UNITED STATES SECURITIES AND EXCHANGE COMMISSION FORM 10-K
WASHINGTON, DC 20549
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 0-14237
FIRST UNITED CORPORATION
(Exact name of registrant as specified in its charter)
Maryland 52-1380770
(State or other jurisdiction (I.R.S. Employer
incorporation or organization) Identification No.)
19 South Second Street
Oakland, Maryland 21550-0009
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (301) 334-9471
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $.01 per share
(Title of class)
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, and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
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 l0-K or any amendment to this Form 10-K. X
The aggregate market value of the voting stock held by non-affiliates of the
registrant as of February 26, 1999: Common Stock $.01
Par Value-$97,183,407
The number of shares outstanding of the registrant's classes of common stock
as of February 26, 1999: 6,154,550 Shares
Documents Incorporated by Reference
Portions of the registrant's definitive proxy statement for the annual
shareholders meeting to be held April 27, l999, are incorporated by reference
into Part III.
[1]
First United Corporation
Table of Contents
PART I
Item l. Business 3
Item 2. Properties 6
Item 3. Legal Proceedings 7
Item 4. Submission of Matters to a Vote of Security Holders 7
PART II
Item 5. Market for the Registrant's Common Stock and
Related Shareholder Matters 8
Item 6. Selected Financial Data 9
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10 - 26
Item 7A. Quantitative and Qualitative Disclosure About
Market Risk 27
Item 8. Financial Statements and Supplementary Data 28-45
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 45
PART III
Item 10. Directors and Executive Officers of the Registrant 46 - 47
Item ll. Executive Compensation 47
Item 12. Security Ownership of Certain Beneficial Owners and
Management 47
Item 13. Certain Relationships and Related Transactions 47
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K 47
Signatures 49
[2]
PART I
Item 1. BUSINESS
FIRST UNITED CORPORATION
First United Corporation (the "Corporation") headquartered in Oakland,
Maryland, is a one-bank holding company with one non-bank subsidiary. The
Corporation was organized under the laws of the State of Maryland in 1985. In
1995, the Corporation merged two of its three wholly owned banking subsidiaries,
First United Bank of West Virginia, N.A. and Myersville Bank, with its other
wholly owned banking subsidiary, First United Bank & Trust.
First United Bank & Trust and Oakfirst Life Insurance Corporation are the
only operating subsidiaries of the Corporation.
FIRST UNITED BANK &TRUST
First United Bank & Trust is a commercial bank whose predecessor bank, First
United National Bank & Trust, was originally chartered in 1990. The deposits of
First United Bank & Trust are insured by the Federal Deposit Insurance
Corporation (FDIC).
First United Bank & Trust operates twenty-two banking offices, five
facilities in Garrett County, Maryland, six in Allegany County, Maryland, three
in Washington County, Maryland, two in Frederick County, Maryland, two in
Mineral County, West Virginia, one in Hampshire County, West Virginia, two in
Berkeley County, West Virginia and one in Hardy County, West Virginia. First
United also operates a total of twenty-seven Automated Teller Machines (ATM's),
seven of which are located in Garrett County, Maryland, nine in Allegany County,
Maryland, four in Washington County, Maryland, three in Frederick County,
Maryland, and one each m Mineral, Hampshire, Berkeley and Hardy Counties in West
Virginia. First United Bank & Trust provides a complete range of retail and
commercial banking services to a customer base in Garrett, Allegany, Washington
and Frederick Counties in Maryland, in Mineral, Hampshire, Berkeley and Hardy
Counties in West Virginia and to residents in surrounding regions of
Pennsylvania and West Virginia. The customer base in the aforementioned
geographical area consists of individuals, businesses and various governmental
units. The services provided by First United Bank & Trust include checking,
savings, NOW and Money Market deposit accounts, business loans, personal loans,
mortgage loans, lines of credit and consumer-oriented financial services
including IRA and KEOGH accounts. In addition, First United Bank & Trust
provides full brokerage services through a networking arrangement with PrimeVest
Financial Services, Inc., a full service broker-dealer. First United Bank &
Trust also provides safe deposit and night depository facilities and a complete
line of trust services. As of December 31, 1998, First United Bank & Trust had
total deposits of $513.54 million and total loans of $508.97 million. The total
market value of assets under the supervision of the Trust Department was
approximately $238 million.
OAKFIRST LIFE INSURANCE CORPORATION
Oakfirst Life Insurance Corporation is a reinsurance company that reinsures
credit life and credit accident and health insurance written by American General
Assurance Company on consumer loans made by First United Bank & Trust. Oakfirst
Life Insurance Corporation, which was chartered in 1989, is a wholly owned
subsidiary of the Corporation.
Competition
The Corporation's banking subsidiary, First United Bank & Trust competes with
various other state banking associations, national banks, branches of major
regional banks, savings and loan associations, savings banks, mortgage companies
and credit unions, as well as other financial service institutions such as
insurance companies, brokerage firms and various other investment firms. In
addition to this local competition, First United Bank & Trust also competes for
banking business with institutions located outside the States of Maryland and
West Vlrginia.
[3]
Supervision and Regulation of Banking Entities
The Corporation is a registered bank holding company subject to regulation
and examination by the Board of Governors of the Federal Reserve System under
the Bank Holding Company Act of 1956 (the "Act"). The Corporation is required to
file with the board of governors, quarterly and annual reports and any
additional information that may be required according to the Act. The Act also
requires every bank holding company to obtain the prior approval of the Federal
Reserve Board before acquiring direct or indirect ownership or control of more
than 5% of the voting shares of any bank which is not already majority owned.
The Act also prohibits a bank holding company, with certain exceptions, from
engaging in or acquiring direct or indirect control of more than 5% of the
voting shares of any company engaged in non-banking activities. One of the
principal exceptions to these provisions is engaging in or acquiring shares of a
company engaged in activities found by the Federal Reserve Board to be so
closely related to banking or managing banks as to be a proper incident thereto.
The Federal Deposit Insurance Corporation Improvement Act of l991 ("FDICIA")
was enacted in December l 991. FDICIA was primarily designed to provide
additional financing for the FDIC by increasing its borrowing ability. The FDIC
was given the authority to increase deposit insurance premiums to repay any
such borrowing. In addition, FDICIA identifies capital standard categories for
financial institutions: well capitalized, adequately capitalized,
undercapitalized, significantly undercapitalized, and critically
undercapitalized. FDICIA imposes progressively more restrictive constraints on
operations, management and capital distributions depending on the category in
which an institution is classified. Pursuant to FDICIA, undercapitalized
institutions must submit recapitalization plans, and a holding company
controlling a failing institution must guarantee such institution's compliance
with its plan.
During 1995, the Bank Insurance Fund (BIF) reached the funding levels
required by FDICIA As a result of the well capitalized position of First United
Bank & Trust, the Bank incurred a reduction in its FDIC premium. As a result of
its continued well capitalized position, the Bank paid no FDIC premiums in 1998
and 1997.
FDICIA also requires the various regulatory agencies to prescribe certain
non-capital standards for safety and soundness relating generally to operations
and management, asset quality and executive compensation and permits regulatory
action against a financial institution that does not meet such standards. The
statute also imposes limitations on certain mergers and consolidations between
insured depository institutions with different home states.
First United Bank & Trust is a state trust insured banking association. Its
operation is subject to Federal and state laws applicable to commercial banks
with trust powers and to regulation by the Federal Reserve Board, and the FDIC.
The Corporation is examined periodically by the Federal Reserve Board, the state
banking subsidiary is regularly examined by the FDIC and Maryland State Banking
Commission and Oakfirst Life Insurance Corporation is periodically examined by
the Arizona Department of Insurance.
In accordance with Federal Reserve regulations, the subsidiary bank is
limited as to the amount it may loan affiliates, including the Corporation,
unless such loans are collateralized by specific obligations. Additionally,
banking law limits the amount of dividends that a bank can pay without prior
approval from bank regulators.
Governmental Monetary and Credit Policies and Economic Controls
The earnings and growth of the banking industry and ultimately of First
United Bank & Trust are affected by the monetary and credit policies of
governmental authorities, including the Federal Reserve System. An important
function of the Federal Reserve System 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 Federal Reserve to implement
these objectives are open market operations in U.S. Government securities,
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 for deposits. The
monetary policies of the Federal Reserve 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.
[4]
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 Federal Reserve System, 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.
Employees
At December 31,1998, the Corporation and its subsidiaries employed
approximately 348 individuals, of whom 71 were officers, 153 were full-time
employees, and 124 part-time employees.
Executive Officers of the Corporation
Information concerning the executive officers of the Corporation is contained
on page 5 of the Corporation's definitive Proxy Statement for the annual
shareholders meeting to be held April 27,1999, and in Part III, Item 10 of this
Annual Report on Form 10-K under the caption "Directors and Executive Officers
of the Registrant," incorporated herein.
Risk Factors
The following factors should be considered carefully in evaluating an
investment in shares of common stock of the Corporation.
Regulatory Risks. The banking industry is subject to many laws and
regulations. Regulations protect depositors, not shareholders. These regulations
and laws increase the Bank's operating expenses and affect the Bank's earnings
and also put the Bank at a disadvantage with less regulated competitors, such as
finance companies, mortgage banking companies, and leasing companies.
Exposure to Local Economic Conditions. Most of the Bank's loans are made to
borrowers located in the Maryland and West Virginia counties in which the Bank
and its branches are located. A decline in local economic conditions would
affect the Bank's earnings.
Credit Risks and Inadequacy of Loan Loss Reserve. When borrowers default and
do not repay the loans made to them by the Bank, the Bank loses money.
Experience shows that some borrowers either will not pay on time or will not pay
at all. Then, the Bank will cancel, or "write off," the defaulted loan or loans.
A "write off" reduces the Bank's assets and hurts the Bank's earnings. The Bank
accounts for losses by reserving what it believes to be an adequate amount to
absorb any anticipated losses. If the Bank's loan loss reserve is not
sufficient, the Bank would have to record a larger loss provision, reducing
current period earnings.
Interest Rate Risk. The Bank's earnings depend greatly on its net interest
income, the difference between the interest earned on loans and investments and
the interest paid on deposits. If the interest rate paid on deposits is high and
the interest rate earned on loans and investments is low, net interest income is
small and the Bank earns less. Because interest rates are established by
competition, the Bank can not control its net interest income.
Risks Associated with Real Estate Lending. The Bank makes many real estate
secured loans. Real estate loans are in demand when interest rates are low and
economic conditions are favorable. Even when economic conditions are favorable
and interest rates are low, these conditions may not continue. The Bank may lose
money if the borrower does not pay a real estate loan. If real estate values
decrease, then the Bank may lose more money when borrowers default.
No Assurance of Growth. The Bank's ability to increase assets and earnings
depends upon many factors, including competition for deposits and loans, the
Bank's branch locations, avoidance of credit losses, and hiring and training of
personnel. Many of these factors are beyond the Bank's control.
Competition. Other banks and non-banks, including savings and loan
associations, credit unions, insurance companies, leasing companies, small loan
companies, finance companies, and mortgage companies, compete with the Bank.
Some of the Bank's competitors offer services and products that the Bank does
not offer. Larger banks and non-bank lenders can make larger loans and service
larger customers. Law changes now permit interstate bank which may increase
competition. Increased competition may decrease the Bank's earnings.
[5]
No Assurance of Cash or Stock Dividends. Whether dividends may be paid to
shareholders depends on the Bank's earnings, its capital needs, law and
regulations, and other factors. The Bank's payment of dividends in the past does
not mean that the Bank will be able to pay dividends in the future.
Stock Not Insured. Investments in the shares of the Corporation's common
stock are not deposits that are insured against loss by the government.
Risk Involved in Acquisitions. Part of the Bank's growth may come from buying
other banks, companies, or offices or branches of these banks or companies. A
newly purchased bank or company or branch may not be profitable after the Bank
buys it and may lose money, particularly at first. The new bank, company or
branch may bring with it unexpected liabilities or bad loans, bad employee
relations, or the new bank, company or branch may lose customers.
Risk of Claims. Customers may sue the Bank for losses due to the Bank's
alleged breach of fiduciary duties, errors and omissions of employees, officers
and agents, incomplete documentation, the Bank's failure to comply with
applicable laws and regulations, or many other reasons. Also, employees of the
Bank conduct all of the Bank's business. The employees may knowingly or
unknowingly violate laws and regulations. Bank management may not be aware of
any violations until after their occurrence. This lack of knowledge will not
insulate the Bank from liability. Claims and legal actions may result in legal
expenses and liabilities that may reduce the Bank's profitability and hurt its
financial condition.
Developments in Technology. Financial services use technology, including
telecommunications, data processing, computers, automation, Internet-based
banking, debit cards, and "smart" cards. Technology changes rapidly. The Bank's
ability to compete successfully with other banks and non-banks may depend on
whether it can exploit technological changes. The Bank may not be able to
exploit technological changes and expensive new technology may not make the Bank
more profitable.
