Form 10-Q
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
_____________________________
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
_______________ _______________
Commission file number 0-19214
____________________________________________
Union National Financial Corporation
________________________________________________________________
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2415179
___________________________________ _______________________
(State of Incorporation) (I.R.S. Employer ID No.)
101 East Main Street, P.O. Box 567, Mount Joy, PA 17552
____________________________________________________ ________
(Address of principal executive offices) Zip Code
(717) 653 - 1441
_________________________________________________________________
(Registrant's telephone number, including area code)
Not Applicable
_________________________________________________________________
(Former name, former address, & former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15 (d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
_______________
Indicate by check mark whether the registrant is an
accelerated filer (as defined in Rule 12b02 of the Exchange Act).
Yes [ ] No [X]
_______________
Indicate the number of shares outstanding of each of the
issuer's classes of common stock, as of the latest practicable
date.
2,458,518 shares of $.25 (par) common stock were
_________________
outstanding as of November 4, 2003.
_________________
UNION NATIONAL FINANCIAL CORPORATION
10Q INDEX Page
#
PART I - FINANCIAL INFORMATION: _________
_______________________
Item 1 - Financial Statements
- Consolidated Statements of Financial Condition 1
- Consolidated Statements of Income 2
- Consolidated Statements of Comprehensive Income 2
- Consolidated Statements of Cash Flows 3
- Notes to Consolidated Financial Statements 4 - 5
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 6 - 16
Item 3 - Quantitative and Qualitative Disclosures About
Market Risk 16 - 18
Item 4 - Controls and Procedures 18
PART II - OTHER INFORMATION
___________________
Item 1 - Legal Proceedings 19
Item 2 - Changes in Securities and Use of Proceeds 19
Item 3 - Defaults Upon Senior Securities 19
Item 4 - Submission of Matters to a Vote of
Security Holders 19
Item 5 - Other Information 19
Item 6 - Exhibits and Reports on Form 8-K 19
Exhibit 31.1 - Certification of Principal Executive
Officer Pursuant to Exchange Act Rules
13a-14(a)/15d-14(a) as Added by
Section 302 of the Sarbanes-Oxley Act
of 2002 20-21
Exhibit 31.2 - Certification of Principal Financial
Officer Pursuant to Exchange Act Rules
13a-14(a)/15d-14(a) as Added by
Section 302 of the Sarbanes-Oxley Act
of 2002 22-23
Exhibit 32 - Certification of Principal Executive
Officer and Principal Financial Officer
Pursuant to 18 U.S.C. Section 1350 as
Added by Section 906 of the Sarbanes-
Oxley Act of 2002 24-25
Signature Page 26
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Union National Financial Corporation
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
(Dollars in thousands, except per share data)9/30/03 12/31/02
_______________________
ASSETS
Cash and Due from Banks $ 8,417 $ 7,215
Interest-Bearing Deposits in Other Banks 218 70
Federal Funds Sold 2,650 2,260
Short-Term Investments 5,000 5,000
________ _______
Total Cash and Cash Equivalents 16,285 14,545
Investment Securities Available-for-Sale 96,132 90,679
Loans Held for Sale 677 892
Loans(Net of Unearned Income) 204,164 199,065
Less: Allowance for Loan Losses (1,906) (1,812)
_______________________
Net Loans 202,258 197,253
Premises and Equipment - Net 6,301 6,320
Restricted Investment in Bank Stocks 4,128 3,772
Other Assets 11,766 7,048
_______________________
TOTAL ASSETS $337,547 $320,509
=======================
LIABILITIES
Deposits:
Noninterest-Bearing $ 29,118 $ 31,141
Interest-Bearing 204,381 192,209
_______________________
Total Deposits 233,499 223,350
Short-Term Borrowings 3,313 3,387
Long-Term Debt 71,874 65,299
Other Liabilities 1,577 1,738
_______________________
TOTAL LIABILITIES 310,263 293,774
STOCKHOLDERS' EQUITY
Common Stock (Par Value $.25 per share) 694 688
Shares: Authorized - 20,000,000; Issued -
2,774,152 in 2003 (2,753,243 in 2002)
Outstanding - 2,510,610 in 2003 (2,517,469
in 2002)
Surplus 9,296 8,939
Retained Earnings 21,611 20,319
Accumulated Other Comprehensive Income 516 1,120
Treasury Stock - 263,542 shares in
2003 (235,774 in 2002), at cost (4,833) (4,331)
_______________________
TOTAL STOCKHOLDERS' EQUITY 27,284 26,735
_______________________
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $337,547 $320,509
=======================
The accompanying notes are an integral part of the
consolidated financial statements.
Union National Financial Corporation
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(Dollars in thousands, Three Months Ended September 30,
except per share data) ___________________________
2003 2002
___________________________
INTEREST INCOME
Interest and Fees on Loans $ 3,474 $ 3,794
Investment Securities:
Taxable Interest 680 739
Tax-Exempt Interest 327 272
Dividends 24 30
Other 3 27
____________________________
Total Interest Income 4,508 4,862
INTEREST EXPENSE
Deposits 817 1,084
Short-Term Borrowings 9 11
Long-Term Debt 840 903
____________________________
Total Interest Expense 1,666 1,998
____________________________
Net Interest Income 2,842 2,864
PROVISION for LOAN LOSSES 69 43
____________________________
Net Interest Income after Provision
for Loan Losses 2,773 2,821
OTHER OPERATING INCOME
Income from Fiduciary Activities 31 30
Service Charges on Deposit Accounts 264 252
Other Service Charges, Commissions, Fees 426 232
Investment Securities Gains 203 138
Mortgage Banking Activities 26 115
Other Income 119 72
____________________________
Total Other Operating Income 1,069 839
OTHER OPERATING EXPENSES
Salaries and Wages 1,269 1,173
Employee Benefits 304 248
Net Occupancy Expense 167 175
Furniture and Equipment Expense 149 161
Professional Fees 145 145
Data Processing Services 175 142
Pennsylvania Shares Tax 69 66
Advertising and Marketing Expenses 64 82
ATM Processing Expenses 68 66
Other Expenses 456 416
____________________________
Total Other Operating Expenses 2,866 2,674
____________________________
Income before Income Taxes 976 986
PROVISION for INCOME TAXES 164 184
____________________________
NET INCOME for PERIOD $ 812 $ 802
============================
PER SHARE INFORMATION
Net Income for Period-Basic $ 0.32 $ 0.31
Net Income for Period-Assuming Dilution 0.32 0.31
Cash Dividends 0.160 0.155
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(UNAUDITED)
Net Income for Period $ 812 $ 802
Other Comprehensive Income, Net of Tax:
Unrealized Holding Gains/(Losses)on
Investment Securities
Available-for-Sale Arising During Period (931) 713
Unrealized Holding Losses on Investment
Securities Transferred to Available-for-Sale
During Period - -
Reclassification Adjustment for Gains
Included in Net Income (134) (91)
___________________________
Total Other Comprehensive Income/(Loss) (1,065) 622
___________________________
COMPREHENSIVE INCOME/(LOSS) for PERIOD $ (253) $ 1,424
===========================
The accompanying notes are an integral part of the consolidated
financial statements.
