# First United Corp: Form 10-Q for the period ended Jun 30, 2011

- Company: [First United Corp](/companies/func.md) (CIK 763907)
- Form: 10-Q
- Filed: 2011-08-11
- Accepted by EDGAR: Aug 11, 2011, 20:16 ET
- Period: 2011-06-30
- Accession: 0001144204-11-045667
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/763907/000114420411045667/v230820_10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/763907/000114420411045667/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2011-06-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2011-04-01 to 2011-06-30 | $5.6m | us-gaap:InterestExpense |
| Interest expense | 6 months, 2011-01-01 to 2011-06-30 | $11.7m | us-gaap:InterestExpense |
| Income tax | 3 months, 2011-04-01 to 2011-06-30 | −$551.0k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 6 months, 2011-01-01 to 2011-06-30 | −$451.0k | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2011-04-01 to 2011-06-30 | $1.1m | us-gaap:NetIncomeLoss |
| Net income | 6 months, 2011-01-01 to 2011-06-30 | $2.1m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2011-04-01 to 2011-06-30 | $0.12 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 6 months, 2011-01-01 to 2011-06-30 | $0.21 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2011-04-01 to 2011-06-30 | $0.12 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 6 months, 2011-01-01 to 2011-06-30 | $0.21 | us-gaap:EarningsPerShareBasic |
| Operating cash flow | 6 months, 2011-01-01 to 2011-06-30 | $44.9m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 6 months, 2011-01-01 to 2011-06-30 | $140.0k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 6 months, 2011-01-01 to 2011-06-30 | $0 | us-gaap:PaymentsOfDividendsCommonStock |
| Cash and equivalents | at 2011-06-30 | $133.4m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2011-06-30 | $1.46bn | us-gaap:Assets |
| Total liabilities | at 2011-06-30 | $1.37bn | us-gaap:Liabilities |
| Long-term debt | at 2011-06-30 | $207.6m | us-gaap:LongTermDebt |
| Shareholders' equity | at 2011-06-30 | $98.1m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 81,347 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.

First United 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”). First United 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 full service insurance provider organized under Maryland law (the “Insurance Group”), First United Statutory Trust I (“Trust I”) and First United Statutory Trust II (“Trust II”), both Connecticut statutory business trusts, and First United Statutory Trust III, a Delaware statutory business trust (“Trust III” and together with Trust I and Trust II, the “Trusts”). The Trusts were formed for the purpose of selling trust preferred securities that qualified as Tier 1 capital. The Bank has three wholly-owned subsidiaries: OakFirst Loan Center, Inc., a West Virginia finance company; OakFirst Loan Center, LLC, a Maryland finance company (collectively, the “OakFirst Loan Centers”), and First OREO Trust, a Maryland statutory trust formed for the purposes of servicing and disposing of the real estate that the Bank acquires through foreclosure or by deed in lieu of foreclosure. The Bank owns a majority interest in Cumberland Liquidation Trust, a Maryland statutory trust formed for the purposes of servicing and disposing of real estate that secured a loan made by another bank and in which the Bank held a participation interest. The Bank also owns 99.9% of the limited partnership interests in Liberty Mews Limited Partnership, a Maryland limited partnership formed for the purpose of acquiring, developing and operating low-income housing units in Garrett County, Maryland. The Bank provides a complete range of retail and commercial banking services to a customer base serviced by a network of 28 offices and 31 automated teller machines.

At June 30, 2011, the Corporation had total assets of approximately $1.46 billion, net loans of approximately $915 million, and deposits of approximately $1.1 billion. Shareholders’ equity at June 30, 2011 was approximately $98 million.

The Corporation maintains an Internet site at www.mybank4.com on which it makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.

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 of America. 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 First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2010.) On an on-going basis, management evaluates estimates, including those related to loan losses and intangible assets, other-than–temporary impairment (“OTTI”) 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 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 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.

#### Goodwill and Other Intangible Assets

ASC Topic 350, *Intangibles - Goodwill and Other*, establishes standards for the amortization of acquired intangible assets and impairment assessment of goodwill. We have $1.7 million related to acquisitions of insurance “books of business” which is subject to amortization. The $12.9 million in recorded goodwill is primarily related to the acquisition of Huntington National Bank branches that occurred in 2003 and the acquisition of insurance books of business in 2008, which is not subject to periodic amortization.

Goodwill arising from business combinations represents the value attributable to unidentifiable intangible elements in the business acquired. Goodwill is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value of each of the Corporation’s reporting units be compared to the carrying amount of its net assets, including goodwill. If the estimated current fair value of the reporting unit exceeds its carrying value, no additional testing is required and an impairment loss is not recorded. Otherwise, additional testing is performed, and to the extent such additional testing results in a conclusion that the carrying value of goodwill exceeds its implied fair value, an impairment loss is recognized.

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. ASC Topic 350 requires an annual evaluation of goodwill for impairment. The determination of whether or not these assets are impaired involves significant judgments and estimates.

#### Accounting for Income Taxes

The Corporation accounts for income taxes by recording deferred income taxes that 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. Management exercises significant judgment in the evaluation of the amount and timing of the recognition of the resulting tax assets and liabilities. The judgments and estimates required for the evaluation are updated based upon changes in business factors and the tax laws.

A valuation allowance is recognized to reduce any deferred tax assets that based upon available information, it is more-likely-than-not all, or any portion, of the deferred tax asset will not be realized. Assessing the need for, and amount of, a valuation allowance for deferred tax assets requires significant judgment and analysis of evidence regarding realization of the deferred tax assets. In most cases, the realization of deferred tax assets is dependent upon the recognition of deferred tax liabilities and generating a sufficient level of taxable income in future periods, which can be difficult to predict. Our largest deferred tax assets involve differences related to allowance for loan losses and unrealized losses on investment securities. Given the nature of our deferred tax assets, management determined no valuation allowances were needed at June 30, 2011 except for a state valuation allowance for certain state deferred tax assets associated with our Parent Company.

Management expects that the Corporation’s adherence to the required accounting guidance may result in increased volatility in quarterly and annual effective income tax rates because of changes in judgment or measurement including changes in actual and forecasted income before taxes, tax laws and regulations, and tax planning strategies.

#### 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 in the accumulated other comprehensive income/(loss) component 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. Gains and losses on the sale of securities are recorded using the specific identification method.

Management systematically evaluates securities for impairment on a quarterly basis. Based upon application of accounting guidance for subsequent measurement in Topic 320 (ASC Section 320-10-35), management assesses whether (a) it has the intent to sell a security being evaluated and (b) it is more likely than not that the Corporation will be required to sell the security prior to its anticipated recovery. If neither applies, then declines in the fair values 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, which are recognized in other comprehensive loss. In estimating OTTI 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 fair value of the security, (4) changes in the rating of the 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 or principal 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. Management also monitors cash flow projections for securities that are considered beneficial interests under the guidance of ASC Subtopic 325-40, *Investments – Other – Beneficial Interests in Securitized Financial Assets*, (ASC Section 325-40-35). This process is described more fully in the Investment Securities section of the Consolidated Balance Sheet Review.

