UNION BANKSHARES INC - Quarter Report: 2009 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

OR

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: September 30, 2009

Commission file number: 001-15985

UNION BANKSHARES, INC.

P.O. BOX 667

MAIN STREET

MORRISVILLE, VT 05661

Registrant’s telephone number:      802-888-6600

Former name, former address and former fiscal year, if changed since last report: Not applicable

Securities registered pursuant to section 12(b) of the Act:

Common Stock, $2.00 par value	Nasdaq Stock Market
(Title of class)	(Exchanges registered on)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]      No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ]      No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of November 13, 2009:

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UNION BANKSHARES, INC.

TABLE OF CONTENTS

PART I

FINANCIAL INFORMATION

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Part l Financial Information

  Item 1. Financial Statements

UNION BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Unaudited)

	September 30, 2009					December 31, 2008
Assets	(Dollars in thousands)
Cash and due from banks		$	5,088				$	4,793
Federal funds sold and overnight deposits			25,261					21,537
Cash and cash equivalents			30,349					26,330
Interest bearing deposits in banks			20,680					14,789
Investment securities available-for-sale			23,968					27,834
Loans held for sale			6,387					3,178
Loans			345,483					350,238
Allowance for loan losses			(3,556)					(3,556)
Unamortized net loan costs (fees)			50					(107)
Net loans			341,977					346,575
Accrued interest receivable			1,535					1,939
Premises and equipment, net			7,506					7,461
Other assets			11,539					11,998
Total assets		$	443,941				$	440,104
Liabilities and Stockholders’ Equity
Liabilities
Deposits
Noninterest bearing		$	59,120				$	61,315
Interest bearing			310,324					303,055
Total deposits			369,444					364,370
Borrowed funds			25,757					27,416
Liability on defined benefit pension plan			4,615					5,232
Accrued interest and other liabilities			3,875					3,936
Total liabilities			403,691					400,954
Commitments and Contingencies
Stockholders’ Equity
Common stock, $2.00 par value; 7,500,000 shares authorized;  4,921,786 shares issued at September 30, 2009 and  December 31, 2008			9,844					9,844
Paid-in capital			216					207
Retained earnings			36,330					35,869
Treasury stock at cost; 459,758 shares at September 30, 2009 and 447,188 shares at December 31, 2008			(3,710)					(3,500)
Accumulated other comprehensive loss			(2,430)					(3,270)
Total stockholders’ equity			40,250					39,150
Total liabilities and stockholders’ equity		$	443,941				$	440,104

See accompanying notes to unaudited interim consolidated financial statements.

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UNION BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

See accompanying notes to unaudited interim consolidated financial statements.

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UNION BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

Nine Months Ended September 30, 2009 and 2008

(Unaudited)

	Common stock										Accumulated
	Shares, net of treasury		Amount		Paid-in capital		Retained earnings		Treasury stock		other comprehensive loss		Total stockholders’ equity
	(Dollars in thousands)
Balances, December 31, 2008	4,474,598		$9,844		$207		$35,869		$(3,500)		$(3,270)		$39,150
Comprehensive income:
Net income	-		-		-		3,947		-		-		3,947
Other comprehensive income,    net of tax:
Change in net unrealized gain    (loss) on investment securities    available-for-sale, net of    reclassification adjustment    and tax effects	-		-		-		-		-		673		673
Change in net unrealized loss    on unfunded defined    benefit plan liability,    net of reclassification    adjustment and tax effects	-		-		-		-		-		167		167
Total other comprehensive    income											840
Total comprehensive    income													4,787
Cash dividends declared    ($0.78 per share)	-		-		-		(3,486)		-		-		(3,486)
Stock based compensation    expense	-		-		9		-		-		-		9
Purchase of treasury stock	12,570		-		-		-		(210)		-		(210)
Balances, September 30, 2009	4,462,028		$9,844		$216		$36,330		$(3,710)		$(2,430)		$40,250
Balances, December 31, 2007	4,502,969		$9,844		$202		$35,791		$(2,939)		$(824)		$42,074
Comprehensive income:
Net income	-		-		-		3,761		-		-		3,761
Other comprehensive loss,    net of tax:
Change in net unrealized gain    (loss) on investment securities    available-for-sale, net of    reclassification adjustment    and tax effects	-		-		-		-		-		(513)		(513)
Change in net unrealized loss    on unfunded defined    benefit plan liability,     net of reclassification    adjustment and tax effects	-		-		-		-		-		17		17
Total other comprehensive    income													(496)
Total comprehensive    income													3,265
Cash dividends declared    ($0.84 per share)	-		-		-		(3,774)		-		-		(3,774)
Stock based compensation    expense	-		-		5		-		-		-		5
Purchase of treasury stock	(19,328)		-		-		-		(387)		-		(387)
Balances, September 30, 2008	4,483,641		$9,844		$207		$35,778		$(3,326)		$(1,320)		$41,183

See accompanying notes to unaudited interim consolidated financial statements.

