UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
( ) TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005 Commission file number 001-15985
UNION BANKSHARES, INC.
VERMONT 03-0283552
P.O. BOX 667
MAIN STREET
MORRISVILLE, VT 05661
Registrant's telephone number: 802-888-6600
Former name, former address and former fiscal year,
if changed since last report: Not applicable
Securities registered pursuant to section 12(b) of the Act:
Common Stock, $2.00 par value
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(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes[X] No [ ]
Indicate by check mark 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. [X]
Indicate by check mark whether the registrant is a large accelerated filer
an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer", in Rule 12b-2 of the
Exchange Act. (check one):
Large accelerated filer [ ] Accelerated filer [ ] Non-accelerated [X]
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the common stock held by non-affiliates of
the registrant on June 30, 2005 was $67,766,573 based on the closing price
on the American Stock Exchange on such date of $21.85 per share. For
purposes of this calculation, all directors and executive officers of the
Registrant are assumed to be affiliates. Such assumption, however, shall
not be deemed to be an admission of such status as to any such individual.
As of March 10, 2006, there were 4,541,032 shares of the registrant's $2
par value common stock issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Specifically designated portions of the following documents are
incorporated by reference in the indicated Part of this Annual Report on
Form 10-K:
Document Part
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Annual Report to Shareholders for the year ended December 31, 2005 I, II
Proxy Statement for the 2006 Annual Meeting of Shareholders III
1
UNION BANKSHARES, INC.
Table of Contents
Part I
Item 1-Business 3
Item 1A- Risk Factors 10
Item 1B-Unresolved Staff Comments 13
Item 2-Properties 13
Item 3-Legal Proceedings 13
Item 4-Submission of Matters to a Vote of Security Holders 14
Part II
Item 5-Market for Registrant's Common Equity, Related Stockholder
Matters, and Issuer Purchases of Equity Securities (a) 14
Item 6-Selected Financial Data 15
Item 7-Management's Discussion and Analysis of Financial Condition and
Results of Operations (a) 16
Item 7A-Quantitative and Qualitative Disclosures about Market Risk (a) 16
Item 8-Financial Statements and Supplementary Data (a) 16
Item 9-Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures 16
Item 9A-Controls and Procedures (a) 16
Item 9B-Other Information 16
Part III
Item 10-Directors and Executive Officers of Registrant (a) (b) 16
Item 11-Executive Compensation (b) 17
Item 12-Security Ownership of Certain Beneficial Owners and Management
and Related Stockholder Matters (b) 17
Item 13-Certain Relationships and Related Transactions (b) 17
Item 14- Principal Accountant Fees and Services (b) 17
Part IV
Item 15-Exhibits and Financial Statement Schedules 18
Signatures 19
Exhibit Index 20
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(a) The information required by Part I, Item 2 and Part II, Items 5, 7,
7A, and 8 is incorporated herein by reference, in whole or in part,
from the 2005 Annual Report to Shareholders.
(b) The information required by Part III Items 10, 11, 12, 13 and 14 is
incorporated herein by reference, in whole or in part, from the
Company's Proxy Statement for the Annual Meeting of Shareholders to
be held on May 17, 2006. The incorporation by reference herein of
portions of the Proxy Statement shall not be deemed to specifically
incorporate by reference the information referred to in Items 306(c),
306(d) and 402 (a)(8) and (9) of Regulation S-K.
2
Part I-Item 1 Business
General: Union Bankshares, Inc. (the "Company") is a one-bank holding
company whose subsidiary is Union Bank ("Union"). It was incorporated in
the State of Vermont in 1982. Union Bank was organized and chartered as a
State bank in 1891 and became a wholly owned subsidiary of the Company in
1982 upon its formation. Both Union Bankshares, Inc. and Union Bank are
headquartered in Morrisville, Vermont.
The Company has one definable business segment, Union Bank, which is a
commercial bank in Northern Vermont. Union is a community bank that
provides a full range of commercial and retail banking services. The
purpose of Union is to make a profit for the Company while competitively
serving the financial needs of the communities, the businesses, and the
citizens within its service area. The Company is in the financial services
business and no lines of financial products are beyond its purview as long
as the Company is equipped and capable of delivering the products
efficiently and effectively within the regulated environment in which it
operates.
Union has 157 full time equivalent employees and considers its employee
relations to be satisfactory. The Company, itself, does not have any paid
employees.
The Company's income is derived principally from interest on loans and
earnings on other investments. Its primary expenses arise from interest
paid on deposits and borrowings and general overhead expenses. The
consolidated assets of the Company have grown from $303 million to $375
million over the last five years or 23.8% while consolidated deposits have
grown from $259 million to $313 million or 20.8% during that same period.
Please refer to the schedule of "Selected Financial Data", which has been
restated for applicable periods for the 3 for 2 stock split in 2003, at
Part II-Item 6 of this annual report for further details.
Description of Services: The Company offers full retail and commercial
banking services to its customers. The Company primarily emphasizes
providing retail banking services to individuals living within its market
area and commercial banking services to corporations, partnerships, small
and medium-sized businesses and sole proprietorships, as well as non-profit
organizations, local municipalities and school districts. The Company's
activities are targeted at increasing residential mortgage and construction
loan originations, and expanding commercial and municipal lending including
the commercial real estate market. The Company utilizes its lending
activities to develop broader customer relationships in areas served by its
network of branches. The Company produces loans primarily for its
portfolio although it periodically sells or participates out a portion of
the loans produced to mitigate interest rate or credit risk. See
"Discussion of Financial Condition" in Part II-Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
("MD&A") for information on the composition of the Company's loan portfolio
by type of loan including loans held for sale and on asset quality.
The Company's retail loan portfolio consists primarily of mortgage loans,
construction (B.U.I.L.D.) loans, home equity loans and lines of credit and
traditional installment loans. The Company's commercial loan portfolio
consists of term loans, lines of credit and commercial real estate loans
provided to primarily locally based borrowers. The municipal loan
portfolio consists of term loans and construction financing. Traditional
installment loans and personal lines of credit are available.
Services offered to our customers include, but are not limited to, the
following:
* Commercial loans for business purposes to business owners and
investors for plant and equipment, lines of credit, working
capital, real estate renovation, and other sound business
purposes;
* Commercial real estate loans on income producing properties
including commercial construction loans;
* SBA guaranteed loans;
* Cash Management services, including account reconciliation,
credit card depository, Automated Clearing House origination,
wire transfers, night depository;
* Municipal term loans and construction financing
* Merchant credit card services for the deposit and immediate
credit of sales drafts from retail merchants, restaurants,
professionals and the local tourism industry;
* Debit MasterCard and VISA credit cards;
* Business checking accounts;
* Other services based on the individual needs of the customer
including standby letters of credit, travelers or bank checks,
and safe deposit boxes;
* Automated Teller Machine ("ATM") services and cards;
* Telephone and Internet banking services including bill pay;
* Home improvement loans, home equity lines of credit, and
overdraft checking privileges against preauthorized lines of
credit;
* Residential mortgage loans;
* B.U.I.L.D. loans for residential construction;
* Retail depository services including personal checking
accounts, NOW accounts, savings accounts, money market
accounts, certificates of deposit, and IRA/SEP/KEOGH accounts.
The deposits of Union are insured by the Bank Insurance Fund of
the Federal Deposit Insurance Corporation ("FDIC") up to legal
limits (generally $100,000 per depositor) with higher levels of
3
insurance coverage available through Union's participation in
the Certificate of Deposit Account Registry Service ("CDARS")
of Promontory Interfinancial Network; and
* Trust and Asset Management services to individuals and
organizations.
The direct lending activities in which the Company engages each carries the
risk that the borrowers will be unable to perform on their obligations. As
such, the monetary and fiscal policies of the Federal Reserve Board and
general economic conditions, nationally, regionally and in the Company's
primary market area have a significant impact on the Company and its
results of operations. To the extent that economic conditions deteriorate,
business and individual borrowers may be less able to meet their
obligations to the Company in full, in a timely manner, resulting in
decreased earnings or losses to the Company. To the extent that loans are
secured by real estate, adverse conditions in the real estate market may
reduce the borrower's ability to generate the necessary cash flow for
repayment of the loan, and reduce the Company's ability to collect the full
amount of the loan upon a default. To the extent the Company makes fixed
rate loans, general increases in interest rates will tend to reduce the
Company's spread as the interest rates it must pay for deposits increase
while interest income is flat. Economic conditions and interest rates may
also adversely affect the value of property pledged as security for loans.
Whenever appropriate and available, the Company seeks federal and state
loan guarantees, such as the Small Business Administration's ("SBA") "7A" and
"504" loan programs to reduce risks. Union is a preferred SBA lender. The
Company generally requires personal guarantees on all commercial loans. The
majority of commercial borrowers are required to forward annual business and
personal financial statements to comply with bank policy. Interest rate risks
to the Company are mitigated by using either variable interest rates, by
fixing rates for a short period of time, or selling/participating a portion
of loans originated.
