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, 2008
Commission file number: 001-15985
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
Securities registered pursuant to section 12(b) of the Act:
Common Stock, $2.00 par value American Stock Exchange
----------------------------- -----------------------
(Title of class) (Exchanges registered on)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
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 a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ]
(Do not check if a smaller reporting company) Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of July 31, 2008:
Common Stock, $2 par value 4,488,822 shares
1
UNION BANKSHARES, INC.
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1. Financial Statements.
Unaudited Consolidated Financial Statements Union Bankshares,
Inc. and Subsidiary
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 Unaudited Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 39
Item 4T. Controls and Procedures. 39
PART II OTHER INFORMATION
Item 1. Legal Proceedings. 40
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 40
Item 4. Submission of Matters to Vote of Security Holders 40
Item 6. Exhibits. 41
Signatures 42
2
Part l Financial Information
Item 1. Financial Statements
UNION BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
June 30, December 31,
2008 2007
---- ----
(Unaudited)
(Dollars in thousands)
Assets
Cash and due from banks $ 12,147 $ 12,815
Federal funds sold and overnight deposits 11,778 614
-------- --------
Cash and cash equivalents 23,925 13,429
Interest bearing deposits in banks 7,986 11,868
Investment securities available-for-sale 27,463 33,822
Loans held for sale 2,486 7,711
Loans 316,988 310,594
Allowance for loan losses (3,424) (3,378)
Unearned net loan fees (104) (111)
-------- --------
Net loans 313,460 307,105
Accrued interest receivable 1,748 2,077
Premises and equipment, net 7,068 6,462
Other assets 11,422 10,887
-------- --------
Total assets $395,558 $393,361
======== ========
Liabilities and Stockholders' Equity
Liabilities
Deposits
Noninterest bearing $ 55,203 $ 56,155
Interest bearing 265,563 267,806
-------- --------
Total deposits 320,766 323,961
Borrowed funds 27,855 20,328
Accrued interest and other liabilities 5,175 6,998
-------- --------
Total liabilities 353,796 351,287
-------- --------
Commitments and Contingencies
Stockholders' Equity
Common stock, $2.00 par value; 7,500,000 shares authorized
at 6/30/08 and 12/31/07; 4,921,786 shares
issued at 6/30/08 and 12/31/07 9,844 9,844
Paid-in capital 205 202
Retained earnings 35,870 35,791
Treasury stock at cost; 432,964 shares at 6/30/08 and 418,817
at 12/31/07 (3,220) (2,939)
Accumulated other comprehensive loss (937) (824)
-------- --------
Total stockholders' equity 41,762 42,074
-------- --------
Total liabilities and stockholders' equity $395,558 $393,361
======== ========
The accompanying notes are an integral part of these unaudited consolidated financial statements.
3
UNION BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2008 2007 2008 2007
---- ---- ---- ----
(Dollars in thousands except Per Share Data)
Interest income
Interest and fees on loans $ 5,594 $ 5,944 $ 11,279 $ 11,844
Interest on debt securities
Taxable 270 256 586 491
Tax exempt 81 50 165 96
Dividends 17 27 39 57
Interest on federal funds sold and overnight deposits 28 77 59 180
Interest on interest bearing deposits in banks 105 122 231 196
--------- --------- --------- ---------
Total interest income 6,095 6,476 12,359 12,864
--------- --------- --------- ---------
Interest expense
Interest on deposits 1,481 1,880 3,137 3,665
Interest on borrowed funds 296 179 564 369
--------- --------- --------- ---------
Total interest expense 1,777 2,059 3,701 4,034
--------- --------- --------- ---------
Net interest income 4,318 4,417 8,658 8,830
Provision for loan losses 90 - 140 45
--------- --------- --------- ---------
Net interest income after provision for loan losses 4,228 4,417 8,518 8,785
--------- --------- --------- ---------
Noninterest income
Trust income 100 83 193 167
Service fees 897 854 1,752 1,650
Net gain on sales of investment securities available-for-sale 16 47 16 37
Net gain on sales of loans held for sale 14 23 172 50
Other income 139 108 153 134
--------- --------- --------- ---------
Total noninterest income 1,166 1,115 2,286 2,038
--------- --------- --------- ---------
Noninterest expense
Salaries and wages 1,604 1,549 3,189 3,127
Pension and employee benefits 706 520 1,374 1,180
Occupancy expense, net 223 214 491 434
Equipment expense 317 281 609 543
Other expenses 1,076 977 2,091 1,905
--------- --------- --------- ---------
Total noninterest expense 3,926 3,541 7,754 7,189
--------- --------- --------- ---------
Income before provision for income taxes 1,468 1,991 3,050 3,634
Provision for income taxes 278 505 454 913
--------- --------- --------- ---------
Net income $ 1,190 $ 1,486 $2,596 $ 2,721
========= ========= ========= =========
Earnings per common share $ 0.27 $ 0.33 $0.58 $ 0.60
========= ========= ========= =========
Weighted average number of common
shares outstanding 4,490,635 4,529,158 4,494,118 4,530,330
========= ========= ========= =========
Dividends per common share $ 0.28 $ 0.28 $0.56 $ 0.56
========= ========= ========= =========
The accompanying notes are an integral part of these unaudited consolidated financial statements.
4
UNION BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
Common Stock
------------------- Accumulated
Shares, other Total
net of Paid-in Retained Treasury comprehensive stockholders'
Treasury Amount capital earnings stock loss equity
-------- ------ ------- -------- -------- ------------- -------------
(Dollars in thousands)
Balances, December 31, 2007 4,502,969 $9,844 $202 $35,791 $(2,939) $(824) $42,074
Comprehensive income:
Net income - - - 2,596 - - 2,596
Other comprehensive income,
net of tax:
Change in net unrealized gain
(loss) on investment
securities available-for-sale,
net of reclassification
adjustment and tax effects - - - - - (124) (124)
Change in net unrealized gain
(loss) on unfunded defined
benefit plan liability,
net of reclassification
adjustment and tax effects - - - - - 11 11
-------
Total other comprehensive
income (113)
-------
Total comprehensive income 2,483
-------
Cash dividends declared
($0.56 per share) - - - (2,517) - - (2,517)
Issuance of stock options - - 3 - - - 3
Purchase of treasury stock (14,147) - - - (281) - (281)
-------- ------ ---- ------- ------- ----- -------
Balances, June 30, 2008 4,488,822 $9,844 $205 $35,870 $(3,220) $(937) $41,762
========= ====== ==== ======= ======== ===== =======
The accompanying notes are an integral part of these unaudited consolidated financial statements.
5
UNION BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
----------------------
June 30, June 30,
2008 2007
---- ----
(Dollars in thousands)
Cash Flows From Operating Activities
Net Income $ 2,596 $ 2,721
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 388 380
Provision for loan losses 140 45
Credit for deferred income taxes (80) (170)
Net amortization of investment securities available-for-sale 2 7
Equity in losses of limited partnerships 194 133
Issuance of stock options 3 5
Write-down of impaired assets 6 -
Write-downs of other real estate owned 11 48
Decrease in unamortized loan fees (8) (12)
Proceeds from sales of loans held for sale 13,023 9,297
Origination of loans held for sale (7,626) (8,663)
Net gain on sales of loans held for sale (172) (50)
Net gain on sales of investment securities available-for-sale (16) (37)
Net loss on disposals of premises and equipment 50 -
Net loss (gain) on sales of repossessed property 2 (4)
Net gain on sales of other real estate owned (1) (28)
Decrease (increase) in accrued interest receivable 316 (167)
Decrease (increase) in other assets 324 (76)
(Decrease) increase in income taxes (366) 47
Decrease in accrued interest payable (501) (58)
Increase in other liabilities 404 874
------- -------
Net cash provided by operating activities 8,689 4,292
------- -------
Cash Flows From Investing Activities
Interest bearing deposits in banks
Maturities and redemptions 5,654 395
Purchases (1,772) (5,417)
Investment securities available-for-sale
Sales 1,803 501
Maturities, calls and paydowns 5,406 1,250
Purchases (1,025) (4,982)
Net (purchase) redemption of Federal Home Loan Bank stock (526) 82
Net (increase) decrease in loans (7,435) 10,254
Recoveries of loans charged off 30 27
Purchases of premises and equipment (1,044) (396)
Investments in limited partnerships (1,129) (356)
6
Six Months Ended
----------------------
June 30, June 30,
2008 2007
---- ----
(Dollars in thousands)
Proceeds from sales of other real estate owned 265 23
Proceeds from sales of premises and equipment - 23
Proceeds from sales of repossessed property 46 23
------- -------
Net cash provided by investing activities 273 1,427
------- -------
Cash Flows From Financing Activities
Net increase in borrowings outstanding 7,527 4,326
Net decrease in noninterest bearing deposits (952) (7,931)
Net decrease in interest bearing deposits (2,243) (3,026)
Purchase of treasury stock (281) (243)
Dividends paid (2,517) (2,538)
------- -------
Net cash provided by (used in) financing activities 1,534 (9,412)
------- -------
Net increase (decrease) in cash and cash equivalents 10,496 (3,693)
Cash and cash equivalents
Beginning 13,429 20,957
------- -------
Ending 23,925 $17,264
======= =======
Supplemental Disclosures of Cash Flow Information
Interest paid $ 4,201 $ 4,092
======= =======
Income taxes paid $ 900 $ 1,035
======= =======
Supplemental Schedule of Noncash Investing and
Financing Activities
Change in unrealized losses on investment securities
available-for-sale $ (189) $ (261)
======= =======
Change in unrealized loss on unfunded defined benefit
pension plan liability $ 17 $ -
======= =======
Other real estate acquired in settlement of loans $ 1,047 $ 197
======= =======
Repossessed property acquired in settlement of loans $ 79 $ 20
======= =======
Investment in limited partnerships acquired by
capital contributions payable $ - $ 902
======= =======
Loans originated to finance the sale of other real estate owned $ 214 $ 115
======= =======
The accompanying notes are an integral part of these unaudited consolidated financial statements.
7
UNION BANKSHARES, INC. AND SUBSIDIARY
Note 1. Basis of Presentation
The accompanying interim unaudited consolidated financial statements of Union
Bankshares, Inc. (the Company) as of June 30, 2008 and 2007, and for the three
and six months then ended have been prepared in conformity with U.S. generally
accepted accounting principles (GAAP), 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,
2007. In the opinion of Company's management, all adjustments, consisting only
of normal recurring adjustments and disclosures necessary for a fair
presentation of the information contained herein have been made. This
information should be read in conjunction with the Company's 2007 Annual Report
to Shareholders, 2007 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
ending December 31, 2008, or any other interim period.
Certain amounts in the 2007 unaudited consolidated financial statements have
been reclassified to conform to the 2008 presentation.
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. Per Share Information
Earnings per common share amounts are computed based on the weighted average
number of shares of common stock outstanding during the period and reduced for
shares held in treasury. The assumed conversion of available outstanding stock
options does not result in material dilution.
Note 4. Recent Accounting Pronouncements
In June, 2008 the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) No. 163, "Accounting for Financial
Guarantee Insurance Contracts an interpretation of FASB Statement No. 60. This
Statement requires that an insurance enterprise recognize a claim liability
prior to an event of default (insured event) when there is evidence that credit
deterioration has occurred in an insured financial obligation. This Statement
also clarifies how Statement 60 applies to financial guarantee insurance
contracts, including recognition and measurement to be used to account for
premium revenue and claim liabilities. This Statement is effective for
financial statements issued for fiscal years beginning after December 15, 2008,
and all interim periods within those fiscal years, except for some disclosures
about the insurance enterprise's risk-management activities. This Statement
requires that disclosures about the risk-management activities of the insurance
enterprise be effective for the first period (including interim periods)
beginning after issuance of this Statement. Except for those disclosures,
earlier application is not permitted. This Statement is not expected to have
any impact on the consolidated financial statements of the Company as it does
not issue any financial guarantee insurance contracts.
In May, 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally
Accepted Accounting Principles." This Statement identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements of nongovernmental entities that are
presented in conformity with GAAP in the United States. The Statement is
effective 60 days following the Securities and Exchange Commission's (SEC)
approval of the Public Company Accounting Oversight Board amendments to AU
Section 411, "The Meaning of Present Fairly in Conformity with Generally
Accepted Accounting Principles." Neither the FASB or the Company expects that
this Statement will result in a change in current practice. However, transition
provisions have been provided if the application of the Statement results in a
change in practice. The Company is evaluating whether or not this Statement
will result in a change in practice.
8
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative
Instruments and Hedging Activities - an amendment of FASB Statement No. 133".
The objective of this Statement is to amend and expand the disclosure
requirements of Statement 133 with the intent to provide users of financial
statements with an enhanced understanding of: a) how and why an entity uses
derivative instruments, b) how derivative instruments and related hedged items
are accounted for under Statement 133 and its related interpretations, and c)
how derivative instruments and related hedged items affect an entity's
financial position, financial performance, and cash flows. The Statement
requires qualitative disclosures about objectives and strategies for using
derivatives, quantitative disclosures about fair value amounts of and gains and
losses on derivative instruments, and disclosures about credit-risk related
contingent features in derivative agreements. The statement is effective for
financial statements issued for fiscal years beginning after November 15, 2008
with earlier adoption encouraged. The Company is in the process of evaluating
the impact of this statement on the disclosures in its financial statements but
it is not expected to have a material impact.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements - an amendment of Accounting Research
Bulletin No.51". The objective of this Statement is to improve the relevance,
comparability, and transparency of the financial information that a reporting
entity provides in its consolidated financial statements by establishing
accounting and reporting standards that require specific financial statement
disclosure, consistent accounting treatment for changes in a parent's ownership
interest and fair value measurement on the deconsolidation of a subsidiary. The
Statement applies to all entities that prepare consolidated financial
statements but will affect only those entities that have an outstanding
noncontrolling interest in one or more subsidiaries or that deconsolidate a
subsidiary. The Statement is effective for fiscal years and interim periods
within those fiscal years, beginning on or after December 15, 2008. Earlier
adoption is prohibited. The Company has no noncontrolling interests in a
subsidiary and therefore does not expect there to be any impact on the
consolidated financial statements.
