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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: September 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 November 1, 2004:
Common Stock, $2 par value 4,554,213 shares
1
UNION BANKSHARES, INC.
TABLE OF CONTENTS
PART I 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 30
PART II OTHER INFORMATION
Item 1. Legal Proceedings. 31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 31
Item 6. Exhibits 31
Signatures 32
2
Item 1. Financial Statements
Union Bankshares, Inc. and Subsidiary
Consolidated Balance Sheets
(Dollars in Thousands)
September 30, December 31,
2004 2003
---- ----
(Unaudited)
Assets:
Cash and due from banks $ 14,684 $ 23,624
Federal funds sold and overnight deposits 2,285 916
-------- --------
Cash and cash equivalents 16,969 24,540
Interest bearing deposits in banks 6,909 6,520
Securities available-for-sale 42,024 44,370
Loans held for sale 9,565 18,524
Loans 275,314 253,222
Allowance for loan losses (3,093) (3,029)
Unearned net loan fees (188) (185)
-------- --------
Net loans 272,033 250,008
-------- --------
Accrued interest receivable 1,629 1,652
Premises and equipment, net 4,946 4,447
Other real estate owned 200 10
Other assets 6,084 6,486
-------- --------
Total assets $360,359 $356,557
======== ========
Liabilities and Stockholders' Equity
Liabilities
Deposits:
Non-interest bearing $ 56,017 $ 48,366
Interest bearing 252,705 257,016
-------- --------
Total deposits 308,722 305,382
Borrowed funds 6,740 7,223
Accrued interest payable and other liabilities 3,022 2,965
-------- --------
Total liabilities 318,484 315,570
Stockholders' Equity:
Common stock, $2 par value; 5,000,000 shares authorized;
4,912,161 shares issued at 9/30/04 and 4,911,261
issued at 12/31/03 9,824 9,822
Paid-in capital 66 55
Retained earnings 33,146 32,071
Treasury stock at cost; 360,948 shares at 9/30/04 and 12/31/03 (1,722) (1,722)
Accumulated other comprehensive income 561 761
-------- --------
Total stockholders' equity 41,875 40,987
-------- --------
Total liabilities and stockholders' equity $360,359 $356,557
======== ========
See accompanying notes to the unaudited consolidated financial statements
3
Union Bankshares, Inc. and Subsidiary
Consolidated Statements of Income
(Unaudited)
(Dollars in Thousands except Per Share Data)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2004 2003 2004 2003
---- ---- ---- ----
Interest income:
Interest and fees on loans $ 4,523 $ 4,594 $ 13,172 $ 13,696
Interest on debt securities
Taxable 458 363 1,324 $ 1,214
Tax exempt 54 57 161 179
Dividends 17 16 49 50
Interest on federal funds sold and overnight deposits 11 14 24 62
Interest on interest bearing deposits in banks 53 37 155 130
--------- --------- --------- ---------
Total interest income 5,116 5,081 14,885 15,331
--------- --------- --------- ---------
Interest expense:
Interest on deposits 719 892 2,201 3,031
Interest on borrowed funds 87 86 266 258
--------- --------- --------- ---------
Total interest expense 806 978 2,467 3,289
--------- --------- --------- ---------
Net interest income 4,310 4,103 12,418 12,042
Provision for loan losses 30 30 30 114
--------- --------- --------- ---------
Net interest income after provision for loan losses 4,280 4,073 12,388 11,928
--------- --------- --------- ---------
Noninterest income:
Trust income 57 40 148 120
Service fees 718 652 2,074 1,974
Net gains on sales of securities - - 25 -
Net gains on sales of loans held for sale 62 90 296 317
Other income 45 46 171 123
--------- --------- --------- ---------
882 828 2,714 2,534
--------- --------- --------- ---------
Noninterest expenses:
Salaries and Wages 1,358 1,298 4,079 4,061
Pension and employee benefits 408 506 1,534 1,434
Occupancy expense, net 174 149 555 506
Equipment expense 250 224 691 671
Net operation of other real estate owned 14 34 49 113
Other expenses 818 754 2,439 2,363
--------- --------- --------- ---------
3,022 2,965 9,347 9,148
--------- --------- --------- ---------
Income before provision for income taxes 2,140 1,936 5,755 5,314
Provision for income taxes 641 574 1,677 1,534
--------- --------- --------- ---------
Net income $ 1,499 $ 1,362 $ 4,078 $ 3,780
========= ========= ========= =========
Earnings per common share $ 0.33 $ 0.30 $ 0.90 $ 0.83
========= ========= ========= =========
Weighted average number of common
shares outstanding 4,551,171 4,548,287 4,550,738 4,546,550
========= ========= ========= =========
Dividends per common share $ 0.22 $ 0.20 $ 0.66 $ 0.60
========= ========= ========= =========
See accompanying notes to the unaudited consolidated financial statements
4
Union Bankshares, Inc. and Subsidiary
Consolidated Statement of Changes in Stockholders' Equity
(Unaudited)
(Dollars in Thousands)
Common Stock
------------------ Accumulated
Shares, Other Total
net of Paid-in Retained Treasury Comprehensive Stockholders'
Treasury Amount Capital Earnings Stock Income Equity
-------- ------ ------- -------- -------- ------------- -------------
Balance, December 31, 2003 4,550,313 $9,822 $55 $32,071 $(1,722) $ 761 $40,987
Comprehensive Income:
Net income - - - 4,078 - - 4,078
Change in net unrealized gain (loss)
on securities available-for-sale,
net of reclassification adjustment
and tax effects - - - - - (200) (200)
-------
Total Comprehensive Income - - - - - - 3,878
-------
Exercise of Stock Options 900 2 11 - - - 13
Cash dividends declared
($0.66 per share) - - - (3,003) - - (3,003)
--------- ------ --- ------- ------- ----- -------
Balance, September 30, 2004 4,551,213 $9,824 $66 $33,146 $(1,722) $ 561 $41,875
========= ====== === ======= ======= ===== =======
See accompanying notes to the unaudited consolidated financial statements
5
Union Bankshares, Inc. and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended
September 30, September 30,
(Dollars in Thousands) 2004 2003
---- ----
Cash Flows From Operating Activities
Net Income $ 4,078 $ 3,780
Adjustments to reconcile net income to net cash
provided by (used in) operating activities
Depreciation 516 489
Provision for loan losses 30 114
Provision (credit) for deferred income taxes 193 (146)
Net amortization on securities 165 202
Equity in losses of limited partnerships 107 94
Write-downs of other real estate owned - 53
Write-downs of impaired securities 42 -
Increase in unamortized loan fees 3 8
Decrease (increase) in loans held for sale, net 9,255 (6,303)
Net gain on sales of securities (25) 0
Net gain on sales of loans held for sale (296) (317)
Net gain on sales of other real estate owned (1) -
Net gain on disposals of premises and equipment (7) (6)
Decrease in accrued interest receivable 23 170
Decrease in other assets 213 80
Decrease in income taxes (91) (212)
Decrease in accrued interest payable (84) (224)
Increase in other liabilities 233 577
-------- --------
Net cash provided by (used in) operating activities 14,354 (1,641)
