UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 1998 Commission File No. 0-20293 UNION BANKSHARES CORPORATION (Exact name of registrant as specified in its charter) Virginia 54-1598552 (State of Incorporation) (I.R.S. Employer Identification No.) 211 North Main Street P.O. Box 446 Bowling Green, Virginia 22427 (Address of principal executive offices) (804) 633-5031 (Registrant's telephone number) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $2 PAR VALUE Union Bankshares Corporation (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. As of September 30, 1998, Union Bankshares Corporation had 7,498,994 shares of Common Stock outstanding. UNION BANKSHARES CORPORATION FORM 10-Q September 30, 1998 INDEX PART 1 - FINANCIAL INFORMATION Page ---- Item 1. Financial Statements Consolidated Balance Sheets as of September 30, 1998 (Unaudited) and December 31, 1997....................................... 1 Consolidated Statements of Income and Comprehensive Income for the three and nine months ended September 30, 1998 and 1997 (Unaudited)........................................ 2 Consolidated Statements of Cash Flows for the nine months ended September 30, 1998 and 1997 (Unaudited)... 3 Notes to Consolidated Financial Statements (Unaudited)................................................. 4-5 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations........... 6-15 PART II - OTHER INFORMATION Item 6 - Exhibits and Reports on Form 8-K.......................... 16 Signatures......................................................... 16 Index to Exhibits.................................................. 17 PART 1 - FINANCIAL INFORMATION Item 1. Financial Statements UNION BANKSHARES CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets (Unaudited) (Dollars in thousands)
September 30, December 31 September 30 ASSETS 1998 1997 1997 - - -------- ---- ---- ---- Cash and cash equivalents: Cash and due from banks $ 19,509 $ 20,959 $ 22,845 Interest-bearing deposits in other banks 499 790 1,003 Federal funds sold 8,650 6,932 5,194 -------- ---------- --------- Total cash and cash equivalents 28,658 28,681 29,042 -------- ---------- --------- Securities available for sale, at fair value 151,216 143,711 140,844 Investment securities fair value of $19,801, $18,059 and $17,952, respectively 19,412 17,769 17,683 -------- ---------- --------- Total securities 170,628 161,480 158,527 -------- ---------- --------- Loans, net of unearned income 464,544 399,351 388,083 Less allowance for loan losses 6,105 4,798 4,668 -------- ---------- --------- Net loans 458,439 394,553 383,415 -------- ---------- --------- Bank premises and equpiment, net 20,735 16,978 16,516 Other real estate owned 1,039 1,746 2,535 Other assets 19,454 12,278 9,214 -------- ---------- --------- Total assets $698,953 $ 615,716 $ 599,249 ======== ========== ========= LIABILITIES AND STOCKHOLDERS' EQUITY Non-interest-bearing demand deposits $ 74,182 $ 65,980 $ 63,687 Interest-bearing deposits: Savings accounts 59,371 55,039 52,472 NOW accounts 75,710 60,010 60,590 Money market accounts 61,762 50,387 49,199 Time deposits of $100,000 and over 71,005 61,171 60,382 Other time deposits 238,092 196,968 195,748 -------- ---------- --------- Total interest-bearing deposits 505,940 423,575 418,391 -------- ---------- --------- Total deposits 580,122 489,555 482,078 -------- ---------- --------- Short-term borrowings 12,788 27,245 21,279 Long-term borrowings 28,355 23,715 23,745 Other liabilities 4,780 7,036 5,161 -------- ---------- --------- Total liabilities 626,045 547,551 532,263 -------- ---------- --------- Stockholders' equity: Common stock, $2 par value. Authorized 24,000,000 shares; issued and outstanding, 7,498,994, 7,151,874 and 7,142,984 shares, respectively 14,998 14,304 14,286 Surplus 337 388 248 Retained earnings 54,957 51,766 51,113 Accumulated other comprehensive income Net unrealized gains on securities available for sale, net of taxes 2,616 1,707 1,339 -------- ---------- --------- Total stockholders' equity 72,908 68,165 66,986 -------- ---------- --------- Total liabilities and stockholders' equity $698,953 $ 615,716 $ 599,249 ======== ========== =========
See accompanying notes to consolidated financial statements. UNION BANKSHARES CORPORATION AND SUBSIDIARIES Consolidated Statements of Income and Comprehensive Income (Unaudited) (Dollars in thousands)
