# First United Corp: Form 10-Q for the period ended Jun 30, 2020

- Company: [First United Corp](/companies/func.md) (CIK 763907)
- Form: 10-Q
- Filed: 2020-08-10
- Accepted by EDGAR: Aug 10, 2020, 17:12 ET
- Period: 2020-06-30
- Accession: 0001562762-20-000332
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/763907/000156276220000332/func-20200630x10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/763907/000156276220000332/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2020-06-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2020-04-01 to 2020-06-30 | $2.4m | us-gaap:InterestExpense |
| Interest expense | 6 months, 2020-01-01 to 2020-06-30 | $5.2m | us-gaap:InterestExpense |
| Income tax | 3 months, 2020-04-01 to 2020-06-30 | $711.0k | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 6 months, 2020-01-01 to 2020-06-30 | $1.2m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2020-04-01 to 2020-06-30 | $2.6m | us-gaap:NetIncomeLoss |
| Net income | 6 months, 2020-01-01 to 2020-06-30 | $4.3m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2020-04-01 to 2020-06-30 | $0.37 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 6 months, 2020-01-01 to 2020-06-30 | $0.62 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2020-04-01 to 2020-06-30 | $0.37 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 6 months, 2020-01-01 to 2020-06-30 | $0.62 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2020-04-01 to 2020-06-30 | 6,992,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 6 months, 2020-01-01 to 2020-06-30 | 7,032,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 6 months, 2020-01-01 to 2020-06-30 | $2.8m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 6 months, 2020-01-01 to 2020-06-30 | $1.3m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 6 months, 2020-01-01 to 2020-06-30 | $1.8m | us-gaap:PaymentsOfDividendsCommonStock |
| Share repurchases | 6 months, 2020-01-01 to 2020-06-30 | $2.8m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2020-06-30 | $117.1m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2020-06-30 | $1.64bn | us-gaap:Assets |
| Total liabilities | at 2020-06-30 | $1.52bn | us-gaap:Liabilities |
| Long-term debt | at 2020-06-30 | $100.9m | us-gaap:LongTermDebt |
| Short-term borrowings | at 2020-06-30 | $36.0m | us-gaap:ShortTermBorrowings |
| Shareholders' equity | at 2020-06-30 | $124.5m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 102,097 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, 2019.

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," "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", including the risk factor set forth in First United Corporation’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2019 entitled, “**The outbreak of the recent coronavirus (‘COVID-19’), or an outbreak of another highly infectious or contagious disease, could adversely affect the Corporation’s business, financial condition and results of operations.”** and any updates thereto that might be contained in subsequent reports filed by First United Corporation. The risks and uncertainties associated with the COVID-19 pandemic and its impact on the Corporation will depend on, among other things, the length of time that the pandemic continues; the duration of the potential imposition of further restrictions on travel in the future; the effect of the pandemic on the global, national, and local economies and on the businesses of our borrowers and their ability to make payments on their obligations; the remedial actions and stimulus measures adopted by federal, state, and local governments; and the inability of employees to work due to illness, quarantine, or government mandates.

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.

(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.

At June 30, 2020, the Corporation’s total assets were $1.6 billion, net loans were $1.2 billion, and deposits were $1.4 billion. Shareholders’ equity at June 30, 2020 was $124.5 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, 2019). On an on-going basis, management evaluates estimates, including those related to loan losses and potential impairment of goodwill, 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, 2019.

#### 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

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, Intangibles - Goodwill and Other, provides guidance on the accounting and reporting of goodwill subsequent to its acquisition. The $11.0 million recorded as goodwill at June 30, 2020 is primarily related to the 2003 acquisition of certain branches.

Goodwill is not amortized but shall be tested at least annually for impairment at a level of accounting referred to as a reporting unit. The Corporation is considered the sole reporting unit. Goodwill of a reporting unit shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Impairment of goodwill is the condition that exists when the carrying amount of a reporting unit that includes goodwill exceeds its fair value. A goodwill impairment loss is recognized for the amount that the carrying amount of a reporting unit, including goodwill, exceeds its fair value, limited to the total amount of goodwill allocated to that reporting unit. An entity may assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, including goodwill. If, after assessing the totality of events or circumstances qualitatively, an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity shall perform the quantitative goodwill impairment test. However, if, after assessing the totality of events or circumstances qualitatively, an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the quantitative goodwill impairment test is unnecessary.

The Corporation performs its annual goodwill assessment each December. However, management notes that the emergence of COVID-19 as a global pandemic during the first half of 2020 has resulted in significant deterioration in the general economic conditions and has caused a deterioration in the environment in which the Corporation operates. The reduction in interest rates and the resultant impact to margin, the impact of full and partial closures on business clients leading to loss of jobs for consumers and reduced cash flow for businesses, the execution of PPP loans and modifications, and the inflow of deposits as customers flock to safety are all signs indicative of the economic and industry stress. While the Corporation’s core income has remained strong year to date due to PPP fees, mortgage banking and steady net interest income, the provision expense has increased as the risk inherent in the loan portfolio has been recognized through changing qualitative factors. The full impact to earnings in the banking industry and to the Corporation specifically, remains uncertain as there have been a multitude of government plans implemented during the second quarter of 2020 aimed at providing financial assistance to businesses. However, the stock price for the Corporation, as well as stock prices of its peers, has been negatively impacted. Based on the totality of the circumstances and the impact of the economic conditions on the stock price, management concluded that it is more likely than not that the fair value of a reporting unit is less than its carrying amount and engaged an independent third party to perform the quantitative analysis of comparing the fair value of the Corporation to its carrying value, including goodwill. The results of that analysis determined that fair value exceeded carrying value and, therefore, management has concluded there is no impairment at June 30, 2020. Management will continue to monitor for potential impairment throughout the remainder of 2020.

#### 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. Increases or decreases in the value of deferred tax assets and liabilities due to a change in tax rates are recognized as income or expense, respectively, in the period that includes the date on which the change becomes effective.

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 the anticipated recovery of any decline in fair value. If neither applies, then any decline in the fair value below the security’s cost that is considered an other-than-temporary decline is 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 Financial Condition section located elsewhere in this MD&A.

#### Fair Value of Investments

We have determined the fair value of our investment securities in accordance with the requirements of ASC Topic 820, *Fair Value Measurements and Disclosures,* which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements required under other accounting pronouncements. The Corporation measures the fair market values of its investments based on the fair value hierarchy established in Topic 820. The determination of fair value of investments and other assets is discussed further in Note 8 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 11 to the consolidated financial statements presented elsewhere in this report.

### Response to COVID-19

Protecting the health, safety, and financial well-being of our associates and customers was and continues to be our goal as we quickly adapted to COVID-19.

The following actions were implemented from our well-designed and tested Business Continuity Plan:

Notified our shareholders and customers in early March as to our enhanced measures to protect our associates and customers

Suspended all business travel, reduced all face to face meetings with outside vendors and customers, and requested all associates postpone personal travel outside of their market areas

- Implemented self-quarantine measures for associates who travel outside the market areas

Implemented plans in mid-March for all eligible associates to work remotely via our Virtual Private Network (“VPN”); utilized Skype and Microsoft teams for internal communication

- Continue to have approximately 80% of the workforce working remotely

Implemented a Pandemic Pay Policy for associates who are unable to work for COVID-19 related reasons, including those who need to care for family members and school children

Increased cleaning and disinfecting services in all physical locations

On March 19, communicated the closure of our branch lobbies and promoted the use of drive up facilities as well as our robust digital banking platform

During the second quarter, we implemented a phased in approach to face to face meetings by appointment to ensure limited number of customers inside the offices.