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UNION BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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See accompanying notes to unaudited interim consolidated financial statements.

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UNION BANKSHARES, INC. AND SUBSIDIARY

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Basis of Presentation

The accompanying unaudited interim consolidated financial statements of Union Bankshares, Inc. (the Company) as of September 30, 2009 and 2008, and for the three and nine months then ended have been prepared in conformity with U.S. generally accepted accounting principles (GAAP) for interim financial information, general practices within the banking industry, and the accounting policies described in the Company’s Annual Report to Shareholders and Annual Report on Form 10-K for the year ended December 31, 2008. In the opinion of Company’s management, all adjustments, consisting only of normal recurring adjustments and disclosures necessary for a fair presentation of the information contained herein, have been made. This information should be read in conjunction with the Company’s 2008 Annual Report to Shareholders and 2008 Annual Report on Form 10-K. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full fiscal year ending December 31, 2009, or any other interim period.

Certain amounts in the 2008 unaudited interim consolidated financial statements have been reclassified to conform to the 2009 presentation.

Note 2. Commitments and Contingencies

In the normal course of business, the Company is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the Company’s financial condition or results of operations.

Note 3. Per Share Information

Earnings per common share amounts are computed based on the weighted average number of shares of common stock outstanding during the period and reduced for shares held in treasury. The assumed conversion of available outstanding stock options does not result in material dilution.

Note 4. Recent Accounting Pronouncements

On June 29, 2009, the Financial Accounting Standards Board (FASB) issued an accounting pronouncement establishing the FASB Accounting Standards Codification™ (the “ASC”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities. This pronouncement is effective for financial statements issued for interim and annual periods ending after September 15, 2009, for most entities. On the effective date, all non-Securities and Exchange Commission (SEC) accounting and reporting standards were superceded. The Company adopted this new accounting pronouncement for the interim period ended September 30, 2009, as required, and adoption did not have a material impact on the Company’s consolidated financial statements.

In June 2009, the FASB issued two related accounting pronouncements changing the accounting principles and disclosure requirements related to securitizations and special-purpose entities. Specifically, these pronouncements eliminate the concept of a “qualifying special-purpose entity”, change the requirements for derecognizing financial assets and change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar) rights should be consolidated. These pronouncements also expand existing disclosure requirements to include more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. These pronouncements will be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Earlier application is prohibited. The recognition and measurement provisions regarding transfers of financial assets shall be applied to transfers that occur on or after the effective date. These new pronouncements will become effective for the Company on January 1, 2010. The Company does not expect that the adoption of these pronouncements will have a material impact on the Company’s consolidated financial statements.

In May 2009, the FASB issued an accounting pronouncement, which establishes general standards for disclosing and accounting for events that occur after the balance sheet date but before financial statements are issued or are available to be issued. This pronouncement was effective for interim and

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annual periods ending after June 15, 2009. The Company has complied with the requirements of this pronouncement. See Note 9.

In August 2009, the FASB issued an accounting pronouncement which provides clarification on measuring liabilities at fair value when a quoted price in an active market is not available. This pronouncement is effective for the first reporting period beginning after issuance. We do not expect adoption of this pronouncement on October 1, 2009 will have a material impact on the Company’s consolidated financial statements.

Note 5. Investment Securities

Investment securities available-for-sale as of the balance sheet dates consisted of the following:

Proceeds from the sale of securities available-for-sale for the nine months ended September 30, 2009 and September 30, 2008 were $4.1 and $1.8 million, respectively. Gross realized gains from sales of investments available-for-sale were $74 thousand and $34 thousand with gross realized losses of $-0- and $18 thousand for the nine months ended September 30, 2009 and 2008, respectively. The specific identification method is used to determine realized gains and losses on sales of available-for-sale securities.