#### Fair Value of Investments

We have determined the fair value of our investment securities in accordance with the requirements of ASC Topic 820, *Fair Value Measurements and Disclosures*, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements required under other accounting pronouncements. The Corporation measures the fair market values of its investments based on the fair value hierarchy established in Topic 820. The determination of fair value of investments and other assets is discussed further in Note 8.

#### Pension Plan Assumptions

Our pension plan costs are calculated using actuarial concepts, as discussed within the requirements of ASC Topic 715, *Compensation – Retirement Benefits.* 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 12.

Other than as discussed above, management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2010.

SELECTED FINANCIAL DATA

The following table sets forth certain selected financial data for the six months ended June 30, 2011 and 2010 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 | As of or For the six months ended June 30, 2011 | 2010 |
| --- | ---: | ---: |
| Basic net income/(loss) per common share | $.21 | $(1.11) |
| Diluted net income/(loss) per common share | $.21 | $(1.11) |
| Dividends Paid on common shares | $0 | $.11 |
| Book Value | $11.04 | $11.42 |
| Significant Ratios |  |  |
| Return on Average Assets (a) | .28% | (.69)% |
| Return on Average Equity (a) | 4.34% | (11.96)% |
| Dividend Payout Ratio (b) | 0 | (11.22)% |
| Average Equity to Average Assets | 6.37% | 5.75% |

Note: (a) Annualized

(b) Cash dividends paid on common stock as a percent of net loss

RESULTS OF OPERATIONS

#### Overview

Consolidated net income available to common shareholders was $1.3 million for the first six months of 2011, compared to a net loss attributable to common shareholders of $6.8 million for the same period of 2010. Basic and diluted net income per common share for the first six months of 2011 was $.21, compared to basic and diluted net loss per common share of $1.11 for the same period of 2010. The change in earnings, from a net loss for the first six months of 2010 to net income for the first six months of 2011, resulted primarily from a $2.6 million reduction in provision expense and a $3.4 million reduction in losses from sales of securities and other real estate owned. In addition, we have realized $19,000 in non-cash OTTI charges for the first six months of 2011 compared to $8.1 million for the same period of 2010. During the first half of 2011, we also recognized a gain of $1.4 million from the sale of a portion of the indirect auto loan portfolio. The decreases in expenses and losses and the gain were offset by a $3.6 million increase in income tax and a decline in net interest income of $3.8 million. The decrease in net interest income was driven by a $7.2 million reduction in interest income on a fully tax-equivalent (“FTE”) basis attributable to lower levels of loans and investment securities, the historically high levels of cash and the lower interest rate environment. The net interest margin for the first six months of 2011, on a fully tax-equivalent basis, decreased to 2.85% from 2.99% for the first six months of 2010 and showed a slight increase as compared to 2.73% for March 31, 2011 and 2.71% for the year ended December 31, 2010. We anticipate that the margin will continue to improve as management intends to continue deploying excess cash into the investment portfolio and repay, rather than renew, brokered deposits and wholesale borrowings at their stated maturities.

The provision for loan losses declined to $4.6 million for the six months ended June 30, 2011, compared to $7.2 million for the same period of 2010. The lower provision expense was primarily due to a leveling in the credit quality of our loan portfolio. Specific allocations were made for impaired loans where management has determined that the collateral supporting the loans is not adequate to cover the loan balance and management increased the qualitative factors affecting the allowance for loan losses as a result of the current recession and distressed economic environment.

Interest expense on our interest-bearing liabilities decreased $3.2 million due in part to a decrease of $186.6 million in average interest-bearing deposits and a $35.7 million decrease in average debt outstanding. The decline in expense was also due to the low interest rate environment, our decision to only increase special pricing for full relationship customers and retail brokered certificates of deposit renewing at lower interest rates due to the short duration of our portfolio.

Other operating income increased $11.6 million during the first six months of 2011 when compared to the same period of 2010. This increase was primarily attributable to an $8.0 million decrease in non-cash credit-related OTTI charges, and a decrease of $3.4 million in net losses related to sales of securities, sales and write downs of other real estate owned and a gain recognized on the sale of a portion of the indirect auto loan portfolio. Operating expenses decreased $1.4 million in the first six months of 2011 when compared to the same period of 2010. This decrease was due primarily to a $.8 million decline in salaries and benefits resulting primarily from expenses related to a reduction in full-time equivalents through attrition within the Corporation and a decline of $.7 million in FDIC premiums attributable to the repayment of brokered deposits.

Consolidated net income available to common shareholders for the second quarter of 2011 totaled $.7 million or $.12 per common share, compared to a net loss attributable to common shareholders of $1.3 million or $.21 per common share for the same period of 2010. The net interest margin for the second quarter of 2011 was 2.95% compared to 2.81% for the same period of 2010. This increase is primarily attributable to the decrease in interest-bearing liabilities of $308.7 million and a lower rate environment when compared to the second quarter 2010.

#### 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 an FTE basis to facilitate performance comparisons between taxable and tax-exempt assets. FTE 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 six months ended June 30, 2011 and 2010:

*(in thousands)*

| Interest-Earning Assets: | For the six months ended June 30, 2011 Average Balance | Interest | Average Rate | 2010 Average Balance | Interest | Average Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans | $978,836 | $27,188 | 5.60% | $1,110,491 | $31,389 | 5.69% |
| Investment securities | 240,132 | 4,182 | 3.51 | 254,575 | 7,182 | 5.69 |
| Other interest earning assets | 189,674 | 238 | .25 | 248,270 | 224 | .18 |
| **Total earning assets** | $1,408,642 | 31,608 | 4.52% | $1,613,336 | 38,795 | 4.85% |
| **Interest-bearing liabilities** |  |  |  |  |  |  |
| Interest-bearing deposits | $1,052,249 | 6,903 | 1.32% | $1,238,849 | 9,222 | 1.50% |
| Short-term borrowings | 40,259 | 127 | .64 | 40,672 | 139 | .69 |
| Long-term borrowings | 227,060 | 4,701 | 4.18 | 262,384 | 5,603 | 4.31 |
| **Total interest-bearing liabilities** | $1,319,568 | 11,731 | 1.79% | $1,541,905 | 14,964 | 1.97% |
| Net interest income and spread |  | $19,877 | 2.73% |  | $23,831 | 2.88% |
| Net interest margin |  |  | **2.85%** |  |  | **2.99%** |

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

Net interest income on an FTE basis decreased $4.0 million during the first six months of 2011 over the same period in 2010 due to a $7.2 million (18.5%) decrease in interest income partially offset by a $3.2 million (21.6%) decrease in interest expense. The decrease in net interest income was primarily due to the reduction in the average balances of earning assets. The lower yield on both loans and investment securities, as funds were reinvested, also contributed to the decline in interest income comparing the two periods. Management has made the decision to invest in shorter duration investment securities during this time of historically low interest rates. The increased non-accrual assets, shorter duration of the portfolio and the lower reinvestment rates negatively impacted the net interest margin resulting in a decline of 14 basis points to 2.85% at June 30, 2011 from 2.99% for the same period of 2010. The net interest margin was 2.73% at March 31, 2011 and 2.71% at December 31, 2010.

