Item 1. Description of Business
General
The Company, a Delaware corporation, is a regional financial services organization based in Ottawa, Illinois, encompassing three bank subsidiaries (the "Banks") and one non-bank subsidiary, UnionFinancial Services & Trust Company ("UnionFinancial"). Together, these entities serve customers in twenty-five bank locations and one non-bank location from the far Western suburbs of the Chicago metropolitan area across Central and Northern Illinois to the Mississippi River in Western Illinois, with banking, trust, insurance, investment and electronic offerings. The Banks and UnionFinancial are collectively referred to as the "Subsidiaries."
Historical
The Company was originally formed in 1982 as the bank holding company for UnionBank, an Illinois state bank with its main office located in Streator, Illinois ("UnionBank"). In 1984, UnionBank/Sandwich, an Illinois state bank with its main office located in Sandwich, Illinois ("Sandwich"), became a subsidiary of the Company. In 1991, the Ottawa National Bank, Ottawa, Illinois, was acquired and merged into UnionBank.
During 1996, the Company acquired all of the issued and outstanding capital stock of Prairie Bancorp, Inc. ("Prairie"), a multi-bank holding company with six bank subsidiaries located in the Illinois communities of Carthage, Hanover, Ladd, Manlius, Tampico and Tiskilwa, and also acquired Country Bancshares, Inc. ("Country"), a one-bank holding company with a bank subsidiary located in Macomb, Illinois.
In 1997, the Company acquired the remaining minority stock ownership interests in and consolidated the operations of certain of the Banks. Also in 1997, Sandwich was merged with and into UnionBank; Tampico National Bank and The First National Bank of Manlius were merged with and into Tiskilwa State Bank under the name "UnionBank/Central"; and the Farmers State Bank of Ferris was merged with and into Omni Bank under the name "UnionBank/West." The Company's other banking subsidiary is UnionBank/Northwest, an Illinois state bank with its main office located in Hanover, Illinois ("UnionBank/Northwest").
During 1998, the Company, through its wholly-owned subsidiary UnionFinancial Services, Inc., acquired the Mercier Insurance Agency, an insurance/brokerage firm. Also, during the first quarter of 1998, UnionData Corp, Inc., a wholly-owned electronic data processing subsidiary of the Company, acquired Sainet, an Internet Service Provider. Both of these endeavors were part of a transformation of the Company's internal structure, intended to create a means for sustained revenue and earnings growth. In addition, during 1998, the Company sold its 81.7% ownership of the outstanding stock of the Bank of Ladd, an Illinois state bank with its main office located in Ladd, Illinois.
During the fourth quarter of 2001, the Company completed the integration between UnionFinancial Services, Inc. and UnionTrust Corporation. The newly formed UnionFinancial Services & Trust Company is headquartered in Peru, Illinois and offers a complete line of insurance, brokerage and trust services. Also during 2001, in order to create a flatter, more efficient organizational structure, UnionData Corp, Inc. collapsed its charter and was, subsequently, absorbed by the holding company. It is now known as the Information Technology division of UnionBancorp, Inc. Continuing its cash management offerings, the department placed a renewed emphasis on improving the internal infrastructure of the organization, under the direction of a three-year technology plan.
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In March of 2003, the Company completed phase one of a two-phase bank charter consolidation initiative. UnionBank/Central was successfully merged into the existing UnionBank in an effort to streamline backroom processes, enhance efficiencies and achieve greater economies of scales. Seamless to our customers, the process has alleviated many intra-company transactions, financial reporting functions and loan participations, while creating a flatter organizational structure. UnionBank/Northwest and UnionBank/West are slated to merge into UnionBank during the first quarter of 2004.
The sale of the Company's Merchant Point of Sale (POS) product was completed in May of 2003. This action was initiated to more effectively reallocate capital and to more effectively mitigate risk to the Company. Under the agreement, the Company will still be able to offer the product and will share in revenues via referral fees and a revenue sharing agreement based on the activity merchants experience.
In June of 2003, the Company entered into an arrangement to sell its book of ISP customers to a local Internet Service Provider (ISP). This action came as a result of the Company's decision to focus its Information Technology division more heavily on core business initiatives, while continuing to ensure that customers are receiving the highest level of service possible.
The Company's newest branch facility in Yorkville, Illinois, one of the fastest growing Chicago suburbs, officially opened for business in December of 2003. The facility is located in the new Yorkville Marketplace development at the intersection of Routes 34 and 47, the most highly trafficked intersection in Kendall County. The 6,500 square foot branch is a full-service bank that offers retail banking services, mortgage lending, asset management and business banking with extended hours for customer convenience.
Operations
The Company's strategic plan contemplates an increase in profitability and stockholder value through an expansion of the Company's market area, a focus on asset quality, an enhanced sales and service environment and improved operational efficiencies, through the targeted use of technology. In the mid-1990's, the Company began implementing this plan by realigning its management structure through the redefinition of certain officers' duties and functions, hiring additional experienced senior executives and developing, among its employees, an aggressive retail culture. The Company believes that it can successfully manage these community-based institutions to increase their profitability, by expanding cross-selling efforts and emphasizing those products and services offering the highest return on investment.
The Company's operating strategy is to provide customers with the business sophistication and breadth of products of a regional financial services company, while retaining the special attention to personal service and the local appeal of a community establishment. In each of the Company's twenty-five locations, customers have access to a wide range of products and services aimed at meeting the demands of a diverse market base. Committed to the concept of one stop financial shopping, customers can ascertain assistance on their banking, trust, insurance and investment needs from the Company's experienced staff or enjoy the convenience of online services from the comfort of their own homes. With its continued growth and evolution, the Company also remains rooted in its strong presence in the communities it serves. The participation of the Company's directors, officers and employees in area civic and service organizations demonstrates this ongoing commitment. Management believes that, together, these qualities distinguish the Company from its competitors and will enable the Company to compete successfully in its market area against other regional and interstate institutions.
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Geographically, the Company serves the financial needs of contiguous counties located in north central Illinois through the Banks. In recent years, the Company has expanded its activities from north central Illinois into markets surrounding the Chicago metropolitan area, as well as into additional areas of Northern and Western Illinois.
The Banks offer a wide range of commercial and retail lending services to corporations, partnerships and individuals, including, but not limited to, commercial business loans, commercial and residential real estate construction and mortgage loans, loan participations, consumer loans, revolving lines of credit and letters of credit. The Banks make direct and indirect installment loans to consumers and commercial customers, originate and service residential mortgages and handle the secondary marketing of those mortgages. Agricultural loans also play a role in the Company's overall lending portfolio, although most of this lending activity is based in the north central portion of the Company's market area. The Banks also offer a full range of depository services including traditional savings, checking and money market accounts. Credit and debit cards, as well as home banking and bill pay options, target those customers who seek the convenience of electronic services.
UnionFinancial provides a variety of additional financial solutions, namely trust and asset management alternatives, a full line of personal and commercial insurance products and personalized investment options. The Company continues to devote special attention to these financial services areas, as the demands of customers steadily move towards non-traditional financial offerings.
Competition
Spanning fifteen Illinois counties, the Company's market area is highly competitive with commercial banks, savings and loan associations and credit unions. In addition, financial institutions, based in surrounding communities and in Chicago, actively compete for customers within the Company's market area. The Company also faces competition from finance companies, insurance companies, mortgage companies, securities brokerage firms, money market funds, loan production offices and other providers of financial services.
The Company competes for loans principally through the range and quality of the services it provides and through competitive interest rates and loan fees. The Company believes that its long-standing presence in the communities it serves and personal service philosophy enhance its ability to compete favorably in attracting and retaining individual and business customers. The Company actively solicits deposit-related customers and competes for deposits by offering customers personal attention, professional service and competitive interest rates.
Under the Gramm-Leach-Bliley Act of 1999, effective March 11, 2000, securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. The Gramm-Leach-Bliley Act, and future action stemming from the Act, is expected to continue to significantly change the competitive environment in which the Company and the Banks conduct business. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties.
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Employees
At December 31, 2003, the Company employed 373 full-time equivalent employees. The Company places high priority on staff development, which involves extensive training on product offerings, customer service, management practices and leadership skills. New employees are selected on the basis of both technical skills and customer service capabilities. None of the Company's employees are covered by a collective bargaining agreement with the Company. The Company offers a variety of employee programs and benefits, and management considers its employee relations to be excellent.
SUPERVISION AND REGULATION
General
Financial institutions and their holding companies are extensively regulated under federal and state law. As a result, the growth and earnings performance of the Company can be affected not only by management decisions and general economic conditions, but also by the requirements of applicable state and federal statutes and regulations and the policies of various governmental regulatory authorities, including the Illinois Commissioner of Banks and Real Estate (the "Commissioner"), the Board of Governors of the Federal Reserve System (the "Federal Reserve"), the Federal Deposit Insurance Corporation (the "FDIC"), the Internal Revenue Service and state taxing authorities and the Securities and Exchange Commission (the "SEC"). The effect of applicable statutes, regulations and regulatory policies can be significant, and cannot be predicted with a high degree of certainty.
Federal and state laws and regulations generally applicable to financial institutions, such as the Company and its subsidiaries, regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to the Company and its subsidiaries establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC's deposit insurance funds and the depositors, rather than the shareholders, of financial institutions.
The following is a summary of the material elements of the regulatory framework that applies to the Company and its subsidiaries. It does not describe all of the statutes, regulations and regulatory policies that apply to the Company and its subsidiaries, nor does it restate all of the requirements of the statutes, regulations and regulatory policies that are described. As such, the following is qualified in its entirety by reference to the applicable statutes, regulations and regulatory policies. Any change in applicable law, regulations or regulatory policies may have a material effect on the business of the Company and its subsidiaries.
The Company
General. The Company, as the sole stockholder of UnionBank; Prairie, as the sole stockholder of UnionBank/Northwest; and Country, as the sole stockholder of UnionBank/West, are each bank holding companies. As bank holding companies, the Company, Prairie and Country are registered with, and are subject to regulation by, the Federal Reserve under the Bank Holding Company Act, as amended (the "BHCA"). In accordance with Federal Reserve policy, the Company, Prairie and Country are expected to act as a source of financial strength to their respective bank subsidiaries and to commit resources to support their respective bank subsidiaries in circumstances where the Company, Prairie or Country might not do so absent such policy. Under the BHCA, the Company, Prairie and Country are subject to periodic examination by the Federal Reserve and are required to file with the Federal Reserve periodic reports of their respective operations
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and such additional information as the Federal Reserve may require. The Company, Prairie and Country are also subject to regulation by the Commissioner under the Illinois Bank Holding Company Act, as amended.
Investments and Activities. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after the acquisition, it would own or control more than 5% of the shares of the other bank or bank holding company (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank; or (iii) merging or consolidating with another bank holding company. Subject to certain conditions (including certain deposit concentration limits established by the BHCA), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States without regard to whether the acquisition is prohibited by the law of the state in which the target bank is located. In approving interstate acquisitions, however, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws which require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company.
The BHCA also generally prohibits the Company, Prairie and Country from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve to be "so closely related to banking ... as to be a proper incident thereto." Under current regulations of the Federal Reserve, the Company and its non-bank subsidiaries are permitted to engage in a variety of banking-related businesses, including the operation of a thrift, consumer finance, equipment leasing, the operation of a computer service bureau (including software development), and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies.
In November, 1999, the Gramm-Leach-Bliley Act ("GLB Act") was signed into law. Under the GLB Act, bank holding companies that meet certain standards and elect to become "financial holding companies" are permitted to engage in a wider range of activities than those permitted to bank holding companies, including securities and insurance activities. Specifically, a bank holding company that elects to become a financial holding company may engage in any activity that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines is (i) financial in nature or incidental thereto, or (ii) complementary to any such financial-in-nature activity, provided that such complementary activity does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. A bank holding company may elect to become a financial holding company only if each of its depository institution subsidiaries is well-capitalized, well-managed, and has a Community Reinvestment Act rating of "satisfactory" or better at their most recent examination.
The GLB Act specifies many activities that are financial in nature, including lending, exchanging, transferring, investing for others, or safeguarding money or securities; underwriting and selling insurance; providing financial, investment or economic advisory services; underwriting, dealing in, or making a market in securities; and those activities currently permitted for bank holding companies that are so closely related to banking or managing or controlling banks, as to be a proper incident thereto.
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The GLB Act changed federal laws to facilitate affiliation between banks and entities engaged in securities and insurance activities. The law also established a system of functional regulation under which banking activities, securities activities, and insurance activities conducted by financial holding companies and their subsidiaries and affiliates will be separately regulated by banking, securities, and insurance regulators, respectively.
Federal law also prohibits any person or company from acquiring "control" of a bank or bank holding company without prior notice to the appropriate federal bank regulator. "Control" is defined in certain cases as the acquisition of 10% of the outstanding shares of a bank or bank holding company.
Capital Requirements. Bank holding companies are required to maintain minimum levels of capital in accordance with Federal Reserve capital adequacy guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.
The Federal Reserve's capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: a risk-based requirement expressed as a percentage of total risk-weighted assets, and a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% for all others. For purposes of these capital standards, Tier 1 capital consists primarily of permanent stockholders' equity less intangible assets (other than certain mortgage servicing rights and purchased credit card relationships). Total capital consists primarily of Tier 1 capital plus certain other debt and equity instruments which do not qualify as Tier 1 capital and a portion of the company's allowance for loan and lease losses.
The risk-based and leverage standards described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve's capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 capital less all intangible assets), well above the minimum levels.
As of December 31, 2003, the Company, Prairie and Country each had regulatory capital in excess of the Federal Reserve's minimum requirements, as follows:
Risk-Based Leverage Capital Ratio Capital Ratio ------------- -------------
Company 12.2% 7.7%
Prairie 18.1% 11.7%
Country 13.2% 7.7%
Dividends. The Delaware General Corporation Law (the "DGCL") allows the Company to pay dividends only out of its surplus (as defined and computed in accordance with the provisions of the DGCL) or if the Company has no such surplus, out of
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its net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.
Further, the Illinois Business Corporation Act, as amended, prohibits an Illinois corporation, such as Prairie or Country, from paying a dividend if, after giving effect to the dividend: (i) the corporation would be insolvent; or (ii) the net assets of the corporation would be less than zero; or (iii) the net assets of the corporation would be less than the maximum amount then payable to stockholders of the corporation who would have preferential distribution rights if the corporation were liquidated.
Additionally, the Federal Reserve has issued a policy statement with regard to the payment of cash dividends by bank holding companies. The policy statement provides that a bank holding company should not pay cash dividends which exceed its net income or which can only be funded in ways that weaken the bank holding company's financial health, such as by borrowing. The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.
Federal Securities Regulation. The Company's common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.
