Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☑ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended September 30, 2021
◻ TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
For the transition period from _______________ to ________________
Commission file number 0-14237
First United Corporation
(Exact name of registrant as specified in its charter)
Maryland
52-1380770
(State or other jurisdiction of incorporation or organization)
(I. R. S. Employer Identification No.)
19 South Second Street, Oakland, Maryland
21550-0009
(Address of principal executive offices)
(Zip Code)
(800) 470-4356
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbols
Name of each exchange on which registered
Common Stock
FUNC
Nasdaq Stock Market
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ◻
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☑ No ◻
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated filer ◻
Accelerated Filer ◻
Non-Accelerated filer ☑
Smaller Reporting Company ☑
Emerging Growth Company ◻
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standard provided pursuant to Section 13(a) of the Exchange Act. ◻
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ◻ No ☑
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 6,177,941 shares of common stock, par value $.01 per share, as of October 31, 2021.
INDEX TO QUARTERLY REPORT
FIRST UNITED CORPORATION
Page
PART I. FINANCIAL INFORMATION
3
Item 1.
Financial Statements (unaudited)
Consolidated Statement of Financial Condition – September 30, 2021 and December 31, 2020
Consolidated Statement of Operations – for the three and nine months ended September 30, 2021 and 2020
4
Consolidated Statement of Comprehensive Loss – for the three and nine months ended September 30, 2021 and 2020
6
Consolidated Statement of Changes in Shareholders’ Equity – for three and nine months ended September 30, 2021 and 2020
8
Consolidated Statement of Cash Flows – for the nine months ended September 30, 2021 and 2020
9
Notes to Consolidated Financial Statements
10
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
45
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
71
Item 4.
Controls and Procedures
PART II. OTHER INFORMATION
72
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
73
SIGNATURES
74
2
Item 1. Financial Statements
First United Corporation and Subsidiaries
Consolidated Statement of Financial Condition
(In thousands, except share data - Unaudited)
September 30,2021
December 31,2020
Assets
Cash and due from banks
$
129,062
146,673
Interest bearing deposits in banks
5,876
2,759
Cash and cash equivalents
134,938
149,432
Investment securities – available for sale (at fair value)
235,564
226,885
Investment securities – held to maturity (fair value $71,707 at September 30, 2021 and $77,612 at December 31, 2020)
61,979
68,263
Restricted investment in bank stock, at cost
1,029
4,468
Loans held for sale
348
3,546
Loans
1,161,868
1,167,812
Unearned fees
(1,171)
(1,730)
Allowance for loan losses
(16,906)
(16,486)
Net loans
1,143,791
1,149,596
Premises and equipment, net
35,213
36,863
Goodwill
11,004
Bank owned life insurance
44,851
43,974
Deferred tax assets
7,946
7,972
Other real estate owned, net
6,663
9,386
Operating lease asset
2,331
2,408
Accrued interest receivable and other assets
22,899
19,617
Total Assets
1,708,556
1,733,414
Liabilities and Shareholders’ Equity
Liabilities:
Non-interest bearing deposits
491,441
420,427
Interest bearing deposits
953,053
1,001,939
Total deposits
1,444,494
1,422,366
Short-term borrowings
72,396
49,160
Long-term borrowings
30,929
100,929
Operating lease liability
2,854
2,958
Accrued interest payable and other liabilities
23,103
26,044
Dividends payable
993
910
Total Liabilities
1,574,769
1,602,367
Shareholders’ Equity:
Common Stock – par value $0.01 per share; Authorized 25,000,000 shares; issued and outstanding 6,617,941 shares at September 30, 2021 and 6,992,911 at December 31, 2020
66
70
Surplus
23,522
30,149
Retained earnings
138,931
129,691
Accumulated other comprehensive loss
(28,732)
(28,863)
Total Shareholders’ Equity
133,787
131,047
Total Liabilities and Shareholders’ Equity
See accompanying notes to the consolidated financial statements
Consolidated Statement of Operations
(In thousands, except per share data)
Nine Months Ended
September 30,
2021
2020
(Unaudited)
Interest income
Interest and fees on loans
39,496
39,192
Interest on investment securities
Taxable
2,864
3,612
Exempt from federal income tax
809
Total investment income
3,673
4,421
Other
239
360
Total interest income
43,408
43,973
Interest expense
Interest on deposits
2,877
4,997
Interest on short-term borrowings
67
68
Interest on long-term borrowings
1,840
2,463
Total interest expense
4,784
7,528
Net interest income
38,624
36,445
Provision for loan losses
4,981
Net interest income after provision for loan losses
38,556
31,464
Other operating income
Net gains on investments, available for sale
154
622
Net gains on investments, held to maturity
(54)
60
Gains on sale of residential mortgage loans
996
1,480
Gains/(losses) on disposal of fixed assets
16
(151)
Net gains
1,112
2,011
Other Income
Service charges on deposit accounts
1,292
1,439
Other service charges
664
517
Trust department
6,441
5,355
Debit card income
2,623
2,052
877
961
Brokerage commissions
854
713
835
374
Total other income
13,586
11,411
Total other operating income
14,698
13,422
Other operating expenses
Salaries and employee benefits
16,214
16,244
FDIC premiums
575
404
Equipment
2,837
2,871
Occupancy
2,102
2,200
Data processing
2,420
3,155
Marketing
408
405
Professional services
3,276
2,506
Contract labor
486
480
Line rentals
606
654
Other real estate owned
(460)
Investor relations
546
1,160
Settlement expense
3,300
—
FHLB prepayment penalty
2,368
2,308
2,890
Total other operating expenses
36,986
32,972
Income before income tax expense
16,268
11,914
Provision for income tax expense
4,047
2,629
Net Income
12,221
9,285
Basic net income per share
1.81
1.32
Diluted net income per share
Weighted average number of basic shares outstanding
6,741
7,008
Weighted average number of diluted shares outstanding
6,746
7,019
Dividends declared per common share
0.45
0.39
Three Months Ended
13,667
12,940
880
960
266
276
1,146
1,236
97
77
14,910
14,253
732
1,515
17
19
536
817
1,285
2,351
13,625
11,902
(597)
160
14,222
11,742
136
734
Gains on disposal of fixed assets
(133)
82
1,176
475
447
232
195
2,166
1,871
900
738
298
373
229
234
223
120
4,523
3,978
4,605
5,154
5,719
5,378
209
201
1,032
978
684
707
819
1,130
129
122
615
602
153
180
123
216
150
116
54
966
13,027
10,540
5,800
6,356
1,412
1,396
4,388
4,960
Basic net income per common share
0.66
0.70
Diluted net income per common share
6,617
6,988
6,624
6,993
0.15
0.13
5
Consolidated Statement of Comprehensive Income
(In thousands)
Comprehensive Income
Other comprehensive income, net of tax and reclassification adjustments:
Net unrealized gains/(losses) on investments with OTTI
2,286
(1,025)
Net unrealized (losses)/gains on all other AFS securities
(3,799)
1,336
Net unrealized gains on HTM securities
110
548
Net unrealized gains/(losses) on cash flow hedges
450
(972)
Net unrealized gains on pension
919
131
Net unrealized gains on SERP
165
102
Other comprehensive income, net of tax
Comprehensive income
12,352
9,405
Comprehensive Income (in thousands)
Net unrealized gains on investments with OTTI
513
481
Net unrealized losses on all other AFS securities
(518)
(656)
31
Net unrealized gains on cash flow hedges
79
Net unrealized (losses)/gains on pension
(424)
1,647
55
34
Other comprehensive (loss)/income, net of tax
(264)
1,632
4,124
6,592
Consolidated Statement of Changes in Shareholders’ Equity
CommonStock
RetainedEarnings
AccumulatedOtherComprehensiveLoss
TotalShareholders'Equity
Balance at January 1, 2021
Net income
3,430
Other comprehensive loss
(4,335)
Stock based compensation
50
Common stock issued - 2,956 shares
46
Common stock dividend declared - $0.15 per share
(1,049)
Balance at March 31, 2021
30,245
132,072
(33,198)
129,189
4,403
Other comprehensive income
4,730
296
Common stock issued - 3,261 shares
56
Common stock repurchase - 400,000 shares
(4)
(7,175)
(7,179)
(939)
Balance at June 30, 2021
23,422
135,536
(28,468)
130,556
43
Common stock issued - 3,337 shares
57
Common stock dividend declared -$0.15 per share
(993)
Balance at September 30, 2021
7
Balance at January 1, 2020
32,359
119,481
(25,971)
125,940
1,755
(5,632)
98
Common stock issued - 2,167 shares
52
Stock repurchase - 145,291 shares
(1)
(2,753)
(2,754)
Common stock dividend declared - $0.13 per share
(910)
Balance at March 31, 2020
29,756
120,326
(31,603)
118,549
2,570
4,120
Common stock issued - 3,465 shares
47
(904)
Balance at June 30, 2020
29,874
121,992
(27,483)
124,453
Common stock issued - 4,245 shares
49
Common stock dividend declared -$0.13 per share
(909)
Balance at September 30, 2020
29,975
126,043
(25,851)
130,237
Consolidated Statement of Cash Flows
Operating activities
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation
2,453
445
221
Gains on sales of other real estate owned
(594)
(93)
Write-(ups)\downs of other real estate owned
(160)
Originations of loans held for sale
(23,618)
(54,039)
Proceeds from sale of loans held for sale
27,758
52,057
Gains from sale of loans held for sale
(942)
(1,480)
(Gains)/losses on disposal of fixed assets
(16)
151
Net amortization of investment securities discounts and premiums- AFS
790
212
Net amortization of investment securities discounts and premiums- HTM
225
Gains on sales/calls of investment securities – AFS
(154)
(622)
Losses/(gains) on investment securities – HTM
(60)
Earnings on Bank owned life insurance
(877)
(961)
Amortization of deferred loan fees
(3,228)
(1,908)
Increase in accrued interest receivable and other assets
(1,638)
(2,624)
Deferred tax (benefit)/expense
(48)
(104)
(228)
Increase in accrued interest payable and other liabilities
(2,326)
(96)
Net cash provided by operating activities
10,437
7,802
Investing activities
Proceeds from maturities/calls of investment securities - AFS
40,045
40,572
Proceeds from maturities/calls of investment securities - HTM
12,286
43,226
Proceeds from sales of investment securities - AFS
13,687
30,831
Purchases of investment securities - AFS
(65,101)
(92,440)
Purchases of investment securities - HTM
(6,332)
(18,633)
Proceeds from sales of other real estate owned
3,477
514
Proceeds from disposal of fixed assets
39
728
Net decrease/(increase) in restricted stock
3,439
(53)
Net decrease/(increase) in loans
67,908
(139,367)
Purchases of loans
(58,943)
Purchases of premises and equipment
(826)
(1,322)
Net cash provided by/(used in) investing activities
9,679
(135,944)
Financing activities
Net increase in deposits
22,128
235,253
Issuance of common stock
103
148
Cash dividends on common stock
(2,898)
(2,739)
Net increase in short-term borrowings
23,236
3,861
Stock repurchase
Net decrease in long-term borrowings
(70,000)
Net cash (used in)/provided by financing activities
(34,610)
233,769
(Decrease)/increase in cash and cash equivalents
(14,494)
105,627
Cash and cash equivalents at beginning of the year
49,979
Cash and cash equivalents at end of period
155,606
Supplemental information
Interest paid
5,033
7,610
Taxes paid
4,637
625
Non-cash investing activities:
Transfers from loans to other real estate owned
183
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1 – Basis of Presentation
The accompanying unaudited consolidated financial statements of First United Corporation and its consolidated subsidiaries, including First United Bank & Trust (the “Bank”), have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information, as required by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 270, Interim Reporting, and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all the information and footnotes required for annual financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation, consisting of normal recurring items, have been included. Certain prior period balances have been reclassified to conform to the current period presentation. Operating results for the three and nine month periods ended September 30, 2021 are not necessarily indicative of the results that may be expected for the full year or for any future interim period. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020.
As used in these notes, the terms “the Corporation” “we”, “us”, and “our” refer to First United Corporation and, unless the context clearly requires otherwise, its consolidated subsidiaries.
The Corporation has evaluated events and transactions occurring subsequent to the statement of financial condition date of September 30, 2021 for items that should potentially be recognized or disclosed in these financial statements.
Note 2 – COVID-19
The COVID-19 pandemic has adversely impacted our business and financial results and that of many of our customers, and the ultimate impact will depend on future developments, which are highly uncertain, cannot be predicted, and are largely outside of our control, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic. The COVID-19 pandemic has created extensive disruptions to the global and U.S. economies and to the lives of individuals throughout the world. Governments, businesses, and the public are taking unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including closures of businesses and schools, fiscal and monetary stimulus, and legislation designed to deliver financial aid and other relief. While the scope, duration, and full effects of COVID-19 are not fully known, the pandemic and the efforts to contain it have disrupted global economic activity, adversely affected the functioning of financial markets, impacted market interest rates, increased economic and market uncertainty, and disrupted trade and supply chains.
Congress, the President, and the Board of Governors of the Federal Reserve System (the “Federal Reserve”) have taken several actions designed to cushion the economic fallout. Most notably, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”), a $2 trillion legislative package, was signed into law at the end of March 2020. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors, such as by providing funds for loans under the Paycheck Protection Program (the “PPP”) administered by the Small Business Administration (the “SBA”). Section 4013 of the CARES Act, “Temporary Relief from Troubled Debt Restructurings,” provides banks the option to temporarily suspend certain requirements under U.S. GAAP related to trouble debt restructurings (“TDRs”) for a limited period of time to account for the effects of COVID-19. Additionally, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “Economic Aid Act”) was enacted on December 27, 2020 and provided for a second round of PPP loans. The PPP Extension Act of 2021, which was enacted on March 30, 2021, extended the PPP application deadline to May 31, 2021 and provided the SBA with additional time to process applications through June 30, 2021. Also, the Consolidated Appropriations Act (the “CAA”) passed on December 27, 2020, which, among other things, extended the provisions of Section 4013 of the CARES Act to January 1, 2022. The Federal Reserve’s actions have included cutting the federal funds rate 150 basis points and targeting a 0 to 25 basis point rate. In addition to the general impact of the COVID-19 pandemic, certain provisions of the CARES Act as well as other legislative and regulatory relief efforts are expected to have a material impact on the Corporation’s operations.
During the first nine months of 2021, we continued to assist our business customers with the PPP loan forgiveness process and to originate additional PPP loans through the third round of funding. We remained diligent in protecting our associates and customers from the lingering effects of the pandemic, delaying opening our lobbies until April 1, 2021. During the third quarter, we made the decision to reclose our lobbies as COVID cases increased in most of our markets and staffing was at reduced levels. Many of our sales and support employees continue to work remotely as we have adjusted to a hybrid work environment. We have continued to monitor our market areas, maintaining travel protocols and utilizing safety precautions while continuing to provide full banking services to our customers.
Paycheck Protection Program
The Corporation continues to actively participate in the PPP. On January 19, 2021, the SBA implemented a third round of funding for PPP loans.
During 2020, the Corporation originated a total of $148.5 million in PPP loans under the first and second rounds of funding, consisting of 1,174 loans with an average loan size of $162 thousand. During 2021, the Corporation originated a total of $66.1 million in PPP loans under the third round of funding, consisting of 870 loans with an average loan size of $80 thousand.
