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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: June 30, 2004
Commission file number: 001-15985
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 August 2, 2004:
Common Stock, $2 par value 4,551,213 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 30
Item 4. Controls and Procedures 31
PART II OTHER INFORMATION
Item 1. Legal Proceedings. 31
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases
of Equity Securities 31
Item 4. Submission of Matters to Vote of Security Holders 31
Item 6. Exhibits and Reports on Form 8-K 32
Signatures 32
2
Item 1. Financial Statements
Union Bankshares, Inc. and Subsidiary
Consolidated Balance Sheets
(Unaudited)
(Dollars in Thousands)
June 30, December 31,
2004 2003
---- ----
Assets
Cash and due from banks $ 14,851 $ 23,624
Federal funds sold and overnight deposits 234 916
-------- --------
Cash and cash equivalents 15,085 24,540
Interest bearing deposits in banks 6,514 6,520
Securities available-for-sale 46,252 44,370
Loans held for sale 12,521 18,524
Loans 253,771 253,222
Allowance for loan losses (3,023) (3,029)
Unearned net loan fees (193) (185)
-------- --------
Net loans 250,555 250,008
-------- --------
Accrued interest receivable 1,533 1,652
Premises and equipment, net 4,929 4,447
Other real estate owned 210 10
Other assets 6,485 6,486
-------- --------
Total assets $344,084 $356,557
======== ========
Liabilities and Stockholders' Equity:
Liabilities:
Deposits:
Non-interest bearing $ 47,852 $ 48,366
Interest bearing 239,139 257,016
-------- --------
Total deposits 286,991 305,382
Borrowed funds 13,035 7,223
Accrued interest and other liabilities 3,072 2,965
-------- --------
Total liabilities 303,098 315,570
-------- --------
Stockholders' Equity:
Common stock, $2 par value; 5,000,000 shares authorized;
4,911,861 shares issued at 6/30/04 and 4,911,261 issued
at 12/31/03 9,824 9,822
Paid-in capital 62 55
Retained earnings 32,648 32,071
Treasury stock at cost; 360,948 shares at 6/30/04
and 12/31/03 (1,722) (1,722)
Accumulated other comprehensive income 174 761
-------- --------
Total stockholders' equity 40,986 40,987
-------- --------
Total liabilities and stockholders' equity $344,084 $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 Six Months Ended
June 30, June 30,
---------------------- ----------------------
(Dollars in Thousands except Per Share Data) 2004 2003 2004 2003
---- ---- ---- ----
Interest income:
Interest and fees on loans $ 4,341 $ 4,573 $ 8,650 $ 9,102
Interest on debt securities
Taxable 432 390 866 851
Tax exempt 54 60 107 122
Dividends 15 15 32 34
Interest on federal funds sold and overnight deposits 7 25 12 48
Interest on interest bearing deposits in banks 53 46 102 93
--------- --------- --------- ---------
Total interest income 4,902 5,109 9,769 10,250
--------- --------- --------- ---------
Interest expense:
Interest on deposits 726 1,024 1,482 2,139
Interest on borrowed funds 91 87 179 172
--------- --------- --------- ---------
Total interest expense 817 1,111 1,661 2,311
--------- --------- --------- ---------
Net interest income 4,085 3,998 8,108 7,939
Provision for loan losses - 42 - 84
--------- --------- --------- ---------
Net interest income after provision for loan losses 4,085 3,956 8,108 7,855
--------- --------- --------- ---------
Noninterest income:
Trust income 47 42 91 80
Service fees 694 665 1,356 1,322
Net gains on sales of securities - - 25 -
Net gains on sales of loans held for sale 54 45 234 227
Other income 75 38 126 77
--------- --------- --------- ---------
870 790 1,832 1,706
--------- --------- --------- ---------
Noninterest expenses:
Salaries and wages 1,312 1,350 2,721 2,763
Pension and employee benefits 529 465 1,126 928
Occupancy expense, net 189 169 381 357
Equipment expense 221 217 441 447
Net operation of other real estate owned 20 10 35 79
Other expenses 878 882 1,621 1,609
--------- --------- --------- ---------
3,149 3,093 6,325 6,183
--------- --------- --------- ---------
Income before provision for income taxes 1,806 1,653 3,615 3,378
Provision for income taxes 501 464 1,036 960
--------- --------- --------- ---------
Net income $ 1,305 $ 1,189 $ 2,579 $ 2,418
========= ========= ========= =========
Earnings per common share $ 0.29 $ 0.26 $ 0.57 $ 0.53
========= ========= ========= =========
Weighted average number of common
shares outstanding 4,550,726 4,545,986 4,550,520 4,545,667
========= ========= ========= =========
Dividends per common share $ 0.22 $ 0.20 $ 0.44 $ 0.40
========= ========= ========= =========
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 - - 2,579 - - 2,579
Change in net unrealized gain (loss) on
securities available-for-sale, net
of reclassification adjustment and
tax effects - - - - (587) (587)
-------
Total Comprehensive income - - - - - 1,992
-------
Exercise of Stock Options 600 2 7 - - - 9
Cash dividends declared
($0.44 per share) - - (2,002) - - (2,002)
-----------------------------------------------------------------------------------
Balance June 30, 2004 4,550,913 $9,824 $62 $32,648 $(1,722) $ 174 $40,986
===================================================================================
See accompanying notes to the unaudited consolidated financial statements
5
Union Bankshares, Inc. and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended
--------------------
June 30, June 30,
(Dollars in Thousands) 2004 2003
-------- --------
Cash Flows From Operating Activities
Net Income $ 2,579 $ 2,418
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 327 328
Provision for loan losses - 84
Credit for deferred income taxes (12) (13)
Net amortization on securities 115 138
Equity in losses of limited partnerships 62 62
Write-downs of other real estate owned - 53
Write-downs of impaired securities 42 -
Increase (decrease) in unamortized loan fees 8 (7)
(Increase) decrease in loans held for sale, net 6,237 (7,766)
Net gain on sales of securities (25) -
Net gain on sales of loans held for sale (234) (227)
Net loss on sales of other real estate owned - 2
Net gain on disposals of premises and equipment (5) (6)
Decrease in accrued interest receivable 118 263
Decrease in other assets 253 117
Increase in income taxes (47) (211)
Decrease in accrued interest payable (136) (258)
Increase in other liabilities 289 256
------- -------
Net cash provided by (used in) operating activities 9,571 (4,767)
------- -------
Cash Flows From Investing Activities
Interest bearing deposits in banks
Maturities and redemptions 1,785 1,985
