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: March 31, 2001 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 March 31, 2001: Common Stock, $2 par value 3,029,729 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 22 Signatures 22 Union Bankshares, Inc. and Subsidiaries Statement of Condition (Unaudited) <TABLE> <CAPTION> March 31 December 31 (Dollars in Thousands) 2001 2000 ----------------------- <S> <C> <C> Assets Cash and due from banks $ 9,405 $ 10,353 Federal funds sold and overnight deposits 12,771 1,070 --------------------- Cash and cash equivalents 22,176 11,423 Interest bearing deposits 1,647 1,721 Securities available-for-sale 51,040 56,642 Federal Home Loan Bank stock 1,036 1,017 Loans held for sale 8,663 9,153 Loans 217,977 215,893 Unearned net loan fees (241) (250) Allowance for loan losses (2,859) (2,863) --------------------- Loans, net 214,877 212,780 --------------------- Accrued interest receivable 2,357 2,597 Bank premises and equipment, net 3,915 3,964 Other real estate owned, net 96 116 Other assets 3,512 3,738 --------------------- Total assets $309,319 $303,151 ===================== Liabilities and Stockholders' equity: Liabilities: Deposits: Non-interest bearing $ 32,496 $ 33,547 Interest bearing 228,495 225,189 --------------------- Total deposits 260,991 258,736 Borrowed funds 8,697 6,382 Accrued interest and other liabilities 3,613 2,876 --------------------- Total liabilities 273,301 267,994 --------------------- Stockholders' equity: Common stock, $2 par value; 5,000,000 shares authorized; 3,263,689 shares issued at 3/31/01 and 12/31/00. 6,527 6,527 Paid-in capital and surplus 240 240 Retained earnings 30,391 30,010 Treasury stock at cost (233,960 shares at 3/31/01 and 12/31/00) (1,592) (1,592) Accumulated other comprehensive income 452 (28) --------------------- Total stockholders' equity 36,018 35,157 --------------------- Total liabilities and stockholders' equity $309,319 $303,151 ===================== </TABLE> See accompanying notes to unaudited financial statements Union Bankshares, Inc. and Subsidiaries Consolidated Statements of Income (Unaudited) <TABLE> <CAPTION> March 31 March 31 (Dollars in Thousands) 2001 2000 ----------------------- <S> <C> <C> Interest income: Interest and fees on loans $ 5,094 $ 4,737 Interest and dividends on investment securities 825 924 Interest on federal funds sold 77 49 Interest on interest bearing deposits 27 29 ------------------------ 6,023 5,739 ------------------------ Interest expense: Interest on deposits 2,414 2,227 Interest on federal funds purchased 2 1 Interest on borrowed funds 111 38 ------------------------ 2,527 2,266 ------------------------ Net interest income 3,496 3,473 Provision for loan losses 56 62 ------------------------ Net interest income after provision for loan losses 3,440 3,411 Noninterest income: Trust department income 87 42 Service fees 571 549 Security gains (losses) (2) 37 Gain on sale of loans 73 9 Other 2 6 ------------------------ 731 643 ------------------------ Noninterest expense: Salaries and wages 1,160 1,099 Pension and other employee benefits 339 298 Occupancy expense, net 165 157 Equipment expense 212 300 Other operating expense 648 663 ------------------------ 2,524 2,517 ------------------------ Income before income tax expense 1,647 1,537 Income tax expense 479 459 ------------------------ Net income $ 1,168 $ 1,078 ======================== Earnings per common share $ .39 $ .36 ======================== Weighted average number of common shares outstanding 3,029,729 3,029,529 ======================== </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, 2000 $6,527 $240 $30,010 $(1,592) $(28) $35,157 Net income 0 0 1,168 0 0 1,168 Change in net unrealized holding gain on securities available-for-sale, net of tax 0 0 0 0 480 480 Comprehensive income 1,648 ------- Cash dividends declared 0 0 (787) 0 0 (787) -------------------------------------------------------------------------------- Balance, March 31, 2001 $6,527 $240 $30,391 $(1,592) $452 $36,018 ================================================================================ </TABLE> Union Bankshares, Inc. and Subsidiaries Consolidated Statement of Cash Flows (UNAUDITED) <TABLE> <CAPTION> March 