10-Q 1 ubc_q.txt FORM 10-Q ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2005 Commission File Number: 0-28846 UnionBancorp, Inc. ------------------------------------------------------ (Exact name of Registrant as specified in its charter) Delaware 36-3145350 ------------------------------- ------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) Number) 321 West Main Street Ottawa, Illinois 61350 ----------------------------------------------------------- (Address of principal executive offices including zip code) (815) 431-2720 ---------------------------------------------------- (Registrant's telephone number, including area code) 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 an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes [ ] No [X]. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. Class Shares outstanding at May 12, 2005 ----------------------------- ---------------------------------- Common Stock, Par Value $1.00 4,038,800 ================================================================================ UnionBancorp, Inc. Form 10-Q Index March 31, 2005 Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements o Unaudited Consolidated Balance Sheets...........................1 o Unaudited Consolidated Statements of Income and Comprehensive Income ......................................2 o Unaudited Consolidated Statements of Cash Flows.................3 o Notes to Unaudited Consolidated Financial Statements............4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................10 Item 3. Quantitative and Qualitative Disclosures About Market Risk...............................................24 Item 4. Controls and Procedures .............................................24 PART II. OTHER INFORMATION Item 1. Legal Proceedings....................................................26 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..........26 Item 3. Defaults Upon Senior Securities......................................26 Item 4. Submission of Matters to a Vote of Security Holders..................26 Item 5. Other Information....................................................27 Item 6. Exhibits.............................................................27 SIGNATURES....................................................................28 UNIONBANCORP, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED BALANCE SHEETS March 31, 2005 and December 31, 2004 (In Thousands, Except Share Data) --------------------------------------------------------------------------------
March 31, December 31, 2005 2004 ------------ ------------ ASSETS Cash and cash equivalents $ 18,860 $ 22,802 Securities available-for-sale 185,766 191,661 Loans 421,523 419,275 Allowance for loan losses (9,948) (9,732) ------------ ------------ Net loans 411,575 409,543 Cash surrender value of life insurance 15,087 14,953 Mortgage servicing rights 2,745 2,772 Premises and equipment, net 13,827 13,463 Goodwill 6,963 6,963 Intangible assets, net 659 703 Other real estate 400 420 Other assets 5,542 6,266 ------------ ------------ Total assets $ 661,424 $ 669,546 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits Non-interest-bearing $ 64,117 $ 55,800 Interest-bearing 439,184 456,677 ------------ ------------ Total deposits 503,301 512,477 Federal funds purchased and securities sold under agreements to repurchase 19,297 12,722 Advances from the Federal Home Loan Bank 57,100 61,900 Notes payable 6,858 6,629 Series B mandatory redeemable preferred stock 831 831 Other liabilities 3,627 4,740 ------------ ------------ Total liabilities 591,014 599,299 ------------ ------------ Stockholders' equity Preferred stock; 200,000 shares authorized; none issued -- -- Series A convertible preferred stock; 2,765 shares authorized, 2,762.24 shares outstanding (aggregate liquidation preference of $2,762) 500 500 Series C preferred stock; 4,500 shares authorized; none issued -- -- Common stock, $1 par value; 10,000,000 shares authorized; 4,667,873 shares issued at March 31, 2005 and 4,640,907 shares issued at December 31, 2004 4,668 4,641 Additional paid-in capital 22,971 22,632 Retained earnings 47,057 46,592 Accumulated other comprehensive income 926 1,351 ------------ ------------ 76,122 75,716 Treasury stock, at cost; 620,263 shares at March 31, 2005 and 608,763 at December 31, 2004 (5,712) (5,469) ------------ ------------ Total stockholders' equity 70,410 70,247 ------------ ------------ Total liabilities and stockholders' equity $ 661,424 $ 669,546 ============ ============
