UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
DC 20549
_______________________
FORM
10-K
|
x
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
|
For
the fiscal year ended December
31, 2006
|
OR
|
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
|
For
the transition period from _____________ to
_____________
|
Commission
file number 0-14237
FIRST
UNITED CORPORATION
(Exact
name of registrant as specified in its charter)
|
Maryland
|
52-1380770
|
|
|
(State
or other jurisdiction of incorporation or
organization)
|
(I.R.S.
Employer Identification Number)
|
|
|
19
South Second Street, Oakland, Maryland
|
21550-0009
|
|
|
(Address
of principal executive offices)
|
(Zip
Code)
|
Registrant’s
telephone number, including area code: (800)
470-4356
Securities
registered pursuant to Section 12(b) of the Act:
|
Title
of Each Class:
|
Name
of Each Exchange on Which Registered:
|
|
|
Common
Stock, par value $.01 per share
|
Nasdaq
Stock Market
|
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. Yes o
No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act. Yes o No x
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or such shorter period that the registrant was required
to
file such reports), and (2) has been subject to such filing requirements for
the
past 90 days. Yes x
No o
Indicate
by check mark if disclosures of delinquent filers pursuant to Item 405 of
Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of the registrant’s knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. (See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). (check
one):
Large
accelerated filer o
Accelerated filer x
Non-accelerated filer o
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).Yes o No x
The
aggregate market value of the registrant’s outstanding voting and non-voting
common equity held by non-affiliates as of June 30, 2006:
$
126,572,358.
The
number of shares of the registrant’s common stock outstanding as of February 28,
2007: 6,146,443
Documents
Incorporated by Reference
Portions
of the registrant’s definitive proxy statement for the 2007 Annual Meeting of
Shareholders to be filed with the SEC in March 2007 pursuant to Regulation
14A
are incorporated by reference into Part III of this Annual Report on Form
10-K.
First
United Corporation
Table
of Contents
|
ITEM
1.
|
Business
|
3
|
|
ITEM
1A.
|
Risk
Factors
|
10
|
|
ITEM
1B.
|
Unresolved
Staff Comments
|
14
|
|
ITEM
2.
|
Properties
|
14
|
|
ITEM
3.
|
Legal
Proceedings
|
15
|
|
ITEM
4.
|
Submission
of Matters to a Vote of Security Holders
|
15
|
|
PART
II
|
||
|
ITEM
5.
|
Market
for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
|
16
|
|
ITEM
6.
|
Selected
Financial Data
|
17
|
|
ITEM
7.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
18
|
|
ITEM
7A.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
38
|
|
ITEM
8.
|
Financial
Statements and Supplementary Data
|
39
|
|
ITEM
9.
|
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
|
67
|
|
ITEM
9A.
|
Controls
and Procedures
|
67
|
|
ITEM
9B.
|
Other
Information
|
70
|
|
PART
III
|
||
|
ITEM
10.
|
Directors,
Executive Officers and Corporate Governance
|
70
|
|
ITEM
11.
|
Executive
Compensation
|
70
|
|
ITEM
12.
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
|
70
|
|
ITEM
13.
|
Certain
Relationships and Related Transactions, and Director
Independence
|
70
|
|
ITEM
14.
|
Principal
Accountant Fees and Services
|
70
|
|
PART
IV
|
||
|
ITEM
15.
|
Exhibits
and Financial Statement Schedules
|
70
|
|
SIGNATURES
|
||
|
EXHIBITS
|
[2]
Forward-Looking
Statements
This
Annual Report of First United Corporation (the “Corporation” on a parent only
basis and “we”, “our” or “us”, on a consolidated basis) filed on Form 10-K may
contain forward-looking statements within the meaning of The Private Securities
Litigation Reform Act of 1995. Readers of this report should be aware of the
speculative nature of “forward-looking statements.” Statements that are not
historical in nature, including those that include the words “anticipate,”
“estimate,” “should,” “expect,” “believe,” “intend,” and similar expressions,
are based on current expectations, estimates and projections about, among other
things, the industry and the markets in which the Corporation operates, and
they
are not guarantees of future performance. Whether actual results will conform
to
expectations and predictions is subject to known and unknown risks and
uncertainties, including risks and uncertainties discussed in this report;
general economic, market, or business conditions; changes in interest rates,
deposit flow, the cost of funds, and demand for loan products and financial
services; changes in the Corporation’s competitive position or competitive
actions by other companies; changes in the quality or composition of loan and
investment portfolios; the ability to manage growth; changes in laws or
regulations or policies of federal and state regulators and agencies; and other
circumstances beyond the Corporation’s control. Consequently, all of the
forward-looking statements made in this document are qualified by these
cautionary statements, and there can be no assurance that the actual results
anticipated will be realized, or if substantially realized, will have the
expected consequences on the Corporation’s business or operations. For a more
complete discussion of these and other risk factors, see Item 1A of Part I
of
this report. Except as required by applicable laws, the Corporation does not
intend to publish updates or revisions of forward-looking statements it makes
to
reflect new information, future events or otherwise.
General
The
Corporation is a Maryland corporation chartered in 1985 and a financial holding
company registered under the federal Bank Holding Company Act of 1956, as
amended (the “BHC Act”). The Corporation’s primary business is serving as the
parent company of First United Bank & Trust, a Maryland trust company (the
“Bank”), First United Insurance Group, LLC, a Maryland insurance agency (the
“Insurance Group”), OakFirst Loan Center, Inc., a West Virginia finance company,
and OakFirst Loan Center, LLC, a Maryland finance company, (together with
OakFirst Loan Center, Inc. the “OakFirst Loan Centers”). OakFirst Loan Center,
Inc. has one subsidiary, First United Insurance Agency, Inc., which is a
Maryland insurance agency.
On
March
31, 2006, the Bank liquidated its subsidiary First United Investment Trust.
This
entity was a Maryland real estate investment trust that held and serviced
mortgage loans. Its assets were transferred to First United Bank &
Trust.
At
December 31, 2006, the Corporation had assets of approximately $1.349 billion,
net loans of approximately $957 million, and deposits of approximately $971
million. Shareholders’ equity at December 31, 2006 was approximately $97
million.
The
Corporation maintains an Internet site at www.mybankfirstunited.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 Securities and Exchange
Commission (the “SEC”).
Banking
Products and Services
The
Bank
operates 25 banking offices, one call center and 34 Automated Teller Machines
(“ATM’s”) in the following Maryland Counties: Garrett, Allegany, Washington and
Frederick; and in the following West Virginia Counties: Mineral, Berkeley,
Hardy
and Monongalia. The Bank is an independent community bank providing a complete
range of retail and commercial banking services to businesses and individuals
in
its market areas. Services offered are essentially the same as those offered by
the regional institutions that compete with the Bank and include checking,
savings, and money market deposit accounts, business loans, personal loans,
mortgage loans, lines of credit, and consumer-oriented financial services
including IRA and employee benefit accounts. In addition, the Bank provides
full
brokerage services through a networking arrangement with PrimeVest Financial
Services, Inc., a full service broker-dealer. The Bank also provides safe
deposit and night depository facilities, and a complete line of insurance
products and trust services. The Bank’s deposits are insured by the Federal
Deposit Insurance Corporation (the “FDIC”).
[3]
Lending
Activities--The
majority of the Corporation’s lending activities are conducted through the
Bank.
The
Bank’s commercial loans are primarily secured by real estate, commercial
equipment, vehicles or other assets of the borrower. Repayment is often
dependent on the successful operation of the borrower and may be affected by
adverse conditions in the local economy or real estate market. The financial
condition and cash flow of commercial borrowers is therefore carefully analyzed
during the loan approval process, and continues to be monitored by obtaining
business financial statements, personal financial statements and income tax
returns. The frequency of this ongoing analysis depends upon the size and
complexity of the credit and collateral that secures the loan. It is also the
Bank’s general policy to obtain personal guarantees from the principals of the
commercial loan borrowers.
Commercial
real estate loans are primarily those secured by land for residential and
commercial development, agricultural purpose properties, service industry
buildings such as restaurants and motels, retail buildings and general purpose
business space. The Bank attempts to mitigate the risks associated with these
loans through low loan to value ratio standards, thorough financial analyses,
and management’s knowledge of the local economy in which the Bank
lends.
The
risk
of loss associated with commercial real estate construction lending is
controlled through conservative underwriting procedures such as loan to value
ratios of 80% or less, obtaining additional collateral when prudent, and closely
monitoring construction projects to control disbursement of funds on
loans.
The
Bank’s residential mortgage portfolio is evenly distributed between variable and
fixed rate loans. Many loans are booked at fixed rates in order to meet the
Bank’s requirements under the Community Reinvestment Act. Other fixed rate
residential mortgage loans are originated in a brokering capacity on behalf
of
other financial institutions, for which the Bank receives a fee. As with any
consumer loan, repayment is dependent on the borrower’s continuing financial
stability, which can be adversely impacted by job loss, divorce, illness, or
personal bankruptcy. Residential mortgage loans exceeding an internal
loan-to-value ratio require private
mortgage insurance. Title insurance protecting the Bank’s lien priority, as well
as fire and casualty insurance, is also required.
Home
equity lines of credit, included within the residential mortgage portfolio,
are
secured by the borrower’s home and can be drawn on at the discretion of the
borrower. These lines of credit are at variable interest rates.
The
Bank
also provides residential real estate construction loans to builders and
individuals for single family dwellings. Residential construction loans are
usually granted based upon “as completed” appraisals and are secured by the
property under construction. Site inspections are performed to determine
pre-specified stages of completion before loan proceeds are disbursed. These
loans typically have maturities of six to 12 months and may have a fixed or
variable rate. Permanent financing for individuals offered by the Bank includes
fixed and variable rate loans with three, five or seven year adjustable rate
mortgages.
A
variety
of other consumer loans are also offered to customers, including indirect and
direct auto loans, and other secured and unsecured lines of credit and term
loans. Careful analysis of an applicant’s creditworthiness is performed before
granting credit, and on-going monitoring of loans outstanding is performed
in an
effort to minimize risk of loss by identifying problem loans early.
An
allowance for loan losses is maintained to provide for anticipated losses from
the Corporation’s lending activities. A complete discussion of the factors
considered in determination of the allowance for loan losses is included in
Item
7 of Part II of this report.
Additionally,
the Corporation meets the lending needs of under-served customer groups within
its market areas in part through OakFirst Loan Center, Inc., located in
Martinsburg, West Virginia, and OakFirst Loan Center, LLC, located in
Hagerstown, Maryland.
Deposit
Activities—The
Bank
offers a full array of deposit products including checking, savings and money
market accounts, regular and IRA certificates of deposit, Christmas Savings
accounts, College Savings accounts, and Health Savings accounts. The Bank also
offers the CDARS program to municipalities, providing them up to $20 million
of
FDIC insurance. In addition, we offer our commercial customers packages which
include Treasury Management, Cash Sweep and various checking opportunities.
[4]
Trust
Services--The
Bank’s Trust Department offers a full range of trust services, including
personal trust, investment agency accounts, charitable trusts, retirement
accounts including IRA roll-overs, 401(k) accounts and defined benefit plans,
estate administration and estate planning.
Information
about the Corporation’s income from and assets related to its banking business
may be found in the consolidated statements of financial condition and the
consolidated statements of income and the related notes thereto included in
Item
8 of Part II of this annual report. At December 31, 2006, 2005 and 2004, the
total market value of assets under the supervision of the Bank’s Trust
Department was approximately $502 million, $468 million and $395 million,
respectively. Trust Department revenues for these years may be found in Item
7
of Part II of this annual report under the caption “Other Operating
Income”.
Insurance
Activities
The
Corporation offers a full range of insurance products and services to customers
in its market areas through the Insurance Group and First United Insurance
Agency, Inc. Information about income from insurance activities for each of
the
years ended December 31, 2006, 2005 and 2004 may be found in Item 7 of Part
II
of this annual report under the caption “Other Operating Income”.
COMPETITION
The
banking business, in all of its phases, is highly competitive. Within their
market areas, the Corporation and its affiliates compete with commercial banks,
(including local banks and branches or affiliates of other larger banks),
savings and loan associations and credit unions for loans and deposits, with
consumer finance companies for loans, with insurance companies and their agents
for insurance products, and with other financial institutions for various types
of products and services. There is also competition for commercial and retail
banking business from banks and financial institutions located outside our
market areas.
The
primary factors in competing for deposits are interest rates, personalized
services, the quality and range of financial services, convenience of office
locations and office hours. The primary factors in competing for loans are
interest rates, loan origination fees, the quality and range of lending services
and personalized services.
To
compete with other financial services providers, the Corporation relies
principally upon local promotional activities, personal relationships
established by officers, directors and employees with its customers, and
specialized services tailored to meet its customers’ needs. In those instances
in which the Corporation is unable to accommodate a customer’s needs, it will
arrange for those services to be provided by other financial services providers
with which it has a relationship.
The
following table sets forth deposit data for the Maryland and West Virginia
Counties in which the Bank maintains offices as of June 30, 2006, the most
recent date for which comparative information is available.
|
Offices
(in
Market)
|
Deposits
(in thousands)
|
Market
Share
|
||||||||
|
Allegany
County, Maryland:
|
||||||||||
|
Susquehanna
Bank
|
6
|
$
|
222,029
|
35.45
|
%
|
|||||
|
Manufacturers
& Traders Trust Company
|
7
|
192,726
|
30.77
|
%
|
||||||
|
First
United Bank & Trust
|
5
|
121,513
|
19.40
|
%
|
||||||
|
Farmers
& Mechanics Bank
|
3
|
59,648
|
9.52
|
%
|
||||||
|
Standard
Bank
|
2
|
30,459
|
4.86
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
[5]
|
Frederick
County, Maryland:
|
||||||||||
|
Farmers
& Mechanics Bank
|
19
|
1,114,657
|
35.61
|
%
|
||||||
|
Branch
Banking & Trust Co.
|
12
|
601,109
|
19.20
|
%
|
||||||
|
Bank
of America NA
|
6
|
272,390
|
8.70
|
%
|
||||||
|
Frederick
County Bank
|
2
|
208,974
|
6.68
|
%
|
||||||
|
Manufacturers
& Traders Trust Company
|
6
|
201,845
|
6.45
|
%
|
||||||
|
Woodsboro
Bank
|
7
|
147,839
|
4.72
|
%
|
||||||
|
Chevy
Chase Bank FSB
|
5
|
133,307
|
4.26
|
%
|
||||||
|
SunTrust
Bank
|
3
|
130,576
|
4.17
|
%
|
||||||
|
Middletown
Valley Bank
|
4
|
115,093
|
3.68
|
%
|
||||||
|
First
United Bank & Trust
|
3
|
92,477
|
2.95
|
%
|
||||||
|
Sandy
Spring Bank
|
4
|
54,046
|
1.73
|
%
|
||||||
|
Provident
Bank of Maryland
|
2
|
32,394
|
1.03
|
%
|
||||||
|
Damascus
Community Bank
|
2
|
15,584
|
0.50
|
%
|
||||||
|
Sovereign
Bank
|
2
|
8,476
|
0.27
|
%
|
||||||
|
Columbia
Bank
|
1
|
1,577
|
0.05
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
|
Garrett
County, Maryland:
|
||||||||||
|
First
United Bank & Trust
|
5
|
454,671
|
69.90
|
%
|
||||||
|
Manufacturers
& Traders Trust Co.
|
5
|
112,330
|
17.27
|
%
|
||||||
|
Susquehanna
Bank
|
2
|
59,749
|
9.19
|
%
|
||||||
|
Clear
Mountain Bank
|
1
|
19,600
|
3.01
|
%
|
||||||
|
Miners
& Merchants Bank
|
1
|
4,069
|
0.63
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
|
Washington
County, Maryland:
|
||||||||||
|
Susquehanna
Bank
|
10
|
508,014
|
27.99
|
%
|
||||||
|
Hagerstown
Trust Co.
|
11
|
397,816
|
21.92
|
%
|
||||||
|
Manufacturers
& Traders Trust Company
|
12
|
397,183
|
21.89
|
%
|
||||||
|
Farmers
& Mechanics Bank
|
6
|
177,852
|
9.80
|
%
|
||||||
|
Sovereign
Bank
|
4
|
172,991
|
9.53
|
%
|
||||||
|
First
United Bank & Trust
|
2
|
56,927
|
3.14
|
%
|
||||||
|
First
National Bank of McConnellsburg
|
1
|
29,852
|
1.65
|
%
|
||||||
|
Chevy
Chase Bank FSB
|
1
|
26,652
|
1.47
|
%
|
||||||
|
Citizens
National Bank of Berkeley Springs
|
1
|
21,399
|
1.18
|
%
|
||||||
|
First
National Bank of Greencastle
|
2
|
16,700
|
0.92
|
%
|
||||||
|
Orrstown
Bank
|
1
|
9,292
|
0.51
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
|
Berkeley
County, West Virginia:
|
||||||||||
|
Branch
Banking & Trust Co.
|
5
|
325,183
|
32.85
|
%
|
||||||
|
Centra
Bank Inc.
|
3
|
166,957
|
16.87
|
%
|
||||||
|
First
United Bank & Trust
|
5
|
123,377
|
12.46
|
%
|
||||||
|
Susquehanna
Bank
|
4
|
112,714
|
11.39
|
%
|
||||||
|
City
National Bank of West Virginia
|
4
|
107,829
|
10.89
|
%
|
||||||
|
Jefferson
Security Bank
|
2
|
61,155
|
6.18
|
%
|
||||||
|
Citizens
National Bank of Berkeley Springs
|
3
|
55,615
|
5.62
|
%
|
||||||
|
Bank
of Charles Town
|
2
|
33,204
|
3.35
|
%
|
||||||
|
Shenandoah
Valley National Bank
|
1
|
3,780
|
0.38
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
[6]
|
Hardy
County, West Virginia:
|
||||||||||
|
Summit
Community Bank, Inc.
|
2
|
212,963
|
60.44
|
%
|
||||||
|
Capon
Valley Bank
|
3
|
99,037
|
28.11
|
%
|
||||||
|
Pendleton
Community Bank, Inc.
|
1
|
18,317
|
5.20
|
%
|
||||||
|
First
United Bank & Trust
|
1
|
14,277
|
4.05
|
%
|
||||||
|
Grant
County Bank
|
1
|
7,776
|
2.21
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
|
Mineral
County, West Virginia:
|
||||||||||
|
Branch
Banking & Trust Co.
|
2
|
75,612
|
32.06
|
%
|
||||||
|
First
United Bank & Trust
|
2
|
74,392
|
31.54
|
%
|
||||||
|
Manufacturers
& Traders Trust Co.
|
2
|
56,523
|
23.96
|
%
|
||||||
|
Grant
County Bank
|
1
|
29,344
|
12.44
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
|
Monongalia
County, West Virginia:
|
||||||||||
|
Centra
Bank, Inc.
|
4
|
369,432
|
25.92
|
%
|
||||||
|
Huntington
National Bank
|
6
|
361,466
|
25.36
|
%
|
||||||
|
Branch
Banking & Trust Co.
|
5
|
321,455
|
22.55
|
%
|
||||||
|
United
Bank
|
4
|
169,220
|
11.87
|
%
|
||||||
|
Wesbanco
Bank, Inc.
|
5
|
94,026
|
6.60
|
%
|
||||||
|
Clear
Mountain Bank
|
4
|
58,690
|
4.12
|
%
|
||||||
|
Citizens
Bank of Morgantown, Inc.
|
1
|
21,747
|
1.53
|
%
|
||||||
|
First
Exchange Bank
|
2
|
15,429
|
1.08
|
%
|
||||||
|
First
United Bank & Trust
|
2
|
13,824
|
0.97
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
For
further information about competition in our market areas, see the Risk Factor
entitled “We
operate in a competitive environment”
in
Item
1A of Part I of this annual report.
SUPERVISION
AND REGULATION
The
following is a summary of the material regulations and policies applicable
to
the Corporation and its subsidiaries and is not intended to be a comprehensive
discussion. Changes in applicable laws and regulations may have a material
effect on our business.
General
The
Corporation is a financial holding company registered with the Board of
Governors of the Federal Reserve System (the “FRB”) under the BHC Act and, as
such, is subject to the supervision, examination and reporting requirements
of
the BHC Act and the regulations of the FRB.
The
Bank
is a Maryland trust company subject to the banking laws of Maryland and to
regulation by the Commissioner of Financial Regulation of Maryland, who is
required by statute to make at least one examination in each calendar year
(or
at 18-month intervals if the Commissioner determines that an examination is
unnecessary in a particular calendar year). The Bank also has offices in West
Virginia, and the operations of these offices are subject to West Virginia
laws
and to supervision and examination by the West Virginia Division of Banking.
As
a member of the FDIC, the Bank is also subject to certain provisions of federal
law and regulations regarding deposit insurance and activities of insured
state-chartered banks, including those that require examination by the FDIC.
In
addition to the foregoing, there are myriad other federal and state laws and
regulations that affect, impact or govern the business of banking, including
consumer lending, deposit-taking, and trust operations.
[7]
All
non-bank subsidiaries of the Corporation are subject to examination by the
FRB,
and, as affiliates of the Bank, are subject to examination by the FDIC and
the
Commissioner of Financial Regulation of Maryland. In addition, OakFirst Loan
Center, Inc. is subject to licensing and regulation by the West Virginia
Division of Banking, OakFirst Loan Center, LLC is subject to licensing and
regulation by the Commissioner of Financial Regulation of Maryland, and the
Insurance Group and First United Insurance Agency, Inc. are each subject to
licensing and regulation by various state insurance authorities. Retail sales
of
insurance products by these insurance affiliates are also subject to the
requirements of the Interagency Statement on Retail Sales of Nondeposit
Investment Products promulgated in 1994 by the FDIC, the FRB, the Office of
the
Comptroller of the Currency, and the Office of Thrift Supervision.
Regulation
of Financial Holding Companies
In
November 1999, the federal Gramm-Leach-Bliley Act (the “GLBA”) was signed into
law. GLBA revises the BHC Act and repeals the affiliation provisions of the
Glass-Steagall Act of 1933, which, taken together, limited the securities,
insurance and other non-banking activities of any company that controls an
FDIC
insured financial institution. Under GLBA, a bank holding company can elect,
subject to certain qualifications, to become a “financial holding company.” GLBA
provides that a financial holding company may engage in a full range of
financial activities, including insurance and securities sales and underwriting
activities, and real estate development, with new expedited notice procedures.
Maryland law generally permits state-chartered banks, including the Bank, to
engage in the same activities, directly or through an affiliate, as national
banking associations. GLBA permits certain qualified national banking
associations to form financial subsidiaries, which have broad authority to
engage in all financial activities except insurance underwriting, insurance
investments, real estate investment or development, or merchant banking. Thus,
GLBA has the effect of broadening the permitted activities of the Corporation
and the Bank.
The
Corporation and its affiliates are subject to the provisions of Section 23A
and
Section 23B of the Federal Reserve Act. Section 23A limits the amount of loans
or extensions of credit to, and investments in, the Corporation and its non-bank
affiliates by the Bank. Section 23B requires that transactions between the
Bank
and the Corporation and its non-bank affiliates be on terms and under
circumstances that are substantially the same as with
non-affiliates.
Under
FRB
policy, the Corporation is expected to act as a source of strength to the Bank,
and the FRB may charge the Corporation with engaging in unsafe and unsound
practices for failure to commit resources to a subsidiary bank when required.
In
addition, under the Financial Institutions Reform, Recovery and Enforcement
Act
of 1989 (“FIRREA”), depository institutions insured by the FDIC can be held
liable for any losses incurred by, or reasonably anticipated to be incurred
by,
the FDIC in connection with (i) the default of a commonly controlled
FDIC-insured depository institution or (ii) any assistance provided by the
FDIC
to a commonly controlled FDIC-insured depository institution in danger of
default. Accordingly, in the event that any insured subsidiary of the
Corporation causes a loss to the FDIC, other insured subsidiaries of the
Corporation could be required to compensate the FDIC by reimbursing it for
the
estimated amount of such loss. Such cross guaranty liabilities generally are
superior in priority to obligations of a financial institution to its
shareholders and obligations to other affiliates.
Federal
Banking Regulation
Federal
banking regulators, such as the FRB and the FDIC, may prohibit the institutions
over which they have supervisory authority from engaging in activities or
investments that the agencies believe are unsafe or unsound banking practices.
Federal banking regulators have extensive enforcement authority over the
institutions they regulate to prohibit or correct activities that violate law,
regulation or a regulatory agreement or which are deemed to be unsafe or unsound
practices. Enforcement actions may include the appointment of a conservator
or
receiver, the issuance of a cease and desist order, the termination of deposit
insurance, the imposition of civil money penalties on the institution, its
directors, officers, employees and institution-affiliated parties, the issuance
of directives to increase capital, the issuance of formal and informal
agreements, the removal of or restrictions on directors, officers, employees
and
institution-affiliated parties, and the enforcement of any such mechanisms
through restraining orders or other court actions.
The
Bank
is subject to certain restrictions on extensions of credit to executive
officers, directors, and principal shareholders or any related interest of
such
persons, which generally require that such credit extensions be made on
substantially the same terms as are available to third parties dealing with
the
Bank and not involve more than the normal risk of repayment. Other laws tie
the
maximum amount that may be loaned to any one customer and its related interests
to capital levels.
[8]
As
part
of the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”),
each federal banking regulator adopted non-capital safety and soundness
standards for institutions under its authority. These standards include internal
controls, information systems and internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, and compensation,
fees and benefits. An institution that fails to meet those standards may be
required by the agency to develop a plan acceptable to meet the standards.
Failure to submit or implement such a plan may subject the institution to
regulatory sanctions. The Corporation, on behalf of the Bank, believes that
the
Bank meets substantially all standards that have been adopted. FDICIA also
imposes new capital standards on insured depository institutions.
The
Community Reinvestment Act (“CRA”) requires the FDIC, in connection with its
examination of financial institutions within its jurisdiction, to evaluate
the
record of those financial institutions in meeting the credit needs of their
communities, including low and moderate income neighborhoods, consistent with
principles of safe and sound banking practices. These factors are also
considered by all regulatory agencies in evaluating mergers, acquisitions and
applications to open a branch or facility. As of the date of its most recent
examination report, the Bank has a CRA rating of “Satisfactory”.
The
Bank’s deposits are insured to a maximum of $100,000 per depositor through the
Deposit Insurance Fund, which is administered by the FDIC, and the Bank is
required to pay semi-annual deposit insurance premium assessments to the FDIC.
The Bank paid $.2 million in FDIC premiums during 2006. The Deposit Insurance
Fund was created pursuant to the
Federal
Deposit Insurance Reform Act of 2005,
which was signed into law on February 8, 2006. Under this new law, (i) the
current $100,000 deposit insurance coverage will be indexed for inflation (with
adjustments every five years, commencing January 1, 2011), and (ii) deposit
insurance coverage for retirement accounts was increased to $250,000 per
participant subject to adjustment for inflation. In addition, the FDIC will
be
given greater latitude in setting the assessment rates for insured depository
institutions which could be used to impose minimum assessments.
For
a
discussion of the regulatory capital requirements and related restrictions
to
which the Corporation and the Bank are subject, see the “Capital Requirements”
discussion that immediately follows.
Capital
Requirements
FDICIA
established a system of prompt corrective action to resolve the problems of
undercapitalized institutions. Under this system, the federal banking regulators
are required to rate supervised institutions on the basis of five capital
categories: “well capitalized,” “adequately capitalized,” “undercapitalized,”
“significantly undercapitalized,” and “critically undercapitalized;” and to take
certain mandatory actions (and are authorized to take other discretionary
actions) with respect to institutions in the three undercapitalized categories.
The severity of the actions will depend upon the category in which the
institution is placed. A depository institution is “well capitalized” if it has
a total risk based capital ratio of 10% or greater, a Tier 1 risk based capital
ratio of 6% or greater, and a leverage ratio of 5% or greater and is not subject
to any order, regulatory agreement, or written directive to meet and maintain
a
specific capital level for any capital measure. An “adequately capitalized”
institution is defined as one that has a total risk based capital ratio of
8% or
greater, a Tier 1 risk based capital ratio of 4% or greater and a leverage
ratio
of 4% or greater (or 3% or greater in the case of a bank with a composite CAMEL
rating of 1).
