Edgar Filing: FIRST UNITED CORP/MD/

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 June 30, 2014

TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT

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		(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 þ 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 þ No ¨

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 ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)	Smaller reporting company þ

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 6,228,366 shares of common stock, par value $.01 per share, as of July 31, 2014.

INDEX TO QUARTERLY REPORT

FIRST UNITED CORPORATION

PART I. FINANCIAL INFORMATION

Item 1.	Financial Statements (unaudited)	3

	Consolidated Statement of Financial Condition – June 30, 2014 and December 31, 2013	3

	Consolidated Statement of Operations - for the three and six months ended June 30, 2014 and 2013	4

	Consolidated Statement of Comprehensive Income/(Loss) – for the three and six months ended June 30, 2014 and 2013	6

	Consolidated Statement of Changes in Shareholders’ Equity - for the six months ended June 30, 2014 and year ended December 31, 2013	7

	Consolidated Statement of Cash Flows - for the six months ended June 30, 2014 and 2013	8

	Notes to Consolidated Financial Statements	9

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	48

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	70

Item 4.	Controls and Procedures	70

PART II. OTHER INFORMATION		71

Item 1.	Legal Proceedings	71

Item 1A.	Risk Factors	71

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	71

Item 3.	Defaults upon Senior Securities	71

Item 4.	Mine Safety Disclosures	72

Item 5.	Other Information	72

Item 6.	Exhibits	72

SIGNATURES		72

EXHIBIT INDEX		73

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

FIRST UNITED CORPORATION

Consolidated Statement of Financial Condition

(In thousands, except per share and percentage data)

	June 30,			December 31,
	2014			2013
	(Unaudited)
Assets
Cash and due from banks	$	54,421		$	32,895
Interest bearing deposits in banks		7,638			10,168
Cash and cash equivalents		62,059			43,063
Investment securities – available-for-sale (at fair value)		205,258			336,589
Investment securities – held to maturity (fair value $107,161 at June 30, 2014
and $3,590 at December 31, 2013, respectively)		107,586			3,900
Restricted investment in bank stock, at cost		7,480			7,913
Loans		825,138			810,240
Allowance for loan losses		(12,463	)		(13,594	)
Net loans		812,675			796,646
Premises and equipment, net		26,312			26,905
Goodwill and other intangible assets, net		11,004			11,004
Bank owned life insurance		32,901			32,413
Deferred tax assets		23,106			29,209
Other real estate owned		12,288			17,031
Accrued interest receivable and other assets		26,906			28,830
Total Assets	$	1,327,575		$	1,333,503
Liabilities and Shareholders’ Equity
Liabilities:
Non-interest bearing deposits	$	193,983		$	175,863
Interest bearing deposits		784,757			801,540
Total deposits		978,740			977,403

Short-term borrowings		37,913			43,676
Long-term borrowings		182,640			182,672
Accrued interest payable and other liabilities		16,371			28,412
Total Liabilities		1,215,664			1,232,163
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 June 30, 2014 and December 31, 2013 (discount of $0 and $6, respectively)		30,000			29,994
Common Stock – par value $.01 per share; Authorized 25,000 shares; issued and outstanding 6,228 shares at June 30, 2014 and 6,211 at December 31, 2013, respectively		62			62
Surplus		21,717			21,661
Retained earnings		75,184			73,836
Accumulated other comprehensive loss		(15,052	)		(24,213	)
Total Shareholders’ Equity		111,911			101,340
Total Liabilities and Shareholders’ Equity	$	1,327,575		$	1,333,503

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

Consolidated Statement of Operations

(In thousands, except per share data)

	Six Months Ended
	June 30,
	2014			2013
	(Unaudited)
Interest income
Interest and fees on loans	$	18,697		$	21,021
Interest on investment securities
Taxable		3,744			2,297
Exempt from federal income tax		804			868
Total investment income		4,548			3,165
Other		176			181
Total interest income		23,421			24,367
Interest expense
Interest on deposits		2,335			2,609
Interest on short-term borrowings		30			29
Interest on long-term borrowings		3,197			3,253
Total interest expense		5,562			5,891
Net interest income		17,859			18,476
Provision for loan losses		941			946
Net interest income after provision for loan losses		16,918			17,530
Other operating income
Changes in fair value on impaired securities		5,070			2,353
Portion of gain recognized in other comprehensive income (before taxes)		(5,070	)		(2,353	)
Net securities impairment losses recognized in operations		0			0
Net gains – other		961			356
Total net gains		961			356
Service charges		1,466			1,757
Trust department		2,568			2,389
Debit card income		987			984
Bank owned life insurance		488			499
Brokerage commissions		406			361
Other		360			356
Total other income		6,275			6,346
Total other operating income		7,236			6,702
Other operating expenses
Salaries and employee benefits		9,703			9,640
FDIC premiums		882			929
Equipment		1,306			1,291
Occupancy		1,276			1,384
Data processing		1,576			1,499
Other real estate owned		1,614			(48	)
Other		4,447			4,598
Total other operating expenses		20,804			19,293
Income before income tax expense		3,350			4,939
Applicable income tax expense		752			1,175
Net Income		2,598			3,764
Accumulated preferred stock dividends and discount accretion		(1,250	)		(878	)
Net Income Available to Common Shareholders	$	1,348		$	2,886
Basic and diluted net income per common share	$	0.22		$	0.47
Weighted average number of basic and diluted shares outstanding		6,217			6,203

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

Consolidated Statement of Operations

(In thousands, except per share data)

	Three Months Ended
	June 30,
	2014			2013
	(Unaudited)
Interest income
Interest and fees on loans	$	9,359		$	10,336
Interest on investment securities
Taxable		1,756			1,155
Exempt from federal income tax		393			440
Total investment income		2,149			1,595
Other		159			148
Total interest income		11,667			12,079
Interest expense
Interest on deposits		1,168			1,282
Interest on short-term borrowings		16			15
Interest on long-term borrowings		1,543			1,639
Total interest expense		2,727			2,936
Net interest income		8,940			9,143
Provision for loan losses		577			81
Net interest income after provision for loan losses		8,363			9,062
Other operating income
Changes in fair value on impaired securities		681			691
Portion of gain recognized in other comprehensive income (before taxes)		(681	)		(691	)
Net securities impairment losses recognized in operations		0			0
Net gains – other		1,024			27
Total net gains		1,024			27
Service charges		757			871
Trust department		1,316			1,190
Debit card income		530			508
Bank owned life insurance		245			250
Brokerage commissions		201			199
Other		186			99
Total other income		3,235			3,117
Total other operating income		4,259			3,144
Other operating expenses
Salaries and employee benefits		5,018			4,796
FDIC premiums		491			478
Equipment		651			649
Occupancy		621			680
Data processing		794			770
Other real estate owned		1,157			(66	)
Other		2,312			2,450
Total other operating expenses		11,044			9,757
Income before income tax expense		1,578			2,449
Applicable income tax expense		338			607
Net Income		1,240			1,842
Accumulated preferred stock dividends and discount accretion		(803	)		(441	)
Net Income Available to Common Shareholders	$	437		$	1,401
Basic and diluted net income per common share	$	0.07		$	0.23
Weighted average number of basic and diluted shares outstanding		6,222			6,207

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

Consolidated Statement of Comprehensive Income/(Loss)

(In thousands)

	Six Months Ended
	June 30,
	2014			2013
Comprehensive Income/(Loss) (in thousands)	(Unaudited)
Net Income	$	2,598		$	3,764

Other comprehensive income/(loss), net of tax and reclassification adjustments:
Net unrealized gains on investments with OTTI		3,042			1,408

Net unrealized gains/(losses) on all other AFS securities		8,342			(5,729	)

Net unrealized losses on HTM securities		(2,372	)		0

Net unrealized gains on cash flow hedges		111			138

Net unrealized gains on Pension		37			91

Net unrealized gains on SERP		1			7

Other comprehensive income/(loss), net of tax		9,161			(4,085	)

Comprehensive income/(loss)	$	11,759		$	(321	)

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

Consolidated Statement of Comprehensive Income/(Loss)

(In thousands)

	Three Months Ended
	June 30,
Comprehensive Income/(Loss) (in thousands)	2014			2013
Net Income	$	1,240		$	1,842

Other comprehensive income/(loss), net of tax and reclassification adjustments:
Net unrealized gains on investments with OTTI		408			413

Net unrealized gains/(losses) on all other AFS securities		5,306			(5,464	)

Net unrealized losses on HTM securities		(2,372	)		0

Net unrealized gains on cash flow hedges		56			78

Net unrealized gains/(losses) on Pension		164			(624	)

Net unrealized gains on SERP		0			3

Other comprehensive income/(loss), net of tax		3,562			(5,594	)

Comprehensive income/(loss)	$	4,802		$	(3,752	)

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

Consolidated Statement of Changes in Shareholders’ Equity

(In thousands)

	Preferred Stock		Common Stock		Surplus		Retained Earnings (unaudited)			Accumulated Other Comprehensive Income/(Loss)			Total Shareholders' Equity
Balance at January 1, 2013	$	29,925	$	62	$	21,573	$	69,168		$	(21,823	)	$	98,905

Net income								6,446						6,446
Other comprehensive loss											(2,390	)		(2,390	)
Stock based compensation						88								88
Preferred stock discount accretion		69						(69	)					0
Preferred stock dividends deferred								(1,709	)					(1,709	)

Balance at December 31, 2013		29,994		62		21,661		73,836			(24,213	)		101,340

Net income								2,598						2,598
Other comprehensive income											9,161			9,161
Stock based compensation						56								56
Preferred stock discount accretion		6						(6	)					0
Preferred stock dividends paid								(1,244	)					(1,244	)

Balance at June 30, 2014	$	30,000	$	62	$	21,717	$	75,184		$	(15,052	)	$	111,911

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

Consolidated Statement of Cash Flows

(In thousands)

	Six Months Ended
	June 30,
	2014			2013
	(Unaudited)
Operating activities
Net income	$	2,598		$	3,764
Adjustments to reconcile net income to net cash (used in)/provided by operating activities:
Provision for loan losses		941			946
Depreciation		994			1,026
Stock compensation		56			43
Loss/(gain) on sales of other real estate owned		970			(62	)
Write-downs of other real estate owned		443			37
Gain on loan sales		(18	)		(131	)
Loss on disposal of fixed assets		3			2
Net amortization of investment securities discounts and premiums		64			697
Loss/(gain) on sales of investment securities – available-for-sale		154			(227	)
Gain on sales of investment securities – held for trading		(1,100	)		0
Amortization of deferred loan fees		(218	)		(265	)
Decrease in accrued interest receivable and other assets		1,985			3,820
Decrease in deferred tax benefit		2			0
(Decrease)/increase in accrued interest payable and other liabilities		(5,354	)		1,502
Earnings on bank owned life insurance		(488	)		(499	)
Net cash (used in)/provided by operating activities		1,032			10,653

Investing activities
Proceeds from maturities/calls of investment securities available-for-sale		100,719			20,705
Proceeds from maturities/calls of investment securities held-to-maturity		1,509			140
Proceeds from sales of investment securities available-for-sale		56,222			35,136
Proceeds from sales of investment securities held for trading		1,100			0
Purchases of investment securities available-for-sale		(114,752	)		(144,941	)
Purchases of investment securities held-to-maturity		(1,256	)		0
Proceeds from sales of other real estate owned		4,745			2,865
Proceeds from loan sales		2,104			18,049
Net decrease in FHLB stock		433			496
Net (increase)/decrease in loans		(20,253	)		9,184
Purchases of premises and equipment		(404	)		(727	)
Net cash provided by/(used in) investing activities		30,167			(59,093	)

Financing activities
Net increase/(decrease) in deposits		1,337			(4,225	)
Preferred stock dividends paid		(7,745	)		0
Net (decrease)/increase in short-term borrowings		(5,763	)		11,697
Payments on long-term borrowings		(32	)		(31	)
Net cash (used in)/provided by financing activities		(12,203	)		7,441
Increase/(decrease) in cash and cash equivalents		18,996			(40,999	)
Cash and cash equivalents at beginning of the year		43,063			83,068
Cash and cash equivalents at end of period	$	62,059		$	42,069

Supplemental information
Interest paid	$	12,327		$	4,868
Non-cash investing activities:
Transfers from loans to other real estate owned	$	1,415		$	4,671
Transfers from securities available for sale to held-to-maturity	$	103,934		$	0

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

NoteS to Consolidated Financial Statements (UNAUDITED)

Note 1 – Basis of Presentation

The accompanying unaudited consolidated financial statements of First United Corporation and its consolidated subsidiaries, including First United Bank & Trust (the “Bank”), 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 8-03 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 six-month periods ended June 30, 2014 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 First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013. For purposes of comparability, certain prior period amounts have been reclassified to conform to the 2014 presentation. Such reclassifications had no impact on net income or equity.

