Toggle SGML Header (+)


Section 1: 10-K (10-K)

20191231 10K FY

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549



FORM 10-K



   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



For the fiscal year ended December 31, 2019

or

   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

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

Securities registered pursuant to Section 12(g) of the Act:  None.



Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes    No 



Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes    No 



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 such shorter period 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 smaller reporting company, or an emerging growth company. See the definitions of “accelerated filer”, “large accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act). : 



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 standards 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 Act).  Yes    No 



The aggregate market value of the registrant’s outstanding voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter:  $129,336,923.



The number of shares of the registrant’s common stock outstanding as of February 29, 2020:  7,112,189.



Documents Incorporated by Reference

None

First United Corporation

Table of Contents


 



FORWARD LOOKING STATEMENTS

PART I

 

 

ITEM 1.

Business

ITEM 1A.

Risk Factors

17 

ITEM 1B.

Unresolved Staff Comments

25 

ITEM 2.

Properties

25 

ITEM 3.

Legal Proceedings

25 

ITEM 4.

Mine Safety Disclosures

25 

PART II

 

 

ITEM 5.

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

26 

ITEM 6.

Selected Financial Data

27 

ITEM 7.

Management's Discussion and Analysis of Financial Condition & Results of Operations

28 

ITEM 7A.

Quantitative and Qualitative Disclosures About Market Risk

51 

ITEM 8.

Financial Statements and Supplementary Data

52 

ITEM 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

109 

ITEM 9A.

Controls and Procedures

109 

ITEM 9B.

Other Information

111 

PART III

 

 

ITEM 10.

Directors, Executive Officers and Corporate Governance

111 

ITEM 11.

Executive Compensation

114 

ITEM 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

123 

ITEM 13.

Certain Relationships and Related Transactions, and Director Independence

125 

ITEM 14.

Principal Accountant Fees and Services

125 

PART IV

 

 

ITEM 15.

Exhibits and Financial Statement Schedules

127 

SIGNATURES

129 





 

2

 

 


 

As used in this Annual Report of Form 10-K, the terms “the Corporation”, “we”, “us”, and “our” mean First United Corporation and unless the context clearly suggests otherwise, its consolidated subsidiaries.



FORWARD LOOKING STATEMENTS



This Annual Report on Form 10-K of First United Corporation contains forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995.  Such statements include projections, predictions, expectations or statements as to beliefs or future events or results or refer to other matters that are not historical facts.  Forward-looking statements are subject to known and unknown risks, uncertainties and other factors that could cause the actual results to differ materially from those contemplated by the statements.  The forward-looking statements contained in this annual report are based on various factors and were derived using numerous assumptions.  In some cases, you can identify these forward-looking statements by words like “may”, “will”, “should”, “expect”, “plan”, “anticipate”, “intend”, “believe”, “estimate”, “predict”, “potential”, or “continue” or the negative of those words and other comparable words.  You should be aware that those statements reflect only our predictions.  If known or unknown risks or uncertainties should materialize, or if underlying assumptions should prove inaccurate, actual results could differ materially from past results and those anticipated, estimated or projected.  You should bear this in mind when reading this annual report and not place undue reliance on these forward-looking statements.  Factors that might cause such differences include, but are not limited to:



·

changes in market rates and prices may adversely impact the value of securities, loans, deposits and other financial instruments and the interest rate sensitivity of our balance sheet;



·

our liquidity requirements could be adversely affected by changes in our assets and liabilities;



·

the effect of legislative or regulatory developments, including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial services industry;



·

competitive factors among financial services organizations, including product and pricing pressures and our ability to attract, develop and retain qualified banking professionals;



·

the effect of changes in accounting policies and practices, as may be adopted by the Financial Accounting Standards Board (the “FASB”), the Securities and Exchange Commission (the “SEC”), and other regulatory agencies; and



·

the effect of fiscal and governmental policies of the United States federal government.



You should also consider carefully the risk factors discussed in Item 1A of Part I of this annual report, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect our business, operating results and financial condition.  The risks discussed in this annual report are factors that, individually or in the aggregate, management believes could cause our actual results to differ materially from expected and historical results.  You should understand that it is not possible to predict or identify all such factors.  Consequently, you should not consider such disclosures to be a complete discussion of all potential risks or uncertainties. 



The forward-looking statements speak only as of the date on which they are made, and, except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.  In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

 

 

3

 

 


 

PART  I

ITEM 1. BUSINESS



General



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”), both Connecticut statutory business trusts.  Until September 14, 2018 when it was canceled, the Corporation also served as the parent company to First United Statutory Trust III, a Delaware statutory business trust (“Trust III” and together with Trust I and Trust II, the “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. 



At December 31, 2019, we had total assets of $1.4 billion, net loans of $1.0 billion, and deposits of $1.1 billion.  Shareholders’ equity at December 31, 2019 was $125.9 million.



The Corporation maintains an Internet website 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.



Banking Products and Services



The Bank operates 25 banking offices, one customer care center and 32 Automated Teller Machines (“ATMs”) in Allegany County, Frederick County, Garrett County, and Washington County in Maryland, and in Mineral County, Berkeley County, Monongalia County and Harrison County in West Virginia.  The Bank is an independent community bank providing a complete range of retail and commercial banking services to businesses and individuals in its market areas.  Services offered are essentially the same as those offered by the regional institutions that compete with the Bank and include checking, savings, money market deposit accounts, and certificates of deposit, business loans, personal loans, mortgage loans, lines of credit, and consumer-oriented retirement accounts including individual retirement accounts (“IRAs”) and employee benefit accounts. In addition, the Bank provides full brokerage services through a networking arrangement with Cetera Investment Services, LLC., a full-service broker-dealer.  The Bank also provides safe deposit and night depository facilities, insurance products and trust services.  The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”).



Lending Activities



Our lending activities are conducted through the Bank.  Since 2010, the Bank has not originated any new loans through the OakFirst Loan Centers and their sole activity is servicing existing loans.



The Bank’s commercial loans are primarily secured by real estate, commercial equipment, vehicles or other assets of the borrower.  Repayment is often dependent on the successful business operations of the borrower and may be affected by adverse conditions in the local economy or real estate market.  The financial condition and cash flow of commercial borrowers is therefore carefully analyzed during the loan approval process, and continues to be monitored throughout the duration of the loan by obtaining business financial statements, personal financial statements and income tax returns.  The frequency of this ongoing analysis depends upon the size and complexity of the credit and collateral that secures the loan. It is also the Bank’s general policy to obtain personal guarantees from the principals of the commercial loan borrowers.



Commercial real estate (“CRE”) loans are primarily those secured by land for residential and commercial development, agricultural purpose properties, service industry buildings such as restaurants and motels, retail buildings and general purpose business space.  The Bank attempts to mitigate the risks associated with these loans through low loan to value ratio standards, thorough financial analyses, and management’s knowledge of the local economy in which the Bank lends.



The risk of loss associated with CRE construction lending is controlled through conservative underwriting procedures such as loan to value ratios of 80% or less, obtaining additional collateral when prudent, analysis of cash flows, and closely monitoring construction projects to control disbursement of funds on loans.



 

4

 

 


 

The Bank’s residential mortgage portfolio is distributed between variable and fixed rate loans.  Some loans are booked at fixed rates in order to meet the Bank’s requirements under the federal Community Reinvestment Act (the “CRA”) or to complement our asset liability mix. Other fixed rate residential mortgage loans are originated in a brokering capacity on behalf of other financial institutions, for which the Bank receives a fee. As with any consumer loan, repayment is dependent on the borrower’s continuing financial stability, which can be adversely impacted by factors such as job loss, divorce, illness, or personal bankruptcy.  Residential mortgage loans exceeding an internal loan-to-value ratio require private mortgage insurance.  Title insurance protecting the Bank’s lien priority, as well as fire and casualty insurance, is also required.



Home equity lines of credit, included within the residential mortgage portfolio, are secured by the borrower’s home and can be drawn on at the discretion of the borrower.  These lines of credit are at variable interest rates.



The Bank also provides residential real estate construction loans to builders and individuals for single family dwellings.  Residential construction loans are usually granted based upon “as completed” appraisals and are secured by the property under construction.  Site inspections are performed to determine pre-specified stages of completion before loan proceeds are disbursed.  These loans typically have maturities of six to twelve months and may have a fixed or variable rate.  Permanent financing for individuals offered by the Bank includes fixed and variable rate loans with five, seven or ten-year adjustable rate mortgages.



A variety of other consumer loans are also offered to customers, including indirect and direct auto loans, and other secured and unsecured lines of credit and term loans. In 2018, the Bank introduced a Student Loan program which offers a product for debt consolidation and an in-school program.  This program is serviced by a third-party.  Careful analysis of an applicant’s creditworthiness is performed before granting credit, and on-going monitoring of loans outstanding is performed in an effort to minimize risk of loss by identifying problem loans early.



An allowance for loan losses is maintained to provide for probable losses from our lending activities.  A complete discussion of the factors considered in determination of the allowance for loan losses is included in Item 7 of Part II of this report.



Deposit Activities



The Bank offers a full array of deposit products including checking, savings and money market accounts, regular and IRA certificates of deposit, Christmas Savings accounts, College Savings accounts, and Health Savings accounts.  The Bank also offers the Certificate of Deposit Account Registry Service®, or CDARS®, program to municipalities, businesses, and consumers through which the Bank provides access to multi-million-dollar certificates of deposit and the Insured Cash Sweep®, or ICS®, program to municipalities, businesses, and consumers through which the Bank provides access to multi-million-dollar savings and demand deposits.  Both programs are FDIC-insured.  In addition, we offer our commercial customers packages which include Treasury Management, Cash Sweep and various checking opportunities.



Information about our income from and assets related to our banking business may be found in the Consolidated Statements of Financial Condition and the Consolidated Statements of Income and the related notes thereto included in Item 8 of Part II of this annual report. 



Wealth Management



The Bank’s Trust Department offers a full range of trust services, including personal trust, investment agency accounts, charitable trusts, retirement accounts including IRA roll-overs, 401(k) accounts and defined benefit plans, estate administration and estate planning. 



At December 31, 2019 and 2018, the total market value of assets under the supervision of the Bank’s Trust Department was approximately $902.2 million and $810.0 million, respectively.  Trust Department revenues for these years may be found in the Consolidated Statements of Income under the heading “Other operating income”, which is contained in Item 8 of Part II of this annual report.



COMPETITION



The banking business, in all of its phases, is highly competitive.  Within our market areas, we compete with commercial banks, (including local banks and branches or affiliates of other larger banks), savings and loan associations and credit unions for loans and deposits, with consumer finance companies for loans, and with other financial institutions for various types of products and services, including trust services.  There is also competition for commercial and retail banking business from banks and financial institutions located outside our market areas and on the internet.



 

5

 

 


 

The primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services, convenience of office locations and office hours. The primary factors in competing for loans are interest rates, loan origination fees, the quality and range of lending services and personalized services.



To compete with other financial services providers, we rely principally upon local promotional activities, personal relationships established by officers, directors and employees with customers, and specialized services tailored to meet customers’ needs. In those instances in which we are unable to accommodate a customer’s needs, we attempt to arrange for those services to be provided by other financial services providers with which we have a relationship.



 

6

 

 


 

The following table sets forth deposit data for the Maryland and West Virginia Counties in which the Bank maintains offices as of June 30, 2019, the most recent date for which comparative information is available.





 

 

 

 

 

 

 



 

 

 

 

 

 

 



 

Offices

 

Deposits

 

Market



 

(in Market)

 

(in thousands)

 

Share

Allegany County, Maryland:

 

 

 

 

 

 

 

Branch Banking and Trust Company

 

 

$

270,973 

 

39.82% 

Manufacturers & Traders Trust Company

 

 

 

175,028 

 

25.72% 

First United Bank & Trust

 

 

 

156,452 

 

22.99% 

Standard Bank, PaSB

 

 

 

78,090 

 

11.47% 

   Source:  FDIC Deposit Market Share Report

 

 

 

 

 

 

 



 

 

 

 

 

 

 

Frederick County, Maryland:

 

 

 

 

 

 

 

PNC Bank NA

 

15 

 

$

1,302,885 

 

25.81% 

Branch Banking & Trust Co.

