UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
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
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(State or other jurisdiction (I.R.S. Employer
incorporation or organization) Identification No.)
19 SOUTH SECOND STREET, OAKLAND, MARYLAND 21550-0009
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (800) 470-4356
Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR
VALUE $.01 PER SHARE
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 10-K or any amendment to this Form 10-K.|_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes |X| No |_|
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of June 30, 2004: $118,400,572.
The number of shares of the registrant's common stock outstanding as of
February 28, 2005: 6,099,383
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement for the 2005
Annual Meeting of Shareholders to be filed with the SEC in March 2005 pursuant
to Regulation 14A are incorporated by reference into Part III of this Annual
Report on Form 10-K.
FIRST UNITED CORPORATION
TABLE OF CONTENTS
PART I
Item 1. Business 3-8
Item 2. Properties 8
Item 3. Legal Proceedings 8
Item 4. Submission of Matters to a Vote of Security Holders 8
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities 9
Item 6. Selected Financial Data 9-10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 10-25
Item 7A. Quantitative and Qualitative Disclosure About Market Risk 25
Item 8. Financial Statements and Supplementary Data 25-45
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 45
Item 9A. Controls and Procedures 45-47
Item 9B. Other Information 48
PART III
Item 10. Directors and Executive Officers of the Registrant 48
Item 11. Executive Compensation 48
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters 48
Item 13. Certain Relationships and Related Transactions 48
Item 14. Principal Accountant Fees and Services 48
PART IV
Item 15. Exhibits and Financial Statement Schedules 48
SIGNATURES 49
EXHIBITS
2
FORWARD-LOOKING STATEMENTS
This Annual Report of First United Corporation (the "Corporation") filed
on Form 10-K may contain forward-looking statements within the meaning of The
Private Securities Litigation Reform Act of 1995. Readers of this report should
be aware of the speculative nature of "forward-looking statements." Statements
that are not historical in nature, including those that include the words
"anticipate," "estimate," "should," "expect," "believe," "intend," and similar
expressions, are based on current expectations, estimates and projections about,
among other things, the industry and the markets in which the Corporation
operates, and they are not guarantees of future performance. Whether actual
results will conform to expectations and predictions is subject to known and
unknown risks and uncertainties, including risks and uncertainties discussed in
this report; general economic, market, or business conditions; changes in
interest rates, deposit flow, the cost of funds, and demand for loan products
and financial services; changes in the Corporation's competitive position or
competitive actions by other companies; changes in the quality or composition of
loan and investment portfolios; the ability to manage growth; changes in laws or
regulations or policies of federal and state regulators and agencies; and other
circumstances beyond the Corporation's control. Consequently, all of the
forward-looking statements made in this document are qualified by these
cautionary statements, and there can be no assurance that the actual results
anticipated will be realized, or if substantially realized, will have the
expected consequences on the Corporation's business or operations. For a more
complete discussion of these risk factors, see Exhibit 99.1 to this report
entitled "Risk Factors." Except as required by applicable laws, the Corporation
does not intend to publish updates or revisions of forward-looking statements it
makes to reflect new information, future events or otherwise.
PART I
ITEM 1. BUSINESS
GENERAL
The Corporation is a Maryland corporation chartered in 1985 and a
financial holding company registered under the federal Bank Holding Company Act
of 1956, as amended (the "BHC Act"). The Corporation and its consolidated
subsidiaries are sometimes referred to as "we", "us", "our", or "Registrant" in
this annual report.
The Corporation's primary business is serving as the parent company of
First United Bank & Trust, a Maryland trust company (the "Bank"), First United
Insurance Group, LLC, a Maryland insurance agency (the "Insurance Group"),
OakFirst Loan Center, Inc., a West Virginia finance company, OakFirst Loan
Center, LLC, a Maryland finance company, (together with OakFirst Loan Center,
Inc. the "OakFirst Loan Centers"), and Oakfirst Life Insurance Corporation, an
Arizona reinsurance company ("Oakfirst Life"). OakFirst Loan Center, Inc. has
one subsidiary, First United Insurance Agency, Inc., which is a Maryland
insurance agency. In addition, the Bank has two direct subsidiaries, First
United Auto Finance, LLC, an inactive indirect automobile leasing limited
liability company, and First United Investment Trust, which is a Maryland real
estate investment trust that invests in mortgage loans (the "Investment Trust").
Until December 31, 2004, the Corporation's full-service insurance
operations were conducted through its subsidiary, Gonder Insurance Agency, Inc.
("Gonder"). Effective January 1, 2005, Gonder was merged into the Insurance
Group.
As of December 31, 2004, the Corporation had assets of approximately
$1,232 million, net loans of approximately $905 million, and deposits of
approximately $851 million. Shareholders' equity at December 31, 2004 was
approximately $86 million.
The Corporation maintains an Internet site at WWW.MYBANKFIRSTUNITED.COM on
which it makes available, free of charge, its Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments
to the foregoing on its Internet site as soon as reasonably practicable after
these reports are electronically filed with, or furnished to, the Securities and
Exchange Commission (the "SEC").
BANKING PRODUCTS AND SERVICES
The Bank operates 24 banking offices, one call center and 34 Automated
Teller Machines ("ATM's") in the following Maryland Counties: Garrett, Allegany,
Washington and Frederick; and in the following West Virginia Counties: Mineral,
Berkeley, Hardy and Monongalia. The Bank is an independent community bank
providing a complete range of retail and commercial banking services to
businesses and individuals in its market area. Services offered are essentially
the same as those offered by larger regional institutions that compete with the
Bank. The services provided by the Bank include checking, savings, and money
market deposit accounts, business loans, personal loans, mortgage loans, lines
of credit, and consumer-oriented financial services including IRA and employee
benefit accounts. In addition, the Bank provides full brokerage services through
a networking arrangement with PrimeVest Financial Services, Inc., a full service
broker-dealer. The Bank also provides safe deposit and night depository
facilities, and a complete line of insurance products and trust services. As of
December 31, 2004, the total market value of assets under the supervision of the
Bank's trust department was approximately $395 million. The Bank's deposits are
insured by the Federal Deposit Insurance Corporation (the "FDIC").
3
LENDING ACTIVITIES
The majority of the Corporation's lending activities are conducted through
the Bank.
Most of the Bank's commercial loans are secured by real estate, commercial
equipment, vehicles or other assets of the business. Repayment is often
dependent on the successful operation of the business and may be affected by
adverse conditions in the local economy or real estate market. The financial
condition and cash flow of commercial borrowers is therefore carefully analyzed
during the loan approval process, and continues to be monitored by obtaining
business financial statements, personal financial statements and income tax
returns. The frequency of this ongoing analysis depends upon the size and
complexity of the credit and collateral that secures the loan. It is also the
Bank's general policy to obtain personal guarantees from the principals of the
commercial loan borrowers.
Commercial real estate loans are primarily those secured by land for
residential and commercial development, agricultural purpose properties, service
industry buildings such as restaurants and motels, retail buildings and general
purpose business space. Low loan to value ratio standards, as well as the
thorough financial analysis performed and the Bank's knowledge of the local
economy in which it lends, can reduce the risk associated with these loans.
The risk of loss associated with commercial real estate construction
lending is controlled through conservative underwriting procedures such as loan
to value ratios of 80% or less, obtaining additional collateral when prudent,
and closely monitoring construction projects to control disbursement of funds on
loans.
The Bank's residential mortgage loans are primarily variable rate loans.
Although the Bank may also originate fixed rate residential mortgage loans, the
Bank is generally acting in a brokering capacity on behalf of other financial
institutions, for which it receives a fee. As with any consumer loan, repayment
is dependent on the borrower's continuing financial stability, which can be
adversely impacted by job loss, divorce, illness, or personal bankruptcy.
Residential mortgage loans exceeding an internal loan-to-value ratio require
private mortgage insurance. Title insurance protecting the Bank's lien priority,
as well as fire and casualty insurance, is required.
Home equity lines of credit, included within the residential mortgage
portfolio, are secured by the borrower's home and can be drawn on at the
discretion of the borrower. These lines of credit are at variable interest
rates.
The Bank also provides residential real estate construction loans to
builders and individuals for single family dwellings. Residential construction
loans are usually granted based upon "as completed" appraisals and are secured
by the property under construction. Site inspections are performed to determine
pre-specified stages of completion before loan proceeds are disbursed. These
loans typically have maturities of six to twelve months and may be fixed or
variable rate. Permanent financing for individuals offered by the Bank includes
fixed and variable rate loans with three, five or seven year adjustable rate
mortgages.
A variety of other consumer loans are also offered to customers, including
indirect and direct auto loans, and other secured and unsecured lines of credit
and term loans. Careful analysis of an applicant's creditworthiness is performed
before granting credit, and on-going monitoring of loans outstanding is
performed in an effort to minimize risk of loss by identifying problem loans
early.
Additionally, the Corporation meets the lending needs of under-served
customer groups within its market areas in part through OakFirst Loan Center,
Inc., located in Martinsburg, West Virginia, and OakFirst Loan Center, LLC,
located in Hagerstown, Maryland.
INSURANCE ACTIVITIES
The Corporation offers a full range of insurance products and services to
customers in its market areas through the Insurance Group and First United
Insurance Agency, Inc. Oakfirst Life reinsures credit life and credit accident
and health insurance written by American General Assurance Company on consumer
loans made by the Bank.
TRUST SERVICES
The Bank's Trust Department offers a full range of trust services,
including personal trust, investment agency accounts, charitable trusts,
retirement accounts including IRA roll-overs, 401(k) accounts, defined benefit
plans, estate administration and estate planning.
COMPETITION
The banking business, in all of its phases, is highly competitive. Within
their market areas, the Corporation and its affiliates compete with commercial
banks, (including local banks and branches or affiliates of other larger banks),
savings and loan associations and credit unions for loans and deposits, with
consumer finance companies for loans, with insurance companies for insurance
products, and with other financial institutions for various types of products
and services. There is also competition for commercial and retail banking
business from banks and financial institutions located outside our market areas.
4
The primary factors in competing for deposits are interest rates,
personalized services, the quality and range of financial services, convenience
of office locations and office hours. The primary factors in competing for loans
are interest rates, loan origination fees, the quality and range of lending
services and personalized services.
To compete with other financial services providers, the Corporation relies
principally upon local promotional activities, personal relationships
established by officers, directors and employees with its customers and
specialized services tailored to meet its customers' needs. In those instances
in which the Corporation is unable to accommodate a customer's needs, it will
arrange for those services to be provided by other financial services providers
with which it has a relationship.
Current banking laws facilitate interstate branching and merger activity
among banks. Since September 1995, certain bank holding companies are authorized
to acquire banks throughout the United States. In addition, since June 1, 1997,
certain banks are permitted to merge with banks organized under the laws of
different states. As a result, interstate banking is now an accepted element of
competition in the banking industry and the Corporation may be brought into
competition with institutions with which it does not presently compete.
SUPERVISION AND REGULATION
The following is a summary of the material regulations and policies
applicable to the Corporation and its subsidiaries and is not intended to be a
comprehensive discussion. Changes in applicable laws and regulations may have a
material effect on the business of the Corporation and Bank.
GENERAL
The Corporation is a financial holding company registered with the Board
of Governors of the Federal Reserve System (the "FRB") under the BHC Act and, as
such, is subject to the supervision, examination and reporting requirements of
the BHC Act and the regulations of the FRB.
The Bank is a Maryland trust company subject to the banking laws of
Maryland and to regulation by the Commissioner of Financial Regulation of
Maryland, who is required by statute to make at least one examination in each
calendar year (or at 18-month intervals if the Commissioner determines that an
examination is unnecessary in a particular calendar year). The Bank also has
offices in West Virginia, and the operations of these offices are subject to
West Virginia laws and to supervision and examination by the West Virginia
Division of Banking. The Bank is a member of the FDIC, so it is also subject to
certain provisions of federal law and regulations and examination by the FDIC.
The Bank is also subject to numerous state and federal statutes and regulations
that affect the business of banking in its market areas, including the provision
of trust services.
All nonbank affiliates of the Corporation are subject to examination by
the FRB, and, as affiliates of the Bank, are subject to examination by the FDIC
and the Commissioner of Financial Regulation of Maryland. In addition, OakFirst
Loan Center, Inc. is subject to licensing and regulation by the West Virginia
Division of Banking, OakFirst Loan Center, LLC is subject to licensing and
regulation by the Commissioner of Financial Regulation of Maryland, and the
Insurance Group and First United Insurance Agency, Inc. are each subject to
licensing and regulation by various state insurance authorities. Retail sales of
insurance products by these insurance affiliates are also subject to the
requirements of the Interagency Statement on Retail Sales of Nondeposit
Investment Products promulgated in 1994 by the FDIC, the FRB, the Office of the
Comptroller of the Currency, and the Office of Thrift Supervision.
REGULATION OF FINANCIAL HOLDING COMPANIES
In November 1999, the federal Gramm-Leach-Bliley Act (the "GLBA") was
signed into law. Effective in pertinent part on March 11, 2000, GLBA revises the
BHC Act and repeals the affiliation provisions of the Glass-Steagall Act of
1933, which, taken together, limited the securities, insurance and other
non-banking activities of any company that controls an FDIC insured financial
institution. Under GLBA, a bank holding company can elect, subject to certain
qualifications, to become a "financial holding company." GLBA provides that a
financial holding company may engage in a full range of financial activities,
including insurance and securities sales and underwriting activities, and real
estate development, with new expedited notice procedures. Maryland law generally
permits Maryland State chartered banks, including the Bank, to engage in the
same activities, directly or through an affiliate, as national banking
associations. GLBA permits certain qualified national banking associations to
form financial subsidiaries, which have broad authority to engage in all
financial activities except insurance underwriting, insurance investments, real
estate investment or development, or merchant banking. Thus, GLBA has the effect
of broadening the permitted activities of the Corporation and the Bank.
5
The Corporation and its affiliates are subject to the provisions of
Section 23A and Section 23B of the Federal Reserve Act. Section 23A limits the
amount of loans or extensions of credit to, and investments in, the Corporation
and its nonbank affiliates by the Bank. Section 23B requires that transactions
between the Bank and the Corporation and its nonbank affiliates be on terms and
under circumstances that are substantially the same as with non-affiliates.
Under FRB policy, the Corporation is expected to act as a source of
strength to its subsidiary banks, and the FRB may charge the Corporation with
engaging in unsafe and unsound practices for failure to commit resources to a
subsidiary bank when required. In addition, under the Financial Institutions
Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), depository institutions
insured by the FDIC can be held liable for any losses incurred by, or reasonably
anticipated to be incurred by, the FDIC in connection with (i) the default of a
commonly controlled FDIC-insured depository institution or (ii) any assistance
provided by the FDIC to a commonly controlled FDIC-insured depository
institution in danger of default. Accordingly, in the event that any insured
subsidiary of the Corporation causes a loss to the FDIC, other insured
subsidiaries of the Corporation could be required to compensate the FDIC by
reimbursing it for the estimated amount of such loss. Such cross guaranty
liabilities generally are superior in priority to obligations of a financial
institution to its shareholders and obligations to other affiliates.
FEDERAL BANKING REGULATION
Federal banking regulators, such as the FRB and the FDIC, may prohibit the
institutions over which they have supervisory authority from engaging in
activities or investments that the agencies believe are unsafe or unsound
banking practices. Federal banking regulators have extensive enforcement
authority over the institutions they regulate to prohibit or correct activities
that violate law, regulation or a regulatory agreement or which are deemed to be
unsafe or unsound practices. Enforcement actions may include the appointment of
a conservator or receiver, the issuance of a cease and desist order, the
termination of deposit insurance, the imposition of civil money penalties on the
institution, its directors, officers, employees and institution-affiliated
parties, the issuance of directives to increase capital, the issuance of formal
and informal agreements, the removal of or restrictions on directors, officers,
employees and institution-affiliated parties, and the enforcement of any such
mechanisms through restraining orders or other court actions.
The Bank is subject to certain restrictions on extensions of credit to
executive officers, directors, and principal shareholders or any related
interest of such persons, which generally require that such credit extensions be
made on substantially the same terms as are available to third parties dealing
with the Bank and not involve more than the normal risk of repayment. Other laws
tie the maximum amount that may be loaned to any one customer and its related
interests to capital levels.
As part of the Federal Deposit Insurance Corporation Improvement Act of
1991 ("FDICIA"), each federal banking regulator adopted non-capital safety and
soundness standards for institutions under its authority. These standards
include internal controls, information systems and internal audit systems, loan
documentation, credit underwriting, interest rate exposure, asset growth, and
compensation, fees and benefits. An institution that fails to meet those
standards may be required by the agency to develop a plan acceptable to meet the
standards. Failure to submit or implement such a plan may subject the
institution to regulatory sanctions. The Corporation, on behalf of the Bank,
believes that the Bank meets substantially all standards that have been adopted.
FDICIA also imposes new capital standards on insured depository institutions.
The Community Reinvestment Act ("CRA") requires that, in connection with
the examination of financial institutions within their jurisdictions, the FDIC
evaluate the record of the financial institution in meeting the credit needs of
their communities including low and moderate income neighborhoods, consistent
with the safe and sound operation of those banks. These factors are also
considered by all regulatory agencies in evaluating mergers, acquisitions and
applications to open a branch or facility. As of the date of its most recent
examination report, the Bank has a CRA rating of "Satisfactory."
As a FDIC member institution, the Bank's deposits are insured to a maximum
of $100,000 per depositor through the Bank Insurance Fund ("BIF"), administered
by the FDIC, and the Bank is required to pay semi-annual deposit insurance
premium assessments to the FDIC. The BIF assessment rates are based upon a
matrix that takes into account a bank's capital level and supervisory rating.
The Bank paid $.2 million in FDIC premiums in 2004.
For a discussion of the regulatory capital requirements and related
restrictions to which the Corporation and the Bank are subject, see "Capital
Requirements" above.
6
CAPITAL REQUIREMENTS
FDICIA established a system of prompt corrective action to resolve the
problems of undercapitalized institutions. Under this system the federal banking
regulators are required to rate supervised institutions on the basis of five
capital categories: "well capitalized," "adequately capitalized,"
"undercapitalized," "significantly undercapitalized," and "critically
undercapitalized;" and to take certain mandatory actions, and are authorized to
take other discretionary actions, with respect to institutions in the three
undercapitalized categories. The severity of the actions will depend upon the
category in which the institution is placed. A depository institution is "well
capitalized" if it has a total risk based capital ratio of 10% or greater, a
Tier 1 risk based capital ratio of 6% or greater, and a leverage ratio of 5% or
greater and is not subject to any order, regulatory agreement, or written
directive to meet and maintain a specific capital level for any capital measure.
An "adequately capitalized" institution is defined as one that has a total risk
based capital ratio of 8% or greater, a Tier 1 risk based capital ratio of 4% or
greater and a leverage ratio of 4% or greater (or 3% or greater in the case of a
bank with a composite CAMEL rating of 1).
FDICIA generally prohibits a depository institution from making any
capital distribution, including the payment of cash dividends, or paying a
management fee to its holding company if the depository institution would
thereafter be undercapitalized. Undercapitalized depository institutions are
subject to growth limitations and are required to submit capital restoration
plans. For a capital restoration plan to be acceptable, the depository
institution's parent holding company must guarantee (subject to certain
limitations) that the institution will comply with such capital restoration
plan.