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The amortized cost and estimated fair value of debt securities available-for-sale (dollars in thousands) by contractual scheduled maturity as of September 30, 2009 were as follows:

Actual maturities may differ for certain debt securities that may be called by the issuer prior to the contractual maturity. Actual maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be prepaid, usually without any penalties. Therefore, these mortgage-backed securities are not included in the maturity categories in the above maturity summary.

Information (dollars in thousands) pertaining to investment securities available-for-sale with gross unrealized losses aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:

The Company evaluates all investment securities on a quarterly basis, and more frequently when economic conditions warrant to determine if an other-than-temporary impairment exists. A debt security is considered impaired if the fair value is less than its amortized cost basis at the report date. If impaired, management then assesses whether the unrealized loss is other-than-temporary. Prior to adoption by FASB of current authoritative guidance, effective for the Company on April 1, 2009, the Company generally recognized an other-than-temporary impairment on debt securities when full recovery of value was not expected or the Company did not have the ability and intent to hold such securities until they have fully recovered their amortized cost. Prior to April 1, 2009, GAAP required other-than-temporary impairment losses, amounting to the difference between the amortized cost and fair value to be recorded, net of tax effect, through net income thereby establishing a new cost basis of the security.

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The Company recognized an other-than-temporary impairment loss of $512 thousand ($338 thousand, net of tax) during the quarter ended September 30, 2008. This impairment loss was recorded, net of tax effect, through net income and as an adjustment to the amortized cost of the securities.

Current authoritative guidance provides that an unrealized loss is generally deemed to be other-than-temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security. The credit loss component of an other-than-temporary impairment write-down is recorded in earnings, net of tax effect, as a component of net other-than-temporary impairment losses in the consolidated statement of income, while the remaining portion of the impairment loss is recognized in other comprehensive income (loss), provided the Company does not intend to sell the underlying debt security and it is “more likely than not” that the Company will not have to sell the debt security prior to recovery.

Management considered the following factors in determining whether a credit loss exists and the period over which the debt security is expected to recover:

•

The length of time, and the extent to which, the fair value has been less than the amortized cost;

•

Adverse conditions specifically related to the security, industry, or geographic area;

•

The historical and implied volatility of the fair value of the security;

•

The payment structure of the debt security and the likelihood of the issuer being able to make payments that may increase in the future;

•

Failure of the issuer of the security to make scheduled interest or principal payments;

•

Any changes to the rating of the security by a rating agency; and

•

Recoveries or additional declines in fair value subsequent to the balance sheet date.

At September 30, 2009, six debt securities, consisting of two nonagency collateralized mortgage obligations, one U.S. Government-sponsored enterprise bond, and three municipal bonds had unrealized losses totalling $26 thousand. One marketable equity security had an unrealized loss of $6 thousand at September 30, 2009. For all securities in the available-for-sale portfolio for which unrealized losses have existed for a period of time as of the reporting date, the Company did not have the intention to sell and believes it will not be required to sell the securities for contractual, regulatory or liquidity reasons prior to recovery of the carrying value of such securities. Management believes that the unrealized losses on any debt or equity securities at September 30, 2009 represent temporary impairments and no other-than-temporary impairments on investment securities were recognized in 2009 through income or other comprehensive income (loss).

Note 6. Defined Benefit Pension Plan

Union Bank, the Company’s sole subsidiary, sponsors a noncontributory defined benefit pension plan covering all eligible employees. The plan provides defined benefits based on years of service and final average salary.

Net periodic pension benefit cost for the three and nine months ended September 30 consisted of the following components:

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Note 7. Other Comprehensive Income (Loss)

Accounting principles generally require recognized revenue, expenses, gains, and losses to be included in net income or loss. Certain changes in assets and liabilities, such as the after-tax-effect of unrealized gains and losses on investment securities available-for-sale, are not reflected in the statement of income, but the cumulative effect of such items from period-to-period is reflected as a separate component of the equity section of the balance sheet (accumulated other comprehensive income or loss). Other comprehensive income or loss, along with net income, comprises the Company’s total comprehensive income or loss. As of the balance sheet dates, the components of accumulated other comprehensive loss, net of tax, were:

The following comprised total comprehensive income for the three and nine months ended September 30:

Note 8: Fair Value Measurements

The Company utilizes FASB ASC Topic 820, Fair Value Measurements and Disclosures, as guidance for accounting for assets and liabilities carried at fair value. This standard defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is a market based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. The guidance in FASB ASC Topic 820 establishes a three-level fair value hierarchy, which prioritizes the inputs used in measuring fair value. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The three levels of the fair value hierarchy are:

•

Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities;

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•

Level 2 - Quoted prices for similar assets or liabilities in active markets, quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability;

•

Level 3 - Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

The following is a description of the valuation methodologies used for the Company’s financial assets that are measured on a recurring basis at estimated fair value:

Investment securities available-for-sale: Certain corporate debt securities, marketable equity securities and mutual funds have been valued using unadjusted quoted prices from active markets and therefore have been classified as level 1. However, the majority of the Company’s investment securities available-for-sale have been valued utilizing level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include market maker bids, quotes and pricing models. Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows.

Assets measured at fair value on a recurring basis at September 30, 2009 and December 31, 2008, segregated by fair value hierarchy level, are summarized below:

Certain other assets and liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Assets and liabilities measured at fair value on a non-recurring basis such as OREO, impaired loans and mortgage servicing

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rights were not significant at September 30, 2009 or December 31, 2008. The Company has not elected to apply the fair value option to any financial assets or liabilities other than those situations where other accounting pronouncements require fair value measurements.

FASB ASC Topic 825, Financial Instruments, requires disclosure of the estimated fair value of financial instruments. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Management’s estimates and assumptions are inherently subjective and involve uncertainties and matters of significant judgment. Changes in assumptions could dramatically affect the estimated fair values.

Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments may be excluded from disclosure requirements. Thus, the aggregate fair value amounts presented may not necessarily represent the actual underlying fair value of such instruments or the Company.

The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:

Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets’ fair values.

Investment securities and interest bearing deposits in banks: Fair values for investment securities and interest bearing deposits in banks are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments or discounted present values of cash flows.

Loans and loans held for sale: Fair values of loans are estimated for portfolios of loans with similar financial characteristics and segregated by loan type. For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans (for example, fixed-rate residential, commercial real estate, and rental property mortgage loans, and commercial and industrial loans) are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future cash flows, future expected loss experience and risk characteristics. The carrying amounts reported in the balance sheet for loans that are held for sale approximate their fair values. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

Deposits: The fair values disclosed for demand deposits or nonmaturity deposits (for example, checking and savings accounts) are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate time deposits approximate their fair values at the reporting date. The fair values for fixed-rate time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on time deposits to a schedule of aggregated contractual maturities on such time deposits.

Borrowed funds: The fair values of the Company’s long-term debt are estimated using discounted cash flow analysis based on interest rates currently being offered on similar debt instruments. The fair values of the Company’s short-term debt approximate the carrying amounts reported in the balance sheet.

Accrued interest receivable and payable: The carrying amounts of accrued interest approximate their fair values.

FHLB of Boston stock: The carrying amount approximates its fair value.

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Off-balance-sheet financial instruments: Fair values for off-balance-sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The only commitments to extend credit that are normally longer than one year in duration are the Home Equity Lines whose interest rates are variable quarterly. The only fees collected for commitments are an annual fee on credit card arrangements and often a flat fee on commercial lines of credit and standby letters of credit. The fair value of off-balance-sheet financial instruments is not significant.

As of the balance sheet dates, the estimated fair values and related carrying amounts of the Company’s significant financial instruments were as follows:

The carrying amounts in the preceding table are included in the balance sheet under the applicable captions.

Note 9. Subsequent Events

Subsequent events represent events or transactions occurring after the balance sheet date but before the financial statements are issued. Financial statements are considered “issued” when they are widely distributed to shareholders and others for general use and reliance in a form and format that complies with GAAP.

Specifically, there are two types of subsequent events:

•

Those comprising events or transactions providing additional evidence about conditions that existed at the balance sheet date, including estimates inherent in the financial statement preparation process (referred to as recognized subsequent events).

•

Those comprising events that provide evidence about conditions not existing at the balance sheet date but, rather, that arose after such date (referred to as nonrecognized subsequent events).

On October 21, 2009, Union Bankshares, Inc. declared a $0.25 per share regular quarterly cash dividend payable November 12, 2009 to stockholders of record on October 31, 2009.

