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Basis of Presentation

3 Months Ended

Mar. 31, 2023

Note 1 – Basis of Presentation

The financial information is presented in accordance with generally accepted accounting principles and general practice for financial institutions in the United States of America (“GAAP”). The Company has prepared these unaudited condensed consolidated financial statements in accordance with GAAP for interim financial information, SEC rules that permit reduced disclosure for interim periods, and Article 10 of Regulation S-X. Certain reclassifications have been made to prior year amounts to conform with current year classifications. These reclassifications did not have a material impact on the Corporation’s consolidated financial condition or results of operations. Operating results for the three month period ended March 31, 2023 are not necessarily indicative of the results that may be expected for the full year or for any future interim period. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in First United Corporation’s Annual Report on Form 10-K for the year ended December 31, 2022.

In preparing financial statements, management is required to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities as of the date of financial statements. In addition, these estimates and assumptions affect revenues and expenses in the financial statements and as such, actual results could differ from those estimates.

In the opinion of management, all adjustments (all of which are of a normal recurring nature) that are necessary for a fair statement are reflected in the unaudited condensed consolidated financial statements.

Principles of Consolidation

The consolidated financial statements include the accounts of First United Corporation, First United Bank & Trust (the “Bank”), First United Statutory Trust I, First United Statutory Trust II, OakFirst Loan Center, LLC, Oakfirst Loan Center, Inc., First OREO Trust and FUBT OREO I, LLC. All significant inter-company accounts and transactions have been eliminated.

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

The Corporation has evaluated events and transactions occurring subsequent to the statement of financial condition date of March 31, 2023 and through the date these consolidated financial statements were issued, for items of potential recognition or disclosure.

Newly Adopted Pronouncements in 2023

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, universally referred to as CECL. The amendments in the ASU, among other things, requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied previously are still permitted, although the inputs to those techniques changed to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on purchased financial assets with credit deterioration. For periodic report filers that are smaller reporting companies, such as the Company, this standard (Topic 326) was effective as of January 1, 2023.

As part of its process of adopting the CECL accounting method, management implemented a third party software solution and determined the appropriate loan segments, methodologies, model assumptions and qualitative components. Our CECL model includes portfolio loan segmentation based upon similar risk characteristics and both a quantitative and qualitative component of the calculation which incorporates a forecasting component of certain economic variables. Our implementation plan also includes the assessment and documentation of appropriate processes, policies and internal controls. Management had a third party independent consultant review and validate our CECL model.

In addition, Topic 326 amends the accounting for credit losses on certain debt securities. The Company did not record any ACL on its debt securities as a result of adopting Topic 326.

The ultimate impact of adopting Topic 326, and at each subsequent reporting period, is highly dependent on credit quality, macroeconomic forecasts and conditions, compensation of our loan portfolio, and other management judgments. The Company adopted Topic 326 using the modified retrospective method. Results beginning after January 1, 2023 are presented under Topic 326, while prior period amounts continue to be reported in accordance with previously applicable GAAP. We made the accounting policy election to not measure an ACL for accrued interest receivables for loans and securities. Accrued interest deemed uncollectible will be written off through interest income.

The following table illustrates the day-one impact of adopting Topic 326.


		January 1, 2023
(Dollars in thousands)		As Reported Under Topic 326		Pre Topic 326		Impact of Topic 326 Adoption
Assets
Allowance for credit losses on loans
Commercial real estate	$	5,202	$	6,345	$	(1,143)
Acquisition and development		964		979		(15)
Commercial and industrial		4,179		2,845		1,334
Residentail mortgage		5,272		3,160		2,112
Consumer		1,085		877		208
Unallocated		-		430		(430)
Allowance for Credit Losses on Loans	$	16,702	$	14,636	$	2,066
Assets:
Investment securities- available for sale (at fair value)	$	125,889	$	125,889	$	-
Investment securities- held to maturity		245,659		245,659		-
Total loans held for investments, net		1,262,792		1,264,858		(2,066)
Net deferred tax asset		11,381		10,605		776
Liabilities:
Life-of-loss reserve on unfunded loan commitments	$	998	$	133	$	865
Equity:
Retained earnings	$	149,638	$	151,793	$	(2,155)

In connection with our adoption of Topic 326, we made changes to our loan portfolio segments to align with the methodology of CECL. Refer to Note 5, Loans and Related Allowance for Credit Losses, for further discussion of these portfolio segments. The adoption of Topic 326 resulted in a Day 1 adjustment of $2.9 million to our ACL, including an increase of $2.0 million to the ACL for loans and $0.9 million to the ACL for unfunded commitments. The Company did not record any ACL on its available-for-sale or held-to-maturity investments upon adoption of ASC 326. Our Company recorded a net decrease to retained earnings of $2.2 million as of January 1, 2023 for the cumulative effect of adopting Topic 326.