In December 2007, the FASB issued Statement No. 141R, (revised) "Business
Combinations" which replaces Statement No. 141. The objective of this Statement
is to improve the relevance, representational faithfulness, and comparability
of the information that a reporting entity provides in its financial reports
about a business combination and its effects. To accomplish that, this
Statement establishes principles and requirements for how the acquirer: (1)
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree, (2) recognizes and measures the goodwill acquired in the business
combination or a gain from a bargain purchase, and (3) determines what
information to disclose to enable users of the financial statements to evaluate
the nature and financial effects of the business combination. The Statement
shall be applied prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Earlier application is
prohibited. This Statement would affect the Company for any acquisitions after
December 31, 2008.
In November 2007, the SEC issued SAB No. 109, "Written Loan Commitments
Recorded at Fair Value Through Earnings". SAB No 109 supersedes SAB 105,
"Application of Accounting Principles to Loan Commitments," and indicates that
the expected net future cash flows from loan servicing should be included in
the measurement of all associated written loan commitments that are accounted
for at fair value through earnings under SFAS No. 159's fair-value election or
for written mortgage loan commitments for loans that will be held-for-sale when
funded that are marked-to-market as derivatives under SFAS No. 133 (derivative
loan commitments). The guidance in SAB No. 109 is applied on a prospective
basis to derivative loan commitments issued or modified in fiscal quarters
beginning after December 15, 2007. SAB No. 109 was adopted by the Company on
January 1, 2008 and did not have a material impact on the Company's
consolidated financial statements.
Note 5. Defined Benefit Pension Plan
Union Bank (Union), the Company's sole subsidiary, sponsors a noncontributory
defined benefit pension plan covering all eligible employees. The plan provides
defined benefits based on years of service and final average salary.
9
Net periodic pension benefit cost for the three and six months ended June 30,
consisted of the following components:
Three Months Ended Six Months Ended
------------------ ----------------
2008 2007 2008 2007
---- ---- ---- ----
(Dollars in thousands)
Service cost $ 136 $ 127 $ 272 $ 259
Interest cost on projected benefit obligation 168 154 335 302
Expected return on plan assets (164) (151) (329) (301)
Amortization of prior service cost 1 1 3 3
Amortization of net loss 7 5 14 10
----- ----- ----- -----
Net periodic benefit cost $ 148 $ 136 $ 295 $ 273
===== ===== ===== =====
There were actuarial assumption changes between the first and second quarters
of 2007 and the first and second quarters of 2008 as SFAS No. 87, Employers'
Accounting for Pensions states that measurements are based on the assumptions
used for the previous year-end measurements unless more recent measurements of
both plan assets and obligations are available, or a significant event occurs.
Therefore, 2008 net periodic benefit costs are based on December 31, 2007
actuarial assumptions while the 2007 costs are based on December 31, 2006
actuarial assumptions.
Note 6. Other Comprehensive Income (Loss)
The components of accumulated other comprehensive loss, net of tax at June 30,
were:
2008 2007
---- ----
(Dollars in thousands)
Net unrealized loss on investment
securities available-for-sale $(125) $ (326)
Defined benefit pension plan:
Net unrealized actuarial loss (791) (822)
Net unrealized prior service cost (21) (27)
----- -------
Total $(937) $(1,175)
===== =======
The following is a summary of changes in other comprehensive income (loss) for
the three and six months ended June 30:
Three Months Ended Six Months Ended
------------------ ----------------
2008 2007 2008 2007
---- ---- ---- ----
(Dollars in thousands)
Investment securities available-for-sale:
Change in net unrealized losses on investment
securities available-for-sale $(465) $(362) $(172) $(224)
Reclassification adjustment for gains realized in income (16) (47) (16) (37)
----- ----- ----- -----
Net unrealized losses (481) (409) (188) (261)
Tax effect (164) (139) (64) (89)
----- ----- ----- -----
Net of tax amount $(317) $(270) $(124) $(172)
----- ----- ----- -----
Defined benefit pension plan:
Reclassification adjustment for amortization of net
actuarial loss, realized in net income $ 7 $ - $ 14 $ -
Reclassification adjustment for amortization of prior
service cost, realized in net income 1 - 3 -
----- ----- ----- -----
Total 8 - 17 -
Tax effect 3 - 6 -
----- ----- ----- -----
Net of tax amount $ 5 $ - $ 11 $ -
----- ----- ----- -----
Total, net of tax $(312) $(270) $(113) $(172)
===== ===== ===== =====
10
Note 7: Fair Value Measurements
The FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and
Financial Liabilities." This Statement generally permits the measurement of
selected eligible financial instruments at fair value at specified election
dates. SFAS No. 157, "Fair Value Measurements", generally establishes the
definition of fair value expands disclosures about fair value measurement and
establishes a hierarchy of the levels of fair value measurement techniques.
SFAS 157 and SFAS 159 are effective for fiscal years beginning after November
15, 2007. Effective January 1, 2008, the Company adopted SFAS 159 and SFAS 157,
but has not elected to apply the fair value option to any financial assets or
liabilities other than those situations where other accounting pronouncements
require fair value measurements. In accordance with FASB Staff Position No.
157-2, "Effective Date of FASB Statement No. 157," the Company has delayed the
application of SFAS No. 157 to nonfinancial assets and nonfinancial liabilities
until January 1, 2009. Management does not anticipate that such application
will have a material effect on the financial position of the Company.
Under SFAS No. 157, the three levels of the fair value hierarchy are:
o Level 1 - Unadjusted quoted prices in active markets that are
accessible at the measurement date for identical, unrestricted
assets or liabilities;
o Level 2 - Quoted prices for similar assets or liabilities in active
markets, quoted prices in markets that are not active, or inputs
that are observable, either directly or indirectly, for
substantially the full term of the asset or liability;
o Level 3 - Prices or valuation techniques that require inputs that
are both significant to the fair value measurement and unobservable
(i.e. supported by little or no market activity).
A financial instrument's level within the fair value hierarchy is based on the
lowest level of input that is significant to the fair value measurement.
The following table presents the fair value measurements of assets recognized
in the accompanying balance sheet measured at fair value on a recurring basis
and the level within the SFAS No. 157 fair value hierarchy in which the fair
value measurements fall at June 30, 2008:
Fair Value Measurements at Reporting Date Using
(Dollars in Thousands)
-----------------------------------------------
Quoted Prices in Significant
Active Markets Other Significant
for Observable Unobservable
Identical Assets Inputs Inputs
Fair Value (Level 1) (Level 2) (Level 3)
------------------------------------------------------------
Investment securities available-for-sale $ 27,463 $ 9,357 $ 18,106 $ -
Fair values for available for sale securities are estimated by an independent
bond pricing service for identical assets or significantly similar securities.
The pricing service uses a variety of techniques to arrive at fair value
including market maker bids, quotes and pricing models. Inputs to the pricing
models include recent trades, benchmark interest rates, spreads and actual and
projected cash flows. Loans originated and intended for sale in the secondary
market are carried at the lower of cost or estimated fair value in the
aggregate. The fair value of loans held for sale is determined, when possible,
using quoted secondary market prices. If no such quoted price exists, the fair
value of a loan is determined using quoted prices for similar asset or assets,
adjusted for the specific attributes of that loan. As of June 30, 2008 the
carrying amount of loans held for sale was at cost and therefore no fair value
disclosure is included on these loans in the table above.
Certain financial assets and financial liabilities are measured at fair value
on a nonrecurring basis, that is, the instruments are not measured at fair
value on an ongoing basis but are subject to fair value adjustments in certain
circumstances (for example, when there is evidence of impairment). Financial
assets and financial liabilities measured at fair value on a non-recurring
basis were not significant at June 30, 2008.
11
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 by management focuses on those factors
that had a material effect on Union Bankshares, Inc.'s (Company's) financial
position as of June 30, 2008, and as of December 31, 2007, and its results of
operations for the three and six months ended June 30, 2008 and 2007. This
discussion is being presented to provide a narrative explanation of the
financial statements and should be read in conjunction with the consolidated
financial statements and related notes and with other financial data appearing
elsewhere in this filing and with the Company's Annual Report on Form 10-K for
the year ended December 31, 2007. In the opinion of the Company's management,
the interim unaudited data reflects all adjustments, consisting only of normal
recurring adjustments, and disclosures necessary to fairly present the
Company's consolidated financial position and results of operations for the
interim period. Management is not aware of the occurrence of any events after
June 30, 2008, which would materially affect the information presented.
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 (SEC), in its reports to stockholders,
including this Quarterly Report, in press releases, 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 that those
predictions, forecasts, projections and other estimates contained in
forward-looking statements will not be achieved. When management uses any of
the words "believes," "expects," "anticipates," "intends," "plans," "seeks,"
"estimates", or similar expressions, they 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 the
Company. This could cause results or performance to differ materially from
those expressed in forward-looking statements. The possible events or factors
that might affect forward-looking statements include, but are not limited to,
the following:
o uses of monetary, fiscal, and tax policy by various governments;
o political, legislative, or regulatory developments in Vermont, New
Hampshire, or the United States including changes in laws concerning
accounting, taxes, financial reporting, banking, and other aspects of the
financial services industry;
o developments in general economic or business conditions nationally, in
Vermont, or in northern New Hampshire, including interest rate
fluctuations, market fluctuations and perceptions, job creation and
unemployment rates, ability to attract new business, and inflation and
the effects of such changes on the Company or its customers;
o changes in the competitive environment for financial services
organizations, including increased competition from tax-advantaged credit
unions, mutual banks and out-of-market competitors offering financial
services over the internet;
o the Company's ability to attract and retain key personnel;
o adverse changes in the local real estate market, which negatively impacts
collateral values and the Company's ability to recoup loan losses through
disposition of real estate collateral;
o changes in technology, including demands for greater automation which
could present operational issues or significant capital outlays;
12
o acts or threats of terrorism or war, and actions taken by the United
States or other governments that might adversely affect business or
economic conditions for the Company or its customers;
o adverse changes in the securities market generally or in the market for
financial institution securities which could adversely affect the value
of the Company's stock;
o any actual or alleged conduct which could harm the Company's reputation;
o natural or other disasters which could affect the ability of the Company
to operate under normal conditions;
o the Company's ability to retain and attract deposits and loans;
o illegal acts of theft or fraud perpetuated against the Company's
subsidiary bank or its customers;
o unanticipated lower revenues or increased cost of funds, loss of
customers or business, or higher operating expenses;
o the failure of assumptions underlying the establishment of the allowance
for loan losses and estimations of values of collateral and various
financial assets and liabilities;
o the amount invested in new business opportunities and the timing of these
investments;
o the failure of actuarial, investment, work force, salary, and other
assumptions underlying the establishment of reserves for future pension
costs or changes in legislative or regulatory requirements;
o future cash requirements might be higher than anticipated due to loan
commitments or unused lines of credit being drawn upon or depositors
withdrawing their funds;
o assumptions made regarding interest rate movement and sensitivity could
vary substantially if actual experience differs from historical
experience which could adversely affect the Company's results of
operations; and
o the creditworthiness of current loan customers is different from
management's understanding or changes dramatically and therefore the
allowance for loan losses becomes inadequate.
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 accompanying notes.
The 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, the Company
has identified the accounting policies and judgments most critical to the
Company. 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 estimates and have a
material impact on the carrying value of assets, liabilities, or 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 for loan losses to increase or decrease
and result in adjustments to the Company's provision for loan losses in future
periods. For additional information see, FINANCIAL CONDITION - Allowance for
Loan Losses below.
13
The Company's pension benefit obligations and net periodic benefit cost are
actuarially determined based on the following assumptions: discount rate,
estimated future return on plan assets, wage base rate, anticipated mortality
rates, Consumer Price Index rate, and rate of increase in compensation levels.
The determination of the pension benefit obligations and net periodic benefit
cost is a critical accounting estimate as it requires the use of estimates and
judgment related to the amount and timing of expected future cash out flows for
benefit payments and cash in flows for maturities and returns on plan assets.
Changes in estimates and assumptions could have a material impact to the
Company's financial condition or results of operations.
The Company also has other key accounting policies, which involve the use of
estimates, judgments and assumptions that are significant to understanding the
results including the valuation of deferred tax assets and of investment
securities. Although management believes that its estimates, assumptions and
judgments are reasonable, they are based upon information presently available.
Actual results may differ significantly from these estimates under different
assumptions, judgments or conditions.
OVERVIEW
The Company's net income was $1.2 million for the quarter ended June 30, 2008,
compared with net income of $1.5 million for the same period in 2007, or a $296
thousand or 19.9% decrease between years. The decrease was the cumulative
result of a drop in net interest income of $99 thousand, a loan loss provision
of $90 thousand for the second quarter of 2008 compared to $0 for the same
period in 2007 and increases in all categories of noninterest expense totaling
$385 thousand. These increases were partially offset by a $51 thousand increase
in noninterest income and a $227 decrease in the provision for income taxes.