Three Months Ended Nine Months Ended September 30 September 30 ------------------- -------------------- 1998 1997 1998 1997 ---- ---- ---- ---- Interest income: Interest and fees on loans $ 10,260 $ 9,140 $ 29,982 $ 25,871 Interest on securities: U.S. government and agency securities 361 786 1,182 2,813 Obligations of states and political subdivisions 1,049 996 3,066 2,989 Other securities 1,115 618 3,156 1,177 Interest on Federal funds sold 121 152 420 366 Interest on interest-bearing deposits in other banks 11 10 57 38 -------- -------- -------- -------- Total interest income 12,917 11,702 37,863 33,254 -------- -------- -------- -------- Interest expense: Interest on deposits 5,645 4,807 16,143 13,876 Interest on other borrowings 593 568 1,985 1,687 -------- -------- -------- -------- Total interest expense 6,238 5,375 18,128 15,563 -------- -------- -------- -------- Net interest income 6,679 6,327 19,735 17,691 Provision for loan losses (note 2) 1,479 310 2,394 730 -------- -------- -------- -------- Net interest income after provision for loan losses 5,200 6,017 17,341 16,961 -------- -------- -------- -------- Other income: Service charges on deposit accounts 754 609 2,093 1,704 Other service charges and fees 493 371 1,458 980 Gains (losses) on securities transactions, net (6) (10) (31) 3 Gains (losses)on sales of other real estate owned and bank premises, net (5) 16 11 424 Other operating income 114 178 252 450 -------- -------- -------- -------- Total other income 1,350 1,164 3,783 3,561 -------- -------- -------- -------- Other expenses: Salaries and benefits 2,776 2,394 7,959 6,798 Occupancy expenses 315 273 930 822 Furniture and equipment expenses 479 298 1,329 1,054 Other operating expenses 1,777 1,564 4,811 4,066 -------- -------- -------- -------- Total other expenses 5,347 4,529 15,029 12,740 -------- -------- -------- -------- Income before income taxes 1,203 2,652 6,095 7,782 Income tax expense 104 641 1,041 1,703 -------- -------- -------- -------- Net income $ 1,099 $ 2,011 $ 5,054 $ 6,079 ======== ======== ======== ======== Other Comprehensive income Unrealized holding (gains) losses arising during the period net of taxes of $301 and $309 for three and nine months of 1998 and $98 and $366 for the three and nine months of 1997 $ 585 $ 191 $ 600 $ 710 Less reclassification adjustments for (gains) losses included in net income, net of taxes of $2 and $11 for three and nine months of 1998 and $3 and ($1) for the three and nine months of 1997 4 7 20 (2) ======== ======== ======== ======== Comprehensive income $ 1,688 $ 2,209 $ 5,674 $ 6,787 ======== ======== ======== ======== Basic earnings per share $ 0.14 $ 0.28 $ 0.69 $ 0.85 ======== ======== ======== ======== Diluted earnings per share $ 0.14 $ 0.28 $ 0.69 $ 0.85 ======== ======== ======== ======== Dividends per share -- 0.19 0.18 ======== ======== ======== ========
See accompanying notes to consolidated financial statements. UNION BANKSHARES CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows (Unaudited) Nine Months Ended September 30, 1998 and 1997 (Dollars in thousands)
1998 1997 ------ ------ Operating activities: Net income $ 5,054 $ 6,079 Adjustments to reconcile net income to net cash and cash equivalents provided by (used in) operating activities: Depreciation of bank premises and equipment 1,170 1,099 Amortization of intangibles 269 32 Provision for loan losses 2,394 730 Gains (losses) on sales of securities available for sale 31 (3) Gains on sale of other real estate owned (11) (424) Increase in other assets (7,879) (1,027) Decrease in other liabilities (2,256) 2,656 -------- -------- Net cash and cash equivalents provided by (used in) operating activities (1,228) 9,142 -------- -------- Investing activities: Net increase in securities (7,834) (9,512) Net increase in loans (66,330) (33,200) Acquisition of bank premises and equipment (4,927) (3,342) Proceeds from sales of other real estate owned 767 5,389 -------- -------- Net cash and cash equivalents used in investing activities (78,324) (40,665) -------- -------- Financing activities: Net increase in non-interest-bearing deposits 8,202 4,352 Net increase in interest-bearing deposits 82,365 22,133 Net decrease in short-term borrowings (14,457) (6,124) Increase in long-term borrowings 4,775 12,800 Issuance (purchase) of common stock 10 (39) Cash dividends paid (1,231) (1,213) Repayment of long-term borrowings (135) (180) -------- -------- Net cash and cash equivalents provided by financing activities 79,529 31,729 -------- -------- Increase (decrease) in cash and cash equivalents (23) 206 Cash and cash equivalents at beginning of period 28,681 28,836 -------- -------- Cash and cash equivalents at end of period $ 28,658 $ 29,042 ======== ========
See accompanying notes to consolidated financial statements. UNION BANKSHARES CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Unaudited) September 30, 1998 1. ACCOUNTING POLICIES The consolidated financial statements include the accounts of Union Bankshares Corporation and its subsidiaries (the "Company"). Significant intercompany accounts and transactions have been eliminated in consolidation. The information contained in the financial statements is unaudited and does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of the interim periods presented have been made. Operating results for the three- and nine-month periods ended September 30, 1998 are not necessarily indicative of the results that may be expected for the year ending December 31, 1998. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 1997 Annual Report to Shareholders. Certain previously reported amounts have been reclassified to conform to current period presentation. 