Purchases (1,779) (1,192)
Securities available-for-sale
Sales 529 351
Maturities, calls and paydowns 6,397 14,793
Purchases (9,829) (6,515)
Purchase of Federal Home Loan Bank Stock - (6)
Decrease (increase) in loans, net (788) 5,397
Recoveries of loans charged off 33 64
Purchases of premises and equipment (815) (275)
6
June 30, June 30,
2004 2003
-------- --------
Investments in limited partnerships - (109)
Proceeds from sales of other real estate owned - 719
Proceeds from sales of premises and equipment 12 11
Proceeds from sales of repossessed property - 41
------- -------
Net cash provided by investing activities (4,455) 15,264
------- -------
Cash Flows From Financing Activities
Increase in borrowings outstanding, net 5,813 503
Proceeds from exercise of stock options 9 13
Net decrease in non-interest bearing deposits (514) (417)
Net decrease in interest bearing deposits (17,877) (8,320)
Proceeds paid out for fractional shares - (4)
Dividends paid (2,002) (1,819)
------- -------
Net cash used in financing activities (14,571) (10,044)
------- -------
Increase (decrease) in cash and cash equivalents $(9,455) $ 453
Cash and cash equivalents
Beginning $24,540 $25,748
------- -------
Ending $15,085 $26,201
======= =======
Supplemental Disclosures of Cash Flow Information:
Interest paid $ 1,796 $ 2,568
======= =======
Income taxes paid $ 1,095 $ 1,180
======= =======
Supplemental Schedule of Noncash Investing and
Financing Activities:
Other real estate acquired in settlement of loans $ 200 $ 109
======= =======
Repossessed property acquired in settlement of loans $ 0 $ 25
======= =======
Loans originated to finance of sale of other
real estate owned - $(1,265)
======= =======
Total change in unrealized gain on securities
available-for-sale $ (889) $ 621
======= =======
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 June 30,
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 ending
December 31, 2004 or any other interim period.
All share and per share amounts have been retroactively adjusted for the
effect of the three for two 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 of Accounting
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 derivative 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 be 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 Company's policy to recognize servicing assets and income only upon the
sale of the underlying loan. Accordingly, adoption of SAB No. 105 will not
have any effect on the Company's financial statements.
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 and six months ended June 30 would have approximated:
8
Three Months Ended Six Months Ended
------------------ -----------------
(Dollars in thousands, except for per share data) 2004 2003 2004 2003
---- ---- ---- ----
Net Income as reported $1,305 $1,189 $2,579 $2,418
Deduct: Total stock-based compensation
expense determined under fair value based
method for all awards, net of related tax effects (5) (1) (9) (2)
------ ------ ------ ------
Pro forma net income $1,300 $1,188 $2,570 $2,416
====== ====== ====== ======
Earnings per common share:
As reported $ 0.29 $ 0.26 $ 0.57 $ 0.53
Pro forma $ 0.29 $ 0.26 $ 0.57 $ 0.53
Note 6. Defined Benefit Pension Plan
Union Bank (Union) sponsors a non-contributory defined benefit pension plan
covering all eligible employees. The employees of the former Citizens
Savings Bank and Trust Company (Citizens) subsidiary 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 and six months ended,
June 30, 2004 and 2003 consisted of the following components:
Three Months Ended Six Months Ended
--------------------- ---------------------
2004 2003 2004 2003
---- ---- ---- ----
Service cost $ 91,648 $ 75,358 $204,211 $150,716
Interest cost on projected benefit obligation 112,048 97,954 218,395 195,908
Expected return on plan assets (93,210) (73,756) (181,007) (147,512)
Amortization of prior service cost 1,539 1,540 3,079 3,080
Amortization of transition asset - (1,912) - (3,824)
Amortization of net loss 19,299 18,837 40,902 37,674
-------- -------- -------- --------
Net periodic benefit cost $131,324 $118,021 $285,580 $236,042
======== ======== ======== ========
The estimated annual employer contribution utilizing the January 1, 2004
employee census has been recalculated by the actuary to be $508,000 compared
to the earlier estimate of $570,000 disclosed in the 2003 Annual Report to
Shareholders.
Note 7. Comprehensive income
The components of other comprehensive income and related tax effects for
the six month period ended June 30, are as follows:
2004 2003
---- ----
(dollars in thousands)
Unrealized holding gains (losses) on available-for-sale securities $(905) $621
Reclassification adjustment for gains realized in income (25) -
Reclassification adjustment for losses recognized in income on impaired securities 41 -
----- ----
Net unrealized gains (losses) (889) 621
Tax effect (302) 211
----- ----
Net of tax amount $(587) $410
===== ====
In June of 2004, the Company wrote down two equity securities to their fair
market value as their value had been below the cost basis for an extended
period of time and management was unsure if the Company would be able to
recover our cost. The impact net of taxes on Net Income for the quarter and
year to date was $27 thousand or less than $.01 per share.
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 June 30, 2004 and as of December 31, 2003, and its results
of operations for the three and six months ended June 30, 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 June 30, 2004, which would
materially affect the information presented.
All share and per share amounts in the discussion below have been
retroactively adjusted for the effect of the three-for-two stock split
of August 8, 2003.
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
* 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
10
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.
OVERVIEW
The Company's net income for the quarter ended June 30, 2004 was $1.3
million, compared with net income of $1.2 million for the second quarter of
2003 or a 9.8% increase between years. Gross interest income decreased
from $5.1 million for the quarter ending June 30, 2003 to $4.9 million
for 2004. This decline was more than offset by the decrease in interest
expense between quarters from $1.1 million in 2003 to $.8 million in 2004.
The Company's total assets shrank from $357 million at December 31, 2003 to
$344 million at June 30, 2004 which reflects normal seasonal run-off
primarily in municipal loans.