Year 2000. The "Year 2000 Issue" describes the problems that may result from
the improper processing of dates and date-sensitive calculations beginning in
the Year 2000. Many existing computer programs use only two digits to identify
the year in the date field of a program. These programs could experience serious
malfunctions when the last two digits of the year change to "00" as a result of
identifying a year designated "00" as the Year 1900 neither than me Year 2000.
A system failure or other disruptions of operations could occur if the Bank's
computer programs and other equipment identify a year designated "00" as the
Year 1900 rather than the Year 2000. The Bank cannot be certain that its
computer programs and other equipment, and the computer programs and other
equipment of its customers, vendors, suppliers and even the government will be
Year 2000 compliant. Any systems failure, disruption, or other losses could
hurt the Bank's earnings.
Anti-Takeover Effects of Certain Charter and Bylaw Provisions. The
Corporation's Articles of Incorporation and Bylaws divide the Corporation's
Board of Directors into three classes and each class serves for a staggered
three-year term. No director may be removed except for cause, and then only by a
vote of at least two-thirds of the total eligible shareholder votes. In
addition, Maryland law contains anti-takeover provisions that apply to the
Corporation. These provisions may discourage or make it more difficult for
another company to buy or merge with the Corporation or may affect the market
price of the Corporation's common stock.
Item 2. PROPERTIES
The main office of the Corporation and First United Bank & Trust occupies
approximately 29,000 square feet at 19 South Second Street, Oakland, Maryland,
and is owned by First United Bank & Trust. First United Bank & Trust operates a
network of twenty-two banking offices throughout Garrett, Allegany, Washington
and Frederick Counties, Maryland and Mineral, Hampshire, Berkeley and Hardy
Counties, West Virginia. All of the banking offices of First United Bank & Trust
are owned by the Corporation except for nine of these offices, which are leased.
The properties of the Corporation which are not owned are held under long-
term leases. Total rent expense for 1998, 1997, and 1996 was $.32, $.26, and
$.23 million, respectively.
[6]
Item 3. LEGAL PROCEEDINGS
The Corporation and its subsidiaries are at times, and in the ordinary course
of business, subject to legal actions. Management, upon the advice of counsel,
is of the opinion that losses, if any, resulting from the settlement of current
legal actions will not have a material adverse effect on the financial condition
of the Corporation.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
[7]
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
MATTERS
The common stock of First United Corporation is listed on The Nasdaq Stock
Market. This listing became effective on September 2, 1992. There are 25,000,000
shares of common stock authorized and the total number of shares outstanding as
of December 31, 1998, was 6,154,726. As of December 31, 1998, the Corporation
had approximately 2,432 holders of record of its common stock. There are also
2,000,000 shares of preferred stock authorized with no shares outstanding as
of December 31,1998. The following tables reflect the high and low trades during
the period, as well as the closing price for the years ended December 31, 1998
and 1997.
1998 High Low Close
1st Quarter $20.00 $17.50 $19.38
2nd Quarter 20.50 19.63 20.00
3rd Quarter 20.50 18.00 18.13
4th Quarter 21.50 16.13 16.63
1997 High Low Close
1st Quarter $17.25 $14.75 $16.00
2nd Quarter 18.50 16.00 17.25
3rd Quarter 18.50 17.00 17.63
4th Quarter 21.00 17.25 20.25
Cash Dividends
Cash dividends were paid by the Corporation on the dates indicated as follows:
1998 1997
February $.15 $.14
May .15 .14
August .15 .14
November .15 .14
Quotes for the Stock can be found on The Nasdaq Stock Market under the symbol
"FUNC." Market Makers for the Stock are:
Ferris Baker Watts Wheat First Union
12 North Liberty St 33 West Franklin Street 2978 Garrett Highway
Cumberland, MD 21502 Hagerstown, MD 21740 Oakland, MD 21550
(301) 724-7161 (800) 388-1248 (301) 334-5806
(800) 776-0629
113 S. Potomac St. 29 North Liberty Street
Hagerstown, MD 21740 Cumberland, MD 21502
(800) 733-7111 (301) 724-2660
On July 31, 1996, as part of the Corporation's capital plan, the Board of
Directors authorized the Corporation's officers to repurchase up to 5% of its
outstanding common stock. On April 29, 1998, the Board of Directors ratified an
amendment to the Plan which would enable the Corporation's management to
repurchase an additional 5% or 309,048 shares. Purchases of the Corporation's
stock under the program were completed in brokered transactions or directly from
the Corporation's market makers. As of December 31, 1998, 352,934 shares have
been repurchased and retired under the Plan authorized by the Board of
Directors.
[8]
Item 6. SELECTED FINANCIAL DATA
(In thousands, except per share data)
1998 1997 1996 1995 1994
Balance Sheet Data
Total Assets $641,114 $569,030 $523,621 $487,169 $459,040
Total Deposits 511,500 500,060 452,539 424,294 391,650
Total Net Loans 505,668 438,738 380,594 358,464 333,375
Total Shareholders' Equity 58,474 56,714 56,815 55,504 51,131
Operating Data
Interest Income $47,242 $43,348 $39,273 $37,274 $33,059
Interest Expense 21,915 18,978 16,376 14,721 11,265
Net Interest Income 25,327 24,370 22,897 22,553 21,794
Provision for Possible
Credit Losses 1,176 935 749 - 165
Other Operating Income 6,316 6,037 4,869 4,290 3,832
Other Operating Expense 19,058 19,530 17,394 18,390 16,220
Income Before Tax 11,409 9,942 9,623 8,453 9,241
Income Tax 3,982 3,297 3,144 2,849 3,014
Net Income $7,427 $6,645 $6,479 $5,604 $6,227
Per Share Data
Net Income $1.20 $1.05 $1.00 $0.86 $0.96
Dividends Paid .60 .56 .51 .46 .43
Book Value $9.50 $9.05 $8.82 $8.54 $7.87
Per Share data has been restated to reflect the 5% stock dividend paid on
March 29, 1996.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
This section presents management's discussion and analysis of the financial
condition and results of operations of First United Corporation and subsidiaries
(collectively, the "Corporation") including First United Bank & Trust (the
"Bank"), and Oakfirst Life Insurance Corporation.
This discussion and analysis should be read in conjunction with the
financial statements which appear elsewhere in this report.
[9]
EARNINGS ANALYSIS
OVERVIEW
The Corporation's net earnings for 1998 increased to $7.43 million, or
11.73% over the $6.65 million re-ported for 1997. Earnings for the year
represent a record level of performance for the Corporation, exceeding the
previous record of $6.65 million achieved in 1997. Return on average assets was
1.24%, 1.21%, and 1.29% in 1998, 1997, and 1996, respectively.
The return on average shareholders' equity for 1998 increased to 12.92% from
the 11.70% reported in 1997. The return on average equity was 11.28% in 1996.
The earnings per share increased to $1.20 in 1998 from $1.05 in 1997, compared
with $1.00 in 1996.
During the first and second quarters of 1997 the Company engaged the
services of Alex Sheshunoff Management Services, Inc., a highly respected
financial consulting group, to facilitate a process improvement program. Based
on the recommendations of the Alex Shesunoff Management Group, Inc., and the
vision of the executive management, several positions in the organization were
changed, new positions were created, and a few positions were eliminated. All
employees were offered a severance package during the restructuring process, and
63 employees chose to accept this package. Throughout this process First United
Bank &; Trust maintained its tradition of no lay-offs affecting its employees.
For those employees accepting the voluntary severance package, the Board of
Directors authorized a total of $554,000 to be charged against earnings during
the first six months of 1997.
Forward-Looking Statements
The Corporation has made certain "forward-looking" statements with respect
to this discussion. Such statements should not be construed as guarantees of
future performance. Actual results may differ from "forward-looking" information
as a result of any number of unforeseeable factors, which include, but are not
limited to, the effect of prevailing economic conditions, the overall direction
of government policies, unforeseeable changes in the general interest rate
environment, competitive factors in the marketplace, and business risk
associated with credit extensions and trust activities, and other risk factors
discussed under the heading "Risk Factors," beginning on page 5 above. These
and other factors could lead to actual results which differ materially from
management's statements regarding future performance.
Net Interest Income
The primary source of earnings continued to be net interest income-the
difference between interest income and related fees on earning assets, and the
interest expense incurred on deposits and other borrowed funds. This segment of
earnings is affected by changes in interest rates, account balances and the mix
of earning assets and interest bearing funding sources.
Total interest income for 1998 increased 8.98% over 1997, from $43.35
million to $47.24 million, primarily due to growth in earning assets. Total
interest expense at $21.92 million represented an increase of 15.49% from $18.98
million in 1997. This increase was the result of growth in depository accounts
as well as the effect of higher rates being paid. During 1998, the Corporation
increased its use of borrowings from the Federal Home Loan Bank of Atlanta.
Interest on this type of borrowing increased by $ 1.42 million to a total of
$ 1.73 million. The net effect of these changes was a 3.94% increase in net
interest income to $25.33 million in 1998 from $24.37 million in 1997. This
compares to $22.90 million in 1996. The improvement in 1997 represents an
increase of 6.42% over 1996's net interest income. Table 3 analyzes the changes
in net interest income attributable to volume and rate components.
For analytical purposes, net interest income is adjusted to a taxable
equivalent basis. This adjustment facilitates performance comparisons between
taxable and tax-exempt assets by increasing tax-exempt income by an amount equal
to the federal income taxes which would have been paid if this income were
taxable at the statutorily applicable rate.
The taxable equivalent net interest margin decreased to 4.56% in 1998 from
4.83% in 1997, compared with 4.97% in 1996. Table 2 compares the components of
the net interest margin and the changes occurring between 1998, 1997 and 1996.
[10]
Allowance for Loan Losses
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.
The Corporation utilizes the methodology outlined in Banking Circular-201
Allowance for Loan and Lease Losses. The starting point for this methodology is
to segregate the loan portfolio into two pools, commercial and homogeneous or
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 potential 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 in which the
collateral value is less than the outstanding loan balance with the allocation
being the dollar difference between the two. Allocations are made for loan
commitments using the methodology outlined above. Allocations are not made for
loans that are cash secured or for the SBA guaranteed portion of loans.
During 1998, management continued to place emphasis on procedures for credit
analysis, problem loan detection, and delinquency follow-ups. As a result of
these efforts, the provision for credit losses in 1998 in-creased to $1.18
million or 0.23% of gross loans. The provision for credit losses was $.94
million and $.75 million for the years ended December 31, 1997 and 1996,
respectively. Gross charge-offs for the years ended December 31, 1998, 1997, and
1996 totaled $.71, $.64, and $.85 million, respectively.
Table 8 presents the activity in the allowance for loan losses by major loan
category for the past five years. Table 9 presents management's allocation of
the allowance for loan losses by major loan category. Specific allocations in
any particular category may be reallocated in the future to reflect current
conditions. Accordingly, the entire allowance is considered available to absorb
losses in any category.
Other Operating Income
The Corporation and its subsidiaries continue to seek ways of obtaining
additional other operating income. Many of the changes the Corporation
implemented in 1997 are fueling the growth in other operating income.
Non-interest income for 1998, at $6.32 million, increased 4.64% over the $6.04
million earned in 1997. In 1998, the Corporation experienced an increase in
income from security gains, Trust and Fiduciary activities, and real estate
appraisal services. The growth in our nontraditional services mentioned above
accounted for most of the 1997 increase of 23.99% in non-interest income over
the $4.87 million earned in 1996.
Other Operating Expense
Non-interest expense decreased $.47 million or 2.41% from $19.53 million in
1997 to $19.06 million in 1998. As previously mentioned, the decrease can be
explained by the one time restructuring costs of $.854 million in 1997, $.554
million of which were related to severance payments to employees incurred during
the first six months of 1997. Excluding the restructuring charges, other
expenses contributing to the increase were costs to increase market awareness
through various advertising campaigns, developing an office supply inventory,
restructuring of a our data processing network, and expenses incurred in the
closing of certain loan campaigns. While some of these expenses will continue,
others represent investments in future efficiencies.
Including the $.554 million in severance payments incurred in 1997, the
Corporation experienced a decrease of $.262 million in salary and employee
benefits in 1998. This decrease is a result of the process improvement program
completed in 1997.
The Corporation incurred an increase in 1998 of $.05 million in occupancy
expense of premises to $1.04 million. Occupancy expense of premises was
comparable at $.99 million and $1.00 million in 1997 and 1996, respectively.
[11]
Expenditures to further increase the role of technology in improving the
efficiency of customer service delivery and internal processing activities
accounted for much of the increase in equipment expenses. An expansion in the
Customer Service Center also contributed to an increase in equipment related
expenses. It is anticipated that the long run efficiencies gained by projects
such as these will be a net benefit to the earnings performance of the
Corporation.
Impact of Year 2000
Company State of Readiness:
This is a Year 2000 readiness disclosure under the Year 2000 information and
readiness disclosure act of 1998.
