UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ending: September 30, 2000 Commission file number: 000-28449 UNION BANKSHARES, INC. VERMONT 03-0283552 P.O. BOX 667 MAIN STREET MORRISVILLE, VT 05661 Registrant's telephone number: 802-888-6600 Former name, former address and former fiscal year, if changed since last report: Not applicable 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 the number of shares outstanding of each of the issuer's classes of common stock as of September 30, 2000: Common Stock, $2 par value 3,029,729 shares UNION BANKSHARES, INC. TABLE OF CONTENTS PART 1 FINANCIAL INFORMATION Financial Statements Union Bankshares, Inc. Consolidated Balance Sheet 3 Consolidated Statement of Income - Year to Date 4 Consolidated Statement of Changes in Stockholder's Equity 5 Consolidated Statement of Cash Flows 6 Notes to Financial Statements 8 Management's Discussion and Analysis of Financial Condition and Results of Operations 10 PART II OTHER INFORMATION Item 6 EXHIBITS AND REPORTS ON FORM 8-K 26 Signatures 27 Union Bankshares, Inc. and Subsidiaries Statement of Condition (Unaudited) <TABLE> <CAPTION> September 30, December 31, (Dollars in Thousands) 2000 1999 ------------- ------------ <S> <C> <C> Assets Cash and due from banks $ 10,293 $ 11,627 Federal funds sold and overnight deposits 5,411 3,474 ------------------------- Total cash and cash equivalents 15,704 15,101 Interest bearing deposits 2,043 1,957 Securities available-for-sale 55,707 60,441 Federal Home Loan Bank stock 1,016 939 Loans held for sale 8,936 8,102 Loans 216,324 201,525 Unearned loan fees (272) (273) Allowance for loan losses (2,868) (2,870) ------------------------- Loans, net 213,184 198,382 ------------------------- Accrued interest receivable 2,405 2,199 Bank premises and equipment, net 3,861 4,040 Other real estate owned, net 137 27 Other assets 4,194 4,288 ------------------------- Total assets $307,187 $295,476 ========================= Liabilities and Stockholders' equity: Liabilities: Deposits: Non-interest bearing $ 34,196 $ 32,989 Interest bearing 224,958 224,604 ------------------------- Total deposits 259,154 257,593 Borrowed funds 10,464 2,872 Accrued interest and other liabilities 3,564 2,791 ------------------------- Total liabilities 273,182 263,256 ------------------------- Stockholders' equity: Common stock ($2 par value; 5,000,000 shares authorized; 3,263,689 and 3,263,489 shares issued at 9/30/00 and 12/31/99) 6,527 6,527 Paid-in capital and surplus 240 238 Retained earnings 29,492 28,180 Treasury stock (233,960 shares at 9/30/00 and 12/31/99) (1,592) (1,592) Accumulated other comprehensive income (662) (1,133) ------------------------- Total stockholders' equity 34,005 32,220 ------------------------- Total liabilities and stockholders' equity $307,187 $295,476 ========================= </TABLE> See accompanying notes to unaudited financial statements Union Bankshares, Inc. and Subsidiaries Consolidated Statements of Income (Unaudited) <TABLE> <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, -------------------- -------------------- (Dollars in Thousands) 2000 1999 2000 1999 ---- ---- ---- ---- <S> <C> <C> <C> <C> Interest income: Interest and fees on loans $ 5,154 $ 4,726 $ 14,803 $ 13,829 Interest and dividends on investment securities 894 911 2,718 2,733 Interest on federal funds sold 95 153 217 309 Interest on interest bearing deposits 31 34 91 95 ---------------------------------------------------------- 6,174 5,824 17,829 16,966 ---------------------------------------------------------- Interest expense: Interest on deposits 2,415 2,225 6,961 6,560 Interest on federal funds purchased 0 1 4 2 Interest on borrowed funds 178 76 273 237 ---------------------------------------------------------- 2,593 2,302 7,238 6,799 ---------------------------------------------------------- Net interest income 3,581 3,522 10,591 10,167 Provision for loan losses 63 62 188 250 ---------------------------------------------------------- Net interest income after provision for loan losses 3,518 3,460 10,403 9,917 ---------------------------------------------------------- Noninterest income: Trust department income 35 46 111 114 Service fees 563 554 1,718 1,724 Security gains 0 0 34 3 Gain on sale of loans 25 7 34 52 Other (1) (19) 8 (4) ---------------------------------------------------------- 622 588 1,905 1,889 ---------------------------------------------------------- Noninterest expense: Salaries and wages 1,121 1,057 3,432 3,145 Pension and other employee benefits 290 264 867 762 Occupancy expense, net 131 134 423 411 Equipment expense 234 264 764 803 Other operating expense 618 731 2,053 2,181 ---------------------------------------------------------- 2,394 2,450 7,539 7,302 ---------------------------------------------------------- Income before income tax expense 1,746 1,598 4,769 4,504 Income tax expense 499 464 1,276 1,354 ---------------------------------------------------------- Net income $ 1,247 $ 1,134 $ 3,493 $ 3,150 ========================================================== Earnings per common share $ 0.41 $ 0.38 $ 1.15 $ 1.04 ========================================================== Weighted average number of common shares outstanding 3,029,718 3,029,438 3,029,593 3,028,134 ========================================================== Dividends declared per share $ 0.24 $ 0.22 $ 0.72 $ 0.66 ========================================================== </TABLE> See accompanying notes to unaudited financial statements Union Bankshares, Inc. and Subsidiaries Consolidated Statement of Changes in Stockholders Equity (Unaudited) <TABLE> <CAPTION> Accumulated Other Total Common Paid-in Capital Retained Treasury Comprehensive Stockholders' Stock & Surplus Earnings Stock Income (Loss) Equity ------ --------------- -------- -------- ------------- ------------- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> Balance, December 31, 1999 $6,527 $238 $28,180 $(1,592) $(1,133) $32,220 Net income 3,493 3,493 Net unrealized holding gain on securities available-for-sale, net of tax 471 471 ------- Comprehensive income 3,964 ------- Cash dividends declared (2,181) (2,181) Treasury stock purchased 0 Exercise of stock option 2 2 ------- Balance September 30, 2000 $6,527 $240 $29,492 $(1,592) $ (662) $34,005 =========================================================================== </TABLE> Union Bankshares, Inc. and Subsidiaries Consolidated Statement of Cash Flows (UNAUDITED) <TABLE> <CAPTION> Year to Date ------------------------------ September 30, September 30, (Dollars in Thousands) 2000 1999 ------------- ------------- <S> <C> <C> Cash Flows From Operating Activities Net Income $ 3,493 $ 3,150 Adjustments to reconcile net income to net cash provided by operating activities Depreciation 603 624 Provision for loan losses 188 250 Provision (credit) for deferred income taxes (102) 219 Amortization, net 0 101 Write-downs of OREO 8 18 Decrease in unamortized loan fees (1) 80 Increase in loans held for sale (800) (5,849) Increase in accrued interest receivable (206) (76) (Increase) decrease in other assets 80 (304) Increase (decrease) in income taxes payable (101) 61 Increase (decrease) in accrued interest payable 182 (157) Increase in other liabilities 591 291 Gain on securities (34) (3) Gain on sale of loans (34) (52) (Gain) (loss) on sale of OREO (4) 11 ------------------------ Net cash provided by operating activities 3,863 (1,636) ------------------------ Cash Flows From Investing Activities Interest bearing deposits Maturities and redemptions 1,090 788 Purchases (1,176) (998) Securities available for sale Maturities and redemptions 9,370 16,867 Purchases (3,888) (19,947) Purchase of Federal Home Loan Bank Stock (77) (35) Decrease in loans, net (15,225) (3,382) Recoveries of loans charged off 99 63 Purchases of premises and equipment, net (424) (212) Proceeds from sale of OREO 23 501 Proceeds from sale of Repossessions 0 64 Investment in Ltd Partnerships (26) (373) ------------------------ Net cash used in investing activities (10,234) (6,728) Cash Flows From Financing Activities Borrowings, net of repayments 7,592 (2,801) Proceeds from exercise of stock options 2 31 Net decrease in demand, NOW, Savings, and money market accounts (1,489) 10,718 Net increase (decrease) in time deposits 3,050 (232) Dividends paid (2,181) (1,687) ------------------------ Net cash provided by financing activities 6,974 6,029 ------------------------ (Decrease) increase in cash and cash equivalents $ 603 $(2,335) Cash and cash equivalents Beginning $15,101 $19,196 ------------------------ Ending $15,704 $16,861 ------------------------ Supplemental Disclosure of Cash Flow Information: Interest Paid $ 7,056 $ 6,956 ======================== Income Taxes Paid $ 1,480 $ 1,577 ======================== </TABLE> UNION BANKSHARES, INC. NOTES TO FINANCIAL STATEMENTS: Note 1. The accompanying interim consolidated financial statements of Union Bankshares, Inc. (the Company) for the interim period ended September 30, 2000 and 1999 and for the quarters then ended have been prepared in accordance with the accounting policies described in the company's annual report to shareholders and Form 10K which are unaudited. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the information contained herein have been made. Certain amounts reported in prior periods have been reclassified for comparative purposes. This information should be read in conjunction with the Company's 1999 Annual report, Form S-4, and Form 8K. Note 2. Acquisition Effective November 30, 1999, following the receipt of all required stockholder, state and federal regulatory approvals, Union Bankshares, Inc. acquired Citizens Saving Bank and Trust Co. This makes Union a two bank holding company. The accompanying consolidated financial statements reflect the merger accounted for in a tax-free transaction as a pooling of interests and are presented as if the companies were combined as of the earliest period presented. However, the financial information is not necessarily indicative of the results of operations, financial position or cash flows that would have occurred had the acquisition been consumated for the periods for which it is given effect, nor is it necessarily indicative of future results of operations, financial position, or cash flows. The financial statements reflect the conversion of each outstanding share of Citizens common stock into 6.5217 shares of Union common stock, with the exchange of 991,089 shares (net of 196 fractional shares redeemed for approximately $4,516) of newly-issued Company common stock. Note 3. Commitments and Contingencies In the normal course of business, the Company is involved in various legal proceedings. In the opinion of management, after consulting with the Company's legal counsel, any liability resulting from such proceedings would not have a material adverse effect on the Company's financial statements. Note 4 Earnings Per Share Earnings per common share amounts are computed based on the weighted average number of shares of common stock outstanding during the period (retroactively adjusted for stock dividends) and reduced for shares held in Treasury. The assumed conversion of available stock options does not result in material dilution. Note 5 Reportable Segments The company has two reportable operating segments, Union Bank (Union) and Citizens Savings Bank and Trust Company (Citizens). Management regularly evaluates separate financial information for each segment in deciding how to allocate resources and in assessing performance. The Company accounts for intersegment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices. Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the period ended September 30, follows: <TABLE> <CAPTION> Intersegment Consolidated 2000 Union Citizens Elimination Other Totals - ---------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Interest income $ 12,008 $ 5,821 $ 0 $ 0 $ 17,829 Interest expense 4,652 2,585 0 1 7,238 Provision for loan loss 0 188 0 0 188 Service fee income 1,355 363 0 0 1,718 Income tax expense (benefit) 999 334 0 (57) 1,276 Net income (loss) 2,921 675 0 (103) 3,493 Assets 205,104 101,622 (17) 478 307,187 <CAPTION> Intersegment Consolidated 1999 Union Citizens Elimination Other Totals - ---------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> Interest income $ 11,117 $ 5,849 $ 0 $ 0 $ 16,966 Interest expense 4,284 2,514 0 1 6,799 Provision for loan loss 63 187 0 0 250 Service fee income 1,292 432 0 0 1,724 Income tax expense (benefit) 910 454 0 (10) 1,354 Net income (loss) 2,563 815 0 (228) 3,150 Assets 195,598 102,206 0 370 298,174 </TABLE> Amounts in the "Other" column encompass activity in Union Bankshares, Inc., the "parent company." Holding company assets are stated after intercompany eliminations. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The following discussion and analysis provides information regarding Union Bankshares, Inc.'s (Union's) financial position as of September 30, 2000 and as of December 31, 1999, and its results of operations for the three and nine months ended September 30, 2000 and 1999. This discussion should be read in conjunction with the information in this document under Financial Statements and related notes and with other financial data appearing elsewhere in this filing. In the opinion of Union's management, the unaudited interim data reflect all adjustments, consisting only of normal recurring adjustments, necessary to fairly present Union's consolidated financial position and results of operations to be expected for the interim period. Management is not aware of the occurrence of any events after September 30, 2000, which would materially affect the information presented below. Union's common stock was listed on the American Stock Exchange on July 13, 2000 with an opening price of $15.125 and it closed on November 10, 2000 at $17.75. The millennium change was basically a non-event as far as problems and both banks completed their year-end processing on schedule. On February 4, 2000, Citizens upgraded their main application software from Jack Henry 20/20 to Jack Henry Silverlake. On that day, Union Bank became the Electronic Data Processing Server for Citizens. Therefore, both of Union's subsidiaries are processed on Union Bank's IBM AS400 located in Morrisville, Vermont. The transition was planned to be as transparent as possible to customers and line staff of Citizens. Citizens reimburses Union for costs incurred under a data processing agreement between the banks. Intercompany revenues and costs have been eliminated in consolidation. Only a few other, non-material operational changes have resulted from the switch and internal controls have been maintained. The Company may from time to time make written or oral statements that are considered "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may include financial projections, statements of plans and objectives for future operations, estimates of future economic performance and assumptions relating thereto. The Company may include forward-looking statements in its filings with the Securities and Exchange Commission, in its reports to stockholders, including this Quarterly Report, in other written materials, and in statements made by senior management to analysts, rating agencies, institutional investors, representatives of the media and others. By their very nature, forward-looking statements are subject to uncertainties, both general and specific, and risk exists that predictions, forecasts, projections and other estimates contained in forward-looking statements will not be achieved. Also when we use any of the words "believes," "expects," "anticipates" or similar expressions, we are making forward-looking statements. Many possible events or factors could affect the future financial results and performance of our company. This could cause results or performance to differ materially from those expressed in our forward-looking statements. The possible events or factors that might affect our forward-looking statements include, but are not limited to, the following: * uses of monetary, fiscal and tax policy by various governments * political, legislative or regulatory developments in Vermont or the United States including changes in laws concerning taxes, banking and other aspects of the financial services industry * developments in general economic or business conditions, including interest rate fluctuations, market fluctuations and perceptions, and inflation * changes in the competitive environment for financial services organizations * the Company's ability to retain key personnel * changes in technology including demands for greater automation * adverse changes in the securities market When relying on forward-looking statements to make decisions with respect to the Company, investors