UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
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Commission file number 0-13270
UNB CORP.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Ohio 34-1442295
- ------------------------------- ---------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
220 Market Avenue, South
Canton, Ohio 44702
- ---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (330) 454-5821
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such report), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
------ ------
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practical date.
Common Stock, $1.00 Stated Value Outstanding at October 31, 1998
11,178,113 Common Shares
UNB CORP.
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 1998
PART I - FINANCIAL INFORMATION
Item 1 - Financial Statements
Interim financial information required by Rule 10-01 of Regulation S-X
(17 CFR Part 210) is included in this Form 10Q as referenced below:
Page
Number(s)
---------
Consolidated Balance Sheets 1
Consolidated Statements of Income 2
Consolidated Statements of Comprehensive Income 3
Condensed Consolidated Statements of Changes in
Shareholders' Equity 4
Consolidated Statements of Cash Flows 5
Notes to the Consolidated Financial Statements 6-12
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 13-23
Item 3 - Quantitative and Qualitative Disclosures About
Market Risk 24-27
PART II - OTHER INFORMATION
Item 4 - Submission of Matters to a Vote of Security Holders 28
Item 5 - Other Information 28
Item 6 - Exhibits and Reports on Form 8-K 28
Signatures 28
UNB CORP.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(In thousands) SEPTEMBER 30, December 31,
1998 1997
------------- ------------
ASSETS
Cash and cash equivalents $ 31,209 $ 28,998
Federal funds sold 16,700 7,500
Interest bearing deposits with banks 430 1,142
Securities, net (Fair value:
$57,632 and $72,999, respectively)(Note 2) 57,623 72,993
Mortgage-backed securities (Fair value:
$76,154 and $67,222, respectively)(Note 2) 76,111 67,845
Loans originated and held for sale 5,327 2,190
Loans:
Total loans (Notes 3 and 6) 672,446 630,418
Less allowance for loan losses (Note 4) (10,338) (9,650)
------------- ------------
Net loans 662,108 620,768
Premises and equipment, net 11,512 11,727
Intangible assets 4,584 5,339
Accrued interest receivable and other assets 10,247 7,811
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TOTAL ASSETS $ 875,851 $ 826,313
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LIABILITIES
Deposits:
Noninterest bearing deposits $ 91,343 $ 82,173
Interest bearing deposits 579,347 567,308
------------- ------------
Total deposits 670,690 649,481
Fed funds purchased and short-term borrowings 63,277 56,511
Federal Home Loan Bank advances and capital lease (Note 6) 56,731 35,650
Accrued taxes, expenses and other liabilities 8,360 8,151
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TOTAL LIABILITIES 799,058 749,793
SHAREHOLDERS' EQUITY
Common stock ($1.00 stated value, 15,000,000 shares authorized;
5,823,192 and 5,821,369 issued and outstanding, respectively) 5,823 5,821
Paid-in capital 30,883 31,277
Retained earnings 42,709 37,123
Unrealized gain on securities available for sale, net of tax 2,960 3,739
Treasury stock,139,488 and 37,154 shares at cost (5,582) (1,440)
------------- ------------
TOTAL SHAREHOLDERS' EQUITY 76,793 76,520
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 875,851 $ 826,313
------------- ------------
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See Notes to the Consolidated Financial Statements
1
UNB CORP.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(In thousands except per share data) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
INTEREST INCOME:
Interest and fees on loans:
Taxable $ 14,529 $ 13,727 $ 42,023 $ 40,582
Tax exempt 34 46 108 142
Interest and dividends on investments & mortgage-backed securities:
Taxable 2,168 1,925 6,541 5,584
Tax exempt 8 13 28 39
Interest on bank deposits and federal funds sold 168 237 630 628
---------- ---------- ---------- ----------
Total interest income 16,907 15,948 49,330 46,975
---------- ---------- ---------- ----------
INTEREST EXPENSE:
Interest on deposits 6,255 6,066 18,739 17,092
Interest on short-term borrowings 757 618 2,242 2,098
Interest on FHLB advances 852 1,200 1,854 3,295
---------- ---------- ---------- ----------
Total interest expense 7,864 7,884 22,835 22,485
---------- ---------- ---------- ----------
NET INTEREST INCOME 9,043 8,064 26,495 24,490
PROVISION FOR LOAN LOSSES (NOTE 4) 325 887 1,461 2,237
---------- ---------- ---------- ----------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 8,718 7,177 25,034 22,253
OTHER INCOME:
Service charges on deposits 710 635 2,168 1,860
Trust Department income 1,001 766 3,157 2,394
Other operating income 752 252 1,499 856
Securities gains, net 0 8 780 36
Gains on loans originated for resale and sold 238 57 776 112
---------- ---------- ---------- ----------
Total other income 2,701 1,718 8,380 5,258
---------- ---------- ---------- ----------
OTHER EXPENSES:
Salary, wages and benefits 3,338 2,789 9,731 8,225
Occupancy 414 343 1,126 971
Equipment 915 830 2,683 2,301
Other operating expense 2,069 1,718 6,752 5,791
---------- ---------- ---------- ----------
Total other expenses 6,736 5,680 20,292 17,288
---------- ---------- ---------- ----------
INCOME BEFORE INCOME TAXES 4,683 3,215 13,122 10,223
PROVISION FOR INCOME TAXES 1,597 1,114 4,496 3,481
---------- ---------- ---------- ----------
NET INCOME $3,086 $2,101 $8,626 $6,742
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
EARNINGS PER SHARE (NOTE 1):
Basic $0.270 $0.180 $0.750 $0.585
Diluted $0.265 $0.180 $0.735 $0.570
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
DIVIDENDS PER SHARE (NOTE 1) $0.090 $0.085 $0.265 $0.240
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
WEIGHTED AVERAGE SHARES OUTSTANDING (NOTE 1):
Basic 11,394,980 11,569,824 11,486,908 11,568,306
Diluted 11,627,734 11,820,346 11,716,514 11,795,870
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Note: Per share data is based on the average number of shares outstanding
adjusted for stock dividends and splits.
See Notes to the Consolidated Financial Statements
2
UNB CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
UNAUDITED
(In thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
1998 1997 1998 1997
------------- ------------- ------------ ----------
Net Income $ 3,086 $ 2,101 $ 8,626 $ 6,742
Other comprehensive income, net of tax
Unrealized gains/(losses) on securities:
Unrealized gains/(losses) arising
during the period (614) 1,128 (272) 1,566
Less: Reclassified adjustment for
accumulated gains/(losses)
included in net income 0 5 507 23
------------- ------------- ------------ ----------
Unrealized gains/(losses) on securities (614) 1,123 (779) 1,543
------------- ------------- ------------ ----------
Comprehensive income $ 2,472 $ 3,224 $ 7,847 $ 8,285
------------- ------------- ------------ ----------
------------- ------------- ------------ ----------
See the Notes to the Consolidated Financial Statements
3
UNB CORP.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
(In thousands except per share data)
NINE MONTHS ENDED
9/30/98 9/30/97
------------ ------------
Balance at beginning of period $ 76,520 $ 71,334
Net Income 8,626 6,742
Shares issued through dividend reinvestment 0 133
Stock options exercised 0 187
Common stock issued 66 0
Cash dividends $0.265 and $0.24 per share, respectively* (3,039) (2,780)
Treasury stock purchases (5,961) (3,217)
Treasury stock sales 1,360 1,474
Change in market value on investment securities
available for sale, net of deferred taxes (779) 1,543
------------ ------------
Balance at end of period $ 76,793 $ 75,416
------------ ------------
------------ ------------
*Per share data adjusted for October, 1998 100% stock dividend.
