Business context and reporting period
First United Corporation is a bank holding company whose primary subsidiary is First United Bank & Trust. This unaudited Form 10-Q covers the three and six months ended June 30, 2018; balance-sheet comparisons are with December 31, 2017. Amounts below are in millions unless stated otherwise.
Financial performance and condition
- Second-quarter earnings: Net income available to common shareholders was $3.016 million, or $0.43 per diluted share, versus $2.085 million, or $0.30, in Q2 2017. Six-month common earnings were $5.522 million, or $0.78 per share, versus $3.524 million, or $0.52.
- Revenue and margin: Q2 net interest income was $10.868 million, up 9.5% year over year; six-month net interest income was $21.450 million, up 11.2%. Fully taxable equivalent net interest margin increased to 3.73% in Q2 from 3.42%, and to 3.71% for the first half from 3.35%. Six-month noninterest income was $7.592 million, up from $6.973 million.
- Profitability and expenses: Q2 pretax income was $3.856 million and income tax expense was $0.840 million; six-month figures were $7.010 million and $1.488 million. Six-month operating expenses rose to $21.316 million from $19.329 million, led by compensation and employee benefits, which increased $1.246 million. Annualized first-half return on average assets was 0.84% and return on average equity 9.94%.
- Assets and funding: Total assets were $1,323.3 million, down $13.2 million from year-end; loans were $941.2 million, up $48.7 million, and deposits were $1,041.1 million, up $1.7 million. Cash and equivalents fell to $25.4 million from $83.8 million. Shareholders’ equity was $113.0 million.
- Credit quality: The allowance for loan losses was $9.769 million, or 1.04% of loans, compared with $9.972 million and 1.12% at year-end. First-half provision expense was $0.716 million; net charge-offs were $0.919 million, an annualized 0.20% of average loans. Nonaccrual loans declined to $5.016 million from $7.118 million, while other real estate owned fell to $8.503 million from $10.141 million.
- Cash flow and debt: For the first half, operating activities provided $6.150 million; investing activities used $44.091 million; financing activities used $20.420 million. Total borrowings were $148.858 million, down $20.916 million from year-end, including $100.929 million long-term and $47.929 million short-term debt. The Bank reported capital ratios above stated well-capitalized thresholds; its total risk-based capital ratio was 15.65%.
Material changes versus comparable periods
- Earnings increased year over year, supported by higher net interest income, stronger wealth-management revenue, lower loan-loss provision, and reduced preferred dividends following prior preferred-stock redemptions.
- Higher loan yields and loan growth drove interest-income gains; the company also purchased a $15 million residential mortgage pool and a $10 million student-loan pool. Deposit pricing pressure and higher compensation, equipment, occupancy, data-processing, and OREO costs partly offset revenue growth.
- Loans grew 5.4% from year-end, led by residential mortgages, commercial and industrial loans, and consumer loans. Cash declined substantially as funds supported loan growth and debt repayments; investing outflows also included $5.413 million of premises and equipment purchases.
- First-half preferred dividends were zero, versus $0.765 million in 2017. Common dividends declared were $0.18 per share for the first half of 2018; none were declared in the comparable 2017 period.
Outlook, commentary, risks and unusual items
- Management provided no specific earnings or revenue guidance. It said liquidity was adequate and it knew of no trends or uncertainties likely to materially impair liquidity or capital resources. The company was asset-sensitive; its model estimated that a 100-basis-point rise would increase net interest income by $0.298 million, while a 100-basis-point decline would reduce it by $1.951 million. These are model estimates subject to assumptions and limitations.
- Key risks identified include economic and market conditions, interest rates and deposit costs, loan and investment portfolio quality, competition, growth management, and regulatory or legal changes. Management reported no material change in risk factors since the 2017 Form 10-K. Disclosure controls were judged effective at a reasonable-assurance level; no material internal-control change was reported. No legal proceedings were reported.
- OREO valuation write-downs were $0.478 million for the first half, contributing to higher OREO expense. The available-for-sale securities portfolio had a $6.695 million net unrealized loss; its $16.147 million collateralized debt obligation portfolio is Level 3 and valued using discounted cash flows and significant unobservable inputs. Management reported no credit-related OTTI charges on these securities during the first half.
- The effective tax rate declined to 21.2% for the first half from 29.0% in 2017, primarily reflecting the federal corporate tax-rate reduction. The filing reports approximately $0.4 million of first-half tax benefit from the Liberty Mews low-income housing investment and related tax losses.
- Off-balance-sheet commitments to extend credit totaled $129.873 million, including $2.745 million of standby letters of credit. Management stated that collateral and guarantees support the letters of credit and that the related liability was not material.
Important facts for investors to verify
- Whether loan growth is sustainable and whether underwriting and credit quality remain sound, particularly in commercial real estate, acquisition and development, and consumer lending.
- Whether the allowance remains adequate as the portfolio grows, and how nonaccrual loans, criticized loans, charge-offs, and OREO valuations develop.
- Whether deposit pricing and funding needs pressure net interest margin, liquidity, or cash balances; review the sensitivity assumptions behind management’s rate scenarios.
- How the Level 3 CDO valuations and unrealized losses respond to changes in credit performance, market liquidity, and valuation assumptions.
- Whether rising operating costs, including compensation and OREO expenses, are offset by recurring revenue growth; distinguish recurring performance from securities gains and tax-related effects.