The overall $204.7 million decrease in average interest-earning assets, driven by the reduction in loans, impacted the 33 basis point decline in the average yield on our average earning assets, which dropped from 4.85% for the first six months of 2010 to 4.52% for the first six months of 2011 (on an FTE basis).

Interest expense decreased during the first six months of 2011 when compared to the same period of 2010 due to an overall reduction in interest rates on deposit products driven by our net-interest margin strategy, our decision to only increase special rates on time deposits for full relationship customers, the reduction in the average balance of total interest-bearing liabilities and the shorter duration of the portfolio. The average balance of interest-bearing liabilities decreased by $222.3 million as management continued its strategy to right-size the balance sheet by using cash to repay brokered deposits and wholesale long-term borrowings. The overall effect was an 18 basis point decrease in the average rate paid on our average interest-bearing liabilities from 1.97% for the six months ended June 30, 2010 to 1.79% for the same period of 2011.

The following table sets forth the average balances, net interest income and expense, and average yields and rates for our interest-earning assets and interest-earning liabilities for the three months ended June 30, 2011 and 2010.

*(in thousands)*

| Interest-Earning Assets: | For the three months ended June 30, 2011 Average Balance | Interest | Average Rate | 2010 Average Balance | Interest | Average Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans | $955,103 | $13,262 | 5.57% | $1,093,159 | $15,521 | 5.69% |
| Investment securities | 242,533 | 2,151 | 3.56 | 226,051 | 3,108 | 5.51 |
| Other interest earning assets | 151,318 | 91 | .24 | 297,588 | 132 | .18 |
| **Total earning assets** | $1,348,954 | 15,504 | 4.61% | $1,616,798 | 18,761 | 4.65% |
| **Interest-bearing liabilities** |  |  |  |  |  |  |
| Interest-bearing deposits | $995,149 | 3,232 | 1.30% | $1,263,040 | 4,607 | 1.46% |
| Short-term borrowings | 39,848 | 66 | .66 | 40,884 | 73 | .72 |
| Long-term borrowings | 218,988 | 2,275 | 4.17 | 258,732 | 2,756 | 4.27 |
| **Total interest-bearing liabilities** | $1,253,985 | 5,573 | 1.78% | $1,562,656 | 7,436 | 1.91% |
| Net interest income and spread |  | $9,931 | 2.83% |  | $11,325 | 2.74% |
| Net interest margin |  |  | **2.95%** |  |  | **2.81%** |

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

Net interest income on an FTE basis decreased $1.4 million during the second quarter of 2011 over the same period in 2010 due to a $3.3 million (17.4%) decrease in interest income partially offset by a $1.9 million (25.1%) decrease in interest expense. The decrease in net interest income was primarily due to the reduction in the average balances of earning assets. The lower yield on both loans and investment securities, as funds were reinvested, also contributed to the decline in interest income comparing the two periods.

#### Provision for Loan Losses

The provision for loan losses was $4.6 million for the first six months of 2011, compared to $7.2 million for the same period of 2010. The lower provision for loan losses resulted primarily from stabilization in our total rolling historical loss rates and qualitative factors utilized in the determination of the allowance for loan losses and stabilization in the level of classified assets (discussed below in the section entitled “FINANCIAL CONDITION” under the heading “Allowance and Provision for Loan Losses”). Approximately $.6 million of the lower provision was related to the sale of $32.5 million of our retail, indirect auto portfolio in the second quarter 2011. Management strives to ensure that the allowance for loan losses reflects a level commensurate with the risk inherent in our loan portfolio.

#### Other Operating Income

Other operating income, exclusive of losses, increased $.1 million during the first six months of 2011 when compared to the same period of 2010. Service charge income decreased $.5 million due primarily to a reduction in non-sufficient funds (NSF) fees resulting from new enacted regulation of overdraft fees. Debit card income increased $.3 million during the first half of 2011 when compared to the same period of 2010 due to increased consumer spending and higher customer awareness of our rewards program. Trust department income increased $.1 million during the first six months of 2011 when compared to the first six months of 2010 due to an increase in assets under management and the fees received on those accounts. Assets under management were approximately $612 million at June 30, 2011, a 14% increase over June 30, 2010.

Net gains of $.6 million were reported through other income in the first six months of 2011, compared to net losses of $10.8 million during the same period of 2010. There were $19,000 in losses during the first six months of 2011 that were attributable to non-cash OTTI charges on the investment portfolio, down from the $8.1 million during the same period of 2010. The reduced OTTI charges are a result of improvement in the financial industry which makes up the primary collateral of the collateralized debt obligation portfolio. Other gains of $.7 million in the first six months of 2011 consisted primarily of a $1.4 million gain from the sale of $32.5 million of our indirect auto loan portfolio and $.3 million from sales of investments offset by $1.0 million in write-downs of other real estate owned.

Other operating income, exclusive of losses, remained fairly stable during the second quarter of 2011 when compared to the same period of 2010. Service charge income decreased $.3 million due primarily to a reduction in non-sufficient funds (NSF) fees. Debit card income increased $.1 million during the second quarter of 2011 when compared to the same period of 2010 due to increased consumer spending and higher customer awareness of our rewards program.

Net gains of $.6 million were reported through other income in the second quarter of 2011, compared to net losses of $1.2 million during the same period of 2010. There were no losses during the second quarter of 2011 that were attributable to non-cash OTTI charges on the investment portfolio, down from the $.6 million during the same period of 2010. Other gains of $.6 million in the second quarter of 2011 consisted primarily of a $1.4 million gain from the sale of $32.5 million of our indirect auto loan portfolio and $.1 million from sales of investments, offset by $.9 million in write-downs of other real estate owned.

The following table shows the major components of other operating income for the six and three months ended June 30, 2011 and 2010, exclusive of net gains/(losses):

|  | Income as % of Total Other Operating Income For the six months ended June 30, 2011 | 2010 | Income as % of Total Other Operating Income For the three months ended June 30, 2011 | 2010 |
| --- | ---: | ---: | ---: | ---: |
| Service charges | 24% | 31% | 25% | 31% |
| Trust department | 28% | 27% | 28% | 27% |
| Insurance commissions | 17% | 18% | 17% | 18% |
| Debit card Income | 15% | 11% | 13% | 11% |
| Bank owned life insurance | 7% | 7% | 7% | 7% |
| Other income | 9% | 6% | 10% | 6% |
|  | 100% | 100% | 100% | 100% |

#### Other Operating Expenses

Other operating expenses decreased $1.4 million (6%) for the first half of 2011 when compared to the first half of 2010. The decrease was primarily due to a decline of $.8 million in salaries and benefits resulting primarily from a reduction of full-time equivalent employees through attrition within the Corporation and a decline of $.7 million in FDIC premiums attributable to the repayment of brokered deposits.

The decrease of $1.2 million (10%) in other operating expenses for the second quarter of 2011 was primarily due to a decline of $.3 million in salaries and benefits resulting primarily from a reduction of full-time equivalent employees through attrition within the Corporation and a decline of $.7 million in FDIC premiums attributable to the repayment of brokered deposits. Other expenses decreased $.2 million for the second quarter of 2011 when compared to the same period of 2010. This decrease is attributable to decreases in postage, contract labor and the completion of amortization of the Huntington branch goodwill in late 2010. The decreases were offset by an increase of $.1 million in data processing expenses.