See Notes to the Consolidated Financial Statements
4
UNB CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
(In thousands) SEPTEMBER 30,
1998 1997
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 8,626 $ 6,742
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization 1,022 741
Provision for loan losses 1,461 2,237
Net securities gains (780) (36)
Net accretion on securities (6) (603)
Amortization of intangible assets 754 761
Loans originated for resale (55,878) (11,227)
Proceeds from sale of loan originations 55,783 9,474
Changes in:
Interest receivable (570) (219)
Interest payable (224) (534)
Other assets and liabilities, net (1,097) 1,842
Deferred income (4) (2)
-------- --------
Net cash from operating activities 9,087 9,176
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net change in interest bearing deposits with banks 712 (608)
Net increase in funds sold (9,200) (4,400)
Investment and mortgage-backed securities:
Proceeds from sales of securities available for sale 9,762 3,221
Proceeds from maturities of securities held to maturity 570 6,688
Proceeds from maturities of securities available for sale 100,219 136,000
Purchases of securities held to maturity (354) (4,883)
Purchases of securities available for sale (91,271) (110,062)
Purchases of mortgage-backed securities available for sale (33,104) (37,672)
Principal payments received on mortgage-backed securities held to maturity 4,503 4,835
Principal payments received on mortgage-backed securities available for sale 16,455 14,864
Net increase in loans made to customers (10,632) (17,285)
Loans purchased (35,374) (1,637)
Purchases of premises and equipment, net (807) (2,228)
Principal payments received under leases 163 152
Leased assets purchased 0 (617)
-------- --------
Net cash from investing activities (48,358) (13,632)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 21,209 29,341
Cash dividends paid, net of shares issued through dividend reinvestment (3,039) (2,647)
Purchase of treasury stock (5,961) 1,090
Sales of treasury stock 1,360 (3,217)
Proceeds from issuance of stock 66 571
Net increase (decrease) in short-term borrowings 6,766 (13,243)
Proceeds from FHLB advances 105,000 10,000
Repayments of FHLB advances (83,886) (23,647)
Proceeds from capital lease 0 248
Repayments on capital lease (33) (28)
-------- --------
Net cash from financing activities 41,482 (1,532)
-------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS 2,211 (5,988)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 28,998 34,762
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 31,209 $ 28,774
-------- --------
-------- --------
See the Notes to the Consolidated Financial Statements
5
UNB CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1 - Summary of Significant Accounting Policies
Unless otherwise indicated, amounts are in thousands, except per share data.
The accompanying consolidated financial statements include the accounts of
UNB Corp. and its wholly owned subsidiaries. All material intercompany
accounts and transactions have been eliminated in consolidation.
These interim financial statements are prepared without audit and reflect all
adjustments of a normal recurring nature which, in the opinion of management,
are necessary to present fairly the consolidated financial position of UNB
Corp. at September 30, 1998, and its results of operations and cash flows for
the periods presented. The accompanying consolidated financial statements do
not purport to contain all the necessary financial disclosures required by
generally accepted accounting principles that might otherwise be necessary in
the circumstances. The Annual Report for UNB Corp. for the year ended
December 31, 1997, contains consolidated financial statements and related
notes which should be read in conjunction with the accompanying consolidated
financial statements.
For consolidated financial statement classification and cash flow reporting
purposes, cash and cash equivalents include currency on hand and non-interest
bearing deposits with banks. For the nine months ended September 30, 1998,
and September 30, 1997, UNB Corp. paid interest in the amount of $23,060 and
$23,019, respectively. For the same nine month periods federal income taxes
paid totaled $4,693 and $3,525, respectively.
The Corporation classifies securities as held to maturity, available for
sale, or trading. Securities classified as held to maturity are those that
management has the positive intent and ability to hold to maturity.
Securities classified as available for sale are those that management intends
to sell or that could be sold for liquidity, investment management, or
similar reasons, even if there is not a present intention for such a sale.
Trading securities are purchased principally for sale in the near term and
are reported at fair value with unrealized gains and losses included in
earnings. The Corporation held no trading securities during the periods
reported.
Securities held to maturity are stated at cost, adjusted for amortization of
premiums and accretion of discounts. Securities available for sale are
carried at fair value with unrealized gains and losses included as a separate
component of shareholders' equity, net of tax. Gains or losses on
dispositions are based on net proceeds and the amortized cost of securities
sold, using the specific identification method.
Management analyzes loans on an individual basis and classifies a loan as
impaired when an analysis of the borrower's operating results and financial
condition indicates that underlying cash flows are not adequate to meet its
debt service requirements. Often this is associated with a delay or shortfall
in payments of 30 days or more. Smaller-balance homogeneous loans are
evaluated for impairment in total and are excluded from reported impaired
loans. Such loans include residential first mortgage loans secured by
one-to-four family residences, residential construction loans and consumer
automobile, boat, RV, home equity and credit card loans with balances less
than $300. In addition, loans held for sale and leases are excluded from
consideration as impaired.
Impaired loans are fully or partially charged off when in management's
opinion an
6
UNB CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
event or events have occurred which provide reasonable certainty that a loss
is probable. When management determines that a loss is probable, a full or
partial charge off is recorded for the amount the book value of the impaired
loan exceeds the present value of the cash flows or the fair value of the
collateral, for collateral dependent loans.
All impaired loans are placed on non-accrual status. However, all non-accrual
loans are not considered impaired because non-accrual loans which have been
brought current are included on non-accrual status for six months and would
not be considered impaired.
Loans considered to be impaired are reduced to the present value of expected
future cash flows or to the fair value of collateral by allocating a portion
of the allowance for loan losses to such loans. Any reduction in carrying
value through impairment or any change in impairment based on cash payments
received or revised cash flow estimates as determined on a quarterly basis
would be applied against the unallocated portion of the allowance for loan
losses and become a specific allocation of the allowance or as an addition to
the provision for loan losses if the unallocated portion of the allowance was
insufficient to cover the impairment.
The Corporation declared a 100% stock dividend to shareholders of record on
October 1, 1998, payable on October 15, 1998. This was recorded by a transfer
from retained earnings to common stock at stated value. All earnings per
share and cash dividends per share have been adjusted for this stock dividend.
On January 1, 1997, the Corporation adopted Financial Accounting Standard No.
125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". The standard revises the accounting for
transfers of financial assets, such as loans and securities, and for
distinguishing between sales and secured borrowings. It is effective for some
transactions in 1997 and others in 1998. The adoption of SFAS No. 125 has not
had a material impact on the Corporation's consolidated financial statements.
Basic and diluted earnings per share are computed under the provisions of
SFAS No. 128, "Earnings Per Share," which was adopted retroactively by the
Corporation on December 31, 1997. All prior amounts have been restated to be
comparable. Basic earnings per share is based on net income divided by the
weighted average number of shares outstanding during the period. Diluted
earnings per share shows the dilutive effect of additional common shares
issuable under stock options assuming the exercise of stock options less the
treasury shares assumed to be purchased from the proceeds using the average
market price of UNB Corp.'s stock for the periods presented.
On January 1, 1998, the Corporation adopted Financial Accounting Standard No.
130, "Reporting Comprehensive Income". This Statement establishes standards
for reporting of comprehensive income and its components for all periods
reported. Comprehensive income includes both net income and other
comprehensive income. Other comprehensive income includes the change in
unrealized gains and losses on securities available for sale and additional
minimum pension liability adjustments.
7
UNB CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
Note 2 - Investment Securities
The amortized cost and estimated fair value of the investment and
mortgage-backed securities, available for sale and held to maturity, as
presented on the consolidated balance sheet at September 30, 1998, and
December 31, 1997, are as follows:
SEPTEMBER 30, 1998
------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
(in thousands of dollars) Cost Gains Losses Value
---- ----- ----- -----
Securities available for sale:
U.S. Treasury securities $ 11,070 $ 94 $ -- $ 11,164
Obligations of U.S. government
agencies and corporations 26,995 296 -- 27,291
Securities held to maturity:
Obligations of state and
political subdivisions 490 -- -- 490
Corporate bonds and other debt
securities 748 9 -- 757
------- ------ ------- -------
Total debt securities 39,303 399 -- 39,702
Equity securities available for sale 13,277 3,834 (212) 16,899
Asset-backed securities available
for sale 999 32 -- 1,031
------- ------ ------- --------
Total investment securities 53,579 4,265 (212) 57,632
Mortgage-backed securities
available for sale 72,962 602 (92) 73,472
Mortgage-backed securities
held to maturity 2,639 43 -- 2,682
------- ------ ------- --------
Total mortgage-backed securities 75,601 645 (92) 76,154
------- ------ ------ --------
Total investment and mortgage-
backed securities $129,180 $4,910 $ (304) $133,786
-------- ------ ------- --------
-------- ------ ------- --------
8
UNB CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
DECEMBER 31, 1997
-----------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
(in thousands of dollars) Cost Gains Losses Value
---- ----- ----- -----
Securities available for sale:
U.S. Treasury securities $17,005 $ 42 $ (1) $ 17,046
Obligations of U.S. government
agencies and corporations 36,476 119 (4) 36,591
Securities held to maturity:
Obligations of state and
political subdivisions 951 2 (1) 952
Corporate bonds and other debt
securities 746 5 -- 751
------- ------ ------- -------
Total debt securities 55,178 168 (6) 55,340
Equity securities available for sale 11,581 5,081 -- 16,662
Asset-backed securities available
for sale 999 -- (2) 997
------- ------ ------- -------
Total investment securities 67,758 5,249 (8) 72,999
Mortgage-backed securities
available for sale 60,281 527 (97) 60,711
Mortgage-backed securities
held to maturity 7,134 79 (2) 7,211
------- ------ ------- -------
Total mortgage-backed securities 67,415 606 (99) 67,922
-------- ------ ------- -------
Total investment and mortgage-
backed securities $135,173 $5,855 $ (107) $140,921
-------- ------ ------- --------
-------- ------ ------- --------
During the nine month periods ended September 30, 1998 and 1997, the proceeds
from sales of securities available for sale were $9,762 and $3,221,
respectively. Net gains of $780 and $36 were recognized in those sales,
respectively. There were no sales or transfers of securities classified as
held to maturity.