Net PPP origination fees recognized in the first nine months of 2021 were $3.2 million due to amortization and forgiveness, compared to $2.4 million in 2020.
During 2020, 290 PPP loans, totaling $34.5 million were forgiven, resulting in 885 loans with a remaining balance of $114.0 million at December 31, 2020. During the first nine months of 2021, an additional 1,384 PPP loans originated under all three rounds, with an aggregate principal balance of $150.0 million, were forgiven, resulting in 371 loans with a total remaining balance of $30.3 million at September 30, 2021.
Of the 2,046 PPP loans originated by the Corporation since the PPP’s inception, 1,675 loans, totaling $184.9 million, have been forgiven through the end of third quarter 2021, representing 86% of the number of loans originated and 82% of originated principal balances.
COVID Modifications
While the COVID-19 pandemic has had an impact on most industries, some have been more affected than others. In accordance with Section 4013 of the CARES Act and related regulatory pronouncements, we have not accounted for modifications of loans affected by the pandemic as troubled debt restructurings (“TDRs”) nor have we designated them as past due or nonaccrual.
As of October 15, 2021, modified loans not treated as TDRs consisted of eleven commercial loans relating to real estate rental, food services and health care sectors and one mortgage loan, with an aggregate balance of $9.9 million. These loans are scheduled to return to contractual payment terms within the next quarter.
Note 3 – Earnings Per Common Share
Basic earnings per common share is derived by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period and does not include the effect of any potentially dilutive common stock equivalents. Diluted earnings per share is derived by dividing net income available to common shareholders by the weighted-average number of shares outstanding, adjusted for the dilutive effect of outstanding common stock equivalents, such as restricted stock units (“RSUs”). At September 30, 2021, there were RSUs relating to 7,073 time-vested shares of common stock outstanding. There were no anti-dilutive shares at September 30, 2021 or 2020.
11
The following tables set forth the calculation of basic and diluted earnings per common share for the nine and three months periods ended September 30, 2021 and 2020:
Nine months ended September 30,
Average
Per Share
(in thousands, except for per share amount)
Income
Shares
Amount
Basic Earnings Per Share:
Diluted Earnings Per Share:
Three months ended September 30,
12
Note 4 – Investments
The following table shows a comparison of amortized cost and fair values of investment securities at September 30, 2021 and December 31, 2020:
(in thousands)
AmortizedCost
GrossUnrealizedGains
GrossUnrealizedLosses
FairValue
OTTIin AOCL
September 30, 2021
Available for Sale:
U.S. government agencies
55,527
235
2,028
53,734
Residential mortgage-backed agencies
30,936
21
603
30,354
Commercial mortgage-backed agencies
55,980
224
695
55,509
Collateralized mortgage obligations
70,766
104
1,791
69,079
Obligations of states and political subdivisions
9,402
394
9,796
Collateralized debt obligations
18,586
95
1,589
17,092
(715)
Total available for sale
241,197
1,073
6,706
Held to Maturity:
32,113
882
32,601
9,697
335
10,032
20,169
8,905
29,074
Total held to maturity
10,122
71,707
December 31, 2020
75,856
899
322
76,433
22,999
100
32,549
529
36
33,042
70,372
1
70,637
10,144
470
10,614
18,544
5,284
13,260
(3,839)
230,464
2,164
5,743
34,597
1,173
38
35,732
11,716
587
12,303
1,348
58
1,406
20,602
7,569
28,171
9,387
77,612
13
The following table shows the Corporation’s investment securities with gross unrealized losses and fair values at September 30, 2021 and December 31, 2020, aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position:
Less than 12 months
12 months or more
UnrealizedLosses
Number ofInvestments
34,325
20,582
41,647
7,725
215
65,329
10,397
127,558
2,874
15
52,447
3,832
8,500
39,611
16,034
39,628
118,172
459
14
2,973
Management systematically evaluates securities for impairment on a quarterly basis. Based upon application of accounting guidance for subsequent measurement in ASC Topic 320 (ASC Section 320-10-35), management assesses whether (a) the Corporation has the intent to sell a security being evaluated and (b) it is more likely than not that the Corporation will be required to sell the security prior to the anticipated recovery of any decline in fair value. If neither applies, then any decline in the fair value below the security’s cost that is considered an other-than-temporary decline is split into two components. The first component is the loss attributable to declining credit quality. Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made. The second component consists of all other losses, which are recognized in other comprehensive loss. In estimating other than temporary impairment (“OTTI”) losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) adverse conditions specifically related to the security, an industry, or a geographic area, (3) the historic and implied volatility of the fair value of the security, (4) changes in the rating of the security by a rating agency, (5) recoveries or additional declines in fair value subsequent to the balance sheet date, (6) failure of the issuer of the security to make scheduled interest or principal payments, and (7) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future. Management also monitors cash flow projections for securities that are considered beneficial interests under the guidance of ASC Subtopic 325-40, Investments – Other – Beneficial Interests in Securitized Financial Assets, (ASC Section 325-40-35).
Management believes that the valuation of certain securities is a critical accounting policy that requires significant estimates in preparation of the Corporation’s consolidated financial statements. Management utilizes an independent third party to prepare both the impairment valuations and fair value determinations for the Corporation’s collateralized debt obligation (“CDO”) portfolio consisting of pooled trust preferred securities. See Note 7 for a discussion of the methodology used by management to determine the fair values of these securities. Based upon a review of credit quality and the cash flow tests performed by the independent third party, management determined that there were no securities that had credit-related OTTI charges during the first nine months of 2021 or 2020.
The Corporation believes that the investment securities that were in an unrealized loss position at September 30, 2021 do not represent other-than-temporary impairment. The Corporation does not intend to sell, nor is it anticipated that the Corporation will be required to sell, any of its impaired investment securities at a loss.
The following tables present a cumulative roll-forward of the amount of non-cash OTTI charges related to credit losses that have been recognized in earnings for the trust preferred securities held in the CDO portfolio during the nine and three month periods ended September 30, 2021 and 2020 that the Corporation does not intend to sell:
Balance of credit-related OTTI at January 1
2,244
2,446
Reduction for increases in cash flows expected to be collected
Balance of credit-related OTTI at September 30
2,093
2,295
Balance of credit-related OTTI at July 1
2,143
2,345
(50)
The amortized cost and estimated fair value of securities by contractual maturity at September 30, 2021 are shown in the following table. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.
Contractual Maturity
Due after one year through five years
4,404
4,466
Due after five years through ten years
10,057
10,198
Due after ten years
69,054
65,958
83,515
80,622
Note 5 – Loans and Related Allowance for Loan Losses
The following table summarizes the primary segments of the loan portfolio at September 30, 2021 and December 31, 2020:
CommercialReal Estate
AcquisitionandDevelopment
CommercialandIndustrial
ResidentialMortgage
Consumer
Total
Individually evaluated for impairment
7,343
842
2,985
18
11,188
Collectively evaluated for impairment
364,442
131,414
195,758
402,900
56,166
1,150,680
Total loans
371,785
132,256
405,885
56,184
3,330
3,185
7,459
365,846
116,119
266,745
375,985
35,658
1,160,353
369,176
116,961
379,170
35,760
The commercial and industrial portfolio in the table above includes $30.3 million and $114.0 million of PPP loans at September 30, 2021 and December 31, 2020, respectively, which are 100% guaranteed by the SBA, and no allowance for loan loss (“ALL”) has been assigned to them.
The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention and Substandard within the internal risk rating system at September 30, 2021 and December 31, 2020:
Pass
SpecialMention
Substandard
Commercial real estate
Non owner-occupied
172,977
13,054
6,209
192,240
All other CRE
171,556
1,407
6,582
179,545
Acquisition and development
1-4 family residential construction
20,321
All other A&D
111,496
439
111,935
Commercial and industrial
178,724
6,087
10,947
Residential mortgage
Residential mortgage - term
338,745
6,282
345,027
Residential mortgage - home equity
60,141
717
60,858
56,056
128
1,110,016
20,548
31,304
178,670
5,526
6,322
190,518
166,504
5,664
6,490
178,658
18,920
97,648
376
98,041
245,185
8,867
12,693
309,177
283
6,117
315,577
62,804
789
63,593
35,648
109
1,114,556
20,360
32,896
The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and non-accrual loans at September 30, 2021 and December 31, 2020:
Current
30-59 DaysPast Due
60-89 DaysPast Due
90 Days+Past Due
Total PastDue andAccruing
Non-Accrual
Total Loans
187,770
4,470
178,880
118
547
111,540
395
195,383
375
342,242
76
975
1,205
1,580
60,149
213
65
278
431
55,794
304
33
35
372
1,152,079
1,086
189
2,348
7,441
190,510
177,360
890
97,660
366
266,708
37
312,500
63
670
710
1,443
1,634
63,036
80
143
414
35,473
230
26
260
27
1,162,167
823
759
724
2,306
3,339
The current status of commercial and industrial loans includes $30.3 million and $114.0 million of PPP loans at September 30, 2021 and December 31, 2020, respectively.
Non-accrual loans that have been subject to partial charge-offs totaled $0.5 million at September 30, 2021 and $0.4 million at December 31, 2020. Loans secured by 1-4 family residential real estate properties in the process of foreclosure totaled $0.2 million at September 30, 2021 and $0.4 million at December 31, 2020. Foreclosure and repossession activities were temporarily suspended as a result of COVID-19 but resumed during the third quarter 2021. Management continues to conform to federal and state mandates relative to the foreclosure processes for both Federal Backed and Non-Federal Backed mortgages. As a percentage of the loan portfolio, accruing loans past due 30 days or more decreased to 0.20%, including PPP loans, or 0.21% excluding PPP loans, compared to 0.20% at December 31, 2020.
The following table summarizes the primary segments of the ALL at September 30, 2021 and December 31, 2020, segregated by the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment:
Unallocated
Individually evaluatedfor impairment
187
205
Collectively evaluatedfor impairment
6,539
2,910
2,400
3,582
840
430
16,701
Total ALL
6,726
3,598
16,906
40
5,539
2,326
2,584
5,110
370
500
16,429
5,543
2,339
5,150
16,486
The evaluation of the need and amount of a specific allocation of the ALL and whether a loan can be removed from impairment status is made on a quarterly basis.
The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not required at September 30, 2021 and December 31, 2020:
Impaired Loans withSpecific Allowance
ImpairedLoans withNo SpecificAllowance
Total Impaired Loans
RecordedInvestment
RelatedAllowances
RecordedInvestment (1)
UnpaidPrincipalBalance
1,715
2,863
4,578
2,765
245
597
1,806
2,214
Residential mortgage – term
261
2,293
2,554
2,615
Residential mortgage – home equity
385
20
Total impaired loans
2,040
9,148
14,693
111
119
3,211
300
576
1,724
936
1,910
2,846
3,031
339
415
51
1,399
6,060
11,063
The following tables present the activity in the ALL for the nine and three month periods ended September 30, 2021 and 2020:
ALL balance at January 1, 2021
Charge-offs
(85)
(141)
(266)
(492)
Recoveries
172
511
112
844
Provision
1,183
484
(695)
(1,460)
626
(70)
ALL balance at September 30, 2021
ALL balance at January 1, 2020
2,882
3,674
1,341
3,828
312
12,537
(1,144)
(232)
(108)
(274)
(1,758)
69
29
149
429
2,343
(136)
926
1,621
227
ALL balance at September 30, 2020
5,294
2,423
2,184
5,407
381
16,189
ALL balance at July 1, 2021
5,675
2,500
2,944
4,859
590
17,068
(59)
(91)
62
473
589
1,051
352
(1,017)
(1,222)
309
ALL balance at July 1, 2020
4,527
4,498
1,997
5,106
386
17,014
(1,113)
(10)
(51)
(1,174)
133
28
764
(969)
293
The ALL is based on estimates, and actual losses may vary from current estimates. Management believes that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.
The following tables present the average recorded investment in impaired loans by class and related interest income recognized for the periods indicated:
Nine months ended
For the year ended
September 30, 2020
Averageinvestment
Interest incomerecognized onan accrual basis
Interest incomerecognized ona cash basis
3,518
134
2,984
3,203
3,201
256
282
599
6,709
8,243
2,642
2,593
2,531
449
604
651
10,465
178
13,554
15,076
Three months ended
4,631
127
2,787
3,278
249
8,158
2,565
451
474
11,229
14,929
64
The Bank modifies loan terms in the normal course of business. Among other reasons, modifications might be made in an effort to retain the loan relationship, to remain competitive in the current interest rate environment and/or to re-amortize or extend the loan’s term to better match the loan’s payment stream with the borrower’s cash flow. A modified loan is considered to be a TDR when the modification occurs in connection with a determination by the Bank that the borrower is troubled (i.e., experiencing financial difficulties). In deciding whether to modify a loan, the Bank evaluates the probability that the borrower will be in payment default on any of its debt obligations in the foreseeable future without modification. To make this determination, the Bank performs a global financial review of the borrower and loan guarantors to assess their current abilities to meet their financial obligations.
Section 4013 of the CARES Act allows financial institutions to suspend application of certain current TDRs accounting guidance under ASC 310-40 for loan modifications related to the COVID-19 pandemic made between March 1, 2020 and the earlier of January 1, 2022 or 60 days after the end of the COVID-19 national emergency, provided certain criteria are met. This relief can be applied to loan modifications for borrowers that defer or delay the payment of principal or interest, or change the interest rate on the loan and that were not more than 30 days past due as of December 31, 2019. In April 2020, federal and state banking regulators issued the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus to provide further interpretation of when a borrower is experiencing financial difficulty, specifically indicating that if the modification is either short-term (i.e., up to nine months) or mandated by a federal or state government in response to the COVID-19 pandemic, the borrower is not experiencing financial difficulty under ASC 310-40. The Corporation continues to prudently work with borrowers negatively impacted by the COVID-19 pandemic while managing credit risks and recognizing appropriate allowance for credit losses on its loan portfolio. See Note 2 to the financial statements included elsewhere in this report for additional information.
There were 14 loans totaling $3.8 million and $4.0 million that were classified as TDRs at September 30, 2021 and December 31, 2020, respectively. The following tables present the volume and recorded investment in TDRs at the times they were modified, by class and type of modification that occurred during the periods indicated:
Temporary RateModification
Extension of Maturity
Modification of Paymentand Other Terms
Number ofContracts
Nine months ended September 30, 2021
202
526
Nine months ended September 30, 2020
2,226
457
356
887
2,582
22
During the nine month period ended September 30, 2021, there were no new TDRs and three existing TDRs that had reached their modification maturity date and was re-modified. The Bank had no significant commitments to lend additional funds to TDRs.
During the nine month period ended September 30, 2020, there were no new TDRs but nine existing TDRs that had reached their modification maturity dates were re-modified. These modifications did not impact the ALL. During the nine months ended September 30, 2021 and 2020, there were no payment defaults.
The following tables present the volume and recorded investment in TDRs at the times they were modified, by class and type of modification that occurred during the periods indicated:
Three months ended September 30, 2021
417
Three months ended September 30, 2020
440
During the three month period ended September 30, 2021, there were no new TDRs and two existing TDRs that had reached their modification maturity dates and were re-modified. The Bank had no significant commitments to lend additional funds to TDR borrowers.