Consistent with the objective of the Company to serve the needs of
individuals, businesses and others within the communities served, the
Company seeks to concentrate its assets in loans. To be consistent with the
requirements of prudent banking practices, adequate assets are invested
in high-grade securities to provide liquidity, diversification of income
sources and safety. See "Discussion of Financial Condition" in Part II-
Item 7, "MD&A" for information on the composition of Union's investment
portfolio by type and maturity.
The risk of nonpayment (or deferred payment) of loans is inherent in
commercial banking. The Company's marketing focus on individuals and small
to medium-sized businesses may result in the assumption by it of certain
lending risks. Management carefully evaluates all loan applications and
attempts to minimize credit risk exposure by use of thorough loan
application, approval and monitoring procedures, however, there can be no
assurance that such procedures will entirely reduce such lending risks.
Source of Business: Management believes that the market segments targeted,
individuals, small to medium sized businesses, and municipalities in the
Company's market area, demand the convenience and personal service that a
smaller, independent financial institution can offer. It is these themes of
convenience and personal service that form the basis of the Company's
business development strategies. At December 31, 2005, Union maintained 12
branch offices, loan production offices in Littleton, New Hampshire and St.
Albans, Vermont, and 28 ATMs, and also provided many of its services via
the telephone and the Internet.
Management's operational strategy includes continued evaluation of changing
market needs and design and implementation of products and services to meet
those needs, which included the opening of a new loan production office in
St. Albans, Vermont in January 2005 which is a further westward expansion
in Franklin County of the Company's service area and the redesign of
Union's personal deposit products to become more competitive in the market.
The strategies for 2006 include the opening of a full service branch
location in Littleton, New Hampshire in March 2006 and the introduction of
a new, more competitive small business checking account also in March 2006.
The directors and management of the Company intend to continue to offer
products and services that will allow the Company to manage responsibly the
growth of its assets, while building and enhancing stockholder value,
preserving Union Bank's image as a premier Vermont community bank and fully
entering into the northern New Hampshire market.
The Company seeks to capitalize upon the extensive business and personal
contacts and relationships of its Directors, Advisory Board members and
Officers to continue to develop the Company's customer base, as well as
relying on Director and Advisory Board referrals, officer-originated
calling programs and customer and shareholder referrals.
Competition: The Company and Union face substantial competition for loans
and deposits in their market area from local commercial banks, savings
banks, tax-exempt credit unions, mortgage brokers, and financial services
affiliates of bank holding companies, as well as from national financial
service providers such as mutual funds, brokerage houses, insurance
companies, consumer finance companies and internet banks. The Company
anticipates continued strong competition from such financial institutions
for the foreseeable future. Within the Company's market area are branches
of several commercial and savings banks that are substantially larger than
the Company. Union focuses on its community banking niche and on providing
convenient locations, hours and modes of delivery to provide superior
customer service. In order to compete with the larger financial
institutions in its service area, Union uses the flexibility and local
autonomy which is accorded by its independent status. This includes an
emphasis on personal service, local promotional activity, and personal
contacts and community service by Union's officers, directors and
employees.
The Company competes for checking, savings, money market accounts and other
deposits by offering depositors competitive products and rates, personal
service, local area expertise, convenient locations and access, and an
array of financial services and products.
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The competition in originating real estate and other loans comes
principally from commercial banks, mortgage banking companies and credit
unions. The Company competes for loan originations primarily through the
interest rates and loan fees it charges, the types of loans it offers, and
the efficiency and quality of services it provides. In addition to
residential mortgage lending and municipal loans, the Company also
emphasizes commercial real estate, construction, and both conventional and
Small Business Administration ("SBA") guaranteed commercial lending. Union
is a preferred SBA lender. Factors that affect the Company's ability to
compete for loans include general and local economic conditions, prevailing
interest rates including the "prime" rate, and pricing volatility of the
secondary loan markets. The Company attempts to promote an increased level
of personal service and expertise within the community to position itself
as a lender to small to middle market business and residential customers,
which tend to be under-served by larger institutions.
The Company competes for personal trust business with trust companies,
commercial banks having trust departments, investment advisory firms,
brokerage firms, mutual funds and insurance companies.
The competitive environment for financial institutions has undergone
significant change in recent years and that trend is likely to continue in
light of changes in applicable law (see "Financial Services Modernization"
below) which permit the integration of the historically separate banking,
insurance and securities industries. Tax-exempt credit unions are becoming
an increasingly significant source of competition. Credit union common
bond requirements and the definition of a credit union "member" have been
interpreted liberally by federal and state credit union regulators while at
the same time, the scope of products credit unions are permitted to offer
has steadily expanded, resulting in greater penetration of this tax-
advantaged segment of the financial services industry into traditional
banking markets. In February of 2003, the SBA expanded the eligibility of
certain lenders programs to include all credit unions. In addition, during
2005, Vermont's credit union statute was comprehensively updated, granting
state-chartered credit unions significantly expanded powers to offer
financial products and services beyond those traditionally offered by
credit unions.
Competitive change is also occurring due to rapid technological advances
which increasingly permit the delivery of financial products and services
without the need for a physical presence in the market area served and
which also are likely to diminish the importance of financial
intermediaries, such as banks, in the transfer of funds between parties.
As a result, the Company's future success will depend in part on its
ability to address customers' needs by using technology.
Regulation and Supervision: The following discussion describes certain
material elements of an extensive regulatory framework applicable to bank
holding companies and their subsidiaries and provides certain information
specific to the Company. This regulatory framework is intended primarily
for the protection of depositors, federal deposit insurance funds and the
banking system as a whole, and not for the protection of security holders.
To the extent that this information describes statutory and regulatory
provisions, it is qualified in its entirety by reference to those
provisions.
As a Vermont-chartered commercial bank, Union is subject to regulation,
examination, and supervision by the Vermont Banking Department and the
FDIC. Regular examinations of Union by the Vermont Banking Department and
the FDIC include examination of the bank's financial condition and
operations, including but not limited to its capital adequacy, loan
reserves, loans, investments, earnings, liquidity, compliance with laws and
regulations, record of performance under the federal Community Reinvestment
Act of 1997 ("CRA"), and the performance of its management.
In addition the Company, as a bank holding company, is subject to
regulation, examination and supervision by the Federal Reserve Board
("FRB"). The regulations of these authorities govern certain of the
operations of the Company and its subsidiary. The following discussion
summarizes the material aspects of various federal and state banking laws
and regulations that apply to the Company and Union.
The Company is also under the jurisdiction of the Securities and Exchange
Commission ("SEC") for matters relating to the offering and sale of its
securities as well as investor reporting requirements. The Company is
subject to restrictions, reporting requirements and review procedures under
federal securities laws and regulations. The Company's common stock is
listed on the American Stock Exchange ("AMEX") under the trading symbol
"UNB" and is subject to the rules of AMEX for listed companies.
Federal Reserve Board Policies and Reserve Requirements. The monetary
policies and regulations of the FRB have had a significant effect on the
operating results of banks in the past and are expected to continue to do
so in the future. FRB policies affect the levels of bank earnings on loans
and investments and the levels of interest paid on bank deposits through
the Federal Reserve System's open-market operations in United States
government securities, regulation of the discount rate on bank borrowings
from Federal Reserve Banks and regulation of non-earning reserve
requirements. Regulation D promulgated by the FRB requires all depository
institutions to maintain reserves against their transaction accounts
(generally, demand deposits, NOW accounts and certain other types of
accounts that permit payments or transfers to third parties) and non-
personal time deposits (generally, money market deposit accounts or other
savings deposits held by corporations or other depositors that are not
natural persons, and certain other types of time deposits), subject to
certain exemptions. Because required reserves must be maintained in the
form of either vault cash, a non-interest bearing account at the Federal
Reserve Bank or a pass-through account as defined by the FRB, the effect of
this reserve requirement is to reduce the amount of Union's interest-
earning assets. As of December 31, 2005, Union's reserve requirement was
approximately $330 thousand which was satisfied by vault cash.
Bank Holding Company Acquisitions and Activities. As a bank holding
company, the Company is subject to supervision and regulation by the FRB
under the Bank Holding Company Act of 1956, as amended (the "BHC Act").
Under the BHC Act, the activities of bank holding
5
companies, such as Union Bankshares, and those of companies that they
control, such as Union, or in which they hold more than 5% of the voting stock,
are limited to banking, managing or controlling banks, furnishing
services to or performing services for their subsidiaries, or certain
activities that the FRB has determined to be so closely related to banking,
managing or controlling banks as to be a proper incident thereto. As
described below, a bank holding company that has elected to become a
"financial holding company" under the federal Gramm-Leach-Bliley Financial
Modernization Act of 1999 ("Gramm-Leach-Bliley Act") may engage in certain
additional activities. Bank holding companies such as Union Bankshares
that have not elected to become financial holding companies, are required
to obtain the prior approval of the FRB to engage in any new activity or to
acquire more than 5% of any class of voting stock of any bank or other
company. Satisfactory capital ratios, CRA ratings and anti-money
laundering policies are generally prerequisites to obtaining Federal
regulatory approval to make acquisitions.