The amortized cost and estimated fair value of debt securities at September
30, 1998, by contractual maturity, are shown on page 10. Actual maturities
will differ from contractual maturities because borrowers may have the right
to call or prepay obligations with or without call or prepayment penalties.
9
UNB CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
SEPTEMBER 30, 1998
------------------
Estimated Weighted
Amortized Fair Average
(in thousands of dollars) Cost Value Yield
Securities available for sale:
U.S. Treasuries
Due in one year or less $3,998 $4,012 6.15%
Due after one year through five years 7,072 7,152 5.49
------- ------- -----
Total 11,070 11,164 5.73
------- ------- -----
U.S. Government agencies and corporations
Due in one year or less 8,999 9,064 6.32
Due after one year through five years 17,996 18,227 6.39
------- ------- -----
Total 26,995 27,291 6.36
------- ------- -----
$38,065 $38,455 6.18%
------- ------- -----
------- ------- -----
Securities held to maturity:
Obligations of state and political subdivisions
Due in one year or less $ 490 490 4.13%
------- ------- -----
Total 490 490 4.13
------- ------- -----
Corp bonds and other debt securities
Due after one year through five years 748 757 8.53
------- ------- -----
Total 748 757 8.53
------- ------- -----
$ 1,238 $ 1,247 6.79%
------- ------- -----
------- ------- -----
Asset-backed securities available for sale $ 999 $ 1,031 7.00%
------- ------- -----
Mortgage-backed and collateralized
mortgage obligations available for sale 72,962 73,472 6.45
------- ------- -----
Mortgage-backed and collateralized
mortgage obligations held to maturity 2,639 2,682 7.46
------ ------ -----
$75,601 $76,154 6.49%
------- ------- -----
------- ------- -----
At September 30, 1998, there were no holdings of securities of any one
issuer, other than the U.S. government and its agencies and corporations,
with an aggregate book value which exceeds 10% of shareholders' equity.
NOTE 3 - LOANS
- --------------
Total loans as presented on the balance sheet are comprised of the following
classifications:
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------ -----------------
Commercial, financial and agricultural $134,150 $ 81,960
Commercial, tax exempt 2,864 3,142
Commercial real estate 81,858 70,896
Residential real estate 243,216 260,190
Consumer loans 210,358 214,230
------- -------
Total loans $672,446 $630,418
-------- --------
-------- --------
10
UNB CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
Impaired loans are as follows:
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------ -----------------
Loans with no allowance for loan
losses allocated $327 $281
Loans with allowance for loan
losses allocated -- --
Amount of allowance allocated -- --
Average of impaired loans,
year-to-date $353 $335
Interest income recognized during
impairment 18 33
Cash-basis interest income
recognized year-to-date 15 32
At September 30, 1998 and December 31, 1997, loans on non-accrual status
and/or past due more than 90 days approximated $1,176 and $945, respectively.
The Other Real Estate Owned balance, net of allowance, at September 30, 1998
and December 31, 1997 was $325.
NOTE 4 - ALLOWANCE FOR LOAN LOSSES
- ----------------------------------
A summary of activity in the allowance for loan losses for the nine months
ended September 30, 1998, and September 30, 1997, are as follows:
(in thousands of dollars) 1998 1997
---- ----
Balance - January 1 $ 9,650 $8,335
Provision charged to operating expense 1,461 2,237
Loans charged off, net of recoveries (773) (1,020)
-------- --------
Balance - September 30 $10,338 $9,552
-------- --------
NOTE 5 - CONCENTRATIONS OF CREDIT RISK AND
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
- ----------------------------------------------------------
The Corporation offers commercial and consumer credit products to customers
within Stark and surrounding counties. The Corporation maintains a
diversified credit portfolio, with commercial loans and leases, commercial
real estate loans, residential mortgage loans and consumer loans comprising
20.4%, 12.1%, 36.2% and 31.3%, respectively, at September 30, 1998. Within
the commercial loan portfolio, aviation loans comprise 40.5% of loans
outstanding at September 30, 1998. Indirect loans accounted for 70.8% of all
consumer loans at September 30, 1998. The dealer network from which the
indirect new and used automobile, marine and RV loans were purchased includes
164 relationships thus far in 1998, the largest of which was responsible for
8.9% of the total indirect dollar volume for the year-to-date 1998.
The Corporation is a party to financial instruments with off-balance sheet
risk. These instruments are required in the normal course of business to meet
the financial needs of its customers. The contract or notional amounts of
these instruments are not included in the consolidated financial statements.
At September 30, 1998, the contract or notional amounts of these instruments,
which primarily include commitments to extend credit, standby letters of
credit and financial guarantees, and interest rate swaps totaled $234,096.
11
UNB CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (continued)
At September 30, 1998, the Corporation held two interest rate swap agreements
with notional amounts of $2.8 million and $19.2 million. The notional amount
of an interest rate swap does not represent an amount exchanged by the
parties and is not a measure of the Corporation's exposure through its use of
derivatives. The amounts exchanged are determined by reference to the
notional amount and the other terms of the interest rate swap. The following
table summarizes the terms of each of the swaps in effect:
SWAP #1 SWAP #2
------- -------
Notional amount $2.8 million $19.2 million
Final expiration November 20, 2000 June 13, 2003
Variable rate in effect
September 30, 1998 5.6875% 5.50%
Fixed rate 2.88% 5.86%
Market value,
September 30, 1998 $69 thousand $(555)thousand
Variable interest payments received are based on the three month LIBOR rate
which is adjusted on a quarterly basis. The income from these agreements for
the nine months ended September 30, 1998 and September 30, 1997 was $62 and
$97, respectively. Under the terms of these contracts, future changes in
LIBOR will affect the payments received, the income or expense generated by
each swap and their market value.
NOTE 6 - FHLB ADVANCES AND CAPITAL LEASE
- ----------------------------------------
The majority of long-term debt at September 30, 1998 is comprised of advances
from the Federal Home Loan Bank (FHLB). Pursuant to collateral agreements
with the FHLB, advances are secured by all FHLB stock and qualifying first
mortgage loans.
A summary of FHLB advances outstanding is as follows:
MATURITY INTEREST RATE AMOUNT
--------------------------------------------------------------------
1998 5.35%-6.70% $3,612
1999 5.35%-6.70% 12,848
2000 5.50%-6.85% 6,226
2001 6.00%-6.70% 3,188
2002 5.95%-6.25% 30,330
2003 6.25% 350
--------------------------------------------------------------------
Total $56,554
--------------------------------------------------------------------
--------------------------------------------------------------------
Based on the Bank's investment in FHLB stock, the maximum dollar amount of
FHLB advance borrowings available to the Bank is $139,480.
In the second quarter of 1997, the Bank entered into capital lease
arrangement in order to finance the acquisition of computer hardware and
related software in the amount of $252. The lease terms call for sixty
monthly payments of approximately $5 with the last payment due in March,
2002. The balance outstanding at September 30, 1998 was $177.
12
UNB CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
INTRODUCTION
The following areas of discussion pertain to the consolidated financial
statements of UNB Corp. at September 30, 1998, compared to December 31, 1997,
and the results of operations for the quarter and year-to-date periods ending
September 30, 1998, compared to the same periods in 1997. It is the intent of
this discussion to provide the reader with a more thorough understanding of the
consolidated financial statements and supporting schedules, and should be read
in conjunction with those consolidated financial statements and schedules.
UNB Corp. is not aware of any trends, events, or uncertainties that might have a
material effect on the soundness of operations; neither is UNB Corp. aware of
any proposed recommendations by regulatory authorities which would have a
similar effect if implemented.
During the first quarter of 1998, operations began for UNB Corp.'s affiliate,
United Insurance Agency, Inc., an Ohio corporation which was chartered on August
23, 1990. This affiliate is licensed to issue accident and health, and variable
life annuity insurance. UNB Corp. is in the process of applying to the State of
Ohio to become licensed to offer life, and property and casualty insurance in
the state. It is not anticipated that the results of operations of this
subsidiary will have a material impact on earnings of UNB Corp. in 1998.