23
During the three month period ended Sept 30, 2020, there were no new TDRs but two existing TDRs that had reached their modification maturity dates were re-modified. These re-modifications did not impact the ALL. During the three months ended September 30, 2021 and 2020, there were no payment defaults under TDRs.
Note 6 - Other Real Estate Owned, net
The following table presents the components of other real estate owned (“OREO”) at September 30, 2021 and December 31, 2020:
945
5,763
8,441
Total OREO, net
The following table presents the activity in the OREO valuation allowance for the nine and three month periods ended September 30, 2021 and 2020:
Balance beginning of period
1,010
1,790
543
1,734
Fair value adjustment
Sales of OREO
(396)
(261)
(89)
(166)
Balance at end of period
454
1,631
The following table presents the components of OREO (income)/expenses, net, for the nine and three month periods ended September 30, 2021 and 2020:
(Gains)/losses on sale of real estate, net
(72)
Fair value adjustment, net
Expenses, net
345
117
Rental and other income
(123)
(2)
(37)
Total OREO (income)/expense, net
Note 7 – Fair Value of Financial Instruments
Fair value is defined as the price to sell an asset or to transfer a liability in an orderly transaction between willing market participants as of the measurement date. Fair value is best determined by values quoted through active trading markets. Active trading markets are characterized by numerous transactions of similar financial instruments between willing buyers and willing sellers. Because no active trading market exists for various types of financial instruments, many of the fair values disclosed were derived using present value discounted cash flows or other valuation techniques described below. As a result, the Corporation’s ability to actually realize these derived values cannot be assumed.
The Corporation measures fair values based on the fair value hierarchy established in ASC Paragraph 820-10-35-37. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1
24
measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of inputs that may be used to measure fair value under the hierarchy are as follows:
Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets and liabilities. This level is the most reliable source of valuation.
Level 2: Quoted prices that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability. Level 2 inputs include inputs other than quoted prices that are observable for the asset or liability (for example, interest rates and yield curves at commonly quoted intervals, volatilities, prepayment speeds, loss severities, credit risks, and default rates). It also includes inputs that are derived principally from or corroborated by observable market data by correlation or other means (market-corroborated inputs). Several sources are utilized for valuing these assets, including a contracted valuation service, Standard & Poor’s (“S&P”) evaluations and pricing services, and other valuation matrices.
Level 3: Prices or valuation techniques that require inputs that are both significant to the valuation assumptions and not readily observable in the market (i.e. supported with little or no market activity). Level 3 instruments are valued based on the best available data, some of which is internally developed, and consider risk premiums that a market participant would require.
The level established within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
Management believes that the Corporation’s valuation techniques are appropriate and consistent with the techniques used by other market participants. However, the use of different methodologies and assumptions could result in a different estimate of fair values at the reporting date. The valuation techniques used by the Corporation to measure, on a recurring basis and on a non-recurring basis, the fair value of assets as of September 30, 2021 are discussed in the paragraphs that follow.
Investments – The fair value of investments is determined using a market approach. As of September 30, 2021, the U.S. Government agencies, residential and commercial mortgage-backed securities, collateralized mortgage obligations, and state and political subdivisions bonds, excluding the tax increment financing (“TIF”) bonds, were classified as Level 2 within the valuation hierarchy. Their fair values were determined based upon market-corroborated inputs and valuation matrices, which were obtained through third party data service providers or securities brokers through which the Corporation has historically transacted both purchases and sales of investment securities. The TIF bonds were classified as Level 3 within the valuation hierarchy as they are not openly traded.
The CDO segment, which consists of pooled trust preferred securities issued by banks, thrifts and insurance companies, is classified as Level 3 within the valuation hierarchy. At September 30, 2021, the Corporation owned nine trust preferred securities with an amortized cost of $18.6 million and a fair value of $17.1 million. As of September 30, 2021, the market for these securities was not active and the markets for similar securities were also not active. Recent developments in the credit markets have had a negative impact on the market for CDOs. Specifically, as COVID-19 developed, which led to deteriorating performance of credit instruments, investors became less willing to buy a range of structured credit products. The result was massive spread-widening across a wide range of credit instruments, and for CDO bonds in particular. At present, we believe that it is not currently economically feasible to form new CDOs or restructure existing CDOs, as the market for CDO bonds has effectively disappeared. The market values for these securities or any securities other than those issued or guaranteed by the U.S. Department of the Treasury are depressed relative to historical levels. Therefore, in the current market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general rather than being an indicator of credit problems with a particular issue. Given the conditions in the current debt markets and the absence of observable transactions in the secondary and new issue markets, management has determined that (a) the few observable transactions and market quotations that are available are not reliable for the purpose of obtaining fair value at September 30, 2021, (b) an income valuation approach technique (i.e. present value) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than a market approach, and (c) the CDO segment is appropriately classified within Level 3 of the valuation hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date.
25
Management uses an independent third party to prepare both the evaluations of OTTI as well as the fair value determinations for its CDO portfolio. Management believes that the valuations are adequately reflected at September 30, 2021.
The approach used by the third party to determine fair value involved several steps, which included detailed credit and structural evaluation of each piece of collateral in each bond, projection of default, recovery and prepayment/amortization probabilities for each piece of collateral in the bond, and discounted cash flow modeling. The discount rate methodology used by the third party combines a baseline current market yield for comparable corporate and structured credit products with adjustments based on evaluations of the differences found in structure and risks associated with actual and projected credit performance of each CDO being valued. Currently, the only active and liquid trading market that exists is for stand-alone trust preferred securities, with a limited market for highly-rated CDO securities that are more senior in the capital structure than the securities in the CDO portfolio. Therefore, adjustments to the baseline discount rate are also made to reflect the additional leverage found in structured instruments.
At September 30, 2021, these conditions had a minimal impact on the trust preferred bonds, although there has been a significant effect on several asset classes in the equity and fixed income markets related to COVID-19. Management will continue to review assumptions as they relate to the impact of COVID-19 during the remainder of the year.
Derivative financial instruments (Cash flow hedge) – The Corporation’s open derivative positions are interest rate swap agreements. Those classified as Level 2 open derivative positions are valued using externally developed pricing models based on observable market inputs provided by a third party and validated by management. The Corporation has considered counterparty credit risk in the valuation of its interest rate swap assets.
Impaired loans – Fair value of the collateral dependent loans is measured based on the loan’s observable market price or the fair value of the collateral (less estimated selling costs). Collateral may be real estate and/or business assets such as equipment, inventory and/or accounts receivable. The value of business equipment, inventory and accounts receivable collateral is based on either net book value of the business’ financial statements or evaluations/appraisals obtained by the Bank. If necessary, these values may be discounted based on management’s review and analysis. Appraised and reported values may be discounted based on management’s historical experience, changes in market conditions from the time of valuation, and/or management’s expertise and knowledge of the client and client’s business. Collateral dependent loans are reviewed and evaluated on at least a quarterly basis for additional individual reserve and adjusted accordingly, based on the factors identified above.
Other real estate owned – OREO included in the table below are considered impaired with specific write-downs. OREO is adjusted to fair value upon acquisition of the real estate collateral. Subsequently, OREO is carried at the lower of carrying value or fair value. The estimated fair value for OREO included in Level 3 is determined by independent market based appraisals and other available market information, less costs to sell, that may be reduced further based on market expectations or an executed sales agreement. If the fair value of the collateral deteriorates subsequent to initial recognition, the Corporation records the OREO as a nonrecurring Level 3 adjustment. Valuation techniques are consistent with those techniques applied in prior periods.
For Level 3 assets and liabilities measured at fair value on a recurring and non-recurring basis as of September 30, 2021 and December 31, 2020, the significant unobservable inputs used in the fair value measurements were as follows:
Fair Value atSeptember 30,2021
ValuationTechnique
SignificantUnobservableInputs
SignificantUnobservableInput Value
Recurring:
Investment Securities – available for sale
Discounted Cash Flow
Discount Rate
4.50%
Non-recurring:
Impaired Loans
2,002
Market Comparable Properties
Marketability Discount
10.0% - 15.0% (1) (weighted avg 10.5%)
Other Real Estate Owned
349
15.0%
Fair Value atDecember 31,2020
5.50%
1,465
10.0% - 15.0% (1) (weighted avg 12.5%)
913
For assets measured at fair value on a recurring and non-recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2021 and December 31, 2020 were as follows:
Fair Value Measurementsat September 30, 2021 Using
Quoted
Prices in
Significant
Assets/(liabilities)
Active Markets
Measured at
for Identical
Observable
Unobservable
Fair Value
Inputs
09/30/21
(Level 1)
(Level 2)
(Level 3)
Investment securities available-for-sale:
Financial derivatives
(727)
Impaired loans
Fair Value Measurementsat December 31, 2020 Using
12/31/20
(1,320)
There were no transfers of assets between any of the fair value hierarchy for the nine and three month periods ended September 30, 2021 or 2020.
The following tables show a reconciliation of the beginning and ending balances for fair valued assets measured on a recurring basis using Level 3 significant unobservable inputs for the nine and three month periods ended September 30, 2021 and 2020:
Fair Value Measurements
Using Significant Unobservable Inputs
Investment Securities
Available for Sale
Beginning balance January 1, 2021
Total losses realized/unrealized:
Included in other comprehensive income
Ending balance September 30, 2021
Fair Value MeasurementsUsing Significant Unobservable Inputs(Level 3)
Investment SecuritiesAvailable for Sale
Beginning balance July 1, 2021
16,230
Total gains realized/unrealized:
862
Beginning balance January 1, 2020
14,354
Included in other comprehensive loss
(1,594)
Ending balance September 30, 2020
12,760
Beginning balance July 1, 2020
11,952
808
There were no gains or losses included in earnings attributable to the change in realized/unrealized gains or losses related to the assets for the nine and three month periods ended September 30, 2021 or 2020.
The disclosed fair values may vary significantly between institutions based on the estimates and assumptions used in the various valuation methodologies. The derived fair values are subjective in nature and involve uncertainties and significant judgment. Therefore, they cannot be determined with precision. Changes in the assumptions could significantly impact the derived estimates of fair value. Disclosure of non-financial assets such as buildings, as well as certain financial instruments such as leases is not required. Accordingly, the aggregate fair values presented do not represent the underlying value of the Corporation.
The following tables present fair value information about financial instruments, whether or not recognized in the Consolidated Statement of Financial Condition, for which it is practicable to estimate that value. The actual carrying amounts and estimated fair values of the Corporation’s financial instruments that are included in the Consolidated Statement of Financial Condition are as follows:
Carrying
Fair
Value
Financial Assets:
Investment securities - AFS
218,472
Investment securities - HTM
42,633
Restricted bank stock
N/A
Loans, net
1,135,878
Accrued interest receivable
5,034
948
4,086
Financial Liabilities:
Deposits - non-maturity
1,270,342
Deposits - time deposits
174,152
175,298
727
Short-term borrowed funds
Long-term borrowed funds
30,980
Accrued interest payable
142
Off balance sheet financial instruments
213,625
49,442
28,170
1,150,186
6,241
907
5,334
1,194,140
228,226
231,241
Financial derivative
1,320
104,825
391
30
Note 8 – Accumulated Other Comprehensive Loss
The following table presents the changes in each component of accumulated other comprehensive loss for the 12 months ended December 31, 2020, the three months ended March 31, 2021, the three months ended June 30, 2021, and the three months ended September 30, 2021:
Investment
securities-
with OTTI
all other
Cash Flow
Pension
AFS
HTM
Hedge
Plan
SERP
Accumulated OCL, net:
Balance - January 1, 2020
(2,542)
(853)
(899)
(20,417)
(1,175)
Other comprehensive income/(loss) before reclassifications
(587)
1,291
(869)
(3,262)
(625)
(4,052)
Amounts reclassified from accumulated other comprehensive loss
(148)
(463)
584
1,049
138
Balance - December 31, 2020
(3,277)
(25)
(315)
(954)
(22,630)
(1,662)
(5,202)
(139)
(4,670)
272
Balance - March 31, 2021
(3,048)
(5,227)
(270)
(549)
(22,497)
(1,607)
1,581
2,034
(34)
938
4,519
(113)
211
Balance - June 30, 2021
(1,504)
(3,306)
(236)
(583)
(21,287)
(1,552)
550
(697)
(586)
273
Balance - September 30, 2021
(991)
(3,824)
(205)
(504)
(21,711)
(1,497)
The following tables present the components of other comprehensive income/(loss) for the nine and three month periods ended September 30, 2021 and 2020:
Before
Tax
Components of Other Comprehensive Income
(Expense)
Benefit
Net
For the nine months ended September 30, 2021
Available for sale (AFS) securities with OTTI:
Unrealized holding gains
3,274
2,397
Less: accretable yield recognized in income
(40)
3,123
(837)
Available for sale securities – all other:
Unrealized holding losses
(5,035)
1,349
(3,686)
Less: gains recognized in income
(41)
113
(5,189)
1,390
Held to maturity securities:
Less: losses recognized in income
Less: amortization recognized in income
Cash flow hedges:
(165)
Pension Plan:
Unrealized net actuarial gain
139
Less: amortization of unrecognized loss
(1,116)
299
(817)
Net pension plan liability adjustment
1,255
(336)
SERP:
Unrealized net actuarial loss
(226)
Less: amortization of prior service costs
Net SERP liability adjustment
179
32
For the nine months ended September 30, 2020
(1,249)
(914)
Net unrealized losses on investments with OTTI
(1,400)
(655)
(167)
455
Net unrealized gains on all other AFS securities
1,824
(488)
44
(809)
217
(592)
749
(201)
(1,335)
363
(895)
240
(1,074)
288
(786)
(103)
156
(36)
Components of Other Comprehensive Loss(in thousands)
BeforeTaxAmount
Tax(Expense)Benefit
For the three months ended September 30, 2021
751
(13)
701
(188)
(708)
190
(3)
42
(11)
108
(29)
(951)
254
(372)
99
(273)
(579)
155
(76)
(56)
75
(20)
(361)
Components of Other Comprehensive Income(in thousands)
For the three months ended September 30, 2020
708
(190)
518
658
(177)
(321)
86
(235)
421
(896)
(74)
90
(18)
1,891
(506)
1,385
(358)
96
(262)
2,249
(602)
(47)
(12)
2,221
(589)
The following table presents the details of amounts reclassified from accumulated other comprehensive loss for the nine and three month periods ended September 30, 2021 and 2020:
Amounts Reclassified from
Accumulated Other Comprehensive Loss
Affected Line Item in the Statement
Where Net Income is Presented
Net unrealized gains on available for sale investment securities with OTTI:
Accretable yield
Interest income on taxable investment securities
Taxes
Net of tax
Net unrealized gains on available for sale investment securities - all others:
Gains recognized
Net unrealized losses on held to maturity securities:
Amortization
(Losses)/gains recognized
(110)
(548)
Net pension plan liability adjustment:
Amortization of unrecognized loss
Other Expense
Net SERP liability adjustment:
Amortization of prior service costs
(102)
Total reclassifications for the period
(868)
(870)
Accretable Yield
Losses recognized
(31)
Other expense
(55)
(322)
Note 9 – Employee Benefit Plans
The following tables present the components of the net periodic pension plan cost for First United Corporation’s noncontributory Defined Benefit Pension Plan (the “Pension Plan”) and the Bank’s Defined Benefit Supplemental Executive Retirement Plan (“Defined Benefit SERP”) for the periods indicated:
Pension Plan
Service cost
169
Interest cost
1,066
1,219
355
406
Expected return on assets
(2,677)
(2,661)
(892)
(887)
Amortization of net actuarial loss
1,116
1,074
358
Net pension credit included in employee benefits and other expense
(378)
(199)
(126)
(66)
Defined Benefit SERP
93
Amortization of recognized loss
226
141
Amortization of prior service cost
Net Defined Benefit SERP expense included in employee benefits and other expense
508
433
170
144
The service cost component of net periodic benefit cost is included in salaries and benefits and all other components of net periodic benefit cost are included in other expense in the Consolidated Statement of Operations for the Pension Plan and the Defined Benefit SERP.
