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
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evidenced by terms such as "anticipate," "estimate," "should," "expect," "believe," "intend," and similar expressions. Although these statements reflect management’s good faith beliefs and projections, they are not guarantees of future performance and they may not prove true. The beliefs, plans and objectives on which forward-looking statements are based involve risks and uncertainties that could cause actual results to differ materially from those addressed in the forward-looking statements. For a discussion of these risks and uncertainties, see the section of the periodic reports that First United Corporation files with the Securities and Exchange Commission entitled "Risk Factors".
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 September 30, 2022, the Corporation’s total assets were $1.8 billion, net loans were $1.3 billion, and deposits were $1.5 billion. Shareholders’ equity at September 30, 2022 was $132.0 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 nine month periods ended September 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 nine months ended
September 30,
2022
2021
Per Share Data
Basic net income per common share (1) - as reported
$
2.72
$
1.81
Basic net income per common share (1) - non-GAAP
$
2.72
$
2.45
Diluted net income per common share (1) - as reported
$
2.72
$
1.81
Diluted net income per common share (1) - non-GAAP
$
2.72
$
2.45
Basic book value per common share - as reported
$
19.83
$
20.22
Diluted book value per common share - as reported
$
19.80
$
20.19
Significant Ratios:
Return on Average Assets (a) (1) - as reported
1.35
%
0.92
%
Settlement and FHLB expenses, net of income tax
—
0.33
%
Adjusted Return on Average Assets (a) (1) (non-GAAP)
1.35
%
1.25
%
Return on Average Equity (a) (1) - as reported
17.66
%
12.45
%
Settlement and FHLB expenses, net of income tax
—
4.43
%
Adjusted Return on Average Equity (a) (1) (non-GAAP)
17.66
%
16.88
%
Average Equity to Average Assets
7.66
%
10.70
%
Capital Ratios:
Consolidated Total Capital (to risk weighted assets)
15.50
%
15.51
%
Consolidated Tier 1 Capital (to risk weighted assets)
14.40
%
14.26
%
Consolidated Common Equity Tier 1 Capital (to risk weighted assets)
12.36
%
12.15
%
Consolidated Tier 1 Capital (to average assets)
11.23
%
10.33
%
(1) See reconciliation of this non-GAAP financial measure provided elsewhere herein associated with settlement and FHLB expenses incurred during the first and third quarters of 2021.
Note: (a) Annualized
RESULTS OF OPERATIONS
Overview
Consolidated net income was $18.1 million for the first nine months of 2022 compared to $12.2 million for the first nine months of 2021. The year-over-year increase was primarily due to a $3.8 million increase in net interest income as a result of a $1.7 million increase in interest income and a $2.2 million decrease in interest expense. Additionally, non-interest expense decreased significantly due to our payment of $3.3 million in litigation settlement expenses during the first quarter of 2021 and a $2.4 million FHLB prepayment penalty for the early repayment of debt recognized in the third quarter of 2021.
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Consolidated net income was $6.9 million for the third quarter of 2022, or $1.04 per diluted share, compared to $4.4 million, or $0.66 per diluted share, for the third quarter of 2021. The year over year increase in net income was driven by an increase in net interest income of $1.5 million and reduced operating expenses of $2.7 million primarily offset by the $2.4 million FHLB prepayment penalty in the third quarter of 2021, offset by an decrease in credit to provision expense of $0.5 million, reduced other operating income, and a decrease of $0.1 million in gains from sales of mortgages.
Comparing the nine months ended September 30, 2022, to the nine months ended September 30, 2021, net interest income, on a non-GAAP, fully taxable equivalent (“FTE”) basis, increased by $3.8 million. Interest income increased by $1.6 million and interest expense decreased by $2.2 million. Interest income for the 2021 period included $3.2 million in fees related to PPP loan forgiveness. The yield on earning assets increased 14 basis points to 3.74% in 2022 compared to 3.60% in 2021 in correlation with the rising interest rate environment and new loans booked at higher rates. Interest expense on deposits decreased $1.4 million while the average balance of deposits increased $5.0 million and interest on long-term borrowings decreased $0.8 million related 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 25 basis points on interest bearing liabilities. We anticipate increased margin pressure in the remaining quarter of 2022 due to increasing deposit pricing demands in our market areas. The net interest margin for the nine months ended September 30, 2022, was 3.53% compared to 3.21% for the nine months ended September 30, 2021.
Net interest income, on a non-GAAP, FTE basis, increased by $1.5 million for the third quarter of 2022 when compared to the third quarter of 2021. This increase was driven by an increase of $1.3 million in interest income from an overall increase in yield of 22 basis points on interest earning assets and an increase in average balances of $36.8 million. Interest income on loans increased $0.4 million due primarily to continued growth in our commercial loan portfolio, increased rates on new loans booked and adjustable-rate loans repricing related to the current rising rate environment. Investment income increased $0.7 million primarily due to an increase in average balances of $70.3 million and an increase of 44 basis points in yield 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 $0.2 million in interest expense was driven primarily by the decline of $49.9 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 third quarter of 2022 was 3.66%, compared to 3.38% for the third quarter of 2021.
Non-interest income for the nine months ended September 30, 2022 decreased by approximately $0.1 million when compared to the same period of 2021. This decrease was primarily due to the decrease in net gains from the sale of residential mortgage loans of $1.0 million as refinance activity has slowed considerably 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 third quarter of 2022 increased by approximately $0.1 million when compared to the same period of 2021. Increased net gains on investments of $0.1 million, debit card income of $0.2 million and brokerage commissions and service charges of $0.1 million were offset by reductions on gains on the sale of mortgage loans of $0.1 million due to management’s decision to book loans to the portfolio in light of the rising interest rate environment Trust department income also decreased $0.2 million as a result of the volatile market and the impact of the rising rate environment on the market value of the assets under management. Assets under management in the trust department were $1.3 billion at September 30, 2022.
For the nine months ended September 30, 2022, non-interest expenses decreased by $5.0 million when compared to the nine months ended September 30, 2021. This decrease was primarily attributable to the one-time litigation settlement expense of $3.3 million recorded in the first quarter of 2021, and $2.4 million in prepayment penalties that were recognized in 2021. The decrease from these one-time expenses was partially offset by a $1.7 million increase in salaries and employee benefits as a result of increased incentives of $1.3 million, stock compensation expense of $0.1 million and reduced deferred loan costs of $0.8 million, which were partially offset by reductions in life and health and pension related expenses.
Operating expenses decreased by $2.7 million when comparing the third quarter of 2022 to the third quarter of 2021. This decrease was driven largely by a decrease of $2.4 million of expense for prepayment penalties related to the repayment of $70.0 million in FHLB debt in 2021 and a reduction of legal expenses of $0.8 million related to the reimbursement of certain litigation expenses in 2021. These decreases were partially offset by an increase of $0.4 million in salaries and employee benefits from increased incentives, part-time salaries and stock compensation expense, partially offset by decreases in 401(k) plan expense.
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The provision for loan losses was a credit of $0.1 million for the third quarter of 2022 compared to a credit of $0.6 million for the third quarter of 2021. The credit to the provision expense recorded in the third quarter of 2022 was primarily attributable to the continuation of payments of loans previously modified due to uncertainties related to COVID-19. Net charge-offs of $88,000 were recorded for the quarter ended September 30, 2022, compared to net recoveries of $0.4 million for 2021. The ratio of the ALL to loans outstanding was 1.22% at September 30, 2022, compared to 1.28% at June 30, 2022 and 1.38% at December 31, 2021.
The effective income tax rates as a percentage of income for the nine months ended September 30, 2022 and September 30, 2021 were 25.8% and 24.9%, respectively. The increased tax rate for the nine months ended September 30, 2022, when compared to the nine months ended September 30, 2021, was primarily related to state tax treatment of litigation settlement expenses in 2021. A new low-income housing tax credit investment in 2021 is expected to begin generating tax credits during the fourth quarter of 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:
Nine months ended September 30,
Three months ended September 30,
2022
2021
2022
2021
(in thousands, except for per share amount)
Net income - as reported
$
18,079
$
12,221
$
6,936
$
4,388
Adjustments:
Settlement expense
—
3,300
—
—
FHLB penalty
—
2,368
—
2368
Income tax effect of adjustment
—
(1,313)
—
(578)
Adjusted net income (non-GAAP)
$
18,079
$
16,576
$
6,936
$
6,178
Basic and Diluted earnings per share - as reported
$
2.72
$
1.81
$
1.04
$
0.66
Adjustments:
Settlement expense
—
0.47
—
—
FHLB penalty
—
0.35
—
0.35
Income tax effect of adjustment
—
(0.18)
—
(0.08)
Adjusted basic and diluted earnings per share (non-GAAP)
$
2.72
$
2.45
$
1.04
$
0.93
Significant Ratios:
Return on Average Assets (1) - as reported
1.35%
0.88%
Settlement, FHLB and contribution expenses, and insurance reimbursement income, net of income tax effect
—
0.23%
Adjusted Return on Average Assets (1) (non-GAAP)
1.35%
1.11%
Return on Average Equity (1) - as reported
17.66%
12.21%
Settlement, FHLB and contribution expenses, and insurance reimbursement income, net of income tax effect
—
2.90%
Adjusted Return on Average Equity (1) (non-GAAP)
17.66%
15.11%
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 nine and three month periods ended September 30, 2022 and 2021.
GAAP
Non-GAAP - FTE
Nine Months Ended
Nine Months Ended
September 30,
September 30,
(dollars in thousands)
2022
2021
2022
2021
Interest income
$
45,063
$
43,408
$
45,771
$
44,113
Interest expense
2,610
4,784
2,610
4,784
Net interest income
$
42,453
$
38,624
$
43,161
$
39,329
Net interest margin %
3.47
%
3.16
%
3.53
%
3.21
%
Three Months Ended
Three Months Ended
September 30,
September 30,
(dollars in thousands)
2022
2021
2022
2021
Interest income
$
16,185
$
14,910
$
16,416
$
15,142
Interest expense
1,044
1,285
1,044
1,285
Net interest income
$
15,141
$
13,625
$
15,372
$
13,857
Net interest margin %
3.61
%
3.32
%
3.66
%
3.38
%
The following tables set forth the average balances, net interest income and expense, and average yields and rates of our interest-earning assets and interest-bearing liabilities for the nine and three month periods ended September 30, 2022 and 2021:
Nine Months Ended
September 30,
2022
2021
Average
Average
Average
Average
(dollars in thousands)
Balance
Interest
Yield/Rate
Balance
Interest
Yield/Rate
Assets
Loans
$
1,203,650
$
39,399
4.38
%
$
1,179,205
$
39,562
4.49
%
Investment Securities:
Taxable
352,446
4,533
1.72
%
267,899
2,864
1.43
%
Non taxable
27,118
1,494
7.37
%
25,487
1,448
7.60
%
Total
379,564
6,027
2.12
%
293,386
4,312
1.96
%
Federal funds sold
47,173
308
0.87
%
156,504
128
0.11
%
Interest-bearing deposits with other banks
3,564
12
0.45
%
3,419
1
0.06
%
Other interest earning assets
1,027
25
3.25
%
3,622
110
4.07
%
Total earning assets
1,634,978
45,771
3.74
%
1,636,136
44,113
3.60
%
Allowance for loan losses
(15,611)
(16,924)
Non-earning assets
166,594
154,464
Total Assets
$
1,785,961
$
1,773,676
Liabilities and Shareholders’ Equity
Interest-bearing demand deposits
$
296,069
$
369
0.17
%
$
211,005
$
460
0.29
%
Interest-bearing money markets
294,481
347
0.16
%
340,322
367
0.14
%
Savings deposits
249,596
70
0.04
%
218,605
63
0.04
%
Time deposits
143,734
711
0.66
%
208,972
1,987
1.27
%
Short-term borrowings
62,175
86
0.18
%
55,151
67
0.16
%
Long-term borrowings
30,929
1,027
4.44
%
92,980
1,840
2.65
%
Total interest-bearing liabilities
1,076,984
2,610
0.32
%
1,127,035
4,784
0.57
%
Non-interest-bearing deposits
540,082
488,870
Other liabilities
32,057
26,850
Shareholders’ Equity
136,838
130,921
Total Liabilities and Shareholders’ Equity
$
1,785,961
$
1,773,676
Net interest income and spread
$
43,161
3.42
%
$
39,329
3.03
%
Net interest margin
3.53
%
3.21
%
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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 $708 and $705, 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 nine months ended September 30, 2022 to the nine months ended September 30, 2021, net interest income, on a non-GAAP, FTE basis, increased by $3.8 million. Interest income increased by $1.7 million and interest expense decreased by $2.2 million. Interest income for the 2021 period included $3.2 million in fees related to PPP loan forgiveness. The yield on earning assets increased 14 basis points to 3.74% in the 2022 period compared to 3.60% in the 2021 period in correlation with the rising interest rate environment and new loans booked at higher rates. Interest expense on deposits decreased $1.4 million while the average balance of deposits increased $5.0 million and interest on long-term borrowings decreased $0.8 million related 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 25 basis points on interest bearing liabilities. We anticipate increased margin pressure in the fourth quarter of 2022 due to increasing deposit pricing demands in our market areas. The net interest margin for the nine months ended September 30, 2022, was 3.53% compared to 3.21% for the nine months ended September 30, 2021.
Three Months Ended
September 30,
2022
2021
(dollars in thousands)
Average
Balance
Interest
Average
Yield/Rate
Average
Balance
Interest
Average
Yield/Rate
Assets
Loans
$
1,240,706
$
14,073
4.50
%
$
1,162,374
$
13,689
4.67
%
Investment Securities:
Taxable
343,581
1,587
1.83
%
274,648
880
1.27
%
Non taxable
26,471
489
7.33
%
25,073
476
7.54
%
Total
370,052
2,076
2.23
%
299,721
1,356
1.79
%
Federal funds sold
52,019
251
1.91
%
159,444
65
0.16
%
Interest-bearing deposits with other banks
1,552
7
1.79
%
4,283
—
—
%
Other interest earning assets
1,026
9
3.48
%
2,772
32
4.64
%
Total earning assets
1,665,355
16,416
3.91
%
1,628,594
15,142
3.69
%
Allowance for loan losses
(15,715)
(17,597)
Non-earning assets
170,092
157,806
Total Assets
$
1,819,732
$
1,768,803
Liabilities and Shareholders’ Equity
Interest-bearing demand deposits
$
305,608
$
187
0.24
%
$
215,085
$
113
0.21
%
Interest-bearing money markets
305,185
210
0.27
%
332,889
79
0.09
%
Savings deposits
253,576
34
0.05
%
230,925
17
0.03
%
Time deposits
134,600
190
0.56
%
184,493
523
1.12
%
Short-term borrowings
66,172
47
0.28
%
63,968
17
0.11
%
Long-term borrowings
30,929
376
4.82
%
77,342
536
2.75
%
Total interest-bearing liabilities
1,096,070
1,044
0.38
%
1,104,702
1,285
0.46
%
Non-interest-bearing deposits
550,978
503,006
Other liabilities
37,499
27,143
Shareholders’ Equity
135,186
133,952
Total Liabilities and Shareholders’ Equity
$
1,819,733
$
1,768,803
Net interest income and spread
$
15,372
3.53
%
$
13,857
3.23
%
Net interest margin
3.66
%
3.38
%
(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 $231 and $232 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 $1.5 million for the third quarter of 2022 when compared to the third quarter of 2021. This increase was driven by an increase of $1.3 million in interest income from an overall increase in yield of 22 basis points on interest earning assets and an increase in average balances of $36.8 million. Interest income on loans increased $0.4 million due primarily to continued growth in our commercial loan portfolio, increased rates on new loans booked and adjustable-rate loans repricing related to the current rising rate environment. Investment income increased $0.7 million primarily due to an increase in average balances of $70.3 million and an increase of 44 basis points in yield 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 $0.2 million in interest expense was driven primarily by the decline of $49.9 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 third quarter of 2022 was 3.66% compared to 3.38% for the third 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 nine and three month periods ended September 30, 2022 and 2021:
For the Nine months ended September 30, 2022
compared to the Nine months ended September 30, 2021
(in thousands and tax equivalent basis)
Volume
Rate
Net
Interest Income:
Loans
$
823
$
(986)
$
(163)
Taxable Investments
907
762
1,669
Non-taxable Investments
93
(47)
46
Federal funds sold
(90)
270
180
Interest-bearing deposits
0
11
11
Other interest earning assets
(79)
(6)
(85)
Total interest income
1,654
4
1,658
Interest Expense:
Interest-bearing demand deposits
185
(276)
(91)
Interest-bearing money markets
(48)
28
(20)
Savings deposits
9
(2)
7
Time deposits
(621)
(655)
(1,276)
Short-term borrowings
8
11
19
Long-term borrowings
(1,233)
420
(813)
Total interest expense
(1,700)
(474)
(2,174)
Net interest income
$
3,354
$
478
$
3,832
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For the Three months ended September 30, 2022 compared to the Three months ended September 30, 2021
(in thousands and tax equivalent basis)
Volume
Rate
Net
Interest Income:
Loans
$
915
$
(531)
$
384
Taxable Investments
219
488
707
Non-taxable Investments
26
(13)
13
Federal funds sold
(43)
229
186
Interest-bearing deposits
0
7
7
Other interest earning assets
(20)
(3)
(23)
Total interest income
1,097
177
1,274
Interest Expense:
Interest-bearing demand deposits
48
26
74
Interest-bearing money markets
(6)
137
131
Savings deposits
2
15
17
Time deposits
(140)
(193)
(333)
Short-term borrowings
1
29
30
Long-term borrowings
(319)
159
(160)
Total interest expense
(414)
173
(241)
Net interest income
$
1,511
$
4
$
1,515
(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 nine and three month periods ended September 30, 2022 and 2021 is illustrated in the following table:
Income as % of
Income as % of
Total Other Income
Total Other Income
Nine Months Ended
Three Months Ended
September 30,
September 30,
(in thousands)
2022
2021
2022
2021
Service charges on deposit accounts
$
1,451
11%
$
1,292
10%
$
523
11%
$
475
10%
Other service charges
686
5%
664
5%
241
5%
232
5%
Trust department
6,238
46%
6,441
49%
2,005
44%
2,166
48%
Debit card income
2,922
22%
2,623
20%
1,053
23%
900
20%
Bank owned life insurance
891
7%
877
7%
302
7%
298
7%
Brokerage commissions
805
6%
854
6%
272
6%
229
5%
Other income
406
3%
431
3%
208
4%
223
5%
$
13,399
100%
$
13,182
100%
$
4,604
100%
$
4,523
100%
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Other Operating Expenses
The composition of other operating expenses for the nine and three month periods ended September 30, 2022 and 2021 is illustrated in the following table:
Expense as % of
Expense as % of
Total Other Operating Expenses
Total Other Operating Expenses
Nine Months Ended
Three Months Ended
September 30,
September 30,
(in thousands)
2022
2021
2022
2021
Salaries and employee benefits
$
17,891
56%
$
16,214
44%
$
6,130
59%
$
5,719
44%
FDIC premiums
479
2%
575
2%
150
2%
209
2%
Equipment
3,110
10%
2,837
8%
1,037
10%
1,032
8%
Occupancy expense of premises
2,172
7%
2,102
6%
734
7%
684
5%
Data processing expense
2,516
8%
2,420
7%
890
9%
819
6%
Marketing expense
409
1%
408
1%
152
1%
129
1%
Professional services
873
2%
2,872
8%
(211)
(2)%
615
5%
Contract labor
482
2%
486
1%
159
2%
153
1%
Telephone
365
1%
606
2%
112
1%
123
1%
Other real estate owned
375
1%
(460)
(1)%
128
1%
150
1%
Investor relations
258
1%
546
1%
39
0%
116
1%
Settlement expense
—
0%
3,300
9%
—
0%
—
0%
FHLB prepayment penalty
—
0%
2,368
6%
—
0%
2,368
18%
Contributions
184
1%
105
0%
121
1%
55
0%
Other
2,437
8%
2,203
6%
895
9%
855
7%
$
31,551
100%
$
36,582
100%
$
10,336
100%
$
13,027
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 September 30, 2022 were $1.8 billion, representing a $51.2 million increase since June 30, 2022 and a $73.8 million increase since December 31, 2021. During the third quarter of 2022, cash and interest-bearing deposits in other banks increased by $9.1 million, the investment portfolio decreased by $7.0 million and gross loans increased by $44.3 million. Other assets including deferred taxes, premises and equipment and accrued interest receivable also increased collectively by $4.7 million.
Total liabilities at September 30, 2022 were $1.7 billion, representing a $52.0 million increase since June 30, 2022 and a $83.7 million increase since December 31, 2021. Total deposits increased by $26.8 million since June 30, 2022 and increased by $41.8 million since December 31, 2021. The increase in deposits during the third quarter was primarily attributable to management’s decision to bring approximately $50.0 million in trust department money market accounts back on-balance sheet as well as an increase in municipal deposit balances, which was partially offset by a $53.3 million reduction in non-interest-bearing deposits during the quarter. This decrease resulted from local businesses utilizing cash balances for large asset purchases as well as re-allocations of funds into higher yielding investment alternatives. Short term borrowings increased $32.0 million since December
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31, 2021, driven by $20.0 million in overnight borrowings and an increase in our overnight investments Treasury product of $12.0 million during the quarter. The increase in overnight borrowings at September 30, 2022 was primarily driven by the strong loan growth and a timing delay of the receipt of deposit funding from a sale of a large local business. These funds were received shortly after quarter end and were subsequently used to repay the $20.0 million in overnight borrowings in full.
Loan Portfolio
The following table presents the composition of our loan portfolio at the dates indicated:
(dollars in thousands)
September 30, 2022
December 31, 2021
Commercial real estate
$
437,973
34%
$
374,291
32%
Acquisition and development
83,107
7%
128,077
11%
Commercial and industrial *
269,004
21%
180,976
16%
Residential mortgage
427,093
33%
404,686
35%
Consumer
60,747
5%
65,657
6%
Total Loans
$
1,277,924
100%
$
1,153,687
100%
*Includes $0.4 million of PPP loans at September 30, 2022 and $7.7 million at December 31, 2021
Outstanding gross loans of $1.3 billion at September 30, 2022 reflected growth of $124.2 million for the first nine months of 2022 and growth of $44.3 million for the third quarter of 2022. Since December 31, 2021, commercial real estate (“CRE”) loans increased by $63.7 million, acquisition and development (“A&D”) loans decreased by $45.0 million and commercial and industrial loans increased by $88.0 million. The growth in the CRE and commercial and industrial portfolios resulted from the of expansion of relationships with existing clients as well as new commercial clients. Residential mortgage loans increased $22.4 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 $4.9 million due to amortization of the existing portfolio offsetting new production.
New commercial loan production for the three months ended September 30, 2022, was approximately $114.2 million. At September 30, 2022, unfunded, committed commercial construction loans totaled approximately $41.1 million. Commercial amortization and payoffs were approximately $95.5 million through September 30, 2022.
New consumer mortgage loan production for the third quarter of 2022 was approximately $30.0 million with most of this production being comprised of in-house mortgages. The pipeline of in-house, portfolio loans as of September 30, 2022 consisted of $16.1 million. Production levels have slowed for residential mortgages when compared to the third quarter of 2021 because of the increasing interest rates for the first nine months of 2022.
Non-accrual loans totaled $1.9 million at September 30, 2022 compared to $2.5 million at December 31, 2021. The decrease in non-accrual balances at September 30, 2022 was primarily related to $0.6 million of principal pay-downs of residential mortgage and home equity loans and the movement of $0.2 million in acquisition and development loans to other real estate owned.
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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)
September 30,
2022
% of
Applicable
Portfolio
December 31,
2021
% of
Applicable
Portfolio
Non-accrual loans:
Commercial real estate
$
63
0.01%
$
81
0.02%
Acquisition and development
152
0.18%
390
0.30%
Commercial and industrial
—
0.00%
90
0.05%
Residential mortgage
1,684
0.39%
1,901
0.47%
Consumer
44
0.07%
—
0.00%
Total non-accrual loans
$
1,943
0.15%
$
2,462
0.21%
Accruing Loans Past Due 90 days or more:
Commercial real estate
$
88
$
—
Residential mortgage
452
148
Consumer
29
152
Total loans past due 90 days or more
$
569
$
300
Total non-accrual and accruing loans past due 90 days or more
$
2,512
$
2,762
Restructured Loans (TDRs):
Performing
$
2,815
$
2,997
Non-accrual (included above)
284
300
Total TDRs
$
3,099
$
3,297
Other real estate owned
$
4,733
$
4,477
Total Non-performing assets
$
7,245
$
7,239
Impaired loans without a valuation allowance
4,726
5,248
Impaired loans with a valuation allowance
287
480
Total impaired loans
$
5,013
$
5,728
Valuation allowance related to impaired loans
$
30
$
64
Non-accrual loans to total loans (as %)
0.15%
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 %)
799.85%
648.05%
Allowance for loan losses to non-performing assets (as %)
214.51%
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 September 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 September 30, 2022 and December 31, 2021:
September 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
102
1
$
106
All other CRE
2
2,059
2
2,178
Acquisition and development
1-4 family residential construction
1
217
1
239
All other A&D
—
—
—
—
Commercial and industrial
—
—
—
—
Residential mortgage
Residential mortgage – term
6
437
6
474
Residential mortgage – home equity
—
—
—
—
Consumer
—
—
—
—
Total performing
10
$
2,815
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
284
2
300
Residential mortgage – home equity
—
—
—
Consumer
—
—
—
—
Total non-accrual
2
284
2
300
Total TDRs
12
$
3,099
12
$
3,297
The level of TDRs was $3.1 million at September 30, 2022 compared to $3.3 million at December 31, 2021, with a slight reduction due to payments made during the first nine months of 2022. There were no new TDRs during the first nine 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 $15.5 million at September 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 nine months ending September 30, 2022 was an annualized 0.06%, compared to net recoveries to average loans of 0.04% for the same period of 2021. Our special assets team continues to aggressively collect on charged-off loans.
