Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
INTRODUCTION
The following discussion and analysis is intended as a review of material changes in and significant factors affecting the financial condition and results of operations of First United Corporation and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto contained in Item 1 of Part I of this report, as well as the audited consolidated financial statements and related notes included in First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2021.
Unless the context clearly suggests otherwise, references in this report to “us”, “we”, “our”, and “the Corporation” are to First United Corporation and its consolidated subsidiaries.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements do not represent historical facts, but are statements about management’s beliefs, plans and objectives about the future, as well as its assumptions and judgments concerning such beliefs, plans and objectives. These statements are evidenced by terms such as "anticipate," "estimate," "should," "expect," "believe," "intend," and similar expressions. Although these statements reflect management’s good faith beliefs and projections, they are not guarantees of future performance and they may not
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prove true. The beliefs, plans and objectives on which forward-looking statements are based involve risks and uncertainties that could cause actual results to differ materially from those addressed in the forward-looking statements. For a discussion of these risks and uncertainties, see the section of the periodic reports that First United Corporation files with the Securities and Exchange Commission entitled "Risk Factors".
FIRST UNITED CORPORATION
First United Corporation is a Maryland corporation chartered in 1985 and a financial holding company registered with the Board of Governors of the Federal Reserve System (the “FRB”) under the Bank Holding Company Act of 1956, as amended. The Corporation’s primary business is serving as the parent company of First United Bank & Trust, a Maryland trust company (the “Bank”), First United Statutory Trust I (“Trust I”) and First United Statutory Trust II (“Trust II” and together with Trust I, the “Trusts”), both Connecticut statutory business trusts. The Trusts were formed for the purpose of selling trust preferred securities that qualified as Tier 1 capital. The Bank has two consumer finance company subsidiaries - OakFirst Loan Center, Inc., a West Virginia corporation, and OakFirst Loan Center, LLC, a Maryland limited liability company - and two subsidiaries that it uses to hold real estate acquired through foreclosure or by deed in lieu of foreclosure - First OREO Trust, a Maryland statutory trust, and FUBT OREO I, LLC, a Maryland limited liability company. In addition, the Bank owns 99.9% of the limited partnership interests in Liberty Mews Limited Partnership, a Maryland limited partnership formed for the purpose of acquiring, developing and operating low-income housing units in Garrett County, Maryland, and a 99.9% non-voting membership interest in MCC FUBT Fund, LC, an Ohio limited liability company formed for the purpose of acquiring, developing and operating low-income housing units in Allegany County, Maryland.
At June 30, 2022, the Corporation’s total assets were $1.8 billion, net loans were $1.2 billion, and deposits were $1.5 billion. Shareholders’ equity at June 30, 2022 was $132.9 million.
The Corporation maintains an Internet site at www.mybank.com on which it makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.
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SELECTED FINANCIAL DATA
The following table sets forth certain selected financial data for the six month periods ended June 30, 2022 and 2021 and is qualified in its entirety by the detailed information and unaudited financial statements, including the notes thereto, included elsewhere in this quarterly report.
As of the six months ended
June 30,
2022
2021
Per Share Data
Basic net income per common share (1) - as reported
$
1.68
$
1.15
Basic net income per common share (1) - non-GAAP
$
1.68
$
1.52
Diluted net income per common share (1) - as reported
$
1.68
$
1.15
Diluted net income per common share (1) - non-GAAP
$
1.68
$
1.52
Basic book value per common share - as reported
$
20.22
$
19.74
Diluted book value per common share - as reported
$
20.19
$
19.72
Significant Ratios:
Return on Average Assets (a) (1) - as reported
1.26
%
0.88
%
Settlement expenses, net of income tax
—
0.30
%
Adjusted Return on Average Assets (a) (1) (non-GAAP)
1.26
%
1.18
%
Return on Average Equity (a) (1) - as reported
16.32
%
12.21
%
Settlement expenses, net of income tax
—
2.64
%
Income tax effect of adjustment
—
1.13
%
Adjusted Return on Average Equity (a) (1) (non-GAAP)
16.32
%
15.98
%
Average Equity to Average Assets
7.75
%
7.29
%
Capital Ratios:
Consolidated Total Capital (to risk weighted assets)
15.56
%
15.80
%
Consolidated Tier 1 Capital (to risk weighted assets)
14.41
%
14.55
%
Consolidated Common Equity Tier 1 Capital (to risk weighted assets)
12.35
%
12.37
%
Consolidated Tier 1 Capital (to average assets)
11.23
%
9.94
%
(1) See reconciliation of this non-GAAP financial measure provided elsewhere herein associated with settlement expenses incurred during the first quarter of 2021.
Note: (a) Annualized
RESULTS OF OPERATIONS
Overview
Consolidated net income was $11.1 million for the first six months of 2022 compared to $7.8 million for the first six months of 2021. Basic and diluted net income per share for the first six months of 2022 were both $1.68, compared to basic and diluted net income per share of $1.15 for the first six months of 2021. The year over year increase was primarily driven by a $2.3 million increase in net interest income; of which, $1.9 million resulted from the decrease in interest expense as costs of funds decreased by approximately 55%. Additionally, comparative year-to-date income increased due to the $3.3 million in litigation settlement expense recognized in 2021.
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Consolidated net income was $5.4 million for the second quarter of 2022, or $0.82 per diluted share, compared to $4.4 million, or $0.66 per diluted share, for the second quarter of 2021. The increase in net income year over year was driven by an increase in net interest income of $1.2 million and reduced operating expenses of $0.4 million, offset by an increase in provision expense of $0.1 million, reduced other operating income, and a decrease of $0.3 million in gains from sales of mortgages. Additionally, we experienced a decrease in gains from sales of available for sale investments and recognized an expense of $0.2 million in expense related to Other Real Estate Owned (“OREO”) in the second quarter 2022 compared to a gain on sale of OREO of $0.2 million in the second quarter of 2021. The OREO expenses were attributable to one development project as we continue to work with the participation group to market and sell the commercial parcels.
Comparing the six months ended June 30, 2022 to the six months ended June 30, 2021, net interest income, on a non-GAAP, fully taxable equivalent (“FTE”) basis, increased by $2.3 million. Interest income increased by $0.4 million and interest expense decreased by $1.9 million. Interest income during the first six months of 2021 included $2.0 million in fees related to Paycheck Protection Program (“PPP”) loan forgiveness that were recognized during that period compared to $0.1 million for the six months ended June 30, 2022. The yield on earning assets increased 10 basis points to 3.66% during the six months of 2022 compared to 3.56% during the same period of 2021, which correlated to the rising interest rate environment and new loans booked at higher rates. Interest expense on deposits decreased $1.3 million while the average balances decreased $10.2 million and interest on long-term borrowings decreased $0.7 million relating to the prepayment of $70.0 million of Federal Home Loan Bank (“FHLB”) advances in the third quarter of 2021. The decreased interest expense resulted in an overall decrease of 32 basis points on interest bearing liabilities. To date, we have not experienced significant pressure on deposit pricing, but we expect to experience increasing rates the remainder of this year given the recent moves by the Federal Reserve. The net interest margin for the six months ended June 30, 2022 was 3.46% compared to 3.13% for the six months ended June 30, 2021.
