UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(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, 2004
_____________________________
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.
2,381,547 shares of $.25 (par) common stock were
_________________
outstanding as of November 5, 2004
________________
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 16-17
Item 4 - Controls and Procedures 18
PART II - OTHER INFORMATION
_________________
Item 1 - Legal Proceedings 19
Item 2 - Unregistered Sales of Equity 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 19
Signature Page 20
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 21-22
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 23-24
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 25-26
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Union National Financial Corporation
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except per share data)9/30/04 12/31/03
(Unaudited) (Audited)
____________________
ASSETS
Cash and Due from Banks $ 10,871 $ 8,426
Interest-Bearing Deposits in Other Banks 132 253
____________________
Total Cash and Cash Equivalents 11,003 8,679
Investment Securities Available-for-Sale 92,408 97,066
Loans Held for Sale - 197
Loans(Net of Unearned Income) 257,962 225,381
Less: Allowance for Loan Losses (2,245) (1,985)
____________________
Net Loans 255,717 223,396
Premises and Equipment - Net 6,645 6,625
Restricted Investment in Bank Stocks 4,735 4,092
Bank-Owned Life Insurance 9,388 7,804
Other Assets 4,412 4,033
____________________
TOTAL ASSETS $ 384,308 $ 351,892
====================
LIABILITIES
Deposits:
Noninterest-Bearing $ 37,927 $ 30,687
Interest-Bearing 217,948 200,387
____________________
Total Deposits 255,875 231,074
Short-Term Borrowings 7,770 9,981
Long-Term Debt 84,558 73,874
Junior Subordinated Debentures 8,248 8,248
Other Liabilities 1,553 1,591
____________________
TOTAL LIABILITIES 358,004 324,768
STOCKHOLDERS' EQUITY
Common Stock (Par Value $.25 per share) 695 690
Shares: Authorized - 20,000,000; Issued -
2,781,240 in 2004 (2,762,099 in 2003)
Outstanding - 2,381,413 in 2004 (2,458,748
in 2003)
Surplus 9,476 9,090
Retained Earnings 23,173 21,963
Accumulated Other Comprehensive Income 780 1,035
Treasury Stock - 399,827 shares in
2004 (303,351 in 2003), at cost (7,820) (5,654)
____________________
TOTAL STOCKHOLDERS' EQUITY 26,304 27,124
____________________
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $ 384,308 $ 351,892
====================
The accompanying notes are an integral part of the
consolidated financial statements.
Union National Financial Corporation
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(Dollars in thousands, except per share data)
Three Months Ended September 30,
________________________________
2004 2003
________________________________
INTEREST INCOME
Interest and Fees on Loans $ 3,971 $ 3,474
Investment Securities:
Taxable Interest 707 680
Tax-Exempt Interest 273 327
Dividends 24 24
Other 2 3
_____________________________
Total Interest Income 4,977 4,508
INTEREST EXPENSE
Deposits 755 817
Short-Term Borrowings 29 9
Long-Term Debt 771 840
Junior Subordinated Debentures 93 -
_____________________________
Total Interest Expense 1,648 1,666
_____________________________
Net Interest Income 3,329 2,842
PROVISION for LOAN LOSSES 95 69
_____________________________
Net Interest Income after Provision
for Loan Losses 3,234 2,773
OTHER OPERATING INCOME
Income from Fiduciary Activities 49 31
Service Charges on Deposit Accounts 418 264
Other Service Charges, Commissions, Fees 344 426
Investment Securities Gains 10 203
Mortgage Banking Activities 81 26
Earnings from Bank-Owned Life
Insurance 96 80
Other Income 50 39
_____________________________
Total Other Operating Income 1,048 1,069
OTHER OPERATING EXPENSES
Salaries and Wages 1,401 1,269
Retirement Plan and Other
Employee Benefits 396 304
Net Occupancy Expense 196 167
Furniture and Equipment Expense 183 149
Professional Fees 153 145
Data Processing Services 201 175
Pennsylvania Shares Tax 71 69
Advertising and Marketing Expenses 91 64
ATM Processing Expenses 74 68
Other Operating Expenses 544 456
_____________________________
Total Other Operating Expenses 3,310 2,866
_____________________________
Income before Income Taxes 972 976
PROVISION for INCOME TAXES 166 164
_____________________________
NET INCOME for PERIOD $ 806 $ 812
=============================
PER SHARE INFORMATION
Net Income for Period - Basic $ 0.34 $ 0.32
Net Income for Period - Assuming
Dilution 0.33 0.32
Cash Dividends 0.16 0.16
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(UNAUDITED)
Net Income for Period $ 806 $ 812
Other Comprehensive Income, Net of Tax:
Unrealized Holding Gains/(Losses)
on Investment Securities
Available-for-Sale Arising During
Period 1,071 (931)
Reclassification Adjustment for Gains
Included in Net Income (7) (134)
_____________________________
Total Other Comprehensive Income/
(Loss) 1,064 (1,065)
_____________________________
COMPREHENSIVE INCOME/(LOSS)
for PERIOD $ 1,870 $ (253)
=============================
The accompanying notes are an integral part of the consolidated
financial statements.