FDICIA
generally prohibits a depository institution from making any capital
distribution, including the payment of cash dividends, or paying a management
fee to its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized depository institutions are subject to growth
limitations and are required to submit capital restoration plans. For a capital
restoration plan to be acceptable, the depository institution’s parent holding
company must guarantee (subject to certain limitations) that the institution
will comply with such capital restoration plan.
Significantly
undercapitalized depository institutions may be subject to a number of other
requirements and restrictions, including orders to sell sufficient voting stock
to become adequately capitalized and requirements to reduce total assets and
stop accepting deposits from correspondent banks. Critically undercapitalized
depository institutions are subject to the appointment of a receiver or
conservator, generally within 90 days of the date such institution is determined
to be critically undercapitalized.
Further
information about our capital resources is provided in the “Capital Resources”
section of Item 7 of Part II of this annual report. Information about the
capital ratios of the Corporation and of the Bank as of December 31, 2006 may
be
found in Note 2 to the Consolidated Financial Statements, which is included
in
Item 8 of Part II of this annual report.
[9]
USA
PATRIOT ACT
Congress
adopted the USA PATRIOT Act (the “Patriot Act”) on October 26, 2001 in response
to the terrorist attacks that occurred on September 11, 2001. Under the Patriot
Act, certain financial institutions, including banks, are required to maintain
and prepare additional records and reports that are designed to assist the
government’s efforts to combat terrorism. The Patriot Act includes sweeping
anti-money laundering and financial transparency laws and required additional
regulations, including, among other things, standards for verifying client
identification when opening an account and rules to promote cooperation among
financial institutions, regulators and law enforcement entities in identifying
parties that may be involved in terrorism or money laundering.
Federal
Securities Law
The
shares of the Corporation’s common stock are registered with the Securities and
Exchange Commission (the “SEC”) under Section 12(b) of the Securities Exchange
Act of 1934, as amended (the “Exchange Act”), and listed on the Nasdaq Stock
Market’s Global Market. The Corporation is subject to information reporting
requirements, proxy solicitation requirements, insider trading restrictions
and
other requirements of the Exchange Act, including the requirements imposed
under
the federal Sarbanes-Oxley Act of 2002. Among other things, loans to and other
transactions with insiders are subject to restrictions and heightened
disclosure, directors and certain committees of the Board must satisfy certain
independence requirements, and the Corporation is generally required to comply
with certain corporate governance requirements.
Governmental
Monetary and Credit Policies and Economic Controls
The
earnings and growth of the banking industry and ultimately of the Bank are
affected by the monetary and credit policies of governmental authorities,
including the FRB. An important function of the FRB is to regulate the national
supply of bank credit in order to control recessionary and inflationary
pressures. Among the instruments of monetary policy used by the FRB to implement
these objectives are open market operations in U.S. Government securities,
changes in the federal funds rate, changes in the discount rate of member bank
borrowings, and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth of
bank
loans, investments and deposits and may also affect interest rates charged
on
loans or paid on deposits. The monetary policies of the FRB authorities have
had
a significant effect on the operating results of commercial banks in the past
and are expected to continue to have such an effect in the future. In view
of
changing conditions in the national economy and in the money markets, as well
as
the effect of actions by monetary and fiscal authorities, including the FRB,
no
prediction can be made as to possible future changes in interest rates, deposit
levels, loan demand or their effect on the business and earnings of the
Corporation and its subsidiaries.
SEASONALITY
Management
does not believe that our business activities are seasonal in nature. Deposit,
loan, and insurance demand may vary depending on local and national economic
conditions, but management believes that any variation will not have a material
impact on our planning or policy-making strategies.
EMPLOYEES
At
December 31, 2006, we employed approximately 463 individuals, of whom 352 were
full-time employees.
|
ITEM
1A.
|
RISK
FACTORS
|
The
following factors should be considered carefully in evaluating an investment
in
shares of common stock of the Corporation.
[10]
Risks
Relating to the Corporation and its Affiliates
The
Corporation’s future depends on the successful growth of its
subsidiaries.
The
Corporation’s primary business activity for the foreseeable future will be to
act as the holding company of the Bank and its other direct and indirect
subsidiaries. Therefore, the Corporation’s future profitability will depend on
the success and growth of these subsidiaries. In the future, part of the
Corporation’s growth may come from buying other banks and buying or establishing
other companies. Such entities may not be profitable after they are purchased
or
established, and they may lose money, particularly at first. A new bank or
company may bring with it unexpected liabilities, bad loans, or bad employee
relations, or the new bank or company may lose customers.
The
majority of our business is concentrated in Maryland and West Virginia; a
significant amount of our business is concentrated in real estate lending.
Because
most of our loans are made to Western Maryland and Northeastern West Virginia
borrowers, a decline in local economic conditions may have a greater effect
on
our earnings and capital than on the earnings and capital of larger financial
institutions whose loan portfolios are geographically diverse. Further, we
make
many real estate secured loans, including construction and land development
loans, all of which are in greater demand when interest rates are low and
economic conditions are good. There can be no guarantee that good economic
conditions or low interest rates will continue to exist. Moreover, the market
values of the real estate securing our loans may deteriorate due to a number
of
unpredictable factors, which could cause us to lose money in the event a
borrower failed to repay a loan and we were forced to foreclose on the property.
Additionally, the Board of Governors of the Federal Reserve System and the
Federal Deposit Insurance Corporation, along with the other federal banking
regulators, issued final guidance on December 6, 2006 entitled “Concentrations
in Commercial Real Estate Lending, Sound Risk Management Practices” directed at
institutions that have particularly high concentrations of commercial real
estate loans within their lending portfolios. This guidance suggests that
institutions whose commercial real estate loans exceed certain percentages
of
capital should implement heightened risk management practices appropriate to
their concentration risk and may be required to maintain higher capital ratios
than institutions with lower concentrations in commercial real estate lending.
Based on our commercial real estate concentration as of December 31, 2006,
we
may be subject to further supervisory analysis during future examinations .
Although we continuously evaluate our concentration and risk management
strategies, we cannot guarantee that any risk management practices we implement
will be effective to prevent losses relating to our commercial real estate
portfolio. Management cannot predict the extent to which this guidance will
impact our operations or capital requirements.
The
Bank may experience loan losses in excess of its
allowance.
The
risk
of credit losses on loans varies with, among other things, general economic
conditions, the type of loan being made, the creditworthiness of the borrower
over the term of the loan and, in the case of a collateralized loan, the value
and marketability of the collateral for the loan. Management of First United
Bank & Trust maintains an allowance for credit losses based upon, among
other things, historical experience, an evaluation of economic conditions and
regular reviews of delinquencies and loan portfolio quality. Based upon such
factors, management makes various assumptions and judgments about the ultimate
collectability of the loan portfolio and provides an allowance for loan losses
based upon a percentage of the outstanding balances and for specific loans
when
their ultimate collectability is considered questionable. If management's
assumptions and judgments prove to be incorrect and the allowance for loan
losses is inadequate to absorb future losses, or if the bank regulatory
authorities require us to increase the allowance for loan losses as a part
of
its examination process, our earnings and capital could be significantly and
adversely affected. Although management uses the best information available
to
make determinations with respect to the allowance for loan losses, future
adjustments may be necessary if economic conditions differ substantially from
the assumptions used or adverse developments arise with respect to our
non-performing or performing loans. Material additions to the allowance for
loan
losses could result in a material decrease in our net income and capital, and
could have a material adverse effect on our financial condition.
Interest
rates and other economic conditions will impact our results of
operations.
Our
results of operations may be materially and adversely affected by changes in
prevailing economic conditions, including declines in real estate values, rapid
changes in interest rates and the monetary and fiscal policies of the federal
government. Our profitability is in part a function of the spread between the
interest rates earned on assets and the interest rates paid on deposits and
other interest-bearing liabilities (i.e., net interest income), including
advances from the Federal Home Loan Bank of Atlanta. Interest rate risk arises
from mismatches (i.e., the interest sensitivity gap) between the dollar amount
of repricing or maturing assets and liabilities and is measured in terms of
the
ratio of the interest rate sensitivity gap to total assets. More assets
repricing or maturing than liabilities over a given time period is considered
asset-sensitive and is reflected as a positive gap, and more liabilities
repricing or maturing than assets over a given time period is considered
liability-sensitive and is reflected as negative gap. An asset-sensitive
position (i.e., a positive gap) could enhance earnings in a rising interest
rate
environment and could negatively impact earnings in a falling interest rate
environment, while a liability-sensitive position (i.e., a negative gap) could
enhance earnings in a falling interest rate environment and negatively impact
earnings in a rising interest rate environment. Fluctuations in interest rates
are not predictable or controllable. We have attempted to structure our asset
and liability management strategies to mitigate the impact on net interest
income of changes in market interest rates, but there can be no assurance that
these attempts will be successful in the event of such changes.
[11]
The
market value of our investments could decline.
As
of
December 31, 2006, we had classified 100% of our investment securities as
available-for-sale pursuant to Statement of Financial Accounting Standards
("SFAS") No. 115 relating to accounting for investments. SFAS No. 115 requires
that unrealized gains and losses in the estimated value of the
available-for-sale portfolio be "marked to market" and reflected as a separate
item in shareholders' equity (net of tax) as accumulated other comprehensive
income. There can be no assurance that future market performance of our
investment portfolio will enable us to realize income from sales of securities.
Shareholders' equity will continue to reflect the unrealized gains and losses
(net of tax) of these investments. Moreover, there can be no assurance that
the
market value of our investment portfolio will not decline, causing a
corresponding decline in shareholders' equity.
Management
believes that several factors will affect the market values of our investment
portfolio. These include, but are not limited to, changes in interest rates
or
expectations of changes, the degree of volatility in the securities markets,
inflation rates or expectations of inflation and the slope of the interest
rate
yield curve (the yield curve refers to the differences between shorter-term
and
longer-term interest rates; a positively sloped yield curve means shorter-term
rates are lower than longer-term rates). Also, the passage of time will affect
the market values of our investment securities, in that the closer they are
to
maturing, the closer the market price should be to par value. These and other
factors may impact specific categories of the portfolio differently, and
management cannot predict the effect these factors may have on any specific
category.
We
operate in a competitive environment.
We
operate in a competitive environment, competing for loans, deposits, and
customers with commercial banks, savings associations and other financial
entities. Competition for deposits comes primarily from other commercial banks,
savings associations, credit unions, money market and mutual funds and other
investment alternatives. Competition for loans comes primarily from other
commercial banks, savings associations, mortgage banking firms, credit unions
and other financial intermediaries. Competition for other products, such as
insurance and securities products, comes from other banks, securities and
brokerage companies, insurance companies, insurance agents and brokers, and
other non-bank financial service providers in our market area. Many of these
competitors are much larger in terms of total assets and capitalization, have
greater access to capital markets, and/or offer a broader range of financial
services than those that we offer. In addition, banks with a larger
capitalization and financial intermediaries not subject to bank regulatory
restrictions have larger lending limits and are thereby able to serve the needs
of larger customers.
In
addition, current banking laws facilitate interstate branching, merger activity
among banks, and expanded activities. Since September 1995, certain bank holding
companies have been authorized to acquire banks throughout the United States.
Since June 1, 1997, certain banks have been permitted to merge with banks
organized under the laws of different states. As a result, interstate banking
is
now an accepted element of competition in the banking industry and the
Corporation may be brought into competition with institutions with which it
does
not presently compete. Moreover, as discussed above, the GLBA revised the BHC
Act in 2000 and repealed the affiliation provisions of the Glass-Steagall Act
of
1933, which, taken together, limited the securities, insurance and other
non-banking activities of any company that controls an FDIC insured financial
institution. These laws may increase the competition we face in our market
areas
in the future, although management cannot predict the degree to which such
competition will impact our financial conditions or results of
operations.
[12]
The
loss of key personnel could disrupt our operations and result in reduced
earnings.
Our
growth and profitability will depend upon our ability to attract and retain
skilled managerial, marketing and technical personnel. Competition for qualified
personnel in the financial services industry is intense, and there can be no
assurance that we will be successful in attracting and retaining such personnel.
Our current executive officers provide valuable services based on their many
years of experience and in-depth knowledge of the banking industry. Due to
the
intense competition for financial professionals, these key personnel would
be
difficult to replace and an unexpected loss of their services could result
in a
disruption to the continuity of operations and a possible reduction in earnings.
The
banking industry is heavily regulated; significant regulatory changes could
adversely affect our operations.
Our
operations will be impacted by current and future legislation and by the
policies established from time to time by various federal and state regulatory
authorities. The Corporation is subject to supervision by the FRB. The Bank
is
subject to supervision and periodic examination by the Maryland Commissioner
of
Financial Regulation, the West Virginia Division of Banking, and the FDIC.
Banking regulations, designed primarily for the safety of depositors, may limit
a financial institution's growth and the return to its investors by restricting
such activities as the payment of dividends, mergers with or acquisitions by
other institutions, investments, loans and interest rates, interest rates paid
on deposits, expansion of branch offices, and the offering of securities or
trust services. The Corporation and the Bank are also subject to capitalization
guidelines established by federal law and could be subject to enforcement
actions to the extent that either is found by regulatory examiners to be
undercapitalized. It is not possible to predict what changes, if any, will
be
made to existing federal and state legislation and regulations or the effect
that such changes may have on our future business and earnings prospects.
Management also cannot predict the nature or the extent of the effect on our
business and earnings of future fiscal or monetary policies, economic controls,
or new federal or state legislation. Further, the cost of compliance with
regulatory requirements may adversely affect our ability to operate
profitably.
We
may be adversely affected by recent legislation.
As
discussed above the GLBA repealed restrictions on banks affiliating with
securities firms and it also permitted bank holding companies that become
financial holding companies to engage in additional financial activities,
including insurance and securities underwriting and agency activities, merchant
banking, and insurance company portfolio investment activities that are
currently not permitted for bank holding companies. Although the Corporation
is
a financial holding company, this law may increase the competition we face
from
larger banks and other companies. It is not possible to predict the full effect
that this law will have on us.
The
Sarbanes-Oxley Act of 2002 requires management of publicly traded companies
to
perform an annual assessment of their internal controls over financial reporting
and to report on whether the system is effective as of the end of the Company’s
fiscal year. Disclosure of significant deficiencies or material weaknesses
in
internal controls could cause an unfavorable impact to shareholder value by
affecting the market value of our stock.
The
Patriot Act reinforced the importance of implementing and following procedures
required by the Bank Secrecy Act and money laundering issues. Non-compliance
with this act or failure to file timely and accurate documentation could expose
the company to adverse publicity as well as fines and penalties assessed by
regulatory agencies.
We
may be subject to claims and the costs of defensive
actions.
Our
customers may sue us for losses due to alleged breaches of fiduciary duties,
errors and omissions of employees, officers and agents, incomplete
documentation, our failure to comply with applicable laws and regulations,
or
many other reasons. Also, our employees may knowingly or unknowingly violate
laws and regulations. Management may not be aware of any violations until after
their occurrence. This lack of knowledge may not insulate us from liability.
Claims and legal actions may result in legal expenses and liabilities that
may
reduce our profitability and hurt our financial condition.
We
may not be able to keep pace with developments in
technology.
We
use
various technologies in conducting our businesses, including telecommunication,
data processing, computers, automation, internet-based banking, and debit cards.
Technology changes rapidly. Our ability to compete successfully with other
financial institutions may depend on whether we can exploit technological
changes. We may not be able to exploit technological changes, and any investment
we do make may not make us more profitable.
[13]
Risks
Relating to the Corporation’s Common Stock
The
Corporation’s ability to pay dividends is limited.
The
Corporation’s ability to pay dividends to shareholders is largely dependent upon
the receipt of dividends from the Bank. Both federal and state laws impose
restrictions on the ability of the Bank to pay dividends. Federal law generally
prohibits the payment of a dividend by a troubled institution. Under Maryland
law, a state-chartered commercial bank may pay dividends only out of undivided
profits or, with the prior approval of the Commissioner, from surplus in excess
of 100% of required capital stock. If however, the surplus of a Maryland bank
is
less than 100% of its required capital stock, cash dividends may not be paid
in
excess of 90% of net earnings. In addition to these specific restrictions,
bank
regulatory agencies also have the ability to prohibit proposed dividends by
a
financial institution which would otherwise be permitted under applicable
regulations if the regulatory body determines that such distribution would
constitute an unsafe or unsound practice. Because of these limitations, there
can be no guarantee that we will declare dividends in any fiscal
quarter.
Shares
of the Corporation’s common stock are not insured.
Shares
of
the Corporation’s common stock do not represent deposits and investments in
these shares are not insured against loss by the government.
Shares
of the Corporation’s common stock are not heavily traded.
The
shares of the Corporation’s common stock are listed on the Nasdaq Global Market
and are not heavily traded. Securities that are not heavily traded can be more
volatile than stock trading in an active public market. Factors such as our
financial results, the introduction of new products and services by us or our
competitors, and various factors affecting the banking industry generally may
have a significant impact on the market price of our common stock. Management
cannot predict the extent to which an active public market for our securities
will develop or be sustained in the future. In recent years, the stock market
has experienced a high level of price and volume volatility, and market prices
for the securities of many companies have experienced wide price fluctuations
that have not necessarily been related to their operating performance.
Therefore, our shareholders may not be able to sell their shares at the volumes,
prices, or times that they desire.
The
Corporation’s Articles of Incorporation and By-Laws may discourage a corporation
takeover.
The
Amended and Restated Articles of Incorporation and By-Laws of the Corporation
contain certain provisions designed to enhance the ability of the Board of
Directors to deal with attempts to acquire control of the corporation. First,
the Board of Directors is classified into three classes. Directors of each
class
serve for staggered three-year periods, and no director may be removed except
for cause, and then only by the affirmative vote of either a majority of the
entire Board of Directors or a majority of the outstanding voting stock. Second,
the Board has the authority to classify and reclassify unissued shares of stock
of any class or series of stock by setting, fixing, eliminating, or altering
in
any one or more respects the preferences, rights, voting powers, restrictions
and qualifications of, dividends on, and redemption, conversion, exchange,
and
other rights of, such securities. The Board could use this authority, along
with
its authority to authorize the issuance of securities of any class or series,
to
issue shares
having terms favorable to management to a person or persons affiliated with
or
otherwise friendly to management. In
addition to the foregoing, Maryland law contains anti-takeover provisions,
such
as restrictions on “control share acquisitions” and “business combinations” with
certain interested stockholders, that apply to the Corporation.
Although
these provisions do not preclude a takeover, they may have the effect of
discouraging a takeover attempt that would not be approved by the Board of
Directors, but pursuant to which shareholders might receive a substantial
premium for their shares over then-current market prices. As a result,
shareholders who might desire to participate in such a transaction might not
have the opportunity to do so. Such provisions will also render the removal
of
the Board of Directors and of management more difficult and, therefore, may
serve to perpetuate current management. Such provisions could potentially
adversely affect the market price of our common stock.
[14]
|
ITEM
1B.
|
UNRESOLVED
STAFF COMMENTS
|
None.
|
ITEM
2.
|
PROPERTIES
|
The
headquarters of the Corporation and the Bank occupies approximately 29,000
square feet at 19 South Second Street, Oakland, Maryland. These premises are
owned by the Corporation. The Bank owns 19 of its banking offices and leases
six. The Corporation also leases three offices of non-bank subsidiaries. A
banking office is currently under construction on a leased site in Washington
County, Maryland. Total rent expense on the leased offices and properties was
$.42 million in 2006. In December of 2005, the Corporation purchased a 30,000
square foot building in Oakland, Maryland to house its operations center.
Management expects that this site will be fully functional in March
2007.
|
ITEM
3.
|
LEGAL
PROCEEDINGS
|
We
are at
times, in the ordinary course of business, subject to legal actions. Management,
upon the advice of counsel, believes that losses, if any, resulting from current
legal actions will not have a material adverse effect on our financial
condition.
|
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY
HOLDERS
|
None.
[15]
PART
II
|
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
|
Shares
of
the Corporation’s common stock are listed on the Nasdaq Stock Market under the
symbol “FUNC”. As of February 28, 2007, the Corporation had 2,085 shareholders
of record. The high and low sales prices for, and the cash dividends declared
on, the shares of the Corporation’s common stock for each quarterly period of
2006 and 2005 are set forth below.
|
2006
|
High
|
Low
|
Dividends
Declared
|
|||||||
|
1st
Quarter
|
$
|
22.83
|
$
|
20.29
|
$
|
.190
|
||||
|
2nd
Quarter
|
23.35
|
20.29
|
.190
|
|||||||
|
3rd
Quarter
|
22.00
|
20.31
|
.190
|
|||||||
|
4th
Quarter
|
22.79
|
21.05
|
.195
|
|||||||
|
2005
|
High
|
Low
|
Dividends
Declared
|
|||||||
|
1st
Quarter
|
$
|
21.70
|
$
|
19.81
|
$
|
.185
|
||||
|
2nd
Quarter
|
20.30
|
18.94
|
.185
|
|||||||
|
3rd
Quarter
|
20.85
|
19.25
|
.185
|
|||||||
|
4th
Quarter
|
21.66
|
19.14
|
.190
|
|||||||
Cash
dividends are typically declared on a quarterly basis and are at the discretion
of the Corporation’s Board of Directors. Dividends to shareholders are generally
dependent on the ability of the Corporation’s subsidiaries, especially the Bank,
to declare dividends to the Corporation. The ability of these entities to
declare dividends are limited by federal and state banking laws and/or state
corporate laws. Further information about these limitations may be found in
Note
13 to the Consolidated Financial Statements and in Item 1A of Part I under
the
caption “The
Corporation’s ability to pay dividends is limited”,
each
of which is incorporated herein by reference. There can be no guarantee that
dividends will be declared in any fiscal quarter.
Market
makers for the Corporation’s common stock are:
|
FERRIS
BAKER WATTS
|
SCOTT
AND STRINGFELLOW, INC.
|
|
|
12
North Liberty St.
|
909
East Main Street
|
|
|
Cumberland,
MD 21502
|
Richmond,
VA 23219
|
|
|
(301)724-7161
|
(804)643-1811
|
|
|
(800)776-0629
|
(800)552-7757
|
|
|
113
S. Potomac St.
|
||
|
Hagerstown,
MD 21740
|
||
|
(301)733-7111
|
||
|
(800)344-4413
|
[16]
First
United Corporation Stock Performance Graph
The
following graph compares the yearly percentage change in the cumulative total
return for First United Corporation common stock for the five years ended
December 31, 2006. This data is compared to the NASDAQ Composite market index
and the SNL $1 billion to $5 billion Bank Index during the same time period.
Total return numbers are calculated as change in stock price for the period
indicated with dividends being reinvested.
|
|
Period
Ending
|
|||||
|
Index
|
12/31/01
|
12/31/02
|
12/31/03
|
12/31/04
|
12/31/05
|
12/31/06
|
|
First
United Corporation
|
100.00
|
106.92
|
164.12
|
143.24
|
153.25
|
163.71
|
|
NASDAQ
Composite
|
100.00
|
68.76
|
103.67
|
113.16
|
115.57
|
127.58
|
|
SNL
$1B-$5B Bank Index
|
100.00
|
115.44
|
156.98
|
193.74
|
190.43
|
220.36
|
Equity
Compensation Plan Information
At
December 31, 2006, the Corporation had no equity compensation plan or
arrangement in effect under which shares of common stock may be issued to its
directors
or officers.
Issuer
Purchases of Securities
[17]
|
ITEM
6.
|
SELECTED
FINANCIAL DATA
|
The
following table sets forth certain selected financial data for the five years
ended December 31, 2006 and is qualified in its entirety by the detailed
information and financial statements, including notes thereto, included
elsewhere or incorporated by reference in this annual report.
(In
thousands, except per share data)
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
Balance
Sheet Data
|
||||||||||||||||
|
Total
Assets
|
$
|
1,349,317
|
$
|
1,310,991
|
$
|
1,233,901
|
$
|
1,108,241
|
$
|
954,388
|
||||||
|
Net
Loans
|
957,126
|
954,545
|
904,635
|
786,051
|
659,758
|
|||||||||||
|
Investment
Securities
|
263,272
|
230,095
|
210,661
|
223,615
|
215,236
|
|||||||||||
|
Deposits
|
971,381
|
955,854
|
850,661
|
750,161
|
610,460
|
|||||||||||
|
Long-term
Borrowings
|
166,330
|
128,373
|
175,415
|
191,735
|
198,772
|
|||||||||||
|
Shareholders’
Equity
|
96,856
|
92,039
|
86,356
|
84,191
|
79,283
|
|||||||||||
|
Operating
Data
|
||||||||||||||||
|
Interest
Income
|
$
|
80,269
|
$
|
69,756
|
$
|
60,682
|
$
|
57,703
|
$
|
57,589
|
||||||
|
Interest
Expense
|
39,335
|
29,413
|
24,016
|
23,601
|
25,702
|
|||||||||||
|
Net
Interest Income
|
40,934
|
40,343
|
36,666
|
34,102
|
31,887
|
|||||||||||
|
Provision
for Loan Losses
|
1,165
|
1,078
|
2,534
|
833
|
1,506
|
|||||||||||
|
Other
Operating Income
|
14,041
|
14,088
|
12,971
|
11,867
|
9,007
|
|||||||||||
|
Other
Operating Expense
|
35,490
|
34,654
|
35,969
|
29,821
|
26,038
|
|||||||||||
|
Income
Before Tax
|
18,320
|
18,699
|
11,134
|
15,315
|
13,350
|
|||||||||||
|
Income
Tax
|
5,743
|
6,548
|
3,507
|
4,566
|
3,695
|
|||||||||||
|
Net
Income
|
$
|
12,577
|
$
|
12,151
|
$
|
7,627
|
$
|
10,749
|
$
|
9,655
|
||||||
|
Per
Share Data
|
||||||||||||||||
|
Net
Income
|
$
|
2.05
|
$
|
1.99
|
$
|
1.25
|
$
|
1.77
|
$
|
1.59
|
||||||
|
Dividends
Paid
|
.76
|
.74
|
.72
|
.70
|
.68
|
|||||||||||
|
Book
Value
|
15.77
|
15.04
|
14.17
|
13.83
|
13.04
|
|||||||||||
|
Significant
Ratios
|
||||||||||||||||
|
Return
on Average Assets
|
.96
|
%
|
.95
|
%
|
.65
|
%
|
1.03
|
%
|
1.13
|
%
|
||||||
|
Return
on Average Equity
|
13.07
|
%
|
13.61
|
%
|
8.91
|
%
|
13.10
|
%
|
12.75
|
%
|
||||||
|
Dividend
Payout Ratio
|
37.07
|
%
|
37.44
|
%
|
58.00
|
%
|
39.65
|
%
|
42.76
|
%
|
||||||
|
Average
Equity to Average Assets
|
7.35
|
%
|
7.00
|
%
|
7.28
|
%
|
7.88
|
%
|
8.84
|
%
|
||||||
|
Total
Risk-based Capital Ratio
|
12.95
|
%
|
12.66
|
%
|
12.24
|
%
|
11.77
|
%
|
14.31
|
%
|
||||||
|
Tier
I Capital to Risk Weighted Assets
|
11.81
|
%
|
11.45
|
%
|
10.81
|
%
|
11.04
|
%
|
13.76
|
%
|
||||||
|
Tier
I Capital to Average Assets
|
9.08
|
%
|
8.64
|
%
|
8.44
|
%
|
8.72
|
%
|
11.72
|
%
|
||||||
[18]
|
ITEM
7.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
This
discussion and analysis should be read in conjunction with the audited
consolidated financial statements and notes thereto for the year ended December
31, 2006, which appear in Item 8 of Part II of this annual report.