Net interest income, on a non-GAAP, FTE basis, increased by $1.2 million for the second quarter 2022 when compared to the second quarter of 2021. This increase was driven by an increase of $0.3 million in interest income related to an overall increase of 15 basis points on interest earning assets despite a decline in average balances of $33.8 million. Interest income on loans decreased $0.2 million due primarily to a reduction of fees related to PPP loan forgiveness recognized during 2021. Investment income increased $0.6 million due to an increase in average balances related to the deployment of excess cash balances to purchase investment securities late in the fourth quarter of 2021 and early in the first quarter of 2022. The reduction of $1.1 million in interest expense resulted from the lowering of deposit rates throughout 2021, the decline of $73.3 million of average balances in the higher cost CD portfolio and the prepayment of $70.0 million of FHLB advances in 2021. The net interest margin for the second quarter of 2022 was 3.52%, compared to 3.15% for the second quarter of 2021.
Non-interest income for the six months ended June 30, 2022 decreased by approximately $0.8 million when compared to the same period of 2021. This decrease was primarily due to the decrease in net gains on sales of residential mortgage loans of $0.8 million as refinance activity has slowed considerably in correlation with rising mortgage interest rates and due to management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio.
Other operating income, including gains, for the second quarter of 2022 decreased by approximately $0.3 million when compared with the same period of 2021. Gains on sales of mortgage loans decreased by approximately $0.3 million related to the diminished refinance activity due to the rising interest rate environment and management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio. Net gains on sales of investments decreased by approximately $0.2 million, which was partially offset by the increase of service charges on deposit accounts by approximately $0.1 million.
For the six months ended June 30, 2022, non-interest expenses decreased by $2.3 million in 2022 when compared to the six months ended June 30, 2021. This decrease was attributable to the one-time litigation settlement expense of $3.3 million, and $1.2 million in legal expenses that were recognized in 2021 along with a $0.2 million reduction in telephone expense and a $0.2 million decline in investor relations costs. These decreases were partially offset by year-over-year increases in salaries and employee benefits of $1.2 million, which was partially related to the reduction of employee wages associated with deferred loan costs and increases of $0.3 million in equipment expenses, $0.9 million in OREO expenses and $0.2 million in miscellaneous other expenses.
Other operating expenses decreased by $0.4 million when comparing the second quarter of 2022 to the second quarter of 2021. This decrease was driven by a decrease in legal and professional fees of approximately $0.9 million and investor relations expense of approximately $0.2 million, which were partially offset by an increase in salaries and employee benefits of approximately $0.3 million and net OREO expenses of approximately $0.4 million. The increase in OREO expenses was driven by expenses
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attributable to one development project as we continue to work with the participation group to market and sell the commercial parcels and gains on sales of properties in 2021 that resulted in a net credit.
The provision for loan losses was $0.6 million for both the second quarter of 2022 and the second quarter of 2021. The provision expense recorded in the second quarter of 2022 was attributable primarily to loan portfolio growth during the quarter and changes in the qualitative factors, particularly related to the current economic outlook. Net charge-offs of $179,000 were recorded for the quarter ended June 30, 2022, compared to net charge offs of $67,000 for 2021. The ratio of the ALL to loans outstanding was 1.28% at June 30, 2022, compared to 1.29% at March 31, 2022 and 1.38% at December 31, 2021.
The effective income tax rates as a percentage of income for the six months ended June 30, 2022 and June 30, 2021 were 24.5% and 25.2%, respectively. The reduced tax rate for the six months ended June 30, 2022 when compared to the six months ended June 30, 2021 was related to an increased benefit at the holding company related to the fair value costs associated with the executive long term incentive plan payouts, and state tax treatment of the litigation settlement expenses. The new low-income housing tax credit investment in 2021 is expected to begin generating tax credits in 2022 and should provide increased tax credits beginning in 2023 and beyond for the term of the tax credit.
Non-GAAP Financial Measures
The Corporation believes that certain non-GAAP financial measures are meaningful because they reflect adjustments commonly made by management, investors, regulators and analysts to evaluate performance trends and the adequacy of common equity. This non-GAAP disclosure has limitations as an analytical tool, should not be viewed as a substitute for performance and financial condition measures determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.
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The following table presents a reconciliation of net income and basic and diluted earnings per share (as reported) to adjusted net income and adjusted basic and diluted earnings per share:
Six months ended June 30,
Three months ended June 30,
2022
2021
2022
2021
(in thousands, except for per share amount)
Net income - as reported
$
11,143
$
7,833
$
5,428
$
4,403
Adjustments:
Settlement expense
—
3,300
—
—
Income tax effect of adjustment
—
(735)
—
—
Adjusted net income (non-GAAP)
$
11,143
$
10,398
$
5,428
$
4,403
Basic and Diluted earnings per share - as reported
$
1.68
$
1.15
$
0.82
$
0.66
Adjustments:
Settlement expense
—
0.47
—
—
Income tax effect of adjustment
—
(0.10)
—
—
Adjusted basic and diluted earnings per share (non-GAAP)
$
1.68
$
1.52
$
0.82
$
0.66
Significant Ratios:
Return on Average Assets (1) - as reported
1.26%
0.88%
Settlement expenses, net of income tax effect
—
0.30%
Adjusted Return on Average Assets (1) (non-GAAP)
1.26%
1.18%
Return on Average Equity (1) - as reported
16.32%
12.21%
Settlement expenses, net of income tax effect
—
3.77%
Adjusted Return on Average Equity (1) (non-GAAP)
16.32%
15.98%
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.
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The tables below summarizes net interest income for the six and three month periods ended June 30, 2022 and 2021.