Regular and up-to-date communication:

- Daily COVID-19 update calls with internal Pandemic Team
- Daily emails to all associates with international, national and state specific updates
- Regularly updated website with helpful links to keep our customers well-informed at www.mybank.com

Relieved the financial pressure for customers:

- Waived certificates of deposit early withdrawal penalties and overdraft fees, on a case by case basis, for non-sufficient funds
- Temporarily waived positive pay/Treasury Management fees for new customer signup for fraud prevention
- Implemented loan modifications and deferral programs for eligible consumer and commercial loan customers experiencing hardships; *See Note 2 for more details*
- Temporarily suspended repossession and foreclosure activity
- Relentlessly processed applications to provide access to our community-oriented business owners for the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”)

### Paycheck Protection Program

The U.S. Government’s Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) established the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) which provides small businesses with resources to maintain payroll, hire back employees who may have been laid off, and to cover applicable overhead expenses. We acted expeditiously to prepare our associates so they could guide our customers on the proper procedures necessary to enable them to take advantage of this program. We developed an SBA PPP specific information site within our website that provided detailed information, links and materials for eligible customers to access. Internally, we reallocated resources to review, process and data enter customer applications, working tirelessly over extended hours to provide access to as many local business owners as possible. As of July 31, 2020, we have funded 1,176 loan applications for approximately $145.9 million. Approximately 78% of the loans were under $100,000 in size and approximately 70% of the businesses receiving the loans employed less than 10 employees. We continued to provide access to the PPP and process applications through August 8, 2020, so that we could assist as many small business owners in our markets as possible. These loans are 100% guaranteed by the SBA, have up to a two or five year maturity, provide for a six month deferral period, and have an interest rate of 1%. These loans may be forgiven, in whole or in part, by the SBA if the borrower meets certain conditions, including by using at least 60% of the loan proceeds for payroll costs. The SBA also established processing fees from 1% to 5%, depending on the loan amount. We anticipate receiving approximately $3.5 million in deferred loan fees.

In April 2020, the Bank established eligibility to participate in the Paycheck Protection Program Liquidity Facility (“PPPLF”) which was established by Congress and administered by the Federal Reserve Bank. This facility uses the SBA guaranteed PPP loans as collateral, offering 100% collateral coverage with no recourse to the Bank. First United’s Board of Directors (the “Board”) and management feel it is prudent to maintain our existing liquidity facilities available for our contingency funding plan given the current economic conditions. The majority of the PPP loan disbursements have been to internal, non-interest-bearing accounts awaiting use by borrowers. As a result, we have not yet accessed the PPPLF, but are prepared to utilize the fund when management determines the timing is appropriate.

During the second quarter, the Bank was approved to participate in the Main Street Lending Program established by the Federal Reserve. This program supports lending to small and medium-sized businesses and non-profit organizations that were in sound financial condition before the onset of the COVID-19 pandemic.

### Liquidity Sources

Management has reviewed its Liquidity Contingency Funding Plan in preparation of funding needs as it relates to the COVID-19 pandemic. As of June 30, 2020, the Corporation had approximately $145.0 million in unsecured lines of credit with its correspondent banks, $1.1 million with the Federal Reserve Discount Window, and approximately $158.1 million of secured borrowings with the Federal Home Loan Bank of Atlanta (“FHLB”). Additionally, the Corporation has access to the brokered certificates of deposit market.

As noted above, the Corporation is eligible to access the PPPLF when it is deemed appropriate.

### Capital

The Corporation’s and the Bank’s capital ratios are strong, and both institutions are considered to be well-capitalized by applicable regulatory measures.

SELECTED FINANCIAL DATA

The following table sets forth certain selected financial data for the six month periods ended June 30, 2020 and 2019 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, 2020 | 2019 |
| --- | ---: | ---: |
| Basic net income per common share | $0.62 | $0.81 |
| Diluted net income per common share | $0.62 | $0.81 |
| Basic book value per common share | $17.82 | $17.75 |
| Diluted book value per common share | $17.81 | $17.75 |
| Significant Ratios |  |  |
| Return on Average Assets (a) | 0.57% | 0.82% |
| Return on Average Equity (a) | 6.97% | 9.39% |
| Average Equity to Average Assets | 8.15% | 8.74% |

Note: (a) Annualized

RESULTS OF OPERATIONS

#### Overview

Consolidated net income was $4.3 million for the six months ended June 30, 2020 compared to $5.8 million for the six months ended June 30, 2019. Basic and diluted net income per share for the first six months of 2020 were both $0.62, compared to basic and diluted net income per share of $0.81 for the same period of 2019, a 23% decrease. The decrease in earnings was primarily due to an increase in the provision for loan losses of $4.1 million, offset by an increase in net interest income of $1.7 million, a decrease in income tax expense of $0.4 million, and an increase of $0.6 million in other operating income and gains. The increase in provision expense for the first six months of 2020 was driven by the uncertainty of the economic environment related to the COVID-19 health crisis. While we believe that our borrowers, both consumer and commercial, will be negatively impacted, the full extent of this impact remains uncertain. Accordingly, we believe it was prudent to adjust qualitative factors to increase our provision expense to account for the uncertainty of the economic conditions and the inherent effects on our loan portfolio. Of the $4.8 million expense for the first six months, $4.4 million is related to qualitative factor adjustments and $0.4 million is related to loan growth in our commercial portfolio. The net interest margin, on a fully taxable equivalent (“FTE”) basis, declined for the six months ended June 30, 2020 to 3.61% compared to 3.70% at June 30, 2019. Excluding the impact of PPP average loan balances of approximately $58.7 million, the net interest margin would have increased slightly to 3.77%.

The provision for loan losses was $4.8 million for the six month period ended June 30, 2020 and $0.7 million for the six month period ended June 30, 2019. The increase in provision expense for the first six months of 2020 was due to the uncertainty of the economic environment related to the COVID-19 health crisis. Of the $4.8 million expense for the six months ended June 30, 2020, $4.4 million is related to qualitative factor adjustments and $0.4 million is related to a change in mix of loans at higher reserve factors.

Net interest income, on a non-GAAP, FTE basis, increased $1.7 million (7.3%) during the six months ended June 30, 2020 when compared to the six months ended June 30, 2019 due to a $1.2 million (4.3%) increase in interest income. Interest expense remained stable when comparing the second quarter of 2020 to the second quarter of 2019, despite an increase in average balances of approximately $67 million. The net interest margin for the six months ended June 30, 2020 was 3.61%, compared to 3.70% for the six months ended June 30, 2019, decreasing only 9 basis points despite a 2.25% drop in the Fed Funds rates year over year. Comparing the six months ended June 30, 2020 to the same period of 2019, the increase in interest income was due to a $1.6 million increase in interest and fees on loans. The increase in interest and fees on loans was due primarily to an increase in average balances of $97.9 million related to the PPP loans. The rate earned on the loan portfolio decreased by 18 basis points, as a result of the significant decline in the rate environment over the past year. The average balance of the investment portfolio decreased by $8.3 million due primarily to calls in the portfolio. The rate earned decreased by 11 basis points due to the calls as well as the reduced rate on the adjustable rate trust preferred CDO portfolio. Excess cash balances attributable to deposit growth were invested at the lower Fed Funds rate, which negatively offset interest income for the six months ended June 30, 2020.

Interest expense on our interest-bearing liabilities decreased during the six months ended June 30, 2020 when compared to the same period of 2019 due to continued rate reductions on our deposit products in response to the declining rate environment, particularly our money market products. The average balance of money market accounts increased $41.0 million during the six months ended 2020 when compared to the same period of 2019 while the rate on these accounts decreased by 26 basis points. With approximately 83% of our deposit portfolio adjustable, we can respond quickly to declining rates. Average growth of $88.2 million in our non-interest bearing accounts allowed us to continually control our cost of deposits. Most of the increase in average deposit balances during the six months ended June 30, 2020 was attributable to the PPP loans.

