UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
DC 20549
FORM
10-K
|
x
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
|
|
For the fiscal year
ended December 31,
2008
|
OR
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¨
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
|
|
For
the transition period from _____________ to
_____________
|
Commission
file number 0-14237
FIRST UNITED
CORPORATION
(Exact
name of registrant as specified in its charter)
|
Maryland
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52-1380770
|
|
|
(State
or other jurisdiction of incorporation or organization)
|
(I.R.S.
Employer Identification Number)
|
|
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19
South Second Street, Oakland, Maryland
|
21550-0009
|
|
|
(Address
of principal executive offices)
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(Zip
Code)
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Registrant’s
telephone number, including area code: (800) 470-4356
Securities
registered pursuant to Section 12(b) of the Act:
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Title
of Each Class:
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Name
of Each Exchange on Which Registered:
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|
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Common
Stock, par value $.01 per share
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NASDAQ
Global Select
Market
|
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes ¨ No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act. Yes ¨ No x
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the
past 90 days. Yes x
No ¨
Indicate
by check mark if disclosures of delinquent filers pursuant to Item 405 of
Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of the registrant’s knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. (See
definition of “accelerated filer”, “large accelerated filer”, and “smaller
reporting company” in Rule 12b-2 of the Exchange Act). (check
one):
Large
accelerated filer ¨ Accelerated
filer x Non-accelerated filer
¨ Smaller
reporting company ¨
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).Yes ¨ No x
The
aggregate market value of the registrant’s outstanding voting and non-voting
common equity held by non-affiliates as of June 30, 2008: $ 106,519,790.
The
number of shares of the registrant’s common stock outstanding as of February 28,
2009: 6,122,411
Documents
Incorporated by Reference
Portions
of the registrant’s definitive proxy statement for the 2008 Annual Meeting of
Shareholders to be filed with the SEC pursuant to Regulation 14A are
incorporated by reference into Part III of this Annual Report on Form
10-K.
First
United Corporation
Table
of Contents
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ITEM
1.
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Business
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3
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ITEM
1A.
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Risk
Factors
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11
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ITEM
1B.
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Unresolved
Staff Comments
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17
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ITEM
2.
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Properties
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17
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ITEM
3.
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Legal
Proceedings
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17
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ITEM
4.
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Submission
of Matters to a Vote of Security Holders
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17
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PART
II
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||
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ITEM
5.
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Market
for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
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18
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ITEM
6.
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Selected
Financial Data
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21
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ITEM
7.
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Management's
Discussion & Analysis of Financial Condition & Results of
Operations
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22
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ITEM
7A.
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Quantitative
and Qualitative Disclosures About Market Risk
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44
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ITEM
8.
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Financial
Statements and Supplementary Data
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45
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ITEM
9.
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Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
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76
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ITEM
9A.
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Controls
and Procedures
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76
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ITEM
9B.
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Other
Information
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79
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PART
III
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||
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ITEM
10.
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Directors,
Executive Officers and Corporate Governance
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79
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ITEM
11.
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Executive
Compensation
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79
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ITEM
12.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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79
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ITEM
13.
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Certain
Relationships and Related Transactions, and Director
Independence
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79
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ITEM
14.
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Principal
Accountant Fees and Services
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79
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PART
IV
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||
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ITEM
15.
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Exhibits
and Financial Statement Schedules
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79
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80
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||
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EXHIBITS
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81
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|
[2]
Forward-Looking
Statements
This
Annual Report of First United Corporation (the “Corporation” on a parent only
basis and “we”, “our” or “us”, on a consolidated basis) filed on Form 10-K may
contain forward-looking statements within the meaning of The Private Securities
Litigation Reform Act of 1995. Readers of this report should be aware of the
speculative nature of “forward-looking statements”. Statements that
are not historical in nature, including those that include the words
“anticipate”, “estimate”, “should”, “expect”, “believe”, “intend”, and similar
expressions, are based on current expectations, estimates and projections about,
among other things, the industry and the markets in which the Corporation
operates, and they are not guarantees of future performance. Whether
actual results will conform to expectations and predictions is subject to known
and unknown risks and uncertainties, including risks and uncertainties discussed
in this report; general economic, market, or business conditions; changes in
interest rates, deposit flow, the cost of funds, and demand for loan products
and financial services; changes in our competitive position or competitive
actions by other companies; changes in the quality or composition of loan and
investment portfolios; the ability to manage growth; changes in laws or
regulations or policies of federal and state regulators and agencies; and other
circumstances beyond our control. Consequently, all of the
forward-looking statements made in this document are qualified by these
cautionary statements, and there can be no assurance that the actual results
anticipated will be realized, or if substantially realized, will have the
expected consequences on our business or operations. For a more
complete discussion of these and other risk factors, see Item 1A of Part I of
this report. Except as required by applicable laws, the Corporation
does not intend to publish updates or revisions of forward-looking statements it
makes to reflect new information, future events or otherwise.
PART
I
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ITEM
1.
|
BUSINESS
|
General
The
Corporation is a Maryland corporation chartered in 1985 and a financial holding
company registered under the federal Bank Holding Company Act of 1956, as
amended (the “BHC Act”). The Corporation’s primary business is
serving as the parent company of First United Bank & Trust, a Maryland trust
company (the “Bank”), First United Insurance Group, LLC, a Maryland insurance
agency (the “Insurance Group”), OakFirst Loan Center, Inc., a West Virginia
finance company, and OakFirst Loan Center, LLC, a Maryland finance company,
(together with OakFirst Loan Center, Inc. the “OakFirst Loan
Centers”). OakFirst Loan Center, Inc. has one subsidiary, First
United Insurance Agency, Inc., which is a Maryland insurance
agency.
At December 31, 2008, the Corporation
had assets of approximately $1.64 billion, net loans of approximately $1.12
billion, and deposits of approximately $1.22 billion. Shareholders’
equity at December 31, 2008 was approximately $73 million.
The
Corporation maintains an Internet site at www.mybankfirstunited.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 Securities and Exchange
Commission (the “SEC”).
Banking
Products and Services
The Bank
operates 26 banking offices, one call center and 32 Automated Teller Machines
(“ATM’s”) in Allegany County, Frederick County, Garrett County, and Washington
County in Maryland, and in Berkeley County, Mineral County, and Monongalia
County in West Virginia. The Bank is an independent community bank
providing a complete range of retail and commercial banking services to
businesses and individuals in its market areas. Services offered are
essentially the same as those offered by the regional institutions that compete
with the Bank and include checking, savings, and money market deposit accounts,
business loans, personal loans, mortgage loans, lines of credit, and
consumer-oriented retirement accounts including individual retirement account
(“IRA”) and employee benefit accounts. In addition, the Bank provides full
brokerage services through a networking arrangement with PrimeVest Financial
Services, Inc., a full service broker-dealer. The Bank also provides
safe deposit and night depository facilities, and a complete line of insurance
products and trust services. The Bank’s deposits are insured by the
Federal Deposit Insurance Corporation (the “FDIC”).
[3]
Lending
Activities—The
majority of the Corporation’s lending activities are conducted through the
Bank.
The
Bank’s commercial loans are primarily secured by real estate, commercial
equipment, vehicles or other assets of the borrower. Repayment is
often dependent on the successful operation of the borrower and may be affected
by adverse conditions in the local economy or real estate market. The
financial condition and cash flow of commercial borrowers is therefore carefully
analyzed during the loan approval process, and continues to be monitored by
obtaining business financial statements, personal financial statements and
income tax returns. The frequency of this ongoing analysis depends
upon the size and complexity of the credit and collateral that secures the loan.
It is also the Bank’s general policy to obtain personal guarantees from the
principals of the commercial loan borrowers.
Commercial
real estate loans are primarily those secured by land for residential and
commercial development, agricultural purpose properties, service industry
buildings such as restaurants and motels, retail buildings and general purpose
business space. The Bank attempts to mitigate the risks associated
with these loans through low loan to value ratio standards, thorough financial
analyses, and management’s knowledge of the local economy in which the Bank
lends.
The risk
of loss associated with commercial real estate construction lending is
controlled through conservative underwriting procedures such as loan to value
ratios of 80% or less, obtaining additional collateral when prudent, and closely
monitoring construction projects to control disbursement of funds on
loans.
The
Bank’s residential mortgage portfolio is distributed between variable and fixed
rate loans. Many loans are booked at fixed rates in order to meet the
Bank’s requirements under the Community Reinvestment Act. Other fixed rate
residential mortgage loans are originated in a brokering capacity on behalf of
other financial institutions, for which the Bank receives a fee. As with any
consumer loan, repayment is dependent on the borrower’s continuing financial
stability, which can be adversely impacted by job loss, divorce, illness, or
personal bankruptcy. Residential mortgage loans exceeding an internal
loan-to-value ratio require private mortgage insurance. Title
insurance protecting the Bank’s lien priority, as well as fire and casualty
insurance, are also required.
Home
equity lines of credit, included within the residential mortgage portfolio, are
secured by the borrower’s home and can be drawn on at the discretion of the
borrower. These lines of credit are at variable interest
rates.
The Bank
also provides residential real estate construction loans to builders and
individuals for single family dwellings. Residential construction
loans are usually granted based upon “as completed” appraisals and are secured
by the property under construction. Site inspections are performed to
determine pre-specified stages of completion before loan proceeds are
disbursed. These loans typically have maturities of six to 12 months
and may have a fixed or variable rate. Permanent financing for
individuals offered by the Bank includes fixed and variable rate loans with
three, five or seven year adjustable rate mortgages.
A variety
of other consumer loans are also offered to customers, including indirect and
direct auto loans, and other secured and unsecured lines of credit and term
loans. Careful analysis of an applicant’s creditworthiness is performed before
granting credit, and on-going monitoring of loans outstanding is performed in an
effort to minimize risk of loss by identifying problem loans early.
An
allowance for loan losses is maintained to provide for anticipated losses from
our lending activities. A complete discussion of the factors
considered in determination of the allowance for loan losses is included in Item
7 of Part II of this report.
Additionally,
we meet the lending needs of under-served customer groups within our market
areas in part through OakFirst Loan Center, Inc., located in Martinsburg, West
Virginia, and OakFirst Loan Center, LLC, located in Hagerstown,
Maryland.
Deposit
Activities—The Bank offers a full array of deposit products including
checking, savings and money market accounts, regular and IRA certificates of
deposit, Christmas Savings accounts, College Savings accounts, and Health
Savings accounts. The Bank also offers the CDARS program to
municipalities, businesses, and consumers, providing them up to $50 million of
FDIC insurance. In addition, we offer our commercial customers
packages which include Treasury Management, Cash Sweep and various checking
opportunities.
[4]
Trust
Services—The
Bank’s Trust Department offers a full range of trust services, including
personal trust, investment agency accounts, charitable trusts, retirement
accounts including IRA roll-overs, 401(k) accounts and defined benefit plans,
estate administration and estate planning.
Information
about our income from and assets related to our banking business may be found in
the consolidated statements of financial condition and the consolidated
statements of income and the related notes thereto included in Item 8 of Part II
of this annual report. At December 31, 2008, 2007 and 2006, the total
market value of assets under the supervision of the Bank’s Trust Department was
approximately $472 million, $547 million and $502 million,
respectively. Trust Department revenues for these years may be found
in the Consolidated Statements of Income under the heading “Other operating
income”, which is contained in Item 8 of Part II of this annual
report.
Insurance
Activities
We offer
a full range of insurance products and services to customers in our market areas
through the Insurance Group and First United Insurance Agency,
Inc. Information about income from insurance activities for each of
the years ended December 31, 2008, 2007 and 2006 may be found under “Other
Operating Income” in the consolidated statements of income included in Item 8 of
Part II of this annual report.
COMPETITION
The
banking business, in all of its phases, is highly competitive. Within
our market areas, we compete with commercial banks, (including local banks and
branches or affiliates of other larger banks), savings and loan associations and
credit unions for loans and deposits, with consumer finance companies for loans,
with insurance companies and their agents for insurance products, and with other
financial institutions for various types of products and
services. There is also competition for commercial and retail banking
business from banks and financial institutions located outside our market
areas.
The
primary factors in competing for deposits are interest rates, personalized
services, the quality and range of financial services, convenience of office
locations and office hours. The primary factors in competing for loans are
interest rates, loan origination fees, the quality and range of lending services
and personalized services.
To
compete with other financial services providers, we rely principally upon local
promotional activities, personal relationships established by officers,
directors and employees with its customers, and specialized services tailored to
meet its customers’ needs. In those instances in which we are unable to
accommodate a customer’s needs, we attempt to arrange for those services to be
provided by other financial services providers with which we have a
relationship.
The following table sets forth deposit
data for the Maryland and West Virginia Counties in which the Bank maintains
offices as of June 30, 2008, the most recent date for which comparative
information is available.
|
Offices
(in Market)
|
Deposits (in thousands)
|
Market Share
|
||||||||||
|
Allegany
County, Maryland:
|
||||||||||||
|
Susquehanna
Bank
|
5 | $ | 224,368 | 36.72 | % | |||||||
|
Manufacturers
& Traders Trust Company
|
7 | 172,975 | 28.31 | % | ||||||||
|
First
United Bank & Trust
|
4 | 126,714 | 20.74 | % | ||||||||
|
PNC
Bank NA
|
3 | 51,300 | 8.39 | % | ||||||||
|
Standard
Bank
|
2 | 35,746 | 5.85 | % | ||||||||
Source: FDIC
Deposit Market Share Report
[5]
|
Frederick
County, Maryland:
|
||||||||||||
|
PNC
Bank NA
|
20 | 1,015,594 | 32.82 | % | ||||||||
|
Branch
Banking & Trust Co.
|
12 | 593,671 | 19.18 | % | ||||||||
|
Frederick
County Bank
|
4 | 225,184 | 7.28 | % | ||||||||
|
Bank
Of America NA
|
5 | 222,764 | 7.20 | % | ||||||||
|
Manufacturers
& Traders Trust Company
|
6 | 185,296 | 5.99 | % | ||||||||
|
Chevy
Chase Bank FSB
|
6 | 152,430 | 4.93 | % | ||||||||
|
Woodsboro
Bank
|
7 | 150,069 | 4.85 | % | ||||||||
|
Middletown
Valley Bank
|
4 | 131,044 | 4.23 | % | ||||||||
|
SunTrust
Bank
|
3 | 121,831 | 3.94 | % | ||||||||
|
First
United Bank & Trust
|
3 | 103,390 | 3.34 | % | ||||||||
|
Sandy
Spring Bank
|
4 | 65,731 | 2.12 | % | ||||||||
|
Provident
Bank of Maryland
|
2 | 34,602 | 1.12 | % | ||||||||
|
Damascus
Community Bank
|
2 | 22,152 | 0.72 | % | ||||||||
|
Wachovia
Bank NA
|
1 | 16,287 | 0.53 | % | ||||||||
|
Columbia
Bank
|
2 | 16,197 | 0.52 | % | ||||||||
|
Sovereign
Bank
|
3 | 15,887 | 0.51 | % | ||||||||
|
Graystone
Bank
|
1 | 11,591 | 0.37 | % | ||||||||
|
BlueRidge
Bank
|
1 | 11,166 | 0.36 | % | ||||||||
Source: FDIC
Deposit Market Share Report
|
Garrett
County, Maryland:
|
||||||||||||
|
First
United Bank & Trust
|
5 | 579,636 | 74.84 | % | ||||||||
|
Manufacturers
& Traders Trust Co.
|
5 | 95,043 | 12.27 | % | ||||||||
|
Susquehanna
Bank
|
2 | 70,569 | 9.11 | % | ||||||||
|
Clear
Mountain Bank
|
1 | 25,408 | 3.28 | % | ||||||||
|
Miners
& Merchants Bank
|
1 | 3,861 | 0.50 | % | ||||||||
Source: FDIC
Deposit Market Share Report
|
Washington
County, Maryland:
|
||||||||||||
|
Susquehanna
Bank
|
10 | 607,697 | 30.67 | % | ||||||||
|
Hagerstown
Trust Co.
|
11 | 398,102 | 20.09 | % | ||||||||
|
Manufacturers
& Traders Trust Company
|
12 | 386,594 | 19.51 | % | ||||||||
|
Sovereign
Bank
|
4 | 195,022 | 9.84 | % | ||||||||
|
PNC
Bank NA
|
6 | 153,804 | 7.76 | % | ||||||||
|
First
United Bank & Trust
|
3 | 68,526 | 3.46 | % | ||||||||
|
First
National Bank of Greencastle
|
3 | 46,069 | 2.33 | % | ||||||||
|
Centra
Bank
|
2 | 37,928 | 1.91 | % | ||||||||
|
Chevy
Chase Bank FSB
|
3 | 37,310 | 1.88 | % | ||||||||
|
Citizens
National Bank of Berkeley Springs
|
1 | 30,892 | 1.56 | % | ||||||||
|
Orrstown
Bank
|
1 | 10,706 | 0.54 | % | ||||||||
|
Jefferson
Security Bank
|
1 | 5,983 | 0.30 | % | ||||||||
|
Middletown
Valley Bank
|
1 | 2,777 | 0.14 | % | ||||||||
Source: FDIC
Deposit Market Share Report
[6]
|
Berkeley
County, West Virginia:
|
||||||||||||
|
Branch
Banking & Trust Co.
|
5 | 311,844 | 30.97 | % | ||||||||
|
Centra
Bank Inc.
|
3 | 217,491 | 21.60 | % | ||||||||
|
First
United Bank & Trust
|
5 | 118,775 | 11.80 | % | ||||||||
|
City
National Bank of West Virginia
|
4 | 106,957 | 10.62 | % | ||||||||
|
Susquehanna
Bank
|
4 | 102,314 | 10.16 | % | ||||||||
|
Jefferson
Security Bank
|
2 | 59,555 | 5.92 | % | ||||||||
|
Bank
of Charles Town
|
2 | 42,352 | 4.21 | % | ||||||||
|
Citizens
National Bank of Berkeley Springs
|
3 | 35,157 | 3.49 | % | ||||||||
|
Summit
Community Bank
|
1 | 9,117 | 0.91 | % | ||||||||
|
MVB
Bank Inc.
|
1 | 3,221 | 0.32 | % | ||||||||
Source: FDIC
Deposit Market Share Report
|
Hardy
County, West Virginia:
|
||||||||||||
|
Summit
Community Bank, Inc.
|
2 | 308,677 | 65.58 | % | ||||||||
|
Capon
Valley Bank
|
3 | 111,206 | 23.63 | % | ||||||||
|
Pendleton
Community Bank, Inc.
|
1 | 23,493 | 4.99 | % | ||||||||
|
First
United Bank & Trust
|
1 | 16,188 | 3.44 | % | ||||||||
|
Grant
County Bank
|
1 | 11,148 | 2.37 | % | ||||||||
Source: FDIC
Deposit Market Share Report
|
Mineral
County, West Virginia:
|
||||||||||||
|
First
United Bank & Trust
|
2 | 82,627 | 33.08 | % | ||||||||
|
Branch
Banking & Trust Co.
|
2 | 80,665 | 32.29 | % | ||||||||
|
Manufacturers
& Traders Trust Co.
|
2 | 49,596 | 19.85 | % | ||||||||
|
Grant
County Bank
|
1 | 36,905 | 14.77 | % | ||||||||
Source: FDIC
Deposit Market Share Report
|
Monongalia
County, West Virginia:
|
||||||||||||
|
Centra
Bank, Inc.
|
6 | 461,896 | 28.39 | % | ||||||||
|
Huntington
National Bank
|
5 | 389,495 | 23.94 | % | ||||||||
|
Branch
Banking & Trust Co.
|
5 | 342,964 | 21.08 | % | ||||||||
|
United
Bank
|
4 | 183,521 | 11.28 | % | ||||||||
|
Wesbanco
Bank, Inc.
|
5 | 85,731 | 5.27 | % | ||||||||
|
Clear
Mountain Bank
|
5 | 77,151 | 4.74 | % | ||||||||
|
First
United Bank & Trust
|
2 | 40,264 | 2.48 | % | ||||||||
|
First
Exchange Bank
|
2 | 23,804 | 1.46 | % | ||||||||
|
Citizens
Bank of Morgantown, Inc.
|
1 | 21,991 | 1.35 | % | ||||||||
Source: FDIC
Deposit Market Share Report
For
further information about competition in our market areas, see the Risk Factor
entitled “We operate in a
competitive environment” in Item 1A of Part I of this annual
report.
SUPERVISION
AND REGULATION
The
following is a summary of the material regulations and policies applicable to
the Corporation and its subsidiaries and is not intended to be a comprehensive
discussion. Changes in applicable laws and regulations may have a
material effect on our business.
[7]
General
The Corporation is a financial holding
company registered with the Board of Governors of the Federal Reserve System
(the “FRB”) under the BHC Act and, as such, is subject to the supervision,
examination and reporting requirements of the BHC Act and the regulations of the
FRB.
The Bank
is a Maryland trust company subject to the banking laws of Maryland and to
regulation by the Commissioner of Financial Regulation of Maryland, who is
required by statute to make at least one examination in each calendar year (or
at 18-month intervals if the Commissioner determines that an examination is
unnecessary in a particular calendar year). The Bank also has offices
in West Virginia, and the operations of these offices are subject to West
Virginia laws and to supervision and examination by the West Virginia Division
of Banking. As a member of the FDIC, the Bank is also subject to
certain provisions of federal law and regulations regarding deposit insurance
and activities of insured state-chartered banks, including those that require
examination by the FDIC. In addition to the foregoing, there are a
myriad of other federal and state laws and regulations that affect, impact or
govern the business of banking, including consumer lending, deposit-taking, and
trust operations.
All
non-bank subsidiaries of the Corporation are subject to examination by the FRB,
and, as affiliates of the Bank, are subject to examination by the FDIC and the
Commissioner of Financial Regulation of Maryland. In addition, OakFirst Loan
Center, Inc. is subject to licensing and regulation by the West Virginia
Division of Banking, OakFirst Loan Center, LLC is subject to licensing and
regulation by the Commissioner of Financial Regulation of Maryland, and the
Insurance Group and First United Insurance Agency, Inc. are each subject to
licensing and regulation by various state insurance authorities. Retail sales of
insurance products by these insurance affiliates are also subject to the
requirements of the Interagency Statement on Retail Sales of Nondeposit
Investment Products promulgated in 1994 by the FDIC, the FRB, the Office of the
Comptroller of the Currency, and the Office of Thrift Supervision.
Regulation
of Financial Holding Companies
In
November 1999, the federal Gramm-Leach-Bliley Act (the “GLB Act”) was signed
into law. The GLB Act revised the BHC Act and repealed the
affiliation provisions of the Glass-Steagall Act of 1933, which, taken together,
limited the securities, insurance and other non-banking activities of any
company that controls an FDIC insured financial institution. Under
the GLB Act, a bank holding company can elect, subject to certain
qualifications, to become a “financial holding company.” The GLB Act
provides that a financial holding company may engage in a full range of
financial activities, including insurance and securities sales and underwriting
activities, and real estate development, with new expedited notice procedures.
Maryland law generally permits state-chartered banks, including the Bank, to
engage in the same activities, directly or through an affiliate, as national
banking associations. The GLB Act permits certain qualified national
banking associations to form financial subsidiaries, which have broad authority
to engage in all financial activities except insurance underwriting, insurance
investments, real estate investment or development, or merchant banking. Thus,
the GLB Act has the effect of broadening the permitted activities of the
Corporation and the Bank.
The
Corporation and its affiliates are subject to the provisions of Section 23A and
Section 23B of the Federal Reserve Act. Section 23A limits the amount
of loans or extensions of credit to, and investments in, the Corporation and its
non-bank affiliates by the Bank. Section 23B requires that
transactions between the Bank and the Corporation and its non-bank affiliates be
on terms and under circumstances that are substantially the same as with
non-affiliates.
Under FRB
policy, the Corporation is expected to act as a source of strength to the Bank,
and the FRB may charge the Corporation with engaging in unsafe and unsound
practices for failure to commit resources to a subsidiary bank when
required. In addition, under the Financial Institutions Reform,
Recovery and Enforcement Act of 1989 (“FIRREA”), depository institutions insured
by the FDIC can be held liable for any losses incurred by, or reasonably
anticipated to be incurred by, the FDIC in connection with (i) the default of a
commonly controlled FDIC-insured depository institution or (ii) any assistance
provided by the FDIC to a commonly controlled FDIC-insured depository
institution in danger of default. Accordingly, in the event that any
insured subsidiary of the Corporation causes a loss to the FDIC, other insured
subsidiaries of the Corporation could be required to compensate the FDIC by
reimbursing it for the estimated amount of such loss. Such cross
guaranty liabilities generally are superior in priority to obligations of a
financial institution to its shareholders and obligations to other
affiliates.
[8]
Federal
Banking Regulation
Federal
banking regulators, such as the FRB and the FDIC, may prohibit the institutions
over which they have supervisory authority from engaging in activities or
investments that the agencies believe are unsafe or unsound banking
practices. Federal banking regulators have extensive enforcement
authority over the institutions they regulate to prohibit or correct activities
that violate law, regulation or a regulatory agreement or which are deemed to be
unsafe or unsound practices. Enforcement actions may include the
appointment of a conservator or receiver, the issuance of a cease and desist
order, the termination of deposit insurance, the imposition of civil money
penalties on the institution, its directors, officers, employees and
institution-affiliated parties, the issuance of directives to increase capital,
the issuance of formal and informal agreements, the removal of or restrictions
on directors, officers, employees and institution-affiliated parties, and the
enforcement of any such mechanisms through restraining orders or other court
actions.
The Bank
is subject to certain restrictions on extensions of credit to executive
officers, directors, and principal shareholders or any related interest of such
persons, which generally require that such credit extensions be made on
substantially the same terms as are available to third parties dealing with the
Bank and not involve more than the normal risk of repayment. Other
laws tie the maximum amount that may be loaned to any one customer and its
related interests to capital levels.
As part
of the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”),
each federal banking regulator adopted non-capital safety and soundness
standards for institutions under its authority. These standards
include internal controls, information systems and internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth, and
compensation, fees and benefits. An institution that fails to meet
those standards may be required by the agency to develop a plan acceptable to
meet the standards. Failure to submit or implement such a plan may
subject the institution to regulatory sanctions. We believe that the
Bank meets substantially all standards that have been adopted. FDICIA
also imposes new capital standards on insured depository
institutions.
The
Community Reinvestment Act (“CRA”) requires the FDIC, in connection with its
examination of financial institutions within its jurisdiction, to evaluate the
record of those financial institutions in meeting the credit needs of their
communities, including low and moderate income neighborhoods, consistent with
principles of safe and sound banking practices. These factors are
also considered by all regulatory agencies in evaluating mergers, acquisitions
and applications to open a branch or facility. As of the date of its
most recent examination report, the Bank has a CRA rating of
“Satisfactory”.
The
Deposit Insurance Fund was created pursuant to the Federal Deposit Insurance
Reform Act of 2005, which was signed into law on February 8,
2006. Under this new law, (i) the current $100,000 deposit insurance
coverage will be indexed for inflation (with adjustments every five years,
commencing January 1, 2011), and (ii) deposit insurance coverage for retirement
accounts was increased to $250,000 per participant subject to adjustment for
inflation. In addition, the FDIC will be given greater latitude in
setting the assessment rates for insured depository institutions which could be
used to impose minimum assessments. Effective October 3, 2008, the
Emergency Economic Stabilization Act of 2008 (the “EESA”) was enacted to
temporarily raise the basic limit on federal deposit insurance coverage from
$100,000 to $250,000 per depositor. The legislation states the limit
will return to $100,000 after December 31, 2009. The coverage for
retirement accounts did not change and remains at $250,000. The Bank
is required to pay semi-annual deposit insurance premium assessments to the
FDIC. The Bank paid $.5 million in FDIC premiums during
2008. Further information about deposit insurance premiums is
provided in Item 7 of Part II of this report under the heading “Recent
Developments”.
On
October 14, 2008, the FDIC announced the creation of the Temporary Liquidity
Guarantee Program (the “TLGP”) to decrease the cost of bank funding and,
hopefully, normalize lending. This program is comprised of two
components. The first component guarantees senior unsecured debt
issued between October 14, 2008 and June 30, 2009. The guarantee will
remain in effect until June 30, 2012 for such debts that mature beyond June 30,
2009. The second component provides full coverage for non-interest
bearing transaction deposit accounts, IOLTAs, and NOW accounts with interest
rates of 0.50 percent or less, regardless of account balance, until December 31,
2009. The Bank elected to participate in both programs and expects
FDIC premiums to increase in 2009 as a result of its participation.
Capital
Requirements
FDICIA
established a system of prompt corrective action to resolve the problems of
undercapitalized institutions. Under this system, the federal banking regulators
are required to rate supervised institutions on the basis of five capital
categories: “well capitalized,” “adequately capitalized,” “undercapitalized,”
“significantly undercapitalized,” and “critically undercapitalized;” and to take
certain mandatory actions (and are authorized to take other discretionary
actions) with respect to institutions in the three undercapitalized
categories. The severity of the actions will depend upon the category
in which the institution is placed. A depository institution is “well
capitalized” if it has a total risk based capital ratio of 10% or greater, a
Tier 1 risk based capital ratio of 6% or greater, and a leverage ratio of 5% or
greater and is not subject to any order, regulatory agreement, or written
directive to meet and maintain a specific capital level for any capital
measure. An “adequately capitalized” institution is defined as one
that has a total risk based capital ratio of 8% or greater, a Tier 1 risk based
capital ratio of 4% or greater and a leverage ratio of 4% or greater (or 3% or
greater in the case of a bank with a composite CAMEL rating of
1).
[9]
FDICIA
generally prohibits a depository institution from making any capital
distribution, including the payment of cash dividends, or paying a management
fee to its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized depository institutions are
subject to growth limitations and are required to submit capital restoration
plans. For a capital restoration plan to be acceptable, the
depository institution’s parent holding company must guarantee (subject to
certain limitations) that the institution will comply with such capital
restoration plan.
Significantly
undercapitalized depository institutions may be subject to a number of other
requirements and restrictions, including orders to sell sufficient voting stock
to become adequately capitalized and requirements to reduce total assets and
stop accepting deposits from correspondent banks. Critically
undercapitalized depository institutions are subject to the appointment of a
receiver or conservator; generally within 90 days of the date such institution
is determined to be critically undercapitalized.
Further
information about our capital resources is provided in the “Capital Resources”
section of Item 7 of Part II of this annual report. Information about
the capital ratios of the Corporation and of the Bank as of December 31, 2008
may be found in Note 2 to the Consolidated Financial Statements, which is
included in Item 8 of Part II of this annual report.
USA
PATRIOT ACT
Congress
adopted the USA PATRIOT Act (the “Patriot Act”) on October 26, 2001 in response
to the terrorist attacks that occurred on September 11, 2001. Under
the Patriot Act, certain financial institutions, including banks, are required
to maintain and prepare additional records and reports that are designed to
assist the government’s efforts to combat terrorism. The Patriot Act
includes sweeping anti-money laundering and financial transparency laws that
require additional regulations, including, among other things, standards for
verifying client identification when opening an account and rules to promote
cooperation among financial institutions, regulators and law enforcement
entities in identifying parties that may be involved in terrorism or money
laundering.
Federal
Securities Law
The
shares of the Corporation’s common stock are registered with the Securities and
Exchange Commission (the “SEC”) under Section 12(b) of the Securities Exchange
Act of 1934, as amended (the “Exchange Act”), and listed on the NASDAQ Global
Select Market. The Corporation is subject to information reporting
requirements, proxy solicitation requirements, insider trading restrictions and
other requirements of the Exchange Act, including the requirements imposed under
the federal Sarbanes-Oxley Act of 2002. Among other things, loans to
and other transactions with insiders are subject to restrictions and heightened
disclosure, directors and certain committees of the Board must satisfy certain
independence requirements, and the Corporation is generally required to comply
with certain corporate governance requirements.
Governmental
Monetary and Credit Policies and Economic Controls
The
earnings and growth of the banking industry and ultimately of the Bank are
affected by the monetary and credit policies of governmental authorities,
including the FRB. An important function of the FRB is to regulate
the national supply of bank credit in order to control recessionary and
inflationary pressures. Among the instruments of monetary policy used by the FRB
to implement these objectives are open market operations in U.S. Government
securities, changes in the federal funds rate, changes in the discount rate of
member bank borrowings, and changes in reserve requirements against member bank
deposits. These means are used in varying combinations to influence
overall growth of bank loans, investments and deposits and may also affect
interest rates charged on loans or paid on deposits. The monetary
policies of the FRB authorities have had a significant effect on the operating
results of commercial banks in the past and are expected to continue to have
such an effect in the future. In view of changing conditions in the
national economy and in the money markets, as well as the effect of actions by
monetary and fiscal authorities, including the FRB, no prediction can be made as
to possible future changes in interest rates, deposit levels, loan demand or
their effect on the business and earnings of the Corporation and its
subsidiaries.
[10]
SEASONALITY
Management does not believe that our
business activities are seasonal in nature. Deposit, loan, and
insurance demand may vary depending on local and national economic conditions,
but management believes that any variation will not have a material impact on
our planning or policy-making strategies.
EMPLOYEES
At
December 31, 2008, we employed approximately 485 individuals, of whom 380 were
full-time employees.
|
ITEM
1A.
|
RISK
FACTORS
|
Our financial condition and results of
operations are subject to numerous risks and uncertainties and could be
materially and adversely affected by any of these risks and
uncertainties. The risks and uncertainties that we believe are the
most significant are discussed below. You should carefully consider
these risks before making an investment decision with respect to any of the
Corporation’s securities. This annual report also contains
forward-looking statements that involve risks and uncertainties. Our
actual results could differ materially from those anticipated in these
forward-looking statements as a result of certain factors, including the risks
faced by us described below and elsewhere in this report.
Risks
Relating to the Corporation and its Affiliates
The
Corporation’s future depends on the successful growth of its
subsidiaries.