GAAP
Non-GAAP - FTE
Six Months Ended
Six Months Ended
June 30,
June 30,
(dollars in thousands)
2022
2021
2022
2021
Interest income
$
28,878
$
28,498
$
29,355
$
28,971
Interest expense
1,566
3,499
1,566
3,499
Net interest income
$
27,312
$
24,999
$
27,789
$
25,472
Net interest margin %
3.40
%
3.07
%
3.46
%
3.13
%
Three Months Ended
Three Months Ended
June 30,
June 30,
(dollars in thousands)
2022
2021
2022
2021
Interest income
$
14,731
$
14,436
$
14,967
$
14,670
Interest expense
760
1,673
760
1,673
Net interest income
$
13,971
$
12,763
$
14,207
$
12,997
Net interest margin %
3.46
%
3.10
%
3.52
%
3.15
%
The following tables set forth the average balances, net interest income and expense, and average yields and rates of our interest-earning assets and interest-bearing liabilities for the six and three month periods ended June 30, 2022 and 2021:
Six Months Ended
June 30,
2022
2021
Average
Average
Average
Average
(dollars in thousands)
Balance
Interest
Yield/Rate
Balance
Interest
Yield/Rate
Assets
Loans
$
1,184,804
$
25,326
4.31
%
$
1,187,760
$
25,873
4.39
%
Investment Securities:
Taxable
356,878
2,946
1.66
%
264,525
1,984
1.51
%
Non taxable
27,447
1,005
7.38
%
25,698
972
7.63
%
Total
384,325
3,951
2.07
%
290,223
2,956
2.05
%
Federal funds sold
44,689
57
0.26
%
155,009
63
0.08
%
Interest-bearing deposits with other banks
4,487
5
0.21
%
2,980
1
0.07
%
Other interest earning assets
1,028
16
3.14
%
4,054
78
3.88
%
Total earning assets
1,619,333
29,355
3.66
%
1,640,026
28,971
3.56
%
Allowance for loan losses
(15,558)
(16,582)
Non-earning assets
172,839
152,853
Total Assets
$
1,776,614
$
1,776,297
Liabilities and Shareholders’ Equity
Interest-bearing demand deposits
$
291,220
$
182
0.13
%
$
208,930
$
347
0.33
%
Interest-bearing money markets
289,377
137
0.10
%
344,100
288
0.17
%
Savings deposits
247,573
36
0.03
%
212,342
46
0.04
%
Time deposits
148,377
521
0.71
%
221,414
1,464
1.33
%
Short-term borrowings
60,144
39
0.13
%
50,670
50
0.20
%
Long-term borrowings
30,929
651
4.24
%
100,929
1,304
2.61
%
Total interest-bearing liabilities
1,067,620
1,566
0.30
%
1,138,385
3,499
0.62
%
Non-interest-bearing deposits
541,992
481,803
Other liabilities
29,337
26,704
Shareholders’ Equity
137,665
129,405
Total Liabilities and Shareholders’ Equity
$
1,776,614
$
1,776,297
Net interest income and spread
$
27,789
3.36
%
$
25,472
2.94
%
Net interest margin
3.46
%
3.13
%
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(1) The above table reflects the average rates earned or paid stated on an FTE basis assuming a 21% tax rate for 2022 and 2021. Non-GAAP interest income on a fully taxable equivalent was $477 and $473, respectively.
(2) Net interest margin is calculated as net interest income divided by average earning assets.
(3) The average yields on investments are based on amortized cost.
Comparing the six months ended June 30, 2022 to the six months ended June 30, 2021, net interest income, on a non-GAAP, FTE basis, increased by $2.3 million. Interest income increased by $0.4 million and interest expense decreased by $1.9 million. Interest income for the first six months of 2021 included $2.0 million in fees related to PPP loan forgiveness that were recognized during that period compared to $0.1 million for the six months ended June 30, 2022. The yield on earning assets increased 10 basis points to 3.66% in 2022 compared to 3.56% in 2021 in correlation with the rising interest rate environment and new loans booked at higher rates. Interest expense on deposits decreased $1.3 million while the average balances decreased $10.2 million and interest on long-term borrowings decreased $0.7 million relating to the prepayment of $70.0 million of FHLB advances in the third quarter of 2021. The decreased interest expense resulted in an overall decrease of 32 basis points on interest bearing liabilities. To date, we have not experienced significant pressure on deposit pricing, but we expect to experience increasing rates the remainder of this year given the recent moves by the Federal Reserve. The net interest margin for the six months ended June 30, 2022 was 3.46% compared to 3.13% for the six months ended June 30, 2021.
Three Months Ended
June 30,
2022
2021
(dollars in thousands)
Average
Balance
Interest
Average
Yield/Rate
Average
Balance
Interest
Average
Yield/Rate
Assets
Loans
$
1,200,651
$
12,876
4.30
%
$
1,173,007
$
13,119
4.49
%
Investment Securities:
Taxable
350,602
1,540
1.76
%
273,196
994
1.46
%
Non taxable
26,879
500
7.46
%
25,325
480
7.60
%
Total
377,481
2,040
2.17
%
298,521
1,474
1.98
%
Federal funds sold
36,151
39
0.43
%
174,346
39
0.09
%
Interest-bearing deposits with other banks
3,728
4
0.43
%
3,288
—
—
%
Other interest earning assets
1,026
8
3.13
%
3,654
38
4.17
%
Total earning assets
1,619,037
14,967
3.71
%
1,652,816
14,670
3.56
%
Allowance for loan losses
(15,221)
(16,758)
Non-earning assets
166,785
147,763
Total Assets
$
1,770,601
$
1,783,821
Liabilities and Shareholders’ Equity
Interest-bearing demand deposits
$
298,571
$
93
0.12
%
$
214,310
$
175
0.33
%
Interest-bearing money markets
282,083
74
0.11
%
328,100
118
0.14
%
Savings deposits
251,187
18
0.03
%
221,614
21
0.04
%
Time deposits
142,013
216
0.61
215,349
685
1.28
%
Short-term borrowings
60,727
21
0.14
%
51,035
26
0.20
%
Long-term borrowings
30,929
338
4.38
%
100,929
648
2.57
%
Total interest-bearing liabilities
1,065,510
760
0.29
%
1,131,337
1,673
0.59
%
Non-interest-bearing deposits
539,488
498,130
Other liabilities
30,564
27,085
Shareholders’ Equity
136,039
127,269
Total Liabilities and Shareholders’ Equity
$
1,771,601
$
1,783,821
Net interest income and spread
$
14,207
3.42
%
$
12,997
2.97
%
Net interest margin
3.52
%
3.15
%
(1) The above table reflects the average rates earned or paid stated on an FTE basis assuming a 21% tax rate for 2022 and 2021. Non-GAAP interest income on a fully taxable equivalent was $236 and $234, respectively.
(2) Net interest margin is calculated as net interest income divided by average earning assets.
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(3) The average yields on investments are based on amortized cost.