and others are cautioned to consider these and other risks and uncertainties. RESULTS OF OPERATIONS The Company's net income for the quarter ended September 30, 2000 was $1.2 million, compared with net income of $1.1 million for the third quarter of 1999. Net income per share was $.41 for the third quarter of 2000 compared to $.38 for the same quarter of 1999. Net income for the first nine months of 2000 was $3.5 million, compared with $3.1 million for the same period in 1999. Net income per share was $1.15 for the first nine months of 2000 compared to $1.04 for the comparable period in 1999. Net Interest Income. The largest component of Union's operating income is net interest income, which is the difference between interest and dividend income received from interest-earning assets and the interest expense paid on its interest-bearing liabilities. Yields Earned and Rates Paid. The following tables show, for the periods indicated, the total amount of income recorded from interest-earning assets, and the related average yields, the interest expense associated with interest-bearing liabilities, expressed in dollars and average rates, and the relative net interest spread and net interest margin. All yield and rate information is calculated on an annualized basis. Yield and rate information for a period is average information for the period, and is calculated by dividing the income or expense item for the period by the average balances of the appropriate balance sheet item during the period. Net interest margin is net interest income divided by average interest- earning assets. Nonaccrual loans are included in asset balances for the appropriate periods, but recognition of interest on such loans is discontinued and any remaining accrued interest receivable is reversed, in conformity with federal regulations. The yields and net interest margins appearing in the following tables have been calculated on a pre-tax basis: <TABLE> <CAPTION> Three months ended September 30, ---------------------------------------------------------------------- 2000 1999 --------------------------------- -------------------------------- Interest Average Interest Average Average Earned/ Yield/ Average Earned/ Yield/ Balance Paid Rate Balance Paid Rate ------- -------- ------- ------- -------- ------- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Average Assets: Federal funds sold $ 5,978 $ 95 6.36% $ 12,061 $ 153 5.07% Interest bearing deposits 2,010 31 6.17% 2,374 34 5.73% Investments (1) (2) 58,275 894 6.33% 59,933 911 6.26% Loans, net (1), (3) 223,429 5,154 9.39% 208,120 4,726 9.18% ------------------------------------------------------------------- Total interest-earning assets (1) 289,692 6,174 8.68% 282,488 5,824 8.36% Cash and due from banks 9,288 9,007 Premises and equipment 3,950 4,244 Other assets 4,531 2,389 -------- -------- Total assets $307,461 $298,128 ======== ======== Average Liabilities and Shareholders' Equity: NOW accounts $ 34,177 $ 163 1.91% $ 34,440 $ 159 1.85% Savings and money market accounts 90,397 851 3.77% 89,778 796 3.55% Certificates of deposit 100,310 1,401 5.59% 99,840 1,270 5.09% Borrowed funds 10,522 178 6.77% 4,063 77 7.58% ------------------------------------------------------------------- Total interest-bearing Liabilities 235,406 2,593 4.41% 228,121 2,302 4.04% Non-interest bearing deposits 33,650 33,305 Other liabilities 5,103 4,660 -------- -------- Total liabilities 274,159 266,086 Shareholders' equity 33,302 32,042 -------- -------- Total liabilities and shareholders' equity $307,461 $298,128 ======== ======== Net interest income (1) $3,581 $3,522 ====== ====== Net interest spread (1) 4.27% 4.32% ==== ==== Net interest margin (1) 5.11% 5.11% ==== ==== <CAPTION> Nine months ended September 30, ---------------------------------------------------------------------- 2000 1999 --------------------------------- -------------------------------- Interest Average Interest Average Average Earned/ Yield/ Average Earned/ Yield/ Balance Paid Rate Balance Paid Rate ------- -------- ------- ------- -------- ------- (dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Average Assets: Federal funds sold $ 4,808 $ 217 6.02% $ 8,559 $ 309 4.80% Interest bearing deposits 2,020 91 6.01% 2,279 95 5.54% Investments (1) (2) 57,216 2,718 6.53% 60,626 2,733 6.21% Loans, net (1), (3) 213,162 14,803 9.39% 202,174 13,829 9.21% ------------------------------------------------------------------- Total interest-earning assets (1) 277,206 17,829 8.72% 273,638 16,966 8.37% Cash and due from banks 8,844 9,009 Premises and equipment 4,013 4,386 Other assets 5,993 5,413 -------- -------- Total assets $296,056 $292,446 ======== ======== Average Liabilities and Shareholders' Equity: NOW accounts $ 32,779 $ 481 1.96% $ 33,415 $ 473 1.89% Savings and money market accounts 90,216 2,509 3.71% 85,881 2,247 3.49% Certificates of deposit 99,628 3,971 5.31% 99,566 3,840 5.14% Borrowed funds 5,587 277 6.61% 5,459 239 5.84% ------------------------------------------------------------------- Total interest-bearing Liabilities 228,210 7,238 4.23% 224,321 6,799 4.03% Non-interest bearing deposits 32,688 31,921 Other liabilities 2,874 4,383 -------- -------- Total liabilities 263,772 260,625 Shareholders' equity 32,284 31,821 -------- -------- Total liabilities and shareholders' equity $296,056 $292,446 ======== ======== Net interest income (1) $10,591 $10,167 ======= ======= Net interest spread (1) 4.49% 4.34% ==== ==== Net interest margin (1) 5.23% 5.07% ==== ==== <FN> (1) Average yield reported on a tax-equivalent basis. (2) The average balance of investments is calculated using the amortized cost basis. (3) Net of unearned income and allowance for loan loss. </FN> </TABLE> Union's net interest income increased by $59 thousand, or 1.7%, to $3.6 million for the three months ended September 30, 2000, from $3.5 million for the three months ended September 30, 1999. This increase was due to the spread between yields earned on assets versus paid on liabilities. The net interest spread decreased by 5 basis points to 4.27% for the three months ended September 30, 2000, from 4.32% for the three months ended September 30, 1999 as interest rates paid on deposits have begun to move upward in response to the earlier increase in the prime rate. The net interest margin for the 2000 period remained unchanged from the 1999 period at 5.11%. Union's net interest income year to date was $10.6 million compared to the prior year of $10.2 million or an increase of 4.2% between the two years. The net interest spread increased by 15 basis points to 4.49% for the nine months ended September 30, 2000 from 4.34% for the nine months ended September 30, 1999. This increase was fueled by the six increases in the prime rate since June 30, 1999 which has taken it from 7.75% to 9.50%. The net interest margin for the 2000 period increased to 5.23% from 5.07% for the 1999 period or an increase of 16 basis points. Rate/Volume Analysis. The following table describes the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have affected Union's interest income and interest expense during the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to: * changes in volume (change in volume multiplied by prior rate); * changes in rate (change in rate multiplied by current volume); and * total change in rate and volume. Changes attributable to both rate and volume have been allocated proportionately to the change due to volume and the change due to rate. <TABLE> <CAPTION> Three Months Ended September 30, 2000 Compared to Three Months Ended September 30, 1999 Increase/(Decrease) Due to Change In ---------------------------------------------- Volume Rate Net ------ ---- --- (dollars in thousands) <S> <C> <C> <C> Interest-earning assets: Federal funds sold $ (77) $ 19 $ (58) Interest bearing deposits (5) 2 (3) Investments (26) 9 (17) Loans, net 321 107 428 ---------------------------- Total interest-earning assets 213 137 350 Interest-bearing liabilities: NOW accounts (1) 5 4 Savings and money market accounts 5 50 55 Certificates of deposit 6 125 131 Borrowed funds 122 (21) 101 ---------------------------- Total interest-bearing liabilities 132 159 291 ---------------------------- Net change in net interest income $ 81 $ (22) $ 59 ============================ <CAPTION> Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30, 1999 Increase/(Decrease) Due to Change In ---------------------------------------------- Volume Rate Net ------ ---- --- (dollars in thousands) <S> <C> <C> <C> Interest-earning assets: Federal funds sold $(135) $ 43 $ (92) Interest bearing deposits (11) 7 (4) Investments (159) 144 (15) Loans, net 706 268 974 ---------------------------- Total interest-earning assets 401 462 863 Interest-bearing liabilities: NOW accounts (9) 17 8 Savings and money market accounts 113 149 262 Certificates of deposit 2 129 131 Borrowed funds 6 32 38 ---------------------------- Total interest-bearing liabilities 112 327 439 ---------------------------- Net change in net interest income $ 289 $ 135 $ 424 ============================ </TABLE> Quarter Ended September 30, 2000 compared to Quarter Ended September 30, 1999. Interest and Dividend Income. Union's interest and dividend income increased by $354,000, or 6.08%, to $6.2 million for the three months ended September 30, 2000, from $5.8 million for the three months ended September 30, 1999. Average earning assets increased by $7.2 million, or 2.5%, to $289.7 million for the three months ended September 30, 2000, from $289.7 million for the three months ended September 30, 1999. Average loans approximated $223.4 million for the three months ended September 30, 2000 up from $208.1 million for the three months ended September 30, 1999. Increases in construction loans and residential real estate secured loans of $6.8 million or 6.6%, the $10.1 million or 14.0% increase in commercial loans, and the $2.9 million or 27.4% increase in loans to municipalities was partially offset by the $4.5 million or 23.4% decrease in personal loans. Construction Lending was strong throughout 1999 and to date through 2000. A conscious decision to retain loans packaged for sale in our portfolio in mid 1999 through mid 2000 accounts for the majority of the increase in both the residential real estate and commercial loan portfolios. The decrease in personal loans is due to a late 1998 decision to exit the Dealer floorplan business at Citizens. The average balance of investment securities (including mortgage-backed securities) decreased by $1.7 million, or 2.8%, to $58.3 million for the three months ended September 30, 2000, from $59.9 million for the three months ended September 30, 1999. The average balance in Interest Bearing Deposits decreased by $364,000 to $2.0 million from $2.3 million or 15.3%. The average level of federal funds sold decreased by $6.1 million or 50.8%, to $5.9 million for the three months ended September 30, 2000, from $12.0 million for the three months ended September 30, 1999. The decrease in the investment portfolio, in Federal Funds Sold and in Interest Bearing Deposits in 2000 reflects the closer attention to cash management since Y2 passed with no liquidity crisis and the continuing growth in our loan portfolio. Interest Income on non-loans was $1 million for 2000 compared to $1.1 million for 1999 reflecting the increase in yields offset by the decrease in volume. Interest Expense. Union's interest expense increased by $291 thousand, or 12.64%, to $2.6 million for the three months ended September 30, 2000 from $2.3 million for the three months ended September 30, 1999. Average interest-bearing liabilities increased by $7.3 million, or 3.2% to $235.4 million for the three months ended September 30, 2000, from $228.1 million for the three months ended September 30, 1999. Average time deposits increased $.5 million, or .5%, to $100.3 million for the three months ended September 30, 2000, from $99.8 million for the three months ended September 30, 1999, while the average balances for money market and saving accounts increased by $.6 million to $90.4 million for the three months ended September 30, 2000, from $89.8 million for the three months ended September 30, 1999. Customers have maintained very liquid positions during the last 9 months as they anticipate the interest rates paid on all deposit instruments will continue to rise. The average balance on funds borrowed has increased from $4.1 million on average in 1999 to $10.5 million in 2000 as Union borrowed from the Federal Home Loan Bank of Boston for liquidity funding and to match some long-term commercial loan commitments. Noninterest Income. Union's noninterest income increased $34,000, or 5.8%, to $622 thousand for the three months ended September 30, 2000, from $588 thousand for the three months ended September 30, 1999. Trust department income fell to $35 thousand in the third quarter of 2000 from $46 thousand in the same period of 1999 or a 23.9% decrease. There was a $25,000 gain on Sale of Loans for 2000 and $7 thousand for 1999. Other noninterest income and service fees (sources of which include deposit and loan servicing fees, ATM fees, and safe deposit fees) increased by $9 thousand, or 1.6%, to $563 thousand for the three months ended September 30, 2000, from $554 thousand for the three months ended September 30, 1999. Noninterest Expense. Union's noninterest expense decreased $56 thousand, or 2.3%, to $2.4 million for the three months ended September 30, 2000, from $2.5 million for the three months ended September 30, 1999. Salaries increased $64,000, or 6%, to $1.1 million for the three months ended September 30, 2000, from $1.0 million for the three months ended September 30, 1999, reflecting normal salary activity. Pension and employee benefits increased $26 thousand or 9.8% to $290 thousand for the three months ended September 30, 2000, from $264 thousand for the three months ended September 30, 1999 mainly due to a $30,000 increase in retirement plans expense. Equipment expense decreased $30 thousand to $234 thousand for the three months ended September 30, 2000, from $264 thousand for the same period in 1999 resulting from decreased depreciation cost on computer equipment and software which are depreciated as an expense over a time period of three to five years, a decrease in equipment repair expense and a decrease in the cost of maintenance contracts. Other operating expense for the quarter was $618 thousand down from $731 thousand for the same quarter in 1999. The decrease of $113 thousand, or 15.4%, is mainly due to the non-recurring Year 200 and merger related expenses during the third quarter of 1999. Income Tax Expense. Union's income tax expense increased by $35,000, or 7.5%, to $499,000 for the three months ended September 30, 2000, from $463 thousand for the comparable period of 1999 because of our increased income. Year to Date September 30, 2000 compared to Year to Date September 30, 1999. Interest and Dividend Income. Union's interest and dividend income increased by $863,000, or 5.1%, to $17.8 million for the nine months ended September 30, 2000, from $17 million for the nine months ended September 30, 1999. Average earning assets increased by $3.6 million, or 1.3%, to $277.2 million for the nine months ended September 30, 2000, from $273.6 million for the nine months ended September 30, 1999. Average loans approximated $213.2 million for the nine months ended September 30, 2000 up from $202.2 million for the nine months ended September 30, 1999. Increases in construction loans of $949 thousand or 16.7%, the $5.1 million or 6.3% increase in residential real estate secured loans, the $9.2 million or 10.7% increase in commercial loans, and the $1.7 million or 17.9% increase in loans to municipalities was partially offset by the $4.7 million or 21.6% decrease in personal loans. Construction Lending was strong throughout 1999 and to date through 2000. A conscious decision to retain loans packaged for sale in our portfolio in mid 1999 through mid 2000 accounts for the majority of the increase in both the residential real estate and commercial loan portfolios. The decrease in personal loans is due to a late 1998 decision to exit the Dealer floorplan business at Citizens. The average balance of investment securities (including mortgage-backed securities) decreased by $3.4 million, or 5.6%, to $57.2 million for the nine months ended September 30, 2000, from $60.6 million for the nine months ended September 30, 1999. The average level of federal funds sold decreased by $3.8 million or 43.8%, to $4.8 million for the nine months ended September 30, 2000, from $8.6 million for the nine months ended September 30, 1999. The average balance in Interest Bearing Deposits decreased by $259,000 to $2.0 million from $2.3 million or 11.3%. The decrease in the