First United Corporation (NASDAQ: FUNC) — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; balance-sheet comparisons are with December 31, 2018 unless stated otherwise. First United is a bank holding company whose primary subsidiary is First United Bank & Trust. Figures below are in U.S. dollars; financial statement amounts are generally in millions.
Key financial results
| Metric | Q1 2019 | Q1 2018 / comparison |
|---|---|---|
| Interest income | $14.07 million | $12.36 million |
| Net interest income | $11.35 million | $10.58 million |
| Net interest margin, fully tax-equivalent | 3.72% | 3.68% |
| Provision for loan losses | $0.35 million | $0.45 million |
| Other operating income, including net gains | $3.72 million | $3.71 million |
| Operating expenses | $10.69 million | $10.69 million |
| Net income | $3.15 million | $2.51 million |
| Diluted earnings per share | $0.44 | $0.35 |
| Return on average assets / equity, annualized | 0.91% / 10.49% | 0.76% / 9.13% |
| Dividend declared per share | $0.09 | $0.09 |
Net income increased about 26% year over year. Higher loan interest income and a lower loan-loss provision drove the improvement; deposit and borrowing costs rose, while noninterest income and total operating expenses were nearly unchanged.
Financial position, cash flow and liquidity
- Assets and loans: Total assets were $1.417 billion; gross loans were $1.005 billion and net loans $993.1 million. Gross loans declined $3.1 million from year-end.
- Deposits and borrowings: Deposits totaled $1.131 billion, up $63.1 million. Short-term borrowings fell $38.0 million to $39.7 million, primarily because $40 million of overnight borrowings was repaid. Long-term borrowings were $100.9 million.
- Cash and cash flow: Cash and cash equivalents ended at $54.0 million, up $30.5 million. Operating cash flow was $1.0 million; investing activities provided $5.0 million and financing activities provided $24.5 million. Deposit growth was the principal funding source for the cash increase and repayment of overnight borrowing.
- Equity and capital: Shareholders’ equity was $122.4 million. At March 31, consolidated total capital, Tier 1 capital, common equity Tier 1 and Tier 1 leverage ratios were 16.40%, 15.30%, 12.83% and 11.56%, respectively. The Bank’s corresponding ratios were 15.72%, 14.59%, 14.59% and 10.78%; each exceeded the filing’s “well capitalized” thresholds.
- Liquidity access: Management stated liquidity was adequate. Available facilities included $100 million of unsecured correspondent lines, $4.2 million at the Fed Discount Window and approximately $144.4 million of FHLB capacity.
Material changes and credit quality
- Nonaccrual loans increased to $11.6 million, or 1.15% of loans, from $4.9 million at year-end. The principal cause was a $7.0 million acquisition-and-development loan placed on nonaccrual after a prospective buyer withdrew and the Bank entered a forbearance agreement.
- Criticized credit measures merit attention: substandard loans rose to $24.7 million from $15.0 million, while special-mention loans declined to $9.4 million from $15.9 million. Accruing loans 30 days or more past due declined to 0.46% of the portfolio from 1.09%, partly because the large A&D loan moved to nonaccrual.
- The allowance for loan losses was $11.5 million, 1.15% of gross loans, versus $11.0 million at year-end. Q1 recorded $0.15 million of net recoveries and a $0.35 million provision. Management considered the allowance adequate, but estimates may differ from actual losses.
- The available-for-sale securities portfolio had fair value of $136.5 million versus amortized cost of $141.9 million. Its $5.4 million net unrealized loss was reflected in accumulated other comprehensive loss. The $15.2 million collateralized debt obligation portfolio is Level 3, valued using significant unobservable inputs; management reported no credit-related OTTI charge in Q1 and did not consider the unrealized losses other-than-temporary.
- Other real estate owned declined to $6.2 million from $6.6 million. The company adopted lease accounting on January 1, recognizing a $2.7 million right-of-use asset and $3.3 million lease liability; management said adoption did not materially affect income or cash flows.
Outlook, risks and contingencies
The filing provides no specific earnings, revenue or margin guidance. Management described the company as asset-sensitive and estimated that a parallel rate increase of 100 basis points would add about $0.82 million to modeled net interest income, while a 100-basis-point decline would reduce it by about $2.08 million. These are model estimates subject to assumptions, not forecasts. Management cited deposit pricing, funding costs, loan demand and credit quality as relevant uncertainties.
Management planned to adopt the expected-credit-loss (CECL) standard on January 1, 2020 and was validating data and models and refining assumptions. The filing also identifies economic and market conditions, interest-rate changes, deposit flows, competition, loan and investment portfolio quality, regulation and growth management as risks. The Bank had $123.0 million of commitments to extend credit and standby letters of credit at quarter-end, including $3.6 million of standby letters. Management considered the associated guarantee liability immaterial. The filing reports no legal proceedings and no material changes to previously disclosed risk factors. Disclosure controls were judged effective at a reasonable-assurance level.
Important facts for investors to verify
- Progress, repayment prospects and collateral support for the $7.0 million A&D loan under forbearance, and whether nonaccrual balances or criticized loans increase further.
- Whether the $11.5 million allowance remains adequate as the portfolio and borrower conditions evolve, including the effect of CECL implementation.
- Assumptions and sensitivity of the Level 3 CDO valuations, including the nine pooled trust-preferred securities and their unrealized losses.
- Whether deposit growth is sustainable and how rising deposit costs affect margins, funding needs and the company’s asset-sensitive position.
- Future operating cash generation and the impact of pension funding, lease obligations and capital distributions on liquidity and capital.