Unassociated Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO
 SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For quarterly period ended September 30, 2009

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
  
(I. R. S. Employer Identification No.)
incorporation or organization)
    

19 South Second Street, Oakland, Maryland     21550-0009
(Address of principal executive offices)         (Zip Code)

(800) 470-4356
(Registrant's telephone number, including area code)

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 for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes R  No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes £ No £ (Not Applicable)

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large accelerated filer £
Accelerated filer R
Non-accelerated filer £ (Do not check if a smaller reporting company)
Smaller reporting company £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).Yes £ No R

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  6,132,448 shares of common stock, par value $.01 per share, as of October 31, 2009.

 
 
 

INDEX TO QUARTERLY REPORT
FIRST UNITED CORPORATION


PART I.  FINANCIAL INFORMATION
  
   
 
Item 1.
Financial Statements (unaudited)
3
   
 
 
Consolidated Statements of Financial Condition –September 30, 2009 and December 31, 2008
3
   
 
 
Consolidated Statements of Operations - for the nine months and three months ended September 30, 2009 and 2008
4
   
 
 
Consolidated Statements of Changes in Shareholders’ Equity - for the nine months ended September 30, 2009 and year ended December 31, 2008
6
   
 
 
Consolidated Statements of Cash Flows - for the nine months ended September 30, 2009 and 2008
7
   
 
 
Notes to Consolidated Financial Statements
8
     
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
25
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
39
     
Item 4.
Controls and Procedures
40 
     
PART II. OTHER INFORMATION
  
     
Item 1.
Legal Proceedings
40 
     
Item 1A.
Risk Factors
40 
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
40 
     
Item 3.
Defaults Upon Senior Securities
40 
     
Item 4.
Submission of Matters to a Vote of Security Holders
40 
     
Item 5.
Other Information
40 
     
Item 6.
Exhibits
41 
     
SIGNATURES
42 
     
EXHIBIT INDEX
43 
 
 
2
 

PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

FIRST UNITED CORPORATION
Consolidated Statements of Financial Condition
(In thousands, except per share and percentage data)
 
   
September 30,
2009
    
December 31,
2008
  
   
(Unaudited)
  
Assets
      
Cash and due from banks
   $ 63,096     $ 18,423  
Interest bearing deposits in banks
     36,575       882  
Cash and cash equivalents
     99,671       19,305  
Investment securities - trading (at fair value)
     183       -  
Investment securities - available-for-sale (at fair value)
     317,887       354,595  
Federal Home Loan Bank stock, at cost
     13,861       13,933  
Loans
     1,138,366       1,134,546  
Allowance for loan losses
     (16,929 )     (14,347 )
Net loans
     1,121,437       1,120,199  
Premises and equipment, net
     32,363       31,124  
Goodwill and other intangible assets, net
     15,455       16,322  
Bank owned life insurance
     30,144       29,743  
Deferred tax assets
     25,379       31,407  
Accrued interest receivable and other assets
     25,369       22,476  
                 
Total Assets
   $ 1,681,749     $ 1,639,104  
                 
Liabilities and Shareholders' Equity
                
Liabilities:
                
Non-interest bearing deposits
   $ 107,608     $ 107,749  
Interest bearing deposits
     1,129,526       1,115,140  
Total deposits
     1,237,134       1,222,889  
Short-term borrowings
     46,229       50,495  
Long-term borrowings
     276,615       277,403  
Accrued interest payable and other liabilities
     14,784       14,529  
Dividends payable
     1,229       1,098  
Total Liabilities
     1,575,991       1,566,414  
                 
Shareholders' Equity:
                
Preferred stock —no par value;
                
Authorized 2,000 shares of which 30 shares of Series A,
$1,000 per share  liquidation preference, 5% cumulative
increasing to 9% cumulative on February 15, 2014, were
issued and outstanding on September 30, 2009 (discount
of $290 and $0, respectively)
           29,724             -  
Common Stock – par value $.01 per share;
                
Authorized 25,000 shares; issued and outstanding 6,132 shares at
September 30, 2009 and 6,113 shares at December 31, 2008
     61       61  
Surplus
     21,183       20,520  
Retained earnings
     86,388       93,092  
Accumulated other comprehensive loss
     (31,598 )     (40,983 )
Total Shareholders' Equity
     105,758       72,690  
                 
Total Liabilities and Shareholders' Equity
   $ 1,681,749     $ 1,639,104  
 
See accompanying notes to the consolidated financial statements.
 
3

FIRST UNITED CORPORATION
Consolidated Statements of Operations
(In thousands, except per share data)

   
Nine Months Ended
September 30,
  
   
2009
    
2008
  
   
(Unaudited)
  
Interest income
            
Interest and fees on loans
   $ 51,571     $ 55,921  
Interest on investment securities:
                
Taxable
     10,316       12,491  
Exempt from federal income tax
     2,932       2,536  
Total investment income
     13,248       15,027  
Other
     65       538  
Total interest income
     64,884       71,486  
Interest expense
                
Interest on deposits
     15,385       23,972  
Interest on short-term borrowings
     237       852  
Interest on long-term borrowings
     8,768       8,208  
Total interest expense
     24,390       33,032  
Net interest income
     40,494       38,454  
Provision for loan losses
     10,837       6,570  
Net interest income after provision for loan losses
     29,657       31,884  
Other operating income
                
