UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 2008
Commission file number: 001-15985
UNION BANKSHARES, INC.
VERMONT 03-0283552
P.O. BOX 667
MAIN STREET
MORRISVILLE, VT 05661
Registrant's telephone number: 802-888-6600
Former name, former address and former fiscal year, if changed since last
report: Not applicable
Securities registered pursuant to section 12(b) of the Act:
Common Stock, $2.00 par value American Stock Exchange
----------------------------- -----------------------
(Title of class) (Exchanges registered on)
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [ ]
(Do not check if a smaller reporting company) Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of May 6, 2008:
Common Stock, $2 par value 4,491,183 shares
1
UNION BANKSHARES, INC.
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1. Financial Statements.
Unaudited Consolidated Financial Statements Union Bankshares,
Inc. and Subsidiary
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statement of Changes in Stockholders' Equity 5
Consolidated Statements of Cash Flows 6
Notes to Unaudited Consolidated Financial Statements 8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations. 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 33
Item 4T. Controls and Procedures. 33
PART II OTHER INFORMATION
Item 1. Legal Proceedings. 33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. 34
Item 6. Exhibits. 34
Signatures 34
2
Part l Financial Information
Item 1. Financial Statements
UNION BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, December 31,
2008 2007
---- ----
(Dollars in thousands)
Assets
Cash and due from banks $ 12,361 $ 12,815
Federal funds sold and overnight deposits 1,022 614
-------- --------
Cash and cash equivalents 13,383 13,429
Interest bearing deposits in banks 9,462 11,868
Investment securities available-for-sale 33,075 33,822
Loans held for sale 6,832 7,711
Loans 309,910 310,594
Allowance for loan losses (3,401) (3,378)
Unearned net loan fees (109) (111)
-------- --------
Net loans 306,400 307,105
Accrued interest receivable 2,091 2,077
Premises and equipment, net 6,857 6,462
Other assets 10,484 10,887
-------- --------
Total assets $388,584 $393,361
======== ========
Liabilities and Stockholders' Equity
Liabilities
Deposits
Noninterest bearing $ 49,154 $ 56,155
Interest bearing 265,777 267,806
-------- --------
Total deposits 314,931 323,961
Borrowed funds 25,099 20,328
Accrued interest and other liabilities 6,354 6,998
-------- --------
Total liabilities 346,384 351,287
-------- --------
Commitments and Contingencies
Stockholders' Equity
Common stock, $2.00 par value; 7,500,00 shares authorized
at 3/31/08 and 12/31/07; 4,921,786 shares
issued at 3/31/08 and 12/31/07 9,844 9,844
Paid-in capital 204 202
Retained earnings 35,938 35,791
Treasury stock at cost; 429,703 shares at 3/31/08 and 418,817
at 12/31/07 (3,155) (2,939)
Accumulated other comprehensive loss (631) (824)
-------- --------
Total stockholders' equity 42,200 42,074
-------- --------
Total liabilities and stockholders' equity $388,584 $393,361
======== ========
See accompanying notes to the unaudited consolidated financial statements.
3
UNION BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended
March 31,
2008 2007
---- ----
(Dollars in thousands except Per Share Data)
Interest income
Interest and fees on loans $ 5,685 $ 5,900
Interest on debt securities
Taxable 316 234
Tax exempt 84 46
Dividends 22 30
Interest on federal funds sold and overnight deposits 31 104
Interest on interest bearing deposits in banks 126 74
--------- ---------
Total interest income 6,264 6,388
--------- ---------
Interest expense
Interest on deposits 1,656 1,785
Interest on borrowed funds 268 190
--------- ---------
Total interest expense 1,924 1,975
--------- ---------
Net interest income 4,340 4,413
Provision for loan losses 50 45
--------- --
Net interest income after provision for loan losses 4,290 4,368
--------- ---------
Noninterest income
Trust income 93 84
Service fees 855 796
Net loss on sales of investment securities available-for-sale - (10)
Net gain on sales of loans held for sale 158 27
Other income 16 24
--------- ---------
Total noninterest income 1,122 921
--------- ---------
Noninterest expenses
Salaries and wages 1,585 1,578
Pension and employee benefits 668 660
Occupancy expense, net 268 220
Equipment expense 292 262
Other expenses 1,017 926
--------- ---------
Total noninterest expense 3,830 3,646
--------- ---------
Income before provision for income taxes 1,582 1,643
Provision for income taxes 176 408
--------- ---------
Net income $ 1,406 $ 1,235
========= =========
Earnings per common share $ 0.31 $ 0.27
========= =========
Weighted average number of common
shares outstanding 4,497,601 4,531,515
========= =========
Dividends per common share $ 0.28 $ 0.28
========= =========
See accompanying notes to the unaudited consolidated financial statements.
4
UNION BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
Common Stock
------------------- Accumulated
Shares, other Total
net of Paid-in Retained Treasury comprehensive stockholders'
Treasury Amount capital earnings stock loss equity
-------- ------ ------- -------- -------- ------------- -------------
(Dollars in thousands)
Balances, December 31, 2007 4,502,969 $9,844 $202 $35,791 $(2,939) $(824) $42,074
Comprehensive income:
Net income - - - 1,406 - - 1,406
Other comprehensive income,
net of tax:
Change in net unrealized gain
(loss) on investment
securities available-for-sale,
net of reclassification
adjustment and tax effects - - - - - 193 193
-------
Total other comprehensive
income 193
-------
Total comprehensive income 1,599
-------
Cash dividends declared
($0.28 per share) - - - (1,259) - - (1,259)
Issuance of stock options - - 2 - - - 2
Purchase of treasury stock (10,886) - - - (216) - (216)
--------- ------ ---- ------- -------- ----- -------
Balances, March 31, 2008 4,492,083 $9,844 $204 $35,938 $(3,155) $(631) $42,200
========= ====== ==== ======= ======== ====== =======
See accompanying notes to the unaudited consolidated financial statements.
5
UNION BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
--------------------------
March 31, March 31,
2008 2007
---- ----
(Dollars in thousands)
Cash Flows From Operating Activities
Net Income $ 1,406 $ 1,235
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation 186 192
Provision for loan losses 50 45
Credit for deferred income taxes (73) (111)
Net amortization of investment securities available-for-sale 1 4
Equity in losses of limited partnerships 97 66
Issuance of stock options 2 2
Write-downs of other real estate owned - 10
Decrease in unamortized loan fees (3) (1)
Proceeds from sales of loans held for sale 5,755 3,437
Origination of loans held for sale (4,717) (4,219)
Net gain on sales of loans held for sale (158) (27)
Net loss on sales of investment securities available-for-sale - 10
Net loss on disposals of premises and equipment 23 -
Net gain on sales of repossessed property (3) -
Net loss (gains) on sales of other real estate owned 2 (20)
Increase in accrued interest receivable (14) (32)
Decrease in other assets 438 131
Increase in income taxes 248 494
(Decrease) increase in accrued interest payable (45) 178
Increase in other liabilities 247 357
-------- --------
Net cash provided by operating activities 3,442 1,751
-------- --------
Cash Flows From Investing Activities
Interest bearing deposits in banks
Maturities and redemptions 3,979 197
Purchases (1,574) (4,987)
Investment securities available-for-sale
Sales - 414
Maturities, calls and paydowns 2,053 695
Purchases (1,014) (3,820)
Net (purchase) redemption of Federal Home Loan Bank stock (283) 82
Net decrease in loans 322 10,294
Recoveries of loans charged off 18 17
Purchases of premises and equipment (604) (144)
Investments in limited partnerships (881) -
6
Three Months Ended
--------------------------
March 31, March 31,
2008 2007
---- ----
(Dollars in thousands)
Proceeds from sales of other real estate owned 214 3
Proceeds from sales of repossessed property 16 -
-------- --------
Net cash used in investing activities 2,246 2,751
-------- --------
Cash Flows From Financing Activities
Net increase in borrowings outstanding 4,771 757
Net decrease in noninterest bearing deposits (7,001) (8,528)
Net (decrease) increase in interest bearing deposits (2,029) 2,217
Purchase of treasury stock (216) (34)
Dividends paid (1,259) (1,269)
-------- --------
Net cash used in financing activities (5,734) (6,857)
-------- --------
Decrease in cash and cash equivalents (46) (2,355)
Cash and cash equivalents
Beginning 13,429 20,957
-------- --------
Ending $ 13,383 $ 18,602
======== ========
Supplemental Disclosures of Cash Flow Information
Interest paid $ 1,969 $ 1,797
======== ========
Income taxes paid $ - $ 25
======== ========
Supplemental Schedule of Noncash Investing and
Financing Activities
Change in unrealized losses on investment securities
available-for-sale $ 293 $ 148
======== ========
Other real estate acquired in settlement of loans $ 255 $ -
======== ========
Repossessed property acquired in settlement of loans $ 63 $ 1
======== ========
Loans originated to finance the sale of other real estate owned $ - $ 115
======== ========
See accompanying notes to the unaudited consolidated financial statements.
7
UNION BANKSHARES, INC. AND SUBSIDIARY
Note 1. Basis of Presentation
The accompanying interim unaudited consolidated financial statements of Union
Bankshares, Inc. (the Company) as of March 31, 2008 and 2007, and for the
quarters then ended have been prepared in conformity with U.S. generally
accepted accounting principles (GAAP), general practices within the banking
industry, and the accounting policies described in the Company's Annual Report
to Shareholders and Annual Report on Form 10-K for the year ended December 31,
2007. In the opinion of Company's management, all adjustments, consisting only
of normal recurring adjustments and disclosures necessary for a fair
presentation of the information contained herein have been made. This
information should be read in conjunction with the Company's 2007 Annual Report
to Shareholders, 2007 Annual Report on Form 10-K, and current reports on Form
8-K. The results of operations for the interim periods are not necessarily
indicative of the results of operations to be expected for the full fiscal year
ending December 31, 2008, or any other interim period.
Certain amounts in the 2007 unaudited consolidated financial statements have
been reclassified to conform to the 2008 presentation.
Note 2. Commitments and Contingencies
In the normal course of business, the Company is involved in various legal
proceedings. In the opinion of management, any liability resulting from such
proceedings would not have a material adverse effect on the Company's financial
condition or results of operations.
Note 3. Per Share Information
Earnings per common share amounts are computed based on the weighted average
number of shares of common stock outstanding during the period and reduced for
shares held in treasury. The assumed conversion of available outstanding stock
options does not result in material dilution.
Note 4. Recent Accounting Pronouncements
In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative
Instruments and Hedging Activities - an amendment of FASB Statement No. 133".
