Item 1. BUSINESS
First United Corporation
The Corporation, headquartered in Oakland, Maryland, is a one-bank financial holding company with four non-bank subsidiaries. The Corporation was organized under the laws of the State of Maryland in 1985.
The direct subsidiaries of the Corporation include First United Bank & Trust, a Maryland chartered trust company (the "Bank"), Oakfirst Life Insurance Corporation, an Arizona reinsurance company, OakFirst Loan Center, Inc., a West Virginia finance company, OakFirst Loan Center, LLC, a Maryland finance company, and First United Capital Trust, a Delaware statutory business trust (the "Trust").
The Corporation maintains an Internet site at www.mybankfirstunited.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 on its Internet site as soon as reasonably practicable after these reports are electronically filed with, or furnished to, the Securities and Exchange Commission (the "SEC").
First United Bank & Trust
The deposits of the Bank are insured by the Federal Deposit Insurance Corporation (the "FDIC"). The Bank operates twenty banking offices and one financial center, five facilities in Garrett County, Maryland, six in Allegany County, Maryland, two in Washington County, Maryland, two in Frederick County, Maryland, two in Mineral County, West Virginia, one in Hampshire County, West Virginia, two in Berkeley County, West Virginia, and one in Hardy County, West Virginia. The Bank also operates a total of thirty Automated Teller Machines ("ATM's"), thirteen of which are located in Garrett County, Maryland, seven in Allegany County, Maryland, two in Washington County, Maryland, four in Frederick County, Maryland, and one each in Mineral, Hampshire, Berkeley and Hardy Counties in West Virginia. The Bank provides a complete range of retail and commercial banking services to a customer base in Garrett, Allegany, Washington, and Frederick Counties in Maryland, in Mineral, Hampshire, Berkeley, and Hardy Counties in West Virginia, and to residents in surrounding regions of Pennsylvania and West Virginia. The customer base in the aforementioned geographical area consists of individuals, businesses, and various governmental units. The Bank is an independent community bank providing service to businesses and individuals in its market area. Services offered are essentially the same as those offered by larger regional institutions that compete with the Bank. The
services provided by the Bank include checking, savings, and Money Market deposit accounts, business loans, personal loans, mortgage loans, lines of credit, and consumer-oriented financial services including IRA and KEOGH accounts. In addition, the Bank provides full brokerage services through a networking arrangement with PrimeVest Financial Services, Inc., a full service broker-dealer. The Bank also provides safe deposit and night depository facilities and a complete line of trust services. As of December 31, 2002, the Bank had total deposits of $649.86 million and total loans and leases of $665.83 million. The total market value of assets under the supervision of the Bank's trust department was approximately $300.25 million.
The Bank has three wholly owned subsidiaries. First United Auto Finance, LLC is a Maryland limited liability company that engages in the business of indirect automobile leasing and was formed by the Bank in October, 1998. As of December 31, 2001, First United Auto Finance, LLC ceased all efforts to actively market automobile leasing. Gonder Insurance Agency, Inc. is a full line insurance agency located in Oakland, Maryland, which the Bank acquired in May, 1999. First United Capital Investments, Inc. is a Delaware corporation located in Wilmington, Delaware, formed in May, 2001. This entity has a subsidiary, First United Investment Trust, which is a Maryland business trust established in May 2001 as a real estate investment trust.
Oakfirst Life Insurance Corporation
Oakfirst Life Insurance Corporation is a reinsurance company that reinsures credit life and credit accident and health insurance written by American General Assurance Company on consumer loans made by the Bank. Oakfirst Life Insurance Corporation, which was chartered in 1989, is a wholly owned subsidiary of the Corporation and is subject to periodic review and examination by the Arizona Department of Insurance.
OakFirst Loan Centers
The Corporation meets the lending needs of under-served customer groups within its market areas in part through its finance company subsidiaries. OakFirst Loan Center, Inc., located in Martinsburg, West Virginia, opened for business in the spring of 2000 and is subject to periodic review and examination by the West Virginia Division of Banking. OakFirst Loan Center, LLC, located in Hagerstown, Maryland, opened in 2001 and is subject to periodic review and examination by the Maryland Commissioner of Financial Regulation.
First United Capital Trust
The Trust is a Delaware business trust organized by the Corporation on July 19, 1999. The Trust issued $23.00 million of aggregate liquidation amount of 9.375% Preferred Securities in August 1999. See note 8 of the consolidated financial statements for additional disclosure.
COMPETITION
The Corporation and the Bank operate in a competitive environment, competing for deposits and loans with commercial banks, thrifts and other financial entities. Principal competitors include other community commercial banks and larger financial institutions with branches in the Bank's market area. Numerous mergers and consolidations involving banks in the Bank's market area have occurred recently, requiring the Bank to compete with banks with greater resources.
The primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services, convenience of office locations and office hours. Competition for deposits comes primarily from other commercial banks, savings associations, credit unions, money market funds and other investment alternatives. The primary factors in competing for loans are interest rates, loan origination fees, the quality and range of lending services and personalized services. Competition for loans comes primarily from other commercial banks, savings associations, mortgage banking firms, credit unions and other financial intermediaries. Many of the financial institutions operating in the Bank's market area offer certain services that the Bank does not offer and have greater financial resources or have substantially higher lending limits than does the Bank.
To compete with other financial services providers, the Bank principally relies upon local promotional activities, personal relationships established by officers, directors and employees with its customers and specialized services tailored to meet its customers' needs. In those instances where the Bank is unable to accommodate a customers' needs, the Bank will arrange for those services to be provided by other banks with which it has a relationship. Current banking laws facilitate interstate branching and merger activity among banks. Since September, 1995, certain bank holding companies are authorized to acquire banks throughout the United States. In addition, on and after June 1, 1997, certain banks are permitted to merge with banks organized under the laws of different states. These changes have resulted in an even greater degree of competition in the banking industry and the Corporation and the Bank may be brought into competition with institutions with which it does not presently compete. As a result, intense competition in the Bank's market area may be expected to continue for the foreseeable future.
CAPITAL REQUIREMENTS
See "Management's Discussion and Analysis of Financial Condition and Results of Operation--Capital Resources".
SUPERVISION AND REGULATION
The following is a summary of the material regulations and policies applicable to the Corporation and its subsidiaries and is not intended to be a comprehensive discussion. Changes in applicable laws and regulations may have a material effect on the business of the Corporation and Banks.
General
The Corporation is a financial holding company registered with the Board of Governors of the Federal Reserve System (the "FRB") under the BHC Act and as such is subject to the supervision, examination and reporting requirements of the BHC Act and the regulations of the FRB.
The Bank is a state chartered trust company and is a member of the FDIC. The Bank is subject to the regulation, supervision, and reporting requirements of the FDIC, as well as the Maryland Commissioner of Financial Regulation. The Bank is also subject to numerous state and federal statutes and regulations that affect the business of banking, including the provision of trust services.
Regulation of Financial Holding Companies
Pursuant to the Gramm-Leach-Bliley Act (the "GLBA"), the Corporation elected to become a "financial holding company" as of April 26, 2001 and, as such, may engage in activities that are in addition to the business of banking. A financial holding company may engage in a full range of financial activities, including, insurance and securities sales and underwriting activities, and real estate development, with new expedited notice procedures. The Gramm-Leach-Bliley Act is described in more detail below.
Subsidiary banks of financial holding companies are subject to certain statutory limits of the transfer of funds to the holding company or any of its nonbank subsidiaries, whether in the form of loans or other extensions of credit, investments in their securities and on the use of their securities as collateral for loans to any borrower. Such transfers of a subsidiary bank to a holding company or one of its nonbanking subsidiaries is limited in amount, and such loans and extensions of credit are required to be collateralized in specified amounts.
Under FRB policy, the Corporation is expected to act as a source of strength to its subsidiary banks, and the FRB may charge the Corporation with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. In addition, under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 ("FIRREA"), depository institutions insured by the FDIC can be held liable for any losses incurred by, or reasonably anticipated to be incurred by, the FDIC in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default. Accordingly, in the event that any insured subsidiary of the
Corporation causes a loss to the FDIC, other insured subsidiaries of the Corporation could be required to compensate the FDIC by reimbursing it for the estimated amount of such loss. Such cross guaranty liabilities generally are superior in priority to obligations of a financial institution to its shareholders and obligations to other affiliates.
Federal Banking Regulation
Federal banking regulators, such as the FRB and the FDIC, may prohibit the institutions over which they have supervisory authority from engaging in activities or investments that the agencies believes are unsafe or unsound banking practices. Federal banking regulators have extensive enforcement authority over the institutions they regulate to prohibit or correct activities that violate law, regulation or a regulatory agreement or which are deemed to be unsafe or unsound practices. Enforcement actions may include the appointment of a conservator or receiver, the issuance of a cease and desist order, the termination of deposit insurance, the imposition of civil money penalties on the institution, its directors, officers, employees and institution-affiliated parties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the removal of or restrictions on directors, officers, employees and institution-affiliated parties, and the enforcement of any such mechanisms through restraining orders or other court actions.
The Bank is subject to certain restrictions on extensions of credit to executive officers, directors, and principal shareholders or any related interest of such persons, which generally require that such credit extensions be made on substantially the same terms as are available to third parties dealing with the Bank and not involve more than the normal risk of repayment. Other laws tie the maximum amount that may be loaned to any one customer and its related interests to capital levels.
Under the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), each federal banking agency is required to prescribe, by regulation, non-capital safety and soundness standards for institutions under its authority. The federal banking agencies have adopted standards covering internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. An institution that fails to meet those standards may be required by the agency to develop a plan acceptable to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. The Corporation, on behalf of the Bank, believes that the Bank meets substantially all standards that have been adopted. FDICIA also imposes new capital standards on insured depository institutions. See "Capital Requirements."
The Community Reinvestment Act ("CRA") requires that, in connection with the examination of financial institutions within their jurisdictions, the FDIC evaluate the record of the financial institution in meeting the credit needs of their communities including low and moderate income neighborhoods, consistent with the safe and sound operation of those banks. These factors are also considered by all regulatory agencies in evaluating mergers, acquisitions and applications to open a branch or facility. As of the date of its most recent examination report, the Bank has a CRA rating of "Satisfactory."
Deposit Insurance
As an FDIC member institution, the Bank's deposits are insured to a maximum of $100,000 per depositor through the Bank Insurance Fund ("BIF"), administered by the FDIC, and the Bank is required to pay semi-annual deposit insurance premium assessments to the FDIC. The BIF assessment rates have a range of 0 to 27 cents for every $100 in assessable deposits. In 1999, deposits insured by BIF were assessed by the Financing Corporation ("FICO") at one-fifth the rate applicable to deposits insured by the Savings Association Insurance Fund ("SAIF"). When Congress imposed this rate differential in 1996, it also provided that the differential would terminate at the end of the 1999 calendar year. Therefore, beginning with assessments paid for the period starting January 1, 2000, insured institutions were assessed at the same FICO rate for both BIF and SAIF-insured deposits. As a result, the Bank paid $.17 million of FDIC premiums in 2002 and $.11 million in 2001.
Federal Deposit Insurance Corporation Improvement Act of 1991
In December 1991, Congress enacted FDICIA, which substantially revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. FDICIA provides for, among other things, (i) a recapitalization of the BIF by increasing the FDIC's borrowing authority and providing for adjustments in its assessment rates; (ii) annual on-site examinations of federally-insured depository institutions by banking regulators; (iii) publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants; (iv) the establishment of uniform accounting standards by federal banking agencies; and (v) the establishment of a "prompt corrective action" system of regulatory supervision and intervention, based on capitalization levels, with more scrutiny and restrictions placed on institutions with lower levels of capital.
