First United Corp: Form 10-Q for the period ended Sep 30, 2024

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, 2023.

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 contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements do not represent historical facts, but are statements about management’s beliefs, plans and objectives about the future, as well as its assumptions and judgments concerning such beliefs, plans and objectives. These statements are evidenced by terms such as "anticipate," "estimate," "should," “will”, "expect," "believe," "intend," and similar expressions. Although these statements reflect management’s good faith beliefs and projections, they are not guarantees of future performance and they may not prove true. The beliefs, plans and objectives on which forward-looking statements are based involve risks and uncertainties that could cause actual results to differ materially from those addressed in the forward-looking statements. For a discussion of these risks and uncertainties, see the section of the periodic reports that First United Corporation files with the Securities and Exchange Commission entitled "Risk Factors".

FIRST UNITED CORPORATION

First United Corporation is a Maryland corporation chartered in 1985 and a financial holding company registered with the Board of Governors of the Federal Reserve System (the “FRB”) under the Bank Holding Company Act of 1956, as amended, that elected financial holding company status in 2021. The Corporation’s primary business is serving as the parent company of First United Bank & Trust, a Maryland trust company (the “Bank”), First United Statutory Trust I (“Trust I”) and First United Statutory Trust II (“Trust II” and together with Trust I, “the Trusts”), both Connecticut statutory business trusts. 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. In addition, the Bank owns 99.9% of the limited partnership interests in Liberty Mews Limited Partnership, a Maryland limited partnership formed for the purpose of acquiring, developing and operating low-income housing units in Garrett County, Maryland, and a 99.9% non-voting membership interest in MCC FUBT Fund, LLC, an Ohio limited liability company formed for the purpose of acquiring, developing and operating low-income housing units in Allegany County, Maryland.

At September 30, 2024, the Corporation’s total assets were $1.9 billion, net loans were $1.4 billion, and deposits were $1.5 billion. Shareholders’ equity at September 30, 2024 was $174.0 million.

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

SELECTED FINANCIAL DATA

The following table sets forth certain selected financial data for the nine-month periods ended September 30, 2024 and 2023 and is qualified in its entirety by the detailed information and unaudited financial statements, including the notes thereto, included elsewhere in this quarterly report.

RESULTS OF OPERATIONS

Overview

Consolidated net income was $5.8 million for the third quarter of 2024. This compares to $4.5 million for the third quarter of 2023 and $4.9 million for the second quarter of 2024. Basic and diluted net income was $0.89 per share for the third quarter of 2024, compared to basic and diluted net income of $0.67 per share for the third quarter of 2023 and $0.75 per share for the second quarter of 2024.

The $1.3 million increase in quarterly net income year over year was primarily driven by a $1.2 million increase in net interest income. The increase in net interest income was related to the $3.0 million increase in interest on loans due to new loans being booked at higher rates and the repricing of adjustable-rate loans. This increase was partially offset by the $0.9 million increase in interest paid on deposits due to continued competitive pricing pressures. An increase of $0.4 million in interest expense on short-term borrowings related to the Bank Term Funding Program (“ BTFP”) was offset by the $0.5 million reduction in interest expense on long-term borrowings related to the repayment of $80.0 million of Federal Home Loan Bank (“FHLB”) advances in the first nine months of 2024. Comparing the third quarter of 2024 to the same period in 2023, other activity was a $0.2 million increase in wealth management income due to improving market conditions and growth of new relationships and a decrease in operating expenses of $0.5 million driven by reductions in check fraud related expenses, occupancy and equipment, data processing, and marketing expenses, partially offset by increased salaries and benefits. The provision for income tax was up $0.6 million when comparing the two quarters due to increased net income before tax.