The Pension Plan is a noncontributory defined benefit pension plan that covers our employees who were hired prior to the freeze and others who were grandfathered into the plan. The benefits are based on years of service and the employees’ compensation during the last five years of employment.
Effective April 30, 2010, the Pension Plan was amended, resulting in a “soft freeze”, the effect of which prohibits new entrants into the plan and ceases crediting of additional years of service after that date. Effective January 1, 2013, the Pension Plan was amended to unfreeze it for those employees for whom the sum of their (a) ages, at their closest birthday plus (b) years of service for vesting purposes equals 80 or greater. The “soft freeze” continues to apply to all other plan participants. Pension benefits for these participants are managed through discretionary contributions to the First United Corporation 401(k) Profit Sharing Plan (the “401(k) Plan”).
The Bank established the Defined Benefit SERP in 2001 as an unfunded supplemental executive retirement plan. The Defined Benefit SERP is available only to a select group of management or highly compensated employees to provide supplemental retirement benefits in excess of limits imposed on qualified plans by federal tax law. Concurrent with the establishment of the Defined Benefit SERP, the Bank acquired Bank Owned Life Insurance (“BOLI”) policies on the senior management personnel and officers of the Bank. The benefits resulting from the favorable tax treatment accorded the earnings on the BOLI policies are intended to provide a source of funds for the future payment of the Defined Benefit SERP benefits as well as other employee benefit costs.
The benefit obligation activity for both the Pension Plan and the Defined Benefit SERP was calculated using an actuarial measurement date of January 1. Plan assets and the benefit obligations were calculated using an actuarial measurement date of December 31.
The Corporation will assess the need for future annual contributions to the pension plan based upon its funded status and an evaluation of the future benefits to be provided thereunder. No contributions were made to the Pension Plan during the first nine months of 2021 and a contribution of $1.0 million was made during the first nine months of 2020. The Corporation expects to fund the annual projected benefit payments for the Defined Benefit SERP from operations.
On January 9, 2015, First United Corporation and members of management who do not participate in the Defined Benefit SERP entered into participation agreements under the Deferred Compensation Plan, each styled as a Defined Contribution SERP Agreement (the “Contribution Agreement”). Pursuant to each Contribution Agreement, First United Corporation agreed, for each Plan Year (as defined in the Deferred Compensation Plan) in which it determines that it has been Profitable (as defined in the Contribution Agreement), to make a discretionary contribution to the participant’s Employer Account in an amount equal to 15% of the participant’s base salary level for such Plan Year, with the first Plan Year being the year ending December 31, 2015. The Contribution Agreement provides that the participant will become 100% vested in the amount maintained in his or her Employer Account upon the earliest to occur of the following events: (a) Normal Retirement (as defined in the Contribution Agreement); (b) Separation from Service (as defined in the Contribution Agreement) following a Change of Control (as defined in the Deferred Compensation Plan) and subsequent Triggering Event (as defined in the Contribution Agreement); (c) Separation from Service due to a Disability (as defined in the Contribution Agreement); (d) with respect to a particular award of Employer Contribution Credits, the participant’s completion of 2 consecutive Years of Service (as defined in the Contribution Agreement) immediately following the Plan Year for which such award was made; or (e) death. Notwithstanding the foregoing, however, a participant will lose entitlement to the amount maintained in his or her Employer Account in the event employment is terminated for Cause (as defined in the Contribution Agreement). In addition, the Contribution Agreement conditions entitlement to the amounts held in the Employer Account on the participant (1) refraining from engaging in Competitive Employment (as defined in the Contribution Agreement) for three years following his or her Separation from Service, (2) refraining from injurious disclosure of confidential information concerning the Corporation, and (3) remaining available, at the First United Corporation’s reasonable request, to provide at least six hours of transition services per month for 12 months following his or her Separation from Service (except in the case of death or Disability), except that only item (2) will apply in the event of a Separation from Service following a Change of Control and subsequent Triggering Event.
In January 2019, the Board approved discretionary contributions to four participants totaling $123,179. The contributions had a two year vesting period that ended on December 31, 2020. In January 2020, the Board of Directors of First United Corporation approved discretionary contributions to four participants totaling $126,058. The Corporation recorded $47,271 of related compensation expense for the first nine months of 2021 and 2020. The Corporation recorded $15,757 for the third quarters of 2021 and 2020 related to these contributions. In January 2021, the Board of Directors approved discretionary contributions to three participants totaling $101,257. The Corporation recorded $37,971 of related compensation expense for the first nine months of 2021 and $12,657 for the third quarter of 2021 related to these contributions. Each discretionary contribution has a two year vesting period.
Note 10 - Equity Compensation Plan Information
At the 2018 Annual Meeting of Shareholders, First United Corporation’s shareholders approved the First United Corporation 2018 Equity Compensation Plan (the “Equity Plan”) which authorizes the issuance of up to 325,000 shares of common stock to employees, directors and qualifying consultants pursuant to stock options, stock appreciation rights, stock awards, dividend equivalents, and other stock-based awards.
The Corporation complies with the provisions of ASC Topic 718, Compensation-Stock Compensation, in measuring and disclosing stock compensation cost. The measurement objective in ASC Paragraph 718-10-30-6 requires public companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. The cost is recognized in expense over the period in which an employee is required to provide service in exchange for the award (the vesting period).
Pursuant to First United Corporation’s director compensation policy, each director receives an annual retainer of 1,000 shares of First United Corporation common stock, plus $10,000 to be paid, at the director’s election, in cash or additional shares of common stock. In June 2020, a total of 13,160 fully vested shares of common stock were issued to directors, which had a grant date fair market value of $14.52 per share. In July 2020, a total of 916 fully vested shares of common stock were issued to a new director, which had a grant date fair market value of $11.22 per share. In May 2021, a total of 12,726 fully vested shares of common stock were issued to directors, which had a grant date fair value of $18.50 per share. Director stock compensation expense was $191,717
for the nine months ended September 30, 2021 and $158,795 for the nine months ended September 30, 2020. Director stock compensation expense was $58,857 for the three months ended September 30, 2021 and $52,114 for the three months ended September 30, 2020.
Restricted Stock Units
On March 26, 2020, pursuant to the Corporation’s Long Term Incentive Plan (the "LTIP"), which is a sub-plan of the Equity Plan, the Compensation Committee of First United Corporation’s Board of Directors (the "Committee") granted RSUs to the Corporation’s principal executive officer, its principal financial officer, and certain of its other executive officers. An RSU contemplates the issuance of shares of common stock of First United Corporation if and when the RSU vests.
The RSUs granted to each of the foregoing officers consist of (a) a performance vesting award for a three year performance period ending December 31, 2021, (b) a performance vesting award for a three year performance period ending December 31, 2022, and (c) a time-vesting award that will vest ratably over a three year period beginning on March 26, 2021. Target performance levels were set based on the annual budget which supports the Corporation’s long-term objective of achieving high performance as compared to peers. Threshold performance is the minimum level of acceptable performance as defined by the Committee and maximum performance represented a level potentially achievable under ideal circumstances. Achievement of the threshold performance level would result in each executive participant earning a payout at 50% of his or her respective target award opportunity. Achievement of the target performance level would result in the executive participant earning the target award and achievement at or above the maximum performance level would result in the executive participant earning 150% of the target opportunity. Actual results for any goal that falls between performance levels would be interpolated to calculate a proportionate award. For the performance period ending December 31, 2021, the RSUs’ performance goal is based on earnings per share for the year ending December 31, 2021. For the performance period ending December 31, 2022, the RSUs’ performance goals are based on earnings per share for the year ending December 31, 2022 and growth in tangible book value per share during the performance period. The threshold, target and maximum performance levels for these grants will be disclosed pursuant to Item 402 of Regulation S-K following the conclusion of the applicable performance period.
To receive any shares under an RSU, a grantee must be employed by the Corporation or one of its subsidiaries on the applicable vesting date, except that a grantee whose employment terminates prior to such vesting date due to death, disability or retirement will be entitled to a pro-rated portion of the shares subject to the RSUs, assuming that, in the case of performance-vesting RSUs, the performance goals had been met at their "target" levels.
In the first quarter of 2020, RSUs relating to 19,934 performance vesting shares and 5,070 time vesting shares (target level) were granted, which had a grant date fair market value of $12.54 per share of common stock underlying each RSU. On March 26, 2021, 1,690 of the 5,070 time vesting shares were issued to participants. Stock compensation expense was $78,381 and $93,727 for the first nine months of 2021 and 2020, respectively. Stock compensation expense was $26,127 and $31,243 for the three month periods ended September 30, 2021 and 2020. Unrecognized compensation expense at September 30, 2021 related to unvested RSUs was $110,173.
In May 2021, RSUs relating to 7,389 performance vesting shares and 3,693 time vesting shares (target level) were granted, which had a grant date fair market value of $17.93 per share of common stock underlying each RSU. The performance period for the performance-vesting RSUs is the three year period ending December 31, 2023. The time-vesting RSUs will vest ratably over a three year period beginning on May 5, 2022. Stock compensation expense was $27,619 for the nine month periods ended September 30, 2021. Stock compensation expense was $16,571 for the three months ended September 30, 2021. Unrecognized compensation expense as of September 30, 2021 related to unvested units was $171,235.
Note 11 – Derivative Financial Instruments
As a part of managing interest rate risk, the Bank entered into interest rate swap agreements to modify the re-pricing characteristics of certain interest-bearing liabilities. The Corporation has designated these interest rate swap agreements as cash flow hedges under the guidance of ASC Subtopic 815-30, Derivatives and Hedging – Cash Flow Hedges. Cash flow hedges have the effective portion of changes in the fair value of the derivative, net of taxes, recorded in net accumulated other comprehensive loss.
In March 2016, the Corporation entered into four interest rate swap contracts totaling $30.0 million notional amount, hedging future cash flows associated with floating rate trust preferred debt. These contracts included a three year $5.0 million contract that matured on September 17, 2019, a five year $5.0 million contract that matured on March 17, 2021, a seven year $5.0 million contract that matures on March 17, 2023 and a 10 year $15.0 million contract that matures on March 17, 2026. As of September 30, 2021, $20.0 million notional amount remains.
The fair value of the interest rate swap contracts was $(727) thousand and $(1.3) million at September 30, 2021 and December 31, 2020, respectively.
For the nine months ended September 30, 2021, the Corporation recorded an increase in the value of the derivatives of $594 thousand and the related deferred tax of $62 thousand in net accumulated other comprehensive loss to reflect the effective portion of cash flow hedges. ASC Subtopic 815-30 requires the net accumulated other comprehensive loss to be reclassified to earnings if the hedge becomes ineffective or is terminated. There was no hedge ineffectiveness recorded for the six months ended September 30, 2021. The Corporation does not expect any material losses relating to these hedges to be reclassified into earnings within the next 12 months.
Interest rate swap agreements are entered into with counterparties that meet established credit standards and the Corporation believes that the credit risk inherent in these contracts is not significant as of September 30, 2021.
The table below discloses the impact of derivative financial instruments on the Corporation’s Consolidated Financial Statements for the nine and three month periods ended September 30, 2021 and 2020.
Derivative in Cash Flow Hedging Relationships
Amount of gain or
(loss) recognized in
income or derivative
(loss) reclassified from
(ineffective portion
accumulated OCI into
and amount excluded
OCI on derivative
income (effective
from effectiveness
(effective portion)
portion) (a)
testing) (b)
Interest rate contracts:
Nine months ended:
Three months ended:
Notes:
Note 12 – Revenue Recognition
ASC Topic 606- Revenue from Contracts with Customers, does not apply to revenue associated with financial instruments, including revenue from loans and securities. ASC Topic 606 does apply to noninterest revenue streams, such as wealth management, including trust and brokerage services, service charges on deposit accounts, interchange fee income – debit card income, and gains/losses on OREO sales. Noninterest revenue streams that are within the scope of ASC Topic 606 are discussed below.
Wealth Management
Trust and asset management income is primarily comprised of fees earned from the management and administration of trusts and other customer assets. The Corporation’s performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based upon the month-end market value of the assets under management and the applicable fee rate. Payment is generally received a few days after month end through a direct charge to customers’ accounts. Optional services such as real estate
41
sales and tax return preparation services are also available to existing trust and asset management customers. The Corporation’s performance obligation for these transactional-based services is generally satisfied, and related revenue recognized, at a point in time (i.e., as incurred). Payment is received shortly after services are rendered.
Service Charges on Deposit Accounts
Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. The Corporation’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Corporation’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.
Interchange Fees – Debit and Credit Card Income
Fees, exchange, and other service charges are primarily comprised of debit and credit card income, ATM fees, merchant services income, and other service charges. Debit and credit card income is primarily comprised of interchange fees earned whenever the Corporation’s debit cards are processed through card payment networks such as Visa. ATM fees are primarily generated when a Corporation cardholder uses a non-Corporation ATM or a non-Corporation cardholder uses a Corporation ATM. Merchant services income mainly represents fees charged to merchants to process their debit and credit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, bill pay service, cashier’s checks, and other services. The Corporation’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month.
The following presents noninterest income, segregated by revenue streams that are within and outside the scope of ASC Topic 606, for the nine and three month periods ended September 30, 2021 and September 30, 2020:
Noninterest income
In-scope of Topic 606:
Noninterest income (in-scope of Topic 606)
11,874
10,076
4,002
3,485
Noninterest income (out-of-scope of Topic 606)
1,712
1,335
521
493
Total Noninterest Income
Note 13 – Regulatory Capital Requirements
The following table presents our capital ratios for the nine months ended September 30, 2021.
Required forCapitalAdequacyPurposes
Requiredto be WellCapitalized
Total Capital (to risk-weighted assets)
Consolidated
15.51
%
16.08
8.00
10.00
First United Bank & Trust
14.64
15.50
Tier 1 Capital (to risk-weighted assets)
14.26
14.83
6.00
13.39
14.25
Common Equity Tier 1 Capital (to risk-weighted assets)
12.15
12.61
4.50
6.50
Tier 1 Capital (to average assets)
10.33
10.36
4.00
5.00
9.59
9.81
As of September 30, 2021, the Bank and the Corporation were considered “well capitalized” under the regulatory framework for prompt corrective action. The ratios at the Bank and Consolidated levels were negatively impacted primarily due to the increased funding from the Bank to the holding company related to the settlement expenses and the stock repurchase program. The decrease at the Corporation level is related to the stock repurchase of 400,000 shares of common stock and the reduction to capital.
First United Corporation’s stock repurchase plan was initially adopted effective January 27, 2021, which authorized the repurchase of up to 400,000 shares of common stock of First United Corporation. The plan authorizes the repurchases to be conducted through open market or private transactions at such times and in such amounts per transaction as the Chairman and Chief Executive Officer of First United Corporation determines to be appropriate.