Overview
The
Corporation is a financial holding company which, through the Bank and its
non-bank subsidiaries, provides an array of financial products and services
primarily
to customers in four Western Maryland counties and four Northeastern West
Virginia counties. Its principal operating subsidiary is the Bank, which
consists of a community banking network of 25 branch offices located throughout
its market areas. Our primary sources of revenue are interest income earned
from
our loan and investment securities portfolios and fees earned from financial
services provided to customers.
Our
2006
net income was $12.6 million, an increase of 4.1% over 2005. The increase in
2006 net income was due to strategic decisions implemented by management over
the past few years, the Bank’s ability to increase its net interest margin, a
focus on controlling our operating costs and a reduction in the effective tax
rate. 2006 proved to be a challenging year with an inverted interest rate yield
curve, a slowed economy and intense competition for retail and commercial
deposits.
Operations
in 2006 were impacted by the following factors and strategic
initiatives:
Slow
Loan and Deposit Growth/Impact on Net Interest Margin --
Loan
growth slowed significantly in 2006 as compared to 2005, resulting in a minimal
net increase in the loan portfolio of $3 million. Commercial loan production
remained at a consistent level with 2005 but was offset by the increased payback
of commercial development loans. Residential mortgage loan growth was tempered
by management during 2006 as a result of strong customer preference for fixed
rate loans. The Bank utilized the secondary market as an outlet for this type
of
lending to prevent excessive growth in the fixed rate portfolio. Management’s
preference for originating adjustable, prime-rate based loans has benefited
us
in the current rising interest rate environment. Although we experienced minimal
increase in loan growth, interest income exceeded interest income generated
in
prior years due to the upward re-pricing of loans. For 2006, interest income
on
loans increased $7.5 million (on a fully taxable equivalent basis) when compared
with 2005. Interest income on investment securities in 2006 increased by $3.7
million (on a fully taxable equivalent basis) due to an increase in the average
yield on the portfolio and a $45 million leverage strategy. (Additional
information on the composition of interest income is available in Table 1
below).
Funding
costs in 2006 increased as a result of the rising interest rate environment
and
the intense deposit competition in our market areas. The shift from core
non-interest bearing accounts to certificates of deposit and higher yielding
money market accounts continued during 2006. A large portion of the new time
deposits received in 2006 were in denominations of $100,000 or more, which
typically require higher interest rates than core deposits. This reliance on
higher rate time deposits and the general increase in interest rates throughout
2006 increased deposit interest expense by approximately $8.2 million when
compared to 2005. Net borrowings increased by $15.4 million adding an additional
$1.7 million of interest expense over the prior year. The combination of slow
loan and deposit growth, rising interest rates on our assets and liabilities,
and the increased level of debt resulted in a minimal increase in net interest
income on a tax equivalent basis of $1.4 million (3%) in 2006 when compared
to
2005.
The
overall net interest margin increased during the year from 3.49% in 2005 to
3.52% in 2006. However, the 2006 net interest margin was negatively impacted
by
a $45 million leverage strategy implemented in the latter half of 2006 in an
attempt to produce additional net interest income.
Early
Redemption of Long-Term Borrowings
-- In
May 2006, the
Bank
participated in a contemporaneous exchange of long-term FHLB advances. The
Bank
exchanged $25 million of long-term advances having a weighted average rate
of
5.01% for $25 million of long-term advances having a weighted average rate
of
4.69%. The exchange resulted in a net gain of $.2 million which will be
amortized over the life of the new borrowing.
Other
Operating Income/Other Operating Expense --
Other
operating income in 2006 decreased slightly when compared to 2005. The Bank
experienced increases in service charge and Trust department income of $.8
million and $.4 million, respectively. Insurance
commissions were down slightly in 2006 compared to 2005 due to lower contingency
income from insurance companies and the closing of Oakfirst Life Insurance,
Inc.
early in 2005. Other income in 2005
included a $.9 million gain on the prepayment of long-term debt. Operating
expenses in 2006 increased by 2.4% when compared to 2005.
This
minimal increase was due primarily to increases in salaries and benefits,
occupancy and other expenses and close monitoring of our operating expenses.
2005 operating expenses included a $.4 million penalty recognized on the
prepayment of long-term debt.
[19]
The
Bank
continued to invest in its core market areas during 2006. A new branch office
was opened during the fourth quarter of 2006 in Morgantown, West Virginia and
construction of another branch began on a newly leased site in Washington
County, Maryland. This new retail branch is anticipated to open late in the
first quarter of 2007. The Corporation purchased a 30,000 square foot building
in Oakland, Maryland in December 2005 for $3 million to house its operations
center. This space will relieve congestion in the Corporation’s headquarters as
well as provide capacity for the Bank’s anticipated growth. Management expects
that this new facility will be ready for use in the first quarter of
2007.
The
Corporation continued its tradition of paying dividends to shareholders during
2006 and, in fact, increased them to $0.76
per
share, a 2.7% increase from $0.74 per share in 2005. The Corporation has paid
quarterly cash dividends consistently since 1985, the year in which it was
formed.
We
will
continue to face risks and challenges in the future, including: changes in
local
economic conditions in our core geographic markets; potential
yield compression on loan and deposit products by existing competitors and
potential new entrants in our markets; changes in interest rates; and changes
to
existing federal and state legislation and regulations over banks and financial
holding companies. For a more complete discussion of these risk factors, see
Item 1A of Part I of this annual report.
Critical
Accounting Policies and Estimates
This
discussion and analysis of the our financial condition and results of operations
is based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires management to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure
of
contingent liabilities. (See Note 1 of the Notes to Consolidated Financial
Statements included in Item 8 of Part II of this annual report.) On an on-going
basis, management evaluates estimates, including those related to loan losses
and intangible assets. Management bases its estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent
from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. Management believes the following critical accounting
policies affect our more significant judgments and estimates used in the
preparation of the consolidated financial statements.
Allowance
for Loan Losses
One
of
our most important accounting policies is that related to the monitoring of
the
loan portfolio. A variety of estimates impact the
carrying value of the loan portfolio, including the calculation of the allowance
for loan losses, the valuation of underlying collateral, the timing of loan
charge-offs and the placement of loans on non-accrual status. The allowance
is
established and maintained at a level that management believes is adequate
to
cover losses resulting from the inability of borrowers to make required payment
on loans. Estimates for loan losses are arrived at by analyzing risks associated
with the specific loans and the loan portfolio, current and historical trends
in
delinquencies and charge-offs, and changes in the size and composition of the
loan portfolio. The analysis also requires consideration of the economic climate
and direction, changes in lending rates, political conditions, legislation
impacting the banking industry and economic conditions specific to Western
Maryland and Northeastern West Virginia. Because the calculation of the
allowance for loan losses relies on management’s estimates and judgments
relating to inherently uncertain events, actual results may differ from
management’s estimates.
The
allowance for loan losses is also discussed below in this Item 7 under the
caption “Allowance and Provision for Loan Losses” and
in
Note 4 to Consolidated Financial Statements contained in Item 8 of Part II
of
this annual report.
Goodwill
and Other Intangible Assets
Statement
of Financial Accounting Standards (SFAS) No. 142, Accounting for Goodwill and
Other Intangible Assets, establishes standards for the amortization of
acquired intangible assets and the non-amortization and impairment assessment
of
goodwill. We have $2.1 million of core deposit intangible assets which are
subject to amortization and $11.9 million in goodwill primarily related to
the
Huntington National Bank branch acquisition that occurred in 2003, which is
not
subject to periodic amortization.
[20]
Goodwill
arising from business combinations represents the value attributable to
unidentifiable intangible elements in the business acquired. Our goodwill
relates to value inherent in the banking business and the value is dependent
upon our ability to provide quality, cost effective services in a highly
competitive local market. This ability relies upon continuing investments in
processing systems, the development of value-added service features and the
ease
of use of our services. As
such,
goodwill value is supported ultimately by revenue that is driven by the volume
of business transacted. A decline in earnings as a result of a lack of
growth
or
the inability to deliver cost effective services over sustained periods can
lead
to impairment of goodwill, which could adversely impact earnings in future
periods. SFAS No. 142 requires an annual evaluation of goodwill for impairment.
The determination of whether or not these assets are impaired involves
significant judgments. Management has concluded that the recorded value of
goodwill was not impaired as a result of the evaluation. However, future changes
in strategy and/or market conditions could significantly impact these judgments
and require adjustments to recorded asset balances.
Other-Than-Temporary
Impairment of Investment Securities
Management
systematically evaluates investment securities for impairment on a quarterly
basis. Declines in the fair value of available for sale securities below their
cost that are considered other than temporary declines are recognized in
earnings as realized losses in the period in which the impairment determination
is made. In estimating other-than-temporary impairment losses, management
considers (1) the length of time and the extent to which the fair value has
been
less than cost, (2) the financial condition and near-term prospects of the
issuer, and (3) the intent and ability of the Corporation to retain its
investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. Gains and losses on the sale of securities
are recorded using the specific identification method.
Pension
Plan Assumptions
Our
pension plan costs are calculated using actuarial concepts, as discussed within
the requirements of Statement of Financial Accounting Standards (SFAS) No.
87,
Employers Accounting for Pensions SFAS No. 132 (R) and as amended by SFAS No.
158, “Employers’ Accounting for Deferred Benefit Pension and Other Post
Retirement Plans.” Pension expense and the determination of our projected
pension liability are based upon two critical assumptions; the discount rate
and
the expected return on plan assets. We evaluate each of these critical
assumptions annually. Other assumptions impact the determination of pension
expense and the projected liability including the primary employee demographics,
such as retirement patterns, employee turnover, mortality rates, and estimated
employer compensation increases. These factors, along with the critical
assumptions, are carefully reviewed by management each year in consultation
with
our pension plan consultants and actuaries. Further information about our
pension plan assumptions, the plan’s funded status, and other plan information
is included in Note 11 to Consolidated Financial Statements, which is included
in Item 8 of Part II of this annual report.
Recent
Accounting Pronouncements and Developments
Note
1 to
the Consolidated Financial Statements included in Item 8, Part II of this annual
report discusses new accounting pronouncements that when adopted, may have
an
effect on our consolidated financial statements.
CONSOLIDATED
STATEMENT OF INCOME REVIEW
Net
Interest Income
Net
interest income is the largest source of operating revenue. Net interest income
is the difference between the interest earned on interest-earning
assets and the interest expense paid on interest-bearing liabilities. For
analytical and discussion purposes, net interest income is adjusted to a taxable
equivalent 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. The table below summarizes net interest income
(on a taxable equivalent basis) for the years 2004-2006 (dollars in
thousands).
[21]
|
2006
|
2005
|
2004
|
||||||||
|
Interest
income
|
$
|
81,838
|
$
|
70,533
|
$
|
61,380
|
||||
|
Interest
expense
|
39,335
|
29,413
|
24,016
|
|||||||
|
Net
interest income
|
42,503
|
41,120
|
37,364
|
|||||||
|
Net
interest margin %
|
3.52
|
%
|
3.49
|
%
|
3.43
|
%
|
||||
Net
interest income increased $1.4 million (3%) in 2006 over the same period in
2005, due to an $11.3 million (16%) increase in interest income offset by a
$9.9
million (34%) increase in interest expense. The increase in interest income
resulted from an increase in average interest-earning assets of $28.1 million
(2%) during 2006 when compared to 2005. This increase is attributable to the
growth that we experienced in our investment portfolio late in 2005 and
throughout 2006. Emphasis on adjustable rate loan products and the rising
interest rate environment contributed to the increase in the average rate on
our
average earning assets of 80 basis points, from 5.98% in 2005 to 6.78% in 2006
(on a fully tax equivalent basis). Interest expense increased during 2006 when
compared to 2005 due to the higher interest rate environment, and an overall
increase in average interest-bearing liabilities of $32.3 million. Deposits
have
increased in 2006 by approximately $16 million due to an increase in brokered
certificates of deposit and a successful retail promotion of a nine month
certificate of deposit. The combined effect of the increasing rate environment
and the volume increases in our average interest-bearing liabilities resulted
in
an 83 basis point increase in the average rate paid on our average
interest-bearing liabilities from 2.76% for 2005 to 3.59% for 2006. The net
result of the aforementioned factors was a 3 basis point increase in the net
interest margin at December 31, 2006 to 3.52% from 3.49% at December 31,
2005.
Comparing
2005 to 2004, net interest income increased $3.8 million (10.1%) due primarily
to the increase in interest income of $9.2 million, offset by an increase in
interest expense of $5.4 million. Interest income from loans increased by $8.3
million due to the $93.5 million increase in the average balance of loans in
2005 and a slight increase of 26 basis points in the average yield on loans.
The
increase in total interest expense was due to increased interest expense on
deposits of $7.0 million (57.8%) offset by a decrease in interest expense on
long-term borrowings of $3.2 million (29.7%). Interest expense on deposits
increased primarily due to a $38.3 million increase in average balances and
a
141 basis point increase in the average yield on time deposits over $100,000.
The decrease in interest expense on long-term borrowings was primarily due
to
the $45.4 million decrease in the average balance coupled with the 50 basis
point decrease in average yield on these borrowings.
As
shown
below, the composition of total interest income remained steady from 2004 to
2005. Loan interest income and fees decreased in 2006 when compared to 2005
as a
percentage of total interest income due to the limited loan growth and the
increase in investment securities as a percentage of interest earning assets
during this time.
|
%
of Total Interest Income
|
|||
|
2006
|
2005
|
2004
|
|
|
Interest
and fees on loans
|
85%
|
88%
|
88%
|
|
Interest
on investment securities
|
15%
|
12%
|
12%
|
Table
1
sets forth the average balances, net interest income and expense and average
yields and rates for our interest-earning assets and interest-bearing
liabilities for 2006, 2005 and 2004. Table 2 sets forth an analysis of volume
and rate changes in interest income and interest expense of our average
interest-earning assets and average interest-bearing liabilities for 2006,
2005
and 2004. Table 2 distinguishes between the changes related to average
outstanding balances (changes in volume created by holding the interest rate
constant) and the changes related to average interest rates (changes in interest
income or expense attributed to average rates created by holding the outstanding
balance constant).
[22]
Distribution
of Assets, Liabilities and Shareholders’ Equity
Interest
Rates and Interest Differential - Tax Equivalent Basis
(Dollars
in thousands)
Table
1
|
For
the Years Ended December 31
|
||||||||||||||||||||||||||||
|
2006
|
2005
|
2004
|
||||||||||||||||||||||||||
|
AVERAGE
BALANCE
|
INTEREST
|
AVERAGE
YIELD/RATE
|
AVERAGE
BALANCE
|
INTEREST
|
AVERAGE
YIELD/RATE
|
AVERAGE
BALANCE
|
INTEREST
|
AVERAGE
YIELD/RATE
|
||||||||||||||||||||
|
Assets
|
||||||||||||||||||||||||||||
|
Loans
|
$
|
957,709
|
$
|
69,049
|
7.21
|
%
|
$
|
954,784
|
$
|
61,601
|
6.45
|
%
|
$
|
861,255
|
$
|
53,313
|
6.19
|
%
|
||||||||||
|
Investment
Securities:
|
||||||||||||||||||||||||||||
|
Taxable
|
171,720
|
7,699
|
4.48
|
179,018
|
6,231
|
3.48
|
191,135
|
5,819
|
3.04
|
|||||||||||||||||||
|
Non taxable
|
65,902
|
4,399
|
6.67
|
30,041
|
2,129
|
7.09
|
23,311
|
1,854
|
7.95
|
|||||||||||||||||||
|
Total
|
237,622
|
12,098
|
5.09
|
209,059
|
8,360
|
4.00
|
214,446
|
7,673
|
3.58
|
|||||||||||||||||||
|
Federal
funds sold
|
463
|
1
|
.21
|
1,876
|
55
|
2.93
|
2,043
|
35
|
1.71
|
|||||||||||||||||||
|
Interest-bearing
deposits with other banks
|
2,811
|
165
|
5.88
|
5,327
|
162
|
3.04
|
3,583
|
56
|
1.57
|
|||||||||||||||||||
|
Other
interest earning assets
|
9,231
|
525
|
5.68
|
8,680
|
355
|
4.09
|
8,439
|
303
|
3.59
|
|||||||||||||||||||
|
Total
earning assets
|
1,207,836
|
81,838
|
6.78
|
%
|
1,179,726
|
70,533
|
5.98
|
%
|
1,089,766
|
61,380
|
5.63
|
%
|
||||||||||||||||
|
Allowance
for loan losses
|
(6,245
|
)
|
(6,975
|
)
|
(6,150
|
)
|
||||||||||||||||||||||
|
Non-earning
assets
|
110,098
|
102,500
|
94,730
|
|||||||||||||||||||||||||
|
Total
Assets
|
$
|
1,311,689
|
$
|
1,275,251
|
$
|
1,178,346
|
||||||||||||||||||||||
|
Liabilities
and Shareholders’ Equity
|
||||||||||||||||||||||||||||
|
Interest-bearing
demand deposits
|
$
|
285,250
|
$
|
6,405
|
2.25
|
%
|
$
|
293,129
|
$
|
4,896
|
1.67
|
%
|
$
|
279,217
|
$
|
2,699
|
.97
|
%
|
||||||||||
|
Savings
deposits
|
47,779
|
462
|
.97
|
58,964
|
242
|
.41
|
63,471
|
237
|
.37
|
|||||||||||||||||||
|
Time
deposits:
|
||||||||||||||||||||||||||||
|
Less
than $100
|
229,829
|
8,439
|
3.67
|
264,503
|
6,023
|
2.28
|
209,708
|
4,950
|
2.36
|
|||||||||||||||||||
|
$100
or more
|
273,305
|
12,043
|
4.41
|
187,412
|
7,943
|
4.24
|
149,113
|
4,222
|
2.83
|
|||||||||||||||||||
|
Short-term
borrowings
|
107,430
|
4,429
|
4.12
|
100,601
|
2,749
|
2.73
|
82,747
|
1,153
|
1.39
|
|||||||||||||||||||
|
Long-term
borrowings
|
153,089
|
7,557
|
4.94
|
159,748
|
7,560
|
4.73
|
205,193
|
10,755
|
5.23
|
|||||||||||||||||||
|
Total
interest-bearing liabilities
|
1,096,682
|
39,335
|
3.59
|
%
|
1,064,357
|
29,413
|
2.76
|
%
|
989,449
|
24,016
|
2.43
|
%
|
||||||||||||||||
|
Non-interest-bearing
Deposits
|
107,595
|
112,860
|
94,871
|
|||||||||||||||||||||||||
|
Other
liabilities
|
11,189
|
8,734
|
8,266
|
|||||||||||||||||||||||||
|
Shareholders’
Equity
|
96,223
|
89,300
|
85,760
|
|||||||||||||||||||||||||
|
Total
Liabilities and Shareholders’ Equity
|
$
|
1,311,689
|
$
|
1,275,251
|
$
|
1,178,346
|
||||||||||||||||||||||
|
Net
interest income and Spread
|
$
|
42,503
|
3.19
|
%
|
$
|
41,120
|
3.22
|
%
|
$
|
37,364
|
3.20
|
%
|
||||||||||||||||
|
Net
interest margin
|
3.52
|
%
|
3.49
|
%
|
3.43
|
%
|
||||||||||||||||||||||
NOTES:
--The
above table reflects the average rates earned or paid stated on a tax equivalent
basis assuming a tax rate of 35% for 2006 and 2005 and 34% for 2004. The fully
taxable equivalent adjustments for the years ended December 31, 2006, 2005,
and
2004 were $1,569, $776, and $698, respectively.
--The
average balances of non-accrual loans for the years ended December 31, 2006,
2005 and 2004, which were reported in the average loan balances for these years,
were $2,705, $3,203, and $4,400, respectively.
--Net
interest margin is calculated as net interest income divided by average earning
assets.
--The
average yields on investments are based on amortized cost.
[23]
Interest
Variance Analysis (1)
(In
thousands and tax equivalent basis)
Table
2
|
2006
Compared to 2005
|
2005
Compared to 2004
|
||||||||||||||||||
|
Volume
|
Rate
|
Net
|
Volume
|
Rate
|
Net
|
||||||||||||||
|
INTEREST
INCOME:
|
|||||||||||||||||||
|
Loans
|
$
|
211
|
$
|
7,237
|
$
|
7,448
|
$
|
6,034
|
$
|
2,253
|
$
|
8,287
|
|||||||
|
Taxable
Investments
|
(327
|
)
|
1,795
|
1,468
|
(422
|
)
|
833
|
411
|
|||||||||||
|
Non-taxable
Investments
|
2,394
|
(124
|
)
|
2,270
|
477
|
(202
|
)
|
275
|
|||||||||||
|
Federal
funds sold
|
(4
|
)
|
(50
|
)
|
(54
|
)
|
(5
|
)
|
25
|
20
|
|||||||||
|
Other
interest earning assets
|
(227
|
)
|
400
|
173
|
142
|
16
|
158
|
||||||||||||
|
Total
interest income
|
2,047
|
9,258
|
11,305
|
6,226
|
2,925
|
9,151
|
|||||||||||||
|
INTEREST
EXPENSE:
|
|||||||||||||||||||
|
Interest-bearing
demand deposits
|
(177
|
)
|
1,686
|
1,509
|
232
|
1,964
|
2,196
|
||||||||||||
|
Savings
deposits
|
(108
|
)
|
328
|
220
|
(18
|
)
|
23
|
5
|
|||||||||||
|
Time
deposits less than $100
|
(1,273
|
)
|
3,689
|
2,416
|
1,248
|
(175
|
)
|
1,073
|
|||||||||||
|
Time
deposits $100 or more
|
3,785
|
315
|
4,100
|
1,623
|
2,098
|
3,721
|
|||||||||||||
|
Short-term
borrowings
|
282
|
1,398
|
1,680
|
488
|
1,108
|
1,596
|
|||||||||||||
|
Long-term
borrowings
|
(329
|
)
|
326
|
(3
|
)
|
(2,151
|
)
|
(1,044
|
)
|
(3,195
|
)
|
||||||||
|
Total
interest expense
|
2,180
|
7,742
|
9,922
|
1,422
|
3,974
|
5,396
|
|||||||||||||
|
Net
interest income
|
$
|
(133
|
)
|
$
|
1,516
|
$
|
1,383
|
$
|
4,804
|
$
|
(1,049
|
)
|
$
|
3,755
|
|||||
|
(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 in 2006 increased by $.1 million over 2005, due
primarily to an increase in the level of non-accrual loans and changes in the
qualitative factors used in the quarterly evaluation of the adequacy of the
allowance for loan losses. These changes were offset by a decrease in net
charge-offs as a percentage of average loans to .11% in 2006 from .15% in 2005
and minimal loan growth in 2006.
The
provision for loan losses decreased to $1.1 million in 2005, compared to $2.5
million in 2004. This decrease was due primarily to the decrease in net
charge-offs as a percentage of average loans to .15% in 2005 from .20% in 2004
and a decrease in specific allocations as compared to 2004.
[24]
Other
Operating Income
The
following table shows the major components of other operating income for the
past three years (in thousands) and the percentage changes during these
years:
|
2006
VS. 2005
|
2005
VS. 2004
|
|||||||||||||||
|
2006
|
2005
|
2004
|
%
CHANGE
|
%
CHANGE
|
||||||||||||
|
Service
charges on deposit accounts
|
$
|
4,630
|
$
|
4,260
|
$
|
3,824
|
8.7
|
%
|
11.4
|
%
|
||||||
|
Other
service charge income
|
1,637
|
1,203
|
925
|
36.1
|
%
|
30.1
|
%
|
|||||||||
|
Trust
department income
|
3,671
|
3,260
|
3,153
|
12.6
|
%
|
3.4
|
%
|
|||||||||
|
Brokerage
commission
|
501
|
613
|
720
|
(18.3
|
%)
|
(14.9
|
%)
|
|||||||||
|
Insurance
commissions
|
1,573
|
1,599
|
1,448
|
(1.6
|
%)
|
10.4
|
%
|
|||||||||
|
Security
gains (losses)
|
4
|
(125
|
)
|
703
|
*
|
*
|
||||||||||
|
Bank
owned life insurance (BOLI)
|
848
|
819
|
626
|
3.5
|
%
|
30.8
|
%
|
|||||||||
|
Gain
on prepayment of long term borrowings
|
--
|
868
|
--
|
|||||||||||||
|
Other
income
|
1,177
|
1,591
|
1,572
|
(26.0
|
%)
|
1.2
|
%
|
|||||||||
|
Total
other operating income
|
$
|
14,041
|
$
|
14,088
|
$
|
12,971
|
(.33
|
%)
|
8.6
|
%
|
||||||
*
not
meaningful
As
the
table above illustrates, other operating income decreased slightly in 2006
by
$.05 million when compared to 2005. This is compared to a $1.1 million (8.6%)
increase in 2005 from 2004.
Service
charges on deposit accounts and other service charge income increased in 2006
versus 2005 and in 2005 versus 2004. These increases are due primarily to
increased customer usage of an account overdraft product. Service charge related
income constitutes 45%, 39%, and 37% of other operating income in 2006, 2005,
and 2004, respectively.
Trust
department income is directly affected by the performance of the equity and
bond
markets, and by the amount of assets under management. Trust income has
increased steadily during the past three years as a result of successful
business development efforts in this area, resulting in increases in the average
market value of assets under management in the Trust Department. Average assets
under management were $502 million, $468 million and $395 million for years
2006, 2005 and 2004, respectively.
Brokerage
commissions have steadily declined over the past three years. Less emphasis
on
this type of business and slower annuity sales have contributed to this decline.
Insurance premium income also declined slightly in 2006 due to the closing
of
the Corporation’s reinsurance company, Oakfirst Life Insurance, Inc., in 2005
and lower contingency income. Contingency income is received from the insurance
carriers based upon claims histories and varies from year to year. First United
Insurance Group purchased a book of business in Morgantown, WV during the latter
half of 2006. Because premium payment schedules are more heavily weighted in
the
first six months of the year, management expects to realize the full benefit
of
this purchase in 2007.
Securities
gains (losses) are the most variable component of other operating income. During
2006, the Bank recorded a minimal gain in the securities portfolio compared
to
the recorded losses in the securities portfolio of $.1 million in 2005. Net
securities gains for 2004 of $.7 million resulted primarily from the sale of
investments held by the Bank’s Delaware subsidiary, First United Securities,
Inc. (“FUS”), in order to utilize certain net operating loss carry-forwards in
that subsidiary prior to its liquidation in May 2004.
[25]
Other
Operating Expense
Other
operating expense for 2006 increased $.8 million (2.4%) over 2005, compared
to a
decrease of $1.3 million (3.7%) over 2004. The following table
shows the major components of other operating expense for the past three years
(in thousands) and the percentage changes during these years:
|
2006
VS. 2005
|
2005
VS. 2004
|
|||||||||||||||
|
2006
|
2005
|
2004
|
%
CHANGE
|
%
CHANGE
|
||||||||||||
|
Salaries
and employee benefits
|
$
|
19,084
|
$
|
18,428
|
$
|
16,907
|
3.6
|
%
|
9.0
|
%
|
||||||
|
Other
expenses
|
9,900
|
9,676
|
10,360
|
2.3
|
%
|
(6.6
|
%)
|
|||||||||
|
Equipment
|
3,011
|
3,067
|
2,952
|
(1.8
|
%)
|
3.9
|
%
|
|||||||||
|
Expenses
related to prepayment of long-term borrowings
|
--
|
437
|
2,728
|
--
|
(84.0
|
%)
|
||||||||||
|
Occupancy
|
2,043
|
1,642
|
1,642
|
24.4
|
%
|
--
|
||||||||||
|
Data
processing
|
1,452
|
1,404
|
1,380
|
3.4
|
%
|
1.7
|
%
|
|||||||||
|
Total
other operating expense
|
$
|
35,490
|
$
|
34,654
|
$
|
35,969
|
2.4
|
%
|
(3.7
|
%)
|
||||||
Salaries
and employee benefits represent approximately 54% of total other operating
expenses in 2006, compared to 53% and 47% in 2005 and 2004, respectively.
Salaries and wages increased by $.7 million in 2006 over
2005,
and $1.5 million in 2005 over 2004. The increase in both periods is directly
related to increased staffing to support our growth objectives and routine
merit
pay increases. The higher increase in 2005 over 2004 was attributable to
increases in performance based incentives resulting from high loan and deposit
growth.