Net interest income, on a non-GAAP, FTE basis, increased by $1.2 million for the second quarter 2022 when compared to the second quarter of 2021. This increase was driven by an increase of $0.3 million in interest income related to an overall increase of 15 basis points on interest earning assets despite a decline in average balances of $33.8 million. Interest income on loans decreased $0.2 million due primarily to a reduction of fees related to PPP loan forgiveness recognized during 2021. Investment income increased $0.6 million due to an increase in average balances related to the deployment of excess cash balances to purchase investment securities late in the fourth quarter of 2021 and early in the first quarter of 2022. The reduction of $1.1 million in interest expense resulted from the lowering of deposit rates throughout 2021, the decline of $73.3 million of average balances in the higher cost CD portfolio and the prepayment of $70.0 million of FHLB advances in 2021. The net interest margin for the second quarter of 2022 was 3.52%, compared to 3.15% for the second quarter of 2021.
The following table sets forth an analysis of volume and rate changes in interest income and interest expense for our average interest-earning assets and average interest-bearing liabilities for the six and three month periods ended June 30, 2022 and 2021:
For the Six months ended June 30, 2022
compared to the Six months ended June 30, 2021
(in thousands and tax equivalent basis)
Volume
Rate
Net
Interest Income:
Loans
$
(65)
$
(482)
$
(547)
Taxable Investments
697
265
962
Non-taxable Investments
67
(34)
33
Federal funds sold
(44)
38
(6)
Interest-bearing deposits
1
3
4
Other interest earning assets
(59)
(3)
(62)
Total interest income
597
(213)
384
Interest Expense:
Interest-bearing demand deposits
136
(301)
(165)
Interest-bearing money markets
(47)
(104)
(151)
Savings deposits
7
(17)
(10)
Time deposits
(486)
(457)
(943)
Short-term borrowings
9
(20)
(11)
Long-term borrowings
(914)
261
(653)
Total interest expense
(1,295)
(638)
(1,933)
Net interest income
$
1,892
$
425
$
2,317
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For the Three months ended June 30, 2022 compared to the Three months ended June 30, 2021
(in thousands and tax equivalent basis)
Volume
Rate
Net
Interest Income:
Loans
$
310
$
(553)
$
(243)
Taxable Investments
283
263
546
Non-taxable Investments
30
(10)
20
Federal funds sold
(31)
31
0
Interest-bearing deposits
0
4
4
Other interest earning assets
(27)
(3)
(30)
Total interest income
565
(268)
297
Interest Expense:
Interest-bearing demand deposits
70
(152)
(82)
Interest-bearing money markets
(16)
(28)
(44)
Savings deposits
3
(6)
(3)
Time deposits
(235)
(234)
(469)
Short-term borrowings
5
(10)
(5)
Long-term borrowings
(450)
140
(310)
Total interest expense
(623)
(290)
(913)
Net interest income
$
1,188
$
22
$
1,210
(1) The change in interest income/expense due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
Provision for Loan Losses
Specific allocations have been made for impaired loans where management has determined that the collateral supporting the loans is not adequate to cover the loan balance, and the qualitative factors affecting the ALL have been adjusted based on the current economic environment and the characteristics of the loan portfolio.
Other Income
The composition of other operating income for the six and three month periods ended June 30, 2022 and 2021 is illustrated in the following table:
Income as % of
Income as % of
Total Other Income
Total Other Income
Six Months Ended
Three Months Ended
June 30,
June 30,
(in thousands)
2022
2021
2022
2021
Service charges on deposit accounts
$
928
11%
$
817
9%
$
463
11%
$
412
10%
Other service charges
445
5%
432
5%
232
5%
221
5%
Trust department
4,233
48%
4,275
47%
2,044
46%
2,034
47%
Debit card income
1,869
21%
1,723
19%
983
22%
913
21%
Bank owned life insurance
589
7%
579
6%
297
7%
293
7%
Brokerage commissions
533
6%
625
7%
313
7%
357
8%
Other income
198
2%
612
7%
81
2%
91
2%
$
8,795
100%
$
9,063
100%
$
4,413
100%
$
4,321
100%
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Other Operating Expenses
The composition of other operating expenses for the six and three month periods ended June 30, 2022 and 2021 is illustrated in the following table:
Expense as % of
Expense as % of
Total Other Operating Expenses
Total Other Operating Expenses
Six Months Ended
Three Months Ended
June 30,
June 30,
(in thousands)
2022
2021
2022
2021
Salaries and employee benefits
$
11,761
55%
$
10,495
44%
$
5,793
54%
$
5,507
50%
FDIC premiums
329
2%
366
1%
155
2%
183
1%
Equipment
2,073
10%
1,805
8%
1,029
10%
954
9%
Occupancy expense of premises
1,438
7%
1,418
6%
711
7%
693
6%
Data processing expense
1,626
8%
1,601
7%
805
8%
875
8%
Marketing expense
257
1%
279
1%
151
1%
133
1%
Professional services
1,084
5%
2,661
11%
564
5%
1,491
14%
Contract labor
323
2%
333
1%
158
2%
185
2%
Telephone
253
1%
483
2%
139
1%
268
2%
Other real estate owned
247
1%
(610)
(3)%
152
1%
(198)
(2)%
Investor relations
219
1%
430
2%
123
1%
306
3%
Settlement expense
—
0%
3,300
14%
—
0%
—
0%
Contributions
63
0%
50
0%
42
0%
27
0%
Other
1,542
7%
1,348
6%
815
8%
608
6%
$
21,215
100%
$
23,959
100%
$
10,637
100%
$
11,032
100%
Provision for Income Taxes
In reporting interim financial information, income tax provisions should be determined under the procedures set forth in Financial Accounting Standards Board’s Accounting Standards Codification (“ASC”) Topic 740, Income Taxes (Section 740-270-30). This guidance provides that at the end of each interim period, an entity should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. The rate so determined should be used in providing for income taxes on a current year-to-date basis. The effective tax rate should reflect anticipated investment tax credits, capital gains rates, and other available tax planning alternatives. In arriving at this effective tax rate, however, no effect should be included for the tax related to significant, unusual or extraordinary items that will be separately reported or reported net of their related tax effect in reports for the interim period or for the fiscal year.
FINANCIAL CONDITION
Balance Sheet Overview
Total assets at June 30, 2022 were $1.8 billion, representing a $7.9 million decrease since March 31, 2022 and a $22.6 million increase since December 31, 2021. During the second quarter of 2022, cash and interest-bearing deposits in other banks decreased by $54.5 million, the investment portfolio decreased by $11.8 million and gross loans increased by $52.2 million. Other assets including deferred taxes, premises and equipment and accrued interest receivable also increased collectively by $6.6 million.