Union National Financial Corporation
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(Dollars in thousands, Nine Months Ended September 30,
except per share data) ___________________________
2003 2002
___________________________
INTEREST INCOME
Interest and Fees on Loans $ 10,523 $ 11,579
Investment Securities:
Taxable Interest 2,047 2,252
Tax-Exempt Interest 914 807
Dividends 84 98
Other 32 52
____________________________
Total Interest Income 13,600 14,788
INTEREST EXPENSE
Deposits 2,594 3,578
Short-Term Borrowings 21 41
Long-Term Debt 2,577 2,594
____________________________
Total Interest Expense 5,192 6,213
____________________________
Net Interest Income 8,408 8,575
PROVISION for LOAN LOSSES 115 128
____________________________
Net Interest Income after Provision
for Loan Losses 8,293 8,447
OTHER OPERATING INCOME
Income from Fiduciary Activities 103 93
Service Charges on Deposit Accounts 756 754
Other Service Charges, Commissions, Fees 931 720
Investment Securities Gains 286 258
Mortgage Banking Activities 795 286
Other Income 272 225
____________________________
Total Other Operating Income 3,143 2,336
OTHER OPERATING EXPENSES
Salaries and Wages 3,722 3,423
Employee Benefits 897 813
Net Occupancy Expense 529 520
Furniture and Equipment Expense 441 479
Professional Fees 361 388
Data Processing Services 510 428
Pennsylvania Shares Tax 190 200
Advertising and Marketing Expenses 175 203
ATM Processing Expenses 201 187
Other Expenses 1,375 1,249
____________________________
Total Other Operating Expenses 8,401 7,890
____________________________
Income before Income Taxes 3,035 2,893
PROVISION for INCOME TAXES 564 542
____________________________
NET INCOME for PERIOD $ 2,471 $ 2,351
============================
PER SHARE INFORMATION
Net Income for Period-Basic $ 0.99 $ 0.92
Net Income for Period-Assuming Dilution 0.97 0.91
Cash Dividends 0.470 0.420
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(UNAUDITED)
Net Income for Period $ 2,471 $ 2,351
Other Comprehensive Income, Net of Tax:
Unrealized Holding Gains/(Losses) on
Investment Securities
Available-for-Sale Arising During Period (415) 846
Unrealized Holding Losses on Investment
Securities Transferred to Available-for-Sale
During Period - (27)
Reclassification Adjustment for Gains
Included in Net Income (189) (170)
____________________________
Total Other Comprehensive Income/(Loss) (604) 649
____________________________
COMPREHENSIVE INCOME/(LOSS) for PERIOD $ 1,867 $ 3,000
============================
The accompanying notes are an integral part of the consolidated
financial statements.
Union National Financial Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine Months Ended September 30,
__________________________
(In thousands) 2003 2002
_________________________
CASH FLOWS from OPERATING ACTIVITIES
Net Income $ 2,471 $ 2,351
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation and Amortization 613 598
Provision for Loan Losses 115 128
Net Amortization of Investment
Securities' Premiums 1,276 488
Investment Securities Gains (286) (258)
Provision for Deferred Income Taxes (3) 48
Increase in Cash-Surrender Value of
Bank-Owned Life Insurance (185) (159)
Gains on Loans Sold (577) (233)
Proceeds from Sales of Loans 23,712 8,281
Loans Originated for Sale (22,920) (8,153)
Increase in Accrued Interest Receivable (135) (76)
Increase in Other Assets (259) (178)
Decrease in Other Liabilities (154) (168)
____________________________
Net Cash Provided by Operating Activities 3,668 2,669
CASH FLOWS from INVESTING ACTIVITIES
Proceeds from Sales of
Available-for-Sale Securities 19,929 27,253
Proceeds from Maturities of
Available-for-Sale Securities 26,592 15,073
Proceeds from Maturities of
Held-to-Maturity Securities - 495
Purchases of Available-for-Sale Securities (53,879) (53,957)
Net Purchases of Restricted Investment
in Bank Stocks (356) (313)
(Net Loans Made to Customers)/ Net Principal
Collected on Loans (5,120) 530
Purchases of Property and Equipment (419) (129)
Purchase of Bank-Owned Life Insurance (4,000) -
____________________________
Net Cash Used in Investing Activities (17,253) (11,048)
CASH FLOWS from FINANCING ACTIVITIES
Net Increase in Demand Deposits
and Savings Accounts 16,089 2,072
Net Decrease in Time Deposits (5,940) (1,083)
Net Increase/(Decrease) in Short-Term
Borrowings (74) 276
Proceeds from Issuance of Long-Term Debt 17,182 16,580
Payment on Long-Term Debt (10,607) (12,533)
Acquisition of Treasury Stock (502) (981)
Issuance of Common Stock 356 275
Cash Dividends Paid (1,179) (1,078)
____________________________
Net Cash Provided by Financing Activities 15,325 3,528
____________________________
Net Increase/(Decrease) in Cash
and Cash Equivalents 1,740 (4,851)
CASH and CASH EQUIVALENTS -
Beginning of Year 14,545 13,289
____________________________
CASH and CASH EQUIVALENTS - End of Period $16,285 $ 8,438
============================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash Payments for:
Interest $ 5,340 $ 6,452
Income Taxes 582 495
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING ACTIVITIES
Reclassification of Held-to-Maturity
Investment Securities to
Available-for-Sale $ - $10,358
Retirement of Treasury Stock (20,000
shares in 2002) - 373
The accompanying notes are an integral part of the consolidated
financial statements.
UNION NATIONAL FINANCIAL CORPORATION
MOUNT JOY, PENNSYLVANIA
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The information contained in this interim report is unaudited
and subject to year-end adjustment and audit. However, in the
opinion of management, the information reflects all adjustments
necessary to present fairly the financial condition and results
of operations for the periods presented. All such adjustments
were of a normal, recurring nature. All material intercompany
transactions have been eliminated in consolidation. The results
of operations for the nine-month period ended September 30, 2003,
are not necessarily indicative of the results to be expected for
the full year.
2. These statements should be read in conjunction with notes to
the financial statements contained in the 2002 Annual Report to
Stockholders.
3. The weighted-average number of shares of common stock
outstanding was as follows:
Basic Assuming Dilution
_____ _________________
Three months ended:
September 30, 2003 2,506,285 2,548,015
September 30, 2002 2,551,939 2,571,690
Nine months ended:
September 30, 2003 2,507,647 2,543,388
September 30, 2002 2,563,968 2,583,391
4. As permitted by SFAS No. 123, Union National accounts for
stock-based compensation in accordance with Accounting Principles
Board Opinion (APB) No. 25. Under APB No. 25, no compensation
expense is recognized in the income statement related to any
options granted under Union National's stock option plans. The
pro forma impact to net income and earnings per share that would
occur if compensation expense was recognized, based on the
estimated fair value of the options on the date of the grant, is
as follows:
Three Months Ended September 30,
__________________________
(In thousands,except per share data) 2003 2002
__________________________
Net Income - As Reported $ 812 $ 802
Less: Stock Based Compensation Cost - -
__________________________
Net Income - Pro Forma $ 812 $ 802
==========================
Net Income Per Share:
As Reported (Basic) $ 0.32 $ 0.31
As Reported (Assuming Dilution) 0.32 0.31
Pro Forma (Basic) 0.32 0.31
Pro Forma (Assuming Dilution) 0.32 0.31
Nine Months Ended September 30,
__________________________
(In thousands,except per share data) 2003 2002
__________________________
Net Income - As Reported $ 2,471 $ 2,351
Less: Stock Based Compensation Cost (59) (182)
__________________________
Net Income - Pro Forma $ 2,412 $ 2,169
==========================
Net Income Per Share:
As Reported (Basic) $ 0.99 $ 0.92
As Reported (Assuming Dilution) 0.97 0.91
Pro Forma (Basic) 0.96 0.85
Pro Forma (Assuming Dilution) 0.95 0.84
5. In January 2003, the Financial Accounting Standards Board
issued FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51" . This
interpretation provides new guidance for the consolidation of
variable interest entities (VIEs) and requires such entities to
be consolidated by their primary beneficiaries if the entities do
not effectively disperse risk among parties involved. The
interpretation also adds disclosure requirements for investors
that are involved with unconsolidated VIEs. The disclosure
requirements apply to all financial statements issued after
January 31, 2003. The consolidation requirements apply
immediately to VIEs created after January 31, 2003, and are
effective for the first fiscal year ending after December 15,
2003, or interim periods beginning after December 15, 2003, for
VIEs acquired before February 1, 2003.
In April 2003, the Financial Accounting Standards Board issued
Statement No. 149, "Amendment of Statement 133 on Derivative
Instruments and Hedging Activities". This statement clarifies
the definition of a derivative and incorporates certain decisions
made by the Board as part of the Derivatives Implementation Group
process. This statement is effective for contracts entered into
or modified, and for hedging
relationships designated after June 30, 2003, and should be
applied prospectively. The provisions of the statement that
relate to implementation issues addressed by the Derivatives
Implementation Group that have been effective should continue to
be applied in accordance with their respective effective dates.
