Item 1. BUSINESS
Union Bankshares Company (the "Company") is a Maine-chartered, federally registered bank holding company headquartered in Ellsworth, Maine incorporated in 1984. The Company is the sole stockholder of Union Trust Company ("Union Trust" or the "Bank"), a Maine chartered commercial bank established in 1887. On August 31, 2000, the Company completed its acquisition of Mid-Coast Bancorp, Inc., and its principal subsidiary, The Waldoboro Bank, FSB. On September 29, 2000, The Waldoboro Bank, FSB was merged with Union Trust.
The Bank is a community-oriented commercial bank with thirteen offices located along Maine's coast, stretching from Waldoboro to Jonesport. The Bank conducts its operations out of its main office in Ellsworth, Maine. It also operates through branch offices located in Ellsworth, Blue Hill, Stonington, Milbridge, Jonesport, Town Hill, Castine, Bar Harbor, Waldoboro, Rockland, Belfast and Camden, Maine. Its deposits are gathered from the general public in these towns and surrounding communities, and its lending activities are concentrated primarily in Hancock, Washington, Knox, Lincoln and Waldo Counties of the State of Maine.
The Company serves the financial needs of individuals, businesses, municipalities and organizations with a full range of community banking services. The community banking business derives its revenues from interest and fees earned in connection with its lending activities, interest and dividends on investment securities, service charges and fees on deposit accounts, and fees and commissions from trust accounts and investment advisory services. As of December 31, 2006, the Company had total assets of $551.0 million, total deposits of $347.8 million and shareholders' equity of $41.6 million.
Competition
The Company contends with considerable competition both in generating loans and attracting deposits. The Company's competition for loans is primarily from other commercial banks, savings banks, credit unions, mortgage banking companies, insurance companies, finance companies, and other institutional lenders. Competitive factors considered for loan generation include interest rates offered, loan fees charged, loan products offered, services provided, and geographic locations.
In attracting deposits, the Company's primary competitors are savings banks, commercial banks, credit unions, as well as other non-bank institutions such as brokerage firms and insurance companies that offer financial alternatives. Competitive factors considered in attracting and retaining deposits include deposit and investment products and their respective rate of return, liquidity, and risk among other factors, convenient branch location and hours of operation, personalized customer service, online access to accounts, and automated teller machines.
Liberal interstate banking laws have resulted in an increase in acquisitions of locally-owned Maine-based banks by non-local entities. Management believes that these acquisitions often result in customer dissatisfaction as the decision-making on loans, marketing, and other aspects of the acquired banks' businesses is shifted from local bank management possessing independent decision-making power to management operating under policies and guidelines from corporate headquarters in other states. Thus, we believe that there will continue to be a need for a bank in our primary market area with local management having decision-making power and emphasizing loans to small and medium sized businesses and to individuals.
The Company has worked and will continue to work to position itself to be competitive in its market area. Our ability to make decisions close to the marketplace, management's commitment to providing quality banking products, the caliber of the professional staff, and the community involvement of the Bank's employees are all factors affecting our ability to be competitive. If the Company and the Bank are unable to compete successfully, however, the business and operations could be adversely affected.
Lending Activities
The Bank's loan portfolio consists primarily of one- to four-family residential real estate loans. To a lesser extent, the Bank's loan portfolio includes commercial real estate loans, commercial and industrial loans, consumer loans and municipal loans. The Bank's borrowers consist of small-to-medium sized businesses and retail customers located primarily in Maine.
Residential Real Estate Loans. The Bank's primary lending activity is the origination of conventional mortgage loans to enable borrowers to purchase or refinance existing homes or to construct new residential dwellings in the Bank's market area. The Bank offers fixed-rate and adjustable-rate mortgage loans with terms up to 30 years. Borrower demand for adjustable-rate loans versus fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, the difference between the interest rates and loan fees offered for fixed-rate mortgage loans and the initial period of interest rates and loan fees for adjustable-rate loans. The loan fees charged, as well as interest rates and other provisions of mortgage loans are determined by the Bank on the basis of its own pricing criteria and competitive market conditions.
Commercial Real Estate Loans. The Bank also offers fixed-rate and adjustable-rate mortgage loans secured by commercial real estate. Loans secured by commercial real estate generally have larger balances and involve a greater degree of risk than one- to four-family residential real estate loans. Of primary concern in commercial real estate lending is the borrower's creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to adverse conditions in the real estate market or the economy, more so than residential real estate loans. In reaching a decision on whether to make a commercial real estate loan, the Bank considers the net operating income of the property, the borrower's expertise, credit history and profitability and the value of the underlying property.
Commercial and Industrial Loans. The Bank makes commercial and industrial loan products and services available to a variety of professionals, sole proprietorships and small-to-medium sized businesses primarily in our market area. These products and services are designed to give business owners borrowing opportunities to support working capital needs, inventory and equipment purchases, facility construction, consolidation, real estate acquisition and vehicle purchases. Although the Bank does originate fixed-rate term loans, substantially all of its commercial loans have variable interest rates indexed to the prime rate as published in The Wall Street Journal.
Consumer Loans. The Bank makes loans for a wide variety of personal and consumer needs. Consumer loans primarily consist of installment loans, home equity loans and cash reserve loans. Unsecured loans generally have a maximum borrowing limit of $15,000 and a maximum term of 3 years. Home equity lines of credit have adjustable rates of interest that are indexed to the prime rate as published in The Wall Street Journal for terms of up to 20 years. Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly.
Municipal Loans. The Bank, as a member of the communities it serves, also actively participates in the local bidding process to obtain municipal loans throughout its market area. Through the bidding process, the municipality is able to receive a competitive rate on short- and longer-term loans providing funds for operating or capital project needs. The Bank also provides a wide array of municipal banking services to enhance the relationship between the Bank and the municipality. Interest earned on a municipal loan is tax exempt for federal tax purposes which enhances the overall yield on each loan. Municipal loan balances are somewhat seasonal, typically reaching a high in August and a low in December.
Loan Originations, Purchases and Sales. Loan applications are obtained through existing customers, solicitation by the Bank's relationship managers, referrals from current or past customers, or walk-in customers. The Bank will also occasionally purchase participation shares in other Maine community bank loans.
The Bank sells a portion of its fixed-rate residential real estate loans with terms in excess of 15 years to the secondary market based on prevailing market interest rate conditions, an analysis of the composition and risk of the loan portfolio, liquidity needs and interest rate risk management goals. Generally, loans are sold without recourse and with loan servicing retained. During 2006, the Bank sold $13.9 million of these loans to Freddie Mac. The Bank also occasionally sells participation interests in its larger commercial loans to other community banks in Maine.
Investment Activities
The Bank's investment portfolio consists primarily of mortgage-backed securities, U.S. Treasury notes and other U.S. Government Agency obligations, corporate debt securities, obligations of states and political subdivisions within the State of Maine and out-of-state municipalities, and other securities. The Bank's investment objectives are to provide and maintain liquidity, to maintain a balance of high quality, diversified investments to minimize risk, to provide collateral for pledging requirements, to establish an acceptable level of interest rate risk, to provide an alternate source of low-risk investments when demand for loans is weak, and to generate a favorable return.
Sources of Funds
Deposits. The Bank offers a wide-range of deposit products including demand deposits, interest checking, money market accounts, savings accounts and time certificates of deposit. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. The majority of the Bank's depositors are residents of Maine. Wholesale certificates of deposit are also used to supplement the Bank's sources of funds.
Borrowings. Borrowings consist of short-term and intermediate term obligations. This funding consists of Federal Home Loan Bank of Boston ("FHLB") advances, federal funds purchased, treasury tax and loan notes and assets sold under repurchase agreements. In a repurchase transaction, the Bank will generally sell a security agreeing to repurchase either the same or a substantially identical security on a specified later date. Repurchase agreements averaged $14.9 million during 2006, down from $15.4 million in 2005. The Bank also borrows from the FHLB to supplement its supply of funds available for lending and to meet deposit withdrawal requirements. The FHLB functions as a central reserve bank providing credit for member financial institutions. As a member of the FHLB, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and qualifying mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of the Bank's net worth or on the FHLB's assessment of the Bank's creditworthiness. At December 31, 2006, the Bank had $129.7 million outstanding in FHLB borrowings with initial maturities ranging from 1 month to 10 years.
Also included in borrowings are junior subordinated debentures payable to the Company's unconsolidated Delaware trust affiliate, Union Bankshares Capital Trust I (the "Trust"), that on February 17, 2006 completed a private placement of $8.0 million of trust preferred securities. As part of this transaction, the Company issued an aggregate principal amount of $8.2 million of 30-year junior subordinated deferrable interest debt securities to the Trust. For the first five years after issuance, the debt securities will bear interest at a Blended Rate equal to the sum of (1) the product of (a) 50% times (b) the floating three month LIBOR plus 1.42% (the "Variable Rate") plus (2) the product of (a) 50% times (b) the 5 year interest rate swap rate fixed two business days prior to closing plus 1.42% (the "Fixed Rate"). Therefore, for the first five years after issuance, the Variable Rate portion of the Blended Rate will float in relation to the floating three month LIBOR rate and the Fixed Rate portion of the Blended Rate will be fixed. The Blended Rate applicable to the last distribution, on January 7, 2007, was 6.63%. The debt securities obligate the Company to pay interest on their principal sum quarterly in arrears on January 7, April 7, July 7, and October 7 of each year. The debentures have a stated maturity of April 7, 2036, but may be redeemed by the Company, in whole or in part, beginning on April 7, 2011, on any interest payment date.
Investment Management, Brokerage and Insurance
The Bank's Investment and Trust Services Group provides advisory and investment management and trust services to a broad range of individuals and institutional customers. In addition, the Bank serves as fiduciary for clients, acting as trustee, agent, or personal representative of estates.
Accounts maintained by the Investment and Trust Services Group consist of "managed" and "non-managed" accounts. "Managed" accounts are those for which the Bank is responsible for administration and investment management and/or investment advice. "Non-managed" accounts are those for which the Bank acts solely as a custodian or directed trustee. The Bank receives fees dependent upon the level and type of service(s) provided. For the year ended December 31, 2006, the Investment and Trust Services
Group generated gross fee revenues of $2.5 million. Total assets under administration as of December 31, 2006, were $379 million, an increase of $49 million, or 2% from December 31, 2005.
The Bank's Cornerstone Investment Services Group provides access to a wide-range of brokerage and insurance products. The majority of accounts maintained consist of retirement and other accounts, annuities, mutual funds, individual stocks and bonds, and life and long term care insurance.
SUPERVISION AND REGULATION
General. The Bank is a Maine-chartered community bank whose deposit accounts are insured up to applicable limits by the Federal Deposit Insurance Corporation ("FDIC"). The Bank is also a member of the Federal Reserve System. The Bank is subject to extensive regulation, examination and supervision by the Maine Bureau of Financial Institutions (the "Bureau") as its chartering regulator, by the FDIC as its deposit insurer and by the Board of Governors of the Federal Reserve System (the "FRB") as its primary federal regulator. The Company, as a financial holding company under the Bank Holding Company Act of 1956, as amended (the "BHCA"), is subject to the rules and regulations of the FRB. The Company is also subject to the rules and regulations of the Securities and Exchange Commission (the "SEC") and the National Association of Security Dealers ("NASD"), to the extent that the NASD rules apply to companies quoted on the OTC Bulletin Board. Both the Company and the Bank are subject to the provisions of the Maine Revised Statues applicable to financial institutions, and the rules and regulations of the Bureau.
The following references to the laws and regulations under which the Bank and the Company are regulated are brief summaries thereof, do not purport to be complete, and are qualified in their entirety by reference to such laws and regulations. These laws and regulations have been established primarily for the protection of consumers and the deposit insurance fund, not Company shareholders. Any change in such laws and regulations, whether by the Bureau, the FDIC, the FRB or the SEC or through legislation, could have a material adverse impact on the Company and the Bank and their operations and shareholders.
Maine Banking Laws and Supervision. The Company and the Bank are subject to Maine law and the rules and regulations of the Bureau. The approval of the Bureau is required to establish or close branches, to merge with another bank, to form a bank holding company, to issue stock or to undertake many other activities. Any Maine bank that does not operate in accordance with the regulations, policies and directives of the Bureau is subject to sanctions.
Loans-to-One-Borrower Limitations. With certain exceptions, the total obligations of a single borrower to the Bank may not exceed 20% of the Bank's total capital. Total loans or other extensions of credit in excess of 10% of total capital must be approved by a majority of the governing body or the executive committee of the Bank. The Bank currently complies with applicable loans-to-one-borrower limitations.
Dividends. Under Maine law, the Company may declare and pay a dividend on its capital stock provided that adequate levels of capital are maintained. The Bureau's minimum capital requirements are set by regulation, and must be at least as stringent as those set forth by federal banking regulations. See "Federal Regulation of the Bank - Capital Requirements." In addition, federal law also may limit the amount of dividends that may be paid by the Bank.
Examination. The Bureau is required to regularly examine each state-chartered bank at least once every 36 months.
Enforcement. The Bureau is authorized to issue cease and desist orders to any state-chartered bank that is engaging in or has engaged in: an unsafe or unsound practice; a violation of a law, rule or regulation relating to the supervision of the institution; a violation of any condition, imposed in writing, in connection with the approval of any application by the superintendent; a violation of any written agreement entered into with the superintendent; or an anticompetitive or deceptive practice, or one that is otherwise injurious to the public interest.
The Bureau may, under certain circumstances, suspend or remove directors or officers of a bank if: (1) the directors or officers have violated a law, rule, regulation or cease and desist order that has become final; engaged in or participated in any unsafe or unsound practice; or committed or engaged in any act, omission, or practice that constitutes a breach of the fiduciary duty of the officer or director; (2) by reason of the violation, practice or breach the bank has suffered or will probably suffer financial loss or other damage, the interests of the bank's depositors or creditors or the public have been or could be prejudiced, or the officer or director has received financial gain or other benefit; and (3) the violation, practice or breach involves personal dishonesty or demonstrates willful or continuing disregard for the safety or soundness of the bank.
Federal Regulation of the Company. The Company is subject to the law and regulations of the State of Maine, the federal law of the United States and the regulations of the FRB.
Capital Requirements. The FRB has adopted capital adequacy guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a bank holding company and in analyzing applications to it under the BHCA. The FRB capital adequacy guidelines generally require bank holding companies to maintain total capital equal to 8% of total risk-adjusted assets, with at least one-half of that amount consisting of Tier 1, or core capital, and up to one-half of that amount consisting of Tier 2, or supplementary capital. Tier 1 capital for bank holding companies generally consists of the sum of common stockholders' equity and perpetual preferred stock (subject in the case of the latter to limitations on the kind and amount of such stocks which may be included as Tier 1 capital), less goodwill and, with certain exceptions, intangibles. Tier 2 capital generally consists of hybrid capital instruments; perpetual preferred stock which is not eligible to be included as Tier 1 capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics, with the categories ranging from 0% (requiring no additional capital) for assets such as cash to 100% for the bulk of assets which are typically held by a bank holding company, including multi-family residential and commercial real estate loans, commercial business loans and consumer loans. Single-family residential first mortgage loans which are not past-due (90 days or more) or non-performing and which have been made in accordance with prudent underwriting standards are assigned a risk-weight of 50%, as are certain privately-issued mortgage-backed securities representing indirect ownership of such loans. Off-balance sheet items also are adjusted to take into account certain risk characteristics.