The
Corporation’s primary business activity for the foreseeable future will be to
act as the holding company of the Bank and its other direct and indirect
subsidiaries. Therefore, the Corporation’s future profitability will
depend on the success and growth of these subsidiaries. In the
future, part of the Corporation’s growth may come from buying other banks and
buying or establishing other companies. Such entities may not be
profitable after they are purchased or established, and they may lose money,
particularly at first. A new bank or company may bring with it
unexpected liabilities, bad loans, or bad employee relations, or the new bank or
company may lose customers.
Interest
rates and other economic conditions will impact our results of
operations.
Our results of operations may be
materially and adversely affected by changes in prevailing economic conditions,
including declines in real estate values, rapid changes in interest rates and
the monetary and fiscal policies of the federal government. Our
profitability is in part a function of the spread between the interest rates
earned on assets and the interest rates paid on deposits and other
interest-bearing liabilities (i.e., net interest income),
including advances from the Federal Home Loan Bank (the “FHLB”) of Atlanta.
Interest rate risk arises from mismatches (i.e., the interest
sensitivity gap) between the dollar amount of repricing or maturing assets and
liabilities and is measured in terms of the ratio of the interest rate
sensitivity gap to total assets. More assets repricing or maturing
than liabilities over a given time period is considered asset-sensitive and is
reflected as a positive gap, and more liabilities repricing or maturing than
assets over a given time period is considered liability-sensitive and is
reflected as negative gap. An asset-sensitive position (i.e., a positive gap) could
enhance earnings in a rising interest rate environment and could negatively
impact earnings in a falling interest rate environment, while a
liability-sensitive position (i.e., a negative gap) could
enhance earnings in a falling interest rate environment and negatively impact
earnings in a rising interest rate environment. Fluctuations in
interest rates are not predictable or controllable. There can be no
assurance that our attempts to structure our asset and liability management
strategies to mitigate the impact on net interest income of changes in market
interest rates will be successful in the event of such changes.
The
majority of our business is concentrated in Maryland and West Virginia; a
significant amount of our business is concentrated in real estate
lending.
Most of our loans are made to Western
Maryland and Northeastern West Virginia borrowers, and many of these loans are
secured by real estate, including construction and land development
loans. Accordingly, a decline in local economic conditions may have a
greater effect on our earnings and capital than on the earnings and capital of
larger financial institutions whose loan portfolios are geographically
diverse. Moreover, the national and local economies have
significantly weakened during the past two years in part due to the
widely-reported problems in the sub-prime mortgage loan market. As a
result, real estate values across the country, including in our market areas,
have decreased and the general availability of credit, especially credit to be
secured by real estate, has also decreased. These conditions have
made it more difficult for real estate owners and owners of loans secured by
real estate to sell their assets at the times and at the prices they
desire. In addition, these conditions have increased the risk that
the market values of the real estate securing our loans may deteriorate, which
could cause us to lose money in the event a borrower fails to repay a loan and
we are forced to foreclose on the property. There can be no guarantee
as to when or whether economic conditions will improve.
[11]
Additionally, the FRB and the FDIC,
along with the other federal banking regulators, issued final guidance on
December 6, 2006 entitled “Concentrations in Commercial Real Estate Lending,
Sound Risk Management Practices” directed at institutions that have particularly
high concentrations of commercial real estate loans within their lending
portfolios. This guidance suggests that institutions whose commercial
real estate loans exceed certain percentages of capital should implement
heightened risk management practices appropriate to their concentration risk and
may be required to maintain higher capital ratios than institutions with lower
concentrations in commercial real estate lending. Based on our
commercial real estate concentration as of December 31, 2008, we may be subject
to further supervisory analysis during future examinations. We cannot
guarantee that any risk management practices we implement will be effective to
prevent losses relating to our commercial real estate
portfolio. Management cannot predict the extent to which this
guidance will impact our operations or capital requirements.
The
Bank may experience loan losses in excess of its allowance.
The risk of credit losses on loans
varies with, among other things, general economic conditions, the type of loan
being made, the creditworthiness of the borrower over the term of the loan and,
in the case of a collateralized loan, the value and marketability of the
collateral for the loan. Management of the Bank maintains an
allowance for loan losses based upon, among other things, historical experience,
an evaluation of economic conditions and regular reviews of delinquencies and
loan portfolio quality. Based upon such factors, management makes various
assumptions and judgments about the ultimate collectability of the loan
portfolio and provides an allowance for loan losses based upon a percentage of
the outstanding balances and for specific loans when their ultimate
collectability is considered questionable. If management’s
assumptions and judgments prove to be incorrect and the allowance for loan
losses is inadequate to absorb future losses, or if the bank regulatory
authorities require us to increase the allowance for loan losses as a part of
its examination process, our earnings and capital could be significantly and
adversely affected. Although management continually monitors our loan
portfolio and makes determinations with respect to the allowance for loan
losses, future adjustments may be necessary if economic conditions differ
substantially from the assumptions used or adverse developments arise with
respect to our non-performing or performing loans. Material additions
to the allowance for loan losses could result in a material decrease in our net
income and capital, and could have a material adverse effect on our financial
condition.
The
market value of our investments could decline.
As of December 31, 2008, we had
classified 100% of our investment securities as available-for-sale pursuant to
Statement of Financial Accounting Standards (“SFAS”) No. 115 relating to
accounting for investments. SFAS No. 115 requires that unrealized
gains and losses in the estimated value of the available-for-sale portfolio be
“marked to market” and reflected as a separate item in shareholders’ equity (net
of tax) as accumulated other comprehensive income. There can be no
assurance that future market performance of our investment portfolio will enable
us to realize income from sales of securities. Shareholders’ equity
will continue to reflect the unrealized gains and losses (net of tax) of these
investments. Moreover, there can be no assurance that the market
value of our investment portfolio will not decline, causing a corresponding
decline in shareholders’ equity.
Our investments include stock issued by
the FHLB of Atlanta. As a member of the FHLB of Atlanta, we are
required to purchase stock of that bank based on how much we borrow from it and
the quality of the collateral that we pledge to secure that
borrowing. In recent months, the banking industry has become
concerned about the financial strength of the banks in the FHLB system, and some
FHLB banks have stopped paying dividends on and redeeming FLHB
stock. On January 30, 2009, the FHLB of Atlanta announced that it was
deferring the declaration of a dividend on its stock for the quarter ended
December 31, 2008 until it completes its year-end analysis of
other-than-temporary impairment which is critical to its net income
determination. The FHLB of Atlanta stated that it anticipates a
decision regarding the dividend to be made in March
2009. Accordingly, there can be no guaranty that the FHLB of Atlanta
will declare a dividend on its stock for the quarter ended December 31, 2008 or
for any future quarter.
[12]
Management
believes that several factors will affect the market values of our investment
portfolio. These include, but are not limited to, changes in interest
rates or expectations of changes, the degree of volatility in the securities
markets, inflation rates or expectations of inflation and the slope of the
interest rate yield curve (the yield curve refers to the differences between
shorter-term and longer-term interest rates; a positively sloped yield curve
means shorter-term rates are lower than longer-term rates). Also, the
passage of time will affect the market values of our investment securities, in
that the closer they are to maturing, the closer the market price should be to
par value. These and other factors may impact specific categories of
the portfolio differently, and management cannot predict the effect these
factors may have on any specific category.
We
operate in a competitive environment.
We operate in a competitive
environment, competing for loans, deposits, and customers with commercial banks,
savings associations and other financial entities. Competition for
deposits comes primarily from other commercial banks, savings associations,
credit unions, money market and mutual funds and other investment
alternatives. Competition for loans comes primarily from other
commercial banks, savings associations, mortgage banking firms, credit unions
and other financial intermediaries. Competition for other products,
such as insurance and securities products, comes from other banks, securities
and brokerage companies, insurance companies, insurance agents and brokers, and
other non-bank financial service providers in our market area. Many
of these competitors are much larger in terms of total assets and
capitalization, have greater access to capital markets, and/or offer a broader
range of financial services than those that we offer. In addition,
banks with a larger capitalization and financial intermediaries not subject to
bank regulatory restrictions have larger lending limits and are thereby able to
serve the needs of larger customers.
In
addition, current banking laws facilitate interstate branching, merger activity
among banks, and expanded activities. Since September 1995, certain
bank holding companies have been authorized to acquire banks throughout the
United States. Since June 1, 1997, certain banks have been permitted
to merge with banks organized under the laws of different states. As
a result, interstate banking is now an accepted element of competition in the
banking industry and the Corporation may be brought into competition with
institutions with which it does not presently compete. Moreover, the
GLB Act revised the BHC Act in 2000 and repealed the affiliation provisions of
the Glass-Steagall Act of 1933, which, taken together, limited the securities,
insurance and other non-banking activities of any company that controls an FDIC
insured financial institution. These laws may increase the
competition we face in our market areas in the future, although management
cannot predict the degree to which such competition will impact our financial
conditions or results of operations.
The
banking industry is heavily regulated; significant regulatory changes could
adversely affect our operations.
Our operations will be impacted by
current and future legislation and by the policies established from time to time
by various federal and state regulatory authorities. The Corporation
is subject to supervision by the FRB. The Bank is subject to
supervision and periodic examination by the Maryland Commissioner of Financial
Regulation, the West Virginia Division of Banking, and the
FDIC. Banking regulations, designed primarily for the safety of
depositors, may limit a financial institution’s growth and the return to its
investors by restricting such activities as the payment of dividends, mergers
with or acquisitions by other institutions, investments, loans and interest
rates, interest rates paid on deposits, expansion of branch offices, and the
offering of securities or trust services. The Corporation and the
Bank are also subject to capitalization guidelines established by federal law
and could be subject to enforcement actions to the extent that either is found
by regulatory examiners to be undercapitalized. It is not possible to predict
what changes, if any, will be made to existing federal and state legislation and
regulations or the effect that such changes may have on our future business and
earnings prospects. Management also cannot predict the nature or the
extent of the effect on our business and earnings of future fiscal or monetary
policies, economic controls, or new federal or state
legislation. Further, the cost of compliance with regulatory
requirements may adversely affect our ability to operate
profitably.
Our
regulatory expenses will likely increase due to the enactment of the Emergency
Economic Stabilization Act and related government programs.
Among
other things, the EESA included a provision to increase the amount of deposits
insured by FDIC to $250,000. The TLGP provides, until December 31,
2009, unlimited deposit insurance on funds in non-interest-bearing transaction
deposit accounts and certain IOLTAs and NOW accounts not otherwise covered by
the existing deposit insurance limit of $250,000, as well as a 100% guarantee of
the newly issued senior debt of all FDIC-insured institutions and their holding
companies issued between October 14, 2008 and June 30, 2009. All
eligible institutions will be covered under the TLGP for the first 30 days
without incurring any costs. After the initial period, participating
institutions will be assessed a charge of 10 basis points per annum for the
additional insured deposits and a charge of 75 basis points per annum for
guaranteed senior unsecured debt. We elected to participate in both
portions of the TLGP, so we expect to incur additional regulatory fees
associated with our participation.
[13]
Customer
concern about deposit insurance may cause a decrease in deposits held at the
Bank.
With recent increased concerns about
bank failures, customers increasingly are concerned about the extent to which
their deposits are insured by the FDIC. Customers may withdraw
deposits from the Bank in an effort to ensure that the amount they have on
deposit with us is fully insured. Decreases in deposits may adversely
affect our funding costs and net income.
Our
funding sources may prove insufficient to replace deposits and support our
future growth.
We rely on customer deposits, advances
from the FHLB, lines of credit at other financial institutions and brokered
funds to fund our operations. Although we have historically been able
to replace maturing deposits and advances if desired, no assurance can be given
that we would be able to replace such funds in the future if our financial
condition or the financial condition of the FHLB or market conditions were to
change. Our financial flexibility will be severely constrained and/or
our cost of funds will increase if we are unable to maintain our access to
funding or if financing necessary to accommodate future growth is not available
at favorable interest rates. Finally, if we are required to rely more heavily on
more expensive funding sources to support future growth, our revenues may not
increase proportionately to cover our costs. In this case, our profitability
would be adversely affected.
The
loss of key personnel could disrupt our operations and result in reduced
earnings.
Our growth and profitability will
depend upon our ability to attract and retain skilled managerial, marketing and
technical personnel. Competition for qualified personnel in the
financial services industry is intense, and there can be no assurance that we
will be successful in attracting and retaining such personnel. Our
current executive officers provide valuable services based on their many years
of experience and in-depth knowledge of the banking industry. Due to
the intense competition for financial professionals, these key personnel would
be difficult to replace and an unexpected loss of their services could result in
a disruption to the continuity of operations and a possible reduction in
earnings.
We
may lose key personnel because of our participation in the Troubled Asset Relief
Program Capital Purchase Program.
On January 30, 2009, we participated in
the Troubled Asset Relief Program (“TARP”) Capital Purchase Program (the “CPP”)
adopted by the U.S. Department of Treasury (“Treasury”) by selling $30 million
in shares of our Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the
“Series A Preferred Stock”) to Treasury and issuing a 10-year common stock
purchase warrant (the “Warrant”) to Treasury. As part of these
transactions, we adopted Treasury’s standards for executive compensation and
corporate governance for the period during which Treasury holds any shares of
the Series A Preferred Stock and/or any shares of common stock that may be
acquired upon exercise of the Warrant. On February 17, 2009, the
American Recovery and Reinvestment Act of 2009 (the “Recovery Act”) was signed
into law, which, among other things, imposes additional executive compensation
restrictions on institutions that participate in TARP for so long as any TARP
assistance remains outstanding. Among these restrictions is a
prohibition against making most severance payments to our “senior executive
officers”, which term includes our Chairman and Chief Executive Officer, our
Chief Financial Officer and, generally, the three next most highly compensated
executive officers, and to the next five most highly compensated
employees. The restrictions also limit the type, timing and amount of
bonuses, retention awards and incentive compensation that may be paid to certain
employees. These restrictions, coupled with the competition we face
from other institutions, including institutions that do not participate in TARP,
may make it more difficult for us to attract and/or retain exceptional key
employees.
Our
lending activities subject us to the risk of environmental
liabilities.
A
significant portion of our loan portfolio is secured by real
property. During the ordinary course of business, we may foreclose on
and take title to properties securing certain loans. In doing so,
there is a risk that hazardous or toxic substances could be found on these
properties. If hazardous or toxic substances are found, we may be
liable for remediation costs, as well as for personal injury and property
damage. Environmental laws may require us to incur substantial
expenses and may materially reduce the affected property’s value or limit our
ability to use or sell the affected property. In addition, future
laws or more stringent interpretations or enforcement policies with respect to
existing laws may increase our exposure to environmental
liability. Although we have policies and procedures to perform an
environmental review before initiating any foreclosure action on real property,
these reviews may not be sufficient to detect all potential environmental
hazards. The remediation costs and any other financial liabilities
associated with an environmental hazard could have a material adverse effect on
our financial condition and results of operations.
[14]
We
may be adversely affected by other recent legislation.
As discussed above, the GLB Act
repealed restrictions on banks affiliating with securities firms and it also
permitted bank holding companies that become financial holding companies to
engage in additional financial activities, including insurance and securities
underwriting and agency activities, merchant banking, and insurance company
portfolio investment activities that are currently not permitted for bank
holding companies. Although the Corporation is a financial holding
company, this law may increase the competition we face from larger banks and
other companies. It is not possible to predict the full effect that
this law will have on us.
The
federal Sarbanes-Oxley Act of 2002 requires management of publicly traded
companies to perform an annual assessment of their internal controls over
financial reporting and to report on whether the system is effective as of the
end of the Company’s fiscal year. Disclosure of significant
deficiencies or material weaknesses in internal controls could cause an
unfavorable impact to shareholder value by affecting the market value of our
stock.
The federal USA PATRIOT Act requires
certain financial institutions, such as the Bank, to maintain and prepare
additional records and reports that are designed to assist the government’s
efforts to combat terrorism. This law includes sweeping anti-money laundering
and financial transparency laws and required additional regulations, including,
among other things, standards for verifying client identification when opening
an account and rules to promote cooperation among financial institutions,
regulators and law enforcement entities in identifying parties that may be
involved in terrorism or money laundering. If we fail to comply with
this law, we could be exposed to adverse publicity as well as fines and
penalties assessed by regulatory agencies.
We
may be subject to claims and the costs of defensive actions.
Our customers may sue us for losses due
to alleged breaches of fiduciary duties, errors and omissions of employees,
officers and agents, incomplete documentation, our failure to comply with
applicable laws and regulations, or many other reasons. Also, our
employees may knowingly or unknowingly violate laws and
regulations. Management may not be aware of any violations until
after their occurrence. This lack of knowledge may not insulate us
from liability. Claims and legal actions may result in legal expenses
and liabilities that may reduce our profitability and hurt our financial
condition.
We
may not be able to keep pace with developments in technology.
We use various technologies in
conducting our businesses, including telecommunication, data processing,
computers, automation, internet-based banking, and debit
cards. Technology changes rapidly. Our ability to compete
successfully with other financial institutions may depend on whether we can
exploit technological changes. We may not be able to exploit
technological changes, and any investment we do make may not make us more
profitable.
Risks
Relating to the Corporation’s Securities
The
Corporation’s shares of common stock, Series A Preferred Stock, and the Warrant
are not insured.
The shares of the Series A Preferred
Stock, the warrant, and the shares of common stock for which the warrant may be
exercised are not deposits and are not insured against loss by the Federal
Deposit Insurance Corporation or any other governmental or private
agency.
The
Corporation’s ability to pay dividends is limited by applicable banking and
corporate law.
The Corporation’s ability to pay
dividends to shareholders is largely dependent upon the receipt of dividends
from the Bank. Both federal and state laws impose restrictions on the
ability of the Bank to pay dividends. Federal law generally prohibits
the payment of a dividend by a troubled institution. Under Maryland
law, a state-chartered commercial bank may pay dividends only out of undivided
profits or, with the prior approval of the Commissioner, from surplus in excess
of 100% of required capital stock. If however, the surplus of a
Maryland bank is less than 100% of its required capital stock, cash dividends
may not be paid in excess of 90% of net earnings. In addition to these specific
restrictions, bank regulatory agencies also have the ability to prohibit
proposed dividends by a financial institution which would otherwise be permitted
under applicable regulations if the regulatory body determines that such
distribution would constitute an unsafe or unsound practice. Because
of these limitations, there can be no guarantee that we will declare dividends
in any fiscal quarter.
[15]
Because
of the Corporation’s participation in TARP, it is subject to several
restrictions relating to shares of its capital stock, including restrictions on
its ability to declare or pay dividends on and repurchase its
shares.
As stated above, the Corporation
recently issued 30,000 shares of the Series A Preferred Stock and the Warrant to
purchase 326,323 shares of common stock. Under the terms of the
transaction documents, the Corporation’s ability to declare or pay dividends on
shares of its capital stock is limited. Specifically, the Corporation
is unable to declare dividends on common stock, other stock ranking junior to
the Series A Preferred Stock (“Junior Stock”), or preferred stock ranking on a
parity with the Series A Preferred Stock (“Parity Stock”) if the Corporation is
in arrears on the dividends on the Series A Preferred Stock. Further,
the Corporation is not permitted to increase dividends on its common stock above
the amount of the last quarterly cash dividend per share declared prior to
October 14, 2008 without Treasury’s approval until January 30, 2012 unless all
of the Series A Preferred Stock has been redeemed or transferred. In
addition, the Corporation’s ability to repurchase its capital stock is
restricted. Treasury’s consent generally is required for the
Corporation to make any stock repurchase until January 30, 2012 unless all of
the Series A Preferred Stock has been redeemed or
transferred. Further, shares of common stock, Junior Stock or Parity
Stock may not be repurchased if the Corporation is in arrears on the Series A
Preferred Stock dividends.
The
Corporation’s ability to pay dividends on its securities is also subject to the
terms of its outstanding debentures.
In March 2004, the Corporation issued
approximately $30.9 million of junior subordinated debentures to First United
Statutory Trust I and First United Statutory Trust II (the
“Trusts”). The Trusts are Connecticut statutory business trusts, with
all outstanding common stock owned by the Corporation, that issued mandatorily
redeemable preferred capital securities to third party investors. In
December 2004, the Corporation issued an additional $5.0 million of
debentures. The terms of the debentures require the Corporation to
make quarterly payments of interest to the holders of the debentures, although
the Corporation has the ability to defer payments of interest for up to 20
consecutive quarterly periods. Should the Corporation make such a
deferral election, however, it would be prohibited from paying dividends or
distributions on, or from repurchasing, redeeming or otherwise acquiring any
shares of its capital stock, including the common stock and the Series A
Preferred Stock. Although the Corporation has no present intention of
deferring payments of interest on its debentures, there can be no assurance that
the Corporation will not elect to do so in the future.
There
is no market for the Series A Preferred Stock or the Warrant, and the common
stock is not heavily traded.
There is no established trading market
for the shares of the Series A Preferred Stock or the Warrant. The
Corporation does not intend to apply for listing of the Series A Preferred Stock
on any securities exchange or for inclusion of the Series A Preferred Stock in
any automated quotation system unless requested by Treasury. The
Corporation’s common stock is listed on the NASDAQ Global Select Market, but
shares of the common stock are not heavily traded. Securities that
are not heavily traded can be more volatile than stock trading in an active
public market. Factors such as our financial results, the
introduction of new products and services by us or our competitors, and various
factors affecting the banking industry generally may have a significant impact
on the market price of the shares the common stock. Management cannot
predict the extent to which an active public market for any of the Corporation’s
securities will develop or be sustained in the future. Accordingly,
holders of the Corporation’s securities may not be able to sell such securities
at the volumes, prices, or times that they desire.
The
Corporation’s Articles of Incorporation and Bylaws and Maryland law may
discourage a corporate takeover.
The Corporation’s Amended and Restated
Articles of Incorporation and Amended and Restated Bylaws, as amended, contain
certain provisions designed to enhance the ability of the Corporation’s Board of
Directors to deal with attempts to acquire control of the
Corporation. First, the Board of Directors is classified into three
classes. Directors of each class serve for staggered three-year
periods, and no director may be removed except for cause, and then only by the
affirmative vote of either a majority of the entire Board of Directors or a
majority of the outstanding voting stock. Second, the Board has the
authority to classify and reclassify unissued shares of stock of any class or
series of stock by setting, fixing, eliminating, or altering in any one or more
respects the preferences, rights, voting powers, restrictions and qualifications
of, dividends on, and redemption, conversion, exchange, and other rights of,
such securities. The Board could use this authority, along with its
authority to authorize the issuance of securities of any class or series, to
issue shares having terms favorable to management to a person or persons
affiliated with or otherwise friendly to management. In addition, the
Bylaws require any shareholder who desires to nominate a director to abide by
strict notice requirements.
[16]
Maryland law also contains
anti-takeover provisions that apply to the Corporation. Maryland’s
Business Combination Act generally prohibits, subject to certain limited
exceptions, corporations from being involved in any “business combination”
(defined as a variety of transactions, including a merger, consolidation, share
exchange, asset transfer or issuance or reclassification of equity securities)
with any “interested shareholder” for a period of five years following the most
recent date on which the interested shareholder became an interested
shareholder. An interested shareholder is defined generally as a
person who is the beneficial owner of 10% or more of the voting power of the
outstanding voting stock of the corporation after the date on which the
corporation had 100 or more beneficial owners of its stock or who is an
affiliate or associate of the corporation and was the beneficial owner, directly
or indirectly, of 10% percent or more of the voting power of the then
outstanding stock of the corporation at any time within the two-year period
immediately prior to the date in question and after the date on which the
corporation had 100 or more beneficial owners of its
stock. Maryland’s Control Share Acquisition Act applies to
acquisitions of “control shares”, which, subject to certain exceptions, are
shares the acquisition of which entitle the holder, directly or indirectly, to
exercise or direct the exercise of the voting power of shares of stock of the
corporation in the election of directors within any of the following ranges of
voting power: one-tenth or more, but less than one-third of all
voting power; one-third or more, but less than a majority of all voting power or
a majority or more of all voting power. Control shares have limited
voting rights.
Although these provisions do not
preclude a takeover, they may have the effect of discouraging, delaying or
deferring a tender offer or takeover attempt that a shareholder might consider
in his or her best interest, including those attempts that might result in a
premium over the market price for the common stock. Such provisions
will also render the removal of the Board of Directors and of management more
difficult and, therefore, may serve to perpetuate current
management. These provisions could potentially adversely affect the
market price of our common stock.
|
ITEM
1B.
|
UNRESOLVED
STAFF COMMENTS
|
None.
|
ITEM
2.
|
PROPERTIES
|
The
headquarters of the Corporation and the Bank occupies approximately 29,000
square feet at 19 South Second Street, Oakland, Maryland, a 30,000 square feet
operations center located at 12892 Garrett Highway, Oakland Maryland and 8,500
square feet at 102 South Second Street, Oakland, Maryland. These premises are
owned by the Corporation. The Bank owns 19 of its banking offices and leases
seven. During the fourth quarter 2008, the Corporation entered into a
lease agreement for an office building to house specialists for lending and
insurance and a retail branch site, both in Frederick, Maryland. The
Corporation also leases eight offices of non-bank subsidiaries. Total
rent expense on the leased offices and properties was $.54 million in
2008.
|
ITEM
3.
|
LEGAL
PROCEEDINGS
|
We are at
times, in the ordinary course of business, subject to legal
actions. Management, upon the advice of counsel, believes that
losses, if any, resulting from current legal actions will not have a material
adverse effect on our financial condition or results of operations.
|
ITEM
4.
|
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY
HOLDERS
|
None.
[17]
PART
II
|
ITEM
5.
|
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
|
Shares of
the Corporation’s common stock are listed on the NASDAQ Global Select Market
under the symbol “FUNC”. As of February 28, 2009, the Corporation had
1,988 shareholders of record. The high and low sales prices for, and the cash
dividends declared on, the shares of the Corporation’s common stock for each
quarterly period of 2008 and 2007 are set forth below. On March 3,
2009, the closing sales price of the common stock was $8.98 per
share.
|
2008
|
High
|
Low
|
Dividends Declared
|
|||||||||
|
1st
Quarter
|
$ | 20.85 | $ | 17.01 | $ | .200 | ||||||
|
2nd
Quarter
|
19.98 | 18.04 | .200 | |||||||||
|
3rd
Quarter
|
20.73 | 16.01 | .200 | |||||||||
|
4th
Quarter
|
20.00 | 13.00 | .200 | |||||||||
|
2007
|
High
|
Low
|
Dividends Declared
|
|||||||||
|
1st
Quarter
|
$ | 23.49 | $ | 21.72 | $ | .195 | ||||||
|
2nd
Quarter
|
24.00 | 19.26 | .195 | |||||||||
|
3rd
Quarter
|
21.50 | 17.95 | .195 | |||||||||
|
4th
Quarter
|
21.95 | 18.70 | .200 | |||||||||
Cash
dividends are typically declared on a quarterly basis and are at the discretion
of the Corporation’s Board of Directors. Dividends to shareholders
are generally dependent on the ability of the Corporation’s subsidiaries,
especially the Bank, to declare dividends to the Corporation. The
ability of these entities to declare dividends is limited by federal and state
banking laws, state corporate laws, and the terms of our other
securities. Further information about these limitations may be found
in Note 13 to the Consolidated Financial Statements and in the risk factors
contained in Item 1A of Part I under the heading “Risks Relating to the
Corporation’s Securities”, which are incorporated herein by
reference. There can be no guarantee that dividends will be declared
in any fiscal quarter.
Market
makers for the Corporation’s common stock are:
SCOTT AND STRINGFELLOW,
INC.
909 East
Main Street
Richmond,
VA 23219
(804)643-1811
(800)552-7757
[18]
First
United Corporation Stock Performance Graph
The following graph compares the yearly
percentage change in the cumulative total return for the Corporation’s common
stock for the five years ended December 31, 2008. This data is
compared to the NASDAQ Composite market index and the SNL $1 billion to $5
billion Bank Index during the same time period. Total return numbers
are calculated as change in stock price for the period indicated with dividends
being reinvested.
|
Period
Ending
|
||||||||||||||||||||||||
|
Index
|
12/31/03
|
12/31/04
|
12/31/05
|
12/31/06
|
12/31/07
|
12/31/08
|
||||||||||||||||||
|
First
United Corporation
|
100.00 | 87.28 | 93.37 | 99.75 | 94.56 | 66.46 | ||||||||||||||||||
|
NASDAQ
Composite
|
100.00 | 108.59 | 110.08 | 120.56 | 132.39 | 78.72 | ||||||||||||||||||
|
SNL
Bank $1B-$5B Index
|
100.00 | 123.42 | 121.31 | 140.38 | 102.26 | 84.81 | ||||||||||||||||||
[19]
Equity
Compensation Plan Information
At the
2007 Annual Meeting of Shareholders, the Corporation’s shareholders approved the
First United Corporation Omnibus Equity Compensation Plan (the “Omnibus Plan”),
which authorizes the grant of stock options, stock appreciation rights, stock
awards, stock units, performance units, dividend equivalents, and other
stock-based awards. Stock compensation expense for 2008 was $.1
million. The following table contains information about the Omnibus
Plan as of December 31, 2008:
|
Plan Category
|
Number of securities to
be issued upon exercise
of outstanding options,
warrants, and rights
(a)
|
Weighted-average
exercise price of
outstanding options,
warrants, and rights
(b)
|
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
(c)(1)
|
|||||||||
|
Equity
compensation plans approved by security holders
|
22,257 | $ | 18.85 | 162,743 | ||||||||
|
Equity
compensation plans not approved by security holders
|
0 | N/A | N/A | |||||||||
|
Total
|
22,257 | $ | 18.85 | 162,743 | ||||||||
|
(1)
|
In
addition to stock options and stock appreciation rights, the Omnibus Plan
permits the grant of stock awards, stock units, performance units,
dividend equivalents, and other stock-based awards. Subject to
the anti-dilution provisions of the Omnibus Plan, the maximum number of
shares for which awards may be granted to any one participant in any
calendar year is 20,000, without regard to whether an award is paid in
cash or shares.
|
Issuer
Repurchases of Securities
The
following table provides information about shares of common stock purchased by
or on behalf of First United Corporation and its affiliates (as defined by
Exchange Act Rule 10b-18) during the quarter ended December 31,
2008:
Issuer
Purchases of Equity Securities
|
Period
|
Total Number of
Shares (or Units)
Purchased (1)
|
Average Price Paid
per Share (or Unit)
|
Total Number of
Shares (or Units)
Purchased as Part
of Publicly
Announced Plans
or Programs
|
Maximum Number
of Shares that May
Yet Be Purchased
Under the Plans or
Programs
|
||||||||||||
|
October
2008
|
4,416 | 18.78 | 4,416 | 209,672 | ||||||||||||
|
November
2008
|
1,471 | 17.12 | 1,471 | 208,201 | ||||||||||||
|
December
2008
|
- | - | - | 208,201 | ||||||||||||
|
Total
|
5,887 | $ | 18.50 | 5,887 | 208,201 | |||||||||||
|
|
(1)
|
All
shares were purchased under First United Corporation’s repurchase plan
that was adopted effective August 15, 2007. The adoption of
this plan was publicly announced on August 21, 2007. The plan
authorizes the repurchase of up to 307,500 shares of common stock in open
market and/or private transactions at such times and in such amounts per
transaction as the Chairman and Chief Executive Officer of First United
Corporation determines to be appropriate. The repurchase plan
was suspended during the fourth quarter 2008 for the period of time that
the Corporation is participating in the Capital Purchase
Program.
|
[20]
|
ITEM
6.
|
SELECTED
FINANCIAL DATA
|
The
following table sets forth certain selected financial data for the five years
ended December 31, 2008 and is qualified in its entirety by the detailed
information and financial statements, including notes thereto, included
elsewhere or incorporated by reference in this annual report.
(In
thousands, except per share data)
|
2008
|
2007
|
2006
|
2005
|
2004
|
||||||||||||||||
|
Balance
Sheet Data
|
||||||||||||||||||||
|
Total
Assets
|
$ | 1,639,104 | $ | 1,478,909 | $ | 1,349,317 | $ | 1,310,991 | $ | 1,233,901 | ||||||||||
|
Net
Loans
|
1,120,199 | 1,035,962 | 957,126 | 954,545 | 904,635 | |||||||||||||||
|
Investment
Securities
|
354,595 | 304,908 | 263,272 | 230,095 | 210,661 | |||||||||||||||
|
Deposits
|
1,222,889 | 1,126,552 | 971,381 | 955,854 | 850,661 | |||||||||||||||
|
Long-term
Borrowings
|
277,403 | 178,451 | 166,330 | 128,373 | 175,415 | |||||||||||||||
|
Shareholders’
Equity
|
72,690 | 104,665 | 96,856 | 92,039 | 86,356 | |||||||||||||||
|
Operating
Data
|
||||||||||||||||||||
|
Interest
Income
|
$ | 95,216 | $ | 93,565 | $ | 80,269 | $ | 69,756 | $ | 60,682 | ||||||||||
|
Interest
Expense
|
43,043 | 49,331 | 39,335 | 29,413 | 24,016 | |||||||||||||||
|
Net
Interest Income
|
52,173 | 44,234 | 40,934 | 40,343 | 36,666 | |||||||||||||||
|
Provision
for Loan Losses
|
12,925 | 2,312 | 1,165 | 1,078 | 2,534 | |||||||||||||||
|
Other
Operating Income
|
13,769 | 15,092 | 14,041 | 14,088 | 12,971 | |||||||||||||||
|
Other
Operating Expense
|
40,573 | 38,475 | 35,490 | 34,654 | 35,969 | |||||||||||||||
|
Income
Before Taxes
|
12,444 | 18,539 | 18,320 | 18,699 | 11,134 | |||||||||||||||
|
Income
Taxes
|
3,573 | 5,746 | 5,743 | 6,548 | 3,507 | |||||||||||||||
|
Net
Income
|
$ | 8,871 | $ | 12,793 | $ | 12,577 | $ | 12,151 | $ | 7,627 | ||||||||||
|
Per
Share Data
|
||||||||||||||||||||
|
Net
Income
|
$ | 1.45 | $ | 2.08 | $ | 2.05 | $ | 1.99 | $ | 1.25 | ||||||||||
|
Dividends
Paid
|
.80 | .78 | .76 | .74 | .72 | |||||||||||||||
|
Book
Value
|
11.89 | 17.05 | 15.77 | 15.04 | 14.17 | |||||||||||||||
|
Significant
Ratios
|
||||||||||||||||||||
|
Return
on Average Assets
|
.55 | % | .90 | % | .96 | % | .95 | % | .65 | % | ||||||||||
|
Return
on Average Equity
|
9.31 | % | 12.70 | % | 13.07 | % | 13.61 | % | 8.91 | % | ||||||||||
|
Dividend
Payout Ratio
|
55.17 | % | 37.50 | % | 37.07 | % | 37.44 | % | 58.00 | % | ||||||||||
|
Average
Equity to Average Assets
|
5.95 | % | 7.10 | % | 7.35 | % | 7.00 | % | 7.28 | % | ||||||||||
|
Total
Risk-based Capital Ratio
|
12.18 | % | 12.51 | % | 12.95 | % | 12.66 | % | 12.24 | % | ||||||||||
|
Tier
I Capital to Risk Weighted Assets
|
10.59 | % | 11.40 | % | 11.81 | % | 11.45 | % | 10.81 | % | ||||||||||
|
Tier
I Capital to Average Assets
|
8.10 | % | 8.91 | % | 9.08 | % | 8.64 | % | 8.44 | % | ||||||||||
[21]
|
ITEM
7.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
This discussion and analysis should be
read in conjunction with the audited consolidated financial statements and notes
thereto for the year ended December 31, 2008, which appear in Item 8 of Part II
of this annual report.
