Exhibit 13
Union Bankshares, Inc.
PHOTO
2004 Annual Report
Union Bankshares, Inc. Dividends Paid to Stockholders by Year
Year Amount
---- ------
1995 $0.37
1996 $0.43
1997 $0.50
1998 $0.55
1999 $0.60
2000 $0.65
2001 $0.71
2002 $0.76
2003 $0.82
2004 $0.90
Note: Dividend amounts have been adjusted for the 1997 and 2003 stock
splits.
* A DECADE OF CONSISTENT DIVIDEND GROWTH AND RETURN FOR OUR SHAREHOLDERS.
Union Bankshares, Inc.
Morrisville VT 05661 * 802-888-6600
Member: American Stock Exchange * www.unionbankvt.com
Printing by R.S. Rowe; Photography and design by Mansfield Media Partners
Union Bankshares, Inc.
2004 Annual Report
. . . where the personal touch is still our hallmark
Each year Union Bank serves as a major sponsor of one of the community's
largest events - the Stowe Rotary Oktoberfest. Staff members create a
different theme each year and hand out apples to parade watchers.
On the cover and below: Scenes from the 2004 Oktoberfest.
PHOTO
letter to shareholders
March 30, 2005
Dear Shareholder:
We are pleased to report to you the financial results of your company for
2004. As the year progressed, net interest income began to improve due to
increases in the prime lending rate coupled with a reduction in our cost of
funds. Overall net interest income improved by $700,000 over 2003 and we
believe this trend will continue during 2005.
The loan portfolio performed well as delinquent loans remained at a
manageable level while net loan charge-offs were actually positive for the
second year in a row.
Loan growth, particularly in the commercial loan area, was strong.
Residential lending was also strong; however, we continue to sell many
fixed rate residential mortgages into the secondary market while we wait
for longer term interest rates to "catch up." Over the past three years, as
interest rates declined, we managed our balance sheet to minimize interest
rate risk in the event rates began to return to more normal levels.
During 2004 we made some major improvements in the technology area.
We installed new check and document imaging hardware and software. Nine of
our older ATMs were replaced, with three more scheduled for 2005.
Communication technology and security were upgraded for phone systems,
internet banking, and the ATM network. Approximately $1.5 million was
expended in these areas during 2004.
Technology has become very important to the support and delivery of
our products and services. We also recognize traditional banking channels,
such as branch offices, are integral to providing customer access. With
this in mind, we formally reorganized many of our backroom tasks related to
technology and deposit gathering into two distinct areas. They are now
referred to as the traditional and electronic banking departments. In 2004,
statistics from the Federal Reserve revealed that electronic transactions
exceeded checks written for the first time. We continue to update our
product offerings and customer access as innovation continues in these
areas.
You will notice the themes in this year's annual report highlight our
community reinvestment activities. We selected these themes, in part,
because we again received a rating of "Outstanding" from the FDIC as the
result of our Community Reinvestment Act examination in June. Part of our
success stems from the commitment of the bank and its staff to actively
participate in the communities we serve.
- ---------------------------------------------------------------------------
You will notice the themes in this year's annual report highlight our
community reinvestment activities. We selected these themes, in part,
because we again received a rating of "Outstanding" from the FDIC as the
result of our Community Reinvestment Act examination in June.
- ---------------------------------------------------------------------------
2
This year William T. Costa, Jr. (Bill, as we all know him) has
reached the mandatory board retirement age of 72 and will be stepping down
as a director. Bill became a director of Citizens Bank in 1972 and of Union
Bank in 1999 as a result of the Citizens acquisition. He is very well known
in Caledonia County and owns and manages various enterprises. Bill's
knowledge of the area and business sense will be missed.
On January 28, 2005, we opened a loan center in downtown
St. Albans, Vt. This office is staffed by experienced bankers familiar with
the market area. We believe our community bank philosophy, capable staff,
and community affiliations will serve us well as we further enter the
Franklin County market.
In February of 2005, Steven J. Bourgeois was elected to the board of
directors of Union Bank and is being nominated for directorship at the
annual meeting of Union Bankshares. Steve served for many years as
president of Franklin Lamoille Bank and is very familiar with, and active
in, Franklin County.
We look forward to 2005 and wish to again recognize the commitment of
our staff, support of our shareholders, and loyalty of our customers.
Sincerely,
/s/ Richard Sargent /s/ Kenneth D. Gibbons
Richard C. Sargent Kenneth D. Gibbons
Chairman President & CEO
PHOTOS of Cynthia D. Borck William T. Costa, Jr.
Kenneth D. Gibbons Franklin G. Hovey II
Richard C. Marron Robert P. Rollins
Richard C. Sargent John H. Steel
3
community banking
Municipal lenders make big impact in small communities
Union Bank has been serving the needs of municipalities in Lamoille and
Caledonia Counties for over 100 years. 2004 brought renewed energy, vision
and a team approach as the bank set out to cultivate new customers in
surrounding rural towns.
The bank's efforts as a good neighbor are paying off. "We stress that
the bank is community oriented," said Rhonda Bennett, Vice President,
explaining the bank's approach when meeting with potential customers.
"Other banks offer this service - we know that - but we also know our
customer service is number one and that our pricing is very competitive."
So competitive, in fact, that over $26 million in municipal loans
were originated in 2004 versus $17 million in 2003, and $13.6 million in
2002.
Cambridge Rescue Building
In 2003, the Town of Cambridge renovated a former private residence
into a new rescue facility. The rescue squad had outgrown its old home, and
sorely needed to update its headquarters. The new facility provided the
squad with much needed space and on-site overnight accommodations for its
out-of-town volunteers.
"There are 18 volunteer members on the squad," said Dave Severance,
rescue squad chief. "But we rely heavily on some folks who don't live here
in town. This gives them a place to stay when they're on call." The upgrade
PHOTO
4
also allowed the squad to accommodate a second ambulance. The facility
opened in March 2004.
Jane Porter, Cambridge Town Clerk, who worked with the bank in
obtaining the financing needed for the rescue squad, shared her confidence
in working with the bank: "The Union Bank has always been wonderful to work
with, and we're fortunate to have such an easy relationship."
Fairfax Community Recreation Path
Just off the community park in Fairfax is a yet-to-be developed site
of a half-mile, paved recreation path. Conceptually, the project has seen
its share of ups and downs. After tabling the idea in the late 1990s, the
Town of Fairfax opted to build a community playground.
In April 2002, when Union Bank opened its first ever Franklin County
office in Fairfax, branch manager Steve Kendall encouraged the town to
apply for a line of credit, a revolving loan that helps bridge temporary
gaps in cash flow. It is typically used for grant anticipation, bond
proceeds or collection of taxes. The Union Bank loan helped jump-start the
project and construction is planned for spring 2005.
New road grader in Concord
Dennis Lamothe, Union Bank Vice President, bid on the purchase of a
new road grader for the Town of Concord. The town's 1987 road grader had
seen better days and was traded in. The bank won the bid in July 2004 and
the town received its new Caterpillar grader just before the snow began to
fall in December.
"In the past, the Town has gone through a bond bank," said Ms.
Quimby, Concord Town Clerk. "The application process is very lengthy and
the timeframe to complete it just isn't long enough. Working with the Union
Bank was friendly, courteous and swift." And, as Dennis added, "We had the
answer about their loan within a week!"
Wolcott Fire Department
While the Wolcott Fire Department received a municipal loan to
purchase a brand new tanker truck, service from Union Bank went much
further than simply writing the loan. The fire department - organized as a
fire district, and not a direct part of the municipality - needed to find a
way to participate in the bank's municipal program.
Rhonda Bennett, working with fire chief Chan Judd and the Town
Selectboard, consulted a municipal law attorney to educate the town on how
to make this work for its unique situation. "Our priority is customer
service," said Rhonda, "and more often than not, that means we make the
effort to educate our customers. Then we try to get creative to see how the
bank can serve their needs."
PHOTOS
Clockwise from previous page: Concord, Vt., Road Foreman
Dane Thorgalsen and Dennis Lamothe with the town's new road
grader. Rhonda Bennett and Rescue Square Chief Dave Severance
stand next to the new ambulance outside their headquarters in
Cambridge. On the site of the recreation path in Fairfax.
From left: Donna Meunier, Fairfax Town Treasurer and acting Town
Clerk; Steve Kendall and Carol Lizzotte, Project Manager for the Fairfax
Community Park and Rec Path. Wolcott Fire Chief Chan Judd with the
department's new tanker truck.
5
industry recognition
Union Bank scores "Outstanding" CRA rating
Union Bank earned an "outstanding" rating in June in its most recent
Community Reinvestment Act (CRA) examination. The Act requires the bank's
supervisory agency, the Federal Deposit Insurance Corporation (FDIC), to
evaluate the bank's performance in meeting the credit needs of the
community it serves. The bank earned this same rating in 1998.
Union Bank was noted for its excellent performance in lending to
customers from all income brackets, especially low- and moderate- income
families and individuals, and to businesses of all sizes - especially small
businesses. Union Bank's participation in several affordable housing
programs, including grant proposals the bank originated, received special
mention.
The bank works with the Vermont Housing Finance Agency (VHFA) and a
host of other agencies, partnerships, and trusts in programs geared to low-
and moderate-income residents.
"The Union Bank has been extremely supportive of our organization's
efforts to create and preserve affordable housing in our region," said
Carol Collins, executive director of the Lamoille Housing Partnership (LHP)
in Morrisville. The bank has helped the LHP in different capacities: as a
low-income housing tax credit equity investor, and in providing a bridge
loan for renovation of an underutilized downtown building, creating eight
fully accessible apartments.
Marsha Mongeon, Union Bank Senior Vice President and Treasurer,
serves on the board of Copley House - a community care facility for
residents with severe and persistent mental illness. The bank was
instrumental in helping the LHP complete extensive renovations to the
Copley House. "Their strong commitment to investing in our local
communities is exemplary," said Carol. "We consider the Union Bank a valued
partner in improving Lamoille County's housing stock."
The bank's BUILD program - in place since 1992 - reinforces this
community service by providing funding for the construction of residential
housing. Twelve hundred residential construction loans totaling more than
$150 million have been provided by this program since its inception.
"A more than reasonable performance" was also achieved by Union Bank
during a review of its investments and services, enhancing credit
availability in its region. The bank provided a number of grants to various
area organizations such as the United Way, Copley Foundation, Inc., Gilman
Housing Trust, Habitat for Humanity, Lamoille Economic Development
Corporation, and the Lamoille Family Center.
Employees cited for
community efforts
Union Bank employees were also praised for their volunteer efforts in
community activities that qualified as community development initiatives.
"Service takes many forms," said Union Bank President Ken Gibbons. "There
is customer service, and then there is the service our employees provide to
their communities. It is what makes us a true community bank."
PHOTO
Union Bank partnered with Cabot Commons, an affordable housing complex in
Cabot, Vt., to help elderly residents remain in the community. Construction
on eight units is nearly complete.
6
Vermont Housing Finance Agency
honors Union Bank staff
Wanda Allaire and Sue Laferriere were honored as top lenders for the second
consecutive year, helping to make Union Bank one of the top lenders for the
VHFA in the state.
Wanda, working from the Northgate Plaza branch, was the top lender in
Lamoille County, while Sue, working from the Railroad Street branch, was
the top lender in the Northeast Kingdom.
"We're grateful to all our participating lenders for helping us
provide loans to Vermonters who qualify for our products," said VHFA
Executive Director Sarah Carpenter. "Each year, we like to take the
opportunity to give special thanks to those originators whose hard work has
put them at the head of the class."
PHOTOS
Sue Laferriere (at top) and Wanda Allaire (below, left)
received their second consecutive VHFA awards in October.
banking growth
Union Bank branches out with St. Albans Loan Center
The newest member of the Union Bank family - the St. Albans Loan Center -
opened in January 2005. The loan center is the second of its kind
at Union Bank. Our first loan center opened in Littleton, N.H., in 2001.
A grand opening celebration took place in February to introduce local
business people to Union Bank officers and staff. The St. Albans Loan
Center is managed by Vice President Mike Curtis and Commercial Lending
Assistant Carol Allen.
Both Mike and Carol know their community well and have a long history
of banking in St. Albans. Because they live and work there, they are well
versed in the needs of the Franklin County small business market and will
assist customers with customized financing solutions. "We look forward to
providing the personal touch only an experienced lending team can offer,"
says Mike. "Working for an innovative community bank like Union Bank has
already set that standard."
The new office is located in the St. Albans Professional Building at
120 North Main Street, in the heart of St. Albans' historic district.
PHOTO
Carol Allen and Mike Curtis at the new St. Albans Loan Center.
7
consumer protection
Protect yourself against financial fraud
Financial fraud is on the rise throughout the country. And Union Bank has
many ways to keep your personal and financial information secure. But the
best way to protect yourself is to start at home. Here are some helpful
tips to get started. Visit our redesigned website at www.unionbankvt.com
for more in-depth consumer protection tips.
Check fraud
Criminals cleverly scam thousands of Americans each year, using
fraudulent checks of outstanding quality, to lure unsuspecting people into
sending them money. While Union Bank employees undergo regular training to
help safeguard our customers, the best person to stop check - and other
types of fraud - is you.
Identity theft & internet fraud
Identity theft occurs when a person's name, social security number,
account numbers, and other personal information is used or transferred by
another person for unlawful activities.
Identity thieves can open new accounts in your name, apply for credit
cards, make unauthorized charges and then leave the bills unpaid. In some
cases, thieves apply for loans and mortgages, and print counterfeit checks
in your name. Thieves can access existing accounts, withdraw money, and use
your checks and credit to make down payments on expensive items.
"Pretexting is another method of identity theft," cautions Peter
Eley, Senior Vice President of Union Bank's Information Technology
division. "A thief poses as a legitimate representative of a survey firm,
bank, internet service provider, employer or government agency, contacts
you by email, phone or mail and attempts to get you to reveal vital
personal information, usually by asking you to verify some data."
Union Bank warns its customers to:
* Be wary of any mail, telephone, or internet requests for
confidential information such as credit card numbers, social security
numbers, PINs, birthdates or even your mother's maiden name.
* Be suspicious of unsolicited emails that look as if they are from
a legitimate company asking you to "verify" and/or to provide information
at a linked website.
* Union Bank, and other legitimate businesses, such as auction
sites, credit card companies, financial institutions, internet service
providers and retailers, will never ask you to "verify" or disclose vital
personal information.
ATM/Debit and Credit Card fraud
Be wary when a waiter, store clerk or anyone to whom you've handed
your debit or credit card takes an extra swipe of the card into a small,
hand-held device known as a skimmer. Skimmers capture a credit or debit
card's details and give thieves the information they need to create a
counterfeit card or to make charges on your account. Paying at the register
helps avoid that scenario.
Don't use ATM machines if there is an unusual-looking device attached
to the card slot or if the keypad is fitted with a transparent overlay.
These "tricks" are used by criminals to record PIN numbers.
ATM terminals located in poorly lit areas, or where people appear to
be loitering, should be avoided.
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Protect Yourself
Thieves rifle through trash to find information about you to steal your
money and identity. Here are a few tips to protect your identity.
* Shred any papers with confidential information, including junk mail.
* Shred receipts, cancelled checks, expired credit cards, bank
statements, doctors' bills, insurance documents, and all credit card
offers and cash advance checks - anything with an account number can be
used in identify theft.
* Pick up mail in a timely fashion, and have the post office hold mail
when you're out of town.
* Don't keep checks or personal information in your car or at work, and
limit the number of credit cards you carry with you. If your purse or
wallet is stolen or lost, immediately cancel all credit cards, contact
credit reporting agencies and your financial institution.
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8
community spirit
PHOTOS
Bank employees
celebrate community
milestone
A parade in St. Johnsbury celebrated the 100th anniversary football game
between Lyndon Institute and St. Johnsbury Academy. Bank employees
participated in the parade with their homemade train.
Left: Stephanie Melen and Holly Gray. Below: The parade winds its way
through downtown.
9
Union Bankshares, Inc. and Subsidiary
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Selected Financial Information
At or For The Years Ended December 31,
----------------------------------------------------------------------
2004 2003 2002 2001 2000
----------------------------------------------------------------------
(Dollars in thousands, except per share data)
<s> <c> <c> <c> <c> <c>
Balance Sheet Data:
Total Assets $ 359,529 $ 356,557 $ 343,492 $ 337,475 $ 303,394
Available-for-Sale Securities 40,966 44,370 45,824 49,610 56,642
Loans, net of unearned income 280,069 271,561 255,907 250,943 224,796
Allowance for loan losses (3,067) (3,029) (2,908) (2,801) (2,863)
Deposits 306,598 305,381 293,004 285,722 258,737
Borrowed funds 7,934 7,223 7,536 10,344 6,382
Stockholders' equity (1) 42,403 40,987 39,169 37,215 35,157
Income Statement Data:
Total interest income $ 20,178 $ 20,372 $ 22,169 $ 24,124 $ 24,126
Total interest expense (3,310) (4,209) (6,364) (9,565) (9,877)
----------------------------------------------------------------------
Net interest and dividend income 16,868 16,163 15,805 14,559 14,249
Provision for loan losses (30) (114) (356) (320) (250)
Noninterest income 3,774 3,603 3,560 3,073 2,569
Noninterest expenses (12,319) (12,060) (11,761) (10,496) (9,944)
----------------------------------------------------------------------
Income before provision for income taxes 8,293 7,592 7,248 6,816 6,624
Provision for income taxes (2,458) (2,205) (2,068) (1,984) (1,825)
----------------------------------------------------------------------
Net income $ 5,835 $ 5,387 $ 5,180 $ 4,832 $ 4,799
======================================================================
Per Common Share Data:
Net income (2)(3) $ 1.28 $ 1.18 $ 1.14 $ 1.06 $ 1.05
Cash dividends paid (3) 0.90 0.82 0.76 0.71 0.65
Book value (1)(3) 9.31 9.01 8.62 8.19 7.73
Weighted average # of shares outstanding (3) 4,551,469 4,547,366 4,543,113 4,546,204 4,544,858
Number of shares outstanding (3) 4,554,663 4,550,313 4,545,288 4,542,788 4,544,960
<FN>
- --------------------
<F1> Stockholders' equity includes unrealized gains or losses, net of
applicable income taxes, on investment securities classified as
"available-for-sale".
<F2> Computed using the weighted average number of shares outstanding for
the period.
<F3> Per common share data and number of shares outstanding for all
periods have been restated to reflect the three-for-two stock split
effected in the form of a 50% stock dividend to shareholders of
record on July 26, 2003
</FN>
10
Union Bankshares, Inc. and Subsidiary
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Management's Responsibility
Union Bankshares, Inc.'s management is responsible for preparation,
integrity and fair presentation of the annual consolidated financial
statements, Management's Discussion and Analysis ("MD&A") and all other
information in the Annual Report. The consolidated financial statements
have been prepared in accordance with U.S. generally accepted accounting
principles and the requirements of the Securities and Exchange Commission
("SEC"), as applicable. The MD&A has been prepared in accordance with the
requirements of securities regulators including Item 303 of Regulation S-K
of the Securities Exchange Act, and their related published requirements.
The consolidated financial statements and information in the MD&A
necessarily include amounts based on informed judgments and estimates of
the expected effects of current events and transactions with appropriate
consideration to materiality. In addition, in preparing the financial
information we must interpret the requirements described above, make
determinations as to the relevancy of information to be included, and make
estimates and assumptions that affect reported information. The MD&A also
includes information regarding the estimated impact of current transactions
and events, sources of liquidity and capital resources, operating trends,
risks and uncertainties. Actual results in the future may differ materially
from our present assessment of this information because future events and
circumstances may not occur as expected.
The financial information presented elsewhere in the Annual Report is
consistent with that in the consolidated financial statements.
In meeting our responsibility for the reliability of financial information,
we maintain and rely on a comprehensive system of internal control and
internal audit, including organizational and procedural controls, internal
accounting controls and internal controls over financial reporting. Our
system of internal control includes communication of our policies and
procedures governing corporate conduct and risk management; comprehensive
business planning; effective segregation of duties; delegation of authority
and personal accountability; careful selection and training of personnel;
and sound and conservative accounting policies which we regularly update.
This structure ensures appropriate internal control over transactions,
assets and records. We also regularly audit internal controls. These
controls and audits are designed to provide us with reasonable assurance
that the financial records are reliable for preparing financial statements
and other financial information, assets are safeguarded against
unauthorized use or disposition, liabilities are recognized, and we are in
compliance with all regulatory requirements.
We, as Union Bankshares, Inc.'s Chief Executive Officer and Chief Financial
Officer, will be certifying Union Bankshares, Inc.'s annual disclosure
document filed with the SEC as required by the federal Sarbanes-Oxley Act
of 2002.
In order to provide their report on our consolidated financial statements,
the Company's Independent Auditors review our system of internal control
and conduct their work to the extent that they consider appropriate.
The Board of Directors is responsible for reviewing and approving the
financial information contained in the Annual Report, including the MD&A,
and overseeing management's responsibilities for the presentation and
preparation of financial information, maintenance of appropriate internal
controls, management and control of major risk areas and assessment of
significant and related party transactions. The Board delegates these
responsibilities to its Audit Committee, comprised solely of non-
management, independent directors. The Audit Committee meets periodically
with management, internal auditors and the independent public accountants.
The Company's Independent Auditors and the Company's Internal Auditors have
full and free access to the Board of Directors and its committees to
discuss audit, financial reporting and related matters with or without
managment present.