The FRB has authority to issue cease and desist orders to prevent or
terminate unsafe or unsound banking practices or violations of law or
regulations and to assess civil money penalties against bank holding
companies and their subsidiaries and other affiliates. The FRB also has
the authority to remove officers, directors and other institution-
affiliated parties.
The FRB has the power to order a holding company or its subsidiaries to
terminate any activity, or to terminate its ownership or control of any
subsidiary, when it has reasonable cause to believe that the continuation
of such activity or such ownership or control constitutes a serious risk to
the financial safety, soundness, or stability of any bank subsidiary of
that holding company.
The FRB has the power to prohibit dividends by bank holding companies if
their actions constitute unsafe or unsound practices. The FRB has issued a
policy statement on the payment of cash dividends by bank holding
companies, which expresses the FRB's view that a bank holding company
should pay cash dividends only to the extent that the company's net income
for the past year is sufficient to cover both the cash dividends and rate
of earnings retention that is consistent with the company's capital needs,
asset quality, and overall financial condition.
Financial Services Modernization. The Gramm-Leach-Bliley Act permits
eligible bank holding companies to elect to become financial holding
companies and thereby engage in a broader range of financial and other
activities than is permitted to bank holding companies generally. Under
the Gramm-Leach-Bliley Act, a financial holding company may engage in
activities that are not traditionally encompassed within the business of
banking but that are "financial in nature," including securities
underwriting, dealing and market making, sponsoring mutual funds and
investment companies, insurance underwriting, merchant banking and
additional activities that the FRB, in consultation with the Secretary of
the Treasury, determines to be financial in nature, or incident or
complementary to such financial activities, provided that such activities
do not pose a substantial risk to the safety and soundness of depository
institutions or the financial system generally. The Gramm-Leach-Bliley Act
effectively permits the integration, under a financial holding company
umbrella, of firms engaged in banking, insurance and securities activities,
and preempts state laws that purport to limit or prohibit such
affiliations. No regulatory approval is required for a financial holding
company to acquire a company, other than a bank or savings association,
engaged in permitted activities.
In order to become a financial holding company, all of the bank holding
company's bank subsidiaries must be well-capitalized and well-managed under
applicable regulatory guidelines, and each of such banks must have been
rated "Satisfactory" or better in its most recent evaluation under the
federal CRA. Once a bank holding company has elected to be treated as a
financial holding company, it may face significant consequences if it
subsequently fails to meet one or more of the criteria for eligibility.
For example, it may be required to enter into an agreement with the FRB
imposing limitations on its operations and requiring divestitures. In
addition, the need to maintain eligibility could hamper a financial holding
company's ability to expand or to acquire financial institutions that do
not meet the required criteria.
As of the date of this report, the Company had not elected to become a
financial holding company.
Source of Strength. Under FRB policy, bank holding companies, such as
Union Bankshares Inc., are expected to act as a source of financial and
management strength to their subsidiary banks, such as Union, and to commit
resources to support them. This support may be called for at times when a
bank holding company may not have the required resources to do so.
Interstate Banking. Under the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 an adequately capitalized and managed bank holding
company is permitted to acquire banks based outside its home state,
generally without regard to whether the state's law would permit the
acquisition. This Act also authorizes banks to merge across state lines
thereby creating interstate branches. In addition, this Act permits banks
to acquire existing interstate branches (short of merger) or to establish
new interstate branches. States were given the right, exercisable before
June 1, 1997, to prohibit altogether or impose certain limitations on
interstate mergers and the acquisition or establishment of interstate
branches. None of the states contiguous to Vermont (New Hampshire, New
York and Massachusetts) has in effect any statute which would substantially
impede the ability of a Vermont bank to acquire or create interstate
branches directly or through an interstate merger. Similarly, Vermont law
does not limit the ability of out-of-state banks to acquire or create
branches in Vermont. Although interstate banking and branching may result
in increased competitive pressures in the markets in which the Company
operates, interstate branching may also present competitive opportunities
for locally-owned and managed banks, such as Union, that are familiar with
the local markets and that emphasize personal service and prompt, local
decision-making. The ability to branch interstate has also benefited
Union, as it has permitted the expansion of its banking operations into New
Hampshire, with the opening of a branch in Littleton in March of 2006.
6
Affiliate Restrictions. Bank holding companies and their affiliates are
subject to certain restrictions under the Federal Reserve Act in their
dealings with each other, such as in connection with extensions of credit,
transfers of assets, and purchase of services among affiliated parties.
Generally, loans or extensions of credit, investments or purchases of
assets by a subsidiary bank from a bank holding company or its affiliates
are limited to 10% of the bank's capital and surplus with respect to each
affiliate and to 20% in the aggregate for all affiliates, and borrowings
are also subject to certain collateral requirements. These transactions,
as well as other transactions between a subsidiary bank and its holding
company or other affiliates must generally be on arms-length terms, that
is, on terms comparable to those involving nonaffiliated companies.
Further, under the Federal Reserve Act and FRB regulations, a bank holding
company and its subsidiaries are prohibited from engaging in certain tie-
in-arrangements in connection with extensions of credit or furnishing of
property or services to third parties. The Company and Union are subject
to these restrictions in their intercompany transactions.
Bank. The various laws and regulations applicable to Union that are
administered by the FDIC and the Vermont Banking Commissioner affect
Union's corporate practices, such as payment of dividends, incurring of
debt and acquisition of financial institutions and other companies. These
laws also affect its business practices, such as payment of interest on
deposits, limitations on loans to one borrower, the charging of interest on
loans, privacy issues and the location of offices. There are no
outstanding regulatory orders resulting from regulatory examinations of the
Company or Union.
Dividend Limitations. As a holding company, Union Bankshares Inc.'s
ability to pay dividends to its stockholders is largely dependent on the
ability of its subsidiary to pay dividends to it. Payment of dividends by
Vermont-chartered banks, such as Union, is subject to applicable state and
federal laws. Under Vermont banking laws, a Vermont-chartered bank may not
authorize dividends or other distributions which would reduce the bank's
capital below the amount of capital required in the bank's Certificate of
General Good or under any capital or surplus standards established by the
Vermont Banking Commissioner. Union does not have any capital restrictions
in its Certificate of General Good and, to date, the Vermont Banking
Commissioner has not adopted capital or surplus standards. Nevertheless,
the capital standards established by the FDIC, described below under
"Capital Requirements," apply to Union, and the capital standards of the
FRB apply to the Company on a consolidated basis. In addition, the FRB,
the FDIC and the Vermont Banking Commissioner are authorized under
applicable federal and state laws to prohibit payment of dividends that
they determine would be an unsafe or unsound practice. Payment of
dividends that deplete the capital of a bank or a bank holding company, or
render it illiquid, could be found to be an unsafe or unsound practice.
Loans to Related Parties. The Company's and Union's authority to extend
credit to their directors, executive officers and 10 percent stockholders,
as well as to entities controlled by such persons, is currently governed by
the requirements of the Federal Reserve Act and Regulation O of the FRB
thereunder. Among other things, these provisions require that extensions
of credit to insiders (i) be made on terms that are substantially the same
as, and follow credit underwriting procedures that are not less stringent
than, those prevailing for comparable transactions with unaffiliated
persons and that do not involve more than the normal risk of repayment or
present other unfavorable features and (ii) not exceed certain limitations
on the amount of credit extended to such persons, individually and in the
aggregate, which limits are based in part, on the amount of the bank's
capital. Under AMEX guidelines, any related party transaction including
loans must be approved by the Company's Audit Committee. In addition,
under the federal Sarbanes-Oxley Act of 2002 (discussed below), the
Company, itself, may not extend or arrange for any personal loans to its
directors and executive officers.
Capital Adequacy Guidelines. The FRB, the FDIC and other federal banking
regulators have issued substantially similar risk-based and leverage
capital guidelines for United States banking organizations. Those
regulatory agencies are also authorized to require that a banking
organization maintain capital above the minimum levels, whether because of
its financial condition or actual or anticipated growth. The FRB's risk-
based capital guidelines define a three-tier capital framework and specify
three relevant capital ratios: Tier 1 Capital Ratio, a Total Capital Ratio
and a "Leverage Ratio." Tier 1 Capital consists of common and qualifying
preferred shareholders' equity, less certain intangibles and other
adjustments. The remainder (Tier 2 and Tier 3 Capital) consists of
subordinate and other qualifying debt, preferred stock that does not
qualify as Tier 1 Capital, and the allowance of credit losses up to 1.25%
of risk-weighted assets.
The sum of Tier 1, Tier 2 and Tier 3 Capital, less investments in
unconsolidated subsidiaries, represents qualifying "Total Capital," at
least 50% of which must consist of Tier 1 Capital. Risk-based capital
ratios are calculated by dividing Tier 1 Capital and Total Capital by risk-
weighted assets. Assets and off-balance sheet exposures are assigned to
one of four categories or risk weights, based primarily on relative credit
risk. The minimum Tier 1 Capital Ratio is 4% and the minimum Total Capital
Ratio is 8%. The Leverage Ratio is determined by dividing Tier 1 Capital
by adjusted average total assets. Although the minimum Leverage Ratio is
3%, most banking organizations are required to maintain Leverage Ratios of
at least 1 to 2 percentage points above 3%.