The decrease in the provision for income taxes was partially a result of the
reduced taxable income and partially a result of $39 thousand in low income and
rehabilitation federal tax credits booked during the second quarter of 2008 on
a late 2007 investment in a low income housing project. The Company faced a
challenging interest rate environment as the prime rate had been reduced seven
times since September 2007 from 8.25% to 5.00% on April 30, 2008. Total
interest income decreased by $381 thousand, or 5.9% to $6.1 million in 2008
versus the $6.5 million in the second quarter of 2007, while the decrease in
interest expense from $2.1 million in 2007 to $1.8 million in 2008 was only
$282 thousand, or 13.7% between periods. The result of the changes in interest
income and expense was that net interest income for the second quarter of 2008
was $4.3 million, down $99 thousand or 2.2% from the second quarter of 2007 of
$4.4 million. During the second quarter of 2008, the Company's net interest
margin decreased 31 basis points to 4.83%, from 5.14% for the second quarter of
2007. The Company's net interest spread declined 24 basis points to 4.38% for
the second quarter of 2008, compared to 4.59% for the same period last year.
The decline in the net interest spread was primarily the result of the decline
in average interest rates earned on loans as the 325 basis point drop in the
prime rate between the second quarter of 2007 and the second quarter of 2008
had an effect on the repricing of adjustable rate loans and the volume of
refinancings, as customers took advantage of the lower rates. Further drops in
the prime rate and/or increases in competitors deposit rates could be
problematic going forward as the individual instruments re-price.
The Company's total assets increased slightly from $393.4 million at December
31, 2007, to $395.6 million at June 30, 2008, an increase of $2.2 million, or
0.6% despite the seasonal payoff on June 30, 2008 of $9.5 million in municipal
loans. Deposits decreased from $324.0 million at December 31, 2007 to $320.8
million at June 30, 2008, a decrease of $3.2 million, or 1.0%. This decrease
reflects a normal seasonal trend for the Company, exacerbated by the redemption
of $10.3 million of municipal certificates of deposit on June 30, 2008, as
municipalities comply with state law requirements for short term funding. Total
loans including loans held for sale increased $1.2 million or 0.4% from $318.3
million at December 31, 2007 to $319.5 million at June 30, 2008. This increase
would have been much larger except for the one day municipal loan aberration as
loan demand has been strong due to lower interest rates, a changing competitive
environment due to the sale of a number of our competitors, and a recent good
winter season in northern Vermont and New Hampshire.
There was no provision for loan losses during the second quarter of 2007 versus
a $90 thousand provision for the second quarter of 2008. The increase in the
provision for the quarter is mainly due to growth in the loan portfolio, as
classified loans decreased between quarters. Total loans have shown
14
strong growth of $12.9 million or 4.2% since June 30, 2007 with the majority of
the growth being in the commercial real estate portfolio, while municipal
loans, which have a very low reserve factor, have dropped $2.1 million. Loans
past due 30-89 days have declined from a year ago but nonperforming loans have
risen from $3.5 million to $7.7 million in that same timeframe. Two million of
the $7.7 million have guarantees of the U.S. Government or state agencies in
place. In addition to the loans that have government guarantees, the balance of
the non-performing loans are comprised of two large customer relationships
which are both conservatively secured by real estate. See Asset Quality Section
on page 26 for further details.
Noninterest expenses are up $385 thousand, or 10.9% for the second quarter of
2008 to $3.9 million from $3.6 million for the second quarter of 2007,
primarily due to the costs of health care which was $152 thousand higher for
the second quarter of 2008 than the second quarter of 2007, an increase in
salary expense of $55 thousand due primarily to hiring associated with the
planned third quarter 2008 addition of two branches, and the increase in
retirement benefit expense accrual of $36 thousand as interest rates and the
stock market have decreased during 2008 thereby increasing the Company's
expense. The Company took a $25 thousand write off to expense the net book
value of the Company's reader/sorter and related software as the Company no
longer utilizes those items since the implementation of electronic branch
capture.
The following unaudited per share information and key ratios depict several
measurements of performance or financial condition for or at the three and six
months ended June 30, 2008 and 2007, respectively:
Three Months Ended June 30, Six Months Ended June 30,
-------------------------- -------------------------
2008 2007 2008 2007
---- ---- ---- ----
Return on average assets (ROA) (1) 1.20% 1.57% 1.32% 1.44%
Return on average equity (ROE) (1) 11.33% 14.31% 12.32% 13.08%
Net interest margin (1)(2) 4.83% 5.14% 4.90% 5.18%
Efficiency ratio (3) 70.37% 63.48% 69.60% 65.25%
Net interest spread (4) 4.38% 4.59% 4.41% 4.61%
Loan to deposit ratio 99.60% 99.25% 99.60% 99.25%
Net loan charge-offs to average loans
not held for sale (1) 0.08% 0.02% 0.06% 0.04%
Allowance for loan losses to loans not
held for sale 1.08% 1.10% 1.08% 1.10%
Non-performing assets to total assets 2.16% 1.05% 2.16% 1.05%
Equity to assets 10.56% 11.10% 10.56% 11.10%
Total capital to risk weighted assets 16.55% 17.20% 16.55% 17.20%
Book value per share $9.30 $9.22 $9.30 $9.22
Earnings per share $0.27 $0.33 $0.58 $0.60
Dividends paid per share $0.28 $0.28 $0.56 $0.56
Dividend payout ratio (5) 103.70% 84.85% 96.55% 93.33%
--------------------
(1) Annualized
(2) The ratio of tax equivalent net interest income to average earning assets.
(3) The ratio of noninterest expense to tax equivalent net interest income and noninterest income excluding
securities gains and losses.
(4) The difference between the average rate earned on assets minus the average rate paid on liabilities.
(5) Cash dividends declared and paid per share divided by consolidated net income per share.
15
RESULTS OF OPERATIONS
Net Interest Income. The largest component of the Company'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
interest-bearing liabilities. The Company's net interest income decreased $99
thousand, or 2.2%, to $4.3 million for the three months ended June 30, 2008,
from $4.4 million for the three months ended June 30, 2007. The net interest
spread decreased 21 basis points to 4.38% for the three months ended June 30,
2008, from 4.59% for the three months ended June 30, 2007. The decline in the
net interest spread was primarily the result of the drop in average interest
rates earned on loans as the 325 basis point drop in the prime rate from
September 2007 to April 2008 had an effect on the repricing of adjustable rate
loans as well as on the volume of refinancing activity as customers took
advantage of the lower rates. The adverse effect of declining rates on the
Company's net interest spread was mitigated somewhat by a 52 basis point
decline in the rate paid on deposits in the second quarter of 2008 versus the
same period last year. The net interest margin for the second quarter of 2008
decreased 31 basis points to 4.83% from the 2007 period at 5.14%. Further
decrease in the prime rate would not necessarily be beneficial to the Company
in the near term, especially if funding rates did not follow a similar downward
trend. See "OTHER FINANCIAL CONSIDERATIONS - Market Risk and Asset and
Liability Management."
Yields Earned and Rates Paid. The following table shows, for the periods
indicated, the total amount of income recorded from average interest-earning
assets and the related average yields, the interest expense associated with
average interest-bearing liabilities, the related average rates paid, and the
relative net interest spread and net interest margin. Yield and rate
information is calculated on an annualized tax equivalent basis. Yield and rate
information for a period is average information for the period, and is
calculated by dividing the annualized tax equivalent income or expense item for
the period by the average balance of the appropriate balance sheet item during
the period. Net interest margin is annualized tax equivalent 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.
16
Three months ended June 30,
-----------------------------------------------------------------------
2008 2007
--------------------------------- ---------------------------------
Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
------- -------- ------- ------- -------- -------
(Dollars in thousands)
Average Assets:
Federal funds sold and
overnight deposits $ 5,624 $ 28 1.97% $ 5,775 $ 77 5.20%
Interest bearing deposits in banks 8,734 105 4.84% 10,357 122 4.75%
Investment securities (1), (2) 29,470 352 5.24% 26,905 310 4.93%
Loans, net (1), (3) 322,887 5,594 7.06% 307,763 5,944 7.85%
FHLB of Boston stock 1,857 16 3.40% 1,385 23 6.68%
-------- ------ ---- -------- ------ ----
Total interest-earning assets (1) 368,572 6,095 6.76% 352,185 6,476 7.49%
Cash and due from banks 9,868 9,969
Premises and equipment 6,891 6,114
Other assets 10,784 9,422
------ -----
Total assets $396,115 $377,690
======== ========
Average Liabilities and Stockholders' Equity:
NOW accounts $ 54,167 $ 76 0.56% $ 52,848 $ 108 0.82%
Savings/money market accounts 91,529 302 1.33% 93,537 416 1.79%
Time deposits 126,098 1,103 3.52% 123,720 1,356 4.40%
Borrowed funds 27,330 296 4.29% 14,455 179 4.91%
-------- ------ ---- -------- ------ ----
Total interest bearing liabilities 299,124 1,777 2.38% 284,560 2,059 2.90%
Noninterest bearing deposits 49,175 45,499
Other liabilities 5,806 6,098
-------- --------
Total liabilities 354,105 336,157
Stockholders' equity 42,010 41,533
-------- --------
Total liabilities and
stockholders' equity $396,115 $377,690
======== ========
Net interest income $4,318 $4,417
====== ======
Net interest spread (1) 4.38% 4.59%
==== =====
Net interest margin (1) 4.83% 5.14%
==== =====
---------
(1) Average yields reported on a tax-equivalent basis.
(2) Average balances of investment securities are calculated on the amortized cost basis.
(3) Includes loans held for sale and is net of unearned income and allowance for loan losses.
17
Six months ended June 30,
2008 2007
---- ----
Interest Average Interest Average
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
------- -------- ------- ------- -------- -------
(Dollars in thousands)
Average Assets:
Federal funds sold and
overnight deposits $ 5,013 $ 59 2.36% $ 6,920 $ 180 5.18%
Interest bearing deposits in banks 9,472 231 4.93% 8,583 196 4.61%
Investment securities (1), (2) 31,330 753 5.25% 25,884 594 4.91%
Loans, net (1), (3) 317,452 11,279 7.26% 308,599 11,844 7.84%
FHLB of Boston stock 1,731 37 4.25% 1,395 50 7.11%
-------- ------- ---- -------- ------- ----
Total interest-earning assets (1) 364,998 12,359 6.94% 351,381 12,864 7.49%
Cash and due from banks 9,892 10,184
Premises and equipment 6,860 6,093
Other assets 11,046 9,140
-------- --------
Total assets $392,796 $376,798
======== ========
Average Liabilities and Stockholders' Equity:
NOW accounts $ 53,168 $ 161 0.61% $ 51,608 $ 202 0.79%
Savings/money market accounts 90,021 637 1.43% 94,216 825 1.77%
Time deposits 125,244 2,339 3.77% 121,244 2,638 4.39%
Borrowed funds 25,835 564 4.34% 14,909 369 4.92%
-------- ------- ---- -------- ------- ----
Total interest bearing liabilities 294,268 3,701 2.53% 281,977 4,034 2.88%
Noninterest bearing deposits 50,210 47,480
Other liabilities 6,168 5,728
-------- --------
Total liabilities 350,646 335,185
Stockholders' equity 42,150 41,613
-------- --------
Total liabilities and
stockholders' equity $392,796 $376,798
======== ========
Net interest income $ 8,658 $ 8,830
======= =======
Net interest spread (1) 4.41% 4.61%
===== =====
Net interest margin (1) 4.90% 5.18%
===== =====
------------------
(1) Average yields reported on a tax-equivalent basis.
(2) Average balances of investment securities are calculated on the amortized cost basis.
(3) Includes loans held for sale and is net of unearned income and allowance for loan losses.
Rate/Volume Analysis. The following table describes the extent to which changes
in average interest rates and changes in volume of average interest earning
assets and interest bearing liabilities have affected the Company's interest
income and interest expense during the period indicated. For each category of
interest earning assets and interest bearing liabilities information is
provided on changes attributable to:
o changes in volume (change in volume multiplied by prior rate);
o changes in rate (change in rate multiplied by prior volume); and
o total change in rate and volume.
18
Changes attributable to both rate and volume have been allocated
proportionately to the change due to volume and the change due to rate.