investment portfolio, Federal Funds Sold and Interest Bearing Deposits in 2000 reflects the closer attention to cash management since Y2K passed with no liquidity crises and the continuing growth in our loan portfolio. Interest Income on non-loans was $3 million for 2000 and $3.1 million for 1999 reflecting the increase in yields offset by the overall decrease in volume. Interest Expense. Union's interest expense increased by $439 thousand, or 6.5%, to $7.2 million for the nine months ended September 30, 2000 from $6.8 million for the nine months ended September 30, 1999. Average interest-bearing liabilities increased by $3.9 million, or 1.7%, to $228.2 million for the nine months ended September 30, 2000, from $224.3 million for the nine months ended September 30, 1999. Average time deposits remained unchanged at $99.6 million for the nine months ended September 30, 2000 and for the nine months ended September 30, 1999, while the average balances for money market and savings accounts increased by $4.3 million to $90.2 million for the nine months ended September 30, 2000, from $85.9 million for the nine months ended September 30, 1999. The 5.0% increase in balances was all in money market accounts as the rate structure was tiered to remain competitive with other financial institutions. Customers have maintained very liquid positions during the last 9 months as they anticipate the interest rates paid on all deposit instruments will continue to rise. The average balance on funds borrowed increased from $5.5 million on average in 1999 to $5.6 million in 2000. Noninterest Income. Union's noninterest income increased $16,000, or .8%, to $1.9 million for the nine months ended September 30, 2000. The results for the period reflected a net gain of $34 thousand from the sale of securities compared to a $3,000 gain from sales during 1999. Trust department income decreased to $111,000 in the nine months of 2000 from $114,000 in the same period of 1999 or a 2.6% decrease. Gain on Sale of Loans dropped $18,000 to $34,000 for 2000 from $52,000 for 1999. This change can be explained by management's decision to retain in portfolio a higher percentage of loans that could be sold due to the interest rate environment and other reinvestment rates available. Other noninterest income and service fees (sources of which include deposit and loan fees, ATM fees, and safe deposit fees) decreased by $6,000, or .3%, to $1.7 million for the nine months ended September 30, 2000, and for the nine months ended September 30, 1999 Noninterest Expense. Union's noninterest expense increased $237,000, or 3.2%, to $7.5 million for the nine months ended September 30, 2000, from $7.3 million for the nine months ended September 30, 1999. Salaries increased $287,000, or 9.1%, to $3.4 million for the nine months ended September 30, 2000, from $3.1 million for the nine months ended September 30, 1999, reflecting normal salary activity, pay for overtime during the first quarter of 2000 related to a Systems Conversion at Citizens, and severance pay for three employees whose positions were eliminated at Citizens due to the consolidation of certain operations within the organization. Pension and employee benefits increased $105 thousand, or 13.8%, to $867 thousand for the nine months ended September 30, 2000, from $762 thousand for the nine months ended September 30, 1999 mainly due to a $12,600 increase in health insurance costs, a $74,500 increase in retirement plans expense, and a $17,600 increase in payroll taxes. Net occupancy expense increased $12 thousand, or 2.9%, to $423,000 for the nine months ended September 30, 2000, from $411,000 for the nine months ended September 30, 1999 due mainly to the increase in fuel costs and property tax expense. Equipment expense decreased $39 thousand or 4.9% to $764 thousand for the nine months ended September 30, 2000, from $803 thousand for the same period in 1999 primarily resulting from decreased equipment repair expense and depreciation expense. Other operating expenses were $2.0 million for the first nine months of 2000 compared to $2.2 million for the same period in 1999. Year 2000 expenses were $1.5 thousand during 2000 compared to $57 thousand in 1999. During the period ended September 30, 2000, Union incurred approximately $1 thousand of expenses related to the merger, including legal and advisory fees compared to $279 thousand during the same period of 1999. Union incurred a net one-time listing fee in 2000 of $11,250 from the American Stock Exchange and a pro-rated annual fee of $4,500. Other large variance categories were Charitable Contributions up $42,300 from $25,600 through September 30, 1999 to $67,900 in 2000. Printing costs were up $26,800 between years from $31,800 to $58,600 due to the expense of a professional annual report, proxy and Form 10-K. State Franchise taxes were up $12,000 between years due to the increase in our deposit base. FDIC assessment was up $17,800 due to increased deposit base and the increased assessment rate. Advertising and public relations expenses were up $18,100 as media exposure was expanded at Citizens. Income Tax Expense. Union's income tax expense decreased by $78,000, or 5.76%, to $1.276 million for the nine months ended September 30, 2000, from $1.354 million for the comparable period of 1999 because of our $114,000 historic rehabilitation credit and low income housing credits that were available to us for the 2000 tax year due to our partnership investment in low income housing projects sponsored by Housing Vermont in our market area and our increased volume of municipal lending. FINANCIAL CONDITION At September 30, 2000, Union had total consolidated assets of $307.2 million, including net loans and loans held for sale of $222.1 million, deposits of $259.2 million and shareholders' equity of $34.0 million. Based on the most recent information published by the Vermont Banking Commissioner, in terms of total assets at December 31, 1999, Union Bank ranked as the 11th largest institution of the 26 commercial banks and savings institutions headquartered in Vermont, and Citizens ranked as the 20th. Union's total assets increased by $11.7 million or 4.0% to $307.2 million at September 30, 2000 from $295.5 million at December 31, 1999. Total net loans and loans held for sale increased by $15.6 million or 7.6% to $222.1 million or 72.3% of total assets at September 30, 2000 as compared to $206.5 million or 69.9% of total assets at December 31, 1999. Cash and cash equivalents, including Federal funds sold, increased approximately $.5 million or 3.3% to $15.6 million at September 30, 2000 from $15.1 million at December 31, 1999. Securities available for sale decreased from $60.4 million at December 31, 1999 to $55.7 million at September 30, 2000, a $4.7 million or 7.8% decrease. Securities maturing have not been replaced dollar for dollar and some securities have been sold in order to fund the increasing loan demand and our decision to hold in portfolio loans available for sale. Deposits increased $1.6 million or .62% to $259.2 million at September 30, 2000 from $257.6 million at December 31, 1999. Total borrowings increased $7.6 million to $10.5 million at September 30, 2000 from $2.9 million at December 31, 1999. The increase was in borrowing from the Federal Home Loan Bank under existing lines of credit to fund loan demand. Loan Portfolio. Union's loan portfolio (including loans held for sale) primarily consists of adjustable- and fixed-rate mortgage loans secured by one-to-four family, multi-family residential or commercial real estate. As of September 30, 2000, Union's loan portfolio totaled $225.3 million, or 73.3%, of assets, of which $108.7 million, or 48.3% of gross loans, consisted of residential mortgages and construction loans, and $67.1 million, or 29.8%, of total loans consisted of commercial real estate loans. As of such date, Union's loan portfolio also included $19.9 million of commercial loans, $14.1 million of municipal loans, and $15.5 million of consumer loans representing, in order, 8.8%, 6.3% and 6.9% of total loans outstanding on September 30, 2000. The following table shows information on the composition of Union's loan portfolio as of September 30, 2000 and December 31, 1999: <TABLE> <CAPTION> September 30, December 31, Loan Type 2000 1999 - ---------------------------------------------------------------- <S> <C> <C> Real Estate $ 99,742 $ 87,154 