On April 16, 2021, First United Corporation entered into a Stock Purchase Agreement with Driver Opportunity Partners I LP (“Driver Partners”) under which, pursuant to the foregoing stock repurchase program. First United Corporation agreed to repurchase 360,737 shares of its common stock held by Driver Partners at a purchase price of $18.00 per share.
Note 14 – Assets and Liabilities Subject to Enforceable Master Netting Arrangements
Interest Rate Swap Agreements
The Corporation has entered into interest rate swap agreements to modify the re-pricing characteristics of certain interest-bearing liabilities as a part of managing interest rate risk. The swap agreements have been designated as cash flow hedges, and accordingly, the fair value of the interest rate swap contracts is reported in Other Assets or Other Liabilities on the Consolidated Statement of Financial Condition. The swap agreements were entered into with a third-party financial institution. The Corporation is party to master netting arrangements with its financial institution counterparty; however, the Corporation does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Collateral, in the form of cash and investment securities, are pledged by the Corporation as the counterparty with net liability positions in accordance with contract thresholds. See Note 12 to the Consolidated Financial Statements for more information.
Securities Sold Under Agreements to Repurchase (“Repurchase Agreements”)
The Bank enters into agreements under which it sells interests in U.S. government agency securities to certain customers subject to an obligation to repurchase, and on the part of the customers to resell, such interests. Under these arrangements, the Bank may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the
Bank to repurchase the assets. As a result, these repurchase agreements are accounted for as collateralized financing arrangements (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability in the Consolidated Statement of Financial Condition, while the securities underlying the repurchase agreements remain in the respective investment securities asset accounts. There is no offsetting or netting of the investment securities assets with the repurchase agreement liabilities. In addition, as the Bank does not enter into reverse repurchase agreements, there is no such offsetting to be done with the repurchase agreements. The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral would be used to settle the fair value of the repurchase agreement should the Bank be in default (i.e. fails to repurchase the U.S. securities on the maturity date of the agreement). The investment security collateral, maintained at 102% of the borrowing, is held by a third party financial institution in the counterparty’s custodial account.
The following table presents the assets and liabilities subject to an enforceable master netting arrangement or repurchase agreements at September 30, 2021 and December 31, 2020.
Net Amounts
Gross Amounts
Gross
of (Assets)/
Not Offset in the
Amounts of
Amounts
Liabilities
Statement of Condition
Recognized
Offset in the
Presented in
Cash
(Assets)/
Statement of
the Statement
Financial
Collateral
Condition
of Condition
Instruments
Pledged
2,000
Repurchase Agreements
(72,396)
(49,160)
Note 15 – Adoption of New Accounting Standards and Effects of New Accounting Pronouncements
In June 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments- Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchases financial assets with credit deterioration since their origination. The new model referred to as current expected credit losses (“CECL”) model, will apply to: (a) financial assets subject to credit losses and measured at amortized cost; and (b) certain off-balance sheet credit exposures. This includes loans, held to maturity debt securities, loan commitments, financial guarantees and net investments in leases as well as reinsurance and trade receivables. The estimate of expected credit losses should consider historical information, current information, and supportable forecasts, including estimates of prepayments. ASU 2016-13 was originally effective for SEC filers for annual periods beginning after December 15, 2019, and interim periods within those annual periods. In November 2019, the FASB approved a delay of the required implementation date of ASU No. 2016-13 for smaller reporting companies, as defined by the Securities and Exchange Commission, including the Corporation, resulting in a required implementation date for the Corporation of January 1, 2023.
Management has formed a focus group consisting of multiple members from areas, including credit, finance, loan servicing, reporting, and information systems. The Corporation is completing its data and model validation analyses, with parallel processing of our existing allowance for loan losses model with the CECL model to follow. The Corporation is currently evaluating the provisions of ASU No. 2016-13 to determine the potential impact the new standard will have on the financial condition or results of operations.
In March 2020, the FASB issued ASU No. 2020-04, “Reference Rate Reform (Topic 848).” The ASU provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendment only applies to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of the reference rate reform. The ASU is effective as of March 12, 2020 through December 31, 2022. The Corporation is in the process of evaluating the impact of this standard on the loan portfolio, investment portfolio, long term debt and interest rate swaps, but believes that its adoption will not have a material impact on the Corporation’s financial condition or results of operations.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
INTRODUCTION
The following discussion and analysis is intended as a review of material changes in and significant factors affecting the financial condition and results of operations of First United Corporation and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto contained in Item 1 of Part I of this report, as well as the audited consolidated financial statements and related notes included in First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020.
Unless the context clearly suggests otherwise, references in this report to “us”, “we”, “our”, and “the Corporation” are to First United Corporation and its consolidated subsidiaries.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements do not represent historical facts, but are statements about management’s beliefs, plans and objectives about the future, as well as its assumptions and judgments concerning such beliefs, plans and objectives. These statements are evidenced by terms such as "anticipate," "estimate," "should," "expect," "believe," "intend," and similar expressions. Although these statements reflect management’s good faith beliefs and projections, they are not guarantees of future performance and they may not prove true. The beliefs, plans and objectives on which forward-looking statements are based involve risks and uncertainties that could cause actual results to differ materially from those addressed in the forward-looking statements. For a discussion of these risks and uncertainties, see the section of the periodic reports that First United Corporation files with the Securities and Exchange Commission entitled "Risk Factors", including the risk factor set forth in First United Corporation’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2020 entitled, “The outbreak of the recent coronavirus (‘COVID-19’), or an outbreak of another highly infectious or contagious disease, could adversely affect the Corporation’s business, financial condition and results of operations.” and any updates thereto that might be contained in subsequent reports filed by First United Corporation. The risks and uncertainties associated with the COVID-19 pandemic and its impact on the Corporation will depend on, among other things, the length of time that the pandemic continues; the duration of the potential imposition of further restrictions on travel in the future; the effect of the pandemic on the global, national, and local economies and on the businesses of our borrowers and their ability to make payments on their obligations; the remedial actions and stimulus measures adopted by federal, state, and local governments; and the inability of employees to work due to illness, quarantine, or government mandates.
First United Corporation is a Maryland corporation chartered in 1985 and a bank holding company registered with the Board of Governors of the Federal Reserve System (the “FRB”) under the Bank Holding Company Act of 1956, as amended. The Corporation’s primary business is serving as the parent company of First United Bank & Trust, a Maryland trust company (the “Bank”), First United Statutory Trust I (“Trust I”) and First United Statutory Trust II (“Trust II” and together with Trust I, the “Trusts”), both Connecticut statutory business trusts. The Trusts were formed for the purpose of selling trust preferred securities that qualified as Tier 1 capital. The Bank has two consumer finance company subsidiaries - OakFirst Loan Center, Inc., a West Virginia corporation, and OakFirst Loan Center, LLC, a Maryland limited liability company - and two subsidiaries that it uses to hold real estate acquired through foreclosure or by deed in lieu of foreclosure - First OREO Trust, a Maryland statutory trust, and FUBT OREO I, LLC, a Maryland limited liability company. In addition, the Bank owns 99.9% of the limited partnership interests in Liberty Mews Limited Partnership, a Maryland limited partnership formed for the purpose of acquiring, developing and operating low-income housing units in Garrett County, Maryland, and a 99.9% non-voting membership interest in MCC FUBT Fund, LC, an Ohio limited liability company formed for the purpose of acquiring, developing and operating low-income housing units in Allegany County, Maryland.
At September 30, 2021, the Corporation’s total assets were $1.7 billion, net loans were $1.1 billion, and deposits were $1.4 billion. Shareholders’ equity at September 30, 2021 was $133.8 million.
The Corporation maintains an Internet site at www.mybank.com on which it makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.
COVID-19
Congress, the President, and the FRB have taken several actions designed to cushion the economic fallout. Most notably, the Coronavirus Aid, Relief and Economic Security Act (the “CARES Act”), a $2 trillion legislative package, was signed into law at the end of March 2020. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors, such as by providing funds for loans under the Paycheck Protection Program (the “PPP”) administered by the Small Business Administration (the “SBA”). Section 4013 of the CARES Act, “Temporary Relief from Troubled Debt Restructurings,” provides banks the option to temporarily suspend certain requirements under U.S. GAAP related to trouble debt restructurings (“TDRs”) for a limited period of time to account for the effects of COVID-19. Additionally, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (the “Economic Aid Act”) was enacted on December 27, 2020 and provided for a second round of PPP loans. The PPP Extension Act of 2021, which was enacted on March 30, 2021, extended the PPP application deadline to May 31, 2021 and provided the SBA with additional time to process applications through June 30, 2021. Also, the Consolidated Appropriations Act (the “CAA”) passed on December 27, 2020, which, among other things, extended the provisions of Section 4013 of the CARES Act to January 1, 2022. The Federal Reserve’s actions have included cutting the federal funds rate 150 basis points and targeting a 0 to 25 basis point rate. In addition to the general impact of the COVID-19 pandemic, certain provisions of the CARES Act as well as other legislative and regulatory relief efforts are expected to have a material impact on the Corporation’s operations.
During 2020, 290 PPP loans, totaling $34.5 million were forgiven, resulting in 885 loans with a remaining balance of $114.0 million at December 31, 2020. During the first nine months of 2021, an additional 1,384 PPP loans originated under all three rounds, with an aggregate principal balance of $150.0 million, were forgiven, resulting in 371 PPP loans with a total remaining balance of $30.3 million at September 30, 2021.
Liquidity Sources
Management has reviewed its Liquidity Contingency Funding Plan in preparation of funding needs as it relates to the COVID-19 pandemic. As of September 30, 2021, the Corporation had approximately $130.0 million in unsecured lines of credit with its correspondent banks, $1.0 million with the Federal Reserve Discount Window, and approximately $189.0 million of secured borrowings with the Federal Home Loan Bank of Atlanta (“FHLB”). Additionally, the Corporation has access to the brokered certificates of deposit market.
The Corporation was eligible to access the FRB’s Paycheck Protection Program Liquidity Facility (“PPPLF”), a source providing funding using PPP loans as collateral at 100% value. The Corporation did not use this program, which expired on July 31, 2021.
Capital
The Corporation’s and the Bank’s capital ratios are strong, and both institutions are considered to be well-capitalized by applicable regulatory measures.
SELECTED FINANCIAL DATA
The following table sets forth certain selected financial data for the nine month periods ended September 30, 2021 and 2020 and is qualified in its entirety by the detailed information and unaudited financial statements, including the notes thereto, included elsewhere in this quarterly report.
As of the nine months ended
Per Share Data
Basic net income per common share (1) - as reported
Basic net income per common share (1) - non-GAAP
2.45
Diluted net income per common share (1) - as reported
Diluted net income per common share (1) - non-GAAP
Basic book value per common share (1) - as reported
20.22
18.63
Diluted book value per common share (1) - as reported
20.19
18.62
Significant Ratios:
Return on Average Assets (a) (1) - as reported
0.92
0.79
Settlement and FHLB expenses, net of income tax
0.33
Adjusted Return on Average Assets (a) (1) (non-GAAP)
1.25
Return on Average Equity (a) (1) - as reported
12.45
9.87
4.43
Adjusted Return on Average Equity (a) (1) (non-GAAP)
16.88
Average Equity to Average Assets
10.70
10.61
Capital Ratios:
Consolidated Total Capital (to risk weighted assets)
16.14
Consolidated Tier 1 Capital (to risk weighted assets)
14.89
Consolidated Common Equity Tier 1 Capital (to risk weighted assets)
12.59
Consolidated Tier 1 Capital (to average assets)
10.37
(1) See reconciliation of this non-GAAP financial measure provided elsewhere herein associated with settlement expenses incurred during the first quarter of 2021 and prepayment penalties incurred during the third quarter of 2021.
Note: (a) Annualized
RESULTS OF OPERATIONS
Overview
Consolidated net income for the nine months ended September 30, 2021 was $12.2 million, inclusive of litigation settlement expenses of $3.3 million and FHLB prepayment penalties of $2.4 million, compared to $9.3 million for the nine months ended September 30, 2020. Basic and diluted net income per share for the first nine months of 2021 were both $1.81, a 37.1% increase when compared to basic and diluted net income per share of $1.32 for the same period of 2020.
The increase in earnings for the first nine months of 2021 was attributable to an increase in net interest income of $2.2 million, reduced provision expense of $4.9 million and an increase in other operating income, including gains on sales of mortgage loans and securities’ of $1.3 million. These changes were partially offset by an increase in other operating expenses of $4.0 million, inclusive of the $3.3 million in litigation settlement expenses and the $2.4 million FHLB prepayment penalty.
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Net interest income, on a non-GAAP, FTE basis, increased by $2.2 million (5.9%) during the nine months ended September 30, 2021 when compared to the nine months ended September 30, 2020 driven by a $2.7 million (36.5%) decrease in interest expense, partially offset by a decrease in interest income of $0.5 million. The decrease in interest expense resulted from proactive efforts to reduce the cost of funds by further reductions to rates on deposit accounts throughout 2021, the runoff of balances in the time deposits of $100,000 or more, including brokered deposits, and the expiration of empowered rates on money market accounts. The prepayment of the FHLB advances in the third quarter should significantly reduce interest expense in the fourth quarter and future years. The net interest margin, on an FTE basis, declined to 3.21% for the nine months ended September 30, 2021 compared to 3.43% for the same period of 2020. Excluding the average balance of PPP loans of $100.6 million and interest and fees of $4.0 million, the net interest margin for the nine months ended September 2021 was 3.07%.
Other operating income, including net gains on sales of mortgage loans and sales of investment securities, increased $1.3 million for the nine months ended September 30, 2021 when compared to the nine months ended September 30, 2020. Gains on the sale of mortgage loans to the secondary market decreased $0.5 million due to refinancing activity occurring at a slower pace than the pace experienced in 2020. Trust and brokerage income increased $1.2 million year-over-year due to growth in new client relationships and assets under management. Debit card income increased $0.6 million for the nine months ended September 30, 2021 when compared to the same period of 2020 due to growth in deposit relationships and increased customer usage of our electronic services. Other income increased $0.5 million, due primarily to the receipt of insurance proceeds related to litigation claims recorded in the first quarter of 2021. Service charge income remained stable when comparing the first nine months of 2021 to the same time period of 2020.
Other operating expenses increased $4.0 million for the nine months ended September 30, 2021 when compared to the same period of 2020. This increase was driven by $3.3 million of litigation settlement expenses recorded in the first quarter of 2021 and a $2.4 million penalty on the prepayment of $70.0 million FHLB advances in the third quarter of 2021. Salaries and benefits remained stable when compared to the first nine months of 2020, as increases in salaries, incentive pay and stock compensation were offset by decreases in pension and life and health insurance costs, a $0.3 million offset in salary expense from deferred loan origination costs primarily attributable to PPP loans and $0.1 million of reduced executive equity compensation due to a timing difference in long-term incentive grants. Federal Deposit Insurance Corporation premiums increased slightly by $0.2 million due to credits received on quarterly assessments in 2020. Equipment, occupancy and technology expenses decreased $0.9 million when compared to the first nine months of 2020 as we began to realize cost savings from our core processor related to a new contract negotiated in the fourth quarter of 2020. Other real estate owned (“OREO”) expenses were a net credit in the first nine months of 2021 due to $0.8 million in gains attributable to the sale of OREO properties. Professional services increased $0.8 million as a result of increased legal and professional fees related to shareholder litigation early in 2021, partially offset by decreased investor relations expenses.
