UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
DC 20549
_______________________
FORM
10-K
|
x
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
|
For
the fiscal year ended December
31, 2006
|
OR
|
o
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
|
|
For
the transition period from _____________ to
_____________
|
Commission
file number 0-14237
FIRST
UNITED CORPORATION
(Exact
name of registrant as specified in its charter)
|
Maryland
|
52-1380770
|
|
|
(State
or other jurisdiction of incorporation or
organization)
|
(I.R.S.
Employer Identification Number)
|
|
|
19
South Second Street, Oakland, Maryland
|
21550-0009
|
|
|
(Address
of principal executive offices)
|
(Zip
Code)
|
Registrant’s
telephone number, including area code: (800)
470-4356
Securities
registered pursuant to Section 12(b) of the Act:
|
Title
of Each Class:
|
Name
of Each Exchange on Which Registered:
|
|
|
Common
Stock, par value $.01 per share
|
Nasdaq
Stock Market
|
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. Yes o
No x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act. Yes o No x
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or such shorter period that the registrant was required
to
file such reports), and (2) has been subject to such filing requirements for
the
past 90 days. Yes x
No o
Indicate
by check mark if disclosures of delinquent filers pursuant to Item 405 of
Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of the registrant’s knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. o
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. (See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act). (check
one):
Large
accelerated filer o
Accelerated filer x
Non-accelerated filer o
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).Yes o No x
The
aggregate market value of the registrant’s outstanding voting and non-voting
common equity held by non-affiliates as of June 30, 2006:
$
126,572,358.
The
number of shares of the registrant’s common stock outstanding as of February 28,
2007: 6,146,443
Documents
Incorporated by Reference
Portions
of the registrant’s definitive proxy statement for the 2007 Annual Meeting of
Shareholders to be filed with the SEC in March 2007 pursuant to Regulation
14A
are incorporated by reference into Part III of this Annual Report on Form
10-K.
First
United Corporation
Table
of Contents
|
ITEM
1.
|
Business
|
3
|
|
ITEM
1A.
|
Risk
Factors
|
10
|
|
ITEM
1B.
|
Unresolved
Staff Comments
|
14
|
|
ITEM
2.
|
Properties
|
14
|
|
ITEM
3.
|
Legal
Proceedings
|
15
|
|
ITEM
4.
|
Submission
of Matters to a Vote of Security Holders
|
15
|
|
PART
II
|
||
|
ITEM
5.
|
Market
for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
|
16
|
|
ITEM
6.
|
Selected
Financial Data
|
17
|
|
ITEM
7.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
18
|
|
ITEM
7A.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
38
|
|
ITEM
8.
|
Financial
Statements and Supplementary Data
|
39
|
|
ITEM
9.
|
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
|
67
|
|
ITEM
9A.
|
Controls
and Procedures
|
67
|
|
ITEM
9B.
|
Other
Information
|
70
|
|
PART
III
|
||
|
ITEM
10.
|
Directors,
Executive Officers and Corporate Governance
|
70
|
|
ITEM
11.
|
Executive
Compensation
|
70
|
|
ITEM
12.
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
|
70
|
|
ITEM
13.
|
Certain
Relationships and Related Transactions, and Director
Independence
|
70
|
|
ITEM
14.
|
Principal
Accountant Fees and Services
|
70
|
|
PART
IV
|
||
|
ITEM
15.
|
Exhibits
and Financial Statement Schedules
|
70
|
|
SIGNATURES
|
||
|
EXHIBITS
|
[2]
Forward-Looking
Statements
This
Annual Report of First United Corporation (the “Corporation” on a parent only
basis and “we”, “our” or “us”, on a consolidated basis) filed on Form 10-K may
contain forward-looking statements within the meaning of The Private Securities
Litigation Reform Act of 1995. Readers of this report should be aware of the
speculative nature of “forward-looking statements.” Statements that are not
historical in nature, including those that include the words “anticipate,”
“estimate,” “should,” “expect,” “believe,” “intend,” and similar expressions,
are based on current expectations, estimates and projections about, among other
things, the industry and the markets in which the Corporation operates, and
they
are not guarantees of future performance. Whether actual results will conform
to
expectations and predictions is subject to known and unknown risks and
uncertainties, including risks and uncertainties discussed in this report;
general economic, market, or business conditions; changes in interest rates,
deposit flow, the cost of funds, and demand for loan products and financial
services; changes in the Corporation’s competitive position or competitive
actions by other companies; changes in the quality or composition of loan and
investment portfolios; the ability to manage growth; changes in laws or
regulations or policies of federal and state regulators and agencies; and other
circumstances beyond the Corporation’s control. Consequently, all of the
forward-looking statements made in this document are qualified by these
cautionary statements, and there can be no assurance that the actual results
anticipated will be realized, or if substantially realized, will have the
expected consequences on the Corporation’s business or operations. For a more
complete discussion of these and other risk factors, see Item 1A of Part I
of
this report. Except as required by applicable laws, the Corporation does not
intend to publish updates or revisions of forward-looking statements it makes
to
reflect new information, future events or otherwise.
General
The
Corporation is a Maryland corporation chartered in 1985 and a financial holding
company registered under the federal Bank Holding Company Act of 1956, as
amended (the “BHC Act”). The Corporation’s primary business is serving as the
parent company of First United Bank & Trust, a Maryland trust company (the
“Bank”), First United Insurance Group, LLC, a Maryland insurance agency (the
“Insurance Group”), OakFirst Loan Center, Inc., a West Virginia finance company,
and OakFirst Loan Center, LLC, a Maryland finance company, (together with
OakFirst Loan Center, Inc. the “OakFirst Loan Centers”). OakFirst Loan Center,
Inc. has one subsidiary, First United Insurance Agency, Inc., which is a
Maryland insurance agency.
On
March
31, 2006, the Bank liquidated its subsidiary First United Investment Trust.
This
entity was a Maryland real estate investment trust that held and serviced
mortgage loans. Its assets were transferred to First United Bank &
Trust.
At
December 31, 2006, the Corporation had assets of approximately $1.349 billion,
net loans of approximately $957 million, and deposits of approximately $971
million. Shareholders’ equity at December 31, 2006 was approximately $97
million.
The
Corporation maintains an Internet site at www.mybankfirstunited.com on which
it
makes available, free of charge, its Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the
foregoing as soon as reasonably practicable after these reports are
electronically filed with, or furnished to, the Securities and Exchange
Commission (the “SEC”).
Banking
Products and Services
The
Bank
operates 25 banking offices, one call center and 34 Automated Teller Machines
(“ATM’s”) in the following Maryland Counties: Garrett, Allegany, Washington and
Frederick; and in the following West Virginia Counties: Mineral, Berkeley,
Hardy
and Monongalia. The Bank is an independent community bank providing a complete
range of retail and commercial banking services to businesses and individuals
in
its market areas. Services offered are essentially the same as those offered by
the regional institutions that compete with the Bank and include checking,
savings, and money market deposit accounts, business loans, personal loans,
mortgage loans, lines of credit, and consumer-oriented financial services
including IRA and employee benefit accounts. In addition, the Bank provides
full
brokerage services through a networking arrangement with PrimeVest Financial
Services, Inc., a full service broker-dealer. The Bank also provides safe
deposit and night depository facilities, and a complete line of insurance
products and trust services. The Bank’s deposits are insured by the Federal
Deposit Insurance Corporation (the “FDIC”).
[3]
Lending
Activities--The
majority of the Corporation’s lending activities are conducted through the
Bank.
The
Bank’s commercial loans are primarily secured by real estate, commercial
equipment, vehicles or other assets of the borrower. Repayment is often
dependent on the successful operation of the borrower and may be affected by
adverse conditions in the local economy or real estate market. The financial
condition and cash flow of commercial borrowers is therefore carefully analyzed
during the loan approval process, and continues to be monitored by obtaining
business financial statements, personal financial statements and income tax
returns. The frequency of this ongoing analysis depends upon the size and
complexity of the credit and collateral that secures the loan. It is also the
Bank’s general policy to obtain personal guarantees from the principals of the
commercial loan borrowers.
Commercial
real estate loans are primarily those secured by land for residential and
commercial development, agricultural purpose properties, service industry
buildings such as restaurants and motels, retail buildings and general purpose
business space. The Bank attempts to mitigate the risks associated with these
loans through low loan to value ratio standards, thorough financial analyses,
and management’s knowledge of the local economy in which the Bank
lends.
The
risk
of loss associated with commercial real estate construction lending is
controlled through conservative underwriting procedures such as loan to value
ratios of 80% or less, obtaining additional collateral when prudent, and closely
monitoring construction projects to control disbursement of funds on
loans.
The
Bank’s residential mortgage portfolio is evenly distributed between variable and
fixed rate loans. Many loans are booked at fixed rates in order to meet the
Bank’s requirements under the Community Reinvestment Act. Other fixed rate
residential mortgage loans are originated in a brokering capacity on behalf
of
other financial institutions, for which the Bank receives a fee. As with any
consumer loan, repayment is dependent on the borrower’s continuing financial
stability, which can be adversely impacted by job loss, divorce, illness, or
personal bankruptcy. Residential mortgage loans exceeding an internal
loan-to-value ratio require private
mortgage insurance. Title insurance protecting the Bank’s lien priority, as well
as fire and casualty insurance, is also required.
Home
equity lines of credit, included within the residential mortgage portfolio,
are
secured by the borrower’s home and can be drawn on at the discretion of the
borrower. These lines of credit are at variable interest rates.
The
Bank
also provides residential real estate construction loans to builders and
individuals for single family dwellings. Residential construction loans are
usually granted based upon “as completed” appraisals and are secured by the
property under construction. Site inspections are performed to determine
pre-specified stages of completion before loan proceeds are disbursed. These
loans typically have maturities of six to 12 months and may have a fixed or
variable rate. Permanent financing for individuals offered by the Bank includes
fixed and variable rate loans with three, five or seven year adjustable rate
mortgages.
A
variety
of other consumer loans are also offered to customers, including indirect and
direct auto loans, and other secured and unsecured lines of credit and term
loans. Careful analysis of an applicant’s creditworthiness is performed before
granting credit, and on-going monitoring of loans outstanding is performed
in an
effort to minimize risk of loss by identifying problem loans early.
An
allowance for loan losses is maintained to provide for anticipated losses from
the Corporation’s lending activities. A complete discussion of the factors
considered in determination of the allowance for loan losses is included in
Item
7 of Part II of this report.
Additionally,
the Corporation meets the lending needs of under-served customer groups within
its market areas in part through OakFirst Loan Center, Inc., located in
Martinsburg, West Virginia, and OakFirst Loan Center, LLC, located in
Hagerstown, Maryland.
Deposit
Activities—The
Bank
offers a full array of deposit products including checking, savings and money
market accounts, regular and IRA certificates of deposit, Christmas Savings
accounts, College Savings accounts, and Health Savings accounts. The Bank also
offers the CDARS program to municipalities, providing them up to $20 million
of
FDIC insurance. In addition, we offer our commercial customers packages which
include Treasury Management, Cash Sweep and various checking opportunities.
[4]
Trust
Services--The
Bank’s Trust Department offers a full range of trust services, including
personal trust, investment agency accounts, charitable trusts, retirement
accounts including IRA roll-overs, 401(k) accounts and defined benefit plans,
estate administration and estate planning.
Information
about the Corporation’s income from and assets related to its banking business
may be found in the consolidated statements of financial condition and the
consolidated statements of income and the related notes thereto included in
Item
8 of Part II of this annual report. At December 31, 2006, 2005 and 2004, the
total market value of assets under the supervision of the Bank’s Trust
Department was approximately $502 million, $468 million and $395 million,
respectively. Trust Department revenues for these years may be found in Item
7
of Part II of this annual report under the caption “Other Operating
Income”.
Insurance
Activities
The
Corporation offers a full range of insurance products and services to customers
in its market areas through the Insurance Group and First United Insurance
Agency, Inc. Information about income from insurance activities for each of
the
years ended December 31, 2006, 2005 and 2004 may be found in Item 7 of Part
II
of this annual report under the caption “Other Operating Income”.
COMPETITION
The
banking business, in all of its phases, is highly competitive. Within their
market areas, the Corporation and its affiliates compete with commercial banks,
(including local banks and branches or affiliates of other larger banks),
savings and loan associations and credit unions for loans and deposits, with
consumer finance companies for loans, with insurance companies and their agents
for insurance products, and with other financial institutions for various types
of products and services. There is also competition for commercial and retail
banking business from banks and financial institutions located outside our
market areas.