/s/ Marsha A. Mongeon /s/ Kenneth D. Gibbons
- ----------------------------- ------------------------------
Marsha A. Mongeon Kenneth D. Gibbons
Chief Financial Officer Chief Executive Officer
11
Union Bankshares, Inc. and Subsidiary
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
of Union Bankshares, Inc.
We have audited the accompanying consolidated balance sheet of Union
Bankshares, Inc. and subsidiary as of December 31, 2004, and the related
consolidated statements of income, changes in stockholders' equity, and
cash flows for the year then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit. The
consolidated financial statements of Union Bankshares, Inc. and subsidiary
for December 31, 2003 and 2002, were audited by other auditors whose report
dated March 5, 2004, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with the standards of the Public
Company Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts
and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Union
Bankshares, Inc. and subsidiary as of December 31, 2004, and the results of
their operations and their cash flows for the year ended December 31, 2004,
in conformity with accounting principles generally accepted in the United
States of America.
Albany, New York
March 11, 2005
VT Reg. No. 092-0000-648
12
Union Bankshares, Inc. and Subsidiary
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Consolidated Balance Sheets
December 31, 2004 and 2003
2004 2003
-----------------------------
<s> <c> <c>
ASSETS
Cash and due from banks $ 16,929,793 $ 23,624,321
Federal funds sold and overnight deposits 4,187,159 916,438
-----------------------------
Cash and cash equivalents 21,116,952 24,540,759
Interest bearing deposits in banks 7,508,703 6,519,693
Securities available-for-sale 40,965,888 44,370,140
Loans held for sale 8,813,910 18,524,338
Loans 271,420,631 253,221,721
Allowance for loan losses (3,066,871) (3,028,813)
Unearned net loan fees (165,654) (185,196)
-----------------------------
Net loans 268,188,106 250,007,712
Accrued interest receivable 1,527,808 1,651,506
Premises and equipment, net 5,121,046 4,447,166
Other assets 6,286,622 6,496,052
-----------------------------
Total assets $359,529,035 $356,557,366
=============================
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits:
Non-interest bearing $ 57,221,189 $ 48,365,594
Interest bearing 249,376,952 257,015,825
-----------------------------
Total deposits 306,598,141 305,381,419
Borrowed funds 7,933,652 7,222,530
Accrued interest and other liabilities 2,594,218 2,966,753
-----------------------------
Total liabilities 317,126,011 315,570,702
-----------------------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, $2.00 par value; 5,000,000 shares authorized;
4,915,611 shares issued in 2004; 4,911,261 shares issued in 2003 9,831,222 9,822,522
Paid-in capital 106,989 54,576
Retained earnings 33,809,456 32,070,843
Treasury stock at cost; 360,948 shares in 2004 and 2003 (1,721,931) (1,721,931)
Accumulated other comprehensive income 377,288 760,654
-----------------------------
Total stockholders' equity 42,403,024 40,986,664
-----------------------------
Total liabilities and stockholders' equity $359,529,035 $356,557,366
=============================
See accompanying notes to consolidated financial statements.
13
Union Bankshares, Inc. and Subsidiary
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Consolidated Statements of Income
Years Ended December 31, 2004, 2003, and 2002
2004 2003 2002
-------------------------------------------
<s> <c> <c> <c>
Interest income
Interest and fees on loans $17,948,375 $18,203,663 $19,251,810
Interest on debt securities
Taxable 1,692,097 1,615,049 2,264,916
Tax exempt 214,449 233,902 256,703
Dividends 68,953 69,178 80,150
Interest on federal funds sold and overnight deposits 47,149 73,807 78,700
Interest on interest bearing deposits in banks 207,163 176,738 236,779
-------------------------------------------
Total interest income 20,178,186 20,372,337 22,169,058
-------------------------------------------
Interest expense
Interest on deposits 2,948,477 3,866,621 5,844,759
Interest on borrowed funds 362,101 342,362 519,182
-------------------------------------------
Total interest expense 3,310,578 4,208,983 6,363,941
-------------------------------------------
Net interest income 16,867,608 16,163,354 15,805,117
Provision for loan losses 30,000 114,000 356,000
-------------------------------------------
Net interest income after provison for loans losses 16,837,608 16,049,354 15,449,117
-------------------------------------------
Noninterest income
Trust income 204,392 162,508 169,208
Service fees 2,802,020 2,660,976 2,558,515
Net gains (losses) on sales of securities 23,443 379 (2,970)
Net gains on sales of loans held for sale 443,965 524,981 661,121
Other income 300,578 253,876 173,720
-------------------------------------------
Total noninterest income 3,774,398 3,602,720 3,559,594
-------------------------------------------
Noninterest expenses
Salaries and wages 5,401,332 5,302,774 5,092,567
Pension and employee benefits 1,972,948 1,912,319 1,680,658
Occupancy expense, net 737,386 691,079 600,244
Equipment expense 930,939 903,280 894,892
Other expenses 3,276,681 3,250,283 3,492,938
-------------------------------------------
Total noninterest expense 12,319,286 12,059,735 11,761,299
-------------------------------------------
Income before provision for income taxes 8,292,720 7,592,339 7,247,412
Provision for income taxes 2,457,593 2,205,253 2,067,598
-------------------------------------------
Net income $ 5,835,127 $ 5,387,086 $ 5,179,814
===========================================
Earnings per common share (See Note 2) $ 1.28 $ 1.18 $ 1.14
Dividends per common share (See Note 2) $ 0.90 $ 0.82 $ 0.76
See accompanying notes to consolidated financial statements.
14
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Consolidated Statements of Changes in Stockholders' Equity
Years Ended December 31, 2004, 2003, and 2002
Common Stock Accumulated
----------------------- other Total
Shares, Net Paid-in Retained Treasury comprehensive stockholders'
of Treasury Amount capital earnings stock income (loss) equity
-------------------------------------------------------------------------------------------
<s> <c> <c> <c> <c> <c> <c> <c>
Balances, December 31, 2001 3,027,557 $6,536,378 $ 277,254 $31,628,920 $(1,721,931) $ 494,415 $37,215,036
-----------
Comprehensive income:
Net income - - - 5,179,814 - - 5,179,814
Change in net unrealized gain
(loss) on securities available-
for-sale, net of reclassification
adjustment and tax effects - - - - - 179,865 179,865
-----------
Total comprehensive income 5,359,679
-----------
Cash dividends declared - - - (3,451,475) - - (3,451,475)
Exercise of stock options 2,500 5,000 40,299 - - - 45,299
------------------------------------------------------------------------------------------
Balances, December 31, 2002 3,030,057 6,541,378 317,553 33,357,259 (1,721,931) 674,280 39,168,539
-----------
Stock split effected in the form of
a stock dividend (See Note 2) 1,515,231 3,271,094 (329,453) (2,945,045) - - (3,404)
-----------
Comprehensive income:
Net income - - - 5,387,086 - - 5,387,086
Change in net unrealized gain
(loss) on securities available-
for-sale, net of reclassification
adjustment and tax effects - - - - - 86,374 86,374
-----------
Total comprehensive income 5,473,460
-----------
Cash dividends declared - - - (3,728,457) - - (3,728,457)
Exercise of stock options 5,025 10,050 66,476 - - - 76,526
------------------------------------------------------------------------------------------
Balances, December 31, 2003 4,550,313 9,822,522 54,576 32,070,843 (1,721,931) 760,654 40,986,664
-----------
Comprehensive income:
Net income - - - 5,835,127 - - 5,835,127
Change in net unrealized gain
(loss) on securities available-
for-sale, net of reclassification
adjustment and tax effects - - - - - (383,366) (383,366)
-----------
Total comprehensive income 5,451,761
-----------
Cash dividends declared - - - (4,096,514) - - (4,096,514)
Exercise of stock options 4,350 8,700 52,413 - - - 61,113
------------------------------------------------------------------------------------------
Balances, December 31, 2004 4,554,663 $9,831,222 $ 106,989 $33,809,456 $(1,721,931) $ 377,288 $42,403,024
==========================================================================================
See accompanying notes to consolidated financial statements.
15
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Consolidated Statements of Cash Flows
Years Ended December 31, 2004, 2003, and 2002
2004 2003 2002
----------------------------------------------
<s> <c> <c> <c>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 5,835,127 $ 5,387,086 $ 5,179,814
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 696,686 654,483 658,004
Provision for loan losses 30,000 114,000 356,000
Provision for deferred income taxes 197,939 1,918 34,604
Net amortization of securities 205,571 261,400 198,030
Equity in losses of limited partnerships 140,104 124,948 124,039
Net losses (gains) on sales of securities (23,443) (379) 2,970
Net gains on sales of loans held for sale (443,965) (524,981) (661,121)
Net gains on sales of other real estate owned (90,191) (22,866) (35,516)
Net gains on disposals of premises and equipment (7,395) (5,609) (1,842)
Write-downs of other real estate owned - 42,846 309,688
Write-downs of impaired assets 41,501 - -
Decrease in unamortized loan fees (19,542) (20,904) (56,980)
Proceeds from sales of loans held for sale 26,269,537 30,186,323 28,772,930
Originations of loans held for sale (16,115,144) (31,046,743) (28,918,100)
Decrease in accrued interest receivable 123,698 238,972 146,088
Decrease (increase) in other assets 90,814 (359,474) (376,999)
(Increase) decrease in income taxes 4,653 (1,409) 48,739
Decrease in accrued interest payable (51,046) (216,388) (308,346)
Increase (decrease) in other liabilities (326,142) (217,340) 271,968
----------------------------------------------
Net cash provided by operating activities 16,558,762 4,595,883 5,743,970
----------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Interest bearing deposits in banks
Maturities and redemptions 3,562,529 3,562,015 2,262,597
Purchases (4,551,539) (4,755,075) (2,889,000)
Securities available-for-sale
Sales 1,761,346 350,553 505,500
Maturities, calls and pay downs 13,161,672 22,958,760 18,510,980
Purchases (12,323,253) (21,986,482) (15,157,949)
Purchase of Federal Home Loan Bank stock - (5,300) (171,700)
Increase in loans, net (18,259,344) (13,686,707) (4,561,567)
Recoveries of loans charged off 124,164 98,581 110,465
Purchase of premises and equipment (1,377,719) (497,439) (1,117,113)
Investments in limited partnerships (100) (378,900) (423,819)
Proceeds from sales of premises and equipment 14,548 13,643 4,802
Proceeds from sales of other real estate owned - 75,396 287,042
Proceeds from sales of repossessed property 12,684 42,251 18,156
----------------------------------------------
Net cash used in investing activities (17,875,012) (14,208,704) (2,621,606)
----------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Increase (decrease) in borrowings outstanding, net 711,122 (313,502) (2,808,409)
Proceeds from exercise of stock options 61,113 76,526 45,299
Net increase in noninterest bearing deposits 8,855,595 7,387,039 1,430,178
Net increase (decrease) in interest bearing deposits (7,638,873) 4,987,911 5,852,660
Proceeds paid out for fractional shares - (3,404) -
Dividends paid (4,096,514) (3,728,457) (3,451,475)
----------------------------------------------
Net cash (used in) provided by financing activities (2,107,557) 8,406,113 1,068,253
----------------------------------------------
Change in cash and cash equivalents (3,423,807) (1,206,708) 4,190,617
Cash and cash equivalents:
Beginning 24,540,759 25,747,467 21,556,850
----------------------------------------------
Ending $ 21,116,952 $ 24,540,759 $ 25,747,467
==============================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid $ 3,361,624 $ 4,425,371 $ 6,672,287
==============================================
Income taxes paid $ 2,283,094 $ 2,223,156 $ 1,984,250
==============================================
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND
FINANCING ACTIVITIES
Other real estate acquired in settlement of loans $ 319,368 $ 130,717 $ 1,231,315
==============================================
Repossessed property acquired in settlement of loans $ 8,916 $ 25,078 $ 53,384
==============================================
Loans originated to finance the sale of other real estate owned $ 283,634 $ 801,296 $ 937,920
==============================================
See accompanying notes to consolidated financial statements.
16
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements
Note 1. Significant Accounting Policies
The accounting and reporting policies of Union Bankshares, Inc. and
Subsidiary (the "Company") are in conformity with U.S. generally accepted
accounting principles and general practices within the banking industry.
The following is a description of the more significant policies.
Basis of presentation and consolidation
The consolidated financial statements include the accounts of Union
Bankshares, Inc., and its wholly-owned subsidiary, Union Bank ("Union"). On
May 16, 2003, the two subsidiaries (Union Bank and Citizens Savings Bank
and Trust Company [Citizens]) of Union Bankshares, Inc. were merged with
the surviving, state chartered bank being Union Bank headquartered in
Morrisville, Vermont. All significant intercompany transactions and
balances have been eliminated. The Company utilizes the accrual method of
accounting for financial reporting purposes.
Nature of operations
The Company provides a variety of financial services to individuals,
municipalities and commercial and non-profit customers through its
branches, ATM's, telebanking, and internet banking systems in northern
Vermont and its loan production offices in St. Albans, Vermont and
Littleton, New Hampshire. This market area encompasses primarily retail
consumers, small businesses, municipalities, agricultural producers, and
the tourism industry. The Company's primary deposit products are checking,
savings, money market accounts, and certificates of deposit and its primary
lending products are commercial, real estate, municipal, and consumer
loans.
Concentration of risk
The Company's operations are affected by various risk factors, including
interest-rate risk, credit risk, and risk from geographic concentration of
lending activities. Management attempts to manage interest rate risk
through various asset/liability management techniques designed to match
maturities of assets and liabilities. Loan policies and administration are
designed to provide assurance that loans will only be granted to credit-
worthy borrowers, although credit losses are expected to occur because of
subjective factors and factors beyond the control of the Company. Although
the Company has a diversified loan portfolio and economic conditions are
relatively stable, most of its lending activities are conducted within the
geographic area where it is located. A substantial portion of the Company's
loans are secured by real estate located throughout Northern Vermont. As a
result, the Company and its borrowers may be especially vulnerable to the
consequences of changes in the local economy and real estate market
conditions. Note 5 discusses the types of securities that the Company
invests in. Note 7 discusses the types of lending which the Company engages
in. In addition, a substantial portion of the Company's loans are secured
by real estate and/or are Small Business Administration ("SBA") guaranteed.
Use of estimates
The preparation of consolidated financial statements in conformity with
U.S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the
date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could
materially differ from those estimates. Material estimates that are
particularly susceptible to significant change relate to the determination
of the allowance for losses on loans, the valuation of real estate acquired
in connection with foreclosures or in satisfaction of loans, deferred tax
assets, judgments regarding impairment of assets and pension plan
accounting. These estimates involve a higher degree of complexity and
subjectivity and the amount of the change that is reasonably possible
cannot be estimated.
Management believes that the allowance for loan losses is adequate to
absorb losses inherent in the portfolio and that other real estate owned is
recorded at its fair value less an estimate of the cost to sell the
property. While management uses available information to recognize losses
on loans and other real estate owned, future additions to the allowance for
loan losses or write downs of other real estate owned may be necessary
based on changes in economic conditions. The ultimate collectibility of a
substantial portion of the Company's loan portfolio is dependent upon
general economic and real estate market conditions in Northern Vermont. In
addition, various regulatory agencies, as an integral part of their
examination process, periodically review the Company's allowance for loan
losses and other real estate owned. Such agencies may require the Company
to recognize additions to the
17
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 1. Significant Accounting Policies (Continued)
allowance for loan losses or write downs of other real estate owned based
on their judgments about information available to them at the time of their
examination, which may not be currently available to management.
Presentation of cash flows
For purposes of presentation in the consolidated statements of cash flows,
cash and cash equivalents includes cash on hand, amounts due from banks
(including cash items in process of clearing), federal funds sold
(generally purchased and sold for one day periods), and overnight deposits.
Trust assets
Assets held by the Trust Department of Union in a fiduciary or agency
capacity, other than trust cash on deposit, are not included in these
consolidated financial statements because they are not assets of Union or
the Company.
Investment securities
Investment securities purchased and held primarily for resale in the near
future are classified as trading securities and are carried at fair value
with unrealized gains and losses included in earnings. Debt securities the
Company has the positive intent and ability to hold to maturity are
classified as held-to-maturity and carried at amortized cost. Debt and
equity securities not classified as either held-to-maturity or trading are
classified as available-for-sale. Investments classified as available-for-
sale are carried at fair value.
Accretion of discounts and amortization of premiums arising at acquisition
are included in income using the effective interest method over the terms
of the securities. Unrealized gains and losses are excluded from earnings
and reported in other comprehensive income, net of tax and reclassification
adjustment, as a separate component of stockholders' equity. The specific
identification method is used to determine realized gains and losses.
Declines in the fair value of held-to-maturity and available-for-sale
securities below their cost that are deemed to be other than temporary are
reflected in earnings as realized losses in Other operating expenses. In
estimating other-than-temporary impairment losses, management considers (1)
the length of time and the extent to which the fair value has been less
than the amortized cost basis, (2) the financial condition and near and
medium-term prospects of the issuer, (3) whether the decline is
attributable to changes in interest rates or credit quality and (4) the
intent and ability of the Company to retain its investment in the issuer
for a period of time sufficient to allow for any anticipated recovery in
fair value.
Loans held for sale
Loans originated and intended for sale in the secondary market are carried
at the lower of cost or estimated fair value in the aggregate. Sales are
normally made without recourse. Gains and losses on the disposition of
loans held for sale are determined on the specific identification basis.
Net unrealized losses are recognized through a valuation allowance by
charges to income.
Loans
Loans receivable that management has the intent and ability to hold for the
foreseeable future or until maturity or pay-off are reported at their
unpaid principal balances adjusted for any charge-offs, the allowance for
loan losses, and any deferred fees or costs on originated loans and
unamortized premiums or discounts on purchased loans.
Loan interest income is accrued daily on outstanding balances. The accrual
of interest is discontinued when a loan is specifically determined to be
impaired or management believes, after considering collection efforts and
other factors, that the borrowers' financial condition is such that
collection of interest is doubtful. Any unpaid interest previously accrued
on those loans is reversed against interest income. A loan may be restored
to accrual status when its financial status has been significantly improved
and there is no principal or interest past due. A loan may also be restored
to accrual status if the borrower makes six consecutive monthly payments or
the lump sum equivalent. Income on non-accrual loans is generally not
recognized unless a loan is placed back in accrual status or after all
principal has been collected. Interest income generally is not recognized
on impaired loans unless the likelihood of further loss is remote. Interest
payments received on such loans are generally applied as a reduction of the
loan principal balance.
18
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 1. Significant Accounting Policies (Continued)
Loan origination and commitment fees and certain direct loan origination
costs are being deferred and the net amount amortized as an adjustment of
the related loan's yield using methods that approximates the interest
method. The Company is generally amortizing these amounts over the
contractual life of the related loan.
Allowance for loan losses
The allowance for loan losses is established as losses are estimated to
have occurred through a provision for loan losses charged to earnings. Loan
losses are charged against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if
any, are credited to the allowance.
The allowance for loan losses is maintained at a level which, in
management's judgment, is adequate to absorb credit losses inherent in the
loan portfolio. The amount of the allowance is based on management's
periodic evaluation of the collectibility of the loan portfolio, including
the nature of the portfolio, credit concentrations, trends in historical
loss experience, specific impaired loans, and economic conditions.
Allowances for impaired loans are generally determined based on collateral
values or the present value of estimated cash flows. This evaluation is
inherently subjective as it requires estimates that are susceptible to
significant revision as more information becomes available or as economic
conditions change.
Premises and equipment
Premises and equipment are stated at cost, less accumulated depreciation.
Depreciation is computed principally by the straight-line method over the
estimated useful lives of the assets. The cost of assets sold or otherwise
disposed of and the related allowance for depreciation is eliminated from
the accounts and the resulting gains or losses are reflected in the income
statement. Maintenance and repairs are charged to current expense as
incurred and the costs of major renewals and betterments are capitalized.
Federal Home Loan Bank stock
As a member of the Federal Home Loan Bank "FHLB" of Boston, Union is
required to invest in common stock of the FHLB of Boston. Effective April
19, 2004, to comply with the Gramm-Leach-Bliley Act, the FHLB of Boston
adopted a capital plan that redeemed its Class A common stock and issued
Class B common stock in its place. While there was no change in the dollar
value of Union's investment upon conversion, the Class B common stock has a
five year notice requirement for redemption and there is no guarantee of
future redemption. Also, there is the possibility of future capital calls
by the FHLB of Boston on member banks to ensure compliance with its capital
plan. FHLB of Boston stock is reported in Other assets at its par value of
$1,240,500 at both December 31, 2004 and 2003. The stock is nonmarketable,
and if redeemed, Union would receive from the FHLB of Boston an amount
equal to the par value of the stock.
Other real estate owned
Real estate properties acquired through or in lieu of loan foreclosure are
to be sold and are initially recorded at estimated fair value at the date
of acquisition establishing a new carrying basis. Thereafter, valuations
are periodically performed by management, and the real estate is carried at
the lower of carrying amount or fair value, less cost to sell. Revenue and
expenses from operations and changes in the valuation are included in other
income and expenses.
Servicing
Servicing assets are recognized as separate assets when rights are acquired
through purchase or through sale of loans with servicing rights retained.
Capitalized servicing rights are reported in other assets and are amortized
against noninterest income in proportion to, and over the period of, the
estimated future net servicing income of the underlying loans. Servicing
assets are evaluated for impairment based upon the fair value of the rights
as compared to amortized cost. Impairment is determined by stratifying
rights by predominant characteristics, such as interest rates and terms.
