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 ending: June 30, 2000 Commission file number: 000-28449 UNION BANKSHARES, INC. VERMONT 03-0283552 P.O. BOX 667 MAIN STREET MORRISVILLE, VT 05661 Registrant's telephone number: 802-888-6600 Former name, former address and former fiscal year, if changed since last report: Not applicable Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of June 30, 2000: Common Stock, $2 par value 3,029,529 shares UNION BANKSHARES, INC. TABLE OF CONTENTS PART 1 FINANCIAL INFORMATION Financial Statements Union Bankshares, Inc. Consolidated Balance Sheet 3 Consolidated Statement of Income - Year to Date 4 Consolidated Statement of Changes in Stockholder's Equity 5 Consolidated Statement of Cash Flows 6 Notes to Financial Statements 8 Management's Discussion and Analysis of Financial Condition and Results of Operations 10 PART II OTHER INFORMATION Item 6 EXHIBITS AND REPORTS ON FORM 8-K 26 Signatures 26 Union Bankshares, Inc. and Subsidiaries Statement of Condition (Unaudited) <TABLE> <CAPTION> June 30 December 31 (Dollars in Thousands) 2000 1999 ---------------------- <S> <C> <C> Assets Cash and due from banks $ 11,612 $ 11,627 Federal funds sold and overnight deposits 5,183 3,474 ---------------------- Total cash and cash equivalents 16,795 15,101 Interest bearing deposits 1,953 1,957 Securities available-for-sale 55,393 60,441 Federal Home Loan Bank stock 1,017 939 Loans held for sale 7,534 8,102 Loans 204,803 201,525 Unearned loan fees (267) (273) Allowance for loan losses (2,934) (2,870) ---------------------- Loans, net 201,602 198,382 ---------------------- Accrued interest receivable 2,222 2,199 Bank premises and equipment, net 3,960 4,040 Other real estate owned, net 99 27 Other assets 4,237 4,288 ---------------------- Total assets $294,812 $295,476 ====================== Liabilities and Stockholders' equity: Liabilities: Deposits: Non-interest bearing $ 32,990 $ 32,989 Interest bearing 215,542 224,604 ---------------------- Total deposits 248,532 257,593 Borrowed funds 10,046 2,872 Accrued interest and other liabilities 3,105 2,791 ---------------------- Total liabilities 261,683 263,256 ====================== Stockholders' equity: Common stock, $2 par value; 5,000,000 shares authorized; 3,263,489 shares issued at 6/30/00 and 12/31/99. 6,527 6,527 Paid-in capital and surplus 238 238 Retained earnings 28,972 28,180 Treasury stock at cost (233,960 shares at 6/30/00 and 12/31/99) (1,592) (1,592) Accumulated other comprehensive income (1,016) (1,133) ---------------------- Total stockholders' equity 33,129 32,220 ---------------------- Total liabilities and stockholders' equity $294,812 $295,476 ====================== </TABLE> See accompanying notes to unaudited financial statements Union Bankshares, Inc. and Subsidiaries Consolidated Statements of Income (Unaudited) <TABLE> <CAPTION> Three Months Ended Six Months Ended ------------------------------------------------------ June 30 June 30 (Dollars in Thousands) 2000 1999 2000 1999 ------------------------------------------------------ <S> <C> <C> <C> <C> Interest income: Interest and fees on loans $ 4,908 $ 4,583 $ 9,649 $ 9,103 Interest and dividends on investment securities 900 920 1,824 1,822 Interest on federal funds sold 73 81 122 156 Interest on interest bearing deposits 31 33 60 61 ------------------------------------------------------ 5,912 5,617 11,655 11,142 Interest expense: Interest on deposits 2,319 2,177 4,546 4,335 Interest on federal funds purchased 3 1 4 1 Interest on borrowed funds 57 71 95 161 ------------------------------------------------------ 2,379 2,249 4,645 4,497 ------------------------------------------------------ Net interest income 3,533 3,368 7,010 6,645 Provision for loan losses 63 88 125 188 ------------------------------------------------------ Net interest income after provision for loan losses 3,470 3,280 6,885 6,457 Noninterest income: Trust department income 34 31 76 68 Service fees 601 607 1,155 1,170 Security gains (losses) (3) 3 34 3 Gain on sale of loans 0 29 9 45 Other 3 8 9 15 ------------------------------------------------------ 635 678 1,283 1,301 Noninterest expense: Salaries and wages 1,212 1,054 2,311 2,088 Pension and other employee benefits 279 237 577 498 Occupancy expense, net 135 133 292 277 Equipment expense 230 264 530 539 Other operating expense 763 738 1,435 1,450 ------------------------------------------------------ 2,619 2,426 5,145 4,852 ------------------------------------------------------ Income before income tax expense 1,486 1,532 3,023 2,906 Income tax expense 318 490 777 890 ------------------------------------------------------ Net income $ 1,168 $ 1,042 $ 2,246 $ 2,016 ====================================================== Earnings per common share $ .38 $ .34 $ .74 $ .66 ====================================================== Weighted average number of common shares outstanding 3,029,529 3,029,438 3,029,529 3,027,471 ====================================================== Dividends declared per share $ 0.24 $ 0.22 $ 0.48 $ 0.44 ====================================================== </TABLE> See accompanying notes to unaudited financial statements Union Bankshares, Inc. and Subsidiaries Consolidated Statements of Changes in Stockholders Equity (Unaudited) <TABLE> <CAPTION> Accumulated Other Total Common Paid-in Capital Retained Treasury Comprehensive Stockholders' Stock & Surplus Earnings Stock Income (Loss) Equity ------------------------------------------------------------------------------ (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> Balance, December 31, 1999 $6,527 $238 $28,180 $(1,592) $(1,133) $32,220 Net income 2,246 2,246 Net unrealized holding loss on securities available-for-sale, net of tax 117 117 ------- Comprehensive income 2,363 ------- Cash dividends declared (1,454) (1,454) Treasury stock purchased 0 Exercise of stock option 0 ------- Balance, June 30, 2000 $6,527 $238 $28,972 $(1,592) $(1,016) $33,129 =========================================================================== </TABLE> Union Bankshares, Inc. and Subsidiaries Consolidated Statement of Cash Flows (UNAUDITED) <TABLE> <CAPTION> Year To Date ------------------------ June 30 June 30 (Dollars in Thousands) 2000 1999 ------------------------ <S> <C> <C> Cash Flows From Operating Activities Net Income $ 2,246 $ 2,016 Adjustments to reconcile net income to net cash provided by operating activities Depreciation 428 426 Provision for loan losses 125 188 Credit for deferred income taxes (42) (18) Amortization, net Securities 30 2 Amortization, net Limited Partnerships 17 0 Write-downs of Other Real Estate Owned 8 4 Increase (decrease) in unamortized loan fees (6) 25 (Increase) decrease in loans held for sale 586 (4,108) (Increase) decrease in accrued interest 242 56 receivable (23) 111 Decrease in other assets Increase (decrease) in income taxes payable (111) 133 Decrease in accrued interest payable (80) (196) Increase in other liabilities 394 130 Gain sold on securities sold (34) (3) Gain on sale of loans (9) (45) (Gain) loss on sale of OREO (2) 10 ----------------------- Net cash (used) provided by operating activities 3,751 (1,269) Cash Flows From Investing Activities Interest bearing deposits Maturities and redemptions 694 689 Purchases (690) (1,169) Securities available for sale Maturities and redemptions 7,381 13,728 Purchases (3,170) (13,728) Purchase of Federal Home Loan Bank Stock (78) (35) (Increase) decrease in loans, net (2,541) 6,065 Recoveries of loans charged off 79 40 Purchases of premises and equipment, net (348) (124) Proceeds from sale of OREO 0 130 Investment in Ltd Partnerships (54) (373) Proceeds from sale of repossessed property 11 56 ----------------------- Net cash provided by investing activities 1,284 5,843 Cash Flows From Financing Activities Borrowings, net of repayments 7,174 275 Proceeds from exercise of stock options 0 37 Net increase (decrease) in demand, NOW, savings, and money market accounts (9,555) 2,736 Net increase (decrease) in time deposits 494 (4,576) Dividends paid (1,454) (1,238) ----------------------- Net cash provided by financing activities (3,341) (2,766) Increase in cash and cash equivalents 1,694 1,808 Cash and cash equivalents Beginning 15,101 19,196 Ending 16,795 21,004 Supplemental Disclosure of Cash Flow Information: Interest Paid $ 4,725 $ 4,683 ----------------------- Income Taxes Paid $ 930 $ 745 ----------------------- </TABLE> UNION BANKSHARES, INC. NOTES TO FINANCIAL STATEMENTS: Note 1. The accompanying interim consolidated financial statements of Union Bankshares, Inc. (the Company) for the interim period ended June 30, 2000 and 1999 and for the quarters then ended have been prepared in accordance with the accounting policies described in the company's annual report to shareholders and Form 10K which are unaudited. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) 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 1999 Annual report, Form S-4, and Form 8K. Note 2. Acquisition Effective November 30, 1999, following the receipt of all required stockholder, state and federal regulatory approvals, Union Bankshares, Inc. acquired Citizens Saving Bank and Trust Co. This makes Union a two bank holding company. The accompanying consolidated financial statements reflect the merger accounted for in a tax-free transaction as a pooling of interests and are presented as if the companies were combined as of the earliest period presented. However, the financial information is not necessarily indicative of the results of operations, financial position or cash flows that would have occurred had the acquisition been consumated for the periods for which it is given effect, nor is it necessarily indicative of future results of operations, financial position, or cash flows. The financial statements reflect the conversion of each outstanding share of Citizens common stock into 6.5217 shares of Union common stock, with the exchange of 991,089 shares (net of 196 fractional shares redeemed for approximately $4,516) of newly-issued Company common stock. Note 3. Commitments and Contingencies In the normal course of business, the Company is involved in various legal proceedings. In the opinion of management, after consulting with the Company's legal counsel, any liability resulting from such proceedings would not have a material adverse effect on the Company's financial statements. Note 4 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 stock dividends) and reduced for shares held in Treasury. The assumed conversion of available stock options does not result in material dilution. Note 5 Reportable Segments The company has two reportable operating segments, Union Bank (Union) and Citizens Savings Bank and Trust Company (Citizens). Management regularly evaluates separate financial information for each segment in deciding how to allocate resources and in assessing performance. The Company accounts for intersegment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices. Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the period ended June 30, follows: <TABLE> <CAPTION> Intersegment Consolidated 2000 Union Citizens Elimination Other Totals - -------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Interest income $ 7,814 $ 3,841 $ 0 $ 0 $ 11,655 Interest expense 2,967 1,677 0 1 4,645 Provision for loan loss 0 125 0 0 125 Service fee income 906 249 0 0 1,155 Income tax expense (benefit) 622 199 0 (44) 777 Net income (loss) 1,943 392 0 (89) 2,246 Assets 194,963 99,432 (47) 464 294,812 <CAPTION> Intersegment Consolidated 1999 Union Citizens Elimination Other Totals - -------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Interest income $ 7,303 $ 3,839 $ 0 $ 0 $ 11,142 Interest expense 2,822 1,674 0 1 4,497 Provision for loan loss 63 125 0 0 188 Service fee income 867 303 0 0 1,170 Income tax expense (benefit) 293 602 0 (5) 890 Net income (loss) 1,664 487 0 (135) 2,016 Assets 184,126 103,992 0 365 288,483 </TABLE> Amounts in the "Other" column encompass activity in Union Bankshares, Inc., the "parent company." Holding company assets are stated after intercompany eliminations. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The following discussion and analysis provides information regarding Union Bankshares, Inc.'s (Union's) financial position as of June 30, 2000 and as of December 31, 1999, and its results of operations for the three and six months ended June 30, 2000 and 1999. This discussion should be read in conjunction with the information in this document under Financial Statements and related notes and with other financial data appearing elsewhere in this filing. In the opinion of Union's management, the unaudited interim data reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly present Union's consolidated financial position and results of operations to be expected for the interim period. Management is not aware of the occurrence of any events after June 30, 2000, which would materially affect the information presented below. Union's common stock was listed on the American Stock Exchange on July 13, 2000 with an opening price of $15.125. The millennium change was basically a non-event as far as problems and both banks completed their year-end processing on schedule. On February 4, 2000, Citizens upgraded their main application software from Jack Henry 20/20 to Jack Henry Silverlake. On that day, Union Bank became the Electronic Data Processing Server for Citizens. Therefore, both of Union's subsidiaries are processed on Union Bank's IBM AS400 located in Morrisville, Vermont. The transition was planned to be as transparent as possible to customers and line staff of Citizens. Citizens reimburses Union for costs incurred under a data processing agreement between the banks. Intercompany revenues and costs have been eliminated in consolidation. Only a few other, non-material operational changes have resulted from the switch and internal controls have been maintained. The Company may from time to time make written or oral statements that are considered "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may include financial projections, statements of plans and objectives for future operations, estimates of future economic performance and assumptions relating thereto. The Company may include forward-looking statements in its filings with the Securities and Exchange Commission, in its reports to stockholders, including this Quarterly Report, in other written materials, and in statements made by senior management to analysts, rating agencies, institutional investors, representatives of the media and others. By their very nature, forward-looking statements are subject to uncertainties, both general and specific, and risk exists that 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" or similar expressions, we are making forward-looking statements. Many possible events or factors 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 or the United States including changes in laws concerning 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 * 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 and systems integration of Citizens * adverse changes in the securities market When relying on forward-looking statements to make decisions with respect to the Company, investors and others are cautioned to consider these and other risks and uncertainties. RESULTS OF OPERATIONS The Company's net income for the quarter ended June 30, 2000 was $1.2 million, compared with net income of $1 million for the second quarter of 1999. Net income per share was $.38 for the second quarter of 2000 compared to $.34 for the same quarter of 1999. Net income for the first six months of 2000 was $2.2 million, compared with $2 million for the same period in 1999. Net income per share was $.74 for the first six months of 2000 compared to $.66 for the comparable period