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UNB > SEC Filings for UNB > Form 10-K on 31-Mar-2014All Recent SEC Filings

Show all filings for UNION BANKSHARES INC



Annual Report

Item 7. 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 consolidated financial position of Union Bankshares, Inc. ("the Company," "our," "we," "us") and its subsidiary, Union Bank ("Union"), as of December 31, 2013 and 2012, and its results of operations for the years ended December 31, 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 in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. The purpose of this presentation is to enhance overall financial disclosures and to provide information about historical financial performance and developing trends as a means to assess to what extent past performance can be used to evaluate the prospects for future performance. The Company meets the qualification requirements under Securities and Exchange Commission ("SEC") rules for smaller reporting companies, and pursuant to such rules, has elected to present audited statements of income, comprehensive income, cash flows and changes in stockholders' equity for each of the preceding two, rather than three, fiscal years. Management is not aware of the occurrence of any events after December 31, 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 SEC, in its reports to stockholders, including this Annual 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 terms "believes," "expects," "anticipates," "intends," "projects," "potential," "plans," "seeks," "estimates," "targets," "goals," "may," "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.

Factors that may cause results or performance to differ materially from those expressed in forward-looking statements include, but are not limited to: (1) continuing general economic conditions and financial instability, either nationally, internationally, regionally or locally resulting from elevated unemployment rates, changes in monetary and fiscal policies, and adverse changes in the credit rating of U.S. government debt; (2) increased competitive pressures from tax-advantaged credit unions and other financial service providers in the Company's northern Vermont and northwestern New Hampshire market area or in the financial services industry generally, from increasing consolidation and integration of financial service providers, and from changes in technology and delivery systems; (3) interest rates change in such a way that continues to put pressure on the Company's margins, or result in lower fee income and lower gain on sale of real estate loans; (4) changes in laws or government rules, or the way in which courts or government agencies interpret or implement those laws or rules, that increase our costs of doing business or otherwise adversely affect the Company's business; (5) changes in federal or state tax policy; (6) changes in the level of nonperforming assets and charge-offs; (7) changes in estimates of future reserve requirements based upon relevant regulatory and accounting requirements; (8) changes in consumer and business spending, borrowing and savings habits; (9) further changes to the calculation of the Company's regulatory capital ratios which, among other things, would require additional regulatory capital, change the framework for risk-weighting of assets and require accumulated other comprehensive income to be reflected in regulatory capital; and (10) the effect of and changes in the United States monetary and fiscal policies, including interest rate policies and regulation of the money supply by the Federal Reserve Board ("FRB").


The Company, like other financial institutions, is subject to a number of risks, many of which are outside of the Company's direct control, though efforts are made to manage those risks while optimizing returns. Managing those risks is an essential part of successfully managing a financial institution. Risk identification and monitoring are key elements in overall risk management. Among the risks inherent in the Company's business operations are: (1) credit risk, which is the risk that loan customers or other counterparties will be unable to perform their contractual obligations, (2) interest rate risk, which is the risk that changes in market rates and prices will adversely affect the Company's financial condition or results of operation, (3) liquidity risk, which

is the risk that the Company will have insufficient funds or access to funds to meet operational needs, (4) price risk, which is the risk to earnings or capital that results from the changes in the value of portfolios of financial instruments, (4) transactional risk, which is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events, (5) compliance risk, which is the risk of loss resulting from violations or nonconformance with laws, rules, regulations, prescribed practices, or ethical standards, (6) strategic risk, which is the risk from adverse business decisions or improper implementation of those decisions, and (7) reputation risk, which is the risk to earnings or capital from negative public opinion.


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 management 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. Nevertheless, because the nature of the judgments and assumptions made by management are inherently subject to a degree of uncertainty, actual results could differ from estimates and have a material impact on the carrying value of assets, liabilities, capital, or the results of operations of the Company.

Allowance for loan losses

The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of its consolidated financial statements. The amount of the allowance is based on management's periodic evaluation of the collectability of the loan portfolio, including the nature, volume and risk characteristics of the portfolio, credit concentrations, trends in historical loss experience, estimated value of any underlying collateral, specific impaired loans and economic conditions. Changes in these qualitative factors may cause management's estimate of the allowance for loan losses to increase or decrease and result in adjustments to the Company's provision for loan losses in future periods. For additional information, see FINANCIAL CONDITION- Allowance for Loan Losses and Credit Quality below.