In March 2022, the FASB issued ASU 2022-02, Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. ASU 2022-02, which eliminates the troubled debt restructuring (TDR) accounting model for creditors that have adopted Topic 326, “Financial Instruments – Credit Losses.” Due to the removal of the TDR accounting model, all loan modifications were evaluated to determine if they resulted in a new loan or a continuation of the existing loan. The amendments in this ASU also required that entities disclose current-period gross chare-offs by year of origination for loans and leases. The amendments in this ASU were effective January 1, 2023. This change did not have a material effect on our consolidated financial statements. Refer to Note 5, Loans and Related Allowance for Credit Losses for disclosures for debtors experiencing financial difficulty and for vintage disclosures related to gross charge-offs by loan segment by year of origination.

Allowance for Credit Losses Policy

The ACL represents an amount which, in management’s judgment, is adequate to absorb expected losses on outstanding loans at the balance sheet date based on the evaluation of the size and current risk characteristics of the loan portfolio, past events, current conditions, reasonable and supportable forecasts of future economic conditions and prepayment experience. The ACL is measured and recorded upon the initial recognition of a financial asset. The ACL is reduced by charge-offs, net of recoveries of previous losses, and is increased or decreased by a provision for credit losses, which is recorded as a current period operating expense.

Determination of an appropriate ACL is inherently complex and requires the use of significant and highly subjective estimates. The reasonableness is reviewed quarterly by management.

Management believes it uses relevant information available to make determinations about the ACL and that it has established the existing allowance in accordance with GAAP. However, the determination of the ACL requires significant judgment, and estimates of expected losses in the loan portfolio can vary significantly from the amounts actually observed. While management uses available information to recognize losses, future additions to the ACL may be necessary based on changes in the loans comprising the portfolio, changes in the current and forecasted economic conditions, changes to the interest rate environment which may directly impact prepayment and curtailment rate assumptions, and changes in the financial condition of borrowers.

The adoption of CECL accounting did not result in a significant change to any other credit risk management and monitoring processes, including identification of past due or delinquent borrowers, nonaccrual practices, assessment of modified loans, or charge-off policy.

The Company’s methodology for estimating the ACL includes:

Segmentation. The Company’s loan portfolio is segmented by homogeneous loan types that behave similarly in economic cycles.

Specific Analysis. A specific reserve analysis is applied to certain individually evaluated loans. These loans are evaluated quarterly generally based on collateral value, observable market value or the present value of expected future cash flows. A specific reserve is established if the fair value is less than the loan balance. A charge-off is recognized when the loss is quantifiable. Individually evaluated loans not specifically analyzed reside in the Quantitative Analysis.

Quantitative Analysis. The Company elected to use Discounted Cash Flow (“DCF”). Economic forecasts include but are not limited to unemployment, the Consumer Price Index, the Housing Affordability Index and Gross State Product. These forecasts are assumed to revert to the long term average and are utilized in the model to estimate the probability of default and loss given default through regression. Model assumptions include, but are not limited to the discount rate, prepayments and curtailments. The product of the probability of default and the loss given default is the estimated loss rate, which varies over time. The estimated loss rate is applied within the appropriate periods in the cash flow model to determine net present value. Net present value is also impacted by assumptions related to the duration between default and recovery. The reserve is based on the differences between the summation of the principal balances taking amortized costs into consideration and the summation of the net present values.

Qualitative Analysis. Based on management’s review and analysis of internal, external and model risks, management may adjust the model output. Management reviews the peaks and troughs of the model’s calibration, taking into account economic forecasts to develop guardrails that serve as the basis for determining the reasonableness of the model’s output and makes adjustments as necessary. This process challenges unexpected variability resulting from outputs beyond the model’s calibration that appear to be unreasonable. Additionally, management may adjust the economic forecast if it is incompatible with known market conditions based on mangement’s experience and perspective.

Loan Commitments and Allowance for Credit Loss on Off-Balance Sheet Credit Exposures

Financial instruments include off-balance sheet credit instruments such as commitments to make loans and commercial letters of credit issued to meet customer financing needs. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for off-balance sheet loan commitments is represented by the contractual amount of those instruments. Such financial instruments are recorded when they are funded.

The Company records a reserve for unfunded commitments (“RUC”) on off-balance sheet credit exposures through a charge to provision for credit loss expense in the Company’s Consolidated Statement of Income. The RUC on off-balance sheet credit exopsures is estimated by loan segment at each balance sheet date under the CECL model using the same methodologies as portfolio loans, taking into consideration the likelihood that funding will occur, and is included in the RUC on the Company’s Consolidated Balance Sheet.

Loan Restructurings

In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a restructured loan. Management strives to identify borrowers in financial difficulty early and work with them to modify the loan to more affordable terms before their loan reaches nonaccrual status. These modified terms that result in a direct change in the timing or amount of contractual cash flows have historically included interest only periods, extended amortization periods beyond what management would typically offer for a similar loan or a below market interest rate when compared to management’s underwriting standards for a similar loan type. These concessions are intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of interest, management measures any impairment on the restructuring as noted above for loans experiencing financial difficulty.

Allowance for Credit Losses – Available-for-Sale and Held-to-Maturity Securities

The Company utilizes ASC 326 to evaluate its available-for-sale (“AFS”) and held-to-maturity (“HTM”) debt security portfolio for expected credit losses. For AFS debt securities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell, the security before recovery of its amortized cost basis. If either criterion is met, the security’s amortized cost basis is written down to fair value through income. For AFS debt securities that do not meet the aforementioned criteria, the Company evaluates whether the decline in fair value has resulted from credit losses or other factors. In making this assessment, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security is compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an ACL is recorded for that credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an ACL is recognized in other comprehensive income, as a non-credit-related impairment.

The Company adopted ASC 326 using the prospective transition approach for debt securities for which other than temporary impairment (“OTTI”) had been recognized prior to January 1, 2023, such as AFS collateralized debt obligations. As a result, the amortized cost basis for such debt securities remained the same before and after the effective date of ASC 326. The effective interest rate on these debt securities was not changed. Amounts previously written recognized in OCI as of January 1, 2023 relating to improvements in cash flows expected to be collected are accreted into income over the remaining life of the asset. Recoveries of amounts previously written off relating to improvements in cash flows after January 1, 2023 are recorded in earnings when received.

The entire amount of an impairment loss is recognized in earnings only when: 1) the Company intends to sell the security or; 2) it is more likely than not that the Company will have to sell the security before recovery of its amortized cost basis; or 3) the Company does not expect to recover the entire amortized cost basis of the security. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in eanings, with the remaining portion being recognized in shareholders’ equity as comprehensive income, net of deferred taxes.

Changes in the allowance for credit losses are not recorded as a provision for (or credit to) credit losses. Losses are charged against the allowance when management believes the uncollectibility of an AFS security is confirmed or when either of the criteria regarding intent or requirement to sell is met. Any impairment not recorded through the an allowance for credit loss is recognized in other comprehensive income as a non-credit-related impairment.

We have made a policy election to exclude accrued interest form the amortized cost basis of AFS debt securities and report accrued interest separately on the Consolidated Balance Sheet. AFS debt securities are placed on nonaccrual status when we no longer expect to receive all contractual amounts due, which is generally at 90 days past due. Accrued interest receivable is reversed

against interest income when a security is placed on nonaccrual status. Accordingly, we do not recognized an allowance for credit loss against accrued interest receivable.

The Company separately evaluates its HTM investment securities for any credit losses. The Company pools like securiites and calculates expected credit losses through an estimate based on a security’s credit rating, which is recognized as part of the allowance for credit losses for held-to-maturity securities and included in the balance of investment securities held-to-maturity on the Consolidated Balance Sheets. If the Company determines that a security indicates evidence of deteriorated credit quality, the security is individually-evaluated and a discounted cash flow analysis is performed and compared to the armotized cost basis.