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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 2004
Commission file number: 000-28449
UNION BANKSHARES, INC.
VERMONT 03-0283552
P.O. BOX 667
MAIN STREET
MORRISVILLE, VT 05661
Registrant's telephone number: 802-888-6600
Former name, former address and former fiscal year, if changed since last
report: Not applicable
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 12b-2 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 May 6, 2004:
Common Stock, $2 par value 4,550,763 shares
1
UNION BANKSHARES, INC.
TABLE OF CONTENTS
PART 1 FINANCIAL INFORMATION
Item 1. Financial Statements.
Consolidated Financial Statements.
Union Bankshares, Inc. and Subsidiary
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statement of Changes in Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 10
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27
Item 4. Controls and Procedures 27
PART II OTHER INFORMATION
Item 1. Legal Proceedings. 28
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 29
2
Item 1. Financial Statements
Union Bankshares, Inc. and Subsidiary
Consolidated Balance Sheets
(Unaudited)
March 31, December 31,
(Dollars in Thousands) 2004 2003
---- ----
Assets
Cash and due from banks $ 20,222 $ 23,624
Federal funds sold and overnight deposits 2,762 916
-------- --------
Cash and cash equivalents 22,984 24,540
Interest bearing deposits in banks 6,321 6,520
Securities available-for-sale 43,346 44,370
Loans held for sale 14,459 18,524
Loans 253,584 253,222
Allowance for loan losses (3,019) (3,029)
Unearned net loan fees (197) (185)
-------- --------
Net loans 250,368 250,008
-------- --------
Accrued interest receivable 1,710 1,652
Premises and equipment, net 4,726 4,447
Other real estate owned 210 10
Other assets 5,932 6,486
-------- --------
Total assets $350,056 $356,557
======== ========
Liabilities and Stockholders' Equity:
Liabilities:
Deposits:
Non-interest bearing $ 47,183 $ 48,366
Interest bearing 247,352 257,016
-------- --------
Total deposits 294,535 305,382
Borrowed funds 10,327 7,223
Accrued interest and other liabilities 3,713 2,965
-------- --------
Total liabilities 308,575 315,570
-------- --------
Stockholders' Equity:
Common stock, $2 par value; 5,000,000 shares authorized;
4,911,261 shares issued at 3/31/04 and 12/31/03 9,822 9,822
Paid-in capital 55 55
Retained earnings 32,344 32,071
Treasury stock at cost; 360,948 shares at 3/31/04 and
12/31/03 (1,722) (1,722)
Accumulated other comprehensive income 982 761
-------- --------
Total stockholders' equity 41,481 40,987
-------- --------
Total liabilities and stockholders' equity $350,056 $356,557
======== ========
See accompanying notes to the unaudited consolidated financial statements
3
Union Bankshares, Inc. and Subsidiary
Consolidated Statements of Income
(Unaudited)
Three Months Ended
March 31,
----------------------
(Dollars in Thousands except Per Share Data) 2004 2003
---- ----
Interest income:
Interest and fees on loans $ 4,309 $ 4,529
Interest on debt securities
Taxable 434 461
Tax exempt 53 62
Dividends 17 20
Interest on federal funds sold and overnight deposits 5 22
Interest on interest bearing deposits in banks 49 47
--------- ---------
Total interest income 4,867 5,141
--------- ---------
Interest expense:
Interest on deposits 756 1,114
Interest on borrowed funds 88 85
--------- ---------
Total interest expense 844 1,199
--------- ---------
Net interest income 4,023 3,942
Provision for loan losses - 42
--------- ---------
Net interest income after provision for loan losses 4,023 3,900
--------- ---------
Noninterest income:
Trust income 44 39
Service fees 662 660
Net gains on sales of securities 25 -
Net gains on sales of loans held for sale 180 182
Other income 51 34
--------- ---------
962 915
--------- ---------
Noninterest expenses:
Salaries and wages 1,409 1,412
Pension and employee benefits 597 431
Occupancy expense, net 192 188
Equipment expense 220 232
Net operation of other real estate owned 15 70
Other expenses 743 758
--------- ---------
3,176 3,091
--------- ---------
Income before provision for income taxes 1,809 1,724
Provision for Income taxes 535 495
--------- ---------
Net income $ 1,274 $ 1,229
========= =========
Earnings per common share $ 0.28 $ 0.27
========= =========
Weighted average number of common
shares outstanding 4,550,313 4,545,346
========= =========
Dividends per common share $ 0.22 $ 0.20
========= =========
See accompanying notes to the unaudited consolidated financial statements
4
Union Bankshares, Inc. and Subsidiary
Consolidated Statement of Changes in Stockholders' Equity
(Unaudited)
Common Stock
------------------- Accumulated
Shares, Other Total
net of Paid-in Retained Treasury Comprehensive Stockholders'
Treasury Amount Capital Earnings Stock Income Equity
-------- ------ ------- -------- -------- ------------- -------------
(Dollars in Thousands)
Balance, December 31, 2003 4,550,313 $9,822 $55 $32,071 $(1,722) $761 $40,987
-------
Comprehensive Income:
Net income - - 1,274 - - 1,274
Change in net unrealized gain (loss) on
securities available-for-sale, net
of reclassification adjustment and
tax effects. - - - - 221 221
-------
Total Comprehensive income - - - - - 1,495
-------
Cash dividends declared
($0.22 per share) - - (1,001) - - (1,001)
-----------------------------------------------------------------------------------
Balance March 31, 2004 4,550,313 $9,822 $55 $32,344 $(1,722) $982 $41,481
===================================================================================
See accompanying notes to the unaudited consolidated financial statements
5
Union Bankshares, Inc. and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)
Three Months Ended
----------------------
March 31, March 31,
(Dollars in Thousands) 2004 2003
--------- ---------
Cash Flows From Operating Activities
Net Income $ 1,274 $ 1,229
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 164 167
Provision for loan losses - 42
Provision for deferred income taxes 78 48
Net amortization on securities 55 74
Equity in losses of limited partnerships 31 31
Write-downs of other real estate owned - 33
Increase (decrease) in unamortized loan fees 12 (5)
(Increase) decrease in loans held for sale, net 4,245 (1,380)
Net gain on sales of securities (25) -
Net gain on sales of loans held for sale (180) (182)
Net (gain) loss on sales of other real estate owned (1) 2
Net gain on disposals of premises and equipment (5) (6)
(Increase) decrease in accrued interest receivable (58) 87
(Increase) decrease in other assets 331 (102)
Increase in income taxes 432 461
Increase (decrease) in accrued interest payable 36 (35)
Increase in other liabilities 280 421
-------- --------
Net cash provided by operating activities 6,669 885
-------- --------
Cash Flows From Investing Activities
Interest bearing deposits in banks
Maturities and redemptions 992 1,190
Purchases (793) (597)
Securities available-for-sale
Sales 529 -
Maturities, calls and paydowns 2,648 9,592
Purchases (1,847) (3,133)
Purchase of Federal Home Loan Bank Stock - (6)
Increase in loans, net (592) (690)
Recoveries of loans charged off 20 33
Purchases of premises and equipment (448) (136)
6
March 31, March 31,
(Dollars in Thousands) 2004 2003
--------- ---------
Proceeds from sales of other real estate owned - 20
Proceeds from sales of premises and equipment 10 10
Proceeds from sales of repossessed property - 14
-------- --------
Net cash provided by investing activities 519 6,297
-------- --------
Cash Flows From Financing Activities
Increase (decrease) in borrowings outstanding, net 3,104 (343)
Proceeds from exercise of stock options - 8
Net decrease in non-interest bearing deposits (1,183) (2,896)
Net decrease in interest bearing deposits (9,664) (6,336)
Dividends paid (1,001) (909)
-------- --------
Net cash used in financing activities (8,744) (10,476)
-------- --------
Decrease in cash and cash equivalents $ (1,556) $ (3,294)
Cash and cash equivalents
Beginning $ 24,540 $ 25,748
-------- --------
Ending $ 22,984 $ 22,454
======== ========
Supplemental Disclosures of Cash Flow Information:
Interest paid $ 809 $ 1,235
======== ========
Income taxes paid $ 25 $ 30
======== ========
Supplemental Schedule of Noncash Investing and
Financing Activities:
Other real estate acquired in settlement of loans $ 200 $ 15
======== ========
Repossessed property acquired in settlement of loans $ 0 $ 25
======== ========
Total change in unrealized gain on securities
available-for-sale $ 335 $ 140
======== ========
See accompanying notes to the unaudited consolidated financial statements
7
UNION BANKSHARES, INC.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS:
Note 1. Basis of Presentation
The accompanying interim unaudited consolidated financial statements of
Union Bankshares, Inc. (the Company) for the interim periods ended March
31, 2004 and 2003 and for the quarters then ended have been prepared in
accordance with U.S. generally accepted accounting principles, general
practices within the banking industry and the accounting policies described
in the Company's Annual Report to Shareholders and Annual Report on Form
10-K for the year ended December 31, 2003. In the opinion of management,
all adjustments (consisting only of normal recurring adjustments) and
disclosures necessary for a fair presentation of the information contained
herein have been made. Certain amounts reported in prior periods have been
reclassified for comparative purposes. This information should be read in
conjunction with the Company's 2003 Annual Report to Shareholders, 2003
Annual Report on Form 10-K, and current reports on Form 8-K. The results of
operations for the interim periods are not necessarily indicative of the
results of operations to be expected for the full fiscal year ended
December 31, 2004 or any other interim period.