Service charges
     4,163       4,741  
Trust department
     2,631       2,989  
Total other-than-temporary security impairment losses
     (18,334 )     —  
Less: Portion of loss recognized in other comprehensive income (before taxes)
     7,492       —  
Net securities impairment losses recognized in earnings
     (10,842 )     —  
Securities losses – trading
     (226 )     —  
Securities gains – available-for-sale
     131       476  
Insurance commissions Bank owned life insurance
     2,123 401       1,602 585  
Other income
     2,244       2,295  
Total other operating income
     625       12,688  
Other operating expenses
                
Salaries and employee benefits
     17,398       16,586  
Occupancy, equipment and data processing
     6,494       6,027  
Other expense
     11,144       8,368  
Total other operating expenses
     35,036       30,981  
(Loss)/Income before income taxes
     (4,754 )     13,591  
Applicable income tax (benefit) expense
     (2,696 )     4,477  
Net (Loss)/Income
     (2,058 )     9,114  
Accumulated preferred stock dividends and discount accretion
     (1,041 )     —-  
Net (Loss)/Income Available to Common Shareholders
   $ (3,099 )   $ 9,114  
Basic net (loss)/income per common share
   $ (.51 )   $ 1.49  
Diluted net (loss)/income per common share 
   $ (.51 )   $  1.49  
Dividends declared per common share
   $ .60     $ .60  
Weighted average number of  common shares outstanding
     6,116       6,113  
Weighted average number of diluted shares outstanding 
     6,116       6,131  

See accompanying notes to the consolidated financial statements.

 
4
 

FIRST UNITED CORPORATION
Consolidated Statements of Operations
(In thousands, except per share data)

   
Three Months Ended
September 30,
  
   
2009
    
2008
  
   
(Unaudited)
  
Interest income
            
Interest and fees on loans
   $ 17,061     $ 18,483  
Interest on investment securities:
                
        Taxable
     3,041       4,321  
        Exempt from federal income tax
     975       845  
       Total investment income
     4,016       5,166  
Other
     61       128  
Total interest income
     21,138       23,777  
Interest expense
                
Interest on deposits
     4,835       7,330  
Interest on short-term borrowings
     82       230  
Interest on long-term borrowings
     2,916       3,016  
       Total interest expense
     7,833       10,576  
Net interest income
     13,305       13,201  
Provision for loan losses
     6,917       4,217  
     Net interest income after provision for loan losses
     6,388       8,984  
Other operating income
                
Service charges
     1,460       1,595  
Trust department
     944       971  
Total other-than-temporary security impairment losses
     (12,538 )     —  
Less: Portion of loss recognized in other comprehensive income (before taxes)
     3,877       —  
Net security impairment losses recognized in earnings
     (8,661 )     —  
Securities gains – trading
     147       —  
Securities gains – available-for-sale
     35       —-  
Insurance commissions
     682       521  
Bank owned life insurance
      133       138  
Other income
     730       553  
        Total other operating (loss)/income
     (4,530 )     3,778  
Other operating expenses
                
 Salaries and employee benefits
     5,551       5,364  
 Occupancy, equipment and data processing
     2,236       2,182  
 Other expense
     3,713       2,430  
         Total other operating expenses
     11,500       9,976  
 (Loss)/Income before income taxes
     (9,642 )     2,786  
 Applicable income tax (benefit) expense
     (4,056 )     921  
Net (Loss)/Income
     (5,586 )     1,865  
     Accumulated preferred stock dividends and discount accretion
     (389 )     —-  
 Net (Loss)/Income Available to Common Shareholders
   $ (5,975 )   $ 1,865  
 Basic net (loss)/income per common share
   $ (.97 )   $ .30  
Diluted net (loss)/income per common share 
   $ (.97 )   $ .30  
 Dividends per common share
   $ .20     $ .20  
Weighted average number of  common shares outstanding      6,132       6,103  
Weighted average number of diluted shares outstanding
     6,132        6,121  

See accompanying notes to the consolidated financial statements.

 
5
 

FIRST UNITED CORPORATION
Consolidated Statements of Changes in Shareholders’ Equity
(Dollars in thousands, except per share data)

   
Preferred
Stock
    
Common
Stock
    
Surplus
    
Retained
Earnings
    
Accumulated
Other
Comprehensive
Loss
    
Total
Shareholders’
Equity
  
Balance at January 1, 2008
   $ -     $ 61     $ 21,400     $ 88,859     $ (5,655 )   $ 104,665  
                                                 
Comprehensive income:
                                                
   Net income
                             8,871               8,871  
   Unrealized loss on securities
        available-for- sale, net of
        income taxes of $20,748
                                     (30,660 )     (30,660 )
   Change in accumulated unrealized
        losses for pension and SERP
        obligations, net of income
        taxes of $2,784
                                     (4,668 )     (4,668 )
Comprehensive loss
                                             (26,457 )
Issuance of 25,814 shares of
       common stock under dividend
       reinvestment plan
                        362                          362  
Repurchase of common stock
                     (1,391 )                     (1,391 )
Stock based compensation
                     149                       149  
Cash dividends declared - $.80 per share
                             (4,638 )             (4,638 )
                                                      
Balance at December 31, 2008
     -       61        20,520       93,092       (40,983 )     72,690  
                                                 
Comprehensive income:
                                                
   Net loss
                             (2,058 )             (2,058 )
   Unrealized gain on securities
        available-for-sale, net of
        reclassifications and income taxes of
$6,466
                                          9,554            9,554  
   Unrealized loss on derivatives, net of income taxes of $115
                                     (169 )     (169 )
Comprehensive income
                                             7,327  
Issuance of 32,373 shares of
       common stock under dividend
       reinvestment plan
                        366                          366  
Stock based compensation
                     (16 )                     (16 )
Preferred stock issued pursuant to
       TARP – 30,000 shares
     29,687                                        29,687  
Preferred stock discount accretion
     37                       (37 )             -  
Warrant issued pursuant to TARP
                     313                       313  
Preferred stock dividends
                             (813 )             (813 )
Cash dividends declared on common stock-
$.60 per share
                                 (3,796 )              (3,796 )
                                                 
Balance at September 30, 2009
   $ 29,724     $ 61     $ 21,183     $ 86,388     $ (31,598 )   $ 105,758  

See accompanying notes to the consolidated financial statements.

