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: September 30, 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 September 30, 2001: Common Stock, $2 par value 3,033,929 shares
1 UNION BANKSHARES, INC. TABLE OF CONTENTS <TABLE> <s> <c> 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 27 </TABLE>
2 Union Bankshares, Inc. and Subsidiaries Statement of Condition (Unaudited) <TABLE> <CAPTION> September 30, December 31, (Dollars in Thousands) 2001 2000 ------------- ------------ <s> <c> <c> Assets Cash and due from banks $ 12,007 $ 10,353 Federal funds sold and overnight deposits 7,398 1,070 ------------------------- Total Cash and Cash Equivalents 19,405 11,423 Interest bearing deposits 3,524 1,721 Securities available-for-sale 52,379 56,642 Federal Home Loan Bank stock 1,064 1,017 Loans held for sale 11,650 9,153 Loans 235,042 215,893 Unearned loan fees (264) (250) Allowance for loan losses (2,794) (2,863) ------------------------- Loans, net 231,984 212,780 ------------------------- Accrued interest receivable 2,113 2,597 Bank premises and equipment, net 4,027 3,964 Other real estate owned, net 78 116 Other assets 3,677 3,729 ------------------------- Total assets $329,901 $303,142 ========================= Liabilities and Stockholders' equity: Liabilities: Deposits: Non-interest bearing $ 39,313 $ 33,547 Interest bearing 240,008 225,189 ------------------------- Total Deposits 279,321 258,736 Borrowed funds 9,724 6,382 Accrued interest and other liabilities 3,480 2,867 ------------------------- Total liabilities 292,525 267,985 ------------------------- Stockholders' equity: Common stock ($2 par value; 5,000,000 shares authorized; 3,267,889 and 3,263,689 shares issued at 9/30/01 and 12/31/00) 6,536 6,527 Paid-in capital and surplus 272 240 Retained earnings 31,281 30,010 Treasury stock (233,960 shares at 9/30/01 and 12/31/00) (1,592) (1,592) Accumulated other comprehensive income 879 (28) ------------------------- Total stockholders' equity 37,376 35,157 ------------------------- Total liabilities and stockholders' equity $329,901 $303,142 ========================= </TABLE> See accompanying notes to unaudited financial statements
3 Union Bankshares, Inc. and Subsidiaries Consolidated Statements of Income (Unaudited) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, ---------------------- ---------------------- (Dollars in Thousands) 2001 2000 2001 2000 ---- ---- ---- ---- <s> <c> <c> <c> <c> Interest income: Interest and fees on loans $ 5,186 $ 5,154 $ 15,458 $ 14,803 Interest and dividends on investment securities 760 894 2,369 2,718 Interest on federal funds sold 98 95 278 217 Interest on interest bearing deposits 41 31 101 91 ------------------------------------------------ 6,085 6,174 18,206 17,829 Interest expense: Interest on deposits 2,174 2,415 6,916 6,961 Interest on federal funds purchased 1 0 4 4 Interest on borrowed funds 156 178 399 273 ------------------------------------------------ 2,331 2,593 7,319 7,238 ------------------------------------------------ Net interest income 3,754 3,581 10,887 10,591 Provision for loan losses 86 63 199 188 ------------------------------------------------ Net interest income after provision for loan losses 3,668 3,518 10,688 10,403 ------------------------------------------------ Noninterest income: Trust department income 54 35 204 111 Service fees 600 563 1,786 1,718 Security gains 5 0 79 34 Gain on sale of loans 1 25 74 34 Other (9) (1) 13 8 ------------------------------------------------ 651 622 2,156 1,905 ------------------------------------------------ Noninterest expense: Salaries and wages 1,210 1,121 3,510 3,432 Pension and other employee benefits 332 290 1,007 867 Occupancy expense, net 149 131 487 423 Equipment expense 212 234 631 764 Other operating expense 674 618 2,087 2,053 ------------------------------------------------ 2,577 2,394 7,722 7,539 ------------------------------------------------ Income before income tax expense 1,741 1,746 5,122 4,769 Income tax expense 519 499 1,487 1,276 ------------------------------------------------ Net income $ 1,222 $ 1,247 $ 3,635 $ 3,493 ================================================ Earnings per common share $ 0.40 $ 0.41 $ 1.20 $ 1.15 ------------------------------------------------ Weighted average number of common shares outstanding 3,033,842 3,029,718 3,031,133 3,029,593 ================================================ Dividends declared per share $ 0.26 $ 0.24 $ 0.78 $ 0.72 ================================================ </TABLE> See accompanying notes to unaudited financial statements