See Accompanying Notes to Unaudited Financial Statements 1. UNIONBANCORP, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME Three Months Ended March 31, 2005 and 2004 (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Three Months Ended March 31, --------------------------- 2005 2004 ------------ ------------ Interest income Loans $ 6,450 $ 7,268 Securities Taxable 1,425 1,905 Exempt from federal income taxes 258 325 Federal funds sold and other 9 10 ------------ ------------ Total interest income 8,142 9,508 Interest expense Deposits 2,319 2,831 Federal funds purchased and securities sold under agreements to repurchase 74 13 Advances from the Federal Home Loan Bank 583 771 Series B mandatory redeemable preferred stock 12 12 Notes payable 69 80 ------------ ------------ Total interest expense 3,057 3,707 ------------ ------------ Net interest income 5,085 5,801 Provision for loan losses 100 750 ------------ ------------ Net interest income after provision for loan losses 4,985 5,051 Noninterest income Service charges 483 711 Trust income 215 184 Mortgage banking income 340 568 Insurance commissions and fees 421 633 Banked owned life insurance 134 172 Gain on sale of assets, net 2 259 Other income 255 397 ------------ ------------ 1,850 2,924 Noninterest expenses Salaries and employee benefits 3,476 4,150 Occupancy expense, net 394 552 Furniture and equipment expense 424 557 Marketing 96 168 Supplies and printing 77 115 Telephone 107 154 Amortization of intangible assets 44 52 Other expenses 928 1,231 ------------ ------------ 5,546 6,979 ------------ ------------ Income before income taxes 1,289 996 Income taxes 325 196 ------------ ------------ Net income 964 800 Preferred stock dividends 52 52 ------------ ------------ Net income for common stockholders $ 912 $ 748 ============ ============ Basic earnings per common share $ 0.23 $ 0.19 ============ ============ Diluted earnings per common share $ 0.22 $ 0.18 ============ ============ Total comprehensive income $ 539 $ 912 ============ ============ See Accompanying Notes to Unaudited Financial Statements 2. UNIONBANCORP, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS Three Months Ended March 31, 2005 and 2004 (In Thousands) --------------------------------------------------------------------------------
Three Months Ended March 31, ------------------------ 2005 2004 ---------- ---------- Cash flows from operating activities Net income $ 964 $ 800 Adjustments to reconcile net income to net cash provided by operating activities Depreciation 418 504 Amortization of intangible assets 44 52 Amortization of mortgage servicing rights 142 179 Amortization of unearned compensation under stock option plans -- 2 Amortization of bond premiums, net 278 375 Provision for loan losses 100 750 Provision for deferred income taxes 466 -- Net change in BOLI (134) (172) Gain on sale of the credit card portfolio -- (259) Gain on sale of assets (2) -- Gain on sale of real estate acquired in settlement of loans (6) -- Gain on sale of loans (236) (515) Proceeds from sales of loans held for sale 10,262 24,087 Origination of loans held for sale (9,011) (21,223) Change in assets and liabilities Decrease in other assets 145 1,479 Increase (decrease) in other liabilities (837) 367 ---------- ---------- Net cash provided by operating activities 2,593 6,426 Cash flows from investing activities Securities available-for-sale Proceeds from maturities and paydowns 14,818 20,530 Proceeds from sales -- 6,498 Purchases (9,902) (25,325) Purchase of loans (3,275) -- Net decrease in loans 128 6,333 Proceeds from sale of credit card portfolio -- 1,900 Purchase of premises and equipment (782) (663) Proceeds from sale of real estate acquired in settlement of loans 26 30 ---------- ---------- Net cash provided by investing activities 1,013 9,303 Cash flows from financing activities Net decrease in deposits (9,176) (23,057) Net increase in federal funds purchased and securities sold under agreements to repurchase 6,575 2,902 Payments on notes payable -- (57) Proceeds from notes payable 250 -- Net increase (decrease) in other borrowed funds (21) -- Net increase (decrease) in advances from the Federal Home Loan Bank (4,800) 2,250 Dividends on common stock (445) (403) Dividends on preferred stock (52) (52) Proceeds from exercise of stock options 364 75 Purchase of treasury stock (243) -- ---------- ---------- Net cash provided by financing activities (7,548) (18,342) ---------- ---------- Net decrease in cash and cash equivalents (3,942) (2,613) Cash and cash equivalents Beginning of period 22,802 22,198 ---------- ---------- End of period $ 18,860 $ 19,585 ========== ========== Supplemental disclosures of cash flow information Cash payments for Interest $ 3,413 $ 3,163 Income taxes 311 --
