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 September 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 R No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R 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 R

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

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

INDEX TO QUARTERLY REPORT

FIRST UNITED CORPORATION

PART I. FINANCIAL INFORMATION	3

Item 1. Financial Statements (unaudited)	3

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

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

Consolidated Statement of Comprehensive Income – for the three and nine months ended September 30, 2014 and 2013	6

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

Consolidated Statement of Cash Flows - for the nine months ended September 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	49

Item 3. Quantitative and Qualitative Disclosures about Market Risk	71

Item 4. Controls and Procedures	71

PART II. OTHER INFORMATION	72

Item 1. Legal Proceedings	72

Item 1A. Risk Factors	72

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	72

Item 3. Defaults upon Senior Securities	72

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)

	September 30,			December 31,
	2014			2013
	(Unaudited)
Assets
Cash and due from banks	$	42,916		$	32,895
Interest bearing deposits in banks		8,224			10,168
Cash and cash equivalents		51,140			43,063
Investment securities – available-for-sale (at fair value)		222,835			336,589
Investment securities – held to maturity (fair value $106,426 at September 30, 2014 and $3,590 at December 31, 2013)		106,961			3,900
Restricted investment in bank stock, at cost		7,524			7,913
Loans		824,925			810,240
Allowance for loan losses		(12,068	)		(13,594	)
Net loans		812,857			796,646
Premises and equipment, net		26,001			26,905
Goodwill and other intangible assets, net		11,004			11,004
Bank owned life insurance		33,150			32,413
Deferred tax assets		23,341			29,209
Other real estate owned		11,588			17,031
Accrued interest receivable and other assets		25,515			28,830
Total Assets	$	1,331,916		$	1,333,503

Liabilities and Shareholders’ Equity
Liabilities:
Non-interest bearing deposits	$	197,612		$	175,863
Interest bearing deposits		775,421			801,540
Total deposits		973,033			977,403

Short-term borrowings		47,994			43,676
Long-term borrowings		182,623			182,672
Accrued interest payable and other liabilities		15,996			28,412
Total Liabilities		1,219,646			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 September 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 September 30, 2014 and 6,211 at December 31, 2013		62			62
Surplus		21,756			21,661
Retained earnings		75,849			73,836
Accumulated other comprehensive loss		(15,397	)		(24,213	)
Total Shareholders’ Equity		112,270			101,340
Total Liabilities and Shareholders’ Equity	$	1,331,916		$	1,333,503

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

Consolidated Statement of Operations

(In thousands, except per share data)

	Nine Months Ended
	September 30,
	2014			2013
	(Unaudited)
Interest income
Interest and fees on loans	$	28,144		$	32,951
Interest on investment securities
Taxable		5,323			3,826
Exempt from federal income tax		1,175			1,315
Total investment income		6,498			5,141
Other		276			254
Total interest income		34,918			38,346
Interest expense
Interest on deposits		3,489			3,860
Interest on short-term borrowings		46			45
Interest on long-term borrowings		4,699			4,919
Total interest expense		8,234			8,824
Net interest income		26,684			29,522
Provision for loan losses		1,629			(161	)
Net interest income after provision for loan losses		25,055			29,683
Other operating income
Changes in fair value on impaired securities		5,648			3,095
Portion of gain recognized in other comprehensive income (before taxes)		(5,648	)		(3,095	)
Net securities impairment losses recognized in operations		0			0
Net gains – other		1,127			254
Total net gains		1,127			254
Service charges		2,213			2,651
Trust department		3,922			3,732
Debit card income		1,516			1,471
Bank owned life insurance		737			753
Brokerage commissions		607			606
Other		439			587
Total other income		9,434			9,800
Total other operating income		10,561			10,054
Other operating expenses
Salaries and employee benefits		14,613			14,730
FDIC premiums		1,360			1,405
Equipment		1,931			1,948
Occupancy		1,868			2,016
Data processing		2,379			2,263
Other real estate owned		2,128			2,766
Other		6,424			7,156
Total other operating expenses		30,703			32,284
Income before income tax expense		4,913			7,453
Provision for income tax expense		975			1,853
Net Income		3,938			5,600
Accumulated preferred stock dividends and discount accretion		(1,925	)		(1,326	)
Net Income Available to Common Shareholders	$	2,013		$	4,274
Basic and diluted net income per common share	$	0.32		$	0.69
Weighted average number of basic and diluted shares outstanding		6,220			6,206

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

Consolidated Statement of Operations

(In thousands, except per share data)

	Three Months Ended
	September 30,
	2014			2013
	(Unaudited)
Interest income
Interest and fees on loans	$	9,447		$	11,930
Interest on investment securities
Taxable		1,579			1,529
Exempt from federal income tax		371			447
Total investment income		1,950			1,976
Other		100			73
Total interest income		11,497			13,979
Interest expense
Interest on deposits		1,154			1,251
Interest on short-term borrowings		16			16
Interest on long-term borrowings		1,502			1,666
Total interest expense		2,672			2,933
Net interest income		8,825			11,046
Provision for loan losses		688			(1,107	)
Net interest income after provision for loan losses		8,137			12,153
Other operating income
Changes in fair value on impaired securities		578			742
Portion of gain recognized in other comprehensive income (before taxes)		(578	)		(742	)
Net securities impairment losses recognized in operations		0			0
Net gains /(losses)– other		166			(102	)
Total net gains/(losses)		166			(102	)
Service charges		747			894
Trust department		1,354			1,343
Debit card income		529			487
Bank owned life insurance		249			254
Brokerage commissions		201			245
Other		79			231
Total other income		3,159			3,454
Total other operating income		3,325			3,352
Other operating expenses
Salaries and employee benefits		4,910			5,090
FDIC premiums		478			476
Equipment		625			657
Occupancy		592			632
Data processing		803			764
Other real estate owned		514			2,814
Other		1,977			2,558
Total other operating expenses		9,899			12,991
Income before income tax expense		1,563			2,514
Provision for income tax expense		223			678
Net Income		1,340			1,836
Accumulated preferred stock dividends and discount accretion		(675	)		(448	)
Net Income Available to Common Shareholders	$	665		$	1,388
Basic and diluted net income per common share	$	0.10		$	0.22
Weighted average number of basic and diluted shares outstanding		6,228			6,211

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

Consolidated Statement of Comprehensive Income/(Loss)

(In thousands)

	Nine Months Ended
	September 30,
	2014			2013
Comprehensive Income (in thousands)	(Unaudited)
Net Income	$	3,938		$	5,600

Other comprehensive income/(loss), net of tax and reclassification adjustments:
Net unrealized gains on investments with OTTI		3,388			1,852

Net unrealized gains/(losses) on all other AFS securities		8,255			(6,369	)

Net unrealized losses on HTM securities		(2,315	)		0

Net unrealized gains on cash flow hedges		137			180

Net unrealized (losses)/gains on Pension		(650	)		525

Net unrealized gains on SERP		1			11

Other comprehensive income/(loss), net of tax		8,816			(3,801	)

Comprehensive income	$	12,754		$	1,799

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

Consolidated Statement of Comprehensive Income/(Loss)

(In thousands)

	Three Months Ended
	September 30,
	2014			2013
Comprehensive Income (in thousands)	(Unaudited)
Net Income	$	1,340		$	1,836

Other comprehensive income/(loss), net of tax and reclassification adjustments:
Net unrealized gains on investments with OTTI		346			444

Net unrealized losses on all other AFS securities		(87	)		(640	)

Net unrealized gains on HTM securities		57			0

Net unrealized gains on cash flow hedges		26			42

Net unrealized (losses)/gains on Pension		(687	)		434

Net unrealized gains on SERP		0			4

Other comprehensive (loss)/income, net of tax		(345	)		284

Comprehensive income	$	995		$	2,120

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			Accumulated Other Comprehensive Income/(Loss)			Total Shareholders' Equity
	(Unaudited)
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								3,938						3,938
Other comprehensive income											8,816			8,816
Stock based compensation						95								95
Preferred stock discount accretion		6						(6	)					0
Preferred stock dividends paid								(1,919	)					(1,919	)

Balance at September 30, 2014	$	30,000	$	62	$	21,756	$	75,849		$	(15,397	)	$	112,270

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

Consolidated Statement of Cash Flows

(In thousands)

	Nine Months Ended
	September 30,
	2014			2013
	(Unaudited)
Operating activities
Net income	$	3,938		$	5,600
Adjustments to reconcile net income to net cash (used in)/provided by operating activities:
Provision for loan losses		1,629			(161	)
Depreciation		1,471			1,541
Stock compensation		95			66
Loss/(gain) on sales of other real estate owned		921			(80	)
Write-downs of other real estate owned		885			2,889
Gain on loan sales		(37	)		(154	)
Loss on disposal of fixed assets		3			24
Net amortization of investment securities discounts and premiums- AFS		152			930
Net amortization of investment securities discounts and premiums- HTM		19			0
Loss/(gain) on sales of investment securities – available-for-sale		7			(124	)
Gain on sales of investment securities – held for trading		(1,100	)		0
Amortization of deferred loan fees		(363	)		(429	)
Decrease in accrued interest receivable and other assets		2,229			4,128
Decrease in deferred tax benefit		(4	)		(1	)
(Decrease)/increase in accrued interest payable and other liabilities		(5,685	)		2,450
Earnings on bank owned life insurance		(737	)		(753	)
Net cash provided by operating activities		3,423			15,926

