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UNB > SEC Filings for UNB > Form 10-Q on 14-Aug-2013All Recent SEC Filings

Show all filings for UNION BANKSHARES INC



Quarterly Report

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis by management focuses on those factors that, in management's view, had a material effect on the financial position of Union Bankshares, Inc. (the Company) as of June 30, 2013 and December 31, 2012, and its results of operations for the three and six months ended June 30, 2013 and 2012. This discussion is being presented to provide a narrative explanation of the consolidated financial statements and should be read in conjunction with the consolidated financial statements and related notes and with other financial data appearing elsewhere in this filing and with the Company's Annual Report on Form 10-K for the year ended December 31, 2012. In the opinion of the Company's management, the interim unaudited data reflects all adjustments, consisting only of normal recurring adjustments, and disclosures necessary to fairly present the Company's consolidated financial position and results of operations for the interim periods presented. Management is not aware of the occurrence of any events after June 30, 2013 which would materially affect the information presented.


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 or conditions and assumptions relating thereto. The Company may include forward-looking statements in its filings with the Securities and Exchange Commission (SEC), in its reports to stockholders, including this quarterly report, in press releases, other written materials, and in statements made by senior management to analysts, rating agencies, institutional investors, representatives of the media and others.

Forward-looking statements reflect management's current expectations and are subject to uncertainties, both general and specific, and risk exists that actual results will differ from those predictions, forecasts, projections and other estimates contained in forward-looking statements. These risks cannot be readily quantified. When management uses any of the words "believes," "expects," "anticipates," "intends," "projects," "plans," "seeks," "estimates," "targets," "goals," "may," "might," "could," "would," "should," or similar expressions, they are making forward-looking statements. Many possible events or factors, including those beyond the control of management, could affect the future financial results and performance of the Company. This could cause results or performance to differ materially from those expressed in forward-looking statements. The possible events or factors that might affect the forward-looking statements include, but are not limited to, the listing in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 and the items added below in this report on Form 10-Q:
investments may not be called as expected due to a rise in long-term interest rates, resulting in a cash inflow reduction or may become other than temporarily impaired;

assumptions made regarding interest rate movement, yield curve and sensitivity could vary substantially if actual experience differs from historical experience or expected results, which could affect the Company's projected results of operations;

excess liquidity due to weaker loan demand, lower draws on unused lines of credit or stronger deposit growth than anticipated may make it difficult to maintain historical yields due to the continuing low interest rate environment and resulting adverse impact on investment returns;

regulatory limitations placed on income producing methods including the limitations on debit and credit card interchange fees and overdraft fees and restrictions on asset sales;

disruptions in U.S. and global financial and credit markets, including the downgrading of U.S. and U.S. Government sponsored debt by one or more credit rating agencies;

proposed and final regulations issued by the Consumer Financial Protection Bureau that impact community banks resulting from changing industry standards and best practices;

the effect of federal and state health care reform efforts, including the federal Patient Protection and Affordable Care Act and Vermont's single-payer universal health care law.

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, including the events and circumstances discussed under "Recent Developments" below, and are reminded not to place undue reliance on such statements. Investors should not consider the foregoing list of factors to be a complete list of risks or uncertainties. Forward-looking statements

Union Bankshares, Inc. Page 28

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.


Data suggests economic activity has expanded at a moderate pace during the first half of 2013. National unemployment rates continue to remain elevated even though there has been improvement in the labor markets. Household spending and business fixed investment saw continued improvement, and the housing sector has strengthened, but mortgage rates have risen and fiscal policy appears to be restraining economic growth. Inflation is somewhat below the Federal Open Market Committee's (FOMC) long-term objective.

It appears that short-term interest rates will continue at historic lows as the FOMC is likely to keep the target range for federal funds rate at 0-25 basis points in order to promote the ongoing economic recovery. The FOMC intends on maintaining this target range as long as the federal unemployment rate remains above 6.5% and inflation remains under control. The Federal Reserve continues to put downward pressure on longer-term interest rates by extending the duration of its treasury securities and continues to reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. The FOMC will closely monitor incoming information on economic and financial developments in coming months.

