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FIRST UNITED CORP/MD/ – 10-K – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and notes thereto for the years endedDecember 31, 2021 and 2020, which are included in Item 8 of Part II of this annual report.
Overview
First United Corporation is a bank holding company that, through the Bank and its non-bank subsidiaries, provides an array of financial products and services primarily to customers in fourWestern Maryland counties and fourNortheastern West Virginia counties. Its principal operating subsidiary is the Bank, which consists of a community banking network of 26 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. Consolidated net income for the year endedDecember 31, 2021 was$19.8 million , inclusive of litigation settlement expenses of$3.3 million ,Federal Home Loan Bank ("FHLB") prepayment penalties of$2.4 million , insurance reimbursement income of$1.4 million and charitable contributions of$1.0 million , compared to$13.8 million for the year endedDecember 31, 2020 . Basic and diluted net income per share for 2021 were both$2.95 , a 49.0% increase when compared to basic and diluted net income per share of$1.98 and$1.97 , respectively, for 2020. The increase in earnings when comparing 2021 to 2020 was primarily due to an increase in net interest income on a non-GAAP, fully taxable equivalent ("FTE") basis, of$4.0 million , an increase in other operating income, including gains, of$2.1 million , and a decrease in provision expense of$6.2 million , offset by an increase in other operating expenses of$3.8 million . The increase in provision expense for 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic and its impact on our borrowers. Other operating income, including net gains, increased$2.1 million for the year endedDecember 31, 2021 when compared to the year endedDecember 31, 2020 . This increase was due primarily to increased trust and brokerage income of$1.3 million related to new client relationships and assets under management, the receipt of a$1.4 million insurance reimbursement, and increased debit card income. The net interest margin, on an FTE basis, declined to 3.28% for the year endedDecember 31, 2021 from 3.34% for the same period of 2020.
The provision for loan losses was a credit of
The higher provision expense recorded in 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic. Net recoveries of$0.3 million were recorded for the year endedDecember 31, 2021 , compared to net charge offs of$1.5 million for 2020. The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.38% atDecember 31, 2021 compared to 1.41% atDecember 31, 2020 .
The ratio of ALL to loans outstanding, excluding PPP loan balances of
million
respectively, non-GAAP.
Other operating income, including net gains on sales of mortgage loans and sales of investment securities, increased$2.1 million for the year endedDecember 31, 2021 when compared to 2020. Gains on the sale of mortgage loans to the secondary market decreased$1.3 million due to refinancing activity occurring at a slower pace than the pace experienced in 2020. Trust and brokerage income increased$1.3 million year-over-year due to growth in new client relationships and assets under management. Debit card income increased$0.7 million for the year endedDecember 31, 2021 , when compared to 2020 due to growth in deposit relationships and increased customer usage of our electronic services. Other miscellaneous income increased$0.4 million . Service charge income remained stable while net gains on investment securities decreased$0.5 million when comparing 2021 to 2020 due to reduced sales activity during 2021. Other operating expenses increased$3.8 million for the year endedDecember 31, 2021 when compared to 2020. This increase was driven by$3.3 million of litigation settlement expenses recorded in the first quarter of 2021, a$2.4 million penalty on the repayment of$70.0 million of FHLB advances in the third quarter of 2021 and a$1.0 million charitable contribution toFirst United Community Dreams Foundation, Inc. Salaries and benefits for 2021 increased$1.0 million when compared to 2020, related to a net increase of$0.7 million due to higher in salaries, incentive pay, stock compensation and 401(k) plan expense, offset by decreases in pension and life and health insurance costs and a$0.3 million offset in salary expense from deferred loan origination costs primarily attributable to PPP loans.FDIC premiums 29
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increased slightly by$0.2 million due to credits received on quarterly assessments in 2020. Equipment, occupancy and technology expenses decreased$0.9 million in 2021 when compared to 2020 as we began to realize cost savings from our core processor related to the new contract negotiated in the third quarter of 2020. Other real estate owned ("OREO") expenses were a net credit in 2021 due to$1.4 million in net gains attributable to the sale of OREO properties.
Professional services decreased
accounting and audit fees of
in consulting expenses and
Outstanding loans of$1.2 billion atDecember 31, 2021 reflected a decline of$14.1 million during 2021. Core commercial loan growth was offset by PPP loans that were forgiven. CRE loans increased by$5.1 million , acquisition and development ("A&D") loans increased by$11.1 million and commercial and industrial ("C&I") loans decreased by$85.8 million , as growth in core portfolio loans of$20.5 million was offset by PPP loans that were forgiven. Residential mortgage loans increased$25.5 million due to the purchase of a$39.0 million loan pool of 1-4 family residential loans, offset by the decline in mortgage portfolio balances due to the continued utilization of theFNMA secondary market for refinancing activity. Given the current low interest rate environment, customers were seeking longer-term, fixed-rate loans and management chose not to book these loans in the portfolio. The consumer loan portfolio increased by$29.9 million due to the purchase of a pool of consumer loans in the second quarter of 2021 and the purchase of a$10.0 million pool of student loans late in the fourth quarter as an effort to deploy excess cash into higher yielding, short-term assets. Management strategically purchased loan pools to complement the portfolio loans and to assist in managing interest rate risk. Net interest income, on a non-GAAP, FTE basis, increased by$4.0 million during the year endedDecember 31, 2021 when compared to the year endedDecember 31, 2020 driven by a$3.9 million decrease in interest expense and a slight increase in interest income of$0.1 million . The decrease in interest expense resulted from proactive efforts to reduce the cost of funds by further reductions to rates on deposit accounts throughout 2021, the runoff of balances in time deposits, including brokered deposits, and the expiration of empowered rates on money market accounts. The net interest margin, on an FTE basis, declined to 3.28% for the year endedDecember 31, 2021 from 3.34% for the year endedDecember 31, 2020 . The net interest margin for the years endedDecember 31, 2021 and 2020 would have been 3.14% and 3.46%, respectively, after excluding the average balance of PPP loans of$79.4 million and$137.0 million , respectively, and interest and fees of$4.8 million and$3.0 million , respectively. Comparing the year endedDecember 31, 2021 with the year endedDecember 31, 2020 , interest income remained stable. Interest and fees on loans increased by$0.8 million and was partially offset by the reduction in investment income of$0.6 million . While the average balance of the investment portfolio increased by$67.3 million , bonds, at higher yielding rates, were called and replaced with lower yielding investments resulting in a decrease in average yield on the investment portfolio of 85 basis points. Excess cash balances during 2021 were invested at the lower Fed Funds rate, which also negatively affected interest income for the year endedDecember 31, 2021 . The increase in interest and fees on loans was due primarily to an increase in average balances of$26.1 million , primarily driven by new loan production at lower yields, offset by the repayment of the PPP loans. The rate earned on the loan portfolio remained stable when comparing the year endedDecember 31, 2021 to the year endedDecember 31, 2020 . Total deposits atDecember 31, 2021 increased by$47.0 million when compared to deposits atDecember 31, 2020 . During 2021, non-interest-bearing deposits increased by$81.2 million , driven by retail and commercial account growth partially attributable to government stimulus programs. Traditional savings accounts increased by$40.5 million as we continued to see significant growth in our Prime Saver product, and total demand deposits increased by$26.6 million . Total money market accounts decreased by$36.3 million . As a part of assets under management, the Trust department manages cash balances for customers as a percentage of their portfolio allocation. These cash balances are in money market accounts. The decrease in money market balances was due primarily to management's decision to sweep approximately$70.0 million of wealth management money market funds off balance sheet in the first quarter of 2021. These funds can be readily shifted back to in-house money market accounts should liquidity needs arise in the future. Time deposits decreased by$65.0 million , due primarily to our continued reduction in the pricing on single-service relationships and municipal bids. The decrease in interest expense for 2021 was driven by a decrease in interest rates of 16 basis points, which offset the increase in average balances of$65.6 million on interest bearing deposits, and a 39 basis point decline in average 30 Table of Contents
rate and
the prepayment of
Proactive efforts to reduce the cost of funds by further reductions to rates on deposit accounts throughout 2021, the runoff of balances in the time deposits, including brokered deposits, and the expiration of empowered rates on money market accounts continued throughout 2021.
Estimates and Critical Accounting Policies
This discussion and analysis of our financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted inthe United States of America . The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. (See Note 1 to the Consolidated Financial Statements.) On an on-going basis, management evaluates estimates and bases those 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. The Company identifies the following critical accounting policies may 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 and resulting interest income, including the calculation of the ALL, the valuation of underlying collateral, and the timing of loan charge-offs. The ALL is established and maintained at a level that is adequate to cover losses resulting from the inability of borrowers to make required payments on loans. Estimates for loan losses are arrived at by analyzing risks associated with specific loans and the loan portfolio, current and historical trends in delinquencies and charge-offs, and changes in the size and composition of the loan portfolio. The analysis also requires consideration of the economic climate and direction, changes in lending rates, political conditions, legislation impacting the banking industry and economic conditions specific toWestern Maryland andNortheastern West Virginia . Because the calculation of the ALL relies on management's estimates and judgments relating to inherently uncertain events, actual results may differ from management's estimates.
