First United Corporation — Q2 2014 Form 10-Q
Business context and period: First United Corporation is a Maryland bank holding company whose primary subsidiary is First United Bank & Trust. This unaudited filing covers the quarter and six months ended June 30, 2014; balance-sheet comparisons are with December 31, 2013. Unless noted otherwise, financial amounts below are in millions of dollars.
Financial performance and condition
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income | $8.94 | $9.14 | $17.86 | $18.48 |
| Net income | $1.24 | $1.84 | $2.60 | $3.76 |
| Net income available to common shareholders | $0.44 | $1.40 | $1.35 | $2.89 |
| Basic and diluted EPS | $0.07 | $0.23 | $0.22 | $0.47 |
| Provision for loan losses | $0.58 | $0.08 | $0.94 | $0.95 |
| Other operating income | $4.26 | $3.14 | $7.24 | $6.70 |
| Other operating expenses | $11.04 | $9.76 | $20.80 | $19.29 |
| Net interest margin, fully tax-equivalent | 3.04% | 3.09% | 3.06% | 3.17% |
- At June 30, total assets were $1,327.6 million, net loans $812.7 million, deposits $978.7 million, and shareholders’ equity $111.9 million. Assets were nearly unchanged from year-end; equity rose from $101.3 million.
- Cash and cash equivalents were $62.1 million, up from $43.1 million at year-end. Six-month cash flows: operating activities provided $1.0 million, investing activities provided $30.2 million, and financing activities used $12.2 million.
- Total borrowings were $220.6 million: $37.9 million short-term repurchase agreements and $182.6 million long-term borrowings. Deposits rose $1.3 million; short-term borrowings fell $5.8 million.
- Regulatory capital ratios at June 30: consolidated total risk-based 15.33%, Tier 1 risk-based 13.91%, and Tier 1 leverage 10.99%; the Bank was also categorized as well capitalized.
Material changes and management commentary
- Six-month common earnings fell to $1.35 million from $2.89 million. Management attributed the decline mainly to lower interest income and higher operating costs, particularly OREO expense; higher securities gains partly offset these factors.
- Net interest income declined as average loan balances and loan yields fell. The six-month FTE margin decreased to 3.06% from 3.17%; management said it would continue targeted deposit pricing and seek a lower-cost deposit mix.
- OREO expense was $1.61 million for the six months, versus OREO income of $0.05 million in 2013. The 2014 expense included a $1.1 million loss on sale of a participation interest in a Pennsylvania hotel property and increased valuation allowances. OREO balances declined to $12.3 million from $17.0 million at year-end.
- Net loans grew $14.9 million, including a $21.4 million increase in commercial and industrial loans, partly offset by a $9.1 million decline in acquisition-and-development loans.
- Non-accrual loans decreased to $15.2 million from $17.4 million at year-end, and total impaired loans fell to $27.9 million from $33.3 million. However, six-month net charge-offs increased to $2.1 million from $1.5 million; the allowance was $12.5 million, or 1.51% of loans, versus $13.6 million and 1.84% at year-end.
- Management reclassified approximately $107.6 million of securities from available-for-sale to held-to-maturity after reviewing interest-rate sensitivity. The transfer carried an approximately $4.0 million unrealized loss, which remains in accumulated other comprehensive income and is amortized over the securities’ remaining lives.
- Q2 securities gains included a $1.1 million gain from selling four CDOs previously written down. The filing links the opportunity to clarification of the Volcker Rule. The CDO portfolio remains a valuation risk: $23.9 million fair value, classified Level 3, with $13.5 million of unrealized losses.
Outlook, risks and contingencies
- The filing provides no earnings or revenue guidance. Management says results for the interim periods are not necessarily indicative of full-year results.
- Management described liquidity as adequate and reported available capacity of $70.0 million in unsecured correspondent lines, $29.9 million at the Federal Reserve discount window, and approximately $22.8 million at the FHLB. The Bank was asset-sensitive to interest rates; management said the investment portfolio restructuring better positioned it for rising rates.
- Regulatory approval remains necessary for future payments on trust preferred debentures and Series A preferred stock. Approvals had been obtained for specified 2014 payments, but could be revoked; future payments are not assured. The company paid approximately $6.5 million of accumulated Series A preferred dividends in May and paid deferred trust-preferred interest in March. Common dividends remained suspended.
- Failure to pay six quarterly Series A preferred dividends could give preferred holders the right to elect up to two additional directors. Arrears on preferred dividends also restrict common-stock dividends and distributions.
- Credit risks include commercial real estate and acquisition-and-development exposures, partial charge-offs, troubled debt restructurings, and reliance on collateral appraisals. CDO fair values depend on significant unobservable valuation inputs and assumptions. Forward-looking results are also exposed to economic conditions, interest rates, funding costs, portfolio quality, regulation, and competition.
- Commitments to extend credit were $99.4 million; standby letters of credit were $0.9 million. Management reported no material legal proceedings and no material change in risk factors other than the preferred-stock governance and dividend risks described above.
Investor verification priorities
- Reconcile the drivers of the earnings decline, including the hotel participation loss, OREO valuation costs, loan yields, and preferred dividends.
- Track subsequent credit performance, charge-offs, non-accrual loans, criticized assets, TDRs, and adequacy of the allowance.
- Review CDO cash-flow assumptions, Level 3 valuations, credit performance, and the effects of securities sales and the AFS-to-HTM transfer.
- Confirm continuing regulatory approvals and funding capacity for preferred dividends and trust-preferred interest; assess implications for common dividends.
- Monitor net interest margin, deposit mix and pricing, loan growth and concentration, and the effect of interest-rate changes on earnings and securities values.