in 1999. Net Interest Income. The largest component of Union'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. Yields Earned and Rates Paid. The following tables show, for the periods indicated, the total amount of income recorded from interest-earning assets, and the related average yields, the interest expense associated with interest-bearing liabilities, expressed in dollars and average rates, and the relative net interest spread and net interest margin. All yield and rate information is calculated on an annualized basis. Yield and rate information for a period is average information for the period, and is calculated by dividing the income or expense item for the period by the average balances of the appropriate balance sheet item during the period. Net interest margin is net interest income divided by average interest-earning assets. Nonaccrual loans are included in asset balances for the appropriate periods, but recognition of interest on such loans is discontinued and any remaining accrued interest receivable is reversed, in conformity with federal regulations. The yields and net interest margins appearing in the following tables have been calculated on a pre-tax basis: <TABLE> <CAPTION> Three months ended June 30, 2000 1999 ------------------------------------------------------------- Interest Average Interest Average Average Earned/ Yield/ Average Earned/ Yield/ Balance Paid Rate Balance Paid Rate ------------------------------------------------------------- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Average Assets: Federal funds sold $ 4,800 $ 73 6.08% $ 6,962 $ 81 4.65% Interest bearing deposits 2,009 31 6.17% 2,386 33 5.53% Investments (1) (2) 58,650 900 6.31% 62,278 920 6.08% Loans, net (1), (3) 211,922 4,908 9.36% 198,246 4,583 9.33% ------------------------------------------------------------ Total interest-earning assets (1) 277,381 5,912 8.63% 269,872 5,617 8.43% Cash and due from banks 8,582 8,391 Premises and equipment 4,064 4,387 Other assets 6,294 6,026 -------- -------- Total assets $296,321 $288,676 ======== ======== Average Liabilities and Shareholders' Equity: NOW accounts $ 33,361 $ 164 1.97% $ 33,523 $ 162 1.93% Savings and money market accounts 89,383 833 3.73% 84,514 735 3.48% Certificates of deposit 100,639 1,322 5.25% 99,951 1,280 5.12% Borrowed funds 3,742 60 6.41% 4,831 72 5.96% ------------------------------------------------------------ Total interest-bearing Liabilities 227,125 2,379 4.19% 222,819 2,249 4.04% Non-interest bearing deposits 31,434 30,416 Other liabilities 5,241 3,422 -------- -------- Total liabilities 263,800 256,657 Shareholders' equity 32,521 32,019 -------- -------- Total liabilities and shareholders' equity $296,321 $288,676 ======== ======== Net interest income (1) $ 3,533 $ 3,368 ======= ======= Net interest spread (1) 4.44% 4.39% Net interest margin (1) 5.20% 5.09% </TABLE> <TABLE> <CAPTION> Six months ended June 30, 2000 1999 ------------------------------------------------------------- Interest Average Interest Average Average Earned/ Yield/ Average Earned/ Yield/ Balance Paid Rate Balance Paid Rate ------------------------------------------------------------- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Average Assets: Federal funds sold $ 4,218 $ 122 5.78% $ 6,776 $ 156 4.61% Interest bearing deposits 2,024 60 5.93% 2,242 61 5.44% Investments (1) (2) 59,667 1,824 6.29% 60,844 1,822 6.15% Loans, net (1), (3) 209,456 9,649 9.30% 198,671 9,103 9.25% ------------------------------------------------------------ Total interest-earning assets (1) 275,365 11,655 8.57% 268,533 11,142 8.40% Cash and due from banks 8,646 8,921 Premises and equipment 4,048 4,457 Other assets 6,361 6,118 -------- -------- Total assets $294,420 $288,029 ======== ======== Average Liabilities and Shareholders' Equity: NOW accounts $ 32,684 $ 317 1.94% $ 32,980 $ 314 1.91% Savings and money market accounts 90,125 1,658 3.68% 83,928 1,451 3.46% Certificates of deposit 99,282 2,571 5.18% 99,430 2,570 5.17% Borrowed funds 3,093 99 6.40% 5,470 162 5.92% ------------------------------------------------------------ Total interest-bearing Liabilities 225,184 4,645 4.13% 221,718 4,497 4.06% Non-interest bearing deposits 31,842 30,940 Other liabilities 5,136 3,461 -------- -------- Total liabilities 262,162 256,119 Shareholders' equity 32,258 31,910 -------- -------- Total liabilities and shareholders' equity $294,420 $288,029 ======== ======== Net interest income (1) $ 7,010 $ 6,645 ======= ======= Net interest spread (1) 4.44% 4.34% Net interest margin (1) 5.20% 5.05% - -------------------- <FN> <F1> Average yield reported on a tax-equivalent basis. <F2> The average balance of investments is calculated using the amortized cost basis. <F3> Net of unearned income and allowance for loan loss. </FN> </TABLE> Union's net interest income increased by $165 thousand, or 4.9%, to $3.5 million for the three months ended June 30, 2000, from $3.4 million for the three months ended June 30, 1999. This increase was due to a more gradual increase in the cost of interest-bearing liabilities compared to the yield earned on interest-bearing assets which was fueled by the six 25 basis point increases in the prime rate since June 30, 1999 which has taken it from 7.75% to 9.50%. The net interest spread increased by 5 basis points to 4.44% for the three months ended June 30, 2000, from 4.39% for the three months ended June 30, 1999. The net interest margin for the 2000 period increased by 11 basis points to 5.2% from 5.09% for the 1999 period. This improvement is mainly due to retaining loans held for sale in our portfolio and the increase in interest rates in general between the two periods which is in our favor. Union's net interest income year to date was $7 million compared to the prior year of $6.6 million or an increase of 5.5% between the two years. The net interest spread increased by 10 basis points to 4.44% for the six months ended June 30, 2000 from 4.34% for the six months ended June 30, 1999. The net interest margin for the 2000 period increased to 5.20% from 5.05% for the 1999 period or an increase of 15 basis points. 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 Union'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 have been allocated proportionately to the change due to volume and the change due to rate. <TABLE> <CAPTION> Three Months Ended June 30, 2000 Compared to Three Months Ended June 30, 1999 Increase/(Decrease) Due to Change In Volume Rate Net ----------------------------------------- (dollars in thousands) <S> <C> <C> <C> Interest-earning assets: Federal funds sold $(25) $ 17 $ (8) Interest bearing deposits (5) 3 (2) Investments (54) 34 (20) Loans, net 318 7 325 --------------------------------- Total interest-earning assets 234 61 295 Interest-bearing liabilities: NOW accounts (1) 3 2 Savings and money market accounts 42 56 98 Certificates of deposit 9 33 42 Borrowed funds (16) 4 (12) --------------------------------- Total interest-bearing liabilities 34 96 130 --------------------------------- Net change in net interest income $200 $ 35 $165 ================================= </TABLE> <TABLE> <CAPTION> Six Months Ended June 30, 2000 Compared to Six Months Ended June 30, 1999 Increase/(Decrease) Due to Change In Volume Rate Net ----------------------------------------- (dollars in thousands) <S> <C> <C> <C> Interest-earning assets: Federal funds sold $(59) $25 $(34) Interest bearing deposits (6) 5 (1) Investments (38) 40 2 Loans, net 496 50 546 --------------------------------- Total interest-earning assets 393 120 513 Interest-bearing liabilities: NOW accounts (2) 5 3 Savings and money market accounts 107 100 207 Certificates of deposit (4) 5 1 Borrowed funds (70) 7 (63) --------------------------------- Total interest-bearing liabilities 31 117 148 --------------------------------- Net change in net interest income $362 $ 3 $365 ================================= </TABLE> Quarter