First United Corporation has evaluated events and transactions occurring subsequent to the statement of financial condition date of June 30, 2014 for items that should potentially be recognized or disclosed in these financial statements as prescribed by ASC Topic 855, Subsequent Events.

As used in these notes to consolidated financial statements, First United Corporation and its consolidated subsidiaries are sometimes collectively referred to as the “Corporation”.

Note 2 – 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 and does not include the effect of any potentially dilutive common stock equivalents. Diluted earnings per share is derived by dividing net income available to common shareholders by the weighted-average number of shares outstanding, adjusted for the dilutive effect of outstanding common stock equivalents. There is no dilutive effect on earnings per share during loss periods. No common stock equivalents were outstanding during the six- and three- month periods ended June 30, 2014 or 2013.

The following table sets forth the calculation of basic and diluted earnings per common share for the six- and three-month periods ended June 30, 2014 and 2013:

	Six Months Ended June 30,
	2014							2013
				Average		Per Share					Average		Per Share
(in thousands, except for per share amount)	Income			Shares		Amount		Income			Shares		Amount
Basic and Diluted Earnings Per Share:
Net income	$	2,598						$	3,764
Preferred stock dividends		(1,244	)						(844	)
Discount accretion on preferred stock		(6	)						(34	)
Net income available to common shareholders	$	1,348			6,217	$	0.22	$	2,886			6,203	$	0.47

	Three Months Ended June 30,
	2014							2013
				Average		Per Share					Average		Per Share
(in thousands, except for per share amount)	Income			Shares		Amount		Income			Shares		Amount
Basic and Diluted Earnings Per Share:
Net income	$	1,240						$	1,842
Preferred stock dividends deferred		(803	)						(424	)
Discount accretion on preferred stock		0							(17	)
Net income available to common shareholders	$	437			6,222	$	0.07	$	1,401			6,207	$	0.23

Note 3 – Net Gains

The following table summarizes the gain activity for the six- and three-month periods ended June 30, 2014 and 2013:

	Six Months Ended						Three Months Ended
	June 30,						June 30,
(in thousands)	2014			2013			2014			2013
Net gains – other:
Available-for-sale securities:
Realized gains	$	205		$	412		$	110		$	0
Realized losses		(359	)		(185	)		(196	)		(23	)
Held-for-trading:
Realized gains		1,100			0			1,100			0
Gain on sale of consumer loans		18			131			10			52
Loss on disposal of fixed assets		(3	)		(2	)		0			(2	)
Net gains – other	$	961		$	356		$	1,024		$	27

Note 4 – 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.

	June 30,		December 31,
(in thousands)	2014		2013
Cash and due from banks, weighted average interest rate of 0.14% (at June 30, 2014)	$	54,421	$	32,895

Interest bearing deposits in banks, which represent funds invested at a correspondent bank, are carried at fair value and, as of June 30, 2014 and December 31, 2013, consisted of daily funds invested at the Federal Home Loan Bank (“FHLB”) of Atlanta, First Tennessee Bank (“FTN”), Merchants and Traders (“M&T”) and Community Bankers Bank (“CBB”).

	June 30,		December 31,
(in thousands)	2014		2013
FHLB daily investments, interest rate of 0.005% (at June 30, 2014)	$	580	$	1,677
FTN daily investments, interest rate of 0.09% (at June 30, 2014)		850		1,350
M&T daily investments, interest rate of 0.20% (at June 30, 2014)		5,048		5,043
M&T daily investments, interest rate of 0.20% (at June 30, 2014)		1,009		1,008
CBB Fed Funds sold, interest rate of 0.22% (at June 30, 2014)		151		1,090
	$	7,638	$	10,168

Note 5 – Investments

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

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.

On June 1, 2014, management reclassified an amortized cost basis of $107.6 million of available-for-sale securities to held to maturity. The unrealized loss of approximately $4.0 million, at the date of transfer, will continue to be reported in a separate component of shareholders’ equity as accumulated other comprehensive income and will be amortized over the remaining life of the securities as an adjustment of yield in a manner consistent with the amortization of any premium or discount.

The following table shows a comparison of amortized cost and fair values of investment securities at June 30, 2014 and December 31, 2013:

(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value		OTTI in AOCI
June 30, 2014
Available for Sale:
U.S. treasuries	$	17,000	$	0	$	0	*	$	17,000	$	0
U.S. government agencies		39,098		139		440			38,797		0
Residential mortgage-backed agencies		48,369		489		730			48,128		0
Commercial mortgage-backed agencies		17,284		75		35			17,324		0
Collateralized mortgage obligations		9,999		113		0			10,112		0
Obligations of states and political subdivisions		48,882		1,437		343			49,976		0
Collateralized debt obligations		37,389		939		14,407			23,921		7,633
Total available for sale	$	218,021	$	3,192	$	15,955		$	205,258	$	7,633
* DeMinimus
Held to Maturity:
U.S. government agencies	$	24,431	$	1	$	137		$	24,295	$	0
Residential mortgage-backed agencies		55,756		81		32			55,805		0
Commercial mortgage-backed agencies		16,524		65		40			16,549		0
Collateralized mortgage obligations		8,150		0		40			8,110		0
Obligations of states and political subdivisions		2,725		0		323			2,402		0
Total held to maturity	$	107,586	$	147	$	572		$	107,161	$	0

December 31, 2013
Available for Sale:
U.S. government agencies	$	97,242	$	14	$	5,221		$	92,035	$	0
Residential mortgage-backed agencies		116,933		334		4,823			112,444		0
Commercial mortgage-backed agencies		31,025		14		1,134			29,905		0
Collateralized mortgage obligations		30,468		84		1,162			29,390		0
Obligations of states and political subdivisions		55,505		895		1,123			55,277		0
Collateralized debt obligations		37,146		778		20,386			17,538		12,703
Total available for sale	$	368,319	$	2,119	$	33,849		$	336,589	$	12,703
Held to Maturity:
Obligations of states and political subdivisions	$	3,900	$	249	$	559		$	3,590	$	0

Proceeds from sales of securities and the realized gains and losses are as follows:

	Six Months Ended				Three Months Ended
	June 30,				June 30,
(in thousands)	2014		2013		2014		2013
Proceeds	$	56,222	$	35,136	$	47,637	$	0
Realized gains		1,305		412		1,210		0
Realized losses		359		185		196		23

The following table shows the Corporation’s securities with gross unrealized losses and fair values at June 30, 2014 and December 31, 2013, aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position:

	Less than 12 months					12 months or more
(in thousands)	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
June 30, 2014
Available for Sale:
U.S. treasuries	$	17,000	$	0	*	$	0	$	0
U.S. government agencies		0		0			18,639		440
Residential mortgage-backed agencies		0		0			24,823		730
Commercial mortgage-backed agencies		9,307		35			0		0
Obligations of states and political subdivisions		0		0			12,663		343
Collateralized debt obligations		0		0			18,785		14,407
Total available for sale	$	26,307	$	35		$	74,910	$	15,920
* DeMinimus
Held to Maturity:
U.S. government agencies	$	16,929	$	137		$	0	$	0
Residential mortgage-backed agencies		25,726		32			0		0
Commercial mortgage-backed agencies		8,110		40			0		0
Collateralized mortgage obligations		9,717		40			0		0
Obligations of states and political subdivisions		0		0			2,402		323
Total held to maturity	$	60,482	$	249		$	2,402	$	323

December 31, 2013
Available for Sale:
U.S. government agencies	$	62,962	$	3,154		$	13,996	$	2,067
Residential mortgage-backed agencies		60,781		1,801			46,570		3,022
Commercial mortgage-backed agencies		21,889		1,134			0		0
Collateralized mortgage obligations		21,201		1,149			3,051		13
Obligations of states and political subdivisions		15,422		1,123			0		0
Collateralized debt obligations		0		0			16,434		20,386
Total available for sale	$	182,255	$	8,361		$	80,051	$	25,488
Held to Maturity:
Obligations of states and political subdivisions	$	0	$	0		$	2,301	$	559

Management systematically evaluates securities for impairment on a quarterly basis. Management assesses whether (a) the Corporation 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 (“OTTI”) 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”.

Management believes that the valuation of certain securities is a critical accounting policy that requires significant estimates in preparation of its consolidated financial statements. Management utilizes an independent third party to prepare both the impairment valuations and fair value determinations for its collateralized debt obligation (“CDO”) portfolio consisting of pooled trust preferred securities. Based on management’s review of the assumptions and results of the third-party review, it does not believe that there were any material differences in the valuations between December 31, 2013 and June 30, 2014.

U.S. Government Treasuries – Available for Sale - One U.S. government treasury has been in an unrealized loss position for less than 12 months as of June 30, 2014. There were no U.S. government treasuries in an unrealized loss position for 12 months or more. The security is of the highest investment grade and the Corporation does not intend to sell it, and it is not more likely than not that the Corporation will be required to sell it before recovery of its amortized cost basis, which may be at maturity. Accordingly, management does not consider this investment to be other-than-temporarily impaired at June 30, 2014.

U.S. Government Agencies – Available for Sale – There were no U.S. government agencies in an unrealized loss position for less than 12 months as of June 30, 2014. There were three U.S. government agencies in an unrealized loss position for 12 months or more. The securities are of the highest investment grade and the Corporation does not intend to sell them, and it is not more likely than not that the Corporation will be required to sell them before recovery of their amortized cost basis, which may be at maturity. Accordingly, management does not consider these investments to be other-than-temporarily impaired at June 30, 2014.

Residential Mortgage-Backed Agencies – Available for Sale - There were no residential mortgage-backed agencies in an unrealized loss position for less than 12 months as of June 30, 2014. There were four residential mortgage-backed agency securities in an unrealized loss position for 12 months or more. The securities are of the highest investment grade and the Corporation does not intend to sell them, and it is not more likely than not that the Corporation will be required to sell the securities before recovery of their amortized cost basis, which may be at maturity. Accordingly, management does not consider these investments to be other-than-temporarily impaired at June 30, 2014.

Commercial Mortgage-Backed Agencies – Available for Sale – There were two commercial mortgage-backed agencies in an unrealized loss position for less than 12 months as of June 30, 2014. There were no commercial mortgage-backed agency securities in an unrealized loss position for 12 months or more. The securities are of the highest investment grade and the Corporation does not intend to sell them, and it is not more likely than not that the Corporation will be required to sell them before recovery of their amortized cost basis, which may be at maturity. Accordingly, management does not consider this investment to be other-than-temporarily impaired at June 30, 2014.

Obligations of State and Political Subdivisions – Available for Sale - No securities have been in an unrealized loss position for less than 12 months at June 30, 2014. There were six securities that have been in an unrealized loss position for 12 months or more. These investments are of investment grade as determined by the major rating agencies and management reviews the ratings of the underlying issuers and performs an in-depth credit analysis on the securities. 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 basis, which may be at maturity. Accordingly, management does not consider these investments to be other-than-temporarily impaired at June 30, 2014.

Collateralized Debt Obligations – Available for Sale - The $14.4 million in unrealized losses greater than 12 months at June 30, 2014 relates to 14 pooled trust preferred securities that are included in the CDO portfolio. See Note 9 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 by the independent third party, management determined that there were no securities that had credit-related non-cash OTTI charges during the first six months of 2014. The unrealized losses on the remaining securities in the portfolio are primarily attributable to continued depression in market interest rates, marketability, liquidity and the current economic environment.