Other operating income, including gains, increased $0.6 million for the six months ended June 30, 2020 when compared to the same period of 2019. The increase was primarily attributable to the $0.7 million increase in net gains offset by a $0.1 million decline in service charge income, primarily non-sufficient funds (“NSF”) income as the consumer and business overdraft activity decreased in the second quarter of 2020 due to reduced consumer spending as well as the receipt of stimulus and PPP funding. Net gains increased when comparing the second quarter of 2020 to the second quarter of 2019 as a result of increased fees on sales of loans related to the high volume of mortgage refinancing activity at historically low rates. Trust and brokerage income remained stable. Debit card income remained flat for the six months ended June 30, 2020 when compared to the same period of 2019 despite reduced consumer spending.

Other operating expenses remained stable for the six months ended June 30, 2020 when compared to the same period of 2019. Salaries and benefits decreased $1.5 million primarily due to the salary costs associated with the origination of the PPP loans as well as the reduced headcount as a result of the voluntary separation program implemented in the fourth quarter of 2019 and reduced life and health insurance costs. These reductions offset the annual merit increases awarded to our associates in April 2019. Federal Deposit Insurance Corporation premiums decreased $0.1 million during the first six months of 2020 when compared to the same period of 2019 due to credits received on quarterly assessments. Equipment, occupancy and technology expenses for the first six months of 2020 increased $0.1 million when compared to the same period of 2019 due to a credit received from our core processor associated with discontinued services. Professional services for the six months ended June 30, 2020 increased $1.4 million when compared to the same period of 2019 as a result of increased legal and professional expenses due to additional costs related to the 2020 annual meeting of shareholders and the related proxy contest, most of which are non-recurring. Investor relations expenses for the six months ended June 30, 2020 increased $1.0 million when compared to the same period of 2019, also due to the additional expenses from the proxy contest. Other real estate owned (“OREO”) expenses for the first six months of 2020 decreased $0.9 million when compared to the same period of 2019 due to valuation allowance write-downs in 2019. Increased marketing, consulting, fraud expenses and Visa processing fees, were offset by reductions in schools and seminars, contributions, dues and licenses, office supplies, mileage, contract labor, business related meals and other employee benefits expenses.

Consolidated net income was $2.6 million for both the second quarter of 2020 and the second quarter of 2019. Basic and diluted net income per common share for the second quarters of 2020 and 2019 were both $0.37. Net interest income increased by $1.1 million when comparing the second quarter of 2020 to the second quarter of 2019. The increase in net interest income and the decrease in interest expense offset the increase in provision expense when comparing the second quarters of 2020 and 2019. The increase in provision expense for the second quarter of 2020 was due to an increase in qualitative factors as noted above. Other operating income for the second quarter of 2020 decreased slightly when compared to the same period of 2019. The decline in the economy negatively impacted the market value of the assets under management in our wealth division which resulted in decreased revenue for the second quarter of 2020. Service charge income, particularly NSF income, declined as a result of significantly reduced overdraft activity.

Management believes this reduction was in part due to the stay-at-home mandates and the supplemental unemployment payments consumers received during the quarter. Net gains increased when comparing the second quarter of 2020 to the second quarter of 2019 as a result of increased loans sold to the secondary market related to the high volume of refinancing activity at historically low rates. Other operating expenses decreased by $0.3 million when comparing the second quarter of 2020 to the second quarter of 2019. This decrease was due to the decrease in salaries and benefits related to the salary costs associated with the origination of PPP loans offset by an increase in professional services and investor relations expenses attributable to the 2020 annual meeting of shareholders and the related proxy contest, offset by continued cost control throughout the company and decreased OREO related expenses due to valuation allowance write-downs in the second quarter of 2019. The net interest margin for the second quarter of 2020 and the second quarter of 2019, on an FTE basis, was 3.53% and 3.68%, respectively. Excluding the impact of PPP average loan balances of approximately $117.4 million, our net interest margin would have been 3.83% for the second quarter of 2020. We were able to mitigate the reduction in rates on the earning assets by continued rate reductions on the deposits during the quarter.

The provision for loan losses was $2.2 million for the second quarter of 2020 and $0.3 for the second quarter of 2019. 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. The increase in provision expense for the second quarter of 2020 was due to the uncertainty of the economic environment related to the COVID-19 health crisis. Of the $2.2 million expense for the quarter ended June 30, 2020, $2.0 million is related to qualitative factor adjustments and $0.2 million is related to a change in mix of loans at higher reserve factors.

Net interest income, on an FTE basis, increased $1.1 million (9.8%) during the second quarter of 2020 over the same period in 2019 due to a $0.7 million (4.9%) increase in interest income combined with a decrease of $0.4 million (15.1%) in interest expense. The net interest margin for the second quarter of 2020 was 3.53%, compared to 3.68% for the second quarter of 2019. As noted above, the participation in the PPP loan program negatively impacted our margin during the second quarter. Excluding the impact of PPP average loan balances of approximately $117.4 million, our net interest margin would have increased to approximately 3.83% for the second quarter of 2020 as we were able to mitigate the reduction in rates on the earning assets by continued rate reductions on the deposits during the quarter.

Comparing the second quarter of 2020 to the same period of 2019, the increase in interest income was primarily due to a $0.9 million increase in interest and fees on loans. The increase in interest and fees on loans was due primarily to an increase in average balances of $156.6 million, primarily related to the average balance of PPP loans of approximately $117.4 million and loan growth in the fourth quarter of 2019. However, the PPP loans negatively impacted the rate earned due to the high volume of loans at the low, fixed interest rate and was the contributing factor to the decrease of 37 basis points in the rate earned. Excess cash balances related to deposit growth also negatively impacted interest income as it was invested at a lower Fed Funds rate. Management has opted to increase liquidity due to economic uncertainties.

Interest expense on our interest-bearing liabilities decreased by $0.4 million during the second quarter of 2020 when compared to the same period of 2019, due primarily to reductions in rates on the deposit portfolio and the repayment of a $10.0 million brokered CD that matured in May.

Other operating income decreased slightly comparing the second quarters of 2020 and 2019. The decline in the economy negatively impacted the market value of the assets under management in our wealth division which resulted in decreased revenue for the second quarter of 2020. Service charge income, particularly NSF income, declined as a result of reduced overdraft activity. Management believes this reduction was in part due to the stay-at-home mandates and the supplemental unemployment payments consumers received during the quarter. Waivers of overdraft fees are reviewed on a case by case basis. Net gains increased when comparing the second quarter of 2020 to the second quarter of 2019 as a result of increased loans sold to the secondary market related to the high volume of mortgage refinancing activity at historically low rates.

Other operating expenses decreased $0.3 million when comparing the second quarter of 2020 to the second quarter of 2019. Salaries and benefits decreased $1.2 million when comparing the second quarter periods. This decrease was due to the salary costs associated to the origination of PPP loans during the second quarter. Equipment and occupancy expenses increased slightly and were offset by reductions in data processing expenses. Professional services and investor relations expenses increased by $0.8 million and $1.0 million, respectively when comparing the second quarter of 2020 to the same time period of 2019. These increases were related to additional costs associated with the 2020 annual meeting of the shareholders and the related proxy contest, most of which are non-recurring. OREO expenses decreased by $0.8 million when comparing the second quarter of 2020 to the second quarter of 2019 due to valuation allowance write-downs on properties in the second quarter of 2019. Other miscellaneous expenses such as marketing, consulting, miscellaneous, trust department expenses increased slightly but were offset by decreases in contributions, personnel related expenses, postage, travel and lodging, mileage, contract labor, schools and seminars and business-related meals. Cost control and increased efficiencies continues to be a strategic focus, resulting in expense savings.

#### 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 a 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 table below summarizes net interest income for the six and three months ended June 30, 2020 and 2019.