See Accompanying Notes to Unaudited Financial Statements 3. UNIONBANCORP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Note 1. Summary of Significant Accounting Policies The accompanying unaudited interim consolidated financial statements of UnionBancorp, Inc. (the "Company") have been prepared in accordance with U.S. generally accepted accounting principles and with the rules and regulations of the Securities and Exchange Commission for interim financial reporting. Accordingly, they do not include all of the information and footnotes required for complete financial statements. In the opinion of management, all normal and recurring adjustments which are necessary to fairly present the results for the interim periods presented have been included. The preparation of financial statements requires management to make estimates and assumptions that affect the recorded amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. For further information with respect to significant accounting policies followed by the Company in the preparation of its consolidated financial statements, refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2004. The annualized results of operations during the three months ended March 31, 2005 are not necessarily indicative of the results expected for the year ending December 31, 2005. All financial information is in thousands (000's), except per share data. Employee compensation expense under stock options is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation. Three Months Ended March 31, ----------------------- 2005 2004 ---------- ---------- Net income as reported for common stockholders $ 912 $ 748 Deduct: stock-based compensation expense Determined under fair value based method 24 30 ---------- ---------- Pro forma net income $ 888 $ 718 ========== ========== Basic earnings per common share as reported $ 0.23 $ 0.19 Pro forma basic earnings per common share 0.22 0.19 Diluted earnings per common share as reported $ 0.22 $ 0.18 Pro forma diluted earnings per common share 0.22 0.18 4. UNIONBANCORP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Note 2. Earnings Per Share Basic earnings per share for the three months ended March 31, 2005 and 2004 were computed by dividing net income by the weighted average number of shares outstanding. Diluted earnings per share for the three months ended March 31, 2005 and 2004 were computed by dividing net income by the weighted average number of shares outstanding, adjusted for the dilutive effect of the stock options. Computations for basic and diluted earnings per share are provided below: Basic Earnings Per Common Share Three Months Ended March 31, ----------------------- 2005 2004 ---------- ---------- Net income available to common shareholders $ 912 $ 748 Weighted average common shares outstanding 4,050 4,031 ---------- ---------- Basic Earnings Per Common Share $ 0.23 $ 0.19 ========== ========== Diluted Earnings Per Common Share Weighted average common shares outstanding 4,050 4,031 Add: dilutive effect of assumed exercised stock options 66 83 ---------- ---------- Weighted average common and dilutive Potential shares outstanding 4,116 4,114 ========== ========== Diluted Earnings Per Common Share $ 0.22 $ 0.18 ========== ========== There were approximately 40,000 and 20,000 options outstanding at March 31, 2005 and 2004, respectively, that were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common stock and were, therefore, antidilutive. Note 3. Securities The Company's consolidated securities portfolio, which represented 30.6% of the Company's 2005 first quarter average earning asset base, is managed to minimize interest rate risk, maintain sufficient liquidity, and maximize return. The portfolio includes several callable agency debentures, adjustable rate mortgage pass-throughs, and collateralized mortgage obligations. Corporate bonds consist of investment grade obligations of public corporations. Equity securities consist of Federal Reserve stock, Federal Home Loan Bank stock, and trust preferred stock. Securities classified as available-for-sale, carried at fair value, were $185,766 at March 31, 2005 compared to $191,661 at December 31, 2004. The Company does not have any securities classified as trading or held-to-maturity. 5. UNIONBANCORP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- The following table describes the fair value, gross unrealized gains and losses of securities available-for-sale at March 31, 2005 and December 31, 2004, respectively:
March 31, 2005 ------------------------------------------- Gross Gross Fair Unrealized Unrealized Value Gains Losses ------------ ------------ ------------ U.S. government agencies $ 19,959 $ 46 $ (195) States and political subdivisions 22,978 722 (9) U.S. government mortgage-backed securities 114,725 1,097 (359) Collateralized mortgage obligations 1,827 -- (14) Equity securities 18,190 48 (19) Corporate 8,087 187 -- ------------ ------------ ------------ $ 185,766 $ 2,100 $ (596) ============ ============ ============ December 31, 2004 ------------------------------------------- Gross Gross Fair Unrealized Unrealized Value Gains Losses ------------ ------------ ------------ U.S. government agencies 20,924 144 (26) States and political subdivisions 24,647 879 (6) U.S. government mortgage-backed securities 117,500 1,205 (318) Collateralized mortgage obligations 2,486 -- (26) Equity securities 17,865 39 (9) Corporate 8,239 323 -- ------------ ------------ ------------ $ 191,661 $ 2,590 $ (385) ============ ============ ============