Ended June 30, 2000 compared to Quarter Ended June 30, 1999. Interest and Dividend Income. Union's interest and dividend income increased by $295,000, or 5.25%, to $5.9 million for the three months ended June 30, 2000, from $5.6 million for the three months ended June 30, 1999. Average earning assets increased by $7.5 million, or 2.8%, to $277.4 million for the three months ended June 30, 2000, from $269.9 million for the three months ended June 30, 1999. Average loans approximated $211.9 million for the three months ended June 30, 2000 up from $198.2 million for the three months ended June 30, 1999. Increases in construction loans of $.8 million or 15.1%, the $6.2 million or 7.8% increase in residential real estate secured loans, the $10.3 million or 12.0% increase in commercial loans, and the $1.1 million or 11.5% increase in loans to municipalities was partially offset by the $4.7 million or 22.4% decrease in personal loans. Construction Lending was strong throughout 1999 and to date through 2000. A conscious decision to retain loans packaged for sale in our portfolio in mid 1999 accounts for the majority of the increase in both the residential real estate and commercial loan portfolios. The decrease in personal loans is due to a late 1998 decision to exit the Dealer floorplan business at Citizens. The average balance of investment securities (including mortgage-backed securities) decreased by $3.6 million, or 5.8%, to $58.6 million for the three months ended June 30, 2000, from $62.3 million for the three months ended June 30, 1999. The average balance in Interest Bearing Deposits decreased by $377,000 to $2.0 million from $2.4 million or 15.8%. The average level of federal funds sold decreased by $2.2 million or 31.1%, to $4.8 million for the three months ended June 30, 2000, from $7.0 million for the three months ended June 30, 1999. The decrease in the investment portfolio, in Federal Funds Sold and in Interest Bearing Deposits in 2000 reflects the closer attention to cash management since Y2 passed with no liquidity crisis, the paydown of debt and the continuing growth in our loan portfolio. Interest Income on non-loans was $1 million for both years reflecting the increase in yields offset by the decrease in volume. Interest Expense. Union's interest expense increased by $130 thousand, or 5.8%, to $2.4 million for the three months ended June 30, 2000 from $2.2 million for the three months ended June 30, 1999. Average interest-bearing liabilities increased by $4.3 million, or 1.9% to $227.1 million for the three months ended June 30, 2000, from $222.8 million for the three months ended June 30, 1999. Average time deposits increased $.7 million, or .7%, to $100.6 million for the three months ended June 30, 2000, from $99.9 million for the three months ended June 30, 1999, while the average balances for money market and saving accounts increased by $4.9 million to $89.4 million for the three months ended June 30, 2000, from $84.5 million for the three months ended June 30, 1999. The 5.8% increase in balances was all in money market accounts as the rate structure was tiered to remain competitive with other financial institutions. Customers have maintained very liquid positions during the last 6 months as they anticipate the interest rates paid on all deposit instruments will continue to rise. The average balance on funds borrowed has dropped from $4.8 million on average in 1999 to $3.7 million in 2000 as Union paid off some long term Federal Home Loan Bank borrowings during the second quarter of 1999. Noninterest Income. Union's noninterest income decreased $43,000, or 6.3%, to $635 thousand for the three months ended June 30, 2000, from $678 thousand for the three months ended June 30, 1999. The results for the period reflected a net loss of $3 thousand from the sale of securities compared to a net gain of $3 thousand from sales during 1999. Trust department income rose to $34 thousand in the second quarter of 2000 from $31 thousand in the same period of 1999 or a 9.7% increase. There was no gain on Sale of Loans for 2000 and $29 thousand for 1999. This change can be explained by management's decision to retain in portfolio a higher percentage of loans that could be sold due to the interest rate environment and other reinvestment rates available. Other noninterest income and service fees (sources of which include deposit and loan fees, ATM fees, and safe deposit fees) decreased by $11 thousand, or 1.8%, to $604 thousand for the three months ended June 30, 2000, from $615 thousand for the three months ended June 30, 1999. This was primarily caused by a drop in Overdraft Fee and Deposit Service Charge income due to the continuing strong economy offset by the increase in ATM income. Noninterest Expense. Union's noninterest expense increased $193 thousand, or 8.0%, to $2.6 million for the three months ended June 30, 2000, from $2.4 million for the three months ended June 30, 1999. Salaries increased $158,000, or 15.0%, to $1.2 million for the three months ended June 30, 2000, from $1.0 million for the three months ended June 30, 1999, reflecting normal salary activity and severance pay for three employees whose positions were eliminated at Citizens due to the consolidation of certain operations within the organization. Pension and employee benefits increased $42 thousand or 17.7% to $279 thousand for the three months ended June 30, 2000, from $237 thousand for the three months ended June 30, 1999 mainly due to a $10,000 increase in payroll taxes and a $30,000 increase in retirement plans expense. Equipment expense decreased $34 thousand to $230 thousand for the three months ended June 30, 2000, from $286 thousand for the same period in 1999 resulting from decreased depreciation cost of $23.7 thousand on computer equipment and software which are depreciated as an expense over a time period of three to five years and a $13,600 decrease in equipment repair expense. Other operating expense for the quarter was $763 thousand up from $738 thousand for the same quarter in 1999. The increase of $25 thousand, or 3.4%, is mainly due to the American Stock Exchange listing fee of $22,500 booked in June of 2000, which is not immediately deductible for income taxes. During the quarter ended June 30, 2000, Union incurred no expenses related to the merger, including legal and advisory fees compared to approximately $71.2 thousand during the second quarter of 1999. Income Tax Expense. Union's income tax expense decreased by $172,000, or 35.1%, to $318,000 for the three months ended June 30, 2000, from $490 thousand for the comparable period of 1999 because of our reduced income, $114,000 historic rehabilitation credit available to us for the second quarter of the 2000 tax year due to our partnership investment in a low income housing project sponsored by Housing Vermont in our market area, and the reduction in non-deductible acquisition expenses related to the merger. Year to Date June 30, 2000 compared to Year to Date June 30, 1999. Interest and Dividend Income. Union's interest and dividend income increased by $513,000, or 4.6%, to $11.6 million for the six months ended June 30, 2000, from $11.1 million for the six months ended June 30, 1999. Average earning assets increased by $6.8 million, or 2.5%, to $275.4 million for the six months ended June 30, 2000, from $268.5 million for the six months ended June 30, 1999. Average loans approximated $209.4 million for the six months ended June 30, 2000 up from $198.7 million for the six months ended June 30, 1999. Increases in construction loans of $.9 million or 16.8%, the $5.9 million or 7.4% increase in residential real estate secured loans, the $8.0 million or 9.4% increase in commercial loans, and the $825 thousand or 8.9% increase in loans to municipalities was partially offset by the $4.8 million or 22.2% decrease in personal loans. Construction Lending was strong throughout 1999 and to date through 2000. A conscious decision to retain loans packaged for sale in our portfolio in mid 1999 accounts for the majority of the increase in both the residential real estate and commercial loan portfolios. The decrease in personal loans is due to a late 1998 decision to exit the Dealer floorplan business at Citizens. The average balance of investment securities (including mortgage-backed securities) decreased by $1.2 million, or 1.9%, to $59.7 million for the six months ended June 30, 2000, from $60.8 million for the six months ended June 30, 1999. The average level of federal funds sold decreased by $2.6 million or 37.8%, to $4.2 million for the six months ended June 30, 2000, from $6.8 million for the six months ended June 30, 1999. The average balance in Interest Bearing Deposits decreased by $218,000 to $2.0 million from $2.2 million or 9.7% The decrease in the investment portfolio, Federal Funds Sold and Interest Bearing Deposits in 2000 reflects the closer attention to cash management since Y2K passed with no liquidity crises, the paydown of debt and the continuing growth in our loan portfolio. Interest Income on non-loans was $2 million for both years reflecting the increase in yields offset by the overall decrease in volume. Interest Expense. Union's interest expense increased by $148 thousand, or 3.3%, to $4.6 million for the six months ended June 30, 2000 from $4.5 million for the six months ended June 30, 1999. Average interest-bearing liabilities increased by $3.5 million, or 1.6%, to $225.2 million for the six months ended June 30, 2000, from $221.7 million for the six months ended June 30, 1999. Average time deposits decreased $148 thousand, or 1.5%, to $99.3 million for the six months ended June 30, 2000, from $99.4 million for the six months ended June 30, 1999, while the average balances for money market and savings accounts increased by $6.2 million to $90.1 million for the six months ended June 30, 2000, from $83.9 million for the six months ended June 30, 1999. The 7.4% increase in balances was all in money market accounts as the rate structure was tiered to remain competitive with other financial institutions. Customers have maintained very liquid positions during the last 6 months as they anticipate the interest rates paid on all deposit instruments will continue to rise. The average balance on funds borrowed has dropped from $5.5 million on average in 1999 to $3.1 million in 2000 as Union paid off some long term Federal Home Loan Bank borrowings during the second quarter of 1999. Noninterest Income. Union's noninterest income decreased $18,000, or 1.4%, to $1.3 million for the six months ended June 30, 2000. The results for the period reflected a net gain of $34 thousand from the sale of securities compared to a $3,000 gain from sales during 1999. Trust department income rose to $76,000 in the first half of 2000 from $68,000 in the same period of 1999 or a 11.8% increase. Gain on Sale of Loans dropped $36,000 to $9,000 for 2000 from $45,000 for 1999. This change can be explained by management's decision to retain in portfolio a higher percentage of loans that could be sold due to the interest rate environment and other reinvestment rates available. Other noninterest income and service fees (sources of which include deposit and loan fees, ATM fees, and safe deposit fees) decreased by $15,000, or 1.3%, to $1.16 million for the six months ended June 30, 2000, from $1.17 million for the six months ended June 30, 1999. This was primarily caused by drops in Overdraft Fee and Service Charges on Deposit income due to the continuing strong economy offset by increased ATM income. Noninterest Expense. Union's noninterest expense increased $293,000, or 6.0%, to $5.1 million for the six months ended June 30, 2000, from $4.8 million for the six months ended June 30, 1999. Salaries increased $223,000, or 10.7%, to $2.3 million for the six months ended June 30, 2000, from $2.1 million for the six months ended June 30, 1999, reflecting normal salary activity, pay for overtime during the first quarter of 2000 related to a Systems Conversion at Citizens, and severance pay for three employees whose positions were eliminated at Citizens due to the consolidation of certain operations within the organization. Pension and employee benefits increased $79 thousand, or 15.9%, to $577 thousand for the six months ended June 30, 2000, from $498 thousand for the six months ended June 30, 1999 mainly due to a $22,500 increase in health insurance costs, a $38,000 increase in retirement plans expense, and a $13,000 increase in payroll taxes. Net occupancy expense increased $15 thousand, or 5.4%, to $292,000 for the six months ended June 30, 2000, from $277,000 for the six months ended June 30, 1999 due mainly to the increase in fuel costs and property tax expense. Equipment expense decreased $9 thousand to $530 thousand for the six months ended June 30, 2000, from $539 thousand for the same period in 1999 primarily resulting from decreased equipment repair expense. Other operating expenses were $1.435 million for the first six months of 2000 compared to $1.450 million for the same period in 1999. Year 2000 expenses were $1.5 thousand during the first half of 2000 compared to $55 thousand in 1999. During the period ended June 30, 2000, Union incurred approximately $1 thousand of expenses related to the merger, including legal and advisory fees compared to $108.8 thousand during the same period of 1999. Union incurred a one-time listing fee in June of 2000 of $22,500 from the American Stock Exchange. Other large variance categories were Charitable Contributions up $45,200 from $14,500 through June 30, 1999 to $59,700 in 2000. Printing costs were up $28,300 between years from $18,400 to $46,700 due to the expense of a professional annual report, proxy and Form 10-K. State Franchise taxes were up $8,000 between years due to the increase in our deposit base. FDIC assessment was up $12,200 due to increased deposit base and the increased assessment rate. Advertising and public relations expenses were up $13,200 as media exposure was expanded at Citizens. Income Tax Expense. Union's income tax expense decreased by $113,000, or 12.7%, to $777,000 for the six months ended June 30, 2000, from $890,000 for the comparable period of 1999 because of our $114,000 historic rehabilitation credit that was available to us for the second quarter of the 2000 tax year due to our partnership investment in a low income housing project sponsored by Housing Vermont in our market area. FINANCIAL CONDITION At June 30, 2000, Union had total consolidated assets of $294.8 million, including net loans and loans held for sale of $209.1 million, deposits of $248.5 million and shareholders' equity of $33.1 million. Based on the most recent information published by the Vermont Banking Commissioner, in terms of total assets at December 31, 1999, Union Bank ranked as the 11th largest institution of the 26 commercial banks and savings institutions headquartered in Vermont, and Citizens ranked as the 20th. Union's total assets decreased by $.7 million or .2% to $294.8 million at June 30, 2000 from $295.5 million at December 31, 1999. Historically, June 30th of each year is our low point in terms of total assets, net loans and deposits. This is a one day aberration as the Towns, Villages and School Districts that we lend to must be out of debt one day during the year. These loans totaled $11.6 million on June 29, 2000, $5.8 million on June 30, 2000 and $12.7 million on July 3. In spite of this drop, total net loans and loans held for sale increased by $2.6 million or 1.3% to $209.1 million or 70.9% of total assets at June 30, 2000 as compared to $206.5 million or 69.9% of total assets at December 31, 1999. Cash and cash equivalents, including Federal funds sold, increased approximately $1.7 million or 11.2% to $16.8 million at June 30, 2000 from $15.1 million at December 31, 1999, which was primarily attributable to the one day increase in liquidity caused by the municipal variation discussed above. Securities available for sale decreased from $60.4 million at December 31, 1999 to $55.4 million at June 30, 2000, a $5 million or 8.3% decrease. Securities maturing have not been replaced dollar for dollar and some securities have been sold in order to fund the increasing loan demand and our decision to hold in portfolio loans available for sale. Deposits decreased $9.1 million or 3.5% to $248.5 million at June 30, 2000 from $257.6 million at December 31, 1999. A $6.0 million drop in Now accounts and a $3.8 million decrease in money market accounts, mainly Municipal accounts, accounted for the decrease. Total borrowings increased $7.2 million to $10.0 million at June 30, 2000 from $2.9 million at December 31, 1999. The increase was in short-term liquidity borrowing from the Federal Home Loan Bank under existing lines of credit to fund loan demand. Loan Portfolio. Union's loan portfolio (including loans held for sale) primarily consists of adjustable- and fixed-rate mortgage loans secured by one-to-four family, multi-family residential or commercial real estate. As of June 30, 2000, Union's loan portfolio totaled $212.3 million, or 72.0%, of assets, of which $103.7 million, or 48.8% of gross loans, consisted of residential mortgages and construction loans, and $67.8 million, or 31.9%, of total loans consisted of commercial real estate loans. As of such date, Union's loan portfolio also included $18.8 million of commercial loans, $5.8 million of municipal loans, and $16.2 million of consumer loans representing, in order, 8.9%, 2.8% and 7.6% of total loans outstanding on June 30, 2000. The following table shows information on the composition of Union's loan portfolio as of June 30, 2000 and December 31, 1999: <TABLE> <CAPTION> June 30, December 31, Loan Type 2000 1999 - ------------------------------------------------------ <S> <C> <C> Real Estate $100,072 $ 87,154 Commercial real estate 64,251 69,807 Commercial 18,441 16,246 Consumer 16,209 18,661 Municipal loans 5,830 9,657 Loans held for sale 7,534 8,102 --------------------- Total loans 212,337 209,627 Deduct: Allowance for loan losses 2,934 2,870 Net deferred loan fees, premiums & discounts 267 273 --------------------- 3,201 3,143 $209,136 $206,484 ===================== </TABLE> Union originates and sells residential mortgages into the secondary market, with most such sales made to the Federal Home Loan Mortgage Corporation (FHLMC). Union services a $151.1 million residential mortgage portfolio, approximately $47.4 million of which is serviced for unaffiliated third parties at June 30, 2000. Additionally, Union originates commercial loans under various SBA programs that provide an agency guarantee for a portion of the loan amount. Union will typically sell the guaranteed portion of the loan to other financial concerns and will retain servicing rights, which generates fee income. Union capitalizes mortgage servicing rights on these fees and recognizes gains and losses on the sale of the principal portion of these notes as they occur. As of June 30, 2000, Union serviced $11.2 million of commercial and commercial real estate loans for unaffiliated third parties. An increase of $12.9 million or 14.8% in residential real estate loans and an increase of $2.2 million or 13.5% in commercial loans was partially offset by a $5.6 million or 8% decrease in commercial real estate loans, a $2.4 million or 13.1% decrease in consumer loans, a drop in municipal loans outstanding of $3.8 million or 39.6% and a drop in loans held for sale of $568 thousand or 7.0%. Asset Quality. Union, like all financial institutions, is exposed to certain credit risks related to the value of the collateral that secures its loans and the ability of borrowers to repay their loans. Management closely monitors Union's loan and investment portfolios and other real estate owned for potential problems on a periodic basis and reports to Union's Board of Directors at regularly scheduled meetings. Union had loans on nonaccrual status totaling $1.6 million at June 30, 2000, $951,000 at December 31, 1999 and $664,000 at June 30, 1999. The increase in non-accrual loans between year-end and June 30, 2000 is mainly due to three commercial loan customers whose properties are in the process of foreclosure by Union. A portion of these loans are backed by SBA guarantees that have not yet been exercised. Interest income not recognized on such loans amounted to approximately $156 thousand and $70 thousand as of June 30, 2000 and 1999, respectively and $183 thousand as of December 31, 1999. Union had $2.1 million and $3.17 million in loans past due 90 days or more and still accruing at June 30, 2000 and December 31, 1999, respectively. At June 30, 2000, Union had internally classified certain loans totaling $1.5 million. 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 Union's credit policy, loans are internally classified when a review indicates any of the following conditions making the likelihood of collection highly questionable: * 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 June 30, 2000, Union had acquired by foreclosure or through repossession real estate worth $99,000, consisting of commercial property, undeveloped land and two residential homes. Allowance for Loan Losses. Some of Union's loan customers ultimately do not make all of their contractually scheduled payments, requiring Union to charge off the remaining principal balance due. Union 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. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, 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. While Union 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. The following table reflects activity in the allowance for loan losses for the quarter and six months ended June 30, 2000 and 1999: <TABLE> <CAPTION> Quarter Ended, June 30 Six Months Ended, June 30, ---------------------------------------------------- 2000 1999 2000 1999 ---------------------------------------------------- (dollars in thousands) <S> <C> <C> <C> <C> Balance at the beginning of period $2,899 $2,885 $2,870 $2,845 Charge-offs: Real Estate 0 0 0 16 Commercial 2 27 16 30 Consumer and other 60 75 124 137 ---------------------------------------------- Total charge-offs 62 102 140 183 ---------------------------------------------- Recoveries: Real Estate 1 0 1 1 Commercial 8 1 29 5 Consumer and other 25 18 49 34 ---------------------------------------------- Total recoveries 34 19 79 40 ---------------------------------------------- Net charge-offs (28) (83) (61) (143) Provision for loan losses 63 88 125 188 ---------------------------------------------- Balance at end of period $2,934 $2,890 $2,934 $2,890 ============================================== </TABLE> The following table shows the breakdown of Union's allowance for loan loss by category of loan and the percentage of loans in each category to total loans in the respective portfolios at the dates indicated: <TABLE> <CAPTION> June 30, December 31, ----------------------------------------------- 2000 1999 ----------------------------------------------- (dollars in thousands) Amount Percent Amount Percent ----------------------------------------------- <S> <C> <C> <C> <C> Real Estate Residential $ 542 18.4% $ 557 42.3% Commercial 1,070 36.4% 1,014 30.6% Construction 99 3.4% 77 3.7% Other Loans Commercial 539 18.4% 416 8.1% Consumer installment 375 12.8% 448 8.6% Home equity loans 28 1.0% 28 1.8% Municipal, Other and Unallocated 281 9.6% 330 4.9% ---------------------------------------------- Total $2,934 100.0% $2,870 100.0% ============================================== Ratio of Net Charge Offs to Average Loans (1) 0.06% 0.16% ------ ------ Ratio of Allowance for Loan Losses to Loans 1.43% 1.42% ------ ------ - -------------------- <FN> <F1> Annualized </FN> </TABLE> Investment Activities At June 30, 2000, the reported value of investment securities available-for-sale was $55.4 million or 18.8% of its assets. Union had no securities classified as held-to-maturity or trading securities. The reported value of securities available-for-sale at June 30, 2000, reflects a negative valuation adjustment of $1.5 million. The offset of this adjustment, net of income tax effect, was a $1 million decrease in Union's other comprehensive income component of shareholders' equity and an increase in net deferred tax assets of $523,000. Deposits. The following table shows information concerning Union's deposits by account type, and the weighted average nominal rates at which interest was paid on such deposits as of June 30, 2000 and December 31, 1999: <TABLE> <CAPTION> Six Months Ended, June 30 Year Ended December 31, 2000 1999 -------------------------------------------------------------- (dollars in thousands) Percent Percent Average of Total Average Average of Total Average Amount Deposits Rate Amount Deposits Rate -------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Non-certificate deposits: Demand deposits $ 31,842 12.54% $ 32,505 12.83% Now accounts 32,684 12.87% 1.94% 34,654 13.67% 1.95% Money Markets 53,954 21.25% 4.36% 49,296 19.45% 4.14% Savings 36,171 14.24% 2.71% 38,064 15.02% 2.71% ------------------ ------------------ Total non-certificate deposits: 154,651 60.90% 154,519 60.97% ------------------ ------------------ Certificates of deposit: Less than $100,000 76,612 30.17% 5.08% 78,030 30.79% 5.05% $100,000 and over 22,670 8.93% 5.65% 20,870 8.24% 5.48% ------------------ ------------------ Total certificates of deposit 99,282 39.10% 98,900 39.03% ------------------ ------------------ Total deposits $253,933 100.00% 3.60% $253,419 100.00% 3.49% ============================================================ </TABLE> The following table sets forth information regarding the amounts of Union's certificates of deposit in amounts of $100,000 or more at June 30, 2000 and December 31, 1999 that mature during the periods indicated: <TABLE> <CAPTION> June 30, 2000 December 31, 1999 ---------------------------------- (dollars in thousands) <S> <C> <C> Within 3 months $ 2,719 $ 2,301 3 to 6 months 6,101 11,872 6 to 12 months 5,427 3,751 Over 12 months 5,883 3,491 -------------------------- $20,130 $21,415 ========================== </TABLE> Borrowings. Borrowings from the Federal Home Loan Bank of Boston were $10 million at June 30, 2000 at a weighted average rate of 6.53%. Borrowings from the Federal Home Loan Bank of Boston were $2.9 million at December 31, 1999 at a weighted average rate of 5.94%. The change between year end 1999 and the end of the second quarter of 2000 is a net increase of $7.1 million in short-term borrowing to fund loan demand. 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. Union's market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. To that end, management actively monitors and manages its interest rate risk exposure. Union does not have any market risk sensitive instruments acquired for trading purposes. Union attempts to structure its balance sheet to maximize net interest income while controlling its exposure to interest rate risk. Union's Asset/Liability Committee 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. Union's Asset/Liability Committee's methods for evaluating interest rate risk include an analysis of Union's interest-rate sensitivity "gap", which provides a static analysis of the maturity and repricing characteristics of Union'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. Union's Asset/Liability Committee meets at least 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. Union historically has maintained a substantial portion of its loan portfolio on a variable rate basis and plans to continue this ALM strategy in the future. The investment portfolio is classified as available for sale and the modified duration is relatively short. Union does not utilize any derivative products or invest in any "high risk" instruments. Our interest rate sensitivity analysis (simulation) as of December 1999 for a flat rate environment projected a Net Interest Income of $7.1 million for the first six months of 2000 compared to actual results of $7.0 million in a rising rate environment, or a 1.0% difference. Union would have anticipated an increase in our net interest margin in the rising rate environment but it was mitigated by the placement of three commercial loan customers into non- accrual during the second quarter of 2000. Net income was projected to be $2.3 million compared to actual results of $2.2 million. The $47 thousand difference would have been greater without the unanticipated $114,000 historic rehabilitation tax credit taken in the second quarter of 2000. The decrease was caused by the payout of $109,000 in severance pay, lower overdraft and deposit service charge income than anticipated, lower than expected net interest margin, charitable contributions being $40,000 higher than planned, and the $22,500 listing fee for the American Stock Exchange. Return on Assets was projected to be 1.59% and actual results were 1.53%. Return on Equity was projected to be 14.11% compared to actual of 13.92%. The lower results of these ratios is based on lower net income as explained above. The Company generally requires collateral or other security to support financial instruments with credit risk. As of June 30, 2000, the contract or notional amount of financial instruments whose contract amount represents credit risk were as follows: <TABLE> <S> <C> Commitments to extend credit $23,496,000 ----------- Standby letters of credit and commercial letters of credit $ 704,000 ----------- Credit Card arrangements $ 2,012,000 ----------- Home Equity Lines of Credit $ 3,742,000 ----------- </TABLE> 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. 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. Union 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 reflect estimated prepayments, which were estimated based on analyses of broker estimates, the results of a prepayment model utilized by Union, and empirical data; * fixed-rate loans reflect scheduled contractual amortization, with no estimated prepayments; and * NOW, money markets, and savings deposits, which do not have contractual maturities, reflect estimated levels of attrition, which are based on detailed studies by Union 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 Union'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. The following tables show Union's rate sensitivity analysis as of June 30, 2000: <TABLE> <CAPTION> June 30, 2000 Cumulative repriced within 3 Months 4 to 12 1 to 3 3 to 5 Over 5 or Less Months Years Years Total Total ------------------------------------------------------------------------ (dollars in thousands, by repricing date) <S> <C> <C> <C> <C> <C> <C> Interest sensitive assets: Federal Funds Sold $ 5,091 $ -0- $ -0- $ -0- $ -0- $ 5,091 Interest bearing deposits 396 693 673 191 -0- 1,953 Investments available for sale (1) 673 4,399 15,430 11,635 22,328 54,465 FHLB Stock -0- -0- -0- -0- 1,019 1,019 Loans (fixed and adjustable rate) 58,698 34,760 30,352 32,642 55,885 212,337 ------------------------------------------------------------------------ Total interest sensitive assets $ 64,858 $ 39,852 $ 46,455 $ 44,468 $ 79,232 $274,865 ------------------------------------------------------------------------ Interest sensitive liabilities: Certificates of deposit $ 22,271 $ 49,393 $ 23,920 $ 693 $ -0- $ 96,277 Money markets 40,287 -0- -0- -0- 10,676 50,963 Regular savings 16,290 -0- -0- -0- 20,466 36,756 Now accounts 19,246 -0- -0- -0- 12,300 31,546 Borrowed funds 6,077 2,232 618 618 501 10,046 ------------------------------------------------------------------------ Total interest sensitive liabilities $104,171 $ 51,625 $ 24,538 $ 1,311 $ 43,943 $225,588 ------------------------------------------------------------------------ Net interest rate sensitivity gap (39,313) (11,773) 21,917 43,157 35,289 49,277 Cumulative net interest rate Sensitivity gap (39,313) (51,086) (29,169) 13,988 49,277 Cumulative net interest rate sensitivity gap as a percentage of total assets (13.33%) (17.33%) (9.89%) 4.74% 16.71% Cumulative interest sensitivity gap as a percentage of total interest-earning assets (14.30%) (18.59%) (10.61%) 5.09% 17.93% Cumulative net interest earning assets as a percentage of cumulative interest-bearing liabilities (17.43%) (22.65%) (12.93%) 6.20% 21.84% - -------------------- <FN> <F1> Investments available for sale exclude marketable equity securities with a fair value of $926,000 which may be sold by Union at any time. </FN> </TABLE> Simulation Analysis. In its simulation analysis, Union uses computer software to simulate the estimated impact on net interest income and capital under various interest rate scenarios, balance sheet trends, and strategies. These simulations incorporate assumptions about balance sheet dynamics such as loans and deposit growth, product pricing, changes in funding mix, and asset and liability repricing and maturity characteristics. Based on the results of these simulations, Union is able to quantify its interest rate risk and develop and implement appropriate strategies. The following chart reflects the results of our latest simulation analysis for each of the next three year ends on Net Interest Income, Net Income, Return on Assets, Return on Equity and Capital Value. The projection utilizes a rate shock of 150 basis points from the current prime rate of 9.5%, this is the highest internal slope monitored and shows the best and worse scenarios analyzed. This slope range was determined to be the most relevant during this economic cycle. UNION BANKSHARES, INC. INTEREST RATE SENSITIVITY ANALYSIS MATRIX JUNE 30, 2000 (in thousands) <TABLE> <CAPTION> Return Return on on Year Prime Net Interest Change Net Assets Equity Capital Change Ending Rate Income % Income % % Value % - ----------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> December-00 11.00 14,300 1.42 4,862 1.64 14.38 17,293 (31,69) 9.50 14,099 0.00 4,733 1.59 14.02 25,316 00.00 8.00 13,902 (1.40) 4,605 1.55 13.66 34,203 35.10 December-01 11.00 14,671 2.61 4,859 1.58 13,37 21,566 (27.00) 9.50 14,298 0.00 4,629 1,51 12.82 29,543 00.00 8.00 13,931 (2,57) 4,402 1.43 12.27 38,380 29.91 December-02 11.00 15,674 4.00 5,277 1.65 13.58 26,169 (23,01) 9.50 15,071 0.00 4,900 1.53 12.79 33,988 00.00 8.00 14,481 (3.92) 4,532 1.42 12.00 42,650 25.48 </TABLE> Liquidity. Liquidity is a measurement of Union'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. Union's principal sources of funds are deposits, amortization and prepayment of loans and securities, maturities of investment securities and other short-term investments, sales of securities available-for-sale, and earnings and funds provided from operations. In addition, as members of the FHLB, Union's subsidiaries have access to preapproved lines of credit up to 2.24% of total assets or $6.6 million. In addition, both subsidiaries maintain Federal Fund lines of credit with upstream correspondent banks and repurchase agreement lines with selected brokerage houses. While scheduled loan and securities payments and FHLB advances are relatively predictable sources of funds, deposit flows and prepayments on loans and mortgage-backed securities are greatly influenced by general interest rates, economic conditions, and competition. Union's liquidity is actively managed on a daily basis, monitored by the Asset/Liability Committee, and reviewed periodically with the Board of Directors. Union's Asset/Liability Committee sets liquidity targets based on Union's financial condition and existing and projected economic and market conditions. The committee measures Union's marketable assets and credit available to fund liquidity requirements and compares the adequacy of that aggregate amount against the aggregate amount of Union'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 Union's liquidity position and funding sources in order to ensure that it has the ability to meet its ongoing commitment to its depositors, to fund loan commitments, and to maintain a portfolio of investment securities. Since many of the loan commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Union's management monitors current and projected cash flows and adjusts positions as necessary to maintain adequate levels of liquidity. Although approximately 74.4% of Union's certificates of deposit will mature within twelve months, management believes, based upon past experience, that Union 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 borrowings, or liquidation of investment securities or loans held for sale. Such steps could result in an increase in Union's cost of funds and adversely impact the net interest margin. Regulatory Capital Requirements.: Union Bank and Citizens (the Banks) are subject to various regulatory capital requirements administered by the federal banking agencies. Management believes, as of June 30, 2000 that the Banks meet all capital adequacy requirements to which they are subject. As of June 30, 2000, the most recent notification from the FDIC categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Banks must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. There are no conditions or events since the notification that management believes have changed either Bank's category. The Banks' actual capital amounts (000's omitted) and ratios are presented in the table: <TABLE> <CAPTION> Minimums To Be Well Minimums Capitalized Under For Capital Prompt Corrective Actual Requirements Action Provisions ---------------------------------------------------------- Amount Ratio Amount Ratio Amount Ratio ---------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> As of June 30, 2000: Total capital to risk weighted assets Union Bank $24,587 19.10% $10,298 8.0% $12,873 10.0% Citizens 11,951 17.28% 5,533 8.0% 6,916 10.0% Tier I capital to risk weighted assets Union Bank $22,842 17.74% $ 5,150 4.0% $ 7,726 6.0% Citizens 11,084 16.03% 2,766 4.0% 4,149 6.0% Tier I capital to average assets Union Bank $22,842 11.76% $ 7,769 4.0% $ 9,712 5.0% Citizens 11,084 11.25% 3,941 4.0% 4,926 5.0% </TABLE> Impact of Inflation and Changing Prices. Union's consolidated financial statements, included in this document, have been prepared in accordance with generally accepted accounting principles, which require the measurements of financial position and results of operations in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Banks have asset and liability structures that are essentially monetary in nature, and their general and administrative costs constitute relatively small percentages of total expenses. Thus, increases in the general price levels for goods and services have a relatively minor effect on Union's total expenses. Interest rates have a more significant impact on Union's financial performance than the effect of general inflation. Interest rates do not necessarily move in the same direction or change in the same magnitude as the prices of goods and services, although periods of increased inflation may accompany a rising interest rate environment. PART II OTHER INFORMATION ITEM 6: EXHIBITS AND REPORTS IN FORM 10-Q A. Exhibits. 27 - Financial Data Schedule B. Current Reports on Form 8-K Report to Shareholders on Second Quarter Results filed on July 14, 2000 Press Release announcing AMEX listing filed on July 14, 2000 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. Union Bankshares, Inc. Dated: August 14, 2000 /s/ Kenneth D. Gibbons ------------------------------------- Kenneth D. Gibbons Director and Chief Executive Officer /s/ Marsha A. Mongeon ------------------------------------- Marsha A. Mongeon Chief Financial Officer and Treasurer