Significantly undercapitalized depository institutions may be subject to a
number of other requirements and restrictions, including orders to sell
sufficient voting stock to become adequately capitalized and requirements to
reduce total assets and stop accepting deposits from correspondent banks.
Critically undercapitalized depository institutions are subject to the
appointment of a receiver or conservator, generally within 90 days of the date
such institution is determined to be critically undercapitalized.
Information about the Corporation's capital resources is provided in this
report under Item 7 of Part II, "Management's Discussion and Analysis of
Financial Condition and Results of Operation--Capital Resources". Information
about the capital ratios of the Corporation and of the Bank as of December 31,
2004 may be found in Note 2 of the Notes to Consolidated Financial Statements
included elsewhere in this annual report.
USA PATRIOT ACT
Congress adopted the USA PATRIOT Act (the "Patriot Act") on October 26,
2001 in response to the terrorist attacks that occurred on September 11, 2001.
Under the Patriot Act, certain financial institutions, including banks, are
required to maintain and prepare additional records and reports that are
designed to assist the government's efforts to combat terrorism. The Patriot Act
includes sweeping anti-money laundering and financial transparency laws and
required additional regulations, including, among other things, standards for
verifying client identification when opening an account and roles to promote
cooperation among financial institutions, regulators and law enforcement
entities in identifying parties that may be involved in terrorism or money
laundering.
FEDERAL SECURITIES LAW
The shares of the Corporation's common stock are registered with the
Securities and Exchange Commission (the "SEC") under Section 12(g) of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"). The
Corporation is subject to information reporting, proxy solicitation, insider
trading restrictions and other requirements of the Exchange Act. The federal
Sarbanes-Oxley Act of 2002 made several changes to the Exchange Act and also
required the SEC and the Nasdaq Stock Market to adopt new rules. These changes
and new rules impose additional requirements and restrictions on the
Corporation, including, among other things, restrictions on loans to and other
transactions with insiders, additional disclosure requirements in the reports
and other documents that the Corporation files with the SEC, new director
independence requirements, certain Board of Director committee requirements, and
other corporate governance requirements.
7
GOVERNMENTAL MONETARY AND CREDIT POLICIES AND ECONOMIC CONTROLS
The earnings and growth of the banking industry and ultimately of the Bank
are affected by the monetary and credit policies of governmental authorities,
including the FRB. An important function of the FRB is to regulate the national
supply of bank credit in order to control recessionary and inflationary
pressures. Among the instruments of monetary policy used by the FRB to implement
these objectives are open market operations in U.S. Government securities,
changes in the federal funds rate, changes in the discount rate of member bank
borrowings, and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth of bank
loans, investments and deposits and may also affect interest rates charged on
loans or paid on deposits. The monetary policies of the FRB authorities have had
a significant effect on the operating results of commercial banks in the past
and are expected to continue to have such an effect in the future. In view of
changing conditions in the national economy and in the money markets, as well as
the effect of actions by monetary and fiscal authorities, including the FRB, no
prediction can be made as to possible future changes in interest rates, deposit
levels, loan demand or their effect on the business and earnings of the
Corporation and its subsidiaries.
EMPLOYEES
At December 31, 2004, the Corporation and its subsidiaries employed
approximately 444 individuals, of whom 331 were full-time employees.
ITEM 2. PROPERTIES
The main office of the Corporation and the Bank occupies approximately
29,000 square feet at 19 South Second Street, Oakland, Maryland. These premises
are owned by the Corporation. The Corporation owns seventeen of its bank offices
and leases seven bank offices and three non-bank subsidiary offices. Total rent
expense on the leased offices was $.4 million in 2004.
ITEM 3. LEGAL PROCEEDINGS
The Corporation and its affiliates are at times, in the ordinary course of
business, subject to legal actions. However, to the knowledge of management, the
Corporation is not currently subject to any such legal action.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
8
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
Shares of the Corporation's common stock are listed on the Nasdaq Stock
Market under the symbol "FUNC". Between July 9, 2003 and June 25, 2004, the
shares of the Corporation's common stock were included in the Russell 3000(R)
Index, which is reconstituted each year to include the 3,000 largest U.S.
companies ranked by market capitalization. As of February 28, 2005, the
Corporation had 2,203 shareholders of record. The high and low sales prices for,
and the cash dividends declared on, the shares of the Corporation's common stock
for each quarterly period of 2004 and 2003 are set forth below. These prices
reflect inter-dealer prices and may not include retail mark-up, mark-down or
commissions, and they may not represent actual transactions.
DIVIDENDS
2004 HIGH LOW DECLARED
- --------------------------------------------------------------------------------
1st Quarter $26.91 $22.30 $.180
2nd Quarter 24.96 19.25 .180
3rd Quarter 21.64 19.35 .180
4th Quarter 21.34 19.65 .185
2003
- --------------------------------------------------------------------------------
1st Quarter $22.10 $16.06 $.175
2nd Quarter 25.50 19.60 .175
3rd Quarter 24.62 20.17 .175
4th Quarter 25.99 21.78 .180
Cash dividends are typically declared on a quarterly basis and are at the
discretion of the Corporation's Board of Directors. Dividends to shareholders
are generally dependent on the ability of the Corporation's subsidiaries,
especially the Bank, to declare dividends to the Corporation. The ability of
these entities to declare dividends are limited by federal and state banking
laws and/or state corporate laws. Further information about these limitations
may be found in Note 12 to the Notes to the Consolidated Financial Statements
and the Risk Factor entitled "Our Ability to Pay Dividends is Limited," each of
which is incorporated here by reference. Accordingly, there is no guarantee that
dividends will be declared in any fiscal quarter.
Market makers for the Corporation's common stock are:
FERRIS BAKER WATTS SCOTT AND STRINGFELLOW, INC.
12 North Liberty St. 909 East Main Street
Cumberland, MD 21502 Richmond, VA 23219
(301)724-7161 (804)643-1811
(800)776-0629 (800)552-7757
113 S. Potomac St.
Hagerstown, MD 21740
(301)733-7111
(800)344-4413
EQUITY COMPENSATION PLAN INFORMATION
At December 31, 2004, the Corporation had no equity compensation plan or
arrangement in effect under which shares of common stock may be issued to its
directors or officers.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected financial data for the
five years ended December 31, 2004 and is qualified in its entirety by the
detailed information and financial statements, including notes thereto, included
elsewhere or incorporated by reference in this annual report. This data should
be read in conjunction with the financial statements and related notes thereto
included elsewhere in this annual report and in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" below.
9
(IN THOUSANDS, EXCEPT PER SHARE DATA)
2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA
Total Assets $1,231,877 $1,108,241 $ 954,388 $ 818,824 $ 848,300
Net Loans 904,635 786,051 659,758 603,801 611,975
Investment Securities 210,661 223,615 215,236 130,692 152,858
Deposits 850,661 750,161 610,460 588,518 636,819
Long-term Borrowings 175,415 191,735 198,772 120,104 122,000
Shareholders' Equity 86,356 84,191 79,283 71,076 65,511
OPERATING DATA
Interest Income $ 60,682 $ 57,703 $ 57,589 $ 63,229 $ 63,516
Interest Expense 24,016 23,601 25,702 33,378 35,039
---------- ---------- ---------- ---------- ----------
Net Interest Income 36,666 34,102 31,887 29,851 28,477
Provision for Loan Losses 2,534 833 1,506 2,926 2,198
Other Operating Income 12,971 11,867 9,007 9,314 7,789
Other Operating Expense 35,969 29,821 26,038 23,381 21,995
---------- ---------- ---------- ---------- ----------
Income Before Tax 11,134 15,315 13,350 12,858 12,073
Income Tax 3,507 4,566 3,695 3,689 3,762
---------- ---------- ---------- ---------- ----------
Net Income $ 7,627 $ 10,749 $ 9,655 $ 9,169 $ 8,311
========== ========== ========== ========== ==========
PER SHARE DATA
Net Income $ 1.25 $ 1.77 $ 1.59 $ 1.51 $ 1.37
Dividends Paid 72 .70 .68 .66 .64
Book Value 14.17 13.83 13.04 11.69 10.77
SIGNIFICANT RATIOS
Return on Average Assets .65% 1.03% 1.13% 1.11% 1.03%
Return on Average Equity 8.91% 13.10% 12.75% 13.26% 13.40%
Dividend Payout Ratio 57.48% 39.65% 42.76% 43.71% 46.72%
Average Equity to Average
Assets 7.28% 7.88% 8.84% 8.34% 7.68%
Total Risk-based Capital
Ratio 12.24% 11.77% 14.31% 15.54% 14.55%
Tier I Capital to Risk
Weighted Assets 10.81% 11.04% 13.76% 14.67% 13.52%
Tier I Capital to Average
Assets 8.44% 8.72% 11.72% 11.22% 10.66%
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This discussion and analysis should be read in conjunction with the
audited consolidated financial statements for the year ended December 31, 2004
which appear elsewhere in this report.
10
EXECUTIVE SUMMARY
The Corporation is a financial holding company which, through its bank and
non-bank subsidiaries, provides an array of financial products and services
primarily to customers in four Western Maryland counties and four Northeastern
West Virginia counties. Its principal operating subsidiary is the Bank, which
consists of a community banking network of 24 banking offices located throughout
its market area. The Corporation's primary sources of revenue are interest
income earned from its loan and investment securities portfolios and fees earned
from financial services provided to customers.
The Corporation's 2004 net income was $7.6 million, a decrease of 29% from
2003 net income of $10.7 million. Earnings per share in 2004 declined to $1.25
per share, compared to $1.77 per share in 2003. The decrease in 2004 net income
was partly due to the Corporation's strategic decisions to redeem certain long
term borrowings which adversely impacted net income in the current year.
Management expects this to positively impact net income in future periods. The
early redemption of long-term borrowings included the following:
Early Redemption of FHLB Advances--In December 2004, the Bank refinanced
$21.5 million of Federal Home Loan Bank of Atlanta ("FHLB") borrowings resulting
in an early redemption penalty of $1.8 million that was charged to 2004
operations (affecting 2004 earnings per share by approximately $0.20 per share,
net of tax). These borrowings were refinanced with a short-term, fixed rate FHLB
advance of $23.3 million. The refinanced advance had an average rate of 5.91%,
and had scheduled maturities between February 2008 and September 2009. The new
advance has a fixed rate of 2.6%, is not convertible and matures in March 2005.
The advance will be repaid from an increase in money market funds during the
first quarter of 2005. The refinancing provided the Bank with the ability to
lower its interest expense and reduce its reliance on longer-term, fixed rate
borrowings.
Issuance/Redemption of Junior Subordinated Debentures--The Corporation
issued approximately $35.9 million of Junior Subordinated Debentures
("Debentures") in 2004, and redeemed approximately $23.7 million of Debentures.
The net result of these issuances and redemptions was to reduce the interest
rate on long-term borrowings. $20.6 million of Debentures were issued in March
2004, with a five year fixed rate of 6.02%, converting to a floating rate
thereafter and maturing in 2034. $10.3 million of Debentures were also issued in
March 2004, with a floating interest rate (3.86% at issuance) also maturing in
2034. In December 2004, the Corporation issued an additional $5.0 million of
Debentures with a five year fixed rate of 5.88%, converting to a floating rate
thereafter and maturing in 2014. On September 30, 2004, the Corporation redeemed
all of its 9.375%, 30-year Junior Subordinated Debentures that it had issued in
1999, for a redemption price of $23.7 million. In connection with this
redemption, approximately $.9 million of unamortized issuance costs were
expensed (affecting 2004 earnings per share by approximately $0.10 per share,
net of tax).
Operations in 2004 were also impacted by the following significant
factors:
Continued Geographic Expansion--The Bank continues to invest in its core
market areas. A new branch office opened in Martinsburg, West Virginia during
2004. In addition, approximately $4.5 million was spent in 2004 for several land
acquisitions in a new market area, Morgantown, West Virginia. Construction of
the first branch office in this market area was substantially completed at the
end of 2004, and the branch was opened February 28, 2005.
Focus on Loan Growth/Impact on Net Interest Margin--The Corporation,
through the Bank, continued to focus in 2004 on the growth of its loan portfolio
in all of its market areas, resulting in a net increase in the loan portfolio of
$119 million during 2004. A significant portion of the new loans recorded in
2004 were variable rate loans, as opposed to longer term fixed rate loans,
thereby reducing the Bank's exposure to reduced earnings in a rising interest
rate environment. The low level of interest rates throughout 2004 resulted in
these new variable rate loans being recorded initially at low rates. However, as
the Bank is asset sensitive at the end of 2004, rising interest rates will
result in these loans re-pricing at higher rates in future periods. While the
impact of the low interest rate environment and the Corporation's strategic
focus on its asset sensitive position negatively impacted net interest income by
$3.0 million, the growth in loans positively impacted the increase in net
interest income by $5.4 million. This resulted in an overall increase in net
interest income of $2.4 million on a fully taxable equivalent basis as shown in
Table 2.
The Bank funded only a portion of its 2004 loan growth from deposits
generated in its local market areas and relied on the purchase of brokered
certificates of deposits, which are generally at higher fixed rates, to fund the
remainder of loan growth. While the dollar amount of net interest income on a
fully taxable equivalent basis increased by $2.4 million (6.9%) in 2004, the
reliance on higher rate deposits, coupled with the lower initial rates on new
adjustable rate loans, resulted in a compression of the net interest margin from
3.58% in 2003 to 3.43% in 2004.
Loan Quality and the Allowance for Loan Losses--The allowance for loan
losses at December 31, 2004 of $6.8 million exceeds by four times the amount of
net loan charge-offs during 2004. The allowance was .75% of year-end loans and
1.7 times total non-accrual loans at year-end 2004, compared to .75% and 2.1
times at December 31, 2003, respectively. The provision for loan losses
increased to $2.5 million in 2004 from $.8 million in 2003. This increase was
necessitated in response to the significant increase of loans in the loan
portfolio as well as to provide for specific losses (approximately $.9 million)
on two commercial loans. Management has analyzed the allowance for loan losses
as of December 31, 2004 and concluded that the allowance is adequate.
11
Other Operating Income/Other Operating Expense--Other operating income in
2004 increased by $1.1 million over 2003 (9.3%) driven primarily by increases in
service charge income from deposit products, trust income and insurance premium
income. Excluding the aforementioned $2.7 million of expenses related to the
early redemption of long-term FHLB advances and junior subordinated debentures,
operating expenses increased by $3.4 million when compared to 2003. Salaries and
benefits expense also increased in 2004 by approximately $1.0 million,
reflecting general salary increases, staffing additions in key areas, and a full
year of compensation costs related to the Huntington branches acquired in
mid-2003. The Corporation also incurred additional professional fees in 2004
related to compliance with the Sarbanes-Oxley Act, and additional costs for
conversion of its network lines associated with branch expansion and
modernization.
Dividends--Despite the reduced level of earnings in 2004, the Corporation
maintained and increased its dividend to shareholders. Dividends increased to
$0.72 per share in 2004, a 2.8% increase from $0.70 per share in 2003. The
Corporation has paid cash dividends consistently since 1985, the year in which
the holding company was formed.
The Corporation will continue to face risks and challenges in the future,
including: changes in local economic conditions in its core geographic markets;
potential yield compression on loan and deposit products by existing competitors
and potential new entrants in its markets; changes in interest rates; and
changes to existing federal and state legislation and regulations over banks and
financial holding companies. For a more complete discussion of these risk
factors, see Exhibit 99.1 "Risk Factors."
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
This discussion and analysis of the Corporation's financial condition and
results of operations is based upon the Corporation's consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial
statements requires management to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent liabilities. (See Note 1 of the Notes to Consolidated
Financial Statements.) On an on-going basis, management evaluates estimates,
including those related to loan losses and intangible assets. Management bases
its estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions. Management believes
the following critical accounting policies affect our more significant judgments
and estimates used in the preparation of the consolidated financial statements.
Allowance for Loan Losses
The most critical accounting policy applied by the Corporation is that
related to the valuation of the loan portfolio. A variety of estimates impact
the carrying value of the loan portfolio, including the calculation of the
allowance for loan losses, valuation of underlying collateral, the timing of
loan charge-offs and the placement of loans on non-accrual status. The allowance
is established and maintained at a level that management believes is adequate to
cover losses resulting from the inability of borrowers to make required payment
on loans. Estimates for loan losses are arrived at by analyzing risks associated
with the specific loans and the loan portfolio, current and historical trends in
delinquencies and charge-offs, and changes in the size and composition of the
loan portfolio. The analysis also requires consideration of the economic climate
and direction, change in lending rates, political conditions, legislation
impacting the banking industry and economic conditions specific to Western
Maryland and Northeastern West Virginia. Because the calculation of the
allowance for loan losses relies on management's estimates and judgments
relating to inherently uncertain events, actual results may differ from
management's estimates.
The allowance for loan losses is also discussed in the "Allowance and
Provision for Loan Losses" section of this Management's Discussion and Analysis
and in Note 4 of Notes to Consolidated Financial Statements.
Goodwill and Other Intangible Assets
Statement of Financial Accounting Standards (SFAS) No. 142, Accounting for
Goodwill and Other Intangible Assets, establishes standards for the amortization
of acquired intangible assets and the non-amortization and impairment assessment
of goodwill. The Corporation has $3.2 million of core deposit intangible assets
which are subject to amortization and $11.9 million in goodwill primarily
related to the Huntington branch acquisition, which is not subject to periodic
amortization.
Goodwill arising from business combinations represents the value
attributable to unidentifiable intangible elements in the business acquired. The
Corporation's goodwill relates to value inherent in the banking business and the
value is dependent upon the Corporation's ability to provide quality, cost
effective services in a highly competitive local market. This ability relies
upon continuing investments in processing systems, the development of
value-added service features and the ease of use of the Corporation's services.
As such, goodwill value is supported ultimately by revenue that is driven by the
volume of business transacted. A decline in earnings as a result of a lack of
growth or the inability to deliver cost effective services over sustained
periods can lead to impairment of goodwill which could adversely impact earnings
in future periods. SFAS No. 142 requires an annual evaluation of goodwill for
impairment. The determination of whether or not these assets are impaired
involves significant judgments. The Corporation has concluded that the recorded
value of goodwill was not impaired as a result of the evaluation. However,
future changes in strategy and/or market conditions could significantly impact
these judgments and require adjustments to recorded asset balances.
12
RECENT DEVELOPMENTS
Management expects to liquidate Oakfirst Life by transferring
substantially all of its assets to the Corporation during the second quarter of
2005. Currently, credit life and credit accident and health insurance are
offered to the Corporation's borrowers through, and are underwritten in part by,
Oakfirst Life. Because of recent changes in federal tax law, the income
generated by Oakfirst Life from this line of business is no longer exempt from
federal income tax, which has been one of the significant benefits of offering
these products through Oakfirst Life. Moreover, because the Corporation's
lending operations have shifted away from direct automobile loans in recent
periods, the Corporation is recognizing smaller underwriting profits from the
sale of these insurance products. In light of the foregoing, management believes
that it would be more beneficial to the Corporation if these insurance products
were offered on a commission-only basis through the Corporation's licensed
insurance agents rather than through Oakfirst Life. Management does not expect
the liquidation or the shift in strategy to have a material adverse impact on
the financial condition or results of operations of the Corporation.