In addition to the risk-based capital requirements, the FRB requires bank holding companies to maintain a minimum leverage capital ratio of Tier 1 capital to total assets of 3.0%. Total assets for this purpose do not include goodwill and any other intangible assets and investments that the FRB determines should be deducted from Tier 1 capital. The FRB has announced that the 3.0% Tier 1 leverage capital ratio requirement is the minimum for the top-rated bank holding companies without any supervisory, financial or operational weaknesses or deficiencies or those that are not experiencing or anticipating significant growth. Other bank holding companies are expected to maintain Tier 1 leverage capital ratios of at least 4.0% to 5.0% or more, depending on their overall condition. The Company is in compliance with the above-described FRB regulatory capital requirements.
Activities. The BHCA prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, or increasing such ownership or control of any bank, without prior approval of the FRB. No approval under the BHCA is required, however, for a bank holding company already owning or controlling 50% of the voting shares of a bank to acquire additional shares of such bank.
The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than banking or managing or controlling banks. Under the BHCA, the FRB is authorized to approve the ownership of shares by a bank holding company in any company, the activities of which the FRB has determined to be so closely related to banking or to managing or controlling banks as to be a proper incident thereto. In making such determinations, the FRB is required to weigh the expected benefit to the public, such as greater convenience, increased competition or gains in efficiency, against the possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.
In addition, a bank holding company which does not qualify and elect to be treated as a financial holding company under the Gramm-Leach-Bliley Financial Services Modernization Act is generally prohibited from engaging in, or acquiring, direct or indirect control of any company engaged in non banking activities. One of the principal exceptions to this prohibition is for activities found by the FRB to be so closely related to banking or managing or controlling banks as to be permissible.
Bank holding companies may qualify to become financial holding companies if they meet certain criteria set forth by the FRB. In 2003, the Company elected to be treated as a financial holding company under the BHCA. As a financial holding company, the Company may conduct activities that are considered "financial in nature" under the BHCA. Such activities include:
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Activities permissible for bank holding companies prior to the enactment of the Act;
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Lending, exchanging, transferring, investing for others, or safeguarding money or securities;
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Underwriting and selling insurance;
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Providing financial, investment, or advisory services;
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Selling pools of assets;
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Underwriting, dealing in, or making a market in securities; and
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Merchant banking.
In order to commence a new activity, the Bank must have received a "Satisfactory" on its latest Community Reinvestment Act exam. See "Federal Regulation of the Bank - Community Reinvestment" below.
The Sarbanes-Oxley Act. As a public company, the Company is subject to the Sarbanes-Oxley Act of 2002, (the "Sarbanes-Oxley Act"), which implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and better protect investors from corporate wrongdoing. The Sarbanes-Oxley Act's principal legislation and the derivative regulation and rule making promulgated by the SEC includes:
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the creation of an independent accounting oversight board;
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auditor independence provisions which restrict non-audit services that accountants may provide to their audit clients;
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additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer certify financial statements;
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a requirement that companies establish and maintain a system of internal control over financial reporting and that a company's management provide an annual report regarding its assessment of the effectiveness of such internal control over financial reporting to the company's independent accountants and that such accountants provide an attestation report with respect to management's assessment of the effectiveness of the company's internal control over financial reporting (the Company, as a non-accelerated filer, is not subject to this provision until the year ending December 31, 2007);
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the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer's securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;
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an increase in the oversight of, and enhancement of certain requirements relating to audit committees of public companies and how they interact with the Company's independent auditors;
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requirement that audit committee members must be independent and are absolutely barred from accepting consulting, advisory or other compensatory fees from the issuer;
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requirement that companies disclose whether at least one member of the committee is a "financial expert" (as such term is defined by the SEC) and if not, why not;
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expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods;
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a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions;
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disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code;
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mandatory disclosure by analysts of potential conflicts of interest; and
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a range of enhanced penalties for fraud and other violations.
Section 402 of the Sarbanes-Oxley Act of 2002 prohibits the extension of personal loans to directors and executive officers of issuers. The prohibition, however, does not apply to mortgages advanced by an insured depository institution, such as the Bank, that are subject to the insider lending restrictions of Section 22(h) of the Federal Reserve Act (the "FRA"). See "Federal Regulation of the Bank - Loans to Insiders" below.
Although the Company has and will continue to incur additional expense in complying with the provisions of the Sarbanes-Oxley Act and the resulting regulations, such compliance will not have a material impact on its results of operations or financial condition.
Federal Securities Law. The Company's common stock is registered with the SEC under Section 12(g) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Thus, the Company is subject to information, proxy solicitation, insider trading restrictions, and other requirements under the Exchange Act.
Federal Regulation of the Bank. The Bank is subject to federal law and regulations of the FRB.
Capital Requirements. Under FRB regulations, the Bank is required to maintain minimum levels of capital. The FRB regulations define two classes of capital known as Tier 1 and Tier 2 capital. For an institution with a rating of 1 (the highest examination rating for banks) under the Uniform Financial Institutions Rating System, the minimum capital leverage requirement is a ratio of Tier 1 capital to total assets of 3%. For all other banks, the minimum leverage capital requirement is 4%, unless the particular circumstances or risk profile of the depository institution warrants a higher leverage capital ratio.
The FRB regulations also require that banks meet a risk-based capital standard. The risk-based capital standard requires the maintenance of a ratio of total capital (which is defined as the sum of Tier 1 capital and Tier 2 capital, minus certain investments or holdings) to risk-weighted assets of at least 8% and a ratio of Tier 1 capital to risk-weighted assets of at least 4%. In determining the amount of risk-weighted assets, all assets, plus certain off balance sheet items, are multiplied by a risk-weight of 0% to 100%, based on the risks the FRB believes are inherent in the type of asset or item.
The federal banking agencies, including the FRB, have also adopted regulations to require an assessment of an institution's exposure to declines in the economic value of a bank's capital due to changes in interest rates when assessing the Bank's capital adequacy. Under such a risk assessment, examiners will evaluate a bank's capital for interest rate risk on a case-by-case basis, with consideration of both quantitative and qualitative factors.
Institutions with significant interest rate risk may be required to hold additional capital. The agencies also issued a joint policy statement providing guidance on interest rate risk management, including a discussion of the critical factors affecting the agencies' evaluation of interest rate risk in connection with capital adequacy. The Bank was considered "well capitalized" under FRB guidelines at December 31, 2006.
Activity Restrictions on State-Chartered Banks. Section 24 of the Federal Deposit Insurance Act ("FDIA"), as amended, which was added by the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), generally limits the activities and investments of state-chartered FDIC insured banks and their subsidiaries to those permissible for national banks and their subsidiaries, unless such activities and investments are specifically exempted by Section 24 or consented to by the FDIC.
Before making a new investment or engaging in a new activity not permissible for a national bank or not otherwise permissible under Section 24 or the FDIC regulations thereunder, an insured bank must seek approval from the FDIC to make such investment or engage in such activity. The FDIC will not approve the activity unless the Bank meets its minimum capital requirements and the FDIC determines that the activity does not present a significant risk to the FDIC insurance funds.
Enforcement. The FRB has extensive enforcement authority over state-chartered member banks, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist orders and to remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and to unsafe or unsound practices.
Deposit Insurance. The FDIC merged the Bank Insurance Fund and the Savings Association Insurance Fund to form the Deposit Insurance Fund (the "DIF") on March 31, 2006. The Bank is a member of the DIF and pays its deposit insurance assessments to the DIF.
Pursuant to FDICIA, the FDIC established a system for setting deposit insurance premiums based upon the risks a particular bank or savings association posed to its deposit insurance fund. Effective January 1, 2007, the FDIC established a risk-based assessment system for determining the deposit insurance assessments to be paid by insured depository institutions. Under the assessment system, the FDIC assigns an institution to one of four risk categories, with the first category having two sub-categories based on the institution's most recent supervisory and capital evaluations, designed to measure risk. Assessment rates currently range from 0.05% of deposits for an institution in the highest sub-category of the highest category to 0.43% of deposits for an institution in the lowest category. The FDIC is authorized to raise the assessment rates as necessary to maintain the required reserve ratio of 1.25%. The FDIC allows the use of credits for assessments previously paid, and the Bank believes that it has credits that will offset certain assessments.
In addition, all federally insured institutions are required to pay assessments to the FDIC at an annual rate of insured deposits to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. These assessments will continue until the Financing Corporation bonds mature in 2017 through 2019.
Under the FDIA, the FDIC may terminate the insurance of an institution's deposits upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable
law, regulation, rule, order or condition imposed by the FDIC. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Transactions with Affiliates of the Bank. The Bank's authority to engage in transactions with its affiliates is limited by the FRB's Regulation W and Sections 23A and 23B of the Federal Reserve Act (the "FRA"). In general, these transactions must be on terms which are as favorable to the Bank as comparable transactions with non-affiliates. In addition, certain types of these transactions referred to as "covered transactions" are subject to quantitative limits based on a percentage of the Bank's capital, thereby restricting the total dollar amount of transactions the Bank may engage in with each individual affiliate and with all affiliates in the aggregate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of guarantees and other similar types of transactions. Affiliates must pledge qualifying collateral in amounts between 100% and 130% of the covered transaction in order to receive loans from the Bank. In addition, applicable regulations prohibit the Bank from lending to any of its affiliates that engage in activities that are not permissible for bank holding companies and from purchasing low-quality (i.e., non-performing) assets from an affiliate or purchasing the securities of any affiliate, other than a subsidiary.
Loans to Insiders. The Bank's authority to extend credit to its directors, executive officers and principal shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of
Sections 22(g) and 22(h) of the FRA and Regulation O of the FRB. Among other things, these provisions require that extensions of credit to insiders:
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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 third parties and that do not involve more than the normal risk of repayment or present other features that are unfavorable to the Bank; and
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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.
The regulations allow small discounts on fees on residential mortgages for directors, officers and employees. In addition, extensions for credit in excess of certain limits must be approved by the Bank's Board of Directors.
Nontraditional Mortgage Product Risk. In September of 2006, the federal banking agencies published final guidance for institutions that originate or service nontraditional or alternative mortgage products, defined to include all residential mortgage loan products that allow borrowers to defer repayment on principal or interest, such as interest-only mortgages and payment option adjustable-rate mortgages. At this time the Bank does not originate or service nontraditional or alternative mortgage products.
Concentrations in Commercial Real Estate Loans. In December of 2006, the FRB adopted guidance entitled "Concentrations in Commercial Real Estate (CRE) Lending, Sound Risk Management Practices," or the CRE Guidance, to address concentrations of commercial real estate loans in institutions. The CRE Guidance reinforces and enhances the FRB's existing regulations and guidelines for real estate lending and loan portfolio management, and establishes specific commercial real estate lending thresholds at which a concentration of commercial real estate loan is deemed to exist. The CRE Guidance applies to institutions with an accumulation of credit concentration exposures and asks that the banks quantify the additional risk such exposures may pose, including stratification of the commercial real estate portfolio by, among other things, property type, geographic market, tenant concentrations, tenant industries, developer concentrations and risk rating. In addition, an institution should perform periodic market analyses for the various property types and geographic markets represented in its portfolio. Further, an institution with commercial real estate concentration risk should also perform portfolio level stress tests or sensitivity analysis to quantify the impact of changing economic conditions on asset quality, earnings and capital. The Bank believes that the CRE Guidance will not have a material impact on the conduct of its business, and the Bank will be able to effectively implement requirements and suggestions set forth in the CRE Guidance during 2007.
Safety and Soundness Standards. Pursuant to the requirements of the FDIA, as amended by the Riegle Community Development and Regulatory Improvement Act of 1994, each federal banking agency, including the FRB, has adopted guidelines establishing general standards relating to internal controls, information and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director, or principal stockholder. In addition, the FRB adopted regulations to require a bank that is given notice by the FRB that it is not satisfying any of such safety and soundness standards to submit a compliance plan to the FRB. If, after being so notified, a bank fails to submit an acceptable compliance plan or fails in any material respect to implement an accepted compliance plan, the FRB may issue an order directing corrective and other actions of the types to which a significantly undercapitalized institution would be subject under the "prompt corrective action" provisions of the FDICIA. If a bank fails to comply with such an order, the FRB may seek to enforce such an order in judicial proceedings and to impose civil monetary penalties.
Prompt Corrective Action. The FDIA also established a system of prompt corrective action to resolve the problems of undercapitalized institutions. The FRB, as well as the other federal banking regulators, adopted regulations governing the supervisory actions that may be taken against undercapitalized institutions. The regulations establish five categories, consisting of "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." The severity of the action authorized or required to be taken under the prompt corrective action regulations increases as a bank's capital decreases within the three undercapitalized categories. The Bank is prohibited from paying dividends or other capital distributions or paying management fees to any controlling person if, following such distribution, the Bank would be undercapitalized.
Community Reinvestment. Under the Community Reinvestment Act ("CRA"), insured depository institutions, including the Bank, have a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of the entire community, including low and moderate-income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires the FRB to assess the depository institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such institution, including applications for additional branches and acquisitions. The CRA requires the FRB to provide a written evaluation of an institution's CRA performance utilizing a four-tiered descriptive rating system, and the institution is required to publicly disclose its CRA rating. The four descriptive ratings are "outstanding," "satisfactory," "needs to improve" and "substantial noncompliance." The Bank received a "Satisfactory" rating on its last CRA exam dated July 31, 2006.
CRA regulations rate an institution based on its actual performance in meeting community needs. In particular, the assessment system focuses on three tests:
*
a lending test, to evaluate the institution's record of making loans in its assessment areas;
*
an investment test, to evaluate the institution's record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses in its assessment area, or a broader area that includes its assessment areas; and
*
a service test, to evaluate the institution's delivery of services through its retail banking channels and the extent and innovativeness of its community development services.
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank ("FHLB") system, which consists of 12 regional FHLB's. The FHLB provides a central credit facility primarily for member institutions. The Bank, as a member of the FHLB of Boston (the "FHLB-Boston"), is required to acquire and hold shares of capital stock in the FHLB-Boston in an amount equal to at least 0.35% of the Bank's "Membership Stock Investment Base," as defined by the FHLB-Boston, or $10,000, whichever is greater. The Bank is also required to own activity based stock, which is based on 4.5% of the Bank's outstanding advances, or 3% for overnight advances. These percentages are subject to change by the FHLB-Boston. The Bank was in compliance with this requirement with an investment in FHLB-Boston stock at December 31, 2006 of $7.7 million. Any FHLB advances must be secured by specified types of collateral, and all long-term advances may be obtained only for the purpose of providing funds for residential housing finance. The FHLB's are required to provide funds for certain purposes including contributing funds for affordable housing programs. These requirements could reduce the amount of dividends that the FHLB's pay to their members and result in the FHLB's imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future FHLB advances increased, the Bank's net interest income would be affected.
