# First United Corp: Form 10-Q for the period ended Mar 31, 2009

- Company: [First United Corp](/companies/func.md) (CIK 763907)
- Form: 10-Q
- Filed: 2009-05-11
- Accepted by EDGAR: May 11, 2009, 18:37 ET
- Period: 2009-03-31
- Accession: 0001144204-09-025308
- Inline XBRL: no
- Main document: https://www.sec.gov/Archives/edgar/data/763907/000114420409025308/v148604_10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/763907/000114420409025308/

## Management's discussion and analysis

As filed, 58,722 characters.

INTRODUCTION

The following discussion and analysis is intended as a review of material changes in and significant factors affecting the financial condition and results of operations of the Corporation and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto contained in Item 1 of Part I of this report. Unless the context clearly suggests otherwise, references in this report to “us”, “we”, “our”, and “the Corporation” are to First United Corporation and its consolidated subsidiaries.

FORWARD-LOOKING STATEMENTS

This report 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 we operate, 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 our loan and investment portfolios; our 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 report 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. These and other risks are discussed in detail in the periodic reports that First United Corporation files with the Securities and Exchange Commission (the “SEC”) (see Item 1A of Part II of this report for further information). Except as required by applicable laws, we do not intend to publish updates or revisions of any forward-looking statements we make to reflect new information, future events or otherwise.

THE COMPANY

First United Corporation is a Maryland corporation that was incorporated in 1985 and is a registered financial holding company under the federal Bank Holding Company Act of 1956, as amended. The Corporation’s primary business activity is acting as the parent company of First United Bank & Trust, a Maryland trust company (the “Bank”), OakFirst Loan Center, Inc., a West Virginia finance company, OakFirst Loan Center, LLC, a Maryland finance company, the Trusts, and First United Insurance Group, LLC, a full service insurance provider organized under Maryland law (the “Insurance Group”). OakFirst Loan Center, Inc. has one subsidiary, First United Insurance Agency, Inc., which is a Maryland insurance agency. 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.

We maintain an Internet site at www.mybankfirstunited.com on which we make available, free of charge, First United Corporation’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.

ESTIMATES AND CRITICAL ACCOUNTING POLICIES

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 to the Consolidated Financial Statements included in Item 8 of Part II of First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2008). On an on-going basis, management evaluates its estimates, including those related to loan losses, intangible assets, other-than-temporary impairment of investment securities and pension plan assumptions. 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 described its critical accounting policies in First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2008. The following discussion updates a critical accounting policy that was contained in the Annual Report on Form 10-K to reflect recent changes in economic conditions.

#### 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 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 securities for impairment on a quarterly basis. Based upon application of Financial Accounting Standards Board Staff Position No. FAS 115-2 and FAS 124-2 (“FSP No. FAS 115-2 and FAS 124-2”), management must assess whether (a) it has the intent to sell the security and (b) if it is more likely than not that it will be required to sell the security prior to its anticipated recovery. If neither apply, declines in the fair value of securities below their cost that are considered other-than-temporary declines are split into two components. The first is the loss attributable to declining credit quality. Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made. The second component consists of all other losses. The other losses are recognized in other comprehensive income. Further discussion about FSP No. FAS 115-2 and FAS 124-2 and its application can be found in the “Investments” section of Management's Discussion and Analysis of Financial Condition and Results of Operations. 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) Adverse conditions specifically related to the security, an industry, or a geographic area, (3) the historic and implied volatility of the security, (4) changes in the rating of a security by a rating agency, (5) recoveries or additional declines in fair value subsequent to the balance sheet date, (6) Failure of the issuer of the security to make scheduled interest payments, and (7) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future.

Other than as discussed above, management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2008.

SELECTED FINANCIAL DATA

The following table sets forth certain selected financial data for the three months ended March 31, 2009 and 2008 and is qualified in its entirety by the detailed information and unaudited financial statements including the notes thereto, included elsewhere in this quarterly report.

| Per Share Data Basic net income per common share Diluted net income per common share Dividends Declared | At or For the Three Months Ended March 31 2009 $.35 $.35 $.20 | 2008 $.51 $.51 $.20 |
| --- | ---: | ---: |
| Book Value | $10.95 | $16.69 |
| Significant Ratios |  |  |
| Return on Average Assets (a) | .58% | .82% |
| Return on Average Equity (a) | 9.66% | 11.92% |
| Dividend Payout Ratio | 51.23% | 37.80% |
| Average Equity to Average Assets | 6.00% | 6.90% |
| Note: (a) Annualized |  |  |