-------- --------
Cash Flows From Investing Activities
Interest bearing deposits in banks
Maturities and redemptions 2,088 2,671
Purchases (2,477) (1,778)
Securities available-for-sale
Sales 529 351
Maturities, calls and paydowns 11,340 19,424
Purchases (10,008) (12,315)
Purchase of Federal Home Loan Bank Stock - (6)
Increase in loans, net (22,376) (14,063)
Recoveries of loans charged off 109 80
Purchases of premises and equipment (1,022) (370)
6
Nine Months Ended
------------------------------
September 30, September 30,
2004 2003
---- ----
Investments in limited partnerships - (109)
Proceeds from sales of other real estate owned 11 746
Proceeds from sales of premises and equipment 14 12
Proceeds from sales of repossessed property - 41
-------- --------
Net cash used in investing activities (21,792) (5,316)
-------- --------
Cash Flows From Financing Activities
(Decrease) increase in borrowings outstanding, net (483) 98
Proceeds from exercise of stock options 13 64
Net increase in non-interest bearing deposits 7,651 6,640
Net (decrease) increase in interest bearing deposits (4,311) 1,629
Proceeds paid out for fractional shares - (4)
Dividends paid (3,003) (2,727)
-------- --------
Net cash (used in) provided by financing activities (133) 5,700
-------- --------
Decrease in cash and cash equivalents $ (7,571) $ (1,257)
Cash and cash equivalents
Beginning $ 24,540 $ 25,748
-------- --------
Ending $ 16,969 $ 24,491
======== ========
Supplemental Disclosures of Cash Flow Information:
Interest paid $ 2,551 $ 3,514
======== ========
Income taxes paid $ 1,575 $ 1,871
======== ========
Supplemental Schedule of Noncash Investing and
Financing Activities:
Other real estate acquired in settlement of loans $ 200 $ 141
======== ========
Repossessed property acquired in settlement of loans $ 9 $ 25
======== ========
Loans originated to finance the sale of other
real estate owned $ - $ (1,376)
======== ========
Total change in unrealized gain on securities
available-for-sale $ (303) $ 155
======== ========
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
September 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 (FASB) 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 nine months ended September 30, 2004 and 2003, would
have approximated:
8
Three Months Ended Nine Months Ended
------------------ -----------------
(Dollars in thousands, except for per share data) 2004 2003 2004 2003
---- ---- ---- ----
Net Income as reported $1,499 $1,362 $4,078 $3,780
Deduct: Total stock-based compensation
expense determined under fair value based
method for all awards, net of related tax effects (5) (1) (14) (3)
------ ------ ------ ------
Pro forma net income $1,494 $1,361 $4,064 $3,777
====== ====== ====== ======
Earnings per common share:
As reported $ 0.33 $ 0.30 $ 0.90 $ 0.83
Pro forma $ 0.33 $ 0.30 $ 0.89 $ 0.83
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 nine months ended,
September 30, 2004 and 2003, consisted of the following components:
Three Months Ended Nine Months Ended
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
(dollars in thousands)
Service cost $102 $ 75 $306 $226
Interest cost on projected benefit obligation 109 98 327 294
Expected return on plan assets (90) (74) (271) (221)
Amortization of prior service cost 2 2 5 5
Amortization of transition asset - (2) - (6)
Amortization of net loss 20 19 61 56
---- ---- ---- ----
Net periodic benefit cost $143 $118 $428 $354
==== ==== ==== ====
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. Other Comprehensive income
The components of other comprehensive income and related tax effects for
the three and nine month periods ended September 30, 2004 and 2003, are as
follows:
Three Months Ended Nine Months Ended
------------------ -----------------
2004 2003 2004 2003
---- ---- ---- ----
(dollars in thousands)
Unrealized holding gains (losses)
on available-for-sale securities $ 586 $(466) $(319) $154
Reclassification adjustment for
gains realized in income - - (25) -
Reclassification adjustment for losses recognized
in income on impaired securities - - 41 -
Net unrealized gains (losses) 586 (466) (303) 154
Tax effect (199) 158 103 (52)
----- ----- ----- ----
Net of tax amount $ 387 $(308) $(200) $102
==== ===== ===== ====
9
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 its cost. The impact net of taxes on Net Income for the second
quarter and year to date was $27 thousand or less than $.01 per share.
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) financial
position as of September 30, 2004 and as of December 31, 2003, and its
results of operations for the three and nine months ended September 30,
2004 and 2003. This discussion should be read in conjunction with the
information in this document under Part I. Financial Statements and
accompanying related notes and with other financial information appearing
elsewhere in this filing. In the opinion of the Company's management, all
adjustments (consisting only of normal recurring adjustments) and
disclosures necessary for a fair presentation of the information contained
herein have been made. Management is not aware of the occurrence of any
events after September 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
this Quarterly Report.
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
10
values of collateral and various financial assets and liabilities
* the amount invested in new business opportunities and the
timing of these investments
When evaluating forward-looking statements to make decisions with respect
to the Company, investors and others are cautioned to consider these and
other risks and uncertainties and are reminded not to place undue reliance
on such statements. Forward-looking statements speak only as of the date
they are made and the Company undertakes no obligation to update them to
reflect new or changed information or events, except as may be required by
federal securities laws.
CRITICAL ACCOUNTING POLICIES
The Company has established various accounting policies which govern the
application of accounting principles generally accepted in the United
States of America in the preparation of the Company's financial statements.
Certain accounting policies involve significant judgments and assumptions
by management which have a material impact on the reported amount of
assets, liabilities, revenues and expenses and related disclosures of
contingent assets and liabilities in the consolidated financial statements
and accompanying 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, the
Company has 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 for loan losses to
increase or decrease and result in adjustments to the Company's provision
for loan losses. For additional information see FINANCIAL CONDITION -
Allowance for Loan Losses below. Although management believes 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, judgments or conditions.