Fair value is determined using prices for similar assets with similar
characteristics, when available, or based upon discounted cash flows using
market-based assumptions. Impairment is recognized through a valuation
allowance for an individual stratum, to the extent that fair value is less
than the capitalized amount for the stratum.
19
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 1. Significant Accounting Policies (Continued)
Investments Carried at Equity
The Company has purchased various limited partnership interests in low
income housing partnerships. These partnerships were established to
acquire, own and rent residential housing for low and moderate income
Vermonters located in Northern Vermont. The investments are accounted for
under a method approximating the equity method of accounting. These equity
investments, which are included in other assets, are recorded at cost and
adjusted for the Company's proportionate share of the partnerships'
undistributed earnings or losses.
Pension plans
Union maintains a non-contributory defined benefit pension plan covering
all eligible employees who meet certain service requirements. The costs of
this plan, based on actuarial computations of current and estimated future
benefits for employees, are charged to pension and other employee benefits
as a current operating expense and are funded as accrued. As of January 1,
2004, former Citizens employees became eligible to participate in the
defined benefit pension plan.
Union also has a contributory 401(k) pension plan covering all employees
who meet certain service requirements. The plan is voluntary, and in 2004,
2003, and 2002, Union, through the discretionary matching component of the
plan, contributed fifty cents for every dollar contributed by participants,
up to six percent of each participant's salary. Citizens had a contributory
401(k) pension plan covering all employees who met certain age and service
requirements. The obligations of Citizens under the plan were assumed by
Union at the time of the merger of the two subsidiaries in May of 2003. The
plan was voluntary, and Citizens/Union, through the discretionary matching
component of the plan, contributed fifty cents for every dollar contributed
by participants, up to six percent of each participant's salary in 2003 and
2002. Contributions to the profit sharing component of the plan were at the
discretion of the Citizens' Board of Directors and were made in 2003 and
2002. Effective January 1, 2004, the Citizens 401(k) pension plan was
merged into the Union 401(k) pension plan.
Advertising costs
The Company expenses advertising costs as incurred.
Earnings per common share
Earnings per common share are computed based on the weighted average number
of shares of common stock outstanding during the period, retroactively
adjusted for stock splits, stock dividends, and stock issues and reduced
for shares held in treasury. The weighted average shares outstanding were
4,551,469, 4,547,366 and 4,543,113 for the years ended December 31, 2004,
2003 and 2002 respectively.
Income taxes
The Company prepares its Federal income tax return on a consolidated basis.
Federal income taxes are allocated to members of the consolidated group
based on taxable income. The Company recognizes income taxes under the
asset and liability method. This involves estimating the Company's actual
current tax exposure as well as assessing temporary differences resulting
from differing treatment of items, such as timing of the deduction of
expenses, for tax and accounting purposes. These differences result in
deferred tax assets and liabilities, which are included in the Company's
consolidated balance sheets. The Company must also assess the likelihood
that any deferred tax assets will be recovered from future taxable income
and to the extent that recovery is not likely, a valuation allowance must
be established. Significant management judgment is required in determining
income tax expense, and deferred tax assets and liabilities. Low-income
housing tax credits and historic rehabilitation credits are recognized as a
reduction of income tax expense in the year they are earned.
Off-balance-sheet financial instruments
In the ordinary course of business, the Company is a party to off-balance-
sheet financial instruments consisting of commitments to unused lines of
credit, commitments under credit card arrangements, commitments to purchase
investment securities, commercial letters of credit and standby letters of
credit. Such financial instruments are recorded in the financial statements
when they become payable.
20
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 1. Significant Accounting Policies (Continued)
Comprehensive income
Accounting principles generally require that recognized revenue, expenses,
gains, and losses be included in net income. Although certain changes in
assets and liabilities, such as unrealized gains and losses on available-
for-sale securities, are not included in Net Income, the cumulative effect
of such items, net of tax effect, is reported as a separate component of
the equity section of the balance sheet as Accumulated Other Comprehensive
Income. Such items, along with net income, are components of comprehensive
income.
The components of other comprehensive income and related tax effects at
December 31 are as follows:
2004 2003 2002
------------------------------------
<s> <c> <c> <c>
Unrealized holding gains (losses) on available-for-sale securities $(598,916) $129,982 $270,819
Reclassification adjustment for losses (gains) realized in income 18,058 (379) 2,970
------------------------------------
Net unrealized gains (losses) (580,858) 129,603 273,789
Tax effect 197,492 (43,229) (93,924)
------------------------------------
Net of tax amount $(383,366) $ 86,374 $179,865
====================================
Transfers of financial assets
Transfers of financial assets are accounted for as sales when control over
the assets has been surrendered. Control over transferred assets is deemed
to be surrendered when the assets have been isolated from the Company, the
transferee obtains the right (free of conditions that constrain it from
taking advantage of that right) to pledge or exchange the transferred
assets, and the Company does not maintain effective control over the
transferred assets through an agreement to repurchase them before their
maturity.
Segment reporting
The Company's operations are solely in the financial services industry and
include providing to its customers traditional banking services. The
Company operates primarily in the geographical regions of northern Vermont
and New Hampshire. Management makes operating decisions and assesses
performance based on an ongoing review of its traditional banking
operations, which constitute the Company's only reportable segment.
Stock option plan
The Company accounts for its stock option plan in accordance with the
provisions of Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees", and related interpretations. As
such, compensation expense is recorded on the date of grant only if the
current market price of the underlying stock exceeds the exercise price.
Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting
for Stock-Based Compensation", permits entities to recognize as expense
over the vesting period the fair value of all stock-based awards on the
date of grant. Alternatively, SFAS No. 123 also allows entities to continue
to apply the provisions of APB Opinion No. 25 and provide pro forma net
income disclosures for employee stock-based awards granted on or after
January 1, 1995 as if the fair value based method defined in SFAS No. 123
had been applied. The Company has elected to apply the accounting
methodology in APB Opinion No. 25 and, as a result, has provided the pro
forma disclosures of net income, earnings per share and other disclosures,
as if the fair value based method of accounting had been applied. The pro
forma effects on net income and earnings per share were not material in
2004, 2003 and 2002. See Note 20.
Recent accounting pronouncements
In December 2004, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 123 (Revised 2004), Shared-Based Payment, or SFAS No. 123R, which
is a revision of SFAS No. 123. SFAS No. 123R supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees, and amends SFAS No. 95, Statement
of Cash Flows. SFAS No. 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized in
the income statement based on their fair values. SFAS No. 123R is effective
beginning July 1, 2005 and will require the Company to expense share-based
payments under the
21
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 1. Significant Accounting Policies (Continued)
"modified prospective" method. Under this method, compensation expense is
recognized at the time of the grant for all share-based payments granted
after July 1, 2005 and also for all awards granted prior to July 1, 2005
that remain unvested on the effective date. The Company has no unvested
share-based payments as of January 2, 2005. The Company had not adopted the
transitional provisions of SFAS No. 123 but had continued to account for
its stock option plan in accordance with the provisions of APB Opinion No.
25. The Company does not expect that the adoption of SFAS No. 123R will
have a significant impact on its results of operations or financial
position but is still in the process of analyzing the future cost of stock
options under the revised statement.
In March 2004, the Securities and Exchange Commission ("SEC") issued SEC
Staff Accounting Bulletin ("SAB") No. 105, "Application of Accounting
Principles to Loan Commitments". SAB No. 105 summarizes the views of the
staff regarding the application of generally accepted accounting principles
to loan commitments accounted for as derivative instruments as required
under the Financial Accounting Standard Board Statement No. 133.
Specifically SAB No. 105 states that servicing assets and their associated
income are to be recognized at the time the servicing asset is created
either through securitization or sale, and not upon the extension of a loan
commitment which upon funding, will either be sold or securitized. It is
the Company's policy to recognize servicing assets and income only upon the
sale of the underlying loan. Accordingly, adoption of SAB No. 105 will not
have any effect on the Company's financial statements.
Reclassifications
Certain amounts in the 2003 and 2002 financial statements have been
reclassified to conform to the current year presentation.
Note 2. Stock Split
On July 16, 2003, the Board of Directors of Union Bankshares, Inc. declared
a three-for-two stock split effected in the form of a 50% stock dividend to
shareholders of record on July 26, 2003, payable on August 8, 2003. The
stock split resulted in the issuance of 1,515,231 additional shares of the
Company's common stock, net of fractional shares settled in cash. Per share
amounts presented in the consolidated financial statements, including
earnings per share, weighted average number of common shares outstanding,
and the dividends declared per share for all periods presented have been
adjusted to retroactively reflect the stock split.
Note 3. Restrictions on Cash and Due From Banks
The Company is required to maintain non-interest bearing reserve balances
in cash with Federal Reserve Bank of Boston. The totals of those reserve
balances were approximately $3,398,000 and $4,426,000 at December 31, 2004
and 2003, respectively.
The nature of the Company's business requires that it maintain amounts due
from banks which, at times, may exceed federally insured limits. The
balance in these accounts at December 31, is as follows:
2004 2003
---------------------------
<s> <c> <c>
Noninterest-bearing accounts $ 559,318 $ 5,263,857
Federal Reserve Bank of Boston 12,538,867 15,144,335
Federal funds sold 4,013,453 647,081
Federal Home Loan Bank of Boston 173,706 269,357
No losses have been experienced in these accounts. The Company was required
to maintain contracted clearing balances of $1,000,000 and $6,000,000 at
December 31, 2004 and 2003, respectively which are included in the Federal
Reserve Bank balances above.
Note 4. Interest Bearing Deposits
Interest bearing deposits consist of certificates of deposit purchased from
various financial institutions. Deposits at each institution are maintained
at or below the FDIC insurable limits of $100,000. Certificates are held
with rates ranging from 1.19% to 7.15% and mature at various dates through
2010 with approximately $2,968,000 scheduled to mature in 2005.
22
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 5. Investment Securities
Securities available-for-sale consists of the following:
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------------
<s> <c> <c> <c> <c>
December 31, 2004:
Debt securities:
U.S. Government and agency and corporation securities $ 8,989,316 $ 8,189 $ (32,362) $ 8,965,143
Mortgage-backed securities 16,524,542 76,832 (129,212) 16,472,162
State and political subdivisions 5,137,263 135,131 (14,549) 5,257,845
Corporate debt securities 8,887,830 230,636 (21,031) 9,097,435
---------------------------------------------------------
Total debt securities 39,538,951 450,788 (197,154) 39,792,585
Marketable equity securities 855,289 318,014 - 1,173,303
---------------------------------------------------------
Total $40,394,240 $ 768,802 $(197,154) $40,965,888
=========================================================
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------------
<s> <c> <c> <c> <c>
December 31, 2003:
Debt securities:
U.S. Government and agency and corporation securities $ 4,902,207 $ 57,357 $ (12,412) $ 4,947,152
Mortgage-backed securities 17,514,780 162,403 (35,581) 17,641,602
State and political subdivisions 5,122,832 225,168 (7,753) 5,340,247
Corporate debt securities 14,781,024 580,058 (11,912) 15,349,170
---------------------------------------------------------
Total debt securities 42,320,843 1,024,986 (67,658) 43,278,171
Marketable equity securities 896,790 244,257 (49,078) 1,091,969
---------------------------------------------------------
Total $43,217,633 $1,269,243 $(116,736) $44,370,140
=========================================================
Investment securities with a carrying amount of $2,456,096 and $3,038,792
at December 31, 2004 and 2003, respectively, were pledged as collateral on
public deposits and for other purposes as required or permitted by law.
23
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 5. Investment Securities (Continued)
Information pertaining to securities with gross unrealized losses at
December 31, 2004, aggregated by investment category and length of time
that individual securities have been in a continuous loss position,
follows:
Less Than 12 Months Over 12 Months Total
------------------------------------------------------------------------------------
Gross Gross Gross
Fair Unrealized Fair Unrealized Fair Unrealized
Value Loss Value Loss Value Loss
------------------------------------------------------------------------------------
<s> <c> <c> <c> <c> <c> <c>
Securities Available-for-Sale
Debt securities:
U.S. Government and agency and
corporation securities $ 7,460,407 $ (32,362) $ - $ - $ 7,460,407 $ (32,362)
Mortgage-backed securities 12,306,222 (128,835) 28,605 (377) 12,334,827 (129,212)
State and political subdivisions 823,218 (14,549) - - 823,218 (14,549)
Corporate debt securities 2,045,070 (21,031) - - 2,045,070 (21,031)
-----------------------------------------------------------------------------------
Total $22,634,917 $(196,777) $28,605 $ (377) $22,663,522 $(197,154)
===================================================================================
Management evaluates debt securities for other-than-temporary impairment at
least on a quarterly basis, and more frequently when economic or market
concerns warrant such evaluation and on a monthly basis for marketable
equity securities. In analyzing an issuer's financial condition, management
considers whether the securities are issued by the federal government or
its agencies, whether downgrades by bond rating agencies have occurred, and
industry analysts' reports. Consideration is given to the length of time
and the extent to which the fair value has been less than the amortized
cost basis, the financial condition and near and medium-term prospects of
the issuer, whether the decline is attributable to changes in interest
rates or credit quality and the intent and ability of the Company to retain
its investment in the issuer for a period of time sufficient to allow for
any anticipated recovery in fair value.
At December 31, 2004, 49 debt securities have unrealized losses with
aggregate depreciation of 0.5% from the Company's amortized cost basis. The
primary factor causing securities with short-term gross unrealized loss is
the change over the last six months in the interest rate environment. Only
1 debt security has an unrealized loss that has been in a continuous loss
position for more than 12 months and that is an annually adjustable rate
GNMA Mortgage Backed Security that pays principal and interest monthly. As
management has the ability to hold this debt security until maturity, or
for the foreseeable future since the security is classified as available-
for-sale, the decline is deemed to be temporary.
During 2004, the Company recognized other than temporary impairment on two
equity securities of $41,501 to their quoted fair market value. The equity
securities remain on the Company's books as of December 31, 2004 and the
fair value of both exceed over their new carrying costs. All realized gains
and losses in 2003 and 2002 were from the sale of securities available-for-
sale. Proceeds from the sale of securities available-for-sale were
$1,761,346, $350,553 and $505,500 in 2004, 2003, and 2002, respectively.
Gross realized gains from sales of investments available-for-sale were
$35,673, $379 and $5,054 with gross realized losses of $12,230, $0 and
$8,024 for the years 2004, 2003, and 2002 respectively.
The scheduled maturities of debt securities available-for-sale as of
December 31, 2004 were as follows:
Amortized Fair
Cost Value
---------------------------
<s> <c> <c>
Due in one year or less $ 8,355,148 $ 8,361,331
Due from one to five years 9,215,329 9,440,145
Due from five to ten years 4,096,068 4,171,427
Due after ten years 1,347,864 1,347,519
---------------------------
23,014,409 23,320,422
Mortgage-backed securities 16,524,543 16,472,163
---------------------------
Total debt securities $39,538,952 $39,792,585
===========================
24
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 5. Investment Securities (Continued)
Actual maturities may differ from contractual maturities in mortgage-backed
securities because the mortgages underlying the securities may be called or
repaid without any penalties. Therefore, these securities are not included
in the maturity categories in the above maturity summary.
Note 6. Loans Held for Sale and Loan Servicing
At December 31, 2004 and 2003, loans held for sale consisted of
conventional residential mortgages, commercial real estate mortgages and
commercial loans originated for subsequent sale. At December 31, 2004 and
2003, the estimate fair value of these loans was in excess of their
carrying value, and therefore no valuation reserve is necessary for loans
held for sale.
Commercial and mortgage loans serviced for others are not included in the
accompanying balance sheets. The unpaid principal balances of commercial
and mortgage loans serviced for others were $86,973,197 and $75,136,195 at
December 31, 2004 and 2003, respectively.
The Company generally retains the servicing rights on loans sold. At
December 31, 2004 and 2003, the unamortized balance of servicing rights on
loans sold with servicing retained was not material. The estimated fair
value of these servicing rights was in excess of their carrying value at
both December 31, 2004 and 2003, and therefore no impairment reserve was
necessary. Loan servicing rights of $194,601, $200,765 and $208,829 were
capitalized in 2004, 2003, and 2002, respectively. Amortization of
servicing rights was $146,445, $141,376 and $87,541 for 2004, 2003, and
2002, respectively.
Note 7. Loans
The composition of net loans at December 31 is as follows:
2004 2003
-----------------------------
<s> <c> <c>
Residential real estate $100,130,337 $ 89,974,291
Construction real estate 20,050,164 18,256,557
Commercial real estate 108,473,777 102,365,743
Commercial 20,583,924 17,876,790
Consumer 8,729,004 9,402,301
Municipal loans 13,453,425 15,346,039
-----------------------------
Gross Loans 271,420,631 253,221,721
Deduct:
Allowance for loan losses (3,066,871) (3,028,813)
Net deferred loan fees, premiums, and discounts (165,654) (185,196)
-----------------------------
(3,232,525) (3,214,009)
-----------------------------
Net Loans $268,188,106 $250,007,712
=============================
Information regarding non-performing loans as of December 31 is as follows:
2004 2003
-------------------------
<s> <c> <c>
Impaired loans $1,019,121 $ 742,312
Total allowance for loan losses related to impaired loans 121,108 110,360
Loans in non-accrual status 1,169,457 1,617,230
Loans past due 90 days or more and still accruing 4,126,040 1,687,672
25
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 7. Loans (Continued)
Information on non-performing and non-accrual loans for the years ended
December 31 is as follows:
2004 2003 2002
--------------------------------------
<s> <c> <c> <c>
Interest income recognized on impaired loans $ 46,625 $ 46,161 $ 64,816
Average investment in impaired loans 1,039,739 745,558 1,180,540
Aggregate interest on non-accrual loans not recognized 338,456 392,732 316,019
At December 31, 2004, the Company was not committed to lend any additional
funds to borrowers whose loans are non-performing.
Residential real estate loans aggregating $3,756,744 and $13,309,460 at
December 31, 2004 and 2003, respectively, were pledged as collateral on
deposits of municipalities.
Note 8. Allowance for Loan Losses
Changes in the allowance for loan losses for the years ended December 2004,
2003 and 2002, are as follows:
2004 2003 2002
----------------------------------------
<s> <c> <c> <c>
Balance, beginning $3,028,813 $2,908,222 $2,800,963
Provision for loan losses 30,000 114,000 356,000
Recoveries of amounts charged off 124,164 98,581 110,465
----------------------------------------
3,182,977 3,120,803 3,267,428
Amounts charged off (116,106) (91,990) (359,206)
----------------------------------------
Balance, ending $3,066,871 $3,028,813 $2,908,222
========================================
Note 9. Premises and Equipment
The major classes of premises and equipment and accumulated depreciation at
December 31 are as follows:
2004 2003
---------------------------
<s> <c> <c>
Land and land improvements $ 689,456 $ 689,456
Buildings and improvements 4,860,283 4,739,273
Furniture and equipment 7,428,107 6,315,043
---------------------------
12,977,846 11,743,772
Less accumulated depreciation (7,856,800) (7,296,606)
---------------------------
$ 5,121,046 $ 4,447,166
===========================
Depreciation included in occupancy and equipment expenses amounted to
$696,686, $654,483, and $658,004 for the years ended December 31, 2004,
2003, and 2002 respectively.
26
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 9. Premises and Equipment (Continued)
The Company is obligated under noncancelable operating leases for premises
that expire in various years through the year 2010. Options to renew for
additional periods are available with these leases. Future minimum rental
commitments for these leases with original or remaining terms of one year
or more at December 31, 2004 were as follows:
<s> <c>
2005 $105,654
2006 92,945
2007 85,352
2008 33,756
2009 28,000
Thereafter 14,000
--------
$359,707
========
Rent expense for 2004, 2003, and 2002 amounted to $107,841, $101,307, and
$106,170, respectively.
Occupancy expense is shown in the consolidated statements net of rental
income of $73,983 in 2004, $71,930 in 2003, and $78,806 in 2002.
Note 10. Other Real Estate Owned
Other real estate owned of $35,734 at December 31, 2004 and $10,131 at
December 31, 2003 was included in Other Assets.
Note 11. Investments Carried at Equity
The carrying values of investments carried at equity were $1,416,232 and
$1,556,236 at December 31, 2004 and 2003, respectively consisting of
investments in limited partnerships for low income housing projects. The
capital contributions payable related to these investments were $0 and
$297,000 at December 31, 2004 and 2003, respectively. The provision for
undistributed net losses of the partnerships charged to earnings was
$140,103, $124,948, and $124,039 for 2004, 2003 and 2002, respectively.
Note 12. Deposits
The following is a summary of interest bearing deposits at December 31:
2004 2003
-----------------------------
<s> <c> <c>
NOW accounts $ 48,948,414 $ 50,092,855
Savings and money market accounts 108,232,927 109,745,098
Time deposits, $100,000 and over 29,324,394 29,861,919
Other time deposits 62,871,217 67,315,953
-----------------------------
$249,376,952 $257,015,825
=============================
The following is a summary of time deposits by maturity at December 31,
2004:
<s> <c>
2005 $68,243,550
2006 15,174,285
2007 6,478,052
2008 1,602,595
2009 697,129
-----------
$92,195,611
===========
27
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 13. Borrowed Funds
At December 31, 2004 and 2003, borrowed funds were comprised of option
advance borrowings from the FHLB of Boston of $7,933,652 and $7,222,530,
respectively. At December 31, 2004 and 2003, all of the borrowings had
fixed interest rates ranging from 2.13% to 6.06% and 2.22% to 6.06%,
respectively. The weighted-average interest rates on the borrowings were
4.09% and 4.43% at December 31, 2004 and 2003, respectively.
