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Section 1: 10-K (BODY OF FORM 10-K)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(  ) TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended
December 31, 2019
Commission file number
 001-15985
UNION BANKSHARES, INC.
 
VERMONT
 
03-0283552
 
P.O. BOX 667
20 LOWER MAIN STREET
MORRISVILLE, VT 05661-0667
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
    UNB
The NASDAQ Stock Market LLC
 
 
(Title of class)
(Trading Symbol(s))
(Exchanges registered on)
 
Securities registered pursuant to Sections 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [  ] No [X]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [  ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X ]    No [ ]
Indicate by check mark whether the registrant has submitted electronically 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 such files). YES [X] NO [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” ”accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer [  ]
Accelerated filer [X]
Non-accelerated filer [  ] (Do not check if a smaller reporting company)
Smaller reporting company [X]
Emerging growth company [ ]
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards proviced pursuant to Section 13(a) of the Exchange Act. [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes [  ] No [X]
The aggregate market value of the common stock held by non-affiliates of the registrant on June 30, 2019 was $145,240,175 based on the closing price on the NASDAQ Stock Market LLC on such date of $37.01 per share. For purposes of this calculation, all directors, executive officers, and named executives of the Registrant are assumed to be affiliates. Such assumption, however, shall not be deemed to be an admission of such status as to any such individual.





DOCUMENTS INCORPORATED BY REFERENCE
Specifically designated portions of the following documents are incorporated by reference in the indicated Part of this Annual Report on Form 10-K:
Document
 
Part
Proxy Statement for the 2020 Annual Meeting of Shareholders
 
III




UNION BANKSHARES, INC.
Table of Contents

Part I
Item 1 -
Business
Item 1A -
Risk Factors
Item 1B -
Unresolved Staff Comments
Item 2 -
Properties
Item 3 -
Legal Proceedings
Item 4 -
Mine Safety Disclosures
 
 
 
Part II
Item 5 -
Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Item 6 -
Selected Financial Data
Item 7 -
Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A -
Quantitative and Qualitative Disclosures about Market Risk
Item 8 -
Financial Statements and Supplementary Data
Item 9 -
Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
Item 9A -
Controls and Procedures
Item 9B -
Other Information
 
 
 
Part III
Item 10 -
Directors, Executive Officers and Corporate Governance (a)
Item 11 -
Executive Compensation (a)
Item 12 -
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters (a)
Item 13 -
Certain Relationships and Related Transactions, and Director Independence (a)
Item 14 -
Principal Accountant Fees and Services (a)
 
 
 
Part IV
Item 15 -
Exhibits, Financial Statement Schedules and Reports on Form 8-K
 
 
 
Signatures
 
Exhibit Index
 

____________________

(a)
The information required by Part III Items 10, 11, 12, 13 and 14 is incorporated herein by reference, in whole or in part, from the Company's Proxy Statement for the Annual Meeting of Shareholders to be held on May 20, 2020. The incorporation by reference herein of portions of the Proxy Statement shall not be deemed to specifically incorporate by reference the information referred to in Items 407(d)(1)-(3) of Regulation S-K. Incorporation by reference of this report into any registration statement filed by the Company under the Securities Act of 1933, as amended shall not be deemed to incorporate by reference the information referred to in Item 201(e) of Regulation S-K.

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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 SEC, in its reports to stockholders, including this Annual 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 terms “believes,” “expects,” “predicts,” “anticipates,” “intends,” "projects," "potential," “plans,” “seeks,” “estimates,” "targets," "goals," “may,” “might,” “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.
Factors that may cause results or performance to differ materially from those expressed in forward-looking statements include, but are not limited to:
weakness in the United States economy in general and the regional and local economies within Northern Vermont and New Hampshire, which could result in deterioration of credit quality, an increase in the allowance for loan losses or a reduced demand for the Company's credit products and services;
Increased competitive pressures, including those from tax-advantaged credit unions and other financial service providers in the Company's northern Vermont and New Hampshire market area or in the financial services industry generally, from increasing consolidation and integration of financial service providers, and from changes in technology and delivery systems;
Interest rates change in such a way that puts pressure on the Company's margins, or that results in lower fee income and lower gain on sale of real estate loans, or that increases interest costs;
Changes in tax or banking laws and regulations;
Changes in the level of nonperforming assets and charge-offs;
Changes in depositor behavior resulting in movement of funds out of bank deposits and into the stock market or other higher-yielding investments;
Changes in estimates of future reserve requirements based upon relevant regulatory and accounting requirements;
Changes in information technology that require increased capital spending or that result in new or increased risks;
Changes in consumer and business spending, borrowing and savings habits;
Changes in accounting principles, including those governing the manner of estimating our credit risk and calculating our loan loss reserve, as may be adopted by the regulatory agencies as well as the FASB, and other accounting standard setters;
Volatility in the securities markets that could adversely affect the value or credit quality of the Company's assets, impairment of goodwill, or the availability and terms of funding necessary to meet the Company's liquidity needs, and that could lead to impairment in the value of the securities in the Company's investment portfolio
Further changes to the regulations governing the calculation of the Company’s regulatory capital ratios;
Increased competitive pressures affecting the ability of the Company to attract, develop and retain employees;
Increased cybersecurity threats;
Changes in trade, monetary, and fiscal policies and laws, including interest rate policies of the FRB; and
Volatility in the financial markets and adverse impacts on the national, state and local economy, due to the Coronavirus pandemic or other significant external events.
When evaluating forward-looking statements to make decisions about the Company and our stock, investors and others are cautioned to consider these and other risks and uncertainties, and are reminded not to place undue reliance on such statements. Investors should not consider the foregoing 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.

PART I
Item 1.    Business

Certain Definitions: Capitalized terms used in the following discussion and not otherwise defined below have the meanings assigned to them in Note 1 to the Company's audited consolidated financial statements contained in Part II, item 8, page 50 of this Annual Report.


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General: Union Bankshares, Inc. (“Company”) is a one-bank holding company whose sole subsidiary is Union Bank (“Union”). It was incorporated in the State of Vermont in 1982. The Company's common stock is traded on the NASDAQ Global Select Market under the symbol "UNB". Union Bank was organized and chartered as a State bank in 1891 and became a wholly owned subsidiary of the Company in 1982 upon its formation. Both Union Bankshares, Inc. and Union Bank are headquartered in Morrisville, Vermont.
The Company's business is that of a community bank in the financial services industry. The Company has one definable business segment, Union Bank, which provides full retail, commercial, municipal banking, and asset management and trust services throughout its 20 banking offices, two loan centers, and several ATMs covering northern Vermont and northern New Hampshire. Also, many of Union's services are provided via the telephone, mobile devices, and through its website, www.ublocal.com. Union seeks to make a profit for the Company while providing quality retail banking services to individuals and commercial banking services to small and medium sized corporations, partnerships, and sole proprietorships, as well as nonprofit organizations, local municipalities and school districts within its market area.
The Company's income is derived principally from interest and fees on loans and earnings on other investments. Its primary expenses arise from interest paid on deposits and borrowings, salaries and wages, health insurance and other employee benefits and other general overhead expenses, including occupancy and equipment expenses. Our profitability depends primarily on net interest income, which is the difference between interest and dividend income on interest-earning assets and interest expense on interest-bearing liabilities. Interest-earning assets include loans, investment securities, and interest-earning deposits in banks. Interest-bearing liabilities primarily include customer deposit accounts and borrowings. Net interest income is dependent upon the level of interest rates and the extent to which such rates change, as well as changes in the volume of various categories of assets and liabilities. Our profitability is also dependent on the level of noninterest income (primarily gains on sale of real estate loans, loan servicing income, and service fees), provision for loan losses, noninterest expenses and income taxes. Our operations and profitability are subject to changes in interest rates, applicable statutes and regulations, changes in corporate tax rates, general economic conditions, the competitive environment, as well as other factors beyond our control.

Employees: The Company itself does not have any paid employees. As of December 31, 2019, Union employed 201 full time equivalent employees. Union employees are not represented by any collective bargaining group. Union maintains comprehensive employee benefit programs for its employees, including medical and dental insurance, long-term and short-term disability insurance, life insurance and a 401(k) plan. Management considers its employee relations to be good.

Description of Services: Services or products offered to our customers include, but are not limited to, the following:
Commercial loans for business purposes to business owners and investors for plant and equipment, working capital, real estate renovation and other sound business purposes;
Commercial real estate loans on income producing properties, including commercial construction loans;
SBA guaranteed loans;
Residential construction and mortgage loans;
Online cash management services, including account reconciliation, credit card depository, Automated Clearing House origination, wire transfers and night depository;
Merchant credit card services for the deposit and immediate credit of sales drafts;
Remote deposit capture for merchants;
Online mortgage applications;
Business checking accounts;
Standby letters of credit, bank checks or money orders, and safe deposit boxes;
ATM services;
Debit MasterCard and ATM cards;
Telephone, internet, and mobile banking services, including bill pay;
Home improvement loans and overdraft checking privileges against preauthorized lines of credit;
Retail depository services including personal checking accounts, checking accounts with interest, savings accounts, money market accounts, certificates of deposit, IRA/SEP/KEOGH accounts and Health Savings accounts; and
Asset management and trust services to individuals and organizations.
Consistent with the objective of the Company to serve the financial needs of individuals, businesses and others within its market areas, the Company seeks to concentrate its assets in loans. For the year ended December 31, 2019, the Company's rate of average loans to average deposits was 93.8%. To be consistent with the requirements of prudent banking practices, adequate levels of assets are invested in high-grade securities, FDIC insured certificates of deposits, or other prudent investment alternatives such as company-owned life insurance and investments in real estate limited partnerships for affordable housing. Deposits are the primary source of funds for use in lending, investing and for other general operating purposes. In addition we obtain funds from principal repayments, sales and prepayments of loans, securities and FDIC insured certificates of deposit. Other funding sources

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may include brokered deposits purchased through CDARS, ICS or through other deposit brokers, and borrowings from the FHLB, correspondent banks or the Federal Reserve discount window.

Competition: The Company and Union face substantial competition for loans and deposits in northern Vermont and New Hampshire from local and regional commercial banks, savings banks, tax exempt credit unions, mortgage brokers, and financial services affiliates of bank holding companies, as well as from national financial service providers such as mutual funds, brokerage houses, insurance companies, consumer finance companies and internet banks. Within the Company's market area are branches of several commercial and savings banks that are substantially larger than Union. Union focuses on its community banking niche and on providing convenient locations, hours and modes of delivery to provide superior customer service. We have seen over the last few years, a trend by customers to turn to local community banks to fulfill their financial needs with organizations and people they know and trust. We are hopeful that this trend will continue. The Company seeks to capitalize upon the extensive business and personal contacts and relationships of its directors, advisory board members and officers to continue to develop the Company's customer base, as well as relying on director and advisory board referrals, officer-originated calling programs and customer and shareholder referrals.
In order to compete with the larger financial institutions in its service area, Union capitalizes on the flexibility and local autonomy which is accorded by its independent status. This includes an emphasis on personal service, timely decision making, local promotional activity, and personal contacts and community service by Union's officers, directors and employees. The Company strives to inform the public about the strength of the Company, the variety and flexibility of services offered, as well as the strength of the local economy relative to the national economy and global problems in the real estate market and provides information on financial topics of interest. The Company also strives to educate future generations by helping them to cultivate sound personal financial habits through its "Save for Success" program for children.
The Company competes for deposit accounts by offering customers competitive products and rates, personal service, local area expertise, convenient locations and access, and an array of financial services and products. Higher interest rates and deposit “specials” offered by competitors as well as the variety of nonbanking investment avenues open to our customers and the public make deposit growth challenging.
The competition in originating real estate and other loans comes principally from commercial banks, savings banks, mortgage banking companies and tax exempt credit unions. The Company competes for loan originations primarily through the interest rates and loan fees it charges, the types of loans it offers, and the efficiency and quality of services it provides. In addition to residential mortgage lending and municipal loans, the Company also emphasizes commercial real estate, construction, and both conventional and SBA guaranteed commercial lending. Factors that affect the Company's ability to compete for loans include general and local economic conditions, prevailing interest rates including the “prime” rate, and pricing volatility of the secondary loan markets. The Company promotes an increased level of personal service and expertise within the community to position itself as a lender to small to middle market business and residential customers, which tend to be under-served by larger institutions.
The Company, through Union's Asset Management Group division, competes for personal and institutional asset management and trust business with trust companies, commercial banks having trust departments, investment advisory firms, brokerage firms, mutual funds and insurance companies.

Regulation and Supervision
General
The following discussion addresses elements of the regulatory framework applicable to bank holding companies and their subsidiaries. This regulatory framework is intended primarily for the protection of depositors, the Federal Deposit Insurance Fund (“DIF”), and the banking system as a whole, rather than the protection of shareholders or non-depository creditors of a bank holding company such as the Company.
As a bank holding company, the Company is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve System (“FRB”) under the Bank Holding Company Act of 1956, as amended (“BHCA”). As a state chartered commercial bank, Union Bank is subject to the regulation and supervision by the FDIC and the DFR.
The following is a summary of certain aspects of various statutes and regulations applicable to the Company and its subsidiary. This summary is not a comprehensive analysis of all applicable laws, and you should refer to the applicable statutes and regulations for more information. Changes in applicable laws or regulations, and in their interpretation and application by regulatory agencies and other governmental authorities, cannot be predicted, but may have a material effect on our business, financial condition or results of operations.
This regulation and supervision establishes a comprehensive framework of activities in which a bank holding company or a bank can engage. The prior approval of the FDIC and DFR is required, among other things, for Union to establish or relocate a branch office, assume deposits or engage in any merger, consolidation, purchase or sale of all or substantially all of the assets of any bank.

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This regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to classification of assets and establishment of adequate credit loss reserves for regulatory purposes. To the extent that this information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions.
The Company is also under the jurisdiction of the SEC for matters relating to the offer and sale of its securities as well as investor reporting requirements. The Company is subject to restrictions, reporting requirements, and review procedures under federal securities laws and regulations. The Company's common stock is listed on the NASDAQ Global Select Market under the trading symbol “UNB” and accordingly, the Company is subject to the rules of NASDAQ for listed companies.

Financial Regulatory Reform Legislation
The Dodd-Frank Act. The Dodd-Frank Act, enacted in 2010, comprehensively reformed the regulation of financial institutions and the products and services they offer. Among other things, the Dodd-Frank Act:
granted the FRB increased supervisory authority and codified the source of strength doctrine,
provided new capital standards applicable to the Company,
modified the scope and costs associated with deposit insurance coverage,
permitted well capitalized and well managed banks to acquire other banks in any state subject to certain deposit concentration limits and other conditions,
permitted the payment of interest on business demand deposit accounts,
established the CFPB and transferred rulemaking authority to it under various consumer protection laws relating to financial products and services,
established new minimum mortgage underwriting standards for residential mortgages,
barred banking organizations, such as the Company, from engaging in proprietary trading and from sponsoring and investing in hedge funds and private equity funds, except as permitted under certain circumstances, and
established the Financial Stability Oversight Council to designate certain activities as posing a risk to the United States financial systems and recommended new or heightened standards and safeguards for financial institutions engaging in such activities.
While the Dodd-Frank Act is focused principally on changes to the financial regulatory system, it includes several corporate governance, disclosure and compensation provisions applicable to public companies. Those provisions include:
A requirement that public companies solicit an advisory vote on executive compensation ("Say-on-Pay"), an advisory vote on the frequency of Say-on-Pay votes and, in the event of a merger or other extraordinary transaction, an advisory vote on certain "golden parachute" payments. The Company's last Say-on-Pay vote was held at the 2019 annual meeting with shareholders approving the Company's executive compensation program by a wide margin,
Requirements that the SEC adopt rules directing the securities exchanges to adopt listing standards with respect to compensation committee independence and the use of consultants,
Provisions calling for the SEC to adopt expanded disclosure requirements for annual proxy statements and other filings, particularly in the area of executive compensation, such as disclosure of pay versus performance, the ratio of CEO pay to the pay of a median employee and policies with regard to hedging transactions conducted by employees and directors,
Provisions requiring the adoption or revision of certain other corporate policies, such as compensation "clawback" policies providing for the recovery of executive compensation in the event of a financial restatement, and
A provision clarifying the SEC's authority to adopt rules requiring issuers to include in their proxy statements solicitations for shareholder nominations for directors.
Although disclosure requirements for public companies increased under the Dodd-Frank Act, the Company is a “smaller reporting company” and as permitted under the rules and regulations of the SEC, has elected to provide certain scaled disclosures in this Annual Report and in its annual meeting proxy statement, including scaled disclosures regarding executive compensation.

Bank Holding Company Regulation
As a bank holding company, the Company is subject to regulation, supervision and examination by the FRB, which has the authority, among other things, to order bank holding companies to cease and desist from unsafe or unsound banking practices; to assess civil money penalties; and to order termination of non-banking activities or termination of ownership and control of a non-banking subsidiary by a bank holding company.
Source of Strength. Under long-standing FRB policy and now codified in the Dodd-Frank Act, bank holding companies, such as Union Bankshares, are required to act as a source of financial and management strength to their subsidiary banks, such as Union, and to commit resources to support them. This support may be called for at times when a bank holding company may not have the required resources to do so.

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Acquisitions and Activities. Under the BHCA, the activities of bank holding companies, such as Union Bankshares Inc., and those of companies that they control, such as Union, or in which they hold more than 5% of the voting stock, are limited to banking, managing or controlling banks, furnishing services to or performing services for their subsidiaries, or certain activities that the FRB has determined to be so closely related to banking, managing or controlling banks as to be a proper incident thereto. Satisfactory capital ratios, CRA ratings and anti-money laundering policies are generally prerequisites to obtaining Federal regulatory approval to make acquisitions. Financial holding companies may engage in certain nonbanking activities not permitted for bank holding companies. Union Bankshares Inc. has not elected to become a financial holding company.
Enforcement Powers. The FRB has the authority to issue cease and desist orders against bank holding companies to prevent or terminate unsafe or unsound banking practices, violations of law and regulations, or conditions imposed by, or violations of agreements with, or commitments to, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals who violate the BHCA or orders or regulations thereunder, to order termination of nonbanking activities of nonbanking subsidiaries of bank holding companies, and to order termination of ownership and control of a nonbanking subsidiary by a bank holding company. There are no enforcement actions currently in place against the Company.
The FRB has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices. The FRB has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the FRB's view that a bank holding company should pay cash dividends only to the extent that the company's net income for the past year is sufficient to cover both the cash dividends and rate of earnings retention that is consistent with the company's capital needs, asset quality and overall financial condition.