Investing activities
Proceeds from maturities/calls of investment securities available-for-sale		122,291			27,160
Proceeds from maturities/calls of investment securities held-to-maturity		3,275			140
Proceeds from sales of investment securities available-for-sale		56,838			50,169
Proceeds from sales of investment securities held for trading		1,100			0
Purchases of investment securities available-for-sale		(153,924	)		(159,423	)
Purchases of investment securities held-to-maturity		(2,421	)		0
Proceeds from sales of other real estate owned		5,667			3,349
Proceeds from loan sales		4,312			20,691
Proceeds from disposal of fixed assets		0			1,421
Net decrease in FHLB stock		389			436
Net (increase)/decrease in loans		(23,782	)		12,151
Purchases of premises and equipment		(570	)		(864	)
Net cash provided by/(used in) investing activities		13,175			(44,770	)

Financing activities
Net decrease in deposits		(4,370	)		(2,491	)
Preferred stock dividends paid		(8,420	)		0
Net increase in short-term borrowings		4,318			19,849
Payments on long-term borrowings		(49	)		(47	)
Net cash (used in)/provided by financing activities		(8,521	)		17,311
Increase/(decrease) in cash and cash equivalents		8,077			(11,533	)
Cash and cash equivalents at beginning of the year		43,063			83,068
Cash and cash equivalents at end of period	$	51,140		$	71,535

Supplemental information
Interest paid	$	14,995		$	7,199
Non-cash investing activities:
Transfers from loans to other real estate owned	$	2,030		$	5,627
Security sold September 30, settled in October	$	618		$	0
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 nine-month periods ended September 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 September 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 nine- and three- month periods ended September 30, 2014 or 2013.

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

	Nine Months Ended September 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	$	3,938						$	5,600
Preferred stock dividends		(1,919	)						(1,274	)
Discount accretion on preferred stock		(6	)						(52	)

Net income available to common shareholders	$	2,013			6,220	$	0.32	$	4,274			6,206	$	0.69

	Three Months Ended September 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	$	1,340						$	1,836
Preferred stock dividends deferred		(675	)						(430	)
Discount accretion on preferred stock		0							(18	)

Net income available to common shareholders	$	665			6,228	$	0.10	$	1,388			6,211	$	0.22

Note 3 – Net Gains/(Losses)

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

	Nine Months Ended						Three Months Ended
	September 30,						September 30,
(in thousands)	2014			2013			2014			2013
Net gains/(losses) – other:
Available-for-sale securities:
Realized gains	$	427		$	447		$	222		$	35
Realized losses		(434	)		(323	)		(75	)		(138	)
Held-for-trading:
Realized gains		1,100			0			0			0
Gain on sale of consumer loans		37			154			19			23
Loss on disposal of fixed assets		(3	)		(24	)		0			(22	)
Net gains/(losses) – other	$	1,127		$	254		$	166		$	(102	)

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 cost which approximates fair value.

	September 30,		December 31,
(in thousands)	2014		2013
Cash and due from banks, weighted average interest rate of 0.16% (at September 30, 2014)	$	42,916	$	32,895

Interest bearing deposits in banks, which represent funds invested at a correspondent bank, are carried at cost which approximates fair value and, as of September 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”).

	September 30,		December 31,
(in thousands)	2014		2013
FHLB daily investments, interest rate of 0.005% (at September 30, 2014)	$	1,314	$	1,677
FTN daily investments, interest rate of 0.07% (at September 30, 2014)		850		1,350
M&T daily investments, interest rate of 0.20% (at September 30, 2014)		5,050		5,043
M&T daily investments, interest rate of 0.20% (at September 30, 2014)		1,010		1,008
CBB Fed Funds sold, interest rate of 0.22% (at September 30, 2014)		0		1,090
	$	8,224	$	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 September 30, 2014 and December 31, 2013:

(in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value		OTTI in AOCI
September 30, 2014
Available for Sale:
U.S. Treasuries	$	29,631	$	4	$	17	$	29,618	$	0
U.S. government agencies		39,088		82		411		38,759		0
Residential mortgage-backed agencies		46,573		276		726		46,123		0
Commercial mortgage-backed agencies		26,737		58		250		26,545		0
Collateralized mortgage obligations		9,286		89		7		9,368		0
Obligations of states and political subdivisions		46,784		1,466		234		48,016		0
Collateralized debt obligations		37,066		1,223		13,883		24,406		7,056
Total available for sale	$	235,165	$	3,198	$	15,528	$	222,835	$	7,056

Held to Maturity:
U.S. government agencies	$	24,476	$	31	$	109	$	24,398	$	0
Residential mortgage-backed agencies		55,572		93		263		55,402		0
Commercial mortgage-backed agencies		16,476		145		73		16,548		0
Collateralized mortgage obligations		7,712		0		110		7,602		0
Obligations of states and political subdivisions		2,725		0		249		2,476		0
Total held to maturity	$	106,961	$	269	$	804	$	106,426	$	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:

	Nine Months Ended				Three Months Ended
	September 30,				September 30,
(in thousands)	2014		2013		2014		2013
Proceeds	$	56,838	$	50,169	$	616	$	15,033
Realized gains		1,527		447		222		35
Realized losses		434		323		75		138

The following table shows the Corporation’s securities with gross unrealized losses and fair values at September 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
September 30, 2014
Available for Sale:
U.S. Treasuries	$	10,078	$	17	$	0	$	0
U.S. government agencies		0		0		18,664		411
Residential mortgage-backed agencies		9,974		1		23,786		725
Commercial mortgage-backed agencies		20,480		235		969		15
Collateralized mortgage obligations		2,174		7		0		0
Obligations of states and political subdivisions		0		0		12,450		234
Collateralized debt obligations		0		0		19,394		13,883
Total available for sale	$	42,706	$	260	$	75,263	$	15,268

Held to Maturity:
U.S. government agencies	$	14,945	$	109	$	0	$	0
Residential mortgage-backed agencies		47,209		263		0		0
Commercial mortgage-backed agencies		9,660		73		0		0
Collateralized mortgage obligations		7,602		110		0		0
Obligations of states and political subdivisions		0		0		2,476		249
Total held to maturity	$	79,416	$	555	$	2,476	$	249

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 the Corporation’s consolidated financial statements. Management utilizes an independent third party to prepare both the impairment valuations and fair value determinations for the Corporation’s 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 September 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 September 30, 2014. 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 September 30, 2014. There were no U.S. government treasuries in an unrealized loss position for 12 months or more.

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 September 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 September 30, 2014.

Residential Mortgage-Backed Agencies – Available for Sale - There was one residential mortgage-backed agency in an unrealized loss position for less than 12 months as of September 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 September 30, 2014.

Commercial Mortgage-Backed Agencies – Available for Sale – There were three commercial mortgage-backed agencies in an unrealized loss position for less than 12 months as of September 30, 2014. There was one commercial mortgage-backed agency security 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 September 30, 2014.

Collateralized Mortgage-Obligations – Available for Sale – There was one collateralized mortgage-obligation security in an unrealized loss position for less than 12 months as of September 30, 2014. 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 September 30, 2014. There were no collateralized mortgage-obligation securities in an unrealized loss position for 12 months or more.

Obligations of State and Political Subdivisions – Available for Sale - No obligations of state and political subdivisions securities have been in an unrealized loss position for less than 12 months at September 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 September 30, 2014.

Collateralized Debt Obligations – Available for Sale - The $13.9 million in unrealized losses greater than 12 months at September 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 nine 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 - Two U.S. government agencies have been in an unrealized loss position for less than 12 months as of September 30, 2014. 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 September 30, 2014. There were no U.S. government agencies in an unrealized loss position for 12 months or more.

Residential Mortgage-Backed Agencies – Held to Maturity - Eighteen residential mortgage-backed agencies have been in an unrealized loss position for less than 12 months as of September 30, 2014. 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 September 30, 2014. There were no residential mortgage-backed agencies in an unrealized loss position for 12 months or more.

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 September 30, 2014. 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 September 30, 2014. There were no commercial mortgage-backed agencies in an unrealized loss position for 12 months or more.

Collateralized Mortgage-Obligations – Held to Maturity - One collateralized mortgage obligation has been in an unrealized loss position for less than 12 months as of September 30, 2014. 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 September 30, 2014. There were no collateralized mortgage obligations in an unrealized loss position for 12 months or more.