Other
expenses increased by $.2 million in 2006 when compared to 2005 due to increases
in marketing, insurance, and contribution expenses. We experienced cost savings
in 2006 associated with corporate restructurings that occurred during 2005.
Comparing 2005 to 2004, other expenses decreased by $.7 million due
to
reduced professional fees associated with various compliance costs in 2005,
such
as the Sarbanes-Oxley Act.
There
were no expenses related to prepayment of long-term borrowings in 2006. Expenses
related to early redemption of long-term borrowings consisted of $.4 million
and
$1.8 million in early payment penalties in 2005 and 2004, respectively, and
a
$.9 million write-off of unamortized issuance costs related to the early
redemption of subordinated debentures in 2004.
Occupancy
and equipment expenses increased by $.3 million from 2005 to 2006 and $.1
million from 2004 to 2005. These increases relate to the growth and expansion
of
the Bank’s retail network.
Applicable
Income Taxes
Income
tax expense amounted to $5.7 million in 2006, compared to $6.5 million in 2005
and $3.5 million in 2004. The resulting
effective tax rates were 31.3%, 35.0% and 31.5% for 2006, 2005 and 2004,
respectively. The decrease in the effective tax rate for 2006 reflects the
effects of management’s efforts during late 2005 and early 2006 to restructure
the composition of the investment portfolio to include more tax exempt municipal
securities. The increase in the effective tax rate in 2005 over 2004 was due
primarily to corporate restructurings in February 2004 and May
2004.
[26]
CONSOLIDATED
BALANCE SHEET REVIEW
Overview
Our
total
assets reached $1.35 billion at December 31, 2006, representing an increase
of
$40 million (3.0%) from year-end 2005.
The
2006
year-end
total interest-earning asset mix shows a consistent percentage of loans as
a
percentage of total assets over the past three years, as illustrated
below:
|
Year
End Percentage of Total Assets
|
|||
|
2006
|
2005
|
2004
|
|
|
Net
loans
|
71%
|
73%
|
73%
|
|
Investments
|
20%
|
18%
|
17%
|
The
year-end total liability mix shows greater reliance on deposits as a source
of
funding during the three year period and reduced reliance on borrowings, as
illustrated below:
|
Year
End Percentage of Total Liabilities
|
|||
|
2006
|
2005
|
2004
|
|
|
Total
deposits
|
78%
|
78%
|
74%
|
|
Total
borrowings
|
21%
|
21%
|
25%
|
Loan
Portfolio
Through
the Bank and the OakFirst Loan Centers, we are actively engaged in originating
loans to customers primarily in Garrett, Allegany, Washington, and Frederick
Counties in Maryland; Mineral, Hardy, Berkeley, Monongalia Counties in West
Virginia; and the surrounding regions of West Virginia and Pennsylvania. We
have
policies and procedures designed to mitigate credit risk and to maintain the
quality of our loan portfolio. These policies include underwriting standards
for
new credits as well as continuous monitoring and reporting policies for asset
quality and the adequacy of the allowance for loan losses. These policies,
coupled with ongoing training efforts, have provided effective checks and
balances for the risk associated with the lending process. Lending authority
is
based on the type of the loan, and the experience of the lending
officer.
Commercial
loans are collateralized primarily by real estate, and to a lesser extent,
by
equipment and vehicles. Unsecured commercial loans represent an insignificant
portion of total commercial loans. Residential mortgage loans are collateralized
by the related property. Any residential mortgage loan exceeding a
specified
internal
loan-to-value ratio requires private mortgage insurance. Installment loans
are
typically collateralized, with loan-to-value ratios which are established based
on the financial condition of the borrower. We will also make unsecured consumer
loans to qualified borrowers meeting our underwriting standards. Additional
information about our loans and underwriting policies can be found in Item
1 of
Part I of this annual report under the caption “Banking Products and Services”.
Table
3
sets forth the composition
of our
loan portfolio. Historically, our policy has been to make the majority of our
loan commitments in our market areas. We had no foreign loans in our portfolio
as of December 31 for all of the periods presented.
[27]
Summary
of Loan Portfolio
(Dollars
in thousands)
Table
3
|
Loans
Outstanding as of December 31
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
Commercial
|
$
|
408,361
|
$
|
404,681
|
$
|
373,893
|
$
|
307,523
|
$
|
242,470
|
||||||
|
Real
Estate - Mortgage
|
359,601
|
337,559
|
319,033
|
264,730
|
233,887
|
|||||||||||
|
Consumer
Installment
|
181,574
|
193,275
|
199,862
|
201,419
|
173,578
|
|||||||||||
|
Real
Estate - Construction
|
14,120
|
25,446
|
18,196
|
16,093
|
11,072
|
|||||||||||
|
Lease
Financing
|
--
|
--
|
466
|
2,260
|
4,819
|
|||||||||||
|
Total
Loans
|
$
|
963,656
|
$
|
960,961
|
$
|
911,450
|
$
|
792,025
|
$
|
665,826
|
||||||
During
2006, gross loans increased by $3 million, or .3% over 2005. This growth was
focused in our commercial ($4 million) and residential mortgage ($22 million)
loan portfolios, offset by a decline in installment ($12 million) and
residential - construction ($11 million) loan portfolios, and remains consistent
with management’s objectives over the past several years. Continued efforts were
made to increase the percentage of loans in the portfolio with adjustable
interest rates. At year-end 2006, adjustable interest rate loans maturing within
one to five years were 53% of total loans, compared to 59% at year-end
2005.
Commercial
loans increased 1% in 2006, following an 8% increase in 2005. Origination of
new
commercial loans remained high in 2006, similar to 2005, as our lenders
continued to identify new customer opportunities and expand existing customer
relationships in all of our market areas, while maintaining existing standards
of credit worthiness. However, during both 2005 and 2006, new loan volume was
offset by high levels of repayment, which stifled growth as compared to prior
years. Most new commercial loans were priced on a variable rate basis, resetting
monthly, which proved to be very popular with business borrowers. Commercial
loans secured by real estate were 82% of total commercial loans at the end
of
2006, compared to 80% in 2005 and 81% in 2004.
Residential
mortgage loans increased by $22 million, or 7%, in 2006 when compared to 2005.
This follows a 6% increase in 2005 over 2004. Growth in the mortgage loan
portfolio during 2006 was primarily in fixed rate mortgages due to the flat
interest rate yield curve. This loan product was utilized to satisfy the
requirements of the Community Reinvestment Act. Actual residential mortgage
growth in 2005 of $50 million over 2004 (16%) was offset by $31 million in
loan
sales during the fourth quarter of 2005. The loans selected for sale were
identified through an extensive analysis of the mortgage portfolio and included
primarily adjustable rate products that management believed presented limited
opportunities for improved yields in the next few years. Proceeds from the
loan
sale were invested in the Bank’s investment portfolio, primarily in higher
yielding tax-exempt municipal securities.
Fixed-interest
rate loans make up 59% of the total loan portfolio at the end of 2006, compared
to 33% of total loans at the end of 2005 and 67% at the end of 2004.
Consumer
installment loans in 2006 decreased by $11.7 million, or 6%, when compared
to
2005. This decrease reflects management’s continued shift toward more commercial
loans with less emphasis on the highly competitive consumer loan market.
Specifically, less focus was placed on generating new indirect
auto loans during 2006 and 2005. Indirect auto loans comprise the largest
percentage of installment loans, 85% at the end of 2006, and 84% and 78% at
the
end of 2005 and 2004, respectively. The remaining lease financing portfolio
was
repaid in 2005 and we discontinued this line of business.
[28]
The
following table
sets
forth remaining maturities, based upon contractual dates, for selected loan
categories as of December 31, 2006 (in thousands):
Maturities
of Loan Portfolio at December 31, 2006
Table
4
|
Maturing
Within
One
Year
|
After
One
But
Within
Five
Years
|
Maturing
After
Five
Years
|
Total
|
||||||||||
|
Commercial
|
$
|
229,467
|
$
|
161,633
|
$
|
17,261
|
$
|
408,361
|
|||||
|
Real
Estate - Mortgage
|
80,183
|
136,425
|
142,993
|
359,601
|
|||||||||
|
Installment
|
10,244
|
16,937
|
154,393
|
181,574
|
|||||||||
|
Real
Estate - Construction
|
--
|
14,120
|
--
|
14,120
|
|||||||||
|
Total
Loans
|
$
|
319,894
|
$
|
329,115
|
$
|
314,647
|
$
|
963,656
|
|||||
|
Classified
by Sensitivity to Change in Interest Rates
|
|||||||||||||
|
Fixed-Interest
Rate Loans
|
$
|
45,375
|
$
|
92,123
|
$
|
291,246
|
$
|
428,744
|
|||||
|
Adjustable-Interest
Rate Loans
|
274,519
|
236,992
|
23,401
|
534,912
|
|||||||||
|
Total
Loans
|
$
|
319,894
|
$
|
329,115
|
$
|
314,647
|
$
|
963,656
|
|||||
It
is our
policy to place a loan in non-accrual status, except for consumer loans,
whenever there is substantial doubt about the ability of a borrower to pay
principal or interest on the outstanding credit. Management considers such
factors as payment history, the nature of the collateral securing the loan,
and
the overall economic situation of the borrower when making a non-accrual
decision. Management closely monitors the status of all non-accrual loans.
A
non-accruing loan is restored to accrual status when principal and interest
payments have been brought current, it becomes well secured, or is in the
process of collection and the prospects of future contractual payments are
no
longer in doubt. Generally, consumer installment loans are not placed on
non-accrual status, but are charged off after they are 120 days contractually
past due. Table 5 sets forth the historical amounts of non-accrual, past-due
and
restructured loans (in thousands) for the past five years:
Risk
Elements of Loan Portfolio
Table
5
|
At
December 31
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
Non-Accrual
Loans
|
$
|
3,190
|
$
|
2,393
|
$
|
3,439
|
$
|
2,774
|
$
|
1,847
|
||||||
|
Accruing
Loans Past Due 90 Days or More
|
619
|
989
|
1,105
|
1,236
|
1,458
|
|||||||||||
|
Restructured
Loans
|
522
|
532
|
544
|
554
|
565
|
|||||||||||
Interest
income not recognized as a result of placing loans on a non-accrual status
was
$.2 million, $.05 million and $.4 million during 2006, 2005 and 2004,
respectively.
Allowance
for Loan Losses
An
allowance for loan losses is maintained to absorb losses from the loan
portfolio. The allowance for loan losses is based on management’s continuing
evaluation of the quality of the loan portfolio, assessment of current economic
conditions, diversification and size of the portfolio, adequacy of collateral,
past and anticipated loss experience, and the amount of non-performing
loans.
We
use
the methodology outlined in FDIC Statement of Policy on Allowance for Loan
and
Lease Losses. The starting point for this methodology is to segregate the loan
portfolio into two pools, non-homogeneous (i.e., commercial) and homogeneous
(i.e., consumer and residential mortgage) loans. Each loan pool is analyzed
with
general allowances and specific allocations being made as appropriate. For
general allowances, the previous eight quarters of loss activity are used in
the
estimation of losses in the current portfolio. These historical loss amounts
are
modified by the following qualitative factors: levels of and trends in
delinquency rates and non-accrual loans; trends in volumes and terms of loans;
effects of changes in lending policies; experience, ability, and depth of
management; national and local economic trends and conditions; and
concentrations of credit in the determination of the general allowance. The
qualitative factors are updated each quarter by information obtained from
internal, regulatory, and governmental sources. Specific allocations of the
allowance for loan losses are made for those loans on the “Watchlist” in which
the collateral value is less than the outstanding loan balance with the
allocation being the dollar difference between the two. The Watchlist represents
loans, identified and closely monitored by management, which possess certain
qualities or characteristics that may lead to collection and loss issues.
Allocations are not made for loans that are cash secured, for the Small Business
Administration and Farm Service Agency guaranteed portion of loans, or for
loans
that are sufficiently collateralized.
[29]
The
allowance for loan losses is based on estimates, and actual losses will vary
from current estimates. These estimates are reviewed quarterly, and as
adjustments, either positive or negative, become necessary, a corresponding
increase or decrease is made in the allowance for loan losses. The methodology
used to determine the adequacy of the allowance for loan losses is consistent
with prior years. An estimate for probable losses related to unfunded lending
commitments, such as letters of credit and binding but unfunded loan commitments
is also prepared. This estimate is computed in a manner similar to the
methodology described above, adjusted for the probability of actually funding
the commitment.
The
balance of the allowance for loan losses increased to $6.5 million at year-end
2006, from $6.4 million at year-end 2005. Several factors contributed to the
$.1
million increase in the balance of the allowance in 2006, including: a 33%
increase in the balance of non-accrual loans (from $2.4 million in 2005 to
$3.2
million in 2006); changes to the qualitative factors which are reveiewed
quarterly; offset by a decrease in impaired loans from $.2 million in 2005
to
$.1 million in 2006; and a decrease in the percentage of net charge-offs to
average outstanding loans from .15% to .11%, due to a decline in the amount
of
commercial and installment loan charge-offs during 2006. At December 31, 2006,
the balance of the allowance was equal to .68% of total loans, which was six
times the amount of net charge-offs for the year.
The
balance of the allowance for loan losses decreased to $6.4 million at year-end
2005, from $6.8 million at year-end 2004. Several factors contributed to the
$.4
million decrease in the balance of the allowance in 2005, including: a 29%
decrease in the balance of non-accrued loans (from $3.4 million in 2004 to
$2.4
million in 2005); a decrease in impaired loans from $.6 million in 2004 to
$.2
million in 2005; and a decrease in the percentage of net charge-offs to average
outstanding loans from .20% to .15%, due to a decline in the amount of
commercial and installment loan charge-offs during 2005. At December 31, 2005,
the balance of the allowance was equal to .67% of total loans, which was four
times the amount of net charge-offs for the year.
As
a
result of management’s evaluation of the loan portfolio using the factors and
methodology described above, the allowance for loan losses is considered
adequate as of December 31, 2006.
[30]
Table
6
presents the activity in the allowance for loan losses by major loan
category
for the past five years.
Analysis
of Activity in the Allowance for Loan Losses
(Dollars
in thousands)
Table
6
|
For
the Years Ended December 31
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
Balance
at Beginning of Period
|
$
|
6,416
|
$
|
6,814
|
$
|
5,974
|
$
|
6,068
|
$
|
5,752
|
||||||
|
Loans
Charged Off:
|
||||||||||||||||
|
Commercial
|
359
|
557
|
808
|
17
|
197
|
|||||||||||
|
Real Estate - Mortgage
|
89
|
162
|
153
|
147
|
97
|
|||||||||||
|
Installment
|
1,127
|
1,171
|
1,244
|
1,556
|
1,535
|
|||||||||||
|
|
|
|
|
|
||||||||||||
|
Total
Charged Off
|
1,575
|
1,890
|
2,205
|
1,720
|
1,829
|
|||||||||||
|
Recoveries
of Loans:
|
||||||||||||||||
|
Commercial
|
110
|
8
|
22
|
50
|
229
|
|||||||||||
|
Real Estate - Mortgage
|
11
|
59
|
67
|
17
|
9
|
|||||||||||
|
Installment
|
403
|
347
|
422
|
425
|
401
|
|||||||||||
|
|
|
|
|
|
||||||||||||
|
Total Recoveries
|
524
|
414
|
511
|
492
|
639
|
|||||||||||
|
|
|
|
|
|
||||||||||||
|
Net
Loans Charged Off
|
1,051
|
1,476
|
1,694
|
1,228
|
1,190
|
|||||||||||
|
Provision
for Loan Losses
|
1,165
|
1,078
|
2,534
|
833
|
1,506
|
|||||||||||
|
Huntington
Branch Acquisition
|
||||||||||||||||
|
Loan Loss Reserve
|
--
|
--
|
--
|
301
|
--
|
|||||||||||
|
Balance
at the End of Period
|
$
|
6,530
|
$
|
6,416
|
$
|
6,814
|
$
|
5,974
|
$
|
6,068
|
||||||
|
Loans
at End of Period
|
$
|
963,656
|
$
|
960,961
|
$
|
911,450
|
$
|
792,025
|
$
|
665,826
|
||||||
|
Daily Average Balance of Loans
|
$
|
957,709
|
$
|
954,784
|
$
|
861,255
|
$
|
727,532
|
$
|
620,049
|
||||||
|
Allowance for Loan Losses to Loans Outstanding
|
.68
|
%
|
.67
|
%
|
.75
|
%
|
.75
|
%
|
.91
|
%
|
||||||
|
Net Charge Offs to Average Loans Outstanding
|
.11
|
%
|
.15
|
%
|
.20
|
%
|
.17
|
%
|
.19
|
%
|
||||||
Table
7
presents management’s allocation of the allowance for loan losses by major loan
category in comparison to that loan category’s percentage of total loans.
Changes in the allocation over time reflect changes in the composition of the
loan portfolio risk profile and refinements to the methodology of determining
the allowance. Specific allocations in any particular category may be
reallocated in the future as needed to reflect current conditions. Accordingly,
the entire allowance is considered available to absorb losses in any
category.
[31]
Allocation
of the Allowance for Loan Losses
(In
thousands at December 31)
Table
7
|
2006
|
%
of Total Loans
|
2005
|
%
of Total Loans
|
2004
|
%
of Total Loans
|
2003
|
%
of Total Loans
|
2002
|
%
of Total Loans
|
||||||||||||||||||||||
|
Commercial
|
$
|
2,983
|
42
|
%
|
$
|
2,777
|
42
|
%
|
$
|
3,050
|
41
|
%
|
$
|
2,166
|
39
|
%
|
$
|
2,149
|
36
|
%
|
|||||||||||
|
Real
Estate-Mortgage
|
1,512
|
39
|
%
|
1,504
|
38
|
%
|
1,454
|
37
|
%
|
1,247
|
35
|
%
|
1,032
|
37
|
%
|
||||||||||||||||
|
Consumer
Installment
|
1,934
|
19
|
%
|
2,060
|
20
|
%
|
2,246
|
22
|
%
|
2,462
|
26
|
%
|
2,675
|
26
|
%
|
||||||||||||||||
|
Lease
Financing
|
--
|
--
|
--
|
--
|
15
|
--
|
52
|
--
|
105
|
1
|
%
|
||||||||||||||||||||
|
Commitments
|
101
|
--
|
75
|
--
|
49
|
--
|
47
|
--
|
33
|
--
|
|||||||||||||||||||||
|
Unallocated
|
--
|
--
|
--
|
--
|
--
|
--
|
74
|
--
|
|||||||||||||||||||||||
|
Total
|
$
|
6,530
|
100
|
%
|
$
|
6,416
|
100
|
%
|
$
|
6,814
|
100
|
%
|
$
|
5,974
|
100
|
%
|
$
|
6,068
|
100
|
%
|
|||||||||||
Investment
Securities
Our
entire security portfolio is categorized as available-for-sale. Investment
securities classified as available-for-sale are held
for
an indefinite period of time and may be sold in response to changing market
and
interest rate conditions or for liquidity purposes as part of our overall
asset/liability management strategy. Available-for-sale securities are reported
at market value, with unrealized gains and losses excluded from earnings and
reported as a separate component of other comprehensive income included in
shareholders’ equity, net of applicable income taxes. We do not currently
purchase securities with the intent to resell and, therefore, do not own any
securities classified as trading securities. For additional information, see
Notes 1 and 3 of the Notes to Consolidated Financial Statements, which are
included in Item 8 of Part II of this annual report.
The
following sets forth the composition of our securities portfolio by major
category as of the indicated dates (in thousands):
|
December
31
(fair
value)
|
|||||||||||||||||||
|
2006
|
As
% of Total
|
2005
|
As
% of Total
|
2004
|
As
% of Total
|
||||||||||||||
|
Securities
Available-for-Sale:
|
|||||||||||||||||||
|
U.S.
government and agencies
|
$
|
97,490
|
37
|
%
|
$
|
107,019
|
47
|
%
|
$
|
102,294
|
48
|
%
|
|||||||
|
Mortgage-backed
securities
|
50,829
|
19
|
%
|
63,938
|
28
|
%
|
74,386
|
35
|
%
|
||||||||||
|
Obligation
of states and political subdivisions
|
68,432
|
26
|
%
|
57,661
|
25
|
%
|
22,461
|
11
|
%
|
||||||||||
|
Corporate
and other debt
|
46,521
|
18
|
%
|
1,077
|
--
|
11,520
|
6
|
%
|
|||||||||||
|
Other
securities
|
--
|
--
|
400
|
--
|
--
|
--
|
|||||||||||||
|
Total
|
$
|
263,272
|
100
|
%
|
$
|
230,095
|
100
|
%
|
$
|
210,661
|
100
|
%
|
|||||||
Total
investment securities increased $33 million (14%) in 2006 when compared to
the
year-end balance in 2005. This increase is attributable to an investment
leverage strategy utilized during 2006. The Bank purchased $45 million of
investment grade corporate bonds with a quarterly adjustable rate and funded
with three month brokered certificates of deposit. U.S. Government agencies
decreased $10 million and tax exempt municipal bonds increased by $11 million
while mortgage-backed securities declined by $13 million due to maturities
and
repayments.
Total
investment securities increased $19 million (9%) in 2005 compared to the
year-end balance in 2004. This increase was attributable to investment of the
proceeds from the mortgage loan sale that occurred during the fourth quarter
of
2005. U.S. Government agencies increased $5 million and tax exempt municipal
bonds increased by $35 million while mortgage-backed securities declined by
$10
million due to maturities and repayments. The significant increase in municipal
bonds is part of management’s strategy to generate additional tax-exempt
income.
At
December 31, 2006, the securities available for sale balance included a net
unrealized loss of $1.2 million, which represents the difference between fair
value and amortized cost. The comparable amount at December 31, 2005 was a
net
unrealized loss of $3.2 million.
[32]
The
fair
value of securities available for sale decreases whenever interest rates
increase and vice versa. The impact on bond prices of rising interest rates
at
the end of 2005 and throughout 2006 is reflected in the unrealized net loss
position of the investment portfolio at year-end 2006. Further increases in
interest rates after December 31, 2006, if sustained, will adversely impact
the
fair value of securities available for sale in 2007 in comparison to the 2006
year-end balance. Net unrealized gains/losses on available-for-sale securities
are included in accumulated comprehensive income, net of tax, which is a
component of shareholders’ equity.
We
manage
our investment portfolios utilizing policies which seek to achieve desired
levels of liquidity, manage interest rate sensitivity, meet earnings objectives,
and provide required collateral support for deposit activities and cash
management overnight investment products. Excluding the U.S. Government
sponsored agencies, we had no concentration of investment securities from any
single issue that exceeded 10% of shareholders’ equity.
Table
8
sets forth the contractual or estimated maturities of the components of our
securities portfolio as of December 31, 2006 and the weighted average yields
on
a tax-equivalent basis.
Investment
Security Maturities, Yields, and Fair Values at December 31,
2006
(Dollars
in thousands)
Table
8
|
Within
1
Year
|
1
Year
Thru
5
Years
|
5
Years
Thru
10 Years
|
Over
10
Years
|
Total
Fair
Value
|
||||||||||||
|
Securities
Available-for-Sale:
|
||||||||||||||||
|
U.S.
government and agencies
|
$
|
31,551
|
$
|
39,563
|
$
|
16,424
|
$
|
9,952
|
$
|
97,490
|
||||||
|
Mortgage-backed
securities
|
272
|
45,421
|
5,136
|
--
|
50,829
|
|||||||||||
|
Obligations
of states and political subdivisions
|
2,909
|
5,439
|
2,830
|
57,254
|
68,432
|
|||||||||||
|
Corporate
and other debt
|
--
|
--
|
--
|
46,521
|
46,521
|
|||||||||||
|
Total
|
$
|
34,732
|
$
|
90,423
|
$
|
24,390
|
$
|
113,727
|
$
|
263,272
|
||||||
|
Percentage
of total
|
13.19
|
%
|
34.35
|
%
|
9.26
|
%
|
43.20
|
%
|
100.00
|
%
|
||||||
|
Weighted
average yield*
|
4.11
|
%
|
5.10
|
%
|
5.53
|
%
|
6.38
|
%
|
5.34
|
%
|
||||||
|
*
Refer to notes on Table 1
|
Deposits
Table
9
sets forth the average deposit balances by major category for 2006, 2005 and
2004:
Average
Deposit Balances
(Dollars
in thousands)
Table
9
|
2006
|
2005
|
2004
|
|||||||||||||||||
|
Average
Balance
|
Avg.
Yield
|
Average
Balance
|
Avg.
Yield
|
Average
Balance
|
Avg.
Yield
|
||||||||||||||
|
Non-interest-bearing
demand deposits
|
$
|
107,595
|
--
|
$
|
112,860
|
--
|
$
|
94,871
|
--
|
||||||||||
|
Interest-bearing
demand deposits
|
285,250
|
2.25
|
%
|
293,129
|
1.67
|
%
|
279,217
|
.97
|
%
|
||||||||||
|
Savings
deposits
|
47,779
|
.97
|
%
|
58,964
|
.41
|
%
|
63,471
|
.37
|
%
|
||||||||||
|
Time
deposits less than $100
|
229,829
|
3.67
|
%
|
264,503
|
2.28
|
%
|
209,708
|
2.36
|
%
|
||||||||||
|
Time
deposits $100 or more
|
273,305
|
4.41
|
%
|
187,412
|
4.24
|
%
|
149,113
|
2.83
|
%
|
||||||||||
|
Total
|
$
|
943,758
|
$
|
916,868
|
$
|
796,380
|
|||||||||||||
[33]
Total
deposits increased $15.5 million in 2006, or 2% when compared to 2005. This
compares to a $105 million (12%) increase during 2005. On an average balance
basis, total deposits increased $27 million (3%) in 2006 versus 2005, following
a $120 million (15%) increase in 2005.
The
increase in deposits resulted primarily from the Bank’s utilization of brokered
certificates of deposit to fund the purchase of corporate bonds combined with
the successful promotion of a 9-month certificate of deposit offered during
most
of 2006. These increases were offset by the decline in non-interest bearing
and
interest bearing demand deposits and savings accounts. The Bank also chose
to
allow high-priced, volatile customer deposits to decline in order to allocate
these resources to customers with full banking relationships.
The
increase in deposits in 2005 resulted primarily from the Bank’s successful
promotion of a 13-month certificate of deposit early in 2005, its purchase
of
brokered certificates of deposit, and the movement of $30 million in trust
money
market funds into the Bank during the second quarter of 2005. At December 31,
2006 and 2005, brokered certificates of deposit amounted to $178.0 million
and
$165.0 million, respectively, or 18% of total deposits at both
year-ends.
The
following table sets forth the maturities of time deposits of $100,000 or more
(in thousands):
Maturity
of Time Deposits of $100,000 or More
(Dollars
in thousands)
Table
10
|
|
December
31, 2006
|
|||
|
Maturities
|
||||
|
3
Months or Less
|
$
|
209,325
|
||
|
3-6
Months
|
87,536
|
|||
|
6-12
Months
|
96,148
|
|||
|
Over
1 Year
|
86,608
|
|||
|
Total
|
$
|
479,617
|
||
The
Bank
has opted to maintain relatively short maturities in its time deposits of
$100,000 or more in anticipation of stable or lower interest rates in the
future.
