Unity Bancorp, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015; unaudited consolidated results. Unless noted, dollar amounts are in millions. Unity Bancorp is a New Jersey bank holding company operating Unity Bank, with 15 branches in New Jersey and Pennsylvania.
Financial performance and condition
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net interest income | $8.37 | $7.31 | $16.39 | $14.59 |
| Noninterest income | $1.89 | $1.64 | $3.53 | $3.17 |
| Net income | $2.43 | $1.53 | $4.37 | $2.82 |
| Diluted earnings per share | $0.28 | $0.20 | $0.51 | $0.37 |
| Net interest margin | 3.70% | 3.49% | 3.67% | 3.53% |
| Efficiency ratio | 64.99% | 70.81% | 66.12% | 71.36% |
- Q2 net income rose 58.9% year over year; first-half net income rose about 54.8%. Return on average assets/equity was 1.01%/13.35% for Q2 and 0.92%/12.23% for the first half.
- Q2 net interest income increased 14.6% year over year, supported by higher average loan balances. Net interest margin improved 21 basis points. First-half net interest income increased 12.3% and margin improved 14 basis points.
- Q2 provision for loan losses was zero, versus $550,000 in Q2 2014. First-half provision was $200,000, versus $1.15 million. Q2 included $223,000 of net recoveries; first-half net charge-offs were $347,000.
- Noninterest expense increased 8.3% in Q2 to $6.65 million and 6.1% for the first half to $13.15 million, primarily reflecting higher compensation and benefits, including expanded lending staff and mortgage commissions.
- Balance sheet at June 30: Assets were $1.024 billion, up 1.5% from year-end 2014. Total loans were $821.7 million, up 7.9%; deposits were $815.4 million, up $21.1 million. Shareholders’ equity was $73.7 million.
- Cash and cash equivalents declined $39.4 million from year-end to $90.4 million. First-half operating cash flow was negative $93,000, investing cash flow was negative $49.9 million, and financing cash flow was positive $10.6 million. Loan growth was the principal use of investing cash.
- Borrowed funds were $115.0 million and subordinated debentures were $15.5 million, for combined borrowings and debentures of $130.5 million, down $10.0 million from year-end. The Bank reported $42.2 million of additional FHLB borrowing capacity.
- Regulatory capital remained above minimums: the Company’s leverage, CET1, Tier 1 risk-based and total risk-based ratios were 9.09%, 9.39%, 11.33% and 12.59%, respectively. Unity Bank was reported as well-capitalized.
Material changes and business developments
- Loan growth was broad-based: commercial loans increased $26.4 million, residential mortgages $22.4 million and consumer loans $10.8 million since year-end; SBA 504 loans declined $5.2 million. Commercial real estate made up $361.9 million of the loan portfolio. Management stated that approximately 96% of loans were secured by real estate.
- Noninterest income benefited from mortgage loan sale gains, which increased to $687,000 in Q2 from $188,000, and higher service and loan fees. There were no SBA loan sales in Q2 2015, compared with $255,000 of related gains in Q2 2014. Security gains were $28,000, versus $268,000.
- Nonperforming loans declined to $8.8 million, or 1.08% of loans, from $11.4 million and 1.49% at year-end 2014. Nonperforming assets were $11.1 million, or 1.08% of assets. OREO increased to $2.3 million from $1.2 million; four properties valued at $2.2 million were taken into OREO during the first half, with a $350,000 charge to the allowance.
- The allowance for loan losses was $12.4 million, equal to 1.51% of loans and 140.36% of nonperforming loans. Total TDRs were $6.2 million; no loans were newly modified as TDRs during the quarter or first half. Management reported no principal forgiveness on TDRs.
- Deposits grew partly through time-deposit promotions and growth in commercial noninterest-bearing accounts. Municipal deposits were $70.3 million; the filing says $64.6 million was held by 11 municipalities with balances above $1.5 million.
Outlook, risks and unusual items
- The filing gives no specific earnings, loan-growth or margin guidance. Management said interim results are not necessarily indicative of full-year results and cited strategic priorities of growing in-market lending and deposit relationships, improving credit quality and growing core earnings.
- Management noted that the prolonged low-interest-rate environment affects results. Changes in economic conditions, interest rates, loan demand, deposit flows and competition could affect the net interest spread and income.
- Liquidity commitments to advance funds to borrowers totaled $192.7 million, including $112.0 million expiring within one year. Management said it believes liquidity is sufficient to honor commitments; many may expire unfunded. The filing also identifies sensitivity of municipal deposits to price competition.
- Credit risks include geographic concentration in the Bank’s markets, collateral-value exposure, and potential losses in a portfolio largely secured by real estate. Potential problem loans totaled $3.1 million. Management stated that future allowance additions may be needed if economic conditions or collateral values change.
- A new unfunded supplemental executive retirement plan for the CEO provides an annual benefit of $156,000 after separation from service after age 66, subject to annual 2% increases and vesting provisions. The plan generated a $498,000 after-tax prior-service-cost adjustment in other comprehensive loss. The plan includes specified change-in-control vesting provisions.
- The Company disclosed a new risk related to potentially exceeding $1 billion in Bank assets at year-end: additional FDIC reporting, internal-control assessment and independent attestation requirements could increase costs and regulatory scrutiny. No legal proceedings were identified as likely to have a material adverse effect. Management reported effective disclosure controls and no significant change in internal control over financial reporting.
Important facts for investors to verify
- Whether loan growth, especially commercial real estate and other real-estate-secured lending, is being matched by stable funding and sustained credit quality.
- Whether lower provisions and net recoveries are sustainable, given rising OREO, potential problem loans and the allowance’s assumptions.
- How much of earnings growth depends on mortgage-sale gains, fees and other income versus recurring net interest income.
- Liquidity coverage for the $192.7 million in lending commitments, municipal deposit concentration, and the availability and cost of FHLB funding.
- The financial and governance implications of the CEO retirement plan and any additional compliance costs if the Bank crosses the $1 billion year-end asset threshold.