*(Dollars in thousands)*

|  | GAAP Six Months Ended 2020 2019 | Non-GAAP - FTE Six Months Ended 2020 2019 |
| --- | ---: | ---: |
| Interest income | $29,720 $28,483 | $30,169 $28,922 |
| Interest expense | 5,177 5,610 | 5,177 5,610 |
| Net interest income | $24,543 $22,873 | $24,992 $23,312 |
| Net interest margin % | 3.54% 3.60% | 3.61% 3.70% |
|  | **Three Months Ended** | **Three Months Ended** |
| **(Dollars in thousands)** | **2020** **2019** | **2020** **2019** |
| Interest income | $15,104 $14,411 | $15,330 $14,617 |
| Interest expense | 2,448 2,884 | 2,448 2,884 |
| Net interest income | $12,656 $11,527 | $12,882 $11,733 |
| Net interest margin % | 3.47% 3.60% | 3.53% 3.68% |

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 and three month periods ended June 30, 2020 and 2019:

*(dollars in thousands)*

| Assets | Six Months Ended June 30, 2020 Average ‎Balance | Interest | Average ‎Yield/Rate | 2019 Average ‎Balance | Interest | Average ‎Yield/Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans | $1,104,922 | $26,280 | 4.77% | $1,007,010 | $24,712 | 4.95% |
| Investment Securities: |  |  |  |  |  |  |
| Taxable | 198,418 | 2,652 | 2.69% | 206,683 | 2,917 | 2.85% |
| Non taxable | 25,974 | 954 | 7.39% | 26,031 | 935 | 7.24% |
| Total | 224,392 | 3,606 | 3.23% | 232,714 | 3,852 | 3.34% |
| Federal funds sold | 59,103 | 154 | 0.52% | 25,600 | 190 | 1.51% |
| Interest-bearing deposits with other banks | 753 | 7 | 1.90% | 1,115 | 9 | 1.69% |
| Other interest earning assets | 4,442 | 122 | 5.53% | 4,560 | 159 | 7.03% |
| **Total earning assets** | 1,393,612 | 30,169 | 4.33% | 1,270,999 | 28,922 | 4.59% |
| Allowance for loan losses | (13,936) |  |  | (11,597) |  |  |
| Non-earning assets | 142,354 |  |  | 142,723 |  |  |
| **Total Assets** | **$1,522,030** |  |  | **$1,402,125** |  |  |
| **Liabilities and Shareholders’ Equity** |  |  |  |  |  |  |
| Interest-bearing demand deposits | $169,055 | $341 | 0.41% | $161,349 | $294 | 0.37% |
| Interest-bearing money markets | 295,035 | 877 | 0.60% | 257,517 | 1,085 | 0.85% |
| Savings deposits | 167,681 | 101 | 0.12% | 160,671 | 148 | 0.19% |
| Time deposits: |  |  |  |  |  |  |
| Less than $100k | 111,854 | 875 | 1.57% | 104,193 | 664 | 1.28% |
| $100k or more | 132,942 | 1,288 | 1.95% | 151,990 | 1,545 | 2.05% |
| Short-term borrowings | 42,975 | 49 | 0.23% | 42,864 | 131 | 0.62% |
| Long-term borrowings | 100,929 | 1,646 | 3.28% | 100,929 | 1,743 | 3.48% |
| **Total interest-bearing liabilities** | 1,020,471 | 5,177 | 1.02% | 979,513 | 5,610 | 1.15% |
| Non-interest-bearing deposits | 340,904 |  |  | 266,022 |  |  |
| Other liabilities | 36,548 |  |  | 34,037 |  |  |
| Shareholders’ Equity | 124,107 |  |  | 122,553 |  |  |
| **Total Liabilities and Shareholders’ Equity** | **$1,522,030** |  |  | **$1,402,125** |  |  |
| Net interest income and spread |  | **$24,992** | 3.31% |  | **$23,312** | 3.44% |
| Net interest margin |  |  | 3.61% |  |  | 3.70% |

Note:

(1) The above table reflects the average rates earned or paid stated on an FTE basis assuming a 21% tax rate for 2020 and 2019. Non-GAAP interest income on a fully taxable equivalent was $449 and $439, 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, FTE basis, increased $1.7 million (7.3%) during the six months ended June 30, 2020 when compared to the six months ended June 30, 2019 due to a $1.2 million (4.3%) increase in interest income. Interest expense remained stable when comparing the second quarter of 2020 to the second quarter of 2019, despite an increase in average balances of approximately $67.0 million. The net interest margin for the six months ended June 30, 2020 was 3.61%, compared to 3.70% for the six months ended June 30, 2019, representing a decrease of only 9 basis points despite a 2.25% drop in the Fed Funds rates year over year. Excluding the impact of PPP average loan balances of approximately $58.7 million, the net interest margin would have increased slightly to 3.77%. Comparing the six months ended June 30, 2020 to the same period of 2019, the increase in interest income was due to a $1.6 million increase in interest and fees on loans. The increase in interest and fees on loans was due primarily to an increase in average balances of $97.9 million related to the PPP loans. The rate earned on the loan portfolio decreased by 18 basis points, due to the significant decline in the rate environment over the past year. The average balance of the investment portfolio decreased by $8.3 million due primarily to calls in the portfolio. The rate earned during the six months ended June 30, 2020 decreased by 11 basis points when compared to the same period of 2019 due to the calls as well as the reduced rate on the adjustable rate trust preferred CDO portfolio. Excess cash balances attributable to deposit growth were invested at the lower Fed Funds rate which negatively offset interest income for the six months ended June 30, 2020.

Interest expense on our interest-bearing liabilities decreased during the six months ended June 30, 2020 when compared to the same period of 2019 due to continued rate reductions on our deposit products in response to the declining rate environment, particularly our money market products. The average balance of money market accounts increased $41.0 million during the six months ended 2020 when compared to the same period of 2019, while the rate on these accounts decreased by 26 basis points. With approximately 83% of our deposit portfolio adjustable, we can respond quickly to declining rates. Average growth of $88.2 million in our non-interest bearing accounts allowed us to continually control our cost of deposits. Most of the increase in average deposit balances during the six months ended June 30, 2020 is attributable to the PPP loans.

I

*(dollars in thousands)*

| Assets | Three Months Ended June 30, 2020 Average ‎Balance | Interest | Average ‎Yield/Rate | 2019 Average ‎Balance | Interest | Average ‎Yield/Rate |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans | $1,164,023 | $13,424 | 4.61% | $1,007,404 | $12,509 | 4.98% |
| Investment Securities: |  |  |  |  |  |  |
| Taxable | 199,721 | 1,344 | 2.71% | 209,319 | 1,450 | 2.79% |
| Non taxable | 26,530 | 488 | 7.40% | 24,425 | 435 | 7.14% |
| Total | 226,251 | 1,832 | 3.26% | 233,744 | 1,885 | 3.24% |
| Federal funds sold | 73,089 | 15 | 0.08% | 34,037 | 145 | 1.72% |
| Interest-bearing deposits with other banks | 863 | 1 | 0.53% | 754 | 4 | 2.14% |
| Other interest earning assets | 4,468 | 58 | 5.23% | 4,379 | 74 | 6.79% |
| **Total earning assets** | 1,468,694 | 15,330 | 4.18% | 1,280,318 | 14,617 | 4.58% |
| Allowance for loan losses | (15,157) |  |  | (11,877) |  |  |
| Non-earning assets | 146,065 |  |  | 146,380 |  |  |
| **Total Assets** | **$1,599,602** |  |  | **$1,414,821** |  |  |
| **Liabilities and Shareholders’ Equity** |  |  |  |  |  |  |
| Interest-bearing demand deposits | $174,498 | $157 | 0.36% | $162,527 | $165 | 0.41% |
| Interest-bearing money markets | 320,219 | 374 | 0.47% | 261,682 | 580 | 0.89% |
| Savings deposits | 174,295 | 39 | 0.09% | 162,850 | 75 | 0.19% |
| Time deposits: |  |  |  |  |  |  |
| Less than $100k | 114,288 | 459 | 1.62% | 104,668 | 349 | 1.34% |
| $100k or more | 125,152 | 583 | 1.87% | 153,688 | 796 | 2.08% |
| Short-term borrowings | 40,671 | 21 | 0.21% | 36,832 | 28 | 0.30% |
| Long-term borrowings | 100,929 | 815 | 3.25% | 100,929 | 891 | 3.55% |
| **Total interest-bearing liabilities** | 1,050,052 | 2,448 | 0.94% | 983,176 | 2,884 | 1.18% |
| Non-interest-bearing deposits | 392,701 |  |  | 266,521 |  |  |
| Other liabilities | 34,152 |  |  | 40,177 |  |  |
| Shareholders’ Equity | 122,697 |  |  | 124,947 |  |  |
| **Total Liabilities and Shareholders’ Equity** | **$1,599,602** |  |  | **$1,414,821** |  |  |
| Net interest income and spread |  | **$12,882** | 3.24% |  | **$11,733** | 3.40% |
| Net interest margin |  |  | 3.53% |  |  | 3.68% |

Note:

(4) The above table reflects the average rates earned or paid stated on an FTE basis assuming a 21% tax rate for 2020 and 2019. Non-GAAP interest income on a fully taxable equivalent was $226 and $206, respectively.