2. ALLOWANCE FOR LOAN LOSSES The following summarizes activity in the allowance for loan losses for the nine months ended September 30, (in thousands): 1998 1997 ---- ---- Balance, January 1 $ 4,798 $ 4,612 Provisions charged to operations 2,394 730 Recoveries credited to allowance 189 160 Loans charged off (1,276) (834) --------- --------- Balance, September 30 $ 6,105 $4,668 ======== ======== 3. Earnings Per Share Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of shares outstanding during the period. Weighted average shares used for the computation of basic EPS were 7,498,994 and 7,142,984 for the three months ended September 30, 1998 and 1997 and 7,277,881 and 7,136,644 for the nine months ended September 30, 1998 and 1997. Diluted EPS is computed using the weighted number of common shares outstanding during the period, including the effect of dilutive potential common shares outstanding attributable to stock options. Weighted average shares used for the computation of diluted EPS were 7,516,968 and 7,175,070 for the three months ended September 30, 1998 and 1997 and 7,309,992 and 7,162,165 for the nine months ended September 30, 1998 and 1997. 4. RECENT ACCOUNTING STATEMENTS In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that a company recognize all derivative instruments as either assets or liabilities in the consolidated balance sheet, and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. For companies with a fiscal year ending on December 31, SFAS 133 is effective as of January 1, 2000. Earlier adoption, as of the beginning of a fiscal quarter, is encouraged but is not mandatory. The impact of adopting SFAS 133 will be dependent on the specific derivative instruments in place at the date of adoption. At this time, Management believes the adoption of this new standard will not have a material impact on the financial condition or results of operations of the Company, and does not anticipate adopting SFAS 133 before January 1, 2000. Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations Union Bankshares Corporation is a multi-bank holding company organized under Virginia law which provides financial services through its wholly-owned subsidiaries, Union Bank & Trust Company, Northern Neck State Bank, King George State Bank, Rappahannock National Bank, Union Investment Services, Inc., and Union Mortgage Company, LLC (collectively, the "Company"). The four subsidiary banks, Union Bank & Trust Company, Northern Neck State Bank, King George State Bank and Rappahannock National Bank, are full service retail commercial banks offering a wide range of banking and related financial services, including demand and time deposits, as well as commercial, industrial, residential construction, residential mortgage and consumer loans. Union Investment Services, Inc., is a full service discount brokerage company which offers a full range of investment services, and sells mutual funds, bonds and stocks. Union Mortgage Company, LLC provides a wide array of mortgage products to the Company's primary trade area. The Company's primary trade area stretches from Fredericksburg, south to Hanover County and east throughout Northern Neck area of Virginia. The Corporate Headquarters are located in Bowling Green, Virginia. Through its banking subsidiaries, the Company operates 27 branches in its primary trade area. During the second quarter of 1998 the Company announced a two-for-one stock split to shareholders of record as of May 21, 1998. All shares and per share data have been adjusted to reflect the split and per value has been reduced from $4 to $2 per share. The Company also announced that it had filed the necessary applications to form a new community bank in Williamsburg, Virginia, The Bank of Williamsburg. The Company anticipates to begin operations of this wholly-owned subsidiary in January of 1999. On July 1, 1998, the Company completed its acquisition of Rappahannock Bankshares, Inc., a $20 million one-bank holding company in Washington, Virginia. The Company exchanged 316.4 shares of its common stock for each outstanding share of Rappahannock Bankshares, Inc. stock. This transaction was accounted for as a pooling-of-interests. The impact of this transaction is not expected to have a material effect on the financial condition or results of operations of the Company. Management's discussion and analysis is presented to aid the reader in understanding and evaluating the financial condition and results of operations of Union Bankshares Corporation and subsidiaries. The analysis focuses on the Consolidated Financial Statements, the footnotes thereto, and the other financial data herein. Highlighted in the discussion are material changes from prior reporting periods and any identifiable trends affecting the Company. Amounts are rounded for presentation purposes, while the percentages presented are computed based on unrounded amounts. Results of Operations Net income for the third quarter of 1998 was $1.1 million, down from $2.0 million for the same period in 1997. The decline in net income for the