Borrowed
Funds
The
following shows the composition of the Corporation’s borrowings at December 31
(in thousands):
|
2006
|
2005
|
2004
|
||||||||
|
Securities
sold under agreements to repurchase
|
$
|
74,879
|
$
|
90,939
|
$
|
86,914
|
||||
|
Short-term
FHLB advances
|
24,500
|
31,000
|
23,319
|
|||||||
|
Total
short-term borrowings
|
99,379
|
121,939
|
110,233
|
|||||||
|
Long-term
FHLB advances
|
130,401
|
92,444
|
139,486
|
|||||||
|
Junior
subordinated debentures
|
35,929
|
35,929
|
35,929
|
|||||||
|
Total
long-term borrowings
|
166,330
|
128,373
|
175,415
|
|||||||
|
Total
borrowings
|
$
|
265,709
|
$
|
250,312
|
$
|
285,648
|
||||
|
Average
balance (from Table 1)
|
$
|
260,519
|
$
|
260,349
|
$
|
287,940
|
||||
[34]
Total
borrowings increased $15 million (6%) in 2006 compared to 2005. The average
balance of total borrowings increased slightly by $.2 million (.06%) in 2006
when compared to 2005, following a $28 million (10%) decrease in 2005 when
compared to 2004. Securities sold under agreements to repurchase declined by
$16
million during 2006. These borrowings consist of overnight sweep accounts for
our business customers and municipalities. Growth of $14 million in this area
was offset by the loss of $30 million from a local County government. During
2006, the Bank took advantage of replacing short-term money with more attractive
long-term advances offered by the Federal Home Loan Bank of Atlanta.
During
2005, higher-rate long term borrowings were repaid early and replaced with
lower
cost short-term borrowings. This strategy, in conjunction with continued
emphasis on increasing low cost in-house deposits, was one of the contributing
factors to the increase in net interest income and net interest margin in 2005.
Management
will continue to closely monitor interest rates within the context of its
overall asset-liability management process. See the “Interest Rate Sensitivity”
section of this Item 7 for further discussion on this topic.
At
December 31, 2006, we had additional borrowing capacity with the FHLB totaling
$18.0 million and an additional $25 million of unused lines of credit with
various financial institutions. See Note 8 to Consolidated Financial Statements,
included in Item 8 of Part II of this annual report, for further details about
our borrowings and additional borrowing capacity, which is incorporated herein
by reference.
Capital
Resources
The
Bank
and the Corporation are subject to risk-based capital regulations, which were
adopted and monitored by federal banking regulators. These guidelines are used
to evaluate capital adequacy and are based on an institution’s asset risk
profile and off-balance sheet exposures, such as unused loan commitments and
stand-by letters of credit. The regulatory guidelines require that a portion
of
total capital be Tier I capital, consisting of common shareholders’ equity,
qualifying portion of trust issued preferred securities, and perpetual preferred
stock, less goodwill and certain other deductions. The remaining capital, or
Tier II capital, consists of elements such as subordinated debt, mandatory
convertible debt, remaining portion of trust issued preferred securities, and
grandfathered senior debt, plus the allowance for loan losses, subject to
certain limitations.
Under
the
risk-based capital regulations, banking organizations are required to maintain
a
minimum 8% (10% for well capitalized banks) total risk-based capital ratio
(total qualifying capital divided by risk-weighted assets), including a Tier
I
ratio of 4% (6% for well capitalized banks). The risk-based capital rules have
been further supplemented by a leverage ratio, defined as Tier I capital divided
by average assets, after certain adjustments. The minimum leverage ratio is
3%
(5% for well capitalized banks) for banking organizations that do not anticipate
significant growth and have well-diversified risk (including no undue interest
rate risk exposure), excellent asset quality, high liquidity and good earnings.
Other banking organizations not in this category are expected to have ratios
of
at least 4-5%, depending on their particular condition and growth plans. Higher
capital ratios could be required if warranted by the particular circumstances
or
risk profile of a given banking organization. In the current regulatory
environment, banking organizations must stay well capitalized in order to
receive favorable regulatory treatment on acquisition and other expansion
activities and favorable risk-based deposit insurance assessments. The
Corporation’s capital policy establishes guidelines meeting these regulatory
requirements, and takes into consideration current or anticipated risks as
well
as potential future growth opportunities.
At
December 31, 2006, the Corporation’s total risk-based capital ratio was 12.95%,
which was well above the regulatory minimum of 8%. The Corporation’s total
risk-based capital ratio for year-end 2005 was 12.66%. As of December 31, 2006,
the most recent notification from the regulators categorizes the Corporation
as
well capitalized under the regulatory framework for prompt corrective action.
See Note 2 to Consolidated Financial Statements, included in Item 8 of Part
II
of this annual report, for additional information regarding regulatory capital
ratios.
Total
shareholders’ equity increased $4.9 million to $96.9 million at December 31,
2006, from $92.0 million at year-end 2005. The return on average equity (ROE)
for 2006 decreased to 13.07% from 13.61% for 2005. While net income increased
in
2006 compared to 2005, capital grew at a faster pace causing the decrease in
ROE.
Cash
dividends of $.76 per share were paid during 2006, compared with $.74 and $.72
paid in 2005 and 2004, respectively. This represents a dividend payout ratio
(cash dividends per share divided by net income per share) of 37.04%, 37.19%,
and 57.48% for 2006, 2005, and 2004, respectively.
[35]
Liquidity
The
Asset
and Liability Management Committee of the Corporation seeks to assess and manage
the risks associated with fluctuating interest rates while maintaining adequate
liquidity. This is accomplished by formulating and implementing policies that
take into account the sources and uses of funds, maturity and repricing
distributions of assets and liabilities, pricing strategies, and marketability
of assets.
The
objective of liquidity management is to maintain sufficient funds to satisfy
the
needs of depositors and borrowers. The principal sources of asset liquidity
are
cash and due from banks, interest-bearing deposits in banks, federal funds
and
investment securities available-for-sale that are not pledged. At December
31,
2006, such liquid assets totaled $117 million. While much more difficult to
quantify, liability liquidity is enhanced by a stable core deposit base, access
to credit lines at other financial institutions, and the Corporation’s ability
to renew maturing deposits. The Corporation’s ability to attract deposits and
borrow funds depends primarily on continued rate competitiveness, profitability,
capitalization and overall financial condition.
When
appropriate, we take advantage of external sources of funds, such as advances
from the FHLB, lines of credit at other financial institutions and brokered
funds. These external sources often provide attractive interest rates and
flexible maturity dates that better enable us to match funding dates and pricing
characteristics with contractual maturity dates and pricing parameters of
earning assets. At December 31, 2006, our available borrowing capacity through
the FHLB and other financial institutions was approximately $43
million.
We
actively manage our liquidity position under the direction of the Asset and
Liability Management Committee of the Corporation’s Board of Directors. Monthly
reviews by management and quarterly reviews by this Committee under prescribed
policies and procedures are intended to ensure that we will maintain adequate
levels of available funds. Management believes that we have adequate liquidity
available to respond to current and anticipated liquidity demands, which will
include completing the renovations to the facility acquired for its operations
center. Additionally, liquidity needs for future branch expansion will be
evaluated as such opportunities arise. Management anticipates opening additional
branches or expanding current facilities in its existing market footprint
annually or bi-annually for the next several years.
At
the
holding company level, the Corporation uses cash to pay dividends to
shareholders and to service its junior subordinated debt. The main sources
of
funding for the holding company include dividends from the Bank and access
to
the capital markets. As discussed in Note 12 of the Notes to Consolidated
Financial Statements, included in Item 8 of Part II of this annual report,
the
Bank is subject to significant regulation and, among other things, may be
limited in its ability to pay dividends or transfer funds to the holding
company. Accordingly, consolidated cash flows as presented in the Consolidated
Statements of Cash Flows may not represent cash immediately available to the
holding company. During 2006, the Bank declared and paid dividends of $6.3
million. As of December 31, 2006, the amount of additional dividends that the
Bank could have paid to the Corporation without regulatory approval was $13.1
million.
Interest
Rate 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.
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. Management has not historically used derivative financial
instruments to manage its interest rate sensitivity. At December 31, 2006,
the
static gap analysis prepared by management indicated that we become liability
sensitive over the next year. In computing the effect on net interest income
of
changes in interest rates, management has assumed that any changes would
immediately affect earnings. Normally, when an organization is liability
sensitive there is a negative impact to net interest income when interest rates
increase. Based on the simulation analysis performed at December 31, 2006 and
2005, management estimated the following changes in net interest income,
assuming the indicated rate changes:
[36]
|
(Dollars
in thousands)
|
|||||||
|
2006
|
2005
|
||||||
|
+200
basis point increase
|
$
|
(3,658
|
)
|
$
|
322
|
||
|
+100
basis point increase
|
$
|
(1,612
|
)
|
$
|
286
|
||
|
-100
basis point decrease
|
$
|
663
|
$
|
(1,228
|
)
|
||
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 Corporation’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.
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 interest rates, which are an important determination
of the Corporation’s earnings.
Contractual
Obligations, Commitments and Off-Balance Sheet
Arrangements
The
following table presents, as of December 31, 2006, significant fixed and
determinable contractual obligations to third parties by payment date and
amounts and expected maturities of significant commitments. Commitments to
extend credit and letters of credit are legally binding, conditional agreements
generally having fixed expiration or termination dates. These commitments
generally require customers to maintain certain credit standards and are
established based on management’s credit assessment of the customer. The
commitments may expire without being drawn upon. Therefore, the total commitment
does not necessarily represent future funding requirements. Further discussion
of the nature of certain obligations and commitments is included in the Notes
to
the Consolidated Financial Statements referenced in the table below, which
are
included in Item 8 of Part II of this annual report.
[37]
|
Payments
Due by Period
|
|||||||||||||||||||
|
Contractual
Obligations
(in
millions)
|
Note
Reference
|
Total
|
Less
than
1
Year
|
1-3
Years
|
3-5
Years
|
More
than
5
Years
|
|||||||||||||
|
Long
term debt
|
8
|
||||||||||||||||||
|
FHLB
Advances
|
$
|
130.4
|
$
|
19.8
|
$
|
26.5
|
$
|
82.00
|
$
|
2.10
|
|||||||||
|
Junior
subordinated debt
|
35.9
|
--
|
--
|
--
|
35.9
|
||||||||||||||
|
Operating
leases
|
5
|
1.9
|
.4
|
.8
|
.7
|
--
|
|||||||||||||
|
Data
processing and telecommunications services
|
5
|
3.3
|
1.4
|
1.9
|
--
|
--
|
|||||||||||||
|
Time
Deposits
|
7
|
533.2
|
453.7
|
66.2
|
12.6
|
.7
|
|||||||||||||
|
Pension/SERP
|
11
|
10,984.0
|
532.0
|
1,198.0
|
1,597.0
|
7,657.0
|
|||||||||||||
|
Commitment
Expiration by Period
|
|||||||||||||||||||
|
Commitments
(in
millions)
|
Note
Reference
|
Total
|
Less
than
1
Year
|
1-3
Years
|
3-5
Years
|
More
than
5
Years
|
|||||||||||||
|
Loan
commitments
|
4
|
$
|
119.8
|
$
|
9.0
|
$
|
19.1
|
$
|
3.4
|
$
|
88.3
|
||||||||
|
Letters
of credit
|
4
|
7.2
|
7.2
|
--
|
--
|
--
|
|||||||||||||
|
ITEM
7A.
|
QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
|
The
information
called
for by this item is incorporated herein by reference to Item 7 of Part II of
this annual report under the caption “Interest Rate Sensitivity”.
[38]
|
Item
8.
|
Financial
Statements and Supplementary
Data
|
Report
of Independent Registered Public Accounting Firm
The
Board
of Directors and Shareholders
First
United Corporation
Oakland,
Maryland
We
have
audited the accompanying consolidated statements of financial condition of
First
United Corporation and subsidiaries as of December 31, 2006, and the related
consolidated statements of income, changes in shareholders’ equity, and cash
flows for the year then ended. These consolidated financial statements are
the
responsibility of the First United Corporation’s management. Our responsibility
is to express an opinion on these consolidated financial statements based on
our
audit. The consolidated financial statements of First United Corporation for
the
years ended December 31, 2005 and 2004 were audited by other auditors,
whose report dated March 9, 2006, expressed an unqualified opinion on those
statements.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In
our
opinion, the 2006 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of First
United Corporation and its subsidiaries as of December 31, 2006, and the
consolidated results of their operations and their cash flows for the year
then
ended, in conformity with accounting principles generally accepted in the United
States of America.
As
discussed in Note 1 to the consolidated financial statements, the Corporation
changed its method of accounting for its defined benefit pension plans in
2006.
We
also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of First United Corporation’s
internal control over financial reporting as of December 31, 2006, based on
criteria established in Internal
Control—Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO),
and our report dated March 9, 2007, expressed an unqualified opinion on
management’s assessment of internal control over financial reporting and an
unqualified opinion on the effectiveness of internal control over financial
reporting.
/s/
Beard
Miller Company LLP
Beard
Miller Company LLP
Baltimore,
Maryland
March 9,
2007
[39]
Report
of Independent Registered Public Accounting Firm
The
Shareholders and Board of Directors
First
United Corporation
We
have
audited the accompanying consolidated balance sheet of First United Corporation
and subsidiaries (the Company) as of December 31, 2005, and the related
consolidated statements of income, changes in shareholders’ equity, and cash
flows for each of the two years in the period ended December 31, 2005. These
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based
on
our audits.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of First United
Corporation and subsidiaries at December 31, 2005, and the consolidated results
of their operations and their cash flows for each of the two years in the period
ended December 31, 2005, in conformity with U.S. generally accepted accounting
principles.
/s/
Ernst
& Young LLP
Pittsburgh,
Pennsylvania
March
9,
2006
[40]
First
United Corporation and Subsidiaries
Consolidated
Statements of Financial Condition
(In
thousands, except per share amounts)
|
December
31
|
|||||||
|
2006
|
2005
|
||||||
|
Assets
|
|||||||
|
Cash
and due from banks
|
$
|
23,325
|
$
|
24,610
|
|||
|
Interest-bearing
deposits in banks
|
2,463
|
5,001
|
|||||
|
Investment
securities available-for-sale (at fair value)
|
263,272
|
230,095
|
|||||
|
Federal
Home Loan Bank stock, at cost
|
9,620
|
8,050
|
|||||
|
Loans
|
963,656
|
960,961
|
|||||
|
Allowance
for loan losses
|
(6,530
|
)
|
(6,416
|
)
|
|||
|
Net
loans
|
957,126
|
954,545
|
|||||
|
Premises
and equipment, net
|
29,852
|
27,049
|
|||||
|
Goodwill
and other intangible assets, net
|
14,033
|
14,591
|
|||||
|
Bank
owned life insurance
|
27,926
|
24,239
|
|||||
|
Accrued
interest receivable and other assets
|
21,700
|
22,811
|
|||||
|
Total
Assets
|
$
|
1,349,317
|
$
|
1,310,991
|
|||
|
Liabilities
and Shareholders’ Equity
|
|||||||
|
Liabilities:
|
|||||||
|
Non-interest-bearing deposits
|
$
|
120,758
|
$
|
114,523
|
|||
|
Interest-bearing deposits
|
850,623
|
841,331
|
|||||
|
Total
deposits
|
971,381
|
955,854
|
|||||
|
Short-term borrowings
|
99,379
|
121,939
|
|||||
|
Long-term borrowings
|
166,330
|
128,373
|
|||||
|
Accrued interest payable and other liabilities
|
14,202
|
11,623
|
|||||
|
Dividends payable
|
1,169
|
1,163
|
|||||
|
Total
Liabilities
|
1,252,461
|
1,218,952
|
|||||
|
Shareholders’
Equity:
|
|||||||
|
Preferred stock-no par value;
authorized
and unissued 2,000 shares
|
|||||||
|
Capital stock-par value $.01 per share;
authorized
25,000 shares, issued and outstanding
6,141
in 2006 and 6,118 in 2005
|
61
|
61
|
|||||
|
Surplus
|
21,448
|
20,946
|
|||||
|
Retained earnings
|
80,927
|
73,012
|
|||||
|
Accumulated other comprehensive loss
|
(5,580
|
)
|
(1,980
|
)
|
|||
|
Total
Shareholders’ Equity
|
96,856
|
92,039
|
|||||
|
Total
Liabilities and Shareholders’ Equity
|
$
|
1,349,317
|
$
|
1,310,991
|
|||
|
See
notes to consolidated financial statements.
|
|||||||
[41]
First
United Corporation and Subsidiaries
Consolidated
Statements of Income
(In
thousands, except share and per share amounts)
|
Year
ended December 31
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Interest
income
|
||||||||||
|
Interest
and fees on loans
|
$
|
69,019
|
$
|
61,570
|
$
|
53,264
|
||||
|
Interest
on investment securities:
|
||||||||||
|
Taxable
|
7,699
|
6,231
|
5,819
|
|||||||
|
Exempt from federal income taxes
|
2,860
|
1,383
|
1,205
|
|||||||
|
10,559
|
7,614
|
7,024
|
||||||||
|
Other
|
690
|
517
|
359
|
|||||||
|
Interest
on federal funds sold
|
1
|
55
|
35
|
|||||||
|
Total
interest income
|
80,269
|
69,756
|
60,682
|
|||||||
|
Interest
expense
|
||||||||||
|
Interest
on deposits
|
27,349
|
19,104
|
12,108
|
|||||||
|
Interest
on short-term borrowings
|
4,429
|
2,749
|
1,153
|
|||||||
|
Interest
on long-term borrowings
|
7,557
|
7,560
|
10,755
|
|||||||
|
Total
interest expense
|
39,335
|
29,413
|
24,016
|
|||||||
|
Net
interest income
|
40,934
|
40,343
|
36,666
|
|||||||
|
Provision
for loan losses
|
1,165
|
1,078
|
2,534
|
|||||||
|
Net
interest income after provision for loan losses
|
39,769
|
39,265
|
34,132
|
|||||||
|
Other
operating income
|
||||||||||
|
Service
charges
|
6,267
|
5,463
|
4,749
|
|||||||
|
Trust
department
|
3,671
|
3,260
|
3,153
|
|||||||
|
Insurance
commissions
|
1,573
|
1,599
|
1,448
|
|||||||
|
Gain
related to prepayment of long term borrowings
|
0
|
868
|
0
|
|||||||
|
Net
securities gains (losses)
|
4
|
(125
|
)
|
703
|
||||||
|
Bank
owned life insurance
|
848
|
819
|
626
|
|||||||
|
Other
income
|
1,678
|
2,204
|
2,292
|
|||||||
|
Total
other operating income
|
14,041
|
14,088
|
12,971
|
|||||||
|
Other
operating expense
|
||||||||||
|
Salaries
and employee benefits
|
19,084
|
18,428
|
16,907
|
|||||||
|
Equipment
|
3,011
|
3,067
|
2,952
|
|||||||
|
Expenses
related to prepayment of long-term borrowings
|
0
|
437
|
2,728
|
|||||||
|
Occupancy
|
2,043
|
1,642
|
1,642
|
|||||||
|
Data
processing
|
1,452
|
1,404
|
1,380
|
|||||||
|
Other
expenses
|
9,900
|
9,676
|
10,360
|
|||||||
|
Total
other operating expenses
|
35,490
|
34,654
|
35,969
|
|||||||
|
Income
before income taxes
|
18,320
|
18,699
|
11,134
|
|||||||
|
Applicable
income taxes
|
5,743
|
6,548
|
3,507
|
|||||||
|
Net
Income
|
$
|
12,577
|
$
|
12,151
|
$
|
7,627
|
||||
|
Earnings
per share
|
$
|
2.05
|
$
|
1.99
|
$
|
1.25
|
||||
|
Weighted
average common shares outstanding
|
6,129,612
|
6,105,699
|
6,088,367
|
|||||||
|
See
notes to consolidated financial statements.
|
||||||||||
[42]
First
United Corporation and Subsidiaries
Consolidated
Statements of Changes in Shareholders’ Equity
(In
thousands, except per share amounts)
|
Capital
Stock
|
Surplus
|
Retained
Earnings
|
Accumulated
Other
Comprehensive
Income/(Loss)
|
Total
Shareholders’
Equity
|
||||||||||||
|
Balance
at January 1, 2004
|
$
|
61
|
$
|
20,324
|
$
|
62,201
|
$
|
1,605
|
$
|
84,191
|
||||||
|
Comprehensive
income:
|
||||||||||||||||
|
Net income for the year
|
7,627
|
7,627
|
||||||||||||||
|
Unrealized
loss on securities available-for
sale,
net of income tax benefit of $629
|
(1,168
|
)
|
(1,168
|
)
|
||||||||||||
|
Comprehensive
income
|
437
|
6,459
|
||||||||||||||
|
Issuance
of 7,000 shares of common
stock
under dividend reinvestment plan
|
129
|
129
|
||||||||||||||
|
Cash
dividends-$.725 per share
|
|
|
(4,423
|
)
|
|
(4,423
|
)
|
|||||||||
|
Balance
at December 31, 2004
|
61
|
20,453
|
65,405
|
437
|
86,356
|
|||||||||||
|
Comprehensive
income:
|
||||||||||||||||
|
Net income for the year
|
12,151
|
12,151
|
||||||||||||||
|
Unrealized loss on securities available-for
sale, net of income tax benefit of $1,301
|
(2,417
|
)
|
(2,417
|
)
|
||||||||||||
|
Comprehensive income
|
(1,980
|
)
|
9,734
|
|||||||||||||
|
Issuance
of 24,758 shares of common
stock
under dividend reinvestment plan
|
493
|
493
|
||||||||||||||
|
Cash
dividends-$.745 per share
|
|
|
(4,544
|
)
|
|
(4,544
|
)
|
|||||||||
|
Balance
at December 31, 2005
|
61
|
20,946
|
73,012
|
(1,980
|
)
|
92,039
|
||||||||||
|
Comprehensive
income:
|
||||||||||||||||
|
Net income for the year
|
12,577
|
12,577
|
||||||||||||||
|
Unrealized gain on securities available-for
sale, net of income taxes of $682
|
1,265
|
1,265
|
||||||||||||||
|
Comprehensive income
|
(715
|
)
|
13,842
|
|||||||||||||
|
Adjustment
to initially adopt SFAS No. 158
net of income taxes of $2,619
|
(4,865
|
)
|
(4,865
|
)
|
||||||||||||
|
Issuance
of 23,241 shares of common
stock
under dividend reinvestment plan
|
502
|
502
|
||||||||||||||
|
Cash
dividends-$.76 per share
|
|
|
(4,662
|
)
|
|
(4,662
|
)
|
|||||||||
|
Balance
at December 31, 2006
|
$
|
61
|
$
|
21,448
|
$
|
80,927
|
$
|
(5,580
|
)
|
$
|
96,856
|
|||||
|
See
notes to consolidated financial statements.
|
[43]
First
United Corporation and Subsidiaries
Consolidated
Statements of Cash Flows
(In
thousands)
|
Year
ended December 31
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Operating
activities
|
||||||||||
|
Net
Income
|
$
|
12,577
|
$
|
12,151
|
$
|
7,627
|
||||
|
Adjustments
to reconcile net income to net cash
provided by operating activities:
|
||||||||||
|
Provision
for loan losses
|
1,165
|
1,078
|
2,534
|
|||||||
|
Depreciation
and amortization
|
2,990
|
3,074
|
2,921
|
|||||||
|
Net
accretion and amortization of investment
security discounts and premiums
|
175
|
483
|
1,106
|
|||||||
|
(Gain)
loss on sale of investment securities
|
(4
|
)
|
125
|
(703
|
)
|
|||||
|
Increase
in accrued interest
receivable and other assets
|
(2,517
|
)
|
(1,838
|
)
|
(5,604
|
)
|
||||
|
(Decrease)
increase in accrued interest payable and
other liabilities
|
(443
|
)
|
1,513
|
920
|
||||||
|
Proceeds
from sale of mortgage loans
|
--
|
30,941
|
--
|
|||||||
|
Earnings
on bank owned life insurance
|
(848
|
)
|
(819
|
)
|
(625
|
)
|
||||
|
Net
cash provided by operating activities
|
13,095
|
46,708
|
8,176
|
|||||||
|
Investing
activities
|
||||||||||
|
Net
decrease (increase) in interest-bearing deposits
in banks
|
2,538
|
(3,146
|
)
|
(381
|
)
|
|||||
|
Proceeds
from maturities of investment securities
available-for-sale
|
56,196
|
87,035
|
127,250
|
|||||||
|
Proceeds
from sales of investment securities
available-for-sale
|
548
|
27,684
|
14,008
|
|||||||
|
Purchases
of investment securities
available-for-sale
|
(88,004
|
)
|
(139,118
|
)
|
(129,912
|
)
|
||||
|
Net
increase in loans
|
(2,726
|
)
|
(80,452
|
)
|
(121,118
|
)
|
||||
|
Net
(increase) decrease in FHLB stock
|
(1,570
|
)
|
1,475
|
(865
|
)
|
|||||
|
Purchase
of premises and equipment
|
(5,287
|
)
|
(5,542
|
)
|
(9,288
|
)
|
||||
|
Purchase
of additional bank owned life insurance
|
(2,839
|
)
|
--
|
(2,300
|
)
|
|||||
|
Net
cash used in investing activities
|
(41,144
|
)
|
(112,064
|
)
|
(122,606
|
)
|
||||
|
Financing
activities
|
||||||||||
|
Net
increase in deposits
|
15,527
|
105,193
|
100,500
|
|||||||
|
Net
(decrease) increase in short-term borrowings
|
(22,560
|
)
|
11,707
|
38,392
|
||||||
|
Proceeds
from long-term borrowings
|
55,000
|
--
|
35,929
|
|||||||
|
Payments
on long-term borrowings
|
(17,043
|
)
|
(47,042
|
)
|
(52,249
|
)
|
||||
|
Cash
dividends paid
|
(4,662
|
)
|
(4,544
|
)
|
(4,384
|
)
|
||||
|
Proceeds
from issuance of common stock
|
502
|
493
|
129
|
|||||||
|
Net
cash provided by financing activities
|
26,764
|
65,807
|
118,317
|
|||||||
|
(Decrease)
increase in cash and
cash equivalents
|
(1,285
|
)
|
451
|
3,887
|
||||||
|
Cash
and cash equivalents at beginning of year
|
24,610
|
24,159
|
20,272
|
|||||||
|
Cash
and cash equivalents at end of year
|
$
|
23,325
|
$
|
24,610
|
$
|
24,159
|
||||
|
Supplemental
information
|
||||||||||
|
Interest
paid
|
$
|
38,363
|
$
|
28,557
|
$
|
23,605
|
||||
|
Income
taxes paid
|
7,860
|
6,750
|
6,262
|
|||||||
|
See
notes to consolidated financial statements
|
[44]
First
United Corporation and Subsidiaries
Notes
to Consolidated Financial Statements
1. Summary
of Significant Accounting Policies
Business
First
United Corporation (“Corporation”) is a registered financial holding company
that was incorporated under the laws of Maryland. It is the parent company
of
First United Bank & Trust (“Bank”), First United Insurance Group, LLC,
(“Insurance Group”) a full-service insurance agency, OakFirst Loan Center, Inc.
and OakFirst Loan Center, LLC, both consumer finance companies. The Bank
provides a complete range of retail and commercial banking services to a
customer base serviced by a network of 25 offices and 34 automated teller
machines. This customer base includes individuals, businesses and various
governmental units. The Insurance Group is a full-services insurance agency.
The
Corporation and its subsidiaries principally operate in four Western Maryland
counties and four West Virginia counties.
Basis
of Presentation
The
accompanying consolidated financial statements have been prepared in accordance
with United States generally accepted accounting principles that require
management to make estimates and assumptions that affect the reported amounts
of
certain assets and liabilities at the date of the financial statements as well
as the reported amount of revenues and expenses during the reporting period.
Actual results could differ from these estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses and the valuation of deferred
tax
assets. For purposes of comparability, certain prior period amounts have been
reclassified to conform with the 2006 presentation.
The
Corporation determines whether it should consolidate other entities or account
for them on the equity
method
of accounting depending on whether it has a controlling financial interest
in an
entity of less than 100% of the voting interest of that entity by considering
the provisions of Accounting Research Bulletin 51 (ARB 51), “Consolidated
Financial Statements”, or a controlling financial interest in a variable
interest entity (“VIE”) by considering the provisions of FASB Interpretation No.