The
primary factors in competing for deposits are interest rates, personalized
services, the quality and range of financial services, convenience of office
locations and office hours. The primary factors in competing for loans are
interest rates, loan origination fees, the quality and range of lending services
and personalized services.
To
compete with other financial services providers, the Corporation relies
principally upon local promotional activities, personal relationships
established by officers, directors and employees with its customers, and
specialized services tailored to meet its customers’ needs. In those instances
in which the Corporation is unable to accommodate a customer’s needs, it will
arrange for those services to be provided by other financial services providers
with which it has a relationship.
The
following table sets forth deposit data for the Maryland and West Virginia
Counties in which the Bank maintains offices as of June 30, 2006, the most
recent date for which comparative information is available.
|
Offices
(in
Market)
|
Deposits
(in thousands)
|
Market
Share
|
||||||||
|
Allegany
County, Maryland:
|
||||||||||
|
Susquehanna
Bank
|
6
|
$
|
222,029
|
35.45
|
%
|
|||||
|
Manufacturers
& Traders Trust Company
|
7
|
192,726
|
30.77
|
%
|
||||||
|
First
United Bank & Trust
|
5
|
121,513
|
19.40
|
%
|
||||||
|
Farmers
& Mechanics Bank
|
3
|
59,648
|
9.52
|
%
|
||||||
|
Standard
Bank
|
2
|
30,459
|
4.86
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
[5]
|
Frederick
County, Maryland:
|
||||||||||
|
Farmers
& Mechanics Bank
|
19
|
1,114,657
|
35.61
|
%
|
||||||
|
Branch
Banking & Trust Co.
|
12
|
601,109
|
19.20
|
%
|
||||||
|
Bank
of America NA
|
6
|
272,390
|
8.70
|
%
|
||||||
|
Frederick
County Bank
|
2
|
208,974
|
6.68
|
%
|
||||||
|
Manufacturers
& Traders Trust Company
|
6
|
201,845
|
6.45
|
%
|
||||||
|
Woodsboro
Bank
|
7
|
147,839
|
4.72
|
%
|
||||||
|
Chevy
Chase Bank FSB
|
5
|
133,307
|
4.26
|
%
|
||||||
|
SunTrust
Bank
|
3
|
130,576
|
4.17
|
%
|
||||||
|
Middletown
Valley Bank
|
4
|
115,093
|
3.68
|
%
|
||||||
|
First
United Bank & Trust
|
3
|
92,477
|
2.95
|
%
|
||||||
|
Sandy
Spring Bank
|
4
|
54,046
|
1.73
|
%
|
||||||
|
Provident
Bank of Maryland
|
2
|
32,394
|
1.03
|
%
|
||||||
|
Damascus
Community Bank
|
2
|
15,584
|
0.50
|
%
|
||||||
|
Sovereign
Bank
|
2
|
8,476
|
0.27
|
%
|
||||||
|
Columbia
Bank
|
1
|
1,577
|
0.05
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
|
Garrett
County, Maryland:
|
||||||||||
|
First
United Bank & Trust
|
5
|
454,671
|
69.90
|
%
|
||||||
|
Manufacturers
& Traders Trust Co.
|
5
|
112,330
|
17.27
|
%
|
||||||
|
Susquehanna
Bank
|
2
|
59,749
|
9.19
|
%
|
||||||
|
Clear
Mountain Bank
|
1
|
19,600
|
3.01
|
%
|
||||||
|
Miners
& Merchants Bank
|
1
|
4,069
|
0.63
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
|
Washington
County, Maryland:
|
||||||||||
|
Susquehanna
Bank
|
10
|
508,014
|
27.99
|
%
|
||||||
|
Hagerstown
Trust Co.
|
11
|
397,816
|
21.92
|
%
|
||||||
|
Manufacturers
& Traders Trust Company
|
12
|
397,183
|
21.89
|
%
|
||||||
|
Farmers
& Mechanics Bank
|
6
|
177,852
|
9.80
|
%
|
||||||
|
Sovereign
Bank
|
4
|
172,991
|
9.53
|
%
|
||||||
|
First
United Bank & Trust
|
2
|
56,927
|
3.14
|
%
|
||||||
|
First
National Bank of McConnellsburg
|
1
|
29,852
|
1.65
|
%
|
||||||
|
Chevy
Chase Bank FSB
|
1
|
26,652
|
1.47
|
%
|
||||||
|
Citizens
National Bank of Berkeley Springs
|
1
|
21,399
|
1.18
|
%
|
||||||
|
First
National Bank of Greencastle
|
2
|
16,700
|
0.92
|
%
|
||||||
|
Orrstown
Bank
|
1
|
9,292
|
0.51
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
|
Berkeley
County, West Virginia:
|
||||||||||
|
Branch
Banking & Trust Co.
|
5
|
325,183
|
32.85
|
%
|
||||||
|
Centra
Bank Inc.
|
3
|
166,957
|
16.87
|
%
|
||||||
|
First
United Bank & Trust
|
5
|
123,377
|
12.46
|
%
|
||||||
|
Susquehanna
Bank
|
4
|
112,714
|
11.39
|
%
|
||||||
|
City
National Bank of West Virginia
|
4
|
107,829
|
10.89
|
%
|
||||||
|
Jefferson
Security Bank
|
2
|
61,155
|
6.18
|
%
|
||||||
|
Citizens
National Bank of Berkeley Springs
|
3
|
55,615
|
5.62
|
%
|
||||||
|
Bank
of Charles Town
|
2
|
33,204
|
3.35
|
%
|
||||||
|
Shenandoah
Valley National Bank
|
1
|
3,780
|
0.38
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
[6]
|
Hardy
County, West Virginia:
|
||||||||||
|
Summit
Community Bank, Inc.
|
2
|
212,963
|
60.44
|
%
|
||||||
|
Capon
Valley Bank
|
3
|
99,037
|
28.11
|
%
|
||||||
|
Pendleton
Community Bank, Inc.
|
1
|
18,317
|
5.20
|
%
|
||||||
|
First
United Bank & Trust
|
1
|
14,277
|
4.05
|
%
|
||||||
|
Grant
County Bank
|
1
|
7,776
|
2.21
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
|
Mineral
County, West Virginia:
|
||||||||||
|
Branch
Banking & Trust Co.
|
2
|
75,612
|
32.06
|
%
|
||||||
|
First
United Bank & Trust
|
2
|
74,392
|
31.54
|
%
|
||||||
|
Manufacturers
& Traders Trust Co.
|
2
|
56,523
|
23.96
|
%
|
||||||
|
Grant
County Bank
|
1
|
29,344
|
12.44
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
|
Monongalia
County, West Virginia:
|
||||||||||
|
Centra
Bank, Inc.
|
4
|
369,432
|
25.92
|
%
|
||||||
|
Huntington
National Bank
|
6
|
361,466
|
25.36
|
%
|
||||||
|
Branch
Banking & Trust Co.
|
5
|
321,455
|
22.55
|
%
|
||||||
|
United
Bank
|
4
|
169,220
|
11.87
|
%
|
||||||
|
Wesbanco
Bank, Inc.
|
5
|
94,026
|
6.60
|
%
|
||||||
|
Clear
Mountain Bank
|
4
|
58,690
|
4.12
|
%
|
||||||
|
Citizens
Bank of Morgantown, Inc.
|
1
|
21,747
|
1.53
|
%
|
||||||
|
First
Exchange Bank
|
2
|
15,429
|
1.08
|
%
|
||||||
|
First
United Bank & Trust
|
2
|
13,824
|
0.97
|
%
|
||||||
Source:
FDIC Deposit Market Share Report
For
further information about competition in our market areas, see the Risk Factor
entitled “We
operate in a competitive environment”
in
Item
1A of Part I of this annual report.
SUPERVISION
AND REGULATION
The
following is a summary of the material regulations and policies applicable
to
the Corporation and its subsidiaries and is not intended to be a comprehensive
discussion. Changes in applicable laws and regulations may have a material
effect on our business.
General
The
Corporation is a financial holding company registered with the Board of
Governors of the Federal Reserve System (the “FRB”) under the BHC Act and, as
such, is subject to the supervision, examination and reporting requirements
of
the BHC Act and the regulations of the FRB.
The
Bank
is a Maryland trust company subject to the banking laws of Maryland and to
regulation by the Commissioner of Financial Regulation of Maryland, who is
required by statute to make at least one examination in each calendar year
(or
at 18-month intervals if the Commissioner determines that an examination is
unnecessary in a particular calendar year). The Bank also has offices in West
Virginia, and the operations of these offices are subject to West Virginia
laws
and to supervision and examination by the West Virginia Division of Banking.
As
a member of the FDIC, the Bank is also subject to certain provisions of federal
law and regulations regarding deposit insurance and activities of insured
state-chartered banks, including those that require examination by the FDIC.
In
addition to the foregoing, there are myriad other federal and state laws and
regulations that affect, impact or govern the business of banking, including
consumer lending, deposit-taking, and trust operations.
[7]
All
non-bank subsidiaries of the Corporation are subject to examination by the
FRB,
and, as affiliates of the Bank, are subject to examination by the FDIC and
the
Commissioner of Financial Regulation of Maryland. In addition, OakFirst Loan
Center, Inc. is subject to licensing and regulation by the West Virginia
Division of Banking, OakFirst Loan Center, LLC is subject to licensing and
regulation by the Commissioner of Financial Regulation of Maryland, and the
Insurance Group and First United Insurance Agency, Inc. are each subject to
licensing and regulation by various state insurance authorities. Retail sales
of
insurance products by these insurance affiliates are also subject to the
requirements of the Interagency Statement on Retail Sales of Nondeposit
Investment Products promulgated in 1994 by the FDIC, the FRB, the Office of
the
Comptroller of the Currency, and the Office of Thrift Supervision.
Regulation
of Financial Holding Companies
In
November 1999, the federal Gramm-Leach-Bliley Act (the “GLBA”) was signed into
law. GLBA revises the BHC Act and repeals the affiliation provisions of the
Glass-Steagall Act of 1933, which, taken together, limited the securities,
insurance and other non-banking activities of any company that controls an
FDIC
insured financial institution. Under GLBA, a bank holding company can elect,
subject to certain qualifications, to become a “financial holding company.” GLBA
provides that a financial holding company may engage in a full range of
financial activities, including insurance and securities sales and underwriting
activities, and real estate development, with new expedited notice procedures.
Maryland law generally permits state-chartered banks, including the Bank, to
engage in the same activities, directly or through an affiliate, as national
banking associations. GLBA permits certain qualified national banking
associations to form financial subsidiaries, which have broad authority to
engage in all financial activities except insurance underwriting, insurance
investments, real estate investment or development, or merchant banking. Thus,
GLBA has the effect of broadening the permitted activities of the Corporation
and the Bank.
The
Corporation and its affiliates are subject to the provisions of Section 23A
and
Section 23B of the Federal Reserve Act. Section 23A limits the amount of loans
or extensions of credit to, and investments in, the Corporation and its non-bank
affiliates by the Bank. Section 23B requires that transactions between the
Bank
and the Corporation and its non-bank affiliates be on terms and under
circumstances that are substantially the same as with
non-affiliates.
Under
FRB
policy, the Corporation is expected to act as a source of strength to the Bank,
and the FRB may charge the Corporation with engaging in unsafe and unsound
practices for failure to commit resources to a subsidiary bank when required.
In
addition, under the Financial Institutions Reform, Recovery and Enforcement
Act
of 1989 (“FIRREA”), depository institutions insured by the FDIC can be held
liable for any losses incurred by, or reasonably anticipated to be incurred
by,
the FDIC in connection with (i) the default of a commonly controlled
FDIC-insured depository institution or (ii) any assistance provided by the
FDIC
to a commonly controlled FDIC-insured depository institution in danger of
default. Accordingly, in the event that any insured subsidiary of the
Corporation causes a loss to the FDIC, other insured subsidiaries of the
Corporation could be required to compensate the FDIC by reimbursing it for
the
estimated amount of such loss. Such cross guaranty liabilities generally are
superior in priority to obligations of a financial institution to its
shareholders and obligations to other affiliates.
Federal
Banking Regulation
Federal
banking regulators, such as the FRB and the FDIC, may prohibit the institutions
over which they have supervisory authority from engaging in activities or
investments that the agencies believe are unsafe or unsound banking practices.