Three Months Ended June 30, 2008
Compared to
Three Months Ended June 30, 2007
Increase/(Decrease) Due to Change In
------------------------------------
Volume Rate Net
------ ---- ---
(Dollars in thousands)
Interest earning assets:
Federal funds sold and overnight deposits $ (2) $ (47) $ (49)
Interest bearing deposits in banks (19) 2 (17)
Investment securities 24 18 42
Loans, net 281 (631) (350)
FHLB of Boston stock 6 (13) (7)
----- ------ ------
Total interest earning assets $ 290 $ (671) $ (381)
----- ------ ------
Interest bearing liabilities:
NOW accounts $ 3 $ (35) $ (32)
Savings/money market accounts (9) (105) (114)
Time deposits 26 (279) (253)
Borrowed funds 143 (26) 117
----- ------ ------
Total interest bearing liabilities $ 163 $ (445) $ (282)
----- ------ ------
Net change in net interest income $ 127 $ (226) $ (99)
----- ------ ------
Six Months Ended June 30, 2008
Compared to
Six Months Ended June 30, 2007
Increase/(Decrease) Due to Change In
------------------------------------
Volume Rate Net
------ ---- ---
(Dollars in thousands)
Interest earning assets:
Federal funds sold and overnight deposits $ (41) $ (80) $ (121)
Interest bearing deposits in banks 22 13 35
Investment securities 121 38 159
Loans, net 340 (905) (565)
FHLB of Boston stock 10 (23) (13)
----- ------ ------
Total interest earning assets $ 452 $ (957) $ (505)
----- ------ ------
Interest bearing liabilities:
NOW accounts $ 6 $ (47) $ (41)
Savings/money market accounts (36) (152) (188)
Time deposits 85 (384) (299)
Borrowed funds 241 (46) 195
----- ------ ------
Total interest bearing liabilities $ 296 $ (629) $ (333)
----- ------ ------
Net change in net interest income $ 156 $ (328) $ (172)
----- ------ ------
Three Months Ended June 30, 2008, compared to Three Months Ended June 30, 2007.
Interest and Dividend Income. The Company's interest and dividend income
decreased $381 thousand, or 5.9%, to $6.1 million for the three months ended
June 30, 2008, from $6.5 million for the three months ended June 30, 2007.
During the second quarter of 2008, average earning assets increased $16.4
million, or 4.7%, to $368.6 million, from $352.2 million for the three months
ended June 30, 2007. However, the increase in interest income resulting from
the rise in average earning assets was more than offset by the lower rates
earned on loans, federal funds sold, and Federal Home Loan Bank of Boston stock
in second quarter of 2008 versus 2007. In particular, interest income on loans
decreased during the second quarter of 2008 versus the 2007 comparison period
despite an increase in average loan volume between periods. Average loans
approximated $322.9 million at an average yield of 7.06% for the three months
ended June 30, 2008, up $15.1 million from $307.8 million at an average yield
of 7.85% for the three months ended June 30, 2007. The increase in volume was
more than offset by a 79 basis point
19
decrease in yield. Loan demand has risen during 2008 due to the lower interest
rates, the successful implementation of a call program and the changes in the
competitive landscape.
The 325 basis point drop in the prime rate from September 2007 at 8.25% to
April 2008 at 5.00% impacted variable rate loans with monthly and quarterly
repricing. The impact on annually repricing loans has not yet been fully felt,
but will not be positive for the Company, as adjustable rate loans continue to
reprice at lower rates.
The average balance of investments (including mortgage-backed securities)
increased $2.6 million or 9.5%, to $29.5 million for the three months ended
June 30, 2008, from $26.9 million for the three months ended June 30, 2007. The
average level of interest bearing deposits in banks for the quarter was $8.7
million, down $1.6 million or 15.7% from the 2007 average level of $10.4
million, as maturing FDIC insured certificates of deposit were utilized to fund
loan demand. The average level of federal funds sold and overnight deposits
decreased $151 thousand, to $5.6 million or 1.97% for the three months ended
June 30, 2008, from $5.8 million or 5.20% for the three months ended June 30,
2007. Interest income from non-loan instruments decreased $31 thousand or 5.8%
between periods, with $501 thousand for the second quarter of 2008 versus $532
thousand for the same period of 2007, reflecting the overall decreases in
yields on federal funds sold and overnight deposits as well as on the FHLB of
Boston stock, coupled with volume decreases on federal funds sold and interest
bearing deposits.
Interest Expense. The Company's interest expense decreased $282 thousand, or
13.7%, to $1.8 million for the three months ended June 30, 2008, from $2.1
million for the three months ended June 30, 2007. Of this decrease, $445
thousand was a result of the decrease in rates, partially offset by the $163
thousand attributable to the increase in volume, primarily related to the rise
in borrowed funds to support loan demand.
Interest expense on deposits decreased $399 thousand or 21.2% to $1.5 million
for the quarter ended June 30, 2008, from $1.9 million for the quarter ended
June 30, 2007. Competition for deposits has remained strong with growth in
average deposits for the quarter at $1.7 million or 0.6%. Interest rates paid
have not dropped as much as anticipated given the prime rate drop. Management
believes consumers have become more rate sensitive over the last two years due
to advertised "specials" and the proliferation of nonlocal financial
institutions trying to gather deposits throughout the Company's market area.
Average time deposits rose to $126.1 million for the three months ended June
30, 2008, from $123.7 million for the three months ended June 30, 2007, or an
increase of $2.4 million or 1.9%. While the majority of these deposits are new
funds for the Company, there has been movement of deposits from lower yielding
savings accounts to higher paying certificates of deposit within its account
base. The average rate paid on time deposits decreased 88 basis points, to
3.52% from 4.40% for the three months ended June 30, 2008 and 2007,
respectively. The average balances for money market and savings accounts
decreased $2.0 million, or 2.2%, to $91.5 million for the three months ended
June 30, 2008, from $93.5 million for the three months ended June 30, 2007 as
interest rates on time deposits continued to be higher, which appeared to
motivate customers to move funds into certificates of deposit and lock in the
higher rates. A $1.4 million or 2.5% increase in NOW accounts brought the
average balance up to $54.2 million from $52.8 million between the two years.
Interest expense on borrowed funds increased from $179 thousand for the quarter
ended June 30, 2007 to $296 thousand for the quarter ended, June 30, 2008 as
average funds borrowed from the FHLB of Boston increased from $14.5 million to
$27.3 million between years, although the average rate paid on borrowed funds
declined 62 basis points between periods. The increasing loan demand, the slow
growth in deposits on average between the quarters ended June 30, 2007 and June
30, 2008, and the opportunity to lock in some low rate long term funding before
the long end of the yield curve rose led the Company to increase its reliance
on borrowed funds.
Provision for Loan Losses. There was a $90 thousand loan loss provision for the
quarter ended June 30, 2008 and there was no provision for the quarter ended
June 30, 2007. The provision was deemed necessary for the second quarter of
2008 in light of net charge-offs for the quarter ended June 30, 2008 of $67
thousand, continuing strong loan growth, an upward trend over the prior year in
the dollar amount of loans with higher risk characteristics and a softening of
the economy, which has resulted in an increase in nonperforming loans. These
factors were partially offset by a decline in classified loans between periods.
20
For further details see, FINANCIAL CONDITION -"Allowance for Loan Losses"
below.
Noninterest income. The following table sets forth changes from the second
quarter of 2007 to the second quarter of 2008 for components of noninterest
income:
For The Three Months Ended June 30,
------------------------------------------
2008 2007 $ Variance % Variance
---- ---- ---------- ----------
(Dollars in thousands)
Trust income $ 100 $ 83 $ 17 20.5
Service fees 897 854 43 5.0
Net gains on sales of investment securities 16 47 (31) (66.0)
Net gains on sales of loans held for sale 14 23 (9) (39.1)
Other 139 108 31 28.7
------ ------ ----
Total noninterest income $1,166 $1,115 $ 51 4.6
====== ====== ====
Trust Income. Trust income has risen for the three months ended June 30, 2008
mainly due to a number of new trust relationships.
Service fees. The increase resulted primarily from a rise in overdraft fees of
$7 thousand, or 2.3%; merchant program income of $12 thousand, or 13.3%; and
ATM/Debit Card usage fees increase of $21 thousand, or 12.0%. These increases
were partially offset by a decline in foreign exchange fees of $11 thousand, or
54.0% as the price of the U.S. dollar continued to decline.
Net gains on sales of loans held for sale. Residential real estate loans of
$7.3 million were sold for a net gain of $14 thousand during the second quarter
of 2008, versus sales of $5.8 million for a net gain of $23 thousand during the
second quarter of 2007.
Other. The increase resulted primarily from the increase in net mortgage
servicing right fees of $13 thousand or 127.7%.
Noninterest expense. The following table sets forth changes from the second
quarter of 2007 to the second quarter of 2008 for components of noninterest
expense:
For The Three Months Ended June 30,
------------------------------------------
2008 2007 $ Variance % Variance
---- ---- ---------- ----------
(Dollars in thousands)
Salaries and wages $1,604 $1,549 $ 55 3.6
Pension and employee benefits 706 520 186 35.8
Occupancy expense, net 223 214 9 4.2
Equipment expense 317 281 36 12.8
Equity in losses of affordable
housing investments 97 66 31 47.0
Other 979 911 68 7.5
------ ------ ----
Total noninterest expense $3,926 $3,541 $385 10.9
====== ====== ====
Salaries and wages and related expenses. The increase in 2008 over 2007 was due
primarily to regular salary activity and hiring associated with the planned
third quarter 2008 addition of two branches. This increase was partially offset
by increased efficiency in operations which allowed the Company to grow while
reducing a few staff positions. There was an increase in the accrual for
pension plan expense of $36 thousand or 31.4% due to lower interest rates in
2008 compared to 2007. There was also an increase of $152 thousand or 73.9% in
the Company's medical costs due to staff or their dependents experiencing a
greater number of serious illnesses or procedures. The Company self-insures
healthcare costs to a specific individual and aggregate level and carries
"excess" coverage for major claims.
Equipment Expense. The increase between years is mainly due to the $25 thousand
write-off during the second quarter of 2008 of the undepreciated value of the
Company's reader/sorter and related software and equipment which are no longer
being utilized due to the implementation of branch capture imaging hardware and
software.
21
Equity in losses of affordable housing investments. Two new investments in low
income housing partnerships were made in late 2007 which increased the amount
of equity in the losses of these projects to be recorded in 2008.
Other. The net change between years has many components of both increases and
decreases; the largest two being an $11 thousand increase in trust department
expenses mainly due to the expansion of the department and a reduction in the
quarter's expenses of foreclosures and other real estate owned which was $56
thousand during the second quarter of 2007 versus $36 thousand during the
second quarter of 2008.
Income Tax Expense. The Company has provided for current and deferred federal
income taxes for the current and all prior periods presented. The Company's
provision for income taxes was $278 thousand for the three months ended June
30, 2008 compared to $505 thousand for the same period in 2007, reflecting the
decrease in taxable net income between periods and the $39 thousand in low
income or rehabilitation tax credits available in 2008 on two low income
housing investments made in late 2007. The Company's effective tax rate
decreased to just 18.9% for the three months ended June 30, 2008, from 25.4%
for the same period in 2007, reflecting the reduction in taxable net income and
the tax credits received.
Six Months Ended June 30, 2008, compared to Six Months Ended June 30, 2007.
Interest and Dividend Income. The Company's interest and dividend income
decreased $505 thousand, or 3.9%, to $12.4 million for the six months ended
June 30, 2008, from $12.9 million for the six months ended June 30, 2007, with
average earning assets increasing $13.6 million, or 3.9%, to $365.0 million for
the six months ended June 30, 2008, from $351.4 million for the six months
ended June 30, 2007. The increase in interest income resulting from the rise in
average earning assets was more than offset by the lower rates earned on loans,
federal funds sold, and FHLB of Boston stock in the first six months of 2008
versus 2007. Interest income on loans decreased during the first six months of
2008 versus the 2007 comparison period despite an increase in average loan
volume between periods. Average loans approximated $317.5 million at an average
yield of 7.26% for the six months ended June 30, 2008, up $8.9 million from
$308.6 million at an average yield of 7.84% for the six months ended June 30,
2007. The increase in volume was more than offset by a 58 basis point decrease
in yield resulting mostly from the 325 basis point drop in the prime rate from
8.25% in September 2007 to 5.00% in April 2008 where it remains as of the date
of this report. Loan demand has risen during 2008 due to lower interest rates,
the successful implementation of a call program and the changes in the
competitive landscape.
The average balance of investments (including mortgage-backed securities)
increased $5.4 million or 21.0%, to $31.3 million for the six months ended June
30, 2008, from $25.9 million for the six months ended June 30, 2007. The
average level of interest bearing deposits in banks for the six months ended
June 30, 2008 was $9.5 million up $0.9 million or 10.4% from the 2007 average
level of $8.6 million, as FDIC insured certificates of deposit in other
financial institutions was one of the highest yielding and safest investment
options available. The increase in the investment portfolio and interest
bearing deposits in banks from the first half of 2007 reflects the slower loan
demand of 2007 but that has changed in 2008 and the cash flows from maturing or
called instruments are being utilized to fund loans. The average level of
federal funds sold and overnight deposits decreased $1.9 million, to $5.0
million at a rate of 2.36% for the six months ended June 30, 2008, from $6.9
million at a rate of 5.18% for the six months ended June 30, 2007, as funds
were utilized to support the rising loan demand. Interest income from non-loan
instruments increased $60 thousand or 5.9% between periods, with $1.1 million
in income for these items for the six months ended June 30, 2008 and $1.0
million for the six months ended June 30, 2007, reflecting the overall increase
in yields on investment securities and volume increases on all instruments
except federal funds sold.
Interest Expense. The Company's interest expense decreased $332 thousand, or
8.2%, to $3.7 million for the six months ended June 30, 2008, from $4.0 million
for the six months ended June 30, 2007. Of this decrease, $628 thousand was a
result of the decrease in rates, partially offset by a $296 thousand increase
attributable to an increase in volume, primarily related to the rise in
borrowed funds to support loan demand.