46R (“FIN 46R”), “Consolidation of Variable Interest Entities”. Under FIN 46, a
VIE is a corporation, partnership, trust or any other legal structure used
for
business purposes that either (a) does not have equity investors with voting
rights or (b) has equity investors that does not provide sufficient financial
resources for the entity to support its activities. Under FIN 46R, an entity
that holds a variable interest in a VIE is required to consolidate the VIE
if
the entity is subject to a majority of the risk of loss from the VIE’s
activities, is entitled to receive a majority of the entity’s residual returns
or both. ARB 51 is considered for entities in which the total equity investment
at risk is sufficient to enable the entity to finance itself independently
and
provides the equity holders with the obligation to absorb losses, the right
to
receive residual returns and the right to make financial and operating
decisions.
As
discussed further in Note 8, the Corporation formed statutory trusts for the
purpose of issuing securities which qualify as regulatory
capital.
These trusts are considered VIEs and are not consolidated, based on the criteria
established in FIN 46. The Corporation’s investment in non-consolidated VIEs is
accounted for using the equity method of accounting.
Principles
of Consolidation
The
consolidated financial
statements of the Corporation include the accounts of the Bank, the Insurance
Group, OakFirst Loan Center, Inc., and OakFirst Loan Center, LLC. All
significant inter-company accounts and transactions have been
eliminated.
Significant
Concentrations of Credit Risk
Most
of
the Corporation’s activities are with customers located in Western Maryland and
Northeastern West Virginia. Note 3 discusses the types of securities in which
the Corporation invests and Note 4 discusses the types of lending in which
the
Corporation engages. The Corporation does not have any significant
concentrations in any one industry or customer.
[45]
Investments
Securities
available-for-sale:
All
securities purchased have been classified as available-for-sale, and as such
are
stated at fair value, with the unrealized gains and losses, net of tax, reported
as a separate component of accumulated other comprehensive
income
(loss) in shareholders’ equity.
The
amortized cost of debt securities classified as available-for-sale is adjusted
for amortization of premiums to the first call date, if applicable, or
to
maturity, and for accretion of discounts to maturity, or in the case of
mortgage-backed securities, over the estimated life of the security. Such
amortization and accretion is included in interest income from investments.
Interest and dividends are included in interest income from investments.
Management systematically evaluates the securities for impairment on a quarterly
basis. Declines in the fair value of available for sale securities below their
cost that are considered other than temporary declines are recognized in
earnings as realized losses in the period in which the impairment determination
is made. In estimating other-than-temporary impairment losses, management
considers (1) the length of time and the extent to which the fair value has
been
less than cost, (2) the financial condition and near-term prospects of the
issuer, and (3) the intent and ability of the Corporation to retain its
investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. Gains and losses on the sale of securities
are recorded using the specific identification method.
Loans
Loans
and
leases that management
has the
intent and ability to hold for the foreseeable future or until maturity or
full
repayment by the borrower
are
reported at their outstanding unpaid principal balance.
Interest
and Fees on Loans
Interest
on loans and leases (other than those on non-accrual status) is recognized
based
upon the principal amount outstanding. Loan fees in excess of the costs incurred
to originate the loan are recognized as income over the life of the loan
utilizing either the interest method or the straight-line method, depending
on
the type of loan. Generally, fees on loans with a specified maturity date,
such
as residential mortgages, are recognized using the interest method. Loan fees
for lines of credit are recognized on the straight-line method.
A
loan is
considered to be past due when a payment has not been received for 30 days
after
its contractual due date. It is the Corporation’s general policy to discontinue
the accrual
of
interest on loans (including impaired loans), except for consumer loans, when
circumstances indicate that collection of principal or interest is doubtful.
After a loan is placed on non-accrual status, interest is not recognized and
cash payments received are applied to the principal balances. A non-accruing
loan is restored to accrual status when principal and interest payments have
been brought current, it becomes well secured, or is in the process of
collection and the prospects of future contractual payments are no longer in
doubt.
Generally,
consumer installment loans are not placed on non-accrual status, but are charged
off after they are 120 days contractually past due. Loans other than consumer
loans are charged-off based on an evaluation of the facts and circumstances
of
each individual loan.
Allowance
for Loan Losses
The
allowance for loan losses is maintained at a level believed by management to
be
sufficient to absorb estimated losses inherent in the loan portfolio. Loans
deemed uncollectible are charged against the allowance, while recoveries are
credited
to it.
Management’s determination of the adequacy of the loan loss reserve is based
upon the impact of economic conditions on the borrower’s ability to repay, past
collection experience, the risk characteristics of the loan portfolio, estimated
fair value of underlying collateral for collateral dependent loans, and such
other factors which, in management’s judgment, deserve current
recognition.
The
Corporation utilizes the methodology outlined in the FDIC Statement of Policy
on
Allowance for Loan and Lease Losses. The starting
point
for this methodology is to segregate the loan portfolio into two pools,
non-homogeneous (i.e. commercial) and homogeneous (i.e. mortgage, consumer)
loans. Each loan pool is analyzed with general allowances and specific
allocations being made as appropriate. For general allowances, the previous
eight quarters of loss activity are used in the estimation of losses in the
current portfolio. These historical loss amounts are modified by the following
qualitative factors: levels of and trends in delinquency and non-accruals;
trends in volumes and terms of loans; effects of changes in lending policies,
experience, ability, and depth of management, national and local economic trends
and conditions; and concentrations of credit in the determination of the general
allowance. The qualitative factors are updated each quarter by the gathering
of
information from internal, regulatory, and governmental sources. Specific
allocations are made for those loans on the Watchlist in which the collateral
value is less than the outstanding loan balance with the allocation being the
dollar difference between the two. The Watchlist represents loans, identified
and closely monitored by management, which possess certain qualities or
characteristics that may lead to collection and loss issues. Allocations are
not
made for loans that are cash secured, for the Small Business Administration
or
Farm Service Agency guaranteed portion of loans, or for loans that are
sufficiently collateralized.
[46]
A
loan is
considered impaired when, based on current information and events, it is
probable that the Corporation will be unable to collect the scheduled payments
of principal or interest when due according to the contractual terms of the
loan
agreement. Factors considered by management in determining impairment include
payment status, collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower’s prior payment record, and the amount of
the shortfall in relation to the principal and interest owed. Impairment is
measured on a loan by loan basis for commercial and construction loans. Large
groups of smaller balance homogeneous loans are collectively evaluated for
impairment. Accordingly, the Corporation does not separately identify individual
consumer and residential loans for impairment disclosures, unless such loans
are
the subject of a restructuring agreement.
Premises
and Equipment
Land
is
carried at cost. Premises and equipment are carried at cost, less accumulated
depreciation. The provision for depreciation for financial reporting has been
made by using
the
straight-line method based on the estimated useful lives of the assets, which
range from 18 to 32 years for buildings and three to 20 years for equipment.
Accelerated depreciation methods are used for income tax purposes.
Goodwill
and Other Intangible Assets
Goodwill
represents the excess of the cost of an acquisition over the fair value of
the
net assets acquired in business combinations. In accordance
with
SFAS No. 142, and SFAS No. 147, which applies specifically to branch purchases
that qualify as business combinations, goodwill is not amortized but is subject
to an annual impairment test.
Core
deposit intangible assets represent
the
present value of future net income to be earned from acquired deposits and
are
being amortized using the straight-line method over their estimated life of
7.2
years.
Bank-Owned
Life Insurance (BOLI)
BOLI
policies are recorded at their cash surrender
values.
Changes in the cash surrender values are recorded as other operating
income.
Income
Taxes
The
Corporation accounts for income taxes using the liability method. Under the
liability method, the deferred tax liability or asset is determined based on
the
difference between the financial statement and tax bases of assets and
liabilities (temporary differences)
and is
measured at the enacted tax rates that will be in effect when these differences
reverse. Deferred tax expense is determined by the change in the net liability
or asset for deferred taxes adjusted for changes in any deferred tax asset
valuation allowance.
Statement
of Cash Flows
Cash
and
cash equivalents are defined as cash and due from banks in the consolidated
statement of cash flows.
Earnings
Per Share
Earnings
per share is computed by dividing net income by the weighted average number
of
common shares outstanding. The Corporation does not have
any
common stock equivalents.
[47]
Trust
Assets and Income
Assets
held in an agency or fiduciary capacity are not assets of the Corporation and,
accordingly, are not included in the accompanying consolidated statements of
financial condition. Income from the Bank’s Trust department represents fees
charged to
customers and is recorded on an accrual basis.
Business
Segments
As
defined by SFAS No. 131, “Disclosure about Segments of an Enterprise and Related
Information,” the Corporation has two operating segments, community banking and
insurance. Because the operating activities of the insurance segment are
immaterial to the consolidated
financial statements, no separate segment disclosures for insurance operations
have been made.
Variable
Interest Entities
In
2003,
the FASB issued Interpretations No. 46 (FIN 46 and FIN 46 R), “Consolidation of
Variable Interest Entities”, which clarified the application of Accounting
Research Bulletin No. 51, “Consolidated Financial Statements” to certain VIEs,
commonly referred to as special-purpose entities (SPEs), in which equity
investors do no have the characteristics
of a
controlling financial interest or do not have sufficient equity at risk for
the
entity to finance its activities without additional subordinated financial
support from other parties.
In
1999,
the Corporation issued approximately $23.7 million in mandatorily redeemable
junior subordinated debentures to First United Capital Trust, a Delaware
business trust (“Capital Trust”), the common stock of which was owned by the
Corporation. Capital
Trust
concurrently issued approximately $23.0 million in mandatorily redeemable
preferred securities to third-party investors. The Corporation’s investment in
Capital Trust was considered a SPE. In accordance with the requirements of
FIN
46 and FIN 46R, the Corporation reported $23.7 million of junior subordinated
debentures as long-term borrowings and its $0.7 million equity interest in
the
Capital Trust as an “Other Asset” at December 31, 2003. On September 30, 2004,
the Corporation exercised its option to redeem the $23.7 million of junior
subordinated debentures and, at the same time, Capital Trust redeemed the
related preferred securities. Capital Trust was thereafter
dissolved.
In
March
2004, the Corporation issued approximately $30.9 million of junior subordinated
debentures to First United Statutory Trust I (“FUST I”) and First United
Statutory Trust II (collectively with FUST I, the “Trusts”). The Trusts are
Connecticut statutory business
trusts,
with all outstanding common stock owned by the Corporation, that issued
mandatorily redeemable preferred capital securities to third party investors.
The Trusts are considered SPEs. In accordance with FIN 46R, the Corporation
reported the $30.9 million of junior subordinated debentures as long-term
borrowings and its $0.9 million equity interest in the Trusts as “Other Assets”
at December 31, 2006, 2005 and 2004.
These
debentures and preferred securities are discussed in detail in Note
8.
Recent
Accounting Pronouncements
In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities-Including an amendment of FASB
Statement No. 115.” SFAS No. 159 permits entities to choose to measure many
financial instruments and certain other items at fair value. Unrealized gains
and losses on items for which the fair value option has been elected will be
recognized in earnings at each subsequent reporting date. SFAS
No.
159 is effective for the Corporation January 1, 2008. Management is evaluating
the impact that the adoption of SFAS No. 159 will have on our consolidated
financial statements.
In
September 2006, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 158, “Employers Accounting for
Defined Benefit Pension and other Post Retirement Plans.” Effective December 31,
2006, the Corporation adopted the provisions of this statement which resulted
in
the recognition of the funded status of its defined benefits pension plan as
an
asset, and its supplemental executive retirement plan as a liability on the
Consolidated Statements of Financial Condition, and the recognition of
unrecognized net actuarial losses, prior service costs and a net transition
asset totaling $4.9 million as a separate component of accumulated other
comprehensive loss, net of tax. Additional disclosures have also been added
as
required by SFAS No. 158. Refer to Note 11 for these disclosures and further
discussion of the Corporation’s pension plan obligations.
[48]
In
September 2006, the FASB issued Statement of Financial Accounting Standards
No.
157, “Fair Value Measurements” (“SFAS No. 157”). SFAS No. 157 was issued to
define fair value, establish a framework for measuring fair value in accordance
with generally accepted accounting principles (GAAP), and expand fair value
disclosure requirements. Prior to issuance of SFAS No. 157, different
definitions of fair value existed within GAAP and there was limited guidance
available on applying existing fair value definitions. SFAS No. 157 does not
require any new fair value measurements. SFAS No. 157 is effective for fiscal
years beginning after November 15, 2007, and interim periods within those fiscal
years. Management does not expect the adoption of SFAS No. 157 to have a
material impact on the Corporation’s consolidated financial statements.
In
June
2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in
Income Taxes” (“FIN No. 48”) to clarify the accounting for uncertainty in income
taxes recognized in an enterprise’s financial statements in accordance with
Statement of Financial Accounting Standards No. 109, “Accounting for Income
Taxes.” FIN No. 48 prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return, and provides guidance on derecognition,
classification, interest and penalties, interim period accounting, and
disclosures. FIN No. 48 requires companies to determine whether it is
more
likely than not
that a
tax position will be sustained upon examination (including appeals and
litigation) based upon its technical merits. If a tax position meets the more
likely than not recognition threshold, it is measured to determine the benefit
amount to recognize in the financial statements. The tax position is measured
at
the largest amount of benefit that is greater than fifty percent likely of
being
realized upon ultimate settlement. FIN No. 48 is effective for fiscal years
beginning after December 15, 2006, with earlier application encouraged.
Management does not anticipate that the adoption of FIN No. 48 will have a
material impact on the Corporation’s consolidated financial statements.
In
June
2006, the Emerging Issues Task Force (EITF) released Issue No. 06-4, “Accounting
for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar Life Insurance Arrangements” (“EITF 06-4”). This EITF consensus
opinion was ratified by the FASB on September 20, 2006. EITF 06-4 requires
employers who have entered into a split-dollar life insurance arrangement with
an employee that extends to post-retirement periods, to recognize a liability
and related compensation costs in accordance with SFAS No. 106, “Accounting for
Post Retirement Benefit Obligations” or Accounting Principles Board Opinion No.
12, “Omnibus Opinion.” The effective date of EITF No. 06-4 is for fiscal years
beginning after December 15, 2006, and the opinion may be adopted through either
a cumulative effect adjustment to retained earnings at the beginning of the
year
of adoption, or through retrospective application to prior periods. Management
has not yet completed all of the analysis required to determine the impact
of
this new accounting standard on the Corporation’s consolidated financial
statements.
In
March
2006, the FASB issued Statement of Financial Accounting Standards No. 156,
“Accounting for Servicing of Financial Assets” (“SFAS No. 156”). SFAS No. 156
amends Statement of Financial Accounting Standards No. 140, “Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,”
with respect to the accounting for separately recognized servicing assets and
servicing liabilities. SFAS No. 156 requires an entity to recognize a servicing
asset or servicing liability each time it undertakes an obligation to service
a
financial asset by entering into a servicing contract in each of several
specific situations. SFAS No. 156 also requires all separately recognized
servicing assets and servicing liabilities to be initially measured at fair
value, if practicable, and permits an entity to choose either of two accepted
measurement methods for each class of separately recognized servicing assets
and
servicing liabilities. Further, SFAS No. 156 permits, at its initial adoption,
a
one-time reclassification of available-for-sale securities to trading securities
by entities with recognized servicing rights. Lastly, the Statement requires
separate presentation of servicing assets and servicing liabilities subsequently
measured at fair value and additional disclosures for all separately recognized
servicing assets and servicing liabilities. SFAS No. 156 is effective for fiscal
years beginning after September 15, 2006. Management does not expect the
adoption of SFAS No. 156 to have a material impact on the Corporation’s
consolidated financial statements.
2. Regulatory
Capital Requirements
The
Corporation and the Bank are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the Corporation
and
the Bank must meet specific capital guidelines that involve quantitative
measures of its assets, liabilities, and certain off-balance sheet items as
calculated under regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgments by the regulators
about
components, risk weightings, and other factors.
[49]
Quantitative
measures established by regulation to ensure capital adequacy require the
Corporation and the Bank to maintain certain minimum
amounts
of capital and ratios of total and Tier I capital to risk-weighted assets,
and
of Tier I capital to average assets (leverage). Management believes, as of
December 31, 2006, that the Corporation and the Bank meet all capital adequacy
requirements to which it is subject.
As
of
December 31, 2006, the most recent notification from the regulators categorized
the Bank as well capitalized
under
the regulatory framework for prompt corrective action. To be categorized as
well
capitalized, total risk-based, Tier I risk-based, and Tier I leverage ratios
must not fall below the percentages shown in the following table. Management
is
not aware of any condition or event which has caused the well capitalized
position to change.
|
Actual
|
For
Capital
Adequacy
Purposes
|
To
Be Well
Capitalized
Under
Prompt
Corrective
Action
Provisions
|
|||||||||||||||||
|
(Dollars
in thousands)
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
|||||||||||||
|
December
31, 2006
|
|||||||||||||||||||
|
Total
Capital (to Risk Weighted Assets)
|
|||||||||||||||||||
|
Consolidated
|
$
|
130,863
|
12.95
|
%
|
$
|
80,737
|
8.00
|
%
|
N/A
|
N/A
|
|||||||||
|
First
United Bank
|
113,770
|
11.40
|
%
|
79,827
|
8.00
|
%
|
99,785
|
10.00
|
%
|
||||||||||
|
Tier
1 Capital (to Risk Weighted Assets)
|
|||||||||||||||||||
|
Consolidated
|
119,332
|
11.81
|
%
|
40,368
|
4.00
|
%
|
N/A
|
N/A
|
|||||||||||
|
First
United Bank
|
107,503
|
10.77
|
%
|
39,914
|
4.00
|
%
|
59,871
|
6.00
|
%
|
||||||||||
|
Tier
1 Capital (to Average Assets)
|
|||||||||||||||||||
|
Consolidated
|
119,332
|
9.08
|
%
|
52,563
|
4.00
|
%
|
N/A
|
N/A
|
|||||||||||
|
First
United Bank
|
107,503
|
8.25
|
%
|
52,116
|
4.00
|
%
|
65,145
|
5.00
|
%
|
||||||||||
|
Actual
|
For
Capital
Adequacy
Purposes
|
To
Be Well
Capitalized
Under
Prompt
Corrective
Action
Provisions
|
|||||||||||||||||
|
(Dollars
in thousands)
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
|||||||||||||
|
December
31, 2005
|
|||||||||||||||||||
|
Total
Capital (to Risk Weighted Assets)
|
|||||||||||||||||||
|
Consolidated
|
$
|
121,773
|
12.66
|
%
|
$
|
76,958
|
8.00
|
%
|
N/A
|
N/A
|
|||||||||
|
First
United Bank
|
105,029
|
11.04
|
%
|
76,116
|
8.00
|
%
|
95,148
|
10.00
|
%
|
||||||||||
|
Tier
1 Capital (to Risk Weighted Assets)
|
|||||||||||||||||||
|
Consolidated
|
110,357
|
11.45
|
%
|
38,479
|
4.00
|
%
|
N/A
|
N/A
|
|||||||||||
|
First
United Bank
|
98,820
|
10.39
|
%
|
38,059
|
4.00
|
%
|
57,089
|
6.00
|
%
|
||||||||||
|
Tier
1 Capital (to Average Assets)
|
|||||||||||||||||||
|
Consolidated
|
110,357
|
8.64
|
%
|
51,120
|
4.00
|
%
|
N/A
|
N/A
|
|||||||||||
|
First
United Bank
|
98,820
|
7.80
|
%
|
50,694
|
4.00
|
%
|
63,368
|
5.00
|
%
|
||||||||||
[50]
3. Investment
Securities
The
following table shows a comparison of amortized cost and fair values of
securities available-for-sale (in thousands):
|
Amortized
Cost
|
Gross
Unrealized
Gains
|
Gross
Unrealized
Losses
|
Fair
Value
|
||||||||||
|
December
31, 2006
|
|||||||||||||
|
U.S.
government and agencies
|
$
|
98,007
|
$
|
125
|
$
|
642
|
$
|
97,490
|
|||||
|
Mortgage-backed
securities
|
51,955
|
26
|
1,152
|
50,829
|
|||||||||
|
Obligations
of states and political subdivisions
|
67,892
|
705
|
165
|
68,432
|
|||||||||
|
Corporate
and other debt securities
|
46,602
|
103
|
184
|
46,521
|
|||||||||
|
Totals
|
$
|
264,456
|
$
|
959
|
$
|
2,143
|
$
|
263,272
|
|||||
|
December
31, 2005
|
|||||||||||||
|
U.S.
government and agencies
|
$
|
108,301
|
$
|
6
|
$
|
1,288
|
$
|
107,019
|
|||||
|
Mortgage-backed
securities
|
65,647
|
33
|
1,742
|
63,938
|
|||||||||
|
Obligations
of states and political subdivisions
|
58,041
|
784
|
1,164
|
57,661
|
|||||||||
|
Corporate
and other debt securities
|
1,381
|
96
|
--
|
1,477
|
|||||||||
|
Totals
|
$
|
233,370
|
$
|
919
|
$
|
4,194
|
$
|
230,095
|
|||||
Proceeds
from sales and calls of securities available-for-sale and the realized gains
and
losses are as follows (in thousands):
|
2006
|
2005
|
2004
|
||||||||
|
Proceeds
|
$
|
548
|
$
|
27,684
|
$
|
14,008
|
||||
|
Realized
gains
|
4
|
93
|
712
|
|||||||
|
Realized
losses
|
--
|
(218
|
)
|
(9
|
)
|
|||||
[51]
The
following table shows the Corporation’s securities available-for-sale with gross
unrealized losses and fair value, aggregated by investment category and length
of time that individual securities have been in a continuous unrealized
position, at December 31, 2006 and 2005 (in thousands):
|
December
31, 2006
|
|||||||||||||
|
Less
than 12 months
|
12
months or more
|
||||||||||||
|
Fair
Value
|
Unrealized
Losses
|
Fair
Value
|
Unrealized
Losses
|
||||||||||
|
U.S.
government agencies
|
$
|
25,878
|
$
|
(127
|
)
|
$
|
56,609
|
$
|
(515
|
)
|
|||
|
Mortgage-backed
securities
|
3,212
|
(7
|
)
|
45,470
|
(1,145
|
)
|
|||||||
|
Obligations
of states and political subdivisions
|
9,844
|
(35
|
)
|
15,234
|
(130
|
)
|
|||||||
|
Corporate
securities
|
33,680
|
(184
|
)
|
--
|
--
|
||||||||
|
$
|
72,614
|
$
|
(353
|
)
|
$
|
117,313
|
$
|
(1,790
|
)
|
||||
|
December
31, 2005
|
|||||||||||||
|
Less
than 12 months
|
12
months or more
|
||||||||||||
|
Fair
Value
|
Unrealized
Losses
|
Fair
Value
|
Unrealized
Losses
|
||||||||||
|
U.S.
government agencies
|
$
|
61,312
|
$
|
(718
|
)
|
$
|
42,005
|
$
|
(570
|
)
|
|||
|
Mortgage-backed
securities
|
42,321
|
(1,163
|
)
|
17,812
|
(579
|
)
|
|||||||
|
Obligations
of states and political subdivisions
|
36,596
|
(1,164
|
)
|
--
|
--
|
||||||||
|
$
|
140,229
|
$
|
(3,045
|
)
|
$
|
59,817
|
$
|
(1,149
|
)
|
||||
The
Corporation does not believe any individual unrealized loss as of December
31,
2006 represents an other-than-temporary impairment. The unrealized losses on
our
investment securities are primarily attributable to changes in interest rates.
The $1.1 million in unrealized losses reported for mortgage-backed securities
at
December 31, 2006 relates primarily to securities issued by the Federal National
Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation, and
the
Government National Mortgage Association (GNMA). All of our investments in
states and other political subdivisions are of the highest investment grade
as
determined by the major rating agencies. The $.2 million in unrealized losses
reported for corporate and other debt at December 31, 2006 relates to Preferred
Term Securities (PreTSLs). The Corporation has both the intent and ability
to
hold the securities in its investment portfolio for the period of time necessary
to recover its amortized cost.
The
amortized cost and estimated fair value of securities available-for-sale by
contractual maturity at December 31, 2006 are shown in the following table.
Actual maturities will differ from contractual maturities because the issuers
of
the securities may have the right to call or prepay obligations with or without
call or prepayment penalties.
|
(in
thousands)
|
|||||||
|
Contractual
Maturity
|
Amortized
Cost
|
Fair
Value
|
|||||
|
Due
in one year or less
|
$
|
34,622
|
$
|
34,460
|
|||
|
Due
after one year through five years
|
45,037
|
45,002
|
|||||
|
Due
after five years through ten years
|
19,209
|
19,254
|
|||||
|
Due
after ten years
|
113,633
|
113,727
|
|||||
|
212,501
|
212,443
|
||||||
|
Mortgage-backed
securities
|
51,955
|
50,829
|
|||||
|
$
|
264,456
|
$
|
263,272
|
||||
[52]
At
December 31, 2006 and 2005, investment securities with a fair value of $146
million and $153 million, respectively, were pledged as permitted or required
to
secure public and trust deposits
and securities sold under agreements to repurchase as required or permitted
by
law.
4. Loans
The
Corporation, through the bank, is active in originating loans to customers
primarily in Western Maryland and Northeastern West Virginia. The following
table is
a
summary of the loan portfolio and loan commitments by principal categories
(in
thousands):
|
December
31, 2006
|
December
31, 2005
|
||||||||||||
|
Loans
|
Loan
Commitments
|
Loans
|
Loan
Commitments
|
||||||||||
|
Commercial
|
$
|
408,361
|
$
|
72,861
|
$
|
404,681
|
$
|
110,000
|
|||||
|
Real
Estate - Mortgage
|
359,601
|
40,557
|
337,559
|
39,350
|
|||||||||
|
Consumer
Installment
|
181,574
|
66
|
193,275
|
42
|
|||||||||
|
Real
Estate - Construction
|
14,120
|
6,312
|
25,446
|
11,701
|
|||||||||
|
Commercial
letters of credit
|
--
|
7,200
|
--
|
5,086
|
|||||||||
|
Total
|
$
|
963,656
|
$
|
126,996
|
$
|
960,961
|
$
|
166,179
|
|||||
Loan
commitments are made to accommodate the financial needs of the Corporation’s
customers. Letters of credit commit the Corporation to make payments on behalf
of customers when certain specified future events occur. Letters of credit
are
issued to customers to support contractual obligations and to insure job
performance. Commitments to extend credit generally have fixed expiration dates,
may require payment of a fee, and contain cancellation clauses in the event
of
an adverse change in the customer’s credit quality. Historically, most letters
of credit expire unfunded, and therefore, cash requirements are substantially
less than the total commitment. Loan commitments and letters of credit have
credit risk essentially the same as that
involved in extending loans to customers and are subject to normal credit
policies. Collateral is obtained based on management’s credit assessment of the
customer. The Corporation considers letters of credit to be guarantees and
the
amount of liability related to such guarantees was not significant at December
31, 2006 and 2005.
In
the
ordinary course of business, executive officers and directors of the
Corporation, including their families and companies in which certain directors
are principal owners, were loan customers of the Bank. Pursuant to the Bank’s
lending policies, such loans were made on the same terms, including collateral,
as those prevailing at the time for comparable transactions with unrelated
persons and do not involve more than the normal risk of collectibility. Changes
in the dollar amount of loans outstanding to officers, directors and their
associates were as follows for the years ended December 31 (in
thousands):
|
2006
|
||||
|
Balance
at January 1
|
$
|
17,685
|
||
|
Loans
or advances
|
13,169
|
|||
|
Repayments
|
(5,532
|
)
|
||
|
Balance
at December 31
|
$
|
25,322
|
||
Activity
in the allowance for loan losses is summarized as follows (in
thousands):
|
2006
|
2005
|
2004
|
||||||||
|
Balance
at January 1
|
$
|
6,416
|
$
|
6,814
|
$
|
5,974
|
||||
|
Gross
credit losses
|
(1,575
|
)
|
(1,890
|
)
|
(2,205
|
)
|
||||
|
Recoveries
|
524
|
414
|
511
|
|||||||
|
Net
credit losses
|
(1,051
|
)
|
(1,476
|
)
|
(1,694
|
)
|
||||
|
Provision
for loan losses
|
1,165
|
1,078
|
2,534
|
|||||||
|
Balance
at December 31
|
$
|
6,530
|
$
|
6,416
|
$
|
6,814
|
||||
[53]
Non-accruing
loans were $3.2 million, $2.4 million, and $3.4 million at December 31, 2006,
2005 and 2004, respectively. Interest income not recognized as a result of
placing loans on a non-accrual status was $.2 million, $.05 million and $.4
million during 2006, 2005 and 2004, respectively. Accruing loans past due 90
days or more were $.6 million, $.9 million and $1.1 million at the end of 2006,
2005 and 2004, respectively.