In Vermont the statewide unemployment rate was 4.4% at June 30, 2013 and 5.1% at December 31, 2012, while in New Hampshire the unemployment rate was at 5.2% at June 30, 2013 and 5.7% at December 31, 2012 The Vermont percentage at June 30, 2013 is the lowest the unemployment rate has been since January of 2008. Rates for both states compare favorably with the national rate of 7.6% at June 30, 2013.

In response to the earlier financial crisis affecting the banking and financial markets, the resulting recession and the changing political environment, many new laws, regulations and programs have been adopted that will or may impact the Company's future earnings and/or efficiency, many of which were referenced in our 2012 Annual Report on Form 10-K. Several of the laws, regulations, and programs mentioned in our 2012 Annual Report on Form 10-K were in the proposed status and have since become effective for the Company. The following are the most relevant:
Among the new regulations imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) are new residential mortgage provisions that mandate more extensive disclosures, require lenders to offer terms that reasonably reflect the consumers' ability to repay a loan, prohibit mandatory arbitration provisions, add new customer protections for high-cost mortgages and set escrow account and appraisal standards. Several final rules were issued during the first quarter of 2013 with effective dates within one year of issuance. Management is currently reviewing the final rules and will implement changes to our processes and related disclosures as deemed necessary.

The Company has evaluated its capital adequacy under the final BASEL III requirements on a pro forma basis and as of June 30, 2013, it would be considered well capitalized under such requirements, including as fully phased in.

Recently the Consumer Financial Protection Bureau finalized rules that govern how mortgage servicers communicate with consumers, offer loss mitigation and foreclosure avoidance options, and conduct the foreclosure process. These rules are promulgated under amendments to the Truth in Lending Act and the Real Estate Settlement Procedures Act adopted as part of the Dodd-Frank Act. These rules become effective January 18, 2014.

Continued implementation of new national and Vermont health care laws will impact individuals and businesses in the coming years and the effect of that impact on the Company and its customers cannot yet be quantified.

Nonbranch methods for customers to access their financial accounts continue to grow in importance and therefore Union now offers a mobile banking option to all customers wanting this method of nonbranch banking. Other electronic alternatives will continue to be explored.

Union's Green Mountain Mall branch in St. Johnsbury, Vermont was closed on April 5, 2013. Customers continue to be served at one of the other three branches located in proximity to the Green Mountain Mall location and account closures have been minimal since the branch closure occurred. The branch staff has been reassigned to other local offices and the lease on the office terminated June 30, 2013.

As previously reported in our 2012 Annual Report on Form 10-K, effective October 5, 2012, Union Bank's Pension Plan was closed to new participants and benefit accrual for participants was frozen. In light of that decision, Union

Union Bankshares, Inc. Page 29

amended its 401(k) plan effective January 1, 2013, to include "Safe Harbor" provisions requiring an annual nondiscretionary minimum contribution to the plan for all eligible plan participants in an amount equal to 3% of eligible earnings of each eligible plan participant.

The cost of doing business has continued to increase dramatically in this regulatory environment as the number and extent of new regulations and the speed with which they must be implemented require additional bank software purchases, greater reliance on service providers and additional staff. Also, the cost of mitigating long-term interest rate risk by selling loans to the secondary market continued to increase during 2013 and it is anticipated that this cost will continue to grow as the government sponsored entities continue to work through their own financial problems.

It is not completely clear at this time what impact current or future government sponsored programs, regulations, legislation, or the U.S. Government's sequester will have on the Company, its customers or the U.S. and global financial markets, but additional regulatory complexity and allocation of Company resources to deal with the impact are likely.


The Company has established various accounting policies which govern the application of U.S. Generally Accepted Accounting Principles (GAAP) 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, capital, revenues and expenses and related disclosures of contingent assets and liabilities in the consolidated financial statements and accompanying notes. The SEC has defined a company's critical accounting policies as the ones that are most important to the portrayal of the company's financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates on matters that are inherently uncertain. Based on this definition, management has identified the accounting policies and judgments most critical to the Company. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from estimates and have a material impact on the carrying value of assets, liabilities, or capital, and/or the results of operations of the Company.

