FIRST UNITED CORP annual report, FY2020

First United Corporation — 2020 Form 10-K Summary

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2020, with comparative results for 2019. First United is a community bank holding company operating primarily in Western Maryland and Northeastern West Virginia. Its banking subsidiary had 25 offices. The consolidated financial statements received an unqualified audit opinion.

Financial performance and position

Metric	2020	2019
Total assets at year-end	$1.733 billion	$1.442 billion
Net loans at year-end	$1.150 billion	$1.037 billion
Deposits at year-end	$1.422 billion	$1.142 billion
Net interest income (GAAP)	$48.5 million	$46.4 million
Net income	$13.8 million	$13.1 million
Diluted earnings per share	$1.97	$1.85
Net interest margin (FTE)	3.34%	3.68%
Provision for loan losses	$5.4 million	$1.3 million
Operating cash flow	$16.2 million	$16.4 million

Net income increased 5.4%; diluted EPS rose about 6.5%. Management attributed the earnings improvement mainly to higher net interest income and gains, and lower operating expenses, partly offset by a larger credit-loss provision.
Interest expense fell $1.9 million, while interest income was broadly stable. The FTE margin declined as loans and investments repriced at lower rates, and low-rate PPP lending and excess cash weighed on yields.
Year-end shareholders’ equity was $131.0 million. Return on average assets was 0.86% and return on average equity was 10.89%, compared with 0.93% and 10.44%, respectively, in 2019.
Cash and cash equivalents increased $99.5 million to $149.4 million. Investing cash outflow was $191.3 million and financing cash inflow was $274.6 million, largely reflecting deposit growth.
Total borrowings were $150.1 million: $49.2 million short-term and $100.9 million long-term. Available funding included $130.0 million in correspondent lines, $134.4 million of additional FHLB capacity and $1.1 million at the Federal Reserve Discount Window; the filing also reports $142.3 million available through brokered money-market funds.
The Corporation’s total risk-based capital ratio was 16.08% and the Bank’s was 15.50%; both were categorized as well capitalized. The Corporation’s ratio was down from 16.29% in 2019.

Material changes and notable items

Loans grew $117.4 million, with commercial and industrial balances increasing $144.4 million, including $114.0 million of PPP loans outstanding at year-end. Residential mortgages declined $59.3 million as refinancing activity rose and the Bank sold qualifying originations to the secondary market.
Deposits increased $280.3 million, including $125.8 million in non-interest-bearing deposits. Growth reflected PPP-related funds and organic customer balances.
The allowance for loan losses rose to $16.5 million from $12.5 million; its ratio to loans was 1.41%, or 1.55% excluding PPP balances. Net charge-offs were $1.5 million, versus net recoveries of $0.2 million in 2019. Management said the provision increase chiefly reflected COVID-19-related uncertainty.
Non-accrual loans declined to $3.3 million from $10.8 million, primarily because an $8.0 million acquisition-and-development loan moved to other real estate owned (OREO). OREO increased to $9.4 million from $4.1 million.
Net gains increased to $2.8 million from $0.3 million, chiefly from mortgage-loan sales and investment-security sales. Trust and brokerage income rose; deposit service charges fell, partly reflecting reduced overdraft activity.
Operating expenses declined $1.5 million overall, but legal and professional services rose $2.7 million and investor-relations costs rose $1.0 million, primarily in connection with the 2020 proxy contest and related litigation. The Corporation reported approximately $3.3 million of proxy-contest costs.
After its February 19, 2021 earnings release, management determined that approximately $0.6 million of previously deferred automated-services consulting costs should have been expensed in fourth-quarter 2020; the adjustment reduced 2020 net income by approximately $0.4 million.
The Corporation declared $0.52 per common share in dividends for 2020, versus $0.44 in 2019, and repurchased 145,291 shares for approximately $2.8 million.

Outlook, risks and contingencies

The filing provides no specific earnings or revenue guidance. Management expected the full benefit of restructuring three $70 million FHLB advances at a lower weighted rate to be realized in 2021. It also estimated that approximately $70 million invested in securities late in December 2020 would add about $0.7 million of earnings in 2021.
COVID-19 remains a central uncertainty for borrowers, credit quality, loan demand, operations and interest rates. The Bank granted 562 loan modifications totaling $230.6 million during 2020; 40 modifications totaling approximately $18.2 million remained active at February 28, 2021. Hospitality and accommodations borrowers are among the more exposed industries.
The Bank processed 1,174 PPP applications totaling $148.9 million in 2020 and approximately $34.5 million in forgiveness requests. It had processed 561 second-round PPP applications totaling $56.4 million by March 11, 2021. Forgiveness eligibility and timing affect fee recognition and outstanding balances.
Interest-rate sensitivity analysis estimated that a 100-basis-point rise would increase net interest income by $1.5 million, while a 100-basis-point decline would reduce it by $2.2 million. These are model estimates, not forecasts, and depend on assumptions.
Other significant risks include geographic and real-estate lending concentration, credit losses exceeding reserves, funding and liquidity conditions, securities valuation, cybersecurity and third-party service disruptions, regulation, and the transition away from LIBOR. The filing states that CECL implementation is scheduled for January 1, 2023.
Driver Opportunity Fund litigation seeks unspecified damages and, among other relief, a new shareholder meeting. The court dismissed six of nine claims in January 2021; reconsideration and amendment motions remained pending as of the filing. The Corporation said it could not assess the case outcome or total defense costs and expects to honor director indemnification and expense-advancement obligations.
Goodwill was $11.0 million. Management concluded no impairment was required at year-end after quarterly quantitative assessments earlier in 2020 and a fourth-quarter qualitative review. The $13.3 million fair value of the pooled trust-preferred CDO securities relies on Level 3 valuation inputs and an illiquid market.

Important facts for investors to verify

How PPP forgiveness, second-round originations and resulting fees affect loan balances, liquidity and earnings.
Whether credit quality worsens as pandemic-related accommodations end, particularly among hospitality, accommodations and real-estate borrowers; monitor criticized loans, modifications, OREO and allowance coverage.
Whether the lower FHLB funding costs and late-2020 securities purchases deliver the anticipated 2021 benefit, and how margin responds to rate changes.
Developments in the Driver litigation, subsequent legal and proxy costs, and any effects on governance or capital allocation.
The assumptions and valuations supporting the allowance for loan losses, goodwill and Level 3 CDO securities.
Dividend capacity and capital levels, including the effects of regulatory limits and the terms of the junior subordinated debentures.