 

10 

 

 

806,671 

 

15.98% 

Bank Of America NA

 

 

 

554,221 

 

10.98% 

Frederick County Bank

 

 

 

385,455 

 

7.64% 

Manufacturers & Traders Trust Company

 

 

 

321,484 

 

6.37% 

Capital One NA

 

 

 

309,171 

 

6.12% 

Woodsboro Bank

 

 

 

234,591 

 

4.65% 

Middletown Valley Bank

 

 

 

220,455 

 

4.37% 

Sandy Spring Bank

 

 

 

210,466 

 

4.17% 

SunTrust Bank

 

 

 

205,751 

 

4.08% 

First United Bank & Trust

 

 

 

176,174 

 

3.49% 

Revere Bank

 

 

 

146,505 

 

2.90% 

Wells Fargo Bank NA

 

 

 

86,164 

 

1.71% 

The Columbia Bank

 

 

 

50,736 

 

1.01% 

Old Line Bank

 

 

 

35,513 

 

0.70% 

Woodforest National Bank

 

 

 

1,702 

 

0.03% 

   Source:  FDIC Deposit Market Share Report

 

 

 

 

 

 

 



 

 

 

 

 

 

 

Garrett County, Maryland:

 

 

 

 

 

 

 

First United Bank & Trust

 

 

$

373,529 

 

61.85% 

Manufacturers & Traders Trust Company

 

 

 

86,389 

 

14.30% 

Branch Banking and Trust Company

 

 

 

65,632 

 

10.87% 

Clear Mountain Bank

 

 

 

53,138 

 

8.80% 

Somerset Trust Company

 

 

 

19,256 

 

3.19% 

Miners & Merchants Bank

 

 

 

5,987 

 

0.99% 

   Source:  FDIC Deposit Market Share Report

 

 

 

 

 

 

 



 

 

 

 

 

 

 

Washington County, Maryland:

 

 

 

 

 

 

 

Branch Banking & Trust Company

 

 

$

598,407 

 

25.41% 

Fulton Financial Corp

 

 

 

506,424 

 

21.50% 

Manufacturers & Traders Trust Company

 

10 

 

 

452,123 

 

19.20% 

PNC Bank NA

 

 

 

265,924 

 

11.29% 

Middletown Valley Bank

 

 

 

203,490 

 

8.64% 

First United Bank & Trust

 

 

 

99,593 

 

4.23% 

CNB Bank, Inc.

 

 

 

90,453 

 

3.84% 

United Bank

 

 

 

67,581 

 

2.87% 

Orrstown Bank

 

 

 

37,792 

 

1.60% 

Potomac Bancshares Inc

 

 

 

20,203 

 

0.86% 

Jefferson Security Bank

 

 

 

7,875 

 

0.33% 

Ameriserv Financial Bank

 

 

 

5,398 

 

0.23% 

   Source:  FDIC Deposit Market Share Report

 

 

 

 

 

 

 





 

7

 

 


 



 

 

 

 

 

 

 

Berkeley County, West Virginia:

 

 

 

 

 

 

 

Branch Banking & Trust Company

 

 

$

363,788 

 

26.49% 

United Bank

 

 

 

271,572 

 

19.77% 

City National Bank of West Virginia

 

 

 

181,794 

 

13.24% 

MVB Bank Inc.

 

 

 

149,960 

 

10.92% 

First United Bank & Trust

 

 

 

129,971 

 

9.46% 

Jefferson Security Bank

 

 

 

92,272 

 

6.72% 

CNB Bank, Inc.

 

 

 

84,089 

 

6.12% 

Bank of Charles Town

 

 

 

81,282 

 

5.92% 

Summit Community Bank

 

 

 

17,026 

 

1.24% 

Woodforest National Bank

 

 

 

1,652 

 

0.12% 

   Source:  FDIC Deposit Market Share Report

 

 

 

 

 

 

 



 

 

 

 

 

 

 

Harrison County, West Virginia:

 

 

 

 

 

 

 

Branch Banking and Trust Company

 

 

$

268,553 

 

18.09% 

MVB Bank, Inc

 

 

 

253,874 

 

17.10% 

The Huntington National Bank

 

 

 

240,754 

 

16.22% 

WesBanco Bank, Inc.

 

 

 

238,726 

 

16.08% 

JP Morgan Chase Bank, NA

 

 

 

187,457 

 

12.63% 

Harrison County Bank

 

 

 

100,792 

 

6.79% 

City National Bank of West Virginia

 

 

 

49,581 

 

3.34% 

Tri-County Bancorp Inc

 

 

 

43,962 

 

2.96% 

Premier Bank, Inc.

 

 

 

29,396 

 

1.98% 

BC Bank, Inc.

 

 

 

14,758 

 

0.99% 

Cornerstone Bank, Inc

 

 

 

14,603 

 

0.98% 

United Bank

 

 

 

14,060 

 

0.95% 

Freedom Bank, Inc

 

 

 

12,324 

 

0.83% 

Clear Mountain Bank

 

 

 

12,204 

 

0.82% 

First United Bank & Trust

 

 

 

3,406 

 

0.23% 

   Source:  FDIC Deposit Market Share Report

 

 

 

 

 

 

 



 

 

 

 

 

 

 

Mineral County, West Virginia:

 

 

 

 

 

 

 

First United Bank & Trust

 

 

$

88,512 

 

35.93% 

Branch Banking & Trust Company

 

 

 

64,329 

 

26.11% 

Manufacturers & Traders Trust Company

 

 

 

53,279 

 

21.63% 

Grant County Bank

 

 

 

30,943 

 

12.56% 

FNB Bank, Inc.

 

 

 

9,274 

 

3.76% 

   Source:  FDIC Deposit Market Share Report

 

 

 

 

 

 

 



 

 

 

 

 

 

 

Monongalia County, West Virginia:

 

 

 

 

 

 

 

United Bank

 

 

$

822,783 

 

31.16% 

Huntington National Bank

 

 

 

476,738 

 

18.06% 

Branch Banking & Trust Company

 

 

 

434,769 

 

16.47% 

MVB Bank, Inc.

 

 

 

247,215 

 

9.36% 

Clear Mountain Bank

 

 

 

237,234 

 

8.99% 

Wesbanco Bank, Inc.

 

 

 

158,782 

 

6.01% 

PNC Bank NA

 

 

 

105,128 

 

3.98% 

First United Bank & Trust

 

 

 

98,976 

 

3.75% 

First Exchange Bank

 

 

 

29,409 

 

1.11% 

Citizens Bank of Morgantown, Inc.

 

 

 

26,312 

 

1.00% 

City National Bank of West Virginia

 

 

 

2,816 

 

0.11% 

   Source:  FDIC Deposit Market Share Report

 

 

 

 

 

 

 



 

8

 

 


 

For further information about competition in our market areas, see the Risk Factor entitled “We operate in a competitive environment, and our inability to effectively compete could adversely and materially impact our financial condition and results of operations” in Item 1A of Part I of this annual report.



SUPERVISION AND REGULATION



The following is a summary of the material regulations and policies applicable to the Corporation and its subsidiaries and is not intended to be a comprehensive discussion.  Changes in applicable laws and regulations may have a material effect on our business.



General



The Corporation is registered with the Federal Reserve as a bank holding company under the BHC Act and, as such, is subject to the supervision, examination and reporting requirements of the BHC Act and the regulations of the Federal Reserve.  As a publicly-traded company whose common stock is registered under Section 12(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and listed on The NASDAQ Global Select Market, the Corporation is also subject to regulation and supervision by the SEC and The NASDAQ Stock Market, LLC (“NASDAQ”).



The Bank is a Maryland trust company subject to the banking laws of Maryland and to regulation by the Commissioner of Financial Regulation of Maryland (the “Maryland Commissioner”), who is required by statute to make at least one examination in each calendar year (or at 18-month intervals if the Maryland Commissioner determines that an examination is unnecessary in a particular calendar year).  The Bank also has offices in West Virginia, and the operations of these offices are subject to West Virginia laws and to supervision and examination by the West Virginia Division of Banking.  As a member of the FDIC, the Bank is also subject to certain provisions of federal laws and regulations regarding deposit insurance and activities of insured state-chartered banks, including those that require examination by the FDIC.  In addition to the foregoing, there are a myriad of other federal and state laws and regulations that affect, or govern the business of banking, including consumer lending, deposit-taking, and trust operations.



All non-bank subsidiaries of the Corporation are subject to examination by the Federal Reserve, and, as affiliates of the Bank, are subject to examination by the FDIC and the Maryland Commissioner. In addition, OakFirst Loan Center, Inc. is subject to licensing and regulation by the West Virginia Division of Banking, and OakFirst Loan Center, LLC is subject to licensing and regulation by the Maryland Commissioner.



Regulatory Reforms



The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was enacted in July 2010, significantly restructured the financial regulatory regime in the United States. Although the Dodd-Frank Act’s provisions that have received the most public attention generally have been those applying to or more likely to affect larger institutions such as banks and bank holding companies with total consolidated assets of $50 billion or more, it contains numerous other provisions that affect all financial institutions, including the Bank.  The Dodd-Frank Act established the Consumer Financial Protection Bureau (the “CFPB”), discussed below, and contains a wide variety of provisions (many of which are not yet effective) affecting the regulation of depository institutions, including fair lending, fair debt collection practices, mortgage loan origination and servicing obligations, bankruptcy, military service member protections, use of credit reports, privacy matters, and disclosure of credit terms and correction of billing errors.  Local, state and national regulatory and enforcement agencies continue efforts to address perceived problems within the mortgage lending and credit card industries through broad or targeted legislative or regulatory initiatives aimed at lenders’ operations in consumer lending markets.  There continues to be a significant amount of legislative and regulatory activity, nationally, locally and at the state level, designed to limit certain lending practices while mandating certain servicing procedures.  Federal bankruptcy and state debtor relief and collection laws, as well as the Servicemembers Civil Relief Act affect the ability of banks, including the Bank, to collect outstanding balances.   



Moreover, the Dodd-Frank Act permits states to adopt stricter consumer protection laws and states’ attorneys general may enforce consumer protection rules issued by the CFPB.  Recently, U.S. financial regulatory agencies have increasingly used a general consumer protection statute to address unethical or otherwise bad business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law.  Prior to the Dodd-Frank Act, there was little formal guidance to provide insight to the parameters for compliance with the “unfair or deceptive acts or practices” (“UDAP”) law.  However, the UDAP provisions have been expanded under the Dodd-Frank Act to apply to “unfair, deceptive or abusive acts or practices”, which has been delegated to the CFPB for supervision.



The implementation of several of the Dodd-Frank Act’s provisions is subject to final rulemaking by the U.S. financial regulatory agencies, and the Dodd-Frank Act’s impact on our business will depend to a large extent on how and when such rules are adopted and implemented by the primary U.S. financial regulatory agencies.  We continue to analyze the impact of rules adopted under

 

9

 

 


 

the Dodd-Frank Act on our business, but the full impact will not be known until the rules and related regulatory initiatives are finalized and their combined impact can be understood.  The Dodd-Frank Act has increased, and will likely continue to increase, our regulatory compliance burdens and costs and may restrict the financial products and services that we offer to our customers in the future.  In particular, the Dodd-Frank Act will require us to invest significant management attention and resources so that we can evaluate the impact of and ensure compliance with this law and its rules.



Regulation of Bank Holding Companies



The Corporation and its affiliates are subject to the provisions of Section 23A and Section 23B of the Federal Reserve Act.  Section 23A limits the amount of loans or extensions of credit to, and investments in, the Corporation and its non-bank affiliates by the Bank.  Section 23B requires that transactions between the Bank and the Corporation and its non-bank affiliates be on terms and under circumstances that are substantially the same as with non-affiliates.



Under Federal Reserve policy, the Corporation is expected to act as a source of strength to the Bank, and the Federal Reserve may charge the Corporation with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required.  This support may be required at times when the bank holding company may not have the resources to provide the support.  Under the prompt corrective action provisions, if a controlled bank is undercapitalized, then the regulators could require the bank holding company to guarantee the bank’s capital restoration plan.  In addition, if the Federal Reserve believes that a bank holding company’s activities, assets or affiliates represent a significant risk to the financial safety, soundness or stability of a controlled bank, then the Federal Reserve could require the bank holding company to terminate the activities, liquidate the assets or divest the affiliates. The regulators may require these and other actions in support of controlled banks even if such actions are not in the best interests of the bank holding company or its stockholders.  Because the Corporation is a bank holding company, it is viewed as a source of financial and managerial strength for any controlled depository institutions, like the Bank.



In addition, under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”), depository institutions insured by the FDIC can be held liable for any losses incurred by, or reasonably anticipated to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default.  Accordingly, in the event that any insured subsidiary of the Corporation causes a loss to the FDIC, other insured subsidiaries of the Corporation could be required to compensate the FDIC by reimbursing it for the estimated amount of such loss.  Such cross guaranty liabilities generally are superior in priority to obligations of a financial institution to its shareholders and obligations to other affiliates.



Federal Banking Regulation



Federal banking regulators, such as the Federal Reserve and the FDIC, may prohibit the institutions over which they have supervisory authority from engaging in activities or investments that the agencies believe are unsafe or unsound banking practices.  Federal banking regulators have extensive enforcement authority over the institutions they regulate to prohibit or correct activities that violate law, regulation or a regulatory agreement or which are deemed to be unsafe or unsound practices.  Enforcement actions may include the appointment of a conservator or receiver, the issuance of a cease and desist order, the termination of deposit insurance, the imposition of civil money penalties on the institution, its directors, officers, employees and institution-affiliated parties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the removal of or restrictions on directors, officers, employees and institution-affiliated parties, and the enforcement of any such mechanisms through restraining orders or other court actions.



The Bank is subject to certain restrictions on extensions of credit to executive officers, directors, and principal shareholders or any related interest of such persons, which generally require that such credit extensions be made on substantially the same terms as those available to persons who are not related to the Bank and not involve more than the normal risk of repayment.  Other laws tie the maximum amount that may be loaned to any one customer and its related interests to capital levels.



