UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
Commission file number: 0-20293
UNION BANKSHARES CORPORATION
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employee
Identification No.)
212 North Main Street, P.O. Box 446, Bowling Green, Virginia 22427
(Address or principal executive offices) (Zip code)
(804) 633-5031
(Registrant’s telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $2 par value
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes x No ¨
The aggregate market value of voting stock held by non-affiliates of the registrant as of June 30, 2003 was approximately $200,455,411.
The number of shares of common stock outstanding as of February 20, 2004 was 7,628,778.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive proxy statement to be used in conjunction with the registrant’s 2004 Annual Meeting of Shareholders are incorporated into Part III of this Form 10-K.
INDEX
PART 1
Item 1.
Business
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Submission of Matters to a Vote of Security Holders
PART II
Item 5.
Market for Registrant’s Common Equity and Related Stockholder Matters
Item 6.
Selected Financial Data
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Financial Statements and Supplementary Data
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
Controls and Procedures
PART III
Item 10.
Directors and Executive Officers of the Registrant
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management
Item 13.
Certain Relationships and Related Transactions
Item 14.
Principal Accounting Fees and Services
PART IV
Item 15.
Exhibits, Financial Statement Schedules and Reports on Form 8-K
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PART I
Item 1. — Business
GENERAL
Union Bankshares Corporation (the “Company” or “Union”) is a multi-bank holding company organized under Virginia law and registered under the Bank Holding Company Act of 1956. The Company is headquartered in Bowling Green, Virginia. The Company is committed to the delivery of financial services through its four community bank subsidiaries (the “Community Banks”) and three non-bank financial services affiliates:
Community Banks
Union Bank & Trust Company
Bowling Green, Virginia
Northern Neck State Bank
Warsaw, Virginia
Rappahannock National Bank
Washington, Virginia
Bank of Williamsburg
Williamsburg, Virginia
Financial Services Affiliates
Mortgage Capital Investors, Inc.
Springfield, Virginia
Union Investment Services, Inc.
Union Insurance Group, LLC
The Company was formed in connection with the July 1993 merger of Northern Neck Bankshares Corporation and Union Bancorp, Inc. and their bank subsidiaries Union Bank & Trust Company and Northern Neck State Bank into Union Bankshares Corporation. On September 1, 1996, King George State Bank and on July 1, 1998, Rappahannock National Bank became wholly-owned subsidiaries of the Company. On February 22, 1999, the Bank of Williamsburg began business as a newly organized bank. In June 1999, after the retirement of its president, King George State Bank was merged into Union Bank & Trust Company (“Union Bank”) and ceased to be a subsidiary bank. Although Union Bankshares was founded in 1993, its subsidiary banks are among the oldest in Virginia. Union Bank and Trust and Rappahannock National Bank began business in 1902 and Northern Neck State Bank dates back to 1907.
Each of the Community Banks is a full service retail commercial bank offering consumers and businesses a wide range of banking and related financial services, including checking, savings, certificates of deposit and other depository services, and loans for commercial, industrial, residential mortgage and consumer purposes. The Community Banks also issue credit cards and deliver automated teller machine services through the use of reciprocally shared ATMs in the major ATM networks. All of the Community Banks offer Internet banking access for banking services and online bill payment for both consumers and commercial companies.
The Company principally serves, through its Community Banks, the Virginia counties of Caroline, Hanover, Henrico, James City, King George, King William, Spotsylvania, Stafford, Richmond, Westmoreland, Essex, Lancaster and Northumberland, and the Cities of Williamsburg, Newport News and Fredericksburg, Virginia. The Community Banks serve their customers through traditional bank branches, as well as convenience branches located in five convenience stores and in a super Wal-Mart store. They also utilize loan production offices to enter new markets as a means to gauge the strength and potential of those markets. In January 2002, the Bank of Williamsburg opened a loan production office servicing Newport News and converted it to a full service branch in May 2002. In August 2002, Union Bank opened a loan production office in the Manassas area (Prince William County). In January 2003, Union Bank opened a loan production office in Henrico County and a full-service branch is expected to open at that location in March 2004. In addition, in November 2003 a branch was opened in the Short Pump area of Richmond. Through its Community Banks, the Company operated 32 branches in its primary trade area at December 31, 2003.
Union Investment Services has provided securities, brokerage and investment advisory services since its formation in February 1993. It is a full service investment company handling all aspects of wealth management including stocks, bonds, annuities, mutual funds and financial planning.
On February 11, 1999, the Company acquired CMK Corporation t/a “Mortgage Capital Investors,” a mortgage loan brokerage company headquartered in Springfield, Virginia, by merger of CMK Corporation into Mortgage Capital Investors, Inc., a wholly owned subsidiary of Union Bank (“MCII”). MCII has seven offices located in Virginia (4) and Maryland (2) and South Carolina (1), and is also licensed to do business in Washington, D.C. MCII provides a variety of mortgage products to customers in those states. The mortgage loans originated by MCII are generally sold in the secondary market through purchase agreements with institutional investors.
On August 31, 2003, the Company formed Union Insurance Group, LLC (“UIG”) an insurance agency in which each of the subsidiary banks owns a proportionate stake based on asset size This agency operates in a joint venture with Bankers Insurance, LLC, a consortium of title agencies owned by community banks across Virginia and managed by the Virginia Bankers Association. UIG generates revenue through sales of various insurance products, including long term care insurance and business owner policies.
Union Bankshares Corporation had assets of $1.2 billion, deposits of $1.0 billion and stockholders’ equity of $118.5 million at December 31, 2003. The Community Banks range in asset size from $46.9 million to $835.7 million at December 31, 2003.
SEGMENTS
The Company has two reportable segments: traditional full service community banks and a mortgage loan origination business, each as described above. See Note 17 in the Notes to Consolidated Financial Statements contained in Item 8, Financial Statement and Supplementary Data, of this Form 10-K and Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this Form 10-K, for certain financial and other information about each of the Company’s operating segments.
ACQUISITION PROGRAM
The Company expands its market area and increases its market share through internal growth, de novo expansion and strategic acquisitions. Strategic acquisitions by the Company to date have included whole bank acquisitions and financial affiliations, as well as branch and deposit acquisitions. The Company generally considers acquisitions of companies in strong growth markets or with unique products or services that might benefit the entire organization. Targeted acquisitions are priced to be economically feasible with minimal short term drag to achieve positive long term benefits. These acquisitions may be paid for in the form of cash, stock or a combination thereof. The amount and type of consideration and deal charges paid could have a dilutive effect on the Company earnings per share or book value, however cost savings and revenue enhancements are also anticipated to provide long term economic benefit to the Company.
On December 19, 2003, the Company announced the signing of a definitive merger agreement with Guaranty Financial Corporation (“Guaranty”). The transaction is valued at approximately $54 million in stock and cash and is expected to take place in the second quarter of 2004, subject to regulatory approval and the approval of Guaranty’s shareholders. Guaranty operates seven branches in the Greater Charlottesville area with nearly $200 million in assets.
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In November 2003, Union Bank opened a branch in a convenience store on Pounce Tract Road in the Short Pump area of western Henrico County. This branch compliments the existing operations of Union Bank and Trust in the Richmond area and furthers its expansion in the Richmond market.
In 2002, the Company, through two of its Community Banks, opened two loan production offices as a means to enter new markets in Newport News and Manassas, Virginia. Both offices have performed well and the Newport News location became a full service branch in May 2002.
EMPLOYEES
As of December 31, 2003, the Company had 521 employees both full and part time, including executive officers, loan and other banking officers, branch personnel, operations personnel and other support personnel. None of the Company’s employees is represented by a union or covered under a collective bargaining agreement. Management of the Company considers their employee relations to be excellent.
COMPETITION
The financial services industry remains highly competitive and constantly evolving. The Company experiences strong competition in all aspects of its business. In its market areas, the Company competes with large national and regional financial institutions, savings and loans and other independent community banks, as well as credit unions, consumer finance companies, mortgage companies, loan productions offices, mutual funds and life insurance companies. Competition has increasingly come from out-of-state banks through their acquisitions of Virginia-based banks. Competition for deposits and loans is affected by factors such as interest rates offered, the number and location of branches and types of products offered, as well as the reputation of the institution. In addition, credit unions have been allowed to increasingly expand their membership definitions and to offer more attractive loan and deposit pricing due to their favorable tax status. At the same time, the Company’s non-bank financial services affiliates also operate in highly competitive environments.
Union Bankshares Corporation is one of the largest independent bank holding companies headquartered in Virginia. The Company believes its community bank framework and philosophy provide a competitive advantage, particularly with regards to larger national and regional institutions, allowing the Company to compete effectively in the markets it serves. The Company’s Community Banks generally have strong and growing market shares within the markets they serve. Due to the significant presence of out of state banks and the Company’s absence in many Virginia markets, the Company’s deposit market share in Virginia as of June 2003 is only 0.74% of the total banking deposits in Virginia. This is up from 0.69% in June 2002 and shows the impact of our penetration in existing and new markets in the state. It is anticipated that the planned acquisition of Guaranty Financial Corporation will increase this number to 0.87%.
SUPERVISION AND REGULATION
Bank holding companies and banks are extensively regulated under both federal and state law. The following description briefly addresses certain provisions of federal and state laws and certain regulations and proposed regulations and the potential impact of such provisions on the Company and the Community Banks. To the extent statutory or regulatory provisions or proposals are described herein, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals.
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Bank Holding Companies
As a bank holding company registered under the Bank Holding Company Act of 1956 (the “BHCA”), the Company is subject to regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The Federal Reserve Board has jurisdiction under the BHCA to approve any bank or non-bank acquisition, merger or consolidation proposed by a bank holding company. The BHCA generally limits the activities of a bank holding company and its subsidiaries to that of banking, managing or controlling banks, or any other activity that is so closely related to banking or to managing or controlling banks as to be a proper incident thereto.
Since September 1995, the BHCA has permitted bank holding companies from any state to acquire banks and bank holding companies located in any other state, subject to certain conditions, including nationwide and state imposed concentration limits. Banks are also able to branch across state lines, provided certain conditions are met, including that applicable state law must expressly permit such interstate branching. Virginia has adopted legislation that permits branching across state lines, provided there is reciprocity with the state in which the out-of-state bank is based.
There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the Federal Deposit Insurance Corporation (the “FDIC”) insurance funds in the event the depository institution becomes in danger of default or is in default. For example, under a policy of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources to support such institutions in circumstances where it might not do so absent such policy. In addition, the “cross-guarantee” provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by either the Savings Association Insurance Fund (“SAIF”) or the Bank Insurance Fund (“BIF”) as a result of the default of a commonly controlled insured depository institution in danger of default. The FDIC may decline to enforce the cross-guarantee provisions if it determines that a waiver is in the best interest of the SAIF or the BIF or both. The FDIC’s claim for damages is superior to claims of stockholders of the insured depository institution or its holding company but is subordinate to claims of depositors, secured creditors and holders of subordinated debt (other than affiliates) of the commonly controlled insured depository institutions.
The Federal Deposit Insurance Act (the “FDIA”) also provides that amounts received from the liquidation or other resolution of any insured depository institution by any receiver must be distributed (after payment of secured claims) to pay the deposit liabilities of the institution prior to payment of any other general creditor or stockholder. This provision would give depositors a preference over general and subordinated creditors and stockholders in the event a receiver is appointed to distribute the assets of the bank.
The Company is registered under the bank holding company laws of Virginia. Accordingly, the Company and the Community Banks (other than Rappahannock National Bank, which is federally regulated) are subject to regulation and supervision by the State Corporation Commission of Virginia (the “SCC”) and the Federal Reserve Bank. Rappahannock National Bank is subject to regulation and supervision by the Office of the Comptroller of the Currency (the “OCC”).
