First United Corporation — Q3 2012 Form 10-Q
Business context and period: First United is a financial holding company whose principal business is community banking through First United Bank & Trust. The unaudited quarter ended September 30, 2012; income and cash-flow comparisons are for the three and nine months ended that date. Financial amounts below are in millions unless stated otherwise.
Key financial results
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net interest income | $9.8 | $9.4 | $29.6 | $28.4 |
| Provision for loan losses | $0.04 | $1.3 | $9.3 | $5.9 |
| Total other operating income | $3.0 | $2.8 | $11.6 | $11.1 |
| Operating expenses | $9.9 | $10.2 | $29.9 | $31.2 |
| Net income | $2.9 | $0.7 | $1.9 | $2.8 |
| Net income available to common shareholders | $2.5 | $0.3 | $0.6 | $1.6 |
| Basic and diluted EPS | $0.40 | $0.05 | $0.10 | $0.26 |
- Fully taxable-equivalent net interest margin was 3.28% in Q3, versus 2.97% a year earlier; for the first nine months it was 3.31%, versus 2.89%. Management attributed the improvement mainly to lower deposit and borrowing costs.
- For the nine months, net interest income on a fully taxable-equivalent basis was $30.4 million, compared with $29.7 million in 2011. Average earning assets and interest income declined, but reduced funding expense more than offset the decline.
- At September 30, total assets were $1.359 billion, deposits $1.003 billion, gross loans $890.0 million, net loans $873.6 million, and shareholders’ equity $98.5 million. Cash and cash equivalents were $88.5 million.
- Borrowings totaled $235.1 million: $52.4 million short-term and $182.8 million long-term. Long-term borrowings decreased from $207.0 million at December 31, 2011, while short-term borrowings rose from $36.9 million.
- For the first nine months, operating cash flow was $9.7 million, investing cash flow was $46.8 million, and financing cash flow was a $33.2 million outflow. Cash and cash equivalents increased $23.4 million to $88.5 million.
- Annualized returns for the nine months were 0.18% on average assets and 2.57% on average equity. Average equity to average assets was 7.06%.
Material changes and credit quality
- Nine-month net income available to common shareholders fell to $0.6 million from $1.6 million, primarily because loan-loss provision expense increased by $3.3 million. Q3 common earnings improved to $2.5 million from $0.3 million, with provision expense of only $0.04 million versus $1.3 million in Q3 2011.
- The higher year-to-date provision reflected major charge-offs, including $9.0 million on a shared national credit for an ethanol plant, $1.1 million on a hotel participation loan, and $0.9 million on a motel loan. Net charge-offs were $12.4 million, versus $7.9 million in the comparable 2011 period.
- The allowance for loan losses was $16.3 million, or 1.84% of loans, down from $19.5 million and 2.19% at December 31, 2011. Non-accrual loans decreased to $29.1 million from $38.2 million; however, loans 90 days or more past due and still accruing increased to $5.9 million from $1.8 million.
- Gross loans declined $48.7 million from year-end, and deposits declined $24.4 million. Non-interest-bearing deposits increased, while larger time deposits fell as the company pursued lower-cost funding. Total assets decreased $31.5 million.
- Other real estate owned rose to $20.6 million from $16.7 million. The company reported $20.9 million of troubled debt restructurings (TDRs), up from $18.0 million at year-end.
- Other operating income included a one-time, tax-free bank-owned life insurance death benefit of approximately $0.7 million and $1.1 million of nine-month net gains, including gains on investment-security and OREO sales. Insurance commission revenue declined following the sale of substantially all insurance-agency assets effective January 1, 2012.
Outlook, risks and contingencies
- No formal earnings or financial guidance is provided. Management said the net interest margin should continue to improve through lower cash levels, reduced non-accrual loans, and a shift toward lower-cost deposits. The company reported that it was asset-sensitive and believed its portfolio restructuring better positioned it for rising rates; interest-rate outcomes remain uncertain.
- Management characterized credit quality as stabilizing aside from the identified large charge-offs and stated that it believed the allowance was adequate. Future provision needs remain dependent on loan quality, portfolio mix, recoveries, collateral values, and economic conditions.
- The available-for-sale securities portfolio had a $20.3 million net unrealized loss at September 30. Its 18 pooled trust-preferred CDO securities had $36.7 million amortized cost and $10.0 million fair value, with $26.6 million in unrealized losses. These CDO valuations rely on Level 3 inputs and discounted-cash-flow estimates; management reported no credit-related OTTI charges during the first nine months of 2012.
- At regulators’ request, the parent continued deferring interest on trust-preferred debentures; cumulative deferred interest was approximately $3.9 million. Cash dividends on Series A preferred stock remained suspended, with approximately $3.1 million accrued. Common dividends were also suspended. Management could not predict when payments would resume; accrued preferred dividends and deferred interest must be addressed before common dividends can be paid.
- Both the company and the Bank were reported as “well capitalized” under prompt-corrective-action rules. The Bank’s total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios were 13.95%, 12.67%, and 10.57%, respectively. The company was reviewing proposed U.S. Basel III rules; the eventual effect was not yet determined.
- Management reported adequate liquidity and no material expected capital commitments in the near term. Loan commitments were $83.9 million and standby letters of credit were $1.5 million. The filing reported no legal proceedings and no material changes to risk factors since year-end.
Most important facts for investors to verify
- Whether credit performance continues to improve after the significant 2012 charge-offs, including delinquency, non-accrual, TDR, OREO, and allowance trends.
- The assumptions and independent valuation support for the Level 3 CDO portfolio, and whether market or credit developments could require further impairment or valuation changes.
- Whether the higher Q3 earnings level is sustainable given the very low quarterly provision and the nonrecurring death benefit and other gains in year-to-date results.
- Progress on funding, liquidity, and the deposit mix, alongside the increase in short-term borrowings and decline in deposits and loans.
- Regulatory conditions and the company’s capacity to resume trust-preferred interest, preferred dividends, and eventually common dividends; also monitor final capital-rule requirements.