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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and notes thereto for the years ended December 31, 2020 and 2019, which are included in Item 8 of Part II of this annual report.

Overview

First United Corporation is a bank holding company that, through the Bank and its non-bank subsidiaries, provides an array of financial products and services primarily to customers in four Western Maryland counties and four Northeastern West Virginia counties. Its principal operating subsidiary is the Bank, which consists of a community banking network of 25 branch offices located throughout its market areas. Our primary sources of revenue are interest income earned from our loan and investment securities portfolios and fees earned from financial services provided to customers.

Consolidated net income was $13.8 million for the year ended December 31, 2020 compared to $13.1 million for the year ended December 31, 2019. Basic and diluted net income per share for the year of 2020 were $1.98 and $1.97, respectively, compared to basic and diluted net income per share of $1.85 for the same period of 2019, a 7.0% increase. Subsequent to the issuance of a press release on February 19, 2021 that described the Corporation’s financial results for the 12 and three month periods ended December 31, 2020, management determined that approximately $0.6 million of previously deferred costs associated with consulting for automated services should be expensed during the fourth quarter of 2020. This determination negatively impacted net income for 2020 by approximately $0.4 million. The increase in earnings when comparing 2020 to 2019 was primarily due to an increase in net interest income of $2.2 million, an increase in other operating income, including gains, of $1.8 million, and a decrease in other operating expenses of $1.5 million partially offset by an increase in the provision for loan losses of $4.1 million. The increase in provision expense for 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic and its impact on our borrowers. Of the $5.4 million net provision expense for the year, $5.9 million was related to COVID-19 qualitative factor adjustments and $0.8 million was related to loan growth and the change in loan mix. Provision expense was partially offset by the release of a specific allocation of $1.3 million based on a new appraisal, as a non-accrual loan moved to the OREO portfolio. Other operating income, including net gains, increased $1.8 million for the year ended December 31, 2020 when compared to the year ended December 31, 2019. This increase was due primarily to gains on the sale of mortgages to the secondary market as well as gains on sales of investment securities. Trust and brokerage income were strong despite market volatility early in 2020. These increases were partially offset by reduced service charge income, primarily NSF income, due to reduced consumer and business overdraft activity. Bank owned life insurance (“BOLI”) income decreased due to the receipt of death claim benefits in 2019. The net interest margin, on a fully-taxable equivalent (“FTE”) basis, declined for the year ended December 31, 2020 to 3.34% compared to 3.68% for the same period of 2019.

The provision for loan losses was $5.4 million for the year ended December 31, 2020, compared to $1.3 million for the year ended December 31, 2019. The increase in provision expense for 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic and its impact on our borrowers. Of the $5.4 million net provision expense for the year, $5.9 million was related to COVID-19 qualitative factor adjustments and $0.8 million was related to loan growth and the change in loan mix. Provision expense was partially offset by the release of a specific allocation of $1.3 million based on a new appraisal, as a non-accrual loan moved to the other real estate owned (“OREO”) portfolio.

Other operating income, including gains, increased $1.8 million for the year ended December 31, 2020 when compared with the same period in 2019. The increase was primarily attributable to the $2.5 million increase in net gains, due primarily to the increase in mortgage origination in 2020 and the sale of those loans to the secondary market. Additionally, 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 gains through the sale of these investments. The increased gains were offset by a $1.0 million decline in BOLI income due to the receipt of $1.1 million in 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 year of 2020 due to reduced consumer spending and increased cash balances resulting from borrowers’ receipt of government stimulus payments and loans under the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”). Trust and brokerage income increased $0.4 million year-over-year although it was negatively affected by market volatility early in the year as trustee fees are directly related to the value of assets under management. Debit card income increased $0.2 million for the year ended December 31, 2020 when compared with the same period of 2019 despite reduced consumer spending. Debit card income continued to increase as we grew our deposit relationships and our customers increased use of our electronic services.

Other operating expenses decreased $1.5 million for the year ended December 31, 2020 when compared with the same period of 2019. Salaries and benefits decreased $3.6 million, primarily due to the $2.5 million salary expense offset related to loan originations, primarily PPP loans, as well as the 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, Financial First Responder bonuses paid and increased incentives for mortgage production. FDIC premiums increased

slightly due to credits received on quarterly assessments in 2019. Equipment, occupancy and technology expenses remained stable when compared to 2019, as we began to realize cost savings from our core processor related to a new contract negotiated in 2020. Professional services increased $2.7 million primarily due to increased legal and professional expenses related to the 2020 proxy contest and related litigation. Investor relations expenses increased $1.0 million, also related to the 2020 proxy contest. OREO expenses decreased $1.5 million when compared to 2019, as we experienced lower valuation allowance write-downs related to updated appraisals. Increased marketing, consulting, miscellaneous expenses, dues and licenses, fraud expenses, miscellaneous loan fees and Visa processing fees were offset by reductions in schools and seminars, contributions, personnel related expenses, printed and office supplies, travel and lodging, 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. Other operating expenses recorded for 2020 include the above-mentioned $0.6 million of expenses associated with consulting for automated services that were previously deferred but that management determined, subsequent to February 19, 2021, should be expensed during the fourth quarter of 2020.

Outstanding loans increased to $1.2 billion at December 31, 2020, compared to $1.1 billion at December 31, 2019. The $117.4 million of growth was primarily attributable to the participation in the PPP loan program and core commercial loan growth partially offset by a decline in our mortgage loan portfolio. CRE loans increased by $33.7 million due to expansion of several new customer relationships as well as an increase in small business loans. Acquisition and development (“A&D”) loans declined by $1.0 million as amortization and payoffs offset new production. Commercial and industrial (“C&I”) loans increased by $144.4 million, including $114.0 million of PPP loans which remained on the balance sheet at December 31, 2020. The growth in the commercial portfolios was offset by a decline in residential mortgage loans of $59.3 million, as refinancing activity continued during the fourth quarter of 2020. Given the current low interest rate environment, customers have preferred longer-term fixed-rate loans. Management has elected to utilize the secondary market rather than hold mortgage loans in the portfolio at the longer-term fixed rates. The consumer loan portfolio declined slightly by $0.4 million during 2020.

Net interest income, on a non-GAAP, FTE basis, increased $2.2 million (4.7%) during the year ended December 31, 2020 when compared with the year ended December 31, 2019, driven by a $0.3 million (0.6%) increase in interest income and a $1.9 million (16.3%) decrease in interest expense. The net interest margin for the year ended December 31, 2020 was 3.34%, compared to 3.68% for the year ended December 31, 2019. The impact of average balances of PPP loans of approximately $137.0 million, offset by the $3.0 million of interest and fees related to these loans, had a negative impact on the margin of approximately 13 basis points. The margin was also negatively affected by the 2.25% drop in the Fed Funds rate since August 2019, which resulted in new loan production and existing loans repricing at lower rates. These factors resulted in a decrease of approximately 14 basis points in average loan yield when compared with the year ended December 31, 2019.

Comparing the year ended December 31, 2020 with the year ended December 31, 2019, interest income remained stable. The increase in interest and fees on loans of $2.0 million was partially offset by the reduction in investment income of $1.0 million. While the average balance of the investment portfolio remained consistent, bonds, at higher yielding rates, were called and replaced with lower yielding investments resulting in a decrease in average yield on the investment portfolio of 44 basis points. Excess cash balances attributable to deposit growth were invested at the lower Fed Funds rate, which also negatively affected interest income for the year ended December 31, 2020. Due to the uncertainties related to the COVID-19 pandemic and the volatile economic environment, the Bank maintained higher levels of liquidity throughout 2020 when compared to 2019. The increase in interest and fees on loans was due primarily to an increase in average balances of $144.5 million, primarily driven by the PPP loans but partially offset by the declining yield. The rate earned on the loan portfolio decreased by 46 basis points as a result of the significant decline in the rate environment over the past year and the high volume of PPP loans booked at the low 1.00% interest rate as noted above.

Total deposits at December 31, 2020 increased by $280.3 million when compared with deposits at December 31, 2019. During 2020, non-interest-bearing deposits increased by $125.8 million. This growth was driven by our retail and commercial account growth as well as deposits from PPP loans. Traditional savings accounts increased by $37.1 million, as we continued to see significant growth in our Prime Saver product. Total demand deposits increased by $42.0 million and total money market accounts increased by $101.1 million, due primarily to growth in our variable rate Value Money Market account. Time deposits less than $100,000 decreased by $7.5 million and time deposits greater than $100,000 decreased by $18.2 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.

The decrease in interest expense, despite an increase in average interest bearing liabilities of $79.7 million, was a direct result of a reduction in the cost of deposits of 21 basis points, a 24 basis point decrease in our short-term borrowings and a 34 basis point decrease in long-term borrowings, primarily driven by maturity of an interest rate swap. In addition, during the fourth quarter of 2020, management restructured three long-term FHLB advances that resulted in a reduced weighted rate on the $70.0 million portfolio of 80 basis points. A portion of this interest expense savings was captured in the fourth quarter of 2020 with the full impact expected in 2021. We proactively monitored the rate environment and reduced rates on our deposit portfolio throughout 2020. The average balance on our interest-bearing money market accounts increased $60.1 million, while the rate on these accounts decreased by 43 basis points. Average growth of $101.4 million in our non-interest-bearing accounts benefited our overall cost of deposits. Deposit growth was

attributable to PPP loan funding and organic deposit growth in low cost core deposits with existing customers as well as new relationship customers during 2020.