Regulation of Union Bank
Union is subject to regulation, supervision, and examination by the FDIC. Pursuant to the Dodd-Frank Act, the FRB may directly examine the subsidiary of the Company. The enforcement powers available to the federal banking regulators include, among other things, the ability to issue cease and desist or removal orders; to terminate insurance of deposits; to assess civil money penalties; to issue directives to increase capital; to place the Bank into receivership; and to initiate injunctive actions against banking organizations and institution-affiliated parties. There are no such enforcement actions currently in place against Union.
Deposit Insurance. As a member of the FDIC, the deposits of Union are permanently insured under the Deposit Insurance Fund (“DIF”) maintained by the FDIC up to $250,000 per ownership category. Under applicable federal laws and regulations, deposit insurance premium assessments to the DIF are based on a supervisory risk rating system, with the most favorably rated institutions paying the lowest premiums. Under this assessment system, risk is defined and measured using an institution's supervisory ratings, combined with certain other risk measures, including certain financial ratios and long-term debt issuer ratings. For the year ended December 31, 2019, the Bank's total FDIC insurance assessment expense was $271 thousand.
Brokered Deposits. The FDICIA restricts the ability of an FDIC insured bank to accept brokered deposits unless it is a well capitalized institution under FDICIA's prompt corrective action guidelines. Union accepts brokered time and money market deposits primarily through its membership with the Promontory Interfinancial Network in CDARS and ICS, respectively. Additionally, Union has established an account with one of its approved investment brokers to accept brokered deposits as an approved liquidity source. The Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 allows the Company to hold reciprocal deposits up to 20 percent of total liabilities without those deposits being treated as brokered for regulatory purposes.
Community Reinvestment Act ("CRA"). Union is subject to the federal CRA, which requires banks to demonstrate their commitment to serving the credit needs of low and moderate income residents of their communities. Union participates in a variety of direct and indirect lending programs and other investments for the benefit of low and moderate income residents in its local communities. The FDIC conducts examinations of insured banks' compliance with CRA requirements and rates institutions as "Outstanding," "Satisfactory," "Needs to Improve," and "Substantial NonCompliance." Failure of an institution to receive at least a "Satisfactory" CRA rating could adversely affect its ability to undertake certain activities, such as branching and acquisitions of other financial institutions, which require regulatory approval based, in part, on the institution's record of CRA compliance. In addition, failure of a bank subsidiary to receive at least a "Satisfactory" rating would disqualify a bank holding company from eligibility to become or remain a financial holding company under the GLBA. Union has received at least a "Satisfactory" rating from all CRA compliance examinations by the FDIC.
Federal Reserve Board Policies and Reserve Requirements. The monetary policies and regulations of the FRB have had a significant effect on the operating results of banks in the past and are expected to continue to do so in the future. FRB policies affect the levels of bank earnings on loans and investments and the levels of interest paid on bank deposits and borrowings through the Federal Reserve System's open-market operations in United States government securities, regulation of the discount rate and terms on bank borrowings from Federal Reserve Banks and regulation of nonearning reserve requirements. Regulation D promulgated by the FRB requires all depository institutions to maintain reserves against their transaction accounts (generally, demand deposits, NOW accounts and certain other types of accounts that permit payments or transfers to third parties) and nonpersonal nontime deposits (generally, money market deposit accounts or other savings deposits held by corporations or other depositors that are not

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natural persons, and certain types of time deposits), subject to certain exemptions. As of December 31, 2019, Union's reserve requirement was approximately $1.8 million, which was satisfied by vault cash.

Capital Adequacy and Safety and Soundness
Capital Adequacy Guidelines. The FDIC and other federal bank regulatory agencies adopted a final rule for leverage and risk-based capital requirements and the method for calculating risk-weighted assets which is consistent with agreements that were reached by the Basel Committee on Banking Supervision under the so-called Basel III framework and certain provisions of the Dodd-Frank Act. Among other things, the rule established a common equity Tier 1 capital ratio with a minimum requirement of 4.5%, increased the minimum Tier 1 risk based ratio from 4.0% to 6.0%, and assigned a higher risk weight of 150% to exposures that are more than 90 days past due or in nonaccrual status as well as certain commercial real estate loans that finance the acquisition, development or construction of real property. The final rule also required accumulated OCI be included for purposes of calculating regulatory capital unless a one time opt-out election was made during the first quarter of 2015. The Company and Union both made the election. The rule limits a banking organization's capital distributions and certain discretionary bonus payments if the banking organization does not hold a "capital conservation buffer" of 2.5% above the minimum capital ratio requirements. Following a multi-year phase in period, the 2.5% capital conservation buffer requirement became fully effective for the Company and Union on January 1, 2019.
The Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 directed the federal banking regulators to adopt rules providing for a simplified regulatory capital framework for qualifying community banking organizations. In September 2019, the banking regulators finalized a rule that introduced the community bank leverage ratio (CBLR) framework as an optional simplified measure of capital adequacy for qualifying institutions. A banking organization with a Tier I leverage ratio greater than 9.0%, less than $10 billion in average consolidated assets, and limited amounts of off-balance sheet exposures and trading assets and liabilities may opt into the CBLR framework and will be deemed "well capitalized" and will not be required to report or calculate risk-based capital. A qualifying community bank may utilize the CBLR framework beginning with the March 31, 2020 regulatory capital calculation. A community banking organization that does not meet the requirements for use of the simplified CBLR framework will continue to calculate its regulatory capital ratios under existing guidelines. Please refer to Note 22 (Regulatory Capital Requirements) to the Company's audited consolidated financial statements contained in Part II, Item 8 of this Annual Report on Form 10-K for the regulatory capital ratios for the Company and Union as of December 31, 2019 and December 31, 2018.
A financial institution's failure to meet minimum regulatory capital standards can lead to other penalties, including termination of deposit insurance or appointment of a conservator or receiver for the financial institution. Risk based capital ratios are the primary measure of regulatory capital presently applicable to bank holding companies. Risk based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure and to minimize disincentives for holding liquid assets.
Federal bank regulatory agencies require banking organizations that engage in significant trading activity to calculate a capital charge for market risk. Significant trading activity means trading activity of at least 10% of total assets or $1 billion, whichever is smaller, calculated on a consolidated basis for bank holding companies. Federal bank regulators may apply the market risk measure to other bank holding companies, as the agency deems necessary or appropriate for safe and sound banking practices. Each agency may exclude organizations that it supervises that otherwise meet the criteria under certain circumstances. The market risk charge will be included in the calculation of an organization's risk based capital ratio. Neither the Company nor Union is currently subject to this special capital charge.
Prompt Corrective Action. FDICIA, among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the respective federal banking agencies to implement systems for “prompt corrective action” for insured depository institutions that do not meet minimum capital requirements. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An “undercapitalized” bank must develop a capital restoration plan and its parent holding company must guarantee that bank's compliance with the plan. The liability of the parent holding company under any such guarantee is limited to the lesser of 5% of the bank's assets at the time it became undercapitalized or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent's general unsecured creditors. In addition, FDICIA requires the various federal banking agencies to prescribe certain noncapital standards for safety and soundness related generally to operations and management, asset quality and executive compensation, and permits regulatory action against a financial institution that does not meet such standards.
The various federal banking agencies have adopted substantially similar regulations that define the five capital categories identified by FDICIA, using the Tier 1 Capital, Common Equity Tier 1 Capital, Total Capital and Leverage Ratios as the relevant capital measures. Such regulations establish various degrees of corrective action to be taken when an institution is considered

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undercapitalized. Under the regulations as in effect during 2019, a “well capitalized” institution must have a Tier 1 capital ratio of at least 8.0%, a Common Equity Tier 1 ratio of 6.5%, a total capital ratio of at least 10% and a leverage ratio of at least 5% and not be subject to a capital directive order.
At December 31, 2019, Union's Tier I and Total Risk Based Capital Ratios were 11.9% and 13.0% respectively, and its Leverage Capital Ratio was 8.1%, and it is considered well capitalized under applicable regulatory guidelines in effect as of such date. However, an increase in the amount of capital that the Company or Union must maintain in order to support a given level of assets would reduce the amount of leverage that our capital could support and increased volatility could be problematic. Our ability to increase our level of interest earning assets or to allocate those assets in the best manner to generate interest income may be adversely affected.
Safety and Soundness Standards. FDICIA, as amended, directs each Federal banking agency to prescribe safety and soundness standards for depository institutions relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, asset quality, earnings and stock valuation. The Community Development and Regulatory Improvement Act of 1994 amended FDICIA by allowing Federal banking regulators to publish guidelines rather than regulations concerning safety and soundness.
FDICIA also contains a variety of other provisions that may affect Union's operations, including reporting requirements, regulatory guidelines for real estate lending, “truth in savings” disclosure provisions, and a requirement to provide 90 days prior notice to customers and regulatory authorities before closing any branch. Union is subject to §112 of FDICIA, which requires an additional annual reporting to the FDIC, FRB, and DFR regarding preparation of the annual financial statements, the maintenance of an internal control structure for financial reporting and compliance with certain designated banking laws, as well as imposition of increased responsibilities on the Company's external auditor and audit committee.

Dividend Restrictions
As a bank holding company, the Company's ability to pay dividends to its stockholders is largely dependent on the ability of its subsidiary to pay dividends to it. Payment of dividends by Vermont-chartered banks, such as Union, is subject to applicable state and federal laws. Under Vermont banking laws, a Vermont-chartered bank may not authorize dividends or other distributions that would reduce the bank's capital below the amount of capital required in the bank's Certificate of General Good or under any capital or surplus standards established by the Commissioner of the DFR. Union does not have any capital restrictions in its Certificate of General Good and, to date, the Commissioner of the DFR has not adopted capital or surplus standards. Nevertheless, the capital standards established by the FDIC, described above under "Prompt Corrective Action" apply to Union, and the capital standards of the FRB apply to the Company on a consolidated basis. In addition, the FRB, the FDIC and the Commissioner of the DFR are authorized under applicable federal and state laws to prohibit payment of dividends that are determined to be an unsafe or unsound practice. Payment of dividends that significantly deplete the capital of a bank or a bank holding company, or render it illiquid, could be found to be an unsafe or unsound practice. Further, the Basel III capital standards limit a financial institution's ability to pay dividends if it does not maintain a required capital conservation buffer.

Consumer Protection Regulation
The Company and Union are subject to a number of federal and state laws designed to protect consumers and prohibit unfair or deceptive business practices, including, but not limited to, the Equal Credit Opportunity Act, the Fair Housing Act, the Home Ownership Protection Act, the Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act of 2003 (the “FACT Act”), GLBA, the Truth in Lending Act, CRA, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the National Flood Insurance Act and various state law counterparts. Union is also subject to laws and regulations to protect consumers in connection with their deposit or electronic transactions. These laws include the Truth in Savings Act, the Electronic Funds Transfer Act and the Expedited Funds Availability Act. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must interact with customers when taking deposits, making loans, collecting loans and providing other services. Further, the Dodd-Frank Act established the CFPB, which has the responsibility for making rules and regulations under the federal consumer protection laws relating to financial products and services. The CFPB also has a broad mandate to prohibit unfair or deceptive acts and practices and is specifically empowered to require certain disclosures to consumers and draft model disclosure forms under the various federal consumer protection laws. The CFPB is charged with enforcing consumer protection laws against banks with assets in excess of $10 billion, while community banks continue to be subject to the enforcement authority of their primary regulator. This supervisory structure may lead to conflicting regulatory guidance for community banks versus larger banks and increase regulatory costs and burdens. Failure to comply with consumer protection laws and regulations can subject financial institutions to enforcement actions, fines and other penalties.
Mortgage Reform. The Dodd-Frank Act prescribes certain standards that mortgage lenders must consider before making a residential mortgage loan, including verifying a borrower’s ability to repay such mortgage loan, and allows borrowers to assert violations of certain provisions of the Truth-in-Lending Act as a defense to foreclosure proceedings. Under the Dodd-Frank Act, prepayment penalties are prohibited for certain mortgage transactions and creditors are prohibited from financing credit life/disability insurance

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policies in connection with a residential mortgage loan or home equity line of credit. In addition, the Dodd-Frank Act prohibits mortgage originators from receiving compensation based on the terms of residential mortgage loans and generally limits the ability of a mortgage originator to be compensated by others if compensation is received from a consumer. The Dodd-Frank Act requires mortgage lenders to make additional disclosures prior to the extension of credit, in each billing statement, and for negative amortization loans and hybrid adjustable rate mortgages. Additionally, the CFPB published rules and forms that combined certain disclosures that consumers receive in connection with applying for and closing on a residential mortgage loan under the Truth in Lending Act (Regulation Z) and the Real Estate Settlement Procedures Act (Regulation X), also known as the TILA and RESPA Integrated Disclosures, or TRID. TRID established new disclosure timing requirements and applies to most closed-end consumer credit transactions secured by real property.
Privacy and Customer Information Security. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, we must provide our customers with a disclosure that explains our policies and procedures regarding the disclosure of such nonpublic personal information. We must also provide an updated notice if we change our information-sharing practices. Except as otherwise required or permitted by law, we are prohibited from disclosing nonpublic personal information except as provided in such policies and procedures. The GLBA also requires that we develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information (as defined under the GLBA), to protect against anticipated threats or hazards to the security or integrity of such information; and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. We are also required to send a notice to customers whose “sensitive information” has been compromised if unauthorized use of this information is “reasonably possible.” Most of the states, including the states where we operate, have enacted legislation concerning breaches of data security and our duties in response to a data breach. Congress continues to consider federal legislation that would require consumer notice of data security breaches. Pursuant to the FACT Act, we have developed and implemented a written identity theft prevention program to detect, prevent, and mitigate identity theft in connection with the opening of certain accounts or certain existing accounts.
Additionally, the FACT Act amends the Fair Credit Reporting Act to generally prohibit a person from using information received from an affiliate to make a solicitation for marketing purposes to a consumer, unless the consumer is given notice and a reasonable opportunity and simple method to opt out of the making of such solicitations.
Home Mortgage Disclosure Act (“HMDA”). HMDA makes information available to the public that helps to show whether financial institutions are serving the housing credit needs of their neighborhoods and communities. The Act requires institutions to gather and compile data about loan applications for home purchase, home improvement and refinances where both the old loan and new loan are secured by a dwelling. The information must be compiled each calendar year on a Loan/Application Register, and submitted to the FFIEC by March 1st of the following year and made available to the public no later than March 31st. The Federal Financial Institutions Examinations Council prepares a series of tables that comprise the disclosure statement for each reporting institution. HMDA applies to financial institutions that have their main office or any branch in a Metropolitan Statistical Area ("MSA"). Union is subject to HMDA as it has branch offices within the Burlington, Vermont MSA. In accordance with the Dodd-Frank Act, the CFPB adopted new regulations effective for covered loan applications with action taken dates on or after January 1, 2018. The new rules expand coverage to include the majority of loan applications secured by a dwelling, including many applications for open-end loans. Additionally, the CFPB has increased the number of data points that must be collected and reported upon, to include information regarding geographical data, loan terms, underwriting practices and loan pricing.

Regulation of Other Activities
Transactions with Related Parties. The Company's and Union's authority to extend credit, purchase or sell an asset from or to their directors, executive officers and 10% or more stockholders, as well as to entities controlled by such persons, is governed by the requirements of the Federal Reserve Act and Regulation O of the FRB thereunder. Among other things, these provisions require that extensions of credit to insiders (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based in part, on the amount of the bank's capital. Under applicable guidelines, any related party transaction, including a loan, must be reviewed by the Company's Audit Committee. In addition, under the federal SOX Act (discussed below), the Company, itself, may not extend or arrange for any personal loans to its directors and executive officers. The Company has a Related Persons Transactions Approval Policy administered by the Company's Audit Committee which incorporates applicable regulatory guidelines and requirements.
Interstate Banking. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 authorized an adequately capitalized and managed bank holding company to acquire banks based outside its home state, generally without regard to whether the state's law would permit the acquisition, and also authorized banks to merge across state lines thereby creating interstate branches. In addition, this Act authorized banks to acquire existing interstate branches (short of merger) or to establish new interstate branches.