4 Union Bankshares, Inc. and Subsidiaries Consolidated Statement 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 3,635 3,635 Change in net unrealized holding gain(loss) on securities available-for-sale, net of tax 907 907 ------- Comprehensive income 4,542 ------- Cash dividends declared (2,364) (2,364) Treasury stock purchased 0 Exercise of stock option 9 32 41 -------------------------------------------------------------------------------- Balance September 30, 2001 $6,536 $272 $31,281 $(1,592) $(879) $37,376 ================================================================================ </TABLE> See accompanying notes to unaudited financial statements
5 Union Bankshares, Inc. and Subsidiaries Consolidated Statement of Cash Flows (UNAUDITED) <TABLE> <CAPTION> Year to Date ------------------------------ September 30, September 30, (Dollars in Thousands) 2001 2000 ------------------------------ <s> <c> <c> Cash Flows From Operating Activities Net Income $ 3,635 $ 3,493 Adjustments to reconcile net income to net cash provided by operating activities Depreciation 462 603 Provision for loan losses 199 188 Credit for deferred income taxes (213) (102) Amortization, net securities 51 0 Amortization, net Limited Partnerships 47 29 Write-downs of Other Real Estate Owned 0 8 Increase (decrease) in unamortized loan fees 14 (1) Decrease (increase) in loans held for sale (2,423) (800) (Increase) in accrued interest receivable 484 (206) (Increase) decrease in other assets (572) 81 Increase (decrease) in income taxes payable 365 (101) Increase (decrease) in accrued interest payable (4) 182 Increase in other liabilities 253 591 Gain on securities sold (79) (34) Gain on sale of loans (74) (34) (Gain) loss on sale of OREO 16 (7) Loss on disposal of fixed assets 9 2 ------------------------ Net cash (used) provided by operating activities 2,170 3,892 Cash Flows From Investing Activities Interest bearing deposits Maturities and redemptions 685 1,090 Purchases (2,563) (1,176) Securities available for sale Maturities and redemptions 22,943 9,370 Purchases (16,781) (3,888) Purchase of Federal Home Loan Bank Stock (47) (77) Increase in loans, net (19,576) (15,225) Recoveries of loans charged off 81 99 Purchases of premises and equipment, net (525) (424) Proceeds from sale of OREO 106 23 Proceeds from sale of repossessed property 21 0
6 Investment in Ltd Partnerships (136) (55) ------------------------ Net cash used in investing activities (15,792) (10,263) Cash Flows From Financing Activities Borrowings, net of repayments 3,342 7,592 Proceeds from exercise of stock options 41 2 Net increase (decrease) in demand, NOW, Savings, and money market accounts 15,422 (1,489) Net increase in time deposits 5,163 3,050 Dividends paid (2,364) (2,181) ------------------------ Net cash provided by financing activities 21,604 6,974 ------------------------ Increase in cash and cash equivalents $ 7,982 $ 603 Cash and cash equivalents Beginning $11,423 $15,101 ======================== Ending $19,405 $15,704 ======================== Supplemental Disclosure of Cash Flow Information: Interest Paid $ 7,324 $ 7,056 Income Taxes Paid $ 1,335 $ 1,480 </TABLE> See accompanying notes to unaudited financial statements
7 UNION BANKSHARES, INC. NOTES TO FINANCIAL STATEMENTS: Note 1. The accompanying unaudited interim consolidated financial statements of Union Bankshares, Inc. (the Company) for the interim period ended September 30, 2001 and 2000 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. 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 10-K, and Form 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.
8 Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the period ended September 30, follows: <TABLE> <CAPTION> Intersegment Consolidated 2001 Union Citizens Elimination Other Totals - --------------------------------------------------------------------------------------------- <s> <c> <c> <c> <c> <c> Interest income $ 12,473 $ 5,733 $ 0 $ 0 $ 18,206 Interest expense 4,862 2,456 0 1 7,319 Provision for loan loss 30 169 0 0 199 Service fee income 1,388 398 0 0 1,786 Income tax expense (benefit) 1,157 381 0 (51) 1,487 Net income (loss) 2,938 776 0 (79) 3,635 Assets 224,862 104,699 (61) 401 329,901 <CAPTION> Intersegment Consolidated 2000 Union Citizens Elimination Other Totals - --------------------------------------------------------------------------------------------- <s> <c> <c> <c> <c> <c> Interest income $ 12,008 $ 5,821 $ 0 $ 0 $ 17,829 Interest expense 4,652 2,585 0 1 7,238 Provision for loan loss 0 188 0 0 188 Service fee income 1,355 363 0 0 1,718 Income tax expense (benefit) 999 334 0 (57) 1,276 Net income (loss) 2,921 675 0 (103) 3,493 Assets 205,104 101,622 (17) 478 307,187 </TABLE> Amounts in the "Other" column encompass activity in Union Bankshares, Inc., the "parent company." Holding company assets are stated after intercompany eliminations.
