# First United Corp: Form 10-Q for the period ended Jun 30, 2018

- Company: [First United Corp](/companies/func.md) (CIK 763907)
- Form: 10-Q
- Filed: 2018-08-09
- Accepted by EDGAR: Aug 9, 2018, 16:02 ET
- Period: 2018-06-30
- Accession: 0001144204-18-043271
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/763907/000114420418043271/tv499039_10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/763907/000114420418043271/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2018-06-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2018-04-01 to 2018-06-30 | $3.7m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Revenue | 6 months, 2018-01-01 to 2018-06-30 | $7.4m | us-gaap:RevenueFromContractWithCustomerExcludingAssessedTax |
| Interest expense | 3 months, 2018-04-01 to 2018-06-30 | $1.9m | us-gaap:InterestExpense |
| Interest expense | 6 months, 2018-01-01 to 2018-06-30 | $3.6m | us-gaap:InterestExpense |
| Income tax | 3 months, 2018-04-01 to 2018-06-30 | $840.0k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 6 months, 2018-01-01 to 2018-06-30 | $1.5m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2018-04-01 to 2018-06-30 | $3.0m | us-gaap:NetIncomeLoss |
| Net income | 6 months, 2018-01-01 to 2018-06-30 | $5.5m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2018-04-01 to 2018-06-30 | $0.43 | us-gaap:EarningsPerShareBasicAndDiluted |
| Diluted EPS | 6 months, 2018-01-01 to 2018-06-30 | $0.78 | us-gaap:EarningsPerShareBasicAndDiluted |
| Operating cash flow | 6 months, 2018-01-01 to 2018-06-30 | $6.2m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 6 months, 2018-01-01 to 2018-06-30 | $5.4m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 6 months, 2018-01-01 to 2018-06-30 | $1.3m | us-gaap:PaymentsOfDividendsCommonStock |
| Cash and equivalents | at 2018-06-30 | $25.4m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2018-06-30 | $1.32bn | us-gaap:Assets |
| Total liabilities | at 2018-06-30 | $1.21bn | us-gaap:Liabilities |
| Long-term debt | at 2018-06-30 | $100.9m | us-gaap:LongTermDebt |
| Short-term borrowings | at 2018-06-30 | $47.9m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2018-06-30 | $113.0m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 88,477 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 First United 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, as well as the audited consolidated financial statements and related notes included in First United Corporation’s annual report on form 10-K for the year ended December 31, 2017.

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

First United Corporation is a Maryland corporation chartered in 1985 and a bank holding company registered with the Board of Governors of the Federal Reserve System (the “FRB”) under the Bank Holding Company Act of 1956, as amended. The Corporation’s primary business is serving as the parent company of First United Bank & Trust, a Maryland trust company (the “Bank”), First United Statutory Trust I (“Trust I”) and First United Statutory Trust II (“Trust II”), 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 two consumer finance company subsidiaries- OakFirst Loan Center, Inc., a West Virginia corporation, and OakFirst Loan Center, LLC, a Maryland limited liability company- and two subsidiaries that it uses to hold real estate acquired through foreclosure or by deed in lieu of foreclosure- First OREO Trust, a Maryland statutory trust, and FUBT OREO I, LLC, a Maryland limited liability company. 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.

At June 30, 2018, the Corporation’s total assets were $1.3 billion, net loans of $931.4 million, and deposits of $1.0 billion. Shareholders’ equity at June 30, 2018 was $113.0 million.

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

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, 2017). 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, income taxes, fair value of investments 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.

Management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2017.

#### 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 “ALL”), the valuation of underlying collateral, the timing of loan charge-offs and the placement of loans on non-accrual status. The ALL 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 outlook, including the economic conditions specific to Western Maryland and Northeastern West Virginia, changes in lending rates, political conditions, and legislation impacting the banking industry. Because the calculation of the ALL 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

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, *Intangibles - Goodwill and Other*, establishes standards for the amortization of acquired intangible assets and impairment assessment of goodwill. The $11.0 million recorded as goodwill at June 30, 2018 is primarily related to the Bank’s 2003 acquisition of Huntington National Bank branches and 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 that 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 ultimately supported 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

We account for income taxes in accordance with ASC Topic 740, *Income Taxes*. Under this guidance, deferred taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates that will apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date.

Management regularly reviews the carrying amount of the Corporation’s net deferred tax assets to determine if the establishment of a valuation allowance is necessary. If management determines, based on the available evidence, that it is more likely than not that all or a portion of our net deferred tax assets will not be realized in future periods, then a deferred tax valuation allowance will be established. Consideration is given to various positive and negative factors that could affect the realization of the deferred tax assets. In evaluating this available evidence, management considers, among other things, historical performance, expectations of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with utilization of operating loss and tax credit carry forwards not expiring, tax planning strategies and timing of reversals of temporary differences. Significant judgment is required in assessing future earnings trends and the timing of reversals of temporary differences. Management’s evaluation is based on current tax laws as well as management’s expectations of future performance.

Management expects that our 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

Management systematically evaluates securities for impairment on a quarterly basis. Based upon application of accounting guidance for subsequent measurement in ASC Topic 320, *Investments – Debt and Equity Securities* (Section 320-10-35), management assesses whether (a) the Corporation 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 9 to the consolidated financial statements presented elsewhere in this report.

#### 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: (a) the discount rate; and (b) 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 15 to the consolidated financial statements presented elsewhere in this report.

SELECTED FINANCIAL DATA

The following table sets forth certain selected financial data for the six-month periods ended June 30, 2018 and 2017 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, 2018 | 2017 |
| --- | ---: | ---: |
| Basic and diluted net income per common share | $0.78 | $0.52 |
| Basic and diluted book value per common share | $15.95 | $15.36 |
| Significant Ratios |  |  |
| Return on Average Assets (a) | 0.84% | 0.68% |
| Return on Average Equity (a) | 9.94% | 7.40% |
| Average Equity to Average Assets | 8.47% | 8.79% |

Note: (a) Annualized

RESULTS OF OPERATIONS

#### Overview

Consolidated net income available to common shareholders was $5.5 million for the first six months of 2018, compared to $3.5 million for the same period of 2017. Basic and diluted net income per common share for the first six months of 2018 were both $.78, compared to basic and diluted net income per common share of $.52 for the same period of 2017. The increase in earnings was primarily due to an increase in net interest income of $2.2 million, an increase of $.4 million in wealth management income, a $.2 million decrease in provision for loan loss expense, and a decrease of $.8 million in preferred stock dividends due to the $10.0 million redemptions of the Corporation’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) in November 2016 and March 2017. These changes were offset by a $1.2 million increase in salaries and benefits attributable to new hires in late 2017, merit increases, and an increase in life and health insurance related to increased claims, an increase of $.4 million in equipment, occupancy and data processing expenses in the first six months of 2018, and an increase in other real estate owned (“OREO”) expenses due to valuation allowance write-downs on properties in the first half of 2018. The net interest margin for the first six months of 2018, the year ended December 31, 2017 and the first six months of 2017, on a fully tax equivalent (“FTE”) basis, was 3.71%, 3.37% and 3.35%, respectively.