U.S. Government Agencies – Held to Maturity - Three U.S. government agencies have been in an unrealized loss position for less than 12 months as of June 30, 2014. There were no U.S. government agencies in an unrealized loss position for 12 months or more. The Corporation has the intent and ability to hold the investments to maturity. Accordingly, management does not consider these investments to be other-than-temporarily impaired at June 30, 2014.

Residential Mortgage-Backed Agencies – Held to Maturity - Three residential mortgage-backed agencies have been in an unrealized loss position for less than 12 months as of June 30, 2014. There were no residential mortgage-backed agencies in an unrealized loss position for 12 months or more. The Corporation has the intent and ability to hold the investments to maturity. Accordingly, management does not consider these investments to be other-than-temporarily impaired at June 30, 2014.

Commercial Mortgage-Backed Agencies – Held to Maturity - One commercial mortgage-backed agency has been in an unrealized loss position for less than 12 months as of June 30, 2014. There were no commercial mortgage-backed agencies in an unrealized loss position for 12 months or more. The Corporation has the intent and ability to hold this investment to maturity. Accordingly, management does not consider this investment to be other-than-temporarily impaired at June 30, 2014.

Collateralized Mortgage-Obligations – Held to Maturity - One collateralized mortgage obligation has been in an unrealized loss position for less than 12 months as of June 30, 2014. There were no collateralized mortgage obligations in an unrealized loss position for 12 months or more. The Corporation has the intent and ability to hold the investment to maturity. Accordingly, management does not consider this investment to be other-than-temporarily impaired at June 30, 2014.

Obligations of State and Political Subdivisions – Held to Maturity – No securities have been in an unrealized loss position for less than 12 months at June 30, 2014. There was one security that has been in an unrealized loss position for 12 months or more. Management performs an in-depth credit analysis on this security. The Corporation has the intent and ability to hold the investment to maturity. Accordingly, management does not consider this investment to be other-than-temporarily impaired at June 30, 2014.

The following tables present a cumulative roll-forward of the amount of non-cash OTTI charges related to credit losses which have been recognized in earnings for the trust preferred securities in the CDO portfolio held and not intended to be sold for the six- and three-month periods ended June 30, 2014 and 2013:

	Six Months Ended June 30,
(in thousands)	2014			2013
Balance of credit-related OTTI at January 1	$	13,422		$	13,959
Reduction for increases in cash flows expected to be collected		(331	)		(264	)
Balance of credit-related OTTI at June 30	$	13,091		$	13,695

	Three Months Ended June 30,
(in thousands)	2014			2013
Balance of credit-related OTTI at April 1	$	13,262		$	13,834
Reduction for increases in cash flows expected to be collected		(171	)		(139	)
Balance of credit-related OTTI at June 30	$	13,091		$	13,695

The amortized cost and estimated fair value of securities by contractual maturity at June 30, 2014 are shown in the following table. Actual maturities may 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.

	June 30, 2014
(in thousands)	Amortized Cost		Fair Value
Contractual Maturity
Available for sale:
Due after one year through five years	$	47,400	$	47,322
Due after five years through ten years		34,461		35,267
Due after ten years		60,508		47,105
		142,369		129,694
Residential mortgage-backed agencies		48,369		48,128
Commercial mortgage-backed agencies		17,284		17,324
Collateralized mortgage obligations		9,999		10,112
	$	218,021	$	205,258
Held to Maturity:
Due after five years through ten years		8,046		8,045
Due after ten years		19,110		18,652
		27,156		26,697
Residential mortgage-backed agencies		55,756		55,805
Commercial mortgage-backed agencies		16,524		16,549
Collateralized mortgage obligations		8,150		8,110
	$	107,586	$	107,161

Note 6 - Restricted Investment in Bank Stock

Restricted stock, which represents required investments in the common stock of the FHLB of Atlanta, Atlantic Community Bankers Bank (“ACBB”) and CBB, 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 (a) 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, (b) 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 (c) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the issuing bank. Management has evaluated the restricted stock for impairment and believes that no impairment charge is necessary as of June 30, 2014.

The Corporation recognizes dividends received on its restricted stock investments on a cash basis. For the six months ended June 30, 2014, dividends of $144,336 were recognized in earnings. For the comparable period of 2013, dividends of $96,734 were recognized in earnings. For the three months ended June 30, 2014 and 2013, dividends of $71,338 and $46,216, respectively were recognized in earnings.

Note 7 – Loans and Related Allowance for Loan Losses

The following table summarizes the primary segments of the loan portfolio as of June 30, 2014 and December 31, 2013:

(in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Residential Mortgage		Consumer		Total
June 30, 2014
Total loans	$	267,027	$	98,200	$	81,171	$	355,188	$	23,552	$	825,138
Individually evaluated for impairment	$	9,767	$	9,376	$	1,927	$	6,877	$	0	$	27,947
Collectively evaluated for impairment	$	257,260	$	88,824	$	79,244	$	348,311	$	23,552	$	797,191

December 31, 2013
Total loans	$	267,978	$	107,250	$	59,788	$	350,906	$	24,318	$	810,240
Individually evaluated for impairment	$	11,740	$	11,703	$	2,299	$	7,546	$	21	$	33,309
Collectively evaluated for impairment	$	256,238	$	95,547	$	57,489	$	343,360	$	24,297	$	776,931

The segments of the Bank’s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. The commercial real estate (“CRE”) loan segment is then segregated into two classes. Non-owner occupied CRE loans, which include loans secured by non-owner occupied, non-farm, and nonresidential properties, generally have a greater risk profile than all other CRE loans, which include loans secured by farmland, multifamily structures and owner-occupied commercial structures. The acquisition and development (“A&D”) loan segment is segregated into two classes. One-to-four family residential construction loans are generally made to individuals for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. All other A&D loans are generally made to developers or investors for the purpose of acquiring, developing and constructing residential or commercial structures. A&D loans have a higher risk profile because the ultimate buyer, once development is completed, is generally not known at the time of the loan is made. The commercial and industrial (“C&I”) loan segment consists of loans made for the purpose of financing the activities of commercial customers. The residential mortgage loan segment is segregated into two classes. Amortizing term loans are primarily first lien loans. Home equity lines of credit are generally second lien loans. The consumer loan segment consists primarily of installment loans (direct and indirect) and overdraft lines of credit connected with customer deposit accounts.

Management uses a 10-point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than 90 days past due are considered Substandard. The portion of a specific allocation of the allowance for loan losses that management believes is associated with a pending event that could trigger loss in the short-term will be classified in the Doubtful category. Any portion of a loan that has been charged off is placed in the Loss category.

To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. The Bank’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in the commercial segments at origination and on an ongoing basis. The Bank’s experienced Credit Quality and Loan Review Department performs an annual review of all commercial relationships of $500,000 or greater. Confirmation of the appropriate risk grade is included as part of the review process on an ongoing basis. The Credit Quality and Loan Review Department continually reviews and assesses loans within the portfolio. In addition, the Bank engages an external consultant to conduct loan reviews on at least an annual basis. Generally, the external consultant reviews commercial relationships greater than $750,000 and/or criticized relationships greater than $500,000. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on a quarterly basis. Loans in the Special Mention and Substandard categories that are collectively evaluated for impairment are given separate consideration in the determination of the allowance.

The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention and Substandard within the internal risk rating system as of June 30, 2014 and December 31, 2013:

(in thousands)	Pass		Special Mention		Substandard		Total
June 30, 2014
Commercial real estate
Non owner-occupied	$	111,329	$	9,113	$	25,093	$	145,535
All other CRE		91,922		8,303		21,267		121,492
Acquisition and development
1-4 family residential construction		12,541		0		1,027		13,568
All other A&D		65,984		1,697		16,951		84,632
Commercial and industrial		78,792		188		2,191		81,171
Residential mortgage
Residential mortgage - term		267,317		798		12,468		280,583
Residential mortgage - home equity		72,192		526		1,887		74,605
Consumer		23,462		0		90		23,552
Total	$	723,539	$	20,625	$	80,974	$	825,138

December 31, 2013
Commercial real estate
Non owner-occupied	$	103,556	$	9,243	$	24,745	$	137,544
All other CRE		100,461		8,479		21,494		130,434
Acquisition and development
1-4 family residential construction		8,764		0		4,497		13,261
All other A&D		73,198		1,787		19,004		93,989
Commercial and industrial		55,768		140		3,880		59,788
Residential mortgage
Residential mortgage - term		261,735		752		11,980		274,467
Residential mortgage - home equity		73,901		628		1,910		76,439
Consumer		24,143		5		170		24,318
Total	$	701,526	$	21,034	$	87,680	$	810,240

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. A loan is considered to be past due when a payment remains unpaid 30 days past its contractual due date. For all loan segments, the accrual of interest is discontinued when principal or interest is delinquent for 90 days or more unless the loan is well-secured and in the process of collection. All non-accrual loans are considered to be impaired. Interest payments received on non-accrual loans are applied as a reduction of the loan principal balance. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. The Corporation’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and non-accrual loans as of June 30, 2014 and December 31, 2013:

(in thousands)	Current		30-59 Days Past Due		60-89 Days Past Due		90 Days+ Past Due		Total Past Due and Accruing		Non-Accrual		Total Loans
June 30, 2014
Commercial real estate
Non owner-occupied	$	141,002	$	3,402	$	260	$	208	$	3,870	$	663	$	145,535
All other CRE		116,152		242		0		0		242		5,098		121,492
Acquisition and development
1-4 family residential construction		13,458		0		0		0		0		110		13,568
All other A&D		78,410		20		47		242		309		5,913		84,632
Commercial and industrial		81,103		52		11		5		68		0		81,171
Residential mortgage
Residential mortgage - term		274,066		741		2,334		665		3,740		2,777		280,583
Residential mortgage - home equity		73,355		364		214		0		578		672		74,605
Consumer		23,203		194		135		20		349		0		23,552
Total	$	800,749	$	5,015	$	3,001	$	1,140	$	9,156	$	15,233	$	825,138

December 31, 2013
Commercial real estate
Non owner-occupied	$	136,462	$	191	$	145	$	65	$	401	$	681	$	137,544
All other CRE		121,985		1,490		207		0		1,697		6,752		130,434
Acquisition and development
1-4 family residential construction		12,018		0		139		0		139		1,104		13,261
All other A&D		88,071		1,075		33		282		1,390		4,528		93,989
Commercial and industrial		59,320		87		57		133		277		191		59,788
Residential mortgage
Residential mortgage - term		259,239		8,258		2,541		634		11,433		3,795		274,467
Residential mortgage - home equity		74,917		656		439		96		1,191		331		76,439
Consumer		23,802		350		128		24		502		14		24,318
Total	$	775,814	$	12,107	$	3,689	$	1,234	$	17,030	$	17,396	$	810,240

Non-accrual loans which have been subject to a partial charge-off totaled $5.1 million as of June 30, 2014, compared to $1.9 million as of December 31, 2013.

An allowance for loan losses (“ALL”) is maintained to absorb losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of non-performing loans.

The Bank’s methodology for determining the ALL is based on the requirements of ASC Section 310-10-35, Receivables-Overall-Subsequent Measurement, for loans individually evaluated for impairment and ASC Subtopic 450-20, Contingencies-Loss Contingencies, for loans collectively evaluated for impairment, as well as the Interagency Policy Statement on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Bank’s ALL.

The following table summarizes the primary segments of the ALL, segregated by the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of June 30, 2014 and December 31, 2013.