9 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 September 30, 2001 and as of December 31, 2000, and its results of operations for the three and nine months ended September 30, 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 September 30, 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 November 8, 2001 at $19.85. The millennium change was basically a non-event as far as problems and both banks completed their year-end processing on schedule. In May of 2001, Citizens Savings Bank and Trust Company opened a loan production office in Littleton, New Hampshire. Littleton is 19 miles east of St. Johnsbury, Vermont where Citizens is based, and is a rapidly growing community with a diverse economic base. This office will generate loans for both consumer and commercial purposes. On October 17, 2001 we announced a stock repurchase plan. The Board of Directors has authorized the repurchase of up to 100,000 shares of common stock, or approximately 3.3% of the Company's outstanding shares. Shares will be repurchased from time to time in the open market or in negotiated transactions as, in the judgement of management, market conditions warrant. The repurchase program is open for an unspecified period of time. 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, New Hampshire 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
10 * the Company's ability to retain key personnel * changes in technology including demands for greater automation * acts of terrorism * 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 September 30, 2001 and 2000 was $1.2 million. Net income per share was $.40 for the third quarter of 2001 compared to $.41 for the same quarter of 2000. Net income for the first nine months of 2001 was $3.6 million, compared with $3.5 million for the same period in 2000. Net income per share was $1.20 for the first nine months of 2001 compared to $1.15 for the comparable period in 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 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 September 30, 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 $ 11,109 $ 98 3.53% $ 5,978 $ 95 6.36% Interest bearing deposits 3,247 41 5.05% 2,010 31 6.17% Investments (1), (2) 50,500 760 6.23% 58,275 894 6.33% Loans, net (1), (3) 238,288 5,186 8.78% 223,429 5,154 9.36% ---------------------------------------------------------------- Total interest-earning assets (1) 303,144 6,085 8.12% 289,692 6,174 8.68% Cash and due from banks 9,965 9,288 Premises and equipment 3,819 3,950 Other assets 6,544 4,531 -------- -------- Total assets $323,472 $307,461 ======== ======== Average Liabilities and Shareholders' Equity: NOW accounts $ 36,769 $ 144 1.57% $ 34,177 $ 163 1.91% Savings and money market accounts 92,977 678 2.92% 90,397 851 3.77% Certificates of deposit 107,224 1,352 5.04% 100,310 1,401 5.59% Borrowed funds 10,421 157 6.03% 10,522 178 6.77% ----------------------------------------------------------------
11 Total interest-bearing Liabilities 247,391 2,331 3.77% 235,406 2,593 4.41% Non-interest bearing deposits 36,767 33,650 Other liabilities 3,569 5,103 -------- -------- Total liabilities 287,727 274,159 Shareholders' equity 35,745 33,302 -------- -------- Total liabilities and shareholders' equity $323,472 $307,461 ======== ======== Net interest income (1) $ 3,754 $ 3,581 ======= ======= Net interest spread (1) 4.35% 4.27% ==== ==== Net interest margin (1) 5.05% 5.11% ==== ==== <CAPTION> Nine months ended September 30, 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 $ 8,821 $ 278 4.20% $ 4,808 $ 217 6.02% Interest bearing deposits 2,459 101 5.48% 2,020 91 6.01% Investments (1), (2) 51,659 2,369 6.31% 57,216 2,718 6.53% Loans, net (1), (3) 230,978 15,458 9.02% 213,162 14,803 9.39% ---------------------------------------------------------------- Total interest-earning assets (1) 293,917 18,206 8.37% 277,206 17,829 8.72% Cash and due from banks 9,941 8,844 Premises and equipment 3,908 4,013 Other assets 5,803 5,993 -------- -------- Total assets $313,569 $296,056 ======== ======== Average Liabilities and Shareholders' Equity: NOW accounts $ 34,985 $ 454 1.73% $ 32,779 $ 481 1.96% Savings and money market accounts 90,246 2,193 3.24% 90,216 2,509 3.71% Certificates of deposit 105,965 4,269 5.37% 99,628 3,971 5.31% Borrowed funds 9,187 403 5.85% 5,587 277 6.61% ---------------------------------------------------------------- Total interest-bearing liabilities 240,383 7,319 4.06% 228,210 7,238 4.23% Non-interest bearing deposits 34,394 32,688 Other liabilities 3,537 2,874 -------- -------- Total liabilities 278,314 263,772 Shareholders' equity 35,255 32,284 -------- -------- Total liabilities and shareholders' equity $313,569 $296,056 ======== ======== Net interest income (1) $10,887 $10,591 ======= ======= Net interest spread (1) 4.31% 4.49% ==== ==== Net interest margin (1) 5.05% 5.23% ==== ==== <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>
12 Union's net interest income increased by $173 thousand, or 4.8%, to $3.75 million for the three months ended September 30, 2001, from $3.58 million for the three months ended September 30, 2000. This increase was due to the spread between yields earned on assets versus paid on liabilities. The net interest spread increased by 8 basis points to 4.35% for the three months ended September 30, 2001, from 4.27% for the three months ended September 30, 2000 as interest rates paid on deposits are moving downward in response to earlier decreases in the prime rate. The net interest margin for the 2001 period dropped to 5.05% from the 2000 period at 5.11%. Union's net interest income year to date was $10.9 million compared to the prior year of $10.6 million or an increase of 2.8% between the two years. The net interest spread decreased by 18 basis points to 4.31% for the nine months ended September 30, 2001 from 4.49% for the nine months ended September 30, 2000. This decrease was fueled by the eight decreases in the prime rate since January 1, 2001 which has taken it from 9.50% to 6% by September 30, 2001 and down to 5.5% on October 3,2001. The net interest margin for the 2001 period decreased to 5.05% from 5.23% for the 2000 period or a decrease of 18 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 September 30, 2001 Compared to Three Months