Federal Reserve System. Under FRB regulations, the Bank is required to maintain noninterest-earning reserves against its transaction accounts. Current FRB regulations generally require a 3% reserve for transaction accounts from $8.5 million to $45.8 million, subject to adjustment by the FRB. The first $8.5 million of otherwise reservable balances, subject to adjustments by the FRB, are exempted from the reserve requirements. A 10% reserve is required for transaction accounts in excess of $45.8 million. The Bank is in compliance with these requirements. Because required reserves must be maintained in the form of either vault cash, a noninterest-bearing account at a Federal Reserve Bank or a pass-through account as defined by the FRB, the effect of this reserve requirement is to reduce the Bank's interest-earning assets.
The Interstate Banking Act. Beginning June 1, 1997, the Interstate Banking Act permitted federal banking agencies to approve merger transactions between banks located in different states, regardless of whether the merger would be prohibited under the law of the two states. The Interstate Banking Act also permitted a state to "opt in" to the provisions of the Interstate Banking Act before June 1, 1997, and permitted a state to "opt out" of the provisions of the Interstate Banking Act by adopting appropriate legislation before that date. Accordingly, beginning June 1, 1997, the Interstate Banking Act permitted a bank, such as the Bank, to acquire an institution by merger in a state other than Maine unless the other state had opted out of the Interstate Banking Act. The Interstate Banking Act also authorizes de novo branching into another state if the host state enacts a law expressly permitting out of state banks to establish such branches within its borders.
The Bank Secrecy Act. The Bank is subject to the Bank Secrecy Act, as amended by the USA PATRIOT Act, which gives the federal government powers to address money laundering and terrorist threats through enhanced domestic security measures, expanded surveillance powers, and mandatory transaction reporting obligations. By way of example, the Bank Secrecy Act imposes an affirmative obligation on the Bank to report currency transactions that exceed certain thresholds and to report other transactions determined to be suspicious.
Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among financial institutions, bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act. Among other requirements, the USA PATRIOT Act imposes the following obligations on financial institutions:
*
all financial institutions must establish anti-money laundering programs that include, at minimum: (i) internal policies, procedures, and controls; (ii) specific designation of an anti-money laundering compliance officer; (iii) ongoing employee training programs; and (iv) an independent audit function to test the anti-money laundering program;
*
all financial institutions must establish and meet minimum standards for customer due diligence, identification and verification;
*
financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) must establish appropriate, specific, and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering through those accounts;
*
financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and are subject to certain recordkeeping obligations with respect to correspondent accounts of foreign banks; and
*
bank regulators are directed to consider a bank's or holding company's effectiveness in combating money laundering when ruling on FRA and Bank Merger Act applications.
Office of Foreign Asset Control. The Bank and the Company, like all United States companies and individuals, are prohibited from transacting business with certain individuals and entities named on the Office of Foreign Asset Control's list of Specially Designated Nationals and Blocked Persons. Failure to comply may result in fines and other penalties. Recently, the Office of Foreign Asset Control issued guidance directed at financial institutions in which it asserted that it may, in its discretion, examine institutions determined to be high-risk or to be lacking in their efforts to comply with these prohibitions.
Acquisition of the Company or the Bank. Under the federal Change in Bank Control Act, any person (including a company), or group acting in concert, seeking to acquire control of the Company or the Bank will be required to submit prior notice to the FRB. Under the Change in Bank Control Act, the FRB has 60 days within which to act on such notices, taking into consideration factors, including the financial and managerial resources of the acquirer, the convenience and needs of the communities served by the Company and the Bank, and the anti-trust effects of the acquisition. The term "control" is defined generally under the BHCA to mean the ownership or power to vote 25% or more of any class of voting securities of an institution or the ability to control in any manner the election of a majority of the institution's directors. Additionally under the Bank Merger Act sections of the FDIA, the prior approval of an insured institution's primary federal regulator is required for an insured institution to merge with or transfer assets to another insured institution or an uninsured institution.
EMPLOYEES
As of December 31, 2006, the Bank had 156 full-time employees and 7 part-time employees. The Bank enjoys good relations with its employees. A variety of employee benefits, including health, life and disability income replacement insurance, a funded, noncontributory pension plan, and a defined contribution plan are available to qualifying employees.
SEASONAL INFORMATION
In the Bank's market area, deposit balances generally increase during the summer and autumn months of each year due to an influx of tourists and seasonal residents returning to the area. In 2006, the maximum amount of deposits at any month end was $353.8 million in October. The deposit fluctuation is predictable and does not have a material adverse effect on the Bank and its operations.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The information required to be set forth under this item is incorporated by reference to the financial statements set forth below in Part II, Item 8 of this report on Form 10-K.
COMPANY WEBSITE
The Company maintains a website at www.uniontrust.com. The Company's reports filed with, or furnished to, the Securities and Exchange Commission ("SEC") are available at the SEC's website at www.sec.gov.
Item 1A.
Item 1A. RISK FACTORS
The Company's loan portfolio includes loans with a higher risk of loss. The Company originates commercial mortgage loans, commercial loans, consumer loans, and residential mortgage loans primarily within our market area. Commercial mortgage, commercial, and consumer loans may expose a lender to greater credit risk than loans secured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate. In addition, commercial real estate and commercial loans may also involve relatively large loan balances to individual borrowers or groups of borrowers. These loans also have greater credit risk than residential real estate for the following reasons:
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Commercial Mortgage Loans.
Repayment is dependent upon income being generated in amounts sufficient to cover operating expenses and debt service.
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Commercial Loans.
Repayment is generally dependent upon the successful operation of the borrower's business.
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Consumer Loans.
Consumer loans (such as personal lines of credit) may or may not be collateralized with assets that provide an adequate source of payment of the loan due to depreciation, damage, or loss.
Any downturn in the real estate market or local economy could adversely affect the value of the properties securing the loans or revenues from the borrower's business thereby increasing the risk of non-performing loans.
If the Company's allowance for loan losses is not sufficient to cover actual loan losses, earnings could decrease. The Company's loan customers may not repay their loans according to their terms and the collateral securing the payment of these loans may be insufficient to pay any remaining loan balance. The Company therefore may experience significant loan losses, which could have a material adverse effect on operating results.
Material additions to the allowance for loan losses also would materially decrease net income, and the charge-off of loans may cause management to increase the allowance. Management makes various assumptions and judgments about the collectibility of the loan portfolio, including the creditworthiness of borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of the loans. The Company relies on loan quality reviews, experience and evaluation of economic conditions, among other factors, in determining the amount of the allowance for loan losses. If any of management's assumptions prove to be incorrect, the allowance for loan losses may not be sufficient to cover losses inherent in the loan portfolio, resulting in additions to the allowance.
Changes in interest rates could adversely affect the Company's results of operations and financial condition. The Company's profitability, like that of most financial institutions, depends substantially on net interest income, which is the difference between the interest income earned on our interest-earning assets and the interest expense paid on our interest-bearing liabilities. Increases in interest rates may decrease loan demand and make it more difficult for borrowers to repay adjustable rate loans. In addition, as market interest rates rise, there will be competitive pressures to increase the rates paid on deposits, which will result in a decrease of net interest income.
The Company is also subject to reinvestment risk associated with changes in interest rates. Changes in interest rates may affect the average life of loans and mortgage-related securities. Decreases in interest rates can result in increased prepayments of loans and mortgage-related securities as borrowers refinance to reduce borrowing costs. Under these circumstances, the Company is subject to reinvestment risk to the extent that it is unable to reinvest the cash received from such prepayments at rates that are comparable to the rates on existing loans and securities.
Earnings may be adversely impacted by an increase in interest rates because a significant portion of the Company's interest-earning assets are long-term, fixed rate mortgage-related assets that will not reprice as long-term interest rates increase while a majority of interest-bearing liabilities are expected to reprice as interest rates increase. Therefore, in an increasing interest rate environment, the cost of funds is expected to increase more rapidly than the yields earned on the loan portfolio and securities portfolio. An increasing rate environment is expected to cause a narrowing of the net interest rate spread and a decrease in net interest income.
The local economy may affect future growth possibilities. The Company's current market area is principally located in Washington, Hancock, Waldo, Knox, and Lincoln Counties, which are located along the coast of the State of Maine. Future growth opportunities depend on the growth and stability of the regional economy and the Company's ability to expand its market area. A downturn in the local economy may limit funds available for deposit and may negatively affect borrowers' ability to repay their loans on a timely basis, both of which could have an impact on profitability.
The Company depends on its executive officers and key personnel to continue the implementation of its long-term business strategy and could be harmed by the loss of their services. Management believes that the continued growth and future success of the Company will depend in large part upon the skills of the management team. The competition for qualified personnel in the financial services industry is intense, and the loss of key personnel or an inability to continue to attract, retain and motivate key personnel could adversely affect the business. The Company cannot assure you that it will be able to retain existing key personnel or attract additional qualified personnel. The loss of the services of one or more of the Company's executive officers and key personnel could impair its ability to continue to develop its business strategy.
The Company operates in a highly regulated environment, and changes in laws and regulations to which it is subject may adversely affect its results of operations. The Company is subject to extensive regulation, supervision and examination by the Maine Bureau of Financial Institutions, as the Bank's chartering authority, by the FDIC as the insurer of the Bank's deposits up to certain limits, and by the FRB, of which the Bank is a member, and which regulates and oversees the Company as a bank holding company. The Bank also belongs to the FHLB System and, as a member of such system, is subject to certain limited regulations promulgated by the FHLB-Boston. This regulation and supervision limits the activities in which the Company and the Bank may engage. The purpose of regulation and supervision is primarily to protect the Bank's depositors and borrowers and, in the case of FDIC regulation, the FDIC's insurance fund. Regulatory authorities have extensive discretion in the exercise of their supervisory and enforcement powers. They may, among other things, impose restrictions on the operation of a banking institution, the classification of assets by such institution and such institution's allowance for loan losses. Regulatory and law enforcement authorities also have wide discretion and extensive enforcement powers under various consumer protection and civil rights laws, including the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair Housing Act, and the Real Estate Settlement Procedures Act. Any change in the laws or regulations applicable to the Company or the Bank, or in banking regulators' supervisory policies or examination procedures, whether by the Maine Bureau of Financial Institutions, the FDIC, other state or federal regulators, the United States Congress or the Maine legislature could have a material adverse effect on the Company's business, financial condition, results of operations and cash flows.
Competition in the Bank's primary market area may reduce its ability to attract and retain deposits and originate loans. The Company contends with considerable competition both in generating loans and attracting deposits. The Company's competition for loans is primarily from other commercial banks, savings banks, credit unions, mortgage banking companies, insurance companies, finance companies, and other institutional lenders. Competitive factors considered for loan generation include interest rates offered, loan fees charged, loan products offered, services provided, and geographic locations.
In attracting deposits, the Company's primary competitors are savings banks, commercial banks, credit unions, as well as other non-bank institutions such as brokerage firms and insurance companies that offer financial alternatives. Competitive factors considered in attracting and retaining deposits include deposit and investment products and their respective rate of return, liquidity, and risk among other factors, convenient branch location and hours of operation, personalized customer service, online access to accounts, and automated teller machines.
If the Company is unable to compete successfully, the business and operations could be adversely affected. Competition for loan originations and deposits may limit future growth and earnings prospects.
If the Company fails to maintain an effective system of internal control over financial reporting, it may not be able to accurately report financial results or prevent fraud, and, as a result, investors and depositors could lose confidence in the Company's financial reporting, which could adversely affect its business, the trading price of its stock and its ability to attract additional deposits. Beginning with the Company's annual report for the fiscal year ending December 31, 2007, the Company will have to include in its annual reports filed with the SEC a report of management regarding internal control over financial reporting. As a result, the Company recently began to document and evaluate its internal control over financial reporting in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act and SEC rules and regulations, which require an annual management report on internal control over financial reporting, including, among other matters, management's assessment of the effectiveness of internal control over financial reporting and an attestation report by the Company's independent auditors addressing these assessments. Accordingly, management has formulated a Committee to assist in (i) assessing and documenting the adequacy of internal control over financial reporting, (ii) improving control processes, where appropriate, and (iii) verifying through testing that controls are functioning as documented. If the Company fails to identify and correct any significant deficiencies in the design or operating effectiveness of its internal control over financial reporting or fails to prevent fraud, current and potential shareholders and depositors could lose confidence in the Company's financial reporting, which could adversely affect its business, financial condition and results of operations, the trading price of its stock and its ability to attract additional deposits.
The Company's Certificate of Incorporation and bylaws may prevent a transaction you may favor or limit growth opportunities, which could cause the market price of the Company's common stock to decline. Certain provisions of the Company's Certificate of Incorporation and bylaws and applicable provisions of Maine and federal law and regulations may delay, inhibit or prevent an organization or person from gaining control of the Company through a tender offer, business combination, proxy contents or some other method, even though you might be in favor of the transaction.
The Company may not be able to pay dividends in the future in accordance with past practice. The Company pays a quarterly dividend to shareholders. However, the Company is dependent primarily upon the Bank for its earnings and funds to pay dividends on its common stock. The payment of dividends also is subject to legal and regulatory restrictions. Any payment of dividends in the future will depend, in large part, on the Bank's earnings, capital requirements, financial condition and other factors considered relevant by the Board of Directors.
Item 1B.
Item 1B. UNRESOLVED STAFF COMMENTS
Not Applicable
Item 2.
Item 2. PROPERTIES
The Company's headquarters and the Bank's main branch are located at 66 Main Street, Ellsworth, Maine, in a three-story building owned by the Bank. The building contains approximately 44,000 square feet. As of December 31, 2006, the Company's properties and leasehold improvements had an aggregate net book value of $7.2 million.
Location
Ownership
Year Opened
Lease Expiration
Corporate Headquarters of the Bank
and the Company
66 Main Street
Ellsworth, Maine 04605
Owned
---
Branch Offices:
51 Main Street
Jonesport, Maine 04649
Owned
---
9 Tenney Hill
Blue Hill, Maine 04614
Owned
---
3 Atlantic Avenue
Stonington, Maine 04681
Owned
---
29 Main Street
Milbridge, Maine 04658
Owned
---
1768 Atlantic Highway
Waldoboro, Maine 04572
Owned
---
75 Elm Street
Camden, Maine 04843
Owned
---
175 High Street
Ellsworth, Maine 04605
Leased
21 Main Street
Castine, Maine 04421
Leased
43 Cottage Street
Bar Harbor, Maine 04609
Leased
17 Belmont Avenue
Belfast, Maine 04915
Leased
1316 State Highway 102
Bar Harbor, Maine
Leased
3 Glen Street
Rockland, Maine 04841
Leased
Item 3.