The ALL is also discussed below in Item 7 under the heading "Allowance for Loan
Losses" and in Note 9 to the Consolidated Financial Statements.
ASC Topic 350, Intangibles -Goodwill and Other provides guidance with respect to goodwill and other intangible assets. Under this guidance, goodwill is not amortized but shall be tested at least annually for impairment at a level of accounting referred to as a reporting unit. The Corporation is considered the sole reporting unit.Goodwill of a reporting unit shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Impairment of goodwill is the condition that exists when the carrying amount of a reporting unit that includes goodwill exceeds its fair value. A goodwill impairment loss is recognized for the amount that the carrying amount of a reporting unit, including goodwill, exceeds its fair value, limited to the total amount of goodwill allocated to that reporting unit. An entity may assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50%) that the fair value of a reporting unit is less than its carrying amount, including goodwill. If, after assessing the totality of events or circumstances qualitatively, an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity shall perform a quantitative goodwill impairment test. However, if, after assessing the totality of events or circumstances qualitatively, an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the quantitative goodwill impairment test is unnecessary.
The Corporation performs an impairment test of goodwill as of
year.
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Having considered each of the qualitative factors and the negative and positive
evidence of the totality of events and circumstances qualitatively, management
has determined that it is not more likely than not that the fair value of our
reporting unit is less than its carrying amount and a quantitative goodwill
impairment test is unnecessary. As such, management concludes there is no
goodwill impairment at December 31, 2021 .
Other than as discussed above, management does not believe that any material
changes in our critical accounting policies have occurred since December 31,
2021 .
Liquidity Sources
Management has reviewed its Liquidity Contingency Funding Plan in preparation of
funding needs as it relates to the COVID-19 pandemic. As of December 31, 2021 ,
the Corporation had approximately $130.0 million in unsecured lines of credit
with its correspondent banks, $1.0 million with the Federal Reserve Discount
Window, and approximately $188.2 million of secured borrowings with the FHLB.
Additionally, the Corporation has access to the brokered certificates of deposit
market.
Capital
The Corporation's and the Bank's capital ratios are strong, and both
institutions are considered to be well-capitalized by applicable regulatory
measures
Adoption of New Accounting Standards and Effects of New Accounting
Pronouncements
Note 1 to the Consolidated Financial Statements discusses new accounting
pronouncements that, when adopted, could affect our future consolidated
financial statements.
CONSOLIDATED STATEMENT OF INCOME REVIEW
Net Interest Income
Net interest income is our largest source of operating revenue. Net interest income is the difference between the interest that we earn on our interest-earning assets and the interest expense we incur on our interest-bearing liabilities. For analytical and discussion purposes, net interest income is adjusted to an FTE basis to facilitate performance comparisons between taxable and tax-exempt assets by increasing tax-exempt income by an amount equal to the federal income taxes that would have been paid if this income were taxable at the statutorily applicable rate. This is a non-GAAP disclosure and it is not materially different than the corresponding GAAP disclosure.
The table below summarizes net interest income for 2021 and 2020.
GAAP Non-GAAP - FTE
(Dollars in thousands) 2021 2020 2021 2020
Interest income
$ 58,256 $ 58,201 $ 59,195 $ 59,118 Interest expense 5,714 9,655 5,714 9,655
Net interest income
Net interest margin % 3.22% 3.28% 3.28% 3.34%
Net interest income, on a non-GAAP, FTE basis, increased by$4.0 million (8.1%) during the year endedDecember 31, 2021 when compared to the year endedDecember 31, 2020 , driven by a$3.9 million (40.8%) decrease in interest expense and a slight increase in interest income of$0.1 million . The decrease in interest expense resulted from proactive efforts to reduce the cost of funds by further reductions in rates on deposit accounts throughout 2021, the runoff of balances in the time deposits, including brokered deposits, and the expiration of empowered rates on money market accounts. The net interest margin, on an FTE basis, declined to 3.28% for the year endedDecember 31, 2021 from 3.34% for the year endedDecember 31, 2020 . The net interest margin for the years endedDecember 31, 2021 and 2020 would 32
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have been 3.14% and 3.46%, respectively, after excluding the average balance of PPP loans of$79.4 million and$137.0 million , respectively, and interest and fees of$4.8 million and$3.0 million , respectively. Comparing the year endedDecember 31, 2021 with the year endedDecember 31, 2020 , interest income remained stable. Interest and fees on loans increased by$0.8 million and was partially offset by the reduction in investment income of$0.6 million . While the average balance of the investment portfolio increased by$67.3 million , bonds, at higher yielding rates, were called and replaced with lower yielding investments resulting in a decrease in average yield on the investment portfolio of 85 basis points. Excess cash balances during 2021 were invested at the lower Fed Funds rate, which also negatively affected interest income for the year endedDecember 31, 2021 . The increase in interest and fees on loans was due primarily to an increase in average balances of$26.1 million , primarily driven by new loan production at lower yields, offset by the repayment of the PPP loans. The rate earned on the loan portfolio remained stable when comparing the year endedDecember 31, 2021 to the year endedDecember 31, 2020 . The decrease in interest expense for 2021 was driven by a decrease in interest rates of 16 basis points, which offset the increase in average balances of$65.6 million on interest bearing deposits, and a 39 basis point decline in average rate and$23.6 million in average balances on long term borrowings related to the prepayment of$70.0 million in FHLB advances in the third quarter of 2021. Proactive efforts to reduce the cost of funds by further reductions to rates on deposit accounts throughout 2021, the runoff of balances in the time deposits, including brokered deposits, and the expiration of empowered rates on money market accounts continued throughout 2021. As shown below, the composition of total interest income between 2021 and 2020 remained relatively stable. % of Total Interest Income 2021 2020 Interest and fees on loans 91% 90% Interest on investment securities 8% 9% Other 1% 1% 33 Table of Contents
The following table sets forth the average balances, net interest income and
expense, and average yields and rates for our interest-earning assets and
interest-bearing liabilities for 2021 and 2020.
Distribution of Assets, Liabilities and Shareholders' Equity
Interest Rates and Interest Differential - Tax Equivalent Basis
For the Years Ended December 31
2021 2020
Average Average
Average Yield/ Average Yield/
(Dollars in thousands) Balance Interest Rate Balance Interest Rate
Assets
Loans $ 1,173,966 $ 53,040 4.52 % $ 1,147,870 $ 52,215 4.55 %
Investment Securities :
Taxable 272,305 3,912 1.44 % 204,243 4,526 2.22 %
Non taxable 25,463 1,928 7.57 % 26,275 1,941 7.39 %
Total 297,768 5,840 1.96 % 230,518 6,467 2.81 %
Federal funds sold 150,556 178 0.12 % 96,417 215 0.22 %
Interest-bearing deposits
with other banks 4,040 2 0.05 % 905 9 0.99 %
Other interest earning
assets 2,969 135 4.55 % 4,455 212 4.76 %
Total earning assets 1,629,299 59,195 3.63 % 1,480,165 59,118 3.99 %
Allowance for loan losses (16,825) (15,362)
Non-earning assets 152,674 148,818
Total Assets $ 1,765,148 $ 1,613,621
Liabilities
and Shareholders' Equity
Interest-bearing demand
deposits $ 214,510 $ 553 0.26 % $ 182,767 $ 724 0.40 %
Interest-bearing money
markets 341,677 436 0.13 % 313,852 1,443 0.46 %
Savings deposits 223,114 81 0.04 % 176,524 166 0.09 %
Time deposits 198,280 2,403 1.21 % 238,805 4,023 1.68 %
Short-term borrowings 57,697 86 0.15 % 46,519 94 0.20 %
Long-term borrowings 77,340 2,155 2.79 % 100,929 3,205 3.18 %
Total interest-bearing
liabilities 1,112,618 5,714 0.51 % 1,059,396 9,655 0.91 %
Non-interest-bearing
deposits 491,967 372,392
Other liabilities 28,013 54,732
Shareholders' Equity 132,550 127,101
Total Liabilities
and Shareholders' Equity $ 1,765,148 $
1,613,621
Net interest income and spread$ 53,481 3.12 %$ 49,463 3.08 % Net interest margin 3.28 % 3.34 % Notes:
The above table reflects the average rates earned or paid stated on an FTE
(1) basis assuming a tax rate of 21% for 2021 and 2020. Non-GAAP interest income
on an FTE basis for the years ended
The average balances of non-accrual loans for the years ended
(2) 2021 and 2020, which were reported in the average loan balances for
these years, were
(3) Net interest margin is calculated as net interest income divided by average
earning assets.