The Banks
All of the Banks are Illinois-chartered banks, the deposit accounts of which are insured by the FDIC's Bank Insurance Fund ("BIF"). The Banks are also members of the Federal Reserve System ("member banks"). As Illinois-chartered, FDIC-insured member banks, the Banks are subject to the examination, supervision, reporting and enforcement requirements of the Commissioner, as the chartering authority for Illinois banks, the Federal Reserve, as the primary federal regulator of member banks, and the FDIC, as administrator of the BIF.
Deposit Insurance. As FDIC-insured institutions, the Banks are required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their respective levels of capital and results of supervisory evaluations. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium. Risk classification, of all insured institutions, is made by the FDIC for each semi-annual assessment period.
During the year ended December 31, 2003, BIF assessments ranged from 0% of deposits to 0.27% of deposits. For the semi-annual assessment period beginning January 1, 2004, BIF assessment rates will continue to range from 0% of deposits to 0.27% of deposits.
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution (i) has engaged or is engaging in unsafe or unsound practices, (ii) is in an unsafe or unsound condition to continue operations or (iii) has violated any applicable law, regulation, order, or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance,
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if the institution has no tangible capital. Management of the Company is not aware of any activity or condition that could result in termination of the deposit insurance of the Banks.
FICO Assessments. Since 1987, a portion of the deposit insurance assessments paid by members of the FDIC's Savings Association Insurance Fund ("SAIF") has been used to cover interest payments due on the outstanding obligations of the Financing Corporation ("FICO"). FICO was created in 1987 to finance the recapitalization of the Federal Savings and Loan Insurance Corporation, the SAIF's predecessor insurance fund. As a result of federal legislation enacted in 1996, beginning as of January 1, 1997, both SAIF members and BIF members became subject to assessments to cover the interest payments on outstanding FICO obligations. These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. Between January 1, 2000 and the final maturity of the outstanding FICO obligations in 2019, BIF members and SAIF members will share the cost of the interest on the FICO bonds on a pro rata basis. During the year ended December 31, 2003, the FICO assessment rate for both SAIF members ranged between approximately 0.0152% of deposits and approximately 0.0168% of deposits. During the year ended December 31, 2003, the Banks paid FICO assessments totaling $98,149.
Supervisory Assessments. All Illinois banks are required to pay supervisory assessments to the Commissioner to fund the operations of the Commissioner. The amount of the assessment is calculated based on the institution's total assets, including consolidated subsidiaries, as reported to the Commissioner. During the year ended December 31, 2003, the Banks paid supervisory assessments to the Commissioner totaling $112,370.
Capital Requirements. The Federal Reserve has established the following minimum capital standards for state-chartered Federal Reserve System member banks, such as the Banks: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all others, and a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. For purposes of these capital standards, Tier 1 capital and total capital consist of substantially the same components as Tier 1 capital and total capital under the Federal Reserve's capital guidelines for bank holding companies (see "--The Company--Capital Requirements").
The capital requirements described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, the regulations of the Federal Reserve provide that additional capital may be required to take adequate account of, among other things, interest rate risk or the risks posed by concentrations of credit, nontraditional activities or securities trading activities.
During the year ended December 31, 2003, none of the Banks was required by the Federal Reserve to increase its capital to an amount in excess of the minimum regulatory requirement. As of December 31, 2003, each of the Banks exceeded its minimum regulatory capital requirements, as follows:
Risk-Based Leverage Capital Ratio Capital Ratio ------------- -------------
UnionBank 12.8% 8.8%
UnionBank/ West 13.2% 7.3%
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Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators' powers depends on whether the institution in question is "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" or "critically undercapitalized," in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators' corrective powers include: requiring the institution to submit a capital restoration plan; limiting the institution's asset growth and restricting its activities; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions between the institution and its affiliates; restricting the interest rate the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution. As of December 31, 2003, each of the Banks was well capitalized, as defined by Federal Reserve regulations.
Additionally, institutions insured by the FDIC may be liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of commonly controlled FDIC insured depository institutions or any assistance provided by the FDIC to commonly controlled FDIC insured depository institutions in danger of default.
Dividends. Under the Illinois Banking Act, Illinois-chartered banks may not pay dividends in excess of their net profits then on hand, after deducting losses and bad debts. The Federal Reserve Act also imposes limitations on the amount of dividends that may be paid by state member banks, such as the Banks. Generally, a member bank may pay dividends out of its undivided profits, in such amounts and at such times as the bank's board of directors deems prudent. Without prior Federal Reserve approval, however, a state member bank may not pay dividends in any calendar year which, in the aggregate, exceed the bank's calendar year-to-date net income plus the bank's retained net income for the two preceding calendar years.
The payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, each of the Banks exceeded its minimum capital requirements under applicable guidelines and had approximately $5.2 million available to be paid as dividends to the Company by the Banks as of December 31, 2003. Notwithstanding the availability of funds for dividends, however, the Federal Reserve may prohibit the payment of any dividends by the Banks if the Federal Reserve determines such payment would constitute an unsafe or unsound practice.
Insider Transactions. The Banks are subject to certain restrictions imposed by federal law on extensions of credit to the Company and its subsidiaries, on investments in the stock or other securities of the Company and its subsidiaries and the acceptance of the stock or other securities of the Company or its subsidiaries as collateral for loans. Certain limitations and reporting requirements are also placed on extensions of credit by the Banks to their respective directors and officers, to directors and officers of the Company and its subsidiaries, to principal stockholders of the Company, and to "related interests" of such directors, officers and principal stockholders. In addition, federal law and regulations may affect the terms upon which any person becoming a director or officer of the Company or one of its subsidiaries or a principal stockholder of the Company may obtain credit from banks with which one of the Banks maintains a correspondent relationship.
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Safety and Soundness Standards. The federal banking agencies have adopted guidelines, which establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution's primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator's order is cured, the regulator may restrict the institution's rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.
Branching Authority. Illinois banks, such as the Banks, have the authority under Illinois law to establish branches anywhere in the State of Illinois, subject to receipt of all required regulatory approvals.
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Riegle-Neal Act"), both state and national banks are allowed to establish interstate branch networks through acquisitions of other banks, subject to certain conditions, including certain limitations on the aggregate amount of deposits that may be held by the surviving bank and all of its insured depository institution affiliates. Illinois law permits interstate mergers, subject to certain conditions, including a prohibition against interstate mergers involving an Illinois bank that has been in existence and continuous operation for fewer than five years.
The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed by the Riegle-Neal Act only if specifically authorized by state law. Certain states permit out-of-state banks to establish de novo branches or acquire branches from another bank. Illinois law currently does not permit out-of-state banks to establish branches in Illinois in this manner, but Illinois-chartered banks may branch into other states in this manner if the law of the state in which the branch will be established or acquired so authorizes and does not require a reciprocal provision under Illinois law.
State Bank Activities. Under federal law and FDIC regulations, FDIC insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law and FDIC regulations also prohibit FDIC insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member.
The GLB Act also authorizes insured state banks to engage in financial activities, through subsidiaries, similar to the activities permitted for financial holding companies. If a state bank wants to establish a subsidiary engaged in financial activities, it must meet certain criteria, including that it and all of its affiliated insured depository institutions are well-capitalized and have a Community Reinvestment Act rating of at least
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"satisfactory" and that it is well-managed. There are capital deduction and financial statement requirements and financial and operational safeguards that apply to subsidiaries engaged in financial activities. Such a subsidiary is considered to be an affiliate of the bank and there are limitations on certain transactions between a bank and a subsidiary engaged in financial activities of the same type that apply to transactions with a bank's holding company and its subsidiaries.
Reserve Requirement. Federal Reserve regulations, as presently in effect, require depository institutions to maintain non-interest earning reserves against their transaction accounts (primarily NOW and regular checking accounts), as follows:
o for the first $6.6 million of net transaction accounts, there is no reserve; o for net transaction accounts totaling over $6.6 million and up to $45.5 million, a reserve of 3%; and o for net transaction accounts totaling in excess of $45.5 million, a reserve requirement of $1.164 million plus 10% against that portion of the total transaction accounts greater than $45.4 million
The dollar amounts and percentages reported here are all subject to adjustment by the Federal Reserve. The effect of maintaining the required non-interest earning reserves is to reduce the Banks' interest earning assets.
Financial Services Subsidiary
UnionBank is the sole stockholder of UnionFinancial Services & Trust Company ("UnionFinancial"), an Illinois corporation licensed as a general insurance agency by the Illinois Department of Insurance (the "Department"). UnionFinancial is subject to supervision and regulation by the Department with regard to compliance with the laws and regulations governing insurance agents and by the Commissioner and the Federal Reserve with regard to compliance with banking laws and regulations applicable to subsidiaries of Illinois-chartered member banks.
UnionFinancial, through its trust division, conducts a full service trust business in the State of Illinois, pursuant to a certificate of authority issued to the Commissioner under the Illinois Corporate Fiduciaries Act (the "Fiduciaries Act"). The Fiduciaries Act requires UnionFinancial, among other things, to maintain a minimum level of capital, as determined by the Commissioner, and to obtain the approval of the Commissioner before opening branch offices for conducting trust activities or acquiring another trust company. The trust division is subject to periodic examination by the Commissioner and the Commissioner has the authority to take action against it to enforce compliance with the laws applicable to its operations.
Item 2.
Item 2. Properties
At December 31, 2003, the Company operated twenty-five banking offices and one non-bank office in Illinois. The principal offices of the Company are located in Ottawa, Illinois. All of the Company's offices are owned by one of the Banks and are not subject to any mortgage or material encumbrance, with the exception of six offices that are leased located in LaSalle and Adams counties. The Company believes that its current facilities are adequate for its existing business.
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In addition to the banking locations listed above, the Banks own thirty-two automated teller machines, some of which are housed within banking offices and some of which are independently located.
At December 31, 2003, the properties and equipment of the Company had an aggregate net book value of approximately $16.6 million.
Item 3.
Item 3. Legal Proceedings
Neither the Company nor any of its subsidiaries are involved in any pending legal proceedings other than routine legal proceedings occurring in the normal course of business, which, in the opinion of management, in the aggregate, are not material to the Company's consolidated financial condition.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
There were no items submitted to a vote of security holders in the fourth quarter of 2003.
PART II
Item 5.
Item 5. Market For Registrant's Common Equity And Related Stockholder Matters
The Company's Common Stock was held by approximately 595 stockholders of record as of March 1, 2004, and is traded on The Nasdaq Stock Market under the symbol "UBCD." The table below indicates the high and low sales prices of the Common Stock for transactions of which the Company is aware, and the dividends declared per share for the Common Stock during the periods indicated. Because the Company is not aware of the price at which certain private transactions in the Common Stock have occurred, the prices shown may not necessarily represent the complete range of prices at which transactions in the Common Stock have occurred during such periods.
12.
Stock Sales --------------------- Cash High Low Dividends --------- --------- ---------
First Quarter ........................... $ 15.00 $ 13.73 $ 0.070 Second Quarter .......................... 15.70 14.25 0.080 Third Quarter ........................... 15.95 14.56 0.080 Fourth Quarter .......................... 16.01 14.75 0.080
First Quarter ........................... $ 16.86 $ 15.15 $ 0.080 Second Quarter .......................... 20.48 16.05 0.090 Third Quarter ........................... 22.52 19.25 0.090 Fourth Quarter .......................... 24.04 20.00 0.090
The holders of the Common Stock are entitled to receive dividends as declared by the Board of Directors of the Company, which considers payment of dividends quarterly. Upon the consummation of the acquisition of Prairie in 1996, preferential dividends were required to be paid or accrued quarterly, with respect to the outstanding shares of Preferred Stock. The ability of the Company to pay dividends in the future will be primarily dependent upon its receipt of dividends from the Banks. In determining cash dividends, the board of directors considers the earnings, capital requirements, debt and dividend servicing requirements, financial ratio guidelines it has established, financial condition of the Company and other relevant factors. The Banks' ability to pay dividends to the Company and the Company's ability to pay dividends to its stockholders are also subject to certain regulatory restrictions.
The Company has paid regular cash dividends on the Common Stock since it commenced operations in 1982. There can be no assurance, however, that any such dividends will be paid by the Company or that such dividends will not be reduced or eliminated in the future. The timing and amount of dividends will depend upon the earnings, capital requirements and financial condition of the Company and the Banks, as well as the general economic conditions and other relevant factors affecting the Company and the Banks. In 1996, the Company entered into a new loan agreement in connection with the acquisition of Prairie and Country, replacing the Company's prior loan agreement. The new loan agreement contains no direct prohibitions against the payment by the Company of dividends, but indirectly restricts such dividends through the required maintenance of minimum capital ratios. In addition, the terms of the Series A Preferred Stock, and the Series B Preferred Stock issued to certain of Prairie's preferred stockholders prohibit the payment of dividends by the Company on the Common Stock during any period for which dividends on the respective series of Preferred Stock are in arrears.
Except in connection with stock dividends and stock splits, the Company has not issued any securities in the past three years which were not registered for sale under the Securities Act of 1933, as amended.
The information from the 2004 Proxy Statement under the caption "Existing Equity Compensation Plans" on page 6 is incorporated by reference.
13.
Item 6.
Item 6. Selected Consolidated Financial Data
Selected consolidated financial data for the five years ended December 31, 2003, consisting of data captioned "Selected Consolidated Financial Data" on page 6 of the Company's 2003 Annual Report to Stockholders filed as an exhibit hereto, is incorporated herein by reference.
Item 7.
Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition
The following discussion provides additional information regarding the operations and financial condition of UnionBancorp, Inc. (the "Company") for the three years ended December 31, 2003. This discussion should be read in conjunction with "Selected Consolidated Financial Data," the consolidated financial statements of the Company, and the accompanying notes thereto. Unless otherwise stated, all earnings per share data included in this section and throughout the remainder of this discussion are presented on a diluted basis. All financial information is in thousands (000's), except per share data.
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UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995
This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1993, as amended, and Section 21E of the Securities Act of 1934 as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations of the Company, are generally identified by the use of words such as "believe," "expect," "intend," "anticipate," "estimate," or "project" or similar expressions. The Company's ability to predict results, or the actual effect of future plans or strategies, is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company and the subsidiaries include, but are not limited to, changes in: interest rates; general economic conditions; legislative/regulatory changes; monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board; the quality and composition of the loan or securities portfolios; demand for loan products; deposit flows; competition; demand for financial services in the Company's market areas; the Company's implementation of new technologies; the Company's ability to develop and maintain secure and reliable electronic systems; and accounting principles, policies, and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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. By their nature, changes in these assumptions and estimates could significantly affect the Company's financial position or results of operations. Actual results could differ from those estimates. Discussed below are those critical accounting policies that are of particular significance to the Company.