31 March 31 (Dollars in Thousands) 2001 2000 -------------------- <S> <C> <C> Cash Flows From Operating Activities Net Income $1,168 $1,078 Adjustments to reconcile net income to net cash provided by operating activities Depreciation 160 247 Provision for loan losses 56 62 Credit for deferred income taxes (39) (78) Amortization, net 37 73 Decrease in unamortized loan fees (9) (5) Decrease in loans held for sale 563 1,313 Decrease (increase) in accrued interest receivable 240 (54) Decrease in other assets 87 249 Increase in income taxes payable 517 532 Increase in accrued interest payable 156 112 Increase in other liabilities 64 182 Loss (gain) on securities 2 (37) Gain on sale of loans (73) (9) Loss (gain) on sale of OREO 1 (1) Loss on disposal of fixed assets 1 1 ------------------ Net cash provided by operating activities 2,931 3,665 Cash Flows From Investing Activities Interest bearing deposits Maturities and redemptions 99 297 Purchases (99) (393) Securities available for sale Sales and Maturities 12,250 5,259 Purchases (5,969) (2,193) Purchase of Federal Home Loan Bank Stock (19) (80) Increase in loans, net (2,172) (2,839) Recoveries of loans charged off 29 45 Purchases of premises and equipment, net (112) (289) Proceeds from sale of OREO 20 0 Proceeds from sale of repossessed property 8 8 ------------------ Net cash provided (used) in investing activities 4,035 (155) Cash Flows From Financing Activities Borrowings, net of repayments 2,315 1,254 Net decrease in demand, Now, savings, and money market accounts (3,652) (8,488) Net increase in time deposits 5,910 2,803 Dividends paid (787) (727) ------------------ Net cash provided (used) by financing activities 3,786 (5,158) Increase (decrease) in cash and cash equivalents 10,752 (1,678) Cash and cash equivalents Beginning 11,424 15,101 Ending 22,176 13,423 Supplemental Disclosure of Cash Flow Information: Interest Paid $2,110 $2,154 ================== Income Taxes Paid $ 0 $ 0 ================== </TABLE> UNION BANKSHARES, INC. NOTES TO FINANCIAL STATEMENTS: Note 1. The accompanying interim unaudited consolidated financial statements of Union Bankshares, Inc. (the Company) for the interim period ended March 31, 2001 and 2000 have been prepared in accordance with the accounting policies described in the company's annual report to shareholders and Form 10K. 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 2000 Annual report, Form 10K, and Forms 8K. Note 2. 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 3. Earnings Per Share Earnings per common share amounts are computed based on the weighted average number of shares of common stock outstanding during the period (retroactively adjusted for stock dividends) and reduced for shares held in Treasury. The assumed conversion of available stock options does not result in material dilution. Note 4. 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 March 31, follows: <TABLE> <CAPTION> Intersegment Consolidated 2001 Union Citizens Elimination Other Totals - --------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Interest income $ 4,144 $ 1,879 $ 0 $ 0 $ 6,023 Interest expense 1,679 848 0 0 2,527 Provision for loan loss 0 56 0 0 56 Service fee income 447 124 0 0 571 Income tax expense (benefit) 373 121 0 (15) 479 Net income (loss) 950 245 0 (27) 1,168 Assets 211,075 98,027 (24) 241 309,319 <CAPTION> Intersegment Consolidated 2000 Union Citizens Elimination Other Totals - --------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Interest income $ 3,841 $ 1,898 $ 0 $ 0 $ 5,739 Interest expense 1,451 815 0 0 2,266 Provision for loan loss 0 62 0 0 62 Service fee income 436 113 0 0 549 Income tax expense (benefit) 373 103 0 (17) 459 Net income (loss) 903 201 0 (26) 1,078 Assets 193,030 98,737 (21) 359 292,105 </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 March 31, 2001 and as of December 31, 2000, and its results of operations for the three months ended March 31, 2001 and 2000. 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 March 31, 2001, 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 and it closed on May 9, 2001 at $17.51. 