Item 3. LEGAL PROCEEDINGS
There are no material legal proceedings pending to which the Company or the Bank is a party, or of which any of their property is the subject, other than ordinary routine litigation incidental to the business.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of our security holders in the fourth quarter of 2006.
PART II
Item 5.
Item 5.
MARKET FOR REGISTRANT'S COMMON STOCK, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common stock has been listed on the OTC Bulletin Board under the symbol "UNBH" since October 28, 2003. Prior to that date, the Company's common stock was not listed on any stock exchange or actively traded. The Company declared quarterly cash dividends totaling $1.60 per share during 2006 and $1.60 per share during 2005.
The following table sets forth the high and low sales prices of our common stock as reported on the OTC Bulletin Board and the dividends declared per share of common stock for the periods indicated.
As of March 9, 2007 there were approximately 723 holders of record of the Company's common stock.
Payment of dividends by the Company on its common stock is subject to various regulatory restrictions and guidelines. Because substantially all of the funds available for the payment of dividends are derived from the Bank, future dividends will depend on the earnings of the Bank, its financial condition, its need for funds, applicable governmental policies and regulations, and other such matters as the Board of Directors deems appropriate. Please see the discussion of dividends under "Maine Banking Laws and Supervision" on page 4. Management believes that the Bank will continue to generate adequate earnings to continue to pay dividends on a quarterly basis.
The following graph provides a comparison of total shareholder return on the common stock of the Company with that of other comparable issuers and illustrates the yearly percentage change in the Company's cumulative total shareholder return on its common stock for each of the last five years. For purposes of comparison, the graph illustrates comparable shareholder return of NASDAQ banks as a group as measured by the NASDAQ Bank Stock Index and in Standard & Poor's 500 Index (S & P 500). The graph assumes a $100 investment on December 31, 2001 in the common stock of the Company, in the NASDAQ Bank Stock Index, and in the S&P 500 and measures the amount by which the market value of each, assuming reinvestment of dividends, has increased as of December 31 of each calendar year since the base measurement point of December 31, 2001. The Company has been listed on the OTC Bulletin Board since October 28, 2003. Prior to that date, the Company's common stock was not listed on any stock exchange or actively traded.
On April 14, 2002, the Board of Directors of the Company adopted a Stock Repurchase Program, which provided for the repurchase of up to 57,700 shares, or 5%, of the Company's then-outstanding common stock. On October 27, 2004, the Board of Directors of the Company amended the Stock Repurchase Program to authorize the repurchase of up to 86,550 shares, or 7.5%, of the Company's common stock outstanding as of April 14, 2002. On February 22, 2006, the Board of Directors of the Company authorized the repurchase of 5,000 additional shares under the Stock Repurchase Program. On April 19, 2006, the Board of Directors of the Company amended the Stock Repurchase Program to authorize the repurchase of an additional 54,529 shares, or 5%, of the Company's common stock outstanding as of April 10, 2006. Originally adopted for a term of 12 months, the Stock Repurchase Program has been extended several times by the Company, and was extended, effective April 19, 2006, until such time as all shares authorized for repurchase under the Stock Repurchase Program have been repurchased. The repurchases may be made from time to time at the discretion of management of the Company. Shares repurchased by the Company are designated as authorized but unissued stock of the Company. The Company may utilize such shares for any purpose the Board of Directors of the Company deems advisable in compliance with applicable law. As of December 31, 2006, a total of 121,465 shares have been repurchased since the plan's inception on April 14, 2002. The Company repurchased 41,736 shares as part of this plan during 2006 at an average price of $62.60.
The following table summarizes the Company's purchases of its common stock during the quarter ended December 31, 2006.
Item 6.
Item 6. SELECTED FINANCIAL DATA
The selected consolidated financial and other data of the Company set forth below does not purport to be complete and should be read in conjunction with the consolidated financial statements and related notes in Part II, Item 8 of this report on Form 10-K.
Certain ratios have been recalculated to conform with current year calculation methods. All share amounts have been restated to reflect the Company's 2-for-1 stock split, in the form of a 100% stock dividend, paid on March 21, 2005.
Item 7.
Item 7.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis reviews the consolidated financial condition of the Company at December 31, 2006 and 2005, as well as the consolidated results of operations for 2006, 2005 and 2004. This discussion should be read in conjunction with the consolidated financial statements and related notes in Part II, Item 8 of this report on Form 10-K.
Certain information discussed below is presented on a fully taxable equivalent basis. Management believes the disclosure of tax-equivalent net interest income information improves the clarity of financial analysis, and is particularly useful to investors in understanding and evaluating the changes and trends in the Company's results of operations.
Executive Overview
The Company posted net income for the year ended December 31, 2006 of $3.8 million, compared to $4.7 million in 2005. Earnings per share decreased $0.78 to $3.50 compared to $4.28 for 2005. Return on average equity was 9.40% compared to 11.61% in 2005 and return on average assets was .69% compared to .91% in 2005.
The Company's results in 2006, versus 2005, reflected a decrease in net interest income of $1.1 million, or 7%, from the prior year, ending the year at $14.7 million. This decrease was the result of continued margin compression resulting in a 41 basis point decline in the net interest margin to 3.00% for fiscal year 2006 from 3.41% for 2005. This decrease was offset in part by continued growth in earning assets during the year. Non-interest income increased by $284,000, to $6.0 million, due primarily to continued growth in financial services fees and commissions as well as increases in bankcard fees and other income, partially offset by net losses on sales of securities. Non-interest expenses ended the year at $15.6 million, an increase of $429,000, or 3%, over the prior year. This increase was mainly the result of an increase in advertising expenses.
Comparing balances at December 31, 2006 to December 31, 2005, total assets increased 4% to $551.0 million. Total deposits increased by $12.8 million, or 4%, while total loans grew to $370.2 million from $355.9 million, a 4% increase over the prior year end. The Company's borrowings increased by $7.1 million, or 5%, during 2006, primarily due to the issuance of $8.2 million of junior subordinated debt securities, related to the issuance of trust preferred securities, (see Note 11 in the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report). As of December 31, 2006, the Company had total shareholders' equity of $41.6 million, or 8% of total assets, and continued to exceed regulatory requirements for well capitalized institutions.
Asset quality, as measured by the following ratios, continued to be favorable. Nonperforming assets represented .58% of total assets at the end of 2006, versus 0.46% at the end of 2005. The ratio of net charge-offs to average loans was 0.00% in 2006, as compared to 0.01% for the prior year.
Critical Accounting Policies
Management's discussion and analysis of the Company's financial condition are based on the consolidated financial statements which are prepared in accordance with accounting principles generally accepted in the United States. The preparation of such financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. On an ongoing basis, management evaluates its estimates, including those related to the allowance for loan losses and the evaluation of mortgage servicing rights. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets that are not readily apparent from other sources. Under different assumptions or conditions, actual results could differ from the amount derived from management's estimates and assumptions.
Allowance for Loan Losses. Management believes the allowance for loan losses is a critical accounting policy that requires the most significant estimates and assumptions used in the preparation of the consolidated financial statements. The allowance for loan losses is based on management's evaluation of the level of the allowance required in relation to the estimated loss exposure in the loan portfolio. Management believes the allowance for loan losses is a significant estimate and therefore regularly evaluates it for adequacy by taking into consideration factors such as prior loan loss experience, the character and size of the loan portfolio, business and economic conditions and management's estimation of probable losses. The use of different estimates or assumptions could produce different provisions for loan losses.
Mortgage Servicing Rights. The valuation of mortgage servicing rights is also a critical accounting policy which requires significant estimates and assumptions. Servicing assets are recognized as separate assets when servicing rights are acquired through the sale of residential mortgage loans. Capitalized servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Management uses, on a quarterly basis, an independent firm which specializes in the valuation of mortgage servicing rights to
determine the fair value which is recorded on the balance sheet. This includes an evaluation for impairment based upon the fair value of the rights, which can vary depending upon current interest rates and prepayment expectations, as compared to amortized cost. When the book value exceeds the fair value, a valuation allowance is recorded against these servicing assets.
Results of Operations
Comparison of 2006 to 2005
Net Income. Net income for the year ended December 31, 2006 was $3.8 million, representing a decrease of 20% or $946,000 from net income of $4.7 million posted in 2005. Earnings per share were $3.50 and $4.28 for the years ended 2006 and 2005, respectively. Return on average equity and return on average assets were 9.40% and .69% for 2006, respectively. These compare to 11.61% and .91% for 2005, respectively.
Net Interest Income. Net interest income, the difference between interest income earned on interest-earning assets and interest expense incurred on interest-bearing liabilities, continues to be the primary source of operating revenue for the Company. During 2006, net interest income accounted for 71% of total revenues for the Company. The amount of net interest income is affected by changes in interest rates and by the volume, mix, and interest rate sensitivity of interest-earning assets and interest-bearing liabilities.
Net interest income, on a fully tax-equivalent basis, was $15.5 million in 2006, a $1.1 million decrease compared to $16.5 million in 2005. During 2006, net interest margin declined 41 basis points to 3.00%, resulting primarily from increases in the cost of interest bearing liabilities over and above improvements in the yield on interest earning assets. This margin pressure was partially offset by an increase in average interest earning assets of $31.0 million, or 6%, in 2006.
The average balance of interest-earning assets for 2006 amounted to $515.4 million, an increase of $31.0 million, or 6%, compared to $484.4 million in 2005. Average loan balances increased $31.7 million, or 9%, for the twelve months ended December 31, 2006 compared to the same period in 2005. The average balance of securities remained at $145.0 million, or 28% of average earning assets, at December 31, 2006. The yield on interest-earning assets increased 48 basis points to 5.90% for 2006, compared to 5.42% for the same period in 2005. The yield on loans increased 51 basis points from 5.81% for the twelve months ended December 31, 2005 to 6.32% for the twelve months ended December 31, 2006 and the yield on investments also increased 32 basis points to 4.83% for the twelve months ended December 31, 2006.
During 2006, the average balance of interest-bearing liabilities increased by $32.8 million, or 8%, over 2005 average balances. Average interest-bearing deposits increased $18.9 million, or 7%, to $283.6 million for 2006 compared to the same period in 2005. Average time deposits grew $21.0 million, or 21%, for the twelve months ended December 31, 2006 compared to the same period in 2005; of this increase, $15.9 million was from brokered time certificates of deposit. Average borrowings for the twelve months ended December 31, 2006 were $174.5 million compared to $160.7 million for the same period in 2005, an increase of $13.8 million, or 9%. The increase in borrowings was in part due to the issuance of $8.2 million of junior subordinated debt securities, related to our issuance of trust preferred securities, (see Note 11 in the Notes to Consolidated Financial Statements included in Part II, Item 8 of this report). The Company has contributed $3.0 million of the proceeds from the issuance of trust preferred securities to the Bank as Tier 1 Capital to support the Bank's growth.
The cost of interest-bearing liabilities increased to 3.26% for 2006, compared to 2.28% for 2005. This increase is, in part, attributable to a 126 basis points increase in the cost of total borrowings to 4.62% for 2006, compared to 3.36% for 2005. Interest expense on the subordinated debt securities for 2006 was $475,000 compared to $0 for 2005. The cost of interest-bearing deposits also increased 81 basis points to 2.43% in 2006 compared to 1.62% in 2005. The increase in overall cost of funds is primarily attributable to higher prevailing market rates during 2006, resulting in an increase in competitive rate pressure within our local markets as well as an overall shift in the deposit mix into higher costing deposit products.
The following table sets forth, for the years indicated, information regarding (i) the total dollar amount of interest income from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average costs; (iii) net interest income; (iv) net interest rate spread; and (v) net interest margin. For purposes of this table and the following discussion, income from interest earning assets and net interest income are presented on a fully taxable equivalent basis and nonaccrual loans have been included in average balances only.
The following table presents certain information on a fully-taxable equivalent basis regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to (i) changes in volume (change in volume multiplied by prior year rate), (ii) changes in rate (change in rate multiplied by prior year volume), and (iii) changes in rate/volume (change in rate multiplied by change in volume).
Non-Interest Income.
The following table summarizes information relating to the Company's non-interest income:
Non-Interest Income
Total non-interest income amounted to $6.0 million for 2006 compared to $5.8 million for 2005, a $284,000, or 5%, increase. The increase is primarily attributable to higher financial services fees and commissions, bankcard fees, and higher levels of other income, partially offset by a $112,000 loss on sale of investment securities.
Financial service fees and commissions, representing 41% of total non-interest income, increased $132,000, or 6%, ending 2006 at $2.5 million compared to $2.4 million in 2005. This increase is primarily due to a continued increase in new business volume and growth in managed assets.
Bankcard fees, which represents 6% of total non-interest income, increased $47,000, or 15%, ending 2006 at $356,000 due to a continued increase in debit card interchange revenue.
Other income increased from 2005 by $188,000, ending at $227,000 for 2006. Primarily within mortgage servicing activities, the increase in residential mortgage sales volumes coupled with improved pricing generated more income associated with establishing the mortgage servicing rights as an offset to increased amortization from prior year loan sales.
During 2006, the Company sold $7.3 million in securities resulting in a net loss of $112,000. The proceeds from the sale were reinvested into higher yielding securities which will produce greater earnings beginning in 2007.
Non-Interest Expense. The following table summarizes information relating to the Company's non-interest expense:
Non-Interest Expense
Total non-interest expense increased by $429,000 or 3%, to $15.6 million for the year ended December 31, 2006 from $15.2 million in 2005. The increase in non-interest expenses in 2006 was primarily due to an increase of $369,000 in advertising and promotional costs in connection with the Bank's new branding efforts as well as, an increase in salaries and employee benefits of $109,000, or 1%, and a $56,000, or 4%, increase in equipment and data processing. These increases were partially offset by a reduction in legal and other professional fees of $143,000, or 18%.
Provision for Loan Losses. The Company did not record any provision for loan loss during 2006 compared to recording a $215,000 recovery in the provision for loan losses in 2005. The allowance for loan losses to total loans decreased from 1.19% at the end of 2005 to 1.15% at the end of 2006. Nonperforming loans represented .86% of total loans at December 31, 2006 compared to .69% at December 31, 2005.
Provision for Income Taxes. Income tax expense amounted to $1.3 million in 2006 compared with $1.8 million in 2005. The resulting effective tax rates were 25.0% for 2006, and 27.7% for 2005. The decrease in the effective tax rate for 2006 was mainly the result of an increase in the percentage of non-taxable income on obligations of the states and political subdivisions to total taxable income.