The objective of this Statement is to amend and expand the disclosure
requirements of Statement 133 with the intent to provide users of financial
statements with an enhanced understanding of: a) how and why an entity uses
derivative instruments, b) how derivative instruments and related hedged items
are accounted for under Statement 133 and its related interpretations, and c)
how derivative instruments and related hedged items affect an entity's
financial position, financial performance, and cash flows. The Statement
requires qualitative disclosures about objectives and strategies for using
derivatives, quantitative disclosures about fair value amounts of and gains and
losses on derivative instruments, and disclosures about credit-risk related
contingent features in derivative agreements. The statement is effective for
financial statements issued for fiscal years beginning after November 15, 2008
with earlier adoption encouraged. The Company is in the process of evaluating
the impact of this statement on the disclosures in its financial statements but
it is not expected to have a material impact.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements - an amendment of Accounting Research
Bulletin No.51". The objective of this Statement is to improve the relevance,
comparability, and transparency of the financial information that a reporting
entity provides in its consolidated financial statements by establishing
accounting and reporting standards that require specific financial statement
disclosure, consistent accounting treatment for changes in a parent's ownership
interest and fair value measurement on the deconsolidation of a subsidiary. The
Statement applies to all entities that prepare consolidated financial
statements but will affect only those entities that have an outstanding
noncontrolling interest in one or more subsidiaries or that deconsolidate a
subsidiary. The Statement is effective for fiscal years and interim periods
within those fiscal years, beginning on or after December 15, 2008. Earlier
adoption is prohibited. The Company has no noncontrolling interests in a
subsidiary and therefore does not expect there to be any impact on the
consolidated financial statements.
8
In December 2007, the FASB issued Statement No. 141R, (revised) "Business
Combinations" which replaces Statement No. 141. The objective of this Statement
is to improve the relevance, representational faithfulness, and comparability
of the information that a reporting entity provides in its financial reports
about a business combination and its effects. To accomplish that, this
Statement establishes principles and requirements for how the acquirer; (1)
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree, (2) recognizes and measures the goodwill acquired in the business
combination or a gain from a bargain purchase, and (3) determines what
information to disclose to enable users of the financial statements to evaluate
the nature and financial effects of the business combination. The Statement
shall be applied prospectively to business combinations for which the
acquisition date is on or after the beginning of the first annual reporting
period beginning on or after December 15, 2008. Earlier application is
prohibited. This Statement will affect the Company for any acquisitions after
December 31, 2008.
In November 2007, the SEC issued SAB No. 109, "Written Loan Commitments
Recorded at Fair Value Through Earnings". SAB No 109 supersedes SAB 105,
"Application of Accounting Principles to Loan Commitments," and indicates that
the expected net future cash flows related to the associated servicing of the
loan should be included in the measurement of all written loan commitments that
are accounted for at fair value through earnings under SFAS No. 159's
fair-value election or for written mortgage loan commitments for loans that
will be held-for-sale when funded that are marked-to-market as derivatives
under SFAS No. 133 (derivative loan commitments). The guidance in SAB No. 109
is applied on a prospective basis to derivative loan commitments issued or
modified in fiscal quarters beginning after December 15, 2007. SAB No. 109 was
adopted by the Company on January 1, 2008 and did not to have a material impact
on the Company's consolidated financial statements.
Note 5. Defined Benefit Pension Plan
Union Bank (Union), the Company's sole subsidiary, sponsors a noncontributory
defined benefit pension plan covering all eligible employees. The plan provides
defined benefits based on years of service and final average salary.
Net periodic pension benefit cost for the three months ended March 31, 2008 and
2007, consisted of the following components:
Three Months Ended
----------------------
2008 2007
---- ----
(Dollars in thousands)
Service cost $ 136 $ 132
Interest cost on projected benefit obligation 168 148
Expected return on plan assets (164) (150)
Amortization of prior service cost 2 2
Amortization of net loss 7 5
----- -----
Net periodic benefit cost $ 149 $ 137
===== =====
There were actuarial assumption changes between the first quarter of 2007 and
the first quarter of 2008 as SFAS No. 87, Employers' Accounting for Pensions
states that measurements are based on the assumptions used for the previous
year-end measurements unless more recent measurements of both plan assets and
obligations are available, or a significant event occurs. Therefore, 2008 net
periodic benefit cost is based on December 31, 2007 actuarial assumptions while
the 2007 cost is based on December 31, 2006 actuarial assumptions.
9
Note 6. Other Comprehensive Income (Loss)
The components of other comprehensive income and related tax effects for the
three months ended March 31, 2008 and 2007, are as follows:
Three Months Ended
----------------------
2008 2007
---- ----
(Dollars in thousands)
Unrealized holding gains on investment
securities available-for-sale $ 293 $138
Reclassification adjustment for losses
realized in income - 10
----- ----
Net unrealized gains 293 148
Tax effect
(100) (50)
----- ----
Net of tax amount $ 193 $ 98
===== ====
Note 7: Fair Value Measurements The FASB issued SFAS No. 159, "The Fair Value
Option for Financial Assets and Financial Liabilities." This Statement
generally permits the measurement of selected eligible financial instruments at
fair value at specified election dates. SFAS No. 157, "Fair Value
Measurements", generally establishes the definition of fair value expands
disclosures about fair value measurement and establishes a hierarchy of the
levels of fair value measurement techniques. SFAS No. 157 and SFAS No. 159 are
effective for fiscal years beginning after November 15, 2007. Effective January
1, 2008, the Company adopted SFAS No. 159 and SFAS No. 157, but has not elected
to apply the fair value option to any financial assets or liabilities other
than those situations where other accounting pronouncements require fair value
measurements. In accordance with FASB Staff Position No. 157-2, "Effective Date
of FASB Statement No. 157," the Company has delayed the application of SFAS No.
157 for nonfinancial assets and nonfinancial liabilities until January 1, 2009.
Under SFAS No. 157, the three levels of the fair value hierarchy are:
o Level 1 - Unadjusted quoted prices in active markets that are
accessible at the measurement date for identical, unrestricted
assets or liabilities;
o Level 2 - Quoted prices for similar assets or liabilities in active
markets, quoted prices in markets that are not active, or inputs
that are observable, either directly or indirectly, for
substantially the full term of the asset or liability;
o Level 3 - Prices or valuation techniques that require inputs that
are both significant to the fair value measurement and unobservable
(i.e. supported by little or no market activity).
A financial instrument's level within the fair value hierarchy is based on the
lowest level of input that is significant to the fair value measurement.
The following table presents the fair value measurements of assets recognized
in the accompanying balance sheet measured at fair value on a recurring basis
and the level within the SFAS No. 157 fair value hierarchy in which the fair
value measurements fall at March 31, 2008:
Fair Value Measurements at Reporting Date Using
Dollars in Thousands
-----------------------------------------------
Quoted Prices in Significant
Active Markets Other Significant
for Observable Unobservable
Identical Assets Inputs Inputs
Fair Value (Level 1) (Level 2) (Level 3)
------------------------------------------------------------
Investment securities available-for-sale $33,075 $11,972 $21,103 $ -
10
Fair values for available for sale securities are estimated by an independent
bond pricing service for identical assets or significantly similar securities.
The pricing service uses a variety of techniques to arrive at fair value
including market maker bids, quotes and pricing models. Inputs to the pricing
models include recent trades, benchmark interest rates, spreads and actual and
projected cash flows. Loans originated and intended for sale in the secondary
market are carried at the lower of cost or estimated fair value in the
aggregate. The fair value of loans held for sale is determined, when possible,
using quoted secondary market prices. If no such quoted price exists, the fair
value of a loan is determined using quoted prices for similar asset or assets,
adjusted for the specific attributes of that loan. As of March 31, 2008 the
carrying amount of loans held for sale was at cost and therefore no fair value
disclosure is included on these loans in the table above.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The following discussion and analysis by management focuses on those factors
that had a material effect on Union Bankshares, Inc.'s (Company's) financial
position as of March 31, 2008, and as of December 31, 2007, and its results of
operations for the three months ended March 31, 2008 and 2007. This discussion
is being presented to provide a narrative explanation of the 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, 2007. 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 period. Management is not aware of the occurrence of any events after
March 31, 2008, which would materially affect the information presented.
CAUTIONARY ADVICE ABOUT FORWARD LOOKING STATEMENTS
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 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 those
predictions, forecasts, projections and other estimates contained in
forward-looking statements will not be achieved. When management uses any of
the words "believes," "expects," "anticipates," "intends," "plans," "seeks,"
"estimates", 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 forward-looking statements include, but are not limited to,
the following:
o uses of monetary, fiscal, and tax policy by various governments;
o political, legislative, or regulatory developments in Vermont, New
Hampshire, or the United States including changes in laws concerning
accounting, taxes, financial reporting, banking, and other aspects of the
financial services industry;
o developments in general economic or business conditions nationally, in
Vermont, or in northern New Hampshire, including interest rate
fluctuations, market fluctuations and perceptions, job creation and
unemployment rates, ability to attract new business, and inflation and
their effects on the Company or its customers;
11
o changes in the competitive environment for financial services
organizations, including increased competition from tax-advantaged credit
unions, mutual banks and out-of-market competitors offering financial
services over the internet;
o the Company's ability to attract and retain key personnel;
o changes in technology, including demands for greater automation which
could present operational issues or significant capital outlays;
o acts or threats of terrorism or war, and actions taken by the United
States or other governments that might adversely affect business or
economic conditions for the Company or its customers;
o adverse changes in the securities market generally or in the market for
financial institution securities which could adversely affect the value
of the Company's stock;
o any actual or alleged conduct which could harm the Company's reputation;
o natural or other disasters which could affect the ability of the Company
to operate under normal conditions;
o the Company's ability to retain and attract deposits and loans;
o illegal acts of theft or fraud perpetuated against the Company's
subsidiary bank or its customers;
o unanticipated lower revenues or increased cost of funds, loss of
customers or business, or higher operating expenses;
o the failure of assumptions underlying the establishment of the allowance
for loan losses and estimations of values of collateral and various
financial assets and liabilities;
o the amount invested in new business opportunities and the timing of these
investments;
o the failure of actuarial, investment, work force, salary, and other
assumptions underlying the establishment of reserves for future pension
costs or changes in legislative or regulatory requirements;
o future cash requirements might be higher than anticipated due to loan
commitments or unused lines of credit being drawn upon or depositors
withdrawing their funds;
o assumptions made regarding interest rate movement and sensitivity could
vary substantially if actual experience differs from historical
experience which could adversely affect the Company's results of
operations; and
o the creditworthiness of current loan customers is different from
management's understanding or changes dramatically and therefore the
allowance for loan losses becomes inadequate.
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 and are reminded not to place undue reliance on such
statements. 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.
CRITICAL ACCOUNTING POLICIES
The Company has established various accounting policies which govern the
application of accounting principles generally accepted in the United States of
America 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,
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 of
matters that are inherently uncertain. Based on this definition, the Company
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 the results of
operations of the Company.
12
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. In estimating the
allowance for loan losses, management utilizes historical experience as well as
other factors including the effect of changes in the local real estate market
on collateral values, the effect on the loan portfolio of current economic
indicators and their probable impact on borrowers and changes in delinquent,
nonperforming or impaired loans. Changes in these 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 below.
The Company's pension benefit obligations and net periodic benefit cost are
actuarially determined based on the following assumptions: discount rate,
estimated future return on plan assets, wage base rate, anticipated mortality
rates, Consumer Price Index rate, and rate of increase in compensation levels.
The determination of the pension benefit obligations and net periodic benefit
cost is a critical accounting estimate as it requires the use of estimates and
judgment related to the amount and timing of expected future cash out flows for
benefit payments and cash in flows for maturities and returns on plan assets.
Changes in estimates and assumptions could have a material impact to the
Company's financial condition 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
results including the valuation of deferred tax assets and of investment
securities. Although management believes that its estimates, assumptions and
judgments are reasonable, they are based upon information presently available.