(in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Residential Mortgage		Consumer		Total
June 30, 2014
Total ALL	$	2,839	$	3,642	$	1,553	$	4,178	$	251	$	12,463
Individually evaluated for impairment	$	0	$	1,392	$	0	$	62	$	0	$	1,454
Collectively evaluated for impairment	$	2,839	$	2,250	$	1,553	$	4,116	$	251	$	11,009

December 31, 2013
Total ALL	$	4,052	$	4,172	$	766	$	4,320	$	284	$	13,594
Individually evaluated for impairment	$	236	$	1,967	$	0	$	80	$	0	$	2,283
Collectively evaluated for impairment	$	3,816	$	2,205	$	766	$	4,240	$	284	$	11,311

Management evaluates individual loans in all of the commercial segments for possible impairment if the loan (a) is greater than $500,000 or (b) is part of a relationship that is greater than $750,000 and is either (i) in nonaccrual status or (ii) risk-rated Substandard and greater than 60 days past due. Loans are considered to be impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. The Bank does not separately evaluate individual consumer and residential mortgage loans for impairment, unless such loans are part of a larger relationship that is impaired; otherwise, loans in these segments are considered impaired when they are classified as non-accrual.

Once the determination has been made that a loan is impaired, the determination of whether a specific allocation of the allowance is necessary is measured by comparing the recorded investment in the loan to the fair value of the loan using one of three methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s observable market price; or (c) the fair value of the collateral less selling costs. The method is selected on a loan-by-loan basis, with management primarily utilizing the fair value of collateral method. If the fair value of the collateral less selling costs method is utilized for collateral securing loans in the commercial segments, then an updated external appraisal is ordered on the collateral supporting the loan if the loan balance is greater than $500,000 and the existing appraisal is greater than 18 months old. If an updated appraisal has not been received and reviewed in time for the determination of estimated fair value at quarter (or year) end, or if the appraisal is found to be deficient in our internal appraisal review process and re-ordered, then the estimated fair value of the collateral is determined by adjusting the existing appraisal by the appropriate percentage from an internally prepared appraisal discount grid. This grid considers the age of a third party appraisal and the geographic region where the collateral is located. The discount rates in the appraisal discount grid are updated periodically to reflect the most current knowledge that management has available, including the results of current appraisals. A specific allocation of the ALL is recorded if there is any deficiency in collateral value determined by comparing the estimated fair value to the recorded investment of the loan. When updated appraisals are received and reviewed, adjustments are made to the specific allocation as needed.

The evaluation of the need and amount of a specific allocation of the ALL and whether a loan can be removed from impairment status is made on a quarterly basis.

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of June 30, 2014 and December 31, 2013:

	Impaired Loans with Specific Allowance				Impaired Loans with No Specific Allowance		Total Impaired Loans
(in thousands)	Recorded Investment		Related Allowances		Recorded Investment		Recorded Investment		Unpaid Principal Balance
June 30, 2014
Commercial real estate
Non owner-occupied	$	0	$	0	$	936	$	936	$	946
All other CRE		0		0		8,831		8,831		8,959
Acquisition and development
1-4 family residential construction		912		130		115		1,027		1,275
All other A&D		5,761		1,262		2,588		8,349		13,350
Commercial and industrial		0		0		1,927		1,927		1,927
Residential mortgage
Residential mortgage - term		346		62		5,840		6,186		6,700
Residential mortgage – home equity		0		0		691		691		691
Consumer		0		0		0		0		0
Total impaired loans	$	7,019	$	1,454	$	20,928	$	27,947	$	33,848

December 31, 2013
Commercial real estate
Non owner-occupied	$	257	$	59	$	922	$	1,179	$	1,191
All other CRE		1,080		177		9,481		10,561		10,689
Acquisition and development
1-4 family residential construction		2,651		634		7		2,658		2,704
All other A&D		4,037		1,333		5,008		9,045		13,394
Commercial and industrial		0		0		2,299		2,299		2,299
Residential mortgage
Residential mortgage - term		988		80		5,979		6,967		7,372
Residential mortgage – home equity		0		0		579		579		579
Consumer		0		0		21		21		21
Total impaired loans	$	9,013	$	2,283	$	24,296	$	33,309	$	38,249

Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate. For general allowances, historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by other qualitative factors.

The classes described above, which are based on the Federal call code assigned to each loan, provide the starting point for the ALL analysis. Management tracks the historical net charge-off activity (full and partial charge-offs, net of full and partial recoveries) at the call code level. A historical charge-off factor is calculated utilizing a defined number of consecutive historical quarters. Consumer pools currently utilize a rolling 12 quarters, while Commercial pools currently utilize a rolling eight quarters.

“Pass” rated credits are segregated from “Criticized” credits for the application of qualitative factors. “Pass” pools for commercial and residential real estate are further segmented based upon the geographic location of the underlying collateral. There are seven geographic regions utilized – six that represent the Bank’s lending footprint and a seventh for all out-of-market credits. Different economic environments and resultant credit risks exist in each region that are acknowledged in the assignment of qualitative factors. Loans in the criticized pools, which possess certain qualities or characteristics that may lead to collection and loss issues, are closely monitored by management and subject to additional qualitative factors.

Management supplements the historical charge-off factor with a number of additional qualitative factors that are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors, which are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources, are: (a) national and local economic trends and conditions; (b) levels of and trends in delinquency rates and non-accrual loans; (c) trends in volumes and terms of loans; (d) effects of changes in lending policies; (e) experience, ability, and depth of lending staff; (f) value of underlying collateral; and (g) concentrations of credit from a loan type, industry and/or geographic standpoint.

Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL. Residential mortgage and consumer loans are charged off after they are 120 days contractually past due. All other loans are charged off based on an evaluation of the facts and circumstances of each individual loan. When the Bank believes that its ability to collect is solely dependent on the liquidation of the collateral, a full or partial charge-off is recorded promptly to bring the recorded investment to an amount that the Bank believes is supported by an ability to collect on the collateral. The circumstances that may impact the Bank’s decision to charge-off all or a portion of a loan include default or non-payment by the borrower, scheduled foreclosure actions, and/or prioritization of the Bank’s claim in bankruptcy. There may be circumstances where, due to pending events, the Bank will place a specific allocation of the ALL on a loan for which a partial charge-off has been previously recognized. This specific allocation may be either charged off or removed depending upon the outcome of the pending event. Full or partial charge-offs are not recovered until full principal and interest on the loan have been collected, even if a subsequent appraisal supports a higher value. Loans with partial charge-offs generally remain in non-accrual status. Both full and partial charge-offs reduce the recorded investment of the loan and the ALL and are considered to be charge-offs for purposes of all credit loss metrics and trends, including the historical rolling charge-off rates used in the determination of the ALL.

Activity in the ALL is presented for the six- and three- months ended June 30, 2014 and June 30, 2013:

(in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Consumer			Total
ALL balance at January 1, 2014	$	4,052		$	4,172		$	766		$	4,320		$	284		$	13,594
Charge-offs		(21	)		(1,520	)		(208	)		(566	)		(263	)		(2,578	)
Recoveries		10			71			7			156			262			506
Provision		(1,202	)		919			988			268			(32	)		941
ALL balance at June 30, 2014	$	2,839		$	3,642		$	1,553		$	4,178		$	251		$	12,463

ALL balance at January 1, 2013	$	5,206		$	5,029		$	906		$	4,507		$	399		$	16,047
Charge-offs		(184	)		(262	)		(1,004	)		(256	)		(275	)		(1,981	)
Recoveries		127			21			51			119			192			510
Provision		112			87			800			(66	)		13			946
ALL balance at June 30, 2013	$	5,261		$	4,875		$	753		$	4,304		$	329		$	15,522

(in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Consumer			Total
ALL balance at April 1, 2014	$	3,399		$	3,896		$	1,070		$	3,962		$	245		$	12,572
Charge-offs		0			(701	)		(56	)		(98	)		(84	)		(939	)
Recoveries		0			59			4			107			83			253
Provision		(560	)		388			535			207			7			577
ALL balance at June 30, 2014	$	2,839		$	3,642		$	1,553		$	4,178		$	251		$	12,463

ALL balance at April 1, 2013	$	5,789		$	4,760		$	645		$	4,483		$	348		$	16,025
Charge-offs		(184	)		(258	)		(128	)		(101	)		(132	)		(803	)
Recoveries		27			13			2			88			89			219
Provision		(371	)		360			234			(166	)		24			81
ALL balance at June 30, 2013	$	5,261		$	4,875		$	753		$	4,304		$	329		$	15,522

The ALL is based on estimates, and actual losses may vary from current estimates. Management believes that the granularity of the homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.

The following tables present the average recorded investment in impaired loans by class and related interest income recognized for the periods indicated:

	Six Months Ended						Six Months Ended
	June 30, 2014						June 30, 2013
(in thousands)	Average investment		Interest income recognized on an accrual basis		Interest income recognized on a cash basis		Average investment		Interest income recognized on an accrual basis		Interest income recognized on a cash basis
Commercial real estate
Non owner-occupied	$	1,105	$	11	$	0	$	5,194	$	23	$	0
All other CRE		9,936		81		44		10,657		178		46
Acquisition and development
1-4 family residential construction		1,919		25		0		2,961		42		0
All other A&D		8,567		96		0		20,022		269		303
Commercial and industrial		2,126		49		2		3,042		66		0
Residential mortgage
Residential mortgage - term		6,648		107		52		4,174		33		2
Residential mortgage – home equity		686		4		1		566		12		0
Consumer		11		0		0		86		0		0
Total	$	30,998	$	373	$	99	$	46,702	$	623	$	351

	Three Months Ended						Three Months Ended
	June 30, 2014						June 30, 2013
(in thousands)	Average investment		Interest income recognized on an accrual basis		Interest income recognized on a cash basis		Average investment		Interest income recognized on an accrual basis		Interest income recognized on a cash basis
Commercial real estate
Non owner-occupied	$	1,068	$	4	$	0	$	5,136	$	11	$	0
All other CRE		9,624		40		43		10,670		89		0
Acquisition and development
1-4 family residential construction		1,549		11		0		3,410		18		0
All other A&D		8,329		35		0		19,008		127		303
Commercial and industrial		2,040		23		0		2,838		31		0
Residential mortgage
Residential mortgage - term		6,489		53		43		4,384		14		0
Residential mortgage – home equity		739		1		0		575		6		0
Consumer		0		0		0		112		0		0
Total	$	29,838	$	167	$	86	$	46,133	$	296	$	303

In the normal course of business, the Bank modifies loan terms for various reasons. These reasons may include as a retention strategy, remaining competitive in the current interest rate environment, and re-amortizing or extending a loan term to better match the loan’s payment stream with the borrower’s cash flows. A modified loan is considered to be a troubled debt restructuring (“TDR”) when the Bank has determined that the borrower is troubled (i.e., experiencing financial difficulties). The Bank evaluates the probability that the borrower will be in payment default on any of its debt obligations in the foreseeable future without modification. To make this determination, the Bank performs a global financial review of the borrower and loan guarantors to assess their current ability to meet their financial obligations.

When the Bank restructures a loan to a troubled borrower, the loan terms (i.e., interest rate, payment amount, amortization period, and/or maturity date) are modified in such a way as to enable the borrower to cover the modified debt service payments based on current financials and cash flow adequacy. If a borrower’s hardship is thought to be temporary, then modified terms are only offered for that time period. Where possible, the Bank obtains additional collateral and/or secondary payment sources at the time of the restructure in order to put the Bank in the best possible position if the borrower is not able to meet the modified terms. To date, the Bank has not forgiven any principal as a restructuring concession. The Bank will not offer modified terms if it believes that modifying the loan terms will only delay an inevitable permanent default.

All loans designated as TDRs are considered impaired loans and may be in either accruing or non-accruing status. The Corporation’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition. Accordingly, the accrual of interest is discontinued when principal or interest is delinquent for 90 days or more unless the loan is well-secured and in the process of collection. If the loan was accruing at the time of the modification, then it continues to be in accruing status subsequent to the modification. Non-accrual TDRs may return to accruing status when there has been sufficient payment performance for a period of at least six months. TDRs are considered to be in payment default if, subsequent to modification, the loans are transferred to non-accrual status or to foreclosure. Loans may be removed from being reported as a TDR in the calendar year following the modification if the interest rate at the time of modification was consistent with the interest rate for a loan with comparable credit risk and the loan has performed according to its modified terms for at least six months.