The Corporation began its Year 2000 renovation in 1997 to prepare its
systems for the century date change. This situation arose when computer systems
and programs were originally designed eliminating the first two digits of the
century, thereby saving valuable and costly disk and memory space. However, as
we near the 21st century, the two-digits of '00' in the year could be
misinterpreted as '1900' instead of '2000'. This could result in a system
failure or miscalculations causing disruptions of operations, a temporary
inability to process transactions, send invoices, or engage in similar normal
business activity.
Following the Federal Financial Institution Examination Council guidelines,
the Corporation's Year 2000 project plan contains these phases: Awareness,
Assessment, Renovation, Validation, and Implementation. A more definitive
description of these phases is detailed below:
Awareness Phase The definition of the problem as well as its scope is
conveyed to Management, the Board of Directors and all staff members to
facilitate the appropriate resources and cooperation to complete the project.
A Year 2000 Task Force was established with a senior member charged with overall
project management. An overall strategy was established which included vendor
management (including service bureaus, vendors, and service providers) and
customer issues. This phase has been completed.
Assessment Phase This phase was designed to assess the size and complexity
of the issue within the Corporation's operating and facility environment. During
this phase, we conducted an inventory of all Information Technology issues
including hardware, software, third party service providers, vendors, and with
those we share information. Additionally, we inventoried all non-Information
Technology items such as facility systems, heating, air conditioning and
ventilation systems, security systems, elevators, and utility companies. These
vendors were then contacted for Year 2000 compliance status, rated as to the
mission-critical status to the continued operation of your company's functions,
and rated as to their project plan for Year 2000 compliance.
To assure compliance going forward, policies were established requiring all
new systems and/or relation-ships to be evaluated for Year 2000 compliance prior
to implementation. A budget was established for 1998 with the remainder of the
project budget allocated for 1999. The final phase of this project included the
definition of contingency plans. This phase has been completed.
Renovation Phase-This phase is the redesign of code, upgrade of hardware
and/or software, vendor certification, and any additional associated changes. As
the Corporation utilizes a service bureau for its core processing (processing
and maintenance of all customer accounts), the renovation phase is mostly one of
vendor monitoring for compliance. Several internal programs were identified as
requiring upgrades and those have been scheduled through the first quarter of
1999. As we utilize a personal computer platform, an intensive review of our
computers confirmed the need for the Corporation to accelerate our computer
replacement and upgrade schedule. This phase is scheduled to be completed by
March 1999. 92% of our systems and service providers have informed us that
they have completed renovation activities.
Validation Phase-Testing is the most time consuming and costly of the phases
established. Not only do all systems need to be tested, but all connections to
outside sources and vendors must be tested as well. Understanding the
consequences of testing in a production environment, your company took the
precaution of establishing a test lab, which closely mirrors our operating
environment. We also hired experts in testing to facilitate
[12]
our test scripts and monitor our process. The validation of our service bureau
for compliance is being completed via proxy testing. Our staff has the
responsibility of reviewing all test scripts, providing feedback, and monitoring
results. This process is scheduled to be completed by March 1999 with follow-up
validation through December 31, 1999. We decided not to implement new systems
and/or upgrades after September 30, 1999 to allow a full quarter for follow-up
testing of our internal systems.
Implementation Phase Validated systems will be implemented using normal
software and hardware implementation procedures. This requires all systems to be
fully backed up prior to loading the validated software onto Year 2000 compliant
computer systems. Any modifications to certified systems must be tested in the
test lab prior to implementation in the production environment. This phase is
scheduled to be completed prior to June 1999. Beginning October 1, 1999, we will
no longer implement new systems or apply upgrades to existing systems to ensure
the validity of our operating environment.
Third Party Issues
As with any business, the Corporation is dependent on third parties for many
of our mission-critical functions. We interact with many other entities
including, but not limited to, Federal Reserve Bank, Credit Bureaus,
Governmental Agencies, and our service providers. Additionally, we rely on
utility companies for our electric, heating, and telecommunications.
The Year 2000 readiness of the systems used by these third parties is beyond
your company's control. As part of our assessment, we have reviewed the Year
2000 plans of our third party relationships and expect all to be compliant prior
to December 31, 1999. We are monitoring their progress closely, and have
developed contingency plans for services provided by third parties deemed to be
mission-critical to your company.
Customer Risk Issues
As required by our regulator, we have reviewed our customers and market
partners for any Year 2000 consequences. This includes a review of our loan and
deposit customer risk by assessing those customers who have either an aggregate
loan balance over $100,000 or have a deposit relationship within the top ten
percent of our entire deposit base. Additionally, we reviewed those we conduct
business with in the investment arena. We have identified no risk of loss as a
result of these reviews as of this time. On-going reviews will be completed
during 1999.
The Costs to Address the Company's Year 2000 Issues
Costs involved in the Year 2000 issue include modifying software, hiring
Year 2000 solution providers, testing and validation of all systems, and
assuring customer awareness. The budget allotted for 1999 is $.175 million. Of
the total $.283 million budgeted for Year 2000 expenses, we have incurred a
total of $.108 million as of December 31, 1998.
The Risks of the Company's Year 2000 Issues
The failure to correct a mission-critical Year 2000 problem could result in
an interruption in, or a failure of, normal business activities and operations.
Such failures could materially and adversely affect the Company's financial
condition or results of operations. Management currently believes that with
modification to existing systems and conversions to new systems, the effects of
the Year 2000 Issue will be minimized.
Despite the Corporation's efforts with respect to third parties, because of
the general uncertainty inherent in the Year 2000 Issue, there can be no
assurance that the systems of other organizations upon which your company's
operations rely will be converted in a timely fashion, or that a failure to
convert by another company, or a conversion that is incompatible with your
company's systems, would not have a material adverse effect on your company.
Contingency Planning
As a regulated financial entity, we are required to maintain a Disaster
Recovery Plan (also know as Business Resumption or Contingency Plans) that
details specific guidelines on maintaining our business functions during and
after various emergency situations. Year 2000 Contingency Planning is more
detailed and has two levels of
[13]
review. First, we completed Remediation Contingency Planning, which sets trigger
dates for all of our mission critical systems that are not compliant. Should a
system or vendor fail to provide Year 2000 certification or miss significant
remediation dates by the trigger date, alternative methods and vendors would be
implemented.
The second phase of Year 2000 Contingency Planning solidifies and expands
our existing Business Recovery plans to include a number of "what if" scenarios
after the century date change. Meetings wore held to review all mission critical
systems and alternative methods described to handle any disruption or
miscalculation after the Year 2000 has arrived. Plans are in place to review our
Business Recovery Plans again during l999 and to simulate instances where these
plans would be implemented.
Information Technology, Development
The Corporation recognizes the need to continue information Technology
development in addition to the Year 2000 project plan. We will continue to
research and develop other technology, initiatives as they pertain to the
company's overall strategic planning process. We are currently implementing
several Information technology projects; however, your company decided to
suspend projects from September 30,1999 until after January 30, 2000. One
project was postponed due to an implementation date too close to this time
period.
Independent Verification
In order to assure the Corporation is making the appropriate progress toward
achieving Year 2000 compliance and to assure our Year 2000 plan is
comprehensive, we have retained the services of an independent third party to
conduct a second review of our Year 2000 efforts. This review was completed in
September 1998 and the results were favorable with only a few minor adjustments
to our plan implemented as a result. We will be completing a second review
during the second quarter of 1999.
Information about the Corporation's Year 2000 project, other than historical
information, should be considered forward looking in nature and subject to
various risks, uncertainties and assumptions. The costs of the project and the
dates on which your company's plans to complete project stages are based on
Management's best estimates, which were derived using numerous assumptions of
future events including the continued availability of certain resources, third
party modification plans and other factors. However, there can be no assurance
that these estimates will be achieved and actual results could differ materially
from those plans. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, the
inability to control third party modification plans and similar uncertainties.
Applicable Income Taxes
Applicable income taxes are detailed in Note 9 of the Corporation's audited
consolidated financial statements. Income tax expense amounted to $3.98 million
in l998 as compared with $3.30 million in l997 and $3.14 million in 1996. These
amounts represented effective tax rates of 34.90%, 33.16%, and 32.67% for 1998,
1997, and 1996, respectively.
Investment Securities
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 as part of the asset/liability management strategy.
Available-for-sale securities are carried at market value, with unrealized gains
and losses excluded from earnings and reported as a separate component of other
comprehensive income included in stockholders' equity net of income taxes. Thc
Corporation does not currently follow a strategy of making security purchases
with a view to near-term resales and therefore, does not own trading securities.
For additional information, see Notes I and 3 to the Corporation's audited
consolidated financial statements.
In June 1998, Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (Statement No.
133), was issued. Statement 133 establishes accounting and reporting standards
for derivative instruments, including certain derivative instruments embedded in
other contracts, and hedging activities. This statement is effective for
financial statements issued for all quarters of all
[14]
fiscal years beginning after June 15, 1998. As permitted, the Corporation early
adopted this Statement on July 1, 1998. With the exception of the
reclassification listed below, the adoption of Statement No. 133 did not have a
material impact on the Corporation's consolidated financial statements as the
Company does not enter into derivative contracts. In connection with the
adoption of this statement, $25.27 million of the investment securities
previously classified as held-to-maturity were reclassified to available-for-
sale. As the securities were marked to market coincident with the
reclassification, the change resulted in an increase of $.25 million, net of tax
to other comprehensive income.
Total investment securities increased $6.10 million or 6.45% in I 998 from
$94.60 million in 1997 to $ 100.70 million in 1998. The Corporation reported a
decrease of $8.31 million or 82.23% during 1998 in its U.S. Treasury securities
from $10.23 million in 1997 to $1.92 million in 1998. Total obligations of state
and political subdivision investments increased $6.76 million or 43.44% in 1998
to $22.33 million as a result of efforts by management to extend the maturity of
the portfolio and to obtain a higher yield.
The Corporation manages its investment portfolios utilizing policies which
seek to achieve desired levels of liquidity, manage interest rate sensitivity
risk, meet earnings objectives and provide required collateral support for
deposit activities. Excluding the U.S. Government sponsored agencies, the
Corporation had no concentrations of investment securities from any single
issues that exceeded 10% of shareholders' equity. Table 4 exhibits the
distribution, by type, of the investment portfolio for the three years ended
December 31, 1998, 1997 and 1996 respectively.
Loan Portfolio
The Corporation, through its Bank, is actively engaged in originating loans
to customers primarily in Garrett, Allegany, Washington and Frederick Counties
in Maryland; Mineral, Hardy, Berkeley and Hampshire Counties in West Virginia
and the surrounding regions of West Virginia and Pennsylvania. The Corporation
has policies and procedures designed to mitigate credit risk and to maintain the
quality of the Corporation's loan portfolio These policies include underwriting
standards for new credits and the continuous monitoring and reporting of asset
quality and the adequacy of the Reserve for Loan and Lease Losses. These
policies, coupled with ongoing training efforts, have provided an effective
check and balance for the risk associated with the lending process. Lending
authority is based on the level of risk, size of the loan and the experience of
the lending officer. Table 5 presents the composition of the Corporation's loan
portfolio.
It has been the historical policy of the Corporation to make the majority of
its loan commitments in the market area it serves. However, with the competitive
nature of the banking industry, the Corporation is forced to look in
nontraditional rnarkets to expand its business. The Corporation had no foreign
loans in its portfolio as of December 31, 1998.
During 1998, gross loans increased $67.58 million or 15.31% to a total of
$508.97 million. In comparison, gross loans at year-end 1997 increased $58.61
million or 15.31% to a total of $441.39 million as compared to the 1996
balances. The indirect lending portfolio experienced substantial growth in 1998.
This portfolio grew 120.76% from $45.49 million at December 31, 1997 to $100.36
million as of December 31, 1998. Thc Corporation has started to expand its
presence in the indirect market by forming a leasing company in late 1998.
Although only a small number of leases were booked as of December 31, 1998, the
Corporation feels that this product will complement its existing indirect
network The Corporation also experienced growth of 16.31 % or $4.68 million in
its home equity product. This product continues to grow due to the tax
advantages that it presents. Table 5 details the dollar amount and percentage
distribution at the various key categories of credit in the loan portfolio.
Funding for loan growth during l998 and 1997 was provided by increased
levels of deposits from within our market area as well as borrowings from
Federal Home Loan Bank of Atlanta ("FHLB") and our upstream correspondent banks.
It is the policy of the Corporation to place a loan on non-accrual status
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. Non-accrual loans are closely monitored by management. 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
[15]
longer in doubt. At December 31, 1998, the Corporation had $.46 million of non-
accrual loans. Table 7 details the historical activity of non-accural loans.
Deposit and Other Funding
Deposit liabilities increased to $511.50 million at December 31, 1998 from
$500.06 million at December 31,1997, or an increase of 2.29%. Although the
$11.44 million in growth does not compare favorably with the $47.52 million
growth experienced in 1997, the Corporation was able to meet its liquidity needs
through borrowings from Federal Home Loan Bank of Atlanta ("FHLB") and other
correspondent banks. These borrowings increased from $6.26 million at December
31, 1997 to $64.58 million at December 31, 1998. This represents an increase of
932.63% over the previous year. The Corporation has an approved credit line with
FHLB in the amount of $181.5 million. The increased competition from other
banks, brokerage firms, and other financial outlets has caused the Corporation
to look to non-traditional sources to cost effectively meet its liquidity needs.