22
Interest expense on deposits decreased $527 thousand or 14.4% to $3.1 million
for the six months ended, June 30, 2008, from $3.7 million for the six months
ended June 30, 2007. Competition for deposits has remained strong with growth
in average deposits for the six months ended June 30, 2008 of $1.4 million or
0.5% from the six months ended June 30, 2007. Volume growth has started to
improve towards the end of the first half of 2008 as there has been a flight to
quality by customers concerned about the stock market declines and bank
failures. Average time deposits rose to $125.2 million for the six months ended
June 30, 2008, from $121.2 million for the six months ended June 30, 2007, or
an increase of $4.0 million or 3.3%. While the majority of these deposits are
new funds for the Company, there has been movement of deposits from lower
yielding savings accounts to higher paying certificates of deposit within its
account base. The average rate paid on time deposits decreased 62 basis points,
to 3.77% from 4.39% for the six months ended June 30, 2008 and 2007,
respectively. The average balances for money market and savings accounts
decreased $4.2 million, or 4.5%, to $90.0 million for the six months ended June
30, 2008, from $94.2 million for the six months ended June 30, 2007 as interest
rates on time deposits were higher which appeared to motivate customers to move
funds into certificates of deposit and lock in the higher rates, especially
given the potential for a steep downward trend in interest rates paid given the
drop in the discount rate by the Federal Open Market Committee (FOMC) and the
decrease in the prime rate during the first six months of 2008. A $1.6 million
or 3.0% increase in NOW accounts brought the average balance up to $53.2
million from $51.6 million between the two years.
Interest expense on borrowed funds increased from $369 thousand for the six
months ended June 30, 2007 to $564 thousand for the six months ended, June 30,
2008 as average funds borrowed from the FHLB of Boston increased from $14.9
million to $25.8 million between years, although the average rate paid on
borrowed funds declined 58 basis points between periods. The increasing loan
demand, the slow growth in deposits on average between the periods ended June
30, 2007 and June 30, 2008, and the opportunity to lock in some low rate long
term funding before the long end of the yield curve rose led the Company to
increase its reliance on borrowed funds.
Provision for Loan Losses. There was a $140 thousand loan loss provision for
the six months ended June 30, 2008 and there was a $45 thousand provision for
the six months ended June 30, 2007. The increase in the provision was deemed
necessary for the first half of 2008 in light of net charge-offs of $94
thousand for the six months ended June 30, 2008, growth in loans not held for
sale of $6.4 million since December 31, 2007, and an increase in past due loans
of $4.0 million. These factors were partially offset by the decrease in
classified loans. For further details see, FINANCIAL CONDITION -"Allowance for
Loan Losses" below.
Noninterest income. The following table sets forth changes from the first half
of 2007 to the first half of 2008 for components of noninterest income:
For The Six Months Ended June 30,
------------------------------------------
2008 2007 $ Variance % Variance
---- ---- ---------- ----------
(Dollars in thousands)
Trust income $ 193 $ 167 $ 26 15.6
Service fees 1,752 1,650 102 6.2
Net gains on sales of investment securities 16 37 (21) (56.8)
Net gains on sales of loans held for sale 172 50 122 244.0
Other 153 134 19 14.2
------ ------ ----
Total noninterest income $2,286 $2,038 $248 12.2
====== ====== ====
Trust Income. Trust income has risen for the six months ended June 30, 2008
mainly due to a number of new trust relationships.
Service fees. The increase resulted primarily from a rise in overdraft fees of
$22 thousand, or 3.6%; merchant program income increase of $37 thousand, or
18.0%; and the increase in ATM/Debit Card usage fees of $41 thousand, or 11.8%.
These increases were partially offset by a decline in foreign exchange fees of
$20.6 thousand, or 71.2% as the price of the U.S. dollar continued to decline.
23
Net gains on sales of loans held for sale. Residential real estate loans of
$12.9 million were sold for a net gain of $172 thousand during the six months
ended June 30, 2008, versus sales of $9.2 million for a net gain of $50
thousand during the six months ended June 30, 2007.
Noninterest expense. The following table sets forth changes from the first half
of 2007 to the first half of 2008 for components of noninterest expense:
For The Six Months Ended June 30,
------------------------------------------
2008 2007 $ Variance % Variance
---- ---- ---------- ----------
(Dollars in thousands)
Salaries and wages $3,189 $3,127 $ 62 2.0
Pension and employee benefits 1,374 1,180 194 16.4
Occupancy expense, net 491 434 57 13.1
Equipment expense 609 543 66 12.2
Equity in losses of affordable
housing investments 194 133 61 45.9
Other 1,897 1,772 125 7.1
------ ------ ----
Total noninterest expense $7,754 $7,189 $565 7.9
====== ====== ====
Salaries and wages and related expenses. The increase in 2008 over 2007 was due
primarily to regular salary activity offset partially by increased efficiency
in operations which allowed the Company to grow while reducing a few staff
positions. An increase in the accrual for pension plan expense of $24 thousand
or 8.8% and a $173 thousand or 36.7% increase in the Company's medical costs
for which the Company is self insured up to specific individual and aggregate
limits were partially offset by a decrease of $15 thousand or 36.6% in the
company's dental insurance costs.
Occupancy expense, net. The $57 thousand or 13.1% increase between periods is
due primarily to the increase in snowplowing costs between years due to a
winter season of heavy snow and ice, the increase in fuel costs despite the
mild winter temperatures, the increase in depreciation and real estate taxes in
2008 as the renovation work on two administrative buildings in Morrisville was
completed in 2007, a decrease in rental income, and the increase in rental
expense.
Equipment Expense. The increase between years is partially due to the purchase
of a Microsoft open license by the Company which allows the Company to increase
the number of personal computers on its network and to migrate to future
software upgrades, the $23 thousand write-off during the first quarter of 2008
of the undepreciated value of the Company's merchant services equipment which
are now being expensed as the value is under the Company's capitalization limit
and the write-off during the second quarter of 2008 of $25 thousand for the
undepreciated value of the reader/sorter and related equipment and software
which are no longer used since the implementation of branch capture imaging
hardware and software.
Equity in losses of affordable housing investments. Two new investments in low
income housing partnerships were made in late 2007 which increased the amount
of equity in the losses of these projects to be recorded in 2008.
Other. The net change between years has many components; the largest being a
$34 thousand increase in training and development costs mainly related to the
roll out of the new personal computers and related software as well as the new
branch imaging system.
Income Tax Expense. The Company has provided for current and deferred federal
income taxes for the current and all prior periods presented. The Company's
provision for income taxes was $454 thousand for the six months ended June 30,
2008 compared to $913 thousand for the same period in 2007, reflecting the
receipt of federal rehabilitation tax credits of $195 thousand available in
2008 resulting from the completion of affordable housing investment partnership
projects, the increase in annual low income housing credits due to the new
projects and the decrease in taxable net income between periods. The Company's
effective tax rate decreased to just 14.9% for the six months ended June 30,
2008, from 25.1% for the same period in 2007, reflecting the federal
rehabilitation tax credit and the reduction in taxable net income.
24
FINANCIAL CONDITION
At June 30, 2008 the Company had total consolidated assets of $395.6 million,
including gross loans and loans held for sale ("total loans") of $319.5
million, deposits of $320.8 million and stockholders' equity of $41.8 million.
The Company's total assets increased $2.2 million or 0.6% to $395.6 million at
June 30, 2008, from $393.4 million at December 31, 2007, which was offset in
part by a normal seasonal fluctuation for the Company in loans associated
primarily with municipal accounts. In particular, the overall increase was
partially offset by the payoff of $9.5 million in tax anticipation municipal
loans on the last business day of June to comply with Vermont law governing
short term municipal finance. As anticipated, municipal loans increased $8.0
million on the first business day of the next quarter, reflecting the seasonal
fluctuations in these loans. Net loans and loans held for sale were $315.9
million, or 79.9% of total assets at June 30, 2008, as compared to $314.8
million, or 80.0% of total assets at December 31, 2007.
Cash and cash equivalents, including federal funds sold and overnight deposits,
increased $10.5 million, or 78.2%, to $23.9 million at June 30, 2008, from
$13.4 million at December 31, 2007. Interest bearing deposits in banks
decreased $3.9 million or 32.7% from $11.9 million at December 31, 2007 to $8.0
million at June 30, 2008 as maturities on these instruments were used to fund
increasing loan demand. Investment securities available-for-sale decreased from
$33.8 million at December 31, 2007, to $27.5 million at June 30, 2008, a $6.3
million, or 18.6%, decrease. The securities available-for-sale and interest
bearing deposits in banks decreased from 11.6% of total assets at December 31,
2007 to 9.0% at June 30, 2008, reflecting deployment of available cash
resources to fund loan demand.
Deposits decreased $3.2 million, or 1.0%, to $320.8 million at June 30, 2008,
from $324.0 million at December 31, 2007, reflecting a pattern of the seasonal
variation in dollars on deposit including the redemption of $10.3 million in
certificates of deposit on the last day of the second quarter by municipal
customers in order to comply with state law to payoff their tax anticipation
notes annually. Municipal time deposits increased $9.7 million on July 1, 2008
as the municipalities redeposited funds at the start of their new fiscal year.
Noninterest bearing deposits decreased from $56.2 million at December 31, 2007
to $55.2 million at June 30, 2008, a $1.0 million or 1.7% decrease. Interest
bearing deposits decreased $2.2 million, or 0.8%, from $267.8 million at
December 31, 2007, to $265.6 million at June 30, 2008. (See average balances
and rates in the Yields Earned and Rates Paid tables on Page 17 as well as the
municipal customer comment above.) Aggressive rate competition from in-market
and out-of-market financial institutions makes deposit accounts harder to
attract and retain.
Total borrowings increased to $27.9 million at June 30, 2008 from $20.3
million, at December 31, 2007 as the Company took advantage of low rate FHLB of
Boston advances available during the first two months of the year to support
the growing loan demand at rates much lower and achievable with greater
administrative ease than medium term time deposits could be gathered, as well
as to specifically match fund a large new loan relationship.
Total stockholders' equity decreased slightly to $41.8 million at June 30, 2008
from $42.1 at December 31, 2007, reflecting net income of $2.6 million for the
first half of 2008, less regular cash dividends paid of $2.5 million, the
purchase of Treasury stock totaling $281 thousand, and an increase of $113
thousand in accumulated other comprehensive loss. (See Capital Resources
section on Page 37)
Loans Held for Sale and Loan Portfolios. The Company's total loans primarily
consist of adjustable-rate and fixed-rate mortgage loans secured by one-to-four
family, multi-family residential or commercial real estate. As of June 30,
2008, the Company's total loan portfolio was $319.5 million, or 80.8% of
assets, up from $318.3 million, or 80.9% of assets as of December 31, 2007, and
up from $306.5 million or 81.6% of assets as of June 30, 2007. Total loans
(including loans held for sale) have increased $1.2 million since December 31,
2007 in spite of the $9.5 million of municipal loans that paid off on June 30,
2008 in accordance with state law. Eight million in municipal loans were booked
on July 1, 2008 as the municipal's fiscal year began. Average net loans
(including loans held for sale) were $308.6 million for the first half of 2007
and have increased to $317.5 million for the first half of 2008. The Company
sold $12.9 million of loans held for sale during the first half of 2008
resulting in a gain on sale of loans of $172 thousand, compared with loan sales
of $9.2 million and related gain on sale of loans of $50 thousand for
25
the first half of 2007. The Company recognizes that competition for good loans
is strong, however is able to originate loans to both current and new customers
while maintaining credit quality. The Company has seen a pickup in loan demand
during the first half of 2008 in part due to lower interest rates which has
engendered some refinancing activity, loans generated from the Bank's call
program and competitive changes in the Bank's marketplace. The good winter
season in both northern Vermont and New Hampshire also encouraged businesses to
put some money back into infrastructure and equipment. The only category where
loan demand has slowed is in the construction portfolio.
The following table shows information on the composition of the Company's total
loan portfolio as of June 30, 2008 and December 31, 2007:
Loan Type June 30, 2008 December 31, 2007
--------- ------------------ ------------------
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in thousands)
Residential real estate $121,192 38.0 $115,303 36.2
Construction real estate 17,839 5.6 20,190 6.4
Commercial real estate 142,912 44.7 133,320 41.9
Commercial 19,095 6.0 16,537 5.2
Consumer 7,197 2.2 7,175 2.3
Municipal loans 8,753 2.7 15,069 4.7
Term Federal Funds Sold - - 3,000 0.9
Loans Held for Sale 2,486 0.8 7,711 2.4
-------- ----- -------- -----
Total loans 319,474 100.0 318,305 100.0
Deduct:
Allowance for loan losses (3,424) (3,378)
Unearned net loan fees (104) (111)
-------- --------
Net loans and loans held for sale $315,946 $314,816
======== ========
The Company originates and sells some residential mortgages into the secondary
market, with most such sales made to the Federal Home Loan Mortgage Corporation
(FHLMC/"Freddie Mac") and the Vermont Housing Finance Agency (VHFA). At June
30, 2008, the Company serviced a $213.9 million residential real estate
mortgage portfolio, approximately $92.2 million of which was serviced for
unaffiliated third parties. Additionally, the Company originates commercial
real estate and commercial loans under various SBA, United States Department of
Agriculture Rural Development Authority and Vermont Economic Development
Authority programs which provide an agency guarantee for a portion of the loan
amount. The Company occasionally sells the guaranteed portion of the loan to
other financial concerns and will retain servicing rights, which generates fee
income. The Company serviced $4.4 million of commercial and commercial real
estate loans for unaffiliated third parties as of June 30, 2008. The Company
capitalizes servicing rights on these fees and recognizes gains and losses on
the sale of the principal portion of these loans as they occur. The unamortized
balance of servicing rights on loans sold with servicing retained was $312
thousand at June 30, 2008, with an estimated market value in excess of their
carrying value.