During the first quarter of 1998, management decided not to activate United
Mortgage Corporation, an affiliate of UNB Corp., which was scheduled to begin
operations in the third quarter of 1998. The mortgage function will remain a
department of the Bank while several of the department's personnel have become
employees of United Banc Financial Services, the finance company affiliate of
the Corporation which is, along with the mortgage function, under the same
manager. These employees complement the finance company with greater
opportunities for expansion of its product line and growth in fee income through
the brokering of B and C quality consumer paper.
FINANCIAL CONDITION
Total assets at September 30, 1998 were $875,851, an increase of $49,538, or
6.0%, from year-end 1997. Highly liquid balances, comprised of cash and cash
equivalents, federal funds sold and interest bearing deposits with banks, showed
a net increase of $10,699, with the majority of the increase in federal funds
sold of $9,200. Balances in the investment and mortgage-backed securities
portfolios reflect a decrease of $7,104, or 5.0%, from 1997 year-end balances.
Net growth in the securities portfolios took place in the first and second
quarters of 1998 with the majority of the growth coming from liquidity created
by a net reduction in the loan portfolio and growth in deposits. Due to the
relatively low, interest rate environment throughout 1998, management's balance
sheet strategy has been to mitigate the Corporation's interest rate risk
inherent in funding longer term, fixed rate mortgages and indirect installment
loans by diverting the funds to the investment portfolio into securities with
durations of approximately two years. During the second quarter as the yield
curve declined in targeted maturity ranges, the mix in the investment portfolio
was shifted from U.S. Treasury and agency securities to mortgage-backed
securities in order to maintain the overall yield in the portfolio. During the
third quarter, balances in the securities portfolio declined as the liquidity
was used to fund the growth in targeted segments of the loan portfolio.
13
UNB CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Total loans outstanding at September 30, 1998 have grown by $42,028, or 6.7%,
from year-end 1997 balances. Most of this growth was experienced in the second
quarter with the acquisition of the aircraft financing line of business and
$35.4 million in loans balances from a large financial institution headquartered
in Ohio. This business segment, now known as the United Bank Aircraft Financing
Group, is headquartered in offices at the Akron/Canton airport and includes
three regional sales offices located in Wichita, Kansas; Sacramento, California;
and Orlando, Florida. The sales staff possesses more than 130 years of combined
aircraft finance experience. The target market for this business segment
consists of high income/net worth individuals (pleasure and business use) and
corporations who use aircraft day-to-day to support transportation needs or
provide a service. Management feels that the acquisition of this specialized
line of business fits well with the Bank's expertise in fulfilling the financial
needs of closely-held and family-owned businesses and high net worth
individuals. The loans acquired were both fixed rate(11% of portfolio) and fixed
rate with floating rate conversion features (89% of portfolio) which provide a
lending alternative which reduces interest rate risk. The aircraft balances are
reported under the commercial loan category. Since the purchase, the aircraft
portfolio has increased to $54.3 million at September 30, 1998.
Commercial real estate loans grew by $10,962, or 15.5% from December, 1997
year-end, while balances in the commercial portfolio (excluding aircraft
financing) declined by $2,120, or 2.3%. The residential real estate portfolio
has declined by $16,974, or 6.5%, from December, 1997 year-end balances
primarily due to continued high levels of refinancing brought on by the relative
levels of current mortgage rates and the strategy to sell as much newly
originated, long-term, fixed rate mortgage loan production as possible in the
secondary market.
Consumer loans declined by $3,872, or 1.8%, from year-end 1997, which is the
result of the combination of two strategies to limit interest rate risk. By
increasing rates, lowering dealer reserves and raising minimum credit scores on
selected credit quality tiers, management has accomplished the goal of reducing
new volume and shrinking the indirect consumer loan portfolio. Also during the
quarter, strategies taken in previous periods of 1998 started to show results
for the home equity product with outstanding balances growing by $6,047, or
22.0%, from year-end 1997 results. Strategies taken included mailings to
existing deposit customers and the addition of a dedicated sales staff to
generate new lines and encourage existing line usage. Also impacting the
consumer loan portfolio was the sale of $1,995 of the relatively small portfolio
in MasterCard credit card loans. Management continues to focus its efforts on
growth in specific areas of the loan portfolio, to realign its loan portfolio
mix to more reflect those of the Bank's high performing peers, in an effort to
increase net interest margin and improve profitability.
With the strategy to avoid placing longer-term, fixed rate originations into the
loan portfolios, the Bank continues to meet the needs of mortgage loan customers
by providing financing alternatives which are being sold to a network of
secondary market buyers. Also, the Bank continues to benefit from its extensive
network of relationships with car, marine and recreational vehicle dealers by
serving as a conduit to investors in sub-prime (B and C quality)indirect
installment paper. In addition, the new United Banc Financial Services office
has a sales staff dedicated to providing credit availability for sub-prime
residential mortgage customers. These loans are also sold to investors in
sub-prime paper. The benfits of these brokerage transactions include pass
through fee income without additional credit risk while maintaining corporate
liquidity.
Total earning assets at September 30, 1998 increased to $828,637 from $782,088
at December 31, 1997, an increase of $46,549, or 6.0%. The ratio of earning
assets to total assets has returned to 1997 year-end levels of 94.6%.
14
UNB CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Total liabilities increased by $49,265, or 6.6%, from year-end 1997 levels.
Total deposits at September 30, 1998 increased by $21,209, or 3.3%, from
year-end 1997. Non-interest bearing demand deposits at September 30, 1998 are
11.2% above 1997 year-end levels while interest bearing demand balances
increased 12.4% for the same period. Growth in both categories continues, the
result of extensive marketing efforts to repackage and promote the Bank's
checking with interest products under the new name of United Bank Club Accounts
which began early in 1998. Savings balances increased $20,238, or 10.8%, from
year-end levels, with the popular Money Market Access product responsible for an
increase of $26,113, or 40.0%, over 1997 year-end balances. The Bank does
frequent mailings to both customers and non- customers to encourage new account
growth. The product continues to attract the balances of sophisticated savers
who seek higher returns than those available in traditional savings products and
the liquidity unavailable in certificates of deposit. Balances in traditional
savings products continue to decline, $5,875 from year-end 1997, the result of
transfers to the Money Market Access product as well as alternative investments
outside the banking industry, both of which currently offer a higher rates of
return to the consumer. Certificate of deposit balances declined by $17,820, or
5.9%, and were influenced by the Bank's reduced marketing efforts and its
current pricing strategy which positions the Bank's interest rates close to the
average of rates offered by the Bank's local market competition.
Other significant sources of balance sheet funding, term and sweep repurchase
agreements increased $6,766, or 12.0%, from year-end levels spurred on by the
increased calling efforts of the Bank's business development officers to
commercial customers. Federal Home Loan Bank (FHLB) advance borrowings increased
by $21,114, or 59.6%. The aircraft loan portfolio purchase was ultimately funded
with a four year, $30 million fixed rate advance after being initially funded
with two successive thirty day advance borrowings. The fixed rate advance took
advantage of a relatively flat advance yield curve, allowing the Bank to extend
its maturity without significant increase in cost. Advances outstanding were
reduced in January, 1998, with the prepayment of a $5 million advance with a
coupon of 6.60%. The transaction included a $41 prepayment penalty, however,
this action helped to stabilize the overall cost of funds going forward in 1998.
The ratio of gross loans to deposits and FHLB advance borrowings was 92.5% at
September 30, 1998 compared to 92.0% at year-end 1997. This ratio reflects a
small increase from year-end. The growth in this ratio from 91.4% at the end of
the second quarter of 1998 reflects loan growth partially funded from liquidity
in the securities portfolios.
Total shareholders' equity at September 30, 1998 was $76,793, an increase of
$273, or less that 1.0%, from year-end 1997. This slight growth in equity was
influenced by several factors. Additions to equity took the form of year-to-date
net income of $8,626 and $66 for the issuance of stock for executive
compensation and stock options exercised. These were offset by the payment of
$3,038 in quarterly cash dividends and net purchases of treasury stock of
$4,603. The treasury stock transactions reflect the reaffirmation of the
commitment by the Board of Directors of the Corporation's to repurchase up to
$16.4 million of its stock. The Board feels that the stock is an excellent value
compared to other market opportunities, and acknowledges the positive impact it
has on return on equity. The Board has authorized up to $5 million in treasury
stock to be held temporarily for use in funding various plans of the Corporation
which require the issuance of its stock. These plans include the dividend
reinvestment plan and internal benefit plans of the Corporation which include
the employee stock purchase plan, the 401-K plan, and the stock option plans of
1987 and 1997. The remainder of the treasury stock will be retired.