Capital Resources
The Bank and the Corporation itself are subject to risk-based capital
regulations which were adopted by Federal banking regulators and became fully
phased in on December 31, 1992. 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 1
Capital, consisting of common shareholders' equity and perpetual preferred
stock, less goodwill and certain other deductions. The remaining capital, or
Tier 2 capital, consists of elements such as subordinated debt, mandatory
convertible debt, and grandfathered senior debt, plus the allowance for credit
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 1 ratio of 4%. The risk-based capital rules have been further
supplemented by a leverage ratio, defined as Tier 1 capital divided by average
assets, after certain adjustments. The minimum leverage ratio is 3% 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 companies
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 guide-
lines meeting these regulatory requirements, and takes into account current or
anticipated risks and future growth opportunities.
On December 31, 1998, the Corporation's total risk-based capital ratio was
13.40%, well above the regulatory minimum of 8%. The risk-based capital ratios
for year-end 1997 and 1996 were 14.82% and 17.92%, respectively.
Total shareholders' equity remained stable, increasing slightly from $56.71
million at year-end 1997 to $58.47 million at year-end 1998. The minimal growth
in capital can be explained by the Corporation's Stock buy-back program and
increased shareholder dividends. Total shareholders' equity at December 31, 1996
was $56.82 million. The equity to assets ratio at December 31,1998, was 9.12%,
compared with 9.97% and 10.84% at year-end 1997 and 1996, respectively.
On July 31, 1996, as part of the Corporation's capital plan, the Board of
Directors also authorized the Corporation's officers to repurchase up to 5% of
its outstanding common stock. Purchases of the Corporation's stock under the
program were completed in brokered transactions or directly from the
Corporation's market
[16]
makers. On April 29, 1998, the Board of Directors ratified an amendment to the
Plan which would enable the Corporation's management to repurchase an additional
5% or 309,048 shares. As of December 31,1998,352,934 or 5.43% shares have been
repurchased and retired under the Plan authorized by the Board of Directors.
Cash dividends of S.60 per share were paid during 1998, compared with $.56
and $.51 in 1997 and 1996, respectively. This represents a dividend payout rate
(dividends per share divided by net income per share) of 50.00%, 53.33%, and
51.00% for 1998, 1997, and 1996, respectively.
ASSET AND LIABILITY MANAGEMENT
Introductlon
The Investment and Funds 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.
Liquidity
The objective of liquidity management is to assure that the withdrawal
demands of depositors and the legitimate credit needs of the Corporation's
delineated market areas arc accommodated Total liquid assets, represented by
cash, investment securities and loans maturing within one year, amounted to
$70.77 million, or 11.04% of total assets at December 31,1998. This compares
with $90.43 million, or 15.89% of l997 year-end assets, and $111.35 million, or
21.26% of 1996 year-end assets.
Additional liquidity of $ l98 million is available from unused lines of
credit at various upstream correspondent banks and the FHLB of Atlanta.
Interest Rate Sensitivity
Interest rate sensitivity refers to the degree that earnings will be
impacted by changes in thc prevailing level of interest rates. Interest rate
risk arises from mismatches in the repricing or maturity characteristics bet
year assets and liabilities. Management seeks to avoid fluctuating net interest
margin, and to enhance consistent growth of net interest income through periods
of changing interest rates. The Corporation uses interest sensitivity gap
analysis and simulation models to assure 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 the Corporation during a
period of declining interest rates.
In order to manage interest sensitivity risk, management of the Corporation
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 updated impact on
net income over specified periods. Management does not use derivative financial
instruments to manage its interest rate sensitivity. At December 31, 1998, the
static gap analysis prepared by management indicated that the Corporation was
liability sensitive over the next year. In computing the effect on pre-tax
income of changes in interest ratios, management has assumed that any changes
would immediately effect earnings. Normally when an organization is liability
sensitive there is a positive impact to income when interest rates
[17]
decline. The simulation analysis shown below shows a negative impact when
interest rates decline 100 or 200 basis points. Management explains this effect
due to the current position of interest rates, whereby certain liability
accounts are currently priced at a level where management feels they cannot be
reduced further in rate, therefore, the full impact of repricing liabilities in
the declining rate environment is not realized. Based on the simulation analysis
performed at year end the Corporation estimates the following changes in income
before taxes assuming the indicated interest rate changes:
December 31, 1998
+200 basis point increase ($.948 million)
+100 basis point increase ($.474 million)
-100 basis point decline ($.146 million)
-200 basis point decline ($.292 million)
December 31, 1997
+200 basis point increase ($1.143 million)
+100 basis point increase ($.572 million)
-100 basis point decline ($.286 million)
-200 basis point decline ($.571 million)
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 prime 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.
Table 13 presents the Corporation's interest rate gap position at December
31, 1998. This is a point in time position which is continually changing and is
not necessarily indicative of the Corporation's position at any other time.
[18]
Table 1
Distribution of Assets, Liabilities and Shareholders' Equity
Interest Rates and Interest Differential-Tax Equivalent Basis
( In thousands )
For the Years Ended Deeember 31,
1998 1997 1996
Average Annual Average Annual Average Annual
Balance Interest Rate Balance Interest Rate Balance Interest Rate
Federal funds
sold 1,463 $ 129 8.82% $ 2,506 $ 181 7.22% $ 3,219 $182 5.65%
Investments:
Taxable 79,655 4,961 6.23% 85,288 5,347 6.27% 93,073 5,663 6.08%
Nontaxable 17,743 1,262 7.11% 14,146 1,056 7.47% 11,139 856 7.68%
------ ------ ------ ------ ------ ------ ------ ------ ------
Total
Investment 97,398 6,223 6.39% 99,434 6,403 6.44% 104,212 6,519 6.26%
Loans 472,007 41,563 8.81% 415,663 37,365 8.99% 364,309 33,113 8.44%
-------- ------- ------ ------- ------ ------- ------- ------ ------
Total earning
assets 570,868 47,915 8.40% 517,603 43,949 8.50% 471,470 39,814 8.44%
Reserve for possible
credit losses(2,998) (2,343) (2,122)
Other non-earning
assets 34,581 33,665 33,867
Total non-earning
assets 31,583 31,322 31,745
Total
Assets $602,451 $548,925 $503,485
========= ========== =========
Liabilities and
Shareholders' Equity
Deposits:
Noninterest-bearing
Deposits $53,430 $ - - $51,807 $ - - $48,097 $ - -
Interest-bearing
demand
deposits 111,076 3,244 2.92% 103,627 2,934 2.83% 97,809 2,781 2.84%
Savings
deposits 55,542 842 1.52% 63,522 1,135 1.79% 77,811 1,783 2.29%
Time deposits
$100,00
or more 59,814 3,528 5.90% 46,417 2,663 5.74% 33,158 1,927 5.81%
Time deposits
less than
$100,000 222,908 12,573 5.64% 214,376 11,933 5.57% 180,684 9,787 5.42%
Short-term
borrowings 36,225 1,728 4.77% 7,211 313 4.34% 3,532 98 2.77%
------ ------- ------ ------- ----- ------ ------- ------ ----
Total deposits and
short-term
borrowings 538,995 21,915 4.07% 486,960 18,978 3.90% 441,091 16,376 3.71%
Other
Liabilities 6,007 5,154 5,976
Shareholders'
equity 57,449 56,811 56,418
Total Liabilities and
Shareholders'
Equity $602,451 $548,925 $503,485
======== ======== =========
**The above table reflects the average rates earned or paid stated on a tax
equivalent basis assuming a tax rate of 34%. The average balances of non-accrual
loans for the years ended December 31, 1998, 1997, and 1996, which were reported
in the average loan balances for these years, were $678, $617, and $1,244,
respectively. The fully taxable equivalent adjustments for the years ended
December 31, 1998, 1997, and 1996 were $673, $601, and $541, respectively.
[19]
Table 2
Net Interest Margin
( In thousands )
1998 1997 1996
Tax Tax Tax
Avgerage Equivalent Avgerage Equivalent Avgerage Equivalent
Balance Rate Balance Rate Balance Rate
Earning Assets $570,868 8.40% $517,603 8.50% $471,740 8.44%
Interest-bearing
Liabililies 485,565 4.07% 435,154 3.90% 392,994 3.71%
Net Benefit of
Noninterest-bearing
Sources 0.45% 0.46% 0.45%
Average Cost of Funds 3.84%
Net Interest Margin 4.56% 4.83% 4.97%
The above table reflects the average rates earned or paid stated on a tax
equivalent basis assuming a tax rate of 34%.
Table 3
Interest Variance Analysis
( In thousands )
1998 Compared To 1997 1997 Compared To 1996
Increase Increase
(Decrease) Due To (Decrease) Due To
Interest income:
Volume Rate Net Volume Rate Net
--------------------------------------------------------
Federal Funds
Sold ($92) $40 ($ 52) ($ 51) $ 50 ($ 1)
Taxable
Investments (351) (35) (386) (488) 172 (316)
Non-Taxable
Investments 256 (50) 206 225 (24) 201
Loans 4,961 (763) 4,198 4,616 (364) 4,252
------ ----- ----- ------ ------- --------
Total Interest
Income 4,744 (808) 3,966 4,302 (166) 4,136
======= ===== ===== ====== ====== ======
Interest expense:
Interest-bearing $2l8 $92 $310 $ 165 ($ 12) $ 153
Savings (121) (172) (293) (255) (393) (648)
Time Deposits 481 159 640 1,875 271 2,146
Time Deposits
$100,000 or more 790 75 865 761 (25) 736
Other borrowings 1,384 3l 1,415 160 55 215
Total Interest ------- ----- ------- ------ ------ -------
Expense 2,752 185 2,937 2,706 (104) 2,602
Net interest
Income $2,022 ($993) $1,029 $1,596 ($ 62) $1,534
======== ====== ====== ======= ======= =======
(1) The change in interest income / expense due to both volume and rate has been
allocated to volume and rate changes in proportion to the relationship of the
absolute dollar amounts of the change in each. The above table is compiled on a
tax equivalent basis. The fully taxable equivalent adjustments for the years
ended December 31,1998 and 1997 were $673 and $601, respectively.
[20]
Table 4
Investment Security Maturities, Yields, and Market Values
( In thousands )
December 31, 1998
U.S. Federal State &
Treas Yield Agen Yield Muni Yield Other Yield Total Yield
Maturity Book Value
Available-for-Sa1e
Within one Year $1,605 6.07%$1,770 6.53% $1,315 7.01% $2,005 6.10% $6,695 6.38%
One to Five Years 296 6.60%24,407 6.12% 5,974 7.00% 7,370 6.47% 38,047 6.33%
Five to Ten Years 0 0.00%18,665 6.24% 2,266 6.85% 658 5.93% 21,589 6.29%
Over Ten Years 0 0.00% 0 0.00% 12,321 6.79% 21,279 6.75% 33,600 6.77%
----- ----- ----- ---- ------- ---- ------- ----- ------ -----
Total Book Value $1,901 $44,842 $21,876 $31,312 $99,931
====== ======= ======== ======== =========
Taxable Equivalent
Yield 6.15% 6.18% 6.86% 6.60% 6.46%
====== ======= ======= ======= =======
Market Value $1,921 $45,082 $22,327 $31,365 $100,695
====== ======= ========= ======== =========
December 31,1997
Book Value $10,136 $31,298 $15,451 $37,257 $94,142
======= ======== ======= ======== =========
December 31,1996
Book Value $20,488 $37,510 $15,254 $36,467 $109,719
======== ======== ========= ======= =========
The above yields have been adjusted to reflect a tax equivalent basis assuming a
tax rate of 34%. The above table includes certain securities which have no
maturity. Therefore, these securities are classified as maturing over ten years.