In May 2003, the Financial Accounting Standards Board issued
Statement No. 150, "Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity". This
statement requires that an issuer classify a financial instrument
that is within its scope as a liability. Many of these
instruments were previously classified as equity. This statement
was effective for financial instruments entered into or modified
after May 31, 2003, and otherwise was effective beginning July 1,
2003.
The provisions of the above interpretation and statements did not
have or are not expected to have a significant impact on the
financial condition or results of operations of Union National.
In November 2002, the Financial Accounting Standards Board (FASB)
issued FASB Interpretation No.45 (FIN 45), "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others". This
interpretation expands the disclosures to be made by a guarantor
in its financial statements about its obligations under certain
guarantees and requires the guarantor to recognize a liability
for the fair value of an obligation assumed under certain
specified guarantees. FIN 45 clarifies the requirements of FASB
Statement No. 5, "Accounting for Contingencies". In general, FIN
45 applies to contracts or indemnification agreements that
contingently require the guarantor to make payments to the
guaranteed party based on changes in an underlying instrument
that is related to an asset, liability or equity security of the
guaranteed party, which would include financial standby letters
of credit. Certain guarantee contracts are excluded from both the
disclosure and recognition requirements of this interpretation,
including, among others, guarantees related to commercial letters
of credit and loan commitments. The disclosure requirements of
FIN 45 require disclosure of the nature of the guarantee, the
maximum potential amount of future payments that the guarantor
could be required to make under the guarantee and the current
amount of the liability, if any, for the guarantor's obligations
under the guarantee. The accounting recognition requirements of
FIN 45 are to be applied prospectively to guarantees issued or
modified after December 31, 2002. Adoption of FIN 45 did not
have a significant impact on Union National's financial condition
or results of operations.
Outstanding letters of credit written are conditional commitments
issued by Union National to guarantee the performance of a
customer to a third party. Union National's exposure to credit
loss in the event of nonperformance by the other party to the
financial instrument for standby letters of credit is represented
by the contractual amount of those instruments. Union National
had $2,782,000 of standby letters of credit as of September 30,
2003. The Bank uses the same credit policies in making
conditional obligations as it does for on-balance sheet
instruments. The majority of these standby letters of credit
expire within the next twelve months. The credit risk involved
in issuing letters of credit is essentially the same as that
involved in extending other loan commitments. Union National
requires collateral and personal guarantees supporting these
letters of credit as deemed necessary. Management believes that
the proceeds obtained through a liquidation of such collateral
and the enforcement of personal guarantees would be sufficient to
cover the maximum potential amount of future payments required
under the corresponding guarantees. The current amount of the
liability as of September 30, 2003, for guarantees under standby
letters of credit issued after December 31, 2002, is not
material.
6. Certain reclassifications have been made to the 2002
consolidated financial statements to conform to the 2003
presentation.
Item 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following is management's discussion and analysis of the
significant changes in the results of operations, capital
resources and liquidity presented in the accompanying
consolidated financial statements for Union National Financial
Corporation, a bank holding company, and its wholly owned
subsidiary, Union National Community Bank. Union National's
consolidated financial condition and results of operations
consist almost entirely of the bank's financial condition and
results of operations. This discussion should be read in
conjunction with the 2001 Annual Report. Current performance
does not guarantee, assure or indicate similar performance in the
future.
We have made forward-looking statements in this document, and in
documents that we incorporate by reference, that are subject to
risks and uncertainties. Forward-looking statements include
information concerning possible or assumed future results of
operations of Union National Financial Corporation, Union
National Community Bank or the combined company. When we use
words such as "believes," "expects," "anticipates" or similar
expressions, we are making forward-looking statements.
Stockholders should note that many factors, some of which are
discussed elsewhere in this document and in the documents that we
incorporate by reference, could affect the future financial
results of Union National Financial Corporation, Union National
Community Bank or the combined company and could cause those
results to differ materially from those expressed in our forward-
looking statements contained or incorporated by reference in this
document. These factors include the following:
* operating, legal and regulatory risks;
* economic, political and competitive forces; and
* the risk that our analyses of these risks and forces could be
incorrect and/or that the strategies developed to address them
could be unsuccessful.
Union National undertakes no obligation to publicly revise or
update these forward- looking statements to reflect events or
circumstances that arise after the date of this report. Readers
should carefully review the risk factors described in other
documents that Union National periodically files with the
Securities and Exchange Commission.
Critical Accounting Policies
____________________________
The reporting of Union National's financial condition and results
of operations is impacted by the application of accounting
policies by management. Certain accounting policies are
particularly sensitive and require significant judgments,
estimates and assumptions to be made by management in matters
that are inherently uncertain.
Union National's provision for loan losses and the level of the
allowance for loan losses involve significant estimates by
management in evaluating the adequacy of the allowance for loan
losses. Management's evaluation is based on Union National's
past loan loss experience, known and inherent risks in the
portfolio, adverse situations that may affect the borrower's
ability to repay (including the timing of future payments), the
estimated value of any underlying collateral, composition of the
loan portfolio, current economic conditions and other relevant
factors. While management uses available information to make
such evaluations, future adjustments to the allowance may be
necessary if economic conditions or loan credit quality differ
substantially from the assumptions used in making the evaluation.
Union National carries all of its investments at fair value with
any unrealized gains or losses reported net of tax as an
adjustment to stockholders' equity. Based on management's
assessment, at September 30, 2003, Union National did not hold
any security that had a fair value decline that is currently
expected to be other than temporary. Consequently, any declines
in a specific security's fair value below amortized cost have not
been provided for in the income statement. Union National's
ability to fully realize the value of its investment in various
securities, including corporate debt securities, is dependent on
the underlying creditworthiness of the
issuing organization.
As permitted by SFAS No. 123, Union National accounts for stock-
based compensation in accordance with Accounting Principles Board
Opinion (APB) No. 25. Under APB No. 25, no compensation expense
is recognized in the income statement related to any options
granted under Union National's stock option plans. The pro forma
impact to net income and earnings per share that would occur if
compensation expense was recognized, based on the estimated fair
value of the options on the date of the grant, is disclosed in
the notes to the consolidated financial statements. Union
National intends to continue to account for stock-based
compensation in this manner unless there is more specific
guidance issued by the Financial Accounting Standards Board or
unless a clear consensus develops in the financial services
industry on the application of accounting methods.
Results of Operations
_____________________
Overview
Basic and diluted earnings per share for the three months ended
September 30, 2003, amounted to 32 cents, an increase of 3.2% as
compared to the same period of 2002 when basic and diluted
earnings per share amounted to 31 cents. Basic earnings per
share for the nine months ended September 30, 2003, amounted to
99 cents with diluted earnings per share of 97 cents as compared
to basic earnings per share of 92 cents and diluted earnings per
share of 91 cents for the same period of last year. Consolidated
net income for the three months ended September 30, 2003, was
$812,000, an increase of 1.2%, as compared to $802,000 for the
same period of 2002. Net income for the nine months ended
September 30, 2003, was $2,471,000, an increase of 5.1%, as
compared to $2,351,000 for the same period of 2002.
Results of operations for the three months and nine months ended
September 30, 2003, as compared to the same periods of 2002 were
impacted by the following items:
* Net income decreased due to a slight decrease in net interest
income.
* Net income increased due to an increase in other operating
income.
* Net income decreased due to an increase in other operating
expense.
The above items are quantified and discussed in further detail
under their respective sections below.
Net income as a percent of total average assets, also known as
return on average assets (ROA), and net income as a percent of
average stockholders' equity, also known as return on average
equity (ROE) were as follows on an annualized basis:
Three Months Nine Months Ended
Ended September 30, September 30,
2003 2002 2003 2002
____ ____ ____ ____
ROA .97% 1.03% 1.02% 1.02%
ROE 11.93% 12.20% 12.20% 12.21%
Management currently expects relatively strong growth in loans
and deposits for the remainder of 2003. It is expected that loan
growth will be driven largely by strong commercial loan demand
and a slowdown in the refinancing and payoff of residential
mortgages. Deposit growth is expected to result from the
acquisition of new commercial business relationships and the
opening of a new office at 38 East Roseville Road in Manheim
Township, PA in November 2003. Management also continues to
develop and promote additional loan and deposit products, to
implement various sales strategies and to offer incentives to
employees to generate loan and deposit growth.