Total liabilities at June 30, 2022 were $1.6 billion, representing a $3.7 million decrease since March 31, 2022 and a $31.6 million increase since December 31, 2021. The increase in total liabilities was also attributable to the change in the market value of the pension plan assets of $9.4 million since December 31, 2021. This decrease is related to the increasing rate environment and market volatility resulting in a pension plan liability of $4.6 million at June 30, 2022 compared to a pension plan asset of $4.8 million at December 31, 2021. Total deposits decreased by $23.2 million since March 31, 2022 and increased by $15.0 million since December 31, 2021. The decline in deposits during the second quarter is primarily attributable to reduced money market balances associated with one local municipality. Short term borrowings increased $12.2 million since December 31, 2021, driven by $18.9 million in overnight borrowings, which were offset by a decrease in other short-term borrowings of $7.9 million during the quarter.
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The increase in overnight borrowings at June 30, 2022 was primarily driven by the strong loan growth coupled with the decline in deposit balances during the second quarter and the timing difference associated with an expected loan pay-off. Management plans to bring approximately $50.0 million in trust department money market accounts which had been placed off-balance sheet in 2021, back on-balance sheet in the third quarter.
Loan Portfolio
The following table presents the composition of our loan portfolio at the dates indicated:
(dollars in thousands)
June 30, 2022
December 31, 2021
Commercial real estate
$
421,942
34%
$
374,291
32%
Acquisition and development
116,115
10%
128,077
11%
Commercial and industrial *
225,640
18%
180,976
16%
Residential mortgage
406,293
33%
404,686
35%
Consumer
63,623
5%
65,657
6%
Total Loans
$
1,233,613
100%
$
1,153,687
100%
*Includes $0.8 million of PPP loans at June 30, 2022 and $7.7 million at December 31, 2021
Outstanding gross loans of $1.2 billion at June 30, 2022 reflected growth of $79.9 million for the first six months of 2022 and growth of $52.2 million for the second quarter of 2022. Since December 31, 2021, commercial real estate (“CRE”) loans increased by $47.7 million, acquisition and development (“A&D”) loans decreased by $12.0 million and commercial and industrial loans increased by $44.6 million. The growth in the commercial real estate and commercial and industrial portfolios is a result of expansion of relationships with existing clients as well as new commercial clients. Residential mortgage loans increased $1.6 million related to the diminished refinance activity due to the rising interest rate environment and management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio. The consumer loan portfolio decreased by $2.0 million due to amortization of the existing portfolio offsetting new production.
New commercial loan production for the three months ended June 30, 2022 was approximately $103.4 million. At June 30, 2022, unfunded, committed commercial construction loans totaled approximately $34.9 million. Commercial amortization and payoffs were approximately $47.7 million through June 30, 2022.
New consumer mortgage loan production for the second quarter of 2022 was approximately $15.1 million with most of this production being comprised of in-house mortgages. The pipeline in-house, portfolio loans as of June 30, 2022 consisted of $13.5 million. Production levels have slowed for residential mortgages as compared to the second quarter of 2021 because of the increasing interest rates for the first six months of 2022.
Non-accrual loans totaled $2.1 million at June 30, 2022 compared to $2.5 million at December 31, 2021. The decrease in non-accrual balances at June 30, 2022 was primarily related to $0.2 million of principal pay-downs of residential mortgage and home equity loans.
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Risk Elements of Loan Portfolio
The following table presents the risk elements of our loan portfolio at the dates indicated. Management is not aware of any potential problem loans other than those listed in this table or discussed below.
(dollars in thousands)
June 30,
2022
% of
Applicable
Portfolio
December 31,
2021
% of
Applicable
Portfolio
Non-accrual loans:
Commercial real estate
$
66
0.02%
$
81
0.02%
Acquisition and development
375
0.32%
390
0.30%
Commercial and industrial
—
0.00%
90
0.05%
Residential mortgage
1,675
0.41%
1,901
0.47%
Consumer
33
0.05%
—
0.00%
Total non-accrual loans
$
2,149
0.17%
$
2,462
0.21%
Accruing Loans Past Due 90 days or more:
Residential mortgage
$
258
$
148
Consumer
67
152
Total loans past due 90 days or more
$
325
$
300
Total non-accrual and accruing loans past due 90 days or more
$
2,474
$
2,762
Restructured Loans (TDRs):
Performing
$
3,134
$
2,997
Non-accrual (included above)
289
300
Total TDRs
$
3,423
$
3,297
Other real estate owned
$
4,517
$
4,477
Total Non-performing assets
$
6,991
$
7,239
Impaired loans without a valuation allowance
4,980
5,248
Impaired loans with a valuation allowance
303
480
Total impaired loans
$
5,283
$
5,728
Valuation allowance related to impaired loans
$
62
$
64
Non-accrual loans to total loans (as %)
0.17%
0.21%
Non-performing loans to total loans (as %)
0.20%
0.24%
Non-performing assets to total assets (as %)
0.40%
0.42%
Allowance for loan losses to non-accrual loans (as %)
732.29%
648.05%
Allowance for loan losses to non-performing assets (as %)
225.10%
220.40%
Performing loans considered to be impaired (including performing troubled debt restructurings, or TDRs), as defined and identified by management, amounted to $3.1 million at June 30, 2022 and $3.0 million at December 31, 2021. Loans are identified as impaired when, based on current information and events, management determines that we will be unable to collect all amounts due according to contractual terms. These loans consist primarily of A&D loans and CRE loans. The fair values are generally determined based upon independent third-party appraisals of the collateral or discounted cash flows based upon the expected proceeds. Specific allocations have been made where management believes there is insufficient collateral to repay the loan balance if liquidated and there is no secondary source of repayment available.
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The following table presents the details of impaired loans that are TDRs by class at June 30, 2022 and December 31, 2021:
June 30, 2022
December 31, 2021
Number of
Recorded
Number of
Recorded
(dollars in thousands)
Contracts
Investment
Contracts
Investment
Performing
Commercial real estate
Non owner-occupied
1
103
1
$
106
All other CRE
2
2,098
2
2,178
Acquisition and development
1-4 family residential construction
1
224
1
239
All other A&D
—
—
—
—
Commercial and industrial
—
—
—
—
Residential mortgage
Residential mortgage – term
11
709
6
474
Residential mortgage – home equity
—
—
—
—
Consumer
—
—
—
—
Total performing
15
$
3,134
10
$
2,997
Non-accrual
Commercial real estate
Non owner-occupied
—
$
—
—
$
—
All other CRE
—
—
—
—
Acquisition and development
1-4 family residential construction
—
—
—
—
All other A&D
—
—
—
—
Commercial and industrial
—
—
—
—
Residential mortgage
Residential mortgage – term
2
289
2
300
Residential mortgage – home equity
—
—
—
Consumer
—
—
—
—
Total non-accrual
2
289
2
300
Total TDRs
17
$
3,423
12
$
3,297
The level of TDRs was $3.2 million at June 30, 2022 compared to $3.4 million at December 31, 2021, with a slight reduction due to payments made during the first six months of 2022. There were no new TDRs during the first six months of 2022.