Recent
Developments
Capital Purchase
Program - As
discussed above, on January 30, 2009 the Corporation participated in the TARP
CPP by issuing 30,000 shares of Series A Preferred Stock, having a liquidation
amount of $1,000 per share, and the Warrant covering 326,323 shares of common
stock to the Treasury for a total sales price of $30 million. The
Warrant may be exercised at any time until January 30, 2019 at an exercise price
of $13.79 per share, or an aggregate exercise price of approximately $4.5
million. The Series A Preferred Stock qualifies as Tier 1 capital and
pays cumulative dividends at a rate of 5% per annum until February 15,
2014. The Warrant counts as tangible common equity.
Holders of the Series A Preferred Stock
are entitled to receive if, as and when declared by the Board of Directors, out
of assets legally available for payment, cumulative cash dividends at a rate per
annum of 5% per share on a liquidation amount of $1,000 per share of Series A
Preferred Stock with respect to each dividend period from January 30, 2009 to,
but excluding, February 15, 2014. From and after February 15, 2014,
holders of Series A Preferred Stock are entitled to receive cumulative cash
dividends at a rate per annum of 9% per share on a liquidation amount of $1,000
per share with respect to each dividend period thereafter. Under the terms of
the Series A Preferred Stock, on and after February 15, 2012, the Corporation
may, at its option, redeem shares of Series A Preferred Stock, in whole or in
part, at any time and from time to time, for cash at a per share amount equal to
the sum of the liquidation preference per share plus any accrued and unpaid
dividends to but excluding the redemption date. The terms of the
Series A Preferred Stock further provide that, prior to February 15, 2012, the
Corporation may redeem shares of Series A Preferred Stock only if it has
received aggregate gross proceeds of not less than $7.50 million from one or
more qualified equity offerings, and the aggregate redemption price may not
exceed the net proceeds received by the Company from such
offerings. The redemption of the Series A Preferred Stock requires
prior regulatory approval.
Until the earlier of (i) January 30,
2012 or (ii) the date on which the Series A Preferred Stock has been redeemed in
full or Treasury has transferred all of the Series A Preferred Stock to
non-affiliates, the terms of the Series A Preferred Securities prohibit the
Corporation from increasing its quarterly cash dividend paid on common stock
above $0.20 per share or repurchasing any shares of common stock or other
capital stock or equity securities or trust preferred securities without the
consent of the Treasury. Accordingly, the Corporation’s
previously-announced common stock repurchase plan has been suspended effective
January 30, 2009.
On February 17, 2009, President Obama
signed the Recovery Act into law. The Recovery Act permits any
institution that receives assistance under TARP (including pursuant to the CPP),
after consultation with the appropriate banking regulators, to repay any such
assistance at any time notwithstanding any repayment restrictions contained in
the instruments defining such assistance. Recent guidance issued by
Treasury states that, as a general rule, any partial repayment must equal at
least 25% of the outstanding assistance. Treasury may waive this
minimum repayment amount. Accordingly, the Corporation may, at any
time and notwithstanding the restrictions on redemption discussed above, and
assuming its regulators do not object, repay all of or a portion of (in 25%
increments, unless waived by Treasury) the $30 million it received as
consideration for the Series A Preferred Stock and the Warrant. If
the Corporation were to repay any assistance, it could also repurchase any or
all of the portion of the Warrant that relates to the repayment. Any
portion of the Warrant that relates to the repayment that the Corporation
chooses not to repurchase must be liquidated by Treasury, at the current market
price.
FDIC Deposit
Insurance Fund Restoration Plan Announced – On February 27, 2009, the
FDIC announced a proposed rule outlining its plan to implement an emergency
special assessment of 20 basis points on all insured depository institutions in
order to restore the Deposit Insurance Fund to an acceptable level. The
assessment, which would be payable on September 30, 2009, would be in addition
to a planned increase in premiums and a change in the way regular premiums are
assessed which the FDIC also approved on February 27, 2009. In
addition, the proposed rule provides that, after June 30, 2009, if the reserve
ratio of the Deposit Insurance Fund is estimated to fall to a level that that
the FDIC believes would adversely affect public confidence or to a level which
is close to or less than zero at the end of a calendar quarter, then an
additional emergency special assessment of up to 10 basis points may be imposed
on all insured depository institutions. If this rule is adopted
as proposed, it could increase the Bank’s FDIC premiums in 2009 by approximately
$2.5 million.
[22]
Overview
The Corporation is a financial holding
company which, through the Bank and its non-bank subsidiaries, provides an array
of financial products and services primarily to customers in four Western
Maryland counties and four Northeastern West Virginia counties. Its
principal operating subsidiary is the Bank, which consists of a community
banking network of 26 branch offices located throughout its market
areas. Our primary sources of revenue are interest income earned from
our loan and investment securities portfolios and fees earned from financial
services provided to customers.
Consolidated net income for 2008
totaled $8.9 million or $1.45 per share, compared to $12.8 million or $2.08 per
share for 2007. The decrease in net income resulted primarily from an
increase in the provision for loan losses to $12.9 million in 2008, compared to
$2.3 million for 2007 and a $2.7 million non-cash other-than-temporary
impairment charge on the investment portfolio. The increase in the
provision in 2008 is due to increased net charge offs, an increase in the level
of non-accrual loans, loan growth during 2008, specific allocations for impaired
loans and changes in the qualitative factors used in the overall assessment of
the adequacy of the allowance for loan losses. Specific allocations
have been provided in instances where losses may occur. Approximately
$4.0 million of the recorded expense is attributable to a real estate and
development loan in Hardy County, West Virginia and deterioration in a group of
loan relationships outside of the Corporation’s market
area. Additional provision expense was also recorded because the
company that services a loan in which the Bank holds a participation interest
failed to remit $1.2 million in principal payments made by the
borrower. The Bank is reviewing its rights with respect to its
insurance carriers and the servicing company’s insurance carriers and bonding
companies, but there can be no assurance that the Bank will ultimately recover
any of this loss.
During
2008, earnings on interest-earning assets increased primarily as a result of an
investment portfolio restructuring and an overall increase in average earning
assets. Interest expense on interest-bearing liabilities decreased
$6.3 million due to the decline in interest rates during 2008 as well as the
enhanced efforts of an internal treasury committee. As a result, the
net interest margin increased to 3.68% in 2008 from 3.51% in 2007.
Operations
in 2008 were impacted by the following factors and strategic
initiatives:
Increased Loan
and Deposit Growth/Impact on Net Interest Margin – We experienced a
significant increase of $91.3 million in loans in 2008 when compared to
2007. The residential mortgage portfolio grew $21.0 million and the
commercial portfolio increased $83.7 million as a result of in-house production
and commercial participations with other financial institutions. We
experienced growth in both fixed rate and adjustable rate
products. These increases were offset by a decline of $13.4 million
in the installment loan portfolio. Interest income on loans in 2008
decreased from the amount generated in 2007 by $2.7 million (on a fully taxable
equivalent basis) due to the decrease in interest rates. Interest
income on investment securities increased by $4.8 million (on a fully taxable
equivalent basis) due to a $79 million increase in the
portfolio. (Additional information on the composition of interest
income is available in Table 1 that appears on page 25).
Funding
costs in 2008 decreased as a result of the declining interest rate environment
and the enhanced efforts of the internal treasury committee. Deposits
at December 31, 2008 increased $96.3 million when compared to deposits at
December 31, 2007, primarily from an $86.6 million increase in our IRA products
and brokered products.
The
decline in the interest rate environment decreased deposit interest expense by
$7.0 million when compared to 2007. Although net borrowings increased by $94.3
million in 2008 when compared to 2007, we realized a minimal increase in
interest expense on these borrowings. The combination of increased
loan and deposit growth, declining interest rates on our assets and liabilities,
and the increased level of debt resulted in an increase in net interest income
on a tax equivalent basis of $8.1 million (18%) in 2008 when compared to
2007.
The
overall net interest margin increased during 2008 to 3.68% from 3.51% in 2007 on
a fully taxable equivalent basis.
Other Operating
Income/Other Operating Expense — Other operating income decreased $1.3
million in 2008 when compared to 2007. Service charge income
increased $.5 million, due primarily to increased customer usage of an account
overdraft product. This increase was offset by decreases in trust
department income, insurance commission income, and realized losses on our
investment portfolio.
Trust
department income is directly affected by the performance of the equity and bond
markets and by the amount of assets under management. Although we
have experienced favorable sales production in our trust department, unfavorable
market conditions have reduced the fees and commissions on our existing accounts
under management resulting in slightly lower income when compared to
2007. Declining market values negatively impacted the value of assets
under management at year-end. Assets under management were $472
million, $547 million and $502 million for years 2008, 2007 and 2006,
respectively.
[23]
Insurance
commissions also decreased in 2008 when compared to 2007 due to a soft insurance
market resulting in lower premium income and a reduction in the amount of
contingency income received in 2008. Contingency income is received
from the insurance carriers based upon claims histories and varies from year to
year. In December 2008, the insurance agency acquired
substantially all of the assets of three insurance agencies, which should enable
the agency to expand its business into central West
Virginia. Information about these acquisitions may be found in Note 1
to the Consolidated Financial Statements included in Item 8 of Part II of this
annual report under the heading “Goodwill and Other Intangible
Assets”. The increase in 2007 as compared to 2006 was due to the
acquisition of two books of business during 2007.
Securities
gains (losses) are the most variable component of other operating
income. During 2008, we recorded a non-cash charge of approximately
$2.7 million as a result of an other-than-temporary impairment analysis
performed on our investment portfolio at year-end. This process is described
more fully in the Investment Securities section of the Consolidated Balance
Sheet Review. This charge was offset by gains realized from sales of
investment securities and calls on fixed-income bonds.
Other
operating expenses increased $2.1 million in 2008 when compared to
2007. This increase is attributable to an increase of $.9 million in
salaries and wages in 2008 when compared to 2007. Other expenses such
as marketing, membership fees and licenses, and information system conversion
costs increased by $.7 million in 2008 when compared to 2007.
Dividends —
The Corporation continued its tradition of paying dividends to
shareholders during 2008, increasing them to $0.80 per share, a 2.6% increase
from $0.78 per share in 2007. The Corporation has paid quarterly cash
dividends consistently since 1985, the year in which it was
formed. However, as noted above, the Corporation is generally
prohibited from increasing this dividend, unless prior consent from Treasury is
given or until the earlier of (i) January 30, 2012 or (ii) the date on which the
Series A Preferred Stock has been redeemed in full or Treasury has transferred
all of the Series A Preferred Stock to non-affiliates.
Looking
Forward — We
will continue to face risks and challenges in the future, including: changes in
local economic conditions in our core geographic markets; potential yield
compression on loan and deposit products from existing competitors and potential
new entrants in our markets; fluctuations in interest rates and changes to
existing federal and state legislation and regulations over banks and financial
holding companies. For a more complete discussion of these and other
risk factors, see Item 1A of Part I of this annual report.
Critical
Accounting Policies and Estimates
This
discussion and analysis of our financial condition and results of operations is
based upon our consolidated financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires
management to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
liabilities. (See Note 1 of the Notes to Consolidated Financial
Statements included in Item 8 of Part II of this annual report.) On an on-going
basis, management evaluates estimates, including those related to loan losses
and intangible assets. Management bases its estimates on historical
experience and on various other assumptions that are believed to be reasonable
under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities that are not
readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. Management
believes the following critical accounting policies affect our more significant
judgments and estimates used in the preparation of the consolidated financial
statements.
Allowance
for Loan Losses
One of
our most important accounting policies is that related to the monitoring of the
loan portfolio. A variety of estimates impact the carrying value of
the loan portfolio, including the calculation of the allowance for loan losses,
the valuation of underlying collateral, the timing of loan charge-offs and the
placement of loans on non-accrual status. The allowance is established and
maintained at a level that management believes is adequate to cover losses
resulting from the inability of borrowers to make required payment on loans.
Estimates for loan losses are arrived at by analyzing risks associated with the
specific loans and the loan portfolio, current and historical trends in
delinquencies and charge-offs, and changes in the size and composition of the
loan portfolio. The analysis also requires consideration of the economic climate
and direction, changes in lending rates, political conditions, legislation
impacting the banking industry and economic conditions specific to Western
Maryland and Northeastern West Virginia. Because the calculation of
the allowance for loan losses relies on management’s estimates and judgments
relating to inherently uncertain events, actual results may differ from
management’s estimates.
[24]
The
allowance for loan losses is also discussed below in this Item 7 under the
caption “Allowance for Loan Losses” and in Note 4 to Consolidated Financial
Statements contained in Item 8 of Part II of this annual report.
Goodwill
and Other Intangible Assets
Statement
of Financial Accounting Standards (SFAS) No. 142, Accounting for Goodwill and
Other Intangible Assets, establishes standards for the amortization of acquired
intangible assets and the non-amortization and impairment assessment of
goodwill. We have $1.0 million of core deposit intangible assets and
$3.4 million related to acquisitions of insurance “books of business” which are
subject to amortization. The $11.9 million in recorded goodwill is primarily
related to the acquisition of Huntington National Bank branches that occurred in
2003, which is not subject to periodic amortization.
Goodwill
arising from business combinations represents the value attributable to
unidentifiable intangible elements in the business acquired. Our goodwill
relates to value inherent in the banking business and the value is dependent
upon our ability to provide quality, cost effective services in a highly
competitive local market. This ability relies upon continuing
investments in processing systems, the development of value-added service
features and the ease of use of our services. As such, goodwill value
is supported ultimately by revenue that is driven by the volume of business
transacted. A decline in earnings as a result of a lack of growth or
the inability to deliver cost effective services over sustained periods can lead
to impairment of goodwill, which could adversely impact earnings in future
periods. SFAS No. 142 requires an annual evaluation of goodwill for
impairment. The determination of whether or not these assets are
impaired involves significant judgments. Management has completed its
annual evaluation for impairment and concluded that the recorded value of
goodwill was not impaired. However, future changes in strategy and/or
market conditions could significantly impact these judgments and require
adjustments to recorded asset balances.
Other-Than-Temporary
Impairment of Investment Securities
Securities
available-for-sale: Securities available-for-sale are stated
at fair value, with the unrealized gains and losses, net of tax, reported as a
separate component of accumulated other comprehensive income/(loss) in
shareholders’ equity.
The amortized cost of debt securities
classified as available-for-sale is adjusted for amortization of premiums to the
first call date, if applicable, or to maturity, and for accretion of discounts
to maturity, or in the case of mortgage-backed securities, over the estimated
life of the security. Such amortization and accretion, plus interest
and dividends, are included in interest income from investments.
Management systematically evaluates
investment securities for impairment on a quarterly basis. Declines
in the fair value of available for sale securities below their cost that are
considered other than temporary declines are recognized in earnings as realized
losses in the period in which the impairment determination is
made. In estimating other-than-temporary impairment losses,
management considers (1) the length of time and the extent to which the fair
value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Corporation to
retain its investment in the issuer for a period of time sufficient to allow for
any anticipated recovery in fair value. This process is described
more fully in the Investment Securities section of the Consolidated Balance
Sheet Review. Gains and losses on the sale of securities are recorded
using the specific identification method.
Fair
Value of Investments
Our entire investment portfolio is
classified as available-for-sale and is therefore carried at fair
value. We have determined the fair value of our investment securities
in accordance with the requirements of Statement of Financial Accounting
Standards (SFAS) No. 157, “Fair Value Instruments.” SFAS No. 157
defines fair value and establishes a framework for measuring fair value under
GAAP and expands the disclosures about fair value measurements. The
Corporation measures the fair market values of its investments based on the fair
value hierarchy established in SFAS No. 157. The determination of
fair value of investments and other assets is discussed further in Note 15 to
Consolidated Financial Statements contained in Item 8 of Part II of this annual
report.
[25]
Pension
Plan Assumptions
Our pension plan costs are calculated
using actuarial concepts, as discussed within the requirements of Statement of
Financial Accounting Standards (SFAS) No. 87, Employers Accounting for
Pensions, SFAS
No. 132 (R) and as amended by SFAS No. 158, “Employers’ Accounting for Deferred
Benefit Pension and Other Post Retirement Plans.” Pension
expense and the determination of our projected pension liability are based upon
two critical assumptions: the discount rate and the expected return on plan
assets. We evaluate each of these critical assumptions
annually. Other assumptions impact the determination of pension
expense and the projected liability including the primary employee demographics,
such as retirement patterns, employee turnover, mortality rates, and estimated
employer compensation increases. These factors, along with the
critical assumptions, are carefully reviewed by management each year in
consultation with our pension plan consultants and actuaries. Further
information about our pension plan assumptions, the plan’s funded status, and
other plan information is included in Note 11 to the Consolidated Financial
Statements, which is included in Item 8 of Part II of this annual
report.
Recent
Accounting Pronouncements and Developments
Note 1 to the Consolidated Financial
Statements included in Item 8, Part II of this annual report discusses new
accounting pronouncements that when adopted, may have an effect on our
consolidated financial statements.
CONSOLIDATED
STATEMENT OF INCOME REVIEW
Net
Interest Income
Net
interest income is our largest source of operating revenue. Net
interest income is the difference between the interest earned on
interest-earning assets and the interest expense incurred on interest-bearing
liabilities. For analytical and discussion purposes, net interest
income is adjusted to a taxable equivalent basis to facilitate performance
comparisons between taxable and tax-exempt assets by increasing tax-exempt
income by an amount equal to the federal income taxes that would have been paid
if this income were taxable at the statutorily applicable rate. The
table below summarizes net interest income (on a taxable equivalent basis) for
the years 2006-2008 (dollars in thousands).
|
2008
|
2007
|
2006
|
||||||||||
|
Interest
income
|
$ | 97,062 | $ | 95,286 | $ | 81,838 | ||||||
|
Interest
expense
|
43,043 | 49,331 | 39,335 | |||||||||
|
Net
interest income
|
$ | 54,019 | $ | 45,955 | $ | 42,503 | ||||||
|
Net
interest margin %
|
3.68 | % | 3.51 | % | 3.52 | % | ||||||
Net
interest income increased $8.1 million (18%) in 2008 over the same period in
2007, due to a $1.8 million (1.9%) increase in interest income coupled with a
$6.3 million (12.7%) decrease in interest expense. The increase in
interest income resulted from an increase in average interest-earning assets of
$158.9 million (12%) during 2008 when compared to 2007. The increased
level of interest earning assets is attributable to the growth that we
experienced in our loan and investment portfolios during 2008. The
declines in the interest rates throughout 2008 contributed to the decrease in
the average yield on our average earning assets of 67 basis points, from 7.29%
in 2007 to 6.62% in 2008 (on a fully tax equivalent basis). The
average yield on loans decreased by 81 basis points and the yield on investment
securities as a percentage of interest earning assets was stable in
2008. Although we experienced an increase in average interest-bearing
liabilities of $212.9 million in 2008, interest expense decreased $6.3 million
due to the decline in interest rates and the enhanced efforts of the internal
treasury committee. Average deposits increased in 2008 by
approximately $146.7 million. Effective management of both retail and
wholesale interest rates resulted in a 110 basis point decrease in the average
rate paid on our average interest-bearing liabilities from 4.21% for 2007 to
3.11% for 2008. The net result of the aforementioned factors
was a 17 basis point increase in the net interest margin at December 31, 2008 to
3.68% from 3.51% at December 31, 2007.
[26]
Comparing
2007 to 2006, net interest income increased $3.5 million (8%) due to a $13.4
million (16%) increase in interest income offset by a $10.0 million (25%)
increase in interest expense. The increase in interest income
resulted from an increase in average interest-earning assets of $100.0 million
(8%) during 2007 when compared to 2006. The increased level of
interest earning assets is attributable to the growth that we experienced in our
loan and investment portfolios during 2007. Emphasis on adjustable
rate loan products and the investment portfolio restructuring contributed to the
increase in the average yield on our average earning assets of 50 basis points,
from 6.78% in 2006 to 7.29% in 2007 (on a fully tax equivalent
basis). The average yield on loans increased by 48 basis points and
the yield on investment securities as a percentage of interest earning assets
increased 90 basis points from 2006 to 2007. Interest expense
increased during 2007 when compared to 2006 due to the higher interest rate
environment, and an overall increase in average interest-bearing liabilities of
$74.2 million. Deposits increased in 2007 by approximately $121
million due to successful retail growth in money market products and the
purchase of $85 million in brokered money market funds. The combined
effect of the competitive retail rate environment and the volume increases in
our average interest-bearing liabilities resulted in a 62 basis point increase
in the average rate paid on our average interest-bearing liabilities from 3.59%
for 2006 to 4.21% for 2007. The net result of the
aforementioned factors was a 1 basis point decline in the net interest margin at
December 31, 2007 to 3.51% from 3.52% at December 31, 2006.
As shown
below, the composition of total interest income over the three-year period from
2006 to 2008 shows a gradual increase in interest on investments and a
corresponding decline in interest and fees on loans. This shift is
attributable to the leverage strategies implemented throughout 2007 and
2008. Leverage strategies are the purchase of investment securities
funded by borrowings of matched terms and durations. The difference
between the rate earned and the rate paid has resulted in additional
earnings. Management has more control over the rates, duration and
structure of the investment portfolio as compared to the loan portfolio which is
customized to the individual needs of each borrower. As such, the
investment portfolio is used as a supplement to our asset liability management
process.
|
%
of Total Interest Income
|
||||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Interest
and fees on loans
|
78 | % | 82 | % | 85 | % | ||||||
|
Interest
on investment securities
|
22 | % | 18 | % | 15 | % | ||||||
Table 1
sets forth the average balances, net interest income and expense and average
yields and rates for our interest-earning assets and interest-bearing
liabilities for 2008, 2007 and 2006. Table 2 sets forth an analysis
of volume and rate changes in interest income and interest expense of our
average interest-earning assets and average interest-bearing liabilities for
2008, 2007 and 2006. Table 2 distinguishes between the changes
related to average outstanding balances (changes in volume created by holding
the interest rate constant) and the changes related to average interest rates
(changes in interest income or expense attributed to average rates created by
holding the outstanding balance constant).
[27]
Distribution
of Assets, Liabilities and Shareholders’ Equity
Interest
Rates and Interest Differential – Tax Equivalent Basis
(Dollars
in thousands)
Table
1
|
For
the Years Ended December 31
|
||||||||||||||||||||||||||||||||||||
|
2008
|
2007
|
2006
|
||||||||||||||||||||||||||||||||||
|
AVERAGE
BALANCE
|
INTEREST
|
AVERAGE
YIELD/RATE
|
AVERAGE
BALANCE
|
INTEREST
|
AVERAGE
YIELD/RATE
|
AVERAGE
BALANCE
|
INTEREST
|
AVERAGE
YIELD/RATE
|
||||||||||||||||||||||||||||
|
Assets
|
||||||||||||||||||||||||||||||||||||
|
Loans
|
$ | 1,081,191 | $ | 74,415 | 6.88 | % | $ | 1,003,854 | $ | 77,158 | 7.69 | % | $ | 957,709 | $ | 69,049 | 7.21 | % | ||||||||||||||||||
|
Investment
Securities:
|
||||||||||||||||||||||||||||||||||||
|
Taxable
|
285,382 | 16,848 | 5.90 | 215,756 | 12,474 | 5.78 | 171,720 | 7,699 | 4.48 | |||||||||||||||||||||||||||
|
Non
taxable
|
82,844 | 5,229 | 6.31 | 73,467 | 4,847 | 6.60 | 65,902 | 4,399 | 6.67 | |||||||||||||||||||||||||||
|
Total
|
368,226 | 22,077 | 6.00 | 289,223 | 17,321 | 5.99 | 237,622 | 12,098 | 5.09 | |||||||||||||||||||||||||||
|
Federal
funds sold
|
368 | 4 | 1.09 | 285 | 11 | 3.86 | 463 | 1 | .21 | |||||||||||||||||||||||||||
|
Interest-bearing
deposits with other banks
|
3,691 | 77 | 2.09 | 5,135 | 241 | 4.69 | 2,811 | 165 | 5.88 | |||||||||||||||||||||||||||
|
Other
interest earning assets
|
13,235 | 489 | 3.69 | 9,363 | 555 | 5.93 | 9,231 | 525 | 5.68 | |||||||||||||||||||||||||||
|
Total
earning assets
|
1,466,711 | 97,062 | 6.62 | % | 1,307,860 | 95,286 | 7.29 | % | 1,207,836 | 81,838 | 6.78 | % | ||||||||||||||||||||||||
|
Allowance
for loan losses
|
(9,002 | ) | (6,584 | ) | (6,245 | ) | ||||||||||||||||||||||||||||||
|
Non-earning
assets
|
142,076 | 118,780 | 110,098 | |||||||||||||||||||||||||||||||||
|
Total
Assets
|
$ | 1,599,785 | $ | 1,420,056 | $ | 1,311,689 | ||||||||||||||||||||||||||||||
|
Liabilities
and Shareholders’ Equity
|
||||||||||||||||||||||||||||||||||||
|
Interest-bearing
demand deposits
|
$ | 414,750 | $ | 6,906 | 1.67 | % | $ | 333,443 | $ | 9,752 | 2.92 | % | $ | 285,250 | $ | 6,405 | 2.25 | % | ||||||||||||||||||
|
Savings
deposits
|
80,812 | 1,035 | 1.28 | 42,123 | 1,445 | 3.43 | 47,779 | 462 | .97 | |||||||||||||||||||||||||||
|
Time
deposits:
|
||||||||||||||||||||||||||||||||||||
|
Less
than $100
|
239,211 | 10,220 | 4.27 | 234,439 | 10,429 | 4.45 | 229,829 | 8,439 | 3.67 | |||||||||||||||||||||||||||
|
$100
or more
|
339,110 | 12,621 | 3.72 | 317,219 | 16,132 | 5.09 | 273,305 | 12,043 | 4.41 | |||||||||||||||||||||||||||
|
Short-term
borrowings
|
55,243 | 1,022 | 1.85 | 70,474 | 2,903 | 4.12 | 107,430 | 4,429 | 4.12 | |||||||||||||||||||||||||||
|
Long-term
borrowings
|
254,680 | 11,239 | 4.41 | 173,208 | 8,670 | 5.01 | 153,089 | 7,557 | 4.94 | |||||||||||||||||||||||||||
|
Total
interest-bearing liabilities
|
1,383,806 | 43,043 | 3.11 | % | 1,170,906 | 49,331 | 4.21 | % | 1,096,682 | 39,335 | 3.59 | % | ||||||||||||||||||||||||
|
Non-interest-bearing
Deposits
|
106,124 | 133,509 | 107,595 | |||||||||||||||||||||||||||||||||
|
Other
liabilities
|
14,595 | 14,885 | 11,189 | |||||||||||||||||||||||||||||||||
|
Shareholders’
Equity
|
95,260 | 100,756 | 96,223 | |||||||||||||||||||||||||||||||||
|
Total
Liabilities and Shareholders’ Equity
|
$ | 1,599,785 | $ | 1,420,056 | $ | 1,311,689 | ||||||||||||||||||||||||||||||
|
Net
interest income and Spread
|
$ | 54,019 | 3.51 | % | $ | 45,955 | 3.08 | % | $ | 42,503 | 3.19 | % | ||||||||||||||||||||||||
|
Net
interest margin
|
3.68 | % | 3.51 | % | 3.52 | % | ||||||||||||||||||||||||||||||
NOTES:
—The
above table reflects the average rates earned or paid stated on a tax equivalent
basis assuming a tax rate of 35% for 2008, 2007 and 2006. The fully
taxable equivalent adjustments for the years ended December 31, 2008, 2007, and
2006 were $1,846, $1,721, and $1,569, respectively.
—The
average balances of non-accrual loans for the years ended December 31, 2008,
2007 and 2006, which were reported in the average loan balances for these years,
were $23,517, $4,167, and $2,705, respectively.
—Net
interest margin is calculated as net interest income divided by average earning
assets.
—The
average yields on investments are based on amortized cost.
[28]
Interest
Variance Analysis (1)
(In
thousands and tax equivalent basis)
Table
2
|
2008
Compared to 2007
|
2007
Compared to 2006
|
|||||||||||||||||||||||
|
Volume
|
Rate
|
Net
|
Volume
|
Rate
|
Net
|
|||||||||||||||||||
|
INTEREST
INCOME:
|
||||||||||||||||||||||||
|
Loans
|
$ | 5,323 | $ | (8,066 | ) | $ | (2,743 | ) | $ | 3,547 | $ | 4,562 | $ | 8,109 | ||||||||||
|
Taxable
Investments
|
4,111 | 264 | 4,375 | 2,546 | 2,229 | 4,775 | ||||||||||||||||||
|
Non-taxable
Investments
|
592 | (210 | ) | 382 | 499 | (51 | ) | 448 | ||||||||||||||||
|
Federal
funds sold
|
1 | (8 | ) | (7 | ) | (7 | ) | 17 | 10 | |||||||||||||||
|
Other
interest earning assets
|
140 | (370 | ) | (230 | ) | 261 | (155 | ) | 106 | |||||||||||||||
|
Total
interest income
|
10,167 | (8,390 | ) | 1,777 | 6,846 | 6,602 | 13,448 | |||||||||||||||||
|
INTEREST
EXPENSE:
|
||||||||||||||||||||||||
|
Interest-bearing
demand deposits
|
1,354 | (4,200 | ) | (2,846 | ) | 1,058 | 1,873 | 2,931 | ||||||||||||||||
|
Savings
deposits
|
495 | (905 | ) | (410 | ) | (194 | ) | 1,177 | 983 | |||||||||||||||
|
Time
deposits less than $100
|
204 | (413 | ) | (209 | ) | 205 | 1,785 | 1,990 | ||||||||||||||||
|
Time
deposits $100 or more
|
815 | (4,326 | ) | (3,511 | ) | 2,233 | 1,856 | 4,089 | ||||||||||||||||
|
Short-term
borrowings
|
(282 | ) | (1,598 | ) | (1,880 | ) | (1,019 | ) | (91 | ) | (1,110 | ) | ||||||||||||
|
Long-term
borrowings
|
3,595 | (1,026 | ) | 2,569 | 1,007 | 106 | 1,113 | |||||||||||||||||
|
Total
interest expense
|
6,181 | (12,468 | ) | (6,287 | ) | 3,290 | 6,706 | 9,996 | ||||||||||||||||
|
Net
interest income
|
$ | 3,986 | $ | 4,078 | $ | 8,064 | $ | 3,556 | $ | (104 | ) | $ | 3,452 | |||||||||||
|
|
(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
The provision for loan losses was $12.9
million for 2008, compared to $2.3 million for 2007. The increase in
the provision in 2008 was due to increased net charge offs, an increase in the
level of non-accrual loans, loan growth during 2008, specific allocations for
impaired loans and changes in the qualitative factors used in the overall
assessment of the adequacy of the allowance for loan losses. We have
closely reviewed and applied sensitivity analysis to the collateral values
related to our loan portfolio to adequately measure potential future
losses. Specific allocations have been provided in instances where
loans have been considered impaired and collateral analysis indicates that
losses may occur. Approximately $4.0 million of the recorded expense
is attributable to a real estate and development loan in Hardy County, West
Virginia and deterioration in a group of loan relationships outside of the
Corporation’s market area. Additional provision expense was also
recorded because the company that services a commercial loan in which the Bank
holds a participation interest failed to remit $1.2 million in principal
payments made by the borrower that were due to the Bank. The Bank is
reviewing its rights with respect to its insurance carriers and the servicing
company’s insurance carriers and bonding companies, but there can be no
assurance that the Bank will ultimately recover any of this loss.
The provision for loan losses was $2.3
million for 2007, compared to $1.2 million for 2006. The increase in
the provision in 2007 was due to increased net charge offs, an increase in the
level of non-accrual loans, loan growth during 2007, and changes in the
qualitative factors used in the overall assessment of the adequacy of the
allowance for loan losses.