Federal bank regulatory agencies require banking organizations that engage
in significant trading activity to calculate a capital charge for market
risk. Significant trading activity means trading activity of at least 10%
of total assets or $1 billion, whichever is smaller, calculated on a
consolidated basis for bank holding companies. Federal bank regulators may
apply the market risk measure to other bank holding companies, as the
agency deems necessary or appropriate for safe and sound banking practices.
Each agency may exclude organizations that it supervises that otherwise
meet the criteria under certain circumstances. The market risk charge will
be included in the calculation of an organization's risk-based capital
ratio. Neither the Company nor Union is currently subject to this special
capital charge.
FRB policy provides that banking organizations generally, and, in
particular, those that are experiencing rapid internal growth or actively
making acquisitions, will be expected to maintain strong capital positions
substantially above the minimum supervisory levels, without significant
reliance on intangible assets, such as goodwill. Furthermore, the capital
guidelines indicate that the FRB will continue to consider
7
a "Tangible Tier 1 Leverage Ratio" in evaluating proposals for expansion or
new activities. The Tangible Tier 1 Leverage Ratio is calculated by
dividing a banking organization's Tier 1 Capital less all intangible assets
by its total consolidated quarterly average assets less all intangible
assets.
The FRB's capital adequacy guidelines generally provide that bank holding
companies with a ratio of intangible assets to tangible Tier 1 Capital in
excess of 25% will be subject to close scrutiny for certain purposes,
including the FRB's evaluation of acquisition proposals. The Company does
not have a material amount of intangibles in its capital base.
The FRB's capital adequacy guidelines exempt certain "small bank holding
companies" from its risk-based capital requirements. Effective March 30,
2006, the consolidated assets test for defining a small bank holding
company for this purpose will be increased from $150 million to $500
million. Although the Company meets the new consolidated assets test, it
will nevertheless not qualify for this regulatory relief because it does
not meet the separate requirement that the small bank holding company not
have a material amount of its securities registered with the Securities and
Exchange Commission.
At December 31, 2005, the Company's consolidated Total and Tier I Risk-
Based Capital Ratios were 17.08% and 15.86%, respectively, and its Leverage
Capital Ratio was 11.10%, and it is considered well-capitalized under the
above regulatory guidelines. In addition, Union is considered well-
capitalized under such guidelines.
Prompt Corrective Action. The Federal Deposit Insurance Corporation
Improvement Act of 1991 ("FDICIA"), among other things, identifies five
capital categories for insured depository institutions (well capitalized,
adequately capitalized, undercapitalized, significantly undercapitalized,
and critically undercapitalized) and requires the respective federal
banking agencies to implement systems for "prompt corrective action" for
insured depository institutions that do not meet minimum capital
requirements. FDICIA imposes progressively more restrictive constraints on
operations, management and capital distributions, depending on the category
in which an institution is classified. Failure to meet the capital
guidelines could also subject a banking institution to capital raising
requirements. An "undercapitalized" bank must develop a capital
restoration plan and its parent holding company must guarantee that bank's
compliance with the plan. The liability of the parent holding company
under any such guarantee is limited to the lesser of 5% of the bank's
assets at the time it became undercapitalized or the amount needed to
comply with the plan. Furthermore, in the event of the bankruptcy of the
parent holding company, such guarantee would take priority over the
parent's general unsecured creditors. In addition, FDICIA requires the
various federal banking agencies to prescribe certain noncapital standards
for safety and soundness related generally to operations and management,
asset quality and executive compensation, and permits regulatory action
against a financial institution that does not meet such standards.
The various federal banking agencies have adopted substantially similar
regulations that define the five capital categories identified by FDICIA,
using the Total Capital, Tier 1 Ratio and the Leverage Ratio as the
relevant capital measures. Such regulations establish various degrees of
corrective action to be taken when an institution is considered
undercapitalized. Under the regulations, a "well capitalized" institution
must have a Tier 1 capital ratio of at least 6%, a total capital ratio of
at least 10% and a leverage ratio of at least 5% and not be subject to a
capital directive order. An "adequately capitalized" institution must have
a Tier 1 capital ratio of at least 4%, a total capital ratio of at least 8%
and a leverage ratio of at least 4%, or 3% in some cases.
Safety and Soundness Standard. FDICIA, as amended, directs each Federal
banking agency to prescribe safety and soundness standards for depository
institutions relating to internal controls, information systems, internal
audit systems, loan documentation, credit underwriting, interest rate
exposure, asset growth, compensation, asset-quality, earnings and stock
valuation. The Community Development and Regulatory Improvement Act of
1994 amended FDICIA by allowing Federal banking regulators to publish
guidelines rather than regulations concerning safety and soundness.
FDICIA also contains a variety of other provisions that may affect Union's
operations, including reporting requirements, regulatory guidelines for
real estate lending, "truth in savings" provisions, and the requirement
that a depository institution give 90 days prior notice to customers and
regulatory authorities before closing any branch.
Community Reinvestment Act. Union is subject to the federal CRA, which
requires banks to demonstrate their commitment to serving the credit needs
of low and moderate income residents of their communities. The bank
participates in a variety of direct and indirect lending programs and other
investments for the benefit of the low and moderate income residents in the
local communities. The FDIC conducts examinations of insured banks'
compliance with CRA requirements and rates institutions as "Outstanding,"
"Satisfactory," "Needs to Improve," and "Substantial Non-Compliance."
Failure of an institution to receive at least a "Satisfactory" CRA rating
could adversely affect its ability to undertake certain activities, such as
acquisitions of other financial institutions, which require regulatory
approval based, in part, on the institution's record of CRA compliance. In
addition, failure of a bank subsidiary to receive at least a "Satisfactory"
rating would disqualify a bank holding company from eligibility to become
or remain a financial holding company under the Gramm-Leach-Bliley Act.
(See "Financial Modernization" above.) At its last CRA compliance
examination by the FDIC, Union received a rating of "Outstanding."
Deposit Insurance Premium Assessments. Under applicable federal laws and
regulations, deposit insurance premium assessments to the Bank Insurance
Fund ("BIF") and the Savings Association Insurance Fund ("SAIF") are based
on a supervisory risk rating system, with the most favorably rated
institutions paying the lowest premiums. The deposits of Union are insured
under the BIF. As a "well capitalized"
8
institution, Union is presently in the most favorable deposit insurance
assessment category, and pays the minimum deposit premium assessment.
Brokered Deposits. FDICIA restricts the ability of an FDIC-insured bank to
accept brokered deposits unless it is a well-capitalized institution under
FDICIA's prompt corrective action guidelines. Union has accepted
brokered deposits through its membership with the Certificate of Deposit
Account Registry Service ("CDARS") of the Promontory International Network.
Consumer Protection Laws. In connection with its lending activities, Union
is subject to a variety of federal and state laws designed to protect
borrowers and to promote lending to various sectors of the economy and
population. In addition to the provisions of the CRA (discussed above),
Union is subject to, among other laws, the federal Home Mortgage Disclosure
Act, the federal Real Estate Settlement Procedures Act, the federal Truth-
in-Lending Act, the federal and Vermont Equal Credit Opportunity Acts, and
the federal and Vermont Fair Credit Reporting Acts. Effective July 1,
2005, the Vermont Banking Department has the authority to enforce directly
certain of these federal statutes.
Union is subject to the provisions of Title V of the Gramm-Leach-Bliley
Act, which requires it to notify consumer customers of its information
collection and sharing practices and restrict those practices in certain
respects. In addition, Union is subject to similar but more restrictive,
requirements of the Vermont Banking Department. Generally those Vermont
requirements prohibit the disclosure of consumer information to
nonaffiliated third parties without the express written consent of the
consumer, except for disclosures permitted under specified regulatory
exceptions.
The deposit-taking activities of Union are subject to various federal and
state requirements, including those mandating uniform disclosures to
depositors with respect to rates of interest, fees, electronic fund
transfers and other terms of consumer deposit accounts, and disclosure of
its policy on the availability of deposited funds.
Bank Secrecy Act. Union is subject to federal laws establishing certain
record keeping, customer identification and reporting requirements
pertaining to large cash transactions, sales of travelers checks and other
monetary instruments and the international transfer of cash or monetary
instruments. New provisions, designed to help combat international
terrorism, were added in 2001 to the Bank Secrecy Act by the USA Patriot
Act. These provisions require banks to avoid establishing or maintaining
correspondent accounts of foreign off-shore banks and banks in
jurisdictions that have been found to fall significantly below
international anti-money laundering standards. In addition, U.S. banks are
prohibited from opening correspondent accounts for off-shore shell banks,
defined as banks that have no physical presence and that are not part of a
regulated and recognized banking company. The USA Patriot Act requires all
financial institutions to adopt an anti-money laundering program. The act
requires banks to establish due diligence policies, procedures and controls
that are reasonably designed to detect and report instances of money
laundering in United States private banking accounts and correspondent
accounts maintained for non-U.S. persons or their representatives.
