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Item 2. Management’s Discussion and Analysis

2023-05-12 compared with 2022-11-10 · 158 added, 308 removed, 301 unchanged (61% of the section changed)

6 unchanged sentences

Forward-looking statements do not represent historical facts, but are statements about management’s beliefs, plans and objectives about the future, as well as its assumptions and judgments concerning such beliefs, plans and objectives.

These statements are

evidenced by terms such as "anticipate,"

These statements are evidenced by terms such as "anticipate,"

"estimate,"

8 unchanged sentences

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 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, and First United Legacy Advisors, LLC, a Maryland limited liability company (“FULA”).

The Trusts were formed for the purpose of selling trust preferred securities that qualified as Tier 1 capital.

FULA was formed to provide investment advice and related services, but it is not yet active.

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.

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 (“Limited Mews”), and a 99.9% non-voting membership interest in MCC FUBT Fund, LLC, an Ohio limited liability company formed for the purpose of acquiring, developing and operating low-income housing units in Allegany County, Maryland (the “MCC Fund”).

At March 31, 2023, the Corporation’s total assets were $1.9 billion, net loans were $1.3 billion, and deposits were $1.6 billion.

Shareholders’ equity at March 31, 2023 was $152.9 million.

The Corporation maintains an Internet site at www.mybank.com on which it makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.

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,

The following table sets forth certain selected financial data for the three month periods ended March 31, 2023 and 2022 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 three months ended

Per Share Data

Basic net income per common share (1) - as reported

Basic net income per common share (1) - non-GAAP

Diluted net income per common share (1) - as reported

Diluted net income per common share (1) - non-GAAP

Basic book value per common share - as reported

Diluted book value per common share - as reported

Basic net income per common share

Diluted net income per common share

Basic book value per common share

Diluted book value per common share

Significant Ratios:

Return on Average Assets (a) (1) - as reported

Settlement and FHLB expenses, net of income tax

Adjusted Return on Average Assets (a) (1) (non-GAAP)

Return on Average Equity (a) (1) - as reported

Settlement and FHLB expenses, net of income tax

Adjusted Return on Average Equity (a) (1) (non-GAAP)

Return on Average Assets (a)

Return on Average Equity (a)

Average Equity to Average Assets

4 unchanged sentences

Consolidated Tier 1 Capital (to average assets)

(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.

(a) Annualized

RESULTS OF OPERATIONS

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.

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.

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.

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,

(in thousands, except for per share amount)

Net income - as reported

Settlement expense

Income tax effect of adjustment

Adjusted net income (non-GAAP)

Basic and Diluted earnings per share - as reported

Settlement expense

Income tax effect of adjustment

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

Significant Ratios:

Return on Average Assets (1) - as reported

Settlement, FHLB and contribution expenses, and insurance reimbursement income, net of income tax effect

Adjusted Return on Average Assets (1) (non-GAAP)

Return on Average Equity (1) - as reported

Settlement, FHLB and contribution expenses, and insurance reimbursement income, net of income tax effect

Adjusted Return on Average Equity (1) (non-GAAP)

Consolidated net income was $4.4 million for the first quarter of 2023 compared to $5.7 million for the first quarter of 2022 and $7.0 million for the fourth quarter of 2022.

Basic net income was $0.66 per share and diluted net income was $0.65 per share for the first quarter of 2023, compared to basic and diluted net income per share of $0.86 for the first quarter of 2022.

The decrease in net income year-over-year was primarily driven by a $1.3 million increase in salaries and employee benefits due to an increase in health insurance costs related to increased claims, as well as increased salary expense for new hires, merit increases effective April 1, 2022, and increased incentive compensation.

Provision for credit losses increased by $1.0 million due to increased qualitative factors related to the potential impact of inflation and rising rates on the cash flows of borrowers.

Data processing expenses increased by $0.1 million, equipment and occupancy expenses increased by $0.1 million and miscellaneous expenses increased by $0.5 million primarily due to increased pension costs.

These increases were partially offset by an increase in net interest income of $1.2 million and a decrease in income tax expense of $0.5 million.

Other operating income, including gains, for the first quarter of 2023 was stable when compared to the same period of 2022.

Increases in service charges and debit card income were offset by a decrease in wealth management income attributable to the decline in market values of assets under management.

Operating expenses increased by $2.1 million when comparing the first quarter of 2023 to the first quarter of 2022.

This increase was driven largely by a $1.3 million increase in salaries and employee benefits attributable to increased salary expense related to new hires and merit increases effective April 1, 2022, increased health insurance costs associated with unusually high claims and increased incentive payouts.