Year-to-date net income for the first nine months of 2024 was $14.4 million compared to $13.3 million for the same period in 2023. The increased net income was driven by a year-over-year increase of $1.6 million in net interest income driven by a $9.3 million increase in interest income primarily related to increased interest and fees on loans, partially offset by a $7.7 million increase in interest expense due to continued pricing pressure on deposits and our use of the BTFP. The increase in net interest income was partially offset by a $1.2 million increase in provision for credit losses driven by an increase in net charge-offs of $1.2 million, which was primarily due to a $1.1 million charge-off in the commercial and industrial portfolio related to one non-accrual credit where collateral was sold through a liquidation auction at depressed prices. Operating income increased $0.9 million, primarily as the result of increased wealth management income. Operating expenses decreased by $0.4 million and was driven by reductions in professional services, and pension benefits expense, a $0.5 million reduction in check fraud expense, and a reduction in other miscellaneous expenses, partially offset by a $0.4 million increase in salaries and benefits.

Other operating income, including net gains, for the third quarter of 2024 increased by $0.2 million when compared to the same period of 2023. The increase was driven by an increase of $0.2 million in trust and brokerage income due to improving market conditions, increased annuity sales and growth in new and existing customer relationships. Gains on sales of mortgages declined slightly when comparing the third quarter of 2024 to the same period of 2023 primarily due to reduced activity in the elevated interest rate environment. Service charge income and debit card income remained stable.

Other operating income for the nine months ended September 30, 2024 increased by $0.9 million when compared to the same period of 2023. This increase was primarily due to the $1.0 million increase in trust and brokerage income that resulted from improving market conditions, increased annuity sales and growth in new and existing customer relationships. Service charge and debit card income were both stable when comparing the first nine months of 2024 to the same period of 2023.

Operating expenses decreased by $0.5 million in the third quarter of 2024 when compared to the third quarter of 2023. The decrease was related to a $0.2 million decrease in occupancy, equipment and data processing expenses, a $0.3 million decrease in check fraud related expenses, and decreases in other miscellaneous expenses such as marketing, contributions, net other real estate owned (“OREO”) expenses, and pension benefit expenses. These decreases were partially offset by a $0.2 million increase in salaries and benefits related to increased executive and employee incentive accruals, 401(k) plan expense and wellness costs offset by overall reduced salaries and wages.

For the nine months ended September 30, 2024, non-interest expenses decreased by $0.4 million when compared to the nine months ended September 30, 2023. The decrease was primarily attributable to a $0.5 million decrease in check fraud expenses and decreases in professional services, equipment, net OREO expense, line rentals, pension benefit expenses, and other miscellaneous expenses such as marketing, contributions, contract labor, and investor relations. These decreases were partially offset by increased occupancy, data processing expenses and salaries and benefits related to increased incentives, 401K expense, wellness expense and loan origination costs, offset by reductions in life and health insurance costs.

Net Interest Income

Net interest income is our largest source of operating revenue. Net interest income is the difference between the interest that we earn on our interest-earning assets and the interest expense we incur on our 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 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. This is a non-GAAP disclosure and management believes it is not materially different than the corresponding GAAP disclosure.

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

(in thousands)

The following tables set forth the average balances, net interest income and expense, and average yields and rates of our interest-earning assets and interest-bearing liabilities for the nine- and three-month periods ended September 30, 2024 and 2023:

(in thousands)

(1) The above table reflects the average rates earned or paid stated on an FTE basis assuming a 21% tax rate for 2024 and 2023. Non-GAAP interest income on a fully taxable equivalent for the nine-month periods ended September 30, 2024 and 2023 was $176 and $566, respectively.

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

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

(dollars in thousands)

(1) The above table reflects the average rates earned or paid stated on an FTE basis assuming a 21% tax rate for 2024 and 2023. Non-GAAP interest income on a fully taxable equivalent for the three-month periods ended September 30, 2024 and 2023 was $61 and $112, respectively.