Allowance for Loan Losses: The allowance for loan losses represents management's estimate of probable credit losses inherent in the loan and lease portfolio. Estimating the amount of the allowance for loan losses requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is charged to operations based on management's periodic evaluation of the factors previously mentioned, as well as other pertinent factors.
The allowance for loan losses consists of an allocated component and an unallocated component. The components of the allowance for loan losses represent an estimation done pursuant to either Statement of Financial Accounting Standards No. (SFAS) 5, Accounting for Contingencies, or SFAS 114, Accounting by Creditors for Impairment of a Loan. The allocated component of the allowance for loan losses reflects expected losses resulting from analyses developed through specific credit allocations for individual loans and historical loss experience for each loan category. The specific credit allocations are based on regular analyses of all loans over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. These analyses involve a high degree of judgment in estimating the amount of loss associated with
15.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
specific loans, including estimating the amount and timing of future cash flows and collateral values. The historical loan loss element is determined statistically using a loss migration analysis that examines loss experience . The loss migration analysis is performed quarterly and loss factors are updated regularly based on actual experience. The allocated component of the allowance for loan losses also includes consideration of concentrations and changes in portfolio mix and volume.
The unallocated portion of the allowance reflects management's estimate of probable inherent but undetected losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower's financial condition, the difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet manifested themselves in loss allocation factors. In addition, the unallocated allowance includes a component that accounts for the inherent imprecision in loan loss models. Uncertainty surrounding the strength and timing of economic cycles also affects estimates of loss. The historical losses used in the migration analysis may not be representative of actual unrealized losses inherent in the portfolio.
There are many factors affecting the allowance for loan losses; some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all of the potential factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provision for credit losses could be required that could adversely affect earnings or financial position in future periods.
Mortgage Servicing Rights: Servicing assets represent purchased rights and the allocated value of retained servicing rights on loans sold. Servicing assets are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the assets, using groupings of the underlying loans as to interest rates and then, secondarily, as to geographic and prepayment characteristics. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment of a grouping is reported as a valuation allowance.
General
UnionBancorp, Inc. (the "Company") is a bank holding company organized under the laws of the state of Delaware. The Company derives most of its revenues and income from the operations of its banking subsidiaries (the "Banks"), but also derives revenue from its nonbank subsidiary, UnionFinancial Services & Trust Company ("UnionFinancial"). The Company provides a full range of services to individual and corporate customers located in the north central and west central Illinois areas. These services include demand, time, and savings deposits; lending; mortgage banking; insurance products; brokerage services; asset management; and trust services. The Company is subject to competition from other financial institutions, including banks, thrifts and credits unions, as well as nonfinancial institutions providing financial services. Additionally, the Company and the Banks are subject to regulations of certain regulatory agencies and undergo periodic examinations by those regulatory agencies.
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UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Fourth Quarter
During the fourth quarter, the Company announced the appointment of Dewey R. Yaeger to the position of President and Chief Executive Officer of UnionBancorp, Inc. Mr. Yaeger first joined the Company in April 2003 as a Senior Vice President and Chief Credit Officer and brings with him a proven track record of high quality performance in his 40 plus year banking career.
The Company has filed applications with the Federal Reserve Bank and the Illinois Office of Banks and Real Estate to merge UnionBank/West and UnionBank/Northwest, stand-alone bank subsidiaries, into the Company's flagship bank, UnionBank. Consolidation of these entities is expected to provide several benefits to the organization including an improved utilization of personnel as a result of the consolidation of various backroom functions, which will result in a reduction in duplicated job functions and a lessening of various administrative and operational tasks. Simplified financial reporting, the elimination of inter-company banking transactions and a flatter, more efficient management structure will improve the Company's workflow, while an increased legal lending limit and additional product and service offerings in our cross-over markets will be advantageous to our existing and future customer base. The transaction is expected to be consummated late in the first quarter of 2004. Since UnionBank/West and UnionBank/Northwest are under common control, the merger will be accounted for at the carrying amount which will have no impact on the consolidated financial statements.
The Company's newest branch facility in Yorkville, Illinois, one of the fastest growing Chicago suburbs, officially opened for business in December of 2003. Aimed at providing one-stop financial shopping to our customers, the Yorkville site will deliver convenience and financial security by offering our full line of financial services including banking, trust, insurance and investment products. The facility is located in the new Yorkville Marketplace development at the intersection of Routes 34 and 47.
Second Quarter
On May 2, 2003, the Board of Directors approved a stock repurchase plan whereby the Company may repurchase from time to time up to 5% of its outstanding shares of common stock in the open market or in private transactions over the next 18 months. Purchases will be dependent upon market conditions and the availability of shares. The repurchase program optimizes the use of capital relative to other investment alternatives and benefits both the Company and the shareholders by enhancing earnings per share and return on equity. To date, the Company has repurchased 10,500 shares at a weighted average cost of $17.92.
Also during the second quarter, the Company made strategic divestitures that resulted in the net gain on the sale of the Company's Internet Service Provider (ISP) and Merchant Point of Sale (POS) product lines. The impact to earnings, net of taxes, was approximately $0.04 per diluted share.
First Quarter
On March 28, 2003 UnionBank/Central, a stand-alone bank subsidiary, was merged into the Company's flagship bank, UnionBank. Consolidation of these entities is expected to provide several benefits to the organization including an improved utilization of personnel as a result of the consolidation of various backroom functions, which will result in a reduction in duplicated job functions and a lessening of various administrative and operational tasks. Simplified financial reporting, the elimination of inter-company banking transactions and a flatter, more efficient management structure will improve the Company's workflow, while an increased legal lending limit and additional product and service offerings in our cross-over markets will be advantageous to our existing and future customer
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UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
base. Since UnionBank/Central was under common control, the merger was accounted for at UnionBank/Central's carrying amount which had no impact on the consolidated financial statements.
Results of Operations
Net Income
2003 compared to 2002. Net income equaled $2,130 or $0.48 per diluted share for the year ended December 31, 2003. This compares to net income of $4,044 or $0.94 per diluted share for the year ended December 31, 2002. This represents a 47.3% decrease in net income and a 48.9% decrease in per share earnings.
The Company's annual results were adversely impacted by a $4,662 increase in the provision for loan losses as compared to 2002. This increase during the year was primarily due to the deterioration of two impaired commercial credits identified in the Company's June 30, 2003 Form 10-Q, downgrades of various other credits, and the lingering effects of the soft economy within several markets that the Company is currently operating.
Positively contributing to earnings were increases in operating performance of the mortgage banking division and other fee based revenue product-lines and a decrease in costs associated with other real estate owned ("OREO"). These improvements were partially offset by operating losses at UnionFinancial and an increase in salaries and employee benefits incurred to support the growing level of business activity and continued investments in the Company.
Return on average assets was 0.28% for the year ended December 31, 2003 compared to 0.53% for the same period in 2002. Return on average stockholders' equity was 3.16% for the year ended December 31, 2003 compared to 6.11% for the same period in 2002.
2002 compared to 2001. Net income equaled $4,044 or $0.94 per diluted share for the year ended December 31, 2002. This compares to net income of $4,454 or $1.05 per diluted share for the year ended December 31, 2001. This represents a 9.2% decrease in net income and a 10.5% decrease in per share earnings.
The Company's annual results were adversely impacted by several factors. These include costs associated with other real estate owned ("OREO"), as the Company recorded a valuation allowance on one OREO property, in addition to other losses on the sale and general operating expenses incurred on OREO; increases in other operating expenses incurred to support the growing level of business activity and continued investments in the Company; and a decrease in the gains on sale of securities. Offsetting these factors were increases in net interest income, revenue generated from the mortgage banking division, and reductions in the provision for loan losses and income taxes.
Also contributing to the change in earnings was the Company's adoption of SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. 147 "Acquisitions of Certain Financial Institutions." The adoption of these accounting standards allowed the Company to cease the amortization of goodwill related to various acquisitions.
Return on average assets was 0.53% for the year ended December 31, 2002 compared to 0.59% for the same period in 2001. Return on average stockholders' equity was 6.11% for the year ended December 31, 2002 compared to 7.04% for the same period in 2001.
18.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Net Interest Income/ Margin
Net interest income is the difference between income earned on interest-earning assets and the interest expense incurred for the funding sources used to finance these assets. Changes in net interest income generally occur due to fluctuations in the volume of earning assets and paying liabilities and rates earned and paid, respectively, on those assets and liabilities. The net yield on total interest-earning assets, also referred to as net interest margin, represents net interest income divided by average interest-earning assets. Net interest margin measures how efficiently the Company uses its earning assets and underlying capital.
The Company's long-term objective is to manage those assets and liabilities to provide the largest possible amount of income while balancing interest rate, credit, liquidity and capital risks. For purposes of this discussion, both net interest income and margin have been adjusted to a fully tax equivalent basis for certain tax-exempt securities and loans.
2003 compared to 2002. Net interest income, on a tax equivalent basis, was $26,066 for the year ended December 31, 2003, compared with $26,289 earned during the same period in 2002. This represented a decrease of $223 or 0.1%. The decrease in net interest income is attributable to the year-over-year reduction of income earned on interest earning assets totaling $4,512 exceeding the year-over-year reduction of interest expense paid on interest bearing liabilities totaling $4,289.
The $4,512 reduction in interest income resulted from a decrease of $4,963 related to rate, partially offset by an increase of $451 due to volume. The majority of the change in interest income was related to a 62 basis point decline in yields earned on average loans as competitive pricing on new and refinanced loans, as well as the repricing of variable rate loans in a lower interest rate environment, put downward pressure on loan yields. Also adversely contributing to the change was a shift in the earning-asset mix away from higher yielding loans to lower yielding investments. The $4,289 reduction in interest expense resulted from decreases of $4,451 associated with rate partially offset by an increase of $162 associated with volume. The majority of the change was attributable to an 86 basis point reduction in rates paid on time deposits due to the repricing dynamics of maturing time deposits, as well as certain steps taken during this period to more favorably manage the mix of funding sources available to the Company.
The net interest margin decreased 9 basis points to 3.65% for the year ended December 31, 2003 from 3.74% during the same period in 2002. The decline resulted primarily from a decrease in yields earned on average loans as competitive pricing on new and refinanced loans, as well as the repricing of variable rate loans in a lower interest rate environment, put downward pressure on loan yields. The expectation of continued low interest rates is likely to maintain pressure on margins for 2004.
2002 compared to 2001. Net interest income, on a tax equivalent basis, was $26,289 for the year ended December 31, 2002, compared with $25,561 earned during the same period in 2001. This represented an increase of $728 or 2.9%. The improvement in net interest income is attributable to the year-over-year reduction of interest expense paid on interest bearing liabilities totaling $9,199 exceeding the year-over-year reduction of interest income earned on interest earning assets totaling $8,471. Also contributing to the increase in net interest income was a shift in the funding mix from higher costing time deposits and other wholesale sources to lower costing core deposits (DDA, Now, IMMIA and Savings).
The $8,471 change in interest income resulted from decreases of $500 associated with volume and $7,971 related to rate. The majority of the decrease in interest income was related to a 113 basis point decline in yields earned on average loans. Also contributing was a shift in the earning-asset mix from higher yielding loans to lower yielding investments. The $9,199 change in interest expense resulted from decreases of $1,266 associated with volume and $7,933
19.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
associated with rate. The majority of the decrease was attributable to a 159 basis point reduction in the rates paid on total time deposits, primarily located in expensive wholesale funding sources. This was a deliberate strategy aimed at reducing the Company's reliance on these higher-cost funding sources and to reduce interest rate risk.
Despite a difficult rate environment, the Company's net interest margin improved in 2002. The net interest margin on a tax equivalent basis for the period increased 10 basis points to 3.74% as compared to the prior year's 3.64%. Lower funding costs, a result of actively reducing funding rates simultaneously with Federal Reserve Board actions, were principally responsible for the margin increase. Also, a decrease in loan balances and an increase in noninterest bearing sources, allowed management to reduce the Company's reliance on high-rate brokered deposits and retail time deposits. These actions were partially offset by narrower loan spreads, due to competitive pressures, overall tightening of loan underwriting standards which resulted in slower than expected loan growth and the cost of carrying a higher level of nonperforming loans. Specifically, yields on interest-earning assets decreased 122 basis points to 6.60% as compared to the prior year's 7.82%. In contrast, rates paid on interest-bearing liabilities decreased 148 basis points to 3.29% as compared to the prior year's 4.77%.
The following table sets forth for each category of interest-earning assets and interest-bearing liabilities the average amounts outstanding, the interest earned or paid on such amounts, and the average rate paid during 2003, 2002 and 2001. The table also sets forth the average rate earned on all interest-earning assets, the average rate paid on all interest-bearing liabilities, and the net yield on average interest-earning assets for the same period. For purposes of this discussion, both net interest income and margin have been adjusted to a fully tax equivalent basis for certain tax-exempt securities and loans.
20.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
- ----------------------------------- (1) Average balance and average rate on securities classified as available-for-sale are based on historical amortized cost balances. (2) Interest income and average rate on non-taxable securities are reflected on a tax equivalent basis based upon a statutory federal income tax rate of 34%. (3) Nonaccrual loans are included in the average balances. (4) Overdraft loans are excluded in the average balances.
21.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
The Company's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as "volume change." It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds referred to as "rate change." The following table reflects the changes in net interest income stemming from changes in interest rates and from asset and liability volume, including mix. Any variance attributable jointly to volume and rate changes is allocated to the volume and rate variances in proportion to the relationship of the absolute dollar amount of the change in each.
Provision for Loan Losses. The amount of the provision for loan losses is based on management's evaluations of the loan portfolio, with particular attention directed toward nonperforming and other potential problem loans. During these evaluations, consideration is also given to such factors as management's evaluation of specific loans, the level and composition of impaired loans, other nonperforming loans, other identified potential problem loans, historical loss experience, results of examinations by regulatory agencies, results of the independent asset quality review process, the market value of collateral, the estimate of discounted cash flows, the strength and availability of guarantees, concentrations of credits, and various other factors, including concentration of credit risk in various industries and current economic conditions.
2003 compared to 2002. The 2003 provision for loan losses charged to operating expense totaled $8,236, an increase of $4,662 in comparison to the $3,574 recorded during the same period a year ago. The Company's provisions were largely attributable to the deterioration of two impaired commercial credits identified in the Company's June 30, 2003 Form 10-Q. As a result of the deterioration of these two loan relationships, the Company specifically provided
22.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
$3,500 to its allowance for loan losses during the third quarter of 2003 for the losses incurred on these two credits. The action comes as a result of management's ongoing workout analysis of these two commercial loan relationships and their current financial status and trends. Primary elements of the debtor corporations filed bankruptcy reorganization proceedings in early September. In both instances, these credits were worth substantially more as ongoing entities than the liquidation of their assets. During the third quarter, the $3,778 loan to a chain of retail convenience outlets was placed on non-accrual. The second credit, a $2,521 loan to a company which conducted business in the agricultural field was placed on nonaccrual status in the second quarter of 2003. The company essentially ceased operations during the third quarter of 2003 resulting in $1,897 of the outstanding loan balance being charged off.