FDICIA establishes a system of prompt corrective action to resolve the problems of undercapitalized institutions. Under this system the federal banking regulators are required to rate supervised institutions on the basis of five capital categories: "well -capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized," and "critically undercapitalized;" and to take certain mandatory actions, and are authorized to take other discretionary actions, with respect to institutions in the three undercapitalized categories. The severity of the actions will depend upon the category in which the institution is placed. A depository institution is "well capitalized" if it has a total risk based capital ratio of 10% or greater, a Tier 1 risk based capital ratio of 6% or greater, and a leverage ratio of 5% or greater and is not subject to any order, regulatory agreement, or written directive to meet and maintain a specific capital level for any capital measure. An "adequately capitalized" institution is defined as one that has a total risk based capital ratio of 8% or greater, a Tier 1 risk based capital ratio of 4% or greater and a leverage ratio of 4% or greater (or 3% or greater in the case of a bank with a composite CAMEL rating of 1).
FDICIA generally prohibits a depository institution from making any capital distribution, including the payment of cash dividends, or paying a management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. For a capital restoration plan to be acceptable, the depository institution's parent holding company must guarantee (subject to certain limitations) that the institution will comply with such capital restoration plan.
Significantly undercapitalized depository institutions may be subject to a number of other requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized and requirements to reduce total assets and stop accepting deposits from correspondent banks. Critically undercapitalized depository institutions are subject to the appointment of a receiver or conservator, generally within 90 days of the date such institution is determined to be critically undercapitalized.
Interstate Banking Legislation
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 was enacted into law on September 29, 1994. The law provides that, among other things, substantially all state law barriers to the acquisition of banks by out of state bank holding companies are eliminated effective September 29, 1995. The law also permitted interstate branching by banks effective June 1, 1997, subject to the ability of states to opt-out completely or to set an earlier effective date. Maryland and West Virginia generally established earlier effective dates of September 29, 1995 and May 31, 1997, respectively.
Gramm-Leach-Bliley Act
In November 1999, the GLBA was signed into law. Effective in pertinent part on March 11, 2000, GLBA revises the Bank Holding Corporation Act of 1956 and repeals the affiliation provisions of the Glass-Steagall Act of 1933, which, taken together, limited the securities, insurance and other non-banking activities of any company that controls an FDIC insured financial institution. Under GLBA, a bank holding company can elect, subject to certain qualifications, to become a "financial holding company." GLBA provides that a financial holding company may engage in a full range of financial activities, including insurance and securities sales and underwriting activities, and
real estate development, with new expedited notice procedures.
Maryland law generally permits Maryland State chartered banks, including the Bank, to engage in the same activities, directly or through an affiliate, as national banking associations. GLBA permits certain qualified national banking associations to form financial subsidiaries, which have broad authority to engage in all financial activities except insurance underwriting, insurance investments, real estate investment or development, or merchant banking. Thus, GLBA has the effect of broadening the permitted activities of the Bank.
Federal Securities Law
The Corporation's common stock is registered with the SEC under Section 12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). The Corporation is subject to information reporting, proxy solicitation, insider trading restrictions and other requirements under the Exchange Act.
Governmental Monetary and Credit Policies and Economic Controls
The earnings and growth of the banking industry and ultimately of the Bank are affected by the monetary and credit policies of governmental authorities, including the FRB. An important function of the FRB is to regulate the national supply of bank credit in order to control recessionary and inflationary pressures. Among the instruments of monetary policy used by the FRB to implement these objectives are open market operations in U.S. Government securities, changes in the federal funds rate, changes in the discount rate of member bank borrowings, and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth of bank loans, investments and deposits and may also affect interest rates charged on loans or paid for deposits. The monetary policies of the FRB authorities have had a significant effect on the operating results of commercial banks in the past and are expected to continue to have such an effect in the future. In view of changing conditions in the national economy and in the money markets, as well as the effect of actions by monetary and fiscal authorities, including the FRB, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or their effect on the business and earnings of the Corporation and its subsidiaries.
Employees
At December 31, 2002, the Corporation and its subsidiaries employed approximately 403 individuals, of whom 86 were officers, 198 were full-time employees, and 119 part-time employees.
RISK FACTORS
The following factors should be considered carefully in evaluating an investment in shares of common stock of the Corporation, and the preferred securities of the Trust.
The Corporation's Future Depends on the Successful Growth of its Subsidiaries
The Corporation's primary business activity for the foreseeable future will be to act as the holding company of the Bank and its other direct and indirect subsidiaries. Therefore, the Corporation's future profitability will depend on the success and growth of these subsidiaries. In the future, part of the Corporation's growth may come from buying other banks and buying or establishing other companies. Such entities may not be profitable after they are purchased or established, and they may lose money, particularly at first. A new bank or company may bring with it unexpected liabilities, bad loans, or bad employee relations, or the new bank or company may lose customers.
The Majority of the Corporation's Business is Concentrated in Maryland and West Virginia; A Significant Amount of the Corporation's Business is Concentrated in Real Estate Lending
Because most of the Bank's loans are made to Maryland and West Virginia borrowers, a decline in local economic conditions may have a greater effect on the Corporation's earnings and capital than on the earnings and capital of larger financial institutions whose loan portfolios are geographically diverse. Further, the Bank makes many real
estate secured loans, which are in greater demand when interest rates are low and economic conditions are good. Even when economic conditions are good and interest rates are low, these conditions may not continue. Additionally, the market values of the real estate securing these loans may deteriorate, and the Corporation may lose money if a borrower fails to repay a real estate loan.
The Bank may Experience Loan Losses in Excess of its Allowance
The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. Management of the Bank maintains an allowance for credit losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectability of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and for specific loans when their ultimate collectability is considered questionable. If management's assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb future losses, or if the bank regulatory authorities require the Bank to increase its allowance for loan losses as a part of its examination process, the Bank's earnings and capital could be significantly and adversely affected. Although management uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the assumptions used or adverse developments arise with respect to the Bank's non-performing or performing loans. Material additions to the allowance for loan losses of one of the Bank would result in a decrease in the Bank's net income and capital, and could have a material adverse effect on the Corporation.
Interest Rates and Other Economic Conditions will Impact Results of Operations
Results of operations for financial institutions, including the Corporation and its subsidiaries, may be materially and adversely affected by changes in prevailing economic conditions, including declines in real estate values, rapid changes in interest rates and the monetary and fiscal policies of the federal government. The Corporation's profitability is in part a function of the spread between the interest rates earned on assets and the interest rates paid on deposits and other interest-bearing liabilities (i.e., net interest income), including advances from the Federal Home Loan Bank of Atlanta (the "FHLB"). Interest rate risk arises from mismatches (i.e., the interest sensitivity gap) between the dollar amount of repricing or maturing assets and liabilities and is measured in terms of the ratio of the interest rate sensitivity gap to total assets. More assets repricing or maturing than liabilities over a given time period is considered asset-sensitive and is reflected as a positive gap, and more liabilities repricing or maturing than assets over a given time period is considered liability-sensitive and is reflected as negative gap. An asset-sensitive position (i.e., a positive gap) could enhance earnings in a rising interest rate environment and could negatively impact earnings in a falling interest rate environment, while a liability-sensitive position (i.e., a negative gap) could enhance earnings in a falling interest rate environment and negatively impact earnings in a rising interest rate environment. Fluctuations in interest rates are not predictable or controllable. The Corporation has attempted to structure its asset and liability management strategies to mitigate the impact on net interest income of changes in market interest rates.
The Market Value of the Corporation's Investments could Decline
As of December 31, 2001, the Corporation had classified 100.00% of its investment securities as available-for-sale pursuant to Statement of Financial Accounting Standards No. 115 ("SFAS 115") relating to accounting for investments. SFAS 115 requires that unrealized gains and losses in the estimated value of the available-for-sale portfolio be "marked to market" and reflected as a separate item in shareholders' equity (net of tax) as accumulated other comprehensive income. The remaining investment securities are classified as held-to-maturity in accordance with SFAS 115, and are stated at amortized cost. In the past, gains on sales of investment securities have not been a significant source of income for the Corporation. There can be no assurance that future market performance of the Corporation's investment portfolio will enable the Corporation to realize income from sales of securities. Stockholders' equity will continue to reflect the unrealized gains and losses (net of tax) of these investments. There can be no assurance that the market value of the Corporation's investment portfolio will not decline, causing a corresponding decline in shareholders' equity.
Management believes that several factors will affect the market values of the Corporation's investment portfolio. These include, but are not limited to, changes in interest rates or expectations of changes, the degree of volatility in the securities markets, inflation rates or expectations of inflation and the slope of the interest rate yield curve (the yield curve refers to the differences between shorter-term and longer-term interest rates; a positively sloped yield curve means shorter-term rates are lower than longer-term rates). Also, the passage of time will affect the market values of our investment securities, in that the closer they are to maturing, the closer the market price should be to par value. These and other factors may impact specific categories of the portfolio differently, and management cannot predict the effect these factors may have on any specific category.
The Corporation's Ability to Pay Dividends is Limited
The Corporation's current ability to pay dividends is largely dependent upon the receipt of dividends from the Bank. Both federal and state laws impose restrictions on the ability of the Bank to pay dividends. Federal law prohibits the payment of a dividend by an uninsured depository institution like the Bank if the depository institution is considered "undercapitalized" or if the payment of the dividend would make the institution "undercapitalized". See "Federal Deposit Insurance Corporation Improvement Act of 1991" above. The Corporation does not anticipate that such provisions will be applied to the Bank. The FRB has issued a policy statement which provides that, as a general matter, insured banks and bank holding companies may pay dividends only out of prior operating earnings. For a Maryland state-chartered bank or trust company, dividends may be paid out of undivided profits or, with the prior approval of the Commissioner, from surplus in excess of 100% of required capital stock. If however, the surplus of a Maryland bank is less than 100% of its required capital stock, cash dividends may not be paid in excess of 90% of net earnings. In addition to these specific restrictions, bank regulatory agencies also have the ability to prohibit proposed dividends by a financial institution which would otherwise be permitted under applicable regulations if the regulatory body determines that such distribution would constitute an unsafe or unsound practice.
The Corporation's Stock is not Heavily Traded
The Corporation's common stock is traded on The Nasdaq National Market and is thinly traded. Thinly traded stock can be more volatile than stock trading in an active public market. Factors such as the Corporation's financial results, the introduction of new products and services by the Corporation or its competitors, and various factors affecting the banking industry generally may have a significant impact on the market price of the Corporation's common stock. Management cannot predict the extent to which an active public market for the Corporation's common stock will develop or be sustained in the future. In recent years, the stock market has experienced a high level of price and volume volatility, and market prices for the stock of many companies have experienced wide price fluctuations that have not necessarily been related to their operating performance. Therefore, the Corporation's shareholders may not be able to sell their shares at the volumes, prices, or times that they desire.
The Corporation's Stock is not Insured
Investments in the shares of the Corporation's common stock are not deposits and are not insured against loss by the government.
The Corporation Operates in a Competitive Market
The Corporation and its subsidiaries operate in a competitive environment, competing for loans, deposits, and customers with commercial banks, savings associations and other financial entities. Competition for deposits comes primarily from other commercial banks, savings associations, credit unions, money market and mutual funds and other investment alternatives. Competition for loans comes primarily from other commercial banks, savings associations, mortgage banking firms, credit unions and other financial intermediaries. Competition for other products, such as insurance and securities products, comes from other banks, securities and brokerage companies, insurance companies, insurance agents and brokers, and other nonbank financial service providers in the Corporation's market area. Many of these competitors are much larger in terms of total assets and capitalization, have greater access to capital markets, and/or offer a broader range of financial services than those offered by the Corporation and its subsidiaries. In
addition, banks with a larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the needs of larger customers. Finally, the Corporation's growth and profitability will depend upon its ability to attract and retain skilled managerial, marketing and technical personnel. Competition for qualified personnel in the financial services industry is intense, and there can be no assurance that the Corporation will be successful in attracting and retaining such personnel.
