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: March 31, 2003 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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No X ----- ----- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of May 9, 2003: Common Stock, $2 par value 3,030,757 shares
1 UNION BANKSHARES, INC. TABLE OF CONTENTS <TABLE> <s> <c> PART 1 FINANCIAL INFORMATION Item 1. Financial Statements. Consolidated Financial Statements. Union Bankshares, Inc. and Subsidiaries Consolidated Balance Sheets 3 Consolidated Statements of Income 4 Consolidated Statements 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 25 Item 4. Controls and Procedures 25 PART II OTHER INFORMATION Item 1. Legal Proceedings. 26 Item 2. Change in Securities and Use of Proceeds 26 Item 6. Exhibits and Reports on Form 8-K 26 Signatures 27 Certifications 28 </TABLE>
2 Item 1. Financial Statements Union Bankshares, Inc. and Subsidiaries Consolidated Balance Sheets <TABLE> <CAPTION> March 31, December 31, (Dollars in Thousands) 2003 2002 --------- ------------ (unaudited) <s> <c> <c> Assets Cash and due from banks $ 15,956 $ 16,035 Federal funds sold and overnight deposits 6,498 9,713 -------- -------- Cash and Cash Equivalents 22,454 25,748 Interest bearing deposits in banks 4,734 5,327 Securities available-for-sale 39,431 45,824 Federal Home Loan Bank stock 1,241 1,235 Loans held for sale 18,701 17,139 Loans 239,596 238,974 Allowance for loan losses (2,955) (2,908) Unearned net loan fees (201) (206) -------- -------- Net loans 236,440 235,860 -------- -------- Accrued interest receivable 1,803 1,890 Premises and equipment, net 4,577 4,612 Other real estate owned 744 784 Other assets 5,060 5,073 -------- -------- Total assets $335,185 $343,492 ======== ======== Liabilities and Stockholders' Equity: Liabilities: Deposits: Noninterest bearing $ 38,080 $ 40,976 Interest bearing 245,692 252,028 -------- -------- Total Deposits 283,772 293,004 Borrowed funds 7,193 7,536 Accrued interest and other liabilities 4,630 3,783 -------- -------- Total liabilities 295,595 304,323 -------- -------- Stockholders' Equity: Common stock, $2 par value; 5,000,000 shares authorized; 3,271,189 shares issued at 3/31/03 and 3,270,689 shares issued at 12/31/02 6,542 6,542 Paid-in capital 326 318 Retained earnings 33,677 33,357 Treasury stock at cost; 240,632 shares at 3/31/03 and 12/31/02 (1,722) (1,722) Accumulated other comprehensive income 767 674 -------- -------- Total stockholders' equity 39,590 39,169 -------- -------- Total liabilities and stockholders' equity $335,185 $343,492 ======== ======== </TABLE> See accompanying notes to the unaudited consolidated financial statements
3 Union Bankshares, Inc. and Subsidiaries Consolidated Statements of Income <TABLE> <CAPTION> Three Months Ended March 31, ------------------ (Dollars in Thousands, except Per Share Data) 2003 2002 ---- ---- (unaudited) <s> <c> <c> Interest income: Interest and fees on loans $ 4,529 $ 4,780 Interest and dividends on securities available-for-sale 543 672 Interest on federal funds sold and overnight deposits 22 30 Interest on interest bearing deposits in banks 47 54 --------- --------- 5,141 5,536 --------- --------- Interest expense: Interest on deposits 1,114 1,623 Interest on federal funds purchased - 1 Interest on borrowed funds 85 131 --------- --------- 1,199 1,755 --------- --------- Net interest income 3,942 3,781 Provision for loan losses 42 90 --------- --------- Net interest income after provision for loan losses 3,900 3,691 --------- --------- Other income: Trust income 39 67 Service fees 660 603 Loss on sale of securities available-for-sale - (3) Gain on sale of loans held for sale 182 27 Other income 23 33 --------- --------- 904 727 --------- --------- Other expenses: Salaries and wages 1,412 1,260 Pension and employee benefits 422 388 Occupancy expense, net 188 160 Equipment expense 232 200 Net operation of other real estate owned 70 85 Other expense 756 695 --------- --------- 3,080 2,788 --------- --------- Income before income tax expense 1,724 1,630 Income tax expense 495 461 --------- --------- Net income $ 1,229 $ 1,169 ========= ========= Earnings per common share $ 0.41 $ 0.39 ========= ========= Weighted average number of common shares outstanding 3,030,329 3,027,557 ========= ========= Dividends declared per share $ 0.30 $ 0.28 ========= ========= </TABLE> See accompanying notes to the unaudited consolidated financial statements
4 Union Bankshares, Inc. and Subsidiaries Consolidated Statement of Changes in Stockholders' Equity (Unaudited) <TABLE> <CAPTION> Accumulated Paid-in Other Common Capital Retained Treasury Comprehensive Stock & Surplus Earnings Stock Income Total ------ --------- -------- -------- ------------- ----- (dollars in thousands) <s> <c> <c> <c> <c> <c> <c> Balance, December 31, 2002 $6,542 $318 $33,357 ($1,722) $674 $39,169 Comprehensive Income: Net income - - 1,229 - - 1,229 Change in net unrealized gain on securities available-for-sale, net of reclassification adjustment and tax effects. - - - - 93 93 ------- Total Comprehensive income - - - - - 1,322 Exercise of stock options - 8 - - - 8 Cash dividends declared ($0.30 per share) - - (909) - - (909) ---------------------------------------------------------------------------- Balance March 31, 2003 $6,542 $326 $33,677 ($1,722) $767 $39,590 ============================================================================ </TABLE> See accompanying notes to the unaudited consolidated financial statements
5 Union Bankshares, Inc. and Subsidiaries Consolidated Statements of Cash Flows (UNAUDITED) <TABLE> <CAPTION> March 31, March 31, 2003 2002 --------- --------- (Dollars in Thousands) <s> <c> <c> Cash Flows From Operating Activities Net Income $ 1,229 $ 1,169 Adjustments to reconcile net income to net cash provided by (used in) operating activities Depreciation 167 147 Provision for loan losses 42 90 Provision for deferred income taxes 4 70 Net amortization on securities available-for-sale 74 46 Equity in losses of limited partnerships 31 30 Write-downs of other real estate owned 33 41 Decrease in unamortized loan fees (5) (1) Proceeds from sales of loans held for sale 6,922 4,444 Net loans made to customers and held for sale (8,302) (7,418) Loss on sale of securities available-for-sale - 3 Gain on sale of loans held for sale (182) (27) Loss on sale of other real estate owned 2 - Loss (gain)on disposal of fixed assets (6) 1 Decrease in accrued interest receivable 87 31 (Increase) decrease in other assets (58) 16 Increase in income taxes 461 445 Decrease in accrued interest payable (35) (100) Increase in other liabilities 421 1 -------- -------- Net cash provided (used in) by operating activities 885 (1,012) Cash Flows From Investing Activities Interest bearing deposits in banks Maturities and redemptions 1,190 972 Purchases (597) (595) Securities available-for-sale Sales - 510 Maturities, calls and paydowns 9,592 6,211 Purchases (3,133) (4,869) Purchase of Federal Home Loan Bank Stock (6) (124) (Increase) decrease in loans, net (690) 1,199 Recoveries of loans charged off 33 38 Purchases of premises and equipment (136) (516)