In the ordinary course of business, the Company occasionally participates out,
on a non-recourse basis, a portion of commercial or real estate loans to other
financial institutions for liquidity or credit concentration management
purposes. The total of loans participated out as of June 30, 2008 was $15.4
million.
Asset Quality. The Company, 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 the Company's loan and investment portfolios, other
real estate and other assets owned for potential problems and reports to the
Company's and the subsidiary's Boards of Directors at regularly scheduled
meetings. Policies set forth portfolio diversification levels to mitigate
concentration risk.
The Company's Board of Directors has set forth lending policies (which are
periodically reviewed and revised as appropriate) that include conservative
individual lending limits for officers, aggregate and advisory board approval
levels, Board approval for large credit relationships, a loan review program
and other limits or standards deemed necessary and prudent. The Company's loan
review department is supervised by an experienced former regulatory examiner
and staffed by a Certified Public Accountant as
26
well as other experienced personnel and encompasses a quality control process
for loan documentation and underwriting. The Company also maintains a
monitoring process to assess the credit quality and degree of risk in the loan
portfolio. 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, exceptions not addressed by the underwriting
guidelines are required to be approved by a senior loan officer or the Board of
Directors. The Company monitors its delinquency levels for any negative or
adverse trends. There can be no assurance, however, that the Company's loan
portfolio will not become subject to increasing pressures from deteriorating
borrower credit due to general or local economic conditions.
Restructured loans include the Company's troubled debt restructurings that
involved forgiving a portion of interest or principal on any loans, refinancing
loans at a rate materially less than the market rate, rescheduling loan
payments, or granting other concessions to a borrower due to financial or
economic reasons related to the debtor's financial difficulties. Restructured
loans do not include qualifying restructured loans that have complied with the
terms of their restructure agreement for a satisfactory period of time. There
were none of these loans at June 30, 2008 and $184 thousand at December 31,
2007.
Loans on which the accrual of interest has been discontinued are designated as
nonaccrual loans. Management reviews the loan portfolio continuously for
evidence of problem loans. Such loans are placed under close supervision with
consideration given to placing the loan on nonaccrual status. 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.
The Company had loans in nonaccrual status totaling $2.8 million, or 0.88% of
gross loans at June 30, 2008, $3.3 million, or 1.06%, at December 31, 2007, and
$3.0 million, or 0.97%, at June 30, 2007. Certain loans in non-accrual status
are covered in part by guarantees of U.S. Government or state agencies.
Approximately $276 thousand of the balances in this category were covered by
such guarantees at June 30, 2008. The aggregate interest income not recognized
on such nonaccrual loans amounted to approximately $469 thousand and $464
thousand as of June 30, 2008 and 2007, respectively and $457 thousand as of
December 31, 2007.
The Company had $4.9 million in loans past due 90 days or more and still
accruing at June 30, 2008 and $2.3 million at December 31, 2007. Certain loans
past due 90 days or more and still accruing interest are covered in part by
guarantees of U.S. Government or state agencies. Approximately $1.7 million of
the commercial and commercial real estate balances in this category were
covered by such guarantees at June 30, 2008. The majority of the increase was
in commercial real estate loans with one well secured relationship of $1.9
million comprising the majority of the increase. We are actively working with
the borrower to bring the loan back to current status.
At June 30, 2008, and December 31, 2007, respectively, the Company had
internally classified certain loans totaling $18 thousand and $21 thousand,
respectively. 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 the Company's credit policy, loans are
internally classified when a review indicates the existence of any of the
following conditions makes the likelihood of collection questionable:
o the financial condition of the borrower is unsatisfactory;
o repayment terms have not been met;
o the borrower has sustained losses that are sizable, either in
absolute terms or relative to net worth;
o confidence is diminished;
o loan covenants have been violated;
o collateral is inadequate; or
o other unfavorable factors are present.
27
The Company has been actively working with customers who may be
delinquent or headed for problems due to the downturn in the economy and the
slowdown in the residential real estate market. Northern New England did not
experience these issues as soon or to the extent of other parts of the country,
however the effects have started to be felt. The downturn in the economy, the
price of gasoline and heating fuel, and the potential for less tourist traffic
are worrisome. To aid customers in reducing their energy costs, the Company has
introduced a new GreenLend(TM) Program working with Efficiency Vermont and the
United States Department of Agriculture Rural Development Agency to offer low
interest rate loans to consumer and commercial customers to purchase, install
or upgrade energy efficient systems or vehicles or renewable energy sources.
One of the benefits of being a community financial institution is our
employees' and Boards' knowledge of the community and borrowers which allows us
to be proactive in working closely with our loan customers. The Company's
delinquency rates have historically run higher than similar institutions while
losses have been lower. The Company did not target sub-prime borrowers and has
not experienced an elevated delinquency in this area.
On occasion real estate properties are acquired through or in lieu of loan
foreclosure. These properties are to be sold and are initially recorded at the
lesser of the recorded loan or fair value at the date of the Company's
acquisition of the property, with fair value based on an appraisal for more
significant properties and on management's estimate for minor properties. The
Company had two residential real estate properties totaling $280 thousand and
four commercial real estate properties totaling $517 thousand classified as
OREO at June 30, 2008, compared to a total of two properties composed of $10
thousand of residential real estate and $216 thousand of commercial real estate
property at December 31, 2007. There was an allowance for losses on other real
estate owned of $11 thousand at June 30, 2008 and $25 thousand at December 31,
2007 which have been netted out of the values above. The other real estate
owned was included in Other Assets on the Consolidated Balance Sheet at both
time periods.
The Company has scheduled auctions for various OREO properties over the next
few months. Due to an apparent softening in the real estate market the
potential to recover all principal and related costs for the auctions is
uncertain.
Allowance for Loan Losses. Some of the Company's loan customers ultimately do
not make all of their contractually scheduled payments, requiring the Company
to charge off a portion or all of the remaining principal balance due. The
Company maintains an allowance for loan losses to absorb such losses. The
allowance is maintained at a level which, by management's best estimate, is
adequate to absorb probable credit losses inherent in the loan portfolio;
however, actual loan losses may vary from current estimates.
Adequacy of the allowance for loan losses is determined using a consistent,
systematic methodology, which analyzes the risk inherent in the loan portfolio.
In addition to evaluating the collectibility of specific loans when determining
the adequacy of the allowance, management also takes into consideration other
factors such as changes in the mix and size of the loan portfolio, historic
loss experience, the amount of delinquencies and loans adversely classified,
industry trends, and the impact of the local and regional economy on the
Company's borrowers. The adequacy of the allowance for loan losses is assessed
by an allocation process whereby specific loss allocations are made against
certain adversely classified loans and general loss allocations are made
against segments of the loan portfolio which have similar attributes. While the
Company allocates the allowance for loan losses based on a percentage by
category to total loans, the portion of the allowance for loan losses allocated
to each category does not represent the total available for future losses which
may occur within the loan category since the total allowance for possible loan
losses is a valuation reserve applicable to the entire portfolio.
The allowance for loan losses is increased by a provision for loan losses,
which is charged to earnings, 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. 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 since the last review and any recommendations as to adjustments in the
allowance. Additionally, bank regulatory agencies regularly review the
Company's allowance for loan losses as an integral part of their examination
process.
28
For the quarter ended June 30, 2008, the methodology used to determine the
provision for loan losses was unchanged from the prior quarter or year. The
Company's loan portfolio balance not held for sale increased from December 31,
2007 despite the maturity of $3.0 million in Term Fed Funds during the first
quarter, the payoff of $9.5 million in municipal loans on June 30, 2008 and a
decrease of $2.4 million in construction real estate loans. All other types of
loans grew between periods, see chart on page 26 for further details.
As a result of the combined changes in volumes and the net charge-offs for the
second quarter of $67 thousand, the Company designated a $90 thousand loan loss
provision for the quarter ended June 30, 2008 which left the allowance for loan
losses at $3.4 million at June 30, 2008 up $46 thousand from December 31, 2007.
The $79 thousand in charge-offs for the quarter included $19 thousand due to
credit card fraud, one commercial real estate relationship which has since been
paid off, one residential property loan which has been moved to other real
estate owned and seven small consumer loan chargeoffs. There were no material
changes in the lending programs or terms during the quarter.
The following table reflects activity in the allowance for loan losses for the
three and six months ended June 30, 2008 and 2007:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2008 2007 2008 2007
------ ------ ------ ------
(Dollars in thousands)
Balance at beginning of period $3,401 $3,342 $3,378 $3,338
Charge-offs
Real Estate 50 -- 50 30
Commercial -- -- 39 --
Consumer and other 29 26 35 54
------ ------ ------ ------
Total charge-offs 79 26 124 84
------ ------ ------ ------
Recoveries
Real Estate 1 1 2 8
Commercial 2 1 4 2
Consumer and other 9 8 24 17
------ ------ ------ ------
Total recoveries 12 10 30 27
------ ------ ------ ------
Net charge-offs (67) (16) (94) (57)
------ ------ ------ ------
Provision for loan losses 90 -- 140 45
------ ------ ------ ------
Balance at end of period $3,424 $3,326 $3,424 $3,326
====== ====== ====== ======
29
The following table shows the internal breakdown of the Company's allowance for
loan losses by category of loan (net of loans held for sale) and the percentage
of loans in each category to total loans in the respective portfolios at the
dates indicated:
June 30, 2008 December 31, 2007
----------------- -----------------
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in thousands)
Real Estate
Residential $ 821 38.4 $ 710 35.7
Commercial 1,997 44.9 2,011 42.9
Construction 178 5.6 202 6.5
Other Loans
Commercial 301 6.0 277 5.3
Consumer installment 112 2.3 112 2.3
Municipal, Other and Unallocated 15 2.8 66 7.3
------ ----- ------ -----
Total $3,424 100.0 $3,378 100.0
====== ===== ====== =====
Ratio of net charge offs to average
loans not held for sale(1) 0.06% 0.07%
Ratio of allowance for
loan losses to loans not held
for sale 1.08% 1.09%
Ratio of allowance for loan losses
to nonperforming loans (2) 44.34% 60.47%
---------------
(1) Annualized
(2) Non-performing loans include loans in non-accrual status and loans past
due 90 days or more and still accruing.
Notwithstanding the categories shown in the table above, all funds in the
allowance for loan losses are available to absorb loan losses in the portfolio,
regardless of loan category.
Management of the Company believes, in their best estimate, that the allowance
for loan losses at June 30, 2008, is adequate to cover probable credit 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 for loan losses at June 30,
2008. See CRITICAL ACCOUNTING POLICIES. While the Company recognizes that an
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 collectability of the Company's loan portfolio.
Investment Activities. At June 30, 2008, the reported value of investment
securities available-for-sale was $27.5 million or 6.9% of assets. The amount
in investment securities available-for-sale decreased slightly from $33.8
million, or 8.6% of assets at December 31, 2007.
The Company had no securities classified as held-to-maturity or trading. The
reported value of investment securities available-for-sale at June 30, 2008
reflects net unrealized losses of $189 thousand compared to a net unrealized
loss of $1 thousand as of December 31, 2007. The offset of the unrealized
losses, net of income tax effect, was a $124 thousand loss reflected in the
Company's accumulated other comprehensive income (loss) component of
stockholders' equity at June 30, 2008.
30
At June 30, 2008, eight securities with a fair value of $1.6 million or 5.8% of
the portfolio have been in an unrealized loss position for more than twelve
months totaling $59 thousand. These unrealized losses consisted of declines in
value of a corporate bond, that has a merger with a stronger organization
pending, and seven collateralized mortgage obligation bonds that have declined
in value due to the current economic and interest rate environment. As of June
30, 2008, based on our evaluation, management concluded that these were not
other than temporarily impaired. The Company has the ability to hold all of
these securities, classified as available-for-sale, for the foreseeable future.
At December 31, 2007, the Company had twenty-nine debt securities with a fair
value of $8.8 million, or 26.0% of the investment portfolio, which have been in
an unrealized loss position for more than 12 months. The unrealized losses on
these securities amounted to $166 thousand as of December 31, 2007.
Deposits. The following table shows information concerning the Company's
average deposits by account type and weighted average nominal rates at which
interest was paid on such deposits for the periods ended June 30, 2008, and
December 31, 2007:
Six Months Ended June 30, 2008 Year Ended December 31, 2007
-------------------------------- -------------------------------
Percent Percent
Average of Total Average Average of Total Average
Amount Deposits Rate Amount Deposits Rate
------- -------- ------- ------- -------- -------
(Dollars in thousands)
Non-time deposits:
Noninterest bearing deposits $ 50,210 15.8 -- $ 49,727 15.5 --
NOW accounts 53,168 16.7 0.61% 55,046 17.2 0.85%
Money Market accounts 50,380 15.8 2.16% 51,470 16.0 2.65%
Savings accounts 39,641 12.4 0.50% 41,377 12.9 0.60%
-------- ----- ---- -------- ----- ----
Total non-time deposits 193,399 60.7 0.83% 197,620 61.6 1.05%
Time deposits:
Less than $100,000 80,584 25.3 3.52% 78,237 24.4 4.07%
$100,000 and over 44,660 14.0 4.24% 45,138 14.0 4.87%
-------- ----- ---- -------- ----- ----
Total time deposits 125,244 39.3 3.77% 123,375 38.4 4.37%
-------- ----- ---- -------- ----- ----
Total deposits $318,643 100.0 1.99% $320,995 100.0 2.33%
======== ===== ==== ======== ===== ====
The Company continues to see some erosion of nontime interest bearing deposits
but is seeing offsetting growth in time deposits.
