UNB

Union Bankshares Inc. 10-Q Summary: Q1 2009

Business Context and Reporting Period

This report covers the quarterly period ended March 31, 2009, for Union Bankshares, Inc., a smaller reporting company headquartered in Morrisville, Vermont. The Company operates primarily through its subsidiary, Union Bank, providing financial services in Vermont and northwestern New Hampshire. The filing reflects operations during a period of significant stress in the U.S. and global financial markets, characterized by historic low interest rates and economic uncertainty.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income Decline: Net income decreased by $139,000 (9.9%) compared to Q1 2008. This was driven by a higher provision for loan losses ($95k vs. $50k), increased FDIC insurance assessments ($123k increase), and a higher effective tax rate (22.2% vs. 11.1% in 2008, where a tax credit was received).
• Interest Rate Environment: The prime rate dropped from 7.25% in Jan 2008 to 3.25% by March 2009. While total interest income fell 6.6%, interest expense fell 22.8%, resulting in a slight 0.5% increase in Net Interest Income ($4.36 million vs. $4.34 million). However, the Net Interest Margin compressed by 40 basis points.
• Balance Sheet Contraction: Total assets decreased 4.2% ($18.3 million) and deposits decreased 4.9% ($17.9 million) from year-end 2008. This was attributed to seasonal declines and a tightening economy, specifically a $13.3 million drop in commercial noninterest-bearing deposits.
• Asset Quality: Net charge-offs increased to $127,000 in Q1 2009 from $27,000 in Q1 2008. Non-performing assets (loans in nonaccrual status plus loans 90+ days past due) totaled $6.8 million (1.85% of total assets), up from 1.70% in Q1 2008.
• Noninterest Income: Increased 14.1% to $1.28 million, primarily due to higher net gains on sales of loans held for sale ($229k vs. $158k) and increased mortgage servicing rights income.

Guidance, Outlook, and Risks

• Dividend Reduction: Citing economic uncertainty, the upcoming FDIC special assessment, and mark-to-market accounting impacts, the Board declared a quarterly dividend of $0.25 per share, a reduction from the previous $0.28 per share, to preserve capital strength.
• FDIC Assessments: The Company anticipates a significant increase in FDIC insurance premiums for 2009. A special assessment of up to 20 basis points is expected, potentially bringing total 2009 assessments to approximately $1.27 million compared to $87,000 in 2008.
• Government Programs: The Company opted out of the TARP Capital Purchase Program but participated in the Temporary Liquidity Guarantee Program for noninterest-bearing transaction deposits. Management believes its capital position is strong enough to withstand current market conditions without government capital injection.
• Market Risks: The Company faces risks from further deterioration in the real estate market, rising unemployment, and the potential for unrealized losses on investment securities to become "other-than-temporary" impairments (OTTI). Interest rate sensitivity analysis indicates that a 300 basis point increase in rates could negatively impact the Net Fair Value Ratio below internal guidelines.
• Outlook: Management remains cautiously optimistic about loan collectability, noting that Vermont has lower foreclosure rates than the national average. Loan demand remains strong due to low rates, though the Company is selling originated residential mortgages to the secondary market to mitigate interest rate risk.

Investor Verification Checklist

• FDIC Assessment Impact: Verify the final amount of the special FDIC assessment and its impact on 2009 earnings, as the $718k estimate is contingent on Senate action.
• Asset Quality Trends: Monitor the ratio of non-performing assets to total assets (currently 1.85%) and the adequacy of the allowance for loan losses (1.02% of loans) given the rising net charge-offs.
• Investment Portfolio Impairment: Review the $366k in unrealized losses on available-for-sale securities to ensure management's assessment of "temporary" impairment remains valid as market conditions evolve.
• Deposit Stability: Track the composition of deposits, specifically the runoff of noninterest-bearing commercial deposits and the reliance on time deposits maturing within 12 months (approx. 85%).
• Dividend Policy: Confirm if the reduced dividend rate of $0.25 per share becomes the new standard or if it is a temporary measure.