Federal banking regulators have extensive enforcement authority over the
institutions they regulate to prohibit or correct activities that violate law,
regulation or a regulatory agreement or which are deemed to be unsafe or unsound
practices. Enforcement actions may include the appointment of a conservator
or
receiver, the issuance of a cease and desist order, the termination of deposit
insurance, the imposition of civil money penalties on the institution, its
directors, officers, employees and institution-affiliated parties, the issuance
of directives to increase capital, the issuance of formal and informal
agreements, the removal of or restrictions on directors, officers, employees
and
institution-affiliated parties, and the enforcement of any such mechanisms
through restraining orders or other court actions.
The
Bank
is subject to certain restrictions on extensions of credit to executive
officers, directors, and principal shareholders or any related interest of
such
persons, which generally require that such credit extensions be made on
substantially the same terms as are available to third parties dealing with
the
Bank and not involve more than the normal risk of repayment. Other laws tie
the
maximum amount that may be loaned to any one customer and its related interests
to capital levels.
[8]
As
part
of the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”),
each federal banking regulator adopted non-capital safety and soundness
standards for institutions under its authority. These standards include internal
controls, information systems and internal audit systems, loan documentation,
credit underwriting, interest rate exposure, asset growth, and compensation,
fees and benefits. An institution that fails to meet those standards may be
required by the agency to develop a plan acceptable to meet the standards.
Failure to submit or implement such a plan may subject the institution to
regulatory sanctions. The Corporation, on behalf of the Bank, believes that
the
Bank meets substantially all standards that have been adopted. FDICIA also
imposes new capital standards on insured depository institutions.
The
Community Reinvestment Act (“CRA”) requires the FDIC, in connection with its
examination of financial institutions within its jurisdiction, to evaluate
the
record of those financial institutions in meeting the credit needs of their
communities, including low and moderate income neighborhoods, consistent with
principles of safe and sound banking practices. These factors are also
considered by all regulatory agencies in evaluating mergers, acquisitions and
applications to open a branch or facility. As of the date of its most recent
examination report, the Bank has a CRA rating of “Satisfactory”.
The
Bank’s deposits are insured to a maximum of $100,000 per depositor through the
Deposit Insurance Fund, which is administered by the FDIC, and the Bank is
required to pay semi-annual deposit insurance premium assessments to the FDIC.
The Bank paid $.2 million in FDIC premiums during 2006. The Deposit Insurance
Fund was created pursuant to the
Federal
Deposit Insurance Reform Act of 2005,
which was signed into law on February 8, 2006. Under this new law, (i) the
current $100,000 deposit insurance coverage will be indexed for inflation (with
adjustments every five years, commencing January 1, 2011), and (ii) deposit
insurance coverage for retirement accounts was increased to $250,000 per
participant subject to adjustment for inflation. In addition, the FDIC will
be
given greater latitude in setting the assessment rates for insured depository
institutions which could be used to impose minimum assessments.
For
a
discussion of the regulatory capital requirements and related restrictions
to
which the Corporation and the Bank are subject, see the “Capital Requirements”
discussion that immediately follows.
Capital
Requirements
FDICIA
established a system of prompt corrective action to resolve the problems of
undercapitalized institutions. Under this system, the federal banking regulators
are required to rate supervised institutions on the basis of five capital
categories: “well capitalized,” “adequately capitalized,” “undercapitalized,”
“significantly undercapitalized,” and “critically undercapitalized;” and to take
certain mandatory actions (and are authorized to take other discretionary
actions) with respect to institutions in the three undercapitalized categories.
The severity of the actions will depend upon the category in which the
institution is placed. A depository institution is “well capitalized” if it has
a total risk based capital ratio of 10% or greater, a Tier 1 risk based capital
ratio of 6% or greater, and a leverage ratio of 5% or greater and is not subject
to any order, regulatory agreement, or written directive to meet and maintain
a
specific capital level for any capital measure. An “adequately capitalized”
institution is defined as one that has a total risk based capital ratio of
8% or
greater, a Tier 1 risk based capital ratio of 4% or greater and a leverage
ratio
of 4% or greater (or 3% or greater in the case of a bank with a composite CAMEL
rating of 1).
FDICIA
generally prohibits a depository institution from making any capital
distribution, including the payment of cash dividends, or paying a management
fee to its holding company if the depository institution would thereafter be
undercapitalized. Undercapitalized depository institutions are subject to growth
limitations and are required to submit capital restoration plans. For a capital
restoration plan to be acceptable, the depository institution’s parent holding
company must guarantee (subject to certain limitations) that the institution
will comply with such capital restoration plan.
Significantly
undercapitalized depository institutions may be subject to a number of other
requirements and restrictions, including orders to sell sufficient voting stock
to become adequately capitalized and requirements to reduce total assets and
stop accepting deposits from correspondent banks. Critically undercapitalized
depository institutions are subject to the appointment of a receiver or
conservator, generally within 90 days of the date such institution is determined
to be critically undercapitalized.
Further
information about our capital resources is provided in the “Capital Resources”
section of Item 7 of Part II of this annual report. Information about the
capital ratios of the Corporation and of the Bank as of December 31, 2006 may
be
found in Note 2 to the Consolidated Financial Statements, which is included
in
Item 8 of Part II of this annual report.
[9]
USA
PATRIOT ACT
Congress
adopted the USA PATRIOT Act (the “Patriot Act”) on October 26, 2001 in response
to the terrorist attacks that occurred on September 11, 2001. Under the Patriot
Act, certain financial institutions, including banks, are required to maintain
and prepare additional records and reports that are designed to assist the
government’s efforts to combat terrorism. The Patriot Act includes sweeping
anti-money laundering and financial transparency laws and required additional
regulations, including, among other things, standards for verifying client
identification when opening an account and rules to promote cooperation among
financial institutions, regulators and law enforcement entities in identifying
parties that may be involved in terrorism or money laundering.
Federal
Securities Law
The
shares of the Corporation’s common stock are registered with the Securities and
Exchange Commission (the “SEC”) under Section 12(b) of the Securities Exchange
Act of 1934, as amended (the “Exchange Act”), and listed on the Nasdaq Stock
Market’s Global Market. The Corporation is subject to information reporting
requirements, proxy solicitation requirements, insider trading restrictions
and
other requirements of the Exchange Act, including the requirements imposed
under
the federal Sarbanes-Oxley Act of 2002. Among other things, loans to and other
transactions with insiders are subject to restrictions and heightened
disclosure, directors and certain committees of the Board must satisfy certain
independence requirements, and the Corporation is generally required to comply
with certain corporate governance requirements.
Governmental
Monetary and Credit Policies and Economic Controls
The
earnings and growth of the banking industry and ultimately of the Bank are
affected by the monetary and credit policies of governmental authorities,
including the FRB. An important function of the FRB is to regulate the national
supply of bank credit in order to control recessionary and inflationary
pressures. Among the instruments of monetary policy used by the FRB to implement
these objectives are open market operations in U.S. Government securities,
changes in the federal funds rate, changes in the discount rate of member bank
borrowings, and changes in reserve requirements against member bank deposits.
These means are used in varying combinations to influence overall growth of
bank
loans, investments and deposits and may also affect interest rates charged
on
loans or paid on deposits. The monetary policies of the FRB authorities have
had
a significant effect on the operating results of commercial banks in the past
and are expected to continue to have such an effect in the future. In view
of
changing conditions in the national economy and in the money markets, as well
as
the effect of actions by monetary and fiscal authorities, including the FRB,
no
prediction can be made as to possible future changes in interest rates, deposit
levels, loan demand or their effect on the business and earnings of the
Corporation and its subsidiaries.
SEASONALITY
Management
does not believe that our business activities are seasonal in nature. Deposit,
loan, and insurance demand may vary depending on local and national economic
conditions, but management believes that any variation will not have a material
impact on our planning or policy-making strategies.
EMPLOYEES
At
December 31, 2006, we employed approximately 463 individuals, of whom 352 were
full-time employees.
|
ITEM
1A.
|
RISK
FACTORS
|
The
following factors should be considered carefully in evaluating an investment
in
shares of common stock of the Corporation.
[10]
Risks
Relating to the Corporation and its Affiliates
The
Corporation’s future depends on the successful growth of its
subsidiaries.
The
Corporation’s primary business activity for the foreseeable future will be to
act as the holding company of the Bank and its other direct and indirect
subsidiaries. Therefore, the Corporation’s future profitability will depend on
the success and growth of these subsidiaries. In the future, part of the
Corporation’s growth may come from buying other banks and buying or establishing
other companies. Such entities may not be profitable after they are purchased
or
established, and they may lose money, particularly at first. A new bank or
company may bring with it unexpected liabilities, bad loans, or bad employee
relations, or the new bank or company may lose customers.
The
majority of our business is concentrated in Maryland and West Virginia; a
significant amount of our business is concentrated in real estate lending.
Because
most of our loans are made to Western Maryland and Northeastern West Virginia
borrowers, a decline in local economic conditions may have a greater effect
on
our earnings and capital than on the earnings and capital of larger financial
institutions whose loan portfolios are geographically diverse. Further, we
make
many real estate secured loans, including construction and land development
loans, all of which are in greater demand when interest rates are low and
economic conditions are good. There can be no guarantee that good economic
conditions or low interest rates will continue to exist. Moreover, the market
values of the real estate securing our loans may deteriorate due to a number
of
unpredictable factors, which could cause us to lose money in the event a
borrower failed to repay a loan and we were forced to foreclose on the property.
Additionally, the Board of Governors of the Federal Reserve System and the
Federal Deposit Insurance Corporation, along with the other federal banking
regulators, issued final guidance on December 6, 2006 entitled “Concentrations
in Commercial Real Estate Lending, Sound Risk Management Practices” directed at
institutions that have particularly high concentrations of commercial real
estate loans within their lending portfolios. This guidance suggests that
institutions whose commercial real estate loans exceed certain percentages
of
capital should implement heightened risk management practices appropriate to
their concentration risk and may be required to maintain higher capital ratios
than institutions with lower concentrations in commercial real estate lending.
Based on our commercial real estate concentration as of December 31, 2006,
we
may be subject to further supervisory analysis during future examinations .
Although we continuously evaluate our concentration and risk management
strategies, we cannot guarantee that any risk management practices we implement
will be effective to prevent losses relating to our commercial real estate
portfolio. Management cannot predict the extent to which this guidance will
impact our operations or capital requirements.
The
Bank may experience loan losses in excess of its
allowance.
The
risk
of credit losses on loans varies with, among other things, general economic
conditions, the type of loan being made, the creditworthiness of the borrower
over the term of the loan and, in the case of a collateralized loan, the value
and marketability of the collateral for the loan. Management of First United
Bank & Trust maintains an allowance for credit losses based upon, among
other things, historical experience, an evaluation of economic conditions and
regular reviews of delinquencies and loan portfolio quality. Based upon such
factors, management makes various assumptions and judgments about the ultimate
collectability of the loan portfolio and provides an allowance for loan losses
based upon a percentage of the outstanding balances and for specific loans
when
their ultimate collectability is considered questionable. If management's
assumptions and judgments prove to be incorrect and the allowance for loan
losses is inadequate to absorb future losses, or if the bank regulatory
authorities require us to increase the allowance for loan losses as a part
of
its examination process, our earnings and capital could be significantly and
adversely affected. Although management uses the best information available
to
make determinations with respect to the allowance for loan losses, future
adjustments may be necessary if economic conditions differ substantially from
the assumptions used or adverse developments arise with respect to our
non-performing or performing loans. Material additions to the allowance for
loan
losses could result in a material decrease in our net income and capital, and
could have a material adverse effect on our financial condition.
Interest
rates and other economic conditions will impact our results of
operations.
Our
results of operations may be materially and adversely affected by changes in
prevailing economic conditions, including declines in real estate values, rapid
changes in interest rates and the monetary and fiscal policies of the federal
government. Our profitability is in part a function of the spread between the
interest rates earned on assets and the interest rates paid on deposits and
other interest-bearing liabilities (i.e., net interest income), including
advances from the Federal Home Loan Bank of Atlanta. Interest rate risk arises
from mismatches (i.e., the interest sensitivity gap) between the dollar amount
of repricing or maturing assets and liabilities and is measured in terms of
the
ratio of the interest rate sensitivity gap to total assets. More assets
repricing or maturing than liabilities over a given time period is considered
asset-sensitive and is reflected as a positive gap, and more liabilities
repricing or maturing than assets over a given time period is considered
liability-sensitive and is reflected as negative gap. An asset-sensitive
position (i.e., a positive gap) could enhance earnings in a rising interest
rate
environment and could negatively impact earnings in a falling interest rate
environment, while a liability-sensitive position (i.e., a negative gap) could
enhance earnings in a falling interest rate environment and negatively impact
earnings in a rising interest rate environment. Fluctuations in interest rates
are not predictable or controllable. We have attempted to structure our asset
and liability management strategies to mitigate the impact on net interest
income of changes in market interest rates, but there can be no assurance that
these attempts will be successful in the event of such changes.