Other than temporary impairment of securities

The other than temporary impairment decision is a critical accounting policy for the Company. Accounting guidance requires a company to perform periodic reviews of individual securities in its investment portfolio to determine whether a decline in the value of a security is other than temporary. A review of other than temporary impairment requires management to make certain judgments regarding the cause and materiality of the decline, its effect on the financial statements and the probability, extent and timing of a valuation recovery, the company's intent and ability to continue to hold the security, and, with respect to debt securities, the likelihood that the company will have to sell the security before its value recovers. Pursuant to these requirements, management assesses valuation declines to determine the extent to which such changes are attributable to (1) fundamental factors specific to the issuer, such as the nature of the issuer and its financial condition, business prospects or other factors or (2) market-related factors, such as interest rates or equity market declines. Declines in the fair value of securities below their costs that are deemed by management to be other than temporary are (1) if equity securities, recorded in earnings as realized losses and (2) if debt securities, recorded in earnings as realized losses to the extent they are deemed credit losses, with noncredit losses recorded in Other comprehensive income (loss). Once an other than temporary loss on a debt or equity security is realized, subsequent gains in the value of the security may not be recognized in income until the security is sold.

Intangible assets

The Company's intangible assets include goodwill, which represents the excess of the purchase price over the fair value of net assets acquired in the 2011 acquisition of three New Hampshire branch offices, as well as a core deposit intangible related to the deposits acquired. The core deposit intangible is amortized on a straight line basis over the estimated average life of the acquired core deposit base of 10 years. The Company evaluates the valuation and amortization of the core deposit intangible if events occur that could result in possible impairment. With respect to goodwill, in accordance with current authoritative guidance, the Company assesses qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of the Company is less than its carrying amount, which could result in goodwill impairment.

Pension liabilities

The Union Bank Pension Plan ("Plan") was closed to new participants on October 5, 2012. The accrual of retirement benefits for current participants was frozen as of that date. The (benefit) cost of the Plan, based on actuarial computations of current benefits for plan participants, is (credited) charged to Pension and other employee benefits.

The Company's defined benefit pension obligation and net periodic (benefit) cost are actuarially determined based on the following assumptions: discount rate, current and expected future return on plan assets, anticipated mortality rates, and Consumer Price Index rate. The determination of the defined benefit pension obligation and net periodic benefit cost is a critical accounting estimate as it requires the use of estimates and judgments related to the amount and timing of expected future cash outflows for benefit payments and cash inflows for maturities and returns on plan assets as well as Company contributions. Changes in estimates, assumptions and actual results could have a material impact on the Company's financial condition and/or results of operations.


The Company also has other key accounting policies, which involve the use of estimates, judgments and assumptions, that are significant to understanding the Company's financial condition and results of operations, including the valuation of deferred tax assets, investment securities and other real estate owned ("OREO"). The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements and in the section below under the caption "FINANCIAL CONDITION" and the subcaptions "Allowance for Loan Losses and Credit Quality", "Investment Activities" and "Liability for Pension Benefits". Although management believes that its estimates, assumptions and judgments are reasonable, they are based upon information presently available and can be impacted by events outside the control of the Company. Actual results may differ significantly from these estimates under different assumptions, judgments or conditions.


Historically, the largest and most variable source of income for the Company is net interest income. The results of operations for the years ended December 31, 2013 and 2012 reflect the impact of changes in rates as well as growth in the volume and change in composition of both interest earning assets and interest bearing liabilities during these periods.

The prime rate remained at 3.25% throughout 2012 and 2013. The discount rate remained at 0.75% and the target federal funds range remained at the 0.00% to 0.25% range throughout both years as well. The continuing low interest rate environment and aggressive rate competition from in-market and out-of-market financial institutions makes deposit accounts increasingly difficult to attract and retain as well as intensifies the competition for loans.

The Company's average assets grew by $12.0 million, or 2.1%, during 2013 to an average of $572.7 million from $560.7 million in 2012. Net interest income increased slightly from $21.7 million in 2012 to $22.0 million in 2013. The net $345 thousand increase was due to the decrease in interest expense of $892 thousand from $3.4 million in 2012 to $2.5 million in 2013 reflecting results of the deleveraging transaction that was executed in December 2012 to payoff advances from the FHLB of Boston of $11.0 million with an average rate of 3.48%. Rates paid on all interest bearing liabilities dropped as well. This decrease in interest expense was partially offset by a decrease in interest income of $547 thousand from $25.0 million in 2012 to $24.5 million in 2013. Yields dropped as adjustable rate loans repriced at lower rates, existing loans were refinanced and new loans, interest bearing deposits in banks and investments were originated or repriced at lower rates. See Yields Earned and Rates Paid and the Rate/ Volume Analysis tables on page 20 through 22, respectively, for further details.