Obligations of State and Political Subdivisions – Held to Maturity – No obligations of state and political subdivisions securities have been in an unrealized loss position for less than 12 months at September 30, 2014. There was one obligations of state and political subdivisions security that has been in an unrealized loss position for 12 months or more. This bond is a Tax Increment Fund (TIF) bond. 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 September 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 nine- and three-month periods ended September 30, 2014 and 2013:

	Nine Months Ended September 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		(501	)		(404	)
Balance of credit-related OTTI at September 30	$	12,921		$	13,555

	Three Months Ended September 30,
(in thousands)	2014			2013
Balance of credit-related OTTI at July 1	$	13,091		$	13,695
Reduction for increases in cash flows expected to be collected		(170	)		(140	)
Balance of credit-related OTTI at September 30	$	12,921		$	13,555

The amortized cost and estimated fair value of securities by contractual maturity at September 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.

	September 30, 2014
(in thousands)	Amortized Cost		Fair Value
Contractual Maturity
Available for sale:
Due in one year or less	$	19,536	$	19,540
Due after one year through five years		44,436	$	44,475
Due after five years through ten years		29,390		30,015
Due after ten years		59,207		46,769
		152,569		140,799

Residential mortgage-backed agencies		46,573		46,123
Commercial mortgage-backed agencies		26,737		26,545
Collateralized mortgage obligations		9,286		9,368
	$	235,165	$	222,835
Held to Maturity:
Due after five years through ten years	$	15,442	$	15,437
Due after ten years		11,759		11,437
		27,201		26,874

Residential mortgage-backed agencies		55,572		55,402
Commercial mortgage-backed agencies		16,476		16,548
Collateralized mortgage obligations		7,712		7,602
	$	106,961	$	106,426

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 September 30, 2014.

The Corporation recognizes dividends received on its restricted stock investments on a cash basis. For the nine months ended September 30, 2014, dividends of $212,665 were recognized in earnings. For the comparable period of 2013, dividends of $145,578 were recognized in earnings. For the three months ended September 30, 2014 and 2013, dividends of $68,329 and $48,844, 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 September 30, 2014 and December 31, 2013:

(in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Residential Mortgage		Consumer		Total
September 30, 2014

Individually evaluated for impairment	$	12,425	$	7,735	$	1,882	$	6,768	$	0	$	28,810
Collectively evaluated for impairment	$	240,662	$	89,251	$	87,476	$	354,597	$	24,129	$	796,115
Total loans	$	253,087	$	96,986	$	89,358	$	361,365	$	24,129	$	824,925

December 31, 2013

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
Total loans	$	267,978	$	107,250	$	59,788	$	350,906	$	24,318	$	810,240

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 September 30, 2014 and December 31, 2013:

(in thousands)	Pass		Special Mention		Substandard		Total
September 30, 2014
Commercial real estate
Non owner-occupied	$	105,951	$	1,305	$	25,355	$	132,611
All other CRE		91,792		8,755		19,929		120,476
Acquisition and development
1-4 family residential construction		12,900		0		1,004		13,904
All other A&D		68,586		1,398		13,098		83,082
Commercial and industrial		86,641		886		1,831		89,358
Residential mortgage
Residential mortgage - term		272,979		701		12,166		285,846
Residential mortgage - home equity		73,857		97		1,565		75,519
Consumer		24,036		0		93		24,129
Total	$	736,742	$	13,142	$	75,041	$	824,925

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 September 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
September 30, 2014
Commercial real estate
Non owner-occupied	$	128,145	$	306	$	3,179	$	187	$	3,672	$	794	$	132,611
All other CRE		115,367		269		0		0		269		4,840		120,476
Acquisition and development
1-4 family residential construction		13,812		0		0		0		0		92		13,904
All other A&D		78,020		0		419		87		506		4,556		83,082
Commercial and industrial		89,102		6		22		0		28		228		89,358
Residential mortgage
Residential mortgage - term		279,157		569		2,263		957		3,789		2,900		285,846
Residential mortgage - home equity		74,465		318		138		95		551		503		75,519
Consumer		23,773		248		79		29		356		0		24,129
Total	$	801,841	$	1,716	$	6,100	$	1,355	$	9,171	$	13,913	$	824,925

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 $4.9 million as of September 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 September 30, 2014 and December 31, 2013.

(in thousands)	Commercial Real Estate		Acquisition and Development		Commercial and Industrial		Residential Mortgage		Consumer		Total
September 30, 2014

Individually evaluated for impairment	$	0	$	1,100	$	0	$	62	$	0	$	1,162
Collectively evaluated for impairment	$	2,592	$	2,610	$	1,591	$	3,917	$	196	$	10,906
Total ALL	$	2,592	$	3,710	$	1,591	$	3,979	$	196	$	12,068

December 31, 2013

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
Total ALL	$	4,052	$	4,172	$	766	$	4,320	$	284	$	13,594

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 September 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
September 30, 2014
Commercial real estate
Non owner-occupied	$	0	$	0	$	4,245	$	4,245	$	4,255
All other CRE		0		0		8,180		8,180		8,308
Acquisition and development
1-4 family residential construction		912		130		92		1,004		1,068
All other A&D		3,162		970		3,569		6,731		12,999
Commercial and industrial		0		0		1,882		1,882		2,691
Residential mortgage
Residential mortgage - term		346		62		5,919		6,265		6,791
Residential mortgage – home equity		0		0		503		503		563
Consumer		0		0		0		0		0
Total impaired loans	$	4,420	$	1,162	$	24,390	$	28,810	$	36,675

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 nine- and three-month periods ended September 30, 2014 and September 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		(85	)		(2,423	)		(213	)		(682	)		(380	)		(3,783	)
Recoveries		11			104			22			183			308			628
Provision		(1,386	)		1,857			1,016			158			(16	)		1,629
ALL balance at September 30, 2014	$	2,592		$	3,710		$	1,591		$	3,979		$	196		$	12,068

ALL balance at January 1, 2013	$	5,206		$	5,029		$	906		$	4,507		$	399		$	16,047
Charge-offs		(233	)		(276	)		(1,051	)		(317	)		(375	)		(2,252	)
Recoveries		1,004			33			68			154			258			1,517
Provision		(1,509	)		495			815			18			20			(161	)
ALL balance at September 30, 2013	$	4,468		$	5,281		$	738		$	4,362		$	302		$	15,151

(in thousands)	Commercial Real Estate			Acquisition and Development			Commercial and Industrial			Residential Mortgage			Consumer			Total
ALL balance at July 1, 2014	$	2,839		$	3,642		$	1,553		$	4,178		$	251		$	12,463
Charge-offs		(64	)		(903	)		(5	)		(116	)		(117	)		(1,205	)
Recoveries		1			33			15			27			46			122
Provision		(184	)		938			28			(110	)		16			688
ALL balance at September 30, 2014	$	2,592		$	3,710		$	1,591		$	3,979		$	196		$	12,068

ALL balance at July 1, 2013	$	5,261		$	4,875		$	753		$	4,304		$	329		$	15,522
Charge-offs		(49	)		(14	)		(47	)		(61	)		(100	)		(271	)
Recoveries		877			12			17			35			66			1,007
Provision		(1,621	)		408			15			84			7			(1,107	)
ALL balance at September 30, 2013	$	4,468		$	5,281		$	738		$	4,362		$	302		$	15,151

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:

	Nine Months Ended						Nine Months Ended
	September 30, 2014						September 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	$	1,890	$	28	$	0	$	4,161	$	33	$	1,454
All other CRE		9,497		116		67		10,698		261		46
Acquisition and development
1-4 family residential construction		1,690		34		0		3,033		59		0
All other A&D		8,108		129		0		18,614		394		575
Commercial and industrial		2,065		70		2		2,844		88		0
Residential mortgage
Residential mortgage - term		6,552		154		55		4,816		56		7
Residential mortgage – home equity		640		4		4		555		18		0
Consumer		11		0		0		75		0		0
Total	$	30,453	$	535	$	128	$	44,796	$	909	$	2,082

	Three Months Ended						Three Months Ended
	September 30, 2014						September 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	$	2,591	$	17	$	0	$	3,048	$	10	$	1,454
All other CRE		8,506		35		23		10,704		83		0
Acquisition and development
1-4 family residential construction		1,016		9		0		3,237		17		0
All other A&D		7,540		33		0		15,879		125		272
Commercial and industrial		1,905		21		0		2,257		22		0
Residential mortgage
Residential mortgage - term		6,225		47		3		5,684		23		5
Residential mortgage – home equity		597		0		3		536		6		0
Consumer		0		0		0		74		0		0
Total	$	28,380	$	162	$	29	$	41,419	$	286	$	1,731

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
Nine Months Ended September 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 September 30, 2014
Commercial real estate
Non owner-occupied		0	$	0		0	$	0		0	$	0
All other CRE		0		0		0		0		0		0
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		0	$	0

During the nine months ended September 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 nine months ended September 30, 2014, three A&D loans totaling $1.7 million, a $.2 million C&I loan and a $.4 million owner-occupied CRE loan that were modified as TDRs within the previous 12 months were transferred to non-accrual, and are considered payment defaults.