[11]
The
market value of our investments could decline.
As
of
December 31, 2006, we had classified 100% of our investment securities as
available-for-sale pursuant to Statement of Financial Accounting Standards
("SFAS") No. 115 relating to accounting for investments. SFAS No. 115 requires
that unrealized gains and losses in the estimated value of the
available-for-sale portfolio be "marked to market" and reflected as a separate
item in shareholders' equity (net of tax) as accumulated other comprehensive
income. There can be no assurance that future market performance of our
investment portfolio will enable us to realize income from sales of securities.
Shareholders' equity will continue to reflect the unrealized gains and losses
(net of tax) of these investments. Moreover, there can be no assurance that
the
market value of our investment portfolio will not decline, causing a
corresponding decline in shareholders' equity.
Management
believes that several factors will affect the market values of our investment
portfolio. These include, but are not limited to, changes in interest rates
or
expectations of changes, the degree of volatility in the securities markets,
inflation rates or expectations of inflation and the slope of the interest
rate
yield curve (the yield curve refers to the differences between shorter-term
and
longer-term interest rates; a positively sloped yield curve means shorter-term
rates are lower than longer-term rates). Also, the passage of time will affect
the market values of our investment securities, in that the closer they are
to
maturing, the closer the market price should be to par value. These and other
factors may impact specific categories of the portfolio differently, and
management cannot predict the effect these factors may have on any specific
category.
We
operate in a competitive environment.
We
operate in a competitive environment, competing for loans, deposits, and
customers with commercial banks, savings associations and other financial
entities. Competition for deposits comes primarily from other commercial banks,
savings associations, credit unions, money market and mutual funds and other
investment alternatives. Competition for loans comes primarily from other
commercial banks, savings associations, mortgage banking firms, credit unions
and other financial intermediaries. Competition for other products, such as
insurance and securities products, comes from other banks, securities and
brokerage companies, insurance companies, insurance agents and brokers, and
other non-bank financial service providers in our market area. Many of these
competitors are much larger in terms of total assets and capitalization, have
greater access to capital markets, and/or offer a broader range of financial
services than those that we offer. In addition, banks with a larger
capitalization and financial intermediaries not subject to bank regulatory
restrictions have larger lending limits and are thereby able to serve the needs
of larger customers.
In
addition, current banking laws facilitate interstate branching, merger activity
among banks, and expanded activities. Since September 1995, certain bank holding
companies have been authorized to acquire banks throughout the United States.
Since June 1, 1997, certain banks have been permitted to merge with banks
organized under the laws of different states. As a result, interstate banking
is
now an accepted element of competition in the banking industry and the
Corporation may be brought into competition with institutions with which it
does
not presently compete. Moreover, as discussed above, the GLBA revised the BHC
Act in 2000 and repealed the affiliation provisions of the Glass-Steagall Act
of
1933, which, taken together, limited the securities, insurance and other
non-banking activities of any company that controls an FDIC insured financial
institution. These laws may increase the competition we face in our market
areas
in the future, although management cannot predict the degree to which such
competition will impact our financial conditions or results of
operations.
[12]
The
loss of key personnel could disrupt our operations and result in reduced
earnings.
Our
growth and profitability will depend upon our ability to attract and retain
skilled managerial, marketing and technical personnel. Competition for qualified
personnel in the financial services industry is intense, and there can be no
assurance that we will be successful in attracting and retaining such personnel.
Our current executive officers provide valuable services based on their many
years of experience and in-depth knowledge of the banking industry. Due to
the
intense competition for financial professionals, these key personnel would
be
difficult to replace and an unexpected loss of their services could result
in a
disruption to the continuity of operations and a possible reduction in earnings.
The
banking industry is heavily regulated; significant regulatory changes could
adversely affect our operations.
Our
operations will be impacted by current and future legislation and by the
policies established from time to time by various federal and state regulatory
authorities. The Corporation is subject to supervision by the FRB. The Bank
is
subject to supervision and periodic examination by the Maryland Commissioner
of
Financial Regulation, the West Virginia Division of Banking, and the FDIC.
Banking regulations, designed primarily for the safety of depositors, may limit
a financial institution's growth and the return to its investors by restricting
such activities as the payment of dividends, mergers with or acquisitions by
other institutions, investments, loans and interest rates, interest rates paid
on deposits, expansion of branch offices, and the offering of securities or
trust services. The Corporation and the Bank are also subject to capitalization
guidelines established by federal law and could be subject to enforcement
actions to the extent that either is found by regulatory examiners to be
undercapitalized. It is not possible to predict what changes, if any, will
be
made to existing federal and state legislation and regulations or the effect
that such changes may have on our future business and earnings prospects.
Management also cannot predict the nature or the extent of the effect on our
business and earnings of future fiscal or monetary policies, economic controls,
or new federal or state legislation. Further, the cost of compliance with
regulatory requirements may adversely affect our ability to operate
profitably.
We
may be adversely affected by recent legislation.
As
discussed above the GLBA repealed restrictions on banks affiliating with
securities firms and it also permitted bank holding companies that become
financial holding companies to engage in additional financial activities,
including insurance and securities underwriting and agency activities, merchant
banking, and insurance company portfolio investment activities that are
currently not permitted for bank holding companies. Although the Corporation
is
a financial holding company, this law may increase the competition we face
from
larger banks and other companies. It is not possible to predict the full effect
that this law will have on us.
The
Sarbanes-Oxley Act of 2002 requires management of publicly traded companies
to
perform an annual assessment of their internal controls over financial reporting
and to report on whether the system is effective as of the end of the Company’s
fiscal year. Disclosure of significant deficiencies or material weaknesses
in
internal controls could cause an unfavorable impact to shareholder value by
affecting the market value of our stock.
The
Patriot Act reinforced the importance of implementing and following procedures
required by the Bank Secrecy Act and money laundering issues. Non-compliance
with this act or failure to file timely and accurate documentation could expose
the company to adverse publicity as well as fines and penalties assessed by
regulatory agencies.
We
may be subject to claims and the costs of defensive
actions.
Our
customers may sue us for losses due to alleged breaches of fiduciary duties,
errors and omissions of employees, officers and agents, incomplete
documentation, our failure to comply with applicable laws and regulations,
or
many other reasons. Also, our employees may knowingly or unknowingly violate
laws and regulations. Management may not be aware of any violations until after
their occurrence. This lack of knowledge may not insulate us from liability.
Claims and legal actions may result in legal expenses and liabilities that
may
reduce our profitability and hurt our financial condition.
We
may not be able to keep pace with developments in
technology.
We
use
various technologies in conducting our businesses, including telecommunication,
data processing, computers, automation, internet-based banking, and debit cards.
Technology changes rapidly. Our ability to compete successfully with other
financial institutions may depend on whether we can exploit technological
changes. We may not be able to exploit technological changes, and any investment
we do make may not make us more profitable.
[13]
Risks
Relating to the Corporation’s Common Stock
The
Corporation’s ability to pay dividends is limited.
The
Corporation’s ability to pay dividends to shareholders is largely dependent upon
the receipt of dividends from the Bank. Both federal and state laws impose
restrictions on the ability of the Bank to pay dividends. Federal law generally
prohibits the payment of a dividend by a troubled institution. Under Maryland
law, a state-chartered commercial bank may pay dividends only out of undivided
profits or, with the prior approval of the Commissioner, from surplus in excess
of 100% of required capital stock. If however, the surplus of a Maryland bank
is
less than 100% of its required capital stock, cash dividends may not be paid
in
excess of 90% of net earnings. In addition to these specific restrictions,
bank
regulatory agencies also have the ability to prohibit proposed dividends by
a
financial institution which would otherwise be permitted under applicable
regulations if the regulatory body determines that such distribution would
constitute an unsafe or unsound practice. Because of these limitations, there
can be no guarantee that we will declare dividends in any fiscal
quarter.
Shares
of the Corporation’s common stock are not insured.
Shares
of
the Corporation’s common stock do not represent deposits and investments in
these shares are not insured against loss by the government.
Shares
of the Corporation’s common stock are not heavily traded.
The
shares of the Corporation’s common stock are listed on the Nasdaq Global Market
and are not heavily traded. Securities that are not heavily traded can be more
volatile than stock trading in an active public market. Factors such as our
financial results, the introduction of new products and services by us or our
competitors, and various factors affecting the banking industry generally may
have a significant impact on the market price of our common stock. Management
cannot predict the extent to which an active public market for our securities
will develop or be sustained in the future. In recent years, the stock market
has experienced a high level of price and volume volatility, and market prices
for the securities of many companies have experienced wide price fluctuations
that have not necessarily been related to their operating performance.
Therefore, our shareholders may not be able to sell their shares at the volumes,
prices, or times that they desire.
The
Corporation’s Articles of Incorporation and By-Laws may discourage a corporation
takeover.
The
Amended and Restated Articles of Incorporation and By-Laws of the Corporation
contain certain provisions designed to enhance the ability of the Board of
Directors to deal with attempts to acquire control of the corporation. First,
the Board of Directors is classified into three classes. Directors of each
class
serve for staggered three-year periods, and no director may be removed except
for cause, and then only by the affirmative vote of either a majority of the
entire Board of Directors or a majority of the outstanding voting stock. Second,
the Board has the authority to classify and reclassify unissued shares of stock
of any class or series of stock by setting, fixing, eliminating, or altering
in
any one or more respects the preferences, rights, voting powers, restrictions
and qualifications of, dividends on, and redemption, conversion, exchange,
and
other rights of, such securities. The Board could use this authority, along
with
its authority to authorize the issuance of securities of any class or series,
to
issue shares
having terms favorable to management to a person or persons affiliated with
or
otherwise friendly to management. In
addition to the foregoing, Maryland law contains anti-takeover provisions,
such
as restrictions on “control share acquisitions” and “business combinations” with
certain interested stockholders, that apply to the Corporation.
Although
these provisions do not preclude a takeover, they may have the effect of
discouraging a takeover attempt that would not be approved by the Board of
Directors, but pursuant to which shareholders might receive a substantial
premium for their shares over then-current market prices. As a result,
shareholders who might desire to participate in such a transaction might not
have the opportunity to do so. Such provisions will also render the removal
of
the Board of Directors and of management more difficult and, therefore, may
serve to perpetuate current management. Such provisions could potentially
adversely affect the market price of our common stock.
[14]
|
ITEM
1B.
|
UNRESOLVED
STAFF COMMENTS
|
None.
|
ITEM
2.
|
PROPERTIES
|
The
headquarters of the Corporation and the Bank occupies approximately 29,000
square feet at 19 South Second Street, Oakland, Maryland. These premises are
owned by the Corporation. The Bank owns 19 of its banking offices and leases
six. The Corporation also leases three offices of non-bank subsidiaries. A
banking office is currently under construction on a leased site in Washington
County, Maryland. Total rent expense on the leased offices and properties was
$.42 million in 2006. In December of 2005, the Corporation purchased a 30,000
square foot building in Oakland, Maryland to house its operations center.
Management expects that this site will be fully functional in March
2007.
|
ITEM
3.
|
LEGAL
PROCEEDINGS
|
We
are at
times, in the ordinary course of business, subject to legal actions. Management,
upon the advice of counsel, believes that losses, if any, resulting from current
legal actions will not have a material adverse effect on our financial
condition.
|
SUBMISSION
OF MATTERS TO A VOTE OF SECURITY
HOLDERS
|
None.
