3.31.11 UNB 10-Q
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 
Washington, D.C. 20549
 
FORM 10-Q
 
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
(  ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 2011
 
Commission file number: 001-15985
 
UNION BANKSHARES, INC.
VERMONT
 
03-0283552
 
P.O. BOX 667
MAIN STREET
MORRISVILLE, VT 05661
 
Registrant’s telephone number:      802-888-6600
 
Former name, former address and former fiscal year, if changed since last report: Not applicable
 
Securities registered pursuant to section 12(b) of the Act:
Common Stock, $2.00 par value
 
Nasdaq Stock Market
(Title of class)
 
(Exchanges registered on)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X]      No [  ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes [ ]      No [  ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” ”accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [  ]
Accelerated filer [  ]
Non-accelerated filer [  ] (Do not check if a smaller reporting company)
Smaller reporting company [ X ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes [  ]      No [X]
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of May 1, 2011:
 
Common Stock, $2 par value
 
4,457,704 shares
 
 
 

UNION BANKSHARES, INC.
TABLE OF CONTENTS
 
PART I FINANCIAL INFORMATION
 
 
 
 
 
 
PART II OTHER INFORMATION
 
 
 
 
 
 
 

PART I FINANCIAL INFORMATION
 
Item 1. Financial Statements
 
UNION BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
March 31, 2011
December 31, 2010
Assets
(Dollars in thousands)
Cash and due from banks
$
5,154
 
$
5,447
 
Federal funds sold and overnight deposits
24,842
 
8,845
 
Cash and cash equivalents
29,996
 
14,292
 
Interest bearing deposits in banks
13,065
 
14,041
 
Investment securities available-for-sale
25,487
 
23,780
 
Investment securities held-to-maturity (fair value $500 and
  $502 at March 31, 2011 and December 31, 2010, respectively)
500
 
500
 
Loans held for sale
2,614
 
5,611
 
Loans
369,087
 
376,272
 
Allowance for loan losses
(3,908
)
(3,755
)
Net deferred loan costs
203
 
188
 
Net loans
365,382
 
372,705
 
Accrued interest receivable
1,650
 
1,560
 
Premises and equipment, net
7,896
 
7,842
 
Other assets
13,062
 
12,664
 
Total assets
$
459,652
 
$
452,995
 
Liabilities and Stockholders’ Equity
 
 
Liabilities
 
 
Deposits
 
 
Noninterest bearing
$
61,362
 
$
64,526
 
Interest bearing
322,657
 
312,134
 
Total deposits
384,019
 
376,660
 
Borrowed funds
26,892
 
28,986
 
Liability for defined benefit pension plan
2,612
 
2,451
 
Accrued interest and other liabilities
4,348
 
3,173
 
Total liabilities
417,871
 
411,270
 
Commitments and Contingencies
 
 
Stockholders’ Equity
 
 
Common stock, $2.00 par value; 7,500,000 shares authorized;
  4,923,286 shares issued at March 31, 2011 and 4,921,786 shares
  issued at December 31, 2010
9,847
 
9,844
 
Additional-paid-in capital
267
 
244
 
Retained earnings
37,537
 
37,623
 
Treasury stock at cost; 466,082 shares at March 31, 2011
  and December 31, 2010
(3,823
)
(3,823
)
Accumulated other comprehensive loss
(2,047
)
(2,163
)
Total stockholders' equity
41,781
 
41,725
 
Total liabilities and stockholders' equity
$
459,652
 
$
452,995
 
See accompanying notes to unaudited interim consolidated financial statements.

Union Bankshares, Inc. Page 1
UNION BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
Three Months Ended
March 31,
 
2011
2010
 
(Dollars in thousands except per share data)
Interest income
 
 
Interest and fees on loans
$
5,196
 
$
5,258
 
Interest on debt securities:
 
 
Taxable
143
 
187
 
Tax exempt
73
 
73
 
Dividends
4
 
—
 
Interest on federal funds sold and overnight deposits
6
 
4
 
Interest on interest bearing deposits in banks
76
 
122
 
Total interest income
5,498
 
5,644
 
Interest expense
 
 
Interest on deposits
673
 
773
 
Interest on borrowed funds
288
 
283
 
Total interest expense
961
 
1,056
 
    Net interest income
4,537
 
4,588
 
Provision for loan losses
150
 
90
 
    Net interest income after provision for loan losses
4,387
 
4,498
 
Noninterest income
 
 
Trust income
132
 
109
 
Service fees
1,006
 
964
 
Net gains on sales of loans held for sale
168
 
102
 
Other income
95
 
44
 
Total noninterest income
1,401
 
1,219
 
Noninterest expenses
 
 
Salaries and wages
1,730
 
1,565
 
Pension and employee benefits
817
 
760
 
Occupancy expense, net
290
 
255
 
Equipment expense
296
 
248
 
Other expenses
1,447
 
1,311
 
Total noninterest expenses
4,580
 
4,139
 
        Income before provision for income taxes
1,208
 
1,578
 
Provision for income taxes
180
 
359
 
        Net income
$
1,028
 
$
1,219
 
Earnings per common share
$
0.23
 
$
0.27
 
Weighted average number of common shares outstanding
4,455,737
 
4,460,764
 
Dividends per common share
$
0.25
 
$
0.25
 
 
 
 
 
See accompanying notes to unaudited interim consolidated financial statements.

Union Bankshares, Inc. Page 2
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Three Months Ended March 31, 2011 and 2010
(Unaudited)
 
Common Stock
 
 
 
 
 
 
Shares,
net of
treasury
Amount
Additional
paid-in
capital
Retained
earnings
Treasury
stock
Accumulated
other
comprehensive
loss
Total
stockholders’
equity
 
(Dollars in thousands)
Balances, December 31, 2010
4,455,704
 
$
9,844
 
$
244
 
$
37,623
 
$
(3,823
)
$
(2,163
)
$
41,725
 
Comprehensive income:
 
 
 
 
 
 
 
Net income
—
 
—
 
—
 
1,028
 
—
 
—
 
1,028
 
    Other comprehensive income,
     net of tax:
 
 
 
 
 
 
 
    Change in net unrealized gain
     on investment securities
     available-for-sale, net of
     reclassification adjustment
     and tax effects
—
 
—
 
—
 
—
 
—
 
85
 
85
 
    Change in net unrealized loss
     on unfunded defined
     benefit plan liability,
     net of reclassification
     adjustment and tax effects
—
 
—
 
—
 
—
 
—
 
31
 
31
 
        Total other comprehensive
         income
 
 
 
 
 
116
 
 
Total comprehensive income
 
 
 
—
 
—
 
—
 
1,144
 
Issuance of common stock
1,500
 
3
 
23
 
—
 
—
 
—
 
26
 
Cash dividends declared
 ($0.25 per share)
—
 
—
 
—
 
(1,114
)
—
 
—
 
(1,114
)
Balances, March 31, 2011
4,457,204
 
$
9,847
 
$
267
 
$
37,537
 
$
(3,823
)
$
(2,047
)
$
41,781
 
Balances, December 31, 2009
4,461,208
 
$
9,844
 
$
219
 
$
36,494
 
$
(3,724
)
$
(1,653
)
$
41,180
 
Comprehensive income:
 
 
 
 
 
 
 
Net income
—
 
—
 
—
 
1,219
 
—
 
—
 
1,219
 
    Other comprehensive income,
     net of tax:
 
 
 
 
 
 
 
    Change in net unrealized gain
     on investment securities
     available-for-sale, net of
     reclassification adjustment
     and tax effects
—
 
—
 
—
 
—
 
—
 
108
 
108
 
    Change in net unrealized loss
     on unfunded defined
     benefit pension plan liability,
     net of reclassification
     adjustment and tax effects
—
 
—
 
—
 
—
 
—
 
28
 
28
 
        Total other comprehensive
         income
 
 
 
 
 
136
 
 
Total comprehensive income
 
 
 
 
 
 
1,355
 
Cash dividends declared
 ($0.25 per share)
—
 
—
 
—
 
(1,115
)
—
 
—
 
(1,115
)
Stock based compensation
 expense
—
 
—
 
6
 
—
 
—
 
—
 
6
 
Purchase of treasury stock
(500
)
—
 
—
 
—
 
(9
)
—
 
(9
)
Balances, March 31, 2010
4,460,708
 
$
9,844
 
$
225
 
$
36,598
 
$
(3,733
)
$
(1,517
)
$
41,417
 
 
See accompanying notes to unaudited interim consolidated financial statements.
 

Union Bankshares, Inc. Page 3
 

UNION BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Three Months Ended
March 31,
 
2011
2010
 
(Dollars in thousands)
Cash Flows From Operating Activities
 
 
Net income
$
1,028
 
$
1,219
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
Depreciation
177
 
151
 
Provision for loan losses
150
 
90
 
Deferred income tax provision
98
 
54
 
Net amortization of investment securities
14
 
5
 
Equity in losses of limited partnerships
106
 
106
 
Stock based compensation expense
—
 
6
 
Net increase in unamortized loan costs
(15
)
(47
)
Proceeds from sales of loans held for sale
16,912
 
8,268
 
Origination of loans held for sale
(13,747
)
(6,963
)
Net gains on sales of loans held for sale
(168
)
(102
)
Net losses on disposals of premises and equipment
—
 
5
 
Write-down of impaired assets
41
 
5
 
Net gains on sales of other real estate owned
(18
)
—
 
Increase in accrued interest receivable
(90
)
(14
)
Decrease in other assets
92
 
561
 
Contribution to defined benefit pension plan
—
 
(61
)
Increase in other liabilities
431
 
105
 
Net cash provided by operating activities
5,011
 
3,388
 
Cash Flows From Investing Activities
 
 
Interest bearing deposits in banks
 
 
Proceeds from maturities and redemptions
1,969
 
4,473
 
Purchases
(993
)
(3,529
)
Investment securities available-for-sale
 
 
Proceeds from maturities, calls and paydowns
685
 
1,495
 
Purchases
(2,277
)
(2,003
)
Net decrease (increase) in loans
7,169
 
(1,324
)
Recoveries of loans charged off
19
 
18
 
Purchases of premises and equipment
(231
)
(493
)
Investments in limited partnerships
—
 
(138
)
Proceeds from sales of other real estate owned
175
 
—
 
Net cash provided by (used in) investing activities
6,516
 
(1,501
)
Cash Flows From Financing Activities
 
 
 
Repayment of long-term debt
(247
)
(209
)
Net decrease in short-term borrowings outstanding
(1,847
)
(3,440
)
Net decrease in noninterest bearing deposits
(3,164
)
(6,339
)
Net increase in interest bearing deposits
10,523
 
2,655
 
Issuance of common stock
26
 
—
 
Purchase of treasury stock
—
 
(9
)
Dividends paid
(1,114
)
(1,115
)
Net cash provided by (used in) financing activities
4,177
 
(8,457
)
Net increase (decrease) in cash and cash equivalents
15,704
 
(6,570
)
Cash and cash equivalents
 
 
Beginning of period
14,292
 
22,132
 
End of period
$
29,996
 
$
15,562
 

Union Bankshares, Inc. Page 4
 

Supplemental Disclosures of Cash Flow Information
 
 
Interest paid
$
864
 
$
1,097
 
Income taxes paid
$
50
 
$
—
 
Supplemental Schedule of Noncash Investing and Financing Activities
 
 
Other real estate acquired in settlement of loans
$
—
 
$
452
 
Other assets acquired in settlement of loans
$
—
 
$
17
 
 
See accompanying notes to unaudited interim consolidated financial statements.