During the nine months ended September 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 nine months ended September 30, 2013, there were three non-owner occupied CRE loans totaling $2.2 million that were transferred to non-accrual and 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 September 30, 2014 and December 31, 2013:

(in thousands)	September 30, 2014		December 31, 2013
Commercial real estate	$	1,897	$	5,306
Acquisition and development		8,715		10,509
Residential mortgage		976		1,216
Total OREO	$	11,588	$	17,031

The following table presents the activity in the OREO valuation allowance for the nine- and three-month periods ended September 30, 2014 and 2013:

	For the Nine Months Ended						For the Three Months Ended
	September 30,						September 30,
(in thousands)	2014			2013			2014			2013
Balance January 1	$	4,047		$	2,766		$	3,742		$	1,988
Fair value write-down		885			2,889			442			2,852
Sales of OREO		(1,155	)		(1,016	)		(407	)		(201	)
Balance at end of period	$	3,777		$	4,639		$	3,777		$	4,639

The following table presents the components of OREO expenses, net for the nine- and three-month periods ended September 30, 2014 and 2013:

	For the Nine Months Ended						For the Three Months Ended
	September 30,						September 30,
(in thousands)	2014			2013			2014			2013
Losses/(gains) on real estate, net	$	921		$	(80	)	$	(49	)	$	(18	)
Fair value write-down, net		885			2,889			442			2,852
Expenses, net		594			495			237			272
Rental and other income		(272	)		(538	)		(116	)		(292	)
Total OREO expense, net	$	2,128		$	2,766		$	514		$	2,814

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.

Management believes that the Corporation’s 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 September 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 September 30, 2014, the U.S. Treasuries, U.S. Government agencies, residential and commercial mortgage-backed securities, collateralized mortgage obligations, and state and political subdivisions 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 September 30, 2014, the Corporation owned 17 pooled trust preferred securities with an amortized cost of $37.1 million and a fair value of $24.4 million. The market for these securities at September 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 September 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 September 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 September 30, 2014, the significant unobservable inputs used in the fair value measurements were as follows:

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

Investment Securities – available for sale	$	24,406		Discounted Cash Flow	Discount Rate	Range of Libor+ 5.00% to 12%

Cash Flow Hedge	$	(228	)	Discounted Cash Flow	Reuters Third Party Market Quote	99.9% (weighted avg 99.9%)

Non-recurring:

Impaired Loans	$	8,099		Market Comparable Properties	Marketability Discount	10% (1) (weighted avg 10%)

Other Real Estate Owned	$	1,767		Market Comparable Properties	Marketability Discount	10% (1) (weighted avg 10%)

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

				Fair Value Measurements at September 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)	09/30/2014			(Level 1)	(Level 2)		(Level 3)
Recurring:
Investment securities available-for-sale:
U.S. Treasuries	$	29,618			$	29,618
U.S. government agencies	$	38,759			$	38,759
Residential mortgage-backed agencies	$	46,123			$	46,123
Commercial mortgage-backed agencies	$	26,545			$	26,545
Collateralized mortgage obligations	$	9,368			$	9,368
Obligations of states and political subdivisions	$	48,016			$	48,016
Collateralized debt obligations	$	24,406					$	24,406
Financial Derivative	$	(228	)				$	(228	)
Non-recurring:
Impaired loans	$	8,099					$	8,099
Other real estate owned	$	1,767					$	1,767

				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 nine-month periods ended September 30, 2014 and September 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 nine- and three-month periods ended September 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		6,868		229
Ending balance September 30, 2014	$	24,406	$	(228	)

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		4,831		301
Ending balance September 30, 2013	$	16,273	$	(548	)

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 July 1, 2014	$	23,921	$	(272	)
Total gains realized/unrealized:
Included in other comprehensive income		485		44
Ending balance September 30, 2014	$	24,406	$	(228	)

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 July 1, 2013	$	15,030	$	(619	)
Total gains realized/unrealized:
Included in other comprehensive income		1,243		71
Ending balance September 30, 2013	$	16,273	$	(548	)

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:

	September 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	$	42,916	$	42,916	$	42,916
Interest bearing deposits in banks		8,224		8,224		8,224
Investment securities - AFS		222,835		222,835			$	198,429	$	24,406
Investment securities - HTM		106,961		106,426				103,950		2,476
Restricted bank stock		7,524		7,524				7,524
Loans, net		812,857		816,589						816,589
Accrued interest receivable		3,785		3,785				3,785

Financial Liabilities:
Deposits – non-maturity		670,602		670,602				670,602
Deposits – time deposits		302,431		308,014				308,014
Short-term borrowed funds		47,994		41,372				41,372
Long-term borrowed funds		182,623		187,646				187,646
Accrued interest payable		886		886				886
Financial derivative		228		228						228
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, June 30, 2014 and September 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	)
Other comprehensive income/(loss) before reclassifications		448			1			0			26			(739	)		0			(264	)
Amounts reclassified from accumulated other comprehensive income		(102	)		(88	)		57			0			52			0			(81	)
Balance - September 30,2014	$	(4,235	)	$	(3,037	)	$	(2,315	)	$	(137	)	$	(5,738	)	$	65		$	(15,397	)

The following tables present the components of comprehensive income for the nine- and three-month periods ended September 30, 2014 and 2013:

Components of Comprehensive Income (in thousands)	Before Tax Amount			Tax (Expense) Benefit			Net
For the nine months ended September 30, 2014
Available for sale (AFS) securities with OTTI:
Unrealized holding gains	$	6,149		$	(2,460	)	$	3,689
Less: accretable yield recognized in income		501			(200	)		301
Net unrealized gains on investments with OTTI		5,648			(2,260	)		3,388

Available for sale securities – all other:
Unrealized holding gains		13,746			(5,496	)		8,250
Less: losses recognized in income		(7	)		2			(5	)
Net unrealized gains on all other AFS securities		13,753			(5,498	)		8,255

Held to maturity securities:
Unrealized holding losses		(3,984	)		1,593			(2,391	)
Less: amortization recognized in income		(127	)		51			(76	)
Net unrealized losses on HTM securities		(3,857	)		1,542			(2,315	)

Cash flow hedges:
Unrealized holding gains		229			(92	)		137

Pension Plan:
Unrealized net actuarial loss		(1,345	)		539			(806	)
Less: amortization of unrecognized loss		(280	)		112			(168	)
Less: amortization of transition asset		30			(12	)		18
Less: amortization of prior service costs		(9	)		3			(6	)
Net pension plan liability adjustment		(1,086	)		436			(650	)

SERP:
Unrealized net actuarial loss		0			0			0
Less: amortization of unrecognized gain		13			(5	)		8
Less: amortization of prior service costs		(15	)		6			(9	)
Net SERP liability adjustment		2			(1	)		1
Other comprehensive income	$	14,689		$	(5,873	)	$	8,816

Components of Comprehensive Income/(Loss) (in thousands)	Before Tax Amount			Tax (Expense) Benefit			Net
For the nine months ended September 30, 2013
Available for sale (AFS) securities with OTTI:
Unrealized holding gains	$	3,500		$	(1,405	)	$	2,095
Less: accretable yield recognized in income		406			(163	)		243
Net unrealized gains on investments with OTTI		3,094			(1,242	)		1,852

Available for sale securities – all other:
Unrealized holding losses		(10,520	)		4,225			(6,295	)
Less: gains recognized in income		124			(50	)		74
Net unrealized losses on all other AFS securities		(10,644	)		4,275			(6,369	)

Cash flow hedges:
Unrealized holding gains		301			(121	)		180

Pension Plan:
Unrealized net actuarial gain		499			(200	)		299
Less: amortization of unrecognized loss		(399	)		160			(239	)
Less: amortization of transition asset		30			(12	)		18
Less: amortization of prior service costs		(9	)		4			(5	)
Net pension plan liability adjustment		877			(352	)		525

SERP:
Unrealized net actuarial loss		0			0			0
Less: amortization of unrecognized loss		(3	)		1			(2	)
Less: amortization of prior service costs		(15	)		6			(9	)
Net SERP liability adjustment		18			(7	)		11
Other comprehensive loss	$	(6,354	)	$	2,553		$	(3,801	)

Components of Comprehensive Income (in thousands)	Before Tax Amount			Tax (Expense) Benefit			Net
For the three months ended September 30, 2014
Available for sale (AFS) securities with OTTI:
Unrealized holding gains	$	748		$	(300	)	$	448
Less: accretable yield recognized in income		170			(68	)		102
Net unrealized gains on investments with OTTI		578			(232	)		346