The composition of other operating expenses for the six and three months ended June 30, 2011 and 2010 is illustrated in the following table.

|  | Expense as % of Total Other Operating Expenses For the six months ended June 30, 2011 | 2010 | Expense as % of Total Other Operating Expenses For the three months ended June 30, 2011 | 2010 |
| --- | ---: | ---: | ---: | ---: |
| Salaries and employee benefits | 48% | 49% | 50% | 47% |
| FDIC premiums | 7% | 9% | 5% | 11% |
| Occupancy, equipment and data processing | 21% | 20% | 21% | 18% |
| Other | 24% | 22% | 24% | 24% |
|  | 100% | 100% | 100% | 100% |

41

#### Applicable Income Taxes

In reporting interim financial information, income tax provisions should be determined under the procedures set forth in ASC Topic, *Income Taxes*, in Section 740-270-30. This guidance provides that at the end of each interim period, an entity should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. The rate so determined should be used in providing for income taxes on a current year-to-date basis. The effective tax rate should reflect anticipated investment tax credits, capital gains rates, and other available tax planning alternatives. However, in arriving at this effective tax rate no effect should be included for the tax related to significant, unusual or extraordinary items that will be separately reported or reported net of their related tax effect in reports for the interim period or for the fiscal year.

Based on the guidance in ASC Topic 740, management has concluded that the OTTI charge meets the definition of a “significant, unusual or extraordinary item that will be separately reported” based on the following:

- The impairment charge related to credit loss is significant and is a highly unusual event for investments, which were investment grade at the time of purchase and have become impaired as a result of the severe decline in the economy and an illiquid credit market; and
- The OTTI is reported as a separate line in the Consolidated Statements of Operations.

The effective tax benefit rate for the first six months of 2011 was 27.5%, compared to an effective tax benefit rate of 40.3% for the first six months of 2010. The decrease thus far in 2011 when compared to the same time period in 2010 was primarily attributable to an increase in earnings in the first half of 2011.

### FINANCIAL CONDITION

#### Balance Sheet Overview

Total assets were $1.5 billion at June 30, 2011, a decrease of $232.9 million since December 31, 2010. During this time period, cash and interest-bearing deposits in banks decreased $165.9 million, our investment portfolio increased $9.7 million, and gross loans decreased $40.9 million, net of the sale of $32.5 million of the indirect auto portfolio. Total liabilities decreased by approximately $235.4 million during the first six months of 2011, reflecting decreases in total deposits of $197.1 million, long-term borrowings of $35.5 million due to repayment of three maturing FHLB advances and short-term borrowings of $3.3 million. Total deposits decreased primarily as a result of repayment of $141.0 million in brokered deposits and the maturity of $48.5 million in CDARs deposits. Shareholders’ equity increased $2.5 million from December 31, 2010 to June 30, 2011 as a result of net income earned during the period.

#### Loan Portfolio

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

*(In thousands)*

|  | June 30, 2011 |  | December 31, 2010 |  |
| --- | ---: | ---: | ---: | ---: |
| Commercial real estate | $320,322 | 34% | $348,584 | 34% |
| Acquisition and development | 152,007 | 16 | 156,892 | 16 |
| Commercial and industrial | 71,699 | 8 | 69,992 | 7 |
| Residential mortgage | 351,078 | 38 | 356,742 | 35 |
| Consumer | 41,292 | 4 | 77,543 | 8 |
| Total Loans | $936,398 | 100% | $1,009,753 | 100% |

Comparing loans at June 30, 2011 to loans at December 31, 2010, outstanding loans decreased by $40.9 million (4.0%), net of the sale of $32.5 million of the indirect auto portfolio. Commercial real estate loans decreased $28.3 million as a result of the payoff of several large loans, charge-offs of loan balances and ongoing scheduled principal payments. Commercial and industrial loans increased $1.7 million and residential mortgages declined $5.7 million. The decrease in the residential mortgage portfolio was attributable to regularly scheduled principal payments on existing loans and management’s decision to use secondary market outlets such as Fannie Mae for the majority of new, longer-term, fixed rate residential loan originations. The consumer portfolio declined $36.3 million due primarily to the sale of $32.5 million of retail installment contracts in our indirect auto loan portfolio and $3.8 million as repayment activity in the indirect auto portfolio exceeded new production due to special financing offered by the automotive manufacturers, credit unions and certain large regional banks. At June 30, 2011, approximately 69% of the commercial loan portfolio was collateralized by real estate compared to approximately 71% and 69% at December 31, 2010 and March 31, 2011, respectively.

During the first quarter of 2011, the Bank moved $44.5 million of its indirect auto loan portfolio to the loans held-for-sale category. Of this amount, $32.5 million of the portfolio was sold on May 6, 2011. The remaining $12.0 million in performing contracts were moved back into the Bank’s loan portfolio.

#### 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.

*(In thousands)*

| Non-accrual loans: | June 30, 2011 | % of Applicable Portfolio | December 31, 2010 | % of Applicable Portfolio |
| --- | ---: | ---: | ---: | ---: |
| Commercial real estate | $12,694 | 4.0% | $11,893 | 3.4% |
| Acquisition and development | 13,537 | 8.9% | 16,269 | 10.4% |
| Commercial and industrial | 10,329 | 14.4% | 1,355 | 1.9% |
| Residential mortgage | 3,499 | 1.0% | 5,236 | 1.5% |
| Consumer | 20 | .0% | 152 | .2% |
| Total non-accrual loans | $40,079 | 4.3% | $34,905 | 3.5% |
| Accruing Loans Past Due 90 days or more: |  |  |  |  |
| Commercial real estate | $0 |  | $0 |  |
| Acquisition and development | 2,587 |  | 128 |  |
| Commercial and industrial | 0 |  | 44 |  |
| Residential mortgage | 549 |  | 2,437 |  |
| Consumer | 62 |  | 183 |  |
| Total loans past due 90 days or more | $3,198 |  | $2,792 |  |
| Total non-accrual and loans past due 90 days or more | $43,277 |  | $37,697 |  |
| Restructured Loans (TDRs): |  |  |  |  |
| Performing | $7,501 |  | $5,506 |  |
| Non-accrual (included above) | 7,946 |  | 9,593 |  |
| Total TDRs | $15,447 |  | $15,099 |  |
| Other Real Estate Owned | $19,143 |  | $18,072 |  |
| Impaired loans without a valuation allowance | $43,405 |  | $42,890 |  |
| Impaired loans with a valuation allowance | 25,077 |  | 19,713 |  |
| Total impaired loans | $68,482 |  | $62,603 |  |
| Valuation allowance related to impaired loans | $5,328 |  | $4,366 |  |

Performing loans considered to be impaired (including performing restructured loans, or TDRs), as defined and identified by management, amounted to $28.4 million at June 30, 2011 and $27.7 million at December 31, 2010. Loans are identified as impaired when, based on current information and events, management determines that we will be unable to collect all amounts due according to contractual terms. These loans consist primarily of acquisition and development loans and commercial real estate loans. The fair values are generally determined based upon independent third party appraisals of the collateral or discounted cash flows based upon the expected proceeds. Specific allocations have been made where management believes there is insufficient collateral to repay the loan balance if liquidated and there is no secondary source of repayment available.