Union National Financial Corporation
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(Dollars in thousands, except per share data)
Nine Months Ended September 30,
_______________________________
2004 2003
_______________________________
INTEREST INCOME
Interest and Fees on Loans $ 11,363 $ 10,523
Investment Securities:
Taxable Interest 2,172 2,047
Tax-Exempt Interest 842 914
Dividends 69 84
Other 5 32
_____________________________
Total Interest Income 14,451 13,600
INTEREST EXPENSE
Deposits 2,203 2,594
Short-Term Borrowings 61 21
Long-Term Debt 2,311 2,577
Junior Subordinated Debentures 261 -
_____________________________
Total Interest Expense 4,836 5,192
_____________________________
Net Interest Income 9,615 8,408
PROVISION for LOAN LOSSES 251 115
_____________________________
Net Interest Income after Provision
for Loan Losses 9,364 8,293
OTHER OPERATING INCOME
Income from Fiduciary Activities 163 103
Service Charges on Deposit Accounts 1,169 756
Other Service Charges, Commissions, Fees 960 931
Investment Securities Gains 174 286
Mortgage Banking Activities 242 795
Earnings from Bank-Owned Life
Insurance 284 185
Other Income 110 87
_____________________________
Total Other Operating Income 3,102 3,143
OTHER OPERATING EXPENSES
Salaries and Wages 4,119 3,722
Retirement Plan and Other
Employee Benefits 1,112 897
Net Occupancy Expense 606 529
Furniture and Equipment Expense 515 441
Professional Fees 435 361
Data Processing Services 527 510
Pennsylvania Shares Tax 197 190
Advertising and Marketing Expenses 279 175
ATM Processing Expenses 223 201
Other Operating Expenses 1,600 1,375
_____________________________
Total Other Operating Expenses 9,613 8,401
_____________________________
Income before Income Taxes 2,853 3,035
PROVISION for INCOME TAXES 482 564
_____________________________
NET INCOME for PERIOD $ 2,371 $ 2,471
=============================
PER SHARE INFORMATION
Net Income for Period - Basic $ 0.98 $ 0.99
Net Income for Period - Assuming
Dilution 0.96 0.97
Cash Dividends 0.48 0.47
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME(UNAUDITED)
Net Income for Period $ 2,371 $ 2,471
Other Comprehensive Income, Net of Tax:
Unrealized Holding Gains/(Losses)
on Investment Securities
Available-for-Sale Arising During
Period (140) (415)
Reclassification Adjustment for Gains
Included in Net Income (115) (189)
_____________________________
Total Other Comprehensive Income/
(Loss) (255) (604)
_____________________________
COMPREHENSIVE INCOME/(LOSS)
for PERIOD $ 2,116 $ 1,867
=============================
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) 2004 2003
_____________ _____________
CASH FLOWS from OPERATING ACTIVITIES
Net Income $ 2,371 $ 2,471
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation and Amortization 691 613
Provision for Loan Losses 251 115
Net Amortization of Investment
Securities' Premiums 905 1,276
Investment Securities Gains (174) (286)
Provision for Deferred Income Taxes (71) (3)
Earnings from Bank-Owned Life
Insurance (284) (185)
Gains on Loans Sold (109) (577)
Proceeds from Sales of Loans 4,137 23,712
Loans Originated for Sale (3,831) (22,920)
Increase in Accrued Interest
Receivable (53) (135)
Increase in Other Assets (294) (259)
Decrease in Other Liabilities (28) (154)
_____________ _____________
Net Cash Provided by Operating
Activities 3,511 3,668
CASH FLOWS from INVESTING ACTIVITIES
Proceeds from Sales of
Available-for-Sale Securities 20,842 19,929
Proceeds from Maturities of
Available-for-Sale Securities 14,046 26,592
Purchases of Available-for-Sale
Securities (31,347) (53,879)
Net Purchases of Restricted
Investments in Bank Stocks (643) (356)
Net Loans Made to Customers (32,572) (5,120)
Purchases of Premises and Equipment (541) (419)
Purchase of Bank-Owned Life Insurance (1,300) (4,000)
_____________ _____________
Net Cash Used in Investing
Activities (31,515) (17,253)
CASH FLOWS from FINANCING ACTIVITIES
Net Increase in Demand Deposits
and Savings Accounts 13,788 16,089
Net Increase/(Decrease) in
Time Deposits 11,013 (5,940)
Net Decrease in Short-Term Borrowings (2,211) (74)
Proceeds from Issuance of
Long-Term Debt 19,271 17,182
Payment on Long-Term Debt (8,587) (10,607)
Acquisition of Treasury Stock (2,166) (502)
Issuance of Common Stock 381 356
Cash Dividends Paid (1,161) (1,179)
_____________ _____________
Net Cash Provided by Financing
Activities 30,328 15,325
_____________ _____________
Net Increase in Cash and
Cash Equivalents 2,324 1,740
CASH and CASH EQUIVALENTS -
Beginning of Year 8,679 14,545
_____________ _____________
CASH and CASH EQUIVALENTS -
End of Period $ 11,003 $ 16,285
============= =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash Payments for:
Interest $ 4,832 $ 5,340
Income Taxes 380 582
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 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, 2004, 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 2003 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, 2004 2,394,958 2,450,288
September 30, 2003 2,506,285 2,548,015
Nine months ended:
September 30, 2004 2,413,541 2,464,146
September 30, 2003 2,507,647 2,543,388
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) 2004 2003
_______ _______
Net Income - As Reported $ 806 $ 812
Less: Stock Based Compensation Cost (64) -
_______ _______
Net Income - Pro Forma $ 742 $ 812
======= =======
Net Income Per Share:
As Reported (Basic) $ 0.34 $ 0.32
As Reported (Assuming Dilution) 0.33 0.32
Pro Forma (Basic) 0.31 0.32
Pro Forma (Assuming Dilution) 0.30 0.32
Nine Months
Ended September 30,
___________________
(In thousands, except per share data) 2004 2003
_______ _______
Net Income - As Reported $2,371 $2,471
Less: Stock Based Compensation Cost (121) (59)
_______ _______
Net Income - Pro Forma $2,250 $2,412
======= =======
Net Income Per Share:
As Reported (Basic) $ 0.98 $ 0.99
As Reported (Assuming Dilution) 0.96 0.97
Pro Forma (Basic) 0.93 0.96
Pro Forma (Assuming Dilution) 0.91 0.95
5. Union National does not issue any guarantees that would
require liability recognition or disclosure, other than its
standby letters of credit. Standby letters of credit written are
conditional commitments issued by Union National to guarantee the
performance of a customer to a third party. Generally, all
letters of credit, when issued have expiration dates within one
year. The credit risk involved in issuing letters of credit is
essentially the same as those that are involved in extending loan
facilities to customers. Union National generally holds
collateral and/or personal guarantees supporting these
commitments. Union National had $4,530,000 of standby letters of
credit as of September 30, 2004. Management believes that the
proceeds obtained through a liquidation of collateral and the
enforcement of guarantees would be sufficient to cover the
potential amount of future payment required under the
corresponding guarantees. The current amount of the liability as
of September 30, 2004, for guarantees under standby letters of
credit issued is not material.