Available for sale securities – all other:
Unrealized holding gains		3			(2	)		1
Less: losses recognized in income		147			(59	)		88
Net unrealized losses on all other AFS securities		(144	)		57			(87	)

Held to maturity securities:
Unrealized holding losses		0			0			0
Less: amortization recognized in income		(95	)		38			(57	)
Net unrealized gains on HTM securities		95			(38	)		57

Cash flow hedges:
Unrealized holding gains		44			(18	)		26

Pension Plan:
Unrealized net actuarial loss		(1,233	)		494			(739	)
Less: amortization of unrecognized loss		(93	)		37			(56	)
Less: amortization of transition asset		10			(4	)		6
Less: amortization of prior service costs		(3	)		1			(2	)
Net pension plan liability adjustment		(1,147	)		460			(687	)

SERP:
Unrealized net actuarial loss		0			0			0
Less: amortization of unrecognized gain		4			(1	)		3
Less: amortization of prior service costs		(5	)		2			(3	)
Net SERP liability adjustment		1			(1	)		0
Other comprehensive loss	$	(573	)	$	228		$	(345	)

Components of Comprehensive Income/(Loss) (in thousands)	Before Tax Amount			Tax (Expense) Benefit			Net
For the three months ended September 30, 2013
Available for sale (AFS) securities with OTTI:
Unrealized holding gains	$	882		$	(354	)	$	528
Less: accretable yield recognized in income		140			(56	)		84
Net unrealized gains on investments with OTTI		742			(298	)		444

Available for sale securities – all other:
Unrealized holding losses		(1,174	)		472			(702	)
Less: gains recognized in income		(103	)		41			(62	)
Net unrealized losses on all other AFS securities		(1,071	)		431			(640	)

Cash flow hedges:
Unrealized holding gains		71			(29	)		42

Pension Plan:
Unrealized net actuarial gain		599			(241	)		358
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		725			(291	)		434

SERP:
Unrealized net actuarial loss		0			0			0
Less: amortization of unrecognized loss		(1	)		0			(1	)
Less: amortization of prior service costs		(5	)		2			(3	)
Net SERP liability adjustment		6			(2	)		4
Other comprehensive income	$	473		$	(189	)	$	284

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

	Amount Reclassified from Accumulated Other Comprehensive Income
Details of Accumulated Other Comprehensive Income Components (in thousands)	For the Nine months ended September 30, 2014			For the Three months ended September 30, 2014			Affected Line Item in the Statement Where Net Income is Presented
Unrealized gains and losses on investment securities with OTTI:
Accretable Yield	$	501		$	170		Interest income on taxable investment securities
Taxes		(200	)		(68	)	Tax benefit
	$	301		$	102		Net of tax
Unrealized gains and losses on available for sale investment securities - all others:
(Gains)/losses on sales	$	(7	)	$	147		Net gains - other
Taxes		2			(59	)	Tax expense/(benefit)
	$	(5	)	$	88		Net of tax
Unrealized gains and losses on held to maturity securities:
Amortization	$	(127	)	$	(95	)	Interest income on taxable investment securities
Taxes		51			38		Tax expense
	$	(76	)	$	(57	)	Net of tax

Net pension plan liability adjustment:
Amortization of unrecognized loss		(280	)		(93	)	Salaries and employee benefits
Amortization of transition asset		30			10		Salaries and employee benefits
Amortization of prior service costs		(9	)		(3	)	Salaries and employee benefits
Taxes		103			34		Tax expense
	$	(156	)	$	(52	)	Net of tax
Net SERP liability adjustment:
Amortization of unrecognized gain		13			4		Salaries and employee benefits
Amortization of prior service costs		(15	)		(5	)	Salaries and employee benefits
Taxes		1			1		Tax expense
	$	(1	)	$	0		Net of tax

Total reclassifications for the period	$	63		$	81		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 September 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 September 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 September 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, First United 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 and interest of $78,572 was paid to Trust I on September 17, 2014, $157,136 in interest was paid to Trust II on September 17, 2014, and $266,650 in interest was paid to Trust III on September 15, 2014. In November 2014, First United Corporation received approval from the Federal Reserve Bank to make the quarterly interest payments due in December 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”). 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. 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 due in August 2014. A dividend payment of $.7 million was paid on August 15, 2014. In November 2014, First United Corporation received approval from the Reserve Bank to make the quarterly dividend payment due in November 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)	Nine Months Ended September 30, 2014			Year Ended December 31, 2013
Securities sold under agreements to repurchase:
Outstanding at end of period	$	47,994		$	43,676
Weighted average interest rate at end of period		0.12	%		0.14	%
Maximum amount outstanding as of any month end	$	53,370		$	61,354
Average amount outstanding	$	44,646		$	47,777
Approximate weighted average rate during the period		0.13	%		0.13	%

At September 30, 2014, the repurchase agreements were secured by $74.2 million in investment securities.

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

	September 30,		December 31,
(In thousands)	2014		2013
FHLB advances, bearing fixed interest at rates ranging from 1.00% to 3.69% at September 30, 2014	$	135,893	$	135,942
Junior subordinated debt, bearing variable interest rates ranging from 2.08% to 2.98% at September 30, 2014		35,929		35,929
Junior subordinated debt, bearing fixed interest rate of 9.88% at September 30, 2014		10,801		10,801
Total long-term debt	$	182,623	$	182,672

At September 30, 2014, the long-term FHLB advances were secured by $147.6 million in loans, $.9 million in cash and $.5 million in investment securities.

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

	September 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		46,694		30,929		77,623		77,672
Total long-term debt	$	146,694	$	35,929	$	182,623	$	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 Nine months ended						For the Three months ended
	September 30,						September 30,
(In thousands)	2014			2013			2014			2013
Service cost	$	193		$	170		$	64		$	56
Interest cost		1,106			934			369			299
Expected return on assets		(1,990	)		(1,780	)		(662	)		(592	)
Amortization of transition asset		(30	)		(30	)		(10	)		(10	)
Amortization of net actuarial loss		280			399			93			133
Amortization of prior service cost		9			9			3			3
Net pension credit included in employee benefits	$	(432	)	$	(298	)	$	(143	)	$	(111	)

SERP	For the Nine months ended					For the Three months ended
	September 30,					September 30,
(In thousands)	2014			2013		2014			2013
Service cost	$	71		$	91	$	23		$	31
Interest cost		172			192		58			64
Amortization of recognized (gain)/loss		(13	)		3		(4	)		1
Amortization of prior service cost		15			15		5			5
Net SERP expense included in employee benefits	$	245		$	301	$	82		$	101

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 September 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 or any portion thereof, in shares of stock. Prior to May 2014, the retainer of the 1,000 shares of stock was paid in shares of stock in the amount of $5,000. 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 $95,035 for the nine months ended September 30, 2014 and $65,806 for the nine months ended September 30, 2013. Stock compensation expense was $39,025 and $22,495 for the three months ended September 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 September 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 September 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 September 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 ($228) thousand at September 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 September 30, 2014.

For the nine months ended September 30, 2014, the Corporation recorded an increase in the value of the derivatives of $229 thousand and the related deferred tax benefit of $92 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 nine months ending September 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 September 30, 2014.

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

Derivative in Cash Flow Hedging

(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:
Nine months ended:
September 30, 2014	$	137	$	0	$	0
September 30, 2013		180		0		0
Three months ended:
September 30, 2014	$	26	$	0	$	0
September 30, 2013		42		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 September 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 $9.5 million at September 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 September 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 September 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:

	September 30,		December 31,
(In thousands)	2014		2013
Investment in LIHTC Partnership
Carrying amount on Balance Sheet of:
Investment (Other Assets)	$	4,570	$	4,980
Maximum exposure to loss		4,570		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.

The following table presents the liabilities subject to an enforceable master netting arrangement or repurchase agreements as of September 30, 2014 and December 31, 2013.

							Gross Amounts Not Offset in the Statement of Condition
(In thousands)	Gross Amounts of Recognized Liabilities		Gross Amounts Offset in the Statement of Condition		Net Amounts of Liabilities Presented in the Statement of Condition		Financial Instruments			Cash Collateral Pledged		Net Amount
September 30, 2014
Interest Rate Swap Agreements	$	228	$	0	$	228	$	(228	)	$	0	$	0

Repurchase Agreements	$	47,994	$	0	$	47,994	$	(47,994	)	$	0	$	0
December 31, 2013
Interest Rate Swap Agreements	$	457	$	0	$	457	$	(457	)	$	0	$	0

Repurchase Agreements	$	43,676	$	0	$	43,676	$	(43,676	)	$	0	$	0

Note 19 – Adoption of New Accounting Standards and Effects of New Accounting Pronouncements

In August 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-14, Classification of Certain Government-Guaranteed Mortgage Loans Upon Foreclosure, an amendment of ASC Subtopic 310-40, Receivables – Troubled Debt Restructurings by Creditors. ASU 2014-14 specifies that a mortgage loan be derecognized and a separate other receivable be recognized upon foreclosure if the loan has a government guarantee that is not separable from the loan before foreclosure; and at the time of foreclosure, the creditor has the intent to convey the real estate to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under the amount of the claim, which must be a fixed amount determined on the basis of the fair value of the real estate. An entity can elect to adopt the amendments in ASU 2014-14 using either a modified retrospective transition method or a prospective transition method. ASU 2014-14 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014, with early adoption permitted. The Corporation is evaluating the provisions of ASU 2014-14, but believes that its adoption will not have a material impact on the Corporation’s financial condition or results of operations.