The contractual maturities of borrowed funds as of December 31, 2004 are as
follows:
<s> <c>
2005 $2,344,231
2006 4,529,646
2007 462,206
2008 238,096
2009 and thereafter 359,473
----------
$7,933,652
==========
Additionally, Union maintains an IDEAL Way Line of Credit with the FHLB of
Boston. As of December 31, 2004, the total amount of this line approximated
$3,551,000. There were no borrowings outstanding on this line at December
31, 2004. Interest on this line is chargeable at a rate determined by the
FHLB of Boston and payable monthly based on daily balances outstanding.
Collateral on these borrowings consists of FHLB of Boston stock purchased
by Union, all funds placed on deposit with the FHLB of Boston, and
qualified first mortgages held by Union, and any additional holdings which
may be pledged as security.
Union also maintains a line of credit with a correspondent bank for the
purchase of overnight Federal Funds. As of December 31, 2004, the total
amount of this line approximated $5,000,000 with no outstanding borrowings.
Interest on this borrowing is chargeable at the Federal Funds rate at the
time of the borrowing and is payable daily.
Note 14. Income Taxes
The components of the provision for income taxes for the years ended
December 31 were as follows:
2004 2003 2002
----------------------------------------
<s> <c> <c> <c>
Currently paid or payable $2,259,654 $2,203,335 $2,032,994
Deferred 197,939 1,918 34,604
----------------------------------------
$2,457,593 $2,205,253 $2,067,598
========================================
The total provision for income taxes differs from the amounts computed at
the statutory federal income tax rate of 34% primarily due to the following
at December 31:
2004 2003 2002
----------------------------------------
<s> <c> <c> <c>
Computed "expected" tax expense $2,819,525 $2,581,395 $2,464,120
Tax exempt interest (203,901) (215,958) (235,933)
Increase in cash surrender value life insurance (36,644) (38,796) (41,050)
Tax credits on limited partnership investments (135,986) (135,986) (142,007)
Other 14,599 14,598 22,468
----------------------------------------
$2,457,593 $2,205,253 $2,067,598
========================================
28
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 14. Income Taxes (Continued)
Listed below are the significant components of the net deferred tax asset
at December 31:
2004 2003
-------------------------
<s> <c> <c>
Components of the deferred tax asset:
Bad debts $ 844,640 $ 829,459
Mark-to-market loans 53,005 136,348
Nonaccrual loan interest 115,075 133,529
Deferred compensation 447,072 466,852
Pension 86,063 65,273
Other 22,056 10,244
-------------------------
Total deferred tax asset 1,567,911 1,641,705
Valuation allowance - -
-------------------------
Total deferred tax asset, net of valuation allowance 1,597,911 1,641,705
-------------------------
Components of the deferred tax liability:
Depreciation (207,043) (140,027)
Mortgage servicing rights (108,007) (91,634)
Limited partnership tax credits (119,882) (119,882)
Unrealized gain on securities available-for-sale (194,360) (391,852)
Other (119,762) (79,006)
-------------------------
Total deferred tax liability (749,054) (822,401)
-------------------------
Net deferred tax asset $ 818,857 $ 819,304
=========================
Deferred tax assets are recognized subject to management's judgment that
realization is more likely than not. Based on the temporary taxable items,
historical taxable income and estimates of future taxable income, the
Company believes that it is more likely than not that the deferred tax
assets at December 31, 2004 will be realized.
Net deferred income tax assets are included in the caption "Other assets"
on the balance sheet at December 31, 2004 and 2003.
29
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 15. Employee Benefits
Union sponsors a non-contributory defined benefit pension plan covering all
eligible employees. The employees of the former Citizens which was merged
into Union in May 2003 became eligible to participate in the plan January
1, 2004. The plan provides defined benefits based on years of service and
final average salary. Union uses a December 31 measurement date for the
plan. Union's policy is to accrue annually an amount equal to the
actuarially calculated expense. Information pertaining to the activity in
the plan using a measurement date of December 31, is as follows:
Obligations and funded status at December 31:
Change in projected benefit obligation 2004 2003
- -------------------------------------- ---------------------------
<s> <c> <c>
Projected benefit obligation at beginning of year $ 7,155,345 $ 5,947,390
Service cost 408,422 301,433
Interest cost 436,429 391,817
Actuarial (gain) loss 196,110 651,091
Benefits paid (155,284) (136,386)
---------------------------
Projected benefit obligation at end of year $ 8,041,022 $ 7,155,345
---------------------------
Change in fair value of plan assets
- -----------------------------------
Fair value of plan assets at beginning of year $ 5,268,288 $ 4,362,968
Actual return on plan assets 634,155 632,131
Employer contributions 508,141 409,575
Benefits paid (155,284) (136,386)
---------------------------
Fair value of plan assets at end of year $ 6,255,300 $ 5,268,288
===========================
Funded status $(1,785,722) $(1,887,057)
Unrecognized prior service cost 53,083 59,241
Unrecognized net actuarial loss 1,479,513 1,635,836
---------------------------
Net amount recognized as accrued benefit cost $ (253,126) $ (191,980)
===========================
2004 2003
---------------------------
<s> <c> <c>
Accumulated benefit obligation at December 31 $ 5,767,765 $ 5,273,339
---------------------------
We use the alternate amortization method for prior service costs, provided
in paragraph 26 of SFAS 87, "Employers' Accounting for Pensions."
Net periodic pension benefit for 2004, 2003, and 2002 consisted of the
following components:
2004 2003 2002
-------------------------------------
<s> <c> <c> <c>
Service cost $ 408,422 $ 301,433 $ 229,995
Interest cost on projected benefit obligation 436,429 391,817 365,281
Expected return on plan assets (363,526) (295,025) (312,705)
Amortization of prior service cost 6,158 6,158 6,158
Amortization of transition asset (7,649) (7,649) (7,656)
Amortization of net loss 89,453 75,348 52,160
-------------------------------------
Net periodic benefit cost $ 569,287 $ 472,082 $ 333,233
=====================================
30
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 15. Employee Benefits (Continued)
Weighted-average assumptions used to determine benefit obligations at
December 31:
2004 2003
---------------
<s> <c> <c>
Discount rate 6.00% 6.00%
Wage base rate 3.50% 3.50%
Consumer Price Index rate 2.25% 2.25%
Weighted-average assumptions used to determine net periodic benefit cost
for years ended December 31:
2004 2003
---------------
<s> <c> <c>
Discount rate 6.00% 6.00%
Rate of increase in compensation levels 4.25% 4.25%
Expected long-term rate of return of plan assets 6.75% 6.75%
The overall expected long-term rate of return on assets was derived to be
consistent with a 2.25% future inflation assumption and returns expected in
that inflation environment. The return is more conservative than the plan's
long term actual results and is at a level that management believes is
sustainable.
Union's pension plan weighted-average asset allocations at December 31,
2004 and 2003, by asset category based on their fair values are as follows:
Plan Assets
-----------------
Asset Category 2004 2003
- -------------- -----------------
<s> <c> <c>
Cash & Equivalents 3.7% 0.5%
Debt Securities 33.0% 35.4%
Equity Securities 50.4% 51.8%
International Mutual Funds 12.9% 12.3%
----------------
Total 100.0% 100.0%
================
The investment philosophy for the pension plan is to prudently invest the
assets of the plan and future contributions received in a diversified
manner that will ensure the future benefits due to participants and
beneficiaries over a long term horizon. The Trustees of the plan seek to
protect the pension plan assets through prudent asset allocation, manager
selection and periodic reviews. Investments in stocks and fixed income
investments should be diversified in a way consistent with risk tolerance
and investment objectives. In order to obtain this goal the investment
objective is to maintain a mix of growth and income investments with
allocation as follows:
<s> <c>
Equity Securities & International Mutual Funds 60-85%
Debt Securities 15-35%
Cash & Equivalents 0-5%
There are no securities of the Company held by the pension plan. The
estimated employer contribution for 2005 is $475,000.
The following table summarizes the estimated future benefit payments
expected to be paid under the Plan:
<s> <c>
2005 $ 181,695
2006 171,344
2007 171,344
2008 171,344
2009 171,344
Years 2010 to 2014 1,979,040
31
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 15. Employee Benefits (Continued)
Additionally, Union Bankshares, Inc. and Union have a non-qualified
Deferred Compensation Plan for Directors and certain key officers. For 2004
and previous years under the plan, current participants could defer
compensation that would otherwise be currently payable. Amounts deferred
accrue interest at the prime rate less 100 basis points and benefits are
payable over a 15 year period upon attainment of a certain age or death.
The benefit obligations under the plan represent general unsecured
obligations of the Company and no assets have to be segregated for such
payments. However, Union Bankshares, Inc. and Union have purchased life
insurance contracts on the lives of each participant in order to fund these
benefits. The benefits accrued under this plan aggregated $1,314,917 and
$1,326,039 at December 31, 2004 and 2003, respectively, and are included in
the financial statement caption "Accrued interest and other liabilities".
The cash surrender value of the life insurance policies purchased to fund
these plans aggregated $1,675,889 and $1,568,112 at December 31, 2004 and
2003, respectively. These amounts are included in the financial statement
caption "Other assets". The current deferred compensation plan will be re-
evaluated during 2005 based on final rules under the federal American Jobs
Creation Act of 2004, which have yet to be issued by the Internal Revenue
Service (IRS).
Union maintains a defined contribution 401(k) plan under which employees
may elect to make tax deferred contributions of up to the IRS maximum from
their annual salary. All employees meeting service requirements are
eligible to participate in the plan. Company contributions fully vest after
three years of service. Union's employer matching contributions to the plan
are at the discretion of the Board of Directors. Employer matching
contributions to the plan were $113,637, $76,930, and $72,845 for 2004,
2003, and 2002, respectively.
Citizens maintained separately a 401(k) plan which included a discretionary
profit sharing component. The 401(k) plan covered all employees meeting
certain eligibility requirements. Employees were permitted to contribute
any amount of their compensation to the 401(k) plan in accordance with IRS
limits. Citizens, at the discretion of their Board of Directors, made
matching contributions up to 6% of an employee's compensation. Matching
contributions to this plan were $21,906 and $29,369 for 2003 and 2002
respectively. Profit sharing contributions were at the discretion of
Citizens' Board of Directors. Contributions were $71,848 and $74,965 for
2003 and 2002 respectively. The Citizens 401(k) plan was merged into the
Union plan effective January 1, 2004.
Note 16. Financial Instruments With Off-Balance-Sheet Risk
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 and to reduce its own exposure to fluctuations in interest rates.
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. Such instruments involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized in the
balance sheet. The contract or notional amounts of those instruments
reflect the extent of involvement the Company has in particular classes 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 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.
32
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 16. Financial Instruments With Off-Balance-Sheet Risk (Continued)
The following table shows financial instruments whose contract amount
represents credit risk:
Contract or
Notional Amount
---------------------------
2004 2003
---------------------------
<s> <c> <c>
Commitments to originate loans $13,773,009 $ 8,921,457
Unused lines of credit 31,907,901 25,379,986
Standby letters of credit 1,003,748 992,660
Credit card arrangements 2,273,323 2,115,122
Equity commitments to affordable housing limited partnerships 1,348,808 890,908
---------------------------
Total $50,306,789 $38,300,133
===========================
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 within 90 days of the
commitment. Unused lines of credit are renewable at least annually except
for home equity lines which have an indefinite expiration date. Unused
lines may have other termination clauses and may require payment of a fee.
Since many of the commitments and lines are expected to expire without
being drawn upon, the total commitment amounts do not necessarily represent
future cash requirements. The Company evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Company, upon issuance of a commitment to extend
credit is based on management's credit evaluation of the customer.
Collateral held varies but may include real estate, accounts receivable,
inventory, property, plant and equipment, and income-producing commercial
properties.
Standby letters of credit are conditional commitments issued by the Company
to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support customer's private borrowing
arrangements. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loans to customers.
At December 31, 2004, the Company had $1,416,232 of investments in tax
advantaged limited partnerships involved in low income housing investment
tax credit projects in its market area and commitments to invest up to an
additional $1,348,808 in such partnerships.
Note 17. Commitments and Contingencies
In the normal course of business, the Company is involved in various legal
proceedings. In the opinion of management, after consulting with the
Company's legal counsel, any liability resulting from such proceedings
would not have a material adverse effect on the Company's financial
statements.
Note 18. Fair Values of Financial Instruments
The fair value of a financial instrument is the current amount that would
be exchanged between willing parties, other than in a forced liquidation.
Fair value is best determined based upon quoted market prices. However, in
many instances, there are no quoted market prices for the Company's various
financial instruments. In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques. Those techniques are significantly affected by the
assumptions used, including the discount rate and estimates of future cash
flows. Management's estimates and assumptions are inherently subjective and
involve uncertainties and matters of significant judgment. Changes in
assumptions could dramatically affect the estimated fair values.
Accordingly, the fair value estimates may not be realized in an immediate
settlement of the instrument. SFAS No. 107 excludes certain financial
instruments and all nonfinancial instruments from its disclosure
requirements. Accordingly, the aggregate fair value amounts presented may
not necessarily represent the underlying fair value of the Company.
33
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 18. Fair Values of Financial Instruments (Continued)
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the
balance sheet for cash and cash equivalents approximate those assets'
fair values.
Investment securities and interest bearing deposits: Fair values for
investment securities and interest bearing deposits are based on
quoted market prices, where available. If quoted market prices are
not available, fair values are based on quoted market prices of
comparable instruments or discounted present values of cash flows.
Loans and loans held for sale: Fair values of loans are estimated for
portfolios of loans with similar financial characteristics and
segregated by loan type. For variable-rate loans that reprice
frequently and with no significant change in credit risk, fair values
are based on carrying amounts. The fair values for other loans (for
example, fixed-rate residential, commercial real estate, and rental
property mortgage loans, and commercial and industrial loans) are
estimated using discounted cash flow analysis, based on interest
rates currently being offered for loans with similar terms to
borrowers of similar credit quality. Loan fair value estimates
include judgments regarding future expected loss experience and risk
characteristics. The carrying amounts reported in the balance sheet
for loans that are held for sale approximate their fair market
values. Fair values for impaired loans are estimated using discounted
cash flow analyses or underlying collateral values, where applicable.
Deposits: The fair values disclosed for demand deposits (for example,
checking and savings accounts) are, by definition, equal to the
amount payable on demand at the reporting date (that is, their
carrying amounts). The carrying amounts of variable rate time
deposits approximate their fair values at the reporting date. The
fair values for fixed rate time deposits are estimated using a
discounted cash flow calculation that applies interest rates
currently being offered on time deposits to a schedule of aggregated
contractual maturities on such time deposits.
Borrowed funds: The fair values of the Company's long-term debt are
estimated using discounted cash flow analysis based on interest rates
currently being offered on similar debt instruments.
Off-balance sheet financial instruments: The estimated fair market
value of off-balance-sheet financial instruments approximates their
contract or notional values as the majority of our credit commitments
are short-term (one year or less) in nature. The only commitments to
extend credit that are longer than one year in duration are the Home
Equity Lines whose interest rates are variable on a quarterly basis.
The only fees collected for commitments are an annual fee on credit
card arrangements and sometimes a flat fee on commercial lines of
credit and standby letters of credit. The fair value of the off-
balance sheet financial instruments is not significant.
The estimated fair values and related carrying amounts of the Company's
significant financial instruments at December 31 are as follows:
2004 2003
---------------------------------------------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
---------------------------------------------------------------
<s> <c> <c> <c> <c>
Financial assets:
Cash and cash equivalents $ 21,116,952 $ 21,116,952 $ 24,633,419 $ 24,633,419
Interest bearing deposits 7,508,703 7,519,068 6,519,693 6,663,325
Securities available-for-sale 40,965,888 40,965,862 44,370,140 44,370,140
Loans and loans held for sale, net 277,002,016 277,254,542 268,532,050 268,501,273
Financial liabilities:
Deposits $306,598,141 $306,341,457 $305,379,443 $305,811,209
Borrowed funds 7,933,652 8,085,683 7,222,530 7,423,404
The carrying amounts in the preceding table are included in the balance
sheet under the applicable captions.
34
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 19. Transactions with Related Parties
The Company has had, and may be expected to have in the future, banking
transactions in the ordinary course of business with principal
stockholders, directors, principal officers, their immediate families and
affiliated companies in which they are principal stockholders (commonly
referred to as related parties), all of which have been, in the opinion of
management, on the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with others.
Aggregate loan transactions with related parties for the year ended
December 31 were as follows:
2004 2003
--------------------------
<s> <c> <c>
Balance, beginning $ 1,051,851 $ 952,927
New loans 1,200,896 1,407,922
Repayments (1,479,222) (928,675)
Other, net (658) (380,323)
--------------------------
Balance, ending $ 772,867 $1,051,851
==========================
Balance available on lines of credit $ 527,199 $ 419,488
==========================
Deposit accounts with related parties were $745,924 and $1,103,194 at
December 31, 2004 and 2003, respectively.
Note 20. Stock Option Plan
Under the Company's 1998 Stock Option Plan, the Company's Board of
Directors, with shareholder approval, authorized the granting to certain
key employees options to purchase up to 75,000 shares of the Company's
common stock. As of December 31, 2004, 51,950 shares remain available for
future option grants. The exercise price of the options is equal to the
market price of the stock at the date of grant. These stock options are
exercisable within five years from the date of grant.
35
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 20. Stock Option Plan (Continued)
Following is a summary of transactions:
Shares Under Option
----------------------------
2004 2003 2002
----------------------------
<s> <c> <c> <c>
Outstanding, January 1 13,675 10,900 10,200
Stock split effected in the form of a stock dividend (3 for 2, effective 8/8/03) - 5,100 -
Granted during the year 3,250 3,000 3,200
Cancelled during the year - (300) -
Exercised during the year (3,250 shares at $13.50 per share and 1,100 shares
at $15.67 per share in 2004; 500 shares at $13.50 per share, 3,450 shares
at $14.67 per share, 375 shares at $15.67 per share and 700 shares
at $19.00 per share in 2003; and 2,200 shares at $18.00 per share and 300 shares
at $19.00 per share in 2002.) (4,350) (5,025) (2,500)
----------------------------
Outstanding, December 31 12,575 13,675 10,900
============================
Stock Options Exercisable at year end: 9,325 10,675 7,700
============================
Outstanding Options at December 31, exercisable at:
$12.67 per share 3,000 3,000 -
$13.50 per share - 3,250 -
$15.67 per share 3,325 4,425 -
$19.00 per share - - 2,700
$20.25 per share - - 2,500
$22.00 per share - - 2,500
$23.50 per share - - 3,200
$25.30 per share 3,000 3,000 -
$26.60 per share 3,250 - -
----------------------------
12,575 13,675 10,900
============================
Had compensation cost been determined on the basis of fair value pursuant
to SFAS No. 123, the effects on net income and
earnings per common share for the years ended December 31 would have been:
2004 2003 2002
----------------------------------------
<s> <c> <c> <c>
Net income as reported $5,835,127 $5,387,086 $5,179,814
Deduct: Total stock-based compensation expense determined
under fair value based method for all awards, net of related tax effects (18,382) (9,026) (4,626)
----------------------------------------
Pro forma net income $5,816,745 $5,378,060 $5,175,188
========================================
Earnings per common share:
As reported $ 1.28 $ 1.18 $ 1.14
Pro forma $ 1.28 $ 1.18 $ 1.14
Note 21. Regulatory Capital Requirements
The Company (on a consolidated basis) and Union are subject to various
regulatory capital requirements administered by the federal banking
agencies. Failure to meet minimum capital requirements can initiate certain
mandatory - and possibly additional discretionary - actions by regulators
that, if undertaken, could have a direct material effect on the Company's
and Union's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, they must meet specific
capital guidelines that involve quantitative measures of their assets,
liabilities, and certain off-balance-sheet items as calculated
36
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 21. Regulatory Capital Requirements (Continued)
under regulatory accounting practices. The Company's and Union's capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and Union to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital
(as defined) to average assets (as defined). Management believes that, as
of December 31, 2004 and 2003, the Company and Union met all capital
adequacy requirements to which they were subject.
As of December 31, 2004 and 2003, the most recent notification from the
FDIC categorized Union as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well capitalized an
institution must maintain minimum total risk-based, Tier I risk-based, and
Tier I leverage ratios as set forth in the table. There are no conditions
or events since the date of the most recent notification that management
believes might result in an adverse change to Union's regulatory capital
category.
Union's and the Company's actual capital amounts (000's omitted) and ratios
are also presented in the table.