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

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

Net interest income, on an FTE basis, increased $1.1 million (9.8%) during the second quarter of 2020 over the same period in 2019 due to a $0.7 million (4.9%) increase in interest income combined with a decrease of $0.4 million (15.1%) in interest expense. The net interest margin for the second quarter of 2020 was 3.53%, compared to 3.68% for the second quarter of 2019. As noted above, the participation in the PPP loan program negatively impacted our margin during the second quarter. Excluding the impact of PPP average loan balances of approximately $117.4 million, our net interest margin would have been 3.67% for the second quarter of 2020 as we were able to mitigate the reduction in rates on the earning assets by continued rate reductions on the deposits during the quarter.

Comparing the second quarter of 2020 to the same period of 2019, the increase in interest income was primarily due to a $0.9 million increase in interest and fees on loans. The increase in interest and fees on loans was due primarily to an increase in average balances of $156.6 million, primarily related to the average balance of PPP loans of approximately $117.4 million and loan growth in the fourth quarter of 2019. However, the PPP loans negatively impacted the rate earned due to the high volume of loans at the low, fixed interest rate and was the contributing factor to the decrease of 37 basis points in the rate earned. Excess cash balances related to deposit growth also negatively impacted interest income as it was invested at a lower Fed Funds rate. Management has opted to increase liquidity due to economic uncertainties.

Interest expense on our interest-bearing liabilities decreased by $0.4 million during the second quarter of 2020 when compared to the same period of 2019, due primarily to reductions in rates on the deposit portfolio and the repayment of a $10.0 million brokered CD that matured in May.

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 and three month periods ended June 30, 2020 and 2019:

*(in thousands and tax equivalent basis)*

| Interest Income: | For the six months ended June 30, 2020 compared to the six months ended June 30, 2019 Volume | Rate | Net |
| --- | ---: | ---: | ---: |
| Loans | $2,423 | $(855) | $1,568 |
| Taxable Investments | (118) | (147) | (265) |
| Non-taxable Investments | (2) | 21 | 19 |
| Federal funds sold | 252 | (288) | (36) |
| Interest-bearing deposits | (3) | 1 | (2) |
| Other interest earning assets | (4) | (33) | (37) |
| Total interest income | 2,548 | (1,301) | 1,247 |
| Interest Expense: |  |  |  |
| Interest-bearing demand deposits | 14 | 33 | 47 |
| Interest-bearing money markets | 159 | (367) | (208) |
| Savings deposits | 6 | (53) | (47) |
| Time deposits less than $100K | 49 | 162 | 211 |
| Time deposits $100K or more | (195) | (62) | (257) |
| Short-term borrowings | — | (82) | (82) |
| Long-term borrowings | — | (97) | (97) |
| Total interest expense | 33 | (466) | (433) |
| Net interest income | $2,515 | $(835) | $1,680 |

*(in thousands and tax equivalent basis)*

| Interest Income: | For the three months ended June 30, 2020 compared to the three months ended June 30, 2019 Volume | Rate | Net |
| --- | ---: | ---: | ---: |
| Loans | $1,950 | $(1,035) | $915 |
| Taxable Investments | (67) | (39) | (106) |
| Non-taxable Investments | 38 | 15 | 53 |
| Federal funds sold | 168 | (298) | (130) |
| Interest-bearing deposits | 1 | (4) | (3) |
| Other interest earning assets | 2 | (18) | (16) |
| Total interest income | 2,092 | (1,379) | 713 |
| Interest Expense: |  |  |  |
| Interest-bearing demand deposits | 12 | (20) | (8) |
| Interest-bearing money markets | 130 | (336) | (206) |
| Savings deposits | 6 | (42) | (36) |
| Time deposits less than $100K | 32 | 78 | 110 |
| Time deposits $100K or more | (148) | (65) | (213) |
| Short-term borrowings | 3 | (10) | (7) |
| Long-term borrowings | — | (76) | (76) |
| Total interest expense | 35 | (471) | (436) |
| Net interest income | $2,057 | $(908) | $1,149 |

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 $4.8 million for the six-month period ended June 30, 2020 and $0.7 million for the six-month period ended June 30, 2019. The increase in provision expense for the first six months of 2020 was due to the uncertainty of the economic environment related to the COVID-19 health crisis. While we believe that our borrowers, both consumer and commercial, will be negatively impacted by the COVID-19 pandemic, the extent of this impact is unknown and very uncertain. Accordingly, we believe it was prudent to adjust qualitative factors to increase our first six months provision expense to account for the rapidly declining economic conditions and the inherent effects on our loan portfolio. Of the $4.8 million expense for the six months ended June 30, 2020, $4.4 million is related to qualitative factor adjustments and $0.4 million is related to the change in mix within the portfolio at higher reserve factors.

The provision for loan losses was $2.2 million for the three-month period ended June 30, 2020 and $0.3 million for the three-month period ended June 30, 2019. The increase in provision expense for the second quarter of 2020 was due to the uncertainty of the economic environment related to the COVID-19 health crisis. While we believe that our borrowers, both consumer and commercial, will be negatively impacted by the COVID-19 pandemic, the extent of this impact is unknown and very uncertain. Accordingly, we believe it was prudent to adjust qualitative factors to increase our second quarter provision expense to account for the rapidly declining economic conditions and the inherent effects on our loan portfolio. Of the $2.2 million expense for the quarter, $2.0 million is related to qualitative factor adjustments and $0.2 million is related to loan growth.

#### Other Operating Income

The following table shows the major components of other operating income for the six and three month periods ended June 30, 2020 and 2019, exclusive of net gains:

|  | Income as % of ‎Total Other Operating Income, exclusive of net gains Six Months Ended June 30, 2020 |  | 2019 |  | Income as % of ‎Total Other Operating Income, exclusive of net gains Three Months Ended June 30, 2020 |  | 2019 |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Service charges on deposit accounts | $992 | 13% | $1,023 | 14% | $377 | 11% | $504 | 13% |
| Other service charges | 322 | 4% | 433 | 6% | 32 | 1% | 225 | 6% |
| Trust department | 3,484 | 47% | 3,547 | 46% | 1,731 | 51% | 1,832 | 47% |
| Debit card income | 1,314 | 18% | 1,276 | 17% | 680 | 20% | 676 | 18% |
| Bank owned life insurance | 588 | 8% | 591 | 8% | 285 | 8% | 288 | 8% |
| Brokerage commissions | 479 | 7% | 441 | 6% | 202 | 6% | 203 | 5% |
| Other income | 254 | 3% | 254 | 3% | 118 | 3% | 130 | 3% |
|  | $7,433 | 100% | $7,565 | 100% | $3,425 | 100% | $3,858 | 100% |