The following per share information and key ratios depict several
measurements of performance or financial condition for or at the quarters
and six months ending June 30, 2004 and 2003, respectively:
11
Quarter Ended Year To Date
------------------------------ ------------------------------
June 30, 2004 June 30, 2003 June 30, 2004 June 30, 2003
------------- ------------- ------------- -------------
Return on average assets (ROA) (1) 1.49% 1.41% 1.47% 1.43%
Return on average equity (ROE) (1) 12.78% 12.47% 12.62% 12.60%
Net interest margin (1), (2) 5.13% 5.22% 5.15% 5.22%
Efficiency ratio (3) 62.62% 63.59% 62.86% 62.75%
Net interest spread (4) 4.89% 4.91% 4.91% 4.89%
Net loan charge-offs to average loans 0.00% 0.00% 0.00% 0.00%
Allowance for loan losses to loans 1.19% 1.28% 1.19% 1.28%
Non-performing assets to total assets 0.90% 0.61% 0.90% 0.61%
Equity to assets 11.62% 11.57% 11.62% 11.57%
Total capital to risk weighted assets 18.39% 18.86% 18.39% 18.86%
Book value per share $ 9.00 $ 8.84 $ 9.00 $ 8.84
Earnings per share $ .29 $ .26 $ .57 $ .53
Dividends paid per share $ .22 $ .20 $ .44 $ .40
Dividend payout ratio 76.70% 76.53% 77.63% 75.23%
Annualized
The ratio of tax equivalent net interest income to average earnings
assets.
The ratio of noninterest expense to tax equivalent net interest income
and other income excluding securities gains and losses from other
income.
The difference between the average rate earned on assets minus the
average rate paid on liabilties.
The prime rate was static throughout the first half of 2004 at 4.00% which
is the lowest it has been since 1959. The prime rate during 2003 was 4.25%
until June 27, 2003 when it dropped to 4:00%. The drop in the prime rate is
partially responsible for the 7 basis point drop in our year to date Net
Interest Margin as our variable rate loans react more fully and quickly
than our core deposit rates as we 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 $87 thousand, or 2.2%, to $4.1 million for the
three months ended June 30, 2004, from $4.0 million for the three months
ended June 30, 2003. The net interest spread decreased by 2 basis points to
4.89 % for the three months ended June 30, 2004, from 4.91% for the three
months ended June 30, 2003 as interest rates paid on liabilities and earned
on assets moved downward in response to earlier decreases in the prime and
market rates. The net interest margin for the second quarter of 2004
decreased 9 basis points to 5.13% from the second quarter of 2003 at 5.22%.
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 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. 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:
12
Three months ended June 30,
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 $ 3,863 $ 7 0.74% $ 9,669 $ 25 1.06%
Interest bearing deposits in banks 6,646 53 3.16% 4,726 46 3.90%
Investments (1), (2) 44,821 501 4.68% 38,888 465 5.04%
Loans, net (1), (3) 268,685 4,341 6.54% 258,962 4,573 7.15%
-------- ------ ---- -------- ------ ----
Total interest-earning assets (1) 324,015 4,902 6.14% 312,245 5,109 6.65%
Cash and due from banks 13,571 14,879
Premises and equipment 4,841 4,569
Other assets 8,747 6,175
-------- --------
Total assets $351,174 $337,868
======== ========
Average Liabilities and
Stockholder's Equity:
Now accounts $ 44,833 $ 44 0.40% $ 42,141 $ 59 0.56%
Savings and money market accounts 111,494 203 0.73% 107,159 274 1.03%
Time deposits 93,871 479 2.05% 99,822 691 2.75%
Borrowed funds 10,334 91 3.48% 7,668 87 4.55%
-------- ------ ---- -------- ------ ----
Total interest-bearing liabilities 260,532 817 1.25% 256,790 1,111 1.74%
Non-interest bearing deposits 46,405 39,853
Other liabilities 3,376 3,103
-------- --------
Total liabilities 310,313 299,746
Stockholder's equity 40,861 38,122
-------- --------
Total liabilities and
stockholders' equity $351,174 $337,868
======== ========
Net interest income $4,085 $3,998
====== ======
Net interest spread (1) 4.89% 4.91%
==== ====
Net interest margin (1) 5.13% 5.22%
==== ====
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.
13
Six months ended June 30,
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 $ 3,372 $ 12 0.74% $ 9,160 $ 48 1.05%
Interest bearing deposits in banks 6,581 102 3.09% 4,890 93 3.82%
Investments (1), (2) 43,508 1,005 4.83% 41,875 1,007 5.06%
Loans, net (1), (3) 267,020 8,650 6.55% 256,146 9,102 7.23%
-------- ------ ---- -------- ------ ----
Total interest-earning assets (1) 320,481 9,769 6.19% 312,071 10,250 6.71%
Cash and due from banks 16,525 14,600
Premises and equipment 4,701 4,604
Other assets 8,737 6,805
-------- --------
Total assets $350,444 $338,080
======== ========
Average Liabilities and
Stockholder's Equity:
Now accounts $ 44,188 $ 87 0.40% $ 41,319 $ 122 0.59%
Savings and money market accounts 111,359 413 0.74% 107,333 566 1.06%
Time deposits 94,606 982 2.08% 100,577 1,451 2.91%
Borrowed funds 9,896 179 3.57% 7,491 172 4.63%
-------- ------ ---- -------- ------ ----
Total interest-bearing liabilities 260,049 1,661 1.28% 256,720 2,311 1.81%
Non-interest bearing deposits 46,286 39,655
Other liabilities 3,236 3,333
-------- --------
Total liabilities 309,571 299,708
Stockholder's equity 40,873 38,372
-------- --------
Total liabilities and
stockholders' equity $350,444 $338,080
======== ========
Net interest income $8,108 $ 7,939
====== =======
Net interest spread (1) 4.91% 4.89%
==== ====
Net interest margin (1) 5.15% 5.22%
==== ====
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
* 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.