During the first nine months of 2003, Union National experienced
strong commercial loan demand and moderate growth in consumer
loans. The growth in consumer loans has been primarily a result
of an increase in home equity lines of credit offered at one-half
percent below prime. However, residential mortgage balances
declined during the first nine months of 2003. The decline in
residential mortgages is primarily due to increased refinancing
activity. Overall, loan balances have increased by $5,099,000
since the beginning of 2003.
Union National now sells most of its new residential mortgage
loans under a program that was implemented in the fourth quarter
of 2001. Mortgages generated for sale under this program
amounted to $22,920,000 for the nine months ended September 30,
2003, and $8,153,000 for the nine months ended September 30,
2002. In addition, there has been a decline in the balance of a
pool of residential mortgage loans that Union National purchased
in November 2001. These purchased mortgage loans had an
outstanding balance of $10,436,000 at September 30, 2003, a
decline of $7,548,000 from December 31, 2002.
The economy in the bank's market area may be negatively impacted
by the effects of national events and may be subject to overall
national economic trends. The overall effects of economic
conditions, as well as other factors, can be seen by a mild
lessening of certain borrowers' financial strength. Management
is monitoring these general and specific trends closely. Their
various effects are discussed later under the section on Credit
Risk and Loan Quality.
Net Interest Income
Net interest income is the amount by which interest income on
loans, investments and other interest-bearing assets exceeds
interest incurred on deposits and other interest-bearing
liabilities. Net interest income is Union National's primary
source of revenue. The amount of net interest income is affected
by changes in interest rates and by changes in the volume and mix
of interest-bearing assets and liabilities.
For analytical and discussion purposes, net interest income and
corresponding yields are presented on a taxable equivalent basis.
Net interest income for the three months ended September 30,
2003, decreased by $47,000, or 1.5%, from the same period of
2002. For the nine months ended September 30, 2003, net interest
income decreased by $97,000, or 1.1%, over the same period of
2002.
In order to enhance the net interest income in future periods,
management has entered into transactions that increase earning
assets funded by advances from the Federal Home Loan Bank (FHLB).
The terms and amounts of the transactions, when combined with the
bank's overall balance sheet structure, maintain the bank within
its interest rate risk policies. As of September 30, 2003, the
bank had long-term advances of $71,874,000 and short-term
advances of $1,000,000 outstanding under its available credit of
$135,117,000 at the FHLB for purposes of funding loan demand and
security purchases. The total advances had a weighted-average
interest rate of 3.89% at September 30, 2003, with maturities
ranging from January 2004 to February 2011.
Impacting net interest income during the first nine months of
2003 were costs incurred on the early payoff of some of these
FHLB borrowings. These additional costs were reflected as
increased interest expense on the related long-term borrowings.
During the three months ended September 30, 2003, total early
payoff costs on borrowings amounted to $116,000, and for the nine
months ended September 30, 2003, total early payoff costs
amounted to $359,000. During the same periods of 2002, Union
National incurred penalties of $110,000 for the three-month
period and $290,000 for the nine months ended September 30, 2002.
During the first nine months of 2003, Union National restructured
$7,261,000 in long-term borrowings with the FHLB. These
borrowings had a weighted-average rate of 4.38% while total
borrowings taken in 2003 had a weighted-average rate of 1.59%.
Gains on the sale of investment securities mostly offset the
costs associated with these payoffs. The restructuring of these
borrowings will benefit Union National with lower funding costs
in future periods. It is currently anticipated that the level of
payoffs and early payoff costs during the remainder of 2003 will
be less than payoffs and early payoff costs incurred during the
same period of 2002. In the following discussion, the interest
rate on average interest-bearing liabilities and the net interest
margin percentage is shown both with and without the impact of
these one-time early payoff costs to provide a better comparison
to prior periods.
The net effect of volume growth in average earning assets and
interest-bearing liabilities increased net interest income by
$216,000 in comparing the three months ended September 30, 2003,
to the same period of 2002 and by $286,000 in comparing the
nine months ended September 30, 2003, to the same period of 2002.
Growth in average earning assets was funded by increased deposits
and additional long-term borrowings. Average earning assets
increased by 7.0% for the three months ended September 30, 2003,
and by 5.3% for the nine months ended September 30, 2003, as
compared to the same periods of 2002.
The overall interest rate on the average total earning assets for
the three months ended September 30, 2003, was 5.98%, as compared
to 6.92% for the same period of last year. The overall interest
rate on the average interest-bearing liabilities was 2.39% (2.22%
without the impact of early payoff costs on long-term FHLB
borrowings) for the three months ended September 30, 2003, and
3.07% (2.90% without the impact of payoff costs) for the three
months ended September 30, 2002. The net effect of these
interest rate changes was to decrease net interest income in the
amount of $263,000 for the three months ended September 30, 2003,
over the same period of 2002. The net interest margin percentage
for the three months ended September 30, 2003, was 3.84% (3.99%
without the impact of payoff costs), as compared to 4.18% (4.33%
without the impact of payoff costs) for the same period of 2002.
For the nine months ended September 30, 2003, the overall
interest rate on the average total earning assets was 6.25%, as
compared to 7.09% for the same period of last year. The overall
interest rate on the average interest-bearing liabilities was
2.59% (2.41% without the impact of early payoff costs on FHLB
borrowings) for the nine months ended September 30, 2003, and
3.26% (3.11% without the impact of payoff costs) for the nine
months ended September 30, 2002. The net effect of these
interest rate changes was to decrease net interest income in the
amount of $383,000 for the nine months ended September 30, 2003,
over the same period of 2002. The net interest margin percentage
for the nine months ended September 30, 2003, was 3.96% (4.12%
without the impact of payoff costs), as compared to 4.22% (4.35%
without the impact of payoff costs) for the same period of 2002.
See management's discussion below concerning the anticipated
impact of these interest rate fluctuations on the results of
operations for the remainder of 2003.
The overall decline in interest rates has been prompted by
actions of the Federal Reserve Bank, which started reducing
interest rates in January 2001. Since that time, the prime
interest rate has declined from 9.50% to 4.00%. The following
chart details recent rate histroy for certain key interest rates
that impact rates on Union National's interest-bearing assets and
liabilites:
9/30/03 6/30/03 12/31/02
_________ _________ _________
Fed Funds Target Rate 1.00% 1.00% 1.25%
Prime Rate 4.00% 4.00% 4.25%
3 Year Treasury Constant
Maturity* 2.23% 1.51% 2.23%
10 Year Treasury Constant
Maturity* 4.27% 3.33% 4.03%
Conventional Mortgage Rate* 6.15% 5.23% 6.05%
9/30/02 6/30/02 12/31/01
_________ _________ _________
Fed Funds Target Rate 1.75% 1.75% 1.75%
Prime Rate 4.75% 4.75% 4.75%
3 Year Treasury Constant 2.32% 3.49% 3.62%
Maturity*
10 Year Treasury Constant 3.87% 4.93% 5.09%
Maturity*
Conventional Mortgage Rate* 6.09% 6.65% 7.07%
As detailed in the above table, there has been a decline in not
only short-term rates, such as the fed funds target rate and the
prime rate, but also in longer-term interest rates. In fact,
longer-term interest rates have declined more significantly than
short-term rates. However, during the third quarter these
longer-term rates have started to rise again. As indicated by
the yields discussed above, this decline in interest rates has
negatively impacted the yield on Union National's earning assets,
but this interest rate decline has also reduced Union National's
funding costs due to a decrease in rates Union National must pay
to attract and retain deposits and must pay on maturing or
repricing advances from the FHLB.
For the remainder of 2003, it is currently anticipated that the
bank's net interest margin percentage will continue to narrow in
comparison to current levels as maturing investments and loans
reprice to current rates. However, some loans have now repriced
to their interest rate floor and will not be impacted. In
addition, Union National will benefit as a portion of maturing
certificates of deposit will reprice to lower current interest
rates.
