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Item 2. Management’s Discussion and Analysis

2024-11-07 compared with 2024-08-07 · 155 added, 136 removed, 478 unchanged (38% of the section changed)

11 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, that elected financial holding company status in 2021.

elected financial holding company status in 2021.

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.

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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, LLC, an Ohio limited liability company formed for the purpose of acquiring, developing and operating low-income housing units in Allegany County, Maryland.

At June 30, 2024, the Corporation’s total assets were $1.9 billion, net loans were $1.4 billion, and deposits were $1.5 billion.

Shareholders’ equity at June 30, 2024 was $164.2 million.

At September 30, 2024, the Corporation’s total assets were $1.9 billion, net loans were $1.4 billion, and deposits were $1.5 billion.

Shareholders’ equity at September 30, 2024 was $174.0 million.

We maintain an Internet site at www.mybank.com on which we make available, free of charge, First United Corporation’s 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 six-month periods ended June 30, 2024 and 2023 and is qualified in its entirety by the detailed information and unaudited financial statements, including the notes thereto, included elsewhere in this quarterly report.

As of the six months ended

The following table sets forth certain selected financial data for the nine-month periods ended September 30, 2024 and 2023 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,

Per Share Data

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RESULTS OF OPERATIONS

Consolidated net income was $4.9 million for the second quarter of 2024.

This compares to $4.4 million for the second quarter of 2023.

Consolidated net income for the first quarter of 2024 was $3.7 million, which was inclusive of $0.4 million, net of tax, in accelerated depreciation expense related to branch closures.

Basic and diluted earnings per share were $0.75 for the second quarter of 2024 compared to $0.66 per share for the second quarter of 2023 and $0.56 per share for the first quarter of 2024.

The $0.5 million increase in quarterly net income year over year was primarily driven by a $1.1 million increase in net interest income, which was offset slightly by an increase of $0.8 million in provision expense.

The increase in net interest income was primarily related to the $3.4 million increase in interest on loans due to new loans being booked at higher rates and the repricing of adjustable-rate loans.

Consolidated net income was $5.8 million for the third quarter of 2024.

This compares to $4.5 million for the third quarter of 2023 and $4.9 million for the second quarter of 2024.

Basic and diluted net income was $0.89 per share for the third quarter of 2024, compared to basic and diluted net income of $0.67 per share for the third quarter of 2023 and $0.75 per share for the second quarter of 2024.

The $1.3 million increase in quarterly net income year over year was primarily driven by a $1.2 million increase in net interest income.

The increase in net interest income was related to the $3.0 million increase in interest on loans due to new loans being booked at higher rates and the repricing of adjustable-rate loans.

This increase was partially offset by the $0.9 million increase in interest paid on deposits due to continued competitive pricing pressures.

An increase of $0.5 million in short-term borrowings related to the FRB’s Bank Term Funding Program (“BTFP”) was offset by the reduction in long-term borrowings related to the repayment of the $40.0 million Federal Home

Loan Bank (“FHLB”) advance in the first quarter of 2024.

The year-over-year increase in provision for credit losses was primarily driven by increased charge-offs in the commercial and industrial portfolio related to one non-accrual credit where collateral was sold through a liquidation auction at depressed prices.

The charge-off was partially offset by continued lower historical losses and improving qualitative factors related to the reduction of non-accrual balances.

Comparing the second quarter of 2024 to the same period in 2023, other activity included a $0.3 million increase in wealth management income due to improving market conditions and growth of new relationships and a decrease in operating expenses of $0.1 million.

The provision for income tax was up $0.2 million when comparing the two quarters due to increased income before tax.

Comparing the six months ended June 30, 2024 to the six months ended June 30, 2023, net interest income, on a non-GAAP, fully tax equivalent (“FTE”) basis, was stable.

Interest income increased by $6.9 million.

Average loan balances increased by $112.9 million and the overall yield increased by 61 basis points in correlation with the rising rate environment and new loans booked at higher rates as well as the repricing of adjustable-rate loans.

Interest expense on deposits increased by $5.6 million, while the average deposit balances increased by $42.5 million, driven by increases of $77.9 million in money market balances and $27.4 million in retail time deposits, partially offset by decreases in savings balances of $50.1 million.

Interest expense on short-term borrowings increased by $0.9 million due to the Bank’s utilization of the BTFP in January 2024.

The increased interest expense resulted in an overall increase of 99 basis points on interest bearing liabilities.

The net interest margin for the six months ended June 30, 2024 was 3.31% compared to 3.39% for the six months ended June 30, 2023.

Other operating income, including net gains, for the second quarter of 2024 increased by $0.3 million when compared to the same period of 2023.