Capital Requirements
The Federal Reserve Board, the OCC and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to United States banking organizations. In addition, those regulatory agencies may from time to time require that a banking organization maintain capital above
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the minimum levels because of its financial condition or actual or anticipated growth. Under the risk-based capital requirements of these federal bank regulatory agencies, the Company and each of the Subsidiary Banks are required to maintain a minimum ratio of total capital to risk-weighted assets of at least 8%. At least half of the total capital is required to be “Tier 1 capital”, which consists principally of common and certain qualifying preferred shareholders’ equity (including Trust Preferred Securities), less certain intangibles and other adjustments. The remainder (“Tier 2 capital”) consists of a limited amount of subordinated and other qualifying debt (including certain hybrid capital instruments) and a limited amount of the general loan loss allowance. The Tier 1 and total capital to risk-weighted asset ratios of the Company as of December 31, 2003 were 10.71% and 11.88%, respectively, exceeding the minimum requirements.
In addition, each of the federal regulatory agencies has established a minimum leverage capital ratio (Tier 1 capital to average tangible assets) (“Tier 1 leverage ratio”). These guidelines provide for a minimum Tier 1 leverage ratio of 4% for banks and bank holding companies that meet certain specified criteria, including that they have the highest regulatory examination rating and are not contemplating significant growth or expansion. The Tier 1 leverage ratio of the Company as of December 31, 2003, was 8.72%, which is above the minimum requirements. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.
The consideration for the pending acquisition of Guaranty will be in the form of stock and cash. It is anticipated that the cash portion of the transaction will be financed through the issuance of trust preferred securities (TRUPs) which qualify as Tier 1 capital for regulatory purposes.
Limits on Dividends and Other Payments
The Company is a legal entity, separate and distinct from its subsidiary institutions. A significant portion of the revenues of the Company result from dividends paid to it by the Community Banks. There are various legal limitations applicable to the payment of dividends by the Community Banks to the Company, as well as the payment of dividends by the Company to its respective shareholders.
The Community Banks are subject to various statutory restrictions on their ability to pay dividends to the Company. Under the current supervisory practices of the Community Banks’ regulatory agencies, prior approval from those agencies is required if cash dividends declared in any given year exceed net income for that year, plus retained net profits of the two preceding years. The payment of dividends by the Community Banks or the Company may also be limited by other factors, such as requirements to maintain capital above regulatory guidelines. Bank regulatory agencies have the authority to prohibit the Community Banks or the Company from engaging in an unsafe or unsound practice in conducting their business. The payment of dividends, depending on the financial condition of the Community Banks, or the Company, could be deemed to constitute such an unsafe or unsound practice.
Under the FDIA, insured depository institutions such as the Community Banks are prohibited from making capital distributions, including the payment of dividends, if, after making such distribution, the institution would become “undercapitalized” (as such term is used in the statute). Based on the Community Banks’ current financial condition, the Company does not expect that this provision will have any impact on its ability to obtain dividends from the Community Banks. Nonbank subsidiaries pay the parent company dividends periodically on a nonregulated basis.
In addition to dividends it receives from the Community Banks, the Company receives management fees from its affiliated companies for various services provided to them including: data processing, item processing, customer accounting, financial accounting, human resources, funds management,
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credit administration, credit support, sales and marketing, collections, facilities management, call center, legal, compliance and internal audit. These fees are charged to each subsidiary based upon various specific allocation methods measuring the usage of such services by that subsidiary. The fees are eliminated from the financial statements in the consolidation process.
Under federal law, the Community Banks may not, subject to certain limited exceptions, make loans or extensions of credit to, or investments in the securities of, the Company or take securities of the Company as collateral for loans to any borrower. The Community Banks are also subject to collateral security requirements for any loans or extensions of credit permitted by such exceptions.
The Community Banks
The Community Banks are supervised and regularly examined by the Federal Reserve Board and the SCC, and in the case of Rappahannock National Bank, the OCC. The various laws and regulations administered by the regulatory agencies affect corporate practices, such as the payment of dividends, incurrance of debt and acquisition of financial institutions and other companies, and affect business practices, such as the payment of interest on deposits, the charging of interest on loans, types of business conducted and location of offices.
The Community Banks are also subject to the requirements of the Community Reinvestment Act (the “CRA”). The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of the local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. Each financial institution’s efforts in meeting community credit needs currently are evaluated as part of the examination process pursuant to twelve assessment factors. These factors also are considered in evaluating mergers, acquisitions and applications to open a branch or facility.
As institutions with deposits insured by the BIF, the Community Banks also are subject to insurance assessments imposed by the FDIC. There is a base assessment for all institutions. In addition, the FDIC has implemented a risk-based assessment schedule, imposing assessments ranging from zero (with a $2,000 minimum assessment) to 0.27% of an institution’s average assessment base. The actual assessment to be paid by each BIF member is based on the institution’s assessment risk classification, which is determined based on whether the institution is considered “well capitalized,” “adequately capitalized” or “undercapitalized,” as such terms have been defined in applicable federal regulations, and whether such institution is considered by its supervisory agency to be financially sound or to have supervisory concerns. In 2003, the Company paid only the base assessment rate through the Community Banks which amounted to $150,181 in deposit insurance premiums.
Other Safety and Soundness Regulations
The federal banking agencies have broad powers under current federal law to make prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” All such terms are defined under uniform regulations defining such capital levels issued by each of the federal banking agencies.
The Gramm-Leach-Bliley Act
Effective on March 11, 2001, the Gramm Leach Bliley Act (the “GLB Act”) allows a bank holding company or other company to certify status as a financial holding company, which will allow such company to engage in activities that are financial in nature, that are incidental to such activities, or are complementary to such activities. The GLB Act enumerates certain activities
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that are deemed financial in nature, such as underwriting insurance or acting as an insurance principal, agent or broker, underwriting, dealing in or making markets in securities, and engaging in merchant banking under certain restrictions. It also authorizes the Federal Reserve Board to determine by regulation what other activities are financial in nature, or incidental or complementary thereto.
Filings with the SEC
The Company files annual, quarterly and other reports under the Securities Exchange Act of 1934 with the Securities and Exchange Commission. These reports are posted and are available at no cost on the Company’s website, www.ubsh.com, through the Investor Relations link, as soon as reasonably practible after the Company files such documents with the SEC. Union’s filings are also available through the SEC’s website at www.sec.gov.
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Item 2. — Properties
The Company, through its subsidiaries, owns or leases buildings that are used in the normal course of business. The corporate headquarters is located at 212 N. Main Street, Bowling Green, Virginia, in a building owned by the Company. The Company’s subsidiaries own or lease various other offices in the counties and cities in which they operate. See the Notes to Consolidated Financial Statements contained in Item 8, Financial Statement and Supplementary Data, of this Form 10-K for information with respect to the amounts at which bank premises and equipment are carried and commitments under long-term leases.
Unless otherwise indicated, the properties below are owned by the Company and its subsidiaries as of December 31, 2003.
Locations
212 North Main Street
211 North Main Street
Route 1
Ladysmith, Virginia
Route 301
Port Royal, Virginia
4540 Lafayette Boulevard
Fredericksburg, Virginia
Route 1 and Ashcake Road
Ashland, Virginia
4210 Plank Road
10415 Courthouse Road
Spotsylvania, Virginia
9665 Sliding Hill Road
700 Kenmore Avenue
Route 360
Manquin, Virginia
9534 Chamberlayne Road
Mechanicsville, Virginia
Cambridge and Layhill Road
Fredericksburg, Virginia (leased)
Massaponax Church Road and Route 1
Spotsylvania, Virginia (leased)
Brock Road and Route 3
2811 Fall Hill Avenue
610 Mechanicsville Turnpike
Mechanicsville, Virginia (leased)
10045 Kings Highway
King George, Virginia
840 McKinney Blvd.
Colonial Beach, Virginia
5510 Morris Road
Thornburg, Virginia
4690 Pouncey Tract Road
Glen Allen, Virginia (leased)
9282 Corporate Circle, Building 7
Ashton Professional Center
Manassas, Virginia (leased)
1773 Parham Road
Richmond, Virginia
5839 Richmond Road
4256 Richmond Road
Route 3, Kings Highway
Montross, Virginia
1649 Tappahannock Blvd
Tappahannock, Virginia
1660 Tappahannock Blvd (Wal-Mart)
Tappahannock, Virginia (leased)
15043 Northumberland Highway
Burgess, Virginia
284 North Main Street
Kilmarnock, Virginia
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876 Main Street
Reedville, Virginia
485 Chesapeake Drive
White Stone, Virginia
7 Bank Road
5125 John Tyler Highway
Williamsburg, Virginia (land leased)
603 Pilot House Drive
Newport News, Virginia (leased)
111 Davis Court
Williamsburg, Virginia (land lease)
5440 Jeff Davis Highway, #103
3 Hillcrest Drive #A100
Frederick, Maryland
7501 Greenway Center, #140
Greenbelt, Maryland
7901 N. Ocean Boulevard
Myrtle Beach, South Carolina
6330 Newtown Road, #211
Norfolk, Virginia
6571 Edsall Road
12741 Darby Brooke Court, Suite 102
Woodbridge, Virginia
Item 3. — Legal Proceedings
In the ordinary course of its operations, the Company and its subsidiaries are parties to various legal proceedings. Based on the information presently available, and after consultation with legal counsel, management believes that the ultimate outcome in such proceedings, in the aggregate, will not have a material adverse effect on the business or the financial condition or results of operations of the Company.
Item 4. — Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2003.
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Item 5. — Market for Registrant’s Common Equity and Related Stockholder Matters
Union Bankshares Corporation’s common stock is traded on the Nasdaq National Market under the symbol “UBSH”. The Company’s common stock began trading on the Nasdaq National Market in October 1993.
There were 7,627,248 shares of the Company’s common stock outstanding at the close of business on December 31, 2003, which were held by 2,273 shareholders of record. The closing price of the Company’s stock on December 31, 2003 was $30.50 per share as compared to $27.25 on December 31, 2002.
The following table summarizes the high and low closing sales prices and dividends declared for quarterly periods during the two years ended December 31, 2003.
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Restrictions on the ability of the Community Banks to transfer funds to the Company at December 31, 2003, are set forth in Note 16 of the Notes to the Consolidated Financial Statements contained in Item 8, Financial Statements and Supplementary Data, of this Form 10-K. A discussion of certain limitations on the ability of the Community Banks to pay dividends to the Company and the ability of the Company to pay dividends on its common stock, is set forth in Part I, Business, of this Form 10-K under the headings “Supervision and Regulation - Limits on Dividends and Other Payments” and “- The Community Banks”.
The dividend amount on the Company’s common stock is established by the Board of Directors semi-annually and dividends are typically paid on May 1st and November 1st of each year. In making its decision on the payment of dividends on the Company’s common stock, the Board considers operating results, financial condition, capital adequacy, regulatory requirements, shareholder returns and other factors.
Equity Compensation Plans
The following table summarizes information, as of December 31, 2003, relating to the Company’s 1993 Stock Option Plan, pursuant to which grants of options to acquire shares of common stock may be granted from time to time.
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Equity Compensation Plan Information
Number of Shares
to be Issued UponExercise
of OutstandingOptions, Warrantsand Rights
Weighted-Average
Exercise Price of
OutstandingOptions,
Warrants andRights
Remaining Available
for Future IssuanceUnder
Equity CompensationPlan
Equity compensation plans approved by shareholders
Equity compensation plans not approved by shareholders
Total
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Item 6. - Selected Financial Data
The following table sets forth selected financial data for the Company for the last five years.