Comparison of 2005 to 2004
Net Income. Net income for the year ended December 31, 2005 was $4.7 million, representing a decrease of 2% or $82,000 from net income of $4.8 million posted in 2004. Earnings per share were $4.28 and $4.24 for the years ended 2005 and 2004, respectively. Return on average equity was 11.61% in 2005, compared to 11.63% in 2004, and return on average assets were .91% for 2005 compared to 1.03% in 2004.
Net Interest Income. Net interest income decreased by $115,000 to $15.8 million from $15.9 million in 2004. On a fully tax-equivalent basis, net interest income was $16.5 million in 2005, a $164,000 increase compared to $16.4 million in 2004 due to growth in the municipal loan and investment portfolios and the non-taxable treatment of these assets. During 2005, tax equivalent net interest margin declined 36 basis points to 3.41%, resulting primarily from increases in the cost of interest bearing liabilities over and above improvements in the yield on interest earning assets. This margin pressure was partially offset by an increase in average interest earning assets of $50.1 million, or 12%, from $434.3 million in 2004 to $484.4 million in 2005.
Provision for Loan Losses. The Company recorded a $215,000 recovery in the provision for loan losses in 2005 compared to provision expense of $222,000 in 2004. The allowance for loan losses to total loans decreased from 1.45% at the end of 2004 to 1.19% at the end of 2005. Nonperforming loans represented .69% of total loans at December 31, 2005 compared to .47% at December 31, 2004.
Non-Interest Income. Non-interest income amounted to $5.8 million for 2005 compared to $5.7 million for 2004, a $38,000 increase. The increase is primarily attributable to higher financial services fees and commissions and service charges and fees on deposit accounts, offset by a decrease in loan fees and other income, and a decrease in gains from the sale of investment securities.
Non-Interest Expense. Non-interest expense increased by $671,000 or 5%, to $15.2 million for the year ended December 31, 2005 from $14.5 in 2004. The increase in non-interest expenses in 2005 was in part attributable to an increase in advertising costs of $63,000 or 22% and increased legal and professional fees of $173,000 or 28%. Salaries and employee benefits, net occupancy and equipment and data processing increased 2% in total from 2004.
Other non-interest expenses increased by $224,000, or 11%, for the year ended December 31, 2005 compared to the same period in 2004. The increase in other non-interest expenses for the year is primarily attributable to an increase in stationary and supplies costs, higher donation expenses associated with the charitable contribution of the Cherryfield facility, and the reversal of reserves related to the valuation of mortgage servicing rights, reducing 2004 expenses by $187,000.
Provision for Income Taxes. Income tax expense amounted to $1.8 million in 2005 compared with $2.0 million in 2004. The resulting effective tax rates were 27.7% for 2005, and 29.8% for 2004. The decrease in the effective tax rate for 2005 was mainly the result of an increase in the percentage of non-taxable income on obligations of states and political subdivisions.
Balance Sheet Review
The Company's total assets increased by $21.1 million, or 4%, from $529.9 million at December 31, 2005 to $551.0 million at December 31, 2006. Total average assets were $551.6 and $519.7 in 2006 and 2005, respectively. These increases were primarily due to continued growth in the Company's loan portfolio. During 2006, average loan balances increased $31.7 million, or 9%, ending December 31, 2006 at $370.3 million compared to $338.5 at December 31, 2005. Total liabilities increased to $509.4 million resulting from $12.8 million growth in deposits and a $7.3 million increase in borrowings and other liabilities. Shareholders' equity totaled $41.6 million and $40.6 million at December 31, 2006 and 2005, respectively.
Loan Portfolio. The Company offers a wide variety of loan products to serve the financial needs of individuals, businesses, municipalities, and nonprofit organizations. At December 31, 2006, total loans (excluding loans held for sale) reached a record high of $370.2 million, an increase of $14.3 million, or 4%, over 2005.
The Company's primary lending activity continues to be the origination of loans secured by real estate primarily in our market area. During 2006, real estate loans totaled $310.6 million, an increase of $18.1 million, or 6%, when compared to December 31, 2005. At December 31, 2006, the Bank's real estate loan portfolio included $233.0 million in residential real estate loans comprised of residential construction loans as well as residential mortgages, most of which are one-to four-family. This category increased over the prior year by $7.3 million, or 3%. Commercial real estate loans totaled $77.7 million, representing an increase of $10.7 million, or 16%, compared to December 31, 2005. During 2006, Management continued to focus on changing the overall composition of the loan portfolio by emphasizing commercial growth while placing less emphasis on portfolio residential lending.
Commercial and industrial loans at $27.9 million remained essentially unchanged from 2005 as new loan originations kept pace with the amortization and pay-down of the existing portfolio.
Consumer loans, primarily consisting of home equity lines of credit, automobile, boat and recreational vehicle loans, loans secured by certificate accounts, and unsecured loans decreased by $844,000 during 2006.
Municipal loans also decreased during 2006, ending the year at $2.0 million compared to $4.9 million at the end of 2005.
The following table summarizes the composition of the Bank's loan portfolio by type of loan at the dates indicated.
Loan Portfolio Composition
The following table sets forth the scheduled contractual amortization of the Bank's loan portfolio at December 31, 2006. The amounts shown below exclude student loans, applicable loans in process, and net deferred loan fees.
Loan Maturity Schedule
The following table sets forth the dollar amount of all loans at December 31, 2006 that are due after December 31, 2007 and have either fixed interest rates or floating or adjustable interest rates. The amounts shown below exclude student loans, applicable loans in process, and net deferred loan fees.
(1)
Floating or adjustable rate loans include loans where the interest rates on those loans may be fixed for a stated period of time, then reprice annually or on a more frequent basis thereafter.
Loan Concentrations. The Bank grants residential, commercial and consumer loans to customers principally located in Hancock, Washington, Knox, Lincoln and Waldo Counties of the State of Maine. Although the loan portfolio is diversified, a substantial portion of our debtors' ability to honor their contracts is dependent upon the economic conditions in the area, especially in the real estate sector. As of December 31, 2006 and 2005, the Company did not have any concentration of loans in one particular industry that exceeded 10% of its total loan portfolio.
Sale of Loans. The Bank's residential real estate portfolio includes both conforming and non-conforming residential mortgage loans. Conforming mortgage loans represent loans originated in compliance with terms, conditions and documentation, which permit the sale of such loans on the secondary market. These loans are generally collateralized by one-to-four family residential real estate, have loan-to-collateral ratios of 80% or less, and are made to borrowers in good credit standing. The right to service the loans and receive servicing fee income is generally retained when conforming loans are sold. Secondary market sales of mortgage loans totaled $13.9 million in 2006, compared to $10.5 million in 2005. Residential mortgages originated during 2006 totaled $73.2 million, compared to $91.8 million during 2005.
The following schedule is a summary of loans with principal and/or interest payments over 30 days past due and still accruing:
Nonperforming Assets. Nonperforming assets consist of nonperforming loans, Other Real Estate Owned, ("OREO") and nonperforming securities. As of December 31, 2006, nonperforming assets totaled $3.2 million, an increase of $735,000 from 2005 and represented .58 % of total assets for the year ending December 31, 2006 compared to .46% for the year ending December 31, 2005. The increase from December 31, 2005 was primarily due to a $1.7 million increase in accruing loans that are contractually past due 90 days or more, partially offset by a decrease in nonaccrual loans of $1.0 million. Loans that are contractually past due by 90 or more days and still accruing include well secured loans with a defined payment strategy posing minimal risk of loss to the Bank.
The following table sets forth information regarding nonperforming assets at the dates indicated.
As a general rule, loans are placed on nonaccrual status when, in the opinion of management, there are doubts as to the collectibility of interest or principal, or when principal or interest is past due 90 days or more, and the loan is not well secured and in the process of collection. Income accruals are suspended and interest previously accrued and uncollected is reversed against interest income at the time the related loan is placed on nonaccrual status. Payments received on nonaccrual loans are recorded as a reduction to principal. For each of these loans, management has evaluated the collectibility of the principal based on its best estimate of the realizable collateral value of the loans and does not anticipate that any losses from liquidation of these loans will have a material effect on future operations.
In accordance with the SEC's Industry Guide 3 Item III. C (1), the gross interest income that would have been recorded in 2006, 2005, and 2004 if nonaccrual and restructured loans had been current in accordance with their original terms and had been outstanding throughout the period or since origination approximates $68,000, $97,000, and $35,000 respectively.
Potential problem loans are any loans, which are not included in nonaccrual or non-performing loans and which are not considered troubled debt restructures. At December 31, 2006, outstanding balances on potential problem loans totaled $7.2 million. Although these are loans where known information about possible credit problems of the borrowers causes management to have concerns as to the ability of such borrowers to comply with present loan repayment terms, most are well collateralized and are not believed to present significant risk of loss. At December 31, 2006, problem loans continued to perform and the Company's management actively monitors these loans to minimize any possible adverse impact to the Bank.
Allowance for Loan Losses. The Company maintains an allowance for possible loan losses through a provision that is charged to income. The process of evaluating the adequacy of the allowance for loan losses involves a high degree of management judgment, based in part on systematic methods. These methods, which are generally quantitative measures, are employed to help ensure that all relevant matters affecting loan collectibility will be consistently identified. Such methods at December 31, 2006 included a loan-by-loan analysis of all impaired loans and loans under close monitoring by management for potential problems, a risk rating analysis for all commercial and commercial real estate loans and a quantitative analysis of residential real estate and consumer loans. Other factors included in the evaluation of the adequacy of the allowance for loan losses involve overall loan growth; the character and mix of the loan portfolio; current trends in nonperforming loans, delinquent loans and net charge-offs; new loan origination; local economic conditions; regulatory changes and other quality considerations.
The Company has a semi-annual independent loan review program that supports the Company's lending strategies, monitors compliance with established loan policies and procedures and identifies credit trends. The review included all criticized and classified assets over $100,000, all loans delinquent over 30 days and over $100,000, new (closed) and renewed loans over $100,000, all loans and commitments over $350,000 and a sampling of remaining commercial loans.
While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on increases in nonperforming loans, changes in economic conditions, or for other reasons that would adversely affect the Company's results of operations. The allowance for loan losses is maintained at a level that management considers adequate to provide for probable loan losses based upon evaluation of known and inherent risks in the loan portfolio. The allowance is increased by provisions for loan losses and by recoveries of loans previously charged-off, and reduced by loans charged-off.
For the year ended December 31, 2006, the Company recorded $0 in provision expense, compared to a reduction in the allowance for loan losses resulting in a net provision benefit of $215,000 in 2005 and provision expense of $222,000 in 2004.
The following table sets forth the breakdown of the allowance for loan losses by loan category for the periods indicated. The allocation of an allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any other category. The unallocated portion of the allowance for loan losses is a general reserve that is not allocated to a specific portion of the loan portfolio.
The following table summarizes the allocation of the allowance for loan losses for the years indicated.
Investment Portfolio. During 2006, the Company's investment portfolio decreased by $190,000 to end the year at $140.5 million, compared to $140.7 million at December 31, 2005.
The Company's securities portfolio consists of securities available for sale, securities which management intends to hold until maturity and Federal Home Loan Bank ("FHLB") stock. Securities available for sale consist of certain mortgage-backed securities, including collateralized mortgage obligations, U.S. Government Agency obligations, state and county municipal securities, money market preferred securities and corporate debt securities. These securities are carried at fair value and unrealized gains and losses, net of applicable income taxes, are recognized as a separate component of shareholders' equity. The fair value of securities available for sale at December 31, 2006 totaled $130.5 million with a pre-tax net unrealized loss of $1.5 million. At the end of 2005, securities available for sale were $128.9 million with pre-tax net unrealized loss of $2.2 million.
Securities which management intends to hold until maturity consist primarily of in-state municipal securities. Securities held to maturity as of December 31, 2006 are carried at their amortized cost of $2.0 million and exclude gross unrealized gains of $42,000 and gross unrealized losses of $0. At the end of 2005, securities held to maturity totaled $2.1 million excluding gross unrealized gains of $65,000 and gross unrealized losses of $0.
The following table shows the book value of the Company's held to maturity securities at the end of each of the last three years.
Book Value of Held to Maturity Securities
The table below shows the relative maturities of held to maturity securities as of December 31, 2006.
Amortized Cost of Securities Held to Maturity
(1)
Weighted average yields on tax exempt obligations have been computed on a tax equivalent basis.
The following table shows the fair value of the Company's available for sale securities at the end of each of the last three years.
The table below shows the relative maturities and carrying value of available for sale debt securities as of December 31, 2006. The table excludes stock investments.
Fair Value of Available for Sale Securities
(1)
Weighted average yields on tax exempt obligations have been computed on a tax equivalent basis.
The Company's net unrealized loss on available for sale securities (net of tax) of $978,000 at December 31, 2006 is largely attributable to the current interest rate environment. The unrealized gain has no effect on regulatory capital or current earnings of the Company. The Company would sell these securities only if it was consistent with the Bank's asset/liability management strategies.
Deposit Activities. The Company offers a wide array of deposit products in its market area, including checking accounts, money market accounts, savings accounts, certificates of deposit and retirement savings accounts. At December 31, 2006, deposits of $347.8 million were $12.8 million, or 4 %, higher than at the end of 2005. The growth during 2006 was experienced primarily in the certificates of deposit category, which are typically added at a higher cost relative to core deposits. Certificates of deposit increased by $19.6 million, or 17%, during 2006. The increase in certificates of deposit is primarily attributable to an increase in wholesale certificates of deposit.
In the Bank's market area, the banking business is somewhat seasonal due to an influx of tourists and seasonal residents returning to the area each spring and summer. As a result, customer deposits fluctuate from a relative high point in mid October to a low point in May. This deposit fluctuation is predictable and does not have a material adverse effect on the Bank.
The Bank's average cost of deposits was 2.09% for the year ended December 31, 2006, compared to 1.38% for the year ended 2005, and 0.96% for the year ended 2004.
The following table sets forth the average deposit balances and costs for the years ended December 31, 2006, 2005, and 2004:
The following table sets forth scheduled maturities of time deposits of $100,000 or more as of December 31, 2006.
Maturities of Time Deposits Over $100,000
Borrowings. The Bank's borrowings amounted to $154.8 million at December 31, 2006, an increase of $7.1 million from the end of 2005. At December 31, 2006, the Bank's borrowings consisted primarily of FHLB borrowings totaling $129.7 million, a decrease of $382,000 from the prior year-end. The remaining borrowings consisted primarily of assets sold under repurchase agreements and junior subordinated debt securities issued in connection with our trust preferred securities offering. These borrowings totaled $25.1 million at December 31, 2006, an increase of $7.5 million over December 31, 2005. See Note 11 "Borrowed Funds" of the Notes to Consolidated Financial Statements included in Part II, Item 8 hereof for a schedule of borrowings outstanding and their interest rates and other information related to the Company's borrowings.