 
6
 

FIRST UNITED CORPORATION
Consolidated Statements of Cash Flows
(In thousands)
   
Nine Months Ended 
September 30,
  
                                                       
  
2009
    
2008
  
Operating activities
  
(Unaudited)
  
Net (loss)/income
   $ (2,058 )   $ 9,114  
Adjustments to reconcile net (loss) income to net
                
    cash provided by operating activities:
                
        Provision for loan losses
     10,837       6,570  
        Depreciation
     2,046       2,130  
        Stock compensation
     (16 )     140  
        Amortization of intangible assets
     867       513  
        Loss on foreclosed real estate
     114       —  
        Net amortization /(accretion) of investment securities discounts and  premiums
      161       (433 )
        Other-than-temporary-impairment loss on securities 
       10,842       —  
        Loss on investment securities- trading
     226       —  
        Gain on investment securities-available for sale
     (131 )     (476 )
        Increase in accrued interest receivable and other assets
     (1,425 )     (3,647 )
        Increase in deferred tax assets
     (437 )     (92 )
        Increase in accrued interest payable and other liabilities
     255       114  
        Earnings on bank owned life insurance
     (401 )     (585 )
Net cash provided by operating activities
     20,880       13,348  
Investing activities
                
Proceeds from maturities of investment securities available-for-sale      73,738       61,742  
Proceeds from sales/calls of investment securities available-for-sale
     37,878       15,270  
Purchases of investment securities available-for-sale
     (70,170 )     (179,169 )
Purchases of investment securities held to maturity
     —       (8,700 )
Proceeds from sales of foreclosed real estate
     1,148       —  
Net increase in loans
     (14,974 )     (60,582 )
Net decrease (increase) in FHLB stock
      72        (4,599 )
Purchases of premises and equipment
     (3,285 )     (1,911 )
Net cash provided by (used in) investing activities
     24,407       (177,949 )
Financing activities
                
Net (decrease) increase in short-term borrowings       (4,266 )       15,742  
Payments on long-term borrowings      (788 )     (15,786 ) 
Proceeds from long-term borrowings
     —       115,000  
Net increase in deposits
     14,245       50,362  
Proceeds from issuance of preferred stock and warrant
     30,000       —  
Cash dividends paid
     (3,665 )     (3,670 )
Preferred stock dividends paid
     (813 )     —  
Proceeds from issuance of common stock
     366       360  
Stock repurchase
     —       (1,248 )
Net cash provided by financing activities
     35,079       160,760  
Increase (decrease) in cash and cash equivalents
     80,366       (3,841 )
   Cash and cash equivalents at beginning of the year
     19,305       25,802  
Cash and cash equivalents at end of period
   $ 99,671     $ 21,961  
Supplemental information
                
Interest paid
   $ 25,679     $ 33,947  
Taxes paid
   $ 1,750     $ 5,120  
Non-cash investing activities:
                
    Transfers from loans to foreclosed real estate    $ 2,899     $ 313  
    Transfers from available-for-sale securities to trading
   $   409     $   —  
 
See accompanying notes to the consolidated financial statements.

 
7
 

FIRST UNITED CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

September 30, 2009

Note A – Basis of Presentation

The accompanying unaudited consolidated financial statements of First United Corporation (the “Corporation”) and its consolidated subsidiaries have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information, as required by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 270, Interim Reporting, and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all the information and footnotes required for annual financial statements.  In the opinion of management, all adjustments considered necessary for a fair presentation, consisting of normal recurring items, have been included.  Operating results for the three- and nine-month periods ended September 30, 2009 are not necessarily indicative of the results that may be expected for the full year or for any future interim period.  These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2008.  For purposes of comparability, certain prior period amounts have been reclassified to conform to the 2009 presentation.  Such reclassifications had no impact on net income.

The Corporation has evaluated events and transactions occurring subsequent to the balance sheet date of September 30, 2009 for items that should potentially be recognized or disclosed in these financial statements as prescribed by ASC Topic 855, Subsequent Events. The evaluation was conducted through November 9, 2009, the date these financial statements were issued.

Note B – Earnings per Common Share

Basic earnings per common share is derived by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period. There is no dilutive effect on the earnings per share during  loss periods.  The outstanding warrant did not have a dilutive effect under the treasury stock method because the average market prices of the common stock for the three- and nine-month periods ended September 30, 2009 of $10.88 per share and $10.87 per share, respectively, did not exceed the exercise price of the warrant ($13.79 per share).