Actual results may differ significantly from these estimates under different
assumptions, judgments or conditions.
OVERVIEW
The Company's net income was $1.406 million for the quarter ended March 31,
2008, compared with net income of $1.235 million for the same period in 2007,
or an $171 thousand or 13.8% increase between years. The increase was a result
of an $184 thousand rehabilitation federal tax credit booked during the first
quarter of 2008 on an investment in a low income housing project in Hardwick,
Vermont. The Company faced a challenging interest rate environment as the prime
rate was reduced three times during the first quarter of 2008 from 7.25% as of
December 31, 2007 to 6.5% on January 22, 2008, 6.0% on January 30, 2008 and
then to 5.25% on March 18, 2008. Total interest income decreased by $124
thousand, or 1.9% in 2008 versus the first quarter of 2007, while the decrease
in interest expense was only $51 thousand, or 2.6% between periods. The result
of the changes in interest income and expense was that net interest income for
the first quarter of 2008 was $4.340 million down $73 thousand or 1.7% from the
first quarter of 2007 of $4.413 million. Toward the end of the first quarter of
2008, the yield curve once again started to trend toward a positive bias with
short term interest rates being lower than long term rates. During the first
quarter of 2008, the Company's net interest margin decreased 27 basis points to
4.95%, from 5.22% for the first quarter of 2007. The Company's net interest
spread declined 23 basis points to 4.41% for the first quarter of 2008,
compared to 4.64% for the same period last year. The decline in the net
interest spread was primarily the result of the decline in average interest
rates earned on loans as the 200 basis point drop in the prime rate has an
immediate effect on immediately adjustable commercial and commercial real
estate loans as well as customers refinancing to take advantage of the lower
rates. Further drops in the prime rate and/or increases in competitors deposit
rates could be problematic going forward as the individual instruments
re-price.
The Company's total assets decreased from $393.4 million at December 31, 2007,
to $388.6 million at March 31, 2008, a decrease of $4.8 million, or 1.2%.
Deposits decreased from $324.0 million at December 31, 2007 to $314.9 million
at March 31, 2008, a decrease of $9.0 million, or 2.8%. Both of these decreases
are a normal seasonal trend for the Company. Total loans including loans held
for sale decreased $1.6 million or 0.5% from $318.3 million at December 31,
2007 to $316.7 million at March 31, 2008. This decrease is much smaller than in
previous years as loan demand is up due to lower interest rates and a good
winter season in northern Vermont and New Hampshire.
13
Noninterest income is up $180 thousand, or 19.1%, to $1.1 million for the first
quarter of 2008 versus $0.9 million for 2007, due to increases in trust income,
service fees and net gain on sales of loans held for sale. Noninterest expenses
are up $163 thousand, or 4.4% for the first quarter of 2008 to $3.8 million
from $3.7 million for the first quarter of 2007, primarily due to the costs to
maintain our facilities due to the abundant snow fall and increasing fuel
prices. Also, the expensing of the net book value of all the Company's merchant
services equipment as the value is under the Company's capitalization limit
resulted in a $23 thousand write-off to equipment expense.
The following unaudited per share information and key ratios depict several
measurements of performance or financial condition for or at the three months
ended March 31, 2008 and 2007, respectively:
Three Months Ended
March 31,
-----------------------
2008 2007
---- ----
Return on average assets (ROA) (1) 1.44% 1.31%
Return on average equity (ROE) (1) 13.33% 11.85%
Net interest margin (1)(2) 4.95% 5.22%
Efficiency ratio (3) 68.83% 67.07%
Net interest spread (4) 4.41% 4.64%
Loan to deposit ratio 100.58% 98.29%
Net loan charge-offs to average loans
not held for sale (1) 0.04% 0.05%
Allowance for loan losses to loans not
held for sale 1.10% 1.10%
Non-performing assets to total assets 1.70% 1.63%
Equity to assets 10.86% 11.14%
Total capital to risk weighted assets 16.72% 17.60%
Book value per share $9.39 $9.26
Earnings per share $0.31 $0.27
Dividends paid per share $0.28 $0.28
Dividend payout ratio (5) 90.32% 103.70%
--------------------
(1) Annualized
(2) The ratio of tax equivalent net interest income to average earning
assets.
(3) The ratio of noninterest expense to tax equivalent net interest income
and noninterest income excluding securities gains and losses.
(4) The difference between the average rate earned on assets minus the
average rate paid on liabilities.
(5) Cash dividends declared and paid per share divided by consolidated net
income per share.
RESULTS OF OPERATIONS
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 decreased $73
thousand, or 1.7%, to $4.34 million for the three months ended March 31, 2008,
from $4.41 million for the three months ended March 31, 2007. The net interest
spread decreased 23 basis points to 4.41% for the three months ended March 31,
2008, from 4.64% for the three months ended March 31, 2007. The decline in the
net interest spread was primarily the result of the drop in average interest
rates earned on loans as the 200 basis point drop in the prime rate since
December 31, 2007 has an immediate effect on immediately adjustable commercial
and commercial real estate loans as well as customers refinancing to take
advantage of the lower rates. The net interest margin for the first quarter of
2008 decreased 27 basis points to 4.95% from the 2007 period at 5.22%. Further
decrease in the prime rate would not necessarily be beneficial to the Company
in the near term, especially if funding rates do not follow a similar downward
trend. See "OTHER FINANCIAL CONSIDERATIONS - Market Risk and Asset and
Liability Management."
14
Yields Earned and Rates Paid. The following table shows, for the periods
indicated, the total amount of income recorded from average interest-earning
assets and the related average yields, the interest expense associated average
with interest-bearing liabilities, the related average rates paid, and the
relative net interest spread and net interest margin. Yield and rate
information is calculated on an annualized tax equivalent basis. Yield and rate
information for a period 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 interest-earning assets. Nonaccrual loans are
included in asset balances for the appropriate periods, but recognition of
interest on such loans is discontinued and any remaining accrued interest
receivable is reversed in conformity with federal regulations.
Three months ended March 31,
-----------------------------------------------------------------------
2008 2007
--------------------------------- ---------------------------------
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 $ 4,401 $ 31 2.83% $ 8,078 $ 104 5.16%
Interest bearing deposits in banks 10,211 126 4.97% 6,789 74 4.40%
Investment securities (1), (2) 33,189 401 5.26% 24,851 284 4.90%
Loans, net (1), (3) 312,017 5,685 7.41% 309,444 5,900 7.84%
FHLB of Boston stock 1,606 21 5.18% 1,405 26 7.53%
-------- ------ ---- -------- ------ ----
Total interest-earning assets (1) 361,424 6,264 7.08% 350,567 6,388 7.50%
Cash and due from banks 9,917 10,402
Premises and equipment 6,829 6,072
Other assets 11,309 8,857
-------- --------
Total assets $389,479 $375,898
======== ========
Average Liabilities and Stockholders' Equity:
NOW accounts $ 52,169 $ 85 0.66% $ 50,355 94 0.76%
Savings/money market accounts 88,513 335 1.52% 94,902 409 1.75%
Time deposits 124,390 1,236 4.00% 118,741 1,282 4.38%
Borrowed funds 24,341 268 4.35% 15,368 190 4.93%
-------- ------ ---- -------- ------ ----
Total interest bearing liabilities 289,413 1,924 2.67% 279,366 1,975 2.86%
Noninterest bearing deposits 51,353 49,481
Other liabilities 6,526 5,351
-------- --------
Total liabilities 347,292 334,198
Stockholders' equity 42,187 41,700
-------- --------
Total liabilities and
stockholders' equity $389,479 $375,898
======== ========
Net interest income $4,340 $4,413
====== ======
Net interest spread (1) 4.41% 4.64%
==== ====
Net interest margin (1) 4.95% 5.22%
==== ====
--------------------
(1) Average yields reported on a tax-equivalent basis.
(2) Average balances of investment securities are calculated on the amortized cost basis.
(3) Includes loans held for sale and is net of unearned income and allowance for loan losses.
15
Rate/Volume Analysis. The following table describes the extent to which changes
in average interest rates and changes in volume of average interest earning
assets and interest bearing liabilities have affected the Company's interest
income and interest expense during the period indicated. For each category of
interest earning assets and interest bearing liabilities information is
provided on changes attributable to:
o changes in volume (change in volume multiplied by prior rate);
o changes in rate (change in rate multiplied by prior volume); and
o total change in rate and volume.
Changes attributable to both rate and volume have been allocated
proportionately to the change due to volume and the change due to rate.
Three Months Ended March 31, 2008
Compared to
Three Months Ended March 31, 2007
Increase/(Decrease) Due to Change In
------------------------------------
Volume Rate Net
------ ---- ---
(Dollars in thousands)
Interest earning assets:
Federal funds sold and overnight deposits $ (36) $ (37) $ (73)
Interest bearing deposits in banks 41 11 52
Investment securities 98 19 117
Loans, net 72 (287) (215)
FHLB of Boston stock 4 (9) (5)
----- ----- -----
Total interest earning assets $ 179 $(303) $(124)
----- ----- -----
Interest bearing liabilities:
NOW accounts $ 3 $ (12) $ (9)
Savings/money market accounts (26) (48) (74)
Time deposits 62 (108) (46)
Borrowed funds 103 (25) 78
----- ----- -----
Total interest bearing liabilities $ 142 $(193) $ (51)
----- ----- -----
Net change in net interest income $ 37 $(110) $ (73)
===== ===== =====
Interest and Dividend Income. The Company's interest and dividend income
decreased $124 thousand, or 1.9%, to $6.3 million for the three months ended
March 31, 2008, from $6.4 million for the three months ended March 31, 2007,
with average earning assets increasing $10.9 million, or 3.1%, to $361.4
million for the three months ended March 31, 2008, from $350.6 million for the
three months ended March 31, 2007. The increase in interest income resulting
from the rise in average earning assets was more than offset by the lower rates
earned on loans, federal funds sold and Federal Home Loan Bank of Boston stock
in first quarter of 2008 versus 2007. Interest income on loans decreased during
the first quarter of 2008 versus the 2007 comparison period despite an increase
in average loan volume between periods. Average loans approximated $312.0
million at an average yield of 7.41% for the three months ended March 31, 2008,
up $2.6 million from $309.4 million at an average yield of 7.84% for the three
months ended March 31, 2007. The increase in volume was more than offset by a
43 basis point decrease in yield. Loan demand has risen during 2008 due to the
lower interest rates, the successful implementation of a call program and the
changes in the competitive landscape.
The 200 basis point drop in the prime rate during the first quarter impacted
variable rate loans with monthly repricing. The impact on quarterly and
annually repricing loans has not yet been felt, but will not be positive for
the Company.
The average balance of investments (including mortgage-backed securities)
increased $8.3 million or 33.6%, to $33.2 million for the three months ended
March 31, 2008, from $24.9 million for the three months ended March 31, 2007.
