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UNB > SEC Filings for UNB > Form 10-Q on 14-Nov-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 September 30, 2013 and December 31, 2012, and its results of operations for the three and nine months ended September 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 September 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 29

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.


Consistent with the first half of 2013, economic activity has continued to expand at a moderate pace based on information received from the most recent Federal Open Market Committee's (FOMC) meeting. 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, but recovery in the housing sector has slowed somewhat in recent months. Inflation is somewhat below the Federal Open Market Committee's (FOMC) long-term objective despite fluctuations due to changing energy prices.

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 FOMC recognizes improvement in economic activity and labor conditions since it began its asset purchase program; however, more evidence is needed to ensure progress will be sustained before adjusting the pace of its purchases. 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 has indicated that it will closely monitor incoming information on economic and financial developments in coming months.

In Vermont the statewide unemployment rate was 4.6% at August 31, 2013 and 5.1% at December 31, 2012, while in New Hampshire the unemployment rate was at 5.0% at August 31, 2013 and 5.7% at December 31, 2012. Rates for both states compare favorably with the national rate of 7.3% at August 31, 2013 and 7.8% at December 31, 2012. Due to a temporary delay in funding during the partial government shutdown, the Bureau of Labor Statistics has indicated that September 2013 unemployment data will be released with the October 2013 data, for which release dates have yet to be scheduled.

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 issued during the first quarter of 2013 become effective for Union in the first quarter of 2014. 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. Management has reviewed the upcoming regulations, attended seminars and trainings and is working with our vendors to facilitate a smooth implementation process for the new regulations that are effective in January 2014.

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

Significant uncertainty surrounds the implementation of federal and Vermont health care reform legislation. The Company will continue to monitor health care reform and its impact on the Company and the individuals and businesses in its market areas. Those impacts cannot yet be quantified.

The federal budget was not approved as of September 30, 2013 and was finally extended for 6 months. One of the consequences of the delay in budget approval was a partial government shut down for approximately three weeks. The impact of the shutdown is not quantifiable for the Company or its customers, but is not expected to have a significant impact.

Union Bankshares, Inc. Page 30

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 and enhancements will continue to be explored.

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 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 staffing resources. 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 regional 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 $2.1 million for the quarter ended September 30, 2013 compared to $2.0 million for the quarter ended September 30, 2012, an increase of $92 thousand, or 4.6%. These results reflected the net effect of an increase in net interest income of $83 thousand, or 1.5%, a decrease in noninterest expenses of $649 thousand, or 11.3%, a decrease in the provision for loan losses of $55 thousand, or 36.7% and a decrease in the provision for income taxes of $7 thousand, or 1.3%, partially offset by a decrease in noninterest income of $702 thousand, or 24.3%.

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 $123 thousand, or 1.9%, to $6.2 million for the third quarter of 2013, versus $6.4 million for the third quarter of 2012, while interest expense decreased $206 thousand, or 25.3%, between periods, from $815 thousand for the third quarter of 2012 to $609 thousand for the third quarter of 2013. These changes in interest income and interest expense resulted in net interest income of $5.6 million for the third quarter of 2013, up $83 thousand, or 1.5%, from the third quarter of 2012 of $5.5 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,

Union Bankshares, Inc. Page 31

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 $702 thousand, or 24.3%, for the quarter due to lower net gains on sales of loans held for sale, which decreased $760 thousand, or 58.4%, from $1.3 million for the quarter ended September 30, 2012 to $541 thousand for the quarter ended September 30, 2013. The decrease in net gains was a result of a decrease in the volume of residential loans sold to the secondary market from $39.7 million in the third quarter of 2012 to $31.7 million in the third quarter of 2013, a decrease of $8.0 million, or 20.1%, as well as lower premiums obtained due to rise in interest rates in late June 2013. The decrease in net gains on sales of loans for the quarter was partially offset by an increase in service fees of $52 thousand, or 4.1%, between periods.

Pension and employee benefits decreased $372 thousand, or 38.4%, for the three month period ended September 30, 2013 compared to the same period for 2012, mainly due to the October 5, 2012 freeze of the pension plan which stopped accrual of benefits and closed the plan to new participants. This decrease was partially offset by an increase of $63 thousand, or 131.5%, in the 401K employer contribution expense related to Safe Harbor contributions that became effective January 1, 2013 with the amendment of the 401K plan. Expenses of Other Real Estate Owned (OREO) decreased $418 thousand, or 100.5%, for the three month period ended September 30, 2013 compared to 2012 and other noninterest expenses increased $141 thousand, or 3.2%, for the three months ended September 30, 2013.

The Company's effective tax rate decreased to 20.8% for the three months ended September 30, 2013 from 21.8% for the same period in 2012, resulting from an increase in tax credits from affordable housing partnership investments, partially offset by an increase in taxable income and a decrease in tax exempt income.

At September 30, 2013, the Company had total consolidated assets of $574.7 million, including gross loans and loans held for sale (total loans) of $475.9 million, deposits of $507.3 million, borrowed funds of $14.2 million and stockholders' equity of $46.7 million. The Company's total assets decreased $2.6 million, or 0.4%, from $577.3 million at December 31, 2012. Although total assets did not change significantly from December 31, 2012 to September 30, 2013, the asset mix changed with cash and cash equivalents decreasing $30.1 million and net loans and loans held for sale increasing a total of $20.7 million and investment securities increasing $10.6 million compared to levels at December 31, 2012 .

Net loans and loans held for sale increased a total of $20.7 million, or 4.6%, to $471.3 million, or 82.0%, of total assets at September 30, 2013, compared to $450.6 million, or 78.1%, of total assets at December 31, 2012.