CONSOLIDATED STATEMENT OF INCOME REVIEW
NET INTEREST INCOME
Net interest income is the largest source of operating revenue. Net
interest income is the difference between the interest earned on
interest-earning assets and the interest expense paid on interest-bearing
liabilities. For analytical and discussion purposes, net interest income is
adjusted to a taxable equivalent basis to facilitate performance comparisons
between taxable and tax-exempt assets by increasing tax-exempt income by an
amount equal to the federal income taxes that would have been paid if this
income were taxable at the statutorily applicable rate. The table below
summarizes net interest income (on a taxable equivalent basis) for the years
2002-2004 (dollars in thousands).
2004 2003 2002
---- ---- ----
Interest income $61,380 $58,558 $58,430
Interest expense 24,016 23,601 25,702
------- ------- -------
Net interest income $37,364 $34,957 $32,728
======= ======= =======
Net interest margin % 3.43% 3.58% 4.08%
Net interest income increased $2.4 million (6.9%) in 2004 when compared to
2003, due primarily to the increase in interest income of $2.8 million, offset
by a slight increase in interest expense of $.4 million. As reflected in the
income statement, interest income from loans increased by $3.9 million, due to
the $133.7 million increase in the average balance of loans in 2004, offset by a
60 basis point decrease in the average yield on loans. During 2004, the Bank
implemented a loan pricing model, that is being used to set pricing for
mortgage, commercial and consumer loan products throughout the Bank, and ensures
loan pricing is consistent with targeted net interest margins.
The increase in total interest expense in 2004 was due to the decline in
interest expense on deposits of $.7 million (5.2%) offset by increased interest
expense on borrowings of $1.1 million (10.1%). Interest expense on deposits
declined primarily due to the 83 basis point decrease in the average yield on
time deposits less than $100,000. The increase in interest expense or borrowings
was primarily due to the $27.7 million increase in the average balance of
short-term borrowings coupled with the 58 basis point increase in average yield
on these borrowings.
Net interest income increased $2.2 million (7%) in 2003 when compared to
2002 due primarily to a reduction in interest expense. Interest income was
virtually unchanged as the increase in average interest-earning assets of $174
million (22%) in 2003 over 2002, was offset by a 129 basis point decline in
yield on such earning assets. Although interest-bearing liabilities increased
$166 million (23%) in 2003 over 2002, a 26% decrease in the effective rate of
these interest-bearing liabilities of 94 basis points resulted in a net decrease
in interest expense of $2.1 million.
The composition of interest income on loans has increased with the
increase in loans as a percentage of interest earning assets. During the past
three years, the composition of interest income is shown below:
% OF TOTAL INTEREST INCOME
2004 2003 2002
---- ---- ----
Interest and fees on loans 88% 86% 85%
Interest on investment securities 12% 14% 15%
13
Table 1 sets forth the average balances, net interest income and expense
and average yields and rates for the Corporation's interest-earning assets and
interest-bearing liabilities for 2004, 2003 and 2002. Table 2 sets forth an
analysis of volume and rate changes in interest income and interest expense of
the Corporation's average interest-earning assets and average interest-bearing
liabilities for 2004, 2003 and 2002. This table distinguishes between the
changes related to average outstanding balances (changes in volume holding the
interest rate constant) and the changes related to average interest rates
(changes in average rate holding the outstanding balance constant).
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST RATES AND INTEREST DIFFERENTIAL--TAX EQUIVALENT BASIS
(DOLLARS IN THOUSANDS)
TABLE 1
FOR THE YEARS ENDED DECEMBER 31
2004 2003
- -------------------------------------------------------------------------------------------------------------
AVERAGE AVERAGE AVERAGE AVERAGE
BALANCE INTEREST YIELD/RATE BALANCE INTEREST YIELD/RATE
- -------------------------------------------------------------------------------------------------------------
ASSETS
Loans $ 861,255 $ 53,313 6.19% $ 727,532 $ 49,403 6.79
Investment securities:
Taxable 191,135 5,819 3.04 196,175 6,484 3.30
Non taxable 23,311 1,854 7.95 30,355 2,195 7.23
----------- ----------- ----------- -----------
Total 214,446 7,673 3.58 226,530 8,679 3.83
Federal funds sold 2,043 35 1.71 4,204 39 .93
Interest-bearing deposits
with other banks 3,583 56 1.57 8,967 101 1.13
Other interest earning
assets 8,439 303 3.59 8,818 336 3.81
----------- ----------- ----------- -----------
TOTAL EARNING ASSETS 1,089,766 61,380 5.63 976,051 58,558 6.00
Allowance for loan losses (6,150) (6,151)
Non-earning assets 94,730 71,473
----------- -----------
TOTAL ASSETS $ 1,178,346 $ 1,041,373
=========== ===========
Liabilities and
Shareholders' Equity
Interest-bearing
demand deposits $ 279,217 $ 2,699 .97% $ 213,420 $ 1,755 .82%
Savings deposits 63,471 237 .37 53,753 218 .40
Time deposits:
Less than $100 209,708 4,950 2.36 219,817 7,002 3.19
$100 or more 149,113 4,222 2.83 139,571 3,800 2.72
Short-term borrowings 82,747 1,153 1.39 55,006 447 .81
Long-term borrowings 205,193 10,755 5.23 190,984 10,379 5.43
----------- ----------- ----------- -----------
TOTAL INTEREST-BEARING
LIABILITIES 989,449 24,016 2.43 872,551 23,601 2.70
----------- ----------- ----------- -----------
Noninterest-bearing
deposits 94,871 75,840
Other liabilities 8,266 10,954
Shareholders' equity 85,760 82,028
----------- -----------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 1,178,346 $ 1,041,373
=========== ===========
Net interest income
and spread 37,364 3.20% $ 34,957 3.30%
=========== ===========
Net interest margin 3.43% 3.58%
FOR THE YEARS ENDED DECEMBER 31
2002
- ------------------------------------------------------------------
AVERAGE AVERAGE
BALANCE INTEREST YIELD/RATE
- ------------------------------------------------------------------
ASSETS
Loans $ 620,049 $ 49,095 7.92%
Investment securities:
Taxable 138,102 6,699 4.85
Non taxable 29,428 2,124 7.22
----------- -----------
Total 167,530 8,823 5.27
Federal funds sold 3,782 63 1.67
Interest-bearing deposits
with other banks 3,155 77 2.43
Other interest earning
assets 7,081 371 5.24
----------- -----------
TOTAL EARNING ASSETS 801,597 58,429 7.29
Allowance for loan losses (5,984)
Non-earning assets 61,718
-----------
TOTAL ASSETS $ 857,331
===========
Liabilities and
Shareholders' Equity
Interest-bearing
demand deposits $ 146,313 $ 1,671 1.14%
Savings deposits 43,655 269 .62
Time deposits:
Less than $100 229,114 10,849 4.74
$100 or more 102,201 4,001 3.91
Short-term borrowings 35,826 289 .81
Long-term borrowings 149,434 8,623 5.77
----------- -----------
TOTAL INTEREST-BEARING
LIABILITIES 706,543 25,702 3.64
----------- -----------
Noninterest-bearing
deposits 65,284
Other liabilities 9,759
Shareholders' equity 75,745
-----------
TOTAL LIABILITIES AND
SHAREHOLDERS' EQUITY $ 857,331
===========
Net interest income
and spread $ 32,727 3.65
===========
Net interest margin 4.08%
NOTES:
- --The above table reflects the average rates earned or paid stated on a tax
equivalent basis assuming a tax rate of 35% for 2004 and 34% for 2003 and 2002.
The fully taxable equivalent adjustments for the years ended December 31, 2004,
2003, and 2002 were $698, $855, and $841, respectively.
- --The average balances of non-accrual loans for the years ended December 31,
2004, 2003 and 2002, which were reported in the average loan balances for these
years, were $4,400, $2,240, and $1,906, respectively.
- --Net interest margin is calculated as net interest income divided by average
earning assets.
- --The average yields on investments are based on amortized cost.
14
INTEREST VARIANCE ANALYSIS (1)
(IN THOUSANDS AND TAX EQUIVALENT BASIS)
TABLE 2
2004 COMPARED TO 2003 2003 COMPARED TO 2002
VOLUME RATE NET VOLUME RATE NET
- ------------------------------------------------------------------------------------------
INTEREST INCOME:
Loans $ 8,278 $(4,368) $ 3,910 $ 7,299 $(6,991) $ 308
Taxable investments (153) (513) (666) 1,919 (2,135) (216)
Non-taxable investments (560) 220 (340) 67 4 71
Federal funds sold (37) 33 (4) 4 (28) (24)
Other interest earning
assets (297) 219 (78) 373 (384) (11)
------- ------- ------- ------- ------- -------
Total interest income 7,231 (4,409) 2,822 9,662 (9,534) 128
------- ------- ------- ------- ------- -------
INTEREST EXPENSE:
Interest-bearing
demand deposits 636 308 944 552 (468) 84
Savings deposits 36 (18) 18 40 (92) (52)
Time deposits less
than $100 (239) (1,812) (2,051) (297) (3,550) (3,847)
Time deposits $100 or
more 270 152 422 1,017 (1,218) (201)
Short-term borrowings 387 319 706 156 (2) 154
Long-term borrowings 745 (369) 376 2,258 (501) 1,757
------- ------- ------- ------- ------- -------
Total interest expense 1,835 (1,420) 415 3,726 (5,831) (2,105)
------- ------- ------- ------- ------- -------
Net interest income $ 5,396 $(2,989) $ 2,407 $ 5,936 $(3,703) $ 2,233
======= ======= ======= ======= ======= =======
(1) The change in interest income/expense due to both volume and rate has been
allocated to volume and rate changes in proportion to the relationship of
the absolute dollar amounts of the change in each.
PROVISION FOR LOAN LOSSES
The provision for loan losses increased to $2.5 million in 2004, compared
to $.8 million in 2003. The $1.7 million increase in the provision was due to
the 15% increase in the loan portfolio of $119 million during 2004, the increase
in net charge-offs as a percentage of average loans to .20% in 2004 from .17% in
2003, and to provide for specific losses of approximately $.9 million on two
commercial loans. The provision for loan losses decreased by $.7 million in 2003
when compared to 2002 due to several factors, including the slight decrease in
overall net charge-offs as a percentage of total average loans (.17% in 2003
versus .19% in 2002) and the Corporation's assessment that the balance of the
allowance for loan losses was adequate as of December 31, 2003.
OTHER OPERATING INCOME
The following table shows the major components of other operating income
for the past three years (in thousands) and the percentage changes during these
years:
2004 VS. 2003 2003 VS. 2002
2004 2003 2002 % CHANGE % CHANGE
- ----------------------------------------------------------------------------------------------------------------
Service charges on deposit accounts $3,824 $3,175 $2,718 20.4% 16.8%
Other service charge income 925 720 714 28.5% .8%
Trust department income 3,153 2,520 2,146 25.1% 17.4%
Brokerage commission 720 701 572 2.7% 22.6%
Insurance premium income 1,448 1,367 1,215 5.9% 12.5%
Security gains (losses) 703 1,009 (366) (30.3%) *
Bank owned life insurance (BOLI) 626 938 960 (33.3%) (2.3%)
Other income 1,572 1,437 1,048 9.3% 37.1%
------ ------ -----
Total other operating income $12,971 $11,867 $9,007 9.3% 31.8%
======= ======= ======
* negligible
As the table above illustrates, other operating income has continued to
increase steadily during the past three years, with a $1.1 million increase in
2004 (9.3%) and a $2.9 million (31.8%) increase in 2003.
15
Service charges on deposit accounts and other service charge income
increased in 2004 versus 2003 and in 2003 versus 2002, correlating to the
increases in average non-interest bearing deposits during those periods of $19.0
million (25%) and $10.6 million (16%), respectively. Service charges on deposit
accounts also increased due to increased emphasis on an account overdraft
product. Service charge related income constitutes 37%, 33%, and 38% of other
operating income in 2004, 2003, and 2002, respectively.
Trust Department income is directly affected by the performance of the
equity and bond markets, and by the amount of assets under management. Trust
income has increased steadily during the past three years as a result of
development efforts in this area and increases in the average market value of
assets under management in the Trust Department, which was $395, $332 and $300
million for years 2004, 2003 and 2002, respectively.
Securities gains (losses) are the most variable component of other
operating income. Securities gains for 2004 include gross gains of $.7 million.
Gains for 2004 resulted primarily from the sale of investments held by the
Bank's Delaware subsidiary, First United Securities, Inc. ("FUS") in order to
utilize certain net operating loss carryforwards in that subsidiary prior to its
liquidation in May 2004. Securities gains for 2003 include gross gains of $1.7
million, offset by securities losses of $.7 million. Gains for 2003 resulted
from the decision to sell certain mortgage-backed securities that were
exhibiting accelerated paybacks due to the historically low interest rate
environment, as well as the sale of corporate and other debt securities to
utilize certain capital loss carryforwards. The gross securities losses in 2003
resulted primarily from the write-down and ultimate sale of Freddie Mac
Preferred equity securities exhibiting other-than-temporary impairment. These
preferred securities initially exhibited other-than-temporary impairment in
2002, which resulted in a $.4 million write down that year.
OTHER OPERATING EXPENSE
2004 other operating expense increased $6.1 million (21%) over 2003. 2003
other operating expense increased $3.8 million (15%) over 2002. The following
table shows the major components of other operating expense for the past three
years (in thousands):
2004 V. 2003 2003 V. 2002
2004 2003 2002 % CHANGE % CHANGE
- ---------------------------------------------------------------------------------------------------------------
Salaries and employee benefits $16,907 $15,995 $13,922 5.7% 14.9%
Other expenses 10,360 8,853 7,573 17.0% 16.9%
Equipment 2,952 2,426 2,090 21.7% 16.1%
Expenses related to early redemption of
long-term borrowings 2,728 -- -- -- --
Occupancy 1,642 1,330 1,293 23.4% 2.9%
Data processing 1,380 1,217 1,160 13.4% 4.9%
------- ------- -------
Total other operating expense $35,969 $29,821 $26,038 20.6% 14.5%
======= ======= =======
Salaries and employee benefits represent approximately 47% of total other
operating expenses in 2004, compared to 54% and 53% in 2003 and 2002,
respectively. Salaries and wages increased by $0.9 million in 2004 over 2003,
and $2.1 million in 2003 over 2002. These increases are directly related to
increased staffing to support the Corporation's growth objectives and increasing
health insurance costs. 2004 salaries and benefits expense also includes a full
year of compensation costs related to the branches acquired in 2003 from the
Huntington National Bank. The addition of these branches added $0.5 million to
salaries and benefits expense in 2003 when compared to 2002.
Other expenses increased by $1.5 million in 2004 compared to 2003, due to
a full year of amortization expense related to the core deposit intangible ($.6
million in 2004 compared to $.2 million in 2003), additional professional fees
incurred in 2004 to comply with the requirements of the Sarbanes-Oxley Act, and
due to costs related to conversion of our network lines related to branch
expansion and modernization. Other expenses in 2003 increased $1.3 million, or
17% in 2003 when compared to 2002. This increase was attributable to increases
in professional fees, outside service providers, insurance costs, and first year
amortization of the core deposit amortization related to the Huntington branch
acquisition.
Expenses related to early redemption of long-term borrowings consisted of
a $1.8 million early payment penalty related to refinance of the FHLB advance
and the $.9 million write-off of unamortized issuance costs related to the early
redemption of subordinated debentures.
Occupancy and equipment expenses have increased $.8 million in 2004,
compared to an increase of $.4 million in 2003. This increase is due to a full
year of operating expenses in 2004 related to the Huntington branch acquisition
in mid-2003. The opening of our new branch office in Martinsburg, West Virginia
and maintenance contracts related to the Bank's new bank-wide security system
also contributed to the increase.
16
APPLICABLE INCOME TAXES
Income tax expense amounted to $3.5 million in 2004, compared to $4.6
million in 2003 and $3.7 million in 2002. The resulting effective tax rates were
31.5%, 30% and 28% for 2004, 2003 and 2002, respectively. The increase in the
2004 effective tax rate compared to 2003 is due primarily to the Bank's
liquidation of First United Capital Investments in February 2004, and its other
Delaware subsidiary, First United Securites, Inc. in May 2004. The principal
items which lowered the Corporation's effective tax rates from the federal
statutory rate in 2004, 2003 and 2002 are tax-exempt income from securities and
loans, and tax-exempt BOLI income.
CONSOLIDATED BALANCE SHEET REVIEW OVERVIEW
The Corporation's total assets reached $1.23 billion at December 31, 2004,
representing an increase of $123.6 million (11.1%) from year-end 2003.
The 2004 year-end asset mix shows the steady increase in loans as a
percentage of total assets over the past three years, as illustrated below:
YEAR END PERCENTAGE OF TOTAL ASSETS
2004 2003 2002
---- ---- ----
Net loans 73% 71% 69%
Investments 17% 20% 22%
Similarly, the year-end liability mix shows a steady increase in total
deposits as a percentage of total liabilities during the three year period, as
illustrated below:
YEAR END PERCENTAGE OF TOTAL LIABILITIES
2004 2003 2002
---- ---- ----
Total deposits 74% 73% 70%
Total borrowings 25% 26% 29%
LOAN PORTFOLIO
The Corporation, through the Bank and the OakFirst Loan Centers, is
actively engaged in originating loans customers primarily in Garrett, Allegany,
Washington, and Frederick Counties in Maryland; Mineral, Hardy, Berkeley,
Monongalia Counties in West Virginia; and the surrounding regions of West
Virginia and Pennsylvania. The Corporation has policies and procedures designed
to mitigate credit risk and to maintain the quality of its loan portfolio. These
policies include underwriting standards for new credits and the continuous
monitoring and reporting of asset quality and the adequacy of the allowance for
loan 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 and type of the loan, and the
experience of the lending officer.
Commercial loans are collateralized primarily by real estate, and to a
lesser extent, by equipment and vehicles Unsecured commercial loans represent an
insignificant portion of total commercial loans. Residential mortgage loans are
collateralized by the related property. Any residential mortgage loan exceeding
an internal loan-to-value ratio requires private mortgage insurance. Installment
loans are typically collateralized, with loan-to-value ratios which established
based on the financial condition of the borrower. The Corporation will also make
unsecured consumer loans to qualified borrowers meeting the underwriting
standards of the Corporation.
Table 3 sets forth the composition of the Corporation's loan portfolio. It
has been the historical policy of Corporation to make the majority of its loan
commitments in its market areas. The Corporation had no foreign loans its
portfolio as of December 31, for all periods presented.