Ended September 30, 2000 ---------------------------------------------- Increase/(Decrease) Due to Change In Volume Rate Net ---------------------------------------------- (dollars in thousands) <s> <c> <c> <c> Interest-earning assets: Federal funds sold $ 81 $ (78) $ 3 Interest bearing deposits 19 (9) 10 Investments (122) (12) (134) Loans, net 362 (330) 32 --------------------------------- Total interest-earning assets 340 (429) (89) Interest-bearing liabilities: NOW accounts 12 (31) (19) Savings and money market accounts 24 (197) (173) Certificates of deposit 97 (146) (49) Borrowed funds (2) (19) (21) --------------------------------- Total interest-bearing liabilities 131 (393) (262) --------------------------------- Net change in net interest income $ 209 $ (36) $ 173 ================================= <CAPTION> Nine Months Ended September 30, 2001 Compared to Nine Months Ended September 30, 2000 --------------------------------------------- Increase/(Decrease) Due to Change In Volume Rate Net ---------------------------------------------- (dollars in thousands) <s> <c> <c> <c> Interest-earning assets: Federal funds sold $ 181 $(120) $ 61 Interest bearing deposits 20 (10) 10 Investments (268) (81) (349)
13 Loans, net 1,275 (620) 655 --------------------------------- Total interest-earning assets 1,208 (831) 377 Interest-bearing liabilities: NOW accounts 33 (60) (27) Savings and money market accounts 1 (317) (316) Certificates of deposit 251 47 298 Borrowed funds 178 (52) 126 --------------------------------- Total interest-bearing liabilities 463 (382) 81 --------------------------------- Net change in net interest income $ 745 $(449) $ 296 ================================= </TABLE> Quarter Ended September 30, 2001 compared to Quarter Ended September 30, 2000. Interest and Dividend Income. Union's interest and dividend income decreased by $89,000, or 1.4%, to $6.1 million for the three months ended September 30, 2001, from $6.2 million for the three months ended September 30, 2000. Average earning assets increased by $13.5 million, or 4.6%, to $303.1 million for the three months ended September 30, 2001, from $289.7 million for the three months ended September 30, 2000. Average loans approximated $238.3 million for the three months ended September 30, 2001 up $14.9 million or 6.7% from $223.4 million for the three months ended September 30, 2000. Increases in construction loans and residential real estate secured loans of $7.4 million or 7.9% and the $17.0 million or 17.2% increase in commercial loans was partially offset by the $4.3 million or 30% decrease in loans to municipalities and the $2.6 million or 16.4% decrease in personal loans. Construction Lending has remained strong throughout the last three years. A conscious decision to retain loans packaged for sale in our portfolio over the last couple of years 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 and the decrease in municipal loans is due to stiffer competition in the market as our competitors recognize the importance of this market. The average balance of investment securities (including mortgage-backed securities) decreased by $7.8 million, or 13.3%, to $50.5 million for the three months ended September 30, 2001, from $58.3 million for the three months ended September 30, 2000. The average balance in Interest Bearing Deposits increased by $1.2 million to $3.2 million from $2.0 million or 61.5%. The average level of federal funds sold increased by $5.1 million or 85.8%, to $11.1 million for the three months ended September 30, 2001, from $6.0 million for the three months ended September 30, 2000. The changes in the investment portfolio, Federal Funds Sold and Interest Bearing Deposits in 2001 reflects the decision to keep our investments shorter in term due to the low interest rate environment and the continuing growth in our loan portfolio. Interest Income on non-loans was $.9 million for 2001 compared to $1 million for 2000 reflecting the decrease in yields and the decrease in volume. Interest Expense. Union's interest expense decreased by $262 thousand, or 10.1%, to $2.3 million for the three months ended September 30, 2001 from $2.6 million for the three months ended September 30, 2000. Average interest-bearing liabilities increased by $12 million, or 5.1% to $247.4 million for the three months ended September 30, 2001, from $235.4 million for the three months ended September 30, 2000. Average time deposits increased $6.9 million, or 6.9%, to $107.2 million for the three months ended September 30, 2001, from $100.3 million for the three months ended September 30, 2000, while the average balances for money market and saving accounts increased by $2.6 million to $93 million for the three months ended September 30, 2001, from $90.4 million for the three months ended September 30, 2000. The average balance in NOW accounts rose $2.6 million or 7.6% from $34.2 million to $36.8 million. Customers have maintained very liquid positions during the last 2 years as they anticipate that interest rates paid on all deposit instruments will rise. Noninterest Income. Union's noninterest income increased $29,000, or 4.7%, to $651 thousand for the three months ended September 30, 2001, from $622 thousand for the three months ended September 30, 2000. Trust department income rose to $54 thousand in the third quarter of 2001 from $35 thousand in the same period of 2000 or a 54.6% increase. There was a $1,000 gain on Sale of Loans for 2001 versus $25 thousand for 2000. Other noninterest income and service fees (sources of which include