15
UNB CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
YEAR 2000 COMPLIANCE
The Year 2000 issue is the result of many computer programs being written using
two digits rather than four to define an applicable year. The Corporation's
hardware, date-driven automated equipment, or computer programs that have date
sensitive software, may recognize a date using "00" as the year 1900 rather than
the year 2000. This faulty recognition could result in a system failure or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions or engage in normal
business activities.
UNB Corp. and its subsidiaries have conducted a comprehensive review of all of
its information technology and non information technology systems to identify
potential Year 2000 compliance problems and to test hardware and software for
compliance. This effort is led by a Year 2000 Compliance Committee which reports
directly to the Board of Directors on a monthly basis. The Committee also
reports the Corporation's progress to its primary regulator, the Office of the
Comptroller of the Currency.
The Corporation is well into the testing phase of the project for both
information technology and non information technology systems. The Committee is
monitoring this phase closely and it anticipates that all testing will be
completed by mid-year 1999. Further, the Corporation is well along in its
efforts at remediation of non-compliant systems either through the replacement
or upgrading of these systems. The Committee believes that all systems will be
Year 2000 compliant by mid year 1999.
The Committee is addressing Year 2000 compliance in the area of fiduciary
(trust) activities. All systems, software, and product vendors have been
contacted regarding their Year 2000 status. In instances where these vendors are
not yet compliant, their progress is being monitored regularly. Analysis of the
issuing entities for the Trust Department's asset holdings is well under way.
The Investment Selection Committee has completed the initial review of the
approved equity list, and has scheduled the next review for the first quarter of
1999.
The Committee continues to address Year 2000 compliance with its vendors,
suppliers, and other third parties to assess their readiness and is reviewing
these contacts and their results. This has been and will continue to be an
on-going process, until all parties can fully declare their compliance.
The Committee is assessing the Y2K risk faced by the Corporations's business
customers. By September 30, 1998, all commercial loan customers were contacted
by mail, either to inform them of the potential Year 2000 risks and issues their
businesses may face or to ask them to complete a questionnaire concerning their
perceived risks and status in addressing Year 2000 preparedness. The
Corporation's major commercial borrowers, defined as borrowers with loans and
commitments in excess of $100,000, were asked to complete a questionnaire. For
the major customers that did not respond to the questionnaires, Year 2000 risk
assessments are being prepared by the loan officers based on their direct
conversations with the customers concerning this issue and their knowledge of
the customers' businesses. Through questionnaires and direct officer calling
efforts, 85% of the Corporation's major commercial customers have been contacted
and assigned a Year 2000 risk rating. The follow-up plan for monitoring
customers identified as having high or moderate risk is being developed and will
be implemented by November 1, 1998.
The Committee oversees the development and implementation of contingency plans
for information technology and non information technology systems and is
monitoring progress in the development of these plans. The Corporation is
currently developing
16
UNB CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
contingency plans and anticipates completion by December 31, 1998.
Based on current information, the Corporation believes that all systems will be
Year 2000 compliant before January 1, 2000, through either the modification of
existing hardware and software or through the purchase of new hardware and
software. The Committee currently anticipates that the Corporation could spend
approximately $600,000 on the Year 2000 project. At this time, management does
not believe that there will be a significant negative impact on earnings due to
this issue. The Year 2000 problem could have a material impact on the operation
of the Corporation if not properly addressed, but management anticipates that
the problem will be resolved and thus will not have a significant impact on the
Corporation's delivery of products and services, or its operations.
RESULTS OF OPERATIONS
UNB Corp.'s net income for the third quarter of 1998 was $3,086 or $0.265 per
diluted share, compared with $2,101, or $0.18 per diluted share for the third
quarter of 1997. This represents an increase in earnings of 46.9% and an
increase in diluted earnings per share of 47.2%. Year-to-date net income of
$8,626 was $1,884, or 27.9%, greater than the same period in 1997. Year-to-date
diluted earnings per share for 1998 of $0.735 are 28.9% greater than 1997. The
largest component of net income, net interest income, increased by $979 and
$2,005 for the third quarter and year-to-date periods, increases of 12.1% and
8.2% over the same periods in 1997, respectively. Total interest income for the
year-to-date was $49,330, an increase of 5.0%, over the same period in 1997,
while interest expense was $22,835, an increase of $350, or 1.6%, over the same
period in 1997. The growth in net interest income was primarily the result of
overall balance sheet growth, third quarter funding of loan growth with
liquidity from the relatively lower yielding securities portfolio, and a change
in the mix of the loan portfolio with the growth concentrated in relative higher
yielding aviation and commercial real estate loans versus consumer installment
and residential mortgage loans. Additional funding of balance sheet growth
through the use of lower cost deposits and the prepayment of relatively more
expensive FHLB advances helped to keep growth in interest expense to a minimum.
The net interest margin for 1998 year-to-date was 4.42%, versus 4.30% for the
same period in 1997, an increase of twelve basis points. Within the Bank, net
interest margin increased by ten basis points. Year-to-date yields on earning
assets declined slightly affected by the decline in total securities of eight
basis points. Yields on loans remained constant. The cost of interest bearing
liabilities declined by eleven basis points, with results in deposits mixed
between the two periods, the cost of short term borrowings was flat and the cost
of FHLB advances declined by 141 basis points, the result of prepayments of
relatively higher cost FHLB advances throughout 1997 and early in 1998. The net
interest margin of 11.3% in United Bank Financial Services had a positive impact
on consolidated net interest margin, although to a small degree because of its
relative size. As the size of this affiliate grows, its impact on net interest
income and margin and operating results will become more significant.
Return on assets and return on equity for the third quarter of 1998 were 1.40%
and 15.77%, respectively, compared to 1.02% and 11.16%, respectively, for the
same period in 1997. Return on assets and return on equity for the year-to-date
ended September 30, 1998 were 1.36% and 14.84%, respectively, compared to 1.12%
and 12.29%, respectively, for the same period in 1997. As competition for loans
and deposits continues with resulting pressure on interest margin, management's
focus on growing fee income from new and existing sources, coupled with more
selective balance sheet growth has aided its performance as measured by its
return on assets
17
UNB CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
and equity. Cost containment measures to be implemented in October, 1998, with
the consolidation of two branch facilities into existing locations, as well as
actions to leverage equity through the purchases of treasury stock, should
reflect in even greater improvements in these two performance measures in the
future.
Non-interest income for the third quarter of 1998 was $2,701, a 57.2% increase
from the same period in 1997. On a year-to-date basis, non-interest income
reached $8,380, an increase of $3,122, or 59.4%, from the same period in 1997.
For the third quarter, all categories of non-interest income except securities
gains showed improvement from the same period in 1997. Gains on sales of
residential mortgage loans of $238 versus $57 in 1997, were the result of
significant refinancing activity due to the level of current market driven
mortgage rates and the Bank's aversion to the interest rate risk associated
investing in fixed rate, long-term assets on the balance sheet. The Trust
Department recorded fee income of $1,001, an increase of $235, or 30.7%, from
the same period in 1997, and was the result of an increase of 12.2% in the value
of managed assets from $744 million at December 31, 1997 to $835 million at
September 30, 1998. Service charges on deposits increased by $75, or 11.8%, due
to the restructuring of fees related to interest and non-interest bearing
checking and savings products and the growth in new accounts due to the Club
Account promotions. Other operating income for the quarter showed an increase of
$500, or 198.9%, from the same period last year and reflects a one time gain of
$271 on the sale of the majority of the MasterCard portfolio to a national
credit card servicer. This category also reflects $233 in income from loan
brokerage activities and $175 in interchange fees earned on the Bank's
Mastermoney debit cards, neither of which were included in prior year's other
income. On a year-to-date basis, the category showing the greatest impact on
other income growth was security gains which reflected $780, the majority of
which was taken on the portfolio of available for sale equity securities held in
UNB Corp.'s parent company during the first quarter, 1998.
Non-interest expense for the third quarter was $6,736, an increase of 18.6% over
the same period in 1997. On a year-to-date basis, non-interest expense reached
$20,292, an increase of $3,004, or 17.4%, from the same period in 1997. On a
year-to-date basis, salary, wages and benefits increased by 18.3% due to annual
merit increases; additions to staff in the Trust and aviation lending areas,
three new in-store branch facilities and United Banc Financial Services;
anticipated increases in incentive payouts; and increased pension expenses over
prior year. Occupancy expenses increased by 16.0%, the result of a full year's
impact of the opening of the new Portage & Frank branch and two in-store
branches as well as the office for United Banc Financial Services, most of which
were completed in the second half of 1997. Also impacting 1998 occupancy was an
additional office opened for the sub-prime loan brokers for United Banc
Financial Services and a third in-store branch in the Wooster Wal*Mart.