The growth was driven by an increase of $0.3 million in wealth management income due to improving market conditions, increased annuity sales and growth in new and existing customer relationships.

Gains on sales of mortgages declined slightly when comparing the second quarter of 2024 to the same time period of 2023 primarily due to reduced activity in the elevated interest rate environment.

Other operating income on service charges and debit card income remained stable.

Other operating income for the six months ended June 30, 2024 increased by $0.8 million when compared to the same period of 2023.

This increase was primarily due to the $0.8 million increase in wealth management income due to improving market conditions, increased annuity sales and growth in new and existing customer relationships.

Service charge and debit card income were both stable when comparing the six months of 2024 to the six months of 2023.

Operating expenses decreased by $0.1 million in the second quarter of 2024 when compared to the second quarter of 2023.

The decrease was related to a $0.2 million decrease in equipment and occupancy expenses resulting from branch closures in late 2023 and a $0.2 million decrease in check fraud related expenses.

These decreases were partially offset by a $0.4 million increase in salaries related to increased health insurance claims, higher salaries and benefits associated with normal merit increases effective April 1, 2024, and reduced loan origination costs due to lower loan production.

Other increases in data processing and marketing expenses were offset by decreases in professional services, contract labor, telephone and other miscellaneous expenses.

For the six months ended June 30, 2024, non-interest expenses increased by $0.1 million when compared to the six months ended June 30, 2023.

Increases in salaries and employee benefits of $0.2 million due to normal merit increases effective April 1, 2024, and increases in FDIC premiums, data processing, equipment and occupancy were offset by decreases in professional services, contract labor, investor relations and other miscellaneous expenses such as pension related expenses, check fraud and membership dues and licenses.

An increase of $0.4 million in interest expense on short-term borrowings related to the Bank Term Funding Program (“ BTFP”) was offset by the $0.5 million reduction in interest expense on long-term borrowings related to the repayment of $80.0 million of Federal Home Loan Bank (“FHLB”) advances in the first nine

months of 2024.

Comparing the third quarter of 2024 to the same period in 2023, other activity was a $0.2 million increase in wealth management income due to improving market conditions and growth of new relationships and a decrease in operating expenses of $0.5 million driven by reductions in check fraud related expenses, occupancy and equipment, data processing, and marketing expenses, partially offset by increased salaries and benefits.

The provision for income tax was up $0.6 million when comparing the two quarters due to increased net income before tax.

Year-to-date net income for the first nine months of 2024 was $14.4 million compared to $13.3 million for the same period in 2023.

The increased net income was driven by a year-over-year increase of $1.6 million in net interest income driven by a $9.3 million increase in interest income primarily related to increased interest and fees on loans, partially offset by a $7.7 million increase in interest expense due to continued pricing pressure on deposits and our use of the BTFP.

The increase in net interest income was partially offset by a $1.2 million increase in provision for credit losses driven by an increase in net charge-offs of $1.2 million, which was primarily due to a $1.1 million charge-off in the commercial and industrial portfolio related to one non-accrual credit where collateral was sold through a liquidation auction at depressed prices.

Operating income increased $0.9 million, primarily as the result of increased wealth management income.

Operating expenses decreased by $0.4 million and was driven by reductions in professional services, and pension benefits expense, a $0.5 million reduction in check fraud expense, and a reduction in other miscellaneous expenses, partially offset by a $0.4 million increase in salaries and benefits.

Other operating income, including net gains, for the third quarter of 2024 increased by $0.2 million when compared to the same period of 2023.

The increase was driven by an increase of $0.2 million in trust and brokerage income due to improving market conditions, increased annuity sales and growth in new and existing customer relationships.

Gains on sales of mortgages declined slightly when comparing the third quarter of 2024 to the same period of 2023 primarily due to reduced activity in the elevated interest rate environment.

Service charge income and debit card income remained stable.

Other operating income for the nine months ended September 30, 2024 increased by $0.9 million when compared to the same period of 2023.

This increase was primarily due to the $1.0 million increase in trust and brokerage income that resulted from improving market conditions, increased annuity sales and growth in new and existing customer relationships.

Service charge and debit card income were both stable when comparing the first nine months of 2024 to the same period of 2023.

Operating expenses decreased by $0.5 million in the third quarter of 2024 when compared to the third quarter of 2023.

The decrease was related to a $0.2 million decrease in occupancy, equipment and data processing expenses, a $0.3 million decrease in check fraud related expenses, and decreases in other miscellaneous expenses such as marketing, contributions, net other real estate owned (“OREO”) expenses, and pension benefit expenses.