6. In January 2003, the Financial Accounting Standards Board
(FASB) issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities, an Interpretation of ARB No. 51"
which was revised in December 2003. This Interpretation provides
guidance for the consolidation of variable interest entities
(VIEs). Union National Capital Trust I, a wholly-owned trust
subsidiary of Union National Financial Corporation, qualifies as
a variable interest entity under FIN 46. Union National Capital
Trust I issued mandatorily
redeemable preferred securities (trust capital securities) to
third-party investors and loaned the proceeds to Union National.
Union National Capital Trust I holds, as its sole asset,
subordinated debentures issued by Union National.
In accordance with the guidance provided by FIN 46, Union
National did not consolidate the accounts of Union National
Capital Trust I. The impact of not consolidating was to report
the total outstanding junior subordinated debentures of
$8,248,000 as an outstanding liability and to include Union
National's $248,000 equity interest in the trust subsidiary as an
"Other Asset" on the balance sheet. For regulatory reporting
purposes, the Federal Reserve Board has indicated that the trust
capital securities will continue to qualify as Tier 1 Capital
subject to previously specified limitations, until further
notice. If regulators make a determination that trust capital
securities can no longer be considered in regulatory capital, the
securities become callable and Union National may redeem them.
The adoption of FIN 46 did not have an impact on Union National's
results of operations or liquidity.
During March 2004, the FASB issued an exposure draft of a new
standard entitled "Share Based Payment," which would amend FASB
Statement No. 123 and FASB Statement No.95, "Statement of Cash
Flows." The new accounting standard, as proposed, would require
the expensing of stock options issued by Union National in the
financial statements using a fair-value-based method and would be
effective for periods beginning after June15, 2005. See Note 4
above for pro forma disclosures regarding the effect on net
income and income per share if we had applied the fair value
recognition provisions of SFAS No. 123. Depending on the method
adopted by Union National to calculate stock-based compensation
expense upon the adoption of Share Based Payment, the pro forma
disclosure in Note 4 may not be indicative of the stock-based
compensation expense to be recognized in periods beginning after
June 15, 2005.
In March 2004, the Securities and Exchange Commission released
Staff Accounting Bulletin (SAB) No. 105, "Application of
Accounting Principles to Loan Commitments." SAB 105 provides
guidance about the measurements of loan commitments recognized at
fair value under FASB Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SAB 105 also
requires companies to disclose their accounting policy for those
loan commitments including methods and assumptions used to
estimate fair value and associated hedging strategies. SAB 105
is effective for all loan commitments accounted for as
derivatives that are entered into after March 31, 2004. The
adoption of SAB 105 is not expected to have a material effect on
Union National's consolidated financial statements.
In March 2004, the Emerging Issues Task Force (EITF) reached
consensus on Issue 03-01, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments." EITF No.
03-01 includes new guidance for evaluating and recording
impairment losses on debt and equity investments, as well as new
disclosure requirements for investments that are deemed to be
temporarily impaired. The accounting guidance of EITF No. 03-01
is effective for fiscal years beginning after June 15, 2004,
while the disclosure requirements are effective for fiscal years
ending after June 15, 2004. Union National has not yet
determined the impact that adoption will have on its financial
position or results of operations as the impact is heavily
dependent on the interest rate environment at the date of
adoption and pending implementation guidance from the Financial
Accounting Standards Board.
7. On October 14, 2004, Union National announced the completion
of the private sale of $3,000,000 of trust preferred securities
by Union National Capital Trust II, a wholly-owned subsidiary of
Union National Financial Corporation. The capital securities
provide for quarterly distributions at an annual coupon rate of
5.28% through November 23, 2007, and at a variable annual coupon
rate, reset quarterly, based on 3-month LIBOR plus 2.00%
thereafter. The securities will mature in November 2034, and are
callable by Union National, subject to any required regulatory
approval, at par, on November 23, 2009. Union National plans to
use the net proceeds from this offering for capital contributions
to Union National Community Bank to fund its operations and
future growth. The issuance of these trust preferred securities
and the capital contribution to Union National Community Bank
will positively impact the capital ratios detailed in the
accompanying Management's Discussion and Analysis under the
section on Stockholders' Equity.
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. Union National's other subsidiary, Union
National Capital Trust I, was established during December 2003
for the purpose of issuing $8,000,000 of trust capital
securities. As disclosed in Note 6, this subsidiary is not
consolidated. This discussion should be read in conjunction with
the financial tables/statistics, financial statements and notes
to financial statements appearing elsewhere in this 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 the
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.
Shareholders 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. The allowance for loan losses is increased by a charge
to the provision 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 and the provision for loan losses
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, 2004, 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
Consolidated net income for the three months ended September 30,
2004, was $806,000, a slight decrease as compared to consolidated
net income of $812,000 for the same period of 2003. Basic
earnings per share for the three months ended September 30, 2004,
amounted to $0.34 and diluted earnings per share amounted to
$0.33, as compared to basic and diluted earnings per share of
$0.32 for the three months ended September 30, 2003.
Consolidated net income for the nine months ended September 30,
2004, was $2,371,000, a decrease of 4.0%, as compared to
consolidated net income of $2,471,000 for the same period of
2003. Basic earnings per share for the nine months ended
September 30, 2004, amounted to $0.98 and diluted earnings per
share amounted to $0.96, as compared to basic earnings per share
of $0.99 and diluted earnings per share of $0.97 for the nine
months ended September 30, 2003.
The following items impacted results of operations for the three
months ended September 30, 2004, as compared to the same period
of 2003:
* Net income increased due to an increase in net interest
income that was largely a result of growth in average
earning assets, which was funded by increased deposits and
borrowings.
* Net income decreased due to an increase in the provision
for loan losses.