OVERVIEW
The Company's net income for the quarter ended September 30, 2004 was $1.50
million, compared with net income of $1.36 million for the third quarter of
2003 or a 10.3% increase between years. Gross interest income increased
from $5.08 million for the quarter ending September 30, 2003 to $5.12
million for 2004. The Company expects growth to continue as the prime rate
was raised three times during the third quarter of 2004 which will have a
beneficial impact on gross interest income. There was also a decrease in
interest expense between quarters from $978 thousand in 2003 to $806 thousand
in 2004. Therefore, net interest income increased for the quarter ending
September 30, 2004 from $4.10 million for the same period in 2003 to $4.31
million for 2004.
11
The Company's total assets grew from $357 million at December 31, 2003 to
$360 million at September 30, 2004.
The following per share information and key ratios depict several
measurements of performance or financial condition for or at the quarters
and nine months ending September 30, 2004 and 2003, respectively:
Quarter Ended Year To Date
------------------------------ ------------------------------
September 30, September 30, September 30, September 30,
2004 2003 2004 2003
------------- ------------- ------------- -------------
Return on average assets (ROA) (1) 1.69% 1.56% 1.55% 1.48%
Return on average equity (ROE) (1) 14.47% 13.88% 13.26% 13.02%
Net interest margin (1), (2) 5.30% 5.22% 5.19% 5.22%
Efficiency ratio (3) 57.48% 59.26% 61.15% 61.91%
Net interest spread (4) 5.03% 4.95% 4.94% 4.91%
Loan to Deposit ratio 92.28% 91.80% 92.28% 91.80%
Net loan charge-offs to average loans 0.00% 0.00% 0.00% 0.00%
Allowance for loan losses to loans 1.12% 1.26% 1.12% 1.26%
Non-performing assets to total assets 0.07% 0.07% 0.07% 0.07%
Equity to assets 11.62% 11.43% 11.62% 11.43%
Total capital to risk weighted assets 18.12% 18.27% 18.12% 18.27%
Book value per share $ 9.20 $ 8.88 $ 9.20 $ 8.88
Earnings per share $ 0.33 $ 0.30 $ 0.90 $ 0.83
Dividends paid per share $ 0.22 $ 0.20 $ 0.66 $ 0.60
Dividend payout ratio (5) 66.78% 66.76% 73.64% 72.14%
Annualized
The ratio of tax equivalent net interest income to average earning
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 liabilities.
Dividends paid divided by net income.
The prime rate was static throughout the first half of 2004 at 4.00% which
was the lowest it had been since 1959. The prime rate was raised three
times during the third quarter at 25 basis points each time. The prime
rate is now 4.75%. The prime rate during 2003 was 4.25% until June 27,
2003, when it was lowered to 4.00%.
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 $207 thousand, or 5.0%, to $4.3 million for
the three months ended September 30, 2004, from $4.1 million for the three
months ended September 30, 2003. The net interest spread increased by 8
basis points to 5.03% for the three months ended September 30, 2004, from
4.95% for the three months ended September 30, 2003, as interest rates paid
on liabilities have not moved up as quickly as rates earned on assets in
response to the quarter's increases in the prime and market rates. The net
interest margin for the third quarter of 2004 increased 8 basis points to
5.30% from the third 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
12
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:
Three months ended September 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 $ 3,418 $ 11 1.27% $ 6,890 $ 14 0.83%
Interest bearing deposits in banks 6,703 53 3.15% 4,386 37 3.42%
Investments (1), (2) 44,577 529 4.95% 36,894 436 4.99%
Loans, net (1), (3) 273,059 4,523 6.63% 269,130 4,594 6.83%
-------- ------- ---- -------- ------- ----
Total interest-earning assets (1) 327,757 5,116 6.27% 317,300 5,081 6.44%
Cash and due from banks 12,696 17,872
Premises and equipment 4,965 4,540
Other assets 7,389 6,724
-------- --------
Total assets $352,807 $346,436
======== ========
Average Liabilities and
Stockholders' Equity:
Now accounts $ 44,883 $ 45 0.40% $ 43,670 $ 53 0.48%
Savings and money market accounts 112,153 206 0.73% 108,545 232 0.85%
Time deposits 90,866 468 2.04% 99,700 607 2.41%
Borrowed funds 9,391 87 3.63% 7,794 86 4.38%
-------- ------- ---- -------- ------- ----
Total interest-bearing liabilities 257,293 806 1.24% 259,709 978 1.49%
Non-interest bearing deposits 50,961 44,026
Other liabilities 3,353 3,757
-------- --------
Total liabilities 311,607 307,492
Stockholders' equity 41,200 38,944
-------- --------
Total liabilities and
stockholders' equity $352,807 $346,436
======== ========
Net interest income $ 4,310 $ 4,103
======= =======
Net interest spread (1) 5.03% 4.95%
==== ====
Net interest margin (1) 5.30% 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
Nine months ended September 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 $ 3,387 $ 24 0.92% $ 8,402 $ 62 0.99%
Interest bearing deposits in banks 6,622 155 3.11% 4,719 130 3.69%
Investments (1), (2) 44,691 1,534 4.78% 40,155 1,443 5.06%
Loans, net (1), (3) 269,048 13,172 6.58% 260,542 13,696 7.09%
-------- ------- ---- -------- ------- ----
Total interest-earning assets (1) 323,748 14,885 6.20% 313,818 15,331 6.62%
Cash and due from banks 15,240 15,713
Premises and equipment 4,790 4,582
Other assets 7,523 7,184
-------- --------
Total assets 351,301 $341,297
======== ========
Average Liabilities and
Stockholders' Equity:
Now accounts $ 44,422 $ 133 0.40% $ 42,128 $ 175 0.55%
Savings and money market accounts 111,625 619 0.74% 107,749 798 0.99%
Time deposits 93,350 1,449 2.07% 100,275 2,058 2.74%
Borrowed funds 9,742 266 3.59% 7,612 258 4.54%
-------- ------- ---- -------- ------- ----
Total interest-bearing liabilities 259,139 2,467 1.27% 257,764 3,289 1.71%
Non-interest bearing deposits 47,855 40,902
Other liabilities 3,221 3,818
-------- --------
Total liabilities 310,215 302,484
Stockholders' equity 41,086 38,813
-------- --------
Total liabilities and
stockholders' equity $351,301 $341,297
======== ========
Net interest income $12,418 $12,042
======= =======
Net interest spread (1) 4.94% 4.91%
==== ====
Net interest margin (1) 5.19% 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 September 30, 2004 Compared
To Three Months Ended September 30, 2003
Increase/(Decrease) Due to Change In
----------------------------------------------
Volume Rate Net
------ ---- ---
(dollars in thousands)
Interest-earning assets:
Federal funds sold and overnight deposits $ (7) $ 4 $ (3)
Interest bearing deposits in banks 20 (4) 16
Investments 98 (5) 93
Loans, net 67 (138) (71)
---- ------- -----
Total interest-earnings assets $178 $ (143) $ 35
Interest-bearing liabilities:
Now accounts $ 1 $ (9) $ (8)
Savings and money market accounts 8 (34) (26)
Time deposits (55) (84) (139)
Borrowed funds 19 (18) 1
---- ------- -----
Total interest-bearing liabilities $(27) $ (145) $(172)
---- ------- -----
Net change in net interest income $205 $ 2 $ 207
==== ======= =====
Nine Months Ended September 30, 2004 Compared
To Nine Months Ended September 30, 2003
Increase/(Decrease) Due to Change In
---------------------------------------------
Volume Rate Net
------ ---- ---
(dollars in thousands)
Interest-earning assets:
Federal funds sold and overnight deposits $(37) $ (1) $ (38)
Interest bearing deposits in banks 54 (29) 25
Investments 180 (89) 91
Loans, net 479 (1,003) (524)
---- ------- -----
Total interest-earnings assets $676 $(1,122) $(446)
Interest-bearing liabilities:
Now accounts $ 9 $ (51) $ (42)
Savings and money market accounts 30 (209) (179)
Time deposits (141) (468) (609)
Borrowed funds 76 (68) 8
---- ------- -----
Total interest-bearing liabilities $(26) $ (796) $(822)
---- ------- -----
Net change in net interest income $702 $ (326) $ 376
==== ======= =====
Quarter Ended September 30, 2004, compared to Quarter Ended September 30, 2003.
Interest and Dividend Income. The Company's interest and dividend income
increased by $35 thousand, to $5.12 million for the three months ended
September 30, 2004, from $5.08 million for the three months ended September
30, 2003, with average earning assets increasing by $10.5 million, or 3.3%,
to $327.8 million for the three months ended September 30, 2004, from
$317.3 million for the three months ended September 30, 2003. The increase
in interest income resulting from the growth in average earning assets was
tempered by the lower rates earned on those assets in 2004 versus 2003.
Average loans approximated $273.1 million for the three months ended
September 30, 2004, up from $269.1 million for the three months ended
September 30, 2003 or 1.5%, while at the same time the average yield on
loans declined from 6.83% for the September 30, 2003, quarter to 6.63% for
the 2004 quarter reflecting the lower rate environment for most of 2004.
The $4.3 million or 23.6% increase in commercial loans, the $2.0 million or
12.4% increase in loans to municipalities and the $13.6 million or 11.6%
increase in commercial real estate loans was partially
15
offset by the $1.2 million or 11.6% decrease in personal loans, the $585
thousand or 3.9% decrease in construction loans, and a $10.7 million, or
11.2% decrease in residential real estate secured loans. There was $6.0
million of residential real estate loans sold during the third quarter of
2004 and $19.1 million year to date as management continues to manage long
term interest rate risk by utilizing the secondary market for loan sales.
The average balance of investments (including mortgage-backed securities)
increased by $7.7 million to $44.6 million for the three months ended
September 30, 2004, from $36.9 million for the three months ended September
30, 2003. The increase in the investment portfolio in 2004 reflects the
movement out of low rate, short term federal funds sold and a reduction in
funds kept in non-interest earning Due From Bank accounts. The average
level of federal funds sold and overnight deposits decreased by $3.5
million or 50.4%, to $3.4 million for the three months ended September 30,
2004, from $6.9 million for the three months ended September 30, 2003. The
average balance in interest bearing deposits in banks increased by $2.3
million to $6.7 million from $4.4 million, or a 52.8% increase. Interest
income from non-loan instruments was $593 thousand for 2004 and $487
thousand for 2003 reflecting the increase in volume slightly offset by the
overall decrease in yields.
Interest Expense. The Company's interest expense decreased $172 thousand,
or 17.6%, to $806 thousand for the three months ended September 30, 2004,
from $978 thousand for the three months ended September 30, 2003, with
average interest-bearing liabilities decreasing $2.4 million, or 0.9%, to
$257.3 million for the three months ended September 30, 2004, from $259.7
million for the three months ended September 30, 2003. The decrease in
interest expense resulting from the decrease in interest-bearing
liabilities was in addition to the lower rates paid in 2004 versus 2003.
Average time deposits were $90.9 million for the three months ended
September 30, 2004, and $99.7 million for the three months ended September
30, 2003, or a decrease of 8.9%. The average balances for money market and
savings accounts increased by $3.6 million, or 3.3% to $112.2 million for
the three months ended September 30, 2004, from $108.5 million for the
three months ended September 30, 2003. The 2.8% or $1.2 million increase
in NOW accounts brought the average balance up to $44.9 million from $43.7
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 $7.8 million for the
three months ended September 30, 2003, to $9.4 million for the three months
ended September 30, 2004 as the Company's subsidiary had borrowed and
paid off two short term Federal Home Loan Bank (FHLB) of Boston bullet
advances totaling $5 million during 2004 for liquidity purposes to
temporarily fund asset growth. These were partially offset by continuing
pay downs on amortizing Federal Home Loan Bank advances.
Noninterest Income. The Company's noninterest income increased $54
thousand, or 6.5%, to $882 thousand for the three months ended September
30, 2004, from $828 thousand for the three months ended September 30, 2003.
Trust department income increased to $57 thousand for the three months of
2004 from $40 thousand in the same period of 2003 or a 42.5% increase
primarily due to fee increases implemented July 1, 2004, and 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 held for sale
was down between quarters at $62 thousand for 2004 and $90 thousand for 2003
as loans totaling $6.0 million were sold during this quarter of 2004 versus
$10.0 million in 2003. Service fees (sources of which include, among
others, deposit and loan servicing fees, ATM fees, and safe deposit fees)
increased $66 thousand or 10.1% to $718 thousand for the three months ended
September 30, 2004, from $652 thousand for the three months ended September
30, 2003. The majority of the increase was in overdraft fees which were
increased earlier in 2004, merchant program income, ATM/Debit Card income
and loan servicing fees. 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 $57
thousand, or 1.9%, to remain stable at $3.0 million for the three months
ended September 30, 2004 and 2003. Salaries increased in 2004 to $1.36
million from $1.30 million or 4.6%. Pension and employee benefits
decreased $98 thousand, or 19.4%, to $408 thousand for the three months
ended September 30, 2004, from $506 thousand for the three months ended
September 30, 2003, mainly due to refining the estimated 2004
16
pension plan costs as all the former eligible Citizens employees became
participants of the Union Bank Defined Benefit Pension Plan effective January
1, 2004, and a reduction in health insurance costs for the quarter. Net
occupancy expense increased $25 thousand, or 16.8%, to $174 thousand for
the three months ended September 30, 2004, from $149 thousand for the three
months ended September 30, 2003, mainly due to the increase in facility
rental expense and the allocation of property insurance costs. Equipment
expense increased $26 thousand or 11.6% to $250 thousand for the three
months ended September 30, 2004, from $224 thousand for the same period in
2003 due to the increase in depreciation expense. Net operation of other
real estate owned was $14 thousand for the three months ended September 30,
2004 compared to $34 thousand for the same period in 2003. Other operating
expenses were up $64 thousand or 8.5% to $818 thousand for the third
quarter of 2004 compared to $754 thousand for the same period in 2003 as
the third quarter of 2004 included increased training and supply costs due
to the implementation of imaging and Check 21. The quarter also included
an increase in other operating expenses of $22 thousand in advertising
costs as product brochures and ads were reworked.
Income Tax Expense. The Company's income tax expense increased by $67
thousand, or 11.7%, to $641 thousand for the three months ended September
30, 2004, from $574 thousand for the comparable period of 2003, mainly due
to increased net taxable income.
Year to Date September 30, 2004, compared to Year to Date September 30, 2003.
Interest and Dividend Income. The Company's interest and dividend income
decreased by $446 thousand, or 2.9%, to $14.9 million for the nine months
ended September 30, 2004, from $15.3 million for the nine months ended
September 30, 2003, reflecting the lower interest rate environment during the
first 6 months of 2004. Average earning assets increased $9.9 million, or
3.2%, to $323.7 million for the nine months ended September 30, 2004, from
$313.8 million for the nine months ended September 30, 2003. Average loans
approximated $269.0 million for the nine months ended September 30, 2004,
up from $260.5 million for the nine months ended September 30, 2003. The
net $8.5 million increase was net of sales of residential real estate loans
during the first nine months of 2004 of $19.1 million. Average residential
real estate loans decreased $10.7 million or 11.2% from $95.1 million for
2003 to $84.4 million for 2004. Average construction loan volume increased
$.4 million or 2.9% from $13.5 million in 2003 to $13.9 million in 2004.
Average commercial real estate loans increased $15.2 million or 13.6% from
$111.8 million in 2003 to $127.0 million in 2004. And, average municipal
loans increased $2.6 million or 18.6% from $14.0 million in 2003 to $16.6
million in 2004. In addition to the reduction resulting from the sales of
residential real estate loans of $19.1 million, average consumer loans
dropped $1.1 million or 12.4% from $10.0 million in 2003 to $8.9 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 $4.5 million, or 11.3%, to $44.7 million for the
nine months ended September 30, 2004, from $40.2 million for the nine
months ended September 30, 2003. The average level of federal funds sold
and overnight deposits decreased by $5.0 million or 59.7%, to $3.4 million
for the nine months ended September 30, 2004, from $8.4 million for the
nine months ended September 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 $1.9 million to $6.6 million from
$4.7 million, or a 40.3% increase. Interest income from non-loan
instruments was $1.7 million for 2004 and $1.6 million for 2003 reflecting
the decrease in yields offset slightly by the overall $1.4 million increase
in volume and the slight lengthening of the portfolio's duration.
Interest Expense. The Company's interest expense decreased by $822
thousand, or 25.0%, to $2.5 million for the nine months ended September 30,
2004, from $3.3 million for the nine months ended September 30, 2003
reflecting the low interest rate environment. This reduction in interest
expense occurred despite an increase of $1.4 million in average interest-
bearing liabilities to $259.1 million for the nine months ended September
30, 2004, from $257.8 million for the nine months ended September 30, 2003.
Average time deposits were $93.4 million for the nine months ended
September 30, 2004, and $100.3 million for the nine months ended September
30, 2003, or a decrease of 6.9%. The average balances for money market and
savings accounts increased by $3.9 million, or 3.6% to $111.6 million for
the nine months ended September 30, 2004, from $107.7 million for the nine
months ended
17
September 30, 2003. The 5.4% increase in NOW accounts brought the average
balance up to $44.4 million from $42.1 million.
Customers have maintained very liquid positions during the last two years
as management believes they anticipate interest rates paid on deposit
instruments will rise and as stock market volatility continues.
The average balance on funds borrowed increased from $7.6 million at
September 30, 2003 to $9.7 million at September 30, 2004, as the Company
borrowed and subsequently paid off 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 $180
thousand, or 7.1%, to $2.7 million for the nine months ended September 30,
2004, from $2.5 million for the nine months ended September 30, 2003. The
current year includes net gains on the sales of securities of $25 thousand
where there were no sales during the nine months of 2003. The results for
the period reflected a net gain of $296 thousand from the sales of $19.1
million of loans held for sale compared to a $317 thousand gain from the
$19.1 million of sales during 2003. The company sold, in both years, many
of the newer, lower rate, long term residential real estate loans into the
secondary market to mitigate interest rate risk. Trust department income
increased to $148 thousand for the nine months of 2004 from $120 thousand in
the same period of 2003, or a 23.3% increase, primarily due to the increase
in July of 2004 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 $100
thousand, or 5.1%, to $2.1 million for the nine months ended September 30,
2004, from 2.0 million for the nine months ended September 30, 2003. Other
income in 2004 was $171 thousand, up 39.0% from $123 thousand in 2003.
This reflects a $24 thousand increase between years in net servicing rights
mainly due to the sales of loans discussed earlier and an increase of $27
thousand in income from the cash surrender value of life insurance.
Noninterest Expense. The Company's noninterest expense increased $199
thousand, or 2.2%, to $9.3 million for the nine months ended September 30,
2004, from $9.1 million for the nine months ended September 30, 2003.
Salaries increased $18 thousand, or 0.4%, to $4.1 million for both the nine
months ended September 30, 2004, and 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 $100 thousand, or 7.0%,
to $1.5 million for the nine months ended September 30, 2004, from $1.4
million for the nine months ended September 30, 2003, mainly due to an $88
thousand increase in employee group insurance plans costs and a $20
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. This was partially offset by
the elimination for 2004 of the profit-sharing component of the defined
contribution plan. Net occupancy expense increased $49 thousand, or
9.7%, to $555 thousand for the nine months ended September 30, 2004, from
$506 thousand for the nine months ended September 30, 2003 mainly due to
the allocation of property insurance and higher building maintenance costs
during the first half of 2004. Equipment expense increased $20 thousand or
3.0% to $691 thousand for the nine months ended September 30, 2004, from
$671 thousand for the same period in 2003. Net operation of other real
estate owned was $49 thousand for the nine months ended September 30, 2004
compared to $113 thousand for the same period in 2003. Other operating
expenses were relatively flat at $2.4 million for the first nine months of
2004 and 2003 only increasing $76 thousand or 3.2% between years. There were
no merger related expenses of the subsidiaries or stock split expenses 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)
Advertising expense has risen from $112 thousand for 2003 to $171 thousand
for 2004 as the Company changed to a contract basis for most of our radio
and print ads, the brochures and advertisements utilized have been
freshened, and new products or services were added.
18
Income Tax Expense. The Company's income tax expense increased by $143
thousand, or 9.3%, to $1.7 million for the nine months ended September 30,
2004, from $1.5 million for the comparable period of 2003, mainly due to
increased taxable income.
FINANCIAL CONDITION
At September 30, 2004, the Company had total consolidated assets of $360
million, including net loans and loans held for sale of $282 million,
deposits of $309 million and stockholders' equity of $42 million. The
Company's total assets increased by $3 million to $360 million at September
30, 2004, from $357 million at December 31, 2003.
Total net loans and loans held for sale increased by $13.0 million or 4.9% to
$281.6 million or 78.1% of total assets at September 30, 2004, as compared to
$268.6 million or 75.3% of total assets at December 31, 2003. Cash and cash
equivalents, including federal funds sold and overnight deposits, decreased
$7.6 million or 30.8% to $17.0 million at September 30, 2004 from $24.5
million at December 31, 2003 as funds were moved into longer term interest
earning assets.
Securities available-for-sale decreased from $44.4 million at December 31,
2003 to $42.0 million at September 30, 2004, a $2.4 million or 5.4%
decrease as loan demand continued to be strong.
Deposits increased $3.3 million or 1.1% to $308.7 million at September 30,
2004, from $305.4 million at December 31, 2003. Total borrowings decreased
$.5 million to $6.7 million at September 30, 2004, from $7.2 million at
December 31, 2003, as the subsidiary bank continued to pay down 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 September 30, 2004, the Company's gross loan portfolio
totaled $284.9 million, or 79.0 %, of assets, of which $117.9 million, or
41.4% of gross loans, consisted of residential mortgages and construction
loans, and $114.9 million, or 40.3%, of total loans consisted of commercial
real estate loans. As of such date, the Company's loan portfolio also
included $21.4 million of commercial loans, $21.6 million of municipal
loans, and $9.0 million of consumer loans representing, in order, 7.5%,
7.6% and 3.2% of total loans outstanding on September 30, 2004.
Gross loans and loans held for sale have increased $13.1 million or 4.8%
since December 31, 2003. An increase of $10.3 million or 10.1% in
commercial real estate loans, an increase of $3.4 million or 19.2% in
commercial loans, an increase in municipal loans of $6.3 million or 40.8%,
an increase of $2.4 million or 2.3% in residential real estate loans, were
partially offset by a decrease of $9.0 million or 48.4% in loans held for
sale and a $.4 million or 4.1% decrease in consumer loans. The Company
sold $19.1 million of loans held for sale during the first nine months of
2004.
The following table shows information on the composition of the Company's
loan portfolio as of September 30, 2004 and December 31, 2003:
Loan Type September 30, 2004 December 31, 2003
- --------- ------------------ -----------------
(dollars in thousands)
Real Estate $110,668 38.8% $108,231 39.8%
Commercial real estate 112,712 39.5% 102,366 37.7%
Commercial 21,303 7.5% 17,877 6.6%
Consumer 9,018 3.2% 9,402 3.5%
Municipal loans 21,613 7.6% 15,346 5.6%
Loans held for sale 9,565 3.4% 18,524 6.8%
-------- ----- -------- -----
Total loans 284,879 100.0% 271,746 100.0%
Deduct:
Allowance for loan losses (3,093) (3,029)
Net unearned loan fees, premiums & discounts (188) (185)
-------- --------
Total net loans and loans held for sale $281,598 $268,532
======== ========
19
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 the interest
margin from the effect of making long term loans in a historically low
interest rate environment. The Company services an $183 million residential
mortgage portfolio, approximately $73 million of which is serviced for
unaffiliated third parties at September 30, 2004. Additionally, the Company
originates commercial real estate and commercial loans under various SBA
programs that provide an agency guarantee for a portion of the loan amount.
The Company occasionally sells the guaranteed portion of the loan to other
financial concerns and will retain servicing rights, which generates fee
income. The Company serviced $4.6 million of commercial and commercial real
estate loans for unaffiliated third parties as of September 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 $307 thousand at September 30, 2004, with an estimated market
value of $397 thousand.
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 September 30, 2004 was $7.2
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 $1.6 million or .57% of
gross loans and loans held for sale at September 30, 2004 and $1.6 million or
0.58% at December 31, 2003. The aggregate interest income not recognized on
such nonaccrual loans amounted to approximately $406 thousand and $411
thousand as of September 30, 2004 and 2003, respectively.
The Company had $836 thousand and $1.7 million in loans past due 90 days or
more and still accruing interest at September 30, 2004 and December 31, 2003,
respectively. At September 30, 2004, the Company had internally classified
certain loans totaling $1.8 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
20
credit policy, loans are internally classified when a review indicates any of
the following conditions makes the likelihood of collection uncertain:
* the financial condition of the borrower is unsatisfactory;
* repayment terms have not been met;
* the borrower has sustained losses that are sizable, either in
absolute terms or relative to net worth;
* confidence is diminished;
* loan covenants have been violated;
* collateral is inadequate; or
* other unfavorable factors are present.