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 to the Consolidated Financial Statements.) On an on-going basis, management evaluates estimates and bases those estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Management believes the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the Consolidated Financial Statements.

Allowance for Loan Losses

One of our most important accounting policies is that related to the monitoring of the loan portfolio. A variety of estimates impact the carrying value of the loan portfolio and resulting interest income, including the calculation of the ALL, the valuation of underlying collateral, and the timing of loan charge-offs. 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 payments 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 direction, changes in lending rates, political conditions, legislation impacting the banking industry and economic conditions specific to Western Maryland and Northeastern West Virginia. 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.

The ALL is also discussed below in Item 7 under the heading “Allowance for Loan Losses” and in Note 8 to the Consolidated Financial Statements.

Goodwill

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.

The emergence of COVID-19 as a global pandemic in beginning in March 2020, resulted in significant deterioration in general economic conditions and caused a deterioration in the environment in which the Corporation operates. This uncertainty resulted in a significant decrease 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, quantitative analyses of the fair value of the Corporation were performed by a third party for each of the first three quarters of 2020 and no impairment was recognized.

During the fourth quarter of 2020, the economy began to see improvements with stimulus funding, decreasing unemployment rates within our market areas, the distributions of COVID-19 vaccines and the significant improvement in our stock price since September 2020. Based on these positive circumstances, Management performed a qualitative assessment on the impairment of goodwill at December 31, 2020.

Having considered each of the qualitative factors and the negative and positive evidence of the totality of events and circumstances qualitatively, management has determined that it is not more likely than not that the fair value of our reporting unit is less

than its carrying amount and a quantitative goodwill impairment test is unnecessary. As such, management concludes there is no goodwill impairment at December 31, 2020.

Accounting for Income Taxes

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

We regularly review the carrying amount of our net deferred tax assets to determine if the establishment of a valuation allowance is necessary. If based on the available evidence, 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 must 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. Our evaluation is based on current tax laws as well as management’s expectations of future performance.

Management expects that the Corporation’s 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.

Additional information about income taxes is set forth below under the heading, “CONSOLIDATED STATEMENT OF INCOME REVIEW – Applicable Income Taxes” and in Note 18 to Consolidated Financial Statements presented in Item 8 of Part II of this annual report.

Other-Than-Temporary Impairment of Investment Securities

Management systematically evaluates the securities in our investment portfolio for impairment on a quarterly basis. Based upon the application of accounting guidance for subsequent measurement in ASC Topic 320 (Section 320-10-35), management assesses whether (i) we have the intent to sell a security being evaluated and (ii) it is more likely than not that we will be required to sell the security prior to its anticipated recovery. If neither applies, then declines in the fair values of securities below their cost that are considered other-than-temporary declines are split into two components. The first is the loss attributable to declining credit quality. Credit losses are recognized in earnings as realized losses in the period in which the impairment determination is made. The second component consists of all other losses, which are recognized in other comprehensive loss. In estimating other-than-temporary impairment (“OTTI”) losses, management considers (a) the length of time and the extent to which the fair value has been less than cost, (b) adverse conditions specifically related to the security, an industry, or a geographic area, (c) the historic and implied volatility of the fair value of the security, (d) changes in the rating of the security by a rating agency, (e) recoveries or additional declines in fair value subsequent to the balance sheet date, (f) failure of the issuer of the security to make scheduled interest or principal payments, and (g) 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 section of the Consolidated Balance Sheet Review entitled “Investment Securities”.

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. We measure the fair market values of our 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 25 to the Consolidated Financial Statements.

Pension Plan Assumptions

Our pension plan costs are calculated using actuarial concepts, as discussed within the requirements of ASC Topic 715, Compensation – Retirement Benefits. Pension expense and the determination of our projected pension liability are based upon two critical assumptions: the discount rate and the expected return on plan assets. We evaluate each of these critical assumptions annually. Other assumptions impact the determination of pension expense and the projected liability including the primary employee

demographics, such as retirement patterns, employee turnover, mortality rates, and estimated employer compensation increases. These factors, along with the critical assumptions, are carefully reviewed by management each year in consultation with our pension plan consultants and actuaries. Further information about our pension plan assumptions, the plan’s funded status, and other plan information is included in Note 20 to the Consolidated Financial Statements.

Other than as discussed above, management does not believe that any material changes in our critical accounting policies have occurred since December 31, 2020.

Response to COVID-19

Early in 2020, we established a set of COVID-19 protocols, focused on protecting the health, safety, and financial well-being of our associates and customers. We sustained frequent ongoing communication with associates and customers, enhanced the use of electronic and digital banking services and upheld consistently high standards for fraud and internal controls all while delivering our full array of financial services to our customers. In addition, we made significant efforts to relieve pandemic related financial pressures for customers:

oWaived certificate of deposit early withdrawal penalties and NSF overdraft fees

oTemporarily waived positive pay/Treasury Management fees for new customer signup, aiding in fraud prevention efforts

oModified and deferred loans for eligible consumer and commercial loan customers experiencing hardships; total of 562 modifications for 2020 totaling $230.6 million; 40 active loan modifications totaling approximately $18.2 million, or 1.7% of the loan portfolio remaining as of February 28, 2021

oSuspended repossession and foreclosure activity

oCommunicated frequently with associates and borrowers, keeping them apprised of changing regulations regarding PPP loan application processes and forgiveness procedures

oProcessed approximately 1,174 PPP loan applications totaling $148.9 million

oProcessed approximately 348, or $34.5 million, in PPP loan forgiveness requests

oAdjusted community office lobby access based upon COVID-19 related spikes within each of our market areas.

oProvided remote work and flexible work hours for 90% of associates to protect their health and allow for care of children or other family members

oWeekly Be Informed! virtual calls and COVID-19 update email for our First United team

oPaid Financial First Responder bonuses to associates

Paycheck Protection Program

The CARES Act established the PPP, which provided small businesses with resources to maintain payroll, hire back employees who may have been laid off, and to cover applicable overhead expenses. We acted expeditiously to prepare our associates so they could guide our customers on the proper procedures necessary to enable them to take advantage of this program. We developed a 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. These loans are 100% guaranteed by the SBA, have up to a two or five year maturity, provide for the earlier of when the Bank received forgiveness payment from the SBA or 10 months after the end of the covered payroll 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. Of the $3.7 million of deferred loan fees, we recognized approximately $2.0 million in 2020.

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 did not access the PPPLF during 2020, but are prepared to utilize the fund if and when management determines the timing is appropriate.

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.

During the third quarter of 2020, the Bank implemented PPP loan 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 December 31, 2020, we have processed loan forgiveness applications for approximately $34.5 million of PPP loans.

In January 2021, President Trump signed the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act into law. This act provides an extension of stimulus package benefits and unemployment through March 14, 2021 as well as funding for additional PPP loans. As of March 11, 2021, we have processed 561 PPP2 loan applications totaling $56.4 million.

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 December 31, 2020, the Corporation had approximately $130.0 million in unsecured lines of credit with its correspondent banks, $1.1 million with the Federal Reserve Discount Window, and approximately $134.4 million of secured borrowings with the 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

Adoption of New Accounting Standards and Effects of New Accounting Pronouncements

Note 1 to the Consolidated Financial Statements discusses new accounting pronouncements that, when adopted, could affect our future consolidated financial statements.

CONSOLIDATED STATEMENT OF INCOME REVIEW

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 2020 and 2019.

GAAP Non-GAAP - FTE

Comparing the year ended December 31, 2020 to the year ended December 31, 2019, interest income remained stable. The increase in interest and fees on loans of $2.0 million was partially offset by the reduction in investment income of $1.0 million. While the average balance of the investment portfolio remained consistent, bonds, at higher yielding rates, were called and replaced with lower yielding investments resulting in a decrease in average yield on the investment portfolio of 44 basis points. Excess cash balances attributable to deposit growth were invested at the lower Fed Funds rate which also negatively affected interest income for the year

ended December 31, 2020. In late December, approximately $70.0 million of excess cash was deployed into the investment portfolio at an average yield of 1% that will provide additional interest income in 2021. Due to the uncertainties related to the COVID-19 pandemic and the volatile economic environment, the Bank maintained higher levels of liquidity in 2020 than in 2019. The increase in interest and fees on loans was due primarily to an increase in average balances of $144.5 million, primarily driven by the PPP loans but partially offset by the declining yield. The rate earned on the loan portfolio decreased by 46 basis points as a result of the significant decline in the rate environment over the past year and the high volume of PPP loans booked at the low 1.00% interest rate as noted above.

As shown below, the composition of total interest income between 2020 and 2019 remained relatively stable.

% of Total Interest Income

Interest and fees on loans 90% 87%

Interest on investment securities 9% 12%

Other 1% 1%

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The following table sets forth the average balances, net interest income and expense, and average yields and rates for our interest-earning assets and interest-bearing liabilities for 2020, 2019 and 2018.

Distribution of Assets, Liabilities and Shareholders’ Equity

Interest Rates and Interest Differential – Tax Equivalent Basis

For the Years Ended December 31

Assets

Investment Securities:

Liabilities and‎ Shareholders’ Equity

Time deposits:

Notes:

(1)The above table reflects the average rates earned or paid stated on a FTE basis assuming a tax rate of 21% for 2020 and 2019, and 35% for 2018. Non-GAAP interest income on a fully taxable equivalent basis for the years ended December 31, 2020, 2019 and 2018 were $917, $868, and $796, respectively.