[29]
Other
Operating Income
The
following table shows the major components of other operating income for the
past three years (dollars in thousands) and the percentage changes during these
years:
|
2008 VS. 2007
|
2007 VS. 2006
|
|||||||||||||||||||
|
2008
|
2007
|
2006
|
% CHANGE
|
% CHANGE
|
||||||||||||||||
|
Service
charges on deposit accounts
|
$ | 5,835 | $ | 4,955 | $ | 4,630 | 17.8 | % | 7.0 | % | ||||||||||
|
Other
service charge income
|
1,639 | 1,994 | 1,637 | -17.8 | % | 21.8 | % | |||||||||||||
|
Trust
department income
|
3,912 | 4,076 | 3,671 | -4.0 | % | 11.0 | % | |||||||||||||
|
Insurance
commissions
|
2,143 | 2,529 | 1,573 | -15.3 | % | 60.8 | % | |||||||||||||
|
Securities
(losses)/gains
|
(1,997 | ) | (1,605 | ) | 4 | -24.4 | % | * | ||||||||||||
|
Bank
owned life insurance (BOLI)
|
704 | 1,114 | 848 | -36.8 | % | 31.4 | % | |||||||||||||
|
Brokerage
commissions
|
745 | 734 | 501 | 1.5 | % | 46.5 | % | |||||||||||||
|
Other
income
|
788 | 1,295 | 1,177 | -39.2 | % | 10.0 | % | |||||||||||||
|
Total
other operating income
|
$ | 13,769 | $ | 15,092 | $ | 14,041 | -8.8 | % | 7.5 | % | ||||||||||
* not
meaningful
As the table above illustrates, other
operating income decreased by $1.3 million in 2008 when compared to
2007. This compares to a $1.05 million (7.5%) increase in 2007 over
2006.
Service charges on deposit accounts
increased in 2008 versus 2007 and in 2007 versus 2006. These
increases are due primarily to increased customer usage of an account overdraft
product. Service charge related income constitutes 54%, 46%, and 45%
of other operating income in 2008, 2007, and 2006, respectively.
Trust department income is directly
affected by the performance of the equity and bond markets and by the amount of
assets under management. Although we have experienced favorable sales
production in our trust division, unfavorable market conditions have reduced the
fees and commissions on our existing accounts under management resulting in
slightly lower income when compared to 2007. Declining market values
negatively impacted the value of assets under management at
year-end. Assets under management were $472 million, $547 million and
$502 million for years 2008, 2007 and 2006, respectively.
Insurance commissions also decreased in
2008 when compared to 2007 due to a soft insurance market resulting in lower
premium income and a reduction in the amount of contingency income received in
2008. Contingency income is received from the insurance carriers
based upon claims histories and varies from year to year. The
increase in 2007 as compared to 2006 was due to the acquisition of two books of
business during 2007.
Securities gains (losses) are the most
variable component of other operating income. During 2008, we
recorded a non-cash charge of approximately $2.7 million as a result of an
other-than-temporary impairment analysis performed on our investment portfolio
at year-end. This process is described more fully in the Investment Securities
section of the Consolidated Balance Sheet Review. This charge was
offset by gains realized from sales of investment securities and calls on
fixed-income bonds.
During 2007, we recorded a
non-recurring pre-tax charge of approximately $1.6 million ($1.0 million or $.18
per share, net of tax) associated with the transfer of certain investment
securities from the available-for-sale category to the trading category during
the first quarter of 2007 and the subsequent sale of those securities during the
second quarter. This sale of securities was part of our overall
restructuring of the investment portfolio designed to improve overall earnings
from the portfolio.
We experienced a decline in other
income during 2008 primarily due to reduced secondary market fees as a result of
a shift to in-house portfolio loans. The decline in the earnings on
our bank owned life insurance (BOLI) is attributable to the overall decrease in
the interest rate environment throughout 2008.
[30]
Other
Operating Expense
Other operating expense for 2008
increased $2.1 million (5.5%) when compared to 2007, compared to an increase in
2007 of $3.0 million (8%) over 2006. The following table shows the
major components of other operating expense for the past three years (in
thousands) and the percentage changes during these years:
|
2008 VS. 2007
|
2007 VS. 2006
|
|||||||||||||||||||
|
2008
|
2007
|
2006
|
% CHANGE
|
% CHANGE
|
||||||||||||||||
|
Salaries
and employee benefits
|
$ | 21,531 | $ | 20,628 | $ | 19,084 | 4.4 | % | 8.1 | % | ||||||||||
|
Other
expenses
|
11,264 | 10,563 | 9,900 | 6.6 | % | 6.7 | % | |||||||||||||
|
Equipment
|
3,364 | 3,224 | 3,011 | 4.3 | % | 7.1 | % | |||||||||||||
|
Occupancy
|
2,693 | 2,388 | 2,043 | 12.8 | % | 16.9 | % | |||||||||||||
|
Data
processing
|
1,721 | 1,672 | 1,452 | 2.9 | % | 15.2 | % | |||||||||||||
|
Total other operating
expense
|
$ | 40,573 | $ | 38,475 | $ | 35,490 | 5.5 | % | 8.4 | % | ||||||||||
Salaries and employee benefits
represent approximately 53% of total other operating expenses in 2008 compared
to 54% in 2007 and 2006. Salaries and wages increased slightly by $.9
million in 2008 over 2007, and $1.5 million in 2007 over
2006. The increase in 2008 when compared to 2007 is primarily
attributable to normal merit increases and new hires to support on-going
operations and production. This increase was offset slightly because
no executive bonuses were paid for 2008.
Other expenses increased slightly by
$.7 million in 2008 when compared to 2007 due to increases in
marketing, membership fees and licenses and miscellaneous conversion costs
as a result of our core processor conversion completed in
April. Comparing 2007 to 2006, other expenses increased by $.7
million due to increases in marketing, insurance, and contribution
expenses.
Occupancy and equipment expenses
increased by $.4 million from 2007 to 2008 and $.6 million from 2006 to
2007. These increases relate to the growth and expansion of the
Bank’s retail network and the opening of our operations center during
2007.
Applicable
Income Taxes
Income tax expense amounted to $3.6
million in 2008 and $5.7 million in 2007 and 2006. The resulting
effective tax rates were 28.7%, 31.0% and 31.3% for 2008, 2007 and 2006,
respectively. The decrease in the effective tax rate from 2007 to
2008 is due primarily from reduced income and the proportionate share of
tax-exempt income to total income.
CONSOLIDATED
BALANCE SHEET REVIEW
Overview
Our total assets reached $1.64 billion
at December 31, 2008, representing an increase of $160 million (10.8%) from
year-end 2007.
The total interest-earning asset mix at
December 31, 2008 shows a comparable percentage of loans and investments as a
percentage of total assets over the past three years, as illustrated
below:
|
Year End Percentage of Total Assets
|
||||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Net
loans
|
68 | % | 70 | % | 71 | % | ||||||
|
Investments
|
22 | % | 21 | % | 20 | % | ||||||
[31]
The year-end total liability mix has
remained consistent during the three-year period as illustrated
below.
|
Year End Percentage of Total Liabilities
|
||||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Total
deposits
|
78 | % | 82 | % | 78 | % | ||||||
|
Total
borrowings
|
21 | % | 17 | % | 21 | % | ||||||
Loan
Portfolio
Through the Bank and the OakFirst Loan
Centers, we are actively engaged in originating loans to customers primarily in
Allegany County, Frederick County, Garrett County, and Washington County in
Maryland, and in Berkeley County, Hardy County, Mineral County, and Monongalia
County in West Virginia; and the surrounding regions of West Virginia and
Pennsylvania. We have policies and procedures designed to mitigate
credit risk and to maintain the quality of our loan portfolio. These
policies include underwriting standards for new credits as well as continuous
monitoring and reporting policies for asset quality and the adequacy of the
allowance for loan losses. These policies, coupled with ongoing
training efforts, have provided effective checks and balances for the risk
associated with the lending process. Lending authority is based on
the type of the loan, and the experience of the lending officer.
Commercial loans are collateralized
primarily by real estate and, to a lesser extent, equipment and vehicles.
Unsecured commercial loans represent an insignificant portion of total
commercial loans. Residential mortgage loans are collateralized by
the related property. Any residential mortgage loan exceeding a
specified internal loan-to-value ratio requires private mortgage
insurance. Installment loans are typically collateralized, with
loan-to-value ratios which are established based on the financial condition of
the borrower. We will also make unsecured consumer loans to qualified
borrowers meeting our underwriting standards. Additional information
about our loans and underwriting policies can be found in Item 1 of Part I of
this annual report under the caption “Banking Products and
Services”.
Table 3 sets forth the composition of
our loan portfolio. Historically, our policy has been to make the
majority of our loan commitments in our market areas. We had no
foreign loans in our portfolio as of December 31 for all of the periods
presented.
Summary
of Loan Portfolio
(Dollars
in thousands)
Table 3
|
Loans Outstanding as of December 31
|
||||||||||||||||||||
|
2008
|
2007
|
2006
|
2005
|
2004
|
||||||||||||||||
|
Commercial
|
$ | 575,962 | $ | 492,302 | $ | 408,361 | $ | 404,681 | $ | 373,893 | ||||||||||
|
Real
Estate – Mortgage
|
403,768 | 384,420 | 359,601 | 337,559 | 319,033 | |||||||||||||||
|
Consumer
Installment
|
140,234 | 153,593 | 181,574 | 193,275 | 199,862 | |||||||||||||||
|
Real
Estate – Construction
|
14,582 | 12,951 | 14,120 | 25,446 | 18,196 | |||||||||||||||
|
Lease
Financing
|
— | — | — | — | 466 | |||||||||||||||
|
Total Loans
|
$ | 1,134,546 | $ | 1,043,266 | $ | 963,656 | $ | 960,961 | $ | 911,450 | ||||||||||
During 2008, gross loans increased by
$91 million, or 8.8%, over 2007. This growth was focused in
our commercial ($84 million) and residential mortgage ($21 million) loan
portfolios, offset by a decline in installment ($13 million) and remains
consistent with management’s objectives over the past several
years. Continued efforts were made to increase the percentage of
loans in the portfolio with adjustable interest rates. At December
31, 2008, adjustable interest rate loans maturing within one to five years were
60% of total loans, compared to 55% at December 31, 2007.
Commercial loans increased 17% in 2008,
following a 20.6% increase in 2007. The growth in the commercial
portfolio is a result of both in-house production and participations with other
institutions. Commercial loans secured by real estate were
74% of total commercial loans at December 31, 2008, compared to
81% and 82% at December 31, 2007 and 2006, respectively.
[32]
Residential
mortgage loans increased by $21 million, or 5%, in 2008 when compared to
2007. This follows a 7% increase in 2007 over 2006. The
growth in the residential portfolio consists of both adjustable and fixed rate
products.
Fixed–interest rate loans made up 38%
of the total loan portfolio at December 31, 2008, compared to 42% and 59% of
total loans at December 31, 2007 and 2006, respectively.
Consumer installment loans in 2008
decreased by $13 million, or 8.7%, when compared to 2007. This
decrease reflects management’s continued shift toward more commercial loans with
less emphasis on the highly competitive consumer loan market and indirect car
dealer loans. Indirect auto loans comprise the largest percentage of
installment loans, 74% at December 31, 2008, and 85% at December 31, 2007 and
2006.
The following table sets forth the
remaining maturities, based upon contractual dates, for selected loan categories
as of December 31, 2008 (in thousands):
Maturities
of Loan Portfolio at December 31, 2008
Table 4
|
Maturing
Within
One Year
|
After One
But Within
Five Years
|
Maturing
After Five
Years
|
Total
|
|||||||||||||
|
Commercial
|
$ | 299,951 | $ | 238,281 | $ | 37,730 | $ | 575,962 | ||||||||
|
Real
Estate – Mortgage
|
121,824 | 106,595 | 175,349 | 403,768 | ||||||||||||
|
Installment
|
6,511 | 101,428 | 32,295 | 140,234 | ||||||||||||
|
Real
Estate – Construction
|
— | 14,582 | — | 14,582 | ||||||||||||
|
Total
Loans
|
$ | 428,286 | $ | 460,886 | $ | 245,374 | $ | 1,134,546 | ||||||||
|
Classified
by Sensitivity to Change in Interest Rates
|
||||||||||||||||
|
Fixed-Interest
Rate Loans
|
$ | 39,868 | $ | 166,462 | $ | 229,440 | $ | 435,770 | ||||||||
|
Adjustable-Interest
Rate Loans
|
388,418 | 294,424 | 15,934 | 698,776 | ||||||||||||
|
Total Loans
|
$ | 428,286 | $ | 460,886 | $ | 245,374 | $ | 1,134,546 | ||||||||
Our policy is to place loans on
non-accrual status, except for consumer loans, whenever there is substantial
doubt about the ability of a borrower to pay principal or interest on the
outstanding credit. Management considers such factors as payment
history, the nature of the collateral securing the loan, and the overall
economic situation of the borrower when making a non-accrual
decision. Management closely monitors the status of all non-accrual
loans. A non-accruing loan is restored to accrual status when
principal and interest payments have been brought current, it becomes well
secured, or is in the process of collection and the prospects of future
contractual payments are no longer in doubt. Generally, consumer
installment loans are not placed on non-accrual status, but are charged off
after they are 120 days contractually past due. Table 5 sets forth
the historical amounts of non-accrual, past-due and restructured loans (in
thousands) for the past five years:
Risk
Elements of Loan Portfolio
Table 5
|
At December 31
|
||||||||||||||||||||
|
2008
|
2007
|
2006
|
2005
|
2004
|
||||||||||||||||
|
Non-Accrual
Loans
|
$ | 24,553 | $ | 5,443 | $ | 3,190 | $ | 2,393 | $ | 3,439 | ||||||||||
|
Accruing
Loans Past Due 90 Days or More
|
3,476 | 3,260 | 619 | 989 | 1,105 | |||||||||||||||
|
Restructured
Loans
|
468 | 0 | 522 | 532 | 544 | |||||||||||||||
|
Other
Real Estate Owned
|
2,424 | 825 | 23 | 133 | 226 | |||||||||||||||
Interest income not recognized as a
result of placing loans on a non-accrual status was $.4 million during 2008 and
$.2 million during 2007 and 2006.
[33]
Allowance
for Loan Losses
An allowance for loan losses is
maintained to absorb losses from the loan portfolio. The allowance
for loan losses 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.
We use the methodology outlined in FDIC
Statement of Policy on Allowance for Loan Losses. The starting point
for this methodology is to segregate the loan portfolio into two pools,
non-homogeneous (i.e., commercial) and homogeneous (i.e., consumer and
residential mortgage) loans. Each loan pool is analyzed with general
allowances and specific allocations being made as appropriate. For
general allowances, the previous eight quarters of loss activity are used in the
estimation of losses in the current portfolio. These historical loss
amounts are modified by the following qualitative factors: levels of and trends
in delinquency rates and non-accrual loans; trends in volumes and terms of
loans; effects of changes in lending policies; experience, ability, and depth of
management; national and local economic trends and conditions; and
concentrations of credit in the determination of the general
allowance. The qualitative factors are updated each quarter by
information obtained from internal, regulatory, and governmental
sources. Specific allocations of the allowance for loan losses are
made for those loans on the “Watchlist” in which the collateral value is less
than the outstanding loan balance with the allocation being the dollar
difference between the two. The Watchlist represents loans,
identified and closely monitored by management, which possess certain qualities
or characteristics that may lead to collection and loss
issues. Allocations are not made for loans that are cash secured, for
the Small Business Administration and Farm Service Agency guaranteed portion of
loans, or for loans that are sufficiently collateralized.
The allowance for loan losses is 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 allowance for loan losses. The
methodology used to determine the adequacy of the allowance for loan losses 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 balance of the allowance for loan
losses increased to $14.3 million at December 31, 2008, from $7.3 million at
December 31, 2007. Several factors contributed to the $7 million
increase in the balance of the allowance in 2008, including: a
significant increase in the balance of non-accrual loans, from $5.4 million in
2007 to $24.6 million in 2008; changes to the qualitative factors which are
reviewed quarterly; an increase in impaired loans from $6.9 million in 2007 to
$83.3 million in 2008; and an increase in the percentage of net charge-offs
to average outstanding loans from .15% in 2007 to .54% in 2008. Non-accrual
loans and impaired loans consist primarily of real estate development loans and
commercial real estate that have experienced a slowdown in the level of sales
activity during the current year. All of these types of credit
facilities were thoroughly reviewed by management during the fourth quarter of
2008 as to the adequacy of the collateral, the valuation of collateral,
secondary sources of repayment, and other credit quality
attributes. Collateral valuations were also subject to a sensitivity
and shock analysis in order to identify loans that may not have sufficient
collateral in the event of a significant decline in the market value of the
collateral. As a result of this extensive review, some specific
allocations of the allowance were made to several of these loans. At
December 31, 2008, the balance of the allowance was equal to 1.26% of total
loans, which was 2.4 times the amount of net charge-offs for the
year.
Performing loans considered impaired
loans, as defined and identified by management, amounted to $56.5 million at
December 31, 2008. Loans are identified as impaired when the loan is
classified as substandard and management determines that it is probable that the
borrower will not be able to pay principal and interest according to the
contractual terms of the loan. These loans consist primarily of
acquisition and development 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 and no secondary source of repayment is available.
During 2008, there was significant
coverage in the media regarding the topic of “sub-prime” loans and the resulting
increase in loan delinquencies and foreclosures. A sub-prime loan is
defined generally as a loan to a borrower with a weak credit record or a reduced
repayment capacity. These borrowers typically pose a higher risk of
default and foreclosure. We generally do not make sub-prime
loans. If credit is extended to a sub-prime borrower, the decision to
lend is based on the presence of facts and circumstances that management
believes mitigate the risks inherent in this type of loan. As of
December 31, 2008, management believes that our exposure to sub-prime loans is
very minimal.
[34]
The balance of the allowance for loan
losses increased to $7.3 million at December 31, 2007, from $6.5 million at
December 31, 2006. Several factors contributed to the $.8 million
increase in the balance of the allowance in 2007, including: a 71%
increase in the balance of non-accrual loans (from $3.2 million in 2006 to $5.4
million in 2007); changes to the qualitative factors which are reviewed
quarterly; an increase in impaired loans from $.1 million in 2006 to $6.9
million in 2007; and an increase in the percentage of net charge-offs to
average outstanding loans from .11% in 2006 to .15% in 2007. Non-accrual
loans and impaired loans consist primarily of real estate acquisition and
development loans that have experienced a slowdown in the level of sales
activity during the current year. All of these types of credit
facilities were thoroughly reviewed by management during the fourth quarter of
2007 as to the adequacy of the collateral, the valuation of collateral, and
other credit quality attributes. Collateral valuations were also
subject to a sensitivity and shock analysis in order to identify loans that may
not have sufficient collateral in the event of a significant decline in the
market value of the collateral. As a result of this extensive review,
some specific allocations of the allowance were made to several A&D
loans. At December 31, 2007, the balance of the allowance was equal
to .70% of total loans, which was five times the amount of net charge-offs for
the year.
As a result of management’s evaluation
of the loan portfolio using the factors and methodology described above,
management believes the allowance for loan losses is adequate as of December 31,
2008.
Table 6 presents the activity in the
allowance for loan losses by major loan category for the past five
years.
Analysis
of Activity in the Allowance for Loan Losses
(Dollars
in thousands)
Table 6
|
For the Years Ended December 31
|
||||||||||||||||||||
|
2008
|
2007
|
2006
|
2005
|
2004
|
||||||||||||||||
|
Balance
at Beginning of Period
|
$ | 7,304 | $ | 6,530 | $ | 6,416 | $ | 6,814 | $ | 5,974 | ||||||||||
|
Loans
Charged Off:
|
||||||||||||||||||||
|
Commercial
|
3,936 | 540 | 359 | 557 | 808 | |||||||||||||||
|
Real
Estate – Mortgage
|
743 | 103 | 89 | 162 | 153 | |||||||||||||||
|
Installment
|
1,408 | 1,171 | 1,127 | 1,171 | 1,244 | |||||||||||||||
|
Deposit
Overdrafts
|
508
|
408
|
—
|
—
|
—
|
|||||||||||||||
|
Total
Charged Off
|
6,595 | 2,222 | 1,575 | 1,890 | 2,205 | |||||||||||||||
|
Recoveries
of Loans:
|
||||||||||||||||||||
|
Commercial
|
147 | 45 | 110 | 8 | 22 | |||||||||||||||
|
Real
Estate – Mortgage
|
39 | 17 | 11 | 59 | 67 | |||||||||||||||
|
Installment
|
375 | 380 | 403 | 347 | 422 | |||||||||||||||
|
Deposit
Overdrafts
|
152
|
242
|
—
|
—
|
—
|
|||||||||||||||
|
Total
Recoveries
|
713 | 684 | 524 | 414 | 511 | |||||||||||||||
|
|
|
|
|
|
||||||||||||||||
|
Net
Loans Charged Off
|
5,882 | 1,538 | 1,051 | 1,476 | 1,694 | |||||||||||||||
|
Provision
for Loan Losses
|
12,925 | 2,312 | 1,165 | 1,078 | 2,534 | |||||||||||||||
|
Balance
at the End of Period
|
$ | 14,347 | $ | 7,304 | $ | 6,530 | $ | 6,416 | $ | 6,814 | ||||||||||
|
Loans
at End of Period
|
$ | 1,134,546 | $ | 1,043,266 | $ | 963,656 | $ | 960,961 | $ | 911,450 | ||||||||||
|
Daily
Average Balance of Loans
|
$ | 1,081,191 | $ | 1,003,854 | $ | 957,709 | $ | 954,784 | $ | 861,255 | ||||||||||
|
Allowance
for Loan Losses to Loans Outstanding
|
1.26 | % | .70 | % | .68 | % | .67 | % | .75 | % | ||||||||||
|
Net
Charge Offs to Average Loans
Outstanding
|
.54 | % | .15 | % | .11 | % | .15 | % | .20 | % | ||||||||||
Table 7
presents management’s allocation of the allowance for loan losses by major loan
category in comparison to that loan category’s percentage of total loans.
Changes in the allocation over time reflect changes in the composition of the
loan portfolio risk profile and refinements to the methodology of determining
the allowance. Specific allocations in any particular category may be
reallocated in the future as needed to reflect current
conditions. Accordingly, the entire allowance is considered available
to absorb losses in any category.
[35]
Allocation
of the Allowance for Loan Losses
(In
thousands at December 31)
Table
7
|
2008
|
% of
Total
Loans
|
2007
|
% of
Total
Loans
|
2006
|
% of
Total
Loans
|
2005
|
% of
Total
Loans
|
2004
|
% of
Total
Loans
|
|||||||||||||||||||||||||||||||
|
Commercial
|
$ | 9,002 | 51 | % | $ | 3,825 | 47 | % | $ | 2,983 | 42 | % | $ | 2,777 | 42 | % | $ | 3,050 | 41 | % | ||||||||||||||||||||
|
Real
Estate-Mortgage
|
3,326 | 37 | % | 1,716 | 38 | % | 1,512 | 39 | % | 1,504 | 38 | % | 1,454 | 37 | % | |||||||||||||||||||||||||
|
Consumer
Installment
|
2,015 | 12 | % | 1,763 | 15 | % | 1,934 | 19 | % | 2,060 | 20 | % | 2,246 | 22 | % | |||||||||||||||||||||||||
|
Lease
Financing
|
— | — | — | — | — | — | — | — | 15 | — | ||||||||||||||||||||||||||||||
|
Other
|
4 | — | 0 | — | 101 | — | 75 | — | 49 | — | ||||||||||||||||||||||||||||||
|
Total
|
$ | 14,347 | 100 | % | $ | 7,304 | 100 | % | $ | 6,530 | 100 | % | $ | 6,416 | 100 | % | $ | 6,814 | 100 | % | ||||||||||||||||||||
Investment
Securities
Our entire investment portfolio is
categorized as available-for-sale. Investment securities classified
as available-for-sale are held for an indefinite period of time and may be sold
in response to changing market and interest rate conditions or for liquidity
purposes as part of our overall asset/liability management
strategy. Available-for-sale securities are reported at market value,
with unrealized gains and losses excluded from earnings and reported as a
separate component of other comprehensive income included in shareholders’
equity, net of applicable income taxes. We do not currently purchase
securities with the intent to resell and, therefore, do not own any securities
classified as trading securities. For additional information, see
Notes 1 and 3 of the Notes to Consolidated Financial Statements, which are
included in Item 8 of Part II of this annual report.
The following sets forth the
composition of our securities portfolio, reported at fair value, by major
category as of the indicated dates (in thousands):
|
December 31
|
||||||||||||||||||||||||
|
(fair
value)
|
||||||||||||||||||||||||
|
2008
|
As % of
Total
|
2007
|
As % of
Total
|
2006
|
As % of
Total
|
|||||||||||||||||||
|
Securities
Available-for-Sale:
|
||||||||||||||||||||||||
|
U.S.
government and agencies
|
$ | 113,645 | 32 | % | $ | 90,768 | 30 | % | $ | 97,490 | 37 | % | ||||||||||||
|
Mortgage-backed
securities
|
123,199 | 35 | % | 60,939 | 20 | % | 50,829 | 19 | % | |||||||||||||||
|
Obligation
of states and political subdivisions
|
93,485 | 26 | % | 85,893 | 28 | % | 68,432 | 26 | % | |||||||||||||||
|
Corporate
and other debt
|
24,266 | 7 | % | 67,308 | 22 | % | 46,521 | 18 | % | |||||||||||||||
|
Total
|
$ | 354,595 | 100 | % | $ | 304,908 | 100 | % | $ | 263,272 | 100 | % | ||||||||||||
Total investment securities increased
$50 million (16%) in 2008 when compared to 2007. Mortgage-backed
securities increased by $62 million and U.S. Government agencies increased by
$23 million while Corporate and other debt decreased $43 million. The
Corporate portfolio consists primarily of Preferred Term Securities which are
pools of debt issued by various banks. The decrease in this sector is
due to a decline in the market value of these securities directly attributable
to the current economic and financial environment.
Total investment securities increased
$42 million (16%) in 2007 when compared to the 2006 year-end
balance. The increase in our investment portfolio since year-end 2006
is primarily due to the purchase of $25 million in corporate bonds during the
first quarter of 2007 as part of a leverage strategy originally implemented
during the fourth quarter of 2006 and the purchase of additional securities in
September 2007. Mortgage-backed securities increased by $10 million
and tax exempt municipal bonds increased by $17 million while U.S. Government
agencies decreased $7 million.
[36]
At December 31, 2008, the securities
available-for-sale balance included a net unrealized loss of $55.7 million,
which represents the difference between fair value and amortized
cost. The comparable amount at December 31, 2007 was a net unrealized
loss of $4.2 million. The fair values of securities
available-for-sale will generally decrease whenever interest rates increase, and
the fair values will typically increase in a declining rate
environment. However, fair values have been largely affected in 2008
by factors such as marketability, liquidity and the current economic
environment.
As more fully discussed in Note 15 of
the Notes to Consolidated Financial Statements included in Item 8 of Part II of
this annual report, effective January 1, 2008, we began measuring fair market
values based on the fair value hierarchy established in SFAS No. 157 and in
Financial Accounting Standards Board Staff Position (FSP) No. FSP
157-3. The hierarchy gives the highest priority to unadjusted quoted
prices in active markets for identical assets or liabilities (Level 1
measurements) and the lowest priority to unobservable inputs (Level 3
measurements). Level 3 prices or valuation techniques require inputs that are
both significant to the valuation assumptions and are not readily observable in
the market (i.e. supported with little or no market activity). These
Level 3 instruments are valued based on both observable and unobservable inputs
derived from the best available data, some of which is internally developed, and
considers risk premiums that a market participant would require.
Approximately $24.3 million (7%) of our
securities available-for-sale were classified using significant unobservable
inputs (Level 3 assets). These securities were Preferred Term
Securities classified as corporate securities and contributed approximately $27
million to the unrealized loss reported in our accumulated other comprehensive
income (loss) on the Statement of Financial Condition. The underlying
issuers for these securities are primarily financial institutions and insurance
companies. Preferred Term Securities contractually allow an issuer to
defer interest payments for up to twenty quarters. Although there
have been deferrals and defaults of some of the underlying issuers, the
structured securities held in our portfolio are generally secured by
over-collateralization or default protection provided by subordinated
tranches.
Management
evaluates on a quarterly basis each security in an unrealized loss position for
other than temporary impairment. In its evaluation, management considers such
factors as the length of time and the extent to which the market value has been
below cost, the financial condition and near-term prospects of the issuer,
including specific events which may have influenced the operations of the
issuer, and our intent and ability to hold the security to an expected recovery
in market value. Due to the duration and the significant market value
decline in our Preferred Term Securities, we performed more extensive testing on
these securities for purposes of evaluating whether an other than temporary
impairment has occurred.
Length of Time and Extent
that Market Value is Less Than Cost
Twenty-one
of the Preferred Term Securities in our portfolio have been in an unrealized
loss position for over 12 months and three have been in an unrealized loss
position for less than 12 months. Although some of the securities
have been in a loss position for over one year, this is not an automatic
indication of an other-than-temporary impairment. Rather, individual
facts and circumstances may indicate that a decline in fair value longer than 12
months may be temporary. Given the extraordinary market conditions
prevalent during 2008, particularly during the third and fourth quarters,
additional consideration has been given to the length of time the securities
have been in a loss position and the likelihood that a market recovery will be
longer than an otherwise orderly market would dictate.
Factors
to be considered in an impairment judgment may be both subjective and objective
and include knowledge and experience about past and current events as well as
assumptions about future events. In the case of the Preferred Term
Securities, the decline in fair value is attributable to adverse conditions in
the market, adverse conditions in the financial industry, as well as adverse
conditions related to the underlying issuers of the securities (all of whom
operate in the financial industry).
Financial Condition and
Near-Term Prospects of the Issuers
The
current economic and financial environment, driven primarily by the significant
delinquencies and foreclosures of subprime loans and the banking crisis, has led
to unprecedented events in the financial industry. During 2008, we
have witnessed a significant decline in housing prices, the collapse of Bear
Stearns, Lehman Brothers, Washington Mutual and Indymac Bank, a federal takeover
of Fannie Mae and Freddie Mac, and the acquisitions of Countrywide and Merrill
Lynch by Bank of America, just to mention a few headline events. All
of these events have contributed to a national and worldwide liquidity and
credit crisis. During this same time period, the Federal Reserve Bank
cut interest rates by 400 basis points and the U.S. government announced a $700
billion bailout plan for financial institutions.
[37]
The underlying issuers of the Preferred
Term Securities in our portfolio all operate in some realm of the financial
industry, most of them community banks. Due to the factors previously
discussed, the current market for Preferred Term Securities is virtually
non-existent. There were no new pooled trust preferred issuances
during 2008 and trading activity for this class of securities (buy side) shows
total quarterly trades in 2008 at 116, 44, 10 and 4 trades,
respectively. The volume has declined from a high of $376 million in
the first quarter of 2007 to just $1 million in the quarter ended December 31,
2008. This is clearly indicative of an inactive and inefficient
market leading to the depressed pricing on these securities.
All of the above mentioned issues –
sub-prime housing, lack of liquidity and credit in the banking industry, coupled
with the general interest rate environment – have a direct, and in some cases
indirect, affect on the underlying banks and insurance company issuers in the
Preferred Term Securities. A few of the underlying institutions have
deferred payment of the interest (as described above) on their securities and
some have defaulted.
Generally Accepted Accounting
Principles (“GAAP”) require management to consider all available evidence in its
evaluation of the realizable value of its investment. Judgment is
required to determine whether factors exist that indicate an impairment loss has
been incurred at the end of a reporting period. The judgment may be
based on both subjective and objective factors. In its analysis,
management considered the credit ratings along with all other available
information to evaluate the credit quality of the underlying collateral. Several
shocks of the collateral were performed in order to determine how much stress
the security could withstand before a break in principal would be
experienced.
In
addition, the securities subject to Emerging Issues Task Force (EITF) Issue No.
99-20, “Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets” (EITF 99-20), are
monitored for significant adverse changes in cash flow projections. On January
12, 2009, the Financial Accounting Standards Board issued FSP EITF
99-20-1, “Amendments to the Impairment Guidance of EITF 99-20”, effective for
interim and annual reporting periods ending after December 15,
2008. The purpose of this guidance is to better align the impairment
guidance and assessment of an other-than-temporary impairment with the related
guidance in FASB Statement No. 115, “Accounting for Certain Investments in Debt
and Equity Securities.” The primary change in the new guidance is the
removal of the requirement to estimate cash flows from the views of a market
participant but rather to base the estimate of cash flows on current information
and events. Further, in making the other-than temporary assessment,
the holder should consider all relevant information about past events, current
conditions, and reasonable and supportable forecasts when estimating future cash
flows. This information should include remaining payment terms of the
security, prepayment speeds, the financial condition of the issuer(s), expected
defaults, and the value of any underlying collateral.
EITF 99-20-1 requires that the present
value of the current estimated cash flows be compared to the present value of
cash flows at the last reporting date. If the present value of the
original cash flows estimated at the initial transaction date (or at the last
date previously revised) is greater than the present value of the current
estimated cash flows, the change is considered adverse (that is an
other-than-temporary impairment should be considered to have occurred under the
consensus in this Issue). As of December 31, 2008, there was no
adverse change in the estimated cash flows noted for the securities in an
unrealized loss position held subject to EITF 99-20.
On
October 13, 2008, as part of the government’s economic stabilization plan, the
Treasury announced two plans, the CPP and the TLGP. The regulators
highly encouraged participation in the programs in order to build capital
levels, supply additional liquidity to the banking industry, and improve
financial ratios for the large regional and national banks and the community
banks. Many of the banks who issued the Preferred Term Securities
have announced participation in the CPP. Management believes that
these programs should help to bolster confidence in the
industry. However, due to the early stages of both programs, a long
recovery is still anticipated as the liquidity works its way through the banking
system.