Occupancy, equipment and data processing expenses increased $0.3 million.

Other miscellaneous expenses increased $0.5 million due to increases in charitable contributions, consulting fees, Visa processing fees, continuing education fees, mileage reimbursements, fraud related expense, and pension costs, offset by slight reductions in contract labor, legal and professional, telephone expense, investor relations, debit card expense, and miscellaneous loan fees.

The effective income tax rates as a percentage of income for the three-month period ended March 31, 2023 and March 31, 2022 were 23.6% and 25.0%, respectively.

The decrease in the tax rate for the period was primarily related to a new low-income housing tax credit investment in 2022 that began generating tax credits during the fourth quarter of 2022 and will continue to generate tax credits in 2023 and future years.

Net Interest Income

3 unchanged sentences

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

The tables below summarizes net interest income for the nine and three month periods ended September 30, 2022 and 2021.

Non-GAAP - FTE

Nine Months Ended

September 30,

(dollars in thousands)

Interest income

Interest expense

Net interest income

Net interest margin %

The tables below summarizes net interest income for the three month periods ended March 31, 2023 and 2022.

Three Months Ended

September 30,

(dollars in thousands)

3 unchanged sentences

Net interest margin %

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,

(dollars in thousands)

Investment Securities:

Federal funds sold

Interest-bearing deposits with other banks

Other interest earning assets

Total earning assets

Allowance for loan losses

Non-earning assets

Liabilities and Shareholders’ Equity

Interest-bearing demand deposits

Interest-bearing money markets

Savings deposits

Time deposits

Short-term borrowings

Long-term borrowings

Total interest-bearing liabilities

Non-interest-bearing deposits

Other liabilities

Shareholders’ Equity

Total Liabilities and Shareholders’ Equity

Net interest income and spread

Net interest margin

(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.

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,

(dollars in thousands)

10 unchanged sentences

Savings deposits

Time deposits

Time deposits - Retail

Time deposits - Brokered

Short-term borrowings

11 unchanged sentences

(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.

Net interest income, on a non-GAAP, FTE basis, increased by $1.2 million for the first quarter of 2023 when compared to the first quarter of 2022.

This increase was driven by an increase of $3.7 million in interest income from an overall increase in yield of 73 basis points on interest earning assets and an increase in average balances of $73.4 million.

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)

Interest Income:

Taxable Investments

Non-taxable Investments

Federal funds sold

Interest-bearing deposits

Other interest earning assets

Total interest income

Interest Expense:

Interest-bearing demand deposits

Interest-bearing money markets

Savings deposits

Time deposits

Short-term borrowings

Long-term borrowings

Total interest expense

Net interest income

For the Three months ended September 30, 2022 compared to the Three months ended September 30, 2021

Interest income on loans increased by $3.0 million due to the increase of 58 basis points in overall yield on the loan portfolio as new loans were booked at higher rates as well as adjustable-rate loans repricing in correlation to the rising rate environment and an increase in average balances of $110.7 million.

Investment income increased by $0.3 million.

The increase of $2.5 million in interest expense was driven by the increase of 82 basis points on interest paid on deposit accounts as well as an increase of $89.3 million in average balances of interest-bearing deposit accounts when compared to 2022.

Increased deposit pricing is a result of the continued pressure on deposits as well as a shift of balances from non-interest-bearing deposits to the interest bearing Insured Cash Sweep (“ICS”) product to ensure full FDIC insurance coverage.

For the Three months ended March 31, 2023

compared to the three months ended March 31, 2022

(in thousands and tax equivalent basis)

10 unchanged sentences

Savings deposits

Time deposits

Time deposits - Retail

Time deposits - Brokered

Short-term borrowings

3 unchanged sentences

(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.

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

Provision for Credit Losses

Specific allocations have been made for 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 ACL/ALL have been adjusted based on the current economic environment and the characteristics of the loan portfolio.

The composition of other operating income for the three month periods ended March 31, 2023 and 2022 is illustrated in the following table:

Income as % of

Total Other Income

Nine Months Ended

Three Months Ended

September 30,

(in thousands)

6 unchanged sentences

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

The composition of other operating expenses for the three month periods ended March 31, 2023 and 2022 is illustrated in the following table:

Expense as % of

Total Other Operating Expenses

Nine Months Ended

Three Months Ended

September 30,

(in thousands)

8 unchanged sentences

Investor relations

Settlement expense

FHLB prepayment penalty

Contributions

7 unchanged sentences

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

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.

Total assets at March 31, 2023 were $1.9 billion, representing a $89.3 million increase since December 31, 2022.