In addition, the Company provided $2,000 to its allowance for loan losses during the fourth quarter of 2003 after an ongoing review of the overall credit quality in the loan portfolio noted a continued deterioration in several seasoned credits during the quarter, downgrades of various other credits, and lingering effects of the soft economy within several markets that the Company is currently operating. In some cases, problem loans had been previously identified; however, the loss incurred was greater than anticipated because of a soft commercial real estate market in specific industries and additional losses in the manufacturing, travel, and technology sectors.
Net charge-offs for the year ended December 31, 2003 were $5,675 compared with $3,419 in the same period of 2002. Annualized net charge-offs increased to 1.18% of average loans for 2003 compared to 0.70% in the same period in 2002. The increased level of net charge-offs, as compared to 2002, resulted from the impact of the weak economic climate and greater scrutiny by management in identifying problem credits for our watch list. As these credits continued to deteriorate, management actively sought methods of improving problem credits or recognized the need to charge-off non-bankable assets. In some cases, problem loans had been previously identified; however, the loss incurred was greater than anticipated. Other factors included an increase in the number of bankruptcies due to the soft commercial real estate market in specific industries and additional losses in the manufacturing, travel, and technology sectors.
Management remains watchful of credit quality issues and believes that current issues within the portfolio are reflective of a challenging economic environment. Should the economic climate continue to deteriorate, borrowers may experience difficulty, and the level of nonperforming loans, charge-offs and delinquencies could rise and require further increases in the provision. Management continues to monitor the loan portfolio. While management currently believes its allowance for loan losses is adequate, the Company is continually reviewing its policies and procedures regarding identification and classification of impaired loans and its asset review process.
2002 compared to 2001. The 2002 provision for loan losses charged to operating expense totaled $3,574, a decrease of $587 in comparison to the $4,161 recorded during the same period a year ago. The Company's year to date provisions are a continued response to the deterioration of several seasoned credits that surfaced and have been reserved for, downgrades of various other credits and the continued softening of the economy. In addition, management also considered several factors surrounding credit-quality, including the level of nonperforming loans, the number of customers filing for bankruptcy, and net charge-offs and delinquencies. In some cases, problem loans had been previously identified; however, the loss incurred was greater than anticipated because of a soft commercial real estate market in specific industries and additional losses in the manufacturing, travel, and technology sectors. The provision is consistent with the Company's practice of focusing on early identification of problem credits, an assessment of probable incurred losses and quick remediation where possible.
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UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Net charge-offs in 2002 were $3,419 compared with $4,280 in 2001. Annualized net charge-offs decreased to 0.70% of average loans for 2002 compared to 0.85% in the same period in 2001. The high, though reduced level of net charge-offs compared to 2001, resulted from the impact of the weak economic climate and greater scrutiny by management in identifying problem credits for our watch list. As these credits continued to deteriorate, management actively sought methods of improving problem credits or recognized the need to charge-off non-bankable assets. In some cases, problem loans had been previously identified; however, the loss incurred was greater than anticipated. Other factors included an increase in the number of bankruptcies due to the soft commercial real estate market in specific industries and additional losses in the manufacturing, travel, and technology sectors.
Noninterest Income. Noninterest income consists of a wide variety of fee-based revenues from bank-related service charges on deposits and mortgage revenues. Also included in this category are revenues generated by the Company's insurance, brokerage, trust and asset management as well as increases in cash surrender value on bank-owned life insurance. The following table summarizes the Company's noninterest income:
NONINTEREST INCOME (Dollars in Thousands)
Years Ended December 31, ------------------------------ 2003 2002 2001 -------- -------- --------
Service charges $ 3,090 $ 2,812 $ 2,748 Merchant fee income 560 1,185 1,095 Trust income 701 775 687 Mortgage banking income 3,947 2,843 2,096 Insurance commissions and fees 2,318 2,188 2,407 Securities gains (losses), net 281 407 798 Other income 2,822 2,245 2,089 -------- -------- --------
Total noninterest income $ 13,719 $ 12,455 $ 11,920 ======== ======== ========
2003 compared to 2002. Noninterest income totaled $13,719 for the year ended December 31, 2003, as compared to $12,455 for the same timeframe in 2002. This represented an increase of $1,264 or 10.1%. Excluding net securities gains of $281 in 2003 and $407 in 2002, noninterest income shows a year-over-year increase of $1,390 or 11.5%. As a percentage of total income (net interest income plus noninterest income), noninterest income, exclusive of securities gains, increased to 34.8% versus 31.9% for 2002.
The majority of the change to noninterest income was related to a $1,104 improvement in mortgage banking income. Mortgage banking income includes gains generated from the sale of loans and net servicing revenue (after amortization of mortgage servicing rights). Originations for 2003 grew to $241,864 from $183,481 for the same period of 2002. Net gains on mortgage activities were higher in 2003 due to higher mortgage origination volume and lower interest rates. Offsetting these gains, were noncash amortization charges in the carrying value of our mortgage servicing rights asset. These charges were due to increased refinancing activity, driven by the declining interest rate environment.
Also contributing to the improvement were increases in service charges reflecting higher volumes of items drawn on customer accounts with insufficient funds, insurance and commissions income largely due to increased brokerage activity and revenue generated from incremental investments in bank-owned life
24.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
insurance (included in other income). Offsetting these improvements were decreases in merchant fee income and ISP income due to the divestiture of these product lines in the second quarter of 2003. The remaining categories remained relatively stable with only slight year-over-year changes.
2002 compared to 2001. Noninterest income totaled $12,455 for the year ended December 31, 2002, as compared to $11,920 for the same timeframe in 2001. This represented an increase of $535 or 4.5%. Exclusive of net securities gains of $407 in 2002 and $798 in 2001, core noninterest income shows a year-over-year increase of $926 or 8.3%. As a percentage of total income (net interest income plus noninterest income), core noninterest income, exclusive of securities gains, increased to 31.9% versus 31.0% for 2001.
A majority of the increase in core noninterest income was related to a $747 improvement in mortgage banking income. Mortgage banking income includes fees generated from net servicing (after amortization of mortgage servicing rights) and the gains realized from the sale of loans. The Company's mortgage loan production increased 11% to a level of $183,481 as declining interest rates resulted in increases in the rate of mortgage refinancing and residential real estate activity. Offsetting the improvement in mortgage loan production, and subsequent gains on the sale of these loans, was a decrease in net servicing due to increasing pre-payment speeds driven by the declining interest rate environment.
Also contributing to the improvement were marginal increases in fees associated with overdraft fees reflecting an increase in returned check charges related to a higher occurrence rate, prestige card transaction fees related to higher transaction volume pushing interchange fees higher, and revenue generated from investments in bank-owned life insurance.
These improvements were offset by lower than anticipated insurance, asset management and brokerage fees (included in insurance commissions and fees). Insurance fees declined largely due to the hardening of the overall insurance market, which has resulted in clients shopping business to other vendors. Asset management and brokerage fees generally follow the amount of total assets under management and conditions in the equity and credit markets. The remaining categories remained relatively stable with only slight year-over-year changes.
Noninterest Expense. Noninterest expense is comprised primarily of compensation and employee benefits, occupancy and other operating expense. The following table summarizes the Company's noninterest expense:
25.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
NONINTEREST EXPENSE (Dollars in Thousands)
Years Ended December 31, ------------------------------ 2003 2002 2001 -------- -------- --------
Salaries and employee benefits $ 16,020 $ 15,284 $ 13,700 Occupancy expense, net 2,138 1,868 1,751 Furniture and equipment expenses 2,094 1,820 1,632 Supplies and printing 541 525 608 Telephone 874 1,074 773 Other real estate expense 178 919 162 Amortization of intangible assets 247 245 945 Other expense 6,515 7,291 6,641 -------- -------- --------
Total noninterest expense $ 28,607 $ 29,026 $ 26,212 ======== ======== ========
2003 compared to 2002. Noninterest expense totaled $28,607 for the year ended December 31, 2003, as compared to $29,026 for the same timeframe in 2002. This represented a decrease of $419 or 1.4%.
A majority of the decrease in noninterest expense was due to a $741 decrease in other real estate owned expense due to the resolution of foreclosed assets during the year. Also contributing to the change were decreases of $581 decrease in merchant expense due to the divestiture of the POS product line in the second quarter of 2003 (included in other expenses) and $200 in telephone expense.
These decreases were partially offset by a $736 increase in salary and employee benefits related to variable commission expense resulting from higher production volume from the mortgage banking and financial services business lines. These areas of the Company operate at a lower gross profit margin and historically generate significant levels of noninterest income but also incur considerable noninterest expense. The remaining categories remained relatively stable with only slight year-over-year changes.
2002 compared to 2001. Noninterest expense totaled $29,026 for the year ended December 31, 2002, as compared to $26,212 for the same timeframe in 2001. This represented an increase of $2,814 or 10.7%.
A majority of the increase in noninterest expense was attributable to a $1,584 rise in salaries and benefits, as we invested in our own future through the recruitment and retention of high-quality, seasoned industry professionals to fill existing vacancies and increased the Company's annual contribution to employee's 401k plan. In addition, a higher concentration of salary expenditures is also currently being realized by our mortgage banking division and financial services division. These divisions, with lower gross profit margins, historically produce significant noninterest income, but also incur considerable noninterest expense. Also contributing to the increase were $757 in costs associated with OREO assets, as the Company recorded a valuation allowance on one property, in addition to other losses on sale and general operating expenses incurred on OREO.
Other reasons for the increase in other expenses were due to the write-down of other assets and fees related to the work-out and collection of nonperforming
26.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
loans. Additionally, furniture and equipment expense and telephone expense increased due to investments in technology which were incurred to improve the Company's network infrastructure.
These increases were partially offset by decreases in supplies and printing and amortization of intangible assets due to the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets" and SFAS No. 147, "Acquisitions of Certain Financial Institutions." The adoption of these accounting standards allowed the Company to cease the amortization of goodwill related to its acquisitions. The effect of this adoption increased earnings by $690 for the twelve months ended December 31, 2002.
Applicable Income Taxes. The following table shows the Company's income before income taxes, as well as applicable income taxes and the effective tax rate for each of the past three years.
Years Ended December 31, -------------------------------- 2003 2002 2001 -------- -------- --------
Income before income taxes $ 2,001 $ 5,178 $ 5,991 Applicable income taxes (129) 1,134 1,537 Effective tax rates -- 21.9% 25.7%
Income tax expense for the periods included benefits for tax-exempt income, tax-advantaged investments and general business tax credits offset by the effect of nondeductible expenses. The Company's effective tax rate was lower than statutory rates due to several factors. First, the Company derives interest income from municipal securities and loans, which are exempt from federal tax and certain U.S. government agency securities, which are exempt from Illinois state tax. Second, the level of tax-exempt income has increased as a percentage of taxable income. And, finally, the Company has reduced tax expense through various tax planning initiatives.
Preferred Stock Dividends. The Company paid $193 of preferred stock dividends in 2003 and $257 of preferred stock dividends in 2002 and 2001.
Interest Rate Sensitivity Management
The business of the Company and the composition of its balance sheet consist of investments in interest-earning assets (primarily loans and securities) which are primarily funded by interest-bearing liabilities (deposits and borrowings). All of the financial instruments of the Company are for other than trading purposes. Such financial instruments have varying levels of sensitivity to changes in market rates of interest. The operating income and net income of the Banks depend, to a substantial extent, on "rate differentials," i.e., the differences between the income the Banks receive from loans, securities, and other earning assets and the interest expense they pay to obtain deposits and other liabilities. These rates are highly sensitive to many factors that are beyond the control of the Banks, including general economic conditions and the policies of various governmental and regulatory authorities.
The Company measures its overall interest rate sensitivity through a net interest income analysis. The net interest income analysis measures the change in net interest income in the event of hypothetical changes in interest rates. This analysis assesses the risk of changes in net interest income in the event of a sudden and sustained 100 to 200 basis point increase in market interest rates or a 100 basis point decrease in market interest rates. The interest rate scenarios are used for analytical purposes and do not necessarily represent management's view of future market movements. The tables below present the Company's projected changes in net interest income for 2003 and 2002 for the various rate shock levels.
27.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
December 31, 2003 Net Interest Income - ----------------- ----------------------------------- Amount Change Change -------- -------- -------- (Dollars in Thousands)
+200 bp $ 22,270 $ (420) (1.85)% +100 bp 22,512 (178) (0.79) Base 22,690 -- -- -100 bp 22,570 (120) (0.53)
Based on the Company's model at December 31, 2003, the effect of an immediate 200 basis point increase in interest rates would decrease the Company's net interest income by 1.85% or approximately $420. The effect of an immediate 100 basis point decrease in rates would decrease the Company's net interest income by $120 or 0.53%. For the December 31, 2003 reporting cycle, the Company has suppressed an immediate 200 basis point decrease in its Asset Liability model due to the abnormally low prevailing interest rate environment.
Net interest income would be adversely affected initially by a significant increase in interest rates due to the recent desire by investors to commit funds to short-term deposits, or transactional accounts that are immediately subject to changes in interest rates. The Company has correspondingly kept its investments shorter in terms of final maturity, but many of the variable rate investments, such as adjustable rate mortgages, are not subject immediately to a change in interest rates. Subsequent to the initial adverse impact of higher interest rates, principal payments on amortizing securities and maturities of non-amortizing securities will allow reinvestment at the new higher level of interest rates. Also the adjustable rate securities will ultimately have coupons adjusted to the higher level of interest rates to also beneficially impact net interest income. If interest rates stay at higher levels, the Company would ultimately reprice a greater amount of assets than liabilities adjusting to the higher level of interest rates.
Additionally, net interest income would be adversely impacted by a decline in interest rates due to the explicit or implicit options in assets it holds. The Company earns a higher yield on callable agency securities due to the additional interest paid by the issuer to retain the right to call a security should interest rates decline. Likewise, a borrower with a fixed rate mortgage or other type of loan retains the option to prepay the mortgage or loan should interest rates decline. The reinvestment by the Company in a lower yielding asset available at the lower level of interest rates adversely impacts net interest income.
December 31, 2002 Net Interest Income - ----------------- ----------------------------------- Amount Change Change -------- -------- -------- (Dollars in Thousands)
+200 bp $ 26,146 $ 822 3.25% +100 bp 25,857 533 2.10 Base 25,324 -- -- -100 bp 24,587 (737) (2.91) -200 bp 23,796 (1,528) (6.03)
Based on the Company's model at December 31, 2002, the effect of an immediate 200 basis point increase in interest rates would increase the Company's net interest income by 3.25% or approximately $822. The effect of an immediate 200 basis point decrease in rates would reduce the Company's net interest income by 6.03% or approximately $1,528.