The provision for loan losses was $0.1 million for the nine months ended September 30, 2021 and $5.0 million for the nine months ended September 30, 2020. The higher provision expense recorded in the first nine months of 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic. Net recoveries of $0.4 million were recorded for the nine months ended September 30, 2021, compared to net charge offs of $1.3 million for the same period of 2020. The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.46% at September 30, 2021 compared to 1.36% at September 30, 2020 and 1.41% at December 31, 2020. The ALL to loans outstanding, excluding PPP loan balances of $30.3 million and $148.9 million, was 1.49% at September 30, 2021 and 1.55% at September 30, 2020 and December 31, 2020, non-GAAP.
Consolidated net income was $4.4 million for the third quarter of 2021 compared to $5.0 million for the third quarter of 2020. Basic and diluted net income per share for the third quarter of 2021 were both $0.66, a 5.7% decrease when compared to basic and diluted net income per share of $0.70 for the third quarter of 2020. The decline in earnings in the third quarter of 2021 was due to an increase in net interest income, a credit to provision expense, and increased wealth management income, offset by increased non-interest expenses, including the prepayment penalty of $2.4 million on FHLB borrowings.
Net interest income, on a non-GAAP, FTE basis, increased by $1.7 million (14.2%) for the third quarter 2021 when compared to the third quarter of 2020. This increase resulted from an increase in interest income of $0.7 million and a decrease in interest expense of $1.1 million. The increase in interest income on loans was a result of increased interest on consumer loans related to the purchase of a loan pool in the second quarter as well as an increase in the unearned fees related to the PPP forgiveness during
the quarter. The reduction of interest expense resulted from the further reduction of deposit rates early in the third quarter and the declining balances in the higher cost CD portfolio. The prepayment of the FHLB advances should positively impact interest expense for the remainder of 2021 and future years. The weighted rate on the $70.0 million FHLB long-term borrowings was 1.90%. The net interest margin for the third quarter of 2021 was 3.38%, compared to 3.12% for the third quarter of 2020. Excluding the average balance of PPP loans of $48.5 million and interest and fees of $1.4 million, the net interest margin for the third quarter of 2021 was 3.12%.
Other operating income, including gains, for the third quarter of 2021 decreased by approximately $0.6 million when compared to the same period of 2020. Service charge income remained stable during the third quarter of 2021 when compared to the third quarter of 2020. Trust and brokerage income increased $0.3 million due to increased production and market values on assets under management. Net gains decreased $1.1 million when comparing the third quarter of 2021 to the third quarter of 2020. This decrease was due to the slowing of refinancing activity in the mortgage portfolio, which resulted in less gains on sales as well as no sales activity in the investment portfolio during the third quarter of 2021. Bank Owned Life Insurance (“BOLI”) income decreased by $0.1 million when comparing the third quarter of 2021 to the third quarter of 2020 due to the receipt of policy proceeds in the third quarter of 2020.
Other operating expenses increased by $2.5 million when comparing the third quarter of 2021 to the third quarter of 2020. This increase was driven by an increase in salaries and benefits of $0.3 million related to a reduction in deferred loan origination costs in 2021 (primarily related to PPP activities) and the $2.4 million prepayment penalties incurred in connection with the prepayment of the FHLB advances. As noted above, the prepayment was a strategic decision to use $70.0 million of cash for the purpose of reducing the cost of funds for the remainder of 2021 and future years. Occupancy, equipment and technology service expenses were stable during the third quarter of 2021 when compared to the third quarter of 2020. Investor relations and professional services costs were also stable during the third quarter of 2021 when compared to the third quarter of 2020. Other miscellaneous expenses, such as Visa processing fees, contract labor, schools and seminars, dues and licenses, in-house training, trust department expense, debit card expense and other personnel related expenses, declined. The decreases were offset by increases in marketing, contributions and consulting expenses.
The effective income tax rates as a percentage of income for the nine-month periods ended September 30, 2021 and 2020 were 24.9% and 22.1%, respectively. The increase in the tax rate for the first nine months of 2021 was primarily due to the reduction in tax exempt income as well as the reduction in tax credits related to the expiration of a low-income housing tax credit in June 2021. A new 2021 investment in low-income housing is expected to provide tax benefits in 2022 and beyond.
Non-GAAP Financial Measures
The Corporation believes that certain non-GAAP financial measures are meaningful because they reflect adjustments commonly made by management, investors, regulators and analysts to evaluate performance trends and the adequacy of common equity. This non-GAAP disclosure has limitations as an analytical tool, should not be viewed as a substitute for performance and financial condition measures determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.
The following table presents a reconciliation of net income and basic and diluted earnings per share (as reported) to adjusted net income and adjusted basic and diluted earnings per share excluding settlement and prepayment penalty expense:
Net income - as reported
Adjustments:
FHLB penalty
Income tax effect of adjustment
(1,313)
Adjusted net income (non-GAAP)
16,576
Basic and Diluted earnings per share - as reported
0.47
0.35
(0.18)
Adjusted basic and diluted earnings per share (non-GAAP)
The following table presents a reconciliation of basic and diluted book value per share (as reported) to adjusted basic and diluted book value per share excluding settlement expense:
Basic book value per share
Equity
Outstanding shares
6,618
6,984
Diluted book value per share
6,625
6,989
Net Interest Income
Net interest income is our largest source of operating revenue. Net interest income is the difference between the interest that we earn on our interest-earning assets and the interest expense we incur on our interest-bearing liabilities. For analytical and discussion purposes, net interest income is adjusted to a FTE basis to facilitate performance comparisons between taxable and tax-exempt assets by increasing tax-exempt income by an amount equal to the federal income taxes that would have been paid if this income were taxable at the statutorily applicable rate. This is a non-GAAP disclosure and management believes it is not materially different than the corresponding GAAP disclosure.
The tables below summarizes net interest income for the nine and three month periods ended September 30, 2021 and 2020.
GAAP
Non-GAAP - FTE
(dollars in thousands)
44,113
44,651
39,329
37,123
Net interest margin %
3.16
3.37
3.21
3.43
15,142
14,481
13,857
12,130
3.32
3.06
3.38
3.12
The following tables set forth the average balances, net interest income and expense, and average yields and rates of our interest-earning assets and interest-bearing liabilities for the nine and three month periods ended September 30, 2021 and 2020:
Balance
Interest
Yield/Rate
1,179,205
39,562
4.49
1,136,473
39,231
4.61
Investment Securities:
267,899
1.43
197,186
Non taxable
25,487
1,448
7.60
26,335
7.34
293,386
4,312
1.96
223,521
5,060
3.02
Federal funds sold
156,504
0.11
79,228
182
0.31
Interest-bearing deposits with other banks
3,419
0.06
889
1.37
Other interest earning assets
3,622
4.07
4,451
5.06
Total earning assets
1,636,136
3.60
1,444,562
4.13
(16,924)
(15,049)
Non-earning assets
154,464
146,213
1,773,676
1,575,726
Interest-bearing demand deposits
211,005
460
0.29
177,848
531
0.40
Interest-bearing money markets
340,322
367
0.14
305,714
1,207
0.53
Savings deposits
218,605
0.04
172,735
0.10
Time deposits:
Less than $100k
100,777
979
1.30
111,757
1,310
1.57
$100k or more
108,195
1,008
129,290
1,813
1.87
55,151
0.16
43,895
0.21
92,980
2.65
3.26
Total interest-bearing liabilities
1,127,035
0.57
1,042,168
0.96
Non-interest-bearing deposits
488,870
362,547
Other liabilities
26,850
45,572
Shareholders’ Equity
130,921
125,439
Net interest income and spread
3.03
3.17
Net interest margin
Net interest income, on a non-GAAP, FTE basis, increased by $2.2 million (5.9%) during the nine months ended September 30, 2021 when compared to the nine months ended September 30, 2020 driven by a $2.7 million (36.5%) decrease in interest expense, partially offset by a decrease in interest income of $0.5 million. The decrease in interest expense resulted from proactive efforts to reduce the cost of funds by further reductions to rates on deposit accounts throughout 2021, the runoff of balances in the time deposits of $100,000 or more, including brokered deposits, and the expiration of empowered rates on money market accounts. The prepayment of the FHLB advances in the third quarter should significantly reduce interest expense in the fourth quarter and future years. The net interest margin, on an FTE basis, declined to 3.21% for the nine months ended September 30, 2021 compared to 3.43% for the same period of 2020. Excluding the average balances of PPP loans of $100.6 million and interest and fees of $4.0 million, the net interest margin for the nine months ended September 2021 was 3.07%.
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The decrease in interest income was driven by a slight increase in interest and fees on loans offset by reduced income on the investment portfolio. While the average balance of the investment portfolio increased by $69.9 million, bonds at higher yielding rates were called and replaced with lower yielding investments, resulting in a decrease in average yield on the investment portfolio of 106 basis points. The increase in the average balance of investments is due to a strategic decision in December 2020 to invest $70.0 million of excess cash into the investment portfolio. Significantly higher cash levels invested at an average yield on Fed Funds of 0.11% for the first nine months of 2021, compared to 0.31% for the first nine months of 2020, also negatively impacted the margin for the first nine months of 2021. The increase in average balance of loans of $42.7 million, driven by PPP loans and the purchase of a $20.0 million consumer loan pool during the second quarter of 2021, offset the declining yield in the portfolio. Interest and fees on loans increased slightly when comparing the first nine months of 2021 to the first nine months of 2020. The average balances of PPP loans of approximately $100.6 million generated $3.2 million of interest and fees but had a negative impact on the margin. The average loan yield was also negatively impacted by the low-rate environment, which resulted in loan production and loans repricing at lower rates. These factors resulted in a decrease of approximately 12 basis points in average loan yield when compared to the nine months ended September 30, 2020.
The decrease in interest expense of $2.7 million, despite an increase in average interest-bearing liabilities of $84.9 million, was a direct result of a reduction in the cost of deposits of 27 basis points, a 5 basis point decrease in the cost of our short-term borrowings and a 61 basis point decrease in the cost of long-term borrowings. The decrease in the rate on long-term borrowings was primarily due to the restructuring of three long-term Federal Home Loan Bank advances late in the fourth quarter of 2020 that resulted in a reduced weighted average rate of 80 basis points on the $70.0 million portfolio. The rate on the long-term borrowings will be reduced further as the $70.0 million of FHLB advances were repaid late in the third quarter of 2021. These advances had a weighted rate of 1.90%. The average balance on our interest-bearing money market accounts increased $34.6 million, while the rate on these accounts decreased by 39 basis points. Average growth of $126.3 million in our non-interest-bearing accounts benefited our overall cost of deposits.
AverageBalance
AverageYield/Rate
1,162,374
13,689
4.67
1,198,888
12,950
4.30
274,648
1.27
194,722
25,073
476
7.54
27,049
494
7.26
299,721
1,356
1.79
221,771
1,454
2.61
159,444
119,039
0.09
4,283
1,157
0.73
2,772
4.64
4.15
1,628,594
3.69
1,545,323
3.73
(17,597)
(17,252)
157,806
153,846
1,768,803
1,681,917
215,085
195,363
332,889
332,012
330
230,925
0.03
182,733
0.08
89,723
253
1.12
111,647
435
1.55
94,770
270
1.13
121,986
525
1.71
63,968
45,719
0.17
77,342
2.75
3.22
1,104,702
0.46
1,090,389
0.86
503,006
407,334
27,143
56,091
133,952
128,103
3.23
2.87
(1)The above table reflects the average rates earned or paid stated on an FTE basis assuming a 21% tax rate for 2021 and 2020. Non-GAAP interest income on a fully taxable equivalent was $232 and $228, respectively.
(2)Net interest margin is calculated as net interest income divided by average earning assets.
(3)The average yields on investments are based on amortized cost.
Net interest income, on a non-GAAP, FTE basis, increased by $1.7 million (14.2%) for the third quarter 2021 when compared to the third quarter of 2020. This increase resulted from an increase in interest income of $0.7 million and a decrease in interest expense of $1.1 million.
The increase in interest income on loans was a result of increased interest on consumer loans related to the purchase of a loan pool in the second quarter as well as an increase in the unearned fees related to the PPP forgiveness during the quarter. The reduction of interest expense resulted from the further reduction of deposit rates early in the third quarter and the declining balances in the higher cost CD portfolio. The prepayment of the FHLB advances should positively impact interest expense for the remainder of 2021 and future years. The weighted rate on the $70.0 million FHLB long-term borrowings was 1.90%. The net interest margin for the third quarter of 2021 was 3.38%, compared to 3.12% for the third quarter of 2020. Excluding the average balance of PPP loans of $48.5 million and interest and fees of $1.4 million, the net interest margin for the third quarter of 2021 was 3.12%.
Participation in the PPP, with an average outstanding loan balance of $48.5 million and an interest rate of 1.0%, negatively impacted the margin for the third quarter of 2021 by 6 basis points. However, deferred fees of approximately $1.3 million recognized during the third quarter of 2021 positively impacted the margin by 32 basis points, with a net positive impact of 26 basis points. Continued elevated cash levels have also negatively impacted the margin.
The decrease in interest expense of $1.1 million, despite an increase in average interest-bearing liabilities of $14.3 million, was a direct result of a reduction in the cost of deposits of 25 basis points, a 6 basis point decrease in the cost of our short-term borrowings and a 47 basis point decrease in the cost of long-term borrowings. The decrease in the rate on long-term borrowings is primarily due to the restructuring of three long-term FHLB advances late in the fourth quarter of 2020 that resulted in a reduced weighted average rate of 80 basis points on the $70.0 million portfolio. The rate on the long-term borrowings will be reduced further as the $70.0 million of FHLB advances were repaid late in the third quarter of 2021. These advances had a weighted rate of 1.90%. The average balance on our interest-bearing money market accounts remained stable, while the rate on these accounts decreased by 31 basis points. Average growth of $95.7 million in our non-interest-bearing accounts benefited our overall cost of deposits as well as the overall reduction to rates on all deposit products in the third quarter.
The following table sets forth an analysis of volume and rate changes in interest income and interest expense for our average interest-earning assets and average interest-bearing liabilities for the nine and three month periods ended September 30, 2021 and 2020:
For the Nine months ended September 30, 2021
compared to the Nine months ended September 30, 2020
(in thousands and tax equivalent basis)
Volume
Rate
Interest Income:
1,477
(1,146)
331
Taxable Investments
1,299
(2,047)
(748)
Non-taxable Investments
0
(234)
Interest-bearing deposits
(8)
(28)
2,904
(3,442)
(538)
Interest Expense:
(170)
(71)
(978)
(840)
(107)
(73)
Time deposits less than $100K
(129)
(202)
(331)
Time deposits $100K or more
(296)
(509)
(805)
(19)
(194)
(429)
(623)
(330)
(2,414)
(2,744)
3,234
(1,028)
2,206
For the Three months ended September 30, 2021 compared to the Three months ended September 30, 2020
(393)
1,132
739
392
(472)
(80)
(15)
661
(77)
(252)
(251)
(97)
(182)
(116)
(255)
(281)
(353)
(713)
(1,066)
313
1,414
1,727
Provision for Loan Losses
The provision for loan losses was $0.1 million for the nine months ended September 30, 2021 and $5.0 million for the nine months ended September 30, 2020. The higher provision expense recorded in the first nine months of 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic. Net recoveries of $0.4 million were recorded for the nine months ended September 30, 2021, compared to net charge offs of $1.3 million for the same period of 2020. The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.46% at September 30, 2021 compared to 1.36% at September 30, 2020 and 1.41% at December 31, 2020. The ALL to loans outstanding, excluding PPP loan balances of $30.3 million and $148.9 million, was 1.49% at September 30, 2021 and 1.55% at September 30, 2020 and December 31, 2020, non-GAAP. Specific allocations have been made for impaired loans where management has determined that the collateral supporting the loans is not adequate to cover the loan balance, and the qualitative factors affecting the ALL have been adjusted based on the current economic environment and the characteristics of the loan portfolio.