(4) The average yields on investments are based on amortized cost.
The following table 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 2021 and 2020. This table 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).
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Interest Variance Analysis (1)
2021 Compared to 2020
(In thousands and tax equivalent basis) Volume Rate Net
Interest Income:
Loans $ 1,187 $ (362) $ 825
Taxable Investments 1,508 (2,122) (614)
Non-taxable Investments (60) 47 (13)
Federal funds sold 121 (158) (37)
Interest-bearing deposits 31 (38) (7)
Other interest earning assets (71) (6) (77)
Total interest income 2,716 (2,639) 77
Interest Expense:
Interest-bearing demand deposits 126 (297)
(171)
Interest-bearing money markets 128 (1,135) (1,007) Savings deposits 44 (129) (85) Time deposits (692) (928) (1,620) Short-term borrowings 23 (31) (8) Long-term borrowings (749) (301) (1,050) Total interest expense (1,120) (2,821) (3,941) Net interest income$ 3,836 $ 182 $ 4,018 Note:
The change in interest income/expense due to both volume and rate has been
(1) allocated to volume and rate changes in proportion to the relationship of the
absolute dollar amounts of the change in each.
Provision for Loan Losses
The provision for loan losses was a credit of
The higher provision expense recorded in 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic. Net recoveries of$0.3 million were recorded for the year endedDecember 31, 2021 , compared to net charge offs of$1.5 million for 2020. The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.38% atDecember 31, 2021 compared to 1.41% atDecember 31, 2020 . The ratio of ALL to loans outstanding, excluding PPP loan balances of$7.7 million and$114.0 million , was 1.39% and 1.55% atDecember 31, 2021 and 2020, respectively, non-GAAP. The ALL reflects a level commensurate with the risk inherent in our loan portfolio.
Other Operating Income
The following table shows the major components of other operating income for the
past two years, exclusive of net gains, and the percentage changes during
these years:
(Dollars in thousands) 2021 2020 % Change Service charges on deposit accounts$ 1,771 $ 1,929 (8.19)% Other service charges 909 699 30.04% Trust department income 8,650 7,446 16.17% Debit card income 3,644 2,902 25.57% Bank owned life insurance 1,176 1,253 (6.15)% Brokerage commissions 1,082 1,004 7.77% Insurance reimbursement 1,375 - 100.00% Other income 912 556 64.03% Total other operating income$ 19,519 $ 15,789 23.62% 35 Table of Contents Other operating income, exclusive of gains, increased$3.7 million during the year endedDecember 31, 2021 when compared to the same period of 2020. The increase was primarily a result of an increase in trust and brokerage income of$1.3 million year-over-year due to growth in new client relationships and assets under management. Debit card income increased$0.8 million for the year endedDecember 31, 2021 when compared to 2020 due to growth in deposit relationships and increased customer usage of our electronic services. Other income increased$0.4 million . Service charge income remained stable while gains on investment securities decreased$0.5 million when comparing 2021 to 2020. Net gains of$1.2 million and$2.8 million were reported through other income for the years endedDecember 31, 2021 and 2020, respectively. The$1.6 million decrease in gains for 2021 was primarily attributable to the decrease in gains on the sale of mortgage loans to the secondary market of$1.3 million due to refinancing activity occurring at a slower pace than the pace experienced in 2020. Other Operating Expense
The following table compares the major components of other operating expense for
2021 and 2020:
(Dollars in thousands) 2021 2020 % Change Salaries and employee benefits $
22,061$ 21,079 4.66% FDIC premiums 772 611 26.35% Equipment 3,898 3,904 (0.15)% Occupancy 2,775 2,860 (2.97)% Data processing 3,204 3,981 (19.52)% Marketing 535 573 (6.63)%
Professional services
3,528 4,204 (16.08)% Contract labor 638 641 (0.47)% Line rentals 737 864 (14.70)%
(Gains)/losses on sales and write downs of foreclosed real estate, net
(945) 11 (8690.91)% Investor relations 676 1,277 (47.06)% Settlement expense 3,300 - 100.00%
FHLB prepayment expense
2,368 - 100.00% Contributions 1,220 127 860.63% Other expenses 2,997 3,802 (21.17)%
Total other operating expense $
47,764
Other operating expenses increased$3.8 million for the year endedDecember 31, 2021 when compared to 2020. This increase was driven by$3.3 million of litigation settlement expenses recorded in the first quarter of 2021, a$2.4 million penalty on the repayment of$70.0 million of FHLB advances in the third quarter of 2021 and the aforementioned$1.0 million charitable contribution toFirst United Community Dreams Foundation, Inc. Salaries and benefits for 2021 increased$1.0 million when compared to 2020, related to a net increase of$0.7 million due to higher in salaries, incentive pay, stock compensation and 401(k) plan expense, offset by decreases in pension and life and health insurance costs and a$0.3 million offset in salary expense from deferred loan origination costs primarily attributable to PPP loans.Federal Deposit Insurance Corporation premiums increased slightly by$0.2 million due to credits received on quarterly assessments in 2020. Equipment, occupancy and technology expenses decreased$0.9 million in 2021 when compared to 2020 as we began to realize cost savings from our core processor related to the new contract negotiated in the third quarter of 2020. OREO expenses were a net credit in the 2021 due to$1.4 million in net gains attributable to the sale of OREO properties. Professional services decreased$0.7 million as a result of increased accounting and audit fees of$0.3 million , offset by reductions of$0.5 million in consulting expenses, and$0.4 million in legal expenses.
Applicable Income Taxes
We recognized a tax expense of$6.5 million in 2021, compared to a tax expense of$3.9 million in 2020. See the discussion under "Income Taxes" in Note 17 to the Consolidated Financial Statements presented elsewhere in this annual report for a detailed analysis of our deferred tax assets and liabilities. Our effective tax rate was 24.9% in 2021 and 22.2% in 2020. The increase in the tax rate for 2021 was primarily due to the reduction in tax exempt income as well as the 36 Table of Contents
reduction in tax credits related to the expiration of a low-income housing tax credit inJune 2021 . A new 2021 investment in a low-income housing tax credit is expected to provide tax benefits in 2022 and beyond. AtDecember 31, 2021 , the Corporation had Maryland Net Operating Losses ("NOLs") of$43.0 million for which a deferred tax asset of$2.8 million has been recorded. There was also aMaryland state interest expense carryforward of$2.5 million , for which a deferred tax asset of$0.2 million has been recorded. There has been and continues to be a full valuation allowance on these NOLs and interest expense deferred tax assets, based on management's belief that it is more likely than not that these NOLs will not be realized prior to the expiration of their carry-forward periods because the Corporation will not generate sufficient taxable income in the future to fully utilize the NOLs. The valuation allowance was$3.0 million and$2.7 million atDecember 31, 2021 and 2020, respectively. We have concluded that no valuation allowance is deemed necessary for our remaining federal and state deferred tax assets atDecember 31, 2021 , as it is more likely than not that they will be realized based on the expected reversal of deferred tax liabilities, the generation of future income sufficient to realize the deferred tax assets as they reverse, and the ability to implement tax planning strategies to prevent the expiration of any carry-forward periods.
GAAP and Non-GAAP measures
The following tables sets forth certain selected financial data for the years endedDecember 31, 2021 and 2020 and is qualified in its entirety by the detailed information and unaudited financial statements, including the notes thereto, included elsewhere in this quarterly report. For the year endedDecember 31, 2021 2021 2020 Per Share Data
Basic net income per common share (1) - as reported $ 2.95$ 1.98 Basic net income per common share (1) - non-GAAP 3.54 1.98 Diluted net income per common share (1) - as reported $ 2.95$ 1.97 Diluted net income per common share (1) - non-GAAP 3.54 1.97
Significant Ratios:
Return on Average Assets (a) (1) - as reported
1.12 % 0.86 %
Settlement, FHLB and contribution expenses, and insurance
reimbursement income, net of income tax effect
0.23 % - Adjusted Return on Average Assets (a) (1) (non-GAAP)
1.35 % 0.86 %
Return on Average Equity (a) (1) - as reported
14.92 % 10.89 %
Settlement, FHLB and contribution expenses, and insurance
reimbursement income, net of income tax effect
2.90 % - Adjusted Return on Average Equity (a) (1) (non-GAAP)
17.82 % 10.89 %
(1) See reconciliation of this non-GAAP financial measure provided elsewhere herein associated with
settlement, FHLB and contribution expenses, and insurance reimbursement incurred during 2021.
