UNION BANKSHARES INC - Quarter Report: 2010 March (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: March 31, 2010

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

April 30, 2010:

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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)

	March 31, 2010					December 31, 2009
Assets	(Dollars in thousands)
Cash and due from banks		$	5,398				$	4,942
Federal funds sold and overnight deposits			10,164					17,190
Cash and cash equivalents			15,562					22,132
Interest bearing deposits in banks			22,031					22,975
Investment securities available-for-sale			25,316					24,649
Loans held for sale			8,059					9,262
Loans			349,531					348,827
Allowance for loan losses			(3,455)					(3,493)
Unamortized net loan costs			125					78
Net loans			346,201					345,412
Accrued interest receivable			1,648					1,634
Premises and equipment, net			7,950					7,613
Prepaid FDIC insurance assessment			1,575					1,804
Other assets			11,948					12,041
Total assets		$	440,290				$	447,522
Liabilities and Stockholders’ Equity
Liabilities
Deposits
Noninterest bearing		$	53,790				$	60,129
Interest bearing			311,353					308,698
Total deposits			365,143					368,827
Borrowed funds			27,344					30,993
Liability for defined benefit pension plan			3,007					3,048
Accrued interest and other liabilities			3,379					3,474
Total liabilities			398,873					406,342
Commitments and Contingencies
Stockholders’ Equity
Common stock, $2.00 par value; 7,500,000 shares authorized;  4,921,786 shares issued at March 31, 2010 and  December 31, 2009			9,844					9,844
Paid-in capital			225					219
Retained earnings			36,598					36,494
Treasury stock at cost; 461,078 shares at March 31, 2010 and  460,578 shares at December 31, 2009			(3,733)					(3,724)
Accumulated other comprehensive loss			(1,517)					(1,653)
Total stockholders' equity			41,417					41,180
Total liabilities and stockholders' equity		$	440,290				$	447,522

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

Three Months Ended March 31, 2010 and 2009

(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, 2009	4,461,208		$9,844		$219		$36,494		$(3,724)		$(1,653)		$41,180
Comprehensive income:
Net income	-		-		-		1,219		-		-		1,219
Other comprehensive income,    net of tax:
Change in net unrealized gain    on investment securities    available-for-sale, net of    reclassification adjustment    and tax effects	-		-		-		-		-		108		108
Change in net unrealized loss    on unfunded defined    benefit plan liability,     net of reclassification    adjustment and tax effects	-		-		-		-		-		28		28
Total other comprehensive    income											136
Total comprehensive    income													1,355
Cash dividends declared    ($0.25 per share)	-		-		-		(1,115)		-		-		(1,115)
Stock based compensation    expense	-		-		6		-		-		-		6
Purchase of treasury stock	(500)		-		-		-		(9)		-		(9)
Balances, March 31, 2010	4,460,708		$9,844		$225		$36,598		$(3,733)		$(1,517)		$41,417
Balances, December 31, 2008	4,474,598		$9,844		$207		$35,869		$(3,500)		$(3,270)		$39,150
Comprehensive income:
Net income	-		-		-		1,267		-		-		1,267
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	-		-		-		-		-		(153)		(153)
Change in net unrealized loss    on unfunded defined    benefit plan liability,    net of reclassification    adjustment and tax effects	-		-		-		-		-		56		56
Total other comprehensive    loss											(97)
Total comprehensive    income													1,170
Cash dividends declared    ($0.28 per share)	-		-		-		(1,252)		-		-		(1,252)
Stock based compensation    expense	-		-		3		-		-		-		3
Purchase of treasury stock	(4,717)		-		-		-		(87)		-		(87)
Balances, March 31, 2009	4,469,881		$9,844		$210		$35,884		$(3,587)		$(3,367)		$38,984

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 March 31, 2010 and 2009, and for the three months then ended have been prepared in conformity with U.S. generally accepted accounting principles (GAAP) for interim financial information, general practices within the banking industry, and the accounting policies described in the Company’s Annual Report to Shareholders and Annual Report on Form 10-K/A for the year ended December 31, 2009. 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 2009 Annual Report to Shareholders and 2009 Annual Report on Form 10-K/A. 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, 2010, or any other interim period.

Certain amounts in the 2009 unaudited interim consolidated financial statements have been reclassified to conform to the 2010 presentation.

Note 2. Commitments and Contingencies

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

Note 3. Per Share Information

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

Note 4. Recent Accounting Pronouncements

In February 2010, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU), Subsequent Events: Amendments to Certain Recognition and Disclosure Requirements, related to events that occur after the balance sheet date but before financial statements are issued. This guidance amends existing standards to address potential conflicts with Securities and Exchange Commission (SEC) guidance and refines the scope of the reissuance disclosure requirements to include revised financial statements only. Under this guidance, SEC filers are no longer required to disclose the date through which subsequent events have been evaluated. The adoption of this update did not have a material effect on the Company’s consolidated financial statements. See Note 9.

In January 2010, the FASB issued an ASU, Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements, to amend the disclosure requirements and clarify existing requirements related to recurring and nonrecurring fair value measurements and employers’ disclosures about postretirement benefit plan assets. The guidance requires new disclosures regarding transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a rollforward of activities, separately reporting purchases, sales, issuance, and settlements, for assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The new disclosure requirements apply to interim and annual reporting periods beginning after December 15, 2009, except for the new rules regarding purchases, sales, issuances and settlements associated with Level 3 measurements which are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. Other than requiring additional disclosures, adoption of this accounting standard did not have a material effect on the Company’s consolidated financial statements. See Note 8.