6 <CAPTION> March 31, March 31, 2003 2002 --------- --------- (Dollars in Thousands) <s> <c> <c> Investment in limited partnerships - (45) Proceeds from sales of other real estate owned 20 - Proceeds from sales of premises and equipment 10 1 Proceeds from sales of repossessed property 14 5 -------- -------- Net cash provided by investing activities 6,297 2,787 Cash Flows From Financing Activities (Decrease) increase in borrowings outstanding, net (343) 1,775 Proceeds from exercise of stock options 8 - Net decrease in noninterest bearing deposits (2,896) (2,523) Net decrease in interest bearing deposits (6,336) (2,278) Dividends paid (909) (848) -------- -------- Net cash used in financing activities (10,476) (3,874) Decrease in cash and cash equivalents $ (3,294) $ (2,099) Cash and cash equivalents Beginning $ 25,748 $ 21,556 Ending $ 22,454 $ 19,457 Supplemental Disclosures of Cash Flow Information: Interest paid $ 1,235 $ 1,855 ======== ======== Income taxes paid $ 30 $ - ======== ======== Supplemental Schedule of Noncash Investing and Financing Activities: Other real estate acquired in settlement of loans $ 15 $ 163 ======== ======== Repossessed property acquired in settlement of loans $ 25 $ 14 ======== ======== Total change in unrealized gain on securities available-for-sale $ 140 $ (335) ======== ======== </TABLE> See accompanying notes to the unaudited consolidated financial statements
7 UNION BANKSHARES, INC. NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS: Note 1. Basis of Presentation The accompanying interim unaudited consolidated financial statements of Union Bankshares, Inc. (the Company) for the interim periods ended March 31, 2003 and 2002 and for the quarters then ended have been prepared in accordance with U.S. generally accepted accounting principles, general practices within the banking industry and the accounting policies described in the Company's Annual Report to Shareholders and Annual Report on Form 10-K for the year ended December 31, 2002. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) and disclosures 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 2002 Annual Report to Shareholders, 2002 Annual Report on Form 10-K, and current reports on Form 8-K. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full fiscal year ended December 31, 2003 or any other interim period. 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. New Accounting Pronouncements In April 2003, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards (Statement) No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. The Statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. The Statement is mainly effective for contracts entered into or modified after June 30, 2003. Management is currently evaluating the impact of this Statement on the company's financial statements but does not anticipate it will have a material impact. Note 5. Stock Option Plan The Company has a stock option plan and continues to apply the intrinsic value based method of accounting in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all stock options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The Company has adopted the disclosure provision of FASB Statement No. 148, Accounting for Stock Based Compensation-Transition and Disclosure. Had compensation costs been determined on the basis of fair value pursuant to FASB Statement No. 123, Accounting for Stock-Based Compensation, the effects on net income and earnings per common share for the three months ended March 31 would have approximated: <TABLE> <CAPTION> (Dollars in thousands, except for per share data) 2003 2002 ---- ---- <s> <c> <c> Net income: As reported $1,229 $1,169 Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects (1) (1) ------ ------ Pro forma net income $1,228 $1,168 ====== ====== Earnings per common share: As reported $ 0.41 $ 0.39 Pro forma $ 0.41 $ 0.39 </TABLE>
8 Note 6. 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. The Company accounts for intersegment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices. Information about reportable segments, and the reconciliation of such information to the consolidated financial statements as of and for the periods ended March 31, 2003 and 2002 follows: <TABLE> <CAPTION> Union Intersegment Consolidated 2003 Bank Citizens Elimination Other Totals - -------------------------------------------------------------------------------------------------- (dollars in thousands) <s> <c> <c> <c> <c> <c> Interest income $ 3,539 $ 1,602 $ 0 $ 0 $ 5,141 Interest expense 733 466 0 0 1,199 Provision for loan loss 21 21 0 0 42 Service fee income 540 120 0 0 660 Income tax expense (benefit) 430 89 0 (24) 495 Net income (loss) 1,085 188 0 (44) 1,229 Assets 231,677 103,130 (80) 458 335,185 <CAPTION> Union Intersegment Consolidated 2002 Bank Citizens Elimination Other Totals - -------------------------------------------------------------------------------------------------- (dollars in thousands) <s> <c> <c> <c> <c> <c> Interest income $ 3,797 $ 1,739 $ 0 $ 0 $ 5,536 Interest expense 1,142 613 0 0 1,755 Provision for loan loss 45 45 0 0 90 Service fee income 482 121 0 0 603 Income tax expense (benefit) 342 136 0 (17) 461 Net income (loss) 926 277 0 (34) 1,169 Assets 231,848 103,622 (45) 423 334,848 </TABLE> Amounts in the "Other" column encompass activity in Union Bankshares, Inc., the "parent company." Parent company assets are stated after intercompany eliminations. Note 7. Comprehensive Income The components of other comprehensive income and related tax effects at March 31, are as follows: <TABLE> <CAPTION> 2003 ---- (dollars in thousands) <s> <c> Unrealized holding gains on available-for-sale securities $140 Reclassification adjustment for losses (gains) realized in income - ---- Net unrealized gains 140 Tax effect 47 ---- Net of tax amount $ 93 </TABLE>