Total
impaired loans amounted to $.1 million and $.2 million at December 31, 2006
and
2005, respectively. Specific allocations of the allowance for loan losses for
impaired loans were equal to these same amounts.
In
December 2005, the Bank sold $31.1 million of its residential mortgage loans.
The loans were sold without recourse and the Bank will continue to service
these
loans. No gain or loss was recognized on the sale. Loan servicing rights of
$0.3
million were recorded as part of this transaction and are being amortized over
the weighted average remaining life of the loans sold.
5. Premises
and Equipment
The
composition of premises and equipment at December 31 is as follows (in
thousands):
|
2006
|
2005
|
||||||
|
Land
|
$
|
8,910
|
$
|
9,232
|
|||
|
Land
Improvements
|
190
|
135
|
|||||
|
Premises
|
20,700
|
16,987
|
|||||
|
Furniture
and Equipment
|
27,610
|
26,533
|
|||||
|
57,410
|
52,887
|
||||||
|
Less
accumulated depreciation
|
(27,558
|
)
|
(25,838
|
)
|
|||
|
Total
|
$
|
29,852
|
$
|
27,049
|
|||
The
Corporation recorded depreciation expense of $2.5 million in 2006 and 2005
and
$2.4 million in 2004.
Pursuant
to the terms of noncancelable operating lease agreements for banking and
subsidiaries’ offices and for data processing and telecommunications equipment
in
effect
at December 31, 2006, future minimum rent commitments under these leases for
each of the next five years are as follows: $1.8, $1.7, $1.0, $.4, and $.3
million. The leases contain options to extend for periods from 1 to 5 years,
not
included in the aforementioned amounts.
Total
rent expense amounted to $.6 million in 2006 and $.5 million in each of 2005
and
2004.
6. Goodwill
and Other Intangible Assets
Goodwill
resulted from the acquisition of four branch offices and a banking center from
The Huntington National Bank in July 2003 and an insurance agency in April
1999.
The Corporation performed its annual impairment test as of December 31, 2006
and
determined that goodwill was not impaired. There can be no assurance
that
goodwill impairment will not occur in the future. The Corporation will continue
to evaluate goodwill for impairment on an annual basis and as events occur
or
circumstances change.
The
significant components of goodwill and acquired intangible assets at December
31
are as follows (in thousands):
|
2006
|
2005
|
||||||||||||||||||||||||
|
Gross
Carrying Amount
|
Accumulated
Amortization
|
Net
Carrying Amount
|
Weighted
Average Remaining Life
|
Gross
Carrying Amount
|
Accumulated
Amortization
|
Net
Carrying Amount
|
Weighted
Average Remaining Life
|
||||||||||||||||||
|
Goodwill
|
$
|
11,900
|
$
|
--
|
$
|
11,900
|
$
|
11,900
|
$
|
--
|
$
|
11,900
|
|||||||||||||
|
Core
deposit intangible assets
|
4,040
|
(1,907
|
)
|
2,133
|
3.8
|
4,040
|
(1,349
|
)
|
2,691
|
4.8
|
|||||||||||||||
|
Total
|
$
|
15,940
|
$
|
(1,907
|
)
|
$
|
14,033
|
$
|
15,940
|
$
|
(1,349
|
)
|
$
|
14,591
|
|||||||||||
[54]
Amortization
expense relating to the core deposit intangible asset acquired in 2003 pursuant
to the Huntington National Bank branch acquisition was $.6 million in 2006,
2005
and 2004. Future estimated annual amortization expense is presented below (in
thousands):
|
2007
|
$
|
558
|
||
|
2008
|
558
|
|||
|
2009
|
558
|
|||
|
2010
|
459
|
|||
7. Deposits
The
aggregate amount of time deposits with a minimum denomination of $100,000 was
$479.6 and $264.8 million at December 31, 2006 and December 31, 2005,
respectively.
The
following is a summary of the scheduled maturities of all time deposits as
of
December 31, 2006 (in thousands):
|
2007
|
$
|
453,690
|
||
|
2008
|
49,085
|
|||
|
2009
|
17,478
|
|||
|
2010
|
9,655
|
|||
|
2011
|
2,620
|
|||
|
Thereafter
|
696
|
8. Borrowed
Funds
The
following is a summary of short-term borrowings at December 31 with original
maturities of less than one year (dollars in thousands):
|
2006
|
2005
|
2004
|
||||||||
|
Short-term
FHLB advance,
Daily borrowings, interest rate of 5.50% (at December 31,
2006)
|
$
|
4,500
|
$
|
31,000
|
$
|
--
|
||||
|
Short-term
FHLB advance,
Interest rate of 5.44% (at December 31, 2006) maturing in May 2007
|
20,000
|
--
|
23,319
|
|||||||
|
2006
|
2005
|
2004
|
||||||||
|
Securities
sold under agreements to repurchase:
|
||||||||||
|
Outstanding
at end of year
|
$
|
74,879
|
$
|
90,939
|
$
|
86,914
|
||||
|
Weighted average interest rate at year end
|
3.96
|
%
|
2.56
|
%
|
2.14
|
%
|
||||
|
Maximum amount outstanding as of
any
month end
|
84,380
|
93,632
|
91,209
|
|||||||
|
Average amount outstanding
|
78,032
|
85,846
|
78,352
|
|||||||
|
Approximate weighted average rate
during
the year
|
3.80
|
%
|
2.68
|
%
|
1.44
|
%
|
||||
[55]
The
following is a summary of long-term borrowings at December 31 with original
maturities exceeding one year (dollars in thousands):
|
2006
|
2005
|
||||||
|
FHLB
advances, bearing interest at rates ranging
from 3.15% to 5.40% at December 31
|
$
|
130,401
|
$
|
92,444
|
|||
|
Junior
subordinated debt, bearing interest at rates
ranging from 6.02% to 8.14% at December 31
|
35,929
|
35,929
|
|||||
|
$
|
166,330
|
$
|
128,373
|
||||
The
contractual maturities of long-term borrowings are as follows:
|
December
31
|
|||||||||||||
|
2006
|
2005
|
||||||||||||
|
Fixed
Rate
|
Floating
Rate
|
Total
|
Total
|
||||||||||
|
(in
thousands)
|
|||||||||||||
|
Due
in 2006
|
$
|
--
|
$
|
--
|
$
|
--
|
$
|
7,044
|
|||||
|
Due
in 2007
|
14,800
|
5,000
|
19,800
|
19,800
|
|||||||||
|
Due
in 2008
|
1,000
|
--
|
1,000
|
1,000
|
|||||||||
|
Due
in 2009
|
25,500
|
--
|
25,500
|
12,500
|
|||||||||
|
Due
in 2010
|
1,000
|
--
|
1,000
|
--
|
|||||||||
|
Due
in 2011
|
51,000
|
30,000
|
81,000
|
--
|
|||||||||
|
Thereafter
|
27,720
|
10,310
|
38,030
|
88,029
|
|||||||||
|
Total
long-term debt
|
$
|
121,020
|
$
|
45,310
|
$
|
166,330
|
$
|
128,373
|
|||||
In
addition to the above, the Corporation has $7.6 million of letters of credit
with the Federal Home Loan Bank of Atlanta (“FHLB”) at December 31, 2006. These
letters of credit are pledged to secure public deposits.
The
Corporation has a borrowing capacity agreement with the FHLB in an amount equal
to 29% of the Bank’s assets. At December 31, 2006, the available line of credit
equaled $388 million. This line of credit, which can be used for both short
or
long-term funding, can only be utilized to the extent of available collateral.
The line is secured by certain qualified mortgage and commercial loans and
investment securities, as follows:
|
1-4
family mortgage loans
|
$
|
140,019
|
||
|
Commercial
loans
|
7,513
|
|||
|
Multifamily
loans
|
2,865
|
|||
|
Investment
securities
|
30,050
|
|||
|
$
|
180,447
|
The
collateralized line of credit totaled $150 million at December 31, 2006, of
which $18 million was available for additional borrowings.
The
Corporation also has various unsecured lines of credit totaling $25.0 million
with various financial institutions to meet daily liquidity requirements. As
of
December 31, 2006, the Corporation had no borrowings under these credit
facilities.
Repurchase
Agreements--The
Corporation has retail repurchase agreements with customers within its local
market areas. Repurchase agreements generally have maturities of one to four
days from the transaction date. These borrowings are collateralized with
securities owned by the company and held in safekeeping at independent
correspondent banks.
[56]
FHLB
Advances--The
FHLB advances consist of various borrowings with maturities generally ranging
from 5 to 10 years with initial fixed rate periods
of one,
two or three years. After the initial fixed rate period the FHLB has one or
more
options to convert each advance to a LIBOR based, variable rate advance, but
the
Corporation may repay the advance in whole or in part, without a penalty, if
the
FHLB exercises its option. At all other times, the Corporation’s early repayment
of any advance could be subject to a prepayment penalty.
In
May
2006, the Bank exchanged $25 million of long-term FHLB advances, yielding 5.01%
for $25 million of long-term FHLB advances, yielding 4.69%. The exchange netted
a gain of $.2 million of which will be amortized over 5 years into interest
expense.
In
December 2005, the Bank prepaid
$25
million of long-term FHLB advances, resulting in a net early redemption gain
of
$.4 million. The prepayment was funded in part by a $15 million brokered
certificate
of deposit which matured in April of 2006. The remaining $10 million was funded
through daily borrowings. Funds for the repayment of the brokered CD and daily
borrowings were provided from scheduled maturities in the investment portfolio.
In December 2004, the Bank refinanced $21.5 million of long-term FHLB advances,
resulting in an early redemption penalty of $1.8 million (included in other
operating expense).
Subordinated
Debt--In
1999, Capital Trust issued 9.375% preferred securities with an aggregate
liquidation amount of $23.0 million ($1,000 per preferred
share) to third-party investors. The proceeds were used to purchase an equal
amount of 9.375% junior subordinated debentures of the Corporation. An
additional $.7 million of junior subordinated debentures was purchased by
Capital Trust from the proceeds of the sale of 100% of the Trust’s common
securities to the Corporation. The junior subordinated debentures represented
the sole assets of Capital Trust, and payments of the junior subordinated
debentures by the Corporation were the sole source of cash flow for Capital
Trust. The preferred securities qualified as regulatory Tier 1 capital of the
Corporation. On
September 30, 2004, the Corporation exercised its right to redeem the junior
subordinated debentures at the same time Capital Trust redeemed the preferred
securities. In conjunction with this early redemption, the Corporation expensed
$.9 million of remaining unamortized issuance costs (included in other operating
expenses) related to the junior subordinated debentures.
In
March
2004, the Trusts issued preferred securities with an aggregate liquidation
amount of $30.9 million to third-party investors. The proceeds of issuance
of the preferred securities were used to purchase an equal amount of junior
subordinated debentures of the Corporation, as follows:
$20.6
million--6.02%
fixed rate for five years payable quarterly, converting to floating rate based
on three-month LIBOR plus 275 basis points, maturing
in 2034, redeemable five years after issuance at the Corporation’s
option.
$10.3
million--floating
rate payable quarterly based on three-month LIBOR plus 275 basis points (8.14%
at December 31, 2006) maturing in 2034, redeemable
five years after issuance at the Corporation’s option.
The
debentures represent the sole assets of the Trusts, and payments of the
debentures by the Corporation are the only sources of cash flow for the
Trusts.
In
December 2004, the Corporation issued an additional $5.0 million of debentures.
The debentures have a fixed rate of 5.88% for the first five years, payable
quarterly, and then converts to a floating rate based on three month LIBOR
plus
185 basis points. The debentures mature in 2014, but are redeemable five years
after issuance at the Corporation’s option.
The
Corporation has the right to defer interest on all of the foregoing debentures
for up to 20 quarterly periods, in which case distributions on the preferred
securities will
also
be deferred. Should this occur, the Corporation may not pay dividends or
distributions on, or repurchase, redeem or acquire any shares of its common
stock.
[57]
9. Other
Comprehensive Income
A
summary
of the activity in accumulated other comprehensive income follows (in
thousands):
|
For
the Year Ending December 31
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Accumulated
unrealized (losses)/gains on securities available for
sale at January 1, net of tax
|
$
|
(1,980
|
)
|
$
|
437
|
$
|
1,605
|
|||
|
Net
unrealized gains/(losses) for the period, net of tax expense (benefit)
of
$683 in 2006, ($1,345) in 2005, and ($382) in 2004
|
1,268
|
(2,498
|
)
|
(710
|
)
|
|||||
|
Reclassification
of (gains)/losses occurring during the period, net of tax (expense)
benefit of $1 in 2006, ($44) in 2005, and $245 in 2004
|
(3
|
)
|
81
|
(458
|
)
|
|||||
|
Effect
on other comprehensive income for the period
|
1,265
|
(2,417
|
)
|
(1,168
|
)
|
|||||
|
Accumulated
unrealized gains/(losses) on securities available for sale at December
31,
net of tax
|
$
|
(715
|
)
|
$
|
(1,980
|
)
|
$
|
437
|
||
|
Accumulated
unrealized losses for pension obligation at January 1, net of
tax
|
$
|
0
|
$
|
0
|
$
|
0
|
||||
|
Prior
service costs, net of tax of $46
|
(85
|
)
|
0
|
0
|
||||||
|
Net
transition asset, net of tax benefit of $116
|
216
|
0
|
0
|
|||||||
|
Net
actuarial loss, net of tax of $1,632
|
(3,032
|
)
|
0
|
0
|
||||||
|
Cumulative
effect of change in accounting for pension obligation
|
(2,901
|
)
|
0
|
0
|
||||||
|
Accumulated
unrealized losses for SERP obligation at January 1, net of
tax
|
0
|
0
|
0
|
|||||||
|
Prior
service costs, net of tax of $252
|
(467
|
)
|
0
|
0
|
||||||
|
Net
actuarial loss, net of tax of $800
|
(1,497
|
)
|
0
|
0
|
||||||
|
Accumulated
unrealized losses for SERP obligation at December 31, net of
tax
|
$
|
(1,964
|
)
|
$
|
0
|
$
|
0
|
|||
|
TOTAL
ACCUMULATED OTHER COMPREHENSIVE
INCOME
(LOSS) AT DECEMBER 31, NET OF TAX
|
$
|
(5,580
|
)
|
$
|
(1,980
|
)
|
$
|
437
|
||
10. Income
Taxes
The
provision for income taxes consists of the following for the years ended
December 31 (in thousands):
|
2006
|
2005
|
2004
|
||||||||
|
Current
Tax Provision:
|
||||||||||
|
Federal
|
$
|
5,179
|
$
|
4,321
|
$
|
4,486
|
||||
|
State
|
1,094
|
978
|
838
|
|||||||
|
$
|
6,273
|
$
|
5,299
|
$
|
5,324
|
|||||
|
Deferred
taxes (benefit) :
|
||||||||||
|
Federal
|
$
|
(469
|
)
|
$
|
1,105
|
$
|
(1,798
|
)
|
||
|
State
|
(61
|
)
|
144
|
(19
|
)
|
|||||
|
$
|
(530
|
)
|
$
|
1,249
|
$
|
(1,817
|
)
|
|||
|
Income
tax expense for the year
|
$
|
5,743
|
$
|
6,548
|
$
|
3,507
|
||||
[58]
The
reconciliation between the statutory federal income tax rate and effective
income tax rate is as follows:
|
2006
|
2005
|
2004
|
||||||||
|
Federal
statutory rate
|
35.0
|
%
|
35.0
|
%
|
35.0
|
%
|
||||
|
Tax-exempt
income on securities and loans
|
(5.6
|
)
|
(2.7
|
)
|
(4.1
|
)
|
||||
|
Tax-exempt
BOLI income
|
(1.6
|
)
|
(1.5
|
)
|
(2.0
|
)
|
||||
|
State
income tax, net of federal tax benefit
|
3.5
|
3.9
|
4.4
|
|||||||
|
Other
|
--
|
.3
|
(1.8
|
)
|
||||||
|
31.3
|
%
|
35.0
|
%
|
31.5
|
%
|
|||||
Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes
and
the amounts used for income tax purposes. Significant components of the
Corporation’s temporary differences as of December 31 are as follows (in
thousands):
|
2006
|
2005
|
||||||
|
Deferred
tax assets:
|
|||||||
|
Allowance for loan losses
|
$
|
2,583
|
$
|
2,538
|
|||
|
Deferred loan fees
|
225
|
173
|
|||||
|
Deferred compensation
|
513
|
558
|
|||||
|
State tax loss carry forwards
|
722
|
658
|
|||||
|
Unrealized loss on investment securities
available-for-sale
|
468
|
1,295
|
|||||
|
Pension/SERP
|
608
|
--
|
|||||
|
Other
|
81
|
88
|
|||||
|
Total
deferred tax assets
|
5,200
|
5,310
|
|||||
|
Valuation allowance
|
(722
|
)
|
(658
|
)
|
|||
|
Total
deferred tax assets less valuation allowance
|
4,478
|
4,652
|
|||||
|
Deferred
tax liabilities:
|
|||||||
|
Amortization of goodwill and core deposit intangible
|
(524
|
)
|
(363
|
)
|
|||
|
Depreciation
|
(943
|
)
|
(1,176
|
)
|
|||
|
Pension
|
--
|
(2,459
|
)
|
||||
|
Other
|
(406
|
)
|
(371
|
)
|
|||
|
Total
deferred tax liabilities
|
(1,873
|
)
|
(4,369
|
)
|
|||
|
Net deferred tax assets
|
$
|
2,605
|
$
|
283
|
|||
State
income tax expense amounted to $1.0 million, $1.1 million and $.8 million during
2006, 2005 and 2004, respectively. The state tax loss carry forwards included
in
deferred tax assets will expire commencing in 2019.
11. Employee
Benefit Plans
The
Corporation sponsors a noncontributory defined benefit pension plan (Plan)
covering substantially all full-time employees who qualify as to age and length
of service. The benefits are based on years of service and the employees’
compensation during the last five years of employment. The Corporation’s funding
policy is to make annual contributions in amounts sufficient to meet the current
year’s minimum funding requirements.
During
2001, the Corporation established an unfunded supplemental executive retirement
plan (SERP) to provide senior management personnel with supplemental
retirement benefits in excess of limits imposed on qualified plans by federal
tax law. Concurrent with the establishment of the SERP, the Corporation acquired
bank owned life insurance (BOLI) policies on the senior management personnel
and
officers of the Corporation. The benefits resulting from the favorable tax
treatment accorded the earnings on the BOLI are intended to provide a source
of
funds for the future payment of the SERP benefits as well as other employee
benefit costs.
The
benefit obligation activity for both the pension plan and SERP was calculated
using an actuarial measurement date of January 1. Plan assets and the benefit
obligations were calculated using an actuarial measurement date of December
31.
The following table summarizes benefit obligation and funded status, plan asset
activity, components of net pension cost, and weighted average assumptions
for
the Corporation’s pension and SERP plans (in thousands):
[59]
|
Pension
|
SERP
|
||||||||||||
|
2006
|
2005
|
2006
|
2005
|
||||||||||
|
Change
in Benefit Obligation
|
|||||||||||||
|
Obligation
at the beginning of the year
|
$
|
18,423
|
$
|
16,718
|
$
|
3,662
|
$
|
2,442
|
|||||
|
Service
cost
|
809
|
799
|
138
|
90
|
|||||||||
|
Interest
cost
|
1,048
|
1,035
|
200
|
134
|
|||||||||
|
Change
in assumptions
|
(591
|
)
|
--
|
--
|
--
|
||||||||
|
Actuarial
losses
|
1
|
318
|
722
|
912
|
|||||||||
|
Benefits
paid
|
(509
|
)
|
(447
|
)
|
(26
|
)
|
(26
|
)
|
|||||
|
Plan
amendments
|
--
|
--
|
--
|
110
|
|||||||||
|
Obligation
at the end of the year
|
19,181
|
18,423
|
4,696
|
3,662
|
|||||||||
|
Change
in Plan Assets
|
|||||||||||||
|
Fair
value at the beginning of the year
|
19,276
|
14,434
|
--
|
--
|
|||||||||
|
Actual
return on plan assets
|
1,707
|
507
|
--
|
--
|
|||||||||
|
Employer
contribution
|
1,000
|
4,782
|
26
|
26
|
|||||||||
|
Benefits
paid
|
(509
|
)
|
(447
|
)
|
(26
|
)
|
(26
|
)
|
|||||
|
Fair
value at the end of the year
|
21,474
|
19,276
|
--
|
-
|
|||||||||
|
Funded
Status
|
$
|
2,293
|
$
|
853
|
$
|
4,696
|
$
|
3,662
|
|||||
|
Reconciliation
of funded status to the amounts reported in the statement of financial
condition:
|
|||||||||||||
|
2006
|
2005
|
2006
|
2005
|
||||||||||
|
Funded
Status
|
$
|
2,293
|
$
|
853
|
$
|
(4,696
|
)
|
$
|
(3,662
|
)
|
|||
|
Unrecognized
net actuarial loss
|
-
|
5,595
|
--
|
1,695
|
|||||||||
|
Unrecognized
prior service cost
|
-
|
142
|
--
|
832
|
|||||||||
|
Unrecognized
net transition asset
|
-
|
(371
|
)
|
--
|
--
|
||||||||
|
Amount
included in other assets, related to pension
plan
at year end
|
$
|
2,293
|
$
|
6,219
|
$
|
(4,696
|
)
|
$
|
(1,135
|
)
|
|||
|
Pension
|
SERP
|
||||||||||||||||||
|
2006
|
2005
|
2004
|
2006
|
2005
|
2004
|
||||||||||||||
|
Components
of Net Pension Cost
|
|||||||||||||||||||
|
Service
cost
|
$
|
809
|
$
|
799
|
$
|
718
|
$
|
138
|
$
|
90
|
$
|
179
|
|||||||
|
Interest
cost
|
1,048
|
1,035
|
938
|
200
|
134
|
100
|
|||||||||||||
|
Expected
return on assets
|
(1,586
|
)
|
(1,406
|
)
|
(1,183
|
)
|
--
|
--
|
--
|
||||||||||
|
Amortization
of transition asset
|
(39
|
)
|
(39
|
)
|
(39
|
)
|
--
|
--
|
--
|
||||||||||
|
Amortization
of recognized loss
|
220
|
189
|
151
|
121
|
53
|
--
|
|||||||||||||
|
Amortization
of prior service cost
|
10
|
10
|
10
|
113
|
103
|
103
|
|||||||||||||
|
Net
pension expense included in employee benefits
|
$
|
462
|
$
|
588
|
$
|
595
|
$
|
572
|
$
|
380
|
$
|
382
|
|||||||
|
Weighted
Average Assumptions used to
determine
benefit obligations:
|
|||||||||||||||||||
|
Discount
rate for benefit obligations
|
6.00
|
%
|
6.15
|
%
|
6.15
|
%
|
5.50
|
%
|
5.50
|
%
|
5.50
|
%
|
|||||||
|
Discount
rate for net pension cost
|
6.15
|
%
|
6.15
|
%
|
6.25
|
%
|
--
|
--
|
--
|
||||||||||
|
Expected
long-term return on assets
|
8.00
|
%
|
8.25
|
%
|
8.25
|
%
|
--
|
--
|
--
|
||||||||||
|
Rate
of compensation increase
|
3.00
|
%
|
4.00
|
%
|
4.00
|
%
|
4.00
|
%
|
4.00
|
%
|
4.00
|
%
|
|||||||
The
accumulated benefit obligation for the pension plan was $16.0 million and $14.1
million at December 31, 2006 and 2005, respectively. The accumulated benefit
obligation for the SERP was $3.7 million and $2.8 million at December 31, 2006
and 2005, respectively.
[60]
The
expected long-term rate of return on Plan assets for the pension plan was
determined by considering historical and future expected returns of the asset
classes invested in by the Plan trustees, and the allocation strategy currently
in place among those classes. The
asset
allocations for the defined benefit pension plan as of December 31, 2006 and
2005, by asset category, are as follows:
|
Percentage
of
Plan
Assets
|
|||||||
|
2006
|
2005
|
||||||
|
ASSET
CATEGORY
|
|||||||
|
Equity securities
|
63
|
%
|
62
|
%
|
|||
|
Debt securities
|
32
|
32
|
|||||
|
Cash and cash equivalents
|
5
|
6
|
|||||
|
Total
|
100
|
%
|
100
|
%
|
|||
The
investment objective for the defined benefit pension plan is to maximize total
return with tolerance for average risk. Asset allocation favors equities, with
a
target allocation of approximately 55% equities securities, 40% fixed income
securities, and 5% cash. Due to volatility in the market, the target allocation
is not always desirable and asset allocations will fluctuate between the
acceptable ranges. A core equity position of large cap stocks will be
maintained. However, more aggressive or volatile sectors will be meaningfully
represented in the asset mix in pursuit of higher returns. Higher volatility
investment strategies such as credit risk, structured finance, and international
bonds will be appropriate strategies in conjunction with the core
position.
It
is
management’s intent to give the investment managers flexibility with respect to
investment decisions and their timing within the overall guidelines. However,
certain investments require specific review and approval by management.
Management is also informed of anticipated changes in nonproprietary investment
managers, significant modifications of any previously approved investment,
or
the anticipated use of derivatives to execute investment
strategies.
The
following summarizes the number of Corporation shares and the fair value of
such
shares that are included in Plan assets at December 31, 2006 and 2005, as well
as dividends paid to the Plan for such years (dollars in
thousands):
|
2006
|
2005
|
||||||
|
Number
of shares held
|
3,000
|
3,839
|
|||||
|
Number
of shares purchased
|
0
|
33
|
|||||
|
Number
of shares sold
|
839
|
11,099
|
|||||
|
Fair
value
|
$
|
66
|
$
|
82
|
|||
|
Dividends
paid
|
$
|
2
|
$
|
6
|
|||
|
Percentage
of total plan assets
|
.31
|
%
|
.42
|
%
|
|||
Estimated
Cash Flows related to the Plan are as follows (in thousands):
Estimated
future benefit payments:
|
Pension
Plan
|
SERP
|
||||||
|
2007
|
$
|
456
|
$
|
76
|
|||
|
2008
|
476
|
70
|
|||||
|
2009
|
586
|
66
|
|||||
|
2010
|
654
|
66
|
|||||
|
2011
|
811
|
66
|
|||||
|
2012-2016
|
6,391
|
1,266
|
|||||
|
$
|
9,374
|
$
|
1,610
|
||||
The
Corporation estimates that it will contribute the minimum required contribution
of $1 million to the pension plan in 2007.