The volume and type of TDR activity is considered in the assessment of the local economic trends’ qualitative factor used in the determination of the ALL for loans that are evaluated collectively for impairment.

The following table presents the volume and recorded investment at the time of modification of TDRs by class and type of modification that occurred during the periods indicated:

	Temporary Rate Modification				Extension of Maturity				Modification of Payment and Other Terms
(in thousands)	Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment		Number of Contracts		Recorded Investment
Six Months Ended June 30, 2014
Commercial real estate
Non owner-occupied		0	$	0		2	$	277		0	$	0
All other CRE		0		0		0		0		4		2,627
Acquisition and development
1-4 family residential construction		0		0		0		0		0		0
All other A&D		0		0		0		0		0		0
Commercial and industrial		0		0		0		0		0		0
Residential mortgage
Residential mortgage – term		1		90		0		0		0		0
Residential mortgage – home equity		0		0		0		0		0		0
Consumer		0		0		0		0		0		0
Total		1	$	90		2	$	277		4	$	2,627

	Temporary Rate								Modification of Payment
	Modification				Extension of Maturity				and Other Terms
	Number of		Recorded		Number of		Recorded		Number of		Recorded
(in thousands)	Contracts		Investment		Contracts		Investment		Contracts		Investment
Three Months Ended June 30, 2014
Commercial real estate
Non owner-occupied		0	$	0		0	$	0		0	$	0
All other CRE		0		0		0		0		3		2,173
Acquisition and development
1-4 family residential construction		0		0		0		0		0		0
All other A&D		0		0		0		0		0		0
Commercial and industrial		0		0		0		0		0		0
Residential mortgage
Residential mortgage – term		0		0		0		0		0		0
Residential mortgage – home equity		0		0		0		0		0		0
Consumer		0		0		0		0		0		0
Total		0	$	0		0	$	0		3	$	2,173

During the six months ended June 30, 2014, there were two new TDRs. In addition, five existing TDRs which had reached their original modification maturity were re-modified. A $1,055 reduction of the ALL resulted from a change to the impairment evaluation of one loan, from evaluated collectively to being evaluated individually. The remaining new TDR was impaired at the time of modification, resulting in no impact to the ALL as a result of the modification. There was no impact to the recorded investment relating to the transfer of these loans.

During the six months ended June 30, 2014, one A&D loan totaling $1.4 million that was modified as a TDR within the previous 12 months was transferred to non-accrual, and is considered a payment default.

During the six months ended June 30, 2013, there were three new TDRs. In addition, four existing TDRs which had reached their original modification maturity were re-modified. An $11,266 reduction of the ALL resulted from a change to the impairment evaluation of the three new loans, from being evaluated collectively to being evaluated individually. There was no impact to the recorded investment relating to the transfer of these loans.

During the six months ended June 30, 2013, there were two non-performing A&D loans totaling $.4 million that were transferred to OREO due to payment defaults.

Note 8 - Other Real Estate Owned

The following table presents the components of OREO as of June 30, 2014 and December 31, 2013:

(in thousands)	June 30, 2014		December 31, 2013
Commercial real estate	$	2,422	$	5,306
Acquisition and development		8,690		10,509
Residential mortgage		1,176		1,216
Total OREO	$	12,288	$	17,031

The following table presents the activity in the OREO valuation allowance for the six- and three- months ended June 30, 2014 and 2013:

	For the Six Months Ended						For the Three Months Ended
	June 30,						June 30,
(in thousands)	2014			2013			2014		2013
Balance January 1	$	4,047		$	2,766		$	3,670	$	2,179
Fair value write-down		443			37			72		17
Sales of OREO		(748	)		(815	)		0		(208	)
Balance at end of period	$	3,742		$	1,988		$	3,742	$	1,988

The following table presents the components of OREO expenses, net for the six- and three- months ended June 30, 2014 and 2013:

	For the Six Months Ended						For the Three Months Ended
	June 30,						June 30,
(in thousands)	2014			2013			2014			2013
Losses/(gains) on real estate, net	$	970		$	(62	)	$	995		$	(55	)
Fair value write-down, net		443			37			72			17
Expenses, net		357			223			169			106
Rental and other income		(156	)		(246	)		(79	)		(134	)
Total OREO expense/(income), net	$	1,614		$	(48	)	$	1,157		$	(66	)

Note 9 – 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. 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.

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.

The Corporation believes that its valuation techniques are appropriate and consistent with the techniques used by 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 valuation techniques used by the Corporation to measure, on a recurring and non-recurring basis, the fair value of assets as of June 30, 2014 are discussed in the paragraphs that follow.

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

The fair value of investments is determined using a market approach. As of June 30, 2014, the U.S. Treasuries, U.S. Government agencies, residential and commercial mortgage-backed securities, collateralized mortgage obligations, and municipal bonds segments are classified as Level 2 within the valuation hierarchy. 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 CDO segment, which consists of pooled trust preferred securities issued by banks, thrifts and insurance companies, is classified as Level 3 within the valuation hierarchy. At June 30, 2014, the Corporation owned 18 pooled trust preferred securities with an amortized cost of $37.4 million and a fair value of $23.9 million. The market for these securities at June 30, 2014 is not active and markets for similar securities are also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which these securities trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive, as few CDOs have been issued since 2007. There are currently very few market participants who are willing to effect transactions in these securities. The market values for these securities or any securities other than those issued or guaranteed by the U.S. Department of the Treasury (the “Treasury”) are depressed relative to historical levels. Therefore, in the current market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general rather than being an indicator of credit problems with a particular issue. Given the conditions in the current debt markets and the absence of observable transactions in the secondary and new issue markets, management has determined that (a) the few observable transactions and market quotations that are available are not reliable for the purpose of obtaining fair value at June 30, 2014, (b) an income valuation approach technique (i.e. present value) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than a market approach, and (c) the CDO segment is appropriately classified within Level 3 of the valuation hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date.

Management utilizes an independent third party to prepare both the evaluations of OTTI as well as the fair value determinations for its CDO portfolio. Management does not believe that there were any material differences in the OTTI evaluations and pricing between June 30, 2014 and December 31, 2013.

The approach used by the third party to determine fair value involves several steps, including detailed credit and structural evaluation of each piece of collateral in each bond, default, recovery and prepayment/amortization probabilities for each piece of collateral in the bond, and discounted cash flow modeling. The discount rate methodology used by the third party combines a baseline current market yield for comparable corporate and structured credit products with adjustments based on evaluations of the differences found in structure and risks associated with actual and projected credit performance of each CDO being valued. Currently, the only active and liquid trading market that exists is for stand-alone trust preferred securities. Therefore, adjustments to the baseline discount rate are also made to reflect the additional leverage found in structured instruments.

Derivative financial instruments (Cash flow hedge) – The Corporation’s open derivative positions are interest rate swaps that are classified as Level 3 within the valuation hierarchy. Open derivative positions are valued using externally developed pricing models based on observable market inputs provided by a third party and validated by management. The Corporation has considered counterparty credit risk in the valuation of its interest rate swap assets.

Impaired loans – Loans included in the table below are those that are considered impaired with a specific allocation or with a partial charge-off, based upon 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.

Other real estate owned – Other real estate owned included in the table below are considered impaired with specific write-downs. Fair value of other real estate owned is 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.

For Level 3 assets and liabilities measured at fair value on a recurring and non-recurring basis as of June 30, 2014, the significant unobservable inputs used in the fair value measurements were as follows:

(in thousands)	Fair Value at June 30, 2014			Valuation Technique	Significant Unobservable Inputs	Significant Unobservable Input Value
Recurring:

Investment Securities – available for sale	$	23,921		Discounted Cash Flow	Discount Rate	Swap+13%; Range of Libor+ 5.25% to 13%

Cash Flow Hedge	$	(272	)	Discounted Cash Flow	Reuters Third Party Market Quote	99.9% (weighted avg 99.9%)

Non-recurring:

Impaired Loans	$	6,781		Market Comparable Properties	Marketability Discount	10% (1) (weighted avg 10%)

OREO	$	2,409		Market Comparable Properties	Marketability Discount	11% (1) (weighted avg 11%)

NOTE:

(1)

Range would include discounts taken since appraisal and estimated values

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 June 30, 2014 and December 31, 2013 are as follows:

				Fair Value Measurements at June 30, 2014 Using
	Assets Measured at Fair Value			Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	06/30/2014			(Level 1)	(Level 2)		(Level 3)
Recurring:
Investment securities available-for-sale:
U.S. treasuries	$	17,000			$	17,000
U.S. government agencies	$	38,797			$	38,797
Residential mortgage-backed agencies	$	48,128			$	48,128
Commercial mortgage-backed agencies	$	17,324			$	17,324
Collateralized mortgage obligations	$	10,112			$	10,112
Obligations of states and political subdivisions	$	49,976			$	49,976
Collateralized debt obligations	$	23,921					$	23,921
Financial Derivative	$	(272	)				$	(272	)
Non-recurring:
Impaired loans	$	6,781					$	6,781
Other real estate owned	$	2,409					$	2,409

				Fair Value Measurements at December 31, 2013 Using
	Assets Measured at Fair Value			Quoted Prices in Active Markets for Identical Assets	Significant Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	12/31/2013			(Level 1)	(Level 2)		(Level 3)
Recurring:
Investment securities available-for-sale:
U.S. government agencies	$	92,035			$	92,035
Residential mortgage-backed agencies	$	112,444			$	112,444
Commercial mortgage-backed agencies	$	29,905			$	29,905
Collateralized mortgage obligations	$	29,390			$	29,390
Obligations of states and political subdivisions	$	55,277			$	55,277
Collateralized debt obligations	$	17,538					$	17,538
Financial Derivative	$	(457	)				$	(457	)
Non-recurring:
Impaired loans	$	8,613					$	8,613
Other real estate owned	$	5,591					$	5,591

There were no transfers of assets between any of the fair value hierarchy for the six- month periods ended June 30, 2014 and June 30, 2013.

The following tables show a reconciliation of the beginning and ending balances for fair valued assets measured on a recurring basis using Level 3 significant unobservable inputs for the six- and three- months ended June 30, 2014 and 2013:

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(In thousands)	Investment Securities Available for Sale		Cash Flow Hedge
Beginning balance January 1, 2014	$	17,538	$	(457	)
Total gains realized/unrealized:
Included in other comprehensive income		6,383		185
Ending balance June 30, 2014	$	23,921	$	(272	)

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	$	0	$	0

	Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
(in thousands)	Investment Securities Available for Sale		Cash Flow Hedge
Beginning balance January 1, 2013	$	11,442	$	(849	)
Total gains realized/unrealized:
Included in other comprehensive income		3,588		230
Ending balance June 30, 2013	$	15,030	$	(619	)

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	$	0	$	0

	Fair Value Measurement Using Significant Unobservable Inputs (Level 3)
(in thousands)	Investment Securities Available for Sale		Cash Flow Hedge
Beginning balance April 1, 2014	$	23,093	$	(365	)
Total gains realized/unrealized:
Included in other comprehensive income		828		93
Ending balance June 30, 2014	$	23,921	$	(272	)

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	$	0	$	0

	Fair Value Measurement Using Significant Unobservable Inputs (Level 3)
(in thousands)	Investment Securities Available for Sale		Cash Flow Hedge
Beginning balance April 1, 2013	$	13,798	$	(747	)
Total gains realized/unrealized:
Included in other comprehensive income		1,232		128
Ending balance June 30, 2013	$	15,030	$	(619	)

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	$	0	$	0

Gains (realized and unrealized) included in earnings for the periods identified above are reported in the Consolidated Statement of Operations in Other Operating Income.

The disclosed fair values may vary significantly between institutions based on the estimates and assumptions used in the various valuation methodologies. The derived fair values are subjective in nature and involve uncertainties and significant judgment. Therefore, they cannot be determined with precision. Changes in the assumptions could significantly impact the derived estimates of fair value. Disclosure of non-financial assets such as buildings as well as certain financial instruments such as leases is not required. Accordingly, the aggregate fair values presented do not represent the underlying value of the Corporation.