RESULTS OF OPERATIONS

#### Overview

Consolidated net income available to common shareholders for the first three months of 2009 totaled $2.1 million or $.35 per common share, compared to $3.1 million or $.51 per common share for the same period of 2008. The decrease in net income resulted primarily from a $.7 million other-than-temporary impairment charge, a $.4 million realized loss on the investment portfolio and $.7 million in increased provision expense. Interest expense on our interest-bearing liabilities decreased $3.3 million due to the low interest rate environment, our decision to only increase special pricing for full relationship customers and certificates of deposit renewing at lower interest rates due to the short duration of our portfolio. As a result, our net interest income for the first three months of 2009 increased $1.8 million when compared to the same period of 2008 and our net interest margin increased from 3.56% in the first three months of 2008 to 3.83% in the first three months of 2009. The provision for loan losses was $2.0 million for the three months ended March 31, 2009, compared to $1.4 million for the same period of 2008. The increased provision is due primarily to specific allocations for impaired loans where management has determined that the collateral supporting the loans is not adequate to cover the loan balance and to increases in the qualitative factors as a result of the current recession and distressed economic environment during 2008 and the first three months of 2009.

Other operating income decreased $1.8 million during the first three months of 2009 when compared to the same period of 2008. This decrease is primarily attributable to the recognition of a $.7 million other-than-temporary impairment charge and a $.4 million realized loss on the investment portfolio. Trust department income and income earned on bank owned life insurance have also declined as compared to the same time period in 2008 due to decreases in the market values of assets under management and reduced interest rates. Management has noted a decrease in consumer spending habits as service charge income has shown declines during the quarter. These declines were offset slightly by increased insurance premium income as a result of acquisitions during 2008. Operating expenses increased $.6 million in the first three months of 2009 when compared to the same period of 2008 due primarily to increases in personnel expenses as we continue our expansion in Morgantown, West Virginia, Frederick, Maryland and in the markets served by our insurance agencies.

#### Net Interest Income

Net interest income is the largest source of operating revenue and 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 fully taxable equivalent basis to facilitate performance comparisons between taxable and tax-exempt assets. Fully taxable equivalent income is determined 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 following table sets forth the average balances, net interest income and expense, and average yields and rates of our interest-earning assets and interest-bearing liabilities for the three months ended March 31, 2009 and 2008.

*(Dollars in thousands)*

| Interest-Earning Assets: | 2009 Average Balance | Interest | Average Rate | 2008 Average Balance | Interest | Average Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans | $1,129,772 | $17,578 | 6.31% | $1,045,689 | $18,960 | 7.29% |
| Investment securities | 339,319 | 5,332 | 6.37 | 352,631 | 5,181 | 5.91 |
| Other interest earning assets | 51,527 | (16) | (.13) | 12,521 | 179 | 5.75 |
| **Total earning assets** | $1,520,618 | 22,894 | 6.11% | $1,410,841 | 24,320 | 6.93% |
| **Interest-bearing liabilities** |  |  |  |  |  |  |
| Interest-bearing deposits | $1,136,001 | 5,549 | 2.01% | $1,043,135 | 9,116 | 3.51% |
| Short-term borrowings | 45,314 | 75 | .67 | 59,090 | 335 | 2.28 |
| Long-term borrowings | 277,292 | 2,923 | 4.28 | 200,122 | 2,378 | 4.78 |
| **Total interest-bearing liabilities** | $1,458,607 | 8,547 | 2.38% | $1,302,347 | 11,829 | 3.65% |
| Net interest income and spread |  | $14,347 | 3.73% |  | $12,491 | 3.28% |
| Net interest margin |  |  | **3.83%** |  |  | **3.56%** |

Note: Interest income and yields are presented on a fully taxable equivalent basis using a 35% tax rate.

Net interest income increased $1.9 million during the first three months of 2009 over the same period in 2008 due to a $3.3 (27.7%) million decrease in interest expense, offset by a $1.4 million (5.9%) decrease in interest income. The decrease in interest income resulted primarily from a decrease in interest rates on loans during the first three months of 2009 when compared to the first three months of 2008. As of March 31, 2009, a reversal of approximately $28,000 is reflected in the other interest earning assets. This reversal was due to the accrual of dividends for “FHLB” stock at a rate of .80% for the fourth quarter of 2008. The Corporation was notified during the first quarter of 2009 that the Federal Home Loan Bank of Atlanta would not be paying a dividend for the fourth quarter 2008. The decreases in interest rates throughout 2008 contributed to the decrease in the average rate on our average earning assets of 82 basis points, from 6.93% for the first three months of 2008 to 6.11% for the first three months of 2009 (on a fully tax equivalent basis).