SUMMARY OF LOAN PORTFOLIO
(DOLLARS IN THOUSANDS)
TABLE 3
LOANS OUTSTANDING AS OF DECEMBER 31
2004 2003 2002 2001 2000
- ------------------------------------------------------------------------------------------
Commercial $373,893 $307,523 $242,470 $189,343 $ 92,914
Residential--Mortgage 319,033 264,730 233,887 238,016 307,577
Installment 199,862 201,419 173,578 164,297 191,937
Residential--Construction 18,196 16,093 11,072 8,578 12,667
Lease Financing 466 2,260 4,819 9,319 11,974
-------- -------- -------- -------- --------
Total Loans $911,450 $792,025 $665,826 $609,553 $617,069
======== ======== ======== ======== ========
17
During 2004, gross loans increased by $119 million, or 15%, over 2003.
This growth was focused in the Corporation's commercial ($66 million) and
residential mortgage ($54 million) loan portfolios, and is consistent with
management's objectives for the year. During 2004, efforts were made to increase
the percentage of loans in the portfolio with adjustable interest rates. At
year-end 2004, adjustable interest rate loans maturing within one to five years
were 38% of total loans, compared to 35% at year-end 2003.
Commercial loans increased 21% in 2004, following a 27% increase in 2003.
New commercial loans in 2004 are attributable to focused efforts by the
Corporation's lenders to identify new customer opportunities, as well as to
expand existing customer relationships in all of its market areas, while
maintaining existing standards of credit worthiness. Additionally, most new
commercial loans were priced on a variable rate basis, resetting monthly, and
were very popular with business borrowers. Commercial loans secured by real
estate were 81% at the end of 2004, compared to 85% in 2003.
Residential mortgage loans increased by $54 million or 20% in 2004 when
compared to 2003. This follows a 13% increase in 2003 over 2002. This increase
is attributable to management's continued emphasis on increasing its mortgage
loan portfolio in its key market areas, and through the use of adjustable-rate
mortgage products that have been well received by borrowers in these market
areas.
Consumer installment loans in 2004 decreased by $1.5 million, or 1%, when
compared to 2003. This decrease reflects management's shift toward more
commercial and mortgage loans, and less emphasis on the highly competitive
consumer loan market. Specifically, less focus was placed on generating new
indirect auto loans during 2004. Indirect auto loans comprise the largest
percentage of installment loans, 78% at the end of 2004 and 76% at the end of
2003.
During 2003, gross loans increased $126 million (19%) over 2002 to $792
million. Approximately two-thirds of this loan growth was derived through the
Corporation's existing customer base, and the remaining one-third was
attributable to the Huntington branch acquisition. The key contributors to this
strong loan growth in 2003 were commercial ($65 million), residential-mortgage
($31 million) and installment ($28 million).
The commercial portfolio grew 27% in 2003, following a 28% increase in
2002. Approximately one-half of this growth in 2003 resulted from the Huntington
branch acquisition. The other one-half is primarily attributable to additional
business with existing customer relationships and a more aggressive pricing
strategy, while maintaining strong credit worthiness standards.
Residential-mortgage loans grew 13% in 2003 after decreasing by 2% in
2002. Approximately one-third of the growth in 2003 resulted from the Huntington
branch acquisition. The remaining two-thirds is attributable to a combination of
an aggressive marketing campaign to solicit and retain existing mortgage
customers, as well as offering a competitive adjustable rate mortgage as an
alternative to the fixed rates offered in the secondary market.
Consumer installment loans grew 16% in 2003 following a 6% increase in
2002. This increase relates primarily to an increase in the indirect automobile
loan portfolio, resulting from an expansion of the Corporation's dealer network
within its market area and a more aggressive pricing strategy.
The following table sets forth remaining maturities, based upon
contractual dates, for selected loan categories as of December 31, 2004 (in
thousands):
MATURITIES OF LOAN PORTFOLIO AT DECEMBER 31, 2004
TABLE 4 MATURING
MATURING AFTER ONE MATURING
WITHIN BUT WITHIN AFTER FIVE
ONE YEAR FIVE YEARS YEARS TOTAL
- --------------------------------------------------------------------------------
Commercial $173,080 $144,213 $ 56,600 $373,893
Residential--Mortgage 11,413 48,675 258,945 319,033
Installment 51,204 133,149 15,509 199,862
Residential--Construction -- 18,196 -- 18,196
Lease Financing 466 -- -- 466
-------- -------- -------- --------
Total Loans $236,163 $344,233 $331,054 $911,450
======== ======== ======== ========
CLASSIFIED BY SENSITIVITY TO
CHANGE IN INTEREST RATES
Fixed-Interest Rate Loans $ 66,652 $171,842 $262,998 $501,492
Adjustable-Interest Rate
Loans 169,511 172,391 68,056 409,958
-------- -------- -------- --------
Total Loans $236,163 $344,233 $331,054 $911,450
======== ======== ======== ========
18
It is the policy of the Corporation to place a loan in non-accrual status,
except for consumer loans, whenever there is substantial doubt about the ability
of a borrower to pay principal or interest on the outstanding credit. Management
considers such factors as payment history, the nature of the collateral securing
the loan, and the overall economic situation of the borrower when making a
non-accrual decision. Management closely monitors non-accrual loans. A
non-accruing loan is restored to accrual status when principal and interest
payments have been brought current, it becomes well secured, or is in the
process of collection and the prospects of future contractual payments are no
longer in doubt. Generally, consumer installment loans are not placed on
non-accrual status, but are charged off after they are 120 days contractually
past due. Table 5 sets forth the historical amounts of non-accrual loans (in
thousands) for the past five years:
RISK ELEMENTS OF LOAN PORTFOLIO
TABLE 5
FOR THE YEARS ENDED DECEMBER 31
2004 2003 2002 2001 2000
- -------------------------------------------------------------------------------------------
Non-Accrual Loans $3,439 $2,774 $1,847 $3,196 $1,066
Accruing Loans Past Due 90 Days or More 1,105 1,236 1,458 1,230 1,448
Interest income not recognized as a result of placing loans on a
non-accrual status was $.4 million during 2004 and $.1 million during 2003 and
2002.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is based on management's continuing
evaluation of the quality of the loan and lease 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 and leases.
The Corporation utilizes the methodology outlined in FDIC Statement of
Policy on Allowance for Loan and Lease Losses. The starting point for this
methodology is to segregate the loan portfolio into two pools, non-homogeneous
(i.e., commercial) and homogeneous (i.e., consumer) loans. Each loan pool is
analyzed with general allowances and specific allocations being made as
appropriate. For general allowances, the previous eight quarters of loss
activity are used in the estimation of losses in the current portfolio. These
historical loss amounts are modified by the following qualitative factors:
levels of and trends in delinquency and non-accruals; trends in volumes and
terms of loans; effects of changes in lending policies; experience, ability, and
depth of management; national and local economic trends and conditions; and
concentrations of credit in the determination of the general allowance. The
qualitative factors are updated each quarter by information obtained from
internal, regulatory, and governmental sources. Specific allocations of the
allowance for loan losses are made for those loans on the "Watchlist" in which
the collateral value is less than the outstanding loan balance with the
allocation being the dollar difference between the two. The Watchlist represents
loans, identified and closely monitored by management, which possess certain
qualities or characteristics that may lead to collection and loss issues.
Allocations are not made for loans that are cash secured, for the Small Business
Administration and Farm Service Agency guaranteed portion of loans, or for loans
that are sufficiently collateralized.
The allowance for loan losses is based on estimates, and actual ultimate
losses will vary from current estimates. These estimates are reviewed quarterly,
and as adjustments, either positive or negative, become necessary, a
corresponding increase or decrease is made in the provision for loan losses. The
methodology used to determine the adequacy of the allowance for loan losses is
consistent with prior years.
The balance of the allowance for loan losses increased to $6.8 million at
year end 2004, from $6.0 million at year end 2003. Several factors contributed
to the $.8 million increase in the balance of the allowance, including: an
increase in the total loan portfolio of $119 million during the year; a slight
increase in net charge-offs as a percentage of average loans to .20% in 2004
from .17% in 2003, caused primarily by a higher level of commercial loan
charge-offs, offset by reduced installment loan charge-offs; and a specific
allocation of $.6 million related to three commercial loans that are on
non-accrual status, based on a thorough analysis of the related collateral
securing these loans. The balance of the allowance at the end of 2004 is equal
to .75% of total loans, and is equal to four times net loan charge-offs for the
year. Based on an evaluation of the loan portfolio using the factors and
methodology outlined above, management has concluded that the allowance for loan
losses is adequate at December 31, 2004.
Although the balance of total loans increased $126 million in 2003,
including $49 million associated with the Huntington branch acquisition (with an
adjustment to the allowance for these loans of $.3 million), the Corporation's
overall net charge off experience relative to total average loans outstanding
has declined to .17% in 2003 from .19% in 2002. Net charge offs relating to the
installment loan portfolio represent approximately 92% and 95% of total net
charge offs for 2003 and 2002, respectively. Generally, installment loans are
charged off after they are 120 days contractually past due. The allowance
allocated to the installment loan portfolio at December 31, 2003 remains more
than twice the current year's net charge offs. Additionally, based upon its
periodic reevaluation of the collateral for a large commercial loan that was in
non-accrual status, the Corporation determined that it was in a secure position
relative to the loan balance, resulting in a $.3 million specific allocation for
that loan facility being removed from the allowance.
As a result of management's evaluation of the loan portfolio using the
factors and methodology described above, the allowance for loan losses was
considered adequate at $6.0 million at December 31, 2003.
19
Table 6 presents the activity in the allowance for loan losses by major loan
category for the past five years.
ANALYSIS OF ACTIVITY IN THE ALLOWANCE FOR LOAN LOSSES
(DOLLARS IN THOUSANDS)
TABLE 6
FOR THE YEARS ENDED DECEMBER 31
2004 2003 2002 2001 2000
- ----------------------------------------------------------------------------------------------------
BALANCE AT BEGINNING OF PERIOD $ 5,974 $ 6,068 $ 5,752 $ 5,094 $ 4,409
LOANS CHARGED OFF:
Commercial 808 17 197 347 49
Residential--Mortgage 153 147 97 64 95
Installment 1,244 1,556 1,535 2,223 1,688
-------- -------- -------- -------- --------
Total Charged Off 2,205 1,720 1,829 2,634 1,832
RECOVERIES OF LOANS:
Commercial 22 50 229 21 10
Residential--Mortgage 67 17 9 7 21
Installment 422 425 401 338 288
-------- -------- -------- -------- --------
Total Recoveries 511 492 639 366 319
-------- -------- -------- -------- --------
Net Loans Charged Off 1,694 1,228 1,190 2,268 1,513
Provision for Loan Losses 2,534 833 1,506 2,926 2,198
Huntington Branch Acquisition
Loan Loss Reserve -- 301 -- -- --
-------- -------- -------- -------- --------
BALANCE AT THE END OF PERIOD $ 6,814 $ 5,974 $ 6,068 $ 5,752 $ 5,094
======== ======== ======== ======== ========
Loans at End of Period $911,450 $792,025 $665,826 $609,553 $617,069
======== ======== ======== ======== ========
Daily Average Balance of
Loans $861,255 $727,532 $620,049 $619,088 $604,995
======== ======== ======== ======== ========
Allowance for Loan Losses
to Loans Outstanding .75% .75% .91% .94% .83%
======== ======== ======== ======== ========
Net Charge Offs to Average
Loans Outstanding .20% .17% .19% .37% .25%
======== ======== ======== ======== ========
Table 7 presents management's allocation of the allowance for loan losses
by major loan category in comparison to that loan category's percentage of total
loans. Changes in the allocation over time reflect changes in the composition of
the loan portfolio risk profile and refinements to the methodology of
determining the allowance. Specific allocations in any particular category may
be reallocated in the future as needed to reflect current conditions.
Accordingly, the entire allowance is considered available to absorb losses in
any category.
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
(IN THOUSANDS)
TABLE 7
DECEMBER 31
% OF TOTAL % OF TOTAL % OF TOTAL
2004 LOANS 2003 LOANS 2002 LOANS
- ------------------------------------------------------------------------------------------------
Commercial $3,050 41% $2,166 39% $2,149 36%
Residential-Mortgage and
Construction 1,454 37% 1,247 35% 1,032 37%
Installment 2,246 22% 2,462 26% 2,675 26%
Lease Financing 15 -- 52 -- 105 1%
Commitments 49 -- 47 -- 33 --
Unallocated -- -- -- -- 74 --
------ ---- ------ ---- ------ ----
Total $6,814 100% $5,974 100% $6,068 100%
====== ==== ====== ==== ====== ====
20
INVESTMENT SECURITIES
The Corporation's entire security portfolio is categorized as
available-for-sale. Investment securities classified as available-for-sale are
held for an indefinite period of time and may be sold in response to changing
market and interest rate conditions or for liquidity purposes as part of the
Corporation's overall 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 shareholders' equity, net of applicable income
taxes. The Corporation does not currently follow a strategy of making security
purchases with a view of near-term resales and therefore, does not own any
securities classified as trading securities. For additional information, see
Notes 1 and 3 of the Notes to Consolidated Financial Statements.
The following sets forth the composition of the Corporation's securities
portfolio by major category as of the indicated dates (in thousands):
AS % AS % AS %
2004 OF TOTAL 2003 OF TOTAL 2002 OF TOTAL
- -------------------------------------------------------------------------------------------------------------------------
Securities Available-for-Sale:
U.S. government and agencies $102,294 48% $ 75,701 34% $ 12,364 6%
Mortgage-backed securities 74,386 35% 89,082 40% 123,351 57%
Obligations of states and political
subdivisions 22,461 11% 29,342 13% 31,354 14%
Corporate and other debt 11,520 6% 18,268 8% 23,153 11%
Other securities -- 11,222 5% 25,014 12%
-------- --- -------- --- -------- ---
Total $210,661 100% $223,615 100% $215,236 100%
======== === ======== === ======== ===
Total investment securities decreased by $13 million (6%) in 2004 compared
to the year-end balance in 2003. This decrease was due to the proceeds of
maturing investment securities being utilized to fund the growth of the
Corporation's loan portfolio. The composition of the investment portfolio
changed during 2004, with almost half of the portfolio as of year end being held
in U.S. government and agency securities. This increase in U.S. government and
agency securities is directly related to the increase in the Corporation's "Cash
Management" product, an overnight repurchase agreement program for business
customers. The U.S. government and agency securities are held as collateral for
this product.
Total investment securities increased by $8 million in 2003 (4%) following
an $85 million (65%) increase in 2002. The most significant shift in asset mix
in 2003 was a $63 million increase in U.S. government and agencies securities
and a $34 million decrease in mortgage-backed securities. The Corporation sold a
portion of its mortgage-backed securities that were exhibiting accelerated
payback due to the historically low mortgage interest rates and reinvested the
proceeds into fixed-term agency securities. Additionally, a portion of the $66
million received in connection with the Huntington branch acquisition was also
invested into agency securities.
The Corporation manages its investment portfolios utilizing policies which
seek to achieve desired levels of liquidity, manage interest rate sensitivity,
meet earnings objectives, and provide required collateral support for deposit
activities and cash management overnight investment products. Excluding the U.S.
Government sponsored agencies, the Corporation had no concentration of
investment securities from any single issues that exceeded 10% of shareholders'
equity.
Table 8 sets forth the contractual or estimated maturities of the
components of the Corporation's securities portfolio as of December 31, 2004 and
the weighted average yields on a tax-equivalent basis.
21
INVESTMENT SECURITY MATURITIES, YIELDS, AND MARKET VALUES AT DECEMBER 31, 2004
(DOLLARS IN THOUSANDS)
TABLE 8
OVER OVER
1 YEAR 5 YEARS OVER TOTAL
WITHIN THRU 5 THRU 10 10 MARKET
1 YEAR YEARS YEARS YEARS VALUE
------ ------ ------- ----- ------
Securities Available-for-Sale:
U.S. government and agencies $ 20,954 $ 81,340 $ -- $ -- $102,294
Mortgage-backed securities 6,094 67,234 1,058 -- 74,386
Obligations of states and
political subdivisions 1,369 1,670 4,184 15,238 22,461
Corporate and other debt 2,422 -- -- 9,098 11,520
-------- -------- -------- -------- --------
Total $ 30,839 $150,244 $ 5,242 $ 24,336 $210,661
======== ======== ======== ======== ========
Percentage of total 14.64% 71.32% 2.49% 11.55% 100.00%
Weighted average yield* 4.02% 3.98% 6.47% 6.78% 4.37%
* Refer to notes to Table 1
DEPOSITS
Table 9 sets forth the average deposit balances by major category for 2004,
2003 and 2002:
AVERAGE DEPOSIT BALANCES
(DOLLARS IN THOUSANDS)
TABLE 9
2004 2003 2002
- -----------------------------------------------------------------------------------------------
AVERAGE AVG. AVERAGE AVG. AVERAGE AVG.
BALANCE YIELD BALANCE YIELD BALANCE YIELD
- -----------------------------------------------------------------------------------------------
Noninterest-bearing
demand deposits $ 94,871 -- $ 75,840 -- $ 65,284 --
Interest-bearing demand
deposits 279,217 .97% 213,420 .82% 146,313 1.14%
Savings deposits 63,471 .37% 53,753 .40% 43,655 .62%
Time deposits less than $100 209,708 2.36% 219,817 3.19% 229,114 4.74%
Time deposits $100 or more 149,113 2.83% 139,571 2.72% 102,201 3.91%
-------- -------- --------
Total $796,380 $702,401 $586,567
======== ======== ========
Total deposits increased $100 million in 2004, or 13% when compared to
2003. This compares to a $140 million (23%) increase during 2003. On an average
balance basis, total deposits increased $94 million (13%) in 2004 versus 2003,
following a $116 million (20%) increase in 2003.
The increase in deposits in 2004 resulted from the Corporation's purchase
of brokered certificates of deposit in excess of $100,000 to help fund its
significant loan growth, as traditional deposit growth could not satisfy the
demand. At December 31, 2004 and 2003, brokered certificates of deposit in
excess of $100,000 amounted to $146.0 million and $50.0 million, respectively.
On an average balance basis, all deposit categories increased when compared to
2003, except for time deposits of less than $100,000.
Approximately 90% of the year-end 2003 balance increase and one-half of
the 2003 average balance increase is attributed to deposits the Corporation
received as part of the Huntington branch acquisition. The remaining increase is
primarily attributed to the full year impact of a new interest-bearing demand
deposit product which was introduced in the spring of 2002 that offers customers
liquidity as well as a competitive rate.