The provision for loan losses was $.7 million for the six months ended June 30, 2018 and $.9 million for the six months ended June 30, 2017. The reduction in provision expense for the first six months of 2018 was primarily driven by a reduction of historical loss factors due to the continued improvement of the loan portfolio offset by loan growth. Specific allocations have been made for impaired loans where management has determined that the collateral supporting the loans is not adequate to cover the loan balance, and the qualitative factors affecting the ALL have been adjusted based on the current economic environment and the characteristics of the loan portfolio.

Net interest income increased $2.2 million when comparing the six month periods ended June 30, 2018 and June 30, 2017. Interest income, when comparing these same periods, increased $2.1 million due primarily to increased interest and fees on the loan portfolio due to loans repricing at higher rates, new loans booked at higher rates as well as the collection of interest and late charges on a payoff of a commercial non-accrual loan in the first quarter of 2018.

Interest expense on our interest-bearing liabilities decreased by $.1 million during the six months ended June 30, 2018 when compared to the same period of 2017 due primarily to an $8.9 million reduction in average long-term borrowings that resulted from the repayment of two FHLB advances totaling $5.0 million at maturity in January 2018, the repayment of $10.8 million of TPS Debentures held by Trust III in March 2017, and the shift of a $15.0 million FHLB advance from a higher cost, long-term borrowing to lower cost overnight borrowings. These decreases were offset slightly by increased interest expense on deposits as we offered product specials and increased pricing for the full relationship customer.

Other operating income increased $.6 million during the first six months of 2018 when compared to the same period of 2017. This increase was primarily attributable to increased wealth management income, service charges, debit card income, and net gains from the investment portfolio. These increases were offset by slight declines in BOLI and other income.

Operating expenses increased $2.0 million in the first six months of 2018 when compared to the same period of 2017. The increase was due primarily to a $1.2 million increase in salaries and benefits attributable to new hires in late 2017, merit increases and an increase in life and health insurance related to increased claims, an increase of $.4 million in equipment, occupancy and data processing expenses, and an increase in OREO expenses due to valuation allowance write-downs on properties, offset by a slight decrease in other miscellaneous expenses such as marketing, personnel related expense, and postage.

Consolidated net income available to common shareholders was $3.0 million for the second quarter of 2018, compared to $2.1 million for the same period of 2017. Basic and diluted net income per common share for the second quarter of 2018 were both $.43, compared to basic and diluted net income per common share of $.30 for the same period of 2017. The increase in earnings was primarily due to an increase in net interest income of $.9 million, an increase of $.1 million in wealth management income, a decrease of $.2 million in preferred stock dividends due to the $10.0 million redemption of Series A Preferred Stock in both November 2016 and March 2017. These changes were offset by a $.6 million increase in salaries and benefits attributable to new hires in late 2017, merit increases and an increase in life and health insurance related to increased claims, an increase of $.2 million in equipment, occupancy and data processing expenses in the second quarter of 2018, an increase in OREO expenses due to valuation allowance write-downs on properties in the second quarter of 2018. The net interest margin for the second quarter of 2018, the year ended December 31, 2017 and the second quarter of 2017, on an FTE basis, was 3.73%, 3.37% and 3.42%, respectively.

The provision for loan losses was $.3 million for both the second quarter of 2018 and 2017. Specific allocations have been made for impaired loans where management has determined that the collateral supporting the loans is not adequate to cover the loan balance, and the qualitative factors affecting the ALL have been adjusted based on the current economic environment and the characteristics of the loan portfolio.

Net interest income increased $.9 million when comparing the second quarter of 2018 to the second quarter of 2017. Interest income, when comparing these same periods, increased $1.0 million due primarily to increased interest and fees on the loan portfolio from loans repricing at higher rates and new loans booked at higher rates. Interest expense increased slightly by $.1 million due primarily to increased pricing on the full relationship customers offset by lower borrowing costs.

Interest expense on our interest-bearing liabilities increased slightly by $.1 million during the second quarter of 2018 when compared to the same period of 2017, due primarily to increased interest expense on deposits as we offered product specials and increased pricing for the full relationship customer.

Other operating income increased $.4 million during second quarter of 2018 when compared to the same period of 2017. This increase was primarily attributable to increased wealth management and debit card income, and net gains on the investment portfolio.

Operating expenses increased $.8 million in the second quarter of 2018 when compared to the same period of 2017. The increase was due primarily to a $.6 million increase in salaries and benefits attributable to new hires in late 2017, merit increases and an increase in life and health insurance related to increased claims, an increase of $.2 million in equipment, occupancy and data processing expenses, and an increase in OREO expenses due to valuation allowance write-downs on properties in the second quarter of 2018.

#### 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-month periods ended June 30, 2018 and 2017:

*(dollars in thousands)*

| Assets | Six months ended June 30, 2018 Average Balance | Interest | Average Yield/Rate | 2017 Average Balance | Interest | Average Yield/Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans | $923,726 | $21,431 | 4.68% | $893,164 | $19,531 | 4.41% |
| Investment Securities: |  |  |  |  |  |  |
| Taxable | 217,374 | 2,921 | 2.71% | 215,686 | 2,743 | 2.56% |
| Non taxable | 18,558 | 847 | 9.20% | 17,057 | 727 | 8.60% |
| Total | 235,932 | 3,768 | 3.22% | 232,743 | 3,470 | 3.01% |
| Federal funds sold | 22,581 | 140 | 1.25% | 45,811 | 173 | 0.76% |
| Interest-bearing deposits with other banks | 2,219 | 9 | 0.82% | 2,122 | 5 | 0.43% |
| Other interest earning assets | 5,108 | 135 | 5.33% | 5,207 | 126 | 4.90% |
| Total earning assets | 1,189,566 | 25,483 | 4.32% | 1,179,047 | 23,305 | 3.99% |
| Allowance for loan losses | (10,569) |  |  | (11,082) |  |  |
| Non-earning assets | 135,448 |  |  | 150,969 |  |  |
| Total Assets | $1,314,445 |  |  | $1,318,934 |  |  |
| Liabilities and Shareholders’ Equity |  |  |  |  |  |  |
| Interest-bearing demand deposits | $174,063 | $71 | 0.08% | $170,618 | $52 | 0.06% |
| Interest-bearing money markets | 216,197 | 331 | 0.31% | 228,770 | 208 | 0.18% |
| Savings deposits | 162,163 | 90 | 0.11% | 155,254 | 87 | 0.11% |
| Time deposits: |  |  |  |  |  |  |
| Less than $100k | 107,635 | 523 | 0.98% | 116,942 | 568 | 0.98% |
| $100k or more | 117,105 | 769 | 1.32% | 119,007 | 662 | 1.12% |
| Short-term borrowings | 50,169 | 124 | 0.50% | 31,397 | 34 | 0.22% |
| Long-term borrowings | 111,592 | 1,728 | 3.12% | 125,822 | 2,109 | 3.38% |
| Total interest-bearing liabilities | 938,924 | 3,636 | 0.78% | 947,810 | 3,720 | 0.79% |
| Non-interest-bearing deposits | 245,202 |  |  | 232,972 |  |  |
| Other liabilities | 19,048 |  |  | 22,233 |  |  |
| Shareholders’ Equity | 111,271 |  |  | 115,919 |  |  |
| Total Liabilities and Shareholders’ Equity | $1,314,445 |  |  | $1,318,934 |  |  |
| Net interest income and spread |  | $21,847 | 3.54% |  | $19,585 | 3.20% |
| Net interest margin |  |  | 3.71% |  |  | 3.35% |

Note:

(1) The above table reflects the average rates earned or paid stated on an FTE basis assuming a 21% tax rate for 2018 and a 35% tax rate for 2017. Non-GAAP interest income on a fully taxable equivalent was $397 and $287, respectively.