Interest expense also decreased during the first three months of 2009 when compared to the same period of 2008 due to a reduction in interest rates on interest-bearing liabilities. Average interest-bearing liabilities increased in the first three months of 2009 by $156.3 million when compared to the same time period for 2008, with interest-bearing deposits increasing by approximately $92.9 million. The effect of the decreasing rate environment throughout 2008, our decision to only increase special pricing for full relationship customers and the short duration of our portfolio resulted in a 127 basis point decrease in the average rate paid on our average interest-bearing liabilities from 3.65% for the three months ended March 31, 2008 to 2.38% for the same period of 2009.

The net result of the aforementioned factors was a 27 basis point increase in the net interest margin during the first three months of 2009 to 3.83% from 3.56% for the same time period of 2008.

#### Provision for Loan Losses

The provision for loan losses was $2.0 million for the first three months of 2009, compared to $1.4 million for the same period of 2008. The increase in the provision was in response to the increase in net charge-offs, specific allocations for impaired loans where management has determined that the collateral supporting the loans is not adequate to cover the loan balance and increases in the qualitative factors as a result of the current recession and distressed economic environment during 2008 and the first three months of 2009. Additional information regarding risk elements in the loan portfolio and management’s assessment of the adequacy of the allowance for loan losses are discussed in the “Allowance and Provision for Loan Losses” section.

#### Other Operating Income

Other operating income decreased $1.8 million during the first three months of 2009 when compared to the same period of 2008. The decrease is primarily attributable to the recognition of a $.7 million other-than-temporary impairment charge and a $.4 million realized loss on the investment portfolio. We also saw decreases in service charge income due to decreased consumer spending. Trust department revenue and income on our bank owned life insurance policies also decreased due to declines in the market values of assets under management and reduced interest rates. These declines were offset slightly by increased insurance premium income as a result of acquisitions during 2008. The composition of operating income is illustrated in the following table. For comparative purposes, the securities (losses)/gains of ($1.1) million at March 31, 2009 and securities gain of $.4 million at March 31, 2008 have been excluded from the following table. However, these amounts are reflected in other operating income on the consolidated statements of income.

|  | Income as % of Total Other Operating Income Three Months ended March 31, 2009 | March 31,2008 |
| --- | ---: | ---: |
| Service charges | 36% | 37% |
| Trust department | 22% | 26% |
| Insurance commissions | 20% | 14% |
| Bank owned life insurance (BOLI) | 4% | 7% |
| Other income | 18% | 16% |
|  | 100% | 100% |

#### Other Operating Expenses

Other operating expenses increased $.6 million or 6.1% for the three months of 2009 when compared to the three months of 2008. The increase was due principally to increases in personnel expenses as we continue our expansion in Morgantown, West Virginia, Frederick, Maryland and in the markets served by our insurance agencies. The composition of operating expense is illustrated in the following table.

|  | Expense as % of Total Other Operating Expenses Three Months ended March 31, 2009 | March 31,2008 |
| --- | ---: | ---: |
| Salaries and employee benefits | 54% | 56% |
| Occupancy, equipment and data processing | 19% | 18% |
| Other | 27% | 26% |
|  | 100% | 100% |

25

#### Applicable Income Taxes

The effective tax rate for the first three months of 2009 was 30%, compared to 32% for the first three months of 2008. The effective tax rate for the year-ended December 31, 2008 was 29%. The slight decrease as compared to the same time period in 2008 is primarily attributable to a decrease in pre-tax income and the increased portion of pre-tax income that is tax-exempt.

### FINANCIAL CONDITION

#### Balance Sheet Overview

Total assets were $1.6 billion at March 31, 2009, an increase of $16.5 million since December 31, 2008. During this time period, gross loans decreased $11.3 million, cash and interest-bearing deposits in banks increased $43.9 million and our investment portfolio decreased $19.7 million. Total liabilities decreased by approximately $7.9 million during the first three months of 2009, reflecting increases in total deposits of $.6 million and decreases in long-term and short-term borrowings of $.3 million and $8.2 million, respectively. The increase of $24.4 million in shareholders’ equity is primarily attributable to the $30.0 million raised in January 2009 through the sale of preferred securities to U.S. Department of the Treasury pursuant to its Capital Purchase Program, offset partially by the $6.8 million increase in the accumulated other comprehensive loss due to the unrealized losses in the investment portfolio at March 31, 2009.