14 deposit and loan fees, ATM fees, and safe deposit fees) increased by $37 thousand, or 6.6%, to $600 thousand for the three months ended September 30, 2001, from $563 thousand for the three months ended September 30, 2000. Noninterest Expense. Union's noninterest expense increased $182 thousand, or 7.6%, to $2.6 million for the three months ended September 30, 2001, from $2.4 million for the three months ended September 30, 2000. Salaries increased $89,000, or 8%, to $1.2 million for the three months ended September 30, 2001, from $1.1 million for the three months ended September 30, 2000, reflecting normal salary activity and growth. Pension and employee benefits increased $42 thousand or 14.5% to $332 thousand for the three months ended September 30, 2001, from $290 thousand for the three months ended September 30, 2000 due to a $14.5 thousand increase in employee insurance plans expense, a $9 thousand increase in payroll taxes and a $19 thousand increase in deferred compensation expense. Occupancy expense for the quarter was $149 thousand, up $18 thousand or 13.7% from the $131 thousand in the third quarter of 2000. The increase was across the majority of individual line items between quarters. Equipment expense decreased $22 thousand to $212 thousand for the three months ended September 30, 2001, from $234 thousand for the same period in 2000 resulting from decreased depreciation cost on computer equipment and software which are depreciated as an expense over a time period of three to five years. Other operating expense for the quarter was $674 thousand up from $618 thousand for the same quarter in 2000. The increase of $55 thousand, or 9%, is mainly due to the increase between quarters in ATM expense from $29.5 thousand to $41.6 thousand due to growth in usage, postage expense increased from $57.8 thousand to $66.9 thousand due to the postal rate increase and privacy disclosure mailing, increase in advertising expense from $34.8 thousand to $54.3 thousand due to employment advertising, increase in contribution expense of $11.5 thousand mainly due to the September 11 Fund contribution, an increase in OREO expense from $4.1 thousand to $13.8 thousand due to the nature of the current properties in OREO. These increases were partially offset by a drop in Merchant Processing expenses of $8.5 thousand between years due to a switch in processors in July of 2000. Income Tax Expense. Union's income tax expense increased by $20,000, or 4.0%, to $519 thousand for the three months ended September 30, 2001, from $499 thousand for the comparable period of 2000 because of our lower non- taxable municipal income in 2001 due to the drop in average municipal loans outstanding. Year to Date September 30, 2001 compared to Year to Date September 30, 2000. Interest and Dividend Income. Union's interest and dividend income increased by $377,000, or 2.1%, to $18.2 million for the nine months ended September 30, 2001, from $17.8 million for the nine months ended September 30, 2000. Average earning assets increased by $16.7 million, or 6.0%, to $293.9 million for the nine months ended September 30, 2001, from $277.2 million for the nine months ended September 30, 2000. Average loans approximated $231 million for the nine months ended September 30, 2001 up from $213.2 million for the nine months ended September 30, 2000. Increases in construction loans of $2.5 million or 37.4%, the $3.5 million or 4.1% increase in residential real estate secured loans and the $14.8 million or 15.5% increase in commercial loans was partially offset by the $2.4 million or 14.9% decrease in personal loans. Construction Lending was strong throughout 2000 and to date through 2001. A conscious decision to retain loans packaged for sale in our portfolio due to the economic environment in mid 1999 to date 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 $5.6 million, or 9.7%, to $51.7 million for the nine months ended September 30, 2001, from $57.2 million for the nine months ended September 30, 2000. The average level of federal funds sold increased by $4 million or 83.5%, to $8.8 million for the nine months ended September 30, 2001, from $4.8 million for the nine months ended September 30, 2000. The average balance in Interest Bearing Deposits increased by $439,000 to $2.5 million from $2.0 million or 21.7%. The decrease in the investment portfolio, Federal Funds Sold and Interest Bearing Deposits in 2000 reflects the continuing growth in our loan portfolio. Interest Income on non-loans was $2.7 million for 2001 and $3 million for 2000 reflecting the decrease in
15 yields and the overall decrease in volume. Interest Expense. Union's interest expense increased by $81 thousand, or 1.1%, to $7.3 million for the nine months ended September 30, 2001 from $7.2 million for the nine months ended September 30, 2000. Average interest-bearing liabilities increased by $12.2 million, or 5.3%, to $240.4 million for the nine months ended September 30, 2001, from $228.2 million for the nine months ended September 30, 2000. Average time deposits were $106 million for the nine months ended September 30, 2001 and $99.6 million for the nine months ended September 30, 2000, or an increase of 6.4%. The average balances for money market and savings accounts increased by $30 thousand for the nine months ended September 30, 2001, from $90.2 million for the nine months ended September 30, 2000. The 6.7% increase in NOW accounts brought the average balance up to $35 million from $32.8 million. Customers have maintained very liquid positions during the last 9 months as they anticipate the interest rates paid on all deposit instruments will rise. The average balance on funds borrowed increased from $5.6 million on average in 2000 to $9.2 million in 2001 due to our strong loan demand and some specific matching on certain commercial loans. Noninterest Income. Union's noninterest income increased $251,000, or 13.2%, to $2.16 million for the nine months ended September 30, 2001. The results for the period reflected a net gain of $79 thousand from the sale of securities compared to a $34,000 gain from sales during 2000. Trust department income increased to $204,000 in the nine months of 2001 from $111,000 in the same period of 2000 or an 83.8% increase due to fee increases, and a number of estate settlements. Gain on Sale of Loans increased $40,000 to $74,000 for 2001 from $34,000 for 2000. Other noninterest income and service fees (sources of which include deposit and loan fees, ATM fees, and safe deposit fees) increased by $73,000, or 4.2%, to $1.8 million for the nine months ended September 30, 2001, from $1.73 million for the nine months ended September 30, 2000. Noninterest Expense. Union's noninterest expense increased $183,000, or 2.4%, to $7.7 million for the nine months ended September 30, 2001, from $7.5 million for the nine months ended September 30, 2000. Salaries increased $78,000, or 2.3%, to $3.5 million for the nine months ended September 30, 2001, from $3.4 million for