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 or the Company's) financial position as of March 31, 2003 and as of December 31, 2002, and its results of operations for the three months ended March 31, 2003 and 2002. 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 reflects all adjustments, consisting only of normal recurring adjustments and disclosures, necessary to fairly present Union's consolidated financial position and results of operations to be expected for the interim period. Management is not aware of the occurrence of any events after March 31, 2003, 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, it closed on March 31, 2003 at $27.00 and on May 9, 2003 at $29.20. On February 18, 2003 we publicly announced the planned merger of our two subsidiary banks, Union Bank and Citizens Savings Bank and Trust Company (Citizens) under the name and banking charter of Union Bank. Union Bankshares had acquired Citizens in December of 1999 and since the acquisition, each subsidiary bank has operated semi-autonomously under the bank holding company. The purpose of merging the two banks is to provide a higher quality of service to the communities served by each bank by improving coordination of products and services as well as enhancing efficiencies. The merger will be treated as a tax-free reorganization. The regulatory approvals for this merger have been received and an anticipated merger date, as of the close of business on May 16, 2003, has been set. On February 18th, we also announced the resignation of Jerry Rowe, President and CEO of Citizens and Vice President and Director of Union Bankshares, Inc. which was effective February 15, 2003. 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. Forward-looking statements reflect management's current expectations and 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," "intends," "plans," "seeks," "estimates" 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
10 * developments in general economic or business conditions, including interest rate fluctuations, market fluctuations and perceptions, and inflation and their effect on the Company or its customers * 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 or war * adverse changes in the securities market * unanticipated lower revenues, loss of customers or business or higher operating expenses * the failure of assumptions underlying the establishment of reserves for loan losses and estimations of values of collateral and various financial assets and liabilities * the amount that we invest in new business opportunities and the timing of these investments When evaluating forward-looking statements to make decisions with respect to the Company, investors and others are cautioned to consider these and other risks and uncertainties and are reminded not to place undue reliance on such statements. Forward-looking statements speak only as of the date they are made and the company undertakes no obligation to update them to reflect new or changed information or events, except as may be required by federal securities laws. CRITICAL ACCOUNTING POLICIES The Company has established various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of the Company's financial statements. Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the reported amount of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities in the consolidated financial statements and related notes. The Securities and Exchange Commission ("SEC") has defined a company's critical accounting policies as the ones that are most important to the portrayal of the Company's financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, we have identified the critical accounting policies and judgments. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company. The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of its consolidated financial statements. In estimating the allowance for loan losses, management utilizes historical experience as well as other factors including the effect of changes in the local real estate market on collateral values, the effect on the loan portfolio of current economic indicators and their probable impact on borrowers and changes in delinquent, nonperforming or impaired loans. Changes in these factors may cause management's estimate of the allowance to increase or decrease and result in adjustments to the Company's provision for loan losses. We also have other key accounting policies, which involve the use of estimates, judgments and assumptions that are significant to understanding our results. For additional information see FINANCIAL CONDITION - Allowance for Loan Losses below. Although we believe that our estimates, assumptions and judgments are reasonable, they are based upon information presently available. Actual results may differ significantly from these estimates under different assumptions, judgment or conditions. RESULTS OF OPERATIONS The Company's net income for the quarter ended March 31, 2003 was $1.23 million, compared with net income of $1.17 million for the first quarter of 2002. Net income per share was $.41 for the first quarter of 2003 compared to $.39 for the same quarter of 2002.
11 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 table shows, 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: <TABLE> <CAPTION> Three months ended March 31, 2003 2002 --------------------------------- --------------------------------- 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 $ 8,652 $ 22 1.04% $ 7,805 $ 30 1.54% Interest bearing deposits in banks 5,054 47 3.74% 4,468 54 4.83% Securities available-for-sale (1), (2) 44,684 543 5.10% 47,552 672 5.89% Loans, net (1), (3) 253,329 4,529 7.32% 248,402 4,780 7.77% -------- ------ ---- -------- ------ ---- Total interest-earning assets (1) 311,719 5,141 6.77% 308,227 5,536 7.28% Cash and due from banks 14,322 12,566 Premises and equipment 4,638 4,375 Other assets 7,834 8,169 -------- -------- Total assets $338,513 $333,337 ======== ======== Average Liabilities and Stockholders' Equity: Now accounts $ 40,497 $ 62 0.63% $ 35,324 $ 105 1.19% Savings and money market accounts 107,507 292 1.10% 104,423 483 1.85% Time deposits 101,333 760 3.04% 103,234 1,035 4.01% Borrowed funds 7,315 85 4.70% 12,299 132 4.29% -------- ------ ---- -------- ------ ---- Total interest-bearing liabilities 256,652 1,199 1.89% 255,280 1,755 2.75% Non-interest bearing deposits 39,458 37,365 Other liabilities 3,820 3,810 -------- -------- Total liabilities 299,930 296,455 Stockholders' equity 38,583 36,882 -------- -------- Total liabilities and stockholders' equity $338,513 $333,337 ======== ======== Net interest income $3,942 $3,781 ====== ====== Net interest spread (1) 4.87% 4.53% ==== ==== Net interest margin (1) 5.21% 5.00% ==== ==== <FN> <F1> Average yield reported on a tax-equivalent basis. <F2> The average balance of securities available-for-sale is calculated on the amortized cost basis. <F3> Includes loans held for sale and is net of unearned income and allowance for loan losses. </FN> </TABLE>