Minimum
To be Well
Minimum Capitalized Under
For Capital Prompt Corrective
Actual Requirement Action Provisions
-------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
-------------------------------------------------------------
<s> <c> <c> <c> <c> <c> <c>
As of December 31, 2004:
Total capital to risk weighted assets
Union $44,361 18.27% $19,425 8.0% $24,281 10.0%
Company 45,212 18.57% 19,477 8.0% N/A N/A
Tier I capital to risk weighted assets
Union 41,182 16.96% 9,713 4.0% 14,569 6.0%
Company 42,026 17.27% 9,734 4.0% N/A N/A
Tier I capital to average assets
Union 41,182 11.42% 14,425 4.0% 18,031 5.0%
Company 42,026 11.62% 14,467 4.0% N/A N/A
Minimum
To be Well
Minimum Capitalized Under
For Capital Prompt Corrective
Actual Requirement Action Provisions
-------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
-------------------------------------------------------------
<s> <c> <c> <c> <c> <c> <c>
As of December 31, 2003:
Total capital to risk weighted assets
Union $42,498 17.67% $19,241 8.0% $24,051 10.0%
Company 43,324 17.99% 19,266 8.0% N/A N/A
Tier I capital to risk weighted assets
Union 39,404 16.39% 9,617 4.0% 14,425 6.0%
Company 40,225 16.70% 9,635 4.0% N/A N/A
Tier I capital to average assets
Union 39,404 11.16% 14,123 4.0% 17,654 5.0%
Company 40,225 11.38% 14,139 4.0% N/A N/A
Dividends paid by Union are the primary source of funds available to the
Company for payment of dividends to its shareholders. Union is subject to
certain requirements imposed by federal banking laws and regulations. These
requirements, among other things, establish minimum levels of capital and
restrict the amount of dividends that may be distributed by Union to the
Company.
37
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 22. Subsequent Events
On January 14, 2005, Union Bankshares, Inc. declared a $0.24 per share
regular and a $0.40 per share special dividend payable January 28, 2005 to
stockholders of record on January 24, 2005. A special dividend was declared
as the Company's primary capital ratio on December 31, 2004 approached 12%,
earnings were better than anticipated, and the current tax treatment of
dividends is beneficial to shareholders.
Note 23. Condensed Financial Information (Parent Company Only)
The following financial statements are for Union Bankshares, Inc. (Parent
Company Only), and should be read in conjunction with the consolidated
financial statements of Union Bankshares, Inc. and Subsidiary.
UNION BANKSHARES, INC. (PARENT COMPANY ONLY)
CONDENSED BALANCE SHEETS
DECEMBER 31, 2004 AND 2003
2004 2003
---------------------------
<s> <c> <c>
ASSETS
Cash $ 925,584 $ 906,476
Investment in Subsidiary-Union 41,559,523 40,165,232
Other assets 545,178 502,473
---------------------------
Total assets $43,030,285 $41,574,181
===========================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities
Other liabilities $ 627,261 $ 587,517
---------------------------
Total liabilities 627,261 587,517
---------------------------
Stockholders' equity
Common stock, $2 par value; 5,000,000 shares authorized;
4,915,611 shares issued in 2004 and 4,911,261 shares issued in 2003 9,831,222 9,822,522
Paid-in capital 106,989 54,576
Retained earnings 33,809,456 32,070,843
Treasury stock, at cost; 360,948 shares in 2004 and 2003 (1,721,931) (1,721,931)
Accumulated other comprehensive income 377,288 760,654
---------------------------
Total stockholders' equity 42,403,024 40,986,664
---------------------------
Total liabilities and stockholders' equity $43,030,285 $41,574,181
===========================
The investment in the subsidiary bank is carried under the equity method of
accounting. The investment and cash, which is on deposit with Union, has
been eliminated in consolidation.
38
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 23. Condensed Financial Information (Parent Company Only) (Continued)
UNION BANKSHARES, INC. (PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
2004 2003 2002
----------------------------------------
<s> <c> <c> <c>
Revenues
Dividends-bank subsidiaries $4,230,000 $4,015,000 $3,795,000
Other income 25,476 29,018 32,829
----------------------------------------
Total revenues 4,255,476 4,044,018 3,827,829
----------------------------------------
Expenses
Interest 838 633 678
Administrative and other 298,520 363,548 283,123
----------------------------------------
Total expenses 299,358 364,181 283,801
----------------------------------------
Income before applicable income tax and equity in undistributed net
income of subsidiaries 3,956,118 3,679,837 3,544,028
Applicable income tax benefit (101,352) (120,260) (95,043)
----------------------------------------
Income before equity (deficit) in undistributed net income of subsidiaries 4,057,470 3,800,097 3,639,071
Equity in undistributed net income-Union 1,777,657 1,586,989 1,691,288
Deficit in undistributed net income-Citizens - - (150,545)
----------------------------------------
Net income $5,835,127 $5,387,086 $5,179,814
========================================
39
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 23. Condensed Financial Information (Parent Company Only) (Continued)
UNION BANKSHARES, INC. (PARENT COMPANY ONLY)
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
2004 2003 2002
-------------------------------------------
<s> <c> <c> <c>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 5,835,127 $ 5,387,086 $ 5,179,814
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in undistributed net income of Union (1,777,657) (1,586,989) (1,691,288)
Deficit in undistributed net income of Citizens - - 150,545
Increase in other assets (42,705) (46,391) (51,581)
Decrease in other liabilities 39,744 63,361 74,870
-------------------------------------------
Net cash provided by operating activities 4,054,509 3,817,067 3,662,360
-------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Dividends paid (4,096,514) (3,728,457) (3,451,475)
Proceeds from exercise of stock options 61,113 76,526 45,299
Proceeds paid out for fractional shares - (3,404) -
-------------------------------------------
Net cash used in financing activities (4,035,401) (3,655,335) (3,406,176)
-------------------------------------------
Net increase in cash 19,108 161,732 256,184
Beginning cash 906,476 744,744 488,560
-------------------------------------------
Ending cash $ 925,584 $ 906,476 $ 744,744
===========================================
SUPPLEMENTAL SCHEDULE OF CASH PAID DURING THE YEAR
Interest $ 838 $ 633 $ 678
===========================================
Income taxes $ 250 $ 250 $ 250
===========================================
40
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Notes to Consolidated Financial Statements (Continued)
Note 24. Quarterly Financial Data (Unaudited)
A summary of financial data for the four quarters of 2004, 2003, and 2002
is presented below (dollars in thousands):
Quarters in 2004 Ended
-------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
-------------------------------------------------
<s> <c> <c> <c> <c>
Interest income $4,867 $4,902 $5,116 $5,293
Interest expense 844 817 806 843
Net interest income 4,023 4,085 4,310 4,450
Provision for loan losses - - 30 -
Noninterest income 962 870 882 1,060
Noninterest expenses 3,176 3,149 3,022 2,972
Net income 1,274 1,305 1,499 1,757
Earnings per common share $ 0.28 $ 0.29 $ 0.33 $ 0.39
Quarters in 2003 Ended
-------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
-------------------------------------------------
<s> <c> <c> <c> <c>
Interest income $5,141 $5,109 $5,081 $5,041
Interest expense 1,199 1,111 978 921
Net interest income 3,942 3,998 4,103 4,120
Provision for loan losses 42 42 30 -
Noninterest income 915 790 828 1,070
Noninterest expenses 3,091 3,093 2,965 2,922
Net income 1,229 1,189 1,362 1,607
Earnings per common share $ 0.27 $ 0.26 $ 0.30 $ 0.35
Quarters in 2002 Ended
-------------------------------------------------
March 31, June 30, Sept. 30, Dec. 31,
-------------------------------------------------
<s> <c> <c> <c> <c>
Interest income $5,536 $5,529 $5,583 $5,521
Interest expense 1,755 1,593 1,546 1,470
Net interest income 3,781 3,936 4,037 4,051
Provision for loan losses 90 105 95 66
Noninterest income 727 761 986 1,086
Noninterest expenses 2,787 3,046 2,951 2,977
Net income 1,169 1,083 1,396 1,532
Earnings per common share $ 0.26 $ 0.23 $ 0.31 $ 0.34
Note 25. Noninterest Other Income and Noninterest Other Expenses
The components of noninterest other income and noninterest other expenses
which are in excess of one percent of total revenues in any of the three
years presented are as follows:
2004 2003 2002
----------------------------------------
<s> <c> <c> <c>
Expenses
Supplies $ 240,189 $ 256,944 $ 236,463
State franchise tax 262,836 253,693 241,169
Postage and shipping 219,966 256,599 255,115
Write-downs of other real estate owned - 42,846 309,688
Expenses of other real estate owned 51,957 63,764 267,036
Other 2,501,733 2,376,437 2,183,467
----------------------------------------
$3,276,681 $3,250,283 $3,492,938
========================================
41
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
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 December 31, 2004 and 2003, and its results of
operations for the years ended December 31, 2004, 2003, and 2002. 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 in this report. The purpose of this presentation is to
enhance overall financial disclosures and to provide information about
historical financial performance and developing trends as a means to assess
to what extent past performance can be used to evaluate the prospects for
future performance. Management is not aware of the occurrence of any events
after December 31, 2004, which would materially affect the information
presented below.
FORWARD-LOOKING STATEMENTS
The Company may from time to time make written or oral statements that are
considered "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements may
include financial projections, statements of plans and objectives for
future operations, estimates of future economic performance and assumptions
relating thereto. The Company may include forward-looking statements in its
filings with the Securities and Exchange Commission, in its reports to
stockholders, including this Annual Report, in other written materials, and
in statements made by senior management to analysts, rating agencies,
institutional investors, representatives of the media and others.
Forward-looking statements reflect management's current expectations and
are subject to uncertainties, both general and specific, and risk exists
those predictions, forecasts, projections and other estimates contained in
forward-looking statements will not be achieved. Also when we use any of
the words "believes," "expects," "anticipates," "intends," "plans,"
"seeks," "estimates" or similar expressions, we are making forward-looking
statements. Many possible events or factors including those beyond the
control of management, could affect the future financial results and
performance of our Company. This could cause results or performance to
differ materially from those expressed in our forward-looking statements.
The possible events or factors that might affect our forward-looking
statements include, but are not limited to, the following:
* uses of monetary, fiscal and tax policy by various governments
* political, legislative or regulatory developments in Vermont, New
Hampshire or the United States including changes in laws concerning
accounting, taxes, banking and other aspects of the financial services
industry
* developments in general economic or business conditions in Vermont and
Northern New Hampshire including interest rate fluctuations, market
fluctuations and perceptions, job creation and unemployment rates,
ability to attract new business, inflation and their effect on the
Company or its customers
* changes in the competitive environment for financial services
organizations including increased competition from tax-advantaged
credit unions
* 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
* the Company's ability to retain key personnel
* changes in technology including demands for greater automation which
could present operational issues or significant capital outlays
* unanticipated lower revenues, loss of customers or business, or higher
operating expenses
* adverse changes in the securities market which could adversely affect
* the value of the Company's stock
* the failure of assumptions underlying the establishment of allowances
for loan losses and estimations of values of collateral and various
financial assets and liabilities
* the failure of actuarial, investment, work force, salary and other
assumptions underlying the establishment of reserves for future pension
costs
* the amount that we invest in new business opportunities and the timing
of these investments
* 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
* 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
* the creditworthiness of current loan customers is different from our
understanding or changes dramatically and therefore the allowance for
loan losses becomes inadequate
42
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
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 related notes. The Securities and Exchange Commission
("SEC") has defined a company's critical accounting policies as the ones
that are most important to the portrayal of the company's financial
condition and results of operations, and which require the company to make
its most difficult and subjective judgments, often as a result of the need
to make estimates of matters that are inherently uncertain. Based on this
definition, 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 these judgments and estimates that could have a material
impact on the carrying values of assets and liabilities and the results of
operations of the Company.
The Company believes the allowance for loan losses is a critical accounting
policy that requires the most significant judgments and estimates used in
the preparation of its consolidated financial statements. In estimating the
allowance for loan losses, management utilizes historical experience as
well as other factors including the effect of changes in the local real
estate market on collateral values, the effect on the loan portfolio of
current economic indicators and their probable impact on borrowers and
changes in delinquent, nonperforming or impaired loans. Changes in these
factors may cause management's estimate of the allowance for loan losses to
increase or decrease and result in adjustments to the Company's provision
for loan losses in future periods. 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
liability for the defined benefit pension plan, valuation of deferred tax
assets and analysis of potential impairment of investment securities. The
most significant accounting policies followed by the Company are presented
in Note 1 to these financial statements and FINANCIAL CONDITION-Allowance
for Loan Losses below. 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 continued to grow and become more profitable during 2004 as we
began to see the impact of the 2004 increases in the prime rate and we
neared the completion of reducing duplicative efforts and costs associated
with the pre-May 2003 running of two individual bank subsidiaries. Earnings
per share grew from $1.18 per share in 2003 to $1.28 in 2004, or 8.5%.
Dividends paid out to shareholders increased from $0.82 per share in 2003
to $0.90 in 2004, or 9.75%, as the Board of Directors continues to evaluate
the utilization of the Company's capital resources.
The Company grew 2.5% in total average assets between 2003 and 2004 as
compared to 1.7% between 2002 and 2003 as we continued in both years to
manage growth through the sale of long-term fixed interest rate loans while
long-term interest rates stayed near a historic low. Despite the fact that
the Prime Rate started to increase from its two year low of 4% on July 1,
2004 to end the year at 5.25%, the yield curve has narrowed and long-term
rates have decreased approximately 55 basis points from 6% to 5.45% in the
same time frame.
The effect of the increases in the prime rate has assisted our net interest
margin during the second half of 2004, which rose from 5.20% for 2003 to
5.24% for 2004, as our variable rate loan portfolio has, for the most part,
adjusted at least once for variable rate mortgages, twice for quarterly
adjustable loans and five times for the immediately adjustable portfolio.
Rates paid on deposit products have risen more slowly which has also had a
positive impact on both the net interest spread and the net interest
margin.
Loan demand moderated somewhat but remained strong in 2004 with a 3.1%
growth over 2003 on our financial statements despite selling $25.8 million
of loans in 2004 which would have taken our growth rate to 12.6% if not for
the sales. Growth for 2003 was 6.1% net of selling loans of $29.7 million
which would have given us a gross growth rate of 17.7%. Loans in non-
accrual status have
43
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
decreased 25% between years. Other non-performing loans, with the exception
of one closely monitored, well collateralized commercial real estate
credit, are also down. For the second year in a row, the ratio of net
charge-offs to average loans not held for sale has been at 0.00% as
recoveries have been greater than charge-offs. Therefore, our allowance for
loan losses has remained adequate and the Company has been able to reduce
its provision for loan losses from $580 thousand in 1996 to $114 thousand
in 2003 and to $30 thousand in 2004, while still maintaining a loan loss
allowance coverage ratio of over 1.1% of total loans not held for sale.
Competition in the financial services market place has been strong during
the last few years for loans but the improvement in the stock market and
the re-introduction of "special" deposit products and teaser rates have
made the competition for deposits intense. The growth in deposits dropped
from $12.4 million or 4.2% in 2003 to $1.2 million or 0.4% in 2004. The
Company has recently completed a review of the deposit products it offers
and will be introducing streamlined offerings in early 2005. The Company
will continue to focus on customer service and its core business of
community banking to provide products and services to the communities it
serves.
The regulatory environment of the last couple of years, including the
federal Sarbanes-Oxley Act of 2002, has put an extensive burden on small
publicly traded companies as there is no difference in the requirements
placed because of size, complexity of operations and products, or other
regulatory oversight which the banking industry already has from states,
the FDIC and the Federal Reserve. The additional requirements add to our
operating costs and divert us somewhat from our objectives of growing and
strengthening our business. The subsidiaries of bank holding companies also
spend a good deal of time and dollars complying with the U.S. Patriot Act
and the Bank Secrecy Act to protect the U.S. financial system and their
customers against identity theft, anti-money laundering, and terrorism.
The following per share information and key ratios depict several
measurements of performance or financial condition for or at the years
ending December 31, 2004 and 2003, respectively:
December 31, 2004 December 31, 2003
---------------------------------------
<s> <c> <c>
Return on average assets (ROA) 1.65% 1.56%
Return on average equity (ROE) 14.17% 13.50%
Net interest margin (1) 5.24% 5.20%
Efficiency ratio (2) 59.02% 60.19%
Net interest spread (3) 4.98% 4.91%
Loan to Deposit ratio 91.40% 88.99%
Net loan charge-offs to average loans 0.00% 0.00%
Allowance for loan losses to loans 1.13% 1.20%
Non-performing assets to total assets 1.48% 0.93%
Equity to assets 11.79% 11.50%
Total capital to risk weighted assets 18.57% 17.99%
Book value per share $9.31 $9.01
Earnings per share $1.28 $1.18
Dividends paid per share $0.90 $0.82
Dividend payout ratio(4) 70.31% 69.49%
<FN>
- --------------------
<F1> The ratio of tax equivalent net interest income to average earning
assets.
<F2> The ratio of noninterest expense to tax equivalent net interest
income and noninterest income excluding securities gains and losses.
<F3> The difference between the average rate earned on assets minus the
average rate paid on liabilities.
<F4> Cash dividend declared and paid per share divided by consolidated net
income per share.
</FN>
44
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
RESULTS OF OPERATIONS
The Company's net income for the year ended December 31, 2004 was $5.8
million compared with net income of $5.4 million for the year 2003. Net
income per share was $1.28 for 2004 compared to $1.18 for 2003. Return on
Assets was 1.65% for 2004 compared to 1.56% for 2003. Return on Equity was
14.17% for 2004 compared to 13.50% for 2003.
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 its interest-bearing liabilities. The Company's net
interest income increased by $704 thousand, or 4.36%, to $16.9 million for
the year ended December 31, 2004, from $16.2 million for the year ended
December 31, 2003. This increase was primarily due to the decrease in the
rates paid on our deposit products as interest rates paid continued to drop
during the first half of 2004 and have not yet increased to the 2003 level
despite the increases in Federal Funds, Discount and Prime rates during the
second half of 2004. On average for the year 92.3% of our assets were
earning interest in 2004 versus 91.5% in 2003 as non-interest bearing
balances maintained at the Federal Reserve Bank of Boston and correspondent
banks decreased when we decided to pay for services utilized in hard
dollars instead of via earnings credit earned through balances maintained
and to provide adequate liquidity given the anticipation of rising interest
rates. The net interest spread increased by 7 basis points to 4.98% for the
year ended December 31, 2004, from 4.91% for the year ended December 31,
2003. The net interest margin for the 2004 period increased by 4 basis
points to 5.24 % from 5.20% for the 2003 period.
45
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Yields Earned and Rates Paid. The following table shows for the periods
indicated, the total amount of income recorded from interest-earning
assets, the related average yields, the interest expense associated with
interest-bearing liabilities, expressed in dollars and average rates, and
the relative net interest spread and net interest margin. Yield and rate
information for a period is average information for the period, and is
calculated by dividing the income or expense item for the period by the
average balances of the appropriate balance sheet item during the period.
Nonaccrual loans are included in asset balances for the appropriate
periods, but recognition of interest on such loans is discontinued and any
remaining accrued interest receivable is reversed, in conformity with
federal regulations. The yields and net interest margins appearing in the
following table have been calculated on a pre-tax basis:
Years ended December 31
---------------------------------------------------------------------------------------------------
2004 2003 2002
---------------------------------------------------------------------------------------------------
Average Income/ Average Average Income/ Average Average Income/ Average
Balance Expense Yield/Rate Balance Expense Yield/Rate Balance Expense Yield/Rate
---------------------------------------------------------------------------------------------------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Average Assets:
Federal funds sold and
overnight deposits $ 3,851 $ 47 1.20% $ 7,733 $ 73 0.95% $ 8,602 $ 123 1.43%
Interest bearing deposits
in banks 6,631 207 3.12% 4,864 177 3.63% 4,022 192 4.79%
Investments (1), (2) 42,787 1,944 4.75% 39,014 1,878 5.08% 46,322 2,557 5.77%
Loans, net (1), (3) 272,204 17,948 6.65% 263,149 18,204 6.98% 253,100 19,252 7.68%
FHLB of Boston stock 1,241 32 2.56% 1,239 40 3.23% 1,196 45 3.78%
-----------------------------------------------------------------------------------------------
Total interest-earning
assets (1) 326,714 20,178 6.25% 315,999 20,372 6.53% 313,242 22,169 7.17%
Cash and due from banks 14,925 16,728 13,168
Premises and equipment 4,855 4,558 4,656
Other assets 7,350 8,005 8,554
-----------------------------------------------------------------------------------------------
Total assets $353,844 $345,290 $339,620
===============================================================================================
Average Liabilities and
Stockholders' Equity:
NOW accounts $ 45,619 $ 185 0.41% $ 43,349 $ 223 0.51% $ 39,143 $ 418 1.07%
Savings/money
accounts 111,893 836 0.75% 108,991 1,036 0.95% 105,858 1,732 1.64%
Time deposits 92,656 1,927 2.08% 99,432 2,607 2.62% 102,757 3,695 3.60%
Borrowed funds 9,674 362 3.66% 7,529 342 4.54% 12,003 519 4.32%
-----------------------------------------------------------------------------------------------
Total interest-bearing
Liabilities 259,842 3,310 1.27% 259,301 4,208 1.62% 259,761 6,364 2.45%
Non-interest bearing deposits 49,638 42,341 37,932
Other liabilities 3,172 3,739 4,223
-----------------------------------------------------------------------------------------------
Total liabilities 312,652 305,381 301,916
Stockholders' equity 41,192 39,909 37,704
-----------------------------------------------------------------------------------------------
Total liabilities and
stockholders equity $353,844 $345,290 $339,620
===============================================================================================
Net interest income $16,868 $16,164 $15,805
====================================================================================
Net interest spread (1) 4.98% 4.91% 4.72%
Net interest margin (1) 5.24% 5.20% 5.14%
<FN>
- --------------------
<F1> Average yields reported on a tax-equivalent basis.
<F2> Average balances of investments are calculated on the amortized cost
basis.
<F3> Includes loans held for sale and is net of unearned income and
allowance for loan losses.