Offsetting the narrowing margin, income from growth in earning
assets which occurred during 2002 and 2003, net of costs
resulting from growth in deposits and borrowings, should increase
net interest income for the remainder of 2003. The netting of
these two factors, as reflected in the bank's current simulation
model and estimates as of September 30, 2003, may result in net
interest income for the remainder of 2003 that reflects a nominal
decrease from the net interest income earned during the same
period of 2002. Expected growth in earning assets during the
remainder of 2003 should also increase the bank's net interest
margin. This expected growth was not reflected in the bank's
model at September 30, 2003. The yield curve during the remainder
of 2003, the options selected by customers and the future mix of
the loan, investment and deposit products in the bank's
portfolios may significantly change the estimates used in the
simulation model. See discussions on Liquidity and Market Risk -
Interest Rate Risk. Union National's net interest income may
also be impacted by future actions of the Federal Reserve Bank.
Provision for Loan Losses
The provision for loan losses was $69,000 for the three months
ended September 30, 2003, as compared to $43,000 for the three
months ended September 30, 2002. Net charge-offs for the three
months ended September 30, 2003, were $3,000, as compared to
$154,000 for the same period of last year. For the nine months
ended September 30, 2003, the provision for loan losses was
$115,000, as compared to $128,000 for the same period of 2002.
Net charge-offs for the nine months ended September 30, 2003,
amounted to $21,000, as compared to $225,000 for the same period
of 2002. Future adjustments to the allowance, and consequently,
the provision for loan losses, may be necessary if economic
conditions or loan credit quality are substantially different
from the assumptions used in establishing the current level of
the allowance for loan losses.
Other Operating Income
Other operating income increased by $230,000, or 27.4%, for the
three months ended September 30, 2003, as compared to the same
period of 2002. For the nine months ended September 30, 2003,
other operating income increased by $807,000, or 34.5%, as
compared to the same period of the prior year. Impacting other
operating income in comparing the third quarter of 2003 to the
same period of 2002 was an increase in income from the sale of
alternative investment products, an increase in investment
securities gains and an increase in earnings on bank-owned life
insurance, which were partially offset by a decline in income
from mortgage banking activities. Impacting other operating
income in comparing the first nine months of 2003 to the same
period of 2002 was a significant increase in income from mortgage
banking activities, an increase in income from the sale of
alternative investment products and an increase in earnings on
bank-owned life insurance.
Income from mortgage banking activities decreased by $89,000 for
the three months ended September 30, 2003, and increased by
$509,000 for the nine months ended September 30, 2003, as
compared to the same periods of the prior year. The overall
level of income from mortgage banking activities during the first
nine months of 2003 was impacted by not only the level of
mortgage activity, but also by the level of interest rates and
changes in interest rates. The decline in income from mortgage
banking activities in the third quarter of 2003 can be attributed
to reduced gains on the sale of residential mortgages. These
gains were reduced as customers locked in rates at historically
low levels, but then interest rates rapidly increased and Union
National sold loans at significantly smaller gains or small
losses. The increase in income from mortgage banking activities
during the first nine months of 2003 related to increased
mortgage activity and falling interest rates that resulted in
increased gains on the sale of mortgages. During the first six
months of 2003, Union National's gains on the sale of mortgages
were higher as customers locked in interest rates at higher
levels and then rates fell by the time the loan was sold. See
discussion and table under section on Net Interest Income for
further details on changes in interest rates.
Union National has instituted some changes in its mortgage sale
process and is now
selling a portion of its mortgage loans in advance at a time
closer to when customers lock in their rate on their mortgage
loan. This will help to mitigate the risk associated with rising
interest rates. However, it is currently expected that the
increase in interest rates will slow down the general level of
mortgage activity. Future changes in interest rates and the
corresponding level of refinancing activity may significantly
impact the future level of income from mortgage banking
activities.
Union National sells the majority of its residential mortgage
loans to the FHLB, but servicing is retained by Union National.
As of September 30, 2003, Union National was servicing 343 loans
through this program with an outstanding balance of $33.7
million.
The increase in commissions from alternative investment products
is a result of increased commissions on the sale of annuities,
mutual funds and brokerage services. Union National has expanded
the sale of alternative investment products and now has a
licensed representative to sell these products in each of our
retail offices. In addition, during the third quarter of 2003,
Union National was able to receive a commission related to the
purchase of bank-owned life insurance through its relationship
with its licensed broker-dealer. Income from the sale of
alternative investment products increased by $199,000, or 234.1%,
for the three months ended September 30, 2003, and increased by
$215,000, or 70.7%, for the nine months ended September 30, 2003,
as compared to the same periods of 2002.
Gains on the sale of investment securities in the first nine
months of 2003 were a result of some restructuring in the
investment security portfolio. Securities gains amounted to
$203,000 for the three months ended September 30, 2003, as
compared to $138,000 for the same period of 2002. For the nine
months ended September 30, 2003, securities gains amounted to
$286,000, as compared to $258,000 for the same period of 2002.
After a thorough analysis, certain securities were sold at a net
gain and the funds were invested in other securities that
management believed had better structures with comparable
earnings rates. Management believes these securities are
positioned better for various changes in interest rates. As
indicated earlier, these gains, along with the increased gains on
the sale of residential mortgage loans, helped offset the costs
of the early payoff of FHLB borrowings. The restructuring of the
FHLB borrowings will benefit future periods.
The increase in earnings on bank-owned life insurance (BOLI) is a
result of an additional $4 million investment in BOLI effected
during the third quarter of 2003. The earnings on BOLI will be
utilized to help fund the cost of various employee benefits.
Other operating income (excluding investment securities gains or
losses) as a percentage of total revenue (net interest income and
other operating income) was as follows:
Three Months Ended Nine Months Ended
__________________ ________________
September 30, 2003 23.4% 25.4%
September 30, 2002 19.7% 19.5%
To generate additional noninterest income, Union National
recently formed StoneBridge Settlement Services, LLC to provide
title insurance and settlement services for our customers. This
will enhance Union National's mortgage banking services.
StoneBridge began operations during the third quarter of 2003.
Other Operating Expenses
The aggregate of noninterest expenses for the three months ended
September 30, 2003, increased by $192,000, or 7.2%, over the same
period of 2002. For the nine months ended September 30, 2003,
noninterest expenses increased by $511,000, or 6.5%, over the
same period of the prior year. These noninterest expense
increases are discussed below as they pertain to the various
expense categories.
Employee salaries and wages increased by $96,000, or 8.2%, for
the three months ended September 30, 2003, as compared to the
same period of last year. For the nine months ended September
30, 2003, salaries and wages increased by $299,000, or 8.7%, over
the
same period of 2002. These increases were essentially due to
staff additions, annual merit and cost-of-living increases and
increased incentives for staff for reaching certain sales and
profitability goals. Staff additions include an experienced
business development officer who will lead our business banking
group, business and credit specialists and other support staff
and sales positions. Additional staff was also added during the
third quarter in preparation for the opening of our new office at
Roseville Road in Manheim Township, PA.
The cost of retirement plans and other employee benefits for the
three months ended September 30, 2003, increased by $56,000, or
22.6%, as compared to the same period of 2002. For the nine
months ended September 30, 2003, employee benefit costs increased
by $84,000, or 10.3%, over the same period of last year. These
increases were primarily a result of increased 401(k) profit
sharing plan expense and payroll tax expense, both of which were
due to increased salary levels and an increase in health
insurance costs.
Other changes in operating expenses as compared to the same
periods of 2002 include the following:
(In thousands) Change for the Periods
Ending September 30, 2003
_______________________________________
Three Months Nine Months
________________ _______________
Data Processing Services $ 33 82
Advertising and Marketing (18) (28)
Appraisal Fees 8 39
Donations 5 25
Postage (17) (28)
Amortization of Mortgage
Servicing Assets and Credit
Enhancement Fees Receivable 15 34
Other Losses - (24)
The increase in data processing costs relates to the
implementation of a new data communications system and the
related costs. The increase in donations is a result of
contributions that Union National made under the PA Educational
Improvement Tax Credit program. Through this program, Union
National receives a 90% tax credit for contributions made to
certain organizations. The increase in appraisal fees and
amortization of mortgage servicing assets and credit enhancement
fees receivable is related to an increase in mortgage banking
activities. The decrease in postage costs is a result of a cost
savings that resulted from a change in the sorting of outgoing
mail. The decrease in other losses relates to a robbery loss at
one of our retail branch locations in the first quarter of 2002.