Intent and Ability to Retain
Investment
The
risk-based capital ratios require that banks set aside additional capital for
securities that are rated below investment grade. Two of our Preferred Term
Securities have been downgraded and management feels that additional downgrades
may be possible. However, based upon models and testing performed on our
investment portfolio, management feels that the Company has adequate capital to
sustain future downgrades. We maintain sufficient capital and
liquidity to cover operating expenses and we do not anticipate any material
commitments or expected outlays of capital in the near term. The decline in fair market
value of these securities does not have a material impact on the operations,
liquidity or the capital resources of the Company.
[38]
Other-Than-Temporary
Impairment Charge
Based
upon our review of credit quality and the cash flow tests performed, management
determined that two of our Preferred Term Securities were other-than-temporarily
impaired. As a result of this assessment, we recorded a $2.7
million loss on these securities as of December 31, 2008. We have
both the intent and ability to hold the remaining securities in our portfolio
for the period of time necessary to recover their amortized cost or until
maturity and do not believe that those securities are other-than-temporarily
impaired.
During 2007, we restructured our
investment portfolio by replacing certain securities with securities having a
longer duration. We determined that the securities earmarked for sale
would, if retained, have subjected our earnings to higher volatility in a
declining interest rate environment. The restructure resulted in a
pre-tax loss of approximately $1.6 million in earnings. The securities sold had
an average book yield of 4.28%. The proceeds from the sale of these
securities were reinvested in securities having an average book yield of
approximately 5.55%. The restructuring of our investment portfolio
enabled us to rebalance the portfolio and restructure the maturity schedule of
the portfolio to mitigate the effects of premium and call risk and to manage our
future interest rate risk and effective tax yield.
There
continues to be ongoing media attention regarding “sub-prime” mortgage
investments. “Sub-prime” mortgages with similar characteristics can
be packaged together and sold as investments. We believe that we do
not have significant exposure to these types of securities.
We manage our investment portfolio
utilizing policies which seek to achieve desired levels of liquidity, manage
interest rate sensitivity, meet earnings objectives, and provide required
collateral support for deposit activities and treasury management overnight
investment products.
Table 8
sets forth the contractual or estimated maturities of the components of our
securities portfolio as of December 31, 2008 and the weighted average yields on
a tax-equivalent basis.
Investment
Security Maturities, Yields, and Fair Values at December 31, 2008
(Dollars
in thousands)
Table 8
|
Within
1 Year
|
1 Year
to 5
Years
|
5 Years
to 10
Years
|
Over
10
Years
|
Total
Fair
Value
|
||||||||||||||||
|
Securities
Available-for-Sale:
|
||||||||||||||||||||
|
U.S.
government and agencies
|
$ | 1,731 | $ | 46,527 | $ | 18,633 | $ | 46,754 | $ | 113,645 | ||||||||||
|
Mortgage-backed
securities
|
806 | 122,393 | — | — | 123,199 | |||||||||||||||
|
Obligations
of states and political subdivisions
|
2,462 | 6,548 | 12,047 | 72,428 | 93,485 | |||||||||||||||
|
Corporate
and other debt
|
— | — | — | 24,266 | 24,266 | |||||||||||||||
|
Total
|
$ | 4,999 | $ | 175,468 | $ | 30,680 | $ | 143,448 | $ | 354,595 | ||||||||||
|
Percentage
of total
|
1.41 | % | 49.48 | % | 8.65 | % | 40.46 | % | 100.00 | % | ||||||||||
|
Weighted average yield
|
5.85 | % | 5.47 | % | 5.82 | % | 5.78 | % | 5.63 | % | ||||||||||
We held
two securities in the name of one issuer exceeding 10 percent of shareholders’
equity, excluding securities issued by U.S. government
agencies. These securities are Wells Fargo mortgage-backed securities
with an aggregate book value of $23.8 million and fair value of $18.8 million at
December 31, 2008.
[39]
Deposits
Table 9 sets forth the average deposit
balances by major category for 2008, 2007 and 2006:
Average
Deposit Balances
(Dollars
in thousands)
Table 9
|
2008
|
2007
|
2006
|
||||||||||||||||||||||
|
Average
Balance
|
Average
Yield
|
Average
Balance
|
Average
Yield
|
Average
Balance
|
Average
Yield
|
|||||||||||||||||||
|
Non-interest-bearing
demand deposits
|
$ | 106,124 | — | $ | 133,509 | — | $ | 107,595 | — | |||||||||||||||
|
Interest-bearing
demand deposits
|
414,750 | 1.67 | % | 333,443 | 2.92 | % | 285,250 | 2.25 | % | |||||||||||||||
|
Savings
deposits
|
80,812 | 1.28 | % | 42,123 | 3.43 | % | 47,779 | .97 | % | |||||||||||||||
|
Time
deposits less than $100K
|
239,211 | 4.27 | % | 234,439 | 4.45 | % | 229,829 | 3.67 | % | |||||||||||||||
|
Time
deposits $100K or more
|
339,110 | 3.72 | % | 317,219 | 5.09 | % | 273,305 | 4.41 | % | |||||||||||||||
|
Total
|
$ | 1,180,007 | $ | 1,060,733 | $ | 943,758 | ||||||||||||||||||
Total
deposits increased $96.3 million in 2008, or 8.6%, when compared to
2007. This compares to a $121.4 million (12.5%) increase during 2007
over 2006. On an average balance basis, total deposits increased $119
million (11.2%) in 2008 versus 2007, following a $117 million (12.4%) increase
in 2007 versus 2006.
The
increase in deposits resulted primarily from growth in in-house Prime Saver and
retirement accounts as well as brokered certificates of deposit and money market
products. At December 31, 2008 and 2007, brokered certificates of
deposit amounted to $168.6 million and $120.8 million, respectively, or 14% and
11% of total deposits at December 31, 2008 and 2007, respectively.
The
following table sets forth the maturities of time deposits of $100,000 or more
(in thousands):
Maturity
of Time Deposits of $100,000 or More
(Dollars
in thousands)
Table 10
|
December 31, 2008
|
||||
|
Maturities
|
||||
|
3
Months or Less
|
$ | 205,725 | ||
|
3-6
Months
|
39,970 | |||
|
6-12
Months
|
50,573 | |||
|
Over
1 Year
|
38,147 | |||
|
Total
|
$ | 334,415 | ||
The Bank has opted to maintain
relatively short maturities in its time deposits of $100,000 or more to directly
match the re-pricing characteristics of a portion of our investment portfolio
and in anticipation of an extended time period of low interest
rates.
[40]
Borrowed
Funds
The following shows the composition of
our borrowings at December 31 (in thousands):
|
2008
|
2007
|
2006
|
||||||||||
|
Securities
sold under agreements to repurchase
|
$ | 41,995 | $ | 34,112 | $ | 74,879 | ||||||
|
Short-term
FHLB advances
|
8,500 | 21,000 | 24,500 | |||||||||
|
Total
short-term borrowings
|
50,495 | 55,112 | 99,379 | |||||||||
|
Long-term
FHLB advances
|
241,474 | 142,522 | 130,401 | |||||||||
|
Junior
subordinated debentures
|
35,929 | 35,929 | 35,929 | |||||||||
|
Total
long-term borrowings
|
277,403 | 178,451 | 166,330 | |||||||||
|
Total
borrowings
|
$ | 327,898 | $ | 233,563 | $ | 265,709 | ||||||
|
Average
balance (from Table 1)
|
$ | 309,923 | $ | 243,682 | $ | 260,519 | ||||||
Total
borrowings increased by $94.3 million or 40% in 2008 when compared to 2007,
while the average balance of borrowings increased by $66.2 million during the
same period. Total borrowings decreased by $32.1 million or 12% in
2007 when compared to 2006, while the average balance of borrowings decreased by
$16.8 million during the same period. During 2008 and 2007, the
Corporation took advantage of opportunities to borrow long-term FHLB advances
and match these borrowings with specific interest earning assets where
possible.
Management
will continue to closely monitor interest rates within the context of its
overall asset-liability management process. See the “Interest Rate
Sensitivity” section of this Item 7 for further discussion on this
topic.
At
December 31, 2008, we had additional borrowing capacity with the FHLB totaling
$9.0 million, an additional $25 million of unused lines of credit with
various financial institutions and $31 million through wholesale money market
funds. See Note 8 to Consolidated Financial Statements, included in
Item 8 of Part II of this annual report, for further details about our
borrowings and additional borrowing capacity, which is incorporated herein by
reference.
Capital
Resources
The Bank and the Corporation are
subject to risk-based capital regulations, which were adopted and monitored by
federal banking regulators. These guidelines are used to evaluate
capital adequacy and are based on an institution’s asset risk profile and
off-balance sheet exposures, such as unused loan commitments and stand-by
letters of credit. The regulatory guidelines require that a portion
of total capital be Tier 1 capital, consisting of common shareholders’ equity,
qualifying portion of trust issued preferred securities, and perpetual preferred
stock, less goodwill and certain other deductions. The remaining
capital, or Tier 2 capital, consists of elements such as subordinated debt,
mandatory convertible debt, remaining portion of trust issued preferred
securities, and grandfathered senior debt, plus the allowance for loan losses,
subject to certain limitations.
Under the risk-based capital
regulations, banking organizations are required to maintain a minimum 8% (10%
for well capitalized banks) total risk-based capital ratio (total qualifying
capital divided by risk-weighted assets), including a Tier 1 ratio of 4% (6% for
well capitalized banks). The risk-based capital rules have
been further supplemented by a leverage ratio, defined as Tier I capital divided
by average assets, after certain adjustments. The minimum leverage
ratio is 3% (5% for well capitalized banks) for banking organizations that do
not anticipate significant growth and have well-diversified risk (including no
undue interest rate risk exposure), excellent asset quality, high liquidity and
good earnings. Other banking organizations not in this category are
expected to have ratios of at least 4-5%, depending on their particular
condition and growth plans. Higher capital ratios could be required
if warranted by the particular circumstances or risk profile of a given banking
organization. In the current regulatory environment, banking
organizations must stay well capitalized in order to receive favorable
regulatory treatment on acquisition and other expansion activities and favorable
risk-based deposit insurance assessments. The Corporation’s capital
policy establishes guidelines meeting these regulatory requirements, and takes
into consideration current or anticipated risks as well as potential future
growth opportunities.
[41]
At December 31, 2008, the Corporation’s
total risk-based capital ratio was 12.18%, which was well above the regulatory
minimum of 8%. The Corporation’s total risk-based capital ratio for
year-end 2007 was 12.51%. As of December 31, 2008, the most recent
notification from the regulators categorizes the Corporation as “well
capitalized” under the regulatory framework for prompt corrective
action. See Note 2 to Consolidated Financial Statements, included in
Item 8 of Part II of this annual report, for additional information regarding
regulatory capital ratios.
Total shareholders’ equity decreased
$32 million to $72.7 million at December 31, 2008, from $104.7 million at
December 31, 2007 primarily due to $41 million of accumulated other
comprehensive loss resulting from reduced income in 2008. The return
on average equity (ROE) for 2008 decreased to 9.31% from 12.70% for
2007.
Cash dividends of $.80 per share were
paid during 2008, compared with $.78 and $.76 paid in 2007 and 2006,
respectively. This represents a dividend payout ratio (cash dividends
per share divided by net income per share) of 55.17%, 37.50%, and 37.07%
for 2008, 2007, and 2006, respectively.
As discussed above, the Corporation
participated in the CPP by issuing $30 million in Series A Preferred Stock
together with a related Warrant to purchase 326,323 shares of common stock on
January 30, 2009. The proceeds of the sale will count as Tier 1
Capital and the Warrant will qualify as tangible common equity.
Liquidity
The Asset and Liability Management
Committee of the Corporation seeks to assess and manage the risks associated
with fluctuating interest rates while maintaining adequate
liquidity. This is accomplished by formulating and implementing
policies that take into account the sources and uses of funds, maturity and
repricing distributions of assets and liabilities, pricing strategies, and
marketability of assets.
The objective of liquidity management
is to maintain sufficient funds to satisfy the needs of depositors and
borrowers. The principal sources of asset liquidity are cash and due
from banks, interest-bearing deposits in banks, federal funds and investment
securities available-for-sale that are not pledged. At December 31,
2008, such liquid assets totaled $173 million. While much more
difficult to quantify, liability liquidity is enhanced by a stable core deposit
base, access to credit lines at other financial institutions, and the
Corporation’s ability to renew maturing deposits. The Corporation’s
ability to attract deposits and borrow funds depends primarily on continued rate
competitiveness, profitability, capitalization and overall financial
condition.
When appropriate, we take advantage of
external sources of funds, such as advances from the FHLB, lines of credit at
other financial institutions and brokered funds. These external
sources often provide attractive interest rates and flexible maturity dates that
better enable us to match funding dates and pricing characteristics with
contractual maturity dates and pricing parameters of earning
assets. At December 31, 2008, our available borrowing capacity
through the FHLB and other financial institutions was approximately $34
million. In addition, we had approximately $31 million available
funding through brokered money market funds.
We actively manage our liquidity
position under the direction of the Asset and Liability Management Committee of
the Corporation’s Board of Directors. Monthly reviews by management
and quarterly reviews by this Committee under prescribed policies and procedures
are intended to ensure that we will maintain adequate levels of available funds.
Management believes that we have adequate liquidity available to respond to
current and anticipated liquidity demands, which could include future branch
expansion. Management anticipates opening additional branches or
expanding current facilities in its existing market footprint annually or
bi-annually for the next several years.
At the holding company level, the
Corporation uses cash to pay dividends to shareholders and to service its junior
subordinated debt. The main sources of funding for the holding
company include dividends from the Bank and access to the capital
markets. As discussed in Note 13 of the Notes to Consolidated
Financial Statements, included in Item 8 of Part II of this annual report, the
Bank is subject to significant regulation and, among other things, may be
limited in its ability to pay dividends or transfer funds to the holding
company. Accordingly, consolidated cash flows as presented in the
Consolidated Statements of Cash Flows may not represent cash immediately
available to the holding company. During 2008, the Bank declared and
paid dividends of $5.9 million. As of December 31, 2008, the amount
of additional dividends that the Bank could have paid to the Corporation without
regulatory approval was $15.0 million.
[42]
Interest
Rate Sensitivity
Our primary market risk is interest
rate fluctuation. Interest rate risk results primarily from the
traditional banking activities that we engage in, such as gathering deposits and
extending loans. Many factors, including economic and financial
conditions, movements in interest rates and consumer preferences affect the
difference between the interest earned on our assets and the interest paid on
our liabilities. Interest rate sensitivity refers to the degree that
earnings will be impacted by changes in the prevailing level of interest
rates. Interest rate risk arises from mismatches in the repricing or
maturity characteristics between interest-bearing assets and
liabilities. Management seeks to minimize fluctuating net interest
margins, and to enhance consistent growth of net interest income through periods
of changing interest rates. Management uses interest sensitivity gap
analysis and simulation models to measure and manage these risks. The
interest rate sensitivity gap analysis assigns each interest-earning asset and
interest-bearing liability to a time frame reflecting its next repricing or
maturity date. The differences between total interest-sensitive
assets and liabilities at each time interval represent the “interest sensitivity
gap” for that interval. A positive gap generally indicates that
rising interest rates during a given interval will increase net interest income,
as more assets than liabilities will reprice. A negative gap position would
benefit us during a period of declining interest rates. During 2008,
we remained negatively gapped although our focus was shifted to begin moving to
a more neutral position in anticipation of rising interest rates.
In order to manage interest sensitivity
risk, management formulates guidelines regarding asset generation and pricing,
funding sources and pricing, and off-balance sheet commitments. These
guidelines are based on management’s outlook regarding future interest rate
movements, the state of the regional and national economy, and other financial
and business risk factors. Management uses computer simulations to
measure the effect on net interest income of various interest rate
scenarios. Key assumptions used in the computer simulations include
cash flows and maturities of interest rate sensitive assets and liabilities,
changes in asset volumes and pricing, and management’s capital
plans. This modeling reflects interest rate changes and the related
impact on net interest income over specified periods. Management has
not historically used derivative financial instruments to manage its interest
rate sensitivity. At December 31, 2008, the static gap analysis
prepared by management indicated that we remained slightly liability sensitive
over the next year. In computing the effect on net interest income of
changes in interest rates, management has assumed that any changes would
immediately affect earnings. Normally, when an organization is
liability sensitive there is a negative impact to net interest income when
interest rates increase. Based on the simulation analysis performed
at December 31, 2008 and 2007, management estimated the following changes in net
interest income, assuming the indicated rate changes:
|
(Dollars in thousands)
|
||||||||
|
2008
|
2007
|
|||||||
|
+200
basis point increase
|
$ | (1,272 | ) | $ | (3,337 | ) | ||
|
+100
basis point increase
|
$ | (257 | ) | $ | (1,693 | ) | ||
|
-100
basis point decrease
|
$ | 551 | $ | 640 | ||||
This estimate is based on assumptions
that may be affected by unforeseeable changes in the general interest rate
environment and any number of unforeseeable factors. Rates on
different assets and liabilities within a single maturity category adjust to
changes in interest rates to varying degrees and over varying periods of
time. The relationships between lending rates and rates paid on
purchased funds are not constant over time. Management can respond to
current or anticipated market conditions by lengthening or shortening the
Corporation’s sensitivity through loan repricings or changing its funding
mix. The rate of growth in interest-free sources of funds will
influence the level of interest-sensitive funding sources. In
addition, the absolute level of interest rates will affect the volume of earning
assets and funding sources. As a result of these limitations, the
interest-sensitive gap is only one factor to be considered in estimating the net
interest margin.
Impact of Inflation – Our
assets and liabilities are primarily monetary in nature, and as such, future
changes in prices do not affect the obligations to pay or receive fixed and
determinable amounts of money. During inflationary periods, monetary
assets lose value in terms of purchasing power and monetary liabilities have
corresponding purchasing power gains. The concept of purchasing power
is not an adequate indicator of the impact of inflation on financial
institutions because it does not incorporate changes in interest rates, which
are an important determination of the Corporation’s earnings.
[43]
Contractual
Obligations, Commitments and Off-Balance Sheet Arrangements
The following table presents, as of
December 31, 2008, significant fixed and determinable contractual obligations to
third parties by payment date and amounts and expected maturities of significant
commitments. Commitments to extend credit and letters of credit are
legally binding, conditional agreements generally having fixed expiration or
termination dates. These commitments generally require customers to
maintain certain credit standards and are established based on management’s
credit assessment of the customer. The commitments may expire without
being drawn upon. Therefore, the total commitment does not
necessarily represent future funding requirements. Further discussion
of the nature of certain obligations and commitments is included in the Notes to
the Consolidated Financial Statements referenced in the table below, which are
included in Item 8 of Part II of this annual report.
|
Payments Due by Period
|
||||||||||||||||||||||||
|
Contractual Obligations
(in millions)
|
Note
Reference
|
Total
|
Less than
1 Year
|
1-3
Years
|
3-5
Years
|
More
than
5 Years
|
||||||||||||||||||
|
Long
term debt
|
8 | |||||||||||||||||||||||
|
FHLB
Advances
|
$ | 241.5 | $ | 14.0 | $ | 82.0 | $ | 44.25 | $ | 101.25 | ||||||||||||||
|
Junior
subordinated debt
|
35.9 | — | — | — | 35.9 | |||||||||||||||||||
|
Operating
leases
|
5 | 2.8 | .7 | 1.1 | 1.0 | — | ||||||||||||||||||
|
Data
processing and telecommunications services
|
5 | 7.8 | 2.2 | 2.9 | 2.7 | — | ||||||||||||||||||
|
Time
Deposits
|
7 | 576.6 | 449.0 | 120.0 | 7.5 | .1 | ||||||||||||||||||
|
Pension/SERP
|
11 | 10.4 | .6 | 1.3 | 1.6 | 6.9 | ||||||||||||||||||
|
Commitment Expiration by Period
|
||||||||||||||||||||||||
|
Commitments
(in millions)
|
Note
Reference
|
Total
|
Less than
1 Year
|
1-3
Years
|
3-5
Years
|
More
than
5 Years
|
||||||||||||||||||
|
Loan
commitments
|
4 | $ | 142.3 | $ | 10.0 | $ | 16.7 | $ | 16.8 | $ | 98.8 | |||||||||||||
|
Letters
of credit
|
4 | 5.9 | 5.9 | — | — | — | ||||||||||||||||||
At December 31, 2008, our off-balance
sheet arrangements were limited to loan commitments and letters of credit
discussed above.
|
ITEM
7A.
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
|
The information called for by this item
is incorporated herein by reference to Item 7 of Part II of this annual report
under the caption “Interest Rate Sensitivity”.
[44]
|
Item
8.
|
Financial
Statements and Supplementary Data
|
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Shareholders
First
United Corporation
Oakland,
Maryland
We have
audited the accompanying consolidated statements of financial condition of First
United Corporation and subsidiaries ("Corporation") as of December 31, 2008 and
2007, and the related consolidated statements of income, changes in
shareholders’ equity, and cash flows for each of the years in the three-year
period ended December 31, 2008. The Corporation's management is
responsible for these financial statements. Our responsibility is to
express an opinion on these financial statements based on our
audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of First United
Corporation and subsidiaries as of December 31, 2008 and 2007, and the
consolidated results of their operations and their cash flows for each of the
years in the three-year period ended December 31, 2008, in conformity with
accounting principles generally accepted in the United States of
America.
As
discussed in Note 1 to the consolidated financial statements, the Corporation
changed its method of accounting for its defined benefit pension plan in
2006.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), First United Corporation’s internal control
over financial reporting as of December 31, 2008, based on criteria established
in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), and our report dated March 4, 2009 expressed an
unqualified opinion.
/s/ Beard
Miller Company LLP
Beard
Miller Company LLP
Pittsburgh,
Pennsylvania
March
4, 2009
[45]
First United Corporation and
Subsidiaries
Consolidated
Statements of Financial Condition
(In
thousands, except per share amounts)
|
December 31
|
||||||||
|
2008
|
2007
|
|||||||
|
Assets
|
||||||||
|
Cash
and due from banks
|
$ | 18,423 | $ | 24,316 | ||||
|
Interest
bearing deposits in banks
|
882 | 1,486 | ||||||
|
Investment
securities available-for-sale (at fair value)
|
354,595 | 304,908 | ||||||
|
Federal
Home Loan Bank stock, at cost
|
13,933 | 9,863 | ||||||
|
Loans
|
1,134,546 | 1,043,266 | ||||||
|
Allowance
for loan losses
|
(14,347 | ) | (7,304 | ) | ||||
|
Net
loans
|
1,120,199 | 1,035,962 | ||||||
|
Premises
and equipment, net
|
31,124 | 31,407 | ||||||
|
Goodwill
and other intangible assets, net
|
16,322 | 14,560 | ||||||
|
Bank
owned life insurance
|
29,743 | 29,039 | ||||||
|
Deferred
tax on investments
|
22,460 | 1,712 | ||||||
|
Accrued
interest receivable and other assets
|
31,423 | 25,656 | ||||||
|
Total
Assets
|
$ | 1,639,104 | $ | 1,478,909 | ||||
|
Liabilities
and Shareholders’ Equity
|
||||||||
|
Liabilities:
|
||||||||
|
Non-interest
bearing deposits
|
$ | 107,749 | $ | 97,976 | ||||
|
Interest
bearing deposits
|
1,115,140 | 1,028,576 | ||||||
|
Total
deposits
|
1,222,889 | 1,126,552 | ||||||
|
Short-term
borrowings
|
50,495 | 55,112 | ||||||
|
Long-term
borrowings
|
277,403 | 178,451 | ||||||
|
Accrued
interest payable and other liabilities
|
14,529 | 12,895 | ||||||
|
Dividends
payable
|
1,098 | 1,234 | ||||||
|
Total
Liabilities
|
1,566,414 | 1,374,244 | ||||||
|
Shareholders’
Equity:
|
||||||||
|
Preferred
stock-no par value; authorized and unissued 2,000 shares
|
||||||||
|
Capital
stock-par value $.01 per share; authorized 25,000 shares, issued and
outstanding 6,113 in 2008 and 6,138 in 2007
|
61 | 61 | ||||||
|
Surplus
|
20,520 | 21,400 | ||||||
|
Retained
earnings
|
93,092 | 88,859 | ||||||
|
Accumulated
other comprehensive loss
|
(40,983 | ) | (5,655 | ) | ||||
|
Total
Shareholders’ Equity
|
72,690 | 104,665 | ||||||
|
Total
Liabilities and Shareholders’ Equity
|
$ | 1,639,104 | $ | 1,478,909 | ||||
See notes
to consolidated financial statements.
[46]
First
United Corporation and Subsidiaries
Consolidated
Statements of Income
(In
thousands, except share and per share amounts)
|
Year ended December 31
|
||||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Interest
income
|
||||||||||||
|
Interest
and fees on loans
|
$ | 74,398 | $ | 77,132 | $ | 69,019 | ||||||
|
Interest
on investment securities:
|
||||||||||||
|
Taxable
|
16,848 | 12,474 | 7,699 | |||||||||
|
Exempt
from federal income taxes
|
3,400 | 3,152 | 2,860 | |||||||||
| 20,248 | 15,626 | 10,559 | ||||||||||
|
Other
|
570 | 807 | 691 | |||||||||
|
Total
interest income
|
95,216 | 93,565 | 80,269 | |||||||||
|
Interest
expense
|
||||||||||||
|
Interest
on deposits
|
30,782 | 37,759 | 27,349 | |||||||||
|
Interest
on short-term borrowings
|
1,022 | 2,902 | 4,429 | |||||||||
|
Interest
on long-term borrowings
|
11,239 | 8,670 | 7,557 | |||||||||
|
Total
interest expense
|
43,043 | 49,331 | 39,335 | |||||||||
|
Net
interest income
|
52,173 | 44,234 | 40,934 | |||||||||
|
Provision
for loan losses
|
12,925 | 2,312 | 1,165 | |||||||||
|
Net
interest income after provision for loan losses
|
39,248 | 41,922 | 39,769 | |||||||||
|
Other
operating income
|
||||||||||||
|
Service
charges
|
7,474 | 6,949 | 6,267 | |||||||||
|
Trust
department
|
3,912 | 4,076 | 3,671 | |||||||||
|
Insurance
commissions
|
2,143 | 2,529 | 1,573 | |||||||||
|
Net
securities (losses)/gains
|
(1,997 | ) | (1,605 | ) | 4 | |||||||
|
Debit
card income
|
1,215 | 1,111 | 899 | |||||||||
|
Bank
owned life insurance
|
704 | 1,114 | 848 | |||||||||
|
Other
|
318 | 918 | 779 | |||||||||
|
Total
other operating income
|
13,769 | 15,092 | 14,041 | |||||||||
|
Other
operating expense
|
||||||||||||
|
Salaries
and employee benefits
|
21,531 | 20,628 | 19,084 | |||||||||
|
Equipment
|
3,364 | 3,224 | 3,011 | |||||||||
|
Occupancy
|
2,693 | 2,388 | 2,043 | |||||||||
|
Data
processing
|
1,721 | 1,672 | 1,452 | |||||||||
|
Other
|
11,264 | 10,563 | 9,900 | |||||||||
|
Total
other operating expenses
|
40,573 | 38,475 | 35,490 | |||||||||
|
Income
before income taxes
|
12,444 | 18,539 | 18,320 | |||||||||
|
Applicable
income taxes
|
3,573 | 5,746 | 5,743 | |||||||||
|
Net
Income
|
$ | 8,871 | $ | 12,793 | $ | 12,577 | ||||||
|
Earnings
per share
|
$ | 1.45 | $ | 2.08 | $ | 2.05 | ||||||
|
Weighted
average common shares outstanding
|
6,112,808 | 6,149,125 | 6,129,612 | |||||||||
See notes to consolidated financial
statements.
[47]
First
United Corporation and Subsidiaries
Consolidated
Statements of Changes in Shareholders’ Equity
(In
thousands, except per share amounts)
|
Capital
Stock
|
Surplus
|
Retained
Earnings
|
Accumulated
Other
Comprehensive
Loss
|
Total
Shareholders’
Equity
|
||||||||||||||||
|
Balance
at January 1, 2006
|
$ | 61 | $ | 20,946 | $ | 73,012 | $ | (1,980 | ) | $ | 92,039 | |||||||||
|
Comprehensive
income:
|
||||||||||||||||||||
|
Net
income for the year
|
12,577 | 12,577 | ||||||||||||||||||
|
Unrealized
gain on securities available-for sale, net of income taxes of
$682
|
1,265 | 1,265 | ||||||||||||||||||
|
Adjustment
to initially adopt SFAS No. 158 net of income taxes of
$2,619
|
(4,865 | ) | (4,865 | ) | ||||||||||||||||
|
Comprehensive
Income
|
8,977 | |||||||||||||||||||
|
Issuance
of 23,241 shares of common stock under dividend reinvestment
plan
|
502 | 502 | ||||||||||||||||||
|
Cash
dividends-$.76 per share
|
(4,662 | ) | (4,662 | ) | ||||||||||||||||
|
Balance
at December 31, 2006
|
61 | 21,448 | 80,927 | (5,580 | ) | 96,856 | ||||||||||||||
|
Comprehensive
income:
|
||||||||||||||||||||
|
Net
income for the year
|
12,793 | 12,793 | ||||||||||||||||||
|
Unrealized
loss on securities available-for sale, net of income taxes of
$1,228
|
(1,815 | ) | (1,815 | ) | ||||||||||||||||
|
Change
in accumulated unrealized losses for pension and SERP obligations, net of
income taxes of $1,178
|
1,740 | 1,740 | ||||||||||||||||||
|
Comprehensive
income
|
12,718 | |||||||||||||||||||
|
Issuance
of 22,824 shares of common stock under dividend reinvestment
plan
|
476 | 476 | ||||||||||||||||||
|
Repurchase
of common stock
|
(524 | ) | (524 | ) | ||||||||||||||||
|
Cash
dividends-$.78 per share
|
(4,861 | ) | (4,861 | ) | ||||||||||||||||
|
Balance
at December 31, 2007
|
$ | 61 | $ | 21,400 | $ | 88,859 | $ | (5,655 | ) | $ | 104,665 | |||||||||
|
Comprehensive
loss:
|
||||||||||||||||||||
|
Net
income for the year
|
8,871 | 8,871 | ||||||||||||||||||
|
Unrealized
loss on securities available-for sale, net of income taxes of
$20,748
|
(30,660 | ) | (30,660 | ) | ||||||||||||||||
|
Change
in accumulated unrealized losses for pension and SERP obligations, net of
income taxes of $2,784
|
(4,668 | ) | (4,668 | ) | ||||||||||||||||
|
Comprehensive
loss
|
(26,457 | ) | ||||||||||||||||||
|
Issuance
of 25,814 shares of common stock under dividend reinvestment
plan
|
362 | 362 | ||||||||||||||||||
|
Repurchase
of common stock
|
(1,391 | ) | (1,391 | ) | ||||||||||||||||
|
Stock
based compensation
|
149 | 149 | ||||||||||||||||||
|
Cash
dividends-$.80 per share
|
(4,638 | ) | (4,638 | ) | ||||||||||||||||
|
Balance
at December 31, 2008
|
$ | 61 | $ | 20,520 | $ | 93,092 | $ | (40,983 | ) | $ | 72,690 | |||||||||
See notes to consolidated financial
statements.