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

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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 are 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. 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 became effective for the Company on January 1, 2010. The adoption of these pronouncements did not have a material effect 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 three months ended March 31, 2010 and 2009 were $0 and $1.3 million, respectively. Gross realized gains from sales of investments available-for-sale were $0 and $21 thousand for the three months ended March 31, 2010 and 2009, respectively and no gross realized losses in either quarter. 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 March 31, 2010 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 lower than its amortized cost basis at the report date. If impaired, management then assesses whether the unrealized loss is other-than-temporary.

Current authoritative guidance provides that an unrealized loss on a debt security is generally deemed to be other-than-temporary and a credit loss is deemed to exist if the present value of the expected future cash flows is less than the amortized cost basis of the debt security. The credit loss component of an other-than-temporary impairment write-down is recorded, net of tax effect, through net income as a

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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) and reflected in stockholders’ equity on the balance sheet, provided the Company does not intend to sell the underlying debt security and it is “more likely than not” that the Company will not have to sell the debt security prior to recovery.

Management considers the following factors in determining whether an other-than-temporary impairment exists and the period over which the debt security is expected to recover:

•

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

•

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

•

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

•

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

•

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 March 31, 2010, ten debt securities, consisting of two nonagency collateralized mortgage obligations, one agency mortgage pass through security, four U.S. Government-sponsored enterprise bonds, and three municipal bonds had unrealized losses totaling $41 thousand. One marketable equity security had an unrealized loss of $3 thousand at March 31, 2010. 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 has the ability to hold such securities for the foreseeable future, and with respect to debt securities until maturity. No declines were deemed by management to be other-than-temporary at March 31, 2010.

Investment securities with a carrying amount of $2.1 million and $3.6 million at March 31, 2010 and December 31, 2009, respectively, were pledged as collateral for public deposits and for other purposes as required or permitted by law.

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 months ended March 31 consisted of the following components:

	Three Months Ended
	2010		2009
	(Dollars in thousands)
Service cost	$153		$156
Interest cost on projected benefit obligation	196		195
Expected return on plan assets	(187)		(144)
Amortization of prior service cost	2		2
Amortization of net loss	44		85
Net periodic benefit cost	$208		$294

Note 7. Other Comprehensive Income (Loss)

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

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The following comprised total comprehensive income for the three months ended March 31:

	Three Months Ended
	2010		2009
	(Dollars in thousands)
Net Income	$1,219		$1,267
Investment securities available-for-sale:
Net unrealized holding gains (losses) on investment  securities available-for-sale, net of tax	108		(139)
Reclassification adjustment for net gains on  investment securities available-for-sale realized in  net income, net of tax	-		(14)
Total	108		(153)
Defined benefit pension plan:
Reclassification adjustment for amortization of net  actuarial loss realized in net income, net of tax	26		55
Reclassification adjustment for amortization of prior  service cost realized in net income, net of tax	2		1
Total	28		56
Total other comprehensive income (loss)	136		(97)
Total comprehensive income	$1,355		$1,170

Note 8: Fair Value Measurements

The Company utilizes FASB Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures, as guidance for accounting for assets and liabilities carried at fair value. This standard defines fair value as the price that would be received, without adjustment for transaction costs, to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is a market based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. The guidance in FASB ASC Topic 820 establishes a three-level fair value hierarchy, which prioritizes the inputs used in measuring fair value. A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

The three levels of the fair value hierarchy are:

•

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

•

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

•

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

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

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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 March 31, 2010 and December 31, 2009, segregated by fair value hierarchy level, are summarized below:

There were no significant transfers in or out of Levels 1 and 2 for the quarter ended March 31, 2010. 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 other real estate owned, impaired loans and mortgage servicing rights were not significant at March 31, 2010 or December 31, 2009. 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

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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 may be excluded from the fair value disclosure requirements. Thus, the aggregate fair value amounts presented may not necessarily represent the actual underlying fair value of all financial instruments of the Company. In addition, all nonfinancial instruments may be excluded from the fair value disclosures.

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

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

Interest bearing deposits in banks: Fair values for interest bearing deposits in banks are based on discounted present values of cash flows.

Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, with the assistance of an independent pricing service, management’s fair value measurements consider observable data which may include market maker bids, quotes and pricing models. Inputs to the pricing models include recent trades, benchmark interest rates, spreads and actual and projected cash flows.

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

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

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

Federal Home Loan Bank of Boston stock: The carrying amount approximates its estimated fair value.

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.

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Off-balance-sheet financial instruments: Estimated 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 estimated 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. Events occurring subsequent to March 31, 2010 have been evaluated as to their potential impact to the consolidated financial statements.

On April 21, 2010, Union Bankshares, Inc. declared a $0.25 per share regular quarterly cash dividend payable May 13, 2010 to stockholders of record on May 1, 2010.