The Department of Treasury has issued regulations implementing the due
diligence requirements. These regulations require minimum standards to
verify customer identity and maintain accurate records, encourages
information-sharing cooperation among financial institutions, federal
banking agencies and law enforcement authorities regarding possible money
laundering or terrorist activities, prohibits the anonymous use of
"concentrations accounts" and requires all covered financial institutions
to have in place an anti-money laundering compliance program. In addition,
the USA Patriot Act amended certain provisions of the federal Right to
Financial Privacy Act to facilitate the access of law enforcement to bank
customer records in connection with investigating international terrorism.
The Act also amends the Bank Holding Company Act and the Bank Merger Act to
require the federal banking agencies to consider the effectiveness of a
financial institution's anti-money laundering program when reviewing an
application under these acts.
Sarbanes-Oxley Act of 2002. In 2002, federal legislation known as the
"Sarbanes-Oxley Act of 2002" was enacted. This far-reaching legislation
was generally intended to protect investors by strengthening corporate
governance and improving the accuracy and reliability of corporate
disclosures made pursuant to securities law. The Sarbanes-Oxley Act
provides for, among other things:
* a prohibition on personal loans made or arranged by the issuer
to its directors and executive officers (except for loans made
by a bank subject to Regulation O);
* independence requirements for audit committee members;
* corporate governance requirements;
* independence requirements for company auditors that restrict
non-audit services that accountants may provide to their audit
clients;
* enhanced disclosure requirements pertaining to corporate
operations and internal controls;
* certification of financial statements on Forms 10-K and 10-Q
reports by the chief executive officer and the chief financial
officer;
* the forfeiture by the chief executive officer and the chief
financial officer of bonuses or other incentive-based
compensation and profits from the sale of an issuer's
securities by such officers in the twelve month period
following initial publication of any financial statements that
later require restatement due to corporate misconduct;
* disclosure of off-balance sheet transactions;
* two-business day filing requirements for insiders filing
reports on Form 4 of transactions in the issuer's securities;
9
* accelerated filing requirements for Forms 10-K and 10-Q by
public companies which qualify as "accelerated filers;"
* disclosure of a code of ethics for principal financial officers
and filing a Form 8-K for a change in or waiver of such code;
* the reporting of securities violations "up the ladder" by both
in-house and outside attorneys;
* restrictions on the use of non-GAAP financial measures in press
releases and SEC filings;
* the formation of a public accounting oversight board; and
* various increased criminal penalties for violations of
securities laws.
Not all of the final rules under the Act have gone into effect for the
Company since it is not an accelerated filer. In particular, the Company
is not subject for 2005 to Section 404 of Sarbanes-Oxley, relating to
certification and attestation of internal controls. In order to be
considered an accelerated filer under the Sarbanes-Oxley Act, the market
value of the Company's outstanding class of stock registered under the
Exchange Act as of June 30 which is held by non-affiliates (so-called
"public float") must exceed $75,000,000.
AMEX. In response to the Sarbanes-Oxley Act, the AMEX, where the Company's
common stock is listed, has implemented new corporate governance listing
standards, including rules strengthening director independence requirements
for boards and committees of the board, the director nomination process and
shareholder communication avenues. These rules require the Company to
annually certify to the AMEX, after each annual meeting, that the Company is
in compliance and will continue to comply with AMEX corporate governance
requirements.
Taxing Authorities. The Company and Union are subject to income taxes at
the Federal level and are individually subject to state taxation based on
the laws of each state in which they operate. The Company and Union file a
consolidated federal tax return with a calendar year-end. The Company and
Union have filed separate tax returns for each state jurisdiction affected
for 2004 and will do the same for 2005. No tax return is currently being
examined or audited by any taxing authority.
Other Proposals. Certain legislative and regulatory proposals that could
affect the Company or Union and the financial services business in general
are periodically introduced before the United States Congress, the Vermont
State Legislature and federal and state government agencies. It is not
known to what extent, if any, legislative proposals will be enacted and
what effect such legislation would have on the structure, regulation and
competitive relationships of financial institutions. Such legislation
could subject the Company and Union to increases in regulation, disclosure
and reporting requirements, competition and the cost of doing business.
In addition to legislative changes, the various federal and state financial
institution regulatory agencies frequently propose rules and regulations to
implement and enforce already existing legislation. It cannot be predicted
whether or in what form any such rules or regulations will be enacted or
the effect that such enactment may have on the Company or Union.
Available Information: The Company files annual, quarterly, and current
reports, proxy statements, and other documents with the SEC under the
Securities Exchange Act of 1934 (the "Exchange Act"). The public may read
and copy any materials that Union Bankshares, Inc. has filed with the SEC
at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC
20549-0213. The public may obtain information on the operation of the
Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC
maintains an Internet website that contains reports, proxy and information
statements, and other information regarding issuers, including Union
Bankshares, that file electronically with the SEC. The public can obtain
any documents that the Company has filed with the SEC at
http://www.sec.gov.
Part I-Item 1A Risk Factors
These are general risk factors affecting Union Bankshares, Inc. They are
further described in Part I-Item 1. "Business", Part II-Item 7
"Management's Discussion and Analysis" and Part II-Item 7a "Quantitative
and Qualitative Disclosures About Market Risk". Additional risks and
uncertainties not currently known to the Company or that are currently
deemed to be immaterial also may materially and adversely affect its
business operations. Any of these risks could materially and adversely
affect the Company's business, financial condition or results of
operations, as well as the value of its common stock.
Changes in the domestic interest rate environment could negatively affect
the Company's net interest income. Interest rate risk is the risk that
changes in market rates and prices will adversely affect the financial
condition or results of operations. Net interest income is the Company's
largest source of revenue and is highly dependent on achieving a positive
spread between the interest earned on assets and the interest paid on
liabilities. Changes in interest rates could negatively impact the ability
to attract deposits, make loans, and achieve a positive spread resulting in
compression of the net interest margin.
Interest rates are highly sensitive to many factors beyond our control,
including general economic conditions such as inflation, recession, and
unemployment. Monetary and fiscal policies of various governmental and
regulatory agencies may also adversely affect the interest rate
environment.
Certain ARM loans reprice based on lagging interest rate indices. The
effect of this lag may also negatively affect net interest income when
general interest rates continue to rise.
10
Additionally, changes in applicable law, if enacted, including those that
would permit banks to pay interest on demand deposit accounts, could have a
significant negative effect on results of operations as a significant
portion of our deposits are noninterest bearing demand deposits.
An increase in loan prepayments or on prepayment of loans underlying
mortgage backed securities may adversely affect profitability. Prepayment
rates are affected by consumer behavior, conditions in the housing and
financial markets, general economic conditions and the relative interest
rates on fixed-rate and adjustable-rate mortgage loans. Changes in prepayment
rates are therefore difficult to predict. The Company may not
be able to reinvest loan and security prepayments at rates comparable to
the prepaid instrument particularly in period of declining interest rates.
An inadequate allowance for loan losses would reduce earnings. Credit risk
is the risk that loan customers will be unable to repay their loans
according to their contractual obligations resulting in a negative impact
on earnings. Although the Company's portfolio composition, with loans
primarily secured by real estate, mitigates loss exposure, volatility and
deterioration in regional or local economies may increase the Company's risk
for credit losses. Management and the Board of Directors assess the
adequacy of the allowance for loan losses, but not limited to, such
factors as:
* the risk characteristics of various classifications of loans;
* previous loan loss experience;
* delinquency trends; specific loans that have loss potential;
* current economic conditions including the estimated fair market
value of the collateral and
* geographic and industry loan concentrations.
If for any reason the quality of the portfolio should weaken, the allowance
for loan losses may not be sufficient to cover actual loan losses, and
future provisions for loan losses could materially and adversely affect
financial results.
Negative events in Northern Vermont could adversely affect the Company.
Negative conditions in Northern Vermont real estate markets where the
majority of the collateral for the Company's mortgage, construction, home
equity and commercial real estate loans are located could adversely affect
the borrower's ability to repay and the value of the collateral. Real
estate values are affected by various factors, including changes in
general, regional or local economic conditions, governmental rules or
policies and natural disasters. These events could also have a negative
impact on loan demand and deposit growth.
The Company's exposure to credit risk is increased by its commercial real
estate, commercial business and construction lending. Commercial real
estate, commercial business and construction lending generally involve
higher credit risk than single-family residential lending. Such loans
involve larger loan balances to a single borrower or groups of related
borrowers.
Economic events and changes in government regulations, which we and our
borrowers cannot control, could have an adverse impact on the cash flows
generated by properties securing our construction and commercial real
estate loans and on the values of the properties securing those loans.