</FN>
46
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Rate/Volume Analysis. The following table describes the extent to which
changes in interest rates and changes in volume of interest-earning assets
and interest-bearing liabilities have affected the Company's interest
income and interest expense during the periods indicated. For each category
of interest-earning assets and interest-bearing liabilities, information is
provided on changes attributable to:
* changes in volume (change in volume multiplied by prior rate);
* changes in rate (change in rate multiplied by current volume); and
* total change in rate and volume.
Changes attributable to both rate and volume have been allocated
proportionately to the change due to volume and the change due to rate.
Year Ended December 31, 2004 Year Ended December 31, 2003
Compared to Year Ended Compared to Year Ended
December 31, 2003 Increase/ December 31, 2002 Increase/
(Decrease) Due to Change In (Decrease) Due to Change In
-----------------------------------------------------------------
Volume Rate Net Volume Rate Net
-----------------------------------------------------------------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c>
Interest-earning assets:
Federal funds sold and overnight deposits $ (36) $ 10 $ (26) $ (12) $ (38) $ (50)
Interest-bearing deposits in banks 64 (34) 30 40 (55) (15)
Investments 199 (133) 66 (415) (264) (679)
Loans, net 637 (893) (256) 783 (1,831) (1,048)
FHLB of Boston stock - (8) (8) 2 (7) (5)
-----------------------------------------------------------------
Total interest-earning assets $ 864 $(1,058) $(194) $ 398 $(2,195) $(1,797)
Interest-bearing liabilities:
NOW accounts $ 11 $ (49) $ (38) $ 46 $ (241) $ (195)
Savings/money market accounts 28 (228) (200) 53 (749) (696)
Time deposits (178) (502) (680) (117) (971) (1,088)
Borrowed funds 105 (85) 20 (193) 16 (177)
-----------------------------------------------------------------
Total interest-bearing liabilities $ (34) $ (864) $(898) $(211) $(1,945) $(2,156)
-----------------------------------------------------------------
Net change in net interest income $ 898 $ (194) $ 704 $ 609 $ (250) $ 359
=================================================================
Interest and Dividend Income. The Company's interest and dividend income
decreased by $0.2 million or 1.0% to $20.2 million for the year ended
December 31, 2004 from $20.4 million for the year ended December 31, 2003.
Average earning assets increased by $10.7 million or 3.4% from $316.0
million at December 31, 2003 to $326.7 million at December 31, 2004.
Average loans were $272.2 million for the year ended December 31, 2004
compared to $263.1 million for the year ended December 31, 2003 which is an
increase of $9.1 million or 3.5%. Increases in construction, commercial
real estate, and municipal loans, were partially offset by a decline in the
installment loan portfolio, a reduction in the home equity portfolio as a
consequence of refinancing activities, and a shrinkage in the residential
mortgage portfolio as the Company sold low fixed rate loans into the
secondary market. Increases in loan volume partially offset the effects of
a lower long-term interest rate environment. The yield on the loan
portfolio decreased from 6.98% for the year ended December 31, 2003 to
6.65% for the year ended December 31, 2004 or a decrease of 33 basis points
as the interest rate environment didn't start to improve until halfway
through 2004.
The average balance of investment securities (including mortgage-backed
securities) increased by $3.8 million or 9.7% from $39.0 million for the
year ended December 31, 2003 to $42.8 million for the year ended December
31, 2004. This increase was in part due to the decision to move funds out
of non-interest bearing balances maintained at the Federal Reserve Bank of
Boston and various correspondent banks when we decided to pay for services
utilized in hard dollars instead of through soft dollars by maintaining
compensating balances. The yield on the investment portfolio dropped from
5.08% for 2003 to 4.75% for 2004 or 33 basis points as the duration of the
portfolio has been kept short in anticipation of the rise in interest rates
which started mid-2004 and to fund the Company's ordinary Liquidity needs.
The average level of federal funds sold and overnight deposits decreased
$3.9 million or 50.2% from $7.7 million for the year ended December 31,
2003 to $3.9 million for the year ended December 31, 2004. The average
47
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
balance of interest-bearing deposits increased by $1.7 million or 36.3% to
$6.6 million for the year ended December 31, 2004 from $4.9 million for the
year ended December 31, 2003. These deposit instruments are FDIC insured.
The yield on interest-bearing deposits in banks dropped from 3.63% for 2003
to 3.12% for 2004 or 51 basis points as a number of long-term higher rate
certificates matured during the year and were replaced with lower rate
certificates due to the current rate environment.
Interest Expense. The Company's interest expense declined $0.9 million or
21.3% from $4.2 million for the year ended December 31, 2003 to $3.3
million for the year ended December 31, 2004. Interest rates paid in 2004
dropped for all categories of liabilities as market rates dropped even
lower during the majority of the year. Average interest-bearing liabilities
increased $0.6 million from $259.3 million for the year ended December 31,
2003 to $259.8 million for the year ended December 31, 2004. Average NOW
accounts increased $2.3 million or 5.2% from $43.3 million for the year
ended December 31, 2003 to $45.6 million for the year ended December 31,
2004 as the economy continued to improve and customers had more disposable
income. The average balances of savings and money market accounts increased
$2.9 million or 2.7%, from $109.0 million for the year ended December 31,
2003 to $111.9 million for the year ended December 31, 2004. The decrease
of $6.8 million or 6.8% in the time deposit category dropped balances from
an average of $99.4 million for the year ended December 31, 2003 to $92.7
million for the year ended December 31, 2004 as customers stayed even more
liquid, perhaps in anticipation of rising rates. The average balance of
borrowed funds increased $2.2 million or 29.1%, from $7.5 million to $9.7
million to fund loan growth since lower cost deposits weren't available as
a funding source. The average rate paid for borrowed funds decreased from
4.54% for the year ended December 31, 2003 to 3.66% for the year ended
December 31, 2004 as some lower rate borrowings were taken down during
2004.
Provision for Loan Losses. Because of continued improvements in nearly all
indicators of the Company's credit quality, the reduced level of net
charge-offs, and management's assessment of economic conditions and risks,
the provision for loan losses was dropped from $114 thousand in 2003 to $30
thousand in 2004.
Noninterest Income. The Company's noninterest income increased by $172
thousand for the year ended December 31, 2004. Trust income increased from
$163 thousand for 2003 to $204 thousand in 2004 as fee increases introduced
in July 2003 were in place for the full year. The year 2004 reflected a
gain from the sale of securities available-for-sale of $23 thousand versus
$379 in 2003. The results for the period reflected a net gain of $444
thousand from the sale of loans compared to a net gain of $525 thousand
from these sales during 2003 as total loans sold dropped from $29.7 million
in 2003 to $25.8 million in 2004 as the residential refinancing boom slowed
down. Service fees (sources of which include, among others, deposit and
loan servicing fees, ATM fees and safe deposit fees) increased by $141
thousand, or 5.3%, to $2.8 million for the year ended December 31, 2004.
Other noninterest income increased by $47 thousand, or 18.4%, to $301
thousand for 2004 from $254 thousand for 2003 due mainly to the increase in
Gain on Sale of Other Real Estate Owned ("OREO") for 2004.
Noninterest Expense. The Company's noninterest expense increased $259
thousand, or 2.2%, to $12.3 million for the year ended December 31, 2004,
from $12.1 million for the year ended December 31, 2003. Salaries increased
$98 thousand, or 1.9%, to $5.4 million for the year ended December 31,
2004, from $5.3 million for the year ended December 31, 2003, reflecting
normal salary activity. Pension and employee benefits increased $61
thousand or 3.2% to $2.0 million for the year ended December 31, 2004, from
$1.9 million for the year ended December 31, 2003 mainly due to the
increase in the accrual for the Defined Benefit Pension Plan caused by the
addition January 1, 2004 of the eligible former Citizens employees to the
plan. That increase was partially offset by the decrease in the cost of
medical insurance coverage. Office occupancy expense increased $46
thousand, or 6.7%, to $737 thousand for the year ended December 31, 2004,
from $691 thousand for the year ended December 31, 2003 due mainly to
building maintenance. Equipment expense increased $28 thousand or 3.1% from
$903 thousand in 2003 to $931 thousand in 2004 mainly due to increased
depreciation expense as computers, software and equipment are upgraded to
remain current and competitive. Other operating expense only increased $27
thousand to $3.28 million for the year ended December 31, 2004 compared to
$3.25 million for 2003 or an 0.8% increase, mainly due to an increase in
advertising expense of $69 thousand from $155 thousand in 2003 to $224
thousand in 2004, and write down on available-for-sale equity securities
deemed impaired of $42 thousand in 2004. These increased noninterest
expenses were partially offset by a decrease in write-downs and costs to
operate other real estate owned which was $52 thousand in 2004 versus $107
thousand in 2003, a reduction in postage and shipping expense to $220
thousand in 2004 compared to $257 thousand in 2003 due to the introduction
of imaged statements in the middle of 2004 and upgraded software
capabilities, the non-recurrance of $72 thousand in costs in 2003 resulting
from the merger of the two subsidiary banks and the $43 thousand of one
time expense related to the 3-for-2 stock split in 2003.
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 increased by $253 thousand, or 11.4%,
to $2.5 million for the year ended December 31, 2004, from $2.2 million for
2003 mainly due to increased taxable income sources. This increase was
partially
48
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
offset by the low income housing tax credits that were available in both
the 2004 and 2003 tax years related to the Company's limited partnership
investments in low income housing projects sponsored by Housing Vermont,
Inc. (a non-profit agency) in its market area. The Company's effective tax
rate for 2004 was 29.6% compared to 29.0% for 2003.
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Interest and Dividend Income. The Company's interest and dividend income
decreased by $1.8 million to $20.4 million for the year ended December 31,
2003 from $22.2 million for the year ended December 31, 2002. Average
earning assets increased by $2.8 million or 0.9% from $313.2 million at
December 31, 2002 to $316.0 million at December 31, 2003. Average loans
were $263.1 million for the year ended December 31, 2003 compared to $253.1
million for the year ended December 31, 2002 which is an increase of $10.0
million or 4.0%. Increases in construction, commercial real estate, and
municipal loans, were partially offset by a decline in the installment loan
portfolio, a reduction in the home equity portfolio as a consequence of
refinancing activities, and a shrinkage in the residential mortgage
portfolio as the Company sold low fixed rate loans into the secondary
market. Increases in loan volume partially offset the effects of a lower
interest rate environment. The yield on the loan portfolio fell from 7.68%
for the year ended December 31, 2002 to 6.98% for the year ended December
31, 2003. This decrease of 70 basis points equates to a 9.1% reduction in
earning power of loan assets.
The average balance of investment securities (including mortgage-backed
securities) decreased by $7.3 million or 15.8% from $46.3 million for the
year ended December 31, 2002 to $39.0 million for the year ended December
31, 2003. This decrease was in part to fund loan demand, as well as to
raise our compensating balances with correspondent banks to reduce hard
dollar account fees. The average level of federal funds sold and overnight
deposits decreased $0.9 million or 10.1% from $8.6 million for the year
ended December 31, 2002 to $7.7 million for the year ended December 31,
2003. The average balance of interest-bearing deposits increased by $0.9
million or 20.9% to $4.9 million for the year ended December 31, 2003 from
$4.0 million for the year ended December 31, 2002.
Interest Expense. The Company's interest expense declined $2.2 million or
33.9% from $6.4 million for the year ended December 31, 2002 to $4.2
million for the year ended December 31, 2003. Interest rates paid in 2003
dropped for all categories of deposits as market rates dropped even lower
during the year. The rates paid on interest-bearing core deposits, which
are over 60% of our interest-bearing deposits, dropped dramatically during
the year as the Company recognized this was not a temporary drop in market
rates and did not want to continue to compress the interest margin. Average
interest-bearing liabilities decreased $.5 million or 0.2% from $259.8
million for the year ended December 31, 2002 to $259.3 million for the year
ended December 31, 2003. Average NOW accounts increased $4.2 million or
10.7% from $39.1 million for the year ended December 31, 2002 to $43.3
million for the year ended December 31, 2003 as the economy started to
improve and customers had more disposable income. The average balances of
savings and money market accounts increased $3.1 million or 3.0%, from
$105.9 million for the year ended December 31, 2002 to $109.0 million for
the year ended December 31, 2003. This increase of $3 million mirrors the
decrease in the time deposit category as customers stayed even more liquid
and our core deposit rates were better than the short-term certificate
rates at certain points in the year. The average balance of borrowed funds
dropped $4.5 million or 37.3%, from $12.0 million to $7.5 million. The
average rate paid for borrowed funds increased from 4.32% for the year
ended December 31, 2002 to 4.54% for the year ended December 31, 2003 as
some short term, lower rate borrowings matured during 2003.
Provision for Loan Losses. Because of continued improvements in nearly all
indicators of the Company's credit quality, the reduced level of net
charge-offs, and management's assessment of economic conditions and risks,
the provision for loan losses was dropped from $356 thousand in 2002 to
$114 thousand in 2003.
Noninterest Income. The Company's noninterest income increased by $43
thousand for the year ended December 31, 2003. The results for the period
reflected a net gain of $525 thousand from the sale of loans compared to a
net gain of $661 thousand from these sales during 2002. Service fees
(sources of which include, among others, deposit and loan servicing fees,
ATM fees and safe deposit fees) increased by $102 thousand, or 4.0%, to
$2.7 million for the year ended December 31, 2003. Other noninterest income
increased by $80 thousand, or 46.1%, to $254 thousand for 2003 from $174
thousand for 2002 due mainly to the new contract for the sale of checkbooks
and a stronger income stream from oil and gas leases, acquired in the
1930's.
Noninterest Expense. The Company's noninterest expense increased $0.3
million, or 2.5%, to $12.1 million for the year ended December 31, 2003,
from $11.8 million for the year ended December 31, 2002. Salaries increased
$210 thousand, or 4.1%, to $5.3 million for the year ended December 31,
2003, from $5.1 million for the year ended December 31, 2002, reflecting
normal salary activity and the $186 thousand non-recurring payments for
separation or reduction in force agreements with four former Citizen
49
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
employees. Pension and employee benefits increased $232 thousand or 13.8 %
to $1.9 million for the year ended December 31, 2003, from $1.7 million for
the year ended December 31, 2002 mainly due to the increase in the accrual
for the Defined Benefit Pension Plan caused by anticipated increases in
future salaries and the performance of the underlying investment
instruments; the increase in the cost of medical insurance coverage, and
the increase in payroll taxes mainly attributable to the non-recurring
payment under the separation agreement. Office occupancy expense increased
$91 thousand, or 15.1%, to $691 thousand for the year ended December 31,
2003, from $600 thousand for the year ended December 31, 2002 due mainly to
building maintenance and increasing property taxes. Other operating expense
decreased $243 thousand to $3.3 million for the year ended December 31,
2003 compared to $3.5 million for 2002 or a 6.9% decrease, mainly due to a
decrease in the write downs and costs to operate other real estate owned
which was of $107 thousand in 2003 versus $577 thousand in 2002, this was
partially offset by $72 thousand in costs resulting from the merger of the
two subsidiary banks and $43 thousand in one time expense related to the 3-
for-2 stock split in 2003.
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 increased by $138 thousand, or 6.7%,
to $2.2 million for the year ended December 31, 2003, from $2.1 million for
2002 mainly due to increased taxable income sources. This increase was
partially offset by the low income housing tax credits that were available
in both the 2003 and 2002 tax years related to the Company's limited
partnership investments in low income housing projects sponsored by Housing
Vermont, Inc. (a non-profit agency) in its market area. The Company's
effective tax rate for 2003 was 29.0% compared to 28.5% for 2002.
FINANCIAL CONDITION
At December 31, 2004, the Company had total consolidated assets of $359.5
million, including net loans and loans held for sale of $277.0 million,
deposits of $306.6 million and stockholders' equity of $42.4 million. Based
on the most recent information published by the Vermont Banking
Commissioner, in terms of total assets at December 31, 2003, Union Bank
ranked as the 5th largest institution of the 19 commercial banks and
savings institutions headquartered in Vermont.
The Company's total assets increased by $2.9 million, or 0.8% to $359.5
million at December 31, 2004 from $356.6 million at December 31, 2003.
Total net loans and loans held for sale increased by $8.5 million or 3.2%
to 277.0 million or 77.0% of total assets at December 31, 2004 as compared
to $268.5 million or 75.3% of total assets at December 31, 2003. This was
due to increases of $6.1 million in commercial real estate loans, a $10.2
million increase in residential real estate loans, a $1.8 million increase
in construction loans, and a $2.7 million increase in commercial loans.
These increases were partially offset by a $0.7 million decrease in loans
to consumers and a $1.9 million decrease in municipal loans. Loan growth
was strong during the year but was moderated by accelerated prepayments
during 2004 due to the continuing low rate environment and management's
decision to continue to sell low fixed rate loans into the secondary market
during 2004 to mitigate future interest rate risk.
Cash and due from banks decreased from $23.6 million at December 31, 2003
to $16.9 million at December 31, 2004 as the Company made a decision in
mid-2004 to stop paying for correspondent bank's service fees via the
maintenance of non-interest bearing balances and moved those funds into
interest-earning assets. Federal funds sold and overnight deposits
increased $3.3 million to $4.2 million at December 31, 2004 from $0.9
million at December 31, 2003. Securities available-for-sale decreased $3.4
million or 7.7% from $44.4 million at December 31, 2003 to $41.0 million at
December 31, 2004. The majority of the decrease was due to funds maturing
that were not all reinvested in securities but were instead used to support
loan demand. There was also a reduction of $599 thousand in the unrealized
holding gains due to the increase in interest rates during the second half
of 2004 which resulted in a reduction in the value of debt securities held.
In June 2004, the Company wrote down through Other expenses two equity
securities by $42 thousand to their quoted fair market value. Their value
had been below the cost basis for an extended period of time and management
was unsure if the Company would be able to recover the cost. The equity
securities remain on the Company's books as of December 31, 2004 and are
both valued over their new carrying costs.
Total deposits increased $1.2 million or 0.4% to $306.6 million at December
31, 2004 from $305.4 million at December 31, 2003. Non-interest bearing
deposits grew 18.3% or $8.9 million from $48.4 million at December 31, 2003
to $57.2 million at December 31, 2004. Interest-bearing deposits decreased
3.0% or $7.6 million from $257.0 million to $249.4 million.
Total equity increased by $1.4 million or 3.4% to $42.4 million at December
31, 2004 from $41.0 million at December 31, 2003 as a result of net income
of $5.8 million and the exercise of employee stock options for $61thousand.
These increases were partially offset by dividend payments of $4.1 million
and a decrease of $383 thousand in the net unrealized holding gain on
securities available-for-sale.
50
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Loan Portfolio. The Company's loan portfolio (including loans held for
sale) primarily consists of adjustable- and fixed-rate mortgage loans
secured by one-to-four family, multi-family residential or commercial real
estate. As of December 31, 2004, the gross loan portfolio totaled $280.2
million or 77.9% of assets compared to $271.7 million or 76.2% of assets as
of December 31, 2003. Gross loans and loans held for sale have increased
$8.5 million or 3.1 % since December 31, 2003, despite selling $25.8
million of loans held for sale during 2004 resulting in a gain on sale of
loans of $444 thousand. Loans sold during 2003 totaled $29.7 million
resulting in a gain on sale of loans of $525 thousand. Management expects
to continue to use this strategy to manage our interest rate exposure in
the future. The composition of the Company's gross loan portfolio including
loans held for sale at December 31 for each of the last five years was as
follows:
2004 2003 2002 2001 2000
------------------------------------------------------------------------------------------------
$ % $ % $ % $ % $ %
------------------------------------------------------------------------------------------------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Residential Real Estate 100,130 35.7 89,974 33.1 94,977 37.1 100,762 40.1 94,223 41.9
Construction Real Estate 20,050 7.2 18,257 6.7 14,370 5.6 11,802 4.7 10,194 4.5
Commercial Real Estate 108,474 38.7 102,366 37.7 86,081 33.6 78,898 31.4 66,186 29.4
Commercial 20,584 7.4 17,877 6.6 19,919 7.8 20,659 8.2 18,215 8.1
Consumer & Other 8,729 3.1 9,402 3.5 10,758 4.2 12,201 4.9 14,626 6.5
Municipal 13,454 4.8 15,346 5.6 12,869 5.0 10,552 4.2 12,449 5.5
Loans Held for Sale 8,814 3.1 18,524 6.8 17,139 6.7 16,333 6.5 9,153 4.1
------------------------------------------------------------------------------------------------
Total Loans 280,235 100.0 271,746 100.0 256,113 100.0 251,207 100.0 225,046 100.0
================================================================================================
The Company originates and sells residential mortgages into the secondary
market, with most such sales made to the Federal Home Loan Mortgage
Corporation ("FHLMC") and the Vermont Housing Finance Agency ("VHFA"). The
Company serviced a residential real estate mortgage portfolio of $174.9
million and $153.1 million at December 31, 2004 and 2003, respectively. Of
that portfolio $74.8 million at December 31, 2004 and $63.1 million at
December 31, 2003 was serviced for unaffiliated third parties.
Additionally, the Company originates commercial real estate and commercial
loans under various Small Business Administration ("SBA ") programs that
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 approximately $6.4 million of commercial and commercial
real estate loans for unaffiliated third parties as of December 31, 2004
and $5.0 million at December 31, 2003. The Company capitalizes servicing
rights on these fees and recognizes gains and losses on the sale of the
principal portion of these notes as they occur. The unamortized balance of
servicing rights on loans sold with servicing retained was $318 thousand as
of December 31, 2004 and $270 thousand as of December 31, 2003, with an
estimated market value in excess of their carrying value at both year ends.