As part of the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), each federal banking regulator adopted non-capital safety and soundness standards for institutions under its authority.  These standards include internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits.  An institution that fails to meet those standards may be required by the agency to develop a plan acceptable to meet the standards.  Failure to submit or implement such a plan may subject the institution to regulatory sanctions.  We believe that the Bank meets substantially all standards that have been adopted.  FDICIA also imposes capital standards on insured depository institutions.



The CRA requires the FDIC, in connection with its examination of financial institutions within its jurisdiction, to evaluate the record of those financial institutions in meeting the credit needs of their communities, including low and moderate income

 

10

 

 


 

neighborhoods, consistent with principles of safe and sound banking practices.  These factors are also considered by all regulatory agencies in evaluating mergers, acquisitions and applications to open a branch or facility.  As of the date of its most recent examination report, the Bank had a CRA rating of “Satisfactory”.



The Bank is also subject to a variety of other laws and regulations with respect to the operation of its business, including, but not limited to, the TILA/RESPA Integrated Disclosure rule (“TRID”), Truth in Lending Act, the Real Estate Settlement Procedures Act, the Truth in Savings Act, the Equal Credit Opportunity Act, the Electronic Funds Transfer Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, Expedited Funds Availability (Regulation CC), Reserve Requirements (Regulation D), Privacy of Consumer Information (Regulation P), Margin Stock Loans (Regulation U), the Right To Financial Privacy Act, the Flood Disaster Protection Act, the Homeowners Protection Act, the Servicemembers Civil Relief Act, the Telephone Consumer Protection Act, the CAN-SPAM Act, the Children’s Online Privacy Protection Act, Bank Secrecy Act/Anti-Money Laundering (“BSA/AML”) and Office of Foreign Assets Control (“OFAC”).



Capital Requirements



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 below under the heading “Liquidity Management”.  At December 31, 2019, the Bank had $115.0 million available through unsecured lines of credit with correspondent banks, $2.1 million available through a secured line of credit with the Fed Discount Window and approximately $143.7 million available through the Federal Home Loan Bank of Atlanta (“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 the 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. 



On July 2, 2013, the Federal Reserve approved final rules that substantially amended the regulatory risk-based capital rules applicable to First United Corporation. The FDIC subsequently approved the same rules. The final rules implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act and were implemented as of March 31, 2015. 



The Basel III capital rules include new risk-based capital and leverage ratios that were phased in between 2015 to 2019, and these rules also refine the definition of what constitutes “capital” for purposes of calculating those ratios. The minimum capital level requirements applicable to the Corporation under the final rules are: (i) a common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4% for all institutions. The final rules also establish a “capital conservation buffer” above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital. The capital conservation buffer was phased in over four years beginning on January 1, 2016.  The maximum buffer was 1.25% of risk-weighted assets for 2017, 1.875% of risk-weighted assets for 2018, and 2.5% of risk-weighted assets for and after 2019. These changes resulted in the following minimum ratios beginning in 2019: (a) a common equity Tier 1 capital ratio of 7.0%, (b) a Tier 1 capital ratio of 8.5% and (c) a total capital ratio of 10.5%. Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses 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.



The Basel III capital final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that no longer qualify as Tier 1 capital, some of which will be phased out over time. Under the final rules, the effects of certain accumulated other comprehensive items are not excluded; however, banking organizations like the Corporation and the Bank that are not considered “advanced approaches” banking organizations may make a one-time permanent election to continue to exclude these items. The Corporation and the Bank made this election in their first quarter 2015 regulatory filings in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of the Corporation’s available-for-sale securities portfolio.  Additionally, the final rules provide that small depository institution holding companies with less than $15 billion in total assets as of December 31, 2009 (which includes the Corporation) will be able to permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010  (such as the Corporation’s TPS Debentures) in additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature.



The Basel III capital rules revised the prompt corrective action framework, which is designed to place restrictions on insured depository institutions if their capital levels begin to show signs of weakness. These revisions were effective January 1, 2015. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions

 

11

 

 


 

are required to meet the following capital level requirements in order to qualify as “well capitalized”: (i) a new common equity Tier 1 capital ratio of 6.5%; (ii) a Tier 1 capital ratio of 8%; (iii) a total capital ratio of 10%; and (iv) a Tier 1 leverage ratio of 5%.



The Basel III capital rules set forth certain changes for the calculation of risk-weighted assets.  These changes include (i) an increased number of credit risk exposure categories and risk weights; (ii) an alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act; (iii) revisions to recognition of credit risk mitigation; (iv) rules for risk weighting of equity exposures and past due loans, and (v) revised capital treatment for derivatives and repo-style transactions.



Regulators may require higher capital ratios when warranted by the particular circumstances or risk profile of a given banking organization.  In the current regulatory environment, banking organizations must stay well-capitalized in order to receive favorable regulatory treatment on acquisition and other expansion activities and favorable risk-based deposit insurance assessments.  Our capital policy establishes guidelines meeting these regulatory requirements and takes into consideration current or anticipated risks as well as potential future growth opportunities.



At December 31, 2019, we were in compliance with the applicable requirements.



In July 2019, the federal banking agencies adopted a final rule that simplifies compliance with certain aspects of the capital rules.  A majority of the simplifications apply solely to banking organizations that are not subject to the advanced approaches capital rule.  The rule simplified the application of regulatory capital treatment for mortgage servicing assets, certain deferred tax assets arising from temporary differences, investments in the capital of unconsolidated financial institutions, and capital issued by a consolidated subsidiary of a banking organization and held by third parties (minority interest).  In addition, the rule revised the treatment of certain acquisition, development, or construction exposures. 



Additional information about our capital ratios is contained in “Consolidated Balance Sheet Review” section of Item 7 of Part II of this annual report under the heading “Capital Resources”. 



Prompt Corrective Action



The Federal Deposit Insurance Act (“FDI Act”) requires, among other things, the federal banking agencies to take “prompt corrective action” in respect of depository institutions that do not meet minimum capital requirements. The FDI Act includes the following five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A depository institution’s capital tier will depend upon how its capital levels compare with various relevant capital measures and certain other factors, as established by regulation. The relevant capital measures are the total capital ratio, the Tier 1 capital ratio and the leverage ratio.



A bank will be (i) “well capitalized” if the institution has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater, and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure, (ii) “adequately capitalized” if the institution has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater, and a leverage ratio of 4.0% or greater and is not “well capitalized”, (iii) “undercapitalized” if the institution has a total risk-based capital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio of less than 4.0% or a leverage ratio of less than 4.0%, (iv) “significantly undercapitalized” if the institution has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 3.0% or a leverage ratio of less than 3.0%, and (v) “critically undercapitalized” if the institution’s tangible equity is equal to or less than 2.0% of average quarterly tangible assets. An institution may be downgraded to, or deemed to be in, a capital category that is lower than indicated by its capital ratios if it is determined to be in an unsafe or unsound condition or if it receives an unsatisfactory examination rating with respect to certain matters. A bank’s capital category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.



Effective January 1, 2015, the Basel III capital rules revised the prompt corrective action requirements by (i) introducing the Common Equity Tier 1 (“CET1”) ratio requirement at each level (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category (other than critically undercapitalized), with the minimum Tier 1 capital ratio for well-capitalized status being 8%; and (iii) eliminating the provision that permitted a bank with a composite supervisory rating of 1 but a leverage ratio of at least 3% to be deemed adequately capitalized.  The Basel III Capital Rules did not change the total risk-based capital requirement for any prompt corrective action category.



The FDI Act generally prohibits a depository institution from making any capital distributions (including payment of a dividend) or paying any management fee to its parent holding company if the depository institution would thereafter be “undercapitalized.” “Undercapitalized” institutions are subject to growth limitations and are required to submit a capital restoration plan. The agencies may not accept such a plan without determining, among other things, that the plan is based on realistic assumptions and is

 

12

 

 


 

likely to succeed in restoring the depository institution’s capital. In addition, for a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan. The bank holding company must also provide appropriate assurances of performance. The aggregate liability of the parent holding company is limited to the lesser of (i) an amount equal to 5.0% of the depository institution’s total assets at the time it became undercapitalized and (ii) the amount which is necessary (or would have been necessary) to bring the institution into compliance with all capital standards applicable with respect to such institution as of the time it fails to comply with the plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.”  Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator.



The appropriate federal banking agency may, under certain circumstances, reclassify a well-capitalized insured depository institution as adequately capitalized. The FDI Act provides that an institution may be reclassified if the appropriate federal banking agency determines (after notice and opportunity for hearing) that the institution is in an unsafe or unsound condition or deems the institution to be engaging in an unsafe or unsound practice.



The appropriate agency is also permitted to require an adequately capitalized or undercapitalized institution to comply with the supervisory provisions as if the institution were in the next lower category (but not treat a significantly undercapitalized institution as critically undercapitalized) based on supervisory information other than the capital levels of the institution.



At December 31, 2019, the Bank and the Corporation were “well capitalized” based on the aforementioned ratios.



Liquidity Requirements



Historically, the regulation and monitoring of bank liquidity has been addressed as a supervisory matter, without required formulaic measures. The Basel III liquidity framework requires banks to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, going forward would be required by regulation. One test, referred to as the liquidity coverage ratio, is designed to ensure that the banking entity maintains an adequate level of unencumbered high-quality liquid assets equal to the entity’s expected net cash outflow for a 30-day time horizon (or, if greater, 25% of its expected total cash outflow) under an acute liquidity stress scenario. The other test, referred to as the net stable funding ratio, is designed to promote more medium- and long-term funding of the assets and activities of banking entities over a one-year time horizon. These requirements will incent banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt as a component of assets and increase the use of long-term debt as a funding source. 



Deposit Insurance



The Bank is a member of the FDIC and pays an insurance premium to the FDIC based upon its assessable deposits on a quarterly basis.  Deposits are insured up to applicable limits by the FDIC and such insurance is backed by the full faith and credit of the United States Government.



Under the Dodd-Frank Act, a permanent increase in deposit insurance was authorized to $250,000.  The coverage limit is per depositor, per insured depository institution for each account ownership category. 



The Dodd-Frank Act also set a new minimum DIF reserve ratio at 1.35% of estimated insured deposits.  The FDIC is required to attain this ratio by September 30, 2020.  The Dodd-Frank Act required the FDIC to redefine the deposit insurance assessment base for an insured depository institution.  Prior to the Dodd-Frank Act, an institution’s assessment base has historically been its domestic deposits, with some adjustments.  As redefined pursuant to the Dodd-Frank Act, an institution’s assessment base is now an amount equal to the institution’s average consolidated total assets during the assessment period minus average tangible equity.  Institutions with $1.0 billion or more in assets at the end of a fiscal quarter, like the Bank, must report their average consolidated total assets on a daily basis and report their average tangible equity on an end-of-month balance basis.  



On September 30, 2018, the Deposit Insurance Fund Reserve Ratio reached 1.36 percent.  As a result, small banks will receive assessment credits for the portion of their assessments that contributed to the growth in the reserve ratio from 1.15 percent to 1.35 percent, to be applied when the reserve ratio is at least 1.38 percent.  In 2019, the Bank received $.3 million in assessment credits and expects to receive final credits of approximately $.1 million by May 2020.



The Federal Deposit Insurance Reform Act of 2005, which created the DIF, gave the FDIC greater latitude in setting the assessment rates for insured depository institutions which could be used to impose minimum assessments.  The FDIC has the flexibility

 

13

 

 


 

to adopt actual rates that are higher or lower than the total base assessment rates adopted without notice and comment, if certain conditions are met. 



DIF-insured institutions pay a Financing Corporation (“FICO”) assessment in order to fund the interest on bonds issued in the 1980s in connection with the failures in the thrift industry.



The FDIC is authorized to conduct examinations of and require reporting by FDIC-insured institutions.  It is also authorized to terminate a depository bank’s deposit insurance upon a finding by the FDIC that the bank’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the bank’s regulatory agency.  The termination of deposit insurance for our bank subsidiary would have a material adverse effect on our earnings, operations and financial condition.



Bank Secrecy Act/Anti-Money Laundering



The Bank Secrecy Act (“BSA”), which is intended to require financial institutions to develop policies, procedures, and practices to prevent and deter money laundering, mandates that every national bank have a written, board-approved program that is reasonably designed to assure and monitor compliance with the BSA.



The program must, at a minimum: (i) provide for a system of internal controls to assure ongoing compliance; (ii) provide for independent testing for compliance; (iii) designate an individual responsible for coordinating and monitoring day-to-day compliance; and (iv) provide training for appropriate personnel.  In addition, state-chartered banks are required to adopt a customer identification program as part of its BSA compliance program.  State-chartered banks are also required to file Suspicious Activity Reports when they detect certain known or suspected violations of federal law or suspicious transactions related to a money laundering activity or a violation of the BSA.



In addition to complying with the BSA, the Bank is subject to the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”). The USA Patriot Act is designed to deny terrorists and criminals the ability to obtain access to the United States’ financial system and has significant implications for depository institutions, brokers, dealers, and other businesses involved in the transfer of money.   The USA Patriot Act mandates that financial service companies implement additional policies and procedures and take heightened measures designed to address any or all of the following matters: customer identification programs, money laundering, terrorist financing, identifying and reporting suspicious activities and currency transactions, currency crimes, and cooperation between financial institutions and law enforcement authorities.



