FIRST UNITED CORP/MD/ - Quarter Report: 2020 September (Form 10-Q)

func-20200930x10q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

R QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For quarterly period ended September 30, 2020

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

For the transition period from _______________ to ________________

Commission file number 0-14237

First United Corporation

(Exact name of registrant as specified in its charter)

Maryland		52-1380770
(State or other jurisdiction of ‎incorporation or organization)		(I. R. S. Employer Identification No.)

19 South Second Street, Oakland, Maryland		21550-0009
(Address of principal executive offices)		(Zip Code)

(800) 470-4356

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class	Trading Symbols	Name of each exchange on which registered
Common Stock	FUNC	Nasdaq Stock Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes R No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):


Large Accelerated filer £	Accelerated Filer R
Non Accelerated filer £	Smaller Reporting Company R
Emerging Growth Company £

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standard provided pursuant to Section 13(a) of the Exchange Act. £

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 6,988,998 shares of common stock, par value $.01 per share, as of October 31, 2020.

INDEX TO QUARTERLY REPORT

FIRST UNITED CORPORATION

		Page
PART I. FINANCIAL INFORMATION		3
Item 1.	Financial Statements (unaudited)	3
	Consolidated Statement of Financial Condition – September 30, 2020 and December 31, 2019	3
	Consolidated Statement of Operations – for the nine and three months ended September 30, 2020 and 2019	4
	Consolidated Statement of Comprehensive Income – for the nine and three months ended September 30, 2020 and 2019	6
	Consolidated Statement of Changes in Shareholders’ Equity – for three months ended March 31, June 30, September 30, 2020 and 2019	7
	Consolidated Statement of Cash Flows – for the nine months ended September 30, 2020 and 2019	9
	Notes to Consolidated Financial Statements	10
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	40
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	65
Item 4.	Controls and Procedures	65

PART II. OTHER INFORMATION		66
Item 1.	Legal Proceedings	66
Item 1A.	Risk Factors	66
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	67
Item 3.	Defaults upon Senior Securities	67
Item 4.	Mine Safety Disclosures	67
Item 5.	Other Information	67
Item 6.	Exhibits	67
SIGNATURES		68

‎

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

FIRST UNITED CORPORATION

Consolidated Statement of Financial Condition

(In thousands, except per share data)



	September 30, ‎2020		December 31, ‎2019
	(Unaudited)
Assets
Cash and due from banks	$	152,460	$	48,512
Interest bearing deposits in banks		3,146		1,467
Cash and cash equivalents		155,606		49,979
Investment securities – available for sale (at fair value)		153,161		131,305
Investment securities – held to maturity (fair value $76,370 at September 30, 2020 and $100,656 at December 31, 2019)		69,221		93,979
Restricted investment in bank stock, at cost		4,468		4,415
Loans held for sale (at fair value)		5,211		1,749
Loans		1,192,345		1,050,369
Unearned fees		(2,900)		(687)
Allowance for loan losses		(16,189)		(12,537)
Net loans		1,173,256		1,037,145
Premises and equipment, net		37,418		38,710
Goodwill		11,004		11,004
Bank owned life insurance		43,682		43,449
Deferred tax assets		7,404		7,441
Other real estate owned, net		3,787		4,127
Operating lease asset		2,445		2,661
Accrued interest receivable and other assets		19,244		16,063
Total Assets	$	1,685,907	$	1,442,027
Liabilities and Shareholders’ Equity
Liabilities:
Non-interest bearing deposits	$	419,935	$	294,649
Interest bearing deposits		957,349		847,382
Total deposits		1,377,284		1,142,031
Short-term borrowings		52,589		48,728
Long-term borrowings		100,929		100,929
Operating lease liability		3,011		3,239
Accrued interest payable and other liabilities		20,947		20,235
Dividends payable		910		925
Total Liabilities		1,555,670		1,316,087
Shareholders’ Equity:
Common Stock – par value $0.01 per share; ‎ Authorized 25,000,000 shares; issued and outstanding ‎6,988,998 shares at September 30, 2020 and 7,110,022 at December 31, 2019		70		71
Surplus		29,975		32,359
Retained earnings		126,043		119,481
Accumulated other comprehensive loss		(25,851)		(25,971)
Total Shareholders’ Equity		130,237		125,940
Total Liabilities and Shareholders’ Equity	$	1,685,907	$	1,442,027

See accompanying notes to the consolidated financial statements

‎

FIRST UNITED CORPORATION

Consolidated Statement of Operations

(In thousands, except per share data)



	Nine Months Ended
	September 30,
	2020		2019
	(Unaudited)
Interest income
Interest and fees on loans	$	39,192	$	37,215
Interest on investment securities
Taxable		3,612		4,333
Exempt from federal income tax		809		771
Total investment income		4,421		5,104
Other		360		764
Total interest income		43,973		43,083
Interest expense
Interest on deposits		4,997		5,800
Interest on short-term borrowings		68		158
Interest on long-term borrowings		2,463		2,656
Total interest expense		7,528		8,614
Net interest income		36,445		34,469
Provision for loan losses		4,981		669
Net interest income after provision for loan losses		31,464		33,800
Other operating income
Net gains		2,011		185
Service charges on deposit accounts		1,439		1,652
Other service charges		517		607
Trust department		5,355		5,345
Debit card income		2,052		1,955
Bank owned life insurance		961		1,970
Brokerage commissions		713		646
Other		374		369
Total other income		11,411		12,544
Total other operating income		13,422		12,729
Other operating expenses
Salaries and employee benefits		16,244		18,644
FDIC premiums		404		337
Equipment		2,871		2,775
Occupancy		2,200		2,112
Data processing		3,155		2,979
Marketing		405		274
Professional services		2,506		776
Contract labor		480		502
Line rentals		654		641
Other real estate owned		3		1,266
Investor relations		1,160		146
Other		2,890		3,225
Total other operating expenses		32,972		33,677
Income before income tax expense		11,914		12,852
Provision for income tax expense		2,629		2,605
Net Income	$	9,285	$	10,247
Basic net income per share	$	1.32	$	1.44
Diluted net income per share	$	1.32	$	1.44
Weighted average number of basic shares outstanding		7,008		7,098
Weighted average number of diluted shares outstanding		7,019		7,098
Dividends declared per common share	$	0.39	$	0.31

See accompanying notes to the consolidated financial statements
‎

FIRST UNITED CORPORATION

Consolidated Statement of Operations

(In thousands, except per share data)



	Three Months Ended
	September 30,
	2020		2019
	(Unaudited)
Interest income
Interest and fees on loans	$	12,940	$	12,529
Interest on investment securities
Taxable		960		1,416
Exempt from federal income tax		276		249
Total investment income		1,236		1,665
Other		77		406
Total interest income		14,253		14,600
Interest expense
Interest on deposits		1,515		2,064
Interest on short-term borrowings		19		27
Interest on long-term borrowings		817		913
Total interest expense		2,351		3,004
Net interest income		11,902		11,596
Provision for loan losses		160		(13)
Net interest income after provision for loan losses		11,742		11,609
Other operating income
Net gains		1,176		89
Service charges on deposit accounts		447		578
Other service charges		195		225
Trust department		1,871		1,798
Debit card income		738		679
Bank owned life insurance		373		1,379
Brokerage commissions		234		205
Other		120		115
Total other income		3,978		4,979
Total other operating income		5,154		5,068
Other operating expenses
Salaries and employee benefits		5,378		6,280
FDIC premiums		201		43
Equipment		978		956
Occupancy		707		694
Data processing		1,130		984
Marketing		122		110
Professional services		602		254
Contract labor		180		171
Line rentals		216		226
Other real estate owned		6		337
Investor relations		54		36
Other		966		1,155
Total other operating expenses		10,540		11,246
Income before income tax expense		6,356		5,431
Provision for income tax expense		1,396		938
Net Income	$	4,960	$	4,493
Basic net income per common share	$	0.70	$	0.63
Diluted net income per common share	$	0.70	$	0.63
Weighted average number of basic shares outstanding		6,988		7,107
Weighted average number of diluted shares outstanding		6,993		7,107
Dividends declared per common share	$	0.13	$	0.13

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

Consolidated Statement of Comprehensive Income



	Nine Months Ended
	September 30,
	2020		2019
Comprehensive Income (in thousands)	(Unaudited)
Net Income	$	9,285	$	10,247
Other comprehensive income, net of tax and reclassification adjustments:
Net unrealized losses on investments with OTTI		(1,025)		(1,131)
Net unrealized gains on all other AFS securities		1,336		2,884
Net unrealized gains on HTM securities		548		178
Net unrealized losses on cash flow hedges		(972)		(1,040)
Net unrealized gains on pension		131		2,957
Net unrealized gains on SERP		102		62
Other comprehensive income, net of tax		120		3,910
Comprehensive income	$	9,405	$	14,157



	Three Months Ended
	September 30,
	2020		2019
Comprehensive Income (in thousands)	(Unaudited)
Net Income	$	4,960	$	4,493
Other comprehensive income/(loss), net of tax and reclassification adjustments:
Net unrealized gains/(losses) on investments with OTTI		481		(857)
Net unrealized (losses)/gains on all other AFS securities		(656)		402
Net unrealized gains on HTM securities		54		60
Net unrealized gains/(losses) on cash flow hedges		72		(239)
Net unrealized gains on pension		1,647		121
Net unrealized gains on SERP		34		20
Other comprehensive income/(loss), net of tax		1,632		(493)
Comprehensive income	$	6,592	$	4,000

See accompanying notes to the consolidated financial statements

‎

FIRST UNITED CORPORATION

Consolidated Statement of Changes in Shareholders’ Equity

(In thousands, except per share data)



	Common ‎Stock		Surplus		Retained ‎Earnings		Accumulated ‎Other ‎Comprehensive ‎Loss		Total ‎Shareholders' ‎Equity
Balance at January 1, 2020	$	71	$	32,359	$	119,481	$	(25,971)	$	125,940
Net income						1,755				1,755
Other comprehensive loss								(5,632)		(5,632)
Stock based compensation				98						98
Common stock issued - 2,167 shares				52						52
Stock repurchase - 145,219 shares		(1)		(2,753)						(2,754)
Common stock dividend declared - ‎$0.13 per share						(910)				(910)
Balance at March 31, 2020	$	70	$	29,756	$	120,326	$	(31,603)	$	118,549

Net income						2,570				2,570
Other comprehensive income								4,120		4,120
Stock based compensation				71						71
Common stock issued - 3,465 shares				47						47
Common stock dividend declared - ‎$0.13 per share						(904)				(904)
Balance at June 30, 2020	$	70	$	29,874	$	121,992	$	(27,483)	$	124,453

Net income						4,960				4,960
Other comprehensive income								1,632		1,632
Stock based compensation				52						52
Common stock issued - 4,245 shares				49						49
Common stock dividend declared - ‎$0.13 per share						(909)				(909)
Balance at September 30, 2020	$	70	$	29,975	$	126,043	$	(25,851)	$	130,237

See accompanying notes to the consolidated financial statements

‎

FIRST UNITED CORPORATION

Consolidated Statement of Changes in Shareholders’ Equity

(In thousands, except per share data)



	Common ‎Stock		Surplus		Retained ‎Earnings		Accumulated ‎Other ‎Comprehensive ‎Loss		Total ‎Shareholders' ‎Equity
Balance at January 1, 2019	$	71	$	31,921	$	109,477	$	(24,403)	$	117,066
Net income						3,151				3,151
Other comprehensive income								2,715		2,715
Stock based compensation				67						67
Common stock issued - 2,355 shares				39						39
Common stock dividend declared - ‎$0.09 per share						(639)				(639)
Balance at March 31, 2019	$	71	$	32,027	$	111,989	$	(21,688)	$	122,399

Net income						2,602				2,602
Other comprehensive income								1,688		1,688
Stock based compensation				67						67
Common stock issued - 2,147 shares				39						39
Common stock dividend declared - ‎$0.09 per share						(640)				(640)
Balance at June 30, 2019	$	71	$	32,133	$	113,951	$	(20,000)	$	126,155

Net income						4,493				4,493
Other comprehensive loss								(493)		(493)
Stock based compensation				66						66
Common stock issued - 1,891 shares				38						38
Common stock dividend declared - ‎$0.13 per share						(920)				(920)
Balance at September 30, 2019	$	71	$	32,237	$	117,524	$	(20,493)	$	129,339

See accompanying notes to the consolidated financial statements

‎

FIRST UNITED CORPORATION

Consolidated Statement of Cash Flows

(In thousands)



	Nine Months Ended
	September 30,
	2020		2019
	(Unaudited)
Operating activities
Net income	$	9,285	$	10,247
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		4,981		669
Depreciation		2,463		2,318
Stock compensation		221		200
Gains on sales of other real estate owned		(93)		(62)
Write-downs of other real estate owned		102		1,140
Originations of loans held for sale		(54,039)		(11,006)
Proceeds from sale of loans held for sale		52,057		11,073
Gains from sale of loans held for sale		(1,480)		(87)
Losses on disposal of fixed assets		151		4
Net amortization/(accretion) of investment securities discounts and premiums- AFS		212		(5)
Net amortization of investment securities discounts and premiums- HTM		225		53
Gains on sales/calls of investment securities – AFS		(622)		(1)
Gain on calls of investment securities – HTM		(60)		—
Bank owned life insurance		(961)		(1,970)
Amortization of deferred loan fees		(1,908)		(611)
Amortization of operating lease asset		216		206
Increase in accrued interest receivable and other assets		(2,624)		(6,652)
Deferred tax expense		—		1,481
Operating lease liability		(228)		(213)
Decrease in accrued interest payable and other liabilities		(96)		(691)
Net cash provided by operating activities		7,802		6,093
Investing activities
Proceeds from maturities/calls of investment securities - AFS		40,572		7,677
Proceeds from maturities/calls of investment securities - HTM		43,226		5,560
Proceeds from sales of investment securities - AFS		30,831		12,046
Purchases of investment securities - AFS		(92,440)		(14,744)
Purchases of investment securities - HTM		(18,633)		(8,207)
Proceeds from sales of other real estate owned		514		1,415
Proceeds from BOLI death benefit		728		2,125
Net (increase)/decrease in restricted stock		(53)		979
Net (increase)/decrease in loans		(139,367)		10,700
Purchases of premises and equipment		(1,322)		(2,830)
Net cash (used in)/provided by investing activities		(135,944)		14,721
Financing activities
Net increase in deposits		235,253		69,260
Issuance of common stock		148		116
Cash dividends on common stock		(2,739)		(2,199)
Net increase/(decrease) in short-term borrowings		3,861		(27,362)
Stock repurchase		(2,754)		—
Net cash provided by financing activities		233,769		39,815
Increase in cash and cash equivalents		105,627		60,629
Cash and cash equivalents at beginning of the year		49,979		23,541
Cash and cash equivalents at end of period	$	155,606	$	84,170
Supplemental information
Interest paid	$	7,610	$	8,550
Taxes paid	$	625	$	891
Non-cash investing activities:
Transfers from loans to other real estate owned	$	183	$	616
Recognition of operating lease right-of-use assets	$	—	$	2,730
Recognition of operating lease liabilities	$	—	$	3,317

See accompanying notes to the consolidated financial statements

FIRST UNITED CORPORATION

NoteS to Consolidated Financial Statements (UNAUDITED)

Note 1 – Basis of Presentation

The accompanying unaudited consolidated financial statements of First United Corporation and its consolidated subsidiaries, including First United Bank & Trust (the “Bank”), have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information, as required by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 270, Interim Reporting, and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all the information and footnotes required for annual financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation, consisting of normal recurring items, have been included. Certain prior period balances have been reclassified to conform to the current period presentation. Operating results for the nine and three month periods ended September 30, 2020 are not necessarily indicative of the results that may be expected for the full year or for any future interim period. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019.

As used in these notes, the terms “the Corporation” “we”, “us”, and “our” refer to First United Corporation and, unless the context clearly requires otherwise, its consolidated subsidiaries.

The Corporation has evaluated events and transactions occurring subsequent to the statement of financial condition date of September 30, 2020 for items that should potentially be recognized or disclosed in these financial statements.

Note 2 – Significant Event

On March 11, 2020, the World Health Organization declared a pandemic as a result of the global spread of the coronavirus, commonly referred to as COVID-19. The spread of the disease quickly accelerated in the United States and to date, all 50 states have reported cases. The U.S. and state governments reacted to the pandemic by issuing shelter at home orders and requiring that non-essential businesses be closed to prevent spread of the virus. The health crisis quickly turned into a financial crisis resulting in guidance and mandates regarding foreclosures and repossessions and accounting and regulatory changes designed to encourage banks to work with customers suffering detrimental financial impact.

As a result of the pandemic effecting the states and local markets in which it operates, the Corporation successfully implemented its Business Continuity Plan with the goal of protecting the health, safety and financial well-being of its associates and customers. As part of its plan to protect the financial well-being of its customers, the Corporation chose to participate and educate its customers on the government sponsored plans established to provide financial assistance to businesses.

The U.S. Government’s Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) established the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) which provides small businesses with resources to maintain payroll, hire back employees who may have been laid off, and to cover applicable overhead expenses. We continued to provide access to the PPP and process applications until the window closed on August 8, 2020. These loans are 100% guaranteed by the SBA, have up to a two year or five year maturity, provide for a nine month deferral period, and have an interest rate of 1%. These loans may be forgiven, in whole or in part, by the SBA if the borrower meets certain conditions, including by using at least 60% of the loan proceeds for payroll costs. The SBA also established processing fees from 1% to 5%, depending on the loan amount. We anticipate receiving approximately $3.5 million in deferred loan fees.

In April 2020, the Bank established eligibility to participate in the Paycheck Protection Program Liquidity Facility (“PPPLF”) which was established by Congress and administered by the Federal Reserve Bank. This facility uses the SBA guaranteed PPP loans as collateral, offering 100% collateral coverage with no recourse to the Bank. The majority of the PPP loan disbursements have been to internal, non-interest-bearing accounts awaiting use by borrowers. During the second quarter of 2020, we did not access this facility. We will continue to monitor our liquidity position and determine appropriate timing to utilize these funds.

During the second quarter of 2020, the Bank was approved to participate in the Main Street Lending Program established by the Federal Reserve. This program supports lending to small and medium-sized businesses and non-profit organizations that were in sound financial condition before the onset of the COVID-19 pandemic.

The CARES Act, enacted on March 27, 2020, provides that, from the period beginning March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States under the National Emergencies Act terminates, the Company may elect to suspend GAAP for loan modifications related to the pandemic that would otherwise be categorized as troubled debt restructurings and suspend any

determination of a loan modified as a result of the effects of the pandemic as being a troubled debt restructuring, including impairment for accounting purposes.

In response to the COVID-19 pandemic, the Company developed a set of guidelines to provide relief to qualified commercial, mortgage and consumer loans customers. These guidelines, as permitted by Section 4013 of the CARES Act, provide for deferment of certain loan payments of up to 180 days to provide relief to qualified commercial, mortgage and consumer loan customers. Initial deferrals of 90 days were granted to qualified customers with the option to request a second deferral for an additional 90 days.

Loans in active modification status declined significantly during the third quarter as businesses started to open back up and begin to return to a more normal operating environment. We continue to have communication with our borrowers as there is still some uncertainty as to how long the pandemic will last.

In accordance with Section 4013 of the CARES Act, we have not accounted for such loans as TDRs, nor have we designated them as past due or nonaccrual. The following table includes data on our consumer, residential mortgage and commercial loan portfolios, including a breakdown by industry, and the percentage of the portfolio that has been modified through October 30, 2020 as a result of COVID-19. For comparative purposes, modifications reported through July 31, 2020 are included.



	Total Loans at 9/30/20 (*)				Active COVID Modifications at 10/30/20				Active COVID Modifications through 7/31/20
Industry Category	# of Loans (**)		Balance (000s)	Balance as % of Total Portfolio	# of Loans		Balance (000s)	Balance as % of Total Portfolio	# of Loans		Balance (000s)	Balance as % of Category
RE/Rental/Leasing - Non-Owner Occupied	90	$	124,370	11.9%	—	$	—	0.0%	25	$	53,664	44.4%
RE/Rental/Leasing - All Other	320		100,358	9.6%	2		141	0.1%	43		23,562	25.2%
Construction - Developers	20		57,977	5.6%	—		—	0.0%	1		2,975	5.2%
Accommodations	33		47,857	4.6%	6		13,519	28.2%	12		33,246	70.0%
Services	207		45,926	4.4%	—		—	0.0%	26		15,539	34.9%
Health Care/Social Assistance	60		34,048	3.3%	—		—	0.0%	16		8,564	25.9%
RE/Rental/Leasing - Multifamily	107		32,204	3.1%	—		—	0.0%	24		11,447	36.9%
RE/Rental/Leasing - Developers	39		25,840	2.5%	—		—	0.0%	3		6,773	23.3%
Manufacturing	50		25,519	2.4%	—		—	0.0%	7		10,710	41.6%
Construction - All Other	268		24,199	2.3%	5		396	1.6%	19		3,142	12.2%
Prof/Scientific/Technical	108		19,820	1.9%	—		—	0.0%	25		7,521	34.1%
Trade	109		16,890	1.6%	—		—	0.0%	5		1,405	9.1%
Transportation/Warehousing	226		15,979	1.5%	—		—	0.0%	5		235	1.6%
Food Service	32		11,110	1.1%	—		—	0.0%	—		—	0.0%
Public Administration	46		10,536	1.0%	—		—	1.9%	11		3,003	31.6%
Entertainment/Recreation	24		8,341	0.8%	1		284	3.4%	6		2,626	36.3%
Agriculture	52		4,595	0.4%	—		—	0.0%	2		508	11.0%
Energy	12		1,645	0.2%	—		—	0.0%	—		—	0.0%
Total Commercial	1,803	$	607,214	58.2%	14	$	14,340	2.4%	230	$	184,920	31.1%
Total Residential Mortgage	2,157		334,185	32.0%	16		4,508	1.2%	93		26,089	7.6%
Total Consumer	6,508		102,091	9.8%	12		403	0.5%	60		3,444	3.3%
Total Loans at September 30, 2020	10,468	$	1,043,490	100.0%	42	$	19,251	1.8%	383	$	214,453	20.6%

(*) Excluding 1,174 PPP loans totaling $148.9 million, 1.6% including PPP loans
(**) Including active loans/lines with no outstanding balance

Note 3 – Earnings Per Common Share

Basic earnings per common share is derived by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period and does not include the effect of any potentially dilutive common stock equivalents. Diluted earnings per share is derived by dividing net income available to common shareholders by the weighted-average number of shares outstanding, adjusted for the dilutive effect of outstanding common stock equivalents, such as restricted stock units (“RSUs”). At September 30, 2020, there were RSUs relating to 5,070 shares of common stock outstanding.