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Year Ended
2021 2020
(in thousands, except for per share amount)
Net income - as reported $ 19,770 $ 13,841
Adjustments:
Settlement expense 3,300 -
FHLB penalty 2,368 -
Charitable contribution 1,000 -
Insurance reimbursement (1,375) -
Income tax effect of adjustment (1,227)
-
Adjusted net income (non-GAAP)$ 23,836 $
13,841
Basic earnings per share - as reported$ 2.95 $
1.98 Adjustments: Settlement expense 0.47 - FHLB penalty 0.35 - Charitable contribution 0.15 - Insurance reimbursement (0.20) -
Income tax effect of adjustment (0.18)
-
Adjusted basic and diluted earnings per share (non-GAAP)
1.98
Diluted earnings per share - as reported$ 2.95 $
1.97
CONSOLIDATED BALANCE SHEET REVIEW
Overview
Total assets atDecember 31, 2021 decreased slightly by$3.6 million sinceDecember 31, 2020 . During 2021, cash and interest-bearing deposits in other banks decreased by$33.7 million , the investment portfolio increased by$47.9 million and gross loans decreased by$14.1 million . Management made strategic decisions to deploy excess cash balances in 2021. Cash was utilized to purchase a$20.0 million consumer loan pool and a$39.0 million pool of mortgage loans for the purpose of offsetting the decline in mortgage portfolio balances due to the continued utilization of theFNMA secondary market for refinancing activity. Management also used$70.0 million to prepay FHLB advances in the third quarter. Additionally, approximately$60.0 million was used to purchase investment securities and to purchase a$10.0 million student loan pool late in the fourth quarter. OREO balances decreased$4.9 million related to the sale of parcels of real estate securing a large commercial participation loan and additional sales of undeveloped lots. We anticipate further reductions to OREO balances during the first quarter of 2022 as we consummate additional sale contracts. Total liabilities decreased by$14.4 million when compared to liabilities atDecember 31, 2020 . The decrease in 2021 was attributable to deposit growth of$47.0 million due to stimulus programs and to growth in core relationships, increased balances in short-term borrowings related to our Treasury Management product, offset by the prepayment of$70.0 million in FHLB long-term borrowings. Total shareholders' equity increased by$10.9 million during the year endedDecember 31, 2021 , as net income of$19.8 million was offset by the repurchase of$7.2 million (400,000 shares) of Common Stock, the payment of$3.9 million in dividends and the improvement of$1.5 million in accumulated other comprehensive loss.
As indicated below, the total interest-earning asset mix remained relatively
constant at
each year is illustrated below.
Year End Percentage
of Total Assets
2021 2020
Cash and cash equivalents 7% 9%
Net loans 66% 66%
Investments 20% 17%
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The year-end total liability mix has remained consistent during the two-year
period as illustrated below.
Year End Percentage
of Total Liabilities
2021 2020
Total deposits 93% 90%
Total borrowings 6% 9%
Loan Portfolio
The Bank is actively engaged in originating loans to customers primarily inAllegany County ,Frederick County ,Garrett County , andWashington County inMaryland , and inBerkeley County ,Mineral County ,Monongalia County , andHarrison County inWest Virginia ; and the surrounding regions ofWest Virginia andPennsylvania . 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 ALL. 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, equipment and vehicles. Unsecured commercial loans represent an insignificant portion of total commercial loans. Residential mortgage loans are collateralized by the related property. Generally, a 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 also have made 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 heading "Banking Products and Services". The following table 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 ofDecember 31 for any of the years presented. Summary of Loan Portfolio
The following table presents the composition of our loan portfolio as of
(In millions) 2021 2020
Commercial real estate
Acquisition and development 128.1 117.0
Commercial and industrial * 181.0 266.7
Residential mortgage
404.7 379.2 Consumer 65.6 35.7 Total Loans$ 1,153.7 $ 1,167.8
*Included
Outstanding loans of$1.2 billion atDecember 31, 2021 reflected a decline of$14.1 million during 2021. Core commercial loan growth was offset by PPP loans that were forgiven. CRE loans increased by$5.1 million , A&D loans increased by$11.1 million and C&I loans decreased by$85.8 million , as growth in core portfolio loans of$20.5 million was offset by PPP loans that were forgiven. Residential mortgage loans increased$25.5 million due to the purchase of a$39.0 million loan pool of 1-4 family residential loans, offset by the decline in mortgage portfolio balances due to the continued utilization of theFNMA secondary market for refinancing activity. Given the current low interest rate environment, customers were seeking longer-term, fixed-rate loans and management chose not to book these longer-term low fixed rate mortgage loans in the portfolio. The consumer loan portfolio increased by$29.9 million due to the purchase of a pool of consumer loans in the second quarter of 2021 and the purchase of a$10.0 million pool of student loans late in 39
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the fourth quarter as an effort to deploy excess cash into higher yielding,
short-term assets. Management strategically purchased loan pools to complement
the portfolio loans and to assist in managing interest rate risk.
Commercial loan production for the year endedDecember 31, 2021 was approximately$178.0 million , with$42.0 million originated during the fourth quarter, exclusive of PPP loan production. PPP loan production was approximately$64.3 million for 2021. AtDecember 31, 2021 , unfunded, committed commercial construction loans totaled approximately$25.5 million . Commercial amortization and payoffs were approximately$119.0 million throughDecember 31, 2021 , exclusive of PPP. Consumer mortgage loan production was approximately$119.3 million throughDecember 31, 2021 . The production and pipeline mix of in-house, portfolio loans and investor loans remained strong as ofDecember 31, 2021 , with those loans totaling$15.3 million , consisting of$13.4 million in portfolio loans and$1.9 million in investor loans. At the end of the second quarter of 2021, management implemented special promotions for residential mortgage products to shift production towards portfolio loans and utilize excess cash balances.
The following table sets forth the maturities, based upon contractual dates, for
selected loan categories as of
Maturities of Loan Portfolio at December 31, 2021
Fixed Rate Loans
Maturing
Maturing After After
Maturing One Year Five Years
Within But Within Within Fifteen Maturing After
(In thousands) One Year Five Years Years Fifteen Years Total
Commercial Real
Estate $ 17,355 $ 185,679 $ 47,268 $ 1,027 $ 251,329
Acquisition and
Development 81,210 4,638 751 - 86,599
Commercial and
Industrial * 21,687 63,330 29,121 147 114,285
Residential Mortgage 1,398 30,781 34,621 99,632 166,432
Consumer 1,790 35,012 18,130 3,333 58,265
Total Loans $ 123,440 $ 319,440 $ 129,891 $ 104,139 $ 676,910
Variable Rate Loans
Maturing
Maturing After After
Maturing One Year Five Years
Within But Within Within Fifteen Maturing After
(In thousands) One Year Five Years Years Fifteen Years Total
Commercial Real
Estate $ 13,923 $ 20,085 $ 64,253 $ 24,701 $ 122,962
Acquisition and
Development 16,843 7,609 6,473 10,553 41,478
Commercial and
Industrial * 29,242 18,903 17,316 1,230 66,691
Residential Mortgage 2,274 2,415 16,314 217,251 238,254
Consumer 3,535 35 290 3,532 7,392
Total Loans $ 65,817 $ 49,047 $
104,646
* Commercial and Industrial includes
Management monitors the performance and credit quality of the loan portfolio by
analyzing the age of the portfolio as determined by the length of time a
required payment is past due. A loan is considered to be past due when a
scheduled payment has not been received for 30 days past its contractual due
date. For all loan segments, the accrual of interest is discontinued when
principal or interest is delinquent for 90 days or more unless the loan is
well-secured and in the process of collection. All non-accrual loans are
considered to be impaired. Interest payments received on non-accrual loans are
applied as a reduction of the loan principal balance. Loans are returned to
accrual status when all principal and interest amounts contractually due are
brought current and future payments are reasonably assured. Our policy for
recognizing interest income on impaired loans does not differ from our overall
policy for interest recognition.