* Net income decreased due to a decrease in commissions on
the sale of alternative investment products and a decrease
in gains on the sale of investment securities.
Partially offsetting these decreases was an increase in
service charges on deposit accounts.
* Net income decreased due to an increase in other operating
expenses.
The following items impacted results of operations for the nine
months ended September 30, 2004, as compared to the same period
of 2003:
* Net income increased due to an increase in net interest
income that was largely a result of growth in average
earning assets, which was funded by increased deposits and
borrowings.
* Net income decreased due to an increase in the provision
for loan losses.
* Net income decreased due to a decrease in income from
mortgage banking activities.
Partially offsetting this decrease was an increase in
income from service charges on deposit accounts as well as
an increase in earnings from bank-owned life insurance.
* Net income decreased due to an increase in other operating
expenses.
The above items are quantified and discussed in further detail
under their respective sections below.
Net income as a percent of average stockholders' equity, also
known as return on average equity (ROE) and net income as a
percent of average realized stockholders' equity, which excludes
the impact of accumulated other comprehensive income/(loss), were
as follows on an annualized basis:
Three Months Ended September 30,
________________________________
2004 2003
______ ______
ROE 12.37% 11.93%
ROE (Realized Equity) 12.75% 12.26%
Nine Months Ended September 30,
_______________________________
2004 2003
______ ______
ROE 12.03% 12.20%
ROE (Realized Equity) 12.38% 12.71%
For Union National, accumulated other comprehensive income/(loss)
is the amount of unrealized gains or losses on available-for-sale
investment securities, net of tax.
Management currently expects relatively strong growth in loans
and deposits for the remainder of 2004. It is expected that loan
growth will be driven largely by strong commercial loan demand
and a continued slowdown in the refinancing and payoff of
residential mortgages. Contributing to commercial loan demand
will be the recent addition of a new agricultural lender and an
experienced business banker. In addition, Union National has
opened a new commercial banking office in Manheim Township, PA in
March 2004 to further penetrate the greater Lancaster commercial
market. These items are discussed further in the Results of
Operations section in the discussion of Other Operating Expenses.
Deposit growth is expected to result from the acquisition of new
commercial business relationships and a new office at 38 East
Roseville Road in Manheim Township, PA that opened in November
2003. In addition, Union National also recently hired an
individual to focus on obtaining new commercial deposit
relationships and the sale of cash management and other corporate
services. 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 2004, Union National experienced
strong commercial loan demand and moderate growth in consumer
loans. The growth in consumer loans was primarily a result of an
increase in balances outstanding under home equity lines of
credit. However, there was a decline in the balance of purchased
residential mortgage and consumer loans. Overall loan balances
have increased by $32,581,000 since the beginning of 2004.
The economy in the bank's market may be negatively impacted by
national events and may be subject to overall national economic
trends. The overall effects of past 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 and investments exceeds interest incurred on deposits and
borrowings. 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-sensitive assets and liabilities.
For analytical and discussion purposes, net interest income and
corresponding yields are presented on a taxable equivalent basis.
Income from tax-exempt assets, primarily loans to or securities
issued by state and local governments, is adjusted by an amount
equivalent to the federal income taxes which would have been paid
if the income received on these assets was taxable at the
statutory rate of 34%.
In order to enhance net interest income in future periods,
management has entered into transactions that increase earning
assets funded by advances from the FHLB. As of September 30,
2004, the bank had received long-term advances of $84,558,000 and
short-term advances of $2,520,000 from its available credit of
$146,488,000 at the FHLB for purposes of funding loan demand and
security purchases. The total advances have maturities that
range from November 2004 to December 2013.
Furthermore, in December 2003, Union National obtained net
funding of $8,000,000 from the issuance of junior subordinated
debentures to a trust subsidiary that then issued trust capital
securities. The floating-rate debentures provide for quarterly
distributions at a variable annual coupon rate, reset quarterly,
based on three-month LIBOR plus 2.85%. The coupon rate was 4.53%
at September 30, 2004. The debentures have a 30-year maturity,
but are callable by Union National, at par, after 5 years. Union
National used the net
proceeds from this offering to fund an additional $4,000,000
capital investment in Union National Community Bank for its
operations and future growth. Union National plans to use the
balance of the funding for the repurchase of common stock and
general corporate purposes. The terms and amounts of the FHLB
borrowings and the issuance of the junior subordinated
debentures, when combined with Union National's overall balance
sheet structure, maintain Union National within its interest rate
risk policy limits.
There were costs of $4,000 incurred on the early payoff of FHLB
borrowings during the first nine months of 2004, and $243,000 in
costs were incurred on the payoff and restructuring of FHLB
borrowings during the first nine months of 2003. For the third
quarter of 2004, early payoff costs on FHLB borrowings amounted
to $4,000, while early payoff costs for the third quarter of 2003
amounted to $116,000. These additional costs were reflected as
increased interest expense on the related long-term borrowings.
Total FHLB advances outstanding at September 30, 2004, represent
an increase of $14,204,000 from September 30, 2003, and the
average interest rate on these borrowings has decreased to 3.47%
from 3.89%. 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
between periods.
In comparing the three months ended September 30, 2004, to the
same period of 2003, the net effect of volume growth in average
earning assets and interest-bearing liabilities increased net
interest income by $407,000. Growth in average earning assets
was funded primarily by increased deposit balances and additional
borrowings. Average earning assets increased by 11.8% for the
three months ended September 30, 2004, as compared to the same
period of 2003.
The overall interest rate on the average total earning assets for
the three months ended September 30, 2004, was 5.91%, as compared
to 5.98% for the same period of last year. The overall interest
rate on the average interest-bearing liabilities was 2.09% for
the three months ended September 30, 2004, and 2.39% (2.22%
without the impact of early payoff costs on long-term FHLB
borrowings) for the three months ended September 30, 2003. The
net effect of these interest rate changes was to increase net
interest income in the amount of $103,000 for the three months
ended September 30, 2004, over the same period of 2003. The net
interest margin percentage for the three months ended September
30, 2004, was 4.02% (4.03% without the impact of payoff costs),
as compared to 3.84% (3.99% without the impact of payoff costs)
for the same period of 2003.