The following table sets forth the maturities of time deposits of $100,000
or more (in thousands):
MATURITY OF TIME DEPOSITS OF $100,000 OR MORE
(DOLLARS IN THOUSANDS)
TABLE 10
DECEMBER 31, 2004
- --------------------------------------------------------------------------------
Maturities
3 Months or Less $ 23,559
3-6 Months 18,992
6-12 Months 39,718
Over 1 Year 105,790
--------
Total $188,059
========
22
BORROWED FUNDS
The following shows the composition of the Corporation's borrowings at
December 31 (in thousands):
2004 2003 2002
----------------------------------
Federal funds purchased $ -- $ 5,800 $ 16,200
Securities sold under agreements to repurchase 86,914 66,040 28,267
Short-term FHLB advances 23,318 -- --
-------- -------- --------
Total short-term borrowings 110,232 71,840 44,467
-------- -------- --------
Long-term FHLB advances 139,486 168,024 175,061
Junior subordinated debentures 35,929 23,711 23,711
-------- -------- --------
Total long-term borrowings 175,415 191,735 198,772
-------- -------- --------
Total borrowings $285,647 $263,575 $243,239
======== ======== ========
Average balance (from Table 1) $287,940 $245,990 $185,260
======== ======== ========
Total borrowings increased $22 million (8%) in 2004 compared to 2003,
following a $20 million (8%) increase over 2002. The average balance of total
borrowings increased by $42 million (17%) in 2004 versus 2003, following a $61
million (33%) increase in 2003 when compared to 2002. The preceeding table
illustrates management's use of more short-term borrowings during the past two
years, and less reliance on long-term borrowings, taking advantage of the
historically low interest rate environment during this time period. Management
will continue to closely monitor interest rates within the context of its
overall asset-liability management process. See further discussion on this topic
in the "Interest Rate Senstivity" section of Management's Discussion and
Analysis.
At December 31, 2004, the Corporation had additional borrowing capacity
with the FHLB totaling $31.0 million and an additional $15 million of unused
lines of credit with various financial institutions. See Note 8 of the Notes to
Consolidated Financial Statements for further details about the Corporation's
borrowings and additional borrowing capacity, which is incorporated herein by
reference.
CAPITAL RESOURCES
The Bank and the Corporation are subject to risk-based capital
regulations, which were adopted and monitored by federal banking regulators.
These guidelines are used to evaluate capital adequacy and are based on an
institution's asset risk profile and off-balance sheet exposures, such as unused
loan commitments and stand-by letters of credit. The regulatory guidelines
require that a portion of total capital be Tier I capital, consisting of common
shareholders' equity, qualifying portion of trust issued preferred securities,
and perpetual preferred stock, less goodwill and certain other deductions. The
remaining capital, or Tier II capital, consists of elements such as subordinated
debt, mandatory convertible debt, remaining portion of trust issued preferred
securities, and grandfathered senior debt, plus the allowance for loan losses,
subject to certain limitations.
Under the risk-based capital regulations, banking organizations are
required to maintain a minimum 8% (10% for well capitalized banks) total
risk-based capital ratio (total qualifying capital divided by risk-weighted
assets), including a Tier I ratio of 4% (6% for well capitalized banks). The
risk-based capital rules have been further supplemented by a leverage ratio,
defined as Tier I capital divided by average assets, after certain adjustments.
The minimum leverage ratio is 3% (5% for well capitalized banks) for banking
organizations that do not anticipate significant growth and have
well-diversified risk (including no undue interest rate risk exposure),
excellent asset quality, high liquidity and good earnings. Other banking
organizations not in this category are expected to have ratios of at least 4-5%,
depending on their particular condition and growth plans. Higher capital ratios
could be required if warranted by the particular circumstances or risk profile
of a given banking organization. In the current regulatory environment, banking
organizations must stay well capitalized in order to receive favorable
regulatory treatment on acquisition and other expansion activities and favorable
risk-based deposit insurance assessments. The Corporation's capital policy
establishes guidelines meeting these regulatory requirements, and takes into
consideration current or anticipated risks as well as potential future growth
opportunities.
At December 31, 2004, the Corporation's total risk-based capital ratio was
12.24%, which was well above the regulatory minimum of 8%. The Corporation's
total risk-based capital ratio for year-end 2003 was 11.77%. The decrease in
2003 was a direct result of the increase in assets and goodwill attributable to
the Huntington branch acquisition. As of December 31, 2004, the most recent
notification from the regulators categorizes the Corporation as well capitalized
under the regulatory framework for prompt corrective action. See Note 2 of the
Notes to Consolidated Financial Statements for additional information regarding
regulatory capital ratios.
Total shareholders' equity increased $2.2 million to $86.4 million at
December 31, 2004, from $84.2 million at year-end 2003. The return on average
equity (ROE) for 2004 declined to 8.91% from 13.10% for 2003. Return on average
equity (ROE) for 2002 was 12.75% . The decrease in ROE in 2004 is due to the
decrease in net income in 2004 of $3.1 million when compared to 2003.
23
Cash dividends of $.72 per share were paid during 2004, compared with $.70
and $.68 paid in 2003 and 2002, respectively. This represents a dividend payout
rate (cash dividends per share divided by net income per share) of 57.6%, 39.5%,
and 42.8% for 2004, 2003, and 2002, respectively.
LIQUIDITY
The Asset and Liability Management Committee of the Corporation seeks to
assess and manage the risks associated with fluctuating interest rates while
maintaining adequate liquidity. This is accomplished by formulating and
implementing policies that take into account the sources and uses of funds,
maturity and repricing distributions of assets and liabilities, pricing
strategies, and marketability of assets.
The objective of liquidity management is to maintain sufficient funds to
satisfy the needs of depositors and borrowers. The principal sources of asset
liquidity are cash and due from banks, interest-bearing deposits in banks,
federal funds and investment securities available-for-sale that are not pledged.
At December 31, 2004, such liquid assets totaled $64 million. While much more
difficult to quantify, liability liquidity is enhanced by a stable core deposit
base, access to credit lines at other financial institutions, and the
Corporation's ability to renew maturing deposits. The Corporation's ability to
attract deposits and borrow funds depends primarily on continued rate
competitiveness, profitability, capitalization and overall financial condition.
When appropriate, the Corporation takes advantage of external sources of
funds, such as advances from the FHLB, lines of credit at other financial
institutions and brokered funds. These external sources often provide attractive
interest rates and flexible maturity dates that better enable the Corporation to
match funding dates and pricing characteristics with contractual maturity dates
and pricing parameters of earning assets. At December 31, 2004, the Corporation
had available borrowing capacity of approximately $46 million through the FHLB
and other financial institutions.
The Corporation actively manages its liquidity position under the
direction of the Asset and Liability Management Committee of the Corporation.
Monthly reviews by management and quarterly reviews by this Board Committee
under prescribed policies and procedures are intended to ensure that the
Corporation will maintain adequate levels of available funds. Management
believes that the Corporation has adequate liquidity available to respond to
current and anticipated liquidity demands.
For information about the Corporation's borrowings, see Note 8 of the
Notes to Consolidated Financial Statements, which is incorporated herein by
reference.
At the holding company level, the Corporation uses cash to pay dividends
to shareholders and to service its junior subordinated debt. The main sources of
funding for the holding company include dividends from the Bank and access to
the capital markets. As discussed in Note 12 of the Notes to Consolidated
Financial Statements, the Bank is subject to significant regulation and, among
other things, may be limited in its ability to pay dividends or transfer funds
to the holding company. Accordingly, consolidated cash flows as presented in the
Consolidated Statements of Cash Flows may not represent cash immediately
available to the holding company. During 2004, the Bank declared and paid
dividends of $8.6 million. As of December 31, 2004, the amount of additional
dividends that the Bank could have paid to the holding company without
regulatory approval was $11.2 million.
INTEREST RATE SENSITIVITY
The Corporation's primary market risk is interest rate fluctuation.
Interest rate sensitivity refers to the degree that earnings will be impacted by
changes in the prevailing level of interest rates. Interest rate risk arises
from mismatches in the repricing or maturity characteristics between
interest-bearing assets and liabilities. Management seeks to minimize
fluctuating net interest margins, and to enhance consistent growth of net
interest income through periods of changing interest rates. The Corporation uses
interest sensitivity gap analysis and simulation models to measure and manage
these risks. The interest rate sensitivity gap analysis assigns each
interest-earning asset and interest-bearing liability to a time frame reflecting
its next repricing or maturity date. The differences between total
interest-sensitive assets and liabilities at each time interval represent the
interest sensitivity gap for that interval. A positive gap generally indicates
that rising interest rates during a given interval will increase net interest
income, as more assets than liabilities will reprice. A negative gap position
would benefit 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
related impact on net interest income over specified periods. Management has not
historically used derivative financial instruments to manage its interest rate
sensitivity. At December 31, 2004, the static gap analysis prepared by
management indicated that the Corporation becomes liability sensitive over the
next year. In computing the effect on net interest income of changes in interest
rates, management has assumed that any changes would immediately affect
earnings. Normally, when an organization is liability sensitive there is a
negative impact to net interest income when interest rates increase. Based on
the simulation analysis performed at December 31, 2004 and 2003, the Corporation
estimated the following changes in net interest income, assuming the indicated
rate changes:
24
(DOLLARS IN THOUSANDS)
2004 2003
- --------------------------------------------------------------------------------
+200 basis point increase $ (592) $ 1,000
+100 basis point increase $ (146) $ 600
- -100 basis point decrease $(1,657) $(1,800)
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.
CONTRACTUAL OBLIGATIONS, COMMITMENTS AND OFF-BALANCE SHEET ARRANGEMENTS
The following table presents, as of December 31, 2004, significant fixed
and determinable contractual obligations to third parties by payment date and
amounts and expected maturities of significant commitments. Commitments to
extend credit and letters of credit are legally binding, conditional agreements
generally having fixed expiration or termination dates. These commitments
generally require customers to maintain certain credit standards and are
established based on management's credit assessment of the customer. The
commitments may expire without being drawn upon. Therefore, the total commitment
does not necessarily represent future funding requirements. Further discussion
of the nature of certain obligations and commitments is included in the
referenced Note in the Notes to Consolidated Financial Statements.
PAYMENTS DUE BY PERIOD
- -----------------------------------------------------------------------------------------------------------
CONTRACTUAL OBLIGATIONS NOTE LESS THAN 1-3 3-5 MORE THAN
(IN MILLIONS) REFERENCE TOTAL 1 YEAR YEARS YEARS 5 YEARS
- -----------------------------------------------------------------------------------------------------------
Long term debt 8
FHLB Advances $139.5 $ 22.0 $ 37.8 $11.5 $ 68.2
Junior subordinated debt 35.9 -- -- -- 35.9
Operating leases 5 .8 .3 .4 .1 --
Data processing and
telecommunications 6.5 1.6 4.0 .9 --
Time Deposits 7 380.4 168.7 181.0 29.4 1.2
COMMITMENT EXPIRATION BY PERIOD
- -----------------------------------------------------------------------------------------------------------
COMMITMENTS NOTE LESS THAN 1-3 3-5 MORE THAN
(IN MILLIONS) REFERENCE TOTAL 1 YEAR YEARS YEARS 5 YEARS
- -----------------------------------------------------------------------------------------------------------
Loan commitments 4 $141.4 $ 25.8 $ 11.4 $ 0.2 $104.0
Letters of credit 4 5.3 5.3 -- -- --
At December 31, 2004, the Corporation's off-balance sheet arrangements
were limited to loan commitments and letters of credit discussed above.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by this item is incorporated herein by
reference to Item 7 of Part II, "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Interest Rate Sensitivity."
25
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
First United Corporation
We have audited the accompanying consolidated statements of financial
condition of First United Corporation and subsidiaries as of December 31, 2004
and 2003, and 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, 2004. These financial statements are the responsibility of
First United Corporation's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of First United
Corporation and subsidiaries at December 31, 2004 and 2003, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2004, in conformity with U.S. generally accepted
accounting principles.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of First
United Corporation's internal control over financial reporting as of December,
31, 2004, based on criteria established in Internal Control--Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 7, 2005, expressed an unqualified opinion
thereon.
[ERNEST & YOUNG LLP LOGO]
Pittsburgh, Pennsylvania
March 7, 2005
26
FIRST UNITED CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31
2004 2003
- ---------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks $ 24,159 $ 20,272
Interest-bearing deposits in banks 1,855 1,474
Investment securities available-for-sale (at market
value) 210,661 223,615
Federal Home Loan Bank stock, at cost 9,525 8,660
Loans 911,450 792,025
Allowance for loan losses (6,814) (5,974)
----------- -----------
Net loans 904,636 786,051
Premises and equipment, net 23,523 16,598
Goodwill and other intangible assets, net 15,149 15,707
Bank owned life insurance 23,420 20,495
Accrued interest receivable and other assets 18,949 15,369
----------- -----------
Total Assets $ 1,231,877 $ 1,108,241
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Noninterest-bearing deposits $ 114,734 $ 99,181
Interest-bearing deposits 735,927 650,980
----------- -----------
Total deposits 850,661 750,161
Short-term borrowings 110,232 71,840
Long-term borrowings 175,415 191,735
Accrued interest and other liabilities 8,086 9,220
Dividends payable 1,127 1,094
----------- -----------
Total Liabilities 1,145,521 1,024,050
----------- -----------
Shareholders' Equity:
Preferred stock--no par value;
authorized and unissued 2,000 shares
Capital stock--par value $.01 per share;
authorized 25,000 shares, issued and outstanding
6,093 in 2004 and 6,087 in 2003 61 61
Surplus 20,453 20,324
Retained earnings 65,405 62,201
Accumulated other comprehensive income 437 1,605
----------- -----------
Total Shareholders' Equity 86,356 84,191
----------- -----------
Total Liabilities and Shareholders' Equity $ 1,231,877 $ 1,108,241
=========== ===========
See notes to consolidated financial statements.
27
FIRST UNITED CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31
2004 2003 2002
- ----------------------------------------------------------------------------------------------------
INTEREST INCOME
Interest and fees on loans $ 53,264 $ 49,316 $ 48,982
Interest on investment securities:
Taxable 6,177 6,921 7,147
Exempt from federal income taxes 1,206 1,427 1,397
----------- ----------- -----------
7,383 8,348 8,544
Interest on federal funds sold 35 39 63
----------- ----------- -----------
Total interest income 60,682 57,703 57,589
INTEREST EXPENSE
Interest on deposits 12,108 12,775 16,790
Interest on short-term borrowings 1,153 447 289
Interest on long-term borrowings 10,755 10,379 8,623
----------- ----------- -----------
Total interest expense 24,016 23,601 25,702
----------- ----------- -----------
Net interest income 36,666 34,102 31,887
Provision for loan losses 2,534 833 1,506
----------- ----------- -----------
Net interest income after provision for loan losses 34,132 33,269 30,381
OTHER OPERATING INCOME
Service charge income 4,749 3,895 3,432
Trust department income 3,153 2,520 2,146
Insurance premium income 1,448 1,367 1,215
Security gains (losses) 703 1,009 (366)
Bank owned life insurance 626 938 960
Other income 2,292 2,138 1,620
----------- ----------- -----------
Total other operating income 12,971 11,867 9,007
OTHER OPERATING EXPENSE
Salaries and employee benefits 16,907 15,995 13,922
Equipment 2,952 2,426 2,090
Expenses related to early redemption of long-term
borrowings 2,728 -- --
Occupancy 1,642 1,330 1,293
Data processing 1,380 1,217 1,160
Other expenses 10,360 8,853 7,573
----------- ----------- -----------
Total other operating expense 35,969 29,821 26,038
----------- ----------- -----------
Income before income taxes 11,134 15,315 13,350
Applicable income taxes 3,507 4,566 3,695
----------- ----------- -----------
Net income $ 7,627 $ 10,749 $ 9,655
=========== =========== ===========
Earnings per share $ 1.25 $ 1.77 $ 1.59
=========== =========== ===========
Weighted average common shares outstanding 6,088,367 6,086,369 6,080,589
=========== =========== ===========
See notes to consolidated financial statements
28
FIRST UNITED CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
ACCUMULATED
OTHER TOTAL
CAPITAL RETAINED COMPREHENSIVE SHAREHOLDERS'
STOCK SURPLUS EARNINGS INCOME EQUITY
- -------------------------------------------------------------------------------------------------------------------
Balance at January 1, 2002 $ 61 $ 20,199 $ 50,254 $ 562 $ 71,076
Comprehensive income:
Net income for the year 9,655 9,655
Unrealized gains on securities
available-for-sale,
net of income taxes of $1,951 2,718 2,718
-------
Comprehensive income 12,373
Cash dividends--$.685 per share (4,166) (4,166)
-------- -------- -------- -------- --------
Balance at December 31, 2002 61 20,199 55,743 3,280 79,283
Comprehensive income:
Net income for the year 10,749 10,749
Unrealized loss on securities
available-for-sale,
net of income tax benefit of $904 (1,675) (1,675)
-------
Comprehensive income 9,074
Issuance of 7,000 shares of common
stock under dividend reinvestment plan 125 125
Cash dividends--$.705 per share (4,291) (4,291)
-------- -------- -------- -------- --------
Balance at December 31, 2003 61 20,324 62,201 1,605 84,191
Comprehensive income:
Net income for the year 7,627 7,627
Unrealized loss on securities
available-for-sale,
net of income tax benefit of $286 (1,168) (1,168)
-------
Comprehensive income 6,459
Issuance of 6,000 shares of common
stock under dividend reinvestment plan 129 129
Cash dividends--$.725 per share (4,423) (4,423)
-------- -------- -------- -------- --------
Balance at December 31, 2004 $ 61 $ 20,453 $ 65,405 $ 437 $ 86,356
======== ======== ======== ======== ========
See notes to consolidated financial statements.
29
FIRST UNITED CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
2004 2003 2002
- --------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 7,627 $ 10,749 $ 9,655
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 2,534 833 1,506
Depreciation and amortization 2,921 2,338 1,748
Net accretion and amortization of investment
security discounts and premiums 1,106 1,935 (995)
(Gain) loss on sale of investment securities (703) (1,009) 366
(Increase) decrease in accrued interest
receivable and other assets (3,582) (3,560) 1,321
(Decrease) increase in accrued interest and
other liabilities (1,102) 41 79
Increase in bank owned life insurance value (625) (938) (960)
--------- -------- ---------
Net cash provided by operating activities 8,176 10,389 12,720
INVESTING ACTIVITIES
Net (increase) decrease in interest-bearing deposits
in banks (381) 4,733 5,041
Proceeds from maturities of investment securities
available-for-sale 127,250 167,130 51,021
Proceeds from sales of investment securities
available-for-sale 14,008 98,615 18,508
Purchases of investment securities available-for-sale (129,912) (277,588) (164,015)
Net increase in loans (121,118) (77,452) (57,463)
Net (increase) decrease in FHLB stock (865) 498
Purchase of premises and equipment (9,288) (4,200) (3,384)
Investment in bank owned life insurance (2,300) -- --
Net cash provided by acquisition -- 66,040 --
--------- -------- ---------
Net cash used in investing activities (122,606) (22,224) (150,292)
FINANCING ACTIVITIES
Net increase in deposits 100,500 8,799 33,091
Net increase in short-term borrowings 38,392 16,240 27,335
Proceeds from long-term borrowings 35,929 -- 80,000
Payments on long-term borrowings (52,249) (7,037) (13,178)
Cash dividends paid (4,384) (4,262) (4,136)
Proceeds from issuance of common stock 129 125 --
--------- -------- ---------
Net cash provided by financing activities 118,317 13,865 123,112
--------- -------- ---------
Increase (decrease) in cash and cash equivalents 3,887 2,030 (14,460)
Cash and cash equivalents at beginning of year 20,272 18,242 32,702
--------- -------- ---------
Cash and cash equivalents at end of year $ 24,159 $ 20,272 $ 18,242
========= ======== =========
SUPPLEMENTAL INFORMATION
Interest paid $ 23,605 $ 24,641 $ 26,384
Income taxes paid 6,262 5,218 3,305
Acquisition of a business:
Fair value of assets acquired:
Loans $ 48,841
Premises and equipment 1,340
Goodwill and other identified intangibles 14,682
Fair value of liabilities assumed:
Demand deposit and savings accounts (79,611)
Certificates of deposits (51,292)
---------
Net cash provided by acquisition $ 66,040
=========
See notes to consolidated financial statements.