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

(3) The average yields on investments are based on amortized cost.

Net interest income, on an FTE basis, increased $2.3 million (11.5%) during the first six months of 2018 over the same period in 2017 due to a $2.2 million (9.3%) increase in interest income and a $.1 million (2.3%) decrease in interest expense. The net interest margin for the first six months of 2018 was 3.71%, compared to 3.35% for the first six months of 2017.

Comparing the first six months of 2018 to the same period of 2017, the increase in interest income was due to increases of $1.9 million in interest and fees on loans and $.3 million in interest income on investments. The increase in interest and fees on loans was due primarily to an increase in the rate earned of 27 basis points attributable to loans repricing, new loans booked at higher rates and increased balances related to the purchases of a $10.0 million student loan pool and a $15.0 million pool of 1-4 family mortgage loans in the first quarter of 2018. The increase in investment interest income was due primarily to an increase in the rate earned of 21 basis points related to the CDO portfolio.

Interest expense on our interest-bearing liabilities decreased by $.1 million during the six months ended June 30, 2018 when compared to the same period of 2017 due primarily to a $14.2 million reduction in average long-term borrowings, which resulted from the repayment of two FHLB advances totaling $5.0 million at maturity in January 2018, the shift of a $15.0 million FHLB advance that matured on April 30, 2018 to short-term borrowings, and the repayment of $10.8 million of TPS Debentures held by Trust III in March 2017. During the six months ended June 30, 2018, interest expense on deposits increased slightly as pricing pressures continued in all markets. We continued to offer empowered pricing on full relationship customers.

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-month periods ended June 30, 2018 and 2017:

*(dollars in thousands)*

| Assets | Three months ended June 30, 2018 Average Balance | Interest | Average Yield/Rate | 2017 Average Balance | Interest | Average Yield/Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans | $939,303 | $10,938 | 4.67% | $893,688 | $9,874 | 4.43% |
| Investment Securities: |  |  |  |  |  |  |
| Taxable | 215,604 | 1,474 | 2.74% | 213,488 | 1,443 | 2.71% |
| Non taxable | 18,328 | 422 | 9.24% | 16,992 | 357 | 8.44% |
| Total | 233,932 | 1,896 | 3.25% | 230,480 | 1,800 | 3.13% |
| Federal funds sold | 10,906 | 15 | 0.55% | 49,379 | 98 | 0.80% |
| Interest-bearing deposits with other banks | 1,790 | 4 | 0.90% | 1,878 | 3 | 0.54% |
| Other interest earning assets | 5,167 | 69 | 5.35% | 5,204 | 59 | 4.58% |
| Total earning assets | 1,191,098 | 12,922 | 4.35% | 1,180,629 | 11,834 | 4.02% |
| Allowance for loan losses | (10,573) |  |  | (11,836) |  |  |
| Non-earning assets | 134,236 |  |  | 148,641 |  |  |
| Total Assets | $1,314,761 |  |  | $1,317,434 |  |  |
| Liabilities and Shareholders’ Equity |  |  |  |  |  |  |
| Interest-bearing demand deposits | $174,961 | $42 | 0.10% | $172,591 | $25 | 0.06% |
| Interest-bearing money markets | 209,801 | 176 | 0.34% | 221,472 | 107 | 0.19% |
| Savings deposits | 164,096 | 46 | 0.11% | 157,844 | 44 | 0.11% |
| Time deposits: |  |  |  |  |  |  |
| Less than $100k | 105,028 | 260 | 0.99% | 116,368 | 281 | 0.97% |
| $100k or more | 116,873 | 404 | 1.39% | 118,980 | 352 | 1.19% |
| Short-term borrowings | 52,576 | 94 | 0.72% | 30,102 | 18 | 0.25% |
| Long-term borrowings | 105,709 | 834 | 3.16% | 120,929 | 935 | 3.10% |
| Total interest-bearing liabilities | 929,044 | 1,856 | 0.80% | 938,286 | 1,762 | 0.75% |
| Non-interest-bearing deposits | 253,713 |  |  | 239,452 |  |  |
| Other liabilities | 19,280 |  |  | 22,581 |  |  |
| Shareholders’ Equity | 112,724 |  |  | 117,115 |  |  |
| Total Liabilities and Shareholders’ Equity | $1,314,761 |  |  | $1,317,434 |  |  |
| Net interest income and spread |  | $11,066 | 3.55% |  | $10,072 | 3.27% |
| Net interest margin |  |  | 3.73% |  |  | 3.42% |

Note:

(1) The above table reflects the average rates earned or paid stated on an FTE basis assuming a 21% tax rate for 2018 and a 35% tax rate for 2017. Non-GAAP interest income on a fully taxable equivalent was $198 and $143, respectively.

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

(3) The average yields on investments are based on amortized cost.

Net interest income, on an FTE basis, increased $1.0 million (9.9%) during the second quarter of 2018 over the same period in 2017 due to a $1.1 million (9.2%) increase in interest income and a $.1 million (5.3%) increase in interest expense. The net interest margin for the second quarter of 2018 was 3.73%, compared to 3.42% for the second quarter of 2017.

Comparing the second quarter of 2018 to the same period of 2017, the increase in interest income was due to increases of $1.0 million in interest and fees on loans and $.1 million in interest income on investments. The increase in interest and fees on loans was due primarily to an increase in the rate earned of 24 basis points attributable to loans repricing at higher rates, new loans booked at higher rates and increased balances related to the purchases of a $10.0 million student loan pool and a $15.0 million pool of 1-4 family mortgage loans in the first quarter of 2018. The increase in investment interest income was due primarily to an increase in the rate earned of 12 basis points related to the CDO portfolio.

Interest expense on our interest-bearing liabilities increased slightly by $.1 million during the second quarter of 2018 when compared to the same period of 2017 due primarily to increased interest expense on deposits as we offered product specials and increased pricing on the full relationship customer.

