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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, 2004
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
incorporation or organization) Identification no.)
19 South Second Street, Oakland, Maryland 21550-0009
----------------------------------------------------
(address of principal executive offices) (zip code)
(301) 334-4715
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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 X No
--- --
Indicate by check mark whether the registrant is an accelerated filer (As
defined in Rule 12b-2 of the Exchange Act). Yes X No
--- --
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date: 6,087,287 shares of common
stock, par value $.01 per share, as of September 30, 2004.
INDEX TO REPORT
FIRST UNITED CORPORATION
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets - September 30, 2004 (unaudited) and
December 31, 2003
Consolidated Statements of Income (unaudited) - for the three months
and nine months ended September 30, 2004 and 2003
Consolidated Statements of Cash Flows (unaudited) - for the nine
months ended September 30, 2004 and 2003
Notes to Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits
SIGNATURES
2
PART I. FINANCIAL INFORMATION
FIRST UNITED CORPORATION
Consolidated Balance Sheets
(In thousands, except per share amounts)
September 30, December
2004 31, 2003
(unaudited)
--------------- --------------
Assets
Cash and due from banks $15,831 $20,272
Federal funds sold - -
Interest-bearing deposits in banks 5,321 1,474
Investment securities available-for-sale (at market value) 217,502 223,615
Federal Home Loan Bank stock, at cost 8,487 8,660
Loans 898,622 792,025
Allowance for loan losses
(6,582) (5,974)
--------------- --------------
Net loans 892,040 786,051
Premises and equipment, net 20,961 16,598
Goodwill and other intangible assets 15,289 15,462
Accrued interest receivable and other assets 35,294 36,109
--------------- --------------
Total Assets $1,210,725 $1,108,241
=============== ==============
Liabilities and Shareholders' Equity
Liabilities:
Non-interest bearing deposits $105,011 $ 99,181
Interest-bearing deposits 724,013 650,980
--------------- --------------
Total deposits 829,024 750,161
Short-term borrowings 94,959 71,840
Long-term borrowings 193,674 191,735
Accrued interest and other liabilities 5,853 9,220
Dividends payable 1,095 1,094
--------------- --------------
Total Liabilities 1,124,605 1,024,050
--------------- --------------
Shareholders' Equity
Preferred stock --no par value;
Authorized and unissued 2,000 shares
Capital Stock -- par value $.01 per share;
Authorized 25,000 shares; issued and outstanding 6,087 shares at
September 30, 2004 and December 31, 2003
61 61
Surplus 20,324 20,324
Retained earnings 64,714 62,201
Accumulated other comprehensive income 1,021 1,605
--------------- --------------
Total Shareholders' Equity 86,120 84,191
--------------- --------------
Total Liabilities and Shareholders' Equity $1,210,725 $1,108,241
=============== ==============
3
FIRST UNITED CORPORATION
Consolidated Statement of Income
(in thousands, except per share data)
Nine Months Ended
September 30,
2004 2003
-------------- --------------
(unaudited)
Interest income
Loans, including fees $ 39,062 $ 36,931
Investment securities:
Taxable 4,600 5,201
Exempt from federal income tax 927 1,085
-------------- --------------
5,527 6,286
Federal funds sold 25 28
-------------- --------------
Total interest income 44,614 43,245
Interest expense
Deposits 8,536 9,813
Short-term borrowings 724 281
Long-term borrowings 8,437 7,821
-------------- --------------
Total interest expense 17,697 17,915
-------------- --------------
Net interest income 26,917 25,330
Provision for loan losses 1,635 696
-------------- --------------
-------------- --------------
Net interest income after provision for
loan losses 25,282 24,634
Other operating income
Service charges on deposit accounts 2,863 2,253
Trust department income 2,042 1,905
Security gains 703 349
Insurance premium income 1,063 997
Other income 2,576 2,862
-------------- --------------
Total other operating income 9,247 8,366
Other operating expenses
Salaries and employees benefits 12,826 11,818
Occupancy, equipment and data processing 4,378 3,624
Amortization of deferred financing fees 910 --
Other expense 7,610 6,461
-------------- --------------
Total other operating expenses 25,724 21,903
-------------- --------------
Income before income taxes 8,805 11,097
Applicable income taxes 3,001 3,144
-------------- --------------
-------------- --------------
Net income $5,804 $7,953
============== ==============
Earnings per share $ .95 $ 1.31
============== ==============
Dividends per share $ .54 $ .53
============== ==============
4
FIRST UNITED CORPORATION
Consolidated Statement of Income
(in thousands, except per share data)
Three Months Ended
September 30,
2004 2003
-------------- --------------
(unaudited)
Interest income
Loans, including fees $ 13,267 $ 12,529
Investment securities:
Taxable 1,584 1,632
Exempt from federal income tax 285 358
-------------- --------------
1,869 1,990
Federal funds sold 24 15
-------------- --------------
Total interest income 15,160 14,534
Interest expense
Deposits 3,104 3,181
Short-term borrowings 331 119
Long-term borrowings 2,913 2,618
-------------- --------------
Total interest expense 6,348 5,919
-------------- --------------
Net interest income 8,812 8,615
Provision for loan losses 851 357
-------------- --------------
Net interest income after provision for
loan losses 7,961 8,258
Other operating income
Service charges on deposit accounts 960 807
Trust department income 642 635