Union Bankshares, Inc. Page 5
UNION BANKSHARES, INC. AND SUBSIDIARY
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
 
Note 1.    Basis of Presentation
The accompanying unaudited interim consolidated financial statements of Union Bankshares, Inc. (the Company) as of March 31, 2011 and 2010, and for the three months then ended, have been prepared in conformity with U.S. generally accepted accounting principles (GAAP) for interim financial information, general practices within the banking industry, and the accounting policies described in the Company’s Annual Report to Shareholders and Annual Report on Form 10-K for the year ended December 31, 2010. In the opinion of Company’s management, all adjustments, consisting only of normal recurring adjustments and disclosures necessary for a fair presentation of the information contained herein, have been made. This information should be read in conjunction with the Company’s 2010 Annual Report to Shareholders and 2010 Annual Report on Form 10-K. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2011, or any other interim period.
 
Certain amounts in the 2010 consolidated financial statements have been reclassified to conform to the 2011 presentation.
 
Note 2. Commitments and Contingencies
In the normal course of business, the Company is involved in various legal and other proceedings. In the opinion of management, any liability resulting from such proceedings is not expected to have a material adverse effect on the Company’s consolidated financial condition or results of operations.
 
Note 3. Per Share Information
Earnings per common share are computed based on the weighted average number of shares of common stock outstanding during the period and reduced for shares held in treasury. The assumed conversion of available outstanding stock options does not result in material dilution and is not included in the calculation.
 
Note 4. Recent Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU), Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements, to amend the disclosure requirements and clarify existing requirements related to recurring and nonrecurring fair value measurements and employers’ disclosures about postretirement benefit plan assets. The guidance requires new disclosures regarding transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a rollforward of activities, separately reporting purchases, sales, issuance, and settlements, for assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The new disclosure requirements apply to interim and annual reporting periods beginning after December 15, 2009, except for the new rules regarding purchases, sales, issuances and settlements associated with Level 3 measurements which are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Other than requiring additional disclosures, adoption of this accounting standard did not have a material effect on the Company’s consolidated financial statements. See Note 10.
 
In July 2010, the FASB issued an ASU, Receivables- Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, to provide additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. The disclosures are required on a disaggregated basis- portfolio segment and class of financing receivable. The new disclosures require an entity to provide credit quality indicators of financing receivables at the end of the reporting period by class, the aging of past due financing receivables at the end of the reporting period by class, the nature and extent of troubled debt restructurings that occurred during the period by class and their effect on the allowance for loan losses, the nature and extent of financing receivables modified as troubled debt restructurings within the previous twelve months that defaulted during the reporting period by class and their effect on the allowance for credit losses, and significant purchases and sales of financing receivables during the reporting period disaggregated by portfolio segment. The ASU also requires an entity to provide disclosures about its financing receivables on a disaggregated basis, including a rollforward schedule of allowance for credit losses for the reporting period on a portfolio segment basis with the ending balance further disaggregated on the basis of the impairment method and the related recorded investment in financing

Union Bankshares, Inc. Page 6
receivables as well as the nonaccrual and impairment status of financing receivables by class. The new and amended disclosures for public entities as of the end of a reporting period were effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period were effective for interim and annual reporting periods beginning on or after December 15, 2010. In January 2011, the FASB issued an ASU, Deferral of the Effective Date of Disclosures about Troubled Debt Restructuring, for public-entity creditors to temporarily delay the effective date of the disclosures about troubled debt restructurings until the FASB completes its deliberations of what constitutes a troubled debt restructuring. The Company adopted the required portions of the accounting standard as of December 31, 2010 with no material impact on the Company's consolidated financial statements. In April 2011, the FASB issued an ASU, A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring, which provides companies new criteria for determining whether a particular loan modification represents a troubled debt restructuring for accounting purposes and it signals when a company should also record an impairment loss associated with the same loan. This new guidance is effective for quarterly and annual reports for periods beginning on or after June 15, 2011. The Company does not anticipate the adoption of the remaining open standards will have a material impact on the Company's consolidated financial statements.See Notes 6 and 7 for additional current disclosures required under this accounting standard.
 
In April 2011, the FASB issued an ASU, Reconsideration of Effective Controls for Repurchase Agreements, to improve the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The update removes the transferor's ability criterion from the consideration of effective control for repurchase or other agreements. The guidance in this ASU is effective for the first interim or annual period beginning on or after December 15, 2011. Management is currently reviewing the ASU but does not believe that it will have a material effect on the Company's consolidated financial statements.
 
Note 5. Investment Securities
Investment securities as of the balance sheet dates consisted of the following:
 
March 31, 2011
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
 
(Dollars in thousands)
Available-for-sale
 
 
 
 
Debt securities:
 
 
 
 
U.S. Government-sponsored enterprises
$
6,316
 
$
—
 
$
(146
)
$
6,170
 
Mortgage-backed
4,294
 
69
 
(14
)
4,349
 
State and political subdivisions
9,842
 
284
 
(112
)
10,014
 
Corporate
4,487
 
316
 
—
 
4,803
 
Total debt securities
24,939
 
669
 
(272
)
25,336
 
Marketable equity securities
50
 
1
 
(5
)
46
 
Mutual funds
105
 
—
 
—
 
105
 
Total
$
25,094
 
$
670
 
$
(277
)
$
25,487
 
Held-to-maturity
 
 
 
 
U.S. Government-sponsored enterprises
$
500
 
$
—
 
$
—
 
$
500
 
 

Union Bankshares, Inc. Page 7
 

December 31, 2010
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
 
(Dollars in thousands)
Available-for-sale
 
 
 
 
Debt securities:
 
 
 
 
U.S. Government-sponsored enterprises
$
4,521
 
$
1
 
$
(63
)
$
4,459
 
Mortgage-backed
4,735
 
87
 
(11
)
4,811
 
State and political subdivisions
9,373
 
175
 
(155
)
9,393
 
Corporate
4,737
 
274
 
(39
)
4,972
 
Total debt securities
23,366
 
537
 
(268
)
23,635
 
Marketable equity securities
50
 
1
 
(6
)
45
 
Mutual funds
100
 
—
 
—
 
100
 
Total
$
23,516
 
$
538
 
$
(274
)
$
23,780
 
Held-to-maturity
 
 
 
 
U.S. Government-sponsored enterprises
$
500
 
$
2
 
$
—
 
$
502
 
 
There were no sales of securities available-for-sale for either the three months ended March 31, 2011 or 2010. The specific identification method is used to determine realized gains and losses on sales of available-for-sale securities.
 
The amortized cost and estimated fair value of debt securities by contractual scheduled maturity as of March 31, 2011 were as follows:
 
Amortized
Cost
Fair
Value
 
(Dollars in thousands)
Available-for-sale
 
 
Due in one year or less
$
1,504
 
$
1,539
 
Due from one to five years
5,091
 
5,248
 
Due from five to ten years
6,727
 
6,860
 
Due after ten years
7,323
 
7,340
 
 
20,645
 
20,987
 
Mortgage-backed securities
4,294
 
4,349
 
Total debt securities
$
24,939
 
$
25,336
 
Held-to-maturity
 
 
Due from five to ten years
$
500
 
$
500
 
 
Actual maturities may differ for certain debt securities that may be called by the issuer prior to the contractual maturity. Actual maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be prepaid, usually without any penalties. Therefore, these mortgage-backed securities are shown separately and not included in the maturity categories in the above maturity summary.
 

Union Bankshares, Inc. Page 8
 

Information pertaining to investment securities available-for-sale with gross unrealized losses as of the balance sheet dates, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
 
March 31, 2011:
Less Than 12 Months
Over 12 Months
Total
 
Fair
Value
Gross
Unrealized
Loss
Fair
Value
Gross
Unrealized
Loss
Fair
Value
Gross
Unrealized
Loss
 
(Dollars in thousands)
Debt securities:
 
 
 
 
 
 
U.S. Government-sponsored
  enterprises
$
5,671
 
$
(146
)
$
—
 
$
—
 
$
5,671
 
$
(146
)
Mortgage-backed
2,072
 
(14
)
—
 
—
 
2,072
 
(14
)
State and political subdivisions
4,087
 
(112
)
—
 
—
 
4,087
 
(112
)
Total debt securities
11,830
 
(272
)
—
 
—
 
11,830
 
(272
)
Marketable equity securities
—
 
—
 
9
 
(5
)
9
 
(5
)
Total
$
11,830
 
$
(272
)
$
9
 
$
(5
)
$
11,839
 
$
(277
)
December 31, 2010:
Less Than 12 Months
Over 12 Months
Total
 
Fair
Value
Gross
Unrealized
Loss
Fair
Value
Gross
Unrealized
Loss
Fair
Value
Gross
Unrealized
Loss
 
(Dollars in thousands)
Debt securities:
 
 
 
 
 
 
U.S. Government-sponsored
  enterprises
$
3,937
 
$
(63
)
$
—
 
$
—
 
$
3,937
 
$
(63
)
Mortgage-backed
862
 
(11
)
—
 
—
 
862
 
(11
)
State and political subdivisions
4,314
 
(155
)
—
 
—
 
4,314
 
(155
)
Corporate
202
 
(39
)
—
 
—
 
202
 
(39
)
Total debt securities
9,315
 
(268
)
—
 
—
 
9,315
 
(268
)
Marketable equity securities
—
 
—
 
8
 
(6
)
8
 
(6
)
Total
$
9,315
 
$
(268
)
$
8
 
$
(6
)
$
9,323
 
$
(274
)
 
The Company evaluates all investment securities on a quarterly basis, and more frequently when economic conditions warrant, to determine if an other-than-temporary impairment exists. A debt security is considered impaired if the fair value is lower than its amortized cost basis at the report date. If impaired, management then assesses whether the unrealized loss is other-than-temporary.
 