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States were given the right, exercisable before June 1, 1997, to prohibit altogether or impose certain limitations on interstate mergers and the acquisition or establishment of interstate branches. The Dodd-Frank Act removed remaining state law impediments to de novo interstate branching. Although interstate banking and branching may result in increased competitive pressures in the markets in which the Company operates, interstate branching may also present competitive opportunities for locally-owned and managed banks, such as Union, that are familiar with the local markets and that emphasize personal service and prompt, local decision-making. The ability to branch interstate has also benefited Union, as it permitted the expansion of its banking operations into New Hampshire, with the conversion of its loan production office in Littleton to a full service branch in March of 2006, the May 2011 acquisition of three New Hampshire branches, the opening of a full service branch in Lincoln in 2014, and the opening of a loan production office in North Conway in 2018.
Affiliate Restrictions. Bank holding companies and their affiliates are subject to certain restrictions under the Federal Reserve Act in their dealings with each other, such as in connection with extensions of credit, transfers of assets, and purchase of services among affiliated parties. The Dodd-Frank Act further tightened these restrictions. Generally, loans or extensions of credit, issuances of guarantees or letters of credit, investments or purchases of assets by a subsidiary bank from a bank holding company or its affiliates are limited to 10% of the bank's capital and surplus (as defined by federal regulations) with respect to each affiliate and to 20% in the aggregate for all affiliates, and borrowings are also subject to certain collateral requirements. These transactions, as well as other transactions between a subsidiary bank and its holding company or other affiliates must generally be on arms-length terms, that is, on terms comparable to those involving nonaffiliated companies. Further, under the Federal Reserve Act and FRB regulations, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in-arrangements in connection with extensions of credit or lease or sale of property, furnishing of property or services to third parties. The Company and Union are subject to these restrictions in their intercompany transactions.
Bank Secrecy Act. Union is subject to federal laws establishing record keeping, customer identification and reporting requirements pertaining to large or suspicious cash transactions, purchases of other monetary instruments and the international transfer of cash or monetary instruments that may signify money laundering. Provisions designed to help combat international terrorism, were added to the Bank Secrecy Act by the 2001 USA Patriot Act. These provisions require banks to avoid establishing or maintaining correspondent accounts of foreign off-shore banks and banks in jurisdictions that have been found to fall significantly below international anti-money laundering standards. U.S. banks are also prohibited from opening correspondent accounts for off-shore shell banks, defined as banks that have no physical presence and that are not part of a regulated and recognized banking company. The USA Patriot Act requires all financial institutions to adopt an anti-money laundering program and to establish due diligence policies, procedures and controls that are reasonably designed to detect and report instances of money laundering in United States private banking accounts and correspondent accounts maintained for non-U.S. persons or their representatives. Effective May, 11, 2018, banks are required to comply with enhanced customer due diligence regulations requiring collection of information on beneficial owners and control persons of legal entity customers.
The due diligence requirements issued by the Department of Treasury require minimum standards to verify customer identity and maintain accurate records, encourage information sharing cooperation among financial institutions, federal banking agencies and law enforcement authorities regarding possible money laundering or terrorist activities, prohibit the anonymous use of “concentration accounts” and require all covered financial institutions to have in place an anti-money laundering compliance program. In addition, the USA Patriot Act amended certain provisions of the federal Right to Financial Privacy Act to facilitate the access of law enforcement to bank customer records in connection with investigating international terrorism.
The USA Patriot Act also amended the BHC Act and the Bank Merger Act to require the federal banking agencies to consider the effectiveness of a financial institution's anti-money laundering program when reviewing applications under these acts for mergers, acquisitions, and certain other expansion activities.
SOX Act. This far reaching federal legislation, enacted in 2002, was generally intended to protect investors by strengthening corporate governance and improving the accuracy and reliability of corporate disclosures made pursuant to federal securities laws. The SOX Act includes provisions addressing, among other matters, the duties, functions and qualifications of audit committees for all public companies; certification of financial statements by the chief executive officer and the chief financial officer; the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; disclosure of off-balance sheet transactions; a prohibition on personal loans to directors and officers, except (in the case of banking companies) loans in the normal course of business; expedited filing requirements for reports of beneficial ownership of company stock by insiders; disclosure of a code of ethics for senior officers, and of any change or waiver of such code; the formation of a public accounting oversight board; auditor independence; disclosure of fees paid to the company's auditors for non-audit services and limitations on the provision of such services; attestation requirements for company management and external auditors, relating to internal controls and procedures; and various increased criminal penalties for violations of federal securities laws.
NASDAQ. In response to the SOX Act, the NASDAQ Exchange on which the Company's common stock is listed, implemented comprehensive corporate governance listing standards, including rules strengthening director independence requirements for boards and committees of the board, the director nomination process and shareholder communication avenues. These rules require

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the Company to annually certify to the NASDAQ, after each annual meeting, that the Company is in compliance and will continue to comply with the NASDAQ corporate governance requirements.
Taxing Authorities. The Company and Union are subject to income taxes at the Federal level and are individually subject to state taxation based on the laws of each state in which they operate. The Company and Union file a consolidated federal tax return with a calendar year end. The Company and Union have filed separate tax returns for each state jurisdiction affected for 2018 and will do the same for 2019. No tax return is currently being examined or audited by any taxing authority that the Company is aware of. The taxing authorities also regulate the information reporting requirements that Union is subject to, and which continue to increase and require resources to comply with.

Available Information
The Company files annual, quarterly, and current reports, proxy statements, and other documents with the SEC under the Securities Exchange Act of 1934 (the “Exchange Act”). These reports, proxy statements, and other documents are available to the public on the internet website maintained by the SEC at www.sec.gov.
Our Internet website address is www.ublocal.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, including any amendments to those reports filed or furnished pursuant to section 13(a) or 15(d), proxy statements filed pursuant to Section 14(a) and reports filed pursuant to Section 16, 13(d) and 13(g) of the Exchange Act are available free of charge through the Investor Relations page of our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the SEC. The information on our website is not incorporated by reference into this report.
The Company will also provide copies of this 2019 Annual Report on Form 10-K, free of charge, upon written request to its Treasurer at the Company's main address, PO Box 667, Morrisville, VT 05661-0667. Shareholder meeting materials for our 2020 Annual Meeting are available at www.materials.proxyvote.com/905400 no later than the date on which they are mailed to shareholders.

Item 1A. Risk Factors
An investment in the Company involves risk, some of which, including market, liquidity, credit, operational, legal, compliance, reputational and strategic risks, could be substantial and is inherent in our business. The material risks and uncertainties that management believes affect the Company are described below. Any of the following risks could affect the Company’s financial condition and results of operations and could be material and/or adverse in nature. You should consider all of the following risks together with all of the other information in this Annual Report on Form 10-K.

Our loans are concentrated in certain areas of Vermont and New Hampshire and adverse conditions in those markets could adversely affect our operations.
We are exposed to real estate and economic factors throughout Vermont and New Hampshire. Further, because a substantial portion of our loan portfolio is secured by real estate in Vermont and New Hampshire, the value of the associated collateral is subject to real estate market conditions in those states and in the northern New England region more generally. Adverse economic, political and business developments or natural hazards may affect these areas and the ability of property owners in these areas to make payments of principal and interest on the underlying mortgages. If these areas experience adverse economic, political or business conditions, or significant natural hazards, we would likely experience higher rates of loss and delinquency on our loan portfolio than if the portfolio were more geographically diverse.

If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings could decrease.
We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. On a quarterly basis the allowance for loan loss is presented to Union's Board of Directors for discussion, review, and approval. We rely on our loan reviews, our experience, and our evaluation of economic conditions, among other factors, in determining the amount of the allowance for loan losses. If our assumptions prove to be incorrect, our allowance for loan losses may not be sufficient to cover the losses we could experience, resulting in additions to our allowance and a related charge to our income. In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, which may have a material adverse effect on our financial condition or results of operations.

Our commercial, commercial real estate and construction loan portfolio may expose us to increased credit risks.
At December 31, 2019, approximately 50% of our loan portfolio was comprised of commercial and commercial real estate loans. In general, commercial and commercial real estate loans have historically posed greater credit risks than owner occupied residential mortgage loans.  The repayment of commercial real estate loans depends on the business and financial condition of borrowers. Economic events and changes in government regulations, which we and our borrowers cannot control or reliably predict, could have an adverse impact on the cash flows generated by the businesses and properties securing our commercial and commercial

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real estate loans and on the values of the collateral securing those loans. Repayment of commercial loans depends substantially on the borrowers’ underlying business, financial condition and cash flows.  Commercial loans are generally collateralized by equipment, inventory, accounts receivable and other fixed assets.  Compared to real estate, that type of collateral is more difficult to monitor, its value is harder to ascertain, it may depreciate more rapidly and it may not be as readily saleable if repossessed.

Changes in interest rates and interest rate volatility may reduce our profitability.
Our consolidated earnings and financial condition are primarily dependent upon net interest income, which is the difference between interest earned from loans and investments and interest paid on deposits and borrowings. Net interest income can be affected significantly by changes in market interest rates. In particular, changes in relative interest rates may reduce our net interest income as the difference between interest income and interest expense decreases. As a result, we have adopted asset and liability management policies to minimize the potential adverse effects of changes in interest rates on net interest income, primarily by altering the mix and maturity of loans, investments and funding sources. However, there can be no assurance that a change in interest rates will not negatively impact our results of operations or financial condition. Because market interest rates may change by differing magnitudes and at different times, significant changes in interest rates over an extended period of time could reduce overall net interest income. An increase in interest rates could also have a negative impact on our results of operations by reducing the ability of borrowers to repay their current loan obligations, which could not only result in increased loan defaults, foreclosures and write-offs, but also necessitate further increases to our allowance for loan losses. Higher interest rates could also cause depositors to shift funds from accounts that have a comparatively lower cost, to accounts with a higher cost. If the cost of interest-bearing deposits increases at a rate greater than the yields on interest-earning assets, net interest income will be negatively affected.

Our cost of funds for banking operations may increase as a result of loss of deposits or a change in deposit mix.
Deposits are a lower cost and stable source of funding. We compete with banks and other financial institutions for deposits. Funding costs may increase if we lose deposits and are forced to replace them with more expensive sources of funding, if clients shift their deposits into higher cost products or if we need to raise interest rates to avoid losing deposits. Higher funding costs reduce our net interest margin, net interest income and net income.

Wholesale funding sources may prove insufficient to replace deposits at maturity and support our operations and future growth.
We and our bank subsidiary must maintain sufficient funds to respond to the needs of depositors and borrowers. To manage liquidity, we draw upon a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. These sources include FHLB advances, liquidity lines of credit with correspondent banks, proceeds from the sale of investments and loans, and liquidity resources at the holding company. Our ability to manage liquidity will be severely constrained if we are unable to maintain access to funding or if adequate financing is not available to accommodate future growth at acceptable costs. In addition, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, operating margins and profitability would be adversely affected. Turbulence in the capital and credit markets may adversely affect our liquidity and financial condition and the willingness of certain counterparties and customers to do business with us.

We operate in a highly regulated environment and may be adversely affected by changes in laws, regulations and monetary policy.
We are subject to regulation and supervision by the FRB and Union Bank is subject to regulation and supervision by the FDIC and the DFR. Federal and state laws and regulations govern numerous matters affecting us, including changes in the ownership or control of banks and bank holding companies, maintenance of adequate capital and sound financial condition, permissible types, amounts and terms of loans and investments, permissible nonbanking activities, the level of reserves against deposits and restrictions on dividend payments. The FDIC and the DFR possess the power to issue cease and desist orders against banks subject to their jurisdiction to prevent or remedy unsafe or unsound banking practices or violations of law, and the FRB possesses similar powers with respect to bank holding companies. These and other restrictions limit the manner in which we may conduct business and obtain financing.
We are also affected by the monetary policies of the FRB. Changes in monetary or legislative policies may affect the interest rates we must offer to attract deposits and the interest rates we must charge on our loans, as well as the manner in which we offer deposits and make loans. These monetary policies have had, and are expected to continue to have, significant effects on the operating results of depository institutions generally, including Union Bank.
The laws, rules, regulations, and supervisory guidance and policies applicable to us are subject to regular modification and change. It is impossible to predict the competitive impact that any such changes would have on the banking and financial services industry in general or on our business in particular. Such changes may, among other things, increase the cost of doing business, limit permissible activities, or affect the competitive balance between banks and other financial institutions. The Dodd-Frank Act instituted major changes to the banking and financial institutions regulatory regimes in light of government intervention in the financial services sector. Other changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways. Such changes could

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subject us to additional costs, limit the types of financial services and products we may offer, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, or policies could result in sanctions by regulatory agencies, civil money penalties, and/or reputational damage, which could have a material adverse effect on our business, financial condition, or results of operations.

Additional requirements imposed by the Dodd-Frank Act could adversely affect us.
The Dodd-Frank Act comprehensively reformed the regulation of financial institutions, products and services. Among other things, the Dodd-Frank Act established the CFPB as an independent bureau of the FRB. The CFPB has the authority to prescribe rules for all depository institutions governing the provision of consumer financial products and services, which may result in rules and regulations that reduce the profitability of such products and services or impose greater costs and restrictions on us and our subsidiaries. The Dodd-Frank Act also established new minimum mortgage underwriting standards for residential mortgages, and the regulatory agencies have focused on the examination and supervision of mortgage lending and servicing activities.
The CFPB’s qualified mortgage rule, or “QM Rule,” became effective on January 10, 2014. The QM Rule requires mortgage lenders, prior to originating most residential mortgage loans, to make a determination of a borrower’s ability to repay the loan and establishes protections from liability under this requirement for so-called “qualified mortgages” that meet certain heightened criteria. If a mortgage lender does not appropriately establish a borrower’s ability to repay the loan, the borrower may be able to assert against the originator of the loan or any subsequent transferee, as a defense to foreclosure by way of recoupment or setoff, a violation of the ability-to-repay requirement. Loans that meet the definition of “qualified mortgage” will be presumed to have complied with the ability-to-repay standard. The QM Rule and related ability-to-repay requirements and similar rules could limit Union's ability to make certain types of loans or loans to certain borrowers, or could make it more expensive and time-consuming to make these loans, which could limit the Bank’s growth or profitability.
Current and future legal and regulatory requirements, restrictions, and regulations, including those imposed under the Dodd-Frank Act, may adversely impact our profitability and may have a material and adverse effect on our business, financial condition, or results of operations; may require us to invest significant management attention and resources to evaluate and make any changes required by the legislation and related regulations; and may make it more difficult for us to attract and retain qualified executive officers and employees.

We may become subject to more stringent capital requirements.
The federal banking agencies issued a joint final rule, or the “Final Capital Rule,” that implemented the Basel III capital standards and established the minimum capital levels required under the Dodd-Frank Act which became effective as of January 1, 2015. The Final Capital Rule established a minimum common equity Tier I capital ratio of 6.5% of risk-weighted assets for a “well capitalized” institution and increased the minimum Tier I capital ratio for a “well capitalized” institution from 6.0% to 8.0%. Additionally, subject to a transition period, the Final Capital Rule requires an institution to maintain a 2.5% common equity Tier I capital conservation buffer over the 6.5% minimum risk-based capital requirement for “adequately capitalized” institutions, or face restrictions on the ability to pay dividends or discretionary bonuses, and engage in share repurchases. The Final Capital Rule increased the required capital for certain categories of assets, including high-volatility construction real estate loans and certain exposures related to securitizations; however, the Final Capital Rule retained the current capital treatment of residential mortgages. Under the Final Capital Rule, we made a one-time, permanent election to continue to exclude accumulated other comprehensive income from capital. If we had not made this election, unrealized gains and losses would be included in the calculation of our regulatory capital. Although, as mandated by the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018, the federal banking regulators in 2019 adopted a simplified capital framework known as the community bank leverage ratio (CBLR) framework for qualifying community banks which will become effective with the March 31, 2020 regulatory capital calculation, the Company is unlikely to qualify to utilize the CBLR framework as of such date. To the extent that the Company does not qualify to utilize the CBLR framework, further increases in applicable capital requirements may adversely affect our ability to pay dividends, or require us to reduce business levels or raise capital, including in ways that may adversely affect our results of operations or financial condition.

We may incur fines, penalties and other negative consequences from regulatory violations, possibly even inadvertent or unintentional violations. 
We maintain systems and procedures designed to ensure that we comply with applicable laws and regulations. However, some legal/regulatory frameworks provide for the imposition of fines or penalties for noncompliance even though the noncompliance was inadvertent or unintentional and even though there was in place at the time systems and procedures designed to ensure compliance. For example, we are subject to regulations issued by the Office of Foreign Assets Control, or “OFAC,” that prohibit financial institutions from participating in the transfer of property belonging to the governments of certain foreign countries and designated nationals of those countries and certain other persons or entities whose interest in property is blocked by OFAC-administered sanctions. OFAC may impose penalties for inadvertent or unintentional violations even if reasonable processes are in place to prevent the violations. There may be other negative consequences resulting from a finding of noncompliance, including

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restrictions on certain activities. Such a finding may also damage our reputation and could restrict the ability of institutional investment managers to invest in our securities.

We face significant legal risks, both from regulatory investigations and proceedings and from private actions brought against us.
From time to time we are named as a defendant or are otherwise involved in various legal proceedings. There is no assurance that litigation with private parties will not increase in the future. Future actions against us may result in judgments, settlements, fines, penalties or other results adverse to us, which could materially adversely affect our business, financial condition or results of operations, or cause serious reputational harm to us. As a participant in the financial services industry, we are exposed to a high level of litigation related to our businesses and operations. Although we maintain insurance, the scope of this coverage may not provide us with full, or even partial, coverage in any particular case. As a result, a judgment against us in any such litigation could have a material adverse effect on our financial condition and results of operation.
Our businesses and operations are also subject to increasing regulatory oversight and scrutiny, which could lead to regulatory investigations or enforcement actions. These and other initiatives from federal and state officials could result in judgments, settlements, fines or penalties, or cause us to be required to restructure our operations and activities, all of which could lead to reputational damage, or higher operational costs, thereby reducing our revenue.

Our financial condition and results of operations have been adversely affected, and may continue to be adversely affected, by general market and economic conditions.
We have been, and continue to be, impacted by general business and economic conditions in the United States and, to a lesser extent, abroad.  These conditions include short-term and long-term interest rates, inflation, money supply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance, unemployment and the strength of the U.S. economy and the local economies in which we operate, all of which are beyond our control. Deterioration or continued weakness in any of these conditions could result in increases in loan delinquencies and nonperforming assets, decreases in loan collateral values, the value of our investment portfolio and demand for our products and services.

Competition in the local banking industry may impair our ability to attract and retain customers at current levels.
Competition in the markets in which we operate may limit our ability to attract and retain customers. In particular, we compete for loans, deposits and other financial products and services with local independent banks, thrift institutions, savings institutions, mortgage brokerage firms, credit unions, finance companies, trust companies, mutual funds, insurance companies and brokerage and investment banking firms operating locally as well as nationally. Additionally, banks and other financial institutions with larger capitalization, as well as financial intermediaries not subject to bank regulatory restrictions, have larger lending limits and are able to serve the credit and investment needs of larger customers. There is also increased competition by out-of-market competitors through the Internet. If we are unable to attract and retain customers, we may be unable to continue our loan growth and our results of operations and financial condition may otherwise be negatively impacted.

If we do not maintain net income growth, the market price of our common stock could be adversely affected.
Our return on stockholders’ equity and other measures of profitability, which affect the market price of our common stock, depend in part on our continued growth and expansion. Our growth strategy has two principal components: internal growth and external growth. Our ability to generate internal growth is affected by the competitive factors described below as well as by the primarily rural characteristics and related demographic features of the markets we serve. Our ability to continue to identify and invest in suitable acquisition candidates on acceptable terms is an important component of our external growth strategy. In pursuing acquisition opportunities, we may be in competition with other companies having similar growth strategies. As a result, we may not be able to identify or acquire promising acquisition candidates on acceptable terms. Competition for these acquisitions could result in increased acquisition prices and a diminished pool of acquisition opportunities. An inability to find suitable acquisition candidates at reasonable prices could slow our growth rate and have a negative effect on the market price of our common stock.