Allowance and Provision for Loan Losses
The ALL is maintained to absorb probable incurred credit losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.
The ALL is also based on estimates, and actual losses will vary from current estimates. These estimates are reviewed quarterly, and as adjustments, either positive or negative, become necessary, a corresponding increase or decrease is made in the ALL. The methodology used to determine the adequacy of the ALL is consistent with prior years. An estimate for probable losses related to unfunded lending commitments, such as letters of credit and binding but unfunded loan commitments is also prepared. This estimate is computed in a manner similar to the methodology described above, adjusted for the probability of actually funding the commitment. The ALL decreased to $15.7 million at June 30, 2022 compared to $16.0 million at December 31, 2021.
The ratio of year-to-date net charge offs to average loans for the six months ending June 30, 2022 was an annualized 0.07%, compared to net charge offs to average loans of 0.01% for 2021. Our special assets team continues to aggressively collect on charged-off loans.
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The ALL at June 30, 2022 is adequate to provide for probable credit losses inherent in our loan portfolio. Amounts that will be recorded for the provision for loan losses in future periods will depend upon trends in the loan balances, including the composition of the loan portfolio, changes in loan quality and loss experience trends, potential recoveries on previously charged-off loans and changes in other qualitative factors. Management also applies interest rate risk, collateral value and debt service sensitivity analyses to the Commercial real estate loan portfolio and obtains new appraisals on specific loans under defined parameters to assist in the determination of the periodic provision for loan losses.
The following table presents a summary of the activity in the ALL for the six months ended June 30:
(dollars in thousands)
2022
2021
Balance, January 1
$
15,955
$
16,486
Charge-offs:
Commercial real estate
—
(81)
Acquisition and development
—
—
Commercial and industrial
(52)
(82)
Residential mortgage
(33)
(175)
Consumer
(545)
—
Total charge-offs
(630)
(257)
Recoveries:
Commercial real estate
1
110
Acquisition and development
20
38
Commercial and industrial
9
29
Residential mortgage
101
78
Consumer
76
—
Total recoveries
207
255
Net losses
(423)
(2)
Provision for loan losses
205
665
Balance at end of period
$
15,737
$
17,149
Allowance for loan losses to gross loans outstanding (as %)
1.28
%
1.49
%
Net (Charge-offs)/Recoveries as a % of Average Applicable Portfolio
2022
2021
Commercial real estate
0.00%
(0.02)%
Acquisition and development
(0.07)%
0.97%
Commercial and industrial
(0.23)%
0.04%
Residential mortgage
0.02%
0.03%
Consumer
0.45%
0.48%
Investment Securities
At June 30, 2022, the total amortized cost basis of the available-for-sale investment portfolio was $149.7 million, compared to a fair value of $132.9 million. Unrealized gains and losses on securities available-for-sale are reflected in accumulated other comprehensive loss, a component of shareholders’ equity. The amortized cost basis of the held to maturity portfolio was $240.6 million, compared to a fair value of $220.3 million.
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The following table presents the composition of our securities portfolio at amortized cost and fair values at the dates indicated:
June 30, 2022
December 31, 2021
Amortized
Fair Value
FV as %
Amortized
Fair Value
FV as %
(dollars in thousands)
Cost
(FV)
of Total
Cost
(FV)
of Total
Securities Available for Sale:
U.S. government agencies
$
11,060
$
9,915
8%
$
69,602
$
67,169
23%
Residential mortgage-backed agencies
47,086
41,246
31%
49,630
48,661
17%
Commercial mortgage-backed agencies
36,498
31,996
24%
51,694
50,868
19%
Collateralized mortgage obligations
27,095
24,150
18%
93,018
90,077
31%
Obligations of state and political subdivisions
8,341
8,323
6%
12,439
12,804
4%
Corporate bonds
1,000
979
1%
—
—
—
Collateralized debt obligations
18,640
16,258
12%
18,609
17,192
6%
Total available for sale
$
149,720
$
132,867
100%
$
294,992
$
286,771
100%
Securities Held to Maturity:
U.S. treasuries
$
37,076
$
35,850
16%
$
—
$
—
—
U.S. government agencies
67,596
58,847
27%
—
—
—
Residential mortgage-backed agencies
27,996
25,717
12%
30,634
30,847
47%
Commercial mortgage-backed agencies
25,440
22,445
10%
5,456
5,601
9%
Collateralized mortgage obligations
59,951
54,293
25%
—
—
—
Obligations of state and political subdivisions
22,529
23,149
10%
20,169
28,921
44%
Total held to maturity
$
240,588
$
220,301
100%
$
56,259
$
65,369
100%
Total fair value of investment securities available for sale decreased by $153.9 million since December 31, 2021 due to the transfer of investments from available-for-sale to held to maturity in the first quarter 2022. At June 30, 2022, the securities classified as available-for-sale included a net unrealized loss of $16.9 million, which represents the difference between the fair value and amortized cost of securities in the portfolio.
The Corporation reassessed classification of certain investments and effective February 1, 2022, the Corporation transferred $139.0 million of callable agencies, obligation of state and political subdivisions, and collateralized mortgage obligations from available for sale to held to maturity securities. The transfer occurred at fair value. The related unrealized loss of $8.4 million included in other comprehensive loss remained in other comprehensive loss, to be amortized out of other comprehensive loss with an offsetting entry to interest income as a yield adjustment over the remaining term of the securities. No gain or loss was recorded at the time of transfer. The transfer of these securities was completed in an effort to mitigate further decline in fair market value in a rising rate environment. Management’s assessment of the portfolio included lower yielding bonds and the risk of extension in an up 300 basis point shock.
As discussed in Note 6 to the consolidated financial statements presented elsewhere in this report, the Corporation measures fair market values based on the fair value hierarchy established in ASC Topic 820, Fair Value Measurements and Disclosures . The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Level 3 prices or valuation techniques require inputs that are both significant to the valuation assumptions and are not readily observable in the market (i.e. supported with little or no market activity). These Level 3 instruments are valued based on both observable and unobservable inputs derived from the best available data, some of which is internally developed, and considers risk premiums that a market participant would require.