In the ordinary course of business, the Company occasionally participates
out a portion of commercial/commercial real estate loans to other financial
institutions for liquidity or credit concentration management purposes. The
total of loans participated out as of December 31, 2004 was $5.8 million
and $7.0 million at December 31, 2003.
51
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table breaks down by classification the maturities of the
gross loans held in portfolio and held for sale as of December 31, 2004:
Within 1 2-5 Over 5
Year Years Years
---------------------------------
(Dollars in thousands)
<s> <c> <c> <c>
Residential Real Estate
Fixed Rate $ 5,986 $13,698 $ 48,175
Variable Rate 1,015 4,530 33,231
Construction Real Estate
Fixed Rate 17,660 764 1,627
Variable Rate - - -
Commercial Real Estate
Fixed Rate 3,059 5,207 3,455
Variable Rate 13,204 30,641 55,113
Commercial
Fixed Rate 2,145 4,006 139
Variable Rate 6,730 6,098 1,570
Municipal
Fixed Rate 11,067 1,469 918
Variable Rate - - -
Consumer & Other
Fixed Rate 4,114 3,772 212
Variable Rate 530 71 30
---------------------------------
Total $65,510 $70,256 $144,470
=================================
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
and other real estate owned for potential problems on a periodic basis and
reports to the Company's and the subsidiary's Boards of Directors at
regularly scheduled meetings.
The Company's loan review procedures include a credit quality assurance
process that begins with approval of lending policies and underwriting
guidelines by the Board of Directors, and includes a loan credit review
department supervised by an experienced, former regulatory examiner, low
individual lending limits for officers, Board approval for large credit
relationships and a quality control process for loan documentation that
includes post-closing reviews. The Company also maintains a monitoring
process for credit extensions. The Company performs periodic concentration
analyses based on various factors such as industries, collateral types,
large credit sizes and officer portfolio loads. The Company has established
underwriting guidelines to be followed by its officers. The Company
monitors its delinquency levels for any negative or adverse trends. The
Company continues to invest in its loan portfolio monitoring system to
enhance its risk management capabilities. There can be no assurance,
however, 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 that the Company would not otherwise consider. Restructured
loans do not include qualifying restructured loans that have complied with
the terms of their restructure agreement for a satisfactory period of time.
Restructured loans in compliance with modified terms totaled $656 thousand
at December 31, 2004 and $27 thousand at December 31, 2003. At December 31,
2004, the Company was not committed to lend any additional funds to
borrowers whose terms have been restructured.
Loans on which the accrual of interest has been discontinued are designated
as nonaccrual loans. Loans are designated as nonaccrual when reasonable
doubt exists as to the full collection of interest and principal. Normally,
when a loan is placed on nonaccrual status, all interest previously accrued
but not collected is reversed against current period interest income.
Income on such loans is then recognized only to the extent that cash is
received and where the future collection of interest and principal is
probable.
52
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
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 on non-accrual status totaling $1.2 million at
December 31, 2004 and $1.6 million at December 31, 2003. The aggregate
interest on non-accrual loans not recognized for the years ended December
31, 2004, 2003 and 2002 was $338 thousand, $393 thousand and $316 thousand,
respectively.
The Company had $4.1 million and $1.7 million in loans past due 90 days or
more and still accruing at December 31, 2004 and 2003, respectively. The
large increase in loans past due 90 days or more and still accruing
interest is due, in large part, to one commercial real estate loan
relationship that management is monitoring closely. The liquid assets and
real estate collateralizing this loan relationship are sufficient in
management's view, to mitigate credit risk. The loan relationship has been
brought current subsequent to year end. At December 31, 2004, the Company
had internally classified certain loans totaling $1.6 million and $1.7
million at December 31. 2003. 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 making the likelihood of
collection questionable:
* the financial condition of the borrower is unsatisfactory;
* repayment terms have not been met;
* the borrower has sustained losses that are sizable, either in
absolute terms or relative to net worth;
* confidence is diminished;
* loan covenants have been violated;
* collateral is inadequate; or
* other unfavorable factors are present.
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
fair value via an appraisal for more significant properties and
management's estimate for minor properties at the date of acquisition
establishing a new carrying basis. The Company had property valued at $35
thousand on December 31, 2004 and $10 thousand on December 31, 2003
classified as OREO.
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 for loan losses is maintained at a level which, in
management's judgment, is adequate to absorb credit losses inherent in the
loan portfolio; however, actual loan losses may vary from current
estimates.
Adequacy of 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 for loan losses, 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 the percentage
category to total loans, the portion of the allowance for loan losses
allocated to each category does not represent the total available for
future losses which may occur within the loan category since the total
allowance for possible loan losses is a valuation reserve applicable to the
entire portfolio.
The allowance is increased by a provision for loan losses, which is charged
to expense and reduced by charge-offs, net of recoveries. The provision for
loan losses represents the current period credit cost associated with
maintaining an appropriate allowance for loan losses. Based on an
evaluation of the loan portfolio, management presents a quarterly analysis
of the allowance for loan losses to the Board of Directors, indicating any
changes in the allowance since the last review and any recommendations as
to adjustments in the allowance. Additionally, various regulatory agencies
periodically review the Company's allowance for loan losses as an integral
part of their examination process.
Credit quality of the commercial portfolios is quantified by a corporate
credit rating system designed to parallel regulatory criteria and
categories of loan risk. Individual loan officers monitor their loans to
ensure appropriate rating assignments are made on a
53
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
timely basis. Risk ratings and quality of commercial and consumer credit
portfolios are also assessed on a regular basis by an independent Credit
Review Department. Credit Review personnel conduct ongoing portfolio
analyses and individual credit reviews to evaluate loan risk and compliance
with corporate lending policies. The level of allowance allocable to each
group of risk-rated loans is then determined by applying a loss factor that
estimates the amount of probable loss in each category. The assigned loss
factor for each risk rating is based upon management's assessment of
historical loss data, portfolio characteristics, economic trends, overall
market conditions and past experience.
Consumer and residential real estate loan quality is evaluated on a
portfolio-wide basis, including delinquency data and other available credit
data, due to the large number of such loans and the relatively small size
of individual credits. Allocations for these loan categories are
principally determined by applying loss factors that represent management's
estimate of inherent losses. In each category, inherent losses are
estimated based upon management's assessment of historical loss data,
portfolio characteristics, economic trends, overall market conditions and
past experience. In addition, certain loans in these categories may be
individually risk-rated if considered necessary by management.
The other method used to allocate the allowance for loan losses entails the
assignment of reserve amounts to individual loans on the basis of loan
impairment. Certain loans are evaluated individually and are judged to be
impaired when management believes it is probable that the Company will not
collect all the contractual interest and principal payments as scheduled in
the loan agreement. Under this method, loans are selected for evaluation
based on internal risk ratings or non-accrual status. A specific reserve
amount is allocated to an individual loan when that loan has been deemed
impaired and when the amount of the probable loss is estimable on the basis
of its collateral value, the present value of anticipated future cash
flows, or its net realizable value.
For the year ended December 31, 2004, the methodology used to determine the
provision for loan losses was unchanged from the prior year. The
composition of the Company's loan portfolio remained relatively unchanged
from December 31, 2003 and there was no material change in the lending
programs or terms during the year.
The following table reflects activity in the allowance for loan losses for
the years ended December 31:
Year Ended December 31,
--------------------------------------------------
2004 2003 2002 2001 2000
--------------------------------------------------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c>
Balance at the beginning of period $3,029 $2,908 $2,801 $2,863 $2,870
Charge-offs:
Real Estate 37 17 108 70 -
Commercial 26 10 115 245 152
Consumer and other 53 65 136 161 229
--------------------------------------------------
Total charge-offs 116 92 359 476 381
--------------------------------------------------
Recoveries:
Real Estate 6 2 8 1 1
Commercial 72 28 24 23 34
Consumer and other 46 69 78 70 89
--------------------------------------------------
Total recoveries 124 99 110 94 124
--------------------------------------------------
Net (charge-offs) recoveries 8 7 (249) (382) (257)
Provision for loan losses 30 114 356 320 250
--------------------------------------------------
Balance at end of period $3,067 $3,029 $2,908 $2,801 $2,863
==================================================
54
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table shows the breakdown of the Company's allowance for loan
loss 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.
December 31, December 31, December 31, December 31, December 31,
2004 2003 2002 2001 2000
--------------------------------------------------------------------------------------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
--------------------------------------------------------------------------------------------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c> <c> <c> <c>
Real Estate
Residential $ 553 32.8% $ 525 31.9% $ 506 35.9% $ 545 39.0% $ 550 38.0%
Commercial 1,733 42.5% 1,578 42.7% 1,409 37.3% 1,302 34.9% 1,193 33.7%
Construction 199 7.3% 183 7.2% 143 6.0% 116 4.9% 102 4.7%
Other Loans
Commercial 349 7.5% 336 7.1% 405 9.1% 419 9.6% 401 9.4%
Consumer installment 138 3.3% 145 3.7% 174 4.7% 208 5.4% 241 6.8%
Home equity loans 32 1.6% 25 1.3% 28 1.5% 29 1.7% 31 1.9%
Municipal, Other and
Unallocated 63 5.0% 237 6.1% 243 5.5% 182 4.5% 345 5.5%
-------------------------------------------------------------------------------------------
Total $3,067 100.0% $3,029 100.0% $2,908 100.0% $2,801 100.0% $2,863 100.0%
===========================================================================================
Ratio of Net Charge-Offs
to Average Loans Not
Held for Sale 0.00% 0.00% 0.11% 0.17% 0.12%
Ratio of Allowance for
Loan Losses to Loans
Not Held for Sale 1.13% 1.20% 1.22% 1.19% 1.33%
Ratio of Allowance for
Loan Losses to
non-performing loans (1) 57.91% 91.65% 127.99% 57.59% 65.10%
<FN>
- --------------------
<F1> Non-performing loans includes loans in non-accrual status plus loans
past due 90 days or more and still accruing.
</FN>
Management of the Company believes that the allowance for loan losses at
December 31, 2004 is adequate to cover losses inherent in the Company's
loan portfolio as of such date. However there can be no assurance that the
Company will not sustain losses in future periods, which could be greater
than the size of the allowance at December 31, 2004.
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 key
credit indicators from the Company's loan portfolio.
Investment Activities. The investment portfolio is used to generate
interest income, manage liquidity and mitigate interest rate sensitivity.
At December 31, 2004, the reported value of investment securities
available-for-sale was $41.0 million or 11.4% of assets compared to $44.4
million or 12.4% of assets at December 31, 2003. The Company had no
securities classified as held-to-maturity or trading. Current accounting
guidance requires banks to recognize all appreciation or depreciation of
the investment portfolio either on the balance sheet or through the income
statement even though a gain or loss has not been realized. Securities
classified as "available-for-sale" are marked to market with any gain or
loss after taxes charged to the equity portion of the balance sheet. The
reported value of securities available-for-sale at December 31, 2004
reflects a positive valuation adjustment of $572 thousand. The offset of
this adjustment, net of income tax effect, was a $377 thousand increase in
the Company's other comprehensive income component of stockholders' equity
and a decrease in net deferred tax assets of $194 thousand.
55
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following tables show as of December 31, 2004 and 2003 the amortized
cost of the Company's investment portfolio maturing within the stated
period.
At December 31, 2004
---------------------------------------------------------------------------------
Maturities
---------------------------------------------------------------------------------
Within One to Five to Over Total Weighted
One Year Five Years Ten Years Ten Years Cost Average Yield
---------------------------------------------------------------------------------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c>
Securities available-for-sale:
U.S. Government, agency and corporation
securities $4,994 $ 2,000 $ 1,499 $ 496 $ 8,989 3.04%
Mortgage-backed securities - 2,819 6,429 7,277 16,525 4.16%
State and political subdivisions 753 1,863 1,670 851 5,137 5.78%
Corporate debt securities 2,609 5,352 927 - 8,888 5.62%
---------------------------------------------------------------------------
Total investment securities $8,356 $12,034 $10,525 $8,624 $39,539 4.44%
===========================================================================
Fair Value $8,362 $12,224 $10,572 $8,635 $39,793
==============================================================
Weighted Average Yield 3.85% 4.54% 4.64% 4.65% 4.44%
At December 31, 2003
---------------------------------------------------------------------------------
Maturities
---------------------------------------------------------------------------------
Within One to Five to Over Total Weighted
One Year Five Years Ten Years Ten Years Cost Average Yield
---------------------------------------------------------------------------------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c>
Securities available-for-sale:
U.S. Government, agency and corporation
securities $1,001 $ 2,000 $ 1,901 $ - $ 4,902 4.01%
Mortgage-backed securities 16 2,602 8,418 6,479 17,515 4.01%
State and political subdivisions 155 1,444 2,770 754 5,123 5.99%
Corporate debt securities 3,297 10,278 1,206 - 14,781 5.84%
---------------------------------------------------------------------------
Total investment securities $4,469 $16,324 $14,295 $7,233 $42,321 4.89%
===========================================================================
Fair Value $4,552 $16,918 $14,473 $7,335 $43,278
==============================================================
Weighted Average Yield 5.65% 5.23% 4.63% 4.06% 4.89%
The tables above exclude marketable equity securities, with a book value of
$855 thousand and a market value of $1.2 million at December 31, 2004 and a
book value of $897 thousand and a market value of $1.1 million at December
31, 2003, which have no maturity but may be sold by the Company at any
time.
56
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
Deposits. The following table shows information concerning the Company's
average deposits by account type, and the weighted average nominal rates at
which interest was paid on such deposits for the years ended December 31,
2004 and 2003:
Year Ended December 31, Year Ended December 31,
2004 2003
------------------------------------------------------------------------
Percent Percent
Average of Total Average Average of Total Average
Amount Deposits Rate Amount Deposits Rate
------------------------------------------------------------------------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c>
Non-time deposits:
Non-interest bearing deposits $ 49,638 16.6% $ 42,341 14.4%
NOW accounts 45,619 15.2% 0.41% 43,349 14.7% 0.51%
Money markets accounts 64,668 21.6% 0.87% 64,417 21.9% 1.05%
Savings accounts 47,225 15.7% 0.58% 44,574 15.2% 0.81%
----------------------------------------------------------------------
Total non-time deposits 207,150 69.1% 194,681 66.2%
----------------------------------------------------------------------
Time deposits:
Less than $100,000 65,663 21.9% 2.00% 72,084 24.5% 2.70%
$100,000 and over 26,993 9.0% 2.28% 27,348 9.3% 2.43%
Total time deposits 92,656 30.9% 99,432 33.8%
----------------------------------------------------------------------
Total deposits $299,806 100.0% 0.98% $294,113 100.0% 1.31%
======================================================================
A maturity distribution of time deposits in denominations of $100,000 or
more at December 31 is as follows:
2004 2003
----------------------
(Dollars in thousands)
<s> <c> <c>
Three months or less $ 8,149 $ 9,399
Over three months through six months 11,717 16,264
Over six months through twelve months 6,298 3,820
Over twelve months 3,160 379
-------------------
$29,324 $29,862
===================
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, and deposit taking
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 and deposits;
the level of interest rates earned on assets and paid for liabilities; and
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
57
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
exposure that can significantly impact the Company's financial position and
operating results. The Company attempts to structure its balance sheet to
maximize net interest income and shareholder value while controlling its
exposure to interest rate risk. 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, 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. The investment
portfolio is all classified as available for sale and the modified duration
is relatively short. The Company does not utilize any derivative products
or invest in any "high risk" instruments.
Our interest rate sensitivity analysis (simulation) as of December 2003 for
a simulated increasing rate environment starting in July of 2004 at 25
basis point intervals each month reaching an anticipated prime rate of
5.25% by November 30, 2004, projected Net Interest Income of $16.7 million
for 2004 based on average assets of $351.0 million compared to actual
results of $16.8 million on average assets of $353.8 million or a 0.8%
positive variance in average assets and a 1.0% positive variance in Net
Interest Income. The actual Prime rate was flat at 4.00% for the first half
of 2004 and increased 25 basis points to 4.25% on July 1, 2004 and an
additional 25 basis points each on August 11th, September 22nd, November
10th and December 14th. Average yields were down in 2004 on interest-
earning assets 28 basis points and average rates were down 35 basis points
on interest-paying liabilities. The Company continued to have high demand
for loans ($275.4 million on average for 2004 with $25.8 million sold
during the year) which resulted in the percentage of loans to interest
earning assets remaining static at 83.3%. The net interest margin for 2004
was 5.24% compared to the projected net interest margin of 5.35%. Net
income was projected to be $5.1 million in the simulated increasing rate
environment compared to actual results of $5.8 million. The $1.0 million
increase in Net Income Before Taxes was mainly attributable to a $221
thousand increase on the Gain on Sale of loans, a $321 thousand increase in
Service Fees, a $90 thousand Gain on the Sale of OREO which was not
anticipated, a reduction in Employee Benefits expense of $149 thousand, a
reduction in Equipment expense of $64 thousand, a reduction in telephone
expense from projection of $55 thousand and a reduction in postage expense
of $68 thousand. These increases were partially offset by the loss of $42
thousand on impaired assets and the increase in correspondent fees of $48
thousand. Return on Assets was 1.65% compared to our simulated increasing
rate projection of 1.46%. Return on Equity was 14.17% compared to our
simulated increasing rate projection of 12.65%. These two ratios were
higher based on higher actual net income as explained above.
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 and to reduce its own exposure to fluctuation in interest rates.
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. Such instruments involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized in the
balance sheet. The contract or notional amounts of those instruments
reflect the extent of involvement the Company has in particular classes 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 exposure to
credit loss. The Company controls the risk of interest rate cap agreements
through credit approvals, limits, and monitoring procedures.
The Company generally require collateral or other security to support
financial instruments with credit risk.
58
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following table shows financial instruments whose contract amount
represents credit risk in each of the future periods presented:
Contract or Notional Amount
-------------------------------------------------------------------------
2005 2006 2007 2008 2009 Thereafter Total
-------------------------------------------------------------------------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c> <c> <c>
Commitments to
originate loans $13,773 $ - $ - $ - $ - $ - $13,773
Unused lines of credit 23,679 1,512 775 397 130 5,415 31,908
Standby letters of credit 596 78 300 - - 30 1,004
Credit card arrangements 2,273 - - - - - 2,273
Equity investment
commitments to housing
limited partnerships 645 347 356 - - - 1,348
-------------------------------------------------------------------------
Total $40,966 $1,937 $1,431 $397 $130 $5,445 $50,306
=========================================================================
Approximately $6.0 million of the unused lines of credit outstanding at
December 31, 2004 relate to real estate construction loans that are
expected to fund within the next twelve months. The remaining lines
primarily relate to revolving lines of credit or other real estate or
commercial loans, and many of these lines may expire without being fully
drawn upon, and therefore the commitment amounts do not necessarily
represent future cash needs.
Commitments to originate loans grew from $8.9 million at December 31, 2003
to $13.8 million at December 31, 2004 mainly due to a large commercial real
estate commitment made in December of 2004. Unused lines of credit grew
from $25.4 million at December 31, 2003 to $31.9 million at December 31,
2004 as growth was experienced in all business segments.
The Company may enter into commitments to sell loans which involve market
and interest rate risk. There were no such commitments at December 31,
2004.
Contractual Obligations: The Company has various financial obligations,
including contractual obligations that may require future cash payments.
Further discussion of the nature of each obligation is included in Notes 9,
12, and 13 of the Notes to Consolidated Financial Statements. The following
table presents, as of December 31, 2004, significant fixed and determinable
contractual obligations to third parties by payment date:
Payments Due By Period
-----------------------------------------------------------------
Less than
1 year 1-3 years 4-5 years Thereafter Total
-----------------------------------------------------------------
(Dollars in thousands)
<s> <c> <c> <c> <c> <c>
Operating lease commitments $ 106 $ 178 $ 62 $ 14 $ 360
Maturities on borrowed funds 2,344 4,992 266 331 7,933
Deposits without stated maturity (1) 214,402 - - - 214,402
Certificates of deposit (1) 68,244 21,652 2,300 - 92,196
Pension plan contributions (2) 475 - - - 475
Deferred compensation payouts 197 259 160 311 927
-----------------------------------------------------------------
Total $285,768 $27,081 $2,788 $656 $316,293
=================================================================
<FN>
- --------------------
<F1> While the Company has a contractual obligation to depositors should
they wish to withdraw all or some of the funds on deposit with the
Bank subsidiary, Management believes, based on historical analysis,
that the majority of these deposits will remain on deposit for the
foreseeable future. The amounts exclude interest accrued.
<F2> Funding requirements for pension benefits after 2005 are excluded due
to the significant variability in the assumptions required to project
the amount and timing of future cash contributions.
</FN>
59
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The Company is required to maintain a noninterest-bearing reserve balance
as established by the Federal Reserve Bank of Boston. The average total
reserve for the 14-day maintenance period ended December 31, 2004 was $3.4
million. The Company has also committed to maintain a noninterest-bearing
contracted clearing balance of $1.0 million at December 31, 2004 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 could
mature or reprice. The amounts of assets and liabilities shown within a
particular period were determined in accordance with the contractual terms
of the assets and liabilities, except that:
* adjustable-rate loans, securities, and FHLB advances are included in
the period when they are first scheduled to adjust and not in the
period in which they mature;
* fixed-rate mortgage-related securities and loans reflect estimated
prepayments, which were estimated based on analyses of broker
estimates, the results of a prepayment model utilized by the Company,
and empirical data;
* other non-mortgage related fixed-rate loans reflect scheduled
contractual amortization, with no estimated prepayments; and
* NOW, money markets, and savings deposits, which do not have
contractual maturities, reflect estimated levels of attrition, which
are based on detailed studies by 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.