[48]
First
United Corporation and Subsidiaries
Consolidated
Statements of Cash Flows
(In thousands)
|
Year ended December 31
|
||||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Operating
activities
|
||||||||||||
|
Net
Income
|
$ | 8,871 | $ | 12,793 | $ | 12,577 | ||||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||||||
|
Provision
for loan losses
|
12,925 | 2,312 | 1,165 | |||||||||
|
Depreciation
|
2,834 | 2,581 | 2,486 | |||||||||
|
Stock
Compensation
|
149 | — | — | |||||||||
|
Amortization
of intangible assets
|
684 | 656 | 504 | |||||||||
|
Net
accretion and amortization of investment security discounts and
premiums
|
(514 | ) | 145 | 175 | ||||||||
|
Loss
(gain) on sale of investment securities
|
1,997 | 1,605 | (4 | ) | ||||||||
|
Deferred
Income Taxes
|
(3,147 | ) | 557 | (530 | ) | |||||||
|
(Increase)
decrease in accrued interest receivable and other assets
|
(7,287 | ) | (3,744 | ) | (1,987 | ) | ||||||
|
Increase
(decrease) in accrued interest payable and other
liabilities
|
1,634 | (1,307 | ) | (443 | ) | |||||||
|
Earnings
on bank owned life insurance
|
(704 | ) | (1,114 | ) | (848 | ) | ||||||
|
Net
cash provided by operating activities
|
17,442 | 14,484 | 13,095 | |||||||||
|
Investing
activities
|
||||||||||||
|
Net
decrease in interest bearing deposits in banks
|
604 | 977 | 2,538 | |||||||||
|
Proceeds
from maturities of investment securities
available-for-sale
|
78,223 | 45,190 | 56,196 | |||||||||
|
Proceeds
from maturities of investment securities held-to-maturity
|
9,000 | — | — | |||||||||
|
Proceeds
from sales of investment securities available-for-sale
|
43,008 | — | 548 | |||||||||
|
Purchases
of investment securities available-for-sale
|
(224,110 | ) | (163,246 | ) | (88,004 | ) | ||||||
|
Purchases
of investment securities held-to-maturity
|
(8,700 | ) | — | — | ||||||||
|
Proceeds
from sales of investment securities held for trading
|
— | 71,611 | — | |||||||||
|
Net
increase in loans
|
(97,162 | ) | (56,193 | ) | (2,726 | ) | ||||||
|
Purchase
of mortgage loans
|
— | (24,955 | ) | — | ||||||||
|
Net
increase in FHLB stock
|
(4,070 | ) | (243 | ) | (1,570 | ) | ||||||
|
Acquisition
of insurance business
|
(2,446 | ) | (680 | ) | — | |||||||
|
Purchase
of premises and equipment
|
(2,551 | ) | (4,135 | ) | (5,287 | ) | ||||||
|
Purchase
of bank owned life insurance
|
— | — | (2,839 | ) | ||||||||
|
Net
cash used in investing activities
|
(208,204 | ) | (131,674 | ) | (41,144 | ) | ||||||
|
Financing
activities
|
||||||||||||
|
Net
increase in deposits
|
96,337 | 155,171 | 15,527 | |||||||||
|
Net
decrease in short-term borrowings
|
(4,617 | ) | (44,267 | ) | (22,560 | ) | ||||||
|
Proceeds
from long-term borrowings
|
115,000 | 73,500 | 55,000 | |||||||||
|
Payments
on long-term borrowings
|
(16,048 | ) | (61,379 | ) | (17,043 | ) | ||||||
|
Cash
dividends paid
|
(4,774 | ) | (4,796 | ) | (4,662 | ) | ||||||
|
Proceeds
from issuance of common stock
|
362 | 476 | 502 | |||||||||
|
Stock
repurchase
|
(1,391 | ) | (524 | ) | — | |||||||
|
Net
cash provided by financing activities
|
184,869 | 118,181 | 26,764 | |||||||||
|
(Decrease)
increase in cash and cash equivalents
|
(5,893 | ) | 991 | (1,285 | ) | |||||||
|
|
||||||||||||
|
Cash
and cash equivalents at beginning of year
|
24,316 | 23,325 | 24,610 | |||||||||
|
|
||||||||||||
|
Cash
and cash equivalents at end of year
|
$ | 18,423 | $ | 24,316 | $ | 23,325 | ||||||
|
Supplemental
information
|
||||||||||||
|
Interest
paid
|
$ | 44,399 | $ | 48,790 | $ | 38,363 | ||||||
|
Income
taxes paid
|
7,280 | 5,620 | 7,860 | |||||||||
See
notes to consolidated financial statements
[49]
First
United Corporation and Subsidiaries
Notes
to Consolidated Financial Statements
|
1.
|
Summary
of Significant Accounting Policies
|
Business
First
United Corporation (“Corporation”) is a registered financial holding company
that was incorporated under the laws of the state of Maryland. It is
the parent company of First United Bank & Trust (“Bank”), First United
Insurance Group, LLC (“Insurance Group”), a full-service insurance agency,
OakFirst Loan Center, Inc. and OakFirst Loan Center, LLC, both consumer finance
companies. OakFirst Loan Center, Inc. owns all of the outstanding
stock of First United Insurance Agency, Inc. The Bank provides a
complete range of retail and commercial banking services to a customer base
serviced by a network of 26 offices and 32 automated teller
machines. This customer base includes individuals, businesses and
various governmental units. The Insurance Group is a full-service
insurance agency. The Corporation and its subsidiaries operate
principally in four Western Maryland counties and four West Virginia
counties.
Basis
of Presentation
The
accompanying consolidated financial statements have been prepared in accordance
with United States generally accepted accounting principles that require
management to make estimates and assumptions that affect the reported amounts of
certain assets and liabilities at the date of the financial statements as well
as the reported amount of revenues and expenses during the reporting
period. Actual results could differ from these
estimates. Material estimates that are particularly susceptible to
significant change in the near term relate to the determination of the allowance
for loan losses, the assessment of other than temporary impairment
pertaining to investment securities, potential impairment of goodwill, and the
valuation of deferred tax assets. For purposes of comparability, certain prior
period amounts have been reclassified to conform with the 2008
presentation. Such reclassifications had no impact on net
income.
The
Corporation determines whether it should consolidate other entities or account
for them on the equity method of accounting depending on whether it has a
controlling financial interest in an entity of less than 100% of the voting
interest of that entity by considering the provisions of Accounting Research
Bulletin 51 (ARB 51), “Consolidated Financial Statements”, or a controlling
financial interest in a variable interest entity (“VIE”) by considering the
provisions of FASB Interpretation No. 46R (“FIN 46R”), “Consolidation of
Variable Interest Entities.” Under FIN 46, a VIE is a corporation,
partnership, trust or any other legal structure used for business purposes that
either (a) does not have equity investors with voting rights or (b) has equity
investors that do not provide sufficient financial resources for the entity to
support its activities. Under FIN 46R, an entity that holds a
variable interest in a VIE is required to consolidate the VIE if the entity is
subject to a majority of the risk of loss from the VIE’s activities, is entitled
to receive a majority of the entity’s residual returns or both. ARB
51 is considered for entities in which the total equity investment at risk is
sufficient to enable the entity to finance itself independently and provides the
equity holders with the obligation to absorb losses, the right to receive
residual returns and the right to make financial and operating
decisions.
As
discussed further in Note 8, the Corporation formed statutory trusts for the
purpose of issuing securities which qualify as regulatory
capital. These trusts are considered VIEs, but are not consolidated,
based on the criteria established in FIN 46. The Corporation’s investment in
non-consolidated VIEs is accounted for using the equity method of
accounting.
Principles
of Consolidation
The
consolidated financial statements of the Corporation include the accounts of the
Bank, the Insurance Group, OakFirst Loan Center, Inc. and its subsidiary, and
OakFirst Loan Center, LLC. All significant inter-company accounts and
transactions have been eliminated.
Significant
Concentrations of Credit Risk
Most of the Corporation’s relationships
are with customers located in Western Maryland and Northeastern West
Virginia. Note 3 discusses the types of securities in which the
Corporation invests and Note 4 discusses the Corporation’s lending
activities. The Corporation does not have any significant
concentrations in any one industry or customer.
Investments
Securities
available-for-sale: All securities as of December 31, 2008 were
classified as available-for-sale, and as such are stated at their fair value,
with the unrealized gains and losses, net of tax, reported as a separate
component of accumulated other comprehensive income (loss) in shareholders’
equity. The fair values of publicly traded investments are determined
using quoted market prices. The fair values of investments are based
upon information that is currently available and may not necessarily represent
amounts that will ultimately be realized, which depends on future events and
circumstances.
[50]
The
amortized cost of debt securities classified as available-for-sale is adjusted
for the amortization of premiums to the first call date, if applicable, or to
maturity, and for the accretion of discounts to maturity, or in the case of
mortgage-backed securities, over the estimated life of the
security. Such amortization and accretion is included in interest
income from investments. Interest and dividends are included in
interest income from investments. Gains and losses on the sale of
securities are recorded using the specific identification
method. Management systematically evaluates the securities for
impairment on a quarterly basis. Declines in the fair value of
available for sale securities below their cost that are considered other than
temporary declines are recognized in earnings as realized losses in the period
in which the impairment determination is made. In estimating
other-than-temporary impairment losses, management considers (1) the length of
time and the extent to which the fair value has been less than cost, (2) the
financial condition and near-term prospects of the issuer, and (3) the intent
and ability of the Corporation to retain its investment in the issuer for a
period of time sufficient to allow for any anticipated recovery in fair
value. This process is described more fully in the Investment
Securities section of the Consolidated Balance Sheet Review.
Securities held for trading:
Securities that are held principally for resale in the near future are reported
at their fair values as investment securities – trading, with changes in fair
value reported in earnings. Interest and dividends on trading
securities are included in investment income.
Fair
Value
During 2008, the Corporation adopted
the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 157,
“Fair Value Measurements.” SFAS No. 157 defines the term of “fair
value” and provides improved guidance for how to measure it. The
Corporation has utilized the fair value criteria in determining the value of its
investment securities and certain other assets. Note 15 to the
consolidated financial statements includes the Corporation’s fair value
disclosures.
Restricted
Investment in Bank Stock
Restricted
stock, which represents required investments in the common stock of a
correspondent bank, is carried at cost and, as of December 31, 2008 and 2007,
consists of the common stock of the Federal Home Loan Bank (“FHLB”) of Atlanta
and Atlantic Central Bankers Bank.
Management evaluates the
restricted stock for impairment in accordance with Statement of Position
(SOP) 01-6, “Accounting by Certain Entities (Including Entities With Trade
Receivables) That Lend to or Finance the Activities of
Others.” Management’s determination of whether these investments are
impaired is based on their assessment of the ultimate
recoverability of their cost rather than by recognizing temporary declines in
value. The determination of whether a decline affects the
ultimate recoverability of their cost is influenced by criteria such as (1) the
significance of the decline in net assets of the Bank as compared to the capital
stock amount for the Bank and the length of time this situation has persisted,
(2) commitments by the Bank to make payments required by law or regulation and
the level of such payments in relation to the operating performance of the Bank,
and (3) the impact of legislative and regulatory changes on institutions and,
accordingly, on the customer base of the Bank.
On January 30, 2009, the FHLB of
Atlanta announced that it was deferring the declaration of a dividend on its
stock for the quarter ended December 31, 2008 until it completes its year-end
analysis of other-than-temporary impairment which is critical to its net income
determination. The FHLB of Atlanta stated that it anticipates a
decision regarding the dividend to be made in March 2009.
Management
believes that no impairment charge in respect of the restricted stock is
necessary as of December 31, 2008.
Loans
Loans and
leases that management has the intent and ability to hold for the foreseeable
future or until maturity or full repayment by the borrower are reported at their
outstanding unpaid principal balance, adjusted for any deferred fees or costs
pertaining to origination.
Interest
and Fees on Loans
Interest
on loans and leases (other than those on non-accrual status) is recognized based
upon the principal amount outstanding. Loan fees in excess of
the costs incurred to originate the loan are recognized as income over the life
of the loan utilizing either the interest method or the straight-line method,
depending on the type of loan. Generally, fees on loans with a
specified maturity date, such as residential mortgages, are recognized using the
interest method. Loan fees for lines of credit are recognized on the
straight-line method.
[51]
A loan is
considered to be past due when a payment has not been received for 30 days after
its contractual due date. It is the Corporation’s general policy to
discontinue the accrual of interest on loans (including impaired loans), except
for consumer loans, when circumstances indicate that collection of principal or
interest is doubtful. After a loan is placed on non-accrual status, interest is
not recognized and cash payments received are applied to the principal balances.
A non-accruing loan is restored to accrual status when principal and interest
payments have been brought current, it becomes well secured or is in the process
of collection and the prospects of future contractual payments are no longer in
doubt.
Generally,
consumer installment loans are not placed on non-accrual status, but are charged
off after they are 120 days contractually past due. Loans other than
consumer loans are charged-off based on an evaluation of the facts and
circumstances of each individual loan.
Allowance
for Loan Losses
The
allowance for loan losses is maintained at a level believed by management to be
sufficient to absorb estimated losses inherent in the loan portfolio. Loans
deemed uncollectible are charged off against the allowance, while recoveries of
amounts previously charged off are credited to it. Management’s determination of
the adequacy of the loan loss reserve is based upon several factors including
the impact of economic conditions on borrowers’ ability to repay their loans,
past collection experience, the risk characteristics of the loan portfolio,
estimated fair value of underlying collateral for collateral dependent loans,
and such other factors which in management’s judgment, deserve current
recognition.
The
Corporation utilizes the methodology outlined in the FDIC Statement of Policy on
Allowance for Loan and Lease Losses. The starting point for this methodology is
to segregate the loan portfolio into two pools, non-homogeneous (i.e.
commercial) and homogeneous (i.e. mortgage, consumer) loans. Each loan pool is
analyzed with general allowances and specific allocations being made as
appropriate. For general allowances, the previous eight quarters of loss
activity are used in the estimation of losses in the current portfolio. These
historical loss amounts are modified by the following qualitative factors:
levels of and trends in delinquency and non-accruals; trends in volumes and
terms of loans; effects of changes in lending policies, experience, ability, and
depth of management, national and local economic trends and conditions; and
concentrations of credit in the determination of the general allowance. The
qualitative factors are updated each quarter by the gathering of information
from internal, regulatory, and governmental sources. Specific allocations are
made for impaired loans in which the collateral value is less than the
outstanding loan balance with the allocation being the dollar difference between
the two. The Corporation maintains a watchlist which represents loans,
identified and closely monitored by management, which possess certain qualities
or characteristics that may lead to collection and loss issues. Allocations are
not made for loans that are cash secured, for the Small Business Administration
or Farm Service Agency guaranteed portion of loans, or for loans that are
sufficiently collateralized.
A loan is
considered impaired when, based on current information and events, it is
probable that the Corporation will be unable to collect the scheduled payments
of principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due. Loans that
experience insignificant payment delays and payment shortfalls generally are not
classified as impaired. Management determines the significance of
payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower’s
prior payment record, and the amount of the shortfall in relation to the
principal and interest owed. Impairment is measured on a loan by loan
basis for commercial and construction loans. Large groups of smaller
balance homogeneous loans are collectively evaluated for
impairment. Accordingly, the Corporation does not separately identify
individual consumer and residential loans for impairment disclosures, unless
such loans are the subject of a restructuring agreement.
The
Corporation maintains an allowance for losses on unfunded commercial lending
commitments and letters of credit to provide for the risk of loss inherent in
these arrangements. The allowance is determined utilizing a
methodology that is similar to that used to determine the allowance for loan
losses, modified to take into account the probability of a draw down on the
commitment. This allowance is reported as a liability on the balance
sheet within accrued interest payable and other liabilities. The
balance in the liability account was $.1 million at December 31,
2008.
Premises
and Equipment
Land is
carried at cost. Premises and equipment are carried at cost, less
accumulated depreciation. The provision for depreciation for financial reporting
has been made by using the straight-line method based on the estimated useful
lives of the assets, which range from 18 to 32 years for buildings and three to
20 years for furniture and equipment. Accelerated depreciation methods are used
for income tax purposes.
[52]
Goodwill
and Other Intangible Assets
Goodwill
represents the excess of the cost of an acquisition over the fair value of the
net assets acquired in business combinations. In accordance with SFAS
No. 147 and 142 which include guidance specific to bank branch purchases that
qualify as business combinations, goodwill is not amortized but is subject to an
annual impairment test.
Other
intangible assets with finite lives are core deposit intangible assets, which
represent the present value of future net income to be earned from acquired
deposits. Core deposit intangibles are being amortized using the
straight-line method over their estimated life of 7.2
years. Insurance agency book of business intangibles are being
amortized using the straight-line method over their estimated
lives.
Bank-Owned
Life Insurance (BOLI)
BOLI
policies are recorded at their cash surrender values. Changes in the cash
surrender values are recorded as other operating income.
Foreclosed
Assets
Assets acquired through, or in lieu of,
loan foreclosure are held for sale and are initially recorded at fair value less
cost to sell at the date of foreclosure, establishing a new cost
basis. Subsequent to foreclosure, valuations are periodically
performed by management and the assets are carried at the lower of carrying
amount or fair value less cost to sell. Revenue and expenses from
operations and changes in the valuation allowance are included in net expenses
from foreclosed assets. Foreclosed assets are included in accrued
interest receivable and other assets and were $2,424,000 and $825,000,
respectively, at December 31, 2008 and 2007.
Income
Taxes
The
Corporation and its subsidiaries file a consolidated federal income tax
return. The Corporation accounts for income taxes using the liability
method. Under the liability method, the deferred tax liability or asset is
determined based on the difference between the financial statement and tax bases
of assets and liabilities (temporary differences) and is measured at the enacted
tax rates that will be in effect when these differences reverse. Deferred tax
expense is determined by the change in the net liability or asset for deferred
taxes adjusted for changes in any deferred tax asset valuation
allowance.
The
Corporation has adopted the provisions of Financial Accounting Standards (FASB)
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” and FASB
Staff Position (“FSP”) FIN 48-1 “Definition of Settlement in FASB Interpretation
No. 48” (FSP FIN 48-1). The Interpretation provides clarification on
accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with FASB Statement of Financial Accounting
Standards (SFAS) No. 109, “Accounting for Income Taxes.” FIN 48
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return, and also provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. The Corporation has not identified any
income tax uncertainties.
The
Corporation files federal and state corporate income tax returns
annually. These returns may be selected for examination by the
Internal Revenue Service and the states where we file, subject to a statute of
limitations. At any given point in time, the Corporation may have
several years of filed tax returns that may be selected for examination or
review by taxing authorities.
Defined
Benefit Plans
In September 2006, the Financial
Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 158, “Employers Accounting for Defined Benefit Pension and
other Post Retirement Plans.” Effective December 31, 2006, the
Corporation adopted the provisions of this Statement which resulted in the
recognition of the funded status of its defined benefits pension plan as an
asset, and its supplemental executive retirement plan as a liability on the
Consolidated Statements of Financial Condition, and the recognition of
unrecognized net actuarial losses, prior service costs and a net transition
asset totaling $4.7 million as a separate component of accumulated other
comprehensive loss, net of tax. Refer to Note 11 for a further
discussion of the Corporation’s pension plan and supplemental executive
retirement plan obligations.
[53]
Statement
of Cash Flows
Cash and
cash equivalents are defined as cash and due from banks in the consolidated
statement of cash flows.
Earnings
Per Share
Earnings
per share is computed by dividing net income by the weighted average number of
common shares outstanding. The Corporation does not have any common stock
equivalents.
Trust
Assets and Income
Assets
held in an agency or fiduciary capacity are not assets of the Corporation and,
accordingly, are not included in the accompanying consolidated statements of
financial condition. Income from the Bank’s trust department represents fees
charged to customers and is recorded on an accrual basis.
Business
Segments
As
defined by SFAS No. 131, “Disclosure about Segments of an Enterprise and Related
Information,” the Corporation has two operating segments, community banking and
insurance. Because the operating activities of the insurance segment are
immaterial to the consolidated financial statements, no separate segment
disclosures for insurance operations have been made.
Equity
Compensation Plan
At the 2007 Annual Meeting of
Shareholders, the Corporation’s shareholders approved the First United
Corporation Omnibus Equity Compensation Plan (the “Omnibus Plan”), which
authorizes the grant of stock options, stock appreciation rights, stock awards,
stock units, performance units, dividend equivalents, and other stock-based
awards to employees or directors totaling up to 185,000 shares.
On June 18, 2008, the Board of
Directors of the Corporation adopted a Long-Term Incentive Program (the
“LTIP”). This program was adopted as a sub-plan of the Corporation’s
Omnibus Equity Compensation Plan to reward participants for increasing
shareholder value, align executive interests with those of shareholders, and
serve as a retention tool for key executives. Under the LTIP,
participants are granted shares of restricted common stock of the
Corporation. The amount awarded is based on a specified percentage of
the participant’s salary as of the date of grant. These shares will
vest if the Corporation meets or exceeds certain performance
thresholds. These performance-related shares are expensed ratably
from the date that the likelihood of meeting the performance measures is
probable through the end of a three year vesting period.
"In conjunction with the adoption of
the LTIP, the Corporation adopted Statement of Financial Accounting Standards
No. 123(R), “Accounting for Share-Based Payments”. SFAS No. 123(R)
required public companies to measure the cost of employee services received in
exchange for an award of equity instruments based on the grant date fair value
of the award, which, for the Corporation, is the market price of the stock on
the date of grant. The cost will be recognized in expense ratably
over the period in which an employee is required to provide service in exchange
for the award (the vesting period)."
As of
December 31, 2008, a total of 18,519 shares had been granted to executive
management under the LTIP at a fair market price of $19.02. These
shares will be earned at the end of a three-year vesting period if the
Corporation meets or exceeds certain performance measures.
Stock-based
awards were also made to directors totaling 3,738 shares at a fair market price
of $18.69 as defined in their annual compensation package. The directors’ shares
were vested immediately.
Share-based
compensation expense for the year ended December 31, 2008 was $.1
million. Unamortized share-based compensation expense as of December
31, 2008 is $.3 million. The 18,519 unvested shares did not
affect the diluted earnings per share.
Stock
Repurchases
Under the Maryland General Corporation
Law, shares of capital stock that are repurchased are cancelled and treated as
authorized but unissued shares. When a share of capital stock is
repurchased, the payment of the repurchase price reduces stated capital by the
par value of that share (currently, $0.01 for common stock and $0.00 for
preferred stock), and any excess over par value reduces capital
surplus.
[54]
Variable
Interest Entities
In March
2004, the Corporation issued approximately $30.9 million of junior subordinated
debentures to First United Statutory Trust I (“FUST I”) and First United
Statutory Trust II (collectively with FUST I, the “Trusts”). The
Trusts are Connecticut statutory business trusts, with all outstanding common
stock owned by the Corporation, that issued mandatorily redeemable preferred
capital securities to third party investors. The Trusts are
considered special-purpose entities (SPEs). In accordance with FIN
46R, the Corporation reported the $30.9 million of junior subordinated
debentures as long-term borrowings and its $0.9 million equity interest in the
Trusts as “Other Assets” at December 31, 2008 and 2007.
These
debentures and preferred securities are discussed in detail in Note
8.
Recent
Accounting Pronouncements
In
December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about
Postretirement Benefit Plan Assets”. This FSP amends SFAS 132(R),
“Employers’ Disclosures about Pensions and Other Postretirement Benefits”, to
provide guidance on an employer’s disclosures about plan assets of a defined
benefit pension or other postretirement plan. The disclosures about
plan assets required by this FSP shall be provided for fiscal years ending after
December 15, 2009. The Corporation is currently reviewing the effect
this new pronouncement will have on its consolidated financial
statements.
In
November 2008, the SEC released a proposed roadmap regarding the potential use
by U.S. issuers of financial statements prepared in accordance with
International Financial Reporting Standards (IFRS). IFRS is a
comprehensive series of accounting standards published by the International
Accounting Standards Board (“IASB”). Under the proposed roadmap, the
Company may be required to prepare financial statements in accordance with IFRS
as early as 2014. The SEC will make a determination in 2011 regarding
the mandatory adoption of IFRS. The Corporation is currently
assessing the impact that this potential change would have on its consolidated
financial statements, and it will continue to monitor the development of the
potential implementation of IFRS.
In May
2008, FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting
Principles.” This standard identifies the sources of accounting
principles and the framework for selecting the principles used in the
preparation of financial statements. This statement is effective 60
days following the SEC’s approval of the Public Company Accounting Oversight
Board (PCAOB) amendments to AU Section 411, “The Meaning of Present Fairly in
Conformity with Generally Accepted Accounting Principles.” The
Corporation is currently evaluating the potential impact the new pronouncement
will have on its consolidated financial statements.
In April
2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, “Determination of the
Useful Life of Intangible Assets.” This FSP amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under FASB Statement
No. 142, “Goodwill and Other Intangible Assets” (SFAS 142). The
intent of this FSP is to improve the consistency between the useful life of a
recognized intangible asset under SFAS 142 and the period of expected cash
flows used to measure the fair value of the asset under SFAS 141R, and other
GAAP. This FSP is effective for financial statements issued for
fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. Early adoption is prohibited. The Corporation is
currently evaluating the potential impact the new pronouncement will have on its
consolidated financial statements.
|
2.
|
Regulatory
Capital Requirements
|
The
Corporation and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Corporation and the Bank must meet specific capital guidelines that involve
quantitative measures of its assets, liabilities, and certain off-balance sheet
items as calculated under regulatory accounting practices. The
capital amounts and classification are also subject to qualitative judgments by
the regulators about components, risk weightings, and other
factors.
Quantitative
measures established by regulation to ensure capital adequacy require the
Corporation and the Bank to maintain certain minimum amounts of capital and
ratios of total and Tier I capital to risk-weighted assets, and of Tier I
capital to average assets (leverage). Management believes, as of
December 31, 2008, that the Corporation and the Bank meet all capital adequacy
requirements to which they are subject.
As of
December 31, 2008, the most recent notification from regulatory agencies
categorized the Bank as “well capitalized” under the regulatory framework for
prompt corrective action. For a financial institution to be
categorized as well capitalized, total risk-based, Tier I risk-based, and Tier I
leverage ratios must not fall below the percentages shown in the following
table. Management is not aware of any condition or event which has
caused the well capitalized position to change.
[55]
|
Actual
|
For Capital
Adequacy Purposes
|
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
|
||||||||||||||||||||||
|
(Dollars in thousands)
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||||||||||
|
December
31, 2008
|
||||||||||||||||||||||||
|
Total
Capital (to Risk Weighted Assets)
|
||||||||||||||||||||||||
|
Consolidated
|
$ | 148,464 | 12.18 | % | $ | 97,541 | 8.00 | % | N/A | N/A | ||||||||||||||
|
First
United Bank
|
131,572 | 10.91 | % | 96,521 | 8.00 | % | 120,652 | 10.00 | % | |||||||||||||||
|
Tier
1 Capital (to Risk Weighted Assets)
|
||||||||||||||||||||||||
|
Consolidated
|
129,117 | 10.59 | % | 48,771 | 4.00 | % | N/A | N/A | ||||||||||||||||
|
First
United Bank
|
117,398 | 9.73 | % | 48,260 | 4.00 | % | 72,391 | 6.00 | % | |||||||||||||||
|
Tier
1 Capital (to Average Assets)
|
||||||||||||||||||||||||
|
Consolidated
|
129,117 | 8.10 | % | 63,751 | 4.00 | % | N/A | N/A | ||||||||||||||||
|
First
United Bank
|
117,398 | 7.43 | % | 63,205 | 4.00 | % | 79,007 | 5.00 | % | |||||||||||||||
|
Actual
|
For Capital
Adequacy Purposes
|
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
|
||||||||||||||||||||||
|
(Dollars in thousands)
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
||||||||||||||||||
|
December
31, 2007
|
||||||||||||||||||||||||
|
Total
Capital (to Risk Weighted Assets)
|
||||||||||||||||||||||||
|
Consolidated
|
$ | 138,993 | 12.51 | % | $ | 88,900 | 8.00 | % | N/A | N/A | ||||||||||||||
|
First
United Bank
|
120,974 | 11.01 | % | 87,877 | 8.00 | % | 109,900 | 10.00 | % | |||||||||||||||
|
Tier
1 Capital (to Risk Weighted Assets)
|
||||||||||||||||||||||||
|
Consolidated
|
126,689 | 11.40 | % | 44,450 | 4.00 | % | N/A | N/A | ||||||||||||||||
|
First
United Bank
|
113,851 | 10.36 | % | 43,938 | 4.00 | % | 65,940 | 6.00 | % | |||||||||||||||
|
Tier
1 Capital (to Average Assets)
|
||||||||||||||||||||||||
|
Consolidated
|
126,689 | 8.91 | % | 56,846 | 4.00 | % | N/A | N/A | ||||||||||||||||
|
First
United Bank
|
113,851 | 8.08 | % | 56,341 | 4.00 | % | 70,427 | 5.00 | % | |||||||||||||||
See Note
17 – Subsequent Event for information on the Corporation’s participation in the
U.S. Treasury’s TARP Capital Purchase Program.
[56]
|
3.
|
Investment
Securities
|
The following table shows a comparison
of amortized cost and fair values of investment securities available-for-sale
(in thousands):
|
Amortized
Cost
|
Gross
Unrealized
Gains
|
Gross
Unrealized
Losses
|
Fair
Value
|
|||||||||||||
|
December
31, 2008
|
||||||||||||||||
|
U.S.
government and agencies
|
$ | 111,938 | $ | 1,885 | $ | 178 | $ | 113,645 | ||||||||
|
Mortgage-backed
securities
|
132,107 | 2,222 | 11,130 | 123,199 | ||||||||||||
|
Obligations
of states and political subdivisions
|
95,876 | 705 | 3,096 | 93,485 | ||||||||||||
|
Corporate
and other debt securities
|
70,324 | — | 46,058 | 24,266 | ||||||||||||
|
Totals
|
$ | 410,245 | $ | 4,812 | $ | 60,462 | $ | 354,595 | ||||||||
|
December
31, 2007
|
||||||||||||||||
|
U.S.
government and agencies
|
$ | 89,211 | $ | 1,557 | $ | — | $ | 90,768 | ||||||||
|
Mortgage-backed
securities
|
60,505 | 450 | 16 | 60,939 | ||||||||||||
|
Obligations
of states and political subdivisions
|
85,896 | 691 | 694 | 85,893 | ||||||||||||
|
Corporate
and other debt securities
|
73,537 | 48 | 6,277 | 67,308 | ||||||||||||
|
Totals
|
$ | 309,149 | $ | 2,746 | $ | 6,987 | $ | 304,908 | ||||||||
Proceeds
from sales and calls of securities and the realized gains and losses are as
follows (in thousands):
|
2008
|
2007
|
2006
|
||||||||||
|
Proceeds
|
$ | 43,008 | $ | 71,611 | $ | 548 | ||||||
|
Realized
gains
|
727 | 10 | 4 | |||||||||
|
Realized
losses1
|
(2,724 | ) | (1,615 | ) | — | |||||||
1 The realized loss reported
for 2008 is attributable to an other-than-temporary impairment
charge
recognized at December 31, 2008.
The associated securities were not sold.
The
following table shows the Corporation’s securities available-for-sale with gross
unrealized losses and fair value, aggregated by investment category and length
of time that individual securities have been in a continuous unrealized
position, at December 31, 2008 and 2007 (in thousands):
|
December 31, 2008
|
||||||||||||||||
|
Less than 12 months
|
12 months or more
|
|||||||||||||||
|
Fair
Value
|
Unrealized
Losses
|
Fair
Value
|
Unrealized
Losses
|
|||||||||||||
|
U.S.
government and agencies
|
$ | 19,822 | $ | (178 | ) | $ | — | $ | — | |||||||
|
Mortgage-backed
securities
|
38,229 | (9,942 | ) | 3,216 | (1,188 | ) | ||||||||||
|
Obligations
of states and political subdivisions
|
66,735 | (2,781 | ) | 3,632 | (315 | ) | ||||||||||
|
Corporate
securities
|
2,159 | (5,393 | ) | 21,724 | (40,665 | ) | ||||||||||
| $ | 126,945 | $ | (18,294 | ) | $ | 28,572 | $ | (42,168 | ) | |||||||
[57]
|
December 31, 2007
|
||||||||||||||||
|
Less than 12 months
|
12 months or more
|
|||||||||||||||
|
Fair
Value
|
Unrealized
Losses
|
Fair
Value
|
Unrealized
Losses
|
|||||||||||||
|
Mortgage-backed
securities
|
$ | 1,251 | $ | (2 | ) | $ | 889 | $ | (14 | ) | ||||||
|
Obligations
of states and political subdivisions
|
24,103 | (337 | ) | 22,681 | (357 | ) | ||||||||||
|
Corporate
securities
|
36,679 | (4,192 | ) | 23,035 | (2,085 | ) | ||||||||||
| $ | 62,033 | $ | (4,531 | ) | $ | 46,605 | $ | (2,456 | ) | |||||||
Management
systematically evaluates securities for impairment on a quarterly
basis. Declines in the fair value of securities below their cost that
are considered other-than-temporary declines are recognized in earnings as
realized losses in the period in which the impairment determination is
made. In estimating other-than-temporary impairment losses,
management considers (1) the length of time and the extent to which the fair
value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Corporation to
retain its investment in the issuer for a period of time sufficient to allow for
any anticipated recovery in fair value. Management also monitors cash
flow projections for certain securities in accordance with Emerging Issues Task
Force (EITF) Issue No. 99-20, “Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized Financial Assets”
(EITF 99-20) which was amended in FSP EITF 99-20-1, “Amendments to the
Impairment Guidance of EITF 99-20”, effective for interim and annual reporting
periods ending after December 15, 2008.
Based
upon a review of credit quality and the cash flow tests performed, management
determined that two of our Corporate Securities were other-than-temporarily
impaired. As a result of this assessment, we recorded a $2.7
million loss on these securities as of December 31, 2008. The
unrealized losses on the remaining investment securities are primarily
attributable to factors such as changes in market interest rates, marketability,
liquidity and the current economic environment. The mortgage-backed
securities portfolio was in an unrealized loss position of $11.1 million at
December 31, 2008. These securities are reviewed for factors such as
loan to value ratio, credit support levels, FICO scores, geographic
concentration, prepayment speeds, delinquencies, coverage ratios and credit
ratings. All of our investments in states and other political
subdivisions are of the highest investment grade as determined by the major
rating agencies. The total $46.1 million in unrealized losses
reported for corporate securities at December 31, 2008 relates to Preferred Term
Securities (PreTSLs). The Corporation has both the intent and ability
to hold the impaired securities in its investment portfolio for the period of
time necessary to recover its amortized cost. See Note 15 for
management’s methods used to determine the fair value of
securities.
The
amortized cost and estimated fair value of securities available-for-sale by
contractual maturity at December 31, 2008 are shown in the following
table. Actual maturities will differ from contractual maturities
because the issuers of the securities may have the right to call or prepay
obligations with or without call or prepayment penalties.
|
(in thousands)
|
||||||||
|
Contractual Maturity
|
Amortized
Cost
|
Fair
Value
|
||||||
|
Due
in one year or less
|
$ | 4,087 | $ | 4,193 | ||||
|
Due
after one year through five years
|
51,888 | 53,075 | ||||||
|
Due
after five years through ten years
|
30,193 | 30,680 | ||||||
|
Due
after ten years
|
191,969 | 143,448 | ||||||
| 278,137 | 231,396 | |||||||
|
Mortgage-backed
securities
|
132,107 | 123,199 | ||||||
| $ | 410,244 | $ | 354,595 | |||||
At
December 31, 2008 and 2007, investment securities with a fair value of $235
million and $134 million, respectively, were pledged as permitted or required to
secure public and trust deposits, for securities sold under agreements to
repurchase as required or permitted by law and as collateral for borrowing
capacity.