Interest income
Interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income
Noninterest expenses
Income before income taxes
Income tax expense
Net income
Return on average assets (ROA)
Return on average equity (ROE)
Efficiency ratio
Net income per share - basic
Net income per share - diluted
Cash dividends declared
Book value at period-end
Total assets
Total deposits
Total loans, net of unearned income
Stockholders’ equity
Allowance for loan losses
Allowance as % of total loans
Market value per share at period-end
Price to earnings ratio
Price to book value ratio
Equity to assets
Dividend payout ratio
Weighted average shares outstanding, basic
Weighted average shares outstanding, diluted
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Item 7. — Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis provides information about the major components of the results of operations and financial condition, liquidity and capital resources of Union Bankshares Corporation and its subsidiaries. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements presented in Item 8, Financial Statements and Supplementary Data, of this Form 10-K.
FORWARD-LOOKING STATEMENTS
Certain statements in this report may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that include projections, predictions, expectations or beliefs about future events or results or otherwise are not statements of historical fact. Such statements are often characterized by the use of qualified words (and their derivatives) such as “expect,” “believe,” “estimate,” “plan,” “project,” or other statements concerning opinions or judgment of the Company and its management about future events. Although the Company believes that its expectations with respect to certain forward-looking statements are based upon reasonable assumptions within the bounds of its existing knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. Actual future results and trends may differ materially from historical results or those anticipated depending on a variety of factors, including, but not limited to, the effects of and changes in: general economic conditions, the interest rate environment, legislative and regulatory requirements, competitive pressures, new products and delivery systems, inflation, changes in the stock and bond markets, technology, and consumer spending and savings habits. The Company does not update any forward-looking statements that may be made from time to time by or on behalf of the Company.
CRITICAL ACCOUNTING POLICIES
General
The accounting and reporting policies of Union Bankshares Corporation and its subsidiaries are in accordance with accounting principles generally accepted in the United States (“GAAP”) and conform to general practices within the banking industry. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and/or results of operations.
The more critical accounting and reporting policies include Union’s accounting for the allowance for loan losses, goodwill and intangibles, and income taxes. Union’s accounting policies are fundamental to understanding the Company’s consolidated financial position and consolidated results of operations. Accordingly, the Company’s significant accounting policies are discussed in detail in Note 1 in the “Notes to Consolidated Financial Statements”.
The following is a summary of the Company’s significant accounting policies that are highly dependent on estimates, assumptions and judgments.
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Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: (i) Statement of Financial Accounting Standard (“SFAS”) No. 5, Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimatable and (ii) SFAS No. 114,Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.
The Company’s allowance for loan losses is the accumulation of various components that are calculated based on independent methodologies. All components of the allowance represent an estimation performed pursuant to either SFAS No. 5 or SFAS No. 114. Management’s estimate of each SFAS No. 5 component is based on certain observable data that management believes are most reflective of the underlying credit losses being estimated. This evaluation includes credit quality trends; collateral values; loan volumes; geographic, borrower and industry concentrations; seasoning of the loan portfolio; the findings of internal credit quality assessments and results from external bank regulatory examinations. These factors, as well as historical losses and current economic and business conditions, are used in developing estimated loss factors used in the calculations.
Reserves for commercial loans are determined by applying estimated loss factors to the portfolio based on management’s evaluation and “risk grading” of the commercial loan portfolio. Reserves are provided for noncommercial loan categories using estimated loss factors applied to the total outstanding loan balance of each loan category. Specific reserves are typically provided on all impaired commercial loans in excess of a defined threshold that are classified in the Special Mention, Substandard or Doubtful risk grades. The specific reserves are determined on a loan-by-loan basis based on management’s evaluation the Company’s exposure for each credit, given the current payment status of the loan and the value of any underlying collateral.
While management uses the best information available to establish the allowance for loan and lease losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations or, if required by regulators, based upon information available to them at the time of their examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates.
Goodwill and Intangibles
SFAS No. 141, Business Combinations, requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. For purchase acquisitions, Union is required to record assets acquired, including identifiable intangible assets, and liabilities assumed at their fair value, which in many instances involves estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analysis or other valuation techniques. Effective January 1, 2001, the Company adopted SFAS No. 142,Goodwill and Other Intangible Assets, which prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of SFAS No. 142 discontinue the amortization of goodwill and intangible assets with indefinite lives but require at least an annual impairment review, and more frequently if certain impairment indicators are in evidence.
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Goodwill is included in other assets and totaled $864,000 at December 31, 2003 and 2002. Based on the testing for goodwill impairment, there were no impairment charges for 2003 or 2002. In 2001, $82,500 was expensed.
Core deposit intangibles are included in other assets and are being amortized on a straight-line basis over the period of expected benefit, which ranges from 10 to 15 years. Core deposit intangibles, net of amortization, amounted to $4,926,000 and $5,500,000 at December 31, 2003 and 2002, respectively. The Company adopted SFAS 147, Acquisitions of Certain Financial Institutions, on January 1, 2002 and determined that core deposit intangibles will continue to be amortized over the estimated useful life.
OVERVIEW
Union Bankshares Corporation’s net income for 2003 totaled $16.7 million or $2.19 per share on a basic and $2.17 on a diluted basis, up 14.9% from $14.5 million or $1.92 per share on a basic and $1.90 on a diluted basis for 2002. Profitability as measured by return on average assets (ROA) for 2003 was 1.42% as compared to 1.41% a year earlier, while return on average equity (ROE) for 2003 was 14.88% as compared to 14.91% in 2002. Core profitability continued to improve as net interest income increased by 6.2% and noninterest income was up 30.2%.
Union’s performance in 2003 was highlighted by a low interest rate environment, an improving economy and corporate growth initiatives that fueled strong growth in the loan portfolio. Continued low interest rates provided a relatively low cost funding source to finance the Company’s strong loan growth. The Company’s loan production offices and bank branches in growth markets experienced strong loan demand, particularly in commercial and real estate loans. Although competition remained intense and compressed the net interest margin, loan growth generated sufficient interest income to offset the impact of lower rates.
The interest rate environment proved favorable for the Company’s mortgage segment. The mortgage segment followed a strong year in 2002 with a 39% increase in mortgage loan production to $535 million in 2003.
Community Bank Segment
Net income for the community bank segment was $14.2 million, an increase of $1.3 million, or 10.3% over 2002. Despite the low interest rate environment, earnings from increased loan volumes offset a decline in securities available for sale to generate a 6.3% increase in income from interest and fees on loans. Deposit interest expense benefited from low rates as a $102.8 million increase in deposit volume still resulted in a 2.9% decrease in interest expense. Net interest income before provision was up 5.2% or $2.0 million. Provision expense decreased $571,000 largely as a result of recoveries of prior charge-offs and higher overall asset quality. Noninterest income in the community bank segment grew by 28.3% in 2003 with service charges on deposit accounts, the primary component of noninterest income, increasing 36.9%. Noninterest expense in the community bank segment increased 9.5% while assets grew by over 10.4%. This ability to grow on a stable cost platform has allowed the Company to realize efficiencies from both internal growth and other expansion opportunities.
With the growth plans for the community bank segment in 2004, earnings will be impacted. The Company expects to complete its acquisition of Guaranty Financial Corporation during the second quarter of 2004. The addition of these seven branches will increase net income in 2004, but is expected to be dilutive to earnings per share in 2004 and accretive in 2005. The Company’s plans also call for the opening of a new branch adjacent to the loan production office in the West End of Richmond in March, 2004, as well as two new locations in Hanover County and two in Chesterfield
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County later in the year. Management anticipates that the opening of de novo branches typically will reduce net earnings of approximately $100,000 in the first full year of operation. Despite the start-up cost associated with de novo expansion, management feels these opportunities to expand the franchise in 2004 are timely and expects a modest rise in income in 2004 with the full benefit of these ventures realized in future years.
Mortgage Segment
The continued decline in mortgage interest rates in 2003 resulted in the lowest rates in decades and stimulated much higher mortgage loan originations than in 2002. The mortgage segment’s loan originations in 2003 totaled $535 million versus $385 million in 2002 and the gains on the sales of the 2003 loans totaled $13.3 million, a 31.4% increase over 2002. Net income for the mortgage banking segment was $2.5 million, an improvement of $837,000 or 52% over $1.6 million in 2002. The mortgage industry expects a decline in production in 2004 of as much as 50% from 2003 levels. Although interest rates are not expected to rise significantly in 2004, the high volumes of refinance activity in recent years is expected to reduce overall mortgage production. Refinanced mortgages represented 50% of the mortgage segment’s loan production for the year as compared to 42% in 2002, both below industry refinance rates. The Company continues to focus on developing and maintaining relationships with builders and realtors to generate loan referrals, to provide a more steady source of origination volume in a more stable rate environment. The Company will seek to add commissioned mortgage lenders to existing mortgage offices and will seek expansion opportunities for new mortgage offices within existing bank markets and new growth markets. Management believes additional cross-selling opportunities exists within the various subsidiaries and will also pursue those prospects.
Consolidated assets grew to $1.2 billion at December 31, 2003, up 10.7% from $1.116 billion a year ago. Loans grew to $878.3 million, up 22.9% over year-end 2002 totals reflecting continued growth in our loan production in all entities. Deposits increased to $1.0 billion at December 31, 2003 from $897.6 million at December 31, 2002, an 11.5% increase. The Company’s capital position grew by 12.3%, from $105.5 million at December 31, 2002 to $118.5 million a year later and remains strong at 9.6% of total assets.
NET INTEREST INCOME
Net interest income, which represents the principal source of earnings for the Company is the amount by which interest income exceeds interest expense. The net interest margin is net interest income expressed as a percentage of interest-earning assets. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income, the net interest margin and net income.
Interest rates in 2003 reached near-term historic lows, as the Federal Reserve furthered its recent accommodative policy to encourage economic recovery. Statistics released in the fourth quarter began to point toward a stronger 2004. The low rates and low inflation sparked a mortgage frenzy which brought on mortgage prepayments on the community bank securities portfolios and the highest mortgage origination volumes ever for the mortgage segment. The Company is in an asset sensitive repricing position. Until rates rise, the margin may compress even more than it is now. The Company will continue to reprice long term liability costs lower and will ultimately benefit from active deposit pricing management when short term rates rise.
During 2003, loan volumes and loans held for sale volumes generated interest income to more than offset the decline in volume and rates in the other asset categories. This resulted in an increase in income from earning assets of $1.6 million. At the same time, volume increases in all the interest bearing liabilities were accompanied by rate declines in all categories. The result was an increase in net interest income. The certificate of deposit categories accounted for the majority of the volume
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increase in deposits with certificates $100,000 and over actually having an increase in the interest expense as a result of the increased volume. The lower rates resulted in a decrease in liability interest expense of $722,000 and an increase in net interest income of $2.3 million. (see Volume and Rate Analysis table).
During 2003, net interest income, on a taxable equivalent basis, which reflects the tax benefits of nontaxable interest income, totaled $45.7 million, an increase of 5.4% from $43.3 million in 2002. The Company’s net interest margin decreased to 4.11% in 2003, as compared to 4.49% in 2002. The yield on earning assets decreased to 6.27% from 7.04% in 2002 while the cost of interest-bearing liabilities decreased from 3.05% in 2002 to 2.62% in 2003. Average interest-bearing liabilities increased by $106.6 million, or 13.2% while average earning assets grew by $144.5 million, or 15.0%. In 2003, deposits increased primarily through internal growth since only one branch opened late in the fourth quarter. The new branches opened in 2002 gave the balance sheet a full year of deposits, ending the year at $19.1 million, an increase of $6.2 million, or 45% from $13.9 at the end of 2002. The majority of the increase came from the existing branch base. Demand deposits continued to grow through the year, as did interest bearing transaction accounts as many investors maintained their liquidity in bank deposits. The margin decreased on a year-to-year basis and continued compression of a lesser magnitude than in 2003 is anticipated for most of 2004, since rates are not expected to rise until late in the year.