The following methods and assumptions were used by the Corporation to estimate its fair value disclosures for financial instruments:

Cash and due from banks: The carrying amounts as reported in the statement of financial condition for cash and due from banks approximate their fair values.

Interest bearing deposits in banks: The carrying amount of interest bearing deposits approximates their fair values.

Securities held to maturity: Investments in debt securities classified as held to maturity are measured subsequently at amortized cost in the statement of financial position.

Restricted investment in bank stock: The carrying value of stock issued by the FHLB of Atlanta, ACBB and CBB approximates fair value based on the redemption provisions of the stock.

Loans (excluding impaired loans with specific loss allowances): For variable-rate loans that re-price frequently or “in one year or less”, and with no significant change in credit risk, fair values are based on carrying values. Fair values for fixed-rate loans that do not re-price frequently are estimated using a discounted cash flow calculation that applies current market interest rates being offered on the various loan products.

Deposits: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings, and certain types of money market accounts, etc.) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on the various certificates of deposit to the cash flow stream.

Borrowed funds: The fair value of the Bank’s FHLB borrowings and junior subordinated debt is calculated based on the discounted value of contractual cash flows, using rates currently existing for borrowings with similar remaining maturities. The carrying amounts of federal funds purchased and securities sold under agreements to repurchase approximate their fair values.

Accrued interest: The carrying amount of accrued interest receivable and payable approximates their fair values.

Off-balance-sheet financial instruments: In the normal course of business, the Bank makes commitments to extend credit and issues standby letters of credit. The Bank expects most of these commitments to expire without being drawn upon; therefore, the commitment amounts do not necessarily represent future cash requirements. Due to the uncertainty of cash flows and difficulty in the predicting the timing of such cash flows, fair values were not estimated for these instruments.

The following tables present fair value information about financial instruments, whether or not recognized in the Consolidated Statement of Financial Condition, for which it is practicable to estimate that value. The actual carrying amounts and estimated fair values of the Corporation’s financial instruments that are included in the Consolidated Statement of Financial Condition are as follows:

	June 30, 2014				Fair Value Measurements
	Carrying		Fair		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Amount		Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets:
Cash and due from banks	$	54,421	$	54,421	$	54,421
Interest bearing deposits in banks		7,638		7,638		7,638
Investment securities - AFS		205,258		205,258			$	181,337	$	23,921
Investment securities - HTM		107,586		107,161				104,759		2,402
Restricted bank stock		7,480		7,480				7,480
Loans, net		812,675		814,466						814,466
Accrued interest receivable		4,125		4,125				4,125

Financial Liabilities:
Deposits – non-maturity		674,241		674,241				674,241
Deposits – time deposits		304,499		310,288				310,288
Short-term borrowed funds		37,913		33,138				33,138
Long-term borrowed funds		182,640		188,147				188,147
Accrued interest payable		882		882				882
Financial derivative		272		272						272
Off balance sheet financial instruments		0		0		0

	December 31, 2013				Fair Value Measurements
	Carrying		Fair		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
(in thousands)	Amount		Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets:
Cash and due from banks	$	32,895	$	32,895	$	32,895
Interest bearing deposits in banks		10,168		10,168		10,168
Investment securities - AFS		336,589		336,589			$	319,051	$	17,538
Investment securities - HTM		3,900		3,590						3,590
Restricted bank stock		7,913		7,913				7,913
Loans, net		796,646		799,937						799,937
Accrued interest receivable		4,342		4,342				4,342

Financial Liabilities:
Deposits- non-maturity		650,761		650,761				650,761
Deposits- time deposits		326,642		333,256				333,256
Short-term borrowed funds		43,676		43,676				43,676
Long-term borrowed funds		182,672		189,135				189,135
Accrued interest payable		7,647		7,647				7,647
Financial derivative		457		457						457
Off balance sheet financial instruments		0		0		0

Loans are measured using a discounted cash flow method. The significant unobservable inputs used in the Level 3 fair value measurements of the Corporation’s loans included in the tables above are calculated based on the Corporation’s internal new volume rate.

Note 10 – Accumulated Other Comprehensive Loss

The following table presents the changes in each component of accumulated other comprehensive loss for the 12 months ended December 31, 2013 and each of the three- month periods ended March 31, 2014 and June 30, 2014:

(in thousands)	Investment securities- with OTTI AFS			Investment securities- all other AFS			Investment securities- HTM			Cash Flow Hedge			Pension Plan			SERP			Total
Accumulated OCL, net:
Balance - January 1, 2013	$	(10,036	)	$	(2,966	)	$	0		$	(507	)	$	(8,262	)	$	(52	)	$	(21,823	)
Other comprehensive income/(loss) before reclassifications		2,735			(8,279	)		0			233			2,871			102			(2,338	)
Amounts reclassified from accumulated other comprehensive income		(322	)		(47	)		0			0			303			14			(52	)
Balance - December 31, 2013	$	(7,623	)	$	(11,292	)	$	0		$	(274	)	$	(5,088	)	$	64		$	(24,213	)
Other comprehensive income/(loss) before reclassifications		2,730			2,995			0			55			(179	)		0			5,601
Amounts reclassified from accumulated other comprehensive income		(96	)		41			0			0			52			1			(2	)
Balance – March 31, 2014	$	(4,989	)	$	(8,256	)	$	0		$	(219	)	$	(5,215	)	$	65		$	(18,614	)
Other comprehensive income/(loss) before reclassifications		511			5,254			(2,391	)		56			112			0			3,542
Amounts reclassified from accumulated other comprehensive income		(103	)		52			19			0			52			0			20
Balance – June 30, 2014	$	(4,581	)	$	(2,950	)	$	(2,372	)	$	(163	)	$	(5,051	)	$	65		$	(15,052	)

The following tables present the components of comprehensive income for the six- and three- months ended June 30, 2014 and 2013:

Components of Comprehensive Income (in thousands)	Before Tax Amount			Tax (Expense) Benefit			Net
For the six months ended June 30, 2014
Available for sale (AFS) securities with OTTI:
Unrealized holding gains	$	5,401		$	(2,160	)	$	3,241
Less: accretable yield recognized in income		331			(132	)		199
Net unrealized gains on investments with OTTI		5,070			(2,028	)		3,042

Available for sale securities – all other:
Unrealized holding gains		13,743			(5,494	)		8,249
Less: losses recognized in income		(154	)		61			(93	)
Net unrealized gains on all other AFS securities		13,897			(5,555	)		8,342

Held to maturity securities:
Unrealized holding losses		(3,984	)		1,593			(2,391	)
Less: amortization recognized in income		(32	)		13			(19	)
Net unrealized losses on HTM securities		(3,952	)		1,580			(2,372	)

Cash flow hedges:
Unrealized holding gains		185			(74	)		111

Pension Plan:
Unrealized net actuarial loss		(112	)		45			(67	)
Less: amortization of unrecognized loss		(187	)		75			(112	)
Less: amortization of transition asset		20			(8	)		12
Less: amortization of prior service costs		(6	)		2			(4	)
Net pension plan liability adjustment		61			(24	)		37

SERP:
Unrealized net actuarial loss		0			0			0
Less: amortization of unrecognized gain		9			(4	)		5
Less: amortization of prior service costs		(10	)		4			(6	)
Net SERP liability adjustment		1			0			1
Other comprehensive income	$	15,262		$	(6,101	)	$	9,161

Components of Comprehensive Income/(Loss) (in thousands)	Before Tax Amount			Tax (Expense) Benefit			Net
For the six months ended June 30, 2013
Available for sale (AFS) securities with OTTI:
Unrealized holding gains	$	2,618		$	(1,051	)	$	1,567
Less: accretable yield recognized in income		265			(106	)		159
Net unrealized gains on investments with OTTI		2,353			(945	)		1,408

Available for sale securities – all other:
Unrealized holding losses		(9,348	)		3,755			(5,593	)
Less: gains recognized in income		227			(91	)		136
Net unrealized losses on all other AFS securities		(9,575	)		3,846			(5,729	)

Cash flow hedges:
Unrealized holding gains		230			(92	)		138

Pension Plan:
Unrealized net actuarial loss		(100	)		39			(61	)
Less: amortization of unrecognized loss		(266	)		106			(160	)
Less: amortization of transition asset		20			(8	)		12
Less: amortization of prior service costs		(6	)		2			(4	)
Net pension plan liability adjustment		152			(61	)		91

SERP:
Unrealized net actuarial loss		0			0			0
Less: amortization of unrecognized loss		(2	)		1			(1	)
Less: amortization of prior service costs		(10	)		4			(6	)
Net SERP liability adjustment		12			(5	)		7
Other comprehensive loss	$	(6,828	)	$	2,743		$	(4,085	)

Components of Comprehensive Income (in thousands)	Before Tax Amount			Tax (Expense) Benefit			Net
For the three months ended June 30, 2014
Available for sale (AFS) securities with OTTI:
Unrealized holding gains	$	852		$	(341	)	$	511
Less: accretable yield recognized in income		171			(68	)		103
Net unrealized gains on investments with OTTI		681			(273	)		408

Available for sale securities – all other:
Unrealized holding gains		8,753			(3,499	)		5,254
Less: losses recognized in income		(86	)		34			(52	)
Net unrealized gains on all other AFS securities		8,839			(3,533	)		5,306

Held to maturity securities:
Unrealized holding losses		(3,984	)		1,593			(2,391	)
Less: amortization recognized in income		(32	)		13			(19	)
Net unrealized losses on HTM securities		(3,952	)		1,580			(2,372	)

Cash flow hedges:
Unrealized holding gains		93			(37	)		56

Pension Plan:
Unrealized net actuarial gain		186			(74	)		112
Less: amortization of unrecognized loss		(94	)		38			(56	)
Less: amortization of transition asset		10			(4	)		6
Less: amortization of prior service costs		(3	)		1			(2	)
Net pension plan liability adjustment		273			(109	)		164

SERP:
Unrealized net actuarial loss		0			0			0
Less: amortization of unrecognized gain		5			(1	)		4
Less: amortization of prior service costs		(5	)		1			(4	)
Net SERP liability adjustment		0			0			0
Other comprehensive income	$	5,934		$	(2,372	)	$	3,562

Components of Comprehensive Income/(Loss) (in thousands)	Before Tax Amount			Tax (Expense) Benefit			Net
For the three months ended June 30, 2013
Available for sale (AFS) securities with OTTI:
Unrealized holding gains	$	830		$	(333	)	$	497
Less: accretable yield recognized in income		139			(55	)		84
Net unrealized gains on investments with OTTI		691			(278	)		413

Available for sale securities – all other:
Unrealized holding losses		(9,154	)		3,677			(5,477	)
Less: gains recognized in income		(23	)		10			(13	)
Net unrealized losses on all other AFS securities		(9,131	)		3,667			(5,464	)

Cash flow hedges:
Unrealized holding gains		129			(51	)		78

Pension Plan:
Unrealized net actuarial loss		(1,169	)		469			(700	)
Less: amortization of unrecognized loss		(133	)		53			(80	)
Less: amortization of transition asset		10			(4	)		6
Less: amortization of prior service costs		(3	)		1			(2	)
Net pension plan liability adjustment		(1,043	)		419			(624	)

SERP:
Unrealized net actuarial loss		0			0			0
Less: amortization of unrecognized loss		(1	)		0			(1	)
Less: amortization of prior service costs		(5	)		3			(2	)
Net SERP liability adjustment		6			(3	)		3
Other comprehensive loss	$	(9,348	)	$	3,754		$	(5,594	)

The following table presents the details of accumulated other comprehensive income components for the six- and three-month periods ended June 30, 2014:

	Amount Reclassified from Accumulated Other Comprehensive Income
Details of Accumulated Other Comprehensive Income Components (in thousands)	For the six months ended June 30, 2014			For the three months ended June 30, 2014			Affected Line Item in the Statement Where Net Income is Presented
Unrealized gains and losses on investment securities with OTTI:
Accretable Yield	$	331		$	171		Interest income on taxable investment securities
Taxes		(132	)		(68	)	Tax expense
	$	199		$	103		Net of tax
Unrealized gains and losses on available for sale investment securities - all others:
Losses on sales	$	(154	)	$	(86	)	Net gains - other
Taxes		61			34		Tax benefit
	$	(93	)	$	(52	)	Net of tax
Unrealized gains and losses on held to maturity securities:
Amortization	$	(32	)	$	(32	)	Interest income on taxable investment securities
Taxes		13			13		Tax expense
	$	(19	)	$	(19	)	Net of tax

Net pension plan liability adjustment:
Amortization of unrecognized loss		(187	)		(94	)	Salaries and employee benefits
Amortization of transition asset		20			10		Salaries and employee benefits
Amortization of prior service costs		(6	)		(3	)	Salaries and employee benefits
Taxes		69			35		Tax benefit
	$	(104	)	$	(52	)	Net of tax
Net SERP liability adjustment:
Amortization of unrecognized gain		9			5		Salaries and employee benefits
Amortization of prior service costs		(10	)		(5	)	Salaries and employee benefits
Taxes		0			0		Tax benefit
	$	(1	)	$	0		Net of tax

Total reclassifications for the period	$	(18	)	$	(20	)	Net of tax

Note 11 – Junior Subordinated Debentures and Restrictions on Dividends

First United Corporation is the parent company to three statutory trust subsidiaries - First United Statutory Trust I and First United Statutory Trust II, both of which are Connecticut statutory trusts (“Trust I” and “Trust II”, respectively), and First United Statutory Trust III, a Delaware statutory trust (“Trust III” and, together with Trust I and Trust II, the “Trusts”). The Trusts were formed for the purposes of selling preferred securities to investors and using the proceeds to purchase junior subordinated debentures from First United Corporation (“TPS Debentures”) that would qualify as regulatory capital.