All share and per share amounts have been retroactively adjusted for the
effect of the stock split of August 8, 2003.
Note 2. Commitments and Contingencies
In the normal course of business, the Company is involved in various legal
proceedings. In the opinion of management any liability resulting from such
proceedings would not have a material adverse effect on the Company's
financial condition or results of operations.
Note 3. Earnings Per Share
Earnings per common share amounts are computed based on the weighted
average number of shares of common stock outstanding during the period
(retroactively adjusted for the August 8, 2003 stock split effected in the
form of a stock dividend) and reduced for shares held in Treasury. The
assumed conversion of available stock options does not result in material
dilution.
Note 4. New Accounting Pronouncement
On March 9, 2004 the Securities and Exchange Commission (SEC) issued SEC
Staff Accounting Bulletin (SAB) No. 105 - Application Principles to Loan
Commitments. SAB No. 105 summarizes the views of the staff regarding the
application of generally accepted accounting principles to loan commitments
accounted for as derivitive instruments as required under the Financial
Accounting Standard Board Statement No. 133. Specifically SAB No. 105 states
that servicing assets and their associated income are to recognized at the
time the servicing asset is created either through securitization or sale,
and not upon the extension of a loan commitment which upon funding, will
either be sold or securitized. It is the Companny's policy to recognize
servicing assets and income only upon the sale of the underlying loan.
Note 5. Stock Option Plan
The Company has a stock option plan and continues to apply the intrinsic
value based method of accounting in accordance with Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees", and
related Interpretations. No stock-based employee compensation cost is
reflected in net income, as all stock options granted under the plan had an
exercise price equal to the market value of the underlying common stock on
the date of grant. Had compensation costs been determined on the
basis of fair value pursuant to FASB Statement No. 123, "Accounting for
Stock-Based Compensation", the effects on net income and earnings per
common share for the three months ended March 31 would have approximated:
8
(Dollars in thousands, except for per share data) 2004 2003
---- ----
Net Income as reported $1,274 $1,229
Deduct: Total stock-based compensation
expense determined under fair value based
method for all awards, net of related tax effects (5) (1)
------ ------
Pro forma net income $1,269 $1,228
====== ======
Earnings per common share:
As reported $ 0.28 $ 0.27
Pro forma $ 0.28 $ 0.27
Note 6 Defined Benefit Pension Plan
Union sponsors a non-contributory defined benefit pension plan covering all
eligible employees. The employees of the former Citizens which was merged
into Union in May 2003 became eligible to participate in the plan January
1, 2004. The plan provides defined benefits based on years of service and
final average salary.
Net periodic pension benefit for the three months ended, March 31, 2004 and
2003 consisted of the following components:
2004 2003
---- ----
Service cost $112,563 $ 75,358
Interest cost on projected benefit obligation 106,347 97,954
Expected return on plan assets (87,797) (73,756)
Amortization of prior service cost 1,540 1,540
Amortization of transition asset - (1,912)
Amortization of net loss 21,603 18,837
-------- --------
Net periodic benefit cost $154,256 $118,021
======== ========
Note 7. Comprehensive income
The components of other comprehensive income and related tax effects for
the three month period ended March 31, are as follows:
2004 2003
---- ----
(dollars in thousands)
Unrealized holding gains on available-for-sale securities $360 $140
Reclassification adjustment for losses (gains) realized in income (25) -
---- ----
Net unrealized gains 335 140
Tax effect 114 47
---- ----
Net of tax amount $221 $ 93
==== ====
9
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The following discussion and analysis focuses on those factors that had a
material effect on Union Bankshares, Inc.'s (the Company's) financial
position as of March 31, 2004 and as of December 31, 2003, and its results
of operations for the three months ended March 31, 2004 and 2003. This
discussion should be read in conjunction with the information in this
document under Financial Statements and related notes and with other
financial data appearing elsewhere in this filing. In the opinion of the
Company's management, the interim unaudited data reflects all adjustments,
consisting only of normal recurring adjustments, and disclosures necessary
to fairly present the Company's consolidated financial position and results
of operations to be expected for the interim period. Management is not
aware of the occurrence of any events after March 31, 2004, which would
materially affect the information presented.
The Company's common stock was listed on the American Stock Exchange on
July 13, 2000 with an opening price of $15.125 (pre-split of the 3 for 2
stock split of August 8, 2003) and it closed on March 31, 2004 at $24.95
and on May 6, 2004 at $23.95.
CAUTIONARY ADVICE ABOUT FORWARD LOOKING STATEMENTS
The Company may from time to time make written or oral statements that are
considered "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements may
include financial projections, statements of plans and objectives for
future operations, estimates of future economic performance and assumptions
relating thereto. The Company may include forward-looking statements in its
filings with the Securities and Exchange Commission, in its reports to
stockholders, including this Quarterly Report, in other written materials,
and in statements made by senior management to analysts, rating agencies,
institutional investors, representatives of the media and others.
Forward-looking statements reflect management's current expectations and
are subject to uncertainties, both general and specific, and risk exists
that those predictions, forecasts, projections and other estimates
contained in forward-looking statements will not be achieved. Also when we
use any of the words "believes," "expects," "anticipates," "intends,"
"plans," "seeks," "estimates" or similar expressions, we are making
forward-looking statements. Many possible events or factors, including
those beyond the control of management, could affect the future financial
results and performance of our Company. This could cause results or
performance to differ materially from those expressed in our forward-
looking statements. The possible events or factors that might affect our
forward-looking statements include, but are not limited to, the following:
* uses of monetary, fiscal and tax policy by various governments
* political, legislative or regulatory developments in Vermont, New
Hampshire or the United States including changes in laws concerning
accounting, taxes, banking and other aspects of the financial
services industry
* developments in general economic or business conditions, including
interest rate fluctuations, market fluctuations and perceptions, and
inflation and their effect on the Company or its customers
* changes in the competitive environment for financial services
organizations
* the Company's ability to retain key personnel
* changes in technology including demands for greater automation
* acts of terrorism or war
* adverse changes in the securities market
* unanticipated lower revenues, loss of customers or business or higher
operating expenses
10
* the failure of assumptions underlying the establishment of reserves
for loan losses and estimations of values of collateral and various
financial assets and liabilities
* the amount that we invest in new business opportunities and the
timing of these investments
When evaluating forward-looking statements to make decisions with respect
to the Company, investors and others are cautioned to consider these and
other risks and uncertainties and are reminded not to place undue reliance
on such statements. Forward-looking statements speak only as of the date
they are made and the Company undertakes no obligation to update them to
reflect new or changed information or events, except as may be required by
federal securities laws.
CRITICAL ACCOUNTING POLICIES
The Company has established various accounting policies which govern the
application of accounting principles generally accepted in the United
States of America in the preparation of the Company's financial statements.
Certain accounting policies involve significant judgments and assumptions
by management which have a material impact on the reported amount of
assets, liabilities, revenues and expenses and related disclosures of
contingent assets and liabilities in the consolidated financial statements
and related notes. The Securities and Exchange Commission has defined a
company's critical accounting policies as the ones that are most important
to the portrayal of the company's financial condition and results of
operations, and which require the company to make its most difficult and
subjective judgments, often as a result of the need to make estimates of
matters that are inherently uncertain. Based on this definition, we have
identified the accounting policies and judgments most critical to the
Company. The judgments and assumptions used by management are based on
historical experience and other factors, which are believed to be
reasonable under the circumstances. Because of the nature of the judgments
and assumptions made by management, actual results could differ from these
judgments and estimates that could have a material impact on the carrying
values of assets and liabilities and the results of operations of the
Company. The Company believes the allowance for loan losses is a critical
accounting policy that requires the most significant judgments and
estimates used in the preparation of its consolidated financial statements.