30
FIRST UNITED CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
First United Corporation ("Corporation") a registered financial holding
company, incorporated under the laws of Maryland. It is the parent company of
First United Bank & Trust ("Bank"), First United Insurance Group, LLC (the
"Insurance Group"), Oakfirst Life Insurance Corporation, and OakFirst Loan
Center, Inc., OakFirst Loan Center, LLC. First United Bank & Trust provides a
complete range of retail and commercial banking services to a customer base
serviced by a network of 24 offices and 34 automated teller machines. This
customer base includes individuals, businesses and various governmental units.
The Insurance Group is a full-services insurance agency that succeeded to all of
the business of Gonder Insurance Agency, Inc. when that entity was merged into
the Insurance Group on January 1, 2005. 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 Loan Center, Inc., and OakFirst Loan
Center, LLC are finance companies. The Corporation and its subsidiaries
principally operate in four Western Maryland counties and four West Virginia
counties.
BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared in
accordance with accounting principles generally accepted in the United States
that requires management to make estimates and assumptions that affect the
reported amounts of certain assets and liabilities at the date of the financial
statements as well as the reported amount of revenues and expenses during the
reporting period. Actual results could differ from these estimates. For purposes
of comparability, certain prior period amounts have been reclassified to conform
with the 2004 presentation.
Additionally, the Corporation also determines whether it should
consolidate other entities or account for them on the equity method of
accounting depending on whether it has a controlling financial interest in an
entity of less than 100% of the voting interest of that entity by considering
the provisions of Accounting Research Bulletin 51 (ARB 51), "Consolidated
Financial Statements", or a controlling financial interest in a variable
interest entity ("VIE") by considering the provisions of FASB Interpretation No.
46 ("FIN 46"), "Consolidation of Variable Interest Entities", issued in January
2003, and FIN 46R issued in December 2003. The Corporation adopted the
provisions of FIN 46 during the fourth quarter of 2003, and FIN 46R in the first
quarter 2004, Under FIN 46, a VIE is a corporation, partnership, trust or any
other legal structure used for business purposes that either (a) does not have
equity investors with voting rights or (b) has equity investors that does not
provide sufficient financial resources for the entity to support its activities.
Under FIN 46R, an entity that holds a variable interest in a VIE is required to
consolidate the VIE if the entity is subject to a majority of the risk of loss
from the VIE's activities, is entitled to receive a majority of the entity's
residual returns or both. ARB 51 is considered for entities in which the total
equity investment at risk is sufficient to enable the entity to finance itself
independently and provides the equity holders with the obligation to absorb
losses, the right to receive residual returns and the right to make financial
and operating decisions.
As discussed further in Note 8, the Corporation has wholly owned trusts
formed for the purpose of issuing securities which qualify as regulatory capital
and are considered VIE's. These trusts are not consolidated, including the
Corporation's investment in First United Capital Trust, a VIE formed in 1999,
that was deconsolidated during the fourth quarter of 2003 based on the criteria
established in FIN 46. The Corporation's investment in non-consolidated VIE's
are accounted for using the equity method of accounting.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of the Corporation include the
accounts of the Bank, Oakfirst Life Insurance Corporation, OakFirst Loan Center,
Inc., OakFirst Loan Center, LLC, and Gonder Insurance Agency. All significant
intercompany accounts and transactions have been eliminated.
COMPLETED BUSINESS COMBINATION
On July 25, 2003, the Corporation consummated, through the Bank, the
acquisition of four banking offices and a commercial banking center located in
Berkeley County, West Virginia, from Huntington Bancshares Incorporated and its
bank subsidiary, the Huntington National Bank. The acquisition was accounted for
under the purchase method of accounting. As a result of the transaction,
approximately $131 million in deposits and $49 million in loans were purchased.
Also, approximately $66 million in cash was received. The acquisition resulted
in recording $4.0 million of core deposit intangibles that will be amortized
over 7.2 years. Additionally, the fair value adjustments required by the
purchase method of accounting consisted of $1.1 million for deposits, which will
be amortized over an estimated 4 years, and $.5 million for loans, which will be
amortized over an estimated 3 years. The resulting goodwill arising from the
transaction totaled $10.8 million, which is expected to be fully deductible for
tax purposes. The acquisition cost has been allocated to the assets acquired and
liabilities assumed based upon their fair values at the date of acquisition.
INVESTMENTS
Securities available-for-sale: All security purchases have been classified
as available-for-sale. Securities available-for-sale are stated at fair market
value, with the unrealized gains and losses, net of tax, reported as a separate
component of other comprehensive income in shareholders' equity.
The amortized cost of debt securities classified as available-for-sale is
adjusted for amortization of premiums to the first call date, if applicable, or
to maturity, and accretion of discounts to maturity, or in the case of
mortgage-backed securities, over the estimated life of the security. Such
amortization and accretion is included in interest income from investments.
Interest and dividends are included in interest income from investments.
Realized gains and losses, and declines in value judged to be
other-than-temporary are included in net securities gains (losses). Management
systematically evaluates securities for other-than-temporary declines in fair
value. The cost of securities sold is based on the specific identification
method.
31
LOANS
Loans and leases that management has the intent and ability to hold for
the foreseeable future or until maturity or full repayment by the borrower are
reported at their outstanding balance.
INTEREST ON LOANS
Interest on loans and leases is recognized based upon the principal amount
outstanding. It is the Corporation's general policy to discontinue the accrual
of interest on loans (including impaired loans), except for consumer loans, when
circumstances indicate that collection of principal or interest is doubtful.
After a loan is placed on non-accrual status, interest is not recognized. Cash
payments received are applied to the principal balances. Generally, consumer
installment loans are not placed on non-accrual status, but are charged off
after they are 120 days contractually past due.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level believed by
management to be sufficient to absorb estimated losses inherent in the loan
portfolio. Loans deemed uncollectible are charged against the allowance, while
recoveries are credited to it. Management's determination of the adequacy of the
loan loss reserve is based upon the impact of economic conditions on the
borrower's ability to repay, past collection experience, the risk
characteristics of the loan portfolio, estimated fair value of underlying
collateral for collateral dependent loans, and such other factors which, in
management's judgement, deserve current recognition.
The Corporation utilizes the methodology outlined in FDIC Statement of
Policy on Allowance for Loan and Lease Losses. The starting point for this
methodology is to segregate the loan portfolio into two pools, non-homogeneous
(i.e. commercial) and homogeneous (i.e. consumer) loans. Each loan pool is
analyzed with general allowances and specific allocations being made as
appropriate. For general allowances, the previous eight quarters of loss
activity are used in the estimation of losses in the current portfolio. These
historical loss amounts are modified by the following qualitative factors:
levels of and trends in delinquency and non-accruals; trends in volumes and
terms of loans; effects of changes in lending policies, experience, ability, and
depth of management, national and local economic trends and conditions; and
concentrations of credit in the determination of the general allowance. The
qualitative factors are updated each quarter by the gathering of information
from internal, regulatory, and governmental sources. Specific allocations are
made for those loans on the Watchlist in which the collateral value is less than
the outstanding loan balance with the allocation being the dollar difference
between the two. The Watchlist represents loans, identified and closely
monitored by management, which possess certain qualities or characteristics that
may lead to collection and loss issues. Allocations are not made for loans that
are cash secured, for the Small Business Administration or Farm Service Agency
guaranteed portion of loans, or for loans that are sufficiently collateralized.
TRUST ASSETS AND INCOME
Assets held in an agency or fiduciary capacity are not assets of the
Corporation and, accordingly, are not included in the accompanying consolidated
statements of financial condition. Income from the Bank's Trust department
represents fees charged to customers and is recorded on an accrual basis.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost, less accumulated depreciation.
The provision for depreciation for financial reporting has been made by using
the straight-line method based on the estimated useful lives of the assets,
which range from 18 to 32 years for buildings and 3 to 20 years for equipment.
Accelerated depreciation methods are used for income tax purposes.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill represents the excess of the cost of an acquisition over the fair
value of the net assets acquired in business combinations. In accordance with
SFAS No. 142, and SFAS No. 147, which applies specifically to branch purchases
that qualify as business combinations, goodwill is not amortized, but is subject
to an annual impairment test.
Core deposit intangible assets represent the present value of future net
income to be earned from acquired deposits and are being amortized using the
straight-line method over their estimated life of 7.2 years.
BANK-OWNED LIFE INSURANCE (BOLI)
BOLI policies are recorded at their cash surrender value. Changes in the
cash surrender value are recorded as other operating income.
INCOME TAXES
The Corporation accounts for income taxes using the liability method.
Under the liability method, the deferred tax liability or asset is determined
based on the difference between the financial statement and tax bases of assets
and liabilities (temporary differences) and is measured at the enacted tax rates
that will be in effect when these differences reverse. Deferred tax expense is
determined by the change in the liability or asset for deferred taxes adjusted
for changes in any deferred tax asset allowance.
STATEMENT OF CASH FLOWS
The Corporation has defined cash and cash equivalents as those amounts
included in the balance sheet caption "Cash and due from banks."
EARNINGS PER SHARE
Earnings per share is computed by dividing net income by the weighted
average number of common shares outstanding. The Corporation does not have any
common stock equivalents.
BUSINESS SEGMENTS
As defined by SFAS No. 131, "Disclosure about Segments of an Enterprise
and Related Information," the Corporation has two operating segments, community
banking and insurance. Because the operating activities of the insurance segment
are immaterial to the consolidated financial statements, no separate segment
disclosures for insurance operations have been made.
32
VARIABLE INTEREST ENTITIES
In January, 2003, the FASB issued Interpretation No. 46 (FIN 46),
"Consolidation of Variable Interest Entities" ("VIEs"), which clarified the
application of Accounting Research Bulletin No. 51, "Consolidated Financial
Statements" to certain VIEs, commonly referred to as special-purpose entities
(SPEs), in which equity investors do no have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. In December, 2003, the FASB reissued FIN 46 with
certain modifications and clarifications.
In 1999, the Corporation issued approximately $23.7 million in mandatorily
redeemable junior subordinated debentures to First United Capital Trust, a
Delaware business trust ("Capital Trust") the common shares of which were owned
by the Corporation. Capital Trust concurrently issued approximately $23.0
million in mandatorily redeemable preferred securities to third-party investors.
The Corporation's investment in Capital Trust was considered a SPE. In
accordance with the requirements of FIN 46 and FIN 46R, in 2003 the Corporation
reported $23.7 million of junior subordinated debentures in long-term borrowings
and its $0.7 million equity interest in the Capital Trust as an "Other Asset."
On September 30, 2004, the Corporation exercised its option and redeemed the
$23.7 million of junior subordinated debentures, and at the same time Capital
Trust redeemed the related preferred securities, thereby dissolving the Trust.
In March 2004, the Corporation issued approximately $30.9 million of
junior subordinated debentures to First United Statutory Trust I and II (FUST I
and FUST II are collectively referred to as the "Trusts"). The Trusts, which are
Connecticut Statutory business trusts, all of the common securities of which are
owned by the Corporation, are considered SPEs and issue mandatorily redeemable
preferred capital securities to third party investors (see Note 8). In
accordance with FIN 46R, the Corporation reported $30.9 million of junior
subordinated debentures as long-term borrowings and its $0.9 million equity
interest in the Trusts as "Other Assets," at December 31, 2004.
These debentures and preferred securities are discussed in detail in Note
8.
2. REGULATORY CAPITAL REQUIREMENTS
The Corporation and the Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Corporation and the Bank must meet specific capital guidelines that involve
quantitative measures of its assets, liabilities, and certain off-balance sheet
items as calculated under regulatory accounting practices. The capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Corporation and the 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, 2004, that
the Corporation and the Bank meet all capital adequacy requirements to which it
is subject.
As of December 31, 2004 and 2003, the most recent notification from the
regulators categorize the Corporation and the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, total risk-based, Tier I risk-based, and Tier I leverage ratios
must not fall below the percentage shown in the following table. Management is
not aware of any condition or event which has caused the well capitalized
position to change.
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
- -------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
- -------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2004
Total Capital (to Risk Weighted
Assets)
Consolidated $112,584 12.24% $73,570 8.00% $91,962 10.00%
First United Bank 97,531 10.70% 72,910 8.00% 91,137 10.00%
Tier I Capital (to Risk Weighted
Assets)
Consolidated 99,410 10.81% 36,785 4.00% 55,177 6.00%
First United Bank 90,870 9.97% 36,455 4.00% 54,682 6.00%
Tier I Capital (to Average Assets)
Consolidated 99,410 8.44% 35,350 3.00% 58,917 5.00%
First United Bank 90,870 7.57% 35,999 3.00% 59,998 5.00%
DECEMBER 31, 2003
Total Capital (to Risk Weighted
Assets)
Consolidated $ 96,809 11.77% $65,808 8.00% $82,260 10.00%
First United Bank 83,658 10.26% 65,247 8.00% 81,559 10.00%
Tier I Capital (to Risk Weighted
Assets)
Consolidated 90,834 11.04% 32,904 4.00% 49,356 6.00%
First United Bank 77,784 9.54% 32,624 4.00% 48,935 6.00%
Tier I Capital (to Average Assets)
Consolidated 90,834 8.72% 31,195 3.00% 51,992 5.00%
First United Bank 77,784 7.53% 31,005 3.00% 51,675 5.00%
33
3. INVESTMENT SECURITIES
The following is a comparison of amortized cost and market values of
securities available-for-sale (in thousands):
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
- -----------------------------------------------------------------------------------------
DECEMBER 31, 2004
U.S. government and agencies $102,790 $ 101 $ 597 $102,294
Mortgage-backed securities 74,324 195 133 74,386
Obligations of states and political
subdivisions 21,503 960 2 22,461
Corporate and other debt securities 11,320 200 -- 11,520
-------- -------- -------- --------
Total debt securities 209,937 1,456 732 210,661
Other securities -- -- -- --
-------- -------- -------- --------
Totals $209,937 $ 1,456 $ 732 $210,661
======== ======== ======== ========
DECEMBER 31, 2003
U.S. government and agencies $ 75,301 $ 526 $ 126 $ 75,701
Mortgage-backed securities 89,066 330 314 89,082
Obligations of states and political
subdivisions 28,239 1,104 1 29,342
Corporate and other debt securities 17,278 990 -- 18,268
-------- -------- -------- --------
Total debt securities 209,884 2,950 441 212,393
Other securities 11,222 -- -- 11,222
-------- -------- -------- --------
Totals $221,106 $ 2,950 $ 441 $223,615
======== ======== ======== ========
Proceeds from sales and calls of securities available-for-sale and the
realized gains and losses are as follows (in thousands):
2004 2003 2002
- -------------------------------------------------------------------------------
Proceeds $ 14,008 $ 98,675 $ 18,508
Realized gains 712 1,755 --
Realized losses (9) (746) (366)
The following shows the Corporation's securities available-for-sale with
gross unrealized losses and fair value, aggregated by investment category and
length of time that individual securities have been in a continuous unrealized
position, at December 31, 2004 and 2003 (in thousands):
DECEMBER 31, 2004
LESS THAN 12 MONTHS 12 MONTHS OR MORE
- --------------------------------------------------------------------------------------------------------
FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES
- --------------------------------------------------------------------------------------------------------
U.S. government and agencies $74,177 $(569) $2,021 $(28)
Mortgage-backed securities 21,428 (77) 5,758 (56)
Obligations of states and political
subdivisions 866 (2) -- --
DECEMBER 31, 2003
LESS THAN 12 MONTHS 12 MONTHS OR MORE
- --------------------------------------------------------------------------------------------------------
FAIR UNREALIZED FAIR UNREALIZED
VALUE LOSSES VALUE LOSSES
- --------------------------------------------------------------------------------------------------------
U.S. government and agencies $25,408 $(126) -- --
Mortgage-backed securities 70,285 (314) -- --
Obligations of states and political
subdivisions 469 (1) -- --
The Corporation does not believe any individual unrealized loss as of
December 31, 2004 represents an other-than-temporary impairment. These
unrealized losses on debt securities are primarily attributable to changes in
interest rates. The Corporation has both the intent and ability to hold the
securities contained in the previous table for a time necessary to recover its
amortized cost.
34
The Corporation recognized a realized loss on investment securities of $.4
million during the first quarter of 2003 and $.4 million in 2002, related to an
other-than-temporary impairment write-down of its investment in Federal Home
Loan Mortgage Corporation (FHLMC) preferred stock. This FHLMC preferred stock
was ultimately sold during the second quarter of 2003.
The amortized cost and estimated fair value of securities
available-for-sale by contractual maturity at December 31, 2004, are shown in
the following table. Actual maturities will differ from contractual maturities
because the issuers of the securities may have the right to call or prepay
obligations with or without call or prepayment penalties.
SECURITIES AVAILABLE-FOR-SALE
(IN THOUSANDS)
- --------------------------------------------------------------------------------
AMORTIZED MARKET
CONTRACTUAL MATURITY COST VALUE
- --------------------------------------------------------------------------------
Due in one year or less $ 24,806 $ 24,745
Due after one year through five years 83,303 83,010
Due after five years through ten years 3,930 4,184
Due after ten years 23,574 24,336
-------- --------
135,613 136,275
Mortgage-backed securities 74,324 74,386
-------- --------
$209,937 $210,661
======== ========
At December 31, 2004 and 2003, investment securities with a market value
of $173 and $150 million, respectively, were pledged to secure public and trust
deposits and securities sold under agreements to repurchase as required or
permitted by law.
4. LOANS
The Corporation, through the bank, is active in originating loans to
customers primarily in Western Maryland and West Virginia. The following table
is a summary of the loan portfolio by principal categories (in thousands):
DECEMBER 31, 2004 DECEMBER 31, 2003
LOAN LOAN
LOANS COMMITMENTS LOANS COMMITMENTS
- --------------------------------------------------------------------------------
Commercial $373,893 $ 91,705 $307,523 $ 21,873
Residential--mortgage 319,033 36,456 264,730 32,663
Installment 199,862 514 201,419 1,173
Residential--construction 18,196 12,734 16,093 13,496
Lease financing 466 -- 2,260 --
Commercial letters of credit -- 5,336 -- 1,239
-------- -------- -------- --------
$911,450 $146,745 $792,025 $ 70,444
======== ======== ======== ========
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, most 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.