An unrealized loss on a debt security is generally deemed to be other-than temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security. The credit loss component of an other-than-temporary impairment write-down is recorded, net of tax effect, through net income as a component of net other-than-temporary impairment losses in the consolidated statement of income, while the remaining portion of the impairment loss is recognized in other comprehensive income (loss), provided the Company does not intend to sell the underlying debt security and it is "more likely than not" that the Company will not have to sell the debt security prior to recovery.
 
Management considers the following factors in determining whether an other-than-temporary impairment exists and the period over which the debt security is expected to recover:
 
•
The length of time, and extent to which, the fair value has been less than the amortized cost;
•
Adverse conditions specifically related to the security, industry, or geographic area;
•
The historical and implied volatility of the fair value of the security;
•
The payment structure of the debt security and the likelihood of the issuer being able to make payments that may increase in the future;

Union Bankshares, Inc. Page 9
 

•
Failure of the issuer of the security to make scheduled interest or principal payments;
•
Any changes to the rating of the security by a rating agency;
•
Recoveries or additional declines in fair value subsequent to the balance sheet date; and
•
The nature of the issuer, including whether it is a private company, public entity or government-sponsored enterprise, and the existence or likelihood of any government or third party guaranty.
 
At March 31, 2011, available-for-sale securities, consisting of thirteen U.S. Government-sponsored enterprises, three agency collateralized mortgage obligations, two agency mortgage-backed securities, five taxable municipal securities, seven tax-exempt municipal securities and one marketable equity security, had unrealized losses of $277 thousand. Only the one marketable equity security has had an unrealized loss of greater than twelve months and the Company has the ability to hold such security for the foreseeable future. No declines were deemed by management to be other-than-temporary at March 31, 2011.
 
Investment securities with a carrying amount of $2.0 million and $1.5 million at March 31, 2011 and December 31, 2010, respectively, were pledged as collateral for public deposits and for other purposes as required or permitted by law.
 
Note 6.  Loans
 
Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their unpaid principal balances, adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans.
 
Loan interest income is accrued daily on outstanding balances. The accrual of interest is discontinued when a loan is specifically determined to be impaired and/or management believes, after considering collection efforts and other factors, that the borrowers' financial condition is such that collection of interest is doubtful. Normally, any unpaid interest previously accrued on those loans is reversed against interest income. A loan may be restored to accrual status when its financial status has significantly improved and there is no principal or interest past due. A loan may also be restored to accrual status if the borrower makes six consecutive monthly payments or the lump sum equivalent. Income on nonaccrual loans is generally not recognized unless a loan is placed back in accrual status or after all principal has been collected. Interest income generally is not recognized on impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are generally applied as a reduction of the loan principal balance. Delinquency status is determined based on contractual terms.
 
Loan origination fees and direct loan origination costs are deferred and amortized as an adjustment of the related loan's yield using methods that approximate the interest method. The Company generally amortizes these amounts over the estimated average life of the related loans.
 
The composition of Net loans as of the balance sheet date was as follows:
 
March 31, 2011
December 31, 2010
 
(Dollars in thousands)
Residential real estate
$
130,705
 
$
132,533
 
Construction real estate
17,861
 
18,578
 
Commercial real estate
163,473
 
167,056
 
Commercial
20,541
 
20,604
 
Consumer
5,667
 
6,046
 
Municipal loans
30,840
 
31,455
 
    Gross loans
369,087
 
376,272
 
Allowance for loan losses
(3,908
)
(3,755
)
Net deferred loan costs
203
 
188
 
    Net loans
$
365,382
 
$
372,705
 
 
Residential real estate loans aggregating $9.6 million and $8.0 million at March 31, 2011 and December 31, 2010, respectively, were pledged as collateral on deposits of municipalities. Qualified first mortgages held by Union may also

Union Bankshares, Inc. Page 10
 

be pledged as collateral for borrowings from the Federal Home Loan Bank (FHLB) of Boston under a blanket lien.
 
A summary of current, past due and nonaccrual loans as of March 31, 2011 was as follows:
 
Current
30-89 Days
Over 90 Days and accruing
Nonaccrual
Total
 
(Dollars in thousands)
Residential real estate
$
121,886
 
$
5,869
 
$
324
 
$
2,626
 
$
130,705
 
Construction real estate
17,504
 
265
 
45
 
47
 
17,861
 
Commercial real estate
158,619
 
3,712
 
9
 
1,133
 
163,473
 
Commercial
19,942
 
423
 
42
 
134
 
20,541
 
Consumer
5,511
 
86
 
8
 
62
 
5,667
 
Municipal
30,840
 
—
 
—
 
—
 
30,840
 
Total
$
354,302
 
$
10,355
 
$
428
 
$
4,002
 
$
369,087
 
 
A summary of current, past due and nonaccrual loans as of December 31, 2010 was as follows:
 
 
Current
30-89 Days
Over 90 Days and accruing
Nonaccrual
Total
 
(Dollars in thousands)
Residential real estate
$
123,573
 
$
6,446
 
$
587
 
$
1,927
 
$
132,533
 
Construction real estate
18,369
 
116
 
45
 
48
 
18,578
 
Commercial real estate
163,524
 
2,729
 
173
 
630
 
167,056
 
Commercial
20,295
 
161
 
—
 
148
 
20,604
 
Consumer
5,953
 
53
 
1
 
39
 
6,046
 
Municipal
31,455
 
—
 
—
 
—
 
31,455
 
Total
$
363,169
 
$
9,505
 
$
806
 
$
2,792
 
$
376,272
 
 
Aggregate interest on nonaccrual loans not recognized was $755 thousand and $677 thousand at March 31, 2011 and December 31, 2010, respectively.
 
 
Note 7.  Allowance for Loan Losses and Credit Quality
 
The allowance for loan losses is established for estimated losses in the loan portfolio through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the loan balance is uncollectible or in accordance with federal guidelines. Subsequent recoveries, if any, are credited to the allowance.
 
The allowance for loan losses is maintained at a level believed by management to be appropriate to absorb probable credit losses inherent in the loan portfolio as of the balance sheet date. The amount of the allowance is based on management's periodic evaluation of the collectability of the loan portfolio, including the nature, volume and risk characteristics of the portfolio, credit concentrations, trends in historical loss experience, estimated value of any underlying collateral, specific impaired loans and economic conditions. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions or other relevant factors.
 
In addition, various regulatory agencies, as an integral part of their examination process, regularly review the Company's allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examination, which may not be currently available to management.
 
The allowance consists of specific, general and unallocated components. The specific component relates to the loans that are classified as either monitor, substandard or special mention. For such loans, the level of allowance allocable

Union Bankshares, Inc. Page 11
 

to those loans is determined through estimating probable loss for each individual credit based on its specific risk attributes. Loans are also evaluated for impairment and may be classified as impaired when management believes it is probable that the Company will not collect all the contractual interest and principal payments as scheduled in the loan agreement. Impaired loans may also include troubled loans that are restructured. A troubled debt restructuring occurs when the Company, for economic or legal reasons related to the borrower's financial difficulties, grants a concession to the borrower that would otherwise not be granted. Troubled debt restructurings may include the transfer of assets to the Company in partial satisfaction of a troubled loan, a modification of a loan's terms, or a combination of both. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer, residential or small balance commercial loans for impairment evaluation, unless such loans are subject to a restructuring agreement or have been identified as impaired as part of a larger customer relationship. A specific reserve amount is allocated to the allowance for individual loans that have been classified as impaired on the basis of the fair value of the collateral for collateral dependent loans, an observable market price, or the present value of anticipated future cash flows. The general component represents the level of allowance allocable to each loan portfolio category with similar risk characteristics and is determined based on historical loss experience, adjusted for qualitative factors. Qualitative factors considered include underwriting, economic and market conditions, portfolio composition, collateral values, delinquencies, lender experience and legal issues. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
 
All evaluations are inherently subjective as they require estimates that are susceptible to significant revision as more information becomes available or as changes occur in economic conditions or other relevant factors.
 
Changes in the Allowance for loan losses for the three months ended March 31, 2011 were as follows:
 
Residential Real Estate
Construction Real Estate
Commercial Real Estate
Commercial
Consumer, Municipal and Unallocated
Total
 
(Dollars in thousands)
Balance, January 1, 2011
$
1,033
 
$
240
 
$
2,117
 
$
250
 
$
115
 
$
3,755
 
Provision for loan losses
134
 
—
 
19
 
11
 
(14
)
150
 
Recoveries of amounts
  charged off
1
 
—
 
—
 
3
 
15
 
19
 
 
1,168
 
240
 
2,136
 
264
 
116
 
3,924
 
Amounts charged off
8
 
—
 
—
 
—
 
8
 
16
 
Balance, March 31, 2011
$
1,160
 
$
240
 
$
2,136
 
$
264
 
$
108
 
$
3,908
 
 
Despite the above allocation, the Allowance for loan losses is general in nature and is available to absorb losses from any loan type.
 