The following tables set forth the calculation of basic and diluted earnings per common share for the nine and three month periods ended September 30, 2020 and 2019:



	Nine months ended September 30,
	2020					2019
			Average	Per Share				Average	Per Share
(in thousands, except for per share amount)	Income		Shares	Amount		Income		Shares	Amount
Basic Earnings Per Share:

Net income	$	9,285	7,008	$	1.32	$	10,247	7,098	$	1.44

Diluted Earnings Per Share:

Net income	$	9,285	7,019	$	1.32	$	10,247	7,098	$	1.44



	Three months ended September 30,
	2020					2019
			Average	Per Share				Average	Per Share
(in thousands, except for per share amount)	Income		Shares	Amount		Income		Shares	Amount
Basic Earnings Per Share:

Net income	$	4,960	6,988	$	0.70	$	4,493	7,107	$	0.63

Diluted Earnings Per Share:

Net income	$	4,960	6,993	$	0.70	$	4,493	7,107	$	0.63

Note 4 – Net Gains

The following table summarizes the gain/(loss) activity for the nine and three month periods ended September 30, 2020 and 2019:



	Nine Months Ended				Three Months Ended
	September 30,				September 30,
(in thousands)	2020		2019		2020		2019
Net gains/(losses):
Available-for-sale securities:
Realized gains	$	622	$	74	$	575	$	1
Realized losses		—		(73)		—		—
Held-to-maturity securities:
Realized gains		60		—		—		—
Gains on sale of residential mortgage loans		1,480		87		734		42
Losses on disposal of fixed assets		(151)		(4)		(133)		(3)
Net gains	$	2,011	$	84	$	1,176	$	40

Note 5 – Investments

The following table shows a comparison of amortized cost and fair values of investment securities at September 30, 2020 and December 31, 2019:



(in thousands)	Amortized ‎Cost		Gross ‎Unrealized ‎Gains		Gross ‎Unrealized ‎Losses		Fair ‎Value		OTTI ‎in AOCL
September 30, 2020
Available for Sale:
U.S. government agencies	$	65,942	$	959	$	30	$	66,871	$	—
Residential mortgage-backed agencies		13,037		219		93		13,163		—
Commercial mortgage-backed agencies		33,566		608		14		34,160		—
Collateralized mortgage obligations		15,226		392		—		15,618		—
Obligations of states and political subdivisions		10,159		430		—		10,589		—
Collateralized debt obligations		18,525		—		5,765		12,760		(4,235)
Total available for sale	$	156,455	$	2,608	$	5,902	$	153,161	$	(4,235)
Held to Maturity:
Residential mortgage-backed agencies	$	34,868	$	1,157	$	—	$	36,025	$	—
Commercial mortgage-backed agencies		11,773		615		—		12,388		—
Collateralized mortgage obligations		1,821		98		—		1,919		—
Obligations of states and political subdivisions		20,759		5,279		—		26,038		—
Total held to maturity	$	69,221	$	7,149	$	—	$	76,370	$	—
December 31, 2019
Available for Sale:
U.S. government agencies	$	39,987	$	—	$	93	$	39,894	$	—
Residential mortgage-backed agencies		4,917		—		17		4,900		—
Commercial mortgage-backed agencies		27,634		222		92		27,764		—
Collateralized mortgage obligations		29,903		129		109		29,923		—
Obligations of states and political subdivisions		14,124		346		—		14,470		—
Collateralized debt obligations		18,443		—		4,089		14,354		(2,835)
Total available for sale	$	135,008	$	697	$	4,400	$	131,305	$	(2,835)
Held to Maturity:
U.S. government agencies	$	16,164	$	659	$	—	$	16,823	$	—
Residential mortgage-backed agencies		42,939		469		155		43,253		—
Commercial mortgage-backed agencies		15,521		344		—		15,865		—
Collateralized mortgage obligations		3,140		3		—		3,143		—
Obligations of states and political subdivisions		16,215		5,357		—		21,572		—
Total held to maturity	$	93,979	$	6,832	$	155	$	100,656	$	—

‎

Proceeds from sales of available for sale securities and the realized gains and losses were as follows:



	Nine Months Ended				Three Months Ended
	September 30,				September 30,
(in thousands)	2020		2019		2020		2019
Proceeds	$	30,831	$	12,046	$	29,751	$	6,669
Realized gains		622		74		575		1
Realized losses		—		73		—		—

The following table shows the Corporation’s investment securities with gross unrealized losses and fair values at September 30, 2020 and December 31, 2019, aggregated by investment category and the length of time that individual securities have been in a continuous unrealized loss position:


	Less than 12 months					12 months or more
(in thousands)	Fair ‎Value		Unrealized ‎Losses		Number of ‎Investments	Fair ‎Value		Unrealized ‎Losses		Number of ‎Investments
September 30, 2020
Available for Sale:
U.S. government agencies	$	16,420	$	30	4	$	—	$	—	—
Residential mortgage-backed agencies		8,512		93	3		—		—
Commercial mortgage-backed agencies		16,109		14	1		—		—	—
Collateralized debt obligations		—		—	—		12,760		5,765	9
Total available for sale	$	41,041	$	137	8	$	12,760	$	5,765	9
December 31, 2019
Available for Sale:
U.S. government agencies	$	24,907	$	80	3	$	14,987	$	13	3
Residential mortgage-backed agencies		4,900		17	1		—		—	—
Commercial mortgage-backed agencies		4,623		37	2		5,793		55	3
Collateralized mortgage obligations		—		—	—		35,472		109	1
Collateralized debt obligations		—		—	—		14,354		4,089	9
Total available for sale	$	34,430	$	134	6	$	70,606	$	4,266	16
Held to Maturity:
Residential mortgage-backed agencies	$	2,722	$	6	3	$	9,486	$	149	12
Total held to maturity	$	2,722	$	6	3	$	9,486	$	149	12

Management systematically evaluates securities for impairment on a quarterly basis. Based upon application of accounting guidance for subsequent measurement in ASC Topic 320 (ASC Section 320-10-35), management assesses whether (a) the Corporation has the intent to sell a security being evaluated and (b) it is more likely than not that the Corporation will be required to sell the security prior to the anticipated recovery of any decline in fair value. If neither applies, then any decline in the fair value below the security’s cost that is considered an other-than-temporary decline is split into two components. The first component is the loss attributable to declining credit quality. Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made. The second component consists of all other losses, which are recognized in other comprehensive loss. In estimating other than temporary impairment (“OTTI”) losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) adverse conditions specifically related to the security, an industry, or a geographic area, (3) the historic and implied volatility of the fair value of the security, (4) changes in the rating of the security by a rating agency, (5) recoveries or additional declines in fair value subsequent to the balance sheet date, (6) failure of the issuer of the security to make scheduled interest or principal payments, and (7) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future. Management also monitors cash flow projections for securities that are considered beneficial interests under the guidance of ASC Subtopic 325-40, Investments – Other – Beneficial Interests in Securitized Financial Assets, (ASC Section 325-40-35).

Management believes that the valuation of certain securities is a critical accounting policy that requires significant estimates in preparation of the Corporation’s consolidated financial statements. Management utilizes an independent third party to prepare both the impairment valuations and fair value determinations for the Corporation’s collateralized debt obligation (“CDO”) portfolio consisting of pooled trust preferred securities. See Note 8 for a discussion of the methodology used by management to determine the fair values of these securities. Based upon a review of credit quality and the cash flow tests performed by the independent third party, management determined that there were no securities that had credit-related non-cash OTTI charges during the first nine months of 2020 or 2019.

The Corporation does not believe that the investment securities that were in an unrealized loss position at September 30, 2020 represent other-than-temporary impairment. The Corporation does not intend to sell, nor is it anticipated that the Corporation would be required to sell, any of its impaired investment securities at a loss.

The following tables present a cumulative roll-forward of the amount of non-cash OTTI charges related to credit losses which have been recognized in earnings for the trust preferred securities in the CDO portfolio held and not intended to be sold for the nine and three month periods ended September 30, 2020 and 2019:



	Nine Months Ended
	September 30,
(in thousands)	2020		2019
Balance of credit-related OTTI at January 1	$	2,446	$	2,646
Reduction for increases in cash flows expected to be collected		(151)		(149)
Balance of credit-related OTTI at September 30	$	2,295	$	2,497




	Three Months Ended
	September 30,
(in thousands)	2020		2019
Balance of credit-related OTTI at July 1	$	2,345	$	2,547
Reduction for increases in cash flows expected to be collected		(50)		(50)
Balance of credit-related OTTI at September 30	$	2,295	$	2,497

The amortized cost and estimated fair value of securities by contractual maturity at September 30, 2020 are shown in the following table. Actual maturities may differ from contractual maturities because the issuers of the securities may have the right to call or prepay obligations with or without call or prepayment penalties.



	September 30, 2020
(in thousands)	Amortized ‎Cost		Fair ‎Value
Contractual Maturity
Available for Sale:
Due after one year through five years	$	4,434	$	4,555
Due after five years through ten years		24,821		25,745
Due after ten years		65,371		59,920
		94,626		90,220
Residential mortgage-backed agencies		13,037		13,163
Commercial mortgage-backed agencies		33,566		34,160
Collateralized mortgage obligations		15,226		15,618
Total available for sale	$	156,455	$	153,161
Held to Maturity:
Due after ten years	$	20,759	$	26,038
Residential mortgage-backed agencies		34,868		36,025
Commercial mortgage-backed agencies		11,773		12,388
Collateralized mortgage obligations		1,821		1,919
Total held to maturity	$	69,221	$	76,370

Note 6 – Loans and Related Allowance for Loan Losses

The following table summarizes the primary segments of the loan portfolio at September 30, 2020 and December 31, 2019:



(in thousands)	Commercial ‎Real Estate		Acquisition ‎and ‎Development		Commercial ‎and ‎Industrial		Residential ‎Mortgage		Consumer		Total
September 30, 2020
Individually evaluated for impairment	$	3,380	$	7,932	$	—	$	3,170	$	31	$	14,513
Collectively evaluated for impairment	$	349,892	$	119,367	$	277,723	$	395,539	$	35,311	$	1,177,832
Total loans	$	353,272	$	127,299	$	277,723	$	398,709	$	35,342	$	1,192,345
December 31, 2019
Individually evaluated for impairment	$	3,179	$	8,570	$	30	$	3,391	$	4	$	15,174
Collectively evaluated for impairment	$	332,325	$	109,320	$	122,322	$	435,033	$	36,195	$	1,035,195
Total loans	$	335,504	$	117,890	$	122,352	$	438,424	$	36,199	$	1,050,369

The increase in the commercial and industrial portfolio in the table above includes $148.9 million of PPP loans which are 100% guaranteed by the SBA and no allowance for loan loss (“ALL”) has been assigned to them.

The following table presents the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention and Substandard within the internal risk rating system at September 30, 2020 and December 31, 2019:



(in thousands)	Pass		Special ‎Mention		Substandard		Total
September 30, 2020
Commercial real estate
Non owner-occupied	$	165,472	$	9,204	$	1,772	$	176,448
All other CRE		166,899		3,358		6,567		176,824
Acquisition and development
1-4 family residential construction		21,684		—		—		21,684
All other A&D		98,057		17		7,541		105,615
Commercial and industrial		260,294		5,005		12,424		277,723
Residential mortgage
Residential mortgage - term		328,232		287		6,157		334,676
Residential mortgage - home equity		63,100		—		933		64,033
Consumer		35,226		3		113		35,342
Total	$	1,138,964	$	17,874	$	35,507	$	1,192,345
December 31, 2019
Commercial real estate
Non owner-occupied	$	164,584	$	2,765	$	1,864	$	169,213
All other CRE		157,407		6,556		2,328		166,291
Acquisition and development
1-4 family residential construction		10,781		—		—		10,781
All other A&D		98,823		18		8,268		107,109
Commercial and industrial		116,221		2,896		3,235		122,352
Residential mortgage
Residential mortgage - term		364,150		59		5,597		369,806
Residential mortgage - home equity		67,143		139		1,336		68,618
Consumer		36,047		4		148		36,199
Total	$	1,015,156	$	12,437	$	22,776	$	1,050,369

The increase of $12.7 million in the substandard category from December 31, 2019 to September 30, 2020 was primarily due to two large relationships in the “All other CRE” and “Commercial and Industrial” categories. These loans are current and well collateralized and are not considered impaired. They were classified as substandard due to a reduction in cash flows and a slight deterioration in the borrower’s balance sheet. The increase in the special mention category is due to the addition of three hotel loans totaling $6.5 million in the non-owner occupied category as business continues to be a reduced capacity thereby reducing cash flows. The increase in the commercial and industrial category is related to one medical profession loan.

‎

The following table presents the classes of the loan portfolio summarized by the aging categories of performing loans and non-accrual loans at September 30, 2020 and December 31, 2019:



(in thousands)	Current		30-59 Days ‎Past Due		60-89 Days ‎Past Due		90 Days+ ‎Past Due		Total Past ‎Due and ‎Accruing		Non- ‎Accrual		Total Loans
September 30, 2020
Commercial real estate
Non owner-occupied	$	176,439	$	—	$	—	$	—	$	—	$	9	$	176,448
All other CRE		175,906		—		—		—		—		918		176,824
Acquisition and development
1-4 family residential construction		21,684		—		—		—		—		—		21,684
All other A&D		98,157		—		—		11		11		7,447		105,615
Commercial and industrial		271,012		6,711		—		—		6,711		—		277,723
Residential mortgage
Residential mortgage - term		331,474		65		951		726		1,742		1,460		334,676
Residential mortgage - home equity		63,435		43		—		76		119		479		64,033
Consumer		35,218		58		35		—		93		31		35,342
Total	$	1,173,325	$	6,877	$	986	$	813	$	8,676	$	10,344	$	1,192,345
December 31, 2019
Commercial real estate
Non owner-occupied	$	169,180	$	—	$	—	$	—	$	—	$	33	$	169,213
All other CRE		165,289		—		355		—		355		647		166,291
Acquisition and development
1-4 family residential construction		10,781		—		—		—		—		—		10,781
All other A&D		98,916		—		—		135		135		8,058		107,109
Commercial and industrial		122,050		272		—		—		272		30		122,352
Residential mortgage
Residential mortgage - term		366,882		267		967		471		1,705		1,219		369,806
Residential mortgage - home equity		67,121		288		286		65		639		858		68,618
Consumer		35,834		261		46		54		361		4		36,199
Total	$	1,036,053	$	1,088	$	1,654	$	725	$	3,467	$	10,849	$	1,050,369

The current status of commercial and industrial loans at September 30, 2020 includes $148.9 million of PPP loans.

Non-accrual loans totaled $10.3 million at September 30, 2020, compared to $10.8 million at December 31, 2019. The decrease in non-accrual balances at September 30, 2020 was primarily due to the charge-off of $1.1 million of a specific allocation attributable to the $8.3 million A&D participation loan that was added to non-accrual loans in the first quarter of 2019. The property collateralizing the loan was acquired at foreclosure in November 2020 and was added to OREO at a carrying value of $7.2 million. During the third quarter of 2020, a purchase agreement for a parcel of acreage within the development was signed with a large warehouse franchise with an anticipated closing date in December 2020. This loan is serviced by another lender. A new appraisal is in process; however, based on the sales contract price, management re-evaluated the reserve and determined that $1.1 million of the $2.4 million specific allocation be charged off and the remaining $1.3 million reversed. Due to the continued uncertainty in the market surrounding the pandemic and increases in allowance qualitative factors, the $1.3 million was re-allocated to the collectively determined portion of the allowance. We anticipate a reduction to the OREO balance of approximately $2.0 million once the sale of the parcel is consummated (anticipated in December 2020).

Non-accrual loans that have been subject to partial charge-offs totaled $7.3 million at September 30, 2020 and $0.2 million December 31, 2019. Loans secured by 1-4 family residential real estate properties in the process of foreclosure were $0.3 million and $0.1 million at September 30, 2020 and December 31, 2019, respectively. All foreclosure and repossession activity has been temporarily suspended as a result of COVID-19. The foreclosure process on the A&D participation loan, as noted above, was imminent prior to the onset of the pandemic. As a percentage of the loan portfolio, accruing loans past due 30 days or more increased to 0.73%, including PPP loans, or 0.83% excluding PPP loans compared to 0.67% at September 30, 2019. This increase is related to one credit totaling $6.7 million which was due to a delay in the preparation of a forbearance agreement.

The following table summarizes the primary segments of the ALL at September 30, 2020 and December 31, 2019, segregated by the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment:



(in thousands)	Commercial ‎Real Estate		Acquisition ‎and ‎Development		Commercial ‎and ‎Industrial		Residential ‎Mortgage		Consumer		Unallocated		Total
September 30, 2020
Individually evaluated ‎for impairment	$	5	$	42	$	—	$	25	$	—	$	—	$	72
Collectively evaluated ‎for impairment	$	5,289	$	2,381	$	2,184	$	5,382	$	381	$	500	$	16,117
Total ALL	$	5,294	$	2,423	$	2,184	$	5,407	$	381	$	500	$	16,189
December 31, 2019
Individually evaluated ‎for impairment	$	9	$	2,142	$	—	$	22	$	—	$	—	$	2,173
Collectively evaluated ‎for impairment	$	2,873	$	1,532	$	1,341	$	3,806	$	312	$	500	$	10,364
Total ALL	$	2,882	$	3,674	$	1,341	$	3,828	$	312	$	500	$	12,537

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

‎

The following table presents impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not required at September 30, 2020 and December 31, 2019:


	Impaired Loans with ‎Specific Allowance				Impaired ‎Loans with ‎No Specific ‎Allowance		Total Impaired Loans
(in thousands)	Recorded ‎Investment		Related ‎Allowances		Recorded ‎Investment		Recorded ‎Investment		Unpaid ‎Principal ‎Balance
September 30, 2020
Commercial real estate
Non owner-occupied	$	113	$	5	$	9	$	122	$	8,127
All other CRE		—		—		3,258		3,258		3,258
Acquisition and development
1-4 family residential construction		—		—		272		272		272
All other A&D		392		42		7,268		7,660		8,812
Commercial and industrial		—		—		—		—		2,214
Residential mortgage
Residential mortgage – term		744		25		1,947		2,691		2,862
Residential mortgage – home equity		—		—		479		479		493
Consumer		31		—		—		31		56
Total impaired loans	$	1,280	$	72	$	13,233	$	14,513	$	26,094
December 31, 2019
Commercial real estate
Non owner-occupied	$	116	$	9	$	33	$	149	$	8,224
All other CRE		—		—		3,030		3,030		3,030
Acquisition and development
1-4 family residential construction		—		—		291		291		291
All other A&D		8,219		2,142		60		8,279		8,340
Commercial and industrial		—		—		30		30		2,266
Residential mortgage
Residential mortgage – term		865		22		1,668		2,533		2,724
Residential mortgage – home equity		—		—		858		858		986
Consumer		—		—		4		4		4
Total impaired loans	$	9,200	$	2,173	$	5,974	$	15,174	$	25,865

‎

The following tables present the activity in the ALL for the nine and three month periods ended September 30, 2020 and 2019:



(in thousands)	Commercial ‎Real Estate		Acquisition ‎and ‎Development		Commercial ‎and ‎Industrial		Residential ‎Mortgage		Consumer		Unallocated		Total
ALL balance at January 1, 2020	$	2,882	$	3,674	$	1,341	$	3,828	$	312	$	500	$	12,537
Charge-offs		—		(1,144)		(232)		(108)		(274)		—		(1,758)
Recoveries		69		29		149		66		116		—		429
Provision		2,343		(136)		926		1,621		227		—		4,981
ALL balance at September 30, 2020	$	5,294	$	2,423	$	2,184	$	5,407	$	381	$	500	$	16,189
ALL balance at January 1, 2019	$	2,780	$	1,721	$	1,187	$	4,544	$	315	$	500	$	11,047
Charge-offs		—		(29)		(75)		(86)		(212)		—		(402)
Recoveries		67		132		77		259		122		—		657
Provision		(162)		1,556		6		(818)		87		—		669
ALL balance at September 30, 2019	$	2,685	$	3,380	$	1,195	$	3,899	$	312	$	500	$	11,971



(in thousands)	Commercial ‎Real Estate		Acquisition ‎and ‎Development		Commercial ‎and ‎Industrial		Residential ‎Mortgage		Consumer		Unallocated		Total
ALL balance at July 1, 2020	$	4,527	$	4,498	$	1,997	$	5,106	$	386	$	500	$	17,014
Charge-offs		—		(1,113)		—		(10)		(51)		—		(1,174)
Recoveries		3		7		133		18		28		—		189
Provision		764		(969)		54		293		18		—		160
ALL balance at September 30, 2020	$	5,294	$	2,423	$	2,184	$	5,407	$	381	$	500	$	16,189
ALL balance at July 1, 2019	$	2,735	$	3,294	$	1,147	$	3,981	$	319	$	500	$	11,976
Charge-offs		—		—		(70)		—		(76)		—		(146)
Recoveries		37		21		1		64		31		—		154
Provision		(87)		65		117		(146)		38		—		(13)
ALL balance at September 30, 2019	$	2,685	$	3,380	$	1,195	$	3,899	$	312	$	500	$	11,971

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

‎

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



	Nine months ended						Nine months ended
	September 30, 2020						September 30, 2019
(in thousands)	Average ‎investment		Interest income ‎recognized on ‎an accrual basis		Interest income ‎recognized on ‎a cash basis		Average ‎investment		Interest income ‎recognized on ‎an accrual basis		Interest income ‎recognized on ‎a cash basis
Commercial real estate
Non owner-occupied	$	134	$	6	$	—	$	241	$	9	$	—
All other CRE		3,201		109		—		4,644		113		68
Acquisition and development
1-4 family residential construction		282		9		—		232		10		—
All other A&D		8,243		9		1		6,062		12		—
Commercial and industrial		16		—		—		25		—		—
Residential mortgage
Residential mortgage – term		2,531		62		—		3,082		75		10
Residential mortgage – home equity		651		—		3		873		—		4
Consumer		18		—		—		12		—		—
Total	$	15,076	$	195	$	4	$	15,171	$	219	$	82



	Three months ended						Three months ended
	September 30, 2020						September 30, 2019
(in thousands)	Average ‎investment		Interest income ‎recognized on ‎an accrual basis		Interest income ‎recognized on ‎a cash basis		Average ‎investment		Interest income ‎recognized on ‎an accrual basis		Interest income ‎recognized on ‎a cash basis
Commercial real estate
Non owner-occupied	$	127	$	3	$	—	$	201	$	3	$	—
All other CRE		3,278		36		—		4,773		37		68
Acquisition and development
1-4 family residential construction		276		3		—		152		1		—
All other A&D		8,158		3		—		8,085		6		—
Commercial and industrial		18		—		—		27		—		—
Residential mortgage
Residential mortgage – term		2,565		19		—		2,701		22		—
Residential mortgage – home equity		474		—		—		928		—		2
Consumer		33		—		—		7		—		—
Total	$	14,929	$	64	$	—	$	16,874	$	69	$	70

The Bank modifies loan terms in the normal course of business. Among other reasons, modifications might be made in an effort to retain the loan relationship, to remain competitive in the current interest rate environment and/or to re-amortize or extend the loan’s term to better match the loan’s payment stream with the borrower’s cash flow. A modified loan is considered to be a TDR when the Bank has determined that the borrower is troubled (i.e., experiencing financial difficulties). The Bank evaluates the probability that the borrower will be in payment default on any of its debt obligations in the foreseeable future without modification. To make this determination, the Bank performs a global financial review of the borrower and loan guarantors to assess their current ability to meet their financial obligations.