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. 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
collectability. Changes in the dollar amount of loans outstanding to officers,
directors and their associates were as follows for the years ended December 31
(in thousands):
2004 2003 2002
- --------------------------------------------------------------------------------
Balance at January 1 $ 16,794 $ 18,796 $ 17,601
Loans or advances 12,396 12,557 9,167
Repayments (13,184) (14,559) (7,972)
-------- -------- --------
Balance at December 31 $ 16,006 $ 16,794 $ 18,796
======== ======== ========
35
Activity in the allowance for loan loss is summarized as follows (in
thousands):
2004 2003 2002
- --------------------------------------------------------------------------------
Balance at January 1 $ 5,974 $ 6,068 $ 5,752
Gross credit losses (2,205) (1,720) (1,829)
Recoveries 511 492 639
------- ------- --------
Net credit losses (1,694) (1,228) (1,190)
Provision for loan losses 2,534 833 1,506
Huntington Branch acquisition loan
loss reserve -- 301 --
------- ------- --------
Balance at December 31 $ 6,814 $ 5,974 $ 6,068
======= ======= =======
Non-accruing loans were $3.4, $2.8, and $1.8 million at December 31, 2004,
2003 and 2002, respectively. Interest income not recognized as a result of
placing loans on a non-accrual status was $.4 million during 2004 and $.1
million during 2003 and 2002.
Total impaired loans amounted to $.6 million and $.3 million at December
31, 2004 and 2003, respectively. Specific allocations of the allowance for loan
losses for impaired loans were equal to these same amounts. There were no
impaired loans or specific allocations at December 31, 2002.
5. PREMISES AND EQUIPMENT
The composition of premises and equipment at December 31 is as follows (in
thousands):
2004 2003
- --------------------------------------------------------------------------------
Land $ 8,397 $ 3,766
Premises 13,489 11,603
Furniture and equipment 25,152 22,512
-------- --------
47,038 37,881
Less accumulated depreciation (23,515) (21,283)
-------- --------
Total $ 23,523 $ 16,598
======== ========
The Corporation recorded depreciation expense of $2.4, $2.1, and $1.8
million in 2004, 2003 and 2002, respectively.
Pursuant to the terms of noncancelable operating lease agreements for
banking and subsidiaries' offices and for data processing and telecommunications
in effect at December 31, 2004, future minimum rent commitments under these
leases for each of the next five years are as follows: $1.9, 2.2, 2.2, .5, and
..5 million. The leases contain options to extend for periods from 1 to 5 years,
not included in the aforementioned amounts.
Total rent expense amounted to $.4 million in each of 2004, 2003 and 2002.
6. GOODWILL AND OTHER INTANGIBLE ASSETS
The Corporation performed its annual impairment test as of December 31,
2004 and determined that goodwill was not impaired. There can be no assurance
that goodwill impairment will not occur in the future. The Corporation will
continue to evaluate goodwill on an annual basis for impairment and as events
occur or circumstances change.
The significant components of goodwill and acquired intangible assets at
December 31 are as follows (in thousands):
2004 2003
- -----------------------------------------------------------------------------------------------------------------------
Weighted Weighted
Gross Net Average Gross Net Average
Carrying Accumulated Carrying Remaining Carrying Accumulated Carrying Remaining
Amount Amortization Amount Life Amount Amortization Amount Life
- -----------------------------------------------------------------------------------------------------------------------
Goodwill $ 11,900 $ -- $ 11,900 $ 11,900 $ -- $ 11,900
Core deposit intangible
assets 4,040 (791) 3,249 5.8 4,040 (233) 3,807 6.8
-------- --------- -------- -------- ------- ---------
Total $ 15,940 $ (791) $ 15,149 $ 15,940 $ (233) $ 15,707
======== ========= ======== ======== ======= =========
36
Amortization expense relating to the core deposit intangible asset
acquired in 2003 was $.6 million in 2004 and $.2 million in 2003. Future
estimated annual amortization expense is presented below (in thousands):
2005 $558
2006 558
2007 558
2008 558
2009 558
2010 459
7. DEPOSITS
The aggregate amount of time deposits with a minimum denomination of
$100,000 was $188.0 and $117.5 million at December 31, 2004 and December 31,
2003, respectively.
The following is a summary of the scheduled maturities of all time
deposits as of December 31, 2004 (in thousands):
2005 168,675
2006 127,418
2007 53,581
2008 16,968
2009 12,486
Thereafter 1,230
8. BORROWED FUNDS
The following is a summary of short-term borrowings at December 31 with
original maturities less than one year (dollars in thousands):
2004 2003 2002
- ------------------------------------------------------------------------------------------
Federal funds purchased (weighted average interest rate
at December 31, 2003 (1.20%) and 2002 (1.51%) $ -- $ 5,800 $16,200
Short-term FHLB advance, interest rate of 2.6% maturing in
March 2005 23,319 -- --
2004 2003 2002
- ------------------------------------------------------------------------------------------
Securities sold under agreements to repurchase:
Outstanding at end of year $86,914 $66,040 $39,400
Weighted average interest at year end 2.14% 1.03% .75%
Maximum amount outstanding as of any month end 91,209 66,040 39,400
Average amount outstanding 78,352 49,278 32,259
Approximate weighted average rate during the year 1.44% .86% .87%
The following is a summary of long-term borrowings at December 31 with
original maturities exceeding one year (dollars in thousands):
2004 2003
- --------------------------------------------------------------------------------------
FHLB advances, bearing interest at rates ranging
from 1.62% to 6.42% at December 31 $139,486 $168,024
Junior subordinated debt, bearing interest at rates
ranging from 4.66% to 6.02% 35,929 23,711
-------- --------
$175,415 $191,735
======== ========
In addition to the above, the Corporation has $11 million of letters of
credit with the Federal Home Loan Bank of Atlanta ("FHLB") at December 31, 2004.
These letters of credit are pledged to secure public deposits.
The Corporation has a borrowing capacity agreement with the FHLB in an
amount equal to 29% of the Bank's assets. At December 31, 2004, the available
line of credit equaled $348 million. This line of credit, which can be used for
both short or long-term funding, can only be utilized to the extent of available
collateral. The line is secured by certain qualified mortgage and commercial
loans and investment securities, as follows:
1-4 family mortgage loans $135,225
Commerical loans 5,140
Investment securities 64,402
--------
$204,767
========
37
The collateralized line of credit totaled $140 million at December 31,
2004, of which $31 million was available for additional borrowings.
The Corporation also has various unsecured lines of credit totaling $15.0
million with various financial institutions to meet daily liquidity
requirements. As of December 31, 2004, the Corporation had no borrowings under
these credit facilities.
Repurchase Agreements--The Corporation has retail repurchase agreements
with customers within its local market areas. Repurchase agreements generally
have maturities of one to four days from the transaction date. These borrowings
are collateralized with securities owned by the company and held in safekeeping
at independent correspondent banks.
FHLB Advances--The FHLB advances consist of various borrowings with
maturities generally ranging from 5 to 10 years with initial fixed rate periods
of one, two or three years. After the initial fixed rate period the FHLB has one
or more options to convert each advance to a LIBOR based, variable rate advance,
but the Corporation may repay the advance in whole or in part, without a
penalty, if the FHLB exercises its option. At all other times, the Corporation's
early repayment of any advance would be subject to a prepayment penalty.
In December 2004, the Bank refinanced $21.5 million of long-term FHLB
advances, resulting in an early redemption penalty of $1.8 million (included in
other expense). The borrowing was refinanced with a short-term FHLB advance that
matures in March 2005.
The weighted average interest rate on all long-term FHLB advances was
4.14% at December 31, 2004.
Maturities of long-term FHLB advances over the next five years are as
follows: 2005, $22.0 million; 2006, $7.0 million; 2007, $30.8 million; 2009,
$11.5 million; and $68.2 million thereafter.
Subordinated Debt--In 1999, Capital Trust issued 9.375% preferred
securities with an aggregate liquidation amount of $23.0 million ($10 per
preferred share) to third-party investors. The proceeds were used to purchase an
equal amount of 9.375% junior subordinated debentures of the Corporation. An
additional $.7 million of junior subordinated debentures was purchased by
Capital Trust from the proceeds of the sale of 100% of the Trust's common
securities to the Corporation. The junior subordinated debentures represented
the sole assets of Capital Trust, and payments under the junior subordinated
debentures were the sole source of cash flow for Capital Trust. The preferred
securities qualified as regulatory Tier 1 capital of the Corporation.
On September 30, 2004, the Corporation exercised its right to redeem the
junior subordinated debentures at the same time Capital Trust redeemed the
preferred securities. In conjunction with this early redemption, the Corporation
expensed $.9 million of remaining unamortized issuance costs (included in other
expenses) related to the junior subordinated debentures.
In March 2004, the Trusts issued preferred securities with an aggregate
liquidation amount of $30.9 million to third-party investors. The proceeds of
issuance of the preferred securities were used to purchase an equal amount of
junior subordinated debentures of the Corporation, as follows:
$20.6 million--6.02% fixed rate for 5 years payable quarterly, converting
to floating rate based on 3 month LIBOR plus 275 basis points,
maturing in 2034, redeemable five years after issuance at the
Corporation's option.
$10.3 million--floating rate payable quarterly based on 3 month LIBOR plus
275 basis points (4.66% at December 31, 2004) maturing in 2034,
redeemable five years after issuance at the Corporation's option.
The debentures represent the sole assets of the Trusts, and payments under
the debentures are the only sources of cash flow for the Trusts.
Additionally, in December 2004, the Corporation issued $5.0 million of
debentures. The debentures have a fixed rate of 5.88% for the first five years,
payable quarterly, which converts to a floating rate based on three month LIBOR
plus 185 basis points. The debentures mature in 2014, but are redeemable five
years after issuance at the Corporation's option.
The Corporation has the right to defer interest on the debentures for up
to 20 quarterly periods, in which case distributions on the preferred securities
will also be deferred. Should this occur, the Corporation may not pay dividends
or distributions on, or repurchase, redeem or acquire any shares of its common
stock.
9. INCOME TAXES
The provision for income taxes consists of the following for the years
ended December 31 (in thousands):
2004 2003 2002
- --------------------------------------------------------------------------------
Taxes currently payable $ 5,324 $ 6,060 $ 3,233
Deferred taxes (benefit) (1,817) (1,494) 462
-------- -------- -------
Income tax expense for the year $ 3,507 $ 4,566 $ 3,695
The reconciliation between the statutory federal income tax rate and
effective income tax rate is as follows:
2004 2003 2002
- --------------------------------------------------------------------------------
Federal statutory rate 35.0% 35.0% 35.0%
Tax-exempt income on securities and loans (4.1) (3.6) (4.2)
Tax-exempt BOLI income (2.0) (2.1) (2.5)
State income tax, net of federal tax benefit 4.4 .6 (.8)
Other (1.8) (.1) .2
---- ---- ----
31.5% 29.8% 27.7%
==== ==== ====
38
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Corporation's temporary differences as of December 31 are as follows (in
thousands):
2004 2003
- -----------------------------------------------------------------------------------
Deferred tax assets:
Allowance for loan losses $ 2,695 $ 2,363
Deferred compensation 506 544
State tax loss carry forwards 575 323
Other 185 94
------- -------
Total deferred tax assets 3,961 3,324
Valuation allowance (575) (321)
------- -------
Total deferred tax assets less valuation allowance 3,386 3,003
Deferred tax liabilities:
Dividend from real estate investment trust -- (1,650)
Depreciation (1,450) (1,121)
Unrealized gain on investment securities available-for-sale (287) (992)
Pension (1,110) (874)
Auto leasing (186) (650)
Other (404) (291)
------- -------
Total deferred tax liabilities (3,437) (5,578)
------- -------
Net deferred tax liabilities $ (51) $(2,575)
======= =======
State income tax expense (benefit) amounted to $.8, $.2 and $(.2) during
2004, 2003 and 2002, respectively. The state loss carry forwards included in
deferred tax assets will expire commencing in 2019.
10. EMPLOYEE BENEFIT PLANS
The Corporation sponsors a noncontributory defined benefit pension plan
(Plan) covering substantially all full-time employees who qualify as to age and
length of service. The benefits are based on years of service and the employees'
compensation during the last five years of employment. The Corporation's funding
policy is to make annual contributions in amounts sufficient to meet the current
year's funding requirements.
The benefit obligation activity was calculated using an actuarial
measurement date of January 1. Plan assets were calculated using an actuarial
measurement date of December 31. The following table summarizes benefit
obligation and funded status, plan asset activity, components of net pension
cost, and weighted average assumptions for the Corporation's pension plan (in
thousands):
2004 2003
- --------------------------------------------------------------------------------
CHANGE IN BENEFIT OBLIGATION
Obligation at the beginning of the year $ 14,724 $ 13,124
Service cost 718 571
Interest cost 938 840
Assumptions 245 1,225
Actuarial (gains) losses 528 (645)
Benefits paid (435) (391)
-------- --------
Obligation at the end of the year $ 16,718 $ 14,724
-------- --------
CHANGE IN PLAN ASSETS
Fair value at the beginning of the year 13,726 11,151
Actual return on plan assets 725 2,157
Employer contribution 418 809
Benefits paid (435) (391)
-------- --------
Fair value at the end of the year 14,434 13,726
-------- --------
FUNDED STATUS (2,285) (998)
Unrecognized net actuarial loss 4,566 3,486
Unrecognized prior service cost 152 162
Unrecognized net transition asset (410) (449)
-------- --------
PREPAID BENEFIT COST $ 2,023 $ 2,201
======== ========
39
2004 2003
- --------------------------------------------------------------------------------
COMPONENTS OF NET PENSION COST
Service cost $ 718 $ 571
Interest cost 938 840
Expected return on assets (1,183) (1,005)
Amortization of transition asset (39) (39)
Recognized loss 151 136
Prior service cost 10 10
------- -------
Net pension expense included in employee benefits $ 595 $ 513
======= =======
WEIGHTED AVERAGE ASSUMPTIONS
Discount rate for benefit obligations 6.15% 6.25%
Discount rate for net pension cost 6.25% 6.75%
Expected long-term return on assets 8.25% 8.25%
Rate of compensation increase 4.00% 4.00%
The accumulated benefit obligation was $13.5 and $11.7 million at December
31, 2004 and 2003, respectively.
The asset allocations for the defined benefit pension plan as of December
31, 2004 and 2003, by asset category, are as follows:
PERCENTAGE OF
PLAN ASSETS
2004 2003
- -------------------------------------------------------------------------------
ASSET CATEGORY
Equity securities 64% 60%
Debt securities 23% 32%
Cash and cash equivalents 13% 8%
--- ---
Total 100% 100%
=== ===
The investment objective for the defined benefit pension plan is to
maximize total return with tolerance for average risk. Asset allocation favors
equities, with a target allocation of approximately 55% equities securities, 40%
fixed income securities, and 5% cash. Due to volatility in the market, the
target allocation is not always desirable and asset allocations will fluctuate
between the acceptable ranges. A core equity position of large cap stocks will
be maintained. However, more aggressive or volatile sectors will be meaningfully
represented in the asset mix in pursuit of higher returns. Higher volatility
investment strategies such as credit risk, structured finance, and international
bonds will be appropriate strategies in conjunction with the core position.
It is management's intent to give the investment managers flexibility
within the overall guidelines with respect to investment decisions and their
timing. However, certain investments require specific review and approval by
management. Management is also informed of anticipated changes in nonproprietary
investment managers, significant modifications of any previously approved
investment, or anticipated use of derivatives to execute investment strategies.
The expected long-term rate of return on Plan assets has been established
by considering historical and future expected returns of the asset classes
invested in by the Plan trustees, and the allocation strategy currently in place
among those classes.
The following summarizes the number of Corporation shares and the fair
value of such shares included that are in Plan assets at December 31, 2004 and
2003, as well as dividends paid to the Plan for such years (dollars in
thousands):
2004 2003
- --------------------------------------------------------------------------------
Number of shares held 14,905 49,084
Number of shares purchased -- 504
Number of shares sold 34,179 503
Fair value $ 348 $ 1,196
Dividends paid $ 33 $ 34
Percentage of total plan assets 2.4% 9%
Estimated Cash Flows related to the Plan are as follows (in thousands):
Estimated future benefit payments:
2005 $487
2006 492
2007 522
2008 552
2009 653
2010-2014 5,289
------
$7,995
======
40
The Corporation estimates that it will contribute $.7 million to the plan
in 2005.
401(K) PROFIT SHARING PLAN
The First United Bank & Trust 401(k) Profit Sharing Plan ("the 401(k)
Plan") is a defined contribution plan that is intended to qualify under section
401(k) of the Internal Revenue Code. The 401(k) Plan covers substantially all
employees of the Corporation. Eligible employees can elect to contribute to the
plan through payroll deductions. Contributions up to 6% of an employee's base
salary are matched on a 50% basis by the Corporation. Expense charged to
operations for the 401(k) Plan was $.4, $.3, and $.2 million in 2004, 2003 and
2002, respectively.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
During 2001, the Corporation established an unfunded supplemental
executive retirement plan (SERP) to provide senior management personnel with
supplemental retirement benefits in excess of limits imposed on qualified plans
by federal tax law. Concurrent with the establishment of the SERP, the
Corporation acquired bank owned life insurance (BOLI) policies on the senior
management personnel and officers of the Corporation. The benefits resulting
from the favorable tax treatment accorded the earnings on the BOLI are intended
to provide a source of funds for the future payment of the SERP benefits as well
as other employee benefit costs. The SERP expense for 2004, 2003 and 2002 was
$.4, $.4 and $.2 million, respectively.
11. FEDERAL RESERVE REQUIREMENTS
The Bank is required to maintain cash reserves with the Federal Reserve
Bank of Richmond based principally on the type and amount of its deposits.
During 2004, the daily average amount of these required reserves was
approximately $11.0 million.
12. RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS OR ADVANCES
Federal and state banking regulations place certain restrictions on
dividends paid and loans or advances made by the Bank to the Corporation. The
total amount of dividends that may be paid at any date is generally limited to
the retained earnings of the Bank, and loans or advances are limited to 10
percent of the Bank's capital stock and surplus on a secured basis. In addition,
dividends paid by the Bank to the Corporation would be prohibited if the effect
thereof would cause the Bank's capital to be reduced below applicable minimum
capital requirements. At December 31, 2004, the Bank could have paid additional
dividends of $11.3 million to the Corporation without regulatory approval.
13. COMMITMENTS AND CONTINGENT LIABILITIES
The Corporation and its subsidiaries are at times, and in the ordinary
course of business, subject to legal actions. However, to the knowledge of
management, the Corporation is not currently subject to any such legal actions.
Loan and letter of credit commitments are discussed in Note 4.
Oakfirst Life Insurance Corporation, a wholly owned subsidiary of the
Corporation, had $9.0 million of life, accident and health insurance in force at
December 31, 2004. In accordance with state insurance laws, this subsidiary is
capitalized at $4.3 million.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
As required by SFAS No. 107, "Disclosures about Fair Value of Financial
Instruments," presented in the following table is fair value information about
financial instruments, whether or not recognized in the statement of financial
condition, for which it is practicable to estimate that value. Fair value is
best determined by values quoted through active trading markets. Active trading
markets are characterized by numerous transactions of similar financial
instruments between willing buyers and willing sellers. Because no active
trading market exists for various types of financial instruments, many of the
fair values disclosed were derived using present value discounted cash flow or
other valuation techniques. As a result, the Corporation's ability to actually
realize these derived values cannot be assumed.