14
Three Months Ended June 30, 2004 Compared
To Three Months Ended June 30, 2003
Increase/(Decrease) Due to Change In
-----------------------------------------
Volume Rate Net
------ ---- ---
(dollars in thousands)
Interest-earning assets:
Federal funds sold and overnight deposits $(15) $ (3) $ (18)
Interest bearing deposits in banks 19 (12) 7
Investments 77 (41) 36
Loans, net 173 (405) (232)
---- ----- -----
Total interest-earnings assets $254 $(461) $(207)
Interest-bearing liabilities:
Now accounts $ 4 $ (19) $ (15)
Savings and money market accounts 11 (82) (71)
Time deposits (42) (170) (212)
Borrowed funds 32 (28) 4
---- ----- -----
Total interest-bearing liabilities $ 5 $(299) $(294)
---- ----- -----
Net change in net interest income $249 $(162) $ 87
==== ===== =====
Six Months Ended June 30, 2004 Compared
To Six Months Ended June 30, 2003
Increase/(Decrease) Due to Change In
---------------------------------------
Volume Rate Net
------ ---- ---
(dollars in thousands)
Interest-earning assets:
Federal funds sold and overnight deposits $(31) $ (5) $ (36)
Interest bearing deposits in banks 33 (24) 9
Investments 45 (47) (2)
Loans, net 412 (864) (452)
---- ----- -----
Total interest-earnings assets $459 $(940) $(481)
Interest-bearing liabilities:
Now accounts $ 8 $ (43) $ (35)
Savings and money market accounts 22 (175) (153)
Time deposits (85) (384) (469)
Borrowed funds 58 (51) 7
---- ----- -----
Total interest-bearing liabilities $ 3 $(653) $(650)
---- ----- -----
Net change in net interest income $456 $(287) $ 169
==== ===== =====
Quarter Ended June 30, 2004 compared to Quarter Ended June 30, 2003.
Interest and Dividend Income. The Company's interest and dividend income
decreased by $207 thousand, or 4.1%, to $4.9 million for the three months
ended June 30, 2004, from $5.1 million for the three months ended June 30,
2003 in spite of average earning assets increasing by $11.8 million, or
3.8%, to $324.0 million for the three months ended June 30, 2004, from
$312.2 million for the three months ended June 30, 2003. The increase in
interest income resulting from the growth in average ernings assets was more
than offset by the lower rates earned on those assets in 2004 versus 2003.
Average loans approximated $268.7 million for the three months ended June
30, 2004 up from $259.0 million for the three months ended June 30, 2003 or
3.8%, while at the same time the average yield on loans declined from 7.15%
for the June 30, 2003 quarter to 6.54% for the 2004 quarter.
15
The $156 thousand or 1.2% increase in construction loans, the $1.8 million
or 8.9% increase in commercial loans, the $3.0 million or 23.0% increase in
loans to municipalities and the $16.6 million or 15.0% increase in
commercial real estate loans was partially offset by the $1.2 million or
11.6% decrease in personal loans and a $10.7 million, or 11.2% decrease in
residential real estate secured loans. There was $5.9 million of
residential real estate loans sold during the second quarter of 2004
compared to $1.9 million in 2003 as management continues 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)
increased by $5.9 million to $44.8 million for the three months ended
June 30, 2004, from $38.9 million for the three months ended June 30, 2003.
The increase in the investment portfolio in 2004 reflects the movement out
of low rate, short term federal funds sold. The average level of federal
funds sold and overnight deposits decreased by $5.8 million or 60.0%, to
$3.9 million for the three months ended June 30, 2004, from $9.7 million
for the three months ended June 30, 2003. The average balance in interest
bearing deposits in banks increased by $1.9 million to $6.6 million from
$4.7 million, or 40.6% increase. Interest income from non-loan instruments
was $561 thousand for 2004 and $536 thousand for 2003 reflecting the
increase in volume and the overall decrease in yields.
Interest Expense. The Company's interest expense decreased by $294
thousand, or 26.5%, to $817 thousand for the three months ended June 30,
2004 from $1.1 million for the three months ended June 30, 2003 in spite of
average interest-bearing liabilities increasing by $3.7 million, or 1.4%,
to $260.5 million for the three months ended June 30, 2004, from $256.8
million for the three months ended June 30, 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 $93.9 million for the three months ended June 30, 2004 and
$99.8 million for the three months ended June 30, 2003, or a decrease of
6.0%. The average balances for money market and savings accounts increased
by $4.3 million, or 4.0% to $111.5 million for the three months ended June
30, 2004, from $107.2 million for the three months ended June 30, 2003. The
6.4% or $2.7 million increase in Now accounts brought the average balance
up to $44.8 million from $42.1 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 increased from $7.7 million for
the three months ended June 30, 2003 to $10.3 million for the three months
ended June 30, 2004 as the Company's subsidiary had taken down two short
term Federal Home Loan Bank (FHLB) of Boston bullet advances of $3 million
each during 2004 for liquidity purposes to temporarily fund asset growth,
and these were partially offset by continuing pay downs on amortizing
Federal Home Loan Bank advances.
Noninterest Income. The Company's noninterest income increased $80
thousand, or 10.1%, to $870 thousand for the three months ended June 30,
2004 from $790 thousand for the three months ended June 30, 2003. Trust
department income increased to $47 thousand for the three months of 2004
from $42 thousand in the same period of 2003 or a 11.9% 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. Gain on
sale of loans was fairly stable between years at $54 thousand for 2004 and
$45 thousand for 2003. Service fees (sources of which include, among
others, deposit and loan servicing fees, ATM fees, and safe deposit fees)
increased by $29 thousand to $694 thousand for the three months ended June
30, 2004, from $665 thousand for the three months ended June 30, 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 $56
thousand, or 1.8%, to remain stable at $3.1 million for the three months
ended June 30, 2004 and 2003. Salaries decreased in 2004 to $1.3 million
from $1.4 million as the efficiencies of merging the two banks in May of
2003 became evident.
Pension and employee benefits increased $64 thousand, or 13.8%, to $529
thousand for the three months ended June 30, 2004, from $465 thousand for
the three months ended June 30, 2003 mainly due to a $72 thousand increase
in pension plan costs as all the former eligible Citizens employees became
eligible for the Union Bank Defined Benefit Pension Plan effective January
1, 2004.
16
Net occupancy expense increased $20 thousand, or 11.8%, to $189 thousand
for the three months ended June 30, 2004, from $169 thousand for the three
months ended June 30, 2003. Equipment expense increased $4 thousand or 1.8%
to $221 thousand for the three months ended June 30, 2004, from $217
thousand for the same period in 2003. Net operation of other real estate
owned was $20 thousand for the three months ended June 30, 2004 compared to
$10 thousand for the same period in 2003. Other operating expenses were down
$4 thousand to $878 thousand for the second quarter of 2004 compared to $882
thousand for the same period in 2003 as the second quarter of 2003 included
$61 thousand of costs associated with assimilating Citizens into Union Bank.