Changes in the Allowance for loan losses for the three months ended March 31, 2010 were as follows:
 
Total
 
(Dollars in thousands)
Balance, January 1, 2010
$
3,493
 
    Provision for loan losses
90
 
    Recoveries of amounts charged off
18
 
 
3,601
 
    Amounts charged off
(146
)
Balance, March 31, 2010
$
3,455
 
 

Union Bankshares, Inc. Page 12
 

At March 31, 2011, the allocation of the Allowance for loan losses summarized on the basis of the Company's impairment methodology was as follows:
 
Residential Real Estate
Construction Real Estate
Commercial Real Estate
Commercial
Consumer, Municipal and Unallocated
Total
 
(Dollars in thousands)
Individually evaluated
   for impairment
$
278
 
$
12
 
$
336
 
$
44
 
$
18
 
$
688
 
Collectively evaluated
   for impairment
882
 
228
 
1,800
 
220
 
90
 
3,220
 
Allocated
$
1,160
 
$
240
 
$
2,136
 
$
264
 
$
108
 
$
3,908
 
 
At December 31, 2010, the allocation of the Allowance for loan losses summarized on the basis of the Company's impairment methodology was as follows:
 
 
Residential Real Estate
Construction Real Estate
Commercial Real Estate
Commercial
Consumer, Municipal and Unallocated
Total
 
(Dollars in thousands)
Individually evaluated
   for impairment
$
199
 
$
12
 
$
295
 
$
39
 
$
20
 
$
565
 
Collectively evaluated
   for impairment
834
 
228
 
1,822
 
211
 
95
 
3,190
 
Allocated
$
1,033
 
$
240
 
$
2,117
 
$
250
 
$
115
 
$
3,755
 
 
The recorded investment in loans summarized on the basis of the Company's impairment methodology as of March 31, 2011 was as follows:
 
Residential Real Estate
Construction Real Estate
Commercial Real Estate
Commercial
Consumer
Municipal
Total
 
(Dollars in thousands)
Individually evaluated
   for impairment
$
2,324
 
$
47
 
$
4,942
 
$
171
 
$
31
 
$
—
 
$
7,515
 
Collectively evaluated
   for impairment
128,381
 
17,814
 
158,531
 
20,370
 
5,636
 
30,840
 
361,572
 
Total
$
130,705
 
$
17,861
 
$
163,473
 
$
20,541
 
$
5,667
 
$
30,840
 
$
369,087
 
 
The recorded investment in loans summarized on the basis of the Company's impairment methodology as of December 31, 2010 was as follows:
 
Residential Real Estate
Construction Real Estate
Commercial Real Estate
Commercial
Consumer
Municipal
Total
 
(Dollars in thousands)
Individually evaluated
   for impairment
$
1,789
 
$
48
 
$
5,224
 
$
146
 
$
30
 
$
—
 
$
7,237
 
Collectively evaluated
   for impairment
130,744
 
18,530
 
161,832
 
20,458
 
6,016
 
31,455
 
369,035
 
Total
$
132,533
 
$
18,578
 
$
167,056
 
$
20,604
 
$
6,046
 
$
31,455
 
$
376,272
 
 

Union Bankshares, Inc. Page 13
 

The following table summarizes the loan ratings applied to the Company's loan types as of March 31, 2011:
 
Residential Real Estate
Construction Real Estate
Commercial Real Estate
Commercial
Consumer
Municipal
Total
 
(Dollars in thousands)
Pass
$
126,121
 
$
17,307
 
$
139,523
 
$
19,212
 
$
5,590
 
$
30,840
 
$
338,593
 
Satisfactory/Monitor
2,260
 
507
 
19,008
 
1,158
 
46
 
—
 
22,979
 
Monitor
224
 
—
 
1,491
 
—
 
—
 
—
 
1,715
 
Substandard
2,100
 
47
 
3,451
 
171
 
31
 
—
 
5,800
 
Total
$
130,705
 
$
17,861
 
$
163,473
 
$
20,541
 
$
5,667
 
$
30,840
 
$
369,087
 
 
The following table summarizes the loan ratings applied to the Company's loan types as of December 31, 2010:
 
Residential Real Estate
Construction Real Estate
Commercial Real Estate
Commercial
Consumer
Municipal
Total
 
(Dollars in thousands)
Pass
$
128,646
 
$
17,999
 
$
142,530
 
$
19,640
 
$
5,991
 
$
31,455
 
$
346,261
 
Satisfactory/Monitor
2,098
 
531
 
19,302
 
818
 
25
 
—
 
22,774
 
Monitor
267
 
—
 
1,873
 
—
 
—
 
—
 
2,140
 
Substandard
1,522
 
48
 
3,351
 
146
 
30
 
—
 
5,097
 
Total
$
132,533
 
$
18,578
 
$
167,056
 
$
20,604
 
$
6,046
 
$
31,455
 
$
376,272
 
 
The following is an overview of the Company's loan rating system:
 
1-3 Rating - Pass
 
Risk-rating grades "1" through "3" comprise those loans ranging from lower than average credit risk defined as borrowers with high liquidity, excellent financial condition, strong management, favorable industry trends or loans secured by highly liquid assets through loans with marginal credit risk, defined as borrowers that while credit worthy, exhibit some characteristics which require special attention by the account officer.
 
4 Rating - Satisfactory/Monitor
 
Borrowers exhibit potential credit weaknesses or downward trends warranting management's attention. While potentially weak, these borrowers are currently marginally acceptable; no loss of principal or interest is envisioned.
 
M Rating - Monitor
 
Loans in this category reflect an increased credit risk. Loans in this category do not presently expose the Bank to a sufficient degree of risk to warrant adverse classification but do possess credit deficiencies deserving management's close attention. These credits are maintained on the watch list.
 
5-8 Substandard
 
Borrowers exhibit well defined weaknesses that jeopardize the orderly liquidation of debt. Loan may be inadequately protected by the net worth and paying capacity of the obligor and/or the underlying collateral is inadequate.
 

Union Bankshares, Inc. Page 14
 

The following table provides information with respect to impaired loans as of and for the three months ended March 31, 2011:
 
March 31, 2011
Three months ended March 31, 2011
 
Recorded Investment
Principal Balance
Related Allowance
Average Recorded Investment
Interest Income Recognized
 
(Dollars in thousands)
With an allowance recorded:
 
 
 
 
 
Residential real estate
$
296
 
$
296
 
$
37
 
 
 
Commercial real estate
263
 
263
 
56
 
 
 
 
559
 
559
 
93
 
 
 
With no allowance recorded:
 
 
 
 
 
Commercial real estate
2,042
 
2,042
 
—
 
 
 
 
 
 
 
 
 
Total:
 
 
 
 
 
Residential real estate
296
 
296
 
37
 
298
 
—
 
Commercial real estate
2,305
 
2,305
 
56
 
2,255
 
21
 
Total
$
2,601
 
$
2,601
 
$
93
 
$
2,553
 
$
21
 
 
The following table provides information with respect to impaired loans as of December 31, 2010:
 
 
December 31, 2010
 
 
 
Recorded Investment
Principal Balance
Related Allowance
 
 
 
(Dollars in thousands)
 
 
With an allowance recorded:
 
 
 
 
 
Residential real estate
$
301
 
$
301
 
$
43
 
 
 
Commercial real estate
1,970
 
1,970
 
40
 
 
 
 
2,271
 
2,271
 
83
 
 
 
With no allowance recorded:
 
 
 
 
 
Commercial real estate
236
 
236
 
—
 
 
 
 
 
 
 
 
 
Total:
 
 
 
 
 
Residential real estate
301
 
301
 
43
 
 
 
Commercial real estate
2,206
 
2,206
 
40
 
 
 
Total
$
2,507
 
$
2,507
 
$
83
 
 
 
 
At March 31, 2011 and December 31, 2010, the Company was not committed to lend any additional funds to borrowers whose loans were nonperforming, impaired or restructured.
 
Note 8. Defined Benefit Pension Plan
Union Bank, the Company’s sole subsidiary, sponsors a noncontributory defined benefit pension plan covering all eligible employees. The plan provides defined benefits based on years of service and final average salary.
 

Union Bankshares, Inc. Page 15
 

Net periodic pension benefit cost for the three months ended March 31 consisted of the following components:
 
Three Months Ended
March 31,
 
2011
2010
 
(Dollars in thousands)
Service cost
$
170
 
$
153
 
Interest cost on projected benefit obligation
209
 
196
 
Expected return on plan assets
(219
)
(187
)
Amortization of prior service cost
2
 
2
 
Amortization of net loss
46
 
44
 
Net periodic benefit cost
$
208
 
$
208
 
 
Note 9. Other Comprehensive Income (Loss)
Accounting principles generally require recognized revenue, expenses, gains, and losses be included in net income or loss. Certain changes in assets and liabilities, such as the after tax effect of unrealized gains and losses on investment securities available-for-sale that are not other than temporarily impaired, are not reflected in the statement of income. The cumulative effect of such items is reflected as a separate component of the equity section of the balance sheet (accumulated other comprehensive income or loss). Other comprehensive income or loss, along with net income, comprises the Company's total comprehensive income or loss. As of the balance sheet dates, the components of accumulated other comprehensive loss, net of tax, were:
 
March 31,
2011
December 31,
2010
 
(Dollars in thousands)
Net unrealized gain on investment securities available-for-sale
$
259
 
$
174
 
Defined benefit pension plan:
 
 
Net unrealized actuarial loss
(2,296
)
(2,327
)
Net unrealized prior service cost
(10
)
(10
)
Total
$
(2,047
)
$
(2,163
)
 
The following comprised total comprehensive income for the three months ended March 31:
 
Three Months Ended
March 31,
 
2011
2010
 
(Dollars in thousands)
Net income
$
1,028
 
$
1,219
 
Investment securities available-for-sale:
 
 
        Net unrealized holding gains on investment
         securities available-for-sale, net of tax
85
 
108
 
Defined benefit pension plan:
 
 
        Reclassification adjustment for amortization of net
         actuarial loss realized in net income, net of tax
31
 
26
 
        Reclassification adjustment for amortization of prior
         service cost realized in net income, net of tax
—
 
2
 
Total
31
 
28
 
Total other comprehensive income
116
 
136
 
Total comprehensive income
$
1,144
 
$
1,355
 
 

Union Bankshares, Inc. Page 16
 

Note 10: Fair Value Measurements and Disclosures
The Company utilizes FASB Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures, as guidance for accounting for assets and liabilities carried at fair value. This standard defines fair value as the price that would be received, without adjustment for transaction costs, to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is a market based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. The guidance in FASB ASC Topic 820 establishes a three-level fair value hierarchy, which prioritizes the inputs used in measuring fair value. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
 
The three levels of the fair value hierarchy are:
 
•
Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical,
unrestricted assets or liabilities;
•
Level 2 - Quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not
active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or
liability;
•
Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement
and unobservable (i.e., supported by little or no market activity).
 
The following is a description of the valuation methodologies used for the Company’s financial assets that are measured on a recurring basis at estimated fair value:
 
Investment securities available-for-sale: Certain corporate debt securities, marketable equity securities and mutual funds have been valued using unadjusted quoted prices from active markets and therefore have been classified as level 1. However, the majority of the Company’s investment securities available-for-sale have been valued utilizing level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include market maker bids, quotes and pricing models. Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows.
 