In estimating the allowance for loan losses, management utilizes historical
experience as well as other factors including the effect of changes in the
local real estate market on collateral values, the effect on the loan
portfolio of current economic indicators and their probable impact on
borrowers and changes in delinquent, nonperforming or impaired loans.
Changes in these factors may cause management's estimate of the allowance
to increase or decrease and result in adjustments to the Company's
provision for loan losses. We also have other key accounting policies,
which involve the use of estimates, judgments and assumptions that are
significant to understanding our results. For additional information see
FINANCIAL CONDITION - Allowance for Loan Losses below. Although we believe
that our estimates, assumptions and judgments are reasonable, they are
based upon information presently available. Actual results may differ
significantly from these estimates under different assumptions, judgment or
conditions.
11
OVERVIEW
The Company's net income for the quarter ended March 31, 2004 was $1.27
million, compared with net income of $1.23 million for the first quarter
of 2003 or a 3.7% increase between years.
The Company's total assets shrank from $357 million at December 31, 2003 to
$350 million at March 31, 2004 which is normal seasonal run-off combined
with the sale of $7.3 million in loans held-for-sale to the secondary
market. Assets have grown 4.4% or $14.9 million since March 31, 2003.
The following per share information and key ratios depict several
measurements of performance or financial condition for or at the quarters
ending March 31, 2004 and 2003, respectively.
First Quarter First Quarter
2004 2003
------------- -------------
Return on average assets (ROA)(1) 1.46% 1.47%
Return on average equity (ROE)(1) 12.40% 12.66%
Net interest margin 5.15% 5.21%
Efficiency ratio 63.71% 63.64%
Net loan charge-offs to average loans 0.02% 0.00%
Allowance for loan losses to loans 1.19% 1.20%
Non-performing assets to total assets 1.03% 0.85%
Equity to assets 11.57% 11.45%
Total capital to risk assets 18.37% 18.75%
Book value per share $ 9.12 $ 8.71
Earnings per share $ .28 $ .27
Dividends paid per share $ .22 $ .20
Dividend payout ratio 78.57% 73.96%
Annualized
The prime rate was static throughout the first quarter of 2004 at 4.00% which
is the lowest it has been since 1959. The prime rate during the first quarter
of 2003 was 4.25%. The drop in the prime rate is partially responsible for
the 6 basis point drop in our Net Interest Margin as out variable rate loans
react more fully and quickly than our core deposit rates as we try to remain
focused on our community banking responsibilities.
RESULTS OF OPERATIONS
Net Interest Income. The largest component of the Company's operating
income is net interest income, which is the difference between interest and
dividend income received from interest-earning assets and the interest
expense paid on its interest-bearing liabilities. The Company's net
interest income increased by $81 thousand, or 2.1%, to $4.02 million for
the three months ended March 31, 2004, from $3.94 million for the three
months ended March 31, 2003. The net interest spread increased by 3 basis
points to 4.90% for the three months ended March 31, 2004, from 4.87% for
the three months ended March 31, 2003 as interest rates paid on liabilities
and earned on assets moved downward in response to earlier decreases in the
prime rate. The net interest margin for the 2004 period decreased 6 basis
points to 5.15% from the 2003 period at 5.21%. A decrease in prime rate is
not necessarily beneficial to Union in the near term, see "OTHER FINANCIAL
CONSIDERATIONS - Market Risk and Asset and Liability Management."
Yields Earned and Rates Paid. The following table shows, for the periods
indicated, the total amount of income recorded from interest-earning
assets, and the related average yields, the interest expense associated
with interest-bearing liabilities, expressed in dollars and average rates,
and the relative net interest spread and net interest margin. All yield and
rate information is calculated on an annualized
12
basis. Yield and rate information for a period is average information for
the period, and is calculated by dividing the annualized income or expense
item for the period by the average balances of the appropriate balance
sheet item during the period. Net interest margin is annualized net
interest income divided by average interest-earning assets. Nonaccrual
loans are included in asset balances for the appropriate periods, but
recognition of interest on such loans is discontinued and any remaining
accrued interest receivable is reversed, in conformity with federal
regulations. The yields, net interest spread and net interest margins
appearing in the following table have been calculated on a pre-tax basis:
Three months ended March 31,
2004 2003
------------------------------- -------------------------------
Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
------- -------- ------- ------- -------- -------
(dollars in thousands)
Average Assets:
Federal funds sold and
overnight deposits $ 2,851 $ 5 0.76% $ 8,652 $ 22 1.04%
Interest bearing deposits in banks 6,517 49 3.03% 5,054 47 3.74%
Investments (1), (2) 44,743 504 4.85% 44,684 543 5.10%
Loans, net (1), (3) 265,341 4,309 6.57% 253,329 4,529 7.32%
-------- ------ ---- -------- ------ ----
Total interest-earning assets (1) 319,452 4,867 6.21% 311,719 5,141 6.77%
Cash and due from banks 19,502 14,322
Premises and equipment 4,560 4,638
Other assets 6,605 7,834
-------- --------
Total assets $350,119 $338,513
======== ========
Average Liabilities and
Stockholders' Equity:
Now accounts $ 43,521 $ 43 0.40% $ 40,497 $ 62 0.63%
Savings and money market accounts 111,218 210 0.76% 107,507 292 1.10%
Time deposits 95,350 503 2.12% 101,333 760 3.04%
Borrowed funds 9,516 88 3.65% 7,315 85 4.70%
-------- ------ ---- -------- ------ ----
Total interest-bearing liabilities 259,605 844 1.31% 256,652 1,199 1.89%
Non-interest bearing deposits 46,152 39,458
Other liabilities 3,278 3,820
-------- --------
Total liabilities 309,035 299,930
Stockholders' equity 41,084 38,583
-------- --------
Total liabilities and
stockholders' equity $350,119 $338,513
======== ========
Net interest income $4,023 $3,942
====== ======
Net interest spread (1) 4.90% 4.87%
==== ====
Net interest margin (1) 5.15% 5.21%
==== ====
Average yield reported on a tax-equivalent basis.
The average balance of investments is calculated on the amortized
cost basis.
Includes loans held for sale and is net of unearned income and
allowance for loan losses.
Rate/Volume Analysis. The following table describes the extent to which
changes in interest rates and changes in volume of interest-earning assets
and interest-bearing liabilities have affected the Company's interest
income and interest expense during the periods indicated. For each category
of interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to:
* changes in volume (change in volume multiplied by prior rate);
* changes in rate (change in rate multiplied by current volume); and
13
* total change in rate and volume.
Changes attributable to both rate and volume including the extra day in
2004 due to leap year have been allocated proportionately to the change due
to volume and the change due to rate.
Three Months Ended March 31, 2004 Compared
to Three Months Ended March 31, 2003
Increase/(Decrease) Due to Change In
------------------------------------------
Volume Rate Net
------ ---- ---
(dollars in thousands)
Interest-earning assets:
Federal funds sold and overnight deposits $ (15) $ (2) $ (17)
Interest bearing deposits in banks 14 (12) 2
Investments 1 (40) (39)
Loans, net 247 (467) (220)
----- ----- -----
Total interest-earning assets 247 (521) (274)
Interest-bearing liabilities:
Now accounts 5 (24) (19)
Savings and money market accounts 11 (93) (82)
Time deposits (42) (215) (257)
Borrowed funds 27 (24) 3
----- ----- -----
Total interest-bearing liabilities 1 (356) (355)
----- ----- -----
Net change in net interest income $ 246 $(165) $ 81
===== ===== =====
Quarter Ended March 31, 2004 compared to Quarter Ended March 31, 2003.
Interest and Dividend Income. The Company's interest and dividend income
decreased by $274 thousand, or 5.3%, to $4.87 million for the three months
ended March 31, 2004, from $5.14 million for the three months ended March
31, 2003 in spite of average earning assets increasing by $7.7 million, or
2.5%, to $319.5 million for the three months ended March 31, 2004, from
$311.7 million for the three months ended March 31, 2003. The increase in
interest income resulting from the increase in average assets was more than
offset by the lower rates earned on these assets in 2004 versus 2003. Average
loans approximated $265.3 million for the three months ended March 31, 2004
up from $253.3 million for the three months ended March 31, 2003 or 4.7%. The
$1.6 million or 12.6% increase in construction loans, the $943 thousand or
5.0% increase in commercial loans, the $2.9 million or 22.7% increase in
loans to municipalities and the $16.2 million or 15.1% increase in
commercial real estate loans was partially offset by the $1.3 million or
12.7% decrease in personal loans and a $8.4 million, or 10.0% decrease in
residential real estate secured loans. There was $7.0 million of
residential real estate and $309 thousand of commercial real estate loans
sold during the first quarter of 2004 as management continued to manage
it's long term interest rate risk by utilizing the secondary market for
loan sales.
