UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: June 30, 2002 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 August 6, 2002: Common Stock, $2 par value 3,027,557 shares
UNION BANKSHARES, INC. TABLE OF CONTENTS <TABLE> <CAPTION> <s> <c> PART I FINANCIAL INFORMATION Item 1. Financial Statements. Consolidated Financial Statements Union Bankshares, Inc. and Subsidiaries Consolidated Balance Sheets 3 Consolidated Statements of Income 4 Consolidated Statement of Changes in Stockholders' Equity 5 Consolidated Statements of Cash Flows 6 Notes to Consolidated Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk. 27 PART II OTHER INFORMATION Item 1. Legal Proceedings. 27 Item 4. Submission of Matters to a Vote of Security Holders. 27 Item 6. EXHIBITS AND REPORTS ON FORM 8-K. 27 Signatures 27 </TABLE>
2 Item 1. Financial Statements. Union Bankshares, Inc. and Subsidiaries Consolidated Balance Sheets (Unaudited) <TABLE> <CAPTION> June 30 December 31 2002 2001 ------- ----------- (dollars in thousands) <s> <c> <c> Assets Cash and due from banks $ 14,341 $ 13,926 Federal funds sold and overnight deposits 2,821 7,630 --------------------- Cash and cash equivalents 17,162 21,556 Interest bearing deposits 3,727 4,700 Securities available-for-sale 47,026 49,613 Federal Home Loan Bank stock 1,235 1,064 Loans held for sale 18,842 16,333 Loans 235,382 234,874 Unearned net loan fees (259) (263) Allowance for loan losses (2,920) (2,801) --------------------- Loans, net 232,203 231,810 --------------------- Accrued interest receivable 1,965 2,037 Premises and equipment, net 4,806 4,156 Other real estate owned, net 1,256 1,296 Other assets 5,106 4,910 --------------------- Total assets $333,328 $337,475 ===================== Liabilities and Stockholders' Equity: Liabilities: Deposits: Non-interest bearing $ 36,489 $ 39,547 Interest bearing 242,580 246,175 --------------------- Total deposits 279,069 285,722 Borrowed funds 12,756 10,344 Accrued interest and other liabilities 3,643 4,194 --------------------- Total liabilities 295,468 300,260 --------------------- Stockholders' Equity: Common stock, $2 par value; 5,000,000 shares authorized; 3,268,189 shares issued at 6/30/02 and 12/31/01. 6,536 6,536 Paid-in capital 277 277 Retained earnings 32,186 31,629 Treasury stock at cost ( 240,632 shares at 6/30/02 and 12/31/01) (1,722) (1,722) Accumulated other comprehensive income 583 495 --------------------- Total stockholders' equity 37,860 37,215 --------------------- Total liabilities and stockholders' equity $333,328 $337,475 ===================== </TABLE> See accompanying notes to consolidated unaudited financial statements
3 Union Bankshares, Inc. and Subsidiaries Consolidated Statements of Income (Unaudited) <TABLE> <CAPTION> 3 Months Ended Six Months Ended June 30 June 30 ---------------------- ---------------------- 2002 2001 2002 2001 ---- ---- ---- ---- (dollars in thousands) <s> <c> <c> <c> <c> Interest income: Interest and fees on loans $ 4,780 $ 5,178 $ 9,560 $ 10,272 Interest and dividends on investment securities 677 784 1,349 1,609 Interest on federal funds sold and overnight deposits 24 103 54 180 Interest on interest bearing deposits 48 33 102 60 ------------------------------------------------ 5,529 6,098 11,065 12,121 ------------------------------------------------ Interest expense: Interest on deposits 1,465 2,328 3,088 4,742 Interest on federal funds purchased 2 1 3 3 Interest on borrowed funds 126 132 257 243 ------------------------------------------------ 1,593 2,461 3,348 4,988 ------------------------------------------------ Net interest income 3,936 3,637 7,717 7,133 Provision for loan losses 105 57 195 113 ------------------------------------------------ Net interest income after provision for loan losses 3,831 3,580 7,522 7,020 Other income: Trust income 49 63 116 150 Service fees 610 615 1,194 1,186 Gain (loss) on sale of securities 0 76 (3) 74 Gain on sale of loans 9 0 36 73 Other 23 20 74 22 ------------------------------------------------ 691 774 1,417 1,505 ------------------------------------------------ Other expenses: Salaries and wages 1,276 1,140 2,536 2,300 Pension and employee benefits 407 336 805 675 Occupancy expense, net 166 172 327 337 Equipment expense 218 217 416 429 Other expense 979 755 1,749 1,403 ------------------------------------------------ 3,046 2,620 5,833 5,144 ------------------------------------------------ Income before income tax expense 1,476 1,734 3,106 3,381 Income tax expense 393 489 854 968 ------------------------------------------------ Net income $ 1,083 $ 1,245 $ 2,252 $ 2,413 ================================================ Earnings per common share $ .35 $ .41 $ .74 $ .80 ================================================ Weighted average number of common shares outstanding 3,027,557 3,029,784 3,027,557 3,029,757 ================================================ Dividends declared per share $ .28 $ .26 $ .56 $ .52 ================================================ </TABLE> See accompanying notes to consolidated unaudited financial statements
4 Union Bankshares, Inc. and Subsidiaries Consolidated Statement of Changes in Stockholders' Equity (Unaudited) <TABLE> <CAPTION> Accumulated Paid-in Other Total Common Capital Retained Treasury Comprehensive Stockholders' Stock & Surplus Earnings Stock Income Equity ------ --------- -------- -------- ------------- ------------- (dollars in thousands) <s> <c> <c> <c> <c> <c> <c> Balance, December 31, 2001 $6,536 $277 $31,629 $(1,722) $495 $37,215 Net income - - 2,252 - - 2,252 Change in net unrealized gain on securities available-for-sale, net of reclassification adjustment and tax effects - - - - 88 88 ------- Comprehensive income - - - - - 2,340 ------- Cash dividends declared ($.56 per share) - - (1,695) - - (1,695) -------------------------------------------------------------------------- Balance June 30, 2002 $6,536 $277 $32,186 $(1,722) $583 $37,860 ========================================================================== </TABLE> See accompanying notes to consolidated unaudited financial statements.