Please refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2012 for a more in-depth discussion of the Company's critical accounting policies. There have been no changes to the Company's critical accounting policies since the filing of that report.


The Company's net income was $1.8 million for the quarter ended June 30, 2013 compared to $1.4 million for the quarter ended June 30, 2012, an increase of $359 thousand, or 25.0%. These results reflected the net effect of an increase in net interest income of $134 thousand, or 2.5%, a decrease in noninterest expenses of $341 thousand, or 6.1% and a decrease in the provision for loan losses of $105 thousand, or 58.3%, partially offset by a decrease of $48 thousand, or 2.2%, in noninterest income and a $173 thousand, or 54.2%, increase in the provision for income taxes.

The Company continues to face a challenging low interest rate environment as the prime rate has remained unchanged at 3.25% since December 2008. Total interest income decreased by $106 thousand, or 1.7%, to $6.1 million for the second quarter of 2013, versus $6.2 million for the second quarter of 2012, while interest expense decreased $240 thousand, or 28.1%, between periods, from $853 thousand for the second quarter of 2012 to $613 thousand for the second quarter of 2013. These changes in interest income and interest expense resulted in net interest income of $5.5 million for the second quarter of 2013, up $134 thousand, or 2.5%, from the second quarter of 2012 of $5.3 million. The continued static low prime rate or further drops in the prime rate and/or increases in competitors' deposit rates or market borrowing rates could be problematic for the Company if loans were to refinance to a lower rate or individual variable rate loan and investment instruments reprice downward at a faster rate than the downward repricing of funding costs. In addition, there is very little relative reduction that can be made in future periods from the deposit rates currently paid as it appears customers are staying in short-term time or nontime deposit accounts which are all currently paying an interest rate of less than one-half percent.

Noninterest income decreased $48 thousand, or 2.2%, for the quarter due to several contributing factors, but primarily due to lower net gains on sales of loans held for sale, which decreased $85 thousand, or 12.7%, from $668 thousand for the quarter ended June 30, 2012 to $583 thousand for the quarter ended June 30, 2013, despite an increase in the volume of residential loans sold to the secondary market from $25.9 million in the second quarter of 2012 to $32.5

Union Bankshares, Inc. Page 30

million in the second quarter of 2013, an increase of $6.6 million, or 25.7%. The increased volume of loan sales was driven by the sustained low long-term mortgage rates, which continued to result in strong loan demand in our branches and the South Burlington loan production office though the rise in long-term rates at the end of the second quarter of 2013 may slow mortgage originations. The decrease in net gains on sales of loans for the quarter was partially offset by a $34 thousand increase in loan servicing fees due to the increased volume of residential real estate loans serviced.

Pension and employee benefits decreased $419 thousand, or 39.6%, for the three month period ended June 30, 2013 compared to the same period for 2012 mainly due to the October 5, 2012 freeze on the pension plan which stopped accrual of benefits and closed the plan to new participants. Equipment expenses increased $47 thousand, or 13.8%, for the three month period ended June 30, 2013 compared to the same period for 2012 due to the renewal of license and maintenance fees that were initially included in the original purchase cost of the related equipment and the accelerated depreciation on equipment that remained at the Green Mountain Mall branch after vacating the space in April 2013. Other noninterest expenses were up $25 thousand, or 1.3%, for the three months ended June 30, 2013.

The Company's effective tax rate increased to 21.5% for the three months ended June 30, 2013 from 18.2% for the same period in 2012, as taxable income increased and was partially offset by increases in both tax exempt income and tax credits from affordable housing partnership investments.

At June 30, 2013, the Company had total consolidated assets of $546.7 million, including gross loans and loans held for sale (total loans) of $449.2 million, deposits of $474.0 million, borrowed funds of $20.2 million and stockholders' equity of $45.8 million. The Company's total assets decreased $30.6 million, or 5.3%, from $577.3 million at December 31, 2012. The decrease in total assets is primarily a result of municipal loans decreasing $15.8 million and cash and cash equivalents dropping $34.3 million as municipal deposits decreased $32.1 million compared to levels at year end. This is a normal seasonal fluctuation due primarily to the effects of the annual municipal funding cycle in the State of Vermont, where the vast majority of municipal borrowers pay off their annual line of credit for one day each fiscal year which is normally the last business day of June.