Section 4013 of the CARES Act allows financial institutions to suspend application of certain current TDRs accounting guidance under ASC 310-40 for loan modifications related to the COVID-19 pandemic made between March 1, 2020 and the earlier of December 31, 2020 or 60 days after the end of the COVID-19 national emergency, provided certain criteria are met. This relief can be applied to loan modifications for borrowers that were not more than 30 days past due as of December 31, 2019 and to loan modifications that defer or delay the payment of principal or interest, or change the interest rate on the loan. In April 2020, federal and state banking regulators issued the Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus to provide further interpretation of when a borrower is experiencing financial difficulty, specifically indicating that if the modification is either short-term (e.g., nine months) or mandated by a federal or state government in response to the COVID-19 pandemic, the borrower is not experiencing financial difficulty under ASC 310-40. The Corporation continues to

prudently work with borrowers negatively impacted by the COVID-19 pandemic while managing credit risks and recognizing appropriate allowance for credit losses on its loan portfolio. See Note 2 to the financial statements included elsewhere in this report for additional information.

There were 14 and 15 loans totaling $4.0 million and $4.2 million, respectively, that were classified as TDRs at September 30, 2020 and December 31, 2019, respectively. The following tables present the volume and recorded investment in TDRs at the times they were modified, by class and type of modification that occurred during the periods indicated:



	Temporary Rate ‎Modification			Extension of Maturity			Modification of Payment ‎and Other Terms
(in thousands)	Number of ‎Contracts	Recorded ‎Investment		Number of ‎Contracts	Recorded ‎Investment		Number of ‎Contracts	Recorded ‎Investment
Nine months ended September 30, 2020
Commercial real estate
Non owner-occupied	—	$	—	—	$	—	—	$	—
All other CRE	—		—	—		—	1		2,226
Acquisition and development
1-4 family residential construction	—		—	—		—	—		—
All other A&D	—		—	2		430	—		—
Commercial and industrial	—		—	—		—	—		—
Residential mortgage
Residential mortgage – term	1		46	2		457	3		356
Residential mortgage – home equity	—		—	—		—	—		—
Consumer	—		—	—		—	—		—
Total	1	$	46	4	$	887	4	$	2,582


	Temporary Rate ‎Modification			Extension of Maturity			Modification of Payment ‎and Other Terms
(in thousands)	Number of ‎Contracts	Recorded ‎Investment		Number of ‎Contracts	Recorded ‎Investment		Number of ‎Contracts	Recorded ‎Investment
Nine months ended September 30, 2019
Commercial real estate
Non owner-occupied	—	$	—	—	$	—	—	$	—
All other CRE	—		—	—		—	—		—
Acquisition and development
1-4 family residential construction	—		—	—		—	—		—
All other A&D	—		—	—		—	1		227
Commercial and industrial	—		—	—		—	—		—
Residential mortgage
Residential mortgage – term	1		149	—		—	1		243
Residential mortgage – home equity	—		—	—		—	—		—
Consumer	—		—	—		—	—		—
Total	1	$	149	—	$	—	2	$	470

During the nine months ended September 30, 2020, there were no new TDRs but nine existing TDRs that had reached their modification maturity dates were re-modified. These re-modifications did not impact the ALL. During the nine months ended September 30, 2020, there were no payment defaults.

During the nine months ended September 30, 2019, there was one new TDR due to a mortgage hardship and two existing TDRs that had reached their modification maturity dates were re-modified. There was no impact to the ALL from the new TDR or the re-modifications. During the nine months ended September 30, 2019, there were no payment defaults.



	Temporary Rate ‎Modification			Extension of Maturity			Modification of Payment ‎and Other Terms
(in thousands)	Number of ‎Contracts	Recorded ‎Investment		Number of ‎Contracts	Recorded ‎Investment		Number of ‎Contracts	Recorded ‎Investment
Three months ended September 30, 2020
Commercial real estate
Non owner-occupied	—	$	—	—	$	—	—	$	—
All other CRE	—		—	—		—	—		—
Acquisition and development
1-4 family residential construction	—		—	—		—	—		—
All other A&D	—		—	1		213	—		—
Commercial and industrial	—		—	—		—	—		—
Residential mortgage
Residential mortgage – term	—		—	1		227	1		111
Residential mortgage – home equity	—		—	—		—	—		—
Consumer	—		—	—		—	—		—
Total	—	$	—	2	$	440	1	$	111

	Temporary Rate ‎Modification			Extension of Maturity			Modification of Payment ‎and Other Terms
(in thousands)	Number of ‎Contracts	Recorded ‎Investment		Number of ‎Contracts	Recorded ‎Investment		Number of ‎Contracts	Recorded ‎Investment
Three months ended September 30, 2019
Commercial real estate
Non owner-occupied	—	$	—	—	$	—	—	$	—
All other CRE	—		—	—		—	—		—
Acquisition and development
1-4 family residential construction	—		—	—		—	—		—
All other A&D	—		—	—		—	—		—
Commercial and industrial	—		—	—		—	—		—
Residential mortgage
Residential mortgage – term	1		149	—		—	—		—
Residential mortgage – home equity	—		—	—		—	—		—
Consumer	—		—	—		—	—		—
Total	1	$	149	—	$	—	—	$	—

During the three months ended September 30, 2020, there were no new TDRs but three existing TDRs that had reached their modification maturity dates were re-modified. These re-modifications did not impact the ALL. During the three months ended September 30, 2020, there were no payment defaults under TDRs.

During the three months ended September 30, 2019, there was one new TDR, no modifications on existing TDRs and no payment defaults. There was no impact to the ALL from the new TDR.

Note 7 - Other Real Estate Owned, net

The following table presents the components of OREO at September 30, 2020 and December 31, 2019:



(in thousands)	September 30, ‎2020		December 31, ‎2019
Commercial real estate	$	2,256	$	2,256
Acquisition and development		1,531		1,780
Residential mortgage		—		91
Total OREO, net	$	3,787	$	4,127

The following table presents the activity in the OREO valuation allowance for the nine and three month periods ended September 30, 2020 and 2019:



	Nine Months Ended				Three Months Ended
	September 30,				September 30,
(in thousands)	2020		2019		2020		2019
Balance beginning of period	$	1,790	$	1,988	$	1,734	$	2,013
Fair value write-down		102		1,140		63		312
Sales of OREO		(261)		(1,159)		(166)		(356)
Balance at end of period	$	1,631	$	1,969	$	1,631	$	1,969

The following table presents the components of OREO expenses, net, for the nine and three month periods ended September 30, 2020 and 2019:



	Nine Months Ended				Three Months Ended
	September 30,				September 30,
(in thousands)	2020		2019		2020		2019
Gains on real estate, net	$	(93)	$	(62)	$	(72)	$	(51)
Fair value write-down, net		102		1,140		63		312
Expenses, net		117		260		52		94
Rental and other income		(123)		(72)		(37)		(18)
Total OREO expense, net	$	3	$	1,266	$	6	$	337

Note 8 – Fair Value of Financial Instruments

Fair value is defined as the price to sell an asset or to transfer a liability in an orderly transaction between willing market participants as of the measurement date. Fair value is best determined by values quoted through active trading markets. Active trading markets are characterized by numerous transactions of similar financial instruments between willing buyers and willing sellers. Because no active trading market exists for various types of financial instruments, many of the fair values disclosed were derived using present value discounted cash flows or other valuation techniques described below. As a result, the Corporation’s ability to actually realize these derived values cannot be assumed.

The Corporation measures fair values based on the fair value hierarchy established in ASC Paragraph 820-10-35-37. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of inputs that may be used to measure fair value under the hierarchy are as follows:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets and liabilities. This level is the most reliable source of valuation.

Level 2: Quoted prices that are not active, or inputs that are observable either directly or indirectly, for substantially the full term of the asset or liability. Level 2 inputs include inputs other than quoted prices that are observable for the asset or liability (for example, interest rates and yield curves at commonly quoted intervals, volatilities, prepayment speeds, loss severities, credit risks, and default rates). It also includes inputs that are derived principally from or corroborated by observable market data by correlation or other means (market-corroborated inputs). Several sources are utilized for valuing these assets, including a contracted valuation service, Standard & Poor’s (“S&P”) evaluations and pricing services, and other valuation matrices.

Level 3: Prices or valuation techniques that require inputs that are both significant to the valuation assumptions and not readily observable in the market (i.e. supported with little or no market activity). Level 3 instruments are valued based on the best available data, some of which is internally developed, and consider risk premiums that a market participant would require.

The level established within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

Management believes that the Corporation’s valuation techniques are appropriate and consistent with the techniques used by other market participants. However, the use of different methodologies and assumptions could result in a different estimate of fair values at the reporting date. The valuation techniques used by the Corporation to measure, on a recurring basis and on a non-recurring basis, the fair value of assets as of September 30, 2020 are discussed in the paragraphs that follow.

Investments – The fair value of investments is determined using a market approach. As of September 30, 2020, the U.S. Government agencies, residential and commercial mortgage-backed securities, collateralized mortgage obligations, and state and political subdivisions bonds, excluding the tax increment financing (“TIF”) bonds, segments are classified as Level 2 within the valuation hierarchy. Their fair values were determined based upon market-corroborated inputs and valuation matrices, which were obtained through third party data service providers or securities brokers through which the Corporation has historically transacted both purchases and sales of investment securities. The TIF bonds are classified as Level 3 within the valuation hierarchy as they are not openly traded.

The collateralized debt obligation (“CDO”) segment, which consists of pooled trust preferred securities issued by banks, thrifts and insurance companies, is classified as Level 3 within the valuation hierarchy. At September 30, 2020, the Corporation owned nine trust preferred securities with an amortized cost of $18.5 million and a fair value of $12.8 million. At September 30, 2020, the market for these securities is not active and the markets for similar securities are also not active. Recent developments in the credit markets have had an negative impact on the market for CDOs. Specifically, as COVID-19 developed, which led to deteriorating performance of credit instruments, investors became less willing to buy a range of structured credit products. The result was massive spread-widening across a wide range of credit instruments, and for CDO bonds in particular. At present, it is no longer economically feasible to form new CDOs or restructure, as the market for CDO bonds has effectively disappeared. The market values for these securities or any securities other than those issued or guaranteed by the U.S. Department of the Treasury are depressed relative to historical levels. Therefore, in the current market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general rather than being an indicator of credit problems with a particular issue. Given the conditions in the current debt markets and the absence of observable transactions in the secondary and new issue markets, management has determined that (a) the few observable transactions and market quotations that are available are not reliable for the purpose of obtaining fair value at September 30, 2020, (b) an income valuation approach technique (i.e. present value) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs will be equally or more representative of fair value than a market approach, and (c) the CDO segment is appropriately classified within Level 3 of the valuation hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date.

Management utilizes on an independent third party to prepare both the evaluations of OTTI as well as the fair value determinations for its CDO portfolio. Management believes that the valuations are adequately reflected at September 30, 2020.

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

At September 30, 2020, there has been minimal impact on the trust preferred bonds, although there has been a significant effect on several asset classes in the equity and fixed income markets related to COVID-19. A review of assumptions, as they relate to the impact of COVID-19, will be on-going through the remainder of the year.

Derivative financial instruments (Cash flow hedge) – The Corporation’s open derivative positions are interest rate swap agreements. Those classified as Level 2 open derivative positions are valued using externally developed pricing models based on observable market inputs provided by a third party and validated by management. The Corporation has considered counterparty credit risk in the valuation of its interest rate swap assets.

Impaired loans – Loans included in the table below are those that are considered impaired with a specific allocation or with a partial charge-off. Fair value consists of the loan balance less its valuation allowance and is generally determined based on independent third-party appraisals of the collateral or discounted cash flows based upon the expected proceeds. These assets are included as Level 3 fair values based upon the lowest level of input that is significant to the fair value measurements.

Other real estate owned – OREO included in the table below are considered impaired with specific write-downs. Fair value of other real estate owned is based on independent third-party appraisals of the properties. These values were determined based on the sales prices of similar properties in the approximate geographic area. These assets are included as Level 3 fair values based upon the lowest level of input that is significant to the fair value measurements.

For Level 3 assets and liabilities measured at fair value on a recurring and non-recurring basis as of September 30, 2020 and December 31, 2019, the significant unobservable inputs used in the fair value measurements were as follows:



(in thousands)	Fair Value at ‎September 30, ‎2020		Valuation ‎Technique	Significant ‎Unobservable ‎Inputs	Significant ‎Unobservable ‎Input Value
Recurring:
Investment Securities – available for sale	$	12,760	Discounted ‎Cash Flow	Discount Rate	LIBOR+ 5.50%
Non-recurring:
Impaired Loans	$	8,198	Market Comparable ‎Properties	Marketability ‎Discount	10.0% - 15.0% (1) ‎(weighted avg 14.9%)
Other Real Estate Owned	$	1,284	Market Comparable ‎Properties	Marketability ‎Discount	15.0%

(in thousands)	Fair Value at ‎December 31, ‎2019		Valuation ‎Technique	Significant ‎Unobservable ‎Inputs	Significant ‎Unobservable ‎Input Value
Recurring:
Investment Securities – available for sale	$	14,354	Discounted ‎Cash Flow	Discount ‎Rate	LIBOR+ 4.75%
Non-recurring:
Impaired Loans	$	6,995	Market Comparable ‎Properties	Marketability ‎Discount	10.0% - 15.0% (1) ‎(weighted avg 12.9%)
Other Real Estate Owned	$	2,571	Market Comparable ‎Properties	Marketability ‎Discount	10.0% - 15.0% (1) ‎(weighted avg 12.5%)

NOTE:

(1)Range would include discounts taken since appraisal and estimated values

‎

For assets measured at fair value on a recurring and non-recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2020 and December 31, 2019 are as follows:



			Fair Value Measurements ‎at September 30, 2020 Using
	Assets/(liabilities) ‎Measured at ‎Fair Value		Quoted ‎Prices in ‎Active Markets ‎for Identical ‎Assets	Significant ‎Other ‎Observable ‎Inputs		Significant ‎Unobservable ‎Inputs
(in thousands)	09/30/20		(Level 1)	(Level 2)		(Level 3)
Recurring:
Investment securities available-for-sale:
U.S. government agencies	$	66,871		$	66,871
Residential mortgage-backed agencies	$	13,163		$	13,163
Commercial mortgage-backed agencies	$	34,160		$	34,160
Collateralized mortgage obligations	$	15,618		$	15,618
Obligations of states and political subdivisions	$	10,589		$	10,589
Collateralized debt obligations	$	12,760				$	12,760
Loans held for sale	$	5,211		$	5,211
Financial derivatives	$	(1,467)		$	(1,467)
Non-recurring:
Impaired loans	$	8,198				$	8,198
Other real estate owned	$	1,284				$	1,284



			Fair Value Measurements ‎at December 31, 2019 Using
	Assets/(liabilities) ‎Measured at ‎Fair Value		Quoted ‎Prices in ‎Active Markets ‎for Identical ‎Assets	Significant ‎Other ‎Observable ‎Inputs		Significant ‎Unobservable ‎Inputs
(in thousands)	12/31/19		(Level 1)	(Level 2)		(Level 3)
Recurring:
Investment securities available-for-sale:
U.S. government agencies	$	39,894		$	39,894
Residential mortgage-backed agencies	$	4,900		$	4,900
Commercial mortgage-backed agencies	$	27,764		$	27,764
Collateralized mortgage obligations	$	29,923		$	29,923
Obligations of states and political subdivisions	$	14,470		$	14,470
Collateralized debt obligations	$	14,354				$	14,354
Loans held for sale	$	1,749		$	1,749
Financial derivatives	$	(133)		$	(133)
Non-recurring:
Impaired loans	$	6,995				$	6,995
Other real estate owned	$	2,571				$	2,571

There were no transfers of assets between any of the fair value hierarchy for the nine and three month periods ended September 30, 2020 or 2019.

The following tables show a reconciliation of the beginning and ending balances for fair valued assets measured on a recurring basis using Level 3 significant unobservable inputs for the nine and three month periods ended September 30, 2020 and 2019:



	Fair Value Measurements ‎Using Significant Unobservable Inputs ‎(Level 3)
(in thousands)	Investment Securities ‎Available for Sale
Beginning balance January 1, 2020	$	14,354
Total losses realized/unrealized:
Included in other comprehensive income		(1,594)
Ending balance September 30, 2020	$	12,760



	Fair Value Measurements ‎Using Significant Unobservable Inputs ‎(Level 3)
(in thousands)	Investment Securities ‎Available for Sale
Beginning balance January 1, 2019	$	15,277
Total losses realized/unrealized:
Included in other comprehensive income		(1,810)
Ending balance September 30, 2019	$	13,467



	Fair Value Measurements ‎Using Significant Unobservable Inputs ‎(Level 3)
(in thousands)	Investment Securities ‎Available for Sale
Beginning balance July 1, 2020	$	11,952
Total gains realized/unrealized:
Included in other comprehensive income		808
Ending balance September 30, 2020	$	12,760



	Fair Value Measurements ‎Using Significant Unobservable Inputs ‎(Level 3)
(in thousands)	Investment Securities ‎Available for Sale
Beginning balance July 1, 2019	$	14,872
Total losses realized/unrealized:
Included in other comprehensive loss		(1,405)
Ending balance September 30, 2019	$	13,467

There were no gains or losses included in earnings attributable to the change in realized/unrealized gains or losses related to the assets for the nine and three month periods ended September 30, 2020 and 2019.