In June 2014, the FASB issued ASU 2014-11, Repurchase-to Maturity Transactions, Repurchase Financings, and Disclosures, an amendment of ASC Topic 860, Transfers and Servicing. The amendments in ASU 2014-11 require repurchase-to-maturity transactions to be accounted for as secured borrowing transactions on the balance sheet, rather than sales; and for repurchase financing arrangements, require separate accounting for a transfer of a financial asset executed contemporaneously with (or in contemplation of) a repurchase agreement with the same counterparty, which also will generally result in secured borrowing accounting for the repurchase agreement. The ASU also introduces new disclosures to increase transparency about the types of collateral pledged for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings, and requires a transferor to disclose information about transactions accounted for as a sale in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets through an agreement with the transferee. For public entities, the accounting changes and disclosure for certain transactions accounted for as a sale are effective for the first interim or annual period beginning after December 15, 2014. The disclosure for transactions accounted for as secured borrowings is required for annual periods beginning after December 15, 2014, and for interim periods beginning after March 15, 2015. Earlier application for a public entity is prohibited. The Corporation is evaluating the provisions of ASU 2014-11, but believes that its adoption will not have a material impact on the Corporation’s financial condition or results of operations.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which establishes a comprehensive revenue recognition standard for virtually all industries under U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. ASU 2014-09 specifies that an entity shall recognize revenue when, or as, the entity satisfies a performance obligation by transferring a promised good or service (i.e. an asset) to a customer. An asset is transferred when, or as, the customer obtains control of the asset. Entities are required to disclose qualitative and quantitative information on the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, with early adoption not permitted. The Corporation is evaluating the provisions of ASU 2014-09, but believes that its adoption will not have a material impact on the Corporation’s financial condition or results of operations.

In January 2014, the FASB issued ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure, which provides guidance clarifying when an in substance repossession or foreclosure occurs that would require a loan receivable to be derecognized and the real estate property recognized. ASU 2014-04 specifies the circumstances when a creditor should be considered to have received physical possession of the residential real estate property collateralizing a consumer mortgage loan, and requires interim and annual disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate that are in the process of foreclosure. An entity can elect to adopt the amendments in ASU 2014-04 using either a modified or a retrospective transition method or a prospective transition method. ASU 2014-04 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014, with early adoption permitted. The Corporation is evaluating the provisions of ASU 2014-04, but believes that its adoption will not have a material impact on the Corporation’s financial condition or results of operations.

In January 2014, the FASB issued ASU 2014-01, Accounting for Investments in Qualified Affordable Housing Projects, which provides amendments and guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit. The amendments permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. The amendments in ASU 2014-01 should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. Additional disclosure requirements are applicable to all reporting entities, regardless of whether the election is made. ASU 2014-01 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2014, with early adoption permitted. At December 31, 2013, the Corporation had a single investment in a flow-through limited liability entity that invests in an affordable housing project, for which it currently utilizes the effective yield method to account for its investment. The Corporation is evaluating whether to change its method of accounting as permitted by ASU 2014-01, but believes that the adoption of ASU 2014-01 will not have a material impact on the Corporation’s financial condition or results of operations.

In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, which provides guidance on financial statement presentation of an unrecognized tax benefit when a net operating loss (“NOL”) carryforward, a similar tax loss, or a tax credit carryforward exists. The ASU is intended to eliminate diversity in practice resulting from a lack of guidance on this topic in current GAAP. Under the ASU, an entity generally must present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements as a reduction to a deferred tax asset for an NOL carryforward, a similar tax loss, or a tax credit carryforward. The Corporation adopted the provisions of ASU 2013-11 effective January 1, 2014. As the Corporation has no unrecognized tax benefits, the adoption of ASU 2013-11 did not have any impact on the Corporation’s financial condition or results of operations.

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

INTRODUCTION

The following discussion and analysis is intended as a review of material changes in and significant factors affecting the financial condition and results of operations of the First United Corporation and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto contained in Item 1 of Part I of this report. Unless the context clearly suggests otherwise, references in this report to “us”, “we”, “our”, and “the Corporation” are to First United Corporation and its consolidated subsidiaries.

FORWARD-LOOKING STATEMENTS

This report may contain forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. Readers of this report should be aware of the speculative nature of “forward-looking statements.” Statements that are not historical in nature, including those that include the words “anticipate”, “estimate”, “should”, “expect”, “believe”, “intend”, and similar expressions, are based on current expectations, estimates and projections about, among other things, the industry and the markets in which we operate, and they are not guarantees of future performance. Whether actual results will conform to expectations and predictions is subject to known and unknown risks and uncertainties, including risks and uncertainties discussed in this report; general economic, market, or business conditions; changes in interest rates, deposit flow, the cost of funds, and demand for loan products and financial services; changes in our competitive position or competitive actions by other companies; changes in the quality or composition of our loan and investment portfolios; our ability to manage growth; changes in laws or regulations or policies of federal and state regulators and agencies; and other circumstances beyond our control. Consequently, all of the forward-looking statements made in this report are qualified by these cautionary statements, and there can be no assurance that the actual results anticipated will be realized, or if substantially realized, will have the expected consequences on our business or operations. These and other risks are discussed in detail in the periodic reports that First United Corporation files with the Securities and Exchange Commission (the “SEC”) (see Item 1A of Part II of this report for further information). Except as required by applicable laws, we do not intend to publish updates or revisions of any forward-looking statements we make to reflect new information, future events or otherwise.

FIRST UNITED CORPORATION

First United Corporation is a Maryland corporation chartered in 1985 and a bank holding company registered under the Federal Bank Holding Company Act of 1956, as amended. Until September 24, 2014, First United Corporation operated as a financial holding company under the Gramm-Leach-Bliley Act. Effective on that date, First United Corporation terminated its financial holding company election because the Corporation is not engaged, and does not anticipate engaging in the foreseeable future, in any activity that requires the election. Accordingly, the termination is not expected to have any material impact on our financial condition or results of operations. First United Corporation’s primary business is serving as the parent company of First United Bank & Trust, a Maryland trust company (the “Bank”), First United Statutory Trust I (“Trust I”) and First United Statutory Trust II (“Trust II”), both Connecticut statutory business trusts, and First United Statutory Trust III, a Delaware statutory business trust (“Trust III” and together with Trust I and Trust II, the “Trusts”). The Trusts were formed for the purpose of selling trust preferred securities that qualified as Tier 1 capital. First United Corporation is also the parent company of First United Insurance Group, LLC, a Maryland limited liability company (the “Insurance Agency”) that, through the close of business on December 31, 2011, operated as a full service insurance agency. Effective on January 1, 2012, the Insurance Agency sold substantially all of its assets, net of cash, to a third-party and is no longer an active subsidiary. The Bank has three wholly-owned subsidiaries: OakFirst Loan Center, Inc., a West Virginia finance company; OakFirst Loan Center, LLC, a Maryland finance company (collectively, the “OakFirst Loan Centers”); and First OREO Trust, a Maryland statutory trust formed for the purposes of servicing and disposing of the real estate that the Bank acquires through foreclosure or by deed in lieu of foreclosure. Until March 27, 2013, the Bank also owned a majority interest in Cumberland Liquidation Trust, a Maryland statutory trust formed for the purposes of servicing and disposing of real estate that secured a loan made by another bank and in which the Bank held a participation interest, but this entity was dissolved on such date. The Bank also owns 99.9% of the limited partnership interests in Liberty Mews Limited Partnership, a Maryland limited partnership formed for the purpose of acquiring, developing and operating low-income housing units in Garrett County, Maryland.

At September 30, 2014, the Corporation had total assets of $1.3 billion, net loans of $812.9 million, and deposits of $973.0 million. Shareholders’ equity at September 30, 2014 was $112.3 million.

The Corporation maintains an Internet site at www.mybank4.com on which it makes available, free of charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to the foregoing as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the SEC.

ESTIMATES AND CRITICAL ACCOUNTING POLICIES

This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. (See Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of Part II of First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2013). On an on-going basis, management evaluates estimates, including those related to loan losses and intangible assets, other-than-temporary impairment (“OTTI”) of investment securities, income taxes, fair value of investments and pension plan assumptions. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the consolidated financial statements.