Prepayments of loans may negatively impact our business.
Generally, our customers may prepay the principal amount of their outstanding loans at any time. The speed at which such prepayments occur, as well as the size of such prepayments, are within our customers’ discretion. If customers prepay the principal amount of their loans, and we are unable to lend those funds to other borrowers or invest the funds at the same or higher interest rates, our interest income will be reduced. A significant reduction in interest income could have a negative impact on our results of operations and financial condition.
 
We may incur significant losses as a result of ineffective risk management processes and strategies.
We seek to monitor and control our risk exposure through a risk and control framework encompassing a variety of separate but complementary financial, credit, operational, compliance and legal reporting systems, internal controls, management review

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processes and other mechanisms. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, those techniques and the judgments that accompany their application may not be effective and may not anticipate every economic and financial outcome in all market environments or the specifics and timing of such outcomes.

Environmental liability associated with our lending activities could result in losses.
In the course of business, we may acquire, through foreclosure, properties securing loans we have originated or purchased that are in default. Particularly in commercial real estate lending, there is a risk that material environmental violations could be discovered at these properties. In this event, we might be required to remedy these violations at the affected properties at our sole cost and expense. The cost of remedial action could substantially exceed the value of affected properties. We may not have adequate remedies against the prior owners or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have an adverse effect on our financial condition and results of operations.

We must adapt to information technology changes in the financial services industry, which could present operational issues, require significant capital spending, or impact our reputation.
The financial services industry is constantly undergoing technological changes, with frequent introductions of new technology-driven products and services. We invest significant resources in information technology system enhancements in order to provide functionality and security at an appropriate level. The effective use of technology increases efficiency and enables financial institutions to better serve customers and reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully implement and integrate future system enhancements could adversely impact the ability to provide timely and accurate financial information in compliance with legal and regulatory requirements, which could result in sanctions from regulatory authorities. Such sanctions could include fines and suspension of trading in our stock, among others. In addition, future system enhancements could have higher than expected costs and/or result in operating inefficiencies, which could increase the costs associated with the implementation as well as ongoing operations.
Failure to properly utilize system enhancements that are implemented in the future could result in impairment charges that adversely impact our financial condition and results of operations and could result in significant costs to remediate or replace the defective components. In addition, we may incur significant training, licensing, maintenance, consulting and amortization expenses during and after systems implementations, and any such costs may continue for an extended period of time.

A failure in or breach of our operational systems, information systems, or infrastructure, or those of our third party vendors and other service providers, may result in financial losses, loss of customers, or damage to our reputation.
We rely heavily on communications and information systems to conduct our business. In addition, we rely on third parties to provide key components of our infrastructure, including internet connections, and network access. These types of information and related systems are critical to the operation of our business and essential to our ability to perform day-to-day operations, and, in some cases, are critical to the operations of certain of our customers. These third parties with which we do business or that facilitate our business activities, including exchanges, clearing firms, financial intermediaries or vendors that provide services or security solutions for our operations, could also be sources of operational and information security risk to us, including breakdowns or failures of their own systems or capacity constraints. Although we have safeguards and business continuity plans in place, our business operations may be adversely affected by significant and widespread disruption to our physical infrastructure or operating systems that support our business and our customers, resulting in financial losses, loss of customers, or damage to our reputation.

An interruption or breach in security of our information systems or those related to merchants and third party vendors, including as a result of cyber attacks, could disrupt our business, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, or result in financial losses.
Our technologies, systems, networks and software, and those of other financial institutions have been, and are likely to continue to be, the target of cybersecurity threats and attacks, which may range from uncoordinated individual attempts to sophisticated and targeted measures directed at us. These cybersecurity threats and attacks may include, but are not limited to, attempts to access information, including customer and company information, malicious code, computer viruses and denial of service attacks that could result in unauthorized access, misuse, loss or destruction of data (including confidential customer information), account takeovers, unavailability of service or other events. These types of threats may result from human error, fraud or malice on the part of external or internal parties, or from accidental technological failure. Further, to access our products and services our customers may use computers and mobile devices that are beyond our security control systems. The risk of a security breach or disruption, particularly through cyber-attack or cyber intrusion, including by computer hackers, has increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased.
Our business requires the collection and retention of large volumes of customer data, including payment card numbers and other personally identifiable information in various information systems that we maintain and in those maintained by third parties with

17



whom we contract to provide data services. We also maintain important internal company data such as personally identifiable information about our employees and information relating to our operations. The integrity and protection of that customer and company data is important to us. As customer, public, legislative and regulatory expectations and requirements regarding operational and information security have increased, our operations systems and infrastructure must continue to be safeguarded and monitored for potential failures, disruptions and breakdowns.
Our customers and employees have been, and will continue to be, targeted by parties using fraudulent e-mails and other communications in attempts to misappropriate passwords, payment card numbers, bank account information or other personal information or to introduce viruses to our customers’ computers. These communications may appear to be legitimate messages sent by the Bank or other businesses, but direct recipients to fake websites operated by the sender of the e-mail or request that the recipient send a password or other confidential information via e-mail or download a program. Despite our efforts to mitigate these threats through product improvements, use of encryption and authentication technology to secure online transmission of confidential consumer information, and customer and employee education, such attempted frauds against us or our merchants and our third party service providers remain a serious issue. The pervasiveness of cyber security incidents in general and the risks of cyber-crime are complex and will continue to evolve.
Although we make significant efforts to maintain the security and integrity of our information systems and have implemented various measures to manage the risk of a security breach or disruption, there can be no assurance that our security efforts and measures will be effective or that attempted security breaches or disruptions would not be successful or damaging. Even the most well-protected information, networks, systems and facilities remain potentially vulnerable because attempted security breaches, particularly cyber-attacks and intrusions, or disruptions will occur in the future, and because the techniques used in such attempts are constantly evolving and generally are not recognized until launched against a target, and in some cases are designed not to be detected and, in fact, may not be detected. Accordingly, we may be unable to anticipate these techniques or to implement adequate security barriers or other preventative measures, and thus it is virtually impossible for us to entirely mitigate this risk. A security breach or other significant disruption could: 1) disrupt the proper functioning of our networks and systems and therefore our operations and/or those of certain of our customers; 2) result in the unauthorized access to, and destruction, loss, theft, misappropriation or release of confidential, sensitive or otherwise valuable information of ours or our customers, including account numbers and other financial information; 3) result in a violation of applicable privacy, data breach and other laws, subjecting the Bank to additional regulatory scrutiny and exposing the Bank to civil litigation, governmental fines and possible financial liability; 4) require significant management attention and resources to remedy the damages that result; or 5) harm our reputation or cause a decrease in the number of customers that choose to do business with us or reduce the level of business that our customers do with us. The occurrence of any such failures, disruptions or security breaches could have a negative impact on our results of operations, financial condition, and cash flows as well as damage our brand and reputation.
Although we maintain an insurance policy covering certain cybersecurity risks which we believe provides appropriate coverage for a financial institution of our size and business and technology profile, we cannot provide any assurance that such policy would be sufficient to cover all financial losses or damages we might suffer in the event that we or one of our third party vendors experiences a system failure or suffers a system intrusion or other cyberattack.

We may be unable to attract and retain key personnel.
Our success depends, in large part, on our ability to attract and retain key personnel.  Competition for qualified personnel in the financial services industry can be intense and we may not be able to hire or retain the key personnel that we depend upon for success.  The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of the loss of their skills, knowledge of the markets in which we operate and years of industry experience, and because of the difficulty of promptly finding qualified replacement personnel.

We are subject to reputational risk.
We are dependent on our reputation within our market area, as a trusted and responsible financial service provider, for all aspects of our relationships with customers, employees, vendors, third-party service providers, and others, with whom we conduct business or potential future business. Our actual or perceived failure to (a) identify and address potential conflicts of interest, ethical issues, money-laundering, or privacy issues; (b) meet legal and regulatory requirements applicable to the Bank and to the Company; (c) maintain the privacy of customer and accompanying personal information; or (d) maintain adequate record keeping; and (e) identify the legal, reputational, credit, liquidity and market risks inherent in our products, could give rise to reputational risk that could harm our business prospects and adversely affect our financial condition and results of operations. If we fail to address any of these issues in an appropriate manner, we could be subject to additional legal risks, which, in turn, could increase the size and number of litigation claims and damages asserted or subject us to enforcement actions, fines and penalties and cause us to incur related costs and expenses. Our ability to attract and retain customers and employees could be adversely affected to the extent our reputation is damaged.


18



We may suffer losses as a result of operational risk or technical system failures.
The potential for operational risk exposure exists throughout our organization. Integral to our performance is the continued efficacy of our internal processes, systems, relationships with third parties and the associates and executives in our day-to-day and ongoing operations. Operational risk also encompasses the failure to implement strategic objectives in a successful, timely and cost-effective manner. Failure to properly manage operational risk subjects us to risks of loss that may vary in size, scale and scope, including loss of customers, operational or technical failures, unlawful tampering with our technical systems, ineffectiveness or exposure due to interruption in third party support, as well as the loss of key individuals or failure on the part of key individuals to perform properly. Although we seek to mitigate operational risk through a system of internal controls, losses from operational risk could take the form of explicit charges, increased operational costs, harm to our reputation or foregone opportunities.

We rely on other companies to provide key components of our business infrastructure.
Third party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers or otherwise conduct our business efficiently and effectively. Replacing these third party vendors could also entail significant business disruption, delay and expense.

We are a holding company and depend on Union Bank for dividends, distributions and other payments.
We are legal entity that is separate and distinct from Union Bank. Our revenue (on a parent company only basis) is derived primarily from interest and dividends paid to us by Union Bank. Our right, and consequently the right of our shareholders, to participate in any distribution of the assets or earnings of any subsidiary through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors (including depositors, in the case of Union Bank), except to the extent that certain claims of Union in a creditor capacity may be recognized.

Our stockholders may not receive dividends on our common stock.
Holders of our common stock are entitled to receive dividends only when, as and if declared by our board of directors. Although we have historically declared cash dividends on our common stock, we are not required to do so and our board of directors may reduce or eliminate our common stock dividend in the future. The FRB has the authority to prohibit a bank holding company, such as us, from paying dividends if it deems such payment to be an unsafe or unsound practice. The FDIC has the authority to use its enforcement powers to prohibit Union from paying dividends to us if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis. Further, our ability to pay dividends would be restricted if we do not maintain a required capital conservation buffer under applicable regulatory capital rules. A reduction or elimination of dividends could adversely affect the market price of our common stock.

Changes in accounting standards can be difficult to predict and can materially impact how we record and report our financial condition and results of operations.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. From time to time, the FASB changes the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can be hard to anticipate and implement and can materially impact how we record and report our financial condition and results of operations. For example, the FASB’s current financial instruments project will significantly change the way the Company's loan loss provision is determined, from an incurred loss model to an expected loss model.

Our financial statements are based in part on assumptions and estimates, which, if wrong, could cause unexpected losses in the future.
Pursuant to GAAP, we are required to use certain assumptions and estimates in preparing our financial statements, including in determining credit loss reserves, reserves related to litigation and the fair value of certain assets and liabilities, among other items. If the assumptions or estimates underlying our financial statements are incorrect, we may experience material losses.

We may need to raise additional capital in the future and such capital may not be available when needed.
As a bank holding company, we are required by regulatory authorities to maintain adequate levels of capital to support our operations.  We may need to raise additional capital in the future to provide us with sufficient capital resources and liquidity to meet our commitments and business needs.  Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of our control, and our financial performance.  We cannot assure you that such capital will be available to us on acceptable terms or at all.  Our inability to raise sufficient additional capital on acceptable terms when needed could subject us to certain activity restrictions or to a variety of enforcement remedies available to the regulatory authorities, including limitations on our ability to pay dividends or pursue acquisitions, the issuance by regulatory authorities of a capital directive to increase capital and the termination of deposit insurance by the FDIC.

19




Certain provisions of our articles of incorporation may have an anti-takeover effect.
Provisions of our certificate of incorporation and bylaws and regulations and federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. The combination of these provisions may inhibit a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

Market volatility may impact our business and the value of our common stock.
Our business performance and the trading price of shares of our common stock may be affected by many factors affecting financial institutions, including volatility in the credit, mortgage and housing markets, the markets for securities relating to mortgages or housing, and the value of debt and mortgage-backed and other securities that we hold in our investment portfolio. Government action and legislation may also impact us and the value of our common stock. We cannot predict what impact, if any, market volatility will have on our business or share price and for these and other reasons our shares of common stock may trade at a price lower than that at which they were purchased.

We may be required to write down goodwill and other identifiable intangible assets.
When we acquire a business, a portion of the purchase price of the acquisition may be allocated to goodwill and other identifiable intangible assets. The excess of the purchase price over the fair value of the net identifiable tangible and intangible assets acquired determines the amount of the purchase price that is allocated to goodwill acquired. At December 31, 2019, our goodwill and other identifiable intangible assets were approximately $2.5 million. Under current accounting standards, if we determine that goodwill or intangible assets are impaired, we would be required to write down the value of these assets to fair value. We conduct an annual review, or more frequently if events or circumstances warrant such, to determine whether goodwill is impaired. We recently completed our goodwill impairment analysis as of December 31, 2019 and concluded goodwill was not impaired. We conduct a review of our other intangible assets for impairment should events or circumstances warrant such. We cannot provide assurance that we will not be required to take an impairment charge in the future. Any impairment charge would have a negative effect on our shareholders’ equity and financial results and may cause a decline in our stock price.
Item 1B. Unresolved Staff Comments
None
Item 2. Properties
As of December 31, 2019, Union operated 15 community banking locations in Lamoille, Caledonia, Chittenden, Franklin and Washington counties of Vermont, five in Grafton and Coos counties of New Hampshire and loan centers in Willistion, Vermont and North Conway, New Hampshire. In addition as of such date, Union also operated several ATMs in northern Vermont and New Hampshire. Union owns, free of encumbrances, 17 of its branch locations and its headquarters and leases three branch locations, the NH loan center location, the land the Williston branch and loan center was built on and certain ATM premises from third parties under terms and conditions considered by management to be favorable to Union. Union also owns or leases certain properties contiguous to its branch locations for staff and customer parking convenience.
Additional information relating to the Company's properties as of December 31, 2019, is set forth in Notes 8 and 9 to the consolidated financial statements contained in Part II, Item 8 of this Annual Report.
Item 3. Legal Proceedings
There are no known pending legal proceedings to which the Company or its subsidiary is a party, or to which any of their properties is subject, other than ordinary litigation arising in the normal course of business activities. Although the amount of any ultimate liability with respect to such proceedings cannot be determined, in the opinion of management, any such liability would not have a material effect on the consolidated financial position or results of operations of the Company and its subsidiary.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Trading Market for Common Stock
The common stock of the Company is traded on the NASDAQ Global Select Market under the trading symbol "UNB."
 
 
 
 
 
 
 
 

20



On February 28, 2020, there were 4,473,186 shares of common stock outstanding held by 503 stockholders of record. The number of stockholders does not reflect the number of beneficial owners, including persons or entities who may hold the stock in nominee or “street name.”
Repurchase of Common Stock
There was no repurchase of the Company's equity securities during the quarter ended December 31, 2019.
 
 
 
 
 
Securities Authorized for Issuance Under Equity Compensation Plans
Information regarding equity securities authorized for issuance under the Company's equity compensation plans is included in Part III, Item 12 of this Annual Report under the caption “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”, and is incorporated herein by reference.

Five Year Performance Graph: The following graph illustrates the annual percentage change in the cumulative total shareholder return of the Company's common stock for the period December 31, 2014 through December 31, 2019. For purposes of comparison, the graph illustrates comparable shareholder returns of the SNL Bank $500M-$1B Index and the NASDAQ Composite Index. The graph assumes a $100 investment on December 31, 2014 in each case and measures the amount by which the market value, assuming reinvestment of dividends, has changed during the five year period ended December 31, 2019.
403292115_chart-ee00351820cc5077bf6a02.jpg
 
Period Ended
Index
12/31/2014

12/31/2015

12/31/2016

12/31/2017

12/31/2018

12/31/2019

Union Bankshares, Inc.
100.00

122.37

206.58

247.03

228.11

179.05

NASDAQ Composite
100.00

106.96

116.45

150.96

146.67

200.49

SNL Bank $500M-$1B
100.00

112.87

152.40

185.93

179.45

231.13

The performance graph and related information furnished under Part II, Item 5 of this Annual Report on Form 10-K shall not be deemed to be “soliciting material” or “filed” with the SEC, nor subject to Exchange Act Regulations 14A or 14C, other than as provided in Item 201 of Regulation S-K, or to the liabilities of Section 18 of the Exchange Act. Such information shall not be

21



deemed to be incorporated by reference into any filing under the Securities Act or Exchange Act except to the extent that the Company specifically incorporates it by reference into such filing.

Item 6. Selected Financial Data
The selected financial data presented in the table below depicts several measurements of performance or financial condition over a period of time. The following information should be read in conjunction with the consolidated financial statements and related notes and with other financial data in Part II, Item 8 of this Annual Report.
 