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

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



	September 30, 2020				Fair Value Measurements
	Carrying		Fair		Quoted ‎Prices in ‎Active Markets ‎for Identical ‎Assets		Significant ‎Other ‎Observable ‎Inputs		Significant ‎Unobservable ‎Inputs
(in thousands)	Amount		Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets:
Cash and due from banks	$	152,460	$	152,460	$	152,460
Interest bearing deposits in banks		3,146		3,146		3,146
Investment securities - AFS		153,161		153,161			$	140,401	$	12,760
Investment securities - HTM		69,221		76,370				50,332		26,038
Restricted bank stock		4,468		4,468				4,468
Loans, net		1,173,256		1,175,465						1,175,465
Loans held for sale		5,211		5,211				5,211
Accrued interest receivable		6,320		6,320				6,320
Financial Liabilities:
Deposits - non-maturity		1,141,596		1,141,596				1,141,596
Deposits - time deposits		235,688		239,136				239,136
Financial derivatives		1,467		1,467				1,467
Short-term borrowed funds		52,589		52,589				52,589
Long-term borrowed funds		100,929		103,338				103,338
Accrued interest payable		417		417				417



	December 31, 2019				Fair Value Measurements
	Carrying		Fair		Quoted ‎Prices in ‎Active Markets ‎for Identical ‎Assets		Significant ‎Other ‎Observable ‎Inputs		Significant ‎Unobservable ‎Inputs
(in thousands)	Amount		Value		(Level 1)		(Level 2)		(Level 3)
Financial Assets:
Cash and due from banks	$	48,512	$	48,512	$	48,512
Interest bearing deposits in banks		1,467		1,467		1,467
Investment securities - AFS		131,305		131,305			$	116,951	$	14,354
Investment securities - HTM		93,979		100,656				79,084		21,572
Restricted bank stock		4,415		4,415				4,415
Loans, net		1,038,894		1,037,032						1,037,032
Loans held for sale		1,749		1,749				1,749
Accrued interest receivable		4,116		4,116				4,116
Financial Liabilities:
Deposits - non-maturity		888,141		888,141				888,141
Deposits - time deposits		253,890		256,227				256,227
Financial derivative		133		133				133
Short-term borrowed funds		48,728		48,728				48,728
Long-term borrowed funds		100,929		100,848				100,848
Accrued interest payable		499		499				499

‎

Note 9 – Accumulated Other Comprehensive Loss

The following table presents the changes in each component of accumulated other comprehensive loss for the 12 months ended December 31, 2019, the three months ended March 31, June 30 and September 30, 2020:



(in thousands)	Investment ‎securities- ‎with OTTI ‎AFS		Investment ‎securities- ‎all other ‎AFS		Investment ‎securities- ‎HTM		Cash Flow ‎Hedge		Pension ‎Plan		SERP		Total
Accumulated OCL, net:
Balance – January 1, 2019	$	(1,899)	$	(3,601)	$	(1,131)	$	773	$	(18,017)	$	(528)	$	(24,403)
Other comprehensive ‎ income/(loss) before ‎ reclassifications		(497)		2,748		—		(858)		(3,189)		(730)		(2,526)
Amounts reclassified from ‎ accumulated other ‎ comprehensive loss		(146)		—		232		—		789		83		958
Balance – December 31, 2019	$	(2,542)	$	(853)	$	(899)	$	(85)	$	(20,417)	$	(1,175)	$	(25,971)
Other comprehensive ‎ income/(loss) before ‎ reclassifications		(1,188)		1,384		—		(963)		(5,177)		—		(5,944)
Amounts reclassified from ‎ accumulated other ‎ comprehensive loss		(37)		—		53		—		262		34		312
Balance - March 31, 2020	$	(3,767)	$	531	$	(846)	$	(1,048)	$	(25,332)	$	(1,141)	$	(31,603)
Other comprehensive ‎ income/(loss) before ‎ reclassifications		(244)		642		—		(81)		3,137		—		3,454
Amounts reclassified from ‎ accumulated other ‎ comprehensive loss		(37)		(34)		441		—		262		34		666
Balance - June 30, 2020	$	(4,048)	$	1,139	$	(405)	$	(1,129)	$	(21,933)	$	(1,107)	$	(27,483)
Other comprehensive ‎ income/(loss) before ‎ reclassifications		518		(235)		—		72		1,385		—		1,740
Amounts reclassified from ‎ accumulated other ‎ comprehensive loss		(37)		(421)		54		—		262		34		(108)
Balance - September 30, 2020	$	(3,567)	$	483	$	(351)	$	(1,057)	$	(20,286)	$	(1,073)	$	(25,851)

The following tables present the components of other comprehensive income/(loss) for the nine and three month periods ended

September 30, 2020 and 2019:



Components of Other Comprehensive Income ‎(in thousands)	Before ‎Tax ‎Amount		Tax ‎(Expense) ‎Benefit		Net
For the nine months ended September 30, 2020
Available for sale (AFS) securities with OTTI:
Unrealized holding losses	$	(1,249)	$	335	$	(914)
Less: accretable yield recognized in income		151		(40)		111
Net unrealized losses on investments with OTTI		(1,400)		375		(1,025)
Available for sale securities – all other:
Unrealized holding gains		2,446		(655)		1,791
Less: gains recognized in income		622		(167)		455
Net unrealized gains on all other AFS securities		1,824		(488)		1,336
Held to maturity securities:
Unrealized holding gains		—		—		—
Less: gains recognized in income		60		(16)		44
Less: amortization recognized in income		(809)		217		(592)
Net unrealized gains on HTM securities		749		(201)		548
Cash flow hedges:
Unrealized holding losses		(1,335)		363		(972)
Pension Plan:
Unrealized net actuarial loss		(895)		240		(655)
Less: amortization of unrecognized loss		(1,074)		288		(786)
Net pension plan liability adjustment		179		(48)		131
SERP:
Unrealized net actuarial loss		—		—		—
Less: amortization of unrecognized loss		(141)		38		(103)
Less: amortization of prior service costs		2		(1)		1
Net SERP liability adjustment		139		(37)		102
Other comprehensive income	$	156	$	(36)	$	120


Components of Other Comprehensive Income ‎(in thousands)	Before ‎Tax ‎Amount		Tax ‎(Expense) ‎Benefit		Net
For the nine months ended September 30, 2019
Available for sale (AFS) securities with OTTI:
Unrealized holding losses	$	(1,401)	$	380	$	(1,021)
Less: accretable yield recognized in income		149		(39)		110
Net unrealized losses on investments with OTTI		(1,550)		419		(1,131)
Available for sale securities – all other:
Unrealized holding gains		3,957		(1,072)		2,885
Less: gains recognized in income		1		—		1
Net unrealized gains on all other AFS securities		3,956		(1,072)		2,884
Held to maturity securities:
Unrealized holding gains		—		—		—
Less: amortization recognized in income		(243)		65		(178)
Net unrealized gains on HTM securities		243		(65)		178
Cash flow hedges:
Unrealized holding losses		(1,427)		387		(1,040)
Pension Plan:
Unrealized net actuarial gain		3,250		(881)		2,369
Less: amortization of unrecognized loss		(807)		219		(588)
Net pension plan liability adjustment		4,057		(1,100)		2,957
SERP:
Unrealized net actuarial loss		—		—		—
Less: amortization of unrecognized loss		(87)		23		(64)
Less: amortization of prior service costs		2		—		2
Net SERP liability adjustment		85		(23)		62
Other comprehensive income	$	5,364	$	(1,454)	$	3,910



Components of Other Comprehensive Income ‎(in thousands)	Before ‎Tax ‎Amount		Tax ‎(Expense) ‎Benefit		Net
For the three months ended September 30, 2020
Available for sale (AFS) securities with OTTI:
Unrealized holding gains	$	708	$	(190)	$	518
Less: accretable yield recognized in income		50		(13)		37
Net unrealized gains on investments with OTTI		658		(177)		481
Available for sale securities – all other:
Unrealized holding losses		(321)		86		(235)
Less: gains recognized in income		575		(154)		421
Net unrealized losses on all other AFS securities		(896)		240		(656)
Held to maturity securities:
Unrealized holding gains		—		—		—
Less: amortization recognized in income		(74)		20		(54)
Net unrealized gains on HTM securities		74		(20)		54
Cash flow hedges:
Unrealized holding gains		90		(18)		72
Pension Plan:
Unrealized net actuarial gain		1,891		(506)		1,385
Less: amortization of unrecognized loss		(358)		96		(262)
Net pension plan liability adjustment		2,249		(602)		1,647
SERP:
Unrealized net actuarial loss		—		—		—
Less: amortization of unrecognized loss		(47)		13		(34)
Less: amortization of prior service costs		1		(1)		—
Net SERP liability adjustment		46		(12)		34
Other comprehensive income	$	2,221	$	(589)	$	1,632



Components of Other Comprehensive Loss ‎(in thousands)	Before ‎Tax ‎Amount		Tax ‎(Expense) ‎Benefit		Net
For the three months ended September 30, 2019
Available for sale (AFS) securities with OTTI:
Unrealized holding losses	$	(1,126)	$	306	$	(820)
Less: accretable yield recognized in income		50		(13)		37
Net unrealized losses on investments with OTTI		(1,176)		319		(857)
Available for sale securities – all other:
Unrealized holding gains		552		(149)		403
Less: gains recognized in income		1		—		1
Net unrealized gains on all other AFS securities		551		(149)		402
Held to maturity securities:
Unrealized holding gains		—		—		—
Less: amortization recognized in income		(82)		22		(60)
Net unrealized gains on HTM securities		82		(22)		60
Cash flow hedges:
Unrealized holding losses		(329)		90		(239)
Pension Plan:
Unrealized net actuarial loss		(103)		28		(75)
Less: amortization of unrecognized loss		(269)		73		(196)
Net pension plan liability adjustment		166		(45)		121
SERP:
Less: amortization of unrecognized loss		(29)		8		(21)
Less: amortization of prior service costs		1		—		1
Net SERP liability adjustment		28		(8)		20
Other comprehensive loss	$	(678)	$	185	$	(493)

The following table presents the details of amounts reclassified from accumulated other comprehensive loss for the nine and three month periods ended September 30, 2020 and 2019:



Amounts Reclassified from	Nine Months Ended
Accumulated Other Comprehensive Loss	September 30,				Affected Line Item in the Statement
(in thousands)	2020		2019		Where Net Income is Presented
Net unrealized gains on available for sale investment securities with OTTI:
Accretable yield		151		149	Interest income on taxable investment securities
Taxes		(40)		(39)	Provision for income tax expense
	$	111	$	110	Net of tax
Net unrealized gains on available for sale investment securities - all others:
Gains on sales	$	622	$	1	Net gains
Taxes		(167)		—	Provision for income tax expense
	$	455	$	1	Net of tax
Net unrealized losses on held to maturity securities:
Amortization	$	(809)	$	(243)	Interest income on taxable investment securities
Gains on calls		60		—	Net gains
Taxes		201		65	Provision for income tax expense
	$	(548)	$	(178)	Net of tax
Net pension plan liability adjustment:
Amortization of unrecognized loss	$	(1,074)	$	(807)	Other Expense
Taxes		288		219	Provision for income tax expense
	$	(786)	$	(588)	Net of tax
Net SERP liability adjustment:
Amortization of unrecognized loss	$	(141)	$	(87)	Other Expense
Amortization of prior service costs		2		2	Salaries and employee benefits
Taxes		37		23	Provision for income tax expense
	$	(102)	$	(62)	Net of tax
Total reclassifications for the period	$	(870)	$	(717)	Net of tax



Amounts Reclassified from	Three Months Ended
Accumulated Other Comprehensive Loss	September 30,				Affected Line Item in the Statement
(in thousands)	2020		2019		Where Net Income is Presented
Net unrealized gains on available for sale investment securities with OTTI:
Accretable Yield	$	50	$	50	Interest income on taxable investment securities
Taxes		(13)		(13)	Provision for income tax expense
	$	37	$	37	Net of tax
Net unrealized gains on available for sale investment securities - all others:
Gains on sales	$	575	$	1	Net gains
Taxes		(154)		—	Provision for income tax expense
	$	421	$	1	Net of tax
Net unrealized losses on held to maturity securities:
Amortization	$	(74)	$	(82)	Interest income on taxable investment securities
Taxes		20		22	Provision for income tax expense
	$	(54)	$	(60)	Net of tax
Net pension plan liability adjustment:
Amortization of unrecognized loss	$	(358)	$	(269)	Other expense
Taxes		96		73	Provision for income tax expense
	$	(262)	$	(196)	Net of tax
Net SERP liability adjustment:
Amortization of unrecognized loss	$	(47)	$	(29)	Other expense
Amortization of prior service costs		1		1	Salaries and employee benefits
Taxes		12		8	Provision for income tax expense
	$	(34)	$	(20)	Net of tax
Total reclassifications for the period	$	108	$	(238)	Net of tax

Note 10 – Borrowed Funds

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



(Dollars in thousands)	Nine Months ‎Ended ‎September 30, 2020		Year Ended ‎December 31, 2019
Securities sold under agreements to repurchase:
Outstanding at end of period	$	52,589	$	48,728
Weighted average interest rate at end of period		0.18%		0.23%
Maximum amount outstanding as of any month end	$	52,589	$	50,345
Average amount outstanding	$	43,895	$	39,778
Approximate weighted average rate during the period		0.21%		0.28%

At September 30, 2020, the repurchase agreements were secured by $75.8 million in investment securities issued by government related agencies. A minimum of 102% of fair value is pledged against account balances.

At September 30, 2020, the long-term advances from the Federal Home Loan Bank of Atlanta (“FHLB”) were secured by $209.0 million in loans.

Note 11 – Employee Benefit Plans

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



Pension Plan	Nine Months Ended				Three Months Ended
	September 30,				September 30,
(in thousands)	2020		2019		2020		2019
Service cost	$	169	$	199	$	57	$	66
Interest cost		1,219		1,311		406		437
Expected return on assets		(2,661)		(2,292)		(887)		(764)
Amortization of net actuarial loss		1,074		807		358		269
Net pension (credit)/expense included in employee benefits ‎ and other expense	$	(199)	$	25	$	(66)	$	8



Defined Benefit SERP	Nine Months Ended				Three Months Ended
	September 30,				September 30,
(in thousands)	2020		2019		2020		2019
Service cost	$	93	$	71	$	31	$	24
Interest cost		201		247		67		82
Amortization of recognized loss		141		87		47		29
Amortization of prior service cost		(2)		(2)		(1)		(1)
Net Defined Benefit SERP expense included in ‎ employee benefits and other expense	$	433	$	403	$	144	$	134

The service cost component of net periodic benefit cost is included in salaries and benefits and all other components of net periodic benefit cost are included in other expense in the Consolidated Statement of Operations for the Corporation’s Pension and Defined Benefit SERP plans.

The Pension Plan is a noncontributory defined benefit pension plan that covers our employees who were hired prior to the freeze and others who were grandfathered into the plan. The benefits are based on years of service and the employees’ compensation during the last five years of employment.

Effective April 30, 2010, the Pension Plan was amended, resulting in a “soft freeze”, the effect of which prohibits new entrants into the plan and ceases crediting of additional years of service after that date. Effective January 1, 2013, the Pension Plan was amended to unfreeze it for those employees for whom the sum of their (a) ages, at their closest birthday plus (b) years of service for vesting

purposes equals 80 or greater. The “soft freeze” continues to apply to all other plan participants. Pension benefits for these participants are managed through discretionary contributions to the First United Corporation 401(k) Profit Sharing Plan (the “401(k) Plan”).

The Bank established the Defined Benefit SERP in 2001 as an unfunded supplemental executive retirement plan. The Defined Benefit SERP is available only to a select group of management or highly compensated employees to provide supplemental retirement benefits in excess of limits imposed on qualified plans by federal tax law. Concurrent with the establishment of the Defined Benefit SERP, the Bank acquired Bank Owned Life Insurance (“BOLI”) policies on the senior management personnel and officers of the Bank. The benefits resulting from the favorable tax treatment accorded the earnings on the BOLI policies are intended to provide a source of funds for the future payment of the Defined Benefit SERP benefits as well as other employee benefit costs.

The benefit obligation activity for both the Pension Plan and Defined Benefit SERP was calculated using an actuarial measurement date of January 1. Plan assets and the benefit obligations were calculated using an actuarial measurement date of December 31.

The Corporation will assess the need for future annual contributions to the pension plan based upon its funded status and an evaluation of the future benefits to be provided thereunder. A contribution of $1.0 million was made to the Pension Plan during the first nine months of 2020. The Corporation expects to fund the annual projected benefit payments for the Defined Benefit SERP from operations.

On January 9, 2015, First United Corporation and members of management who do not participate in the Defined Benefit SERP entered into participation agreements under the Deferred Compensation Plan, each styled as a Defined Contribution SERP Agreement (the “Contribution Agreement”). Pursuant to each Contribution Agreement, First United Corporation agreed, for each Plan Year (as defined in the Deferred Compensation Plan) in which it determines that it has been Profitable (as defined in the Contribution Agreement), to make a discretionary contribution to the participant’s Employer Account in an amount equal to 15% of the participant’s base salary level for such Plan Year, with the first Plan Year being the year ending December 31, 2015. The Contribution Agreement provides that the participant will become 100% vested in the amount maintained in his or her Employer Account upon the earliest to occur of the following events: (a) Normal Retirement (as defined in the Contribution Agreement); (b) Separation from Service (as defined in the Contribution Agreement) following a Change of Control (as defined in the Deferred Compensation Plan) and subsequent Triggering Event (as defined in the Contribution Agreement); (c) Separation from Service due to a Disability (as defined in the Contribution Agreement); (d) with respect to a particular award of Employer Contribution Credits, the participant’s completion of 2 consecutive Years of Service (as defined in the Contribution Agreement) immediately following the Plan Year for which such award was made; or (e) death. Notwithstanding the foregoing, however, a participant will lose entitlement to the amount maintained in his or her Employer Account in the event employment is terminated for Cause (as defined in the Contribution Agreement). In addition, the Contribution Agreement conditions entitlement to the amounts held in the Employer Account on the participant (1) refraining from engaging in Competitive Employment (as defined in the Contribution Agreement) for three years following his or her Separation from Service, (2) refraining from injurious disclosure of confidential information concerning the Corporation, and (3) remaining available, at the First United Corporation’s reasonable request, to provide at least six hours of transition services per month for 12 months following his or her Separation from Service (except in the case of death or Disability), except that only item (2) will apply in the event of a Separation from Service following a Change of Control and subsequent Triggering Event.

In January 2018, the Board approved discretionary contributions to four participants totaling $119,252. The contributions vested on December 31, 2019. In January 2019, the Board of Directors of First United Corporation approved discretionary contributions to four participants totaling $123,179. The Corporation recorded $36,020 and $44,719 of related compensation expense for the first nine months of 2020 and 2019, respectively, related to these contributions. The Corporation recorded $12,007 and $14,906 of related compensation expense for the third quarters of 2020 and 2019, respectively, related to these contributions. In January 2020, the Board approved discretionary contributions to four participants totaling $126,058. The Corporation recorded $47,272 of related compensation for the first nine months of 2020 and $15,757 for the third quarter of 2020 related to these contributions. Each of the above annual contributions has a two year vesting period.

Note 12 - Equity Compensation Plan Information

At the 2018 Annual Meeting of Shareholders, First United Corporation’s shareholders approved the First United Corporation 2018 Equity Compensation Plan which authorizes the issuance of up to 325,000 shares of common stock to employees, directors and qualifying consultants pursuant to stock options, stock appreciation rights, stock awards, dividend equivalents, and other stock-based awards.

The Corporation complies with the provisions of ASC Topic 718, Compensation-Stock Compensation, in measuring and disclosing stock compensation cost. The measurement objective in ASC Paragraph 718-10-30-6 requires public companies to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. The cost is recognized in expense over the period in which an employee is required to provide service in exchange for the award (the vesting period).

Stock based awards were made to non employee directors in June 2020 pursuant to First United Corporation’s director compensation policy. Each director receives an annual retainer of 1,000 shares of First United Corporation common stock, plus $10,000 to be paid, at the director’s election, in cash or additional shares of common stock. In June 2020, a total of 13,160 fully vested shares of common stock were issued to directors, which had a grant date fair market value of $14.52 per share. Director stock compensation expense was $158,795 for the nine months ended September 30, 2020 and $200,594 for the nine months ended September 30, 2019. Director stock compensation expense was $52,114 for the three months ended September 30, 2020 and $66,893 for the three months ended September 30, 2019.

Restricted Stock Units

On March 26, 2020, pursuant to the recently adopted Long Term Incentive Plan (the "LTIP"), the Compensation Committee (the "Committee") of the Corporation granted restricted stock units (“RSU”) to the Corporation's principal executive officer, its principal financial officer, and certain of its other executive officers. An RSU contemplates the issuance of shares of common stock of the Corporation if and when the RSU vests.

The RSUs granted to each of the foregoing officers consist of (a) a performance vesting award for a three-year performance period ending December 31, 2021, (b) a performance vesting award for a three year performance period ending December 31, 2022, and (c) a time-vesting award that will vest ratably over a three-year period beginning on March 26, 2021. Under the performance vesting RSUs, the officers will receive 50% of the target number of shares if at least one of the threshold performance levels is met, 100% of the target number of shares if at least one of the target performance levels is met, and 150% of the target number of shares if at least one of the maximum performance levels is met. Actual vesting amounts will be pro-rated between threshold and target levels and target and maximum levels to reward incremental improvement. For the performance period ending December 31, 2021, the RSUs' performance goal is based on earnings per share for the year ending December 31, 2021. For the performance period ending December 31, 2022, the RSUs' performance goals are based on earnings per share for the year ending December 31, 2022 and growth in tangible book value per share during the performance period. The threshold, target and maximum performance levels for these grants will be disclosed pursuant to Item 402 of Regulation S-K following the conclusion of the applicable performance period.

To receive any shares under a RSU, a grantee must be employed by the Corporation or one of its subsidiaries on the applicable vesting date, except that a grantee whose employment terminates prior to such vesting date due to death, disability or retirement will be entitled to a pro-rated portion of the shares subject to the RSUs, assuming that, in the case of performance-vesting RSUs, the performance goals had been met at their "target" levels.

In the first quarter of 2020, RSUs relating to 25,004 shares of common stock (target level) were granted, which had a grant date fair market value of $12.54 per share of common stock underlying each RSU. Stock compensation expense was $93,727 for the first nine months of 2020 and $31,243 for the third quarter of 2020. Compensation expense related to unvested units was $219,797.

Note 13 – Derivative Financial Instruments

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

In March 2016, the Corporation entered into four interest rate swap contracts totaling $30.0 million notional amount, hedging future cash flows associated with floating rate trust preferred debt. These contracts include a three year $5.0 million contract that matured on September 17, 2019, a five year $5.0 million contract that matures on March 17, 2021, a seven year $5.0 million contract that matures on March 17, 2023 and a 10 year $15.0 million contract that matures on March 17, 2026.

The fair value of the interest rate swap contracts was $(1.5) million and $(133) thousand at September 30, 2020 and December 31, 2019, respectively.

For the nine months ended September 30, 2020, the Corporation recorded a decrease in the value of the derivatives of $1.3 million and the related deferred tax of $363 thousand in net accumulated other comprehensive loss to reflect the effective portion of cash flow hedges. ASC Subtopic 815-30 requires the net accumulated other comprehensive loss to be reclassified to earnings if the hedge becomes ineffective or is terminated. There was no hedge ineffectiveness recorded for the nine months ended September 30, 2020. The Corporation does not expect any losses relating to these hedges to be reclassified into earnings within the next 12 months.

Interest rate swap agreements are entered into with counterparties that meet established credit standards and the Corporation believes that the credit risk inherent in these contracts is not significant as of September 30, 2020.

The table below discloses the impact of derivative financial instruments on the Corporation’s Consolidated Financial Statements for the nine and three month periods ended September 30, 2020 and 2019.