The average level of interest bearing deposits in banks for the quarter was
$10.2 million up $3.4 million or 50.4% from the 2007 average level of $6.8
million, as FDIC insured certificates of deposit in other financial
institutions was one of the highest yielding investment options
16
available. The increase in the investment portfolio and interest bearing
deposits in banks from the first quarter of 2007 reflects the slower loan
demand of 2007 but that has changed in 2008 and the cash flows from maturing or
called instruments are being utilized to fund loans. The average level of
federal funds sold and overnight deposits decreased $3.7 million, to $4.4
million at 2.83% for the three months ended March 31, 2008, from $8.1 million
at 5.16% for the three months ended March 31, 2007 as funds were utilized to
support the rising loan demand. Interest income from non-loan instruments
increased $91 thousand or 18.6% between periods, with $579 thousand for the
first quarter of 2008 and $488 thousand for the same period of 2007, reflecting
the overall increases in yields on interest bearing deposits and investment
securities and volume increases on all instruments except federal funds sold.
Interest Expense. The Company's interest expense decreased $51 thousand, or
2.6%, to $1.9 million for the three months ended March 31, 2008, from $2.0
million for the three months ended March 31, 2007. Of this decrease, $193
thousand was a result of the decrease in rates, partially offset by the $142
thousand increase in volume, primarily related to the rise in borrowed funds to
support loan demand.
Interest expense on deposits decreased $129 thousand or 7.2% to $1.7 million
for the quarter ended, March 31, 2008, from $1.8 million for the quarter ended
March 31, 2007. Competition for deposits has remained strong especially since
interest rates paid have started to drop and the stock market has remained
relatively stable. Management believes consumers have become more rate
sensitive over the last two years due to advertised "specials" and the
proliferation of nonlocal financial institutions trying to gather deposits
throughout the Company's market area reflecting this rate sensitivity. Average
time deposits rose to $124.4 million for the three months ended March 31, 2008,
from $118.7 million for the three months ended March 31, 2007, or an increase
of $5.6 million or 4.8%. While the majority of these deposits are new funds for
the Company, there has been movement of deposits from lower yielding savings
and NOW accounts to higher paying certificates of deposit within its account
base. The average rate paid on time deposits decreased 38 basis points, to
4.00% from 4.38% for the three months ended March 31, 2008 and 2007,
respectively. The average balances for money market and savings accounts
decreased $6.4 million, or 6.7%, to $88.5 million for the three months ended
March 31, 2008, from $94.9 million for the three months ended March 31, 2007 as
interest rates on time deposits continued to be higher which appeared to
motivate customers to move funds into certificates of deposit and lock in the
higher rates especially given the potential for a steep downward trend in
interest rates paid given the drop in the discount rate by the Federal Open
Market Committee (FOMC) and the decrease in the prime rate during the first
quarter of 2008. A $1.8 million or 3.6% increase in NOW accounts brought the
average balance up to $52.2 million from $50.4 million between the two years.
Interest expense on borrowed funds increased from $190 thousand for the quarter
ended March 31, 2007 to $268 thousand for the quarter ended, March 31, 2008 as
average funds borrowed from the FHLB of Boston increased from $15.4 million to
$24.3 million between years, although the average rate paid on borrowed funds
declined 58 basis points between periods. The increasing loan demand, the slow
growth in deposits on average between the quarters ended March 31, 2007 and
March 31, 2008, and the opportunity to lock in some low rate long term funding
before the long end of the yield curve rose led the Company to increase its
reliance on borrowed funds.
Provision for Loan Losses. There was a $50 thousand loan loss provision for the
quarter ended March 31, 2008 and a $45 thousand provision for the quarter ended
March 31, 2007. The provision was deemed necessary for the first quarter of
2008 as the net charge-offs for the quarter ended March 31, 2008 were $27
thousand and there had been an upward trend over the prior year in the dollar
amount of loans with higher risk characteristics and a perceived softening of
the economy. For further details see, FINANCIAL CONDITION -"Allowance for Loan
Losses" below.
17
Noninterest income. The following table sets forth changes from the first
quarter of 2007 to the first quarter of 2008 for components of noninterest
income:
For The Three Months Ended March 31,
------------------------------------------
2008 2007 $ Variance % Variance
---- ---- ---------- ----------
(Dollars in thousands)
Trust income $ 93 $ 84 $ 9 10.7
Service fees 855 796 59 7.4
Net gains on sales of investment securities - (10) 10 100.0
Net gains on sales of loans held for sale 158 27 131 485.2
Other 16 24 (8) (33.3)
------ ---- ----
Total noninterest income $1,122 $921 $201 21.8
====== ==== ====
Service fees. The increase resulted primarily from a rise in overdraft fees of
$15 thousand, or 5.2%; merchant program income increase of $25 thousand, or
21.7%; and ATM/Debit Card usage fees of $20 thousand, or 11.3%. These increases
were partially offset by a decline in foreign exchange fees of $10 thousand, or
100.0% as the price of the U.S. dollar continued to decline.
Net gains on sales of loans held for sale. Residential real estate loans of
$5.6 million were sold for a net gain of $158 thousand during the first quarter
of 2008, versus sales of $3.4 million for a net gain of $27 thousand during the
first quarter of 2007.
Noninterest expense. The following table sets forth changes from the first
quarter of 2007 to the first quarter of 2008 for components of noninterest
expense:
For The Three Months Ended March 31,
--------------------------------------------
2008 2007 $ Variance % Variance
---- ---- ---------- ----------
(Dollars in thousands)
Salaries and wages $1,585 $1,578 $ 7 0.4
Pension and employee benefits 668 660 8 1.2
Occupancy expense, net 268 220 48 21.8
Equipment expense 292 262 30 11.5
Equity in losses of affordable
housing investments 97 66 31 47.0
Other 920 860 60 7.0
------ ------ ----
Total noninterest expense $3,830 $3,646 $184 5.0
====== ====== ====
Salaries and wages and related expenses. The increase in 2008 over 2007 was due
primarily to regular salary activity offset partially by increased efficiency
in operations which allowed the Company to grow while reducing a few staff
positions. A decrease in the accrual for pension plan expense of $12 thousand
or 7.2% and a decrease of $7 thousand or 27.7% in the Company's dental
insurance costs were offset by a $21 thousand or 7.8% increase in the Company's
medical costs and the effect of an $8 thousand one time credit adjustment
during the first quarter of 2007 for workman's compensation insurance.
Occupancy expense, net. The $48 thousand or 21.8% increase between periods is
due primarily to the increase in snowplowing costs of $12 thousand or a 92.4%
increase between years due to a winter season of heavy snow and ice, the
increase in fuel costs despite the mild winter temperatures of $13 thousand or
44.3%, and the increased depreciation and real estate taxes in 2008 as the
renovation work on two administrative buildings in Morrisville were completed
in 2007.
Equipment Expense. The increase between years is partially due to the purchase
of a Microsoft open license by the Company which will allow the Company to
increase the number of personal computers on its network and to migrate to
future software upgrades and the $23 thousand write-off during the first
quarter of 2008 of the undepreciated value of the Company's merchant services
equipment which are now being expensed as the value is under the Company's
capitalization limit.
Equity in losses of affordable housing investments. Two new investments in low
income housing investments were made in late 2007 and equity in the losses of
these projects account for the change between 2007 and 2008.
18
Other. The net change between years has many components; the largest being a
$27 thousand increase in training and development costs mainly related to the
roll out of the new personal computers and related software as well as the new
branch imaging system.
Income Tax Expense. The Company has provided for current and deferred federal
income taxes for the current and all prior periods presented. The Company's
provision for income taxes was $176 thousand for the three months ended March
31, 2008 compared to $408 thousand for the same period in 2007, reflecting the
receipt of the federal rehabilitation tax credit of $184 thousand available in
the first quarter of 2008 as a result of the completion of an affordable
housing investment partnership project and the decrease in taxable net income
between periods. The Company's effective tax rate decreased to just 11.1% for
the three months ended March 31, 2008, from 24.8% for the same period in 2007,
reflecting the federal rehabilitation tax credit and the reduction in taxable
net income.
FINANCIAL CONDITION
At March 31, 2008 the Company had total consolidated assets of $388.6 million,
including gross loans and loans held for sale ("total loans") of $316.7
million, deposits of $314.9 million and stockholders' equity of $42.2 million.
The Company's total assets decreased $4.8 million or 1.2% to $388.6 million at
March 31, 2008, from $393.4 million at December 31, 2007, which is a normal
seasonal fluctuation for the Company. Net loans and loans held for sale were
$313.2 million, or 80.6% of total assets at March 31, 2008, as compared to
$314.8 million, or 80.0% of total assets at December 31, 2007.
Cash and cash equivalents, including federal funds sold and overnight deposits,
decreased $46 thousand, or 0.3%, to $13.4 million at March 31, 2008, from $13.4
million at December 31, 2007. Interest bearing deposits in banks decreased $2.4
million or 20.3% from $11.9 million at December 31, 2007 to $9.5 million at
March 31, 2008 as these instruments were allowed to mature to fund increasing
loan demand. Investment securities available-for-sale decreased from $33.8
million at December 31, 2007, to $33.1 million at March 31, 2008, a $747
thousand, or 2.2%, decrease. The securities available-for-sale and interest
bearing deposits in banks decreased from 11.6% of total assets at December 31,
2007 to 10.9% at March 31, 2008.
Deposits decreased $9.0 million, or 2.8%, to $314.9 million at March 31, 2008,
from $324.0 million at December 31, 2007. Noninterest bearing deposits
decreased from $56.2 million at December 31, 2007 to $49.2 million at March 31,
2008, or $7 million or 12.5%. This decrease is a normal seasonal variance and
smaller in both dollars and percentage than we've seen in recent years due to
the strong winter season. Interest bearing deposits decreased $2.0 million, or
0.8%, from $267.8 million at December 31, 2007, to $265.8 million at March 31,
2008. (See average balances and rates in the Yields Earned and Rates Paid
tables on Page 16.) Aggressive rate competition from in-market and
out-of-market financial institutions, makes deposit accounts harder to attract
and retain as well as the low rate environment makes other investments (e.g.
stock market) more attractive to some investors.
Total borrowings increased to $25.1 million at March 31, 2008 from $20.3
million, at December 31, 2007 as the Company took advantage of low rate FHLB of
Boston advances available during the first two months of the quarter to support
the growing loan demand at rates much lower and easier generation than medium
term time deposits could be gathered.
Total stockholders' equity increased slightly to $42.2 million at March 31,
2008 from December 31, 2007, reflecting net income of $1.4 million for the
first three months of 2008, less regular cash dividends paid of $1.3 million,
the purchase of Treasury stock totaling $216 thousand, and a decrease of $193
thousand in accumulated other comprehensive loss. (See Capital Resources
section on Page 32)
Loans Held for Sale and Loan Portfolios. The Company's total loans primarily
consist of adjustable-rate and fixed-rate mortgage loans secured by one-to-four
family, multi-family residential or commercial real estate. As of March 31,
2008, the Company's total loan portfolio was $316.7 million, or 81.5% of
assets, down from $318.3 million, or 80.9% of assets as of December 31, 2007,
but up from $308.1 million or 81.8% of assets as of March 31. 2007. Total loans
(including loans held for sale) have decreased $1.6 million since December 31,
2007. Average net loans (including loans held for sale) were
19
$309.4 million for the 2007 comparison period and have increased to $312.0
million for the first three months of 2008. The Company sold $5.6 million of
loans held for sale during the first three months of 2008 resulting in a gain
on sale of loans of $158 thousand, compared with loan sales of $3.4 million and
related gain on sale of loans of $27 thousand for the first three months of
2007. The Company recognizes that competition for good loans is strong and
continues to call on both current and prospective customers while maintaining
credit quality. The Company has seen a pickup in loan demand during the first
quarter of 2008 in part due to lower interest rates which has engendered some
refinancing activity, loans generated from the Bank's call program and
competitive changes in the Bank's marketplace. The good winter season in both
northern Vermont and New Hampshire has also encouraged businesses to put some
money back into infrastructure and equipment.