Union Bankshares, Inc. Page 17
 

Assets measured at fair value on a recurring basis at March 31, 2011 and December 31, 2010, segregated by fair value hierarchy level, are summarized below:
 
 
Fair Value Measurements
 
Fair
Value
Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
 
(Dollars in thousands)
March 31, 2011:
 
 
 
 
Investment securities available-for-sale
 
 
 
 
Debt securities:
 
 
 
 
U.S. Government-sponsored enterprises
$
6,170
 
$
—
 
$
6,170
 
$
—
 
Mortgage-backed
4,349
 
—
 
4,349
 
—
 
State and political subdivisions
10,014
 
—
 
10,014
 
—
 
Corporate
4,803
 
4,294
 
509
 
—
 
Total debt securities
25,336
 
4,294
 
21,042
 
—
 
Marketable equity securities
46
 
46
 
—
 
—
 
Mutual funds
105
 
105
 
—
 
—
 
Total
$
25,487
 
$
4,445
 
$
21,042
 
$
—
 
 
 
 
 
 
December 31, 2010:
 
 
 
 
Investment securities available-for-sale
 
 
 
 
Debt securities:
 
 
 
 
U.S. Government-sponsored enterprises
$
4,459
 
$
—
 
$
4,459
 
—
 
Mortgage-backed
4,811
 
—
 
4,811
 
—
 
State and political subdivisions
9,393
 
—
 
9,393
 
—
 
Corporate
4,972
 
2,105
 
2,867
 
—
 
Total debt securities
23,635
 
2,105
 
21,530
 
—
 
Marketable equity securities
45
 
45
 
—
 
—
 
Mutual funds
100
 
100
 
—
 
—
 
Total
$
23,780
 
$
2,250
 
$
21,530
 
$
—
 
 
There were no significant transfers in or out of Levels 1 and 2 for the quarter ended March 31, 2011. Certain other assets and liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Assets and liabilities measured at fair value on a nonrecurring basis such as investment securities held-to-maturity, other real estate owned, impaired loans and mortgage servicing rights were not significant at March 31, 2011 or December 31, 2010. The Company has not elected to apply the fair value option to any financial assets or liabilities other than those situations where other accounting pronouncements require fair value measurements.
 
FASB ASC Topic 825, Financial Instruments, requires disclosure of the estimated fair value of financial instruments. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Management’s estimates and assumptions are inherently subjective and involve uncertainties and matters of significant judgment. Changes in assumptions could dramatically affect the estimated fair values.
 

Union Bankshares, Inc. Page 18
 

Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments may be excluded from disclosure requirements. Thus, the aggregate fair value amounts presented may not necessarily represent the actual underlying fair value of such instruments of the Company.
 
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
 
Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values.
 
Interest bearing deposits in banks: Fair values for interest bearing deposits in banks are based on discounted present values of cash flows.
 
Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair value measurements consider observable data which may include market maker bids, quotes and pricing models. Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows.
 
Loans and loans held for sale: Fair values of loans are estimated for portfolios of loans with similar financial characteristics and segregated by loan type. For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans (for example, fixed-rate residential, commercial real estate, and rental property mortgage loans, and commercial and industrial loans) are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future cash flows, future expected loss experience and risk characteristics. The carrying amounts reported in the balance sheet for loans that are held for sale approximate their estimated fair values. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
 
Accrued interest receivable and payable: The carrying amounts of accrued interest approximate their fair values.
 
Federal Home Loan Bank (FHLB) of Boston stock: The carrying amount approximates its fair value.
 
Deposits: The fair values disclosed for demand deposits or nonmaturity deposits (for example, checking and savings accounts) are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate time deposits approximate their estimated fair values at the reporting date. The fair values for fixed-rate time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on time deposits to a schedule of aggregated contractual maturities on such time deposits.
 
Borrowed funds: The fair values of the Company’s long-term debt are estimated using discounted cash flow analysis based on interest rates currently being offered on similar debt instruments. The fair values of the Company’s short-term debt approximate the carrying amounts reported in the balance sheet.
 
Off-balance-sheet financial instruments: Fair values for off-balance-sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The only commitments to extend credit that are normally longer than one year in duration are the Home Equity Lines whose interest rates are variable quarterly. The only fees collected for commitments are an annual fee on credit card arrangements and often a flat fee on commercial lines of credit and standby letters of credit. The fair value of off-balance-sheet financial instruments is not significant.
 

Union Bankshares, Inc. Page 19
 

As of the balance sheet dates, the estimated fair values and related carrying amounts of the Company's significant financial instruments were as follows:
 
 
March 31, 2011
December 31, 2010
 
Carrying
Amount
Estimated
Fair Value
Carrying
Amount
Estimated
Fair Value
Financial assets
(Dollars in thousands)
Cash and cash equivalents
$
29,996
 
$
29,996
 
$
14,292
 
$
14,292
 
Interest bearing deposits in banks
13,065
 
13,292
 
14,041
 
14,292
 
Investment securities
25,987
 
25,987
 
24,280
 
24,282
 
Loans and loans held for sale, net
367,996
 
360,129
 
378,316
 
373,718
 
Accrued interest receivable
1,650
 
1,650
 
1,560
 
1,560
 
FHLB of Boston stock
1,922
 
1,922
 
1,922
 
1,922
 
Financial liabilities
 
 
 
 
Deposits
$
384,019
 
$
383,853
 
$
376,660
 
$
376,729
 
Borrowed funds
26,892
 
29,600
 
28,986
 
30,780
 
Accrued interest payable
483
 
483
 
389
 
389
 
 
The carrying amounts in the preceding table are included in the balance sheet under the applicable captions.
 
Note 11. Subsequent Events
Subsequent events represent events or transactions occurring after the balance sheet date but before the financial statements are issued. Financial statements are considered “issued” when they are widely distributed to shareholders and others for general use and reliance in a form and format that complies with GAAP. Events occurring subsequent to March 31, 2011 have been evaluated as to their potential impact to the consolidated financial statements.
 
In May, 2011, Union Bank received regulatory approval to complete its previously announced acquisition of three New Hampshire branch offices of Northway Bank, including approximately $80 million in deposits and $33 million in performing loans, the branch real estate in Groveton and North Woodstock and assumption of the branch lease in Littleton. The transaction is expected to close in late May, 2011.
 
On April 20, 2011, Union Bankshares, Inc. declared a $0.25 per share regular quarterly cash dividend payable May 12, 2011, to stockholders of record on April 30, 2011.
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
 
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
GENERAL
 
The following discussion and analysis by management focuses on those factors that, in management's view, had a material effect on the financial position of Union Bankshares, Inc. (the Company) as of March 31, 2011 and December 31, 2010, and its results of operations for the three months ended March 31, 2011 and 2010. This discussion is being presented to provide a narrative explanation of the consolidated financial statements and should be read in conjunction with the consolidated financial statements and related notes and with other financial data appearing elsewhere in this filing and with the Company's Annual Report on Form 10-K for the year ended December 31, 2010. In the opinion of the Company's management, the interim unaudited data reflects all adjustments, consisting only of normal recurring adjustments, and disclosures necessary to fairly present the Company's consolidated financial position and results of operations for the interim periods presented. Management is not aware of the occurrence of any events after March 31, 2011 which would materially affect the information presented.
 

Union Bankshares, Inc. Page 20
 

CAUTIONARY ADVICE ABOUT FORWARD LOOKING STATEMENTS
 
The Company may from time to time make written or oral statements that are considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may include financial projections, statements of plans and objectives for future operations, estimates of future economic performance or conditions and assumptions relating thereto. The Company may include forward-looking statements in its filings with the Securities and Exchange Commission (SEC), in its reports to stockholders, including this quarterly report, in press releases, other written materials, and in statements made by senior management to analysts, rating agencies, institutional investors, representatives of the media and others.
 
Forward-looking statements reflect management's current expectations and are subject to uncertainties, both general and specific, and risk exists that actual results will differ from those predictions, forecasts, projections and other estimates contained in forward-looking statements. These risks cannot be readily quantified. When management uses any of the words “believes,” “expects,” “anticipates,” “intends,” "projects," “plans,” “seeks,” “estimates,” "targets," "goals," “may,” “could,” “would,” “should,” or similar expressions, they are making forward-looking statements. Many possible events or factors, including those beyond the control of management, could affect the future financial results and performance of the Company. This could cause results or performance to differ materially from those expressed in forward-looking statements. Management has discussed some of the more likely factors that might affect forward-looking statements in this report on Form 10-Q. Those factors include the following:
 
•
loans and investments may be called or prepaid prior to their contractual maturity or become other than temporarily impaired;
•
future cash requirements might be higher than anticipated due to loan commitments or unused lines of credit being drawn upon or depositors withdrawing their funds at higher volumes or in different time frames than anticipated based on historical patterns and contractual terms;
•
assumptions made regarding interest rate movement and sensitivity could vary substantially if actual experience differs from historical experience, which could adversely affect the Company's results of operations;
•
further expansion of fair value accounting as proposed by the Financial Accounting Standards Board (FASB) which could result in, among other things, volatility in reported asset values and earnings;
•
uncontrollable increases in the cost of doing business, such as increased costs of Federal Deposit Insurance Corporation (FDIC) insurance or higher taxes, assessments, compliance or audit expense imposed by regulatory or legislative bodies;
•
regulatory limitations placed on income producing methods including the limiting of debit and credit card interchange fees, limiting the assessment of overdraft fees and restricting of asset sales;
•
the failure of actuarial, investment, work force, salary and other assumptions underlying the establishment of reserves for future pension costs or changes in legislative or regulatory requirements affecting such costs;
•
further disruptions in U.S. and global financial and credit markets;
•
ability of financial institutions to offer interest bearing transaction accounts to all customers as of July 21, 2011 and the resulting competitive impacts and the impact on the cost of deposits;
•
further modification of FDIC deposit insurance providing unlimited insurance coverage for two years beginning January 1, 2011 for any noninterest bearing transaction accounts and IOLTA accounts;
•
changes to the Company's and/ or the financial market operations resulting from the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act or the Act);
•
adverse changes in the local real estate market, which negatively impact collateral values and the Company's ability to recoup loan losses through disposition of real estate collateral;
•
changes in monetary, regulatory or tax policy that could affect consumer behavior;
•
continuing economic instability, including high unemployment rates, higher taxation and resolution of entitlement programs; and
•
changes in state foreclosure policies or procedures, which may result in delays in lien enforcement and additional cost.
 
When evaluating forward-looking statements to make decisions with respect to the Company, investors and others are cautioned to consider these and other risks and uncertainties, including the events and circumstances discussed under “Recent Developments” below, and are reminded not to place undue reliance on such statements and should not consider any such list of factors to be a complete list of risks or uncertainties. Forward-looking statements speak only as of the date they are made and the Company undertakes no obligation to update them to reflect new or changed information or events, except as may be required by federal securities laws.
 

Union Bankshares, Inc. Page 21
 

RECENT DEVELOPMENTS
 
In May, 2011, Union Bank received regulatory approval to complete its previously announced acquisition of three New Hampshire branch offices of Northway Bank, including approximately $80 million in deposits and $33 million in performing loans, the branch real estate in Groveton and North Woodstock and assumption of the branch lease in Littleton. The transaction is expected to close in late May, 2011.
 