Mortgage Lending and Servicing



The Bank’s mortgage lending and servicing activities are subject to various laws and regulations that are enforced by the federal banking regulators and the CFPB, such as the Truth in Lending Act, the Real Estate Settlement Procedures Act, and various rules adopted thereunder, including those relating to consumer disclosures, appraisal requirements, mortgage originator compensation, prohibitions on mandatory arbitration provisions under certain circumstances, and the obligation to credit payments and provide payoff statements within certain time periods and provide certain notices prior to interest rate and payment adjustments.

 

The Bank is required to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms.  Qualified mortgages that that are not “higher-priced” are afforded a safe harbor presumption of compliance with the ability to repay rules, while qualified mortgages that are “higher-priced” garner a rebuttable presumption of compliance with the ability to repay rules.  In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments, or a term exceeding 30 years, where the lender determines that the borrower has the ability to repay, and where the borrower’s points and fees do not exceed 3% of the total loan amount.  “Higher-priced” mortgages must have escrow accounts for taxes and insurance and similar recurring expenses.



On November 20, 2013, the CFPB issued a final rule on integrated mortgage disclosures under the Truth-in-Lending Act and the Real Estate Settlement Procedures Act, for which compliance was required by October 3, 2015.  At December 31, 2019, we believe that we are in compliance.



Consumer Lending – Military Lending Act



The Military Lending Act (the “MLA”), which was initially implemented in 2007, was amended and its coverage significantly expanded in 2015.  The Department of Defense (the “DOD”) issued a final rule under the MLA that took effect on October 15, 2015, but financial institutions were not required to take action until October 3, 2016.  The types of credit covered under the MLA were expanded to include virtually all consumer loan and credit card products (except for loans secured by residential real property and certain

 

14

 

 


 

purchase-money motor vehicle/personal property secured transactions).  Lenders must now provide specific written and oral disclosures concerning the protections of the MLA to active duty members of the military and dependents of active duty members of the military (“covered borrowers”).  The rule imposes a 36% “Military Annual Percentage Rate” cap that includes costs associated with credit insurance premiums, fees for ancillary products, finance charges associated with the transactions, and application and participation charges.  In addition, loan terms cannot include (i) a mandatory arbitration provision, (ii) a waiver of consumer protection laws, (iii) mandatory allotments from military benefits, or (iv) a prepayment penalty.  The revised rule also prohibits “roll-over” or refinances of the same loan unless the new loan provides more favorable terms for the covered borrower.  Lenders may verify covered borrower status using a DOD database or information provided by credit bureaus.  We believe that we are in compliance with the revised rule. 



Cybersecurity



We rely on electronic communications and information systems to conduct our operations and store sensitive data.  We employ an in-depth approach that leverages people, processes, and technology to manage and maintain cybersecurity controls.  In addition, we employ a variety of preventative and detective tools to monitor, block, and provide alerts regarding suspicious activity, as well as to report on any suspected advanced persistent threats.  Notwithstanding the strength of our defensive measures, the threat from cyber-attacks is severe, attacks are sophisticated and increasing in volume, and attackers respond rapidly to changes in defensive measures.



The federal banking regulators have adopted guidelines for establishing information security standards and cybersecurity programs for implementing safeguards under the supervision of a financial institution’s board of directors.  These guidelines, along with related regulatory materials, increasingly focus on risk management and processes related to information technology and the use of third parties in the provision of financial products and services.  The federal banking regulators expect financial institutions to establish lines of defense and to ensure that their risk management processes address the risk posed by compromised customer credentials, and also expect financial institutions to maintain sufficient business continuity planning processes to ensure rapid recovery, resumption and maintenance of the institution's operations after a cyberattack.  If we fail to meet the expectations set forth in this regulatory guidance, then we could be subject to various regulatory actions and we may be required to devote significant resources to any required remediation efforts.



Federal Securities Laws and NASDAQ Rules



The shares of the Corporation’s common stock are registered with the SEC under Section 12(b) of the Exchange and listed on the NASDAQ Global Select Market.  The Corporation is subject to information reporting requirements, proxy solicitation requirements, insider trading restrictions and other requirements of the Exchange Act, including the requirements imposed under the federal Sarbanes-Oxley Act of 2002, and rules adopted by NASDAQ.  Among other things, loans to and other transactions with insiders are subject to restrictions and heightened disclosure, directors and certain committees of the Board must satisfy certain independence requirements, the Corporation must comply with certain enhanced corporate governance requirements, and various issuances of securities by the Corporation require shareholder approval.



Governmental Monetary and Credit Policies and Economic Controls



The earnings and growth of the banking industry and ultimately of the Bank are affected by the monetary and credit policies of governmental authorities, including the Federal Reserve.  An important function of the Federal Reserve is to regulate the national supply of bank credit in order to control recessionary and inflationary pressures. Among the instruments of monetary policy used by the Federal Reserve to implement these objectives are open market operations in U.S. Government securities, changes in the federal funds rate, changes in the discount rate of member bank borrowings, and changes in reserve requirements against member bank deposits.  These means are used in varying combinations to influence overall growth of bank loans, investments and deposits and may also affect interest rates charged on loans or paid on deposits.  The monetary policies of the Federal Reserve authorities have had a significant effect on the operating results of commercial banks in the past and are expected to continue to have such an effect in the future.  In view of changing conditions in the national economy and in the money markets, as well as the effect of actions by monetary and fiscal authorities, including the Federal Reserve, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or their effect on our businesses and earnings.



SEASONALITY



Management does not believe that our business activities are seasonal in nature.  Deposit and loan demand may vary depending on local and national economic conditions, but management believes that any variation will not have a material impact on our planning or policy-making strategies.



 

15

 

 


 

EMPLOYEES



At December 31, 2019, we employed 319 individuals, of whom 285 were full-time employees.

 

16

 

 


 

ITEM 1A. RISK FACTORS



The significant risks and uncertainties related to us, our business and our securities of which we are aware are discussed below.  Investors and shareholders should carefully consider these risks and uncertainties before making investment decisions with respect to the Corporation’s securities.  Any of these factors could materially and adversely affect our business, financial condition, operating results and prospects and could negatively impact the market price of the Corporation’s securities.  If any of these risks materialize, the holders of the Corporation’s securities could lose all or part of their investments in the Corporation.  Additional risks and uncertainties that we do not yet know of, or that we currently think are immaterial, may also impair our business operations.  Investors and shareholders should also consider the other information contained in this annual report, including our financial statements and the related notes, before making investment decisions with respect to the Corporation’s securities. 



Risks Relating to First United Corporation and its Affiliates



First United Corporation’s future success depends on the successful growth of its subsidiaries.



The Corporation’s primary business activity for the foreseeable future will be to act as the holding company of the Bank and its other direct and indirect subsidiaries.  Therefore, the Corporation’s future profitability will depend on the success and growth of these subsidiaries.  



We could be adversely affected by risks associated with future acquisitions and expansions.



Although our core growth strategy is focused around organic growth, we may from time to time consider acquisition and expansion opportunities involving a bank or other entity operating in the financial services industry.  We cannot predict if or when we will engage in such a strategic transaction, or the nature or terms of any such transaction.  To the extent that we grow through an acquisition, we cannot assure investors that we will be able to adequately and profitably manage that growth or that an acquired business will be integrated into our existing businesses as efficiently or as timely as we may anticipate.  Acquiring another business would generally involve risks commonly associated with acquisitions, including:



·

increased capital needs;

·

increased and new regulatory and compliance requirements;

·

implementation or remediation of controls, procedures and policies with respect to the acquired business;

·

diversion of management time and focus from operation of our then-existing business to acquisition-integration challenges;

·

coordination of product, sales, marketing and program and systems management functions;

·

transition of the acquired business’s users and customers onto our systems;

·

retention of employees from the acquired business;

·

integration of employees from the acquired business into our organization;

·

integration of the acquired business’s accounting, information management, human resources and other administrative systems and operations with ours;

·

potential liability for activities of the acquired business prior to the acquisition, including violations of law, commercial disputes and tax and other known and unknown liabilities;

·

potential increased litigation or other claims in connection with the acquired business, including claims brought by regulators, terminated employees, customers, former stockholders, vendors, or other third parties; and

·

potential goodwill impairment.



Our failure to execute our acquisition strategy could adversely affect our business, results of operations, financial condition and future prospects risks of unknown or contingent liabilities. 



Interest rates and other economic conditions will impact our results of operations.



Our net income depends primarily upon our net interest income. Net interest income is the difference between interest income earned on loans, investments and other interest-earning assets and the interest expense incurred on deposits and borrowed funds. The level of net interest income is primarily a function of the average balance of our interest-earning assets, the average balance of our interest-bearing liabilities, and the spread between the yield on such assets and the cost of such liabilities. These factors are influenced by both the pricing and mix of our interest-earning assets and our interest-bearing liabilities which, in turn, are impacted by such external factors as the local economy, competition for loans and deposits, the monetary policy of the Federal Open Market Committee of the Federal Reserve Board of Governors, and market interest rates.



Different types of assets and liabilities may react differently, and at different times, to changes in market interest rates. We expect that we will periodically experience gaps in the interest rate sensitivities of our assets and liabilities. That means either our

 

17

 

 


 

interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. When interest-bearing liabilities mature or re-price more quickly than interest-earning assets, an increase in market rates of interest could reduce our net interest income. Likewise, when interest-earning assets mature or re-price more quickly than interest-bearing liabilities, falling interest rates could reduce our net interest income. We are unable to predict changes in market interest rates, which are affected by many factors beyond our control, including inflation, deflation, recession, unemployment, money supply, domestic and international events and changes in the United States and other financial markets.



We also attempt to manage risk from changes in market interest rates, in part, by controlling the mix of interest rate sensitive assets and interest rate sensitive liabilities. However, interest rate risk management techniques are not exact. A rapid increase or decrease in interest rates could adversely affect our results of operations and financial performance.



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.

The Corporation’s business is dependent upon the willingness and ability of its customers to conduct banking and other financial transactions. The spread of a highly infectious or contagious disease, such as COVID-19, could cause severe disruptions in the U.S. economy, which could in turn disrupt the business, activities, and operations of the Corporation’s customers, as well the business and operations of the Corporation. Moreover, since the beginning of January 2020, the coronavirus outbreak has caused significant disruption in the financial markets both globally and in the United States. The spread of COVID-19, or an outbreak of another highly infectious or contagious disease, may result in a significant decrease in business and/or cause the Corporation’s customers to be unable to meet existing payment or other obligations to the Corporation, particularly in the event of a spread of COVID-19 or an outbreak of an infectious disease in the Corporation’s market area. A spread of COVID-19, or an outbreak of another contagious disease, could also negatively impact the availability of key personnel of the Corporation necessary to conduct the business of the Corporation. Such a spread or outbreak could also negatively impact the business and operations of third-party service providers who perform critical services for the Corporation’s business. If COVID-19, or another highly infectious or contagious disease, spreads or the response to contain COVID-19 is unsuccessful, the Corporation could experience a material adverse effect on its business, financial condition, and results of operations.

The majority of our business is concentrated in Maryland and West Virginia, much of which involves real estate lending, so a decline in the real estate and credit markets could materially and adversely impact our financial condition and results of operations. 



Most of the Bank’s loans are made to borrowers located in Western Maryland and Northeastern West Virginia, and many of these loans, including construction and land development loans, are secured by real estate.  At December 31, 2019, approximately 12%, or $117.9 million, of our total loans were real estate acquisition, construction and development loans that were secured by real estate.  Accordingly, a decline in local economic conditions would likely have an adverse impact on our financial condition and results of operations, and the impact on us would likely be greater than the impact felt by larger financial institutions whose loan portfolios are geographically diverse.  We cannot guarantee that any risk management practices we implement to address our geographic and loan concentrations will be effective to prevent losses relating to our loan portfolio. 



The Bank’s concentrations of commercial real estate loans could subject it to increased regulatory scrutiny and directives, which could force us to preserve or raise capital and/or limit future commercial lending activities.



The federal banking regulators believe that institutions that have particularly high concentrations of CRE loans within their lending portfolios face a heightened risk of financial difficulties in the event of adverse changes in the economy and CRE markets.  Accordingly, through published guidance, these regulators have directed institutions whose concentrations exceed certain percentages of capital to implement heightened risk management practices appropriate to their concentration risk.  The guidance provides that banking regulators may require such institutions to reduce their concentrations and/or maintain higher capital ratios than institutions with lower concentrations in CRE.  At December 31, 2019, our CRE concentrations were below the heightened risk management thresholds set forth in this guidance. 



The Bank may experience loan losses in excess of its allowance, which would reduce our earnings.



The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loans being made, the creditworthiness of the borrowers over the term of the loans and, in the case of collateralized loans, the value and marketability of the collateral for the loans.  Management of the Bank maintains an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectability of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and for specific loans when their ultimate collectability

 

18

 

 


 

is considered questionable.  If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb future losses, or if the bank regulatory authorities require us to increase the allowance for loan losses as a part of its examination process, our earnings and capital could be significantly and adversely affected.  Although management continually monitors our loan portfolio and makes determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the assumptions used or adverse developments arise with respect to our non-performing or performing loans.  Material additions to the allowance for loan losses could result in a material decrease in our net income and capital; and could have a material adverse effect on our financial condition.