Derivative in Cash Flow Hedging Relationships
(in thousands)	Amount of gain or (loss) recognized in OCI on derivative (effective portion)		Amount of gain or (loss) reclassified from accumulated OCI into income (effective portion) (a)		Amount of gain or (loss) recognized in income or derivative (ineffective portion and amount excluded from effectiveness testing) (b)
Interest rate contracts:
Nine months ended:
September 30, 2020	$	(972)	$	—	$	—
September 30, 2019		(1,040)		—		—
Three months ended:
September 30, 2020	$	72	$	—	$	—
September 30, 2019		(239)		—		—

Notes:

(a) Reported as interest expense

(b) Reported as other income

Note 14 – Assets and Liabilities Subject to Enforceable Master Netting Arrangements

Interest Rate Swap Agreements

The Corporation has entered into interest rate swap agreements to modify the re-pricing characteristics of certain interest-bearing liabilities as a part of managing interest rate risk. The swap agreements have been designated as cash flow hedges, and accordingly, the fair value of the interest rate swap contracts is reported in Other Assets or Other Liabilities on the Consolidated Statement of Financial Condition. The swap agreements were entered into with a third-party financial institution. The Corporation is party to master netting arrangements with its financial institution counterparty; however, the Corporation does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Collateral, in the form of cash and investment securities, are pledged by the Corporation as the counterparty with net liability positions in accordance with contract thresholds. See Note 13 to the Consolidated Financial Statements for more information.

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

The Bank enters into agreements under which it sells interests in U.S. securities to certain customers subject to an obligation to repurchase, and on the part of the customers to resell, such interests. Under these arrangements, the Bank may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Bank to repurchase the assets. As a result, these repurchase agreements are accounted for as collateralized financing arrangements (i.e., secured borrowings) and not as a sale and subsequent repurchase of securities. The obligation to repurchase the securities is reflected as a liability in the Consolidated Statement of Financial Condition, while the securities underlying the repurchase agreements remain in the respective investment securities asset accounts. There is no offsetting or netting of the investment securities assets with the repurchase agreement liabilities. In addition, as the Bank does not enter into reverse repurchase agreements, there is no such offsetting to be done with the repurchase agreements. The right of setoff for a repurchase agreement resembles a secured borrowing, whereby the collateral would be used to settle the fair value of the repurchase agreement should the Bank be in default (i.e. fails to repurchase the U.S. securities on the maturity date of the agreement). The investment security collateral, maintained at 102% of the borrowing, is held by a third party financial institution in the counterparty’s custodial account.

The following table presents the assets and liabilities subject to an enforceable master netting arrangement or repurchase agreements at September 30, 2020 and December 31, 2019.



							Gross Amounts ‎Not Offset in the ‎Statement of Condition
(in thousands)	Gross ‎Amounts of ‎Recognized ‎(Assets)/ ‎Liabilities		Gross ‎Amounts ‎Offset in the ‎Statement of ‎Condition		Net Amounts ‎of (Assets)/ ‎Liabilities ‎Presented in ‎the Statement ‎of Condition		Financial ‎Instruments		Cash ‎Collateral ‎Pledged		Net ‎Amount
September 30, 2020
Interest Rate Swap Agreements	$	1,467	$	—	$	1,467	$	(1,467)	$	2,000	$	—
Repurchase Agreements	$	52,589	$	—	$	52,589	$	(52,589)	$	—	$	—
December 31, 2019
Interest Rate Swap Agreements	$	133	$	—	$	133	$	(133)	$	—	$	—
Repurchase Agreements	$	48,728	$	—	$	48,728	$	(48,728)	$	—	$	—

Note 15 - Goodwill

Accounting Standards Codification (“ASC”) Topic 350, Intangibles – Goodwill and Other provides guidance with respect to goodwill. Under this guidance, goodwill is not amortized but shall be tested at least annually for impairment at a level of accounting referred to as a reporting unit. The Corporation is considered the sole reporting unit. Goodwill of a reporting unit shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Impairment of goodwill is the condition that exists when the carrying amount of a reporting unit that includes goodwill exceeds its fair value. A goodwill impairment loss is recognized for the amount that the carrying amount of a reporting unit, including goodwill, exceeds its fair value, limited to the total amount of goodwill allocated to that reporting unit.

An entity may assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, including goodwill. If, after assessing the totality of events or circumstances qualitatively, an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity shall perform a quantitative goodwill impairment test. However, if, after assessing the totality of events or circumstances qualitatively, an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the quantitative goodwill impairment test is unnecessary.

Management notes that the emergence of COVID-19 as a global pandemic during the first nine months of 2020 has resulted in significant deterioration in general economic conditions and has caused a deterioration in the environment in which the Corporation operates. This uncertainty has resulted in a significant decreases in the market prices for the stock of institutions in the financial services industry, including the Corporation. Based on the totality of the circumstances and the impact of the economic conditions on the stock price, the events more likely than not reduce the fair value of a reporting unit below its carrying amount, including goodwill. As such, a quantitative analysis of the fair value of the Corporation as of September 30, 2020 was performed.

We utilized an independent third party in our analysis which considered both income and market approaches. The income approach used a discounted cash flow analysis based on a five-year forecast of results, including potential cost synergies a buyer would consider. The market approaches took into account the fair value of comparable companies (public guideline companies) as well as the Corporation’s current stock price adjusted for a control premium. We assigned weightings of 50% to the income approach, 40% to the public guideline companies’ result and 10% to the Corporation’s stock price with control premium result. The results indicated the Corporation’s fair value exceeded its carrying value by approximately 3% and no impairment was recognized.

The assumptions used in the impairment test of goodwill are susceptible to change based on changes in economic conditions and other factors, including our stock price. Any change in the assumptions which we utilize to determine the carrying value of goodwill could adversely impact our results of operations.

Note 16 – Adoption of New Accounting Standards and Effects of New Accounting Pronouncements

In June 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments- Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchases financial assets with credit deterioration since their origination. The new model referred to as current expected credit losses (“CECL”) model, will apply to: (a) financial assets subject to credit losses and measured at amortized cost; and (b) certain off-balance sheet credit exposures. This includes loans, held to maturity debt securities, loan commitments, financial guarantees and net investments in leases as well as reinsurance and trade receivables. The

estimate of expected credit losses should consider historical information, current information, and supportable forecasts, including estimates of prepayments. ASU 2016-13 was originally effective for SEC filers for annual periods beginning after December 15, 2019, and interim periods within those annual periods. In November 2019, the FASB approved a delay of the required implementation date of ASU No. 2016-13 for smaller reporting companies, as defined by the Securities and Exchange Commission, including the Corporation, resulting in a required implementation date for the Corporation of January 1, 2023.

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820)” - Changes to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements on fair value measurements by requiring that Level 3 fair value disclosures include the range and weighted average of significant unobservable inputs used to develop those fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 became effective for the Corporation on January 1, 2020 and did not have a significant impact on its financial condition or results of operations.

In March 2020, the FASB issued ASU No. 2020-04, “Reference Rate Reform (Topic 848).” The ASU provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendment only applies to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of the reference rate reform. The ASU is effective as of March 12, 2020 through December 31, 2022. The Corporation is in the process of evaluating the impact of this standard but believes that its adoption will not have a material impact on the Corporation’s financial condition or results of operations.

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

INTRODUCTION

The following discussion and analysis is intended as a review of material changes in and significant factors affecting the financial condition and results of operations of First United Corporation and its consolidated subsidiaries for the periods indicated. This discussion and analysis should be read in conjunction with the unaudited consolidated financial statements and the notes thereto contained in Item 1 of Part I of this report, as well as the audited consolidated financial statements and related notes included in First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019.

Unless the context clearly suggests otherwise, references in this report to “us”, “we”, “our”, and “the Corporation” are to First United Corporation and its consolidated subsidiaries.

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements do not represent historical facts, but are statements about management's beliefs, plans and objectives about the future, as well as its assumptions and judgments concerning such beliefs, plans and objectives. These statements are evidenced by terms such as "anticipate," "estimate," "should," "expect," "believe," "intend," and similar expressions. Although these statements reflect management's good faith beliefs and projections, they are not guarantees of future performance and they may not prove true. The beliefs, plans and objectives on which forward-looking statements are based involve risks and uncertainties that could cause actual results to differ materially from those addressed in the forward-looking statements. For a discussion of these risks and uncertainties, see the section of the periodic reports that First United Corporation files with the Securities and Exchange Commission entitled "Risk Factors", including the risk factor set forth in First United Corporation’s Annual Report on Form 10-K, as amended, for the year ended December 31, 2019 entitled, “The outbreak of the recent coronavirus (‘COVID-19’), or an outbreak of another highly infectious or contagious disease, could adversely affect the Corporation’s business, financial condition and results of operations.” and any updates thereto that might be contained in subsequent reports filed by First United Corporation. The risks and uncertainties associated with the COVID-19 pandemic and its impact on the Corporation will depend on, among other things, the length of time that the pandemic continues; the duration of the potential imposition of further restrictions on travel in the future; the effect of the pandemic on the global, national, and local economies and on the businesses of our borrowers and their ability to make payments on their obligations; the remedial actions and stimulus measures adopted by federal, state, and local governments; and the inability of employees to work due to illness, quarantine, or government mandates.

FIRST UNITED CORPORATION

First United Corporation is a Maryland corporation chartered in 1985 and a bank holding company registered with the Board of Governors of the Federal Reserve System (the “FRB”) under the Bank Holding Company Act of 1956, as amended. The Corporation’s primary business is serving as the parent company of First United Bank & Trust, a Maryland trust company (the “Bank”), First United Statutory Trust I (“Trust I”) and First United Statutory Trust II (“Trust II”), both Connecticut statutory business trusts.

(Trust I and Trust II, the “Trusts”). The Trusts were formed for the purpose of selling trust preferred securities that qualified as Tier 1 capital. The Bank has two consumer finance company subsidiaries - OakFirst Loan Center, Inc., a West Virginia corporation, and OakFirst Loan Center, LLC, a Maryland limited liability company - and two subsidiaries that it uses to hold real estate acquired through foreclosure or by deed in lieu of foreclosure - First OREO Trust, a Maryland statutory trust, and FUBT OREO I, LLC, a Maryland limited liability company.

At September 30, 2020, the Corporation’s total assets were $1.7 billion, net loans were $1.2 billion, and deposits were $1.4 billion. Shareholders’ equity at September 30, 2020 was $130.2 million.

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

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ESTIMATES AND CRITICAL ACCOUNTING POLICIES

This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent liabilities. (See Note 1 of the Notes to Consolidated Financial Statements included in Item 8 of Part II of First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019). On an on-going basis, management evaluates estimates, including those related to loan losses and potential impairment of goodwill, other-than-temporary impairment (“OTTI”) of investment securities, income taxes, fair value of investments and pension plan assumptions. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the consolidated financial statements.

Management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2019.

Allowance for Loan Losses

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

Goodwill

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 350, Intangibles - Goodwill and Other, provides guidance on the accounting and reporting of goodwill subsequent to its acquisition. The $11.0 million recorded as goodwill at September 30, 2020 is primarily related to the 2003 acquisition of certain branches.

Goodwill is not amortized but shall be tested at least annually for impairment at a level of accounting referred to as a reporting unit. The Corporation is considered the sole reporting unit. Goodwill of a reporting unit shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Impairment of goodwill is the condition that exists when the carrying amount of a reporting unit that includes goodwill exceeds its fair value. A goodwill impairment loss is recognized for the amount that the carrying amount of a reporting unit, including goodwill, exceeds its fair value, limited to the total amount of goodwill allocated to that reporting unit. An entity may assess qualitative factors to determine whether it is more likely than not (that is, a likelihood of more than 50 percent) that the fair value of a reporting unit is less than its carrying amount, including goodwill. If, after assessing the totality of events or circumstances qualitatively, an entity determines that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity shall perform the quantitative goodwill impairment test. However, if, after assessing the totality of events or circumstances qualitatively, an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then the quantitative goodwill impairment test is unnecessary.

The Corporation performs its annual goodwill assessment each December. However, management notes that the emergence of COVID-19 as a global pandemic during the first nine months of 2020 has resulted in significant deterioration in the general economic conditions and has caused a deterioration in the environment in which the Corporation operates. The reduction in interest rates and the resultant impact to margin, the impact of full and partial closures on business clients leading to loss of jobs for consumers and reduced cash flow for businesses, the execution of Paycheck Protection Program (“PPP”) loans and modifications, and the inflow of deposits as customers flock to safety are all signs indicative of the economic and industry stress. While the Corporation’s core income has remained strong year to date due to PPP fees, mortgage banking and steady net interest income, the provision expense has increased as the risk inherent in the loan portfolio has been recognized through changing qualitative factors. The full impact to earnings in the banking industry and to the Corporation specifically, remains uncertain as there have been a multitude of government plans implemented during the second quarter of 2020 aimed at providing financial assistance to businesses. However, the stock price for the Corporation has been negatively impacted, as has been the case with stock prices of the Corporation’s peers. Based on the totality of the circumstances and

the impact of the economic conditions on the stock price, management concluded that it is more likely than not that the fair value of a reporting unit is less than its carrying amount and engaged an independent third party to perform the quantitative analysis of comparing the fair value of the Corporation to its carrying value, including goodwill.

The quantitative assessment of goodwill was performed utilizing a discounted cash flow analysis (“income approach”) and estimates of selected market information (“market approach”). The income approach measures the fair value of an interest in a business by discounting expected future cash flows to present value. One market approach takes into consideration the fair values of comparable companies operating in similar lines of business that are potentially subject to similar economic and environmental factors and could be considered reasonable investment alternatives. The second market approach considered the Corporation’s current stock price adjusted for a control premium. The results of the income approach were weighted at 50% while the results of the market approaches were weighted 40% and 10%, respectively. The results of the quantitative impairment analysis indicated that the Corporation’s fair value exceeded the carrying value by approximately 3%.

Accounting for Income Taxes

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

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

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

Other-Than-Temporary Impairment of Investment Securities

Management systematically evaluates securities for impairment on a quarterly basis. Based upon application of accounting guidance for subsequent measurement in ASC Topic 320, Investments – Debt and Equity Securities (Section 320-10-35), management assesses whether (a) the Corporation has the intent to sell a security being evaluated and (b) it is more likely than not that the Corporation will be required to sell the security prior to the anticipated recovery of any decline in fair value. If neither applies, then any decline in the fair value below the security’s cost that is considered an other-than-temporary decline is split into two components. The first is the loss attributable to declining credit quality. Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made. The second component consists of all other losses, which are recognized in other comprehensive loss. In estimating OTTI losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) adverse conditions specifically related to the security, an industry, or a geographic area, (3) the historic and implied volatility of the fair value of the security, (4) changes in the rating of the security by a rating agency, (5) recoveries or additional declines in fair value subsequent to the balance sheet date, (6) failure of the issuer of the security to make scheduled interest or principal payments, and (7) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future. Management also monitors cash flow projections for securities that are considered beneficial interests under the guidance of ASC Subtopic 325-40, Investments – Other – Beneficial Interests in Securitized Financial Assets, (ASC Section 325-40-35). This process is described more fully in the Investment Securities section of the Financial Condition section located elsewhere in this MD&A.

Fair Value of Investments

We have determined the fair value of our investment securities in accordance with the requirements of ASC Topic 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements required under other accounting pronouncements. The Corporation measures the fair market values of its investments based on the fair value hierarchy established in Topic 820. The determination of fair value of investments and other assets is discussed further in Note 8 to the consolidated financial statements presented elsewhere in this report.

Pension Plan Assumptions

Our pension plan costs are calculated using actuarial concepts, as discussed within the requirements of ASC Topic 715, Compensation – Retirement Benefits. Pension expense and the determination of our projected pension liability are based upon two critical assumptions: (a) the discount rate; and (b) the expected return on plan assets. We evaluate each of these critical assumptions annually. Other assumptions impact the determination of pension expense and the projected liability including the primary employee demographics, such as retirement patterns, employee turnover, mortality rates, and estimated employer compensation increases. These factors, along with the critical assumptions, are carefully reviewed by management each year in consultation with our pension plan consultants and actuaries. Further information about our pension plan assumptions, the plan’s funded status, and other plan information is included in Note 11 to the consolidated financial statements presented elsewhere in this report.

Response to COVID-19

Protecting the health, safety, and financial well-being of our associates and customers was and continues to be our goal as we quickly adapted to COVID-19.

The following actions were implemented from our well-designed and tested Business Continuity Plan:

Notified our shareholders and customers in early March as to our enhanced measures to protect our associates and customers

Suspended all business travel, reduced all face to face meetings with outside vendors and customers, and requested all associates postpone personal travel outside of their market areas

oImplemented self-quarantine measures for associates who travel outside the market areas

Implemented plans in mid-March for all eligible associates to work remotely via our Virtual Private Network (“VPN”); utilized Skype and Microsoft teams for internal communication

oContinue to have approximately 80% of the workforce working remotely

Implemented a Pandemic Pay Policy for associates who are unable to work for COVID-19 related reasons, including those who need to care for family members and school children

Increased cleaning and disinfecting services in all physical locations

On March 19, communicated the closure of our branch lobbies and promoted the use of drive up facilities as well as our robust digital banking platform

During the month of October, we reopened our community office lobbies while maintaining proper safety controls.

Regular and up-to-date communication:

oWeekly COVID-19 update calls with internal Pandemic Team

oWeekly emails to all associates with international, national and state specific updates

oWeekly Teams meetings with all associates to ensure continued interaction for those associates still working remotely

oRegularly updated website with helpful links to keep our customers well-informed at www.mybank.com

Relieved the financial pressure for customers:

oWaived certificates of deposit early withdrawal penalties and overdraft fees, on a case by case basis, for non-sufficient funds

oTemporarily waived positive pay/Treasury Management fees for new customer signup for fraud prevention

oImplemented loan modifications and deferral programs for eligible consumer and commercial loan customers experiencing hardships; See Note 2 for more details

oTemporarily suspended repossession and foreclosure activity

oContinued frequent communication with associates and borrowers, keeping them apprised of changing regulations regarding PPP loan forgiveness

Paycheck Protection Program

associates so they could guide our customers on the proper procedures necessary to enable them to take advantage of this program. We developed an SBA PPP specific information site within our website that provided detailed information, links and materials for eligible customers to access. Internally, we reallocated resources to review, process and data enter customer applications, working tirelessly over extended hours to provide access to as many local business owners as possible. As of September 30, 2020, we have funded 1,174 loan applications for approximately $148.9 million. These loans are 100% guaranteed by the SBA, have up to a two or five year maturity, provide for a nine month deferral period, and have an interest rate of 1%. These loans may be forgiven, in whole or in part, by the SBA if the borrower meets certain conditions, including by using at least 60% of the loan proceeds for payroll costs. The SBA also established processing fees from 1% to 5%, depending on the loan amount. We anticipate recognizing approximately $3.5 million in deferred loan fees.

In April 2020, the Bank established eligibility to participate in the Paycheck Protection Program Liquidity Facility (“PPPLF”) which was established by Congress and administered by the Federal Reserve Bank. This facility uses the SBA guaranteed PPP loans as collateral, offering 100% collateral coverage with no recourse to the Bank. The Bank’s board of directors and management team believe that it is prudent to maintain our existing liquidity facilities available for our contingency funding plan given the current economic conditions. The majority of the PPP loan disbursements have been to internal, non-interest-bearing accounts awaiting use by borrowers. As a result, we have not yet accessed the PPPLF, but are prepared to utilize the fund if and when management determines the timing is appropriate.

During the third quarter of 2020, the Bank implemented forgiveness processes to assist our borrowers with applications. Communication with the associates and borrowers was a focus as we helped them through this process. As of October 26, 2020, 51 loans, or 4.4%, of total PPP loans, have been approved by SBA, 123 loans, or 10.5%, of total PPP loans, have been submitted and pending SBA validation, and an additional 76 loans, or 6.5% of total PPP loans, are under review at the Bank.

Liquidity Sources

Management has reviewed its Liquidity Contingency Funding Plan in preparation of funding needs as it relates to the COVID-19 pandemic. As of September 30, 2020, the Corporation had approximately $145.0 million in unsecured lines of credit with its correspondent banks, $1.1 million with the Federal Reserve Discount Window, and approximately $137.5 million of secured borrowings with the Federal Home Loan Bank of Atlanta (“FHLB”). Additionally, the Corporation has access to the brokered certificates of deposit market.

As noted above, the Corporation is eligible to access the PPPLF when it is deemed appropriate.

Capital

The Corporation’s and the Bank’s capital ratios are strong, and both institutions are considered to be well-capitalized by applicable regulatory measures.

SELECTED FINANCIAL DATA

The following table sets forth certain selected financial data for the nine month periods ended September 30, 2020 and 2019 and is qualified in its entirety by the detailed information and unaudited financial statements, including the notes thereto, included elsewhere in this quarterly report.



	As of or for the nine months ended
	September 30,
	2020		2019
Per Share Data
Basic net income per common share	$	1.32	$	1.44
Diluted net income per common share	$	1.32	$	1.44
Basic book value per common share	$	18.63	$	18.20
Diluted book value per common share	$	18.62	$	18.20
Significant Ratios
Return on Average Assets (a)		0.79%		0.97%
Return on Average Equity (a)		9.87%		10.96%
Average Equity to Average Assets		10.61%		8.82%

Note: ^(a) Annualized

RESULTS OF OPERATIONS

Overview

Consolidated net income was $9.3 million for the nine months ended September 30, 2020 compared to $10.2 million for the nine months ended September 30, 2019. Basic and diluted net income per share for the first nine months of 2020 were both $1.32, compared to basic and diluted net income per share of $1.44 for the same period of 2019, an 8.3% decrease. The decrease in earnings was primarily due to an increase in the provision for loan losses of $4.3 million, offset by an increase in net interest income of $2.0 million, an increase of $0.7 million in other operating income, including gains, and a decrease in other operating expenses of $0.7 million. The increase in provision expense for the first nine months of 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 health crisis and its impact on our borrowers. Of the $5.0 million expense for the first nine months, $4.4 million was related to qualitative factor adjustments and $0.6 million was related to loan growth and the change in mix at higher reserve factors. The net interest margin, on a FTE basis, declined for the nine months ended September 30, 2020 to 3.43% compared to 3.67% at September 30, 2019.

The provision for loan losses was $5.0 million for the nine month period ended September 30, 2020 and $0.7 million for the nine month period ended September 30, 2019. The increase in provision expense for the first nine months of 2020 was due to the uncertainty of the economic environment related to the COVID-19 health crisis. Of the $5.0 million expense for the nine months ended September 30, 2020, $4.4 million is related to qualitative factor adjustments and $0.6 million is related to loan growth and a change in mix of loans at higher reserve factors.