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 * 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 March 31, 2001 was $1.17 million, compared with net income of $1.08 million for the first quarter of 2001. Net income per share was $.39 for the first quarter of 2001 compared to $.36 for the same quarter of 2000. 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 balance 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 March 31, 2001 2000 ------------------------------- ------------------------------- 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 $ 5,821 $ 77 5.29% $ 3,635 $ 49 5.39% Interest bearing deposits 1,695 27 6.37% 1,982 29 5.85% Investments (1) (2) 53,482 825 6.36% 60,683 924 6.26% Loans, net (1) (3) 222,613 5,094 9.26% 206,946 4,741 9.25% ---------------------------------------------------------------- Total interest-earning assets (1) 283,611 6,023 8.61% 273,246 5,743 8.51% Cash and due from banks 9,791 8,766 Premises and equipment 3,978 4,033 Other assets 5,994 6,579 -------- -------- Total assets $303,374 $292,624 ======== ======== Average Liabilities and Shareholders' Equity: Now accounts $ 33,365 164 1.97% $ 32,008 $ 153 1.91% Savings and money market accounts 87,675 792 3.61% 90,868 825 3.63% Certificates of deposit 103,596 1,458 5.63% 97,925 1,249 5.10% Borrowed funds 7,213 113 6.27% 2,443 39 6.39% ---------------------------------------------------------------- Total interest-bearing Liabilities 231,849 2,527 4.36% 223,244 2,266 4.06% Non-interest bearing deposits 33,097 32,250 Other liabilities 3,258 5,085 -------- -------- Total liabilities 268,204 260,579 Shareholders' equity 35,170 32,045 -------- -------- Total liabilities and shareholders' equity $303,374 $292,624 ======== ======== Net interest income (1) $3,496 $3,477 ====== ====== Net interest spread (1) 4.25% 4.45% Net interest margin (1) 5.05% 5.19% <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 $19 thousand, or .5%, to $3.50 million for the three months ended March 31, 2001, from $3.48 million for the three months ended March 31, 2000. This increase was primarily due to loan demand experienced over the last year which has resulted in our average balances in loans increasing to 73.4% of total assets on average for the quarter from 70.7% last year and therefore the amount of investments held at lower yields has dropped. The net interest spread decreased by 20 basis points to 4.25% for the three months ended March 31, 2001, from 4.45% for the three months ended March 31, 2000. The net interest margin for the 2001 period decreased by 14 basis points to 5.05% from 5.19% for the 2000 period. The decrease in the net interest spread and the net interest margin is a result of slower movement to decrease rates paid on deposits during the first quarter of 2001, while our interest sensitive assets, which are short term in nature or adjust immediately when there is a change in prime, react much faster. 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 March 31, 2001 Compared to Three Months Ended March 31, 2000 ------------------------------------------ Increase/(Decrease) Due to Change In Volume Rate Net ------------------------------------------ (dollars in thousands) <S> <C> <C> <C> Interest-earning assets: Federal funds sold $ 29 $ (1) $ 28 Interest bearing deposits (4) 2 (2) Investments (112) 13 (99) Loans, net 348 5 353 -------------------------------- Total interest-earning assets 261 19 280 -------------------------------- Interest-bearing liabilities: Now accounts 6 5 11 Savings and money market accounts (29) (4) (33) Certificates of deposit 72 137 209 Borrowed funds 76 (2) 74 -------------------------------- Total interest-bearing liabilities 125 136 261 -------------------------------- Net change in net interest income $ 136 $(117) $ 19 ================================ </TABLE> Interest and Dividend Income. Union's interest and dividend income increased by $280,000, or 4.9%, to $6.0 million for the three months ended March 31, 2001, from $5.7 million for the three months ended March 31, 2000. Average earning assets increased by $10.4 million, or 3.8%, to $283.6 million for the three months ended March 31, 2001, from $273.2 million for the three months ended March 31, 2000. Average loans approximated $222.6 million for the three months ended March 31, 2001 up from $207 