The Banking Industry is Heavily Regulated; Significant Regulatory Changes could Adversely Affect the Corporation's Operations
The Corporation's operations and those of the Bank are and will be affected by current and future legislation and by the policies established from time to time by various federal and state regulatory authorities. The Corporation is subject to supervision by the FRB. The Bank is subject to supervision and periodic examination by the Maryland Commissioner and the FDIC. Banking regulations, designed primarily for the safety of depositors, may limit a financial institution's growth and the return to its investors by restricting such activities as the payment of dividends, mergers with or acquisitions by other institutions, investments, loans and interest rates, interest rates paid on deposits, expansion of branch offices, and the offering of securities or trust services. The Bank is also subject to capitalization guidelines established by federal law and could be subject to enforcement actions to the extent that the Bank is found by regulatory examiners to be undercapitalized. It is not possible to predict what changes, if any, will be made to existing federal and state legislation and regulations or the effect that such changes may have on the Corporation's future business and earnings prospects, as well as those of the Bank. Management also cannot predict the nature or the extent of the effect on the Corporation's business and earnings of future fiscal or monetary policies, economic controls, or new federal or state legislation. Further, the cost of compliance with regulatory requirements may adversely affect the Corporation's ability to operate profitably.
The Corporation may be Adversely Affected by Recent Legislation
The GLBA was signed into law on November 12, 1999. Among other things, GLBA repeals restrictions on banks affiliating with securities firms. It also permits bank holding companies that become financial holding companies to engage in additional financial activities, including insurance and securities underwriting and agency activities, merchant banking, and insurance company portfolio investment activities that are currently not permitted for bank holding companies. GLBA may have the result of increasing the competition the Corporation faces from larger banks and other companies. It is not possible to predict the full effect that GLBA will have on the Corporation.
In addition, recent changes in other federal banking laws facilitate interstate branching and merger activity among banks. Such changes may result in an even greater degree of competition in the banking industry, and the Corporation may be brought into competition with institutions with which it does not presently compete. From time to time other changes are proposed to laws affecting the banking industry, and these changes could have a material effect on the Corporation's business and prospects. The Corporation's future profitability may be adversely affected by increased competition resulting from this legislation.
The Corporation may be Subject to Claims
Customers may sue the Corporation and its subsidiaries for losses due to alleged breaches of fiduciary duties, errors and omissions of employees, officers and agents, incomplete documentation, the failure of the Corporation and/or its subsidiaries to comply with applicable laws and regulations, or many other reasons. Also, the employees of the Corporation and/or its subsidiaries may knowingly or unknowingly violate laws and regulations. Corporation management may not be aware of any violations until after their occurrence. This lack of knowledge may not insulate the Corporation and its subsidiaries from liability. Claims and legal actions may result in legal expenses and liabilities that may reduce the Corporation's profitability and hurt its financial condition.
The Corporation may not be Able to Keep Pace with Developments in Technology
The Corporation and its subsidiaries use various technologies in their respective businesses, including telecommunication, data processing, computers, automation, internet-based banking, and debit cards. Technology
changes rapidly. The Corporation's ability to compete successfully with other banks and non-banks may depend on whether it can exploit technological changes. The Corporation may not be able to exploit technological changes, and any investment it does make may not make it more profitable.
The Corporation's Articles of Incorporation and By-Laws may Discourage a Corporate Takeover
The Corporation's Amended and Restated Articles of Incorporation ("Articles") and By-Laws contain certain provisions designed to enhance the ability of the Board of Directors to deal with attempts to acquire control of the Corporation. These provisions provide for the classification of the Corporation's Board of Directors into three classes; directors of each class generally serve for staggered three-year periods. No director may be removed except for cause and then only by a vote of at least two-thirds of the total eligible shareholder votes. In addition, Maryland law contains anti-takeover provisions that apply to the Corporation. Although these provisions do not preclude a takeover, they may have the effect of discouraging a future takeover attempt which would not be approved by the Corporation's Board of Directors, but pursuant to which shareholders might receive a substantial premium for their shares over then-current market prices. As a result, shareholders who might desire to participate in such a transaction might not have the opportunity to do so. Such provisions will also render the removal of the Corporation's Board of Directors and of management more difficult and, therefore, may serve to perpetuate current management. As a result of the foregoing, such provisions could potentially adversely affect the market price of the common stock.
Item 1A.
Item 1A. Executive Officers
Information about the Corporation's executive officers is set forth below
William B. Grant, age 49, Chairman of the Board and Chief Executive Officer. Mr. Grant has been Chairman of the Board and Chief Executive Officer since 1996. Previously, he had been Secretary of the Corporation since 1990 and Executive Vice-President of the Bank since 1987.
Robert W. Kurtz age 56, President, Chief Financial Officer, Secretary/Treasurer. Mr. Kurtz has been President of the Corporation since 1996 and Chief Financial Officer, Secretary, and Treasurer since 1997. Previously, he had been Chief Operating Officer of the Corporation since 1996, Treasurer of the Corporation since 1990 and Executive Vice-President of the Bank since 1987.
Jeannette R. Fitzwater, age 42, Senior Vice President and Director of Human Resources. Mrs. Fitzwater was appointed Senior Vice President and Director of Human Resources in 1997. She had been First Vice President, Director of Marketing and Regional Sales Manager of the Bank since 1994.
Philip D. Frantz, age 42, Senior Vice President and Director of Operations & Support. Mr. Frantz was appointed Senior Vice President in 1993 and previously had been the Controller of the organization since 1988. He was appointed Director of Operations & Support of the Corporation in 1997.
Steven M. Lantz, age 46, Senior Vice President and Director of Lending. Mr. Lantz was appointed Senior Vice President and Director of Lending of the Corporation in 1997. He had been First Vice President and Commercial Services Manager of the Bank since 1993.
Eugene D. Helbig, Jr., age 50, Senior Vice President and Senior Trust Officer. Mr. Helbig was appointed Senior Vice President in 1997 and Senior Trust Officer in 1993. He had been a First Vice President of the Bank since 1993.
Frederick A. Thayer, IV, age 44, Senior Vice President, Director of Sales and CRA Officer. Mr. Thayer was appointed Senior Vice President and Director of Sales in 1997. Previously, he had been First Vice President, Regional Executive Officer and Regional Sales Manager of the Bank since 1993.
All officers are elected annually by the Board of Directors and hold office at the pleasure of the Board.
Item 2.
Item 2. PROPERTIES
The main office of the Corporation and the Bank occupies approximately 29,000 square feet at 19 South Second Street, Oakland, Maryland, and is owned by the Corporation. The Bank operates a network of twenty banking offices and one financial center throughout Garrett, Allegany, Washington and Frederick Counties, Maryland and Mineral, Hampshire, Berkeley and Hardy Counties, West Virginia. Except for seven leased offices, all of the Bank's banking offices are owned by the Bank.
The properties of the Corporation which are not owned are held under long-term leases. Total rent expense for 2002, 2001, and 2000 was $.33, $.32, and $.29 million, respectively.
Item 3.
Item 3. LEGAL PROCEEDINGS
The Corporation and its subsidiaries are at times, and in the ordinary course of business, subject to legal actions. Management, upon the advice of counsel, is of the opinion that losses, if any, resulting from the settlement of current legal actions will not have a material adverse effect on the financial condition of the Corporation.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of shareholders during the fourth quarter of 2002.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
Shares of the Corporation's common stock are traded on the Nasdaq Stock Market under the symbol "FUNC". There are 25,000,000 shares of the Corporation's common stock authorized for issuance, and the total number of shares outstanding as of December 31, 2002, was 6,080,589. As of December 31, 2002, the Corporation had approximately 2,296 holders of record of its common stock. There are also 2,000,000 shares of preferred stock authorized with no shares outstanding as of December 31, 2002. The following tables reflect the high and low sales prices during the period stated, as well as the closing price for the years ended December 31, 2002 and 2001.
Cash dividends on shares of the Corporation's common stock were paid on the dates indicated as follows:
For information about restrictions on the Corporation's ability to pay dividends, see "Risk Factors--The Corporation's Ability to Pay Dividends is Limited."
Market Makers for the Corporation's common stock are: Ferris Baker Watts Advest, Inc. Scott and Stringfellow, Inc. 12 North Liberty St. 90 State House Square 909 East Main Street Cumberland, MD 21502 Hartford, CT 06103 Richmond, VA 23219 (301) 724-7161 (860) 509-1000 (804) 643-1811 (800) 776-0629 (800) 797-9642 (800) 552-7757
113 S. Potomac St. Hagerstown, MD 21740 (301) 733-7111 (800) 344-4413
Equity Compensation Plan Information
The Corporation has not adopted any equity compensation plan or arrangement under which shares of common stock may be issued.
Item 6.
Item 6. SELECTED FINANCIAL DATA
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This discussion and analysis should be read in conjunction with the financial statements which appear elsewhere in this report.
EARNINGS ANALYSIS
Overview
The Corporation posted record net earnings for 2002 of $9.66 million. This is a 5.34% increase over the $9.17 million reported for 2001. Returns on average assets were 1.13%, 1.11%, and 1.03% in 2002, 2001, and 2000, respectively. The return on average shareholders' equity for 2002 was 12.75%. This ratio was 13.26% in 2001 and 13.40% in 2000. Earnings per share increased to $1.59 in 2002, from $1.51 in 2001, and $1.37 in 2000.
Comparing December 31, 2002 balances to balances at December 31, 2001, total assets were $953.68 million versus $818.11 million, respectively, a 16.57% increase. Total deposits increased $33.09 million or 5.37%, while gross loans and leases grew $56.27 million to $665.83 million or 9.23%. During the same time period, shareholders' equity increased $8.21 million to $79.28 million, which was 8.31% of assets.
The Corporation's performance in 2002, as compared to 2001, reflects an increase in average earning assets as well as an increase in the net interest margin. Average earning assets were $801.60 million in 2002 as compared to $776.54 million in 2001. This is an increase of 3.23%. Average earning assets increased 1.87 % from 2000 to 2001. The Corporation's net interest margin in 2002 was 4.09%, as compared to 3.93% in 2001.
Asset quality continued to be favorable as compared to peers. Non-performing assets represented 0.35% of total assets at December 31, 2002. This same ratio was 0.54% for the year ending December 31, 2001. The ratio of net charge-offs to average loans and leases was 0.19% in 2002 as compared to 0.37% for the prior year. The allowance for probable loan and lease losses as a percentage of non-performing loans was 180% as of December 31, 2002.
On February 13, 2003, the Corporation and the Bank entered into a Purchase and Assumption Agreement with The Huntington National Bank to purchase four branch offices located in Berkeley County, West Virginia. The acquisition will involve the assumption of approximately $140 million in deposit liabilities and the purchase of $54 million in outstanding loans as well as three buildings and fixed assets at these locations. The fourth building is leased, which lease will be assumed by the Bank.
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 paid on interest-bearing liabilities.