During the first quarter of 2023, cash and interest-bearing deposits in other banks increased by $81.6 million as a result of the implementation of the contingency funding plan and obtaining $61.1 million of brokered certificates of deposit and $80.0 million in FHLB borrowings.

Implementing the contingency funding plan and the increase in on-balance sheet liquidity was a precautionary move given the market disruptions associated with the volatile banking environment and the near-term uncertainties regarding growth in the deposit portfolio.

The investment portfolio decreased by $4.5 million associated with normal principal amortization and gross loans increased by $9.6 million.

Other assets, including deferred taxes, premises and equipment, and accrued interest receivable, remained stable.

Total liabilities at March 31, 2023 were $1.8 billion, representing an $88.2 million increase since December 31, 2022.

Total deposits increased by $20.6 million since December 31, 2022.

The increase in deposits during the first quarter was primarily attributable to $61.1 million in new brokered deposits, which was partially offset by a decrease of approximately $38.1 million in non-interest deposits from a shift to interest bearing accounts, the effects of consumer and commercial spending and the competitive market for deposits.

Short term borrowings decreased by $12.5 million since December 31, 2022 due to municipalities in our Treasury management product utilizing cash for normal spending.

Long term borrowings increased by $80.0 million in the first

quarter of 2023 when compared to December 31, 2022 due to the acquisition of $80.0 million in FHLB borrowings related to the implementation of our Contingency Funding Plan.

Loan Portfolio

1 unchanged sentence

(dollars in thousands)

September 30, 2022

March 31, 2023

December 31, 2022

3 unchanged sentences

Residential mortgage

*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.

*Includes $0.3 million of PPP loans at March 31, 2023 and $0.4 million at December 31, 2022

Outstanding loans of $1.3 billion at March 31, 2023 reflected growth of $9.6 million for the first quarter of 2023.

Since December 31, 2022, commercial real estate loans decreased by $5.5 million and acquisition and development loans increased by $6.4 million.

Commercial and industrial loans decreased by $3.4 million since December 31, 2022, primarily due to seasonal fluctuations of floor plan lending.

Residential mortgage loans increased $11.8 million related to management’s strategic decision to book new mortgage loans at higher rates to our in-house portfolio.

The consumer loan portfolio increased slightly by $0.3 million.

New commercial loan production for the three months ended March 31, 2023 was approximately $52.8 million.

The pipeline of commercial loans as of March 31, 2023 was $42.3 million.

At March 31, 2023, unfunded, committed commercial construction loans totaled approximately $42.6 million.

Commercial amortization and payoffs were approximately $38.9 million through March 31, 2023 due primarily to pay-offs of short-term commercial loans as well as normal amortizations of the commercial loan portfolio.

New consumer mortgage loan production for the first quarter of 2023 was approximately $19.0 million, with most of this production comprised of in-house mortgages.

The pipeline of in-house, portfolio loans as of March 31, 2023, was $20.3 million.

The residential mortgage production level normalized in the first quarter of 2023 due to the increasing interest rates that occurred throughout 2022 and 2023.

Non-accrual loans totaled $3.3 million at March 31, 2023 compared to $3.5 million at December 31, 2022.

The decrease in non-accrual balances at March 31, 2023 was related to principal reductions.

OREO balances decreased by $0.1 million since December 31, 2022 due to sales of OREO properties.

Risk Elements of Loan Portfolio

2 unchanged sentences

(dollars in thousands)

September 30,

Non-accrual loans:

1 unchanged sentence

Acquisition and development

Commercial and industrial

Residential mortgage

1 unchanged sentence

Accruing Loans Past Due 90 days or more:

Commercial real estate

Residential mortgage

1 unchanged sentence

Total non-accrual and accruing loans past due 90 days or more

Restructured Loans (TDRs):

Non-accrual (included above)

Other real estate owned

Total Non-performing assets

Impaired loans without a valuation allowance

Impaired loans with a valuation allowance

Total impaired loans

Valuation allowance related to impaired loans

Non-accrual loans to total loans (as %)

1 unchanged sentence

Non-performing assets to total assets (as %)

Allowance for loan losses to non-accrual loans (as %)

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

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.

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

(dollars in thousands)

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

Residential mortgage – home equity

Total performing

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

Residential mortgage – home equity

Total non-accrual

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.

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:

Allowance for credit losses to non-accrual loans (as %)

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

Allowance for Credit Losses

The ACL represents an amount which, in management’s judgment, is adequate to absorb expected credit losses over the life of outstanding loans as of the balance sheet date based on the evaluation of current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions and prepayment experience.