The average balance of investments (including mortgage-backed securities
and Federal Home Loan Bank of Boston stock) increased by only $59 thousand
to $44.74 million for the three months ended March 31, 2004, from $44.68
million for the three months ended March 31, 2003. The slight increase in
the investment portfolio in 2004 reflects the continuing growth in our loan
portfolio. The average level of federal funds sold and overnight deposits
decreased by $5.8 million or 67.0%, to $2.9 million for the three months
ended March 31, 2004, from $8.7 million for the three months ended March
31, 2003. The average balance in interest bearing deposits in banks
increased by $1.5 million to $6.5 million from $5.1 million, or 28.9%
increase. Interest income from non-loan instruments was $558 thousand for
2004 and $612 thousand for 2003 reflecting the decrease in yields and the
overall decrease in volume.
Interest Expense. The Company's interest expense decreased by $355
thousand, or 29.6%, to $844 thousand for the three months ended March 31,
2004 from $1.2 million for the three months ended March 31, 2003 in spite of
average interest-bearing liabilities increased by $3.0 million, or 1.2%, to
$259.6 million for the three months ended March 31, 2004, from $256.7 million
for the three months ended March
14
31, 2003. The increase in interest expense resulting from the increase in
interest-bearing liabilities was more than offset by the lower rates paid
in 2004 versus 2003. Average time deposits were $95.4 million for the three
months ended March 31, 2004 and $101.3 million for the three months ended
March 31, 2003, or a decrease of 5.9%. The average balances for money
market and savings accounts increased by $3.7 million, or 3.5% to $111.2
million for the three months ended March 31, 2004, from $107.5 million for
the three months ended March 31, 2003. The 7.5% or $3.0 million increase in
Now accounts brought the average balance up to $43.5 million from $40.5
million. Management believes that customers have maintained very liquid
positions during the last few years as they anticipate the interest rates
paid on all deposit instruments will rise.
The average balance on funds borrowed has increased from $7.3 million for
the three months ended March 31, 2003 to $9.5 million for the three months
ended March 31, 2004 as the Company's subsidiary took down a short term
Federal Home Loan Bank (FHLB) of Boston bullet advance of $3 million for
liquidity purposes, match funded a $475 thousand loan with a long term
amortizing advance and these were partially offset by continuing pay downs
on amortizing Federal Home Loan Bank advances.
Noninterest Income. The Company's noninterest income increased $47
thousand, or 5.1%, to $962 thousand for the three months ended March 31,
2004 from $915 thousand for the three months ended March 31, 2003. Trust
department income increased to $44 thousand for the three months of 2004
from $39 thousand in the same period of 2003 or a 12.8% increase primarily
due to the increase in the stock market since the majority of the fee
income is based on the market value of assets under management. There was a
gain on the sale of securities in 2004 as one security was sold. Gain on
sale of loans was stable between years at $180 thousand for 2004 and $182
thousand for 2003. Service fees (sources of which include, among others,
deposit and loan servicing fees, ATM fees, and safe deposit fees) were flat
between years and only increased by $2 thousand to $662 thousand for the
three months ended March 31, 2004, from $660 thousand for the three months
ended March 31, 2003. The main components of other income in both years are
net servicing rights on loans sold and the increase in the cash surrender
value of life insurance owned under the deferred compensation plan.
Noninterest Expense. The Company's noninterest expense increased $85
thousand, or 2.7%, to $3.2 million for the three months ended March 31,
2004, from $3.1 million for the three months ended March 31, 2003. Salaries
were steady between the two quarters at $1.4 million as the normal salary
growth of 2004 was masked by the 2003 first quarter accrual under a
separation agreement with the former president of Citizens Savings Bank &
Trust Company (Citizens). Pension and employee benefits increased $166
thousand, or 38.5%, to $597 thousand for the three months ended March 31,
2004, from $431 thousand for the three months ended March 31, 2003 mainly
due to an $104 thousand increase in health insurance expense between years
and a $58 thousand increase in pension plan costs as all the former eligible
Citizens employees became eligible for the Unon Bank Defined Benefit Pension
Plan effective January 1, 2004. Net occupancy expense increased $4 thousand,
or 2.1%, to $192 thousand for the three months ended March 31, 2004, from
$188 thousand for the three months ended March 31, 2003. Equipment expense
decreased $12 thousand or 5.1% to $220 thousand for the three months ended
March 31, 2004, from $232 thousand for the same period in 2002 reflecting
savings from the merger of the two banks which was effective May 16, 2003.
Net operation of other real estate owned was $15 thousand for the three
months ended March 31, 2004 compared to $70 thousand for the same period in
2003. Other operating expenses were down $15 thousand or 2.0% to $743
thousand for the first three months of 2004 compared to $758 thousand for
the same period in 2003 as the first quarter of 2003 included $61 thousand
of costs associated with assimilating Citizens into Union Bank.
Income Tax Expense. The Company's income tax expense increased by $40
thousand, or 8.1%, to $535 thousand for the three months ended March 31,
2004, from $495 thousand for the comparable period of 2003, mainly due to
increased net taxable income.
15
FINANCIAL CONDITION
At March 31, 2004, The Company had total consolidated assets of $350.1
million, including net loans and loans held for sale of $264.8 million,
deposits of $294.5 million and stockholders' equity of $41.5 million. The
Company's total assets decreased by $6.5 million or 1.8% to $350.0 million
at March 31, 2004 from $356.6 million at December 31, 2003 which is part of
the seasonality of our business and reflective of the sale of loans
totaling $7.3 million during the first quarter of 2004. Total net loans and
loans held for sale decreased by $3.7 million or 1.4% to $264.8 million or
75.6% of total assets at March 31, 2004 as compared to $268.5 million or
75.3% of total assets at December 31, 2003. Cash and cash equivalents,
including federal funds sold and overnight deposits, decreased $1.6 million
or 6.3% to $23.0 million at March 31, 2004 from $24.5 million at December
31, 2003.
Securities available-for-sale decreased from $44.4 million at December 31,
2003 to $43.3 million at March 31, 2004, a $1.0 million or 2.3% decrease.
Securities maturing have not been replaced dollar for dollar in order to
fund loan demand, our decision to currently hold in portfolio a portion of
loans held-for-sale, and a seasonal decrease in our deposits.
Deposits decreased $10.8 million or 3.6% to $294.5 million at March 31,
2004 from $305.4 million at December 31, 2003 which is a seasonal
fluctuation (See average balances in the Yields Earned and Rates Paid table
on Page 12). Total borrowings increased $3.1 million to $10.3 million at
March 31, 2004 from $7.2 million at December 31, 2003 as we took down $3
million in a short term advance to fund liquidity needs and a $475 thousand
amortizing advance to match funding on a particular loan which were offset
by continuing pay downs of older amortizing Federal Home Loan Bank
advances.
Loan Portfolio. The Company's loan portfolio (including loans held for
sale) primarily consists of adjustable-rate and fixed-rate mortgage loans
secured by one-to-four family, multi-family residential or commercial real
estate. As of March 31, 2004, the Company's gross loan portfolio totaled
$268.0 million, or 76.6%, of assets, of which $113.0 million, or 42.2% of
gross loans, consisted of residential mortgages and construction loans, and
$108.8 million, or 40.5%, of total loans consisted of commercial real
estate loans. As of such date, the Company's loan portfolio also included
$21.5 million of commercial loans, $15.7 million of municipal loans, and
$9.1 million of consumer loans representing, in order, 8.0%, 5.9% and 3.4%
of total loans outstanding on March 31, 2004.
Gross loans and loans held for sale have decrease $3.7 million or 1.4% since
December 31, 2003. An increase of $4.1 million or 4.0% in commercial real
estate loans, an increase of $3.4 million or 19.3% in commercial loans, and
an increase in municipal loans of $384 thousand or 2.5% was partially offset
by a decrease of $7.3 million or 6.7% in residential real estate loans, a
decrease of $4.1 million or 21.9% in loans held for sale and a $332 thousand
or 3.5% decrease in consumer loans. The Company sold $7.3 million of loans
held for sale during the first quarter of 2004.