Security gains 2 12
Insurance premium income 361 394
Other income 837 938
-------------- --------------
Total other operating income 2,802 2,786
Other operating expenses
Salaries and employees benefits 4,279 3,980
Occupancy, equipment and data processing 1,504 1,241
Amortization of deferred financing fees 910 --
Other expense 2,402 2,771
-------------- --------------
Total other operating expenses 9,095 7,992
-------------- --------------
Income before income taxes 1,668 3,052
Applicable income taxes 573 872
-------------- --------------
Net income $1,095 $2,180
============== ==============
Earnings per share $ .18 $ .36
============== ==============
Dividends per share $ .18 $ .18
============== ==============
5
FIRST UNITED CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Nine Months Ended
September 30,
2004 2003
-------------- --------------
(Unaudited)
Operating activities
Net Income $5,804 $ 7,953
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 1,635 696
Depreciation 1,754 1,547
Amortization of intangible assets 419 116
Amortization of deferred financing fees 910 --
Net amortization (accretion) of 953 (1,587)
investment security discounts and
premiums
Gain on sale of investment securities (349) (703)
(Decrease) increase in accrued interest
receivable and other assets 117 (2,603)
(Decrease) increase in accrued interest
and other liabilities (3,367) (2,035)
Increase in bank owned life insurance (458) (691)
value
-------------- --------------
Net cash provided by operating activities 7,064 3,047
Investing activities
Net increase in interest-bearing deposits in banks (3,847) (2,771)
Proceeds from maturities and sales of
investment securities available-for-sale 119,142 257,089
Purchases of investment securities available-
for-sale (113,692) (278,889)
Net increase in loans (107,624) (64,513)
Purchases of premises and equipment (6,117) (2,921)
Net cash provided by acquisition 66,040 -
-------------- --------------
Net cash used in investing activities (112,138) (25,965)
Financing activities
Net increase (decrease) in short-term 23,119 4,080
borrowings
Proceeds from issuance of junior subordinated 30,929 --
debentures
Redemption of junior subordinated
debentures (23,711) --
Net decrease in other long-term borrowings (5,279) (4,691)
Net increase in deposits 78,863 33,851
Cash dividends paid (3,288) (3,196)
Proceeds from issuance of common stock -- 125
-------------- --------------
Net cash provided by financing
activities 100,633 30,169
-------------- --------------
Cash and cash equivalents at beginning of the
year 20,272 18,242
Increase (decrease) in cash and cash
equivalents (4,441) 7,251
-------------- --------------
Cash and cash equivalents at end of period $15,831 $25,493
============== ==============
6
FIRST UNITED CORPORATION
Notes to Unaudited Consolidated Financial Statements
September 30, 2004
Note A -- Basis of Presentation
The accompanying unaudited consolidated financial statements of First
United Corporation (the "Corporation") and its consolidated subsidiaries have
been prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with the instructions to
Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all
the information and footnotes required for complete 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,
2004, are not necessarily indicative of the results that may be expected for a
full year or for any other interim period. These consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements and footnotes thereto included in the Corporation's Annual Report on
Form 10-K for the year ended December 31, 2003. For purposes of comparability,
certain prior period amounts have been reclassified to conform to the current
period presentation.
Note B - Earnings per Share
Earnings per share are based on the weighted average number of shares of
common stock outstanding of 6,087,287 for the three- and nine-month periods
ended September 30, 2004. For the three- and nine- month periods ended September
30, 2003, the weighted average number of shares of common stock outstanding were
6,087,443 and 6,086,154, respectively. The Corporation does not have any common
stock equivalents.
Note C - Comprehensive Income
Unrealized gains and losses on investment securities available-for-sale are
the only items included in accumulated other comprehensive income. Total
comprehensive income (which consists of net income plus the change in unrealized
gains (losses) on investment securities available-for-sale, net of taxes and
reclassification adjustments) was $5.2 and $6.6 million for the nine months
ended September 30, 2004 and 2003, respectively.
Note D - Junior Subordinated Debentures
The Corporation has issued approximately $30.9 million of junior
subordinated debentures. Approximately $20.6 million was issued in March 2004 to
First United Statutory Trust I, a Connecticut statutory trust ("FUST I"), and
$10.3 million was issued in March 2004 to First United Statutory Trust II, also
a Connecticut statutory trust ("FUST II") (collectively, the "Trusts"). These
borrowed funds represent the proceeds from the issuance of a like amount of
trust preferred securities by the Trusts.
In accordance with the provisions of FIN 46, the Trusts are not
consolidated with the Corporation for financial reporting purposes, and their
financial positions and results of operations are not included in our
consolidated financial position and results of operations. Despite this
deconsolidation, the Federal Reserve Board continues to permit up to 25% of the
Corporation's Tier I capital to be comprised of, together with other cumulative
preferred stock, trust preferred securities issued by the Corporation's
deconsolidated subsidiaries.