Deposits decreased $2.6 million, or 0.5%, to $507.3 million at September 30, 2013, from $510.0 million at December 31, 2012. The decrease in deposits was primarily related to a drop in municipal NOW and money market accounts between periods, partially offset by increases in demand deposit and savings accounts.

The Company's total capital increased from $45.0 million at December 31, 2012 to $46.7 million at September 30, 2013. The regulatory guidelines for the well capitalized capital category continue to be met with the total risk based capital ratio increasing to 12.99% at September 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 32

The following unaudited per share information and key ratios depict several
measurements of performance or financial condition for the three and nine months
ended September 30, 2013 and 2012, respectively:
                                              Three Months Ended or At September  Nine Months Ended or At September
                                                             30,                                 30,
                                                  2013               2012              2013              2012
Return on average assets (ROA) (1)                  1.44 %               1.40 %          1.31 %               1.12 %
Return on average equity (1)                       18.01 %              19.21 %         16.35 %              15.20 %
Net interest margin (1)(2)                          4.23 %               4.32 %          4.21 %               4.30 %
Efficiency ratio (3)                               63.87 %              66.68 %         66.41 %              71.49 %
Net interest spread (4)                             4.12 %               4.20 %          4.11 %               4.16 %
Loan to deposit ratio                              93.81 %              92.01 %         93.81 %              92.01 %
Net loan charge-offs to average loans not
held for sale (1)                                   0.06 %               0.16 %          0.03 %               0.06 %
Allowance for loan losses to loans not held
for sale (5)                                        1.01 %               1.01 %          1.01 %               1.01 %
Nonperforming assets to total assets (6)            0.52 %               0.86 %          0.52 %               0.86 %
Equity to assets                                    8.12 %               7.23 %          8.12 %               7.23 %
Total capital to risk weighted assets              12.99 %              12.17 %         12.99 %              12.17 %
Book value per share                         $     10.47     $           9.45     $     10.47     $           9.45
Earnings per share                           $      0.47     $           0.44     $      1.26     $           1.04
Dividends paid per share                     $      0.25     $           0.25     $      0.75     $           0.75
Dividend payout ratio (7)                          53.19 %              56.82 %         59.52 %              72.12 %

(1) Annualized.

(2) The ratio of tax equivalent net interest income to average earning assets. See pages 34 and 35 for more information.

(3) The ratio of noninterest expense ($5.1 million in 2013 and $5.7 million in 2012) to tax equivalent net interest income ($5.8 million in 2013 and $5.7 million in 2012) and noninterest income ($2.2 million in 2013 and $2.9 million in 2012) excluding securities (losses) gains (none in 2013 and 2012) for the three months ended September 30, 2013 and 2012, respectively.

The ratio of noninterest expense ($15.5 million in 2013 and $16.8 million in 2012) to tax equivalent net interest income ($16.9 million in 2013 and $16.7 million in 2012) and noninterest income ($6.5 million in 2013 and $6.9 million in 2012) excluding securities (losses) gains ($(1) thousand in 2013 and $44 thousand in 2012) for the nine months ended September 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 34 and 35 for more information.

(5) Calculation includes the net carrying amount of loans recorded at fair value from the branch acquisitions as of September 30, 2013 ($18.4 million) and September 30, 2012 ($23.7 million). Excluding such loans, the allowance for loan losses to loans not purchased and not held for sale was 1.05% at September 30, 2013 and 1.07% at September 30, 2012.

(6) Nonperforming assets are loans or investment securities that are in nonaccrual or 90 or more days past due as well as 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 $83 thousand, or 1.5%, to $5.6 million for the three months ended September 30, 2013 from $5.5 million for the three months ended September 30, 2012. The net interest spread decreased 8 basis points to 4.12% for the three months ended September 30, 2013, from 4.20% for the three months ended September 30, 2012 despite a 19 basis point drop in the average interest rate paid on interest bearing liabilities, from 0.74% for the three months ended September 30, 2012 to 0.55% for the three months ended September 30, 2013, as the average yields earned on interest earning assets dropped 27 basis points from 4.94% for the three months ended September 30, 2012 to 4.67% for the three month period ended September 30, 2013 . The net interest margin for the third quarter of 2013 decreased 9 basis points to 4.23% from 4.32% for the

Union Bankshares, Inc. Page 33

third 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 September 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                         $  10,491   $        3      0.09 % $  18,891   $        4      0.08 %
Interest bearing deposits in
banks                               21,389           59      1.08 %    20,001           63      1.25 %
Investment securities (1), (2)      36,747          224      2.81 %    32,246          220      3.27 %
Loans, net (1), (3)                473,243        5,944      5.10 %   454,255        6,066      5.44 %
Nonmarketable equity securities      2,053            2      0.32 %     1,976            2      0.47 %
Total interest earning assets
(1)                                543,923        6,232      4.67 %   527,369        6,355      4.94 %
Cash and due from banks              4,486                              4,780
Premises and equipment              10,517                             10,331
Other assets                        17,347                             22,129
Total assets                     $ 576,273                          $ 564,609
Average Liabilities and
Stockholders' Equity:
Interest bearing checking
accounts                         $  92,375   $       21      0.09 % $  88,384   $       32      0.15 %
Savings/money market accounts      169,956           84      0.19 %   170,186          106      0.25 %
Time deposits                      154,069          371      0.96 %   150,034          442      1.17 %
Borrowed funds                      21,661          133      2.42 %    26,640          235      3.46 %
Total interest bearing
. . .
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