5 Union Bankshares, Inc. and Subsidiaries Consolidated Statements of Cash Flows (Unaudited) <TABLE> <CAPTION> Year to Date ---------------------- June 30 June 30 2002 2001 --------- --------- (dollars in thousands) <s> <c> <c> Cash Flows From Operating Activities Net Income $ 2,252 $ 2,413 Adjustments to reconcile net income to net cash provided by operating activities Depreciation 304 314 Provision for loan losses 195 113 Provision (credit) for deferred income taxes 150 (152) Net amortization on securities 91 25 Equity in losses of limited partnerships 62 31 Write-downs of other real estate owned 250 0 Increase (decrease) in unamortized loan fees (4) 9 Increase in loans held for sale (2,473) (1,403) Decrease in accrued interest receivable 72 335 Increase in other assets (431) (374) Increase in income taxes 18 375 Decrease in accrued interest payable (463) (204) Increase in other liabilities 148 246 Loss (gain) on sale of securities 3 (74) Gain on sale of loans (36) (73) Gain on sale of OREO (15) (16) (Gain) loss on disposal of fixed assets (1) 9 ------------------ Net cash provided by operating activities 122 1,574 Cash Flows From Investing Activities Interest bearing deposits Maturities and redemptions 1,568 396 Purchases (595) (1,481) Securities available for sale Sales and Maturities 9,052 18,554 Purchases (6,422) (10,760) Purchase of Federal Home Loan Bank Stock (171) (47) Increase in loans, net (871) (9,068) Recoveries of loans charged off 60 64 Purchases of premises and equipment, net (953) (97)
6 Investments in limited partnerships (254) (136) Proceeds from sale of OREO 0 80 Proceeds from sale of repossessed property 6 17 ------------------ Net cash provided (used) by investing activities 1,420 (2,478) Cash Flows From Financing Activities Borrowings, net of repayments 2,412 4,495 Proceeds from exercise of stock options 0 2 Net increase (decrease) in non-interest bearing deposits (3,058) 3,818 Net decrease in interest bearing deposits (3,595) (1,303) Dividends paid (1,695) (1,575) ------------------ Net cash provided (used) by financing activities (5,936) 5,437 Increase (decrease) in cash and cash equivalents (4,394) 4,533 Cash and cash equivalents Beginning 21,556 11,423 Ending 17,162 15,956 Supplemental Disclosure of Cash Flow Information: Interest Paid $ 3,811 $ 5,155 ================== Income Taxes Paid $ 1,013 $ 735 ================== Supplemental Schedule of Noncash Investing and Financing Activities: Other Real Estate Acquired in Settlement of Loans 1,209 85 Repossessed Property Acquired in Settlement of Loans 32 12 Loans Originated to Finance the Sale of Other Real Estate Owned (1,044) 0 Total Change in Unrealized Gain (Loss) on Securities Available-For-Sale 134 715 </TABLE> See accompanying notes to consolidated unaudited financial statements.
7 UNION BANKSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS: Note 1. The accompanying interim unaudited consolidated financial statements of Union Bankshares, Inc. (the Company) for the interim periods ended June 30, 2002 and 2001 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 Annual Report on Form 10K for the year ended December 31, 2001. 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 2001 Annual Report to Shareholders, 2001 Annual Report on Form 10K, and current reports on 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 any liability resulting from such proceedings would not have a material adverse effect on the Company's financial condition or results of operations. Note 3. Earnings Per Share Earnings per common share amounts are computed based on the weighted average number of shares of common stock outstanding during the period (retroactively adjusted for 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 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. In accordance with applicable bank regulatory requirements, the Company accounts for intersegment sales and transfers at current market prices.
8 Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the periods ended June 30, follows: <TABLE> <CAPTION> (dollars in thousands) Intersegment Consolidated 2002 Union Citizens Elimination Other Totals - --------------------------------------------------------------------------------------------- <s> <c> <c> <c> <c> <c> Interest income $ 7,592 $ 3,473 $ 0 $ 0 $ 11,065 Interest expense 2,158 1,190 0 0 3,348 Provision for loan losses 90 105 0 0 195 Service fee income 936 258 0 0 1,194 Income tax expense (benefit) 620 273 0 (39) 854 Net income (loss) 1,785 558 0 (91) 2,252 Assets 228,171 104,777 (39) 419 333,328 <CAPTION> (dollars in thousands) Intersegment Consolidated 2001 Union Citizens Elimination Other Totals - --------------------------------------------------------------------------------------------- <s> <c> <c> <c> <c> <c> Interest income $ 8,312 $ 3,809 $ 0 $ 0 $ 12,121 Interest expense 3,328 1,660 0 0 4,988 Provision for loan losses 0 113 0 0 113 Service fee income 913 273 0 0 1,186 Income tax expense (benefit) 754 252 0 (38) 968 Net income (loss) 1,956 518 0 (61) 2,413 Assets 210,937 100,601 (42) 393 311,889 </TABLE> Amounts in the "Other" column encompass activity in Union Bankshares, Inc., the "parent company." Holding company assets are stated after intercompany eliminations.