The following table shows information on the composition of the Company's
loan portfolio as of March 31, 2004 and December 31, 2003:
Loan Type March 31, 2004 December 31, 2003
- --------- ----------------- -----------------
(dollars in thousands)
Real Estate $100,964 37.7% $108,231 39.8%
Commercial real estate 106,495 39.7% 102,366 37.7%
Commercial 21,325 7.9% 17,877 6.6%
Consumer 9,070 3.4% 9,402 3.5%
Municipal loans 15,730 5.9% 15,346 5.6%
Loans held for sale 14,459 5.4% 18,524 6.8%
-------- ----- -------- -----
Total loans 268,043 100.0% 271,746 100.0%
Deduct:
Allowance for loan losses (3,019) (3,029)
Net deferred loan fees, premiums & discounts (197) (185)
-------- --------
$264,827 $268,532
======== ========
16
The Company originates and sells residential mortgages into the secondary
market, with most such sales made to the Federal Home Loan Mortgage
Corporation (FHLMC) and the Vermont Housing Finance Agency (VHFA). Management
expects to continue to use this strategy in an effort to protect our interest
margin from the effect of making long term loans in a historically low
interest rate environment. The Company services a $168.2 million residential
mortgage portfolio, approximately $67.2 million of which is serviced for
unaffiliated third parties at March 31, 2004. Additionally, the Company
originates commercial real estate and commercial loans under various SBA
programs that provide an agency guarantee for a portion of the loan amount.
The Company occasionally sells the guaranteed portion of the loan to other
financial concerns and will retain servicing rights, which generates fee
income. The Company serviced $6.3 million of commercial and commercial real
estate loans for unaffiliated third parties as of March 31, 2004. The
Company capitalizes servicing rights on these fees and recognizes gains and
losses on the sale of the principal portion of these loans as they occur.
The unamortized balance of servicing rights on loans sold with servicing
retained was $292 thousand at March 31, 2004 with an estimated market value
that exceeded the book value.
In the ordinary course of business, the Company occasionally participates
out a portion of commercial/commercial real estate loans to other financial
institutions for liquidity or credit concentration management purposes. The
total of loans participated out as of March 31, 2004 was $5.9 million.
Asset Quality. The Company, like all financial institutions, is exposed to
certain credit risks including those related to the value of the collateral
that secures its loans and the ability of borrowers to repay their loans.
Management closely monitors the Company's loan and investment portfolios
and other real estate owned for potential problems on a periodic basis and
reports to the Company's and the subsidiary's Boards of Directors at
regularly scheduled meetings.
The Company's loan review procedures include a credit quality assurance
process that begins with approval of lending policies and underwriting
guidelines by the Board of Directors, a loan review department, low
individual lending limits for officers, Board approval for large credit
relationships and a quality control process for loan documentation that
includes post-closing reviews. The Company also maintains a monitoring
process for credit extensions. The Company performs periodic concentration
analyses based on various factors such as industries, collateral types,
large credit sizes and officer portfolio loads. The Company has established
underwriting guidelines to be followed by its officers. The Company
monitors its delinquency levels for any negative or adverse trends. The
Company continues to invest in its loan portfolio monitoring system to
enhance its risk management capabilities. There can be no assurance,
however, the Company's loan portfolio will not become subject to increasing
pressures from deteriorating borrower credit due to general or local
economic conditions.
Loans on which the accrual of interest has been discontinued are designated
as nonaccrual loans. Loans are designated as nonaccrual when reasonable
doubt exists as to the full collection of interest and principal. Normally,
when a loan is placed on nonaccrual status, all interest previously accrued
but not collected is reversed against current period interest income.
Income on such loans is then recognized only to the extent that cash is
received and where the future collection of interest and principal is
probable. Interest accruals are resumed on such loans only when they are
brought fully current with respect to interest and principal and when, in
the judgment of management, the loans are estimated to be fully collectible
as to both principal and interest.
The Company had loans on nonaccrual status totaling $1.4 million or 0.53%
of gross loans at March 31, 2004, $1.6 million or 0.58% at December 31,
2003 and $1.8 million or 0.75% at March 31, 2003. The aggregate interest
income not recognized on such nonaccrual loans amounted to approximately
$412 thousand and $380 thousand as of March 31, 2004 and 2003, respectively
and $393 thousand as of December 31, 2003.
The Company had $2.0 million and $1.7 million in loans past due 90 days or
more and still accruing at March 31, 2004 and December 31, 2003,
respectively. At March 31, 2004, the Company had internally classified
certain loans totaling $1.9 million and $1.7 million at December 31, 2003.
In management's
17
view, such loans represent a higher degree of risk and could become
nonperforming loans in the future.
While still on a performing status, in accordance with the Company's credit
policy, loans are internally classified when a review indicates any of the
following conditions makes the likelihood of collection uncertain:
* the financial condition of the borrower is unsatisfactory;
* repayment terms have not been met;
* the borrower has sustained losses that are sizable, either in
absolute terms or relative to net worth;
* confidence is diminished;
* loan covenants have been violated;
* collateral is inadequate; or
* other unfavorable factors are present.
At March 31, 2004, the Company had acquired by foreclosure or through
repossession real estate worth $210 thousand, consisting of one commercial
property and one piece of undeveloped land. The balance at December 31,
2003 was $10 thousand.
Allowance for Loan Losses. Some of the Company's loan customers ultimately
do not make all of their contractually scheduled payments, requiring the
Company to charge off a portion or all of the remaining principal balance
due. The Company maintains an allowance for loan losses to absorb such
losses. The allowance for loan losses is maintained at a level which, in
management's judgment, is adequate to absorb credit losses inherent in the
loan portfolio; however, actual loan losses may vary from current
estimates. The amount of the allowance is based on management's evaluation
of the collectibility of the loan portfolio, including the composition of
the portfolio, growth of the portfolio, credit concentrations, trends in
historical loss experience, delinquency and past due trends, specific
impaired loans, and economic conditions. Allowances for impaired loans are
generally determined based on collateral values or the present value of
estimated cash flows. The allowance is increased by a provision for loan
losses, which is charged to expense and reduced by charge-offs, net of
recoveries. The provision for loan losses represents the current period
credit cost associated with maintaining an appropriate allowance for loan
losses. While the Company allocates the allowance for loan losses based
on the percentage category to total loans, the portion of the allowance for
loan losses allocated to each category does not represent the total
available for future losses which may occur within the loan category since
the total allowance for possible loan losses is a valuation reserve
applicable to the entire portfolio. Based on an evaluation of the loan
portfolio, management presents a quarterly analysis of the allowance for
loan losses to the Board of Directors, indicating any changes in the
allowance since the last review and any recommendations as to adjustments
in the allowance.
For the quarter ended March 31, 2004, the methodology used to determine the
provision for loan losses was unchanged from the prior year. The
composition of the Company's loan portfolio remained relatively unchanged
from December 31, 2003 and there was no material change in the lending
programs or terms during the quarter.
18
The following table reflects activity in the allowance for loan losses for
the three months ended March 31, 2004 and 2003:
3 Months Ended, March 31,
-------------------------
2004 2003
---- ----
(dollars in thousands)
Balance at the beginning of period $3,029 $2,908
Charge-offs:
Real Estate 26 -
Commercial - 10
Consumer and other 4 18
------ ------
Total charge-offs 30 28
------ ------
Recoveries:
Real Estate - -
Commercial 3 16
Consumer and other 17 17
------ ------
Total recoveries 20 33
------ ------
Net (charge-offs) recoveries (10) 5
Provision for loan losses - 42
------ ------
Balance at end of period $3,019 $2,955
====== ======
The following table shows the breakdown of the Company's allowance for loan
loss by category of loan (net of loans held for sale) and the percentage of
loans in each category to total loans in the respective portfolios at the
dates indicated:
March 31, December 31,
2004 2003
----------------- -----------------
(dollars in thousands)
Amount Percent Amount Percent
------ ------- ------ -------
Real Estate
Residential $ 528 31.9% $ 525 31.9%
Commercial 1,705 42.0% 1,578 42.7%
Construction 166 6.6% 183 7.2%
Other Loans
Commercial 382 8.4% 336 7.1%
Consumer installment 140 3.6% 145 3.7%
Home equity loans 25 1.3% 25 1.3%
Municipal, Other and
Unallocated 73 6.2% 237 6.1%
------ ----- ------ -----
Total $3,019 100.0% $3,029 100.0%
====== ===== ====== =====
Ratio of Net Charge Offs to
Average Loans not held
for sale (1) 0.02% 0.00%
----- -----
Ratio of Allowance for Loan
Losses to Loans not held
for sale 1.19% 1.20%
----- -----
Annualized
Management of the Company believes that the allowance for loan losses at
March 31, 2004 is adequate to cover losses inherent in the Company's loan
portfolio as of such date. However there can be no
19
assurance that the Company will not sustain losses in future periods, which
could be greater than the size of the allowance at March 31, 2004. See
CRITICAL ACCOUNTING POLICIES.
