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UNB > SEC Filings for UNB > Form 10-Q on 14-Nov-2012All 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, 2012 and December 31, 2011, and its results of operations for the three and nine months ended September 30, 2012 and 2011. 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, 2011. 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, 2012 which would materially affect the information presented.

Union Bankshares, Inc. Page 27


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," "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, 2011 and the items added below in this report on Form 10-Q:
loans and investments may be called or prepaid prior to their contractual maturity or become other than temporarily impaired;

loans and deposits acquired with the acquisition of three New Hampshire branches in May 2011 could perform differently than management anticipates in its forecasts and growth in the New Hampshire markets could be lower or slower than anticipated;

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;

impact of regulatory changes to risk based capital calculations which might require changes to the mix of balance sheet assets in order to attain the desired capital ratios, might result in greater capital volatility due to the inclusion in regulatory capital of changes in other comprehensive income/loss, and might restrict dividends payable to shareholders or compensation paid to executives if desired capital ratios are not acheived;

proposed and final regulations issued by the Consumer Financial Protection Bureau applicable to large banks and the indirect impact on community banks resulting from changing industry standards and best practices;

continuing economic instability, resulting from elevated unemployment rates, higher taxation, governmental budget issues, national and local election results, reform of entitlement programs and/or natural disasters; and

the effect of federal and state health care reform efforts, including the federal Patient Protection and Affordable Care Act and Vermont's recently enacted 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 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.


On October 5, 2012, the Company closed The Union Bank Pension Plan (Plan), which is a defined benefit pension plan, to new participants and froze the accrual of retirement benefits for current participants. Union Bank intends to continue to maintain the frozen Plan and related Trust and to distribute benefits to participants at such time and in

Union Bankshares, Inc. Page 28

such manner as provided under the terms of the Plan. The adjustment resulting from the curtailment of the plan to be booked in October 2012 will reduce the unfunded pension liability by $3.6 million, the resulting deferred tax asset by $1.2 million and increase stockholders' equity by $2.4 million. There is projected to be no pension expense for the fourth quarter of 2012. The Company will continue to recognize pension expense and cash funding obligations for the remaining life of the associated liability for the frozen benefits under the Plan.

Economic data suggests economic activity is expanding at a moderate pace. As discussed in the October 2012 Federal Open Market Committee (FOMC) press release, growth in employment has been slow and the unemployment rate remains elevated. Household spending has advanced but growth in business fixed investment has slowed. Inflation recently picked up, reflecting higher energy prices. The continued strains in the global financial markets pose significant downside risks to the economic outlook. Also, hurricane Sandy has had a significant impact on the east coast that has not been fully assessed.

It appears that 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 currently anticipates that economic conditions are likely to warrant exceptionally low levels for the target federal funds rate at least through mid-2015. The Federal Reserve, in an attempt to continue to put downward pressure on longer-term interest rates, is 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.

Vermont's and New Hampshire's unemployment rates have increased slightly over the last couple of months and are 5.4% and 5.7%, respectively, as of September 30, 2012. These rates compare favorably with the national unemployment rate of 7.8% for the same period.

Vermont and New Hampshire continue to have lower residential foreclosure and delinquency rates than the national average. Union Bank (Union), the Company's subsidiary, has earned a favorable reputation for residential lending programs and has recently been granted an Unconditional Direct Endorsement Approval from the Department of Housing and Urban Development (HUD) for the origination of Federal Housing Administration (FHA) loans. This direct endorsement provides Union the ability to more quickly and efficiently serve FHA-eligible home buyers. Demand for construction and purchase mortgage loans strengthened during the last months of 2011 and has remained strong throughout the first nine months of 2012.

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 2011 Annual Report on Form 10-K. In addition, there have been new laws, regulations and actions enacted since our 2011 Annual Report that will or may impact the Company's future earnings and/or efficiency. The following are the most relevant:

Among the new regulations imposed by the 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. The relevant regulations promulgated to date regarding these provisions have been implemented by Union, but there are still additional regulations to be written.

As required by SEC regulations, the Company now files its financial statements both in EDGAR format and in eXtensible Business Reporting Language (XBRL), and posts such XBRL information on its website. The second year of mandated XBRL compliance will require significant administrative resources and result in additional costs.

The Basel III Capital Framework, if adopted as proposed, will increase minimum capital levels and add a new capital conservation buffer in the coming years. The Company's capital ratios continue to be over the proposed minimums. The Basel III proposal would also implement on a phased basis, a leverage ratio, a liquidity coverage ratio, a net stable funding ratio, and increased risk percentages on certain asset categories which will negatively impact the Company's risk based capital ratios. The Basel III proposal would also increase volatility in regulatory capital calculations by requiring that changes in other comprehensive income/loss be reflected in the calculation. In the current proposal, the Company will not be subject to all the regulations proposed as some are only applicable to "large" or "complex" financial institutions. On November 9, 2012, the Federal Reserve and other federal banking regulators announced that in light of the volume of comments received and concerns expressed by many bank, the proposed January 1, 2013 effective date for final rules would be delayed. No final implementation date has been established.