[21]
Summary Of Loan Portfolio
( In thoussnds )
Table 5
Loans Outstanding as of December 31,
1998 1997 1996 1995 1994
-----------------------------------------------------
Commercial, Financial,
& Agricultural $81,666 $67,399 $56,325 $56,893 $47,111
Real Estate-
Construction 11,315 11,716 21,097 10,696 19,838
Real Estate-
Mortgage 286,514 287,153 249,389 242,789 220,991
Installment 129,477 75,124 55,969 50,206 47,785
---------- --------- ---------- -------- ---------
Total $508,972 $441,392 $382,780 $360,584 $335,725
========= ========= ======== ========= =========
Commercial, Financial,
& Agricultural 16.05% 15.27% 14.72% 15.78% 14.03%
Real Estate-
Construction 2.22% 2.65% 5.51% 2.97% 5.91%
Real Estate-
Mortgage 56.29% 65.06% 65.15% 67.33% 65.83%
Installment 25.44% 17.02% 14.62% 13.92% 14.23%
--------- -------- -------- -------- ---------
Total 100.00% 100.00% 100.00% 100.00% 100.00%
======== ======== ======= ========= =========
Maturities of Loan Portfolio
( In thousands )
Table 6
Maturing
Maturing After One Maturing
Within But Within After Five
One Year Five Years Years Total
-------------------------------------------------------
Commercial, Financial,
& Agricultural $8,501 $62,644 $10,521 $81,666
Real Estate-
Construction - 11,315 - 11,315
Real Estate-
Mortgage 11,425 49,729 225,360 286,514
Installment 30,515 94,289 4,673 129,477
--------- --------- ---------- -----------
Total $50,441 $217,977 $240,554 $508,972
========= ========= ========= ==========
Classified by Sensitivity to Change in Interest Rates
Fixed-interest
Rate Loans S37,781 $161,332 $32,491 $231,604
Adjustable-interest
Rate Loans 12,660 56,645 208,063 277,368
--------- ---------- ---------- -----------
Total $50,441 $217,977 $240,554 $508,972
========== ======== ======== =========
[22]
Table 7
Risk Elements of Loan Portfolio
( In thousands )
For the Years Ended December 31
1998 1997 1996 1995 1994
---------------------------------------------
Non-accrual Loans $460 $562 $ 976 $1,075 $1,027
Accruing Loans Past Due
90 Days or More 544 563 659 963 489
Information with respect to non-accrual loans at December 31,1998 and 1997 is
as follows:
1998 1997
-------------------
Interest income that would have been recorded
under original terms $ 30 $ 40
Interest income recorded during the period 6 20
Activity of Loan Loss Provision
Table 8 ( In thousands )
Summary of Loan Loss Experience
For the Years Ended December 31
1998 1997 1996 1995 1994
Balance at Beginning of Period $2,654 $2,186 $2,120 $2,350 $2,306
Loans Charged Off:
Commercial, Financial, and
Agricultural 163 135 476 19 35
Real Estate-Mortgage 205 211 135 205 164
Installment 340 292 236 186 121
------- ------- ------ ------ -----
Total Charged Off 708 638 847 410 320
Recoveries of Loans:
Commercial, Financial, and
Agricultural 43 52 29 59 39
Real Estate-Mortgage 28 39 8 31 35
Installment 111 80 127 90 125
-------- ------ ------- ------ ------
Total Recoveries 182 171 164 180 199
Net Loans Charged Off 526 467 683 230 121
Provision Charged to Operations 1,176 935 749 - 165
Balance at the End of Period 3,304 2,654 2,186 2,120 2,350
======= ======= ======= ======== =======
Loans Net of Unearned Income
at End of Period $508,972 $441,392 $382,780 $360,584 $335,725
========= ======== ======== ======== =========
Daily Average Balance of Loans $472,007 $415,663 $364,309 $352,720 $324,140
========= ======== ======= ======== ========
Allowance for Possible Loan Loss to
Loans Outstanding 0.65% 0.60% 0.57% 0.59% 0.70%
========= ======= ======== ======= ========
Net Charge Offs to Average
Loans Outstanding 0.11% 0.11% 0.19% 0.07% 0.04%
======== ======= ======= ====== =======
[23]
Allocation of Allowance for Loan Losses
( In thousands )
Table 9
1998 1997 1996 1995 1994
-------------------------------------------------
Commercial $957 $784 $509 $301 $457
Real Estate - Mortgage 966 1,095 923 1,214 661
Home Equity 136 93 73 48 11
Consumer 942 443 201 206 223
Commitments 279 239 180 171 78
Unallocated 24 - 300 180 920
------- -------- ------- ------- --------
Total $3,304 $2,654 $2,186 $2,120 $2,350
======= ======= ======= ======== ========
Average Deposit Balances
( In thousands )
Table 10
Deposits by Major Classification for the Years Ended December 31,
1998 1997 1996
Average Average Average
Balance Yield Balance Yield Balance Yield
-------------------------------------------------------------
Noninterest-bearing
demand deposits $53,430 $51,807 $48,097
Interest-bearing
demand deposits 111,076 2.92% 103,627 2.83% 97,807 2.84%
Savings deposits 55,542 1.52% 63,522 1.79% 77,811 2.29%
Time deposits $100,000
or more 59,814 5.90% 46,417 5.74% 33,158 5.81%
Time deposits less than
than $100,000 22,908 5.64% 214,376 5.57% 180,684 5.42%
--------- -------- ---------
Total $502,770 $479,749 $437,559
========= ========= ==========
[24]
Maturity of Time Deposits
( In thousands )
Table 11
December 31, 1998
Greater than Less Than
$100,000 $100,000
--------------------------------
Maturities
3 Months or Less $ 7,337 $32,055
3 - 6 Months 11,958 18,202
6-12 Months 11,611 22,676
Over 1 Year 32,298 139,368
---------- -----------
Total $63,204 $212,301
========== ==========
Summary of Significant Ratios
Table 12
1998 1997 1996
--------------------------------
Return on Average Assets 1.24% 1.21% 1.29%
Return on Average Equity 12.92% 11.70% 11.28%
Dividend Payout Ratio Total 50.00% 53.33% 51.00%
Equity to Total Assets at Year End Tier I 9.12% 9.97% 10.84%
Capital to Risk Weighted Assets Total 12.68% 14.16% 17.26%
Risk-based Capital Ratio Tier I 13.40% 14.82% 17.92%
Capital to Average Assets 9.71% 10.33% 11.31%
[25]
Summary of Interest Sensitivity Analysis
( In thousands )
Table 13
As of December 31, 1998
0-90 91-365 1-5 Over 5
Days Days Years Years Total
-----------------------------------------------------
Assets
Rate Sensitive
Securities
(Available-for-Sale)(1) $17,761 $26,076 $33,727 $23,131 $100,659
Loans(2) 93,638 102,887 263,488 48,959 508,972
------- -------- -------- -------- ---------
Total Rate Sensitive $111,399 $128,963 $297,215 $72,090 $609,667
Liabilities
Rate Sensitive Deposits
Savings $51,492 $ - $ - $ - $51,492
Investors' Choice 7,141 - - - 7,141
Time Deposits Less
than $100,000 32,055 40,878 139,368 - 212,301
Time Deposits $100,000
or more 7,337 23,569 32,298 - 63,204
IMMA, PMA, & Trust DDA 52,388 - - - 52,388
One & Now accounts 62,017 - - - 62,017
Federal Home Loan Bank borrowings and
Other Borrowed Funds 24,575 5,000 35,000 - 64,575
-------- -------- --------- ------- ---------
Total Rate Sensitive $237,005 $69,447 $206,666 $ - $513,118
- -------------------------------------------------------------------------------
GAP ( Rate sensitive Assets less Rate
Sensitive Liabilities ) ($125,606) $59,516 $90,549 $72,090 $96,549
- -------------------------------------------------------------------------------
GAP to Total Assets -19.59% 9.28% 14.12% 11.24% 15.06%
Cumulative GAP to
Total Assets -19.59% -10.31% 3.82% 15.06% -
(1) Securities are based on estimated maturities at book value
(2) Adjustable Rate Loans are shown in the time frame corresponding to the next
contractual interest rate adjustment
(3) Transaction Accounts such as IMMA, ONE, and NOW are generally assumed to be
subject to repricing within one year. This is based on the Corporation's
historical experience with respect to such accounts.
[26]
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding the exposure of the Company's financial
instruments see "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Interest Rate Sensitivity" on pages 17 and 18 of the
Annual Report to Stockholders for the year ended December 31, 1998. The
Company's principal market risk exposure is to interest rates.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) The following audited consolidated financial statements and related
documents are set forth in this Annual Report on Form 10-K on the
following pages:
Page Number
Independent Auditors' Report . . . . . . . . . . . . . .29
Consolidated Statements of Financial Condition . . . . .30
Consolidated Statements of Income . . . . . . . . . . .31
Consolidated Statements of Changes in
Shareholders' Equity . . . . . . . . . . . . . 32
Consolidated Statements of Cash Flows . . . . . . . . .33
Notes to Consolidated Financial Statements . . . . . 35-45
(b) The following supplementary data is set forth in this Annual Report on
Form 10-K on the following pages:
Quarterly Results of Operations . . . . . . . . . . . .45
[27]
Report of Management
Financial Statements
First United Corporation (the "Corporation") is responsible for the
preparation, integrity and fair presentation of its published financial
statements as of December 31, 1998, and for the year then ended. The
consolidated financial statements of the Corporation have been prepared in
accordance with generally accepted principles and, as such, include some amounts
that are based on judgments and estimates of management.
Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining effective
internal control over financial reporting presented in conformity with generally
accepted accounting principles and the instructions to the Consolidated
Financial Statements for Bank Holding Companies with Total Consolidated Assets
of $150 million or More (FR Y-9 C instructions). The system contains monitoring
mechanisms, and actions are taken to correct deficiencies identified.
There are inherent limitations in the effectiveness of an internal control
including the possibility of human error and the circumvention or overriding of
controls. Accordingly, even effective internal control can provide only
reasonable assurance with respect to financial statement preparation. Further,
because of changes in conditions, the effectiveness of internal control may vary
over time.
Management assessed the Corporation's internal control over financial
reporting presented in conformity with generally accepted accounting principles
and FRY-9 C instructions as of December 31, 1998. This assessment was based on
criteria for effective internal control over financial reporting described in
"Internal Control- Integrated Framework" issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on this assessment, management
believes that the Corporation maintained effective internal control over
financial reporting presented in conformity with generally accepted accounting
principles and FR Y-9 C instructions as of December 31, 1998.
Compliance with Laws and Regulations
Management is responsible for compliance with the federal and state laws and
regulations concerning dividend restrictions and federal laws and regulations
concerning loans to insiders designated by the FDIC as safety and soundness laws
and regulations.
Management has assessed compliance by First United Bank & Trust ("the Bank")
with the designated laws and regulations relating to safety and soundness. Based
on this assessment, management believes that the Bank complied, in all
significant respects, with the designated laws and regulations related to safety
and soundness for the year ended December 31, 1998.
William B. Grant Robert W. Kurtz
Chairman and Chief Executive Officer President and Chief Financial Officer
First United Corporation First United Corporation
And and
First United Bank & Trust First United Bank & Trust
[28]
Report of Independent Auditors
Board of Directors and Shareholders
First United Corporation
We have audited the accompanying consolidated statements of financial
condition of First United Corporation and subsidaries as of December 31, 1998
and 1997, the related consolidated statements of income, changes in
shareholders' equity, and cash flows for each of the three years in the period
ended December 31, 1998. 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 audits in accordance with generally accepted auditing
standards. 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, 1998 and 1997, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles.
Ernst & Young, LLP
Baltimore, Maryland
February 5, 1999
First United Corporation and Subsidiaries
Consolidated Statements of Financial Condition
(In thousands, except per share amounts)
December 31,
Assets 1998 1997
-----------------------
Cash and due from banks $13,633 $17,586
Investments:
Available-for-sale securities-at market value
(amortized cost-$99,931 and $64,600 at
December 31, l998 and 1997, respectively) 100,695 65,053
Held-to-maturity securities (market value $0
and $29,800 at Deccmbcr 31, 1998
and 1997, respectively) - 29,542
--------- ---------
Total investment securities 100,695 94,595
Loans 508,972 441,392
Reserve for possible credit losses (3,304) (2,654)
--------- ---------
Net loans 505,668 438,738
Bank premises and equipment 9,136 9,250
Accrued interest receivable and other assets 11,982 8,861
---------- ----------
Total Assets $641,114 $569,030
=========== ===========
Liabilities and Shareholders' Equity
Liabilities:
Noninterest-bearing deposits $54,554 $51,309
Interest-bearing deposits 456,946 448,751
---------- ----------
Total deposits 511,500 500,060
Federal Home Loan Bank borrowings and
other borrowed money 64,575 6,225
Reserve for taxes, interest and other liabilities 5,594 5,094
Dividends payable 971 937
--------- ---------
Total Liabilities 582,640 512,316
Shareholders' Equity:
Preferred stock - no par value
Authorized and unissued 2,000 shares
Capital stock - par value $.01 per share
Authonzed 25,000 shares, issued and outstanding 6,155
and 6,260 shares at December 31, 1998
and 1997, respectively 62 63
Surplus 21,384 23,463
Retained earnings 36,559 32,913
Accumulated other comprehensive income 469 277
--------- ---------
Total Shareholders' Equity 58,474 56,714
Total Liabilities and Shareholders' Equity $641,114 $569,030
========== =========
See notes to consolidated financial statements.