During 2002, net interest income, on a taxable equivalent basis totaled $43.3 million, an increase of 20.8% from $35.9 million in 2001. The Company’s net interest margin increased to 4.49% in 2002, as compared to 4.17% in 2001. The yield on earning assets decreased to 7.04% from 7.94% in 2001 while the cost of interest-bearing liabilities decreased to 3.05% in 2002 from 4.42% in 2001. Average interest-bearing liabilities increased by $72.8 million, or 9.9% while average earning assets grew by $104.7 million, or 12.2%.
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The following table shows interest income on earning assets and related average yields, as well as interest expense on interest-bearing liabilities and related average rates paid for the periods indicated.
AVERAGE BALANCES, INCOME AND EXPENSES, YIELDS
AND RATES (TAXABLE EQUIVALENT BASIS)
YEARS ENDED DECEMBER 31,
Yield/
Rate
ASSETS
Securities:
Taxable
Tax-exempt(1)
Total securities
Loans, net
Loans held for sale
Federal funds sold
Money market investments
Interest-bearing deposits in other banks
Total earning assets
Total non-earning assets
LIABILITIES AND STOCKHOLDERS EQUITY
Interest-bearing deposits:
Checking
Money market savings
Regular savings
Certificates of deposit:
$100,000 and over
Under $100,000
Total interest-bearing deposits
Other borrowings
Total interest-bearing liabilities
Noninterest bearing liabilities:
Demand deposits
Other liabilities
Total liabilities
Total liabilities and stockholders’ equity
Interest rate spread
Interest expense as a percent of average earning assets
Net interest margin
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The following table summarizes changes in net interest income attributable to changes in the volume of interest-bearing assets and liabilities compared to changes in interest rates. Nonaccrual loans are included in average loans outstanding.
VOLUME AND RATE ANALYSIS* (TAXABLE EQUIVALENT BASIS)
(dollars in thousands)
2003 vs. 2002
Increase (Decrease)
Due to Changes in:
2002 vs. 2001
EARNING ASSETS:
Tax-exempt
INTEREST-BEARING LIABILITIES:
CDs $100,000 and over
CDs < $100,000
Change in net interest income
INTEREST SENSITIVITY
An important element of earnings performance and the maintenance of sufficient liquidity is proper management of the interest sensitivity gap and liquidity gap. The interest sensitivity gap is the difference between interest sensitive assets and interest sensitive liabilities in a specific time interval. This gap can be managed by repricing assets or liabilities, which are variable rate instruments, by replacing an asset or liability at maturity or by adjusting the interest rate during the life of the asset or liability. Matching the amounts of assets and liabilities maturing in the same time interval helps to hedge interest rate risk and to minimize the impact of rising or falling interest rates on net interest income.
The Company determines the overall magnitude of interest sensitivity risk and then formulates policies governing asset generation and pricing, funding sources and pricing, and off-balance sheet commitments. These decisions are based on management’s expectations regarding future interest rate movements, the state of the national and regional economy, and other financial and business risk factors. The Company uses computer simulations to measure the effect of various interest rate scenarios on net interest income. This modeling reflects interest rate changes and the related impact on net interest income and net income over specified time horizons.
At December 31, 2003, the Company had $36.2 million more liabilities than assets subject to repricing within one year based on gap modeling and was, therefore, in an liability-sensitive position. This was a point in time anomaly caused by a sudden decline in demand deposit balances. Based on other modeling forecasts, the Company is actually less asset sensitive than at the beginning of 2003. An asset-sensitive Company generally will be impacted favorably by increasing interest rates while a liability-sensitive company’s net interest margin and net interest income generally will be impacted favorably by declining interest rates. At December 31, 2002, the Company had $168.1 million more assets than liabilities subject to repricing within one year.
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Although the gap report shows the Company to be liability sensitive, computer simulation modeling shows the Company’s net interest income tends to increase when interest rates rise and fall when interest rates decline. The explanation for this is that interest rate changes affect bank products differently. For example, if the prime rate changes by 1.00% (100 basis points or bps), the change on certificates of deposit may only be 0.75% (75 bps), while other interest bearing deposit accounts may only change 0.10% (10 bps). Also, despite their fixed terms, loan products are often refinanced as rates decline, but rarely refinanced as rates rise. Assets and liabilities repriced throughout the year resulting in a decrease in the earning asset rate, a decrease in the cost of funds rate and a decrease in net interest margin.
EARNINGS SIMULATION ANALYSIS
Management uses simulation analysis to measure the sensitivity of net interest income to changes in interest rates. The model calculates an earnings estimate based on current and projected balances and rates. This method is subject to the accuracy of the assumptions that underlie the process, but it provides a better analysis of the sensitivity of earnings to changes in interest rates than other analysis, such as the static gap analysis discussed above.
Assumptions used in the model are derived from historical trends and management’s outlook and include loan and deposit growth rates and projected yields and rates. All maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in like instruments. Mortgage loans and mortgage backed securities prepayment assumptions are based on industry estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Different interest rate scenarios and yield curves are used to measure the sensitivity of earnings to changing interest rates. Interest rates on different asset and liability accounts move differently when the prime rate changes and are reflected in the different rate scenarios.
The following table represents the interest rate sensitivity on net interest income for the Company using different rate scenarios:
Change in Prime Rate
% Change in Net Interest Income
+200 basis points
+100 basis points
Flat
-100 basis points
-200 basis points
ECONOMIC VALUE SIMULATION
Economic value simulation is used to calculate the estimated fair value of assets and liabilities over different interest rate environments. Economic values are calculated based on discounted cash flow analysis. The net economic value of equity is the economic value of all assets minus the market value of all liabilities. The change in net economic value over different rate environments is an indication of the longer term earnings capability of the balance sheet. The same assumptions are used in the economic value simulation as in the earnings simulation. The following chart reflects the estimated change in net economic value over different rate environments using economic value simulation:
Change in Net Economic Value
(Dollars in Thousands)
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NONINTEREST INCOME
Noninterest income increased by $5.3 million or 30.2%, from $17.5 million in 2002 to $22.8 million in 2003. This increase is primarily due to a $3.2 million increase in gains on sales of loans, which rose from $10.1 million in 2002 to $13.3 million in 2003. Stimulated by continued low mortgage interest rates, the mortgage originations growth carried through the third quarter of 2003. Service charges on deposits rose 36.9% from $4.1 million to $5.6 million as a result of a new overdraft privilege service which the Community Banks began offering in June, 2003. Other service charges, commissions and fee income were down slightly from $2.6 million in 2002 to $2.5 million in 2003 as net brokerage commissions were down $119,000. A securities gain of $113,000 represents a $272,000 change from a loss of $159,000 a year ago. Such sales of securities are typically related to minor adjustments in the structure of the portfolio. The Company also recorded a gain of $156,000 on the disposal of other real estate owned. In addition, other operating income was up from $800,000 in 2002 to $1.2 million in 2003. This increase was the result of a full years contribution of $189,000 from the Bank of Williamsburg’s investment in Johnson Mortgage Company, LLC, rental income of $69,000 from the Richmond LPO building and a one time death benefit of $125,000 from a subsidiary director’s life insurance.
In 2002, noninterest income increased by 9.0% from $16.1 million in 2001 to $17.5 million. This increase was primarily due to a $1.2 million increase in gains on sales of loans, which rose from $8.9 million in 2001 to $10.1 million in 2002. The growth in mortgage originations, stimulated by low mortgage interest rates, led to this increase. Service charges on deposits rose 11.5% from $3.7 million to $4.1 million. Other service charges, commissions and fee income were up slightly from $2.5 million in 2001 to $2.6 million as ATM fees continued to grow while brokerage commissions were slowed by the down stock market. A securities loss of $159,000 in 2002 represented a $284,000 change from gains of $125,000 in 2001. This was partially offset by gains on the sale of other real estate and fixed assets as a result of sales of a former branch site and several nonperforming asset properties. In addition, other operating income was down from $906,000 in 2001 to $800,000 in 2002. This decline was principally the result of a decrease in the earnings rate on bank owned life insurance.
NONINTEREST EXPENSES
Noninterest expenses were up $4.8 million or 13.4% to $40.7 million in 2003, compared to $35.9 million in 2002. Salaries and benefits were $25.1 million in 2003, up $3.8 million or 17.9% compared to $21.3 million in 2002. The increase in mortgage loan originations and gains on loan sales within the mortgage segment resulted in an increase of $2.1 million in salaries and benefits of which $1.5 million was commission based compensation. The community bank segment’s salaries and benefits were up $1.7 million from 2002 to 2003. This was the result of a full year of expenses from the two new branches opened during 2002 and the addition of one new branch in 2003, a full year from the loan production office in Manassas, Virginia opened in 2002, the loan production office in Richmond for 2003, higher group insurance, expanded staffing in the retail locations and merit increases. Occupancy expenses were $2.7 million, up $366,000 over $2.3 million in 2002. This was the result of a new main office at the Rappahannock National Bank, building improvements to the operations center and various branches and the relocation of the Newport News office. Equipment expense was
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down slightly at $2.6 million versus $2.7 million in 2002. Other operating expense was $10.3 million, up $759,000 compared to $9.5 million in 2002. This was the result of increases in operating expense, data processing fees from outsourcing this service, marketing, other taxes and other expenses. Much of these increased costs were related to the new locations, new product advertising and general operating costs. In addition, during 2003, the Company elected to outsource its data processing function to its core processing vendor. This decision was based on analysis of the costs to upgrade and administer the existing internal system versus migration to the vendor’s cost effective platform.
In 2002, noninterest expenses totaled $35.9 million, an increase of $3.5 million versus $32.4 million in 2001. Salaries and benefits were $21.3 million in 2002, up $2.2 million or 11.6% compared to $19.1 million in 2001. The increase in mortgage loan originations and gains on loan sales within the mortgage segment resulted in an increase of $1.1 million in salaries and benefits of which $572,000 was commission based compensation. The community bank segment’s salaries and benefits were up $1.1 million year-to-year. This was the result of two new branches, a loan production office in Manassas, Virginia, higher group insurance, some increased support staffing and normal increases. Occupancy expenses were $2.3 million, up $139,000 over $2.2 million in 2001. Equipment expense was down slightly at $2.7 million versus $2.9 million in 2001. Other operating expense was $9.5 million, up $1.2 million compared to $8.3 million in 2001. This was the result of increases in operating expense, marketing, other taxes and other expenses. Much of these increased costs were related to the new locations, new product advertising, Centennial celebrations at two of the Company’s Community Banks and operating costs and core deposit expenses.
LOAN PORTFOLIO
Loans, net of unearned income, totaled $878.3 million at December 31, 2003, an increase of 22.9% over $714.8 million at December 31, 2002. Loans secured by real estate continues to represent the Company’s largest category, comprising 72.7% of the total loan portfolio at December 31, 2003. Of this total, 1-4 family residential loans, not including home equity lines, comprised 25.9% of the total loan portfolio at December 31, 2003, down slightly from 26.6% in 2002. Loans secured by commercial real estate comprised 27.3% of the total loan portfolio at December 31, 2003, as compared to 28.0% in 2002, and consist of income producing properties, as well as commercial and industrial loans where real estate constitutes a secondary source of collateral. Real estate construction loans accounted for 12.0% of total loans outstanding at December 31, 2003. Home equity lines were up significantly in 2003, comprising 5.5% of the total loan portfolio compared to 4.5% in 2002 The Company’s charge-off rate for all loans secured by real estate has historically been low.
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Commercial
Loans to finance agriculture production and other loans to farmers
Real estate:
Real estate construction
Real estate mortgage:
Residential (1-4 family)
Home equity lines
Multi-family
Agriculture
Total real estate
Loans to individuals:
Consumer
Credit card
Total loans to individuals
All other loans
Total loans
Less unearned income
Total net loans
Commercial loans, secured by non-real estate business assets comprised 12.8% of total loans at the end of 2003, an increase from 11.0% at the end of 2002 and reflective of management’s focus on small business lending activities. The Company’s consumer loan portfolio, its second largest category, consists principally of installment loans. Such loans to individuals for household, family and other personal expenditures totaled 12.6% of total loans at December 31, 2003, down from 14.3% in 2001. This continues a trend as increased competition for automobile loans and the internet financing companies continued to impact this portfolio significantly in 2003. Loans to the agricultural industry totaled less than 1.0% of the loan portfolio in each of the last five years.