Liquidity and Capital Resources
Liquidity. Liquidity, as it pertains to the Company, is the ability to generate adequate amounts of cash to meet current and future financial obligations. The Company's primary sources of funds consist of deposits, borrowings, and the amortization, prepayment and maturities of loans and securities. While scheduled repayment of loans and maturities of securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by the general level of interest rates, seasonality, economic conditions and competitive factors. In addition, as an alternative source of funding to borrowings, the Bank will occasionally purchase brokered certificates of deposits. At December 31, 2006, the Bank had $32.1 million of brokered certificates of deposits outstanding. The Company had $21.8 million in brokered certificates of deposits for the comparable period of 2005.
The Company, as a separately incorporated bank holding company, has no significant operations other than serving as the sole stockholder of the Bank. The Company's commitments and debt service requirement, at December 31, 2006, consist of $8.4 million of junior subordinated debt securities, including accrued interest, issued to an unconsolidated subsidiary, Union Bankshares Capital Trust I, (see Note 11 to the Notes to Consolidated Financial Statements included in Part II, Item 8 hereof). The Company has contributed $3.0 million of the proceeds from the issuance of trust preferred securities to the Bank as Tier 1 Capital to support the Bank's growth.
The Company actively manages its liquidity position under the direction of the Asset/Liability Management Committee. Periodic review under prescribed policies and procedures is intended to ensure that the Company will maintain adequate levels of available funds. At December 31, 2006, the Company's liquidity position was well within policy guidelines. Management believes that the Company has adequate liquidity available to respond to current and future funding requirements.
Capital Resources. The Federal Reserve Board ("FRB"), the Federal Deposit Insurance Corporation ("FDIC"), and other regulatory agencies have established capital guidelines for banks and bank holding companies. Risk-based capital guidelines issued by the federal regulatory agencies require banks to meet a minimum Tier 1 leverage capital
ratio of 4.0%, a Tier 1 risk-based capital ratio of 4.0% and a total risk-based capital ratio of 8.0%. At December 31, 2006, the Company and the Bank exceeded all of their regulatory capital requirements.
At December 31, 2006, the Company had a Tier 1 risk-based capital ratio and a total risk-based capital ratio of 13.51% and 14.76%, respectively, compared to 11.50% and 12.75%, respectively, at December 31, 2005. At December 31, 2006, the Company and the Bank had a Tier 1 leverage ratio of 7.99% and 7.22%, respectively, compared to 6.83% and 6.80%, respectively, at December 31, 2005.
Off-Balance Sheet Risks and Commitments
As of December 31, 2006 and 2005, the total of approved loan commitments outstanding, commitments under unused lines of credit and unadvanced portions of loans amounted to $73.8 million and $70.5 million, respectively. See Note 16 to the Notes to Consolidated Financial Statements included in Part II, Item 8 hereof for further discussion of our off-balance sheet risk.
Contractual Obligations
The following table is a summary of the Company's contractual cash obligations and other commitments as of December 31, 2006.
Contractual Obligations by Maturity
SFAS No. 157 ("SFAS 157"), "Fair Value Measurements" In September 2006, the FASB issued SFAS 157. SFAS 157 was issued to provide consistency and comparability in determining fair value measurements and to provide for expanded disclosures about fair value measurements. The definition of fair value maintains the exchange price notion in earlier definitions of fair value but focuses on the exit price of the asset or liability. The exit price is the price that would be received to sell the asset or paid to transfer the liability adjusted for certain inherent risks and restrictions. Expanded disclosures are also required about the use of fair value to measure assets and liabilities. The effective date is for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not believe the adoption of SFAS 157 will have a material impact on the Company's financial position or results of operations.
SFAS No. 158 ("SFAS 158"), "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - An Amendment of FASB Statements No. 87, 88, 106, and 132(R). In September 2006, the FASB issued SFAS 158. SFAS 158 requires companies to recognize the over-funded and under-funded status of a single employer defined benefit postretirement plan as an asset or liability in its balance sheet and to recognize changes in the funded status in comprehensive income in the year in which the change occurred. However, gains or losses, prior service costs or credits, and transition assets or obligations that have not yet been included in net periodic benefit cost as of the end of 2006, the fiscal year in which SFAS 158 is initially adopted, are to be recognized as components of the ending balance of accumulated other comprehensive income, net of tax. Additionally, SFAS 158 requires companies to measure the funded status of a plan as of the date of the Company's fiscal year-end statements with limited exceptions. The Company adopted SFAS 158 as of December 31, 2006 for its defined benefit pension plan and its post retirement benefits plan, the effects of which can be seen within Note 12 "Employee Benefits" hereof.
FASB Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes" In June 2006, FASB issued FIN 48, an interpretation of SFAS No. 109, "Accounting for Income Taxes" in order to add clarity to the accounting for uncertainty in income taxes recognized in a Company's financial statements. The interpretation requires that only tax positions that are more likely than not to be sustained upon a tax examination are to be recognized in a Company's financial statements to the extent that the benefit has a greater than 50% likelihood of being recognized. The differences that arise between the amounts recognized in the financial statements and the amounts recognized in the tax return will lead to an increase or decrease in current taxes, an increase or decrease to the deferred tax asset or deferred tax liability, respectively, or both. FIN 48 is effective for fiscal years beginning after December 15, 2006 with early application encouraged if interim financial statements have not yet been issued. The adoption of FIN 48 did not have a material impact on the Company's financial position.
Staff Accounting Bulletin ("SAB") No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. In September 2006, the SEC issued SAB No. 108. SAB 108 provides guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year's financial statements are materially misstated. SAB No. 108 addresses the diversity in practice in quantifying financial statement misstatements and financial statement disclosure by considering the impact of prior year misstatements on the current financial statements. SAB 108 requires registrants to apply the new quantification guidance to errors in existence at the beginning of the first fiscal year ending after November 15, 2006 by correcting errors determined to be material under this new quantification method through a one-time cumulative effect income adjustment to its beginning-of-year retained earnings. Upon adoption of SAB 108, the Company recorded a one-time cumulative effect income adjustment to its beginning-of-year retained earnings of $218,000. See Note 14 to the Consolidated Financial Statements for additional information on the adoption of SAB 108.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the sensitivity of income to changes in interest rates, foreign exchange rates, commodity prices, equity prices and other market-driven rates or prices. The Company has no trading operations, and therefore is only exposed to non-trading market risk. The Company's primary market risk exposure is interest rate risk. The ongoing monitoring and management of this risk is an important component of the Company's asset/liability management process, which is governed by policies established by its Board of Directors that are reviewed and approved annually. The Board of Directors delegates responsibility for carrying out the asset/liability management policies to the Asset/Liability Committee ("ALCO"), whose members are comprised of the Bank's senior management. In this capacity ALCO develops guidelines and strategies, consistent with policies established by the Board of Directors, which monitor and coordinate the Bank's interest rate sensitivity and the sources, uses and pricing of funds.
Net interest income sensitivity to movements in interest rates is measured through the use of a simulation model that analyzes resulting net interest income under various interest rate scenarios established by regulators. Projected net interest income (NII) is modeled, based on a gradual shift in market interest rates ("ramped") over a 12-month period. The model is based on the actual maturity and repricing characteristics of interest rate sensitive assets and liabilities and factors in projections for activity levels by product lines of the Company. Assumptions are made as to the changing relationship between different interest rates as interest rates increase/decrease (basis risk) and the customer's ability to prepay loans and withdraw deposit balances or transfer them to a higher yielding account (option risk). The sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for NII exposure over a one-year horizon, assuming no balance sheet growth, given both a 200 basis point (bp) upward and downward shift in interest rates.
The following table sets forth the estimated effects on the Company's net interest income for the periods indicated and reflects such change as a percentage of projected net interest income for the subsequent 12-month period.
Interest Rate Sensitivity
The results implied in the above table indicate estimated changes in simulated net interest income for the subsequent 12 months assuming a gradual shift in market rates up or down of 200 basis points across the entire yield curve. This sensitivity analysis does not represent a Company forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including but not limited to: the nature and timing of interest rate levels including yield curve shape; prepayments on loans and securities; deposit decay rates; pricing decisions on loans and deposits and reinvestment/replacement of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions, including how customer preferences or competitor influences might change.
Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will differ due to: prepayment/refinancing levels likely deviating from those assumed; the potential effect of changing debt service levels on customers with adjustable rate loans; depositor early withdrawals and product preference changes, and other internal/external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Union Bankshares Company
We have audited the accompanying consolidated balance sheets of Union Bankshares Company and Subsidiary as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above represent fairly, in all material respects, the consolidated financial position of Union Bankshares Company and Subsidiary as of December 31, 2006 and 2005, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America.
As discussed in Notes 12 and 14 to the consolidated financial statements, the Company changed its method of evaluating materiality of financial statement misstatements in connection with the adoption of SEC Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" and changed its method of accounting for pension and other postretirement benefits pursuant to Statement of Financial Accounting Standards No. 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R),in 2006.
Portland, Maine
March 29, 2007
UNION BANKSHARES COMPANY AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2006 AND 2005
Dollars in thousands, except per share data
UNION BANKSHARES COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
Dollars in thousands, except per share data
UNION BANKSHARES COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
Dollars in thousands, except per share data
UNION BANKSHARES COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
Dollars in thousands, except per share data
UNION BANKSHARES COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006, 2005 AND 2004
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Union Bankshares Company (the "Company") is a state-chartered, federally registered bank holding company headquartered in Ellsworth, Maine incorporated in 1984. The Company is the sole stockholder of Union Trust Company (the "Bank"), a Maine chartered commercial bank established in 1887. The Company provides a full range of banking services to individual and corporate customers through its subsidiary branches in Maine. It is subject to the regulations of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities. During 2006, the Company was also the sponsor of a Delaware statutory trust named Union Bankshares Capital Trust I which was formed to issue trust preferred securities.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Union Trust Company (the Bank). All significant intercompany balances and transactions have been eliminated in the accompanying financial statements.
Operating Segments
Operations are managed and financial performance is evaluated on a corporate-wide basis. Accordingly, all the Company's banking operations are considered by management to be aggregated in one reportable operating segment.
Accounting Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in the future relate to the determination of the allowance for loan losses, valuation of goodwill, the valuation of mortgage servicing rights, the valuation of the deferred tax asset and the expense for postretirement plans.
Earnings and Cash Dividends per Share
Earnings per share is based upon the weighted average number of common shares outstanding during each year. The Company declared quarterly cash dividends totaling $1.60 per share in 2006 and 2005.
Securities
Available for Sale Securities
Available for sale securities consist of marketable securities that the Company anticipates could be made available for sale in response to changes in market interest rates, liquidity needs, changes in funding sources and similar factors. These assets are specifically identified and are carried at fair value. Amortization of premiums and accretion of discounts are recorded as an adjustment to yield. Unrealized holding gains and losses for these assets, net of related income taxes, are excluded from earnings and are reported as a net amount in a separate component of shareholders' equity. When a decline in market value is considered other than temporary, the loss is recognized in the consolidated statements of income, resulting in the establishment of a new cost basis. Gains and losses on the sale of available for sale securities are determined using the specific identification method.
Held to Maturity Securities
Held to maturity securities consist of debt securities that the Company has the positive intent and ability to hold until maturity. Debt securities classified as held to maturity are carried at amortized cost, adjusted for amortization of premiums and accretion of discounts. When a decline in market value is considered other than temporary, the loss is recognized in the consolidated statements of income, resulting in the establishment of a new cost basis for the security.
Other Investment Securities
Other investment securities consist of Federal Home Loan Bank (FHLB) stock and Federal Reserve Bank stock. These securities are carried at cost, which approximates market value at December 31, 2006 and 2005, and have been evaluated for impairment.
Loans Held for Sale
Loans held for sale are loans originated for the purpose of potential subsequent sale. These loans are carried at the lower of aggregate cost or market value as determined by current investor yield requirements. Gains and losses on the sale of these loans are computed on the basis of specific identification.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balances. Loan commitments are recorded when funded.
Allowance for Loan Losses
The allowance for loan losses is established by management to absorb charge-offs of loans deemed uncollectible. This allowance is increased by provisions charged to operating expense and by recoveries on loans previously charged off. The amount of the provision is based on management's evaluation of the loan portfolio. Considerations include past and anticipated loan loss experience, current economic conditions, the character and size of the loan portfolio and the need to maintain the allowance at a level adequate to absorb probable losses.
Loans considered to be impaired are reduced to the present value of expected future cash flows or to the fair value of collateral, by allocating a portion of the allowance for loan losses to such loans. If these allocations cause the allowance to increase, the increase is reported as loan loss provision.
Loan Servicing
Mortgage loans serviced for others are not included in the accompanying balance sheets. The Bank recognizes a loan servicing fee for the difference between the principal and interest payment collected on the loan and the payment remitted to the investor.
Capitalized mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing revenues. Impairment of mortgage servicing rights is assessed based on the fair value of those rights. Fair values are estimated using discounted cash flows based on a current market interest rate. For purposes of measuring impairment, the rights are stratified based on the following risk characteristics of the underlying loans: interest rate, fixed versus variable rate, and period of origination. The amount of impairment recognized is the amount by which the capitalized mortgage servicing rights for a stratum exceed their fair value.
Premises, Furniture and Equipment
Premises, furniture and equipment are stated at cost less accumulated depreciation. Depreciation expense is computed by accelerated and straight-line methods over the estimated useful life of each type of asset. Leasehold improvements are amortized over the lesser of the terms of the respective leases or the service lives of the improvements. Maintenance and repairs are charged to expense as incurred; betterments are capitalized.
Intangible Assets
The core deposit intangible is amortized on a straight-line basis over 7 years. The core deposit intangible is reviewed for possible impairment when it is determined that events or changed circumstances may affect the underlying basis of the asset.
Upon adoption of Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets", on January 1, 2002, amortization of goodwill was discontinued and the goodwill asset is evaluated for impairment annually, or more frequently upon the occurrence of certain events. Prior to the adoption of SFAS No. 142, goodwill was amortized on a straight-line basis over 15 years.
At December 31, 2006 and 2005, in accordance with SFAS No. 142, the Company completed its annual review of goodwill and determined that there was no impairment.
Other Real Estate Owned
Other real estate owned, which is included in other assets, is recorded at the lower of cost or fair value less estimated costs to sell at the time the Company takes possession of the property. Losses arising from the acquisition of such properties are charged against the allowance for loan losses. Operating expenses and any subsequent provisions to reduce the carrying value are charged to operations. Gains and losses upon disposition are reflected in earnings as realized.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Accrual of Interest Income and Expense
Interest on loans and investment securities is taken into income using methods that relate the income earned to the balances of loans outstanding and investment securities. Interest expense on liabilities is derived by applying applicable interest rates to principal amounts outstanding. The recording of interest income on problem loan accounts ceases when collectibility within a reasonable period of time becomes doubtful. Interest income accruals are resumed only when they are brought fully current with respect to principal and interest, and when management expects the loan to be fully collectible. Loans 30 days or more past due are considered delinquent.