Subsequent events have been evaluated through November 13, 2009, the issuance date of the September 30, 2009 financial statements.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

GENERAL

The following discussion and analysis by management focuses on those factors that had a material effect on Union Bankshares, Inc.’s (Company) financial position as of September 30, 2009, and as of December 31, 2008, and its results of operations for the three and nine months ended September 30, 2009 and 2008. This discussion is being presented to provide a narrative explanation of the financial statements and should be read in conjunction with the consolidated financial statements and related notes and with other financial data appearing elsewhere in this filing and with the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. In the opinion of the Company’s management, the interim unaudited data reflects all adjustments, consisting only of normal recurring adjustments, and disclosures necessary to fairly present the Company’s consolidated financial position and results of operations for the interim period. Management is not aware of the occurrence of any events between September 30, 2009 and November 13, 2009 which would materially affect the information presented.

CAUTIONARY ADVICE ABOUT FORWARD LOOKING STATEMENTS

The Company may from time to time make written or oral statements that are considered “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may include financial projections, statements of plans and objectives for future operations, estimates of future economic performance and assumptions relating thereto. The Company may include forward-looking statements in its filings with the Securities and Exchange Commission (SEC), in its reports to stockholders, including this Quarterly Report, in press releases, other written materials, and in statements made by senior management to analysts, rating agencies, institutional investors, representatives of the media and others.

Forward-looking statements reflect management’s current expectations and are subject to uncertainties, both general and specific, and risk exists that those predictions, forecasts, projections and other estimates contained in forward-looking statements will not be achieved. When management uses any of the words “believes,” “expects,” “anticipates,” “intends,” “plans,” “seeks,” “estimates”, or similar expressions, they are making forward–looking statements. Many possible events or factors, including those beyond the control of management, could affect the future financial results and performance of the Company. This could cause results or performance to differ materially from those expressed in forward-looking statements. The possible events or factors that might affect the forward-looking statements include, but are not limited to, the listing in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 and the items added below:

•

disruptions in U.S. and global financial and credit markets;

•

the implementation of international financial reporting standards (IFRS) for United States companies;

•

impact of governmental interposition in financial services or other industries;

•

adverse changes in the local real estate market, which negatively impact collateral values and the Company’s ability to recoup loan losses through disposition of real estate collateral; and

•

further expansion of fair value accounting or disclosure.

When evaluating forward-looking statements to make decisions with respect to the Company, investors and others are cautioned to consider these and other risks and uncertainties, including the events and circumstances discussed under “Recent Developments” below, and are reminded not to place undue reliance on such statements. 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.

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RECENT DEVELOPMENTS

The U.S. and global economies have experienced significant stress and disruptions in the financial sector over the last twelve months but are showing signs of stabilization. Interest rates remain at historic lows, bank failures are higher than they have been in over 15 years and the amount of U.S. Government dollars pumped into the system is unprecedented. Dramatic slowdowns in certain sectors of the housing industry with falling home prices, continuing foreclosures and increasing unemployment have resulted in major issues for some financial institutions, including government-sponsored entities and investment banks. These issues have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. The economic instability progressed to many other business and government sectors and appears to be affecting the majority of consumers as well.

Despite the volatile economy, Vermont continues to have one of the lowest residential foreclosure rates in the country. Also, as northern New England did not experience the dramatic run up in housing prices that preceded the current economic downturn, likewise, we have not seen the values drop as far as other parts of the country.

In response to the financial crisis affecting the banking and financial markets, many new laws, regulations and programs have been promulgated. We will not attempt to discuss them all within this Form 10-Q but will mention the ones that continue or will have a known financial impact on the Company.

In October 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law. Pursuant to the EESA, the Federal Deposit Insurance Corporation temporarily increased the deposit insurance coverage limits to $250,000 per ownership category at each insured financial institution. That coverage has been extended until December 31, 2013.

After receiving a recommendation from the boards of the Federal Deposit Insurance Corporation (the “FDIC”) and the Federal Reserve System (the “Federal Reserve”), the Treasury signed the systemic risk exception to the FDIC Act, enabling the FDIC to temporarily provide a 100% guarantee on deposits in noninterest bearing transaction deposit accounts under a Temporary Liquidity Guarantee Program. Coverage under the Temporary Liquidity Guarantee Program was available for 30 days without charge and for calendar year 2009 at a cost of 10 basis points per annum for noninterest bearing transaction deposits in excess of the $250,000 insured deposit limit. The program has been extended until June 30, 2010 at a cost of 15 basis points per annum and the Company is continuing its participation in this program through that date.