Net loans and loans held for sale decreased a total of $6.0 million, or 1.3%, to $444.6 million, or 81.3%, of total assets at June 30, 2013, compared to $450.6 million, or 78.1%, of total assets at December 31, 2012.

Deposits decreased $36.0 million, or 7.1%, to $474.0 million at June 30, 2013, from $510.0 million at December 31, 2012. Similar to the decline in total assets at June 30, 2013 compared to December 31, 2012, total deposits decreased primarily as a result of the seasonal fluctuation of the municipal funding cycle in that municipalities redeem deposit monies to paydown outstanding loan balances.

The Company's total capital increased from $45.0 million at December 31, 2012 to $45.8 million at June 30, 2013. The regulatory guidelines for the well capitalized capital category continue to be met with the total risk based capital ratio increasing to 13.19% at June 30, 2013 from 12.95% at December 31, 2012. The regulatory guideline for well capitalized is 10.0% and the minimum requirement is 8.0%.

Union Bankshares, Inc. Page 31

The following unaudited per share information and key ratios depict several
measurements of performance or financial condition for the three and six months
ended June 30, 2013 and 2012, respectively:
                                             Three Months Ended or At June 30,    Six Months Ended or At June 30,
                                                  2013             2012                2013               2012
Return on average assets (ROA) (1)                  1.27 %              1.04 %             1.25 %             0.97 %
Return on average equity (1)                       15.65 %             14.17 %            15.51 %            13.16 %
Net interest margin (1)(2)                          4.25 %              4.30 %             4.20 %             4.29 %
Efficiency ratio (3)                               68.57 %             72.67 %            67.72 %            74.26 %
Net interest spread (4)                             4.15 %              4.18 %             4.10 %             4.16 %
Loan to deposit ratio                              94.77 %             94.96 %            94.77 %            94.96 %
Net loan charge-offs to average loans not
held for sale (1)                                   0.03 %              0.01 %             0.02 %                *
Allowance for loan losses to loans not held
for sale (5)                                        1.07 %              1.09 %             1.07 %             1.09 %
Nonperforming assets to total assets (6)            0.67 %              1.31 %             0.67 %             1.31 %
Equity to assets                                    8.38 %              7.68 %             8.38 %             7.68 %
Total capital to risk weighted assets              13.19 %             12.22 %            13.19 %            12.22 %
Book value per share                         $     10.27     $          9.20   $          10.27     $         9.20
Earnings per share                           $      0.40     $          0.32   $           0.79     $         0.60
Dividends paid per share                     $      0.25     $          0.25   $           0.50     $         0.50
Dividend payout ratio (7)                          62.50 %             78.13 %            63.29 %            83.33 %


* Net charge-offs were so small that the percentage was less than 0.01%.

(1) Annualized.

(2) The ratio of tax equivalent net interest income to average earning assets. See pages 33 and 34 for more information.

(3) The ratio of noninterest expense ($5.2 million in 2013 and $5.6 million in 2012) to tax equivalent net interest income ($5.6 million in 2013 and $5.5 million in 2012) and noninterest income ($2.1 million in 2013 and $2.2 million in 2012) excluding securities (losses) gains ($(4) thousand in 2013 and $2 thousand in 2012) for the three months ended June 30, 2013 and 2012, respectively.

The ratio of noninterest expense ($10.4 million in 2013 and $11.1 million in 2012) to tax equivalent net interest income ($11.1 million in 2013 and $10.9 million in 2012) and noninterest income ($4.3 million in 2013 and $4.0 million in 2012) excluding securities (losses) gains ($(1) thousand in 2013 and $44 thousand in 2012) for the six months ended June 30, 2013 and 2012, respectively.
(4) The difference between the average rate earned on earning assets and the average rate paid on interest bearing liabilities. See pages 33 and 34 for more information.