Commercial real estate 67,126 69,807 Commercial 19,870 16,246 Consumer 15,507 18,661 Municipal loans 14,079 9,657 Loans held for sale 8,936 8,102 -------------------------- Total loans 225,260 209,627 Deduct: Allowance for loan losses 2,868 2,870 Net deferred loan fees, premiums & discounts 272 273 -------------------------- 3,140 3,143 $222,120 $206,484 ========================== </TABLE> Union originates and sells residential mortgages into the secondary market, with most such sales made to the Federal Home Loan Mortgage Corporation (FHLMC). Union services a $152.1 million residential mortgage portfolio, approximately $48.4 million of which is serviced for unaffiliated third parties at September 30, 2000. Additionally, Union originates commercial loans under various SBA programs that provide an agency guarantee for a portion of the loan amount. Union will typically sell the guaranteed portion of the loan to other financial concerns and will retain servicing rights, which generates fee income. Union capitalizes mortgage servicing rights on these fees and recognizes gains and losses on the sale of the principal portion of these notes as they occur. As of September 30, 2000, Union serviced $9.4 million of commercial and commercial real estate loans for unaffiliated third parties. An increase of $12.6 million or 14.4% in residential real estate loans and an increase of $3.6 million or 22.3% in commercial loans was partially offset by a $2.7 million or 3.8% decrease in commercial real estate loans and a $3.1 million or 16.9% decrease in consumer loans. There were also increases in municipal loans outstanding of $4.4 million or 45.8% and in loans held for sale of $834 thousand or 10.3%. Asset Quality. Union, like all financial institutions, is exposed to certain credit risks related to the value of the collateral that secures its loans and the ability of borrowers to repay their loans. Management closely monitors Union's loan and investment portfolios and other real estate owned for potential problems on a periodic basis and reports to Union's Board of Directors at regularly scheduled meetings. Union had loans on nonaccrual status totaling $1.5 million at September 30, 2000, $951,000 at December 31, 1999 and $912,000 at September 30, 1999. The increase in non-accrual loans between year-end and September 30, 2000 is mainly due to three commercial loan customers whose properties are in the process of foreclosure by Union.. Interest income not recognized on such loans amounted to approximately $228 thousand and $183 thousand as of September 30, 2000 and 1999, respectively and $183 thousand as of December 31, 1999. Union had $3.14 million and $3.17 million in loans past due 90 days or more and still accruing at September 30, 2000 and December 31, 1999, respectively. At September 30, 2000, Union had internally classified certain loans totaling $1.2 million. In management's view, such loans represent a higher degree of risk and could become nonperforming loans in the future. While still on a performing status, in accordance with Union's credit policy, loans are internally classified when a review indicates any of the following conditions making the likelihood of collection highly questionable: * the financial condition of the borrower is unsatisfactory; * repayment terms have not been met; * the borrower has sustained losses that are sizable, either in absolute terms or relative to net worth; * confidence is diminished; * loan covenants have been violated; * collateral is inadequate; or * other unfavorable factors are present. At September 30, 2000, Union had acquired by foreclosure or through repossession real estate worth $137,000, consisting of commercial property, undeveloped land and two residential homes. Allowance for Loan Losses. Some of Union's loan customers ultimately do not make all of their contractually scheduled payments, requiring Union to charge off the remaining principal balance due. Union maintains an allowance for loan losses to absorb such losses. The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. While Union allocates the allowance for loan losses based on the percentage category to total loans, the portion of the allowance for loan losses allocated to each category does not represent the total available for future losses which may occur within the loan category since the total allowance for possible loan losses is a valuation reserve applicable to the entire portfolio. The following table reflects activity in the allowance for loan losses for the quarter and nine months ended September 30, 2000 and 1999: <TABLE> <CAPTION> Quarter Ended, September 30, 9 Months Ended, September 30, ---------------------------- ----------------------------- 2000 1999 2000 1999 ---- ---- ---- ---- (dollars in thousands) <S> <C> <C> <C> <C> Balance at the beginning of period $2,934 $2,890 $2,870 $2,845 Charge-offs: Real Estate 0 8 0 24 Commercial 110 0 126 30 Consumer and other 39 56 163 193 -------------------------------------------------- Total charge-offs 149 64 289 247 -------------------------------------------------- Recoveries: Real Estate 0 1 1 2 Commercial 3 4 32 9 Consumer and other 17 18 66 52 -------------------------------------------------- Total recoveries 20 23 99 63 -------------------------------------------------- Net charge-offs (129) (41) (190) (184) Provision for loan losses 63 62 188 250 -------------------------------------------------- Balance at end of period $2,868 $2,911 $2,868 $2,911 ================================================== </TABLE> The following table shows the breakdown of Union's allowance for loan loss by category of loan and the percentage of loans in each category to total loans in the respective portfolios at the dates indicated: <TABLE> <CAPTION> September 30, December 31, 2000 1999 ------------------- -------------------- (dollars in thousands) Amount Percent Amount Percent ------ ------- ------ ------- <S> <C> <C> <C> <C> Real Estate Residential $ 597 40.1% $ 557 42.3% Commercial 1,104 31.7% 1,014 30.6% Construction 95 4.2% 77 3.7% Other Loans Commercial 518 9.2% 416 8.1% Consumer installment 357 6.7% 448 8.6% Home equity loans 30 1.7% 28 1.8% Municipal, Other and Unallocated 167 6.4% 330 4.9% ------------------------------------------- Total $2,868 100.0% $2,870 100.0% =========================================== Ratio of Net Charge Offs to Average Loans (1) 0.07% 0.16% ----- ----- Ratio of Allowance for Loan Losses to Average Loans 1.35% 1.42% ----- ----- <FN> (1) Annualized </FN> </TABLE> Investment Activities At September 30, 2000, the reported value of investment securities available-for-sale was $55.7 million or 18.1% of its assets. Union had no securities classified as held-to-maturity or trading securities. The reported value of securities available-for-sale at September 30, 2000, reflects a negative valuation adjustment of $1 million. The offset of this adjustment, net of income tax effect, was a $662 thousand decrease in Union's other comprehensive income component of shareholders' equity and an increase in net deferred tax assets of $341,000. Deposits. The following table shows information concerning Union's deposits by account type, and the weighted average nominal rates at which interest was paid on such deposits as of September 30, 2000 and December 31, 1999: <TABLE> <CAPTION> Nine Months Ended, September 30 Year Ended December 31, 2000 1999 ------------------------------- ------------------------------- (dollars in thousands) Percent Percent Average Of Total Average Average of Total Average Amount Deposits Rate Amount Deposits Rate ------- -------- ------- ------- -------- ------- <S> <C> <C> <C> <C> <C> <C> Non-certificate deposits: Demand deposits $ 32,688 12.80% $ 32,505 12.83% Now accounts 32,779 12.84% 1.96% 34,654 13.67% 1.95% Money Markets 53,788 21.07% 4.41% 49,296 19.45% 4.14% Savings 36,428 14.27% 2.71% 38,064 15.02% 2.71% ------------------- ------------------- Total non-certificate deposits: 155,683 60.98% 154,519 60.97% ------------------- ------------------- Certificates of deposit: Less than $100,000 76,783 30.07% 5.17% 78,030 30.79% 5.05% $100,000 and over 22,845 8.95% 5.80% 20,870 8.24% 5.48% ------------------- ------------------- Total certificates of deposit 99,628 39.02% 98,900 39.03% ------------------- ------------------- Total deposits $255,311 100.00% 3.64% $253,419 100.00% 3.49% =================================================================== </TABLE> The