Year-to-date equipment expenses increased by $382, or 16.6%, from the same
period of 1997, the result of increased depreciation on office furniture and
equipment for the new facilities, a full year's depreciation on new computer
output to laser disk technology (COLD) put in place in the second quarter of
1997 and increased costs of mainframe and outside computer software services. On
a year-to-date basis, other operating expenses increased from prior year by
16.6%. Included in this increase were expenses related to the Corporation taking
the necessary steps to becoming Year 2000 compliant. In addition, charges were
taken for costs related to the implementation of strategic changes in the Bank's
retail delivery systems which include the consolidation of the Beach City branch
into the Brewster branch and the consolidation of the Uniontown branch into the
Hartville branch. These two branches will be closed in October, 1998 due to a
declining customer base, lack of
18
UNB CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
population growth in their respective areas and the proximity of other branch
offices. These steps are designed to reduce expenses, increase efficiency and
allow the Corporation to continue to provide high levels of customer service.
Bank management is evaluating all the Bank's offices looking for ways to reduce
operating costs while improving the delivery of its services at a level its
customers expect.
The Bank has continued involvement in legal proceedings concerning a seven and
one half acre parcel of property acquired through foreclosure and located in the
northwest quadrant of Stark County. A large national petroleum company, owner of
the facility at the date it was taken out of service, is the party responsible
for the contamination cleanup according to the State of Ohio's Bureau of
Underground Storage Tanks (BUSTER) regulations. After review of several
environmental assessments filed with the agency by the Bank and the petroleum
company, BUSTER is now in agreement with the petroleum company's findings, that
the levels of contaminants are such that immediate remediation is not required.
Because the findings indicate the contamination will remediate itself over time,
the State has issued a one year extension on any formal remediation plan. The
extension expires in the third quarter of 1998, after which the petroleum
company has another 90 days to file its remediation plan. Any formal remediation
steps may not be likely until the first quarter of 1999. The Bank has entered
into a verbal option with a developer who is offering the land on a
build-to-lease or build-to-own solicitation. The land is also listed with a
commercial real estate agent. Followups are also being conducted with a third
party who has requested additional soil testing and/or flood plain reports.
Management believes that limited interest has been generated to date due to the
availability of other commercial properties in the vicinity. However, due to the
growth experienced in this area of the county, as land available for development
disappears, management anticipates interest will increase. Estimated cleanup
costs, should they become the responsibility of the Bank, are not material to
the business or financial condition of the Registrant and have been set up as an
allowance against the property's value on the Corporation's Consolidated Balance
Sheet.
ALLOWANCE FOR LOAN LOSSES
The provision for loan losses for the third quarter of 1998 was $325, a
reduction of $562, or 63.4% from third quarter, 1997. On a year-to-date basis,
the provision for loan losses was $1,461, or $776 less than the same period in
1997. Management's decision to reduce the provision was based on the Bank's
declining trend in charge-offs and the level of the unallocated balance within
the loan loss allowance. On a regular basis, management reviews the amounts of
provision for loan losses charged to operating expense based on its evaluation
of the loan portfolio's credit quality, the adequacy of the allowance for loan
losses under current economic conditions and current and anticipated loan
growth. The Corporation's reserve-to-loans ratio at September 30, 1998 was 1.54%
compared to 1.53% at December 31, 1997.
Net charge-offs, as a percentage of average loans outstanding for the third
quarter of 1998, were .02% versus .05% for the same quarter in 1997. Continued
record levels of consumer debt outstanding and record bankruptcy filings
experienced nationally causes management to remain cautious in its expectations
for future net-charge offs. Another factor which remains a concern of management
is the Year 2000 readiness of commercial customers and what impact that may have
on their ability to conduct business and in turn service their debt
requirements.
19
UNB CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
Based on the above concerns, management expects to increase the provision for
loan losses in the fourth quarter over levels recorded in the third quarter of
the year.
Impaired loans at September 30, 1998 were $327, an increase of $46 from December
31, 1997. Non-performing loans, which include non-accrual loans and loans past
due 90 days or more, were $1,176 at September 30, 1998 compared to $945 at
December 31, 1997, an increase of $231, or 24.4%. The ratio of non-performing
loans to total loans outstanding at September 30, 1998 was 0.17%, a slight
increase from the 0.15% recorded at year-end 1997. The ratio of non-performing
assets which include other real estate owned was 0.22%, while the ratio for the
Corporation's peers, all bank holding companies with consolidated assets between
$500 million and $1 billion, stands at 0.72%.
CAPITAL RESOURCES
Shareholders' equity totaled $76,793 at September 30, 1998, an increase of $273,
or less than 1.0%, compared to the balance at December 31, 1997. The ratio of
equity-to-assets at September 30, 1998 was 8.77% versus 9.26% at December 31,
1997. The decrease of 49 basis points reflects faster growth in assets than in
shareholders' equity. The two factors most responsible for the slower growth in
shareholders' equity were cash dividends of $3,039 and net purchases of treasury
stock of $4,601. Also responsible, to a smaller degree was the reduction in
market value on investment securities available for sale, net of deferred taxes
of $779, brought about to a great extent, by the sale of equity securities with
significant market appreciation over cost in the first quarter. Growth in equity
has also slowed due to the use of treasury stock to fund the dividend
reinvestment plan and other plans of the Corporation which require the issuance
of stock while also supporting growth in earnings per share.
On August 13, 1998 the Board of Directors voted to temporarily suspend the
Dividend Reinvestment Plan, effective September 16, 1998. The Board felt that
capital was growing at a rate faster than could be utilized efficiently to
maximize future shareholder value. The Board of Dirctors has the option to
reinstate the plan should opportunities arise to efficiently use the capital
generated. Also on August 13, 1998, the Board of Directors approved the
payment of a 2 for 1 stock split payable on October 15, 1998 to shareholders
of record on October 1, 1998. The Board felt a split was advantageous at this
time to provide the stock with additional liquidity and to help sustain its
past performance levels.
The rate of primary capital (shareholders' equity plus the allowance for loan
losses less intangible assets) to total adjusted assets was 13.27% at September
30, 1998. The risk-based capital ratio was 12.24%, while the Tier 1 capital and
core leverage ratios reached 10.99% and 7.87%, respectively, at September 30,
1998. The levels achieved in these ratios are above required regulatory minimums
and maintain the Corporation in the "well capitalized" category under the
guidelines of the Federal Deposit Insurance Corporation Act of 1991 (FDICIA).
The dividend of $0.09 per share for the quarter (adjusted for the October 15,
1998 stock split) was a 5.9% increase over the dividend paid in the third
quarter, 1997. The year-to-date dividend of $0.265 (adjusted for the October 15,
1998 stock split), represents 35.2% of year-to-date earnings and falls within
the Corporation's dividend policy which provides for cash dividend payouts
within a
20
UNB CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
range of 35% to 50% of earnings.
LIQUIDITY
Management ensures that the liquidity position of the Corporation is adequate
to meet the credit needs and cash demands of its borrowers and depositors
through the ability to readily convert assets to cash and raise funds in the
market place in a timely and cost effective manner. Total cash, federal funds
sold, investment and mortgage-backed securities available for sale of
$177,766 represent 20.3% of total assets at September 30, 1998. Of the
investments available for sale, $38,455 are held in U.S. Treasury and Agency
securities, 34.0% of which mature within one year. Approximately $97,633 of
total Corporate securities are pledged as collateral to secure public fund
deposits, sweep or term repurchase agreements or other obligations. The
Corporation's ability to raise funds in the market place is provided by the
Bank's branch network, in addition to the availability of Federal Home Loan
Bank (FHLB) advance borrowings, brokered deposits, Federal funds purchased
and securities sold under agreement to repurchase.
Management focuses on the ratio of gross loans to deposits and FHLB Advance
borrowings in measuring and managing Corporate liquidity. This ratio was
92.5% at September 30, 1998 compared to 92.0% at year-end 1997 and 91.4% at
June 30, 1998 The increase during the third quarter reflects loan growth
funded with liquidity from the cash flows and maturities in the securities
portfolio.
The liquidity needs of the Holding Company, primarily cash dividends, security
purchases and vendor payments, are met through cash, short term investments and
dividends from the Bank.
INTEREST RATE SENSITIVITY
In the normal course of business, the Corporation is exposed to interest rate
risk caused by the differences in cash flows and repricing characteristics that
occur in various assets and liabilities as a result of changes in interest
rates. The asset and liability management process is designed to measure and
manage that risk to maintain consistent levels of net interest income and net
present value of equity under any interest rate scenario.