9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The following discussion and analysis provides information regarding Union Bankshares, Inc.'s (Union's) financial position as of June 30, 2002 and as of December 31, 2001, and its results of operations for the three and six months ended June 30, 2002 and 2001. 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 interim unaudited data reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly present Union's consolidated financial position and results of operations to be expected for the interim period. Management is not aware of the occurrence of any events after June 30, 2002, which would materially affect the information presented. 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 August 6, 2002 at $22.95. 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 it is a rapidly growing community with a diverse economic base. This office generates loans for both consumer and commercial purposes. On April 15, 2002 we modified our Route 108 Branch in Stowe to a fully electronic branch. On April 22, 2002 our newest, full service branch was opened by Union Bank in Fairfax, Vermont, which is the Company's first entry into the Franklin County market. CAUTIONARY ADVICE ABOUT FORWARD LOOKING STATEMENTS The Company may from time to time make written or oral statements that are considered "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may include financial projections, statements of plans and objectives for future operations, estimates of future economic performance and assumptions relating thereto. The Company may include forward-looking statements in 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 those predictions, forecasts, projections and other estimates contained in forward-looking statements will not be achieved. Also when we use any of the words "believes," "expects," "anticipates" or similar expressions, we are making forward-looking statements. Many possible events or factors, including those beyond the control of management, could affect the future financial results and performance of our company. This could cause results or performance to differ materially from those expressed in our forward- looking statements. The possible events or factors that might affect our forward-looking statements include, but are not limited to, the following: * uses of monetary, fiscal and tax policy by various governments * political, legislative or regulatory developments in Vermont, New Hampshire or the United States including changes in laws concerning accounting, taxes, banking and other aspects of the financial services industry * developments in general economic or business conditions, including interest rate fluctuations, market
10 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 * acts of terrorism * adverse changes in the securities market * unanticipated lower revenues, loss of customers or business or higher operating expenses When relying on forward-looking statements to make decisions with respect to the Company, investors and others are cautioned to consider these and other risks and uncertainties. RESULTS OF OPERATIONS The Company's net income for the quarter ended June 30, 2002 was $ 1.083 million, compared with net income of $1.245 million for the second quarter of 2001. Net income per share was $.35 for the second quarter of 2002 compared to $.41 for the same quarter of 2001. Net income for the first six months of 2002 was $2.252 million, compared with $2.413 million for the same period in 2001. Net income per share was $.74 for the first six months of 2002 compared to $.80 for the comparable period in 2001. 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 annualized income or expense item for the period by the average balances of the appropriate balance sheet item during the period. Net interest margin is annualized 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, net interest spread and net interest margins appearing in the following tables have been calculated on a pre-tax basis:
11 <TABLE> <CAPTION> Three months ended June 30, 2002 2001 ------------------------------- ------------------------------- 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 and overnight deposits $ 5,901 $ 24 1.63% $ 9,356 $ 103 4.40% Interest bearing deposits 3,932 48 4.94% 2,416 33 5.46% Investments (1) (2) 48,820 677 5.79% 51,082 784 6.34% Loans, net (1) (3) 249,381 4,780 7.76% 231,909 5,178 9.04% ---------------------------------------------------------------- Total interest-earning assets (1) 308,034 5,529 7.29% 294,763 6,098 8.40% Cash and due from banks 12,740 8,589 Premises and equipment 4,739 3,927 Other assets 7,851 5,868 -------- -------- Total assets $333,364 $313,147 ======== ======== Average Liabilities and Shareholders' Equity: Now accounts $ 37,608 $ 107 1.14% $ 34,760 $ 146 1.68% Savings and money market accounts 103,415 431 1.67% 90,015 723 3.21% Certificates of deposit 101,418 927 3.67% 107,021 1,459 5.45% Borrowed funds 13,476 128 3.81% 9,834 133 5.41% ---------------------------------------------------------------- Total interest-bearing liabilities 255,917 1,593 2.50% 241,630 2,461 4.07% Non-interest bearing deposits 36,047 33,489 Other liabilities 4,085 2,669 -------- -------- Total liabilities 296,049 277,788 Shareholders' equity 37,315 35,359 -------- -------- Total liabilities and shareholders' equity $333,364 $313,147 ======== ======== Net interest income (1) $3,936 $3,637 ====== ====== Net interest spread (1) 4.79% 4.33% Net interest margin (1) 5.21% 5.06% <FN> - -------------------- <F1> Average yield reported on a tax-equivalent basis. <F2> The average balance of investments is calculated using the amortized cost basis. <F3> Includes loans held for sale and is net of unearned income and allowance for loan losses. </FN> </TABLE>
12 <TABLE> <CAPTION> Six months ended June 30, 2002 2001 ------------------------------- ------------------------------- 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 and overnight deposits $ 6,886 $ 54 1.58% $ 7,570 $ 180 4.76% Interest bearing deposits 4,199 102 4.90% 2,055 60 5.84% Investments (1) (2) 48,599 1,349 5.78% 52,246 1,609 6.35% Loans, net (1) (3) 248,876 9,560 7.82% 227,185 10,272 9.15% ---------------------------------------------------------------- Total interest-earning assets (1) 308,560 11,065 7.32% 289,056 12,121 8.51% Cash and due from banks 12,672 9,186 Premises and equipment 4,557 3,952 Other assets 7,748 5,713 -------- -------- Total assets $333,537 $307,907 ======== ======== Average Liabilities and Shareholders' Equity: Now accounts $ 36,459 $ 211 1.17% $ 34,037 $ 310 1.82% Savings and money market accounts 103,930 914 1.77% 88,846 1,515 3.41% Certificates of deposit 102,334 1,963 3.87% 105,314 2,917 5.54% Borrowed funds 13,014 260 4.03% 8,583 246 5.73% ---------------------------------------------------------------- Total interest-bearing liabilities 255,737 3,348 2.64% 236,780 4,988 4.21% Non-interest bearing deposits 36,443 33,275 Other liabilities 4,002 2,836 -------- -------- Total liabilities 296,182 272,891 Shareholders' equity 37,355 35,016 -------- -------- Total liabilities and shareholders' equity $333,537 $307,907 ======== ======== Net interest income (1) $ 7,717 $7,133 ======= ====== Net interest spread (1) 4.68% 4.30% Net interest margin (1) 5.13% 5.06% <FN> - -------------------- <F1> Average yield reported on a tax-equivalent basis. <F2> The average balance of investments is calculated using the amortized cost basis. <F3> Includes loans held for sale and is net of unearned income and allowance for loan losses. </FN> </TABLE> Union's net interest income increased by $299 thousand, or 8.22%, to $3.936 million for the three months ended June 30, 2002, from $3.637 million for the three months ended June 30, 2001. This increase was due to the increase in average interest earning assets to $308.0 million from $294.8 million for the second quarter of 2001 offset partially by the drop in yield from 8.40% to 7.29%. And, while average interest bearing liabilities rose $14.3 million the rate dropped from 4.07% to 2.50%. The net interest spread increased by 46 basis points to 4.79% for the three months ended June 30, 2002, from 4.33% for the three months ended June 30, 2001. The net interest margin for the 2002 period increased by 15 basis points to 5.21% from 5.06% for the 2001 period. Union's net interest income year to date was $7.717 million compared to the prior year of $7.133 million or an increase of 8.19% between the two years. This increase was due to the increase in average interest earning assets to $308.6 million for 2002 from $289.1 million for 2001 partially offset by the decrease in yield from 8.51% to 7.32%. And, while average interest bearing liabilities grew $19.0 million, the rate paid dropped from 4.21% to 2.64% between years. The net interest spread increased by 38 basis points to 4.68% for the six months ended June 30, 2002 from 4.30% for the six months ended June