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The following sets forth the amounts of non-accrual, past-due and restructured
loans for the past two years:
Risk Elements of Loan Portfolio
At December 31,
(In thousands) 2021 2020
Non-accrual loans:
Commercial real estate $ 81 $ 898
Acquisition and development 390 366
Commercial and industrial 90 -
Residential mortgage 1,901 2,048
Consumer - 27
Total non-accrual loans $ 2,462 $ 3,339
Accruing Loans Past Due 90 days or more:
Acquisition and development - 10
Residential mortgage 148 710
Consumer 152 4
Total accruing loans past due 90 days or more$ 300 $
724
Total non-accrual and past due 90 days or more$ 2,762 $
4,063 Restructured Loans (TDRs): Performing$ 2,997 $ 3,657 Non-accrual (included above) 300 301 Total TDRs$ 3,297 $ 3,958 Other Real Estate Owned$ 4,477 $ 9,386 Total Non-performing assets$ 7,239 $ 13,449
Impaired loans without a valuation allowance$ 5,248 $
6,060
Impaired loans with a valuation allowance 480
1,399
Total impaired loans$ 5,728 $
7,459
Valuation allowance related to impaired loans$ 64 $
57
Non-accrual loans to total loans (as %) 0.21%
0.29%
Non-performing loans to total loans (as %) 0.24%
0.35%
Non-performing assets to total assets (as %) 0.42%
0.78%
Allowance for loan losses to non-accrual loans (as %) 648.05% 493.74%
Allowance for loan losses to non-performing assets (as %) 220.40% 122.58%
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The following table sets forth the percent applicable by portfolio for
non-accrual loans for the past two years:
Non-Accrual Loans as a % of Applicable Portfolio
2021 2020
Commercial real estate 0.0% 0.2%
Acquisition and development 0.3% 0.3%
Commercial and industrial 0.0% 0.0%
Residential mortgage 0.5% 0.5%
Consumer 0.0% 0.1%
We would have recognized
accordance with their terms. During 2021, we recognized, on a cash basis,
Performing loans considered to be impaired (including performing troubled debt restructurings, or TDRs), as defined and identified by management, amounted to$3.3 million atDecember 31, 2021 and$4.1 million atDecember 31, 2020 . Loans are identified as impaired when, based on current information and events, management determines that we will be unable to collect all amounts due according to contractual terms. These loans consist primarily of A&D loans and CRE loans. The fair values are generally determined based upon independent third-party appraisals of the collateral or discounted cash flows based upon the expected proceeds. Specific allocations have been made where there is insufficient collateral to repay the loan balance if liquidated and there is no secondary source of repayment available. The level of performing impaired loans (other than performing TDRs) decreased by$0.6 million during the year endedDecember 31, 2021 . The increase in allowance for loan losses as a percentage of non-accrual loans was related to the reduction in non-accrual loans during 2021 and the increase in allowance for loan losses to non-performing assets was primarily related to the decrease in OREO balances in 2021. A troubled debt restructuring is the restructuring of a loan in which one or more concessions are granted to a borrower who is experiencing financial difficulties. A loan will be classified as a TDR if the Bank restructures the loan's terms (i.e., interest rate, payment amount, amortization period and/or maturity date) after determining that the borrower is experiencing financial difficulties. A modified loan is considered to be a TDR when the Bank has determined that the borrower is experiencing financial difficulties. The Bank evaluates the probability that the borrower will be in payment default on any of its debt in the foreseeable future without modification. To make this determination, the Bank performs a global financial review of the borrower and loan guarantors to assess their current ability to meet their financial obligations. 42 Table of Contents The following table presents the details of TDRs by loan class atDecember 31, 2021 andDecember 31, 2020 : December 31, 2021 December 31, 2020 Number of Recorded Number of Recorded (Dollars in thousands) Contracts Investment Contracts Investment Performing Commercial real estate Non owner-occupied 1$ 106 1$ 224 All other CRE 2 2,178 2 2,208 Acquisition and development
1-4 family residential construction 1 239
1 266 All other A&D - - 1 210 Commercial and industrial - - - - Residential mortgage Residential mortgage - term 6 474 7 749
Residential mortgage - home equity - -
- - Consumer - - - - Total performing 10$ 2,997 12$ 3,657 Non-accrual Commercial real estate Non owner-occupied - $ - - $ - All other CRE - - - - Acquisition and development
1-4 family residential construction - -
- - All other A&D - - - - Commercial and industrial - - - - Residential mortgage Residential mortgage - term 2 300 2 301
Residential mortgage - home equity - -
- - Consumer - - - - Total non-accrual 2 300 2 301 Total TDRs 12$ 3,297 14$ 3,958
The level of TDRs decreased by$0.7 million during the year endedDecember 31, 2021 . There were no new loans added to TDRs and four loans already in performing TDRs were re-modified. During the year endedDecember 31, 2021 , two loans totaling$0.4 million paid off. Net principal payments totaling$0.2 million were received during the same time period. AtDecember 31, 2021 , there were no additional funds committed to be advanced in connection with TDRs. Interest income not recognized due to rate modifications of TDRs was$61 thousand and interest income recognized on all TDRs was$0.2 million in 2021. While the COVID-19 pandemic has had an impact on most industries, some have been more affected than others. In accordance with Section 4013 of the Coronavirus Aid, Relief, and Economic Security Act and related regulatory pronouncements, we have not accounted for modifications of loans affected by the pandemic as troubled debt restructurings nor have we designated them as past due or nonaccrual. As ofDecember 31, 2021 , total loan modifications of$9.4 million were performed in accordance with the CARES Act. This amount included 13 commercial loans related to real estate rental, food services and health care sectors. These loans are scheduled to return to contractual payment terms within the first
quarter of 2022.
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Allowance for Loan Losses
The ALL is maintained to absorb probable incurred credit losses from the loan
portfolio. The ALL is based on management's continuing evaluation of the quality
of the loan portfolio, assessment of current economic conditions,
diversification and size of the portfolio, adequacy of collateral, past and
anticipated loss experience, and the amount of non-performing loans.
The ALL is also based on estimates, and actual losses will vary from current
estimates. These estimates are reviewed quarterly, and as adjustments, either
positive or negative, become necessary, a corresponding increase or decrease is
made in the ALL. The methodology used to determine the adequacy of the ALL is
consistent with prior years. An estimate for probable losses related to unfunded
lending commitments, such as letters of credit and binding but unfunded loan
commitments is also prepared. This estimate is computed in a manner similar to
the methodology described above, adjusted for the probability of actually
funding the commitment. At December 31, 2021 and 2020, the balance for reserve
for probable losses on unfunded commitments, included in other liabilities in
the consolidated statements of financial condition, was $0.1 million .
The ALL was $16.0 million at December 31, 2021 compared to $16.5 million at
December 31, 2020 , a decrease of 3.2% that resulted primarily from improvements
in unemployment rates and a decline in total delinquencies. Net recoveries of
$0.3 million were recorded for 2021, compared to net charge-offs of $1.5 million
for 2020. The ratio of the ALL to loans outstanding, including PPP loan
balances, was 1.38% at December 31, 2021 compared to 1.41% at December 31, 2020 .
The ALL to loans outstanding, excluding PPP loan balances of $7.7 million and
$114.0 million , was 1.39% and 1.55% at December 31, 2021 and 2020, respectively,
non-GAAP.
The ratio of net recoveries to average loans for the year ended December 31,
2021 was an annualized 0.02%, compared to net charge-offs to average loans of
0.13% for the year ended December 31, 2020 . The improvement was primarily
related to the $1.1 million charge off of a formerly allocated specific
allowance on an adversely classified non-accrual participation loan during the
third quarter of 2020. This loan was subsequently purchased by the lending group
at foreclosure and moved to the OREO portfolio. The project is now being
aggressively marketed. Our special assets team continues to effectively collect
on charged-off loans, resulting in ongoing overall low charge-off ratios.
Accruing loans past due 30 days or more increased to 0.31%, compared to 0.20% at
December 31, 2020 . Non-accrual loans totaled $2.5 million at December 31, 2021
compared to $3.3 million at December 31, 2020 . The decrease in non-accrual
balances at December 31, 2021 was primarily related to $0.8 million of one CRE
loan that paid off in the fourth quarter of 2021. Two hospitality loans,
totaling approximately $4.0 million , that were moved to non-accrual status
during the first quarter of 2021 returned to accrual status in the fourth
quarter of 2021 after successfully paying full contractual payments for six
months.
The ALL at December 31, 2021 is adequate to provide for probable losses inherent
in our loan portfolio. Amounts that will be recorded for the provision for loan
losses in future periods will depend upon trends in the loan balances, including
the composition of the loan portfolio, changes in loan quality and loss
experience trends, potential recoveries on previously charged-off loans and
changes in other qualitative factors. Management also applies interest rate
risk, collateral value and debt service sensitivity analyses to the CRE loan
portfolio and obtains new appraisals on specific loans under defined parameters
to assist in the determination of the periodic provision for loan losses.
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The following table presents the activity in the ALL by major loan category for
the past two years.