The Bank uses a dynamic computer model to generate earnings simulations,
duration and net present value forecasts and gap analyses, each of which
measures interest rate risk from a different perspective. The model incorporates
a large number of assumptions, including the absolute level of future interest
rates, the slope of the yield curve, various rate spread relationships,
prepayment speeds, repricing opportunities and changes in the volume of multiple
loan, investment and deposit categories. Management believes that individually
and in the aggregate these assumptions are reasonable, but the complexity of the
simulation modeling process and the inherent limitations of the various
methodologies results in a sophisticated estimate, not a precise calculation of
exposure. The Asset and Liability Management Committee reviews updated interest
rate risk position information monthly in addition to regular weekly monitoring
of changes in balance sheet volume, pricing and mix.
At September 30, 1998, assuming an immediate, parallel 200 basis point shift in
market yields, the Bank's net interest income for the next twelve months was
21
UNB CORP.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (continued)
calculated to vary between -1.29% for a 200 basis point increase, and +0.98% for
a 200 basis point decrease, denoting a negative income sensitivity to rising
interest rates. For the same two interest rate scenarios, the net present value
of portfolio equity was projected to increase by 3.06% and decrease by 1.12%,
respectively. The duration of total assets is less than the duration of total
liabilities by 2.1 months, indicating that assets will reprice slightly quicker
than liabilities. The duration of assets has held constant since the end of
1997. Duration on liabilities has increased since year-end 1997 with the most
significant impact coming from the four year FHLB advances used to permanently
fund the aircraft loan purchase.
A further discussion of interest rate sensitivity is included in Item 3,
Quantitative and Qualitative Disclosures About Market Risk, found on page 24.
CONCENTRATION OF CREDIT RISK
The Corporation maintains a diversified credit portfolio, with relatively
smaller balance, homogeneous consumer installment, credit card and residential
mortgage loans comprising 67.4% of total loans outstanding at September 30,
1998. Residential mortgages, automobile, recreational vehicle and boat loans
were the four largest concentrations in the loan portfolio by loan type.
Commercial (including aviation) and commercial real estate loans comprise the
remaining 20.4% and 12.2% of loans outstanding, respectively. Aviation loans
comprise 40.5% of the commercial loan portfolio. The two largest industry
concentrations identified within the loan portfolio, manufacturers and suppliers
of structural wood components for the construction industry and offices and
clinics of medical professionals, have commitments outstanding which represent
31.0% and 44.3%, respectively, of total Bank capital. Within the commercial real
estate portfolio, real estate is mainly held as collateral while the cash flows
of the business are considered the primary source of repayment on the loans.
With all loan types, management attempts to balance credit risk versus return by
employing conservative credit standards and comprehensive underwriting
guidelines in addition to the loan review function which monitors credits during
and after the approval process.
FORWARD LOOKING STATEMENTS
Certain statements contained in this report that are not historical facts are
forward looking statements that are subject to certain risks and uncertainties.
When used herein, the terms "anticipates," "plans," "expects," "believes," and
similar expressions as they relate to UNB Corp. or its management are intended
to identify such forward looking statements. UNB Corp.'s actual results,
performance or achievements may materially differ from those expressed or
implied in the forward looking statements. Risks and uncertainties that could
cause or contribute to such material differences include, but are not limited
to, general economic conditions, interest rate environment, competitive
conditions in the financial services industry, changes in law, governmental
policies and regulations, and rapidly changing technology affecting financial
services.
22
UNB CORP.
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
(VALUATION RESERVES)
SEPTEMBER 30, 1998
(000'S omitted)
1998 1997
-------- --------
Balance at January 1, $ 9,650 $ 8,335
Charge-Offs (Domestic):
Commercial, Financial, Agricultural 49 243
Real Estate - Commercial 0 0
Real Estate - Residential 135 20
Consumer Loans 1,534 1,776
-------- --------
Total Charge-Offs 1,718 2,039
-------- --------
Recoveries (Domestic):
Commercial, Financial, Agricultural 33 165
Real Estate - Commercial 0 8
Real Estate - Residential 134 74
Consumer Loans 778 772
-------- --------
Total Recoveries 945 1,019
-------- --------
Net Charge-Offs 773 1,020
-------- --------
Provision for loan losses 1,461 2,237
Balance at September 30, $ 10,338 $ 9,552
-------- --------
-------- --------
Ratio of net charge-offs during this
quarter to average loans outstanding this quarter 0.02% 0.05%
-------- --------
-------- --------
Allowance as a percentage of total loans 1.54% 1.50%
-------- --------
-------- --------
23
UNB CORP.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
UNB Corp's primary market risk exposure is interest rate risk, which is defined
as the potential loss of income or capital as a result of changes in interest
rates. The nature of the banking business means that some level of interest rate
risk will always be present, but the Corporation has the responsibility to
manage that risk to minimize the negative impact on both the earnings and
capital. Evaluating the Corporation's exposure to changes in interest rates
includes assessing both the management process used to control interest rate
risk and the calculated level of risk. The Corporation maintains the appropriate
policies, procedures, management information systems and internal controls as
required by the Joint Agency Policy Statement on Risk. The Company's exposure to
interest rate risk is calculated on a monthly basis and reviewed by senior
management and the Board of Directors.
The Corporation uses a number of methods to calculate and measure interest rate
risk. The asset/liability gap compares the dollar amounts of assets and
liabilities that will mature or reprice in a given time period to determine the
level and direction of interest rate sensitivity. The Corporation is considered
asset sensitive if more assets than liabilities mature or reprice in the
specified time frame and liability sensitive if more liabilities than assets
mature or reprice in that same period. Asset sensitivity, or a positive gap,
indicates that the Corporation's exposure is to falling rates, since more assets
than liabilities could reprice or be reinvested at lower levels. Liability
sensitivity, or a negative gap, means that the Corporation's exposure is to
rising rates since more liabilities than assets could reprice at higher rates.
The Corporation makes a number of assumptions when calculating its gap position.
The most significant assumption is the assignment of deposit balances without a
stated maturity date to specific time frames. Since these deposits are subject
to withdrawal on demand, and have rates that can be changed at any time, they
could be considered immediately repriceable and assigned to the shortest
maturity, resulting in a significant level of liability sensitivity. However,
actual practice indicates that balances are withdrawn and replaced over a much
longer time frame, and rates are modified less frequently and in smaller
increments than changes which occur in financial market rates. To compensate for
these extremes, the Corporation uses multiple deposit distribution assumptions
to provide a range of interest rate risk measurements that it uses as a guide
for managing various assets and liabilities. As of September 30, the
Corporation's modified twelve month cumulative gap was at 1.52% compared to
- -6.36% in the previous period primarily as a result of the lengthening of the
funding for the loan portfolio purchase in June from thirty days to four years.
As illustrated here, one of the shortcomings of the gap analysis is that the use
of a static balance sheet results in a measure of interest rate risk at one
specific point in time. Another limitation is the implied assumption that assets
and liabilities in the same time period will reprice by the same magnitude.
Simulation analysis provides a more dynamic interpretation of the impact of
rates on the Corporation's forecasted income and net present value of assets,
liabilities and capital. The Corporation makes certain assumptions regarding the
level of interest rates, prepayments on assets with imbedded options including
loans and asset backed securities, and the behavior of deposits without
contractual maturity dates. These assumptions, in addition to actual rates and
maturity and repricing dates on loans, investments and deposits, are
incorporated into a computer model which calculates forecasted net income and
24
UNB CORP.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (continued)
discounts the projected cash flows of rate sensitive assets and liabilities to
determine the present value of the Corporation's capital. The model then applies
a predetermined immediate parallel increase or decrease in the level of interest
rates to forecast the impact on both net interest income and capital one year
forward. While this methodology provides a more comprehensive appraisal of
interest rate risk, it is not necessarily indicative of actual or expected
financial performance. Changes in interest rates that affect the entire yield
curve equally at a single point in time are not typical. The residential
mortgage prepayment assumptions are based on industry medians and could differ
from the Corporation's actual results due to non-financial prepayment incentives
and other local factors. Moreover, the model does not include any interim
changes in strategy the Corporation might instate in response to shifts in
interest rates.
At quarter-end, the Corporation's interest rate shock analysis forecasted an
increase in net interest income 0.98% in response to a decrease of 200 basis
points in market rates and a decrease in net interest income of 1.29% based on a
corresponding increase in market rates. The forecasted changes in the market
value of equity were -1.12% and +3.06% for the same period. Although the model
results indicate that the Corporation would benefit from a decrease in rates, it
cannot fully predict the potential for residential mortgage loans to refinance
in the current volatile interest rate environment. The resulting decrease in
income would offset some portion of the projected reduction in interest expense.
Interest rate risk can be managed by using a variety of techniques, including
selling existing assets or repaying liabilities, pricing loans and deposits to
attract preferred maturities, developing alternative sources of funding or
structuring new products to hedge existing exposures. In addition to these
balance sheet strategies, the Corporation can also use derivative financial
instruments such as interest rate swaps, caps, and floors to minimize the
potential impact of adverse changes in interest rates.
The following table provides information about the Corporation's financial
instruments that are sensitive to changes in interest rates. The expected
maturity dates for residential mortgage loans and securities backed by or
indexed to residential mortgage loans were calculated by adjusting the
contractual maturity for prepayments corresponding to median industry data.
Installment loan prepayment speeds were based on historical experience. Deposit
accounts without contractual maturity dates were stratified by expected decay
rates according to historical analysis.
The Corporation has two pay-fixed amortizing interest rate swaps executed as
hedges against fixed rate mortgages held in the portfolio, one executed in 1993
and the other in 1998. The net cash flow and market value of the swaps move
inversely with those of the fixed rate loans in the portfolio, which reduces the
Corporation's exposure to changing interest rates. If rates rise, the
Corporation receives net cash flow from the swaps which compensates for the
opportunity loss of holding an asset with a below market yield. Alternatively,
the increase in the market value of the swap would balance the loss on the
mortgage loans if the loans were sold. If rates fall, the net cash flow given up
is offset by the increased value of assets with an above market yield. The gain
that would be realized on the sale of the loans would counteract the loss on the
termination of the interest rate swap.
The Corporation entered into the second swap in response to the investment in
long term, fixed rate mortgages which are unsaleable in the secondary market.
25
UNB CORP.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (continued)
The swap, which has a fixed rate of 5.86% and a quarterly-reset variable rate of
3 month LIBOR, will amortize quarterly over a five year period. Short- and
intermediate-term Treasury rates on which the swap yield curve is based have
declined approximately 100 basis points since the swap was executed, resulting
in a negative market value at September 30, 1998 of $555.
26
UNB CORP.
QUANTITATIVE DISCLOSURE OF MARKET RISK
ONE YEAR TWO YEARS THREE YEARS FOUR YEARS
Balance Rate Balance Rate Balance Rate Balance Rate
------------------------------------------------------------------------
ASSETS
Short Term Investments 17,130 5.47%
Securities 19,635 6.37% 14,431 6.29% 2,073 6.63% 3,521 6.27%
Collateralized Mortgage Obligations 28,366 6.72% 20,356 6.65% 10,379 6.65% 5,072 6.70%
and Mortgage Backed Securities (1)
Fixed Rate Loans (2) (3) 117,267 8.04% 64,093 9.15% 45,981 8.96% 32,615 8.62%
Variable Rate Loans (4) (5) (6) 54,352 8.40% 37,411 8.35% 52,494 8.38% 23,839 8.21%
LIABILITIES
Interest Bearing Demand & Savings (7) 30,496 3.12% 32,359 3.25% 37,032 2.86% 29,452 3.18%
Time Deposits 203,032 5.53% 47,642 5.75% 23,770 6.07% 6,500 6.11%
Repurchase Agreements 58,557 4.69%
Short Term Borrowings 4,720 5.50%
FHLB Advances 12,941 6.26% 8,319 6.11% 4,299 6.32% 30,315 5.95%
Capital Leases 56 8.15% 56 8.15% 56 8.15% 9 8.15%
OFF-BALANCE SHEET
Interest Rate Swap (8) 1,275 1,200 900
Average Pay Rate (Fixed) 2.88% 2.88% 2.88%
Average Receive Rate (Variable) 5.69% 5.69% 5.69%
Interest Rate Swap (9) 3,080 2,692 2,350 2,048
Average Pay Rate (Fixed) 5.86% 5.86% 5.86% 5.86%
Average Receive Rate (Variable) 5.50% 5.50% 5.50% 5.50%
FIVE YEARS MORE THAN 5 YEARS TOTAL Fair
Balance Rate Balance Rate Balance Rate Value
------------------------------------------------------------------
ASSETS
Short Term Investments 17,130 5.47% 17,130
Securities 1,284 6.72% 16,679 5.39% 57,623 6.10% 57,632
Collateralized Mortgage Obligations 1,704 6.91% 10,234 5.96% 76,111 6.63% 76,155
and Mortgage Backed Securities (1)
Fixed Rate Loans (2) (3) 13,934 9.17% 91,838 9.30% 365,727 8.59% 368,718
Variable Rate Loans (4) (5) (6) 21,446 8.25% 122,503 8.13% 312,046 6.74% 325,818
LIABILITIES
Interest Bearing Demand & Savings (7) 46,959 2.88% 114,715 2.21% 291,013 2.94% 271,791
Time Deposits 6,590 5.94% 800 5.78% 288,334 5.60% 2,291,804
Repurchase Agreements 58,557 4.69% 58,594
Short Term Borrowings 4,720 5.50% 4,720
FHLB Advances 330 6.25% 350 6.25% 56,554 5.91% 58,728
Capital Leases 0 0.00% 0 0.00% 177 8.15% 201
OFF-BALANCE SHEET
Interest Rate Swap (8) 69
Average Pay Rate (Fixed)
Average Receive Rate (Variable)
Interest Rate Swap (9) 8,995 (555)
Average Pay Rate (Fixed) 5.86%
Average Receive Rate (Variable) 5.50%
(1) Expected cash flows on Collateralized Mortgage Obligations and
Mortgage Backed Securities are revised monthly based on median estimates
of prepayment speeds developed by major broker dealers as published by
Bloomberg Financial Markets.
(2) For residential mortgage loans, prepayments are revised monthly
based on the median prepayment speeds developed by major broker dealers
as published by Bloomberg Financial Markets. The prepayment rates are
assigned based on the interest rate on the loan and the number of months
elapsed since the loan was originated.
(3) For installment loans, prepayments are revised monthly based on
actual historical cash flow and equate to approximately 12% to 24%.
(4) Substantially all of the variable rate commercial loans are repriced
based on the prime rate.
(5) Variable rate commercial real estate loans are based on prime or the
three year constant maturity treasury rate.
(6) Substantially all the variable rate residential mortgage loans
reprice based on the one year or three year constant maturity treasury
rate subject to various periodic and lifetime caps and floors.
(7) For deposits without contractual maturity dates, decay rates are
calculated annually by individual product type based on the current age
of the accounts.
(8) At quarter-end September, 1998, the notional principal amount of the
interest rate swap was $2,775 and the market value was $69. The notional
amount will amortize quarterly according to a predetermined schedule
until its maturity on 11/26/00. The Company pays a fixed rate of 2.88%
and receives a variable rate of three month LIBOR reset quarterly, which
at quarter-end was 5.6875%.
(9) At quarter-end September, 1998, the notional principal amount of the
interest rate swap was $19,164 and the market value was $(555). The
notional amount will amortize quarterly according to a predetermined
schedule until its maturity on 6/18/03. The Company pays a fixed rate of
5.86% and receives a variable rate of three month LIBOR reset quarterly,
which at quarter-end was 5.50%.
27
UNB CORP.
PART II - OTHER INFORMATION
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
UNB Corp. held a special Meeting of Shareholders on October 1, 1998, for purpose
of voting on a proposed amendment to the articles of incorporation to increase
the number of no par value Common Shares from the 15,000,000 shares presently
authorized to 50,000,000 shares. The purposes for increasing the number of
authorized Common Shares are to have additional shares available for issuance in
the future for stock splits, stock dividends, acquisitions, shareholders' rights
plans, and other corporate purposes. These additional shares may be issued on
authorization of the Board of Directors without further approval of
Shareholders, except as may be required by law. The adoption of the proposed
amendment required the affirmative vote of the holders of 66-2/3% of the
outstanding shares of the Corporation. If so adopted, a Certificate of Amendment
to the Corporation's Articles of Incorporation would be filed with the Secretary
of the State of Ohio. Results of shareholder voting on this issue was as
follows:
Proposed Amendment
to Corporation's Articles
of Incorporation
-------------------------
For 5,024,844
Against 99,739
Abstain 10,920
Shares not
voted by Brokers 118,952
ITEM 5 - OTHER INFORMATION
N/A
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
A. Exhibit
Number Exhibit
------- -------
27.198 Financial Data Schedule for quarter ended September 30, 1998(1)
27.197 Financial Data Schedule for quarter ended September 30, 1997(1)
B. Reports - Form 8-K - No reports on Form 8-K were filed by the Registrant
during the third quarter of 1998.
(1) Filed only in electronic format pursuant to Item 601(b)(27) of
Regulation S-K.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
UNB CORP.
----------------------------------
(Registrant)
Date November 13, 1998 James J. Pennitti
----------------- ----------------------------------
James J. Pennetti
(Duly authorized officer and
Treasurer, UNB Corp.)
28