The Company decided it was not in the best interest of the Company or its shareholders to participate in any of the other governmental programs available under the Troubled Asset Purchase Program given the strength of the Company’s capital position, the nature of the government restrictions with the possibility of additional restrictions in the future, the fact that the Company did not target sub-prime borrowers and the fact that the Company is able to meet the lending and withdrawal needs of our customers with our available funding sources. (For additional information, see Capital Resources on page 47.)

Union Bank is participating in the U.S. Small Business Administration’s (SBA) temporary America’s Recovery Capital (ARC) program which offers interest-free loans of up to $35,000 to viable small businesses, which carry a 100% guaranty from the SBA to the lender and require no fees paid to the SBA. The program pays participating lenders a market rate of interest while the ARC loans are outstanding.

In addition, as a result of the weakness of certain financial institutions, the FDIC is continuing to take action that will result in increased FDIC insurance assessments for United States FDIC-insured financial institutions, including Union. Under the deposit insurance restoration plan approved by the FDIC in October 2008, the FDIC Board set a rate schedule to raise the insurance reserve ratio to 1.15% within five years. On February 27, 2009, the FDIC announced that the restoration plan horizon has been extended to seven years in light of the current significant strains on banks and the financial system and the likelihood of a severe recession. In addition, the FDIC announced a special assessment of 5 basis points assessed on net assets at June 30, 2009 and collected on September 30, 2009. This special assessment totaled $191 thousand for the Company and we anticipate our total premium assessment for

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2009 will be approximately $700 thousand compared to $87 thousand for 2008. In September 2009, the FDIC proposed that banks prepay three and one quarter years of regular assessments on December 30, 2009. The FDIC would maintain its current assessment rates through 2010 but effective January 1, 2011, the rate would increase by three basis points. Additionally, the agency’s restoration plan would be extended from seven to eight years. If approved, the Company will book the prepayment as an asset and expense an appropriate amount monthly through the statement of income. The Company anticipates its Prepaid Assessment will be approximately $1.8 million.

It is not completely clear at this time what impact current or future government sponsored programs will have on the Company, its customers or the U.S. and global financial markets.

CRITICAL ACCOUNTING POLICIES

The Company has established various accounting policies which govern the application of accounting principles generally accepted in the United States of America (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 the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Based on this definition, the Company has identified the accounting policies and judgments most critical to the Company. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from estimates and have a material impact on the carrying value of assets, liabilities, capital, or the results of operations of the Company.

The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of its consolidated financial statements. Adequacy of the allowance for loan losses is determined quarterly using a consistent, systematic methodology, which analyzes the risk inherent in the loan portfolio. In addition to evaluating the collectability of specific loans when determining the adequacy of the allowance, management also takes into consideration other factors such as changes in the mix and size of the loan portfolio, historical loss experience, the amount of delinquencies and loans adversely classified, industry trends, and the impact of the local and regional economy on the Company’s borrowers. Changes in these factors may cause management’s estimate of the allowance for loan losses to increase or decrease and result in adjustments to the Company’s provision for loan losses in future periods. For additional information, see FINANCIAL CONDITION – Allowance for Loan Losses below.

The decision to recognize other-than-temporary impairment on investment securities available-for-sale has become more difficult as complete information is not always available and market conditions and other relevant factors are subject to rapid changes. The other-than-temporary impairment decision has become a critical accounting policy for the Company. Accounting guidance requires companies to perform periodic reviews of individual securities in their investment portfolios to determine whether a decline in the value of a security is other-than-temporary. A review of other-than-temporary impairment requires companies to make certain judgments regarding the cause and materiality of the decline, its effect on the financial statements and the probability, extent and timing of a valuation recovery, the company’s intent and ability to continue to hold the security, and, with respect to debt securities, the likelihood that the Company will have to sell the security before its value recovers. Pursuant to these requirements, management assesses valuation declines to determine the extent to which such changes are attributable to (1) fundamental factors specific to the issuer, such as the nature of the issuer and its financial condition, business prospects or other factors or (2) market-related factors, such as interest rates or equity market declines. Declines in the fair value of securities below their costs that are deemed by management to be other-than-temporary are (1) if equity securities, recorded in earnings as realized losses and (2) if debt securities, recorded in earnings as realized losses to the extent they are deemed credit losses, with noncredit losses recorded in Other Comprehensive Income.