The following table sets forth the calculation of basic and diluted earnings per common share for the nine- and three-month periods ended September 30, 2009 and 2008 (in thousands, except for per share amounts):

   
For the nine months ended
  
   
September 30, 2009
    
September 30, 2008
  
   
Income
    
Average
Shares
    
Per
Share
Amount
    
Income
    
Average
Shares
    
Per
Share
Amount
  
Basic Earnings Per Share:
                                    
Net (loss)/income
   $ (2,058 )               $ 9,114              
Accumulated preferred stock dividends
     (1,004 )                 —              
Discount accretion on preferred stock
     (37 )                     —                  
Net (loss)/income available to common shareholders
   $ (3,099 )     6,116     $ (.51 )   $ 9,114       6,113     $ 1.49  
                                                 
Diluted Earnings Per Share:
                                                
Net (loss)/income available to common shareholders
   $ (3,099 )     6,116     $ (.51 )   $ 9,114       6,113     $ 1.49  
Non-vested employee stock award
                                         18           
Diluted net (loss)/income available to common shareholders
   $ (3,099 )     6,116     $ (.51 )   $ 9,114       6,131     $ 1.49  
 
 
8
 

   
For the three months ended
  
   
September 30, 2009
    
September 30, 2008
  
   
Income
    
Average
Shares
    
Per
Share
Amount
    
Income
    
Average
Shares
    
Per
Share
Amount
  
Basic Earnings Per Share:
                                    
Net (loss)/income
   $ (5,586 )               $ 1,865              
Accumulated preferred stock dividends
     (375 )                 —              
Discount accretion on preferred stock
     (14 )                      —                  
Net (loss)/income available to common shareholders
   $ (5,975 )     6,132     $ (.97 )   $ 1,865       6,103     $ .30  
                                                 
Diluted Earnings Per Share:
                                                
Net (loss)/income available to common shareholders
   $ (5,975 )     6,132     $ (.97 )   $ 1,865       6,103     $ .30  
Non-vested employee stock award
                                             18           
Diluted net (loss)/income available to common shareholders
   $ (5,975 )     6,132     $ (.97 )   $ 1,865       6,121     $ .30  

Note C – Investments

The investment portfolio is classified and accounted for based on the guidance of ASC Topic 320, Investments – Debt and Equity Securities.

Securities held for trading: Securities that are held principally for resale in the near future are reported at their fair values (See Note F) as investment securities – trading, with changes in fair value reported in earnings.  Interest and dividends on trading securities are included in interest income from investments.

Securities available-for-sale: Securities classified as available-for-sale are stated at their fair values (See Note F), with the unrealized gains and losses, net of tax, reported as a separate component of accumulated other comprehensive income (loss) in shareholders’ equity.   The fair values of investments are based upon information that is currently available and may not necessarily represent amounts that will ultimately be realized, which depend on future events and circumstances that are beyond the control of the Corporation.

The amortized cost of debt securities classified as available-for-sale is adjusted for the amortization of premiums to the first call date, if applicable, or to maturity, and for the accretion of discounts to maturity, or, in the case of mortgage-backed securities, over the estimated life of the security.  Such amortization and accretion is included in interest income from investments.  Interest and dividends are included in interest income from investments.  Gains and losses on the sale of securities are recorded using the specific identification method.

Management systematically evaluates securities for impairment on a quarterly basis.  Based upon application of new accounting guidance for subsequent measurement in Topic 320 (ASC Section 320-10-35), which the Corporation early adopted effective March 31, 2009 according to the effective date provisions of ASC Paragraph 320-10-65-1, management assesses whether (a) it has the intent to sell a security being evaluated and (b) it is more likely than not that the Corporation will be required to sell the security prior to its anticipated recovery.  If neither applies, then declines in the fair values of securities below their cost that are considered other-than-temporary declines are split into two components.  The first is the loss attributable to declining credit quality.  Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made.  The second component consists of all other losses, which are recognized in other comprehensive loss.  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) adverse conditions specifically related to the security, an industry, or a geographic area, (3) the historic and implied volatility of the fair value of the security, (4) changes in the rating of the security by a rating agency, (5) recoveries or additional declines in fair value subsequent to the balance sheet date, (6) failure of the issuer of the security to make scheduled interest or principal payments, and (7) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future.  Management also monitors cash flow projections for securities that are considered beneficial interests under the guidance of ASC Subtopic 325-40, Investments – Other – Beneficial Interests in Securitized Financial Assets, (ASC Section 325-40-35). Further discussion about the evaluation of securities for impairment can be found in Item 2 of Part I of this report under the heading “Investment Securities”.
 
9
 
The following table shows a comparison of amortized cost and fair values of investment securities available-for-sale, at September 30, 2009 and December 31, 2008 (in thousands):
 
   
Amortized
Cost
    
Gross
Unrealized
Gains
    
Gross
Unrealized
Losses
    
Fair
 Value
  
September 30, 2009
                        
U.S. government agencies
   $ 93,769     $ 1,067     $ 153     $ 94,683  
Residential mortgage-backed agencies
     63,822       3,410       —       67,232  
Collateralized mortgage obligations
     42,918       —       8,183       34,735  
Obligations of states and political subdivisions
     97,080       3,542       144       100,478  
Collateralized debt obligations
     59,928       —        39,169       20,759  
                                 
Totals
   $ 357,517     $ 8,019     $ 47,649     $ 317,887  
 
December 31, 2008
                                
U.S. government agencies
   $ 111,938     $ 1,885     $ 178     $ 113,645  
Residential mortgage-backed agencies
     80,354       2,222       15       82,561  
Collateralized mortgage obligations
     51,753       —       11,115       40,638  
Obligations of states and political subdivisions
     95,876       705       3,096       93,485  
Collateralized debt obligations
     70,324       —        46,058       24,266  
                                 