Other operating expense for 2004 included a $41 thousand write-down to the
lower of cost or market on two equity securities that were deemed impaired.
(see Footnote 7 for further details)
Income Tax Expense. The Company's income tax expense increased by $37
thousand, or 8.0%, to $501 thousand for the three months ended June 30,
2004, from $464 thousand for the comparable period of 2003, mainly due to
increased net taxable income.
Year to Date June 30, 2004 compared to Year to Date June 30, 2003.
Interest and Dividend Income. The Company's interest and dividend income
decreased by $481 thousand, or 4.7%, to $9.8 million for the six months
ended June 30, 2004, from $10.3 million for the six months ended June 30,
2003 reflecting the low interest rate environment. Average earning assets
increased by $8.4 million, or 2.7%, to $320.5 million for the six months
ended June 30, 2004, from $312.1 million for the six months ended June 30,
2003. Average loans approximated $267.0 million for the six months ended
June 30, 2004 up from $256.1 million for the six months ended June 30,
2003. The net $10.9 million increase was net of sales of residential real
estate loans during the first half of 2004 of $13.2 million versus sale of
$8.9 million during 2003. Average construction loan volume increased $.9
million or 6.9% from $12.7 million in 2003 to $13.6 million in 2004. Average
commercial real estate loans increased $16.1 million or 14.8% from $109.1
million in 2003 to $125.2 million in 2004. And, average municipal loans
increased $3.0 million or 22.9% from $12.9 million in 2003 to $15.9 million
in 2004. In addition to the reduction resulting from the sales of residential
real estate loans of $13.2 million, average consumer loans dropped $1.2
million or 12.3% from $10.2 million in 2003 to $9.0 million in 2004. The
local economy continues to support both residential and commercial growth
in 2004.
The average balance of investment securities (including mortgage-backed
securities) increased by $1.6 million, or 3.8%, to $43.5 million for the
six months ended June 30, 2004, from $41.9 million for the six months ended
June 30, 2003. The average level of federal funds sold and overnight
deposits decreased by $5.8 million or 63.2%, to $3.4 million for the six
months ended June 30, 2004, from $9.2 million for the six months ended June
30, 2003 as funds were moved from overnight positions to a ladder of
investments. The average balance in interest bearing deposits in banks
increased by $1.7 million to $6.6 million from $4.9 million, or a 34.6%
increase. The net decrease of $2.5 million in the investment portfolio,
federal funds sold and interest bearing deposits in banks during 2004
reflects the continuing growth in our loan portfolio. Interest income from
non-loan instruments was $1.1 million for both 2004 and 2003 reflecting the
decrease in yields and the overall decrease in volume but offset by the
lengthening of the portfolio's duration.
Interest Expense. The Company's interest expense decreased by $650
thousand, or 28.1%, to $1.7 million for the six months ended June 30, 2004
from $2.3 million for the six months ended June 30, 2003 reflecting the low
interest rate environment. The reduction in interest expense occurred despite
an increase of $3.3 million or 1.3% in average interest-bearing liabilities
to $260.0 million for the six months ended June 30, 2004, from $256.7 million
for the six months ended June 30, 2003. Average time deposits were $94.6
million for the six months ended June 30, 2004 and $100.6 million for the six
months ended June 30, 2003, or a decrease of 5.9%. The average balances for
money market and savings accounts increased by $4.1 million, or 3.8% to
$111.4 million for the six months ended June 30, 2004, from $107.3 million
for the six months ended June 30, 2003. The 6.9% increase in NOW accounts
brought the average balance up to $44.2 million from $41.3 million.
Customers have maintained very liquid positions during the last 2 years as
management believes they anticipate interest rates paid on deposit
instruments will rise and as stock market volatility continues.
17
The average balance on funds borrowed increased from $7.5 million at
June 30, 2003 to $9.9 million at June 30 2004 as the Company took down
liquidity advances to temporarily fund asset growth during 2004 while
continuing to pay down amortizing Federal Home Loan Bank Advances.
Noninterest Income. The Company's noninterest income increased $126
thousand, or 7.4%, to $1.8 million for the six months ended June 30, 2004
from $1.7 million for the six months ended June 30, 2003. The current year
includes net gains on the sales of securities of $25 thousand where there
were no sales during the first half of 2003. The results for the period
reflected a net gain of $234 thousand from the sale of loans compared to a
$227 thousand gain from sales during 2003 resulting from the sale of some
of the newer lower rate, long term residential real estate loans into the
secondary market to mitigate our interest rate risk. Trust department
income increased to $91 thousand for the six months of 2004 from $80
thousand in the same period of 2003 or a 13.7% increase primarily due to
the increase in fees charged and the increase in the stock market since the
majority of the fee income is based on the market value of the assets under
management. Service fees (sources of which include, among others, deposit
and loan servicing fees, ATM fees, and safe deposit fees) increased by $34
thousand, or 2.68%, to $1.4 million for the six months ended June 30, 2004,
from $1.3 million for the six months ended June 30, 2003. Other income in
2004 was $126 thousand, up 63.6% from $77 thousand in 2003. The increase
reflects a $42 thousand increase between years in net servicing rights
mainly due to the sales discussed earlier and an increase of $10 thousand
in income from the cash surrender value of life insurance.
Noninterest Expense. The Company's noninterest expense increased $142
thousand, or 2.2%, to $6.3 million for the six months ended June 30, 2004,
from $6.2 million for the six months ended June 30, 2003. Salaries
decreased $42 thousand, or 1.5%, to $2.7 million for the six months ended
June 30, 2004, from $2.8 million for the six months ended June 30, 2003,
reflecting normal salary activity and the non-reoccurence of the 2003
accrual for $186 thousand for separation or reduction in force agreements
with four former employees at Citizens. Pension and employee benefits
increased $198 thousand, or 21.3%, to $1.1 million for the six months ended
June 30, 2004, from $928 thousand for the six months ended June 30, 2003
mainly due to a $90 thousand increase in employee group insurance plans
costs and a $112 thousand increase in retirement plan costs due mainly to
the increasing cost of the defined benefit pension plan. The addition of
the former Citizens employees to the defined benefit plan effective January
1, 2004 is responsible for the majority of the increase. Net occupancy
expense increased $24 thousand, or 6.7%, to $381 thousand for the six
months ended June 30, 2004, from $357 thousand for the six months ended
June 30, 2003. Equipment expense decreased $6 thousand or 1.3% to $441
thousand for the six months ended June 30, 2004, from $447 thousand for the
same period in 2003. Net operation of other real estate owned was $35
thousand for the six months ended June 30, 2004 compared to $79 thousand
for the same period in 2003. Other operating expenses were flat at $1.6
million for the first six months of 2004 and 2003 since there were no
merger related expenses of the subsidiaries in 2004 as there were in 2003.