On September 30, 2004, the Corporation redeemed all of its 9.375% Junior
Subordinated Deferrable Interest Debentures that it issued to First United
Capital Trust ("Capital Trust") in 1999. The aggregate redemption price paid by
the Corporation was approximately $23.7 million. Capital Trust was dissolved on
October 12, 2004. In connection with the redemption, approximately $.91 million
of unamortized issuance costs were expensed.
7
Note E - Internal Restructurings
On May 14, 2004, First United Bank & Trust, a Maryland trust company and
the Corporation's wholly-owned subsidiary (the "Bank"), completed its
publicly-announced restructuring by liquidating First United Securities, Inc., a
Delaware corporation and subsidiary of the Bank that held and managed a portion
of our investment portfolio. This liquidation follows the Bank's liquidation on
February 28, 2004 of another subsidiary, First United Capital Investments, Inc.
("FUCI").
Primarily as a result of the previously announced restructurings involving
First United Securities, Inc. and First United Capital Investments, Inc., the
Corporation's effective tax rate increased to 34% for the first nine months of
2004, as compared to 28% for the first nine months of 2003 and 30% for the year
ended December 31, 2003.
Note F - Contractual Obligations, Commitments and Off-Balance Sheet Arrangements
Loan commitments are made to accommodate the financial needs of our
customers. Letters of credit commit us to make payments on behalf of customers
when certain specified future events occur. These obligations are not recorded
in the Corporation's financial statements. The credit risks inherent in loan
commitments and letters of credit are essentially the same as those involved in
extending loans to customers, and these arrangements are subject to our normal
credit policies. The Corporation's exposure to credit loss in the event the
customer does not satisfy the terms of these arrangements equals the notional
amount of the obligation less the value of any collateral. Loan commitments and
letters of credit totaled $92 million and $4.4 million, respectively, at
September 30, 2004. The Corporation is not party to any other off-balance sheet
arrangements.
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
significant factors affecting the financial condition and results of operations
of 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 presented
herein. Unless the context clearly suggests otherwise, references to "us", "we",
"our", or "the Corporation" in this report 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 document are qualified by these cautionary statements,
and there can be no assurance that the actual results anticipated will be
realized, or if substantially realized, will have the expected consequences on
our business or operations. These and other risk factors are discussed in detail
in Exhibit 99.1 to our Annual Report on Form 10-K for the year ended December
31, 2003. 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.
8
THE COMPANY
The Corporation is a Maryland corporation that was incorporated in 1985 and
it is registered as both a financial holding company and a bank holding company
under the federal Bank Holding Company Act of 1956, as amended. The
Corporation's primary business activity is acting as the parent company of the
Bank, Oakfirst Life Insurance Company, an Arizona reinsurance company, OakFirst
Loan Center, Inc., a West Virginia finance company, OakFirst Loan Center, LLC, a
Maryland finance company, Gonder Insurance Agency, Inc., a Maryland insurance
producer firm ("Gonder"), and the Trusts. OakFirst Loan Center, Inc. has one
subsidiary, First United Insurance Agency, Inc., which is a Maryland insurance
producer firm. The Bank has two direct subsidiaries: First United Investment
Trust, a Maryland real estate investment trust that invests in mortgage loans
(the "Investment Trust"); and First United Auto Finance, LLC, an inactive
indirect automobile leasing limited liability company. Gonder was transferred to
the Corporation through a dividend declared and paid by the Bank, effective as
of the close of business on September 30, 2004. The Corporation recently formed
a new subsidiary, First United Insurance Group, LLC ("FUIG"), which is a
Maryland limited liability company and licensed insurance producer firm. Pending
the receipt by FUIG of all necessary insurance licenses, management intends to
merge Gonder with and into FUIG on or about December 31, 2004, with FUIG as the
surviving entity.
We maintain an Internet site at www.mybankfirstunited.com on which we make
available, free of charge, our Annual Report on Form 10-K, Quarterly Reports on
Form 10-Q, Current Reports on Form 8-K, Section 16 Filings, and all amendments
to the foregoing on our Internet site as soon as reasonably practicable after
these reports are electronically filed with, or furnished to, the SEC.
SELECTED FINANCIAL DATA
Selected financial data relating to the Corporation's results of operations
and financial condition is listed below. This data should be read in conjunction
with the unaudited consolidated financial statements and management's discussion
and analysis that follows.
At or For the Nine Months
Ended September 30,
-------------------
2004 2003
Per Share Data $ .95 $ 1.31
Net Income .54 .53
Dividends Paid 14.15 13.68
Book Value
Significant Ratios
Return on Average Assets (a) .67% 1.04%
Return on Average Equity (a) 9.05 13.06
Dividend Payout Ratio 56.64 40.17
Average Equity to Average Assets 7.39 7.98
Note: (a) Annualized
9
RESULTS OF OPERATIONS
Overview
Net income for the nine months ended September 30, 2004 totaled $5.8
million, or $.95 per share, a 28% decrease over net income of $8.0 million, or
$1.31 per share, for the same period of 2003. Net income for the third quarter
of 2004 was $1.1 million, or $.18 per share, compared to $2.2 million, or $.36
per share, for the third quarter of 2003, a 50% decrease. The three- and
nine-month comparisons reflect an increase in net interest income, on a fully
tax-equivalent basis, of $.1 million and $1.6 million, respectively. These
increases in net-interest income are offset by higher costs related to a higher
effective tax rate of 34% in 2004 versus 28% in 2003 as a result of our recent
internal restructurings, the March 2004 issuance of approximately $31 million of
junior subordinated debentures, and the September 2004 redemption of
approximately $24 million of our junior subordinated debentures. As a result of
this redemption, approximately $.91 million of pretax unamortized issuance costs
were expensed. The increase in the provision for loan losses and the
professional fees associated with compliance with the Sarbanes-Oxley Act also
contributed to these comparison decreases.