The following table sets forth an analysis of volume and rate changes in interest income and interest expense for our average interest-earning assets and average interest-bearing liabilities for the six-month periods ended June 30, 2018 and 2017:

*(in thousands and tax equivalent basis)*

| Interest Income: | 2018 Compared to 2017 Volume | Rate | Net |
| --- | ---: | ---: | ---: |
| Loans | $674 | $1,226 | $1,900 |
| Taxable Investments | 22 | 156 | 178 |
| Non-taxable Investments | 65 | 55 | 120 |
| Federal funds sold | (88) | 55 | (33) |
| Other interest earning assets | 0 | 13 | 13 |
| Total interest income | 673 | 1,505 | 2,178 |
| Interest Expense: |  |  |  |
| Interest-bearing demand deposits | 1 | 18 | 19 |
| Interest-bearing money markets | (11) | 134 | 123 |
| Savings deposits | 4 | (1) | 3 |
| Time deposits less than $100 | (46) | 1 | (45) |
| Time deposits $100 or more | (11) | 118 | 107 |
| Short-term borrowings | 21 | 69 | 90 |
| Long-term borrowings | (240) | (141) | (381) |
| Total interest expense | (282) | 198 | (84) |
| Net interest income | $955 | $1,307 | $2,262 |

Note:

(1) The change in interest income/expense due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

The following table sets forth an analysis of volume and rate changes in interest income and interest expense for our average interest-earning assets and average interest-bearing liabilities for the three-month periods ended June 30, 2018 and 2017:

*(in thousands and tax equivalent basis)*

| Interest Income: | 2018 Compared to 2017 Volume | Rate | Net |
| --- | ---: | ---: | ---: |
| Loans | $505 | $559 | $1,064 |
| Taxable Investments | 14 | 17 | 31 |
| Non-taxable Investments | 28 | 37 | 65 |
| Federal funds sold | (77) | (6) | (83) |
| Other interest earning assets | (2) | 13 | 11 |
| Total interest income | 468 | 620 | 1,088 |
| Interest Expense: |  |  |  |
| Interest-bearing demand deposits | 0 | 17 | 17 |
| Interest-bearing money markets | (6) | 75 | 69 |
| Savings deposits | 2 | 0 | 2 |
| Time deposits less than $100 | (27) | 6 | (21) |
| Time deposits $100 or more | (6) | 58 | 52 |
| Short-term borrowings | 14 | 62 | 76 |
| Long-term borrowings | (118) | 17 | (101) |
| Total interest expense | (141) | 235 | 94 |
| Net interest income | $609 | $385 | $994 |

Note:

(1) The change in interest income/expense due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

#### Provision for Loan Losses

The provision for loan losses was $.7 million for the six months ended June 30, 2018 and $.9 million for the six months ended June 30, 2017. The reduction in provision expense for the first six months of 2018 was primarily driven by a reduction of historical loss factors due to the continued improvement of the loan portfolio offset by loan growth. The provision for loan losses was $.3 million for the second quarter of 2018 and 2017. Management evaluates the ALL to ensure that it reflects a level commensurate with the risk inherent in our loan portfolio.

#### Other Operating Income

Other operating income, exclusive of gains, increased $.5 million during the first six months of 2018 when compared to the same period of 2017. This increase was primarily attributable to increased wealth management income, service charges and debit card income. These increases were offset by slight declines in BOLI and other income.

Net gains of $.2 million were reported in other income for the first six months of 2018, compared to net gains of $14 thousand during the same period of 2017.

Other operating income, exclusive of gains, increased $.3 million during the second quarter of 2018 when compared to the same period of 2017. This increase was primarily attributable to increased wealth management and debit card income.

Net gains of $.1 million were reported in other income for the second quarter of 2018, compared to net gains of $9 thousand during the same period of 2017.

The following table shows the major components of other operating income for the six- and three-month periods ended June 30, 2018 and 2017, exclusive of net gains:

|  | Income as % of Total Other Operating Income For the Six months ended June 30, 2018 |  | 2017 |  | Income as % of Total Other Operating Income For the Three months ended June 30, 2018 |  | 2017 |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Service charges | $1,560 | 21% | $1,508 | 22% | $768 | 21% | $773 | 22% |
| Trust department | 3,305 | 45% | 3,050 | 44% | 1,641 | 44% | 1,535 | 44% |
| Debit card Income | 1,201 | 16% | 1,144 | 16% | 648 | 17% | 575 | 16% |
| Bank owned life insurance | 584 | 8% | 600 | 9% | 285 | 8% | 291 | 9% |
| Brokerage commissions | 551 | 7% | 426 | 6% | 306 | 8% | 213 | 6% |
| Other income | 210 | 3% | 231 | 3% | 87 | 2% | 95 | 3% |
|  | $7,411 | 100% | $6,959 | 100% | $3,735 | 100% | $3,482 | 100% |

#### Other Operating Expenses

Operating expenses increased $2.0 million in the first six months of 2018 when compared to the same period of 2017. The increase was due primarily to a $1.2 million increase in salaries and benefits attributable to new hires in late 2017, merit increases and an increase in life and health insurance related to increased claims, an increase of $.4 million in equipment, occupancy and data processing expenses, an increase in OREO expenses due to valuation allowance write-downs on properties, offset by a slight decrease in other miscellaneous expenses such as marketing, personnel related expense, and postage.

Operating expenses increased $.8 million in the second quarter of 2018 when compared to the same period of 2017. The increase was due primarily to a $.6 million increase in salaries and benefits attributable to new hires in late 2017, merit increases and an increase in life and health insurance related to increased claims, an increase of $.2 million in equipment, occupancy and data processing expenses, and an increase in OREO expenses due to valuation allowance write-downs on properties in the second quarter of 2018.

The composition of other operating expenses for the six- and three-month periods ended June 30, 2018 and 2017 is illustrated in the following table:

|  | Expense as % of Total Other Operating Expenses For the Six months ended June 30, 2018 |  | 2017 |  | Expense as % of Total Other Operating Expenses For the Three months ended June 30, 2018 |  | 2017 |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Salaries and employee benefits | $12,038 | 56% | $10,792 | 56% | $6,119 | 58% | $5,525 | 56% |
| FDIC premiums | 303 | 1% | 268 | 2% | 170 | 2% | 184 | 2% |
| Occupancy, equipment and data processing | 4,531 | 21% | 4,180 | 21% | 2,278 | 21% | 2,112 | 21% |
| Professional Services | 643 | 3% | 537 | 3% | 307 | 3% | 284 | 3% |
| Contract Labor | 337 | 2% | 406 | 3% | 161 | 1% | 279 | 3% |
| Telephony Expense | 430 | 2% | 402 | 2% | 219 | 2% | 200 | 2% |
| Other real estate owned | 493 | 2% | 212 | 1% | 108 | 1% | 38 | 0% |
| Other | 2,541 | 13% | 2,532 | 12% | 1,263 | 12% | 1,237 | 13% |
|  | $21,316 | 100% | $19,329 | 100% | $10,625 | 100% | $9,859 | 100% |

#### Provision for Income Taxes

In reporting interim financial information, income tax provisions should be determined under the procedures set forth in ASC Topic 740, *Income Taxes* (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. In arriving at this effective tax rate, however, no effect should be included for the tax related to significant, unusual or extraordinary items that will be separately reported or reported net of their related tax effect in reports for the interim period or for the fiscal year.

The effective tax rate for the first six months of 2018 was 21.2%, compared to an effective tax rate of 28.9% for the first six months of 2017. The effective tax rate for the second quarter of 2018 was 21.8%, compared to an effective tax rate of 29.2% for the second quarter of 2017. The decrease in the effective rate was due to the enactment of the Tax Cuts and Jobs Act on December 22, 2017 which reduced the U.S. federal income tax rate for C Corporations from 35% to 21%. This reduction will continue to affect future periods.