#### Loan Portfolio

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

*(Dollars in millions)*

|  | March 31, 2009 |  | December 31, 2008 |  |
| --- | ---: | ---: | ---: | ---: |
| Commercial | $582.0 | 52% | $575.9 | 51% |
| Residential – Mortgage | 400.7 | 36 | 403.8 | 36 |
| Installment | 128.9 | 11 | 140.2 | 12 |
| Residential – Construction | 11.6 | 1 | 14.6 | 1 |
| Total Loans | $1,123.2 | 100% | $1,134.5 | 100% |

Comparing loans at March 31, 2009 to loans at December 31, 2008, our loan portfolio has decreased by $11.3 million (1.0%). Continued growth in commercial loans ($6.1 million) was offset by a decline in our residential mortgage and construction portfolio ($6.1 million) and a decline in our installment portfolio ($11.3 million). The decrease in installment loans is primarily attributable to a decline in the indirect loan portfolio resulting from a slowdown in economic activity and management’s de-emphasis of this form of lending product. The decrease in the residential mortgage portfolio is attributable to the increased amount of loan refinancings that are occurring as consumers seek long-term fixed rate loans. The growth in the commercial portfolio is a result of continuous growth in our new market areas. At March 31, 2009, approximately 73% of the commercial loan portfolio was collateralized by real estate, compared to 74% at December 31, 2008.

#### Risk Elements of Loan Portfolio

The following table presents the risk elements of our loan portfolio at the dates indicated. Management is not aware of any potential problem loans other than those listed in this table or discussed below.

*(Dollars in thousands)*

|  | March 31, 2009 | December 31, 2008 |
| --- | ---: | ---: |
| Non-accrual loans | $38,176 | $24,553 |
| Accruing loans past due 90 days or more | 467 | 3,476 |
| Total | $38,643 | $28,029 |
| Total as a percentage of total loans | 3.44% | 2.47% |

Performing loans considered impaired loans, as defined and identified by management, amounted to $30.0 million at March 31, 2009 and $56.5 million at December 31, 2008. This decrease since December 31, 2008 is directly attributable to the charge offs of several large commercial loans and an increase in non-accrual loans. 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.

As of March 31, 2009, we had $63.8 million in funded real estate acquisition and development loans throughout our market areas. We rely on various monitoring policies and procedures and the extensive experience of our lending and credit personnel to help mitigate the risks related to this type of lending activity.

During the past several years, there has been 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 defaults and foreclosure. We generally do not make sub-prime loans. When we do make such loans, 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. Management believes that, as of March 31, 2009, our exposure to risk related to sub-prime loans is very low. However, it should be noted that the weak economy and the national banking crisis have adversely affected local housing markets and the demand for and availability of credit.

#### Allowance and Provision 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 following table presents a summary of the activity in the allowance for loan losses for the three months ended March 31 (dollars in thousands):

|  | 2009 | 2008 |
| --- | ---: | ---: |
| Balance, January 1 | $14,347 | $7,304 |
| Gross charge offs | (3,408) | (721) |
| Recoveries | 297 | 187 |
| Net credit losses | (3,111) | (534) |
| Provision for loan losses | 2,049 | 1,387 |
| Balance at end of period | $13,285 | $8,157 |
| Allowance for Loan Losses to loans outstanding (as %) | 1.18% | .77% |
| Net charge-offs to average loans outstanding during the period, annualized (as %) | 1.10% | .21% |

The allowance for loan losses decreased to $13.3 million at March 31, 2009, compared to $14.3 million at December 31, 2008. The provision for loan losses was $2.0 million for the first three months of 2009, compared to $1.4 million for the same period of 2008. The increase in the provision for loan losses in the first three months of 2009 compared to the same period of 2008 was in response to the increase in net charge-offs and non-performing loans, the results of our quarterly review of the adequacy of the qualitative factors affecting the allowance, and specific allocations for impaired loans. As part of our loan review process, management has noted an increase in foreclosures and bankruptcies in the geographic areas where we operate. Additionally, the current economic environment has caused a decline in real estate sales. Consequently, we have closely reviewed and applied sensitivity analysis to collateral values to more adequately measure potential future losses. Where necessary, we have obtained new appraisals on collateral. Specific allocations of the allowance have been provided in these instances where losses may occur.

Net charge-offs relating to the installment loan portfolio represent 18% of our total net charge-offs for the first three months of 2009. Generally, installment loans are charged-off after they are 120 days contractually past due. Loans past due 30 days or more were $3.0 million or 2.33% of the installment portfolio at March 31, 2009, compared to $4.85 million or 3.46% at December 31, 2008.

Management believes that the allowance at March 31, 2009 is adequate to provide for probable losses inherent in our loan portfolio. Amounts that will be recorded for the provision for loan losses in future periods will depend upon trends in the loan balances, including the composition of the loan portfolio, changes in loan quality and loss experience trends, potential recoveries on previously charged-off loans and changes in other qualitative factors.