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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 the financial position of Union Bankshares, Inc. (the Company) as of March 31, 2010, and as of December 31, 2009, and its results of operations for the three months ended March 31, 2010 and 2009. This discussion is being presented to provide a narrative explanation of the consolidated financial statements and should be read in conjunction with the consolidated financial statements and related notes and with other financial data appearing elsewhere in this filing and with the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2009. 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 after March 31, 2010 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 or conditions and assumptions relating thereto. The Company may include forward-looking statements in its filings with the Securities and Exchange Commission (SEC), in its reports to stockholders, including this Quarterly Report, in press releases, other written materials, and in statements made by senior management to analysts, rating agencies, institutional investors, representatives of the media and others.

Forward-looking statements reflect management’s current expectations and are subject to uncertainties, both general and specific, and risk exists that actual results will differ from those predictions, forecasts, projections and other estimates contained in forward-looking statements. These risks cannot be readily quantified. When management uses any of the words “believes,” “expects,” “anticipates,” “intends,” “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 and could cause results or performance to differ materially from those expressed in forward-looking statements. Management has discussed some of the more likely factors that might affect forward-looking statements in this report on Form 10-Q. Those factors include the following:

•

loans and investments may be called or prepaid prior to their contractual maturity or become other than temporarily impaired;

•

future cash requirements might be higher than anticipated due to loan commitments or unused lines of credit being drawn upon or depositors withdrawing their funds at higher volumes or in different time frames than anticipated based on historical patterns;

•

assumptions made regarding interest rate movement and sensitivity could vary substantially if actual experience differs from historical experience, which could adversely affect the Company’s results of operations;

•

further expansion of fair value accounting;

•

uncontrollable increases in the cost of doing business, such as increased costs of FDIC insurance or higher taxes, assessments or compliance expense imposed by regulatory or legislative bodies;

•

regulatory limitations placed on income producing methods;

•

the failure of actuarial, investment, work force, salary and other assumptions underlying the establishment of reserves for future pension costs or changes in legislative or regulatory requirements affecting such costs;

•

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

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•

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

•

changes in monetary, regulatory or tax policy that could affect consumer behavior, including the expiration on April 30, 2010 of the $8,000 federal tax credit for first time homebuyers; and

•

continuing economic instability, including high unemployment rates, higher taxation and resolution of entitlement programs.

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.

RECENT DEVELOPMENTS

The U.S. and global economies have experienced significant stress and disruptions in the financial sector over the last two years but certain segments are showing signs of stabilization or recovery. Interest rates remain at historic lows, bank failures are higher than they have been in over 15 years, the Federal Deposit Insurance Corporation (FDIC) has collected three years of prepaid assessments from the remaining banks and the amount of government dollars pumped into the financial system is unprecedented. Dramatic slowdowns in the housing industry with falling home prices, continuing foreclosures and the high unemployment rate have resulted in significant problems for some financial institutions, including government-sponsored entities and investment banks. These problems have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Economic instability progressed to many other business and government sectors and has affected the majority of consumers as well. Tough decisions face our elected representatives and local municipal governments as the recession continues and they face how to recover from the deficit situation without making the current recession worse. Resolution of the future of taxation, entitlement programs including healthcare and government spending will affect all consumers and businesses including Union Bankshares.

Despite the volatile economy, Vermont continues to have the lowest residential foreclosure rate in the country with 143 foreclosures in 2009, but the pace of foreclosures did increase 4.4% in 2009 from 2008. Also, as northern New England had not experienced the dramatic run up in housing prices, likewise, we have not seen the values drop as far as other parts of the country.

In response to the financial crisis affecting the banking and financial markets, many new laws, regulations and programs have been adopted or proposed. The Company’s annual report on Form 10-K/A discusses those that management believes will have a known impact. The discussion below mentions those government actions or initiatives that have changed during the last four months or whose financial impact on the Company is not now known.

The requirement under the Sarbanes-Oxley Act for the preparation and inclusion in a nonaccelerated filer’s annual report of an independent auditor’s attestation regarding the effectiveness of the company’s internal controls over financial reporting was again delayed from an effective date of 2009 to 2010. There is currently a federal legislative proposal to eliminate that requirement completely for community banks.

In 2008, after receiving a recommendation from the boards of the FDIC and the Federal Reserve System (Federal Reserve), the U.S. Department of the Treasury (U.S. Treasury) signed the systemic risk exception to the Federal Deposit Insurance Act, enabling the FDIC to temporarily provide a 100% guarantee on deposits in noninterest bearing transaction deposit accounts under a Temporary Liquidity Guarantee Program (TLGP). Coverage under the TLGP 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 and eligible NOW accounts in excess of the $250,000 insured deposit limit. The program was extended until June 30, 2010 at a cost to the Company of 15 basis points per annum (the lowest risk-based pricing level) and was recently extended again at the same cost until December 31, 2010 with the possibility of an additional 12 month extension. The Company continues its participation in this program.

17

The cost of doing business has increased dramatically in this regulatory environment as the number and extent of new regulations and the speed with which they must be implemented have put a strain on software providers and staff as well as customers. The cost of mitigating long term interest rate risk by selling loans to the secondary market has increased dramatically and it is anticipated that this cost will continue to grow as the government sponsored entities continue to work through their own financial problems. There have also been many new regulations adopted that limit the type and amount of fees that may be imposed, which will have a future negative impact on community banks which did not create the economic problems but will be a big part of the solution.