the nine months ended September 30, 2000, reflecting normal salary activity. Pension and employee benefits increased $140 thousand, or 16.1%, to $1 million for the nine months ended September 30, 2001, from $867 thousand for the nine months ended September 30, 2000 mainly due to a $77,400 increase in employee group insurance plan costs, a $29,000 or 10% increase in retirement plans expense, an increase of $21,500 in Deferred Compensation expense and an $11,000 increase in payroll taxes. Net occupancy expense increased $64 thousand, or 15.1%, to $487,000 for the nine months ended September 30, 2001, from $423,000 for the nine months ended September 30, 2000 due mainly to the increase in depreciation expense, maintenance costs and property tax expense. Equipment expense decreased $133 thousand or 17.4% to $631 thousand for the nine months ended September 30, 2001, from $764 thousand for the same period in 2000 primarily resulting from decreased depreciation expense. Other operating expenses were $2.09 million for the first nine months of 2001 compared to $2.05 million for the same period in 2000 and the increase was due to the cost of the privacy disclosure mailing. Income Tax Expense. Union's income tax expense increased by $211,000, or 16.5%, to $1.487 million for the nine months ended September 30, 2001, from $1.276 million for the comparable period of 2000 because of our higher income before tax and the $114,000 historic rehabilitation credit that was available to us for the 2000 tax year due to our partnership investment in low income housing projects sponsored by Housing Vermont in our market area.
16 FINANCIAL CONDITION At September 30, 2001, Union had total consolidated assets of $329.9 million, including net loans and loans held for sale of $243.6 million, deposits of $279.3 million and shareholders' equity of $37.4 million. Based on the most recent information published by the Vermont Banking Commissioner, in terms of total assets at December 31, 2000, Union Bank ranked as the 10th largest institution of the 23 commercial banks and savings institutions headquartered in Vermont, and Citizens ranked as the 19th. Union's total assets increased by $26.7 million or 8.8% to $329.9 million at September 30, 2001 from $303.2 million at December 31, 2000. Total net loans and loans held for sale increased by $21.7 million or 9.8% to $243.6 million or 73.8% of total assets at September 30, 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 $8.0 million or 69.9% to $19.4 million at September 30, 2001 from $11.4 million at December 31, 2000. Securities available for sale decreased from $56.6 million at December 31, 2000 to $52.4 million at September 30, 2001, a $4.3 million or 7.5% 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 increased $20.6 million or 7.9% to $279.3 million at September 30, 2001 from $258.7 million at December 31, 2000. Total borrowings increased $3.3 million to $9.7 million at September 30, 2001 from $6.4 million at December 31, 2000. The increase was in 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 September 30, 2001, Union's loan portfolio totaled $246.7 million, or 74.8%, of assets, of which $121.9 million, or 49.4% of gross loans, consisted of residential mortgages and construction loans, and $75.2 million, or 30.5%, of total loans consisted of commercial real estate loans. As of such date, Union's loan portfolio also included $25.7 million of commercial loans, $10.9 million of municipal loans, and $13.0 million of consumer loans representing, in order, 10.4%, 4.4% and 5.3% of total loans outstanding on September 30, 2001. The following table shows information on the composition of Union's loan portfolio as of September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> September 30, December 31, Loan Type 2001 2000 - --------- ----------------------------- <s> <c> <c> Real Estate $114,108 $104,417 Commercial real estate 71,673 66,186 Commercial 25,386 18,214 Consumer 12,951 14,628 Municipal loans 10,924 12,448 Loans held for sale 11,650 9,153 ------------------------- Total loans 246,692 225,046 Deduct: Allowance for loan losses 2,794 2,863 Net deferred loan fees, premiums & discounts 264 250 ------------------------- 3,058 3,113 -------------------------
17 $243,634 $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 $168.7 million residential mortgage portfolio, approximately $46.7 million of which is serviced for unaffiliated third parties at September 30, 2001. Additionally, Union originates commercial loans under various SBA programs that provide an agency guarantee for a portion of the loan amount. Union will sometimes 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 September 30, 2001, Union serviced $7.7 million of commercial and commercial real estate loans for unaffiliated third parties. An increase of $9.7 million or 9.3% in residential real estate loans, an increase of $7.2 million or 39.4% in commercial loans and a $5.5 million or 8.3% increase in commercial real estate loans was partially offset by a $1.7 million or 11.5% decrease in consumer loans and a decrease in municipal loans outstanding of $1.5 million or 12.2%. Loans held for sale increased $2.5 million or 27.3%. 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 $2.1 million at September 30, 2001, $1.5 million at December 31, 2000 and $1.5 million at September 30, 2000. The increase in non-accrual loans between year-end and September 30, 2001 is mainly due to four commercial loan customers whose properties are in the process of foreclosure by Union. Interest income not recognized on such loans amounted to approximately $472 thousand and $228 thousand as of September 30, 2001 and 2000, respectively and $289 thousand as of December 31, 2000. Union had $2.2 million and $1.5 million in loans past due 90 days or more and still accruing at September 30, 2001 and December 31, 2000, respectively. At September 30, 2001, Union had internally classified certain loans totaling $795 thousand. 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 September 30, 2000, Union had acquired by foreclosure or through repossession real estate worth $78,000, consisting of two commercial properties. 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