13 30, 2001. The net interest margin for the 2002 period increased to 5.13% from 5.06% for the 2001 period or an increase of 7 basis points. Rate/Volume Analysis. The following table describes the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have affected Union's interest income and interest expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: * changes in volume (change in volume multiplied by prior rate); * changes in rate (change in rate multiplied by current volume); and * total change in rate and volume. Changes attributable to both rate and volume have been allocated proportionately to the change due to volume and the change due to rate. <TABLE> <CAPTION> Three Months Ended June 30, 2002 Compared to Three Months Ended June 30, 2001 ----------------------------------------- Increase/(Decrease) Due to Change In Volume Rate Net ------ ---- --- (dollars in thousands) <s> <c> <c> <c> Interest-earning assets: Federal funds sold and overnight deposits $ (38) $ (41) $ (79) Interest bearing deposits 20 (5) 15 Investments (38) (69) (107) Loans, net 394 (792) (398) ------------------------------- Total interest-earning assets 338 (907) (569) Interest-bearing liabilities: Now accounts 12 (51) (39) Savings and money market accounts 106 (398) (292) Certificates of deposit (77) (455) (532) Borrowed funds 49 (54) (5) ------------------------------- Total interest-bearing liabilities 90 (958) (868) ------------------------------- Net change in net interest income $ 248 $ 51 $ 299 =============================== <CAPTION> Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001 ----------------------------------------- Increase/(Decrease) Due to Change In Volume Rate Net ------ ---- --- (dollars in thousands) <s> <c> <c> <c> Interest-earning assets: Federal funds sold and overnight deposits $ (16) $ (110) $ (126) Interest bearing deposits 62 (20) 42 Investments (119) (141) (260) Loans, net 1,000 (1,712) (712) ------------------------------- Total interest-earning assets 927 (1,983) (1,056) Interest-bearing liabilities: Now accounts 22 (121) (99) Savings and money market accounts 258 (859) (601) Certificates of deposit (82) (872) (954) Borrowed funds 125 (111) 14 ------------------------------- Total interest-bearing liabilities 323 (1,963) (1,640) ------------------------------- Net change in net interest income $ 604 $ (20) $ 584 =============================== </TABLE>
14 Quarter Ended June 30, 2002 compared to Quarter Ended June 30, 2001. Interest and Dividend Income. Union's interest and dividend income decreased by $569 thousand or 9.3%, to $5.5 million for the three months ended June 30, 2002, from $6.1 million for the three months ended June 30, 2001. Average earning assets increased by $13.3 million, or 4.5%, to $308.0 million for the three months ended June 30, 2002, from $294.8 million for the three months ended June 30, 2001. Average loans approximated $249.4 million for the three months ended June 30, 2002 up from $231.9 million for the three months ended June 30, 2001. The $9.3 million, or 12.0% increase in residential real estate secured loans and the $12.4 million, or 11.1% increase in commercial and commercial real estate loans was partially offset by the $1.8 million, or 13.3% decrease in personal loans, the $1.5 million, or 12.2% decrease in municipal loans and the $1.4 million, or 14.4% decrease in construction loans. 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 in part to a late 1998 decision to exit the indirect lending business at Citizens. The average balance of investment securities (including mortgage-backed securities) decreased by $2.3 million, or 4.4%, to $48.8 million for the three months ended June 30, 2002, from $51.1 million for the three months ended June 30, 2001. The average balance in interest bearing deposits increased by $1.5 million to $3.9 million from $2.4 million or 62.7%. The average level of federal funds sold and overnight deposits decreased by $3.5 million or 36.9%, to $5.9 million for the three months ended June 30, 2002, from $9.4 million for the three months ended June 30, 2001. The net decrease in the investment portfolio, federal funds sold and overnight deposits, and interest bearing deposits in 2002 reflects the continuing growth in our loan portfolio. Interest Income on non-loans was $749 thousand in 2002 compared to $920 thousand for 2001, which is explained by the $4.2 million decrease in volume and the drop in interest rates. Interest Expense. Union's interest expense decreased by $868 thousand, or 35.3%, to $1.6 million for the three months ended June 30, 2002 from $2.5 million for the three months ended June 30, 2001. Average interest-bearing liabilities increased by $14.3 million, or 5.9% to $255.9 million for the three months ended June 30, 2002, from $241.6 million for the three months ended June 30, 2001. Average time deposits decreased $5.6 million, or 5.2%, to $101.4 million for the three months ended June 30, 2002, from $107.0 million for the three months ended June 30, 2001. The average balances for money market and saving accounts increased by $13.4 million, or 14.9% to $103.4 million for the three months ended June 30, 2002, from $90.0 million for the three months ended June 30, 2001. Now accounts increased $2.8 million, or 8.2% mainly due to municipal account balances. The average balance on funds borrowed has increased from $9.8 million on average in 2001 to $13.5 million in 2002 as Union's subsidiaries took some short term Federal Home Loan Bank borrowings during the second quarter of 2002 to fund loan demand. Noninterest Income. Union's noninterest income decreased $83 thousand or 10.7%, to $691 thousand for the three months ended June 30, 2002, from $774 thousand for the three months ended June 30, 2001. Trust department income dropped to $49 thousand in the second quarter of 2002 from $63 thousand in the same period of 2001 or a 22.2% decrease as there was not a repeat of estate settlements in the second quarter of 2002. Gain on sales of loans was $9 thousand for the second quarter of 2002 and there was none in the second quarter of 2001. Other noninterest income and service fees (sources of which include among others, deposit and loan servicing fees, ATM fees, and safe deposit fees) decreased by $2 thousand, to $633 thousand for the three months ended June 30, 2002, from $635 thousand for the three months ended June 30, 2001. There was a $76 thousand gain on the sale of securities in the second quarter of 2001 that was not repeated in 2002. Noninterest Expense. Union's noninterest expense was up $426 thousand, at $3.05 million for the three months ended June 30, 2002, compared to $2.62 million for the three months ended June 30, 2001.