#### Other Operating Expenses

The composition of other operating expenses for the six and three month periods ended June 30, 2020 and 2019 is illustrated in the following table:

|  | Expense as % of ‎Total Other Operating Expenses Six Months Ended June 30, 2020 |  | 2019 |  | Expense as % of ‎Total Other Operating Expenses Three Months Ended June 30, 2020 |  | 2019 |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Salaries and employee benefits | $10,866 | 49% | $12,364 | 56% | $4,943 | 44% | $6,146 | 51% |
| FDIC premiums | 203 | 1% | 294 | 1% | 160 | 1% | 183 | 2% |
| Equipment | 1,893 | 8% | 1,819 | 8% | 967 | 8% | 936 | 8% |
| Occupancy | 1,493 | 7% | 1,418 | 6% | 746 | 7% | 706 | 6% |
| Data processing | 2,025 | 9% | 1,995 | 9% | 973 | 9% | 1,054 | 9% |
| Marketing | 283 | 1% | 164 | 1% | 153 | 1% | 96 | 1% |
| Professional services | 1,904 | 8% | 522 | 2% | 1,181 | 10% | 318 | 3% |
| Contract labor | 300 | 1% | 331 | 1% | 149 | 1% | 175 | 1% |
| Line rentals | 438 | 2% | 415 | 2% | 221 | 2% | 198 | 2% |
| Other real estate owned | (3) | 0% | 929 | 4% | (3) | 0% | 786 | 7% |
| Investor relations | 1,106 | 5% | 109 | 0% | 1,013 | 9% | 62 | 1% |
| Other | 1,924 | 9% | 2,071 | 10% | 924 | 8% | 1,081 | 9% |
|  | $22,432 | 100% | $22,431 | 100% | $11,427 | 100% | $11,741 | 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 income tax rate as a percentage of income for the six months ended June 30, 2020 and 2019 remained stable at 22.2% and 22.5%, respectively.

FINANCIAL CONDITION

#### Balance Sheet Overview

Total assets at June 30, 2020 increased by $197.6 million to $1.6 billion since December 31, 2019. During the first six months of 2020, cash and interest-bearing deposits in other banks increased by $67.1 million, the investment portfolio decreased by $5.1 million and gross loans increased by $136.6 million offset by the increase to the ALL of $4.5 million. The increase in cash was due to continued deposit growth, consisting of both core deposit growth and deposits related to the PPP loans, cash flow from calls on the investment portfolio, commercial loan payoffs in the first quarter as well as refinances of balances in our mortgage portfolio. OREO balances remained stable as there was minimal activity in this portfolio during the first six months. Total liabilities increased by $199.1 million. This increase was attributable to the strong deposit growth of $209.5 million, including deposit balances related to the PPP loans at June 30, 2020. The deposit growth, excluding the PPP deposits, during the first six months of 2020 was due to increased relationship balances as customers favored insured products given the volatile economic environment. Our Treasury Management overnight investment sweep decreased by $12.7 million as municipalities utilized their existing cash for working capital needs during these unprecedented times. Total shareholders’ equity decreased by $1.5 million in the first six months of 2020. This decrease was due primarily to the increase in accumulated other comprehensive loss related to the slight decline in the market values of our pension plan assets since December 31, 2019. Our stock repurchase of $2.7 million during the first quarter of 2020, reflected in surplus, was offset by an increase in retained earnings attributable to year-to-date net income offset by common stock dividends of $1.8 million.

#### Loan Portfolio

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

*(dollars in thousands)*

|  | June 30, 2020 |  | December 31, 2019 |  |
| --- | ---: | ---: | ---: | ---: |
| Commercial real estate | $340,314 | 28% | $335,504 | 31% |
| Acquisition and development | 126,338 | 11% | 117,890 | 12% |
| Commercial and industrial | 272,186 | 23% | 122,352 | 11% |
| Residential mortgage | 412,478 | 35% | 438,424 | 43% |
| Consumer | 35,624 | 3% | 36,199 | 3% |
| Total Loans | $1,186,940 | 100% | $1,050,369 | 100% |

Outstanding loans increased to $1.2 billion at June 30, 2020 when compared to December 31, 2019. This growth was primarily attributable to the participation in the SBA PPP loan program. Commercial real estate (“CRE”) loans increased $4.8 million due to expansion of customer relationships as well as an increase in small business loans. Acquisition and development (“A&D”) loans increased $8.4 million as new production offset amortization and payoffs. Commercial and industrial (“C&I”) loans increased $149.8 million, including $144.4 million of PPP loans. The growth in the commercial portfolios was offset by a decline in residential mortgage loans of $25.9 million as refinancing activity increased and the customer preferred longer-term fixed rate loans were sold to Fannie Mae. Given the current low-rate interest environment, management has elected to utilize the secondary market rather than portfolio the loans at this time. The consumer loan portfolio declined slightly during the first six months of 2020.

Commercial loan production for the first six months of 2020 was approximately $76.4 million, most of which was construction production that will fund over the next 12 months. Amortization and payoffs were approximately $28.4 million in the first six months of 2020. Despite a decline in balances, the mortgage department had record production of approximately $61.4 million in the first six months of 2020. While both in-house and secondary market products are utilized, the longer-term fixed rate loans are primarily being sold to Fannie Mae. We continue to book first time homebuyer, adjustable rate and non-conforming jumbo mortgages to our portfolio. The mortgage pipeline remained strong at $27.6 million at quarter end. We anticipate reduced loan demand for the remainder of 2020, which may impact the net interest margin.

#### 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, ‎2020 | % of ‎Applicable ‎Portfolio | December 31, ‎2019 | % of ‎Applicable ‎Portfolio |
| --- | ---: | ---: | ---: | ---: |
| Commercial real estate | $973 | 0.29% | $680 | 0.20% |
| Acquisition and development | 8,439 | 6.68% | 8,058 | 6.80% |
| Commercial and industrial | 18 | 0.01% | 30 | 0.00% |
| Residential mortgage | 1,617 | 0.39% | 2,077 | 0.50% |
| Consumer | 34 | 0.10% | 4 | 0.00% |
| Total non-accrual loans | $11,081 | 0.93% | $10,849 | 1.03% |
| Accruing Loans Past Due 90 days or more: |  |  |  |  |
| Acquisition and development | — |  | 135 |  |
| Residential mortgage | 294 |  | 536 |  |
| Consumer | 3 |  | 54 |  |
| Total loans past due 90 days or more | $297 |  | $725 |  |
| Total non-accrual and accruing loans past due ‎ 90 days or more | $11,378 |  | $11,574 |  |
| Restructured Loans (TDRs): |  |  |  |  |
| Performing | $3,725 |  | $3,842 |  |
| Non-accrual (included above) | 314 |  | 324 |  |
| Total TDRs | $4,039 |  | $4,166 |  |
| Other real estate owned | $3,926 |  | $4,127 |  |
| Impaired loans without a valuation allowance | $5,857 |  | $5,974 |  |
| Impaired loans with a valuation allowance | 9,466 |  | 9,200 |  |
| Total impaired loans | $15,323 |  | $15,174 |  |
| Valuation allowance related to impaired loans | $2,359 |  | $2,174 |  |

Performing loans considered to be impaired (including performing troubled debt restructurings, or TDRs), as defined and identified by management, amounted to $4.0 million at June 30, 2020 and $4.6 million at December 31, 2019. 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.

Loans that have been modified in reliance on Section 4013 of the U.S. Government’s Coronavirus Aid, Relief, and Economic Security Act and the guidance issued thereunder are not treated as TDRs. Information about these loans can be found in Notes 2 and 6 to the consolidated financial statements presented in Item 1 of Part I of this report.