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The Company’s pension benefit obligations and net periodic benefit cost are actuarially determined based on the following assumptions: discount rate, current and estimated future return on plan assets, wage base rate, anticipated mortality rates, Consumer Price Index, and rate of increase in compensation levels. The annual determination of the pension benefit obligations and net periodic benefit cost is a critical accounting estimate as it requires the use of estimates and judgment 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 financial condition or results of operations.

The Company also has other key accounting policies, which involve the use of estimates, judgments and assumptions that are significant to understanding the Company’s financial results including the valuation of deferred tax assets, and determination of the fair values of investment securities and other real estate owned. See FINANCIAL CONDITION – Allowance for Loan Losses and Investment Activities below. Although management believes that its estimates, assumptions and judgments are reasonable, they are based upon information presently available and can be impacted by events outside the control of the Company. Actual results may differ significantly from these estimates under different assumptions, judgments or conditions.

OVERVIEW

The Company’s net income was $1.45 million for the quarter ended September 30, 2009 and $1.17 million for the quarter ended September 30, 2008, an increase of $280 thousand, or 24.0%. These results reflected an increase in net interest income of $157 thousand, or 3.6%, and an increase of $671 thousand, or 80.1%, in noninterest income. The increase in noninterest income was mainly due to the increase in net gains on sales of loans held for sale from $74 thousand for the quarter ended September 30, 2008 to $314 thousand for the quarter ended September 30, 2009 and the third quarter 2008 write-down of $512 thousand on impaired investment securities available-for-sale. Salaries and wages were also lower by $73 thousand, or 4.5%, for the third quarter of 2009 compared to the same period last year due to the deferral of $30 thousand of loan origination costs for 2009 and increased operating efficiencies despite the addition of two full service branches in the third quarter of 2008. These positive changes were partially offset by a net increase in noninterest expense of $290 thousand between periods, which reflected an increase of $87 thousand in the FDIC insurance assessment due to higher rates and deposit growth and a $126 thousand increase, or 86.3%, in the defined benefit pension plan expense.

The Company continued to face a challenging interest rate environment as the prime rate has been reduced seven times since January 1, 2008 from 7.25% to 3.25% on September 30, 2009. Total interest income decreased by $356 thousand, or 5.7%, to $5.8 million in the third quarter of 2009 versus $6.2 million in the third quarter of 2008, but that decrease was more than offset by the decrease in interest expense from $1.8 million in 2008 to $1.3 million in 2009, a decrease of $513 thousand, or 28.7%, between periods. The result of the changes in interest income and interest expense was that net interest income for the third quarter of 2009 was $4.6 million, up $157 thousand, or 3.6%, from the third quarter of 2008 of $4.4 million. The increase in net interest income was more a function of the decrease in interest paid on interest bearing liabilities as this mitigated the decrease in interest income. During the third quarter of 2009, the Company’s net interest margin decreased 17 basis points to 4.50%, from 4.67% for the third quarter of 2008. The Company’s net interest spread declined 3 basis points to 4.22% for the third quarter of 2009, compared to 4.25% for the same period last year. The decline in the net interest spread was primarily the result of the decline in average interest rates earned on loans as the 400 basis point drop in the prime rate between January 1, 2008 and September 30, 2009 had an effect on the repricing of adjustable rate loans and the volume of refinancings, as customers took advantage of the lower rates. Further drops in the prime rate and/or increases in competitors’ deposit rates could be problematic as individual instruments continue to reprice.

The Company’s total assets increased from $440.1 million at December 31, 2008, to $443.9 million at September 30, 2009, an increase of $3.8 million, or 0.9%. Deposits increased from $364.4 million at December 31, 2008 to $369.4 million at September 30, 2009, an increase of $5.1 million, or 1.4%.

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Borrowed funds decreased from $27.4 million at December 31, 2008 to $25.8 million at September 30, 2009, a decrease of $1.6 million, or 6.0%. Total loans, including loans held for sale, decreased $1.5 million, or 0.4%, from $353.4 million at December 31, 2008 to $351.9 million at September 30, 2009. Total loans at September 30, 2009 are net of $53.6 million in residential real estate loans sold during the first nine months of 2009. Despite a weakening economy and our conservative underwriting practices, loan demand during the first nine months of 2009 was strong due, in large part, to lower interest rates which have sparked both existing and new customers to refinance loans. The Company has also benefited from a changing competitive environment as some of our competitors have changed their lending and pricing practices.

The Company’s asset quality has remained strong with September 30, 2009 total nonperforming assets at $6.3 million, or 1.42% of total assets, compared to $8.1 million, or 1.85% of total assets, at December 31, 2008 and $8.5 million, or 2.01% of total assets, at September 30, 2008.