60
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following tables show the Company's rate sensitivity analysis as of
December 31, 2004 and 2003:
December 31, 2004
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)
<s> <c> <c> <c> <c> <c> <c>
Interest sensitive assets:
Federal funds sold and
overnight deposits $ 4,187 $ - $ - $ - $ - $ 4,187
Interest-bearing deposits in banks 693 2,371 3,461 885 99 7,509
Investments available-for-sale (1) (3) 1,980 10,193 10,572 7,895 9,153 39,793
Loans (2) (3) 119,005 60,505 60,499 32,128 7,932 280,069
FHLB Stock - - - - 1,241 1,241
-------------------------------------------------------------------------
Total interest sensitive assets $125,865 $73,069 $ 74,532 $ 40,908 $ 18,425 $332,799
=========================================================================
Interest sensitive liabilities:
Time deposits $ 21,008 $47,236 21,652 $ 2,300 - $ 92,196
Money markets 9,197 - - - 51,210 60,407
Regular savings 6,473 - - - 41,353 47,826
NOW accounts 20,616 - - - 28,332 48,948
Borrowed funds (3) 1,778 860 2,490 2,806 - 7,934
-------------------------------------------------------------------------
Total interest sensitive liabilities $ 59,072 $48,096 $ 24,142 $ 5,106 $ 120,895 $257,311
=========================================================================
Net interest rate sensitivity gap $ 66,793 $24,973 $ 50,390 $ 35,802 $(102,470) $ 75,488
Cumulative net interest rate sensitivity gap $ 66,793 $91,766 $142,156 $177,958 $ 75,488
Cumulative net interest rate sensitivity gap as
a percentage of total assets 18.6% 25.5% 39.5% 49.5% 21.0%
Cumulative interest sensitivity gap as a
percentage of total interest-earning assets 20.1% 27.6% 42.7% 53.5% 22.7%
Cumulative net interest sensitivity gap as
percentage of total interest-bearing liabilities 26.0% 35.7% 55.2% 69.2% 29.3%
<FN>
- --------------------
<F1> Investments available for sale exclude marketable equity securities
with a fair value of $1.2 million that may be sold by the Company at
any time.
<F2> Balances shown net of unearned income of $166 thousand.
<F3> Estimated repayment assumptions considered in Asset/Liability model.
</FN>
61
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
December 31, 2003
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)
<s> <c> <c> <c> <c> <c> <c>
Interest sensitive assets:
Federal funds sold and
overnight deposits $ 916 $ - $ - $ - $ - $ 916
Interest-bearing deposits in banks 986 2,266 2,178 992 98 6,520
Investments available-for-sale (1) (3) 3,018 7,109 12,663 10,438 10,050 43,278
Loans (2) (3) 104,749 55,462 45,680 48,344 17,326 271,561
FHLB Stock - - - - 1,241 1,241
-------------------------------------------------------------------------
Total interest sensitive assets $109,669 $64,837 $ 60,521 $ 59,774 $ 28,715 $323,516
=========================================================================
Interest sensitive liabilities:
Time deposits $ 22,725 $47,514 $ 23,991 $ 2,948 $ - $ 97,178
Money markets 8,977 - - - 55,205 64,182
Regular savings 6,043 - - - 39,520 45,563
NOW accounts 20,488 - - - 29,605 50,093
Borrowed funds (3) 354 1,086 3,079 2,703 - 7,222
-------------------------------------------------------------------------
Total interest sensitive liabilities $ 58,587 $48,600 $ 27,070 $ 5,651 $ 124,330 $264,238
=========================================================================
Net interest rate sensitivity gap $ 51,082 $16,237 $ 33,451 $ 54,123 $ (95,615) $ 59,278
Cumulative net interest rate sensitivity gap $ 51,082 $67,319 $100,770 $154,893 $ 59,278
Cumulative net interest rate sensitivity gap
as a percentage of total assets 14.3% 18.9% 28.3% 43.4% 16.6%
Cumulative interest sensitivity gap as a
percentage of total interest-earning assets 15.8% 20.8% 31.2% 47.9% 18.3%
Cumulative net interest sensitivity gap as a
percentage of total interest-bearing liabilities 19.3% 25.5% 38.1% 58.6% 22.4%
<FN>
- --------------------
<F1> Investments available for sale exclude marketable equity securities
with a fair value of $1.1 million that may be sold by the Company at
any time.
<F2> Balances shown net of unearned income of $185 thousand.
<F3> Estimated repayment assumptions considered in Asset/Liability model.
</FN>
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
loans and deposit growth, product pricing, prepayment speeds on mortgage
related assets and 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.
62
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
The following chart reflects the results of our latest simulation analysis
for next year-end on Net Interest Income, Net Income, Return on Assets,
Return on Equity and Net Fair Value Ratio. The projection utilizes a rate
shock of up 300 basis points and down 200 basis points from the year-end
prime rate of 5.00%; this rise is the highest internal slope monitored. The
down 200 basis points was chosen as with the current low level of interest
rates the potential for interest-bearing deposit accounts to respond to
further drops in projected rates is limited, therefore calculations for
rate decreases greater than 200 basis points would have been misleading.
This slope range was determined to be the most relevant during this
economic cycle.
UNION BANKSHARES, INC.
INTEREST RATE SENSITIVITY SIMULATION ANALYSIS
DECEMBER 31, 2004
(Dollars in thousands)
Year Prime Net Interest Net Return on Return on Net Fair
Ending Rate Income Change % Income Assets % Equity % Value Ratio
- ----------------------------------------------------------------------------------------------------------
<s> <c> <c> <c> <c> <c> <c> <c>
December-05 8.25 $19,074 9.42 $7,024 1.92 16.18 9.28%
5.25 17,431 0.00 5,926 1.63 13.79 11.22%
3.25 15,744 (9.68) 4,798 1.32 11.27 12.56%
The resulting projected effect of these estimates on Net Interest Income
and the Net Fair Value Ratio for the year ending December 31, 2005 are
within the approved ALCO 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.
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 roll
over risk on deposits and limits reliance on volatile short-term purchased
funds. Short-term funding needs arise from declines in deposits or other
funding sources, funding of loan commitments and 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 year ended, December 31, 2004, the Company's ratio
of average loans to average deposits was 90.8% compared to the average for
the year ended December 31, 2003 of 89.5%.
In addition, as Union is a member of the FHLB of Boston, it has access to
preapproved lines of credit up to $9.9 million or 2.8% of total assets at
December 31, 2004 over and above the term advances already drawn on the
line. This line of credit could be used for either short-term or long-term
liquidity or other needs. Union maintains a $5.0 million preapproved
Federal Funds line of credit with an upstream correspondent bank and a
repurchase agreement line with a brokerage house. There were no balances
outstanding on either line at December 31, 2004.
Union maintains an IDEAL Way Line of Credit with the Federal Home Loan Bank
of Boston. The total line available was $3.6 million as of both December
31, 2004 and 2003 as there were no borrowings against this line of credit.
Interest on these borrowings is chargeable at a rate determined by the
Federal Home Loan Bank and payable monthly. Should Union utilize this line
of credit, qualified portions of the loan and investment portfolios would
collateralize these borrowings.
While scheduled loan and securities payments and FHLB advances are
relatively predictable sources of funds, deposit flows and prepayments on
loans and mortgage-backed securities are greatly influenced by general
interest rates, economic conditions, and competition. 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
Company's ALCO sets liquidity targets based on the Company's financial
condition and existing and projected economic and market conditions. 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 sensitive or volatile
liabilities, such as core deposits and time deposits in excess of $100,000,
borrowings with short
63
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
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 74.0% of time deposits will mature within twelve
months, management believes, based upon past experience, that the Company
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. A reduction in total deposits could be offset
by purchases of federal funds, short-or long-term FHLB borrowings,
utilization of the repurchase agreement line or liquidation of investment
securities or loans held for sale. Such steps could result in an increase
in the Company's cost of funds and 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
cash flows are subject to substantial uncertainty. We continually evaluate
opportunities to buy/sell securities and loans available for sale, obtain
credit facilities from lenders, or restructure our debt for strategic
reasons or to further strengthen our financial position.
Capital Resources. Our capital management is designed to maintain an
optimum level of capital in a cost-effective structure that: meets our
target regulatory ratios; supports our internal assessment of economic
capital; funds our business strategies; and builds long-term stockholder
value. In support of the latter goal, a three-for-two stock split was
declared and effected in the form of a stock dividend payable August 8,
2003. The information presented in the following paragraphs regarding our
capital has been retroactively adjusted to reflect the split with the
exception of the information regarding the stock repurchase plan.
The total dollar value of the Company's stockholders' equity was $42.4
million at December 31, 2004 reflecting net income of $5.8 million for
2004, less dividends paid of $4.1 million, and a reduction in accumulated
other comprehensive income of $383 thousand compared to $41.0 million at
year end 2003. The Company has 5,000,000 shares of $2.00 par value common
stock authorized. As of December 31, 2004, the Company had 4,915,611 shares
issued, of which 4,554,663 were outstanding and 360,948 were held in
Treasury. Also as of December 31, 2004, there were outstanding employee
incentive stock options with respect to 12,575 shares of the Company's
common stock, granted pursuant to the Company's 1998 Incentive Stock Option
Plan of which 9,325 were exercisable. Of the 75,000 shares authorized for
issuance under the 1998 Plan, 51,950 shares remained available for future
option grants at December 31, 2004.
On October 17, 2001, the Company announced a stock repurchase program that
was not amended to reflect the stock split. The Board of Directors had
authorized the repurchase of up to 100,000 shares of common stock, or
approximately 2.2% of the Company's outstanding shares. Shares could be
repurchased in the open market or in negotiated transactions. The
repurchase program was open for an unspecified period of time but was
terminated March 17, 2004 by the Board of Directors. As of such date the
Company had repurchased 6,672 shares under this program, for a total cost
of $129.5 thousand. No repurchases had been made since 2001.
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.
For the Company and Union at December 31, 2004, total capital to risk
weighted assets was 18.57% and 18.27% respectively. Tier I capital to risk
weighted assets was 17.27%, and 16.96% respectively and Tier I capital to
average assets was 11.62% and 11.42%, respectively. Union is categorized as
well capitalized under the regulatory framework and the Company is well
over the minimum capital requirements.
On January 14, 2005, the Company declared a $0.24 per share regular and a
$0.40 per share special dividend payable January 28, 2005 to stockholders
of record on January 24, 2005. A special dividend was declared as the
Company's primary capital ratio on December 31, 2004 approached 12%,
earnings were better than anticipated, and the current tax treatment of
dividends is beneficial to shareholders.
Impact of Inflation and Changing Prices. The Company's consolidated
financial statements, included in this document, have been prepared in
accordance with U.S. generally accepted accounting principles, which
require the measurements of financial position and results of operations in
terms of historical dollars, without considering changes in the relative
purchasing power of money over time due to inflation. Banks have asset and
liability structures that are essentially monetary in nature, and their
general and administrative costs constitute relatively small percentages of
total expenses. Thus, increases in the general price levels for
64
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Management's Discussion and Analysis of Financial Condition and
Results of Operations (Continued)
goods and services have a relatively minor effect on the Company's total
expenses. Interest rates have a more significant impact on the Company's
financial performance than the effect of general inflation. Until July of
2004, because of the uneven nature of the expansion of the U.S. economy,
the Federal Reserve had kept overnight rates at 40 year lows but have moved
the targeted federal funds rates up five 25 basis points steps between then
and December 31, 2004. Interest rates do not necessarily move in the same
direction or change in the same magnitude as the prices of goods and
services, although periods of increased inflation may accompany a rising
interest rate environment.
Regulatory Matters. The Company and its subsidiary bank 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 2004, the Vermont State Department of Banking,
the Federal Deposit Insurance Corporation, and the Federal Reserve Bank of
Boston performed various examinations of the Company and Union pursuant to
their regular, periodic regulatory reviews. No comments were received from
these various bodies that would have a material adverse effect on either
Company's liquidity, capital resources, or operations.
65
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Change in Independent Auditor
On June 1, 2004, the partners of the Company's former independent auditor,
Urbach Kahn & Werlin LLP, announced that they were joining the independent
accounting firm of UHY LLP, a newly-formed New York limited liability
partnership, organized by the partners of four accounting firms with
offices in seven (7) states. UHY LLP is a legal entity that is separate
from Urbach Kahn & Werlin LLP. Following formation of UHY LLP, Urbach Kahn
& Werlin LLP began the process of ceasing to provide audit services to
public companies, and accordingly, on November 17, 2004 it resigned as the
Company's independent auditor. On that same date, the Audit Committee of
the Company's Board of Directors approved the appointment of UHY LLP as the
Company's independent auditor for the year ended December 31, 2004 and the
interim period prior to such year-end, to replace Urbach Kahn & Werlin LLP.
Prior to this appointment, neither the Company nor anyone on its behalf had
consulted with UHY LLP during 2004 or the preceding two fiscal years
regarding (1) the application of accounting principles to a specific
transaction, either completed or proposed, (2) the type of audit opinion
that might be rendered on the Company's financial statements, (3) any
matter that was the subject of a disagreement within the meaning of Item
304 of Securities and Exchange Commission Regulation S-K, or (4) any
reportable event within the meaning of Item 304 of Regulation S-K.
None of the reports of Urbach Kahn & Werlin LLP on the Company's financial
statements for either of the past two fiscal years prior to their
resignation contained an adverse opinion or disclaimer of opinion, or was
qualified or modified as to uncertainty, audit scope or accounting
principles. In addition, during the Company's two fiscal years and
subsequent interim periods prior to their resignation, (1) there were no
disagreements between the Company and Urbach Kahn & Werlin LLP on any
matter of accounting principles or practices, financial statement
disclosure, or auditing scope or procedure, which disagreements, if not
resolved to the satisfaction of Urbach Kahn & Werlin LLP, would have caused
it to make reference to the subject matter of the disagreements in
connection with its report, and (2) there were no reportable events as
within the meaning of Item 304 of Regulation S-K. In accordance with such
regulation, Urbach Kahn & Werlin LLP has furnished to the Company a letter
addressed to the Securities and Exchange Commission stating that it agrees
with the statements in this paragraph.
As required by the rules of the Securities and Exchange Commission, the
Company disclosed the change in its independent auditor in a Current Report
on Form 8-K filed with the Commission on November 17, 2004.
66
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Market for Union Bankshares' Common Shares and Related Stockholder Matters
On March 17, 2005, there were 4,554,663 shares of common stock outstanding
held by 683 stockholders of record. The number of stockholders does not
reflect the number of persons or entities who may hold the stock in nominee
or "street name."
Union Bankshares' common stock was listed on the American Stock Exchange on
July 13, 2000. The Company's stock trades under the symbol UNB. LaBranche &
Co. of New York City are the market specialists for Union Bankshares, Inc.
stock. The high and low prices for shares of the Company's common stock for
2003, as well as cash dividends paid thereon have all been adjusted for the
3-for-2 stock split effected August 8, 2003 and are presented below:
2004 2003
-------------------------------------------------------------------
High Low Dividends High Low Dividends
-------------------------------------------------------------------
<s> <c> <c> <c> <c> <c> <c>
First Quarter $26.60 $24.81 $.22 $20.27 $16.47 $.20
Second Quarter $25.00 $21.75 $.22 $20.93 $18.00 $.20
Third Quarter $24.20 $22.45 $.22 $29.85 $19.80 $.20
Fourth Quarter $25.00 $23.20 $.24 $29.90 $24.60 $.22
On January 14, 2005, the Company declared a regular dividend of $.24 and a
special dividend of $.40 per share to stockholders of record as of January
24, 2005, payable January 28, 2005.
67
Union Bankshares, Inc. and Subsidiary
- ---------------------------------------------------------------------------
Shareholder Assistance and Investor Information
If you need assistance with a change in registration of certificates,
reporting lost certificates, non-receipt or loss of dividend checks,
assistance regarding direct deposit of dividends, information about the
Company, or to receive copies of financial reports, please contact:
JoAnn A. Tallman, Assistant Secretary
Union Bankshares, Inc.
P.O. Box 667
Morrisville, VT 05661-0667
Phone: 802-888-6600
Facsimile: 802-888-4921
E-mail: ubexec@unionbankvt.com
----------------------
Form 10-K
A copy of the Form 10-K Report filed with the Securities and Exchange
Commission may be obtained without charge upon written request to:
Marsha A. Mongeon, Treasurer and Chief Financial Officer
Union Bankshares, Inc.
P.O. Box 667
Morrisville, VT 05661-0667
Corporate Name: Union Bankshares, Inc.
Corporate Transfer Agent: Union Bank, P.O. Box 667, Morrisville,
VT 05661-0667
68
Union Bankshares, Inc. & Union Bank * Directors PHOTO
Richard C. Sargent, Chairman Franklin G. Hovey II
Cynthia D. Borck Richard C. Marron
William T. Costa, Jr. Robert P. Rollins
Kenneth D. Gibbons John H. Steel
Union Bankshares, Inc. * Officers
Richard C. Sargent, Chairman
Cynthia D. Borck, Vice President
Kenneth D. Gibbons, President & CEO
Marsha A. Mongeon, Vice President/Treasurer
Robert P. Rollins, Secretary
JoAnn A. Tallman, Assistant Secretary
Citizens Division Advisory Board
Cynthia D. Borck, Kenneth D. Gibbons, J.R. Alexis Clouatre,
Franklin G. Hovey II, William T. Costa, Jr., Dwight A. Davis
<s> <s>
Union Bank * Officers
Wanda L. Allaire Stephen H. Kendall
Assistant Vice President, Morrisville Assistant Vice President, Fairfax
Rhonda L. Bennett Susan O. Laferriere
Vice President, Morrisville Vice President, St. Johnsbury
John T. Booth, Jr. Margaret S. Lambert
Finance Officer, Morrisville Assistant Vice President, Morrisville
Cynthia D. Borck Dennis J. Lamothe
Executive Vice President, Morrisville Vice President, St. Johnsbury
Stacey L.B. Chase Susan F. Lassiter
Assistant Treasurer, Morrisville Assistant Vice President, Jeffersonville
Alice H. Claflin Phillip L. Martin
Trust Officer, St. Johnsbury Vice President, Stowe
Jeffrey G. Coslett Marsha A. Mongeon
Assistant Vice President, Morrisville Senior Vice President/Treasurer, Morrisville
Michael C. Curtis Mildred R. Nelson
Vice President, St. Albans Assistant Vice President, Littleton
Peter J. Eley Barbara A. Olden
Senior Vice President, Morrisville Assistant Vice President, St. Johnsbury Ctr.
Fern C. Farmer Deborah J. Partlow
Assistant Vice President, Morrisville Trust Officer, Morrisville
Patsy S. French Colleen D. Putvain
Assistant Vice President, Jeffersonville Assistant Treasurer, Morrisville
Karen C. Gammell Robert P. Rollins
Assistant Treasurer, Lyndonville Secretary, Morrisville
Kenneth D. Gibbons Ruth P. Schwartz
President & CEO, Morrisville Vice President, Morrisville
Melissa A. Greene Robyn A. Sheltra
Assistant Treasurer, Hardwick Assistant Treasurer, Stowe
Claire A. Hindes David S. Silverman
Assistant Vice President, Morrisville Senior Vice President, Morrisville
Patricia N. Hogan Sara J. Small
Vice President, Morrisville Assistant Treasurer, Morrisville
Tracey D. Holbrook JoAnn A. Tallman
Vice President, St. Johnsbury Assistant Secretary, Morrisville
Lynne P. Jewett Francis E. Welch
Assistant Treasurer, Morrisville Assistant Vice President, Morrisville
Peter R. Jones
Vice President, Morrisville
UNION BANK OFFICES St. Johnsbury*
Morrisville* 325 Portland Street
Main Office 802-748-3121
20 Lower Main Street
802-888-6600 St. Johnsbury Center*
Green Mountain Mall
Morrisville* 1998 Memorial Drive
Northgate Plaza 802-748-2454
Route 100
802-888-6860 Lyndonville*
183 Depot Street
Jeffersonville* 802-626-3100
44 Main Street
802-644-6600 (*ATMs at these branches)
Hyde Park
250 Main Street
802-888-6880
PHOTO
Johnson*
198 Lower Main Street
802-635-6600
Stowe* REMOTE ATMs
47 Park Street Ben & Jerry's, Waterbury
802-253-6600 Big John's Riverside Store, Jericho
Burke Mountain Ski Area
Hardwick* Cold Hollow Cider Mill, Waterbury Ctr.
103 Vt Route 15 Copley Hospital, Morrisville
802-472-8100 Marty's First Stop, Danville
The Elmore Store
Fairfax* Smugglers' Notch Resort (2)
Route 104 Stowe Mountain Resort (3)
802-849-2600 Baileys at Burke, East Burke
Johnson State College
Littleton Loan Center Stowe Mountain Road
241 Main Street Taft Corners, Williston
Littleton, NH Trapp Family Lodge, Stowe
603-444-7136
EXPRESS TELEBANKING (TM)
St. Albans Loan Center 802-888-6448, 800-583-2869
120 North Main Street or 802-748-0815
802-524-9000
INTERNET BANKING
St. Johnsbury* www.unionbankvt.com
364 Railroad Street
802-748-3131