In March 2004, Trust I and Trust II issued preferred securities with an aggregate liquidation amount of $30.0 million to third-party investors and issued common equity with an aggregate liquidation amount of $.9 million to First United Corporation. Trust I and Trust II used the proceeds of these offerings to purchase an equal amount of TPS Debentures, as follows:

$20.6 million—floating rate payable quarterly based on three-month LIBOR plus 275 basis points (2.98% at June 30, 2014), maturing in 2034, became redeemable five years after issuance at First United Corporation’s option.

$10.3 million—floating rate payable quarterly based on three-month LIBOR plus 275 basis points (2.98% at June 30, 2014) maturing in 2034, became redeemable five years after issuance at First United Corporation’s option.

In December 2004, First United Corporation issued $5.0 million of junior subordinated debentures to third-party investors that were not tied to preferred securities. The debentures had a fixed rate of 5.88% for the first five years, payable quarterly, and converted to a floating rate in March 2010 based on the three month LIBOR plus 185 basis points (2.08% at June 30, 2014). The debentures mature in 2015, but became redeemable five years after issuance at First United Corporation’s option.

In December 2009, Trust III issued 9.875% fixed-rate preferred securities with an aggregate liquidation amount of approximately $7.0 million to private investors and issued common securities to First United Corporation with an aggregate liquidation amount of approximately $.2 million. Trust III used the proceeds of the offering to purchase approximately $7.2 million of 9.875% fixed-rate TPS Debentures. Interest on these TPS Debentures are payable quarterly, and the TPS Debentures mature in 2040 but are redeemable five years after issuance at First United Corporation’s option.

In January 2010, Trust III issued an additional $3.5 million of 9.875% fixed-rate preferred securities to private investors and issued common securities to First United Corporation with an aggregate liquidation amount of $.1 million. Trust III used the proceeds of the offering to purchase $3.6 million of 9.875% fixed-rate TPS Debentures. Interest on these TPS Debentures is payable quarterly, and the TPS Debentures mature in 2040 but are redeemable five years after issuance at First United Corporation’s option.

The TPS Debentures issued to each of the Trusts represent the sole assets of that Trust, and payments of the TPS Debentures by First United Corporation are the only sources of cash flow for the Trust. First United Corporation has the right, without triggering a default, to defer interest on all of the TPS Debentures for up to 20 quarterly periods, in which case distributions on the preferred securities will also be deferred. Should this occur, the Corporation may not pay dividends or distributions on, or repurchase, redeem or acquire any shares of its capital stock.

At the request of the Federal Reserve Bank of Richmond (the “Reserve Bank”) in December 2010, First United Corporation’s Board of Directors elected to defer quarterly interest payments under the TPS Debentures beginning with the payments due in March 2011. In February 2014, First United Corporation received approval from the Reserve Bank to terminate this deferral by making the quarterly interest payments due to the Trusts in March 2014 and paying all deferred interest for prior quarters. In connection with this deferral termination, deferred interest of approximately $1.024 million as well as $77,166 of current interest was paid to Trust I on March 17, 2014, deferred interest of approximately $2.048 million as well as $154,325 in current interest was paid to Trust II on March 17, 2014, and deferred interest of approximately $3.763 million as well as $266,650 in current interest was paid to Trust III on March 15, 2014. In April 2014, First United Corporation received approval from the Federal Reserve Bank to make the quarterly interest payments due in June 2014, and interest of $78,604 was paid to Trust I on June 17, 2014, $157,202 in interest was paid to Trust II on June 17, 2014, and $266,650 in interest was paid to Trust III on June 16, 2014. In July 2014, First United Corporation received approval from the Federal Reserve Bank to make the quarterly interest payments due in September 2014. Until further notice from the Reserve Bank, First United Corporation is required to obtain the Reserve Bank’s prior approval before making any future interest payments under the TPS Debentures. In considering a request for approval, the Reserve Bank will consider, among other things, the Corporation’s financial condition and its quarterly results of operations. In addition to this pre-approval requirement, First United Corporation’s ability to make future quarterly interest payments under the TPS Debentures will depend in large part on its receipt of dividends from the Bank, and the Bank may make dividend payments only with the prior approval of the Federal Deposit Insurance Corporation (the “FDIC”) and the Maryland Commissioner of Financial Regulation (the “Maryland Commissioner”). Although the FDIC and the Maryland Commissioner have authorized the Bank to pay dividends to the Corporation in an aggregate amount necessary for the Corporation to make the quarterly interest payments due in September 2014 and December 2014, that approval is subject to revocation by the FDIC and the Maryland Commissioner at any time if they determine that the Bank’s financial condition and/or results of operations do not support the payment of dividends. As a result of these limitations, no assurance can be given that First United Corporation will make the quarterly interest payments due under the TPS Debentures in any future quarter. In the event that First United Corporation and/or the Bank do not receive the approvals necessary for First United Corporation to make future quarterly interest payments, First United Corporation will have to again elect to defer interest payments. The terms of the TPS Debentures permit First United Corporation to elect to defer payments of interest for up to 20 consecutive quarterly periods, provided that no event of default exists under the TPS Debentures at the time of the election. An election to defer interest payments is not considered a default under the TPS Debentures.

Interest payments on the $5.0 million junior subordinated debentures that were issued outside of trust preferred securities offerings cannot be, and have not been, deferred.

The terms of First United Corporation’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”) call for the payment, if declared by the Board of Directors of First United Corporation, of cash dividends on February 15^th, May 15^th, August 15^th and November 15^th of each year. On November 15, 2010, at the request of the Reserve Bank, the Board of Directors of First United Corporation voted to suspend quarterly cash dividends on the Series A Preferred Stock beginning with the dividend payment due November 15, 2010. The terms of First United Corporation’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”) call for the payment, if declared by the Board of Directors of First United Corporation, of cash dividends on February 15^th, May 15^th, August 15^th and November 15^th of each year. On November 15, 2010, at the request of the Reserve Bank, the Board of Directors of First United Corporation voted to suspend quarterly cash dividends on the Series A Preferred Stock beginning with the dividend payment due November 15, 2010. During the suspension, dividends of $.4 million per dividend period continued to accrue. In April 2014, First United Corporation received approval from the Reserve Bank to terminate this deferral by making the quarterly dividend payment due to the Treasury in May 2014 and paying all unpaid dividends that accrued during the suspension period. Cumulative deferred dividends on the Series A Preferred Stock of approximately $6.5 million were paid on May 15, 2014. In July 2014, First United Corporation received approval from the Reserve Bank to make the quarterly dividend payment of $.7 million due in August 2014. Until further notice from the Reserve Bank, First United Corporation is required to obtain the Reserve Bank’s prior approval before making any future quarterly dividend payment. In considering a request for approval, the Reserve Bank will consider, among other things, the Corporation’s financial condition and its quarterly results of operations. In addition, First United Corporation’s ability to make future quarterly dividend payments on the Series A Preferred Stock will depend in large part on its receipt of dividends from the Bank, the declaration and payment of which, as discussed above, are subject to the prior approval of the FDIC and the Maryland Commissioner. If First United Corporation and/or the Bank do not obtain the regulatory approvals required for a particular quarterly dividend, then First United Corporation would have to again suspend quarterly dividend payments, which would result in a prohibition against paying any dividends or other distributions on the outstanding shares of First United Corporation’s common stock during the suspension period.

First United Corporation’s Board of Directors suspended the payment of dividends on the common stock in December 2010 when it approved the above-mentioned deferral of dividends on the Series A Preferred Stock, and this suspension remains in effect.

Note 12 – Borrowed Funds

The following is a summary of short-term borrowings with original maturities of less than one year:

(Dollars in thousands)	Six Months Ended June 30, 2014			Year Ended December 31, 2013
Securities sold under agreements to repurchase:
Outstanding at end of period	$	37,913		$	43,676
Weighted average interest rate at end of period		0.15	%		0.14	%
Maximum amount outstanding as of any month end	$	48,195		$	61,354
Average amount outstanding	$	43,397		$	47,777
Approximate weighted average rate during the period		0.13	%		0.13	%

At June 30, 2014, the repurchase agreements were secured by $57.4 million in investment securities.

The following is a summary of long-term borrowings with original maturities exceeding one year:

	June 30,		December 31,
(In thousands)	2014		2013
FHLB advances, bearing fixed interest at rates ranging from 1.00% to 3.69% at June 30, 2014	$	135,910	$	135,942
Junior subordinated debt, bearing variable interest rates ranging from 2.08% to 2.98% at June 30, 2014		35,929		35,929
Junior subordinated debt, bearing fixed interest rate of 9.88% at June 30, 2014		10,801		10,801
Total long-term debt	$	182,640	$	182,672

At June 30, 2014, the long-term FHLB advances were secured by $171.2 million in loans and $ .6 million in investment securities.

The contractual maturities of all long-term borrowings are as follows:

	June 30, 2014						December 31, 2013
(In thousands)	Fixed Rate		Floating Rate		Total		Total
Due in 2014	$	0	$	0	$	0	$	0
Due in 2015		30,000		5,000		35,000		35,000
Due in 2016		0		0		0		0
Due in 2017		0		0		0		0
Due in 2018		70,000		0		70,000		70,000
Due in 2019		0		0		0		0
Thereafter		46,711		30,929		77,640		77,672
Total long-term debt	$	146,711	$	35,929	$	182,640	$	182,672

Note 13 - Pension and SERP Plans

The following table presents the components of the net periodic pension plan cost for First United Corporation’s Defined Benefit Pension Plan (the “Pension Plan”) and the Bank’s Supplemental Executive Retirement Plan (“SERP”) for the periods indicated:

Pension	For the six months ended						For the three months ended
	June 30,						June 30,
(In thousands)	2014			2013			2014			2013
Service cost	$	129		$	114		$	64		$	57
Interest cost		737			635			371			305
Expected return on assets		(1,328	)		(1,188	)		(663	)		(594	)
Amortization of transition asset		(20	)		(20	)		(10	)		(10	)
Amortization of net actuarial loss		187			266			94			133
Amortization of prior service cost		6			6			3			3
Net pension credit included in employee benefits	$	(289	)	$	(187	)	$	(141	)	$	(106	)

SERP	For the six months ended					For the three months ended
	June 30,					June 30,
(In thousands)	2014			2013		2014			2013
Service cost	$	48		$	60	$	24		$	30
Interest cost		114			128		57			64
Amortization of recognized (gain)/loss		(9	)		2		(5	)		1
Amortization of prior service cost		10			10		5			5
Net SERP expense included in employee benefits	$	163		$	200	$	81		$	100

Effective April 30, 2010, the Pension Plan was amended, resulting in a “soft freeze”. The effects of the amendment were to prohibit new entrants into the plan and to cease crediting additional years of service after that date. Effective January 1, 2013, the plan was amended to unfreeze the plan for those employees for whom the sum of (a) their ages, at their closest birthday, plus (b) years of service for vesting purposes equal 80 or greater. The “soft freeze” continues to apply to all other plan participants. Pension benefits for these participants will be managed through discretionary contributions to the 401(k) Profit Sharing Plan. The Corporation anticipates that the plan changes will have a minimal impact on the consolidated financial statements.