Totals
   $ 410,245     $ 4,812     $ 60,462     $ 354,595  
 
The following table shows the Corporation’s securities available-for-sale with gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2009 and December 31, 2008 (in thousands):
 
   
September 30, 2009
  
   
Less than 12 months
    
12 months or more
  
   
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
  
                         
U.S. government agencies
   $ 9,997     $ 3     $ 14,850     $ 150  
Residential mortgage-backed agencies
     —       —       —       —  
Collateralized mortgage obligations
     —       —       34,735       8,183  
Obligations of states and political
    Subdivisions
     905       13       8,208       131  
Collateralized debt obligations
     —        —       20,759       39,169  
    $ 10,902     $ 16     $ 78,552     $ 47,633  
       
   
December 31, 2008
  
   
Less than 12 months
    
12 months or more
  
   
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
  
                                 
U.S. government agencies
   $ 19,822     $ 178     $ —     $ —  
Residential mortgage-backed agencies     806       15       —       —  
Collateralized mortgage obligations
     37,423       9,927       3,216       1,188  
Obligations of states and political Subdivisions
     66,735       2,781       3,632       315  
Collateralized debt obligations
     2,159       5,393       21,724       40,665  
    $ 126,945     $ 18,294     $ 28,572     $ 42,168  
 
10
 
The amortized cost and estimated fair value of available-for-sale securities by contractual maturity at September 30, 2009 are shown in the following table.  Actual maturities will differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.
 
   
 (in thousands)
  
Contractual Maturity
  
Amortized
 Cost
    
Fair
 Value
  
Due in one year or less
   $ 2,460     $ 2,478  
Due after one year through five years
     25,817       26,254  
Due after five years through ten years
     16,718       17,407  
Due after ten years
     205,782       169,781  
      250,777       215,920  
Residential mortgage-backed agencies
     63,822       67,232  
Collateralized mortgage obligations
     42,918       34,735  
    $ 357,517     $ 317,887  

U.S. Government Agencies – The unrealized losses on the Corporation’s investments in U.S. government agencies of $153,000 are attributable to the lower interest rate environment and call features associated with the securities with premiums paid at the time of purchase.  All of these securities are of the highest investment grade.  The fair value of one security has been impaired for over 12 months and the fair value of one security has been impaired for less than 12 months.  Contractually, the issuers are not permitted to settle the securities at a price less than the amortized cost basis of the individual investments.  The Corporation does not intend to sell these investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost bases, which may be at maturity.  Accordingly, management does not consider these investments to be other-than-temporarily impaired at September 30, 2009.

Residential Mortgage-Backed Agencies - The residential mortgage-backed agencies are in an unrealized gain position of $3.4 million at September 30, 2009.  All of these securities are of the highest investment grade.  Therefore, no impairment exists at September 30, 2009.

Collateralized Mortgage Obligations – The collateralized mortgage obligations are in an unrealized loss position of $8.2 million at September 30, 2009.  All nine of these securities are private label residential mortgage-backed securities and have been in an unrealized loss position for 12 months or more.  These securities are reviewed for factors such as loan to value ratio, credit support levels, borrower FICO scores, geographic concentration, prepayment speeds, delinquencies, coverage ratios and credit ratings.  Management believes that all of the securities continue to demonstrate collateral coverage ratios that are adequate to support the Corporation’s investment.  The Corporation purchased all of these securities at a discount relative to their face amounts.  All of these securities were of the highest investment grade at the time of purchase.  As of September 30, 2009, two have been downgraded to one level below investment grade and five have been downgraded more than one level below investment grade.  All of these securities continue to perform as expected at the time of purchase.  This class of securities has been reduced by $8.8 million since December 31, 2008 due to principal paydown.  The Corporation does not intend to sell these investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost bases, which may be at maturity.  Accordingly, management does not consider these investments to be other-than-temporarily impaired at September 30, 2009.

Obligations of State and Political Subdivisions – The unrealized losses on the Corporation’s investments in state and political subdivisions were in an unrealized loss position of $144,000 at September 30, 2009.  Ten securities carried a fair value less than amortized cost basis for over 12 months and two securities have been in an unrealized loss position for less than 12 months.  All of the Corporation’s investments in states and other political subdivisions are of investment grade as determined by the major rating agencies.  Management believes that this portfolio is well-diversified throughout the United States, and all bonds continue to perform according to their contractual terms.  The Corporation does not intend to sell these investments and it is not more likely than not that the Corporation will be required to sell the investments before recovery of their amortized cost bases, which may be at maturity.  Accordingly, management does not consider these investments to be other-than-temporarily impaired at September 30, 2009.

Collateralized Debt Obligations - The $39.2 million in unrealized losses reported for collateralized debt obligations at September 30, 2009 relates to 22 pooled trust preferred securities.  See Note F for a discussion of the methodology used by management to determine the fair values of these securities.  Based upon a review of credit quality and the cash flow tests performed, management determined that six of the collateralized debt obligations in the Corporation’s portfolio were other-than-temporarily impaired.  As a result of this assessment, the Corporation recorded an $18.3 million other-than-temporary impairment loss on these securities as of September 30, 2009.  Year to date, $10.8 million of other-than-temporary losses have been recognized in earnings on the six trust preferred securities and $226,000 of losses have been recognized as a result of moving four securities to trading.  The unrealized losses on the remaining investment securities are primarily attributable to factors such as changes in market interest rates, marketability, liquidity and the current economic environment.
 