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

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

Net interest income, on a non-GAAP, fully tax equivalent (“ FTE”) basis, increased by $1.2 million for the third quarter of 2024 when compared to the third quarter of 2023. This increase was driven by a $2.0 million increase in interest income. Interest income on loans increased by $3.0 million due to the increase in average balances of $69.7 million and a 58 basis point increase in the overall yield on the loan portfolio as new loans were booked at higher rates as well as adjustable-rate loans repricing in correlation to the elevated rate environment. Investment income decreased by $0.3 million due to a decrease of $63.2 million in average balances related to the balance sheet restructuring of our investment portfolio in the fourth quarter of 2023 and the maturity of $37.5 million in U.S. Treasury bonds in the first four months of 2024. The overall yield on the investment portfolio increased by 14 basis points primarily driven by the increased rate on the trust preferred portfolio and the maturity and sale of lower rate investments. Average cash balances declined by $42.0 million as cash from the investment portfolio and on balance sheet liquidity was shifted to fund higher yielding loans. Interest expense increased by $0.8 million year over year due to an increase of 34 basis points on interest paid on deposit accounts. The average deposit balances decreased by $7.4 million when compared to the third quarter of 2023 due primarily to the decrease of $13.1 million in retail time deposits, a $60.2 million decrease in brokered time deposits and a $32.3 million decrease in savings accounts, which was mostly offset by an increase of $96.6 million in money market accounts and a slight increase of $1.6 million in interest-bearing demand deposits.

Comparing the nine months ended September 30, 2024 to the nine months ended September 30, 2023, net interest income, on a non-GAAP, FTE basis, increased by $1.2 million. Interest income increased by $8.9 million. Average loan balances increased by $98.3 million and the overall yield increased by 61 basis points in correlation with the elevated rate environment as new loans were booked at higher rates as well as the repricing of adjustable-rate loans. Interest expense on deposits increased by $6.5 million while the average deposit balances increased by $24.7 million, driven by increases of $77.7 million in money market balances and $13.7 million in retail time deposits, partially offset by decreases in savings balances of $44.1 million and brokered time deposits of $26.0 million. Interest expense on short-term borrowings increased by $1.3 million due to the Bank’s utilization of the BTFP program since January 2024. The increased interest expense resulted in an overall increase of 75 basis points on the cost of interest-bearing liabilities. The net interest margin for the nine months ended September 30, 2024 was 3.34% compared to 3.30% for the nine months ended September 30, 2023.

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

(in thousands and tax equivalent basis)

(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.

(in thousands and tax equivalent basis)

(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 Credit Losses

Specific allocations have been made for loans where management has determined that the collateral supporting the loans is not adequate to cover the loan balance, and the qualitative factors affecting the estimated allowance for credit losses (“ACL”) have been adjusted based on the current economic environment and the characteristics of the loan portfolio. For the first nine months of 2024 and 2023, net provision expense was $2.4 million and $1.2 million, respectively. For both of the third quarters ended September 30, 2024 and 2023, net provision expense was $0.3 million. The increased provision expense recorded in 2024 was primarily related to an increases of $1.2 in net charge-offs, which was primarily due to a $1.1 million charge-off related to one non-accrual commercial and industrial loan relationship and was partially offset by improving qualitative risk factors of our loan portfolio.

Other Income

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

(in thousands)

Other Operating Expenses

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

(in thousands)

Provision for Income Taxes

In reporting interim financial information, income tax provisions should be determined under the procedures set forth in Financial Accounting Standards Board’s Accounting Standards Codification (“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 income tax rates as a percentage of income for the nine month periods ended September 30, 2024 and September 30, 2023 were 24.6% and 23.6%, respectively.

Non-GAAP Financial Measures

The Corporation believes that certain non-GAAP financial measures are meaningful because they reflect adjustments commonly made by management, investors, regulators and analysts to evaluate performance trends and the adequacy of common equity. This non-GAAP disclosure has limitations as an analytical tool, should not be viewed as a substitute for performance and financial condition measures determined in accordance with GAAP, and should not be considered in isolation or as a substitute for analysis of results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies.