Allowance for Loan Losses

One of our most important accounting policies is that related to the monitoring of the loan portfolio. A variety of estimates impact the carrying value of the loan portfolio, including the calculation of the allowance for loan losses (the “ALL”), the valuation of underlying collateral, the timing of loan charge-offs and the placement of loans on non-accrual status. The ALL is established and maintained at a level that management believes is adequate to cover losses resulting from the inability of borrowers to make required payment on loans. Estimates for loan losses are arrived at by analyzing risks associated with specific loans and the loan portfolio, current and historical trends in delinquencies and charge-offs, and changes in the size and composition of the loan portfolio. The analysis also requires consideration of the economic climate and outlook, including the economic conditions specific to Western Maryland and Northeastern West Virginia, changes in lending rates, political conditions, and legislation impacting the banking industry. Because the calculation of the ALL relies on management’s estimates and judgments relating to inherently uncertain events, actual results may differ from management’s estimates.

Goodwill and Other Intangible Assets

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, Intangibles - Goodwill and Other, establishes standards for the amortization of acquired intangible assets and impairment assessment of goodwill. The $11 million recorded as goodwill at September 30, 2014 is primarily related to the Bank’s 2003 acquisition of Huntington National Bank branches and is not subject to periodic amortization.

Goodwill arising from business combinations represents the value attributable to unidentifiable intangible elements in the business acquired. Goodwill is not amortized but is tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value of each of the Corporation’s reporting units be compared to the carrying amount of its net assets, including goodwill. If the estimated current fair value of the reporting unit exceeds its carrying value, no additional testing is required and an impairment loss is not recorded. Otherwise, additional testing is performed, and to the extent such additional testing results in a conclusion that the carrying value of goodwill exceeds its implied fair value, an impairment loss is recognized.

Our goodwill relates to value inherent in the banking business, and that value is dependent upon our ability to provide quality, cost effective services in a highly competitive local market. This ability relies upon continuing investments in processing systems, the development of value-added service features and the ease of use of our services. As such, goodwill value is ultimately supported by revenue that is driven by the volume of business transacted. A decline in earnings as a result of a lack of growth or the inability to deliver cost effective services over sustained periods can lead to impairment of goodwill, which could adversely impact earnings in future periods. ASC Topic 350 requires an annual evaluation of goodwill for impairment. The determination of whether or not these assets are impaired involves significant judgments and estimates.

Accounting for Income Taxes

We account for income taxes in accordance with ASC Topic 740, Income Taxes. Under this guidance, deferred taxes are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates that will apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income or expense in the period that includes the enactment date.

Management regularly reviews the carrying amount of the Corporation’s net deferred tax assets to determine if the establishment of a valuation allowance is necessary. If management determines, based on the available evidence, that it is more likely than not that all or a portion of our net deferred tax assets will not be realized in future periods, then a deferred tax valuation allowance will be established. Consideration is given to various positive and negative factors that could affect the realization of the deferred tax assets. In evaluating this available evidence, management considers, among other things, historical performance, expectations of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with utilization of operating loss and tax credit carry forwards not expiring, tax planning strategies and timing of reversals of temporary differences. Significant judgment is required in assessing future earnings trends and the timing of reversals of temporary differences. Management’s evaluation is based on current tax laws as well as management’s expectations of future performance.

Management expects that our adherence to the required accounting guidance may result in increased volatility in quarterly and annual effective income tax rates because of changes in judgment or measurement including changes in actual and forecasted income before taxes, tax laws and regulations, and tax planning strategies.

Other-Than-Temporary Impairment of Investment Securities

Management systematically evaluates securities for impairment on a quarterly basis. Based upon application of accounting guidance for subsequent measurement in ASC Topic 320, Investments – Debt and Equity Securities (Section 320-10-35), 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 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). This process is described more fully in the Investment Securities section of the Consolidated Balance Sheet Review.

Fair Value of Investments

We have determined the fair value of our investment securities in accordance with the requirements 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 measures the fair market values of its investments based on the fair value hierarchy established in Topic 820. The determination of fair value of investments and other assets is discussed further in Note 9 to the consolidated financial statements presented elsewhere in this report.

Pension Plan Assumptions

Our pension plan costs are calculated using actuarial concepts, as discussed within the requirements of ASC Topic 715, Compensation – Retirement Benefits. Pension expense and the determination of our projected pension liability are based upon two critical assumptions: the discount rate and the expected return on plan assets. We evaluate each of these critical assumptions annually. Other assumptions impact the determination of pension expense and the projected liability including the primary employee demographics, such as retirement patterns, employee turnover, mortality rates, and estimated employer compensation increases. These factors, along with the critical assumptions, are carefully reviewed by management each year in consultation with our pension plan consultants and actuaries. Further information about our pension plan assumptions, the plan’s funded status, and other plan information is included in Note 13 to the consolidated financial statements presented elsewhere in this report.

Other than as discussed above, management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2013.

SELECTED FINANCIAL DATA

The following table sets forth certain selected financial data for the nine-month periods ended September 30, 2014 and 2013 and is qualified in its entirety by the detailed information and unaudited financial statements, including the notes thereto, included elsewhere in this quarterly report.

	As of or For the Nine months ended September 30,
	2014			2013
Per Share Data
Basic and diluted net income per common share	$	0.32		$	0.69
Book Value	$	13.21		$	11.18

Significant Ratios
Return on Average Assets ^(a)		0.39	%		0.56	%
Return on Average Equity ^(a)		4.79	%		7.52	%
Average Equity to Average Assets		8.18	%		7.50	%

Note: ^(a) Annualized

RESULTS OF OPERATIONS

Overview

Consolidated net income available to common shareholders was $2.0 million for the first nine months of 2014, compared to $4.3 million for the same period of 2013. Basic and diluted net income per common share for the first nine months of 2014 was $.32, compared to basic and diluted net income per common share of $.69 for the same period of 2013. The decrease in earnings was due to a decrease of $3.4 million in interest income, primarily interest on loans, and an increase in provision expense of $1.8 million, offset by an increase of $.5 million in other operating income, a decrease of $.6 million in interest expense, and a $1.6 million decrease in other operating expenses. The increase in other operating income was primarily attributable to an increase of $.9 million in gains on sales of securities. The decrease in other operating expenses was due to a decrease of $.6 million in Other Real Estate Owned (“OREO”) expenses and a decrease of $.7 million in other miscellaneous expenses. The net interest margin for the first nine months of 2014, on a fully tax equivalent (“FTE”) basis, decreased to 3.02% from 3.37% for the first nine months of 2013 due primarily to loans repricing at lower rates and new loans booked at lower rates due to the continued low rate environment and pricing competition in our market areas. The net interest margin for the year ended December 31, 2013, on an FTE basis, was 3.25%.

The provision for loan losses increased to $1.6 million for the nine months ended September 30, 2014 compared to $(.2) for the nine months ended September 30, 2013. The increase was driven by rolling historical loss rates and the qualitative factors as well as a $.8 million recovery on a large commercial real estate credit during the third quarter of 2013. Specific allocations have been made for impaired loans where management has determined that the collateral supporting the loans is not adequate to cover the loan balance, and the qualitative factors affecting the ALL have been adjusted based on the current economic environment and the characteristics of the loan portfolio.

Interest expense on our interest-bearing liabilities decreased $.2 million during the nine months ended September 30, 2014 when compared to the same period of 2013 due to a decrease of $10.1 million in average interest-bearing deposits as well as a 5 basis point decrease in the average rate and a decrease of 15 basis points on long-term borrowings. During the first nine months of 2014, our management and retail staff focus has shifted our deposit mix away from higher cost certificates of deposit and towards lower cost money market and transaction accounts. We expect this shift to continue through the remainder of 2014.

Other operating income increased $.5 million during the first nine months of 2014 when compared to the same period of 2013. This increase was primarily attributable to $1.1 million in gains on the sale of securities for the first nine months of 2014 compared to $.3 million for the first nine months of 2013. This increase was offset by a reduction in OREO rental income of $.3 million due to the sale of a property.

Operating expenses decreased $1.6 million in the first nine months of 2014 when compared to the same period of 2013. This decrease was due to a decrease of $.6 million in OREO expenses relating to an increase in the valuation allowance during the first nine months of 2013 in order to better position the properties for retail sale. Declines in other miscellaneous expenses such as miscellaneous loan fees, deferred compensation, and personnel related expenses also contributed to the decrease.

Consolidated net income available to common shareholders was $.7 million, or $.10 per common share, for the third quarter of 2014, compared to $1.4 million, or $.22 per common share, for the same period of 2013. The decrease in earnings for the third quarter of 2014 compared to the third quarter of 2013 was due to a decrease in net interest income of $2.2 million, a $1.8 million increase in provision expense, and an increase of $.2 million in dividends attributable to the increase in rate from 5.0% to 9.0% on the Series A Preferred Stock. These items were offset by a $3.1 million decrease in other operating expenses. The decrease in other operating expenses for the third quarter of 2014 was primarily attributable to a $2.3 million reduction in OREO expenses as discussed above. Declines in other miscellaneous expenses such as miscellaneous loan fees, deferred compensation, and personnel related expenses also contributed to the decrease. The net interest margin for the third quarter of 2014, on a FTE basis, was 2.96%, compared to 3.77% for the same period of 2013. The decline in the net interest margin for the third quarter was due primarily to the decline in loan yields from loans repricing at lower rates and new loans booked at lower rates due to pricing competition in our market areas.