In addition, as a result of the weakness of certain financial institutions, the FDIC has taken action that has and will result in increased future FDIC insurance assessments for United States FDIC-insured financial institutions, including Union Bank (Union). Based on the FDIC insurance premium schedule for 2010, we anticipate our assessment expense to be $525 thousand for 2010, of which $133 thousand was expensed during the first quarter of 2010, compared to $684 thousand for 2009. Our estimate of 2010 FDIC assessment expense could be affected if another special assessment is levied, additional rate increases are imposed during 2010, or deposit levels differ significantly from our forecast. Banks were required to prepay an estimated three year assessment to the FDIC on December 30, 2009, which resulted in the Company recording a $1.8 million nonearning asset at December 31, 2009 which will be amortized over that three year period as the actual expense is recognized monthly. The FDIC has also announced that it will increase its current assessment rate by three basis points effective January 1, 2011 which will increase the Company’s future costs.

Some of the current legislative or regulatory proposals that are currently open might have a positive impact on the Company and/ or consumers such as: ending the problem of too-big-to-fail banks by regulating large financial firm activities so that they pose less systematic risk; setting the base deposit insurance assessments on assets less tangible capital instead of domestic deposits to ensure large firms pay their fair share of insurance premiums; and increased regulatory focus by a new Consumer Financial Protection Bureau on nonbank lenders and other nondepository financial institutions which are responsible for most of the abusive lending practices that have occurred.

It is not completely clear at this time what impact current or future government sponsored programs, regulations or legislation will have on the Company, its customers or the U.S. and global financial markets but there are a number of proposals pending that if or when enacted could have a future impact on the Company’s operating environment. Among those that might have a future impact are a change in supervisory regulators, the formation of a new federal regulator in the form of the Consumer Financial Protection Bureau referred to above, adoption of rules related to the Credit Card Act, overdraft rules for Debit and ATM cards, healthcare reform, mortgage bankruptcy cram down, Sarbanes-Oxley reform, increase in regulatory capital levels, more stringent liquidity requirements, credit and other concentration regulations, additional fair value accounting requirements or a merger of U.S. GAAP accounting and international financial reporting standards. In February, 2010 the Obama Administration called on Congress to create a new small business lending fund under which $30 billion in Troubled Asset Relief Program (TARP) funds would be transferred to a new program outside of TARP to support small business lending by small and medium size banks. These pending proposals will continue to be monitored and evaluated by Company’s management.

CRITICAL ACCOUNTING POLICIES

The Company has established various accounting policies which govern the application of accounting principles generally accepted (GAAP) in the United States of America 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 on matters that are inherently uncertain. Based on this definition, the Company has identified the accounting policies and judgments

18

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 adequacy of the allowance for loan losses to increase or decrease and result in adjustments to the Company’s provision for loan losses in future periods. For additional information see FINANCIAL CONDITION- Allowance for Loan Losses below.

Given the disruptions in the financial markets over the last eighteen months, 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 cost that are deemed by management to be other-than-temporary are (1) if equity securities, recorded in earnings as realized losses and (2) if debt securities, recorded in earnings as realized losses to the extent they are deemed credit losses, with noncredit losses recorded in Other comprehensive income (loss). Once an other-than-temporary loss on a debt or equity security is realized, subsequent gains in the value of the security may not be recognized in income until the security is sold.

The Company’s 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 rate, and rate of increase in compensation levels. The determination of the pension benefit obligations and net periodic benefit cost is a critical accounting estimate as it requires the use of estimates and judgments related to the amount and timing of expected future cash outflows for benefit payments and cash inflows for maturities and returns on plan assets as well as Company contributions. Changes in estimates, assumptions and actual results could have a material impact to the Company’s financial condition and/or results of operations.

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

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OVERVIEW

The Company’s net income was $1.219 million for the quarter ended March 31, 2010 compared to $1.267 million for the quarter ended March 31, 2009, a decrease of $48 thousand, or 3.8%. These results reflected an increase in net interest income of $226 thousand, or 5.2%, which was more than offset by the combined effect of a decrease of $132 thousand, or 9.8%, in noninterest income and an increase of $149 thousand, or 3.7%, in noninterest expenses.

The Company continued to face a challenging low interest rate environment as the prime rate has remained unchanged at 3.25% for the last 15 months. Total interest income decreased by $206 thousand, or 3.5%, to $5.6 million in the first quarter of 2010 versus total interest income of $5.8 million in the first quarter of 2009, but that decrease was more than offset by the decrease in interest expense from $1.5 million in 2009 to $1.1 million in 2010, a decrease of $432 thousand, or 29.0%, between periods. The result of the changes in interest income and interest expense was that net interest income for the first quarter of 2010 was $4.6 million, up $226 thousand, or 5.2%, from the first quarter of 2009 of $4.4 million. The increase in net interest income was attributable to the decrease in interest paid on interest bearing liabilities, which mitigated the decrease in interest income. During the first quarter of 2010, the Company’s net interest margin increased 11 basis points to 4.65%, from 4.54% for the first quarter of 2009. The Company’s net interest spread increased 21 basis points to 4.41% for the first quarter of 2010, compared to 4.20% for the same period last year. Further drops in the prime rate and/or increases in competitors’ deposit rates could be problematic as individual instruments continue to reprice.

The decrease in noninterest income was mainly due to the decrease in net gains on sales of loans held for sale from $300 thousand for the quarter ended March 31, 2009 to $102 thousand for the quarter ended March 31, 2010, as the volume of loans sold to the secondary market decreased from $17.9 million in the first quarter of 2009 to $8.2 million in 2010. This decrease was partially offset by the $113 thousand, or 13.3%, increase in service fee income which is mainly due to the increase in debit card and ATM income.