At or For The Years Ended December 31,
 
2019
2018
2017
2016
2015
Financial Condition Data:
(Dollars in thousands, except per share data)
Investment securities
$
87,393

$
73,405

$
66,439

$
66,555

$
59,327

Loans and loans held for sale
677,686

645,360

594,562

541,093

506,141

Allowance for loan losses
6,122

5,739

5,408

5,247

5,201

Total assets
872,912

805,337

745,831

691,381

628,879

Deposits
744,027

706,770

647,574

597,660

560,408

Borrowed funds
47,164

27,821

31,581

31,595

9,564

Stockholders' equity
71,843

64,491

58,661

56,279

53,568

Operating Data:
 
 
 
 
 
Interest and dividend income
$
36,002

$
32,180

$
29,017

$
26,836

$
25,144

Interest expense
5,616

3,581

2,255

2,061

2,025

Net interest income
30,386

28,599

26,762

24,775

23,119

Provision for loan losses
775

450

200

150

550

Net interest income after provision for loan losses
29,611

28,149

26,562

24,625

22,569

Noninterest income
10,323

9,473

9,395

10,140

9,792

Noninterest expenses
27,456

29,277

23,848

23,618

21,765

Income before provision for income taxes
12,478

8,345

12,109

11,147

10,596

Provision for income taxes
1,830

1,273

3,660

2,636

2,718

Net income
$
10,648

$
7,072

$
8,449

$
8,511

$
7,878

Ratios:
 
 
 
 
 
Return on average assets
1.30
%
0.94
%
1.21
%
1.30
%
1.27
%
Return on average equity
15.63
%
11.80
%
14.53
%
15.25
%
14.80
%
Net interest margin (1)
4.05
%
4.08
%
4.22
%
4.17
%
4.10
%
Efficiency ratio (2)
66.65
%
76.22
%
64.52
%
67.97
%
66.25
%
Net interest spread (3)
3.86
%
3.95
%
4.13
%
4.09
%
4.02
%
Total loans to deposits ratio
91.08
%
91.31
%
91.81
%
90.54
%
90.32
%
Net loan charge-offs to average loans not held for sale
0.06
%
0.02
%
0.01
%
0.02
%
0.01
%
Allowance for loan losses to loans not held for sale
0.91
%
0.89
%
0.92
%
0.98
%
1.04
%
Nonperforming assets to total assets (4)
0.40
%
0.24
%
0.23
%
0.63
%
0.53
%
Equity to assets
8.23
%
8.01
%
7.87
%
8.14
%
8.52
%
Total capital to risk weighted assets
13.02
%
12.86
%
13.66
%
13.32
%
13.42
%
Per common share data:
 
 
 
 
 
Book value per common share
$
16.06

$
14.44

$
13.14

$
12.61

$
12.02

Earnings per common share
$
2.38

$
1.58

$
1.89

$
1.91

$
1.77

Dividends paid per common share
$
1.24

$
1.20

$
1.16

$
1.11

$
1.08

Dividend payout ratio (5)
52.10
%
75.95
%
61.38
%
58.12
%
61.02
%
____________________
(1)
The ratio of tax equivalent net interest income to average earning assets. See page 27 in Part II, Item 7 of this Annual Report for more information.

22



(2)
The ratio of noninterest expense to tax equivalent net interest income and noninterest income, excluding securities gains (losses).
(3)
The difference between the average rate earned on earning assets and the average rate paid on interest bearing liabilities. See page 27 in Part II, Item 7 of this Annual Report for more information.
(4)
Nonperforming assets are loans or investment securities that are in nonaccrual or 90 or more days past due as well as OREO or OAO.
(5)
Cash dividends declared and paid per common share divided by consolidated net income per share.
Item 7. 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 consolidated financial position of Union Bankshares, Inc. ("the Company," "our," "we," "us") and its subsidiary, Union Bank ("Union"), as of December 31, 2019 and 2018, and its consolidated results of operations for the years then ended. The Company is considered a "smaller reporting company" under the disclosure rules of the SEC. Accordingly, the Company has elected to provide its audited statements of income, comprehensive income, cash flows, and changes in stockholders' equity for a two year, rather than a three year period and intends to provide smaller reporting company scaled disclosures where management deems appropriate.

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 contained in Item 8, Part II of this Annual Report. The purpose of this presentation is to enhance overall financial disclosures and to provide information about historical financial performance and developing trends as a means to assess to what extent past performance can be used to evaluate the prospects for future performance. Management is not aware of the occurrence of any events after December 31, 2019 which would materially affect the information presented.
CERTAIN DEFINITIONS
Capitalized terms used in the following discussion and not otherwise defined below have the meanings assigned to them in Note 1 to the Company's audited consolidated financial statements contained in Part II, item 8, page 50 of this Annual Report.
NON-GAAP FINANCIAL MEASURES
The following discussion contains certain non-GAAP financial measures in addition to results presented in accordance with GAAP. These non-GAAP measures are intended to provide the reader with additional supplemental perspectives on operating results, performance trends, and financial condition. Non-GAAP financial measures are not a substitute for GAAP measures; they should be read and used in conjunction with the Company’s GAAP financial information. The Company’s non-GAAP measures may not be comparable to similar non-GAAP information which may be presented by other companies. In all cases, it should be understood that non-GAAP operating measures do not depict amounts that accrue directly to the benefit of shareholders. An item that management excludes when computing non-GAAP adjusted earnings can be of substantial importance to the Company’s results and condition for any particular year. A reconciliation of non-GAAP financial measures to GAAP measures is provided below.
The SEC has exempted from the definition of non-GAAP financial measures certain commonly used financial measures that are not based on GAAP. However, two non-GAAP financial measures commonly used by financial institutions, namely tax-equivalent net interest income and tax-equivalent net interest margin (as presented in the tables in the section labeled Yields Earned and Rates Paid), have not been specifically exempted by the SEC, and may therefore constitute non-GAAP financial measures under Regulation G. We are unable to state with certainty whether the SEC would regard those measures as subject to Regulation G. Management believes that these non-GAAP financial measures are useful in evaluating the Company’s financial performance and facilitate comparisons with the performance of other financial institutions. However, that information should be considered supplemental in nature and not as a substitute for related financial information prepared in accordance with GAAP.

The discussion below includes references to the Company's net income and earnings per share for the year ended December 31, 2018 before deduction of expenses related to termination of Union's Defined Benefit Pension Plan during the fourth quarter of 2018. In management's view, that information, which is considered non-GAAP information, may be useful to investors as it will improve comparability of core operations year over year and in future periods. The non-GAAP net income amount and EPS reflect adjustments of the non-recurring charges associated with termination of Union’s Defined Benefit Pension Plan, net of tax effect. A reconciliation of the non-GAAP information to GAAP net income and EPS is provided below.

23



Non-GAAP Reconciliation - Net Income Before Pension Expense (Unaudited)
 
 
 
 
 
 
Year Ended December 31, 2018
Earnings Per
Common Share (1)
 
 
(Dollars in thousands,
except per share data)
 
Net income - GAAP
$
7,072

$
1.58

 
Pension expense
4,631

 
 
Income tax benefit
(900
)
 
 
Net income before pension expense - Non-GAAP
$
10,803

$
2.42

 
____________________
(1)
Basic earnings per share were computed based on the weighted average number of shares outstanding during the year (4,465,675 shares). The assumed exercise of outstanding stock options and vesting of restricted stock units do not result in material dilution and were excluded from the calculation.
CRITICAL ACCOUNTING POLICIES
The Company has established various accounting policies which govern the application of 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 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 management 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, management 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. Nevertheless, because the nature of the judgments and assumptions made by management are inherently subject to a degree of uncertainty, 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.
Allowance for loan losses
The Company believes the ALL is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of its consolidated financial statements. The amount of the ALL 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. Changes in these qualitative factors may cause management's estimate of the ALL 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 and Credit Quality below.
Other than temporary impairment of securities
The OTTI decision is a critical accounting policy for the Company. Accounting guidance requires a company to perform periodic reviews of individual debt securities in its investment portfolio to determine whether a decline in the value of a security is OTT. A review of OTTI requires management 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 rates or equity market declines. Declines in the fair value of debt securities below their costs that are deemed by management to be OTT are recorded in earnings as realized losses to the extent they are deemed credit losses, with noncredit losses recorded in OCI (loss). Once an OTT loss on a debt security is realized, subsequent gains in the value of the security may not be recognized in income until the security is sold.

Mortgage servicing rights
MSRs associated with loans originated and sold, where servicing is retained, are required to be capitalized and initially recorded at fair value on the acquisition date and are subsequently accounted for using the “amortization method”. Mortgage servicing rights are amortized against non-interest income in proportion to, and over the period of, estimated future net servicing income of the underlying financial assets. The value of capitalized servicing rights represents the estimated present value of the future

24



servicing fees arising from the right to service loans for third parties. The carrying value of the mortgage servicing rights is periodically reviewed for impairment based on a determination of estimated fair value compared to amortized cost, and impairment, if any, is recognized through a valuation allowance and is recorded as a reduction of non-interest income. Subsequent improvement (if any) in the estimated fair value of impaired mortgage servicing rights is reflected in a positive valuation adjustment and is recognized in non-interest income up to (but not in excess of) the amount of the prior impairment. Critical accounting policies for mortgage servicing rights relate to the initial valuation and subsequent impairment tests. The methodology used to determine the valuation of mortgage servicing rights requires the development and use of a number of estimates, including anticipated principal amortization and prepayments. Factors that may significantly affect the estimates used are changes in interest rates and the payment performance of the underlying loans. The Company analyzes and accounts for the value of its servicing rights with the assistance of a third party consultant.
Intangible assets
The Company's intangible assets include goodwill, which represents the excess of the purchase price over the fair value of net assets acquired in the 2011 Branch Acquisition, as well as a core deposit intangible related to the deposits acquired. The core deposit intangible is amortized on a straight line basis over the estimated average life of the acquired core deposit base of 10 years. The Company evaluates the valuation and amortization of the core deposit intangible if events occur that could result in possible impairment. With respect to goodwill, in accordance with current authoritative guidance, the Company assesses qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of the Company is less than its carrying amount, which could result in goodwill impairment.
Pension liabilities
The Company's defined benefit pension obligation and net periodic benefit costs, reflected in its financial statements for the year ended December 31, 2018, were actuarially determined based on the following assumptions: discount rate, current and expected future return on plan assets, anticipated mortality rates, and Consumer Price Index rate. Prior to termination of the plan in the fourth quarter of 2018, the determination of the defined benefit pension obligation and net periodic benefit cost was a critical accounting estimate as it required 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 on the Company's reported financial condition and/or results of operations for 2018 and prior periods.
Other
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 taxes, investment securities and OREO. The most significant accounting policies followed by the Company are presented in Note 1 to the consolidated financial statements and in the section below under the caption “FINANCIAL CONDITION” and the subcaptions “Allowance for Loan Losses and Credit Quality” and ”Investment Activities”. 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.
OVERVIEW
During 2019, the Federal Reserve reduced the Federal Funds target rate from 2.5% to 1.75%, which also resulted in a decrease in the national prime rate from 5.5% to 4.75%. The Company holds variable rate loans in the portfolio that are indexed to the national prime rate, however, not all of these variable rate loans are set to reprice immediately upon a change to the index. Therefore, the Company did not recognize an immediate decline in loan interest income related to this reduction in rates. The decrease in rates on a national level does impact the interest rates offered on new loans and has resulted in rate reduction requests from select customers with existing loans.
The Company opened two full service branch locations in Chittenden County, Vermont in May and August of 2019. The new locations have contributed to increases in customer loan and deposit balances on the balance sheet, but have also contributed to increases in overhead expense, specifically related to salaries and wages, occupancy and equipment expenses.
The Company's net income was $10.6 million, or $2.38 per share, for 2019 compared to $7.1 million, or $1.58 per share for 2018. The increase in net income reflects the combined effect of increases in net interest income of $1.8 million or 6.2%, and in noninterest income of $850 thousand, or 9.0%, and a decrease in noninterest expense of $1.8 million, or 6.2%, which was partially offset by an increases in the provision for loan losses of $325 thousand, or 72.2%, and in the provision for income taxes of $557 thousand, or 43.8%.
The Company's net income for 2018 included the one-time charges of $3.7 million (net of tax effect) related to the settlement of the assets and liabilities of the Defined Benefit Pension Plan; absent those charges, the Company would have reported net income

25



of $10.8 million, or $2.42 per share, for the year ended December 31, 2018. (Please refer to the discussion under "Non-GAAP Financial Measures", including the reconciliation to GAAP net income for the year ended December 31, 2018.)
As of December 31, 2019, the Company had total consolidated assets of $872.9 million, an increase of 8.4% compared to December 31, 2018. The growth year over year is attributable to strong loan demand, funded with customer deposits, low rate funding options from the FHLB, and purchased deposits.
Net loans and loans held for sale increased $32.0 million or 5.0%, to $672.6 million, or 77.1% of total assets, at December 31, 2019, compared to $640.6 million, or 79.5% of total assets, at December 31, 2018. The Company experienced growth in all loan classes except municipal loans which decreased $5.5 million, or 11.29%, year over year.
The Company's primary source of funding, customer deposits, increased $37.3 million, or 5.3%, to reach $744.0 million at December 31, 2019. During 2019, management successfully focused on growing deposits by not only expanding its branch network, but by also enhancing its products and services to meet the needs of customers. This organic growth was supplemented by the use of purchased deposits.
The Company's total capital increased from $64.5 million at December 31, 2018 to $71.8 million at December 31, 2019. This increase reflects net income of $10.6 million for 2019, less regular cash dividends paid of $5.5 million, and a $2.0 million increase in accumulated OCI resulting primarily from increases in the fair market value of the Company's investment portfolio. (See Capital Resources on page 41.)
RESULTS OF OPERATIONS
For the year ended December 31, 2019, net income was $10.6 million compared to $7.1 million for the year ended December 31, 2018. The primary components of these results, which include net interest income, provision for loan losses, noninterest income, noninterest expenses, and provision for income taxes, are discussed below:
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 paid on interest bearing liabilities. Net interest income is affected by various factors, including but not limited to: changes in interest rates, loan and deposit pricing strategies, the volume and mix of interest earning assets and interest bearing liabilities, and the level of nonperforming assets. The net interest margin is calculated as net interest income on a fully tax equivalent basis as a percentage of average interest earning assets. The net interest margin for the years ended December 31, 2019 and 2018 was 4.05%, and 4.08%, respectively.
Net interest income was $30.4 million on a fully tax equivalent basis for 2019, compared to $28.6 million for 2018, an increase of $1.8 million, or 6.2%. The increase in net interest income is reflective of growth in average earning assets of $51.3 million, or 7.2% during 2019 and a 20 bp increase in the average yield on average earning assets. These increases were partially offset by an increase of $45.5 million, or 8.1% in average interest bearing liabilities and a 29 bp increase in average rates paid on interest bearing liabilities. As illustrated in the Rate/Volume Analysis in the following pages, the increase in volume of average loan balances of $41.2 million, or 6.7%, compared to 2018 was the primary driver of the increase in interest income. Conversely, the increase in rates paid on customer deposit balances was the primary driver of the increase in interest expense. As a result, the net interest margin decreased three bp to 4.05% in 2019 compared to 4.08% in 2018.
The average cost of funding, which is tied primarily to our customer deposits, increased 29 bp to 0.92% for the year ended December 31, 2019, compared to 0.63% for the year ended December 31, 2018. During 2019, Union's municipal and commercial customers continued to utilize the ICS account, a fully FDIC insured money market account through Promontory Interfinancial Network, contributing to the $4.4 million, or 1.70%, increase in average balances in savings and money market accounts. Average time deposits increased $29.2 million, or 25.03% during 2019 due to deposit accounts opened at the newest branch locations in Chittenden County, Vermont and deposit gathering strategies utilized throughout the remainder of the branch network. Additionally, the average rate paid on savings and money market accounts increased 19 bps to 0.74% for the year ended December 31, 2019, compared to 0.55% for the year ended December 31, 2018 and the average rate paid on time deposits increased 54 bps to 1.58% for the year ended December 31, 2019, compared to 1.04% for the year ended December 31, 2018. The average balance of borrowed funds decreased $2.4 million, or 5.5%, for the year ended December 31, 2019, however the average rate paid increased 53 bps, to 2.18% for the year ended December 31, 2019. See the following tables for details.


26



The following table shows for the periods indicated the total amount of tax equivalent interest income from average interest earning assets, the related average tax equivalent yields, the tax equivalent interest expense associated with average interest bearing liabilities, the related tax equivalent average rates paid, and the resulting tax equivalent net interest spread and margin:
 
Years Ended December 31,
 
2019
2018
2017
 
Average
Balance
Interest
Earned/
Paid
Average
Yield/
Rate
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
$
14,808

$
190

1.26
%
$
12,274

$
104

0.84
%
$
17,700

$
114

0.64
%
Interest bearing deposits in banks
7,813

195

2.49
%
9,805

207

2.11
%
8,642

147

1.70
%
Investment securities (1), (2)
81,602

2,265

2.91
%
71,673

1,836

2.75
%
66,925

1,678

2.96
%
Loans, net (1), (3)
656,937

33,209

5.12
%
615,739

29,883

4.91
%
560,059

26,978

4.92
%
Nonmarketable equity securities
2,433

143

5.89
%
2,840

150

5.27
%
2,423

100

4.12
%
Total interest earning assets (1)
763,593

36,002

4.78
%
712,331

32,180

4.58
%
655,749

29,017

4.56
%
Cash and due from banks
5,027

 
 
4,264

 
 
4,217

 
 
Premises and equipment
19,177

 
 
15,043

 
 
13,286

 
 
Other assets
28,608

 
 
22,769

 
 
22,477

 
 
Total assets
$
816,405

 
 
$
754,407

 
 
$
695,729

 
 
Average Liabilities and Stockholders' Equity:
 
 
 
 
 
 
 
 
 
Interest bearing checking accounts
$
161,789

$
487

0.30
%
$
147,553

$
233

0.16
%
$
147,677

$
205

0.14
%
Savings/money market accounts
262,105

1,937

0.74
%
257,717

1,423

0.55
%
233,345

856

0.37
%
Time deposits
145,935

2,301

1.58
%
116,717

1,215

1.04
%
103,019

710

0.69
%
Borrowed funds
40,230

891

2.18
%
42,582

710

1.65
%
35,190

484

1.36
%
Total interest bearing liabilities
610,059

5,616

0.92
%
564,569

3,581

0.63
%
519,231

2,255

0.43
%
Noninterest bearing deposits
130,322

 
 
121,902

 
 
112,914

 
 
Other liabilities
7,916

 
 
7,986

 
 
5,446

 
 
Total liabilities
748,297

 
 
694,457

 
 
637,591

 
 
Stockholders' equity
68,108

 
 
59,950

 
 
58,138

 
 
Total liabilities and stockholders’ equity
$
816,405

 
 
$
754,407

 
 
$
695,729

 
 
Net interest income
 
$
30,386

 
 
$
28,599

 
 
$
26,762

 
Net interest spread (1)
 
 
3.86
%
 
 
3.95
%
 
 
4.13
%
Net interest margin (1)
 
 
4.05
%
 
 
4.08
%
 
 
4.22
%
____________________
(1)
Average yields reported on a tax equivalent basis using a marginal federal corporate income tax rate of 21% for the years ended December 31, 2019 and 2018 and 34% for the year ended December 31, 2017.
(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, unamortized costs and premiums and is net of the ALL.