FINANCIAL CONDITION

#### Balance Sheet Overview

Total assets at June 30, 2018 remained unchanged at $1.3 billion when compared to December 31, 2017. During the first six months of 2018, cash and interest-bearing deposits in other banks decreased $58.4 million, the investment portfolio decreased $7.5 million and gross loans increased $48.7 million. Premises and equipment increased $4.3 million due to bank-wide building renovation projects associated with our new brand efforts. Total liabilities decreased $17.7 million during the first six months of 2018 primarily due to a $20.0 million reduction in repurchase agreements where customers (primarily municipalities) are using funds in their Treasury Management accounts. The $20.0 million reduction in long-term borrowings was due to the repayment of two FHLB advances totaling $5.0 million at maturity in January 2018 and the shift of a $15.0 million FHLB advance from long-term borrowings to short-term borrowings at maturity on April 30, 2018. Total deposits increased slightly by $1.7 million.

#### Loan Portfolio

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

*(dollars in thousands)*

|  | June 30, 2018 |  | December 31, 2017 |  |
| --- | ---: | ---: | ---: | ---: |
| Commercial real estate | $290,695 | 31% | $283,162 | 32% |
| Acquisition and development | 111,779 | 12% | 110,530 | 12% |
| Commercial and industrial | 88,174 | 9% | 76,723 | 8% |
| Residential mortgage | 417,282 | 44% | 398,648 | 45% |
| Consumer | 33,271 | 4% | 23,455 | 3% |
| Total Loans | $941,201 | 100% | $892,518 | 100% |

Comparing June 30, 2018 to December 31, 2017, outstanding loans increased by $48.7 million (5.4%). Commercial real estate (“CRE”) loans increased $7.5 million due primarily to several new large relationships in the first six months of 2018. Acquisition and development (“A&D”) loans increased $1.2 million. Commercial and industrial (“C&I”) loans increased $11.5 million due to several new relationships as well as new balances for one large existing relationship of approximately $5.0 million. Residential mortgages increased $18.6 million primarily due to the purchase of a $15.0 million 1-4 family mortgage pool in February 2018, and in house growth continuing in our professional program, offset slightly by amortization on existing balances. The consumer portfolio increased $9.8 million due to the purchase of a $10.0 million student loan pool in the first quarter of 2018 offset by regular amortization. Approximately 28% of the commercial loan portfolio was collateralized by real estate at both June 30, 2018 and December 31, 2017.

#### 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)*

| Non-accrual loans: | June 30, 2018 | % of Applicable Portfolio | December 31, 2017 | % of Applicable Portfolio |
| --- | ---: | ---: | ---: | ---: |
| Commercial real estate | $2,937 | 1.01% | $4,453 | 1.60% |
| Acquisition and development | 42 | 0.04% | 211 | 0.20% |
| Commercial and industrial | 16 | 0.02% | 378 | 0.50% |
| Residential mortgage | 1,998 | 0.50% | 2,046 | 0.50% |
| Consumer | 23 | 0.07% | 30 | 0.10% |
| Total non-accrual loans | $5,016 | 0.53% | $7,118 | 0.80% |
| Accruing Loans Past Due 90 days or more: |  |  |  |  |
| Commercial real estate | $25 |  | $0 |  |
| Acquisition and development | 0 |  | 144 |  |
| Commercial and industrial | 3 |  | 6 |  |
| Residential mortgage | 397 |  | 430 |  |
| Consumer | 6 |  | 15 |  |
| Total loans past due 90 days or more | $431 |  | $595 |  |
| Total non-accrual and accruing loans past due 90 days or more | $5,447 |  | $7,713 |  |
| Restructured Loans (TDRs): |  |  |  |  |
| Performing | $4,883 |  | $5,121 |  |
| Non-accrual (included above) | 241 |  | 834 |  |
| Total TDRs | $5,124 |  | $5,955 |  |
| Other real estate owned | $8,503 |  | $10,141 |  |
| Impaired loans without a valuation allowance | $10,945 |  | $12,317 |  |
| Impaired loans with a valuation allowance | 1,594 |  | 2,634 |  |
| Total impaired loans | $12,539 |  | $14,951 |  |
| Valuation allowance related to impaired loans | $175 |  | $362 |  |

Performing loans considered to be impaired (including performing troubled debt restructurings, or TDRs), as defined and identified by management, amounted to $7.5 million at June 30, 2018 and $7.8 million at December 31, 2017. Loans are identified as impaired when, based on current information and events, management determines that we will be unable to collect all amounts due according to contractual terms. These loans consist primarily of A&D loans and CRE loans. The fair values are generally determined based upon independent third- party appraisals of the collateral or discounted cash flows based upon the expected proceeds. Specific allocations have been made where management believes there is insufficient collateral to repay the loan balance if liquidated and there is no secondary source of repayment available.

The following table presents the details of impaired loans that are TDRs by class at June 30, 2018 and December 31, 2017:

*(in thousands)*

| Performing Commercial real estate | June 30, 2018 Number of Contracts | Recorded Investment | December 31, 2017 Number of Contracts | Recorded Investment |
| --- | ---: | ---: | ---: | ---: |
| Non owner-occupied | 3 | $363 | 3 | $370 |
| All other CRE | 2 | 2,618 | 2 | 2,685 |
| Acquisition and development |  |  |  |  |
| 1-4 family residential construction | 1 | 457 | 1 | 527 |
| All other A&D | 1 | 233 | 1 | 238 |
| Commercial and industrial | 0 | 0 | 0 | 0 |
| Residential mortgage |  |  |  |  |
| Residential mortgage – term | 7 | 1,212 | 8 | 1,301 |
| Residential mortgage – home equity | 0 | 0 | 0 | 0 |
| Consumer | 0 | 0 | 0 | 0 |
| Total performing | 14 | $4,883 | 15 | $5,121 |
| Non-accrual |  |  |  |  |
| Commercial real estate |  |  |  |  |
| Non owner-occupied | 0 | $0 | 0 | $0 |
| All other CRE | 0 | 0 | 2 | 583 |
| Acquisition and development |  |  |  |  |
| 1-4 family residential construction | 0 | 0 | 0 | 0 |
| All other A&D | 0 | 0 | 0 | 0 |
| Commercial and industrial | 0 | 0 | 0 | 0 |
| Residential mortgage |  |  |  |  |
| Residential mortgage – term | 2 | 241 | 2 | 251 |
| Residential mortgage – home equity | 0 | 0 | 0 | 0 |
| Consumer | 0 | 0 | 0 | 0 |
| Total non-accrual | 2 | 241 | 4 | 834 |
| Total TDRs | 16 | $5,124 | 19 | $5,955 |

The level of TDRs decreased $.8 million during the six months ended June 30, 2018. There were two non-accrual loans totaling $.6 million that were repaid in the first quarter of 2018 and one performing TDR that moved to OREO. Additionally, $.2 million in net principal payments were received during the same time period.

#### Allowance and Provision for Loan Losses

The ALL is maintained to absorb losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.

The ALL is also based on estimates, and actual losses will vary from current estimates. These estimates are reviewed quarterly, and as adjustments, either positive or negative, become necessary, a corresponding increase or decrease is made in the ALL. The methodology used to determine the adequacy of the ALL is consistent with prior years. An estimate for probable losses related to unfunded lending commitments, such as letters of credit and binding but unfunded loan commitments is also prepared. This estimate is computed in a manner similar to the methodology described above, adjusted for the probability of actually funding the commitment.