Salaries and wages were higher by $68 thousand, or 4.5%, for the first quarter of 2010 compared to the same period last year. Pension and employee benefits were up $60 thousand, or 8.6%. Occupancy expense, net of rental income, was down $38 thousand, or 13.0%. Equipment expense was down $51 thousand, or 17.1%. Other expenses were up $110 thousand, or 10.3%.

The Company’s total assets decreased from $447.5 million at December 31, 2009, to $440.3 million at March 31, 2010, a decrease of $7.2 million, or 1.6%, which is a normal seasonal decline largely associated with the municipal finance cycle. Deposits decreased from $368.8 million at December 31, 2009 to $365.1 million at March 31, 2010, a decrease of $3.7 million, or 1.0%. Borrowed funds decreased from $31.0 million at December 31, 2009 to $27.3 million at March 31, 2010, a decrease of $3.7 million, or 11.9%. Total loans, including loans held for sale, decreased slightly by $499 thousand from $358.1 million at December 31, 2009 to $357.6 million at March 31, 2010. Total loans at March 31, 2010 are net of $8.2 million in residential real estate loans sold during the first three months of 2010.

The Company’s asset quality has remained strong with March 31, 2010 total nonperforming assets at $4.9 million, or 1.12% of total assets, compared to $5.2 million, or 1.15% of total assets, at December 31, 2009 and $7.8 million, or 1.85% of total assets, at March 31, 2009.

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The following unaudited per share information and key ratios depict several measurements of performance or financial condition for the three months ended or at March 31, 2010 and 2009, respectively:

	Three Months Ended March 31,
	2010		2009
Return on average assets (ROA) (1)	1.12%		1.19%
Return on average equity (ROE) (1)	11.89%		13.00%
Net interest margin (1)(2)	4.65%		4.54%
Efficiency ratio (3)	69.97%		68.59%
Net interest spread (4)	4.41%		4.20%
Loan to deposit ratio	97.93%		100.68%
Net loan charge-offs to average loans  not held for sale (1)	0.15%		0.15%
Allowance for loan losses to loans not  held for sale	0.99%		1.02%
Nonperforming assets to total assets (5)	1.12%		1.85%
Equity to assets	9.41%		9.24%
Total capital to risk weighted assets	15.34%		15.44%
Book value per share	$9.28		$8.72
Earnings per share	$0.27		$0.28
Dividends paid per share	$0.25		$0.28
Dividend payout ratio (6)	92.59%		100.00%

____________________

(1)

Annualized.

(2)

The ratio of tax equivalent net interest income to average earning assets. See page 22 for more information.

(3)

The ratio of noninterest expense ($4.1 million in 2010 and $4.0 million in 2009) to tax equivalent net  interest income ($4.7 million in 2010 and $4.5 million in 2009) and noninterest income ($1.2 million in 2010 and $1.3 million in 2009) excluding securities gains ($0 in 2010 and $21 thousand in 2009).

(4)

The difference between the average rate earned on earning assets minus the average rate paid on interest bearing liabilities. See page 23 for more information.

(5)

Nonperforming assets are loans or investment securities that are in nonaccrual or 90 or more days past due as well as other real estate or assets owned.

(6)

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

RESULTS OF OPERATIONS

Net Interest Income. The largest component of the Company’s operating income is net interest income, which is the difference between interest and dividend income received from interest earning assets and the interest expense paid on interest bearing liabilities. The Company’s net interest income increased $226 thousand, or 5.2%, to $4.59 million for the three months ended March 31, 2010, from $4.36 million for the three months ended March 31, 2009. The net interest spread increased 21 basis points to 4.41% for the three months ended March 31, 2010, from 4.20% for the three months ended March 31, 2009. The increase in the net interest spread was primarily the result of the drop in average interest rates paid on interest bearing liabilities from 1.84% for the quarter ended March 31, 2009 to 1.28% for the quarter ended March 31, 2010. The net interest margin for the first quarter of 2010 increased 11 basis points to 4.65% from the 2009 comparison period at 4.54%, reflecting the net effect of an increase in net interest income of $226 thousand and an increase of $9.2 million, or 2.3%, in average earning assets.

Yields Earned and Rates Paid. The following table shows for the periods indicated the total amount of income recorded from average interest earning assets and the related average tax equivalent yields, the interest expense associated with average interest bearing liabilities, the related average rates paid, and the resulting tax equivalent net interest spread and margin. Yield and rate information is average information for the period, and is calculated by dividing the annualized tax equivalent income or expense item for the period by the average balance of the appropriate balance sheet item during the period. Net interest margin is annualized tax equivalent net interest income divided by average earning assets. Nonaccrual loans or investments are included in asset balances for the appropriate periods, but

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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 $108 thousand and $125 thousand for the three months ended March 31, 2010 and 2009, 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 2010 and 2009:

	For The Three Months Ended March 31,
	2010		2009
	(Dollars in thousands)
Net interest income as presented	$4,588		$4,362
Effect of tax-exempt interest
Securities available-for-sale	31		33
Loans	77		92
Net interest income, tax equivalent	$4,696		$4,487

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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, if applicable.

(3)

Includes loans held for sale as well as nonaccrual loans and unamortized costs and is net of the allowance for loan losses.