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

(in thousands, except for per share amount)

FINANCIAL CONDITION

Balance Sheet Overview

Total assets at September 30, 2024 were $1.9 billion, representing a $10.3 million increase since December 31, 2023. During the first nine months of 2024, cash and interest-bearing deposits in other banks increased by $12.6 million. The investment portfolio decreased by $44.3 million due to the maturities of $37.5 million of U.S. Treasury bonds during the year and normal principal amortization of our mortgage-backed securities (“MBS”) portfolio. Cash from the investment maturities was shifted to gross loans, which increased by $41.2 million and other real estate OREO decreased by $1.6 million due to sales of properties. Pension assets increased by $5.1 million due to increased market values. Deferred tax assets decreased by $1.8 million due to the increased fair values of available for sale securities and pension assets when compared to December 31, 2023.

Total liabilities at September 30, 2024 were $1.7 billion, representing a $1.8 million decrease since December 31, 2023. Total deposits decreased by $10.6 million when compared to December 31, 2023 related to decreases in savings deposits of $14.8 million, non-interest-bearing demand deposits of $8.2 million, and retail time deposits of $23.7 million and the repayment of $30.0 million in brokered certificates of deposits, partially offset by increases in interest-bearing demand deposits of $31.6 million and money markets of $34.6 million. Short-term borrowings increased by $4.8 million since December 31, 2023, which were comprised of $29.0 million in overnight borrowings from the Federal Reserve offset by a shift of approximately $22.0 million in overnight investment sweep balances to FDIC insured accounts as a result of management’s strategy to release pledging of investment securities for municipalities to provide additional liquidity. Long-term borrowings increased by $10.0 million in the first nine months of 2024 when compared to December 31, 2023. Maturities of FHLB advances of $40.0 million in March and $40.0 million in September were fully repaid. During the third quarter of 2024 and after the Federal Reserve announced that it would reduce rates by 50 basis points, management made the strategic decision to reduce funding costs and borrowed $90.0 million in three new FHLB advances with maturities of 12 and 18-months and a weighted average rate of 3.89%. $41.1 million was utilized to prepay the principal and accrued interest of the BTFP borrowings at a rate of 4.87% that was scheduled to mature in January of 2025 and approximately $30.0 million was utilized to repay overnight borrowings related to the repayment of the September $40.0 million maturity. The remainder is currently held in overnight cash investments.

Loan Portfolio

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

(in thousands)

Outstanding loans of $1.4 billion at September 30, 2024 reflected growth of $24.9 million since June 30, 2024 and $41.2 million for the first nine months of 2024. Since December 31, 2023, commercial real estate loans increased by $9.1 million, acquisition and development loans increased by $15.8 million, commercial and industrial loans increased by $3.4 million, residential mortgage loans increased $19.3 million, and consumer loans decreased by $6.5 million.

New commercial loan production for the three months ended September 30, 2024 was approximately $52.1 million. The pipeline of commercial loans at September 30, 2024 was $19.5 million. At September 30, 2024, unfunded, committed commercial construction loans totaled approximately $8.3 million. Commercial amortization and payoffs were approximately $92.8 million through September 30, 2024, due primarily to pay-offs of short-term commercial loans as well as normal amortizations of the commercial loan portfolio.

New consumer mortgage loan production for the third quarter of 2024 was approximately $19.9 million, with most of this production comprised of mortgages to be held on balance sheet. The pipeline of in-house, portfolio loans as of September 30, 2024 was $12.8 million. The residential mortgage production level increased in the third quarter of 2024 due to the seasonality of this line of business, particularly construction lending. Unfunded commitments related to residential construction loans totaled $11.9 million at September 30, 2024.