(2)The average balances of non-accrual loans for the years ended December 31, 2020, 2019 and 2018, which were reported in the average loan balances for these years, were $9,945, $11,455, and $5,023, respectively.

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

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

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The following table sets forth an analysis of volume and rate changes in interest income and interest expense of our average interest-earning assets and average interest-bearing liabilities for 2020, 2019 and 2018. This table distinguishes between the changes related to average outstanding balances (changes in volume created by holding the interest rate constant) and the changes related to average interest rates (changes in interest income or expense attributed to average rates created by holding the outstanding balance constant).

Interest Variance Analysis (1)

(In thousands and tax equivalent basis) Volume Rate Net Volume Rate Net

Interest Income:

Interest-bearing deposits (7) (7) (14) (6) 12 6

Interest Expense:

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 $5.4 million for the year ended December 31, 2020 and $1.3 million for the year ended December 31, 2019. Net charge-offs of $1.5 million were recorded for 2020, compared to net recoveries of $0.2 million for 2019. The increase in provision expense for 2020 was driven by an increase in the qualitative factors reflecting the uncertainty of the economic environment related to the COVID-19 pandemic and its impact on our borrowers. Of the $5.4 million net provision expense for the year, $5.9 million was related to COVID-19 qualitative factor adjustments and $0.8 million was related to loan growth and the change in loan mix. Provision expense was partially offset by the release of a specific allocation of $1.3 million based on a new appraisal, as a non-accrual loan moved to the OREO portfolio. Management believes that the ALL reflects a level commensurate with the risk inherent in our loan portfolio.

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Other Operating Income

The following table shows the major components of other operating income for the past two years, exclusive of net gains, and the percentage changes during these years:

(Dollars in thousands) 2020 2019 % Change

Other operating income, exclusive of gains, decreased $0.7 million during the year ended December 31, 2020 when compared to the same period of 2019. The decrease was primarily a result of the decrease in BOLI income relating to the $1.1 million BOLI death benefit proceeds received during the third quarter 2019. Service charge income, primarily NSF income, decreased as the consumer and business overdraft activity decreased in the year of 2020 due to reduced consumer spending and increased cash balances resulting from the receipt of government stimulus payments and PPP funding. Trust and brokerage income increased $0.4 million year-over-year although it was negatively affected by market volatility early in the year as trustee fees are directly related to the value of assets under management. Debit card income increased $0.2 million for the year ended December 31, 2020 when compared with the same period of 2019 despite reduced consumer spending. Debit card income continues to increase as we grow our deposit relationships and our customers increase use of our electronic services.

Net gains of $2.8 million and $0.3 million were reported through other income for the years ended December 31, 2020 and 2019, respectively. The $2.5 million increase in gains was attributable to the increased sales of mortgage loans to Fannie Mae as well as gains on sales in the investment portfolio.

Other Operating Expense

The following table compares the major components of other operating expense for 2020 and 2019:

(Dollars in thousands) 2020 2019 % Change

Other operating expenses decreased $1.5 million for the year ended December 31, 2020 when compared to the same period of 2019. Salaries and benefits decreased $3.6 million, primarily due to the $2.5 million salary expense offset related to loan originations, primarily PPP loans, as well as the 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, our payment of Financial First Responder bonuses, and increased incentives for mortgage production. FDIC premiums increased slightly due to credits received on quarterly assessments in 2019. Equipment, occupancy and technology expenses remained stable when compared with 2019 as we began to realize cost savings from our core processor related to a new contract negotiated in 2020. Professional services increased $2.7 million primarily due to increased legal and professional expenses related to the 2020 proxy contest and related litigation. Investor relations expenses increased $1.0 million, also related to the 2020 proxy contest. OREO expenses decreased $1.5 million as compared with 2019 as we experienced lower valuation allowance write-downs related to updated appraisals.

Increased marketing, consulting, miscellaneous expenses, dues and licenses, fraud expenses, miscellaneous loan fees and Visa processing fees, were offset by reductions in schools and seminars, contributions, personnel related expenses, printed and office supplies, travel and lodging, 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. Other operating expenses recorded for 2020 include $0.6 million of expenses associated with consulting for automated services that were previously deferred but that management determined, subsequent to February 19, 2021, should be expensed during the fourth quarter of 2020.

Applicable Income Taxes

We recognized a tax expense of $3.9 million in 2020, compared to a tax expense of $3.3 million in 2019. See the discussion under “Income Taxes” in Note 18 to the Consolidated Financial Statements presented elsewhere in this annual report for a detailed analysis of our deferred tax assets and liabilities. Our effective tax rate was 22.2% in 2020 and 20.3% in 2019. The increase in the effective tax rate was primarily due to the reduced tax exempt income, particularly related to the $1.1 million of BOLI death benefit proceeds received in 2019.

At December 31, 2020, the Corporation had Maryland Net Operating Losses (“NOLs”) of $40.4 million for which a deferred tax asset of $2.7 million has been recorded. There has been and continues to be a full valuation allowance on these NOLs based on management’s belief that it is more likely than not that these NOLs will not be realized prior to the expiration of their carry-forward periods because the Corporation will not generate sufficient taxable income in the future to fully utilize the NOLs. The valuation allowance was $2.7 million at December 31, 2020 and $2.6 million at December 31, 2019.

We have concluded that no valuation allowance is deemed necessary for our remaining federal and state deferred tax assets at December 31, 2020, as it is more likely than not that they will be realized based on the expected reversal of deferred tax liabilities, the generation of future income sufficient to realize the deferred tax assets as they reverse, and the ability to implement tax planning strategies to prevent the expiration of any carry-forward periods.

CONSOLIDATED BALANCE SHEET REVIEW

Overview

Total assets at December 31, 2020 increased by $291.4 million to $1.7 billion from December 31, 2019. During 2020, cash and interest-bearing deposits in other banks increased by $99.5 million, the investment portfolio increased by $69.9 million and gross loans increased by $117.4 million but were offset by an increase in unearned fees of $1.0 million and an increase to the ALL of $4.0 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 as well as continued refinances of balances in our mortgage portfolio. The increase in the securities portfolio resulted from a strategic decision to purchase approximately $70.0 million of new investments in December 2020 as an alternative to holding low yielding cash balances. These investments will provide additional earnings in 2021 of approximately $0.7 million. OREO balances increased due to the movement of one large commercial participation loan from non-accrual loans to OREO after the foreclosure sale of the property early in the fourth quarter of 2020. This addition was partially offset by the sale of properties during the fourth quarter of 2020. Accrued interest receivable and other assets increased $3.6 million during 2020. Total liabilities increased by $286.3 million when compared with liabilities at December 31, 2019. This increase was primarily attributable to the strong deposit growth of $280.3 million, inclusive of the remaining deposit balances related to the PPP loans at December 31, 2020. Deposit growth of $182.9 million, excluding the PPP deposits, during the year 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 remained constant. Accrued interest payable and other liabilities increased $5.8 million. This increase was primarily related to $2.1 million of assets in 2019 in reserve for taxes moving to a liability in 2020. Total shareholders’ equity increased by $5.1 million during 2020, primarily due to the increase in earnings attributable to year-to-date net income, partially offset by common stock dividends of $3.6 million and the decline in surplus of $2.8 million related to stock repurchases during the first quarter of 2020 and the increase of $2.9 million in accumulated other comprehensive loss.

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As indicated below, the total interest-earning asset mix remained constant at December 31, 2020 as compared to December 31, 2019. The mix for each year is illustrated below:

Year End Percentage‎of Total Assets

Cash and cash equivalents 9% 3%

The year-end total liability mix has remained consistent during the two-year period as illustrated below.

Year End Percentage‎of Total Liabilities

Total deposits 90% 87%

Total borrowings 9% 11%

Loan Portfolio

The Bank is actively engaged in originating loans to customers primarily in Allegany County, Frederick County, Garrett County, and Washington County in Maryland, and in Berkeley County, Mineral County, Monongalia County, and Harrison County in West Virginia; and the surrounding regions of West Virginia and Pennsylvania. We have policies and procedures designed to mitigate credit risk and to maintain the quality of our loan portfolio. These policies include underwriting standards for new credits as well as continuous monitoring and reporting policies for asset quality and the adequacy of the ALL. These policies, coupled with ongoing training efforts, have provided effective checks and balances for the risk associated with the lending process. Lending authority is based on the type of the loan, and the experience of the lending officer.

Commercial loans are collateralized primarily by real estate and, to a lesser extent, equipment and vehicles. Unsecured commercial loans represent an insignificant portion of total commercial loans. Residential mortgage loans are collateralized by the related property. Generally, a residential mortgage loan exceeding a specified internal loan-to-value ratio requires private mortgage insurance. Installment loans are typically collateralized, with loan-to-value ratios which are established based on the financial condition of the borrower. We also have made unsecured consumer loans to qualified borrowers meeting our underwriting standards. Additional information about our loans and underwriting policies can be found in Item 1 of Part I of this annual report under the heading “Banking Products and Services”.