12 Union's net interest income increased by $161 thousand, or 4.26%, to $3.94 million for the three months ended March 31, 2003, from $3.78 million for the three months ended March 31, 2002. The net interest spread increased by 34 basis points to 4.87% for the three months ended March 31, 2003, from 4.53% for the three months ended March 31, 2002 as interest rates paid on most liabilities and earned on most assets moved downward in response to earlier decreases in the prime rate. The net interest margin for the 2003 period increased 21 basis points to 5.21% from the 2002 period at 5.00%. A decrease in prime rate is not necessarily beneficial to Union in the near term, see "OTHER FINANCIAL CONSIDERATIONS - Market Risk and Asset and Liability Management." Rate/Volume Analysis. The following table describes the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have affected Union's interest income and interest expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: * changes in volume (change in volume multiplied by prior rate); * changes in rate (change in rate multiplied by current volume); and * total change in rate and volume. Changes attributable to both rate and volume have been allocated proportionately to the change due to volume and the change due to rate. <TABLE> <CAPTION> Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002 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 $ 3 $ (11) $ (8) Interest bearing deposits in banks 7 (14) (7) Securities available-for-sale (42) (87) (129) Loans, net 62 (313) (251) ---- ----- ----- Total interest-earning assets 30 (425) (395) Interest-bearing liabilities: Now accounts 14 (57) (43) Savings and money market accounts 11 (202) (191) Time deposits (26) (249) (275) Borrowed funds (54) 7 (47) ---- ----- ----- Total interest-bearing liabilities (55) (501) (556) ---- ----- ----- Net change in net interest income $ 85 $ 76 $ 161 ==== ===== ===== </TABLE> Quarter Ended March 31, 2003 compared to Quarter Ended March 31, 2002. Interest and Dividend Income. Union's interest and dividend income decreased by $395 thousand, or 7.13%, to $5.1 million for the three months ended March 31, 2003, from $5.5 million for the three months ended March 31, 2002. Average earning assets increased by $3.5 million, or 1.1%, to $311.7 million for the three months ended March 31, 2003, from $308.2 million for the three months ended March 31, 2002. Average loans approximated $253.3 million for the three months ended March 31, 2003 up from $248.4 million for the three months ended March 31, 2002. The $2.9 million or 30.0% increase in construction loans and the $4.0 million or 3.3% increase in commercial loans was partially offset by the $1.5 million or 12.7% decrease in personal loans and a $1.7 million, or 2.0% decrease in residential real estate secured loans. The average balance of securities available-for-sale (including mortgage- backed securities) decreased by $2.9 million, or 6.0%, to $44.7 million for the three months ended March 31, 2003, from $47.6 million for the three months ended March 31, 2002. The decrease in the investment portfolio in 2003 reflects the continuing growth in our loan portfolio. The average level of federal funds sold and
13 overnight deposits increased by $847 thousand or 10.9%, to $8.7 million for the three months ended March 31, 2003, from $7.8 million for the three months ended March 31, 2002. The average balance in interest bearing deposits in banks increased by $586 thousand to $5.1 million from $4.5 million, or 13.1% increase. Interest income from non-loan instruments was $612 thousand for 2003 and $756 thousand for 2002 reflecting the decrease in yields and the overall decrease in volume. Interest Expense. Union's interest expense decreased by $556 thousand, or 31.7%, to $1.2 million for the three months ended March 31, 2003 from $1.76 million for the three months ended March 31, 2002. Average interest- bearing liabilities increased by $1.4 million, or .5%, to $256.7 million for the three months ended March 31, 2003, from $255.3 million for the three months ended March 31, 2002. Average time deposits were $101.3 million for the three months ended March 31, 2003 and $103.2 million for the three months ended March 31, 2002, or a decrease of 1.8%. The average balances for money market and savings accounts increased by $3.1 million, or 3.0% to $107.5 million for the three months ended March 31, 2003, from $104.4 million for the three months ended March 31, 2002. The 14.9% increase in Now accounts brought the average balance up to $40.5 million from $35.3 million. Customers have maintained very liquid positions during the last 2 years as they anticipate the interest rates paid on all deposit instruments will rise. The average balance on funds borrowed has decreased from $12.3 million in 2002 to $7.3 million in 2003 as Union's subsidiaries continued to pay down amortizing Federal Home Loan Bank advances. Noninterest Income. Union's noninterest income increased $177 thousand, or 24.3%, to $904 thousand for the three months ended March 31, 2003 from $727 thousand for the three months ended March 31, 2002. Trust department income decreased to $39 thousand for the three months of 2003 from $67 thousand in the same period of 2002 or a 42.95% decrease primarily due to the decline in interest rates and the stock market since the majority of the fee income is based on the asset's market value. Gain on Sale of Loans increased $155 thousand to $182 thousand for 2003 from $27 thousand for 2002. Service fees (sources of which include, among others, deposit and loan servicing fees, ATM fees, and safe deposit fees) increased by $57 thousand, or 9.5%, to $660 thousand for the three months ended March 31, 2003, from $603 thousand for the three months ended March 31, 2002. The main component of other income in 2003 is $15 thousand representing net servicing rights. Noninterest Expense. Union's noninterest expense increased $292 thousand, or 10.5%, to $3.08 million for the three months ended March 31, 2003, from $2.79 million for the three months ended March 31, 2002. Salaries increased $152 thousand, or 12.1%, to $1.41 million for the three months ended March 31, 2003, from $1.26 million for the three months ended March 31, 2002, reflecting normal salary activity, an accrual under a separation agreement with the former president of Citizens, growth and the addition of the Fairfax, Vermont branch in April of 2002. Pension and employee benefits increased $34 thousand, or 8.8%, to $422 thousand for the three months ended March 31, 2003, from $388 thousand for the three months ended March 31, 2002 mainly due to a $27 thousand increase in pension plan costs. Net occupancy expense increased $28 thousand, or 17.5%, to $188 thousand for the three months ended March 31, 2003, from $160 thousand for the three months ended March 31, 2002. Equipment expense increased $32 thousand or 16.0% to $232 thousand for the three months ended March 31, 2003, from $200 thousand for the same period in 2002. Net operation of other real estate owned was $70 thousand for the three months ended March 31, 2003 compared to $85 thousand for the same period in 2002. Other operating expenses were $756 thousand for the first three months of 2003 compared to $695 thousand for the same period in 2002. The increase of $61 thousand, or 8.8%, is mainly due to the costs associated with assimilating Citizens Savings Bank & Trust Company into Union Bank and increased professional and legal fees. Income Tax Expense. Union's income tax expense increased by $34 thousand, or 7.4%, to $495 thousand for the three months ended March 31, 2003, from $461 thousand for the comparable period of 2002, mainly due to increased income before taxes.