The carrying values of impaired loans are periodically adjusted to reflect cash payments, revised estimates of future cash flows and increases in the present value of expected cash flows due to the passage of time. Cash payments representing interest income are reported as such. Other cash payments are reported as reductions in carrying value, while increases or decreases due to changes in estimates of future payments and due to the passage of time are reflected in the loan loss provision.
Loan Origination Fees and Costs
Loan origination fees and certain direct loan origination costs are recognized over the life of the related loan as an adjustment to, or reduction of, the loan's yield.
Advertising Costs
The Company expenses advertising costs as they are incurred.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.
Comprehensive Income
Comprehensive income includes both net income and other comprehensive income (loss). The only components of other comprehensive income (loss) are net unrealized gains and losses on available for sale securities and adjustments to the liability for pension and postretirement plans, net of deferred taxes. The required disclosures for all periods presented are included in the consolidated statement of changes in shareholders' equity.
Treasury Stock
A revision to the Maine Business Corporation Act requires that stock reacquired by a corporation be classified as "authorized but unissued", effectively eliminating a corporation's ability to hold stock in treasury. In order to recognize the effect of the revision, the Company retired its treasury stock as of June 30, 2004. The 23,014 shares so retired are available for reissuance as authorized, but unissued shares.
Reclassifications
Certain 2004 and 2005 balances have been reclassified to conform with the 2006 presentation.
2. CASH AND DUE FROM BANKS
The Federal Reserve Board requires the Bank to maintain a reserve balance. The amount of this reserve balance as of December 31, 2006 was $606,000. In the normal course of business, the Bank has funds on deposit at other financial institutions in amounts in excess of the $100,000 insured by the Federal Deposit Insurance Corporation.
3. AVAILABLE FOR SALE SECURITIES
The Company carries available for sale securities at fair value. A summary of the cost and fair values of available for sale securities at December 31, 2006 and 2005 is as follows:
The amortized cost and fair value of available for sale debt securities at December 31, 2006, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Mortgage-backed securities are allocated among the above maturity groupings based on their final maturity dates.
Proceeds from the sale of securities were $7.3 million, $2.3 million, and $20.9 million in 2006, 2005 and 2004, respectively. Gross realized gains were $0, $4,000, and $237,000 in 2006, 2005 and 2004, respectively. Gross realized losses were $112,000 in 2006 and $0 in 2005 and 2004.
The fair value and unrealized losses on available for sale securities that have been in a continuous unrealized loss position for less than 12 months and for 12 months or longer as of December 31, 2006 and 2005 are as follows:
Available for sale securities consist of marketable securities that the Company anticipates could be made available for sale in response to changes in the market, interest rates, liquidity needs, and changes in funding sources. As of December 31, 2006, there were 3 securities with a fair value of $7.1 million and an unrealized loss of $49,000 that have been in a continuous unrealized loss position for less than 12 months. There were also 61 securities with a 12 month or more continuous unrealized loss position that had a fair value of $69.4 million and an unrealized loss of $1.9 million. On a monthly basis, management reviews the unrealized loss position for the Company's portfolio, in addition to industry analyst reports, sector credit ratings and interest rate risk profiles, and has concluded that the impairment was not other than temporary and was primarily due to the increase in interest rates.
4. HELD TO MATURITY SECURITIES
The carrying amounts of held to maturity securities for 2006 and 2005 as shown in the Company's consolidated balance sheets, and their approximate fair values at December 31, are as follows:
The amortized cost and fair value of held to maturity securities at December 31, 2006, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Nontaxable interest income on municipal investments was $1.0 million, $1.0 million and $686,000 for 2006, 2005 and 2004, respectively.
5. LOANS
The Company's lending activities are conducted principally in Maine. The Company originates single family and multi-family residential loans, commercial real estate loans, commercial and industrial loans, municipal loans and a variety of consumer loans. In addition, the Company makes loans for the construction of residential homes, multi-family properties and commercial real estate properties.
The following table summarizes the composition of the Bank's loan portfolio by type of loan at the dates indicated.
Loan Portfolio Composition
Net deferred fees included in loans at December 31, 2006 and December 31, 2005 were $195,000 and $174,000, respectively.
At December 31, 2006 and 2005, loans on nonaccrual status totaled approximately $1.3 million and $2.3 million, respectively. If interest had been accrued on such loans, interest income on loans would have been approximately $68,000, $97,000, and $35,000 higher in 2006, 2005 and 2004, respectively. Loans delinquent by 90 days or more that were still on accrual status at December 31, 2006 and 2005 totaled approximately $1.9 million and $186,000, respectively.
As of December 31, 2006 and 2005, the Bank's recorded investment in impaired loans and the related valuation allowance was as follows:
Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance might be necessary based on changes in economic conditions, particularly in northern New England. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance. These agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
7. LOAN SERVICING
Residential real estate mortgages are originated by the Company both for portfolio and for sale into the secondary market. The Company may sell its loans to institutional investors such as the Federal Home Loan Mortgage Corporation. Under loan sale and servicing agreements with the investor, the Company generally continues to service the residential real estate mortgages. The Company pays the investor an agreed upon rate on the loan, which is less than the interest rate the Company receives from the borrower. The Company retains the difference as a fee for servicing the residential real estate mortgages. As required by SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities", the Company capitalizes mortgage servicing rights at their fair value upon sale of the related loans, amortizes the asset over the estimated life of the serviced loan, and periodically assesses the asset for impairment.
The following summarizes mortgage servicing rights capitalized and amortized, along with the activity in the related valuation allowance:
Gain on loans sold was $119,000, $100,000 and $164,000 in 2006, 2005 and 2004, respectively.
8. PREMISES, FURNITURE AND EQUIPMENT
Detail of bank premises, furniture and equipment is as follows:
Depreciation expense related to bank premises, furniture and equipment was $699,000 in 2006, $663,000 in 2005, and $637,000 in 2004.
In 2006, the Company recorded an impairment charge in accordance with the provisions of SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", totaling $110,000. The impairment charge related to the land and building which previously housed the Rockland branch operation and represented the difference between the fair value of the land and building, as determined by a commercial appraisal, and its carrying value. The impairment loss was included in other expense in the consolidated statement of income.
At December 31, 2006, the Bank was obligated under a number of noncancellable leases for premises and equipment that are accounted for as operating leases. Leases for real property contain original terms from 2 to 20 years with renewal options up to 20 years. Management expects that, in the normal course of business, most leases will be renewed or replaced by other leases, or, when available, purchase options may be exercised.
Rental expense was $225,000
in 2006, $245,000 in 2005, and $257,000 in 2004.
The minimum annual lease commitments under noncancellable leases in effect at December 31, 2006 are as follows:
9. INTANGIBLE ASSETS
On August 31, 2000, the Company acquired the outstanding stock of Mid-Coast Bancorp, Inc. and its subsidiary, The Waldoboro Bank, FSB. The acquisition was accounted for under the purchase method of accounting for business combinations. The Company has an intangible asset subject to amortization related to the acquisition. The core deposit intangible is being amortized on a straight-line basis over 7 years, and reviewed for possible impairment when it is determined that events or changed circumstances may affect the underlying basis of the asset.
The carrying amount is as follows:
11. BORROWED FUNDS
Borrowed funds consist of advances from the FHLB, assets sold under repurchase agreements, junior subordinated debentures and treasury tax and loan notes.
Short- and long-term borrowings from the FHLB consist of fixed and variable rate borrowings and are collateralized by a blanket pledge agreement on the Bank's FHLB stock, certain qualified investment securities, deposits at the FHLB, one-to-four family mortgages held in the Bank's portfolio and certain commercial real estate loans. The Company, through its subsidiary, has an available line of credit with the FHLB of $5.0 million. The amount of borrowings with a call option totaled $28.5 million at December 31, 2006.
Borrowings from the FHLB are summarized as follows:
Borrowings at December 31, 2006 mature as follows:
Securities sold under agreements to repurchase generally mature within one day from the transaction date. The Bank provides collateral based upon the par value of the underlying securities. At December 31, 2006, securities with a fair value of $27.2 million were pledged to collateralize other borrowed funds. Information concerning securities sold under agreements to repurchase for 2006 is summarized as follows:
On February 17, 2006, the Company completed a private placement of $8.0 million of trust preferred securities, through a newly formed Delaware trust affiliate, Union Bankshares Capital Trust I (the "Trust"). As part of this transaction, the Company issued an aggregate principal amount of $8.2 million of 30-year junior subordinated deferrable interest debt securities to the Trust. The debt securities were issued pursuant to the terms of an Indenture dated as of February 17, 2006, between the Company, as Issuer, and Wells Fargo Bank, National Association, as Trustee. Under regulatory capital requirements, trust preferred securities, within certain limitations, qualify as Tier I capital. The Company raised capital through the Trust as support for asset growth.
The debt securities obligate the Company to pay interest on their principal sum quarterly in arrears on January 7, April 7, July 7, and October 7 of each year. The debt securities mature on April 7, 2036, but may be redeemed by the Company, in whole or in part, beginning on April 7, 2011, on any interest payment date. The debt securities may also be redeemed by the Company in whole or in part, within 90 days of the occurrence of certain special redemption events as defined in the Indenture.
During 2006, the Company recorded $475,000 of interest expense related to the subordinated debt. At December 31, 2006, $3.0 million of the trust preferred securities was included in the Bank's Tier 1 capital, which amounted to 7.6% of total Tier 1 capital, while the $8.0 million was included in the Company's total Tier 1 capital and amounting to 18.0% of Tier 1 capital of the Company.
During 2006, the Company entered into a long-term capital lease obligation for a new branch office building in Town Hill, Maine, which extends for 20 years. The present value of the lease payments over twenty years ($92,400 per year for the first five years of the lease term and increasing by the Consumer Price Index plus one percent every five years) exceeded 90% of the fair value of the Town Hill office building.
The future minimum lease payments over the remaining terms of the lease and the outstanding capital lease obligation at December 31, 2006 are as follows:
12. EMPLOYEE BENEFITS
Defined Benefit Pension Plan
The Company's subsidiary has a noncontributory defined benefit pension plan covering substantially all permanent full-time employees. The defined benefit pension plan was frozen as of May 15, 2005. As a result, all affected employees retain any benefits accumulated to the effective date, but are no longer eligible to increase their benefit. Contributions for 2006 and 2005 were $0 and the expected contribution for 2007 is $0.
It is the subsidiary's policy to fund the plan sufficiently to meet the minimum requirements set forth in the Employee Retirement Income Security Act of 1974, plus such additional amounts as the Company may determine to be appropriate from time to time.
The accumulated benefit obligation at December 31, 2006, 2005 and 2004 was $7.1 million, $6.9 million, and $6.5 million, respectively. At December 31, 2006 and 2005, the accumulated benefit obligation exceeded the fair value of plan assets. The Company recognized an additional minimum liability equal to the unfunded accumulated benefit obligation of $939,000 and $1.2 million at December 31, 2006 and 2005, respectively. At December 31, 2006 and 2005, the minimum pension liability adjustment was recorded as a separate component of equity, net of a deferred tax asset of $319,000 and $395,000, respectively.
Pension expense amounted to $61,000, $40,000 and $565,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
The measurement date for the pension plan was December 31, 2006.
Plan Assets
The Company's pension plan weighted-average asset allocations at December 31, 2006 and 2005, by asset category are as follows:
Investment Policies
The Retirement Plan for the Employees of Union Trust Company (the "Plan") was established in 1959 to provide for the payment of benefits to employees of Union Trust Company. The Plan is overseen by a Pension Plan Committee who meets annually to review asset performance and compliance to investment guidelines and to set the investment policy guidelines. A complete review is presented annually to the Board of Directors' Compensation Committee.
The Bank utilizes the investment management services of Union Trust Company's Trust Department. The goal of the Union Trust Pension Fund (the "Fund") is to provide sufficient funds to pay the pension obligations which the Bank has incurred for current and future retirees. As such, it should be conservatively managed with the appropriate mix of fixed income and equity securities. On an annual basis, the Fund should obtain sufficient cash to pay all obligations from income, the Bank's contribution or appreciation in the value of the equity portion of the portfolio. Growth in the total value of the Fund will come from excess growth or Bank contribution.
The asset allocation shall be as follows:
-
Fixed Income
:
At least 40% - 50% of the portfolio should be invested in high quality fixed income securities. A preference exists for U.S. Treasury and Agency securities. As much as 30% of the fixed income portfolio may be invested in corporate bonds rated A or better, and with final maturities of no greater than 15 years. The Treasury and Agency portion of the portfolio should be a balanced portfolio with maturities ranging from 2 - 15 years upon purchase.
-
Common Stocks
:
Up to 50% - 60% of the portfolio may be invested in a diversified group of high quality common stocks or common stock equivalents. (1) The portfolio should consist of no more than thirty individual companies spread across at least eight industries. (2) At the time of purchase, there shall be a maximum of ten percent of the portfolio in any one equity. (3) After appreciation, there shall be no more than 15% of the total portfolio value in any one equity. (4) There shall be no more than 25% of the equity portfolio in any one industry.
-
Expected Long Term Rate of Return
:
Basis for the expected long term rate of return assumption: the 7% and 8% expected long term rate of return assumption in 2006 and 2005, respectively, was derived from historical rates of return on stocks, government bonds and 30 day T-Bills, assuming a portfolio comprised of 55% stocks, 45% bonds and 5% cash equivalents.
The following table sets forth the estimated future benefit payments for the years indicated for the Company's noncontributory defined benefit pension plan:
Postretirement Benefits Other Than Pensions
The Company sponsors a postretirement benefit program that provides medical coverage and life insurance benefits to certain employees and directors who meet minimum age and service requirements. Active employees and directors accrue benefits over a 25-year period.
In December 2003, the President signed the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act) into law. The Act includes the following two new features to Medicare (Medicare Part D) that could affect the measurement of the accumulated postretirement benefit obligation (APBO) and net periodic postretirement benefit cost for the Plan:
-
A subsidy to plan sponsors that is based on 28% of an individual beneficiary's annual prescription drug costs between $250 and $5,000, and,
-
The opportunity for a retiree to obtain a prescription drug benefit under Medicare.
During 2004, the Financial Accounting Standards Board (FASB) Staff issued FASB Staff Position (FSP) FAS 106-2, "Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003." The FSP addresses employers' accounting for the effects of the Act and is effective for the Company beginning in 2005. The accounting for the Act will depend on the Company's assessment as to whether the prescription drug benefits available under its plan are actuarially equivalent to Medicare Part D, among other factors. Currently, the Company has not determined the benefit it provides would be considered actuarially equivalent to the benefit provided under the Act and, accordingly, the potential impact of the Act is not reflected in measurement of the APBO or net periodic postretirement benefit cost.
The measurement date for postretirement benefits was December 31, 2006. The expected contribution cost for 2007 is $52,000 for postretirement benefits.