million for the three months ended March 31, 2000. Increases in construction loans of $2.4 million or 31.3%, the $2 million or 2.3% increase in residential real estate secured loans, the $2.1 million or 21.2% increase in municipal loans and the $12.2 million or 13.5% increase in commercial and commercial real estate loans was partially offset by the $3.2 million or 18.7% decrease in personal loans. Construction and commercial lending was strong throughout 2000 and into the winter of 2001. A conscious decision to retain a number of loans packaged for sale in our portfolio accounts for a portion 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 $7.2 million, or 11.9%, to $53.5 million for the three months ended March 31, 2001, from $60.7 million for the three months ended March 31, 2000. The average level of federal funds sold increased by $2.2 million or 60%, to $5.8 million for the three months ended March 31, 2001, from $3.6 million for the three months ended March 31, 2000. The decrease in the investment portfolio and Interest Bearing Deposits in 2001 reflects the continuing growth in our loan portfolio. Interest Income on non-loans was $929 thousand for 2001 and $1 million for 2000, reflecting the increase in yields offset by the decrease in volume. Interest Expense. Union's interest expense increased by $261 thousand, or 11.5%, to $2.53 million for the three months ended March 31, 2001 from $2.27 million for the three months ended March 31, 2000. Average interest- bearing liabilities increased by $8.6 million, or 3.8% to $231.8 million for the three months ended March 31, 2001, from $223.2 million for the three months ended March 31, 2000. Average time deposits increased $5.7 million, or 5.8%, to $103.6 million for the three months ended March 31, 2001, from $97.9 million for the three months ended March 31, 2000, while the average balances for money market and saving accounts decreased by $3.2 million to $87.7 million for the three months ended March 31, 2001, from $90.9 million for the three months ended March 31, 2000. Now accounts increased $1.5 million or 4.6% mainly due to municipal account balances. The average balance of funds borrowed rose from $2.4 million on average in 2000 to $7.2 million in 2001 as Union took some advances from the Federal Home Loan Bank to match against specific loan commitments. Noninterest Income. Union's noninterest income increased $88,000, or 13.7%, to $731 thousand for the three months ended March 31, 2001, from $643 thousand for the three months ended March 31, 2000. The results for the period reflected a net loss of $2 thousand from the sale of securities compared to a $37 thousand gain from sales during 2000. Trust department income rose to $87,000 in the first quarter of 2001 from $42,000 in the same period of 2000 or a 107% increase. Gain on Sale of Loans rose $64,000 to $73,000 for 2001 from $9,000 for 2000 as we positioned our balance sheet for an anticipated drop in interest rates. Other noninterest income and service fees (sources of which include deposit and loan servicing fees, ATM fees, and safe deposit fees) increased by $18,000, or 3.2%, to $573 thousand for the three months ended March 31, 2001, from $555 thousand for the three months ended March 31, 2000. This was primarily due to an increase in ATM income. Noninterest Expense. Union's noninterest expense only increased $7,000, or .3%, to $2.524 million for the three months ended March 31, 2001, from $2.517 million for the three months ended March 31, 2000. Salaries increased $61,000, or 5.5%, to $1.16 million for the three months ended March 31, 2001, from $1.1 million for the three months ended March 31, 2000, reflecting normal salary activity offset by pay for overtime during the 1st quarter of 2000 related to a Systems Conversion at Citizens. Pension and employee benefits increased $41 thousand, or 13.8%, to $339 thousand for the three months ended March 31, 2001, from $298 thousand for the three months ended March 31, 2000 mainly due to a $17,000 increase in health insurance costs and a $18,000 increase in retirement plans expense. Net occupancy expense increased $8 thousand, or 5.1%, to $165,000 for the three months ended March 31, 2001, from $157,000 for the