On December 31, 2012, the temporary unlimited insurance coverage for noninterest bearing transaction and IOLTA accounts by the FDIC is scheduled to expire.

Union Bankshares, Inc. Page 29

On April 5, 2012, the Jumpstart Our Business Startups Act (Jobs Act) was signed into law by the President. The general provisions of the Jobs Act were aimed at increasing small businesses' ability to raise capital and this may be a benefit to the Company in the future. The Jobs Act also provides new deregistration thresholds which could allow the Company to consider deregistering its common stock and become exempt from complying with its current Securities and Exchange Act reporting requirements. The Company is evaluating these provisions and their potential impact.

Recently the Consumer Financial Protection Bureau outlined new rules that the Bureau intends to adopt that will impact mortgage servicing. These rules will implement revisions to the Truth in Lending Act and the Real Estate Settlement Procedures Act adopted as part of the Dodd-Frank Act. Some of the proposed rules were published in July 2012, with final rules to be promulgated in January 2013. There are additional regulations still to be promulgated.

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 can not yet be quantified.

The cost of doing business as usual has increased dramatically in this regulatory environment as the number and extent of new regulations and the speed with which they must be implemented put a strain on software providers and staff as well as customers. Also, the cost of mitigating long-term interest rate risk by selling loans to the secondary market continues to increase and it is anticipated that this cost will continue to grow.

It is not completely clear at this time what impact current or future government sponsored programs, regulations or legislation will have on the Company, its customers or the U.S. and global financial markets but additional regulatory complexity requiring the allocation of Company resources is 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, 2011 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 $2.0 million for the quarter ended September 30, 2012 compared to $1.4 million for the quarter ended September 30, 2011, an increase of $554 thousand, or 38.8%. These results reflected the net effect of an increase in net interest income of $438 thousand, or 8.6%, and an increase of $876 thousand, or 43.5%, in noninterest income, partially offset by an increase in noninterest expenses of $600 thousand, or 11.7%, and a $160 thousand, or 40.8%, increase in the provision for income taxes. The results for the third quarter 2011 comparative period include $62 thousand of pre-tax branch acquisition expenses, whereas there were no such expenses recognized in the third quarter 2012.

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 increased by $237 thousand, or 3.9%, to $6.4 million for the third quarter of 2012, versus $6.1 million for the third quarter of 2011, while interest expense decreased $201 thousand, or 19.8% between periods, from $1.0 million for the third quarter of 2011 to $815 thousand for the third quarter of 2012. These changes in interest income and interest expense resulted in net interest income for the third quarter of 2012 of $5.5 million, up $438 thousand, or 8.6%, from the third quarter of 2011 of $5.1 million. The continued static low prime

Union Bankshares, Inc. Page 30

rate or further drops in the prime rate and/or increases in competitors' deposit 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 increased $876 thousand, or 43.5%, for the quarter due to several contributing factors. Net gains on sales of loans held for sale increased $818 thousand, or 169.4%, from $483 thousand for the quarter ended September 30, 2011 to $1.3 million for the quarter ended September 30, 2012. The volume of residential loans sold to the secondary market increased from $19.8 million in the third quarter of 2011 to $39.7 million in the third quarter of 2012, an increase of $19.9 million, or 100%. The continuing volume of sales was driven by the sustained low long-term mortgage rates, which continued to result in strong loan demand in our branches and the loan production office. There was also an increase of $121 thousand, or 10.5%, in service fee income in the areas of fees earned for debit card and ATM transactions, merchant program income, and overdraft charges related to deposit account services.

Salaries and wages were higher by $135 thousand, or 6.4%, for the third quarter of 2012 compared to the same period last year, reflecting normal salary increases, the increased staffing due to loan demand, increased commissions in the loan production office, and the introduction of the Short Term Incentive Performance Plan (STIPP) during the first quarter of 2012. Pension and employee benefits were up $178 thousand, or 22.5%, with the majority of the increase due to the cost of the defined benefit pension plan which has been frozen to new participants and future benefit accruals as of October 5, 2012. Equipment expenses increased due to the increased number of banking locations, new ATM's, accelerated depreciation of software programs that will not be utilized in future years, and higher costs of operation in 2012. Also, Union purchased the banking facility of the newly acquired branch located in Littleton, New Hampshire as of March 31, 2012. As a result, Union experienced an increase in occupancy expenses other than rent expense; however, these expenses were partially offset with an increase in rental income.

Other noninterest expenses were up $296 thousand, or 18.5%, for the three months ended September 30, 2012, which has numerous components. The largest changes were the $43 thousand increase in equity in losses of affordable housing investments in the third quarter of 2012 from the additional investments made in late 2011 and early 2012, the $439 thousand increase in expenses incurred related to Other Real Estate Owned (OREO) and Other Assets Owned (OAO), and the $27 thousand increase in expense related to utilization of ATM and debit cards. These increases were partially offset by a reduction in marketing costs of $43 thousand, and by the fact that the Company did not incur any prepayment penalties on Federal Home Loan Bank advances, nor any branch acquisition expenses during the third quarter of 2012.