(4)

Dividends on the Federal Home Loan Bank (FHLB) of Boston stock were suspended effective during the fourth quarter of 2008.

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Rate/Volume Analysis. The following table describes the extent to which changes in average interest rates (on a fully tax-equivalent basis) and changes in volume of average interest earning assets and interest bearing liabilities have affected the Company’s interest income and interest expense during the period indicated. For each category of interest earning assets and interest bearing liabilities, information is provided on changes attributable to:

•

changes in volume (change in volume multiplied by prior rate);

•

changes in rate (change in rate multiplied by prior volume); and

•

total change in rate and volume.

Changes attributable to both rate and volume have been allocated proportionately to the change due to volume and the change due to rate.

	Three Months Ended March 31, 2010 Compared to Three Months Ended March 31, 2009 Increase/(Decrease) Due to Change In
	Volume		Rate		Net
	(Dollars in thousands)
Interest earning assets:
Federal funds sold and overnight deposits	$   1		$     1		$     2
Interest bearing deposits in banks	50		(51)		(1)
Investment securities	(37)		(17)		(54)
Loans, net	30		(183)		(153)
Total interest earning assets	$44		$(250)		$(206)
Interest bearing liabilities:
NOW accounts	$    -		$  (11)		$  (11)
Savings/money market accounts	17		(46)		(29)
Time deposits	(35)		(339)		(374)
Borrowed funds	9		(27)		(18)
Total interest bearing liabilities	(9)		(423)		(432)
Net change in net interest income	$53		$ 173		$ 226

Three Months Ended March 31, 2010, Compared to Three Months Ended March 31, 2009.

Interest and Dividend Income. The Company’s interest and dividend income decreased $206 thousand, or 3.5%, to $5.64 million for the three months ended March 31, 2010, from $5.85 million for the same period last year, despite an increase in average earning assets of $9.2 million, or 2.3%, to $409.8 million, from $400.6 million for the three months ended March 31, 2009. The positive effect on interest income resulting from the rise in average earning assets was more than offset by the lower rates earned on all interest earning assets except federal funds sold and overnight deposits in the first quarter of 2010 versus 2009. In particular, interest income on loans decreased $153 thousand, or 2.8%, to $5.3 million for the first quarter of 2010 versus the $5.4 million for the 2009 comparison period, despite an increase in average loan volume between periods. Average loans approximated $352.3 million at an average yield of 6.14% for the three months ended March 31, 2010, up $1.8 million from an average of $350.4 million at an average yield of 6.37% for the three months ended March 31, 2009. However, the increase in average volume was more than offset by a 23 basis point decrease in average yield. Loan demand has slowed somewhat during 2010 despite the continuing low interest rates as it appears that customers are being conservative in viewing the economic outlook and the majority of customers who could refinance to lower interest rates have done so over the preceding eighteen months as rates have been at historic lows since December 2008.

The Company has continued to manage interest rate risk by selling low rate qualified residential mortgages originated during 2010 to the secondary market and has benefited from the sale of these mortgages, with gains on the sales of such loans totaling $102 thousand for the quarter ended March 31,

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2010, compared to $300 thousand during the same period last year. Sales of residential mortgages totaled $8.2 million during the first quarter of 2010 versus $17.9 million during the same quarter of 2009.

The average balance of investments (including mortgage-backed securities) decreased $3.1 million, or 11.5%, to $23.8 million for the three months ended March 31, 2010, from $26.9 million for the three months ended March 31, 2009. Maturing investments and principal paydowns were reinvested into short term FDIC insured interest bearing deposits or left at the Federal Reserve Bank of Boston to provide financial security and liquidity to utilize for future loan growth or to reinvest in investment securities once interest rates rise. The average level of interest bearing deposits in the Bank for the quarter was $20.9 million, up $7.1 million, or 51.7%, from the 2009 average level of $13.8 million. The average level of federal funds sold and overnight deposits increased $3.3 million, to $10.8 million, or 43.4%, for the three months ended March 31, 2010, from $7.6 million for the three months ended March 31, 2009. Interest income from nonloan instruments decreased $53 thousand, or 12.1%, between periods, with $386 thousand for the first quarter of 2010 versus $439 thousand for the same period of 2009, reflecting the decreases in yields on all types of interest earning assets except federal funds sold and overnight deposits.

Interest Expense. The Company’s interest expense decreased $432 thousand, or 29.0%, to $1.1 million for the three months ended March 31, 2010, from $1.5 million for the three months ended March 31, 2009. The decrease reflected a $423 thousand decrease attributable to lower rates on all interest bearing liabilities, and a $9 thousand decrease attributable to lower volume for time deposits, partially offset by a higher volume in savings/ money market accounts and borrowed funds.

Interest expense on deposits decreased $414 thousand, or 34.9%, to $773 thousand for the quarter ended March 31, 2010, from $1.2 million for the quarter ended March 31, 2009. Although competition for deposits has remained strong, the $6.5 million, or 2.2%, growth in average interest bearing deposits for the quarter ended March 31, 2010 to $304.5 million compared to average interest bearing deposits of $298.0 million for the same period last year reflects the overall growth in the franchise and the continuing uncertainty surrounding the financial markets, which has resulted in the flight of investments to the safety of FDIC insured deposits. Average time deposits decreased to $131.3 million for the three months ended March 31, 2010, from $136.3 million for the three months ended March 31, 2009, or a decrease of $5.0 million, or 3.7%. The average rate paid on time deposits during the first quarter of 2010 decreased 104 basis points, to 1.82% from 2.86% for the first quarter of 2009. The average balances for money market and savings accounts increased $11.0 million, or 10.7%, to $114.1 million for the three months ended March 31, 2010, from $103.1 million for the three months ended March 31, 2009. A $492 thousand, or 0.8%, increase in NOW accounts brought the average balance up to $59.0 million from $58.5 million between the two years.