period was due principally to a special provision of $975,000 to the allowance for loan losses related to a single credit relationship in the third quarter of 1998. Diluted earnings per share amounted to $.14 in the third quarter of 1998, as compared to $.28 in the third quarter of 1997. The Company's annualized return on assets for the third quarter of 1998 was .63% as compared to 1.35% a year ago. The Company's annualized return on equity totaled 6.06% and 12.12% for the three months ended September 30, 1998 and 1997, respectively. Net income for the first nine months of 1998 was $5.1 million, down from $6.1 million for the same period in 1997. Excluding nonrecurring pretax gains and losses on sales of other real estate and securities in the first nine months of 1997 and the effect of the aforementioned special provision for loan losses in the third quarter of 1998, net income was unchanged in the first nine months of 1998 from 1997 totals. Diluted earnings per share amounted to $.69 in the first nine months of 1998, as compared to $.85 in the same period in 1997. The Company's annualized return on assets for the first nine months of 1998 was 1.00% as compared to 1.42% a year ago. The Company's annualized return on equity totaled 9.38% and 12.99% for the nine months ended September 30, 1998 and 1997, respectively. Net Interest Income Net interest income on a tax-equivalent basis for the third quarter of 1998 increased by 5.7% to $7.1 million from $6.8 million for the same period a year ago. Despite declining interest rates, the Company has been able to maintain a strong net interest margin by managing its interest rate spread and increasing the volume of earning assets over interest-bearing liablities. The current interest rate environment and competition for deposits continues to put pressure on net interest margins. Average earning assets during the third quarter of 1998 increased by $93.5 million to $644.0 million from the third quarter of 1997, while average interest-bearing liabilities grew by $79.4 million to $541.8 million over this same period. The Company's yield on average earning assets was 8.24%, down from 8.74% a year ago, while its cost of average interest-bearing liabilities also decreased slightly from 4.61% to 4.57%.
Union Bankshares Corporation Average Balances, Income and Expenses, Yields and Rates (Taxable Equivalent Basis) ------------------------------------------------------------------------------------------- Quarters Ended September 30, ------------------------------------------------------------------------------------------- 1998 1997 1996 ------------------------------------------------------------------------------------------- Interest Interest Interest Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/ Balance Expense Rate Balance Expense Rate Balance Expense Rate ------------------------------------------------------------------------------------------- Assets: Securities: Taxable . . . . . . . . . . . . . . . $ $ $ $ $ $ . . . . . . 93,622 1,578 6.69% 89,168 1,460 6.50% 79,036 1,157 6.45% Tax-exempt(1) . . . . . . . . . . . . . . . . 74,599 1,405 7.47% 68,144 1,365 7.95% 68,556 1,415 8.32% --------------------- -------------------- --------------------- Total securities . . . . . . . . . . . . . 168,221 2,983 7.04% 157,312 2,825 7.12% 147,592 2,572 7.32% Loans, net. . . . . . . . . . . . . . . . . . . . . . 461,579 10,260 8.82% 379,890 9,140 9.55% 352,188 8,210 9.33% Federal funds sold . . . . . . . . . . . . . . . 11,974 121 4.01% 12,820 152 4.70% 9,986 103 6.56% Interest-bearing deposits - - - - - - in other banks . . . . . . . . . . . . . . . . 2,227 11 1.96% 508 10 7.81% 1,187 15 6.02% --------------------- -------------------- --------------------- Total earning assets . . . . . . . . 644,001 13,375 8.24% 550,530 12,127 8.74% 510,953 10,900 8.68% Allowance for loan losses . . . . . . . . . . (5,319) (4,654) (4,624) Total non-earning assets . . . . . . . . . 57,889 45,627 46,596 =========== =========== =========== Total assets . . . . . . . . . . . . . . . . . $ $ $ . . 696,571 591,503 552,925 =========== =========== =========== Liabilities & Stockholders' Equity: Interest-bearing deposits: Checking . . . . . . . . . . . . . . . $ $ $ $ $ $ . . . . . 74,790 455 2.41% 60,012 405 2.68% 48,418 302 2.47% Regular savings . . . . . . . . . . . . . . . 59,388 449 3.00% 52,448 409 3.09% 62,692 511 3.56% Money market savings . . . . . . . . . . 62,477 530 3.37% 49,285 425 3.42% 53,857 439 3.23% Certificates of deposit: - - - - - - $100,000 and over . . . . . . . . . . . . . . 71,041 968 5.41% 60,300 804 5.29% 53,318 652 5.03% Under $100,000 . . . . . . . . . . . . . . . 231,804 3,243 5.55% 195,019 2,764 5.62% 172,986 2,483 5.72% --------------------- -------------------- --------------------- Total interest-bearing - - - - - - deposits . . . . . . . . . . . . . . . . 499,500 5,645 4.48% 417,064 4,807 4.57% 391,271 4,387 4.54% Other borrowings . . . . . . . . . . . . . . . . . 