[61]
Amounts
included in accumulated other comprehensive loss as of December 31, 2006, net
of
tax, are as follows
(in
thousands):
|
Pension
|
SERP
|
||||||
|
Unrecognized
net actuarial loss
|
$
|
3,032
|
$
|
1,497
|
|||
|
Unrecognized
prior service costs
|
85
|
467
|
|||||
|
Net
transition asset
|
(216
|
)
|
--
|
||||
|
$
|
2,901
|
$
|
1,964
|
||||
The
estimated costs that will be amortized from accumulated other comprehensive
loss
into net periodic pension cost during the next fiscal year are as follows (in
thousands):
|
Pension
|
SERP
|
||||||
|
Prior
service cost
|
$
|
10
|
$
|
113
|
|||
|
Net
transition asset
|
(39
|
)
|
--
|
||||
|
Net
actuarial loss
|
283
|
203
|
|||||
|
$
|
254
|
$
|
316
|
||||
The
combined incremental effect of applying SFAS No. 158 on individual line items
in
the statement of financial condition at December 31, 2006 for the defined
benefit plan and SERP was as follows (in thousands):
|
Before
application of Statement No. 158
|
Reclassification
|
After
application of Statement No. 158
|
||||||||
|
Accrued
Interest Receivable and other assets
|
$
|
23,544
|
$
|
(1,844
|
)
|
$
|
21,700
|
|||
|
Total
Assets
|
1,351,161
|
(1,844
|
)
|
1,349,317
|
||||||
|
Accrued
Interest Payable and other liabilities
|
11,181
|
3,021
|
14,202
|
|||||||
|
Total
Liabilities
|
1,249,440
|
3,021
|
1,252,461
|
|||||||
|
Accumulated
Other Comprehensive Income/(Loss)
|
(715
|
)
|
(4,865
|
)
|
(5,580
|
)
|
||||
|
Shareholders’
Equity
|
101,721
|
(4,865
|
)
|
96,856
|
||||||
401(K)
Profit Sharing Plan
The
First
United Bank & Trust 401(k) Profit Sharing Plan (“the 401(k) Plan”) is a
defined contribution plan that is intended to qualify under section 401(k)
of
the Internal Revenue Code. The 401(k) Plan covers substantially all employees
of
the Corporation. Eligible employees can elect to contribute to the plan through
payroll deductions. Contributions up to 6% of an employee’s base salary are
matched on a 50% basis by the Corporation. Expense charged to operations for
the
401(k) Plan was $.5 million, $.4 million, and $.4 million in 2006, 2005 and
2004, respectively.
Supplemental
Executive Retirement Plan
The
Corporation expects to fund the projected benefit payments annually from
operations.
[62]
12. Federal
Reserve Requirements
The
Bank
is required to maintain cash reserves with the Federal Reserve Bank of Richmond
based principally on the type and amount of its deposits. During
2006, the daily average amount of these required reserves was approximately
$1.9
million.
13. Restrictions
on Subsidiary Dividends, Loans or Advances
Federal
and state banking regulations place certain restrictions on the amount of
dividends paid and loans or advances made by the Bank to the Corporation. The
total
amount of dividends that may be paid at any date is generally limited to the
retained earnings of the Bank, and loans or advances are limited to 10 percent
of the Bank’s capital stock and surplus on a secured basis. In addition,
dividends paid by the Bank to the Corporation would be prohibited if the effect
thereof would cause the Bank’s capital to be reduced below applicable minimum
capital requirements. At December 31, 2006, the Bank could have paid additional
dividends of $13.1 million to the Corporation without regulatory
approval.
14. Commitments
and Contingent Liabilities
The
Corporation and its subsidiaries are at times, and in the ordinary course of
business, subject to legal actions. However, to the knowledge of management,
the Corporation is not currently subject to any such legal actions.
Loan
and
letter of credit commitments are discussed in Note 4.
15. Fair
Value of Financial Instruments
As
required by SFAS No. 107, “Disclosures about Fair Value of Financial
Instruments,” presented in the following table is fair value information about
financial
instruments, whether or not recognized in the statement of financial condition,
for which it is practicable to estimate that value. Fair value is best
determined by values quoted through active trading markets. Active trading
markets are characterized by numerous transactions of similar financial
instruments between willing buyers and willing sellers. Because no active
trading market exists for various types of financial instruments, many of the
fair values disclosed were derived using present value discounted cash flow
or
other valuation techniques. As a result, the Corporation’s ability to actually
realize these derived values cannot be assumed.
The
fair
values disclosed under SFAS No. 107 may vary significantly between institutions
based on the estimates and assumptions used in the various valuation
methodologies. The derived fair values are subjective in nature and involve
uncertainties and significant judgment. Therefore, they cannot be determined
with precision. Changes in the assumptions could significantly impact the
derived estimates of fair value. SFAS No. 107 excludes disclosure of non
financial assets such as buildings as well as certain financial instruments
such
as leases. Accordingly, the aggregate fair values presented do not represent
the
underlying value of the Corporation.
[63]
The
actual carrying amounts and estimated fair values of the Corporation’s financial
instruments that are included in the statement of financial condition
at
December 31 are as follows (in thousands):
|
2006
|
2005
|
||||||||||||
|
Carrying
Amount
|
Fair
Value
|
Carrying
Amount
|
Fair
Value
|
||||||||||
|
Financial
Assets:
|
|||||||||||||
|
Cash and cash equivalents
|
$
|
23,325
|
$
|
23,325
|
$
|
24,610
|
$
|
24,610
|
|||||
|
Interest-bearing deposits in banks
|
2,463
|
2,463
|
5,001
|
5,001
|
|||||||||
|
Investment securities
|
263,272
|
263,272
|
230,095
|
230,095
|
|||||||||
|
Federal Home Loan Bank stock
|
9,620
|
9,620
|
8,050
|
8,050
|
|||||||||
|
Loans, net
|
957,126
|
943,173
|
954,545
|
949,622
|
|||||||||
|
Accrued interest receivable
|
6,249
|
6,249
|
6,114
|
6,114
|
|||||||||
|
Financial
Liabilities:
|
|||||||||||||
|
Deposits
|
971,381
|
967,849
|
955,854
|
952,350
|
|||||||||
|
Borrowed funds
|
265,709
|
265,400
|
250,312
|
253,744
|
|||||||||
|
Accrued interest payable
|
5,110
|
5,110
|
4,129
|
4,129
|
|||||||||
|
Off Balance Sheet Financial Instruments
|
--
|
--
|
--
|
--
|
|||||||||
The
following methods and assumptions were used by the Corporation in estimating
its
fair value disclosures for financial instruments:
Cash
and cash equivalents:
The
carrying amounts as reported in the statement of financial condition for cash
and due from banks approximate their fair values.
Interest-bearing
deposits in banks:
The
carrying amount of interest-bearing deposits approximates their fair
values.
Investment
securities:
Fair
values of investment securities are based on quoted market values.
Federal
Home Loan Bank stock:
The
carrying value of Federal Home Loan stock approximates fair value based on
the
redemption provisions of the Federal Home Loan Bank.
Loans:
For
variable rate loans and leases that reprice frequently or “in one year or less,”
and with no significant change in credit risk, fair values are based on carrying
values. Fair values for fixed rate loans and leases and loans and leases that
do
not reprice frequently are estimated using a discounted cash flow calculation
that applies current interest rates being offered on the various loan
products.
Deposits:
The fair
values disclosed for demand deposits (e.g., interest and non-interest checking,
savings, and certain types of money market accounts) are, by definition, equal
to the amount payable on demand at the reporting date (i.e., their carrying
amounts). The carrying amounts for variable rate certificates of deposit
approximate their fair values at the reporting date. Fair values for fixed
rate
certificates of deposit are estimated using a discounted cash flow calculation
that applies interest rates currently being offered on the various certificates
of deposit to the cash flow stream.
Borrowed
funds:
The fair
value of the Corporation’s Federal Home Loan Bank borrowings and junior
subordinated debt is calculated based on the discounted value of contractual
cash flows, using rates currently existing for borrowings with
similar
remaining maturities. The carrying amounts of federal funds purchased and
securities sold under agreements to repurchase approximate their fair
values.
Accrued
Interest:
The
carrying amount of accrued interest receivable and payable approximates their
fair values.
Off-Balance-Sheet
Financial Instruments:
In the
normal course of business, the Corporation makes commitments to extend credit
and issues standby letters of credit. The Corporation expects most of these
commitments to expire without being drawn upon, therefore the commitment amounts
do not necessarily represent future cash requirements. Due to the uncertainty
of
cash flows and difficulty in the predicting the timing of such cash flows,
fair
values were not estimated for these instruments. The Corporation did not have
any derivative financial instruments at December 31, 2006 or 2005.
[64]
16. Parent
Company Financial Information (Parent Company Only)
Condensed
Statements of Financial Condition (in thousands)
|
December
31
|
|||||||
|
2006
|
2005
|
||||||
|
Assets
|
|||||||
|
Cash
|
$
|
1,593
|
$
|
2,067
|
|||
|
Investment
securities
|
1,221
|
1,230
|
|||||
|
Investment
in bank subsidiary
|
115,914
|
111,384
|
|||||
|
Other
assets
|
7,043
|
5,711
|
|||||
|
Investment
in non-bank subsidiaries
|
9,653
|
9,962
|
|||||
|
Total
Assets
|
$
|
135,424
|
$
|
130,354
|
|||
|
Liabilities
and Shareholder’s Equity
|
|||||||
|
Accrued
interest and other liabilities
|
$
|
1,470
|
$
|
1,223
|
|||
|
Dividends
payable
|
1,169
|
1,163
|
|||||
|
Junior
subordinated debt
|
35,929
|
35,929
|
|||||
|
Shareholders’
equity
|
96,856
|
92,039
|
|||||
|
Total
Liabilities and Shareholder’s Equity
|
$
|
135,424
|
$
|
130,354
|
|||
Condensed
Statements of Income (in thousands)
|
Year
Ended December 31
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Income:
|
||||||||||
|
Dividend
income from bank subsidiary
|
$
|
5,819
|
$
|
8,009
|
$
|
8,718
|
||||
|
Other
Income
|
284
|
253
|
422
|
|||||||
|
Total
Income
|
6,103
|
8,262
|
9,140
|
|||||||
|
Expenses:
|
||||||||||
|
Interest
expense
|
2,355
|
2,179
|
2,927
|
|||||||
|
Other
expenses
|
142
|
127
|
942
|
|||||||
|
Total
Expenses
|
2,497
|
2,306
|
3,869
|
|||||||
|
Income
before income taxes and equity in undistributed
net income of subsidiaries
|
3,606
|
5,956
|
5,271
|
|||||||
|
Income
tax benefit
|
--
|
--
|
1,205
|
|||||||
|
Equity
in undistributed net income of subsidiaries:
|
||||||||||
|
Bank
|
8,124
|
5,518
|
1,080
|
|||||||
|
Non-bank
|
847
|
677
|
71
|
|||||||
|
Net
Income
|
$
|
12,577
|
$
|
12,151
|
$
|
7,627
|
||||
[65]
Condensed
Statements of Cash Flows (in thousands)
|
Year
Ended December 31
|
||||||||||
|
2006
|
2005
|
2004
|
||||||||
|
Operating
Activities
|
||||||||||
|
Net
Income
|
$
|
12,577
|
$
|
12,151
|
$
|
7,627
|
||||
|
Adjustments
to reconcile net income to net cash
provided by operating activities:
|
||||||||||
|
Equity
in undistributed net income
of subsidiaries
|
(8,971
|
)
|
(6,195
|
)
|
(1,151
|
)
|
||||
|
Decrease
(increase) in other assets
|
1,208
|
(237
|
)
|
(830
|
)
|
|||||
|
Increase
in accrued interest payable and other
liabilities
|
138
|
250
|
232
|
|||||||
|
Increase
in dividends payable
|
6
|
36
|
34
|
|||||||
|
Net
cash provided by operating activities
|
4,958
|
6,005
|
5,912
|
|||||||
|
Investing
Activities
|
||||||||||
|
Proceeds
from investment maturities
|
9
|
38
|
269
|
|||||||
|
Net
investment in subsidiaries
|
(1,281
|
)
|
(1,331
|
)
|
(1,704
|
)
|
||||
|
Capital
transfer to Bank
|
--
|
--
|
(12,000
|
)
|
||||||
|
Net
cash used in investing activities
|
(1,272
|
)
|
(1,293
|
)
|
(13,435
|
)
|
||||
|
Financing
Activities
|
||||||||||
|
Cash
dividends
|
(4,662
|
)
|
(4,544
|
)
|
(4,384
|
)
|
||||
|
Proceeds
from issuance of common stock
|
502
|
493
|
129
|
|||||||
|
Proceeds
from issuance of long term debt
|
--
|
--
|
12,218
|
|||||||
|
Net
cash provided by (used in)
financing activities
|
(4,160
|
)
|
(4,051
|
)
|
7,963
|
|||||
|
(Decrease)
increase in cash and cash equivalents
|
(474
|
)
|
661
|
440
|
||||||
|
Cash
and cash equivalents at beginning of year
|
2,067
|
1,406
|
966
|
|||||||
|
Cash
and cash equivalents at end of year
|
$
|
1,593
|
$
|
2,067
|
$
|
1,406
|
||||
17. Quarterly
Results of Operations (Unaudited)
The
following is a summary of the quarterly results of operations for the years
ended December 31, 2006 and 2005 (in thousands, except per share
amounts):
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
||||||||||
|
2006
|
|||||||||||||
|
Interest
income
|
$
|
18,977
|
$
|
19,539
|
$
|
20,560
|
$
|
21,193
|
|||||
|
Interest
expense
|
8,840
|
9,225
|
10,380
|
10,890
|
|||||||||
|
Net
interest income
|
10,137
|
10,314
|
10,180
|
10,303
|
|||||||||
|
Provision
for loan losses
|
(77
|
)
|
157
|
499
|
586
|
||||||||
|
Other
income
|
3,512
|
3,304
|
3,510
|
3,711
|
|||||||||
|
Gains
(losses) on securities
|
4
|
0
|
0
|
0
|
|||||||||
|
Other
expenses
|
9,518
|
8,936
|
8,538
|
8,498
|
|||||||||
|
Income
before income taxes
|
4,212
|
4,525
|
4,653
|
4,930
|
|||||||||
|
Applicable
income taxes
|
1,407
|
1,481
|
1,388
|
1,467
|
|||||||||
|
Net
income
|
$
|
2,805
|
$
|
3,044
|
$
|
3,265
|
$
|
3,463
|
|||||
|
Earnings
per share
|
$
|
.46
|
$
|
.50
|
$
|
.53
|
$
|
.56
|
|||||
[66]
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
||||||||||
|
2005
|
|||||||||||||
|
Interest
income
|
$
|
16,150
|
$
|
16,826
|
$
|
18,099
|
$
|
18,681
|
|||||
|
Interest
expense
|
6,560
|
6,833
|
7,710
|
8,310
|
|||||||||
|
Net
interest income
|
9,590
|
9,993
|
10,389
|
10,371
|
|||||||||
|
Provision
for loan losses
|
(91
|
)
|
1,007
|
356
|
(194
|
)
|
|||||||
|
Other
income
|
3,053
|
3,097
|
3,430
|
4,633
|
|||||||||
|
Gains
(losses) on securities
|
28
|
(218
|
)
|
59
|
6
|
||||||||
|
Other
expenses
|
8,479
|
8,509
|
8,787
|
8,879
|
|||||||||
|
Income
before income taxes
|
4,283
|
3,356
|
4,735
|
6,325
|
|||||||||
|
Applicable
income taxes
|
1,529
|
1,219
|
1,691
|
2,109
|
|||||||||
|
Net
income
|
$
|
2,754
|
$
|
2,137
|
$
|
3,044
|
$
|
4,216
|
|||||
|
Earnings
per share
|
$
|
.45
|
$
|
.35
|
$
|
.50
|
$
|
.69
|
|||||
[67]
|
ITEM
9.
|
CHANGES
IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
|
None.
|
CONTROLS
AND PROCEDURES
|
The
Corporation maintains disclosure controls and procedures that are designed
to
ensure that information required to be disclosed in the Corporation’s
reports filed under the Securities Exchange Act of 1934 with the SEC, such
as
this annual report, is recorded, processed, summarized and reported within
the
time periods specified in those rules and forms, and that such information
is
accumulated and communicated to the Corporation’s management, including the
Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”), as
appropriate, to allow for timely decisions regarding required disclosure. A
control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered
relative to their costs. These inherent limitations include the realities that
judgments in decision-making can be faulty, and that breakdowns can occur
because of simple error or mistake. Additionally, controls can be circumvented
by the individual acts of some persons, by collusion of two or more people,
or
by management override of the control. The design of any system of controls
also
is 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, a control 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 December
31,
2006 was carried out under the supervision and with the participation of the
Corporation’s management, including the CEO and the CFO. Based on that
evaluation, the Corporation’s management, including the CEO and the CFO, has
concluded that the Corporation’s disclosure controls and procedures are, in
fact, effective at the reasonable assurance level.
During
the fourth quarter of 2006, there was no change in the Corporation’s internal
control over financial reporting that has materially affected,
or is reasonably likely to materially affect, the Corporation’s internal control
over financial reporting.
As
required by Section 404 of the Sarbanes-Oxley Act of 2002, management has
performed an evaluation and testing of the Corporation’s internal control
over
financial reporting as of December 31, 2006. Management’s report on the
Corporation’s internal control over financial reporting and the related
attestation report of the Corporation’s registered public accounting firm are
included on the following pages.
[68]
Management’s
Report on Internal Control Over Financial Reporting
The
Board
of Directors and Shareholders
First
United Corporation
The
Corporation’s management is responsible for establishing and maintaining
adequate internal control over financial reporting. This internal control
system was designed to provide reasonable assurance to management and the Board
of Directors as to the reliability of the Corporation’s financial reporting and
the preparation and presentation of financial statements for external purposes
in accordance with accounting principles generally accepted in the United
States, as well as to safeguard assets from unauthorized use or
disposition.
An
internal control system, no matter how well designed, has inherent limitations.
Therefore, even those systems determined to be effective can provide
only reasonable assurance with respect to financial statement preparation and
presentation and may not prevent or detect misstatements in the financial
statements or the unauthorized use or disposition of the Corporation’s assets.
Also, projections of any evaluation of effectiveness of internal controls to
future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with policies
and procedures may deteriorate.
Management
assessed the effectiveness of the Corporation’s internal control over financial
reporting as of December 31, 2006, based on the criteria set
forth
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
in Internal Control--Integrated Framework. Based on this assessment and on
the
foregoing criteria, management has concluded that, as of December 31, 2006,
the
Corporation’s internal control over financial reporting is
effective.
Beard
Miller Company LLP, an independent registered public accounting firm, has
audited the Consolidated Financial Statements of the Corporation for the
year
ended December 31, 2006, appearing elsewhere in this annual report, and has
issued an attestation report on management’s assessment of the effectiveness of
the Corporation’s internal control over financial reporting as of December 31,
2006, as stated in their report, which is included herein.
|
/s/
William B. Grant
|
/s/
Carissa L. Rodeheaver
|
|
|
William
B. Grant, Esq., CFP
|
Carissa
L. Rodeheaver, CPA, CFP
|
|
|
Chairman
of the Board and
|
Senior
Vice President and
|
|
|
Chief
Executive Officer
|
Chief
Financial Officer
|
[69]
Report
of Independent Registered Public Accounting Firm
To
the
Board of Directors and Stockholders
First
United Corporation
Oakland,
Maryland
We
have
audited management’s assessment, included in the accompanying Management’s
Report on Internal Control Over Financial Reporting, that First United
Corporation maintained effective internal control over financial reporting
as of
December 31, 2006, based on criteria established in Internal
Control—Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
First United Corporation’s management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting. Our responsibility
is to express an opinion on management’s assessment and an opinion on the
effectiveness of the Corporation’s internal control over financial reporting
based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control
over
financial reporting, evaluating management’s assessment, testing and evaluating
the design and operating effectiveness of internal control, and performing
such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain
to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors
of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In
our
opinion, management’s assessment that First United Corporation maintained
effective internal control over financial reporting as of December 31,
2006, is fairly stated, in all material respects, based on criteria established
in Internal
Control—Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Also in our opinion, First United Corporation maintained, in all material
respects, effective internal control over financial reporting as of
December 31, 2006, based on criteria established in Internal
Control—Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO).
We
have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated statements of financial
condition and the related consolidated statements of income, changes in
shareholders’ equity, and cash flows of First United Corporation as of and for
the year ended December 31, 2006, and our report dated March 9, 2007
expressed an unqualified opinion.
/s/
Beard
Miller Company LLP
Beard
Miller Company LLP
Baltimore,
Maryland
March 9,
2007
[70]
|
ITEM
9B.
|
OTHER
INFORMATION
|
None.
|
DIRECTORS,
EXECUTIVE OFFICERS AND
CORPORATE GOVERNANCE
|
The
Corporation has adopted a Code of Ethics applicable to its principal executive
officer, principal financial officer, principal accounting officer, or
controller, or persons performing similar functions, a Code of Ethics applicable
to all employees, and a Code of Ethics applicable to members of the Board of
Directors. Copies of the Corporation’s Codes of Ethics are available free of
charge upon request to Mr. Robert W. Kurtz, Secretary, First United Corporation,
c/o First United Bank & Trust, P.O. Box 9, Oakland, MD 21550-0009 or on the
Corporation’s website at www.mybankfirstunited.com.
All
other
information required by this item is incorporated by reference herein to the
Corporation’s definitive Proxy Statement for the 2007 Annual Stockholders
Meeting to be filed with the SEC in March of 2007 pursuant to Regulation
14A.
|
ITEM
11.
|
EXECUTIVE
COMPENSATION
|
The
information required by this item is incorporated by reference herein to the
Corporation’s definitive Proxy Statement for the 2007 Annual Stockholders
Meeting
to be filed with the SEC in March of 2007 pursuant to Regulation
14A.
|
ITEM
12.
|
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED
STOCKHOLDER MATTERS
|
The
information required by this item is incorporated by reference herein to the
Corporation’s definitive Proxy Statement for the 2007 Annual Stockholders
Meeting
to be filed with the SEC in March of 2007 pursuant to Regulation
14A.
|
ITEM
13.
|
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS,
AND DIRECTOR INDEPENDENCE
|
The
information required by this item is incorporated by reference herein to the
Corporation’s definitive Proxy Statement for the 2007 Annual Stockholders
Meeting
to be filed with the SEC in March of 2007 pursuant to Regulation
14A.
|
ITEM
14.
|
PRINCIPAL
ACCOUNTANT FEES AND
SERVICES
|
The
information required by this item is incorporated by reference herein to the
Corporation’s definitive Proxy Statement for the 2007 Annual Stockholders
Meeting
to be filed with the SEC in March of 2007 pursuant to Regulation
14A.
[71]
PART
IV
|
EXHIBITS
AND FINANCIAL STATEMENT
SCHEDULES
|
(a)(1),
(2) and (c) Financial Statements.
Reports
of Independent Registered Public Accounting Firms
Consolidated
Statements of Financial Condition as of December 31, 2006 and 2005
Consolidated
Statements of Income for the years ended December 31, 2006, 2005 and
2004
Consolidated
Statements of Changes in Shareholders’ Equity for the years ended December 31,
2006, 2005 and
2004
Consolidated
Statements of Cash Flows for the years ended December 31, 2006, 2005 and
2004
Notes
to
Consolidated Financial Statements for the years ended December 31, 2006, 2005
and 2004
(a)
(3)
and (b) Exhibits.
The
exhibits filed or furnished with this annual report are shown on the Exhibit
List that follows the signatures to this annual report.
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
|
First
United Corporation
|
||
|
Dated:
March 9, 2007
|
By:
|
/s/
William B. Grant
|
|
William
B. Grant, Esq., CFP
|
||
|
Chairman
of the Board and Chief Executive
Officer
|
||
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the registrant
and in the capacities indicated.
|
/s/
William B. Grant
|
/s/
David J. Beachy
|
|
|
(William
B. Grant) Director, Chief Executive Officer
|
(David
J. Beachy) Director--March 9, 2007
|
|
|
March
9, 2007
|
||
|
/s/
M. Kathryn Burkey
|
/s/
Faye E. Cannon
|
|
|
(M.
Kathryn Burkey) Director--March 9, 2007
|
(Faye
E. Cannon) Director--March 9, 2007
|
|
|
/s/
Paul Cox, Jr.
|
/s/
Raymond F. Hinkle
|
|
|
(Paul
Cox, Jr.) Director--March 9, 2007
|
(Raymond
F. Hinkle) Director--March 9, 2007
|
|
|
/s/
Robert W. Kurtz
|
/s/
John W. McCullough
|
|
|
(Robert
W. Kurtz) Director, President and Chief
|
(John
W. McCullough) Director--March 9, 2007
|
|
|
Risk
Officer--March 9, 2007
|
||
|
/s/
Elaine L. McDonald
|
/s/
Donald E. Moran
|
|
|
(Elaine
L. McDonald) Director--March 9, 2007
|
(Donald
E. Moran) Director--March 9, 2007
|
[72]
|
/s/
Karen F. Myers
|
/s/
Carissa L. Rodeheaver
|
|
|
(Karen
F. Myers) Director--March 9, 2007
|
(Carissa
L. Rodeheaver) SVP & Chief Financial Officer-
|
|
|
March
9, 2007
|
||
|
/s/
Gary R. Ruddell
|
/s/
I. Robert Rudy
|
|
|
(Gary
R. Ruddell) Director--March 9, 2007
|
(I.
Robert Rudy) Director--March 9, 2007
|
|
|
/s/
Robert G. Stuck
|
||
|
(Richard
G. Stanton) Director - March 9, 2007
|
(Robert
G. Stuck) Director--March 9, 2007
|
|
|
/s/
H. Andrew Walls, III
|
||
|
(H.
Andrew Walls, III) Director--March 9, 2007
|
[73]
EXHIBIT
INDEX
| Exhibit |
Description
|
|
3.1
|
Amended
and Restated Articles of Incorporation (incorporated by reference
to
Exhibit 3.1 of the Corporation's Quarterly Report on Form 10-Q for
the
period ended September 30, 1998)
|
|
3.2
|
Amended
and Restated By-Laws (incorporated by reference to Exhibit 3(ii)
of the
Corporation's Annual Report on Form 10-K for the year ended December
31,
1997)
|
|
10.1
|
First
United Bank & Trust Amended and Restated Supplemental Executive
Retirement Plan (“SERP”) (incorporated by reference to Exhibit 10.4 of the
Corporation’s Current Report on Form 8-K filed on February 21,
2007)
|
|
10.2
|
Amended
and Restated SERP Agreement with William B. Grant (incorporated by
reference to Exhibit 10.5 of the Corporation’s Current Report on Form 8-K
filed on February 21, 2007)
|
|
10.3
|
Form
of Amended and Restated SERP Agreement with executive officers other
than
William B. Grant (incorporated by reference to Exhibit 10.6 of the
Corporation’s Current Report on Form 8-K filed on February 21,
2007)
|
|
10.4
|
Form
of Endorsement Split Dollar Agreement between the Bank and each of
William
B. Grant, Robert W. Kurtz, Jeannette R. Fitzwater, Phillip D. Frantz,
Eugene D. Helbig, Jr., Steven M. Lantz, Robin M. Murray, Carissa
L.
Rodeheaver, and Frederick A. Thayer, IV (incorporated by reference
to
Exhibit 10.3 of the Corporation’s Quarterly Report on Form 10-Q for the
period ended September 30, 2003)
|
|
10.5
|
First
United Corporation Executive and Director Deferred Compensation Plan
(incorporated by reference to Exhibit 10.10 of the Corporation’s Quarterly
Report on Form 10-Q for the period ended September 30,
2003)
|
|
10.6
|
First
United Corporation Change in Control Plan (incorporated by reference
to
Exhibit 10.1 of the Corporation’s Current Report on Form 8-K filed on
February 21, 2007)
|
|
10.7
|
Change
in Control Severance Plan Agreement with William B. Grant (incorporated
by
reference to Exhibit 10.2 the Corporation’s Current Report on Form 8-K
filed on February 21, 2007)
|
|
10.8
|
Form
of Change in Control Severance Plan Agreement with executive officers
other than William B. Grant (incorporated by reference to Exhibit
10.3 the
Corporation’s Current Report on Form 8-K filed on February 21,
2007)
|
|
21
|
Subsidiaries
of the Corporation, incorporated by reference to page 3 of this Annual
Report on Form 10-K.
|
|
23.1
|
Consent
of Beard Miller Company LLP (filed
herewith)
|
|
23.2
|
Consent
of Ernst & Young LLP (filed
herewith)
|
|
31.1
|
Certifications
of the CEO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
herewith)
|
|
31.2
|
Certifications
of the CFO pursuant to Section 302 of the Sarbanes-Oxley Act (filed
herewith)
|
|
32.1
|
Certification
of the CEO pursuant to Section 906 of the Sarbanes-Oxley Act (furnished
herewith)
|
|
32.2
|
Certification
of the CFO pursuant to Section 906 of the Sarbanes-Oxley Act (furnished
herewith)
|
[74]