28.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Financial Condition
General. As of December 31, 2003, the Company had total assets of $793,422, gross loans of $476,812, total deposits of $638,032, and total stockholders' equity of $68,047. Total assets increased by $1,806 or 0.2% from year-end 2002. Total gross loans decreased $6,417 or 1.3% from year-end 2002 and reflected tighter underwriting standards, an overall softening of loan demand, and normal paydowns. Total deposits decreased by $3,926 or 0.6% from year-end 2002.
Loans and Asset Quality. The Company offers a broad range of products, including granting agribusiness, commercial, residential, and installment loans, designed to meet the credit needs of its borrowers. The Company's loans are diversified by borrower and industry group. The following table describes the composition of loans by major categories outstanding.
The following table describes the composition of loans by major categories outstanding.
29.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
As of December 31, 2003 and 2002, commitments of the Banks under standby letters of credit and unused lines of credit totaled approximately $100,169 and $104,560, respectively.
Stated loan maturities (including rate loans reset to market interest rates) of the total loan portfolio, net of unearned income, at December 31, 2003 were as follows:
STATED LOAN MATURITIES (1) (Dollars in Thousands)
Within 1 to 5 After 5 1 Year Years Years Total ---------- ---------- ---------- ----------
Commercial $ 72,572 $ 30,440 $ 2,755 $ 105,767 Agricultural 25,702 7,543 521 33,766 Real estate 139,811 135,530 21,573 296,914 Installment 17,310 23,008 47 40,365 ---------- ---------- ---------- ----------
Total $ 255,395 $ 196,521 $ 24,896 $ 476,812 ========== ========== ========== ==========
- -------------------- (1) Maturities based upon contractual maturity dates
The maturities presented above are based upon contractual maturities. Many of these loans are made on a short-term basis with the possibility of renewal at time of maturity. All loans, however, are reviewed on a continuous basis for creditworthiness.
30.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Rate sensitivities of the total loan portfolio, net of unearned income, at December 31, 2003 were as follows:
LOAN REPRICING (Dollars in Thousands)
Within 1 to 5 After 5 1 Year Years Years Total ---------- ---------- ---------- ----------
Fixed rate $ 79,596 $ 84,182 $ 15,283 $ 179,061 Variable rate 174,326 110,813 4,463 289,602 Nonaccrual 1,472 1,525 5,152 8,149 ---------- ---------- ---------- ----------
Total $ 255,394 $ 196,520 $ 24,898 $ 476,812 ========== ========== ========== ==========
Nonperforming Assets. The Company's financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on its loan portfolio, unless a loan is placed on nonaccrual status. Loans are placed on nonaccrual status when there are serious doubts regarding the collectibility of all principal and interest due under the terms of the loans. Amounts received on nonaccrual loans generally are applied first to principal and then to interest after all principal has been collected. It is the policy of the Company not to renegotiate the terms of a loan because of a delinquent status. Rather, a loan is generally transferred to nonaccrual status if it is not in the process of collection and is delinquent in payment of either principal or interest beyond 90 days. Loans which are 90 days delinquent but are well secured and in the process of collection are not included in nonperforming assets. Other nonperforming assets consist of real estate acquired through loan foreclosures or other workout situations and other assets acquired through repossessions.
The classification of a loan as nonaccrual does not necessarily indicate that the principal is uncollectible, in whole or in part. The Banks make a determination as to collectibility on a case-by-case basis. The Banks consider both the adequacy of the collateral and the other resources of the borrower in determining the steps to be taken to collect nonaccrual loans. The final determination as to the steps taken is made based upon the specific facts of each situation. Alternatives that are typically considered to collect nonaccrual loans are foreclosure, collection under guarantees, loan restructuring, or judicial collection actions.
Each of the Company's loans is assigned a rating based upon an internally developed grading system. A separate credit administration department also reviews grade assignments on an ongoing basis. Management continuously monitors nonperforming, impaired, and past due loans to prevent further deterioration of these loans. The Company has an independent loan review function which is separate from the lending function and is responsible for the review of new and existing loans.
The level of nonperforming loans at December 31, 2003 increased to $8,477 versus the $4,760 that existed as of December 31, 2002. The level of nonperforming loans to total end of period loans was 1.78% at December 31, 2003, as compared to 0.99% at December 31, 2002. The reserve coverage ratio (allowance to nonperforming loans) was reported at 106.30% as of December 31, 2003 as compared to 135.50% as of December 31, 2002.
As previously discussed in the Provision for Loan Loss Section of the MD&A, the Company increased its provision for loan losses during 2003. The action primarily comes as a result of management's ongoing workout analysis of the two
31.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
previously mentioned commercial loan relationships and their current financial status and trends. Primary elements of the debtor corporations filed bankruptcy reorganization proceedings in early September. In both instances, these credits were worth substantially more as ongoing entities than the liquidation of their assets. During the third quarter, the $3,778 loan to a chain of retail convenience outlets was placed on non-accrual. The second credit, a $2,521 loan to a company which conducted business in the agricultural field was placed on nonaccrual status in the second quarter of 2003. The company essentially ceased operations during the third quarter of 2003 resulting in $1,897 of the outstanding loan balance being charged off.
The $1,330 decrease in other real estate owned, when compared to December 31, 2002, was primarily related to the sale of a single hotel property that was placed in other real estate owned in the fourth quarter of 2001.
Other Potential Problem Loans. The Company has other potential problem loans that are currently performing and do not meet the criteria for impairment, but where some concern exists. Excluding nonperforming loans and loans that management has classified as impaired, these other potential problem loans totaled $5,086 at December 31, 2003 as compared to $3,725 at December 31, 2002. The classification of these loans, however, does not imply that management expects losses on each of these loans, but believes that a higher level of scrutiny and close monitoring is prudent under the circumstances. Such classifications relate to specific concerns for each individual borrower and do not relate to any concentration risk common to all loans in this group.
The following table sets forth a summary of nonperforming assets at December 31, 2003:
The following table sets forth a summary of other real estate owned and other collateral acquired at December 31, 2003:
OTHER REAL ESTATE OWNED (Dollars in Thousands)
Number Net Book of Carrying Parcels Value -------- --------
Developed property 2 $ 227 Vacant land or unsold lots -- -- -------- -------- Total other real estate owned 2 $ 227 ======== ========
32.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Allowance for Loan Losses. In originating loans, the Company recognizes that credit losses will be experienced and the risk of loss will vary with, among other things, general economic conditions; the type of loan being made; the creditworthiness of the borrower over the term of the loan; and, in the case of a collateralized loan, the quality of the collateral for such a loan. The allowance for loan losses represents the Company's estimate of the allowance necessary to provide for probable incurred losses in the loan portfolio. In making this determination, the Company analyzes the ultimate collectibility of the loans in its portfolio, incorporating feedback provided by internal loan staff, the independent loan review function, and information provided by examinations performed by regulatory agencies. The Company makes an ongoing evaluation as to the adequacy of the allowance for loan losses.
On a quarterly basis, management reviews the adequacy of the allowance for loan losses. Commercial credits are graded by the loan officers and the Loan Review function validates the officers' grades. In the event that the loan review function downgrades the loan, it is included in the allowance analysis at the lower grade. The grading system is in compliance with the regulatory classifications and the allowance is allocated to the loans based on the regulatory grading, except in instances where there are known differences (i.e., collateral value is nominal, etc.). To establish the appropriate level of the allowance, a sample of loans (including impaired and nonperforming loans) are reviewed and classified as to potential loss exposure.
Based on an estimation done pursuant to the requirements of Financial Accounting Standards Board ("FASB") Statement No. 5, "Accounting for Contingencies," and FASB Statements Nos. 114 and 118, "Accounting by Creditors for Impairment of a Loan," the analysis of the allowance for loan losses consists of three components: (i) specific credit allocation established for expected losses resulting from analysis developed through specific credit allocations on individual loans for which the recorded investment in the loan exceeds its fair value; (ii) general portfolio allocation based on historical loan loss experience for each loan category; and (iii) unallocated subjective reserves based on general economic conditions as well as specific economic factors in the markets in which the Company operates.
The specific credit allocation component of the allowance for loan losses is based on a regular analysis of loans over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. The fair value of the loan is determined based on either the present value of expected future cash flows discounted at the loan's effective interest rate, the market price of the loan, or, if the loan is collateral dependent, the fair value of the underlying collateral less cost of sale.
The general portfolio allocation component of the allowance for loan losses is determined statistically using a loss migration analysis that examines historical loan loss experience. The loss migration analysis is performed quarterly and loss factors are updated regularly based on actual experience. The general portfolio allocation element of the allowance for loan losses also includes consideration of the amounts necessary for concentrations and changes in portfolio mix and volume.
The unallocated allowance recognizes estimated probable inherent but undetected losses in the loan portfolio. The decrease in the unallocated allowance in 2003 relative to the allocated allowance and to the 2002 unallocated allowance reflects a refinement in the overall allowance calculation process as more of the total balance is being allocated to particular loan categories.
The allowance for loan losses is based on estimates, and ultimate losses will vary from current estimates. These estimates are reviewed monthly, and as adjustments, either positive or negative, become necessary, a corresponding increase or decrease is made in the provision for loan losses. The composition of the loan portfolio has not significantly changed since year-end 2002. The methodology used to determine the adequacy of the allowance for loan losses is consistent with prior years, and there were no reallocations.
33.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Along with other financial institutions, management remains watchful of credit quality issues and believes that current issues within the portfolio are reflective of a challenging economic environment. Should the economic climate continue to deteriorate, borrowers may experience difficulty, and the level of nonperforming loans, charge-offs, and delinquencies could rise and require further increases in the provision. Management continues to monitor the loan portfolio and take appropriate action to proactively limit credit exposure.
At December 31, 2003, the allowance for loan losses was $9,011 or 1.89% of total loans as compared to $6,450 or 1.33% at December 31, 2002. The change from December 31, 2002 is due to the increase in impaired loans previously discussed and as a result, additional provisions have been made to the allowance for loan losses.
34.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
The following table presents a detailed analysis of the Company's allowance for loan losses.
35.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
The following table sets forth an allocation of the allowance for loan losses among the various loan categories.
Securities Activities. The Company's consolidated securities portfolio, which represented 31.8% of the Company's average earning asset base as of December 31, 2003, as compared to 28.8% in the same period of 2002, is managed to minimize interest rate risk, maintain sufficient liquidity, and maximize return. The portfolio includes several callable agency debentures, adjustable rate mortgage pass-throughs, and collateralized mortgage obligations. Corporate bonds consist of investment grade obligations of public corporations. Equity securities consist of Federal Reserve stock, Federal Home Loan Bank stock, and trust preferred stock. The Company's financial planning anticipates income streams generated by the securities portfolio based on normal maturity and reinvestment.
The exposure of capital to market valuation adjustments has been reduced by the reduction in relative size of the portfolio, the shortening of the average life of the securities by the passage of time and the sale of floating rate securities with lower lifetime caps. In addition, some of the callable securities that have been purchased have shorter final maturities, which also reduce the sensitivity of the Economic Value of Equity (EVE) to changes in the level of interest rates. Securities classified as available-for-sale, carried at fair value, were $252,248 at December 31, 2003 compared to $227,229 at December 31, 2002. The Company does not have any securities classified as trading or held-to-maturity.
36.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
The following table describes the composition of securities by major category and maturity.
The following table sets forth the contractual, callable or estimated maturities and yields of the securities portfolio as of December 31, 2003. Mortgage backed and collateralized mortgage obligation securities are included at estimated maturity.
- --------------- (1) Rates on obligations of states and political subdivisions have been adjusted to tax equivalent yields using a 34% income tax rate
37.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Deposit Activities. Deposits are attracted through the offering of a broad variety of deposit instruments, including checking accounts, money market accounts, regular savings accounts, term certificate accounts (including "jumbo" certificates in denominations of $100,000 or more), and retirement savings plans. The Company's average balance of total deposits was $620,551 for 2003, representing a decrease of $557 or 0.1% compared with the average balance of total deposits for 2002.
The following table sets forth certain information regarding the Banks' average deposits.
As of December 31, 2003, average time deposits over $100,000 represented 25.4% of total average deposits, compared with 24.4% of total average deposits as of December 31, 2002. The Company's large denomination time deposits are generally from customers within the local market areas of its subsidiary banks and provide a greater degree of stability than is typically associated with brokered deposit customers with limited business relationships.
The following table sets forth the remaining maturities for time deposits of $100,000 or more at December 31, 2003.
TIME DEPOSITS OF $100,000 OR MORE (Dollars in Thousands)
Maturity Range
Three months or less $ 68,381 Over three months through six months 38,155 Over six months through twelve months 26,160 Over twelve months 30,556 ----------
Total $ 163,252 ==========
38.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Return on Equity and Assets. The following table presents various ratios for the Company.
RETURN ON EQUITY AND ASSETS
For the Years Ended December 31, -------------------------- 2003 2002 2001 ------ ------ ------
Return on average assets 0.28% 0.53% 0.59% Return on average equity 3.16 6.11 7.04 Average equity to average assets 8.87 8.71 8.37 Dividend payout ratio for common stock 74.39 32.59 25.59
Liquidity
The Company manages its liquidity position with the objective of maintaining sufficient funds to respond to the needs of depositors and borrowers and to take advantage of earnings enhancement opportunities. In addition to the normal inflow of funds from core-deposit growth together with repayments and maturities of loans and investments, the Company utilizes other short-term funding sources such as brokered time deposits, securities sold under agreements to repurchase, overnight federal funds purchased from correspondent banks and the acceptance of short-term deposits from public entities, and Federal Home Loan Bank advances.
The Company monitors and manages its liquidity position on several bases, which vary depending upon the time period. As the time period is expanded, other data is factored in, including estimated loan funding requirements, estimated loan payoffs, investment portfolio maturities or calls, and anticipated depository buildups or runoffs.
The Company classifies all of its securities as available-for-sale, thereby maintaining significant liquidity. The Company's liquidity position is further enhanced by structuring its loan portfolio interest payments as monthly and by the significant representation of retail credit and residential mortgage loans in the Company's loan portfolio, resulting in a steady stream of loan repayments. In managing its investment portfolio, the Company provides for staggered maturities so that cash flows are provided as such investments mature.
The Company's cash flows are comprised of three classifications: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Cash flows used in investing activities offset by those provided by operating activities and financing activities, resulted in a net decrease in cash and cash equivalents of $16,764 from December 31, 2002 to December 31, 2003.