Net interest income, on a non-GAAP, FTE basis, increased $2.0 million (5.7%) during the nine months ended September 30, 2020 when compared to the nine months ended September 30, 2019 due to a $0.9 million (2.1%) increase in interest income. Interest expense decreased $1.1 million when compared to the same time period of 2019, despite an increase in average balances of $62.8 million. The net interest margin for the nine months ended September 30, 2020 was 3.43%, compared to 3.67% for the nine months ended September 30, 2019. The impact of average balances of PPP loans of approximately $91.0 million, offset by the $1.5 million of interest and fees related to these loans, had a negative impact on the margin of approximately 9 basis points. The margin was also negatively impacted by the 2.25% drop in the Fed Funds rate since August of 2019, which resulted in loan production and loans repricing at lower rates. The foregoing factors resulted in a decrease of approximately 16 basis points in the loan yield when compared to the nine months ended September 30, 2019.

Comparing the nine months ended September 30, 2020 to the same period of 2019, the increase in interest income was due to a $2.0 million increase in interest and fees on loans. Excess cash balances attributable to deposit growth were invested at the lower Fed Funds rate, which negatively impacted interest income for the nine months ended September 30, 2020. The increase in interest and fees on loans was due primarily to an increase in average balances of $136.6 million, primarily driven by the PPP loans but offset by the declining yield. The rate earned on the loan portfolio decreased by 37 basis points as a result of the significant decline in the rate environment over the past year and the high volume of PPP loans at the low 1.00% interest rate as noted above. Additionally, the average balance of the investment portfolio decreased by $9.3 million due primarily to calls and sales of securities. The rate earned on investments decreased by 26 basis points due to the calls as well as the reduced rate on the adjustable rate trust preferred collateralized debt obligations (“CDO”) portfolio.

Interest expense on our interest-bearing liabilities decreased $1.1 million during the nine months ended September 30, 2020 when compared to 2019 due to continued rate reductions on our deposit products in response to the declining rate environment, particularly our money market products. The average balance of money market accounts increased $51.1 million during the first nine months of 2020 when compared to the same period of 2019, while the rate on these accounts decreased by 34 basis points. We continue to monitor the rate environment in our markets and have been able to proactively reduce rates on our deposit products to mitigate the reduced interest income on our loan portfolio. Average growth of $93.9 million in our non-interest bearing accounts benefited our overall cost of deposits. Deposit growth was attributable to PPP funding and organic deposit growth in low cost core deposits with existing customers as well as new relationship customers through the first nine months of 2020.

Other operating income, including gains, increased $0.7 million for the nine months ended September 30, 2020 when compared to 2019. The increase was primarily attributable to the $1.8 million increase in net gains offset by a $1.0 million decline in Bank Owned Life Insurance (“BOLI”) income due to the receipt of $1.1 million death benefits in the third quarter of 2019. Service charge income, primarily NSF income, decreased as the consumer and business overdraft activity decreased in the first nine months quarter of 2020 due to reduced consumer spending as well as the receipt of stimulus and PPP funding. The increase in net gains was a result of increased fees on the sale of loans related to the high volume of mortgage refinancing activity due to historically low rates, as well as gains on the sale of investments. As prepayment speeds on investments held for sale were elevated due to the low rate environment and the investments were prepaying at par, we made the decision to capture $0.6 million in gains on the sale of these investments. Trust and brokerage income remained stable, impacted by market volatility early in the year which impacted fees that are directly related to the value of assets under management. Debit card income was stable for the nine months ended September 30, 2020 when compared to the same period of 2019 despite reduced consumer spending.

Other operating expenses decreased $0.7 million for the nine months ended September 30, 2020 when compared to the same period of 2019. Salaries and benefits decreased $2.4 million, primarily due to the $1.7 million salary expense offset related to loan originations, primarily related to PPP loans, as well as reduced headcount resulting from the voluntary separation program implemented in the fourth quarter of 2019 and reduced life and health insurance costs. These reductions offset the annual merit increases awarded to our associates in April 2020. Federal Deposit Insurance Corporation premiums increased slightly due to credits received on quarterly assessments in 2019. Equipment, occupancy and technology expenses increased $0.4 million when compared to the nine months ended September 30, 2019 due to final branch modernizations placed into service in the fourth quarter of 2019 and the first quarter of 2020. Professional services increased $1.7 million as a result of increased legal and professional expenses due to costs related to the 2020 annual meeting of shareholders (the “2020 Meeting”) and related proxy contest. Investor relations expenses increased $1.0 million, which also related to the 2020 Meeting and related proxy contest. OREO expenses decreased $1.3 million due to valuation allowance write-downs in 2019. Increased marketing, consulting, fraud expenses and Visa processing fees were offset by reductions in schools and seminars, contributions, dues and licenses, office supplies, mileage, contract labor, business related meals and other employee benefits expenses, most of which were related to limited operations as a result of the pandemic and management’s continued focus on cost savings and efficiencies.

Consolidated net income was $5.0 million for the third quarter of 2020 compared to $4.5 million for the third quarter of 2019. Basic and diluted net income per common share for the third quarter of 2020 were both $0.70, compared to basic and diluted net income per common share of $0.63 for the third quarter of 2019. Net interest income increased slightly by $0.3 million when comparing the third quarter of 2020 to the third quarter of 2019. The increase in net interest income was due to the decrease in interest expense of $0.7 million, offset by a decrease in interest income of $0.3 million when comparing the third quarters of 2020 and 2019. Other operating income for the third quarter of 2020 decreased by approximately $1.0 million when compared to the same period of 2019. Service charge income, particularly non-sufficient funds (“NSF”) income, declined as a result of significantly reduced overdraft activity during the third quarter of 2020 when compared to the third quarter of 2019. Trust and brokerage income increased slightly due to increased production and market values on assets under management. These increases were offset by the reduction in BOLI income due to the receipt of $1.1 million in death benefits in the third quarter of 2019. Net gains increased $1.1 million when comparing the third quarter of 2020 to the third quarter of 2019. As prepayment speeds were elevated due to the low rate environment and investments were prepaying at par, we made the decision to capture $0.6 million in gains on the sale of investments. Higher levels of gains of approximately $0.7 million on the sale of mortgage loans to the secondary market, related to the high volume of refinancing activity at historically low rates, continued during the third quarter of 2020. Other operating expenses decreased by $0.7 million when comparing the third quarter of 2020 to the third quarter of 2019. This decrease was driven by the decrease in salaries and benefits related to reduced due to reduced headcount, reduced health insurance costs and the salary costs associated with loan originations. Other miscellaneous expenses, such as contributions, office supplies, travel and lodging, schools and seminars, mileage and business-related meals, declined as a result of limitations imposed due to the pandemic. These decreases were offset by an increase in data processing fees and increased legal expenses. The net interest margin for the third quarter of 2020 and the third quarter of 2019, on an FTE basis, was 3.12% and 3.62%, respectively. The reduced margin was attributable to lower loan yields and increased cash levels.

environment and the characteristics of the loan portfolio. During the third quarter of 2020, factor adjustments were offset by a re-allocation of a $1.3 million specific on an adversely classified, non-accrual loan. See Note 6 for further discussion.

Net interest income, on an FTE basis, increased $0.3 million (2.7%) during the third quarter of 2020 over the same period in 2019 as a result of a decrease in interest expense of approximately $0.7 million (21.7%), offset by a $0.3 million (2.2%) decrease in interest income. The net interest margin for the third quarter of 2020 was 3.12%, compared to 3.62% for the third quarter of 2019. As noted above, the participation in the PPP loan program and the reduced rate environment negatively impacted our margin during the third quarter.

Comparing the third quarter of 2020 to the same period of 2019, the decrease in interest income was primarily due to a $0.4 million increase in interest and fees on loans, offset by a $0.7 million decrease in investment and other interest income. The increase in interest and fees on loans was due to an increase in average balances of $213.1 million. The increase in average balances was attributable to PPP loans of approximately $145.0 million and new loans booked during the third quarter, all at lower rates. This increased activity, combined with existing loans repricing at lower rates contributed to the decrease of 75 basis points in the rate earned on the portfolio. During the third quarter, we continued to see pricing pressure in all markets as borrowers sought to take advantage of the reduced rate environment. Excess cash balances related to deposit growth, invested at the lower Fed funds rate, also negatively impacted interest income. Higher cash balances were maintained to preserve liquidity due to economic uncertainties.

Other operating income, including gains, for the third quarter of 2020 increased by approximately $0.1 million when compared to the same period of 2019. Service charge income, particularly NSF income, declined as a result of significantly reduced overdraft activity during the third quarter of 2020 when compared to the third quarter of 2019. Trust and brokerage income increased slightly due to increased production and market values on assets under management. These increases were offset by the reduction in BOLI income due to the receipt of $1.1 million in death benefits in the third quarter of 2019. Net gains increased $1.1 million when comparing the third quarter of 2020 to the third quarter of 2019. As prepayment speeds were elevated due to the low rate environment and investments were prepaying at par, we made the decision to capture $0.6 million in gains on the sale of investments. Higher levels of gains of approximately $0.7 million on the sale of mortgage loans to the secondary market, related to the high volume of refinancing activity at historically low rates, continued during the third quarter of 2020.

Other operating expenses decreased $0.7 million when comparing the third quarter of 2020 to the third quarter of 2019. Salaries and benefits decreased $0.9 million due to reduced headcount associated with the voluntary separation program introduced in the fourth quarter of 2019, reduced health insurance costs and the salary expense offset associated with the origination of loans during the third quarter. Equipment, occupancy and data processing expenses increased by $0.2 million. Legal and professional expenses increased by $0.3 million when comparing the third quarter of 2020 to the same time period of 2019 and was attributable to the recent litigation. OREO expenses decreased by $0.3 million when comparing the third quarter of 2020 to the third quarter of 2019 due to valuation allowance write-downs on properties in the third quarter of 2019. Other miscellaneous expenses such as marketing, consulting, miscellaneous, trust department expenses increased slightly but were offset by decreases in contributions, personnel related expenses, postage, travel and lodging, mileage, contract labor, schools and seminars and business-related meals. Most of the expense reductions are related to limited operations as a result of the pandemic and management’s continued focus on cost savings and efficiencies.

Net Interest Income

Net interest income is our largest source of operating revenue. Net interest income is the difference between the interest that we earn on our interest-earning assets and the interest expense we incur on our interest-bearing liabilities. For analytical and discussion purposes, net interest income is adjusted to a FTE basis to facilitate performance comparisons between taxable and tax-exempt assets by increasing tax-exempt income by an amount equal to the federal income taxes that would have been paid if this income were taxable at the statutorily applicable rate. This is a non-GAAP disclosure and management believes it is not materially different than the corresponding GAAP disclosure.

‎

The table below summarizes net interest income for the nine and three months ended September 30, 2020 and 2019.


		GAAP				Non-GAAP - FTE
	Nine Months Ended					Nine Months Ended
(dollars in thousands)		2020		2019		2020		2019
Interest income	$	43,973	$	43,083	$	44,651	$	43,732
Interest expense		7,528		8,614		7,528		8,614
Net interest income	$	36,445	$	34,469	$	37,123	$	35,118
Net interest margin %		3.37%		3.59%		3.43%		3.67%

	Three Months Ended					Three Months Ended
(dollars in thousands)		2020		2019		2020		2019
Interest income	$	14,253	$	14,600	$	14,481	$	14,810
Interest expense		2,351		3,004		2,351		3,004
Net interest income	$	11,902	$	11,596	$	12,130	$	11,806
Net interest margin %		3.06%		3.55%		3.12%		3.62%

The following table sets forth the average balances, net interest income and expense, and average yields and rates of our interest-earning assets and interest-bearing liabilities for the nine and three month periods ended September 30, 2020 and 2019:



	Nine Months Ended
	September 30,
	2020					2019
(dollars in thousands)	Average ‎Balance		Interest		Average ‎Yield/Rate	Average ‎Balance		Interest		Average ‎Yield/Rate
Assets
Loans	$	1,136,473	$	39,231	4.61%	$	999,851	$	37,255	4.98%
Investment Securities:
Taxable		197,186		3,612	2.45%		207,261		4,333	2.79%
Non taxable		26,335		1,448	7.34%		25,540		1,380	7.22%
Total		223,521		5,060	3.02%		232,801		5,713	3.28%
Federal funds sold		79,228		182	0.31%		40,977		522	1.70%
Interest-bearing deposits with other banks		889		9	1.37%		1,111		16	1.92%
Other interest earning assets		4,451		169	5.06%		4,511		226	6.70%
Total earning assets		1,444,562		44,651	4.13%		1,279,251		43,732	4.57%
Allowance for loan losses		(15,049)					(11,835)
Non-earning assets		146,213					145,426
Total Assets	$	1,575,726				$	1,412,842
Liabilities and Shareholders’ Equity
Interest-bearing demand deposits	$	177,848	$	531	0.40%	$	160,975	$	466	0.39%
Interest-bearing money markets		305,714		1,207	0.53%		254,638		1,666	0.87%
Savings deposits		172,735		136	0.10%		161,148		225	0.19%
Time deposits:
Less than $100k		111,757		1,310	1.57%		106,006		1,066	1.34%
$100k or more		129,290		1,813	1.87%		154,457		2,377	2.06%
Short-term borrowings		43,895		68	0.21%		41,195		158	0.51%
Long-term borrowings		100,929		2,463	3.26%		100,929		2,656	3.52%
Total interest-bearing liabilities		1,042,168		7,528	0.96%		979,348		8,614	1.18%
Non-interest-bearing deposits		362,547					268,637
Other liabilities		45,572					40,212
Shareholders’ Equity		125,439					124,645
Total Liabilities and Shareholders’ Equity	$	1,575,726				$	1,412,842
Net interest income and spread			$	37,123	3.17%			$	35,118	3.39%
Net interest margin					3.43%					3.67%

Note:

(1)The above table reflects the average rates earned or paid stated on an FTE basis assuming a 21% tax rate for 2020 and 2019. Non-GAAP interest income on a fully taxable equivalent was $679 and $649, respectively.

(2)Net interest margin is calculated as net interest income divided by average earning assets.

(3)The average yields on investments are based on amortized cost.

Net interest income, on a non-GAAP, FTE basis, increased $2.0 million (5.7%) during the nine months ended September 30, 2020 when compared to the nine months ended September 30, 2019 due to a $0.9 million (2.1%) increase in interest income. Interest expense decreased $1.1 million comparing the same time period, despite an increase in average balances of $62.8 million. The net interest margin for the nine months ended September 30, 2020 was 3.43%, compared to 3.67% for the nine months ended September 30, 2019. The impact of average balances of PPP loans of approximately $91.0 million offset by the $1.5 million of interest and fees related to these loans, had a negative impact on the margin of approximately 9 basis points. The margin was also negatively impacted by the 2.25% drop in the Fed Funds rate since August of 2019 which resulted in loan production and loans repricing at lower rates. This resulted in a decrease of approximately 16 basis points in the loan yield compared to the nine months ended September 30, 2019.

Comparing the nine months ended September 30, 2020 to the same period of 2019, the increase in interest income was due to a $2.0 million increase in interest and fees on loans. Excess cash balances attributable to deposit growth were invested at the lower Fed Funds rate which negatively impacted interest income for the nine months ended September 30, 2020. The increase in interest and fees on loans was due primarily to an increase in average balances of $136.6 million primarily driven by the PPP loans offset by the declining yield. The rate earned on the loan portfolio decreased by 37 basis points as a result of the significant decline in the rate environment over the past year and the high volume of PPP loans at the low 1.00% rate as noted above. Additionally, the average balance of the investment portfolio decreased by $9.3 million due primarily to calls and sales of securities. The rate earned on investments decreased by 26 basis points due to the calls as well as the reduced rate on the adjustable rate trust preferred CDO portfolio.

Interest expense on our interest-bearing liabilities decreased $1.1 million during the nine months ended September 30, 2020 when compared to the same period of 2019 due to continued rate reductions on our deposit products in response to the declining rate environment, particularly our money market products. The average balance of money market accounts increased $51.1 million during the nine months ended 2020 when compared to same period of 2019 while the rate on these accounts decreased by 34 basis points. We continue to monitor the rate environment in our markets and have been able to proactively reduce rates on our deposit products to mitigate the reduced interest income on our loan portfolio. Average growth of $93.9 million in our non-interest bearing accounts benefits our overall cost of deposits. Deposit growth was attributable to PPP funding and organic deposit growth in low cost core deposits with existing customers as well as new relationship customers through the first nine months of 2020.



	Three Months Ended
	September 30,
	2020					2019
(dollars in thousands)	Average ‎Balance		Interest		Average ‎Yield/Rate	Average ‎Balance		Interest		Average ‎Yield/Rate
Assets
Loans	$	1,198,888	$	12,950	4.30%	$	985,767	$	12,543	5.05%
Investment Securities:
Taxable		194,722		960	1.96%		208,418		1,416	2.70%
Non taxable		27,049		494	7.26%		24,575		445	7.18%
Total		221,771		1,454	2.61%		232,993		1,861	3.17%
Federal funds sold		119,039		28	0.09%		71,230		332	1.85%
Interest-bearing deposits with other banks		1,157		2	0.73%		1,103		7	2.52%
Other interest earning assets		4,468		47	4.15%		4,415		67	6.02%
Total earning assets		1,545,323		14,481	3.73%		1,295,508		14,810	4.54%
Allowance for loan losses		(17,252)					(12,302)
Non-earning assets		153,846					150,789
Total Assets	$	1,681,917				$	1,433,995
Liabilities and Shareholders’ Equity
Interest-bearing demand deposits	$	195,363	$	190	0.39%	$	160,309	$	172	0.43%
Interest-bearing money markets		332,012		330	0.40%		256,551		581	0.90%
Savings deposits		182,733		35	0.08%		162,088		77	0.19%
Time deposits:
Less than $100k		111,647		435	1.55%		109,493		402	1.46%
$100k or more		121,986		525	1.71%		159,390		832	2.07%
Short-term borrowings		45,719		19	0.17%		37,910		27	0.28%
Long-term borrowings		100,929		817	3.22%		100,929		913	3.59%
Total interest-bearing liabilities		1,090,389		2,351	0.86%		986,670		3,004	1.21%
Non-interest-bearing deposits		407,334					274,538
Other liabilities		56,091					43,957
Shareholders’ Equity		128,103					128,830
Total Liabilities and Shareholders’ Equity	$	1,681,917				$	1,433,995
Net interest income and spread			$	12,130	2.87%			$	11,806	3.33%
Net interest margin					3.12%					3.62%

Note:

(2)Net interest margin is calculated as net interest income divided by average earning assets.

(3)The average yields on investments are based on amortized cost.

Net interest income, on an FTE basis, increased $0.3 million (2.7%) during the third quarter of 2020 over the same period in 2019 driven by a decrease in interest expense of approximately $0.7 million (21.7%) offset by a $0.3 million (2.2%) decrease in interest income. The net interest margin for the third quarter of 2020 was 3.12%, compared to 3.62% for the third quarter of 2019. As noted above, the participation in the PPP loan program and the reduced rate environment negatively impacted our margin during the third quarter.

Comparing the third quarter of 2020 to the same period of 2019, the increase in interest income was primarily due to a $0.4 million increase in interest and fees on loans. The increase in interest and fees on loans was due to an increase in average balances of $213.1 million. The increase in average balances is attributable to PPP loans of approximately $145.0 million and new loans booked during the third quarter, all at lower rates. This activity, combined with existing loans repricing at lower rates, contributed to the decrease of 75 basis points in the rate earned on the portfolio. During the third quarter of 2020, we continued to see pricing pressure in all markets as borrowers sought to take advantage of the reduced rate environment. Excess cash balances related to deposit growth, invested at the lower Fed funds rate, also negatively impacted interest income. Higher cash balances were maintained to preserve liquidity due to economic uncertainties.

Interest expense on our interest-bearing liabilities decreased by $0.7 million during the third quarter of 2020 when compared to the same period of 2019, due primarily to reductions in rates on the deposit portfolio and certificates of deposit rolling over at lower rates due to rate empowerments expiring. The following table sets forth an analysis of volume and rate changes in interest income and interest expense for our average interest-earning assets and average interest-bearing liabilities for the nine and three month periods ended September 30, 2020 and 2019:


	For the Nine months ended September 30, 2020 compared to the Nine months ended September 30, 2019
(in thousands and tax equivalent basis)	Volume		Rate		Net
Interest Income:
Loans	$	5,105	$	(3,129)	$	1,976
Taxable Investments		(211)		(510)		(721)
Non-taxable Investments		43		25		68
Federal funds sold		489		(829)		(340)
Interest-bearing deposits		(3)		(4)		(7)
Other interest earning assets		(3)		(54)		(57)
Total interest income		5,420		(4,501)		919
Interest Expense:
Interest-bearing demand deposits		49		16		65
Interest-bearing money markets		335		(794)		(459)
Savings deposits		16		(105)		(89)
Time deposits less than $100K		58		186		244
Time deposits $100K or more		(388)		(176)		(564)
Short-term borrowings		10		(100)		(90)
Long-term borrowings		—		(193)		(193)
Total interest expense		80		(1,166)		(1,086)
Net interest income	$	5,340	$	(3,335)	$	2,005

‎



	For the Three months ended September 30, 2020 compared to the Three months ended September 30, 2019
(in thousands and tax equivalent basis)	Volume		Rate		Net
Interest Income:
Loans	$	2,690	$	(2,283)	$	407
Taxable Investments		(92)		(364)		(456)
Non-taxable Investments		44		5		49
Federal funds sold		221		(525)		(304)
Interest-bearing deposits		0		(5)		(5)
Other interest earning assets		1		(21)		(20)
Total interest income		2,864		(3,193)		(329)
Interest Expense:
Interest-bearing demand deposits		37		(19)		18
Interest-bearing money markets		169		(420)		(251)
Savings deposits		10		(52)		(42)
Time deposits less than $100K		8		25		33
Time deposits $100K or more		(194)		(113)		(307)
Short-term borrowings		6		(14)		(8)
Long-term borrowings		—		(96)		(96)
Total interest expense		36		(689)		(653)
Net interest income	$	2,828	$	(2,504)	$	324

Note:

(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.