Our performance ratios for the first nine months of 2004 have decreased
when compared to the same period last year. This decrease is primarily a result
of lower earnings. Annualized Returns on Average Equity ("ROAE") for the
nine-month period ending September 30, 2004 were 9.05%, compared to 13.06% for
the same period last year. Annualized Returns on Average Assets ("ROAA") were
..67% and 1.04% for the first nine months of 2004 and 2003, respectively.
Net Interest Income
Net interest income is the largest source of operating revenue. Net
interest income is the difference between the interest earned on earning assets
and the interest expense incurred on interest-bearing liabilities. For
analytical and discussion purposes, net interest income is adjusted to a taxable
equivalent basis to facilitate performance comparisons between taxable and
tax-exempt assets by increasing tax-exempt income by an amount equal to the
federal income taxes that would have been paid if this income were taxable at
the statutorily applicable rate. The 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 months
ended September 30, 2004 and 2003.
Nine Months Ended September 30,
2004 2003
Average Average Average Average
(Dollars in thousands) Balance Interest Rate Balance Interest Rate
- --------------------------------------------------------------------------------------------------------------------
Interest-Earning Assets:
Loans $ 837,607 $ 39,101 6.22% $ 701,682 $ 37,001 7.03%
Investment securities 214,752 5,760 3.58 234,110 6,505 3.70
Other interest earning assets 16,343 290 2.37 22,790 264 2.56
------------------------------------ ------------------------------------
Total earning assets $ 1,068,702 45,151 5.63% $ 958,581 43,770 6.11%
============= ===========
Interest-bearing liabilities
Interest-bearing deposits $ 700,794 8,536 1.62 610,465 9,813 2.14
Short-term borrowings 78,893 724 1.22 45,484 281 .82
Long-term borrowings 208,852 8,437 5.39 192,105 7,821 5.43
------------------------------------ ------------------------------------
Total interest-bearing liabilities $ 988,539 17,697 2.39 $ 848,055 17,915 2.82
Net interest income and spread $ 27,454 3.24% $ 25,855 3.29%
=========== ==========
Net interest margin 3.43% 3.61%
10
Note: Interest income and yields are presented on a fully tax equivalent basis
using a 34% tax rate.
Net interest income, on a fully tax-equivalent basis, increased $1.6
million (6%) during the first nine months of 2004 when compared to the same
period in 2003. The increase in interest income resulted from an increase in
average interest-earning assets of $110.1 million (12%) during the first nine
months of 2004, which was partially offset by a 48 basis point decline in yield
on such earning assets. The growth in average loans and average earning assets
is attributable to strong demand in our core markets. Although average
interest-bearing liabilities increased $140.5 million (17%) during the first
nine months of 2004, a 15% decrease in the effective rate of these
interest-bearing liabilities of 43 basis points resulted in a decrease in
interest expense of $.2 million. The growth in our average interest-bearing
deposits resulted primarily from our purchase of brokered certificates of
deposit to fund loan growth. Also contributing to the increase in total-interest
bearing liabilities is the increase in short-term borrowings, resulting from
continued emphasis on our "Cash Management" program. The historically low
interest rate environment, however, continues to compress our net interest
margin, which decreased 18 basis points for the nine months ended September 30,
2004 when compared to the nine months ended September 30, 2003.
For the Quarter Ended September 30,
2004 2003
Average Average Average Average
(Dollars in thousands) Balance Interest Rate Balance Interest Rate
- -------------------------------------------- ------------- ----------- ---------- ------------- ---------- ---------
Interest-Earning Assets:
Loans $ 870,660 $ 13,272 6.10% 748,352 $ 12,549 6.71%
Investment securities 214,990 1,921 3.57 255,450 2,079 3.26
Other interest earning assets 18,745 127 2.71 26,967 119 1.77
- -------------------------------------------- ------------- ----------- ---------- ------------- ---------- ----------
Total earning assets $ 1,104,395 15,320 5.55% 1,030,769 14,747 5.72%
============= =============
Interest-bearing liabilities
Interest-bearing deposits $ 729,976 3,104 1.70 666,533 3,181 1.91
Short-term borrowings 84,414 331 1.57 53,887 119 .88
Long-term borrowings 218,070 2,915 5.34 193,904 2,618 5.40
------------- ----------- ---------- ------------- ---------- ---------
Total interest-bearing liabilities $1,032,460 6,350 2.46 $ 914,324 5,918 2.59
============= ----------- ============= ----------
Net interest income and spread 8,970 3.09% 8,829 3.13%
=========== ==========
Net interest margin 3.25% 3.43%
Note: Interest income and yields are presented on a fully tax equivalent basis
using a 34% tax rate.