three months ended March 31, 2000. Equipment expense decreased $88 thousand to $212 thousand for the three months ended March 31, 2001, from $300 thousand for the same period in 2000, primarily resulting from decreased depreciation cost on computer equipment and purchased software which are depreciated as an expense over a time period of three to five years, since we are now processing both banks at one location, thus reducing a lot of duplicative equipment and software. Other operating expenses decreased $15,000, or 2.3%, to $648 thousand in 2001 from $663 thousand in 2000 partially due to a decrease in the number of Directors and therefore, their fees. FINANCIAL CONDITION At March 31, 2001, Union had total consolidated assets of $309 million, including net loans and loans held for sale of $223 million, deposits of $261 million and shareholders' equity of $36 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 increased by $6.1 million, or 2.01%, to $309.3 million at March 31, 2001 from $303.2 million at December 31, 2000. Total net loans and loans held for sale increased by $1.6 million or .7% to $223.5 million or 72.3% of total assets at March 31, 2001 as compared to $221.9 million or 73.2% of total assets at December 31, 2000. Cash and cash equivalents, including Federal funds sold, increased approximately $10.8 million or 94.1% to $22.2 million at March 31, 2001 from $11.4 million at December 31, 2000, which was primarily attributable to higher than anticipated municipal time deposits on March 31, 2001 and some borrowings taken to match against large commercial loan commitments which did not close until April. Deposits increased $2.3 million, or .87%, to $261.0 million at March 31, 2001 from $258.7 million at December 31, 2000. A $7.4 million drop in Now accounts, mainly Municipal accounts and a $1.0 million drop in demand deposits was more than offset by a $4.8 million increase in Savings and Money Market accounts and a $5.9 million increased investment in time deposits. Total borrowings increased $2.3 million to $8.7 million at March 31, 2001 from $6.4 million at December 31, 2000. The increase was in borrowings from the Federal Home Loan Bank to match certain loan commitments. 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 March 31, 2001, Union's loan portfolio totaled $223.5 million, or 72.3%, of assets, of which $107.6 million, or 47.5% of gross loans, consisted of residential mortgages and construction loans, and $73.1 million, or 32.2%, of total loans consisted of commercial real estate loans. As of such date, Union's loan portfolio also included $20.4 million of commercial loans, $12.2 million of municipal loans, and $13.3 million of consumer loans representing, in order, 9.0%, 5.4% and 5.9% of total loans outstanding on March 31, 2001. The following table shows information on the composition of Union's loan portfolio as of March 31, 2001 and December 31, 2000. <TABLE> <CAPTION> March 31, December 31, Loan Type 2001 2000 - --------- ------------------------- (dollars in thousands) <S> <C> <C> Real Estate $104,121 $104,417 Commercial real estate 68.335 66,186 Commercial 20,014 18,214 Consumer 13,344 14,628 Municipal loans 12,163 12,448 Loans held for sale 8,663 9,153 ----------------------- Total loans 226,640 225,046 Deduct: Allowance for loan losses 2,859 2,863 Net deferred loan fees, premiums & discounts 241 250 ----------------------- $223,540 $221,933 ======================= </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 $150.0 million residential mortgage portfolio, approximately $42.4 million of which is serviced for unaffiliated third parties at March 31, 2001. Additionally, Union originates commercial loans under various SBA programs that provide an agency guarantee for a portion of the loan amount. Union sometimes sells 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 March 31, 2001, Union serviced $9.5 million of commercial and commercial real estate loans for unaffiliated third parties. Gross loans and loans held for sale have increased $1.6 million or .7% since December 31, 2000. The increase in Commercial Real Estate loans not held for sale was $2.1 million or an annualized growth rate of 13.0% and an increase in Commercial loans of $1.8 million or an annualized growth rate of 39.5%. There was growth in the residential real estate loan arena but it was negated by the sale of $2.5 million of these loans during the quarter. The growth was partially offset by the shrinkage of our consumer loan portfolio by $1.3 million or 8.8%, this runoff is the continuing result of the discontinuance of the dealer floorplan program in late 1998. 