[58]
|
4.
|
Loans
|
The
Corporation, through the Bank, is active in originating loans to customers
primarily in Western Maryland and Northeastern West Virginia. The
following table is a summary of the loan portfolio and loan commitments by
principal categories (in thousands):
|
December 31, 2008
|
December 31, 2007
|
|||||||||||||||
|
Loans
|
Loan
Commitments
|
Loans
|
Loan
Commitments
|
|||||||||||||
|
Commercial
|
$ | 575,962 | $ | 88,640 | $ | 492,302 | $ | 92,301 | ||||||||
|
Real
Estate – Mortgage
|
403,768 | 44,304 | 384,420 | 42,819 | ||||||||||||
|
Consumer
Installment
|
140,234 | 3,897 | 153,593 | 66 | ||||||||||||
|
Real
Estate – Construction
|
14,582 | 5,441 | 12,951 | 8,645 | ||||||||||||
|
Commercial
letters of credit
|
— | 5,943 | — | 7,488 | ||||||||||||
|
Total
|
$ | 1,134,546 | $ | 148,225 | $ | 1,043,266 | $ | 151,319 | ||||||||
Loan
commitments are made to accommodate the financial needs of the Corporation’s
customers. Letters of credit commit the Corporation to make payments on behalf
of customers when certain specified future events occur. Letters of
credit are issued to customers to support contractual obligations and to insure
job performance. Commitments to extend credit generally have fixed expiration
dates, may require payment of a fee, and contain cancellation clauses in the
event of an adverse change in the customer’s credit
quality. Historically, most letters of credit expire unfunded, and
therefore, cash requirements are substantially less than the total
commitment. Loan commitments and letters of credit have credit risk
essentially the same as that involved in extending loans to customers and are
subject to normal credit policies. Collateral is obtained based on
management’s credit assessment of the customer. The Corporation
considers letters of credit to be guarantees and the amount of liability related
to such guarantees was not significant at December 31, 2008 and
2007.
In the
ordinary course of business, executive officers and directors of the
Corporation, including their families and companies in which certain directors
are principal owners, were loan customers of the Bank. Pursuant to
the Bank’s lending policies, such loans were made on the same terms, including
collateral, as those prevailing at the time for comparable transactions with
unrelated persons and do not involve more than the normal risk of
collectability. Changes in the dollar amount of loans outstanding to
officers, directors and their associates were as follows for the year ended
December 31 (in thousands):
|
2008
|
||||
|
Balance
at January 1
|
$ | 28,417 | ||
|
Loans
or advances
|
3,655 | |||
|
Repayments¹
|
(17,846 | ) | ||
|
Balance
at December 31
|
$ | 14,226 | ||
¹ Amount
includes a reclassification of balances due to the resignation of a
director.
Activity
in the allowance for loan losses is summarized as follows (in
thousands):
|
2008
|
2007
|
2006
|
||||||||||
|
Balance
at January 1
|
$ | 7,304 | $ | 6,530 | $ | 6,416 | ||||||
|
Gross
credit losses
|
(6,595 | ) | (2,222 | ) | (1,575 | ) | ||||||
|
Recoveries
|
713 | 684 | 524 | |||||||||
|
Net
credit losses
|
(5,882 | ) | (1,538 | ) | (1,051 | ) | ||||||
|
Provision
for loan losses
|
12,925 | 2,312 | 1,165 | |||||||||
|
Balance
at December 31
|
$ | 14,347 | $ | 7,304 | $ | 6,530 | ||||||
Non-accruing
loans were $24.6 million, $5.4 million, and $3.2 million at December 31, 2008,
2007 and 2006, respectively. Interest income not recognized as a result of
placing loans on a non-accrual status was $.4 million during 2008 and $.2
million during 2007 and 2006. Accruing loans past due 90 days or more
were $3.5 million, $3.3 million and $.6 million at the end of 2008, 2007 and
2006, respectively.
[59]
The
following is a summary of information pertaining to impaired and non-accrual
loans (in thousands):
|
Years Ended December 31,
|
||||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Impaired
loans without a valuation allowance
|
$ | 66,816 | $ | 6,814 | $ | - | ||||||
|
Impaired
loans with a valuation allowance
|
16,519 | 176 | 127 | |||||||||
|
Total
impaired loans
|
$ | 83,335 | $ | 6,990 | $ | 127 | ||||||
|
Valuation
allowance related to impaired loans
|
$ | 4,759 | $ | 176 | $ | 127 | ||||||
|
Average
investment in impaired loans
|
$ | 28,180 | $ | 1,472 | $ | 166 | ||||||
|
Interest
income recognized on an accrual basis on impaired loans
|
$ | 4,658 | $ | 225 | $ | - | ||||||
|
Interest
income recognized on a cash basis on impaired loans
|
$ | 410 | $ | 162 | $ | 178 | ||||||
No
additional funds are committed to be advanced in connection with impaired
loans. A loan is considered impaired when, based on current
information and events, it is probable that the Corporation will be unable to
collect the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. Impairment is measured
on a loan by loan basis for commercial and construction loans. Large
groups of smaller balance homogeneous loans are collectively evaluated for
impairment. Based upon the current economic environment and its
effect on the overall real estate markets, the amount of impaired loans has
increased significantly from December 31, 2007.
5. Premises
and Equipment
The
composition of premises and equipment at December 31 is as follows (in
thousands):
|
2008
|
2007
|
|||||||
|
Land
|
$ | 8,910 | $ | 8,910 | ||||
|
Land
Improvements
|
322 | 316 | ||||||
|
Premises
|
23,058 | 22,340 | ||||||
|
Furniture
and Equipment
|
21,071 | 29,475 | ||||||
| 53,361 | 61,041 | |||||||
|
Less
accumulated depreciation
|
(22,237 | ) | (29,634 | ) | ||||
|
Total
|
$ | 31,124 | $ | 31,407 | ||||
The
Corporation recorded depreciation expense of $2.8 million, $2.6 million and $2.5
million in 2008, 2007 and 2006, respectively.
Pursuant
to the terms of noncancelable operating lease agreements for banking and
subsidiaries’ offices and for data processing and telecommunications equipment
in effect at December 31, 2008, future minimum rent commitments under these
leases for each of the next five years are as follows: $2.9, $2.0, $2.0, $1.9,
and $1.8 million. The leases contain options to extend for periods from one to
five years, not included in the aforementioned amounts.
Total
rent expense for offices amounted to $.7 million in 2008 and 2007 and $.6
million in 2006.
6. Goodwill
and Other Intangible Assets
Goodwill
resulted from the acquisition of four branch offices and a banking center from
The Huntington National Bank in July 2003 and an insurance agency in April
1999. The Corporation performed its annual impairment test as of
December 31, 2008 and determined that goodwill was not
impaired. There can be no assurance that goodwill impairment will not
occur in the future. The Corporation will continue to evaluate goodwill for
impairment on an annual basis and as events occur or circumstances
change.
Effective
as of December 31, 2008, the Insurance Group acquired substantially all the
assets of three insurance agencies. These acquisitions
resulted in an increase of $2.4 in goodwill and intangible
assets. The estimated goodwill and intangible assets are based upon a
preliminary valuation and are subject to change during the allocation period as
defined by SFAS No. 141, “Business Combinations”.
[60]
The
significant components of goodwill and acquired intangible assets at December 31
are as follows (in thousands):
|
2008
|
2007
|
|||||||||||||||||||||||||||||||
|
Gross
Carrying
Amount
|
Accumulated
Amortization
|
Net
Carrying
Amount
|
Weighted
Average
Remaining
Life
|
Gross
Carrying
Amount
|
Accumulated
Amortization
|
Net
Carrying
Amount
|
Weighted
Average
Remaining
Life
|
|||||||||||||||||||||||||
|
Goodwill
|
$ | 11,900 | $ | — | $ | 11,900 | $ | 11,900 | $ | — | $ | 11,900 | ||||||||||||||||||||
|
Core
deposit intangible
assets
|
4,040 | (3,023 | ) | 1,017 | 1.8 | 4,040 | (2,465 | ) | 1,575 | 2.8 | ||||||||||||||||||||||
|
Insurance
agency book of businesses
|
3,651 | (246 | ) | 3,405 | 9.1 | 1,205 | (120 | ) | 1,085 | 7.8 | ||||||||||||||||||||||
|
Total
|
$ | 19,591 | $ | (3,269 | ) | $ | 16,322 | $ | 17,145 | $ | (2,585 | ) | $ | 14,560 | ||||||||||||||||||
Amortization
expense relating to amortizable intangible assets was $.7 million in 2008 and
2007 and $.5 million in 2006. Future estimated annual amortization
expense is presented below (in thousands):
|
Year
|
Annual
Amortization
|
|||
|
2009
|
$ | 835 | ||
|
2010
|
737 | |||
|
2011
|
277 | |||
|
2012
|
277 | |||
|
2013
|
272 | |||
7. Deposits
The
aggregate amount of time deposits with a minimum denomination of $100,000 was
$334.4 million and $299.6 million at December 31, 2008 and December 31, 2007,
respectively.
The
following is a summary of the scheduled maturities of all time deposits as of
December 31, 2008 (in thousands):
|
2009
|
$ | 449,026 | ||
|
2010
|
44,713 | |||
|
2011
|
75,300 | |||
|
2012
|
3,251 | |||
|
2013
|
4,235 | |||
|
Thereafter
|
49 |
8. Borrowed
Funds
The
following is a summary of short-term borrowings at December 31 with original
maturities of less than one year (dollars in thousands):
|
2008
|
2007
|
2006
|
||||||||||
|
Short-term
FHLB advance,
Daily
borrowings, interest rate of .46% (at December 31, 2008)
|
$ | 8,500 | $ | 21,000 | $ | 4,500 | ||||||
|
Short-term
FHLB advance,
Interest
rate of 5.44% (at December 31, 2006) matured in May 2007
|
— | — | 20,000 | |||||||||
|
Securities
sold under agreements to repurchase:
|
||||||||||||
|
Outstanding
at end of year
|
$ | 41,995 | $ | 34,112 | $ | 74,879 | ||||||
|
Weighted
average interest rate at year end
|
1.33 | % | 5.99 | % | 3.96 | % | ||||||
|
Maximum
amount outstanding as of any
month end
|
$ | 47,811 | $ | 70,746 | $ | 84,380 | ||||||
|
Average
amount outstanding
|
38,128 | 55,140 | 78,032 | |||||||||
|
Approximate
weighted average rate during
the year
|
1.46 | % | 3.71 | % | 3.80 | % | ||||||
[61]
The
following is a summary of long-term borrowings at December 31 with original
maturities exceeding one year (dollars in thousands):
|
2008
|
2007
|
|||||||
|
FHLB
advances, bearing interest at rates ranging from
2.46% to 4.98% at December 31, 2008
|
$ | 241,474 | $ | 142,522 | ||||
|
Junior
subordinated debt, bearing interest at rates ranging
from 4.62% to 6.02% at December 31, 2008
|
35,929 | 35,929 | ||||||
| $ | 277,403 | $ | 178,451 | |||||
The contractual maturities of long-term
borrowings are as follows:
|
December 31
|
||||||||||||||||
|
2008
|
2007
|
|||||||||||||||
|
Fixed
Rate
|
Floating
Rate
|
Total
|
Total
|
|||||||||||||
|
(in
thousands)
|
||||||||||||||||
|
Due
in 2008
|
— | — | — | 1,000 | ||||||||||||
|
Due
in 2009
|
14,000 | — | 14,000 | 14,000 | ||||||||||||
|
Due
in 2010
|
31,000 | — | 31,000 | 31,000 | ||||||||||||
|
Due
in 2011
|
51,000 | — | 51,000 | 51,000 | ||||||||||||
|
Due
in 2012
|
44,250 | — | 44,250 | 44,250 | ||||||||||||
|
Due
in 2013
|
— | — | — | — | ||||||||||||
|
Thereafter
|
126,843 | 10,310 | 137,153 | 37,201 | ||||||||||||
|
Total
long-term debt
|
$ | 267,093 | $ | 10,310 | $ | 277,403 | $ | 178,451 | ||||||||
The
Corporation has a borrowing capacity agreement with the FHLB in an amount equal
to 29% of the Bank’s assets. At December 31, 2008, the available line
of credit equaled $470 million. This line of credit, which can be
used for both short and long-term funding, can only be utilized to the extent of
available collateral. The line is secured by certain qualified
mortgage and commercial loans and investment securities, as
follows:
|
1-4
family mortgage loans
|
$ | 134,451 | ||
|
Commercial
loans
|
14,441 | |||
|
Multi-family
loans
|
2,541 | |||
|
Home
equity loans
|
11,746 | |||
|
Investment
securities
|
95,624 | |||
| $ | 258,803 |
The
collateralized line of credit totaled $259 million at December 31, 2008, of
which $9 million was available for additional borrowings.
The
Corporation also has various unsecured lines of credit totaling $25.0 million
with various financial institutions to meet daily liquidity
requirements. As of December 31, 2008, the Corporation had no
borrowings under these credit facilities. In addition, we had
approximately $31 million of available funding through brokered money market
funds.
Repurchase
Agreements—The Corporation has retail repurchase agreements with
customers within its local market areas. Repurchase agreements
generally have maturities of one to four days from the transaction date. These
borrowings are collateralized with securities owned by the company and held in
safekeeping at independent correspondent banks.
FHLB
Advances—The FHLB advances consist of various borrowings with maturities
generally ranging from 5 to 10 years with initial fixed rate periods of one, two
or three years. After the initial fixed rate period the FHLB has one or more
options to convert each advance to a LIBOR based, variable rate advance, but the
Corporation may repay the advance in whole or in part, without a penalty, if the
FHLB exercises its option. At all other times, the Corporation’s early repayment
of any advance could be subject to a prepayment penalty.
In May
2006, the Bank exchanged $25 million of long-term FHLB advances with an interest
rate of 5.01% for $25 million of long-term FHLB advances with an interest rate
of 4.69%. The exchange netted a gain of $.2 million which is being
amortized over 5 years into interest expense.
[62]
Subordinated
Debt— In March 2004, the Trusts issued preferred securities with an
aggregate liquidation amount of $30.9 million to third-party
investors. The proceeds of issuance of the preferred securities were
used to purchase an equal amount of junior subordinated debentures of the
Corporation, as follows:
$20.6 million—6.02%
fixed rate for five years payable quarterly, converting to floating rate based
on three-month LIBOR plus 275 basis points, maturing in 2034, redeemable five
years after issuance at the Corporation’s option.
$10.3
million—floating rate payable quarterly based on three-month LIBOR plus
275 basis points (4.62% at December 31, 2008) maturing in 2034, redeemable five
years after issuance at the Corporation’s option.
The
debentures represent the sole assets of the Trusts, and payments of the
debentures by the Corporation are the only sources of cash flow for the
Trusts.
In
December 2004, the Corporation issued an additional $5.0 million of
debentures. The debentures have a fixed rate of 5.88% for the first
five years, payable quarterly, and then convert to a floating rate based on the
three month LIBOR plus 185 basis points. The debentures mature in
2014, but are redeemable five years after issuance at the Corporation’s
option.
The
Corporation has the right to defer interest on all of the foregoing debentures
for up to 20 quarterly periods, in which case distributions on the preferred
securities will also be deferred. Should this occur, the Corporation
may not pay dividends or distributions on, or repurchase, redeem or acquire any
shares of its capital stock.
[63]
9. Other
Comprehensive Loss
A summary
of the activity in accumulated other comprehensive loss follows (in
thousands):
|
For the Year Ended December 31
|
||||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Accumulated
unrealized losses on securities available for sale at January 1, net of
tax
|
$ | (2,530 | ) | $ | (715 | ) | $ | (1,980 | ) | |||
|
Net
unrealized (losses)/gains for the period, net of tax
|
(31,851 | ) | (2,771 | ) | 1,268 | |||||||
|
Reclassification
of losses/(gains) occurring during the period, net of tax
|
1,191 | 956 | (3 | ) | ||||||||
|
Effect
on other comprehensive (loss) income for the period
|
(30,660 | ) | (1,815 | ) | 1,265 | |||||||
|
Accumulated
unrealized losses on securities available for sale at December 31, net of
tax ($22,460) in 2008, ($1,712) in 2007 and ($468) in 2006
|
$ | (33,190 | ) | $ | (2,530 | ) | $ | (715 | ) | |||
|
Accumulated
unrealized losses for pension obligation at January 1, net of
tax
|
$ | (2,750 | ) | $ | (2,901 | ) | $ | - | ||||
|
Cumulative
effect of change in accounting for pension obligation – adoption of SFAS
No. 158, net of tax
|
- | - | (2,901 | ) | ||||||||
|
Change
in accumulated unrealized losses for pension obligation, net of
tax
|
(4,636 | ) | 151 | - | ||||||||
|
Accumulated
unrealized losses for Pension obligation at December 31, net of tax of
($3,137) in 2008, ($1,859) in 2007 and ($1,562) in 2006
|
$ | (7,386 | ) | $ | (2,750 | ) | $ | (2,901 | ) | |||
|
Accumulated
unrealized losses for SERP obligation at January 1, net of
tax
|
$ | (375 | ) | (1,964 | ) | - | ||||||
|
Cumulative
effect of change in accounting for SERP obligation – adoption of SFAS No.
158, net of tax
|
- | - | (1,964 | ) | ||||||||
|
Change
in accumulated unrealized losses for SERP obligation, net of
tax
|
(32 | ) | 1,589 | - | ||||||||
|
Accumulated
unrealized losses for SERP obligation at December 31, net of tax of ($22)
in 2008, ($255) in 2007 and ($1,052) in 2006
|
$ | (407 | ) | $ | (375 | ) | $ | (1,964 | ) | |||
|
Total
accumulated other comprehensive loss at December 31, net of tax of
($25,619) at 2008, ($3,826) at 2007 and ($3,082) at 2006
|
$ | (40,983 | ) | $ | (5,655 | ) | $ | (5,580 | ) | |||
[64]
10. Income
Taxes
The
provision for income taxes consists of the following for the years ended
December 31 (in thousands):
|
2008
|
2007
|
2006
|
||||||||||
|
Current
Tax Provision:
|
||||||||||||
|
Federal
|
$ | 5,337 | $ | 4,275 | $ | 5,179 | ||||||
|
State
|
1,383 | 914 | 1,094 | |||||||||
| $ | 6,720 | $ | 5,189 | $ | 6,273 | |||||||
|
Deferred
taxes (benefit) :
|
||||||||||||
|
Federal
|
$ | (2,699 | ) | $ | 455 | $ | (469 | ) | ||||
|
State
|
(448 | ) | 102 | (61 | ) | |||||||
| $ | (3,147 | ) | $ | 557 | $ | (530 | ) | |||||
|
Income
tax expense for the year
|
$ | 3,573 | $ | 5,746 | $ | 5,743 | ||||||
The
reconciliation between the statutory federal income tax rate and effective
income tax rate is as follows:
|
2008
|
2007
|
2006
|
||||||||||
|
Federal
statutory rate
|
35.0 | % | 35.0 | % | 35.0 | % | ||||||
|
Tax-exempt
income on securities and loans
|
(9.0 | ) | (5.9 | ) | (5.6 | ) | ||||||
|
Tax-exempt
BOLI income
|
(2.0 | ) | (2.1 | ) | (1.6 | ) | ||||||
|
State
income tax, net of federal tax benefit
|
4.7 | 4.0 | 3.5 | |||||||||
| 28.7 | % | 31.0 | % | 31.3 | % | |||||||
Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Corporation’s temporary differences as of December 31 are as follows (in
thousands):
|
2008
|
2007
|
|||||||
|
Deferred
tax assets:
|
||||||||
|
Allowance
for loan losses
|
$ | 5,790 | $ | 2,948 | ||||
|
Deferred
loan fees
|
271 | 198 | ||||||
|
Deferred
compensation
|
613 | 491 | ||||||
|
State
tax loss carry forwards
|
1,001 | 916 | ||||||
|
Unrealized
loss on investment securities available-for-sale
|
22,460 | 1,712 | ||||||
|
Pension/SERP
|
428 | — | ||||||
|
Other
than temporary impairment on investment securities
|
1,100 | — | ||||||
|
Other
real estate owned
|
518 | — | ||||||
|
Other
|
113 | 685 | ||||||
|
Total
deferred tax assets
|
32,294 | 6,950 | ||||||
|
Valuation
allowance
|
(1,001 | ) | (916 | ) | ||||
|
Total
deferred tax assets less valuation allowance
|
31,293 | 6,034 | ||||||
|
Deferred
tax liabilities:
|
||||||||
|
Amortization
of goodwill and core deposit intangible
|
(837 | ) | (688 | ) | ||||
|
Pension/SERP
|
— | (1,833 | ) | |||||
|
Depreciation
|
(820 | ) | (741 | ) | ||||
|
Other
|
(70 | ) | (239 | ) | ||||
|
Total
deferred tax liabilities
|
(1,727 | ) | (3,501 | ) | ||||
|
Net
deferred tax assets
|
$ | 29,566 | $ | 2,533 | ||||
State
income tax expense amounted to $.9 million during 2008 and $1.0 million during
2007 and 2006. The state tax loss carry forwards included in deferred
tax assets will expire commencing in 2019. Tax expense related to
securities gains during 2008 was $.3 million.
[65]
11. Employee
Benefit Plans
The
Corporation sponsors a noncontributory defined benefit pension plan (Plan)
covering substantially all full-time employees who qualify as to age and length
of service. The benefits are based on years of service and the employees’
compensation during the last five years of employment. The
Corporation’s funding policy is to make annual contributions in amounts
sufficient to meet the current year’s minimum funding requirements.
During
2001, the Corporation established an unfunded supplemental executive retirement
plan (SERP) to provide senior management personnel with supplemental retirement
benefits in excess of limits imposed on qualified plans by federal tax
law. Concurrent with the establishment of the SERP, the Corporation
acquired bank owned life insurance (BOLI) policies on the senior management
personnel and officers of the Corporation. The benefits resulting
from the favorable tax treatment accorded the earnings on the BOLI are intended
to provide a source of funds for the future payment of the SERP benefits as well
as other employee benefit costs.
The
benefit obligation activity for both the pension plan and SERP was calculated
using an actuarial measurement date of January 1. Plan assets and the benefit
obligations were calculated using an actuarial measurement date of December 31.
The following table summarizes benefit obligation and funded status, plan asset
activity, components of net pension cost, and weighted average assumptions for
the Corporation’s pension and SERP plans (in thousands):
|
Pension
|
SERP
|
|||||||||||||||
|
2008
|
2007
|
2008
|
2007
|
|||||||||||||
|
Change
in Benefit Obligation
|
||||||||||||||||
|
Obligation
at the beginning of the year
|
$ | 20,922 | $ | 19,181 | $ | 3,036 | $ | 4,696 | ||||||||
|
Service
cost
|
923 | 809 | 106 | 179 | ||||||||||||
|
Interest
cost
|
1,263 | 1,155 | 181 | 256 | ||||||||||||
|
Change
in assumptions
|
(2,336 | ) | — | — | — | |||||||||||
|
Actuarial
losses/(gains)
|
400 | 331 | 149 | (2,069 | ) | |||||||||||
|
Benefits
paid
|
(629 | ) | (554 | ) | (26 | ) | (26 | ) | ||||||||
|
Obligation
at the end of the year
|
20,543 | 20,922 | 3,446 | 3,036 | ||||||||||||
|
Change
in Plan Assets
|
||||||||||||||||
|
Fair
value at the beginning of the year
|
27,856 | 21,474 | — | — | ||||||||||||
|
Actual
return on plan assets
|
(7,482 | ) | 1,936 | — | — | |||||||||||
|
Employer
contribution
|
2,500 | 5,000 | 26 | 26 | ||||||||||||
|
Benefits
paid
|
(629 | ) | (554 | ) | (26 | ) | (26 | ) | ||||||||
|
Fair
value at the end of the year
|
22,245 | 27,856 | — | — | ||||||||||||
|
Funded
Status
|
$ | 1,702 | $ | 6,934 | $ | (3,446 | ) | $ | (3,036 | ) | ||||||
|
Pension
|
SERP
|
|||||||||||||||||||||||
|
2008
|
2007
|
2006
|
2008
|
2007
|
2006
|
|||||||||||||||||||
|
Components
of Net Pension Cost
|
||||||||||||||||||||||||
|
Service
cost
|
$ | 923 | $ | 809 | $ | 809 | $ | 106 | $ | 179 | $ | 138 | ||||||||||||
|
Interest
cost
|
1,263 | 1,155 | 1,048 | 181 | 256 | 200 | ||||||||||||||||||
|
Expected
return on assets
|
(2,340 | ) | (1,891 | ) | (1,586 | ) | — | — | — | |||||||||||||||
|
Amortization
of transition asset
|
(39 | ) | (39 | ) | (39 | ) | — | — | — | |||||||||||||||
|
Amortization
of recognized loss
|
142 | 169 | 220 | 0 | 203 | 121 | ||||||||||||||||||
|
Amortization
of prior service cost
|
10 | 10 | 10 | 113 | 113 | 113 | ||||||||||||||||||
|
Net
pension (income)/expense in employee benefits
|
$ | (41 | ) | $ | 213 | $ | 462 | $ | 400 | $ | 751 | $ | 572 | |||||||||||
|
Weighted
Average Assumptions used to determine
benefit obligations:
|
||||||||||||||||||||||||
|
Discount
rate for benefit obligations
|
6.00 | % | 6.00 | % | 6.00 | % | 6.00 | % | 6.00 | % | 5.50 | % | ||||||||||||
|
Discount
rate for net pension cost
|
6.00 | % | 6.00 | % | 6.15 | % | — | — | — | |||||||||||||||
|
Expected
long-term return on assets
|
7.75 | % | 8.00 | % | 8.00 | % | — | — | — | |||||||||||||||
|
Rate
of compensation increase
|
4.00 | % | 3.00 | % | 3.00 | % | 4.00 | % | 4.00 | % | 4.00 | % | ||||||||||||
[66]
The
accumulated benefit obligation for the pension plan was $16.7 million and
$16.0 million at December 31, 2008 and 2007, respectively. The
accumulated benefit obligation for the SERP was $3.4 million and $3.0 million at
December 31, 2008 and 2007, respectively.
The
expected long-term rate of return on Plan assets for the pension plan was
determined by considering historical and future expected returns of the asset
classes invested in by the Plan trustees, and the allocation strategy currently
in place among those classes. The actual asset allocations for the
defined benefit pension plan as of December 31, 2008 and 2007, by asset
category, are as follows:
|
Percentage
of
Plan
Assets
|
||||||||
|
2008
|
2007
|
|||||||
|
ASSET
CATEGORY
|
||||||||
|
Equity
securities
|
50 | % | 62 | % | ||||
|
Debt
securities
|
45 | 32 | ||||||
|
Cash
and cash equivalents
|
5 | 6 | ||||||
|
Total
|
100 | % | 100 | % | ||||
The
investment objective for the defined benefit pension plan is to maximize total
return with tolerance for average risk. Asset allocation favors
equities, with a target allocation of approximately 55% equity securities, 40%
fixed income securities, and 5% cash. Due to volatility in the
market, the target allocation is not always desirable and asset allocations will
fluctuate between the acceptable ranges. A core equity position of
large cap stocks will be maintained. However, more aggressive or
volatile sectors will be meaningfully represented in the asset mix in pursuit of
higher returns. Higher volatility investment strategies such as credit risk,
structured finance, and international bonds will be appropriate strategies in
conjunction with the core position.
It is
management’s intent to give the plan’s investment managers flexibility with
respect to investment decisions and their timing within the overall
guidelines. However, certain investments require specific review and
approval by management. Management is also informed of anticipated
changes in nonproprietary investment managers, significant modifications of any
previously approved investment, or the anticipated use of derivatives to execute
investment strategies.
The
following summarizes the number of shares of the Corporation’s common stock and
the fair value of such shares that are included in Plan assets at December 31,
2008 and 2007, as well as dividends paid to the Plan for such years (dollars in
thousands):
|
2008
|
2007
|
|||||||
|
Number
of shares held
|
3,000 | 3,000 | ||||||
|
Number
of shares purchased
|
0 | 0 | ||||||
|
Number
of shares sold
|
0 | 0 | ||||||
|
Fair
value
|
$ | 40 | $ | 60 | ||||
|
Dividends
paid
|
$ | 2 | $ | 2 | ||||
|
Percentage
of total plan assets
|
.18 | % | .21 | % | ||||
Estimated Cash Flows related to the
Plan are as follows (in thousands):
Estimated future benefit
payments
|
Pension
Plan
|
SERP
|
|||||||
|
2009
|
$ | 583 | $ | 48 | ||||
|
2010
|
593 | 48 | ||||||
|
2011
|
623 | 48 | ||||||
|
2012
|
640 | 86 | ||||||
|
2013
|
710 | 133 | ||||||
|
2014-2018
|
5,810 | 1,136 | ||||||
| $ | 8,959 | $ | 1,499 | |||||
[67]
The
Corporation’s contribution to the pension plan in 2009 is dependent upon market
conditions and a full evaluation of the plan. The Corporation expects
to fund the annual projected benefit payments for the SERP from
operations.
Amounts
included in accumulated other comprehensive loss as of December 31, 2008 and
2007, net of tax, are as follows (in thousands):
|
2008
|
2007
|
|||||||||||||||
|
Pension
|
SERP
|
Pension
|
SERP
|
|||||||||||||
|
Unrecognized
net actuarial loss
|
$ | 7,470 | $ | 104 | $ | 2,851 | $ | 14 | ||||||||
|
Unrecognized
prior service costs
|
67 | 303 | 73 | 361 | ||||||||||||
|
Net
transition asset
|
(151 | ) | — | (174 | ) | — | ||||||||||
| $ | 7,386 | $ | 407 | $ | 2,750 | $ | 375 | |||||||||
Other changes in plan assets and
benefit obligations recognized in other comprehensive loss during the year ended
December 31, 2008 were as follows:
|
Defined
Benefit Pension Plan
|
||||
|
Amortization
of prior service costs
|
$ | (10 | ) | |
|
Amortization
of transition asset
|
39 | |||
|
Amortization
of unrecognized loss
|
(142 | ) | ||
| $ | (113 | ) | ||
|
Supplemental
Executive Retirement Plan
|
||||
|
Net
actuarial loss during the period
|
$ | 149 | ||
|
Amortization
of prior service costs
|
(113 | ) | ||
| $ | 36 | |||
| $ | (77 | ) | ||
|
Tax
effect
|
31 | |||
|
Amount
included in other comprehensive income, net of tax
|
$ | (46 | ) | |
The
estimated costs that will be amortized from accumulated other comprehensive loss
into net periodic pension cost during the next fiscal year are as follows (in
thousands):
|
Pension
|
SERP
|
|||||||
|
Prior
service costs
|
$ | 10 | $ | 113 | ||||
|
Net
transition asset
|
(39 | ) | — | |||||
|
Net
actuarial loss
|
142 | — | ||||||
| $ | 113 | $ | 113 | |||||
401(K) Profit Sharing
Plan
The First
United Bank & Trust 401(k) Profit Sharing Plan (“the 401(k) Plan”) is a
defined contribution plan that is intended to qualify under section 401(k) of
the Internal Revenue Code. The 401(k) Plan covers substantially all
employees of the Bank and its affiliates. Eligible employees can
elect to contribute to the plan through payroll deductions. The first
1% of contributions of an employee’s base salary are matched at 100% and the
next 5% are matched on a 50% basis by the Corporation. Expense
charged to operations for the 401(k) Plan was $.5 million, $.3 million, and $.5
million in 2008, 2007 and 2006, respectively.
12. Federal
Reserve Requirements
The Bank
is required to maintain cash reserves with the Federal Reserve Bank of Richmond
based principally on the type and amount of its deposits. During
2008, the daily average amount of these required reserves was approximately $1.6
million.
[68]
13. Restrictions
on Subsidiary Dividends, Loans or Advances
Federal
and state banking regulations place certain restrictions on the amount of
dividends paid and loans or advances made by the Bank to the
Corporation. The total amount of dividends that may be paid at any
date is generally limited to the retained earnings of the Bank, and loans or
advances are limited to 10 percent of the Bank’s capital stock and surplus on a
secured basis. In addition, dividends paid by the Bank to the
Corporation would be prohibited if the effect thereof would cause the Bank’s
capital to be reduced below applicable minimum capital
requirements. At December 31, 2008, the Bank could have paid
additional dividends of $15.0 million to the Corporation without regulatory
approval.
14. Commitments
and Contingent Liabilities
The
Corporation and its subsidiaries are at times, and in the ordinary course of
business, subject to legal actions. However, to the knowledge of
management, the Corporation is not currently subject to any such legal
actions.
Loan and
letter of credit commitments are discussed in Note 4.
15. Fair
Value of Financial Instruments
As
required by SFAS No. 107, “Disclosures about Fair Value of Financial
Instruments,” presented in the following table is fair value information about
financial instruments, whether or not recognized in the statement of financial
condition, for which it is practicable to estimate that value. Fair
value is best determined by values quoted through active trading
markets. Active trading markets are characterized by numerous
transactions of similar financial instruments between willing buyers and willing
sellers. Because no active trading market exists for various types of
financial instruments, many of the fair values disclosed were derived using
present value discounted cash flow or other valuation techniques. As
a result, the Corporation’s ability to actually realize these derived values
cannot be assumed.
The fair
values disclosed under SFAS No. 107 may vary significantly between institutions
based on the estimates and assumptions used in the various valuation
methodologies. The derived fair values are subjective in nature and
involve uncertainties and significant judgment. Therefore, they cannot be
determined with precision. Changes in the assumptions could significantly impact
the derived estimates of fair value. SFAS No. 107 excludes disclosure
of non financial assets such as buildings as well as certain financial
instruments such as leases. Accordingly, the aggregate fair values
presented do not represent the underlying value of the Corporation.