Income Taxes
Union National's income tax expense decreased by $20,000 for the
three months ended September 30, 2003, as compared to the same
period of last year. For the nine months ended September 30,
2003, income tax expense increased by $22,000, as compared to the
same period of 2002. Union National's effective tax rates were
as follows:
Three Months Ended Nine Months Ended
__________________ _________________
September 30, 2003 16.8% 18.6%
September 30, 2002 18.7% 18.7%
The effective tax rate for Union National is below the statutory
rate due to tax-exempt earnings on investments, loans and bank-
owned life insurance and the impact of tax credits. The
realization of net deferred tax assets is dependent on future
earnings of Union National. Management currently anticipates
future earnings will be adequate to utilize these deferred tax
assets.
Regulatory Activity
___________________
From time to time, various types of federal and state legislation
have been proposed that could result in additional regulation of,
and restrictions on, the business of Union National and the bank.
As a consequence of the extensive regulation of commercial
banking activities in the United States, Union National's and the
bank's
business is particularly susceptible to being affected by federal
and state legislation and regulations that may increase the cost
of doing business. Specifically, Union National is susceptible
to changes in tax law that may increase the cost of doing
business or impact Union National's ability to realize the value
of deferred tax assets. Management is not aware of any current
specific recommendations by regulatory authorities or proposed
legislation, which if implemented, would have a material adverse
effect upon the liquidity, capital resources or results of
operations. However, the general cost of compliance with
numerous federal and state laws and regulations does have, and in
the future may have, a negative impact on Union National's
results of operations.
Further, the business of Union National is affected by the state
of the financial services industry in general. The bank is
routinely examined by the OCC and no material adverse impact is
anticipated on current or future operations and financial
position as a result of this process. The last Community
Reinvestment Act performance evaluation by the OCC resulted in a
"satisfactory" rating of the bank's record of meeting the credit
needs of its entire community.
Credit Risk and Loan Quality
____________________________
Other than as described herein, management does not believe there
are any trends, events or uncertainties that are reasonably
expected to have a material impact on future results of
operations, liquidity or capital resources. Further, based on
known information, management believes that the effects of
current and past economic conditions, including the continuing
economic slowdown, and other unfavorable specific business
conditions may result in the inability of loans amounting to
$2,407,000 to comply with their respective repayment terms. This
compares to the amount of $1,689,000 at December 31, 2002. These
loans are secured with real estate, equipment, inventory and
vehicles. Management currently believes that probable losses on
these loans have already been provided for in the allowance for
loan losses. These loans are not considered impaired as defined
by current generally accepted accounting principles. The
borrowers are of special mention since they have shown a decline
in financial strength and payment quality. Management has
increased its monitoring of the borrowers' financial strength.
In addition, management currently expects that a portion of these
loans may be classified as nonperforming in the remaining months
of 2003.
At September 30, 2003, total nonperforming loans amounted to
$1,358,000, or 0.7% of total net loans, as compared to a level of
$1,674,000, or 0.8%, at December 31, 2002. These loans are
essentially collateralized with real estate. Historically, the
percentage of nonperforming loans to total net loans as of
December 31, for the previous five-year period was an average of
0.9%.
Schedule of Nonperforming Assets:
September 30, December 31,
(In thousands) 2003 2002
_____________ ____________
Nonaccruing Loans $ 1,345 $ 1,310
Accrual Loans - 90 days
or more past due 13 364
Restructured Accrual Loans - -
___________ ___________
Total Nonperforming Loans 1,358 1,674
Foreclosed Real Estate 104 307
___________ ___________
Total Nonperforming Assets $ 1,462 $ 1,981
=========== ===========
Nonperforming Loans
as a % of Net Loans 0.7% 0.8%
=========== ===========
Allowance for Loan Losses
as a % of Nonperforming Loans 140% 108%
=========== ===========
In addition to the credit risk present in the loan portfolio,
Union National also has credit risk associated with its
investment security holdings. Based on recent national economic
trends and other factors, Union National has increased its
monitoring of its corporate debt securities and changes in their
credit ratings as
published by bond rating agencies. As of September 30, 2003,
Union National had corporate debt securities that were rated
below investment grade and were carried at a fair value of
$954,000 and had unrealized losses of $56,000. Union National's
ability to fully realize the value of its investment in various
securities, including corporate debt securities, is dependent on
the underlying creditworthiness of the issuing organization.
This creditworthiness may be impacted by various national
economic trends and other factors. As discussed earlier, Union
National carries all of its investments at fair value with any
unrealized gains or losses reported net of tax as an adjustment
to stockholders' equity. Based on management's assessment, at
September 30, 2003, Union National did not hold any security that
had a fair value decline that is currently expected to be other
than temporary. Consequently, any declines in a specific
security's fair value below amortized cost have not been provided
for in the income statement because management currently expects
these fair value declines to be temporary. As of September 30,
2003, Union National held corporate debt securities with a total
fair value of $22,777,000 and net unrealized gains on these
securities amounted to $216,000.
Allowance for Loan Losses
_________________________
The allowance for loan losses is maintained at a level believed
adequate by management to absorb estimated probable loan losses.
Management is responsible for the adequacy of the allowance for
loan losses, which is formally reviewed by management and the
Board of Directors on a quarterly basis. In addition, ongoing
loan reviews are performed on selected portions of the loan
portfolio by an independent consultant.
The allowance is increased by provisions charged to operating
expense and reduced by net charge-offs. Management's periodic
evaluation of the adequacy of the allowance is based on Union
National's past loan loss experience, known and inherent risks in
the portfolio, adverse situations that may affect the borrower's
ability to repay (including the timing of future payments), the
estimated value of any underlying collateral, composition of the
loan portfolio, current economic conditions and other relevant
factors. While management uses available information to make
such evaluations, future adjustments to the allowance may be
necessary if economic conditions differ substantially from the
assumptions used in making the evaluation. In addition, various
regulatory agencies, as an integral part of their examination
process, review the bank's allowance for loan losses. Such
agencies may require the bank to recognize additions to the
allowance based on their judgment of information available to
them at the time of their examination. After management's
assessment, no adjustment to the allowance for loan losses was
necessary as a result of the Office of Comptroller's most recent
examination.
Management believes, based on information currently available,
that the current allowance for loan losses of $1,906,000 is
adequate to meet potential loan losses. In addition, management
expects loan charge-offs, net of recoveries for the remainder of
2003 to be below the level of net loan charge-offs for the same
period of 2002.
Analysis of Allowance for Loan Losses:
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands) 2003 2002 2003 2002
________ ________ ________ ________
Average Total Loans Outstanding
(Less Unearned Income)$200,847 $202,320 $197,981 $202,684
======== ======== ======== ========
Allowance for Loan Losses,
Beginning of Period $ 1,840 $ 1,907 $ 1,812 $ 1,893
Loans Charged-Off
During Period 5 189 40 319
Recoveries of Loans Previously
Charged-Off 2 35 19 94
________ ________ ________ ________
Net Loans Charged-Off 3 154 21 225
Addition to Provision for Loan Losses
Charged to Operations 69 43 115 128
________ ________ ________ ________
Allowance for Loan Losses,
End of Period $ 1,906 $ 1,796 $ 1,906 $ 1,796
======== ======== ======== ========
Ratio of Net Loans Charged-Off to Average
Loans Outstanding
(Annualized) .01% .30% .01% .15%
======== ======== ======== ========
Ratio of Allowance for Loan Losses to
Net Loans at End of Period 0.93% 0.89%
======== ========
Liquidity
_________
Union National's objective is to maintain adequate liquidity to
fund needs at a reasonable cost and to provide contingency plans
to meet unanticipated funding needs or a loss of funding sources,
while minimizing interest rate risk. Adequate liquidity provides
resources for credit needs of borrowers, for depositor
withdrawals and for funding corporate operations. Sources of
liquidity are as follows:
* proceeds from the sale or maturity of investment
securities;
* overnight correspondent bank borrowings on various credit
lines and borrowing capacity available from the FHLB;
* acquisition of brokered certificates of deposit (CDs);
* payments on loans and mortgage-backed securities; and
* a growing core deposit base.