The following table presents a summary of the activity in the ALL for the six months ended June 30:

*(dollars in thousands)*

|  | 2018 | 2017 |
| --- | ---: | ---: |
| Balance, January 1 | $9,972 | $9,918 |
| Charge-offs: |  |  |
| Commercial real estate | (889) | (2,745) |
| Acquisition and development | (98) | (18) |
| Commercial and industrial | (10) | (33) |
| Residential mortgage | (240) | (236) |
| Consumer | (175) | (143) |
| Total charge-offs | (1,412) | (3,175) |
| Recoveries: |  |  |
| Commercial real estate | 60 | 63 |
| Acquisition and development | 258 | 188 |
| Commercial and industrial | 31 | 1,651 |
| Residential mortgage | 65 | 253 |
| Consumer | 79 | 116 |
| Total recoveries | 493 | 2,271 |
| Net credit losses | (919) | (904) |
| Provision for loan losses | 716 | 908 |
| Balance at end of period | $9,769 | $9,922 |
| Allowance for loan losses to gross loans outstanding (as %) | 1.04% | 1.11% |
| Net charge-offs to average loans outstanding during the period, annualized (as %) | 0.20% | 0.20% |

The ALL was $9.8 million at June 30, 2018 and $10.0 million at December 31, 2017. The provision for loan losses for the first six months of 2018 was $.7 million, compared to $.9 million for the first six months of 2017. Net credit losses of $.9 million were recorded for the both of the six months ended June 30, 2018 and 2017. The ratio of the ALL to loans outstanding was 1.04% at June 30, 2018, 1.12% at December 31, 2017, and 1.11% at June 30, 2017.

The ratio of net charge-offs to average loans for the six months ended June 30, 2018 and 2017 was an annualized .20%, compared to .28% for the year ended December 31, 2017. The CRE portfolio had an annualized net charge-off rate of .58% as of June 30, 2018, compared 1.43% as of December 31, 2017. The increased charge-offs in 2017 were related to one large commercial loan. The A&D loans had an annualized net recovery rate of .29% as of June 30, 2018, compared to .11% as of December 31, 2017. The C&I loans had a net recovery rate of .05% as of June 30, 2018, compared to 2.21% as of December 31, 2017. The reduction in recoveries in the C&I portfolio in 2018 was due to a large recovery on a loan on an ethanol plant in the first quarter of 2017 that had been charged off in prior years. The residential mortgage ratios were a net charge-off rate of .09% as of June 30, 2018, compared to .01% as of December 31, 2017, and the consumer loan ratios were net charge-off rates of .68% and .53% as of June 30, 2018 and December 31, 2017, respectively.

Management believes that the ALL at June 30, 2018 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, 2018, the total amortized cost basis of the available-for-sale investment portfolio was $149.0 million, compared to a fair value of $142.3 million. Unrealized gains and losses on securities available-for-sale are reflected in accumulated other comprehensive loss, a component of shareholders’ equity. The amortized cost basis of the held to maturity portfolio was $90.3 million, compared to a fair value of $89.2 million.

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

*(dollars in thousands)*

| Securities Available-for-Sale: | June 30, 2018 Amortized Cost | Fair Value (FV) | FV as % of Total | December 31, 2017 Amortized Cost | Fair Value (FV) | FV as % of Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| U.S. government agencies | $30,000 | $28,751 | 20% | $30,000 | $29,256 | 20% |
| Commercial mortgage-backed agencies | 40,450 | 38,843 | 27% | 41,771 | 40,891 | 28% |
| Collateralized mortgage obligations | 39,103 | 37,625 | 27% | 41,298 | 40,384 | 28% |
| Obligations of state and political subdivisions | 21,088 | 20,937 | 15% | 20,772 | 21,019 | 14% |
| Collateralized debt obligations | 18,357 | 16,147 | 11% | 19,711 | 14,920 | 10% |
| Total available for sale | $148,998 | $142,303 | 100% | $153,552 | $146,470 | 100% |
| Securities Held to Maturity: |  |  |  |  |  |  |
| U.S. government agencies | $15,946 | $15,934 | 18% | $15,876 | $16,323 | 17% |
| Residential mortgage-backed agencies | 45,297 | 43,855 | 49% | 47,771 | 47,442 | 50% |
| Commercial mortgage-backed agencies | 16,643 | 16,416 | 19% | 17,288 | 17,518 | 18% |
| Collateralized mortgage obligations | 3,989 | 3,771 | 4% | 4,187 | 4,118 | 4% |
| Obligations of state and political subdivisions | 8,420 | 9,266 | 10% | 8,510 | 9,945 | 11% |
| Total held to maturity | $90,295 | $89,242 | 100% | $93,632 | $95,346 | 100% |

Total investment securities available-for-sale decreased by $4.2 million since December 31, 2017. At June 30, 2018, the securities classified as available-for-sale included a net unrealized loss of $6.7 million, which represents the difference between the fair value and amortized cost of securities in the portfolio.

As discussed in Note 9 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 $126.1 million of the available-for-sale portfolio was valued using Level 2 pricing and had net unrealized losses of $4.5 million at June 30, 2018. The remaining $16.1 million of the securities available-for-sale represents the entire CDO portfolio, which was valued using significant unobservable inputs (Level 3 assets). The $2.2 million in net unrealized losses associated with this portfolio relates to 9 pooled trust preferred securities that comprise the CDO portfolio. Net unrealized losses of $1.2 million represent non-credit related OTTI charges on seven of the securities, while $1.0 million of unrealized losses relates to two securities which have had no credit related OTTI.

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, 2018:

### 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 XVIII\* | C | 1,941 | 1,457 | (484) | C | 676,565 | 14.83% | 309,576 | 584 | 0.19% | 44 / 60 |
| Preferred Term Security XVIII | C | 2,785 | 2,185 | (600) | C | 676,565 | 14.83% | 309,576 | 584 | 0.19% | 44 / 60 |
| Preferred Term Security XIX\* | C | 1,798 | 1,759 | (39) | C | 700,535 | 5.71% | 499,563 | 17,476 | 3.50% | 52 / 59 |
| Preferred Term Security XIX\* | C | 1,070 | 1,055 | (15) | C | 700,535 | 5.71% | 499,563 | 17,476 | 3.50% | 52 / 59 |
| Preferred Term Security XIX\* | C | 2,469 | 2,463 | (6) | C | 700,535 | 5.71% | 499,563 | 17,476 | 3.50% | 52 / 59 |
| Preferred Term Security XIX\* | C | 1,072 | 1,055 | (17) | C | 700,535 | 5.71% | 499,563 | 17,476 | 3.50% | 52 / 59 |
| Preferred Term Security XXII\* | C-1 | 1,531 | 1,378 | (153) | C | 1,386,600 | 11.97% | 885,324 | 48,511 | 5.48% | 62 / 77 |
| Preferred Term Security XXII\* | C-1 | 3,827 | 3,446 | (381) | C | 1,386,600 | 11.97% | 885,324 | 48,511 | 5.48% | 62 / 77 |
| Preferred Term Security XXIII | C-1 | 1,864 | 1,349 | (515) | C | 1,467,000 | 15.47% | 860,233 | 62,391 | 7.25% | 84 / 99 |
| Total Level 3 Securities Available for Sale |  | $18,357 | $16,147 | $(2,210) |  |  |  |  |  |  |  |

\* 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 5.71% to 15.47% 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 ASC Topic 320 (Section 320-10-35), management must assess whether (a) the Corporation 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, 2018 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 effect transactions in 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, 2018, (b) an income valuation approach technique (i.e. present value) that maximizes the use of relevant unobservable 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 relies on an independent third party to prepare both the evaluations of OTTI and the fair value determinations for the CDO portfolio. Management does not believe that there were any material differences in the OTTI evaluations and pricing between December 31, 2017 and June 30, 2018.