11
 
The following tables present a roll-forward of the amount of other-than-temporary impairment (“OTTI”) related to credit losses which have been recognized in earnings.
 
   
Other-Than-
Temporary
Impairment
Credit Losses
recorded in
Earnings
(in thousands)
    
Other-Than-
Temporary
Impairment
Losses
recorded in
Other
Comprehensive
Income
(in thousands)
  
Beginning balance January 1, 2009
   $ 2,724     $ 0  
Other-than-temporary losses recognized during the period:
                
Additions for OTTI not
previously recognized
     7,925       5,881  
Additional increases for OTTI previously
recognized when there is no intent to
sell and no requirements to sell before
recovery of amortized cost basis
     2,917       1,611  
Total other-than-temporary losses recognized during the period
     10,842       7,492  
                 
Ending balance September 30, 2009
   $ 13,566     $ 7,492  
 
   
Other-Than-
Temporary
Impairment
Credit Losses
recorded in
Earnings
(in thousands)
    
Other-Than-
Temporary
Impairment
Losses recorded
in Other
Comprehensive
Income
(in thousands)
  
Beginning balance July 1, 2009
   $ 4,905     $ 3,615  
Other-than-temporary losses recognized during the period:
                
Additions for OTTI not previously
recognized
     5,744       5,881  
Additional increases(decreases) for OTTI
previously recognized when there is
no intent to sell and no requirements
to sell before recovery of amortized cost basis
     2,917       (2,004 )
Total other-than-temporary losses recognized during the period
     8,661       3,877  
                 
Ending balance September 30, 2009
   $ 13,566     $ 7,492  
                 
 
 
12
 

Note D – Cash and Cash Equivalents

Cash and due from banks, which represents vault cash in the retail offices and invested cash balances at the Federal Reserve, is carried at fair value.

   
September 30,
2009
    
December 31,
2008
  
             
Cash and due from banks, weighted average interest rate of .22% (atSeptember 30, 2009)
   $ 63,096     $ 18,423  

Interest bearing deposits in banks, which represent funds invested at a correspondent bank, are carried at fair value and, as of September 30, 2009 and December 31, 2008, consisted of daily funds invested at the Federal Home Loan Bank (“FHLB”) of Atlanta and First Tennessee Bank (“FTN”).

   
September 30,
2009
    
December 31,
2008
  
             
FHLB daily investments, interest rate of 0.01% (at September 30, 2009)
   $ 36,003     $ 882  
    550       —  
FTN Fed Funds sold, interest rate of 0.25% (at September 30, 2009)
     22       —  

Note E - Restricted Investment in Bank Stock

Restricted stock, which represents required investments in the common stock of the FHLB of Atlanta and Atlantic Central Bankers Bank, is carried at cost and is considered a long-term investment.

Management evaluates the restricted stock for impairment in accordance with ASC Industry Topic 942, Financial Services – Depository and Lending, (ASC Section 942-325-35).  Management’s evaluation of potential impairment is based on management’s assessment of the ultimate recoverability of the cost of the restricted stock rather than by recognizing temporary declines in value.  The determination of whether a decline affects the ultimate recoverability is influenced by criteria such as (1) the significance of the decline in net assets of the issuing bank as compared to the capital stock amount for that bank and the length of time this situation has persisted, (2) commitments by the issuing bank to make payments required by law or regulation and the level of such payments in relation to the operating performance of that bank, and (3) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the issuing bank.

On March 25, 2009, the FHLB of Atlanta announced that it would not pay a dividend for the fourth quarter of 2008.  On June 3, 2009, the FHLB of Atlanta announced that it would not pay a dividend for first quarter of 2009.  During the first quarter of 2009, the Corporation reversed approximately $28,000 in dividends that were accrued for the fourth quarter of 2008.  On August 12, 2009, FHLB of Atlanta announced that a dividend for the second quarter of 2009 would be paid.  A dividend of $29,000 was posted during the third quarter of 2009.  The Corporation has not accrued any dividends for the third quarter of 2009.

Management believes that no impairment charge in respect of the restricted stock is necessary as of September 30, 2009.

Note F – Fair Value of Financial Instruments

The Corporation complies with the guidance of ASC Topic 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements required under other accounting pronouncements. This guidance applies only to fair value measurements required or permitted under current accounting guidelines, but does not require any new fair value measurements.  The Corporation also follows the guidance on matters relating to all financial instruments found in ASC Subtopic 825-10, Financial Instruments – Overall.

Fair value is defined as the price to sell an asset or to transfer a liability in an orderly transaction between willing market participants as of the measurement date.  Fair value is best determined by values quoted through active trading markets.  Active trading markets are characterized by numerous transactions of similar financial instruments between willing buyers and willing sellers. Because no active trading market exists for various types of financial instruments, many of the fair values disclosed were derived using present value discounted cash flows or other valuation techniques described below.  As a result, the Corporation’s ability to actually realize these derived values cannot be assumed.

 
13
 


The Corporation measures fair values based on the fair value hierarchy established in ASC Paragraph 820-10-35-37.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements).  The three levels of inputs that may be used to measure fair value under the hierarchy are as follows:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets and liabilities.  This level is the most reliable source of valuation.