The Company continued to manage growth and interest rate risk during 2013 through the sale of $123.1 million in long-term fixed-rate residential loans and the net participation of an additional $815 thousand in commercial real estate loans. The Company realized $2.3 million in net gains on sales of loans held for sale in 2013 compared to $3.6 million in 2012. The historically low prime rate and low long-term mortgage rates throughout 2013 continued to drive customer refinancings and also contributed to the 6 basis point, or 1.4%, decrease in the net interest margin, to 4.21% for 2013 as compared to 4.27% for 2012.

With the modest improvements in the economy, loan demand remained steady in 2013, with total loan growth of $9.8 million, or 2.2%, over 2012, net of loan sales of $123.1 million in 2013. Commercial real estate loans grew $13.5 million, or 6.8%, residential real estate loans grew $4.5 million, or 2.9%, and municipal loans grew $5.7 million, or 20.0%, while construction real estate loans dropped $5.1 million, or 14.2%, and residential loans held for sale dropped $7.2 million, or 65.1%. The Company's asset quality remained strong compared to the banking industry as a whole, when measured by net charge-offs of 0.07% to average loans not held for sale in 2013, which reflects a slight increase from 0.05% in 2012. Loans in nonaccrual status decreased between years to $1.4 million at December 31, 2013 versus $2.8 million at December 31, 2012. Other nonperforming loans decreased to $263 thousand at December 31, 2013 from $307 thousand at December 31, 2012. The Company's ratio of allowance for loan losses

to loans not held for sale was 1.01% at December 31, 2013 compared to 1.05% at December 31, 2012. The decrease in the 2013 loan loss provision to $305 thousand from $660 thousand in 2012 reflects the composition of the loan portfolio, net charge offs, the general economy and management's assessment of credit quality.

Deposits grew $8.4 million, or 1.6%, from $510.0 million at December 31, 2012 to $518.4 million at December 31, 2013. Total average deposits grew $19.9 million, or 4.1%, between years with average nontime deposits growing $21.5 million, or 6.5%, during the same time frame, while average time deposits dropped $1.6 million, or 1.0%. Interest rates paid on deposits have dropped steadily over the last three years but there is little room left to drop them more in the future. The growth in deposits was utilized to support growth in both the investment and loan portfolios.

The Company's total capital increased $4.8 million, or 10.60%, from $45.0 million at December 31, 2012 to $49.8 million at December 31, 2013. The increase in total capital is due to the combined effect of net income of $7.1 million and an increase of $3.1 million in other comprehensive income attributable to the change in the unfunded defined benefit pension liability, offset by $4.5 million in dividends paid in 2013 and a decrease in other comprehensive income of $1.0 million resulting from unrealized losses on investment securities available-for-sale. Capital ratios continue to meet the regulatory guidelines for well capitalized, and increased as of December 31, 2013. The Company's total risk based capital ratio at December 31, 2012 was 12.95% and had increased to 13.28% at December 31, 2013. The regulatory guideline for well capitalized insured depository institutions is 10.00% and the minimum requirement is 8.00%.

The following per share information and key ratios depict several measurements of performance or financial condition for or at the years ended December 31:

                                                           2013      2012      2011
Return on average assets ("ROA")                            1.25 %    1.22 %   1.04 %
Return on average equity ("ROE")                           15.46 %   16.35 %  12.47 %
Net interest margin (1)                                     4.21 %    4.27 %   4.29 %
Efficiency ratio (2)                                       68.04 %   71.51 %  72.61 %
Net interest spread (3)                                     4.10 %    4.14 %   4.11 %
Total loans to deposits ratio                              89.70 %   89.25 %  90.66 %
Net loan charge-offs to average loans not held for sale     0.07 %    0.05 %   0.08 %
Allowance for loan losses to loans not held for sale (4)    1.01 %    1.05 %   1.00 %
Nonperforming assets to total assets (5)                    0.39 %    0.73 %   1.40 %
Equity to assets                                            8.51 %    7.80 %   7.30 %
Total capital to risk weighted assets                      13.28 %   12.95 %  12.17 %
Book value per common share                              $ 11.17   $ 10.11   $ 9.05
Earnings per common share                                $  1.60   $  1.54   $ 1.17
Dividends paid per common share                          $  1.01   $  1.00   $ 1.00
Dividend payout ratio (6)                                  63.13 %   64.94 %  85.47 %


(1) The ratio of tax equivalent net interest income to average earning assets. See page 21 for more information.