Management believes that its core deposits are fairly stable even
in periods of changing interest rates. Liquidity management is
governed by policies and measured on a quarterly basis. These
measurements indicate that liquidity generally remains stable and
consistently exceeds the bank's minimum defined level. There are
no known trends, or any known demands, commitments, events or
uncertainties that will result in, or that are reasonably likely
to result in, liquidity increasing or decreasing in any material
way.
Membership in the FHLB provides the bank with liquidity
alternatives such as short- or long-term funding on fixed- or
variable-rate terms. As of September 30, 2003, the bank had
long-term advances of $71,874,000 and short-term advances of
$1,000,000 outstanding under its available credit of $135,117,000
at the FHLB for purposes of funding loan demand and mortgage-
backed security purchases. Over the next twelve months, advances
of $7,000,000 are due and advances of $25,000,000 are
convertible. The FHLB's convertible fixed-rate advances allow
the FHLB the periodic option to convert to a LIBOR adjustable-
rate advance. Upon the FHLB's conversion, the bank has the
option to repay the respective advances in full. See section on
Market Risk - Interest Rate Risk for further analysis of these
advances.
As indicated above, another alternative source of liquidity for
Union National is the use of brokered CDs. Union National
currently has $2,000,000 in brokered CDs outstanding. These CDs
mature in June 2004.
Stockholders' Equity
____________________
Union National and the bank maintain capital ratios that are well
above the minimum total capital levels required by federal
regulatory authorities and are considered to be well-capitalized
under regulatory guidelines. Except as discussed below
concerning Union National's common stock repurchase plan, there
are no known trends or uncertainties, including regulatory
matters that are expected to have a material impact on the
capital resources of Union National for 2003. In addition, see
discussion on Regulatory Activity.
On January 9, 2003, the Board of Directors of Union National
authorized and approved a plan to purchase up to 100,000 shares
of its outstanding common stock in open market or privately
negotiated transactions. The number of shares to be purchased
under the plan represents approximately 4.0% of the outstanding
shares of Union National. The Board of Directors believes that a
redemption or repurchase of this type is in the best interests of
Union National and its stockholders as a method to enhance long-
term shareholder value. Currently, the shares are to be held as
treasury shares (issued, but not outstanding shares). As of
September 30, 2003, approximately 27,000 shares have been
repurchased under this plan and in October 2003 Union National
purchased an
additional 52,000 shares.
Union National also recently opened a new retail office location
at 38 East Roseville Road in Manheim Township, PA. This location
opened for business on November 10, 2003. In addition, Union
National continues to evaluate further opportunities for retail
office expansion in new markets. The opening of new offices will
require significant expenditures for building improvements and
fixed asset purchases.
Union National and the bank have risk-based capital ratios that
exceed the regulatory requirements. The risk-based capital
guidelines require banks to maintain a minimum risk-based capital
ratio of 8.0% at September 30, 2003, as compared to the bank's
current risk-based capital ratio of 10.58%. The total risk-based
capital ratio is computed by dividing stockholders' equity (as
adjusted) plus the allowance for loan losses by risk-adjusted
assets. Risk-adjusted assets are determined by assigning credit
risk-weighting factors from 0% to 100% to various categories of
assets and off-balance-sheet financial instruments. Banking
regulations also require the bank to maintain certain minimum
capital levels in relation to bank assets. Failure to meet
minimum capital requirements could result in prompt regulatory
action. As of September 30, 2003, the bank was categorized as
well-capitalized. Management is not aware of any conditions or
events that would adversely affect the bank's capital. The bank
maintains the following leverage and risk-based capital ratios:
(In thousands) September 30, December 31,
2003 2002
___________ ___________
Tier I - Total Stockholders' Equity $ 25,352 $ 24,621
(as adjusted)
Tier II - Allowance for Loan Losses 1,906 1,812
___________ ___________
Total Qualifying Capital $ 27,258 $ 26,433
=========== ===========
Risk-adjusted On-balance-sheet Assets $229,670 $207,458
Risk-adjusted Off-balance-sheet Exposure 27,958 18,108
___________ ___________
Total Risk-adjusted Assets $257,628 $225,566
=========== ===========
Leverage Ratio:
Tier I Capital to Average Total Assets 7.60% 7.88%
Minimum Required 4.00 4.00
To Be Well-Capitalized Under Prompt
Corrective Action Provisions 5.00 5.00
Risk-based Capital Ratios:
Tier I Capital Ratio - Actual 9.84% 10.91%
Minimum Required 4.00 4.00
To Be Well-Capitalized under Prompt
Corrective Action Provisions 6.00 6.00
Total Capital Ratio - Actual 10.58% 11.72%
Minimum Required 8.00 8.00
To Be Well-Capitalized under Prompt
Corrective Action Provisions 10.00 10.00
Total Risk-Based Capital in Excess of the
Minimum Regulatory Requirement $ 6,648 $ 8,388
=========== ===========
Item 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK
Market Risk - Interest Rate Risk
________________________________
As a financial institution, Union National's primary component of
market risk is interest rate volatility. Fluctuations in
interest rates will ultimately impact the level of income and
expense recorded on a large portion of the bank's assets and
liabilities. Virtually all of Union National's interest-
sensitive assets and liabilities are held by the bank, and
therefore, interest rate risk management procedures are performed
by the bank. The nature of the bank's current operations is such
that the bank is not subject to foreign currency exchange or
commodity price risk. Union National does not own any trading
assets.
The objectives of interest rate risk management are to maintain
or increase net interest income over a broad range of market
interest rate movements. The Asset and Liability Management
Committee is responsible for managing interest rate risk using
policies approved by the bank's board of directors. The bank
manages interest rate risk by changing the mix or repricing
characteristics of its investment securities portfolio and
borrowings from the Federal Home Loan Bank and by the promotion
or development of specific loan and deposit products. The bank
retains an outside consulting group to assist in monitoring its
interest rate risk using income simulation models on a quarterly
basis. The simulation model measures the sensitivity of future
net interest income to hypothetical changes in market interest
rates.
The simulation model is utilized by the bank to determine the
effect of gradual increases or decreases in market interest rates
on net interest income and net income. Certain assumptions are
made in the simulation model and these are revised based on
defined scenarios of assumed speed and direction changes of
market interest rates. These assumptions are inherently
uncertain due to the timing, magnitude and frequency of rate
changes and changes in market conditions, as well as management
strategies, among other factors. Because it is difficult to
accurately quantify into assumptions the reaction of depositors
and borrowers to market interest rate changes, the actual net
interest income and net income results may differ from simulated
results. While assumptions are developed based upon current
economic and local market conditions, management cannot make any
assurances as to the predictive nature of these assumptions.
The simulation model assumes a hypothetical gradual shift in
market interest rates over a twelve-month period. The simulated
results represent the hypothetical effects to the bank's net
interest income and net income. Projections for loan and deposit
growth are ignored in the simulation model. The simulation model
includes all of the bank's earning assets and interest-bearing
liabilities and assumes a parallel and prorated shift in interest
rates over a twelve-month period.
The simulation model currently indicates that a hypothetical one-
percent general decline in prevailing market interest rates over
a one-year period will have an immaterial positive impact on the
bank's net interest income over the next twelve months as
compared to the constant rate scenario. Only a decline in
interest rates of one-percent was modeled at September 30, 2003,
based on management's assessment of potential future interest
rate levels. In addition, a hypothetical two-percent general
rise in rates will have an immaterial positive impact on net
interest income over the next twelve months.
In addition to the above scenarios, management modeled the impact
of a "flattening" interest rate yield curve on the bank's net
interest income. The rate assumptions for this scenario included
an increase in short-term interest rates while minimizing
increases in longer-term interest rates. Management determined
that this is a potential scenario considering current market
interest rates as compared to historical average interest rates.
A "flattening" interest rate environment with short-term interest
rates increasing two-percent will have an immaterial negative
impact on net interest income over the next twelve months as
compared to the constant rate scenario. The computations do not
contemplate any actions management or the Asset Liability
Management Committee could undertake in response to changes in
market conditions or market interest rates.