While the Company recognizes that any economic slowdown may adversely
impact its borrowers' financial performance and ultimately their
ability to repay their loans, management continues to be cautiously
optimistic about the key credit indicators from the Company's loan
portfolio.
Investment Activities At March 31, 2004 the reported value of investment
securities available-for-sale was $43.3 million or 12.4% of its assets. The
Company had no securities classified as held-to-maturity or trading
securities. The reported value of securities available-for-sale at March
31, 2004, reflects a positive valuation adjustment of $1.5 million. The
offset of this adjustment, net of income tax effect, was a $982 thousand
increase in the Company's other comprehensive income component of
stockholders' equity and a decrease in net deferred tax assets of $506
thousand.
At December 31, 2003, the Company had one debt security and two equity
securities with a fair value of $662 thousand that had unrealized losses
of $55 thousand that had existed for more than 12 months. Those same three
securities are still in a loss position as of March 31, 2004 but their
market value has increased to $670 thousand and the unrealized loss is now
$47 thousand. Management believes that the trend in market value will
continue to improve and has not identified any credit issues that would
lead us to believe that the decline in market value is other than temporary.
Deposits. The following table shows information concerning the Company's
average deposits by account type, and the weighted average nominal rates at
which interest was paid on such deposits for the periods ending March 31, 2004
and December 31, 2003:
Three Months Ended, March 31, Year Ended December 31,
2004 2003
------------------------------- -------------------------------
(dollars in thousands)
Percent Percent
Average Of Total Average Average of Total Average
Amount Deposits Rate Amount Deposits Rate
------- -------- ------- ------- -------- -------
Non-time deposits:
Demand deposits $ 46,152 15.6% $ 42,341 14.4%
Now accounts 43,521 14.7% 0.40% 43,349 14.7% 0.51%
Money Markets 64,967 21.9% 0.86% 64,417 21.9% 1.05%
Savings 46,251 15.6% 0.62% 44,574 15.2% 0.81%
-------- ------ -------- ------
Total non-time deposits: 200,891 67.8% 194,681 66.2%
-------- ------ -------- ------
Time deposits:
Less than $100,000 66,133 22.3% 2.11% 72,084 24.5% 2.70%
$100,000 and over 29,217 9.9% 2.14% 27,348 9.3% 2.43%
-------- ------ -------- ------
Total time deposits 95,350 32.2% 99,432 33.8%
-------- ------ -------- ------
Total deposits $296,241 100.00% 1.03% $294,113 100.00% 1.31%
======== ====== ==== ======== ====== ====
20
The following table sets forth information regarding the amounts of the
Company's time deposits in amounts of $100,000 or more at March 31, 2004
and December 31, 2003 that mature during the periods indicated:
March 31, 2004 December 31, 2003
-------------- -----------------
(dollars in thousands)
Within 3 months $14,806 $ 9,399
3 to 6 months 1,518 16,264
6 to 12 months 3,975 3,820
Over 12 months 4,436 379
------- -------
$24,735 $29,862
======= =======
Borrowings. Borrowings from the Federal Home Loan Bank of Boston (FHLB) were
$10.3 million at March 31, 2004 at a weighted average rate of 3.58%.
Borrowings from the FHLB of Boston were $7.2 million at December 31, 2003 at
a weighted average rate of 4.43%. The change between year end 2003 and the
end of the first quarter of 2004 is a net increase of $3.1 million which
was comprised of borrowing $3 million for short term liquidity needs, $475
thousand in a long term amortizer advance to match funding on a new loan
and offset by continuing paydowns on amortizing advances.
OTHER FINANCIAL CONSIDERATIONS
Market Risk and Asset and Liability Management. Market risk is the risk of
loss in a financial instrument arising from adverse changes in market
prices and rates, foreign currency exchange rates, commodity prices and
equity prices. The Company's market risk arises primarily from interest
rate risk inherent in its lending, investing and deposit taking activities
as yields on assets change in a different time period or in a different
amount from that of interest costs on liabilities. Many other factors also
affect the Company's exposure to changes in interest rates, such as general
economic and financial conditions, competitive pressures, customer
preferences, and historical pricing relationships.
The earnings of the Company and its principal subsidiary are affected not
only by general economic conditions, but also by the monetary and fiscal
policies of the United States and its agencies, particularly the Federal
Reserve System. The monetary policies of the Federal Reserve System
influence to a significant extent the overall growth of loans, investments
and deposits; the level of interest rates earned on assets and paid for
liabilities; and interest rates charged on loans and paid on deposits. The
nature and impact of future changes in monetary policies are often not
predictable.
A key element in the process of managing market risk involves direct
involvement by senior management and oversight by the Board of Directors as
to the level of risk assumed by the Company in its balance sheet. The Board
of Directors reviews and approves risk management policies, including risk
limits and guidelines and reviews quarterly our current position in
relationship to those limits and guidelines. Daily oversight functions are
delegated to the Asset Liability Management Committee ("ALCO"). The ALCO,
consisting of senior business and finance officers, actively measures,
monitors, controls and manages its interest rate risk exposure that can
significantly impact the Company's financial position and operating results.
The Company does not have any market risk sensitive instruments acquired
for trading purposes. The Company attempts to structure its balance sheet
to maximize net interest income and shareholder value while controlling its
exposure to interest rate risk. The ALCO formulates strategies to manage
interest rate risk by evaluating the impact on earnings and capital of such
factors as current interest rate forecasts and economic indicators,
potential changes in such forecasts and indicators, liquidity, and various
business strategies. The ALCO's methods for evaluating interest rate risk
include an analysis of the Company's interest-rate sensitivity "gap", which
provides a static analysis of the maturity and repricing characteristics of
the Company's entire balance sheet, and a simulation analysis, which
calculates projected net interest income based on alternative balance sheet
and interest rate
21
scenarios, including "rate shock" scenarios involving immediate substantial
increases or decreases in market rates of interest.
The Company's ALCO meets weekly to set loan and deposit rates, make
investment decisions, monitor liquidity and evaluate the loan demand
pipeline. Deposit runoff is monitored daily and loan prepayments evaluated
monthly. The Company historically has maintained a substantial portion of
its loan portfolio on a variable rate basis and plans to continue this
Asset/Liability Management (ALM) strategy in the future. Portions of the
variable rate loan portfolio have interest rate floors and caps which are
taken into account by the Company's ALM modeling software to predict
interest rate sensitivity, including prepayment risk. The investment
portfolio is all classified as available-for-sale and the modified duration
is relatively short. The Company does not utilize any derivative products or
invest in any "high risk" instruments.
The Company's interest rate sensitivity analysis (simulation) as of December
2003 for a flat rate environment projected a Net Interest Income of $3.906
million for the first three months of 2004 compared to actual results of
$4.023 million in a flat rate environment, or a 3% difference. Net income
was projected to be $1.248 million in a flat rate environment compared to
actual results of $1.274 million. Return on Assets was projected to be
1.45% in a flat rate environment and actual results were 1.46%. Return on
Equity was projected to be 12.67% in a flat rate environment compared to
actual of 12.40%.
Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements. The
Company is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers
and to reduce its own exposure to fluctuations in interest rates. These
financial instruments include commitments to extend credit, standby letters
of credit, interest rate caps and floors written on adjustable rate loans,
commitments to participate in or sell loans and commitments to buy or sell
securities. Such instruments involve, to varying degrees, elements of credit
and interest rate risk in excess of the amount recognized in the balance
sheet.
The Company generally requires collateral or other security to support
financial instruments with credit risk. As of March 31, 2004, the contract
or notional amount of financial instruments whose contract or notional
amount represents credit risk were as follows rounded to the nearest
thousand:
Commitments to extend credit $30,366
-------
Standby letters of credit $ 985
-------
Credit Card arrangements $ 2,324
=======
Home Equity Lines of Credit $ 4,762
-------
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee.