The
actual carrying amounts and estimated fair values of the Corporation’s financial
instruments that are included in the statement of financial condition at
December 31 are as follows (in thousands):
|
2008
|
2007
|
|||||||||||||||
|
Carrying
Amount
|
Fair
Value
|
Carrying
Amount
|
Fair
Value
|
|||||||||||||
|
Financial
Assets:
|
||||||||||||||||
|
Cash
and cash equivalents
|
$ | 18,423 | $ | 18,423 | $ | 24,316 | $ | 24,316 | ||||||||
|
Interest
bearing deposits in banks
|
882 | 882 | 1,486 | 1,486 | ||||||||||||
|
Investment
securities
|
354,595 | 354,595 | 304,908 | 304,908 | ||||||||||||
|
Federal
Home Loan Bank stock
|
13,933 | 13,933 | 9,863 | 9,863 | ||||||||||||
|
Loans,
net
|
1,120,199 | 1,125,029 | 1,035,962 | 1,037,567 | ||||||||||||
|
Accrued
interest receivable
|
7,713 | 7,713 | 7,478 | 7,478 | ||||||||||||
|
Financial
Liabilities:
|
||||||||||||||||
|
Deposits
|
1,222,889 | 1,229,834 | 1,126,552 | 1,127,172 | ||||||||||||
|
Borrowed
funds
|
327,898 | 346,110 | 233,563 | 237,428 | ||||||||||||
|
Accrued
interest payable
|
4,295 | 4,295 | 5,651 | 5,651 | ||||||||||||
|
Off
Balance Sheet Financial Instruments
|
— | — | — | — | ||||||||||||
The
following methods and assumptions were used by the Corporation in estimating its
fair value disclosures for financial instruments:
Cash and cash
equivalents: The carrying amounts as reported in the statement
of financial condition for cash and due from banks approximate their fair
values.
[69]
Interest-bearing
deposits in banks: The carrying amount of interest-bearing
deposits approximates their fair values.
Investment
securities: The Corporation measures fair values of its investments
based on the Financial Accounting Standards Board (FASB) Statement No. 157,
“Fair Value Measurements” (SFAS 157), which defines fair value, establishes a
framework for measuring fair value under GAAP and expands disclosures about fair
value measurements. SFAS 157 applies to other accounting
pronouncements that require or permit fair value measurements. The
Corporation measures fair values based on the fair value hierarchy established
in SFAS 157. 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). The three levels of inputs that may be used to measure
fair value under SFAS 157 are as follows:
Level
1: Unadjusted quoted prices in active markets that are
accessible at the measurement date for identical, unrestricted assets and
liabilities. This level is the most reliable source of
valuation.
Level
2: Quoted prices that are not active, or inputs that are
observable either directly or indirectly, for substantially the full term of the
asset or liability. Level 2 inputs include “inputs other than quoted
prices that are observable for the asset or liability (for example, interest
rates and yield curves at commonly quoted intervals, volatilities, prepayment
speeds, loss severities, credit risks, and default rates).” It also
includes “inputs that are derived principally from or corroborated by observable
market data by correlation or other means (market-corroborated
inputs).” Several sources are utilized for valuing these securities
including a contracted valuation service, Standard & Poor’s (S&P)
evaluations and pricing services, and other valuation matrices.
Level
3: Prices or valuation techniques that require inputs
that are both significant to the valuation assumptions and that are not readily
observable in the market (i.e., supported with little or no market
activity). These Level 3 instruments are valued based on the best
available data, some of which is internally developed, and considers risk
premiums that a market participant would require.
An asset
or liability’s level within the fair value hierarchy is based on the lowest
level of input that is significant to the fair value measurement.
For
assets measured at fair value on a recurring and non-recurring basis, the fair
value measurements by level within the fair value hierarchy used at December 31,
2008 are as follows;
|
Fair
Value Measurements at
December
31, 2008 Using
(Dollars
in Thousands)
|
||||||||||||||||
|
Description
|
Assets
Measured
at
Fair
Value
12/31/08
|
Quoted
Prices
in
Active
Markets
for
Identical
Assets
(Level
1)
|
Significant
Other
Observable
Inputs
(Level
2)
|
Significant
Unobservable
Inputs
(Level
3)
|
||||||||||||
|
Investment
securities available-for-sale
|
$ | 354,595 | $ | — | $ | 330,329 | $ | 24,266 | ||||||||
|
Impaired
loans¹
|
$ | 11,760 | $ | 11,760 | ||||||||||||
|
Foreclosed
Real Estate
|
$ | 2,424 | $ | 2,424 | ||||||||||||
¹ The impaired loans fair
value consists of the impaired loans with a valuation allowance balance of
$16,519 net of the $4,759 valuation allowance.
In
December 2007, the FASB issued FASB Staff Position 157-2, Effective Date of FASB
Statement No. 157 (“FSP 157-2”). FSP 157-2 delays the effective date
of SFAS 157 for all non-financial assets and liabilities, except those that are
recognized or disclosed at fair value on a recurring basis (at least annually)
to fiscal years beginning after November 15, 2008 and interim periods within
those fiscal years.
FASB
Staff Position 157-3, “Determining the Fair Value of a Financial
Asset When the Market for That Asset is Not Active” (FSP 157-3), was
issued on October 10, 2008 and is effective for current and prior
periods. The objective of FSP 157-3 is to clarify FASB Statement No.
157, “Fair Value Measurements”, in a market that is not active and to illustrate
key considerations that may be used to determine the fair value of a financial
asset when the market for that asset is not active. The Corporation
believes that its valuation techniques are appropriate and consistent with other
market participants. However, the use of different methodologies and
assumptions could result in a different estimate of fair value at the reporting
date. The following valuation techniques were used to measure the
fair value of assets in the table above which are measured on a recurring basis
as of December 31, 2008.
[70]
Investments
available-for-sale – The
fair value of investments available-for-sale was determined using a market
approach. As of December 31, 2008, Level 2 investment securities
available-for-sale included U.S. Government Agencies and mortgage backed
securities, private label mortgage backed securities and municipal bonds which
are not as actively traded. Their fair values were determined based
upon market-corroborated inputs and valuation matrices which are obtained
through third party data service providers or securities brokers through which
the Corporation has historically transacted both purchases and sales of
investment securities. The level 3 investments consisted of Preferred Term
Securities supported by Trust Preferred Securities which are issued primarily by
financial institutions and insurance companies. The Corporation
obtained fair values for these securities from an experienced independent third
party pricing provider, Moody’s Analytics. Information such as
performance of the underlying collateral, deferral/default rates, cash flow
projections, related relevant trades, models and other analytical tools are
utilized by the third-party in determining individual security
valuations
At
December 31, 2008, the Bank owned 26 pooled Preferred Term Securities with a par
value of $72.7 million and a fair value of $24.3 million. Management
has determined that the market for these securities is currently
inactive. We reached this determination based on a significant
decline in the trading volume of these securities relative to historical levels.
The market for Preferred Term Securities is virtually non-existent at this
time. There were no new pooled trust preferred issuances during 2008
and trading activity for this class of securities (buy side) shows total
quarterly trades in 2008 at 116, 44, ten and four, respectively. The
trading volume has declined from a high of $376 million in the first quarter of
2007 to $1 million in the quarter ended December 31, 2008. In
management’s opinion, this is clearly indicative of an inactive and inefficient
market leading to the depressed pricing on these
securities. Observable prices for these securities are available
based upon broker models and these inputs have been considered in Moody’s
pricing models. However, the few observable transactions and market
quotations that are available are not reliable for purposes of determining fair
value at December 31, 2008. Accordingly, our Preferred Term
Securities will be classified within Level 3 of the fair value hierarchy because
we determined that significant adjustments are required to determine fair value
at the measurement date.
In
determining the fair value of the securities, Moody’s Analytics utilized an
income valuation approach (present value technique) which maximizes the use of
observable inputs and minimizes the use of unobservable inputs. This
approach is more indicative of fair value than the market approach that has been
used historically, and involves several steps. The credit quality of
the collateral was estimated using the average probability of default values for
each underlying issuer, adjusted for credit ratings. The default
probabilities also considered the potential for correlation among issuers within
the same industry, such as banks with other banks. The loss given
default was assumed to be 95%, allowing for a 5% recovery of
collateral. The cash flows for the securities were forecast for the
underlying collateral and applied to each tranche in the structure to determine
the resulting distribution among the securities. These expected cash
flows were then discounted to calculate the present value of the
security. The effective discount rates Moody’s utilized for the
various securities in the present value calculation ranged from 6.78% to 34.97%
and are highly dependent upon the credit quality of the collateral, the relative
position of the tranche in the capital structure of the security and the
prepayment assumptions. Moody’s Analytics modeled the
calculations in several thousand scenarios using a Monte Carlo engine and the
average price was used for valuation purposes. Due to the current
market conditions as well as the limited trading activity of these securities,
the market value of the securities is highly sensitive to assumption changes and
market volatility.
Impaired
loans – Loans included in the preceding table are those that are
accounted for under FASB Statement No. 114 (SFAS 114), “Accounting by Creditors
for Impairment of a Loan”, in which the Corporation has measured impairment
generally based on the fair value of the loan’s collateral. Fair
value is generally determined based upon independent third party appraisals of
the collateral or discounted cash flows based upon the expected
proceeds. These assets are included as Level 3 fair values, based
upon the lowest level of input that is significant to the fair value
measurements. The fair value consists of the loan balance less its
valuation allowance as determined under SFAS 114.
Foreclosed real
estate – Fair value of foreclosed assets was based on independent third
party appraisals of the properties. These values were determined
based on the sales prices of similar properties in the approximate geographic
area.
[71]
The
following tables show a reconciliation of the beginning and ending balances for
fair valued assets measured using Level 3 significant unobservable inputs for
the year ended December 31, 2008:
|
Fair Value Measurements Using Significant
Unobservable Inputs
(Dollars
in Thousands)
|
||||||||||||
|
Investments
Securities
Available for Sale
|
Impaired
Loans
|
Foreclosed Real
Estate
|
||||||||||
|
Beginning
balance January 1, 2008
|
$ | 67,308 | $ | 6,814 | $ | 825 | ||||||
|
Total
gains/(losses) realized/unrealized:
|
||||||||||||
|
Included
in other comprehensive loss
|
(43,042 | ) | — | — | ||||||||
|
Sales
|
— | — | (425 | ) | ||||||||
|
Payments/maturities/credits
|
— | (6,321 | ) | — | ||||||||
|
Properties/loans
added
|
— | 11,267 | 2,024 | |||||||||
|
Ending
balance December 31, 2008
|
$ | 24,266 | $ | 11,760 | $ | 2,424 | ||||||
Federal Home Loan Bank
stock: The
carrying value of Federal Home Loan stock approximates fair value based on the
redemption provisions of the Federal Home Loan Bank.
Loans: For
variable rate loans and leases that reprice frequently or “in one year or less,”
and with no significant change in credit risk, fair values are based on carrying
values. Fair values for fixed rate loans and leases and loans and
leases that do not reprice frequently are estimated using a discounted cash flow
calculation that applies current market interest rates being offered on the
various loan products.
Deposits: The
fair values disclosed for demand deposits (e.g., interest and non-interest
checking, savings, and certain types of money market accounts) are, by
definition, equal to the amount payable on demand at the reporting date (i.e.,
their carrying amounts). Fair values for fixed rate certificates of
deposit are estimated using a discounted cash flow calculation that applies
interest rates currently being offered on the various certificates of deposit to
the cash flow stream.
Borrowed
funds: The fair value of the Corporation’s Federal Home Loan Bank
borrowings and junior subordinated debt is calculated based on the discounted
value of contractual cash flows, using rates currently existing for borrowings
with similar remaining maturities. The carrying amounts of federal
funds purchased and securities sold under agreements to repurchase approximate
their fair values.
Accrued
Interest: The carrying amount of accrued interest receivable
and payable approximates their fair values.
Off-Balance-Sheet
Financial Instruments: In the normal course of business, the
Corporation makes commitments to extend credit and issues standby letters of
credit. The Corporation expects most of these commitments to expire
without being drawn upon, therefore the commitment amounts do not necessarily
represent future cash requirements. Due to the uncertainty of cash
flows and difficulty in the predicting the timing of such cash flows, fair
values were not estimated for these instruments. The Corporation did
not have any derivative financial instruments at December 31, 2008 or
2007.
[72]
16. Parent
Company Only Financial Information
Condensed
Statements of Financial Condition (in thousands)
|
December
31
|
||||||||
|
2008
|
2007
|
|||||||
|
Assets
|
||||||||
|
Cash
|
$ | 482 | $ | 1,486 | ||||
|
Investment
securities
|
1,236 | 1,216 | ||||||
|
Investment
in bank subsidiary
|
88,346 | 121,632 | ||||||
|
Investment
in non-bank subsidiaries
|
13,247 | 11,923 | ||||||
|
Other
assets
|
7,586 | 6,919 | ||||||
|
Total
Assets
|
$ | 110,897 | $ | 143,176 | ||||
|
Liabilities
and Shareholder’s Equity
|
||||||||
|
Accrued
interest and other liabilities
|
$ | 1,180 | $ | 1,348 | ||||
|
Dividends
payable
|
1,098 | 1,234 | ||||||
|
Junior
subordinated debt
|
35,929 | 35,929 | ||||||
|
Shareholders’
equity
|
72,690 | 104,665 | ||||||
|
Total
Liabilities and Shareholder’s Equity
|
$ | 110,897 | $ | 143,176 | ||||
Condensed
Statements of Income (in thousands)
|
Year
Ended December 31
|
||||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Income:
|
||||||||||||
|
Dividend
income from bank subsidiary
|
$ | 8,192 | $ | 7,912 | $ | 5,819 | ||||||
|
Other
income
|
(34 | ) | 299 | 284 | ||||||||
|
Total
Income
|
8,158 | 8,211 | 6,103 | |||||||||
|
Expenses:
|
||||||||||||
|
Interest
expense
|
2,175 | 2,384 | 2,355 | |||||||||
|
Other
expenses
|
(10 | ) | 169 | 142 | ||||||||
|
Total
Expenses
|
2,165 | 2,553 | 2,497 | |||||||||
|
Income
before income taxes and equity in undistributed net income of
subsidiaries
|
5,993 | 5,658 | 3,606 | |||||||||
|
Equity
in undistributed net income of subsidiaries:
|
||||||||||||
|
Bank
|
2,054 | 5,790 | 8,124 | |||||||||
|
Non-bank
|
824 | 1,345 | 847 | |||||||||
|
Net
Income
|
$ | 8,871 | $ | 12,793 | $ | 12,577 | ||||||
[73]
Condensed
Statements of Cash Flows (in thousands)
|
Year
Ended December 31
|
||||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Operating
Activities
|
||||||||||||
|
Net
Income
|
$ | 8,871 | $ | 12,793 | $ | 12,577 | ||||||
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||||||
|
Equity
in undistributed net income of subsidiaries
|
(2,878 | ) | (7,135 | ) | (8,971 | ) | ||||||
|
Decrease
(increase) in other assets
|
(667 | ) | 124 | 1,208 | ||||||||
|
Increase
(decrease) in accrued interest payable and other
liabilities
|
(168 | ) | (122 | ) | 138 | |||||||
|
Stock
Compensation
|
149 | - | - | |||||||||
|
Increase
(decrease) in dividends payable
|
(136 | ) | 65 | 6 | ||||||||
|
|
||||||||||||
|
Net
cash provided by operating activities
|
5,171 | 5,725 | 4,958 | |||||||||
|
Investing
Activities
|
||||||||||||
|
Proceeds
from investment maturities
|
(20 | ) | — | 9 | ||||||||
|
Net
investment in subsidiaries
|
(352 | ) | (988 | ) | (1,281 | ) | ||||||
|
|
||||||||||||
|
Net
cash used in investing activities
|
(372 | ) | (988 | ) | (1,272 | ) | ||||||
|
Financing
Activities
|
||||||||||||
|
Cash
dividends
|
(4,774 | ) | (4,796 | ) | (4,662 | ) | ||||||
|
Proceeds
from issuance of common stock
|
362 | 476 | 502 | |||||||||
|
Repurchase
of Common Stock
|
(1,391 | ) | (524 | ) | — | |||||||
|
Net
cash provided by (used in) financing activities
|
(5,803 | ) | (4,844 | ) | (4,160 | ) | ||||||
|
Decrease
in cash and cash equivalents
|
(1,004 | ) | (107 | ) | (474 | ) | ||||||
|
Cash
and cash equivalents at beginning of year
|
1,486 | 1,593 | 2,067 | |||||||||
|
Cash
and cash equivalents at end of year
|
$ | 482 | $ | 1,486 | $ | 1,593 | ||||||
17. Subsequent
Event
On
January 30, 2009, pursuant to the U.S. Department of Treasury’s TARP Capital
Purchase Program, the Corporation issued the following securities to the initial
selling security holder for an aggregate consideration of
$30,000,000: (i) 30,000 shares of Fixed Rate Cumulative Perpetual
Preferred Stock, Series A, having no par per share; and (ii) a warrant to
purchase 326,323 shares of common stock, par value $.01 per share, for an
exercise price of $13.79 per share. The proceeds from this
transaction count as Tier 1 capital and the warrant qualifies as tangible common
equity. The operative documents relating to this transaction have
been filed with the U.S. Securities and Exchange Commission and are referenced
as Exhibits 4.1 through 4.4 to this annual report.
[74]
18. Quarterly
Results of Operations (Unaudited)
The
following is a summary of the quarterly results of operations for the years
ended December 31, 2008 and 2007 (in thousands, except per share
amounts):
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
|||||||||||||
|
2008
|
||||||||||||||||
|
Interest
income
|
$ | 23,858 | $ | 23,851 | $ | 23,777 | $ | 23,730 | ||||||||
|
Interest
expense
|
11,829 | 10,627 | 10,576 | 10,011 | ||||||||||||
|
Net
interest income
|
12,029 | 13,224 | 13,201 | 13,719 | ||||||||||||
|
Provision
for loan losses
|
1,387 | 966 | 4,217 | 6,355 | ||||||||||||
|
Other
income
|
3,941 | 4,493 | 3,778 | 3,554 | ||||||||||||
|
Gains
(losses) on securities
|
399 | 77 | - | (2,473 | ) | |||||||||||
|
Other
expenses
|
10,354 | 10,651 | 9,976 | 9,592 | ||||||||||||
|
Income
(loss) before income taxes
|
4,628 | 6,177 | 2,786 | (1,147 | ) | |||||||||||
|
Applicable
income taxes
|
1,493 | 2,063 | 921 | (904 | ) | |||||||||||
|
Net
income (loss)
|
$ | 3,135 | $ | 4,114 | $ | 1,865 | $ | (243 | ) | |||||||
|
Earnings
(loss) per share
|
$ | .51 | $ | .68 | $ | .30 | $ | (.04 | ) | |||||||
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
|||||||||||||
|
2007
|
||||||||||||||||
|
Interest
income
|
$ | 21,418 | $ | 22,841 | $ | 24,262 | $ | 25,044 | ||||||||
|
Interest
expense
|
11,353 | 11,947 | 13,021 | 13,010 | ||||||||||||
|
Net
interest income
|
10,065 | 10,894 | 11,241 | 12,034 | ||||||||||||
|
Provision
for loan losses
|
163 | 367 | 790 | 992 | ||||||||||||
|
Other
income
|
3,872 | 4,117 | 4,063 | 4,645 | ||||||||||||
|
Gains
(losses) on securities
|
(1,511 | ) | (99 | ) | 0 | 5 | ||||||||||
|
Other
expenses
|
9,243 | 9,836 | 9,626 | 9,770 | ||||||||||||
|
Income
before income taxes
|
3,020 | 4,709 | 4,888 | 5,922 | ||||||||||||
|
Applicable
income taxes
|
959 | 1,504 | 1,333 | 1,950 | ||||||||||||
|
Net
income
|
$ | 2,061 | $ | 3,205 | $ | 3,555 | $ | 3,972 | ||||||||
|
Earnings
per share
|
$ | .34 | $ | .52 | $ | .58 | $ | .64 | ||||||||
[75]
|
ITEM
9.
|
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
|
None.
|
ITEM
9A.
|
CONTROLS
AND PROCEDURES
|
The
Corporation maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Corporation’s reports
filed under the Securities Exchange Act of 1934 with the SEC, such as this
annual report, is recorded, processed, summarized and reported within the time
periods specified in those rules and forms, and that such information is
accumulated and communicated to the Corporation’s management, including the
Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), as
appropriate, to allow for timely decisions regarding required
disclosure. A control system, no matter how well conceived and
operated, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Further, the design of a
control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their
costs. These inherent limitations include the realities that
judgments in decision-making can be faulty, and that breakdowns can occur
because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions;
over time, a control may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may
deteriorate.
An
evaluation of the effectiveness of these disclosure controls as of December 31,
2008 was carried out under the supervision and with the participation of the
Corporation’s management, including the CEO and the CFO. Based on
that evaluation, the Corporation’s management, including the CEO and the CFO,
has concluded that the Corporation’s disclosure controls and procedures are, in
fact, effective at the reasonable assurance level.
During
the fourth quarter of 2008, there was no change in the Corporation’s internal
control over financial reporting that has materially affected, or is reasonably
likely to materially affect, the Corporation’s internal control over financial
reporting.
As
required by Section 404 of the Sarbanes-Oxley Act of 2002, management has
performed an evaluation and testing of the Corporation’s internal control over
financial reporting as of December 31, 2008. Management’s report on
the Corporation’s internal control over financial reporting and the related
attestation report of the Corporation’s registered public accounting firm are
included on the following pages.
[76]
Management’s
Report on Internal Control Over Financial Reporting
The Board
of Directors and Shareholders
First
United Corporation
The
Corporation’s management is responsible for establishing and maintaining
adequate internal control over financial reporting. This internal
control system was designed to provide reasonable assurance to management and
the Board of Directors as to the reliability of the Corporation’s financial
reporting and the preparation and presentation of financial statements for
external purposes in accordance with accounting principles generally accepted in
the United States, as well as to safeguard assets from unauthorized use or
disposition.
An
internal control system, no matter how well designed, has inherent
limitations. Therefore, even those systems determined to be effective
can provide only reasonable assurance with respect to financial statement
preparation and presentation and may not prevent or detect misstatements in the
financial statements or the unauthorized use or disposition of the Corporation’s
assets. Also, projections of any evaluation of effectiveness of
internal controls to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with policies and procedures may deteriorate.
Management
assessed the effectiveness of the Corporation’s internal control over financial
reporting as of December 31, 2008, based on the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) in
Internal Control—Integrated Framework. Based on this assessment and
on the foregoing criteria, management has concluded that, as of December 31,
2008, the Corporation’s internal control over financial reporting is
effective.
Beard
Miller Company LLP, an independent registered public accounting firm, has
audited the Consolidated Financial Statements of the Corporation for the year
ended December 31, 2008, appearing elsewhere in this annual report, and has
issued an attestation report on the effectiveness of the Corporation’s internal
control over financial reporting as of December 31, 2008, as stated in their
report, which is included herein.
|
/s/ William B. Grant
|
/s/ Carissa L.
Rodeheaver
|
|
|
William
B. Grant, Esq., CFP
|
Carissa
L. Rodeheaver, CPA, CFP
|
|
|
Chairman
of the Board and
|
Executive
Vice President and
|
|
|
Chief
Executive Officer
|
Chief
Financial Officer
|
[77]
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Shareholders
First
United Corporation
Oakland,
Maryland
We have
audited First United Corporation’s internal control over financial reporting as
of December 31, 2008, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). First United Corporation’s management is
responsible for maintaining effective internal control over financial reporting
and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Management's Report on Internal Control
Over Financial Reporting. Our responsibility is to express an opinion
on the Corporation’s internal control over financial reporting based on our
audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit of internal control over financial
reporting included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, and testing and
evaluating the design and operating effectiveness of internal control, based on
the assessed risk. Our audit also included performing such other
procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our
opinion, First United Corporation maintained, in all material respects,
effective internal control over financial reporting as of December 31, 2008,
based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated statements of financial
condition and the related consolidated statements of income, changes in
shareholders’ equity, and cash flows of First United Corporation, and our report
dated March 4, 2009, expressed an unqualified opinion.
|
/s/
Beard Miller Company LLP
|
Beard
Miller Company LLP
Pittsburgh,
Pennsylvania
March 4,
2009
[78]
|
ITEM
9B.
|
OTHER
INFORMATION
|
None.
PART
III
|
ITEM
10.
|
DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE
|
The
Corporation has adopted a Code of Ethics applicable to its principal executive
officer, principal financial officer, principal accounting officer, or
controller, or persons performing similar functions, a Code of Ethics applicable
to all employees, and a Code of Ethics applicable to members of the Board of
Directors. Copies of the Corporation’s Codes of Ethics are available
free of charge upon request to Mr. Robert W. Kurtz, Secretary, First United
Corporation, c/o First United Bank & Trust, P.O. Box 9, Oakland, MD
21550-0009 or on the Corporation’s website at
www.mybankfirstunited.com.
All other
information required by this item is incorporated herein by reference to the
Corporation’s definitive Proxy Statement for the 2009 Annual Meeting of
Shareholders to be filed with the SEC pursuant to Regulation 14A.
|
ITEM
11.
|
EXECUTIVE
COMPENSATION
|
The
information required by this item is incorporated herein by reference to the
Corporation’s definitive Proxy Statement for the 2009 Annual Meeting of
Shareholders to be filed with the SEC pursuant to Regulation 14A.
|
ITEM
12.
|
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
|
The
information regarding the Corporation’s equity compensation plans required by
this item is incorporated herein by reference to Item 5 of Part II of this
annual report. All other information required by this item is
incorporated herein by reference to the Corporation’s definitive Proxy Statement
for the 2009 Annual Meeting of Shareholders to be filed with the SEC pursuant to
Regulation 14A.
|
ITEM
13.
|
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
|
The
information required by this item is incorporated herein by reference to the
Corporation’s definitive Proxy Statement for the 2009 Annual Meeting of
Shareholders to be filed with the SEC pursuant to Regulation 14A.
|
ITEM
14.
|
PRINCIPAL
ACCOUNTANT FEES AND SERVICES
|
The
information required by this item is incorporated herein by reference to the
Corporation’s definitive Proxy Statement for the 2009 Annual Meeting of
Shareholders to be filed with the SEC pursuant to Regulation 14A.
PART
IV
|
ITEM
15.
|
EXHIBITS
AND FINANCIAL STATEMENT SCHEDULES
|
(a)(1), (2) and
(c) Financial Statements.
Report of
Independent Registered Public Accounting Firm
Consolidated
Statements of Financial Condition as of December 31, 2008 and 2007
Consolidated
Statements of Income for the years ended December 31, 2008, 2007 and
2006
Consolidated
Statements of Changes in Shareholders’ Equity for the years ended December 31,
2008, 2007and 2006
Consolidated
Statements of Cash Flows for the years ended December 31, 2008, 2007 and
2006
Notes to
Consolidated Financial Statements for the years ended December 31, 2008, 2007
and 2006
[79]
(a)(3) and
(b) Exhibits.
The
exhibits filed or furnished with this annual report are shown on the Exhibit
List that follows the signatures to this annual report, which Exhibit List is
incorporated herein by reference.
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
|
FIRST
UNITED CORPORATION
|
||
|
Dated: March
2, 2009
|
By:
|
/s/ William B. Grant
|
|
William
B. Grant, Esq., CFP
|
||
|
Chairman
of the Board and Chief Executive
Officer
|
||
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities indicated.
|
/s/ William B. Grant
|
/s/ David J. Beachy
|
|
|
(William
B. Grant) Director, Chief Executive Officer
|
(David
J. Beachy) Director—March 2, 2009
|
|
|
March
2, 2009
|
||
|
/s/ M. Kathryn Burkey
|
/s/ Faye E. Cannon
|
|
|
(M.
Kathryn Burkey) Director—March 2, 2009
|
(Faye
E. Cannon) Director—March 2, 2009
|
|
|
/s/ Paul Cox, Jr.
|
/s/ Raymond F. Hinkle
|
|
|
(Paul
Cox, Jr.) Director—March 2, 2009
|
(Raymond
F. Hinkle) Director—March 2, 2009
|
|
|
/s/ Robert W. Kurtz
|
/s/ John W. McCullough
|
|
|
(Robert
W. Kurtz) Director, President and Chief
|
(John
W. McCullough) Director—March 2, 2009
|
|
|
Risk
Officer—March 2, 2009
|
||
|
/s/ Elaine L. McDonald
|
/s/ Donald E. Moran
|
|
|
(Elaine
L. McDonald) Director—March 2, 2009
|
(Donald
E. Moran) Director—March 2, 2009
|
|
|
/s/ Carissa L. Rodeheaver
|
/s/ Gary R. Ruddell
|
|
|
(Carissa
L. Rodeheaver) EVP & Chief Financial Officer-
|
(Gary
R. Ruddell) Director—March 2, 2009
|
|
|
March
2, 2009
|
||
|
/s/ I. Robert Rudy
|
/s/
Richard G. Stanton
|
|
|
(I.
Robert Rudy) Director—March 2, 2009
|
(Richard
G. Stanton) Director – March 2, 2009
|
|
|
/s/ Robert G. Stuck
|
/s/ H. Andrew Walls, III
|
|
|
(Robert
G. Stuck) Director—March 2, 2009
|
(H.
Andrew Walls, III) Director—March 2,
2009
|
[80]
EXHIBIT
INDEX
|
Exhibit
|
Description
|
|
3.1
|
Amended
and Restated Articles of Incorporation (incorporated by reference to
Exhibit 3.1 of the Corporation's Quarterly Report on Form 10-Q for the
period ended June 30, 1998)
|
|
3.2(i)
|
Amended
and Restated By-Laws (filed herewith)
|
|
3.2(ii)
|
First
Amendment to Amended and Restated Bylaws (filed
herewith)
|
|
3.2(iii)
|
Second
Amendment to Amended and Restated Bylaws (filed
herewith)
|
|
4.1
|
Letter
Agreement, including the related Securities Purchase Agreement – Standard
Terms, dated January 30, 2009 by and between the Corporation and the U.S.
Department of Treasury (incorporated by reference to Exhibit 10.1 of the
Corporation’s Form 8-K filed on February 2, 2009)
|
|
4.2
|
Certificate
of Notice, including the Certificate of Designations incorporated therein,
relating to the Fixed Rate Cumulative Perpetual Preferred Stock, Series A
(incorporated by reference Exhibit 4.1 of the Corporation’s Form 8-K filed
on February 2, 2009)
|
|
4.3
|
Sample
Stock Certificate for Series A Preferred Stock for the Series A Preferred
Stock (incorporated by reference Exhibit 4.3 of the Corporation’s Form 8-K
filed on February 2, 2009)
|
|
4.4
|
Common
Stock Purchase Warrant dated January 30, 2009 issued to the U.S.
Department of Treasury (incorporated by reference to Exhibit 4.2 of the
Corporation’s Form 8-K filed on February 2, 2009)
|
|
10.1
|
First
United Bank & Trust Amended and Restated Supplemental Executive
Retirement Plan (“SERP”) (incorporated by reference to Exhibit 10.4 of the
Corporation’s Current Report on Form 8-K filed on February 21,
2007)
|
|
10.2
|
Amended
and Restated SERP Agreement with William B. Grant (incorporated by
reference to Exhibit 10.5 of the Corporation’s Current Report on Form 8-K
filed on February 21, 2007)
|
|
10.3
|
Form
of Amended and Restated SERP Agreement with executive officers other than
William B. Grant (incorporated by reference to Exhibit 10.6 of the
Corporation’s Current Report on Form 8-K filed on February 21,
2007)
|
|
10.4
|
Form
of Endorsement Split Dollar Agreement between the Bank and each of William
B. Grant, Robert W. Kurtz, Jeannette R. Fitzwater, Phillip D. Frantz,
Eugene D. Helbig, Jr., Steven M. Lantz, Robin M. Murray, Carissa L.
Rodeheaver, and Frederick A. Thayer, IV (incorporated by reference to
Exhibit 10.3 of the Corporation’s Quarterly Report on Form 10-Q for the
period ended September 30, 2003)
|
|
10.5
|
Amended
and Restated First United Corporation Executive and Director Deferred
Compensation Plan (incorporated by reference to Exhibit 10.1 of the
Corporation’s Current Report on Form 8-K filed on November 24,
2008)
|
|
10.6
|
Amended
and Restated First United Corporation Change in Control Severance Plan
(incorporated by reference to Exhibit 10.5 of the Corporation’s Current
Report on Form 8-K filed on June 23, 2008)
|
|
10.7
|
Form
of Change in Control Severance Plan Agreement with executive officers
other than William B. Grant (incorporated by reference to Exhibit 10.3 of
the Corporation’s Current Report on Form 8-K filed on February 21,
2007)
|
|
10.8
|
First
United Corporation Omnibus Equity Compensation Plan (incorporated by
reference to Appendix B to the Corporation’s 2007 definitive proxy
statement filed on March 23, 2007)
|
|
10.9
|
First
United Corporation Long-Term Incentive Plan (incorporated by reference to
Exhibit 10.1 of the Corporation’s Current Report on Form 8-K filed on June
23, 2008)
|
|
10.10
|
Restricted
Stock Agreement for William B. Grant (incorporated by reference to Exhibit
10.2 of the Corporation’s Current Report on Form 8-K filed on June 23,
2008)
|
|
10.11
|
Form
of Restricted Stock Agreement for Executive Officers other than the Chief
Executive Officer (incorporated by reference to Exhibit 10.3 of the
Corporation’s Current Report on Form 8-K filed on June 23,
2008)
|
|
10.12
|
First
United Corporation Executive Pay for Performance Plan (incorporated by
reference to Exhibit 10.4 of the Corporation’s Current Report on Form 8-K
filed on June 23, 2008)
|
|
21
|
Subsidiaries
of the Corporation, incorporated by reference to the list of subsidiaries
in the discussion entitled “General” in Item 1 of Part I of this Annual
Report on Form 10-K.
|
[81]
|
23.1
|
Consent
of Beard Miller Company LLP (filed herewith)
|
|
31.1
|
Certifications
of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
herewith)
|
|
31.2
|
Certifications
of the CFO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
herewith)
|
|
32.1
|
Certifications
pursuant to Section 906 of the Sarbanes-Oxley Act (furnished
herewith)
|
[82]