The level of performing impaired loans (other than performing TDRs) decreased $1.3 million during the six months ended June 30, 2011. One $0.8 million commercial real estate loan was added to performing impaired and two commercial real estate loans totaling $1.3 million were removed from impaired status due to satisfactory payment performance. Net principal repayments totaling $0.8 million were received on other performing impaired loans in the year-to-date period. Management will continue to monitor all loans that have been removed from an impaired status and take appropriate steps to ensure that satisfactory performance is sustained.

The level of TDRs increased $0.3 million during the six months ended June 30, 2011, reflecting the addition of three loans totaling $3.5 million to performing TDRs and the repayment of one performing $0.3 million TDR and two non-accrual TDRs totaling $.7 million. Loans totaling $1.0 million that had been modified prior to 2011 at market rates were removed from performing TDRs during the first quarter because the borrowers had made at least six consecutive payments and were current at March 31, 2011. Principal payments of $1.2 million were received on loans classified as TDRs during the six months ended June 30, 2011.

The following table presents the details of impaired loans that are troubled debt restructurings by class as of June 30, 2011:

*(in thousands)*

| June 30, 2011 Commercial real estate | Troubled Debt Restructurings at Period End Number of Contracts | Recorded Investment | New Troubled Debt Restructurings in YTD Period Number of Contracts | Recorded Investment | Troubled Debt Restructurings that Subsequently Defaulted during Prior 12 Months Number of Contracts | Recorded Investment |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Non owner-occupied | 2 | $1,623 | 0 | $0 | 0 | $0 |
| All other CRE | 1 | 3,210 | 1 | 3,233 | 0 | 0 |
| Acquisition and development 1-4 family residential construction | 0 | 0 | 0 | 0 | 1 | 324 |
| All other A&D | 7 | 8,066 | 0 | 0 | 2 | 3,338 |
| Commercial and industrial | 2 | 1,226 | 0 | 0 | 0 | 0 |
| Residential mortgage |  |  |  |  |  |  |
| Residential mortgage – term | 5 | 1,322 | 2 | 234 | 1 | 249 |
| Residential mortgage – home equity | 0 | 0 | 0 | 0 | 0 | 0 |
| Consumer | 0 | 0 | 0 | 0 | 0 | 0 |
| Total | 17 | $15,447 | 3 | $3,467 | 4 | $3,911 |

#### 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.

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 six months ended June 30:

*(in thousands)*

|  | 2011 | 2010 |
| --- | ---: | ---: |
| Balance, January 1 | $22,138 | $20,090 |
| Charge-offs: |  |  |
| Commercial real estate | (4,530) | (464) |
| Acquisition and development | (721) | (1,848) |
| Commercial and industrial | (248) | (343) |
| Residential mortgage | (802) | (1,466) |
| Consumer | (476) | (1,196) |
| Total charge-offs | (6,777) | (5,317) |
| Recoveries: |  |  |
| Commercial real estate | 78 | 85 |
| Acquisition and development | 271 | 1,045 |
| Commercial and industrial | 10 | 233 |
| Residential mortgage | 391 | 171 |
| Consumer | 285 | 289 |
| Total recoveries | 1,035 | 1,823 |
| Net credit losses | (5,742) | (3,494) |
| Provision for loan losses | 4,605 | 7,186 |
| Balance at end of period | $21,001 | $23,782 |
| Allowance for loan losses to loans outstanding (as %) | 2.24% | 2.20% |
| Net charge-offs to average loans outstanding during the period, annualized (as %) | 1.17% | .62% |

The allowance for loan losses decreased to $21.0 million at June 30, 2011, compared to $22.1 million at December 31, 2010 and $23.8 million at June 30, 2010. The provision for loan losses for the first six months of 2011 decreased to $4.6 million from $7.2 million for the same period in 2010. Net charge-offs rose to $5.7 million from $3.5 million. Included in the net charge-offs for June 30, 2011 were partial charge-offs of $4.3 million for two large commercial real estate loans. The decrease in the provision for loan losses from June 30, 2010 to June 30, 2011 resulted from management’s analysis of the adequacy of the loan loss reserve, declining loan balances and improving economic conditions as noted by the Federal Reserve. The sale of $32.5 million of the indirect auto portfolio, releasing $.6 million in provision expense, was a contributing factor to the lower provision expense through June 30, 2011. The allowance for loan losses to loans outstanding as of June 30, 2011 of 2.24% is higher than the 2.20% from the same period last year due to a focused effort by management to recognize potential problem loans and record specific allocations and adjust qualitative factors to reflect the current quality of the loan portfolio.

Net charge-offs to average loans for the six months ended June 30, 2011 totaled an annualized 1.17% compared to an annualized 0.62% for the same period in 2010 and 1.28% for the year ended December 31, 2010. Relative to December 31, 2010, all segments of loans, with the exception of commercial real estate loans, showed improvement. The annualized net charge-off ratio for commercial real estate loans as of June 30, 2011 was 2.66% compared to .13% as of December 31, 2010, as a result of the $4.3 million partial charge-offs described above. The annualized net charge-off ratio for acquisition and development loans as of June 30, 2011 was 0.58% compared to 4.46% as of December 31, 2010. The ratios for commercial and industrial loans were 0.67% and 2.23% for June 30, 2011 and December 31, 2010, respectively. The residential mortgage ratios were 0.23% and 0.44% and the consumer loan ratios were 0.64% and 1.34%. Accruing loans past due 30 days or more declined to 1.28% of the loan portfolio at June 30, 2011 compared to 3.62% at December 31, 2010. We recognized improvements in the delinquency ratios in all loan segments with the exception of consumer loans which had a delinquency ratio of 4.52% at June 30, 2011 compared to 3.87% at December 31, 2011. Although the 30 days or more past due loans declined by $1.1 million, the sale of $32.5 million of our indirect auto portfolio negatively impacted the past due ratio. The improvements were attributable to a combination of a slowly improving economy and vigorous collection efforts by the Bank.

Non-accrual loans totaled $40.1 million as of June 30, 2011 compared to $44.6 million as of June 30, 2010 and $34.9 million as of December 31, 2010. Non-accrual loans, which have been subject to a partial charge-off, totaled $12.8 million as of June 30, 2011 compared to $3.4 million as of June 30, 2010 and $2.9 million as of December 31, 2010. Comparing the periods ending June 30, 2011 and June 30, 2010, total non-accrual loan balances have declined. Additionally, potential losses have been recognized in significantly more non-accrual loans as June 30, 2011 than for the same time period of 2010.

Management believes that the allowance for loan losses at June 30, 2011 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. Management also applies interest rate risk, collateral value and debt service sensitivity analyses to the Commercial real estate loan portfolio and obtains new appraisals on specific loans under defined parameters to assist in the determination of the periodic provision for loan losses.