The composition of other operating income for the nine and three month periods ended September 30, 2021 and 2020 is illustrated in the following table:
Income as % of
Total Other Income
10%
13%
11%
5%
47%
48%
19%
18%
20%
7%
8%
9%
6%
Other income
3%
100%
Other Operating Expenses
The composition of other operating expenses for the nine and three month periods ended September 30, 2021 and 2020 is illustrated in the following table:
Expense as % of
Total Other Operating Expenses
44%
49%
51%
2%
1%
(1)%
0%
Provision for Income Taxes
In reporting interim financial information, income tax provisions should be determined under the procedures set forth in Financial Accounting Standards Board’s Accounting Standards Codification (“ASC”) Topic 740, Income Taxes (Section 740-270-30). This guidance provides that at the end of each interim period, an entity should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. The rate so determined should be used in providing for income taxes on a current year-to-date basis. The effective tax rate should reflect anticipated investment tax credits, capital gains rates, and other available tax planning alternatives. In arriving at this effective tax rate, however, no effect should be included for the tax related to significant, unusual or extraordinary items that will be separately reported or reported net of their related tax effect in reports for the interim period or for the fiscal year.
The effective income tax rate as a percentage of income increased to 24.9% at September 30, 2021 from 22.1% at September 30, 2020 primarily due to a reduction in tax exempt income and the reduction in low income housing tax credits that expired in June 2021. A new investment in a low income housing tax credit will reduce the effective tax rate beginning in 2022 and future years.
FINANCIAL CONDITION
Balance Sheet Overview
Total assets at September 30, 2021 decreased to $1.7 billion, representing a $24.9 million decrease since December 31, 2020. During the first nine months of 2021, cash and interest-bearing deposits in other banks decreased by $14.5 million, the investment portfolio increased by $2.4 million and gross loans decreased by $5.9 million. The decrease in cash was due primarily to the strategic decision to deploy $39.0 million of cash to purchase a pool of mortgage loans for the purpose of offsetting mortgage portfolio balances that have been declining due to continued refinancing activity. Management also used $70.0 million to prepay FHLB advances. Although the Bank recorded $2.4 million in penalties in connection with the FHLP prepayments, management anticipates that the resulting reduction in interest expense for the remainder of 2021 and in future years will offset the penalty and have a significant impact on the cost of funds. OREO balances decreased $2.7 million due to the sale of a parcel of real estate
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securing a large commercial participation loan in the first quarter of 2021 and the additional sales of undeveloped lots. We anticipate further reduction to OREO balances over the next quarter as we consummate additional sales contracts.
Total liabilities decreased by $27.6 million when compared to liabilities at December 31, 2020. The decrease in the first nine months of 2021 was attributable to deposit growth of $22.1 million due to stimulus programs and to growth in core relationships, increased balances in short-term borrowings related to our Treasury Management product, offset by the prepayment of $70.0 million in FHLB long-term borrowings. Total shareholders’ equity increased slightly during the first nine months of 2021, as net income of $12.2 million was offset by the repurchase of $7.2 million (400,000 shares) of First United Corporation common stock.
Loan Portfolio
The following table presents the composition of our loan portfolio at the dates indicated:
32%
17%
23%
35%
Outstanding loans of $1.2 billion at September 30, 2021 reflected a decline of $5.9 million during the first nine months of 2021, which was primarily attributable to growth in our mortgage loan portfolio due to the purchase of a $39.0 million loan pool, offset by a decline of portfolio balances. This loan pool consisted of individual adjustable and fixed rate residential mortgage loans. Core commercial loan growth was offset by PPP loan forgiveness. Commercial real estate (“CRE”) loans increased by $2.6 million, acquisition and development (“A&D”) loans increased by $15.3 million and commercial and industrial (“C&I”) loans decreased by $71.0 million, as growth in core portfolio loans of $12.7 million was offset by PPP loan forgiveness. Residential mortgage loans increased $26.7 million due to the purchase of a pool of 1-4 family residential loans, offset by the continued refinancing activity. Given the current low interest rate environment, customers appear to be seeking longer-term, fixed-rate loans and we continued to use the secondary market rather than hold these longer-term fixed rate mortgage loans in the portfolio. The consumer loan portfolio increased by $20.4 million due to the purchase of a pool of consumer loans in the second quarter of 2021 as an effort to deploy excess cash into higher yielding, short-term assets.
Commercial loan production for the first nine months of 2021 was approximately $147.9 million, with $46.7 million originated during the third quarter, exclusive of PPP loan production. PPP loan production was approximately $66.1 million for the first nine months of 2021. At September 30, 2021, unfunded, committed commercial construction loans totaled approximately $26.6 million. Commercial amortization and payoffs were approximately $117.3 million through September 30, 2021, exclusive of PPP.
Consumer mortgage loan production was approximately $89.6 million through September 30, 2021. The production and pipeline mix of in-house, portfolio loans and investor loans remained strong as of September 30, 2021, with those loans totaling $20.0 million, consisting of $16.0 million in portfolio loans and $4.0 million in investor loans. At the end of the second quarter of 2021, management implemented special promotions for residential mortgage products to shift production towards portfolio loans and utilize excess cash balances.
Non-accrual loans totaled $7.4 million at September 30, 2021 compared to $3.3 million at December 31, 2020. The increase in the non-accrual balance at September 30, 2021 was due to the movement of two hospitality loans, totaling approximately $4.0 million, to non-accrual status during the first quarter of 2021. These loans suffered reduced cash flows due to the impact of the COVID-19 pandemic, received modifications and were classified as substandard at December 31, 2020. These loans have returned to their contractual payment terms but will remain on non-accrual status until they pay full contractual payments for six months.
Risk Elements of Loan Portfolio
The following table presents the risk elements of our loan portfolio at the dates indicated. Management is not aware of any potential problem loans other than those listed in this table or discussed below.
% ofApplicablePortfolio
Non-accrual loans:
5,017
1.35%
898
0.24%
0.30%
0.31%
0.50%
2,048
0.54%
0.03%
0.08%
Total non-accrual loans
0.64%
0.29%
Accruing Loans Past Due 90 days or more:
Total loans past due 90 days or more
Total non-accrual and accruing loans past due 90 days or more
7,630
4,063
Restructured Loans (TDRs):
Performing
3,475
3,657
Non-accrual (included above)
284
301
Total TDRs
3,759
3,958
Impaired loans without a valuation allowance
Impaired loans with a valuation allowance
Valuation allowance related to impaired loans
Performing loans considered to be impaired (including performing troubled debt restructurings, or TDRs), as defined and identified by management, amounted to $7.6 million at September 30, 2021 and $4.1 million at December 31, 2020. Loans are identified as impaired when, based on current information and events, management determines that we will be unable to collect all amounts due according to contractual terms. These loans consist primarily of A&D loans and CRE loans. The fair values are generally determined based upon independent third-party appraisals of the collateral or discounted cash flows based upon the expected proceeds. Specific allocations have been made where management believes there is insufficient collateral to repay the loan balance if liquidated and there is no secondary source of repayment available.
Loans that have been modified in reliance on Section 4013 of the CARES Act and the guidance issued thereunder are not treated as TDRs. Information about these loans can be found in Notes 2 and 5 to the consolidated financial statements presented in Item 1 of Part I of this report.
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The following table presents the details of impaired loans that are TDRs by class at September 30, 2021 and December 31, 2020:
Number of
Recorded
Contracts
2,110
2,208
210
703
Total performing
Non-accrual
Total non-accrual
The level of TDRs was $3.8 million at September 30, 2021 compared to $4.0 million at December 31, 2020, with a slight reduction due to payments made during the first nine months of 2021. There were no new TDRs during the first nine months of 2021.
Allowance and Provision for Loan Losses
The ALL is maintained to absorb probable incurred credit losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.
The ALL is also based on estimates, and actual losses will vary from current estimates. These estimates are reviewed quarterly, and as adjustments, either positive or negative, become necessary, a corresponding increase or decrease is made in the ALL. The methodology used to determine the adequacy of the ALL is consistent with prior years. An estimate for probable losses related to unfunded lending commitments, such as letters of credit and binding but unfunded loan commitments is also prepared. This estimate is computed in a manner similar to the methodology described above, adjusted for the probability of actually funding the commitment.
The following table presents a summary of the activity in the ALL for the nine months ended September 30:
Balance, January 1
Charge-offs:
Total charge-offs
Recoveries:
Total recoveries
Net recoveries/(credit charge-offs)
(1,329)
Allowance for loan losses to gross loans outstanding (as %)
1.46
1.36
Net recoveries/(credit charge-offs) to average loans outstanding during the period, annualized (as %)
(0.16)
The ALL increased to $16.9 million at September 30, 2021 compared to $16.5 million at December 31, 2020. The provision for loan losses was $0.1 million for the nine months ended September 30, 2021 and $5.0 million for the nine months ended September 30, 2020. The higher provision expense recorded in the first nine months of 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic. Net recoveries of $0.4 million were recorded for the nine months ended September 30, 2021, compared to net charge offs of $1.3 million for the same period of 2020. The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.46% at September 30, 2021 compared to 1.36% at September 30, 2020 and 1.41% at December 31, 2020. The ALL to loans outstanding, excluding PPP loan balances of $30.3 million and $148.9 million, was 1.49% at September 30, 2021 and 1.55% at September 30, 2020 and December 31, 2020, non-GAAP.
The ratio of net recoveries to average loans for the nine months ended September 30, 2021 was an annualized 0.04%, compared to net charge offs to average loans of 0.16% for the nine months ended September 30, 2020. The CRE portfolio did not have any charge offs or recoveries in the first nine months of 2021, compared to an annualized net recovery rate of 0.03% as of September 30, 2020. The A&D loans had an annualized net recovery rate of 0.01% as of September 30, 2021, compared to a net charge-off rate of 1.21% as of September 30, 2020. The decrease is related to a $1.10 million charge off on a non-accrual loan in 2020, which subsequently moved to OREO. The C&I portfolio had net recoveries to average loans of 0.06% as of September 30, 2021, compared to net charge-offs of 0.06% as of September 30, 2020. The residential mortgage ratios were a net charge-off rate of 0.01% as of September 30, 2021 and 2020. The consumer loan ratios were net charge-off rates of 0.02% and 0.59% as of September 30, 2021 and September 30, 2020, respectively. Our special assets team continues to aggressively collect on charged-off loans.
Management believes that the ALL at September 30, 2021 was adequate to provide for probable credit losses inherent in our loan portfolio. Amounts that will be recorded for the provision for loan losses in future periods will depend upon trends in the loan balances, including the composition of the loan portfolio, changes in loan quality and loss experience trends, potential recoveries on previously charged-off loans and changes in other qualitative factors. Management also applies interest rate risk, collateral value and debt service sensitivity analyses to the Commercial real estate loan portfolio and obtains new appraisals on specific loans under defined parameters to assist in the determination of the periodic provision for loan losses.
At September 30, 2021, the total amortized cost basis of the available-for-sale investment portfolio was $241.2 million, compared to a fair value of $235.6 million. Unrealized gains and losses on securities available-for-sale are reflected in accumulated other comprehensive loss, a component of shareholders’ equity. The amortized cost basis of the held to maturity portfolio was $62.0 million, compared to a fair value of $71.7 million.
The following table presents the composition of our securities portfolio at amortized cost and fair values at the dates indicated:
Amortized
FV as %
Cost
(FV)
of Total
Securities Available-for-Sale:
34%
24%
14%
29%
31%
Obligations of state and political subdivisions
4%
Securities Held to Maturity:
45%
46%
16%
41%
36%
Total fair value of investment securities available-for-sale increased by $8.7 million since December 31, 2020. At September 30, 2021, the securities classified as available-for-sale included a net unrealized loss of $5.6 million, which represents the difference between the fair value and amortized cost of securities in the portfolio.
As discussed in Note 7 to the consolidated financial statements presented elsewhere in this report, the Corporation measures fair market values based on the fair value hierarchy established in ASC Topic 820, Fair Value Measurements and Disclosures. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Level 3 prices or valuation techniques require inputs that are both significant to the valuation assumptions and are not readily observable in the market (i.e. supported with little or no market activity). These Level 3 instruments are valued based on both observable and unobservable inputs derived from the best available data, some of which is internally developed, and considers risk premiums that a market participant would require.
Approximately $218.5 million of the available-for-sale portfolio was valued using Level 2 pricing and had net unrealized losses of $4.1 million at September 30, 2021. The remaining $17.1 million of the securities available-for-sale represents the entire collateralized debt obligation (“CDO”) portfolio, which was valued using significant unobservable inputs (Level 3 assets). The $1.5 million in net unrealized losses associated with this portfolio relates to nine pooled trust preferred securities that comprise the CDO portfolio. Net unrealized losses of $0.7 million represent non-credit related OTTI charges on seven of the securities, while $0.8 million of unrealized losses relates to two securities which have had no credit related OTTI.
The following table provides a summary of the trust preferred securities in the CDO portfolio and the credit status of these securities as of September 30, 2021:
Level 3 Investment Securities Available for Sale
Investment Description
First United Level 3 Investments
Security Credit Status
Deferrals/
Defaults
Support
Unrealized
Lower
as % of
Issuers/
Market
Gain/
Credit
Original
Deal
Class
(Loss)
Rating
Issuers
Preferred Term Security XVIII*
C
1,894
1,522
676,565
14.82%
268,049
21,124
7.88%
40 / 56
Preferred Term Security XVIII
2,717
2,283
(434)
Preferred Term Security XIX*
1,842
1,860
700,535
6.57%
412,787
30,381
7.36%
47 / 52
1,102
2,604
1,103
Preferred Term Security XXII*
C-1
1,599
1,491
1,386,600
9.59%
624,548
82,765
13.25%
58 / 72
3,997
3,728
(269)
Preferred Term Security XXIII
1,778
1,372
(406)
1,467,000
12.95%
658,365
76,775
11.66%
70 / 82
Total Level 3 Securities Available for Sale
(1,494)
*Security has been deemed other-than-temporarily impaired and loss has been recognized in accordance with ASC Section 320-10-35.
The terms of the debentures underlying trust preferred securities allow the issuer of the debentures to defer interest payments for up to 20 quarters, and, in such case, the terms of the related trust preferred securities allow their issuers to defer dividend payments for up to 20 quarters. Some of the issuers of the trust preferred securities in our investment portfolio have defaulted and/or deferred payments ranging from 6.57% to 14.82% of the total collateral balances underlying the securities. The securities were designed to include structural features that provide investors with credit enhancement or support to provide default protection by subordinated tranches. These features include over-collateralization of the notes or subordination, excess interest or spread which will redirect funds in situations where collateral is insufficient, and a specified order of principal payments. There are securities in our portfolio that are under-collateralized, which does represent additional stress on our tranche. However, in these cases, the terms of the securities require excess interest to be redirected from subordinate tranches as credit support, which provides additional support to our investment.