These decreases were partially offset by a $0.2 million increase in salaries and benefits related to increased executive and employee incentive accruals, 401(k) plan expense and wellness costs offset by overall reduced salaries and wages.

For the nine months ended September 30, 2024, non-interest expenses decreased by $0.4 million when compared to the nine months ended September 30, 2023.

The decrease was primarily attributable to a $0.5 million decrease in check fraud expenses and decreases in professional services, equipment, net OREO expense, line rentals, pension benefit expenses, and other miscellaneous expenses such as marketing, contributions, contract labor, and investor relations.

These decreases were partially offset by increased occupancy, data processing expenses and salaries and benefits related to increased incentives, 401K expense, wellness expense and loan origination costs, offset by reductions in life and health insurance costs.

Net Interest Income

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

The tables below summarize net interest income for the six- and three-month periods ended June 30, 2024 and 2023.

Six Months Ended

The tables below summarize net interest income for the nine- and three-month periods ended September 30, 2024 and 2023.

Nine Months Ended

September 30,

(in thousands)

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Three Months Ended

(dollars in thousands)

September 30,

(in thousands)

Interest income

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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 six- and three-month periods ended June 30, 2024 and 2023:

Six Months Ended

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, 2024 and 2023:

Nine Months Ended

September 30,

(in thousands)

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(1) The above table reflects the average rates earned or paid stated on an FTE basis assuming a 21% tax rate for 2024 and 2023.

Non-GAAP interest income on a fully taxable equivalent for the six-month periods ended June 30, 2024 and 2023 was $116 and $452, respectively.

Non-GAAP interest income on a fully taxable equivalent for the nine-month periods ended September 30, 2024 and 2023 was $176 and $566, respectively.

(2) Net interest margin is calculated as net interest income divided by average earning assets.

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Three Months Ended

September 30,

(dollars in thousands)

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(1) The above table reflects the average rates earned or paid stated on an FTE basis assuming a 21% tax rate for 2024 and 2023.

Non-GAAP interest income on a fully taxable equivalent for the three-month periods ended June 30, 2024 and 2023 was $58 and $225, respectively.

Non-GAAP interest income on a fully taxable equivalent for the three-month periods ended September 30, 2024 and 2023 was $61 and $112, 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.

Net interest income, on a non-GAAP, FTE basis, increased by $0.9 million for the second quarter of 2024 when compared to the second quarter of 2023.

Net interest income, on a non-GAAP, fully tax equivalent (“ FTE”) basis, increased by $1.2 million for the third quarter of 2024 when compared to the third quarter of 2023.

This increase was driven by a $2.0 million increase in interest income.

Interest income on loans increased by $3.4 million due to the increase in average balances of $97.6 million and a 64 basis point increase in the 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.

Interest income on loans increased by $3.0 million due to the increase in average balances of $69.7 million and a 58 basis point increase in the 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 elevated rate environment.

Investment income decreased by $0.3 million due to a decrease of $63.2 million in average balances related to the balance sheet restructuring of our investment portfolio in the fourth quarter of 2023 and the maturity of $37.5 million in U.S.

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The overall yield on the investment portfolio increased by 14 basis points primarily driven by the increased rate on the trust preferred portfolio and the maturity and sale of lower rate investments.

Average cash balances declined by $42.0 million as cash from the investment portfolio and on balance sheet liquidity was shifted to fund higher yielding loans.

Interest expense increased by $0.8 million year over year due to an increase of 34 basis points on interest paid on deposit accounts.

The average deposit balances increased by $24.5 million when compared to the second quarter of 2023 due primarily to the increase of $96.4 million in money market account, which was partially offset by decreases of $43.2 million and $36.7 million in average savings deposits and average time deposits, respectively.

Comparing the six months ended June 30, 2024 to the six months ended June 30, 2023, net interest income, on a non-GAAP, FTE basis, was stable.

The average deposit balances decreased by $7.4 million when compared to the third quarter of 2023 due primarily to the decrease of $13.1 million in retail time deposits, a $60.2 million decrease in brokered time deposits and a $32.3 million decrease in savings accounts, which was mostly offset by an increase of $96.6 million in money market accounts and a slight increase of $1.6 million in interest-bearing demand deposits.

Comparing the nine months ended September 30, 2024 to the nine months ended September 30, 2023, net interest income, on a non-GAAP, FTE basis, increased by $1.2 million.

Interest income increased by $8.9 million.

Interest expense on deposits increased by $5.6 million while the average deposit balances increased by $42.5 million, driven by increases of $77.9 million in money market balances and $27.4 million in retail time deposits, partially offset by decreases in savings balances of $50.1 million.