The following table sets forth the composition of our loan portfolio. Historically, our policy has been to make the majority of our loan commitments in our market areas. We had no foreign loans in our portfolio as of December 31 for any of the years presented.

Summary of Loan Portfolio

The following table presents the composition of our loan portfolio as of December 31 for the past five years:

Outstanding loans increased to $1.2 billion at December 31, 2020, compared to $1.1 billion at December 31, 2019. The $117.4 million of growth was primarily attributable to the participation in the PPP loan program and core commercial loan growth partially offset by a decline in our mortgage loan portfolio. CRE loans increased by $33.7 million due to expansion of several new customer relationships as well as an increase in small business loans. A&D loans declined by $0.9 million as amortization and payoffs offset new production. C&I loans increased by $144.4 million, including $114.0 million of PPP loans which remained on the balance sheet at December 31, 2020. The growth in the commercial portfolios was offset by a decline in residential mortgage loans of $59.3 million, as we saw robust refinancing activity during 2020. Given the current low interest rate environment, customers preferred

longer-term fixed-rate loans. Management elected to utilize the secondary market rather than hold mortgage loans in the portfolio at the longer-term fixed rates. The consumer loan portfolio declined slightly by $0.5 million during 2020.

Commercial loan production for 2020 was approximately $190.1 million, including PPP loan originations. Commercial construction funding continued to ramp up during the fourth quarter as projects are entering their larger draw periods, which should result in increased outstanding balances in 2021. At 2020 year-end, unfunded, committed commercial construction loans equaled $41.0 million. Commercial amortization and payoffs were approximately $85.2 million through December 31, 2020, including approximately $34.5 million of PPP loan forgiveness. Consumer mortgage loan production continued at a record pace, with the production of approximately $144.6 million for 2020. The production and pipeline mix of in-house, portfolio loans and investor loans remained robust at December 31, 2020, with those loans totaling $24.6 million, consisting of $12.0 million in portfolio loans and $12.6 million in investor loans.

The following table sets forth the maturities, based upon contractual dates, for selected loan categories as of December 31, 2020:

Maturities of Loan Portfolio at December 31, 2020

Classified by Sensitivity to Change in Interest Rates

Management monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a required payment is past due. A loan is considered to be past due when a scheduled payment has not been received for 30 days past its contractual due date. For all loan segments, the accrual of interest is discontinued when principal or interest is delinquent for 90 days or more unless the loan is well-secured and in the process of collection. All non-accrual loans are considered to be impaired. Interest payments received on non-accrual loans are applied as a reduction of the loan principal balance. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. Our policy for recognizing interest income on impaired loans does not differ from our overall policy for interest recognition.

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The following sets forth the amounts of non-accrual, past-due and restructured loans for the past five years:

Risk Elements of Loan Portfolio

At December 31,

Non-accrual loans:

Commercial and industrial — 30 — 378 —

Accruing Loans Past Due 90 days or more:

Commercial and industrial — — — 6 11

Restructured Loans (TDRs):

Valuation allowance related to impaired loans $ 57 $ 2,173 $ 144 $ 362 $ 260

Non-Accrual Loans as a % of Applicable Portfolio

Acquisition and development 0.3% 6.8% 0.1% 0.2% 0.1%

We would have recognized $0.5 million in interest income for the year ended December 31, 2020 had our non-accrual loans been current and performing in accordance with their terms. During 2020, we recognized, on a cash basis, $0.1 million of interest income on non-accrual loans that paid off.

Performing loans considered to be impaired (including performing troubled debt restructurings, or TDRs), as defined and identified by management, amounted to $4.1 million at December 31, 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 movement of the A&D loan to OREO, as previously discussed.

The level of performing impaired loans (other than performing TDRs) increased by $0.4 million during the year ended December 31, 2020.

A troubled debt restructuring is the restructuring of a loan in which one or more concessions are granted to a borrower who is experiencing financial difficulties. A loan will be classified as a TDR if the Bank restructures the loan’s terms (i.e., interest rate, payment amount, amortization period and/or maturity date) after determining that the borrower is experiencing financial difficulties. A modified loan is considered to be a TDR when the Bank has determined that the borrower is experiencing financial difficulties. The Bank evaluates the probability that the borrower will be in payment default on any of its debt 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. The following table presents the details of TDRs by loan class at December 31, 2020 and December 31, 2019:

Performing

Commercial real estate

Acquisition and development

Commercial and industrial 0 — 0 —

Residential mortgage

Residential mortgage – home equity 0 — 0 —

Consumer 0 — 0 —

Non-accrual

Commercial real estate

Non owner-occupied 0 $ — 0 $ —

All other CRE 0 — 0 —

Acquisition and development

1-4 family residential construction 0 — 0 —

All other A&D 0 — 0 —

Commercial and industrial 0 — 0 —

Residential mortgage

Residential mortgage – home equity 0 — 0 —

Consumer 0 — 0 —

The level of TDRs decreased by $0.2 million during the year ended December 31, 2020. There were no new loans added to TDRs and nine loans already in performing TDRs were re-modified. During the year ended December 31, 2020, one loan totaling $32 thousand paid off. Net principal payments totaling $0.2 million were received during the same time period.

At December 31, 2020, there were no additional funds committed to be advanced in connection with TDRs. Interest income not recognized due to rate modifications of TDRs was $28 thousand and interest income recognized on all TDRs was $0.2 million in 2020.

Section 4013 of the CARES Act allows financial institutions to suspend application of certain current TDR accounting guidance under ASC Subtopic 310-40 for loan modifications related to the COVID-19 pandemic made between March 1, 2020 and the date that is 60 days after the end of the COVID-19 national emergency, provided that 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 that 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 (i.e., six months or less) or mandated by a federal or state government in response to the COVID-19 pandemic, the borrower is not experiencing financial difficulty as determined under ASC Subtopic 310-40. In response to the COVID-19 pandemic, the Bank developed a set of guidelines to provide relief to qualified commercial, mortgage and consumer loans customers,

including the deferment of certain loan payments on these loans of up to 180 days. Initial deferrals of 90 days were granted to qualified customers with the option to request a second deferral for an additional 90 days. During 2020, 562 loans totaling $230.6 million were granted deferrals for interest or principal and interest payments. At December 31, 2020, 40 loans totaling $18.2 million remain in modification status. See Note 2 to the Consolidated Financial Statements presented elsewhere in this annual report for additional information regarding these modified loans.

The Bank has not characterized any of these modified loans as TDRs because they met the criteria established pursuant to Section 4013 of the CARES Act and the guidance issued thereunder, nor has the Bank designated them as past due or nonaccrual. The Bank continues to prudently work with borrowers who have been negatively impacted by the COVID-19 pandemic while managing credit risks and recognizing an appropriate ALL.

Allowance 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 ALL was $16.5 million at December 31, 2020 compared to $12.5 million at December 31, 2019, an increase of 31.5% that resulted primarily from adjustments to qualitative factors associated with the negative trend in the economic outlook and uncertainties in credit quality directly related to COVID-19. Net charge-offs of $1.5 million were recorded for 2020, compared to net recoveries of $0.2 million for 2019. The ratio of the ALL to loans outstanding, including PPP loan balances, was 1.41% at December 31, 2020 compared to 1.19% at December 31, 2019 and 1.36% at September 30, 2020. The ALL to loans outstanding, excluding PPP loan balances of $114.0 million, was 1.55% at December 31, 2020.

The ratio of net charge-offs to average loans for the year ended December 31, 2020 was an annualized 0.13%, compared to net recoveries to average loans of 0.02% for the year ended December 31, 2019. Details of the ratio, by loan type are shown below. The increase in net charge offs in the A&D portfolio is related to the $1.1 million charge off of a formerly allocated specific allowance on an adversely classified non-accrual participation loan during the third quarter of 2020. This loan was subsequently purchased by the lending group at foreclosure and moved to the OREO portfolio. The project is now being aggressively marketed. Our special assets team continues to effectively collect on charged-off loans, resulting in ongoing overall low charge-off ratios.

Accruing loans past due 30 days or more decreased to 0.20%, including PPP loans, or 0.22% excluding PPP loans, compared to 0.67% at December 31, 2019. Non-accrual loans totaled $3.3 million at December 31, 2020 compared to $10.8 million at December 31, 2019. The decrease in non-accrual balances at December 31, 2020 was primarily due to the movement of the $8.0 million A&D participation loan to OREO as described previously. In February 2021, a parcel was sold within the development which reduced the OREO balance by $2.2 million.

Management believes that the ALL at December 31, 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 CRE loan portfolio and obtains new appraisals on specific loans under defined parameters to assist in the determination of the periodic provision for loan losses.

The following table presents the activity in the ALL by major loan category for the past five years.

Analysis of Activity in the Allowance for Loan Losses

For the Years Ended December 31,

Charge-offs:

Recoveries:

Allowance for loan losses to total loans‎(as %) 1.41% 1.19% 1.10% 1.12% 1.11%

The following presents management’s allocation of the ALL by major loan category in comparison to that loan category’s percentage of total loans. Changes in the allocation over time reflect changes in the composition of the loan portfolio risk profile and refinements to the methodology of determining the ALL. Specific allocations in any particular category may be reallocated in the future as needed to reflect current conditions. Accordingly, the entire ALL is considered available to absorb losses in any category.