During 2003, the Company experienced net cash outflows of $33,789 in investing activities primarily due to purchases of securities. In contrast, net cash inflows were provided by $13,846 in operating activities due to proceeds from net loans sales and net income; and $3,179 in financing activities due to an increase in FHLB advances partially offset by a net decrease in deposits.
The Banks' securities portfolios, federal funds sold, and cash and due from bank deposit balances serve as the primary sources of liquidity for the Company. At December 31, 2003, 25.6% of the Banks' interest-bearing liabilities were in the form of time deposits of $100,000 and over. Management believes these deposits to be a stable source of funds. However, if a large number of these time deposits matured at approximately the same time and were not renewed, the Banks' liquidity could be adversely affected. Currently, the maturities of the Banks' large time deposits are spread throughout the year, with 41.9% maturing in the first quarter of 2004, 23.4% maturing in the second quarter of 2004, 16.0%
39.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
maturing in the third and fourth quarters of 2004, and the remaining 18.7% maturing thereafter. The Banks monitor those maturities in an effort to minimize any adverse effect on liquidity.
The Company's borrowings included notes payable at December 31, 2003 in the principal amount of $7,275 payable to the Company's principal correspondent bank. The note is renewable annually, requires quarterly interest payments, and is collateralized by the Company's stock in the Banks.
The Company's principal source of funds for repayment of the indebtedness is dividends from the Banks. At December 31, 2003, approximately $5,200 was available for dividends without regulatory approval.
Contractual Obligations, Commitments, Contingencies, and Off-Balance Sheet Financial Instruments
The Company has entered into contractual obligations and commitments and off-balance sheet financial instruments. The following tables summarize the Company's contractual cash obligations and other commitments and off-balance sheet instruments as of December 31, 2003.
Capital Resources
Stockholders' Equity
The Company is committed to managing capital for maximum shareholder benefit and maintaining strong protection for depositors and creditors. Stockholders' equity at December 31, 2003 was $68,047, a decrease of $17 or 0.1%, from December 31, 2002. The stockholders' equity decrease was largely the result of earnings for 2003 less dividends paid to shareholders and a $1,030 decrease in accumulated other comprehensive income. Average equity as a percentage of average assets was 8.9% at December 31, 2003, compared to 8.7% at December 31, 2002. Book value per common share equaled $16.77 at December 31, 2003, a slight decrease from $16.97 at the end of 2002.
Stock Repurchase
On May 2, 2003, the Board of Directors approved a stock repurchase plan whereby the Company may repurchase from time to time up to 5% of its outstanding shares of common stock in the open market or in private transactions over the next 18 months. Purchases will be dependent upon market conditions and the availability of shares. The repurchase program optimizes the use of capital relative to other
40.
UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
investment alternatives and benefits both the Company and the shareholders by enhancing earnings per share and return on equity. To date, the Company has repurchased 10,500 shares at a weighted average cost of $17.92.
Capital Measurements
The Banks are expected to meet a minimum risk-based capital to risk-weighted assets ratio of 8%, of which at least one-half (or 4%) must be in the form of Tier 1 (core) capital. The remaining one-half (or 4%) may be in the form of Tier 1 (core) or Tier 2 (supplementary) capital. The amount of loan loss allowance that may be included in capital is limited to 1.25% of risk-weighted assets. The ratio of Tier 1 (core) and the combined amount of Tier 1 (core) and Tier 2 (supplementary) capital to risk-weighted assets for the Company was 10.75% and 12.15%, respectively, at December 31, 2003. The Company is currently, and expects to continue to be, in compliance with these guidelines.
As of December 31, 2003, the Tier 2 risk-based capital was comprised of $6,959 in allowance for loan losses (limited to 1.25% of risk-weighted assets) and $831 of Mandatory Redeemable Series B Preferred Stock. The Series A Preferred Stock is convertible into common stock, subject to certain adjustments intended to offset the amount of losses incurred by the Company upon the post-closing sale of certain securities acquired in conjunction with the 1996 acquisition of Prairie.
The following table sets forth an analysis of the Company's capital ratios:
Impact of Inflation, Changing Prices, and Monetary Policies
The financial statements and related financial data concerning the Company have been prepared in accordance with accounting principles generally accepted in the United States of America which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary effect of inflation on the operations of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, changes in interest rates have a more significant effect on the performance of a financial institution than do the effects of changes in the general rate of inflation and changes in prices. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Interest rates are highly sensitive to many factors which are beyond the control of the Company, including the influence of domestic and foreign economic conditions and the monetary and fiscal policies of the United States government and federal agencies, particularly the FRB.
41.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The discussion under the caption "Interest Rate Sensitivity Management" contained in Item 7 of this Form 10-K is incorporated herein by this reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
Independent Auditors Report...................................................43
Consolidated Balance Sheets (December 31, 2003 and 2002) .....................44
Consolidated Statements of Income (For the years December 31, 2003, 2002 and 2001).....................45
Consolidated Statements of Stockholders' Equity (For the years December 31, 2003, 2002 and 2001).....................46
Consolidated Statements of Cash Flows (For the years December 31, 2003, 2002 and 2001).....................48
Notes.........................................................................50
Supplementary Data
The Supplementary Financial Information required to be included in this Item 8 is hereby incorporated by reference by Note 21 to the Notes to Consolidated Financial Statements contained herein.
42.
[COMPANY LOGO OMITTED] Crowe
Crowe Chizek and Company LLC Member Horwath International
REPORT OF INDEPENDENT AUDITORS
To the Stockholders and Board of Directors UnionBancorp, Inc.
We have audited the accompanying consolidated balance sheets of UnionBancorp, Inc. as of December 31, 2003 and 2002, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of UnionBancorp, Inc. and Subsidiaries at December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.
As disclosed in Note 1, during 2002, the Company adopted new accounting guidance for goodwill and intangible assets.
/s/ CROWE CHIZEK AND COMPANY LLC
Oak Brook, Illinois January 23, 2004
43.
See Accompanying Notes to Consolidated Financial Statements.
44.
See Accompanying Notes to Consolidated Financial Statements.
45.
(Continued)
46.
See Accompanying Notes to Consolidated Financial Statements.
47.
(Continued)
48.
See Accompanying Notes to Consolidated Financial Statements.
49.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 1. Nature of Operations and Summary of Significant Accounting Policies
UnionBancorp, Inc. ("the Company") is a bank holding company organized under the laws of the state of Delaware. The Company provides a full range of banking services to individual and corporate customers located in the north central and west central areas of Illinois. These services include demand, time, and savings deposits; lending; mortgage banking; insurance products; brokerage services; and trust services. The Company is subject to competition from other financial institutions and nonfinancial institutions providing financial services. Additionally, the Company and its bank subsidiaries ("the Banks") are subject to regulations of certain regulatory agencies and undergo periodic examinations by those regulatory agencies.
Basis of presentation - ---------------------
The consolidated financial statements include the accounts of the Company and its subsidiaries UnionBank, UnionBank/West, and UnionBank/Northwest. Intercompany balances and transactions have been eliminated in consolidation.
The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and with general practice in the banking industry. In preparing the financial statements, management makes estimates and assumptions based on available information that affects 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 income and expenses during the reporting period, and actual results could differ. The allowance for loan losses, value of mortgage servicing rights, and fair values of financial instruments are particularly subject to change.
Assets held in an agency or fiduciary capacity, other than trust cash on deposit with the Banks, are not assets of the Company and, accordingly, are not included in the accompanying consolidated financial statements.
Cash flows - ----------
Cash and cash equivalents includes cash, deposits with other financial institutions under 90 days, and federal funds sold. Loan disbursements and collections, repurchase agreements, federal funds purchased, and transactions in deposit accounts are reported, net.
Securities - ----------
Securities classified as available-for-sale are those securities that the Company intends to hold for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. Securities available-for-sale are carried at fair value with unrealized gains or losses, net of the related deferred income tax effect, reported in other comprehensive income. Securities such as Federal Home Loan Bank stock and Federal Reserve Bank stock are carried at cost.
(Continued)
50.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
Interest income is reported net of amortization of premiums and accretion of discounts. Gains or losses from the sale of securities are determined using the specific identification method. Securities are written down to fair value when a decline in fair value is not temporary.
Derivatives - -----------
All derivative instruments are recorded at their fair values. If derivative instruments are designated as hedges of fair values, both the change in the fair value of the hedge and the hedged item are included in current earnings. Fair value adjustments related to cash flow hedges are recorded in other comprehensive income and reclassified to earnings when the hedge transaction is reflected in earnings. Ineffective portions of hedges are reflected in earnings as they occur. At December 31, 2003 and 2002, the Company had no material derivative instruments.
Loan commitments and related financial instruments - --------------------------------------------------
Financial instruments include off-balance-sheet credit instruments such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Loans - -----
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and an allowance for loan losses. Loans originated and intended for sale in the secondary market are reported at the lower of cost or market, on an aggregate basis. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings.
Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. Consumer loans are typically charged off no later than 180 days past due. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors.
(Continued)
51.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
A loan is impaired when full payment under the loan terms is not expected. Commercial and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.
Mortgage servicing rights - -------------------------
Servicing assets represent purchased rights and the allocated value of retained servicing rights on loans sold. Servicing assets are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the assets, using groupings of the underlying loans as to interest rates and then, secondarily, as to geographic and prepayment characteristics. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment of a grouping is reported as a valuation allowance, to the extent that fair value is less than the capitalized amount for a grouping.
Foreclosed assets - -----------------
Assets acquired through or instead of loan foreclosure are initially recorded at fair value when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed.
Premises and equipment - ----------------------
Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Building and related components are depreciated using the straight-line method with useful lives ranging from 15 to 39 years. Furniture, fixtures, and equipment are depreciated using the straight-line (or accelerated) method with useful lives ranging from 3 to 10 years. The cost of maintenance and repairs is charged to income as incurred; significant improvements are capitalized.
Company-owned life insurance - ----------------------------
The Company has invested in company-owned life insurance policies, for which the Company is also the beneficiary, on certain members of management. Company-owned life insurance is recorded at its cash surrender value or the amount that can be realized. These policies have an aggregate face value of 36.4 million and $36.1 million with an approximate cash surrender value of $14.1 million and $13.8 million at December 31, 2003 and 2002, respectively.
(Continued)
52.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
Goodwill and other intangible assets - ------------------------------------
Goodwill results from prior business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Upon adopting new accounting guidance on January 1, 2002 and October 1, 2002, the Company ceased amortizing goodwill. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. The effect on net income of ceasing goodwill amortization in 2003 and 2002 was $690,000.
Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from whole bank, branch, and insurance company acquisitions. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives, which is ten years.
Long-term assets - ----------------
Premises and equipment, core deposit, and other intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.
Repurchase agreements - ---------------------
Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.
Income taxes - ------------
Deferred tax assets and liabilities are recognized for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. Deferred taxes are recognized for the estimated taxes ultimately payable or recoverable based on enacted tax laws. Changes in enacted tax rates and laws are reflected in the financial statements in the periods they occur.
Earnings per share - ------------------
Basic earnings per share is based on weighted-average common shares outstanding. Diluted earnings per share assumes the issuance of any dilutive potential common shares under stock options and Series A converted preferred shares using the treasury stock method.
Financial instruments - ---------------------
Financial instruments include off-balance-sheet credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
(Continued)
53.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
Stock compensation - ------------------
Employee compensation expense under stock options is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation.
The pro forma effects are computed using option pricing models, using the following weighted-average assumptions as of grant date.
Stockholders' Equity: - ---------------------
Preferred stock - ---------------
The Company's Certificate of Incorporation authorizes its Board of Directors to fix or alter the rights, preferences, privileges, and restrictions of 200,000 shares of preferred stock.
(Continued)
54.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
The Company has the following classes of preferred stock issued or authorized:
Series A Convertible Preferred Stock: The Company has authorized 2,765 shares of Series A Convertible Preferred Stock. There were 2,762.24 shares of Series A Convertible Preferred Stock issued at December 31, 2003 and 2002. Preferential cumulative cash dividends are payable quarterly at an annual rate of $75.00 per share. Dividends accrue on each share of Series A Preferred Stock from the date of issuance and from day to day thereafter, whether or not earned or declared. The shares of Series A Preferred Stock are convertible into 99,769 common shares. Series A Preferred Stock is not redeemable for cash. Upon dissolution, winding up, or liquidation of the Company, voluntary or otherwise, holders of Series A Preferred Stock will be entitled to receive, out of the assets of the Company available for distribution to stockholders, the amount of $1,000 per share, plus any accrued but unpaid dividends, before any payment or distribution may be made on shares of common stock or any other securities issued by the Company that rank junior to the Series A Preferred Stock.
Series B Mandatory Redeemable Preferred Stock: The Company has authorized 1,092 shares of Series B Mandatory Redeemable Preferred Stock. There were 831 shares of Series B Mandatory Redeemable Preferred Stock issued at December 31, 2003 and 2002. Preferential cumulative cash dividends are payable quarterly at an annual rate of $60.00 per share. Dividends accrue on each share of Series B Preferred Stock from the date of issuance and from day to day, thereafter, whether or not earned or declared. Each original holder of Series B Preferred Stock (or upon such holder's death, their executor or personal representatives) will have the option, exercisable at their sole discretion, to sell, and the Company will be obligated to redeem such holder's shares of Series B Preferred Stock upon the earlier to occur of the death of the respective original holder of Series B Preferred Stock or ten years after the original issuance date of the Series B Preferred Stock. The per share price payable by the Company for such shares of Series B Preferred Stock will be equal to $1,000 per share, plus any accrued but unpaid dividends. Upon dissolution, wind up, or liquidation of the Company, voluntary or otherwise, holders of Series B Preferred Stock will be entitled to receive, out of the assets of the Company available for distribution to stockholders, the amount of $1,000 per share, plus any accrued but unpaid dividends, before any payment or distribution may be made on shares of common stock or any other securities issued by the Company that rank junior to the Series B Preferred Stock.
The Company adopted FASB Statement 150, Accounting for Certain Financial Instruments With Characteristics of Both Liabilities and Equities, during the fourth quarter of 2003.
Statement 150 requires reporting mandatorily redeemable shares as liabilities, as well as obligations not in the form of shares to repurchase shares that may require cash payment and some obligations that may be settled by issuing a variable number of equity shares. To comply with this statement, the Company reclassified 831 shares of Series B mandatory redeemable preferred stock into liabilities for balance sheet presentation for the 2003 year. In addition, the dividends in the fourth quarter of 2003 were reclassified to interest expense.