[15]
PART
II
|
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
|
Shares
of
the Corporation’s common stock are listed on the Nasdaq Stock Market under the
symbol “FUNC”. As of February 28, 2007, the Corporation had 2,085 shareholders
of record. The high and low sales prices for, and the cash dividends declared
on, the shares of the Corporation’s common stock for each quarterly period of
2006 and 2005 are set forth below.
|
2006
|
High
|
Low
|
Dividends
Declared
|
|||||||
|
1st
Quarter
|
$
|
22.83
|
$
|
20.29
|
$
|
.190
|
||||
|
2nd
Quarter
|
23.35
|
20.29
|
.190
|
|||||||
|
3rd
Quarter
|
22.00
|
20.31
|
.190
|
|||||||
|
4th
Quarter
|
22.79
|
21.05
|
.195
|
|||||||
|
2005
|
High
|
Low
|
Dividends
Declared
|
|||||||
|
1st
Quarter
|
$
|
21.70
|
$
|
19.81
|
$
|
.185
|
||||
|
2nd
Quarter
|
20.30
|
18.94
|
.185
|
|||||||
|
3rd
Quarter
|
20.85
|
19.25
|
.185
|
|||||||
|
4th
Quarter
|
21.66
|
19.14
|
.190
|
|||||||
Cash
dividends are typically declared on a quarterly basis and are at the discretion
of the Corporation’s Board of Directors. Dividends to shareholders are generally
dependent on the ability of the Corporation’s subsidiaries, especially the Bank,
to declare dividends to the Corporation. The ability of these entities to
declare dividends are limited by federal and state banking laws and/or state
corporate laws. Further information about these limitations may be found in
Note
13 to the Consolidated Financial Statements and in Item 1A of Part I under
the
caption “The
Corporation’s ability to pay dividends is limited”,
each
of which is incorporated herein by reference. There can be no guarantee that
dividends will be declared in any fiscal quarter.
Market
makers for the Corporation’s common stock are:
|
FERRIS
BAKER WATTS
|
SCOTT
AND STRINGFELLOW, INC.
|
|
|
12
North Liberty St.
|
909
East Main Street
|
|
|
Cumberland,
MD 21502
|
Richmond,
VA 23219
|
|
|
(301)724-7161
|
(804)643-1811
|
|
|
(800)776-0629
|
(800)552-7757
|
|
|
113
S. Potomac St.
|
||
|
Hagerstown,
MD 21740
|
||
|
(301)733-7111
|
||
|
(800)344-4413
|
[16]
First
United Corporation Stock Performance Graph
The
following graph compares the yearly percentage change in the cumulative total
return for First United Corporation common stock for the five years ended
December 31, 2006. This data is compared to the NASDAQ Composite market index
and the SNL $1 billion to $5 billion Bank Index during the same time period.
Total return numbers are calculated as change in stock price for the period
indicated with dividends being reinvested.
|
|
Period
Ending
|
|||||
|
Index
|
12/31/01
|
12/31/02
|
12/31/03
|
12/31/04
|
12/31/05
|
12/31/06
|
|
First
United Corporation
|
100.00
|
106.92
|
164.12
|
143.24
|
153.25
|
163.71
|
|
NASDAQ
Composite
|
100.00
|
68.76
|
103.67
|
113.16
|
115.57
|
127.58
|
|
SNL
$1B-$5B Bank Index
|
100.00
|
115.44
|
156.98
|
193.74
|
190.43
|
220.36
|
Equity
Compensation Plan Information
At
December 31, 2006, the Corporation had no equity compensation plan or
arrangement in effect under which shares of common stock may be issued to its
directors
or officers.
Issuer
Purchases of Securities
[17]
|
ITEM
6.
|
SELECTED
FINANCIAL DATA
|
The
following table sets forth certain selected financial data for the five years
ended December 31, 2006 and is qualified in its entirety by the detailed
information and financial statements, including notes thereto, included
elsewhere or incorporated by reference in this annual report.
(In
thousands, except per share data)
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
Balance
Sheet Data
|
||||||||||||||||
|
Total
Assets
|
$
|
1,349,317
|
$
|
1,310,991
|
$
|
1,233,901
|
$
|
1,108,241
|
$
|
954,388
|
||||||
|
Net
Loans
|
957,126
|
954,545
|
904,635
|
786,051
|
659,758
|
|||||||||||
|
Investment
Securities
|
263,272
|
230,095
|
210,661
|
223,615
|
215,236
|
|||||||||||
|
Deposits
|
971,381
|
955,854
|
850,661
|
750,161
|
610,460
|
|||||||||||
|
Long-term
Borrowings
|
166,330
|
128,373
|
175,415
|
191,735
|
198,772
|
|||||||||||
|
Shareholders’
Equity
|
96,856
|
92,039
|
86,356
|
84,191
|
79,283
|
|||||||||||
|
Operating
Data
|
||||||||||||||||
|
Interest
Income
|
$
|
80,269
|
$
|
69,756
|
$
|
60,682
|
$
|
57,703
|
$
|
57,589
|
||||||
|
Interest
Expense
|
39,335
|
29,413
|
24,016
|
23,601
|
25,702
|
|||||||||||
|
Net
Interest Income
|
40,934
|
40,343
|
36,666
|
34,102
|
31,887
|
|||||||||||
|
Provision
for Loan Losses
|
1,165
|
1,078
|
2,534
|
833
|
1,506
|
|||||||||||
|
Other
Operating Income
|
14,041
|
14,088
|
12,971
|
11,867
|
9,007
|
|||||||||||
|
Other
Operating Expense
|
35,490
|
34,654
|
35,969
|
29,821
|
26,038
|
|||||||||||
|
Income
Before Tax
|
18,320
|
18,699
|
11,134
|
15,315
|
13,350
|
|||||||||||
|
Income
Tax
|
5,743
|
6,548
|
3,507
|
4,566
|
3,695
|
|||||||||||
|
Net
Income
|
$
|
12,577
|
$
|
12,151
|
$
|
7,627
|
$
|
10,749
|
$
|
9,655
|
||||||
|
Per
Share Data
|
||||||||||||||||
|
Net
Income
|
$
|
2.05
|
$
|
1.99
|
$
|
1.25
|
$
|
1.77
|
$
|
1.59
|
||||||
|
Dividends
Paid
|
.76
|
.74
|
.72
|
.70
|
.68
|
|||||||||||
|
Book
Value
|
15.77
|
15.04
|
14.17
|
13.83
|
13.04
|
|||||||||||
|
Significant
Ratios
|
||||||||||||||||
|
Return
on Average Assets
|
.96
|
%
|
.95
|
%
|
.65
|
%
|
1.03
|
%
|
1.13
|
%
|
||||||
|
Return
on Average Equity
|
13.07
|
%
|
13.61
|
%
|
8.91
|
%
|
13.10
|
%
|
12.75
|
%
|
||||||
|
Dividend
Payout Ratio
|
37.07
|
%
|
37.44
|
%
|
58.00
|
%
|
39.65
|
%
|
42.76
|
%
|
||||||
|
Average
Equity to Average Assets
|
7.35
|
%
|
7.00
|
%
|
7.28
|
%
|
7.88
|
%
|
8.84
|
%
|
||||||
|
Total
Risk-based Capital Ratio
|
12.95
|
%
|
12.66
|
%
|
12.24
|
%
|
11.77
|
%
|
14.31
|
%
|
||||||
|
Tier
I Capital to Risk Weighted Assets
|
11.81
|
%
|
11.45
|
%
|
10.81
|
%
|
11.04
|
%
|
13.76
|
%
|
||||||
|
Tier
I Capital to Average Assets
|
9.08
|
%
|
8.64
|
%
|
8.44
|
%
|
8.72
|
%
|
11.72
|
%
|
||||||
[18]
|
ITEM
7.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
This
discussion and analysis should be read in conjunction with the audited
consolidated financial statements and notes thereto for the year ended December
31, 2006, which appear in Item 8 of Part II of this annual report.
Overview
The
Corporation is a financial holding company which, through the Bank and its
non-bank subsidiaries, provides an array of financial products and services
primarily
to customers in four Western Maryland counties and four Northeastern West
Virginia counties. Its principal operating subsidiary is the Bank, which
consists of a community banking network of 25 branch offices located throughout
its market areas. Our primary sources of revenue are interest income earned
from
our loan and investment securities portfolios and fees earned from financial
services provided to customers.
Our
2006
net income was $12.6 million, an increase of 4.1% over 2005. The increase in
2006 net income was due to strategic decisions implemented by management over
the past few years, the Bank’s ability to increase its net interest margin, a
focus on controlling our operating costs and a reduction in the effective tax
rate. 2006 proved to be a challenging year with an inverted interest rate yield
curve, a slowed economy and intense competition for retail and commercial
deposits.
Operations
in 2006 were impacted by the following factors and strategic
initiatives:
Slow
Loan and Deposit Growth/Impact on Net Interest Margin --
Loan
growth slowed significantly in 2006 as compared to 2005, resulting in a minimal
net increase in the loan portfolio of $3 million. Commercial loan production
remained at a consistent level with 2005 but was offset by the increased payback
of commercial development loans. Residential mortgage loan growth was tempered
by management during 2006 as a result of strong customer preference for fixed
rate loans. The Bank utilized the secondary market as an outlet for this type
of
lending to prevent excessive growth in the fixed rate portfolio. Management’s
preference for originating adjustable, prime-rate based loans has benefited
us
in the current rising interest rate environment. Although we experienced minimal
increase in loan growth, interest income exceeded interest income generated
in
prior years due to the upward re-pricing of loans. For 2006, interest income
on
loans increased $7.5 million (on a fully taxable equivalent basis) when compared
with 2005. Interest income on investment securities in 2006 increased by $3.7
million (on a fully taxable equivalent basis) due to an increase in the average
yield on the portfolio and a $45 million leverage strategy. (Additional
information on the composition of interest income is available in Table 1
below).
Funding
costs in 2006 increased as a result of the rising interest rate environment
and
the intense deposit competition in our market areas. The shift from core
non-interest bearing accounts to certificates of deposit and higher yielding
money market accounts continued during 2006. A large portion of the new time
deposits received in 2006 were in denominations of $100,000 or more, which
typically require higher interest rates than core deposits. This reliance on
higher rate time deposits and the general increase in interest rates throughout
2006 increased deposit interest expense by approximately $8.2 million when
compared to 2005. Net borrowings increased by $15.4 million adding an additional
$1.7 million of interest expense over the prior year. The combination of slow
loan and deposit growth, rising interest rates on our assets and liabilities,
and the increased level of debt resulted in a minimal increase in net interest
income on a tax equivalent basis of $1.4 million (3%) in 2006 when compared
to
2005.
The
overall net interest margin increased during the year from 3.49% in 2005 to
3.52% in 2006. However, the 2006 net interest margin was negatively impacted
by
a $45 million leverage strategy implemented in the latter half of 2006 in an
attempt to produce additional net interest income.
Early
Redemption of Long-Term Borrowings
-- In
May 2006, the
Bank
participated in a contemporaneous exchange of long-term FHLB advances. The
Bank
exchanged $25 million of long-term advances having a weighted average rate
of
5.01% for $25 million of long-term advances having a weighted average rate
of
4.69%. The exchange resulted in a net gain of $.2 million which will be
amortized over the life of the new borrowing.
Other
Operating Income/Other Operating Expense --
Other
operating income in 2006 decreased slightly when compared to 2005. The Bank
experienced increases in service charge and Trust department income of $.8
million and $.4 million, respectively. Insurance
commissions were down slightly in 2006 compared to 2005 due to lower contingency
income from insurance companies and the closing of Oakfirst Life Insurance,
Inc.
early in 2005. Other income in 2005
included a $.9 million gain on the prepayment of long-term debt. Operating
expenses in 2006 increased by 2.4% when compared to 2005.
This
minimal increase was due primarily to increases in salaries and benefits,
occupancy and other expenses and close monitoring of our operating expenses.
2005 operating expenses included a $.4 million penalty recognized on the
prepayment of long-term debt.
[19]
The
Bank
continued to invest in its core market areas during 2006. A new branch office
was opened during the fourth quarter of 2006 in Morgantown, West Virginia and
construction of another branch began on a newly leased site in Washington
County, Maryland. This new retail branch is anticipated to open late in the
first quarter of 2007. The Corporation purchased a 30,000 square foot building
in Oakland, Maryland in December 2005 for $3 million to house its operations
center. This space will relieve congestion in the Corporation’s headquarters as
well as provide capacity for the Bank’s anticipated growth. Management expects
that this new facility will be ready for use in the first quarter of
2007.
The
Corporation continued its tradition of paying dividends to shareholders during
2006 and, in fact, increased them to $0.76
per
share, a 2.7% increase from $0.74 per share in 2005. The Corporation has paid
quarterly cash dividends consistently since 1985, the year in which it was
formed.
We
will
continue to face risks and challenges in the future, including: changes in
local
economic conditions in our core geographic markets; potential
yield compression on loan and deposit products by existing competitors and
potential new entrants in our markets; changes in interest rates; and changes
to
existing federal and state legislation and regulations over banks and financial
holding companies. For a more complete discussion of these risk factors, see
Item 1A of Part I of this annual report.