18 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 nine months ended September 30, 2001 and 2000: <TABLE> <CAPTION> Quarter Ended, September 30, 9 Months Ended, September 30, ---------------------------- ----------------------------- 2001 2000 2001 2000 ------------------------------------------------------------- (dollars in thousands) <s> <c> <c> <c> <c> Balance at the beginning of period $2,770 $2,934 $2,863 $2,870 Charge-offs: Real Estate 8 0 39 0 Commercial 20 110 191 126 Consumer and other 51 39 119 163 ------------------------------------------------------ Total charge-offs 79 149 349 289 ------------------------------------------------------ Recoveries: Real Estate 0 0 1 1 Commercial 1 3 18 32 Consumer and other 16 17 62 66 ------------------------------------------------------ Total recoveries 17 20 81 99 ------------------------------------------------------ Net charge-offs (62) (129) (268) (190) Provision for loan losses 86 63 199 188 ------------------------------------------------------ Balance at end of period $2,794 $2,868 $2,794 $2,868 ====================================================== </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> September 30, December 31, 2001 2000 ----------------- ----------------- (dollars in thousands) Amount Percent Amount Percent -------------------------------------- <s> <c> <c> <c> <c> Real Estate Residential $ 646 40.1% $ 595 40.5% Commercial 1,313 33.2% 1,193 32.3% Construction 126 5.1% 102 4.5% Other Loans Commercial 408 9.3% 401 9.1% Consumer installment 265 5.1% 319 6.5% Home equity loans 30 1.6% 31 1.8% Municipal, Other and Unallocated 6 5.6% 222 5.3% ------------------------------------ Total $2,794 100.0% $2,863 100.0% ==================================== Ratio of Net Charge Offs to Average Loans (1) 0.15% 0.12% ------ ------ Ratio of Allowance for Loan Losses to Average Loans 1.21% 1.34% ------ ------
19 <FN> - -------------------- <F1> Annualized </FN> </TABLE> Investment Activities At September 30, 2001, the reported value of investment securities available-for-sale was $52.4 million or 15.9% of its assets. Union had no securities classified as held-to-maturity or trading securities. The reported value of securities available-for-sale at September 30, 2001, reflects a positive valuation adjustment of $1.3 million. The offset of this adjustment, net of income tax effect, was a $879 thousand increase in Union's other comprehensive income component of shareholders' equity and a decrease in net deferred tax assets of $453 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 September 30, 2001 and December 31, 2000: <TABLE> <CAPTION> Nine Months Ended, September 30 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 $ 34,394 12.95% $ 32,906 12.81% Now accounts 34,985 13.17% 1.73% 34,383 13.39% 2.04% Money Markets 54,963 20.69% 3.87% 53,770 20.94% 4.45% Savings 35,283 13.29% 2.28% 37,153 14.47% 2.72% ------------------ ------------------ Total non-certificate deposits: 159,625 60.10% 158,212 61.61% ------------------ ------------------ Certificates of deposit: Less than $100,000 77,108 29.03% 5.25% 75,483 29.40% 5.29% $100,000 and over 28,857 10.87% 5.74% 23,088 8.99% 5.89% ------------------ ------------------ Total certificates of deposit 105,965 39.90% 98,571 38.39% ------------------ ------------------ Total deposits $265,590 100.00% 3.48% $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 September 30, 2001 and December 31, 2000 that mature during the periods indicated: <TABLE> <CAPTION> September 30, 2001 December 31, 2000 --------------------------------------- (dollars in thousands) <s> <c> <c> Within 3 months $ 8,030 $ 6,757 3 to 6 months 4,584 11,259 6 to 12 months 11,335 4,439 Over 12 months 6,208 3,739 ---------------------------- $30,157 $26,194 ============================ </TABLE> Borrowings. Borrowings from the Federal Home Loan Bank of Boston were $9.7 million at September 30, 2001 at a weighted average rate of 5.67%. 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
20 end 2000 and the end of the third quarter of 2001 is a net increase of $3.3 million in 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 risks. 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 $11.7 million for the first nine months of 2001 compared to actual results of $10.9 million in a falling rate environment, or a 4.2% difference. Union had anticipated a decrease in our net interest margin to $10.8 million in a 300 basis point falling rate environment and since rates had dropped 350 basis points by the end of the third quarter, we were pleased the ALM strategies implemented during 2001 forestalled a more dramatic drop. Net income was projected to be $4.3 million in a flat rate environment and $3.7 million in a down 300 basis point environment compared to actual results of $3.6 million. The $627 thousand decrease in Net Income from projections is mainly due to the decrease in Net Interest Income. And, partially due to $47.8 thousand higher than anticipated employee insurance plan costs, $30.1 thousand increase in building rent and maintenance costs, $18.0 thousand cost increase in postage expense, $20.4 thousand increase in advertising outlays, $18.5 thousand increase in legal fees, $17.0 thousand unanticipated OREO expenses and Trust Department expenses higher than budgeted by $16.4 thousand. Return on Assets was projected to be 1.87% in a flat rate environment and 1.62% in a down 300 basis point environment and actual results were 1.55%. Return on Equity was projected to be 15.74% in a flat rate environment and 13.70% in a down 300 basis point environment compared to actual of 13.75%. The results of these ratios are based on lower net income as explained above exacerbated by higher average assets than had been anticipated. The Company generally requires collateral or other security to support financial instruments with credit risk. As of September 30, 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 $24,448,000 ----------- Standby letters of credit and commercial letters of credit $ 1,173,000 ----------- Credit Card arrangements $ 2,006,000 ----------- Home Equity Lines of Credit $ 3,585,000 ----------- </TABLE> Commitments to extend credit are agreements to lend to a customer as long as there is no violation of
21 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.