The Company's effective tax rate increased slightly to 21.8% for the three months ended September 30, 2012 from 21.6% for the same period in 2011, as taxable income before provision for income taxes increased, with partially offsetting positive impacts from both tax exempt income and tax credits from affordable housing partnership investments.

At September 30, 2012, the Company had total consolidated assets of $582.9 million, including gross loans and loans held for sale (total loans) of $464.5 million, deposits of $504.8 million, borrowed funds of $25.8 million and stockholders' equity of $42.1 million. The Company's total assets increased $30.2 million, or 5.5%, to $582.9 million at September 30, 2012, from $552.8 million at December 31, 2011. The increase in total assets is due to increased customer deposits, strong loan demand and higher volume of loan sales resulting in high liquidity levels.

Net loans and loans held for sale increased a total of $34.9 million, or 8.2%, to $460.1 million, or 78.9%, of total assets at September 30, 2012, compared to $425.2 million, or 76.9%, of total assets at December 31, 2011.

Deposits increased $31.4 million, or 6.6%, to $504.8 million at September 30, 2012, from $473.4 million at December 31, 2011. Total deposits increased as customers continue to deposit monies in nontime deposit or short term time deposit accounts as they continue to anticipate a rise in interest rates.

The Company's total capital increased from $40.3 million at December 31, 2011 to $42.1 million at September 30, 2012. The regulatory guidelines for the well capitalized capital category continue to be met with the total risk based capital ratio of 12.17% at September 30, 2012 and December 31, 2011. The regulatory guideline for well capitalized is 10.0% and for minimum requirements is 8.0%. In October 2012, Union Bankshares, Inc. received the prestigious Sm-All Star Award for 2012 from investment banking firm Sandler O'Neill & Partners, LP. The award recognizes the

Union Bankshares, Inc. Page 31

top performing small-cap banks and thrifts in the United States by evaluating eight performance measurements. The Company is one of only 15 alumni to win this award more than once, having previously earned the recognition in 2009.

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, 2012 and 2011, respectively:

                                                 Three Months Ended or At         Nine Months Ended or At
                                                      September 30,                    September 30,
                                                   2012             2011            2012             2011
Return on average assets (ROA) (1)                   1.40 %            1.07 %         1.12 %            0.95 %
Return on average equity (1)                        19.21 %           13.63 %        15.20 %           11.17 %
Net interest margin (1)(2)                           4.32 %            4.19 %         4.30 %            4.29 %
Efficiency ratio (3)                                66.68 %           72.67 %        71.49 %           75.02 %
Net interest spread (4)                              4.20 %            4.04 %         4.16 %            4.10 %
Loan to deposit ratio                               92.01 %           90.95 %        92.01 %           90.95 %
Net loan charge-offs to average loans not
held for sale (1)                                    0.16 %            0.02 %         0.06 %            0.01 %
Allowance for loan losses to loans not held
for sale (5)                                         1.01 %            0.99 %         1.01 %            0.99 %
Nonperforming assets to total assets (6)             0.86 %            1.22 %         0.86 %            1.22 %
Equity to assets                                     7.23 %            7.80 %         7.23 %            7.80 %
Total capital to risk weighted assets               12.17 %           12.25 %        12.17 %           12.25 %
Book value per share                         $       9.45      $       9.56   $       9.45      $       9.56
Earnings per share                           $       0.44      $       0.32   $       1.04      $       0.78
Dividends paid per share                     $       0.25      $       0.25   $       0.75      $       0.75
Dividend payout ratio (7)                           56.82 %           78.13 %        72.12 %           96.15 %

(1) Annualized.

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

(3) The ratio of noninterest expense ($5.7 million in 2012 and $5.1 million in 2011) to tax equivalent net interest income ($5.7 million in 2012 and $5.2 million in 2011) and noninterest income ($2.9 million in 2012 and $1.8 million in 2011) excluding securities gains ($0 in 2012 and $173 thousand in 2011) for the three months ended September 30, 2012 and 2011, respectively.

The ratio of noninterest expense ($16.8 million in 2012 and $14.7 million in 2011) to tax equivalent net interest income ($16.7 million in 2012 and $14.8 million in 2011) and noninterest income ($6.9 million in 2012 and $4.9 million in 2011) excluding securities gains ($44 thousand in 2012 and $183 thousand in 2011) for the nine months ended September 30, 2012 and 2011, 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 September 30, 2012 ($23.7 million). Excluding such loans, the allowance for loan losses to loans not purchased and not held for sale was 1.07% 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 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 $438 thousand, or 8.6%, to $5.5 million for the three months ended September 30, 2012, from $5.1 million for the three months ended September 30, 2011. The net interest spread increased 16 basis points to 4.20% for the three months ended September 30, 2012, from 4.04% for the three months ended September 30, 2011. . . .

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