#### Investment Securities

At March 31, 2009, $334.9 million of our investment securities portfolio was classified as available-for-sale and $.02 million was classified as held-for-trading. Unrealized gains and losses on securities available-for-sale are reflected in accumulated other comprehensive loss, a component of shareholders’ equity. At March 31, 2009, the total cost basis of the investment portfolio was $402.0 million, compared to a fair value of $334.9 million.

The following table presents the composition of our securities portfolio available-for-sale at amortized cost and fair values at the dates indicated:

*(Dollars in millions)*

| Securities Available-for-Sale: | March 31, 2009 Amortized Cost | Fair Value (FV) | FV As % of Total | December 31, 2008 Amortized Cost | Fair Value (FV) | FV As % of Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| U.S. government and agencies | $106.4 | $107.3 | 32% | $111.9 | $113.6 | 32% |
| Residential mortgage-backed securities | 124.6 | 116.3 | 35 | 132.1 | 123.2 | 35 |
| Obligations of states and political subdivisions | 101.6 | 101.1 | 30 | 95.9 | 93.5 | 26 |
| Collateralized debt obligations | 69.4 | 10.2 | 3 | 70.3 | 24.3 | 7 |
| Total Investment Securities | $402.0 | $334.9 | 100% | $410.2 | $354.6 | 100% |

28

The amortized cost and estimated fair value of available-for-sale securities by contractual maturity at March 31, 2009 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 | $4,189 | $4,273 |
| Due after one year through five years | 32,486 | 33,121 |
| Due after five years through ten years | 23,341 | 23,915 |
| Due after ten years | 217,353 | 157,242 |
|  | 277,369 | 218,551 |
| Mortgage-backed securities | 124,629 | 116,337 |
|  | $401,998 | $334,888 |

Total investment securities have decreased $19.7 million since December 31, 2008. U.S. government agencies decreased by $6.3 million during the quarter primarily due to calls in the portfolio. Residential mortgage-backed securities decreased by $6.9 million as a result of increased paydowns on the underlying loans. The collateralized debt obligations portfolio consists primarily of trust preferred securities which are preferred term securities issued by trust subsidiaries of financial institutions and insurance companies that are collateralized by junior subordinated debentures issued by those parent institutions. The decrease in this sector of $14.1 million is due to a decline in the market value of these securities directly attributable to the current economic and financial environment. The decreases in the sectors were offset by an increase in the value of state and political subdivisions of $7.6 million.

At March 31, 2009, the securities classified as available-for-sale included a net unrealized loss of $67.1 million, which represents the difference between the fair value and amortized cost of securities in the portfolio. The comparable amount at December 31, 2008 was an unrealized loss of $55.6 million. Typically, 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 also been affected by factors such as marketability, liquidity and the current economic environment.

As discussed in Note F, effective January 1, 2008, the Corporation began measuring fair market values based on the fair value hierarchy established in SFAS 157 as amended in April 2009, by FSP No. 157-4, *Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“*FSP No. FAS 157-4”). This FSP provides additional guidance on determining when the volume and level of activity for the asset or liability has significantly decreased. The FSP also includes guidance on identifying circumstances when a transaction may not be considered orderly. 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 $10.2 million (3%) of our securities available-for-sale were classified using significant unobservable inputs (Level 3 assets). These trust preferred securities are classified as collateralized debt obligations and contributed approximately $59.2 million to the unrealized loss reported in our accumulated other comprehensive loss on the Statement of Financial Condition. The terms of the debentures underlying trust preferred securities allow the issuer of the debentures to defer interest payments for up to 20 quarters, and, in such case, the terms of the related trust preferred securities allow their issuers to defer dividend payments for up to 20 quarters. Some of the issuers of the trust preferred securities in our investment portfolio have defaulted and/or deferred payments thereunder ranging from 4.1% to 16.6% of the total collateral balances underlying the securities. However, these structured securities are generally secured by over-collateralization or default protection provided by subordinated tranches.

Management systematically evaluates securities for impairment on a quarterly basis. Based upon application of FSP No. FAS 115-2 and FAS 124-2, management must assess whether (a) it has the intent to sell the security and (b) if it is more likely than not that it will be required to sell the security prior to its anticipated recovery. If neither apply, declines in the fair value of securities below their cost that are considered other-than-temporary declines are split into two components. The first is the loss attributable to declining credit quality. Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made. The second component consists of all other losses. The other losses are recognized in other comprehensive income. In estimating 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) Adverse conditions specifically related to the security, an industry, or a geographic area, (3) the historic and implied volatility of the security, (4) changes in the rating of a security by a rating agency, (5) recoveries or additional declines in fair value subsequent to the balance sheet date, (6) Failure of the issuer of the security to make scheduled interest payments, and (7) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future. Due to the duration and the significant market value decline in the trust preferred securities held in our portfolio, we performed more extensive testing on these securities for purposes of evaluating whether or not an other-than-temporary impairment has occurred.