The Company's contractual obligations at March 31, 2004 are substantially
unchanged from December 31, 2003 with the exception of the change in balances
in the deposits and borrowings which are discussed in the "Financial
Condition" section earlier.
Interest Rate Sensitivity "Gap" Analysis. An interest rate sensitivity
"gap" is defined as the difference between interest-earning assets and
interest-bearing liabilities maturing or repricing within a given time
period. A gap is considered positive when the amount of interest rate
sensitive assets exceeds the amount of interest rate sensitive liabilities.
A gap is considered negative when the amount of interest rate sensitive
liabilities exceeds the amount of interest rate sensitive assets. During a
period of rising interest rates, a negative gap would tend to adversely
affect net interest income, while a positive gap would tend to result in an
increase in net interest income. During a period of falling interest rates,
a negative gap would tend to result in an increase in net interest income,
while a positive gap would tend to affect net interest income adversely.
Because different types of assets and liabilities with the same or similar
maturities may react differently to changes in overall market interest
rates or conditions, changes in interest rates may affect net interest
income positively or negatively even if an institution were perfectly
matched in each maturity category.
22
The Company prepares its interest rate sensitivity "gap" analysis by
scheduling interest-earning assets and interest-bearing liabilities into
periods based upon the next date on which such assets and liabilities could
mature or reprice. The amounts of assets and liabilities shown within a
particular period were determined in accordance with the contractual terms
of the assets and liabilities, except that:
* adjustable-rate loans, securities, and FHLB advances are included in
the period when they are first scheduled to adjust and not in the
period in which they mature;
* fixed-rate mortgage-related securities and loans reflect estimated
prepayments, which were estimated based on analyses of broker
estimates, the results of a prepayment model utilized by the Company,
and empirical data;
* other non-mortgage-related fixed-rate loans reflect scheduled
contractual amortization, with no estimated prepayments; and
* Now, money markets, and savings deposits, which do not have
contractual maturities, reflect estimated levels of attrition, which
are based on detailed studies by the Company of the sensitivity of
each such category of deposit to changes in interest rates.
Management believes that these assumptions approximate actual experience
and considers them reasonable. However, the interest rate sensitivity of
the Company's assets and liabilities in the tables could vary substantially
if different assumptions were used or actual experience differs from the
historical experience on which the assumptions are based.
23
The following table shows the Company's rate sensitivity analysis as of
March 31, 2004:
March 31, 2004
Cumulative repriced within
3 Months 4 to 12 1 to 3 3 to 5 Over 5
or Less Months Years Years Total Total
-------- ------- ------ ------ ------ -----
(dollars in thousands, by repricing date)
Interest sensitive assets:
Federal funds sold
overnight deposits $ 2,762 $ - $ - $ - $ - $ 2,762
Interest bearing deposits in banks 787 1,863 2,260 1,179 232 6,321
Securities available-for-sale (1) 2,338 7,825 13,644 8,188 10,233 42,228
FHLB Stock - - - - 1,241 1,241
Loans and loans held for sale (2) 116,098 47,995 54,666 31,747 17,340 267,846
-------- ------- ------- ------- -------- --------
Total interest sensitive assets $121,985 $57,683 $70,570 $41,114 $ 29,046 $320,398
======== ======= ======= ======= ======== ========
Interest sensitive liabilities:
Time deposits $ 29,741 $36,180 $23,163 $ 2,795 - $ 91,879
Money markets 9,253 - - - 56,905 66,158
Regular savings 12,775 - - - 35,046 47,821
NOW accounts 18,448 - - - 23,046 41,494
Borrowed funds (3) 328 4,007 2,860 3,132 - 10,327
-------- ------- ------- ------- -------- --------
Total interest sensitive liabilities $ 70,545 $40,187 $26,023 $ 5,927 $114,997 $257,679
======== ======= ======= ======= ======== ========
Net interest rate sensitivity gap 51,440 17,496 44,547 35,187 (85,951) 62,719
Cumulative net interest rate
sensitivity gap 51,440 68,936 113,483 148,670 62,719
Cumulative net interest rate
sensitivity gap as a
percentage of total assets 14.69% 19.69% 32.42% 42.47% 17.92%
Cumulative net interest rate sensitivity
gap as a percentage of total
interest-sensitive assets 16.06% 21.52% 35.42% 46.40% 19.58%
Cumulative net interest rate sensitivity
gap as a percentage of total
interest-sensitive liabilities 19.96% 26.75% 44.04% 57.70% 24.34%
Securities available-for-sale exclude marketable equity securities
with a fair value of $1.1 million that may be sold by the Company
at any time.
Balances shown net of unearned income of $197 thousand.
Estimated repayment assumptions considered in Asset/Liability model.
Simulation Analysis. In its simulation analysis, the Company uses computer
software to simulate the estimated impact on net interest income and
capital (Net Fair Value) under various interest rate scenarios, balance
sheet trends, and strategies. These simulations incorporate assumptions
about balance sheet dynamics such as loans and deposit growth, product
pricing, prepayment speeds on mortgage related assets and principal
maturities on other financial instruments, and changes in funding mix.
While such assumptions are inherently uncertain as actual rate changes
rarely follow any given forecast and asset-liability pricing and other
model inputs usually do not remain constant in their historical
relationships, management believes that these assumptions are reasonable.
Based on the results of these simulations, the Company is able to quantify
its estimate of interest rate risk and develop and implement appropriate
strategies.
The following chart reflects the results of our latest simulation analysis
for each of the next two year ends on Net Interest Income, Net Income,
Return on Assets, Return on Equity and Net Fair Value Ratio. The projection
utilizes a rate shock of up 300 basis points and down 100 basis points from
the current prime
24
rate of 4.00%, this rise is the highest internal slope monitored and down
100 basis points was chosen as with the current historic low level of
interest rates the potential for interest-bearing deposit accounts to
respond to further drops in projected rates is limited, therefore
calculations for rate decreases greater than 100 basis points would have
been misleading. This slope range was determined to be the most relevant
during this economic cycle.
UNION BANKSHARES, INC.
INTEREST RATE SENSITIVITY ANALYSIS MATRIX
MARCH 31, 2004
(in thousands)
Return Return
on on Net Fair
Year Prime Net Interest Change Net Assets Equity Value
Ending Rate Income % Income % % Ratio
------ ----- ------------ ------ ------ ------ ------ --------
December-04 7.00 18,226 14.00 6,625 1.87 16.10 7.46
4.00 15,987 0.00 5,123 1.45 12.63 11.45
3.00 15,164 (5.15) 4,572 1.29 11.33 12.52
December-05 7.00 20,920 27.25 8,459 2.31 18.84 7.55
4.00 16,440 0.00 5,455 1.50 13.00 11.52
3.00 14,784 (10.70) 4,347 1.20 10.64 12.76
The resulting effect of these estimates on Net Interest Income and the Net
Fair Value Ratio for December 31, 2004 are within the approved ALCO
guidelines. The simulations of earnings do not incorporate any management
actions, which might moderate the negative consequences of interest rate
deviations. Therefore, they do not reflect likely actual results, but serve
as conservative estimates of interest rate risk.
Liquidity. Managing liquidity risk is essential to maintaining both
depositor confidence and stability in earnings. Liquidity is a measurement
of the Company's ability to meet potential cash requirements, including
ongoing commitments to fund deposit withdrawals, repay borrowings, fund
investment and lending activities, and for other general business purposes.
The Company's principal sources of funds are deposits, amortization and
prepayment of loans and securities, maturities of investment securities and
other short-term investments, sales of securities and loans available-for-
sale, and earnings and funds provided from operations. Maintaining a
relatively stable funding base, which is achieved by diversifying funding
sources, competitively pricing deposit products, and extending the
contractual maturity of liabilities, reduces the Company's exposure to roll
over risk on deposits and limits reliance on volatile short-term purchased
funds. Short-term funding needs arise from declines in deposits or other
funding sources, funding of loan commitments and request for new loans. The
Company's strategy is to fund assets to the maximum extent possible with
core deposits that provide a sizable source of relatively stable and low-
cost funds.
In addition, as Union Bank is a member of the FHLB of Boston, it has access
to pre-approved lines of credit up to 4.1% of total assets. Union Bank
maintains a $4 million pre-approved Federal Fund line of credit with an
upstream correspondent bank and a repurchase agreement line with a selected
brokerage house, there were no balances outstanding on either.