Interest expense on short-term borrowings increased by $0.9 million due to the Bank’s utilization of the BTFP in January 2024.

The increased interest expense resulted in an overall increase of 99 basis points on interest bearing liabilities.

The net interest margin for the six months ended June 30, 2024 was 3.31% compared to 3.39% for the six months ended June 30, 2023.

The following table sets forth an analysis of volume and rate changes in interest income and interest expense for our average interest-earning assets and average interest-bearing liabilities for the six- and three-month periods ended June 30, 2024 and 2023:

For the six months ended June 30, 2024

compared to the six months ended June 30, 2023

Average loan balances increased by $98.3 million and the overall yield increased by 61 basis points in correlation with the elevated rate environment as new loans were booked at higher rates as well as the repricing of adjustable-rate loans.

Interest expense on deposits increased by $6.5 million while the average deposit balances increased by $24.7 million, driven by increases of $77.7 million in money market balances and $13.7 million in retail time deposits, partially offset by decreases in savings balances of $44.1 million and brokered time deposits of $26.0 million.

Interest expense on short-term borrowings increased by $1.3 million due to the Bank’s utilization of the BTFP program since January 2024.

The increased interest expense resulted in an overall increase of 75 basis points on the cost of interest-bearing liabilities.

The net interest margin for the nine months ended September 30, 2024 was 3.34% compared to 3.30% for the nine months ended September 30, 2023.

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, 2024 and 2023:

For the nine months ended September 30, 2024

compared to the nine months ended September 30, 2023

(in thousands and tax equivalent basis)

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(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.

For the Three months ended June 30, 2024 compared to the Three months ended June 30, 2023

For the Three months ended September 30, 2024 compared to the Three months ended September 30, 2023

(in thousands and tax equivalent basis)

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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 estimated allowance for credit losses (“ACL”) have been adjusted based on the current economic environment and the characteristics of the loan portfolio.

For the first six months of 2024 and 2023, net provision expense was $2.1 million and $0.9 million, respectively.

For the second quarters of 2024 and 2023, net provision expense was $1.2 million and $0.4 million, respectively.

The increased provision expense recorded in 2024 was primarily related to $1.1 million in charge-offs related to one non-accrual commercial and industrial loan relationship and was partially offset by improving qualitative risk factors of our loan portfolio.

The composition of other operating income for the six- and three-month periods ended June 30, 2024 and 2023 is illustrated in the following table:

For the first nine months of 2024 and 2023, net provision expense was $2.4 million and $1.2 million, respectively.

For both of the third quarters ended September 30, 2024 and 2023, net provision expense was $0.3 million.

The increased provision expense recorded in 2024 was primarily related to an increases of $1.2 in net charge-offs, which was primarily due to a $1.1 million charge-off related to one non-accrual commercial and industrial loan relationship and was partially offset by improving qualitative risk factors of our loan portfolio.

The composition of other operating income for the nine- and three-month periods ended September 30, 2024 and 2023 is illustrated in the following table:

Income as % of

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Total Other Income

Six Months Ended

Nine Months Ended

Three Months Ended

September 30,

(in thousands)

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Other Operating Expenses

The composition of other operating expenses for the six- and three-month periods ended June 30, 2024 and 2023 is illustrated in the following table:

The composition of other operating expenses for the nine- and three-month periods ended September 30, 2024 and 2023 is illustrated in the following table:

Expense as % of

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Total Other Operating Expenses

Six Months Ended

Nine Months Ended

Three Months Ended

September 30,

(in thousands)

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In arriving at this effective tax rate, however, no effect should be included for the tax related to significant, unusual or extraordinary items that will be separately reported or reported net of their related tax effect in reports for the interim period or for the fiscal year.

The effective income tax rates as a percentage of income for the six month periods ended June 30, 2024 and June 30, 2023 were 24.3% and 24.0%, respectively.

The effective income tax rates as a percentage of income for the nine month periods ended September 30, 2024 and September 30, 2023 were 24.6% and 23.6%, respectively.

Non-GAAP Financial Measures

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The following table presents a reconciliation of net income and diluted earnings per share (as reported) to adjusted net income and adjusted diluted earnings per share:

Three months ended June 30,

Six months ended June 30,

Three months ended September 30,

Nine months ended September 30,

(in thousands, except for per share amount)

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Income tax effect of adjustments

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

Adjusted diluted earnings per share (non-GAAP)

Significant Ratios:

Six months ended June 30,

Nine months ended September 30,

Return on Average Assets - as reported

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Balance Sheet Overview

Total assets at June 30, 2024 were $1.9 billion, representing a $37.3 million decrease since December 31, 2023.