Non-accrual loans totaled $8.1 million at September 30, 2024 compared to $4.0 million at December 31, 2023. The increase in non-accrual balances at September 30, 2024 was related to two commercial and industrial loan relationships totaling $12.1 million that were moved to non-accrual during the first quarter of 2024. Subsequent to being moved to non-accrual, one of the borrowers sold a piece of collateral to reduce outstanding balances by approximately $5.5 million. The Bank also recognized approximately $1.1 million in net charge-offs and $3.0 million in principal reductions on the other commercial and industrial credit from the liquidation of collateral at depressed prices.

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

(in thousands)

Our loan portfolio does not consist of any loans secured by office buildings located in major metropolitan areas or that are over four stories or any retail properties rented to major big box retail tenants. There have been no significant changes in our commercial real estate concentrations since December 31, 2023.

Risk Elements of Loan Portfolio

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

(in thousands)

Allowance for Credit Losses

The ACL represents an amount that, in management’s judgment, is adequate to absorb expected credit losses over the life of outstanding loans as of the balance sheet date based on the evaluation of current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions and prepayment experience. The ACL is measured and recorded upon the initial recognition of a financial asset. The ACL is reduced by charge-offs, net of recoveries of previous losses, and is increased by a provision or decreased by a provision for credit losses, which is recorded as a current period operating expense.

Determination of an appropriate ACL is inherently complex and requires the use of subjective estimates. The reasonableness of the ACL is reviewed quarterly by management.

Management believes it uses relevant information available to make determination about the ACL and that it has established the existing allowance in accordance with GAAP. However, the determination of the ACL requires significant judgment, and estimates of expected credit losses in the loan portfolio can vary from the amounts actually observed. While management uses available information to recognize expected credit losses, future additions to the ACL may be necessary based on changes in the loans comprising the portfolio, changes in the current and forecasted economic conditions, changes to the interest rate environment which may directly impact prepayment and curtailment rate assumptions, and changes in the financial condition of borrowers.

The ACL “base case” model is derived from various economic forecasts provided by widely recognized sources. Management evaluates the variability of market conditions by examining the peak and trough of economic cycles. These peaks and troughs are used to stress the base case model to develop a range of potential outcomes. Management then determines the appropriate reserve through an evaluation of these various outcomes relative to current economic conditions and known risks in the portfolio. Management enhances its calculation with the use of Moody’s economic forecast data to provide additional support to substantiate its ACL.

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

(in thousands)

Net (Charge-offs)/Recoveries as a % of Average Applicable Portfolio

Investment Securities

At September 30, 2024, the total amortized cost basis of the available-for-sale investment portfolio was $111.9 million compared to a fair value of $93.2 million. Unrealized gains and losses on available-for-sale securities are reflected in accumulated other comprehensive loss, a component of shareholders’ equity. The amortized cost basis of the held to maturity portfolio was $174.1 million compared to a fair value of $149.3 million.

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

(in thousands)

Total fair value of investment securities available for sale decreased by $4.0 million since December 31, 2023 due primarily to principal paydowns of the portfolio. At September 30, 2024, the securities classified as available-for-sale included a net unrealized loss of $18.8 million, which represents the difference between the fair value and amortized cost of securities in the portfolio.

Total amortized cost of securities held to maturity decreased by $40.2 million since December 31, 2023 due primarily to the maturity of $37.5 million in U.S. Treasury bonds and $2.7 million in other principal paydowns of the portfolio. Proceeds from the maturities and principal paydowns were utilized for the repayment of FHLB advances.

As discussed in Note 6 to the consolidated financial statements presented elsewhere in this report, the Corporation measures fair market values based on the fair value hierarchy established in ASC Topic 820, Fair Value Measurements and Disclosures. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Level 3 prices or valuation techniques require inputs that are both significant to the valuation assumptions and are not readily observable in the market (i.e. supported with little or no market activity). 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 $78.4 million of the available-for-sale portfolio was valued using Level 2 pricing and had net unrealized losses of $14.9 million at September 30, 2024. The remaining $14.8 million of the available-for-sale securities represents the entire collateralized debt obligation portfolio, which was valued using significant unobservable inputs (Level 3 assets). The $3.9 million in net unrealized losses associated with this portfolio relates to nine pooled trust preferred securities that comprise the collateralized debt obligation portfolio.