15 Salaries increased $136 thousand, or 12.0%, to $1.3 million for the three months ended June 30, 2002, from $1.1 million for the three months ended June 30, 2001, due to the normal salary activity, growth and the addition of the loan production office in Littleton, NH and the staff for the Fairfax, VT branch. Pension and employee benefits increased $71 thousand or 21.1% to $407 thousand for the three months ended June 30, 2002, from $336 thousand for the three months ended June 30, 2001 mainly due to a $56 thousand increase in health insurance costs. Occupancy expense decreased $6 thousand or 3.5% to $166 thousand from $172 thousand in 2001. Other expense for the quarter was up $224 thousand from $755 thousand for the same quarter in 2001 to $979 thousand in 2002, mainly due to the write down of $204 thousand on one commercial OREO property in April 2002. Income Tax Expense. Union's income tax expense decreased by $96 thousand, or 19.6%, to $393 thousand for the three months ended June 30, 2002, from $489 thousand for the comparable period of 2001 because of our decreased income before taxes and the increased federal income tax credits available to us in 2002 due to investments in low income housing projects. Year to Date June 30, 2002 compared to Year to Date June 30, 2001. Interest and Dividend Income. Union's interest and dividend income decreased by $1.06 million, or 8.7%, to $11.1 million for the six months ended June 30, 2002, from $12.1 million for the six months ended June 30, 2001. Average earning assets increased by $19.5 million, or 6.7%, to $308.6 million for the six months ended June 30, 2002, from $289.1 million for the six months ended June 30, 2001. Average loans approximated $248.9 million for the six months ended June 30, 2002 up from $227.2 million for the six months ended June 30, 2001. Increases of $9.5 million or 12.3% increase in residential real estate secured loans, and the $16.0 million or 15.0% increase in commercial and commercial real estate loans, was partially offset by the $2.0 million or 14.4% decrease in personal loans, the $1.4 million or 11.9% decrease in loans to municipalities and the $835 thousand or 8.5% decrease in construction loans. A conscious decision to retain some of the loans packaged for sale in our portfolio accounts for the majority of the increase in both the residential real estate and commercial loan portfolios. We expanded our commercial lending staff in 1999 at Union Bank and in both 2000 and 2001 at Citizens, which is one reason for our growth in that area. The decrease in personal loans is due in part to a late 1998 decision to exit the indirect lending business at Citizens. The average balance of investment securities (including mortgage-backed securities) decreased by $3.6 million, or 7.0%, to $48.6 million for the six months ended June 30, 2002, from $52.2 million for the six months ended June 30, 2001. The average level of federal funds sold and overnight deposits decreased by $.7 million, or 9.0%, to $6.9 million for the six months ended June 30, 2002, from $7.6 million for the six months ended June 30, 2001. The average balance in interest bearing deposits grew $2.1 million or 104% from $2.1 million in 2001 to $4.2 million in 2002. The net decrease in the investment portfolio, federal funds sold and overnight deposits, and interest bearing deposits in 2002 reflects the continuing growth in our loan portfolio. Interest Income on non-loans was $1.5 million in 2002 and $1.8 million for 2001 reflecting the decrease in yields and overall decrease in volume. Interest Expense. Union's interest expense decreased by $1.6 million, or 32.9%, to $3.3 million for the six months ended June 30, 2002 from $5.0 million for the six months ended June 30, 2001. Average interest-bearing liabilities increased by $19.0 million, or 8.0%, to $255.7 million for the six months ended June 30, 2002, from $236.8 million for the six months ended June 30, 2001. Average time deposits decreased $3.0 million, or 2.8%, to $102.3 million for the six months ended June 30, 2002, from $105.3 million for the six months ended June 30, 2001, while the average balances for money market and savings accounts increased by $15.1 million, or 17.0%, to $103.9 million for the six months ended June 30, 2002, from $88.8 million for the six months ended June 30, 2001. The average balance in Now accounts grew $2.4 million, or 7.1%, from $34.0 million to $36.4 million. Customers have maintained very liquid positions during the last year as they anticipate the interest rates paid on all deposit instruments, will rise. The average balance on funds borrowed has increased from $8.6 million in 2001 to $13.0 million in 2002 as Union's subsidiaries took some short-term Federal Home Loan Bank advances during the second
16 quarter of 2002 to fund loan demand. Noninterest Income. Union's noninterest income decreased $88 thousand, or 5.8%, to $1.4 million for the six months ended June 30, 2002 from $1.5 million for the six months ended June 30, 2001. The results for the period reflected a net loss of $3 thousand from the sale of securities compared to a $74 thousand gain from sales during 2001. Trust department income dropped to $116 thousand in the first half of 2002 from $150 thousand in the same period of 2001 or a 22.7% decrease due to the number of estate settlements handled in the first half of 2001 which were not repeated in 2002 but which were partially offset by the increase in fees charged in 2002. Gain on sale of loans decreased $37 thousand to $36 thousand for 2002 from $73 thousand for 2001. Other income increased from $22 thousand in 2001 to $74 thousand in 2002 mainly due the increase of $34 thousand from the gain on mortgage servicing rights. Noninterest Expense. Union's noninterest expense increased $689 thousand to $5.8 million for the six months ended June 30, 2002 from $5.1 million for the six months ended June 30, 2001. Salaries increased $236 thousand, or 10.3%, to $2.5 million for the six months ended June 30, 2002, from $2.3 million for the six months ended June 30, 2001, reflecting normal salary activity, growth and the addition of the loan production office in Littleton, NH and the staff for the Fairfax, VT branch. Pension and employee benefits increased $130 thousand, or 19.3%, to $805 thousand for the six months ended June 30, 2002, from $675 thousand for the six months ended June 30, 2001 mainly due to a $84 thousand increase in health insurance costs and the increase in staff. Net occupancy expense decreased $10 thousand, or 3.0%, to $327 thousand for the six months ended June 30, 2002, from $337 thousand for the six months ended June 30, 2001. Equipment expense decreased $13 thousand to $416 thousand for the six months ended June 30, 2002, from $429 thousand for the same period in 2001 primarily resulting from a decrease of costs for maintenance contracts. Other expense was $1.7 million for the first six months of 2002 compared to $1.4 million for the same period in 2001 or a 24.7% increase mainly due to the write down of $204 thousand on one commercial OREO property in April 2002. Income Tax Expense. Union's income tax expense decreased by $114 thousand, or 11.8%, to $854 thousand for the six months ended June 30, 2002, from $968 thousand for the comparable