27



Tax exempt interest income amounted to $2.4 million, and $2.0 million for the years ended December 31, 2019 and 2018, respectively. The following table presents the effect of tax exempt income on the calculation of net interest income, using a marginal federal corporate income tax rate of 21% for the years ended December 31, 2019 and 2018:
 
Years Ended December 31,
 
2019
2018
 
(Dollars in thousands)
Net interest income as presented
$
30,386

$
28,599

Effect of tax-exempt interest
 
 
Investment securities
109

136

Loans
405

328

Net interest income, tax equivalent
$
30,900

$
29,063


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 periods 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.
 
Year Ended December 31, 2019
Compared to Year Ended
December 31, 2018
Increase/(Decrease) Due to Change In
Year Ended December 31, 2018
Compared to Year Ended
December 31, 2017
Increase/(Decrease) Due to Change In
 
Volume
Rate
Net
Volume
Rate
Net
 
(Dollars in thousands)
Interest earning assets:
 
 
 
 
 
 
Federal funds sold and overnight deposits
$
25

$
61

$
86

$
(40
)
$
30

$
(10
)
Interest bearing deposits in banks
(46
)
34

(12
)
22

38

60

Investment securities
300

129

429

223

(65
)
158

Loans, net
2,036

1,290

3,326

3,008

(103
)
2,905

Nonmarketable equity securities
(23
)
16

(7
)
19

31

50

Total interest earning assets
$
2,292

$
1,530

$
3,822

$
3,232

$
(69
)
$
3,163

Interest bearing liabilities:
 
 
 
 
 
 
Interest bearing checking accounts
$
25

$
229

$
254

$

$
28

$
28

Savings/money market accounts
24

490

514

97

470

567

Time deposits
355

731

1,086

104

401

505

Borrowed funds
(39
)
220

181

112

114

226

Total interest bearing liabilities
$
365

$
1,670

$
2,035

$
313

$
1,013

$
1,326

Net change in net interest income
$
1,927

$
(140
)
$
1,787

$
2,919

$
(1,082
)
$
1,837


Provision for Loan Losses. The provision for loan losses was $775 thousand and $450 thousand for the years ended December 31, 2019 and 2018 , respectively. The provision for 2019 was deemed appropriate by management based on the size and mix of the loan portfolio, the level of nonperforming loans, the results of the qualitative factor review and economic conditions. For further details, see FINANCIAL CONDITION Asset Quality and Allowance for Loan Losses below.

28



Noninterest Income. The following table sets forth the components of noninterest income for the years ended December 31, 2019 and 2018 :
 
For The Years Ended December 31,
 
2019
2018
$ Variance
% Variance
 
(Dollars in thousands)
Trust income
$
692

$
751

$
(59
)
(7.9
)
Service fees
6,108

6,151

(43
)
(0.7
)
Net gains on sales of investment securities AFS
25

10

15

150.0
 %
Net gains on sales of loans held for sale
2,895

1,847

1,048

56.7

Income from Company-owned life insurance
281

488

(207
)
(42.4
)
Other income
322

226

96

42.5

Total noninterest income
$
10,323

$
9,473

$
850

9.0

The significant changes in noninterest income for the year ended December 31, 2019 compared to the year ended December 31, 2018 are described below:
Trust income. The decrease in trust income is primarily due to the absence of income from Union's defined benefit pension plan during 2019 as a result of the termination of the plan and settlement of the plan's assets and liabilities in the fourth quarter of 2018.
Service fees. Service fees decreased for the year ended December 31, 2019 primarily due to a reduction in credit card income of $125 thousand as the Company sold its corporate credit card portfolio in 2018, and a $29 thousand reduction in service charges on deposit accounts. These decreases were partially offset by an increase in loan servicing fees of $56 thousand due to the increase in our serviced loan portfolio from $534.2 million at December 31, 2018 to $579.9 million at December 31, 2019, or an increase of 8.6%, and an additional increase of $62 thousand in ATM network income.
Net gains on sales of loans held for sale. Continuing the Company's strategy to mitigate long-term interest rate risk, residential and commercial loans totaling $158.3 million were sold to the secondary market during 2019, versus residential and commercial loan sales of $116.7 million during 2018. The increase in net gains on sales of real estate loans reflects both an increase in the volume of sold loans and higher premiums on those sales due to a declining rate environment in 2019, compared to a rising rate environment during most of 2018.
Income from Company-owned life insurance. COLI income decreased $207 thousand due to the receipt in 2018 of $252 thousand of proceeds from the death benefit on an insurance policy on the life of a former director, despite an increase in 2019 as a result of a $3.0 million purchase of additional COLI covering select officers of Union during the third quarter.
Other income. Other income increased for 2019 compared to 2018 due to increases of $131 thousand in prepayment penalties from early payoff of commercial loans, $52 thousand in oil and gas income and income from MSRs, net of amortization of $72 thousand between periods. The increase in MSR income is due to higher volumes of loans sold in 2019. Other income for 2018 included the gain on the sale of a bank owned branch building of $191 thousand.


29



Noninterest Expense. The following table sets forth the components of noninterest expenses for the years ended December 31, 2019 and 2018:
 
For The Years Ended December 31,
 
2019
2018
$ Variance
% Variance
 
(Dollars in thousands)
Salaries and wages
$
11,821

$
10,748

$
1,073

10.0

Pension expense

4,631

(4,631
)
(100.0
)
Employee benefits
4,194

3,653

541

14.8

Occupancy expense, net
1,806

1,447

359

24.8

Equipment expense
2,475

2,134

341

16.0

ATM network and debit card expense
790

690

100

14.5

Advertising and public relations
555

456

99

21.7

Vermont franchise tax
678

620

58

9.4

FDIC insurance assessment
271

350

(79
)
(22.6
)
Professional fees
701

625

76

12.2

Director and advisory board fees
502

450

52

11.6

Other expenses
3,663

3,473

190

5.5

Total noninterest expense
$
27,456

$
29,277

$
(1,821
)
(6.2
)
The significant changes in noninterest expense for the year ended December 31, 2019 compared to the year ended December 31, 2018 are described below:
Salaries and wages. The $1.1 million increase in salaries and wages is due to normal annual salary increases, an increase of $287 thousand in commissions paid to mortgage loan originators, an increase of $145 thousand in incentive bonus payments to select officers of Union, increases in staff for new branch locations as well as additions in support departments which resulted in an increase of 6 full time equivalent employees from 195 to 201 as of December 31, 2019.
Pension expense. There were no expenses related to Union's Defined Benefit Pension Plan incurred in 2019, as the settlement of all assets and liabilities under the Plan was completed by December 31, 2018.
Employee benefits. The increase in employee benefits is due to a $264 thousand increase in premium costs on insurance provided by the Company to its employees, an increase of $66 thousand in 401k contributions, and an increase of $152 thousand in other employee benefits related to the Company's deferred compensation plans.
Occupancy expense, net. The Company's occupancy expenses increased $359 thousand due to increases in depreciation expense, utilities, and repairs and maintenance. These increases are primarily due to our branch expansion projects with the opening of two full service branches in Vermont during 2019 and a loan production office in New Hampshire on December 31, 2018.
Equipment expense. The increase in equipment expenses between periods is due to a $206 thousand increase in depreciation expense and a $136 thousand increase in software license and maintenance costs.
ATM network and debit card expense. The $100 thousand increase in expenses during 2019 is due to a $45 thousand increase in expenses related to the redemption of reward points customers earned on signature based debit card transactions. Additionally, changes in services with ATM and debit card service providers have resulted in an increase in expense of $55 thousand between periods.
Advertising and public relations. Advertising and public relations costs increased during 2019 as anticipated for items related to the new branch locations. Also, in 2019 Union created a new brand anthem video to be utilized in several media channels.
Vermont franchise taxes. The overall increase in deposit accounts during 2019 resulted in an increase in Vermont franchise tax expense.
FDIC insurance assessment. The FDIC awarded assessment credits to banks having total consolidated assets of less than $10 billion for the portion of their assessments that contributed to the growth in the Deposit Insurance Reserve Ratio. Union was awarded a credit in the amount of $179 thousand which was utilized in 2019. Application of this credit resulted in a reduction in expense for the year ended December 31, 2019 compared to the prior year. The benefit of the credit was partially offset by an increase in the amount of the assessments for 2019 due to an increase in the assessment factor as well as an increase in average assets to which the factor is applied.

30



Professional fees. During 2019, additional consultants were engaged to assist with internal audits, employment searches, and other advisory services that were not utilized in 2018, resulting in a $76 thousand increase between periods.
Director and advisory board fees. The increase in fees is attributable to an annual increase in cash paid for directors fees, the implementation of equity compensation for directors, and the addition of a member to the Company's board of directors during 2019.
Other expenses. Other expenses increased $190 thousand during 2019 primarily due to an increases in donations of $39 thousand, printing and supplies of $49 thousand, travel and meeting costs of $20 thousand, and legal expenses of $30 thousand. The remaining variances between the comparison periods is comprised of smaller dollar changes in various miscellaneous expense categories.

Provision for Income Taxes. The Company has provided for current and deferred federal income taxes for the current and prior periods presented. The Company's net provision for income taxes was $1.8 million for 2019 and $1.3 million for 2018. The Company’s effective tax rate for 2019 decreased to 14.7% compared to 15.3% for 2018. The decrease in the effective corporate income tax rate during the comparison periods is due to increases in tax exempt income, tax benefits received from limited partnership investments discussed below, and $25 thousand in federal income tax credits related to the installation of solar panels on the two newest branch locations.
Amortization expense related to limited partnership investments included as a component of tax expense amounted to $745 thousand and $591 thousand for the years ended December 31, 2019 and 2018, respectively. These investments provide tax benefits, including tax credits. Low income housing tax credits with respect to limited partnership investments are also included as a component of income tax expense and amounted to $803 thousand and $656 thousand for the years ended December 31, 2019 and 2018, respectively. See Note 11 to the Company's consolidated financial statements.

FINANCIAL CONDITION
At December 31, 2019, the Company had total consolidated assets of $872.9 million, including gross loans and loans held for sale (total loans) of $677.7 million, deposits of $744.0 million and stockholders' equity of $71.8 million. The Company’s total assets increased $67.6 million, or 8.4%, from $805.3 million at December 31, 2018.

Net loans and loans held for sale increased $32.0 million, or 5.0%, to $672.6 million, or 77.1% of total assets, at December 31, 2019, compared to $640.6 million, or 79.5% of total assets, at December 31, 2018. (See Loan Portfolio below.)

Total deposits increased $37.3 million, or 5.3% to $744.0 million at December 31, 2019, from $706.8 million at December 31, 2018. There were increases in time deposits of $19.6 million, or 15.2%, interest bearing deposits of $14.2 million, or 3.2%, and noninterest bearing deposits of $3.5 million, or 2.6%. (See average balances and rates in the Yields Earned and Rates Paid table on page 27.)

Total borrowed funds increased $19.3 million, or 69.5%, from $27.8 million at December 31, 2018 to $47.2 million at December 31, 2019. FHLB advances increased $19.7 million, while customer overnight collateralized repurchase sweeps decreased $370 thousand between December 31, 2018 and December 31, 2019. (See Borrowings on page 39.)

Total stockholders’ equity increased $7.4 million, or 11.4%, from $64.5 million at December 31, 2018 to $71.8 million at December 31, 2019. (See Capital Resources on page 41.)

Loan Portfolio. The Company's gross loan portfolio (including loans held for sale) increased $32.3 million, or 5.0%, to $677.7 million, representing 77.6% of assets at December 31, 2019, from $645.4 million, representing 80.1% of assets at December 31, 2018. The Company's loans consist primarily of adjustable-rate and fixed-rate mortgage loans secured by one-to-four family, multi-family residential or commercial real estate. Real estate secured loans represented $559.1 million, or 82.5%, of total loans at December 31, 2019 compared to $522.0 million, or 80.9%, of total loans at December 31, 2018. Although competition for good loans is strong, especially in the commercial sector, the Company has been able to originate loans to both current and new customers while maintaining credit quality. The composition of the Company's loan portfolio remained relatively unchanged from December 31, 2018. There was no material change in the Company's lending programs or terms during 2019.


31



The composition of the Company's loan portfolio at year-end for each of the last five years was as follows:
 
2019
2018
2017
2016
2015
 
$
%
$
%
$
%
$
%
$
%
 
(Dollars in thousands)
Residential real estate
$
192,125

28.4
$
187,320

29.0
$
178,999

30.1
$
172,727

31.9
$
165,396

32.7
Construction real estate
69,617

10.3
55,322

8.6
42,935

7.2
34,189

6.3
42,889

8.5
Commercial real estate
289,883

42.8
276,500

42.8
254,291

42.8
249,063

46.0
230,442

45.5
Commercial
47,699

7.0
47,228

7.3
50,719

8.5
41,999

7.8
21,397

4.2
Consumer
3,562

0.5
3,241

0.5
3,894

0.7
3,962

0.7
3,963

0.8
Municipal
67,358

9.9
72,850

11.3
55,777

9.4
31,350

5.8
36,419

7.2
Loans held for sale
7,442

1.1
2,899

0.5
7,947

1.3
7,803

1.5
5,635

1.1
Total loans
$
677,686

100.0
$
645,360

100.0
$
594,562

100.0
$
541,093

100.0
$
506,141

100.0

The Company originates and sells qualified residential mortgage loans in various secondary market avenues, with a majority of sales made to the FHLMC/Freddie Mac, generally with servicing rights retained. At December 31, 2019, the Company serviced a $754.7 million residential real estate mortgage portfolio, of which $7.4 million was held for sale and approximately $555.1 million was serviced for unaffiliated third parties. This compares to a residential real estate mortgage servicing portfolio of $709.7 million at December 31, 2018, of which $2.9 million was held for sale and approximately $519.5 million was serviced for unaffiliated third parties. Loans held for sale are accounted for at the lower of cost or fair value and are reviewed by management at least quarterly based on current market pricing.

The Company sold $158.0 million of qualified residential real estate loans originated during 2019 to the secondary market to mitigate long-term interest rate risk and to generate fee income, compared to sales of $116.7 million during 2018. The Company originates and sells FHA, VA, and RD residential mortgage loans, and also has an Unconditional Direct Endorsement Approval from HUD which allows the Company to approve FHA loans originated in any of its Vermont or New Hampshire locations without needing prior HUD underwriting approval. The Company sells FHA, VA and RD loans as originated with servicing released. Some of the government backed loans qualify for zero down payments without geographic or income restrictions. These loan products increase the Company's ability to serve the borrowing needs of residents in the communities served, including low and moderate income borrowers, while the government guaranty mitigates the Company's exposure to credit risk.

The Company also originates commercial real estate and commercial loans under various SBA, USDA and State sponsored programs which provide a government agency guaranty for a portion of the loan amount. There was $4.0 million and $4.1 million guaranteed under these various programs at December 31, 2019 and 2018, respectively, on aggregate balances of $5.1 million and $5.2 million in subject loans for the same time periods. The Company occasionally sells the guaranteed portion of a loan to other financial concerns and retains servicing rights, which generates fee income. There were $315 thousand in commercial real estate and commercial loans sold during 2019 and no commercial real estate or commercial loans sold during 2018. The Company recognizes gains and losses on the sale of the principal portion of these loans as they occur.

The Company serviced $24.8 million and $14.8 million of commercial and commercial real estate loans for unaffiliated third parties as of December 31, 2019 and 2018, respectively. This includes $23.1 million and $12.8 million of commercial or commercial real estate loans the Company had participated out to other financial institutions at December 31, 2019 and 2018, respectively. These loans were participated in the ordinary course of business on a nonrecourse basis, for liquidity or credit concentration management purposes.

As of December 31, 2019, total loans serviced had grown to $1.3 billion, which includes total loans on the balance sheet of $677.7 million as well as total loans sold with servicing retained of $579.9 million, compared to total loans serviced of $1.2 billion as of December 31, 2018.

The Company capitalizes MSRs for all loans sold with servicing retained and recognizes gains and losses on the sale of the principal portion of these loans as they occur. The unamortized balance of MSRs on loans sold with servicing retained was $1.7 million as of December 31, 2019 and December 31, 2018, with an estimated market value in excess of the carrying value at both year ends. Management periodically evaluates and measures the servicing assets for impairment.