Economic data continues to suggest a slow but positive trend towards economic recovery. Vermont and New Hampshire's unemployment rates have continued to drop throughout late 2010 and into 2011 to 5.4% and 5.2%, respectively as of March 31, 2011. These rates compare favorably with that of the United States, which had a rate of 8.8% for the same period. Interest rates remain near historic lows, which has allowed many consumers and commercial customers to reduce their monthly debt payments by refinancing their loans. Inflation appears controlled but recent global unrest, the related rise in the price of oil, the weak dollar and now an increase in grocery prices may cause an inflationary spiral. Many financial institutions who accepted government support have repaid those funds and the U.S. financial markets appear to be operating more independently now. The positive growth in stock market values have also added to a boost in consumer confidence. The value of construction contracts in January 2011, which is the latest data available, show an increase over both January 2010 and 2009 for Vermont and New Hampshire and the Company has seen a recent increase in applications for its "B.U.I.L.D." loan program, which is a sign of an improving economy.
 
Vermont and New Hampshire continue to have some of the lowest residential foreclosure rates in the country. Also, as northern New England had not experienced the dramatic run up in housing prices, likewise, we have not seen the values drop as far as other parts of the country.
 
In response to the earlier financial crisis affecting the banking and financial markets, the resulting recession and the changing political environment, many new laws, regulations and programs have been adopted or proposed. We will not attempt to discuss them all within this quarterly report but will update the ones that have been issued or modified since our annual report and which may have a financial impact on the Company.
 
The following positive developments will/may impact the Company in the future:
 
•
The second quarter 2011 change in the FDIC insurance assessment base from total deposits to net assets will reduce the Company's future assessment costs and put community banks, which generally rely more heavily on deposits as a funding source, on a more level playing field with national and regional financial institutions.
•
The decision in February 2011 to waive the 90 day recourse period upon the sale of SBA loans to the secondary market makes that a more attractive alternative for community banks and the continuing development of loan programs for small business customers is always a benefit to a community bank.
•
The FASB, citing outreach activities in which "almost all" constituents believe that amortized cost is significantly more relevant for purposes of measuring most loans, agreed to consider amortized cost as a primary attribute (in addition to fair value) for measuring financial instruments. Therefore loans and debt securities that are held as part of the "customer financing activities of a bank" may continue to be recorded at amortized cost, which will reduce future volatity in a company's financial statements while providing their readers with the most current information.
•
Starting July 21, 2011, banks will be permitted to pay interest on business checking accounts. Although it may increase a banks' overall cost of funds, this change will allow them to compete with nonbanks for these customer funds.
•
The growing recognition by the banking regulators that a one size fits all approach to regulations may not be in the industry's best interest or be adequate to address the attendent risks in each company's business model may bring some regulatory relief to community banks, as evidenced by the new Basel III capital standards and recent risk monitoring and mitigation guidance issued earlier in 2011 by the Office of Thrift Supervision.
•
The recognition in the Obama administration's recent report to Congress, "Reforming America's Housing Finance Market" that smaller lenders and community banks serve their communities more effectively than larger lenders.
•
The proposed Federal Reserve and FDIC rulemaking implementing the credit risk retention requirements of section 941 of the Dodd-Frank Act, which would generally require private securitizers to retain not less than 5% of the credit risk of the assets collateralizing any asset-backed securities issuance.
•
The Federal Home Loan Bank (FHLB) of Boston, of which Union is a member, has resumed quarterly dividend payments, with a modest dividend paid in both the first and second quarters of 2011 after two years of no dividend payment.

Union Bankshares, Inc. Page 22
 

 
•
The increased information reporting requirements and the requirement to provide health insurance vouchers to low income employees who may be participating in government sponsored insurance programs under the 2010 Health-Care Reform Act have been repealed.
 
There have been new laws, regulations and actions proposed or enacted that may be problematic for the Company in terms of future earnings and/or efficiency. The following are the most relevant:
 
•
The Dodd-Frank Act represents the biggest re-write of financial regulation in decades and bankers are faced with an estimated 5,000 pages of new or expanded regulations as a result of the bill which will take several years to implement with the full impact on the banking industry not yet known.
•
By March 15, 2012, all existing ATM's must meet the new Americans with Disabilities Act accessibility standards which will require the replacement of deployed nonconforming ATM's over the next twelve months. A review of the Company's existing machines is currently being undertaken.
•
The establishment of the new Consumer Financial Protection Bureau created by the Dodd-Frank Act may lead to conflicting regulatory guidance for community banks and increase regulatory costs and burdens but to date no new rules have been published.
•
State and national health care reform initiatives may increase employer costs to provide employer sponsored group health care plans to eligible employees. The Vermont legislature is moving towards a single payer, all inclusive model for Vermont residents.
•
The Dodd-Frank Act included a provision (the Durbin amendment) which required the Federal Reserve to set rates for debit card transaction interchange fees by April 21, 2011, to become effective July 21, 2011. The rates have been set but there has been quite a bit of debate surrounding the proposed rates and it is Management's current understanding that the implementation date may be delayed. (There were more than 41 billion debit card transactions worldwide in 2010 up 28% from the previous year.) Even though banks with assets of $10 billion or less are exempt from this provision, in reality the rate set will likely become the new norm. This price control measure will benefit the merchants at the expense of the banks and ultimately the consumers, as the rates being proposed are substantially below the cost of processing a transaction, which creates an unsustainable structure as currently proposed.
•
Among the new regulations imposed by the Dodd-Frank Act are new residential mortgage provisions that mandate more extensive disclosures, require lenders to offer terms that reasonably reflect the consumers' ability to repay a loan, prohibit mandatory arbitration provisions, add new customer protections for high-cost mortgages and set escrow account and appraisal standards. The relevant regulations promulgated to date regarding these provisions have been implemented by Union.
•
The Basel III Capital Framework published in December 2010 will increase minimum capital levels and add a new capital conservation buffer over the next nine years. Union Bankshares' ratios are well over those new minimums plus the buffer at March 31, 2011. Basel III will also implement a leverage ratio starting in 2013, a liquidity coverage ratio in 2015 and a net stable funding ratio in 2018 but these ratios have yet to be defined.
•
There are still numerous provisions of the Dodd-Frank Act that originally had an effective date of July 21, 2011 for which final regulations or guidance has not yet been issued.
 
The cost of doing business as usual has increased dramatically in this regulatory environment as the number and extent of new regulations and the speed with which they must be implemented have put a strain on software providers and staff as well as customers. Also, the cost of mitigating long term interest rate risk by selling loans to the secondary market has continued to increase and it is anticipated that this cost will continue to grow as the government sponsored entities continue to work through their own financial problems.
 
It is not completely clear at this time what impact current or future government sponsored programs, regulations or legislation will have on the Company, its customers or the U.S. and global financial markets but additional regulatory complexity and allocation of Company resources to deal with it is likely.
 
 
 
CRITICAL ACCOUNTING POLICIES
 
The Company has established various accounting policies which govern the application of U.S. Generally Accepted Accounting Principles (GAAP) in the preparation of the Company's financial statements. Certain accounting policies involve significant judgments and assumptions by management which have a material impact on the reported amount of assets, liabilities, capital, revenues and expenses and related disclosures of contingent assets and liabilities in the

Union Bankshares, Inc. Page 23
 

consolidated financial statements and accompanying notes. The SEC has defined a company's critical accounting policies as the ones that are most important to the portrayal of the company's financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates on matters that are inherently uncertain. Based on this definition, the Company has identified the accounting policies and judgments most critical to the Company. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from estimates and have a material impact on the carrying value of assets, liabilities, capital, or the results of operations of the Company.
 
The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of its consolidated financial statements. Adequacy of the allowance for loan losses is determined quarterly using a consistent, systematic methodology, which analyzes the risk inherent in the loan portfolio. In addition to evaluating the collectability of specific loans when determining the adequacy of the allowance, management also takes into consideration other qualitative factors such as changes in the mix and size of the loan portfolio, historical loss experience, the amount of delinquencies and loans adversely classified, industry trends, and the impact of the local and regional economy on the Company's borrowers. Changes in these qualitative factors may cause management's estimate of the adequacy of the allowance for loan losses to increase or decrease and result in adjustments to the Company's provision for loan losses in future periods. For additional information see FINANCIAL CONDITION- Allowance for Loan Losses below.
 
Given the disruptions in the financial markets during recent years, the decision to recognize other-than-temporary impairment on investment securities has become more difficult as complete information is not always available and market conditions and other relevant factors are subject to rapid changes. The other-than-temporary impairment decision is a critical accounting policy for the Company. Accounting guidance requires companies to perform periodic reviews of individual securities in their investment portfolios to determine whether a decline in the value of a security is other-than-temporary. A review of other-than-temporary impairment requires companies to make certain judgments regarding the cause and materiality of the decline, its effect on the financial statements and the probability, extent and timing of a valuation recovery, the company's intent and ability to continue to hold the security, and, with respect to debt securities, the likelihood that the company will have to sell the security before its value recovers. Pursuant to these requirements, management assesses valuation declines to determine the extent to which such changes are attributable to (1) fundamental factors specific to the issuer, such as the nature of the issuer and its financial condition, business prospects or other factors or (2) market-related factors, such as interest rate changes or equity market declines. Declines in the fair value of securities below their cost that are deemed by management to be other-than-temporary are (1) if equity securities, recorded in earnings as realized losses and (2) if debt securities, recorded in earnings as realized losses to the extent they are deemed credit losses, with noncredit losses recorded in Other comprehensive income (loss). Once an other-than-temporary loss on a debt or equity security is realized, subsequent gains in the value of the security may not be recognized in income until the security is sold.
 
The Company's defined benefit pension obligation and net periodic benefit cost are actuarially determined based on the following assumptions: discount rate, current and estimated future return on plan assets, wage base rate, anticipated mortality rates, Consumer Price Index, and rate of increase in compensation levels. The determination of the pension benefit obligation and net periodic benefit cost is a critical accounting estimate as it requires the use of estimates and judgments related to the amount and timing of expected future cash outflows for benefit payments and cash inflows for maturities and returns on plan assets as well as Company contributions. Changes in estimates, assumptions and actual results could have a material impact to the Company's financial condition and/or results of operations.
 
The Company also has other key accounting policies, which involve the use of estimates, judgments and assumptions, that are significant to understanding the Company's financial condition and results of operations, including the valuation of deferred tax assets, investment securities and other real estate owned (OREO). See FINANCIAL CONDITION and the subcaptions Allowance for Loan Losses, Investment Activities and Liability for Pension Benefits below. Although management believes that its estimates, assumptions and judgments are reasonable, they are based upon information presently available and can be impacted by events outside the control of the Company. Actual results may differ significantly from these estimates under different assumptions, judgments or conditions.
 