(2) The ratio of noninterest expense ($21.2 million in 2013, $23.0 million in 2012 and $19.8 million in 2011) to tax equivalent net interest income
($22.7 million in 2013, $22.4 million in 2012 and $20.3 million in 2011) and noninterest income ($8.5 million in 2013, $10.5 million in 2012 and $7.1 million in 2011) excluding securities (losses) gains ($(1) thousand in 2013, $673 thousand in 2012 and $183 thousand in 2011).

(3) The difference between the average rate earned on earning assets and the average rate paid on interest bearing liabilities. See page 21 for more information.

(4) Calculation includes the net carrying amount of loans recorded at fair value from the 2011 branch acquisition as of December 31, 2013 ($17.0 million), December 31, 2012 ($22.9 million) and December 31, 2011 ($27.9 million). Excluding such loans, the allowance for loan losses to loans not purchased and not held for sale was 1.05% at December 31, 2013, 1.11% at December 31, 2012 and 1.07% at December 31, 2011.

(5) Nonperforming assets are loans or investment securities that are in nonaccrual or 90 or more days past due as well as other real estate or assets owned.

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


The Company's net income for the year ended December 31, 2013, was $7.1 million compared with net income of $6.8 million for the year 2012, an increase of 4.3%. Pressure on the net interest margin continued due to the prevailing low interest rate environment, resulting in a decrease of 6 basis points from 4.27% for 2012 to 4.21% for 2013. Earnings per share increased to $1.60 in 2013 from $1.54 in 2012, reflecting the combined effect of the following income and expense items:
Net interest income increased $345 thousand, or 1.6%, with a 2.9% growth in average interest earning assets; the Provision for loan losses decreased $355 thousand, or 53.8%; noninterest income decreased $2.0 million, or 19.2%; noninterest expense decreased $1.8 million, or 7.9% and the Provision for income taxes increased $199 thousand, or 12.0%.

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 level of net interest income can fluctuate over time due to changes in the level and mix of interest earning assets and interest bearing liabilities and from changes in the yields earned and costs of funds. The Company's net interest income increased slightly $345 thousand, or 1.6%, to $22.0 million for the year ended December 31, 2013, from $21.7 million for the year ended December 31, 2012. This increase was due primarily to the combined effect of the decrease in interest expense of $892 thousand from $3.4 million in 2012 to $2.5 million in 2013 and the decrease in interest income of $547 thousand from $25.0 million in 2012 to $24.5 million in 2013. The decrease in interest expense reflects a combination of lower rates paid on deposit accounts and results from the deleveraging transaction that was executed in December 2012 with the sale of $11.7 million in available-for-sale debt securities, of varying types, with an estimated yield of 3.10% and the payoff of advances from the FHLB of Boston of $11.0 million with an average rate of 3.48%. In addition, both years reflected the historically low 3.25% prime rate. Asset yields dropped as adjustable rate loans repriced at lower rates, existing loans were refinanced and new loans and investments originated at lower rates. However, the effect of this continuing decrease in yields was partially offset by the growth in average interest earning assets to $539.4 million in 2013 from $524.3 million in 2012. The Company's net interest income increased $1.9 million, or 9.7%, to $21.7 million for the year ended December 31, 2012, from $19.8 million for the year ended December 31, 2011.

On average for the year, 94.2% of assets earned interest in 2013 compared to 93.5% in 2012. The net interest spread decreased to 4.10% for the year ended December 31, 2013, from 4.14% for the year ended December 31, 2012, as rates dropped slightly more on interest earning assets than on interest bearing liabilities. Rates were already near historic lows coming into 2012 and have moved even lower in 2013. The net interest margin for the 2013 period decreased 6 basis points to 4.21% from 4.27% for the 2012 period, reflecting the change in the composition of average interest earning assets and repricing of such assets at lower rates.

Yields Earned and Rates Paid. The following table shows 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 year, and is calculated by dividing the tax equivalent income or expense item for the year by the average balance of the appropriate balance sheet item for that year. Net interest margin is 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.

The following table presents average balance sheet data and an analysis of net interest income which illustrates interest income earned and interest expense paid for each major component of interest earning assets and interest bearing liabilities:

                                                          Years Ended December 31,
                                   2013                             2012                             2011
                                  Interest   Average               Interest   Average               Interest   Average
                       Average     Earned/    Yield/    Average     Earned/    Yield/    Average     Earned/    Yield/
                       Balance      Paid       Rate     Balance      Paid       Rate     Balance      Paid       Rate
                                          (Dollars in thousands)
Average Assets:
Federal funds sold
and overnight
deposits             $  17,920   $      32     0.18 % $  17,789   $      27     0.15 % $  18,578   $      34     0.18 %
Interest bearing
deposits in banks       21,371         226     1.06 %    21,994         270     1.23 %    16,596         309     1.86 %
. . .
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