During the first six months of 2024, cash and interest-bearing deposits in other banks decreased by $4.7 million.

Total assets at September 30, 2024 were $1.9 billion, representing a $10.3 million increase since December 31, 2023.

During the first nine months of 2024, cash and interest-bearing deposits in other banks increased by $12.6 million.

The investment portfolio decreased by $44.3 million due to the maturities of $37.5 million of U.S.

Treasury bonds during the year and normal principal amortization of our mortgage-backed securities (“MBS”) portfolio.

Gross loans increased by $16.3 million and other real estate owned (“OREO”) decreased by $1.5 million due to sales of OREO properties.

Other assets, including deferred taxes, premises and equipment, and accrued interest receivable, decreased by $2.7 million.

Total liabilities at June 30, 2024 were $1.7 billion, representing a $39.6 million decrease since December 31, 2023.

Total deposits decreased by $13.9 million when compared to December 31, 2023.

The decrease in deposits was attributable to decreases in savings deposits of $11.2 million, and retail time deposits of $22.1 million, as well as the repayment of $15.0 million in brokered certificates of deposits, partially offset by increases in demand deposits of $22.2 million and money markets of $16.0 million.

Short-term borrowings increased by $17.1 million since December 31, 2023 due to the Bank’s utilization of the BTFP to obtain $40.0 million in borrowings during January 2024 at a rate of 4.87% with a one-year maturity.

The increase from the BTFP funding was partially offset by the shift of approximately $22.0 million in overnight investment sweep balances to the ICS product as a result of management’s strategy to release pledging of investment securities for municipalities to increase available liquidity.

Long-term borrowings decreased by $40.0 million in the first six month of 2024 when compared to December 31, 2023 due to the repayment of $40.0 million in FHLB borrowings at its maturity in the first quarter of 2024.

Cash from the investment maturities was shifted to gross loans, which increased by $41.2 million and other real estate OREO decreased by $1.6 million due to sales of properties.

Pension assets increased by $5.1 million due to increased market values.

Deferred tax assets decreased by $1.8 million due to the increased fair values of available for sale securities and pension assets when compared to December 31, 2023.

Total liabilities at September 30, 2024 were $1.7 billion, representing a $1.8 million decrease since December 31, 2023.

Total deposits decreased by $10.6 million when compared to December 31, 2023 related to decreases in savings deposits of $14.8 million, non-interest-bearing demand deposits of $8.2 million, and retail time deposits of $23.7 million and the repayment of $30.0 million in brokered certificates of deposits, partially offset by increases in interest-bearing demand deposits of $31.6 million and money markets of $34.6 million.

Short-term borrowings increased by $4.8 million since December 31, 2023, which were comprised of $29.0 million in overnight borrowings from the Federal Reserve offset by a shift of approximately $22.0 million in overnight investment sweep balances to FDIC insured accounts as a result of management’s strategy to release pledging of investment securities for municipalities to provide additional liquidity.

Long-term borrowings increased by $10.0 million in the first nine months

of 2024 when compared to December 31, 2023.

Maturities of FHLB advances of $40.0 million in March and $40.0 million in September were fully repaid.

During the third quarter of 2024 and after the Federal Reserve announced that it would reduce rates by 50 basis points, management made the strategic decision to reduce funding costs and borrowed $90.0 million in three new FHLB advances with maturities of 12 and 18-months and a weighted average rate of 3.89%.

$41.1 million was utilized to prepay the principal and accrued interest of the BTFP borrowings at a rate of 4.87% that was scheduled to mature in January of 2025 and approximately $30.0 million was utilized to repay overnight borrowings related to the repayment of the September $40.0 million maturity.

The remainder is currently held in overnight cash investments.

Loan Portfolio

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(in thousands)

June 30, 2024

September 30, 2024

December 31, 2023

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Residential mortgage

Outstanding loans of $1.4 billion at June 30, 2024 reflected growth of $16.3 million for the first six months of 2024.

Since December 31, 2023, commercial real estate loans increased by $7.3 million and acquisition and development loans increased by $11.2 million.

Commercial and industrial loans decreased by $8.9 million, driven by the repayment of $5.5 million of a non-accrual loan late in second quarter and the $1.1 million charge-off of a non-accrual equipment loan.

Residential mortgage loans increased by $11.2 million and consumer loans decreased by $4.5 million.

New commercial loan production for the three months ended June 30, 2024 was approximately $36.9 million.

The $64.9 million in the pipeline of commercial loans was robust as of June 30, 2024.

At June 30, 2024, unfunded, committed commercial construction loans totaled approximately $12.6 million.