These loans also involve greater risk because they are not all fully
amortizing over the loan period, but may have a balloon payment due at
maturity. A borrower's ability to make a balloon payment typically will
depend on being able to either refinance the loan or timely sell the
underlying property.
Repayment of both secured and unsecured commercial business loans depends
substantially on the borrowers' underlying business, financial condition
and cash flows. Unsecured loans generally involve a higher degree of risk
of loss than do secured loans because, without collateral, repayment is
solely dependent upon the success of the borrowers' business. Secured
commercial business loans are generally collaterized by equipment, leases,
inventory and accounts receivable. Compared to real estate, that type of
collateral is more difficult to monitor, it may depreciate more rapidly,
and it may be difficult to appraise and liquidate if repossessed.
Risk of loss on a construction loan depends largely upon whether the
initial estimate of the property's value at completion of construction
equals or exceeds the cost of the property construction (including
interest) and the availability of permanent take-out financing. If the
estimate of value is inaccurate, there are delays or if actual construction
costs exceed estimates, the value of the property securing the construction
loan may be insufficient to ensure full repayment when completed through a
permanent loan or by seizure of collateral.
Commercial real estate, commercial business and construction loans are more
susceptible to a risk of loss during a downturn in the business cycle. The
underwriting, review and monitoring performed by the Company's officers and
directors cannot eliminate all of the risks related to these loans.
Competition with other financial institutions could adversely affect the
Company's profitability. The banking and financial services industry is
very competitive. Legal and regulatory developments have made it easier for
new and sometimes unregulated competitors to compete. Consolidation among
financial service providers has resulted in fewer very large national and
regional banking and financial institutions holding a large accumulation of
assets, having significantly greater resources, and cover a wider geographic
presence. In addition, competition has grown from the establishment of
branches by other banks in the Company's market area and other financial
services providers that target its existing or potential customers.
11
Technological developments have allowed competitors including some non-
depository institutions, to compete more effectively in local markets and
have expanded the range of financial products, services and capital
available to the Company's target customers. If the Company is unable to
implement, maintain and use such technologies effectively, it may not be
able to offer products or achieve cost-efficiencies necessary to compete in
the financial services industry. In addition, some of these competitors
have fewer regulatory constraints and lower cost structures.
The Company relies heavily on the proper functioning of its technology.
The Company relies on its computer systems, and outside servicers providing
technology, for much of its business, including recording financial
transactions. If its computer systems or outside technology sources fail,
are not reliable or there is a breach of security, the Company's ability to
maintain accurate financial records may be impaired, which could materially
affect results of operations and financial condition.
The Company is dependent upon the services of its management team. The
Company is dependent upon the ability and experience of a number of key
management personnel who have substantial experience with its operations,
the financial services industry and the markets in which it offers
services. It is possible that the loss of the services of one or more of
the Company's senior executives or key managers would have an adverse
effect on results of operations. The Company's success also depends on its
ability to continue to attract, manage and retain other qualified middle
management personnel as we grow.
Terrorist activities could cause reductions in investor confidence and
substantial volatility in real estate and securities markets. It is
impossible to predict the extent to which terrorist activities may occur in
the United States or other regions, or their effect on a particular
security issue. It is also uncertain what effects any past or future
terrorist activities and/or any consequent actions on the part of the
United States government and others will have on the United States and
world financial markets, local, regional and national economics, and real
estate markets across the United States. Among other things, reduced
investor confidence could result in substantial volatility in securities
markets, a decline in general economic conditions and real estate related
investments and an increase in loan defaults. Such unexpected losses and
events could materially affect the Company's results of operations. Tourism
and the travel industry are important factors to the general economy of
much of the Company's target market, which could be adversely affected by
terrorism.
The Company is subject to extensive financial services industry
regulation that could restrict its activities and impose financial
requirements or limitations on the conduct of business and limit its
ability to receive dividends from Union. Union is subject to extensive
regulation, supervision and examination by the Vermont Banking Department
as its primary regulator, and by the Federal Deposit Insurance Corporation
(FDIC), which insures its deposits. As a member of the Federal Home Loan
Bank ("FHLB") of Boston, Union must also comply with applicable regulations
of the Federal Housing Finance Board and the FHLB. Regulation by these
agencies is intended primarily for the protection of depositors and the
deposit insurance fund and not for the benefit of the Company's
stockholders. Union's activities are also regulated under consumer
protection laws applicable to its lending, deposit and other activities. A
sufficient claim against Union under these laws could have a material
adverse effect on our results.
Proposals for further regulation of the financial services industry are
continually being introduced in the United States Congress. The agencies
regulating the financial services industry also periodically adopt changes
to their regulations. Proposals that are now receiving a great deal of
attention include regulation of government sponsored-entities. It is
possible that one or more legislative proposals may be adopted or
regulatory changes may be made that would have an adverse effect on the
business of the Company.
Negative public opinion could damage the Company's reputation and adversely
affect its earnings. Reputational risk is the risk to the Company's
operations from negative public opinion. Negative public opinion can result
from the actual or perceived manner in which the Company conducts business
activities, including sales practices, practices in the loan origination
and servicing operations and retail banking operations, management of
actual or potential conflicts of interest and ethical issues; and the
protection of confidential customer information. Negative public opinion
can adversely affect the Company's ability to keep and attract customers
and can expose it to litigation.
The volume of trading in the Company's common stock has been light. As a
result, shareholders may not be able to quickly and easily sell their
common stock and the stock price may fluctuate significantly. Union
Bankshares, Inc. common stock currently trades on the AMEX and trading
volume has been light, averaging less than 1000 shares per week over the
past year, and there can be no assurance that an active and liquid market
for the common stock will develop. In addition, the absence of an active
and liquid trading market could result in greater volatility in the price
of the Company's stock.
The number of shares owned by the Company's directors and executive
officers could make it more difficult, or impossible, to obtain approval
for some matters submitted to shareholder vote, including mergers and
acquisitions. Your interests may not be the same as those of the Board and
management. Directors, executive officers and their affiliates own
approximately 28.4% of the outstanding common stock as of December 31,
2005. By voting against a proposal submitted to shareholders, the Company's
directors and officers, as a group, may be able to block, or make approval
more difficult to obtain, for proposals requiring the vote of shareholders,
such as some mergers, share exchanges, asset sales and amendments to the
Articles of Incorporation.
12
Internal controls and procedures may fail or be circumvented. Management
regularly reviews and updates internal controls, disclosure controls and
procedures, and corporate governance policies and procedures. Any system
of controls, however well designed and operated, is based in part on
certain assumptions and can provide only reasonable, not absolute,
assurances that the objectives of the system are met. Any failure or
circumvention of controls and procedures or failure to comply with
regulations related to controls and procedures could have a material
adverse effect on the Company's business, results of operations or
financial condition.
An investment in the Company's common stock is not an insured deposit. The
Company's common stock is not a bank deposit and, therefore, is not insured
against loss by the FDIC, any other deposit insurance fund or by any other
public or private entity. Investment in the Company's common stock is
subject to the same market forces that affect the price of common stock in
any company.
Union Bankshares, Inc.'s articles of incorporation as well as certain
banking laws may have an anti-takeover effect. The Company's articles of
incorporation provide that certain business combinations with a substantial
shareholder or its affiliates require approval by the affirmative vote of
the holders of at least 67% of the outstanding common stock. A substantial
shareholder is one who together with its affiliates owns 5% of more of the
Company's outstanding common stock. The Company's Board of Directors has
the right to override the 67% vote requirement in any particular
transaction. These provisions as well as certain federal banking laws,
including regulatory approval requirements for control acquisitions, could
make it more difficult for a third party to acquire the Company, even if
doing so would be perceived to be beneficial to the shareholders. The
combination of these provisions may inhibit a non-negotiated merger, tender
offer or other business combination, which, in turn, could adversely affect
the market price of the Company's common stock.
If the Company is unable to borrow funds through access to capital markets,
it may not be able to meet the cash flow requirements of its depositors and
borrowers or make strategic acquisitions or investments. Liquidity is the
ability to meet cash flow needs on a timely basis at a reasonable cost.
The liquidity of the Company is used to make loans and to repay deposit
liabilities as they become due or are demanded by customers. Liquidity
polices and limits are established by the Board of Directors. The
Company's Asset/Liability Committee regularly monitors the overall
liquidity position to ensure that various alternative strategies exist to
cover unanticipated events that could affect liquidity. The
Asset/Liability Committee also establishes policies and monitors guidelines
to diversify the Bank's wholesale funding sources to avoid concentrations
in any one market source. Wholesale funding sources include Federal funds
purchased, securities sold under repurchase agreements, and non-core
deposits. Union is also a member of the FHLB of Boston, which provides
funding through advances to members that are collateralized with
mortgage-related assets.
There are other sources of liquidity available should they be needed.
These sources include the sale or securitization of loans, the ability to
acquire additional national market, non-core deposits, the issuance of
additional collateralized borrowings such as FHLB advances, the issuance of
debt securities, and the issuance of preferred or common securities in
public or private transactions. Union could also borrow through the
Federal Reserve's discount window.