period of 2001, due to lower income before taxes and the increased federal tax credits available in 2002 due to investments in low income housing projects. FINANCIAL CONDITION At June 30, 2002, Union had total consolidated assets of $333.3 million, including net loans and loans held for sale of $251.0 million, deposits of $279.1 million and stockholders' equity of $37.9 million. Based on the most recent information published by the Vermont Banking Commissioner, in terms of total assets at December 31, 2001, 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 decreased by $4.2 million or 1.2% to $333.3 million at June 30, 2002 from $337.5 million at December 31, 2001. Historically, June 30th of each year is our low point in terms of total assets, net loans and deposits. This is a one-day aberration as the Towns, Villages and School Districts that we lend to must be out of debt one day during the year. These loans totaled $10.6 million on December 31, 2001, $11.4 million on June 27, 2002, $7.6 million on June 28, 2002 (last business day of the month) and $9.3 million on July 1. In spite of this drop, total net loans and loans held for sale increased by $2.9 million or 1.2% to $251.0 million or 75.3% of total assets at June 30, 2002 as compared to $248.1 million or 73.5% of total assets at December 31, 2001. Cash and cash equivalents, including federal funds sold and overnight deposits, decreased approximately $4.4 million or 20.4% to $17.2 million at June 30, 2002 from $21.6 million at December 31, 2001, which was attributable to the one day decrease in liquidity caused by the municipal aberration discussed above, and continuing loan demand. Securities available for sale decreased from $49.6 million at December 31, 2001 to $47.0 million at June 30, 2002, a $2.6 million or 5.2% decrease. Securities maturing have not been replaced dollar for dollar
17 and some securities have been sold in order to fund loan demand and our decision to currently hold in portfolio a portion of loans available for sale. Deposits decreased $6.6 million or 2.3% to $279.1 million at June 30, 2002 from $285.7 million at December 31, 2001. A $3.0 million decrease in non- interest bearing deposits and a $11.9 million drop in municipal certificates of deposits (which are one day anomalies as discussed previously) were partially offset by a $3.2 million increase in savings accounts, a $2.3 million increase in money market accounts and a $1.8 million increase in Now accounts. Total borrowings increased $2.4 million to $12.8 million at June 30, 2002 from $10.3 million at December 31, 2001. The increase was in advances from the Federal Home Loan Bank under existing lines of credit to fund loan demand. Loan Portfolio. Union's loan portfolio (including loans held for sale) primarily consists of adjustable- and fixed-rate mortgage loans secured by one-to-four family, multi-family residential or commercial real estate. As of June 30, 2002, Union's gross loan portfolio totaled $254.2 million, or 76.3%, of assets, of which $125.6 million, or 49.4% of gross loans, consisted of residential mortgages and construction loans, and $87.6 million, or 34.5%, of total loans consisted of commercial real estate loans. As of such date, Union's loan portfolio also included $21.9 million of commercial loans, $7.6 million of municipal loans, and $11.5 million of consumer loans representing, in order, 8.6%, 3.0% and 4.5% of total loans outstanding on June 30, 2002. The following table shows information on the composition of Union's loan portfolio as of June 30, 2002 and December 31, 2001: <TABLE> <CAPTION> June 30, December 31, Loan Type 2002 2001 - --------- -------- ------------ (dollars in thousands) <s> <c> <c> Real Estate $110,693 $112,564 Commercial real estate 83,943 78,898 Commercial 21,605 20,659 Consumer 11,510 12,201 Municipal loans 7,631 10,552 Loans held for sale 18,842 16,333 ----------------------- Total loans 254,224 251,207 Deduct: Allowance for loan losses (2,920) (2,801) Net deferred loan fees, premiums & discounts (259) (263) ----------------------- $251,045 $248,143 ======================= </TABLE> Union originates and sells residential mortgages into the secondary market, with most such sales made to the Federal Home Loan Mortgage Corporation (FHLMC) and the Vermont Housing Finance Agency (VHFA). Union services an $137.6 million residential mortgage portfolio, approximately $45.6 million of which is serviced for unaffiliated third parties at June 30, 2002. 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 serviced $8.5 million of commercial and commercial real estate loans for unaffiliated third parties as of June 30, 2002. 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. Gross loans and loans held for sale have been increased $3.0 million or 1.2% since December 31, 2001. An increase of $23.2 million or 29.3% in commercial real estate loans, an increase of $1.0 million or 5.0% in commercial loans and an increase in loans held for sale of $2.5 million or 15.4% was partially offset by a $20.6 million or 18.3% decrease in residential real estate loans which is mainly due to the sale of loans
18 on the secondary market and where we are currently in the building cycle on our construction loans, $204 thousand or 1.7% decrease in consumer loans and a temporary, seasonal drop in municipal loans outstanding of $2.9 million or 27.7%. Asset Quality. Union, like all financial institutions, is exposed to certain credit risks including those related to the value of the collateral that secures its loans and the ability of borrowers to repay their loans. Management closely monitors Union's loan and investment portfolios and other real estate owned for potential problems on a periodic basis and reports to Union's and the subsidiaries' Boards of Directors at regularly scheduled meetings. Union had loans on nonaccrual status totaling $1.6 million at June 30, 2002, $1.8 million at December 31, 2001 and $1.9 million at June 30, 2001. Interest income not recognized on such loans amounted to approximately $317 thousand and $486 thousand as of June 30, 2002 and 2001, respectively and $450 thousand as of December 31, 2001. Union had $1.1 million and $3.0 million in loans past due 90 days or more and still accruing at June 30, 2002 and December 31, 2001, respectively. At June 30, 2002, Union had internally classified certain loans totaling $1.7 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 one or more of the following conditions makes the likelihood of collection uncertain: * the financial condition of the borrower is unsatisfactory; * repayment terms have not been met; * the borrower has sustained losses that are sizable, either in absolute terms or relative to net worth; * confidence is diminished; * loan covenants have been violated; * collateral is inadequate; or * other unfavorable factors are present. At June 30, 2002, Union had acquired by foreclosure or through repossession real estate worth $1.256 million consisting of 4 commercial properties, 1 piece of undeveloped land and 4 residential homes. Allowance for Loan Losses. Some of Union's loan customers ultimately do not make all of their contractually scheduled payments, requiring Union to charge off a portion or all of 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.