As interest rates declined in 2002, total interest income decreased in 2002 by 8.91%, from $63.23 million in 2001 to $57.59 million in 2002. Interest income was $63.15 million in 2000. Similarly, decreasing interest rates caused total interest expense to decrease 23.00%, from $33.38 million in 2001 to $25.70 million in 2002. Total interest expense was $35.04 million in 2000. Interest expense on savings deposits and interest-bearing transaction accounts decreased $1.48 million in 2002 to $2.18 million from $3.66 million in 2001, reflecting the immediate effects of declining interest rates. Interest expense on time deposits decreased $6.7 million in 2002 to $14.89 million from $21.59 million in 2001. Through effective management of deposit and loan rates, net interest income increased to $31.89 million in 2002 from $29.85 million in 2001, an increase of 6.83%.
Table 2 analyzes the changes in net interest income attributable to volume and rate components. For analytical purposes, net interest income is adjusted to a taxable equivalent basis. This adjustment facilitates 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. In 2002, declining rates caused net interest income to increase $.43 million over 2001, while volume caused net interest income to increase $1.77 million. The taxable equivalent net interest margin increased to 4.09% in 2002 from 3.93% in 2001 and 3.84% in 2000. Table 1 compares the components of the net interest margin and the changes occurring between 2002, 2001, and 2000.
**The above table reflects the average rates earned or paid stated on a tax equivalent basis assuming a tax rate of 34%. The average balances of non-
accrual loans for the years ended December 31, 2002, 2001, and 2000, which were reported in the average loan balances for these years, were $1,906, $1,719, and $667, respectively. The fully taxable equivalent adjustments for the years ended December 31, 2002, 2001, and 2000 were $917, $749, and $791, respectively.
(1) The change in interest income/expense due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
The above table is compiled on a tax equivalent basis. The fully taxable equivalent adjustments for the years ended December 31, 2002 and 2001 were $917 and $749, respectively.
Operating Income
Non-interest income declined in 2002 to a total of $9.01 or 3.33% from the 2001 total of $9.32 million. Non-interest income was $8.16 million in 2000. Non-operating items affecting this comparison include security losses of $.37 million that were recognized in 2002 compared to a gain of $.58 million in 2001. Secondly, a capital gain of $.06 million was recognized in 2001 due to the sale of a bank property. No bank properties were sold in 2002.
Income from trust and fiduciary activities in 2002 was $2.15 million. This is a decrease of $.36 million from the $2.51 million earned in 2001and the $2.28 million in 2000. Trust and fiduciary activity income is directly affected by the performance of the equity and bond markets because the majority of trust account fees are calculated based on the market value of the assets under management. The Bank's Trust Department managed accounts whose average market values were $300.25 million at December 31, 2002 as compared to $298.13 million at December 31, 2001.
Service charges on deposit accounts increased $.28 million due primarily to increases in return check charges. Insurance premium income increased $.17 million or 15.8% in 2002 over 2001 levels.
Other income increased $.55 million or 20.09% to $3.29 million in 2002 over 2001. Within this category, income from bank-owned life insurance investments increased $.36 million in 2002 over 2001. Debit card income increased $.06 million in 2002 over 2001, and secondary market fees increased $.06 million in 2002. Business Manager fee income decreased $.24 million in 2002 as compared to 2001.
Operating Expense
Operating expense increased $2.66 million or 11.37% in 2002 to a level of $26.04 million. Operating expense in 2001 totaled $23.38 million. The major categories of operating expense include salaries and employee benefits, occupancy and equipment expenses, data processing expense, and other non-interest expenses associated with the daily operations of the Company.
Salaries and employee benefits, the largest component of non-interest expenses, increased $1.42 million or 11.38% in 2002. Within this category, employee salaries increased $.72 million in 2002 over 2001, due primarily to salary increases and new employees. Employee incentives increased $.32 million in 2002 over 2001, due to an expanded incentive program. Pension costs and the costs of a supplemental executive retirement plan (SERP) increased $.17 million and $.16 million, respectively, in 2002 over 2001.
Occupancy expense increased $.04 million in 2002. Equipment expense increased $.24 million in 2002 over 2001, due largely to software and equipment maintenance agreement costs, and the depreciation costs of software and equipment purchased in 2002. Data processing expense increased $.11 million in 2002 over 2001.
Other expense increased $.85 million in 2002 over 2001, resulting from increased legal and professional fees, increased consulting fees, vendor commission expense, and other miscellaneous cost increases.
Operating Expense Management
Management believes that the efficiency ratio is an important measure of operating expense performance and cost management. The ratio is calculated by analyzing non-interest expenses as a percentage of net interest income plus total non-interest income. During 2002, the Corporation's efficiency ratio was 62.39%. The ratio in 2001 was 58.58%. The ratio in 2000 was 59.36%. Lower ratios indicate improved productivity.
Applicable Income Taxes
Applicable income taxes are detailed in Note 9 of the Corporation's audited consolidated financial statements. Income tax expense amounted to $3.70 million in 2002 compared with $3.69 million in 2001 and $3.76 million in 2000. These amounts represented effective tax rates of 27.68%, 28.69%, and 31.16%, for 2002, 2001, and 2000, respectively. In 2001, the Corporation established First United Investment Trust, a Maryland real estate investment trust, and its parent company First United Capital Investments, a Delaware corporation. The establishment of these entities eliminated most of the income taxes due to the state of Maryland and income taxes due to the state of West Virginia, thereby reducing the Corporation's effective tax rate.
Balance Sheet Overview
The Corporation's total assets reached $953.68 million at December 31, 2002. This is an increase of $135.57 million or 16.57% over the December 31, 2001 total of $818.11 million. Earning assets increased 20.06% or $148.75 million to a total of $890.36 million at December 31, 2002. Earning assets totaled $741.61 million at December 31, 2001.
Investment Securities
The Corporation's entire security portfolio is categorized as available-for-sale. Investment securities classified as available-for-sale are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions as part of the asset/liability management strategy. Available-for-sale securities are carried at market value, with unrealized gains and losses excluded from earnings and reported as a separate component of other comprehensive income included in shareholders' equity, net of income taxes. The Corporation does not currently
follow a strategy of making security purchases with a view of near-term resales and therefore, does not own trading securities. For additional information, see Notes 1 and 3 to the Corporation's audited consolidated financial statements.
Total investment securities increased $84.55 million or 64.70% in 2002 from $130.69 million in 2001 to a total of $215.24 million. The asset mix within the security portfolio shifted slightly with increases in the purchase of mortgage-backed securities. The mortgage-backed securities were purchased as part of the leverage growth strategy program and policy that was adopted and implemented by the Corporation during the third quarter of 2002. This program and policy was adopted with the goal of achieving increased returns on equity and earnings per share for the Corporation's shareholders. In July of 2002, the Corporation borrowed $40.00 million in structured borrowings from the Federal Home Loan Bank of Atlanta and reinvested these funds in mortgage backed securities. In September of 2002, a second leverage strategy was executed in the amount of $40.00 million. It is anticipated that the Corporation will earn a favorable spread between the rate earned on the securities and the cost of the borrowings. Because interest rate risk is inherent in leveraging, the Corporation mitigated its risk through the matching of the maturities of the investments with the borrowings. Management is committed to leverage growth strategies that will limit security purchases to those that it believes will minimize credit risk and will help to meet the objectives of the Corporation's investment and asset/liability management policies.
The Corporation manages its investment portfolios utilizing policies which seek to achieve desired levels of liquidity, manage interest rate sensitivity, meet earnings objectives, and provide required collateral support for deposit activities. Excluding the U.S. Government sponsored agencies, the Corporation had no concentration of investment securities from any single issues that exceeded 10% of shareholders' equity. Table 3 exhibits the distribution, by type, of the investment portfolio for the three years ended December 31, 2002, 2001, and 2000, respectively.
The above yields have been adjusted to reflect a tax equivalent basis assuming a tax rate of 34%. The above table includes certain securities which have no maturity. Therefore, these securities are classified as an addition to securities maturing over ten years.
Loan and Lease Portfolio
The Corporation, through the Bank and the OakFirst Loan Centers, is actively engaged in originating loans to customers primarily in Garrett, Allegany, Washington, and Frederick Counties in Maryland; Mineral, Hardy, Berkeley, Hampshire Counties in West Virginia; and the surrounding regions of West Virginia and Pennsylvania. The Corporation has policies and procedures designed to mitigate credit risk and to maintain the quality of the Corporation's loan portfolio. These policies include underwriting standards for new credits and the continuous monitoring and reporting of asset quality and the adequacy of the reserve for probable loan and lease losses. These policies, coupled with ongoing training efforts, have provided an effective check and balance for the risk associated with the lending process. Lending authority is based on the level of risk, size of the loan, and the experience of the lending officer. Table 4 presents the composition of the Corporation's loan and lease portfolio. It has been the historical policy of the Corporation to make the majority of its loan commitments in the market area it serves. The Corporation had no foreign loans in its portfolio as of December 31, 2002.
During 2002, gross loans and leases increased $56.27 million or 9.23% over 2001 to $665.83 million. Loans and leases decreased $5.09 million in 2001. The Company allocates significant resources to seeking and serving its loan customers. The commercial portfolio was the primary driver of growth in the overall loan portfolio in 2002. Commercial loan growth totaled $53.13 million in 2002. Loans included in this category are commercial real estate loans, commercial installment loans, and commercial lines of credit.
Residential mortgages decreased $1.63 million in 2002 over 2001. The Company experienced record refinancings in 2002 as customers took advantage of historically low interest rates through alternative vendors. The Company chose to not grow its balance sheet with fixed rate mortgages at these low levels. Home equity loans increased $6.84 million in 2002 over 2001. This growth is attributed to a variety of special promotions held during the year.
Total consumer installment loans grew $9.28 million in 2002. Within this category, the consumer indirect auto installment portfolio grew $3.16 million in 2002. This portfolio decreased $30.29 million in 2001. Direct auto installment loans grew $2.48 million in 2002 over 2001. Table 5 details the maturities of the loan and lease portfolio.
It is the policy of the Corporation to place a loan in non-accrual status whenever there is substantial doubt about the ability of a borrower to pay principal or interest on the outstanding credit. Management considers such factors as payment history, the nature of the collateral securing the loan, and the overall economic situation of the borrower when making a non-accrual decision. Management closely monitors non-accrual loans. A non-accruing loan is restored to accrual status when principal and interest payments have been brought current, it becomes well secured, or is in the process of collection and the prospects of future contractual payments are no longer in doubt. At December 31, 2002, the Corporation had $1.85 million of non-accrual loans. Table 6 details the historical activity of non-accrual loans.
Allowance for Probable Loan and Lease Losses
The reserve for probable loan and lease losses is based on management's continuing evaluation of the quality of the loan and lease portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of nonperforming loans and leases.
The Corporation utilizes the methodology outlined in FDIC Statement of Policy on Allowance for Loan and Lease Losses. The starting point for this methodology is to segregate the loan portfolio into two pools, non-homogeneous (i.e., commercial) and homogeneous (i.e., consumer) loans. Each loan pool is analyzed with general allowances and specific allocations being made as appropriate. For general allowances, the previous eight quarters of loss activity are used in the estimation of probable losses in the current portfolio. These historical loss amounts are modified by the following qualitative factors: levels of and trends in delinquency and non-accruals; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of management; national and local economic trends and conditions; and concentrations of credit in the determination of the general allowance. The qualitative factors are updated each quarter by the gathering of information from internal, regulatory, and governmental sources. Specific allocations are made for those loans on the Watchlist in which the collateral value is less than the outstanding loan balance with the allocation being the dollar difference between the two. Allocations are made for loan commitments using the methodology outlined above. The Watchlist represents loans, identified and closely monitored by management, which possess certain qualities or characteristics that may lead to collection and loss issues. Allocations are not made for loans that are cash secured or for the Small Business Administration guaranteed portion of loans.