Analysis of Activity in the Allowance for Loan Losses
For the Years Ended December 31,
(In thousands) 2021 2020
Balance, January 1 $ 16,486 $ 12,537
Charge-offs:
Commercial real estate (14) -
Acquisition and development (85) (1,172)
Commercial and industrial (2) (232)
Residential mortgage (141) (217)
Consumer (396) (341)
Total charge-offs (638) (1,962)
Recoveries:
Commercial real estate - 69
Acquisition and development 175 37
Commercial and industrial 513 151
Residential mortgage 66 83
Consumer 170 170
Total recoveries 924 510
Net credit recoveries/(losses) 286 (1,452)
Provision/(credit) for loan losses (817) 5,401
Balance at end of period $ 15,955 $ 16,486
Allowance for loan losses to total loans (as %) 1.38% 1.41%
Net (Charge-offs)/Recoveries as a % of Average Applicable Portfolio
2021 2020
Commercial real estate (0.0)% 0.0%
Acquisition and development 0.1% (1.0)%
Commercial and industrial 0.2% 0.0%
Residential mortgage (0.0)% 0.0%
Consumer (0.4)% (0.5)%
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The following presents management's allocation of the ALL 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 ALL. Specific
allocations in any particular category may be reallocated in the future as
needed to reflect current conditions. Accordingly, the entire ALL is considered
available to absorb losses in any category.
Allocation of the Allowance for Loan Losses
For the Years Ended December 31,
% of % of
Total Total
(In thousands) 2021 Loans 2020 Loans
Commercial real estate $ 6,032 32% $ 5,543 32%
Acquisition and development 2,615 11% 2,339 10%
Commercial and industrial 2,460 16% 2,584 23%
Residential mortgage 3,484 35% 5,150 32%
Consumer 934 6% 370 3%
Unallocated 430 0% 500 0%
Total $ 15,955 100% $ 16,486 100%
Investment Securities
The following table sets forth the composition of our investment securities
portfolio by major category as of the indicated dates:
At December 31,
2021 2020
Fair FV As Fair FV As
Amortized Value % of Amortized Value % of
(In thousands) Cost (FV) Total Cost (FV) Total
Securities
Available-for-Sale:
U.S. government agencies $ 69,602 $ 67,169 23% $ 75,856 $ 76,433 34%
Residential
mortgage-backed agencies 49,630 48,661 17% 22,999 22,899 10%
Commercial
mortgage-backed agencies 51,694 50,868 19% 32,549 33,042 14%
Collateralized mortgage
obligations 93,018 90,077 31% 70,372 70,637 31%
Obligations of states
and political
subdivisions 12,439 12,804 4% 10,144 10,614 5%
Collateralized debt
obligations 18,609 17,192 6% 18,544 13,260 6%
Total available for sale $ 294,992 $ 286,771 100% $ 230,464 $ 226,885 100%
Securities Held to
Maturity:
Residential
mortgage-backed agencies $ 30,634 $ 30,847 47% $ 34,597 $ 35,732 46%
Commercial
mortgage-backed agencies 5,456 5,601 9% 11,716 12,303 16%
Collateralized mortgage
obligations - - 0% 1,348 1,406 2%
Obligations of states
and
political subdivisions 20,169 28,921 44% 20,602 28,171 36%
Total held to maturity $ 56,259 $ 65,369 100% $ 68,263 $ 77,612 100%
Total fair value of investment securities available-for-sale at December 31,
2021 increased by $59.9 million when compared to December 31, 2020 . At
December 31, 2021 , the securities classified as available-for-sale included a
net unrealized loss of $8.2 million , compared to a net unrealized loss of
$3.6 million at December 31, 2020 . These unrealized losses represent the
difference between the fair value and amortized cost of securities in the
portfolio. On June 1, 2014 , management reclassified an amortized cost basis of
$107.6 million of available-for-sale securities to held to maturity. The
unrealized loss of approximately $4.0 million , at the date of transfer, will
continue to be reported in a separate component of shareholders' equity as
accumulated other comprehensive income and will be amortized over the remaining
life of the securities as an adjustment of yield in a manner consistent with the
amortization of any premium or discount.
As discussed in Note 23 to the Consolidated Financial Statements, we measure
fair market values based on the fair value hierarchy established in ASC Topic
820, Fair Value Measurements and Disclosures. The hierarchy gives the highest
priority to unadjusted quoted prices in active markets for identical assets or
liabilities (Level 1 measurements) and the lowest priority to unobservable
inputs (Level 3 measurements). Level 3 prices or valuation techniques require
inputs that are both significant to the valuation assumptions and are not
readily observable in the market (i.e. supported with little
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or no market activity). These Level 3 instruments are valued based on both
observable and unobservable inputs derived from the best available data, some of
which is internally developed, and considers risk premiums that a market
participant would require.
Approximately$269.6 million of the available-for-sale portfolio was valued using Level 2 pricing and had net unrealized losses of$6.8 million atDecember 31, 2021 . The remaining$17.2 million of the securities available-for-sale represents the entire CDO portfolio, which was valued using significant unobservable inputs, or Level 3 pricing. The$1.4 million in net unrealized losses associated with the collateralized debt obligation ("CDO") portfolio relates to nine pooled trust preferred securities. Unrealized losses of$0.6 million was related to seven of the securities that have had non-credit related OTTI charges. The remaining$0.8 million of unrealized losses was related to two securities which have had no OTTI charges. The unrealized losses on these securities are primarily attributable to continued depression in the marketability and liquidity associated with CDOs.
The following table provides a summary of the trust preferred securities in the
CDO portfolio and the credit status of the securities as of
Investment Description First United Level 3 Investments Security Credit Status
Deferrals/ Collateral Number of
Defaults Support Performing
Fair Lowest as % of as % of Issuers/
Amortized Market Unrealized Credit Original Original Performing Collateral Performing Total
Deal Class Cost Value Gain/(Loss) Rating Collateral Collateral Collateral Support Collateral Issuers
Preferred Term Security
8.24% XVIII* C 1,894 1,532 (362) C 676,565 14.82% 267,395 22,044 40 / 56
Preferred Term Security XVIII C 2,717 2,299
(418) C 676,565 14.82% 267,395 22,044 8.24% 40 / 56
Preferred Term Security XIX*
C 1,845 1,868 23 C 700,535 6.57% 407,420 31,335 7.69% 44 / 52 Preferred Term Security XIX* C 1,104 1,121 17 C 700,535 6.57% 407,420 31,335 7.69% 44 / 52 Preferred Term Security XIX* C 2,558 2,615 57 C 700,535 6.57% 407,420 31,335 7.69% 44 / 52 Preferred Term Security XIX* C 1,106 1,121 15 C 700,535 6.57% 407,420 31,335 7.69% 44 / 52 Preferred Term Security XXII* C-1 1,604 1,503
(101) C 1,386,600 10.31% 624,548 74,381 11.91% 58 / 72
Preferred Term Security XXII*
C-1 4,010 3,757
(253) C 1,386,600 10.31% 624,548 74,381 11.91% 58 / 72
Preferred Term Security XXIII
C-1 1,771 1,376
(395) C 1,467,000 12.95% 658,365 104,609 15.89% 70 / 82
Total Level 3 Securities Available for Sale
18,609 17,192
(1,417)
* Security has been deemed other-than-temporarily impaired and loss has been
recognized in accordance with ASC Section 320-10-35.
The terms of the debentures underlying trust preferred securities allow the
issuer of the debentures to defer interest payments for up to 20 quarters, and,
in such case, the terms of the related trust preferred securities require their
issuers to contemporaneously defer dividend payments. The issuers of the trust
preferred securities in our investment portfolio have defaulted and/or deferred
payments, ranging from 6.57% to 14.82% of the total collateral balances
underlying the securities. The securities were designed to include structural
features that provide investors with credit enhancement or support to provide
default protection by subordinated tranches. These features include
over-collateralization of the notes or subordination, excess interest or spread
which will redirect funds in situations where collateral is insufficient, and a
specified order of principal payments. There are securities in our portfolio
that are under-collateralized, which does represent additional stress on our
tranche. However, in these cases, the terms of the securities require excess
interest to be redirected from subordinate tranches as credit support, which
provides additional support to our investment.