Commercial amortization and payoffs were approximately $51.6 million through June 30, 2024, 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 second quarter of 2024 was approximately $19.1 million, with most of this production comprised of portfolio mortgages.

The pipeline of in-house, portfolio loans as of June 30, 2024 was $19.4 million.

The residential mortgage production level increased in the second quarter of 2024 due to the seasonality of this line of business, particularly construction lending.

Unfunded commitments related to residential construction loans totaled $13.5 million at June 30, 2024.

Non-accrual loans totaled $9.4 million at June 30, 2024 compared to $4.0 million at December 31, 2023.

The increase in non-accrual balances at June 30, 2024 was related to two commercial and industrial loan relationships totaling $12.1 million that were moved to non-accrual during the first quarter of 2024.

The reduction in non-accrual balances during the second quarter of 2024 is related to a borrower’s decision to sell a piece of collateral and reduce outstanding balances by approximately $5.5 million and the charge-off of $1.1 million on another commercial and industrial credit.

The following table presents loans in our commercial real estate portfolio by industry type at June 30, 2024.

Outstanding loans of $1.4 billion at September 30, 2024 reflected growth of $24.9 million since June 30, 2024 and $41.2 million for the first nine months of 2024.

Since December 31, 2023, commercial real estate loans increased by $9.1 million, acquisition and development loans increased by $15.8 million, commercial and industrial loans increased by $3.4 million, residential mortgage loans increased $19.3 million, and consumer loans decreased by $6.5 million.

New commercial loan production for the three months ended September 30, 2024 was approximately $52.1 million.

The pipeline of commercial loans at September 30, 2024 was $19.5 million.

At September 30, 2024, unfunded, committed commercial construction loans totaled approximately $8.3 million.

Commercial amortization and payoffs were approximately $92.8 million through September 30, 2024, 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 third quarter of 2024 was approximately $19.9 million, with most of this production comprised of mortgages to be held on balance sheet.

The pipeline of in-house, portfolio loans as of September 30, 2024 was $12.8 million.

The residential mortgage production level increased in the third quarter of 2024 due to the seasonality of this line of business, particularly construction lending.

Unfunded commitments related to residential construction loans totaled $11.9 million at September 30, 2024.

Non-accrual loans totaled $8.1 million at September 30, 2024 compared to $4.0 million at December 31, 2023.

The increase in non-accrual balances at September 30, 2024 was related to two commercial and industrial loan relationships totaling $12.1 million that were moved to non-accrual during the first quarter of 2024.

Subsequent to being moved to non-accrual, one of the borrowers sold a piece of collateral to reduce outstanding balances by approximately $5.5 million.

The Bank also recognized approximately $1.1 million in net charge-offs and $3.0 million in principal reductions on the other commercial and industrial credit from the liquidation of collateral at depressed prices.

The following table presents loans in our commercial real estate portfolio by industry type at September 30, 2024.

(in thousands)

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(in thousands)

September 30,

Non-accrual loans:

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Accruing Loans Past Due 90 days or more:

Commercial and industrial

Residential mortgage

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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 represents an amount that, 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 provision 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.

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

The reasonableness of the ACL is reviewed quarterly by management.

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Management enhances its calculation with the use of Moody’s economic forecast data to provide additional support to substantiate its ACL.

The following table presents a summary of the activity in the ACL for the six-month periods ended June 30, 2024 and 2023:

The following table presents a summary of the activity in the ACL for the nine-month periods ended September 30, 2024 and 2023:

(in thousands)

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Total recoveries

Credit/loan loss expense

Credit loss expense

Balance at end of period

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Investment Securities

At June 30, 2024, the total amortized cost basis of the available-for-sale investment portfolio was $115.8 million compared to a fair value of $93.0 million.

At September 30, 2024, the total amortized cost basis of the available-for-sale investment portfolio was $111.9 million compared to a fair value of $93.2 million.

Unrealized gains and losses on available-for-sale securities 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:

June 30, 2024

September 30, 2024

December 31, 2023

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Total fair value of investment securities available for sale decreased by $4.0 million since December 31, 2023 due primarily to principal paydowns of the portfolio.

At June 30, 2024, the securities classified as available-for-sale included a net unrealized loss of $22.8 million, which represents the difference between the fair value and amortized cost of securities in the portfolio.

At September 30, 2024, the securities classified as available-for-sale included a net unrealized loss of $18.8 million, which represents the difference between the fair value and amortized cost of securities in the portfolio.

Total amortized cost of securities held to maturity decreased by $40.2 million since December 31, 2023 due primarily to the maturity of $37.5 million in U.S.

Treasury bonds and $2.7 million in other principal paydowns of the portfolio.