Other operating expense for 2004 included a $41 thousand write-down to the
lower of cost or market on two equity securities that were deemed impaired.
(see Footnote 7 for further details)
Income Tax Expense. The Company's income tax expense increased by $76
thousand, or 7.9%, to $1.0 million for the six months ended June 30, 2004,
from $960 thousand for the comparable period of 2003, mainly due to
increased taxable income.
FINANCIAL CONDITION
At June 30, 2004, The Company had total consolidated assets of $344
million, including net loans and loans held for sale of $263 million,
deposits of $287 million and stockholders' equity of $41 million. The
Company's total assets decreased by $13 million or 3.5% to $344 million at
June 30, 2004 from $357 million at December 31, 2003 which is part of the
seasonality of our business due to our involvement in the local
municipality market. Historically, June 30th of each year is our low point
in terms of total assets, net loans and deposits. This is a one-day
aberration as the Towns, Villages and School Districts that we lend to must
be out of debt one day during the year. These loans totaled $15.3 million
on December 31, 2003, $16.4 million on Monday, June 28, 2004, $7.3 million
on June 30, 2004 and $13.7 million on July 2, 2004.
18
Total net loans and loans held for sale decreased by $5 million or 2.0% to
$263 million or 76.5% of total assets at June 30, 2004 as compared to $268
million or 75.3% of total assets at December 31, 2003. Cash and cash
equivalents, including federal funds sold and overnight deposits, decreased
$9 million or 37.5% to $15 million at June 30, 2004 from $24 million at
December 31, 2003 as we moved funds into interest earning assets. This
movement is masked at June 30th due to the aberrations caused by municipal
activity.
Securities available-for-sale increased from $44 million at December 31,
2003 to $46 million at June 30, 2004, a $2 million or 4.5% increase.
Deposits decreased $18 million or 5.9 % to $287 million at June 30, 2004
from $305 million at December 31, 2003 which is a seasonal fluctuation
caused by the municipal market (See average balances in the Yields Earned
and Rates Paid table on Page 14). Total borrowings increased $5 million to
$13 million at June 30, 2004 from $7 million at December 31, 2003 as we took
down $6 million in short term advances for liquidity needs to temporarily
fund asset growth and a $475 thousand amortizing advance to match funding on
a particular loan which were partially 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 June 30, 2004, the Company's gross loan portfolio totaled
$266.3 million, or 77.4 %, of assets, of which $113.3 million, or 42.5% of
gross loans, consisted of residential mortgages and construction loans, and
$114.8 million, or 43.1%, of total loans consisted of commercial real
estate loans. As of such date, the Company's loan portfolio also included
$21.7 million of commercial loans, $7.3 million of municipal loans, and
$9.2 million of consumer loans representing, in order, 8.2%, 2.7% and 3.5%
of total loans outstanding on June 30, 2004.
Gross loans and loans held for sale have decreased $5.5 million or 2.0%
since December 31, 2003. An increase of $10.2 million or 10.0% in
commercial real estate loans, an increase of $3.7 million or 20.7% in
commercial loans, were offset by a decrease in municipal loans of $8.1
million or 52.5% (see municipality discussion above), a decrease of $5.1
million or 4.7% in residential real estate loans, a decrease of $6.0 million
or 32.4% in loans held for sale and a $.2 million or 1.8% decrease in
consumer loans. The Company sold $13.2 million of loans held for sale during
the first half of 2004.
The following table shows information on the composition of the Company's
loan portfolio as of June 30, 2004 and December 31, 2003:
Loan Type June 30, 2004 December 31, 2003
- --------- ------------------- -------------------
(dollars in thousands)
Real Estate $103,109 38.7% $108,231 39.8%
Commercial real estate 112,560 42.3% 102,366 37.7%
Commercial 21,583 8.1% 17,877 6.6%
Consumer 9,230 3.5% 9,402 3.5%
Municipal loans 7,289 2.7% 15,346 5.6%
Loans held for sale 12,521 4.7% 18,524 6.8%
-------- ----- -------- -----
Total loans 266,292 100.0% 271,746 100.0%
Deduct:
Allowance for loan losses (3,023) (3,029)
Net unearned loan fees, premiums & discounts (193) (185)
-------- --------
$263,076 $268,532
======== ========
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 $183
million residential mortgage portfolio, approximately $70 million of which
is serviced for unaffiliated third parties at June 30, 2004. Additionally,
the Company originates commercial
19
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 $4.7 million of commercial and commercial real estate loans
for unaffiliated third parties as of June 30, 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 $303
thousand at June 30, 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 June 30, 2004 was $6.9 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 $1.7 million or .65% of
gross loans and loans held for sale at June 30, 2004, $1.6 million or 0.58%
at December 31, 2003 and $959 thousand or .37% at June 30, 2003. The
aggregate interest income not recognized on such nonaccrual loans amounted
to approximately $418 thousand and $406 thousand as of June 30, 2004 and
2003, respectively and $393 thousand as of December 31, 2003.
The Company had $1.4 million and $1.7 million in loans past due 90 days or
more and still accruing at June 30, 2004 and December 31, 2003,
respectively. At June 30, 2004, the Company had internally classified
certain loans totaling $1.9 million and $1.7 million at December 31, 2003.
In management's 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;
20
* confidence is diminished;
* loan covenants have been violated;
* collateral is inadequate; or
* other unfavorable factors are present.
At June 30, 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. There was no provision for loans losses deemed necessary in either
the second quarter of 2004 or year to date. 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 June 30, 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.