Net interest income, on a fully tax-equivalent basis, increased $.1 million
in the third quarter of 2004, compared to the third quarter of 2003. This
increase resulted from a $.5 million increase in interest income during the
period, coupled with a $.4 million increase in interest expense. The increase in
interest income resulted from an increase in average interest-earning assets of
$73.6 million (7%) during the third quarter of 2004 when compared to the third
quarter of 2003, which was partially offset by a 17 basis point decline in yield
on such earning assets. The greater part of the growth in average loans and
average earning assets is attributable to strong demand in our core markets. The
increase in interest expense resulted from an increase in average
interest-bearing liabilities of $118.1 million (13%) during the third quarter of
2004 when compared to the third quarter of 2003, which was partially offset by a
13 basis point decline in yield on such interest-bearing liabilities. As stated
previously, the growth in our average interest-bearing deposits resulted
primarily from our purchase of brokered certificates of deposit to fund loan
growth. The continued emphasis on our "Cash Management" program resulted in an
increase in short-term borrowings, which also contributed to the increase in
total-interest bearing liabilities. Our ability to realize substantial net
interest income during the third quarter of 2004 was hindered by the decline in
the net-interest margin of 18 basis points, when compared to the net-interest
margin of third quarter 2003.
11
Other Operating Income
Other operating income increased $.9 million (11%) during the first nine
months of 2004 when compared to the same period for 2003. Service charges on
deposit accounts accounted for more than half of this increase, which is made up
primarily of fees associated with renewed concentration on an overdraft
protection product. Also, trust income increased by approximately $.1 million
(7%) during the first nine months of 2004 when compared to the same period last
year. Additionally, during the first nine months of 2004, net securities gains
increased $.4 million when compared to the same period in 2003. These net
securities gains included a write down and an ultimate sale in Freddie Mac
Preferred equity securities exhibiting other-than-temporary impairment,
contributing a combined $.6 million loss to net securities gains of $.3 million.
Comparing the third quarter of 2004 to the third quarter of 2003, other
operating income remained unchanged at $2.8 million.
Other Operating Expense
Other operating expense for the first nine months of 2004 increased $3.8
million (18%), when compared to the same period of 2003. For the third quarter
of 2004, other operating expenses increased $1.1 million when compared to the
third quarter of 2003. Salaries and employee benefits increased $1.0 million
(9%) and $.3 million (8%) during the first nine months and third quarter of
2004, respectively, when compared to the same periods last year. These increases
are attributable to the addition of employees that are necessary to support our
growth objectives.
Occupancy and equipment expense for the first nine months and third quarter
of 2004 increased $.8 million (21%) and $.3 million (22%), respectively,
compared to the same periods of 2003. These increases are principally due to
branch expansion in the Martinsburg, West Virginia area and maintenance
contracts associated with our new bank-wide security system.
Other expenses for the first nine months of 2004 increased $1.2 million
(18%) when compared to the same period of 2003. This increase resulted from
increased professional fees associated with compliance with the Sarbanes-Oxley
Act and conversion of network lines associated with branch expansion and
modernization. Other expenses decreased $.4 million (13%) in the third quarter
of 2004 when compared to the third quarter of 2003. The third quarter of 2003
included costs relating to $.1 million in real estate owned expenses due to a
loss on a property located in Keyser, West Virginia, $.1 million of expense due
to the loss on a check paid by the Bank, and a $.1 million reconciling
difference which the Company concluded was not recoverable. These expenses
result in a reduction of costs when compared to the third quarter of 2004.
A write-off of approximately $.9 million related to issuance costs arising
from the redemption on September 30, 2004 of our 9.375% junior subordinated
debentures issued to Capital Trust occurred during the third quarter of 2004.
Please refer to Note D to the consolidated financial statements for further
information.
Applicable Income Taxes
Income tax expense for the three and nine months ended September 30, 2004
was $.6 million and $3.0 million, respectively, compared to $ .9 million and
$3.1 million for the same periods in 2003. The effective tax rate for the three-
and nine-month periods ended September 30, 2004 increased to 34%, as compared to
28% for the same periods in 2003 and 30% for the year ended December 31, 2003.
These increases are primarily attributable to our internal restructurings
discussed in Note D to the consolidated financial statements. The resulting
increase in our effective tax rate has increased tax expense by approximately
$.5 million and $.1 million for the nine months and quarter ending September 30,
2004, respectively.
12
FINANCIAL CONDITION
Balance Sheet Overview
Our total assets reached $1.2 billion at September 30, 2004, representing
an increase of $.1 billion (9%) from December 31, 2003. The main source of this
increase was a $106.6 million increase in our loan portfolio, partially offset
by a $6.1 million decrease in our investment portfolio, which was primarily used
to help fund the aforementioned loan growth. Net premises and equipment
increased $4.4 million. The majority of this increase is attributable to the
acquisition of real estate that management intends to use for expansion of the
Bank's branch network over the next three years.