42,256 593 5.57% 45,328 568 4.97% 39,986 581 5.76% --------------------- -------------------- --------------------- Total interest-bearing - - - - - - liabilities . . . . . . . . . . . . . . . 541,756 6,238 4.57% 462,392 5,375 4.61% 431,257 4,968 4.65% - - - - - - Non-interest bearing liabilities: - - - Demand deposits . . . . . . . . . . . . . . 76,838 61,070 59,661 Other liabilities . . . . . . . . . . . . . . . . 6,657 5,465 5,137 Total liabilities . . . . . . . . . . . . . 625,251 528,927 496,055 Stockholders' equity . . . . . . . . . . . . . . 71,320 62,576 56,870 ----------- ----------- ----------- Total liabilities and stockholders' equity . . . . $ $ $ . . . . . . . 696,571 591,503 552,925 =========== =========== =========== Net interest income . . . . . . $ $ $ . . . . . . . . 7,137 6,752 5,932 ========== ========= ========== Interest rate spread . . . . . . . . . . . . . . . 3.67% 4.13% 4.03% Interest expense as a percent of average earning assets . . . . . . . . . 3.89% 3.93% 3.98% Net interest margin . . . . . . . . . . . . . . . 4.39% 4.88% 4.76%
(1) Income and yields are reported on a taxable equivalent basis. COMBINED The following table presents the Company's interest sensitivity position at September 30, 1998. This one-day position, which is continually changing, is not necessarily indicative of the Company's position at any other time.
Interest Sensitivity Analysis September 30, 1998 ---------------------------------------------------------- Within 90-365 1-5 Over 90 Days Days Years 5 Years Total ----------- ---------- ---------- ----------- ---------- (In thousands) Earning Assets: Loans, net of unearned income (3) . . . . . . . $ 100,629 $ 42,968 $174,893 $ 143,263 $ 461,753 Investment securities . . . . . . . . . . . . . 810 3,137 12,063 3,402 19,412 Securities available for sale . . . . . . . . . 1,584 6,044 47,010 96,578 151,216 Federal funds sold . . . . . . . . . . . . . . 8,650 - - - 8,650 Other short-term investments . . . . . . . . . 400 - 99 - 499 ----------- ---------- ---------- ----------- ---------- Total earning assets . . . . . . . . . . . . . 112,073 52,149 234,065 243,243 641,530 ----------- ---------- ---------- ----------- ---------- Interest-Bearing Liabilities: Interest checking (2) . . . . . . . . . . . . . $ - $ - $ 75,710 $ - $ 75,710 Regular savings (2) . . . . . . . . . . . . . . 6,090 - 53,281 - 59,371 Money market savings . . . . . . . . . . . . . 61,762 - - - 61,762 Certificates of deposit: $100,000 and over . . . . . . . . . . . . . . 21,094 30,498 19,413 - 71,005 Under $100,000 . . . . . . . . . . . . . . . 43,171 84,842 110,079 - 238,092 Short-term borrowings . . . . . . . . . . . . . 12,788 - - - 12,788 Long-term borrowings . . . . . . . . . . . . . - 5,150 16,600 6,605 28,355 ----------- ---------- ---------- ----------- ---------- Total interest-bearing liabilities . . . . . . . . . . . . . . . . . . . 144,905 120,490 275,083 6,605 547,083 ----------- ---------- ---------- ----------- ---------- Period gap . . . . . . . . . . . . . . . . . . . . (32,832) (68,341) (41,018) 236,638 Cumulative gap . . . . . . . . . . . . . . . . . $ (32,832) $(101,173) $(142,191) $ 94,447 $ 94,447 =========== ========== ========== =========== ========== Ratio of cumulative gap to total earning assets . . . . . . . . . . . . -5.12% -15.77% -22.16% 14.72% =========== ========== ========== ===========
(1) The repricing dates may differ from maturity dates for certain assets due to prepayment assumptions. (2) The Company has found that interest-bearing checking deposits and regular savings deposits are not sensitive to changes in related market rates and therefore, it has placed them predominantly in the "1-5 Years" column. (3) Excludes non-accrual loans Earnings Simulation Analysis Management uses simulation analysis to measure the sensitivity of net interest income to changes in interest rates. The model calculates an earnings estimate based on current and projected balances and rates. This method is subject to the accuracy of the assumptions that underlie the process, but it provides a better analysis of the sensitivity of earnings to changes in interest rates than other analysis such as the static gap analysis. Assumptions used in the model, including loan and deposit growth rates, are derived from seasonal trends and management's outlook, as are the assumptions used to project yields and rates for new loans and deposits. All maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in like instruments. Mortgage loans and mortgage backed securities prepayment assumptions are based on industry estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Different interest rate scenarios and yield curves are used to measure the sensitivity of earnings to changing interest rates. Interest rates on different asset and liability accounts move differently when the prime rate changes and are accounted for in the different rate scenarios. The following table represents the interest rate sensitivity on net interest income for the Company using different rate scenarios: % Change in Change in Prime Rate Net Interest Income -------------------- ------------------- +200 basis points +3.1% Flat 0 -200 basis points -3.3% Market Value Simulation Market value simulation is used to calculate the estimated fair value of assets and liabilities over different interest rate environments. Market values are calculated based on discounted cash flow analysis. The net market value is the market value of all assets minus the market value of all liabilities. The change in net market value over different rate environments is an indication of the longer term repricing risk in the balance sheet. The same assumptions are used in the market value simulation as in the earnings simulation. The following chart reflects the change in net market value over different rate environments(dollars in thousands): Change in Prime Rate Change in Net Market Value -------------------- -------------------------- +200 basis points $ -9,722 +100 basis points -538 Flat 498 -100 basis points 17,862 -200 basis points 26,701 Provision for Possible Loan Losses The provision for possible loan losses totaled $1,479,000 for the third quarter of 1998, up from $310,000 for the third quarter of 1997. The provision for the first nine months of 1998 totaled $2,394,000, up from $730,000 a year ago. These provisions reflect a special provision of $975,000 recorded in the third quarter of 1998 related to a single credit relationship. Management does not feel this loss is indicative of any decline in the overall quality of the Company's loan portfolio. (See Asset Quality) Non-Interest Income Non-interest income for the nine months ended 1998 totaled $3.8 million, up from $3.6 a year ago. This increase is due principally to the increases in income from mortgage brokerage and was partially offset by net gains of approximately $424,000 on sales of real estate owned in the first nine months of 1997. The remaining increase in non-interest income is due to increases in service fees on deposit accounts, increases in other service fees and increased brokerage commissions. Management continues to seek additional sources of non-interest income, including increased emphasis on its credit card operations, mortgage banking activities and brokerage services. Non-Interest Expense Non-interest expense increased by 18.0% for the nine months of 1998, totaling $15.0 million as compared to $12.7 million for 1997. Personnel costs comprised much of this change, increasing approximately 17.0% over 1997, due principally to the Signet branch acquisition and continued growth. The remaining cost is attributable to infrastructure associated with the consolidation of certain functions and the development and introduction of new products and delivery systems, which are expected to enhance future earnings through increased revenue and/or improved efficiencies. The Company continues to stress budgetary expense controls. Financial Condition Total assets as of September 30, 1998 were $699.0 million, an increase of 13.5% from $615.7 million at December 31, 1997 and 16.6% from $599.2 million at September 30, 1997. Asset growth was fueled by the Signet branch acquisition and steady loan demand, as loans totaled $464.5 million at September 30, 1998, an increase of 16.3% from $399.4 million at December 31, 1997, and 19.7% from $388.1 million at September 30, 1997. Stockholders' equity totaled $72.9 million at September 30, 1998 which represents a book value of $9.72 per share. Asset and deposit growth in the first nine months were principally a result of the acquisition of the former Signet branches which added $62.5 million in deposits to the balance sheet. Proceeds from this acquisition were invested in a variety of investment products including government securities, mortgage backed securities and whole loans. These branches add significantly to the Company's presence in the Northern Neck region, and although they may cause a short-term drag on earnings, they provide significant potential for growth in market share. Deposit growth, irrespective of the Signet acquisition, remained steady. Total deposits at September 30, 1998 were $580.1 million, up 18.5% from $489.6 million at December 31, 1997 and 20.3% from $482.1 million a year earlier. Other borrowings totaled $41.1 million at September 30, 1998 a 19.3% decrease over $51.0 million at the end of 1997 and a 8.6% decrease from $45.0 million at September 30, 1997. The Company continues to utilize other borrowings to supplement deposit growth and, periodically, engages in wholesale leverage transactions. These wholesale leverage transactions have typically been executed at spreads of approximately 150 to 200 basis points and, although they have negatively impacted the Company's net interest margin (as a percentage), they have had a positive effect on earnings and return on equity. Continued competition for deposits, particularly as it impacts certificate of deposit rates, is reflected in the deposit mix. Management continues to focus on increasing lower cost deposit products, including non-interest bearing demand deposits and savings accounts. Increased competition