14 FINANCIAL CONDITION At March 31, 2003, Union had total consolidated assets of $335.2 million, including net loans and loans held for sale of $255.1 million, deposits of $283.8 million and stockholders' equity of $39.6 million. Union's total assets decreased by $8.3 million or 2.4% to $335.2 million at March 31, 2003 from $343.5 million at December 31, 2002. Total net loans and loans held for sale increased by $2.1 million or .8% to $255.1 million or 76.1% of total assets at March 31, 2003 as compared to $253.0 million or 73.7% of total assets at December 31, 2002. Cash and cash equivalents, including federal funds sold and overnight deposits, decreased $3.3 million or 12.8% to $22.4 million at March 31, 2003 from $25.7 million at December 31, 2002. Securities available for sale decreased from $45.8 million at December 31, 2002 to $39.4 million at March 31, 2003, a $6.4 million or 14.0% decrease. Securities maturing have not been replaced dollar for dollar in order to fund loan demand, our decision to currently hold in portfolio a portion of loans available for sale, and a decrease in our non-core deposits. Deposits decreased $9.2 million or 3.1% to $283.8 million at March 31, 2003 from $293.0 million at December 31, 2002, which is a seasonal fluctuation (see average balances in Yields Earned and Rates Paid on Page 12). Total borrowings decreased $343 thousand to $7.2 million at March 31, 2003 from $7.5 million at December 31, 2002 due to pay downs of amortizing Federal Home Loan Bank advances. Loan Portfolio. Union's loan portfolio (including loans held for sale) primarily consists of adjustable- and fixed-rate mortgage loans secured by one-to-four family, multi-family residential or commercial real estate. As of March 31, 2003, Union's gross loan portfolio totaled $258.3 million, or 77.1%, of assets, of which $108.2 million, or 41.9% of gross loans, consisted of residential mortgages and construction loans, and $88.1 million, or 34.1%, of total loans consisted of commercial real estate loans. As of such date, Union's loan portfolio also included $20.0 million of commercial loans, $12.7 million of municipal loans, and $10.5 million of consumer loans representing, in order, 7.8%, 4.9% and 4.1% of total loans outstanding on March 31, 2003. The following table shows information on the composition of Union's loan portfolio as of March 31, 2003 and December 31, 2002: <TABLE> <CAPTION> March 31, December 31, Loan Type 2003 2002 - --------- --------- ------------ (dollars in thousands) <s> <c> <c> Real estate $108,232 $109,347 Commercial real estate 88,138 86,081 Commercial 20,039 19,919 Consumer 10,462 10,758 Municipal loans 12,725 12,869 Loans held for sale 18,701 17,139 -------- -------- Total loans 258,297 256,113 Deduct: Allowance for loan losses 2,955 2,908 Net deferred loan fees, premiums & discounts 201 206 -------- -------- $255,141 $252,999 ======== ======== </TABLE>
15 The banks originate and sell 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 a $165.1 million residential mortgage portfolio, approximately $56.9 million of which is serviced for unaffiliated third parties at March 31, 2003. Additionally, Union originates commercial real estate and commercial loans under various SBA programs that provide an agency guarantee for a portion of the loan amount. Union occasionally sells the guaranteed portion of the loan to other financial concerns and will retain servicing rights, which generates fee income. Union serviced $8.0 million of commercial and commercial real estate loans for unaffiliated third parties as of March 31, 2003. Union capitalizes servicing rights on these fees and recognizes gains and losses on the sale of the principal portion of these notes as they occur. The unamortized balance of servicing rights on loans sold with servicing retained was not material at March 31, 2003. Gross loans and loans held for sale have increased $2.2 million or .9% since December 31, 2002. An increase of $2.1 million or 2.4% in commercial real estate loans, an increase of $120 thousand or .6% in commercial loans, and an increase in loans held for sale of $1.6 million or 9.1% was partially offset by a decrease of $1.1 million or 1.0% in residential real estate loans, a decrease of $144 thousand or 1.1% in municipal loans and a $296 thousand or 2.8% decrease in consumer loans. 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. The Company's loan review procedures include a credit quality assurance process that begins with approval of lending policies and underwriting guidelines by the Board of Directors, a loan review department staffed by experienced former regulatory personnel, low individual lending limits for officers, Board approval for large credit relationships and a quality control process for loan documentation. The Company also maintains a monitoring process for credit extensions. The Company performs periodic concentration analyses based on various factors such as industries, collateral types, large credit sizes and officer portfolio loads. The Company has established underwriting guidelines to be followed by its officers. The Company monitors its delinquency levels for any negative or adverse trends. The Company continues to invest in its loan portfolio monitoring system to enhance its risk management capabilities. There can be no assurance, however, the Company's loan portfolio will not become subject to increasing pressures from deteriorating borrower credit due to general or local economic conditions. Loans on which the accrual of interest has been discontinued are designated as nonaccrual loans. Loans are designated as nonaccrual when reasonable doubt exists as to the full collection of interest and principal. Normally, when a loan is placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is received and where the future collection of interest and principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest. Union had loans on nonaccrual status totaling $1.8 million or 0.75% of gross loans at March 31, 2003, $1.5 million or 0.63% at December 31, 2002 and $1.9 million or 0.81% at March 31, 2002. The aggregate interest income not recognized on such nonaccrual loans amounted to approximately $380 thousand and $432 thousand as of March 31, 2003 and 2002, respectively and $316 thousand as of December 31, 2002.