Our total liabilities reached $1.1 billion at September 30, 2004,
representing an increase of $100.6 million (10%) from December 31, 2003. Total
deposits increased $78.9 million when compared to 2003 year-end. This increase
is primarily due to the purchase of brokered certificates of deposit during the
first nine months of 2004, in order to fund loan growth. Short-term borrowings
increased $23.1 million when compared to 2003 year-end, predominantly from the
increase in balances of our "Cash Management" product. For the nine-month period
ended September 30, 2004, long-term borrowings increased $1.9 million.
Loan Portfolio
The following table presents the composition of our loan portfolio at
the dates indicated:
(Dollars in millions) September 30, 2004 December 31, 2003
- -------------------------------------------------------------------------------
Commercial $ 356.2 40% $ 307.5 39%
Residential-Mortgage 307.6 34 264.7 33
Installment 216.7 24 201.4 26
Residential-Construction 17.3 2 16.1 2
Lease Financing .8 - 2.3 --
--------- ------ --------- -----
Total Loans $ 898.6 100% $ 792.0 100%
========= ====== ========= =====
During the first nine months of 2004, our loan portfolio grew $106.6
million (14%). The key contributors to this growth were $48.7 million in
commercial loans, $42.9 million in residential mortgage loans, and $15.3 million
in installment loans. Existing customer relationships in our core markets are
responsible for much of the commercial loan growth during the period, and
management intends to continue its focus on commercial lending operations for
the foreseeable future.
Our residential-mortgage portfolio grew 16% during the first nine months of
2004. This growth is attributable primarily to our competitively priced
adjustable rate mortgage products for lot and construction loans, which are
marketed as an alternative to the fixed rates offered in the secondary market.
Management believes that this strategy should aid us in a rising rate
environment.
Risk Elements of Loan Portfolio
The following table presents the risk elements of our loan portfolio at the
dates indicated. We have no knowledge of any potential problem loans other than
those listed in this table.
September 30, December 31,
(Dollars in thousands) 2004 2003
- --------------------------------------------------------------------------------
Non-accrual loans $ 6,024 2,774
Accruing loans past due 90 days or more 1,068 1,236
---------- -----------
Total $ 7,092 $ 4,010
========== ===========
Total as a percentage of total loans .79% .51%
========== ===========
13
Allowance and Provision for Loan Losses
The allowance for loan losses is based on our continuing evaluation of the
quality of the loan portfolio, assessment of current economic conditions,
diversification and size of the portfolio, adequacy of collateral, past and
anticipated loss experience, and the amount of non-performing loans. We utilize
the methodology outlined in the FDIC Statement of Policy on Allowance of Loan
and Lease Losses. To determine an appropriate allowance, we first segregate the
loan portfolio into two pools, non-homogeneous (i.e. commercial) and homogeneous
(i.e. consumer) loans. Each loan pool is then analyzed with general allowances
and specific allocations being made as appropriate. For general allowances,
historical loss activity, modified by current qualitative factors, are used in
the estimate of losses in the current portfolio. Specific allocations are
considered for individual loans that are identified in our internal grading
system as those which possess certain qualities or characteristics that may lead
to collection and loss issues.
The following table presents a summary of the activity in the allowance for
loan losses for the nine months ended September 30 (dollars in thousands):
2004 2003
Balance, January 1 $ 5,974 $ 6,068
Gross credit losses (1,440) (1,249)
Recoveries 413 354
-------- --------
Net credit losses (1,027) (895)
-------- --------
Provision for loan losses 1,635 696
Adjustment for acquisition of Huntington 301
-------- --------
Balance at end of period $ 6,582 $ 6,170
======== ========
Allowance for Loan Losses to loans outstanding .73% .79%
======== ========
Net charge-offs to average loans outstanding
during the period, annualized .16% .17%
======== ========
Although the balance of our total loans increased $106.6 million during the
first nine months of 2004, our annualized net charge off experience relative to
total average loans outstanding remained stable at .16% for this period,
compared to .17% for the first nine months of 2003 and .17% for the year ended
December 31, 2003.
Net charge offs relating to the installment loan portfolio represent the
majority of total net charge-offs for the first nine months of 2004. Generally,
installment loans are charged off after they are 120 days contractually past
due. The quality of the installment loan portfolio has improved, as loans past
due 30 days or more were $2.7 million of the installment portfolio at September
30, 2004. This compares equally to the $2.7 million at December 31, 2003.
However, the ratio of loans past due 30 days or more to total installment loans
has decreased from 1.4% at December 31, 2003 to 1.2% at September 30, 2004. At
September 30, 2003, loans past due 30 days or more were $3.4 million or 1.7% of
the installment portfolio.
This improvement in installment loan delinquencies, as well as our overall
loss experience, has been considered in management's assessment of the allowance
for loan losses. However, countering this improvement was a $3.3 million
increase in non-accrual loans during the first nine months of 2004 when compared
to year-end 2003. The increase is a result of the addition of two agriculture
loans to non-accrual status in the second quarter of 2004. Our exposure to these
relationships has been appropriately considered in determining the adequacy of
the allowance for loan losses. As a result of management's evaluation of the
loan portfolio using the factors and methodology summarized above, the allowance
for loan losses increased slightly to $6.6 million at September 30, 2004,
compared to $6.0 million at December 31, 2003. Management believes that the
allowance for loan losses at September 30, 2004 is adequate to absorb the
probable loan losses inherent in the loan portfolio.