Critical
Accounting Policies and Estimates
This
discussion and analysis of the our financial condition and results of operations
is based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires management to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure
of
contingent liabilities. (See Note 1 of the Notes to Consolidated Financial
Statements included in Item 8 of Part II of this annual report.) On an on-going
basis, management evaluates estimates, including those related to loan losses
and intangible assets. Management bases its estimates on historical experience
and on various other assumptions that are believed to be reasonable under the
circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent
from
other sources. Actual results may differ from these estimates under different
assumptions or conditions. Management believes the following critical accounting
policies affect our more significant judgments and estimates used in the
preparation of the consolidated financial statements.
Allowance
for Loan Losses
One
of
our most important accounting policies is that related to the monitoring of
the
loan portfolio. A variety of estimates impact the
carrying value of the loan portfolio, including the calculation of the allowance
for loan losses, the valuation of underlying collateral, the timing of loan
charge-offs and the placement of loans on non-accrual status. The allowance
is
established and maintained at a level that management believes is adequate
to
cover losses resulting from the inability of borrowers to make required payment
on loans. Estimates for loan losses are arrived at by analyzing risks associated
with the specific loans and the loan portfolio, current and historical trends
in
delinquencies and charge-offs, and changes in the size and composition of the
loan portfolio. The analysis also requires consideration of the economic climate
and direction, changes in lending rates, political conditions, legislation
impacting the banking industry and economic conditions specific to Western
Maryland and Northeastern West Virginia. Because the calculation of the
allowance for loan losses relies on management’s estimates and judgments
relating to inherently uncertain events, actual results may differ from
management’s estimates.
The
allowance for loan losses is also discussed below in this Item 7 under the
caption “Allowance and Provision for Loan Losses” and
in
Note 4 to Consolidated Financial Statements contained in Item 8 of Part II
of
this annual report.
Goodwill
and Other Intangible Assets
Statement
of Financial Accounting Standards (SFAS) No. 142, Accounting for Goodwill and
Other Intangible Assets, establishes standards for the amortization of
acquired intangible assets and the non-amortization and impairment assessment
of
goodwill. We have $2.1 million of core deposit intangible assets which are
subject to amortization and $11.9 million in goodwill primarily related to
the
Huntington National Bank branch acquisition that occurred in 2003, which is
not
subject to periodic amortization.
[20]
Goodwill
arising from business combinations represents the value attributable to
unidentifiable intangible elements in the business acquired. Our goodwill
relates to value inherent in the banking business and the value is dependent
upon our ability to provide quality, cost effective services in a highly
competitive local market. This ability relies upon continuing investments in
processing systems, the development of value-added service features and the
ease
of use of our services. As
such,
goodwill value is supported ultimately by revenue that is driven by the volume
of business transacted. A decline in earnings as a result of a lack of
growth
or
the inability to deliver cost effective services over sustained periods can
lead
to impairment of goodwill, which could adversely impact earnings in future
periods. SFAS No. 142 requires an annual evaluation of goodwill for impairment.
The determination of whether or not these assets are impaired involves
significant judgments. Management has concluded that the recorded value of
goodwill was not impaired as a result of the evaluation. However, future changes
in strategy and/or market conditions could significantly impact these judgments
and require adjustments to recorded asset balances.
Other-Than-Temporary
Impairment of Investment Securities
Management
systematically evaluates investment securities for impairment on a quarterly
basis. Declines in the fair value of available for sale securities below their
cost that are considered other than temporary declines are recognized in
earnings as realized losses in the period in which the impairment determination
is made. In estimating other-than-temporary impairment losses, management
considers (1) the length of time and the extent to which the fair value has
been
less than cost, (2) the financial condition and near-term prospects of the
issuer, and (3) the intent and ability of the Corporation to retain its
investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value. Gains and losses on the sale of securities
are recorded using the specific identification method.
Pension
Plan Assumptions
Our
pension plan costs are calculated using actuarial concepts, as discussed within
the requirements of Statement of Financial Accounting Standards (SFAS) No.
87,
Employers Accounting for Pensions SFAS No. 132 (R) and as amended by SFAS No.
158, “Employers’ Accounting for Deferred Benefit Pension and Other Post
Retirement Plans.” Pension expense and the determination of our projected
pension liability are based upon two critical assumptions; the discount rate
and
the expected return on plan assets. We evaluate each of these critical
assumptions annually. Other assumptions impact the determination of pension
expense and the projected liability including the primary employee demographics,
such as retirement patterns, employee turnover, mortality rates, and estimated
employer compensation increases. These factors, along with the critical
assumptions, are carefully reviewed by management each year in consultation
with
our pension plan consultants and actuaries. Further information about our
pension plan assumptions, the plan’s funded status, and other plan information
is included in Note 11 to Consolidated Financial Statements, which is included
in Item 8 of Part II of this annual report.
Recent
Accounting Pronouncements and Developments
Note
1 to
the Consolidated Financial Statements included in Item 8, Part II of this annual
report discusses new accounting pronouncements that when adopted, may have
an
effect on our consolidated financial statements.
CONSOLIDATED
STATEMENT OF INCOME REVIEW
Net
Interest Income
Net
interest income is the largest source of operating revenue. Net interest income
is the difference between the interest earned on interest-earning
assets and the interest expense paid on interest-bearing liabilities. For
analytical and discussion purposes, net interest income is adjusted to a taxable
equivalent basis to facilitate performance comparisons between taxable and
tax-exempt assets by increasing tax-exempt income by an amount equal to the
federal income taxes that would have been paid if this income were taxable
at
the statutorily applicable rate. The table below summarizes net interest income
(on a taxable equivalent basis) for the years 2004-2006 (dollars in
thousands).
[21]
|
2006
|
2005
|
2004
|
||||||||
|
Interest
income
|
$
|
81,838
|
$
|
70,533
|
$
|
61,380
|
||||
|
Interest
expense
|
39,335
|
29,413
|
24,016
|
|||||||
|
Net
interest income
|
42,503
|
41,120
|
37,364
|
|||||||
|
Net
interest margin %
|
3.52
|
%
|
3.49
|
%
|
3.43
|
%
|
||||
Net
interest income increased $1.4 million (3%) in 2006 over the same period in
2005, due to an $11.3 million (16%) increase in interest income offset by a
$9.9
million (34%) increase in interest expense. The increase in interest income
resulted from an increase in average interest-earning assets of $28.1 million
(2%) during 2006 when compared to 2005. This increase is attributable to the
growth that we experienced in our investment portfolio late in 2005 and
throughout 2006. Emphasis on adjustable rate loan products and the rising
interest rate environment contributed to the increase in the average rate on
our
average earning assets of 80 basis points, from 5.98% in 2005 to 6.78% in 2006
(on a fully tax equivalent basis). Interest expense increased during 2006 when
compared to 2005 due to the higher interest rate environment, and an overall
increase in average interest-bearing liabilities of $32.3 million. Deposits
have
increased in 2006 by approximately $16 million due to an increase in brokered
certificates of deposit and a successful retail promotion of a nine month
certificate of deposit. The combined effect of the increasing rate environment
and the volume increases in our average interest-bearing liabilities resulted
in
an 83 basis point increase in the average rate paid on our average
interest-bearing liabilities from 2.76% for 2005 to 3.59% for 2006. The net
result of the aforementioned factors was a 3 basis point increase in the net
interest margin at December 31, 2006 to 3.52% from 3.49% at December 31,
2005.
Comparing
2005 to 2004, net interest income increased $3.8 million (10.1%) due primarily
to the increase in interest income of $9.2 million, offset by an increase in
interest expense of $5.4 million. Interest income from loans increased by $8.3
million due to the $93.5 million increase in the average balance of loans in
2005 and a slight increase of 26 basis points in the average yield on loans.
The
increase in total interest expense was due to increased interest expense on
deposits of $7.0 million (57.8%) offset by a decrease in interest expense on
long-term borrowings of $3.2 million (29.7%). Interest expense on deposits
increased primarily due to a $38.3 million increase in average balances and
a
141 basis point increase in the average yield on time deposits over $100,000.
The decrease in interest expense on long-term borrowings was primarily due
to
the $45.4 million decrease in the average balance coupled with the 50 basis
point decrease in average yield on these borrowings.
As
shown
below, the composition of total interest income remained steady from 2004 to
2005. Loan interest income and fees decreased in 2006 when compared to 2005
as a
percentage of total interest income due to the limited loan growth and the
increase in investment securities as a percentage of interest earning assets
during this time.
|
%
of Total Interest Income
|
|||
|
2006
|
2005
|
2004
|
|
|
Interest
and fees on loans
|
85%
|
88%
|
88%
|
|
Interest
on investment securities
|
15%
|
12%
|
12%
|
Table
1
sets forth the average balances, net interest income and expense and average
yields and rates for our interest-earning assets and interest-bearing
liabilities for 2006, 2005 and 2004. Table 2 sets forth an analysis of volume
and rate changes in interest income and interest expense of our average
interest-earning assets and average interest-bearing liabilities for 2006,
2005
and 2004. Table 2 distinguishes between the changes related to average
outstanding balances (changes in volume created by holding the interest rate
constant) and the changes related to average interest rates (changes in interest
income or expense attributed to average rates created by holding the outstanding
balance constant).
[22]
Distribution
of Assets, Liabilities and Shareholders’ Equity
Interest
Rates and Interest Differential - Tax Equivalent Basis
(Dollars
in thousands)
Table
1
|
For
the Years Ended December 31
|
||||||||||||||||||||||||||||
|
2006
|
2005
|
2004
|
||||||||||||||||||||||||||
|
AVERAGE
BALANCE
|
INTEREST
|
AVERAGE
YIELD/RATE
|
AVERAGE
BALANCE
|
INTEREST
|
AVERAGE
YIELD/RATE
|
AVERAGE
BALANCE
|
INTEREST
|
AVERAGE
YIELD/RATE
|
||||||||||||||||||||
|
Assets
|
||||||||||||||||||||||||||||
|
Loans
|
$
|
957,709
|
$
|
69,049
|
7.21
|
%
|
$
|
954,784
|
$
|
61,601
|
6.45
|
%
|
$
|
861,255
|
$
|
53,313
|
6.19
|
%
|
||||||||||
|
Investment
Securities:
|
||||||||||||||||||||||||||||
|
Taxable
|
171,720
|
7,699
|
4.48
|
179,018
|
6,231
|
3.48
|
191,135
|
5,819
|
3.04
|
|||||||||||||||||||
|
Non taxable
|
65,902
|
4,399
|
6.67
|
30,041
|
2,129
|
7.09
|
23,311
|
1,854
|
7.95
|
|||||||||||||||||||
|
Total
|
237,622
|
12,098
|
5.09
|
209,059
|
8,360
|
4.00
|
214,446
|
7,673
|
3.58
|
|||||||||||||||||||
|
Federal
funds sold
|
463
|
1
|
.21
|
1,876
|
55
|
2.93
|
2,043
|
35
|
1.71
|
|||||||||||||||||||
|
Interest-bearing
deposits with other banks
|
2,811
|
165
|
5.88
|
5,327
|
162
|
3.04
|
3,583
|
56
|
1.57
|
|||||||||||||||||||
|
Other
interest earning assets
|
9,231
|
525
|
5.68
|
8,680
|
355
|
4.09
|
8,439
|
303
|
3.59
|
|||||||||||||||||||
|
Total
earning assets
|
1,207,836
|
81,838
|
6.78
|
%
|
1,179,726
|
70,533
|
5.98
|
%
|
1,089,766
|
61,380
|
5.63
|
%
|
||||||||||||||||
|
Allowance
for loan losses
|
(6,245
|
)
|
(6,975
|
)
|
(6,150
|
)
|
||||||||||||||||||||||
|
Non-earning
assets
|
110,098
|
102,500
|
94,730
|
|||||||||||||||||||||||||
|
Total
Assets
|
$
|
1,311,689
|
$
|
1,275,251
|
$
|
1,178,346
|
||||||||||||||||||||||
|
Liabilities
and Shareholders’ Equity
|
||||||||||||||||||||||||||||
|
Interest-bearing
demand deposits
|
$
|
285,250
|
$
|
6,405
|
2.25
|
%
|
$
|
293,129
|
$
|
4,896
|
1.67
|
%
|
$
|
279,217
|
$
|
2,699
|
.97
|
%
|
||||||||||
|
Savings
deposits
|
47,779
|
462
|
.97
|
58,964
|
242
|
.41
|
63,471
|
237
|
.37
|
|||||||||||||||||||
|
Time
deposits:
|
||||||||||||||||||||||||||||
|
Less
than $100
|
229,829
|
8,439
|
3.67
|
264,503
|
6,023
|
2.28
|
209,708
|
4,950
|
2.36
|
|||||||||||||||||||
|
$100
or more
|
273,305
|
12,043
|
4.41
|
187,412
|
7,943
|
4.24
|
149,113
|
4,222
|
2.83
|
|||||||||||||||||||
|
Short-term
borrowings
|
107,430
|
4,429
|
4.12
|
100,601
|
2,749
|
2.73
|
82,747
|
1,153
|
1.39
|
|||||||||||||||||||
|
Long-term
borrowings
|
153,089
|
7,557
|
4.94
|
159,748
|
7,560
|
4.73
|
205,193
|
10,755
|
5.23
|
|||||||||||||||||||
|
Total
interest-bearing liabilities
|
1,096,682
|
39,335
|
3.59
|
%
|
1,064,357
|
29,413
|
2.76
|
%
|
989,449
|
24,016
|
2.43
|
%
|
||||||||||||||||
|
Non-interest-bearing
Deposits
|
107,595
|
112,860
|
94,871
|
|||||||||||||||||||||||||
|
Other
liabilities
|
11,189
|
8,734
|
8,266
|
|||||||||||||||||||||||||
|
Shareholders’
Equity
|
96,223
|
89,300
|
85,760
|
|||||||||||||||||||||||||
|
Total
Liabilities and Shareholders’ Equity
|
$
|
1,311,689
|
$
|
1,275,251
|
$
|
1,178,346
|
||||||||||||||||||||||
|
Net
interest income and Spread
|
$
|
42,503
|
3.19
|
%
|
$
|
41,120
|
3.22
|
%
|
$
|
37,364
|
3.20
|
%
|
||||||||||||||||
|
Net
interest margin
|
3.52
|
%
|
3.49
|
%
|
3.43
|
%
|
||||||||||||||||||||||
NOTES:
--The
above table reflects the average rates earned or paid stated on a tax equivalent
basis assuming a tax rate of 35% for 2006 and 2005 and 34% for 2004. The fully
taxable equivalent adjustments for the years ended December 31, 2006, 2005,
and
2004 were $1,569, $776, and $698, respectively.