Approximately $116.6 million of the available-for-sale portfolio was valued using Level 2 pricing and had net unrealized losses of $14.5 million at June 30, 2022. The remaining $16.3 million of the securities available-for-sale represents the entire collateralized debt obligation (“CDO”) portfolio, which was valued using significant unobservable inputs (Level 3 assets). The $2.4 million in net unrealized losses associated with this portfolio relates to nine pooled trust preferred securities that comprise the CDO portfolio. Net unrealized losses of $1.4 million represent non-credit related OTTI charges on seven of the securities, while $1.0 million of unrealized losses relates to two securities which have had no credit related OTTI.
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Deposits
The following table presents the composition of our deposits at the dates indicated:
(dollars in thousands)
June 30, 2022
December 31, 2021
Non-interest-bearing demand deposits
$
527,761
36%
$
501,627
34%
Interest-bearing deposits:
Demand
299,532
20%
228,175
16%
Money Market
269,994
18%
339,748
23%
Savings deposits
252,153
17%
236,595
16%
Time deposits
134,914
9%
163,229
11%
Total Deposits
$
1,484,354
100%
$
1,469,374
100%
Total deposits at June 30, 2022 increased $15.0 million when compared to deposits at December 31, 2021. Non-interest-bearing deposits increased $26.1 million primarily related to the new commercial business gained during 2022. Interest bearing demand deposits increased $71.4 million. Traditional savings accounts increased $15.6 million. Money market balances decreased $69.8 million driven by one local municipality opting to move their funds to a state-sponsored deposit account that offers a higher yield as well as a movement of balances to the trust department for higher rates, while maintaining the customer relationship. Time deposits decreased $28.3 million related to maturing time deposits moving into other deposit products.
Borrowed Funds
The following table presents the composition of our borrowings at the dates indicated:
(in thousands)
June 30,
2022
December 31,
2021
Fed Funds Purchased, weighted average interest rate of 1.75% at June 30, 2022
$
18,900
$
—
Securities sold under agreements to repurchase
$
51,014
$
57,699
Total short-term borrowings
69,914
57,699
Junior subordinated debt
30,929
30,929
Total long-term borrowings
$
30,929
$
30,929
Short-term borrowings increased $12.2 million since December 31, 2021, driven by $18.9 million in overnight borrowings, which were offset by a decrease in other short-term borrowings of $6.7 million during the six months related to our Treasury Management customers utilizing their funds.
Liquidity Management
Liquidity is a financial institution’s capability to meet customer demands for deposit withdrawals while funding all credit-worthy loans. The factors that determine the institution’s liquidity are:
● Reliability and stability of core deposits;
● Cash flow structure and pledging status of investments; and
● Potential for unexpected loan demand.
We actively manage our liquidity position through regular meetings of a sub-committee of executive management, known as the Treasury Team, which looks forward 12 months at 30-day intervals. The measurement is based upon the projection of funds sold or purchased position, along with ratios and trends developed to measure dependence on purchased funds and core growth. Monthly reviews by management and quarterly reviews by the Asset and Liability Committee under prescribed policies and procedures are designed to ensure that we will maintain adequate levels of available funds.
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It is our policy to manage our affairs so that liquidity needs are fully satisfied through normal Bank operations. That is, the Bank will manage its liquidity to minimize the need to make unplanned sales of assets or to borrow funds under emergency conditions. The Bank will use funding sources where the interest cost is relatively insensitive to market changes in the short run (periods of one year or less) to satisfy operating cash needs. The remaining normal funding will come from interest-sensitive liabilities, either deposits or borrowed funds. When the marginal cost of needed wholesale funding is lower than the cost of raising this funding in the retail markets, the Corporation may supplement retail funding with external funding sources such as:
1. Unsecured Fed Funds lines of credit with upstream correspondent banks (M&T Bank, Pacific Coast Banker’s Bank, PNC Financial Services, Atlantic Community Bankers Bank, Community Bankers Bank and Zions National Bank).
2. Secured advances with the FHLB, which are collateralized by eligible one to four family residential mortgage loans, home equity lines of credit, commercial real estate loans, various securities and pledged cash.
3. Secured line of credit with the Fed Discount Window for use in borrowing funds up to 90 days, using municipal securities as collateral.
4. Brokered deposits, including CDs and money market funds, provide a method to generate deposits quickly. These deposits are strictly rate driven but often provide the most cost-effective means of funding growth.
5. One Way Buy CDARS/ICS funding – a form of brokered deposits that has become a viable supplement to brokered deposits obtained directly.
Management believes that we have adequate liquidity available to respond to current and anticipated liquidity demands and is not aware of any trends or demands, commitments, events or uncertainties that are likely to materially affect our ability to maintain liquidity at satisfactory levels.
Market Risk and Interest Sensitivity
Our primary market risk is interest rate fluctuation. Interest rate risk results primarily from the traditional banking activities that we engage in, such as gathering deposits and extending loans. Many factors, including economic and financial conditions, movements in interest rates and consumer preferences affect the difference between the interest earned on our assets and the interest paid on our liabilities. Interest rate sensitivity refers to the degree that earnings will be impacted by changes in the prevailing level of interest rates. Interest rate risk arises from mismatches in the repricing or maturity characteristics between interest-bearing assets and liabilities. Management seeks to minimize fluctuating net interest margins, and to enhance consistent growth of net interest income through periods of changing interest rates. Management uses interest sensitivity gap analysis and simulation models to measure and manage these risks. The interest rate sensitivity gap analysis assigns each interest-earning asset and interest-bearing liability to a time frame reflecting its next repricing or maturity date. The differences between total interest-sensitive assets and liabilities at each time interval represent the interest sensitivity gap for that interval. A positive gap generally indicates that rising interest rates during a given interval will increase net interest income, as more assets than liabilities will reprice. A negative gap position would benefit us during a period of declining interest rates.
At June 30, 2022, we were asset sensitive.
Our interest rate risk management goals are:
● Ensure that the Board of Directors and senior management will provide effective oversight and ensure that risks are adequately identified, measured, monitored and controlled;
● Enable dynamic measurement and management of interest rate risk;
● Select strategies that optimize our ability to meet our long-range financial goals while maintaining interest rate risk within policy limits established by the Board of Directors;
● Use both income and market value oriented techniques to select strategies that optimize the relationship between risk and return; and
● Establish interest rate risk exposure limits for fluctuation in net interest income (“NII”), net income and economic value of equity.