(Continued)
55.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
Series C Junior Participating Preferred Stock: The Company has authorized 4,500 shares of Series C Junior Participating Preferred Stock. There were no shares issued at December 31, 2003 and 2002. The Series C Preferred Stock is only issuable upon exercise of rights issued pursuant to the Company's Stockholder Rights Plan. Each share of Series C Junior Participating Preferred Stock is entitled to, when, as, and if declared, a minimum preferential quarterly dividend payment of $3.00 per share but will be entitled to an aggregate dividend of 1,000 times the dividend declared per share of common stock. In the event of liquidation, dissolution, or winding up of the Company, the holders of the Series C Preferred Stock will be entitled to a minimum preferential payment of $1,000 per share (plus any accrued but unpaid dividends) and will be entitled to an aggregate payment of 1,000 times the payment made per share of common stock. Each share of Series C Preferred Stock will have 1,000 votes, voting together with the common stock. Finally, in the event of any merger, consolidation, or other transaction in which outstanding shares of common stock are converted or exchanged, each share of Series C Preferred Stock will be entitled to receive 1,000 times the amount received per share of common stock. These rights are protected by customary antidilution provisions.
Stockholder rights plan - -----------------------
On July 17, 1996, the Company declared a dividend of one preferred share purchase right (a "Right") for each outstanding share of common stock. Each Right entitles the registered holder to purchase from the Company one one-thousandth of a share of Series C Junior Participating Preferred Stock, no par value, of the Company at a price of $50.00 per one one-thousandth of a share of preferred stock ("the Purchase Price"), subject to adjustment.
The Rights are not exercisable until the earlier to occur of: (i) 10 days after a person or group ("Acquiring Person") has acquired beneficial ownership of 15% or more of the outstanding shares of common stock or (ii) 10 business days (or such later date as determined by the Board of Directors) following the commencement of a tender offer or exchange offer ("the Distribution Date"). Unless extended, the Rights will expire on August 4, 2006. At any time prior to the time an Acquiring Person becomes such, the Board of Directors of the Company may redeem the Rights in whole, but not in part, at a price of $.01 per Right.
Dividend restriction - --------------------
Banking regulations require the maintenance of certain capital levels and may limit the amount of dividends that may be paid by the subsidiary banks to the holding company or by the holding company to stockholders.
Fair value of financial instruments - -----------------------------------
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
(Continued)
56.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 1. Nature of Operations and Summary of Significant Accounting Policies (Continued)
Loss contingencies - ------------------
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.
Comprehensive income - --------------------
Comprehensive income includes both net income and other comprehensive income elements, including the change in unrealized gains and losses on securities available-for-sale, net of tax.
Adoption of new accounting standards - ------------------------------------
During 2003, the Company adopted FASB Statement 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities; FASB Statement 132 (revised 2003), Employers' Disclosures About Pensions and Other Postretirement Benefits; FASB Interpretation 45, Guarantor's Accounting and Disclosure Requirements for Guarantees; and FASB Interpretation 46, Consolidation of Variable Interest Entities. Adoption of these new standards did not materially affect the Company's operating results or financial condition.
Operating segments - ------------------
Internal financial information is primarily reported and aggregated in the following lines of business: banking, mortgage banking, financial services, and other.
Reclassifications - -----------------
Certain items in the financial statements as of and for the years ended December 31, 2002 and 2001 have been reclassified, with no effect on net income, to conform with the current year presentation.
Note 2. Business Acquisitions and Divestitures
On May 22, 2003, the Company sold its Internet Service Provider ("ISP") product line. The Company sold the related assets of the product line, subscriber accounts, and the "sainet.net" and "udnet.net" domains for approximately $364. The Company recorded a gain of approximately $237 on the sale.
On October 31, 2003, the Company purchased the assets of the Howard Marshall Agency including Walnut Street Securities. The Company purchased the customer lists of Howard Marshall and Walnut Street for a total of $580 and fixed assets totaling $20. In addition, an additional $125 can be paid on the fifth anniversary of the closing date if certain performance criteria are met. This acquisition was incorporated into UnionFinancial Services & Trust Company.
(Continued)
57.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 3. Securities
The fair value of securities available-for-sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:
At December 31, 2003, approximately 34% of the fair value of equity securities consists of Federal Home Loan Bank stock and Federal Reserve Bank stock.
Sales of securities available-for-sale were as follows:
Years Ended December 31, ------------------------------------- 2003 2002 2001 ---------- ---------- ----------
Proceeds $ 72,398 $ 19,640 $ 21,582 Realized gains 281 409 798 Realized losses -- (2) --
(Continued)
58.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 3. Securities (Continued)
The fair value of securities classified as available-for-sale at December 31, 2003, by contractual maturity, are shown below. Securities not due at a single maturity date, primarily mortgage-backed securities and collateralized mortgage obligations, are shown separately.
Fair Value - ----------
Due in one year or less $ 27,601 Due after one year through five years 36,271 Due after five years through ten years 6,077 Due after ten years 642 U.S. government agency mortgage-backed securities 158,305 Collateralized mortgage obligations 5,972 Equity securities 17,380 ----------
$ 252,248 ==========
As of December 31, 2003, the Company held callable securities carried at a fair value of $30,270. The amortized cost of these securities was $29,867 as of December 31, 2003.
Securities with carrying values of approximately $179,000 and $174,000 at December 31, 2003 and 2002, respectively, were pledged to secure public deposits and securities sold under agreements to repurchase and for other purposes as required or permitted by law.
Securities with unrealized losses at year-end 2003 not recognized in income are as follows:
Unrealized losses on securities have not been recognized into income because management has the intent and ability to hold them for the foreseeable future, and the decline in fair value is largely due to market interest rates. The fair value is expected to recover as securities approach their maturity date.
(Continued)
59.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 4. Loans
The major classifications of loans follow:
December 31, -------------------- 2003 2002 -------- --------
Commercial $139,533 $136,656 Commercial real estate 134,985 147,253 Real estate 158,002 139,020 Real estate loans held for sale 3,927 7,565 Installment 37,415 49,949 Other 2,950 2,786 -------- --------
$476,812 $483,229 ======== ========
The following table presents data on impaired loans:
The Company has approximately $328 and $829 of loans past due 90 days and still accruing interest at December 31, 2003 and 2002.
The Company and its subsidiaries conduct most of their business activities, including granting agribusiness, commercial, residential, and installment loans, with customers located in north central and west central Illinois. The Banks' loan portfolios include a concentration of loans to agricultural and agricultural-related industries amounting to approximately $70,858 and $71,155 as of December 31, 2003 and 2002, respectively.
(Continued)
60.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 4. Loans (Continued)
In the normal course of business, loans are made to executive officers, directors, and principal stockholders of the Company and its subsidiaries and to parties that the Company or its directors, executive officers, and stockholders have the ability to significantly influence (related parties). Changes in such loans during the year ended December 31, 2003 follow:
Balance at December 31, 2002 $ 36,509 New loans, extensions, and modifications 21,531 Repayments (23,828) Change in classification (9,928) ---------
Balance at December 31, 2003 $ 24,284 =========
Note 5. Loan Servicing
The following summarizes the secondary mortgage market activities:
Years Ended December 31, ------------------------------------ 2003 2002 2001 ---------- ---------- ----------
Proceeds from sales of mortgage loans $ 205,272 $ 157,815 $ 137,393 ========== ========== ==========
Gain on sales of mortgage loans $ 4,727 $ 2,909 $ 1,961 ========== ========== ==========
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheet. The unpaid principal balances of these loans are summarized as follows:
December 31, ----------------------- 2003 2002 ---------- ----------
Federal Home Loan Mortgage Corporation $ 3,783 $ 7,430 Federal National Mortgage Association 302,774 279,746 Small Business Administration 3,504 5,324 Other 9,084 3,321 ---------- ----------
$ 319,145 $ 295,821 ========== ==========
Custodial escrow balances maintained in connection with the foregoing loan servicing were approximately $1,477 and $1,252 at December 31, 2003 and 2002, respectively.
(Continued)
61.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 5. Loan Servicing (Continued)
Following is an analysis of the changes in originated mortgage servicing rights:
Years Ended December 31, ------------------------------------ 2003 2002 2001 ---------- ---------- ----------
Balance at beginning of year $ 2,640 $ 2,102 $ 1,423 Originated mortgage servicing rights 1,867 1,493 1,288 Amortization (1,732) (955) (609) ---------- ---------- ----------
Balance at end of year $ 2,775 $ 2,640 $ 2,102 ========== ========== ==========
Loans held for sale, which are included in real estate loans, are summarized as follows:
December 31, ----------------------- 2003 2002 ---------- ----------
Secured by one-to-four-family residences $ 3,529 $ 7,495 Small Business Administration loans 398 70 ---------- ----------
$ 3,927 $ 7,565 ========== ==========
Note 6. Allowance for Loan Losses
An analysis of activity in the allowance for loan losses follows:
Years Ended December 31, -------------------------------------- 2003 2002 2001 ---------- ---------- ----------
Balance at beginning of year $ 6,450 $ 6,295 $ 6,414 Provision for loan losses 8,236 3,574 4,161 Recoveries 554 459 395 Loans charged off (6,229) (3,878) (4,675) ---------- ---------- ----------
Balance at end of year $ 9,011 $ 6,450 $ 6,295 ========== ========== ==========
(Continued)
62.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 7. Premises and Equipment
Premises and equipment consisted of:
December 31, ----------------------- 2003 2002 ---------- ----------
Land $ 2,425 $ 1,760 Buildings 15,727 12,823 Furniture and equipment 16,105 14,220 Construction in process -- 724 ---------- ---------- 34,257 29,527 Less accumulated depreciation 17,681 15,472 ---------- ----------
$ 16,576 $ 14,055 ========== ==========
Note 8. Goodwill and Intangible Assets
Goodwill is no longer amortized starting in 2002. The effect of not amortizing goodwill is summarized as follows:
(Continued)
63.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 8. Goodwill and Intangible Assets (Continued)
Acquired Intangible Assets
Acquired intangible assets were as follows as of year end:
Aggregate amortization expense was $247, $245, and $255 for 2003, 2002, and 2001.
Estimated amortization expense for subsequent years:
2004 $ 295 2005 295 2006 202 2007 72 2008 62 Thereafter 280
Note 9. Deposits
Deposit account balances by type are summarized as follows:
December 31, ----------------------- 2003 2002 ---------- ----------
Non-interest-bearing demand deposits $ 89,424 $ 90,606 Savings, NOW, and money market accounts 203,536 202,681 Time deposits of $100 or more 163,252 152,395 Other time deposits 181,820 196,276 ---------- ----------
$ 638,032 $ 641,958 ========== ==========
(Continued)
64.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 9. Deposits (Continued)
At December 31, 2003, the scheduled maturities of time deposits are as follows:
Year Amount ---- ----------
2004 $ 262,193 2005 39,054 2006 19,305 2007 8,211 2008 14,347 Thereafter 1,962 ----------
$ 345,072 ==========
Time certificates of deposit in denominations of $100 or more mature as follows:
December 31, ----------------------- 2003 2002 ---------- ----------
3 months or less $ 68,381 $ 43,223 Over 3 months through 6 months 38,155 36,679 Over 6 months through 12 months 26,160 27,458 Over 12 months 30,556 45,035 ---------- ----------
$ 163,252 $ 152,395 ========== ==========
Note 10. Borrowed Funds
Borrowed funds include federal funds purchased and securities sold under agreements to repurchase, advances from the Federal Home Loan Bank, and notes payable to third parties.
A summary of short-term borrowings follows:
December 31, ----------------------- 2003 2002 ---------- ----------
Securities sold under agreements to repurchase $ 1,533 $ 3,588 ========== ==========
Federal funds purchased and securities sold under agreement to repurchase generally mature within one to ninety days from the transaction date.
(Continued)
65.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 10. Borrowed Funds (Continued)
At December 31, 2003, $20 million of Federal Home Loan Bank advances have various call provisions. The Company maintains a collateral pledge agreement covering secured advances whereby the Company had specifically pledged $66.1 million of first mortgage loans on improved residential and mixed use farm property free of all other pledges, liens, and encumbrances (not more than 90 days delinquent) and securities carried at $33,140. The scheduled maturities of advances from the Federal Home Loan Bank at December 31, 2003 are as follows:
Average Year Interest Rate Amount ---- ------------- ----------
2004 4.60% $ 20,550 2005 4.13 16,900 2006 5.03 8,300 2007 3.68 5,200 2008 2.96 13,300 Thereafter 4.67 8,200 ----------
$ 72,450 ==========
Notes payable consisted of the following at December 31, 2003 and 2002:
(Continued)
66.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 10. Borrowed Funds (Continued)
The note payable agreements with LaSalle National Bank contain certain covenants that limit the amount of dividends paid, the purchase of other banks and/or businesses, the purchase of investments not in the ordinary course of business, the changes in capital structure, and the guarantees of other liabilities and obligations. In addition, the Company must maintain certain financial ratios. The Company was in compliance with or had obtained appropriate waivers for all covenants for the year ended December 31, 2003.
Information concerning borrowed funds is as follows:
(Continued)
67.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 11. Income Taxes
Income taxes consisted of:
Years Ended December 31, ------------------------------------- 2003 2002 2001 ---------- ---------- ---------- Federal Current $ 419 $ 969 $ 1,219 Deferred (535) 52 279 ---------- ---------- ---------- (116) 1,021 1,498 State Current 68 92 (26) Deferred (81) 21 65 ---------- ---------- ---------- (13) 113 39 ---------- ---------- ----------
$ (129) $ 1,134 $ 1,537 ========== ========== ==========
The Company's income tax expense differed from the statutory federal rate of 34% as follows:
The significant components of deferred income tax assets and liabilities consisted of:
December 31, ----------------------- 2003 2002 ---------- ---------- Deferred tax assets Allowance for loan losses $ 3,445 $ 2,513 Deferred compensation, other 368 384 Deferred tax credits 210 -- ---------- ---------- Total deferred tax assets 4,023 2,897
(Continued)
68.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 11. Income Taxes (Continued)
Note 12. Benefit Plans
The Company's Employee Stock Ownership Plan ("the Plan") covers all full-time employees who have completed six months of service and have attained the minimum age of twenty and one-half years. Vesting in the Plan is based on years of continuous service. A participant is fully vested after seven years of credited service. The Plan owns 485,055 shares of the Company's common stock. All shares held by the Plan are allocated to plan participants. The Company expenses all cash contributions made to the Plan. Contributions were $262, $385, and $335 for the years ended December 31, 2003, 2002, and 2001.
Effective January 1, 1999, the Company established a 401(k) salary reduction plan ["the 401(k) plan"] covering substantially all employees. Eligible employees may elect to make tax deferred contributions within a specified range of their compensation as defined in the 401(k) plan. The Company contributes at its discretion. Contributions to the 401(k) plan are expensed currently and approximated $344, $301, and $149 for the years ended December 31, 2003, 2002, and 2001.