The approach used by the third party to determine fair value involved several steps, which included detailed credit and structural evaluation of each piece of collateral in each bond, projection of 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, with a limited market for highly-rated CDO securities that are more senior in the capital structure than the securities in the CDO portfolio. 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 first six months of 2018.

#### Deposits

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

*(dollars in thousands)*

| Non-interest bearing demand deposits: | June 30, 2018 |  | December 31, 2017 |  |
| --- | ---: | ---: | ---: | ---: |
| Retail | $268,422 | 25.8% | $249,694 | 24.0% |
| Brokered / ICS | 3,321 | 0.3% | 2,355 | 0.3% |
| Interest-bearing deposits: |  |  |  |  |
| Demand | 171,628 | 16.5% | 171,742 | 16.5% |
| Money Market: |  |  |  |  |
| Retail | 154,868 | 14.9% | 165,276 | 15.9% |
| Brokered/ICS | 56,418 | 5.4% | 58,413 | 5.6% |
| Savings deposits | 164,301 | 15.8% | 157,783 | 15.2% |
| Time deposits less than $100,000: |  |  |  |  |
| Retail | 103,070 | 9.9% | 107,238 | 10.3% |
| Brokered/CDARS | 489 | 0.0% | 358 | 0.0% |
| Time deposits $100,000 or more: |  |  |  |  |
| Retail | 116,586 | 11.2% | 124,488 | 12.0% |
| Brokered/CDARS | 2,017 | 0.2% | 2,043 | 0.2% |
| Total Deposits | $1,041,120 | 100% | $1,039,390 | 100% |

Total deposits increased $1.7 million during the first six months of 2018 when compared to deposits at December 31, 2017. During the first six months of 2018, non-interest bearing deposits increased $19.7 million. This growth is due to new account openings as well as increased balances in existing accounts. Traditional savings accounts increased $6.5 million due to continued growth in our Prime Saver product. Total demand deposits decreased $.1 million and total money market accounts decreased $12.4 million due to decreased balances in our ICS money market account relating to the re-allocation of cash in our trust accounts. Time deposits less than $100,000 decreased $4.0 million and time deposits greater than $100,000 decreased $7.9 million. The decrease in time deposits greater than $100,000 was due to the maturity of one large certificate of deposit for a municipality in the first quarter of 2018.

On May 22, 2018, the Economic Growth Regulatory Relief and Consumer Protection Act was signed into law. As a result of this act, most reciprocal deposits are no longer considered brokered deposits. We anticipate that the deposits indicated as brokered in the table above will not be classified as brokered deposits when the regulations implementing this act become effective.

#### Borrowed Funds

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

*(in thousands)*

|  | June 30, 2018 | December 31, 2017 |
| --- | ---: | ---: |
| Fed Funds Purchased | $19,000 | $0 |
| Securities sold under agreements to repurchase | 28,929 | 48,845 |
| Total short-term borrowings | $47,929 | $48,845 |
| FHLB advances | $70,000 | $90,000 |
| Junior subordinated debt | 30,929 | 30,929 |
| Total long-term borrowings | $100,929 | $120,929 |

Total short-term borrowings decreased by $.9 million during the first six months of 2018. This decrease was due to a decrease in repurchase agreements, or our Treasury management product, due to the usage of funds in customer’s accounts of $19.9 million offset by an increase of $19.0 million in overnight borrowings. Long-term borrowings decreased by $20.0 million during the first six months of 2018 due to the repayment of two FLHB advance totaling $5.0 million at maturity in January 2018 and one FHLB advance totaling $15.0 million at maturity in April 2018.

#### 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 institution’s 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 regular meetings of a sub-committee of executive management, known as the Treasury Team, which looks forward 12 months at 30-day intervals. The measurement is based upon the projection of funds sold or purchased position, along with ratios and trends developed to measure dependence on purchased funds and core growth. 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 Corporation may supplement retail funding with external funding sources such as:

1\. Unsecured Fed Funds lines of credit with upstream correspondent banks (M&T Bank, PNC Bank, Atlantic Community Bankers Bank, Community Bankers Bank, SunTrust and Zions National Bank).

2\. Secured advances with the FHLB of Atlanta, which are collateralized by eligible one to four family residential mortgage loans, home equity lines of credit, commercial real estate loans, various securities and pledged cash.

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.

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

Management believes that we have adequate liquidity available to respond to current and anticipated liquidity demands and is not aware of any trends or demands, commitments, events or uncertainties that are likely to materially affect our ability to maintain liquidity at satisfactory levels.

#### 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.

At June 30, 2018, we were 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.

Based on the simulation analysis performed at June 30, 2018 and December 31, 2017, management estimated the following changes in net interest income, assuming the indicated rate changes:

*(Dollars in thousands)*

|  | June 30, 2018 | December 31, 2017 |
| --- | ---: | ---: |
| +400 basis points | $115 | $(371) |
| +300 basis points | $204 | $(30) |
| +200 basis points | $286 | $261 |
| +100 basis points | $298 | $387 |
| -100 basis points | $(1,951) | $(3,003) |

This estimate is based on assumptions that may be affected by unforeseeable changes in the general interest rate environment and any number of unforeseeable factors. Rates on different assets and liabilities within a single maturity category adjust to changes in interest rates to varying degrees and over varying periods of time. The relationships between lending rates and rates paid on purchased funds are not constant over time. Management can respond to current or anticipated market conditions by lengthening or shortening the Bank’s sensitivity through loan repricings or changing its funding mix. The rate of growth in interest-free sources of funds will influence the level of interest-sensitive funding sources. In addition, the absolute level of interest rates will affect the volume of earning assets and funding sources. As a result of these limitations, the interest-sensitive gap is only one factor to be considered in estimating the net interest margin.

Management believes that no material changes in our market risks, our procedures used to evaluate and mitigate those risks, or our actual or simulated sensitivity positions have occurred since December 31, 2017. Our NII simulation analysis as of December 31, 2017 is included in Item 7 of Part II Item 7 of Part II of our Annual Report on Form 10-K for the year ended December 31, 2017 under the heading “Market Risk and Interest Sensitivity.

*Impact of Inflation –* Our assets and liabilities are primarily monetary in nature, and as such, future changes in prices do not affect the obligations to pay or receive fixed and determinable amounts of money. During inflationary periods, monetary assets lose value in terms of purchasing power and monetary liabilities have corresponding purchasing power gains. The concept of purchasing power is not an adequate indicator of the impact of inflation on financial institutions because it does not incorporate changes in our earnings.

#### Capital Resources

We require capital to fund loans, satisfy our obligations under the Bank’s letters of credit, meet the deposit withdrawal demands of the Bank’s customers, and satisfy our other monetary obligations. To the extent that deposits are not adequate to fund our capital requirements, we can rely on the funding sources identified above under the heading “Liquidity Management”. At June 30, 2018, the Bank had $56.0 million available through unsecured lines of credit with correspondent banks, $4.7 million available through a secured line of credit with the Fed Discount Window and approximately $124.9 million available through the FHLB. Management is not aware of any demands, commitments, events or uncertainties that are likely to materially affect our ability to meet our future capital requirements.