In comparing the nine months ended September 30, 2004, to the
same period of 2003, the net effect of volume growth in average
earning assets and interest-bearing liabilities increased net
interest income by $1,171,000. Average earning assets increased
by 11.7% for the nine months ended September 30, 2004, as
compared to the same period of 2003.
The overall interest rate on the average total earning assets for
the nine months ended September 30, 2004, was 5.91%, as compared
to 6.25% for the same period of last year. The overall interest
rate on the average interest-bearing liabilities was 2.13% for
the nine months ended September 30, 2004, and 2.59% (2.41%
without the impact of early payoff costs on long-term FHLB
borrowings) for the nine months ended September 30, 2003. The
net effect of these interest rate changes was to decrease net
interest income in the amount of $3,000 for the nine months ended
September 30, 2004, over the same period of 2003. The net
interest margin percentage for the nine months ended September
30, 2004, was 4.01%, as compared to 3.96% (4.12% without the
impact of payoff costs) for the same period 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%. However, in
June, August and again in September 2004, the Federal Reserve
increased rates and the prime interest rate now stands at 5.00%.
The following chart details recent rate history for certain key
interest rates that impact rates on Union National's interest-
bearing assets and liabilities:
9/30/04 6/30/04 12/31/03
_________ _________ _________
Fed Funds Target Rate 1.75% 1.25% 1.00%
Prime Rate 4.75% 4.25% 4.00%
3 Year Treasury Constant
Maturity* 2.83% 3.26% 2.44%
10 Year Treasury Constant
Maturity* 4.13% 4.73% 4.27%
Conventional Mortgage Rate* 5.75% 6.29% 5.88%
*These rates are the average rate for the month as published by
the Federal Reserve in Statistical Release H.15.
9/30/03 12/31/02
_________ _________
Fed Funds Target Rate 1.00% 1.25%
Prime Rate 4.00% 4.25%
3 Year Treasury Constant 2.23% 2.23%
Maturity*
10 Year Treasury Constant 4.27% 4.03%
Maturity*
Conventional Mortgage Rate* 6.15% 6.05%
*These rates are the average rate for the month as published by
the Federal Reserve in Statistical Release H.15.
Over a period of years, interest rates have declined
significantly, but as detailed in the above table, these rates
have more recently stabilized and have begun to increase
slightly.
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 2004, it is currently anticipated that Union
National's net interest margin percentage will be comparable to
current levels. However, income from growth in earning assets
which occurred during 2003 and 2004, net of costs resulting from
growth in deposits and borrowings, should increase net interest
income for the remainder of 2004. The netting of these two
factors, as reflected in Union National's current simulation
model and estimates as of September 30, 2004, may result in net
interest income for the remainder of 2004 that reflects a
moderate increase over the net interest income earned during the
same period of 2003. Expected growth in earning assets during
the remainder of 2004 should also increase Union National's net
interest margin. This expected growth was not reflected in the
model at September 30, 2004. Union National's net interest
income may be impacted by future actions of the Federal Reserve
Bank.
Union National's current net interest income simulation model
includes an investment in BOLI that had a value of $9,388,000 at
September 30, 2004. This is a financial transaction reflected in
the net interest margin of the model, but for financial reporting
purposes the increase in the cash surrender value of the life
insurance is recorded as other noninterest income. Although the
effective interest rate impact of expected cash flows on
investments and of renewing certificates of deposit can be
reasonably estimated at current interest rate levels, the yield
curve during 2004, 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 models. See discussions on Liquidity and Market
Risk - Interest Rate Risk.
Provision for Loan Losses
The loan loss provision is an estimated expense charged to
earnings to provide for losses attributable to uncollectible
loans. The provision is based on management's analysis of the
adequacy of the allowance for loan losses. The provision for
loan losses was $95,000 for the three months ended September 30,
2004, as compared to $69,000 for the three months ended September
30, 2003. For the nine-month period, the provision for loan
losses was $251,000, as compared to $115,000 for the same period
of 2003. For the three months ended September 30, 2004, Union
National had net recoveries of $19,000 and for the same period of
2003 there were net charge-offs of $3,000. For the nine months
ended September 30, 2004, net recoveries amounted to $9,000 as
compared to net charge-offs of $22,000 for the same period of
2003. The increased provision for loan losses in 2004 can be
primarily attributed to growth in outstanding loan balances.
Future adjustments to the allowance, and consequently the
provision for loan losses, may be necessary if economic
conditions or loan credit quality differ substantially from the
assumptions used in making management's evaluation of the level
of the allowance for loan losses as compared to the balance of
outstanding loans. See discussion on Loan Quality/Allowance for
Loan Losses.
Other Operating Income
Other operating income for the three months ended September 30,
2004, was $1,048,000, representing a decrease of $21,000 or 2.0%,
from the same period of 2003. For the nine months ended
September 30, 2004, other operating income decreased $41,000, or
1.3%, in comparison to the same period of 2003. The decline in
income for the three-month period was a result of a decrease in
investment securities gains of $193,000 and a decline in income
from the sale of alternative investment products. For the nine-
month period ended September 30, 2004, the decline in other
operating income resulted from a decline in income from mortgage
banking activities primarily as a result of a slow down in
refinancing activity. Mortgage banking income was down $553,000
in comparing the nine-month period ended September 30, 2004, to
the same period of 2003.
Partially offsetting the items mentioned above were the following
increases in comparison to the comparable periods of 2003 (in
thousands):
Three Months
Ended
September 30, 2004
__________________
Income from Fiduciary Activities $ 18
Service Charges on Deposit Accounts 154
Merchant Credit Card Fees 23
Earnings from Bank-Owned Life Insurance 16
Nine Months
Ended
September 30, 2004
__________________
Income from Fiduciary Activities $ 60
Service Charges on Deposit Accounts 413
Merchant Credit Card Fees 49
Earnings from Bank-Owned Life Insurance 99
The increased income from service charges on deposit accounts is
primarily from increased insufficient funds charges related to a
new product called "Overdraft Privilege" introduced to customers
in November 2003. With Overdraft Privilege customers are
permitted to overdraw their accounts subject to certain limits.