19 The following table reflects activity in the allowance for loan losses for the three and six months ended June 30, 2002 and 2001: <TABLE> <CAPTION> 3 Months Ended, June 30 Six Months Ended, June 30, ----------------------- -------------------------- 2002 2001 2002 2001 ---- ---- ---- ---- (dollars in thousands) <s> <c> <c> <c> <c> Balance at the beginning of period $2,834 $2,859 $2,801 $2,863 Charge-offs: Real Estate 6 31 6 31 Commercial 16 133 63 171 Consumer and other 19 17 67 68 ---------------------------------------------- Total charge-offs 41 181 136 270 ---------------------------------------------- Recoveries: Real Estate 1 1 7 1 Commercial 1 14 11 17 Consumer and other 20 20 42 46 ---------------------------------------------- Total recoveries 22 35 60 64 ---------------------------------------------- Net charge-offs (19) (146) (76) (206) Provision for loan losses 105 57 195 113 ---------------------------------------------- Balance at end of period $2,920 $2,770 $2,920 $2,770 ============================================== </TABLE> The following table shows the breakdown of Union's allowance for loan losses by category of loan and the percentage of loans in each category to total loans in the respective portfolios at the dates indicated: <TABLE> <CAPTION> June 30, December 31, 2002 2001 ------------------ ------------------ (dollars in thousands) Amount Percent Amount Percent ------ ------- ------ ------- <s> <c> <c> <c> <c> Real Estate Residential $ 598 41.3% $ 610 41.3% Commercial 1,448 36.8% 1,342 34.1% Construction 96 3.8% 116 4.6% Other Loans Commercial 408 8.9% 421 9.1% Consumer installment 222 4.5% 253 4.9% Home equity loans 29 1.5% 29 1.6% Municipal, Other and Unallocated 119 3.2% 30 4.4% Total $2,920 100.0% $2,801 100.0% ======================================= Ratio of Net Charge Offs to Average Loans(1) .01% 0.16% ----- ----- Ratio of Allowance for Loan Losses to Loans 1.15% 1.12% ----- ----- <FN> - -------------------- <F1> Annualized </FN> </TABLE>
20 Investment Activities. At June 30, 2002, the reported value of investment securities available-for-sale was $47.0 million or 14.1% of total assets. Union had no securities classified as held-to-maturity or trading securities. The reported value of securities available-for-sale at June 30, 2002, reflects a positive valuation adjustment of $883 thousand. The offset of this adjustment, net of income tax effect, was a $583 thousand increase in Union's other comprehensive income component of shareholders' equity and a decrease in net deferred tax assets of $300 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 June 30, 2002 and December 31, 2001: <TABLE> <CAPTION> Six Months Ended, June 30 Year Ended December 31, 2002 2001 --------------------------------- --------------------------------- (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 $ 36,443 13.05% $ 35,251 13.07% Now accounts 36,459 13.06% 1.17% 36,320 13.47% 1.63% Money Markets 66,376 23.78% 2.02% 56,875 21.09% 3.50% Savings 37,554 13.45% 1.34% 35,642 13.21% 2.13% ------------------- ------------------- Total non-certificate deposits: 176,832 63.34% 164,088 60.84% ------------------- ------------------- Certificates of deposit: Less than $100,000 73,720 26.41% 3.65% 76,641 28.42% 5.03% $100,000 and over 28,614 10.25% 4.45% 28,954 10.74% 5.53% ------------------- ------------------- Total certificates of deposit 102,334 36.66% 105,595 39.16% ------------------- ------------------- Total deposits 279,166 100.00% 2.23% $269,683 100.00% 3.26% ===================================================================== </TABLE> The following table sets forth information regarding the amounts of Union's certificates of deposit in amounts of $100,000 or more at June 30, 2002 and December 31, 2001 that mature during the periods indicated: <TABLE> <CAPTION> June 30, 2002 December 31, 2001 ------------- ----------------- (dollars in thousands) <s> <c> <c> Within 3 months $ 4,449 $ 6,288 3 to 6 months 4,995 13,681 6 to 12 months 8,547 3,189 Over 12 months 3,266 6,711 --------------------------- $21,255 $29,869 =========================== </TABLE> Borrowings. Borrowings from the Federal Home Loan Bank of Boston were $12.8 million at June 30, 2002 at a weighted average rate of 3.82%. Borrowings from the Federal Home Loan Bank of Boston were $10.3 million at December 31, 2001 at a weighted average rate of 5.06%. The change between
21 year end 2001 and the end of the second quarter of 2002 is a net increase of $2.5 million 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 interest rates, foreign currency exchange rates, commodity prices and equity prices. Union's market risk arises primarily from interest rate risk inherent in its lending, investing 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 2001 for a flat rate environment projected a Net Interest Income of $7.4 million for the first six months of 2002 compared to actual results of $7.7 million in a flat rate environment, or a 4.1% difference. The Prime rate has remained constant throughout 2002 at 4.75%. Our results were stronger than anticipated because of continuing strong loan demand. Net income was projected to be $2.4 million in a flat rate environment compared to actual results of $2.3 million, the difference is mainly due to the write down on one commercial OREO property. Therefore, our results for the first six months of 2002 were close to our projections in a flat rate environment. Return on Assets was projected to be 1.43% in a flat rate environment and actual results were 1.35%. Return on Equity was projected to be 13.27% in a flat rate environment compared to actual of 12.06%. The Company generally requires collateral or other security to support financial instruments with credit risk. As of June 30, 2002, the contract or notional amount of financial instruments whose contract amount represents credit risk were as follows rounded to the nearest thousand: <TABLE> <s> <c> Commitments to extend credit $28,019 ------- Standby letters of credit and commercial letters of credit $ 1,046 ------- Credit Card arrangements $ 2,038 ------- Home Equity Lines of Credit $ 3,362 ------- </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.
22 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 and loans reflect estimated prepayments, which were estimated based on analyses of broker estimates, the results of a prepayment model utilized by Union, and empirical data; * other non-mortgage-related 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.
23 The following tables show Union's rate sensitivity analysis as of June 30, 2002: <TABLE> <CAPTION> June 30, 2002 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 and overnight deposits $ 2,821 $ 0 $ 0 $ 0 $ 0 $ 2,821 Interest bearing deposits 395 1,383 1,454 495 0 3,727 Investments available for sale (1) 2,524 7,088 17,233 8,294 11,130 46,269 FHLB Stock 0 0 0 0 1,235 1,235 Loans (fixed and adjustable rate) 77,077 49,774 61,582 42,920 19,692 251,045 ----------------------------------------------------------------------- Total interest sensitive assets $82,817 $58,245 $80,269 $ 51,709 $ 32,057 $305,097 ----------------------------------------------------------------------- Interest sensitive liabilities: Certificates of deposit $24,350 $48,381 $18,077 $ 2,417 $ 3 $ 93,288 Money markets 28,613 0 0 0 38,450 67,063 Regular savings 6,324 0 0 0 33,180 39,504 Now accounts 31,151 0 0 0 11,634 42,785 Borrowed funds 1,353 4,184 2,623 3,655 941 12,756 ----------------------------------------------------------------------- Total interest sensitive liabilities $91,791 $52,565 $20,700 $ 6,072 $ 84,208 $255,336 ----------------------------------------------------------------------- Net interest rate sensitivity gap (8,974) 5,680 59,569 45,637 (52,151) Cumulative net interest rate sensitivity gap (8,974) (3,294) 56,275 101,912 49,761 Cumulative net interest rate sensitivity gap as a percentage of total assets (2.69%) (0.99%) 16.88% 30.57% 14.93% Cumulative net interest rate sensitivity gap as a percentage of total interest-earning assets (2.94%) (1.08%) 18.44% 33.40% 16.31% Cumulative net interest rate sensitivity gap as a percentage of total interest-bearing liabilities (3.51%) (1.29%) 22.04% 39.91% 19.49% <FN> - -------------------- <F1> Investments available for sale exclude marketable equity securities with a fair value of $ 757,000 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 4.75%, 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.