16 Union had $307 thousand and $778 thousand in loans past due 90 days or more and still accruing at March 31, 2003 and December 31, 2002, respectively. At March 31, 2003, Union had internally classified certain loans totaling $1.8 million. In management's view, such loans represent a higher degree of risk and could become nonperforming loans in the future. While still on a performing status, in accordance with Union's credit policy, loans are internally classified when a review indicates any of the following conditions 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 March 31, 2003, Union had acquired by foreclosure or through repossession real estate worth $744 thousand, consisting of three commercial properties and one piece of undeveloped land. Two of the commercial properties have subsequently been sold. The balance at December 31, 2002 was $784 thousand. 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; however, actual loan losses may vary from current estimates. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the composition of the portfolio, growth of the portfolio, credit concentrations, trends in historical loss experience, delinquency and past due trends, 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. The provision for loan losses represents the current period credit cost associated with maintaining an appropriate allowance for loan losses. 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. Based on an evaluation of the loan portfolio, management presents a quarterly analysis of the allowance for loan losses to the Board of Directors, indicating any changes in the allowance since the last review and any recommendations as to adjustments in the allowance. For the quarter ended March 31, 2003, the methodology used to determine the provision for loan losses was unchanged from the prior year. The composition of the Company's loan portfolio remained relatively unchanged from December 31, 2002 and there was no material change in the lending programs or terms during the quarter.
17 The following table reflects activity in the allowance for loan losses for the three months ended March 31, 2003 and 2002: <TABLE> <CAPTION> 3 Months Ended, March 31, ------------------------- 2003 2002 ---- ---- (dollars in thousands) <s> <c> <c> Balance at the beginning of period $2,908 $2,801 Charge-offs: Real Estate - - Commercial 10 47 Consumer and other 18 48 ------ ------ Total charge-offs 28 95 ------ ------ Recoveries: Real Estate - 6 Commercial 16 10 Consumer and other 17 22 ------ ------ Total recoveries 33 38 ------ ------ Net (charge-offs) recoveries 5 (57) Provision for loan losses 42 90 ------ ------ Balance at end of period $2,955 $2,834 ====== ====== </TABLE> The following table shows the breakdown of Union's allowance for loan loss by category of loan and the percentage of loans in each category to total loans in the respective portfolios at the dates indicated: <TABLE> <CAPTION> March 31, December 31, 2003 2002 ------------------ ------------------ (dollars in thousands) Amount Percent Amount Percent ------ ------- ------ ------- <s> <c> <c> <c> <c> Real Estate Residential $ 572 38.7% $ 580 39.2% Commercial 1,472 36.6% 1,428 35.6% Construction 143 5.5% 144 5.6% Other Loans Commercial 395 8.0% 412 8.7% Consumer installment 193 4.0% 208 4.3% Home equity loans 26 1.3% 28 1.5% Municipal, Other and Unallocated 154 5.9% 108 5.1% ------ ----- ------ ----- Total $2,955 100.0% $2,908 100.0% ====== ===== ====== ===== Ratio of Net Charge Offs to Average Loans not held for sale (1) 0.00% 0.11% ----- ----- Ratio of Allowance for Loan Losses to Loans not held for sale 1.23% 1.22% ----- ----- <FN> <F1> Annualized </FN> </TABLE> Management of the Company believes that the allowance for loan losses at March 31, 2003 is adequate to cover losses inherent in the Company's loan portfolio as of such date. However there can be no assurance that the Company will not sustain losses in future periods, which could be greater than the size of the allowance at March 31, 2003. See CRITICAL ACCOUNTING POLICIES.
18 While the Company recognizes that the current economic slowdown may adversely impact its borrowers' financial performance and ultimately their ability to repay their loans, management continues to be cautiously optimistic about the key credit indicators from the Company's loan portfolio. Investment Activities At March 31, 2003, the reported value of investment securities available-for-sale was $39.4 million or 11.8% of its assets. Union had no securities classified as held-to-maturity or trading securities. The reported value of securities available-for-sale at March 31, 2003, reflects a positive valuation adjustment of $1.2 million. The offset of this adjustment, net of income tax effect, was a $767 thousand increase in Union's other comprehensive income component of stockholders' equity and a decrease in net deferred tax assets of $395 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 for the period ending March 31, 2003 and December 31, 2002: <TABLE> <CAPTION> Three Months Ended, March 31, Year Ended December 31, 2003 2002 --------------------------------- --------------------------------- (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-time deposits: Demand deposits $ 39,458 13.66% $ 37,932 13.28% Now accounts 40,497 14.02% 0.63% 39,143 13.70% 1.07% Money Markets 64,458 22.32% 1.24% 66,562 23.30% 1.85% Savings 43,049 14.91% 0.89% 39,296 13.75% 1.27% -------- ------ -------- ------ Total non-time deposits: 187,462 64.91% 182,933 64.03% -------- ------ -------- ------ Time deposits: Less than $100,000 72,204 25.00% 2.98% 75,021 26.26% 3.18% $100,000 and over 29,129 10.09% 3.19% 27,736 9.71% 4.71% -------- ------ -------- ------ Total time deposits 101,333 35.09% 102,757 35.97% -------- ------ -------- ------ Total deposits $288,795 100.00% 1.56% $285,690 100.00% 2.05% ======== ====== ==== ======== ====== ==== </TABLE> The following table sets forth information regarding the amounts of Union's time deposits in amounts of $100,000 or more at March 31, 2003 and December 31, 2002 that mature during the periods indicated: <TABLE> <CAPTION> March 31, 2003 December 31, 2002 -------------- ----------------- (dollars in thousands) <s> <c> <c> Within 3 months $13,799 $ 9,629 3 to 6 months 3,034 13,090 6 to 12 months 3,315 3,113 Over 12 months 4,656 4,217 ------- ------- $24,804 $30,049 ======= ======= </TABLE>
19 Borrowings. Borrowings from the Federal Home Loan Bank of Boston were $7.2 million at March 31, 2003 at a weighted average rate of 4.66%. Borrowings from the Federal Home Loan Bank of Boston were $7.5 million at December 31, 2002 at a weighted average rate of 4.62%. The change between year end 2002 and the end of the first quarter of 2003 is a net decrease of $300 thousand. 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, 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 Asset/Liability Management (ALM) strategy in the future. The investment portfolio is all 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 2002 for a flat rate environment projected a Net Interest Income of $3.930 million for the first three months of 2003 compared to actual results of $3.942 million in a flat rate environment, or an .3% difference. Net income was projected to be $1.095 million in a flat rate environment compared to actual results of $1.229 million. The $134 thousand increase in Net Income from projections is mainly due to the Gain on Sale of Loans and net mortgage servicing rights offset by merger expenses and the accrual under the separation agreement. Return on Assets was projected to be 1.32% in a flat rate environment and actual results were 1.47%. Return on Equity was projected to be 11.87% in a flat rate environment compared to actual of 12.66%. The Company generally requires collateral or other security to support financial instruments with credit risk. As of March 31, 2003, the contract or notional amount of financial instruments whose contract or notional amount represents credit risk were as follows rounded to the nearest thousand: <TABLE> <s> <c> Commitments to extend credit $28,020 ------- Standby letters of credit and commercial letters of credit $ 1,239 ------- Credit Card arrangements $ 2,200 ======= Home Equity Lines of Credit $ 3,879 ------- </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.