Level 2: Quoted prices that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability.  Level 2 inputs include inputs other than quoted prices that are observable for the asset or liability (for example, interest rates and yield curves at commonly quoted intervals, volatilities, prepayment speeds, loss severities, credit risks, and default rates).  It also includes inputs that are derived principally from or corroborated by observable market data by correlation or other means (market-corroborated inputs).  Several sources are utilized for valuing these assets, including a contracted valuation service, Standard & Poor’s (S&P) evaluations and pricing services, and other valuation matrices.

Level 3: Prices or valuation techniques that require inputs that are both significant to the valuation assumptions and not readily observable in the market (i.e. supported with little or no market activity).  Level 3 instruments are valued based on the best available data, some of which is internally developed, and consider risk premiums that a market participant would require.

The level established within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

In April 2009, FASB issued additional guidance in ASC Subparagraphs 820-10-35-51A and 820-10-35-51B on determining when the volume and level of activity for the asset or liability has significantly decreased and provides a list of factors that a reporting entity should evaluate to determine whether there has been a significant decrease in the volume and level of activity for the asset or liability in relation to normal market activity for the asset or liability. When the reporting entity concludes there has been a significant decrease in the volume and level of activity for the asset or liability, further analysis of the information from that market is needed and significant adjustments to the related prices may be necessary to estimate fair value.  The new guidance also clarifies in ASC Subparagraphs 820-10-35-51E and 820-10-35-51F that when there has been a significant decrease in the volume and level of activity for the asset or liability, some transactions may not be orderly. In those situations, the entity must evaluate the weight of the evidence to determine whether the transaction is orderly. The guidance provides a list of circumstances that may indicate that a transaction is not orderly. A transaction price that is not associated with an orderly transaction is given little, if any, weight when estimating fair value. The Corporation elected to early adopt this guidance for its March 31, 2009 financial statements as provided in the effective date provisions of ASC Paragraph 820-10-65-4.

The Corporation believes that its valuation techniques are appropriate and consistent with other market participants.  However, the use of different methodologies and assumptions could result in a different estimate of fair values at the reporting date.  The following valuation techniques were used to measure the fair value of assets in the table below which are measured on a recurring and non-recurring basis as of September 30, 2009.

Investments held for trading – The fair value of investments held for trading is determined using a market approach. The Level 3 investments consist of four pooled trust preferred securities, which are preferred term securities issued by trust subsidiaries of financial institutions and insurance companies and collateralized by junior subordinated debentures issued to those trusts by the parent institution. Two securities were deemed to be other-than-temporarily impaired at December 31, 2008 and were moved to trading during the first quarter of 2009.  The remaining two securities were moved to trading during the third quarter of 2009.  The Corporation obtained fair values for these securities from Moody’s Analytics, an experienced independent third-party pricing provider.  Information such as performance of the underlying collateral, deferral/default rates, cash flow projections, related relevant trades, models and other analytical tools are utilized by the third-party in determining individual security valuations in accordance with proper accounting guidance.  A full explanation of the pricing methodology used by Moody’s Analytics is presented in the next section, under Investments available for sale.

 
14
 

Investments available for sale – The fair value of investments available-for-sale is determined using a market approach.  As of September 30, 2009, Level 2 investment securities available-for-sale include U.S. Government Agencies and residential mortgage-backed securities, private label residential mortgage-backed securities and municipal bonds which are not as actively traded.  Their fair values were determined based upon market-corroborated inputs and valuation matrices which were obtained through third party data service providers or securities brokers through which the Corporation has historically transacted both purchases and sales of investment securities. The Level 3 investments consist of pooled trust preferred securities.  The Corporation obtained fair values for these securities from Moody’s Analytics.  Information such as performance of the underlying collateral, deferral/default rates, cash flow projections, related relevant trades, models and other analytical tools were utilized by the third-party in determining individual security valuations in accordance with proper accounting guidance.

At September 30, 2009, the Bank owned 22 pooled trust preferred securities with a par value of $59.9 million and a fair value of $20.8 million. Based upon application of the guidance in ASC Subparagraph 820-10-35-51A, management has determined that there has been a significant decrease in the volume and level of activity in these securities.  The market for pooled trust preferred securities continues to be non-existent.  There were no new pooled trust preferred issuances during 2008 and there have been none to date in 2009.  Trading activity for pooled trust preferred securities indicates only three total trades during the first quarter of 2009 and zero trades during the third quarter of 2009, compared to a high of 116 trades in the first quarter of 2008.  The volume has declined from a high of $376 million in the first quarter of 2007 to $0 during the third quarter of 2009.  The trading and issuance data presented, along with information from traders, indicates that there is currently an inactive and inefficient market in pooled trust preferred securities which is contributing to the depressed pricing on these securities.

Observable prices for these securities are available based upon broker models and these inputs have been considered in the pricing models used by Moody’s Analytics.  However, the few observable transactions and market quotations that are available are not reliable for purposes of determining fair value at September 30, 2009.  Accordingly, the pooled trust preferred securities portion of the Corporation’s investment portfolio will be classified within Level 3 of the fair value hierarchy because management determined that significant adjustments are required to determine fair value at the measurement date.