Twenty-four of the trust preferred securities in our portfolio have been in an unrealized loss position for over 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 over the past nine months and the current economic recession, 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 trust preferred 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).

The current economic and financial environment, driven primarily by the significant delinquencies and foreclosures of sub-prime loans and the banking crisis, have led to unprecedented events in the financial industry. Large banks and investment firms have failed or consolidated with others, many banks have been closed by regulators and the capital structure of many financial institutions has been weakened. All of these events have contributed to national and worldwide liquidity and credit crises. The Federal Reserve System and the U.S. Treasury have taken steps to lower interest rates, inject capital into financial institutions through various stimulus programs, have established outlets to sell troubled assets, and have developed programs to modify trouble mortgage loans. New accounting guidance has been provided to relieve the uncertainties of fair market accounting applications in an inactive market and to provide relief from other-than-temporary impairment not related to credit problems. The fair market values of the trust preferred securities in our portfolio have shown the affects of these factors as all of the underlying issuers (most of which are community banks) operate in some realm of the financial industry.

Due to the factors previously discussed, the current market for the trust preferred securities in our portfolio is virtually non-existent. Based upon application of FSP No. FAS 157-4, management has determined that there has been a significant decrease in the volume and level of activity in these securities. There are few recent transactions in the market for these securities relative to historical levels. There were no new pooled trust preferred issuances during 2008 or during the first quarter of 2009 and trading activity for this class of securities (buy side) shows only three total trades during the first quarter of 2009 compared to a high of 116 trades in the first quarter of 2008. The volume has declined from a high of $376 million in the first quarter of 2007 to only $1 million during the first quarter of 2009. Price quotations are clearly indicative of distressed trades and vary significantly from prices achieved during an active market. Comparing the corporation’s estimate of cash flows, taking into consideration all available market data and nonperformance risk, there is a significant increase in the implied liquidity risk premiums and yields on the securities. This has led to a wide bid-ask spread as buyers for the securities are seeking “fire-sale” prices and owners of the securities are not willing to accept such pricing.

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 trust preferred securities. The generally accepted accounting principles that we use to prepare our financial statements require management to consider all available evidence in its evaluation of the realizable value of an 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 as part of its overall evaluation of the underlying collateral. Two of the trust preferred securities were downgraded by Moody’s in the fourth quarter of 2008 and an additional eight were downgraded in March 2009. Due to the credit downgrades, management performed an in-depth analysis of the underlying issuers in every trust preferred security owned by the Corporation and shock tests of collateral values were performed in order to determine how much stress the securities could withstand before a loss in principal would be experienced.

In addition, the securities subject to Emerging Issues Task Force 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 (“FASB”) issued FSP No. 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). The following assumptions were used in our EITF 99-20-1 cash flow tests:

1\. Default Rate – .75% applied annually to bank and insurance collateral; 15% recovery after two years.

- Based upon FDIC data, the default data since the late 70’s demonstrates that BIF insured institutions defaulted at a rate of approximately 36 basis points (bps) per year.
- Based upon AM Best number of impairments experienced in the insurance industry of 72 bps per year.
- On 11/21/08, Standard & Poor’s published “Global Methodology for Rating Trust Preferred/Hybrid Securities Revised”. This study lists a recovery assumption of 15%.

2\. Prepayment Speed – 5% in yr 5; 2% each in yrs 6–29; 100% at maturity;

- Based upon a preferred term security historical collateral redemption summary; updated since 9/30/08 to reflect the slow-down in pre-payment speeds and the reluctance on the part of banks to release capital in the current market environment. Anticipated life to maturity is used because auction take-out is currently considered unlikely.

3\. LIBOR Rate is assumed to remain constant for all periods

4\. Additional Defaults and Deferrals – actual defaults that have been experienced in the pools and actual and announced deferrals have been incorporated into expected cash flows for each individual security.

5\. Discount Rate – the rate equal to the current yield used to accrete the beneficial interest as required in EITF 99-20-1, paragraph 12b (book yield).

The results of the cash flow analyses showed that the present value of the current estimated cash flows were greater than or equal to the present value of cash flows at the last reporting date for all but one security. This security showed an 18% reduction in cash flows since December 31, 2008. As a result, management determined that we do not expect to recover the security’s entire amortized cost basis and as such, this security is other-than-temporarily impaired at March 31, 2009.