A new accounting standard will likely require us to increase our allowance for loan losses and may have a material adverse effect on our financial condition and results of operations.

 

The FASB has adopted a new accounting standard that was originally effective for the Corporation and the Bank beginning with our first full fiscal year after December 15, 2019. 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 SEC, and other non-SEC reporting entities, including the Corporation, resulting in a required implementation date for the Corporation of January 1, 2023.  This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses.  This standard will change the current method of providing allowances for loan losses that are probable, which would likely require us to increase our allowance for loan losses, and to greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses may have a material adverse effect on our financial condition and results of operations.



The market value of our investments could decline.



At December 31, 2019, investment securities in our investment portfolio having a cost basis of $135.0 million and a market value of $131.3 million were classified as available-for-sale pursuant to FASB Accounting Standards Codification (“ASC”) Topic 320, Investments – Debt and Equity Securities, relating to accounting for investments.  Topic 320 requires that unrealized gains and losses in the estimated value of the available-for-sale portfolio be “marked to market” and reflected as a separate item in shareholders’ equity (net of tax) as accumulated other comprehensive loss.  There can be no assurance that future market performance of our investment portfolio will enable us to realize income from sales of securities.  Shareholders’ equity will continue to reflect the unrealized gains and losses (net of tax) of these investments.  Moreover, there can be no assurance that the market value of our investment portfolio will not decline, causing a corresponding decline in shareholders’ equity.



Management believes that several factors could affect the market value of our investment portfolio.  These include, but are not limited to, changes in interest rates or expectations of changes, the degree of volatility in the securities markets, inflation rates or expectations of inflation and the slope of the interest rate yield curve (the yield curve refers to the differences between shorter-term and longer-term interest rates; a positively sloped yield curve means shorter-term rates are lower than longer-term rates).  Also, the passage of time will affect the market values of our investment securities, in that the closer they are to maturing, the closer the market price should be to par value.  These and other factors may impact specific categories of the portfolio differently, and management cannot predict the effect these factors may have on any specific category.



Impairment of investment securities, goodwill, or deferred tax assets could require charges to earnings, which could result in a negative impact on our results of operations.



In assessing whether the impairment of investment securities is other-than-temporary, management considers the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability to retain our investment in the security for a period of time sufficient to allow for any anticipated recovery in fair value in the near term.  See the discussion under the heading “Estimates and Critical Accounting Policies – Other-Than-Temporary Impairment of Investment Securities” in Item 7 of Part II of this annual report for further information.



Under current accounting standards, goodwill is not amortized but, instead, is subject to impairment tests on at least an annual basis or more frequently if an event occurs or circumstances change that reduce the fair value of a reporting unit below its carrying amount.  A decline in the price of the Corporation’s common stock or occurrence of a triggering event following any of our quarterly earnings releases and prior to the filing of the periodic report for that period could, under certain circumstances, cause us to perform a goodwill impairment test and result in an impairment charge being recorded for that period which was not reflected in such earnings release.  In the event that we conclude that all or a portion of our goodwill may be impaired, a non-cash charge for the amount of such impairment would be recorded to earnings.  Such a charge would have no impact on tangible capital.  At December 31, 2019, we had recorded goodwill of $11.0 million, representing approximately 8.7% of shareholders’ equity.  See the discussion under the heading “Estimates and Critical Accounting Policies – Goodwill” in Item 7 of Part II of this annual report for further information.

 

19

 

 


 



At December 31, 2019, our net deferred tax assets were valued at $7.4 million.  Included in that total is $2.6 million of state net operating loss carryforwards associated with separate company tax filings of the Corporation, which we do not expect to use and, thus, we have established a $2.6 million valuation allowance.  The federal net operating loss (“NOL”) carryforward was fully utilized in 2018.  A deferred tax asset is reduced by a valuation allowance if, based on the weight of the evidence available, both negative and positive, including the recent trend of quarterly earnings, management believes that it is more likely than not that some portion or all of the total deferred tax asset will not be realized.  Moreover, our ability to utilize our net operating loss carryforwards to offset future taxable income may be significantly limited if we experience an “ownership change,” as determined under Section 382 of the Code. If an ownership change were to occur, the limitations imposed by Section 382 of the Code could result in a portion of our net operating loss carryforwards expiring unused, thereby impairing their value. Section 382’s provisions are complex, and we cannot predict any circumstances surrounding the future ownership of the common stock.  Accordingly, we cannot provide any assurance that we will not experience an ownership change in the future. 



The impact of each of these impairment matters could have a material adverse effect on our business, results of operations, and financial condition.



We operate in a competitive environment, and our inability to effectively compete could adversely and materially impact our financial condition and results of operations.



We operate in a competitive environment, competing for loans, deposits, and customers with commercial banks, savings associations and other financial entities.  Competition for deposits comes primarily from other commercial banks, savings associations, credit unions, money market and mutual funds and other investment alternatives.  Competition for loans comes primarily from other commercial banks, savings associations, mortgage banking firms, credit unions and other financial intermediaries.  Competition for other products, such as securities products, comes from other banks, securities and brokerage companies, and other non-bank financial service providers in our market area.  Many of these competitors are much larger in terms of total assets and capitalization, have greater access to capital markets, and/or offer a broader range of financial services than those that we offer.  In addition, banks with a larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the needs of larger customers.



In addition, changes to the banking laws over the last several years have facilitated interstate branching, merger and expanded activities by banks and holding companies.  For example, the federal Gramm-Leach-Bliley Act (the “GLB Act”) revised the BHC Act and repealed the affiliation provisions of the Glass-Steagall Act of 1933, which, taken together, limited the securities and other non-banking activities of any company that controls an FDIC insured financial institution.  As a result, the ability of financial institutions to branch across state lines and the ability of these institutions to engage in previously-prohibited activities are now accepted elements of competition in the banking industry.  These changes may bring us into competition with more and a wider array of institutions, which may reduce our ability to attract or retain customers.  Management cannot predict the extent to which we will face such additional competition or the degree to which such competition will impact our financial conditions or results of operations.



The banking industry is heavily regulated; significant regulatory changes could adversely affect our operations.



Our operations will be impacted by current and future legislation and by the policies established from time to time by various federal and state regulatory authorities.  The Corporation is subject to supervision by the Federal Reserve.  The Bank is subject to supervision and periodic examination by the Maryland Commissioner of Financial Regulation, the West Virginia Division of Banking, and the FDIC.  Banking regulations, designed primarily for the safety of depositors, may limit a financial institution’s growth and the return to its investors by restricting such activities as the payment of dividends, mergers with or acquisitions by other institutions, investments, loans and interest rates, interest rates paid on deposits, expansion of branch offices, and the offering of securities or trust services.  The Corporation and the Bank are also subject to capitalization guidelines established by federal law and could be subject to enforcement actions to the extent that either is found by regulatory examiners to be undercapitalized. It is not possible to predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on our future business and earnings prospects.  Management also cannot predict the nature or the extent of the effect on our business and earnings of future fiscal or monetary policies, economic controls, or new federal or state legislation.  Further, the cost of compliance with regulatory requirements may adversely affect our ability to operate profitably.



The full impact of the Dodd-Frank Act is unknown because some rule making efforts are still required to fully implement all of its requirements and the implementation of some enforcement efforts is just beginning.  We anticipate continued increases in regulatory expenses as a result of the Dodd-Frank Act.



The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States and affects the lending, investment, trading and operating activities of all financial institutions.  Based on the text of the Dodd-Frank Act and the

 

20

 

 


 

implementing regulations, it is anticipated that the costs to banks may increase or fee income may decrease significantly, which could adversely affect our results of operations, financial condition and/or liquidity.



The Consumer Financial Protection Bureau may continue to reshape the consumer financial laws through rulemaking and enforcement of the prohibitions against unfair, deceptive and abusive business practices.  Compliance with any such change may impact our business operations.



The CFPB has broad rulemaking authority to administer and carry out the provisions of the Dodd-Frank Act with respect to financial institutions that offer covered financial products and services to consumers.  The CFPB has also been directed to adopt rules identifying practices or acts that are unfair, deceptive or abusive in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service.  The concept of what may be considered to be an “abusive” practice is new under the law.  We have been required to dedicate significant personnel resources to address the compliance burdens imposed by the CFBP’s adoption of various rules, and the adoption of additional rules in the future would likely require us to dedicate even more resources. 



Bank regulators and other regulations, including the Basel III Capital Rules, may require higher capital levels, impacting our ability to pay dividends or repurchase our stock.



The capital standards to which we are subject, including the standards created by the Basel III Capital Rules, may materially limit our ability to use our capital resources and/or could require us to raise additional capital by issuing common stock.  The issuance of additional shares of common stock could dilute existing stockholders.



A material weakness or significant deficiency in our disclosure or internal controls could have an adverse effect on us.



The Corporation is required by the Sarbanes-Oxley Act of 2002 to establish and maintain disclosure controls and procedures and internal control over financial reporting.  These control systems are intended to provide reasonable assurance that material information relating to the Corporation is made known to our management and reported as required by the Exchange Act, to provide reasonable assurance regarding the reliability and preparation of our financial statements, and to provide reasonable assurance that fraud and other unauthorized uses of our assets are detected and prevented. We may not be able to maintain controls and procedures that are effective at the reasonable assurance level.  If that were to happen, our ability to provide timely and accurate information about the Corporation, including financial information, to investors could be compromised and our results of operations could be harmed. Moreover, if the Corporation or its independent registered public accounting firm were to identify a material weakness or significant deficiency in any of those control systems, our reputation could be harmed and investors could lose confidence in us, which could cause the market price of the Corporation’s stock to decline and/or limit the trading market for the common stock.



The Bank’s funding sources may prove insufficient to replace deposits and support our future growth.



The Bank relies on customer deposits, advances from the FHLB, lines of credit at other financial institutions and brokered funds to fund our operations.  Although the Bank has historically been able to replace maturing deposits and advances if desired, no assurance can be given that the Bank would be able to replace such funds in the future if our financial condition or the financial condition of the FHLB or market conditions were to change.  Our financial flexibility will be severely constrained and/or our cost of funds will increase if we are unable to maintain our access to funding or if financing necessary to accommodate future growth is not available at favorable interest rates.  Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs.  In that case, our profitability would be adversely affected.



The loss of key personnel could disrupt our operations and result in reduced earnings.



Our growth and profitability will depend upon our ability to attract and retain skilled managerial, marketing and technical personnel.  Competition for qualified personnel in the financial services industry is intense, and there can be no assurance that we will be successful in attracting and retaining such personnel.  Our current executive officers provide valuable services based on their many years of experience and in-depth knowledge of the banking industry and the market areas we serve.  Due to the intense competition for financial professionals, these key personnel would be difficult to replace and an unexpected loss of their services could result in a disruption to the continuity of operations and a possible reduction in earnings. 



The Bank’s lending activities subject the Bank to the risk of environmental liabilities.



A significant portion of the Bank’s loan portfolio is secured by real property.  During the ordinary course of business, the Bank may foreclose on and take title to properties securing certain loans.  In doing so, there is a risk that hazardous or toxic substances could be found on these properties.  If hazardous or toxic substances are found, the Bank may be liable for remediation costs, as well as for

 

21

 

 


 

personal injury and property damage.  Environmental laws may require the Bank to incur substantial expenses and may materially reduce the affected property’s value or limit the Bank’s ability to use or sell the affected property.  In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase the Bank’s exposure to environmental liability.  Although the Bank has policies and procedures to perform an environmental review before initiating any foreclosure action on real property, these reviews may not be sufficient to detect all potential environmental hazards.  The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on our financial condition and results of operations.



We are a community bank and our ability to maintain our reputation is critical to the success of our business.

 

We are a community banking institution, and our reputation is one of the most valuable components of our business. A key component of our business strategy is to rely on our reputation for customer service and knowledge of local markets to expand our presence by capturing new business opportunities from existing and prospective customers in our current market and contiguous areas. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected by the actions of our employees, by our inability to conduct our operations in a manner that is appealing to current or prospective customers, or otherwise, our business and, therefore, our operating results may be materially adversely affected.



We may be subject to claims and the costs of defensive actions, and such claims and costs could materially and adversely impact our financial condition and results of operations.



Our customers may sue us for losses due to alleged breaches of fiduciary duties, errors and omissions of employees, officers and agents, incomplete documentation, our failure to comply with applicable laws and regulations, or many other reasons.  Also, our employees may knowingly or unknowingly violate laws and regulations.  Management may not be aware of any violations until after their occurrence.  This lack of knowledge may not insulate us from liability.  Claims and legal actions will result in legal expenses and could subject us to liabilities that may reduce our profitability and hurt our financial condition.



We may not be able to keep pace with developments in technology.



We use various technologies in conducting our businesses, including telecommunication, data processing, computers, automation, internet-based banking, and debit cards.  Technology changes rapidly. Our ability to compete successfully with other financial institutions may depend on whether we can exploit technological changes.  We may not be able to exploit technological changes, and any investment we do make may not make us more profitable.