Union Bankshares, Inc. Page 24
 

OVERVIEW
 
The Company's net income was $1.0 million for the quarter ended March 31, 2011 compared to $1.2 million for the quarter ended March 31, 2010, a decrease of $191 thousand, or 15.7%. These results reflected the net effect of a decrease in net interest income of $51 thousand, or 1.1%, an increase of $182 thousand, or 14.9%, in noninterest income, an increase of $441 thousand, or 10.7%, in noninterest expenses, an increase of $60 thousand, or 66.7%, in the provision for loan losses and a $179 thousand, or 49.9%, decrease in the provision for income taxes.
 
The Company continued to face a challenging low interest rate environment as the prime rate has remained unchanged at 3.25% for the last 27 months. Total interest income decreased by $146 thousand, or 2.6%, to $5.5 million in the first quarter of 2011, versus total interest income of $5.6 million in the first quarter of 2010, but that decrease was partially offset by the decrease in interest expense from $1.1 million in 2010 to $961 thousand in 2011, a decrease of $95 thousand, or 9.0%, between periods. The result of the changes in interest income and interest expense was that net interest income for the first quarter of 2011 was $4.5 million, down $51 thousand, or 1.1%, from the first quarter of 2010 of $4.6 million. The decrease in net interest income was mainly attributable to the decrease in interest earned on investment securities and loans but was partially mitigated by the decrease in interest paid on interest-bearing deposits. During the first quarter of 2011, the Company's net interest margin decreased 22 basis points to 4.43%, from 4.65% for the first quarter of 2010. The Company's net interest spread decreased 20 basis points to 4.21% for the first quarter of 2011, compared to 4.41% for the same period last year. Further drops in the prime rate and/or increases in competitors' deposit or market borrowing rates could be problematic if individual variable rate loan and investment instruments continue to reprice downward at a faster rate than the downward repricing of deposit products.
 
The increase in noninterest income was partially due to the increase of $66 thousand in net gains on sales of loans held for sale from $102 thousand for the quarter ended March 31, 2010 to $168 thousand for the quarter ended March 31, 2011, as the volume of loans sold to the secondary market to mitigate long term interest rate risk more than doubled from $8.2 million in the first quarter of 2010 to $16.7 million in the first quarter of 2011. The volume increase was driven by the continuing low long term mortgage rates creating loan demand mainly from customers either purchasing properties or financing properties through Union when their previous mortgage was held elsewhere. There was also an increase of $42 thousand, or 4.4%, in service fee income, which was mainly due to the increase in debit card and ATM income as well as increases in loan servicing fees and merchant program income. These increases were partially offset by the decrease in overdraft and service fee income on deposit accounts. Both trust income and mortgage servicing rights income increased in the first quarter of 2011 compared to the similar period in 2010.
 
Salaries and wages were higher by $165 thousand, or 10.5%, for the first quarter of 2011 compared to the same period last year due to annual pay increases and the opening of the South Burlington, Vermont loan production office in August 2010. Pension and employee benefits were up $57 thousand, or 7.5%. All other noninterest expenses combined were up $219 thousand, or 12.1%.
 
The Company's effective tax rate decreased to 14.9% for the three months ended March 31, 2011 from 22.8% for the same period in 2010, as taxable income decreased and tax exempt income increased.
 
The Company's total assets increased from $453.0 million at December 31, 2010, to $459.7 million at March 31, 2011, an increase of $6.7 million, or 1.5%. Deposits increased from $376.7 million at December 31, 2010 to $384.0 million at March 31, 2011, an increase of $7.3 million, or 1.9%. Borrowed funds decreased from $29.0 million at December 31, 2010 to $26.9 million at March 31, 2011, a decrease of $2.1 million, or 7.2%. Total loans, including loans held for sale, decreased by $10.2 million, or 2.7%, from $381.9 million at December 31, 2010 to $371.7 million at March 31, 2011. Total loans at March 31, 2011 are net of $16.7 million residential real estate loans sold by the Company during the first three months of 2011 to mitigate future interest rate risk.
 
Although nonperforming assets increased during the first quarter, the Company's asset quality remained strong, with March 31, 2011 total nonperforming assets at $5.8 million, or 1.27% of total assets, compared to $5.2 million, or 1.15% of total assets, at December 31, 2010 and $4.9 million, or 1.12% of total assets, at March 31, 2010. The loan loss provision for the quarter ended March 31, 2011 was $150 thousand, up from $90 thousand for the same period in 2010. The higher provision was deemed by management to be appropriate in light of the increase in nonperforming loans, an increase in the qualitative reserve economic factor for residential, junior lien and construction portfolios, a change in the mix of the portfolio and the outlook for future economic conditions.
 

Union Bankshares, Inc. Page 25
 

The following unaudited per share information and key ratios depict several measurements of performance or financial condition for the three months ended or at March 31, 2011 and 2010, respectively:
 
 
Three Months Ended March 31,
 
2011
2010
Return on average assets (ROA) (1)
0.91
%
1.12
%
Return on average equity (ROE) (1)
9.94
%
11.89
%
Net interest margin (1)(2)
4.43
%
4.65
%
Efficiency ratio (3)
75.54
%
69.97
%
Net interest spread (4)
4.21
%
4.41
%
Loan to deposit ratio
96.79
%
97.93
%
Net loan charge-offs to average loans not held for sale (1)
—
 
0.15
%
Allowance for loan losses to loans not held for sale
1.06
%
0.99
%
Nonperforming assets to total assets (5)
1.27
%
1.12
%
Equity to assets
9.09
%
9.41
%
Total capital to risk weighted assets
15.43
%
15.34
%
Book value per share
$
9.37
 
$
9.28
 
Earnings per share
$
0.23
 
$
0.27
 
Dividends paid per share
$
0.25
 
$
0.25
 
Dividend payout ratio (6)
108.7
%
92.59
%
____________________
(1)
Annualized.
(2)
The ratio of tax equivalent net interest income to average earning assets. See page 27 for more information.
(3)
The ratio of noninterest expense ($4.6 million in 2011 and $4.1 million in 2010) to tax equivalent net interest income ($4.7 million in both 2011 and 2010) and noninterest income ($1.4 million in 2011 and $1.2 million in 2010) excluding securities gains (of $0 in both 2011 and 2010).
(4)
The difference between the average rate earned on earning assets and the average rate paid on  interest bearing liabilities. See page 27 for more information.
(5)
Nonperforming assets are loans or investment securities that are in nonaccrual or 90 or more days past due as well as other real estate or assets owned.
(6)
Cash dividends declared and paid per share divided by consolidated net income per share.
RESULTS OF OPERATIONS
 
Net Interest Income. The largest component of the Company’s operating income is net interest income, which is the difference between interest and dividend income received from interest earning assets and the interest expense paid on interest bearing liabilities. The Company’s net interest income decreased $51 thousand, or 1.1%, to $4.5 million for the three months ended March 31, 2011, from $4.6 million for the three months ended March 31, 2010. The net interest spread decreased 20 basis points to 4.21% for the three months ended March 31, 2011, from 4.41% for the three months ended March 31, 2010. The decrease in the net interest spread was primarily the result of the drop in average interest rates earned on interest earning assets from 5.69% for the quarter ended March 31, 2010 to 5.34% for the quarter ended March 31, 2011. The net interest margin for the first quarter of 2011 decreased 22 basis points to 4.43% from the 2010 comparison period at 4.65%, reflecting the net effect of a decrease in net interest income of $51 thousand and an increase of $17.4 million, or 4.2%, in average earning assets.
 
Yields Earned and Rates Paid. The following table shows for the periods indicated the total amount of income recorded from average interest earning assets, the related average tax equivalent yields, the interest expense associated with average interest bearing liabilities, the related average rates paid, and the resulting tax equivalent net interest spread and margin. Yield and rate information is average information for the period, and is calculated by dividing the annualized tax equivalent income or expense item for the period by the average balance of the appropriate balance sheet item during the period. Net interest margin is annualized tax equivalent net interest income divided by average earning assets. Nonaccrual loans or investments are included in asset balances for the appropriate periods, but recognition of interest on such loans or investments is discontinued and any remaining accrued interest receivable is reversed in conformity with federal regulations.

Union Bankshares, Inc. Page 26
 

 
 
 
Three Months Ended March 31,
 
2011
2010
 
Average
Balance
Interest
Earned/
Paid
Average
Yield/
Rate
Average
Balance
Interest
Earned/
Paid
Average
Yield/
Rate
 
(Dollars in thousands)
Average Assets:
 
 
 
 
 
 
Federal funds sold and overnight deposits
$
14,329
 
$
6
 
0.16
%
$
10,829
 
$
4
 
0.14
%
Interest bearing deposits in banks
13,320
 
76
 
2.31
%
20,918
 
122
 
2.36
%
Investment securities (1), (2)
23,916
 
219
 
4.17
%
23,815
 
260
 
4.88
%
Loans, net (1), (3)
373,654
 
5,196
 
5.74
%
352,283
 
5,258
 
6.14
%
FHLB of Boston stock (4)
1,922
 
1
 
0.30
%
1,922
 
—
 
—
 
Total interest earning assets (1)
427,141
 
5,498
 
5.34
%
409,767
 
5,644
 
5.69
%
Cash and due from banks
5,427
 
 
 
5,241
 
 
 
Premises and equipment
7,824
 
 
 
7,917
 
 
 
Other assets
12,232
 
 
 
13,045
 
 
 
Total assets
$
452,624
 
 
 
$
435,970
 
 
 
Average Liabilities and Stockholders' Equity:
 
 
 
 
 
 
NOW accounts
$
61,521
 
$
30
 
0.20
%
$
59,031
 
$
33
 
0.22
%
Savings/money market accounts
124,870
 
144
 
0.47
%
114,139
 
152
 
0.54
%
Time deposits
129,639
 
499
 
1.56
%
131,283
 
588
 
1.82
%
Borrowed funds
28,451
 
288
 
4.05
%
29,764
 
283
 
3.80
%
Total interest bearing liabilities
344,481
 
961
 
1.13
%
334,217
 
1,056
 
1.28
%
Noninterest bearing deposits
60,747
 
 
 
54,577
 
 
 
Other liabilities
6,034
 
 
 
6,170
 
 
 
Total liabilities
411,262
 
 
 
394,964
 
 
 
Stockholders' equity
41,362
 
 
 
41,006
 
 
 
Total liabilities and stockholders’ equity
$
452,624
 
 
 
$
435,970
 
 
 
Net interest income
 
$
4,537
 
 
 
$
4,588
 
 
Net interest spread (1)
 
 
4.21
%
 
 
4.41
%
Net interest margin (1)
 
 
4.43
%
 
 
4.65
%
__________________
(1)
Average yields reported on a tax equivalent basis using a marginal tax rate of 34%.
(2)
Average balances of investment securities are calculated on the amortized cost basis and include nonaccrual securities, if applicable.
(3)
Includes loans held for sale as well as nonaccrual loans and unamortized costs and is net of the allowance for loan losses.
(4)
Dividends on the Federal Home Loan Bank (FHLB) of Boston stock were suspended effective the fourth quarter of 2008 and resumed during the first quarter of 2011.
 