22 The following tables show Union's rate sensitivity analysis as of September 30, 2001: <TABLE> <CAPTION> September 30, 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> <c> Interest sensitive assets: Federal Funds Sold $ 7,398 $ 0 $ 0 $ 0 $ 0 $ 7,398 Interest bearing deposits 297 1,565 1,275 387 0 3,524 Investments available for sale (1) 3,504 6,944 12,184 9,271 19,600 51,503 FHLB Stock 0 0 0 0 1,064 1,064 Loans (fixed and adjustable rate) 73,365 40,486 41,489 34,541 56,811 246,692 -------------------------------------------------------------------- Total interest sensitive assets $84,564 $48,995 $54,948 $44,199 $77,475 $310,181 -------------------------------------------------------------------- Interest sensitive liabilities: Certificates of deposit $31,408 $50,566 $19,664 $ 4,439 $ 2 $106,079 Money markets 12,428 0 0 0 46,480 58,908 Regular savings 4,448 0 0 0 32,755 37,203 Now accounts 27,202 0 0 0 10,616 37,818 Borrowed funds 723 2,677 4,365 1,959 0 9,724 -------------------------------------------------------------------- Total interest sensitive liabilities $76,209 $53,243 $24,029 $ 6,398 $89,853 $249,732 -------------------------------------------------------------------- Net interest rate sensitivity gap 8,355 (4,248) 30,919 37,801 (12,378) 60,449 Cumulative net interest rate sensitivity gap 8,355 4,107 35,026 72,827 60,449 Cumulative net interest rate sensitivity gap as a percentage of total assets 2.53% 1.24% 10.62% 22.08% 18.32% Cumulative interest sensitivity gap as a percentage of total interest-earning assets 2.69% 1.32% 11.29% 23.48% 19.49% Cumulative net interest earning assets as a percentage of cumulative interest-bearing liabilities 3.34% 1.64% 14.03% 29.16% 24.21% <FN> - -------------------- <F1> Investments available for sale exclude marketable equity securities with a fair value of $876,000 that 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 300 basis points from the current prime rate of 6.0%, 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.
23 UNION BANKSHARES, INC. INTEREST RATE SENSITIVITY ANALYSIS MATRIX SEPTEMBER 30, 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 9.00 14,339 1.07 4,950 1.56 13.87 28,312 (38.38) 6.00 14,187 0.00 4,850 1.53 13.60 45,948 00.00 3.00 14,072 (.81) 4,775 1.51 13.40 64,845 41.13 December-02 9.00 19,080 10.63 7,779 2.26 20.12 17,956 (63.83) 6.00 17,199 0.00 6,526 1.90 17.18 49,637 00.00 3.00 15,228 (11.13) 5,215 1.52 13.98 87,924 77.13 </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% of total assets. 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
24 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 76.7% 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 September 30, 2001 that the Banks meet all capital adequacy requirements to which they are subject. As of September 30, 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 September 30, 2001: Total capital to risk weighted assets Union Bank $26,916 17.09% $12,600 8.0% $15,750 10.0% Citizens 11,960 16.62% 5,757 8.0% 7,196 10.0% Tier I capital to risk weighted assets Union Bank $25,026 15.89% $ 6,300 4.0% $ 9,450 6.0% Citizens 11,059 15.37% 2,878 4.0% 4,317 6.0% Tier I capital to average assets Union Bank $25,026 11.34% $ 8,828 4.0% $11,034 5.0% Citizens 11,059 10.78% 4,104 4.0% 5,129 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.
25 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 Third Quarter Results filed on October 18, 2001 Press Release announcing declaration of a third quarter dividend filed on October 11, 2001 Press Release announcing an increase in third quarter earnings and a dividend filed on October 11, 2001 Press Release announcing a stock repurchase program filed on October 18, 2001
26 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. November 14, 2001 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
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