Note 13. Stock Option Plans
In April 1993, the Company adopted the UnionBancorp 1993 Stock Option Plan ("the 1993 Option Plan"). Under the 1993 Option Plan, nonqualified options, incentive stock options, and/or stock appreciation rights may be granted to employees and outside directors of the Company and its subsidiaries to purchase the Company's common stock at an exercise price to be determined by the 1993 Option Plan's administrative committee. Pursuant to the 1993 Option Plan, 600,000 shares of the Company's unissued common stock have been reserved and are available for issuance upon the exercise of options and rights granted under the 1993 Option Plan. The options have an exercise period of ten years from the date of grant.
In 1999, the Company adopted the UnionBancorp, Inc. non-qualified Stock Option Plan ("the 1999 Option Plan"). Under the 1999 Option Plan, nonqualified options may be granted to employees and eligible directors of the Company and its subsidiaries to purchase the Company's common stock at 100% of the fair market value on the date the option is granted. The Company has authorized 50,000 shares for issuance under the 1999 Option Plan. During 1999, 40,750 of these shares were granted and are 100% fully vested. The options have an exercise period of ten years from the date of grant.
(Continued)
69.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 13. Stock Option Plans (Continued)
In April 2003, the Company adopted the UnionBancorp 2003 Stock Option Plan ("the 2003 Option Plan"). Under the 2003 Option Plan, nonqualified options, incentive stock options, and/or stock appreciation rights may be granted to employees and outside directors of the Company and its subsidiaries to purchase the Company's common stock at an exercise price to be determined by the 2003 Option Plan's administrative committee. Pursuant to the 2003 Option Plan, 200,000 shares of the Company's unissued common stock have been reserved and are available for issuance upon the exercise of options and rights granted under the 2003 Option Plan. The options have an exercise period of ten years from the date of grant.
A summary of the status of the option plans as of December 31, 2003, 2002, and 2001 and changes during the years ended on those dates is presented below.
Options outstanding at year-end 2003 were as follows:
(Continued)
70.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 13. Stock Option Plans (Continued)
Grants under the option plans are accounted for following APB Opinion No. 25 and related interpretations. Accordingly, no compensation cost has been recognized for incentive stock option grants under the option plans. The compensation cost charged to income for nonqualified stock option grants was $21, $45, and $61 for the years ended December 31, 2003, 2002, and 2001.
Note 14. Earnings Per Share
A reconciliation of the numerators and denominators for earnings per common share computations for the years ended December 31 is presented below (shares in thousands). The Convertible Preferred Stock is antidilutive for all years presented and has not been included in the diluted earnings per share calculation. In addition, options to purchase 20,000 shares of common stock were outstanding at December 31, 2003 but were not included in the computation of diluted earnings per share because the exercise price was greater than the average market price and, therefore, were antidilutive.
Note 15. Regulatory Matters
The Company and the Banks are subject to regulatory capital requirements administered by the federal banking agencies. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Banks must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.
Upon receiving regulatory approval, the Company merged UnionBank and UnionBank/Central in March of 2003. During 2003, the Company also filed the required application with the appropriate regulatory agency for approval to merge UnionBank, UnionBank/West, and UnionBank/Northwest. This merger is anticipated to become effective in late March 2004.
(Continued)
71.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 15. Regulatory Matters (Continued)
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Banks to maintain minimum amounts and ratios of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. Management believes, as of December 31, 2003, that the Company and the Banks meet all of the capital adequacy requirements to which they are subject.
As of December 31, 2003, the most recent notification from the corresponding regulatory agency categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Banks must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Banks' categories.
(Continued)
72.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 15. Regulatory Matters (Continued)
The Company's ability to pay dividends is dependent on the subsidiary banks, which are restricted by various laws and regulations. These regulations pose no practical restrictions to paying dividends at historical levels. At December 31, 2003 the subsidiary banks had $5.2 million of retained earnings available for dividends under these regulations.
Note 16. Fair Value of Financial Instruments
The methods and assumptions used to estimate fair value are described as follows:
The carrying amount is the estimated fair value for cash and due from banks, federal funds sold, short-term borrowings, Federal Home Loan Bank stock, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes and, if no such information is available, on the rate and term of the security and information about the issuer. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, the fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. The fair value of loans held for sale is based on market quotes. The fair value of debt and redeemable stock is based on current rates for similar financing. The fair value of off-balance-sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements.
(Continued)
73.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 16. Fair Value of Financial Instruments (Continued)
The estimated fair values of the Company's financial instruments were as follows:
In addition, other assets and liabilities of the Company that are not defined as financial instruments are not included in the above disclosures, such as property and equipment. Also, nonfinancial instruments typically not recognized in financial statements nevertheless may have value but are not included in the above disclosures. These include, among other items, the estimated earnings power of core deposit accounts, the earnings potential of loan servicing rights, the earnings potential of the trust operations, the trained work force, customer goodwill, and similar items.
Note 17. Commitments, Contingencies, and Credit Risk
In the normal course of business, there are various contingent liabilities outstanding, such as claims and legal actions, which are not reflected in the consolidated financial statements. In the opinion of management, no material losses are anticipated as a result of these actions or claims.
The Banks are parties to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.
The contractual amounts of these instruments reflect the extent of involvement in particular classes of financial instruments.
(Continued)
74.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 17. Commitments, Contingencies, and Credit Risk (Continued)
The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit written is represented by the contractual amount of those instruments. The Banks use the same credit policies in making commitments and conditional obligations as they do for on-balance-sheet instruments. Financial instruments whose contract amounts represent credit risk are as follows:
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. For commitments to extend credit, the Banks evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained is based on management's credit evaluation of the customer. Collateral held varies, but may include accounts receivable; inventory; property, plant, and equipment; and income producing commercial properties.
Standby letters of credit are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan commitments to customers. The standby letters of credit are unsecured.
The Company has employment agreements with certain executive officers and certain other management personnel. These agreements generally continue until terminated by the executive or the Company and provide for continued salary and benefits to the executive under certain circumstances. The agreements provide the employees with additional rights after a change of control of the Company occurs.
Note 18. Condensed Financial Information - Parent Company Only
The primary source of funds for the Company is dividends from its subsidiaries. By regulation, the Banks are prohibited from paying dividends that would reduce regulatory capital below a specific percentage of assets without regulatory approval. As a practical matter, dividend payments are restricted to maintain prudent capital levels.
(Continued)
75.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 18. Condensed Financial Information - Parent Company Only (Continued)
Condensed financial information for UnionBancorp, Inc. follows:
Balance Sheets (Parent Company Only)
December 31, ----------------------- ASSETS 2003 2002 ---------- ----------
Cash and cash equivalents $ 928 $ 259 Investment in subsidiaries 75,507 76,548 Premises and equipment 636 830 Other assets 614 453 ---------- ----------
$ 77,685 $ 78,090 ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY December 31, ----------------------- Liabilities 2003 2002 ---------- ----------
Notes payable $ 7,275 $ 8,275 Mandatory redeemable preferred stock 831 -- Other liabilities 1,532 920 ---------- ---------- 9,638 9,195
Mandatory redeemable preferred stock -- 831
Stockholders' equity 68,047 68,064 ---------- ----------
$ 77,685 $ 78,090 ========== ==========
Income Statements (Parent Company Only)
(Continued)
76.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 18. Condensed Financial Information - Parent Company Only (Continued)
Statements of Cash Flows (Parent Company Only)
(Continued)
77.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 19. Other Comprehensive Income
Changes in other comprehensive income components and related taxes are as follows:
Note 20. Segment Information
The reportable segments are determined by the products and services offered, primarily distinguished between banking, mortgage banking, financial services, and other operations. Loans, investments, and deposits provide the revenues in the banking segment; insurance, brokerage, and trust in the financial services segment; and holding company services are categorized as other.
The accounting policies used are the same as those described in the summary of significant accounting policies. Segment performance is evaluated using net interest income. Information reported internally for performance assessment follows.
(Continued)
78.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 20. Segment Information (Continued)
(Continued)
79.
UNIONBANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) - --------------------------------------------------------------------------------
Note 21. Quarterly Results of Operations (Unaudited)
(A) The net income for the quarter was impacted by an increase in the provision for loan losses, which was influenced by deterioration in the overall credit quality and the impact of various identified credits.
(B) These amounts have been adjusted to reflect the adoption of SFAS No. 147 as of January 1, 2002.
(Continued)
80.
Item 9.
Item 9. Changes in and Disagreements on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
The Company's Chief Executive Officer and Chief Financial Officer carried out an evaluation, with the participation of other members of management as they deemed appropriate, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as contemplated by Exchange Act Rule 13a-14 as of December 31, 2003. Based upon, and as of the date of that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective, in all material respects, in timely alerting them to material information relating to the Company (and its consolidated subsidiaries) required to be included in the periodic reports the Company is required to file and submit to the SEC under the Exchange Act.
There were no significant changes to the Company's internal controls or in other factors that could significantly affect these internal controls during the quarter ended December 31, 2003. There were no significant deficiencies or material weaknesses identified in the evaluation and, therefore, no corrective actions were taken.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information beginning on page 2 of the Company's 2004 Proxy Statement under the caption "Election of Directors", pages 6 through 8 of the 2004 Proxy Statement under the caption "Security Ownership of Certain Beneficial Owners and Management", on page 15 under the caption "Audit Committee Financial Expert" and on page 5 under the caption "Code of Ethics" is incorporated by reference. The information regarding executive officers not provided in the 2004 Proxy Statement is noted below.
Executive Officers
The term of office for the executive officers of the Company is from the date of election until the next annual organizational meeting of the Board of Directors. In addition to the information provided in the 2004 Proxy Statement, the names and ages of the executive officers of the Company as of December 31, 2003, as well as the offices of the Company and the Subsidiaries held by these officers on that date, and principal occupations for the past five years are set forth below.
Rick R. Clary, 42, was named President and Chief Operating Officer of UnionBank in the fourth quarter of 2003. Mr. Clary previously served as the Regional Bank President of the Company's Central Region and as Chief Operating Officer. Prior to the merger, he served as President & Chief Executive Officer of UnionBank/Central and as a member of their Board of Directors. In January of 2004, after being named President, Mr. Clary joined the Board of Directors of UnionBank. Mr. Clary began employment with the Bank of Ladd in 1992 and became employed with UnionBancorp as a result of the acquisition of Prairie Bancorp, Inc.
Jimmie D. Lansford, 64, was promoted from Senior Vice President to Executive Vice President in the fourth quarter of 2000 and continues to serve as the Director of Organizational Development & Planning, a position he has held since 1996. Mr. Lansford was previously a member of the UnionBank/Northwest and
(Continued)
81.
holding company Boards of Directors and served as Chairman of the Board for UnionBank. In addition to his vast array of in-house responsibilities, he is active in the local community college where he serves on the Board of Trustees and is a past Chairman. Prior to his tenure with the Company, Mr. Lansford was the Chief Executive Officer of St. Mary's Hospital in Streator, Illinois.
Kurt R. Stevenson, 37, was promoted to Senior Vice President and Chief Financial Officer in the fourth quarter of 2003, after having served as the Company's Vice President and Chief Financial Officer since June of 2000. Also in 2000 and 2001, Mr. Stevenson served on the Board of Directors of UnionFinancial Services, Inc., prior to its integration with UnionTrust Corporation. Before stepping into his new role, he had been acting as the Company's Vice President and Controller since 1996 and had served in various operational capacities since joining the organization. In 2002, Mr. Stevenson was also named Cashier of UnionBank, in addition to his corporate responsibilities. He first started employment with the Ottawa National Bank in 1987 and, subsequently, began work with the Company following the acquisition in 1991.
Dewey R. Yaeger, 63, was named President and Chief Executive Officer of UnionBancorp, Inc. in the fourth quarter of 2003. Mr. Yaeger first joined the Company in April of 2003 as a Senior Vice President and Chief Credit Officer and had been acting in an interim capacity as President and Chief Executive Officer since September of 2003. He currently serves as a member of the Boards of Directors for UnionBancorp, UnionBank, UnionBank/West and UnionFinancial Services & Trust Company. Mr. Yaeger previously served as the President and Chief Executive Officer of Castle Bank, N.A. headquartered in DeKalb, Illinois.
Item 11.
Item 11. Executive Compensation
The information on pages 9 through 11 of the 2004 Proxy Statement under the caption "Executive Compensation" is incorporated by reference, excluding however the information contained under the sub-heading "Board Compensation Committee Report on Executive Compensation."
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information on pages 6 through 8 of the 2004 Proxy Statement under the caption "Security Ownership of Certain Beneficial Owners and Management" is incorporated by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information on page 14 of the 2004 Proxy Statement under the caption "Transactions with Management" is incorporated by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information on page 14 of the 2004 Proxy Statement under the caption "Accountant Fees" is incorporated by reference.
(Continued)
82.
Item 15.
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a)(1) Index to Financial Statements
The index to Financial Statements is contained in Item 8, appearing on page 42 of this Form 10-K.
(a)(2) Financial Statement Schedules
All schedules are omitted because they are not required or applicable, or the required information is shown in the Consolidated Financial Statements or the notes thereto.
(a)(3) Schedule of Exhibits
The Exhibit Index which immediately follows the signature pages to this Form 10-K is incorporated by reference.
(b) Reports on Form 8-K
Registrant filed a Form 8-K on October 7, 2003 related to an announcement of an increase in its loan loss provision for two impaired commercial credits.
Registrant filed a Form 8-K on November 13, 2003 in connection with its third quarter 2003 earnings announcement.
Registrant filed a Form 8-K on December 30, 2003 to announce its plan to provide approximately $1.9 million to its loan loss during this fourth quarter of 2003.
(c) Exhibits
The exhibits required to be filed with this Form 10-K are included with this Form 10-K and are located immediately following the Exhibit Index to this Form 10-K.
(Continued)
83.
SIGNATURES
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 24, 2004.
UNIONBANCORP, INC.
By: /s/ DEWEY R. YAEGER ------------------------------------- Dewey R. Yaeger President and Principal Executive Officer
By: /s/ KURT R. STEVENSON ------------------------------------- Kurt R. Stevenson Senior Vice President and Principal Financial and Accounting Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 24, 2004.
/s/ RICHARD J. BERRY /s/ I. J. REINHARDT, JR. - ----------------------------------- ----------------------------------- Richard J. Berry I. J. Reinhardt, Jr. Director Director
/s/ WALTER E. BREIPOHL /s/ JOHN A. SHINKLE - ----------------------------------- ----------------------------------- Walter E. Breipohl John A. Shinkle Director Director
/s/ ROBERT J. DOTY /s/ SCOTT C. SULLIVAN - ----------------------------------- ----------------------------------- Robert J. Doty Scott C. Sullivan Director Director
/s/ DENNIS J. MCDONNELL /s/ JOHN A. TRAINOR - ----------------------------------- ----------------------------------- Dennis J. McDonnell John A. Trainor Director Director
/s/ DEWEY R. YAEGER ----------------------------------- Dewey R. Yaeger Director
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