(5) Calculation includes the net carrying amount of loans recorded at fair value from the branch acquisitions as of June 30, 2013 ($19.3 million) and June 30, 2012 ($26.0 million). Excluding such loans, the allowance for loan losses to loans not purchased and not held for sale was 1.12% at June 30, 2013 and 1.16% at June 30, 2012.

(6) Nonperforming assets are loans or investment securities that are in nonaccrual or 90 or more days past due as well as Other Real Estate Owned ("OREO") or Other Assets Owned ("OAO").

(7) Cash dividends declared and paid per share divided by consolidated net income per share.


Net Interest Income. The largest component of the Company's operating income is net interest income, which is the difference between interest and dividend income received from interest earning assets and the interest expense paid on interest bearing liabilities. The Company's net interest income increased $134 thousand, or 2.5%, to $5.5 million for the three months ended June 30, 2013 from $5.3 million for the three months ended June 30, 2012. The net interest spread decreased 3 basis points to 4.15% for the three months ended June 30, 2013, from 4.18% for the three months ended June 30, 2012 despite a 23 basis point drop in the average interest rate paid on interest bearing liabilities, from 0.79% for the three months ended June 30, 2012 to 0.56% for the three months ended June 30, 2013, as the average yields earned on interest earning assets dropped 26 basis points from 4.97% for the quarter ended June 30, 2012 to

Union Bankshares, Inc. Page 32

4.71% for the quarter ended June 30, 2013. The net interest margin for the second quarter of 2013 decreased 5 basis points to 4.25% from 4.30% for the second quarter of 2012. The prolonged low rate environment continues to put pressure on the Company's net interest spread and margin.

Yields Earned and Rates Paid. The following tables show for the periods indicated the total amount of income recorded from average interest earning assets, the related average tax equivalent yields, the interest expense associated with average interest bearing liabilities, the related average rates paid, and the resulting tax equivalent net interest spread and margin. Yield and rate information is average information for the period, and is calculated by dividing the annualized tax equivalent income or expense item for the period by the average balance of the appropriate balance sheet item during the period. Net interest margin is annualized tax equivalent net interest income divided by average earning assets. Nonaccrual loans or investments are included in asset balances for the appropriate periods, but recognition of interest on such loans or investments is discontinued and any remaining accrued interest receivable is reversed in conformity with federal regulations.

                                                      Three Months Ended June 30,
                                                2013                               2012
                                               Interest    Average                Interest    Average
                                   Average     Earned/     Yield/     Average     Earned/     Yield/
                                   Balance       Paid       Rate      Balance       Paid       Rate
                                                        (Dollars in thousands)
Average Assets:
Federal funds sold and overnight
deposits                         $  16,670   $       10      0.25 % $  10,407   $        3      0.12 %
Interest bearing deposits in
banks                               22,624           59      1.05 %    23,627           72      1.22 %
Investment securities (1), (2)      36,704          221      2.76 %    40,388          267      3.07 %
Loans, net (1), (3)                453,798        5,787      5.23 %   437,411        5,840      5.48 %
Nonmarketable equity securities      1,811            2      0.44 %     1,868            3      0.56 %
Total interest earning assets
(1)                                531,607        6,079      4.71 %   513,701        6,185      4.97 %
Cash and due from banks              4,390                              5,316
Premises and equipment              10,283                             10,346
Other assets                        19,385                             21,887
Total assets                     $ 565,665                          $ 551,250
Average Liabilities and
Stockholders' Equity:
Interest bearing checking
accounts                         $  90,975   $       20      0.09 % $  86,107   $       37      0.17 %
Savings/money market accounts      179,839           90      0.20 %   162,963          101      0.25 %
Time deposits                      146,358          376      1.03 %   153,934          481      1.26 %
Borrowed funds                      16,913          127      2.97 %    28,678          234      3.22 %
Total interest bearing
liabilities                        434,085          613      0.56 %   431,682          853      0.79 %
Noninterest bearing deposits        80,038                             69,882
. . .
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