Our information systems may experience an interruption or a breach in security, due to cyber-attacks.



In the ordinary course of business, we collect and store sensitive data, including proprietary business information and personally identifiable information of our customers and employees in systems and on networks. The secure processing, maintenance, and use of this information is critical to our operations and business strategy.  In addition, we rely heavily on communications and information systems to conduct our business.  Any failure, interruption, or breach in security or operational integrity of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan, and other systems.  Although we have invested in various technologies and continually review processes and practices that are designed to protect our networks, computers, and data from damage or unauthorized access, our computer systems and infrastructure may nevertheless be vulnerable to attacks by hackers or breached due to employee error, malfeasance, or other disruptions.  Further, cyber-attacks can originate from a variety of sources and the techniques used are increasingly sophisticated.  A breach of any kind could compromise our systems, and the information stored there could be accessed, damaged, or disclosed.  A breach in security or other failure could result in legal claims, regulatory penalties, disruptions in operations, increased expenses, loss of customers and business partners, and damage to our reputation, which could in turn adversely affect our business, financial condition and/or results of operations.  Furthermore, as cyber threats continue to evolve and increase, we may be required to expend significant additional financial and operational resources to modify or enhance our protective measures, or to investigate and remediate any identified information security vulnerabilities.



Safeguarding our business and customer information increases our cost of operations. To the extent that we, or our third-party vendors, are unable to prevent the theft of or unauthorized access to this information, our operations may become disrupted, we may be subject to claims, and our net income may be adversely affected.



Our business depends heavily on the use of computer systems, the Internet and other means of electronic communication and recordkeeping.  Accordingly, we must protect our computer systems and network from break-ins, security breaches, and other risks that could disrupt our operations or jeopardize the security of our business and customer information.  Moreover, we use third party vendors

 

22

 

 


 

to provide products and services necessary to conduct our day-to-day operations, which exposes us to risk that these vendors will not perform in accordance with the service arrangements, including by failing to protect the confidential information we entrust to them.  Any security measures that we or our vendors implement, including encryption and authentication technology that we use to effect secure transmissions of confidential information, may not be effective to prevent the loss or theft of our information or to prevent risks associated with the Internet, such as cyber-fraud.  Advances in computer capabilities, new discoveries in the field of cryptography, or other developments could permit unauthorized persons to gain access to our confidential information in spite of the use of security measures that we believe are adequate.  Any compromise of our security measures or of the security measures employed by our vendors of our third party could disrupt our business and/or could subject us to claims from our customers, either of which could have a material adverse effect on our business, financial condition and results of operations.



Risks Relating to First United Corporation’s Securities



We are subject to risks from a proxy contest and/or the actions of activist shareholders.

On December 3, 2019, Driver Management Company LLC, Driver Opportunity Partners I LP, and J. Abbott R. Cooper (collectively, “Driver”), notified the Corporation of Driver’s intent to nominate three candidates for election to the Corporation’s Board of Directors at the 2020 annual meeting of shareholders.  A proxy contest or related activities on the part of Driver or other activist shareholders could adversely affect our business for a number of reasons, including, without limitation, the following:

"

Responding to proxy contests and other actions by activist stockholders can be costly and time-consuming, disrupting our operations and diverting the attention of management and our employees;

"

Perceived uncertainties as to our future direction may result in the loss of potential business opportunities and may make it more difficult to attract and retain qualified personnel, business partners, customers and others important to our success, any of which could negatively affect our business and our results of operations and financial condition; and

"

If nominees advanced by activist shareholders are elected or appointed to our Board of Directors with a specific agenda, it may adversely affect our ability to effectively and timely implement our strategic plans or to realize long-term value from our assets, and this could in turn have an adverse effect on our business and on our results of operations and financial condition.

Proxy contests may cause our stock price to experience periods of volatility.  Further, if a proxy contest results in a change in control of our Board of Directors, such an event could subject us to risks relating to certain third parties’ rights under our existing contractual obligations, which could adversely affect our business.

The shares of common stock are not insured.



The shares of the Corporation’s common stock are not deposits and are not insured against loss by the FDIC or any other governmental or private agency. 



The common stock is not heavily traded.



The Corporation’s common stock is listed on the NASDAQ Global Select Market, but shares of the common stock are not heavily traded.  Securities that are not heavily traded can be more volatile than stock trading in an active public market.  Factors such as our financial results, the introduction of new products and services by us or our competitors, various factors affecting the banking industry generally, and investor speculation as to our future plans and strategies could have a significant impact on the market price and trading volume of the shares of our common stock.  Likewise, events that are unrelated to the Corporation but that affect the equity markets generally, such as international health crises, wars, political instability and similar factors, could also have a significant impact on the market price and trading volume of the shares of common stock.  Management cannot predict the extent to which an active public market for the common stock will develop or be sustained in the future.  Accordingly, shareholders may not be able to sell their shares at the volumes, prices, or times that they desire.



Significant sales of the common stock, or the perception that significant sales may occur in the future, could adversely affect the market price for the common stock.

 

The sale of a substantial number of shares amounts of the Corporation’s common stock could adversely affect the market price of the common stock. The availability of shares for future sale could adversely affect the prevailing market price of the common stock and could cause the market price of the common stock to remain low for a substantial amount of time. In addition, the Corporation may grant equity awards under its equity compensation plans from time to time in effect, including fully-vested shares of common stock.  It

 

23

 

 


 

is possible that if a significant percentage of such available shares were attempted to be sold within a short period of time, the market for the shares would be adversely affected.  Management cannot predict whether the market for the common stock could absorb a large number of attempted sales in a short period of time, regardless of the price at which they might be offered.  Even if a substantial number of sales do not occur within a short period of time, the mere existence of this “market overhang” could have a negative impact on the market for the common stock and our ability to raise capital in the future.



The Corporation’s ability to pay dividends on the common stock is subject to the terms of the outstanding TPS Debentures, which prohibit the Corporation from paying dividends during an interest deferral period. 



In March 2004, the Corporation issued approximately $30.9 million, in the aggregate, of junior subordinated debentures (“TPS Debentures”) to the Trusts in connection with the Trusts’ sales to third party investors of $30.0 million, in the aggregate, in mandatorily redeemable preferred capital securities.  The terms of the TPS Debentures require the Corporation to make quarterly payments of interest to the Trusts, as the holders of the TPS Debentures, although the Corporation has the right to defer payments of interest for up to 20 consecutive quarterly periods.  An election to defer interest payments does not constitute an event of default under the terms of the TPS Debentures.  The terms of the TPS Debentures prohibit the Corporation from declaring or paying any dividends or making other distributions on, or from repurchasing, redeeming or otherwise acquiring, any shares of its capital securities, including the common stock, if the Corporation elects to defer quarterly interest payments under the TPS Debentures.  In addition, a deferral election will require the Trusts to likewise defer the payment of quarterly dividends on their related trust preferred securities.



Applicable banking and Maryland laws impose additional restrictions on the ability of the Corporation and the Bank to pay dividends and make other distributions on their capital securities, and, in any event, the payment of dividends is at the discretion of the boards of directors of the Corporation and the Bank. 



In the past, the Corporation has funded dividends on its capital securities using cash received from the Bank, and this will likely be the case for the foreseeable future.  No assurance can be given that the Bank will be able to pay dividends to the Corporation for these purposes at times and/or in amounts requested by the Corporation.  Both federal and state laws impose restrictions on the ability of the Bank to pay dividends.  Under Maryland law, a state-chartered commercial bank may pay dividends only out of undivided profits or, with the prior approval of the Maryland Commissioner, from surplus in excess of 100% of required capital stock.  If, however, the surplus of a Maryland bank is less than 100% of its required capital stock, cash dividends may not be paid in excess of 90% of net earnings.  In addition to these specific restrictions, bank regulatory agencies have the ability to prohibit proposed dividends by a financial institution which would otherwise be permitted under applicable regulations if the regulatory body determines that such distribution would constitute an unsafe or unsound practice.  Banks that are considered “troubled institution” are prohibited by federal law from paying dividends altogether.  Notwithstanding the foregoing, shareholders must understand that the declaration and payment of dividends and the amounts thereof are at the discretion of the Corporation’s Board of Directors.  Thus, even at times when the Corporation is not prohibited from paying cash dividends on its capital securities, neither the payment of such dividends nor the amounts thereof can be guaranteed.



The Corporation’s Articles of Incorporation and Bylaws and Maryland law may discourage a corporate takeover.



The Corporation’s Amended and Restated Articles of Incorporation (the “Charter”) and its Amended and Restated Bylaws, as amended (the “Bylaws”), contain certain provisions designed to enhance the ability of the Corporation’s Board of Directors to deal with attempts to acquire control of the Corporation.  First, the Board of Directors is classified into three classes.  Directors of each class serve for staggered three-year periods, and no director may be removed except for cause, and then only by the affirmative vote of either a majority of the entire Board of Directors or a majority of the outstanding voting stock.  Second, the board has the authority to classify and reclassify unissued shares of stock of any class or series of stock by setting, fixing, eliminating, or altering in any one or more respects the preferences, rights, voting powers, restrictions and qualifications of, dividends on, and redemption, conversion, exchange, and other rights of, such securities.  The board could use this authority, along with its authority to authorize the issuance of securities of any class or series, to issue shares having terms favorable to management or to a person or persons affiliated with or otherwise friendly to management.  In addition, the Bylaws require any shareholder who desires to nominate a director to abide by strict notice requirements.



Maryland corporation laws include provisions that could discourage a sale or takeover of the Corporation.  The Maryland Business Combination Act generally prohibits, subject to certain limited exceptions, corporations from being involved in any “business combination” (defined as a variety of transactions, including a merger, consolidation, share exchange, asset transfer or issuance or reclassification of equity securities) with any “interested shareholder” for a period of five years following the most recent date on which the interested shareholder became an interested shareholder.  An interested shareholder is defined generally as a person who is the beneficial owner of 10% or more of the voting power of the outstanding voting stock of the corporation after the date on which the corporation had 100 or more beneficial owners of its stock or who is an affiliate or associate of the corporation and was the beneficial owner, directly or indirectly, of 10% percent or more of the voting power of the then outstanding stock of the corporation at any time

 

24

 

 


 

within the two-year period immediately prior to the date in question and after the date on which the corporation had 100 or more beneficial owners of its stock.  The Maryland Control Share Acquisition Act applies to acquisitions of “control shares”, which, subject to certain exceptions, are shares the acquisition of which entitle the holder, directly or indirectly, to exercise or direct the exercise of the voting power of shares of stock of the corporation in the election of directors within any of the following ranges of voting power:  one-tenth or more, but less than one-third of all voting power; one-third or more, but less than a majority of all voting power or a majority or more of all voting power.  Control shares have limited voting rights.  Maryland banking laws provide that the Maryland Commissioner must approve certain acquisitions of the common stock of the Corporation and the Bank, and impose penalties on persons who effect such an acquisition without approval. 



Although these provisions do not preclude a sale or takeover, they may have the effect of discouraging, delaying or deferring a sale, tender offer, or takeover attempt that a shareholder might consider in his or her best interest, including those attempts that might result in a premium over the market price for the common stock.  Such provisions will also render the removal of the Board of Directors and of management more difficult and, therefore, may serve to perpetuate current management.  These provisions could potentially adversely affect the market prices of the Corporation’s securities.



 

ITEM 1B. UNRESOLVED STAFF COMMENTS



None.

 

ITEM 2. PROPERTIES



The headquarters of the Corporation and the Bank occupies approximately 29,000 square feet at 19 South Second Street, Oakland, Maryland, and a 30,000 square feet operations center located at 12892 Garrett Highway, Oakland Maryland.  These premises are owned by the Corporation. The Bank owns 19 of its banking offices and leases six.  The Bank also leases one office that is used for disaster recovery purposes.  Total rent expense on the leased offices and properties was $.4 million in 2019.



ITEM 3. LEGAL PROCEEDINGS



We are at times, in the ordinary course of business, subject to legal actions.  Management, upon the advice of counsel, believes that losses, if any, resulting from current legal actions will not have a material adverse effect on our financial condition or results of operations.



ITEM 4. MINE SAFETY DISCLOSURES



Not applicable.

 

25

 

 


 

PART II



ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES



Shares of the Corporation’s common stock are listed on the NASDAQ Global Select Market under the symbol “FUNC”.  As of February 29, 2020, the Corporation had 1,263 shareholders of record. 







The ability of the Corporation to declare dividends is limited by federal banking laws and Maryland corporation laws.  Subject to these and the terms of its other securities, including the TPS Debentures, the payment of dividends on the shares of common stock and the amounts thereof are at the discretion of the Corporation’s board of directors.  In November 2010, the Corporation’s board of directors suspended the declaration and payment of cash dividends.  This suspension was lifted in 2018.  Cash dividends are typically declared on a quarterly basis.  When paid, dividends to shareholders are dependent on the ability of the Corporation’s subsidiaries, especially the Bank, to declare dividends to the Corporation.  Like the Corporation, the Bank’s ability to declare and pay dividends is subject to limitations imposed by federal and Maryland banking and Maryland corporation laws.  A complete discussion of these and other dividend restrictions is contained in Item 1A of Part I of this annual report under the heading “Risks Relating to First United Corporation’s Securities and in Note 21 to the Consolidated Financial Statements, both of which are incorporated herein by reference.  Accordingly, there can be no assurance that dividends will be declared on the shares of common stock in any future fiscal quarter. 