FSP No. FAS 115-2 and FAS 124-2 requires that an entity compare its best estimate of the present value of the cash flows expected to be collected from the security with the amortized cost basis of the security. Any shortfall in that comparison represents a credit loss. In accordance with 99-20-1, the present value of cash flows for the security deemed to be other-than-temporarily impaired at March 31, 2009 was compared to the present value of the cash flows previously projected at December 31, 2008. The cash flows were discounted at 3.88% which is the current yield used to accrete the beneficial interest. Based on this calculation, a credit loss in the amount of approximately $.75 million was recognized in quarterly earnings for the period.

The following table presents a roll-forward of the amount of other-than-temporary impairment related to credit losses which have been recognized in earnings.

|  | Total Other- Than-Temporary Impairment Loss | Other-Than-Temporary Impairment Credit Losses recorded in Earnings | Other-Than-Temporary Impairment Losses recorded in Other Comprehensive Income |
| --- | ---: | ---: | ---: |
| Beginning balance January 1, 2009 | $0 | $0 | $0 |
| Other-than-temporary Losses Recognized during the Period | 3,342 | 750 | 2,592 |
| Ending balance March 31, 2009 | $3,342 | $750 | $2,592 |

On October 13, 2008, as part of the U.S. government’s economic stabilization plan, the U.S. Treasury announced two plans, the Capital Purchase Program (“CPP”) and the Temporary Liquid Guarantee Program (“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. A third program, the Capital Assistance Program, was adopted during the first quarter of 2009. Many of the banks who issued the trust preferred securities in our portfolio have announced participation in one or more of these programs. Management believes that these programs should help to bolster confidence in the industry and, eventually, provide capital and liquidity to the banking industry, but a long recovery is anticipated.

Management does not intend to sell these securities nor is it more likely than not that it will be required to sell the securities prior to recovery. The risk-based capital ratios require that banks set aside additional capital for securities that are rated below investment grade. Securities rated one level below investment grade require a 200% risk weighting. Additional methods are applicable to securities rated more than one level below investment grade. As of March 31, 2009, management believes that we maintain sufficient capital and liquidity to cover the additional capital requirements of these securities and future operating expenses. Additionally, we do not anticipate any material commitments or expected outlays of capital in the near term. The decline in the fair market values of these securities has not had a material impact on our operations, liquidity or capital resources.

#### Deposits

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

*(Dollars in millions)*

|  | March 31, 2009 |  | December 31, 2008 |  |
| --- | ---: | ---: | ---: | ---: |
| Non-interest-bearing demand deposits | $123.0 | 10% | $107.7 | 9% |
| Interest-bearing demand deposits | 422.0 | 34 | 430.9 | 35 |
| Savings deposits | 33.8 | 3 | 33.1 | 3 |
| Time deposits less than $.1 | 296.5 | 24 | 298.8 | 24 |
| Time deposits $.1 or more | 348.2 | 29 | 352.4 | 29 |
| Total Deposits | $1,223.5 | 100% | $1,222.9 | 100% |

Deposits increased $.6 million during the first three months of 2009 when compared to deposits at December 31, 2008. Interest-bearing demand deposits decreased $8.9 million and non-interest-bearing demand deposits increased $15.3 million. Time deposits decreased $6.5 million due to the reduction of wholesale and public funding of $57 million offset by increased retail deposits due to successful promotions in time deposit products. We are shifting our focus to longer-term liabilities as we anticipate a flat to rising interest rate environment in the future.

#### Borrowed Funds

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

*(Dollars in millions)*

|  | March 31, 2009 | December 31, 2008 |
| --- | ---: | ---: |
| Short-term borrowings | $0.0 | $8.5 |
| Securities sold under agreements to repurchase | 42.3 | 42.0 |
| Total short-term borrowings | $42.3 | $50.5 |
| FHLB advances | $241.2 | $241.5 |
| Junior subordinated debt | 35.9 | 35.9 |
| Total long-term borrowings | $277.1 | $277.4 |

Total short-term borrowings decreased by approximately $8.2 million during the first three months of 2009, primarily as a result of a decrease in our overnight borrowings. Long-term borrowings decreased during the first three months of 2009 by $.3 million due to monthly amortization of long-term advances.

#### Liquidity and Capital Resources

We derive liquidity through increased customer deposits, maturities in or sale of the investment portfolio, loan repayments and income from earning assets. When deposits are not adequate to fund customer loan demand, liquidity needs can be met in the short-term funds markets through arrangements with our correspondent banks or through the purchase of brokered certificates of deposit. The Bank is also a member of the Federal Home Loan Bank of Atlanta, which provides another source of liquidity. As discussed in Note H to the consolidated financial statements presented elsewhere in this report, we may from time to time access capital markets and/or borrow funds from private investors to meet some of our liquidity needs. We actively manage our liquidity position through the Asset and Liability Management Committee of the Board of Directors. Monthly reviews by management and quarterly reviews by the committee under prescribed policies and procedures are designed to ensure that we will maintain adequate levels of available funds.