As a participant in the Certificate of Deposit Account Registry Service (CDARS)
of Promontory Interfinancial Network, LLC, there were $8.5 million of time
deposits $100,000 or less on the balance sheet at June 30, 2008 which are
considered to be "brokered" deposits. The deposits are matched dollar for
dollar with Union's customer deposits which have been placed in other financial
institutions in order to provide those customers with full FDIC insurance
coverage.
The following table sets forth information regarding the Company's time
deposits in amounts of $100,000 and over at June 30, 2008 and December 31, 2007
that mature during the periods indicated:
June 30, 2008 December 31, 2007
------------- -----------------
(Dollars in thousands)
Within 3 months $15,474 $15,443
3 to 6 months 9,090 16,706
6 to 12 months 10,099 11,859
Over 12 months 3,247 2,135
----- -----
$37,910 $46,143
======= =======
31
Certificates of deposit held by the majority of municipal and school district
customers matured and were redeemed on June 30, 2008 which is a normal seasonal
occurrence within the State of Vermont.
Borrowings. Borrowings from the FHLB of Boston were $27.9 million at June 30,
2008, at a weighted average rate of 4.31%, and $20.3 million at December 31,
2007, at a weighted average rate of 4.83%. Borrowings were up at June 30, 2008
as the Company took advantage of some medium term, low-rate advances to fund
increasing loan demand at lower interest rates and easier generation than time
deposits could be gathered, as well as to match fund a large new loan
relationship.
OTHER FINANCIAL CONSIDERATIONS
Market Risk and Asset and Liability Management. Market risk is the potential of
loss in a financial instrument arising from adverse changes in market prices,
interest rates, foreign currency exchange rates, commodity prices, and equity
prices. The Company's market risk arises primarily from interest rate risk
inherent in its lending, investing, deposit taking and borrowing activities as
yields on assets change in a different time period or in a different amount
from that of interest costs on liabilities. Many other factors also affect the
Company's exposure to changes in interest rates, such as general and local
economic and financial conditions, competitive pressures, customer preferences,
and historical pricing relationships.
The earnings of the Company and its subsidiary are affected not only by general
economic conditions, but also by the monetary and fiscal policies of the United
States and its agencies, particularly the Federal Reserve System. The monetary
policies of the Federal Reserve System influence to a significant extent the
overall growth of loans, investments, deposits and borrowings; the level of
interest rates earned on assets and paid for liabilities; and including
interest rates charged on loans and paid on deposits. The nature and impact of
future changes in monetary policies are often not predictable.
A key element in the process of managing market risk involves direct
involvement by senior management and oversight by the Board of Directors as to
the level of risk assumed by the Company in its balance sheet. The Board of
Directors reviews and approves risk management policies, including risk limits
and guidelines and reviews quarterly the current position in relationship to
those limits and guidelines. Daily oversight functions are delegated to the
Asset Liability Management Committee ("ALCO"). The ALCO, consisting of senior
business and finance officers, actively measures, monitors, controls and
manages the interest rate risk exposure that can significantly impact the
Company's financial condition and operating results. The ALCO sets liquidity
targets based on the Company's financial position and existing and projected
economic and market conditions. The Company does not have any market risk
sensitive instruments acquired for trading purposes. The Company attempts to
structure its balance sheet to maximize net interest income and shareholder
value while controlling its exposure to interest rate risk. Strategies might
include selling or participating out loans held for sale or investments
available-for-sale. The ALCO 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, competitive pressures and various business
strategies. The ALCO's methods for evaluating interest rate risk include an
analysis of the Company's interest rate sensitivity "gap", which provides a
static analysis of the maturity and repricing characteristics of the Company'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.
Members of ALCO meet 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. The
Company 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. Portions of the variable-rate loan portfolio have
interest rate floors and caps which are taken into account by the Company's ALM
modeling software to predict interest rate sensitivity, including prepayment
risk. As of June 30, 2008, the investment portfolio is all classified as
available-for-sale and the modified duration was relatively short. The Company
does not utilize any derivative products or invest in any "high risk"
instruments.
32
The Company's interest rate sensitivity analysis (simulation) as of December
2007 for a 200 basis point declining rate environment (Prime at December 31,
2007 was 7.25% and had dropped to 5.00% by June 30, 2008) projected the
following for the six months ended June 30, 2008, compared to the actual
results:
June 30, 2008
-------------------------------------
Percentage
Projected Actual Difference
--------- ------ ----------
(Dollars in thousands)
Net Interest Income $ 8,234 $8,658 5.1%
Net Income $ 2,139 $2,596 21.4%
Return on Assets 1.12% 1.32% 17.9%
Return on Equity 10.40% 12.32% 18.5%
Actual net income is higher than projected mainly due to the higher actual net
interest income than projected as interest rates did not drop on January 1st as
an immediate shock would imply but the prime rate dropped 75 basis points to
6.5% on January 22, 2008, another 50 basis points to 6.0% on January 30, 2008,
a third drop of 75 basis points on March 18, 2008 to 5.25% and a fourth 25
basis point prime rate drop on April 30, 2008 to bring the Prime Rate down to
5.00%. Also, contributing to higher than expected net income was the gain on
sale of loans projected at $84 thousand and actual gain for the six months
ending June 30, 2008 was $172 thousand. In addition, the federal rehabilitation
tax credit received in the first half of 2008 for $195 thousand from late 2007
investments in affordable housing partnerships which were not projected in the
simulation.
Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements. The
Company is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers, to
reduce its own exposure to fluctuations in interest rates, and to implement its
strategic objectives. These financial instruments include commitments to extend
credit, standby letters of credit, interest rate caps and floors written on
adjustable-rate loans, commitments to participate in or sell loans, and
commitments to buy or sell securities, certificates of deposit or other
investment instruments. Such instruments involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized on the
balance sheet. The contract or notional amounts of these instruments reflect
the extent of involvement the Company has in a particular class of financial
instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments. For interest rate caps and floors written on adjustable-rate
loans, the contract or notional amounts do not represent the Company's exposure
to credit loss. The Company controls the risk of interest rate cap agreements
through credit approvals, limits, and monitoring procedures.
The Company generally requires collateral or other security to support
financial instruments with credit risk. As of June 30, 2008 and December 31,
2007, the contract or notional amount of financial instruments that represent
credit risk was as follows:
June 30, 2008 December 31, 2007
------------- -----------------
(Dollars in thousands)
Commitments to originate loans $12,353 $ 7,084
Unused lines of credit 30,964 35,784
Standby letters of credit 1,510 1,248
Credit card arrangements 1,681 1,633
Equity investment commitment to housing
limited partnership 214 214
FHLB of Boston MPF credit enhancement
obligation, net 29 -
------- -------
Total $46,751 $45,963
======= =======
33
Commitments to originate loans 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. Since many of the loan commitments are expected to
expire without being drawn upon and not all credit lines will be utilized, the
total commitment amounts do not necessarily represent future cash requirements.
The Company has various financial obligations, including contractual
obligations that may require further cash payments. The Company's significant
fixed and determinable contractual obligations to third parties at June 30,
2008, and December 31, 2007, were as follows:
June 30, 2008 December 31, 2007
------------- -----------------
(Dollars in thousands)
Operating lease commitments $ 366 $ 309
Maturities on borrowed funds 27,855 20,328
Deposits without stated maturity (1) 201,902 198,083
Certificates of deposit (1) 118,864 125,878
Pension plan contributions (2) 540 600
Deferred compensation payouts (3) 391 470
Equity in housing limited partnerships 267 1,610
Real estate and construction contracts (4) 270 288
-------- --------
Total $350,455 $347,566
======== ========
--------------
(1) While Union has a contractual obligation to depositors should they wish
to withdraw all or some of the funds on deposit, management believes,
based on historical analysis, that the majority of these deposits will
remain on deposit for the foreseeable future. The amounts exclude payable
interest accrued.
(2) Funding requirements for pension benefits after 2008 are excluded due to
the significant variability in the assumptions required to project the
amount and timing of future cash contributions.
(3) The Company owns life insurance on the lives of the payees, in an amount
sufficient to reimburse the Company for the deferred compensation
payments should the Company desire to utilize the death benefit proceeds
for that purpose. The policies have a current cash surrender value of
$2.1 million which is reflected in the balance sheet under Other Assets.
(4) Contract to construct a new branch site in St. Albans, Vermont.
The Company's subsidiary bank is required (as are all banks) to maintain vault
cash or a noninterest bearing reserve balance as established by Federal Reserve
regulations. The Bank's average total reserve for the 14 day maintenance period
including June 30, 2008 was $352 thousand and for December 31, 2007 was $387
thousand, both of which were satisfied by vault cash. The Company has also
committed to maintain a noninterest bearing contracted clearing balance of $1.0
million at June 30, 2008 with the Federal Reserve Bank of Boston.
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.
The Company 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
34
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:
o adjustable-rate loans, investment securities, variable-rate time
deposits, and FHLB of Boston advances are included in the period when
they are first scheduled to adjust and not in the period in which they
mature;
o 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 the Company, and empirical
data;
o other nonmortgage related fixed-rate loans reflect scheduled contractual
amortization, with no estimated prepayments; and
o NOW, money markets, and savings deposits, which do not have contractual
maturities, reflect estimated levels of attrition, which are based on
detailed studies by the Company 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 the
Company's assets and liabilities in the tables could vary substantially if
different assumptions were used or actual experience differs from the
historical experience on which the assumptions are based.
The following table shows the Company's rate sensitivity analysis as of June
30, 2008:
Cumulative repriced within
-------------------------------------------------------------------------
3 Months 4 to 12 1 to 3 3 to 5 Over 5
or Less Months Years Years Years Total
-------- ------- ------ ------ ------ -----
(Dollars in thousands, by repricing date)
Interest sensitive assets:
Federal funds sold and overnight deposits $ 11,778 $ - $ - $ - $ - $ 11,778
Interest bearing deposits in banks 2,370 1,781 1,963 1,872 - 7,986
Investment securities available-for-sale (1)(3) 1,128 2,889 7,902 5,215 10,276 27,410
FHLB Stock - - - - 1,922 1,922
Loans and loans held for sale (2)(3) 89,089 49,104 68,612 60,647 51,918 319,370
-------- ------- ------- -------- -------- --------
Total interest sensitive assets $104,365 $53,774 $78,477 $ 67,734 $ 64,116 $368,466
======== ======= ======= ======== ======== ========
Interest sensitive liabilities:
Time deposits $ 42,871 $58,799 $15,418 $ 1,777 $ - $118,865
Money markets 5,951 - - - 45,666 51,617
Regular savings 3,088 - - - 37,662 40,750
NOW accounts 13,204 - - - 41,127 54,331
Borrowed funds 219 672 1,901 9,002 16,061 27,855
-------- ------- ------- -------- -------- --------
Total interest sensitive liabilities $ 65,333 $59,471 $17,319 $ 10,779 $140,516 $293,418
======== ======= ======= ======== ======== ========
Net interest rate sensitivity gap $ 39,032 $(5,697) $61,158 $ 56,955 $(76,400) $ 75,048
Cumulative net interest rate sensitivity gap $ 39,032 $33,335 $94,493 $151,448 $ 75,048
Cumulative net interest rate sensitivity gap
as a percentage of total assets 9.9% 8.4% 23.9% 38.3% 19.0%
Cumulative net interest rate sensitivity gap
as a percentage of total Interest
sensitive assets 10.6% 9.0% 25.6% 41.1% 20.4%
Cumulative net interest rate sensitivity gap
as a percentage of total Interest sensitive
liabilities 13.3% 11.4% 32.2% 51.6% 25.6%
35
(1) Investment securities available-for-sale exclude marketable equity
securities with a fair value of $13 thousand and mutual funds with a
value of $40 thousand that may be sold by the Company at any time.
(2) Balances shown net of unearned income of $104 thousand.
(3) Estimated repayment assumptions considered in Asset/Liability model.
Simulation Analysis. In its simulation analysis, the Company uses computer
software to simulate the estimated impact on net interest income and capital
(Net Fair Value) under various interest rate scenarios, balance sheet trends,
and strategies over a relatively short time horizon. These simulations
incorporate assumptions about balance sheet dynamics such as loan and deposit
growth, product pricing, prepayment speeds on mortgage related assets,
principal maturities on other financial instruments, and changes in funding
mix. While such assumptions are inherently uncertain as actual rate changes
rarely follow any given forecast and asset-liability pricing and other model
inputs usually do not remain constant in their historical relationships,
management believes that these assumptions are reasonable. Based on the results
of these simulations, the Company is able to quantify its estimate of interest
rate risk and develop and implement appropriate strategies.
The following chart reflects the cumulative results of the Company's latest
simulation analysis for the next twelve months on net interest income, net
income, return on assets, return on equity and net fair value ratio. Shocks are
intended to capture interest rate risk under extreme conditions by immediately
shifting to the new level. The projection utilizes a proportional rate shock,
of up and down 300 basis points from the June 30, 2008 prime rate of 5.00%,
this is the highest and lowest internal slopes monitored. This slope range was
determined to be the most relevant during this economic cycle.