#### Investment Securities

At June 30, 2011, the total amortized cost basis of the available-for-sale investment portfolio was $262.2 million, compared to a fair value of $239.3 million. Unrealized gains and losses on securities available-for-sale are reflected in accumulated other comprehensive loss, a component of shareholders’ equity.

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 thousands)*

| Securities Available-for-Sale: | June 30, 2011 Amortized Cost | Fair Value (FV) | FV as % of Total | December 31, 2010 Amortized Cost | Fair Value (FV) | FV as % of Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| U.S. government agencies | $34,422 | $34,476 | 14% | $24,813 | $24,850 | 11% |
| Residential mortgage-backed agencies | 118,183 | 119,830 | 50% | 98,109 | 99,613 | 43% |
| Collateralized mortgage obligations | 686 | 588 | 1% | 763 | 662 | 1% |
| Obligations of states and political subdivisions | 72,736 | 73,728 | 31% | 94,250 | 94,724 | 41% |
| Collateralized debt obligations | 36,210 | 10,726 | 4% | 36,533 | 9,838 | 4% |
| Total Investment Securities | $262,237 | $239,348 | 100% | $254,468 | $229,687 | 100% |

Total investment securities have increased $9.7 million since December 31, 2010. At June 30, 2011, the securities classified as available-for-sale included a net unrealized loss of $22.9 million, which represents the difference between the fair value and amortized cost of securities in the portfolio.

As discussed in Note 8 to the consolidated financial statements presented elsewhere in this report, the Corporation measures fair market values based on the fair value hierarchy established in ASC Topic 820, *Fair Value Measurements and Disclosures*. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Level 3 prices or valuation techniques require inputs that are both significant to the valuation assumptions and are not readily observable in the market (i.e. supported with little or no market activity). 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 $228.6 million of the available-for-sale portfolio was valued using Level 2 pricing, and had net unrealized gains of $2.6 million at June 30, 2011. The remaining $10.7 million of the securities available-for-sale represents the entire collateralized debt obligation (“CDO”) portfolio, which was valued using significant unobservable inputs (Level 3 assets). The $25.5 million in unrealized losses associated with this portfolio relates to 18 pooled trust preferred securities that comprise the CDO portfolio. Unrealized losses of $17.3 million represent non-credit related OTTI charges on 13 of the securities, while $8.2 million of unrealized losses relates to five securities which have had no credit related OTTI. The unrealized losses on these securities were primarily attributable to continued depression in the marketability and liquidity associated with CDOs.

The following table provides a summary of the trust preferred securities in the CDO portfolio and the credit status of these securities as of June 30, 2011.

*Level 3 Investment Securities Available for Sale (Dollars in Thousands)*

| Investment Description Deal | Class | First United Level 3 Investments Amortized Cost | Fair Market Value | Unrealized Gain/(Loss) | Lowest Credit Rating | Security Credit Status Original Collateral | Deferrals/ Defaults as % of Original Collateral | Performing Collateral | Collateral Support | Collateral Support as % of Performing Collateral | Number of Performing Issuers/Total Issuers |
| --- | --- | ---: | ---: | ---: | --- | ---: | ---: | ---: | ---: | ---: | --- |
| Preferred Term Security I | Mezz | 769 | 434 | (335) | C | 303,112 | 32.66% | 132,500 | (58,257) | -43.97% | 16/25 |
| Preferred Term Security XI\* | B-1 | 1,364 | 458 | (906) | C | 635,775 | 28.83% | 405,465 | (126,986) | -31.32% | 44/64 |
| Preferred Term Security XVI\* | C | 166 | 61 | (105) | C | 606,040 | 45.74% | 298,365 | (199,948) | -67.01% | 33/56 |
| Preferred Term Security XVIII | C | 3,019 | 1,015 | (2,004) | C | 676,565 | 26.06% | 500,225 | (92,529) | -18.50% | 55/80 |
| Preferred Term Security XVIII\* | C | 2,059 | 677 | (1,382) | C | 676,565 | 26.06% | 500,225 | (92,529) | -18.50% | 55/80 |
| Preferred Term Security XIX\* | C | 3,022 | 505 | (2,517) | C | 700,535 | 27.46% | 507,506 | (116,769) | -23.01% | 50/73 |
| Preferred Term Security XIX\* | C | 1,308 | 216 | (1,092) | C | 700,535 | 27.46% | 507,506 | (116,769) | -23.01% | 50/73 |
| Preferred Term Security XIX\* | C | 2,196 | 361 | (1,835) | C | 700,535 | 27.46% | 507,506 | (116,769) | -23.01% | 50/73 |
| Preferred Term Security XIX\* | C | 1,310 | 216 | (1,093) | C | 700,535 | 27.46% | 507,506 | (116,769) | -23.01% | 50/73 |
| Preferred Term Security XXII\* | C-1 | 1,558 | 270 | (1,288) | C | 1,386,600 | 30.90% | 958,100 | (246,946) | -25.77% | 62/97 |
| Preferred Term Security XXII\* | C-l | 3,895 | 675 | (3,220) | C | 1,386,600 | 30.90% | 958,100 | (246,946) | -25.77% | 62/97 |
| Preferred Term Security XXIII\* | C-l | 2,033 | 635 | (1,398) | C | 1,467,000 | 26.07% | 1,005,500 | (201,112) | -20.00% | 92/124 |
| Preferred Term Security XXIII\* | D-1 | 658 | 111 | (547) | C | 1,467,000 | 26.07% | 1,005,500 | (309,595) | -30.79% | 92/124 |
| Preferred Term Security XXIII\* | D-1 | 1,975 | 333 | (1,642) | C | 1,467,000 | 26.07% | 1,005,500 | (309,595) | -30.79% | 92/124 |
| Preferred Term Security XXIV\* | C-l | 879 | 123 | (756) | C | 1,050,600 | 37.29% | 658,800 | (269,544) | -40.91% | 59/92 |
| Preferred Term Security I-P-I | B-2 | 2,000 | 1,065 | (935) | CCC- | 351,000 | 9.26% | 161,000 | 2,667 | 1.66% | 15/17 |
| Preferred Term Security I-P-IV | B-1 | 3,000 | 1,339 | (1,661) | CCC - | 325,000 | 14.15% | 264,350 | 10,779 | 4.08% | 28/32 |
| Preferred Term Security I-P-IV | B-1 | 5,000 | 2,232 | (2,768) | CCC - | 325,000 | 14.15% | 264,350 | 10,779 | 4.08% | 28/32 |
| Total Level 3 Securities Available for Sale |  | 36,210 | 10,726 | (25,464) |  |  |  |  |  |  |  |

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

The terms of the debentures underlying trust preferred securities allow the issuer of the debentures to defer interest payments for up to 20 quarters, and, in such case, the terms of the related trust preferred securities 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 ranging from 9.26% to 45.74% of the total collateral balances underlying the securities. The securities were designed to include structural features that provide investors with credit enhancement or support to provide default protection by subordinated tranches. These features include over-collateralization of the notes or subordination, excess interest or spread which will redirect funds in situations where collateral is insufficient, and a specified order of principal payments. There are securities in our portfolio that are under-collateralized, which does represent additional stress on our tranche. However, in these cases, the terms of the securities require excess interest to be redirected from subordinate tranches as credit support, which provides additional support to our investment.