The fair values disclosed under SFAS No. 107 may vary significantly
between institutions based on the estimates and assumptions used in the various
valuation methodologies. 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.
The actual carrying amounts and estimated fair values of the Corporation's
financial instruments that are included in the statement of financial condition
at December 31 are as follows (in thousands):
41
2004 2003
- --------------------------------------------------------------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
- --------------------------------------------------------------------------------
Financial Assets:
Cash and cash equivalents $ 24,159 $ 24,159 $ 20,272 $ 20,272
Interest-bearing deposits in
banks 1,855 1,855 1,474 1,474
Investment securities 210,661 10,661 223,615 223,615
Federal Home Loan Bank stock 9,525 9,525 8,660 8,660
Bank Owned Life Insurance 23,420 23,420 20,494 20,494
Loans 904,635 900,647 792,025 791,310
Accrued interest receivable 5,200 5,200 5,268 5,268
Financial Liabilities:
Deposits 850,661 790,555 750,161 753,753
Borrowed funds 285,647 286,292 263,575 268,337
Accrued interest payable 3,187 3,187 2,776 2,776
The following methods and assumptions were used by the Corporation in
estimating its fair value disclosures for financial instruments:
CASH AND CASH EQUIVALENTS: The carrying amounts as reported in the
statement of financial condition for cash and due from banks and federal funds
sold approximate their fair values.
INTEREST-BEARING DEPOSITS IN BANKS: The carrying amount of
interest-bearing deposits approximate their fair values.
INVESTMENT SECURITIES: Fair values of investment securities are based on
quoted market values.
FEDERAL HOME LOAN BANK STOCK: The carrying value of Federal Home Loan
stock approximates fair value based on the redemption provisions of the Federal
Home Loan Bank.
LOANS: For variable rate loans and leases that reprice frequently or "in
one year or less," and with no significant change in credit risk, fair values
are based on carrying values. Fair values for fixed rate loans and leases and
loans and leases that do not reprice frequently are estimated using a discounted
cash flow calculation that applies current interest rates being offered on the
various loan products.
BANK OWNED LIFE INSURANCE: The carrying amount of Bank Owned Life
Insurance approximates its fair value.
DEPOSITS: The fair values disclosed for demand deposits (e.g., interest
and non-interest checking, savings, and certain types of money market accounts)
are, by definition, equal to the amount payable on demand at the reporting date
(i.e., their carrying amounts). The carrying amounts for variable rate
certificates of deposit approximate their fair values at the reporting date.
Fair values for fixed rate certificates of deposit are estimated using a
discounted cash flow calculation that applies interest rates currently being
offered on the various certificates of deposit to the cash flow stream.
BORROWED FUNDS: The fair value of the Corporation's Federal Home Loan Bank
borrowings and junior subordinated debt is calculated based on the discounted
value of contractual cash flows, using rates currently existing for borrowings
with similar remaining maturities. The carrying amounts of federal funds
purchased and securities sold under agreements to repurchase approximate their
fair values.
ACCRUED INTEREST: The carrying amount of accrued interest receivable and
payable approximates their fair values.
OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS: In the normal course of business,
the Corporation makes commitments to extend credit and issues standby letters of
credit. The Corporation expects most of these commitments to expire without
being drawn upon, therefore the commitment amounts do not necessarily represent
future cash requirements. Due to the uncertainty of cash flows and difficulty in
the predicting the timing of such cash flows, fair values were not estimated for
these instruments. The Corporation does not have any derivative financial
instruments at December 31, 2004 or 2003.
42
15. PARENT COMPANY FINANCIAL INFORMATION (PARENT COMPANY ONLY)
Condensed Statements of Financial Condition (in thousands)
DECEMBER 31,
2004 2003
- --------------------------------------------------------------------------------
ASSETS
Cash $ 1,406 $ 966
Investment securities 1,268 1,537
Investment in bank subsidiary 106,052 94,735
Other assets 5,583 4,753
Investment in non-bank subsidiaries 9,851 7,854
-------- --------
Total Assets $124,160 $109,845
======== ========
LIABILITIES AND SHAREHOLDER'S EQUITY
Accrued interest and other liabilities $ 1,082 $ 850
Dividends payable 1,127 1,093
Junior subordinated debt 35,929 23,711
Shareholders' equity 86,022 84,191
-------- --------
Total Liabilities and Shareholder's Equity $124,160 $109,845
======== ========
Condensed Statements of Income (in thousands)
YEAR ENDED DECEMBER 31,
2004 2003 2002
- -----------------------------------------------------------------------------------------
INCOME:
Dividend income from bank subsidiary $ 8,718 $ 6,786 $ 6,670
Other income 422 84 86
------- ------- -------
Total income $ 9,140 6,870 6,756
EXPENSES:
Interest expense 2,927 2,192 2,192
Other expenses 942 127 4
------- ------- -------
Total expenses 3,869 2,319 2,196
------- ------- -------
Income before income taxes and equity in undistributed
net income of subsidiaries 5,271 4,551 4,560
Income tax benefit 1,205 795 741
Equity in undistributed net income (loss) of subsidiaries:
Bank 1,080 5,118 4,243
Non-bank 71 285 111
------- ------- -------
NET INCOME $ 7,627 $10,749 $ 9,655
======= ======= =======
43
Condensed Statements of Cash Flows (in thousands)
YEAR ENDED DECEMBER 31,
2004 2003 2002
- ---------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 7,627 $ 10,749 $ 9,655
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed net income of subsidiaries (1,151) (5,403) (4,354)
Increase in other assets (830) (1,615) (678)
Decrease (increase) in accrued interest and other
liabilities 232 822 (16)
Increase in dividends payable 34 31 43
-------- -------- --------
Net cash provided by operating activities 5,912 4,584 4,650
INVESTING ACTIVITIES
Proceeds from investment maturities 269 -- 246
Net investment in subsidiaries (1,401) (636) (732)
Capital transfer to Bank (12,000) -- --
-------- -------- --------
Net cash used in investing activities (13,132) (636) (486)
FINANCING ACTIVITIES
Cash dividends (4,433) (4,262) (4,166)
Proceeds from issuance of common stock (125) 125 --
Proceeds from issuance of long term debt 12,218 -- --
-------- -------- --------
Net cash provided by (used in) financing activities 7,660 (4,137) (4,166)
(Decrease) increase in cash and cash equivalents 440 (189) (2)
Cash and cash equivalents at beginning of year 966 1,155 1,157
-------- -------- --------
Cash and cash equivalents at end of year $ 1,406 $ 966 $ 1,155
======== ======== ========
16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the quarterly results of operations for the
years ended December 31, 2004 and 2003 (in thousands):
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
- -------------------------------------------------------------------------------
2004
Interest income $14,601 $14,853 $15,160 $16,067
Interest expense 5,493 5,856 6,348 6,319
------- ------- ------- -------
Net interest income 9,108 8,997 8,812 9,748
Provision for possible loan losses 45 739 851 899
Other income 2,767 2,977 2,800 3,724
Gains (losses) on securities 674 27 2 --
Other expenses 8,396 8,233 8,185 8,426
Expenses related to early redemption of
long-term borrowings -- -- 910 1,818
------- ------- ------- -------
Income before income taxes 4,108 3,029 1,668 2,329
Applicable income taxes 1,396 1,032 573 506
------- ------- ------- -------
Net income $ 2,712 $ 1,997 $ 1,095 $ 1,823
======= ======= ======= =======
Earnings per share $ .45 $ .33 $ .18 $ .29
======= ======= ======= =======
44
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
- -------------------------------------------------------------------------------
2003
Interest income $ 14,240 $ 14,471 $ 14,534 $ 14,458
Interest expense 6,146 5,850 5,919 5,686
-------- -------- -------- --------
Net interest income 8,094 8,621 8,615 8,772
Provision for possible loan losses 656 (317) 357 137
Other income 3,071 2,509 2,786 3,501
Other expenses 7,110 6,801 7,992 7,918
-------- -------- -------- --------
Income before income taxes 3,399 4,646 3,052 4,218
Applicable income taxes 947 1,325 872 1,422
-------- -------- -------- --------
Net income $ 2,452 $ 3,321 $ 2,180 $ 2,796
======== ======== ======== ========
Earnings per share $ .40 $ .54 $ .36 $ .46
======== ======== ======== ========
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Corporation maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in the
Corporation's reports filed under the Securities Exchange Act of 1934 with the
SEC, such as this annual report, is recorded, processed, summarized and reported
within the time periods specified in those rules and forms, and that such
information is accumulated and communicated to the Corporation's management,
including the Chief Executive Officer ("CEO") and the Chief Financial Officer
("CFO"), as appropriate, to allow for timely decisions regarding required
disclosure. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any system of
controls also is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions; over time,
control may become inadequate because of changes in conditions, or the degree of
compliance with the policies or procedures may deteriorate.
An evaluation of the effectiveness of these disclosure controls as of
December 31, 2004 was carried out under the supervision and with the
participation of the Corporation's management, including the CEO and the CFO.
Based on that evaluation, the Corporation's management, including the CEO and
the CFO, has concluded that the Corporation's disclosure controls and procedures
are effective.
During the fourth quarter of 2004, there was no change in the
Corporation's internal control over financial reporting that has materially
affected, or is reasonably likely to materially affect, the Corporation's
internal control over financial reporting.
As required by Section 404 of the Sarbanes-Oxley Act of 2002, management
has performed an evaluation and testing of the Corporation's internal control
over financial reporting as of December 31, 2004. Management's report on the
Corporation's internal control over financial reporting, and the related
attestation report of the registered public accounting firm, are included on the
following pages.
45
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The Board of Directors and Shareholders
First United Corporation
The Corporation's management is responsible for establishing and
maintaining adequate internal control over financial reporting. This internal
control system was designed to provide reasonable assurance to management and
the Board of Directors as to the reliability of the Corporation's financial
reporting and the preparation and presentation of financial statements for
external purposes in accordance with accounting principles generally accepted in
the United States, as well as to safeguard assets from unauthorized use or
disposition.
An internal control system, no matter how well designed, has inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation and may not prevent or detect misstatements in the
financial statements or the unauthorized use or disposition of the Corporation's
assets. Also, projections of any evaluation of effectiveness of internal
controls to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with policies and procedures may deteriorate.
Management assessed the effectiveness of the Corporation's internal
control over financial reporting as of December 31, 2004, based on the criteria
set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) in Internal Control--Integrated Framework. Based on this
assessment and on the foregoing criteria, management has concluded that, as of
December 31, 2004, the Corporation's internal control over financial reporting
is effective.
Ernst & Young LLP, an independent registered public accounting firm, has
audited the Consolidated Financial Statements of the Corporation for the three
years ended December 31, 2004, appearing elsewhere in this annual report, and
has issued an attestation report on management's assessment of the effectiveness
of the Corporation's internal control over financial reporting as of December
31, 2004, as stated in their report, which is included herein.
/s/ William B. Grant /s/ Robert W. Kurtz
- -------------------------- ----------------------------
William B. Grant Robert W. Kurtz
Chairman of the Board and, President and,
Chief Executive Officer Chief Financial Officer
46
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders
First United Corporation
We have audited the management's assessment, included in the accompanying
Management's Report on Internal Control Over Financial Reporting, that First
United Corporation maintained effective internal control over financial
reporting as of December 31, 2004, based on criteria established in Internal
Control--Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). First United
Corporation's management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting. Our responsibility is to express an
opinion on management's assessment and an opinion on the effectiveness of the
company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating management's assessment, testing
and evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we considered necessary in the
circumstances. We believe that our audit provides a reasonable basis for our
opinion.
A company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company assets
that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies of procedures may deteriorate.
In our opinion, management's assessment that First United Corporation
maintained effective internal control over financial reporting as of December
31, 2004, is fairly stated, in all material respects, based on the COSO
criteria. Also, in our opinion, First United Corporation maintained, in all
material respects, effective internal control over financial reporting as of
December 31, 2004, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated statements
of financial condition of First United Corporation as of December 31, 2004 and
2003, and 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, 2004, of First United Corporation and our report dated March
7, 2005, expressed an unqualified opinion thereon.
[ERNEST & YOUNG LLP LOGO]
Pittsburgh, Pennsylvania
March 7, 2005
47
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
For a listing of the Corporation's executive officers, see Executive
Officers in the annual Proxy Statement.
The Corporation has adopted a Code of Ethics applicable to its principal
executive officer, principal financial officer, principal accounting officer, or
controller, or persons performing similar functions, a Code of Ethics applicable
to all employees, and a Code of Ethics applicable to members of the Board of
Directors. Copies of the Corporation's Codes of Ethics are available free of
charge upon request to Mr. Robert W. Kurtz, Secretary, First United Corporation,
c/o First United Bank & Trust, P.O. Box 9, Oakland, MD 21550-0009.
All other information required by this item is incorporated by reference
herein to the Corporation's definitive Proxy Statement for the 2005 Annual
Stockholders Meeting to be filed with the SEC in March of 2005 pursuant to
Regulation 14A.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference herein
to the Corporation's definitive Proxy Statement for the 2005 Annual Stockholders
Meeting to be filed with the SEC in March of 2005 pursuant to Regulation 14A.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated by reference herein
to the Corporation's definitive Proxy Statement for the 2005 Annual Stockholders
Meeting to be filed with the SEC in March of 2005 pursuant to Regulation 14A.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference herein
to the Corporation's definitive Proxy Statement for the 2005 Annual Stockholders
Meeting to be filed with the SEC in March of 2005 pursuant to Regulation 14A.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is incorporated by reference herein
to the Corporation's definitive Proxy Statement for the 2005 Annual Stockholders
Meeting to be filed with the SEC in March of 2005 pursuant to Regulation 14A.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) (1), (2) Financial Statements.
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Financial Condition as of December 31, 2004 and
2003
Consolidated Statements of Income for the years ended December 31, 2004,
2003 and 2002
Consolidated Statements of Changes in Shareholders' Equity for the years
ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the years ended December 31,
2004, 2003 and 2002
Notes to Consolidated Financial Statements for the years ended December
31, 2004, 2003 and 2002
(a) (3) Exhibits
The exhibits filed with this annual report on Form 10-K are listed in
the Exhibit Index that follows the signatures.
48
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
First United Corporation
By: /s/ William B. Grant
-----------------------------
William B. Grant
Chairman of the Board
and Chief Executive Officer
March 14, 2005
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated.
/s/ William B. Grant
- ---------------------------------------------
(William B. Grant) Director, Chief Executive Officer
March 14, 2005
/s/ David J. Beachy
- ---------------------------------------------
(David J. Beachy) Director--March 14, 2005
/s/ Rex W. Burton
- ---------------------------------------------
(Rex W. Burton) Director--March 14, 2005
/s/ Faye E. Cannon
- ---------------------------------------------
(Faye E. Cannon) Director--March 14, 2005
/s/ Paul Cox, Jr.
- ---------------------------------------------
(Paul Cox, Jr.) Director--March 14, 2005
/s/ Raymond F. Hinkle
- ---------------------------------------------
(Raymond F. Hinkle) Director--March 14, 2005
/s/ Robert W. Kurtz
- ---------------------------------------------
(Robert W. Kurtz) Director, President and Chief
Financial Officer--March 14, 2005
/s/ John W. McCullough
- ---------------------------------------------
(John W. McCullough) Director--March 14, 2005
/s/ Elaine L. McDonald
- ---------------------------------------------
(Elaine L. McDonald) Director--March 14, 2005
/s/ Donald E. Moran
- ---------------------------------------------
(Donald E. Moran) Director--March 14, 2005
/s/ Karen F. Myers
- ---------------------------------------------
(Karen F. Myers) Director--March 14, 2005
/s/ Gary R. Ruddell
- ---------------------------------------------
(Gary R. Ruddell) Director--March 14, 2005
/s/ I. Robert Rudy
- ---------------------------------------------
(I. Robert Rudy) Director--March 14, 2005
/s/ Richard G. Stanton
- ---------------------------------------------
(Richard G. Stanton) Director--March 14, 2005
/s/ Robert G. Stuck
- ---------------------------------------------
(Robert G. Stuck) Director--March 14, 2005
49
EXHIBIT INDEX
EXHIBIT DESCRIPTION
3.1 Amended and Restated Articles of Incorporation (incorporated by
reference to Exhibit 3.1 of the Corporation's Quarterly Report on
Form 10-Q for the period ended June 30, 1998).
3.2 Amended and Restated By-Laws (incorporated by reference to Exhibit
3(ii) of the Corporation's Annual Report on Form 10-K for the year
ended December 31, 1997).
10.1 First United Bank & Trust Supplemental Executive Retirement Plan
("SERP") (incorporated by reference to Exhibit 10.1 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003).
10.2 Form of SERP Participation Agreement between the Bank and each of
William B. Grant, Robert W. Kurtz, Jeannette R. Fitzwater, Phillip
D. Frantz, Eugene D. Helbig, Jr., Steven M. Lantz, Robin M. Murray,
Frederick A. Thayer, IV (incorporated by reference to Exhibit 10.2
of the Corporation's Quarterly Report on Form 10-Q for the period
ended June 30, 2003).
10.3 Endorsement Split Dollar Agreement between the Bank and William B.
Grant (incorporated by reference to Exhibit 10.3 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003).
10.4 Endorsement Split Dollar Agreement between the Bank and Robert W.
Kurtz (incorporated by reference to Exhibit 10.4 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003.
10.5 Endorsement Split Dollar Agreement between the Bank and Jeannette R.
Fitzwater (incorporated by reference to Exhibit 10.5 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003).
10.6 Endorsement Split Dollar Agreement between the Bank and Phillip D.
Frantz (incorporated by reference to Exhibit 10.6 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003).
10.7 Endorsement Split Dollar Agreement between the Bank and Eugene D.
Helbig, Jr. (incorporated by reference to Exhibit 10.7 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003).
10.8 Endorsement Split Dollar Agreement between the Bank and Steven M.
Lantz (incorporated by reference to Exhibit 10.8 of the
Corporation's Quarterly Report on Form 10-Q for the period June 30,
2003).
10.9 Endorsement Split Dollar Agreement between the Bank and Robin M.
Murray (incorporated by reference to Exhibit 10.9 of the
Corporation's Quarterly Report on Form 10-Q for the period June 30,
2003).
10.10 Endorsement Split Dollar Agreement between the Bank and Frederick A.
Thayer, IV (incorporated by reference to Exhibit 10.10 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003).
10.11 First United Corporation Executive and Director Deferred
Compensation Plan (incorporated by reference to Exhibit 10.11 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
September 30, 2003).
21 Subsidiaries of the Corporation, incorporated by reference to page 3
of this Annual Report on Form 10-K.
23.1 Consent of Ernst & Young LLP (filed herewith)
31.1 Certifications of the CEO pursuant to Section 302 of the
Sarbanes-Oxley Act (filed herewith)
31.2 Certifications of the CFO pursuant to Section 302 of the
Sarbanes-Oxley Act (filed herewith)
32.1 Certification of the CEO pursuant to 18 U.S.C. ss. 1350 (furnished
herewith)
32.2 Certification of the CFO pursuant to 18 U.S.C. ss. 1350 (furnished
herewith)
99.1 Risk Factors (filed herewith)