The following unaudited per share information and key ratios depict several measurements of performance or financial condition for or at the three and nine months ended September 30, 2009 and 2008, respectively:

____________________

(1)

Annualized.

(2)

The ratio of tax equivalent net interest income to average earning assets. See page 21 for more information.

(3)

The difference between the average rate earned on assets minus the average rate paid on liabilities. See page 21 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 other real estate or assets owned.

(5)

Cash dividends declared and paid per share divided by consolidated net income per share.

RESULTS OF OPERATIONS

Net Interest Income. The largest component of the Company’s operating income is net interest income, which is the difference between interest and dividend income received from interest-earning assets and the interest expense paid on interest-bearing liabilities. The Company’s net interest income increased $157 thousand, or 3.6%, to $4.6 million for the three months ended September 30, 2009, from $4.4 million for the three months ended September 30, 2008. The net interest spread decreased 3 basis points

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to 4.22% for the three months ended September 30, 2009, from 4.25% for the three months ended September 30, 2008. The decline in the net interest spread was primarily the result of the drop in average interest rates earned on loans from 6.85% for the quarter ended September 30, 2008 to 6.25% for the quarter ended September 30, 2009. The prime rate was 7.25% on January 1, 2008, 5.00% by September 30, 2008 and 3.25% throughout 2009, which affected the repricing of adjustable rate loans as well as the volume of new loans and refinancing activity during the last 21 months, as customers took advantage of the lower rates. The adverse effect of declining rates on the Company’s net interest spread was mitigated by a 77 basis point decline in the average rate paid on interest bearing liabilities in the third quarter of 2009 versus the same period last year. The net interest margin for the third quarter of 2009 decreased 17 basis points to 4.50% from the 2008 comparison period at 4.67% reflecting the net effect of an increase in net interest income of $157 thousand and an increase of $29.2 million, or 7.6%, in average earning assets.

The trend of increasing pressure on the net interest spread and net interest margin were also reflected in the year-to-date results, with a decline of 10 basis points in the net interest spread from 4.34% for the nine months ended September 30, 2008 to 4.24% for the nine months ended September 30, 2009. The net interest margin declined 25 basis points from 4.80% to 4.55% over the same period. Further decrease in the prime rate would not necessarily be beneficial to the Company in the near term, especially if funding rates did not follow a similar downward trend. (See Market Risk and Asset and Liability Management on page 41.)

Yields Earned and Rates Paid. The following tables show, for the periods indicated, the total amount of income recorded from average interest-earning assets and the related average yields, the interest expense associated with average interest-bearing liabilities, the related average rates paid, and the relative net interest spread and net interest margin. Yield and rate information is calculated on an annualized tax equivalent basis. Yield and rate information for a period is average information for the period, and is calculated by dividing the annualized tax equivalent income or expense item for the period by the average balance of the appropriate balance sheet item during the period. Net interest margin is annualized tax equivalent net interest income divided by average interest-earning assets. Nonaccrual loans and investments are included in asset balances for the appropriate periods, but recognition of interest on such loans or investments is discontinued and any remaining accrued interest receivable is reversed in conformity with federal regulations.

Tax-exempt interest income amounted to $315 thousand and $284 thousand for the three months ended September 30, 2009 and 2008, respectively, and $955 thousand and $787 thousand for the nine months ended September 30, 2009 and 2008, respectively. The following table presents the effect of tax-exempt income on the calculation of the net interest margin, using a marginal tax rate of 34% for 2009 and 2008:

	For The Three Months ended, September 30,				For The Nine Months ended, September 30,
	2009		2008		2009			2008
	(Dollars in thousands)
Net interest income as presented	$4,571		$4,414		$13,388			$13,072
Effect of tax-exempt interest
Securities available-for-sale	30		33		96			103
Loans	103		87		308			230
Net interest income, tax equivalent	$4,704		$4,534		$13,792			$13,405

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____________________

(1)

Average yields reported on a tax-equivalent basis using a marginal tax rate of 34%.

(2)

Average balances of investment securities are calculated on the amortized cost basis and include nonaccrual securities.

(3)

Includes loans held for sale as well as nonaccrual loans and is net of unearned income and allowance or loan losses.

(4)

Dividends on this stock were suspended effective during the fourth quarter of 2008.

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