Management systematically evaluates securities for impairment on a quarterly basis. Based upon application of Topic 320 (ASC Section 320-10-35), management must assess whether (a) it has the intent to sell the security and (b) it is more likely than not that the Corporation will be required to sell the security prior to its anticipated recovery. If neither applies, then declines in the fair value of securities below their cost that are considered other-than-temporary declines are split into two components. The first is the loss attributable to declining credit quality. Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made. The second component consists of all other losses. The other losses are recognized in other comprehensive income. In estimating OTTI charges, management considers (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 pooled trust preferred securities held in our portfolio, we performed more extensive testing on these securities for purposes of evaluating whether or not an OTTI has occurred.

The market for these securities as of June 30, 2011 is not active and markets for similar securities are also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which these securities trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive, as no new CDOs have been issued since 2007. There are currently very few market participants who are willing to transact for these securities. The market values for these securities, or any securities other than those issued or guaranteed by the U.S. Department of the Treasury (the “Treasury”), are very depressed relative to historical levels. Therefore, in the current market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general rather than being an indicator of credit problems with a particular issue. Given the conditions in the current debt markets and the absence of observable transactions in the secondary and new issue markets, management has determined that (a) the few observable transactions and market quotations that are available are not reliable for the purpose of obtaining fair value at June 30, 2011, (b) an income valuation approach technique (i.e. present value) that maximizes the use of relevant observable inputs and minimizes the use of observable inputs will be equally or more representative of fair value than a market approach, and (c) the CDO segment is appropriately classified within Level 3 of the valuation hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date.

Management utilizes an independent third party to prepare both the evaluations of OTTI as well as the fair value determinations for its CDO portfolio. Management does not believe that there were any material differences in the impairment evaluations and pricing between December 31, 2010 and June 30, 2011.

The approach of the third party to determine fair value involved several steps, including detailed credit and structural evaluation of each piece of collateral in each bond, default, recovery and prepayment/amortization probabilities for each piece of collateral in the bond, and discounted cash flow modeling. The discount rate methodology used by the third party combines a baseline current market yield for comparable corporate and structured credit products with adjustments based on evaluations of the differences found in structure and risks associated with actual and projected credit performance of each CDO being valued. Currently, the only active and liquid trading market that exists is for stand-alone trust preferred securities. Therefore, adjustments to the baseline discount rate are also made to reflect the additional leverage found in structured instruments.

Based upon a review of credit quality and the cash flow tests performed by the independent third party, management determined that no securities had credit-related OTTI during the second quarter of 2011 and one security with previously recorded OTTI had no further impairment. As a result of the assessment, the Corporation recorded $19,000 in credit-related non-cash OTTI charges on the CDO security in earnings for the six-month period ended June 30, 2011. Management does not intend to sell this security nor is it more likely than not that the Corporation will be required to sell the security 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. Management believes that, as of June 30, 2011, 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.

#### Deposits

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

*(In thousands)*

|  | June 30, 2011 |  | December 31, 2010 |  |
| --- | ---: | ---: | ---: | ---: |
| Non-interest bearing demand deposits | $128,741 | 12% | $121,142 | 9% |
| Interest-bearing deposits: |  |  |  |  |
| Demand | 97,142 | 9 | 100,472 | 8 |
| Money Market: |  |  |  |  |
| Retail | 219,954 | 20 | 217,401 | 17 |
| Brokered | 0 | 0 | 55,545 | 4 |
| Savings deposits | 103,258 | 9 | 93,543 | 7 |
| Time deposits less than $100,000 | 260,651 | 24 | 278,588 | 22 |
| Time deposits $100,000 or more: |  |  |  |  |
| Retail | 213,765 | 19 | 221,564 | 17 |
| Brokered/CDARS | 81,055 | 7 | 213,391 | 16 |
| Total Deposits | $1,104,566 | 100% | $1,301,646 | 100% |

48

Total deposits decreased $197.1 million during the first six months of 2011 when compared to deposits at December 31, 2010. Non-interest bearing deposits increased $7.6 million. Traditional savings accounts increased $9.7 million due to continued growth in our Prime Saver product. Total money market accounts decreased $53.0 million due primarily to the repayment of $55.5 million in brokered accounts. Time deposits less than $100,000 declined $17.9 million and time deposits greater than $100,000 decreased $140.1 million. The decrease in time deposits greater than $100,000 was primarily due to the repayment of $85.5 million in brokered certificates of deposits and $46.8 million of maturities in our CDARS product. Although brokered deposits are at very low rates in the current environment, management made the decision to right-size the balance sheet by using cash to repay brokered deposits and to allow certificates of deposit for non-relationship customers to run off. Our internal treasury team has developed a strategy to increase our net interest margin by changing the mix of our deposit base and focusing on customers with full banking relationships.

#### Borrowed Funds

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

*(In thousands)*

|  | June 30, 2011 | December 31, 2010 |
| --- | ---: | ---: |
| Securities sold under agreements to repurchase | $35,875 | $39,139 |
| Total short-term borrowings | $35,875 | $39,139 |
| FHLB advances | $160,842 | $196,370 |
| Junior subordinated debt | 46,730 | 46,730 |
| Total long-term borrowings | $207,572 | $243,100 |

Total short-term borrowings decreased by approximately $3.3 million during the first six months of 2011 due to treasury management customers utilizing their cash. Long-term borrowings decreased during the first six months of 2011 by $35.5 million due to the repayment of one FHLB advance totaling $35.0 million and scheduled monthly amortization of long-term advances. Provided that we can maintain sufficient liquidity levels, management intends to repay the $15.0 million FHLB advance at its December 2011 maturity.

#### Liquidity Management

Liquidity is a financial institution’s capability to meet customer demands for deposit withdrawals while funding all credit-worthy loans. The factors that determine the institutions liquidity are:

- Reliability and stability of core deposits;
- Cash flow structure and pledging status of investments; and
- Potential for unexpected loan demand.

We actively manage our liquidity position through weekly meetings of a sub-committee of executive management, known as the Treasury Sub-Committee, which looks forward 12 months at 30-day intervals. The measurement is based upon the projection of funds sold or purchased position, along with ratios and trends developed to measure dependence on purchased funds and core growth. Monthly reviews by management and quarterly reviews by the Asset and Liability Committee under prescribed policies and procedures are designed to ensure that we will maintain adequate levels of available funds.

