UNION BANKSHARES INC annual report, FY2018

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Union Bankshares, Inc. — 2018 Form 10-K

Business context and reporting period

This annual report covers the fiscal year ended December 31, 2018, with comparisons to 2017 and 2016. Union Bankshares is a Vermont bank holding company whose sole subsidiary, Union Bank, operates a community banking business in northern Vermont and New Hampshire. The bank provides retail, commercial and municipal banking, lending, and trust and asset management services.

Financial performance and position

  • Profitability: Net income was $7.1 million, down 16.3% from $8.4 million in 2017; diluted earnings per share was not materially different from basic EPS of $1.58, compared with $1.89 in 2017. GAAP income before taxes was $8.3 million. Management’s non-GAAP measure excluding the pension termination expense was net income of $10.8 million, or $2.42 per share.
  • Revenue and margin: Interest and dividend income was $32.2 million; net interest income was $28.6 million, up 6.9%. Noninterest income was $9.5 million, up 0.8%. Net interest margin declined to 4.08% from 4.22%, while the net interest spread fell to 3.95% from 4.13%.
  • Expenses and taxes: Noninterest expense rose 22.8% to $29.4 million, largely due to $4.6 million of pension expense, including a $4.0 million settlement loss. The effective tax rate fell to 14.4% from 29.9%, principally reflecting the lower federal corporate tax rate and a $900,000 tax benefit related to the pension settlement.
  • Assets and lending: Total assets increased 8.0% to $805.3 million. Gross loans and loans held for sale rose 8.5% to $645.4 million; net loans were $637.7 million. Loans were 80.1% of assets, and real-estate-secured loans were 80.9% of total loans.
  • Credit quality: Nonperforming assets were $2.0 million, or 0.24% of assets, versus $1.7 million, or 0.23%, in 2017. The allowance for loan losses was $5.7 million, 0.89% of loans not held for sale; net charge-offs were 0.02% of average loans. The allowance covered 293.4% of nonperforming loans.
  • Funding and liquidity: Deposits increased 9.1% to $706.8 million. Borrowed funds declined 11.9% to $27.8 million. Year-end cash and cash equivalents were $37.3 million. The bank reported $54.5 million of remaining FHLB borrowing capacity and a $15 million correspondent-bank federal funds line, with no outstanding balance on that line. Deposit growth included purchased CDARS deposits.
  • Cash flow and capital: Operating cash flow was $16.8 million; investing activities used $68.0 million and financing activities provided $50.0 million, resulting in a $1.2 million decrease in cash and cash equivalents. Stockholders’ equity rose 9.9% to $64.5 million. The bank’s total risk-based capital ratio was 12.82%, and it was classified as well capitalized. Dividends paid were $1.20 per share.

Changes versus prior periods

  • Net interest income grew with loan and earning-asset expansion, but higher deposit and borrowing costs compressed the net interest margin.
  • Reported earnings fell despite higher net interest income, principally because of the pension plan termination and settlement expense. The fourth quarter recorded a net loss of $436,000, compared with net income of $1.9 million in fourth-quarter 2017.
  • Loans and deposits both expanded; purchased CDARS deposits contributed to funding, while year-end borrowing balances decreased.
  • Nonperforming loans increased to $2.0 million from $1.7 million, although the nonperforming-asset ratio remained low. The allowance-to-loans ratio declined to 0.89% from 0.92%.

Outlook, risks and unusual items

  • The defined benefit pension plan was fully settled by year-end 2018. Management said the company would have no remaining obligations or related periodic pension expense in future periods.
  • The filing provides no formal earnings or revenue guidance. Management described itself as cautiously optimistic about loan collectability and reported favorable local employment and tourism conditions, while noting that future outcomes remain uncertain.
  • Management warned that further interest-rate increases could require higher deposit rates and pressure margins. Its December 2018 interest-rate model showed projected net interest income changes of -30% under both a 200-basis-point rise and a 200-basis-point fall, and -45% under a 300-basis-point rise. The company cautioned that these are modeled sensitivities, not forecasts.
  • Principal risks include concentration in Vermont and New Hampshire, substantial real estate and commercial lending exposure, borrower and collateral deterioration, competition for deposits, funding costs, interest-rate risk, regulation, cybersecurity and third-party technology risks, and the potential for credit losses exceeding the allowance.
  • Off-balance-sheet commitments totaled $139.8 million, including $109.5 million of unused lines of credit and $22.7 million of loan-originating commitments. These amounts do not necessarily represent expected cash outflows because some commitments may not be drawn.
  • Auditors issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded that controls were effective. The filing reported no material pending litigation or active enforcement actions.

Important facts for investors to verify

  • Reconcile the $4.6 million pension expense and related tax benefit to the non-GAAP earnings adjustment, and assess the sustainability of earnings after the plan termination.
  • Review deposit composition and pricing, including purchased and reciprocal deposits, large time-deposit maturities, and the effect of rising rates on funding costs and net interest margin.
  • Assess commercial, commercial real estate and construction exposure, local-market concentration, delinquencies, nonperforming loans, TDRs and allowance adequacy.
  • Evaluate the assumptions behind the interest-rate sensitivity scenarios and the bank’s capacity to manage liquidity and commitments if deposit outflows or loan draws rise.
  • Track implementation of the expected-credit-loss standard (CECL), which the filing said was under preparation, and any resulting effect on provisions and capital.
  • Confirm subsequent dividend declarations and regulatory capital levels; the board declared a $0.31-per-share quarterly dividend in January 2019.