REMAINING MATURITIES OF SELECTED LOANS
At December 31, 2003
(in thousands)
Real Estate Construction
Loans, net of unearned income, totaled $714.8 million at December 31, 2002, an increase of 19.1% over $600.2 million at December 31, 2001. This growth in 2002 was fueled largely by commercial real estate and commercial loan growth.
The Company is focused on providing community-based financial services and discourages the origination of portfolio loans outside of its principal trade area. The Company maintains a policy not to originate or purchase loans to foreign entities or loans classified by regulators as highly leveraged transactions. To manage the growth of the real estate loans in the loan portfolio, facilitate asset/liability management and generate additional fee income, the Company sells a portion of conforming first mortgage residential real estate loans to the secondary market as they are originated. Mortgage Capital Investors, Inc. serves as a mortgage brokerage operation, selling the majority of its loan production in the secondary market or selling loans to the affiliated banks that meet the banks’ current asset/liability management needs. This venture has provided the banks’ customers with enhanced mortgage products and the Company with improved efficiencies through the consolidation of this function.
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ASSET QUALITY—ALLOWANCE/PROVISION FOR LOAN LOSSES
The allowance for loan losses represents management’s estimate of the amount deemed adequate to provide for potential losses inherent in the loan portfolio. Among other factors, management considers the Company’s historical loss experience, the size and composition of the loan portfolio, the value and adequacy of collateral and guarantors, non-performing credits and current and anticipated economic conditions. There are additional risks of future loan losses, which cannot be precisely quantified nor attributed to particular loans or classes of loans. Because those risks include general economic trends as well as conditions affecting individual borrowers, the allowance for loan losses is an estimate. The allowance is also subject to regulatory examinations and determination as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and size of the allowance in comparison to peer companies identified by regulatory agencies.
Management maintains a list of loans which have a potential weakness that may need special attention. This list is used to monitor such loans and is used in the determination of the sufficiency of the Company’s allowance for loan losses. As of December 31, 2003, the allowance for loan losses was $11.5 million or 1.31% of total loans as compared to $9.2 million, or 1.28% in 2002. The provision for loan losses was $2.3 million in 2003 and $2.9 million in 2002. This modest decline in the provision expense reflects stronger asset quality and a year in which recoveries were more than charge-offs. Recoveries in 2003 included $609,598 related to a loan charged off in 1998 and 1999. Additional recoveries on that loan are anticipated in 2004.
ALLOWANCE FOR LOAN LOSSES
Balance, beginning of year
Loans charged-off:
Real estate
Total loans charged-off
Recoveries:
Total recoveries
Net charge-offs (recoveries)
Balance, end of year
Ratio of allowance for loan losses to total loans outstanding at end of year
Ratio of net charge-offs to average loans outstanding during year
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The table below shows an allocation among loan categories based upon analysis of the loan portfolio’s composition, historical loan loss experience, and other factors and the ratio of the related outstanding loan balances to total loans.
(Percent is loans in category divided by total loans.)
ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
December 31:
Commercial, financial and agriculture
Real estate mortgage
Consumer & other
NONPERFORMING ASSETS
Nonperforming assets were $9.6 million at December 31, 2003, up from $910,000 at December 31, 2002. Nonaccrual loans increased to $9.2 million in 2003 from $136,000 in 2002 and foreclosed properties were down from $774,000 in 2002 to $444,000 in 2003.
Nonaccrual loans
Foreclosed properties
Real estate investment
Total nonperforming assets
Loans past due 90 days and accruing interest
Nonperforming assets to year-end loans, foreclosed properties and real estate investment
Allowance for loan losses to nonaccrual loans
Most of the nonperforming assets are secured by real estate within the Company’s trade area. Based on the estimated fair values of the related real estate, management considers these amounts to be recoverable, with any individual deficiency considered in the allowance for loan losses. As of December 31, 2003, nonperforming assets of $9.6 million included a single credit relationship with two loans totaling $8.1 million. A specific reserve of $885,000 has been allocated on this relationship based on loan impairment analysis. Management will continue to monitor this credit, making any appropriate adjustments to that reserve.
At December 31, 2002, nonperforming assets totaled $910,000, down from $1.7 million at December 31, 2001. Nonaccrual loans decreased by $779,000 in 2002 while foreclosed properties increased by $135,000.
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SECURITIES
At December 31, 2003, all $240.1 million of the Company’s securities were classified as available for sale, as compared to $272.8 million at December 31, 2002. The Company seeks to diversify its portfolio to minimize risk and to maintain a large amount of securities issued by states and political subdivisions due to the tax benefits such securities provide. It also purchases mortgage backed securities because of the reinvestment opportunities from the cash flows and the higher yield offered from these securities. The investment portfolio has a high percentage of municipals and mortgage backed securities, which is the main reason for the high taxable equivalent yield the portfolio attains compared to its peers. The Company does not engage in structured derivative or hedging activities. During 2003, the Company experienced a larger than normal volume of prepayments from the mortgaged backed securities. These funds were reinvested in loans or shorter term securities.
MATURITIES OF SECURITIES AVAILABLE FOR SALE
TOTAL
U.S. government and agency securities:
Amortized cost
Fair value
Weighted average yield(1)
Mortgage backed securities:
Municipal bonds:
Other securities:
Total securities:
DEPOSITS
Total deposits grew $102.8 million or 11.5% in 2003 with deposits in existing branches accounting for most of that growth. The Company also opened one new branch, through Union Bank in November 2003. The two branches opened in 2002 which had deposits of $13.8 million at the end of 2002, added $5.2 million in 2003 and stand at $19.0 million. Increased competition for customer deposits continues to be a challenge for the Company and management continues to focus on customer relationships and delivery of financial products and services to those customers. In the low interest rate environment that continues to exist in the markets, pricing deposits while maintaining a reasonable spread will continue as a major challenge in 2004. If funds begin to flow back into the equities market as expected, competition for deposits will intensify, creating additional pressure on the net interest margin.
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Total deposits increased from $897.6 million at December 31, 2002 to $1.0 billion at December 31, 2003. Over this same period, average interest-bearing deposits were $809.6 million, or 14.8% over the 2002 average of $705.5 million. Average now accounts and money market accounts continued to rise with increases of $15.7 and $12.7 respectively. However, average certificates of deposits rose $63.9 million with customers moving to longer term investments to generate income. In 2003, the Company’s lowest cost funding source, noninterest-bearing demand deposits increased by a total of $13.0 million from December 31, 2002 helping to reduce the overall cost of funds. On an average balance basis, demand deposits were up $25.7 million compared to 2002. The Company has no brokered deposits.
AVERAGE DEPOSITS AND RATES PAID
YEARS ENDED
DECEMBER 31,
Noninterest-bearing demand deposits
NOW accounts
Money market accounts
Savings accounts
Time deposits of $100,000 and over
Other time deposits
Total interest-bearing
Total average deposits
MATURITIES OF CERTIFICATES OF DEPOSIT OF $100,000 AND OVER
Total deposits grew from $784.1 million at December 31, 2001 to $897.6 million at December 31, 2002. Over this same period, average interest-bearing deposits were $705.5 million, or 12.2% over the 2001 average of $628.8 million. The Company also acquired $14.9 million in deposits from another financial institution through a branch purchase in the fourth quarter of 2001.
CAPITAL RESOURCES
Capital resources represent funds, earned or obtained, over which financial institutions can exercise greater or longer control in comparison with deposits and borrowed funds. The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to size, composition, and quality of the Company’s resources and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses, yet allow management to effectively leverage its capital to maximize return to shareholders.
The Federal Reserve Board, along with the OCC and the FDIC, has adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total assets is 8.0%, of which 4.0% must be Tier 1 capital, consisting of common equity, retained earnings and a limited amount of perpetual preferred stock, less certain goodwill items. The Company had a ratio of total capital to risk-weighted assets of 11.88% and 12.15% on December 31, 2003 and 2002, respectively. The Company’s ratio of
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Tier 1 capital to risk-weighted assets was 10.71% and 11.05% at December 31, 2003 and 2002, respectively, allowing the Company to meet the definition of “well-capitalized” for regulatory purposes. Both of these ratios exceeded the fully phased-in capital requirements in 2003 and 2002.
The Company’s strategic plan includes a targeted equity to asset ratio between 8% and 9%. In 2003, that ratio was 9.6%.
In connection with its impending acquisition of Guaranty Financial, the Company anticipates issuing trust preferred securities to fund the cash portion of that acquisition which will approximate $23 million. These debt instruments qualify for regulatory treatment as Tier 1 capital and will allow the Company to maintain its categorization as well-capitalized for regulatory purposes.
ANALYSIS OF CAPITAL
Tier 1 capital:
Common stock
Surplus
Retained earnings
Total equity
Less: core deposit intangibles/goodwill
Total Tier 1 capital
Tier 2 capital:
Total Tier 2 capital
Total risk-based capital
Risk-weighted assets
Capital ratios:
Tier 1 risk-based capital ratio
Total risk-based capital ratio
Tier 1 capital to average adjusted total assets
Equity to total assets
OFF BALANCE SHEET OBLIGATIONS
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 and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contractual amounts of these instruments reflect the extent of the Company’s involvement in particular classes of financial instruments.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit written is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Unless noted otherwise, the Company does not require collateral or other security to support financial instruments with credit risk.
Commitments to extend credit 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 commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
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The Company evaluates each customer’s creditworthiness on a case-by-case basis. At December 31, 2003 and 2002, the Company had outstanding loan commitments approximating $318,803,000 and $231,841,000, respectively.
Letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The amount of standby letters of credit whose contract amounts represent credit risk totaled approximately $17,068,000 and $12,368,000 at December 31, 2003 and 2002, respectively.
At December 31, 2003, the mortgage company had rate lock commitments to originate mortgage loans amounting to approximately $20.1 million and loans held for sale of $28.7 million. The mortgage company has entered into corresponding mandatory commitments, on a best-efforts basis, to sell loans of approximately $48.8 million. These commitments to sell loans are designed to eliminate the mortgage company’s exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.
LIQUIDITY
Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, Federal funds sold, investments and loans maturing within one year. The Company’s ability to obtain deposits and purchase funds at favorable rates determines its liability liquidity. As a result of the Company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity, which is sufficient to satisfy its depositors’ requirements and to meet it customers’ credit needs.
At December 31, 2003, cash and cash equivalents and securities classified as available for sale comprised 22.8% of total assets, compared to 28.6% at December 31, 2002. Asset liquidity is also provided by managing loan and securities maturities and cash flows.
Additional sources of liquidity available to the Company include its capacity to borrow additional funds when necessary. The subsidiary banks maintain Federal funds lines with several regional banks totaling approximately $64.6 million at December 31, 2003. At year-end 2003, the banks had outstanding $42.6 million of borrowings pursuant to securities sold under agreements to repurchase transactions with a maturity of one day. The Company also had a line of credit with the Federal Home Loan Bank of Atlanta for $458 million at December 31, 2003.
The following table presents the Company’s contractual obligations and scheduled payment amounts due at the various intervals over the next five years and beyond as of December 31, 2003.