In addition to operational requirements, the Bank and the Corporation are subject to risk-based capital regulations, which were adopted and are monitored by federal banking regulators. These regulations are used to evaluate capital adequacy and require an analysis of an institution’s asset risk profile and off-balance sheet exposures, such as unused loan commitments and stand-by letters of credit.

On July 2, 2013, the FRB approved final rules that substantially amended the regulatory risk-based capital rules applicable to First United Corporation. The FDIC subsequently approved the same rules which apply to the Bank. The final rules implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act and were implemented as of March 31, 2015.

The Basel III capital rules include new risk-based capital and leverage ratios, which will be phased in from 2015 to 2019, and which refine the definition of what constitutes “capital” for purposes of calculating those ratios. The new minimum capital level requirements applicable to the Corporation under the final rules are: (a) a new common equity Tier 1 capital ratio of 4.5%; (b) a Tier 1 capital ratio of 6% (increased from 4%); (c) a total capital ratio of 8% (unchanged from current rules); and (d) a Tier 1 leverage ratio of 4% for all institutions. The final rules also establish a “capital conservation buffer” above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital. The capital conservation buffer will be phased-in over four years beginning on January 1, 2016, as follows: the maximum buffer will be 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. This will result in the following minimum ratios beginning in 2019: (1) a common equity Tier 1 capital ratio of 7.0%, (2) a Tier 1 capital ratio of 8.5%, and (3) a total capital ratio of 10.5%. Under the final rules, institutions are subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

The Basel III capital final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses, as well as certain instruments that no longer qualify as Tier 1 capital, some of which will be phased out over time. Under the final rules, the effects of certain accumulated other comprehensive items are not excluded; however, banking organizations like the Corporation and the Bank that are not considered “advanced approaches” banking organizations may make a one-time permanent election to continue to exclude these items. The Corporation and the Bank made this election in their first quarter 2015 regulatory filings in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of the Corporation’s available-for-sale securities portfolio. Additionally, the final rules provide that small depository institution holding companies with less than $15 billion in total assets as of December 31, 2009 (which includes the Corporation) will be able to permanently include non-qualifying instruments that were issued and included in Tier 1 or Tier 2 capital prior to May 19, 2010 (such as the Corporation’s TPS Debentures) in additional Tier 1 or Tier 2 capital until they redeem such instruments or until the instruments mature.

The Basel III capital rules also contain revisions to the prompt corrective action framework, which is designed to place restrictions on insured depository institutions if their capital levels begin to show signs of weakness. These revisions were effective January 1, 2015. Under the prompt corrective action requirements, which are designed to complement the capital conservation buffer, insured depository institutions are required to meet the following capital level requirements in order to qualify as “well capitalized”: (a) a new common equity Tier 1 capital ratio of 6.5%; (b) a Tier 1 capital ratio of 8% (increased from 6%); (c) a total capital ratio of 10% (unchanged from current rules); and (d) a Tier 1 leverage ratio of 5% (increased from 4%).

The Basel III capital rules set forth certain changes for the calculation of risk-weighted assets. These changes include (a) an increased number of credit risk exposure categories and risk weights; (b) an alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act; (c) revisions to recognition of credit risk mitigation; (d) rules for risk weighting of equity exposures and past due loans, and (e) revised capital treatment for derivatives and repo-style transactions.

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, 2018 | December 31, 2017 | Required for Capital Adequacy Purposes | Required to be Well Capitalized |
| --- | ---: | ---: | ---: | ---: |
| Consolidated | 16.28% | 15.98% | 8.00% | 10.00% |
| First United Bank & Trust | 15.65% | 15.58% | 8.00% | 10.00% |
| Tier 1 Capital (to risk-weighted assets) |  |  |  |  |
| Consolidated | 15.30% | 14.97% | 6.00% | 8.00% |
| First United Bank & Trust | 14.64% | 14.51% | 6.00% | 8.00% |
| Common Equity Tier 1 Capital (to risk-weighted assets) |  |  |  |  |
| Consolidated | 12.77% | 12.54% | 4.50% | 6.50% |
| First United Bank & Trust | 14.64% | 14.51% | 4.50% | 6.50% |
| Tier 1 Capital (to average assets) |  |  |  |  |
| Consolidated | 11.63% | 11.00% | 4.00% | 5.00% |
| First United Bank & Trust | 10.75% | 10.21% | 4.00% | 5.00% |

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

### Contractual Obligations

The Corporation enters into contractual obligations in the normal course of business. Among these obligations are FHLB advances and junior subordinated debentures, operating lease agreements for banking and subsidiaries’ offices and for data processing and telecommunications equipment. Payments required under these obligations are set forth in the table following as of December 31, 2017:

*(In thousands)*

|  | Less than 1 year | 1-3 years | 3-5 years | After 5 years | Total |
| --- | ---: | ---: | ---: | ---: | ---: |
| Short-term borrowings | $48,845 | $0 | $0 | $0 | $48,845 |
| Long-term borrowings | 20,000 | 50,000 | 20,000 | 30,929 | 120,929 |
| Certificates of deposit | 97,039 | 69,402 | 67,686 | 0 | 234,127 |
| Operating lease obligations | 3,237 | 5,895 | 5,692 | 3,707 | 18,531 |
| Capital lease obligations | 143 | 286 | 286 | 2,283 | 2,998 |
| Total | $169,264 | $125,583 | $93,664 | $36,919 | $425,430 |

As of June 30, 2018, two FHLB advances totaling $5.0 million were repaid at maturity in January 2018 and one $15.0 million advance was shifted from long-term borrowings to short-term borrowings at maturity on April 30, 2018.

### Commitments

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. We are not a party to any other off-balance sheet arrangements.

Commitments to extend credit in the form of consumer, commercial and business at the dates indicated were as follows:

*(In thousands)*

|  | June 30, 2018 | December 31, 2017 |
| --- | ---: | ---: |
| Residential Mortgage - home equity | $50,489 | $52,251 |
| Residential Mortgage - construction | 12,865 | 13,512 |
| Commercial | 59,950 | 56,968 |
| Consumer - personal credit lines | 3,824 | 4,012 |
| Standby letters of credit | 2,745 | 2,633 |
| Total | $129,873 | $129,376 |

## Market risk

As filed, 379 characters.

The information required by this item is included 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, 2017 under the heading “Market Risk and Interest Sensitivity” both of which are incorporated in this Item 3 by reference.

## Controls and procedures

As filed, 2,280 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 First United Corporation’s principal executive officer (“PEO”) and its principal financial officer (“PFO”), 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, 2018 was carried out under the supervision and with the participation of management, including the PEO and the PFO. Based on that evaluation, management, including the PEO and the PFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the quarter ended June 30, 2018, 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, 347 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 First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2017. Management does not believe that any material changes in our risk factors have occurred since they were last disclosed.

Filed Aug 9, 2018.
Source: SEC EDGAR, the filing index for accession 0001144204-18-043271. Last ingested by Listed: Nov 3, 2026, 22:37 ET. No prices; not investment advice.