following table sets forth information regarding the amounts of Union's certificates of deposit in amounts of $100,000 or more at September 30, 2000 and December 31, 1999 that mature during the periods indicated: <TABLE> <CAPTION> September 30, 2000 December 31, 1999 ------------------ ----------------- (dollars in thousands) <S> <C> <C> Within 3 months $ 6,138 $ 2,301 3 to 6 months 4,651 11,872 6 to 12 months 8,048 3,751 Over 12 months 4,771 3,491 ------------------------------ $23,608 $21,415 ============================== </TABLE> Borrowings. Borrowings from the Federal Home Loan Bank of Boston were $10.5 million at September 30, 2000 at a weighted average rate of 6.75%. Borrowings from the Federal Home Loan Bank of Boston were $2.9 million at December 31, 1999 at a weighted average rate of 5.94%. The change between year end 1999 and the end of the third quarter of 2000 is a net increase of $7.6 million in borrowing to fund loan demand. Other Financial Considerations Market Risk and Asset and Liability Management. Market risk is the risk of loss in a financial instrument arising from adverse changes in market prices and rates, foreign currency exchange rates, commodity prices and equity prices. Union's market risk arises primarily from interest rate risk inherent in its lending and deposit taking activities. To that end, management actively monitors and manages its interest rate risk exposure. Union does not have any market risk sensitive instruments acquired for trading purposes. Union attempts to structure its balance sheet to maximize net interest income while controlling its exposure to interest rate risk. Union's Asset/Liability Committee formulates strategies to manage interest rate risk by evaluating the impact on earnings and capital of such factors as current interest rate forecasts and economic indicators, potential changes in such forecasts and indicators, liquidity, and various business strategies. Union's Asset/Liability Committee's methods for evaluating interest rate risk include an analysis of Union's interest-rate sensitivity "gap", which provides a static analysis of the maturity and repricing characteristics of Union's entire balance sheet, and a simulation analysis, which calculates projected net interest income based on alternative balance sheet and interest rate scenarios, including "rate shock" scenarios involving immediate substantial increases or decreases in market rates of interest. Union's Asset/Liability Committee meets at least weekly to set loan and deposit rates, make investment decisions, monitor liquidity and evaluate the loan demand pipeline. Deposit runoff is monitored daily and loan prepayments evaluated monthly. Union historically has maintained a substantial portion of its loan portfolio on a variable rate basis and plans to continue this ALM strategy in the future. The investment portfolio is classified as available for sale and the modified duration is relatively short. Union does not utilize any derivative products or invest in any "high risk" instruments. Our interest rate sensitivity analysis (simulation) as of December 1999 for a flat rate environment projected a Net Interest Income of $10.4 million for the first nine months of 2000 compared to actual results of $10.6 million in a rising rate environment, or a 2.3% difference. Union anticipated an increase in our net interest margin in the rising rate environment but it was somewhat mitigated by the placement of three commercial loan customers into non-accrual during the second quarter of 2000. Net income was projected to be $2.9 million compared to actual results of $3.5 million. The $644 thousand increase in Net Income from projections is mainly due to the increase in Net Interest Income, the unanticipated $123,000 in tax credits for rehabilitation snd low income housing taken to date in 2000, the gain on securities sold, the reduction in equipment expense from what had been anticipated and higher investments in tax free municipal lending. Return on Assets was projected to be 1.65% and actual results were 1.57%. Rrturn on Equity was projected to be 14.54% compared to actual of 14.43%. The results of these ratios is based on higher net income as explained above offset by higher average assets and stockholders' equity than had been anticipated. The Company generally requires collateral or other security to support financial instruments with credit risk. As of September 30, 2000, the contract or notional amount of financial instruments whose contract amount represents credit risk were as follows: <TABLE> <S> <C> Commitments to extend credit $15,096,000 Standby letters of credit and commercial letters of credit $ 689,000 Credit Card arrangements $ 2,092,000 Home Equity Lines of Credit $ 3,728,000 </TABLE> 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. Interest Rate Sensitivity "Gap" Analysis. An interest rate sensitivity "gap" is defined as the difference between interest-earning assets and interest-bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to affect net interest income adversely. Because different types of assets and liabilities with the same or similar maturities may react differently to changes in overall market interest rates or conditions, changes in interest rates may affect net interest income positively or negatively even if an institution were perfectly matched in each maturity category. Union prepares its interest rate sensitivity "gap" analysis by scheduling interest-earning assets and interest-bearing liabilities into periods based upon the next date on which such assets and liabilities could mature or reprice. The amounts of assets and liabilities shown within a particular period were determined in accordance with the contractual terms of the assets and liabilities, except that: * adjustable-rate loans, securities, and FHLB advances are included in the period when they are first scheduled to adjust and not in the period in which they mature; * fixed-rate mortgage-related securities reflect estimated prepayments, which were estimated based on analyses of broker estimates, the results of a prepayment model utilized by Union, and empirical data; * fixed-rate loans reflect scheduled contractual amortization, with no estimated prepayments; and * NOW, money markets, and savings deposits, which do not have contractual maturities, reflect estimated levels of attrition, which are based on detailed studies by Union of the sensitivity of each such category of deposit to changes in interest rates. Management believes that these assumptions approximate actual experience and considers them reasonable. However, the interest rate sensitivity of Union's assets and liabilities in the tables could vary substantially if different assumptions were used or actual experience differs from the historical experience on which the assumptions are based. The following tables show Union's rate sensitivity analysis as of September 30, 2000: <TABLE> <CAPTION> September 30, 2000 Cumulative repriced within ---------------------------------------------------------------------------- 3 Months 4 to 12 1 to 3 3 to 5 Over 5 or Less Months Years Years Total Total -------- ------- ------ ------ ------ ----- (dollars in thousands, by repricing date) <S> <C> <C> <C> <C> <C> <C> Interest sensitive assets: Federal Funds Sold $ 5,355 $ -0- $ -0- $ -0- $ -0- $ 5,355 Interest bearing deposits 396 685 771 191 -0- 2,043 Investments available for sale (1) -0- 5,770 17,333 13,761 17,845 54,709 FHLB Stock -0- -0- -0- -0- 1,016 1,016 Loans (fixed and adjustable rate) 57,888 42,657 17,093 26,018 81,604 225,260 ------------------------------------------------------------------------------ Total interest sensitive assets $ 63,639 $ 49,112 $ 35,197 $ 39,970 $100,465 $288,383 ============================================================================== Interest sensitive liabilities: Certificates of deposit $ 27,434 $ 51,713 $ 18,893 $ 863 $ -0- $ 98,903 Money markets 25,705 -0- -0- -0- 29,218 54,923 Regular savings 3,859 -0- -0- -0- 32,996 36,855 Now accounts 17,715 -0- -0- -0- 16,562 34,277 Borrowed funds 4,074 2,225 3,116 639 410 10,464 ------------------------------------------------------------------------------ Total interest sensitive liabilities $ 78,787 $ 53,938 $ 22,009 $ 1,502 $ 79,186 $235,422 ============================================================================== Net interest