14
The provision for loan losses was $1.6 million for the first nine months of
2004, as compared to $.7 million for the same period of 2003. The provision for
the third quarter of 2004 was $.9 million, as compared to $.4 million for the
third quarter of 2003. The increase in the provision is primarily due to the two
agriculture loans that were placed in non-accrual status as discussed above.
Amounts to be recorded for the provision for loan losses in future periods will
depend upon trends in the loan balances, including the composition of the loan
portfolio, changes in loan quality and loss experience trends, potential
recoveries on previously charged-off loans, and other factors that would have an
impact on inherent losses in the loan portfolio.
Investment Securities
At September 30, 2004, our entire investment securities portfolio was
categorized as available-for-sale and carried at market value. The following
table presents the composition of our securities portfolio at the dates
indicated:
(Dollars in millions) September 30, 2004 December 31, 2003
- --------------------------------------------------------------------------------
U.S. government and agencies $ 102.6 47% $ 75.7 34%
Mortgage-backed securities 79.1 37 89.1 40
Obligations of states and political
subdivisions 24.2 11 29.3 13
Corporate and other debt securities 11.6 5 18.3 8
Other securities - - 11.2 5
--------- ----- --------- -----
Total Investment Securities $ 217.5 100% $223.6 100%
The $6.1 million decrease in our securities portfolio during the first nine
months of 2004 was primarily attributable to the utilization of matured and
called securities to fund rapid loan growth during the period. Of the $6.1
million decline, $.8 million was a result of the decrease in market value
compared to the market value of our portfolio at December 31, 2003.
Deposits
The following table presents the composition of our deposits at the
dates indicated:
(Dollars in millions) September 30, 2004 December 31, 2003
- --------------------------------------------------------------------------------
Noninterest-bearing demand deposits $ 105.0 13% $ 99.1 13%
Interest-bearing demand deposits 268.1 37 254.1 34
Savings deposits 64.2 11 61.0 8
Time deposits less than $.1 194.7 5 218.4 29
Time deposits $.1 or more 197.0 - 117.5 26
--------- ----- --------- -----
Total Deposits $ 829.0 100% $750.1 100%
========= ===== ========= =====
Deposits grew $78.9 million, or 11%, during the first nine months of 2004.
This increase was primarily attributable to an increase in brokered certificates
of deposit, of $100,000 or over. Brokered certificates of deposit were purchased
in order to fund the rapid loan growth during the period.
Borrowed Funds
The following table presents the composition of our borrowings at the dates
indicated:
(In millions) September 30, December 31,
2004 2003
- --------------------------------------------------------------------------------
Federal funds purchased $ 7.0 $ 5.8
Securities sold under agreements to repurchase 88.0 66.0
---- ----
Total short-term borrowings $ 95.0 $ 71.8
====== ======
FHLB advances $ 162.8 $ 168.0
Junior subordinated debt 30.9 23.7
---- ----
Total long-term borrowings $ 193.7 $ 191.7
======= =======
15
In March 2004, we issued approximately $31 million of junior subordinated
debentures to FUST I and FUST II. On September 30, 2004, we redeemed $23.7
million of the junior subordinated debentures issued to Capital Trust in 1999.
As a result of this redemption, approximately $.91 million of pretax unamortized
issuance costs were expensed. Using the blended initial weighted average rate of
the trust preferred securities recently issued by the Trusts, management
believes that it will take approximately 12 months (from September 30, 2004) of
interest savings to offset this expense. For further information about our
debentures and the trust preferred securities, see Note D to the consolidated
financial statements above.
Liquidity and Capital
We derive liquidity through increased customer deposits, maturities in the
investment portfolio, loan repayments and income from earning assets. To the
extent that deposits are not adequate to fund customer loan demand, liquidity
needs can be met in the short-term funds markets through arrangements with our
correspondent banks or through the purchase of brokered certificates of deposit.
The Bank is also a member of the Federal Home Loan Bank of Atlanta, which
provides another source of liquidity. Finally, as evidenced by the issuance of
the trust preferred securities as discussed above in Note D to the consolidated
financial statements, we may from time to time access capital markets to meet
some of our liquidity needs. Management knows of no known trends or demands,
commitments, events or uncertainties that will materially affect our ability to
maintain liquidity at satisfactory levels.
The following table presents our capital ratios at September 30, 2004:
For
Capital To Be
Adequacy Well
Actual Purposes Capitalized
- --------------------------------------------------------------------------------
Total Capital (to risk-weighted assets) 11.80% 8.00% 10.00%
Tier 1 Capital (to risk-weighted assets) 10.89 4.00 6.00
Tier 1 Capital (to average assets) 8.48 3.00 5.00
We are categorized as "well capitalized" under federal banking regulatory
capital requirements. The redemption on September 30, 2004 of our junior
subordinated debentures issued to Capital Trust required Capital Trust to redeem
an equal amount of its trust preferred securities. This reduced our total
capital by approximately $23.0 million. The redemption had no material impact on
the ratio of Tier 1 capital to risk-weighted assets or the ratio of Tier 1
capital to average assets.