Interest expense on borrowed funds decreased $18 thousand, or 6.0%, from $301 thousand for the quarter ended March 31, 2009 to $283 thousand for the quarter ended March 31, 2010, despite an increase of $848 thousand in average funds borrowed from $28.9 million to $29.8 million, or 2.9%, between years as rates remained low. The average rate paid on borrowed funds declined 37 basis points between periods.

Provision for Loan Losses. There was a $90 thousand loan loss provision for the quarter ended March 31, 2010 compared to a $95 thousand loan loss provision for the quarter ended March 31, 2009. Although the winter season for tourism was not the best in 2010 due to below average snowfall, there was a decrease in past due and nonaccrual loans of $4.5 million between years as well as a decline of $851 thousand since December 31, 2009. The lower provision in the first quarter of 2010 was deemed appropriate in light of the decrease in past due and nonaccrual loans, the review of various qualitative factors, net charge-offs for the quarter of $128 thousand, which was virtually unchanged from net charge-offs of $127 thousand for the quarter ended March 31, 2009, the volume increase in the loan portfolio and the slight change in the makeup of the loan portfolio. For further details see, FINANCIAL CONDITION Allowance for Loan Losses and Asset Quality below.

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Noninterest Income. The following table sets forth changes from the first quarter of 2009 to the first quarter of 2010 for components of noninterest income:

Noninterest income net of gains, losses, and write-downs on investment securities available-for-sale was $1.219 million, or 17.8%, of total income for the three months ended March 31, 2010 versus $1.330 million, or 18.5%, of total income for the three months ended March 31, 2009. This decrease between years is mainly due to the effect of lower net gains on residential real estate loans sold.

Trust income. Trust income increased by $18 thousand, or 19.8%, between the quarters ended March 31, 2010 and March 31, 2009 as dollars in both managed and nonmanaged fiduciary accounts grew by 24.5% and 7.8%, respectively between March 31, 2009 and 2010. Fees are normally charged on asset values.

Service fees. Service fees increased $113 thousand, or 13.3%, between the first quarter of 2009 and the first quarter of 2010. The main reason was due to the growth in debit card and ATM fees due to a change in the billing breakdown from net fees to gross fees from the servicer (the reader will note an increased expense for these services in noninterest expense discussed below) as well as the growth in the volume of electronic transactions.

Net gains on sales of loans held for sale. Residential real estate loans of $8.2 million were sold for a net gain of $102 thousand during the first quarter of 2010, versus sales of $17.9 million for a net gain of $300 thousand during the first quarter of 2009.

Other income. The decrease resulted primarily from the decrease in net mortgage servicing rights recognized in the first quarter of 2010 of $69 thousand compared to the first quarter of 2009 of $2 thousand, due to the decrease in the volume of loans sold in 2010 versus 2009.

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Noninterest Expense. The following table sets forth changes from the first quarter of 2009 to the first quarter of 2010 for components of noninterest expense:

Salaries and wages. The increase in 2010 over 2009 was due primarily to normal annual salary increases as well as the recognition, as a reduction in salary expense, of $34 thousand for deferred loan origination costs in the first quarter 2010 versus $51 thousand in the first quarter of 2009 due to the decrease in loan originations.

Pension and employee benefits. There was also an increase of $133 thousand, or 81.7%, in the Company’s medical costs from $163 thousand for the first quarter of 2009, to $296 thousand for the first quarter of 2010, as the Company booked a $129 thousand credit in the first quarter of 2009 for a recovery of accrued costs under the old self-insured medical plan which was terminated December 31, 2008, with six months of runout liability for services received but not yet billed. There was an $86 thousand, or 29.4%, decrease in the defined benefit pension plan expense for the first quarter to $208 thousand for 2010 from the prior year’s first quarter expense of $294 thousand. This decrease is mainly due to the increase in asset values within the plan as of the January 1, 2010 actuarial valuation date, compared to the prior year, given the change in the financial markets and the $2.1 million contribution to the plan by the Company during 2009.

Occupancy expense. The decrease between the first quarter of 2010 and 2009 is mainly due to the mild winter in 2010 where fuel and snow removal costs were below normal.

Equipment expense. The decrease between years is mainly due to the decrease in depreciation expense.

Expenses of OREO and other assets owned, net. The costs incurred during the first quarter of 2010 included higher legal and operating costs than normally would be incurred due to the commercial nature of the properties. The increased costs were partially mitigated as expenses for the three months ended March 31, 2009 included $13 thousand in the write-down of value of two OREO properties to their fair market value less estimated costs to sell, while the expenses for the three months ended March 31, 2010 did not include any write-downs.

Delivery fees on sales of loans. These expenses represent delivery fees paid to the secondary market purchasers upon the sale of qualified residential loans. Sales volume decreased from $17.9 million in the first quarter of 2009 to $8.2 million in the first quarter of 2010 which accounts for the decrease in related loan fees, but the delivery fees charged on each loan have continued to increase between years. It is the normal practice of the Company to collect these fees from the customer at the time of closing and that income is reflected in interest and fees on loans.