20 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.
21 The following tables show Union's rate sensitivity analysis as of March 31, 2003: <TABLE> <CAPTION> March 31, 2003 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 overnight deposits $ 5,478 $ - $ - $ - $ - $ 5,478 Interest bearing deposits in banks 796 2,080 1,359 499 - 4,734 Securities available-for-sale (1) 3,362 7,145 12,424 6,484 9,489 38,904 FHLB Stock - - - - 1,241 1,241 Loans (2) 94,776 59,949 51,728 35,859 15,784 258,096 -------- ------- ------- ------- ------- -------- Total interest sensitive assets $104,412 $69,174 $65,511 $42,842 $26,514 $308,453 ======== ======= ======= ======= ======= ======== Interest sensitive liabilities: Time deposits $ 34,054 $38,013 $21,684 $ 3,062 $ 2 $ 96,815 Money markets 21,113 - - - 43,836 64,949 Regular savings 14,327 - - - 30,795 45,122 NOW accounts 19,361 - - - 19,445 38,806 Borrowed funds (3) 318 997 3,033 2,845 - 7,193 -------- ------- ------- ------- ------- -------- Total interest sensitive liabilities $ 89,173 $39,010 $24,717 $ 5,907 $94,078 $252,885 ======== ======= ======= ======= ======= ======== Net interest rate sensitivity gap 15,239 30,164 40,794 36,935 (67,564) 55,568 Cumulative net interest rate sensitivity gap 15,239 45,403 86,197 123,132 55,568 Cumulative net interest rate sensitivity gap as a percentage of total assets 4.55% 13.55% 25.72% 36.74% 16.58% Cumulative net interest rate sensitivity gap as a percentage of total interest-sensitive assets 4.94% 14.72% 27.94% 39.92% 18.02% Cumulative net interest rate sensitivity gap as a percentage of total interest-sensitive liabilities 6.03% 17.95% 34.09% 48.69% 21.97% <FN> <F1> Securities available-for-sale exclude marketable equity securities with a fair value of $527 thousand that may be sold by Union at any time. <F2> Balances shown net of unearned income of $201 thousand. <F3> Estimated repayment assumptions considered in Asset/Liability model. </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 two year ends on Net Interest Income, Net Income, Return on Assets, Return on Equity and Capital to Asset Ratio. The projection utilizes a rate shock of 300 basis points from the current prime rate of 4.25%, 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.
22 UNION BANKSHARES, INC. INTEREST RATE SENSITIVITY ANALYSIS MATRIX MARCH 31, 2003 (in thousands) <TABLE> <CAPTION> Return Return on on Capital Year Prime Net Interest Change Net Assets Equity to Asset Ending Rate Income % Income % % Ratio ------ ----- ------------ ------ ------ ------ ------ -------- <s> <c> <c> <c> <c> <c> <c> <c> December-03 7.25 17,528 11.84 6,513 1.92 16.48 12.02 4.25 15,672 0.00 5,272 1.56 13.50 11.70 1.25 13,661 (12.83) 3,927 1.16 10.17 11.35 December-04 7.25 20,628 27.73 8,629 2.44 19.89 12.78 4.25 16,150 0.00 5,616 1.60 13.80 11.74 1.25 11,182 (30.76) 2,278 .65 6.03 10.51 </TABLE> Liquidity. Managing liquidity risk is essential to maintaining both depositor confidence and stability in earnings. 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 and loans available-for-sale, and earnings and funds provided from operations. Maintaining a relatively stable funding base, which is achieved by diversifying funding sources, competitively pricing deposit products, and extending the contractual maturity of liabilities, reduces the Company's exposure to roll over risk on deposits and limits reliance on volatile short-term purchased funds. Short-term funding needs arise from declines in deposits or other funding sources, funding of loan commitments and request for new loans. The Company's strategy is to fund assets to the maximum extent possible with core deposits that provide a sizable source of relatively stable and low- cost funds. In addition, as both subsidiary banks are members of the FHLB, Union's subsidiaries have access to preapproved lines of credit up to 15.2% of total assets. Union Bank maintains a $4 million pre-approved Federal Fund line of credit with an upstream correspondent bank 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 subsidiaries' 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.
23 Union's management monitors current and projected cash flows and adjusts positions as necessary to maintain adequate levels of liquidity. Although approximately 74.1% of Union's time deposits 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. Management believes the Company has sufficient liquidity to meet all reasonable borrower, depositor, and creditor needs in the present economic environment. However, any projections of future cash need and flows are subject to substantial uncertainty. We continually evaluate opportunities to buy/sell securities and loans available for sale, obtain credit facilities from lenders, or restructure our debt for strategic reasons or to further strengthen our financial position. Capital Resources. Our capital management is designed to maintain an optimum level of capital in a cost-effective structure that: meets our target regulatory ratios; supports our internal assessment of economic capital; funds our business strategies; and builds long-term stockholder value. The total dollar value of Union's stockholders' equity was $39.6 million at March 31, 2003 reflecting net income of $1.2 million for the first three months of 2003, less dividends paid of $909 thousand, compared to $39.2 million of stockholders' equity at year end 2002. Union has 5 million shares of $2.00 par value common stock authorized. As of March 31, 2003, Union had 3,271,189 shares issued, of which 3,030,557 were outstanding and 240,632 were held in Treasury. Also as of March 31, 2003, there were outstanding employee incentive stock options with respect to 10,400 shares of Union's common stock, granted pursuant to Union's 1998 Incentive Stock Option Plan. Of the 50,000 shares authorized for issuance under the 1998 Plan, 38,800 shares remain available for future option grants. On October 17, 2001, the Company announced a stock repurchase program. 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 judgment 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, for a total cost of $129.5 thousand. No repurchases have been made since 2001. Union Bank and Citizens (the Banks) are subject to various regulatory capital requirements administered by the federal banking agencies. Management believes, as of March 31, 2003 that the Banks meet all capital adequacy requirements to which they are subject. As of March 31, 2003, both Banks and the Company are considered well capitalized under the regulatory framework. To be categorized as well capitalized, the Banks and the Company 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 or the Company's category.