In determining the fair values of the securities, Moody’s Analytics utilized an income valuation approach (present value technique) which maximizes the use of observable inputs and minimizes the use of unobservable inputs.  This approach is more indicative of fair value than the market approach that has been used historically, and involves several steps.  The credit quality of the collateral was estimated using the average probability of default values for each underlying issuer, adjusted for credit ratings.  The default probabilities also considered the potential for correlation among issuers within the same industry, such as banks with other banks.  The loss given default was assumed to be 95%, allowing for a 5% recovery of collateral.  Management elected to utilize the option assuming that there were no defaults or deferrals for a two-year time period for those banks who have publicly announced participation in the Treasury’s Capital Purchase Program. The cash flows for the securities were forecast for the underlying collateral and applied to each tranche in the structure to determine the resulting distribution among the securities.  These expected cash flows were then discounted to calculate the present value of the security.  The effective discount rate utilized by Moody’s Analytics for the various securities in the present value calculation was the three-month LIBOR plus 200 basis points (a risk free rate plus a premium for illiquidity).  The resulting prices are highly dependent upon the credit quality of the collateral, the relative position of the tranche in the capital structure of the security and the prepayment assumptions.   Moody’s Analytics modeled the calculations in several thousand scenarios using a Monte Carlo engine and the average price was used for valuation purposes.  Due to the current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility.

Impaired loans – Loans included in the table below are those that are considered impaired under the guidance of the loan impairment subsection of the Receivables Topic, ASC Section 310-10-35, under which the Corporation has measured impairment generally based on the fair value of the loan’s collateral.  Fair value consists of the loan balance less its valuation allowance and is generally determined based on independent third-party appraisals of the collateral or discounted cash flows based upon the expected proceeds.  These assets are included as Level 3 fair values based upon the lowest level of input that is significant to the fair value measurements.

Foreclosed real estate – Fair value of foreclosed assets was based on independent third-party appraisals of the properties.  These values were determined based on the sales prices of similar properties in the approximate geographic area.  These assets are included as Level 3 fair values based upon the lowest level of input that is significant to the fair value measurements.

 
15
 

For assets measured at fair value on a recurring and non-recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2009 and December 31, 2008 are as follows:
 
       
Fair Value Measurements at
September 30, 2009 Using
(Dollars in Thousands)
  
Description
  
Assets
Measured
at Fair
Value
09/30/09
  
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
  
Significant
Other
Observable
Inputs
 (Level 2)
    
Significant
Unobservable
Inputs
 (Level 3)
  
Recurring:
                    
Investment securities - trading
   $ 183             $ 183  
Investment securities available-for-sale:
                        
   U.S. government agencies
   $ 94,683       $ 94,683          
   Residential mortgage-backed agencies
   $ 67,232       $ 67,232          
   Collateralized mortgage obligations
   $ 34,735       $ 34,735          
   Obligations of states and political
        Subdivisions
   $ 100,478       $ 100,478          
   Collateralized debt obligations
   $ 20,759               $ 20,759  
Financial Derivative
   $ (284 )             $ (284 )
 Non-recurring:                          
Impaired loans¹
   $ 9,931               $ 9,931  
Foreclosed real estate
   $ 4,061               $ 4,061  
¹ The impaired loans fair value consists of impaired loans net of the $4,458 valuation allowance.
  
 
       
Fair Value Measurements at 
December 31, 2008 Using
(Dollars in Thousands)
  
Description
  
Assets
Measured
at Fair
Value
12/31/08
  
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
  
Significant
Other
Observable
Inputs
 (Level 2)
    
Significant
Unobservable
Inputs
 (Level 3)
  
Recurring:                    
Investment securities available-for-sale:
                    
    U.S. government agencies
   $ 113,645       $ 113,645        
    Residential mortgage-backed agencies
   $ 82,561       $ 82,561        
    Collateralized mortgage obligations
   $ 40,638       $ 40,638        
    Obligations of states and political
Subdivisions
   $ 93,485       $ 93,485        
    Collateralized debt obligations
   $ 24,266               $ 24,266  
Financial Derivative
     —                 —  
                           
Non-recurring:                          
Impaired loans¹
   $  11,760               $  11,760  
Foreclosed real estate
   $ 2,424               $ 2,424  
¹ The impaired loans fair value consists of impaired loans net of the $4,759 valuation allowance.
  
 
 
16
 

The following tables show a reconciliation of the beginning and ending balances for fair valued assets measured using Level 3 significant unobservable inputs for the nine and three months ended September 30, 2009:
 
   
Fair Value Measurements Using Significant
Unobservable inputs
(Level 3)
(Dollars in Thousands)
  
   
Investment
Securities
Available for Sale
    
Investment
Securities -
Trading
    
Cash Flow Hedge
    
Impaired
Loans
    
Foreclosed Real
Estate
  
Beginning balance January 1, 2009
   $ 24,266     $ —     $ —     $ 11,760     $ 2,424  
    Total gains/(losses) realized/unrealized:
                                        
       Included in earnings (or changes in net assets)
     (10,842 )     (226 )     —       —       (114 )
       Included in other comprehensive loss
     7,744       —               —       —  
    Purchases, issuances, and settlements
     —       —       (284 )     —       —  
    Transfers from Available for Sale to Trading
     (409 )     409               —       —  
    Transfers in and/or out of Level 3
     —       —               —       —  
    Sales
     —       —               —       (1,148 )
    Payments/credits/charge-offs
     —       —               (10,881 )     —  
    Properties/loans added
      —       —       (284 )      9,052       2,899  
Ending balance September 30, 2009
   $ 20,759     $ 183     $ (284 )   $ 9,931     $ 4,061  
The amount of total gains or losses for the period
included in earnings attributable to the change
in realized/ unrealized gains or losses related to
assets still held at the reporting date
   $ (10,842 )   $ (226 )   $ —     $ —     $ (49 )