32



The following table breaks down by classification the contractual maturities of the gross loans held in portfolio and for sale as of December 31, 2019:
 
Within 1
Year
2-5
Years
Over 5
Years
Total
 
(Dollars in thousands)
Fixed rate
 
 
 
 
Residential real estate
$
879

$
2,640

$
102,365

$
105,884

Construction real estate
26,736

837

4,720

32,293

Commercial real estate
3,379

6,083

23,864

33,326

Commercial
2,029

11,222

19,450

32,701

Consumer
1,720

1,648

158

3,526

Municipal
52,584

4,364

10,410

67,358

Total fixed rate
87,327

26,794

160,967

275,088

Variable rate
 
 
 
 
Residential real estate
1,632

1,273

90,778

93,683

Construction real estate
2,102

1,961

33,261

37,324

Commercial real estate
9,136

5,203

242,218

256,557

Commercial
7,655

2,458

4,885

14,998

Consumer
36



36

Total variable rate
20,561

10,895

371,142

402,598

 
$
107,888

$
37,689

$
532,109

$
677,686

Asset Quality. The Company, like all financial institutions, is exposed to certain credit risks, including those related to the value of the collateral that secures its loans and the ability of borrowers to repay their loans. Consistent application of the Company’s conservative loan policies has helped to mitigate this risk and has been prudent for both the Company and its customers. The Company's Board has set forth well-defined lending policies (which are periodically reviewed and revised as appropriate) that include conservative individual lending limits for officers, aggregate and advisory board approval levels, Board approval for large credit relationships, a quality control program, a loan review program and other limits or standards deemed necessary and prudent. The Company's loan review program encompasses a review process for loan documentation and underwriting for select loans as well as a monitoring process for credit extensions to assess the credit quality and degree of risk in the loan portfolio. Management performs, and shares with the Board, periodic concentration analyses based on various factors such as industries, collateral types, location, large credit sizes and officer portfolio loads. Board approved policies set forth portfolio diversification levels to mitigate concentration risk and the Company participates large credits out to other financial institutions to further mitigate that risk. The Company has established underwriting guidelines to be followed by its officers; material exceptions are required to be approved by a senior loan officer, the President or the Board.
The Company does not make loans that are interest only, have teaser rates or that result in negative amortization of the principal, except for construction, lines of credit and other short-term loans for either commercial or consumer purposes where the credit risk is evaluated on a borrower-by-borrower basis. The Company evaluates the borrower's ability to pay on variable-rate loans over a variety of interest rate scenarios, not only the rate at origination.
The majority of the Company's loan portfolio is secured by real estate located throughout the Company's primary market area of northern Vermont and New Hampshire. For residential loans, the Company generally does not lend more than 80% of the appraised value of the home without a government guaranty or the borrower purchasing private mortgage insurance. Although the Company lends up to 80% of the collateral value on commercial real estate loans to strong borrowers, the majority of commercial real estate loans do not exceed 75% of the appraised collateral value. Rarely, the loan to value may go up to 100% on loans with government guarantees or other mitigating circumstances. Although the Company's loan portfolio consists of different business segments, there is a portion of the loan portfolio centered in tourism related loans. The Company has implemented risk management strategies to mitigate exposure to this industry through utilizing government guaranty programs as well as participations with other financial institutions as discussed above. Additionally, the loan portfolio contains many loans to seasoned and well established businesses and/or well secured loans which further reduce the Company's risk. Management closely follows the local and national economies and their impact on the local businesses, especially on the tourism industry, as part of the Company's risk management program.
The Company also monitors its delinquency levels for any adverse trends. There can be no assurance that the Company's loan portfolio will not become subject to increasing pressures from deteriorating borrower financial strength or declining collateral values due to general or local economic conditions. Renewed market volatility, high unemployment rates or weakness in the general economic condition of the country or our market area, may have a negative effect on our customers’ ability to make their

33



loan payments on a timely basis and/or on underlying collateral values. Management closely monitors the Company’s loan and investment portfolios, OREO and OAO for potential problems and reports to the Boards of the Company and Union at regularly scheduled meetings. Repossessed assets and loans or investments that are 90 days or more past due or in nonaccrual status are considered to be nonperforming assets.
TDR loans involve one or more of the following: forgiving a portion of interest or principal, refinancing at a rate materially less than the market rate, rescheduling loan payments, or granting other concessions to a borrower due to financial or economic reasons related to the debtor's financial difficulties that the Company would not ordinarily grant. When evaluating the ALL, management makes a specific allocation for TDR loans as they are considered impaired.
The following table details the composition of the Company's nonperforming assets as of December 31:
 
2019
2018
2017
2016
2015
 
(Dollars in thousands)
Nonaccrual loans
$
2,323

$
816

$
1,191

$
3,545

$
2,521

Loans past due 90 days or more and still accruing interest
1,179

1,140

494

840

836

Total nonperforming loans
3,502

1,956

1,685

4,385

3,357

OREO


36



Total nonperforming assets
$
3,502

$
1,956

$
1,721

$
4,385

$
3,357

 
 
 
 
 
 
Guarantees of U.S. or state government agencies on the above nonperforming loans
$
286

$
114

$
131

$
599

$
291

TDR loans
$
2,871

$
3,309

$
3,252

$
3,419

$
2,732

The following table shows trends of certain asset quality ratios monitored by Company's management at December 31:
 
2019
2018
2017
2016
2015
Allowance for loan losses to loans not held for sale
0.91
%
0.89
%
0.92
%
0.98
%
1.04
%
Allowance for loan losses to nonperforming loans
174.81
%
293.40
%
320.95
%
119.66
%
154.93
%
Nonperforming loans to total loans
0.52
%
0.30
%
0.28
%
0.81
%
0.66
%
Nonperforming assets to total assets
0.40
%
0.24
%
0.23
%
0.63
%
0.53
%
Delinquent loans (30 days to nonaccruing) to total loans
1.35
%
1.41
%
1.05
%
1.55
%
1.61
%
Net charge-offs to average loans not held for sale
0.06
%
0.02
%
0.01
%
0.02
%
0.01
%

Nonperforming loans at December 31, 2019 increased $1.5 million, or 79.0%, and increased as a percentage of assets from 0.24% at December 31, 2018 to 0.40% at December 31, 2019, with the ALL as a percentage of nonperforming loans decreasing from 293.40% to 174.81%. Management considers the asset quality ratios to be at favorable levels. The Company's success at keeping the ratios at favorable levels is the result of continued focus on maintaining strict underwriting standards, as well as our practice, as a community bank, of actively working with troubled borrowers to resolve the borrower's delinquency, while maintaining the safe and sound credit practices of Union and safeguarding our strong capital position. There were two residential real estate loans totaling $64 thousand in process of foreclosure at December 31, 2019. The aggregate interest on nonaccrual loans not recognized was $271 thousand and $338 thousand for the years ended December 31, 2019 and 2018, respectively.

The Company had loans rated substandard that were on a performing status totaling $1.7 million at December 31, 2019 and $2.0 million at December 31, 2018. In management's view, such loans represent a higher degree of risk of becoming nonperforming loans in the future. While still on a performing status, in accordance with the Company's credit policy, loans are internally classified when a review indicates the existence of any of the following conditions, making the likelihood of collection questionable:
the financial condition of the borrower is unsatisfactory;
repayment terms have not been met;
the borrower has sustained losses that are sizable, either in absolute terms or relative to net worth;
confidence in the borrower's ability to repay is diminished;
loan covenants have been violated;
collateral is inadequate; or
other unfavorable factors are present.
Although management believes that the Company's nonperforming and internally classified loans are generally well-secured and that probable credit losses inherent in the loan portfolio are provided for in the Company's ALL, there can be no assurance that

34



future deterioration in economic conditions and/or collateral values, or changes in other relevant factors will not result in future credit losses. The Company’s management is focused on the impact that the economy may have on its borrowers and closely monitors industry and geographic concentrations for evidence of financial problems. During 2018 and 2019, the region's tourist industry has seen successful results for all tourist seasons throughout the year. Improvement in local economic indicators have also been identified during this time period. The unemployment rate has stabilized in Vermont and was 2.3% for December 31, 2019 compared to 2.7% for December 31, 2018. The New Hampshire unemployment rate was 2.6% for December 31, 2019 compared to 2.5% for December 31, 2018. These rates compare favorably with the nationwide rate of 3.5% and 3.9% for the comparable periods. Management will continue to monitor the national, regional and local economic environment and its impact on unemployment, business failures and real estate values in the Company’s market area.
On occasion, the Company acquires residential or commercial real estate properties through or in lieu of loan foreclosure. These properties are held for sale and are initially recorded as OREO at fair value less estimated selling costs at the date of the Company’s acquisition of the property, with fair value based on an appraisal for more significant properties and on a broker’s price opinion for less significant properties. Holding costs and declines in fair value of properties acquired are expensed as incurred. Declines in the fair value after acquisition of the property result in charges against income before tax. There were no such declines during 2019 and 2018. The Company evaluates each OREO property at least quarterly for changes in the fair value. The Company had no properties classified as OREO at December 31, 2019 or December 31, 2018.

Allowance for Loan Losses. Some of the Company’s loan customers ultimately do not make all of their contractually scheduled payments, requiring the Company to charge off a portion or all of the remaining principal balance due. The Company maintains an ALL to absorb such losses. The ALL is maintained at a level believed by management to be appropriate to absorb probable credit losses inherent in the loan portfolio as of the evaluation date; however, actual loan losses may vary from management's current estimates.

The ALL is evaluated 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 appropriate level of the ALL, management also takes into consideration other qualitative factors such as changes in the mix and size of the loan portfolio, credit concentrations, historic 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 as well as the estimated value of any underlying collateral. The appropriate level of the ALL is assessed by an allocation process whereby specific loss allocations are made against impaired loans and general loss allocations are made against segments of the loan portfolio that have similar attributes. Although the ALL is assessed by allocating reserves by loan category, the total ALL is available to absorb losses that may occur within any loan category.

The ALL is increased by a provision for loan losses charged to earnings, and reduced by charge-offs, net of recoveries. The provision for loan losses represents management's estimate of the current period credit cost associated with maintaining an appropriate ALL. Based on an evaluation of the loan portfolio and other relevant qualitative factors, management presents a quarterly analysis of the appropriate level of the ALL to the Board, indicating any changes in the ALL since the last review and any recommendations as to adjustments in the ALL and the level of future provisions.

Credit quality of the commercial portfolio is quantified by a credit risk rating system designed to parallel regulatory criteria and categories of loan risk and has historically been well received by the various regulatory authorities. Individual loan officers and credit department personnel monitor loans to ensure appropriate rating assignments are made on a timely basis. Risk ratings and quality of commercial and retail credit portfolios are also assessed on a regular basis by an independent loan review function.

The level of ALL allocable to each loan portfolio category with similar risk characteristics is determined based on historical charge-offs, adjusted for qualitative risk factors. A quarterly analysis of various qualitative factors, including portfolio characteristics, national and local economic trends, overall market conditions, and levels of, and trends in, delinquencies and nonperforming loans, helps to ensure that areas with the potential risk for loss are considered in management's ALL estimate. In addition, loans are also evaluated for specific 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. Commercial loans with balances greater than $500 thousand was established by management as the threshold for individual impairment evaluation with a specific reserve allocated when warranted. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer, real estate 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 ALL 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.


35



The following table reflects activity in the ALL for the years ended December 31:
 
2019
2018
2017
2016
2015
 
(Dollars in thousands)
Balance at the beginning of year
$
5,739

$
5,408

$
5,247

$
5,201

$
4,694

Charge-offs
402

157

207

163

126

Recoveries
10

38

168

59

83

Net charge-offs
(392
)
(119
)
(39
)
(104
)
(43
)
Provision for loan losses
775

450

200

150

550

Balance at the end of year
$
6,122

$
5,739

$
5,408

$
5,247

$
5,201

Provision charged to income as a
  percent of average loans
0.12
%
0.07
%
0.04
%
0.03
%
0.11
%

The following table (net of loans held for sale) shows the internal breakdown by class of loans of the Company's ALL and the percentage of loans in each category to total loans in the respective portfolios at December 31:
 
2019
2018
2017
2016
2015
 
$
%
$
%
$
%
$
%
$
%
 
(Dollars in thousands)
Residential real estate
$
1,392

28.7
$
1,368

29.2
$
1,361

30.5
$
1,399

32.4
$
1,419

33.0
Construction real estate
774

10.4
617

8.6
488

7.3
391

6.4
514

8.6
Commercial real estate
3,178

43.3
2,933

43.0
2,707

43.4
2,687

46.7
2,792

46.0
Commercial
394

7.1
354

7.4
395

8.6
342

7.9
209

4.3
Consumer
23

0.5
23

0.5
30

0.7
26

0.7
28

0.8
Municipal
76

10.0
82

11.3
64

9.5
40

5.9
38

7.3
Unallocated
285

362

363

362

201

Total
$
6,122

100.0
5,739

100.0
$
5,408

100.0
$
5,247

100.0
$
5,201

100.0
There were no changes to the reserve factors assigned to any of the loan portfolios based on the qualitative factor reviews performed during 2019. Management of the Company believes, in its best estimate, that the ALL at December 31, 2019 is appropriate to cover probable credit losses inherent in the Company’s loan portfolio as of such date. However, there can be no assurance that the Company will not sustain losses in future periods which could be greater than the size of the ALL at December 31, 2019. In addition, our banking regulators, as an integral part of their examination process, periodically review our ALL. Such agencies may require us to recognize adjustments to the ALL based on their judgments about information available to them at the time of their examination. A large adjustment to the ALL for losses in future periods may require increased provisions to replenish the ALL, which could negatively affect earnings. While the Company recognizes that economic slowdowns or financial and credit market turmoil may adversely impact its borrowers' financial performance and ultimately their ability to repay their loans, management continues to be cautiously optimistic about the collectability of the Company's loan portfolio.

Investment Activities. The investment portfolio is used to generate interest and dividend income, manage liquidity and mitigate interest rate sensitivity. At December 31, 2019, the fair value of investment securities AFS was $87.4 million, or 10.0% of total assets, compared to $73.4 million, or 9.1% of total assets at December 31, 2018. There were no investment securities classified as HTM at December 31, 2019 or 2018. The Company had no investments classified as trading as of either date. Investment securities classified as AFS are marked-to-market, with any unrealized gain or loss after estimated taxes charged to the equity portion of the balance sheet through the accumulated OCI component of stockholders' equity. The fair value of investment securities AFS at December 31, 2019 reflects a net unrealized gain of $1.2 million, compared to a net unrealized loss of $1.3 million at December 31, 2018.
At December 31, 2019, 41 debt securities had unrealized losses of $266 thousand, with aggregate depreciation of 0.31% from the Company's amortized cost basis. Securities are evaluated at least quarterly for OTTI and at December 31, 2019, in management's estimation, no security was OTTI. Management's evaluation of OTTI is subject to risks and uncertainties and is intended to determine the appropriate amount and timing of recognition of any impairment charge. The assessment of whether such impairment for debt securities has occurred is based on management's best estimate of the cash flows expected to be collected at the individual security level. We regularly monitor our investment portfolio to ensure securities that may be OTTI are identified in a timely manner and that any impairment charge is recognized in the proper period and, with respect to debt securities, that the impairment is properly allocated between credit losses recognized in earnings and noncredit unrealized losses recognized in OCI. Further deterioration in credit quality, imbalances in liquidity in the financial marketplace or a quick rise in interest rates might adversely

36



affect the fair value of the Company's investment portfolio and may increase the potential that certain unrealized losses will be designated as OTT in future periods, resulting in write-downs and related charges to earnings.
At December 31, 2019, the Company had no investments in a single company or entity (other than U.S. Government-sponsored enterprise securities) that had an aggregate book value in excess of 2% of our stockholders' equity. As of December 31, 2019, all MBS the Company owned were issued by the Government National Mortgage Association, Fannie Mae or the FHLMC/Freddie Mac. Although the Fannie Mae and Freddie Mac debt securities are not explicitly guaranteed by the federal government, one of the stated purposes of the U.S. Treasury's September, 2008 conservatorship and capital support of the two institutions was to stabilize the market in their debt securities, and that purpose was again evident in legislation passed by Congress in late 2009 which effectively lifted any dollar ceiling on the implicit U.S. Treasury guaranty of Fannie Mae and Freddie Mac debt securities.
The following tables show as of December 31, the amortized cost, fair value and weighted average yield on a tax equivalent basis of the Company's investment debt securities portfolio maturing within the stated periods:
 
December 31, 2019
 
Maturities
 
 
Within
One Year
One to
Five Years
Five to
Ten Years
Over
Ten Years
Amortized
Cost
Weighted
Average
Yield
Investment securities available-for-sale:
(Dollars in thousands)
U.S. Government-sponsored enterprises
$

$
191

$
3,170

$
2,988

$
6,349

2.63
%
Agency MBS


3,167

42,336

45,503

2.23
%
State and political subdivisions
680

1,097

8,159

16,553

26,489

2.53
%
Corporate debt

2,479

5,325


7,804

3.26
%
Total investment debt securities
$
680

$
3,767

$
19,821

$
61,877

$
86,145

2.45
%
 
 
 
 
 
 

 
Fair value
$
688

$
3,923

$
20,224

$
62,558

$
87,393

 
 
 
 
 
 
 
 
Weighted average yield
3.09
%
3.27
%
2.69
%
2.31
%
2.45
%
 
 
December 31, 2018
 
Maturities
 
Within
One Year
One to
Five Years
Five to
Ten Years
Over
Ten Years
Amortized
Cost
Weighted
Average
Yield
Investment securities available-for-sale:
(Dollars in thousands)
U.S. Government-sponsored enterprises
$

$

$
2,846

$
3,682

$
6,528

2.83
%
Agency MBS

1,382

1,681

33,788

36,851

2.81
%
State and political subdivisions
200

3,572

10,798

8,957

23,527

2.42
%
Corporate debt

490

7,302


7,792

3.67
%
Total investment debt securities
$
200

$
5,444

$
22,627

$
46,427

$
74,698

2.78
%
 
 
 
 
 
 

 
Fair value
$
202

$
5,443

$
22,227

$
45,533

$
73,405

 
 
 
 
 
 
 
 
Weighted average yield
3.30
%
2.47
%
2.87
%
2.76
%
2.78
%
 
 
 
 
 
 
 
 
The tables above exclude mutual fund securities with a book and fair value of $690 thousand at December 31, 2019 and $556 thousand at December 31, 2018.

Federal Home Loan Bank of Boston Stock. Union is a member of the FHLB, with an investment of $2.5 million and $2.3 million in its Class B common stock at December 31, 2019 and 2018, respectively. Union is required to invest in $100 par value stock of the FHLB in an amount to satisfy unpaid principal balances on qualifying loans, plus an amount to satisfy an activity based requirement. The stock is nonmarketable, and is redeemable by the FHLB at par value. Also, there is the possibility of future capital calls by the FHLB on member banks to ensure compliance with its capital plan. Union's investment in FHLB stock is carried at cost in Other assets on the consolidated balance sheets. Similar to evaluating investment securities for OTTI, the Company has evaluated its investment in the FHLB. The FHLB remains in compliance with all regulatory capital ratios as of December 31, 2019 and 2018. Management's most recent evaluation of the Company's holdings of FHLB common stock concluded that the investment was not impaired at December 31, 2019.