This service can help customers avoid merchant costs and the
embarrassment of having checks returned. Overdraft Privilege
should also generate increased fee income for Union National
during the remainder of 2004. With increased overdrafts there is
also increased exposure to loss, however, the increased revenue
is currently expected to more than offset any related losses.
The increase in earnings on BOLI is a result of an additional
$4,000,000 investment in BOLI during the third quarter of 2003
and an additional investment of $1,300,000 in June 2004.
Other Operating Expenses
The aggregate of other operating expenses increased by $444,000,
or 15.5%, for the three months ended September 30, 2004, as
compared to the same period of 2003. For the nine months ended
September 30, 2004, other operating expenses increased by
$1,212,000, or 14.4%, in comparison to the same period of 2003.
These increases in other operating expenses are discussed below
as they pertain to the various expense categories.
During the third quarter of 2004, salaries and wages increased by
$132,000 in comparison to the third quarter of 2003. For the
nine months ended September 30, 2004, salaries and wages
increased by $397,000 in comparison to the same period of 2003.
This increase was essentially due to staff additions and annual
merit and cost-of-living increases. Staff additions included
staff for a new retail office location at 38 E. Roseville Road in
Manheim Township which opened in November 2003, an agricultural
lender, an experienced business banker, a salesperson for
corporate services, a retirement plan salesperson, a salesperson
for trust and investment management products and services,
business and credit specialists and other support staff and sales
positions.
Employee benefit costs increased by $92,000 for the third quarter
of 2004 as compared to 2003. For the nine-month period, employee
benefit costs increased by $215,000. Increased employee benefit
costs relate to increased staff and salary levels, increased
health insurance premiums and costs related to a supplemental
executive retirement plan.
Other changes in operating expenses in comparison to the
comparable periods of 2003 included the following (in thousands):
Three Months Nine months
Ended Ended
September 30, 2004 September 30, 2004
__________________ __________________
Occupancy & Equipment Costs $ 63 $ 151
Professional Fees 8 74
Data Processing Services 26 17
Advertising & Marketing 27 104
The increase in net occupancy expense and furniture and equipment
expense primarily was a result of the opening of our new Manheim
Township office in November 2003 and the opening of our new
commercial banking office in Manheim Township, PA in March 2004.
The increase in professional fees is primarily attributable to
professional fees related to the implementation of our Overdraft
Privilege product. The increase in advertising and marketing
expense was primarily a result of the opening of a new office as
well as several advertising campaigns undertaken in 2004.
Income Taxes
Union National's income tax expense increased by $2,000 for the
three months ended September 30, 2004, as compared to the same
period of last year. For the nine months ended September 30,
2004, income tax expense decreased by $82,000 in comparison to
the same period of 2003. Union National's effective tax rates
were as follows:
Three Months Ended Nine months Ended
__________________ __________________
September 30, 2004 17.1% 16.9%
September 30, 2003 16.8% 18.6%
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 decrease
in the effective tax rate for 2004 is due to a higher percentage
of income being derived from tax-exempt sources. As of September
30, 2004, Union National had a net deferred tax asset of
$280,000. The realization of deferred tax assets is dependent on
future earnings of Union National. Management currently
anticipates future earnings will be adequate to utilize 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.
The Sarbanes-Oxley Act, enacted in July 2002, represents a
comprehensive revision of laws affecting corporate governance,
accounting obligations and corporate reporting. Certain
provisions of this act have yet to take effect for Union
National. The full impact of the Sarbanes-Oxley Act and the
increased costs related to Union National's compliance are still
uncertain and evolving.
Other than the cost of the compliance with the Sarbanes-Oxley Act
described above, 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 Office of the Comptroller of the
Currency (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
$1,804,000 to comply with their respective repayment terms. This
compares to the amount of $1,879,000 at December 31, 2003. 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 2004.
At September 30, 2004, total nonperforming loans amounted to
$1,607,000, or 0.6% of net loans, as compared to a level of
$1,342,000, or 0.6%, at December 31, 2003. These loans are
essentially collateralized with real estate. Historically, the
percentage of nonperforming loans to 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) 2004 2003
_____________ ____________
Nonaccruing Loans $ 1,587 $ 1,334
Accrual Loans -90 days or more past due 20 8
Restructured Accrual Loans - -
_____________ ____________
Total Nonperforming Loans 1,607 1,342
Foreclosed Real Estate 108 104
_____________ ____________
Total Nonperforming Assets $ 1,715 $ 1,446
============= ============
Nonperforming Loans
as a % of Net Loans 0.6% 0.6%
============= ============
Allowance for Loan Losses
as a % of Nonperforming Loans 140% 148%
============= ============
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, 2004, Union National had corporate debt securities
that were rated below investment grade and were carried at a fair
value of $203,000 and had unrealized losses of $7,000. 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, 2004, 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, 2004, Union National held corporate debt
securities with a total fair value of $15,687,000 and net
unrealized gains on these securities amounted to $98,000.
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 on a
quarterly basis.
The allowance is increased by provisions charged to operating
expense and reduced by net charge-offs. Management's 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 OCC's most recent examination.
Management believes, based on information currently available,
that the current allowance for loan losses of $2,245,000 is
adequate to meet potential loan losses. In addition, management
expects loan charge-offs, net of recoveries for the remainder of
2004 to reflect a slight increase in comparison to net loan
charge-offs for the same period of 2003.