Management systematically evaluates securities for impairment on a quarterly basis. Based upon application of ASC Topic 320 (Section 320-10-35), management must assess whether (a) the Corporation has the intent to sell the security and (b) it is more likely than not that the Corporation will be required to sell the security prior to its anticipated recovery. If neither applies, then declines in the fair value of securities below their cost that are considered other-than-temporary declines are split into two components. The first is the loss attributable to declining credit quality. Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made. The second component consists of all other losses. The other losses are recognized in other comprehensive income. In estimating OTTI charges, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) adverse conditions specifically related to the security, an industry, or a geographic area, (3) the historic and implied volatility of the security, (4) changes in the rating of a security by a rating agency, (5) recoveries or additional declines in fair value subsequent to the balance sheet date, (6) failure of the issuer of the security to make scheduled interest payments, and (7) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future. Due to the duration and the significant market value decline in the pooled trust preferred securities held in our portfolio, we performed more extensive testing on these securities for purposes of evaluating whether or not an OTTI has occurred.
The market for these securities as of September 30, 2021 was not active and markets for similar securities were also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which these securities trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive, as no new CDOs have been issued since 2007. There are currently very few market participants who are willing to effect transactions in these securities. The market values for these securities, or any securities other than those issued or guaranteed by the U.S. Department of the Treasury (the “Treasury”), are very depressed relative to historical levels. Therefore, in the current market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general rather than being an indicator of credit problems with a particular issue. Given the conditions in the current debt markets and the absence of observable transactions in the secondary and new issue markets, management has determined that (a) the few observable transactions and market quotations that are available are not reliable for the purpose of obtaining fair value at September 30, 2021, (b) an income valuation
approach technique (i.e. present value) that maximizes the use of relevant unobservable inputs and minimizes the use of observable inputs will be equally or more representative of fair value than a market approach, and (c) the CDO segment is appropriately classified within Level 3 of the valuation hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date.
Management uses an independent third party to prepare both the evaluations of OTTI and the fair value determinations for the CDO portfolio. Management does not believe that there were any material differences in the OTTI evaluations and pricing between December 31, 2020 and September 30, 2021.
Based upon a review of credit quality and the cash flow tests performed by the independent third party, management determined that no securities had credit-related OTTI during the first nine months of 2021. Additionally, there has been no change in the performing collateral, no decline in the percentage of deferrals/defaults to original collateral, and increases in collateral support for each of the positions held by the Corporation.
Deposits
The following table presents the composition of our deposits at the dates indicated:
Non-interest bearing demand deposits:
Retail
30%
Interest-bearing deposits:
Demand
212,385
15%
201,571
Money Market:
333,113
376,096
26%
233,403
196,046
Time deposits less than $100,000:
74,166
88,728
Time deposits $100,000 or more:
99,986
139,498
Total Deposits
Total deposits at September 30, 2021 increased by $22.1 million when compared to deposits at December 31, 2020. During the first nine months of 2021, non-interest-bearing deposits increased by $71.0 million, driven by retail and commercial account growth partially attributable to government stimulus programs. Traditional savings accounts increased by $37.4 million as we continued to see significant growth in our Prime Saver product, and total demand deposits increased by $10.8 million. Total money market accounts decreased by $43.0 million due primarily to management’s decision to sweep approximately $70.0 million of wealth management money market funds off balance sheet in the first quarter of 2021. These funds can be readily shifted back to in-house money market accounts should liquidity needs arise in the future. Time deposits decreased by $54.1 million, primarily in time deposits over $100,000, due to repayment of a $10.0 million brokered CD in May 2021 and as we continued to reduce pricing on single-service relationships and municipal bids.
Borrowed Funds
The following table presents the composition of our borrowings at the dates indicated:
Securities sold under agreements to repurchase
Total short-term borrowings
FHLB advances
70,000
Junior subordinated debt
Total long-term borrowings
Total short-term borrowings increased by $23.2 million during the first nine months of 2021. This increase was due to increased cash balances from our existing accounts. Long-term borrowings decreased $70.0 million as management made the strategic decision to deploy excess cash and prepay the FHLB advances during the third quarter.
Liquidity Management
Liquidity is a financial institution’s capability to meet customer demands for deposit withdrawals while funding all credit-worthy loans. The factors that determine the institution’s liquidity are:
We actively manage our liquidity position through regular meetings of a sub-committee of executive management, known as the Treasury Team, which looks forward 12 months at 30-day intervals. The measurement is based upon the projection of funds sold or purchased position, along with ratios and trends developed to measure dependence on purchased funds and core growth. Monthly reviews by management and quarterly reviews by the Asset and Liability Committee under prescribed policies and procedures are designed to ensure that we will maintain adequate levels of available funds.
It is our policy to manage our affairs so that liquidity needs are fully satisfied through normal Bank operations. That is, the Bank will manage its liquidity to minimize the need to make unplanned sales of assets or to borrow funds under emergency conditions. The Bank will use funding sources where the interest cost is relatively insensitive to market changes in the short run (periods of one year or less) to satisfy operating cash needs. The remaining normal funding will come from interest-sensitive liabilities, either deposits or borrowed funds. When the marginal cost of needed wholesale funding is lower than the cost of raising this funding in the retail markets, the Corporation may supplement retail funding with external funding sources such as:
Management believes that we have adequate liquidity available to respond to current and anticipated liquidity demands and is not aware of any trends or demands, commitments, events or uncertainties that are likely to materially affect our ability to maintain liquidity at satisfactory levels.
Market Risk and Interest Sensitivity
Our primary market risk is interest rate fluctuation. Interest rate risk results primarily from the traditional banking activities that we engage in, such as gathering deposits and extending loans. Many factors, including economic and financial conditions, movements in interest rates and consumer preferences affect the difference between the interest earned on our assets and the interest paid on our liabilities. Interest rate sensitivity refers to the degree that earnings will be impacted by changes in the prevailing level of interest rates. Interest rate risk arises from mismatches in the repricing or maturity characteristics between interest-bearing assets and liabilities. Management seeks to minimize fluctuating net interest margins, and to enhance consistent growth of net interest income through periods of changing interest rates. Management uses interest sensitivity gap analysis and simulation models to measure and manage these risks. The interest rate sensitivity gap analysis assigns each interest-earning asset and interest-bearing liability to a time frame reflecting its next repricing or maturity date. The differences between total interest-sensitive assets and liabilities at each time interval represent the interest sensitivity gap for that interval. A positive gap generally indicates that rising interest rates during a given interval will increase net interest income, as more assets than liabilities will reprice. A negative gap position would benefit us during a period of declining interest rates.
At September 30, 2021, we were asset sensitive.
Our interest rate risk management goals are:
In order to manage interest sensitivity risk, management formulates guidelines regarding asset generation and pricing, funding sources and pricing, and off-balance sheet commitments. These guidelines are based on management’s outlook regarding future interest rate movements, the state of the regional and national economy, and other financial and business risk factors. Management uses computer simulations to measure the effect on net interest income of various interest rate scenarios. Key assumptions used in the computer simulations include cash flows and maturities of interest rate sensitive assets and liabilities, changes in asset volumes and pricing, and management’s capital plans. This modeling reflects interest rate changes and the related impact on net interest income over specified periods.
We evaluate the effect of a change in interest rates of +/-100 basis points to +/-400 basis points on both NII and Net Portfolio Value (“NPV”) / Economic Value of Equity (“EVE”). We concentrate on NII rather than net income as long as NII remains the significant contributor to net income.
NII modeling allows management to view how changes in interest rates will affect the spread between the yield paid on assets and the cost of deposits and borrowed funds. Unlike traditional Gap modeling, NII modeling takes into account the different degree to which installments in the same repricing period will adjust to a change in interest rates. It also allows the use of different assumptions in a falling versus a rising rate environment. The period considered by the NII modeling is the next eight quarters.
NPV / EVE modeling focuses on the change in the market value of equity. NPV / EVE is defined as the market value of assets less the market value of liabilities plus/minus the market value of any off-balance sheet positions. By effectively looking at the present value of all future cash flows on or off the balance sheet, NPV / EVE modeling takes a longer-term view of interest rate risk. This complements the shorter-term view of the NII modeling.
Measures of NII at risk produced by simulation analysis are indicators of an institution’s short-term performance in alternative rate environments. These measures are typically based upon a relatively brief period, usually one year. They do not necessarily indicate the long-term prospects or economic value of the institution.
Based on the simulation analysis performed at September 30, 2021 and December 31, 2020, management estimated the following changes in net interest income, assuming the indicated rate changes:
(Dollars in thousands)
+400 basis points
5,124
+300 basis points
2,896
4,067
+200 basis points
2,097
2,897
+100 basis points
1,022
1,527
-100 basis points
(2,952)
(2,174)
This estimate is based on assumptions that may be affected by unforeseeable changes in the general interest rate environment and any number of unforeseeable factors. Rates on different assets and liabilities within a single maturity category adjust to changes in interest rates to varying degrees and over varying periods of time. The relationships between lending rates and rates paid on purchased funds are not constant over time. Management can respond to current or anticipated market conditions by lengthening or shortening the Bank’s sensitivity through loan repricings or changing its funding mix. The rate of growth in interest-free sources of funds will influence the level of interest-sensitive funding sources. In addition, the absolute level of interest rates will affect the volume of earning assets and funding sources. As a result of these limitations, the interest-sensitive gap is only one factor to be considered in estimating the net interest margin.
Management believes that no material changes in our market risks, our procedures used to evaluate and mitigate those risks, or our actual or simulated sensitivity positions have occurred since December 31, 2020. Our NII simulation analysis as of December 31, 2020 is included in Item 7 of Part II Item 7 of Part II of our Annual Report on Form 10-K for the year ended December 31, 2020 under the heading “Market Risk and Interest Sensitivity.
Impact of Inflation – Our assets and liabilities are primarily monetary in nature, and as such, future changes in prices do not affect the obligations to pay or receive fixed and determinable amounts of money. During inflationary periods, monetary assets lose value in terms of purchasing power and monetary liabilities have corresponding purchasing power gains. The concept of purchasing power is not an adequate indicator of the impact of inflation on financial institutions because it does not incorporate changes in our earnings.
Capital Resources
We require capital to fund loans, satisfy our obligations under the Bank’s letters of credit, meet the deposit withdrawal demands of the Bank’s customers, and satisfy our other monetary obligations. To the extent that deposits are not adequate to fund our capital requirements, we can rely on the funding sources identified above under the heading “Liquidity Management”. At September 30, 2021, the Bank had $130.0 million available through unsecured lines of credit with correspondent banks, $1.0 million available through a secured line of credit with the Fed Discount Window and approximately $189.0 million available through the FHLB. Management is not aware of any demands, commitments, events or uncertainties that are likely to materially affect our ability to meet our future capital requirements.
In addition to operational requirements, the Bank and First United Corporation are subject to risk-based capital regulations, which were adopted and are monitored by federal banking regulators. These regulations are used to evaluate capital adequacy and require an analysis of an institution’s asset risk profile and off-balance sheet exposures, such as unused loan commitments and stand-by letters of credit. Based on capital ratios at September 30, 2021, both the Bank and First United Corporation are considered to be well-capitalized.
The following table presents our capital ratios as of the dates indicated:
The minimum capital level requirements applicable to the Company and the Bank are: (1) a common equity Tier 1 capital ratio of 4.5%; (2) a Tier 1 capital ratio of 6%; (3) a total capital ratio of 8%; and (4) a Tier 1 leverage ratio of 4%. The rules also establish a “capital conservation buffer” of 2.5% above the regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital. An institution would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses to executive officers if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.
Contractual Obligations, Commitments and Off-Balance Sheet Arrangements
Contractual Obligations
The Corporation enters into contractual obligations in the normal course of business. Among these obligations are FHLB advances and junior subordinated debentures, operating lease agreements for banking and subsidiaries’ offices and for data processing and telecommunications equipment. Comparing September 30, 2021 to December 31, 2020, short-term borrowings increased by $23.2 million during the first nine months of 2021. This increase was due to increased cash balances from our existing accounts. Long-term borrowings decreased $70.0 million as management made the strategic decision to deploy excess cash and prepay the FHLB advances during the third quarter.
Commitments
Loan commitments are made to accommodate the financial needs of our customers. Letters of credit commit us to make payments on behalf of customers when certain specified future events occur. The credit risks inherent in loan commitments and letters of credit are essentially the same as those involved in extending loans to customers, and these arrangements are subject to our normal credit policies. We are not a party to any other off-balance sheet arrangements.
Commitments to extend credit in the form of consumer, commercial and business at the dates indicated were as follows:
Residential Mortgage - home equity
64,316
59,615
Residential Mortgage - construction
21,210
12,220
Commercial
139,233
125,294
Consumer - personal credit lines
4,654
4,314
Standby letters of credit
16,731
17,675
246,144
219,118
The increase of $27.0 million in commitments at September 30, 2021 when compared to December 31, 2020 was due to continued demand for consumer and commercial construction funding during the first nine months of 2021. Management will continue to monitor these balances.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The information required by this item is included in Item 2 of Part I of this report under the caption “Market Risk and Interest Sensitivity” and in Item 7 of Part II of First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020 under the heading “Market Risk and Interest Sensitivity” both of which are incorporated in this Item 3 by reference.
Item 4. Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 with the SEC, such as this Quarterly Report, is recorded, processed, summarized and reported within the periods specified in those rules and forms, and that such information is accumulated and communicated to our management, including First United Corporation’s principal executive officer (“PEO”) and its principal financial officer (“PFO”), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.
An evaluation of the effectiveness of these disclosure controls as of September 30, 2021 was carried out under the supervision and with the participation of management, including the PEO and the PFO. Based on that evaluation, management, including the PEO and the PFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level.
During the nine months ended September 30, 2021, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 1A. Risk Factors
The risks and uncertainties to which our financial condition and operations are subject are discussed in detail in Item 1A of Part I of First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020. Management does not believe that any material changes in our risk factors have occurred since they were last disclosed except as follows.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Mine Safety Disclosures
Not Applicable.
Item 5. Other Information
Item 6. Exhibits
The exhibits filed or furnished with this quarterly report are listed in the following Exhibit Index.
Exhibit
Description
31.1
Certifications of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)
31.2
Certifications of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)
Certification of the Principal Executive Officer and the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act (furnished herewith)
101.INS
Inline XBRL Instance Document (filed herewith)
101.SCH
Inline XBRL Taxonomy Extension Schema (filed herewith)
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase (filed herewith)
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase (filed herewith)
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase (filed herewith)
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase (filed herewith)
The cover page of First United Corporation’s Quarterly Report on Form 10Q for the quarter ended September 30, 2021 formatted in Inline XBRL, included within the Exhibit 101 attachments (filed herewith).
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 9, 2021
/s/ Carissa L. Rodeheaver
Carissa L. Rodeheaver, CPA
Chairman of the Board, President and Chief Executive Officer
(Principal Executive Officer)
/s/ Tonya K. Sturm
Tonya K. Sturm, Senior Vice President,
Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)