Other expenses. The net change between quarters ended March 31, 2010 and 2009 has many components, some increases and some decreases; the largest being a $40 thousand increase in debit card/ ATM expenses due to the new gross billing system referred to above, as well as the growth in

27

volume of electronic transactions. Professional fees also increased in 2010 primarily due to the anticipated cost of the Sarbanes-Oxley internal control report required from our independent auditors for 2010.

Income Tax Expense. The Company has provided for current and deferred federal income taxes for the quarters ended March 31, 2010 and 2009. The Company's provision for income taxes was $359 thousand for the three months ended March 31, 2010 compared to $361 thousand for the same period in 2009. The Company’s effective tax rate increased to 22.8% for the three months ended March 31, 2010, from 22.2% for the same period in 2009.

FINANCIAL CONDITION

At March 31, 2010, the Company had total consolidated assets of $440.3 million, including gross loans and loans held for sale (“total loans”) of $357.7 million, deposits of $365.3 million and stockholders' equity of $41.4 million. The Company’s total assets decreased $7.2 million, or 1.6%, to $440.3 million at March 31, 2010, from $447.5 million at December 31, 2009 but this is a normal seasonal fluctuation due in part to the effects of the municipal financing cycle. Net loans and loans held for sale decreased to $354.3 million, or 80.4%, of total assets at March 31, 2010, compared to $354.7 million, or 79.3%, of total assets at December 31, 2009.

Cash and cash equivalents, including federal funds sold and overnight deposits, decreased $6.6 million, or 29.7%, to $15.6 million at March 31, 2010, from $22.1 million at December 31, 2009. Interest bearing deposits in banks decreased $944 thousand, or 4.1%, from $23.0 million at December 31, 2009 to $22.0 million at March 31, 2010. Investment securities available-for-sale increased from $24.6 million at December 31, 2009, to $25.3 million at March 31, 2010, a $667 thousand, or 2.7%, increase. Total nonloan interest bearing assets decreased from 14.5% of total assets at December 31, 2009 to 13.1% at March 31, 2010, reflecting the normal seasonal fluctuation.

Deposits decreased $3.7 million, or 1.0%, to $365.1 million at March 31, 2010, from $368.8 million at December 31, 2009. This decrease is a normal seasonal fluctuation due in part to the effects of the municipal financing cycle and was much smaller in the first quarter of 2010 than it has been over the last few years. Noninterest bearing deposits decreased $6.3 million, or 10.5%, from $60.1 million at December 31, 2009 to $53.8 million at March 31, 2010. Interest bearing deposits increased $2.6 million, or 0.9%, from $308.7 million at December 31, 2009, to $311.3 million at March 31, 2010. (See average balances and rates in the Yields Earned and Rates Paid tables on pages 23 and 24.) Aggressive rate competition from in-market and out-of-market financial institutions makes deposit accounts increasingly hard to attract and retain. Noninterest bearing deposits are especially difficult to develop and increase.

Total borrowings decreased $3.7 million, or 11.9%, at March 31, 2010, from $31.0 million at December 31, 2009 to $27.3 million at March 31, 2010 due to a payoff of a short-term FHLB of Boston advance and normal monthly payments on amortizing advances at the FHLB of Boston.

Total stockholders’ equity increased $237 thousand to $41.4 million at March 31, 2010 from $41.2 million at December 31, 2009. This increase reflects net income of $1.219 million for the first three months of 2010 and the $136 thousand positive change in accumulated other comprehensive loss, less regular cash dividends paid of $1.115 million and the purchase of Treasury stock totaling $9 thousand. (See Capital Resources on page 42.)

Loans Held for Sale and Loan Portfolios. Total loans (including loans held for sale) decreased $499 thousand, or 0.1%, to $357.6 million from $358.1 million at December 31, 2009. At March 31, 2010, the Company’s total loan portfolio represented 81.2% of assets, down in dollars but up in percentage from $358.1 million, or 80.0%, of assets at December 31, 2009 and up in dollars but down in percentage from $348.9 million, or 82.7%, of assets at March 31, 2009. The Company’s loans primarily consist 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 $312.3 million, or 87.3%, of total loans at March 31, 2010 and $311.7 million, or 87.0%, of total loans at December 31, 2009. Junior liens on one-to-four family residences, on which the Company does not also hold the first mortgage, only account for

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$11.9 million, or 3.8%, of the $312.3 million of real estate secured loans at March 31, 2010. Average net loans (including loans held for sale) were $350.4 million for the first three months of 2009 and increased $1.9 million, or 0.5%, to $352.3 million for the first three months of 2010. The Company sold $8.2 million of residential mortgage loans held for sale during the first three months of 2010, resulting in a net gain on sale of loans of $102 thousand, compared with loan sales of $17.9 million and related net gain on sale of loans of $300 thousand for the first three months of 2009. While competition for good loans is strong, the Company has been able to originate loans to both current and new customers while maintaining credit quality. Loan demand, while down from the frenzied pace of 2009, has been steady during the first three months of 2010. Management expects demand may slow over the coming months if interest rates rise and as the number of customers who can refinance complete the process.

The following table shows information on the composition of the Company’s total loan portfolio at the dates indicated: