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Item 7. Management’s Discussion and Analysis

2023-03-24 compared with 2022-03-25 · 175 added, 229 removed, 524 unchanged (44% of the section changed)

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Our primary sources of revenue are interest income earned from our loan and investment securities portfolios and fees earned from financial services provided to customers.

Consolidated net income for the year ended December 31, 2021 was $19.8 million, inclusive of litigation settlement expenses of $3.3 million, Federal Home Loan Bank (“FHLB”) prepayment penalties of $2.4 million, insurance reimbursement income of $1.4 million and charitable contributions of $1.0 million, compared to $13.8 million for the year ended December 31, 2020.

Basic and diluted net income per share for 2021 were both $2.95, a 49.0% increase when compared to basic and diluted net income per share of $1.98 and $1.97, respectively, for 2020.

The increase in earnings when comparing 2021 to 2020 was primarily due to an increase in net interest income on a non-GAAP, fully taxable equivalent (“FTE”) basis, of $4.0 million, an increase in other operating income, including gains, of $2.1 million, and a decrease in provision expense of $6.2 million, offset by an increase in other operating expenses of $3.8 million.

The increase in provision expense for 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic and its impact on our borrowers.

Other operating income, including net gains, increased $2.1 million for the year ended December 31, 2021 when compared to the year ended December 31, 2020.

This increase was due primarily to increased trust and brokerage income of $1.3 million related to new client relationships and assets under management, the receipt of a $1.4 million insurance reimbursement, and increased debit card income.

The net interest margin, on an FTE basis, declined to 3.28% for the year ended December 31, 2021 from 3.34% for the same period of 2020.

The provision for loan losses was a credit of $0.8 million for the year ended December 31, 2021 and an expense of $5.4 million for the year December 31, 2020.

The higher provision expense recorded in 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic.

Net recoveries of $0.3 million were recorded for the year ended December 31, 2021, compared to net charge offs of $1.5 million for 2020.

The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.38% at December 31, 2021 compared to 1.41% at December 31, 2020.

Consolidated net income for the year ended December 31, 2022 was $25.0 million compared to $19.8 million in 2021.

The year-over-year increase was primarily due to a $5.1 million increase in net interest income resulting from a $4.2 million increase in interest income and a decrease in interest expense of $0.9 million.

Net gains were down $1.1 million in 2022 when compared to 2021 as management made the strategic decision to book the higher rate mortgage loans in 2022 as opposed to selling them to the secondary market.

Other income declined in 2022 due to a decrease of $0.4 million in trust and brokerage income and a decrease of $1.4 million due to an insurance reimbursement received in 2021.

These declines were slightly offset by an increase of $0.2 million in service charges and debit card income.

Provision expense was up $0.2 million as compared to 2021.

Salaries and benefits increased by $2.1 million when compared to 2021 due to a lower reduction of loan origination costs of $1.0 million and a $1.1 million increase due to performance related pay and the competitive employment environment.

Other changes year-over-year included increased other real estate owned (“OREO”) expenses of $1.5 million in 2022 due to gains on sale of OREO booked during 2021, other net increases in expenses of $0.8 million and increased income taxes of $1.6 million.

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 prepayment penalty for the early repayment of $70.0 million of FHLB advances recognized in the third quarter of 2021, a reduction of $2.4 million in professional and investor relations expenses primarily related to reimbursement of $0.7 in litigation expenses, a reduction of $0.4 million in investor relations costs and a $1.3 million reduction in legal fees.

Charitable contributions also declined by $0.9 million primarily due to the decision to make a $1.0 million contribution in 2021 to fund the newly created First United Community Dreams Foundation (the “Foundation”).

The provision for loan losses was a credit of $0.6 million for the year ended December 31, 2022 and a credit of $0.8 million for the year December 31, 2021.

Net charge-offs of $0.7 million were recorded for the year ended December 31, 2022, compared to net recoveries of $0.3 million for 2021.

The ratio of the ALL to loans outstanding, including Paycheck Protection Program (“PPP”) loan balances, was 1.14% at December 31, 2022 compared to 1.38% at December 31, 2021.

The ratio of ALL to loans outstanding, excluding PPP loan balances of $0.4 million and $7.7 million, was 1.14% and 1.39% at December 31, 2022 and 2021, respectively, non-GAAP.

Other operating income, including net gains on sales of mortgage loans and sales of investment securities, increased $2.1 million for the year ended December 31, 2021 when compared to 2020.

Gains on the sale of mortgage loans to the secondary market decreased $1.3 million due to refinancing activity occurring at a slower pace than the pace experienced in 2020.

Trust and brokerage income increased $1.3 million year-over-year due to growth in new client relationships and assets under management.

Debit card income increased $0.7 million for the year ended December 31, 2021, when compared to 2020 due to growth in deposit relationships and increased customer usage of our electronic services.

Other miscellaneous income increased $0.4 million.

Service charge income remained stable while net gains on investment securities decreased $0.5 million when comparing 2021 to 2020 due to reduced sales activity during 2021.

Other operating expenses increased $3.8 million for the year ended December 31, 2021 when compared to 2020.

This increase was driven by $3.3 million of litigation settlement expenses recorded in the first quarter of 2021, a $2.4 million penalty on the repayment of $70.0 million of FHLB advances in the third quarter of 2021 and a $1.0 million charitable contribution to First United Community Dreams Foundation, Inc.

Salaries and benefits for 2021 increased $1.0 million when compared to 2020, related to a net increase of $0.7 million due to higher in salaries, incentive pay, stock compensation and 401(k) plan expense, offset by decreases in pension and life and health insurance costs and a $0.3 million offset in salary expense from deferred loan origination costs primarily attributable to PPP loans.

FDIC premiums

increased slightly by $0.2 million due to credits received on quarterly assessments in 2020.

Equipment, occupancy and technology expenses decreased $0.9 million in 2021 when compared to 2020 as we began to realize cost savings from our core processor related to the new contract negotiated in the third quarter of 2020.

Other real estate owned (“OREO”) expenses were a net credit in 2021 due to $1.4 million in net gains attributable to the sale of OREO properties.

Professional services decreased $0.7 million as a result of increased accounting and audit fees of $0.3 million, offset by reductions of $0.5 million in consulting expenses and $0.4 million in legal expenses.

Outstanding loans of $1.2 billion at December 31, 2021 reflected a decline of $14.1 million during 2021.

Core commercial loan growth was offset by PPP loans that were forgiven.

CRE loans increased by $5.1 million, acquisition and development (“A&D”) loans increased by $11.1 million and commercial and industrial (“C&I”) loans decreased by $85.8 million, as growth in core portfolio loans of $20.5 million was offset by PPP loans that were forgiven.

Residential mortgage loans increased $25.5 million due to the purchase of a $39.0 million loan pool of 1-4 family residential loans, offset by the decline in mortgage portfolio balances due to the continued utilization of the FNMA secondary market for refinancing activity.

Given the current low interest rate environment, customers were seeking longer-term, fixed-rate loans and management chose not to book these loans in the portfolio.

The consumer loan portfolio increased by $29.9 million due to the purchase of a pool of consumer loans in the second quarter of 2021 and the purchase of a $10.0 million pool of student loans late in the fourth quarter as an effort to deploy excess cash into higher yielding, short-term assets.

Management strategically purchased loan pools to complement the portfolio loans and to assist in managing interest rate risk.

Net interest income, on a non-GAAP, FTE basis, increased by $4.0 million during the year ended December 31, 2021 when compared to the year ended December 31, 2020 driven by a $3.9 million decrease in interest expense and a slight increase in interest income of $0.1 million.

The decrease in interest expense resulted from proactive efforts to reduce the cost of funds by further reductions to rates on deposit accounts throughout 2021, the runoff of balances in time deposits, including brokered deposits, and the expiration of empowered rates on money market accounts.

The net interest margin, on an FTE basis, declined to 3.28% for the year ended December 31, 2021 from 3.34% for the year ended December 31, 2020.

The net interest margin for the years ended December 31, 2021 and 2020 would have been 3.14% and 3.46%, respectively, after excluding the average balance of PPP loans of $79.4 million and $137.0 million, respectively, and interest and fees of $4.8 million and $3.0 million, respectively.

Comparing the year ended December 31, 2021 with the year ended December 31, 2020, interest income remained stable.

Interest and fees on loans increased by $0.8 million and was partially offset by the reduction in investment income of $0.6 million.

While the average balance of the investment portfolio increased by $67.3 million, bonds, at higher yielding rates, were called and replaced with lower yielding investments resulting in a decrease in average yield on the investment portfolio of 85 basis points.

Excess cash balances during 2021 were invested at the lower Fed Funds rate, which also negatively affected interest income for the year ended December 31, 2021.

The increase in interest and fees on loans was due primarily to an increase in average balances of $26.1 million, primarily driven by new loan production at lower yields, offset by the repayment of the PPP loans.

Other operating income, including net gains on sales of mortgage loans and sales of investment securities, decreased by approximately $2.7 million when compared to 2021.

This decrease was partially due to a $1.4 million insurance reimbursement that was received in 2021 and a decrease in net gains from the sale of residential mortgage loans of $1.1 million as refinance activity slowed considerably and due to management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio.

These decreases were partially offset by a net increase in service charge, debit card and other income of $0.2 million.

Other operating expenses decreased $4.6 million compared to the year ended December 31, 2021.

Salaries and benefits increased by $2.1 million compared to 2021 due to a lower reduction of loan origination costs of $1.0 million and a $1.1 million increase due to performance related pay and the competitive employment environment.

Other changes year-over-year included increased OREO expenses of $1.5 million in 2022 due to gains on sale of OREO booked during 2021 and other net increases in expenses of $0.8 million.

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in professional and investor relations expenses primarily related to reimbursement of $0.7 in litigation expenses, a reduction of $0.4 million in investor relations costs and a $1.3 million reduction in legal fees.

Charitable contributions also declined by $0.9 million primarily due to the funding of the Foundation at the end of 2021.

Outstanding loans of $1.3 billion at December 31, 2022 reflected a growth of $125.8 million during 2022.

Since December 31, 2021, commercial real estate loans increased by $84.5 million and acquisition and development loans decreased by $57.5 million due primarily to the payoff of one large credit early in the third quarter.

Commercial and industrial loans increased by $64.4 million for the year, primarily in new floor plan business, new commercial clients and continued expansion of existing client relationships.

Residential mortgage loans increased $39.7 million related to management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio.

The consumer loan portfolio decreased by $5.4 million due to amortization and payoffs of the existing portfolio slightly offset by new production.

Net interest income, on a non-GAAP, fully-taxable equivalent (“FTE”) basis, increased by $5.1 million.

Interest income increased by $4.2 million and interest expense decreased by $0.9 million.

The yield on earning assets increased 22 basis points to 3.85% in 2022 compared to 3.63% in 2021 in correlation with an increase in average earning assets as well as the rising interest rate environment and new loans booked at higher rates.

Interest expense on deposits decreased by $0.2 million while the average balance of deposits increased by $26.1 million and interest on long-term borrowings decreased by $0.7 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 7 basis points on the cost of interest-bearing liabilities.

We anticipate increased margin pressure in 2023 due to increasing deposit pricing demands in our market areas.

The net interest margin for the year ended December 31, 2022 was 3.56% compared to 3.28% for the year ended December 31, 2021.

Comparing the year ended December 31, 2022 with the year ended December 31, 2021, interest income increased by $4.2 million.

Interest and fees on loans increased by $1.5 million and investment income increased by $2.4 million.

Excess cash balances during 2022 were invested at the Fed Funds rate, which also positively affected interest income for the year ended December 31, 2022 when compared to 2021.

Increases in loan interest income stemmed from the growth of core loans in 2022.

The rate earned on the loan portfolio remained stable when comparing the year ended December 31, 2022 to the year ended December 31, 2021.

Total deposits at December 31, 2022 increased by $101.4 million when compared to deposits at December 31, 2021.

During 2021, non-interest-bearing deposits increased by $81.2 million, driven by retail and commercial account growth partially attributable to government stimulus programs.

Traditional savings accounts increased by $40.5 million as we continued to see significant growth in our Prime Saver product, and total demand deposits increased by $26.6 million.

Total money market accounts decreased by $36.3 million.

As a part of assets under management, the Trust department manages cash balances for customers as a percentage of their portfolio allocation.

These cash balances are in money market accounts.

The decrease in money market balances was due primarily to management’s decision to sweep approximately $70.0 million of wealth management money market funds off balance sheet in the first quarter of 2021.

These funds can be readily shifted back to in-house money market accounts should liquidity needs arise in the future.

Time deposits decreased by $65.0 million, due primarily to our continued reduction in the pricing on single-service relationships and municipal bids.

rate and $23.6 million in average balances on long term borrowings related to the prepayment of $70.0 million in FHLB advances in the third quarter of 2021.

Proactive efforts to reduce the cost of funds by further reductions to rates on deposit accounts throughout 2021, the runoff of balances in the time deposits, including brokered deposits, and the expiration of empowered rates on money market accounts continued throughout 2021.

Non-interest-bearing deposits increased by $5.0 million.

Interest bearing demand deposits increased by $99.5 million and traditional savings accounts increased by $14.1 million.

The increase in interest bearing demand deposits was attributable to an increase in municipality funding into a higher yielding indexed product.

Money market balances increased by $25.4 million.

Time deposits decreased by $42.7 million related to maturing balances moving to more liquid accounts, or brokerage investment accounts, due to the rising deposit rates as well as municipal funds moving to higher yielding State funding alternatives.

The decrease in interest expense for 2022 was driven by a decrease in interest rates of 7 basis points, which offset the increase in average balances of $26.1 million on interest bearing deposits, and a $46.4 million decline in average balances on long term borrowings related to the prepayment of $70.0 million in FHLB advances in the third quarter of 2021.

This decrease in average long-term borrowings help offset the increase in yields of 190 basis points on interest paid on borrowings during 2022.

Estimates and Critical Accounting Policies

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The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities.

(See Note 1 to the Consolidated Financial Statements.) On an on-going basis, management evaluates estimates and bases those estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

(See Note 1 to the Consolidated Financial Statements.) On an on-going basis, management evaluates estimates and bases

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those estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

Actual results may differ from these estimates under different assumptions or conditions.

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The ALL is also discussed below in Item 7 under the heading “Allowance for Loan Losses” and in Note 6 to the Consolidated Financial Statements.

Goodwill and Other Intangible Assets

ASC Topic 350, Intangibles – Goodwill and Other provides guidance with respect to goodwill and other intangible assets.

Under this guidance, goodwill is not amortized but shall be tested at least annually for impairment at a level of accounting referred to as a reporting unit.

The Corporation is considered the sole reporting unit.

Goodwill of a reporting unit shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.

Impairment of goodwill is the condition that exists when the carrying amount of a reporting unit that includes goodwill exceeds its fair value.

A goodwill impairment loss is recognized for the amount that the carrying amount of a reporting unit, including goodwill, exceeds its fair value, limited to the total amount of goodwill allocated to that reporting unit.

An entity may assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount, including goodwill.

If, after assessing the totality of events or circumstances qualitatively, an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity shall perform a quantitative goodwill impairment test.

However, if, after assessing the totality of events or circumstances qualitatively, an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the quantitative goodwill impairment test is unnecessary .

The Corporation performs an impairment test of goodwill as of December 31 each year.

Having considered each of the qualitative factors and the negative and positive evidence of the totality of events and circumstances qualitatively, management has determined that it is not more likely than not that the fair value of our reporting unit is less than its carrying amount and a quantitative goodwill impairment test is unnecessary.

As such, management concludes there is no goodwill impairment at December 31, 2021.

Other than as discussed above, management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2021.

Liquidity Sources

Management has reviewed its Liquidity Contingency Funding Plan in preparation of funding needs as it relates to the COVID-19 pandemic.

As of December 31, 2021, the Corporation had approximately $130.0 million in unsecured lines of credit with its correspondent banks, $1.0 million with the Federal Reserve Discount Window, and approximately $188.2 million of secured borrowings with the FHLB.

As of December 31, 2022, the Corporation had approximately $140.0 million in unsecured lines of credit with its correspondent banks, $9.6 million available through a secured line of credit with the Federal Reserve Discount Window, and approximately $195.3 million of secured borrowings with the FHLB.

Additionally, the Corporation has access to the brokered certificates of deposit market.

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This is a non-GAAP disclosure and it is not materially different than the corresponding GAAP disclosure.

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The table below summarizes net interest income for 2022 and 2021.

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Net interest margin %

Net interest income, on a non-GAAP, FTE basis, increased by $4.0 million (8.1%) during the year ended December 31, 2021 when compared to the year ended December 31, 2020, driven by a $3.9 million (40.8%) decrease in interest expense and a slight increase in interest income of $0.1 million.

Net interest income, on a non-GAAP, FTE basis, increased by $5.1 million (9.5%) during the year ended December 31, 2022 when compared to the year ended December 31, 2021, driven by a $4.2 million (7.0%) increase in interest income and a decrease in interest expense of $0.9 million (16.2%).

The decrease in interest expense resulted from proactive efforts to reduce the cost of funds by further reductions in rates on deposit accounts throughout 2021, the runoff of balances in the time deposits, including brokered deposits, and the expiration of empowered rates on money market accounts.

The net interest margin, on an FTE basis, declined to 3.28% for the year ended December 31, 2021 from 3.34% for the year ended December 31, 2020.

The net interest margin for the years ended December 31, 2021 and 2020 would

have been 3.14% and 3.46%, respectively, after excluding the average balance of PPP loans of $79.4 million and $137.0 million, respectively, and interest and fees of $4.8 million and $3.0 million, respectively.

Comparing the year ended December 31, 2021 with the year ended December 31, 2020, interest income remained stable.

Interest and fees on loans increased by $0.8 million and was partially offset by the reduction in investment income of $0.6 million.

Excess cash balances during 2021 were invested at the lower Fed Funds rate, which also negatively affected interest income for the year ended December 31, 2021.

The net interest margin, on an FTE basis, increased to 3.56% for the year ended December 31, 2022 from 3.28% for the year ended December 31, 2021.

Comparing the year ended December 31, 2022 with the year ended December 31, 2021, interest income increased by $4.2 million .

Interest and fees on loans increased by $1.5 million investment income increased by of $2.4 million.

The increase in interest on loans was primarily due to an increase of $49.4 million in average loan balance in 2022 compared to 2021.

The rate earned on the loan portfolio remained stable when comparing the year ended December 31, 2022 to the year ended December 31, 2021.

The decrease in interest expense for 2021 was driven by a decrease in interest rates of 16 basis points, which offset the increase in average balances of $65.6 million on interest bearing deposits, and a 39 basis point decline in average rate and $23.6 million in average balances on long term borrowings related to the prepayment of $70.0 million in FHLB advances in the third quarter of 2021.

The increase in investment income was due to the increase in average balances of $77.7 million for the year ended December 31, 2022 compared to the year ended December 31, 2021 as well as an increase in interest yield of 23 basis points.

The decrease in interest expense for 2022 was driven by a decrease of $46.4 million in average balances on long term borrowings related to the prepayment of $70.0 million in FHLB advances in the third quarter of 2021.

The decrease of $0.7 million in interest expense on long-term borrowing was partially offset by the 190 basis point increase in rate paid on borrowings for the year ended December 31, 2022 compared to 2021.

Average rates paid on deposit accounts decreased slightly in 2022 compared to 2021, which was offset by the growth of $26.1 million in interest-bearing deposits during the year.

As shown below, the composition of total interest income between 2022 and 2021 remained relatively stable.

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Interest on investment securities

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The following table sets forth the average balances, net interest income and expense, and average yields and rates for our interest-earning assets and interest-bearing liabilities for 2022 and 2021:

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This table distinguishes between the changes related to average outstanding balances (changes in volume created by holding the interest rate constant) and the changes related to average interest rates (changes in interest income or expense attributed to average rates created by holding the outstanding balance constant).

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Interest Variance Analysis (1)

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Provision for Loan Losses

The provision for loan losses was a credit of $0.8 million for the year ended December 31, 2021 and an expense of $5.4 million for the year December 31, 2020.

The higher provision expense recorded in 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic.

Net recoveries of $0.3 million were recorded for the year ended December 31, 2021, compared to net charge offs of $1.5 million for 2020.

The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.38% at December 31, 2021 compared to 1.41% at December 31, 2020.

The ratio of ALL to loans outstanding, excluding PPP loan balances of $7.7 million and $114.0 million, was 1.39% and 1.55% at December 31, 2021 and 2020, respectively, non-GAAP.

The provision for loan losses was a credit of $0.6 million for the year ended December 31, 2022 and a credit of $0.8 million for the year ended December 31, 2021.

Net charge-offs of $0.7 million were recorded for the year ended December 31, 2022, compared to net recoveries of $0.3 million for 2021.

The ratio of the ALL to loans outstanding was 1.14% at December 31, 2022 compared to 1.38% at December 31, 2021.

The ALL reflects a level commensurate with the risk inherent in our loan portfolio.

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Other Operating Income

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Total other operating income

Other operating income, exclusive of gains, increased $3.7 million during the year ended December 31, 2021 when compared to the same period of 2020.

The increase was primarily a result of an increase in trust and brokerage income of $1.3 million year-over-year due to growth in new client relationships and assets under management.

Debit card income increased $0.8 million for the year ended December 31, 2021 when compared to 2020 due to growth in deposit relationships and increased customer usage of our electronic services.

Other income increased $0.4 million.

Service charge income remained stable while gains on investment securities decreased $0.5 million when comparing 2021 to 2020.

Other operating income, exclusive of gains, decreased $1.6 million during the year ended December 31, 2022 when compared to the same period of 2021.

The decrease was primarily a result of a decrease of $1.4 million in insurance reimbursements and a $0.4 million decrease in trust income in 2022 when compared to 2021.

These decreases were partially offset by increased debit card income of $0.3 million for the year ended December 31, 2022 when compared to 2021 due to growth in deposit relationships and increased customer usage of our electronic services and increased service charge income of $0.2 million in 2022 when compared to 2021.

Other income decreased $0.4 million.

Net gains of $0.2 million and $1.2 million were reported through other income for the years ended December 31, 2022 and 2021, respectively.

The $1.6 million decrease in gains for 2021 was primarily attributable to the decrease in gains on the sale of mortgage loans to the secondary market of $1.3 million due to refinancing activity occurring at a slower pace than the pace experienced in 2020.

The $1.1 million decrease in gains for 2022 was primarily attributable to the decrease in gains on the sale of mortgage loans to the secondary market of $1.1 million due to refinancing activity occurring at a slower pace than the pace experienced in 2021 and due to management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio.

Other Operating Expense

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Contract labor

(Gains)/losses on sales and write downs of foreclosed real estate, net

Total OREO expenses/(income), net

Investor relations

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Total other operating expense

Other operating expenses increased $3.8 million for the year ended December 31, 2021 when compared to 2020.

This increase was driven by $3.3 million of litigation settlement expenses recorded in the first quarter of 2021, a $2.4 million penalty on the repayment of $70.0 million of FHLB advances in the third quarter of 2021 and the aforementioned $1.0 million charitable contribution to First United Community Dreams Foundation, Inc.

Federal Deposit Insurance Corporation premiums increased slightly by $0.2 million due to credits received on quarterly assessments in 2020.

OREO expenses were a net credit in the 2021 due to $1.4 million in net gains attributable to the sale of OREO properties.

Professional services decreased $0.7 million as a result of increased accounting and audit fees of $0.3 million, offset by reductions of $0.5 million in consulting expenses, and $0.4 million in legal expenses.

Other operating expenses decreased $4.6 million for the year ended December 31, 2022 when compared to 2021.

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Other changes year-over-year included increased OREO expenses of $1.5 million in 2022 due to gains on sale of OREO booked during 2021 and other net increases in expenses of $0.8 million.

Charitable contributions also declined by $0.9 million primarily due to the funding of the Foundation at the end of 2021.

Applicable Income Taxes

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Our effective tax rate was 24.5% in 2022 and 24.9% in 2021.

The increase in the tax rate for 2021 was primarily due to the reduction in tax exempt income as well as the

reduction in tax credits related to the expiration of a low-income housing tax credit in June 2021.

A new 2021 investment in a low-income housing tax credit is expected to provide tax benefits in 2022 and beyond.

The decrease in the tax rate for 2022 was primarily due to the increase in tax credits related to a new 2021 investment in a low-income housing tax credit that began to provide tax benefits in 2022 and will continue to provide benefits in the coming years.

At December 31, 2022, the Corporation had Maryland Net Operating Losses (“NOLs”) of $41.0 million for which a deferred tax asset of $2.7 million has been recorded.

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We have concluded that no valuation allowance is deemed necessary for our remaining federal and state deferred tax assets at December 31, 2022, as it is more likely than not that they will be realized based on the expected reversal of deferred tax liabilities, the generation of future income sufficient to realize the deferred tax assets as they reverse, and the ability to implement tax planning strategies to prevent the expiration of any carry-forward periods.

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GAAP and Non-GAAP measures

The following tables sets forth certain selected financial data for the years ended December 31, 2021 and 2020 and is qualified in its entirety by the detailed information and unaudited financial statements, including the notes thereto, included elsewhere in this quarterly report.

The following tables sets forth certain selected financial data for the years ended December 31, 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 annual report.

For the year ended

December 31, 2021

Per Share Data

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Income tax effect of adjustment

Adjusted basic and diluted earnings per share (non-GAAP)

Adjusted basic earnings per share (non-GAAP)

Diluted earnings per share - as reported

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CONSOLIDATED BALANCE SHEET REVIEW

Total assets at December 31, 2021 decreased slightly by $3.6 million since December 31, 2020.

During 2021, cash and interest-bearing deposits in other banks decreased by $33.7 million, the investment portfolio increased by $47.9 million and gross loans decreased by $14.1 million.

Total assets at December 31, 2022 increased by $118.3 million since December 31, 2021.

During 2022, cash and interest-bearing deposits in other banks decreased by $41.4 million, the investment portfolio increased by $18.5 million and gross loans increased by $125.8 million.

Management made strategic decisions to deploy excess cash balances in 2022.

Cash was utilized to purchase a $20.0 million consumer loan pool and a $39.0 million pool of mortgage loans for the purpose of offsetting the decline in mortgage portfolio balances due to the continued utilization of the FNMA secondary market for refinancing activity.

Management also used $70.0 million to prepay FHLB advances in the third quarter.

Additionally, approximately $60.0 million was used to purchase investment securities and to purchase a $10.0 million student loan pool late in the fourth quarter.

OREO balances decreased $4.9 million related to the sale of parcels of real estate securing a large commercial participation loan and additional sales of undeveloped lots.

We anticipate further reductions to OREO balances during the first quarter of 2022 as we consummate additional sale contracts.

Total liabilities decreased by $14.4 million when compared to liabilities at December 31, 2020.

The decrease in 2021 was attributable to deposit growth of $47.0 million due to stimulus programs and to growth in core relationships, increased balances in short-term borrowings related to our Treasury Management product, offset by the prepayment of $70.0 million in FHLB long-term borrowings.

Total shareholders’ equity increased by $10.9 million during the year ended December 31, 2021, as net income of $19.8 million was offset by the repurchase of $7.2 million (400,000 shares) of Common Stock, the payment of $3.9 million in dividends and the improvement of $1.5 million in accumulated other comprehensive loss.

Cash was utilized to purchase a $73.3 million in securities in 2022.

OREO balances increased by $0.3 million due to foreclosure activity in 2022.

Other assets, including deferred taxes, premises and equipment, and accrued interest receivable, increased by $3.4 million.

Total liabilities increased by $101.4 million since December 31, 2021.

Non-interest bearing deposits increased by $5.0 million.

Interest bearing demand deposits increased by $99.5 million and traditional savings accounts increased by $14.1 million.

The increase in interest bearing demand deposits was attributable to an increase in municipality funding into a higher yielding indexed product.

Money market balances increased by $25.4 million.

Time deposits decreased by $42.7 million related to maturing balances moving to more liquid accounts, or broker investment accounts, due to the rising deposit rates as well as municipal funds moving to higher yielding State funding alternatives.

Total shareholders’ equity increased by $9.9 million during the year ended December 31, 2022, as net income of $25.0 million and the issuance of $0.7 million of new shares of common stock was offset by other comprehensive losses of $11.7 million and the payment of $4.2 million in dividends.

As indicated below, the total interest-earning asset mix remained relatively constant at December 31, 2022 as compared to December 31, 2021.

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Installment loans are typically collateralized, with loan-to-value ratios which are established based on the financial condition of the borrower.

We also have made unsecured consumer loans to qualified borrowers meeting our underwriting standards.

We also have made unsecured consumer loans to qualified

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borrowers meeting our underwriting standards.

Additional information about our loans and underwriting policies can be found in Item 1 of Part I of this annual report under the heading “Banking Products and Services”.

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Residential mortgage

*Included $7.7 million of PPP loans at December 31, 2021 and $114.0 million at December 31, 2020

Outstanding loans of $1.2 billion at December 31, 2021 reflected a decline of $14.1 million during 2021.

Core commercial loan growth was offset by PPP loans that were forgiven.

CRE loans increased by $5.1 million, A&D loans increased by $11.1 million and C&I loans decreased by $85.8 million, as growth in core portfolio loans of $20.5 million was offset by PPP loans that were forgiven.

Given the current low interest rate environment, customers were seeking longer-term, fixed-rate loans and management chose not to book these longer-term low fixed rate mortgage loans in the portfolio.

The consumer loan portfolio increased by $29.9 million due to the purchase of a pool of consumer loans in the second quarter of 2021 and the purchase of a $10.0 million pool of student loans late in

the fourth quarter as an effort to deploy excess cash into higher yielding, short-term assets.

Management strategically purchased loan pools to complement the portfolio loans and to assist in managing interest rate risk.

Commercial loan production for the year ended December 31, 2021 was approximately $178.0 million, with $42.0 million originated during the fourth quarter, exclusive of PPP loan production.

PPP loan production was approximately $64.3 million for 2021.

*Includes PPP loans of $0.4 million and $7.7 million at December 31, 2022 and December 31, 2021, respectively.

Outstanding loans of $1.3 billion at December 31, 2022 reflected an increase of $125.8 million during 2022.

Commercial and industrial loans increased by $64.4 million for the year, primarily in new floor plan business, new commercial clients and continued expansion of existing client relationships.

Residential mortgage loans increased $39.7 million related to management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio.

The consumer loan portfolio decreased by $5.3 million due to amortization and payoffs of the existing portfolio slightly offset by new production.

Commercial loan production for the year ended December 31, 2022 was approximately $374.2 million, with $53.3 million originated during the fourth quarter.

At December 31, 2022, unfunded, committed commercial construction loans totaled approximately $27.8 million.

Commercial amortization and payoffs were approximately $119.0 million through December 31, 2021, exclusive of PPP.

Commercial amortization and payoffs were approximately $282.7 million through December 31, 2022.

Consumer mortgage loan production was approximately $91.8 million through December 31, 2022.

The production and pipeline mix of in-house, portfolio loans and investor loans remained strong as of December 31, 2021, with those loans totaling $15.3 million, consisting of $13.4 million in portfolio loans and $1.9 million in investor loans.

At the end of the second quarter of 2021, management implemented special promotions for residential mortgage products to shift production towards portfolio loans and utilize excess cash balances.

The pipeline of in-house, portfolio loans as of December 31, 2022, consisted of $7.5 million.

The residential mortgage production level slowed in the fourth quarter of 2022 due to the increasing interest rates that occurred in 2022.

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The following table sets forth the maturities, based upon contractual dates, for selected loan categories as of December 31, 2022:

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Our policy for recognizing interest income on impaired loans does not differ from our overall policy for interest recognition.

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The following sets forth the amounts of non-accrual, past-due and restructured loans for the past two years:

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Accruing Loans Past Due 90 days or more:

Acquisition and development

Residential mortgage

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Allowance for loan losses to non-performing assets (as %)

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The following table sets forth the percent applicable by portfolio for non-accrual loans for the past two years:

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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.

These loans consist primarily of acquisition and development 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.

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The level of performing impaired loans (other than performing TDRs) decreased by $0.3 million during the year ended December 31, 2022.

The increase in allowance for loan losses as a percentage of non-accrual loans was related to the reduction in non-accrual loans during 2021 and the increase in allowance for loan losses to non-performing assets was primarily related to the decrease in OREO balances in 2021.

The decrease in allowance for loan losses as a percentage of non-accrual loans was related to the increase in non-accrual loans in 2022 compared to 2021.

A troubled debt restructuring is the restructuring of a loan in which one or more concessions are granted to a borrower who is experiencing financial difficulties.

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To make this determination, the Bank performs a global financial review of the borrower and loan guarantors to assess their current ability to meet their financial obligations.

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The following table presents the details of TDRs by loan class at December 31, 2022 and December 31, 2021:

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The level of TDRs decreased by $0.3 million during the year ended December 31, 2022.

There were no new loans added to TDRs and four loans already in performing TDRs were re-modified.

During the year ended December 31, 2021, two loans totaling $0.4 million paid off.

There were no new loans added to TDRs and one loan already in performing TDRs was re-modified.

Net principal payments totaling $0.3 million were received during the same time period.

At December 31, 2022, there were no additional funds committed to be advanced in connection with TDRs.

Interest income not recognized due to rate modifications of TDRs was $61 thousand and interest income recognized on all TDRs was $0.2 million in 2021.

While the COVID-19 pandemic has had an impact on most industries, some have been more affected than others.

In accordance with Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act and related regulatory pronouncements, we have not accounted for modifications of loans affected by the pandemic as troubled debt restructurings nor have we designated them as past due or nonaccrual.

As of December 31, 2021, total loan modifications of $9.4 million were performed in accordance with the CARES Act.

This amount included 13 commercial loans related to real estate rental, food services and health care sectors.

These loans are scheduled to return to contractual payment terms within the first quarter of 2022.

In 2022, interest income not recognized due to rate modifications of TDRs was $55 thousand and interest income recognized on all TDRs was $0.2 million.

Allowance for Loan Losses

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This estimate is computed in a manner similar to the methodology described above, adjusted for the probability of actually funding the commitment.

At December 31, 2021 and 2020, the balance for reserve for probable losses on unfunded commitments, included in other liabilities in the consolidated statements of financial condition, was $0.1 million.

At December 31, 2022 and 2021, the balance for reserve

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for probable losses on unfunded commitments, included in other liabilities in the consolidated statements of financial condition was $0.1 million.

The ALL was $14.6 million at December 31, 2022 compared to $16.0 million at December 31, 2021, a decrease of 8.3% that resulted primarily from improvements in unemployment rates and a decline in total delinquencies.

Net recoveries of $0.3 million were recorded for 2021, compared to net charge-offs of $1.5 million for 2020.

The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.38% at December 31, 2021 compared to 1.41% at December 31, 2020.

The ALL to loans outstanding, excluding PPP loan balances of $7.7 million and $114.0 million, was 1.39% and 1.55% at December 31, 2021 and 2020, respectively, non-GAAP.

The ratio of net recoveries to average loans for the year ended December 31, 2021 was an annualized 0.02%, compared to net charge-offs to average loans of 0.13% for the year ended December 31, 2020.

The improvement was primarily related to the $1.1 million charge off of a formerly allocated specific allowance on an adversely classified non-accrual participation loan during the third quarter of 2020.

This loan was subsequently purchased by the lending group at foreclosure and moved to the OREO portfolio.

The project is now being aggressively marketed.

Net charge-offs of $0.7 million were recorded for 2022, compared to net recoveries of $0.3 million for 2021.

The ratio of the ALL to loans outstanding was 1.14% at December 31, 2022 compared to 1.38% at December 31, 2021.

The ratio of net charge-offs to average loans for the year ended December 31, 2022 was an annualized 0.06%, compared to net recoveries to average loans of 0.02% for the year ended December 31, 2021.

The increase in net charge-offs was primarily related to increased charge-offs in our consumer loan portfolio.

Our special assets team continues to effectively collect on charged-off loans, resulting in ongoing overall low charge-off ratios.

Accruing loans past due 30 days or more increased to 0.31%, compared to 0.20% at December 31, 2020.

Accruing loans past due 30 days or more decreased to 0.16%, compared to 0.31% at December 31, 2021.

Non-accrual loans totaled $3.5 million at December 31, 2022 compared to $2.5 million at December 31, 2021.

The decrease in non-accrual balances at December 31, 2021 was primarily related to $0.8 million of one CRE loan that paid off in the fourth quarter of 2021.

Two hospitality loans, totaling approximately $4.0 million, that were moved to non-accrual status during the first quarter of 2021 returned to accrual status in the fourth quarter of 2021 after successfully paying full contractual payments for six months.

The increase in non-accrual balances at December 31, 2022 was primarily related to one residential real estate loan of $1.5 million added to non-accrual in 2022.

This was partially offset by reductions in principal balance of existing non-accrual loans.

The ALL at December 31, 2022 is adequate to provide for probable losses inherent in our loan portfolio.

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Management also applies interest rate risk, collateral value and debt service sensitivity analyses to the CRE loan portfolio and obtains new appraisals on specific loans under defined parameters to assist in the determination of the periodic provision for loan losses.

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The following table presents the activity in the ALL by major loan category for the past two years.

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Total recoveries

Net credit recoveries/(losses)

Provision/(credit) for loan losses

Net credit (losses)/recoveries

Credit for loan losses

Balance at end of period

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Residential mortgage

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The following presents management’s allocation of the ALL by major loan category in comparison to that loan category’s percentage of total loans.

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Obligations of states and political subdivisions

Corporate bonds

Collateralized debt obligations

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Securities Held to Maturity:

government agencies

Residential mortgage-backed agencies

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Total held to maturity

Total fair value of investment securities available-for-sale at December 31, 2021 increased by $59.9 million when compared to December 31, 2020.

At December 31, 2021, the securities classified as available-for-sale included a net unrealized loss of $8.2 million, compared to a net unrealized loss of $3.6 million at December 31, 2020.

These unrealized losses represent the difference between the fair value and amortized cost of securities in the portfolio.

On June 1, 2014, management reclassified an amortized cost basis of $107.6 million of available-for-sale securities to held to maturity.

The unrealized loss of approximately $4.0 million, at the date of transfer, will continue to be reported in a separate component of shareholders’ equity as accumulated other comprehensive income and will be amortized over the remaining life of the securities as an adjustment of yield in a manner consistent with the amortization of any premium or discount.

As discussed in Note 23 to the Consolidated Financial Statements, we measure fair market values based on the fair value hierarchy established in ASC Topic 820, Fair Value Measurements and Disclosures .

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The fair value of investment securities available for sale decreased by $160.9 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 December 31, 2022, the securities classified as available for sale included a net unrealized loss of $24.0 million, which represents the difference between the fair value and the 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 transferred 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 effect to mitigate further decline in fair market value value in a rising rate environment.

Management’s assessment of the potential included lower yielding bonds and the risk of extension in an up 300 basis point shock.

As discussed in Note 20 to the Consolidated Financial Statements presented elsewhere in this report, we measure 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).

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 $110.0 million of the available-for-sale portfolio was valued using Level 2 pricing and had net unrealized losses of $21.2 million at December 31, 2022.

The remaining $17.2 million of the securities available-for-sale represents the entire CDO portfolio, which was valued using significant unobservable inputs, or Level 3 pricing.

The $1.4 million in net unrealized losses associated with the collateralized debt obligation (“CDO”) portfolio relates to nine pooled trust preferred securities.

Unrealized losses of $0.6 million was related to seven of the securities that have had non-credit related OTTI charges.

The remaining $0.8 million of unrealized losses was related to two securities which have had no OTTI charges.

The unrealized losses on these securities are primarily attributable to continued depression in the marketability and liquidity associated with CDOs.

The following table provides a summary of the trust preferred securities in the CDO portfolio and the credit status of the securities as of December 31, 2021.

Investment Description

First United Level 3 Investments

Security Credit Status

Preferred Term Security XVIII*

Preferred Term Security XVIII

Preferred Term Security XIX*

Preferred Term Security XXII*

Preferred Term Security XXIII

Total Level 3 Securities Available for Sale

* Security has been deemed other-than-temporarily impaired and loss has been recognized in accordance with ASC Section 320-10-35.

The terms of the debentures underlying trust preferred securities allow the issuer of the debentures to defer interest payments for up to 20 quarters, and, in such case, the terms of the related trust preferred securities require their issuers to contemporaneously defer dividend payments.

The issuers of the trust preferred securities in our investment portfolio have defaulted and/or deferred payments, ranging from 6.57% to 14.82% of the total collateral balances underlying the securities.

The securities were designed to include structural features that provide investors with credit enhancement or support to provide default protection by subordinated tranches.

These features include over-collateralization of the notes or subordination, excess interest or spread which will redirect funds in situations where collateral is insufficient, and a specified order of principal payments.

There are securities in our portfolio that are under-collateralized, which does represent additional stress on our tranche.

However, in these cases, the terms of the securities require excess interest to be redirected from subordinate tranches as credit support, which provides additional support to our investment.

Management systematically evaluates securities for impairment on a quarterly basis.

Based upon application of ASC Topic 320 (Section 320-10-35), management must assess whether (i) the Corporation has the intent to sell the security and (ii) it is more likely than not that the Corporation will be required to sell the security prior to its anticipated recovery.

If neither applies, then declines in the fair value of securities below their cost that are considered other-than-temporary declines are split into two components.

The first is the loss attributable to declining credit quality.

Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made.

The second component consists of all other losses.

The other losses are recognized in other comprehensive income.

In estimating OTTI charges, management considers (a) the length of time and the extent to which the fair value has been less than cost, (b) adverse conditions specifically related to the security, an industry, or a geographic area, (c) the historic and implied volatility of the security, (d) changes in the rating of a security by a rating agency, (e) recoveries or additional declines in fair value subsequent to the balance sheet date, (f) failure of the issuer of the security to make scheduled interest payments, and (g) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase

in the future.

Due to the duration and the significant market value decline in the pooled trust preferred securities held in our portfolio, we performed more extensive testing on these securities for purposes of evaluating whether or not an OTTI has occurred.

The market for these securities as of December 31, 2021 was not active and markets for similar securities were also not active.

The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which these securities trade and then by a significant decrease in the volume of trades relative to historical levels.

The new issue market is also inactive, as no new CDOs have been issued since 2007.

There are currently very few market participants who are willing to effect transactions in these securities.

The market values for these securities, or any securities other than those issued or guaranteed by the U.S.

Department of the Treasury (the “Treasury”), are very depressed relative to historical levels.

Therefore, in the current market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general rather than being an indicator of credit problems with a particular issue.

Given the conditions in the current debt markets and the absence of observable transactions in the secondary and new issue markets, management has determined that (a) the few observable transactions and market quotations that are available are not reliable for the purpose of obtaining fair value at December 31, 2021, (b) an income valuation approach technique (i.e.

present value) that maximizes the use of relevant unobservable inputs and minimizes the use of observable inputs will be equally or more representative of fair value than a market approach, and (c) the CDO segment is appropriately classified within Level 3 of the valuation hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date.

Management relies on an independent third party to prepare both the evaluations of OTTI and the fair value determinations for the CDO portfolio.

Management does not believe that there were any material differences in the OTTI evaluations and pricing between December 31, 2021 and December 31, 2020.

The approach used by the third party to determine fair value involved several steps, which included detailed credit and structural evaluation of each piece of collateral in each bond, projection of default, recovery and prepayment/amortization probabilities for each piece of collateral in the bond, and discounted cash flow modeling.

The discount rate methodology used by the third party combines a baseline current market yield for comparable corporate and structured credit products with adjustments based on evaluations of the differences found in structure and risks associated with actual and projected credit performance of each CDO being valued.

Currently, the only active and liquid trading market that exists is for stand-alone trust preferred securities, with a limited market for highly-rated CDO securities that are more senior in the capital structure than the securities in the CDO portfolio.

Therefore, adjustments to the baseline discount rate are also made to reflect the additional leverage found in structured instruments.

Based upon a review of credit quality and the cash flow tests performed by the independent third party, management determined that no additional credit-related OTTI was required during 2021.

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, or Level 3 pricing.

The $2.8 million in net unrealized losses associated with the CDO 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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The following table sets forth the contractual or estimated maturities of the components of our investment securities portfolio as of December 31, 2022 and the weighted average yields on a tax-equivalent basis.

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Obligations of states and political subdivisions

Corporate bonds

Collateralized debt obligations

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Held to Maturity:

US Treasuries

government agencies

Residential mortgage-backed agencies

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Total Deposits

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Total deposits at December 31, 2022 increased by $101.4 million when compared to deposits at December 31, 2021.

During 2021, non-interest-bearing deposits increased by $81.2 million, driven by retail and commercial account growth partially attributable to government stimulus programs.

Traditional savings accounts increased by $40.5 million as we continued to see significant growth in our Prime Saver product, and total demand deposits increased by $26.6 million.

Total money market accounts decreased by $36.3 million due primarily to management’s decision to sweep approximately $70.0 million of wealth management money market funds off balance sheet in the first quarter of 2021.

These funds can be readily shifted back to in-house money market accounts should liquidity needs arise in the future.

Time deposits decreased by $65.0 million, primarily due to the continued efforts to reduce pricing on single-service relationships and municipal bids.

Non-interest-bearing deposits increased by $5.0 million.

Interest bearing demand deposits increased by $99.5 million and traditional savings accounts increased by $14.1 million.

The increase in interest bearing demand deposits was attributable to an increase in municipality funding into a higher yielding indexed product.

Money market balances increased by $25.4 million.

Borrowed Funds

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Total short-term borrowings

Long-term FHLB advances

Junior subordinated debentures

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Approximate weighted average rate during the year

Total borrowings decreased by $61.5 million, or 40.9%, in 2021 when compared to 2020 due to the prepayment of $70.0 million in FHLB advances in 2021, offset by increased balances in our existing accounts in our Treasury Management product.

Total borrowings increased by $6.9 million, or 7.7%, in 2022 when compared to 2021 due to increased balances in our existing accounts in our Treasury Management product.

Management will continue to closely monitor interest rates within the context of its overall asset-liability management process.

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We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

We generally require collateral or other security to support the financial instruments with credit risk.

We generally require collateral or other security to support the financial

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instruments with credit risk.

The amount of collateral or other security is determined based on management’s credit evaluation of the counterparty.

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To the extent that deposits are not adequate to fund our capital requirements, we can rely on the funding sources identified below under the heading “Liquidity Management”.

At December 31, 2021, the Bank had $130.0 million available through unsecured lines of credit with correspondent banks, $1.0 million available through a secured line of credit with the Fed Discount Window and approximately $188.2 million available through the FHLB.

At December 31, 2022, the Bank had $140.0 million available through unsecured lines of credit with correspondent banks, $9.6 million available through a secured line of credit with the Federal Reserve Discount Window and approximately $195.3 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.

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The total risk-based capital ratios of the Corporation and the Bank at December 31, 2021 were 15.89% and 14.97%, respectively.

The decrease in 2021 for the Corporation was attributable to the repurchase of 400,000 common shares ($7.2 million);

and the Bank was primarily due to dividend funding to the Corporation.

The decrease at the Bank was primarily due to dividend funding to the Corporation.

At December 31, 2022, the most recent notification from the regulators categorizes the Corporation and the Bank as “well capitalized” under the regulatory framework for prompt corrective action.

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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.

That is, the Bank will manage its liquidity to minimize the need to make unplanned sales of assets or to borrow funds

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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.

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Cash and various securities may also be pledged as collateral.

● Secured line of credit with the Fed Discount Window for use in borrowing funds up to 90 days, using municipal securities as collateral.

● Secured line of credit with the Federal Reserve Discount Window for use in borrowing funds up to 90 days, using municipal securities as collateral.

● Brokered deposits, including CDs and money market funds, provide a method to generate deposits quickly.

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● Establish interest rate risk exposure limits for fluctuation in net interest income (“NII”), net income and economic value of equity.

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In order to manage interest sensitivity risk, management formulates guidelines regarding asset generation and pricing, funding sources and pricing, and off-balance sheet commitments.

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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.

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.

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.

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-100 basis points

-200 basis points

-300 basis points

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.

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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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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information called for by this item is incorporated herein by reference to Item 7 of Part II of this annual report under the heading “Market Risk and Interest Sensitivity”.

As a smaller reporting company, the Corporation is not required to provide the information contemplated by this item.

See Item 7 of Part II of this report under the heading “Market Risk and Interest Sensitivity” for a discussion of the Corporation’s primary market risk.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis