UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2002
Commission File No. 0-20293
UNION BANKSHARES CORPORATION (Exact name of registrant as specified in its charter)
Virginia
54-1598552
(State of Incorporation)
(I.R.S. Employer Identification No.)
212 North Main Street
P.O. Box 446
Bowling Green, Virginia 22427
(Address of principal executive offices)
(804) 633-5031
(Registrant’s telephone number)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $2 PAR VALUE Indicate by checkmark 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 o
As of July 29, 2002, Union Bankshares Corporation had 7,559,567 shares of Common Stock outstanding.
UNION BANKSHARES CORPORATION FORM 10-Q June 30, 2002
INDEX
PART 1 –FINANCIAL INFORMATION
Page
Item 1 –Financial Statements
Consolidated Balance Sheets as of June 30, 2002 (Unaudited) and December 31, 2001 (Audited)
1
Consolidated Statements of Income (Unaudited) For the three months and six months ended June 30, 2002 and 2001
2
Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) For the six months ended June 30, 2002 and 2001
3
Consolidated Statements of Cash Flows (Unaudited) For the six months ended June 30, 2002 and 2001
4
Notes to Consolidated Financial Statements (Unaudited)
5 - 10
Item 2 –Management’s Discussion and Analysis of Financial Condition and Results of Operations
11 - 21
Item 3 –Quantitative and Qualitative Disclosures about Market Risk
22 - 23
PART II –OTHER INFORMATION
Item 1 –Legal Proceedings
24
Item 2 –Changes in Securities and Use of Proceeds
Item 3 –Defaults Upon Senior Securities
Item 4 –Submission of Matters to a Vote of Security Holders
Item 5 –Other Information
Item 6 –Exhibits and Reports on Form 8-K
Signatures
25
Index to Exhibits
26
PART 1 - FINANCIAL INFORMATION Item 1. Financial Statements
UNION BANKSHARES CORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS (dollars in thousands, except share information)
June 30, 2002
December 31, 2001
ASSETS
(Unaudited)
Cash and cash equivalents:
Cash and due from banks
$
25,160
28,769
Interest-bearing deposits in other banks
1,276
462
Money market investments
98
2,023
Federal funds sold
4,067
7,661
Total cash and cash equivalents
30,601
38,915
Securities available for sale, at fair value
260,375
257,062
Loans held for sale
19,423
43,485
Loans, net of unearned income
670,160
600,164
Less allowance for loan losses
8,434
7,336
Net loans
661,726
592,828
Bank premises and equipment, net
19,848
19,191
Other real estate owned
1,087
768
Other assets
28,695
30,848
Total assets
1,021,755
983,097
LIABILITIES AND STOCKHOLDERS’ EQUITY
Noninterest-bearing demand deposits
119,054
110,913
Interest-bearing deposits:
NOW accounts
121,547
112,940
Money market accounts
84,050
79,176
Savings accounts
78,114
72,897
Time deposits of $100,000 and over
131,578
133,629
Other time deposits
279,329
274,529
Total interest-bearing deposits
694,618
673,171
Total deposits
813,672
784,084
Securities sold under agreements to repurchase
37,590
41,083
Long-term borrowings
62,275
62,731
Other liabilities
10,461
6,220
Total liabilities
923,998
894,118
Commitments and contingencies
Stockholders’ equity:
Common stock, $2 par value. Authorized 24,000,000 shares; issued and outstanding, 7,559,567 , and 7,525,912 shares, respectively
15,119
15,052
Surplus
1,011
446
Retained earnings
76,046
71,419
Accumulated other comprehensive income
5,581
2,062
Total stockholders’ equity
97,757
88,979
Total liabilities and stockholders’ equity
See accompanying notes to consolidated financial statements.
UNION BANKSHARES CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME (Unaudited) (dollars in thousands, except per share amounts)
Three Months Ended June 30,
Six Months Ended June 30,
2002
2001
Interest and dividend income :
Interest and fees on loans
12,472
13,025
24,669
26,170
Interest on Federal funds sold
37
55
93
127
Interest on interest-bearing deposits in other banks
10
7
18
Interest on money market investments
6
—
12
Interest and dividends on securities:
Taxable
2,432
2,223
4,873
4,419
Nontaxable
1,168
1,176
2,332
2,358
Total interest and dividend income
16,119
16,489
31,986
33,092
Interest expense:
Interest on deposits
5,034
7,128
10,249
14,265
Interest on short-term borrowings
116
408
223
731
Interest on long-term borrowings
922
995
1,835
2,201
Total interest expense
6,072
8,531
12,307
17,197
Net interest income
10,047
7,958
19,679
15,895
Provision for loan losses
739
393
1,569
825
Net interest income after provision for loan losses
9,308
7,565
18,110
15,070
Noninterest income:
Service charges on deposit accounts
1,015
954
1,860
1,872
Other service charges, commissions and fees
650
662
1,305
1,231
Gains (losses) on securities transactions, net
(162
)
9
(161
30
Gains on sales of loans
2,071
2,121
4,214
3,931
Gains on sales of other real estate owned and bank premises, net
67
72
82
84
Other operating income
191
271
360
554
Total noninterest income
3,832
4,089
7,660
7,702
Noninterest expenses:
Salaries and benefits
5,082
4,801
10,145
9,273
Occupancy expenses
518
1,108
1,061
Furniture and equipment expenses
653
698
1,354
1,428
Other operating expenses
2,360
1,954
4,691
3,967
Total noninterest expenses
8,649
7,971
17,298
15,729
Income before income taxes
4,491
3,683
8,472
7,043
Income tax expense
1,038
797
1,961
1,487
Net income
3,453
2,886
6,511
5,556
Basic net income per share
0.46
0.38
0.86
0.74
Diluted net income per share
0.45
UNION BANKSHARES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY SIX MONTHS ENDED JUNE 30, 2002 AND 2001 (dollars in thousands)
Common Stock
Retained Earnings
Accumulated Other Comprehensive Income (Loss)
Comprehensive Income
Total
Balance - December 31, 2000
15,033
403
63,201
(285
78,352
Comprehensive income:
Net income - for six months ended June 30, 2001
Unrealized holding gains arising during the period (net of tax, $1,494)
2,900
Reclassification adjustment for gains included in net income (net of tax, $10)
(20
Other comprehensive income (net of tax, $1,484)
2,880
Total comprehensive income
8,436
Cash dividends - 2001 ($.44 per share semi annually)
(1,658
Issuance of common stock under Dividend Reinvestment Plan (12,930 shares)
168
194
Stock repurchased under Stock Repurchase Plan (25,300 shares)
(50
(348
(398
Issuance of common stock in exchange for net assets in acquisition (19,606 shares)
39
192
231
Balance - June 30, 2001 (Unaudited)
15,048
415
67,099
2,595
85,157
Balance - December 31, 2001
Net income - for six months ended June 30, 2002
Unrealized holding gains arising during the period (net of tax, $1,758)
3,413
Reclassification adjustment for loss included in net income (net of tax, $55)
106
Other comprehensive income (net of tax, $1,813)
3,519
10,030
Cash dividends - 2002 ($.50 per share semi annually)
(1,884
Issuance of common stock under Dividend Reinvestment Plan (9,549 shares)
19
196
215
Issuance of common stock under Incentive Stock Option Plan (6,950 shares)
14
70
Issuance of common stock in exchange for net assets in acquisition (17,156 shares)
34
299
333
Balance - June 30, 2002 (Unaudited)
UNION BANKSHARES CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows (Unaudited) Six Months Ended June 30, 2002 and 2001 (dollars in thousands)
Operating activities:
Adjustments to reconcile net income to net cash andcash equivalents provided by (used in)operating activities:
Depreciation of bank premises and equipment
988
949
Amortization
991
631
(Gains) losses on sales of securities available for sale
161
(30
Gains on sales of other real estate owned and fixed assets, net
(82
(84
(Increase) decrease in loans held for sale
24,062
(13,287
Increase (decrease) in other assets
232
(455
(Increase) decrease in other liabilities
4,240
(671
Net cash and cash equivalents provided by (used in) operating activities
38,672
(6,566
Investing activities:
Purchase of securities available for sale
(24,364
(18,305
Proceeds from sale of securities available for sale
5,250
613
Proceeds from maturities of securities available for sale
20,643
11,628
Net increase in loans
(70,946
(7,420
Purchases of bank premises and equipment
(2,037
(428
Proceeds from sales of bank premises and equipment
218
16
Proceeds from sales of other real estate owned
195
861
Net cash and cash equivalents used in investing activities
(71,041
(13,035
Financing activities:
Net increase in noninterest-bearing deposits
8,141
7,402
Net increase in interest-bearing deposits
21,447
21,125
Net increase (decrease) in short-term borrowings
(3,492
17,925
Net decrease in long-term borrowings
(456
(10,548
Issuance of common stock
Purchase of common stock
Cash dividends paid
Net cash and cash equivalents provided by financing activities
24,055
34,042
Increase (decrease) in cash and cash equivalents
(8,314
14,441
Cash and cash equivalents at beginning of period
22,869
Cash and cash equivalents at end of period
37,310
Supplemental Disclosure of Cash Flow Information
Cash payments for:
Interest
12,552
17,412
Income taxes
2,017
1,106
UNION BANKSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited) June 30, 2002
1.
ACCOUNTING POLICIES
The consolidated financial statements include the accounts of Union Bankshares Corporation and its subsidiaries (the “Company”). Significant intercompany accounts and transactions have been eliminated in consolidation.
The information contained in the financial statements is unaudited and does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of the interim periods presented have been made. Operating results for the three and six month periods ended June 30, 2002 are not necessarily indicative of the results that may be expected for the year ending December 31, 2002.
These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2001 Annual Report. Certain previously reported amounts have been reclassified to conform to current period presentation.
2.
ALLOWANCE FOR LOAN LOSSES
The following summarizes activity in the allowance for loan losses for the six months ended June 30, (in thousands):
Balance, January 1
7,389
Provisions charged to operations
Recoveries credited to allowance
154
Loans charged off
(702
(452
Balance, June 30
7,916
5
3.
EARNINGS PER SHARE
Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of shares outstanding during the period. Diluted EPS is computed using the weighted average number of common shares outstanding during the period, including the effect of dilutive potential common shares outstanding attributable to stock options. At June 30, 2002 there were no stock options that were anti-dilutive. The following is a reconcilement of the denominators of the basic and diluted EPS computations for the three and the six months ended June 30, 2002 and 2001.
(In thousands except per share data )
Earnings per common share computation:
Numerator: Net Income
Denominator: Average common shares outstanding
7,552
7,537
7,544
7,527
Earnings per common share
Diluted earnings per common share computation:
Dilutive shares contingently issuable
15
59
Average diluted common shares outstanding
7,624
7,603
7,543
Diluted earnings per share
4.
SEGMENT REPORTING DISCLOSURES
Union Bankshares Corporation has two reportable segments: traditional full service community banking and mortgage loan origination. The community bank segment includes four banks which provide loan, deposit, investment, and trust services to retail and commercial customers throughout their locations in Virginia. The mortgage segment provides a variety of mortgage loan products principally in Virginia and Maryland. These loans are originated and sold primarily in the secondary market through purchase commitments from investors, which subject the Company to only de minimis risk.
Profit and loss is measured by net income after taxes including realized gains and losses on the Company’s investment portfolio. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies of the Company. Intersegment transactions are recorded at cost and eliminated as part of the consolidation process.
Both of the Company’s reportable segments are service based. The mortgage business is a fee based business while the banks are driven principally by net interest income. The banks provide a distribution and referral network through their customers for the mortgage loan origination business. The mortgage segment offers a more limited network for the banks, due largely to the minimal degree of overlapping geographic markets.
The community bank segment provides the mortgage segment with the short-term funds needed to originate mortgage loans through a warehouse line of credit and charges the mortgage banking segment interest. These transactions are eliminated in the consolidation process. A management fee for back room support services is charged to all subsidiaries and eliminated in the consolidation totals.
Information about reportable segments and reconciliation of such information to the consolidated financial statements for the three and six months ended June 30, 2002 and 2001 follows:
Union Bankshares Corporation Segment Report
Community Banks
Mortgage
Elimination
Consolidated Totals
Three Months ended June 30, 2002
(in thousands )
9,887
160
9,148
Noninterest income
1,806
2,070
(44
Noninterest expenses
6,774
1,919
4,180
311
932
3,248
205
Assets
1,018,509
21,520
(18,274
Three Months ended June 30, 2001
7,785
173
7,392
2,013
2,119
(43
6,151
1,863
3,254
429
651
146
2,603
283
925,641
31,007
(32,649
923,999
Six Months ended June 30, 2002
19,159
520
17,590
3,534
4,213
(87
13,453
3,932
7,671
801
1,689
272
5,982
529
Six Months ended June 30, 2001
15,632
263
14,807
3,856
(85
12,252
3,562
6,411
632
1,272
5,139
417
8
5.
RECENT ACCOUNTING STATEMENTS
In July 2001, the Financial Accounting Standards Board issued two statements – Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets, which impact the accounting for goodwill and other intangible assets. Statement 141 eliminates the pooling method of accounting for business combinations and requires that intangible assets that meet certain criteria be reported separately from goodwill. Statement 142 eliminates the amortization of goodwill and other intangibles that are determined to have an indefinite life. The Statement requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life.
Upon adoption of these Statements, an organization is required to re-evaluate goodwill and other intangible assets that arose from business combinations entered into before July 1, 2001. If the recorded other intangible assets do not meet the criteria for recognition, they should be classified as goodwill. Similarly, if there are other intangible assets that meet the criteria for recognition but were not separately recorded from goodwill, they should be reclassified from goodwill. An organization also must reassess the useful lives of intangible assets and adjust the remaining amortization periods accordingly.
These standards were implemented by the Company as of January 1, 2002. Goodwill in the amount of $864,000 was deemed to be goodwill and is not being amortized. This change caused an increase in net income of approximately $77,000 on an annual basis. Under the new accounting requirement, core deposit intangibles will continue to be amortized. The adoption of these standards did not have a material impact on the financial statements.
6.
EXPANSION ACTIVITY
On January 2, 2002, the Company opened a loan production office (LPO) in Newport News as part of the Bank of Williamsburg. Based on the early success of the LPO and the potential of the market, the Bank of Williamsburg filed for regulatory approval and opened a full service branch at this location in early May 2002. The initial location will continue to serve as the branch until a larger location is found. Management is currently negotiating a lease at a nearby location.
7.
STOCK REPURCHASE
The Company had authorization from the Board of Directors of Union Bankshares to buy up to 100,000 shares of the Company’s outstanding common stock in the open market at prices that management and the Board of Directors determine are prudent. In the third quarter, the Board will consider whether to issue a new authorization. The Company considers current market conditions and the Company’s current capital level, in addition to other factors, when deciding whether to repurchase stock.
During the first six months of 2002 the Company did not repurchase any shares of its common stock in the open market. In 2001, for the same time period, the Company repurchased 25,300 shares at an average cost of $15.73 per share.
8.
FORWARD-LOOKING STATEMENTS
Certain statements in this report may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Although the Company believes that its expectations with respect to certain forward-looking statements are based upon reasonable assumptions within the bounds of its existing knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Actual future results and trends may differ materially from historical results or those anticipated depending on a variety of factors, including, but not limited to, the effects of and changes in: general economic conditions, the interest rate environment, legislative and regulatory requirements, competitive pressures, new products and delivery systems, inflation, changes in the stock and bond markets, technology, and consumer spending and savings habits. Forward looking statements speak only as of the date they are made. The Company does not undertake a duty to update forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Union Bankshares Corporation (the “Company”) is a multi-bank holding company organized under Virginia law which provides financial services through its wholly-owned bank subsidiaries, Union Bank & Trust Company, Northern Neck State Bank, Rappahannock National Bank, Bank of Williamsburg, as well as Union Investment Services, Inc., and Mortgage Capital Investors, Inc. The four subsidiary banks are full service retail commercial banks offering a wide range of banking and related financial services, including demand and time deposits, as well as commercial, industrial, residential construction, residential mortgage and consumer loans. Union Investment Services Inc., is a full service discount brokerage company, which offers a full range of investment services and sells mutual funds, stocks and bonds. Mortgage Capital Investors, Inc., a subsidiary of Union Bank & Trust Company, provides a wide array of mortgage products. Many of the services offered by the banks and the mortgage company can be accessed through internet sites.
The Company’s primary trade area stretches from Rappahannock County to Fredericksburg, south to Hanover County, east to Newport News and throughout the Northern Neck region of Virginia. The corporate headquarters is located in Bowling Green, Virginia. Through its banking subsidiaries, the Company operates 30 branches in its primary trade area. In addition to the primary banking trade area, Mortgage Capital Investors, Inc. expands the Company’s mortgage origination business to other strong housing markets in Virginia, Maryland and South Carolina.
Management’s discussion and analysis is presented to aid the reader in understanding and evaluating the financial condition and results of operations of the Company. The analysis focuses on the consolidated financial statements, the footnotes thereto, and the other financial data herein. Highlighted in the discussion are material changes from prior reporting periods and any identifiable trends affecting the Company. Amounts are rounded for presentation purposes, while the percentages presented may be computed based on unrounded amounts.
Critical Accounting Policies
General The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. The Company uses historical loss factors as one factor in determining the inherent loss that may be present in its loan portfolio. Actual losses could differ significantly from the historical factors that are used. The fair value of the investment portfolio is based on period end valuations but changes daily with the market. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of these transactions would be the same, the timing of events that would impact these transactions could change.
11
Allowance for Loan Losses The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimatable and (ii) SFAS 114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.
The Company’s allowance for loan losses model has three basic components: the formula allowance, the specific allowance and a calculation for unfunded loans. Each of these components is determined based upon estimates that can and do change when actual events occur. These estimates are reevaluated at least quarterly as part of a review of the adequacy of the allowance for loan loss. The allowance formula uses historical losses and current economic and business conditions in developing estimated loss factors as an indicator of future losses for various loan classifications; as a result, the estimated losses could differ from the losses incurred in the future. The specific allowance uses various techniques such as historical loss information, expected cash flows and fair market value of collateral to arrive at an estimate of losses. The use of these values is inherently subjective and actual losses could be greater or less than the estimates. The allowance calculation for unfunded loans uses historical factors to determine the losses that are attributable to these loans. Management periodically reassesses the approach taken in these estimates in order to enhance the process.
Core Deposit Intangibles In July 2001, the Financial Accounting Standards Board issued two statements – Statement 141, Business Combinations, and Statement 142, Goodwill and Other Intangible Assets, which impacts the accounting for goodwill and other intangible assets. Statement 141 eliminated the pooling method of accounting for business combinations and required that intangible assets that meet certain criteria be reported separately from goodwill. Statement 142 eliminated the amortization of goodwill and other intangibles that are determined to have an indefinite life. The Statement requires, at a minimum, annual impairment tests for goodwill and other intangible assets that are determined to have an indefinite life.
Subsequent to the effective date of SFAS 142 an apparent conflict with SFAS 72 was raised as an issue, which allows certain intangibles arising from Bank and Thrift acquisitions to be amortized over their estimated useful lives. Upon adoption of these Statements, the Company re-evaluated its intangible assets that arose from branch acquisitions prior to July 1, 2001. It was determined that the intangible assets arising from branch acquisitions will continue to be amortized over their estimated lives in accordance with SFAS 72.
Overview
Net income for the second quarter of 2002 was $3.5 million, up 19.6% from $2.9 million for the same period in 2001. This increase was principally the result of significant improvement in the community banking segment. Earnings for that segment increased by $645,000 or 24.8% over the prior year’s second quarter due to improvement in the net interest margin and increases in loans. The mortgage segment’s performance declined with net income of $205,000 for the quarter ended June 30, 2002 compared to $283,000 in the comparable quarter of last year.
Diluted earnings per share amounted to $.45 in the second quarter of 2002, as compared to $.38 in the same quarter of 2001. The Company’s annualized return on average assets for the three months ended June 30, 2002 was 1.38% as compared to 1.27% a year ago. The Company’s annualized return on average equity totaled 14.80% and 13.73% for the three months ended June 30, 2002 and 2001, respectively.
Net income from the Company’s community bank segment increased from $2.6 million in the second quarter of 2001 to over $3.2 million in the second quarter of 2002. Much of this increase is attributable to improvements in net interest income and was driven largely by increases in earning assets and reductions in interest expense. Loan growth between year end 2001 and June 30, 2002 amounted to $70.0 million while deposits grew only $29.6 million over the same period. This growth in earning assets helped to offset the impact of declining rates on interest income. In addition, interest expense declined significantly in a low interest rate environment. Higher rate certificates of deposit repriced at lower rates over the first half of 2002 and management focused on funding loan growth with low cost deposits and on locking in these low interest rates over longer terms.
The mortgage segment reported net income of $205,000, a decrease of $78,000 or 27.6% in the second quarter of 2002, reflecting a slowing in the refinance market from its strong beginning in early 2001 and a lower inventory of homes in some of its markets. While the declining interest rate environment over the last 12 to 18 months has resulted in significant increases in both mortgage refinancing and home purchases, refinanced loans comprised only 26% of MCI’s loans in the second quarter of 2002, down from 30% in 2001. MCI continues to focus its efforts toward the home purchase market, working with home buyers, builders, realtors and other referral sources for a stable loan production platform. The Company continues to monitor production volumes so adjustments in staffing and other areas can be made promptly. While mortgage rates remain attractive, the slowly recovering economy, possible rising interest rates and general uncertainty felt by consumers could adversely influence production over the next several quarters.
Total assets as of June 30, 2002 were $1.022 billion, an increase of 3.9% from $983.1 million at December 31, 2001. Loans totaled $670.2 million at June 30, 2002, an increase of $70.0 million or 11.7% from $600.2 million at December 31, 2001. Approximately $23.4 million of this growth has been generated by the Bank of Williamsburg subsidiary through the new loan officers in Newport News. Many of these loans resulted from relationships the loan officers had previously established with these borrowers. The remaining growth in loans is attributable to increases in both the consumer and the commercial areas. The securities portfolio increased to $260.4 million in the second three months of 2002 versus $257.1 at year end 2001. Loans held for sale decreased $24.1 million to $19.4 million compared to the December 31, 2001 balance of $43.5 million reflecting slowing in the mortgage origination market. Stockholders’ equity totaled $97.8 million at June 30, 2002, which represents a book value of $12.93 per share.
Total deposits at June 30, 2002 were $813.7 million, up 3.8% from $784.1 million at December 31, 2001. Other borrowings totaled $99.9 million at June 30, 2002, a 3.8% decrease from $103.8 million at year end 2001. The other borrowings change is the result of a $3.5 million decrease in securities sold under agreement to repurchase (principally with customers).
Competition for deposits, particularly as it impacts certificate of deposit (CD) rates, is rate sensitive. Management continues to focus on increasing and retaining lower cost deposit
13
products, (including noninterest-bearing demand deposits and savings accounts) and locking in current lower rates with longer (3-5 year) CD rates, in an effort to maintain a lower cost of funds and a strong interest margin. Increased competition for both loans and deposits is expected to contribute to some narrowing of the net interest margin should rates start to rise.
On a year to year basis, loan growth out paced deposit growth, changing a trend that had deposits growing faster over most of 2001. Loans are up 14.0% at $670.2 million compared to $587.9 million in June 2001. Deposits are up 12.9% at $813.7 million compared to $721.0 million in June 2001. Since December 31, 2001, loans are up 11.7% while deposits are only up 3.8%. The slowing of deposit growth in the first quarter has continued in the second quarter. This has benefited our performance as higher yielding earning assets have increased, older deposits have repriced at lower rates and deposit growth has occurred mainly in lower rate transaction accounts. However, the largest increase in deposits has been in the more liquid demand, NOW and money market categories. As investors sense a positive change in the economy and the stock market, some of those deposits may move back into the stock market and may cause the net interest margin to compress depending on the Company’s liquidity levels.
Net income for the six months ended June 30, 2002 was $6.5 million, up from $5.6 million for the same period in 2001. This increase was the result of significant improvement in the community banking segment with increased earnings of $843,000 or 16.4% over the prior year due to improved net interest margin and increases in loans. The mortgage segment’s performance increased with net income of $529,000 for the six months ended June 30, 2002 compared to $417,000 at the same point last year. Diluted earnings per share amounted to $.86 at June 30, 2002, as compared to $.74 at June 30, 2001. The Company’s annualized return on average assets for the six months ended June 30, 2002 was 1.33% as compared to 1.25% a year ago while the annualized return on average equity totaled 14.25% and 13.66% for the same period, respectively.
Net Interest Income
Net interest income on a tax-equivalent basis for the second quarter of 2002 increased by 24.5% to $10.8 million from $8.6 million for the same period a year ago. Over that time, average interest earning assets grew by $88.5 million or 10.4% and average interest-bearing liabilities increased by 8.3%. For the quarter ended June 30, 2002 interest-bearing deposits grew $70.4 million while other borrowings declined $10.2 million compared to the same quarter in 2001. The net interest income increase is largely attributable to a decline of $2.5 million in interest-bearing liability costs compared to the prior year’s second quarter. Most of this decrease was in the cost of interest-bearing deposits reflecting the impact of the 11 rate cuts by the Federal Reserve in 2001 and an increase in lower cost deposits in the deposit mix. Average interest-bearing deposits were up $70.4 million with 60.1% of this increase coming in NOW and money market accounts. The interest rate spread was up significantly at 4.11% for the second quarter compared to 3.42% a year ago. The Company’s yield on average earning assets was 7.20%, down 92 basis points from 8.12% a year ago, while its cost of average interest-bearing liabilities decreased 161 basis points from 4.70% in the second quarter 2001 to 3.09% in the comparable quarter of 2002. This reflects a faster decline in the cost of liabilities versus the income from earning assets which is caused by the lag in deposit repricing compared to asset repricing. Other borrowings and the interest rates charged on such borrowings are down which further lowers the cost of funds. This favorable margin should continue over the next couple of quarters due to our asset sensitive balance sheet position. However, as interest rates
rise the margin will widen since the banks are asset sensitive (repricing earlier at higher rates) and the deposit repricing will lag.
In addition, the subsidiary banks have periodically engaged in wholesale leverage transactions to better leverage their capital position by borrowing funds to invest in securities at margins of 150 to 200 basis points. Although such transactions increase net income and return on equity, they negatively impact the net interest margin. As of June 30, 2002 such transactions accounted for $10 million of the Company’s total borrowings.
Included in the average earning assets is $15.1 million in loans held for sale. These loans are mortgage loans originated by the mortgage segment and held for the short period between closing with the customer and funding by the investor. While this spread provides a positive contribution to interest income and net income, it negatively impacts the net interest margin as these loans are generally funded at more narrow, short-term spreads. These loans ultimately generate most of their earnings in the noninterest income category through gains on sales of loans.
Union Bankshares Corporation
AVERAGE BALANCES, INCOME AND EXPENSES, YIELDS AND RATES (TAXABLE EQUIVALENT BASIS)
For the three months ended June 30,
2000
Average Balance
Interest Income/ Expense
Yield/ Rate
(Dollars in thousands)
Assets:
Securities:
165,835
5.88
%
128,943
6.92
123,582
2,302
7.49
Tax-exempt(1)
93,143
1,771
7.63
92,092
1,783
7.77
98,094
1,866
7.65
Total securities
258,978
4,203
6.51
221,035
4,006
7.27
221,676
4,168
7.56
Loans, net
652,687
12,418
588,163
12,927
8.82
581,678
12,736
8.81
15,079
4.26
31,609
2.20
10,850
0.07
8,736
1.70
6,941
3.18
77
5.22
583
3.44
1,010
1.59
870
4.61
856
7.52
Total earning assets
937,073
16,827
7.20
848,618
17,171
8.12
815,137
16,923
8.35
Allowance for loan losses
(8,089
(7,900
(7,341
Total non-earning assets
71,736
69,549
53,379
1,000,720
910,267
861,175
Liabilities & Stockholders’ Equity:
Checking
120,243
292
0.97
98,444
438
1.78
103,018
2.16
Money market savings
84,788
309
1.46
64,322
475
2.96
61,971
511
3.32
Regular savings
76,672
256
1.34
58,911
2.84
57,072
337
2.37
Certificates of deposit:
$100,000 and over
131,709
1,392
4.24
127,217
1,905
6.01
107,307
1,489
5.58
Under $100,000
276,457
2,785
4.04
270,601
3,893
5.77
260,668
3,630
5.60
689,869
2.93
619,495
4.62
590,036
6,521
4.45
Other borrowings
98,485
4.23
108,646
1,403
5.18
112,646
1,861
6.64
Total interest-bearing liabilities
788,354
3.09
728,141
4.70
702,682
8,382
4.80
Noninterest bearing liabilities:
Demand deposits
111,971
92,202
86,161
6,798
5,613
2,725
907,123
825,956
791,568
Stockholders’ equity
93,597
84,311
69,607
10,755
8,640
8,541
Interest rate spread
4.11
3.42
3.55
Interest expense as a percent of average earning assets
2.60
4.03
4.14
Net interest margin
4.60
4.09
4.21
For the six months ended June 30,
166,060
5.92
127,034
7.01
121,776
4,490
7.41
92,096
7.74
92,808
3,573
7.76
98,353
3,753
7.67
258,156
8,407
6.57
219,842
7,992
7.33
220,129
8,243
7.53
632,563
24,355
585,518
26,088
8.98
568,881
24,708
8.73
21,019
4.99
24,633
2.15
7,554
(11
-0.29
12,162
1.54
6,199
4.13
422
20
9.53
1,223
1.98
878
1.61
803
4.52
972
32
6.62
926,001
33,394
836,995
34,488
8.31
797,958
32,992
(7,825
(7,747
(7,092
70,698
69,382
57,900
Total assets.
988,874
898,630
848,766
Liabilities & Stockholders' Equity:
117,037
569
0.98
97,170
890
1.85
100,076
1,056
2.12
83,165
610
1.48
63,179
3.03
62,567
1,016
3.27
75,225
502
1.35
57,784
728
2.54
57,881
688
2.39
131,868
2,813
4.30
127,072
3,796
6.02
105,473
2,853
5.44
275,965
5,755
268,543
7,902
5.93
254,342
6,937
5.48
683,260
3.02
613,748
4.69
580,339
12,550
4.35
97,904
2,058
107,016
2,932
5.52
113,546
3,512
6.22
781,164
720,764
4.81
693,885
16,062
4.66
108,426
90,021
83,301
7,171
5,806
2,879
896,761
816,591
780,065
Stockholders' equity
92,113
82,039
68,701
Total liabilities and stockholders' equity
21,087
17,291
16,930
4.10
3.50
3.66
2.68
4.05
4.59
4.17
4.27
(1) Income and yields are reported on a taxable equivalent basis.
17
Provision for Loan Losses
The provision for loan losses totaled $739,000 for the second quarter of 2002, up from $393,000 for the second quarter of 2001. For the six months ended June 30, 2002, the provision was $1,569,000 versus $825,000 for the same period in 2001. These provisions reflect management’s assessment of the credit risk in the portfolio and the performance of the loan portfolio which increased 11.7% for the six months ended June 30, 2002 compared to June 30, 2001. (See Asset Quality)
Noninterest Income
Noninterest income for the three months ended June 30, 2002 totaled $3.8 million, down from $4.1 million for the same period a year ago. Most of the decrease was the result of selling a down graded corporate bond at a loss of $162,000. Gains on sales of loans in the mortgage banking segment comprised a small part of this decline with a decrease of $50,000 from the same period in 2001. Service charges on deposit accounts increased $61,000 reflecting increases in overdraft and return check charges and commercial account charges. Other service charges and fees decreased $12,000, reflecting a $66,000 decline in brokerage commissions which was partially offset by increases in debit card income, letter of credit fees, ATM surcharges and other fee income. Other operating income decreased $80,000 over the prior year, reflecting $28,000 in lower income from the bank owned life insurance (BOLI) and the liquidation of the Company’s remaining investment in an income producing property. Management continues to seek additional sources of noninterest income, including increased emphasis on cross-selling services and better leveraging the financial services available throughout the organization.
Noninterest Expense
Noninterest expense in the second quarter of 2002 totaled $8.6 million, an increase of $678,000 over the same period in 2001. Personnel costs were up $281,000 over last year’s second quarter, with salaries and other benefits categories up reflecting normal increases, the addition of the Newport News branch and higher group insurance expense while commission costs were down slightly as a result of lower mortgage loan production . Occupancy expense was up $36,000 largely as a result of increases in rental costs for the office in Newport News and in depreciation expense for the new branches in Tappahannock and Newport News. Furniture & equipment expense was down $45,000 largely from a decline in depreciation expense and amortization of software. These decreases were the result of software and equipment, from the expansion in 1998 and the upgrades in 1999 to facilitate the back office consolidation, becoming fully depreciated.
Other operating expenses were up $406,000 over last year’s second quarter. The increases are primarily the result of: operating expenses up $130,000 from software, postage, internet, telephone and courier and armor car costs; professional services up $34,000; marketing up $137,000 which includes the introduction of internet banking and preparation for centennial celebrations at Union Bank and Trust and Rappahannock National Bank, franchise tax up $20,000 and other expense up $93,000 due to other losses associated with a fraud issue that is in the process of being resolved. Most of these increases were in the community bank segment. Management continues to monitor expenses closely to ensure the increases are in line with the Company’s expectations.
Asset Quality
The allowance for loan losses is an estimate of an amount adequate to absorb potential losses inherent in the loan portfolio. General economic trends, as well as conditions affecting individual borrowers, affect the level of credit losses. Management’s determination of the adequacy of the allowance is based on a quarterly evaluation that considers the composition of the loan portfolio, the value and adequacy of the collateral, current economic conditions, historical loan loss experience, and other risk factors. The allowance is also subject to regulatory examinations and determination as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and comparison to peer groups. The level of the allowance to net loans outstanding will vary depending on the overall results of the quarterly review. The review is approved by the Credit Risk Committee (comprised of members of senior management) and reviewed with the Audit Committee of the Board of Directors. Management believes the allowance is adequate at this time and will continue to make adjustments as the changing economy and the loan portfolio’s performance warrant.
The allowance for loan losses totaled $8.4 million at June 30, 2002 or 1.26% of total loans, as compared to 1.22% at December 31, 2001 and 1.35% at June 30, 2001.
June 30, 2001
(dollars in thousands)
Nonaccrual loans
636
915
539
Foreclosed properties
1,623
Nonperforming assets
1,723
1,683
2,162
Allowance as % of total loans
1.26
1.22
Allowance as % of nonperforming assets
489
436
366
Nonperforming assets to loans and foreclosed properties
.26
.28
.37
Net charge-offs to average loans
.15
.10
Capital Resources
Capital resources represent funds, earned or obtained, over which financial institutions can exercise greater or longer control in comparison with deposits and borrowed funds. The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to the size, composition, and quality of the Company’s resources and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses.
Since December 31, 2001 shareholders equity has increased by $8.8 million, principally as a result of net income of $6.5 million for the first six months of 2002. This increase was partially offset by dividends paid to shareholders of $1.9 million. In addition, shareholders equity increased by $3.5 million due to increases in the value of the Company’s security portfolio and by $632,000 from stock issued under the dividend reinvestment and incentive stock plans and in connection with a prior acquisition.
The Federal Reserve, along with the Comptroller of the Currency and the Federal Deposit Insurance Corporation, has adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total assets is 8.0%, of which 4.0% must be Tier 1 capital, consisting of common equity and retained earnings, less certain goodwill items.
At June 30, 2002, the Company’s ratio of total capital to risk-weighted assets was 11.95% and its ratio of Tier 1 capital to risk-weighted assets was 10.88%. Both ratios exceed the minimum capital requirements. The following summarizes the Company’s regulatory capital and related ratios at June 30, 2002 (dollars in thousands):
Tier 1 capital
85,543
Tier 2 capital
Total risk-based capital
93,977
Total risk-weighted assets
786,410
Capital Ratios:
Tier 1 risk-based capital ratio
10.88
Total risk-based capital ratio
11.95
Leverage ratio (Tier 1 capital to average adjusted total assets)
8.61
Equity to assets ratio
9.56
The Company’s book value per share at June 30, 2002 was $12.93. Dividends to stockholders are typically paid semi-annually in May and November and were last paid on May 1, 2002.
Liquidity
Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, money market investments, Federal funds sold, securities available for sale and loans maturing within one year. The Company’s ability to obtain deposits and purchase funds at favorable rates determines its liability liquidity. Additional sources of liquidity available to the Company include its capacity to borrow additional funds when necessary through Federal funds lines with several regional banks and a line of credit with the Federal Home Loan Bank. Management considers the Company’s overall liquidity to be sufficient to satisfy its depositors’ requirements and to meet its customers’ credit needs.
At June 30, 2002 cash, interest-bearing deposits in other banks, money market investments, Federal funds sold, securities available for sale, loans available for sale and loans that mature or reprice in one year were 40.4% of total earning assets. At June 30, 2002 approximately $311.9 million or 45.2% of total loans are scheduled to mature or reprice within the next year. In addition to deposits, the Company utilizes Federal funds purchased, FHLB advances, securities sold under agreements to repurchase and customer repurchase agreements, to fund the growth in its loan portfolio, securities purchases, and periodically, wholesale leverage transactions.
21
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. The Company’s market risk is composed primarily of interest rate risk. The Company’s Asset and Liability Management Committee (ALCO) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to this risk. The Board of Directors reviews the guidelines established by ALCO.
Interest rate risk is monitored through the use of three complimentary modeling tools: static gap analysis, earnings simulation modeling and economic value simulation (net present value estimation). Each of these models measure changes in a variety of interest rate scenarios. While each of the interest rate risk measures has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. Static gap which measures aggregate repricing values is less utilized since it does not effectively measure the earnings impact on the Company and is not addressed here. But earnings simulation and economic value models which more effectively measure the earnings impact are utilized by management on a regular basis and are explained below.
Earnings Simulation Analysis
Management uses simulation analysis to measure the sensitivity of net income to changes in interest rates. The model calculates an earnings estimate based on current and projected balances and rates. This method is subject to the accuracy of the assumptions that underlie the process, but it provides a better analysis of the sensitivity of earnings to changes in interest rates than other analysis such as the static gap analysis.
Assumptions used in the model, including loan and deposit growth rates, are derived from seasonal trends and management’s outlook, as are the assumptions used to project yields and rates for new loans and deposits. All maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in like instruments. Mortgage loans and mortgage backed securities prepayment assumptions are based on industry estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Different interest rate scenarios and yield curves are used to measure the sensitivity of earnings to changing interest rates. Interest rates on different asset and liability accounts move differently when the prime rate changes and are accounted for in the different rate scenarios.
22
The following table represents the interest rate sensitivity on (FTE) net income for the Company using different rate scenarios as of:
Change in Prime Rate
June 30, 2002 % Change in Net Income
+200 basis points
+11.72
+100 basis points
+ 5.98
Most likely
0
-100 basis points
- 6.41
-200 basis points
-12.21
Economic Value Simulation
Economic value simulation is used to calculate the estimated fair value of assets and liabilities over different interest rate environments. Economic values are calculated based on discounted cash flow analysis. The economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in economic value of equity over different rate environments is an indication of the longer term repricing risk in the balance sheet. The same assumptions are used in the economic value simulation as in the earnings simulation.
The following chart reflects the change in net market value over different rate environments as of June 30:
Change in Economic Value of Equity
(dollars in thousands
-5,648
-1,934
-2,837
-6,785
23
PART II - OTHER INFORMATION
Item 1 – Legal Proceedings
Item 2 – Changes in Securities and Use of Proceeds
Item 3 – Defaults Upon Senior Securities
Item 4 – Submission of Matters to a Vote of Security Holders
(a) The annual meeting of stockholders of Union Bankshares Corporation was held on April 16, 2002.
(b),(c) The following directors were elected for terms expiring in 2005:
FOR
WITHHELD
G.William Beale
5,640,838
95,398
B. Walton Mahon
5,703,665
32,571
The following directors’ terms of office continued after the meeting:
Frank B. Bradley
Ronald L. Hicks
W. Tayloe Murphy, Jr.
M. Raymond Piland, III
D. Whittaker
William M. Wright
Item 5 – Other Information
Item 6 – Exhibits and Reports on Form 8-K
(a)
See attached list of exhibits
(b)
Form 8-K - None
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.
(Registrant)
/s/ G. William Beale
August 13, 2002
(Date)
G. William Beale,
President, Chief Executive Officer and Director
/s/ D. Anthony Peay
D. Anthony Peay,
Senior Vice President and Chief Financial Officer
UNION BANKSHARES CORPORATION AND SUBSIDIARIESIndex to Exhibits Form 10-Q /June 30, 2002
Exhibit No.
Description
Plan of acquisition, reorganization, arrangement, liquidation or succession
Not Applicable
Instruments defining the rights of security holders, including indentures
Material contracts
Statement re: computation of per share earnings
Letter re: unaudited interim financial information
Letter re: change in accounting principles
Previously unfiled documents
Report furnished to security holders
Published report re: matters submitted to vote of security holders
None
Consents of experts and counsel
Power of Attorney
99
Additional Exhibits
99.1