Allocation of the Allowance for Loan Losses

For the Years Ended December 31,

Investment Securities

The following table sets forth the composition of our securities portfolio by major category as of the indicated dates:

At December 31,

Securities Available-for-Sale:

Securities Held to Maturity:

Total fair value of investment securities available-for-sale at December 31, 2020 increased by $95.6 million when compared to December 31, 2019. At December 31, 2020, the securities classified as available-for-sale included a net unrealized loss of $3.6 million, compared to a net unrealized loss of $3.7 million at December 31, 2019. These unrealized losses represent the difference between the fair value and amortized cost of securities in the portfolio. On June 1, 2014, management reclassified an amortized cost basis of $107.6 million of available-for-sale securities to held to maturity. The unrealized loss of approximately $4.0 million, at the date of transfer, will continue to be reported in a separate component of shareholders’ equity as accumulated other comprehensive income and will be amortized over the remaining life of the securities as an adjustment of yield in a manner consistent with the amortization of any premium or discount.

As discussed in Note 25 to the Consolidated Financial Statements, we measure 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 $213.6 million of the available-for-sale portfolio was valued using Level 2 pricing and had net unrealized gains of $1.7 million at December 31, 2020. The remaining $13.3 million of the securities available-for-sale represents the entire CDO portfolio, which was valued using significant unobservable inputs, or Level 3 pricing. The $5.3 million in net unrealized losses associated with the collateralized debt obligation (“CDO”) portfolio relates to nine pooled trust preferred securities. Unrealized losses of $3.8 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 no credit related OTTI. The unrealized losses on these securities are primarily attributable to continued depression in the marketability and liquidity associated with CDOs.

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The following table provides a summary of the trust preferred securities in the CDO portfolio and the credit status of the securities as of December 31, 2020.

Investment Description First United Level 3 Investments Security Credit Status

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 require their issuers to contemporaneously defer dividend payments. 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 (i) the Corporation has the intent to sell the security and (ii) 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 (a) the length of time and the extent to which the fair value has been less than cost, (b) adverse conditions specifically related to the security, an industry, or a geographic area, (c) the historic and implied volatility of the security, (d) changes in the rating of a security by a rating agency, (e) recoveries or additional declines in fair value subsequent to the balance sheet date, (f) failure of the issuer of the security to make scheduled interest payments, and (g) 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 December 31, 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 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 (i) the few observable transactions and market quotations that are available are not reliable for the purpose of obtaining fair value at December 31, 2020, (ii) 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 relies 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, 2020 and December 31, 2019.

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.

Based upon a review of credit quality and the cash flow tests performed by the independent third party, management determined that no additional credit-related OTTI was required during 2020.

The following table sets forth the contractual or estimated maturities of the components of our securities portfolio as of December 31, 2020 and the weighted average yields on a tax-equivalent basis.

Investment Security Maturities, Yields, and Fair Values at December 31, 2020

Securities Available-for-Sale:

Residential mortgage-backed agencies — — — 22,899 22,899

Collateralized debt obligations — — — 13,260 13,260

Held to Maturity:

Commercial mortgage-backed agencies — 12,303 $ — — 12,303

Collateralized mortgage obligations 1,406 — — — 1,406

Obligations of states and‎ political subdivisions — — — 28,171 28,171

The weighted average yield was calculated using historical cost balances and does not give effect to changes in fair value. The negative weighted average yield was due to increased paydowns on mortgage-backed securities which impacted their factors and three month conditional prepayment rate. At December 31, 2020, one Tax Increment Funding bond totaling $18.4 million exceeded 10% of shareholders’ equity.

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Deposits

The following table sets forth the actual and average deposit balances by major category for 2020, 2019 and 2018:

Deposit Balances

Interest-bearing deposits:

Money Market:

Time deposits less‎ than $100K:

Time deposits $100K‎ or more:

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The following table sets forth the maturities of time deposits of $100,000 or more:

Maturity of Time Deposits of $100,000 or More

(In thousands) December 31, 2020

Maturities

Borrowed Funds

The following shows the composition of our borrowings at December 31:

The following is a summary of short-term borrowings at December 31 with original maturities of less than one year:

Securities sold under agreements to repurchase:

Weighted average interest rate at year end 0.19% 0.23% 0.24%

Approximate weighted average rate during the year 0.20% 0.28% 0.20%

Total borrowings increased slightly by $0.4 million, or 0.29%, in 2020 when compared to 2019 due to increased balances in our existing accounts in our Treasury Management product.

Management will continue to closely monitor interest rates within the context of its overall asset-liability management process. See the discussion under the heading “Interest Rate Sensitivity” in this Item 7 for further information on this topic.

At December 31, 2020, we had additional borrowing capacity with the FHLB totaling $134.4 million, an additional $130.0 million of unused lines of credit with various financial institutions, $1.1 million of an unused secured line of credit with the Federal Reserve Bank and approximately $142.3 million available through wholesale money market funds. See Note 13 to the Consolidated Financial Statements presented elsewhere in this annual report for further details about our borrowings and additional borrowing capacity, which is incorporated herein by reference.

Off-Balance Sheet Arrangements

In the normal course of business, to meet the financing needs of its customers, the Bank is a party to financial instruments with off-balance sheet risk. These financial instruments include commitments to extend credit, lines of credit, and standby letters of credit. Our exposure to credit loss in the event of nonperformance by the other party to these financial instruments is represented by the contractual amount of the instruments. 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 use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. We generally require collateral or other security to support the financial instruments with credit risk. The amount of collateral or other security is determined based on management’s credit evaluation of the counterparty. We evaluate each customer’s creditworthiness on a case-by-case basis.

Loan commitments and letters of credit totaled $201.4 million and $17.7 million, respectively, at December 31, 2020. Management does not believe that any of the foregoing arrangements have or are reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. We are not a party to any other off-balance sheet arrangements. See Note 24 to the Consolidated Financial Statements presented elsewhere in this annual report for additional information on these arrangements.

Capital Resources

We require capital to fund loans, satisfy our obligations under the Bank’s letters of credit, meet the deposit withdraw 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 below under the heading “Liquidity Management”. At December 31, 2020, the Bank had $130.0 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 $134.4 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 the 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. Detailed information about these capital regulations and their requirements is set forth in the “Supervision and Regulation” section of Item 1 of Part I of this annual report under the heading “Capital Requirements”.

At December 31, 2020, the Corporation’s total risk-based capital ratio was 16.08% and the Bank’s total risk-based capital ratio was 15.50%, both of which were well above the regulatory minimum of 8%. The total risk-based capital ratios of the Corporation and the Bank at December 31, 2019 were 16.29% and 15.60%, respectively. The decreases for the Corporation and the Bank in 2020 were due to increased earnings offset by the dividend funding and the stock repurchase of approximately $2.8 million.

At December 31, 2020, the most recent notification from the regulators categorizes the Corporation and the Bank as “well capitalized” under the regulatory framework for prompt corrective action. See Note 5 to the Consolidated Financial Statements presented elsewhere in this annual report for additional information regarding regulatory capital ratios.

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 meetings of a sub-committee of executive management, 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:

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

Secured advances with the FHLB of Atlanta, which are collateralized by eligible one to four family residential mortgage loans, home equity lines of credit, commercial real estate loans. Cash and various securities may also be pledged as collateral.

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

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.

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

Secured Federal Reserve Bank PPPLF – an eligible line of credit secured by PPP loans.

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.

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 December 31, 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-rangefinancial 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.

NIImodeling allowsmanagement to view how changes in interest rateswill affect the spread between the yield earned 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/ EVEmodeling 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 December 31, 2020 and 2019, management estimated the following changes in net interest income, assuming the indicated rate changes:

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.

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.

‎

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information called for by this item is incorporated herein by reference to Item 7 of Part II of this annual report under the heading “Market Risk and Interest Sensitivity”.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Page

Report of Independent Registered Public Accounting Firm 54

Consolidated Statement of Financial Condition at December 31, 2020 and 2019 56

‎

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders

First United Corporation and Subsidiaries

Opinion on the Financial Statements

We have audited the accompanying consolidated statements of financial condition of First United Corporation and Subsidiaries (Corporation) as of December 31, 2020 and 2019, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for the years then ended, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Corporation as of December 31, 2020 and 2019, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on the Corporation's consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Corporation in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Corporation's internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Allowance for Loan Losses – General Component Qualitative Factors

As discussed in Notes 1 and 8 to the consolidated financial statements, the allowance for loan losses is established through a provision for loan losses and represents an amount, which, in management’s judgment, will be adequate to absorb losses in the loan portfolio. The Corporation’s allowance for loan losses was $16.5 million at December 31, 2020 and consists of specific and general components of $57 thousand and $16.4 million, respectively. Management develops the general component based on historical loan loss experience adjusted for qualitative factors not reflected in the historical loss experience. Historical loss ratios are measured on a rolling twelve-quarter basis for consumer loans and eight quarters for commercial loans. The qualitative factors used by the Corporation include factors such as national and local economic conditions, levels of and trends in delinquency rates and nonaccrual loans, trends in volumes and terms of loans, changes in lending policies, lending personnel, and collateral, as well as concentrations in loan types, industry, and geography. The adjustments for qualitative factors require a significant amount of judgment by management and involve a high degree of estimation uncertainty.

We identified the qualitative factor component of the allowance for loan losses as a critical audit matter as auditing the underlying qualitative factors required significant auditor judgment as amounts determined by management rely on analysis that is highly subjective and includes significant estimation uncertainty.

Our audit procedures related to the qualitative factor component of the allowance for loan losses included the following, among others:

Obtaining an understanding of the relevant controls related to the allowance for loan losses and testing such controls for design and operating effectiveness, including controls related to management’s establishment, review, and approval of the qualitative factors, and the completeness and accuracy of data used in determining qualitative factors.

Evaluation of the appropriateness of management’s methodology for estimating the allowance for loan losses.

Testing of the completeness and accuracy of data used by management in determining qualitative factor adjustments by agreeing them to internal and external source data.

Testing of management’s conclusions regarding the appropriateness of the qualitative factor adjustments and agreement of any changes therein to the allowance for loan losses calculation.

Goodwill Impairment Evaluation

The Corporation has recorded goodwill of $11 million. As discussed in Notes 1 and 15 to the consolidated financial statements, goodwill is not amortized but is tested for impairment at least annually. Impairment exists when the fair value of the reporting unit is less than its carrying amount. Due to volatility in its stock price and economic conditions resulting from the COVID-19 pandemic, the Corporation engaged a third-party valuation specialist to perform a quantitative test of goodwill impairment at September 30, 2020 using a discounted cash flow analysis (income approach) and estimates of selected market information (market approach). Each approach was weighted 50%. The determination of the fair value of the Corporation requires management to make significant estimates and assumptions including, among other things, the selection of appropriate discount rates, the identification of relevant market comparables and the development of cash flow projections. At December 31, 2020, its annual impairment testing date, the Corporation performed a qualitative review to determine if changes since September 30, 2020 resulted in a conclusion that it was more likely than not that fair value was less than carrying value. The Corporation concluded fair value continued to be in excess of carrying value at December 31, 2020.

We identified the goodwill impairment assessment as a critical audit matter due to the degree of auditor judgment in performing procedures over the key assumptions noted above.

Our audit procedures performed to address this critical matter included the following, among others:

Obtaining an understanding of internal controls relevant to the goodwill impairment assessment and testing such controls for design and operating effectiveness, including controls related to management’s establishment, review, and approval of the assumptions, including those used by the third-party valuation specialist, and the completeness and accuracy of data used.

Evaluation of the methodologies used in management’s analysis, including the weightings assigned to each approach and testing the completeness and accuracy of data used in management’s calculations.

Evaluation of management’s ability to forecast cash flows by comparing actual results to historical annual budgets.

Involvement of an employed valuation specialist to (1) evaluate the key assumptions and inputs used by the management’s third-party valuation specialist, including discount rate, terminal growth rate, control premium, and market comparable entities; and (2) test the overall reasonableness of fair value and conclusion of no impairment by calculating an independent expectation as of December 31, 2020.

/s/ Baker Tilly US, LLP

We have served as the Corporation’s auditor since 2006.

Baker Tilly US, LLP (formerly known as Baker Tilly Virchow Krause, LLP)

Pittsburgh, Pennsylvania

March 25, 2021

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First United Corporation and Subsidiaries

Consolidated Statement of Financial Condition

(In thousands, except per share amounts)

December 31,

Assets

Interest bearing deposits in banks 2,759 1,467

Investment securities – available-for-sale (at fair value) 226,885 131,305

Restricted investment in bank stock, at cost 4,468 4,415

Loans held for sale (at fair value) 3,546 1,749

Accrued interest receivable and other assets 19,617 16,063

Liabilities and Shareholders’ Equity

Liabilities:

Accrued interest payable and other liabilities 26,044 20,235

Shareholders’ Equity:

Accumulated other comprehensive loss (28,863) (25,971)

See notes to consolidated financial statements

‎

First United Corporation and Subsidiaries

Consolidated Statement of Income

(In thousands, except per share data)

Year Ended

December 31,

Interest income

Interest on investment securities

Exempt from federal income tax 1,084 1,031

Interest expense

Interest on short-term borrowings 94 188

Interest on long-term borrowings 3,205 3,550

Net interest income after provision for loan losses 43,145 45,071

Other operating income

Service charges on deposit accounts 1,929 2,192

Other operating expenses

Other real estate owned expenses 11 1,542

Provision for income tax expense 3,947 3,336

Basic net income per share $ 1.98 $ 1.85

Diluted net income per share 1.97 1.85

Weighted average number of basic shares outstanding 7,004 7,101

Weighted average number of diluted shares outstanding 7,013 7,101

Dividends declared per common share $ 0.52 $ 0.44

See notes to consolidated financial statements

‎

First United Corporation and Subsidiaries

Consolidated Statement of Comprehensive Income

(In thousands)

Year Ended

December 31,

Other comprehensive (loss)/income, net of tax and reclassification adjustments:

Net unrealized losses on investments with OTTI (735) (643)

Net unrealized gains on all other AFS securities 828 2,748

Net unrealized gains on HTM securities 584 232

Net unrealized losses on cash flow hedges (869) (858)

Net unrealized losses on pension plan liability (2,213) (2,400)

Net unrealized losses on SERP liability (487) (647)

Other comprehensive loss, net of tax (2,892) (1,568)

See notes to consolidated financial statements

‎

First United Corporation and Subsidiaries

Consolidated Statement of Changes in Shareholders’ Equity

(In thousands, except number of shares)

Other comprehensive loss, net of tax (1,568) (1,568)

Common stock dividend declared -‎ $0.44 per share (3,125) (3,125)

Stock based compensation 268 268

Other comprehensive loss, net of tax (2,892) (2,892)

Common stock dividend declared -‎ $0.52 per share (3,631) (3,631)

Stock based compensation 345 345

See notes to consolidated financial statements

‎

First United Corporation and Subsidiaries

Consolidated Statement of Cash Flows

(In thousands)

Year Ended

December 31,

Operating activities

Gains on sales of other real estate owned (130) (160)

Write-downs of other real estate owned 116 1,459

Origination of loans held for sale (73,797) (20,668)

Proceeds from sales of loans held for sale 74,403 19,502

Gains on sales of loans held for sale (2,403) (337)

Loss on disposal of fixed assets 150 3

Net amortization of investment securities discounts and premiums- HTM 352 114

Net gain on sales of investment securities – available-for-sale (632) —

Net losses on calls of investment securities – held to maturity 97 —

Amortization of deferred loan fees (2,683) (935)

Earnings on bank owned life insurance (1,253) (2,257)

Amortization of operating lease right of use asset 253 277

Operating lease liability (281) (287)

Increase in accrued interest receivable and other assets (6,830) (3)

Increase in accrued interest payable and other liabilities 5,010 900

Net cash provided by operating activities 16,169 16,390

Investing activities

Proceeds from sales of investment securities available-for-sale 43,278 21,872

Purchases of investment securities available-for-sale (184,079) (39,307)

Purchases of investment securities held-to-maturity (21,658) (8,207)

Proceeds from sales of other real estate owned 2,175 2,777

Net (increase)/decrease in FHLB stock (53) 979

Purchases of premises and equipment (1,604) (3,973)

Net cash used in investing activities (191,281) (32,522)

Financing activities

Proceeds from issuance of common stock 198 170

Cash dividends paid on common stock (3,646) (3,125)

Net increase/(decrease) in short-term borrowings 432 (28,979)

Stock repurchase (2,754) —

Net cash provided by financing activities 274,565 42,570

Increase in cash and cash equivalents 99,453 26,438

Cash and cash equivalents at beginning of the year 49,979 23,541

Cash and cash equivalents at end of period $ 149,432 $ 49,979

Supplemental information

Non-cash investing activities:

Transfers from loans to other real estate owned $ 7,420 $ 1,605

Initial recognition of operating lease liabilities at adoption $ — $ 3,317

See notes to consolidated financial statements

First United Corporation and Subsidiaries

Notes to Consolidated Financial Statements

1. Summary of Significant Accounting Policies

Business

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 “Federal Reserve”) 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. Until September 14, 2019 when it was canceled, the Corporation also served as the parent company to First United Statutory Trust III, a Delaware statutory business trust (“Trust III” and together with Trust I and Trust II, the “Trusts”). The Trusts were formed for the purpose of selling trust preferred securities that qualified as Tier 1 capital. 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. The Bank also owns 99.9% of the limited partnership interests in Liberty Mews Limited Partnership; a Maryland limited partnership formed for the purpose of acquiring, developing and operating low-income housing units in Garrett County, Maryland (“Liberty Mews”).

First United Corporation and its subsidiaries operate principally in four counties in Western Maryland and four counties in West Virginia.

As used in these Notes, the terms “the Corporation”, “we”, “us”, and “our” mean First United Corporation and, unless the context clearly suggests otherwise, its consolidated subsidiaries.

Basis of Presentation

The accompanying consolidated financial statements of the Corporation have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) as required by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) that require management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities at the date of the financial statements as well as the reported amount of revenues and expenses during the reporting period. Actual results could differ from these estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the assessment of other-than-temporary impairment (“OTTI”) pertaining to investment securities, potential impairment of goodwill, and the valuation of deferred tax assets. For purposes of comparability, certain prior period amounts have been reclassified to conform to the 2019 presentation. Such reclassifications had no impact on net income or shareholders’ equity.

The Corporation has evaluated events and transactions occurring subsequent to the statement of financial condition date of December 31, 2020 for items that should potentially be recognized or disclosed in these consolidated financial statements as prescribed by ASC Topic 855, Subsequent Events.

Principles of Consolidation

The consolidated financial statements of the Corporation include the accounts of First United Corporation, the Bank, the OakFirst Loan Centers, First OREO Trust and FUBT OREO I, LLC. All significant inter-company accounts and transactions have been eliminated.

First United Corporation determines whether it has a controlling financial interest in an entity by first evaluating whether the entity is a voting interest entity or a variable interest entity (“VIE”) in accordance with GAAP. Voting interest entities are entities in which the total equity investment at risk is sufficient to enable the entity to finance itself independently and provides the equity holders with the obligation to absorb losses, the right to receive residual returns and the right to make financial and operating decisions. The Corporation consolidates voting interest entities in which it has 100%, or at least a majority, of the voting interest. As defined in applicable accounting standards, a VIE is an entity that either (i) does not have equity investors with voting rights or (ii) has equity investors that do not provide sufficient financial resources for the entity to support its activities. A controlling financial interest in an entity exists when an enterprise has a variable interest, or a combination of variable interests that will absorb a majority of an entity’s expected losses, receive a majority of an entity’s expected residual returns, or both. The enterprise with a controlling financial interest, known as the primary beneficiary, consolidates the VIE.

The Corporation accounts for its investment in Liberty Mews utilizing the effective yield method under guidance that applies specifically to investments in limited partnerships that operate qualified affordable housing projects. Under the effective yield method,

the investor recognizes tax credits as they are allocated and amortizes the initial cost of the investment to provide a constant effective yield over the period that tax credits are allocated to the investor. The effective yield is the internal rate of return on the investment, based on the cost of the investment and the guaranteed tax credits allocated to the investor. The tax credit allocated, net of the amortization of the investment in the limited partnership, is recognized in the income statement as a component of income taxes attributable to continuing operations.

Significant Concentrations of Credit Risk

Most of the Corporation’s relationships are with customers located in Western Maryland and Northeastern West Virginia. At December 31, 2020, approximately 10%, or $117.0 million, of total loans were secured by real estate acquisition, construction and development projects, with $115.0 million performing according to their contractual terms and $2.0 million considered to be impaired based on management’s concerns about the borrowers’ ability to comply with present repayment terms. Of the $2.0 million in impaired loans, $1.1 million were performing, $0.5 million were classified as troubled debt restructurings (“TDRs”) performing in accordance with their modified terms and $0.4 million were classified as non-performing loans at December 31, 2020. Additionally, loans collateralized by commercial rental properties represented 15% of the total loan portfolio as of December 31, 2020. Note 7 discusses the types of securities in which the Corporation invests and Note 8 discusses the Corporation’s lending activities.

Investments

The investment portfolio is classified and accounted for based on the guidance of ASC Topic 320, Investments – Debt and Equity Securities. Securities bought and held principally for the purpose of selling them in the near term are classified as trading account securities and reported at fair value with unrealized gains and losses included in net gains/losses in other operating income. Securities purchased with the intent and ability to hold the securities to maturity are classified as held-to-maturity securities and are recorded at amortized cost. All other investment securities are classified as available-for-sale. These securities are held for an indefinite period of time and may be sold in response to changing market and interest rate conditions or for liquidity purposes as part of our overall asset/liability management strategy. Available-for-sale securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of other comprehensive income included in the consolidated statement of comprehensive income, net of applicable income taxes.

The amortized cost of debt securities is adjusted for the amortization of premiums to the first call date, if applicable, or to maturity, and for the accretion of discounts to maturity, or, in the case of mortgage-backed securities, over the estimated life of the security. Such amortization and accretion is included in interest income from investments. Interest and dividends are included in interest income from investments. Gains and losses on the sale of securities are recorded using the specific identification method.

Restricted Investment in Bank Stock

Restricted stock, which represents required investments in the common stock of the Federal Home Loan Bank (“FHLB”) of Atlanta, Atlantic Community Bankers Bank (“ACBB”) and Community Banker’s Bank (“CBB”), is carried at cost and is considered a long-term investment.

Management evaluates the restricted stock for impairment in accordance with ASC Industry Topic 942, Financial Services – Depository and Lending, (942-325-35). Management’s evaluation of potential impairment is based on its assessment of the ultimate recoverability of the cost of the restricted stock rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability is influenced by criteria such as (i) the significance of the decline in net assets of the issuing bank as compared to the capital stock amount for that bank and the length of time this situation has persisted, (ii) commitments by the issuing bank to make payments required by law or regulation and the level of such payments in relation to the operating performance of that bank, and (iii) the impact of legislative and regulatory changes on institutions and, accordingly, on the customer base of the issuing bank. Management has evaluated the restricted stock for impairment and believes that no impairment charge is necessary as of December 31, 2020 or 2019.

The Corporation recognizes dividends on a cash basis. For the years ended December 31, 2020 and December 31, 2019, dividends of $212,252 and $290,415, respectively, were recorded in other operating income.

Loans

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or full repayment by the borrower are reported at their unpaid principal balance outstanding, adjusted for any deferred fees or costs pertaining to origination. Loans that management has the intent to sell are reported at the lower of cost or fair value determined on an individual basis. Loans held for sale were $3.5 million at December 31, 2020 and $1.7 million at December 31, 2019.

The segments of the Bank’s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. The commercial real estate (“CRE”) loan segment is further disaggregated into two classes. Non-owner occupied CRE loans, which include loans secured by non-owner occupied nonfarm nonresidential properties, generally have a greater risk profile than all other CRE loans, which include loans secured by farmland, multifamily structures and owner-occupied commercial structures. The acquisition and development (“A&D”) loan segment is further disaggregated into two classes. One-to-four family residential construction loans are generally made to individuals for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. All other A&D loans are generally made to developers or investors for the purpose of acquiring, developing and constructing residential or commercial structures. These loans have a higher risk profile because the ultimate buyer, once development is completed, is generally not known at the time of the A&D loan. The commercial and industrial (“C&I”) loan segment consists of loans made for the purpose of financing the activities of commercial customers. The residential mortgage loan segment is further disaggregated into two classes: amortizing term loans, which are primarily first liens, and home equity lines of credit, which are generally second liens. The consumer loan segment consists primarily of installment loans (direct and indirect), student loans and overdraft lines of credit connected with customer deposit accounts.

Interest and Fees on Loans

Interest on loans (other than those on non-accrual status) is recognized based upon the principal amount outstanding. Loan fees in excess of the costs incurred to originate the loan are recognized as income over the life of the loan utilizing either the interest method or the straight-line method, depending on the type of loan. Generally, fees on loans with a specified maturity date, such as residential mortgages, are recognized using the interest method. Loan fees for lines of credit are recognized using the straight-line method.

A loan is considered to be past due when a payment has not been received for 30 days past its contractual due date. For all loan segments, the accrual of interest is discontinued when principal or interest is delinquent for 90 days or more unless the loan is well-secured and in the process of collection. All non-accrual loans are considered to be impaired. Interest payments received on non-accrual loans are applied as a reduction of the loan principal balance. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured. The Corporation’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

Generally, consumer installment loans are not placed on non-accrual status, but are charged off after they are 120 days contractually past due. Loans other than consumer loans are charged-off based on an evaluation of the facts and circumstances of each individual loan.

Allowance for Loan Losses

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

The Corporation’s methodology for determining the ALL is based on the requirements of ASC Section 310-10-35, Receivables-Overall-Subsequent Measurement, for loans individually evaluated for impairment and ASC Subtopic 450-20, Contingencies-Loss Contingencies, for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance. The total of the two components represents the Bank’s ALL.

The Corporation maintains an ALL on unfunded commercial lending commitments and letters of credit to provide for the risk of loss inherent in these arrangements. The allowance is determined utilizing a methodology that is similar to that used to determine the ALL, modified to take into account the probability of a draw down on the commitment. This allowance is reported as a liability on the balance sheet within accrued interest payable and other liabilities. The balance in the liability account was $109,559 at December 31, 2020 and $78,463 at December 31, 2019.

Premises and Equipment

Land is carried at cost. Premises and equipment are carried at cost, less accumulated depreciation. The provision for depreciation for financial reporting has been made by using the straight-line method based on the estimated useful lives of the assets, which range from 10 to 31.5 years for buildings and 3 to 20 years for furniture and equipment. Accelerated depreciation methods are used for income tax purposes.

Goodwill

Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired in business combinations. In accordance with ASC Topic 350, Intangibles - Goodwill and Other, goodwill is not amortized but is subject to an annual impairment test.

Bank-Owned Life Insurance (“BOLI”)

BOLI policies are recorded at their cash surrender values. Changes in the cash surrender values are recorded as other operating income.

Other Real Estate Owned (“OREO”)

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less the cost to sell at the date of foreclosure, with any losses charged to the ALL, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Changes in the valuation allowance, sales gains and losses, and revenue and expenses from holding and operating properties are all included in net expenses from other real estate owned.

Income Taxes

First United Corporation and its subsidiaries file a consolidated federal income tax return. Income taxes are accounted for using the asset and liability method. Under the asset and liability method, the deferred tax liability or asset is determined based on the difference between the financial statement and tax bases of assets and liabilities (temporary differences) and is measured at the enacted tax rates that will be in effect when these differences reverse. Deferred tax expense is determined by the change in the net liability or asset for deferred taxes adjusted for changes in any deferred tax asset valuation allowance.

ASC Topic 740, Taxes, provides clarification on accounting for uncertainty in income taxes recognized in an enterprise’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. We have not identified any income tax uncertainties.

State corporate income tax returns are filed annually. Federal and state returns may be selected for examination by the Internal Revenue Service and the states where we file, subject to statutes of limitations. At any given point in time, the Corporation may have several years of filed tax returns that may be selected for examination or review by taxing authorities.

Interest and penalties on income taxes are recognized as a component of income tax expense.

Defined Benefit Plans

The defined benefit pension plan and supplemental executive retirement plan are accounted for in accordance with ASC Topic 715, Compensation – Retirement Benefits. Under the provisions of Topic 715, the defined benefit pension plan and the supplemental executive retirement plan are recognized as liabilities in the Consolidated Statement of Financial Condition, and unrecognized net actuarial losses, prior service costs and a net transition asset are recognized as a separate component of other comprehensive loss, net of tax. Actuarial gains and losses in excess of 10 percent of the greater of plan assets or the pension benefit obligation are amortized over a blend of future service of active employees and life expectancy of inactive participants. Refer to Note 20 for a further discussion of the pension plan and supplemental executive retirement plan obligations.

Statement of Cash Flows

Cash and cash equivalents are defined as cash and due from banks and interest-bearing deposits in banks in the Consolidated Statement of Cash Flows.

Trust Assets and Income

Assets held in an agency or fiduciary capacity are not the Bank’s assets and, accordingly, are not included in the Consolidated Statement of Financial Condition. Income from the Bank’s trust department represents fees charged to customers.

Business Segments

The Corporation operates in one segment, community banking, as defined by ASC Topic 280, Segment Reporting. The Corporation in its entirety is managed and evaluated on an ongoing basis by First United Corporation’s Board of Directors and executive management, with no division or subsidiary receiving separate analysis regarding performance or resource allocation.

Stock Repurchases

Under the Maryland General Corporation Law, shares of capital stock that are repurchased are cancelled and treated as authorized but unissued shares. When a share of capital stock is repurchased, the payment of the repurchase price reduces stated capital by the par value of that share (currently, $0.01 for common stock), and any excess over par value reduces capital surplus. During 2020, the Corporation repurchased 145,291 shares of common stock at a weighted average price of $18.96. The Trust department purchased 194,124 shares as an investment in the pension plan at a weighted average price of $13.49.

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 August 2018, the FASB issued ASU 2018-14, “Compensation-Retirement Benefits-Defined Benefit Plans-General”. The amendments in this update remove disclosures that are no longer considered cost beneficial, clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant. The update is effective for public business entities for fiscal years ending after December 15, 2020. Early adoption is permitted. The Corporation adopted this ASU effective December 31, 2020.

In August 2018, the FASB issued ASU 2018-15, “Customer’s Accounting forImplementation Costs incurred in a Cloud Computing Arrangement that is a Service Contract”. This update amends Subtopic 350-40 “Intangibles-Goodwill and other-Internal-Use Software” by adding a subsection to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software and hosting arrangements that include an internal-use software license. The update is effective for public business entities for fiscal years ending after December 15, 2019, and interim periods within those fiscal years. ASU 2018-15 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 on the loan portfolio, investment portfolio and interest rate swaps, but believes that its adoption will not have a material impact on the Corporation’s financial condition or results of operations.

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. In response, President Trump declared a public health emergency and issued two related national emergency declarations on March 13, 2020. In addition, 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 the earlier of when the Bank received forgiveness payment from the SBA or 10 months after the end of the covered payroll 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, which resulted in $3.7 million of deferred loan fees. Of the $3.7 million in deferred fees, we recognized approximately $2.0 million in 2020.

In January 2021, President Trump signed the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (“CARES II”) into law. CARES II provides an extension of stimulus package benefits and unemployment through March 14, 2021 as well as funding for additional PPP loans. PPP loans made under CARES II have the same general loan terms as PPP loans made under the CARES Act. These loans have a maturity of five years and processing fees of the lessor of 0.50% or $2,500 up to 5.0%, depending on the loan amount.

During 2020, we processed 1,174 loan applications totaling $148.9 million and have received forgiveness of $34.5 million. Thus far in 2021, we have processed 561 PPP2 loan applications totaling $56.4 million.

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 2020, we did not access this facility. We will continue to monitor our liquidity position and determine appropriate timing to utilize these funds.

During 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.

Section 4013 of the CARES Act allows financial institutions to suspend application of certain current TDR accounting guidance under ASC Subtopic 310-40 for loan modifications related to the COVID-19 pandemic made between March 1, 2020 and the date that is 60 days after the end of the COVID-19 national emergency, provided that 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 that 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 (i.e., six months or less) or mandated by a federal or state government in response to the COVID-19 pandemic, the borrower is not experiencing financial difficulty as determined under ASC Subtopic 310-40. In response to the COVID-19 pandemic, the Corporation developed a set of guidelines to provide relief to qualified commercial, mortgage and consumer loans customers, including the deferment of certain loan payments on these loans of up to 180 days. Initial deferrals of 90 days were granted to qualified customers with the option to request a second deferral for an additional 90 days. Of the 19 commercial loans in modification status at December 31, 2020, there were seven classified loans. In accommodations, three were on their third deferral with one on its fourth deferral; two loans in owner occupied rentals on their third deferral period and one loan in food service in its third deferral period.

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We have not characterized as TDRs any modified loans that met the criteria established pursuant to Section 4013 of the CARES Act, 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, the percentage of the portfolio that has been modified through February 28, 2021, as well as loans still subject to modifications at February 28, 2021 as a result of COVID-19. For comparative purposes, total modifications for 2020 are included.

(*) Excluding 884 PPP loans totaling $114.0 million, 1.6% including PPP loans

(**) Including active loans/lines with no outstanding balance

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. There were 5,070 common stock equivalents of restricted stock units at December 31, 2020 and no common stock equivalents at December 31, 2019.

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The following table sets forth the calculation of basic and diluted earnings per common share for the years ended December 31, 2020 and 2019:

Average Per Share Average Per Share

Basic Earnings Per Share:

Diluted Earnings Per Share:

4. Net Gains

The following table summarizes the gain/(loss) activity for the years ended December 31, 2020 and 2019:

Net gains/(losses):

Available-for-sale securities:

Realized losses (185) (75)

Held-to-Maturity:

Realized losses (97) —

Gain on sale of consumer loans 2,403 337

Loss on disposal of fixed assets (150) (3)

5. Regulatory Capital Requirements

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 a number of funding sources, including an unsecured Fed Funds lines of credit with upstream correspondent banks; secured advances with the FHLB of Atlanta, which are collateralized by eligible one to four family residential mortgage loans, home equity lines of credit, commercial real estate loans, and various securities. Cash may also be pledged as collateral. In addition, First United Corporation has a secured line of credit with the Fed Discount Window for use in borrowing funds up to 90 days, using municipal securities as collateral; brokered deposits, including CDs and money market funds; and One Way Buy CDARS/ ICS funding, which is a form of brokered deposits that has become a viable supplement to brokered deposits obtained directly. At December 31, 2020, the Bank had $130.0 million available through unsecured lines of credit with correspondent banks, $1.1 million through a secured line of credit with the Fed Discount Window and approximately $134.4 million at 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.

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The following table presents our capital ratios for years ended December 31, 2020 and 2019:

(in thousands) Amount Ratio Amount Ratio Amount Ratio

Total Capital (to risk-weighted assets)

Tier 1 Capital (to risk-weighted assets)

Common Equity Tier 1 Capital‎ (to risk-weighted assets)

Tier 1 Capital (to average assets)

(in thousands) Amount Ratio Amount Ratio Amount Ratio

Total Capital (to risk-weighted assets)

Tier 1 Capital (to risk-weighted assets)

Common Equity Tier 1 Capital‎ (to risk-weighted assets)

Tier 1 Capital (to average assets)

As of December 31, 2020 and 2019, the most recent notifications from the regulators categorized First United Corporation and the Bank as “well capitalized” under the regulatory framework for prompt corrective action. The consolidated total risk-based capital ratios include $30.9 million of First United Corporation’s junior subordinated debentures (“TPS Debentures”) which qualified as Tier 1 capital at December 31, 2020 under guidance issued by the Federal Reserve. At the Bank and Consolidated level, the ratios decreased when comparing December 31, 2020 to December 31, 2019. At December 31, 2020, we were in compliance with the requirements.

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6. Cash and Cash Equivalents

Cash and due from banks, which represents vault cash in the retail offices and invested cash balances at the Federal Reserve, is carried at fair value.

Interest bearing deposits in banks, which represent funds invested at a correspondent bank, are carried at fair value and, as of December 31, 2020 and 2019, consisted of daily funds invested at the FHLB of Atlanta, and M&T Bank. In addition, at December 31, 2020, cash was pledged at Raymond James for the interest rate swap.

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7. Investment Securities

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

Available for Sale:

First United Corp/Md/ FUNC US Equity

FUNC · 10-K · period ended 2020-12-31

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

First United Corp/Md/ FUNC US Equity☆

FUNC · 10-K · period ended 2020-12-31

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

First United Corp/Md/ FUNC US Equity