Analysis of Allowance for Loan Losses:
Three Months Ended
September 30,
(In thousands) 2004 2003
________ ________
Average Total Loans Outstanding
(Less Unearned Income) $251,366 $200,847
======== ========
Allowance for Loan Losses,
Beginning of Period $ 2,131 $ 1,840
Loans Charged-Off During Period (4) (5)
Recoveries of Loans Previously
Charged-Off 23 2
________ ________
Net Loans (Charged-Off)/Recovered 19 (3)
Addition to Provision for Loan Losses
Charged to Operations 95 69
________ ________
Allowance for Loan Losses,
End of Period $ 2,245 $ 1,906
======== ========
Ratio of Net Loans (Charged-Off)/Recovered
to Average Loans Outstanding (Annualized) .03% (.01)%
======== ========
Ratio of Allowance for Loan Losses to
Net Loans at End of Period
Nine Months Ended
September 30,
(In thousands) 2004 2003
________ ________
Average Total Loans Outstanding
(Less Unearned Income) $239,866 $197,981
======== ========
Allowance for Loan Losses,
Beginning of Period $ 1,985 $ 1,812
Loans Charged-Off During Period (21) (40)
Recoveries of Loans Previously
Charged-Off 30 19
________ ________
Net Loans (Charged-Off)/Recovered 9 (21)
Addition to Provision for Loan Losses
Charged to Operations 251 115
________ ________
Allowance for Loan Losses,
End of Period $ 2,245 $ 1,906
======== ========
Ratio of Net Loans (Charged-Off)/Recovered
to Average Loans Outstanding (Annualized) .01% (.01)%
======== ========
Ratio of Allowance for Loan Losses to
Net Loans at End of Period 0.87% 0.93%
======== ========
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 exceeds the bank's minimum defined levels.
There are no known trends, except the anticipated loan and
deposit growth previously discussed in the Results of Operations
section, 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 additional
liquidity alternatives such as short- or long-term funding on
fixed- or variable-rate terms. As of September 30, 2004, the
bank had received long-term advances of $84,558,000 and short-
term advances of $2,520,000 from its available credit of
$146,488,000 at the FHLB for purposes of funding loan demand and
mortgage-backed security purchases. Total outstanding FHLB
borrowings at September 30, 2004, had a weighted-average rate of
3.47% and total FHLB borrowings of $72,874,000 at September 30,
2003, had a weighted-average rate of 3.89%. As of September 30,
2004, advances of $18,895,000 are due in the next twelve months
and advances of $25,000,000 are currently convertible by the FHLB
on a quarterly basis. 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.
Union National recently became the first bank in Lancaster County
to offer our customers FDIC insurance coverage beyond $100,000
through a unique program called the Certificate of Deposit
Account Registry Service (CDARS). Through this program customers
may be able to invest up to $10 million with Union National and
maintain full FDIC insurance coverage. Union National is also
able to bid for and obtain additional brokered CDs through this
program as an additional source of liquidity. As of September
30, 2004, Union National had $14,600,000 outstanding in brokered
CDs and in CDs gathered through the CDARS program.
Stockholders' Equity
____________________
Union National and the bank maintain capital ratios that are well
above the minimum total capital levels required by federal
regulatory authorities. Except as discussed below concerning
Union National's common stock repurchase plan, Union National's
planned purchase of a new retail branch location and the Federal
Reserve position on trust capital securities, there are no known
trends or uncertainties, including regulatory matters that are
expected to have a material adverse impact on the capital
resources of Union National for the remainder of 2004.
On December 19, 2003, the Board of Directors of Union National
authorized and approved a plan to purchase up to 120,000 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 4.9% 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, 2004, Union National purchased approximately 97,000
shares under this plan.
In November 2004, Union National became obligated for the
purchase of real estate located in Lancaster County, PA in the
amount of $1,300,000. It is currently anticipated that
settlement of this transaction will occur in January 2006. It is
also currently anticipated that Union National will construct a
retail banking facility on this property in the future.
Union National and the bank are subject to various regulatory
capital requirements administered by the federal banking
agencies. Failure to meet the minimum capital requirements can
initiate certain mandatory and possibly additional discretionary
actions by regulators that, if undertaken, could have a direct
material effect on Union National's financial statements. Under
capital adequacy guidelines and the regulatory framework for
prompt corrective action, Union National and the bank must meet
specific capital guidelines that involve quantitative measures of
their assets, liabilities and certain
off-balance sheet items as calculated under regulatory accounting
practices. The capital amounts and classification are also
subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital
adequacy require Union National and the bank to maintain minimum
amounts and ratios (set forth below) of Tier 1 capital to average
assets and of Tier 1 and total capital (as defined in the
regulations) to risk-weighted assets. Management believes, as of
September 30, 2004, that Union National and the bank meet all
capital adequacy requirements to which they are subject.
As of September 30, 2004, the most recent notification from the
regulators categorized the bank as "well-capitalized" under the
regulatory framework for prompt corrective action. There are no
conditions or events since that notification that management
believes have changed the bank's category.
Union National and the bank maintained the following regulatory
capital levels and leverage and risk-based capital ratios:
September 30, December 31,
2004 2003
(In thousands) _____________ ___________
Union National Financial Corporation:
_____________________________________
Tier I Capital $ 33,493 $ 34,047
Tier II Capital 2,324 2,080
_________ _________
Total Qualifying Capital $ 35,817 $ 36,127
========= =========
Risk-adjusted On-balance Sheet Assets $ 278,173 $ 246,617
Risk-adjusted Off-balance Sheet Exposure 40,986 28,271
_________ _________
Total Risk-adjusted Assets $ 319,159 $ 274,888
========= =========
Actual Capital Ratio:
Tier I Capital to Average Total Assets 8.89% 10.10%
Minimum Required 4.00 4.00
Risk-based Capital Ratios:
Tier I Capital Ratio - Actual 10.49% 12.39%
Minimum Required 4.00 4.00
Total Capital Ratio - Actual 11.22% 13.14%
Minimum Required 8.00 8.00
Total Risk-Based Capital in Excess of the
Minimum Regulatory Requirement $ 10,284 $ 14,136
========= =========
Union National Community Bank:
______________________________
Tier I Capital $ 30,421 $ 29,125
Tier II Capital 2,245 1,985
_________ _________
Total Qualifying Capital $ 32,666 $ 31,110
========= =========
Risk-adjusted On-balance Sheet Assets $ 277,154 $ 245,686
Risk-adjusted Off-balance Sheet Exposure 40,986 28,271
_________ _________
Total Risk-adjusted Assets $ 318,140 $ 273,957
========= =========
Actual Capital Ratio:
Tier I Capital to Average Total Assets 8.10% 8.65%
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 9.56% 10.63%
Minimum Required 4.00 4.00
To Be Well-Capitalized Under Prompt
Corrective Action Provisions 6.00 6.00
Total Capital Ratio - Actual 10.27% 11.36%
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 $ 7,215 $ 9,193
========= =========
Included in Tier 1 regulatory capital of Union National Financial
Corporation detailed above is $8,000,000 of trust capital
securities issued through Union National Capital Trust I, a
wholly-owned subsidiary of Union National. As disclosed in Note
6, these securities would become callable if the Federal Reserve
makes a determination that trust capital securities can no longer
be considered in regulatory capital.