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Management believes that the ALL at September 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 nine months ended September 30:
(dollars in thousands)
2022
2021
Balance, January 1
$
15,955
$
16,486
Charge-offs:
Acquisition and development
(20)
(85)
Commercial and industrial
(134)
—
Residential mortgage
(34)
(141)
Consumer
(726)
(266)
Total charge-offs
(914)
(492)
Recoveries:
Commercial real estate
1
—
Acquisition and development
21
172
Commercial and industrial
92
511
Residential mortgage
172
49
Consumer
117
112
Total recoveries
403
844
Net losses
(511)
352
Provision for loan losses
97
68
Balance at end of period
$
15,541
$
16,906
Allowance for loan losses to gross loans outstanding (as %)
1.22
%
1.46
%
Net (Charge-offs)/Recoveries as a % of Average Applicable Portfolio
2022
2021
Commercial real estate
0.00%
0.00%
Acquisition and development
0.00%
0.09%
Commercial and industrial
(0.02)%
0.29%
Residential mortgage
0.04%
(0.03)%
Consumer
(1.28)%
(0.45)%
Investment Securities
At September 30, 2022, the total amortized cost basis of the available-for-sale investment portfolio was $151.9 million, compared to a fair value of $128.0 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 $238.4 million, compared to a fair value of $205.7 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:
September 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
$
11,052
$
9,447
8%
$
69,602
$
67,169
23%
Residential mortgage-backed agencies
45,899
37,734
29%
49,630
48,661
17%
Commercial mortgage-backed agencies
37,766
31,611
25%
51,694
50,868
19%
Collateralized mortgage obligations
26,336
21,701
17%
93,018
90,077
31%
Obligations of state and political subdivisions
11,208
10,744
8%
12,439
12,804
4%
Corporate bonds
1,000
920
1%
—
—
—
Collateralized debt obligations
18,648
15,882
12%
18,609
17,192
6%
Total available for sale
$
151,909
$
128,039
100%
$
294,992
$
286,771
100%
Securities Held to Maturity:
U.S. treasuries
$
37,140
$
35,413
17%
$
—
$
—
—
U.S. government agencies
67,665
54,812
27%
—
—
—
Residential mortgage-backed agencies
29,536
25,617
13%
30,634
30,847
47%
Commercial mortgage-backed agencies
23,018
18,640
9%
5,456
5,601
9%
Collateralized mortgage obligations
58,462
48,840
24%
—
—
—
Obligations of state and political subdivisions
22,624
22,423
10%
20,169
28,921
44%
Total held to maturity
$
238,445
$
205,745
100%
$
56,259
$
65,369
100%
Total fair value of investment securities available for sale decreased by $158.7 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 September 30, 2022, the securities classified as available-for-sale included a net unrealized loss of $23.9 million, which represents the difference between the fair value and amortized cost of securities in the portfolio.
The Corporation reassessed the 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 $112.2 million of the available for sale portfolio was valued using Level 2 pricing and had net unrealized losses of $21.1 million at September 30, 2022. The remaining $15.9 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 $2.8 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 $1.7 million represent non-credit related other than temporary impairment (“OTTI”) charges on seven of the securities, while $1.1 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)
September 30, 2022
December 31, 2021
Non-interest-bearing demand deposits
$
474,444
32%
$
501,627
34%
Interest-bearing deposits:
Demand
304,110
20%
228,175
16%
Money Market
352,757
23%
339,748
23%
Savings deposits
255,505
17%
236,595
16%
Time deposits
124,302
8%
163,229
11%
Total Deposits
$
1,511,118
100%
$
1,469,374
100%
Total deposits at September 30, 2022 increased $41.7 million when compared to deposits at December 31, 2021. Non-interest-bearing deposits decreased $27.2 million, primarily due to deposit relationships moving deposits off-balance sheet to higher yielding deposit products. Interest bearing demand deposits increased $75.9 million and traditional savings accounts increased $18.9 million. Money market balances increased $13.0 million, driven primarily by management’s decision to bring trust department money market accounts back on-balance sheet in the third quarter, offset by the outflow of municipal balances into a higher rate state funding facility. Time deposits decreased $38.9 million related to maturing balances moving to more liquid accounts in anticipation of rising deposit rates as well as municipal funds moving to higher yielding alternatives.
Borrowed Funds
The following table presents the composition of our borrowings at the dates indicated:
(in thousands)
September 30,
2022
December 31,
2021
Fed Funds Purchased, weighted average interest rate of 3.25% at September 30, 2022
$
20,000
$
—
Securities sold under agreements to repurchase
$
69,726
$
57,699
Total short-term borrowings
89,726
57,699
Junior subordinated debt
30,929
30,929
Total long-term borrowings
$
30,929
$
30,929
Short term borrowings increased $32.0 million since December 31, 2021, driven by $20.0 million in overnight borrowings and an increase in our overnight investments Treasury product of $12.0 million during the third quarter of 2022. The increase in overnight borrowings at September 30, 2022 was primarily driven by the strong loan growth and a timing delay of the receipt of deposit funding from a large customer driven transaction. These funds were received shortly after quarter end and subsequently were repaid the $20.0 million in overnight borrowings in full.
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
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sold or purchased position, along with ratios and trends developed to measure dependence on purchased funds and core growth. Monthly reviews by management and quarterly reviews by the Asset and Liability Committee under prescribed policies and procedures are designed to ensure that we will maintain adequate levels of available funds.