The ACL is measured and recorded upon the initial recognition of a financial asset.

The ACL is reduced by charge-offs, net of recoveries of previous losses, and is increased by a provision or decreased by a recovery for credit losses, which is recorded as a current period operating expense.

Determination of an appropriate ACL is inherently complex and requires the use of highly subjective estimates.

The reasonableness of the ACL is reviewed quarterly by management.

Management believes it uses relevant information available to make determination about the ACL and that it has established the existing allowance in accordance with GAAP.

However, the determination of the ACL requires significant judgment, and estimates of expected credit losses in the loan portfolio can vary from the amounts actually observed.

While management uses available information to recognize expected credit losses, future additions to the ACL may be necessary based on changes in the loans comprising the portfolio, changes in the current and forecasted economic conditions, changes to the interest rate environment which may directly impact prepayment and curtailment rate assumptions, and changes in the financial condition of borrowers.

The ACL “base case” model is derived from various economic forecasts provided by widely recognized sources.

Management evaluates the variability of market conditions by examining the peak and trough of economic cycles.

These peaks and torughs are used to stress the base case model to develop a range of potential outcomes.

Management then determines the appropriate reserve through an evaluation of these various outcomes relative to current economic conditions and known risks in the portfolio.

The following table presents a summary of the activity in the ACL and ALL for the three months ended March 31:

(dollars in thousands)

Balance, January 1

Impact of CECL Adoption

Commercial real estate

Acquisition and development

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Total recoveries

Provision for loan losses

Credit Loss Expense/(Credit)

Balance at end of period

Allowance for loan losses to gross loans outstanding (as %)

Allowance for credit/loan losses to gross loans outstanding (as %)

Net (Charge-offs)/Recoveries as a % of Average Applicable Portfolio

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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.

At March 31, 2023, the total amortized cost basis of the available-for-sale investment portfolio was $148.2 million, compared to a fair value of $124.0 million.

Unrealized gains and losses on securities available-for-sale are reflected in accumulated other comprehensive loss, a component of shareholders’ equity.

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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

March 31, 2023

December 31, 2022

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Total held to maturity

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.

Total fair value of investment securities available for sale decreased by $1.9 million since December 31, 2022 due to principal paydowns of the portfolio in the first quarter of 2023.

At March 31, 2023, the securities classified as available-for-sale included a net unrealized loss of $24.3 million, which represents the difference between the fair value and amortized cost of securities in the portfolio.

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 .

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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.

Approximately $109.9 million of the available for sale portfolio was valued using Level 2 pricing and had net unrealized losses of $21.1 million at March 31, 2023.

The remaining $14.1 million of the securities available for sale represents the entire collateralized debt obligation (“CDO”) portfolio, which was valued using significant unobservable inputs (Level 3 assets).

The $4.5 million in net unrealized losses associated with this portfolio relates to nine pooled trust preferred securities that comprise the CDO portfolio.

Net unrealized losses of $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.

Net unrealized losses of $3.3 million represent non-credit related OTTI charges on seven of the securities, while $1.2 million of unrealized losses relates to two securities which have had no OTTI related charges.

The following table presents the composition of our deposits at the dates indicated:

(dollars in thousands)

September 30, 2022

March 31, 2023

December 31, 2022

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Savings deposits

Time deposits

Time deposits- retail

Time deposits- brokered

Total Deposits

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.

Total deposits at March 31, 2023 increased by $20.6 million when compared to December 31, 2022.

In 2023, non-interest-bearing deposits decreased by $38.1 million primarily due to the shift of balances into interest bearing accounts to ensure full FDIC coverage through the ICS product, consumer and commercial spending and the competitive deposit market.

Interest bearing demand deposits increased by $34.9 million and traditional savings and money market accounts decreased by $34.3 million.

Total time deposits increased by $58.0 million.

This increase in time deposits was primarily driven by management’s decision to acquire $61.1 million in brokered deposits during the first quarter of 2023 as a result of the market disruption.

The following table summarizes the percentage of deposits that are insured by deposit insurance or otherwise fully collateralized by securities compared to uninsured deposits as of March 31, 2023 and December 31, 2022.

March 31, 2023

December 31, 2022

(dollars in thousands)

Insured/collateralized deposits

Uninsured deposits

The following table summarizes the percentage of deposit balances from retail customers compared to business customers as of March 31, 2023 and December 31, 2022.

March 31, 2023

December 31, 2022

(dollars in thousands)

Retail deposits

Business deposits

Deposit outflows experienced in the latter half of 2022 and in January 2023 were due to the competitive pricing landscape and inflationary spending.