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 Union National's assets
and liabilities. The nature of Union National's current
operations is such that Union National 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 Union National's Board of Directors. Union
National manages interest rate risk by changing the mix or
repricing characteristics of its investment securities portfolio
and borrowings from the FHLB and by the promotion or development
of specific loan and deposit products. Union National retains an
outside consulting group to assist in monitoring its interest
rate risk using a net interest income simulation model on a
quarterly basis. The simulation model measures the sensitivity
of future net interest income to hypothetical changes in market
interest rates.
In an effort to assess market risk, Union National utilizes a
simulation model to determine the effect of gradual increases or
decreases in market interest rates on net interest income and net
income. The aforementioned assumptions 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. This is based
on a review of historical changes in market interest rates and
the level and curve of current interest rates. The simulated
results represent the hypothetical effects to Union National's
net interest income and net income. Projections for loan and
deposit growth were ignored in the simulation model. The
simulation model includes all of Union National'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 a nominal negative 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, 2004,
based on management's assessment of potential future interest
rate
levels. In addition, a hypothetical two-percent general rise in
rates will have a nominal 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 a nominal positive 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.
Union National managed its interest rate risk position in 2004 by
the following:
* increasing its use of adjustable- and floating-rate loans
for new or refinanced commercial and agricultural loans
* the repositioning and restructuring of its investment
security portfolio;
* managing and expanding the bank's core deposit base
including deposits obtained in the bank's commercial cash
management programs; and
* additions to and repositioning of fixed- and variable-rate
advances from the FHLB.
The above strategies and actions impact interest rate risk and
are all included in Union National'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
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, 2004, Union
National's Chief Executive Officer and Chief Financial Officer
concluded that the disclosure controls and procedures were
adequate.
Changes in Internal Controls
During the quarter ended September 30, 2004, Union National made
no significant changes in its internal controls or in other
factors that could significantly affect these controls.
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. Unregistered Sales of Equity Securities and Use of
Proceeds
ISSUER PURCHASES OF EQUITY SECURITIES
(c)
Total Number of
Shares
(a) Purchased as
Total (b) Part of
Number of Average Publicly
Shares Price Paid Announced Plans
Period Purchased per Share or Programs*
_________________________________________________________________
July 1, 2004 to
July 31, 2004 1,345 $23.65 1,345
August 1, 2004 to
August 31, 2004 4,173 $23.59 4,173
September 1, 2004 to
September 30, 2004 15,164 $23.02 15,164
______ ______
Total 20,682 $23.17 20,682
====== ======
*On December 19, 2003, the Board of Directors of Union National
authorized and approved a plan to purchase up to 120,000 shares
of its outstanding common stock in open market or privately
negotiated transactions.
(d)
Maximum Number
of Shares that
May Yet Be
Purchased
Under the
Plans or
Programs*
_________________________________________________________________
July 1, 2004 to
July 31, 2004 42,352
August 1, 2004 to
August 31, 2004 38,179
September 1, 2004 to
September 30, 2004 23,015
Total
*On December 19, 2003, the Board of Directors of Union National
authorized and approved a plan to purchase up to 120,000 shares
of its outstanding common stock in open market or privately
negotiated transactions.
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:
(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
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 12, 2004
By /S/ Clement M. Hoober
_______________________
Clement M. Hoober
Treasurer/Chief Financial Officer
(Principal Financial and
Accounting Officer)
Date: November 12, 2004
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
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 the registrant 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-14) for the registrant and we 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 the registrant,
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 the registrant's
disclosure controls and procedures and presented in
this report our conclusions about the effectiveness
of the disclosure controls and procedures as of the
end of the period covered by this quarterly report
based on such evaluation; and
(c) disclosed in this report any change in the
registrant's internal control over financial
reporting that occurred during the registrant's most
recent fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the
registrant'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 the
registrant's auditors and the audit committee of
registrant's board of directors (or persons performing
the equivalent function):
(a) all significant deficiencies and material weaknesses
in the design or operation of the internal control
over financial reporting which are reasonably likely
to adversely affect the registrant'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 the registrant's internal controls over
financial reporting.
By /S/ Mark D. Gainer
_______________________
President/CEO
Date: November 12, 2004
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
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 the registrant 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-14) for the registrant and we 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 the registrant,
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 the registrant's
disclosure controls and procedures and presented in
this report our conclusions about the effectiveness
of the disclosure controls and procedures as of the
end of the period covered by this quarterly report
based on such evaluation; and
(c) disclosed in this report any change in the
registrant's internal control over financial
reporting that occurred during the registrant's most
recent fiscal quarter that has materially affected,
or is reasonably likely to materially affect, the
registrant'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 the
registrant's auditors and the audit committee of
registrant's board of directors (or persons performing
the equivalent function):
(a) all significant deficiencies and material weaknesses
in the design or operation of the internal control
over financial reporting which are reasonably likely
to adversely affect the registrant'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 the registrant's internal controls over
financial reporting.
By /S/ Clement M. Hoober
_______________________
Treasurer/CFO
Date: November 12, 2004
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, 2004, as filed with the Securities and Exchange
Commission on the date hereof (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 12, 2004
By /S/ Clement M. Hoober
______________________
Treasurer/CFO
Date: November 12, 2004