In response to current economic conditions, management has performed an extensive review of the Bank’s liquidity position and has identified areas to increase liquidity over the next three to six months. We have identified alternative methods to reduce the pledges on securities in our investment portfolio. We are reducing our indirect lending and investing excess cash flow in short-term investments, and have identified the availability of a money market funding source from our in-house broker dealer. In addition, the FDIC Temporary Liquidity Guarantee Program, which was announced as part of the government’s economic stabilization plan, has also allowed us to release investment collateral.

Management believes that we have adequate liquidity available to respond to current and anticipated liquidity demands and is unaware of any trends or demands, commitments, events or uncertainties that will materially affect our ability to maintain liquidity at satisfactory levels.

The following table presents the Corporation’s capital ratios at March 31, 2009:

|  | Actual | Required For Capital Adequacy Purposes | Required To Be Well Capitalized |
| --- | ---: | ---: | ---: |
| Total Capital (to risk-weighted assets) | 12.22% | 8.00% | 10.00% |
| Tier 1 Capital (to risk-weighted assets) | 10.97 | 4.00 | 6.00 |
| Tier 1 Capital (to average assets) | 9.65 | 3.00 | 5.00 |

33

At March 31, 2009, First United Corporation and the Bank were categorized as “well capitalized” under federal banking regulatory capital requirements. On January 30, 2009, pursuant to the Treasury’s TARP Capital Purchase Program, the Corporation issued the following securities to Treasury 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 are on file with the SEC and available to the public free of charge.

Holders of the Series A Preferred Stock are entitled to receive, if 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 Corporation 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 U.S. Treasury Department (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 received assistance under the Troubled Asset Relief Program (TARP), Capital Purchase Program, after consultation with the appropriate banking regulators, to redeem any or all of the preferred securities sold to Treasury at any time notwithstanding the repayment restrictions contained in those securities, subject to a minimum redemption amount of 25%. 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) the $30 million received as consideration for the Series A Preferred Stock and the Warrant. If the Corporation were to redeem the Preferred Stock, it could also repurchase a pro rata portion of the Warrant. Treasury would be required to liquidate any portion of the Warrant that is not repurchased, at the current market price.

First United Corporation paid a cash dividend of $.20 per share on February 2, 2009. On March 25, 2009, the Board of Directors declared another dividend of an equal amount, to be paid on May 1, 2009 to shareholders of record as of April 14, 2009.

#### Contractual Obligations, Commitments and Off-Balance Sheet Arrangements

Loan commitments are made to accommodate the financial needs of our customers. Letters of credit commit us to make payments on behalf of customers when certain specified future events occur. The credit risks inherent in loan commitments and letters of credit are essentially the same as those involved in extending loans to customers, and these arrangements are subject to our normal credit policies. Loan commitments and letters of credit totaled $132.4 million and $5.9 million, respectively, at March 31, 2009, compared to $142.3 million and $5.9 million, respectively, at December 31, 2008. We are not a party to any other off-balance sheet arrangements.

See Note I for further disclosure on Borrowed Funds. There have been no other significant changes to contractual obligations as presented at December 31, 2008.

## Market risk

As filed, 565 characters.

Our primary market risk is interest rate fluctuation and we have procedures in place to evaluate and mitigate this risk. This market risk and our procedures are described in First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2008 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operation – Interest Rate Sensitivity”. Management believes that no material changes in our market risks or in the procedures used to evaluate and mitigate these risks have occurred since December 31, 2008.

## Controls and procedures

As filed, 2,244 characters.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 with the SEC, such as this Quarterly Report, is recorded, processed, summarized and reported within the periods specified in those rules and forms, and that such information is accumulated and communicated to our 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 is also 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, controls 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 March 31, 2009 was carried out under the supervision and with the participation of Management, including the CEO and the CFO. Based on that evaluation, Management, including the CEO and the CFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the first quarter of 2009, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 345 characters.

The risks and uncertainties to which our financial condition and operations are subject are discussed in detail in Item 1A of Part I of the Annual Report of First United Corporation on Form 10-K for the year ended December 31, 2008. Management does not believe that any material changes in our risk factors have occurred since December 31, 2008.

Filed May 11, 2009.
Source: SEC EDGAR, the filing index for accession 0001144204-09-025308. Last ingested by Listed: Nov 3, 2026, 22:37 ET. No prices; not investment advice.