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 $1.9 million at March 31, 2001, $1.5 million at December 31, 2000 and $709,000 at March 31, 2000. Interest income not recognized on such loans amounted to approximately $420 thousand and $215 thousand as of March 31, 2001 and 2000, respectively and $289 thousand as of December 31, 2000. Union had $866 thousand and $2.9 million in loans past due 90 days or more and still accruing at March 31, 2001 and December 31, 2000, respectively. At March 31, 2001, Union had internally classified certain loans totaling $1.4 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 March 31, 2001, Union had acquired by foreclosure or through repossession real estate worth $96,000, consisting of commercial and residential property 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 three months ended March 31, 2001 and 2000: <TABLE> <CAPTION> Three Months Ended, March 31 ---------------------------- 2001 2000 ---------------------------- (dollars in thousands) <S> <C> <C> Balance at the beginning of period $2,863 $2,870 Charge-offs: Real Estate 0 0 Commercial 38 14 Consumer and other 51 64 ----------------- Total charge-offs 89 78 ----------------- Recoveries: Real Estate 0 0 Commercial 3 21 Consumer and other 26 24 ----------------- Total recoveries 29 45 ----------------- Net charge-offs (60) (33) Provision for loan losses 56 62 ----------------- Balance at end of period $2,859 $2,899 ================= </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> March 31, December 31, 2001 2000 ----------------- ----------------- (dollars in thousands) Amount Percent Amount Percent -------------------------------------- <S> <C> <C> <C> <C> Real Estate Residential $ 575 39.4% $ 595 40.5% Commercial 1,210 33.1% 1,193 32.3% Construction 108 4.8% 102 4.5% Other Loans Commercial 440 10.0% 401 9.1% Consumer installment 290 5.9% 319 6.5% Home equity loans 29 1.7% 31 1.8% Municipal, Other and Unallocated 207 5.1% 222 5.3% ------------------------------------- Total $2,859 100.0% $2,863 100.0% ===================================== Ratio of Net Charge Offs to Average Loans (1) 0.11% 0.12% ------ ------ Ratio of Allowance for Loan Losses to Loans 1.31% 1.33% ------ ------ <FN> <F1> Annualized </FN> </TABLE> Investment Activities At March 31, 2001 the reported value of investment securities available-for-sale was $51.0 million or 16.5% of its assets. Union had no securities classified as held-to-maturity or trading securities. The reported value of securities available-for-sale at March 31, 2001 reflects a positive valuation adjustment of $685 thousand. The offset of this adjustment, net of income tax effect, was a $452 thousand million increase in Union's other comprehensive income component of shareholders' equity and a decrease in net deferred tax assets of $233 thousand. 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 March 31, 2001 and December 31, 2000: <TABLE> <CAPTION> Three Months Ended, March 31 Year Ended December 31, 2001 2000 ------------------------------- ------------------------------ (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 $ 33,097 12.84% $ 32,906 12.81% Now accounts 33,365 12.95% 1.97% 34,383 13.39% 2.04% Money Markets 52,771 20.47% 4.42% 53,770 20.94% 4.45% Savings 34,904 13.54% 2.50% 37,153 14.47% 2.72% ------------------ ------------------ Total non-certificate deposits: 154,137 59.80% 158,212 61.61% ------------------ ------------------ Certificates of deposit: Less than $100,000 76,336 29.62% 5.55% 75,483 29.40% 5.29% $100,000 and over 27,260 10.58% 6.16% 23,088 8.99% 5.89% ------------------ ------------------- Total certificates of deposit 103,596 40.20% 98,571 38.39% ------------------ ------------------- Total deposits $257,733 100.00% 3.80% $256,783 100.00% 3.68% ================================================================ </TABLE> The following table sets forth information regarding the amounts of Union's certificates of deposit in amounts of $100,000 or more at March 31, 2001 and December 31, 2000 that mature during the periods indicated: <TABLE> <CAPTION> March 31, 2001 December 31, 2000 ----------------------------------- (dollars in thousands) <S> <C> <C> Within 3 months $13,433 $ 6,757 3 to 6 months 3,714 11,259 6 to 12 months 7,821 4,439 Over 12 months 5,010 3,739 -------------------------- $29,978 $26,194 ========================== </TABLE> Borrowings. Borrowings from the Federal Home Loan Bank of Boston were $8.7 million at March 31, 2001 at a weighted average rate of 5.87%. Borrowings from the Federal Home Loan Bank of Boston were $6.4 million at December 31, 2000 at a weighted average rate of 6.60%. The change between year end 2000 and the end of the first quarter of 2001 is a net increase of $2.3 million in matched borrowings 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 2000 for a flat rate environment projected a Net Interest Income of $3.62 million for the first three months of 2001 compared to actual results of $3.50 million or a 3.4% difference. During the first quarter of 2001, the prime rate, which is used as the driver rate for our simulation analysis, dropped from 9.5% to 8.0% in 50 basis point steps. The average prime rate for the quarter was 8.63% and if we look at our projected interest rate sensitivity analysis shocked for a 100 basis point drop then our projected net interest income for the quarter was $3.54 million compared to our actual result of $3.50 million. The difference is due to a slower dropping of rates paid on deposit instruments than the changes in prime rate which affect our variable rate loan portfolio and the calling of some investment securities which we were not able to re-invest at a comparable rate. Net income was projected to be $1.35 million in a flat rate environment and $1.30 million in a 100 basis point drop environment compared to actual results of $1.17 million. Of the $180 thousand difference between our flat rate simulation and our actual results, half is related to net interest margin being lower than anticipated, the remainder of the difference relates to lower overdraft fees, lower service charges on deposits, loss of $2.4 thousand on securities sold versus projected gains of $50 thousand, higher health insurance expense and higher equipment depreciation expense during the first quarter of 2001. These were partially offset by higher ATM fees, Trust income and Gain on Loans sold than anticipated. Return on Assets was projected to be 1.83% in a flat rate environment, 1.76% in a down 100 basis point environment and actual results were 1.59%. Return on Equity was projected to be 15.64% in a flat rate environment, 15.08% in a down 100 basis point environment and actual results were 13.75%. The lower results of these ratios are based on lower net income for the quarter as explained above combined with a higher level of assets and stockholders' equity than used in our simulation. The Company generally requires collateral or other security to support financial instruments with credit risk. As of March 31, 2001, the contract or notional amount of financial instruments whose contract amount represents credit risk were as follows: <TABLE> <S> <C> Commitments to extend credit $24,427,000 ----------- Standby letters of credit and commercial letters of credit $ 793,000 ----------- Credit Card arrangements $ 2,084,000 ----------- Home Equity Lines of Credit $ 3,845,000 ----------- </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 amount 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 March 31, 2001: <TABLE> <CAPTION> March 31, 2001 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> Interest sensitive assets: Federal Funds Sold $12,771 $ -0- $ -0- $ -0- $ -0- $ 12,771 Interest bearing deposits 297 664 495 191 -0- 1,647 Investments available for sale (1) 2,781 8,303 7,327 10,172 21,400 49,983 FHLB Stock -0- -0- -0- -0- 1,036 1,036 Loans (fixed and adjustable rate) 80,205 53,576 48,989 19,735 23,894 226,399 ---------------------------------------------------------------- Total interest sensitive assets $96,054 $62,543 $56,811 $30,098 $46,330 $291,836 ---------------------------------------------------------------- Interest sensitive liabilities: Certificates of deposit $34,642 $53,323 $15,270 $ 3,589 $ 2 $106,826 Money markets 16,770 -0- -0- -0- 38,749 55,519 Regular savings 4,790 -0- -0- -0- 30,388 35,178 Now accounts 17,409 -0- -0- -0- 13,563 30,972 Borrowed funds 69 3,210 3,074 1,941 403 8,697 ---------------------------------------------------------------- Total interest sensitive liabilities $73,680 $56,533 $18,344 $ 5,530 $83,105 $237,192 ---------------------------------------------------------------- Net interest rate sensitivity gap 22,374 6,010 38,467 24,568 (36,775) 54,644 Cumulative net interest rate sensitivity gap 22,374 28,384 66,851 91,419 54,644 Cumulative net interest rate sensitivity gap as a percentage of total assets 7.23% 9.18% 21.61% 29.55% 17.66% Cumulative interest sensitivity gap as a percentage of total interest-earning assets 7.67% 9.73% 22.91% 31.32% 18.72% Cumulative net interest earning assets as a percentage of cumulative interest-bearing liabilities 9.43% 11.97% 28.18% 38.54% 23.04% <FN> - -------------------- <F1> Investments available for sale exclude marketable equity securities with a fair value of $1,057,000 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 the next two year ends on Net Interest Income, Net Income, Return on Assets, Return on Equity and Capital Value. The projection utilizes a rate shock of 300 basis points from the current prime rate of 8%, 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 MARCH 31, 2001 (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-01 11.00 15,858 7.71 6,136 1.98 16.81 26,227 (29.70) 8.00 14,722 0.00 5,366 1.73 14.84 37,308 0.00 5.00 13,641 (7.35) 4,632 1.50 12.93 49,032 31.43 December-02 11.00 19,025 15.43 8,068 2.52 19.65 28,090 (31.58) 8.00 16,483 0.00 6,363 2.00 16.13 41,056 0.00 5.00 14,038 (14.83) 4,723 1.49 12.46 56,010 36.42 </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 2.1% of total assets. In addition, both subsidiaries maintain Federal Fund lines of credit with upstream correspondent banks totaling $4 million 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 net loan to deposit ratio, the 90 day and 1 year maturity gaps and long term (>3 year) assets repricing compared to total assets. 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 81.1% 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 March 31, 2001, that the Banks meet all capital adequacy requirements to which they are subject. As of March 31, 2001, 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 March 31, 2001: Total capital to risk weighted assets Union Bank $26,143 18.18% $11,504 8.0% $14,380 10.0% Citizens 11,959 17.65% 5,421 8.0% 6,776 10.0% Tier I capital to risk weighted assets Union Bank $24,197 16.83% $ 5,751 4.0% $ 8,626 6.0% Citizens 11,109 16.40% 2,710 4.0% 4,066 6.0% Tier I capital to average assets Union Bank $24,197 11.77% $ 8,221 4.0% $10,276 5.0% Citizens 11,109 11.39% 3,901 4.0% 4,876 5.0% </TABLE> Impact of Inflation and Changing Prices. Union's consolidated financial statements, included in this document, have been prepared in accordance with U.S. generally accepted accounting principles, which require the measurements of financial position and results of operations in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Banks have asset and liability structures that are essentially monetary in nature, and their general and administrative costs constitute relatively small percentages of total expenses. Thus, increases in the general price levels for goods and services have a relatively minor effect on 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. Current Reports on Form 8-K 1. Press Release on Fourth Quarter Results and Dividend Announcement filed on January 4, 2001 2. Dividend Announcement filed on January 4, 2001 3. Change in Registrant's Certifying Accountant filed on February 27, 2001 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. /s/ Kenneth D. Gibbons -------------------------------- Kenneth D. Gibbons Director and Chief Executive Officer /s/ Marsha A. Mongeon -------------------------------- Marsha A. Mongeon Chief Financial Officer and Treasurer