--The
average balances of non-accrual loans for the years ended December 31, 2006,
2005 and 2004, which were reported in the average loan balances for these years,
were $2,705, $3,203, and $4,400, respectively.
--Net
interest margin is calculated as net interest income divided by average earning
assets.
--The
average yields on investments are based on amortized cost.
[23]
Interest
Variance Analysis (1)
(In
thousands and tax equivalent basis)
Table
2
|
2006
Compared to 2005
|
2005
Compared to 2004
|
||||||||||||||||||
|
Volume
|
Rate
|
Net
|
Volume
|
Rate
|
Net
|
||||||||||||||
|
INTEREST
INCOME:
|
|||||||||||||||||||
|
Loans
|
$
|
211
|
$
|
7,237
|
$
|
7,448
|
$
|
6,034
|
$
|
2,253
|
$
|
8,287
|
|||||||
|
Taxable
Investments
|
(327
|
)
|
1,795
|
1,468
|
(422
|
)
|
833
|
411
|
|||||||||||
|
Non-taxable
Investments
|
2,394
|
(124
|
)
|
2,270
|
477
|
(202
|
)
|
275
|
|||||||||||
|
Federal
funds sold
|
(4
|
)
|
(50
|
)
|
(54
|
)
|
(5
|
)
|
25
|
20
|
|||||||||
|
Other
interest earning assets
|
(227
|
)
|
400
|
173
|
142
|
16
|
158
|
||||||||||||
|
Total
interest income
|
2,047
|
9,258
|
11,305
|
6,226
|
2,925
|
9,151
|
|||||||||||||
|
INTEREST
EXPENSE:
|
|||||||||||||||||||
|
Interest-bearing
demand deposits
|
(177
|
)
|
1,686
|
1,509
|
232
|
1,964
|
2,196
|
||||||||||||
|
Savings
deposits
|
(108
|
)
|
328
|
220
|
(18
|
)
|
23
|
5
|
|||||||||||
|
Time
deposits less than $100
|
(1,273
|
)
|
3,689
|
2,416
|
1,248
|
(175
|
)
|
1,073
|
|||||||||||
|
Time
deposits $100 or more
|
3,785
|
315
|
4,100
|
1,623
|
2,098
|
3,721
|
|||||||||||||
|
Short-term
borrowings
|
282
|
1,398
|
1,680
|
488
|
1,108
|
1,596
|
|||||||||||||
|
Long-term
borrowings
|
(329
|
)
|
326
|
(3
|
)
|
(2,151
|
)
|
(1,044
|
)
|
(3,195
|
)
|
||||||||
|
Total
interest expense
|
2,180
|
7,742
|
9,922
|
1,422
|
3,974
|
5,396
|
|||||||||||||
|
Net
interest income
|
$
|
(133
|
)
|
$
|
1,516
|
$
|
1,383
|
$
|
4,804
|
$
|
(1,049
|
)
|
$
|
3,755
|
|||||
|
(1)
|
The
change in interest income/expense due to both volume and rate has
been
allocated to volume and rate changes in proportion to the relationship
of
the absolute dollar amounts of the change in
each.
|
Provision
for Loan Losses
The
provision for loan losses in 2006 increased by $.1 million over 2005, due
primarily to an increase in the level of non-accrual loans and changes in the
qualitative factors used in the quarterly evaluation of the adequacy of the
allowance for loan losses. These changes were offset by a decrease in net
charge-offs as a percentage of average loans to .11% in 2006 from .15% in 2005
and minimal loan growth in 2006.
The
provision for loan losses decreased to $1.1 million in 2005, compared to $2.5
million in 2004. This decrease was due primarily to the decrease in net
charge-offs as a percentage of average loans to .15% in 2005 from .20% in 2004
and a decrease in specific allocations as compared to 2004.
[24]
Other
Operating Income
The
following table shows the major components of other operating income for the
past three years (in thousands) and the percentage changes during these
years:
|
2006
VS. 2005
|
2005
VS. 2004
|
|||||||||||||||
|
2006
|
2005
|
2004
|
%
CHANGE
|
%
CHANGE
|
||||||||||||
|
Service
charges on deposit accounts
|
$
|
4,630
|
$
|
4,260
|
$
|
3,824
|
8.7
|
%
|
11.4
|
%
|
||||||
|
Other
service charge income
|
1,637
|
1,203
|
925
|
36.1
|
%
|
30.1
|
%
|
|||||||||
|
Trust
department income
|
3,671
|
3,260
|
3,153
|
12.6
|
%
|
3.4
|
%
|
|||||||||
|
Brokerage
commission
|
501
|
613
|
720
|
(18.3
|
%)
|
(14.9
|
%)
|
|||||||||
|
Insurance
commissions
|
1,573
|
1,599
|
1,448
|
(1.6
|
%)
|
10.4
|
%
|
|||||||||
|
Security
gains (losses)
|
4
|
(125
|
)
|
703
|
*
|
*
|
||||||||||
|
Bank
owned life insurance (BOLI)
|
848
|
819
|
626
|
3.5
|
%
|
30.8
|
%
|
|||||||||
|
Gain
on prepayment of long term borrowings
|
--
|
868
|
--
|
|||||||||||||
|
Other
income
|
1,177
|
1,591
|
1,572
|
(26.0
|
%)
|
1.2
|
%
|
|||||||||
|
Total
other operating income
|
$
|
14,041
|
$
|
14,088
|
$
|
12,971
|
(.33
|
%)
|
8.6
|
%
|
||||||
*
not
meaningful
As
the
table above illustrates, other operating income decreased slightly in 2006
by
$.05 million when compared to 2005. This is compared to a $1.1 million (8.6%)
increase in 2005 from 2004.
Service
charges on deposit accounts and other service charge income increased in 2006
versus 2005 and in 2005 versus 2004. These increases are due primarily to
increased customer usage of an account overdraft product. Service charge related
income constitutes 45%, 39%, and 37% of other operating income in 2006, 2005,
and 2004, respectively.
Trust
department income is directly affected by the performance of the equity and
bond
markets, and by the amount of assets under management. Trust income has
increased steadily during the past three years as a result of successful
business development efforts in this area, resulting in increases in the average
market value of assets under management in the Trust Department. Average assets
under management were $502 million, $468 million and $395 million for years
2006, 2005 and 2004, respectively.
Brokerage
commissions have steadily declined over the past three years. Less emphasis
on
this type of business and slower annuity sales have contributed to this decline.
Insurance premium income also declined slightly in 2006 due to the closing
of
the Corporation’s reinsurance company, Oakfirst Life Insurance, Inc., in 2005
and lower contingency income. Contingency income is received from the insurance
carriers based upon claims histories and varies from year to year. First United
Insurance Group purchased a book of business in Morgantown, WV during the latter
half of 2006. Because premium payment schedules are more heavily weighted in
the
first six months of the year, management expects to realize the full benefit
of
this purchase in 2007.
Securities
gains (losses) are the most variable component of other operating income. During
2006, the Bank recorded a minimal gain in the securities portfolio compared
to
the recorded losses in the securities portfolio of $.1 million in 2005. Net
securities gains for 2004 of $.7 million resulted primarily from the sale of
investments held by the Bank’s Delaware subsidiary, First United Securities,
Inc. (“FUS”), in order to utilize certain net operating loss carry-forwards in
that subsidiary prior to its liquidation in May 2004.
[25]
Other
Operating Expense
Other
operating expense for 2006 increased $.8 million (2.4%) over 2005, compared
to a
decrease of $1.3 million (3.7%) over 2004. The following table
shows the major components of other operating expense for the past three years
(in thousands) and the percentage changes during these years:
|
2006
VS. 2005
|
2005
VS. 2004
|
|||||||||||||||
|
2006
|
2005
|
2004
|
%
CHANGE
|
%
CHANGE
|
||||||||||||
|
Salaries
and employee benefits
|
$
|
19,084
|
$
|
18,428
|
$
|
16,907
|
3.6
|
%
|
9.0
|
%
|
||||||
|
Other
expenses
|
9,900
|
9,676
|
10,360
|
2.3
|
%
|
(6.6
|
%)
|
|||||||||
|
Equipment
|
3,011
|
3,067
|
2,952
|
(1.8
|
%)
|
3.9
|
%
|
|||||||||
|
Expenses
related to prepayment of long-term borrowings
|
--
|
437
|
2,728
|
--
|
(84.0
|
%)
|
||||||||||
|
Occupancy
|
2,043
|
1,642
|
1,642
|
24.4
|
%
|
--
|
||||||||||
|
Data
processing
|
1,452
|
1,404
|
1,380
|
3.4
|
%
|
1.7
|
%
|
|||||||||
|
Total
other operating expense
|
$
|
35,490
|
$
|
34,654
|
$
|
35,969
|
2.4
|
%
|
(3.7
|
%)
|
||||||
Salaries
and employee benefits represent approximately 54% of total other operating
expenses in 2006, compared to 53% and 47% in 2005 and 2004, respectively.
Salaries and wages increased by $.7 million in 2006 over
2005,
and $1.5 million in 2005 over 2004. The increase in both periods is directly
related to increased staffing to support our growth objectives and routine
merit
pay increases. The higher increase in 2005 over 2004 was attributable to
increases in performance based incentives resulting from high loan and deposit
growth.
Other
expenses increased by $.2 million in 2006 when compared to 2005 due to increases
in marketing, insurance, and contribution expenses. We experienced cost savings
in 2006 associated with corporate restructurings that occurred during 2005.
Comparing 2005 to 2004, other expenses decreased by $.7 million due
to
reduced professional fees associated with various compliance costs in 2005,
such
as the Sarbanes-Oxley Act.
There
were no expenses related to prepayment of long-term borrowings in 2006. Expenses
related to early redemption of long-term borrowings consisted of $.4 million
and
$1.8 million in early payment penalties in 2005 and 2004, respectively, and
a
$.9 million write-off of unamortized issuance costs related to the early
redemption of subordinated debentures in 2004.
Occupancy
and equipment expenses increased by $.3 million from 2005 to 2006 and $.1
million from 2004 to 2005. These increases relate to the growth and expansion
of
the Bank’s retail network.
Applicable
Income Taxes
Income
tax expense amounted to $5.7 million in 2006, compared to $6.5 million in 2005
and $3.5 million in 2004. The resulting
effective tax rates were 31.3%, 35.0% and 31.5% for 2006, 2005 and 2004,
respectively. The decrease in the effective tax rate for 2006 reflects the
effects of management’s efforts during late 2005 and early 2006 to restructure
the composition of the investment portfolio to include more tax exempt municipal
securities. The increase in the effective tax rate in 2005 over 2004 was due
primarily to corporate restructurings in February 2004 and May
2004.