While scheduled loan and securities payments and FHLB advances are
relatively predictable sources of funds, deposit flows and prepayments on
loans and mortgage-backed securities are greatly influenced by
25
general interest rates, economic conditions, and competition. The Company's
liquidity is actively managed on a daily basis, monitored by the ALCO, and
reviewed periodically with the subsidiary's Board of Directors. The
Company's ALCO sets liquidity targets based on the Company's financial
condition and existing and projected economic and market conditions. The
committee measures the Company's marketable assets and credit available to
fund liquidity requirements and compares the adequacy of that aggregate
amount against the aggregate amount of the Company's sensitive or volatile
liabilities, such as core deposits and time deposits in excess of $100,000,
term deposits with short maturities, and credit commitments outstanding.
The committee's primary objective is to manage the Company's liquidity
position and funding sources in order to ensure that it has the ability to
meet its ongoing commitment to its depositors, to fund loan commitments,
and to maintain a portfolio of investment securities. Since many of the
loan commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
The Company's management monitors current and projected cash flows and
adjusts positions as necessary to maintain adequate levels of liquidity.
Although approximately 72.4% of the Company's time deposits will mature
within twelve months, management believes, based upon past experience, that
Union Bank will retain a substantial portion of these deposits. Management
will continue to offer a competitive but prudent pricing strategy to
facilitate retention of such deposits. Any reduction in total deposits could
be offset by purchases of federal funds, short-term FHLB of Boston
borrowings, or liquidation of investment securities or loans held for sale.
Such steps could result in an increase in the Company's cost of funds and
adversely impact the net interest margin. Management believes the Company
has sufficient liquidity to meet all reasonable borrower, depositor, and
creditor needs in the present economic environment. However, any
projections of future cash need and flows are subject to substantial
uncertainty. We continually evaluate opportunities to buy/sell securities
and loans held-for-sale, obtain credit facilities from lenders, or
restructure our debt for strategic reasons or to further strengthen our
financial position.
Capital Resources. Our capital management is designed to maintain an
optimum level of capital in a cost-effective structure that: meets our
target regulatory ratios; supports our internal assessment of economic
capital; funds our business strategies; and builds long-term stockholder
value. In support of these goals a three-for-two stock split was declared
and effected in the form of a stock dividend payable August 8, 2003. The
information presented in the following paragraphs regarding our capital has
been retroactively adjusted to reflect the split.
The total dollar value of Union's stockholders' equity was $41.5 million at
March 31, 2004 reflecting net income of $1.27 million for the first three
months of 2004, less dividends paid of $1.00 million, compared to $41.0
million at year end 2003. Union Bankshares, Inc. has 5 million shares of
$2.00 par value common stock authorized. As of March 31, 2004, the Company
had 4,911,261 shares issued, of which 4,550,313 were outstanding and
360,948 were held in Treasury. Also as of March 31, 2004, there were
outstanding employee incentive stock options with respect to 16,925 shares
of the Company's common stock, granted pursuant to Union Bankshare's 1998
Incentive Stock Option Plan. Of the 75,000 shares authorized for issuance
under the 1998 Plan, 51,950 shares remain available for future option
grants.
On March 17, 2004, the Company terminated a stock repurchase program that
authorized the repurchase of up to 100,000 shares of common stock and that
had been open since October 17, 2001. Under the program the Company had
repurchased 6,672 shares, for a total cost of $129.5 thousand. No repurchases
had been made since 2001.
During the quarter ended March 31, 2004, the Compamy granted to certain
executive officers of Union Bankshares or it's subsidiary, Union Bank,
incentive stock options with respect to an aggregate of 3,250 shares of its
common stock, pursuant to its 1998 Incentive Stock Option Plan. The exercise
price of all such options represented the fair market value of the shares on
the date of grant. Participation in Union Bankshares' 1998 Incentive Stock
Option Plan is limited to those (currently 5 active participants) selected
by the Board. During the same period, no incentive stock options granted
pursuant to the 1998 plan were exercised.
26
Union Bank and Union Bankshares, Inc. are subject to various regulatory
capital requirements administered by the federal banking agencies.
Management believes, as of March 31, 2004 that they both meet all capital
adequacy requirements to which they are subject. As of March 31, 2004, the
most recent calculations categorize both as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as
well capitalized, the companies must maintain minimum total risk-based,
Tier I risk-based, and Tier I leverage ratios as set forth in the table
below. There are no conditions or events since the notification that
management believes have changed either companies' category.
Union Bank's and the Company's actual capital amounts and ratios as of
March 31, 2004 are presented in the table:
Minimums
To Be Well
Minimums Capitalized Under
For Capital Prompt Corrective
Actual Requirements Action Provisions
---------------- ---------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(dollars in thousands)
As of March 31, 2004:
Total capital to risk weighted assets
Union Bank $42,720 18.05% $18,934 8.0% $23,668 10.0%
Company 43,563 18.37% 18,971 8.0% 12,714 10.0%
Tier I capital to risk weighted assets
Union Bank $39,661 16.76% $ 9,466 4.0% $14,198 6.0%
Company 40,498 17.08% 9,484 4.0% 14,226 6.0%
Tier I capital to average assets
Union Bank $39,661 11.39% $13,928 4.0% $17,410 5.0%
Company 40,998 11.57% 14,174 4.0% N/A N/A
Impact of Inflation and Changing Prices. The Company's consolidated
financial statements, included in this document, have been prepared in
accordance with U.S. generally accepted accounting principles, which
require the measurements of financial position and results of operations in
terms of historical dollars, without considering changes in the relative
purchasing power of money over time due to inflation. Banks have asset and
liability structures that are essentially monetary in nature, and their
general and administrative costs constitute relatively small percentages of
total expenses. Thus, increases in the general price levels for goods and
services have a relatively minor effect on the Company's total expenses.
Interest rates have a more significant impact on the Company's financial
performance than the effect of general inflation and because of the uneven
nature of the expansion of the U.S. economy, the Federal Reserve has kept
overnight rates at 40 year lows. Interest rates do not necessarily move in
the same direction or change in the same magnitude as the prices of goods
and services, although periods of increased inflation may accompany a
rising interest rate environment.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Information called for by this item is incorporated by reference in
Management's Discussion and Analysis of Financial Condition and Results of
Operations under the titlement "OTHER FINANCIAL CONSIDERATIONS" on pages 20
through 25 in this Form 10-Q.
Item 4. Controls and Procedures.
The Company's chief executive officer and chief financial officer evaluated
the effectiveness of the design and operation of the Company's disclosure
controls and procedures (as defined in Rule 13a-15(e) under
27
the Exchange Act) as of the report date and concluded that those disclosure
controls and procedures are effective in alerting them in a timely manner
to material information about the Company and its consolidated subsidiary
required to be disclosed in the Company's periodic reports filed with the
Securities and Exchange Commission.
There have been no changes in the Company's internal controls or in other
factors known to the Company that could significantly affect these controls
subsequent to their evaluation. While the Company believes that its
existing disclosure controls and procedures have been effective to
accomplish these objectives, the Company intends to continue to examine,
refine and formalize its disclosure controls and procedures and to monitor
ongoing developments in this area.
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
There are no known pending legal proceedings to which the Company or its
subsidiary is a party, or to which any of their properties is subject,
other than ordinary litigation arising in the normal course of business
activities. Although the amount of any ultimate liability with respect to
such proceedings cannot be determined, in the opinion of management, based
upon the opinion of counsel, any such liability will not have a material
effect on the consolidated financial position of the Company and its
subsidiary.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
(b) Current Reports on Form 8-K
During 2004 the Company has filed 8-K reports relating to the following:
1. Report to Stockholders on First Quarter Results for 2004 filed
on April 27, 2004
2. Press Release announcing dividend declaration and first quarter
earnings for 2004 filed on April 15, 2004.
3. Union Bankshares, Inc. Company Overview dated December 31, 2003
and notification of the termination of the stock buyback
program filed on March 19, 2004.
4. Report to Stockholders on Fourth Quarter Results for 2003 filed
on January 28, 2004.
5. Press Release announcing dividend declaration and fourth
quarter earnings for 2003 filed on January 14, 2004.
28
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.
May 13, 2004 Union Bankshares, Inc.
s/ Kenneth D. Gibbons
---------------------
Kenneth D. Gibbons
Director, President and Chief
Executive Officer
s/ Marsha A. Mongeon
--------------------
Marsha A. Mongeon
Chief Financial Officer and Treasurer
(Principal Financial Officer)
EXHIBIT INDEX
31.1 Certification of the Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
29