Changes in deposit levels were not directly related to recent market disruptions.

Borrowed Funds

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(in thousands)

September 30,

Fed Funds Purchased, weighted average interest rate of 3.25% at September 30, 2022

Securities sold under agreements to repurchase

Total short-term borrowings

FHLB advances

Junior subordinated debt

Total long-term borrowings

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.

Short term borrowings decreased $12.5 million since December 31, 2022, driven by the utilization of cash by municipalities in our Treasury Management product.

Long-term borrowings increased by $80.0 million due to management’s decision to implement the Contingency Funding plan in regards to the recent market disruption.

Two new borrowings totaling $80.0 million in FHLB advances were obtained in the first quarter of 2023.

Liquidity Management

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We actively manage our liquidity position through regular meetings of a sub-committee of executive management, known as the Treasury Team, which looks forward 12 months at 30-day intervals.

The measurement is based upon the projection of funds

sold or purchased position, along with ratios and trends developed to measure dependence on purchased funds and core growth.

The measurement is based upon the projection of funds sold or purchased position, along with ratios and trends developed to measure dependence on purchased funds and core growth.

Monthly reviews by management and quarterly reviews by the Asset and Liability Committee under prescribed policies and procedures are designed to ensure that we will maintain adequate levels of available funds.

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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:

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).

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.

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 and Community Bankers Bank).

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.

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

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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.

Bank Term Funding Program – A Federal Reserve program collateralized by government agency securities, if needed.

The following table presents sources of liquidity available to the Company as of March 31, 2023.

(dollars in thousands)

Total Availability

Net Availability

Internal Sources

Unpledged securities

External Sources

Federal Reserve (discount window)

Correspondent unsecured lines of credit

Bank Term Funding Program*

*Bank Term Funding Program ("BTFP") has been established and can be utilized if needed.

$122 million available for BTFP included in unpledged above.

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

Due to the recent market disruption, management implemented the Liquidiity Contingency Plan and 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

10 unchanged sentences

A negative gap position would benefit us during a period of declining interest rates.

At September 30, 2022, we were asset sensitive.

At March 31, 2023, we were asset sensitive.

Our interest rate risk management goals are:

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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:

Based on the simulation analysis performed at March 31, 2023 and December 31, 2022, management estimated the following changes in net interest income, assuming the indicated rate changes:

(Dollars in thousands)

September 30,

+400 basis points

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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 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.

Based on capital ratios at March 31, 2023, the Bank was considered to be well-capitalized.

We adopted CECL effective January 1, 2023 and elected to implement the regulatory agencies’ capital transition entirely upon implementation.

The following table presents the Bank’s capital ratios as of the dates indicated:

September 30,

Total Capital (to risk-weighted assets)

First United Bank & Trust

Tier 1 Capital (to risk-weighted assets)

First United Bank & Trust

Common Equity Tier 1 Capital (to risk-weighted assets)

First United Bank & Trust

Tier 1 Capital (to average assets)

First United Bank & Trust

As of March 31, 2023 and December 31, 2022, the Bank was considered “well capitalized” under the regulatory framework for prompt corrective action.

We adopted CECL effective January 1, 2023 and elected not to implement the regulatory agencies’ capital transition and instead opted to record the impact to ouc capital ratios immediately upon implementation.

Effective with the implementation of CECL, a $2.2 million, net of tax, adjustment was made to retained earnings.

The adjustment did not have a material impact to our capital ratios.

Contractual Obligations, Commitments and Off-Balance Sheet Arrangements

2 unchanged sentences

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.

Comparing March 31, 2023 to December 31, 2022, short-term borrowings decreased $12.5 million, driven by a the utilization of cash balances by municipalities related to the overnight investments product.

Long-term borrowings increased by $80.0 million during the quarter due to management’s decision to obtain $80 million in FHLB advances during the first quarter of 2023.

Loan commitments are made to accommodate the financial needs of our customers.

4 unchanged sentences

(in thousands)

September 30,

Residential Mortgage - home equity

2 unchanged sentences

Standby letters of credit

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.

The increase of $10.4 million in commitments at March 31, 2023 when compared to December 31, 2022 was due to new business in construction commitments in the commercial portfolio as well as new home equity lines of credit.

Upon adoption of ASC 326 on January 1, 2023, the Company recorded an initial increase to the ACL for off-balance sheet exposures of $0.9 million.

Credit loss expense for off-balance sheet credit exposures totaled $0.1 million for the period ending March 31, 2023.

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-Q

Item 2. Management’s Discussion and Analysis