The bank managed its interest rate risk position in 2003 by the
following:
* increasing its use of adjustable- and floating-rate loans
for new or refinanced commercial and agricultural loans;
* repositioning of its investment security portfolio into
certain types of mortgage-backed and asset-backed
securities to better prepare for any future increase in
interest rates;
* managing and expanding the bank's core deposit base
including deposits obtained in the bank's commercial cash
management programs and premium money market accounts; and
* additions to or restructuring of fixed-rate advances from
the Federal Home Loan Bank.
The above strategies and actions impact interest rate risk and
are all included in the bank's quarterly simulation models in
order to determine future asset and liability management
strategies. See the related discussions in the section on Net
Interest Income.
Item 4 - CONTROLS AND PROCEDURES
Controls and Procedures
_______________________
Evaluation of Disclosure Controls and Procedures
Union National maintains controls and procedures designed to
ensure that information required to be disclosed in the reports
that the company files or submits under the Securities Exchange
Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in the rules and forms of the
Securities and Exchange Commission. Based upon their evaluation
of those controls and procedures as of September 30, 2003, Union
National's Chief Executive Officer and Chief Financial Officer
concluded that the disclosure controls and procedures were
adequate.
Changes in Internal Controls
Union National made no significant changes in its internal
controls or in other factors that could significantly affect
these controls subsequent to the date of the evaluation of the
controls by the Chief Executive Officer and Chief Financial
Officer.
Part II - Other Information:
Item 1. Legal Proceedings
Management is not aware of any litigation that would have a
material adverse effect on the consolidated financial position of
Union National. There are no proceedings pending other than the
ordinary routine litigation incident to the business of Union
National and its subsidiary, Union National Community Bank. In
addition, no material proceedings are pending or are known to be
threatened or contemplated against Union National and the bank by
government authorities.
Item 2. Changes in Securities and Use of Proceeds - Nothing to
report.
Item 3. Defaults Upon Senior Securities - Nothing to report.
Item 4. Submission of Matters to a Vote of Security Holders -
Nothing to report.
Item 5. Other Information - Nothing to report.
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits
Exhibit No. 31.1- Certification of Principal Executive
Officer Pursuant to Exchange Act Rules 13a-14(a)/15d-
14(a) as added by Section 302 of the Sarbanes-Oxley Act
of 2002
Exhibit No. 31.2 - Certification of Principal Financial
Officer Pursuant to Exchange Act Rules 13a-14(a)/15d-
14(a) as added by Section 302 of the Sarbanes-Oxley Act
of 2002
Exhibit No. 32 - Certification of Principal Executive
Officer and Principal Financial Officer Pursuant to 18
U.S.C. Section 1350 as Added by Section 906 of the
Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
Union National filed a report on form 8-K via EDGAR
dated July 16, 2003. The report was filed pursuant to
Item 12, Results of Operations and Financial Condition,
and reported the issuance of a press release. The press
release was attached to the report as an exhibit and
reported second quarter earnings for 2003 and announced
the third quarter cash dividend for 2003.
Union National filed a report on form 8-K via EDGAR
dated September 12, 2003. The report was filed pursuant
to Item 5, Other Events, and reported the issuance of a
press release. The press release was attached to the
report as an exhibit and announced the addition of James
R. Godfrey, President of HealthGuard of Lancaster, to
the Board of Directors.
EXHIBIT 31.1
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
PURSUANT TO EXCHANGE ACT RULES
13A-14(A)/15D-14(A) AS ADDED BY SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
PURSUANT TO EXCHANGE ACT RULES
13A-14(A)/15D-14(A) AS ADDED BY SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Mark D. Gainer, President/CEO, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Union
National Financial Corporation;
2. Based on my knowledge, the quarterly report does not
contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements
made, in light of the circumstances under which such
statements were made, not misleading with respect to the
period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of
Union National as of, and for, the periods presented in
this quarterly report;
4. Union National's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) for Union National and have:
(a) Designed such disclosure controls and procedures, or
caused such disclosure controls and procedures to be
designed under our supervision, to ensure that material
information relating to Union National, including its
consolidated subsidiaries, is made known to us by
others within those entities, particularly during the
period in which this quarterly report is being
prepared;
(b) Evaluated the effectiveness of Union National's
disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of
the disclosure controls and procedures, as of September
30, 2003, based upon such evaluation; and
(c) Disclosed in this report any change in Union National's
internal control over financial reporting that occurred
during Union National's quarter ended September 30,
2003, that has materially affected, or is reasonably
likely to materially affect, Union National's internal
control over financial reporting; and
5. Union National's other certifying officer and I have
disclosed, based on our most recent evaluation of internal
control over financial reporting, to Union National's
auditors and the audit committee of Union National's board
of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in
the design or operation of internal control over
financial reporting which are reasonably likely to
adversely affect Union National's ability to record,
process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves
management or other employees who have a significant
role in Union National's internal control over financial
reporting.
By: /s/ Mark D. Gainer
________________________
President/CEO
Date: November 14, 2003
EXHIBIT 31.2
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
PURSUANT TO EXCHANGE ACT RULES
13A-14(A)/15D-14(A) AS ADDED BY SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
PURSUANT TO EXCHANGE ACT RULES
13A-14(A)/15D-14(A) AS ADDED BY SECTION 302
OF THE SARBANES-OXLEY ACT OF 2002
I, Clement M. Hoober, Treasurer/CFO, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Union
National Financial Corporation;
2. Based on my knowledge, the quarterly report does not
contain any untrue statement of a material fact or omit to
state a material fact necessary to make the statements
made, in light of the circumstances under which such
statements were made, not misleading with respect to the
period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of Union
National as of, and for, the periods presented in this
quarterly report;
4. Union National's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-15(e) and 15d-15(e)) for Union National and have:
(a) Designed such disclosure controls and procedures, or
caused such disclosure controls and procedures to be
designed under our supervision, to ensure that material
information relating to Union National, including its
consolidated subsidiaries, is made known to us by
others within those entities, particularly during the
period in which this quarterly report is being
prepared;
(b) Evaluated the effectiveness of Union National's
disclosure controls and procedures and presented in
this report our conclusions about the effectiveness of
the disclosure controls and procedures, as of September
30, 2003, based upon such evaluation; and
(c) Disclosed in this report any change in Union National's
internal control over financial reporting that occurred
during Union National's quarter ended September 30,
2003, that has materially affected, or is reasonably
likely to materially affect, Union National's internal
control over financial reporting; and
5. Union National's other certifying officer and I have
disclosed, based on our most recent evaluation of internal
control over financial reporting, to Union National's
auditors and the audit committee of Union National's board
of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in
the design or operation of internal control over
financial reporting which are reasonably likely to
adversely affect Union National's ability to
record, process, summarize and report financial
information; and
(b) Any fraud, whether or not material, that involves
management or other employees who have a significant
role in Union National's internal control over financial
reporting.
By: /s/ Clement M. Hoober
________________________
Treasurer/CFO
Date: November 14, 2003
EXHIBIT 32
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER AND
PRINCIPAL FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350
AS ADDED BY SECTION 906 OF THE
SARBANES-OXLEY ACT OF 2002
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER AND
PRINCIPAL FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350
AS ADDED BY SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the quarterly report of Union National
Financial Corporation on Form 10-Q for the period ending
September 30, 2003, as filed with the Securities and Exchange
Commission (the "Report"), I, Mark D. Gainer, President/CEO, and
I, Clement M. Hoober, Treasurer/CFO, certify, pursuant to 18
U.S.C. Section 1350, as added pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section
13(a) or 15(d) of the Securities Exchange Act of 1934.
2. To my knowledge, the information contained in the Report
fairly presents, in all material respects the financial
condition and results of operations of Union National as of
the dates and for the periods expressed in the Report.
By /s/ Mark D. Gainer
_________________________
President/CEO
Date: November 14, 2003
By /s/ Clement M. Hoober
_________________________
Treasurer/CFO
Date: November 14, 2003
SIGNATURES
__________
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
Union National Financial Corporation
(Registrant)
By /s/ Mark D. Gainer
_______________________
Mark D. Gainer
President/Chief Executive Officer
(Principal Executive Officer)
Date: November 14, 2003
By /s/ Clement M. Hoober
_______________________
Clement M. Hoober
Treasurer/Chief Financial Officer
(Principal Financial and
Accounting Officer)
Date: November 14, 2003