Proceeds from the maturities and principal paydowns were reinvested into cash at the Federal Reserve Bank of Richmond in anticipation of the $40.0 million maturing FHLB advance.

Proceeds from the maturities and principal paydowns were utilized for the repayment of FHLB advances.

As discussed in Note 6 to the consolidated financial statements presented elsewhere in this report, the Corporation measures fair market values based on the fair value hierarchy established in ASC Topic 820, Fair Value Measurements and Disclosures .

The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).

Level 3 prices or valuation techniques require

inputs that are both significant to the valuation assumptions and are not readily observable in the market (i.e.

supported with little or no market activity).

Level 3 prices or valuation techniques require inputs that are both significant to the valuation assumptions and are not readily observable in the market (i.e.

supported with little or

no market activity).

These Level 3 instruments are valued based on both observable and unobservable inputs derived from the best available data, some of which is internally developed, and considers risk premiums that a market participant would require.

Approximately $79.0 million of the available-for-sale portfolio was valued using Level 2 pricing and had net unrealized losses of $18.2 million at June 30, 2024.

The remaining $14.0 million of the securities available-for-sale represents the entire collateralized debt obligation portfolio, which was valued using significant unobservable inputs (Level 3 assets).

Approximately $78.4 million of the available-for-sale portfolio was valued using Level 2 pricing and had net unrealized losses of $14.9 million at September 30, 2024.

The remaining $14.8 million of the available-for-sale securities represents the entire collateralized debt obligation portfolio, which was valued using significant unobservable inputs (Level 3 assets).

The $3.9 million in net unrealized losses associated with this portfolio relates to nine pooled trust preferred securities that comprise the collateralized debt obligation portfolio.

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(in thousands)

June 30, 2024

September 30, 2024

December 31, 2023

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Interest-bearing deposits:

Money market- retail

Money market- brokered

Savings deposits

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Total Deposits

Total deposits at June 30, 2024 decreased by $13.9 million when compared to December 31, 2023.

Total deposits at September 30, 2024 decreased by $10.6 million when compared to December 31, 2023.

Non-interest-bearing deposits decreased by $8.2 million.

Interest-bearing demand deposits increased by $22.2 million, primarily related to the shift of approximately $22.0 million in overnight investment sweep balances into the ICS product due to management’s strategy to release pledging of investment securities for municipalities to increase available liquidity.

Money market accounts increased by $16.0 million due primarily to the expansion of current relationships and new relationships during the first six months.

Interest-bearing demand deposits increased by $31.6 million year-to-date, primarily related to the shift of approximately $22.0 million in overnight investment sweep balances into FDIC insured accounts due to management’s strategy to release pledging of investment securities for municipalities to provide additional liquidity as well as seasonal fluctuations in municipal deposit balances compared to December 2023.

Money market accounts increased by $34.6 million due primarily to the expansion of current relationships and new relationships during the first nine months.

Traditional savings accounts decreased by $14.8 million and time deposits decreased by $53.7 million.

The decrease in time deposits was due to a decrease of $22.1 million in retail Certificates of Deposit (“CDs”) related to maturities of a nine-month special CD promotion in 2023 and the maturity and repayment of a $15.0 million brokered CD.

The decrease in time deposits was due to a decrease of $23.7 million in retail CDs primarily related to maturities of a nine-month special CD promotion in 2023 and the maturity and repayment of $30.0 million in brokered CDs during the year.

The Bank has worked closely with customers as these CDs mature to transition them to other deposit and wealth management products offered by the Bank.

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 June 30, 2024 and December 31, 2023.

June 30, 2024

September 30, 2024

December 31, 2023

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Insured deposits

Uninsured but collateralized deposits

Uninsured and fully collateralized deposits

Uninsured and uncollateralized deposits

The following table summarizes the percentage of deposit balances from retail customers compared to business customers as of June 30, 2024 and December 31, 2023.

June 30, 2024

The following table summarizes the percentage of deposit balances from retail customers compared to business customers as of September 30, 2024 and December 31, 2023.

September 30, 2024

December 31, 2023

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(in thousands)

Bank Term Funding Program

September 30,

Overnight borrowings from Federal Reserve Discount Window

Securities sold under agreements to repurchase

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Total long-term borrowings

Short-term borrowings increased by $17.1 million as the Bank borrowed $40.0 million from the BTFP in January 2024, partially offset by a decrease of approximately $22.0 million in other short-term borrowings due primarily to management’s strategic decision to shift municipal customers into the ICS deposit product.

Long-term borrowings decreased by $40.0 million as a $40.0 million FHLB advance matured in March 2024 and was fully repaid utilizing proceeds from lower yielding investment maturities.