Provision for Loan Losses

The provision for loan losses was $5.0 million for the nine month period ended September 30, 2020 and $0.7 million for the nine month period ended September 30, 2019. The increase in provision expense for the first nine months of 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 health crisis and its impact on our borrowers. Of the $5.0 million expense for the nine months ended September 30, 2020, $4.4 million is related to qualitative factor adjustments and $0.6 million is related to loan growth as well as the change in mix within the portfolio at higher reserve factors.

The provision for loan losses was $0.2 million for the third quarter of 2020 and $(13) thousand for the third quarter of 2019. Specific allocations have been made for impaired loans where management has determined that the collateral supporting the loans is not adequate to cover the loan balance, and the qualitative factors affecting the ALL have been adjusted based on the current economic environment and the characteristics of the loan portfolio. During the third quarter of 2020, factor adjustments were offset by a re-allocation of a $1.3 million specific on an adversely classified, non-accrual loan. See Note 6 for further details.

Other Operating Income

The following table shows the major components of other operating income for the nine and three month periods ended September 30, 2020 and 2019, exclusive of net gains:



	Income as % of ‎Total Other Operating Income, exclusive of net gains						Income as % of ‎Total Other Operating Income, exclusive of net gains
	Nine Months Ended						Three Months Ended
	September 30,						September 30,
(in thousands)	2020			2019			2020			2019
Service charges on deposit accounts	$	1,439	13%	$	1,652	14%	$	447	11%	$	578	13%
Other service charges		517	5%		607	6%		195	5%		225	6%
Trust department		5,355	47%		5,345	46%		1,871	47%		1,798	47%
Debit card income		2,052	18%		1,955	17%		738	19%		679	18%
Bank owned life insurance		961	8%		1,970	8%		373	9%		1,379	8%
Brokerage commissions		713	6%		646	6%		234	6%		205	5%
Other income		374	3%		369	3%		120	3%		115	3%
	$	11,411	100%	$	12,544	100%	$	3,978	100%	$	4,979	100%

Other Operating Expenses

The composition of other operating expenses for the nine and three month periods ended September 30, 2020 and 2019 is illustrated in the following table:



	Expense as % of ‎Total Other Operating Expenses						Expense as % of ‎Total Other Operating Expenses
	Nine Months Ended						Three Months Ended
	September 30,						September 30,
(in thousands)	2020			2019			2020			2019
Salaries and employee benefits	$	16,244	49%	$	18,644	56%	$	5,378	51%	$	6,280	55%
FDIC premiums		404	1%		337	1%		201	2%		43	0%
Equipment		2,871	9%		2,775	8%		978	9%		956	9%
Occupancy		2,200	7%		2,112	6%		707	7%		694	6%
Data processing		3,155	10%		2,979	9%		1,130	11%		984	9%
Marketing		405	1%		274	1%		122	1%		110	1%
Professional services		2,506	8%		776	2%		602	6%		254	2%
Contract labor		480	1%		502	1%		180	2%		171	2%
Line rentals		654	2%		641	2%		216	2%		226	2%
Other real estate owned		3	0%		1,266	4%		6	0%		337	3%
Investor relations		1,160	3%		146	0%		54	0%		36	0%
Other		2,890	9%		3,225	11%		966	9%		1,155	10%
	$	32,972	100%	$	33,677	100%	$	10,540	100%	$	11,246	100%

Provision for Income Taxes

In reporting interim financial information, income tax provisions should be determined under the procedures set forth in ASC Topic 740, Income Taxes (Section 740-270-30). This guidance provides that at the end of each interim period, an entity should make its best estimate of the effective tax rate expected to be applicable for the full fiscal year. The rate so determined should be used in providing for income taxes on a current year-to-date basis. The effective tax rate should reflect anticipated investment tax credits, capital gains rates, and other available tax planning alternatives. In arriving at this effective tax rate, however, no effect should be included for the tax related to significant, unusual or extraordinary items that will be separately reported or reported net of their related tax effect in reports for the interim period or for the fiscal year.

The effective income tax rate as a percentage of income increased to 22.1% at September 30, 2020 from 20.3% at September 30, 2019 primarily due to a reduction of tax exempt income related to BOLI income during the first nine months of 2020.

FINANCIAL CONDITION

Balance Sheet Overview

Total assets at September 30, 2020 increased by $243.9 million to $1.7 billion from December 31, 2019. During the first nine months of 2020, cash and interest-bearing deposits in other banks increased by $105.6 million, the investment portfolio decreased by $2.9 million and gross loans increased by $142.0 million, offset by the increase to the ALL of $3.7 million. The increase in cash was due to continued deposit growth, consisting of both core deposit growth and deposits related to the PPP loans, cash flow from calls on the investment portfolio, commercial loan payoffs in the first quarter as well as continued refinances of balances in our mortgage portfolio. OREO balances declined slightly due to minimal activity in this portfolio during the first nine months of 2020. Total liabilities increased by $239.6 million. This increase was attributable to the strong deposit growth of $235.3 million, inclusive of the remaining deposit balances related to the PPP loans at September 30, 2020. The deposit growth, excluding the PPP deposits, during the first nine months of 2020 was due to increased relationship balances as we continued to grow core relationships and customers favored insured products given the volatile economic environment. Our Treasury Management overnight investment sweep increased by $3.9 million as we saw growth in existing municipality accounts during the third quarter of 2020. Total shareholders’ equity increased by $4.3 million in the first nine months of 2020, primarily due to the increase in earnings attributable to year-to-date net income offset by common stock dividends of $2.7 million and the decline in surplus related to the stock repurchase of $2.7 million during the first quarter of 2020.

Loan Portfolio

The following table presents the composition of our loan portfolio at the dates indicated:



(dollars in thousands)	September 30, 2020			December 31, 2019
Commercial real estate	$	353,272	30%	$	335,504	31%
Acquisition and development		127,299	11%		117,890	12%
Commercial and industrial		277,723	23%		122,352	11%
Residential mortgage		398,709	33%		438,424	43%
Consumer		35,342	3%		36,199	3%
Total Loans	$	1,192,345	100%	$	1,050,369	100%

Outstanding loans increased to $1.2 billion at September 30, 2020 when compared to December 31, 2019. The $142.0 million of growth was primarily attributable to the participation in the SBA PPP loan program and core commercial loan growth, offset by a decline in our mortgage loan portfolio. Commercial real estate (“CRE”) loans increased by $17.8 million due to expansion of several new customer relationships as well as an increase in small business loans. Acquisition and development (“A&D”) loans increased by $9.4 million as new production offset amortization and payoffs. Commercial and industrial (“C&I”) loans increased by $155.4 million, including $148.9 million of PPP loans. The growth in the commercial portfolios was offset by a decline in residential mortgage loans of $39.7 million as refinancing activity continued during the third quarter. Given the current low interest rate environment, management has elected to utilize the secondary market rather than portfolio these longer term, fixed rate loans at this time. The consumer loan portfolio declined slightly by $0.9 million during the first nine months of 2020.

Commercial loan production for the first nine months of 2020 was approximately $101.6 million. Commercial construction funding continues to ramp up as projects are entering their larger draw periods, which should result in increased outstanding balances. At quarter end, unfunded committed commercial construction equaled $43.7 million. Commercial amortization and payoffs were approximately $40.4 million through September 30, 2020. Consumer mortgage loan production continued at a record pace with production of approximately $101.8 million for the first nine months of 2020. The production and pipeline mix of in-house, portfolio loans and investor loans have continued to even out during the third quarter. The consumer mortgage pipeline remained robust as of September 30, 2020 at $36.9 million, consisting of $16.4 million in portfolio loans and $20.5 million in investor loans.

‎

Risk Elements of Loan Portfolio

The following table presents the risk elements of our loan portfolio at the dates indicated. Management is not aware of any potential problem loans other than those listed in this table or discussed below.



(dollars in thousands)	September 30, ‎2020		% of ‎Applicable ‎Portfolio	December 31, ‎2019		% of ‎Applicable ‎Portfolio
Non-accrual loans:
Commercial real estate	$	927	0.26%	$	680	0.20%
Acquisition and development		7,447	5.85%		8,058	6.80%
Commercial and industrial		—	0.00%		30	0.00%
Residential mortgage		1,939	0.49%		2,077	0.50%
Consumer		31	0.09%		4	0.00%
Total non-accrual loans	$	10,344	0.87%	$	10,849	1.03%
Accruing Loans Past Due 90 days or more:
Acquisition and development		11			135
Residential mortgage		802			536
Consumer		—			54
Total loans past due 90 days or more	$	813		$	725
Total non-accrual and accruing loans past due ‎ 90 days or more	$	11,157		$	11,574
Restructured Loans (TDRs):
Performing	$	3,700		$	3,842
Non-accrual (included above)		308			324
Total TDRs	$	4,008		$	4,166
Other real estate owned	$	3,787		$	4,127
Impaired loans without a valuation allowance	$	13,233		$	5,974
Impaired loans with a valuation allowance		1,280			9,200
Total impaired loans	$	14,513		$	15,174
Valuation allowance related to impaired loans	$	72		$	2,174

Performing loans considered to be impaired (including performing troubled debt restructurings, or TDRs), as defined and identified by management, amounted to $4.0 million at September 30, 2020 and $4.6 million at December 31, 2019. Loans are identified as impaired when, based on current information and events, management determines that we will be unable to collect all amounts due according to contractual terms. These loans consist primarily of A&D loans and CRE loans. The fair values are generally determined based upon independent third-party appraisals of the collateral or discounted cash flows based upon the expected proceeds. Specific allocations have been made where management believes there is insufficient collateral to repay the loan balance if liquidated and there is no secondary source of repayment available. The decrease in valuation allowance related to impaired loans is due to the charge off of $1.1 million and re-allocation of $1.3 million of specific on the A&D loan. See Note 6 for further details.

Loans that have been modified in reliance on Section 4013 of the U.S. Government’s Coronavirus Aid, Relief, and Economic Security Act and the guidance issued thereunder are not treated as TDRs. Information about these loans can be found in Notes 2 and 6 to the consolidated financial statements presented in Item 1 of Part I of this report.

‎

The following table presents the details of impaired loans that are TDRs by class at September 30, 2020 and December 31, 2019:



	September 30, 2020			December 31, 2019
(dollars in thousands)	Number of ‎Contracts	Recorded ‎Investment		Number of ‎Contracts	Recorded ‎Investment
Performing
Commercial real estate
Non owner-occupied	2	$	226	2	$	235
All other CRE	1		2,226	1		2,265
Acquisition and development
1-4 family residential construction	1		272	1		291
All other A&D	1		213	1		220
Commercial and industrial	—		—	—		—
Residential mortgage
Residential mortgage – term	7		763	8		831
Residential mortgage – home equity	—		—	—		—
Consumer	—		—	—		—
Total performing	12	$	3,700	13	$	3,842
Non-accrual
Commercial real estate
Non owner-occupied	—	$	—	—	$	—
All other CRE	—		—	—		—
Acquisition and development
1-4 family residential construction	—		—	—		—
All other A&D	—		—	—		—
Commercial and industrial	—		—	—		—
Residential mortgage
Residential mortgage – term	2		308	2		324
Residential mortgage – home equity	—		—	—		—
Consumer	—		—	—		—
Total non-accrual	2		308	2		324
Total TDRs	14	$	4,008	15	$	4,166

The level of TDRs decreased to $4.0 million at September 30, 2020 when compared to $4.2 million at December 31, 2019, with a slight reduction due to payments made during the first nine months. There were no new TDRs during the first nine months of 2020.

Allowance and Provision for Loan Losses

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

The ALL is also based on estimates, and actual losses will vary from current estimates. These estimates are reviewed quarterly, and as adjustments, either positive or negative, become necessary, a corresponding increase or decrease is made in the ALL. The methodology used to determine the adequacy of the ALL is consistent with prior years. An estimate for probable losses related to unfunded lending commitments, such as letters of credit and binding but unfunded loan commitments is also prepared. This estimate is computed in a manner similar to the methodology described above, adjusted for the probability of actually funding the commitment.

The following table presents a summary of the activity in the ALL for the nine months ended September 30:



(dollars in thousands)	2020		2019
Balance, January 1	$	12,537	$	11,047
Charge-offs:
Acquisition and development		(1,144)		(29)
Commercial and industrial		(232)		(75)
Residential mortgage		(108)		(86)
Consumer		(274)		(212)
Total charge-offs		(1,758)		(402)
Recoveries:
Commercial real estate		69		67
Acquisition and development		29		132
Commercial and industrial		149		77
Residential mortgage		66		259
Consumer		116		122
Total recoveries		429		657
Net credit (charge-offs)/recoveries		(1,329)		255
Provision for loan losses		4,981		669
Balance at end of period	$	16,189	$	11,971

Allowance for loan losses to gross loans outstanding (as %)		1.36%		1.20%
Net credit (charge-offs)/recoveries to average loans outstanding during the period, annualized (as %)		(0.16)%		0.03%

The ALL was $16.2 million at September 30, 2020 compared to $12.5 million at December 31, 2019, an increase of 29.1% that resulted primarily from adjustments to qualitative factors associated with the negative trend in the economic outlook directly related to COVID-19. The provision for loan losses was $5.0 million for the nine months ended September 30, 2020 and $0.7 million for the nine months ended September 30, 2019. Net charge-offs of $1.3 million were recorded for the first nine months of 2020, compared to net recoveries of $0.3 million for 2019. COVID-19 related factor adjustments of $6.3 million were offset by a re-allocation of $1.3 million on an adversely classified, non-accrual loan as discussed in Note 6. Absent the COVID-19 related qualitative factor adjustments for the nine months of 2020, the provision expense would have been approximately $0.6 million that was primarily attributable to non-PPP growth in the portfolio. The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.36% at September 30, 2020 compared to 1.20% at September 30, 2019 and 1.43% at June 30, 2020. The ALL to loans outstanding, excluding PPP loan balances of $148.9 million, was 1.55% at September 30, 2020.

The ratio of net charge offs to average loans for the nine months ended September 30, 2020 was an annualized 0.16%, compared to net recoveries to average loans of 0.03% for the nine months ended September 30, 2019. The CRE portfolio had an annualized net recovery rate of .03% as of both September 30, 2020, and September 30, 2019. The A&D loans had an annualized net charge-off rate of 1.21% as of September 30, 2020, compared to a net recovery rate of 0.12% as of September 30, 2019. This increase is related to the charge off of $1.1 million on the adversely classified non-accrual participation loan as mentioned above. The C&I portfolio had net charge-offs to average loans of 0.06% as of September 30, 2020, compared to net recoveries of $2 thousand as of September 30, 2019. The residential mortgage ratios were a net charge-off rate of 0.01% as of September 30, 2020, compared to a net recovery rate of 0.05% as of September 30, 2019, and the consumer loan ratios were net charge-off rates of 0.59% and 0.34% as of September 30, 2020 and September 30, 2019, respectively. Our special assets team continues to aggressively collect on charged-off loans.

Management believes that the ALL at September 30, 2020 is adequate to provide for probable losses inherent in our loan portfolio. Amounts that will be recorded for the provision for loan losses in future periods will depend upon trends in the loan balances, including the composition of the loan portfolio, changes in loan quality and loss experience trends, potential recoveries on previously charged-off loans and changes in other qualitative factors. Management also applies interest rate risk, collateral value and debt service sensitivity analyses to the Commercial real estate loan portfolio and obtains new appraisals on specific loans under defined parameters to assist in the determination of the periodic provision for loan losses.

Investment Securities

At September 30, 2020, the total amortized cost basis of the available-for-sale investment portfolio was $156.5 million, compared to a fair value of $153.2 million. Unrealized gains and losses on securities available-for-sale are reflected in accumulated other comprehensive loss, a component of shareholders’ equity. The amortized cost basis of the held to maturity portfolio was $69.2 million, compared to a fair value of $76.4 million.

The following table presents the composition of our securities portfolio at amortized cost and fair values at the dates indicated:



	September 30, 2020					December 31, 2019
	Amortized		Fair Value		FV as %	Amortized		Fair Value		FV as %
(dollars in thousands)	Cost		(FV)		of Total	Cost		(FV)		of Total
Securities Available-for-Sale:
U.S. government agencies	$	65,942	$	66,871	44%	$	39,987	$	39,894	30%
Residential mortgage-backed agencies		13,037		13,163	9%		4,917		4,900	4%
Commercial mortgage-backed agencies		33,566		34,160	22%		27,634		27,764	21%
Collateralized mortgage obligations		15,226		15,618	10%		29,903		29,923	23%
Obligations of state and political subdivisions		10,159		10,589	7%		14,124		14,470	11%
Collateralized debt obligations		18,525		12,760	8%		18,443		14,354	11%
Total available for sale	$	156,455	$	153,161	100%	$	135,008	$	131,305	100%
Securities Held to Maturity:
U.S. government agencies	$	—	$	—	—	$	16,164	$	16,823	17%
Residential mortgage-backed agencies		34,868		36,025	47%		42,939		43,253	43%
Commercial mortgage-backed agencies		11,773		12,388	16%		15,521		15,865	16%
Collateralized mortgage obligations		1,821		1,919	3%		3,140		3,143	3%
Obligations of state and political subdivisions		20,759		26,038	34%		16,215		21,572	21%
Total held to maturity	$	69,221	$	76,370	100%	$	93,979	$	100,656	100%

Total fair value of investment securities available-for-sale increased by $21.9 million since December 31, 2019. At September 30, 2020, the securities classified as available-for-sale included a net unrealized loss of $3.3 million, which represents the difference between the fair value and amortized cost of securities in the portfolio. This unrealized loss at September 30, 2020 is related to the CDO portfolio. All other available securities were at an unrealized gain position.

As discussed in Note 8 to the consolidated financial statements presented elsewhere in this report, the Corporation measures fair market values based on the fair value hierarchy established in ASC Topic 820, Fair Value Measurements and Disclosures. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). Level 3 prices or valuation techniques require inputs that are both significant to the valuation assumptions and are not readily observable in the market (i.e. supported with little or no market activity). These Level 3 instruments are valued based on both observable and unobservable inputs derived from the best available data, some of which is internally developed, and considers risk premiums that a market participant would require.

Approximately $140.4 million of the available-for-sale portfolio was valued using Level 2 pricing and had net unrealized gains of $2.5 million at September 30, 2020. The remaining $12.8 million of the securities available-for-sale represents the entire CDO portfolio, which was valued using significant unobservable inputs (Level 3 assets). The $5.8 million in net unrealized losses associated with this portfolio relates to nine pooled trust preferred securities that comprise the CDO portfolio. Net unrealized losses of $4.3 million represent non-credit related OTTI charges on seven of the securities, while $1.5 million of unrealized losses relates to two securities which have had no credit related OTTI.

The following table provides a summary of the trust preferred securities in the CDO portfolio and the credit status of these securities as of September 30, 2020:


Level 3 Investment Securities Available for Sale
(dollars in thousands)
Investment Description			First United Level 3 Investments						Security Credit Status
Deal	Class		Amortized ‎Cost		Fair ‎Market ‎Value		Unrealized ‎Gain/ ‎(Loss)	Lower ‎Credit ‎Rating	Original ‎Collateral	Deferrals/ ‎Defaults ‎as % of ‎Original ‎Collateral	Performing ‎Collateral	Collateral ‎Support	Collateral ‎Support ‎as % of ‎Performing ‎Collateral	Number of ‎Performing ‎Issuers/ ‎Total ‎Issuers
Preferred Term Security XVIII*	C	$	1,894	$	1,139	$	(755)	C	676,565	14.83%	268,437	19,130	7.13%	40 / 56
Preferred Term Security XVIII	C		2,717		1,708		(1,009)	C	676,565	14.83%	268,437	19,130	7.13%	40 / 56
Preferred Term Security XIX*	C		1,845		1,399		(446)	C	505,062	5.14%	469,062	33,181	7.07%	50 / 55
Preferred Term Security XIX*	C		1,100		840		(260)	C	505,062	5.14%	469,062	33,181	7.07%	50 / 55
Preferred Term Security XIX*	C		2,541		1,959		(582)	C	505,062	5.14%	469,062	33,181	7.07%	50 / 55
Preferred Term Security XIX*	C		1,101		840		(261)	C	505,062	5.14%	469,062	33,181	7.07%	50 / 55
Preferred Term Security XXII*	C-1		1,578		1,098		(480)	C	807,548	10.31%	664,548	69,263	10.42%	59 / 73
Preferred Term Security XXII*	C-1		3,945		2,747		(1,198)	C	807,548	10.31%	664,548	69,263	10.42%	59 / 73
Preferred Term Security XXIII	C-1		1,804		1,030		(774)	C	895,365	14.52%	682,365	67,917	9.95%	71 / 85

Total Level 3 Securities Available for Sale		$	18,525	$	12,760	$	(5,765)

*Security has been deemed other-than-temporarily impaired and loss has been recognized in accordance with ASC Section 320-10-35.

The terms of the debentures underlying trust preferred securities allow the issuer of the debentures to defer interest payments for up to 20 quarters, and, in such case, the terms of the related trust preferred securities allow their issuers to defer dividend payments for up to 20 quarters. Some of the issuers of the trust preferred securities in our investment portfolio have defaulted and/or deferred payments ranging from 5.14% to 14.83% of the total collateral balances underlying the securities. The securities were designed to include structural features that provide investors with credit enhancement or support to provide default protection by subordinated tranches. These features include over-collateralization of the notes or subordination, excess interest or spread which will redirect funds in situations where collateral is insufficient, and a specified order of principal payments. There are securities in our portfolio that are under-collateralized, which does represent additional stress on our tranche. However, in these cases, the terms of the securities require excess interest to be redirected from subordinate tranches as credit support, which provides additional support to our investment.