24 INTEREST RATE SENSITIVITY ANALYSIS MATRIX JUNE 30, 2002 (dollars 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-02 7.75 16,073 4.61 5,458 1.60 14.58 24,253 -43.02 4.75 15,365 0.00 4,977 1.46 13.36 42,565 00.00 1.75 14,519 -5.50 4,406 1.30 11.88 58,512 37.46 December-03 7.75 18,690 15.62 6,948 1.99 17.37 21,841 -50.13 4.75 16,164 0.00 5,252 1.51 13.56 43,799 00.00 1.75 12,625 -21.90 2,887 .83 7.78 69,226 58.05 </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 16.52% of total assets. In addition, subsidiaries maintain Federal Fund lines of credit with upstream correspondent banks and repurchase agreement lines with selected brokerage houses. While scheduled loan and securities payments and FHLB advances are relatively predictable sources of funds, deposit flows and prepayments on loans and mortgage-backed securities are greatly influenced by general interest rates, economic conditions, and competition. Union's liquidity is actively managed on a daily basis, monitored by the Asset/Liability Committee, and reviewed periodically with the Board of Directors. Union's Asset/Liability Committee sets liquidity targets based on Union's financial condition and existing and projected economic and market conditions. The committee measures Union's marketable assets and credit available to fund liquidity requirements and compares the adequacy of that aggregate amount against the aggregate amount of Union's sensitive or volatile liabilities, such as core deposits and time deposits in excess of $100,000, term deposits with short maturities, and credit commitments outstanding. The committee's primary objective is to manage Union's liquidity position and funding sources in order to ensure that it has the ability to meet its ongoing commitment to its depositors, to fund loan commitments, and to maintain a portfolio of investment securities. Since many of the loan commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Union's management monitors current and projected cash flows and adjusts positions as necessary to maintain adequate levels of liquidity. Although approximately 78% of Union's certificates of deposit will mature within twelve months, management believes, based upon past experience, that Union will retain a
25 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. Capital Resources. The total dollar value of Union's shareholders' equity is $37.9 million at June 30, 2002, compared to $37.2 million at year-end 2001. Union has 5 million shares of $2.00 par value common stock authorized. As of June 30, 2002, Union had 3,268,189 shares issued, of which 3,027,557 were outstanding and 240,632 shares were held in Treasury. Also as of June 30, 2002, there were outstanding employee incentive stock options with respect to 10,200 shares of Union's common stock, granted pursuant to Union's 1998 Incentive Stock Option Plan and a predecessor plan. Of the 50,000 shares authorized for issuance under the 1998 Plan, 42,000 shares remain available for future option grants. On October 17, 2001, the Company 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 are 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. To date we have repurchased 6,672 shares under this program. Union Bank and Citizens (the Banks) are subject to various regulatory capital requirements administered by the federal banking agencies. Management believes, as of June 30, 2002 that the Banks meet all capital adequacy requirements to which they are subject. As of June 30, 2002, 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' and the Company's actual capital amounts 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 ------ ----- ------ ----- ------ ----- (dollars in thousands) <s> <c> <c> <c> <c> <c> <c> As of June 30, 2002: Total capital to risk weighted assets Union Bank $27,725 16.75% $13,242 8.0% $16,552 10.0% Citizens 11,814 16.71% 5,656 8.0% 7,070 10.0% Consolidated 40,712 17.20% 18,936 8.0% 23,670 10.0% Tier I capital to risk weighted assets Union Bank $25,815 15.60% $ 6,619 4.0% $ 9,929 6.0% Citizens 10,928 15.46% 2,827 4.0% 4,241 6.0% Consolidated 37,727 15.94% 9,467 4.0% 14,201 6.0% Tier I capital to average assets Union Bank $25,815 11.23% $ 9,195 4.0% $11,494 5.0% Citizens 10,928 10.61% 4,120 4.0% 5,150 5.0% Consolidated 37,727 11.32% 13,331 4.0% 16,664 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.
26 Item 3. Quantitative and Qualitative Disclosures About Market Risk. Information called for by this item is incorporated by reference in Management's Discussion and Analysis of Financial Condition and Results of Operations under the titlement "Other Financial Considerations" on pages 22 through 26 in this Form 10-Q. PART II OTHER INFORMATION Item 1. Legal Proceedings. In the normal course of business, the Company's bank subsidiaries are involved in various legal proceedings incidental to their business, none of which management deems to be material to the Company's financial position. Item 4. Submission of Matters to a Vote of Security Holders. The annual shareholders meeting was held on May 15, 2002. The only matter submitted to a vote by the shareholders was as follows: a) To fix the number of directors at ten for the ensuring year and to elect the following individuals as directors for the ensuing year: <TABLE> <CAPTION> Votes Votes Votes Broker Nominee For Withheld Abstained Non-votes ------- ----- -------- --------- --------- <s> <c> <c> <c> <c> Cynthia D. Borck 2,948,482 1,238 1,169 0 William T. Costa 2,948,416 1,304 1,169 0 Kenneth D. Gibbons 2,948,677 1,043 1,169 0 Franklin G. Hovey, II 2,946,291 3,429 1,169 0 Richard C. Marron 2,947,320 2,400 1,169 0 Robert P. Rollins 2,949,720 0 1,169 0 Jerry S. Rowe 2,949,720 0 1,169 0 Richard C. Sargent 2,947,601 2,119 1,169 0 W. Arlen Smith 2,948,677 1,043 1,169 0 John H. Steel 2,949,720 0 1,169 0 </TABLE> Item 6: EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 99.1 Certification of the Chief Executive Officer and the Chief Financial Officer (b) Current Reports on Form 8-K 1. Report to Shareholders on Second Quarter Results filed on July 19, 2002 2. Press Releases announcing dividend declaration and second quarter earnings filed on July 8, 2002 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. August 14, 2002 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 (Principal Accounting Officer)
27 EXHIBIT INDEX 99.1 Certification of the Chief Executive Officer and the Chief Financial Officer
28