[30]
First United Corporation and Subsidiaries
Consolidated Statements of Income
(In thousands, except per share amounts)
Year ended December 31,
1998 1997 1996
---------------------------------------
Interest income
Interest and fees on loans $41,322 $37,125 $32,865
Interest on investment securities:
Taxable 4,961 5,347 5,663
Exempt From federal income taxes 830 695 563
------- -------- --------
5,791 6,042 6,226
Interest on federal funds sold 129 181 182
------- --------- ---------
Total interest income 47,242 43,348 39,273
Interest expense
Interest on deposits:
Savings 843 1,135 1,783
Interest-bearing transaction accounts 3,366 2,934 2,781
Time, $100,000 or more 3,528 2,663 1,927
Other time 12,450 11,933 9,787
Interest on Federal Home Loan Bank borrowings
and other borrowed money 1,728 313 98
-------- -------- --------
Total interest expense 21,915 18,978 16,376
Net interest income 25,327 24,370 22,897
Provision for possible credit losses 1,176 935 749
------- -------- --------
Net interest income after provision for
possible credit losses 24,151 23,435 22,148
Other operating income
Trust Department income 1,495 1,275 1,200
Service charges on deposit accounts 2,237 2,322 1,759
Insurance premium income 264 295 318
Security gains 238 91 24
Other income 2,082 2,054 1,568
-------- -------- -------
6,316 6,037 4,869
Other operating expense
Salaries and employee benefits 9,521 9,229 8,819
Occupancy expense of premises 1,038 985 997
Equipment expense 1,676 1,656 1,503
Data processing expense 627 581 561
Deposit assessment and related fees 155 164 109
Restructuring costs - 554 273
Other expense 6,041 6,361 5,035
---------- -------- --------
19,058 19,530 17,394
Income before income taxes 11,409 9,942 9,623
Applicable income taxes 3,982 3,297 3,144
------- -------- ------
Net Income $7,427 $6,645 $6,479
======= ======= =======
Earnings per share $1.20 $1.05 $1.00
======= ======== ========
See notes to consolidated financial statements.
[31]
First United Corporation and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity
(In thousands, except per share amounts)
Accumulated
Other Total
Capital Retained Comprensive Shareholders'
Stock Surplus Earnings Income Equity
Balance at January 1, 1996 $ 62 $23,184 S32,065 $ 193 $55,504
Net unrealized gains on investment securities,
net of tax (accumulated amount of S213 at
December 31, 1996) 20 20
Net income for the year 6,479 6,479
Other comprehensive income 6,499
Dividend reinvestment and
stock purchase plan 28 28
Acquisition and retirement
of common stock (1) (972) (973)
Cash dividends-$.51 per share (4,243) (4,243)
5% Stock Dividend 3 4,421 (4,424) 0
------ -------- -------- ------- ---------
Balance at December 31, 1996 $64 $26,661 $29,877 $213 $56,815
Net unrealized gains on
investment securities, net of tax
(accumulated amount of $277 at
December 31, 1997) 64 64
Net income for the year 6,645 6,645
Other comprehensive income 6,709
Acquisition and retirement
of common stock (1) (3,200) (3,201)
Cash dividends-$.56 per share (3,609) (3,609)
----- -------- ---------- ------- ---------
Balance at December 31, 1997 $63 $23,461 $32,913 $277 $56,714
Net unrealized gains on investment
securities, net of tax
(accumulated amount of S469 at
December 31, 1998) 192 192
Net income for the year 7,427 7,427
Other comprehensive income 7,619
Dividend reinvestment and
stock purchase plan 28 28
Aquisition and retirement
of common stock (1) (2,105) (2,106)
Cash dividends-$.60 per share (3,781) (3,781)
------- -------- --------- ------- ---------
Balance at December 31, 1998 $62 $21,384 $36,559 $469 $58,474
See notes to consolidated financial statements
[32]
First United Corporation and Subsidiaries
Consolidated Statements of Cash Flows
( In thousands )
Year Ended December 31
1998 1997 1996
-------------------------------------
Operating activities
Net income $7,427 $6,645 $6,479
Adjustments to reconcile net income to
net cash provided by operating activities:
Provision for possible credit losses 1,176 935 749
Provision for depreciation 1,549 1,460 1,299
Net accretion and amortization of investment
security discounts and premiums 222 (116) 345
Gain on sale of investment securities (238) (91) (24)
Increase in accrued interest
receivable and other assets (3,121) (1,440) (483)
Increase (decrease) in reserve for taxes,
interest and other liabilities 534 (236) 1,896
-------- -------- -------
Net cash provided by operating activities 7,549 7,157 10,261
Investing activities
Proceeds from maturities and sales of
investment securities available-for-sale 59,775 74,960 59,489
Purchases of available-for-sale
investment securities (62,570) (56,774) (65,444)
Purchases of investment securities
held-to-maturity (8,625) (8,490) (13,041)
Proceeds from maturities of investment
securities held-to-maturity 5,530 6,048 4,777
Net increase in loans (68,108) (59,079) (22,879)
Purchase of premises and equipment (1,435) (1,379) (1,025)
--------- -------- ---------
Net cash used in investing activities (75,433) (44,714) (38,123)
Financing activities
Net (decrease) increase in demand deposits,
NOW accounts and savings accounts (1,180) 5,367 (623)
Net increase in certificates of
Deposit 12,620 42,154 28,869
Increase (decrease) in Federal Home Loan Bank
borrowings and other borrowed funds 58,350 (1,775) 5,000
Cash dividends paid (3,781) (3,609) (4,243)
Proceeds from issuance of common stock 28 - 28
Acquisition and retirement of common stock (2,106) (3,201) (973)
-------- --------- ---------
Net cash provided by financing activities 63,931 38,936 28,058
Increase in cash and cash equivalents (3,953) 1,379 196
Cash and cash equivalents at beginning of year 17,586 16,207 16,011
-------- -------- ---------
Cash and cash equivalents at end of year $13,633 $17,586 $16,207
======== ======== =========
See notes to consolidated financial statements.
[33]
First United Corporation and Subsidiaries
Notes to Consolidated Financial Statements
( In thousands, except per share amounts )
1. Summary of Significant Accounting Policies
Principles of Consolidation
Thc accompanying financial statements of First United Corporation (Corporation)
include thc accounts of its wholly owned subsidiaries First United Bank & Trust
(Bank) and Oakfirst Life Insurance Corporation (Non-Bank). All significant
intercompany accounts and transactions have been eliminated.
Business
First United Corporation is a registered bank holding company, incorporated
under the laws of Maryland. It is the parent company of First United Bank &
Trust and Oakfirst Life Insurance Corporation. First United Bank & Trust
provides a complete range of retail and commercial banking services to a
customer base serviced by a network oft twenty-two offices and twenty-seven
automated teller machines. This customer base includes individuals, businesses
and various governmental units. Oakfirst Life Insurance Corporation is a
reinsurance company that reinsures credit life and credit accident and health
insurance written by U.S. Life Credit Life Insurance Corporation on consumer
loans made by First United Bank & Trust
Basis of Presentation
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles that require the
Corporation 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.
Investments
Securities available-for-sale: Beginning in 1998, all security purchases are
classified as available-for-sale. Available-for-sale securities are stated at
fair value, with the unrealized gains and losses, net of tax, reported as a
separate component of other comprehensive income in the Corporation's
shareholders' equity.
Securities held-to-maturity: Debt securities are classified as held-to-
maturity when the Corporation has the positive intent and ability to hold the
securities to maturity. Held-to-maturity securities are stated as amortized
cost.
The amortized cost of debt securities classified as held-to-maturity or
available-for-sale is adjusted for amortization of premiums and accretion of
discounts to maturity, or in the case of mortgage-backed securities, over the
estimated life of the security. Such amortization is included in interest income
from investments. Interest and dividends are included in interest income from
investments. Realized gains and losses, and declines in value judged to bc
other-than-temporary are included in net securities gains (losses). The cost of
securities sold is based on the specific identification method.
At December 31, 1998 and 1997, there were no securities held in the
investment portfolio which were classified as trading.
Interest on Loans
Interest on loans is recognized based upon the principal amount outstanding.
It is the Corporation's policy to generally discontinue the accrual of interest
on loans (including impaired loans) when circumstances indicate that collection
of principal or interest is doubtful. After a loan is placed on non-accrual
interest is recognized only to thc extent of cash received.
Bank Premises and Equipment
Bank premises and equipment are carried at cost less accumulated provision
for depreciation. The provision for depreciation for financial reporting
generally has been made by using the straight-line method based on the estimated
useful lives of the assets, which range from 15 to 31.5 years for buildings and
4 to 20 years for equipment. The provision for depreciation for general tax
purposes and for the Alternative Minimum Tax generally has been made using the
double-declining balance method and the ACRS method based on thc estimated
useful lives of the assets which range from 18 to 31.5 years for buildings and
4 to l0 years for equipment.
[34]
1. Summary of Significant Accounting Policies (continued)
Reserve for Possible Credit Losses
The allowance for loan losses is maintained at a level believed adequate by
management to absorb potential losses. 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 judgement, deserve current recognition. Management's evaluation is
inherently subjective as it requires estimates concerning, the underlying
collateral values on impaired loans that may be susceptible to change.
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 bc in effect when these differences reverse. Deferred tax expense
is determined by the change in the liability or asset for deferred taxes
adjusted for changes in any deferred tax asset allowance.
Statement of Cash Flow
The Corporation has defined cash and cash equivalents as those amounts
included in the balance sheet captions "Cash and due from banks" and "Federal
funds sold." The Corporation paid $21,915, $18,978, and $16,376 in interest on
deposits and other borrowed funds for the years ending December 3}, 1998, 1997,
and 1996, respectively.
Earnings Per Share
Earnings per share ("basic" was computed based on the weighted average
number of common shares outstanding of 6,209, 6,343, and 6,492 for 1998, 1997,
and 1996, respectively The Corporation does not have any common stock
equivalents.
Other Comprehensive Income
On January 1, 1998, the Corporation adopted Statement of Financial
Accounting Standards No. 130, Reporting Comprehensive Income" (Statement No.
130). Statement No. 130 establishes standards for the reporting and disclosure
of comprehensive income and its components in thc financial statements. The
adoption of Statement No. 130 had no impact on the Corporation's consolidated
financial statements. For purposes of comparability, prior years' financial
statements have been reclassified to conform to the requirements of Statement
No. 130. Accumulated other comprehensive represents thc unrealized gains and
losses on thc Company's investment securities, net of income taxes. For the
years ended December 31, 1998, 1997, and 1996 total comprehensive income, net
income plus the change in unrealized gains on investment securities, amounted to
$7,619, $6,709, and S6,499 net of income taxes, respectively.
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 an 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. Thc capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation and thc Bank to maintain minimum amounts 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, 1998, that
the Corporation and the Bank meet all capital adequacy requirements to which it
is subject.
As of December 31, 1998, the Corporation and the Bank were well capitalized
under the regulatory framework for prompt corrective action. To be categorized
as well capitalized, minimum total risk-based, Tier I risk-based, and Tier I
leverage ratios must be maintained. Management is not aware of any condition or
event which has caused thc well capitalized position to change.
[35]
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
- -----------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
- -----------------------------------------------------------------------------
December 31, 1998
Total Capital
(to Risk Weighted Assets)
Consolidated $61,778 13.40% $36,870 8.00% $46,099 10.00%
First United Bank 49,915 10.89% 36,665 8.00% 45,831 10.00%
Tier I Capital
(to Risk Weighted Assets)
Consolidated 58,474 12.68% 18,440 4 00% 27,660 6.00%
First United Bank 46,611 10.17% 18,332 4.00% 27,499 6.00%
Tier I Capital
(to Average Assets)
Consolidated 58,474 9.71% 18,073 3.00% 30,123 5.00%
First United Bank 46,611 8.07% 17,328 3.00% 28,880 5 00%
December 31, 1997
Total Capital
(to Risk Weighted Assets)
Consolidated $59,368 14.82% $32,048 8.00% $40,059 10.00%
First United Bank 47,622 11.96% 31,858 8.00% 39,823 10.00%
Tier I Capital
(to Risk Weighted Assets)
Consolidated 56,714 14.16% 16,024 4 00% 24,036 6.00%
First United Bank 44,968 11.29% 15,929 4.00% 23,894 6.00%
Tier I Capital
(to Average Assets)
Consolidated 56,714 10.33% 16,468 3.00% 27,446 5.00%
First United Bank 44,968 8.34% 16,176 3.00% 26,960 5.00%
Investment Securities
In June l998, Statement of Financial Accounting Standards No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (Statement No.
133), was issued. Statement 133 establishes accounting and reporting standards
for derivative instruments, including certain derivative instruments embedded in
other contracts, and hedging activities. This statement is effective for
financial statements issued for all quarters of all fiscal years beginning after
June 15, 1999. Except for this reclassification listed below, the adoption of
StatementNo.133 did not have a material impact on the Corporation's consolidated
financial statements as the Company does not enter into derivative contracts. As
permitted, this Statement as of July 1, l998. In connection with the adoption of
this statement, $25,265,806 of thc investment securities previously classified
as held-to-maturity were reclassified to available-for-sale. As the securities
were marked to market coincident with the reclassification, the change resulted
in an increase of $.25 million to other comprehensive income (net of taxes).