During 2002, management continued to place emphasis on procedures for credit analysis, problem loan detection, and delinquency follow-ups. As a result of these efforts, the provision for probable loan and lease losses in 2002 decreased over 2001 to $1.51 million or 0.23% of the gross loan total of $665.83 million. The provision for probable loan and lease losses was $2.93 million and $2.20 million for the years ended December 31, 2001 and 2000, respectively. Gross charge-offs for the years ended December 31, 2002, 2001, and 2000 totaled $1.83, $2.63, and $1.83 million, respectively.
Table 7 presents the activity in the allowance for loan and lease losses by major loan category for the past five years. Table 8 presents management's allocation of the allowance for loan and lease losses by major loan category. Specific allocations in any particular category may be reallocated in the future to reflect current conditions. Accordingly, the entire allowance is considered available to absorb losses in any category.
Deposits and Other Funding
Deposit liabilities increased to $649.86 million at December 31, 2002 from $616.77 million at December 31, 2001. This is an increase of $33.09 million or 5.37%. The increase in deposit liabilities includes a net decrease of $4.5 million in brokered deposits. Growth in non-interest bearing deposits was $8.42 million or 13.09%. This growth was in both personal and business accounts. Interest bearing deposits increased $24.67 million or 4.47% in 2002 over 2002. This growth can be attributed to a new product, My Easy Access CD that was introduced in the spring of 2002. This account offers customers liquidity as well as a competitive interest rate on their deposits. Table 9 exhibits the average deposit balances for years ended December 31, 2002, 2001, and 2000, respectively. The maturities of time deposits are shown in Table 10.
Total borrowings from the Federal Home Loan Bank of Atlanta increased $94.16 million in 2002 over 2001 to a level of $191.26 million. This increase is reflective of the leverage strategies executed during the third quarter of 2002 that totaled $80.00 million. The funds were borrowed for the purpose of investing in securities under the Company's leverage program and policy. Note 8 to the consolidated financial statements provides more detail on the line of credit.
The Trust issued $23.00 million of aggregate liquidation amount of 9.375% Preferred Securities (the "Capital Securities"). The payment terms require the Trust to distribute 9.375% annually per $10 liquidation amount of Capital Securities, with equal payments on March 31, June 30, September 30, and December 31 of each year, beginning September 30, 1999. Under the FRB's current risk-based capital guidelines, the capital securities are includable in the Corporation's Tier I and Tier II capital. For financial statement purposes, these securities are classified as other borrowed funds. See Note 8 to the consolidated financial statements for additional detail.
Maturity of Time Deposits ( In thousands ) Table 10 December 31, 2002 Greater than Less Than $100,000 $100,000 -------- --------
Maturities 3 Months or Less........................... $ 23,118 $ 51,067 3 - 6 Months............................... 14,452 43,247 6-12 Months................................ 40,591 60,584 Over 1 Year................................ 22,459 55,064 - --------- -------- Total...................................... $ 100,620 $209,962 ========= ========
Maturities of time deposits greater than $100,000 are as follows: 2004--$12.75 million, 2005--$8.56 million, 2006--$1.09 million.
Capital Resources
The Bank and the Corporation are subject to risk-based capital regulations, which were adopted by federal banking regulators. These guidelines are used to evaluate capital adequacy and are based on an institution's asset risk profile and off-balance sheet exposures, such as unused loan commitments and stand-by letters of credit. The regulatory guidelines require that a portion of total capital be Tier I capital, consisting of common shareholders' equity, trust issued
preferred securities, and perpetual preferred stock, less goodwill and certain other deductions. The remaining capital, or Tier II capital, consists of elements such as subordinated debt, mandatory convertible debt, trust issued preferred securities, and grandfathered senior debt, plus the reserve for probable loan and lease losses, subject to certain limitations.
Under the risk-based capital regulations, banking organizations are required to maintain a minimum 8% (10% for well capitalized banks) total risk-based capital ratio (total qualifying capital divided by risk-weighted assets), including a Tier I ratio of 4%. The risk-based capital rules have been further supplemented by a leverage ratio, defined as Tier I capital divided by average assets, after certain adjustments. The minimum leverage ratio is 3% for banking organizations that do not anticipate significant growth and have well-diversified risk (including no undue interest rate risk exposure), excellent asset quality, high liquidity and good earnings. Other banking organizations not in this category are expected to have ratios of at least 4-5%, depending on their particular condition and growth plans. Higher capital ratios could be required if warranted by the particular circumstances or risk profile of a given banking organization. In the current regulatory environment, banking organizations must stay well capitalized in order to receive favorable regulatory treatment on acquisition and other expansion activities and favorable risk-based deposit insurance assessments. The Corporation's capital policy establishes guidelines meeting these regulatory requirements, and takes into account current or anticipated risks and future growth opportunities.
On December 31, 2002, the Corporation's total risk-based capital ratio was 14.31%, well above the regulatory minimum of 8%. The Corporation's total risk-based capital ratios for year-end 2001 and 2000 were 15.54% and 14.55%, respectively.
Total shareholders' equity increased $8.20 million to $79.28 million at December 31, 2002, from $71.08 million at year-end 2001. The equity to assets ratio at December 31, 2002, was 8.31%, compared with 8.69% at year-end 2001.
Cash dividends of $.68 per share were paid during 2002, compared with $.66 and $.64 paid in 2001 and 2000, respectively. This represents a dividend payout rate (dividends per share divided by net income per share) of 42.76%, 43.71%, and 46.72% for 2002, 2001, and 2000, respectively.
ASSET AND LIABILITY MANAGEMENT Introduction
The Asset and Liability Management Committee of the Corporation seeks to assess and manage the risks associated with fluctuating interest rates while maintaining adequate liquidity. This is accomplished by formulating and implementing policies that take into account the sources and uses of funds, maturity and repricing distributions of assets and liabilities, pricing strategies, and marketability of assets.
Liquidity
The objective of liquidity management is to assure that the withdrawal demands of depositors and the legitimate credit needs of the Corporation's delineated market areas are accommodated. Total liquid assets, represented by cash, federal funds sold, interest bearing deposits in banks, investment securities available for sale and loans and leases maturing within one year, amounted to $104.37 million, or 10.95% of total assets at December 31, 2002. This compares with $99.71 million or 12.19% of 2001 total assets, and $116.79 million or 13.78% of 2000 total assets.
Additional liquidity of $10.88 million is available from unused lines of credit at various upstream correspondent banks and the FHLB of Atlanta.
Interest Rate Sensitivity
The Corporation's primary market risk is interest rate fluctuation. Interest rate sensitivity refers to the degree that earnings will be impacted by changes in the prevailing level of interest rates. Interest rate risk arises from mismatches in the repricing or maturity characteristics between assets and liabilities. Management seeks to avoid fluctuating net interest margins, and to enhance consistent growth of net interest income through periods of changing interest rates. The Corporation uses interest sensitivity gap analysis and simulation models to measure and manage these risks. The interest rate sensitivity gap analysis assigns each interest-earning asset and interest-bearing liability to a time frame reflecting its next repricing or maturity date. The differences between total interest-sensitive assets and liabilities at each time interval represent the interest sensitivity gap for that interval. A positive gap generally indicates that rising interest rates during a given interval will increase net interest income, as more assets than liabilities will reprice. A negative gap position would benefit the Corporation during a period of declining interest rates.
In order to manage interest sensitivity risk, management of the Corporation formulates guidelines regarding asset generation and pricing, funding sources and pricing, and off-balance sheet commitments. These guidelines are based on management's outlook regarding future interest rate movements, the state of the regional and national economy, and other financial and business risk factors. Management uses computer simulations to measure the effect on net interest income of various interest rate scenarios. Key assumptions used in the computer simulations include cash flows and maturities of interest rate sensitive assets and liabilities, changes in asset volumes and pricing, and management's capital plans. This modeling reflects interest rate changes and the related impact on net income over specified periods. Management does not use derivative financial instruments to manage its interest rate sensitivity. At December 31, 2002, the static gap analysis prepared by management indicated that the Corporation was asset sensitive over the next year. In computing the effect on pre-tax income of changes in interest rates, management has assumed that any changes would immediately affect earnings. Normally, when an organization is asset sensitive there is a positive impact to income when interest rates increase. The simulation analysis shown below shows a positive impact when interest rates increase 100 or 200 basis points in 2002 and in 2001. Based on the simulation analysis performed at year-end, the Corporation estimates the following changes in income before taxes, assuming the indicated rate changes:
December 31, 2002 +200 basis point increase........................$ 2.300 million +100 basis point increase........................$1.150 million -100 basis point decrease........................($1.614 million) -200 basis point decrease........................($3.229 million) December 31, 2001 +200 basis point increase........................$.531 million +100 basis point increase........................$.266 million -100 basis point decrease........................($.697 million) -200 basis point decrease........................($1.394 million)
This estimate is based on assumptions that may be affected by unforeseeable changes in the general interest rate environment and any number of unforeseeable factors. Rates on different assets and liabilities within a single maturity category adjust to changes in interest rates to varying degrees and over varying periods of time. The relationships between prime rates and rates paid on purchased funds are not constant over time. Management can respond to current or anticipated market conditions by lengthening or shortening the Corporation's sensitivity through loan repricings or changing its funding mix. The rate of growth in interest-free sources of funds will influence the level of interest-sensitive funding sources. In addition, the absolute level of interest rates will affect the volume of earning assets and funding sources. As a result of these limitations, the interest-sensitive gap is only one factor to be considered in estimating the net interest-margin.
Table 12 presents the Corporation's interest rate gap position at December 31, 2002. This is a point in time position, which is continually changing and is not necessarily indicative of the Corporation's position at any other time.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For information regarding the Company's exposure to market risk see "Management's Discussion and Analysis of Financial Condition and Results of Operations--Interest Rate Sensitivity."
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
(a) The following audited consolidated financial statements and related documents are set forth in this Annual Report on Form 10-K on the following pages:
Page Number Independent Auditors' Report...........................................31 Consolidated Statements of Financial Condition.........................32 Consolidated Statements of Income......................................33 Consolidated Statements of Changes in Shareholders' Equity.............34 Consolidated Statements of Cash Flows..................................35 Notes to Consolidated Financial Statements..........................36-50
(b) The following supplementary data is set forth in this Annual Report on Form 10-K on the following pages:
Quarterly Results of Operations.......................................50
Report of Management
The accompanying consolidated financial statements were prepared by management, which is responsible for the integrity and objectivity of the information presented, including amounts that must necessarily be based on judgments and estimates. The consolidated financial statements were prepared in conformity with generally accepted accounting principles, and in situations where acceptable alternative accounting principles exist, management selected the method that was appropriate in the circumstances. Financial information appearing throughout this Annual Report to Stockholders is consistent with the consolidated financial statements.
Management depends upon the Corporation's systems of internal control in meeting its responsibilities for reliable consolidated financial statements. In management's opinion, these systems provide reasonable assurance that assets are safeguarded and transactions are properly recorded and executed in accordance with management's authorizations. Judgments are required to assess and balance the relative cost and expected benefits of these controls. As an integral part of the systems of internal control, the Corporation maintains a professional staff of internal auditors who conduct operational and special audits and coordinate audit coverage with the independent auditors.
The Corporation's independent auditors, Ernst & Young LLP, whose independent professional opinion appears separately, have audited the consolidated financial statements.
The Audit Committee of the Board of Directors, composed solely of independent directors, meets periodically with the internal auditors, the independent auditors, and management to review the work of each and evaluate whether each is properly discharging its responsibilities. The independent auditors have open and unimpaired access to the Audit Committee to discuss the results of their audit work, their evaluations of the adequacy of internal controls, and the quality of financial reporting.
William B. Grant Robert W. Kurtz Chairman and Chief Executive Officer President and Chief Financial Officer First United Corporation First United Corporation and and First United Bank & Trust First United Bank & Trust
Report of Independent Auditors
We have audited the accompanying consolidated statements of financial condition of First United Corporation and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of First United Corporation and subsidiaries at December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States.
Baltimore, Maryland February 14, 2003
First United Corporation and Subsidiaries Consolidated Statements of Financial Condition (In thousands, except per share amounts)
See notes to consolidated financial statements.
First United Corporation and Subsidiaries Consolidated Statements of Income (In thousands, except per share amounts)
First United Corporation and Subsidiaries Consolidated Statements of Changes in Shareholders' Equity (In thousands, except per share amounts)
See notes to consolidated financial statements.
First United Corporation and Subsidiaries Consolidated Statements of Cash Flows (In thousands)
See notes to consolidated financial statements.
First United Corporation and Subsidiaries Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Principles of Consolidation The accompanying financial statements of First United Corporation (Corporation) include the accounts of its wholly owned subsidiaries, First United Bank & Trust (Bank), Oakfirst Life Insurance Corporation, OakFirst Loan Center, Inc., OakFirst Loan Center, LLC, and First United Capital Trust. All significant intercompany accounts and transactions have been eliminated.
Business First United Corporation is a registered financial holding company, incorporated under the laws of Maryland. It is the parent company of First United Bank & Trust, OakFirst Life Insurance Corporation, OakFirst Loan Center, Inc., OakFirst Loan Center, LLC, and First United Capital Trust. First United Bank & Trust provides a complete range of retail and commercial banking services to a customer base serviced by a network of twenty offices and thirty automated teller machines. This customer base includes individuals, businesses and various governmental units. Oakfirst Life Insurance Corporation is a reinsurance company that reinsures credit life and credit accident and health insurance written by American General Assurance Company on consumer loans made by First United Bank & Trust. OakFirst Loan Center, Inc., and OakFirst Loan Center, LLC are finance companies. First United Capital Trust is a Delaware Business Trust.
Basis of Presentation The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles that require the Corporation to make estimates and assumptions that affect the reported amounts of certain assets and liabilities at the date of the financial statements as well as the reported amount of revenues and expenses during the reporting period. Actual results could differ from these estimates. For purposes of comparability, certain prior period amounts have been reclassified to conform with the 2002 presentation.
Investments Securities available-for-sale: All security purchases have been classified as available-for-sale. Available-for-sale securities are stated at fair market value, with the unrealized gains and losses, net of tax, reported as a separate component of other comprehensive income in shareholders' equity. The amortized cost of debt securities classified as available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization is included in interest income from investments. Interest and dividends are included in interest income from investments. Realized gains and losses, and declines in value judged to be other-than-temporary are included in net securities gains (losses). The cost of securities sold is based on the specific identification method.
Loans Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay off generally are reported at their outstanding loan balance.
Interest on Loans and Leases Interest on loans and leases is recognized based upon the principal amount outstanding. It is the Corporation's policy to generally discontinue the accrual of interest on loans (including impaired loans) when circumstances indicate that collection of principal or interest is doubtful. After a loan is placed on non-accrual, interest is not recognized. Cash payments received are applied to the principal balances.
Trust Assets and Income Assets held in an agency or fiduciary capacity are not assets of the Corporation and, accordingly, are not included in the accompanying consolidated statements of financial condition. Income from the Bank's Trust Department represents fees charged to customers and is recorded on an accrual basis.
Bank Premises and Equipment
Bank premises and equipment are carried at cost, less accumulated provision for depreciation. The provision for depreciation for financial reporting generally has been made by using the straight-line method based on the estimated useful lives of the assets, which range from 18 to 31.5 years for buildings and 3 to 20 years for equipment. The provision for depreciation for general tax purposes and for the Alternative Minimum Tax generally has been made using the double-declining balance method and the ACRS method based on the estimated useful lives of the assets which range from 18 to 31.5 years for buildings and 4 to 10 years for equipment.
Pursuant to the terms of noncancelable lease agreements in effect at December 31, 2002, pertaining to banking premises, future minimum rent commitments under various operating leases are as follows: 2003--$.33 million, 2004--$.33 million, 2005--$.33 million. The leases contain options to extend for periods from 1 to 5 years. The cost of such rentals is not included in the aforementioned amounts. Total rent expense for the years ended December 31, 2002, 2001, and 2000 amounted to $.33 million, $.32 million, and $.29 million, respectively.
Reserve for Probable Loan and Lease Losses
The reserve for probable loan and lease losses is maintained at a level believed adequate by management to absorb losses inherent in the portfolio. Management's determination of the adequacy of the loan loss reserve is based upon the impact of economic conditions on the borrower's ability to repay, past collection experience, the risk characteristics of the loan portfolio, estimated fair value of underlying collateral for collateral dependent loans, and such other factors which, in management's judgement, deserve current recognition. The Corporation utilizes the methodology outlined in FDIC Statement of Policy on Allowance for Loan and Lease Losses. The starting point for this methodology is to segregate the loan portfolio into two pools, non-homogeneous (i.e. commercial) and homogeneous (i.e. consumer) loans. Each loan pool is analyzed with general allowances and specific allocations being made as appropriate. For general allowances, the previous eight quarters of loss activity are used in the estimation of probable losses in the current portfolio. These historical loss amounts are modified by the following qualitative factors: levels of and trends in delinquency and non-accruals, trends in volumes and terms of loans, effects of changes in lending policies, experience, ability, and depth of management, national and local economic trends and conditions, and concentrations of credit in the determination of the general allowance. The qualitative factors are updated each quarter by the gathering of information from internal, regulatory, and governmental sources. Specific allocations are made for those loans on the Watchlist in which the collateral value is less than the outstanding loan balance with the allocation being the dollar difference between the two. The Watchlist represents loans, identified and closely monitored by management, which possess certain qualities or characteristics that may lead to collection and loss issues. Allocations are not made for loans that are cash secured or for the SBA guaranteed portion of loans.
Income Taxes
The Corporation accounts for income taxes using the liability method. Under the liability method, the deferred tax liability or asset is determined based on the difference between the financial statement and tax bases of assets and liabilities (temporary differences) and is measured at the enacted tax rates that will be in effect when these differences reverse. Deferred tax expense is determined by the change in the liability or asset for deferred taxes adjusted for changes in any deferred tax asset allowance. In 2001, the Corporation established First United Investment Trust, a Maryland real estate investment trust, and its parent company, First United Capital Investments, a Delaware Corporation, as subsidiaries of First United Bank & Trust. The establishment of these entities eliminated most of the income taxes due to the state of Maryland and income taxes due to the state of West Virginia.
Statement of Cash Flows
The Corporation has defined cash and cash equivalents as those amounts included in the balance sheet captions "Cash and due from banks" and "Federal funds sold." The Corporation paid $26.38, $34.08, and $34.57 million in interest on deposits and other borrowed funds for the years ending December 31, 2002, 2001, and 2000, respectively.
Earnings Per Share
Earnings per share ("basic") was computed based on the weighted average number of common shares outstanding of 6,081 million for 2002, 2001, and 2000, respectively. The Corporation does not have any common stock equivalents.
Comprehensive Income
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("Statement No. 130") establishes standards for the reporting and disclosure of comprehensive income and its components in the financial
statements. Accumulated other comprehensive income represents the unrealized gains and losses on the Corporation's available-for-sale investment securities, net of income taxes. For the years ended December 31, 2002, 2001 and 2000 total comprehensive income, net income plus the change in unrealized gains on investment securities, net of income taxes, amounted to $12.37, $9.61, and $11.39 million, respectively.
Business Segments
As defined by Statement of Financial Accounting Standards No. 131, "Disclosure about Segments of an Enterprise and Related Information," the Corporation has two operating segments, community banking and insurance. Since the operating activities of the insurance segment are immaterial to the consolidated financial statements, no separate segment disclosures for insurance operations have been made.
New Accounting Pronouncements
In June 2001, Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("Statement No. 142"), was issued. In accordance with Statement No. 142, goodwill and intangible assets determined to have indefinite lives will no longer be amortized, but instead be subject to an annual impairment test. Other intangible assets will continue to be amortized over their estimated useful lives. Statement No. 142 became effective for fiscal years beginning after December 15, 2001. Through a transitional evaluation completed by an independent third party prior to September 30, 2002, the Corporation determined that none of the goodwill carried on its books as of January 1, 2002 was subject to impairment. This evaluation is completed on an annual basis, and in a subsequent evaluation dated December 31, 2002, the Corporation determined none of the $0.79 million goodwill carried on its books as of December 31, 2002 was subject to impairment.
In October 2002, Statement of Financial Accounting Standards No. 147, "Acquisitions of Certain Financial Institutions, an amendment of SFAS No. 72 and SFAS No. 144 and FASB Interpretation No. 9", was issued. This statement addresses the financial accounting and reporting for the acquisition of all or part of a financial institution that does not qualify as a business combination. The acquisition of all or part of a financial institution that meets the definition of a business combination shall be accounted for by the purchase method in accordance with SFAS No. 141, "Business Combinations." As discussed in Note 17, on February 13, 2003, the Corporation entered into a Purchase and Assumption Agreement to purchase four branches of Huntington National Bank. The Corporation is currently assessing the impact this statement will have on its accounting for these branch acquisitions.
2. Regulatory Capital Requirements
The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets (leverage). Management believes, as of December 31, 2002, that the Corporation and the Bank meet all capital adequacy requirements to which it is subject.
As of December 31, 2002, the Corporation and the Bank were well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, total risk-based, Tier I risk-based, and Tier I leverage ratios must not fall below the percentage shown in the following table. Management is not aware of any condition or event which has caused the well capitalized position to change.
3. Investment Securities
The following is a comparison of amortized cost and market values of available-for-sale securities and held-to-maturity securities:
3. Investment Securities (continued)
During the years ended December 31, 2002, 2001 and 2000, available-for-sale securities with a fair market value at the date of sale of $1.16, $29.67, and $34.99 million, respectively, were sold. The gross realized gains on such sales totaled $.0, $.51, and $.27 million, respectively. The gross realized losses on the sales were $.01, $.01, and $.39 million, respectively. Additionally, available-for-sale securities totaling $17.35 million were called in 2002.
At December 31, 2002, the Corporation recognized a $.36 million realized loss on investment securities related to an other-than-temporary impairment write-down of its investment in Federal Home Loan Mortgage Corporation preferred stock. The loss was recognized because the fair value of the investments had been below cost for several months, a key determinant of when a security is considered other-than-temporarily impaired under generally accepted accounting principles.
The amortized cost and estimated fair value of debt and marketable equity securities at December 31, 2002, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without prepayment penalties. Equity securities consist of various money market accounts and FHLMC Preferred Stock. These securities have no maturity and therefore are classified in the "Due after ten years" maturity line.
(in thousands) Available-for-Sale Securities
Amortized Market Cost Value
Due in one year or less................... $ 1,385 $ 1,402 Due after one year through five years..... 16,923 17,777 Due after five years through ten years.... 17,417 17,932 Due after ten years....................... 174,280 178,125 --------- --------- $210,005 $ 215,236 ========= =========
At December 31, 2002, investment securities with a market value of $119.43 million were pledged to secure public and trust deposits as required or permitted by law.
4. Reserve for Probable Loan and Lease Losses
Activity in the reserve for probable loan and lease losses is summarized as follows:
Non-accruing loans were $1.85, $3.20, and $1.07 million at December 31, 2002, 2001 and 2000, respectively. Interest income not recognized as a result of non-accruing loans was $.03, $.05, and $.01 million during the years ended December 31, 2002, 2001, and 2000, respectively.
5. Loans and Leases and Concentrations of Credit Risk
The Corporation through its banking subsidiary is active in originating loans and leases to customers primarily in Garrett, Allegany, Washington and Frederick counties in Maryland; and Mineral, Hardy, Berkeley, and Hampshire Counties in West Virginia, and the surrounding regions of West Virginia and Pennsylvania. The following table presents the Corporation's composition of credit risk by significant concentration.
December 31, 2002 -----------------
Loans Loan (in thousands) & Leases Commitments Total - -------------- -------- ----------- -----
Commercial....................... $242,470 $34,741 $277,211 Residential--construction........ 11,072 7,413 18,485 Residential--mortgage............ 233,886 23,871 257,757 Installment...................... 173,579 1,856 175,435 Lease financing.................. 4,819 -- 4,819 Letters of credit................ -- 1,873 1,873 -------- -------- -------- $665,826 $69,754 $735,580 ======== ======== ========
December 31, 2001 -----------------
Loans Loan (in thousands) & Leases Commitments Total - -------------- -------- ----------- -----
Commercial........................ $189,343 $20,172 $209,515 Real estate--construction......... 8,578 5,413 13,991 Real estate--mortgage............. 238,016 21,504 259,520 Installment....................... 164,297 3,825 168,122 Lease financing................... 9,319 -- 9,319 Letters of credit................. -- 2,274 2,274 -------- ------- -------- $609,553 $53,188 $662,741 ======== ======= ========
Loan commitments are made to accommodate the financial needs of the Corporation's customers. Letters of credit commit the Corporation to make payments on behalf of customers when certain specified future events occur. Letters of credit are issued to customers to support contractual obligations and to insure job performance. Historically, most letters of credit expire unfunded. Loan commitments and letters of credit have credit risk essentially the same as that involved in extending loans to customers and are subject to normal credit policies. Collateral is obtained based on
management's credit assessment of the customer.
Commercial loans are collateralized by real estate and equipment, and the loan-to-value ratios generally do not exceed 75 percent. Real estate mortgage loans are collateralized by the related property, and the loan-to-value ratios generally do not exceed 89 percent. Any consumer real estate mortgage loan exceeding a loan-to-value ratio of 89 percent requires private mortgage insurance. Installment loans are typically collateralized with loan-to-value ratios which are established based on the financial condition of the borrower and generally range from 80 percent to 90 percent of the amount of the loan. The Corporation will also make unsecured consumer loans to qualified borrowers meeting the underwriting standards of the Corporation.
6. Bank Premises and Equipment
The composition of Bank premises and equipment is as follows:
(in thousands) 2002 2001 - ------------------------------------------------------------------------------
Bank premises............................................ $12,131 $11,045 Equipment................................................ 20,359 18,112 ------- ------- 32,490 29,157 Less accumulated depreciation............................ (19,327) (17,630) ------- ------- Total.................................................... $13,163 $11,527 ======= =======
The Corporation recorded depreciation expense of $1.77, $1.60, and $1.55 million in 2002, 2001 and 2000, respectively.
7. Fair Value of Financial Instruments
As required by Statement of Financial Accounting Standards ("SFAS") No. 107, "Disclosures about Fair Value of Financial Instruments," the Corporation has presented fair value information about financial instruments, whether or not recognized in the statement of financial condition, for which it is practicable to estimate that value. 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 flow or other valuation techniques. As a result, the Corporation's ability to actually realize these derived values cannot be assumed.
The fair values disclosed under SFAS No. 107 may vary significantly between institutions based on the estimates and assumptions used in the various valuation methodologies. SFAS No. 107 excludes disclosure of non financial assets such as buildings as well as certain financial instruments such as leases. Accordingly, the aggregate fair values presented do not represent the underlying value of the Corporation.
The actual carrying amounts and estimated fair values of the Corporation's financial instruments that are included in the statement of financial condition at December 31 are as follows:
The following methods and assumptions were used by the Corporation in estimating 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 those assets' fair values. Federal Funds Sold: The carrying amount of federal funds sold approximate their fair values. Interest-Bearing Deposits in Banks: The carrying amount of interest-bearing deposits maturing within ninety days approximate their fair values. Investment Securities: Fair values of investment securities are based on quoted market values. Federal Home Loan Bank Stock: The carrying value of Federal Home Loan stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank. Loans and Leases: For variable rate loans and leases that reprice 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 and leases and loans and leases that do not reprice frequently are estimated using a discounted cash flow calculation that applies current 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) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts for variable rate certificates of deposit approximate their fair values at the reporting date. 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. Federal Home Loan Bank Borrowings and Other Borrowed Funds: The fair value of the Corporation's Federal Home Loan Bank borrowings is calculated based on the discounted value of contractural cash flows, using rates currently existing for borrowings from the Federal Home Loan Bank with similar remaining maturities. The fair value of the Corporation's other long-term debt, the trust issued guaranteed preferred beneficial interests in the Corporation's junior subordinated deferrable interest debentures, is based upon its quoted market price. The carrying amounts of federal funds purchased approximate their fair values. Off-Balance-Sheet Financial Instruments: In the normal course of business, the Corporation makes commitments to extend credit and issues standby letters of credit. As a result of excessive costs, the Corporation considers estimation of fair values for commitments and standby letters of credit to be impracticable. The Corporation does not have any derivative financial instruments at December 31, 2002 or 2001.
8. Federal Home Loan Bank (FHLB) Advances and Other Borrowings Borrowings consist of the following:
The Corporation, through its banking subsidiary, First United Bank & Trust, has a borrowing capacity agreement with the FHLB of Atlanta in an amount equal to 29% of the Bank's assets. At December 31, 2002, the line of credit equaled $274.52 million. This line of credit can only be utilized to the extent of available collateral. It is secured with a blanket lien on the 1-4 family mortgage portfolio, a blanket lien on the commercial real estate loan portfolio, and certain investment securities. The collateralized line of credit totaled $224.88 million at December 31, 2002.
First United Capital Trust (the "Trust"), a Delaware Business trust organized by the Corporation on July 19, 1999, issued $23.00 million of aggregate liquidation amount of 9.375% Preferred Securities (the "Capital Securities"). The payment terms require the Trust to distribute 9.375% annually per $10 liquidation amount of Capital Securities in equal payments on March 31, June 30, September 30 and December 31 of each year, beginning September 30, 1999. Under the Federal Reserve's current risk-based capital guidelines, the capital securities are includable in the Corporation's Tier I and Tier II capital ratios. For financial reporting purposes, the Trust is treated as a wholly owned
subsidiary of the Corporation. The Capital Securities represent preferred undivided interests in the assets of the Trust, and are classified in the Corporation's consolidated balance sheet as other long term debt, with distributions on the securities included in interest expense.
The proceeds from the issuance of the Capital Securities were used by the Trust to purchase $23.00 million aggregate principal amount of junior subordinated debentures (Junior Subordinated Debentures) issued by the Corporation to the Trust. The Junior Subordinated Debentures represent the sole asset of the Trust, and payments under the Junior Subordinated Debentures are the sole source of cash flow for the Trust.
Holders of the Capital Securities receive preferential cumulative cash distributions quarterly on each distribution date at the distribution rate stated above unless the Corporation exercises its right to extend the payment of interest on the Junior Subordinated Debentures for up to 20 quarterly periods, in which case payment of distributions on the Capital Securities will be deferred for a comparable period. During an extended interest period, the Corporation may not pay dividends or distributions on, or repurchase, redeem or acquire any shares of its capital stock. The agreements governing the Capital Securities, in the aggregate, provide a full, irrevocable and unconditional guarantee by the Corporation of the payment of distributions on, the redemption of, and any liquidation distribution with respect to the Capital Securities. The obligations of the Corporation under this guarantee and the Capital Securities are subordinate and junior in right of payment to all senior indebtedness of the Corporation
The Capital Securities are mandatorily redeemable in whole, but not in part, upon repayment at the stated maturity dates of the Junior Subordinated Debentures or the earlier redemption of the Junior Subordinated Debentures in whole upon the occurrence of one or more tax, investment company, or capital treatment events (Events) set forth in the indentures relating to the Capital Securities, and in whole or in part at any time after September 30, 2004, the stated optional redemption date, contemporaneously with the Corporation's optional redemption of the related Junior Subordinated Debentures in whole or in part. The Junior Subordinated Debentures are redeemable prior to their stated maturity date at the Corporation's option (i) on or after the stated optional redemption dates, in whole at any time or in part from time to time, or (ii) in whole, but not in part, at any time within 90 days following the occurrence and during the continuation of one or more of the Events, in each case subject to possible regulatory approval.
The Corporation's banking subsidiary First United Bank & Trust has established various unsecured lines of credit totaling $5.0 million at various upstream correspondent banks. The Bank has also established $7.00 million reverse repurchase lines of credit with correspondent banks. As of December 31, 2002, the Corporation had $5 million in borrowings with these correspondent banks. The Corporation utilizes the lines to meet daily liquidity requirements and does not rely on lines of credit as a source of long term liquidity.
Maturities of FHLB advances are as follows: 2003, $7.04 million; 2004, $18.54 million; 2005, $22.04 million; 2006, $7.04 million; 2007, $4.55 million.
9. Income Taxes
A reconciliation of the statutory income tax at the applicable rates to the income tax expense included in the statement of income is as follows:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Corporation's deferred tax assets and liabilities as of December 31 are as follows:
During 2002, the Corporation increased its valuation allowance for certain state loss carry forwards generated during the year. The state loss carry forwards will expire commencing in 2019.
The Corporation made income tax payments of $3.30 million, $.04 million, and $4.51 million for the years ending December 31, 2002, 2001, and 2000, respectively.
10. Employee Benefit Plans
The Corporation sponsors a noncontributory defined benefit pension plan covering substantially all full-time employees who qualify as to age and length of service. The benefits are based on years of service and the employees' compensation during the last five years of employment. The Corporation's funding policy is to make annual contributions in amounts sufficient to meet the current year's funding requirements.
The following table summarizes benefit obligation and plan asset activity for the Corporation's pension plan:
401(k) Profit Sharing Plan
The First United Bank & Trust 401(k) Profit Sharing Plan ("the 401(k) Plan") is a defined contribution plan that is intended to qualify under section 401(k) of the Internal Revenue Code. The 401(k) Plan covers substantially all employees of the Corporation. Eligible employees can elect to contribute to the plan through payroll deductions. Contributions up to 6% of an employee's base salary are matched on a 50% basis by the Corporation. Expense charged to operations for the 401(k) Plan was $.20, $.30, and $.16 million in 2002, 2001 and 2000, respectively.
Supplemental Executive Retirement Plan
During 2001, the Corporation established an unfunded supplemental executive retirement plan (SERP) to provide
senior management personnel with supplemental retirement benefits in excess of limits imposed on qualified plans by federal tax law. Concurrent with the establishment of the SERP, the Corporation acquired bank owned life insurance (BOLI) policies on the senior management personnel and officers of the Corporation. The benefits resulting from the favorable tax treatment accorded the earnings on the BOLI are intended to provide a source of funds for the payment of the SERP benefits and other employee benefit costs. The cash surrender value of the BOLI is $19.56 million and is reported in other assets in the statement of financial condition. The SERP expense for 2002 was approximately $.21 million, and the SERP liability outstanding at December 31, 2002 was approximately $0.23 million.
11. Federal Reserve Requirements
The Bank is required to maintain cash reserves with the Federal Reserve Bank of Richmond based principally on the type and amount of its deposits. During 2002, the daily average amount of these required reserves was approximately $8.20 million.