[26]
CONSOLIDATED
BALANCE SHEET REVIEW
Overview
Our
total
assets reached $1.35 billion at December 31, 2006, representing an increase
of
$40 million (3.0%) from year-end 2005.
The
2006
year-end
total interest-earning asset mix shows a consistent percentage of loans as
a
percentage of total assets over the past three years, as illustrated
below:
|
Year
End Percentage of Total Assets
|
|||
|
2006
|
2005
|
2004
|
|
|
Net
loans
|
71%
|
73%
|
73%
|
|
Investments
|
20%
|
18%
|
17%
|
The
year-end total liability mix shows greater reliance on deposits as a source
of
funding during the three year period and reduced reliance on borrowings, as
illustrated below:
|
Year
End Percentage of Total Liabilities
|
|||
|
2006
|
2005
|
2004
|
|
|
Total
deposits
|
78%
|
78%
|
74%
|
|
Total
borrowings
|
21%
|
21%
|
25%
|
Loan
Portfolio
Through
the Bank and the OakFirst Loan Centers, we are actively engaged in originating
loans to customers primarily in Garrett, Allegany, Washington, and Frederick
Counties in Maryland; Mineral, Hardy, Berkeley, Monongalia Counties in West
Virginia; and the surrounding regions of West Virginia and Pennsylvania. We
have
policies and procedures designed to mitigate credit risk and to maintain the
quality of our loan portfolio. These policies include underwriting standards
for
new credits as well as continuous monitoring and reporting policies for asset
quality and the adequacy of the allowance for loan losses. These policies,
coupled with ongoing training efforts, have provided effective checks and
balances for the risk associated with the lending process. Lending authority
is
based on the type of the loan, and the experience of the lending
officer.
Commercial
loans are collateralized primarily by real estate, and to a lesser extent,
by
equipment and vehicles. Unsecured commercial loans represent an insignificant
portion of total commercial loans. Residential mortgage loans are collateralized
by the related property. Any residential mortgage loan exceeding a
specified
internal
loan-to-value ratio requires private mortgage insurance. Installment loans
are
typically collateralized, with loan-to-value ratios which are established based
on the financial condition of the borrower. We will also make unsecured consumer
loans to qualified borrowers meeting our underwriting standards. Additional
information about our loans and underwriting policies can be found in Item
1 of
Part I of this annual report under the caption “Banking Products and Services”.
Table
3
sets forth the composition
of our
loan portfolio. Historically, our policy has been to make the majority of our
loan commitments in our market areas. We had no foreign loans in our portfolio
as of December 31 for all of the periods presented.
[27]
Summary
of Loan Portfolio
(Dollars
in thousands)
Table
3
|
Loans
Outstanding as of December 31
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
Commercial
|
$
|
408,361
|
$
|
404,681
|
$
|
373,893
|
$
|
307,523
|
$
|
242,470
|
||||||
|
Real
Estate - Mortgage
|
359,601
|
337,559
|
319,033
|
264,730
|
233,887
|
|||||||||||
|
Consumer
Installment
|
181,574
|
193,275
|
199,862
|
201,419
|
173,578
|
|||||||||||
|
Real
Estate - Construction
|
14,120
|
25,446
|
18,196
|
16,093
|
11,072
|
|||||||||||
|
Lease
Financing
|
--
|
--
|
466
|
2,260
|
4,819
|
|||||||||||
|
Total
Loans
|
$
|
963,656
|
$
|
960,961
|
$
|
911,450
|
$
|
792,025
|
$
|
665,826
|
||||||
During
2006, gross loans increased by $3 million, or .3% over 2005. This growth was
focused in our commercial ($4 million) and residential mortgage ($22 million)
loan portfolios, offset by a decline in installment ($12 million) and
residential - construction ($11 million) loan portfolios, and remains consistent
with management’s objectives over the past several years. Continued efforts were
made to increase the percentage of loans in the portfolio with adjustable
interest rates. At year-end 2006, adjustable interest rate loans maturing within
one to five years were 53% of total loans, compared to 59% at year-end
2005.
Commercial
loans increased 1% in 2006, following an 8% increase in 2005. Origination of
new
commercial loans remained high in 2006, similar to 2005, as our lenders
continued to identify new customer opportunities and expand existing customer
relationships in all of our market areas, while maintaining existing standards
of credit worthiness. However, during both 2005 and 2006, new loan volume was
offset by high levels of repayment, which stifled growth as compared to prior
years. Most new commercial loans were priced on a variable rate basis, resetting
monthly, which proved to be very popular with business borrowers. Commercial
loans secured by real estate were 82% of total commercial loans at the end
of
2006, compared to 80% in 2005 and 81% in 2004.
Residential
mortgage loans increased by $22 million, or 7%, in 2006 when compared to 2005.
This follows a 6% increase in 2005 over 2004. Growth in the mortgage loan
portfolio during 2006 was primarily in fixed rate mortgages due to the flat
interest rate yield curve. This loan product was utilized to satisfy the
requirements of the Community Reinvestment Act. Actual residential mortgage
growth in 2005 of $50 million over 2004 (16%) was offset by $31 million in
loan
sales during the fourth quarter of 2005. The loans selected for sale were
identified through an extensive analysis of the mortgage portfolio and included
primarily adjustable rate products that management believed presented limited
opportunities for improved yields in the next few years. Proceeds from the
loan
sale were invested in the Bank’s investment portfolio, primarily in higher
yielding tax-exempt municipal securities.
Fixed-interest
rate loans make up 59% of the total loan portfolio at the end of 2006, compared
to 33% of total loans at the end of 2005 and 67% at the end of 2004.
Consumer
installment loans in 2006 decreased by $11.7 million, or 6%, when compared
to
2005. This decrease reflects management’s continued shift toward more commercial
loans with less emphasis on the highly competitive consumer loan market.
Specifically, less focus was placed on generating new indirect
auto loans during 2006 and 2005. Indirect auto loans comprise the largest
percentage of installment loans, 85% at the end of 2006, and 84% and 78% at
the
end of 2005 and 2004, respectively. The remaining lease financing portfolio
was
repaid in 2005 and we discontinued this line of business.
[28]
The
following table
sets
forth remaining maturities, based upon contractual dates, for selected loan
categories as of December 31, 2006 (in thousands):
Maturities
of Loan Portfolio at December 31, 2006
Table
4
|
Maturing
Within
One
Year
|
After
One
But
Within
Five
Years
|
Maturing
After
Five
Years
|
Total
|
||||||||||
|
Commercial
|
$
|
229,467
|
$
|
161,633
|
$
|
17,261
|
$
|
408,361
|
|||||
|
Real
Estate - Mortgage
|
80,183
|
136,425
|
142,993
|
359,601
|
|||||||||
|
Installment
|
10,244
|
16,937
|
154,393
|
181,574
|
|||||||||
|
Real
Estate - Construction
|
--
|
14,120
|
--
|
14,120
|
|||||||||
|
Total
Loans
|
$
|
319,894
|
$
|
329,115
|
$
|
314,647
|
$
|
963,656
|
|||||
|
Classified
by Sensitivity to Change in Interest Rates
|
|||||||||||||
|
Fixed-Interest
Rate Loans
|
$
|
45,375
|
$
|
92,123
|
$
|
291,246
|
$
|
428,744
|
|||||
|
Adjustable-Interest
Rate Loans
|
274,519
|
236,992
|
23,401
|
534,912
|
|||||||||
|
Total
Loans
|
$
|
319,894
|
$
|
329,115
|
$
|
314,647
|
$
|
963,656
|
|||||
It
is our
policy to place a loan in non-accrual status, except for consumer loans,
whenever there is substantial doubt about the ability of a borrower to pay
principal or interest on the outstanding credit. Management considers such
factors as payment history, the nature of the collateral securing the loan,
and
the overall economic situation of the borrower when making a non-accrual
decision. Management closely monitors the status of all non-accrual loans.
A
non-accruing loan is restored to accrual status when principal and interest
payments have been brought current, it becomes well secured, or is in the
process of collection and the prospects of future contractual payments are
no
longer in doubt. Generally, consumer installment loans are not placed on
non-accrual status, but are charged off after they are 120 days contractually
past due. Table 5 sets forth the historical amounts of non-accrual, past-due
and
restructured loans (in thousands) for the past five years:
Risk
Elements of Loan Portfolio
Table
5
|
At
December 31
|
||||||||||||||||
|
2006
|
2005
|
2004
|
2003
|
2002
|
||||||||||||
|
Non-Accrual
Loans
|
$
|
3,190
|
$
|
2,393
|
$
|
3,439
|
$
|
2,774
|
$
|
1,847
|
||||||
|
Accruing
Loans Past Due 90 Days or More
|
619
|
989
|
1,105
|
1,236
|
1,458
|
|||||||||||
|
Restructured
Loans
|
522
|
532
|
544
|
554
|
565
|
|||||||||||
Interest
income not recognized as a result of placing loans on a non-accrual status
was
$.2 million, $.05 million and $.4 million during 2006, 2005 and 2004,
respectively.
Allowance
for Loan Losses
An
allowance for loan losses is maintained to absorb losses from the loan
portfolio. The allowance for loan losses is based on management’s continuing
evaluation of the quality of the loan portfolio, assessment of current economic
conditions, diversification and size of the portfolio, adequacy of collateral,
past and anticipated loss experience, and the amount of non-performing
loans.
We
use
the methodology outlined in FDIC Statement of Policy on Allowance for Loan
and
Lease Losses. The starting point for this methodology is to segregate the loan
portfolio into two pools, non-homogeneous (i.e., commercial) and homogeneous
(i.e., consumer and residential mortgage) loans. Each loan pool is analyzed
with
general allowances and specific allocations being made as appropriate. For
general allowances, the previous eight quarters of loss activity are used in
the
estimation of losses in the current portfolio. These historical loss amounts
are
modified by the following qualitative factors: levels of and trends in
delinquency rates and non-accrual loans; trends in volumes and terms of loans;
effects of changes in lending policies; experience, ability, and depth of
management; national and local economic trends and conditions; and
concentrations of credit in the determination of the general allowance. The
qualitative factors are updated each quarter by information obtained from
internal, regulatory, and governmental sources. Specific allocations of the
allowance for loan losses are made for those loans on the “Watchlist” in which
the collateral value is less than the outstanding loan balance with the
allocation being the dollar difference between the two. The Watchlist represents
loans, identified and closely monitored by management, which possess certain
qualities or characteristics that may lead to collection and loss issues.
Allocations are not made for loans that are cash secured, for the Small Business
Administration and Farm Service Agency guaranteed portion of loans, or for
loans
that are sufficiently collateralized.
[29]
The
allowance for loan losses is based on estimates, and actual losses will vary
from current estimates. These estimates are reviewed quarterly, and as
adjustments, either positive or negative, become necessary, a corresponding
increase or decrease is made in the allowance for loan losses. The methodology
used to determine the adequacy of the allowance for loan losses is consistent
with prior years. An estimate for probable losses related to unfunded lending
commitments, such as letters of credit and binding but unfunded loan commitments
is also prepared. This estimate is computed in a manner similar to the
methodology described above, adjusted for the probability of actually funding
the commitment.
The
balance of the allowance for loan losses increased to $6.5 million at year-end
2006, from $6.4 million at year-end 2005. Several factors contributed to the
$.1
million increase in the balance of the allowance in 2006, including: a 33%
increase in the balance of non-accrual loans (from $2.4 million in 2005 to
$3.2
million in 2006); changes to the qualitative factors which are reveiewed
quarterly; offset by a decrease in impaired loans from $.2 million in 2005
to
$.1 million in 2006; and a decrease in the percentage of net charge-offs to
average outstanding loans from .15% to .11%, due to a decline in the amount
of
commercial and installment loan charge-offs during 2006. At December 31, 2006,
the balance of the allowance was equal to .68% of total loans, which was six
times the amount of net charge-offs for the year.
The
balance of the allowance for loan losses decreased to $6.4 million at year-end
2005, from $6.8 million at year-end 2004. Several factors contributed to the
$.4
million decrease in the balance of the allowance in 2005, including: a 29%
decrease in the balance of non-accrued loans (from $3.4 million in 2004 to
$2.4
million in 2005); a decrease in impaired loans from $.6 million in 2004 to
$.2
million in 2005; and a decrease in the percentage of net charge-offs to average