The following table shows information on the composition of the Company's total
loan portfolio as of March 31, 2008 and December 31, 2007:
Loan Type March 31, 2008 December 31, 2007
--------- ------------------ ------------------
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in thousands)
Residential real estate $118,098 37.3 $115,303 36.2
Construction real estate 18,055 5.7 20,190 6.4
Commercial real estate 133,816 42.2 133,320 41.9
Commercial 17,221 5.4 16,537 5.2
Consumer 6,675 2.1 7,175 2.3
Municipal loans 16,045 5.1 15,069 4.7
Term Federal Funds Sold - - 3,000 0.9
Loans Held for Sale 6,832 2.2 7,711 2.4
-------- ----- -------- -----
Total loans 316,742 100.0 318,305 100.0
Deduct:
Allowance for loan losses (3,401) (3,378)
Unearned net loan fees (109) (111)
-------- --------
Net loans and loans held for sale $313,232 $314,816
======== ========
The Company originates and sells some residential mortgages into the secondary
market, with most such sales made to the Federal Home Loan Mortgage Corporation
(FHLMC/"Freddie Mac") and the Vermont Housing Finance Agency (VHFA). At March
31, 2008, the Company serviced a $207.0 million residential real estate
mortgage portfolio, approximately $88.9 million of which was serviced for
unaffiliated third parties. Additionally, the Company originates commercial
real estate and commercial loans under various SBA, United States Department of
Agriculture Rural Development Authority and Vermont Economic Development
Authority programs which provide an agency guarantee for a portion of the loan
amount. The Company occasionally sells the guaranteed portion of the loan to
other financial concerns and will retain servicing rights, which generates fee
income. The Company serviced $6.5 million of commercial and commercial real
estate loans for unaffiliated third parties as of March 31, 2008. The Company
capitalizes servicing rights on these fees and recognizes gains and losses on
the sale of the principal portion of these loans as they occur. The unamortized
balance of servicing rights on loans sold with servicing retained was $289
thousand at March 31, 2008, with an estimated market value in excess of their
carrying value.
In the ordinary course of business, the Company occasionally participates out,
on a non-recourse basis, a portion of commercial or real estate loans to other
financial institutions for liquidity or credit concentration management
purposes. The total of loans participated out as of March 31, 2008 was $12.1
million.
Asset Quality. The Company, like all financial institutions, is exposed to
certain credit risks including those related to the value of the collateral
that secures its loans and the ability of borrowers to repay their loans.
Management closely monitors the Company's loan and investment portfolios and
other real estate owned for potential problems and reports to the Company's and
the subsidiary's Boards of Directors at regularly scheduled meetings. Policy
sets forth portfolio diversification levels to mitigate concentration risk.
20
The Company's Board of Directors has set forth lending policies (which are
periodically reviewed and revised as appropriate) that include conservative
individual lending limits for officers, aggregate and advisory board approval
levels, Board approval for large credit relationships, a loan review program
and other limits or standards deemed necessary and prudent. The Company's loan
credit review department is supervised by an experienced former regulatory
examiner and staffed by a Certified Public Accountant as well as other
experienced personnel and encompasses a quality control process for loan
documentation and underwriting that may include a post-closing review. The
Company also maintains a monitoring process for credit extensions. The Company
performs periodic concentration analyses based on various factors such as
industries, collateral types, large credit sizes and officer portfolio loads.
The Company has established underwriting guidelines to be followed by its
officers, exceptions are required to be approved by a senior loan officer or
the Board of Directors. The Company monitors its delinquency levels for any
negative or adverse trends. There can be no assurance, however, that the
Company's loan portfolio will not become subject to increasing pressures from
deteriorating borrower credit due to general or local economic conditions.
Restructured loans include the Company's troubled debt restructurings that
involved forgiving a portion of interest or principal on any loans, refinancing
loans at a rate materially less than the market rate, rescheduling loan
payments, or granting other concessions to a borrower due to financial or
economic reasons related to the debtor's financial difficulties. Restructured
loans do not include qualifying restructured loans that have complied with the
terms of their restructure agreement for a satisfactory period of time.
Restructured loans in compliance with modified terms totaled $180 thousand at
March 31, 2008 and $184 thousand at December 31, 2007. At March 31, 2008 the
Company was not committed to lend any additional funds to borrowers whose terms
have been restructured.
Loans on which the accrual of interest has been discontinued are designated as
nonaccrual loans. Management reviews the loan portfolio continuously for
evidence of problems loans. Such loans are placed under close supervision with
consideration given to placing the loan on nonaccrual status. Loans are
designated as nonaccrual when reasonable doubt exists as to the full collection
of interest and principal. Normally, when a loan is placed on nonaccrual
status, all interest previously accrued but not collected is reversed against
current period interest income. Income on such loans is then recognized only to
the extent that cash is received and where the future collection of interest
and principal is probable. Interest accruals are resumed on such loans only
when they are brought fully current with respect to interest and principal and
when, in the judgment of management, the loans are estimated to be fully
collectible as to both principal and interest.
The Company had loans in nonaccrual status totaling $3.8 million, or 1.22% of
gross loans at March 31, 2008, $3.3 million, or 1.06%, at December 31, 2007,
and $3.0 million, or 0.99%, at March 31, 2007. Loans to one borrower totaling
$480 thousand in nonaccrual status at March 31, 2008 have paid off subsequent
to quarter end. Certain loans in non-accrual status are covered in part by
guarantees of U.S. Government or state agencies. Approximately $201 thousand of
the balances in this category were covered by such guarantees at March 31,
2008. The aggregate interest income not recognized on such nonaccrual loans
amounted to approximately $533 thousand and $389 thousand as of March 31, 2008
and 2007, respectively and $457 thousand as of December 31, 2007.
The Company had $2.5 million in loans past due 90 days or more and still
accruing at March 31, 2008 and $2.3 million at December 31, 2007. Certain loans
past due 90 days or more and still accruing interest are covered in part by
guarantees of U.S. Government or state agencies. Approximately $1.5 million of
the balances in this category were covered by such guarantees at March 31,
2008.
At March 31 2008, and December 31, 2007, respectively, the Company had
internally classified certain loans totaling $19 thousand and $21 thousand,
respectively. In management's view, such loans represent a higher degree of
risk and could become nonperforming loans in the future. While still on a
performing status, in accordance with the Company's credit policy, loans are
internally classified when a review indicates the existence of any of the
following conditions makes the likelihood of collection questionable:
o the financial condition of the borrower is unsatisfactory;
o repayment terms have not been met;
21
o the borrower has sustained losses that are sizable, either in
absolute terms or relative to net worth;
o confidence is diminished;
o loan covenants have been violated;
o collateral is inadequate; or
o other unfavorable factors are present.
The Company has been actively working with customers who may be delinquent or
headed for problems due to the downturn in the economy and the slowdown in the
residential real estate market, although northern New England has not yet
experienced these issues to the extent of other parts of the country.
One of the benefits of being a community financial institution is our
employees' and Boards' knowledge of the community and borrowers which allows us
to be proactive in working closely with our loan customers. The Company's
delinquency rates have historically run higher than similar institutions while
losses have been lower. The Company has not targeted sub-prime borrowers and
has not experienced an elevated delinquency in this area.
On occasion real estate properties are acquired through or in lieu of loan
foreclosure. These properties are to be sold and are initially recorded at the
lesser of the recorded loan or fair value at the date of the Company's
acquisition of the property, with fair value based on an appraisal for more
significant properties and on management's estimate for minor properties. The
Company had $10 thousand in residential real estate and $255 thousand of
commercial real estate property classified as OREO at March 31, 2008 compared
to $10 thousand of residential real estate and $216 thousand of commercial real
estate property at December 31, 2007. The other real estate owned was included
in Other Assets on the Consolidated Balance Sheet at both time periods.
Allowance for Loan Losses. Some of the Company's loan customers ultimately do
not make all of their contractually scheduled payments, requiring the Company
to charge off a portion or all of the remaining principal balance due. The
Company maintains an allowance for loan losses to absorb such losses. The
allowance is maintained at a level which, by management's best estimate, is
adequate to absorb probable credit losses inherent in the loan portfolio;
however, actual loan losses may vary from current estimates. Adequacy of the
allowance for loan losses is determined using a consistent, systematic
methodology, which analyzes the risk inherent in the loan portfolio. In
addition to evaluating the collectibility of specific loans when determining
the adequacy of the allowance, management also takes into consideration other
factors such as changes in the mix and size of the loan portfolio, historic
loss experience, the amount of delinquencies and loans adversely classified,
industry trends, and the impact of the local and regional economy on the
Company's borrowers. The adequacy of the allowance for loan losses is assessed
by an allocation process whereby specific loss allocations are made against
certain adversely classified loans and general loss allocations are made
against segments of the loan portfolio which have similar attributes. While the
Company allocates the allowance for loan losses based on a percentage by
category to total loans, the portion of the allowance for loan losses allocated
to each category does not represent the total available for future losses which
may occur within the loan category since the total allowance for possible loan
losses is a valuation reserve applicable to the entire portfolio.
The allowance for loan losses is increased by a provision for loan losses,
which is charged to earnings, and reduced by charge-offs, net of recoveries.
The provision for loan losses represents the current period credit cost
associated with maintaining an appropriate allowance for loan losses. Based on
an evaluation of the loan portfolio, management presents a quarterly analysis
of the allowance for loan losses to the Board of Directors, indicating any
changes since the last review and any recommendations as to adjustments in the
allowance. Additionally, bank regulatory agencies regularly review the
Company's allowance for loan losses as an integral part of their examination
process.
For the three months ended March 31, 2008, the methodology used to determine
the provision for loan losses was unchanged from the prior quarter or year. The
Company's loan portfolio balance not held for sale decreased slightly from
December 31, 2007 as $3 million in Term Fed Funds matured during the first
quarter, construction real estate loans were at a seasonal low and there was
some runoff in the consumer loan portfolio. All other types of loans grew
between periods, see chart on page 21 for further details. As a result of the
combined changes in volumes and the net charge-offs for the first quarter of
$27 thousand,
22
the Company designated a $50 thousand loan loss provision for the quarter ended
March 31, 2008 which left the allowance for loan losses unchanged at $3.4
million at March 31, 2008. The charge-offs for the quarter was primarily on one
loan relationship for which the estimated fair value of the collateral has been
moved to Other Assets Owned and sold during April 2008. There were no material
changes in the lending programs or terms during the quarter.