The following table presents the details of impaired loans that are TDRs by class at June 30, 2020 and December 31, 2019:

*(in thousands)*

| Performing Commercial real estate | June 30, 2020 Number of ‎Contracts | Recorded ‎Investment | December 31, 2019 Number of ‎Contracts | Recorded ‎Investment |
| --- | ---: | ---: | ---: | ---: |
| Non owner-occupied | 2 | $230 | 2 | $235 |
| All other CRE | 1 | 2,226 | 1 | 2,265 |
| Acquisition and development |  |  |  |  |
| 1-4 family residential construction | 1 | 279 | 1 | 291 |
| All other A&D | 1 | 216 | 1 | 220 |
| Commercial and industrial | — | — | — | — |
| Residential mortgage |  |  |  |  |
| Residential mortgage – term | 7 | 774 | 8 | 831 |
| Residential mortgage – home equity | — | — | — | — |
| Consumer | — | — | — | — |
| Total performing | 12 | $3,725 | 13 | $3,842 |
| **Non-accrual** |  |  |  |  |
| Commercial real estate |  |  |  |  |
| Non owner-occupied | — | $— | — | $— |
| All other CRE | — | — | — | — |
| Acquisition and development |  |  |  |  |
| 1-4 family residential construction | — | — | — | — |
| All other A&D | — | — | — | — |
| Commercial and industrial | — | — | — | — |
| Residential mortgage |  |  |  |  |
| Residential mortgage – term | 2 | 314 | 2 | 324 |
| Residential mortgage – home equity | — | — | — | — |
| Consumer | — | — | — | — |
| Total non-accrual | 2 | 314 | 2 | 324 |
| Total TDRs | 14 | $4,039 | 15 | $4,166 |

The level of TDRs decreased to $4.0 million at June 30, 2020 when compared to $4.2 million at December 31, 2019, with a slight reduction due to payments made during the quarter. There were no new TDRs during the first six months of 2020.

#### 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)*

|  | 2020 | 2019 |
| --- | ---: | ---: |
| Balance, January 1 | $12,537 | $11,047 |
| Charge-offs: |  |  |
| Acquisition and development | (31) | (29) |
| Commercial and industrial | (232) | (5) |
| Residential mortgage | (98) | (86) |
| Consumer | (223) | (136) |
| Total charge-offs | (584) | (256) |
| Recoveries: |  |  |
| Commercial real estate | 66 | 30 |
| Acquisition and development | 22 | 111 |
| Commercial and industrial | 16 | 76 |
| Residential mortgage | 48 | 195 |
| Consumer | 88 | 91 |
| Total recoveries | 240 | 503 |
| Net credit (charge-offs)/recoveries | (344) | 247 |
| Provision for loan losses | 4,821 | 682 |
| Balance at end of period | $17,014 | $11,976 |
| Allowance for loan losses to gross loans outstanding (as %) | 1.43% | 1.19% |
| Net credit (charge-offs)/recoveries to average loans outstanding during the period, annualized (as %) | (0.06)% | 0.05% |

The ALL was $17.0 million at June 30, 2020 compared to $12.5 million at December 31, 2019, an increase of 35.7% that primarily resulted from adjustment to qualitative factors associated with the negative trend in the economic outlook directly related to COVID-19. The provision for loan losses was $4.8 million for the six months ended June 30, 2020 and $0.7 million for the six months ended June 30, 2019. Net charge-offs of $0.3 million were recorded for the first six months of 2020, compared to net recoveries of $0.2 million for 2019. Absent the COVID-19 related factor adjustments attributable to $4.8 million in provision expense for the six months, the provision expense would have been approximately $0.4 million. The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.43% at June 30, 2020 compared to 1.19% at June 30, 2019. The ALL to loans outstanding, excluding PPP loan balances of $144.4 million, was 1.62%.

The ratio of net charge offs to average loans for the six months ended June 30, 2020 was an annualized 0.06%, compared to net recoveries to average loans of 0.05% for the six months ended June 30, 2019. The CRE portfolio had an annualized net recovery rate of .04% as of June 30, 2020, compared to a net recovery rate of 0.02% as of June 30, 2019. The A&D loans had an annualized net charge-off rate of 0.01% as of June 30, 2020, compared to a net recovery rate of 0.14% as of June 30, 2019. The C&I portfolio had net charge-offs to average loans of 0.22% as of June 30, 2020, compared to a net recovery rate of 0.13% as of June 30, 2019. The residential mortgage ratios were a net charge-off rate of 0.02% as of June 30, 2020, compared to a net recovery rate of 0.05% as of June 30, 2019, and the consumer loan ratios were net charge-off rates of 0.75% and 0.95% as of June 30, 2020 and June 30, 2019, respectively. Our special assets team continues to aggressively collect on charged-off loans.

Management believes that the ALL at June 30, 2020 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, 2020, the total amortized cost basis of the available-for-sale investment portfolio was $149.3 million, compared to a fair value of $146.2 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 $74.0 million, compared to a fair value of $80.7 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, 2020 Amortized Cost | Fair Value (FV) | FV as % of Total | December 31, 2019 Amortized Cost | Fair Value (FV) | FV as % of Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| U.S. government agencies | $46,020 | $46,945 | 32% | $39,987 | $39,894 | 30% |
| Residential mortgage-backed agencies | 18,472 | 18,776 | 13% | 4,917 | 4,900 | 4% |
| Commercial mortgage-backed agencies | 27,949 | 29,143 | 20% | 27,634 | 27,764 | 21% |
| Collateralized mortgage obligations | 25,235 | 25,818 | 18% | 29,903 | 29,923 | 23% |
| Obligations of state and political subdivisions | 13,059 | 13,556 | 9% | 14,124 | 14,470 | 11% |
| Collateralized debt obligations | 18,515 | 11,952 | 8% | 18,443 | 14,354 | 11% |
| Total available for sale | $149,250 | $146,190 | 100% | $135,008 | $131,305 | 100% |
| **Securities Held to Maturity:** |  |  |  |  |  |  |
| U.S. government agencies | $— | $— | 0% | $16,164 | $16,823 | 17% |
| Residential mortgage-backed agencies | 38,742 | 40,061 | 50% | 42,939 | 43,253 | 43% |
| Commercial mortgage-backed agencies | 11,829 | 12,503 | 16% | 15,521 | 15,865 | 16% |
| Collateralized mortgage obligations | 2,645 | 2,821 | 3% | 3,140 | 3,143 | 3% |
| Obligations of state and political subdivisions | 20,759 | 25,317 | 31% | 16,215 | 21,572 | 21% |
| Total held to maturity | $73,975 | $80,702 | 100% | $93,979 | $100,656 | 100% |

Total fair value of investment securities available-for-sale increased by $14.9 million since December 31, 2019. At June 30, 2020, the securities classified as available-for-sale included a net unrealized loss of $3.1 million, which represents the difference between the fair value and amortized cost of securities in the portfolio. This unrealized loss at June 30, 2020 is related to the CDO portfolio. All other available securities were at an unrealized gain position.

As discussed in Note 8 to the consolidated financial statements presented elsewhere in this report, the Corporation measures fair market values based on the fair value hierarchy established in ASC Topic 820, *Fair Value Measurements and Disclosures*. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Level 3 prices or valuation techniques require inputs that are both significant to the valuation assumptions and are not readily observable in the market (i.e. supported with little or no market activity). These Level 3 instruments are valued based on both observable and unobservable inputs derived from the best available data, some of which is internally developed, and considers risk premiums that a market participant would require.