If the Company was unable to access funding sources when
needed, it might be unable to meet customers' needs, which could adversely
impact its financial condition, results of operations, cash flows, and
level of regulatory-qualifying capital. For further discussion, see the
"Liquidity" section of Part II-Item 7A "Quantitative and Qualitative
Disclosures About Market Risk".
Part I-Item 1B. Unsolved Staff Comments
None
Part I-Item 2 Properties
As of December 31, 2005, Union operated 12 community-banking locations in
Lamoille, Caledonia and Franklin counties of Vermont and loan production
offices in Littleton, New Hampshire and St. Albans, Vermont. Union also
operates 28 ATMs in northern Vermont and as of March 2006, one in
Littleton, NH Union owns, free of encumbrances, nine of its branch
locations and leases the other branches, the loan production offices and
certain ATM premises from third parties under terms and conditions
considered by management to be favorable to the Bank. On March 20, 2006 a
thirteenth banking location was opened in Littleton, NH and the Littleton
loan production office was incorporated into it.
Additional information relating to the Company's properties as of December
31, 2005, is set forth in Note 9 to the consolidated financial statements
and incorporated herein by reference.
Part I-Item 3 Legal Proceedings
There are no known pending legal proceedings to which the Company or its
subsidiary is a party, or to which any of their properties is subject,
other than ordinary litigation arising in the normal course of business
activities. Although the amount of any ultimate liability with respect to
such proceedings cannot be determined, in the opinion of management, any
such liability will not have a material effect on the consolidated
financial position of the Company and its subsidiary.
Part I-Item 4 Submission of Matters to a vote of Security Holders
There were no matters submitted to a vote of security holders through a
solicitation of proxies or otherwise during the fourth quarter of 2005.
Part II-Item 5 Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
Please refer to page 65 of the Company's 2005 Annual Report to
Shareholders, which information is incorporated herein by reference.
ISSUER PURCHASES OF EQUITY SECURITIES
-----------------------------------------------------------------------------------------------------------------------------
Total Number of Shares Purchased Maximum Number of Shares that
Total Number of Average Price as Part of Publicly Announced Plans May Yet Be Purchased Under the
Period Shares Purchased Paid per Share or Programs (1) Plans or Programs.
-----------------------------------------------------------------------------------------------------------------------------
November, 2005 15,000 $21.00 15,000 85,000
--------------------
On November 18, 2005, the Company announced a stock repurchase
program. The Board of Directors has authorized the repurchase of up
to $2.15 million or 100,000 shares of common stock, or approximately
2.2% of the Company's outstanding shares. Shares can be repurchased
in the open market or in negotiated transactions. The repurchase
program is open for an unspecified period of time.
During the quarter ended December 31, 2005, 3,000 incentive stock options
previously granted pursuant to the Company's 1998 Incentive Stock Option
Plan ("Plan") were exercised by one participant, at an aggregate exercise
price of $38,010. Participation in the Plan is limited to those senior
officers of the corporation or its subsidiary (currently five active
participants) selected by the Board of Directors in its discretion. The
exercise price of all options granted under the Plan represents the fair
market value of the shares on the date of grant. There were 3,250 options
granted under the Plan during 2005 at an option price of $23.30 per share.
The shares issued to Plan participants upon exercise of incentive stock
options have not been registered with the Securities and Exchange
Commission. Such shares are restricted securities, issued under statutory
exemptions available under the Securities Act of 1933, including Section
4(2) thereof, for offers and sales not involving a public offering.
14
Part II-Item 6 Selected Financial Data
At or For The Years Ended December 31,
------------------------------------------------------------
2005 2004 2003 2002 2001
------------------------------------------------------------
(Dollars in thousands except per share data)
Balance Sheet Data:
Total assets $374,746 $359,529 $356,650 $343,492 $337,475
Investment securities 32,408 40,966 44,370 45,824 49,610
Loans held for sale 6,546 8,814 18,524 17,139 16,333
Loans, net of unearned income 300,525 271,255 253,037 238,768 234,610
Allowance for loan losses (3,071) (3,067) (3,029) (2,908) (2,801)
Total nonperforming loans 4,607 5,295 3,305 2,272 4,864
Total nonperforming assets 4,607 5,330 3,315 3,074 6,160
Other real estate owned - 35 10 784 1,296
Deposits 313,299 306,598 305,379 293,004 285,722
Borrowed funds 16,256 7,934 7,223 7,536 10,344
Stockholders' equity (1) 41,603 42,403 40,987 39,169 37,215
Income Statement Data:
Net interest and dividend income $ 17,757 $ 16,868 $ 16,163 $ 15,805 $ 14,559
Provision for loan losses 60 30 114 356 320
Noninterest income 4,055 3,774 3,603 3,560 3,073
Noninterest expenses 13,056 12,319 12,060 11,761 10,496
Net income 6,237 5,835 5,387 5,180 4,832
Per Common Share Data:
Net income (2)(4) $ 1.37 $ 1.28 $ 1.18 $ 1.14 $ 1.06
Cash dividends paid(4) 1.38 0.90 0.82 0.76 0.71
Book value (1)(4) 9.16 9.31 9.01 8.62 8.19
Selected Ratios:
Return on average assets (ROA) 1.71% 1.65% 1.56% 1.52% 1.51%
Return on average equity (ROE) 15.23% 14.17% 13.50% 13.74% 13.34%
Dividend payout ratio (3)(8) 100.73% 70.31% 69.49% 66.67% 66.67%
Interest rate spread (5) 4.99% 4.98% 4.91% 4.72% 4.29%
Net interest margin (6) 5.33% 5.24% 5.20% 5.14% 4.99%
Operating expenses to average assets 3.58% 3.48% 3.49% 3.46% 3.29%
Efficiency ratio (7) 59.42% 59.02% 60.19% 60.73% 60.06%
Average interest earning assets to
average interest bearing liabilities 125.64% 125.73% 121.87% 120.59% 122.11%
Average stockholders' equity to
average assets 11.24% 11.64% 11.56% 11.10% 11.35%
Tier 1 leverage capital ratio 11.10% 11.62% 11.38% 11.03% 11.06%
Tier 1 risk-based capital ratio 15.86% 17.27% 16.70% 16.74% 15.59%
Total risk-based capital ratio 17.08% 18.57% 17.99% 17.99% 16.83%
Asset Quality Ratios:
Nonperforming loans to total loans 1.50% 1.89% 1.22% .89% 1.94%
Nonperforming assets to total assets 1.23% 1.48% .93% .89% 1.83%
Allowance for loan losses to
nonperforming loans 66.66% 57.91% 91.65% 127.99% 57.59%
Allowance for loan losses to
loans not held for sale 1.02% 1.13% 1.20% 1.22% 1.19%
--------------------
Stockholders' equity includes unrealized gains or losses, net of
applicable income taxes, on investment securities classified as
"available-for-sale."
Computed using the weighted average number of shares outstanding for
the period.
Cash dividend declared and paid per share divided by consolidated net
income per share.
Per common share data for all periods have been restated to reflect
the three for two stock split effected in the form of a 50% stock
dividend distributed on August 8, 2003 to shareholders of record on
July 26, 2003.
The difference between the average rate earned on assets minus the
average rate paid on liabilities.
The ratio of tax equivalent net interest income to average earning
assets.
The ratio of noninterest expense to tax equivalent net interest
income and noninterest income excluding securities gains and losses.
Includes a $0.40 per share special cash dividend in 2005.
15
Part II-Item 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations
Please refer to pages 41 to 64 of the Company's 2005 Annual Report to
Shareholders section entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations", which information is
incorporated herein by reference.
Part II-Item 7A Quantitative and Qualitative Disclosures About Market Risk
Please refer to pages 58 to 64 of the Company's 2005 Annual Report to
Shareholders section entitled "Other Financial Considerations", which
information is incorporated herein by reference.
Part II-Item 8 Financial Statements and Supplementary Data
The consolidated balance sheets of Union Bankshares, Inc. as of December
31, 2005 and 2004, and the related consolidated statements of income,
changes in stockholders' equity and cash flows for each of the years in the
three year period ended December 31, 2005, together with related notes and
the report of UHY LLP independent registered public accounting firm, with
respect to the financial statements for the years ended December 31, 2005
and 2004, all as contained on pages 12 to 40 of the Company's 2005 Annual
Report to Shareholders, are incorporated herein by reference.
The reissued report of the Company's predecessor independent accountants
with respect to certain of the financial statements for the year ended
December 31, 2003 is filed as Exhibit 99 to this report and is incorporated
herein by reference.
Part II - Item 9 Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.
None
Part II - Item 9A Controls and Procedures
The Company's chief executive officer and chief financial officer, with the
assistance of the Disclosure Control Committee, evaluated the effectiveness
of the design and operation of the Company's disclosure controls and
procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of
December 31, 2005. Based on this evaluation they concluded that those
disclosure controls and procedures are effective in alerting them in a
timely manner to material information about the Company and its
consolidated subsidiary required to be disclosed in the Company's periodic
reports filed with the Securities and Exchange Commission.