The Corporation’s Board of Directors periodically evaluates the Corporation’s dividend policy, both internally and in consultation with the Federal Reserve. 



Issuer Repurchases



Neither the Corporation nor any of its affiliates (as defined by Exchange Act Rule 10b-18) repurchased any shares of the Corporation’s common stock during 2019



Equity Compensation Plan Information



Pursuant to the SEC’s Regulation S-K Compliance and Disclosure Interpretation 106.01, the information regarding the Corporation’s equity compensation plans required by this Item pursuant to Item 201(d) of Regulation S-K is located in Item 12 of Part III of this annual report and is incorporated herein by reference. 

 

26

 

 


 

ITEM 6. SELECTED FINANCIAL DATA



The following table sets forth certain selected financial data for each of the last five calendar years and is qualified in its entirety by the detailed information and financial statements, including notes thereto, included elsewhere or incorporated by reference in this annual report. 





 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(Dollars in thousands, except for share data)

 

2019

 

2018

 

2017

 

2016

 

2015

Balance Sheet Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Assets

 

$

1,442,027 

 

$

1,383,760 

 

$

1,335,867 

 

$

1,317,675 

 

$

1,322,988 

Net Loans

 

 

1,038,894 

 

 

996,103 

 

 

882,117 

 

 

881,670 

 

 

866,801 

Investment Securities

 

 

225,284 

 

 

231,651 

 

 

240,102 

 

 

237,169 

 

 

275,792 

Deposits

 

 

1,142,031 

 

 

1,067,527 

 

 

1,039,390 

 

 

1,014,229 

 

 

998,794 

Long-term Borrowings

 

 

100,929 

 

 

100,929 

 

 

120,929 

 

 

131,737 

 

 

147,537 

Shareholders’ Equity

 

 

125,940 

 

 

117,066 

 

 

108,390 

 

 

113,698 

 

 

120,771 

Operating Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest Income

 

$

57,920 

 

$

52,294 

 

$

46,949 

 

$

45,863 

 

$

45,032 

Interest Expense

 

 

11,529 

 

 

8,112 

 

 

7,371 

 

 

8,223 

 

 

9,407 

Net Interest Income

 

 

46,391 

 

 

44,182 

 

 

39,578 

 

 

37,640 

 

 

35,625 

Provision for Loan Losses

 

 

1,320 

 

 

2,111 

 

 

2,534 

 

 

3,122 

 

 

1,054 

Other Operating Income

 

 

16,636 

 

 

15,041 

 

 

14,311 

 

 

14,127 

 

 

24,992 

Net Gains

 

 

147 

 

 

127 

 

 

29 

 

 

526 

 

 

1,016 

Other Operating Expense

 

 

45,389 

 

 

43,808 

 

 

39,170 

 

 

39,107 

 

 

41,115 

Income Before Taxes

 

 

16,465 

 

 

13,431 

 

 

12,214 

 

 

10,064 

 

 

19,464 

Income Tax expense (1)

 

 

3,336 

 

 

2,764 

 

 

6,945 

 

 

2,783 

 

 

6,473 

Net Income

 

$

13,129 

 

$

10,667 

 

$

5,269 

 

$

7,281 

 

$

12,991 

Accumulated preferred stock dividends and
  discount accretion

 

 

 —

 

 

 —

 

 

(1,215)

 

 

(2,025)

 

 

(2,700)

Net income available to common shareholders

 

$

13,129 

 

$

10,667 

 

$

4,054 

 

$

5,256 

 

$

10,291 

Per Share Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted net income per common share

 

$

1.85 

 

$

1.51 

 

$

0.58 

 

$

0.84 

 

$

1.65 

Dividends Paid

 

 

0.40 

 

 

0.27 

 

 

 —

 

 

 —

 

 

 —

Book Value

 

 

17.71 

 

 

16.52 

 

 

15.34 

 

 

14.95 

 

 

14.51 

Significant Ratios

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Return on Average Assets

 

 

0.93% 

 

 

0.81% 

 

 

0.40% 

 

 

0.55% 

 

 

0.98% 

Return on Average Equity

 

 

10.44% 

 

 

9.39% 

 

 

4.52% 

 

 

6.38% 

 

 

11.40% 

Average Equity to Average Assets

 

 

8.86% 

 

 

8.66% 

 

 

8.82% 

 

 

8.62% 

 

 

8.69% 

Dividend Payout Ratio

 

 

21.70% 

 

 

17.88% 

 

 

0.00% 

 

 

0.00% 

 

 

0.00% 

Total Risk-based Capital Ratio

 

 

16.29% 

 

 

15.91% 

 

 

15.98% 

 

 

16.71% 

 

 

17.21% 

Tier I Capital to Risk Weighted Assets

 

 

15.17% 

 

 

14.87% 

 

 

14.97% 

 

 

14.76% 

 

 

15.24% 

Tier I Capital to Average Assets

 

 

11.77% 

 

 

11.47% 

 

 

11.00% 

 

 

10.95% 

 

 

11.64% 

Common Equity Tier I to Risk Weighted Assets

 

 

12.79% 

 

 

12.45% 

 

 

12.54% 

 

 

10.74% 

 

 

9.99% 



(1)

2017 includes $3,226 from tax reform impact

 

27

 

 


 



ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS



This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and notes thereto for the years ended December 31, 2019 and 2018, which are included in Item 8 of Part II of this annual report.



Overview



First United Corporation is a bank holding company that, through the Bank and its non-bank subsidiaries, provides an array of financial products and services primarily to customers in four Western Maryland counties and four Northeastern West Virginia counties.  Its principal operating subsidiary is the Bank, which consists of a community banking network of 25 branch offices located throughout its market areas.  Our primary sources of revenue are interest income earned from our loan and investment securities portfolios and fees earned from financial services provided to customers.



Consolidated net income was $13.1 million for the year ended December 31, 2019, compared to $10.7 million for 2018.  Basic and diluted net income per share for 2019 were both $1.85, compared to basic and diluted net income per share of $1.51 for 2018, a 23% increase. The increase in earnings was primarily due to an increase in net interest income of $2.2 million, a decrease in the provision for loan losses of $.8 million, an increase of $1.6 million in other operating income and gains, offset by a $1.6 million increase in other operating expenses and an increase of $.6 million in income taxes.  The net interest margins, on a GAAP and fully tax equivalent (“FTE”) basis, for the years ended December 31, 2019 and 2018 were 3.61% and 3.68% and 3.67% and 3.74%, respectively. 



The provision for loan losses decreased to $1.3 million for the year ended December 31, 2019, compared to $2.1 million for the year ended December 31, 2018.  The decrease was driven primarily by decreased loan growth and net recoveries during 2019.  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 allowance for loan losses (the “ALL”) have been adjusted based on the current economic environment and the characteristics of the loan portfolio.



Other operating income, including gains, increased $1.6 million for the year ended December 31, 2019 when compared to 2018.  The increase was primarily attributable to the $1.1 million gain from bank owned life insurance (“BOLI”) death benefit proceeds that were received in the third quarter of 2019.  When comparing 2019 to 2018, trust and brokerage income increased $.3 million due to expansion of customer relationships and favorable market returns, and debit card income increased $.2 million due to increased usage resulting from our new technology and marketing promotions.  Service charge income remained flat for the year ended December 31, 2019 when compared to 2018.



Other operating expenses increased $1.6 million for the year ended December 31, 2019 when compared to 2018.  Salaries and benefits increased $.5 million due to annual merit increases, increased life and health insurance costs related to increased claims, and severance expenses related to a voluntary employee separation program that became effective in the fourth quarter of 2019.  These increases were partially offset by decreases in incentives and pension and 401(k) plan expenses.  The voluntary employee separation program resulted in the recognition of $.2 million in net severance expense in the fourth quarter of 2019 and is projected to provide salary and benefit savings in 2020 of approximately $1.4 million.  FDIC premiums decreased $.2 million due to credits received on our quarterly assessments. Equipment, occupancy and technology expenses increased $1.1 million when compared to 2018, due to the upgrade of technology equipment and services and the associated maintenance costs, as well as the implementation of the final stages of branch modernization.  Other real estate owned (“OREO”) expenses remained consistent with 2018 and were primarily due to valuation allowances from updated appraisals and reduced prices to encourage quicker sales.  Other miscellaneous expenses remained flat when compared to 2018 due to heightened focus on expense control.  Increased legal and professional, fraud expenses, Visa processing fees, employee benefits expense and investor relations expense were offset by reductions in marketing, directors’ fees, consulting, dues and licenses, postage, office supplies, contract labor, trust department expenses and miscellaneous loan fees.



Total loans increased by $44.4 million to $1.1 billion at December 31, 2019 when compared to December 31, 2018.  Commercial real estate (“CRE”) loans increased $28.6 million, acquisition and development (“A&D”) loans remained stable, commercial and industrial (“C&I”) loans increased $10.9 million, residential mortgage loans increased $3.3 million, and the consumer loan portfolio increased by $2.1 million.  The commercial loan pipeline at December 31, 2019 remains strong at $61.0 million.  Approximately 29% and 27% of the commercial loan portfolio was collateralized by real estate at December 31, 2019 and 2018, respectively.     



Net interest income, on an FTE basis, increased $2.3 million (5.1%) during the year ended December 31, 2019 when compared to the year ended December 31, 2018 due to a $5.7 million (10.7%) increase in interest income, offset by a $3.4 million (42.1%) increase in interest expense.  The net interest margin for the year ended December 31, 2019 was 3.68%, compared to 3.74% for the year ended December 31, 2018, declining only 6 basis points despite a 75 basis point reduction in the Fed rates.

 

28

 

 


 



Comparing 2019 to 2018, the increase in interest income was due to a $5.1 million increase in interest and fees on loans.  The increase in interest and fees on loans was due primarily to an increase in average balances of $57.0 million related to the strong loan growth in 2018 and an increase in the rate earned of 24 basis points attributable to loans repricing early in 2019, prior to the start of the declining interest rate environment.  Excess cash balances due to deposit growth early in the year were invested at the lower Fed Funds rate until deployed in the fourth quarter for loan growth.  This negatively impacted interest income for the year ended December 31, 2019.  Additional information on the composition of interest income is available in Table 1 that appears on page 30 of this report.



Total deposits at December 31, 2019 increased $74.5 million when compared to deposits at December 31, 2018.  During 2019, non-interest bearing deposits increased $32.4 million. This growth was driven by both our retail market and our commercial market, as we continued to grow existing relationships as well as cultivate new relationships. Traditional savings accounts increased $2.7 million, as our Prime Saver product continued to be the savings product of choice.  Total demand deposits decreased $3.8 million and total money market accounts increased $41.0 million, due primarily to growth in our variable rate Value money market account introduced in late 2018.  Time deposits less than $100,000 decreased $2.9 million and time deposits greater than $100,000 increased $5.1 million.  Growth in time deposits greater than $100,000 was primarily related to new deposits for a local municipality as well as new deposits in CDARs for a local hospital.  In the fourth quarter of 2018, two brokered certificates of deposit (“CD”) were purchased to shift $25.0 million of overnight borrowings as a tool to manage interest rate risk.  A $15.0 million brokered CD was fully repaid in November 2019 at its maturity, and the remaining $10.0 million brokered CD matures in May 2020.



Interest expense on our interest-bearing liabilities increased $3.4 million during the year ended December 31, 2019 when compared to 2018, due primarily to increased rates implemented during 2018 and the first two quarters of 2019.  Additionally, we experienced growth in our deposit products, primarily our money market and special rate certificates of deposit.  In the latter half of 2019, deposit rates were reduced as a result of the Fed rate cuts and sales of a higher cost CD product was discontinued.  Average growth of $31.0 million in our non-interest bearing accounts offset the higher interest expense and allowed us to effectively control our cost of deposits.



Estimates and Critical Accounting Policies



This discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities.  (See Note 1 to the Consolidated Financial Statements.)  On an on-going basis, management evaluates estimates and bases those estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.  Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the Consolidated Financial Statements.



Allowance for Loan Losses

One of our most important accounting policies is that related to the monitoring of the loan portfolio.  A variety of estimates impact the carrying value of the loan portfolio and resulting interest income, including the calculation of the ALL, the valuation of underlying collateral, and the timing of loan charge-offs. The ALL is established and maintained at a level that management believes is adequate to cover losses resulting from the inability of borrowers to make required payments on loans. Estimates for loan losses are arrived at by analyzing risks associated with specific loans and the loan portfolio, current and historical trends in delinquencies and charge-offs, and changes in the size and composition of the loan portfolio. The analysis also requires consideration of the economic climate and direction, changes in lending rates, political conditions, legislation impacting the banking industry and economic conditions specific to Western Maryland and Northeastern West Virginia.  Because the calculation of the ALL relies on management’s estimates and judgments relating to inherently uncertain events, actual results may differ from management’s estimates.



The ALL is also discussed below in Item 7 under the heading “Allowance for Loan Losses” and in Note 7 to the Consolidated Financial Statements.