We paid a cash dividend of $.18 per share on August 1, 2004. On September
15, 2004, we declared another dividend of an equal amount, to be paid on
November 1, 2004 to stockholders of record at October 15, 2004.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our primary market risk is interest rate fluctuation. We have procedures in
place to evaluate and mitigate these risks. This market risk and our procedures
are described in our Annual Report on Form 10-K for the year ended December 31,
2003 under the caption "Management's Discussion and Analysis of Financial
Condition and Results of Operation - Interest Rate Sensitivity". Management
believes that there has been no material change in our market risks or in the
procedures used to evaluate and mitigate these risks since December 31, 2003.
16
Item 4. Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure
that information required to be disclosed in our reports filed under the
Securities Exchange Act of 1934 with the SEC, such as this Quarterly Report, is
recorded, processed, summarized and reported within the time periods specified
in those rules and forms, and that such information is accumulated and
communicated to our management, including the Chief Executive Officer ("CEO")
and the Chief Financial Officer ("CFO"), as appropriate, to allow for timely
decisions regarding required disclosure. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control system are met. Further, the design of a
control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. These
inherent limitations include the realities that judgments in decision-making can
be faulty, and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management override of the
control. The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be no assurance
that any design will succeed in achieving its stated goals under all potential
future conditions; over time, control may become inadequate because of changes
in conditions, or the degree of compliance with the policies or procedures may
deteriorate.
An evaluation of the effectiveness of these disclosure controls as of
September 30, 2004 was carried out under the supervision and with the
participation of our management, including the CEO and the CFO. Based on that
evaluation, management, including the CEO and the CFO, has concluded that our
disclosure controls and procedures are effective.
During the third quarter of 2004, there was no change in our internal
control over financial reporting that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None.
Item 6. Exhibits
The exhibits filed or furnished with this quarterly report are
listed in the Exhibit Index that follows the signatures, which
index is incorporated herein by reference.
17
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST UNITED CORPORATION
Date: November 5, 2004 /s/ William B. Grant
----------------------------------------
William B. Grant, Chairman of the Board
and Chief Executive Officer
Date November 5, 2004 /s/ Robert W. Kurtz
----------------------------------------
Robert W. Kurtz, President and Chief
Financial Officer
18
EXHIBIT INDEX
Exhibit Description
3.1 Amended and Restated Articles of Incorporation (incorporated by
reference to Exhibit 3.1 of the Corporation's Quarterly Report on
Form 10-Q for the period ended June 30, 1998)
3.2 Amended and Restated By-Laws (incorporated by reference to Exhibit
3(ii) of the Corporation's Annual Report on Form 10-K for the year
ended December 31, 1997)
10.1 First United Bank & Trust Supplemental Executive Retirement Plan
("SERP") (incorporated by reference to Exhibit 10.1 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003)
10.2 Form of SERP Participation Agreement between the Bank and each of
William B. Grant, Robert W. Kurtz, Jeannette R. Fitzwater, Phillip
D. Frantz, Eugene D. Helbig, Jr., Steven M. Lantz, Robin M. Murray,
Frederick A. Thayer, IV (incorporated by reference to Exhibit 10.2
of the Corporation's Quarterly Report on Form 10-Q for the period
ended June 30, 2003)
10.3 Endorsement Split Dollar Agreement between the Bank and William B.
Grant (incorporated by reference to Exhibit 10.3 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003)
10.4 Endorsement Split Dollar Agreement between the Bank and Robert W.
Kurtz (incorporated by reference to Exhibit 10.4 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003)
10.5 Endorsement Split Dollar Agreement between the Bank and Jeannette R.
Fitzwater (incorporated by reference to Exhibit 10.5 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003)
10.6 Endorsement Split Dollar Agreement between the Bank and Phillip D.
Frantz (incorporated by reference to Exhibit 10.6 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003)
10.7 Endorsement Split Dollar Agreement between the Bank and Eugene D.
Helbig, Jr. (incorporated by reference to Exhibit 10.7 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003)
10.8 Endorsement Split Dollar Agreement between the Bank and Steven M.
Lantz (incorporated by reference to Exhibit 10.8 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003)
10.9 Endorsement Split Dollar Agreement between the Bank and Robin M.
Murray (incorporated by reference to Exhibit 10.9 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003)
10.10 Endorsement Split Dollar Agreement between the Bank and Frederick A.
Thayer, IV (incorporated by reference to Exhibit 10.10 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
June 30, 2003)
10.11 First United Corporation Executive and Director Deferred
Compensation Plan (incorporated by reference to Exhibit 10.10 of the
Corporation's Quarterly Report on Form 10-Q for the period ended
September 30, 2003)
31.1 Certifications of the CEO pursuant to Section 302 of the
Sarbanes-Oxley Act (filed herewith)
31.2 Certifications of the CFO pursuant to Section 302 of the
Sarbanes-Oxley Act (filed herewith)
32.1 Certification of the CEO pursuant to 18 U.S.C. ss. 1350 (furnished
herewith)
32.2 Certification of the CFO pursuant to 18 U.S.C. ss. 1350 (furnished
herewith)
19