The following is a comparison of book and market values of available-for-
sale securities and held-to-maturity securities:
Available-for-Sale Securities
----------------------------------------------
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
----------------------------------------------
December 31, 1998
U. S. Treasury securities and obligations of
U. S. government agencies $46,743 $277 $17 $47,003
Obligations of states and
political subdivisions 21,876 529 78 22,327
Mortgage-backed securities 23,628 68 59 23,637
U.S. corporate securities 2,604 44 - 2,648
Total debt securities $94,851 $918 $154 $95,615
Equity securities Totals 5,080 - - 5,080
--------- ------ ------- ----------
Totals $99,931 $918 $154 $100,695
========= ======= ======= ==========
[36]
3. Investment Securities (continued)
Available-for-Sale Securities
----------------------------------------------------
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------
December 31, 1997
U. S. Treasury securities and obligations of
U. S. government agencies $41,434 $267 $8 $41,693
Obligations of states and
political subdivisions 6,249 111 - 6,360
Mortgage-backed securities 16,917 108 25 17,000
--------- ------- ------ ---------
Total debt securities $64,600 $486 $ 33 $65,053
========= ======== ====== =======
Held-to-Maturity Securities
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
December 31, 1997
Obligations of states and
political subdivisions $9,203 $178 $ - $9,381
U.S. corporate securities 15,896 83 3 15,976
------- ----- ------- ---------
Total debt securities 25,099 341 63 25,357
Equity securities 4,443 - - 4,443
-------- ------- -------- ---------
Totals $29,542 $261 $ 3 $ 29,800
======== ====== ======= ==========
Available-for-Sale Securities
-------------------------------------------------
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
-------------------------------------------------
December 31, 1996
U. S. Treasury securities and obligations of
U. S. government agencies $56,480 $341 $ 63 $56,758
Obligations of states and
political subdivisions 6,892 89 25 6,956
Mortgage-backed securities 19,990 104 97 19,997
-------- ------ ------- ---------
Total debt securities $83,362 $534 $ 185 $83,711
======== ======= ====== =========
Held-to-Maturity Securities
------------------------------------------------
Gross Gross Estimated
Unrealized Unrealized Fair
Cost Gains Losses Value
------------------------------------------------
December 31, 1996
U.S. Treasury securities and obligations of
U.S. government agencies $1,518 $ - $ 18 $ 1,500
Obligations of states and
political subdivisions $8,362 $336 $ 6 $ 8,692
U.S. corporate securities 13,559 72 17 13,614
------- ------ ------- ---------
Total debt securities 23,439 408 41 23,806
Equity securities 2,918 - - 2,918
------- ------- ------- ---------
Totals $26,357 $408 $41 $ 26,724
======== ====== ====== =========
During the years ended December 31, 1998, 1997, and 1996, available-for-sale
securities with a fair market value at the date of sale of $33.76, $4.83, and
$4.74 million were sold. The gross realized gains on such sales totaled $.271,
$.091, and $.024 million. The gross realized losses on the sales were $.033,
$.003, and $0 million.
The amortized cost and estimated fair value of debt and marketable equity
securities at December 31, 1998, by contractual maturity, are shown below.
Actual maturities will differ from contractual maturities because the issuers of
[37]
3. Investment Securities (continued)
the securities may have thc right to prepay obligations without prepayment
penalties. Equity securities consist of Federal Reserve Bank and Federal Home
Loan Bar k Stock. These securities have no maturity and therefore are classified
in the "Due after ten years" maturity line.
Available-for-Sale Securities
Amortized Market
Cost Value
Due in one year or less $6,695 $6,744
Due after one year through five years 38,047 38,454
Due after five years through ten years 21,589 21,730
Due after ten years 33,601 33,767
--------- -----------
Total $99,931 $100,695
========= ===========
At December 31, 1998, investment securities with a book value of $25.00
million were pledged to secure public and trust deposits as required or
permitted by law.
4. Reserve for Possible Credit Losses
Activity in the reserve for possible credit losses is summarized as follows:
1998 1997 1996
Balance at January 1 $2,654 $2,186 $2,120
Provision charged to operating expense 1,176 935 749
3,830 3,121 2,869
Gross credit losses (708) (638) (847)
Recoveries 182 171 164
Net credit losses (526) (467) (683)
---------- -------- ---------
Balance at December 31 $3,304 $2,654 $2,186
======== ======= ========
Non-accruing loans were $460, $562, and S976 at December 31, 1998, 1997,
and 1996, respectively. Interest income not recognized as a result of non-
accruing loans was $24, $20, and $37 during the years ended December 31, 1998,
1997, and 1996, respectively.
5. Loans and Concentrations of Credit Risk
The Corporation through its banking subsidiary is active in originating
loans to customers primarily in Garrett, Allegany, Washington and Frederick
counties in Maryland; and Mineral, Hardy, Berkeley and Hampshire Counties in
West Virginia, and the surrounding regions of West Virginia and Pennsylvania.
The following table presents the Corporation's composition of credit risk by
significant concentration.
December 31, 1998
Loan
Loans Commitments Total
Commercial, financial and agricultural $80,528 $24,437 $104,965
Real estate construction 11,315 4,532 15,847
Real estate mortgage 286,514 20,375 306,889
Installment 129,477 3,369 132,846
Letters of credit 1,138 1,138 2,276
--------- ----------- ----------
Total $508,972 $53,851 $562,823
======== ========= =========
[38]
5. Loans and Concentrations of Credit Risk (continued)
December 31, 1997
Loan
Loans Commitments Total
Commercial, financial and agricultural $65,988 $25,087 $ 91,075
Real estate construction 11,716 3,889 15,605
Real estate mortgage 287,153 16,416 303,569
Installment 75,124 3,403 78,527
Letters of credit 1,411 773 2,184
--------- --------- ---------
Total $441,392 $49,568 $490,960
========== ========== ==========
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. Historically, more than 99 percent of letters of
credit expire unfunded. 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.
Commercial, financial and agricultural loans are collateralized by real
estate and equipment, and the loan-to-value ratios generally do not exceed 75
percent. Real estate mortgage loans are collateralized by the related property,
and the loan-to-value ratios generally do not exceed 85 percent.
Any consumer real estate mortgage loan exceeding a loan-to-value ratio of 85
percent will require private mortgage insurance. Installment loans are typically
collateralized with loan-to-value ratios which are established based on
historical experience and the financial condition of the borrower and generally
range from 80 percent to 90 percent of the amount of the loan. The Corporation
will also make unsecured consumer loans to qualified borrowers meeting the
underwriting standards of the Corporation.
6. Bank Premises and Equipment
The composition of Bank premises and equipment is as follows:
1998 1997
------------------------
Bank premises $9,010 $8,773
Equipment 13,245 12,235
--------- ----------
22,255 21,008
Less accumulated depreciation (13,119) (11,758)
---------- -----------
Total $9,136 $9,250
========== ==========
The Corporation recorded depreciation expense of $1,549, $1,460 and $1,299
in 1998, 1997, and 1996, respectively.
7. Fair Value of Financial Instruments
As required by the Statement of Financial Accounting Standards ("SFAS")
No.107, "Disclosures about Fair Value of Financial Instruments," the Corporation
has presented 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. 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.
[39]
7. Fair Value of Financial instruments (continued)
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:
1998 1997
--------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------------------------------------------------
Cash and due from banks $13,633 $13,633 $17,586 $17,586
Investment securities 100,695 100,695 94,595 94,853
Loans 508,972 505,927 441,392 441,613
Deposits 511,500 506,243 500,060 498,393
Federal Home Loan Bank borrowings
and other borrowed funds 64,575 64,575 6,225 6,225
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 short-term instruments approximate those
assets' fair values.
Investment Securities Fair values for investment securities are based on
quoted market values.
Loans Receivable: For variable rate loans 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 loans 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.
Federal Home Loan Bank Borrowings and Other Borrowed Funds: Federal funds
purchased and other borrowed funds include federal funds purchased, Federal Home
Loan Bank borrowings and other short-term borrowings. The fair value of short-
term borrowings approximates the carrying value of these instruments based upon
their short-term nature.
Deposit Liabilities: 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.
Off-Balance-Sheet Financial Instruments: In the normal course of business,
the Corporation makes commitments to extend credit and issues standby letters of
credit. As a result of excessive costs, the Corporation considers estimation of
fair values for commitments and standby letters of credit to otherwise be
impracticable. The Corporation's estimate of impairment due to collectibility
concerns related to these off-balance-sheet financial instruments is included in
the reserve for possible credit losses. The Corporation does not have any
derivative financial instruments at December 31, 1998 or 1997.
8. Federal Home Loan Bank (FHLB) Advances and Other Borrowings
Borrowings consist of the following:
December 31, 1998
FHLB advances payable to FHLB Atlanta,
secured by all FHLB advances and certain first mortgage loans
Due December 2, 1999 @ 5.15% $24,575
Due September 24, 2002 @ 5.66% 5,000
Due February 4, 2008 @ 5.49% 10,000
Due September 11, 2008 @ 4.69% 25,000
--------
Total $64,575
========
[40]
December 31, 1997
FHLB advances payable to FHLB Atlanta,
secured by all FHLB advances and certain first mortgage loans:
Due January 5, 1998 @ 5.81% $1,075
Due September 24, 2002 @5.66% 5,000
Correspondent Bank borrowings
Due January 2, 1998 @ 6.00% 150
--------
Total $6,225
========
The Corporation, through its banking subsidiary, First United Bank & Trust,
has a credit agreement with FHLB of Atlanta in an amount up to $ 181.5 million.
The line of credit is secured with the first lien on the 1 -4 family mortgage
portfolio totaling $207.8 million on December 31, 1998.
The Corporation's banking subsidiary First United Bank & Trust has
established various unsecured lines of credit totaling $8 million at various
upstream correspondent banks. The Bank has also established a $8 million reverse
repurchase lines of credit with correspondent banks. As of December 31, 1998,
the Corporation had no borrowings with these correspondent banks. The
Corporation utilizes the lines to meet daily liquidity requirements and does not
rely on lines as a source of long-term liquidity.
9. Income Tax
A reconciliation of the statutory income tax at the applicable rates to the
income tax expense included in the statement of income is as follows:
Liability Method
1998 1997 1996
Income before income taxes $11,409 $9,942 $9,623
Statutory income tax rate 34% 34% 34%
------- -------- -------
Income tax 3,879 3,380 3,272
State franchise tax, net of
federal tax benefit 324 257 274
Effect of nontaxable interest
and loan income (430) (390) (360)
Effect of TEFRA interest limitation 47 37 31
Merger Costs 16 - -
Other 146 13 (73)
------ -------- -------
Income tax expense for the year $3,982 $3,297 $3,144
======== ======= =======
Taxes currently payable $4,022 $3,568 $3,309
Deferred taxes (benefit) (40) (271) (165)
-------- -------- -------
Income tax expense for the year $3,982 $3,297 $3,144
======== ======= =======
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 deferred tax assets and liabilities as of December 31 are as
follows:
1998 1997
--------------------------
Deferred tax assets:
Reserve for possible credit losses $1,083 $685
Deferred loan origination fees 222 194
Pension expense - 91
Merger costs 16 132
Unrealized loss on real property 119 122
Deferred compensation 58 46
Other 10 12
-------- --------
Total deferred tax assets 1,508 1,236
Valuation allowance (16) (132)
---------- --------
Total deferred tax assets less
valuation allowance 1,492 1,104
[41]
Deferred tax liabilities;
Pension (265) -
Market discount (98) (72)
Excess depreciation (407) (378)
Employee compensation (86) (84)
Unrealized gain on investment
securities (295) (174)
Prepaid expenses (37) (53)
Other 1 (6)
--------- ----------
Total deferred tax liability (1,187) (721)
---------- ----------
Net deferred tax asset $305 $383
=========== ==========
The Corporation made income tax payments of $3,400, $2,920, and $3,529 for
the years ending December 31, 1998, l997 and 1996, respectively.
10. Employee Benefit Plans
Statement of Financial Accounting Standards No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" ( Statement No.
132 ), effective for financial statements issued for fiscal years beginning
after December 15, 1997, revises employers' disclosures about pension and other
postretirement benefit plans. lt does not change the measurement or recognition
of those plans. Thc adoption of statement No. 132 did not have an impact on thc
Corporation's consolidated financial statements. For comparability, prior year
financial statement disclosures have been restated to conform with requirements
of Statement No. 132.