Deposits

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

(in thousands)

Total deposits at September 30, 2024 decreased by $10.6 million when compared to December 31, 2023. Non-interest-bearing deposits decreased by $8.2 million. Interest-bearing demand deposits increased by $31.6 million year-to-date, primarily related to the shift of approximately $22.0 million in overnight investment sweep balances into FDIC insured accounts due to management’s strategy to release pledging of investment securities for municipalities to provide additional liquidity as well as seasonal fluctuations in municipal deposit balances compared to December 2023. Money market accounts increased by $34.6 million due primarily to the expansion of current relationships and new relationships during the first nine months. Traditional savings accounts decreased by $14.8 million and time deposits decreased by $53.7 million. The decrease in time deposits was due to a decrease of $23.7 million in retail CDs primarily related to maturities of a nine-month special CD promotion in 2023 and the maturity and repayment of $30.0 million in brokered CDs during the year. The Bank has worked closely with customers as these CDs mature to transition them to other deposit and wealth management products offered by the Bank.

The following table summarizes the percentage of deposits that are insured by deposit insurance or otherwise fully collateralized by securities compared to uninsured deposits as of September 30, 2024 and December 31, 2023.

(in thousands)

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

(in thousands)

Borrowed Funds

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

(in thousands)

Short-term borrowings increased by $4.8 million when compared to December 31, 2023, which were comprised of $29.0 million in overnight borrowings from the Federal Reserve, offset by a shift of approximately $22.0 million in overnight investment sweep balances into FDIC insured accounts due to management’s strategy to release pledging of investment securities for municipalities to provide additional liquidity. Long-term borrowings increased by $10.0 million in the first nine months of 2024 when compared to December 31, 2023. Maturities of FHLB advances of $40.0 million in March and $40.0 million in September were fully repaid. During the third quarter of 2024 and after the Federal Reserve announced that it would reduce rates by 50 basis points, management made the strategic decision to reduce funding costs and borrowed $90.0 million in three new FHLB advances with maturities of 12 and 18 months and a weighted average rate of 3.89%. $41.1 million was utilized to prepay the principal and accrued interest of the BTFP borrowing at a rate of 4.87% that was scheduled to mature in January of 2025 and approximately $30.0 million was utilized to repay overnight borrowings related to the repayment of the September $40.0 million maturity. The remainder is currently held in overnight cash investments.

Liquidity Management

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, Pacific Coast Banker’s Bank, PNC Financial Services, Atlantic Community Bankers Bank, Community Bankers Bank and Zions National Bank).

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

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.

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

(in thousands)

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.

Due to the market disruption and uncertainties, management implemented the Liquidity Contingency Plan in the first quarter and 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 September 30, 2024, 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.

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

(in thousands)

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, 2023. Our NII simulation analysis as of December 31, 2023 is included in Item 7 of Part II of our Annual Report on Form 10-K for the year ended December 31, 2023 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”.

In addition to operational requirements, the Bank is 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.

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

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

Contractual Obligations, Commitments and Off-Balance Sheet Arrangements

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

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)

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

For the nine-month periods ended September 30, 2024 and 2023, net credit loss expense for off-balance sheet exposures was a credit of approximately $17,000 and a credit of approximately $14,000, respectively. For the third quarter of 2024 and 2023, net credit loss for off-balance sheet exposures was an expense of approximately $55,000 and a credit of approximately $104,000, respectively.

First United Corporation is a “smaller reporting company” as defined in Rule 12b-2 promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and, accordingly, is not required to include the information required by this item.

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Exchange Act with the Securities and Exchange Commission (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 September 30, 2024 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 nine months ended September 30, 2024, 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.

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, 2023. Management does not believe that any material changes in our risk factors have occurred since they were last disclosed.