The Corporation will assess the need for future annual contributions to the pension plan based upon its funded status and an evaluation of the future benefits to be provided thereunder. The Corporation expects to fund the annual projected benefit payments for the SERP from operations.

Note 14 - Equity Compensation Plan Information

At the 2007 Annual Meeting of Shareholders, First United Corporation’s shareholders approved the First United Corporation Omnibus Equity Compensation Plan (the “Omnibus Plan”), which authorizes the issuance of up to 185,000 shares of common stock pursuant to the grant of stock options, stock appreciation rights, stock awards, stock units, performance units, dividend equivalents, and other stock-based awards to employees or directors.

On June 18, 2008, the Board of Directors of First United Corporation adopted a Long-Term Incentive Program (the “LTIP”). This program was adopted as a sub-plan of the Omnibus Plan to reward participants for increasing shareholder value, align executive interests with those of shareholders, and serve as a retention tool for key executives. Under the LTIP, participants are granted shares of restricted common stock of First United Corporation. The amount of an award is based on a specified percentage of the participant’s salary as of the date of grant. These shares will vest if the Corporation meets or exceeds certain performance thresholds. There were no grants of restricted stock outstanding at June 30, 2014.

The Corporation complies with the provisions of ASC Topic 718, Compensation-Stock Compensation, in measuring and disclosing stock compensation cost. The measurement objective in ASC Paragraph 718-10-30-6 requires public companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. The cost is recognized in expense over the period in which an employee is required to provide service in exchange for the award (the vesting period). The performance-related shares granted in connection with the LTIP are expensed ratably from the date that the likelihood of meeting the performance measures is probable through the end of a three year vesting period.

The American Recovery and Reinvestment Act of 2009 (the “Recovery Act”) imposes restrictions on the type and timing of bonuses and incentive compensation that may be accrued for or paid to certain employees of institutions like First United Corporation that participated in Treasury’s Capital Purchase Program. The Recovery Act generally limits bonuses and incentive compensation to grants of long-term restricted stock that, among other requirements, cannot fully vest until the Capital Purchase Program assistance is repaid.

Stock-based awards were made to non-employee directors in May 2014 pursuant to First United Corporation’s director compensation policy. Beginning May 2014, each director’s annual retainer is paid in 1,000 shares of common stock, with the remainder of $10,000 paid in cash. Prior to May 2014 and since 2011, each non-employee director was given the option to receive the remainder of his or her retainer, or any portion thereof, in shares of stock. A total of 17,779 fully-vested shares of common stock were issued to directors in 2014, which had a fair market value of $8.78 per share. Director stock compensation expense was $56,010 for the six months ended June 30, 2014 and $43,311 for the six months ended June 30, 2013. Stock compensation expense was $33,515 and $21,660 for the three months ended June 30, 2014 and 2013, respectively.

Note 15 – Letters of Credit and Off Balance Sheet Liabilities

The Corporation does not issue any guarantees that would require liability recognition or disclosure other than the standby letters of credit issued by the Bank. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Generally, the Bank’s letters of credit are issued with expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank generally holds collateral and/or personal guarantees supporting these commitments. The Bank had $.9 million of outstanding standby letters of credit at June 30, 2014 and $1.1 million as of December 31, 2013. Management believes that the proceeds obtained through a liquidation of collateral and the enforcement of guarantees would be sufficient to cover the potential amount of future payment required by the letters of credit. Management does not believe that the amount of the liability associated with guarantees under standby letters of credit outstanding at June 30, 2014 and December 31, 2013 is material.

Note 16 – Derivative Financial Instruments

As a part of managing interest rate risk, the Bank entered into interest rate swap agreements to modify the re-pricing characteristics of certain interest-bearing liabilities. The Corporation has designated these interest rate swap agreements as cash flow hedges under the guidance of ASC Subtopic 815-30, Derivatives and Hedging – Cash Flow Hedges. Cash flow hedges have the effective portion of changes in the fair value of the derivative, net of taxes, recorded in net accumulated other comprehensive income.

In July 2009, the Corporation entered into three interest rate swap contracts totaling $20.0 million notional amount, hedging future cash flows associated with floating rate trust preferred debt. As of June 30, 2014, swap contracts totaling $5.0 million notional amount remained, as the three-year $5.0 million contract matured on June 15, 2012 and the five-year $10.0 million contract matured on June 17, 2014. The seven-year $5 million contract matures June 17, 2016. The fair value of the interest rate swap contract was ($272) thousand at June 30, 2014 and ($457) thousand at December 31, 2013 and was reported in Other Liabilities on the Consolidated Statement of Financial Condition. Cash in the amount of $.9 million was posted as collateral as of June 30, 2014.

For the six months ended June 30, 2014, the Corporation recorded an increase in the value of the derivatives of $185 thousand and the related deferred tax benefit of $74 thousand in net accumulated other comprehensive loss to reflect the effective portion of cash flow hedges. ASC Subtopic 815-30 requires this amount to be reclassified to earnings if the hedge becomes ineffective or is terminated. There was no hedge ineffectiveness recorded for the six months ending June 30, 2014. The Corporation does not expect any losses relating to these hedges to be reclassified into earnings within the next 12 months.

Interest rate swap agreements are entered into with counterparties that meet established credit standards and the Corporation believes that the credit risk inherent in these contracts is not significant as of June 30, 2014.

The table below discloses the impact of derivative financial instruments on the Corporation’s Consolidated Financial Statements for the six- and three- months ended June 30, 2014 and 2013.

Derivative in Cash Flow Hedging Relationships
(In thousands)	Amount of gain recognized in OCI on derivative (effective portion)		Amount of gain or (loss) reclassified from accumulated OCI into income (effective portion) ^(a)		Amount of gain or (loss) recognized in income or derivative (ineffective portion and amount excluded from effectiveness testing) ^(b)
Interest rate contracts:
Six months ended:
June 30, 2014	$	111	$	0	$	0
June 30, 2013		138		0		0
Three months ended:
June 30, 2014	$	56	$	0	$	0
June 30, 2013		78		0		0

Notes:

(a)

Reported as interest expense

(b)

Reported as other income

Note 17 – Variable Interest Entities (VIE)

As noted in Note 11, First United Corporation created the Trusts for the purposes of raising regulatory capital through the sale of mandatorily redeemable preferred capital securities to third party investors and common equity interests to First United Corporation. The Trusts are considered Variable Interest Entities (“VIEs”), but are not consolidated because First United Corporation is not the primary beneficiary of the Trusts. At June 30, 2014, the Corporation reported all of the $41.7 million of TPS Debentures issued in connection with these offerings as long-term borrowings (along with the $5.0 million of stand-alone junior subordinated debentures), and it reported its $1.3 million equity interest in the Trusts as “Other Assets”.

In November 2009, the Bank became a 99.99% limited partner in Liberty Mews Limited Partnership (the “Partnership”), a Maryland limited partnership formed for the purpose of acquiring, developing and operating low-income housing units in Garrett County, Maryland. The Partnership was financed with a total of $10.6 million of funding, including a $6.1 million equity contribution from the Bank as the limited partner. The Partnership used the proceeds from these sources to purchase the land and construct a 36-unit low income housing rental complex at a total cost of $10.6 million. The total assets of the Partnership were approximately $9.6 million at June 30, 2014 and $9.7 million at December 31, 2013.

As of December 31, 2011, the Bank had made contributions to the Partnership totaling $6.1 million. The project was completed in June 2011, and the Bank is entitled to $8.4 million in federal investment tax credits over a 10-year period as long as certain qualifying hurdles are maintained. The Bank will also receive the benefit of tax operating losses from the Partnership to the extent of its capital contribution. The investment in the Partnership assists the Bank in achieving its community reinvestment initiatives.

Because the Partnership is considered to be a VIE, management performed an analysis to determine whether its involvement with the Partnership would lead it to determine that it must consolidate the Partnership. In performing its analysis, management evaluated the risks creating the variability in the Partnership and identified which activities most significantly impact the VIE’s economic performance. Finally, it examined each of the variable interest holders to determine which, if any, of the holders was the primary beneficiary based on their power to direct the most significant activities and their obligation to absorb potentially significant losses of the Partnership.

The Bank, as a limited partner, generally has no voting rights. The Bank is not in any way involved in the daily management of the Partnership and has no other rights that provide it with the power to direct the activities that most significantly impact the Partnership’s economic performance, which are to develop and operate the housing project in such a manner that complies with specific tax credit guidelines. As a limited partner, there is no recourse to the Bank by the creditors of the Partnership. The tax credits that result from the Bank’s investment in the Partnership are generally subject to recapture should the partnership fail to comply with the applicable government regulations. The Bank has not provided any financial or other support to the Partnership beyond its required capital contributions and does not anticipate providing such support in the future. Management currently believes that no material losses are probable as a result of the Bank’s investment in the Partnership.

On the basis of management’s analysis, the general partner is deemed to be the primary beneficiary of the Partnership. Because the Bank is not the primary beneficiary, the Partnership has not been included in the Corporation’s consolidated financial statements.

At June 30, 2014 and December 31, 2013, the Corporation included its total investment in the Partnership in “Other Assets” in its Consolidated Statement of Financial Condition. As of June 30, 2014, the Corporation’s commitment in the Partnership was fully funded. The following table presents details of the Bank’s involvement with the Partnership at the dates indicated:

	June 30,		December 31,
(In thousands)	2014		2013
Investment in LIHTC Partnership
Carrying amount on Balance Sheet of:
Investment (Other Assets)	$	4,709	$	4,980
Maximum exposure to loss		4,709		4,980

Note 18 – Assets and Liabilities Subject to Enforceable Master Netting Arrangements

Interest Rate Swap Agreements (“Swap Agreements”)

The Corporation has entered into interest rate swap agreements to modify the re-pricing characteristics of certain interest-bearing liabilities as a part of managing interest rate risk. The swap agreements have been designated as cash flow hedges, and accordingly, the fair value of the interest rate swap contracts is reported in Other Liabilities on the Consolidated Statement of Financial Condition. The swap agreements were entered into with a third party financial institution. The Corporation is party to master netting arrangements with its financial institution counterparty; however the Corporation does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Collateral, in the form of cash, is pledged by the Corporation as the counterparty with net liability positions in accordance with contract thresholds. See Note 16 to the Consolidated Financial Statements for more information.

Securities Sold Under Agreements to Repurchase (“Repurchase Agreements”)

The Bank enters into agreements under which it sells interests in U.S. securities to certain customers subject to an obligation to repurchase, and on the part of the customers to resell, such interests. Under these arrangements, the Bank may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Bank to repurchase the assets. As a result, these repurchase agreements are accounted for as collateralized financing arrangements (i.e. secured borrowings) and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability in the Consolidated Statement of Condition, while the securities underlying the repurchase agreements remain in the respective investment securities asset accounts. There is no offsetting or netting of the investment securities assets with the repurchase agreement liabilities. In addition, as the Bank does not enter into reverse repurchase agreements, there is no such offsetting to be done with the repurchase agreements. The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral would be used to settle the fair value of the repurchase agreement should the Bank be in default (i.e. fails to repurchase the U.S. securities on the maturity date of the agreement). The investment security collateral is held by a third party financial institution in the counterparty’s custodial account.