1998 1997
-----------------------------------
Change in Benefit Obligation
Obligation at the beginning of the year $7,143 $7,480
Service cost 308 260
Interest cost 551 494
Actual (gain) loss 1,004 (688)
Benefits paid (430) (403)
--------- ---------
Obligation at the end of the year $8,576 $7,142
========= =========
Change in Plan Assets
Fair value at the beginning of the year $8,502 $7,476
Actual return on plan assets 1,465 1,097
Employer contribution 741 331
Benefits paid (430) (403)
---------- --------
Fair value at the end of the year $10,278 $8,502
========== =========
Funded Status 1,701 1,360
Unrecognized actuarial gain (295) (539)
Unrecognized prior service cost (28) (30)
Unrecognized transition asset (644) (684)
---------- --------
Prepaid benefit cost $734 $107
========= ========
Discount rate 6.75% 7.50%
Expected return on assets 8.50% 8.00%
Rate of pay increase 3.75% 4.00%
[42]
Employee Benefit Plans (continued)
1998 1997 1996
Net Pension cost included the following:
Service costs-benefits earned during the year $ 308 $259 $301
Interest cost on projected benefit obligation 552 494 523
Actual return on plan assets (1,465) (1,097) (545)
Net amortization and deferral 718 453 (39)
------ ------- ------
Net pension expense included in employee benefits $113 $110 $240
====== ====== ========
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 Intel Revenue Code. The 401(k) Plan covers substantially all
employees of the Corporation. Eligible employees can elect to contribute,
through payroll deductions, up to 10% of their base salary, with contributions
up to 6% of base salary matched on a 50% basis by the Corporation. Expense
charged to operations for the 401(k) Plan was $162, $ 120, and $ 105 in 1998,
1997, and 1996, respectively.
11. Federal Reserve Requirements
The banking subsidiaries are required to maintain reserves with the Federal
Reserve Bank During 1998, the daily average amount of these required reserves
was approximately $7.641 million.
12. Restrictions on Subsidiary Dividends; Loans or Advances
Banking law limits the amount of dividends which a bank can pay without
obtaining prior approval from bank regulators. Under this law the banking
subsidiaries could, without regulatory approval, declare additional dividends
in 1998 of approximately $2.227 million plus an additional amount equal to the
net profits for 1999 up to the date of any such dividend declaration.
Under Federal Reserve regulations, the banking subsidiaries are also limited
to the amount they may loan to their affiliates, including the Corporation,
unless such loans are collateralized by specified obligations. Although no
transfers were made, $6,178 in funds were available for transfer from the Bank
to the Corporation in the form of loans as of December 31, 1998.
13. Parent Company Financial Information (Parent Company Only)
Condensed Statements of Financial Condition
December 31,
Asset 1998 1997
---------------------------
Cash $1,286 $544
Investment securities 5,354 6,572
Investment in bank subsidiary 46,611 44,981
Dividend receivable and other assets 436 106
Investment in non-bank subsidiary 5,758 5,478
--------- ---------
Total Assets $59,445 $57,681
========= =========
Liabilities and Shareholder's Equity
Reserve for taxes, interest
and other liabilities - $30
Dividends payable 971 937
Shareholders' equity 58,474 56,714
Total Liabilities and ---------- -----------
Shareholder's Equity $59,445 $57,681
=========== ===========
[43]
13. Parent Company Financial Information (Parent Company Only) (continued)
Condensed Statement of Income Year ended December 31,
Income: 1998 1997 1996
Dividend income from subsidiaries $5,380 $5,335 $6,170
Other income 335 334 329
-------- -------- --------
Total income 5,715 5,669 6,499
Expense:
Other expenses 5 10 13
Income before income taxes and equity in
undistributed net income of subsidiaries 5,710 5,659 6,486
Equity in undistributed net income of subsidiaries:
Bank 1,412 681 (326)
Non-Bank 313 313 324
Less income tax (8) (8) (5)
------- -------- -------
Net income $7,427 $6,645 $6,479
======== ========= ========
Condensed Statement of Cash Flows
Year ended December 31
Operating activities 1998 1997 1996
--------------------------------------
Net income $7,427 $6,645 $6,479
Adjustments to reconcile net income to net cash provided
by operating activities:
Increase in dividends payable 34 35 902
Undistributed equity in subsidiaries:
Bank (1,412) (681) 326
Non-bank (313) (313) (324)
Increase in other assets (330) (313) (324)
(Decrease) increase in other liabilities (30) (888) (872)
-------- ------- --------
Net cash provided by operating activities 5,376 4,804 8,208
Investing activities
Purchase of investment securities (114) (205) (2,962)
Proceeds from investment maturities 1,338 628 -
------- ------- ---------
Net cash used in investing activities 1,224 423 (2,962)
Financing activities
Cash dividends (3,781) (3,609) (4,243)
Proceeds of issuance of common stock 28 - 28
Acquisition and retirement of common stock (2,106) (3,201) (972)
-------- --------- ---------
Net cash used by financing activities (5,858) (6,810) (5,187)
Increase in cash and cash equivalents 742 (1,583) 59
Cash and cash equivalents at beginning of year 544 2,127 2,068
-------- -------- -------
Cash and cash equivalents at end of year $1,286 $ 544 $2,127
======== ======== =========
14. Commitments and Contingent Liabilities
The Corporation and its subsidiaries are at times, and in the ordinary
course of business, subject to legal actions. Management, upon the advice of
counsel, is of the opinion that losses, if any, resulting from the settlement of
current legal actions will not have a material adverse effect on the financial
condition of the Corporation.
Oakfirst Life Insurance Corporation, a wholly owned subsidiary of the
Corporation, had $8.501 million of life, accident and health insurance in force
at December 31, 1998. In accordance with state insurance laws, this subsidiary
is capitalized at $5.76 million.
[44]
15. Related Party Transacffons
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 Corporation and its
subsidiaries. Pursuant to the Corporation's policy, 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:
l998 1997 1996
-----------------------------------
Balance, January 1 $8,046 $7,981 $6,626
Loans or advances 3,303 5,239 2,775
Repayments (3,415) (5,174) (1,420)
-------- --------- --------
Balance, December 31 $7,934 $8,046 $7,981
======= ======== ========
16. Quarterly Results of Operations (Unaudited)
The following is a summary of the quarterly results of operations for the
years ended December 31, 1997 and 1996.
Three months ended
1998 March 31 June 30 September December
Interest income $11,226 $11,630 $12,002 $12,385
Interest expense 5,216 5,283 5,655 5,761
-------- -------- --------- --------
Net interest income 6,010 6,347 6,347 6,624
Provision for possible
credit losses 250 225 341 360
Other income 1,559 1,510 1,648 1,589
Other expenses 4,747 4,950 4,756 4,596
-------- ------- -------- --------
Income before income taxes 2,572 2,682 2,898 3,257
Applicable income taxes 894 936 1,012 1,140
-------- --------- --------- ----------
Net income $1,678 $1,746 $1,886 $2,117
======= ========= ======= =========
Earnings per share $.27 $.28 $.30 $.35
======= ========== ======= ========
Three months ended
1997 March 31 June 30 September December
--------------------------------------------------
Interest income $10,381 $10,603 $11,025 $11,339
Interest expense 4,397 4,548 4,887 5,146
Net interest income 5,984 6,055 6,138 6,193
Provision for possible
credit losses 124 123 376 312
Other income 1,200 1,757 1,577 1,503
Other expenses 5,003 5,202 4,852 4,473
------- ------- -------- ---------
Income before income taxes 2,057 2,487 2,487 2,911
Applicable income taxes 681 790 888 988
-------- ------- -------- ---------
Net income $1,376 $1,697 $1,649 $1,923
======= ======= ======== ========
Earnings per share $.21 $.27 $.26 $.31
======== ====== ========= ========
Item 9. CHANGES IN AND DISAGREEMENTSWITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
[45]
PART 111
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OFTHE REGISTRANT
The information with respect to Directors of the Registrant is incorporated by
reference from the Registrant's definitive Proxy Statement for the annual
shareholders meeting to be held April 27, 1999, from pages 2 through 6.
Executive Officers of the Registrant are:
NAME POSITION AGE
William B Grant Chairman of the Board and 45
Chief Executive Officer
Robert W. Kurtz President, 52
Chief Financial Officer and
Secretary/Treasurer
Benjamin W. Ridder Executive Vlce President and 57
Director of Retail Banking
Jeannette R. Fitzwater Senior Vlce President and 38
Director of Human Resources
Philip D. Frantz Senior V1ce President and 38
Director of Operations & Support
Steven M. Lantz Senior Vice President and 42
Director of Lending
Eugene D. Helbig, Jr. Senior Vlce President 46
Senior Trust Officer
Frederick A Thayer IV Senior Vice President 40
Director of Sales and CRA Officer
As defined by me rules and regulations of the Securities and Exchange
Commission, family relationships exist among Directors, Nominees and Executive
Officers. Director Frederick A. Thayer III is the father of Senior Vice
President Frederick A. Thayer IV. Director I. Robert Rudy is the brother of
Senior Vice President Jeannette Rudy Fitzwater. No other family relationships
exist.
All officers are elected annually by the Board of Directors and hold office at
the pleasure of the Board.
Mr. Grant has been Chairman of the Board and Chief Executive Officer since 1996.
Previously, he had been Secretary of First United Corporation since 1990 and
Executive Vice-President of First United Bank & Trust since 1987.
Mr. Kurtz has been President of First United Corporation since 1996 and Chief
Financial Officer, Secretary, and Treasurer since 1997. Previously, he had been
Chief Operating Officer of First United Corporation since 1996, Treasurer of
First United Corporation since 1990 and Executive Vice-President of First United
Bank & Trust since 1987.
Mr. Ridder has been Executive Vice President and Director of Retail Banking of
First United Corporation since 1997. Previously, he had been Senior Vice
President of the Corporation since 1987.
Mrs. Fitzwater was appointed Senior Vice President and Director of Human
Resources in 1997. She had been First Vice President, Director of Marketing and
Regional Sales Manager of First United Bank & Trust since 1994.
Mr. Frantz was appointed Senior Vice President in 1993 and previously had been
the Controller of the organization since 1988. He was appointed Director of
Operations & Support of the Corporation in 1997.
Mr. Lantz was appointed Senior Vice President and Director of Lending of the
Corporation in 1997. He had been First V1ce President and Commercial Services
Manager of First United Bank & Trust since 1993.
[46]
Item 10. Directors and Executive Officers of the Registrant (continued)
Mr. Helbig was appointed Senior Vice President in 1997 and Senior Trust Officer
in 1993. He had been a First Vice President since 1993.
Mr. Thayer was appointed Senior Vice President and Director of Sales in 1997.
Previously, he had been First Vice President, Regional Executive Officer and
Regional Sales Manager of First United Bank & Trust since 1993.
Item 11. EXECUTIVE COMPENSATION
Information required by Item 11 is incorporated by reference from pages 4
and 5 of the definitive Proxy Statement of the Corporation for the annual
meeting of shareholders to be held on April 27, 1999.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information required by Item 12 is incorporated by reference from pages 2
and 3 of the definitive Proxy Statement of the Corporation for the annual
meeting of shareholders to be held on April 27, 1999.
Item 13. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS
The information required by Item 13 is incorporated by reference from page 6
of the definitive Proxy Statement of the Corporation for the annual meeting of
shareholders to be held on April 27, 1999, and from Note 15 on page 45 of this
Form 10-K. There are no other relationships required to be disclosed in this
item pursuant to the instructions for this report.
PART IV.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) and (2) Financial Statements and Financial Statement Schedules.
The consolidated financial statements of the Corporation are listed on pages
24-27 of the Annual Report on Form 10-K. All schedules applicable to the
Corporation are shown in the financial statements or in the notes thereto
included in this Annual Report on Form 10-K.
All other schedules to the consolidated financial statements required by
Article 9 of Regulation S-X and all other schedules to the financial statements
of the Registrant required by Article 5 of Regulation S-X are not required under
the related instructions or are inapplicable and, therefore, have been omitted.
(3) Listing of Exhibits.
21.1-Subsidiaries of the Corporation, incorporated by reference on pages 3
of this Form 10-K.
23.1-Consent of Ernst & Young, LLP
27.1-Financial Data Schedule, filed electronically herewithin
(b) The Registrant filed one current report on Form 8-K during the quarter ended
December 31, 1998, dated October 22, 1998, regarding the Bank's execution of
a letter of intent to acquire Gonder Insurance Agency, Inc., a Maryland
insurance agency.
[47]
Signatures
Pursuant to the requirements of Section 13 or l5(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
/s/ William B. Grant
William B.Grant
Chairman of the Board and
Chief Executive Officer
Pursuant to thc 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.
Signatures
/s/ (David J. Beachy) Director /s/(Dr. Andrew E. Mance) Director
/s/(Donald M. Browning) Director /s/(Donald E Moran) Director
/s/(Rex W. Burton) Director /s/(Richard G. Stanton) Director
/s/ (Richard D. Dailey Jr.) Director /s/ (I. Robert Rudy) Director
/s/ (Paul Cox, Jr) Director /s/ (Robert G. Stuck) Director
/s/ (Frederick A. Thayer, III) Director /s/ (James F. Scarpelli Sr,) Director
/s/ (Robert W. Kurtz) Director /s/ (Karen F. Myers) Director
/s/ (Maynard G. Grossnickle) Director /s/ (Elaine L. McDonald) Director
/s/ (Raymond F. Hinkle) Director
[49]
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
( Form S - 3 No. 33-26248) of First United Corporation and in the related
Prospectus of our report dated February 5, 1999, with respect to the
consolidated financial statements of First United Corporation included in this
Annual Report ( Form 10 - K ) for the year ended December 31, 1998.
Ernst & Young, LLP
Baltimore, Maryland
March 17, 1999