Management systematically evaluates securities for impairment on a quarterly
basis. Based upon application of ASC Topic 320 (Section 320-10-35), management
must assess whether (i) the Corporation has the intent to sell the security and
(ii) it is more likely than not that the Corporation will be required to sell
the security prior to its anticipated recovery. If neither applies, then
declines in the fair value of securities below their cost that are considered
other-than-temporary declines are split into two components. The first is the
loss attributable to declining credit quality. Credit losses are recognized in
earnings as realized losses in the period in which the impairment determination
is made. The second component consists of all other losses. The other losses are
recognized in other comprehensive income. In estimating OTTI charges, management
considers (a) the length of time and the extent to which the fair value has been
less than cost, (b) adverse conditions specifically related to the security, an
industry, or a geographic area, (c) the historic and implied volatility of the
security, (d) changes in the rating of a security by a rating agency,
(e) recoveries or additional declines in fair value subsequent to the balance
sheet date, (f) failure of the issuer of the security to make scheduled interest
payments, and (g) the payment structure of the debt security and the likelihood
of the issuer being able to make payments that increase
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in the future. Due to the duration and the significant market value decline in the pooled trust preferred securities held in our portfolio, we performed more extensive testing on these securities for purposes of evaluating whether or not an OTTI has occurred. The market for these securities as ofDecember 31, 2021 was not active and markets for similar securities were also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which these securities trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive, as no new CDOs have been issued since 2007. There are currently very few market participants who are willing to effect transactions in these securities. The market values for these securities, or any securities other than those issued or guaranteed by theU.S. Department of the Treasury (the "Treasury"), are very depressed relative to historical levels. Therefore, in the current market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general rather than being an indicator of credit problems with a particular issue. Given the conditions in the current debt markets and the absence of observable transactions in the secondary and new issue markets, management has determined that (a) the few observable transactions and market quotations that are available are not reliable for the purpose of obtaining fair value atDecember 31, 2021 , (b) an income valuation approach technique (i.e. present value) that maximizes the use of relevant unobservable inputs and minimizes the use of observable inputs will be equally or more representative of fair value than a market approach, and (c) the CDO segment is appropriately classified within Level 3 of the valuation hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date. Management relies on an independent third party to prepare both the evaluations of OTTI and the fair value determinations for the CDO portfolio. Management does not believe that there were any material differences in the OTTI evaluations and pricing betweenDecember 31, 2021 andDecember 31, 2020 . The approach used by the third party to determine fair value involved several steps, which included detailed credit and structural evaluation of each piece of collateral in each bond, projection of default, recovery and prepayment/amortization probabilities for each piece of collateral in the bond, and discounted cash flow modeling. The discount rate methodology used by the third party combines a baseline current market yield for comparable corporate and structured credit products with adjustments based on evaluations of the differences found in structure and risks associated with actual and projected credit performance of each CDO being valued. Currently, the only active and liquid trading market that exists is for stand-alone trust preferred securities, with a limited market for highly-rated CDO securities that are more senior in the capital structure than the securities in the CDO portfolio. Therefore, adjustments to the baseline discount rate are also made to reflect the additional leverage found in structured instruments. Based upon a review of credit quality and the cash flow tests performed by the independent third party, management determined that no additional credit-related OTTI was required during 2021. 48
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The following table sets forth the contractual or estimated maturities of the components of our investment securities portfolio as ofDecember 31, 2021 and the weighted average yields on a tax-equivalent basis. Investment Security Maturities, Yields, and Fair Values atDecember 31, 2021 Within 1 Year 5 Years Over Total (In thousands) 1 Year To 5 Years To 10 Years 10 Years Fair Value Securities Available-for-Sale: U.S. government agencies $ -$ 5,064 $ 18,536 $ 43,569 $ 67,169 Residential mortgage-backed agencies - 10,380 28,156 10,125 48,661 Commercial mortgage-backed agencies 239 21,840 28,789 - 50,868 Collateralized mortgage obligations 3,007 41,309 45,761 - 90,077 Obligations of states and political subdivisions - 4,437 508 7,859 12,804 Collateralized debt obligations - - - 17,192 17,192 Total available for sale$ 3,246 $ 83,030 $ 121,750 $ 78,745 $ 286,771 Percentage of total 1.13% 28.95% 42.46% 27.46% 100.00% Weighted average yield 1.06% 1.30% 1.47% 1.10% 1.31% Held to Maturity: Residential mortgage-backed agencies$ 1,859 $ 8,795 $ 139$ 20,054 $ 30,847 Commercial mortgage-backed agencies - 5,601 $ - - 5,601 Collateralized mortgage obligations - - - - - Obligations of states and political subdivisions - - - 28,921 28,921 Total held to maturity$ 1,859 $ 14,396 $ 139$ 48,975 $ 65,369 Percentage of total 2.85% 22.02% 0.21% 74.92% 100.00% Weighted average yield (0.76)% 2.63% 5.33% 3.08% 2.88% The weighted average yield was calculated using historical cost balances and does not give effect to changes in fair value. The negative weighted average yield was due to increased paydowns on mortgage-backed securities that impacted their factors and three month conditional prepayment rate. AtDecember 31, 2021 , one Tax Increment Funding bond totaling$18.3 million exceeded 10% of shareholders' equity. 49 Table of Contents Deposits The following table sets forth the deposit balances by major category for 2021 and 2020: Deposit Balances 2021 2020 (In thousands) Actual Balance Percent Actual Balance Percent Non-interest-bearing demand deposits$ 501,627 34%$ 420,427 30% Interest-bearing deposits: Demand 228,175 16% 201,571 14% Money Market 339,748 23% 376,096 26% Savings deposits 236,595 16% 196,046 14% Time deposits 163,229 11% 228,226 16% Total Deposits$ 1,469,374 100%$ 1,422,366 100% Total deposits atDecember 31, 2021 increased by$47.0 million when compared to deposits atDecember 31, 2020 . During 2021, non-interest-bearing deposits increased by$81.2 million , driven by retail and commercial account growth partially attributable to government stimulus programs. Traditional savings accounts increased by$40.5 million as we continued to see significant growth in our Prime Saver product, and total demand deposits increased by$26.6 million . Total money market accounts decreased by$36.3 million due primarily to management's decision to sweep approximately$70.0 million of wealth management money market funds off balance sheet in the first quarter of 2021. These funds can be readily shifted back to in-house money market accounts should liquidity needs arise in the future. Time deposits decreased by$65.0 million , primarily due to the continued efforts to reduce pricing on single-service relationships and municipal bids. Borrowed Funds
The following shows the composition of our borrowings at
(In thousands) 2021 2020
Securities sold under agreements to repurchase
Total short-term borrowings
$ 57,699 $ 49,160 Long-term FHLB advances $ -$ 70,000 Junior subordinated debentures 30,929 30,929 Total long-term borrowings$ 30,929 $ 100,929 Total borrowings$ 88,628 $ 150,089 Average balance (from Table 1)$ 135,037 $ 147,448 50 Table of Contents
The following is a summary of short-term borrowings at
maturities of less than one year:
(Dollars in thousands) 2021 2020 Securities sold under agreements to repurchase: Outstanding at end of year$ 57,699 $ 49,160 Weighted average interest rate at year end 0.15% 0.19%
Maximum amount outstanding as of any month end
Average amount outstanding
57,697 46,519
Approximate weighted average rate during the year 0.15% 0.20%
Total borrowings decreased by$61.5 million , or 40.9%, in 2021 when compared to 2020 due to the prepayment of$70.0 million in FHLB advances in 2021, offset by increased balances in our existing accounts in our Treasury Management product. Management will continue to closely monitor interest rates within the context of its overall asset-liability management process. See the discussion under the heading "Interest Rate Sensitivity" in this Item 7 for further information on this topic. AtDecember 31, 2021 , we had additional borrowing capacity with the FHLB totaling$188.2 million , an additional$130.0 million of unused lines of credit with various financial institutions, and$1.0 million of an unused secured line of credit with theFederal Reserve Bank . See Note 14 to the Consolidated Financial Statements presented elsewhere in this annual report for further details about our borrowings and additional borrowing capacity, which is incorporated herein by reference.
Off-Balance Sheet Arrangements
In the normal course of business, to meet the financing needs of its customers, the Bank is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit, lines of credit, and standby letters of credit. Our exposure to credit loss in the event of nonperformance by the other party to these financial instruments is represented by the contractual amount of the instruments. The credit risks inherent in loan commitments and letters of credit are essentially the same as those involved in extending loans to customers, and these arrangements are subject to our normal credit policies. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. We generally require collateral or other security to support the financial instruments with credit risk. The amount of collateral or other security is determined based on management's credit evaluation of the counterparty. We evaluate each customer's creditworthiness on a case-by-case basis. Loan commitments and letters of credit totaled$226.0 million and$16.7 million , respectively, atDecember 31, 2021 . Management does not believe that any of the foregoing arrangements have or are reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. We are not a party to any other off-balance sheet arrangements. See Note 22 to the Consolidated Financial Statements presented elsewhere in this annual report for additional information on these arrangements.