Other operating income remained consistent during the third quarter of 2014 when compared to the same period of 2013. The increase in gains on sales of securities was offset by reductions in other income such as OREO rental income.

Operating expenses decreased $3.1 million in the third quarter of 2014 when compared to the same period of 2013. This decrease was due primarily to a decrease of $2.3 million in OREO expenses relating to the valuation allowance in OREO in the third quarter of 2013 as noted above. Declines in other miscellaneous expenses such as miscellaneous loan fees, deferred compensation, and personnel related expenses also contributed to the decrease.

Net Interest Income

Net interest income is the largest source of operating revenue and is the difference between the interest earned on interest-earning assets and the interest expense incurred on interest-bearing liabilities. For analytical and discussion purposes, net interest income is adjusted to an FTE basis to facilitate performance comparisons between taxable and tax-exempt assets. FTE income is determined by increasing tax-exempt income by an amount equal to the federal income taxes that would have been paid if this income were taxable at the statutorily applicable rate.

The following table sets forth the average balances, net interest income and expense, and average yields and rates of our interest-earning assets and interest-bearing liabilities for the nine-month periods ended September 30, 2014 and 2013:

	Nine Months Ended September 30,
	2014							2013
(in thousands)	Average Balance		Interest		Average Rate			Average Balance		Interest		Average Rate
Interest-earning assets:
Loans	$	816,144	$	28,172		4.62	%	$	851,559	$	32,977		5.17	%
Investment securities		343,288		7,204		2.81	%		273,470		5,848		2.84	%
Other interest earning assets		52,839		276		0.70	%		76,675		254		0.44	%
Total earning assets	$	1,212,271		35,652		3.93	%	$	1,201,704		39,079		4.34	%

Interest-bearing liabilities
Interest-bearing deposits	$	791,534		3,489		0.59	%	$	801,644		3,860		0.64	%
Short-term borrowings		45,009		46		0.14	%		46,532		45		0.12	%
Long-term borrowings		182,646		4,699		3.44	%		182,710		4,919		3.59	%
Total interest-bearing liabilities	$	1,019,189		8,234		1.08	%	$	1,030,886		8,824		1.13	%

Net interest income and spread			$	27,418		2.85	%			$	30,255		3.21	%
Net interest margin						3.02	%						3.37	%

Note: Interest income and yields are presented on a fully taxable equivalent basis using a 40% tax rate.

Net interest income on an FTE basis decreased $2.8 million (9.4%) during the first nine months of 2014 over the same period in 2013 due to a $3.4 million (8.8%) decrease in interest income, which was partially offset by a $.6 million (6.7%) decrease in interest expense. The decrease in interest income was primarily due to the $35.4 million (4.2%) reduction in the average balance of loans and a decrease of 55 basis points on yields when comparing the first nine months of 2014 to the same period of 2013. The reduction in loan yields is attributable to loans repricing at lower rates and new loans booked at lower rates. The decline in interest income was partially offset by a decline in interest expense due to the reduction in the average rate on interest-bearing deposits and a decrease of 15 basis points on long-term borrowings. We saw a decrease in the net interest margin in the first nine months of 2014 to 3.02% when compared to 3.25% for the year ended December 31, 2013 and 3.37% for the first nine months of 2013.

When comparing the nine months ended September 30, 2014 to the same period of 2013, there was an overall $10.6 million increase in average interest-earning assets, driven by an increase of $69.8 million in investment securities, offset by a $35.4 million reduction in loans and a $23.8 million decrease in other interest-earning assets, primarily cash.

Interest expense decreased during the first nine months of 2014 when compared to the same period of 2013 due primarily to an overall reduction in the average rate paid on interest-bearing liabilities. The overall effect was a 5 basis point decrease in the average rate paid and a decrease of $11.7 million on our average interest-bearing liabilities, from 1.13% for the nine months ended September 30, 2013 to 1.08% for the same period of 2014.

The following table sets forth the average balances, net interest income and expense, and average yields and rates of our interest-bearing assets and interest-bearing liabilities for the three months ended September 30, 2014 and 2013:

	Three Months Ended September 30,
	2014							2013
(in thousands)	Average Balance		Interest		Average Rate			Average Balance		Interest		Average Rate
Interest-Earning Assets:
Loans	$	824,268	$	9,456		4.55	%	$	834,576	$	11,940		5.67	%
Investment securities		318,491		2,175		2.71	%		300,790		2,216		2.92	%
Other interest earning assets		71,795		100		0.55	%		58,168		73		0.16	%
Total earning assets	$	1,214,554		11,731		3.83	%	$	1,193,534		14,229		4.72	%

Interest-bearing liabilities
Interest-bearing deposits	$	786,638		1,154		0.58	%	$	818,902		1,251		0.59	%
Short-term borrowings		47,181		16		0.13	%		51,383		16		0.11	%
Long-term borrowings		182,631		1,502		3.26	%		182,697		1,666		3.61	%
Total interest-bearing liabilities	$	1,016,450		2,672		1.04	%	$	1,052,982		2,933		1.11	%

Net interest income and spread			$	9,059		2.79	%			$	11,296		3.61	%
Net interest margin						2.96	%						3.77	%

Note: Interest income and yields are presented on a fully taxable equivalent basis using a 40% tax rate.

Net interest income on an FTE basis decreased $2.2 million (19.8%) during the third quarter of 2014 over the same period in 2013 due to a $2.5 million (17.5%) decrease in interest income, offset by a decrease of $.3 million (8.9%) in interest expense. The decrease in interest income was impacted by the decrease in loan balances as well as a 112 basis point decrease in the average rate of loans when comparing the two periods. The decrease in average rate is primarily attributable to loans repricing at lower rates and new loans booked at lower rates due to the continued low rate environment as well as pricing competition in our market areas. We saw a decrease in the net interest margin in the third quarter of 2014 to 2.96% when compared to 3.77% for the three months ended September 30, 2013.

Interest expense decreased during the third quarter of 2014 when compared to the same period of 2013 due to the overall reduction in average interest-bearing liabilities of $36.5 million and the 35 basis point reduction in the average rate paid on long-term borrowings. This reduction in balances was due to the reduction of $32.3 million in interest-bearing deposits as management continued to focus on shifting the deposit mix and reducing certificates of deposit and a $4.2 million decrease in short-term borrowings. The overall effect was a 7 basis point decrease in the average rate paid on our average interest-bearing liabilities, from 1.11% for the three months ended September 30, 2013 to 1.04% for the same period of 2014.

Provision for Loan Losses

The provision for loan losses was $1.6 million for the first nine months of 2014 compared to $(.2) for the nine months ended September 30, 2013. Although, through the first nine months of 2014, we continued to experience a reduction in our total rolling historical loss rates and the qualitative factors utilized in the determination of the ALL, as well as continued reduction in the level of classified and impaired assets (discussed below in the section entitled “FINANCIAL CONDITION” under the heading “Allowance and Provision for Loan Losses”), provision expense was higher due to the recovery of $.8 million on a large commercial real estate loan during the first nine months of 2013. Management strives to ensure that the ALL reflects a level commensurate with the risk inherent in our loan portfolio.

Other Operating Income

Other operating income, exclusive of gains, decreased $.4 million during the first nine months of 2014 when compared to the same period of 2013. Service charge income decreased $.4 million in the first nine months of 2014 when compared to the first nine months of 2013 due to reduced NSF fees. The reduction in NSF fees is due to the increased regulations on fees.

Net gains of $1.1 million were reported through other income in the first nine months of 2014, compared to net gains of $.3 million during the same period of 2013. The increase in net gains during the first nine months of 2014 when compared to the same period of 2013 was due to a net gain of $1.1 million realized on sales of investment securities.

Other operating income, exclusive of gains, decreased $.3 million during the third quarter of 2014 when compared to the same period of 2013 due to a decline in service charge income of $.2 million primarily from a reduction in NSF fee income and a reduction of other income of $.1 million.

Net gains of $.2 million were reported through other income in the third quarter of 2014, compared to net losses of $.1 million during the same period of 2013. This increase in gains was due to the gain on the sale of one CDO investment. As a result of the activity spurred by the Volcker Rule, which was clarified during the first quarter of 2014, we had the opportunity to take advantage of the market and sell this security at a gain to book value.

The following table shows the major components of other operating income for the nine- and three-month periods ended September 30, 2014 and 2013, exclusive of net gains:

Income as % of Total Other Operating
Income

Income as % of&nbs