The following table reflects activity in the allowance for loan losses for
the three months ended June 30, 2004 and 2003:
Three Months Ended, June 30, Six months Ended, June 30,
---------------------------- --------------------------
2004 2003 2004 2003
---- ---- ---- ----
(dollars in thousands)
Balance at the beginning of period $3,019 $2,955 $3,029 $2,908
Charge-offs
Real Estate 8 17 34 17
Commercial - - - 10
Consumer and other 1 18 5 36
------ ------ ------ ------
Total charge-offs 9 35 39 63
------ ------ ------ ------
Recoveries
Real Estate - - - -
Commercial 2 9 5 25
Consumer and other 11 22 28 39
------ ------ ------ ------
Total recoveries 13 31 33 64
------ ------ ------ ------
Net (charge-offs)/recoveries 4 (4) (6) 1
Provision for loan losses - 42 - 84
------ ------ ------ ------
Balance at end of period $3,023 $2,993 $3,023 $2,993
====== ====== ====== ======
21
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:
June 30, December 31,
2004 2003
----------------- -----------------
(dollars in thousands)
Amount Percent Amount Percent
------ ------- ------ -------
Real Estate
Residential $ 512 32.6% $ 525 31.9%
Commercial 1,782 44.4% 1,578 42.7%
Construction 166 6.5% 183 7.2%
Other Loans
Commercial 384 8.5% 336 7.1%
Consumer installment 144 3.6% 145 3.7%
Home equity loans 28 1.5% 25 1.3%
Municipal, Other and
Unallocated 7 2.9% 237 6.1%
------ ----- ------ -----
Total $3,023 100.0% $3,029 100.0%
====== ===== ====== =====
Ratio of Net Charge Offs to
Average Loans not held
for sale (1) 0.00% 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
June 30, 2004 is adequate to cover losses inherent in the Company's loan
portfolio as of such date. However there can be no assurance that the
Company will not sustain losses in future periods, which could be greater
than the size of the allowance at June 30, 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 June 30, 2004 the reported value of investment
securities available-for-sale was $46 million or 13.4% 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 June 30,
2004, reflects a positive valuation adjustment of $264 thousand. The offset
of this adjustment, net of income tax effect, was reflected in the
accumulated other comprehensive income component of stockholders'
equity.
At December 31, 2003, the Company had one debt security and two equity
securities with fair values of $662 thousand that had unrealized losses of
$55 thousand that had existed for more than 12 months. The debt security
has since paid off. The two equity securities were written down in June of
2004 to their fair market value. (see Footnote 7 for further details). An
agency mortgage backed security has been in a loss position for more than
12 months as of June 30, 2004 with a market value of $819 thousand and an
unrealized loss of $28 thousand. Management believes that the Company has
the ability to hold this security to maturity if necessary to ultimately
recover our cost and has not identified any credit issues that would lead
us to believe that the decline in market value is other than temporary as a
result of rising interest rates.
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 June 30,
2004 and December 31, 2003:
22
Six Months Ended, June 30, 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 $ 46,286 15.6% $ 42,341 14.4%
Now accounts 44,188 14.9% 0.40% 43,349 14.7% 0.51%
Money Markets 64,587 21.8% 0.85% 64,417 21.9% 1.05%
Savings 46,772 15.8% 0.59% 44,574 15.2% 0.81%
-------- ----- -------- -----
Total non-time deposits: 201,833 68.1% 194,681 66.2%
-------- ----- -------- -----
Time deposits:
Less than $100,000 67,119 22.6% 2.01% 72,084 24.5% 2.70%
$100,000 and over 27,487 9.3% 2.23% 27,348 9.3% 2.43%
-------- ----- -------- -----
Total time deposits 94,606 31.9% 99,432 33.8%
-------- ----- -------- -----
Total deposits $296,439 100.0% 1.00% $294,113 100.0% 1.31%
======== ===== ==== ======== ===== ====
The following table sets forth information regarding the amounts of the
Company's time deposits in amounts of $100,000 or more at June 30, 2004 and
December 31, 2003 that mature during the periods indicated:
June 30, 2004 December 31, 2003
------------- -----------------
(dollars in thousands)
Within 3 months $ 5,814 $ 9,399
3 to 6 months $ 4,420 16,264
6 to 12 months $ 3,031 3,820
Over 12 months $ 4,031 379
------- -------
$17,296 $29,862
======= =======
Borrowings. Borrowings from the Federal Home Loan Bank of Boston (FHLB)
were $13 million at June 30, 2004 at a weighted average rate of 3.02%, and
$7 million at December 31, 2003 at a weighted average rate of 4.43%. The
change between year end 2003 and the end of the second quarter of 2004 is a
net increase of $5.8 million which was comprised of borrowing $6 million for
short term liquidity needs to temporarily fund asset growth and $475 thousand
in a long term amortizing advance to match funding on a new loan which were
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.
23
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 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 $7.814 million for the first six months of 2004 compared to actual
results of $8.108 million in a flat rate environment, or a 4% difference.
Net income was projected to be $2.437 million in a flat rate environment
compared to actual results of $2.579 million. Return on Assets was
projected to be 1.41% in a flat rate environment and actual results were
1.47%. Return on Equity was projected to be 12.34% in a flat rate
environment compared to actual of 12.62%.
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. However, 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.
24
The Company generally requires collateral or other security to support
financial instruments with credit risk. As of June 30, 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 $40,154
-------
Standby letters of credit $ 1,139
-------
Credit Card arrangements $ 2,297
=======
Home Equity Lines of Credit $ 5,632
-------
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 with off balance sheet risk at
June 30, 2004 are substantially unchanged from December 31, 2003.
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.
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.