Capital Resources
We require capital to fund loans, satisfy our obligations under the Bank's letters of credit, meet the deposit withdraw demands of the Bank's customers, and satisfy our other monetary obligations. To the extent that deposits are not adequate to fund our capital requirements, we can rely on the funding sources identified below under the heading "Liquidity Management". AtDecember 31, 2021 , the Bank had$130.0 million available through unsecured lines of credit with correspondent banks,$1.0 million available through a secured line of credit with the Fed Discount Window and approximately$188.2 million available through the FHLB. Management is not aware of any demands, commitments, events or uncertainties that are likely to materially affect our ability to meet our future capital requirements. 51
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In addition to operational requirements, the Bank and the Corporation are subject to risk-based capital regulations, which were adopted and are monitored by federal banking regulators. These regulations are used to evaluate capital adequacy and require an analysis of an institution's asset risk profile and off-balance sheet exposures, such as unused loan commitments and stand-by letters of credit. Detailed information about these capital regulations and their requirements is set forth in the "Supervision and Regulation" section of Item 1 of Part I of this annual report under the heading "Capital Requirements". AtDecember 31, 2021 , the Corporation's total risk-based capital ratio was 15.89% and the Bank's total risk-based capital ratio was 14.97%, both of which were well above the regulatory minimum of 8%. The total risk-based capital ratios of the Corporation and the Bank atDecember 31, 2020 were 16.08% and 15.50%, respectively. The decrease in 2021 for the Corporation was attributable to the repurchase of 400,000 common shares ($7.2 million ); and the Bank was primarily due to dividend funding to the Corporation.
At
categorizes the Corporation and the Bank as "well capitalized" under the
regulatory framework for prompt corrective action. See Note 6 to the
Consolidated Financial Statements presented elsewhere in this annual report for
additional information regarding regulatory capital ratios.
Liquidity Management
Liquidity is a financial institution's capability to meet customer demands for
deposit withdrawals while funding all credit-worthy loans. The factors that
determine the institution's liquidity are:
? Reliability and stability of core deposits;
? Cash flow structure and pledging status of investments; and
? Potential for unexpected loan demand.
We actively manage our liquidity position through meetings of a sub-committee of executive management, which looks forward 12 months at 30-day intervals. The measurement is based upon the projection of funds sold or purchased position, along with ratios and trends developed to measure dependence on purchased funds and core growth. Monthly reviews by management and quarterly reviews by theAsset and Liability Committee under prescribed policies and procedures are designed to ensure that we will maintain adequate levels of available funds. It is our policy to manage our affairs so that liquidity needs are fully satisfied through normal Bank operations. That is, the Bank will manage its liquidity to minimize the need to make unplanned sales of assets or to borrow funds under emergency conditions. The Bank will use funding sources where the interest cost is relatively insensitive to market changes in the short run (periods of one year or less) to satisfy operating cash needs. The remaining normal funding will come from interest-sensitive liabilities, either deposits or borrowed funds. When the marginal cost of needed wholesale funding is lower than the cost of raising this funding in the retail markets, the Corporation may supplement retail funding with external funding sources such as:
Unsecured Fed Funds lines of credit with upstream correspondent banks (M&T
? Bank,
Services, Pacific Coast Banker's Bank and
Secured advances with the FHLB of
? one to four family residential mortgage loans, home equity lines of credit,
commercial real estate loans. Cash and various securities may also be pledged
as collateral.
? Secured line of credit with the Fed Discount Window for use in borrowing funds
up to 90 days, using municipal securities as collateral.
Brokered deposits, including CDs and money market funds, provide a method to
? generate deposits quickly. These deposits are strictly rate driven but often
provide the most cost effective means of funding growth.
? One Way Buy CDARS/ICS funding - a form of brokered deposits that has become a
viable supplement to brokered deposits obtained directly.
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We have adequate liquidity available to respond to current and anticipated liquidity demands and is not aware of any trends or demands, commitments, events or uncertainties that are likely to materially affect our ability to maintain liquidity at satisfactory levels.
Market Risk and Interest Sensitivity
Our primary market risk is interest rate fluctuation. Interest rate risk results primarily from the traditional banking activities that we engage in, such as gathering deposits and extending loans. Many factors, including economic and financial conditions, movements in interest rates and consumer preferences affect the difference between the interest earned on our assets and the interest paid on our liabilities. Interest rate sensitivity refers to the degree that earnings will be impacted by changes in the prevailing level of interest rates. Interest rate risk arises from mismatches in the repricing or maturity characteristics between interest-bearing assets and liabilities. Management seeks to minimize fluctuating net interest margins, and to enhance consistent growth of net interest income through periods of changing interest rates. Management uses interest sensitivity gap analysis and simulation models to measure and manage these risks. The interest rate sensitivity gap analysis assigns each interest-earning asset and interest-bearing liability to a time frame reflecting its next repricing or maturity date. The differences between total interest-sensitive assets and liabilities at each time interval represent the interest sensitivity gap for that interval. A positive gap generally indicates that rising interest rates during a given interval will increase net interest income, as more assets than liabilities will reprice. A negative gap position would benefit us during a period of declining interest rates.
At
Our interest rate risk management goals are:
Ensure that the Board of Directors and senior management will provide effective
? oversight and ensure that risks are adequately identified, measured, monitored
and controlled;
? Enable dynamic measurement and management of interest rate risk;
Select strategies that optimize our ability to meet our long-range financial
? goals while maintaining interest rate risk within policy limits established by
the Board of Directors;
? Use both income and market value oriented techniques to select strategies that
optimize the relationship between risk and return; and
? Establish interest rate risk exposure limits for fluctuation in net interest
income ("NII"), net income and economic value of equity.
In order to manage interest sensitivity risk, management formulates guidelines
regarding asset generation and pricing, funding sources and pricing, and
off-balance sheet commitments. These guidelines are based on management's
outlook regarding future interest rate movements, the state of the regional and
national economy, and other financial and business risk factors. Management uses
computer simulations to measure the effect on net interest income of various
interest rate scenarios. Key assumptions used in the computer simulations
include cash flows and maturities of interest rate sensitive assets and
liabilities, changes in asset volumes and pricing, and management's capital
plans. This modeling reflects interest rate changes and the related impact on
net interest income over specified periods.
We evaluate the effect of a change in interest rates of +/-100 basis points to
+/-400 basis points on both NII and Net Portfolio Value ("NPV") / Economic Value
of Equity ("EVE"). We concentrate on NII rather than net income as long as NII
remains the significant contributor to net income.
NII modeling allows management to view how changes in interest rates will affect
the spread between the yield earned on assets and the cost of deposits and
borrowed funds. Unlike traditional Gap modeling, NII modeling takes into account
the different degree to which installments in the same repricing period will
adjust to a change in interest rates. It also allows the use of different
assumptions in a falling versus a rising rate environment. The period considered
by the NII modeling is the next eight quarters.
NPV / EVE modeling focuses on the change in the market value of equity. NPV /
EVE is defined as the market value of assets less the market value of
liabilities plus/minus the market value of any off-balance sheet positions. By
53
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effectively looking at the present value of all future cash flows on or off the
balance sheet, NPV / EVE modeling takes a longer-term view of interest rate
risk. This complements the shorter-term view of the NII modeling.
Measures of NII at risk produced by simulation analysis are indicators of an institution's short-term performance in alternative rate environments. These measures are typically based upon a relatively brief period, usually one year. They do not necessarily indicate the long-term prospects or economic value of the institution.
Based on the simulation analysis performed at
management estimated the following changes in net interest income, assuming the
indicated rate changes:
(Dollars in thousands) 2021 2020 +400 basis points$ 4,072 $ 5,124 +300 basis points$ 3,233 $ 4,067 +200 basis points$ 2,315 $ 2,897 +100 basis points$ 1,160 $ 1,527 -100 basis points$ (3,110) $ (2,174)
This estimate is based on assumptions that may be affected by unforeseeable changes in the general interest rate environment and any number of unforeseeable factors. Rates on different assets and liabilities within a single maturity category adjust to changes in interest rates to varying degrees and over varying periods of time. The relationships between lending rates and rates paid on purchased funds are not constant over time. Management can respond to current or anticipated market conditions by lengthening or shortening the Bank's sensitivity through loan repricings or changing its funding mix. The rate of growth in interest-free sources of funds will influence the level of interest-sensitive funding sources. In addition, the absolute level of interest rates will affect the volume of earning assets and funding sources. As a result of these limitations, the interest-sensitive gap is only one factor to be considered in estimating the net interest margin. Impact of Inflation - Our assets and liabilities are primarily monetary in nature, and as such, future changes in prices do not affect the obligations to pay or receive fixed and determinable amounts of money. During inflationary periods, monetary assets lose value in terms of purchasing power and monetary liabilities have corresponding purchasing power gains. The concept of purchasing power is not an adequate indicator of the impact of inflation on financial institutions because it does not incorporate changes in our earnings.
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 heading "Market Risk and
Interest Sensitivity".
54
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