014. The interim financial statements are unaudited. Dollar amounts below are in millions unless noted.
Business context
United is a bank holding company. Results include Virginia Commerce Bancorp (VCB) only from its acquisition on January 31, 2014, so reported year-over-year growth is substantially affected by the acquisition.
Financial performance and condition
- Earnings: Net income was $30.1 million, up from $21.6 million in Q1 2013; diluted EPS was $0.48 versus $0.43. Return on average assets was 1.14%, and return on average equity was 8.57%.
- Interest income and margin: Net interest income was $85.3 million, up 27.7%; net interest margin was 3.70%, down 5 basis points year over year. Tax-equivalent net interest income was $86.9 million. Average earning assets grew 28.9%, primarily due to VCB, while average earning-asset yield declined 15 basis points.
- Other income and costs: Other income was $26.5 million, including an $9.0 million gain on a building sale. Excluding that gain and securities impairment and sale/call results, management reported noninterest income of $17.4 million, down 8.8% year over year. Noninterest expense rose 26.8% to $61.2 million, mainly reflecting VCB and $3.6 million of merger severance charges.
- Credit costs: Provision for loan losses was $4.7 million versus $5.2 million; net charge-offs were $4.5 million. Nonperforming loans were $96.1 million, or 1.10% of loans, versus $81.1 million, or 1.21%, at year-end. The allowance for loan losses was $74.3 million; coverage of nonperforming loans was 77.33%, down from 91.46% at year-end. Management attributed the lower coverage partly to acquisition accounting, which prevented carryover of VCB’s prior allowance.
- Balance sheet: Total assets were $11.89 billion, up 36.1% from year-end, largely from VCB. Net loans were $8.69 billion; deposits were $8.58 billion; total borrowings were $1.61 billion; and shareholders’ equity was $1.62 billion. Cash and cash equivalents were $579.4 million.
- Cash flow and liquidity: Operating, investing and financing activities provided $35.3 million, $64.3 million and $63.2 million, respectively. Cash and equivalents increased $162.8 million during the quarter. Management said liquidity was sufficient and expected to meet obligations over the next 12 months. United reported $1.34 billion of additional FHLB borrowing capacity, subject to collateral requirements.
- Capital and dividends: United reported a 13.33% risk-based capital ratio, 12.42% Tier 1 capital ratio and 11.60% leverage ratio, and said it and its banking subsidiaries were well capitalized. The quarterly dividend was $0.32 per share.
Material changes and unusual items
- United acquired VCB for approximately $585.5 million, principally in United shares, adding about $2.77 billion of assets, $2.10 billion of loans and $2.02 billion of deposits at acquisition. The transaction added approximately $335.1 million of goodwill. VCB contributed approximately $23.3 million of revenue and $10.1 million of net income from the acquisition date through March 31.
- Reported net income benefited from the $9.0 million pretax building-sale gain. Q1 also included $0.6 million of net other-than-temporary impairment losses on investment securities and $0.8 million of net gains on securities sales/calls.
- Pro forma results assuming VCB had been acquired at the start of each comparable quarter showed revenue of $121.3 million and net income of $23.0 million for Q1 2014, versus $116.2 million and $28.9 million for Q1 2013. The filing cautions that these unaudited pro forma figures are not indicative of actual or future results.
- Organic loans grew $54.4 million, while deposits declined $63.7 million, during the quarter. Total borrowings increased $606.7 million from year-end, with funding levels also affected by VCB and changes in FHLB advances and repurchase agreements.
Outlook, risks and contingencies
- Management expected an effective tax rate of approximately 33% on 2014 future earnings. The filing provides no specific earnings or revenue guidance.
- Management expects operating cost savings and synergies from VCB, but these were not included in the pro forma results. Integration costs and the timing and realization of synergies remain relevant uncertainties.
- Investment risk includes trust-preferred collateralized debt obligations (Trup CDOs): their fair value was $46.2 million against $68.3 million amortized cost, and $639,000 of credit-related impairment was recognized in Q1. Management used Level 3 valuation inputs; a 200-basis-point increase in discount rates was estimated to reduce their fair value by about 18%, or $8.1 million. The Volcker Rule may require divestiture of certain securities, subject to applicable extensions and exceptions.
- Interest-rate modeling estimated that a sustained +100-basis-point shock would reduce one-year net interest income by 0.39%, while +200 basis points would increase it by 0.17%; a −100-basis-point shock would increase it by 0.91%. These are model estimates, not forecasts.
- Off-balance-sheet exposures included $2.53 billion of loan commitments and $164.6 million of standby letters of credit. The company reported $2.8 million of liabilities for uncertain tax positions. Management said ordinary-course litigation was not expected to materially affect financial position.
- Management said United would meet Basel III capital requirements on a fully phased-in basis if effective at March 31, 2014. The rules were scheduled to take effect for United on January 1, 2015, subject to phase-in.
Most important facts for investors to verify
- How much reported earnings growth reflects VCB and the building-sale gain, versus recurring organic performance.
- Whether VCB integration costs, expected savings and pro forma profitability develop as anticipated.
- Credit performance in acquired and existing loans, particularly past-due and impaired loans, and the adequacy of allowance coverage after acquisition accounting.
- Trup CDO valuation assumptions, future impairment charges and any effect of Volcker Rule requirements.
- Funding mix and borrowing costs, including repurchase agreements and FHLB advances, alongside the company’s interest-rate sensitivity.