The following table reflects activity in the allowance for loan losses for the
three months ended March 31, 2008 and 2007:
Three Months Ended, March 31,
-----------------------------
2008 2007
---- ----
(Dollars in thousands)
Balance at beginning of period $3,378 $3,338
Charge-offs
Real Estate - (30)
Commercial (39) -
Consumer and other (6) (28)
------ ------
Total charge-offs (45) (58)
------ ------
Recoveries
Real Estate 1 7
Commercial 3 1
Consumer and other 14 9
------ ------
Total recoveries 18 17
------ ------
Net charge-offs (27) (41)
------ ------
Provision for loan losses 50 45
------ ------
Balance at end of period $3,401 $3,342
====== ======
The following table shows the internal breakdown of the Company's allowance for
loan losses by category of loan (net of loans held for sale) and the percentage
of loans in each category to total loans in the respective portfolios at the
dates indicated:
March 31, 2008 December 31, 2007
----------------- -----------------
Amount Percent Amount Percent
------ ------- ------ -------
(Dollars in thousands)
Real Estate
Residential $ 736 38.0 $ 710 35.7
Commercial 2,055 43.2 2,011 42.9
Construction 181 5.8 202 6.5
Other Loans
Commercial 299 5.6 277 5.3
Consumer installment 107 2.2 112 2.3
Municipal, Other and
Unallocated 23 5.2 66 7.3
------ ----- ------ -----
Total $3,401 100.0 $3,378 100.0
====== ===== ====== =====
Ratio of net charge offs to
average loans not held for sale (1) 0.04% 0.07%
Ratio of allowance for loan
losses to loans not held
for sale 1.10% 1.09%
Ratio of allowance for loan
losses to nonperforming
loans (2) 53.60% 60.47%
--------------------
(1) Annualized
(2) Non-performing loans include loans in non-accrual status and loans past
due 90 days or more and still accruing.
23
Notwithstanding the categories shown in the table above, all funds in the
allowance for loan losses are available to absorb loan losses in the portfolio,
regardless of loan category.
Management of the Company believes, in their best estimate, that the allowance
for loan losses at March 31, 2008, is adequate to cover probable credit losses
inherent in the Company's loan portfolio as of such date. However, there can be
no assurance that the Company will not sustain losses in future periods, which
could be greater than the size of the allowance for loan losses at March 31,
2008. See CRITICAL ACCOUNTING POLICIES. While the Company recognizes that an
economic slowdown may adversely impact its borrowers' financial performance and
ultimately their ability to repay their loans, management continues to be
cautiously optimistic about the collectability of the Company's loan portfolio.
Investment Activities. At March 31, 2008, the reported value of investment
securities available-for-sale was $33.1 million or 8.5% of assets. The amount
in investment securities available-for-sale decreased slightly from $33.8
million, or 8.6% of assets at December 31, 2007.
The Company had no securities classified as held-to-maturity or trading. The
reported value of investment securities available-for-sale at March 31, 2008
reflects net unrealized gains of $292 thousand compared to a net unrealized
loss of $1 thousand as of December 31, 2007. The offset of the unrealized
gains, net of income tax effect, was a $193 thousand gain reflected in the
Company's accumulated other comprehensive income component of stockholders'
equity at March 31, 2008.
At March 31, 2008, ten securities with a fair value of $2.4 million or 7.3% of
the portfolio have been in an unrealized loss position for more than twelve
months totaling $148 thousand. These unrealized losses are mainly attributed to
the decline in value of two corporate bonds in the financial services sector.
As of March 31, 2008, based on our evaluation, management concluded that these
were not other than temporarily impaired. The Company has the ability to hold
all of these securities, classified as available-for-sale, for the foreseeable
future.
On May 2, 2008, we received notification that one of the merger agreements for
one of the bonds mentioned above may not be consummated as originally
anticipated. The uncertainty in this agreement raised concern as to whether our
investment would be made whole. As a result of this information, we decided to
sell the bond on May 2, 2008, and will incur an after tax loss of approximately
$12 thousand. Subsequent to our sale of the bond, the rating agencies
downgraded the paper to "junk" status.
At December 31, 2007, the Company had twenty-nine debt securities with a fair
value of $8.8 million with an unrealized loss of $166 thousand, or 26.0% of the
value of the amortized cost of the entire investment portfolio, that had
existed for more than 12 months.
24
Deposits. The following table shows information concerning the Company's
average deposits by account type and weighted average nominal rates at which
interest was paid on such deposits for the periods ended March 31, 2008, and
December 31, 2007:
Three Months Ended March 31, 2008 Year Ended December 31, 2007
--------------------------------- -------------------------------
Percent Percent
Average of Total Average Average of Total Average
Amount Deposits Rate Amount Deposits Rate
------- -------- ------- ------- -------- -------
(Dollars in thousands)
Non-time deposits:
Noninterest bearing deposits $ 51,353 16.2 - $ 49,727 15.5 -
NOW accounts 52,169 16.5 0.66% 55,046 17.2 0.85%
Money Market accounts 49,791 15.7 2.28% 51,470 16.0 2.65%
Savings accounts 38,722 12.2 0.55% 41,377 12.9 0.60%
-------- ----- ---- -------- ----- ----
Total non-time deposits 192,035 60.6 0.88% 197,620 61.6 1.05%
Time deposits:
Less than $100,000 79,922 25.3 3.75% 78,237 24.4 4.07%
$100,000 and over 44,468 14.1 4.44% 45,138 14.0 4.87%
-------- ----- ---- -------- ----- ----
Total time deposits 124,390 39.4 4.00% 123,375 38.4 4.37%
-------- ----- ---- -------- ----- ----
Total deposits $316,425 100.0 2.11% $320,995 100.0 2.33%
======== ===== ==== ======== ===== ====
The seasonal decrease in non-time deposits is normal for the first quarter of
the year and is less on both a pure dollar basis and a percentage basis than
seen in recent years and management believes that is due to the "strong" winter
season in the Company's operating area which experienced heavier than normal
snowfall and an extended winter recreational season.
As a participant in the Certificate of Deposit Account Registry Service (CDARS)
of Promontory Interfinancial Network, LLC, there were $8.1 million of time
deposits $100,000 or less on the balance sheet at March 31, 2008 which are
considered to be "brokered" deposits. The deposits are matched dollar for
dollar with Union's customer deposits which have been placed in other financial
institutions in order to provide those customers with full FDIC insurance
coverage.
The following table sets forth information regarding the Company's time
deposits in amounts of $100,000 and over at March 31, 2008, and December 31,
2007, that mature during the periods indicated:
March 31, 2008 December 31, 2007
-------------- -----------------
(Dollars in thousands)
Within 3 months $21,373 $15,443
3 to 6 months 6,882 16,706
6 to 12 months 8,865 11,859
Over 12 months 6,483 2,135
------- -------
$43,603 $46,143
======= =======
Certificates of deposit held by the majority of municipal and school district
customers mature in June 2008 which is a normal seasonal occurrence within the
State of Vermont.
Borrowings. Borrowings from the FHLB of Boston were $25.1 million at March 31,
2008, at a weighted average rate of 4.24%, and $20.3 million at December 31,
2007, at a weighted average rate of 4.83%. Borrowings were up at March 31, 2008
as the Company took advantage of some medium term, low-rate advances to fund
increasing loan demand at lower interest rates and easier generation than time
deposits could be gathered.
25
OTHER FINANCIAL CONSIDERATIONS
Market Risk and Asset and Liability Management. Market risk is the potential of
loss in a financial instrument arising from adverse changes in market prices,
interest rates, foreign currency exchange rates, commodity prices, and equity
prices. The Company's market risk arises primarily from interest rate risk
inherent in its lending, investing, deposit taking and borrowing activities as
yields on assets change in a different time period or in a different amount
from that of interest costs on liabilities. Many other factors also affect the
Company's exposure to changes in interest rates, such as general and local
economic and financial conditions, competitive pressures, customer preferences,
and historical pricing relationships.
The earnings of the Company and its subsidiary are affected not only by general
economic conditions, but also by the monetary and fiscal policies of the United
States and its agencies, particularly the Federal Reserve System. The monetary
policies of the Federal Reserve System influence to a significant extent the
overall growth of loans, investments, deposits and borrowings; the level of
interest rates earned on assets and paid for liabilities; and including
interest rates charged on loans and paid on deposits. The nature and impact of
future changes in monetary policies are often not predictable.
A key element in the process of managing market risk involves direct
involvement by senior management and oversight by the Board of Directors as to
the level of risk assumed by the Company in its balance sheet. The Board of
Directors reviews and approves risk management policies, including risk limits
and guidelines and reviews quarterly the current position in relationship to
those limits and guidelines. Daily oversight functions are delegated to the
Asset Liability Management Committee ("ALCO"). The ALCO, consisting of senior
business and finance officers, actively measures, monitors, controls and
manages the interest rate risk exposure that can significantly impact the
Company's financial condition and operating results. The ALCO sets liquidity
targets based on the Company's financial position and existing and projected
economic and market conditions. The Company does not have any market risk
sensitive instruments acquired for trading purposes. The Company attempts to
structure its balance sheet to maximize net interest income and shareholder
value while controlling its exposure to interest rate risk. Strategies might
include selling or participating out loans held for sale or investments
available-for-sale. The ALCO formulates strategies to manage interest rate risk
by evaluating the impact on earnings and capital of such factors as current
interest rate forecasts and economic indicators, potential changes in such
forecasts and indicators, liquidity, competitive pressures and various business
strategies. The ALCO's methods for evaluating interest rate risk include an
analysis of the Company's interest rate sensitivity "gap", which provides a
static analysis of the maturity and repricing characteristics of the Company's
entire balance sheet, and a simulation analysis, which calculates projected net
interest income based on alternative balance sheet and interest rate scenarios,
including "rate shock" scenarios involving immediate substantial increases or
decreases in market rates of interest.
Members of ALCO meet at least weekly to set loan and deposit rates, make
investment decisions, monitor liquidity and evaluate the loan demand pipeline.
Deposit runoff is monitored daily and loan prepayments evaluated monthly. The
Company historically has maintained a substantial portion of its loan portfolio
on a variable-rate basis and plans to continue this Asset/Liability Management
(ALM) strategy in the future. Portions of the variable-rate loan portfolio have
interest rate floors and caps which are taken into account by the Company's ALM
modeling software to predict interest rate sensitivity, including prepayment
risk. As of March 31, 2008, the investment portfolio is all classified as
available-for-sale and the modified duration was relatively short. The Company
does not utilize any derivative products or invest in any "high risk"
instruments.
26
The Company's interest rate sensitivity analysis (simulation) as of December
2007 for a 200 basis point declining rate environment (Prime at December 31,
2007 was 7.25% and dropped to 5.25% by March 31, 2008) projected the following
for the three months ended March 31, 2008, compared to the actual results:
March 31, 2008
-------------------------------------
Percentage
Projected Actual Difference
--------- ------ ----------
(Dollars in thousands)
Net Interest Income $4,183 $4,340 3.8%
Net Income $1,092 $1,406 28.8%
Return on Assets 1.15% 1.44% 25.2%
Return on Equity 10.58% 13.33% 26.0%
Actual net income is higher than projected mainly due to the higher actual net
interest income than projected as interest rates did not drop on January 1st as
an immediate shock would imply but the prime rate dropped 75 basis points to
6.5% on January 22, 2008, another 50 basis points to 6.0% on January 30, 2008
and a third drop of 75 basis points on March 18, 2008 to 5.25%. Also,
contributing to higher than expected net income was the gain on sale of loans
projected at $84 thousand and actual gain for the quarter ending March 31, 2008
was $158 thousand. In addition, the federal rehabilitation tax credit received
in the first quarter of 2008 for $184 thousand as a result of an investment in
an affordable housing partnership which was not projected in the simulation.