Contractual Obligations and Commitments
Long term debt
Operating leases
Repurchase agreements
Total Contractual obligations and commitments
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RECENT ACCOUNTING PRONOUNCEMENTS
In December 2002, the Financial Accounting Standards Board (“FASB”) issued “SFAS” No. 148,“Accounting for Stock-Based Compensation – Transition and Disclosure,” which amends SFAS No. 123 to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. The provisions of the Statement were effective December 31, 2002. Management currently intends to continue to account for stock-based compensation under the intrinsic value method set forth in Accounting Principles Board (“APB”) Opinion 25 and related interpretations. For this reason, the transition guidance of SFAS No. 148 does not have an impact on the Company’s consolidated financial position or consolidated results of operations. The Statement does amend existing guidance with respect to required disclosures, regardless of the method of accounting used. The revised disclosure requirements are presented herein.
In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”). The Interpretation elaborates on the disclosures to be made by a guarantor in its financial statements under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The recognition requirements of the Interpretation were effective beginning January 1, 2003. The initial adoption of the Interpretation did not materially affect the Company, and management does not anticipate that the recognition requirements of this Interpretation will have a materially adverse impact on either the Company’s consolidated financial position or consolidated results of operations in the future.
In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). This Interpretation provides guidance with respect to the identification of variable interest entities and when the assets, liabilities, noncontrolling interests, and results of operations of a variable interest entity need to be included in a company’s consolidated financial statements. The Interpretation requires consolidation by business enterprises of variable interest entities in cases where (a) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity, or (b) in cases where the equity investors lack one or more of the essential characteristics of a controlling financial interest, which include the ability to make decisions about the entity’s activities through voting rights, the obligations to absorb the expected losses of the entity if they occur, or the right to receive the expected residual returns of the entity if they occur. Management has evaluated the Company’s investments in variable interest entities and potential variable interest entities or transactions, particularly in limited liability partnerships involved in low-income housing development and trust preferred securities structures. The implementation of FIN 46 did not have a significant impact on either the Company’s consolidated financial position or consolidated results of operations. Interpretive guidance relating to FIN 46 is continuing to evolve and the Company’s management will continue to assess various aspects of consolidations and variable interest entity accounting as additional guidance becomes available.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” The Statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The Statement is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003 and is not expected to have an impact on the Company’s consolidated financial statements.
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In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This Statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of these instruments were previously classified as equity. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatory redeemable financial instruments of nonpublic entities. Adoption of the Statement did not result in an impact on the Company’s consolidated financial statements.
In November 2003, the FASB’s Emerging Issues Task Force reached a consensus on a new disclosure requirement related to unrealized losses on investment securities. The new disclosure requires a table of securities which have unrealized losses as of the reporting date. The table must distinguish between those securities which have been in a continuous unrealized loss position for twelve months or more and those securities which have been in a continuous unrealized loss position for less than twelve months. The table is to include the aggregate unrealized losses of securities whose fair values are below book values as of the reporting date, and the aggregate fair value of securities whose fair values are below book values as of the reporting date. In addition to the quantitative disclosure, FASB requires a narrative discussion that provides sufficient information to allow financial statement users to understand the quantitative disclosures and the information that was considered in determining whether impairment was not other-than-temporary. The new disclosure requirements apply to fiscal years ending after December 15, 2003. The Company has included the required disclosures in their consolidated financial statements.
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QUARTERLY RESULTS
The table below lists the Company’s quarterly performance for the years ended December 31, 2003 and 2002.
Net income per share
Basic
Diluted
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Item 7A. — Quantitative and Qualitative Disclosures About Market Risk
This information is incorporated herein by reference from Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, on pages 17 through 18 of this Form 10-K.
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Item 8. — Financial Statements and Supplementary Data
Independent Auditor’s Report
To the Stockholders and Directors
Union Bankshares Corporation
We have audited the accompanying consolidated balance sheets of Union Bankshares Corporation and Subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each of the years ended December 31, 2003, 2002 and 2001. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the financial statements of Mortgage Capital Investors, a consolidated subsidiary which reflects total assets and revenue constituting 3% and 17%, respectively, in 2003, 4% and 14%, respectively, in 2002, 5% and 13%, respectively, in 2001, of the related consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts included for Mortgage Capital Investors, is based solely on the report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Union Bankshares Corporation and Subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years ended December 31, 2003, 2002, and 2001, in conformity with accounting principles generally accepted in the United States of America.
/s/ Yount, Hyde & Barbour, P.C.
Winchester, Virginia
January 14, 2004
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UNION BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002
Cash and cash equivalents:
Cash and due from banks
Total cash and cash equivalents
Securities available for sale, at fair value
Loans, net of unearned income
Less allowance for loan losses
Net loans
Bank premises and equipment, net
Other real estate owned
Other assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Securities sold under agreement to repurchase
Other short-term borrowings
Long-term borrowings
Commitments and contingencies
Stockholders’ equity:
Common stock, $2 par value. Authorized 24,000,000 shares; issued and outstanding, 7,627,248 shares in 2003 and 7,579,707 shares in 2002
Accumulated other comprehensive income
Total stockholders’ equity
See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(dollars in thousands, except per share amounts)
Interest and dividend income :
Interest and fees on loans
Interest on Federal funds sold
Interest on interest-bearing deposits in other banks
Interest on money market investments
Interest and dividends on securities:
Nontaxable
Total interest and dividend income
Interest expense:
Interest on deposits
Interest on short-term borrowings
Interest on long-term borrowings
Total interest expense
Noninterest income:
Service charges on deposit accounts
Other service charges, commissions and fees
Gains (losses) on securities transactions, net
Gains on sales of loans
Gains on sales of other real estate owned and bank premises, net
Other operating income
Total noninterest income
Noninterest expenses:
Salaries and benefits
Occupancy expenses
Furniture and equipment expenses
Other operating expenses
Total noninterest expenses
Earnings per share, basic
Earnings per share, diluted
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CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Comprehensive
Income (Loss)
Balance - December 31, 2000
Comprehensive income:
Net income - 2001
Unrealized holding gains arising during the period (net of tax, $1,251)
Reclassification adjustment for gains included in net income (net of tax, $42)
Other comprehensive income (net of tax, $1,209)
Total comprehensive income
Cash dividends - 2001 ($.46 per share)
Issuance of common stock under Dividend Reinvestment Plan (26,330 shares)
Stock repurchased under Stock Repurchase Plan (38,158 shares)
Issuance of common stock for services rendered (1,600 shares)
Issuance of common stock in exchange for net assets in acquisition (19,606 shares)
Balance - December 31, 2001
Net income - 2002
Unrealized holding gains arising during the period (net of tax, $2,435)
Reclassification adjustment for losses included in net income (net of tax, $54)
Other comprehensive income (net of tax, $2,489)
Cash dividends - 2002 ($.52 per share)
Issuance of common stock under Dividend Reinvestment Plan (18,389 shares)
Issuance of common stock under Incentive Stock Option Plan (16,850 shares)
Issuance of common stock for services rendered (1,400 shares)
Issuance of common stock in exchange for net assets in acquisition (17,156 shares)
Balance - December 31, 2002
Net income - 2003
Unrealized holding gains arising during the period (net of tax, $39)
Reclassification adjustment for gains included in net income (net of tax, $38)
Other comprehensive income (loss) (net of tax, $77)
Cash dividends - 2003 ($.60 per share)
Issuance of common stock under Dividend Reinvestment Plan (16,501 shares)
Issuance of common stock under Incentive Stock Option Plan (26,703 shares)
Issuance of common stock for services rendered (8,196 shares)
Stock repurchased under Stock Repurchase Plan and option exchange (3,859 shares)
Balance - December 31, 2003
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CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDING DECEMBER 31, 2003, 2002 AND 2001
Operating activities:
Adjustments to reconcile net income to net cash and cash equivalents provided by (used in) operating activities:
Depreciation of bank premises and equipment
Amortization
(Gains) losses on securities transactions, net
Origination of loans held for sale
Proceeds from sales of loans held for sale
Gains on sales of other real estate owned and fixed assets, net
Deferred income tax expense (benefit)
Other, net
Net cash and cash equivalents provided by (used in) operating activities
Investing activities:
Purchases of securities available for sale
Proceeds from sales of securities available for sale
Proceeds from maturities of securities available for sale
Net increase in loans
Purchases of bank premises and equipment
Proceeds from sales of bank premises and equipment
Proceeds from sales of other real estate owned
Acquisition of branch, net of cash acquired
Net cash and cash equivalents used in investing activities
Financing activities:
Net increase in noninterest-bearing deposits
Net increase in interest-bearing deposits
Net increase (decrease) in short-term borrowings
Proceeds from long-term borrowings
Repayment of long-term borrowings
Cash dividends paid
Issuance of common stock
Purchase of common stock
Net cash and cash equivalents provided by financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
Supplemental Disclosure of Cash Flow Information
Cash payments for:
Interest
Income taxes
Supplemental schedule of noncash investing and financing activities:
Loan balances transferred to foreclosed properties
Unrealized gain on securities available for sale
Issuance of common stock in exchange for net assets in acquisition
Issuance of common stock for services rendered
Transfer of investment securities to securities available for sale
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
The accounting policies and practices of Union Bankshares Corporation and subsidiaries (the “Company”) conform to accounting principles generally accepted in the United States of America and to general practice within the banking industry. Major policies and practices are described below:
The consolidated financial statements include the accounts of Union Bankshares Corporation and its wholly owned subsidiaries. Union Bankshares Corporation is a bank holding Company that owns all of the outstanding common stock of its banking subsidiaries, Union Bank and Trust Company, Northern Neck State Bank, Rappahannock National Bank, Bank of Williamsburg and of Union Investment Services. Mortgage Capital Investors is a wholly owned subsidiary of Union Bank and Trust Company. The Bank of Williamsburg has a non-controlling interest in Johnson Mortgage Company, which is accounted for under the equity method of accounting. All significant intercompany balances and transactions have been eliminated. The accompanying consolidated financial statements for prior periods reflect certain reclassifications in order to conform to the 2003 presentation.
When securities are purchased, they are classified as investment securities when management has the intent and the Company has the ability to hold them to maturity. Investment securities are carried at cost, adjusted for amortization of premiums and accretion of discounts. The Company has no securities in this category.
Securities classified as available for sale are those debt and equity securities that management intends to hold for an indefinite period of time, including securities used as part of the Company’s asset/liability strategy, and that may be sold in response to changes in interest rates, liquidity needs or other similar factors. Securities available for sale are recorded at estimated fair value. The net unrealized gains or losses on securities available for sale, net of deferred taxes, are included in accumulated other comprehensive income (loss) in stockholders’ equity.
Purchased premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value, determined in the aggregate based on sales commitments to permanent investors or on current market rates for loans of similar quality and type. In addition, the Company requires a firm purchase commitment from a permanent investor before a loan can be closed, thus limiting interest rate risk. As a result, loans held for sale are stated at fair value. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
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The Company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans throughout its market area. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.
The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in process of collection. Credit card loans and other personal loans are typically charged-off no later than 180 days past due. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal and interest is considered doubtful.
All interest accrued but not collected for loans that are placed on nonaccrual status or charged-off is reversed against interest income if it is from current period or charged against allowance if it is from a prior period. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance that management considers adequate to absorb potential losses in the portfolio. Loans are charged against the allowance when management believes the collectibility of the principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance. Management’s determination of the adequacy of the allowance is based on an evaluation of the composition of the loan portfolio, the value and adequacy of collateral, current economic conditions, historical loan loss experience, and other risk factors. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions, particularly those affecting real estate values. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
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Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.
Bank premises and equipment is stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using either the straight-line or accelerated method based on the type of asset involved. It is the policy of the Company to capitalize additions and improvements and to depreciate the cost thereof over their estimated useful lives ranging from 3 to 40 years. Maintenance, repairs and renewals are expensed as they are incurred.
Core deposit intangibles are included in other assets and are being amortized on a straight-line basis over the period of expected benefit, which ranges from 10 to 15 years. Core deposit intangibles, net of amortization amounted to $4,926,000 and $5,500,000 at December 31, 2003 and 2002, respectively. Based on the guidance in SFAS 147, the Company amortizes the core deposit intangible over the estimated useful life as it has in the past.