There have been no changes in the Company's internal controls or in other
factors known to the Company that could significantly affect these controls
subsequent to the date of the evaluation referred to above. While the
Company believes that its existing disclosure controls and procedures have
been effective to accomplish these objectives, the Company intends to
continue to examine, refine and formalize its disclosure controls and
procedures and to monitor ongoing developments in this area.
Part II - Item 9B Other Information
None
Part III-Item 10 Directors and Executive Officers of Registrant
The following information from the Company's Proxy Statement for the 2006
Annual Meeting of Shareholders is hereby incorporated by reference:
Listing of the names, ages, principal occupations and business experience
of the directors under the caption "PROPOSAL I: TO ELECT DIRECTORS"
Listing of the names, ages, titles and business experience of the executive
officers under the caption "EXECUTIVE OFFICERS"
Information regarding compliance with Section 16(a) of the Securities
Exchange Act of 1934 under the caption "SHARE OWNERSHIP INFORMATION -
Section 16(a) Beneficial Ownership Reporting Compliance"
Information regarding the Company's Audit Committee under the caption
"Board Committees"
The Company has adopted a Code of Ethics for Senior Financial Officers and
the Chief Executive Officer, filed as Exhibit 14.1 to this report. The
Company has adopted a Code of Ethics for all directors, officers and
employees, filed as Exhibit 14.2 to this report.
16
Part III-Item 11 Executive Compensation
The following information from the Company's Proxy Statement for the 2006
Annual Meeting of Shareholders is hereby incorporated by reference:
Information regarding compensation of directors under the caption "PROPOSAL
I: TO ELECT DIRECTORS - Directors' Compensation"
Information regarding executive compensation and benefit plans under the
caption "EXECUTIVE OFFICERS - Executive Compensation and Benefit Plans"
Information regarding management interlocks and certain transactions under
the caption "PROPOSAL I: TO ELECT DIRECTORS - Compensation Committee
Interlocks and Insider Participation"
Part III-Item 12 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
The following information from the Company's Proxy Statement for the 2006
Annual Meeting of Shareholders is hereby incorporated by reference:
Information regarding the share ownership of management and principal
shareholders under the caption "SHARE OWNERSHIP INFORMATION - Share
Ownership of Management and Principal Holders"
The following table summarizes equity compensation under the Company's
Incentive Stock Option Plan, the only equity compensation plan of the
company:
Equity Compensation Plan Information as of December 31, 2005:
Number of securities
remaining available for future
Number of securities to be issuance under equity
issued upon exercise of Weighted-average exercise compensation plans
outstanding options, price of outstanding options, (excluding securities reflected
Plan Category warrants and rights warrants and rights in column (a)
Column a Column b Column c
--------------------------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders 12,825 $22.63 48,700
Equity compensation plans
not approved by security
holders - - -
------ ------ ------
Total 12,825 $22.63 48,700
====== ====== ======
Part III-Item 13 Certain Relationships and Related Party Transactions
The following information from the Company's Proxy Statement for the 2006
Annual Meeting of Shareholders is hereby incorporated by reference:
Information regarding transactions with management under the caption
"PROPOSAL I: TO ELECT DIRECTORS - Transactions with Management and
Directors"
Part III-Item 14 Principal Accountant Fees and Services
The following information from the Company's Proxy Statement for the 2006
Annual Meeting of Shareholders is hereby incorporated by reference:
Information on fees paid to the Independent Auditors set forth under the
caption "Independent Auditors"
17
Part IV-Item 15 Exhibits and Financial Statement Schedules
Documents Filed as Part of this Report:
(1) The following consolidated financial statements, as included in
the 2005 Annual Report to Shareholders, are incorporated herein
by reference (See Exhibit 13.1):
1) Report of Independent Registered Public Accounting Firm
2) Consolidated Balance Sheet at December 31, 2005 and 2004
3) Consolidated Statement of Income for the years ended
December 31, 2005, 2004 and 2003
4) Consolidated Statement of Changes in Stockholders' Equity
for the years ended December 31, 2005, 2004 and 2003
5) Consolidated Statement of Cash Flows for the years ended
December 31, 2005, 2004 and 2003
6) Notes to the Consolidated Financial Statements
(2) Report of Former Independent Accountant (See Exhibit 99)
(3) The following exhibits are either filed herewith as part of
this report, or are incorporated herein by reference.
Item No:
3.1 Amended and Restated Articles of Incorporation of Union
Bankshares, Inc. (as of May 7, 1997), previously filed with the
Commission as Exhibit 3.1 to the Company's Registration
Statement on Form S-4 (#333-82709) and incorporated herein by
reference.
3.2 Amendment filed May 19, 1998 to Amended and Restated Articles
of Association of Union Bankshares, Inc., adding new sections 8
and 9, previously filed with the Commission as Exhibit 3.1 to
the Company's Registration Statement on Form S-4 (#333-82709)
and incorporated herein by reference.
3.3 Amendment filed November 24, 1999 to Amended and Restated
Articles of Association of Union Bankshares, Inc. increasing
the authorized common shares to 5,000,000, previously filed
with the Commission on December 10, 1999 as Exhibit 3.3 to the
Company's Current Report on Form 8-K 12g3, and incorporated
herein by reference.
3.4 Bylaws of Union Bankshares, Inc., as amended, previously filed
with the Commission as Exhibit 3.1 to the Company's
Registration Statement on Form S-4 (#333-82709) and
incorporated herein by reference.
10.1 Stock Registration Agreement dated as of February 16, 1999,
among Union Bankshares, Inc., Genevieve L. Hovey, individually
and as Trustee of the Genevieve L. Hovey Trust (U.A. dated
8/22/89), and Franklin G. Hovey, II, individually, previously
filed with the Commission as Exhibit 3.1 to the Company's
Registration Statement on Form S-4 (#333-82709) and
incorporated herein by reference.
10.2 1998 Incentive Stock Option Plan of Union Bankshares, Inc. and
Subsidiary, previously filed with the Commission as Exhibit 3.1
to the Company's Registration Statement on Form S-4 (#333-
82709) and incorporated herein by reference.*
10.3 Form of Union Bankshares, Inc. Deferred Compensation Plan and
Agreement, previously filed with the Commission as Exhibit 10.3
to the Company's 2001 Form 10-K and incorporated herein by
reference.*
13 The following specifically designated portions of Union's 2005
Annual Report to Shareholders have been incorporated by
reference in this Report on Form 10-K, is filed herewith:
pages 12 to 64.
14.1 Code of Ethics for Senior Financial Officers and the Chief
Executive Officer, (as revised, March 15, 2006).
14.2 Code of Ethics (for all directors, officers and employees, as
revised, May 4, 2005).
16 Letter from Urbach Kahn & Werlin LLP, our former independent
accountants, dated November 17, 2004, previously filed with the
commission as Exhibit 16.1 to Form 8-K filed on November 17,
2004 and incorporated herein by reference.
21 Subsidiary of Union Bankshares, Inc.
Union Bank, Morrisville, Vermont.
31.1 Certifications of Chief Executive Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
31.2 Certifications of Chief Financial Officer pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99 Report of Former Independent Accountant.
--------------------
* denotes compensatory plan or agreement
18
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, as of
March 30, 2006.
Union Bankshares, Inc.
By: /s/ Kenneth D. Gibbons By: /s/ Marsha A. Mongeon
------------------------- ------------------------------
Kenneth D. Gibbons Marsha A. Mongeon
President and Chief Treasurer and Chief Financial/
Executive Officer Accounting 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 as of March 30, 2006.
Name Title
/s/ Richard C. Sargent Director, Chairman of the Board
------------------------------
Richard C. Sargent
/s/ Kenneth D. Gibbons Director, President and Chief
------------------------------ Executive Officer
Kenneth D. Gibbons (Principal Executive Officer)
/s/ Marsha A. Mongeon Treasurer and Chief
------------------------------ Financial/Accounting Officer
Marsha A. Mongeon (Principal Financial/
Accounting Officer)
/s/ Cynthia D. Borck Director and Vice President
------------------------------
Cynthia D. Borck
/s/ Steven J. Bourgeois Director
------------------------------
Steven J. Bourgeois
/s/ Franklin G. Hovey II Director
------------------------------
Franklin G. Hovey II
/s/ Richard C. Marron Director
------------------------------
Richard C. Marron
/s/ Robert P. Rollins Director
------------------------------
Robert P. Rollins
/s/ John H. Steele Director
------------------------------
John H. Steele
19
EXHIBT INDEX *
13 Union Bankshares, Inc. Annual Report to Shareholders.
14.1 Code of Ethics for Senior Financial Officers and the Chief Executive
Officer, (as revised, March 15, 2006).
14.2 Code of Ethics (for all directors, officers and employees, as
revised, May 4, 2005).
31.1 Certifications of Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certifications of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of the Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Certification of the Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
99 Report of Former Independent Accountant.
--------------------
* other than exhibits incorporated by reference to prior filings.
20