To manage interest sensitivity risk, management formulates guidelines regarding asset generation and pricing, funding sources and pricing, and off-balance sheet commitments. These guidelines are based on management’s outlook regarding future
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interest rate movements, the state of the regional and national economy, and other financial and business risk factors. Management uses computer simulations to measure the effect on net interest income of various interest rate scenarios. Key assumptions used in the computer simulations include cash flows and maturities of interest rate sensitive assets and liabilities, changes in asset volumes and pricing, and management’s capital plans. This modeling reflects interest rate changes and the related impact on net interest income over specified periods.
We evaluate the effect of a change in interest rates of +/-100 basis points to +/-400 basis points on both NII and Net Portfolio Value (“NPV”) / Economic Value of Equity (“EVE”). We concentrate on NII rather than net income as long as NII remains the significant contributor to net income.
NII modeling allows management to view how changes in interest rates will affect the spread between the yield paid on assets and the cost of deposits and borrowed funds. Unlike traditional Gap modeling, NII modeling takes into account the different degree to which installments in the same repricing period will adjust to a change in interest rates. It also allows the use of different assumptions in a falling versus a rising rate environment. The period considered by the NII modeling is the next eight quarters.
NPV / EVE modeling focuses on the change in the market value of equity. NPV / EVE is defined as the market value of assets less the market value of liabilities plus/minus the market value of any off-balance sheet positions. By effectively looking at the present value of all future cash flows on or off the balance sheet, NPV / EVE modeling takes a longer-term view of interest rate risk. This complements the shorter-term view of the NII modeling.
Measures of NII at risk produced by simulation analysis are indicators of an institution’s short-term performance in alternative rate environments. These measures are typically based upon a relatively brief period, usually one year. They do not necessarily indicate the long-term prospects or economic value of the institution.
Based on the simulation analysis performed at June 30, 2022 and December 31, 2021, management estimated the following changes in net interest income, assuming the indicated rate changes:
(Dollars in thousands)
June 30,
2022
December 31,
2021
+400 basis points
$
963
$
4,072
+300 basis points
$
825
$
3,233
+200 basis points
$
677
$
2,315
+100 basis points
$
492
$
1,160
-100 basis points
$
(3,060)
$
(3,110)
This estimate is based on assumptions that may be affected by unforeseeable changes in the general interest rate environment and any number of unforeseeable factors. Rates on different assets and liabilities within a single maturity category adjust to changes in interest rates to varying degrees and over varying periods of time. The relationships between lending rates and rates paid on purchased funds are not constant over time. Management can respond to current or anticipated market conditions by lengthening or shortening the Bank’s sensitivity through loan repricings or changing its funding mix. The rate of growth in interest-free sources of funds will influence the level of interest-sensitive funding sources. In addition, the absolute level of interest rates will affect the volume of earning assets and funding sources. As a result of these limitations, the interest-sensitive gap is only one factor to be considered in estimating the net interest margin.
Management believes that no material changes in our market risks, our procedures used to evaluate and mitigate those risks, or our actual or simulated sensitivity positions have occurred since December 31, 2021. Our NII simulation analysis as of December 31, 2021 is included in Item 7 of Part II of our Annual Report on Form 10-K for the year ended December 31, 2021 under the heading “Market Risk and Interest Sensitivity.
Impact of Inflation – Our assets and liabilities are primarily monetary in nature, and as such, future changes in prices do not affect the obligations to pay or receive fixed and determinable amounts of money. During inflationary periods, monetary assets lose value in terms of purchasing power and monetary liabilities have corresponding purchasing power gains. The concept of purchasing power is not an adequate indicator of the impact of inflation on financial institutions because it does not incorporate changes in our earnings.
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Capital Resources
We require capital to fund loans, satisfy our obligations under the Bank’s letters of credit, meet the deposit withdrawal demands of the Bank’s customers, and satisfy our other monetary obligations. To the extent that deposits are not adequate to fund our capital requirements, we can rely on the funding sources identified above under the heading “Liquidity Management”. At June 30, 2022, the Bank had $111.1 million available through unsecured lines of credit with correspondent banks, and approximately $189.8 million available through the FHLB. Management is not aware of any demands, commitments, events or uncertainties that are likely to materially affect our ability to meet our future capital requirements.
In addition to operational requirements, the Bank is subject to risk-based capital regulations, which were adopted and are monitored by federal banking regulators. These regulations are used to evaluate capital adequacy and require an analysis of an institution’s asset risk profile and off-balance sheet exposures, such as unused loan commitments and stand-by letters of credit. Based on capital ratios at June 30, 2022, the Bank was considered to be well-capitalized.
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The following table presents the Bank’s capital ratios as of the dates indicated:
June 30,
2022
December 31,
2021
Required for
Capital
Adequacy
Purposes
Required
to be Well
Capitalized
Total Capital (to risk-weighted assets)
First United Bank & Trust
14.64
%
14.97
%
8.00
%
10.00
%
Tier 1 Capital (to risk-weighted assets)
First United Bank & Trust
13.46
%
13.72
%
6.00
%
8.00
%
Common Equity Tier 1 Capital (to risk-weighted assets)
First United Bank & Trust
13.46
%
13.72
%
4.50
%
6.50
%
Tier 1 Capital (to average assets)
First United Bank & Trust
10.40
%
10.00
%
4.00
%
5.00
%
Contractual Obligations, Commitments and Off-Balance Sheet Arrangements
Contractual Obligations
The Corporation enters into contractual obligations in the normal course of business. Among these obligations are FHLB advances and junior subordinated debentures, operating lease agreements for banking and subsidiaries’ offices and for data processing and telecommunications equipment. Comparing June 30, 2022 to December 31, 2021, short-term borrowings increased $12.2 million, driven by $18.9 million in overnight borrowings, which were offset by a decrease in other short-term borrowings of $6.7 million during the period related to our Treasury Management customers utilizing their funds.
Commitments
Loan commitments are made to accommodate the financial needs of our customers. Letters of credit commit us to make payments on behalf of customers when certain specified future events occur. The credit risks inherent in loan commitments and letters of credit are essentially the same as those involved in extending loans to customers, and these arrangements are subject to our normal credit policies. We are not a party to any other off-balance sheet arrangements.
Commitments to extend credit in the form of consumer, commercial and business at the dates indicated were as follows:
(in thousands)
June 30,
2022
December 31,
2021
Residential Mortgage - home equity
$
68,811
$
66,874
Residential Mortgage - construction
22,552
18,657
Commercial
140,935
136,897
Consumer - personal credit lines
4,509
4,551
Standby letters of credit
15,922
15,711
Total
$
252,729
$
242,690
The increase of $10.0 million in commitments at June 30, 2022 when compared to December 31, 2021 was due to new business in construction commitments in the residential mortgage and commercial portfolios.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.