25
The following table shows the Company's rate sensitivity analysis as of
June 30, 2004:
June 30, 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 and
overnight deposits $ 234 $ - $ - $ - $ - $ 234
Interest bearing deposits in banks 297 2,552 2,063 1,475 127 6,514
Securities available-for-sale (1) 2,815 8,677 13,604 10,140 9,929 45,165
FHLB Stock - - - - 1,241 1,241
Loans and loans held for sale (2) 114,819 48,899 57,099 31,784 13,498 266,099
-------- ------- -------- -------- -------- --------
Total interest sensitive assets $118,165 $60,128 $ 72,766 $ 43,399 $ 24,795 $319,253
Interest sensitive liabilities:
Time deposits $ 22,840 $36,563 $ 21,188 $ 2,955 $ - $ 83,546
Money markets 9,090 - - - 52,415 61,505
Regular savings 7,993 - - - 39,600 47,593
NOW accounts 16,892 - - - 29,603 46,495
Borrowed funds (3) 6,315 966 2,745 3,009 - 13,035
-------- ------- -------- -------- -------- --------
Total interest sensitive liabilities $ 63,130 $37,529 $ 23,933 $ 5,964 $121,618 $252,174
Net interest rate sensitivity gap $ 55,035 $22,599 $ 48,833 $ 37,435 $(96,823) $ 67,079
Cumulative net interest rate
sensitivity gap $ 55,035 $77,634 $126,467 $163,902 $ 67,079
Cumulative net interest rate
sensitivity gap as a
percentage of total assets 16.0% 22.6% 36.7% 47.6% 19.5%
Cumulative net interest rate sensitivity
gap as a percentage of total
interest-sensitive assets 17.2% 24.3% 39.6% 51.3% 21.0%
Cumulative net interest rate sensitivity
gap as a percentage of total
interest-sensitive liabilities 21.8% 30.8% 50.2% 65.0% 26.6%
Securities available-for-sale exclude marketable equity securities
with a fair value of $1,087 million that may be sold by the Company
at any time.
Balances shown net of unearned income of $193 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.
26
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 June 30, 2003 prime 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
JUNE 30, 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 17,251 8.3 6,123 1.73 14.78 9.39
4.00 15,931 0.0 5,235 1.48 12.72 12.41
3.00 15,462 (2.9) 4,920 1.40 11.98 13.21
December-05 7.00 20,203 22.9 7,917 2.16 17.80 9.20
4.00 16,434 0.0 5,392 1.48 12.72 12.64
3.00 14,989 (8.8) 4,427 1.22 10.64 13.73
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 internal sources of funds are deposits, amortization
and prepayment of loans and securities, maturing of investment securities
and other short-term investments, sales of securities and loans available-for-
sale, and earnings and other 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 requests 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 undrawn lines of credit of $4.8 million at June 30, 2004.
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. As of June 30, 2004, there were no balances
outstanding on either.
27
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 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.
The Company's management monitors current and projected cash flows and
adjusts positions as necessary to maintain adequate levels of liquidity.
Although approximately 71.1% 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 the later 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 $41.0 million at
June 30, 2004 reflecting net income of $2.579 million for the first six
months of 2004, less dividends paid of $2.0 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 June 30, 2004, the Company
had 4,911,861 shares issued, of which, 4,550,913 were outstanding and
360,948 were held in Treasury. Also as of June 30, 2004, there were
outstanding employee incentive stock options with respect to 16,325 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 June 30, 2004, the Company did not grant any
incentive stock options pursuant to its 1998 Incentive Stock Option Plan.
During that same period, 600 incentive stock options granted pursuant to
the 1998 plan were exercised.
Union Bank and Union Bankshares, Inc. are subject to various regulatory
capital requirements administered by the federal banking agencies.
Management believes, as of June 30, 2004 that they both meet all capital
adequacy requirements to which they are subject. As of June 30, 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,
28
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 June
30, 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 June 30, 2004:
Total capital to risk weighted assets
Union Bank $43,072 18.08% $19,058 8.0% $23,823 10.0%
Company $43,894 18.39% $19,095 8.0% $23,868 10.0%
Tier I capital to risk weighted assets
Union Bank $39,990 16.79% $ 9,527 4.0% $14,291 6.0%
Company $40,812 17.10% $ 9,547 4.0% $14,320 6.0%
Tier I capital to average assets
Union Bank $39,990 11.43% $13,995 4.0% $17,493 5.0%
Company $40,812 11.62% $14,049 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 to
Management's Discussion and Analysis of Financial Condition and Results of
Operations under the capton "OTHER FINANCIAL CONSIDERATIONS" in Part 1,
Item 2 on pages 24 through 30 of 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 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
29
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 2. Changes in Securities, Use of Proceeds and Issuer Purchases of
Equity Securities.
During the quarter ended June 30, 2004, incentive stock options previously
granted pursuant to the Company's 1998 Incentive Stock Option Plan ("Plan")
were exercised by three participants, with respect to an aggregate of 600
shares, at an aggregate exercise price of $8,860. Participation in the Plan
is limited to those senior officers of the corporation or it's subsidiary
(currently five active participants) selected by the Board of Directors in
its discretion. The exercise price of all options granted under the Plan
represents the fair market value of the shares on the date of grant. There
have been 3,250 options granted under the Plan to date during 2004 at an
option price of $26.60 per share. The shares issued to Plan participants
upon exercise of incentive stock options have not been registered with the
Securities and Exchange Commission. Such shares are restricted securities,
issued under statutory exemptions available under the Securities Act of
1933, including Section 4(2) thereof, for offers and sales not involving a
public offering.
Item 4. Submission to Matter to a Vote of Security Holders
The Company held its annual meeting of shareholders on May 19, 2004. Of
4,550,313 shares outstanding on the record date of the meeting (April 1,
2004), 3,840,573 shares were represented in person or by proxy. The only
matter voted on by the shareholders at the meeting was to fix the number
of directors at eight and to elect the following individuals as directors
(each of which was an incumbent director) for the ensuing year.
Votes Votes Votes Broker
Nominees For Withheld Abstained Non-votes
- -------- ----- -------- --------- ---------
Cynthia D. Borck 3,836,909 1,912 1,255
William T. Costa 3,834,522 4,299 1,255
Kenneth D. Gibbons 3,836,909 1,912 1,255
Franklin G. Hovey, II 3,838,806 15 1,255
Richard C. Marron 3,835,221 3,600 1,255
Robert P. Rollins 3,838,821 -- 1,255
Richard C. Sargent 3,835,593 3,228 1,255
John H. Steel 3,838,821 -- 1,255
30
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
Since March 31, 2004 the Company filed 8-K reports relating to the following:
1. Report to Stockholders on Second Quarter Results for 2004 filed
on July 28, 2004
2. Press Release announcing dividend declaration and second
quarter earnings for 2004 filed on July 15, 2004.
3. Report to Stockholders on First Quarter Results for 2004 filed
on April 27, 2004.
4. Press Release announcing dividend declaration and first quarter
earnings for 2004 filed on April 15, 2004.
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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.
August 11, 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.
32