24 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 March 31, 2003: Total capital to risk weighted assets Union Bank $29,155 19.17% $12,167 8.0% $15,209 10.0% Citizens 11,570 16.77% 5,519 8.0% 6,899 10.0% Consolidated 41,531 18.75% 17,720 8.0% 22,150 10.0% Tier I capital to risk weighted assets Union Bank $27,333 17.97% $ 6,084 4.0% $ 9,126 6.0% Citizens 10,704 15.52% 2,759 4.0% 4,138 6.0% Consolidated 38,759 17.49% 8,864 4.0% 13,296 6.0% Tier I capital to average assets Union Bank $27,333 11.61% $ 9,417 4.0% $11,771 5.0% Citizens 10,704 10.45% 4,097 4.0% 5,122 5.0% Consolidated 38,759 11.45% 13,540 4.0% N/A N/A </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 and because of the uneven nature of the expansion of the U.S. economy, the Federal Reserve has kept overnight rates at 40 year lows. 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. 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 20 through 25 in this Form 10-Q. Item 4. Controls and Procedures. The Company's chief executive officer and chief financial officer have evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-14(c) and Rule 15d-14(c) under the Exchange Act) as of a date within 90 days of the filing of this report and concluded that those disclosure controls and procedures are effective in alerting them in a timely manner to material information about the Company and its consolidated subsidiaries required to be disclosed in the Company's periodic reports filed with the Securities and Exchange Commission.
25 There have been no changes in the Company's internal controls or in other factors known to the Company that could significantly affect these controls subsequent to their evaluation. While the Company believes that its existing disclosure controls and procedures have been effective to accomplish these objectives, the Company intends to continue to examine, refine and formalize its disclosure controls and procedures and to monitor ongoing developments in this area. PART II OTHER INFORMATION Item 1. Legal Proceedings. There are no known pending legal proceedings to which Union or either of its subsidiaries is a party, or to which any of their properties is subject, other than ordinary litigation arising in the normal course of business activities. Although the amount of any ultimate liability with respect to such proceedings cannot be determined, in the opinion of management, based upon the opinion of counsel, any such liability will not have a material effect on the consolidated financial position of Union and its subsidiaries. Item 2. Changes in Securities and use of Proceeds Between January 1, 2000 and March 31, 2003, Union granted to certain executive officers of Union or it's subsidiary, Union Bank, incentive stock options with respect to an aggregate of 6,200 shares of its common stock, pursuant to its 1998 Incentive Stock Option Plan. The exercise price of all such options represented the fair market value of the shares on the date of grant. Participation in Union's 1998 Incentive Stock Option Plan is limited to those (currently 6 active participants) selected by the Board. During that same period, incentive stock options granted pursuant to the 1998 plan and a predecessor incentive stock option plan were exercised by certain executive officers with respect to an aggregate 7,700 shares, at a cumulative exercise price of $103,100, including 500 shares at a cumulative exercise price of $9,500, during the first quarter of 2003. The shares issued to the participants upon exercise of such incentive stock options have not been registered with the Securities and Exchange Commission. The shares are restricted securities, issued under statutory exemptions available under the Securities Act of 1933, including section 4(2) thereof, and not involving a public offering. Item 6: Exhibit and Reports on Form 8-K. (a) Exhibits 10.1 Separation Agreement and General Release between Jerry Rowe and Citizens Savings Bank and Trust Co.. 99.1 Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2 Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
26 (b) Current Reports on Form 8-K 1. Union Bankshares, Inc. Company Overview date December 31, 2002 filed on May 9, 2003. 2. Report to Stockholders on First Quarter Results for 2003 filed on April 30, 2003 3. Press Release announcing dividend declaration and first quarter earnings for 2003 filed on April 17, 2003. 4. Press Release of February 18, 2003 announcing the planned merger of our two subsidiary banks, Union Bank and Citizens Savings Bank and Trust Company under the name and banking charter of Union Bank as well as the resignation of Jerry Rowe, President and CEO of Citizens and Vice President and Director of Union Bankshares. Letter to stockholders announcing the same information. 5. Report to Stockholders on Fourth Quarter Results for 2002 filed on January 28, 2003. 6. Press Release announcing dividend declaration and fourth quarter earnings for 2002 filed on January 17, 2003. 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. May 14, 2003 Union Bankshares, Inc. s/ Kenneth D. Gibbons --------------------- Kenneth D. Gibbons Director, President and Chief Executive Officer s/ Marsha A. Mongeon -------------------- Marsha A. Mongeon Chief Financial Officer and Treasurer (Principal Financial Officer)
27 CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER I, Kenneth D. Gibbons, President and Chief Executive Officer of Union Bankshares, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Union Bankshares, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Kenneth D. Gibbons _______________________ Kenneth D. Gibbons President and Chief Executive Officer
28 CERTIFICATION OF THE CHIEF FINANCIAL OFFICER I, Marsha A. Mongeon, Treasurer and Chief Financial Officer of Union Bankshares, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Union Bankshares, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 14, 2003 /s/ Marsha A. Mongeon _______________________ Marsha A. Mongeon Treasurer and Chief Financial Officer EXHIBIT INDEX 10.1 Separation Agreement and General Release between Jerry Rowe and Citizens Savings Bank and Trust Co. 99.1 Certification of the Chief Executive Officer 99.2 Certification of the Chief Financial Officer
29