It is our policy to manage our affairs so that liquidity needs are fully satisfied through normal Bank operations. That is, the Bank will manage its liquidity to minimize the need to make unplanned sales of assets or to borrow funds under emergency conditions. The Bank will use funding sources where the interest cost is relatively insensitive to market changes in the short run (periods of one year or less) to satisfy operating cash needs. The remaining normal funding will come from interest-sensitive liabilities, either deposits or borrowed funds. When the marginal cost of needed wholesale funding is lower than the cost of raising this funding in the retail markets, the Company may supplement retail funding with external funding sources such as:

1\. Unsecured Fed Funds lines of credit with upstream correspondent banks (FTN Financial, M&T Bank, Atlantic Central Banker’s Bank, Community Banker’s Bank);

2\. Secured advances with the FHLB of Atlanta, which are collateralized by eligible one to four family residential mortgage portfolio, home equity lines of credit portfolio, commercial real estate loan portfolio, and various securities. Cash may also be pledged as collateral;

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

4\. Brokered deposits, including CDs and money market funds, provide a method to generate deposits quickly. These deposits are strictly rate driven but often provide the most cost effective means of funding growth; and

5\. One Way Buy CDARS funding – a form of brokered deposits that has become a viable supplement to brokered deposits obtained directly.

During 2010, management made the decision to accumulate high levels of cash in order to protect the Bank against the risks associated with the criticized assets on our balance sheet. Given the economic environment, management believed that the increased liquidity position was prudent even though it would negatively impact the net interest margin. As a result of stabilization in our asset quality and management’s decision to reduce assets given our current capital levels, our strategic plan calls for management to use cash to repay brokered deposits, non-relationship certificates of deposit and wholesale FHLB advances throughout 2011. Reduction in these liabilities, deemed to be volatile funding by regulatory definition, should not have an impact on our levels of liquidity.

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.

#### Market Risk and Interest 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.

Throughout 2010, we shifted our focus on a shorter duration balance sheet to move to a more neutral to slightly asset sensitive position as we anticipate a rising rate environment in the future. As of June 30, 2011, we were slightly asset sensitive.

Our interest rate risk management goals are:

- Ensure that the Board of Directors and senior management will provide effective oversight and ensure that risks are adequately identified, measured, monitored and controlled;
- Enable dynamic measurement and management of interest rate risk;
- Select strategies that optimize our ability to meet our long-range financial goals while maintaining interest rate risk within policy limits established by the Board of Directors;
- Use both income and market value oriented techniques to select strategies that optimize the relationship between risk and return; and
- Establish interest rate risk exposure limits for fluctuation in net interest income (“NII”), net income and economic value of equity.

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.

We evaluate the effect of a change in interest rates of +/-100 basis points to +/-400 basis points on both NII and Net Portfolio Value (“NPV”) / Economic Value of Equity (“EVE”). We concentrate on NII rather than net income as long as NII remains the significant contributor to net income.

NII modeling allows management to view how changes in interest rates will affect the spread between the yield paid on assets and the cost of deposits and borrowed funds. Unlike traditional Gap modeling, NII modeling takes into account the different degree to which installments in the same repricing period will adjust to a change in interest rates. It also allows the use of different assumptions in a falling versus a rising rate environment. The period considered by the NII modeling is the next eight quarters.

NPV / EVE modeling focuses on the change in the market value of equity. NPV / EVE is defined as the market value of assets less the market value of liabilities plus/minus the market value of any off-balance sheet positions. By effectively looking at the present value of all future cash flows on or off the balance sheet, NPV / EVE modeling takes a longer-term view of interest rate risk. This complements the shorter-term view of the NII modeling.

Measures of NII at risk produced by simulation analysis are indicators of an institution’s short-term performance in alternative rate environments. These measures are typically based upon a relatively brief period, usually one year. They do not necessarily indicate the long-term prospects or economic value of the institution.

#### Capital Resources

The Bank and First United Corporation are subject to risk-based capital regulations, which were adopted and are 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 4% (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. Regulators may require higher capital ratios when 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. Our capital policy establishes guidelines meeting these regulatory requirements and takes into consideration current or anticipated risks as well as potential future growth opportunities.

The following table presents our capital ratios:

| Total Capital (to risk-weighted assets) | June 30, 2011 | December 31, 2010 | Required for Capital Adequacy Purposes | Required To Be Well Capitalized |
| --- | ---: | ---: | ---: | ---: |
| Consolidated | 12.60% | 11.57% | 8.00% | 10.00% |
| First United Bank & Trust | 12.73% | 11.53% | 8.00% | 10.00% |
| Tier 1 Capital (to risk-weighted assets) |  |  |  |  |
| Consolidated | 10.84% | 9.74% | 4.00% | 6.00% |
| First United Bank & Trust | 11.46% | 10.26% | 4.00% | 6.00% |
| Tier 1 Capital (to average assets) |  |  |  |  |
| Consolidated | 8.68% | 7.34% | 4.00% | 5.00% |
| First United Bank & Trust | 9.17% | 7.73% | 4.00% | 5.00% |

51

As of June 30, 2011, the most recent notification from the regulators categorized First United Corporation and the Bank as “well capitalized” under the regulatory framework for prompt corrective action.

In January 2009, pursuant to the Treasury’s Troubled Asset Purchase Program Capital Purchase Program, First United Corporation sold 30,000 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”) and a related warrant to purchase 326,323 shares of its common stock for an exercise price of $13.79 per share to the Treasury for an aggregate purchase price of $30 million. The proceeds from this transaction count as Tier 1 capital and the warrant qualifies as tangible common equity.

Since December 31, 2010, First United Corporation has not paid cash dividends on its Series A Preferred Stock. The February and May 2011 payments of $.4 million each have been deferred. Management cannot predict whether any future regularly quarterly dividend payments on the Series A Preferred Stock will likewise be deferred. The ability of First United Corporation to make these dividend payments depends on our earnings in future quarters.

In December 2010, the Board of Directors of First United Corporation voted to stop paying quarterly cash dividends on the common stock starting in 2011 in connection with the above-mentioned deferral of dividends on the Series A Preferred Stock.

On December 15, 2010, the Corporation elected to defer quarterly interest payments under the TPS Debentures starting with the payments due in March 2011. The total amount due under all TPS Debentures as of June 30, 2011 was $1.0 million. The ability of First United Corporation to make these interest payments depends on our earnings in future quarters.

#### 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 $95.3 million and $1.9 million, respectively, at June 30, 2011, compared to $88.1 million and $4.9 million, respectively, at December 31, 2010. We are not a party to any other off-balance sheet arrangements.

See Note 11 to the consolidated financial statements presented elsewhere in this report for further disclosure on Borrowed Funds. There have been no other significant changes to contractual obligations as presented at December 31, 2010.

## Market risk

As filed, 724 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 above in Item 2 of Part I of this report under the caption “*Market Risk and Interest Sensitivity”*, and in Item 7 of Part II of First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2010 under the caption “**Market Risk and Interest Sensitivity”.** Management believes that no material changes in our procedures used to evaluate and mitigate these risks have occurred since December 31, 2010. We believe the investment portfolio restructuring has better positioned the Corporation for a rising interest rate environment.

## Controls and procedures

As filed, 2,240 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 June 30, 2011 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 half of 2011, 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, 331 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 Corporation’s Annual Report on Form 10-K for the year ended December 31, 2010. Management does not believe that any material changes in our risk factors have occurred since December 31, 2010.

Filed Aug 11, 2011.
Source: SEC EDGAR, the filing index for accession 0001144204-11-045667. Last ingested by Listed: Nov 3, 2026, 22:37 ET. No prices; not investment advice.