It is our policy to manage our affairs so that liquidity needs are fully satisfied through normal Bank operations. That is, the Bank will manage its liquidity to minimize the need to make unplanned sales of assets or to borrow funds under emergency conditions. The Bank will use funding sources where the interest cost is relatively insensitive to market changes in the short run (periods of one year or less) to satisfy operating cash needs. The remaining normal funding will come from interest-sensitive liabilities, either deposits or borrowed funds. When the marginal cost of needed wholesale funding is lower than the cost of raising this funding in the retail markets, the Corporation may supplement retail funding with external funding sources such as:
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 September 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
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● 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 interest rate movements, the state of the regional and national economy, and other financial and business risk factors. Management uses computer simulations to measure the effect on net interest income of various interest rate scenarios. Key assumptions used in the computer simulations include cash flows and maturities of interest rate sensitive assets and liabilities, changes in asset volumes and pricing, and management’s capital plans. This modeling reflects interest rate changes and the related impact on net interest income over specified periods.
We evaluate the effect of a change in interest rates of +/-100 basis points to +/-400 basis points on both NII and Net Portfolio Value (“NPV”) / Economic Value of Equity (“EVE”). We concentrate on NII rather than net income as long as NII remains the significant contributor to net income.
NII modeling allows management to view how changes in interest rates will affect the spread between the yield paid on assets and the cost of deposits and borrowed funds. Unlike traditional Gap modeling, NII modeling takes into account the different degree to which installments in the same repricing period will adjust to a change in interest rates. It also allows the use of different assumptions in a falling versus a rising rate environment. The period considered by the NII modeling is the next eight quarters.
NPV / EVE modeling focuses on the change in the market value of equity. NPV / EVE is defined as the market value of assets less the market value of liabilities plus/minus the market value of any off-balance sheet positions. By effectively looking at the present value of all future cash flows on or off the balance sheet, NPV / EVE modeling takes a longer-term view of interest rate risk. This complements the shorter-term view of the NII modeling.
Measures of NII at risk produced by simulation analysis are indicators of an institution’s short-term performance in alternative rate environments. These measures are typically based upon a relatively brief period, usually one year. They do not necessarily indicate the long-term prospects or economic value of the institution.
Based on the simulation analysis performed at September 30, 2022 and December 31, 2021, management estimated the following changes in net interest income, assuming the indicated rate changes:
(Dollars in thousands)
September 30,
2022
December 31,
2021
+400 basis points
$
12,983
$
4,072
+300 basis points
$
9,738
$
3,233
+200 basis points
$
6,521
$
2,315
+100 basis points
$
3,298
$
1,160
-100 basis points
$
(3,437)
$
(3,110)
-200 basis points
$
(6,940)
N/A
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.
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Impact of Inflation – Our assets and liabilities are primarily monetary in nature, and as such, future changes in prices do not affect the obligations to pay or receive fixed and determinable amounts of money. During inflationary periods, monetary assets lose value in terms of purchasing power and monetary liabilities have corresponding purchasing power gains. The concept of purchasing power is not an adequate indicator of the impact of inflation on financial institutions because it does not incorporate changes in our earnings.
Capital Resources
We require capital to fund loans, satisfy our obligations under the Bank’s letters of credit, meet the deposit withdrawal demands of the Bank’s customers, and satisfy our other monetary obligations. To the extent that deposits are not adequate to fund our capital requirements, we can rely on the funding sources identified above under the heading “Liquidity Management”. At September 30, 2022, the Bank had $110.0 million available through unsecured lines of credit with correspondent banks, $7.4 million available through a secured line of credit with the Fed Discount Window and approximately $179.3 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 September 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:
September 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
14.49
%
14.97
%
8.00
%
10.00
%
Tier 1 Capital (to risk-weighted assets)
First United Bank & Trust
13.36
%
13.72
%
6.00
%
8.00
%
Common Equity Tier 1 Capital (to risk-weighted assets)
First United Bank & Trust
13.36
%
13.72
%
4.50
%
6.50
%
Tier 1 Capital (to average assets)
First United Bank & Trust
10.33
%
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 September 30, 2022 to December 31, 2021, short-term borrowings increased $32.0 million, driven by $20.0 million in overnight borrowings and an increase of $12.0 million during the period related to our overnight investments Treasury product.
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)
September 30,
2022
December 31,
2021
Residential Mortgage - home equity
$
70,095
$
66,874
Residential Mortgage - construction
22,682
18,657
Commercial
160,504
136,897
Consumer - personal credit lines
4,375
4,551
Standby letters of credit
16,040
15,711
Total
$
273,696
$
242,690
The increase of $31.0 million in commitments at September 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.