At September 30, 2004, the Company had acquired by foreclosure or through
repossession real estate worth $200 thousand, consisting of one commercial
property which is currently under contract to sell. 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 loan losses deemed necessary in the
first half of 2004 and the provision was $30 thousand for the third quarter
of 2004. 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 September 30, 2004, the methodology used to determine
the provision and allowance 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 and nine months ended September 30, 2004 and 2003:
21
Three Months Nine Months
Ended, September 30, Ended, September 30,
-------------------- --------------------
2004 2003 2004 2003
---- ---- ---- ----
(dollars in thousands)
Balance at the beginning of period $3,023 $2,993 $3,029 $2,908
Charge-offs
Real Estate 3 - 37 17
Commercial 13 - 13 10
Consumer and other 20 7 25 43
------ ------ ------ ------
Total charge-offs 36 7 75 70
------ ------ ------ ------
Recoveries
Real Estate - 1 - 2
Commercial 66 1 71 26
Consumer and other 10 14 38 52
------ ------ ------ ------
Total recoveries 76 16 109 80
------ ------ ------ ------
Net recoveries 40 9 34 10
Provision for loan losses 30 30 30 114
------ ------ ------ ------
Balance at end of period $3,093 $3,032 $3,093 $3,032
====== ====== ====== ======
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:
September 30, 2004 December 31, 2003
------------------- -----------------
(dollars in thousands)
Amount Percent Amount Percent
------ ------- ------ -------
Real Estate
Residential $ 502 31.3% $ 525 31.9%
Commercial 1,799 40.9% 1,578 42.7%
Construction 208 7.5% 183 7.2%
Other Loans
Commercial 363 7.7% 336 7.1%
Consumer installment 139 3.3% 145 3.7%
Home equity loans 28 1.4% 25 1.3%
Municipal, Other and
Unallocated 54 7.9% 237 6.1%
------ ----- ------ -----
Total $3,093 100% $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 1.12% 1.20%
----- -----
Annualized
Management of the Company believes that the allowance for loan losses at
September 30, 2004, is adequate to cover losses inherent in the Company's
loan portfolio as of such date. However there can
22
be no assurance that the Company will not sustain losses in future periods,
which could be greater than the size of the allowance at September 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 September 30, 2004, the reported value of
investment securities available-for-sale was $42.0 million or 11.6% of its
assets. The Company had no securities classified as held-to-maturity or
trading. The reported value of securities available-for-sale at September
30, 2004, reflects a positive valuation adjustment of $850 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). Two
agency mortgage backed securities have been in a loss position for more
than 12 months as of September 30, 2004, with a market value of $799
thousand and an unrealized loss of $26 thousand. Management believes that
the Company has the ability to hold these securities to maturity if
necessary to ultimately recover its cost and has not identified any credit
quality issues that would lead management 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 September
30, 2004 and December 31, 2003:
Nine Months Ended, Year Ended
September 30, 2004 December 31, 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 $ 47,855 16.1% $ 42,341 14.4%
Now accounts 44,422 14.9% 0.40% 43,349 14.7% 0.51%
Money Markets 64,500 21.7% 0.85% 64,417 21.9% 1.05%
Savings 47,125 15.9% 0.58% 44,574 15.2% 0.81%
-------- ----- -------- -----
Total non-time deposits: 203,902 68.6% 194,681 66.2%
-------- ----- -------- -----
Time deposits:
Less than $100,000 66,447 22.4% 1.99% 72,084 24.5% 2.70%
$100,000 and over 26,903 9.0% 2.25% 27,348 9.3% 2.43%
-------- ----- -------- -----
Total time deposits 93,350 31.4% 2.07% 99,432 33.8% 2.62%
-------- ----- -------- -----
Total deposits $297,252 100.0% 0.99% $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 September 30,
2004 and December 31, 2003, that mature during the periods indicated:
23
September 30, 2004 December 31, 2003
------------------ -----------------
(dollars in thousands)
Within 3 months $ 8,955 $ 9,399
3 to 6 months 13,155 16,264
6 to 12 months 2,983 3,820
Over 12 months 388 379
------- -------
$25,481 $29,862
======= =======
Borrowings. Borrowings from the Federal Home Loan Bank of Boston (FHLB)
were $6.7 million at September 30, 2004, at a weighted average rate of
4.52%, and $7.2 million at December 31, 2003, at a weighted average rate of
4.43%. The change between year end 2003 and the end of the third quarter
of 2004 is a net decrease of $.5 million which was comprised of borrowing
$475 thousand in a long-term amortizing advance to match funding on a new
loan offset by continuing paydowns on amortizing advances.
OTHER FINANCIAL CONSIDERATIONS
Market Risk and Asset and Liability Management. Market risk is the risk of
loss in a financial instrument arising from adverse changes in market
prices and rates, foreign currency exchange rates, commodity prices and
equity prices. The Company's market risk arises primarily from interest
rate risk inherent in its lending, investing and deposit taking activities
as yields on assets change in a different time period or in a different
amount from that of interest costs on liabilities. Many other factors also
affect the Company's exposure to changes in interest rates, such as general
economic and financial conditions, competitive pressures, customer
preferences, and historical pricing relationships.
The earnings of the Company and its principal subsidiary are affected not
only by general economic conditions, but also by the monetary and fiscal
policies of the United States and its agencies, particularly the Federal
Reserve System. The monetary policies of the Federal Reserve System
influence to a significant extent the overall growth of loans, investments
and deposits; the level of interest rates earned on assets and paid for
liabilities; and interest rates charged on loans and paid on deposits. The
nature and impact of future changes in monetary policies are often not
predictable.
A key element in the process of managing market risk involves direct
involvement by senior management and oversight by the Board of Directors as
to the level of risk assumed by the Company in its balance sheet. The
Board of Directors reviews and approves risk management policies, including
risk limits and guidelines and reviews quarterly the 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 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.
Members of the Company's ALCO meet 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.
24
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 $12.2 million for the first nine months of 2004 compared to actual
results of $12.4 million, in a rate environment which was flat until July
1, 2004, and has had three 25 basis point prime rate increases since that
date. Net income was projected to be $3.7 million in a flat rate
environment compared to actual results of $4.1 million. Return on Assets
was projected to be 1.40% in a flat rate environment and actual results
were 1.55%. Return on Equity was projected to be 12.17% in a flat rate
environment compared to actual of 13.26%.
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.
The Company generally requires collateral or other security to support
financial instruments with credit risk. As of September 30, 2004, the
contract or notional amount of financial instruments whose contract or
notional amount represents credit risk was as follows rounded to the
nearest thousand:
Commitments to extend credit $41,396
Standby letters of credit 1,120
Credit Card arrangements 2,340
Home Equity Lines of Credit 5,900
-------
Total $50,756
=======
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 nature of the Company's contractual obligations with off balance sheet
risk at September 30, 2004, are substantially unchanged from December 31,
2003, but the volume has grown $13.3 million or 35.7% from $37.4 million at
December 31, 2003. Loan demand has continued to be very strong throughout
2004 especially on the commercial lending side of the Bank.
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.
25
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 estimated
prepayments based on the historical results of a prepayment model
utilized by the Company; and
* NOW, money market, 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.