Management systematically evaluates securities for impairment on a quarterly basis. Based upon application of ASC Topic 320 (Section 320-10-35), management must assess whether (a) the Corporation has the intent to sell the security and (b) it is more likely than not that the Corporation will be required to sell the security prior to its anticipated recovery. If neither applies, then declines in the fair value of securities below their cost that are considered other-than-temporary declines are split into two components. The first is the loss attributable to declining credit quality. Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made. The second component consists of all other losses. The other losses are recognized in other comprehensive income. In estimating OTTI charges, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) adverse conditions specifically related to the security, an industry, or a geographic area, (3) the historic and implied volatility of the security, (4) changes in the rating of a security by a rating agency, (5) recoveries or additional declines in fair value subsequent to the balance sheet date, (6) failure of the issuer of the security to make scheduled interest payments, and (7) the payment structure of the debt security and the likelihood of the issuer being able to make payments that increase in the future. Due to the duration and the significant market value decline in the pooled trust preferred securities held in our portfolio, we performed more extensive testing on these securities for purposes of evaluating whether or not an OTTI has occurred.

The market for these securities as of September 30, 2020 is not active and markets for similar securities are also not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which these securities trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market is also inactive, as no new CDOs have been issued since 2007. There are currently very few market participants who are willing to effect transactions in these securities. The market values for these securities, or any securities other than those issued or guaranteed by the U.S. Department of the Treasury (the “Treasury”), are very depressed relative to historical levels. Therefore, in the current market, a low market price for a particular bond may only provide evidence of stress in the credit markets in general rather than being an indicator of credit problems with a particular issue. Given the conditions in the current debt markets and the absence of observable transactions in the secondary and new issue markets, management has determined that (a) the few observable transactions and market quotations that are available are not reliable for the purpose of obtaining fair value at September 30, 2020, (b) an income valuation approach technique (i.e. present value) that maximizes the use of relevant unobservable inputs and minimizes the use of observable inputs will be equally or more

representative of fair value than a market approach, and (c) the CDO segment is appropriately classified within Level 3 of the valuation hierarchy because management determined that significant adjustments were required to determine fair value at the measurement date.

Management utilizes on an independent third party to prepare both the evaluations of OTTI and the fair value determinations for the CDO portfolio. Management does not believe that there were any material differences in the OTTI evaluations and pricing between December 31, 2019 and September 30, 2020.

Based upon a review of credit quality and the cash flow tests performed by the independent third party, management determined that no securities had credit-related OTTI during the first nine months of 2020. Additionally, there has been no change in the performing collateral, no decline in the percentage of deferrals/defaults to original collateral, and increases in collateral support for each of the positions held by the Corporation.

Deposits

The following table presents the composition of our deposits at the dates indicated:



(dollars in thousands)	September 30, 2020			December 31, 2019
Non-interest bearing demand deposits:
Retail	$	419,935	31%	$	294,649	26%
Interest-bearing deposits:
Demand		197,177	14%		159,567	14%
Money Market:
Retail		340,095	25%		275,007	24%
Savings deposits		184,389	13%		158,918	14%
Time deposits less than $100,000:
Retail		91,255	7%		96,198	8%
Time deposits $100,000 or more:
Retail		144,433	10%		147,692	13%
Brokered		—	0%		10,000	1%
Total Deposits	$	1,377,284	100%	$	1,142,031	100%

Total deposits at September 30, 2020 increased by $235.3 million when compared to deposits at December 31, 2019. During the first nine months of 2020, non-interest-bearing deposits increased by $125.3 million. This growth was driven by our retail and commercial markets as well as deposits from PPP loans. Traditional savings accounts increased by $25.5 million, as we continue to see significant growth in our Prime Saver product. Total demand deposits increased by $37.6 million and total money market accounts increased by $65.1 million, due primarily to growth in our variable rate Value Money Market account. Time deposits less than $100,000 decreased by $4.9 million and time deposits greater than $100,000 decreased by $13.3 million. The decline in time deposits greater than $100,000 was due to a local municipality utilizing a maturing certificate of deposit for cash needs during this unprecedented economic environment as well as our repayment of the full outstanding balance of $10.0 million in a brokered CD that matured in May 2020.

Borrowed Funds

The following table presents the composition of our borrowings at the dates indicated:



(in thousands)	September 30, ‎2020		December 31, ‎2019
Securities sold under agreements to repurchase	$	52,589	$	48,728
Total short-term borrowings		52,589		48,728
FHLB advances	$	70,000	$	70,000
Junior subordinated debt		30,929		30,929
Total long-term borrowings	$	100,929	$	100,929

Total short-term borrowings increased by $3.9 million during the first nine months of 2020. This increase is due to the increase in our Treasury Management overnight investment sweep as we saw growth in balances from our existing municipality accounts. Long-term borrowings remained constant during the first nine months of 2020.

Liquidity Management

Liquidity is a financial institution’s capability to meet customer demands for deposit withdrawals while funding all credit-worthy loans. The factors that determine the institution’s liquidity are:

Reliability and stability of core deposits;

Cash flow structure and pledging status of investments; and

Potential for unexpected loan demand.

We actively manage our liquidity position through regular meetings of a sub-committee of executive management, known as the Treasury Team, which looks forward 12 months at 30-day intervals. The measurement is based upon the projection of funds sold or purchased position, along with ratios and trends developed to measure dependence on purchased funds and core growth. Monthly reviews by management and quarterly reviews by the Asset and Liability Committee under prescribed policies and procedures are designed to ensure that we will maintain adequate levels of available funds.

It is our policy to manage our affairs so that liquidity needs are fully satisfied through normal Bank operations. That is, the Bank will manage its liquidity to minimize the need to make unplanned sales of assets or to borrow funds under emergency conditions. The Bank will use funding sources where the interest cost is relatively insensitive to market changes in the short run (periods of one year or less) to satisfy operating cash needs. The remaining normal funding will come from interest-sensitive liabilities, either deposits or borrowed funds. When the marginal cost of needed wholesale funding is lower than the cost of raising this funding in the retail markets, the Corporation may supplement retail funding with external funding sources such as:

1.Unsecured Fed Funds lines of credit with upstream correspondent banks (M&T Bank, Pacific Coast Banker’s Bank, PNC Financial Services, Atlantic Community Bankers Bank, Community Bankers Bank, SunTrust and Zions National Bank).

2.Secured advances with the FHLB, which are collateralized by eligible one to four family residential mortgage loans, home equity lines of credit, commercial real estate loans, various securities and pledged cash.

3.Secured line of credit with the Fed Discount Window for use in borrowing funds up to 90 days, using municipal securities as collateral.

4.Brokered deposits, including CDs and money market funds, provide a method to generate deposits quickly. These deposits are strictly rate driven but often provide the most cost-effective means of funding growth.

5.One Way Buy CDARS/ICS funding – a form of brokered deposits that has become a viable supplement to brokered deposits obtained directly.

6.Federal Reserve PPPLF – provides funding and uses SBA PPP loans as collateral at 100% value

Management believes that we have adequate liquidity available to respond to current and anticipated liquidity demands and is not aware of any trends or demands, commitments, events or uncertainties that are likely to materially affect our ability to maintain liquidity at satisfactory levels. Please refer to the section of this Item 2 entitled “Response to COVID-19” for more details on our primary sources of liquidity.

Market Risk and Interest Sensitivity

Our primary market risk is interest rate fluctuation. Interest rate risk results primarily from the traditional banking activities that we engage in, such as gathering deposits and extending loans. Many factors, including economic and financial conditions, movements in interest rates and consumer preferences affect the difference between the interest earned on our assets and the interest

paid on our liabilities. 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 interest-bearing assets and liabilities. Management seeks to minimize fluctuating net interest margins, and to enhance consistent growth of net interest income through periods of changing interest rates. Management 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 us during a period of declining interest rates.

At September 30, 2020, we were asset sensitive.

Our interest rate risk management goals are:

Ensure that the Board of Directors and senior management will provide effective oversight and ensure that risks are adequately identified, measured, monitored and controlled;

Enable dynamic measurement and management of interest rate risk;

Select strategies that optimize our ability to meet our long-range financial goals while maintaining interest rate risk within policy limits established by the Board of Directors;

Use both income and market value oriented techniques to select strategies that optimize the relationship between risk and return; and

Establish interest rate risk exposure limits for fluctuation in net interest income (“NII”), net income and economic value of equity.

In order to manage interest sensitivity risk, management 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 interest income over specified periods.

We evaluate the effect of a change in interest rates of +/-100 basis points to +/-400 basis points on both NII and Net Portfolio Value (“NPV”) / Economic Value of Equity (“EVE”). We concentrate on NII rather than net income as long as NII remains the significant contributor to net income.

NII modeling allows management to view how changes in interest rates will affect the spread between the yield paid on assets and the cost of deposits and borrowed funds. Unlike traditional Gap modeling, NII modeling takes into account the different degree to which installments in the same repricing period will adjust to a change in interest rates. It also allows the use of different assumptions in a falling versus a rising rate environment. The period considered by the NII modeling is the next eight quarters.

NPV / EVE modeling focuses on the change in the market value of equity. NPV / EVE is defined as the market value of assets less the market value of liabilities plus/minus the market value of any off-balance sheet positions. By effectively looking at the present value of all future cash flows on or off the balance sheet, NPV / EVE modeling takes a longer-term view of interest rate risk. This complements the shorter-term view of the NII modeling.

Measures of NII at risk produced by simulation analysis are indicators of an institution’s short-term performance in alternative rate environments. These measures are typically based upon a relatively brief period, usually one year. They do not necessarily indicate the long-term prospects or economic value of the institution.

Based on the simulation analysis performed at September 30, 2020 and December 31, 2019, management estimated the following changes in net interest income, assuming the indicated rate changes:


(Dollars in thousands)	September 30, ‎2020		December 31, ‎2019
+400 basis points	$	7,719	$	1,500
+300 basis points	$	5,978	$	1,381
+200 basis points	$	4,097	$	1,075
+100 basis points	$	2,043	$	645
-100 basis points	$	(1,841)	$	(2,477)

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 lending 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 Bank’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.

Management believes that no material changes in our market risks, our procedures used to evaluate and mitigate those risks, or our actual or simulated sensitivity positions have occurred since December 31, 2019. Our NII simulation analysis as of December 31, 2019 is included in Item 7 of Part II Item 7 of Part II of our Annual Report on Form 10-K for the year ended December 31, 2019 under the heading “Market Risk and Interest Sensitivity.

Impact of Inflation – Our assets and liabilities are primarily monetary in nature, and as such, future changes in prices do not affect the obligations to pay or receive fixed and determinable amounts of money. During inflationary periods, monetary assets lose value in terms of purchasing power and monetary liabilities have corresponding purchasing power gains. The concept of purchasing power is not an adequate indicator of the impact of inflation on financial institutions because it does not incorporate changes in our earnings.

Capital Resources

We require capital to fund loans, satisfy our obligations under the Bank’s letters of credit, meet the deposit withdrawal demands of the Bank’s customers, and satisfy our other monetary obligations. To the extent that deposits are not adequate to fund our capital requirements, we can rely on the funding sources identified above under the heading “Liquidity Management”. At September 30, 2020, the Bank had $145.0 million available through unsecured lines of credit with correspondent banks, $1.1 million available through a secured line of credit with the Fed Discount Window and approximately $137.5 million available through the FHLB. Management is not aware of any demands, commitments, events or uncertainties that are likely to materially affect our ability to meet our future capital requirements.

In addition to operational requirements, the Bank and First United Corporation are subject to risk-based capital regulations, which were adopted and are monitored by federal banking regulators. These regulations are used to evaluate capital adequacy and require an analysis of an institution’s asset risk profile and off-balance sheet exposures, such as unused loan commitments and stand-by letters of credit. Based on capital ratios at September 30, 2020, both the Bank and First United Corporation are considered to be well-capitalized.

The following table presents our capital ratios as of the dates indicated:



	September 30, ‎2020	December 31, ‎2019	Required for ‎Capital ‎Adequacy ‎Purposes	Required ‎to be Well ‎Capitalized
Total Capital (to risk-weighted assets)
Consolidated	16.14%	16.29%	8.00%	10.00%
First United Bank & Trust	15.36%	15.60%	8.00%	10.00%
Tier 1 Capital (to risk-weighted assets)
Consolidated	14.89%	15.17%	6.00%	8.00%
First United Bank & Trust	14.11%	14.44%	6.00%	8.00%
Common Equity Tier 1 Capital (to risk-weighted assets)
Consolidated	12.59%	12.79%	4.50%	6.50%
First United Bank & Trust	14.11%	14.44%	4.50%	6.50%
Tier 1 Capital (to average assets)
Consolidated	10.37%	11.77%	4.00%	5.00%
First United Bank & Trust	9.64%	10.99%	4.00%	5.00%

Contractual Obligations, Commitments and Off-Balance Sheet Arrangements

Contractual Obligations

The Corporation enters into contractual obligations in the normal course of business. Among these obligations are FHLB advances and junior subordinated debentures, operating lease agreements for banking and subsidiaries’ offices and for data processing and telecommunications equipment. Comparing September 30, 2020 to December 31, 2019, short-term borrowings increased $3.9 million, primarily due to the increase in our Treasury Management overnight investment sweep accounts as we saw growth in balances from our existing municipality accounts.

Commitments

Loan commitments are made to accommodate the financial needs of our customers. Letters of credit commit us to make payments on behalf of customers when certain specified future events occur. The credit risks inherent in loan commitments and letters of credit are essentially the same as those involved in extending loans to customers, and these arrangements are subject to our normal credit policies. We are not a party to any other off-balance sheet arrangements.

Commitments to extend credit in the form of consumer, commercial and business at the dates indicated were as follows:



(in thousands)	September 30, ‎2020		December 31, ‎2019
Residential Mortgage - home equity	$	57,294	$	53,827
Residential Mortgage - construction		10,919		4,995
Commercial		123,192		85,089
Consumer - personal credit lines		4,266		3,903
Standby letters of credit		11,690		9,112
Total	$	207,361	$	156,926

The increase of $50.4 million in commitments at September 30, 2020 compared to December 31, 2019 was due to increased demand for consumer and commercial construction funding during the first nine months of 2020. Management will continue to monitor these balances as the COVID-19 pandemic has slowed the underlying projects and disbursements of funds.
‎

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The information required by this item is included in Item 2 of Part I of this report under the caption “Market Risk and Interest Sensitivity” and in Item 7 of Part II of First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019 under the heading “Market Risk and Interest Sensitivity” both of which are incorporated in this Item 3 by reference.

Item 4. Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 with the SEC, such as this Quarterly Report, is recorded, processed, summarized and reported within the periods specified in those rules and forms, and that such information is accumulated and communicated to our management, including First United Corporation’s principal executive officer (“PEO”) and its principal financial officer (“PFO”), as appropriate, to allow for timely decisions regarding required disclosure. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls is also 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, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate.

An evaluation of the effectiveness of these disclosure controls as of September 30, 2020 was carried out under the supervision and with the participation of management, including the PEO and the PFO. Based on that evaluation, management, including the PEO and the PFO, has concluded that our disclosure controls and procedures are, in fact, effective at the reasonable assurance level.

During the quarter ended September 30, 2020, there was no change in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

‎

Part II. OTHER INFORMATION

Item 1. Legal Proceedings

On September 4, 2020, Driver Opportunity Partners I LP (“Driver”) filed a lawsuit against the Corporation, all of its current directors, and former directors Robert W. Kurtz and Elaine L. McDonald (the individuals being collectively referred to as the “Director Defendants”) in the United States District Court for the District of Maryland and styled Driver Opportunity Partners I LP v. First United Corp., et al., No. 1:20-cv-2575 RDB (the “Driver Litigation”). Driver’s complaint follows a lawsuit filed by the Corporation in May 2020 against Driver and affiliated persons seeking a declaration that Driver’s acquisition of approximately 5.1% of the Corporation’s outstanding common stock during 2019 violated Maryland law, rendering those shares ineligible to be voted for five years, including at the 2020 Meeting. In connection with the 2020 Meeting, Driver ran a proxy contest seeking to replace three of the Corporation’s directors with nominees of its own. The declaratory relief action, now pending in the same court, is captioned First United Corp. v. Driver Opportunity Partners I LP, et al., No. 1:20-cv-2592-RDB.

For its complaint, Driver alleges that certain acts and omissions of the Corporation and/or the Director Defendants in connection with the 2020 Meeting and/or in response to Driver’s proxy contest (i) constituted breaches of fiduciary duties allegedly owed to Driver by the Director Defendants, (ii) constituted abuses of process by the Corporation, (iii) constituted malicious prosecution of Driver by the Corporation, (iv) defamed Driver, (v) tortuously interfered with Driver’s economic relations, (vi) constituted unfair competition, and (vii) resulted in the Defendant Directors being unjustly enriched. Driver seeks unspecified compensatory and punitive damages and asks the court to vacate the results of director election at the 2020 Meeting and order a new meeting of shareholders for the purpose of electing directors.

The Corporation and the Director Defendants believe that Driver’s claims lack merit and intend to defend the lawsuit vigorously. The Company maintains insurance coverages that it believes will cover portions of the legal expenses associated with the Driver Litigation and any damages that might be awarded to Driver. The Corporation has certain obligations both to indemnify and to advance defense expenses to each of the Director Defendants to the fullest extent permissible under Maryland law, and the Corporation intends to honor those obligations. It is not possible at this time for the Corporation to assess the likelihood of success of any of its and the Defendant Directors’ defenses or, thus, the outcome of the litigation, or the amount of legal fees that it and the Director Defendants will incur in defending the Driver Litigation.

Item 1A. Risk Factors

The risks and uncertainties to which our financial condition and operations are subject are discussed in detail in Item 1A of Part I of First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2019. Management does not believe that any material changes in our risk factors have occurred since they were last disclosed except as follows.

Risks Relating to First United Corporation and its Affiliates

First United Corporation will likely incur significant expenses and faces the possibility of damages in connection with recent litigation.

As discussed in in Item 1 of Part II of this report, the Corporation, its directors, and two former directors have been sued by Driver. The Driver Litigation will likely be time consuming and involve significant defense and other costs. We cannot predict what expenses that we might incur in connection with the Driver Litigation. The Driver Litigation, if decided adversely to us, could result in significant monetary damages and reputational harm and require us to incur significant expenses related to holding a new meeting of shareholders, if the court were to order such a meeting as part of the relief granted. Subject to certain conditions imposed by Maryland law, our bylaws require us to indemnify and advance expenses to each of the current and former directors who are parties to the Driver Litigation. Further, our insurance policies might not cover all expenses and/or claims that have been or might be brought against us and the individual defendants, and insurance coverage might not continue to be available to us at a reasonable cost. As a result, we are exposed to the possibility of substantial uninsured liabilities in connection with the Driver Litigation, including pursuant to our indemnification obligations, which could materially and adversely affect our business, prospects, results of operations and financial condition.

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

The following table provides information about shares of common stock purchased by or on behalf of First United Corporation and its affiliates (as defined by Exchange Act Rule 10b-18) during the three-month period ended September 30, 2020:


Issuer Purchases of Equity Securities
Period	Total Number of Shares (or Units) Purchased (1)		Average Price Paid per Share (or Unit)	Total Number of Shares (or Units) Purchased as Part of Publicly Announced Plans or Programs	Maximum Number (or Approximate Dollar Value) of Shares (or Units) that May Yet Be Purchased Under the Plans or Programs
July 2020	—		—	—	367,581
August 2020	4,031		11.40	4,031	513,550
September 2020	30,065	$	11.41	30,065	483,485
Total	34,096	$	11.41	34,096	483,485

(1) The shares were purchased by the Trust Department of First United Bank & Trust (the “Trust Department”) in open-market transactions using assets in the First United Corporation noncontributory defined benefit pension plan (the “Pension Plan”). On November 20, 2019, the Board of Directors of First United Corporation authorized the Trust Department, which administers the Pension Plan, to use up to 10% of the Pension Plan’s assets to purchase up to 150,000 shares of common stock, to be held as an investment in the Pension Plan. Such authorization, which was publicly announced, permits the Trust Department to purchase the shares in open market transactions or privately-negotiated transactions at such times, in such amounts, at such prices, and upon such other terms as are determined in the discretion of the Trust Department. On August 26, 2020, the Board of Directors of First United Corporation authorized the Trust Department to purchase up to an additional 150,000 shares of common stock, to be held as an investment in the Pension Plan. In addition to the foregoing, the Board of Directors of the Corporation authorized, on April 30, 2020, the Corporation to purchase up to an aggregate of 354,449 shares of its common stock over a 12 month period. On November 20, 2019, the Board voted to increase the number of shares that may be purchased to 500,000 shares and to extend the term of the repurchase program through November 20, 2020. All of these authorizations were publicly announced.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not Applicable.

Item 5. Other Information

None.

Item 6. Exhibits

The exhibits filed or furnished with this quarterly report are listed in the following Exhibit Index.

Exhibit		Description
31.1		Certifications of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)
31.2		Certifications of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act (filed herewith)
32		Certification of the Principal Executive Officer and the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act (furnished herewith)
101.INS		XBRL Instance Document (filed herewith)
101.SCH		XBRL Taxonomy Extension Schema (filed herewith)
101.CAL		XBRL Taxonomy Extension Calculation Linkbase (filed herewith)
101.DEF		XBRL Taxonomy Extension Definition Linkbase (filed herewith)
101.LAB		XBRL Taxonomy Extension Label Linkbase (filed herewith)
101.PRE		XBRL Taxonomy Extension Presentation Linkbase (filed herewith)
104		The cover page of First United Corporation’s Quarterly Report on Form 10Q for the quarter ended September 30, 2020, formatted in Inline XBRL, included within the Exhibit 101 attachments (filed herewith).

‎

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	FIRST UNITED CORPORATION


Date: November 10, 2020	/s/ Carissa L. Rodeheaver
	Carissa L. Rodeheaver, CPA, CFP
	Chairman of the Board, President and Chief Executive Officer
	(Principal Executive Officer)


Date: November 10, 2020	/s/ Tonya K. Sturm
	Tonya K. Sturm, Senior Vice President,
	Chief Financial Officer
	(Principal Financial Officer and Principal Accounting Officer)