INTEREST RATE SENSITIVITY ANALYSIS MATRIX
(Dollars in thousands)
Return on Return on Net Fair
12 Months Prime Net Interest Change Net Assets Equity Value
Ending Rate Income % Income % % Ratio
June-09 8.00% $20,037 9.7 $6,600 1.66 15.86 8.99%
5.00% $18,265 0.00 $5,342 1.31 12.77 10.55%
2.00% $15,448 (15.4) $3,366 0.75 7.58 12.06%
The resulting projected cumulative effect of these estimates on net interest
income and the net fair value ratio for the twelve month period ending June 30,
2009, are within approved ALCO guidelines for interest rate risk but the return
on assets and equity in a down 300 basis point shock scenario are lower than
Board guidelines. The simulations of earnings do not incorporate any management
actions, which might moderate the negative consequences of interest rate
deviations. Therefore, they do not reflect likely actual results, but serve as
conservative estimates of interest rate risk under different rate scenarios.
Liquidity. Managing liquidity risk is essential to maintaining both depositor
confidence and stability in earnings. Liquidity is a measurement of the
Company'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. The Company'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, 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 rollover 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,
draws on unused lines of credit and requests 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. For the
quarter ended, June 30, 2008, the Company's ratio of average loans to average
deposits was 99.7% compared to the prior year of 98.7%.
36
In addition, as Union Bank is a member of the FHLB of Boston, it had access to
unused lines of credit up to $3.5 million at June 30, 2008 over and above the
$27.9 million term advances already drawn on the lines, based on FHLB of Boston
estimate as of that date; with the purchase of required FHLB of Boston capital
stock that amount would rise to $21.4 million. This line of credit could be
used for either short or long term liquidity or other needs. In addition to its
borrowing arrangements with the FHLB of Boston, Union Bank maintains a $7.5
million pre-approved Federal Funds line of credit with an upstream
correspondent bank and a small repurchase agreement line with a selected
brokerage house. There were no balances outstanding on either line at June 30,
2008. Union is a member of the Certificate of Deposit Account Registry Service
("CDARS") of Promontory Interfinancial Network which allows Union to provide
higher FDIC deposit insurance to customers by exchanging deposits with other
members and allows Union to purchase deposits from other members as another
source of funding. There were no purchased deposits at either June 30, 2008 or
December 31, 2007, although Union had exchanged $8.5 million and $6.6 million
of deposits, respectively, with other CDARS members at those dates.
While scheduled loan and securities payments and FHLB of Boston 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. The Company's liquidity is
actively managed on a daily basis, monitored by the ALCO, and reviewed
periodically with the subsidiary's Board of Directors. The ALCO measures the
Company's marketable assets and credit available to fund liquidity requirements
and compares the adequacy of that aggregate amount against the aggregate amount
of the Company's interest sensitive or volatile liabilities, such as core
deposits and time deposits in excess of $100,000, borrowings and term deposits
with short maturities, and credit commitments outstanding. The primary
objective is to manage the Company'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 unused lines of credit, and to
maintain a portfolio of investment securities.
The Company's management monitors current and projected cash flows and adjusts
positions as necessary to maintain adequate levels of liquidity. Although
approximately 84.9% of the Company's time deposits will mature within twelve
months, management believes, based upon past experience, (percentage of time
deposits to mature within twelve months has ranged from 72.3% to 87.8% over the
preceding eight years) the relationships developed with local municipalities,
and the variety of deposit products, that Union Bank 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. The inverted
yield curve for the last year, the proliferation of certificate of deposit
specials and the general economic uncertainty have contributed to the
shortening of the maturities in time deposits. A reduction in total deposits
could be offset by purchases of federal funds, purchases of deposits,
short-or-long-term FHLB borrowings, utilization of the repurchase agreement
line, or liquidation of investment securities, purchased brokerage certificates
of deposit or loans held for sale. Such steps could result in an increase in
the Company's cost of funds or a decrease in the yield earned on assets and
therefore adversely impact the net interest spread and 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 needs and flows are subject to substantial
uncertainty. Management continually evaluates opportunities to buy/sell
securities and loans available-for-sale, obtain credit facilities from lenders,
or restructure debt for strategic reasons or to further strengthen the
Company's financial position.
Capital Resources. Capital management is designed to maintain an optimum level
of capital in a cost-effective structure that meets target regulatory ratios;
supports management's internal assessment of economic capital; funds the
Company's business strategies; and builds long-term stockholder value.
Dividends are generally increased in line with long-term trends in earnings per
share growth and conservative earnings projections, while sufficient profits
are retained to support anticipated business growth, fund strategic investments
and provide continued support for deposits. However, for the three months ended
June 30, 2008, dividends per share exceeded earnings per share resulting in a
dividend payout ratio of 103.70% compared to 96.55% for the six months ended
June 30, 2008. The Company and its subsidiary are considered well capitalized
under the capital adequacy requirements to which they are subject even with
these payout ratios. It is expected future earnings will improve and the past
quarter reflected a number of onetime unusual items.
37
The total dollar value of the Company's stockholders' equity at June 30, 2008
was $41.8 down $300 thousand from December 31, 2007 at $42.1 million,
reflecting net income of $2.6 million for the first six months of 2008, less
cash dividends paid of $2.5 million, the purchase of 14,147 shares of Treasury
stock totaling $281 thousand, and an increase of $113 thousand in accumulated
other comprehensive loss.
Union Bankshares, Inc. has 7,500,000 shares of $2.00 par value common stock
authorized. As of June 30, 2008, the Company had 4,921,786 shares issued, of
which 4,488,822 were outstanding and 432,964 were held in Treasury.
The Board of Directors has authorized the repurchase of up to 100,000 shares of
common stock, or approximately 2.2% of the Company's outstanding shares at the
authorization date, for an aggregate repurchase cost not to exceed $2.15
million. Shares can be repurchased in the open market or in negotiated
transactions. The repurchase program is open for an unspecified period of time
and as such was reauthorized by the Board of Directors at their March 19, 2008
meeting. As of June 30, 2008 the Company had repurchased 14,147 shares under
this program, for a total cost of $281 thousand during the first half of 2008,
and 82,902 shares at a total cost of $1.7 million since the inception of the
program in November, 2005.
As of June 30, 2008, there were outstanding employee incentive stock options
with respect to shares of the Company's common stock, granted pursuant to Union
Bankshares' 1998 Incentive Stock Option Plan. As of such date, 12,750 options
were currently exercisable; however none of those options were "in the money".
Of the 75,000 shares authorized for issuance under the 1998 Plan, 42,200 shares
that had been available for future option grants were taken out of reserve when
the 1998 Plan expired in May 2008. A new plan called the 2008 Incentive Stock
Option Plan of Union Bankshares, Inc. and Subsidiary was approved by the
shareholders at the 2008 annual meeting. The stock to be issued upon exercise
of options granted under this Plan consists of authorized but unissued shares
of the Common Stock and/or shares held in treasury. Subject to standard
anti-dilution adjustments the aggregate number of shares of Common Stock that
may be delivered upon exercise of all options granted under the Plan may not
exceed fifty thousand (50,000) shares. The Corporation will at all times
reserve and keep available such number of shares of Common Stock as shall be
sufficient to satisfy the requirements of the Plan. During the second quarter
of 2008, no incentive stock options were granted or exercised pursuant to
either the 2008 or the 1998 plan.
Union Bankshares, Inc. and Union Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Management believes,
as of June 30, 2008, that both companies meet all capital adequacy requirements
to which they are subject. As of June 30, 2008, the most recent calculation
categorizes Union Bank as well capitalized under the regulatory framework for
prompt corrective action. The prompt corrective action capital category
framework applies to FDIC insured depository institutions such as Union but
does not apply directly to bank holding companies such as the Company. To be
categorized as well capitalized, Union Bank 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 June 30, 2008, that
management believes have changed either company's category.
38
Union Bank's and the Company's actual capital amounts and ratios as of June 30,
2008, are presented in the following table:
Minimums
To Be Well
Minimums Capitalized Under
For Capital Prompt Corrective
Actual Requirements Action Provisions
----------------- ---------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in thousands)
Total capital to risk weighted assets
Union Bank $45,875 16.5% $22,242 8.0% $27,803 10.0%
Company $46,129 16.6% $22,298 8.0% N/A N/A
Tier I capital to risk weighted assets
Union Bank $42,451 15.3% $11,120 4.0% $16,680 6.0%
Company $42,696 15.3% $11,148 4.0% N/A N/A
Tier I capital to average assets
Union Bank $42,451 10.8% $15,796 4.0% $19,745 5.0%
Company $42,696 10.8% $15,828 4.0% N/A N/A
Regulatory Matters. The Company and Union are subject to periodic examinations
by the various regulatory agencies. These examinations include, but are not
limited to, procedures designed to review lending practices, risk management,
credit quality, liquidity, compliance and capital adequacy. During 2008, the
Vermont State Department of Banking performed an examination of Union Bank
pursuant to their regular, periodic regulatory reviews. No comments were
received from these various bodies that would have a material adverse effect on
the Company's liquidity, financial position, capital resources, or results of
operations.
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 caption "OTHER FINANCIAL CONSIDERATIONS" on pages 32
through 36 in this Form 10-Q.
Item 4T. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures. The Company's chief executive
officer and chief financial officer, with the assistance of the Disclosure
Control Committee, evaluated the effectiveness of the design and operation of
the Company's disclosure controls and procedures (as defined in Rule 13a-15(e)
under the Exchange Act) as of June 30, 2008. Based on this evaluation they
concluded that those disclosure controls and procedures are effective to ensure
that information required to be disclosed by the Company in the reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by the Company in the reports that it files with the
Commission is accumulated and communicated to the Company's management,
including its principal executive and principal financial officer, or persons
performing similar functions, as appropriate to allow timely decisions
regarding required information.
Management's Report on Internal Control Over Financial Reporting. The Company's
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rule
13a-15(f). The Company's management, including the Chief Executive Officer and
Chief Financial Officer, conducted an evaluation of the effectiveness of the
Company's internal control over financial reporting based on the Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on the results of this
evaluation, the Company's management concluded that, as of June 30, 2008, the
Company's internal control over financial reporting was effective to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles.
39
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 the date of the evaluation referred to above. 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 the Company or its
subsidiary 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, any such liability would
not have a material effect on the consolidated financial position of the
Company and its subsidiary.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
ISSUER PURCHASES OF EQUITY SECURITIES
-------------------------------------
Maximum Number of
Shares that May Yet Be
Total Numbers of Shares Purchased Purchased Under
Total Number of Average Price as Part of Publicly Announced Plans the Plans or
Period Shares Purchased Paid per Share or Programs (1) Programs
-------------- ---------------- -------------- ----------------------------------- ----------------------
April 2008 700 $19.96 700 30,545
May 2008 1,761 $19.58 1,761 28,784
June 2008 800 $20.89 800 27,984
(1) Since November 18, 2005, the Company has maintained an informal stock repurchase program pursuant to which the
Company may repurchase up to $2.15 million or 100,000 shares of common stock, or approximately 2.2% of the
Company's outstanding shares as of the authorization date. Shares can be repurchased in the open market or in
negotiated transactions. The repurchase program is open for an unspecified period of time and as such was
reauthorized by the Board of Directors at their March 19, 2008 meeting. As of June 30, 2008 the Company had
repurchased 14,147 shares under this program for a total cost of $281 thousand during 2008. Since inception of the
program, the Company has repurchased 82,902 shares at a total cost of $1.7 million.
Item 4. Submission of Matters to a Vote of Security Holders.
The Company held its annual meeting of shareholders on May 21, 2008. Of
4,492,083 shares outstanding on the record date of the meeting (March 31, 2008)
and entitled to vote, 3,468,164 shares were represented in person or by proxy.
Two matters were voted on by the shareholders at the meeting; one was to fix
the number of directors at nine and to elect the following individuals as
directors for the ensuing year:
Votes Votes Votes Broker
Nominees For Withheld Abstained Non-votes
Cynthia D. Borck 3,431,226 36,938 0 -
Steven J. Bourgeois 3,451,746 16,418 0 -
Kenneth D. Gibbons 3,427,991 40,173 0 -
Franklin G. Hovey, II 3,448,710 19,454 0 -
Richard C. Marron 3,451,718 16,446 0 -
Robert P. Rollins 3,443,721 24,443 0 -
Richard C. Sargent 3,427,799 43,365 0 -
John H. Steel 3,451,746 16,418 0 -
Schuyler W. Sweet 3,451,723 16,441 0 -
40
The second was to approve the 2008 Incentive Stock Option Plan of Union
Bankshares, Inc. and subsidiary which was intended to replace the Company's
1998 Incentive Stock Option Plan, which expired at the annual meeting. There
were 2,665,958 votes for, 147,927 votes against, 84,127 votes abstained and
570,152 broker nonvotes. The number of votes in favor was sufficient to approve
the Plan.
Item 6. Exhibits.
31.1 Certification of the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
41
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, 2008 Union Bankshares, Inc.
/s/ Kenneth D. Gibbons
-------------------------------------
Kenneth D. Gibbons
Director, President and
Chief Executive Officer
/s/ Marsha A. Mongeon
-------------------------------------
August 1, 2008 Marsha A. Mongeon
Chief Financial Officer and Treasurer
(Principal Financial Officer)
EXHIBIT INDEX
31.1 Certification of the Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
42