Commitments, Contingent Liabilities, and Off-Balance Sheet Arrangements. The
Company is a party to financial instruments with off-balance-sheet risk in the
normal course of business to meet the financing needs of its customers, to
reduce its own exposure to fluctuations in interest rates, and to implement its
strategic objectives. These financial instruments include commitments to extend
credit, standby letters of credit, interest rate caps and floors written on
adjustable-rate loans, commitments to participate in or sell loans, and
commitments to buy or sell securities, certificates of deposit or other
investment instruments. Such instruments involve, to varying degrees, elements
of credit and interest rate risk in excess of the amount recognized on the
balance sheet. The contract or notional amounts of these instruments reflect
the extent of involvement the Company has in a particular class of financial
instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual notional amount of
those instruments. The Company uses the same credit policies in making
commitments and conditional obligations as it does for on-balance-sheet
instruments. For interest rate caps and floors written on adjustable-rate
loans, the contract or notional amounts do not represent the Company's exposure
to credit loss. The Company controls the risk of interest rate cap agreements
through credit approvals, limits, and monitoring procedures.
The Company generally requires collateral or other security to support
financial instruments with credit risk. As of March 31, 2008 and December 31,
2007, the contract or notional amount of financial instruments that represent
credit risk was as follows:
March 31, 2008 December 31, 2007
-------------- -----------------
(Dollars in thousands)
Commitments to originate loans $13,768 $ 7,084
Unused lines of credit 37,414 35,784
Standby letters of credit 1,240 1,248
Credit card arrangements 1,667 1,633
Equity investment commitment to
housing limited partnership 214 214
------- -------
Total $54,303 $45,963
======= =======
Commitments to originate loans are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the loan commitments are expected to
expire without being drawn upon and not all credit lines will be utilized, the
total commitment amounts do not necessarily represent future cash requirements.
27
The Company has various financial obligations, including contractual
obligations that may require further cash payments. The Company's significant
fixed and determinable contractual obligations to third parties at March 31,
2008, and December 31, 2007, were as follows:
March 31, 2008 December 31, 2007
-------------- -----------------
(Dollars in thousands)
Operating lease commitments $ 284 $ 309
Maturities on borrowed funds 25,099 20,328
Deposits without stated maturity (1) 190,730 198,083
Certificates of deposit (1) 124,201 125,878
Pension plan contributions (2) 600 600
Deferred compensation payouts (3) 395 470
Equity in housing limited partnerships 516 1,610
Real estate and construction contracts (4) 534 288
-------- --------
Total $342,359 $347,566
======== ========
--------------------
(1) While Union has a contractual obligation to depositors should they wish
to withdraw all or some of the funds on deposit, management believes,
based on historical analysis, that the majority of these deposits will
remain on deposit for the foreseeable future. The amounts exclude payable
interest accrued.
(2) Funding requirements for pension benefits after 2008 are excluded due to
the significant variability in the assumptions required to project the
amount and timing of future cash contributions.
(3) The Company owns life insurance on the lives of the payees, in an amount
sufficient to reimburse the Company for the deferred compensation
payments should the Company desire to utilize the death benefit proceeds
for that purpose. The policies have a current cash surrender value of
$3.3 million which is reflected in the balance sheet under Other Assets.
(4) Contracts to purchase and construct a new branch site in St. Albans,
Vermont.
The Company's subsidiary bank is required (as are all banks) to maintain vault
cash or a noninterest bearing reserve balance as established by Federal Reserve
regulations. The Bank's average total reserve for the 14 day maintenance period
including March 31, 2008 was $342 thousand and for December 31, 2007 was $387
thousand, both of which were satisfied by vault cash. The Company has also
committed to maintain a noninterest bearing contracted clearing balance of $1.0
million at March 31 2008 with the Federal Reserve Bank of Boston.
Interest Rate Sensitivity "Gap" Analysis. An interest rate sensitivity "gap" is
defined as the difference between interest earning assets and interest bearing
liabilities maturing or repricing within a given time period. A gap is
considered positive when the amount of interest rate sensitive assets exceeds
the amount of interest rate sensitive liabilities. A gap is considered negative
when the amount of interest rate sensitive liabilities exceeds the amount of
interest rate sensitive assets. During a period of rising interest rates, a
negative gap would tend to adversely affect net interest income, while a
positive gap would tend to result in an increase in net interest income. During
a period of falling interest rates, a negative gap would tend to result in an
increase in net interest income, while a positive gap would tend to affect net
interest income adversely. Because different types of assets and liabilities
with the same or similar maturities may react differently to changes in overall
market interest rates or conditions, changes in interest rates may affect net
interest income positively or negatively even if an institution were perfectly
matched in each maturity category.
The Company prepares its interest rate sensitivity "gap" analysis by scheduling
interest earning assets and interest bearing liabilities into periods based
upon the next date on which such assets and liabilities could mature or
reprice. The amounts of assets and liabilities shown within a particular period
were determined in accordance with the contractual terms of the assets and
liabilities, except that:
o adjustable-rate loans, investment securities, variable-rate time
deposits, and FHLB of Boston advances are included in the period when
they are first scheduled to adjust and not in the period in which they
mature;
28
o fixed-rate mortgage-related securities and loans reflect estimated
prepayments, which were estimated based on analyses of broker estimates,
the results of a prepayment model utilized by the Company, and empirical
data;
o other nonmortgage related fixed-rate loans reflect scheduled contractual
amortization, with no estimated prepayments; and
o NOW, money markets, and savings deposits, which do not have contractual
maturities, reflect estimated levels of attrition, which are based on
detailed studies by the Company of the sensitivity of each such category
of deposit to changes in interest rates.
Management believes that these assumptions approximate actual experience and
considers them reasonable. However, the interest rate sensitivity of the
Company's assets and liabilities in the tables could vary substantially if
different assumptions were used or actual experience differs from the
historical experience on which the assumptions are based.
The following table shows the Company's rate sensitivity analysis as of March
31, 2008:
Cumulative repriced within
-------------------------------------------------------------------------
3 Months 4 to 12 1 to 3 3 to 5 Over 5
or Less Months Years Years Years Total
-------- ------- ------ ------ ------ -----
(Dollars in thousands, by repricing date)
Interest sensitive assets:
Federal funds sold and
overnight deposits $ 1,022 $ - $ - $ - $ - $ 1,022
Interest bearing deposits in banks 990 3,854 2,746 1,872 - 9,462
Investment securities available-for-sale (1)(3) 4,545 2,412 8,425 5,631 11,967 32,980
FHLB Stock - - - - 1,679 1,679
Loans and loans held for sale (2)(3) 93,763 43,154 72,339 59,736 47,641 316,633
-------- ------- ------- -------- -------- --------
Total interest sensitive assets $100,320 $49,420 $83,510 $ 67,239 $ 61,287 $361,776
======== ======= ======= ======== ======== ========
Interest sensitive liabilities:
Time deposits $ 55,744 $43,397 $24,151 $ 909 $ - $124,201
Money markets 4,834 - - - 45,072 49,906
Regular savings 4,065 - - - 36,104 40,169
NOW accounts 14,238 - - - 37,263 51,501
Borrowed funds 3,231 518 2,192 7,861 11,297 25,099
-------- ------- ------- -------- -------- --------
Total interest sensitive liabilities $ 82,112 $43,915 $26,343 $ 8,770 $129,736 $290,876
======== ======= ======= ======== ======== ========
Net interest rate sensitivity gap $ 18,208 $ 5,505 $57,167 $ 58,469 $(68,449) $ 70,900
Cumulative net interest rate
sensitivity gap $ 18,208 $23,713 $80,880 $139,349 $ 70,900
Cumulative net interest rate
sensitivity gap as a
percentage of total assets 4.7% 6.1% 20.8% 35.9% 18.2%
Cumulative net interest rate sensitivity
gap as a percentage of total
Interest sensitive assets 5.0% 6.6% 22.4% 38.5% 19.6%
Cumulative net interest rate sensitivity
gap as a percentage of total
Interest sensitive liabilities 6.3% 8.2% 27.8% 47.9% 24.4%
(1) Investment securities available-for-sale exclude marketable equity securities with a fair value of $66 thousand and
mutual funds with a value of $29 thousand that may be sold by the Company at any time.
(2) Balances shown net of unearned income of $109 thousand.
(3) Estimated repayment assumptions considered in Asset/Liability model.
29
Simulation Analysis. In its simulation analysis, the Company uses computer
software to simulate the estimated impact on net interest income and capital
(Net Fair Value) under various interest rate scenarios, balance sheet trends,
and strategies over a relatively short time horizon. These simulations
incorporate assumptions about balance sheet dynamics such as loan and deposit
growth, product pricing, prepayment speeds on mortgage related assets,
principal maturities on other financial instruments, and changes in funding
mix. While such assumptions are inherently uncertain as actual rate changes
rarely follow any given forecast and asset-liability pricing and other model
inputs usually do not remain constant in their historical relationships,
management believes that these assumptions are reasonable. Based on the results
of these simulations, the Company is able to quantify its estimate of interest
rate risk and develop and implement appropriate strategies.
The following chart reflects the cumulative results of the Company's latest
simulation analysis for the next twelve months on net interest income, net
income, return on assets, return on equity and net fair value ratio. Shocks are
intended to capture interest rate risk under extreme conditions by immediately
shifting to the new level. The projection utilizes a proportional rate shock,
of up and down 300 basis points from the March 31, 2008 prime rate of 5.25%,
this is the highest and lowest internal slopes monitored. This slope range was
determined to be the most relevant during this economic cycle.
INTEREST RATE SENSITIVITY ANALYSIS MATRIX
(Dollars in thousands)
Return on Return on Net Fair
12 Months Prime Net Interest Change Net Assets Equity Value
Ending Rate Income % Income % % Ratio
--------- ----- ------------ ------ ------ --------- --------- --------
March-09 8.25% $20,212 10.02 $6,678 1.80 16.65 8.43%
5.25% $18,371 0.00 $5,441 1.38 13.07 10.65%
2.25% $16,172 (11.96) $3,962 0.88 8.53 12.82%
The resulting projected cumulative effect of these estimates on net interest
income and the net fair value ratio for the twelve month period ending March
31, 2009, are within approved ALCO guidelines for interest rate risk but the
return on assets and equity in a down 300 basis point shock scenario are lower
than Board guidelines. The simulations of earnings do not incorporate any
management actions, which might moderate the negative consequences of interest
rate deviations. Therefore, they do not reflect likely actual results, but
serve as conservative estimates of interest rate risk under different rate
scenarios.
Liquidity. Managing liquidity risk is essential to maintaining both depositor
confidence and stability in earnings. Liquidity is a measurement of the
Company's ability to meet potential cash requirements, including ongoing
commitments to fund deposit withdrawals, repay borrowings, fund investment and
lending activities, and for other general business purposes. The Company's
principal sources of funds are deposits, amortization and prepayment of loans
and securities, maturities of investment securities and other short-term
investments, sales of securities and loans available-for-sale, earnings and
funds provided from operations. Maintaining a relatively stable funding base,
which is achieved by diversifying funding sources, competitively pricing
deposit products, and extending the contractual maturity of liabilities,
reduces the Company's exposure to rollover risk on deposits and limits reliance
on volatile short-term purchased funds. Short-term funding needs arise from
declines in deposits or other funding sources, funding of loan commitments,
draws on unused lines of credit and requests for new loans. The Company's
strategy is to fund assets, to the maximum extent possible, with core deposits
that provide a sizable source of relatively stable and low-cost funds. For the
quarter ended, March 31, 2008, the Company's ratio of average loans to average
deposits was 99.7% compared to the prior year of 98.7%.