for funds, particularly by non-banks, continues to contribute to a narrowing of the net interest margin which has been largely offset by increases in the volume of earning assets. Asset Quality The allowance for loan losses is an estimate of an amount adequate to provide for potential losses in the loan portfolio. The level of credit losses is affected by general economic trends as well as conditions affecting individual borrowers. The allowance is also subject to regulatory examinations and determination as to adequacy, which may take in to account such factors as the methodology used to calculate the allowance and comparison to peer groups. The allowance for loan losses totaled $6.1 million at September 30, 1998 or 1.20% of total loans, as compared to 1.15% at December 31, 1997 and 1.16% at September 30, 1997. At September 30, 1998, non-performing assets of $4.8 million included foreclosed properties of $1.0 million and a $1.0 million investment in income-producing property. September 30, December 31, September 30, 1998 1997 1997 ----- ---- ---- Non-accrual loans $2,791 $2,140 $ 284 Foreclosed properties 1,039 1,850 1,876 Real estate investment 960 1,050 2,017 ------ ----- ------- Non-performing assets $4,790 $5,040 $4,177 ====== ====== ====== Allowance for loan losses $6,105 $4,798 $4,668 Allowance as % of total loans 1.20% 1.15% 1.16% Non-performing assets to loans and foreclosed properties 1.20% 1.24% 1.10% Capital Resources Capital resources represent funds, earned or obtained, over which financial institutions can exercise greater or longer control in comparison with deposits and borrowed funds. The adequacy of the Company's capital is reviewed by management on an ongoing basis with reference to the size, composition, and quality of the Company's resources and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and absorb potential losses. The Federal Reserve, along with the Comptroller of the Currency and the Federal Deposit Insurance Corporation, has adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total assets is 8.0%, of which 4.0% must be Tier 1 capital, consisting of common equity and retained earnings, less certain goodwill items. At September 30, 1998, the Company's ratio of total capital to risk-weighted assets was 13.68% and its ratio of Tier 1 capital to risk-weighted assets was 12.50%. Both ratios exceed the fully phased-in capital requirements. The following summarizes the Company's regulatory capital and related ratios at September 30, 1998: Tier 1 capital $ 64,579 Tier 2 capital $ 6,104 Total risk-based capital $ 70,683 Total risk-weighted assets $ 516,599 Capital Ratios: Tier 1 risk-based capital ratio 12.50% Total risk-based capital ratio 13.68% Leverage ratio (Tier I capital to average adjusted total assets) 9.27% Equity to assets ratio 9.82% The Company's book value per share at September 30, 1998 was $9.72. Dividends to stockholders are typically declared and paid semi-annually in June and December. Liquidity Liquidity represents an institution's ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest bearing deposits with banks, federal funds sold, investments and loans maturing within one year. The Company's ability to obtain deposits and purchase funds at favorable rates determines its liability liquidity. Additional sources of liquidity available to the Company include its capacity to borrow additional funds when necessary through Federal funds lines with several regional banks and a line of credit with the Federal Home Loan Bank. Management considers the Company's overall liquidity to be sufficient to satisfy its depositors' requirements and to meet its customers' credit needs. At September 30, 1998, cash, interest-bearing deposits in other banks, federal funds sold, securities available for sale and loans maturing or repricing in one year were 53.5% of total earning assets. At September 30, 1998 approximately $143.6 million or 31.1% of total loans would mature or reprice within the next year. The Company utilizes federal funds purchased, FHLB advances, securities sold under agreements to repurchase and customer repurchase agreements, in addition to deposits, to fund the growth in its loan portfolio, and to fund securities purchases, periodically in wholesale leverage transactions. Year 2000 The Year 2000 issue affects virtually all companies and organizations. Many companies have existing computer applications which use only two digits to identify a year in the date field. These applications were designed and developed without considering the impact of the change of the century. If not corrected these computer applications may fail or create erroneous results in the Year 2000. Because the Company relies on information processing and communications to conduct much of its business, the Year 2000 issue is of concern to the company. The Company has developed a Corporate Year 2000 team involving associates from all areas in the organization. The team has been in-place since September of 1997. The project's scope includes all information technology (IT), both internally developed and purchased from third parties, material vendors, producer and customer relationships. The Company has completed the awareness and assessment phases for its material IT systems ("mission-critical systems") and is currently in the remediation and testing phases. The Company anticipates that it will complete the remediation and testing phases for its mission-critical IT systems and these systems are targeted to be made Year 2000 compliant and validated by December 31, 1998. The Company has been in contact with its material business partners to determine their state of readiness and the potential impact on the Company. The Company has identified the following general categories of business partners as material to the Company's ability to conduct its operations: Software, hardware and telecommunication providers, other banks and investment brokers, major deposit and loan customers and utilities. Where the Company has determined that the relationship with a business partner is material to its ability to conduct normal operations, the Company has sent letters to the business partner requesting an update on the status of its Year 2000 initiative. Where deemed necessary, the Company is following-up with the business partner to obtain further information. The Company has not currently identified a material business partner that will be noncompliant. However, there can be no assurances that all material business partners will be compliant and such noncompliance could have a material effect on the Company's financial position and results of operations. The Company has also devoted significant time and effort in developing customer awareness, including seminars designed to both educate and reassure its customers and the general public. Although it expects all of its mission-critical IT systems to be Year 2000 compliant by December 31, 1998, the Company is developing a contingency plan for noncompliance of its mission-critical IT systems. If the Company becomes aware of noncompliant business partners, one option will be to evaluate using other vendors. The Company expects its review of material business partners to be completed by December 31, 1998. At that time the Company will be able to completely evaluate the need to replace any material business partners. In some instances the establishment of a contingency plan is not possible or is cost prohibitive. In these situations, noncompliance by the Company or its material business partners could have a material adverse impact on the Company's financial position and results of operations. The Company expects to incur internal staff costs as well as consulting and other expenses related to the infrastructure and facilities enhancements necessary to prepare its systems for the Year 2000. Testing and conversion of system applications is expected to cost approximately $250,000. This estimate includes some costs, such as the purchase of computer hardware, that will qualify as depreciable assets for accounting purposes, with the related depreciation expense recognized over the estimated lives of the related assets. However, the majority of the costs will be expensed as incurred. A significant portion of these costs are not likely to be incremental costs, but rather a redeployment of existing information technology resources. Approximately $25,000 of this amount was incurred as of September 30, 1998. The remainder of the estimated cost of the project is expected to be incurred in the fourth quarter of 1998 and in 1999. All costs of the Year 2000 project have been expensed as incurred. PART II - OTHER INFORMATION Item 6 - Exhibits and Reports on Form 8-K (a) No Form 8-K was required to be filed during the most recently completed quarter. Signatures Pursuant to the requirements 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. Union Bankshares Corporation (Registrant) November 16, 1998 s/ G. William Beale - - ------------------------ -------------------------------- (Date) G. William Beale, President, Chief Executive Officer and Director November 16, 1998 s/ D. Anthony Peay - - ------------------------- --------------------------------- (Date) D. Anthony Peay, Vice President and Chief Financial Officer UNION BANKSHARES CORPORATION AND SUBSIDIARIES Index to Exhibits Form 10-Q /September 30, 1998 Exhibit No. Description 2 Plan of acquisition, reorganization, arrangement, liquidation or succession- Not Applicable 4 Instruments defining the rights of security holders, including indentures Not Applicable 10 Material contracts Not Applicable 11 Statement re: computation of per share earnings Not Applicable 15 Letter re: unaudited interim financial information Not Applicable 18 Letter re: change in accounting principles Not Applicable 19 Previously unfiled documents Not Applicable 20 Report furnished to security holders Not Applicable 22 Published report re: matters submitted to vote of security holders None 23 Consents of experts and counsel Not Applicable 24 Power of Attorney Not Applicable 99 Additional Exhibits None