Goodwill



Accounting Standards Codification (“ASC”) Topic 350, Intangibles - Goodwill and Other, establishes standards for the amortization of acquired intangible assets and impairment assessment of goodwill.  The $11.0 million in recorded goodwill at December 31, 2019 is related to the Bank’s 2003 acquisition of Huntington National Bank branches and is not subject to periodic amortization.



 

29

 

 


 

Goodwill arising from business combinations represents the value attributable to unidentifiable intangible elements in the business acquired. Goodwill is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value of each of an entity’s reporting units be compared to the carrying amount of its net assets, including goodwill.  If the estimated current fair value of the reporting unit exceeds its carrying value, then no additional testing is required and an impairment loss is not recorded. Otherwise, additional testing is performed and, to the extent such additional testing results in a conclusion that the carrying value of goodwill exceeds its implied fair value, an impairment loss is recognized.



For evaluation purposes, the Corporation is considered to be a single reporting unit.  Accordingly, our goodwill relates to value inherent in the banking business and the value is dependent upon our ability to provide quality, cost effective services in a highly competitive local market.  This ability relies upon continuing investments in processing systems, the development of value-added service features and the ease of use of our services.  As such, goodwill value is supported ultimately by revenue that is driven by the volume of business transacted.  A decline in earnings as a result of a lack of growth or the inability to deliver cost effective services over sustained periods can lead to impairment of goodwill, which could adversely impact earnings in future periods.  ASC Topic 350 requires an annual evaluation of goodwill for impairment.  The determination of whether or not these assets are impaired involves significant judgments and estimates. 



At December 31, 2019, the date of the Corporation’s annual impairment test, the fair value of the Corporation as determined by the price of its common stock exceeded the carrying amount of the Corporation’s common equity.



Based on the results of the evaluation, management concluded that the recorded value of goodwill at December 31, 2019 was not impaired.   However, future changes in strategy and/or market conditions could significantly impact these judgments and require adjustments to recorded asset balances.  Management will continue to evaluate goodwill for impairment on an annual basis and as events occur or circumstances change. 



Accounting for Income Taxes



We account for income taxes in accordance with ASC Topic 740, “Income Taxes”.  Under this guidance, deferred taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates that will apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date.



We regularly review the carrying amount of our net deferred tax assets to determine if the establishment of a valuation allowance is necessary.  If based on the available evidence, it is more likely than not that all or a portion of our net deferred tax assets will not be realized in future periods, then a deferred tax valuation allowance must be established.  Consideration is given to various positive and negative factors that could affect the realization of the deferred tax assets.  In evaluating this available evidence, management considers, among other things, historical performance, expectations of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with utilization of operating loss and tax credit carry forwards not expiring, tax planning strategies and timing of reversals of temporary differences.  Significant judgment is required in assessing future earnings trends and the timing of reversals of temporary differences.  Our evaluation is based on current tax laws as well as management’s expectations of future performance.



Management expects that the Corporation’s adherence to the required accounting guidance may result in increased volatility in quarterly and annual effective income tax rates because of changes in judgment or measurement including changes in actual and forecasted income before taxes, tax laws and regulations, and tax planning strategies. 



Additional information about income taxes is set forth below under the heading, “CONSOLIDATED STATEMENT OF INCOME REVIEW – Applicable Income Taxes” and in Note 17 to Consolidated Financial Statements presented in Item 8 of Part II of this annual report.



Other-Than-Temporary Impairment of Investment Securities



Management systematically evaluates the securities in our investment portfolio for impairment on a quarterly basis.  Based upon the application of accounting guidance for subsequent measurement in ASC Topic 320 (Section 320-10-35), management assesses whether (i) we have the intent to sell a security being evaluated and (ii) it is more likely than not that we will be required to sell the security prior to its anticipated recovery.  If neither applies, then declines in the fair values 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

 

30

 

 


 

component consists of all other losses, which are recognized in other comprehensive loss.  In estimating other-than-temporary impairment (“OTTI”) losses, management considers (a) the length of time and the extent to which the fair value has been less than cost, (b) adverse conditions specifically related to the security, an industry, or a geographic area, (c) the historic and implied volatility of the fair value of the security, (d) changes in the rating of the security by a rating agency, (e) recoveries or additional declines in fair value subsequent to the balance sheet date, (f) failure of the issuer of the security to make scheduled interest or principal payments, and (g) 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).  This process is described more fully in the section of the Consolidated Balance Sheet Review entitled “Investment Securities”. 



Fair Value of Investments



We have determined the fair value of our investment securities in accordance with the requirements of ASC Topic 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements required under other accounting pronouncements.  We measure the fair market values of our investments based on the fair value hierarchy established in Topic 820. The determination of fair value of investments and other assets is discussed further in Note 23 to the Consolidated Financial Statements.



Pension Plan Assumptions



Our pension plan costs are calculated using actuarial concepts, as discussed within the requirements of ASC Topic 715, Compensation – Retirement Benefits.  Pension expense and the determination of our projected pension liability are based upon two critical assumptions: the discount rate and the expected return on plan assets.  We evaluate each of these critical assumptions annually.  Other assumptions impact the determination of pension expense and the projected liability including the primary employee demographics, such as retirement patterns, employee turnover, mortality rates, and estimated employer compensation increases.  These factors, along with the critical assumptions, are carefully reviewed by management each year in consultation with our pension plan consultants and actuaries.  Further information about our pension plan assumptions, the plan’s funded status, and other plan information is included in Note 18 to the Consolidated Financial Statements.



Other than as discussed above, management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2019.



Adoption of New Accounting Standards and Effects of New Accounting Pronouncements



Note 1 to the Consolidated Financial Statements discusses new accounting pronouncements that, when adopted, could affect our future consolidated financial statements.



CONSOLIDATED STATEMENT OF INCOME REVIEW



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 table below summarizes net interest income for 2019 and 2018.







 

 

 

 

 

 

 

 

 

 

 

 



 

GAAP

 

Non-GAAP - FTE

(Dollars in thousands)

 

2019

 

2018

 

2019

 

2018

Interest income

 

$

57,920 

 

$

52,294 

 

$

58,788 

 

$

53,090 

Interest expense

 

 

11,529 

 

 

8,112 

 

 

11,529 

 

 

8,112 

Net interest income

 

$

46,391 

 

$

44,182 

 

$

47,259 

 

$

44,978 

Net interest margin %

 

 

3.61% 

 

 

3.67% 

 

 

3.68% 

 

 

3.74% 



Net interest income, on a non-GAAP, FTE basis, increased $2.3 million (5.1%) during the year ended December 31, 2019 when compared to the year ended December 31, 2018 due to a $5.7 million (10.7%) increase in interest income, offset by a $3.4 million

 

31

 

 


 

(42.1%) increase in interest expense.  The net interest margin for the year ended December 31, 2019 was 3.68%, compared to 3.74% for the year ended December 31, 2018, declining only 6 basis points despite a 75 basis point reduction in the Fed rates.

 

Comparing 2019 to 2018, the increase in interest income was due to a $5.1 million increase in interest and fees on loans.  The increase in interest and fees on loans was due primarily to an increase in average balances of $57.0 million related to the strong loan growth in 2018 and an increase in the rate earned of 24 basis points attributable to loans repricing early in 2019, prior to the start of the declining interest rate environment.  Excess cash balances due to deposit growth early in the year were invested at the lower Fed Funds rate until deployed in the fourth quarter for loan growth.  This negatively impacted interest income for the year ended December 31, 2019.

 

Interest expense on our interest-bearing liabilities increased $3.4 million during the year ended December 31, 2019 when compared to 2018, due primarily to increased rates implemented during 2018 and the first two quarters of 2019.  Additionally, we experienced growth in our deposit products, primarily our money market and special rate certificates of deposit.  In the latter half of 2019, deposit rates were reduced as a result of the Fed rate cuts and sales of a higher cost CD product was discontinued.  Average growth of $31.0 million in our non-interest bearing accounts offset the higher interest expense and allowed us to effectively control our cost of deposits.



As shown below, the composition of total interest income between 2019 and 2018 remained relatively stable. 





 

 

 

 



 

 

 

 



 

% of Total Interest Income



 

2019

 

2018

Interest and fees on loans

 

87% 

 

86% 

Interest on investment securities

 

12% 

 

13% 

Other

 

1% 

 

1% 



 

32

 

 


 

The following table sets forth the average balances, net interest income and expense, and average yields and rates for our interest-earning assets and interest-bearing liabilities for 2019, 2018 and 2017. 



Distribution of Assets, Liabilities and Shareholders’ Equity

Interest Rates and Interest Differential – Tax Equivalent Basis







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

For the Years Ended December 31



 

2019

 

2018

 

2017

(Dollars in thousands)

 

Average
Balance

 

Interest

 

Average
Yield/
Rate

 

Average
Balance

 

Interest

 

Average
Yield/
Rate

 

Average
Balance

 

Interest

 

Average
Yield/
Rate

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans

 

$

1,003,379 

 

$

50,254 

 

5.01% 

 

$

946,376 

 

$

45,119 

 

4.77% 

 

$

889,880 

 

$

39,670 

 

4.46% 

Investment Securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable

 

 

205,209 

 

 

5,648 

 

2.75 

 

 

215,944 

 

 

5,820 

 

2.70 

 

 

220,107 

 

 

5,554 

 

2.52 

Non taxable

 

 

25,512 

 

 

1,846 

 

7.24 

 

 

17,838 

 

 

1,699 

 

9.52 

 

 

17,602 

 

 

1,527 

 

8.68 

Total

 

 

230,721 

 

 

7,494 

 

3.25 

 

 

233,782 

 

 

7,519 

 

3.22 

 

 

237,709 

 

 

7,081 

 

3.01 

Federal funds sold

 

 

45,152 

 

 

727 

 

1.61 

 

 

16,594 

 

 

155 

 

0.93 

 

 

59,275 

 

 

574 

 

0.97 

Interest-bearing deposits with
  other banks

 

 

1,279 

 

 

23 

 

1.79 

 

 

2,024 

 

 

17 

 

0.84 

 

 

1,879 

 

 

 

0.48 

Other interest earning assets

 

 

4,487 

 

 

290 

 

6.48 

 

 

5,037 

 

 

280 

 

5.56 

 

 

5,206 

 

 

252 

 

4.84 

Total earning assets

 

 

1,285,018 

 

 

58,788 

 

4.57% 

 

 

1,203,813 

 

 

53,090 

 

4.41% 

 

 

1,193,949 

 

 

47,586 

 

3.99% 

Allowance for loan losses

 

 

(11,961)

 

 

 

 

 

 

 

(10,428)

 

 

 

 

 

 

 

(10,854)

 

 

 

 

 

Non-earning assets

 

 

145,870 

 

 

 

 

 

 

 

118,517 

 

 

 

 

 

 

 

138,918 

 

 

 

 

 

Total Assets

 

$

1,418,927 

 

 

 

 

 

 

$

1,311,902 

 

 

 

 

 

 

$

1,322,013 

 

 

 

 

 

Liabilities and
  Shareholders’ Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest-bearing demand deposits

 

$

160,776 

 

$

594 

 

0.37% 

 

$

170,642 

 

$

180 

 

0.11% 

 

$

171,697 

 

$

113 

 

0.07% 

Interest-bearing money markets

 

 

253,737 

 

 

2,254 

 

0.89 

 

 

211,969 

 

 

937 

 

0.44 

 

 

221,325 

 

 

467 

 

0.21 

Savings deposits

 

 

160,751 

 

 

299 

 

0.19 

 

 

160,968 

 

 

199 

 

0.12 

 

 

156,538 

 

 

176 

 

0.11 

Time deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Less than $100k

 

 

107,215 

 

 

1,486 

 

1.39 

 

 

104,289 

 

 

1,054 

 

1.01 

 

 

114,503 

 

 

1,123 

 

0.98 

$100k or more

 

 

153,727 

 

 

3,158 

 

2.05 

 

 

123,170 

 

 

1,876 

 

1.52 

 

 

120,190 

 

 

1,412 

 

1.17 

Short-term borrowings

 

 

42,579 

 

 

188 

 

0.44 

 

 

61,774 

 

 

525 

 

0.85 

 

 

37,376 

 

 

73 

 

0.2 

Long-term borrowings

 

 

100,929 

 

 

3,550 

 

3.52 

 

 

106,217 

 

 

3,341 

 

3.15 

 

 

123,356 

 

 

4,007 

 

3.25 

Total interest-bearing
  liabilities

 

 

979,714 

 

 

11,529 

 

1.18% 

 

 

939,029 

 

 

8,112 

 

0.86% 

 

 

944,985 

 

 

7,371 

 

0.78% 

Non-interest-bearing deposits

 

 

270,945 

 

 

 

 

 

 

 

239,838 

 

 

 

 

 

 

 

237,578 

 

 

 

 

 

Other liabilities

 

 

42,496 

 

 

 

 

 

 

 

19,376 

 

 

 

 

 

 

 

22,867 

 

 

 

 

 

Shareholders’ Equity

 

 

125,774 

 

 

 

 

 

 

 

113,659 

 

 

 

 

 

 

 

116,583 

 

 

 

 

 

Total Liabiliti