Approximately $134.2 million of the available-for-sale portfolio was valued using Level 2 pricing and had net unrealized gains of $3.5 million at June 30, 2020. The remaining $12.0 million of the securities available-for-sale represents the entire CDO portfolio, which was valued using significant unobservable inputs (Level 3 assets). The $6.6 million in net unrealized losses associated with this portfolio relates to nine pooled trust preferred securities that comprise the CDO portfolio. Net unrealized losses of $4.9 million represent non-credit related OTTI charges on seven of the securities, while $1.7 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, 2020:

*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) | Lower ‎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 | $1,894 | $1,064 | $(830) | C | 676,565 | 14.83% | 268,437 | 19,130 | 7.13% | 40 / 56 |
| Preferred Term Security XVIII C | 2,717 | 1,596 | (1,121) | C | 676,565 | 14.83% | 268,437 | 19,130 | 7.13% | 40 / 56 |
| Preferred Term Security XIX\* C | 1,845 | 1,317 | (528) | C | 700,535 | 5.48% | 469,362 | 31,451 | 6.70% | 50 / 55 |
| Preferred Term Security XIX\* C | 1,100 | 790 | (310) | C | 700,535 | 5.48% | 469,362 | 31,451 | 6.70% | 50 / 55 |
| Preferred Term Security XIX\* C | 2,542 | 1,844 | (698) | C | 700,535 | 5.48% | 469,362 | 31,451 | 6.70% | 50 / 55 |
| Preferred Term Security XIX\* C | 1,102 | 790 | (312) | C | 700,535 | 5.48% | 469,362 | 31,451 | 6.70% | 50 / 55 |
| Preferred Term Security XXII\* C-1 | 1,573 | 1,023 | (550) | C | 1,386,600 | 10.31% | 664,548 | 69,263 | 10.42% | 59 / 73 |
| Preferred Term Security XXII\* C-1 | 3,931 | 2,558 | (1,373) | C | 1,386,600 | 10.31% | 664,548 | 69,263 | 10.42% | 59 / 73 |
| Preferred Term Security XXIII C-1 | 1,811 | 970 | (841) | C | 1,467,000 | 14.52% | 673,608 | 65,698 | 9.75% | 71 / 85 |
| Total Level 3 Securities Available for Sale | $18,515 | $11,952 | $(6,563) |  |  |  |  |  |  |  |

\*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 5.48% to 14.83% 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, 2020 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, 2020, (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 utilizes 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, 2019 and June 30, 2020.

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 2020. Additionally, there has been no change in the performing collateral, no decline in the percentage of deferrals/defaults to original collateral, and increases in collateral support for each of the positions held by the Corporation.

#### Deposits

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

*(dollars in thousands)*

| Non-interest bearing demand deposits: | June 30, 2020 |  | December 31, 2019 |  |
| --- | ---: | ---: | ---: | ---: |
| Retail | $425,274 | 32% | $294,649 | 26% |
| Interest-bearing deposits: |  |  |  |  |
| Demand | 184,983 | 14% | 159,567 | 14% |
| Money Market: |  |  |  |  |
| Retail | 327,078 | 24% | 275,007 | 24% |
| Savings deposits | 179,404 | 13% | 158,918 | 14% |
| Time deposits less than $100,000: |  |  |  |  |
| Retail | 94,093 | 7% | 96,198 | 8% |
| Time deposits $100,000 or more: |  |  |  |  |
| Retail | 140,736 | 10% | 147,692 | 13% |
| Brokered | — | 0% | 10,000 | 1% |
| Total Deposits | $1,351,568 | 100% | $1,142,031 | 100% |

Total deposits at June 30, 2020 increased by $209.5 million when compared to deposits at December 31, 2019. During the first six months of 2020, non-interest-bearing deposits increased by $130.6 million. This growth was driven by both our retail and commercial markets as well as deposit balances from PPP loans in the second quarter. Traditional savings accounts increased by $20.5 million, as our Prime Saver product continued to be the savings product of choice. Total demand deposits increased by $25.4 million and total money market accounts increased by $52.1 million, due primarily to growth in our variable rate Value Money Market account introduced in late 2019. Time deposits less than $100,000 decreased by $2.1 million and time deposits greater than $100,000 decreased by $17.0 million. The decline in time deposits greater than $100,000 was due to a local municipality utilizing a maturing certificate of deposit for cash needs during this unprecedented economic environment as well as our repayment of the full outstanding balance of $10.0 million in a brokered CD that matured in May.

#### Borrowed Funds

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

*(in thousands)*

|  | June 30, ‎2020 | December 31, ‎2019 |
| --- | ---: | ---: |
| Securities sold under agreements to repurchase | $36,001 | $48,728 |
| Total short-term borrowings | 36,001 | 48,728 |
| FHLB advances | $70,000 | $70,000 |
| Junior subordinated debt | 30,929 | 30,929 |
| Total long-term borrowings | $100,929 | $100,929 |

59

Total short-term borrowings decreased by $12.7 million during the first six months of 2020. This decrease is due to the decline in our Treasury Management overnight investment sweep as municipalities utilized their existing cash for working capital needs during these unprecedented times. Long-term borrowings remained constant during the first six months of 2020.

#### 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, SunTrust 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, 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.

6\. Federal Reserve PPPLF – provides funding and uses SBA PPP loans as collateral at 100% value

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. **Please refer to the section of this Item 2 entitled “*****Response to COVID-19”*** **for more details on our primary sources of liquidity.**

#### 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, 2020, 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, 2020 and December 31, 2019, management estimated the following changes in net interest income, assuming the indicated rate changes:

*(Dollars in thousands)*

|  | June 30, ‎2020 | December 31, ‎2019 |
| --- | ---: | ---: |
| +400 basis points | $4,008 | $1,500 |
| +300 basis points | $3,212 | $1,381 |
| +200 basis points | $2,291 | $1,075 |
| +100 basis points | $1,208 | $645 |
| -100 basis points | $(1,656) | $(2,477) |

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, 2019. Our NII simulation analysis as of December 31,

2019 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, 2019 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, 2020, the Bank had $145.0 million available through unsecured lines of credit with correspondent banks, $1.1 million available through a secured line of credit with the Fed Discount Window and approximately $158.1 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 First United 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. Based on capital ratios at June 30, 2020, both the Bank and First United Corporation are considered to be well-capitalized.

The following table presents our capital ratios as of the dates indicated:

| Total Capital (to risk-weighted assets) | June 30, ‎2020 | December 31, ‎2019 | Required for ‎Capital ‎Adequacy ‎Purposes | Required ‎to be Well ‎Capitalized |
| --- | ---: | ---: | ---: | ---: |
| Consolidated | 15.87% | 16.29% | 8.00% | 10.00% |
| First United Bank & Trust | 15.11% | 15.60% | 8.00% | 10.00% |
| Tier 1 Capital (to risk-weighted assets) |  |  |  |  |
| Consolidated | 14.62% | 15.17% | 6.00% | 8.00% |
| First United Bank & Trust | 13.85% | 14.44% | 6.00% | 8.00% |
| Common Equity Tier 1 Capital (to risk-weighted assets) |  |  |  |  |
| Consolidated | 12.33% | 12.79% | 4.50% | 6.50% |
| First United Bank & Trust | 13.85% | 14.44% | 4.50% | 6.50% |
| Tier 1 Capital (to average assets) |  |  |  |  |
| Consolidated | 10.46% | 11.77% | 4.00% | 5.00% |
| First United Bank & Trust | 9.72% | 10.99% | 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. Comparing June 30, 2020 to December 31, 2019, short-term borrowings decreased $12.7 million, primarily due to the decline in our Treasury Management overnight investment sweep accounts as municipalities utilized their cash for working capital needs during these unprecedented times.

### 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, ‎2020 | December 31, ‎2019 |
| --- | ---: | ---: |
| Residential Mortgage - home equity | $55,774 | $53,827 |
| Residential Mortgage - construction | 10,839 | 4,995 |
| Commercial | 121,094 | 85,089 |
| Consumer - personal credit lines | 4,232 | 3,903 |
| Standby letters of credit | 9,567 | 9,112 |
| Total | $201,506 | $156,926 |

The increase of $44.6 million in commitments at June 30, 2020 compared to December 31, 2019 was due to increased demand for consumer and commercial construction early in the quarter. Management will continue to monitor these balances as the COVID-19 pandemic has slowed the underlying projects and disbursements of funds.

## 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, 2019 under the heading “Market Risk and Interest Sensitivity” both of which are incorporated in this Item 3 by reference.

## Controls and procedures

As filed, 2,283 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, 2020 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 six months ended June 30, 2020, 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, 2019. Management does not believe that any material changes in our risk factors have occurred since they were last disclosed.

Filed Aug 10, 2020.
Source: SEC EDGAR, the filing index for accession 0001562762-20-000332. Last ingested by Listed: Nov 3, 2026, 22:37 ET. No prices; not investment advice.