In addition, as Union Bank is a member of the FHLB of Boston, it had access to
unused lines of credit up to $854 thousand at March 31 2008 over and above the
$21.9 million term advances already drawn on the lines based on FHLB estimate
as of that date; with the purchase of required FHLB of Boston capital stock
that amount would rise to $13.7 million. This line of credit could be used for
either short or long term liquidity or other needs. In addition to its
borrowing arrangements with the FHLB of Boston, Union Bank maintains a $7.5
million pre-approved Federal Funds line of credit with an upstream
correspondent bank
30
and a small repurchase agreement line with a selected brokerage house. There
were no balances outstanding on either line at March 31, 2008. Union is a
member of the Certificate of Deposit Account Registry Service ("CDARS") of
Promontory Interfinancial Network which allows Union to provide higher FDIC
deposit insurance to customers by exchanging deposits with other members and
allows Union to purchase deposits from other members as another source of
funding. There were no purchased deposits at either March 31, 2008 or December
31, 2007, although Union had exchanged $8.1 million and $6.6 million,
respectively, with other CDARS members as of those dates.
While scheduled loan and securities payments and FHLB of Boston advances are
relatively predictable sources of funds, deposit flows and prepayments on loans
and mortgage-backed securities are greatly influenced by general interest
rates, economic conditions, and competition. The Company's liquidity is
actively managed on a daily basis, monitored by the ALCO, and reviewed
periodically with the subsidiary's Board of Directors. The ALCO measures the
Company's marketable assets and credit available to fund liquidity requirements
and compares the adequacy of that aggregate amount against the aggregate amount
of the Company's interest sensitive or volatile liabilities, such as core
deposits and time deposits in excess of $100,000, borrowings and term deposits
with short maturities, and credit commitments outstanding. The primary
objective is to manage the Company's liquidity position and funding sources in
order to ensure that it has the ability to meet its ongoing commitment to its
depositors, to fund loan commitments and unused lines of credit, and to
maintain a portfolio of investment securities.
The Company's management monitors current and projected cash flows and adjusts
positions as necessary to maintain adequate levels of liquidity. Although
approximately 79.2% of the Company's time deposits will mature within twelve
months, management believes, based upon past experience, (percentage of time
deposits to mature within twelve months has ranged from 72.3% to 87.8% over the
preceding eight years) the relationships developed with local municipalities,
and the variety of deposit products, that Union Bank will retain a substantial
portion of these deposits. Management will continue to offer a competitive but
prudent pricing strategy to facilitate retention of such deposits. The inverted
yield curve for the last year, the proliferation of certificate of deposit
specials and the general economic uncertainty have contributed to the
shortening of the maturities in time deposits. A reduction in total deposits
could be offset by purchases of federal funds, purchases of deposits,
short-or-long-term FHLB borrowings, utilization of the repurchase agreement
line, or liquidation of investment securities, purchased brokerage certificates
of deposit or loans held for sale. Such steps could result in an increase in
the Company's cost of funds or a decrease in the yield earned on assets and
therefore adversely impact the net interest spread and margin. Management
believes the Company has sufficient liquidity to meet all reasonable borrower,
depositor, and creditor needs in the present economic environment. However, any
projections of future cash needs and flows are subject to substantial
uncertainty. Management continually evaluates opportunities to buy/sell
securities and loans available-for-sale, obtain credit facilities from lenders,
or restructure debt for strategic reasons or to further strengthen the
Company's financial position.
Capital Resources. Capital management is designed to maintain an optimum level
of capital in a cost-effective structure that meets target regulatory ratios;
supports management's internal assessment of economic capital; funds the
Company's business strategies; and builds long-term stockholder value.
Dividends are generally increased in line with long-term trends in earnings per
share growth and conservative earnings projections, while sufficient profits
are retained to support anticipated business growth, fund strategic investments
and provide continued support for deposits.
The total dollar value of the Company's stockholders' equity at March 31, 2008
was up $126 thousand from December 31, 2007 at $42.2 million, reflecting net
income of $1.4 million for the first three months of 2008, less cash dividends
paid of $1.3 million, the purchase of 10,886 shares of Treasury stock totaling
$216 thousand, and a decrease of $193 thousand in accumulated other
comprehensive loss.
Union Bankshares, Inc. has 7,500,000 shares of $2.00 par value common stock
authorized. As of March 31, 2008, the Company had 4,921,786 shares issued, of
which 4,492,083 were outstanding and 429,703 were held in Treasury.
31
The Board of Directors has authorized the repurchase of up to 100,000 shares of
common stock, or approximately 2.2% of the Company's outstanding shares at the
authorization date, for an aggregate repurchase cost not to exceed $2.15
million. Shares can be repurchased in the open market or in negotiated
transactions. The repurchase program is open for an unspecified period of time.
As of March 31, 2008 the Company had repurchased 10,886 shares under this
program, for a total cost of $216 thousand during the quarter, and 68,755
shares at a total cost of $1.4 million since the inception of the program in
November, 2005.
As of March 31, 2008, there were outstanding employee incentive stock options
with respect to shares of the Company's common stock, granted pursuant to Union
Bankshares' 1998 Incentive Stock Option Plan. As of such date, 12,750 options
were currently exercisable and none of those options were "in the money". Of
the 75,000 shares authorized for issuance under the 1998 Plan, 42,200 shares
remain available for future option grants. During the first quarter of 2008, no
incentive stock options were granted or exercised pursuant to the 1998 plan.
Union Bankshares, Inc. and Union Bank are subject to various regulatory capital
requirements administered by the federal banking agencies. Management believes,
as of March 31, 2008, that both companies meet all capital adequacy
requirements to which they are subject. As of March 31, 2008, the most recent
calculation categorizes Union Bank as well capitalized under the regulatory
framework for prompt corrective action. The prompt corrective action capital
category framework applies to FDIC insured depository institutions such as
Union but does not apply directly to bank holding companies such as the
Company. To be categorized as well capitalized, Union Bank must maintain
minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set
forth in the table below. There are no conditions or events since March 31,
2008, that management believes have changed either company's category.
Union Bank's and the Company's actual capital amounts and ratios as of March
31, 2008, are presented in the following table:
Minimums
To Be Well
Minimums Capitalized Under
For Capital Prompt Corrective
Actual Requirements Action Provisions
----------------- ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollars in thousands)
Total capital to risk weighted assets
Union Bank $45,922 16.7% $21,946 8.0% $27,432 10.0%
Company $46,001 16.7% $22,010 8.0% N/A N/A
Tier I capital to risk weighted assets
Union Bank $42,512 15.5% $10,971 4.0% $16,456 6.0%
Company $42,582 15.5% $11,003 4.0% N/A N/A
Tier I capital to average assets
Union Bank $42,512 11.0% $15,529 4.0% $19,412 5.0%
Company $42,582 11.3% $15,020 4.0% N/A N/A
Regulatory Matters. The Company and Union are subject to periodic examinations
by the various regulatory agencies. These examinations include, but are not
limited to, procedures designed to review lending practices, risk management,
credit quality, liquidity, compliance and capital adequacy. During 2007 the
Vermont State Department of Banking, the Federal Deposit Insurance Corporation,
and the Federal Reserve Bank of Boston performed various examinations of the
Company and Union pursuant to their regular, periodic regulatory reviews. No
comments were received from these various bodies that would have a material
adverse effect on the Company's liquidity, financial position, capital
resources, or results of operations.
32
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Information called for by this item is incorporated by reference in
Management's Discussion and Analysis of Financial Condition and Results of
Operations under the caption "OTHER FINANCIAL CONSIDERATIONS" on pages 26
through 33 in this Form 10-Q.
Item 4T. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures. The Company's chief executive
officer and chief financial officer, with the assistance of the Disclosure
Control Committee, evaluated the effectiveness of the design and operation of
the Company's disclosure controls and procedures (as defined in Rule 13a-15(e)
under the Exchange Act) as of March 31, 2008. Based on this evaluation they
concluded that those disclosure controls and procedures are effective to ensure
that information required to be disclosed by the Company in the reports that it
files or submits under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by the Company in the reports that it files with the
Commission is accumulated and communicated to the Company's management,
including its principal executive and principal financial officer, or persons
performing similar functions, as appropriate to allow timely decisions
regarding required information.
Management's Report on Internal Control Over Financial Reporting. The Company's
management is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act Rule
13a-15(f). The Company's management, including the Chief Executive Officer and
Chief Financial Officer, conducted an evaluation of the effectiveness of the
Company's internal control over financial reporting based on the Internal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on the results of this
evaluation, the Company's management concluded that, as of March 31, 2008, the
Company's internal control over financial reporting was effective to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles.
There have been no changes in the Company's internal controls or in other
factors known to the Company that could significantly affect these controls
subsequent to the date of the evaluation referred to above. While the Company
believes that its existing disclosure controls and procedures have been
effective to accomplish these objectives, the Company intends to continue to
examine, refine and formalize its disclosure controls and procedures and to
monitor ongoing developments in this area.
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
There are no known pending legal proceedings to which the Company or its
subsidiary is a party, or to which any of their properties is subject, other
than ordinary litigation arising in the normal course of business activities.
Although the amount of any ultimate liability with respect to such proceedings
cannot be determined, in the opinion of management, any such liability would
not have a material effect on the consolidated financial position of the
Company and its subsidiary.
33
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
ISSUER PURCHASES OF EQUITY SECURITIES
-------------------------------------
Maximum Number of
Shares that May Yet Be
Total Numbers of Shares Purchased Purchased Under
Total Number of Average Price as Part of Publicly Announced Plans the Plans or
Period Shares Purchased Paid per Share or Programs (1) Programs
------------------------------------------------------------------------------------------------------------------------
January 2008 4,736 $19.96 4,736 37,395
February 2008 300 $20.42 300 37,095
March 2008 5,850 $19.61 5,850 31,245
(1) Since November 18, 2005, the Company has maintained an informal stock repurchase program pursuant to which the
Company may repurchase up to $2.15 million or 100,000 shares of common stock, or approximately 2.2% of the
Company's outstanding shares as of the authorization date. Shares can be repurchased in the open market or in
negotiated transactions. The repurchase program is open for an unspecified period of time. As of March 31, 2008
the Company had repurchased 10,886 shares under this program for a total cost of $215 thousand during 2008. Since
inception of the program, the Company has repurchased 68,755 shares at a total cost of $1.4 million.
Item 6. Exhibits.
31.1 Certification of the Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized.
May 15, 2008 Union Bankshares, Inc.
/s/ Kenneth D. Gibbons
-------------------------------------
Kenneth D. Gibbons
Director, President and
Chief Executive Officer
/s/ Marsha A. Mongeon
-------------------------------------
Marsha A. Mongeon
Chief Financial Officer and Treasurer
(Principal Financial Officer)
34
EXHIBIT INDEX
31.1 Certification of the Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of the Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
35