37



Deposits. The following table shows information concerning the Company's average deposits by account type and the weighted average nominal rates at which interest was paid on such deposits for the years ended December 31:
 
2019
2018
2017
 
Average
Balance
Percent
of Total
Deposits
Average
Rate Paid
Average
Balance
Percent
of Total
Deposits
Average
Rate Paid
Average
Balance
Percent
of Total
Deposits
Average
Rate Paid
 
(Dollars in thousands)
Nontime deposits:
 
 
 
 
 
 
 
 
 
Noninterest bearing deposits
$
130,322

18.6

$
121,902

18.9

$
112,914

19.0

Interest bearing checking accounts
161,789

23.1
0.30
%
147,553

22.9
0.16
%
147,677

24.9
0.14
%
Money market accounts
157,102

22.5
1.13
%
153,135

23.8
0.83
%
131,008

22.0
0.53
%
Savings accounts
105,003

15.0
0.15
%
104,582

16.3
0.15
%
98,930

16.6
0.15
%
Total nontime deposits
554,216

79.2
0.44
%
527,172

81.9
0.31
%
490,529

82.5
0.21
%
Time deposits:
 
 
 
 
 
 
 
 
 
Less than $100,000
75,087

10.7
1.34
%
63,710

9.9
0.87
%
61,787

10.4
0.65
%
$100,000 and over
70,848

10.1
1.83
%
53,007

8.2
1.24
%
41,976

7.1
0.72
%
Total time deposits
145,935

20.8
1.58
%
116,717

18.1
1.04
%
103,763

17.5
0.69
%
Total deposits
$
700,151

100.0
0.67
%
$
643,889

100.0
0.45
%
$
594,292

100.0
0.30
%

The Company participates in CDARS, which permits the Company to offer full deposit insurance coverage to its customers by exchanging deposit balances with other CDARS participants. CDARS also provides the Company with an additional source of funding and liquidity through the purchase of deposits. There were no purchased deposits as of December 31, 2019. At December 31, 2018, $15.0 million of the Company's CDARS deposits represented purchased deposits. These deposits are included in time deposits on the consolidated balance sheets. There were $12.0 million of time deposits of $250,000 or less on the balance sheet at December 31, 2019 and $11.3 million at December 31, 2018, which were exchanged with other CDARS participants.

The Company also participates in the ICS program, a service through which Union can offer its customers demand or savings products with access to unlimited FDIC insurance, while receiving reciprocal deposits from other FDIC-insured banks. Like the exchange of certificate of deposit accounts through CDARS, exchange of demand or savings deposits through ICS provides a depositor with full deposit insurance coverage of excess balances, thereby helping the Company retain the full amount of the deposit on its balance sheet. As with the CDARS program, in addition to reciprocal deposits, participating banks may also purchase one-way ICS deposits. There were $115.3 million and $102.9 million in exchanged ICS demand and money market deposits on the balance sheet at December 31, 2019 and December 31, 2018, respectively. There were no purchased ICS deposits at December 31, 2019 or December 31, 2018.

The Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 allows the Company to hold reciprocal deposits up to 20 percent of total liabilities without those deposits being treated as brokered for regulatory purposes.

At December 31, 2019, there were $12.0 million in retail brokered deposits issued under a master certificate of deposit program with a deposit broker for the purpose of providing a supplemental source of funding and liquidity. These deposits mature in February 2020. There were $1.0 million of retail brokered deposits at December 31, 2018.

Deposits grew $37.3 million, or 5.3%, from $706.8 million at December 31, 2018 to $744.0 million at December 31, 2019. Total average deposits grew $56.3 million, or 8.7%, between years, with average nontime deposits growing $27.0 million, or 5.1%, and average time deposits increasing $29.2 million, or 25.0%, during the same time frame. These changes are primarily the result of customers taking advantage of deposit promotions that were offered during 2019, including special promotions in connection with the opening of branch locations in new market areas. In addition, there was a decrease of $15.0 million in purchased CDARS deposits outstanding at December 31, 2019 compared to December 31, 2018.

A provision of the Dodd-Frank Act permanently raised FDIC deposit insurance coverage to $250 thousand per depositor per insured depository institution for each account ownership category. At December 31, 2019, the Company had deposit accounts with less than the maximum FDIC insured deposit amount of $250 thousand totaling $576.9 million, or 77.5% of total deposits.

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An additional $22.1 million of municipal deposits were over the FDIC insurance coverage limit at December 31, 2019 and were collateralized under applicable state regulations by letters of credit issued by the FHLB.

The following table provides a maturity distribution of the Company’s time deposits in amounts of $100 thousand and over at December 31:
 
 
2019
2018
 
 
 
(Dollars in thousands)
 
 
Three months or less
$
27,377

$
24,518

 
 
Over three months through six months
7,351

9,125

 
 
Over six months through twelve months
20,160

12,820

 
 
Over twelve months
18,161

18,011

 
 
 
$
73,049

$
64,474

 
The Company's time deposits in amounts of $100 thousand and over increased $8.6 million, or 13.3%, between December 31, 2018 and December 31, 2019, primarily as the result of customers taking advantage of time deposit promotions that were offered during 2019, including special promotions in connection with the opening of branch locations in new market areas.

Borrowings. Advances from the FHLB are another key source of funds to support earning assets. These funds are also used to manage the Bank's interest rate and liquidity risk exposures. The Company's borrowed funds at December 31, 2019 were comprised of borrowings from the FHLB of $47.2 million, at a weighted average rate of 2.01%. At December 31, 2018, borrowed funds were comprised of FHLB advances of $27.5 million, at a weighted average rate of 1.84%, and overnight secured customer repurchase agreement sweeps of $370 thousand, at a weighted average rate of 0.20%. The maximum borrowings outstanding on overnight secured customer repurchase agreement sweeps during 2018 was $3.5 million. The Company had no overnight federal funds purchased on December 31, 2019 or 2018. Average borrowings outstanding for 2019 were $40.2 million, compared to average borrowings outstanding for 2018 of $42.6 million, with the weighted average interest rate on the Company's borrowings increasing from 1.65% for 2018 to 2.18% for 2019, reflecting the rising interest rate environment.

The Company has the authority, up to its available borrowing capacity with the FHLB, to collateralize public unit deposits with letters of credit issued by the FHLB. FHLB letters of credit in the amount of $24.8 million and $17.3 million were utilized as collateral for these deposits at December 31, 2019 and December 31, 2018, respectively. Total fees paid by the Company in connection with the issuance of these letters of credit were $27 thousand and $28 thousand for the years ended December 31, 2019 and 2018, respectively.

Commitments, Contingent Liabilities, and Off-Balance-Sheet Arrangements. The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers, to reduce its own exposure to fluctuations in interest rates, and to implement its strategic objectives. These financial instruments include commitments to extend credit, standby letters of credit, interest rate caps and floors written on adjustable-rate loans, commitments to participate in or sell loans, commitments to buy or sell securities, certificates of deposit or other investment instruments and risk-sharing commitments or guarantees on certain sold loans. Such instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized on the balance sheet. The contractual or notional amounts of these instruments reflect the extent of involvement the Company has in a particular class of financial instrument.

The Company's maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. For interest rate caps and floors written on adjustable-rate loans, the contractual or notional amounts do not represent the Company’s exposure to credit loss. The Company controls the risk of interest rate cap agreements through credit approvals, limits and monitoring procedures. The Company generally requires collateral or other security to support financial instruments with credit risk.


39



The following table details the contractual or notional amount of financial instruments that represented credit risk at December 31, 2019:
 
Contract or Notional Amount
 
2020
2021
2022
2023
2024
Thereafter
Total
 
(Dollars in thousands)
Commitments to originate loans
$
35,689

$

$

$

$

$

$
35,689

Unused lines of credit
83,102

18,085

348

1,767

301

20

103,623

Standby and commercial letters of credit
381

291

25

235

84

1,292

2,308

Credit card arrangements
311






311

MPF credit enhancement obligation, net
687






687

Commitment to purchase
   investment in a real estate
   limited partnership
3,000






3,000

Total
$
123,170

$
18,376

$
373

$
2,002

$
385

$
1,312

$
145,618

Commitments to originate loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have a fixed expiration date or other termination clause and may require payment of a fee. The unused lines of credit total includes $12.0 million of lines available under the overdraft privilege program and is included in the 2019 funding period. Approximately $20.2 million of the unused lines of credit relate to real estate construction loans that are expected to fund within the next twelve months. The remaining lines primarily relate to revolving lines of credit for other real estate or commercial loans. Since many of the loan commitments are expected to expire without being drawn upon and not all credit lines will be utilized, the total commitment amounts do not necessarily represent future cash requirements. Lines of credit incur seasonal volume fluctuations due to the nature of some customers' businesses, such as tourism and maple syrup products production.

Unused lines of credit decreased $5.8 million, or 5.3%, from $109.5 million at December 31, 2018 to $103.6 million at December 31, 2019. Some of the larger lines have underlying participation agreements in place with other financial institutions in order to permit the Company to support the credit needs of larger dollar borrowers without bearing all the credit risk in the Company's balance sheet. Commitments to originate loans increased $13.0 million, or 57.4%, from $22.7 million at December 31, 2018 to $35.7 million at December 31, 2019.

The Company may, from time-to-time, enter into commitments to purchase, participate or sell loans, securities, certificates of deposit, or other investment instruments which involve market and interest rate risk. At December 31, 2019, the Company had binding commitments to sell residential mortgage loans at fixed rates totaling $7.1 million.

The Company sells 1-4 family residential mortgage loans under the MPF loss-sharing program with FHLB, when management believes it is economically advantageous to do so. Under this program the Company shares in the credit risk of each mortgage, while receiving fee income in return. The Company is responsible for a Credit Enhancement Obligation based on the credit quality of these loans. FHLB funds a first loss account based on the Company's outstanding MPF mortgage balances. This creates a laddered approach to sharing in any losses. In the event of default, homeowner's equity and private mortgage insurance, if any, are the first sources of repayment; the FHLB first loss account funds are then utilized, followed by the member's Credit Enhancement Obligation, with the balance the responsibility of FHLB. These loans must meet specific underwriting standards of the FHLB. As of December 31, 2019, the Company had $30.8 million in loans sold through the MPF program with an outstanding balance of $13.0 million and a contract for the potential delivery of an additional $9.8 million of future loan sales. The volume of loans sold to the MPF program and the corresponding Credit Enhancement Obligation are closely monitored by management. As of December 31, 2019, the notional amount of the maximum contingent contractual liability related to this program was $705 thousand, of which $18 thousand was recorded as a reserve through Other liabilities. Since inception of the Company's MPF participation in 2015, the Company has not experienced any losses under this program.

Liquidity. Liquidity is a measurement of the Company’s ability to meet potential cash requirements, including ongoing commitments to fund deposit withdrawals, repay borrowings, fund investment and lending activities, and for other general business
purposes. The primary objective of liquidity management is to maintain a balance between sources and uses of funds to meet our
cash flow needs in the most economical and expedient manner. The Company’s principal sources of funds are deposits; whole-sale funding options including purchased deposits, amortization, prepayment and maturity of loans, investment securities, interest bearing deposits and other short-term investments; sales of securities and loans AFS; earnings; and funds provided from operations. Contractual principal repayments on loans are a relatively predictable source of funds; however, deposit flows and loan and investment prepayments are less predictable and can be significantly influenced by market interest rates, economic conditions,

40



and rates offered by our competitors. Managing liquidity risk is essential to maintaining both depositor confidence and earnings stability.
At December 31, 2019, Union, as a member of FHLB, had access to unused lines of credit of $65.8 million, over and above the $61.7 million in combined outstanding borrowings and other credit subject to collateralization, subject to the purchase of required FHLB Class B common stock and evaluation by the FHLB of the underlying collateral available. This line of credit can be used for either short-term or long-term liquidity or other funding needs.
Union also maintains an IDEAL Way Line of Credit with the FHLB. The total line available was $551 thousand at December 31, 2019. There were no borrowings against this line of credit as of such date. Interest on this line is chargeable at a rate determined by the FHLB and payable monthly. Should Union utilize this line of credit, qualified portions of the loan and investment portfolios would collateralize these borrowings.
In addition to its borrowing arrangements with the FHLB, Union maintains a pre-approved federal funds line of credit totaling $15.0 million with an upstream correspondent bank, a master brokered deposit agreement with a brokerage firm, one-way buy options with CDARS and ICS as well as access to the FRB discount window, which would require pledging of qualified assets. In addition to the funding sources available to Union, the Company established a $5.0 million revolving line of credit with a correspondent bank during 2019. Core deposits are the lowest cost of funds the Company has access to but these deposits may not be sufficient to cover the on balance sheet liquidity needs which makes using these other funding sources necessary. At December 31, 2019 there were no purchased CDARS or ICS deposits, $12.0 million in retail brokered deposits issued under a master certificate of deposit program with a deposit broker, and no outstanding advances on the federal funds line or at the FRB discount window.

Union's investment and residential loan portfolios provide a significant amount of contingent liquidity that could be accessed in a reasonable time period through sales of those portfolios. We also have additional contingent liquidity sources with access to the brokered deposit market and the FRB discount window. These sources are considered as liquidity alternatives in our contingent liquidity plan. Management believes the Company has sufficient liquidity to meet all reasonable borrower, depositor, and creditor needs in the present economic environment. However, any projections of future cash needs and flows are subject to substantial uncertainty, including factors outside the Company's control.

Capital Resources. Capital management is designed to maintain an optimum level of capital in a cost-effective structure that meets target regulatory ratios, supports management’s internal assessment of economic capital, funds the Company’s business strategies and builds long-term stockholder value. Dividends are generally in line with long-term trends in earnings per share and conservative earnings projections, while sufficient profits are retained to support anticipated business growth, fund strategic investments, maintain required regulatory capital levels and provide continued support for deposits. The Company and Union continue to satisfy all capital adequacy requirements to which they are subject and Union is considered well capitalized under the FDIC's Prompt Corrective Action framework. The Company continues to evaluate growth opportunities both through internal growth or potential acquisitions. The dividend payouts and stock repurchases during the last few years reflect the Board’s desire to utilize our capital for the benefit of the stockholders.
Stockholders’ equity increased from $64.5 million at December 31, 2018 to $71.8 million at December 31, 2019, reflecting net income of $10.6 million for 2019, an increase of $2.0 million in accumulated OCI due to an increase in the fair market value of the Company's AFS securities, an increase of $165 thousand from stock based compensation, a $44 thousand increase due to the issuance of 2,000 shares of common stock from the exercise of incentive stock options and a $39 thousand increase due to the issuance of common stock under the DRIP. These increases were partially offset by cash dividends declared of $5.5 million and stock repurchases of $13 thousand during 2019.
The Company has 7,500,000 shares of $2.00 par value common stock authorized. As of December 31, 2019, the Company had 4,948,245 shares issued, of which 4,471,977 were outstanding and 476,268 were held in treasury. Following stockholder approval in 2014, the Company adopted the 2014 Equity Plan which replaced the 2008 ISO Plan. As of December 31, 2019, there were outstanding employee incentive stock options with respect to 1,000 shares granted under the 2008 ISO Plan, all of which were exercisable, and outstanding employee incentive stock options with respect to 4,500 shares granted under the 2014 Equity Plan, all of which were exercisable. Also as of December 31, 2019, there were outstanding RSUs with respect to 433 shares granted in 2017, 2,120 shares granted in 2018 and 10,143 shares granted in 2019 as to which vesting requirements had not yet been met.
In January 2020, the Company's Board reauthorized for 2020 the limited stock repurchase plan that was initially established in May of 2010. The limited stock repurchase plan allows the repurchase of up to a fixed number of shares of the Company's common stock each calendar quarter in open market purchases or privately negotiated transactions, as management may deem advisable and as market conditions may warrant. The repurchase authorization for a calendar quarter (currently 2,500 shares) expires at the end of that quarter to the extent it has not been exercised, and is not carried forward into future quarters. During 2019, the Company repurchased 300 shares under the program at a total cost of $13 thousand. Since inception, as of December 31, 2019, the Company had repurchased 17,693 shares under the program, for a total cost of $472 thousand.

41



The Company maintains a DRIP whereby registered stockholders may elect to reinvest cash dividends and optional cash contributions to purchase additional shares of the Company's common stock. The Company has reserved 200,000 shares of its common stock for issuance and sale under the DRIP. As of December 31, 2019, 2,503 shares of stock had been issued from treasury stock since inception of the DRIP, including 1,042 shares in 2019.
The Company's total capital to risk weighted assets increased to 13.0% at December 31, 2019, from 12.9% at December 31, 2018. Tier I capital to risk weighted assets increased to 12.0% at December 31, 2019, from 11.8% at December 31, 2018 and Tier I capital to average assets increased to 8.1% at December 31, 2019 from 8.0% at December 31, 2018. Union is categorized as well capitalized under the Prompt Corrective Action regulatory framework and the Company is well over applicable minimum capital adequacy requirements. The Company's December 31, 2019 capital adequacy was determined based on the BASEL III requirements, which took effect on January 1, 2015 and were fully phased in on January 1, 2019. See Note 22 for additional discussion of the Company's and Union's regulatory capital ratios.

Impact of Inflation and Changing Prices. The Company's consolidated financial statements have been prepared in accordance with GAAP, which allows for the measurement of financial position and results of operations in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Banks have asset and liability structures that are essentially monetary in nature, and their general and administrative costs constitute relatively small percentages of total expenses. Thus, increases in the general price levels for goods and services have a relatively minor effect on the Company's total expenses but could have an impact on our loan customers' financial condition. Interest rates have a more significant impact on the Company's financial performance than the effect of general inflation. The target federal funds rate decreased three times during 2019, which has resulted in an decrease in the U.S prime rate to 4.75% as of December 31, 2019. These decreases in rates have had a negative impact on the Company's net interest income for the year ended December 31, 2019 compared to the expected amounts based on budget assumptions. Through December 31, 2019 the decreases in the target federal funds rate have not had a direct impact on the rates paid on customer deposit accounts as competition for customer deposits remains strong and customers are expecting to receive higher rates for their monies. Further decreases in the target federal funds rate in 2020 may result in less than expected interest income on loans and investments. Management is hopeful that rates paid on deposit accounts will see some relief if further decreases in the target rate continues. Market rates are out of the Company's control but can have a dramatic impact on net interest income.
Interest rates do not necessarily move in the same direction or change in the same magnitude as the prices of goods and services, although periods of increased inflation may accompany a rising interest rate environment. Inflation in the price of goods and services, while not having a substantial impact on the operating results of the Company, does affect all customers and therefore may impact their ability to keep funds on deposit or make timely loan payments. The Company is aware of and evaluates this risk along with others in making business decisions. The levels of deficit spending by federal, state and local governments and control of the money supply by the FRB including further quantitative easing of the money supply, may have unanticipated impacts on interest rates or inflation in future periods that could have an unfavorable impact on the future operating results of the Company.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Omitted, in accordance with the regulatory relief available to smaller reporting companies in SEC Release Nos. 33-10513 (effective September 10, 2018).

42



Item 8. Financial Statements and Supplementary Data
UNION BANKSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
December 31, 2019 and 2018
 
2019
2018
Assets
(Dollars in thousands)
Cash and due from banks
$
5,405

$
4,045

Federal funds sold and overnight deposits
45,729

33,244

Cash and cash equivalents