Union Bankshares, Inc. Page 27
 

Tax exempt interest income amounted to $296 thousand and $256 thousand for the three months ended March 31, 2011 and 2010, respectively. The following table presents the effect of tax exempt income on the calculation of the net interest margin, using a marginal tax rate of 34% for 2011 and 2010:
 
For The Three Months
Ended March 31,
 
2011
2010
 
(Dollars in thousands)
Net interest income as presented
$
4,537
 
$
4,588
 
Effect of tax-exempt interest
 
 
Investment securities
31
 
31
 
Loans
94
 
77
 
Net interest income, tax equivalent
$
4,662
 
$
4,696
 
 
Rate/Volume Analysis. The following table describes the extent to which changes in average interest rates (on a fully tax-equivalent basis) and changes in volume of average interest earning assets and interest bearing liabilities have affected the Company's interest income and interest expense during the period indicated. For each category of interest earning assets and interest bearing liabilities, information is provided on changes attributable to:
 
•
changes in volume (change in volume multiplied by prior rate);
•
changes in rate (change in rate multiplied by prior volume); and
•
total change in rate and volume.
 
Changes attributable to both rate and volume have been allocated proportionately to the change due to volume and the change due to rate.
 
Three Months Ended March 31, 2011
Compared to
Three Months Ended March 31, 2010
Increase/(Decrease) Due to Change In
 
Volume
Rate
Net
 
(Dollars in thousands)
Interest earning assets:
 
 
 
Federal funds sold and overnight deposits
1
 
1
 
2
 
Interest bearing deposits in banks
(43
)
(3
)
(46
)
Investment securities
1
 
(42
)
(41
)
Loans, net
305
 
(367
)
(62
)
FHLB of Boston stock
—
 
1
 
1
 
Total interest earning assets
264
 
(410
)
(146
)
Interest bearing liabilities:
 
 
 
NOW accounts
1
 
(4
)
(3
)
Savings/money market accounts
13
 
(21
)
(8
)
Time deposits
(7
)
(82
)
(89
)
Borrowed funds
(12
)
17
 
5
 
Total interest bearing liabilities
(5
)
(90
)
(95
)
Net change in net interest income
269
 
(320
)
(51
)
 
Three Months Ended March 31, 2011, Compared to Three Months Ended March 31, 2010.
 
Interest and Dividend Income. The Company’s interest and dividend income decreased $146 thousand, or 2.6%, to $5.5 million for the three months ended March 31, 2011, from $5.6 million for the same period last year, despite an increase in average earning assets of $17.4 million, or 4.2%, to $427.1 million, from $409.8 million for the three months ended March 31, 2010. The positive effect on interest income resulting from the rise in the average volume of earning assets was more than offset by the lower rates earned on interest bearing deposits in banks, investment securities and loans in the first quarter of 2011 versus 2010. In particular, interest income on loans decreased $62 thousand, or

Union Bankshares, Inc. Page 28
 

1.2%, to $5.2 million for the first quarter of 2011 versus the $5.3 million for the 2010 comparison period, despite an increase of $21.4 million in average loan volume between periods. Average loans approximated $373.7 million at an average yield of 5.74% for the three months ended March 31, 2011, up $21.4 million from an average of $352.3 million at an average yield of 6.14% for the three months ended March 31, 2010. The increase in average loan volume was more than offset by a 40 basis point decrease in average yield.
 
The Company has continued to manage interest rate risk by selling low rate qualified residential mortgages originated during 2011 to the secondary market and has benefited from the sale of these mortgages, with gains of $168 thousand on loan sales of $16.7 million for the quarter ended March 31, 2011, compared to gains of $102 thousand on loan sales of $8.2 million during the same period last year.
 
The average balance of investments (including mortgage-backed securities) increased $101 thousand, or 0.4%, to $23.9 million for the three months ended March 31, 2011, from $23.8 million for the three months ended March 31, 2010. The average balance invested in interest bearing deposits in banks for the quarter was $13.3 million, down $7.6 million, or 36.3%, from the average level of $20.9 million for the 2010 comparison period. The average balance of federal funds sold and overnight deposits increased $3.5 million, or 32.3%, to $14.3 million for the three months ended March 31, 2011, from $10.8 million for the three months ended March 31, 2010. Interest income from nonloan instruments decreased $84 thousand, or 21.8%, between periods, with $302 thousand for the first quarter of 2011 versus $386 thousand for the same period of 2010, reflecting the decreases in yields on interest bearing deposits and investment securities as well as the overall decrease in volume.
 
Interest Expense. The Company’s interest expense decreased $95 thousand, or 9.0%, to $961 thousand for the three months ended March 31, 2011, from $1.1 million for the three months ended March 31, 2010. The decrease was primarily attributable to lower rates on all interest bearing liabilities except borrowed funds.
 
Interest expense on deposits decreased $100 thousand, or 12.9%, to $673 thousand for the quarter ended March 31, 2011, from $773 thousand for the quarter ended March 31, 2010. Although competition for deposits has remained strong, average interest bearing deposits for the quarter ended March 31, 2011 increased $11.5 million, or 3.8%, to $316.0 million compared to average interest bearing deposits of $304.5 million for the same period last year. This increase reflects the overall growth in the franchise as well as the impact of higher FDIC insurance coverage and the continuing uncertainty surrounding the financial markets. Average time deposits decreased to $129.6 million for the three months ended March 31, 2011, from $131.3 million for the three months ended March 31, 2010, or a decrease of $1.6 million, or 1.3%. The average rate paid on time deposits during the first quarter of 2011 decreased 26 basis points, to 1.56% from 1.82% for the first quarter of 2010. The average balances for money market and savings accounts increased $10.7 million, or 9.4%, to $124.9 million for the three months ended March 31, 2011, from $114.1 million for the three months ended March 31, 2010 while the average rate paid on these deposits dropped from 0.54% to 0.47%. A $2.5 million, or 4.2%, increase in NOW accounts brought the average balance up to $61.5 million from $59.0 million between the two comparison periods while the average rate paid dropped to 0.20% from 0.22%.
 
Provision for Loan Losses. There was a $150 thousand loan loss provision for the quarter ended March 31, 2011 compared to a $90 thousand loan loss provision for the quarter ended March 31, 2010. Although improvement in travel and tourism industry sales has been reported during 2011 in comparison to 2010, the industry has not rebounded to pre-recession levels and the impact of the decline in revenue during the last two years is still evident in the local market. Nonperforming loans increased by $850 thousand between March 31, 2010 and March 31, 2011; while loans specifically reserved for increased by approximately $312 thousand. Between December 31, 2010 and March 31, 2011, nonperforming loans increased by $832 thousand and loans specifically reserved for increased approximately $278 thousand. As a result of the qualitative review during the first quarter 2011, the economic reserve factors assigned to the residential, junior lien and construction portfolios all increased by 0.05%. The higher provision in the first quarter of 2011 was deemed appropriate by management in light of the increase in nonperforming loans (90+ days past due or nonaccrual), as well as the change in reserve factors, the change in the mix of the portfolio and current economic conditions. For further details see, FINANCIAL CONDITION Allowance for Loan Losses and Asset Quality below.
 

Union Bankshares, Inc. Page 29
 

Noninterest Income. The following table sets forth changes from the first quarter of 2010 to the first quarter of 2011 for components of noninterest income:
 
For The Three Months Ended March 31,
 
2011
2010
$ Variance
% Variance
 
(Dollars in thousands)
Trust income
$
132
 
$
109
 
$
23
 
21.1
Service fees
1,006
 
964
 
42
 
4.4
Net gains on sales of loans held for sale
168
 
102
 
66
 
64.7
Other income
95
 
44
 
51
 
115.9
Total noninterest income
$
1,401
 
$
1,219
 
$
182
 
14.9
 
Noninterest income was $1.4 million, or 20.3%, of total income for the three months ended March 31, 2011 versus $1.2 million, or 17.8%, of total income for the three months ended March 31, 2010. This increase between years reflected the effect of higher income in all categories.
 
Trust income. Trust income increased by $23 thousand, or 21.1%, between the quarters ended March 31, 2011 and March 31, 2010, as dollars in managed and nonmanaged fiduciary accounts grew by 40.3% and 5.6%, respectively, between March 31, 2010 and 2011. Fees are normally charged on asset values.
 
Service fees. Service fees increased $42 thousand, or 4.4%, between the first quarter of 2010 and the first quarter of 2011. A main reason was due to the growth in debit card and ATM fees resulting from the growth in the volume of electronic transactions. There was also an increase in loan servicing fees between years due to the increased volume of residential mortgage loans serviced as well as an increase in merchant program income as commercial customers’ electronic transactions increased. These increases were partially offset by the decrease in overdraft and service fee income on deposit accounts.
 
Net gains on sales of loans held for sale. Residential real estate loans of $16.7 million were sold for a net gain of $168 thousand during the first quarter of 2011, versus sales of $8.2 million for a net gain of $102 thousand during the first quarter of 2010. The volume of loans sold to mitigate low long term mortgage rates more than doubled in 2011 as the loan demand created by these low rates from customers either purchasing properties or financing properties through Union when their previous mortgage was held elsewhere was very strong.
 
Other income. Other income increased $51 thousand, or 115.9%, which was mainly due to the net income from mortgage servicing rights due to the higher volume of residential loan sales in the first quarter of 2011.
 
Noninterest Expense. The following table sets forth changes from the first quarter of 2010 to the first quarter of 2011 for components of noninterest expense:
 
For The Three Months Ended March 31,
 
2011
2010
$ Variance
% Variance
 
(Dollars in thousands)
Salaries and wages
$
1,730
 
$
1,565
 
$
165
 
10.5
 
Pension and employee benefits
817
 
760
 
57
 
7.5
 
Occupancy expense, net
290
 
255