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (SFAS) No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Additionally, it further clarifies the criteria for the initial recognition and measurement of intangible assets separate from goodwill. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001 and prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of SFAS No. 142 discontinue the amortization of goodwill and intangible assets with indefinite lives. Instead, these assets will be subject to at least an annual impairment review, and more frequently if certain impairment indicators are in evidence. SFAS No. 142 also requires that reporting units be identified for the purpose of assessing potential future impairments of goodwill.
Goodwill is included in other assets and totaled $864,000 at December 31, 2003 and 2002. The goodwill is no longer amortized, but instead tested for impairment at least annually. Based on the testing, there were no impairment charges for 2003 or 2002. Application of the nonamortization provision of the statement resulted in additional net income of $82,500 for the years ended December 31, 2003 and 2002.
Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.
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Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets.
For purposes of reporting cash flows, the Company defines cash and cash equivalents as cash, due from banks, interest-bearing deposits in other banks, money market investments and Federal funds sold.
Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of common shares outstanding during the year. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method.
Comprehensive income (loss) represents all changes in equity of an enterprise that result from recognized transactions and other economic events of the period. Other comprehensive income (loss) refers to revenues, expenses, gains and losses that under accounting principles generally accepted in the United States are included in comprehensive income but excluded from net income, such as unrealized gains and losses on certain investments in debt and equity securities.
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate and deferred tax assets and liabilities.
The Company follows the policy of charging the cost of advertising to expense as incurred. Total advertising costs included in other operating expenses for 2003, 2002 and 2001 was $1,509,000, $1,448,000 and $1,046,000, respectively.
In the ordinary course of business, the Company has entered into commitments to extend credit and standby letters of credit. Such financial instruments are recorded when they are funded.
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The Company enters into commitments to originate mortgage loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. The period of time between issuance of a loan commitment and closing and sale of the loan generally ranges from 60 to 120 days. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the Company commits to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. As a result the Company is not exposed to losses nor will it realize significant gains related to its rate lock commitments due to changes in interest rates. The correlation between the rate lock commitments and the best efforts contracts is very high due to their similarity.
The market value of rate lock commitments and best efforts contracts is not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded in stand-alone markets. The Company determines the fair value of rate lock commitments and best efforts contracts by measuring the change in the value of the underlying asset while taking into consideration the probability that the rate lock commitments will close. Because of the high correlation between rate lock commitments and best efforts contracts, no gain or loss occurs on the rate lock commitments.
The Company accounts for the Plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based compensation cost is reflected in net income, as all options granted under the Plan have an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based compensation.
Total stock-based compensation expense determined under fair value based method for all awards
Basic - as reported
Basic - pro forma
Diluted - as reported
Diluted - pro forma
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The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:
Dividend yield
Expected life
Expected volatility
Risk-free interest rate
The amortized cost, gross unrealized gains and losses and estimated fair value of securities available for sale at December 31, 2003 and 2002 are summarized as follows (in thousands):
EstimatedFair
Value
U.S. government and agency securities
Obligations of states and political subdivisions
Corporate and other bonds
Mortgage-backed securities
Federal Reserve Bank stock
Federal Home Loan Bank stock
Other securities
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The amortized cost and estimated fair value (in thousands) of securities available for sale at December 31, 2003, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Securities with an amortized cost of approximately $59,056,000 and $72,319,000 at December 31, 2003 and 2002 were pledged to secure public deposits, repurchase agreements and for other purposes.
Sales of securities available for sale produced the following results for the years ended December 31, 2003, 2002 and 2001 (in thousands):
Proceeds
Gross realized gains
Gross realized (losses)
Net realized gains (losses)
The primary purpose of the investment portfolio is to generate income and meet liquidity needs of the Company through readily saleable financial instruments. The portfolio is made up of fixed rate bonds, whose prices move inversely with rates. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The Company monitors the portfolio which is subject to liquidity needs, market rate changes and credit risk changes to see if adjustments are needed. The primary concern in a loss situation is the credit quality of the business behind the instrument. In 2002, the Company sold a loss position instrument because the overall credit quality had deteriorated and was not expected to improve. The sale limited the potential loss. The primary cause of impairments is the decline in the prices of the bonds as rates have risen. There are approximately 20 accounts in the consolidated portfolio of the four banks that have losses. These losses are relative to the market rates and the timing of purchases and are not a material concern since they have moved up and down with the market. Some of those positions have been adjusted in the current year.
LOSSES
Unrealized
Losses
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As permitted under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” the Company transferred investment securities with a book value of $5,465,000 and a market value of $5,528,000 to securities available for sale as of January 1, 2001.
Loans are stated at their face amount, net of unearned income, and consist of the following at December 31, 2003 and 2002 (in thousands):
Mortgage loans on real estate:
Residential 1-4 family
Construction
Second mortgages
Equity lines of credit
Multifamily
Total real estate loans
Commercial Loans
Consumer installment loans
Personal
Credit cards
Total consumer installment loans
All other loans and agriculture loans
Gross loans
Less unearned income on loans
At December 31, 2003 and 2002, the recorded investment in loans which have been identified as impaired loans, in accordance with Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan” (SFAS 114), totaled $9,174,000 and $136,000 , respectively. The valuation allowance related to impaired loans on December 31, 2003 and 2002 is $1,469,000 and $32,000, respectively. At December 31, 2003, 2002 and 2001, the average investment in impaired loans was $ 9,956,000, $742,000 and $1,202,000, respectively. The amount of interest income recorded by the Company during 2003, 2002 and 2001 on impaired loans was approximately $280,000, $50,000 and $49,000, respectively. There were no nonaccrual loans excluded from impaired loan disclosure at December 31, 2003 and December 31, 2002.
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Activity in the allowance for loan losses for the years ended December 31, 2003, 2002 and 2001 is summarized below (in thousands):
Provision charged to operations
Recoveries credited to allowance
Loans charged off
Bank premises and equipment as of December 31, 2003 and 2002 are as follows (in thousands):
Land
Land improvements and buildings
Leasehold improvements
Furniture and equipment
Construction in progress
Less accumulated depreciation and amortization
Depreciation expense for 2003, 2002 and 2001 was $2,041,000, $2,062,000 and $1,961,000 respectively. Future minimum rental payments required under non-cancelable operating leases that have initial or remaining terms in excess of one year as of December 31, 2003 are approximately $638,000 for 2004, $412,000 for 2005, $383,000 for 2006, $301,000 for 2007, $309,000 for 2008 and $1,689,000 thereafter. Rental expense for years ended December 31, 2003, 2002 and 2001 totaled $1,170,000, $1,118,000 and $1,110,000, respectively.
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The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2003 and 2002 was $177,458,000 and $152,968,000, respectively. At December 31, 2003, the scheduled maturities of time deposits are as follows (in thousands):
2004
2005
2006
2007
2008
Thereafter
Short-term borrowings consist of the following at December 31, 2003 and 2002 (dollars in thousands):
Securities sold under agreements to repurchase
Weighted interest rate
Average for the year ended December 31:
Outstanding
Interest rate
Maximum month-end outstanding
Short-term borrowings consist of securities sold under agreements to repurchase, which are secured transactions with customers and generally mature the day following the date sold. Short-term borrowings may also include Federal funds purchased, which are unsecured overnight borrowings from other financial institutions, and advances from the Federal Home Loan Bank of Atlanta, which are secured by mortgage-related assets. The carrying value of the loans pledged as collateral for FHLB advances total $390 million at December 31, 2003.
At December 31, 2003, the Company’s fixed-rate long-term debt totals $64,875,000 and matures through 2013. The interest rate on the fixed-rate notes payable ranges from 2.36% to 6.61%. At December 31, 2002, the Company had fixed-rate long-term debt totaling $60,125,000, maturing through 2011. The interest rate on the notes payable ranged from 3.20% to 6.61% at December 31, 2002.
At December 31, 2003, the Company’s floating-rate long-term debt totals $1,333,000 and matures through 2005. The floating rates are based on the 30 day LIBOR plus 95 basis points. The interest rate on floating-rate long-term debt ranged from 2.06% to 2.33% during 2003. At December 31, 2002, the Company had floating-rate long-term debt totaling $2,094,000.
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The contractual maturities of long-term debt are at December 31, 2003 as follows (dollars in thousands):
Due in 2004
Due in 2005
Due in 2006
Due in 2007
Due in 2008
Total long term debt
The subsidiary banks maintain Federal funds lines with several regional banks totaling approximately $64.6 million at December 31, 2003. The Company also had a line of credit with the Federal Home Loan Bank of Atlanta for $458 million at December 31, 2003.
Net deferred tax assets (liabilities) consist of the following components as of December 31, 2003 and 2002 (in thousands):
Deferred tax assets:
Benefit plans
Other
Total deferred tax assets
Deferred tax liabilities:
Depreciation
Securities available for sale
Total deferred tax liabilities
Net deferred tax liability
In assessing the realizability of deferred tax assets, management considers the scheduled reversal of temporary differences, projected future taxable income, and tax planning strategies. Management believes it is more likely than not the Company will realize its deferred tax assets and, accordingly, no valuation allowance has been established.
The provision for income taxes charged to operations for the years ended December 31, 2003, 2002 and 2001 consists of the following (in thousands):
Current tax expense
Deferred tax expense (benefit)
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The income tax expense differs from the amount of income tax determined by applying the U.S. Federal income tax rate to pretax income for the years ended December 31, 2003, 2002 and 2001, due to the following (in thousands):
Computed “expected” tax expense
(Decrease) in taxes resulting from:
Tax-exempt interest income
Low income housing credits totaled $41,800, $41,581 and $79,735 for the years ended December 31, 2003, 2002 and 2001, respectively.
The Company has a 401 (k) Plan that allows employees to save for retirement on a pre-tax basis. The 401 (k) Plan provides for matching contributions by the Company for employee contributions of up to 3% of each employee’s compensation. The Company also has an Employee Stock Ownership Plan (‘ESOP”). The Company makes discretionary profit sharing contributions into the 401 (k) Plan, ESOP and in cash. Company discretionary contributions to both the 401 (k) Plan and the ESOP are allocated to participant accounts in proportion to each participant’s compensation and vested over a six year time interval. Employee contributions to the ESOP are not allowed and the 401 (k) does not provide for investment in the Company’s stock. Company discretionary profit sharing payments made in 2003, 2002 and 2001 are as follows (in thousands):
401(k) Plan
ESOP
Cash
The Company has an obligation to certain members of the subsidiary banks’ Boards of Directors under deferred compensation plans in the amount of $1,543,000 and $992,000 at December 31, 2003 and 2002, respectively. A portion of the benefits will be funded by life insurance.
In December 2001, the Company’s Board of Directors approved an incentive compensation plan as a means of attracting, rewarding and retaining management. The plan is based on both corporate and individual objectives established annually for each participant. The corporate goals are based on earnings per share growth and performance relative to peer banks, while the individual goals are based on specific performance evaluation objectives. Each participant is evaluated within these two categories to determine eligibility and rate of payment based on performance. Salaries and benefits expense includes $ 315,000 and $ 502,000 for 2003 and 2002, respectively for incentive compensation under this plan.
The Company had a stock option plan adopted in 1993 that authorized the reservation of up to 400,000 shares of common stock and provided for the granting of incentive options to certain employees. This plan terminated in 2003 in accordance with plan provisions. A new plan (the “Plan”) was adopted in 2003 which makes available up to 350,000 shares of common stock for granting restricted stock awards and stock options in the form of incentive stock options and non-statutory stock options to certain employees. Under the Plan, the option price cannot be less than the fair market value of the stock on the date granted. An option’s maximum term is ten years from the date of grant. Options granted under the Plan may be subject to a graded vesting schedule.