The following table sets forth the estimated future benefit payments for the years indicated for the Company's postretirement health and life insurance program:
Effective December 31, 2006, the Company adopted SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - An Amendment of FASB Statements No. 87, 88, 106, and 132(R)," which requires the Company to recognize the over funded or under funded status of a single employer defined benefit postretirement plan as an asset or liability on its balance sheet and to recognize changes in the funded status in comprehensive income in the year in which the change occurred. However, gains or losses, prior service costs or credits, and transition assets or obligations that have not yet been included in net periodic benefit cost as of the end of 2006, the fiscal year in which SFAS 158 is initially applied, are to be recognized as components of the ending balance of accumulated other comprehensive income, net of tax.
The following table sets forth the benefit obligations, fair value of plan assets and funded status for the Company's pension and other postretirement benefit plans at and for the years ended December 31, 2006, 2005 and 2004.
Amounts in accumulated other comprehensive loss expected to be recognized as components of net periodic benefit cost in 2007 are $44,000 of net actuarial loss.
The incremental effects of applying SFAS No. 158 on individual line items in the balance sheet as of December 31, 2006 are as follows:
Before Application
of SFAS No. 158
Adjustment
After Application
of SFAS No. 158
Other liabilities
$ 7,064
$(226)
$ 6,838
Total liabilities
$509,608
$(226)
$509,382
Accumulated other comprehensive income (loss)
$ (620)
$ 226
$ (394)
Total shareholders' equity
$ 41,367
$ 226
$ 41,593
Amounts not yet reflected in net periodic benefit cost and included in accumulated other comprehensive income (loss) are as follows:
Weighted-average assumptions as of December 31 are as follows:
For measurement purposes, the annual rate of increase in the per capita health care cost of covered benefits was 11% for 2007, decreasing by 1% annually to 5% for 2013 and later years. The effects of a one-percentage-point change in the assumed health care cost trend rate on the aggregate service and interest cost components of the net periodic postretirement health care benefit cost and on the postretirement benefit obligation would be:
401(k) Plan
The Company has established a defined contribution plan under Section 401(k) of the Internal Revenue Code. Plan participants, who consist of all employees meeting minimum age and service requirements who elect to participate, are permitted to contribute a percentage of their wages to the plan on a pre-tax basis. In 2005, the Company amended the Plan to include an employer-paid match on amounts deferred by employees and an annual discretionary profit sharing contribution paid by the Company. The profit sharing plan expenses were $376,000 and $340,000 in 2006 and 2005, respectively, while plan expenses for employer-paid match contributions were $60,000 and $39,000 for 2006 and 2005, respectively.
The actual tax expense for 2006, 2005 and 2004 differs from the "expected" tax expense for those years (computed by applying the applicable U.S. federal corporate tax rate to income before income taxes) due to the following:
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are presented as follows:
The Bank has sufficient refundable taxes paid in available carryback years to fully realize its recorded deferred tax asset of $2.2 million at December 31, 2006. The deferred tax asset and liability are included in other assets and other liabilities in the balance sheet at December 31, 2006 and 2005.
14. STAFF ACCOUNTING BULLETIN NO. 108 (SAB 108)
In September 2006, the SEC released SAB 108. The transition provisions of SAB 108 permit the Company to adjust for the cumulative effect on retained earnings of errors relating to prior years deemed to be immaterial under an income statement approach that are material under the balance sheet approach. The Company adopted SAB 108 effective the beginning of the fiscal year ended December 31, 2006. In accordance with SAB 108, the Company has adjusted beginning retained earnings for fiscal 2006 in the accompanying Consolidated Financial Statements for the item described below.
Tax Accounting Adjustments: The Company adjusted its beginning retained earnings for fiscal 2006 for a historical misstatement in deferred taxes payable related to minor income tax expense items accumulated over a period of years that were not considered material in past years. This resulted in an overstatement of other liabilities of $218,000. The cumulative effect of the above mentioned item on fiscal 2006 beginning balances is presented below:
Description
Noncurrrent
Liabilities
Retained
Earnings
Tax Accounting Adjustment
$(217,587)
$217,587
Total
$(217,587)
$217,587
15. REGULATORY MATTERS
The Company and Bank are subject to various regulatory capital requirements administered by Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory (and possibly additional discretionary) actions by regulators that could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Company's and Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and Bank's capital amounts and classification are also subject to qualitative judgments by the regulators regarding components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2006, that the Company and Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2006, the most recent notification from the Federal Reserve Board (the "Board") categorized the Bank as well capitalized under the regulatory framework. To be so categorized, the Bank must maintain minimum total risk based, Tier I risk based and Tier I leverage ratios as set forth in the table. Management believes no conditions or events that would alter the Bank's categorization have occurred since the Board's notification.
The actual capital amounts and ratios for the Company and the Bank as of December 31, 2006 and 2005 are presented in the table below:
The Company may not declare or pay a cash dividend on or repurchase any of its capital stock if the effect thereof would cause the capital of the Company to be reduced below the capital requirements imposed by the Federal Reserve Board.
16. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATION OF CREDIT RISK
In the normal course of business, the Bank is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. The instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheet. The contract amounts of these instruments reflect the extent of involvement the Bank has in particular classes of financial instruments.
At December 31, 2006 and 2005, the following financial instruments, whose contract amounts represent credit risk, were outstanding:
The Bank's exposure to credit loss in the event of nonperformance by the other parties to the above financial instruments is represented by the contractual amounts of the instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon the credit extension, is based on management's credit evaluation of the counterparty. The types of collateral held include residential and commercial real estate and, to a lesser degree, personal property, business inventory and accounts receivable.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Expiration dates are usually within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.
The Bank grants residential, commercial and consumer loans principally to customers in Maine's Hancock, Washington, Waldo, Knox and Lincoln counties. Although the loan portfolio is diversified, a substantial portion of the debtors' ability to honor their contracts depends upon local economic conditions, especially in the real estate sector. At December 31, 2006, there were no borrowers whose total indebtedness to the Bank exceeded regulatory limits.
The consolidated balance sheets do not include various contingent liabilities such as liabilities for assets held in trust. Management does not anticipate any loss as a result of these contingencies.
17. LITIGATION
At December 31, 2006, the Company was involved in litigation arising from normal banking, financial and other activities of the Bank. Management, after consultation with legal counsel, does not anticipate that the ultimate liability, if any, arising out of these matters will have a material effect on the Company's financial condition.
18. FAIR VALUE OF FINANCIAL INSTRUMENTS
Fair value estimates, methods and assumptions are set forth below for the Bank's financial instruments. Fair values are calculated based on the value of one unit without regard to any premium or discount that may result from concentrations of ownership of a financial instrument, possible tax ramifications or estimated transaction costs. If these considerations had been incorporated into the fair value estimates, the aggregate fair value amount could have changed.
Cash and Cash Equivalents.
The fair value of cash, due from banks and federal funds sold approximates their relative book values at December 31, 2006 and 2005, as these financial instruments have short maturities.
Investment Securities.
Fair values are estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sources other than dealer quotations, so fair value estimates are based on quoted market prices of similar instruments, adjusted for differences between the quoted instruments and the instruments being valued.
Other Investment Securities, Federal Home Loan Bank Stock and Federal Reserve Bank Stock.
The fair value of these financial instruments approximates the book value as these instruments do not have a market, nor is it practical to estimate their fair value without incurring excessive costs.
Loans Held for Sale.
The fair value of this financial instrument approximates the book value as the instrument has a short maturity.
Loans.
Fair values are estimated for portfolios of loans with similar financial characteristics. Management has determined that the fair value approximates book value on all loans with maturities of one year or less or variable interest rates. The fair values of all other loans are estimated based on bid quotations received from securities dealers. The estimates of maturity are based on the Bank's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions and the effects of estimated prepayments.
Cash Surrender Value of Bank Owned Life Insurance.
The fair value is based on the actual cash surrender value of bank owned life insurance.
Accrued Interest Receivable.
The fair value of this financial instrument approximates the book value as the instrument has a short maturity.
Capitalized Mortgage Servicing Rights.
The fair value of mortgage servicing rights is based on the expected present value of future mortgage servicing income, net of estimated servicing costs, considering market consensus loan prepayment predictions.
Deposits.
Fair value of deposits with no stated maturity, such as non-interest bearing demand deposits, savings deposits, NOW accounts and money market and checking accounts, equals the amount payable on demand. The fair values of certificates of deposit are based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.
The fair value estimates do not include the benefit that results from the low cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market. If that value was considered, the fair value of the Bank's net assets could increase.
Accrued Interest Payable.
The fair value of this financial instrument approximates the book value as the instrument has a short maturity.
Borrowings from Federal Home Loan Bank.
The fair values of borrowings are estimated using discounted cash flow analyses based on the Bank's current incremental borrowing rates for similar types of borrowing arrangements.
Subordinated Debt.
The fair value is estimated using current rates for debentures of similar maturity.
Other Borrowed Funds.
The carrying amount of borrowings under repurchase agreements maturing within 90 days approximates their fair value.
Commitments to Extend Credit.
The Bank has not estimated the fair values of commitments to originate loans due to their short-term nature and their relative immateriality.
Limitations.
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instruments. These values do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment, and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. The latter may include deferred tax assets, bank premises and equipment and other real estate owned. In addition, tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.
A summary of the fair values of the Company's significant financial instruments at December 31, 2006 and 2005 follows:
19. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table provides a summary of the quarterly results of operations for the years ended December 31, 2006 and 2005. Certain balances from the prior quarters have been reclassified to conform with the fourth quarter 2006 presentation. Basic earnings per share have been restated to reflect the Company's 2-for-1 stock split, in the form of a 100% stock dividend, paid on March 21, 2005.
20. PARENT-ONLY CONDENSED FINANCIAL STATEMENTS
The condensed financial statements of Union Bankshares Company as of December 31, 2006 and 2005 and for each of the years ended December 31, 2006, 2005 and 2004 are presented as follows:
Item 9.
Item 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A.
Item 9A.
CONTROLS AND PROCEDURES
Management of the Company, including the Company's Chief Executive Officer and the Company's Chief Financial Officer, has evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, the Company's Chief Executive Officer and the Company's Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is (i) recorded, processed, summarized and reported as and when required, and (ii) accumulated and communicated to the Company's management, including the Company's President and Chief Executive Officer and the Company's Senior Vice President and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
There have been no changes in the Company's internal control over financial reporting identified in connection with the evaluation that occurred during the Company's last fiscal quarter that has materially affected, or that is reasonably likely to materially affect, the Company's internal control over financial reporting.
Item 9B.
Item 9B.
OTHER INFORMATION
None.
PART III
Item 10.
Item 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information included in the Proxy Statement under the captions "Section 16(a) Beneficial Ownership Reporting Compliance," "Election of Directors," "Information about Management and the Board of Directors - Executive Officers Who Are Not Directors" "Information about Management and the Board of Directors - Audit Committee," "Information about Management and the Board of Directors - Corporate Governance Committee" and "Compensation of Directors and Executive Officers" is incorporated herein by reference.
The Company has adopted a Code of Ethics, which applies to the Company's principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions for the Company. Our Code of Ethics meets the requirements of a "code of ethics" as defined by Item 406 of Regulation S-K. On January 18, 2006, the Board of Directors of Union Bankshares Company (the "Board") amended and restated the Code of Ethics of Union Bankshares Company. The Company filed the Amended and Restated Code of Ethics with the SEC as an exhibit to the Current Report on Form 8-K filed on January 23, 2006.
Copies of the Code of Ethics are available free of charge upon written request to Sally J. Hutchins, Clerk, Union Bankshares Company, P.O. Box 479, Ellsworth, Maine 04605.
Item 11.
Item 11.
EXECUTIVE COMPENSATION
The information included in the Proxy Statement under the captions "Information about Management and the Board of Directors - Compensation Committee" "Compensation of Directors and Executive Officers" "Report of the Compensation Committee" is incorporated herein by reference.
Item 12.
Item 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
The information included in the Proxy Statement under the caption "Security Ownership of Certain Beneficial Owners and Management" is incorporated herein by reference.
Item 13.
Item 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE
The information included in the Proxy Statement under the caption "Compensation of Directors and Executive Officers - Transactions with Certain Related Persons" "Information about Management and the Board of Directors - Board Meetings" is incorporated herein by reference.
Item 14.
Item 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information included in the Proxy Statement under the captions "Ratification of Independent Registered Public Accountants - Principal Accountant Fees and Services" and "Ratification of Independent Registered Public Accountants - Pre-Approval Policies" is incorporated herein by reference.
(a)
The following financial statements are incorporated by reference to Part II, Item 8 of this report on Form 10-K:
Consolidated Balance Sheets - December 31, 2006 and 2005;
Consolidated Statements of Income - Years Ended December 31, 2006, 2005 and 2004;
Consolidated Statements of Changes in Shareholders' Equity - Years Ended December 31, 2006, 2005 and 2004;
Consolidated Statements of Cash Flows - Years Ended December 31, 2006, 2005 and 2004; and
Notes to Consolidated Financial Statements.
(b)
Exhibits
Exhibit Index
Exhibit No.
Description
*3.1
Amended and Restated Articles of Incorporation of Union Bankshares Company (the "Company")
**3.2
Amended and Restated Bylaws of the Company
***4.1
Form of Floating Rate Junior Subordinated Debt Security issued by the Company to Wells Fargo Bank, National Association, dated February 17, 2006.
****10.1
Stock Purchase Plan for the employees of Union Trust Company (the "Bank")
******10.2
Form of Deferred Compensation Agreement between Union Trust Company and each of Mr. Peter A. Blyberg, President and Chief Executive Officer, Mr. John P. Lynch, Executive Vice President,
and Ms. Rebecca J. Sargent, Senior Vice President and Senior Financial Services Officer.
****10.3
Salary Continuation Agreements for the Executive Officers of the Bank
***10.4
Indenture by and between the Company, as Issuer, and Wells Fargo Bank, National Association, as Trustee, dated February 17, 2006, for Floating Rate Junior Subordinated Debt Securities.
***10.5
Guarantee Agreement executed and delivered by the Company and Wells Fargo Bank, National Association for the benefit of the Holders from time to time of the Capital Securities of Union Bankshares Capital Trust I
******10.6
Form of Amendment to the Deferred Compensation Agreements between the Company and each of Mr. Peter A. Blyberg, President and Chief Executive Officer, Mr. John P. Lynch, Executive Vice President, and Ms. Rebecca J. Sargent, Senior Vice President and Senior Financial Services Officer.
2006 Annual Report to Shareholders
*****14
Amended and Restated Code of Ethics of the Company
Subsidiaries of the Company
31.1
Rule 13a-14(a)/15d-14(a) Certification of the CEO
31.2
Rule 13a-14(a)/15d-14(a) Certification of the CFO
32.1
Section 1350 Certification of the CEO
32.2
Section 1350 Certification of the CFO