12. Restrictions on Subsidiary Dividends, Loans or Advances
Federal and state banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Corporation. The total amount of dividends, which may be paid at any date, is generally limited to the retained earnings of the Bank, and loans or advances are limited to 10 percent of the Bank's capital stock and surplus on a secured basis. In addition, dividends paid by the Bank to the Corporation would be prohibited if the effect thereof would cause the Bank's capital to be reduced below applicable minimum capital requirements. Although no transfers were made, $10.42 million in funds were available for transfer from the Bank to the Corporation in the form of loans as of December 31, 2002.
13. Parent Company Financial Information (Parent Company Only)
Condensed Statements of Financial Condition December 31, 2002 2001 ---- ----
Assets Cash..................................................... $ 1,155 $ 1,157 Investment securities.................................... 1,520 1,451 Investment in bank subsidiary............................ 91,274 84,390 Dividend receivable and other assets..................... 2,427 1,749 Investment in non-bank subsidiary........................ 6,997 6,405 -------- ------- Total Assets............................................. 103,373 $95,152 ======== ======= Liabilities and Shareholder's Equity Reserve for taxes, interest, and other liabilities....... $ 28 $ 44 Dividends payable........................................ 1,062 1,032 Other long term debt..................................... 23,000 23,000 Shareholders' equity..................................... 79,283 71,076 -------- ------- Total Liabilities and Shareholder's Equity............... $103,373 $95,152 ======== =======
14. Commitments and Contingent Liabilities
The Corporation and its subsidiaries are at times, and in the ordinary course of business, subject to legal actions. Management, upon the advice of counsel, is of the opinion that losses, if any, resulting from the settlement of current legal actions will not have a material adverse effect on the financial condition of the Corporation.
Oakfirst Life Insurance Corporation, a wholly owned subsidiary of the Corporation, had $7.69 million of life, accident and health insurance in force at December 31, 2002. In accordance with state insurance laws, this subsidiary is capitalized at $4.13 million.
15. Related Party Transactions
In the ordinary course of business, executive officers and directors of the Corporation, including their families and companies in which certain directors are principal owners, were loan customers of the Corporation and its subsidiaries. Pursuant to the Corporation's policy, such loans were made on the same terms, including collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than the normal risk of collectability. Changes in the dollar amount of loans outstanding to officers, directors and their associates were as follows for the years ended December 31:
16. Quarterly Results of Operations (Unaudited)
The following is a summary of the quarterly results of operations for the years ended December 31, 2002 and 2001.
17. Subsequent Event
On February 13, 2003, First United Corporation and its bank subsidiary, First United Bank & Trust, a Maryland trust company, entered into a Purchase and Assumption Agreement with Huntington Bancshares Incorporated and its bank
subsidiary, Huntington National Bank, a national banking association, to purchase four Huntington National Bank offices located in Berkeley County, West Virginia. The acquisition will involve the assumption of approximately $140 million in deposit liabilities and the purchase of $54 million in outstanding loans, as well as the acquisition of certain real estate interests associated with the banking offices. The acquisition is subject to, among other things, the receipt of various bank regulatory approvals.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information with respect to Directors of the Registrant is incorporated by reference from the Registrant's definitive Proxy Statement for the annual shareholders meeting to be held April 29, 2003, from pages 2 through 6. For a listing of the Corporation's executive officers, see Item 1A of Part I of this Annual Report on Form 10-K.
Item 11.
Item 11. EXECUTIVE COMPENSATION
Information required by Item 11 is incorporated by reference from pages 4 and 5 of the definitive Proxy Statement of the Corporation for the annual meeting of shareholders to be held on April 29, 2003.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
Information required by Item 12 is incorporated by reference from pages 2 and 3 of the definitive Proxy Statement of the Corporation for the annual meeting of shareholders to be held on April 29, 2002.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by Item 13 is incorporated by reference from page 5 of the definitive Proxy Statement of the Corporation for the annual meeting of shareholders to be held on April 29, 2002, and from Note 15 on page 45 of this Annual Report on Form 10-K.
Item 14.
Item 14. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Within the 90 days prior to the date of this report, the Corporation carried out an evaluation ("Evaluation"), under the supervision and with the participation of the Corporation's management, including the Corporation's Chief Executive Officer ("CEO") and its President/Chief Financial Officer ("CFO"), of the effectiveness of the design and operation of the Company's disclosure controls and procedures ("Disclosure Controls") and its internal controls and procedures for financial reporting ("Internal Controls").
Disclosure Controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 ("Exchange Act"), such as this Annual Report, is recorded, processed, summarized and reported within the time periods specified in the rules and forms issued by the SEC. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Internal Controls are procedures that are designed with the objective of providing reasonable assurance that (i) our transactions are properly authorized; (ii) our assets are safeguarded against unauthorized or improper use; and (iii) our transactions are properly recorded and reported, all to permit the preparation of our financial statements in conformity with generally accepted accounting principles.
CEO and CFO Certifications
Appearing immediately following the Signatures section of this Annual Report there are "Certifications" of the CEO and the CFO. The Certifications are required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002. The section of the Annual Report that you are currently reading is the information concerning the Evaluation, and this information should be read in conjunction with the Certifications for a more complete understanding of the topics presented.
Limitations on the effectiveness of controls
The Corporation's management, including the CEO and CFO, does not expect that our Disclosure Controls or our Internal Controls will prevent all error and all fraud. 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. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Corporation have been detected. 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. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Conclusions
Based upon the Evaluation, the Corporation's CEO and the CFO have concluded that the Corporation's Disclosure Controls are effective in timely alerting them to material information relating to the Corporation (including its consolidated subsidiaries) required to be included in the Corporation's periodic SEC filings, and that our Internal Controls are effective to provide reasonable assurance that our financial statements are fairly presented in conformity with generally accepted accounting principles.
(b) Changes in Internal Controls. There were no significant changes in the Corporation's Internal Controls or in other factors that could significantly affect those Internal Controls, including any corrective actions with regard to significant deficiencies and material weaknesses.
PART IV
Item 15.
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) Financial Statements. The consolidated financial statements of the Corporation are listed on pages 25-43 of the Annual Report on Form 10-K. (a)(2) Financial Statement Schedules No Financial Statement Schedules are required to be filed. (a)(3) Listing of Exhibits. Exhibit 3.1--Amended and Restated (incorporated by reference to Exhibit 3.1 of the Corporation's Quarterly Report on Form 10-Q filed with the SEC on June 3, 1998) Exhibit 3.2--Amended and Restated By-Laws (incorporated by reference to Exhibit 3.ii of the Corporation's Annual Report on Form 10-K filed with the SEC on June 3, 1998) Exhibit 21.1--Subsidiaries of the Corporation, incorporated by reference on pages 3 of this Form 10-K.
Exhibit 23.1--Consent of Ernst & Young, LLP Exhibit 27.1--Financial Data Schedule, filed electronically herewith (b) Reports on Form 8-K No Current Reports on Form 8-K were filed by the Corporation during the last quarter covered by this report.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
By: /s/ William B. Grant ------------------------ William B. Grant Chairman of the Board and Chief Executive Officer March 19, 2003 --------------
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated.
/s/ William B. Grant (William B. Grant) Director, Chief Executive Officer - March 19, 2003 - ---------------------------------------------------------------------
/s/ David J. Beachy (David J. Beachy) Director- March 19, 2003 - ---------------------------------------------------------------------
/s/ Donald M. Browning (Donald M. Browning) Director - March 19, 2003 - ---------------------------------------------------------------------
/s/ Rex W. Burton (Rex W. Burton) Director - March 19, 2003 - ---------------------------------------------------------------------
/s/ Paul Cox, Jr. (Paul Cox, Jr.) Director - March 19, 2003 - ---------------------------------------------------------------------
/s/ Frederick A. Thayer, III (Frederick A. Thayer, III) Director - March 19, 2003 - ---------------------------------------------------------------------
/s/ Robert W. Kurtz (Robert W. Kurtz) Director, President and Chief Financial Officer - March 19, 2003 - ---------------------------------------------------------------------
/s/ Maynard G. Grossnickle (Maynard G. Grossnickle) Director - March 19, 2003 - ---------------------------------------------------------------------
/s/ Raymond F. Hinkle (Raymond F. Hinkle) Director - March 19, 2003 - ---------------------------------------------------------------------
/s/ Donald E. Moran (Donald E. Moran) Director - March 19, 2003 - ---------------------------------------------------------------------
/s/ Richard G. Stanton (Richard G. Stanton) Director - March 19, 2003 - ---------------------------------------------------------------------
/s/ I. Robert Rudy (I. Robert Rudy) Director - March 19, 2003 - ---------------------------------------------------------------------
/s/ Robert G. Stuck (Robert G. Stuck) Director - March 19, 2003 - ---------------------------------------------------------------------
/s/ James F. Scarpelli, Sr. (James F. Scarpelli, Sr.) Director - March 19, 2003 - ---------------------------------------------------------------------
/s/ Karen F. Myers (Karen F. Myers) Director - March 19, 2003 - ---------------------------------------------------------------------
/s/ Elaine L. McDonald (Elaine L. McDonald) Director - March 19, 2003 - ---------------------------------------------------------------------
CERTIFICATIONS
I, William B. Grant, certify that:
1. I have reviewed this Annual Report on Form 10-K (this "Report") of First United Corporation (the "Corporation");
2. Based on my knowledge, this Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Report;
3. Based on my knowledge, the financial statements, and other financial information included in this Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Corporation as of, and for, the periods presented in this Report;
4. The Corporation's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Corporation and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the Corporation, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) evaluated the effectiveness of the Corporation's disclosure controls and procedures as of the date within 90 days prior to the filing date of this report (the "Evaluation Date"); and
c) presented in this Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The Corporation's other certifying officers and I have disclosed, based on our most recent evaluation, to the Corporation's auditors and the audit committee of the Corporation's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls that could adversely affect the Corporation's ability to record, process, summarize and report financial data and have identified for the Corporation's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Corporation's internal controls; and
6. The Corporation's other certifying officers and I have indicated in this Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weakness.
Date: March 19, 2003
/s/ William B. Grant -------------------- By: William B. Grant Title: Chairman of the Board/CEO
I, Robert W. Kurtz, certify that:
1. I have reviewed this Annual Report on Form 10-K (this "Report") of First United Corporation (the "Corporation");
2. Based on my knowledge, this Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Report;
3. Based on my knowledge, the financial statements, and other financial information included in this Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Corporation as of, and for, the periods presented in this Report;
4. The Corporation's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Corporation and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the Corporation, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b) evaluated the effectiveness of the Corporation's disclosure controls and procedures as of the date within 90 days prior to the filing date of this report (the "Evaluation Date"); and
c) presented in this Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The Corporation's other certifying officers and I have disclosed, based on our most recent evaluation, to the Corporation's auditors and the audit committee of the Corporation's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls that could adversely affect the Corporation's ability to record, process, summarize and report financial data and have identified for the Corporation's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Corporation's internal controls; and
6. The Corporation's other certifying officers and I have indicated in this Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weakness.
Date: March 19, 2003 /s/ Robert W. Kurtz ------------------- By: Robert W. Kurtz Title: President and CFO
Exhibit Index
Exhibit 3.1 Amended and Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 of the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1998)
Exhibit 3.2 Amended and Restated By-Laws (incorporated by reference to Exhibit 3(ii) of the Company's Annual Report on Form 10-K for the year ended December 31, 1997)
Exhibit 21.1 Subsidiaries of the Corporation, incorporated by reference on pages 3 of this Form 10-K.
Exhibit 23.1 Consent of Ernst & Young, LLP
Exhibit 27.1 Financial Data Schedule, filed electronically herewith