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A summary of changes for the Plan for the years 2003, 2002 and 2001 follows:
Options outstanding, January 1
Granted
Forfeited
Exercised
Options outstanding, December 31
Weighted average fair value per option of options granted during year
A summary of options outstanding at December 31, 2003 follows:
Range of
ExercisePrice
Number
Weighted
Average
RemainingContractual Life
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Commitments to extend credit 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 commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. At December 31, 2003 and 2002, the Company had outstanding loan commitments approximating $318,803,000 and $231,841,000, respectively.
The Company has entered into transactions with its directors, principal officers and affiliated companies in which they are principal stockholders. Such transactions were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. The aggregate amount of loans to such related parties totaled $20,697,000 and $17,481,000 as of December 31, 2003 and 2002, respectively. During 2003 new advances to such related parties amounted to $15,900,000 and repayments amounted to $12,684,000.
The following is a reconciliation of the denominators of the basic and diluted EPS computations for December 31, 2003 2002 and 2001:
For the Year Ended December 31, 2003
Basic EPS
Effect of dilutive stock options
Diluted EPS
For the Year Ended December 31, 2002
For the Year Ended December 31, 2001
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Stock options representing 33,000 and 74,140 average shares were not included in the calculation of earnings per share as their effect would have been antidilutive in 2003 and 2001, respectively.
Various legal claims arise from time to time in the normal course of business, which, in the opinion of management, will have no material effect on the Company’s consolidated financial statements.
The Company must maintain a reserve against its deposits in accordance with Regulation D of the Federal Reserve Act. For the final weekly reporting period in the years ended December 31, 2003 and 2002, the aggregate amount of daily average required reserves was approximately $868,000 and $1,495,000 .
The Company has approximately $2,558,000 in deposits in financial institutions in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) at December 31, 2003.
The Corporation and its subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Banks’ financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action (PCA), the Company and Banks must meet specific capital guidelines that involve quantitative measures of their assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company and Banks to maintain minimum amounts and ratios of Total and Tier I capital (as defined) to Average Assets (as defined). Management believes, as of December 31, 2003, that the Company and Banks meet all capital adequacy requirements to which they are subject.
The most recent notification from the Federal Reserve Bank as of December 31, 2003, categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately capitalized, an institution must maintain minimum Total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Banks’ category.
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The Company’s and principal banking subsidiaries’ actual capital amounts and ratios are also presented in the table.
As of December 31, 2003
Total capital to risk weighted assets
Consolidated
Union Bank & Trust
Tier 1 capital to risk weighted assets
Tier 1 capital to average adjusted assets
As of December 31, 2002
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based on quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instruments. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
CASH AND CASH EQUIVALENTS
For those short-term instruments, the carrying amount is a reasonable estimate of fair value.
INVESTMENT SECURITIES AND SECURITIES AVAILABLE FOR SALE
For investment securities and securities available for sale, fair value is determined by quoted market price. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.
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LOANS HELD FOR SALE
Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.
LOANS
The fair value of performing loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Fair value for significant nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows.
The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.
BORROWINGS
The carrying value of short-term borrowings is a reasonable estimate of fair value. The fair value of long-term borrowings is estimated based on interest rates currently available for debt with similar terms and remaining maturities.
ACCRUED INTEREST
The carrying amounts of accrued interest approximate fair value.
COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT
The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At December 31, 2003 and 2002, the fair value of loan commitments and standby letters of credit was immaterial.
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The carrying amounts and estimated fair values of the Company’s financial instruments as of December 31, 2003 and 2002 are as follows (in thousands):
Fair
Financial assets:
Cash and cash equivalents
Accrued interest receivable
Financial liabilities:
Deposits
Borrowings
Accrued interest payable
The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.
The primary source of funds for the dividends paid by Union Bankshares Corporation (the “Parent Company”) is dividends received from its subsidiary banks. The payment of such dividends by the subsidiary banks and the ability of the banks to loan or advance funds to the Parent Company are subject to certain statutory limitations which contemplate that the current year earnings and earnings retained for the two preceding years may be paid to the Parent Company without regulatory approval. As of December 31, 2003, the aggregate amount of unrestricted funds, which could be transferred from the Company’s subsidiaries to the Parent Company, without prior regulatory approval, totaled $23,629,000 or 19.9% of the consolidated net assets.
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Financial information for the Parent Company follows:
UNION BANKSHARES CORPORATION (“PARENT COMPANY ONLY”)
BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
Assets:
Premises and equipment, net
Investment in subsidiaries
Liabilities and Stockholders’ Equity:
Long-term debt
CONDENSED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2003, 2002 and 2001
Income:
Dividends received from subsidiaries
Management fee received from subsidiaries
Equity in undistributed net income of subsidiaries
Other income
Total income
Expense:
Operating expenses
Total expense
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CONDENSED STATEMENTS OF CASH FLOWS
Adjustments to reconcile net income to net cash provided by operating activities:
(Increase) decrease in other assets
Net cash provided by operating activities
Purchase of securities
Proceeds from maturity of securities
Purchase of equipment
Net cash used in investing activities
Issuance of common stock under plans
Repurchase of common stock under plans
Net cash used in financing activities
Increase in cash and cash equivalents
Union Bankshares Corporation has two reportable segments: traditional full service community banks and a mortgage loan origination business. The community bank business includes four banks, which provide loan, deposit, investment, and trust services to retail and commercial customers throughout their 32 retail locations in Virginia. The mortgage segment provides a variety of mortgage loan products principally in Virginia and Maryland. These loans are originated and sold primarily in the secondary market through purchase commitments from investors, which subject the Company to only de minimis risk.
Profit and loss is measured by net income after taxes including realized gains and losses on the Company’s investment portfolio. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Intersegment transactions are recorded at cost and eliminated as part of the consolidation process.
Both of the Company’s reportable segments are service based. The mortgage business is a fee-based business while the banks are driven principally by net interest income. The banks provide a distribution and referral network through their customers for the mortgage loan origination business. The mortgage segment offers a more limited network for the banks, due largely to the minimal degree of overlapping geographic markets.
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The community bank segment provides the mortgage segment with the short-term funds needed to originate mortgage loans through a warehouse line of credit and charges the mortgage banking segment interest at the 3 month Libor rate. These transactions are eliminated in the consolidation process. A management fee for back room support services is charged to all subsidiaries and eliminated in the consolidation totals. Information about reportable segments and reconciliation of such information to the consolidated financial statements for the years ended December 31, 2003, 2002 and 2001 follows:
2003 (dollars in thousands)
Capitalized expenditures
2002 (dollars in thousands)
2001 (dollars in thousands)
On December 19, 2003 the Company announced it had signed a definitive merger agreement with Guaranty Financial Corporation (“Guaranty”) which was unanimously approved by both company’s board of directors. The transaction is valued at $54 million in stock and cash and is expected to take place in the second quarter of 2004 subject to regulatory approval and the approval of Guaranty’s shareholders. Guaranty operates seven branches in the Greater Charlottesville area with nearly $200 million in assets.
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Item 9. — Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable. During the past two years, there have been no changes in or reportable disagreement with the certifying accountants for the Company or any of its subsidiaries.
Item 9A. — Controls and Procedures
Under the supervision and with the participation of the Company’s management, including the chief executive officer and chief financial officer, the Company has evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K. Based on that evaluation, the chief executive officer and chief financial officer have concluded that these controls and procedures are effective. There were no significant changes in the internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is accumulated and communicated to management of the Company, including the principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
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Item 10. — Directors and Executive Officers of the Registrant
This information, as applicable to directors, is incorporated herein by reference from pages 2 and 3 of the Company’s definitive proxy statement to be used in conjunction with the Company’s 2004 Annual Meeting of Shareholders to be held April 20, 2004 (“Proxy Statement”), from the section titled “Election of Directors.” Executive officers of the Company are listed below (All ages and positions are as of December 31, 2003):
Name (Age)
Title and Principal Occupation
During Past Five Years
G. William Beale (54)
D. Anthony Peay (44)
John C. Neal (54)
N. Byrd Newton (60)
Information on Section 16(a) beneficial ownership reporting compliance for the directors and executive officers of the Company is incorporated herein by reference from page 14 of the Proxy Statement from the section titled “Section 16(a) Beneficial Ownership Reporting Compliance.”
The Company has adopted a broadbased code of ethics for all employees and directors. The Company has also adopted a code of ethics tailored for senior officers who have financial responsibilities. A copy of the code may be obtained by request from the corporate secretary.
Item 11. — Executive Compensation
This information is incorporated herein by reference from page 5 and pages 8 through 11 of the Proxy Statement from the sections titled “Election of Directors—Directors’ Fees” and “Executive Compensation.”
Item 12. — Security Ownership of Certain Beneficial Owners
This information is incorporated herein by reference from page 7 of the Proxy Statement from section titled “Ownership of Company Common Stock” and page 14 of the Proxy Statement from the section titled “Equity Compensation Plans” and from Item 5 of this 10-K..
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Item 13. — Certain Relationships and Related Transactions
This information is incorporated herein by reference from page 12 of the Proxy Statement from the section titled “Interest of Directors and Officers in Certain Transactions.”
Item 14. — Principal Accounting Fees and Services
This information is incorporated herein by reference from page 6 of the Proxy Statement from the section titled “Principal Accounting Fees.”
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Item 15. — Exhibits, Financial Statement Schedules and Reports on Form 8-K
The following documents are filed as part of this report:
(a)(1) Financial Statements
The following consolidated financial statements and reports of independent auditors of the Company are in Part II, Item 8 on pages 34 thru 38:
Consolidated Balance Sheets - December 31, 2003 and 2002
Consolidated Statements of Income - Years ended December 31, 2003, 2002 and 2001
Consolidated Statements of Changes in Stockholders’ Equity - Years ended December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows -Years ended December 31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules
All schedules are omitted since they are not required, are not applicable, or the required information is shown in the consolidated financial statements or notes thereto.
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(a)(3) Exhibits
The following exhibits are filed as part of this Form 10-K and this list includes the Exhibit Index.
Description
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The following reports on Form 8-K were filed during the fourth quarter of 2003:
In a report on Form 8-K filed October 16, 2003, the Company issued a press release announcing second quarter results for the quarter ending September 30, 2003. The press release, with summary financial information, was filed pursuant to Item 7 and Item 12.
In a report on Form 8-K filed October 31, 2003, the Company issued a press release announcing the appointment of two new directors: Mr. R. Hunter Morin and Mr. Robert C. Sledd. The press release, with summary financial information, was filed pursuant to Item 7 and Item 9.
In a report on Form 8-K filed December 19, 2003, the Company issued a press release announcing a definitive merger agreement with Guaranty Financial Corporation, a Virginia bank holding company. The merger agreement defines the terms of the Company acquiring Guaranty Financial Corporation. The press release, with summary financial information, was filed pursuant to Item 5 and Item 7.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By:
/s/ G. William Beale
Date: March 8, 2004
G. William Beale
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 8, 2004.
Signature
Title
/ s/ G. William Beale G.
President, Chief Executive Officer and
Director (principal executive officer)
/s/ Frank B. Bradley, III
Frank B. Bradley, III
Director
/s/ Ronald L. Hicks
Ronald L. Hicks
Chairman of the Board of Directors
/ s/ W. Tayloe Murphy, Jr.
W. Tayloe Murphy, Jr.
Vice Chairman of the Board of Directors
/s/ Walton Mahon
Walton Mahon
/s/ R. Hunter Morin
R. Hunter Morin
/ s/ D. Anthony Peay
D. Anthony Peay
Executive Vice President and Chief
Financial Officer (principal financial officer)
/s/ M. Raymond Piland, III
M. Raymond Piland, III
/s/ Robert C. Sledd
Robert C. Sledd
/s/ Ronald L. Tillett
Ronald L. Tillett
/s/ A.D. Whittaker
A.D. Whittaker
/s/ William M. Wright
William M. Wright
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