rate sensitivity gap (15,148) (4,826) 13,188 38,468 21,279 52,961 Cumulative net interest rate Sensitivity gap (15,148) (19,974) (6,786) 31,682 52,961 Cumulative net interest rate sensitivity gap as a percentage of total assets (4.93)% (6.50)% (2.21)% 10.31% 17.24% Cumulative interest sensitivity gap as a percentage of total interest-earning assets (5.25)% (6.93)% (2.35)% 10.99% 18.36% Cumulative net interest earning assets as a percentage of cumulative interest-bearing liabilities (6.43)% (8.48)% (2.88)% 13.46% 22.50% <FN> (1) Investments available for sale exclude marketable equity securities with a fair value of $998,000 which may be sold by Union at any time. </FN> </TABLE> Simulation Analysis. In its simulation analysis, Union uses computer software to simulate the estimated impact on net interest income and capital under various interest rate scenarios, balance sheet trends, and strategies. These simulations incorporate assumptions about balance sheet dynamics such as loans and deposit growth, product pricing, changes in funding mix, and asset and liability repricing and maturity characteristics. Based on the results of these simulations, Union is able to quantify its interest rate risk and develop and implement appropriate strategies. The following chart reflects the results of our latest simulation analysis for each of the next three year ends on Net Interest Income, Net Income, Return on Assets, Return on Equity and Capital Value. The projection utilizes a rate shock of 150 basis points from the current prime rate of 9.5%, this is the highest internal slope monitored and shows the best and worse scenarios analyzed. This slope range was determined to be the most relevant during this economic cycle. UNION BANKSHARES, INC. INTEREST RATE SENSITIVITY ANALYSIS MATRIX SEPTEMBER 30, 2000 (in thousands) <TABLE> <CAPTION> Return on Return on Year Prime Net Interest Change Net Assets Equity Capital Change Ending Rate Income % Income % % Value % ------ ----- ------------ ------ ------ --------- --------- ------- ------ <S> <C> <C> <C> <C> <C> <C> <C> <C> December-00 11.00 14,126 0.68 4,955 1.66 14.59 17,101 (32.03) 9.50 14,030 0.00 4,893 1.63 14.42 25,162 00.00 8.00 13,935 (0.68) 4,830 1.61 14.24 34,101 35.53 December-01 11.00 14,829 2.68 5,559 1.80 15.06 22,226 (23.91) 9.50 14,442 0.00 5,299 1.72 14.43 29,211 00.00 8.00 14,059 (2.65) 5,041 1.63 13.80 36,971 26.57 December-02 11.00 15,183 3.73 5,821 1.82 14.51 26,607 (19.45) 9.50 14,637 0.00 5,449 1.71 13.76 33,034 00.00 8.00 14,102 (3.66) 5,084 1.60 13.10 40,178 21.63 </TABLE> Liquidity. Liquidity is a measurement of Union's ability to meet potential cash requirements, including ongoing commitments to fund deposit withdrawals, repay borrowings, fund investment and lending activities, and for other general business purposes. Union's principal sources of funds are deposits, amortization and prepayment of loans and securities, maturities of investment securities and other short-term investments, sales of securities available-for-sale, and earnings and funds provided from operations. In addition, as members of the FHLB, Union's subsidiaries have access to preapproved lines of credit up to 2.15% of total assets or $6.6 million. In addition, both subsidiaries maintain Federal Fund lines of credit with upstream correspondent banks and repurchase agreement lines with selected brokerage houses. While scheduled loan and securities payments and FHLB advances are relatively predictable sources of funds, deposit flows and prepayments on loans and mortgage-backed securities are greatly influenced by general interest rates, economic conditions, and competition. Union's liquidity is actively managed on a daily basis, monitored by the Asset/Liability Committee, and reviewed periodically with the Board of Directors. Union's Asset/Liability Committee sets liquidity targets based on Union's financial condition and existing and projected economic and market conditions. The committee measures Union's marketable assets and credit available to fund liquidity requirements and compares the adequacy of that aggregate amount against the aggregate amount of Union's sensitive or volatile liabilities, such as core deposits and time deposits in excess of $100,000, term deposits with short maturities, and credit commitments outstanding. The committee's primary objective is to manage Union's liquidity position and funding sources in order to ensure that it has the ability to meet its ongoing commitment to its depositors, to fund loan commitments, and to maintain a portfolio of investment securities. Since many of the loan commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Union's management monitors current and projected cash flows and adjusts positions as necessary to maintain adequate levels of liquidity. Although approximately 78.3% of Union's certificates of deposit will mature within twelve months, management believes, based upon past experience, that Union will retain a substantial portion of these deposits. Management will continue to offer a competitive but prudent pricing strategy to facilitate retention of such deposits. Any reduction in total deposits could be offset by purchases of federal funds, short-term FHLB borrowings, or liquidation of investment securities or loans held for sale. Such steps could result in an increase in Union's cost of funds and adversely impact the net interest margin. Regulatory Capital Requirements.: Union Bank and Citizens (the Banks) are subject to various regulatory capital requirements administered by the federal banking agencies. Management believes, as of September 30, 2000 that the Banks meet all capital adequacy requirements to which they are subject. As of September 30, 2000, the most recent notification from the FDIC categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Banks must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. There are no conditions or events since the notification that management believes have changed either Bank's category. The Banks' actual capital amounts (000's omitted) and ratios are presented in the table: <TABLE> <CAPTION> Minimums To Be Well Minimums Capitalized Under For Capital Prompt Corrective Actual Requirements Action Provisions ------------------ ----------------- ------------------ Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- <S> <C> <C> <C> <C> <C> <C> As of September 30, 2000: Total capital to risk weighted assets Union Bank $25,204 18.47% $10,917 8.0% $13,646 10.0% Citizens 11,972 17.67% 5,420 8.0% 6,775 10.0% Tier I capital to risk weighted assets Union Bank $23,331 17.10% $ 5,458 4.0% $ 8,186 6.0% Citizens 11,122 16.41% 2,711 4.0% 4,067 6.0% Tier I capital to average assets Union Bank $23,331 11.41% $ 8,179 4.0% $10,224 5.0% Citizens 11,122 11.07% 4,019 4.0% 5,023 5.0% Impact of Inflation and Changing Prices. Union's consolidated financial statements, included in this document, have been prepared in accordance with generally accepted accounting principles, which require the measurements of financial position and results of operations in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Banks have asset and liability structures that are essentially monetary in nature, and their general and administrative costs constitute relatively small percentages of total expenses. Thus, increases in the general price levels for goods and services have a relatively minor effect on Union's total expenses. Interest rates have a more significant impact on Union's financial performance than the effect of general inflation. Interest rates do not necessarily move in the same direction or change in the same magnitude as the prices of goods and services, although periods of increased inflation may accompany a rising interest rate environment. PART II OTHER INFORMATION ITEM 6: EXHIBITS AND REPORTS IN FORM 10-Q A. Exhibits. 27 - Financial Data Schedule B. Current Reports on Form 8-K Report to Shareholders on Third Quarter Results filed on October 16, 2000 Press Release announcing declaration of a third quarter dividend filed on October 6, 2000 Press Release announcing an increase in third quarter earnings and a dividend filed on October 6, 2000 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. November 14, 2000 Union Bankshares, Inc. s/ Kenneth D. Gibbons Kenneth D. Gibbons Director and Chief Executive Officer s/ Marsha A. Mongeon Marsha A. Mongeon Chief Financial Officer and Treasurer </TABLE>