26
The following table shows the Company's rate sensitivity analysis as of
September 30, 2004:
Cumulative repriced within
3 Months 4 to 12 1 to 3 3 to 5 Over 5
or less Months Years Years Years Total
-------- ------- ------ ------ ------ -----
(dollars in thousands, by repricing date)
Interest sensitive assets:
Federal funds sold and
overnight deposits $ 2,285 $ - $ - $ - $ - $ 2,285
Interest bearing deposits in banks 1,469 1,485 2,776 1,179 - 6,909
Securities available-for-sale (1) 4,241 9,163 12,123 7,719 7,659 40,905
FHLB Stock - - - - 1,241 1,241
Loans and loans held for sale (2) 166,443 50,686 38,837 15,799 12,926 284,691
-------- -------- -------- -------- --------- --------
Total interest sensitive assets $174,438 $ 61,334 $ 53,736 $ 24,697 $ 21,826 $336,031
-------- -------- -------- -------- --------- --------
Interest sensitive liabilities:
Time deposits $ 24,061 $ 41,872 $ 20,615 $ 2,671 $ - $ 89,219
Money markets 10,171 - - - 58,609 68,780
Regular savings 8,271 - - - 39,947 48,218
NOW accounts 16,760 - - - 29,728 46,488
Borrowed funds (3) 302 927 2,631 2,880 - 6,740
-------- -------- -------- -------- --------- --------
Total interest sensitive liabilities $ 59,565 $ 42,799 $ 23,246 $ 5,551 $ 128,284 $259,445
-------- -------- -------- -------- --------- --------
Net interest rate sensitivity gap $114,873 $ 18,535 $ 30,490 $ 19,146 $(106,458) $ 76,586
Cumulative net interest rate
sensitivity gap $114,873 $133,408 $163,898 $183,044 $ 76,586
Cumulative net interest rate
sensitivity gap as a
percentage of total assets 31.88% 37.02% 45.48% 50.79% 21.25%
Cumulative net interest rate sensitivity
gap as a percentage of total
interest-sensitive assets 34.18% 39.70% 48.77% 54.47% 22.79%
Cumulative net interest rate sensitivity
gap as a percentage of total
interest-sensitive liabilities 44.28% 51.42% 63.17% 70.55% 29.52%
Securities available-for-sale exclude marketable equity securities
with a fair value of $1.1 million that may be sold by the Company at
any time.
Balances shown net of unearned income of $188 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 loan 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.
27
The following chart reflects the results of the 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 and down 300 basis points from the
September 30, 2004, prime rate of 4.75%, these are highest internal slopes
monitored.
UNION BANKSHARES, INC.
INTEREST RATE SENSITIVITY ANALYSIS MATRIX
September 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 7.75 17,044 5.0 6,198 1.74 14.97 8.75
4.75 16,233 0.0 5,662 1.60 13.72 11.43
1.75 15,391 (5.2) 5,107 1.45 12.41 13.67
December-05 7.75 22,159 28.4 9,085 2.46 20.17 8.44
4.75 17,252 0.0 5,977 1.58 13.50 11.70
1.75 11,912 (30.9) 2,221 0.61 5.45 14.66
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 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 $4.4 million at September 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 September 30, 2004, there were no
balances outstanding on either.
While scheduled loan and securities payments and FHLB advances are
relatively predictable sources of funds, deposit flows and prepayments on
loans and mortgage-backed securities are greatly influenced
28
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 74.4% of the Company's time deposits will mature
within twelve months, management believes, based upon past experience, that
Union Bank will retain a substantial portion of these deposits. Management
will continue to offer a competitive but prudent pricing strategy to
facilitate retention of such deposits. Any reduction in total deposits
could be offset by purchases of federal funds, short-term FHLB of Boston
borrowings, or liquidation of investment securities or loans held for sale.
Such steps could result in an increase in the Company's cost of funds and
adversely impact the net interest margin. Management believes the Company
has sufficient liquidity to meet all reasonable borrower, depositor, and
creditor needs in the present economic environment. However, any
projections of future cash needs and flows are subject to substantial
uncertainty. The Company continually evaluate opportunities to buy/sell
securities and loans held-for-sale, obtain credit facilities from lenders,
or restructure debt for strategic reasons or to further strengthen our
financial position.
CAPITAL RESOURCES
The Company's capital management is designed to maintain an optimum level of
capital in a cost-effective structure that: meets target regulatory ratios;
supports the internal assessment of economic capital; funds business
strategies; and builds long-term stockholder value. In support of the latter
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 total dollar value of Union's stockholders' equity was $41.9 million at
September 30, 2004 reflecting net income of $4.1 million for the first nine
months of 2004, less dividends paid of $3.0 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 September 30, 2004, the
Company had 4,912,161 shares issued, of which, 4,551,213 were outstanding
and 360,948 were held in Treasury. Also as of September 30, 2004, there
were outstanding employee incentive stock options with respect to 16,025
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.
During the quarter ended September 30, 2004, the Company did not grant any
incentive stock options pursuant to its 1998 Incentive Stock Option Plan.
During that same period, 300 incentive stock options granted pursuant to
the 1998 plan were exercised.
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.
Union Bank and Union Bankshares, Inc. are subject to various regulatory
capital requirements administered by the federal banking agencies.
Management believes, as of September 30, 2004, that they both meet all
capital adequacy requirements to which they are subject. As of September
30, 2004, the most recent calculations categorize both as well capitalized
under the regulatory framework for prompt corrective action.
29
To be categorized as well capitalized, the companies must maintain minimum
total risk-based, Tier I risk-based, and Tier I leverage ratios as set
forth in the table below. There are no conditions or events since September
30, 2004 that management believes have changed either company's category.
Union Bank's and the Company's actual capital amounts and ratios as of
September 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)
Total capital to risk weighted assets
Union Bank $43,670 17.82% $19,605 8.0% $24,506 10.0%
Company $44,503 18.12% $19,648 8.0% $24,560 10.0%
Tier I capital to risk weighted assets
Union Bank $40,487 16.52% $ 9,803 4.0% $14,705 6.0%
Company $41,314 16.82% $ 9,825 4.0% $14,737 6.0%
Tier I capital to average assets
Union Bank $40,487 11.51% $14,070 4.0% $17,588 5.0%
Company $41,314 11.71% $14,112 4.0% n/a n/a
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 caption "OTHER FINANCIAL CONSIDERATIONS" in Part I,
Item 2 on pages 24 through 29 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 objectives, the Company
intends to continue to examine, refine and formalize its disclosure
controls and procedures and to monitor ongoing developments in this area.
30
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. Unregistered Sales of Equity Securites and Use of Proceeds
During the quarter ended September 30, 2004, incentive stock options
previously granted pursuant to the Company's 1998 Incentive Stock Option
Plan ("Plan") were exercised by one participant, with respect to an
aggregate of 300 shares, at an aggregate exercise price of $4,700.
Participation in the Plan is limited to those senior officers of the
corporation or its 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 6. Exhibits
10.1 Form of Stock Option Agreement for awards under 1998 Incentive
Stock Option Plan.
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.
31
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.
November 12, 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
10.1 Form of Stock Option Agreement for awards under 1998 Incentive Stock
Option Plan.
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