Short-term borrowings increased by $4.8 million when compared to December 31, 2023, which were comprised of $29.0 million in overnight borrowings from the Federal Reserve, offset by a shift of approximately $22.0 million in overnight investment sweep balances into FDIC insured accounts due to management’s strategy to release pledging of investment securities for municipalities to provide additional liquidity.

Long-term borrowings increased by $10.0 million in the first nine months of 2024 when compared to December 31, 2023.

Maturities of FHLB advances of $40.0 million in March and $40.0 million in September were fully repaid.

$41.1 million was utilized to prepay the principal and accrued interest of the BTFP borrowing at a rate of 4.87% that was scheduled to mature in January of 2025 and approximately $30.0 million was utilized to repay overnight borrowings related to the repayment of the September $40.0 million maturity.

The remainder is currently held in overnight cash investments.

Liquidity Management

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The Bank will use funding sources where the interest cost is relatively insensitive to market changes in the short run (periods of one year or less) to satisfy operating cash needs.

The remaining normal funding will come from interest-sensitive liabilities, either deposits or borrowed funds.

The remaining normal funding will come from interest-sensitive

liabilities, either deposits or borrowed funds.

When the marginal cost of needed wholesale funding is lower than the cost of raising this funding in the retail markets, the Corporation may supplement retail funding with external funding sources such as:

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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.

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

The Bank obtained $40.0 million in funds through the BTFP in January 2024 at a fixed rate of 4.87%

The following table presents sources of liquidity available to the Corporation as of June 30, 2024.

The following table presents sources of liquidity available to the Corporation as of September 30, 2024.

(in thousands)

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Correspondent unsecured lines of credit

Bank Term Funding Program

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

At June 30, 2024, we were asset sensitive.

At September 30, 2024, 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 June 30, 2024 and December 31, 2023, management estimated the following changes in net interest income, assuming the indicated rate changes:

Based on the simulation analysis performed at September 30, 2024 and December 31, 2023, management estimated the following changes in net interest income, assuming the indicated rate changes:

(in thousands)

September 30,

+400 basis points

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

September 30,

Total Capital (to risk-weighted assets)

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Tier 1 Capital (to average assets)

As of both June 30, 2024 and December 31, 2023, the Bank was considered “well capitalized” under the regulatory framework for prompt corrective action.

As of both September 30, 2024 and December 31, 2023, the Bank was considered “well capitalized” under the regulatory framework for prompt corrective action.

Contractual Obligations, Commitments and Off-Balance Sheet Arrangements

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Among these obligations are FHLB advances and junior subordinated debentures, operating lease agreements for banking and subsidiaries’ offices and for data processing and telecommunications equipment.

Comparing June 30, 2024 to December 31, 2023, short-term borrowings increased by $17.1 million as the Bank borrowed $40.0 million from the BTFP in January 2024, which was partially offset by a decrease of $22.9 million in other short-term borrowings due primarily to the shift of approximately $22.0 million in overnight investment sweep balances into the ICS product to release pledging of investment securities for municipalities to increase available liquidity.

Comparing September 30, 2024 to December 31, 2023, short-term borrowings increased by $4.8 million as the Bank borrowed $29.0 million in overnight borrowings from the Federal Reserve, which was partially offset by a decrease of $24.2 million in other short-term borrowings due primarily to the shift of approximately $22.0 million in overnight investment sweep balances into the ICS product to release pledging of investment securities for municipalities to increase available liquidity.

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

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(in thousands)

September 30,

Residential mortgage - home equity

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Standby letters of credit

The decrease of $13.5 million in commitments at June 30, 2024 when compared to December 31, 2023 was due to businesses utilizing construction funding.

The decrease of $14.8 million in commitments at September 30, 2024 when compared to December 31, 2023 was due to businesses and consumers utilizing construction funding.

These balances shifted to loans outstanding.

For the six-month periods ended June 30, 2024 and 2023, net credit loss expense for off-balance sheet exposures was a credit of approximately $72,000 and an expense of approximately $90,000, respectively.

For the second quarter of 2024 and 2023, net credit loss for off-balance sheet exposures was a credit of approximately $57,000 and a credit of approximately $39,000, respectively.

For the nine-month periods ended September 30, 2024 and 2023, net credit loss expense for off-balance sheet exposures was a credit of approximately $17,000 and a credit of approximately $14,000, respectively.

For the third quarter of 2024 and 2023, net credit loss for off-balance sheet exposures was an expense of approximately $55,000 and a credit of approximately $104,000, respectively.

Quantitative and Qualitative Disclosures about 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-Q

Item 2. Management’s Discussion and Analysis