6. UNIONBANCORP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Note 4. Loans The Company offers a broad range of products, including agribusiness, commercial, residential, and installment loans, designed to meet the credit needs of its borrowers. The Company concentrates its lending activity in the geographic market areas that it serves, generally lending to consumers and small to mid-sized businesses from which deposits are garnered in the same market areas. As a result, the Company strives to maintain a loan portfolio that is diverse in terms of loan type, industry, borrower and geographic concentrations. The following table describes the composition of loans by major categories outstanding as of March 31, 2005 and December 31, 2004, respectively: March 31, 2005 December 31, 2004 ----------------------- ----------------------- $ % $ % ---------- ---------- ---------- ---------- Commercial $ 101,398 24.06% $ 91,941 21.93% Agricultural 25,316 6.01 28,718 6.85 Real estate: Commercial mortgages 128,601 30.50 129,597 30.91 Construction 38,843 9.21 38,882 9.27 Agricultural 30,859 7.32 30,601 7.30 1-4 family mortgages 77,278 18.33 77,566 18.50 Installment 18,824 4.47 21,502 5.13 Other 404 0.10 468 0.11 ---------- ---------- ---------- ---------- Total loans 421,523 100.00% 419,275 100.00% ========== ========== Allowance for loan losses (9,948) (9,732) ---------- ---------- Loans, net $ 411,575 $ 409,543 ========== ========== 7. UNIONBANCORP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Note 5. Allowance For Loan Losses In originating loans, the Company recognizes that credit losses will be experienced and the risk of loss will vary with, among other things, current economic conditions; the type of loan being made; the creditworthiness of the borrower over the term of the loan; and in the case of a collateralized loan, the quality of the collateral for such loan. The allowance for loan losses represents the Company's estimate of the allowance necessary to provide for probable incurred losses in the loan portfolio. In making this determination, the Company analyzes the ultimate collectibility of the loans in its portfolio, incorporating feedback provided by internal loan staff, the independent loan review function and information provided by examinations performed by regulatory agencies. The Company makes an ongoing evaluation as to the adequacy of the allowance for loan losses. Transactions in the allowance for loan losses for the three months ended March 31, 2005 and 2004 are summarized below: Three Months Ended March 31, ------------------------- 2005 2004 ---------- ---------- Beginning balance $ 9,732 $ 9,011 Charge-offs: Commercial -- 394 Real estate mortgages 6 72 Installment and other loans 197 181 ---------- ---------- Total charge-offs 203 647 ---------- ---------- Recoveries: Commercial 292 552 Real estate mortgages 16 193 Installment and other loans 11 23 ---------- ---------- Total recoveries 319 768 ---------- ---------- Net charge-offs (116) (121) ---------- ---------- Provision for loan losses 100 750 ---------- ---------- Ending balance $ 9,948 $ 9,882 ========== ========== Period end total loans, net of unearned interest $ 421,523 $ 466,591 ========== ========== Average loans $ 417,549 $ 467,350 ========== ========== Ratio of net charge-offs to average loans (0.03%) (0.03%) Ratio of provision for loan losses to average loans 0.02% 0.16% Ratio of allowance for loan losses to ending total loans 2.36% 2.12% Ratio of allowance for loan losses to total nonperforming loans 198.09% 138.13% Ratio of allowance at end of period to average loans 2.38% 2.11% 8. UNIONBANCORP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Note 6. Contingent Liabilities And Other Matters Neither the Company nor any of its subsidiaries are involved in any pending legal proceedings other than routine legal proceedings occurring in the normal course of business, which, in the opinion of management, in the aggregate, are not material to the Company's consolidated financial condition. Note 7. Segment Information The reportable segments are determined by the products and services offered, primarily distinguished between banking, mortgage banking, financial services, and other operations. Loans, investments, and deposits generate the revenues in the banking segment; secondary mortgage sales and servicing generates the revenue in the mortgage banking segment; insurance, brokerage, and trust services generate the revenue in the financial services segment; and holding company services generate the revenue in the operations segment. The accounting policies used with respect to segment reporting are the same as those described in the summary of significant accounting policies set forth in Note 1 on page 4. Segment performance is evaluated using net interest income. Information reported internally for performance assessment follows.
Three Months Ended ----------------------------------------------------------------- March 31, 2005 ----------------------------------------------------------------- Banking Mortgage Financial Other Consolidated Segment Banking Services Operations Totals ---------- ---------- ---------- ---------- ---------- Net interest income(loss) $ 5,072 $ 93 $ (4) $ (76) $ 5,085 Other revenue (loss) 935 340 634 (59) 1,850 Other expense 4,184 267 792 303 5,546 Segment profit (loss) 1,288 166 (150) (340) 964 Noncash items Depreciation 323 23 44 28 418 Provision for loan losses 100 -- -- -- 100 Other intangibles 30 -- -- 14 44 Goodwill 5,143 -- 1,820 -- 6,963 Segment assets 653,784 3,953 5,159 (1,472) 661,424 Three Months Ended ----------------------------------------------------------------- March 31, 2004 ----------------------------------------------------------------- Banking Mortgage Financial Other Consolidated Segment Banking Services Operations Totals ---------- ---------- ---------- ---------- ---------- Net interest income (loss) $ 5,750 $ 174 $ -- $ (123) $ 5,801 Other revenue 1,506 562 855 1 2,924 Other expense 3,278 750 1,123 1,828 6,979 Segment profit (loss) 1,466 (9) (175) (482) 800 Noncash items Depreciation 375 25 43 61 504 Provision for loan losses 750 -- -- -- 750 Other intangibles 52 -- -- -- 52 Goodwill 5,822 -- 1,820 -- 7,642 Segment assets 762,408 5,435 7,423 1,133 779,399
9. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- The following discussion provides an analysis of the Company's results of operations and financial condition for the three months ended March 31, 2005 as compared to the same period in 2004. Management's discussion and analysis (MD&A) should be read in conjunction with the consolidated financial statements and accompanying notes presented elsewhere in this report as well as the Company's 2004 Annual Report on Form 10-K. Annualized results of operations during the three months ended March 31, 2005 are not necessarily indicative of results to be expected for the full year of 2005. Unless otherwise stated, all earnings per share data included in this section and throughout the remainder of this discussion are presented on a diluted basis. All financial information is in thousands (000's), except per share data. Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995 This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934 as amended. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 and is including this statement for purposes of these safe harbor provisions. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations of the Company, are generally identified by the use of words such as "believe," "expect," "intend," "anticipate," "estimate," "project," "planned" or "potential" or similar expressions. The Company's ability to predict results, or the actual effect of future plans or strategies, is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects of the Company and the subsidiaries include, but are not limited to, changes in: interest rates; general economic conditions; legislative/regulatory changes; monetary and fiscal policies of the U.S. government, including policies of the U.S. Treasury and the Federal Reserve Board; the quality and composition of the loan or securities portfolios; demand for loan products; deposit flows; competition; demand for financial services in the Company's market areas; the Company's implementation of new technologies; the Company's ability to develop and maintain secure and reliable electronic systems; and accounting principles, policies, and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Critical Accounting Policies and Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. By their nature, changes in these assumptions and estimates could significantly affect the Company's financial position or results of operations. Actual results could differ from those estimates. Discussed below are those critical accounting policies that are of particular significance to the Company. Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required based on past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, current economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged off. Loan losses are charged against the allowance when management believes that the uncollectibility of a loan balance is confirmed. Mortgage Servicing Rights: Servicing assets represent purchased rights and the allocated value of retained servicing rights on loans sold. Servicing assets are expensed in proportion to, and over the period of, estimated net 10. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- servicing revenues. Impairment is evaluated based on the fair value of the assets, using groupings of the underlying loans as to interest rates and then, secondarily, as to geographic and prepayment characteristics. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment of a grouping is reported as a valuation allowance. General UnionBancorp, Inc. is a bank holding company organized under the laws of the state of Delaware. The Company derives most of its revenues and income from the operations of its bank subsidiary, UnionBank (the "Bank"), but also derives revenue from its Financial Services Division. The Company provides a full range of services to individual and corporate customers located in the north central and central Illinois areas. These services include demand, time, and savings deposits; lending; mortgage banking; insurance products; brokerage services; asset management; and trust services. The Company is subject to competition from other financial institutions, including banks, thrifts and credits unions, as well as nonfinancial institutions providing financial services. Additionally, the Company and the Bank are subject to regulations of certain regulatory agencies and undergo periodic examinations by those regulatory agencies. First Quarter Highlights o Asset quality trends continued to show improvement as a result of the Company's ongoing efforts to enhance the credit process. These improvements have driven nonperforming loans to a 30% decrease from first quarter 2004 levels. The reserve coverage ratio (allowance to nonperforming loans) was reported at 198.09% as of March 31, 2005 as compared to 231.6% as of December 31, 2004 and 138.13% as of March 31, 2004. Because of the improvement in asset quality, the Company was able to decrease the loan loss provision by $650 for the first quarter of 2005 as compared to the same period in 2004. o The net interest margin strengthened during the first quarter of 2005 increasing to 3.52% after being relatively stable the previous four quarters and being 3.33% for the fourth quarter of 2004. o Noninterest income, excluding gain on sale of assets, decreased $817 or 31% during the first quarter of 2005 as compared to the same period in 2004. The year-over-year decrease is attributable to a drop in revenue generated from mortgage banking division and a decrease in other fee-based revenue related to the divestiture of the Company's western Illinois sales and service centers during the third quarter of 2004. o Noninterest expense experienced a $1,433 or 21% decrease during the first quarter of 2005 as compared to the same period in 2004. This decrease was due, in large part, to savings related to the divestiture of the Company's western Illinois sales and service centers, a decrease in legal fees associated with the workout of problem credits and cost containment in most categories of expense. o The Company's Board of Directors, in a continuing effort to enhance shareholder value, approved the payment of a 10.0% increase in the quarterly cash dividend to $0.11 from $0.10 on the Company's common stock during the first quarter of 2005. This marks the 80th consecutive quarter of dividends paid to stockholders. 11. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Results of Operations Net Income Net income equaled $964 or $0.22 per diluted share for the three months ended March 31, 2005, versus $800 or $0.18 per diluted share for the same period in 2004. The Company's quarterly results were positively impacted by improved asset quality that allowed lower than anticipated funding for the provision of loan losses, aggressive management of noninterest expense levels, and a shift in the funding mix leading to a savings in interest expense. These items were partially offset by decreases in interest income due to a reduction in loan yields and an adverse shift in the earning-asset mix from higher yielding loans to lower yielding securities. Also contributing to the change in earnings were decreases in revenue generated from the mortgage banking division due to a slowdown in new and refinancing activity and lower revenue generation from the insurance and brokerage product lines. Return on average assets was 0.59% for the first quarter of 2005 compared to 0.41% for the same period in 2004. Return on average stockholders' equity was 5.52% for the first quarter of 2005 compared to 4.67% for the same period in 2004. Net Interest Income/ Margin Net interest income is the difference between income earned on interest-earning assets and the interest expense incurred for the funding sources used to finance these assets. Changes in net interest income generally occur due to fluctuations in the volume of earning assets and paying liabilities and the rates earned and paid, respectively, on those assets and liabilities. The net yield on total interest-earning assets, also referred to as net interest margin, represents net interest income divided by average interest-earning assets. Net interest margin measures how efficiently the Company uses its earning assets and underlying capital. The Company's long-term objective is to manage those assets and liabilities to provide the largest possible amount of income while balancing interest rate, credit, liquidity and capital risks. For purposes of this discussion, both net interest income and margin have been adjusted to a fully tax equivalent basis for certain tax-exempt securities and loans. Net interest income, on a tax equivalent basis, was $5,242 for the three months ended March 31, 2005, compared with $5,988 earned during the same three-month period in 2004. This represented a decrease of $746 or 12.5% from the prior year period. The decline in net interest income is attributable to the quarter-over-quarter reduction of interest income earned on interest-earning assets totaling $1,396 exceeding the quarter-over-quarter decrease in interest expense paid on interest bearing liabilities totaling $650. The $1,396 reduction in interest income resulted from a decrease of $1,627 due to volume partially offset by an increase in the applicable rate which generated an increase of $231. The majority of the change in interest income was related to the decrease in the volume within the loan portfolio as the divestiture of the Company's western Illinois sales and service centers reduced the portfolio by $49,801 for the first quarter of 2005 as compared to the same period in 2004. This was partially offset by higher rates driven from a more disciplined approach to pricing loans and the rising interest rate environment. The $650 reduction in interest expense resulted from decreases of $714 associated with volume offset partially by a $64 increase associated with rate. The majority of the change was attributable to a $104,529 reduction in deposits related to the sale of the Company's branches in Western Illinois, as well as certain steps taken during this period to more favorably manage the mix of funding sources available to the Company. 12. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- The net interest margin increased 18 basis points to 3.52% in the first quarter 2005 as compared with 3.34% for the same period in 2004. The increase in the net interest margin in the first quarter 2005 when compared to 2004 resulted primarily from an increase in yields due to repricing of variable rate assets in a higher interest rate environment and a shift in the earning-asset mix to higher yielding loans from lower yielding investments. The Company's net interest income is affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as "volume change." It is also affected by changes in yields earned on interest-earning assets and rates paid on interest-bearing deposits and other borrowed funds referred to as "rate change." The following table details each category of average amounts outstanding for interest-earning assets and interest-bearing liabilities, average rate earned on all interest-earning assets, average rate paid on all interest-bearing liabilities, and the net yield on average interest-earning assets. In addition, the table reflects the changes in net interest income stemming from changes in interest rates and from asset and liability volume, including mix. The change in interest attributable to both rate and volume has been allocated to the changes in the rate and the volume on a pro rata basis. 13. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME
For the Three Months Ended March 31, ---------------------------------------------------------- 2005 2004 --------------------------- ---------------------------- Interest Interest Change Due To: Average Income/ Average Average Income/ Average ------------------------------ Balance Expense Rate Balance Expense Rate Volume Rate Net -------- -------- ------- -------- -------- ------- -------- -------- -------- ASSETS Interest-earning assets Interest-earning deposits $ 128 $ -- --% $ 205 $ 1 1.96% $ -- $ (1) $ (1) Securities (1) Taxable 162,356 1,425 3.56 223,997 1,905 3.41 (557) 77 (480) Non-taxable (2) 22,355 391 7.09 26,931 491 7.31 (115) 15 (100) -------- -------- ------- -------- -------- ------- -------- -------- -------- Total securities (tax equivalent) 184,711 1,816 3.99 250,928 2,396 3.83 (672) 92 (580) -------- -------- ------- -------- -------- ------- -------- -------- -------- Federal funds sold 1,651 9 2.21 3,288 9 1.10 (6) 6 -- -------- -------- ------- -------- -------- ------- -------- -------- -------- Loans (3)(4) Commercial 119,704 1,848 6.26 138,499 2,003 5.80 (296) 141 (155) Real estate 277,454 4,178 6.11 291,082 4,407 6.07 (260) 31 (229) Installment and other 20,391 448 8.91 37,769 879 9.33 (393) (38) (431) -------- -------- ------- -------- -------- ------- -------- -------- -------- Gross loans (tax equivalent) 417,549 6,474 6.29 467,350 7,289 6.26 (949) 134 (815) -------- -------- ------- -------- -------- ------- -------- -------- -------- Total interest-earning assets 604,039 8,299 5.57 721,771 9,695 5.39 (1,627) 231 (1,396) -------- -------- ------- -------- -------- ------- -------- -------- -------- Noninterest-earning assets Cash and cash equivalents 17,556 22,225 Premises and equipment, net 13,441 16,357 Other assets 23,859 29,002 -------- -------- Total nonearning assets 54,856 67,584 -------- -------- Total assets $658,895 $789,355 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities NOW accounts $ 70,554 $ 165 0.95% $ 47,389 $ 67 0.56% $ 40 $ 58 $ 98 Money market accounts 58,160 214 1.49 118,212 349 1.18 (208) 73 (135) Savings deposits 43,290 62 0.58 49,436 79 0.64 (10) (7) (17) Time deposits 275,901 1,878 2.76 337,397 2,348 2.79 (444) (26) (470) Federal funds purchased and repurchase agreements 11,098 74 2.70 2,212 13 2.36 59 2 61 Advances from FHLB 60,210 583 3.93 74,469 771 4.15 (147) (41) (188) Notes payable 7,537 81 4.36 7,870 80 4.08 (4) 5 1 -------- -------- ------- -------- -------- ------- -------- -------- -------- Total interest-bearing liabilities 526,750 3,057 2.35 636,985 3,707 2.33 (714) 64 (650) -------- -------- ------- -------- -------- ------- -------- -------- -------- Noninterest-bearing liabilities Noninterest-bearing deposits 57,341 78,067 Other liabilities 4,034 5,449 -------- -------- Total noninterest-bearing liabilities 61,375 83,516 -------- -------- Stockholders' equity 70,770 68,854 -------- -------- Total liabilities and stockholders' equity $658,895 $789,355 ======== ======== Net interest income (tax equivalent) $ 5,242 $ 5,988 $ (913) $ 167 $ (746) ======== ======== ======== ======== ======== Net interest income (tax equivalent) to total earning assets 3.52% 3.34% ======== ======== Interest-bearing liabilities to earning assets 87.20% 88.25% ======== ======== -----------------------------------
(1) Average balance and average rate on securities classified as available-for-sale is based on historical amortized cost balances. (2) Interest income and average rate on non-taxable securities are reflected on a tax equivalent basis based upon a statutory federal income tax rate of 34%. (3) Nonaccrual loans are included in the average balances. (4) Overdraft loans are excluded in the average balances. 14. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Provision for Loan Losses The provision for loan losses charged to operating expense for the first quarter of 2005 totaled $100, a decrease of $650 from the $750 recorded during the same period a year ago. The decrease in the provision was primarily due to a decrease in non-performing and action/watch list loans from the first quarter of 2004 through the first quarter of 2005, as well as resolutions, either through charge-off of non-bankable assets or through successful workout strategies that have been executed. Nonperforming loans decreased $2,132 from $7,154 as of March 31, 2004 to $5,022 as of March 31, 2005. Net charge-offs for the first quarter of 2005 were ($116) compared with ($121) for the comparable period in 2004. Annualized net charge-offs were (0.03%) of average loans for the first quarter of 2005 and for the same period in 2004. See "Nonperforming Assets" and "Other Potential Problem Loans" for further information. The amount of the provision for loan losses is based on management's evaluations of the loan portfolio, with particular attention directed toward nonperforming, impaired and other potential problem loans. During these evaluations, consideration is also given to such factors as management's evaluation of specific loans, the level and composition of impaired loans, other nonperforming loans, other identified potential problem loans, historical loss experience, results of examinations by regulatory agencies, results of the independent asset quality review process, the market value of collateral, the estimate of discounted cash flows, the strength and availability of guarantees, concentrations of credits, and various other factors, including concentration of credit risk in various industries and current economic conditions. Management remains watchful of credit quality issues and believes that issues within the portfolio are reflective of the challenging economic environment experienced over the past few years. Should the economic climate deteriorate from current levels, borrowers may experience difficulty, and the level of nonperforming loans, charge-offs and delinquencies could rise and require further increases in the provision. 15. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Noninterest Income Noninterest income consists of a wide variety of fee-based revenues from bank-related service charges on deposits and mortgage revenues. Also included in this category are revenues generated by the Company's insurance, brokerage, trust and asset management product lines as well as increases in cash surrender value on bank-owned life insurance. The following table summarizes the Company's noninterest income: Three Months Ended March 31, ------------------------ 2005 2004 ---------- ---------- Service charges $ 483 $ 711 Trust income 215 184 Mortgage banking income 340 568 Insurance commissions and fees 421 633 Bank owned life insurance 134 172 Gain on the sale of assets 2 259 Other income 255 397 ---------- ---------- 1,850 $ 2,924 ========== ========== Noninterest income totaled $1,850 for the three months ended March 31, 2005, compared to $2,924 for the same period in 2004. Exclusive of the gain on sale of assets for both periods, noninterest income equaled $1,848 for the three months ended March 31, 2005, compared to $2,665 for the same period in 2004. This represented a decrease of $817 or 31%. The quarter-over-quarter decrease was primarily attributable to a decrease in mortgage banking income related to a slowdown in new and refinancing loan production activity and a decrease in insurance revenue is related to lower production volumes and account retention being lower in 2005 than in 2004. Also contributing were volume related decreases in overdraft fees (included in service charges) and service charges due to the Company's exiting of their western Illinois sales and service centers in 2004. Additionally, most other fee categories for the quarter have shown a decrease as well when compared to 2004 results for the same period. 16. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Noninterest Expense Noninterest expense is comprised primarily of compensation and employee benefits, occupancy and other operating expense. The following table summarizes the Company's noninterest expense: Three Months Ended March 31, ----------------------- 2005 2004 ---------- ---------- Salaries and employee benefits $ 3,476 $ 4,150 Occupancy expense, net 394 552 Furniture and equipment expense 424 557 Marketing 96 168 Supplies and printing 77 115 Telephone 107 154 Amortization of intangible assets 44 52 Other expenses 928 1,231 ---------- ---------- $ 5,546 $ 6,979 ========== ========== Noninterest expense totaled $5,546 for the three months ended March 31, 2005, as compared to $6,979 for the same period in 2004. This represented a decrease of $1,433 or 21%. This improvement in noninterest expense was primarily due to savings related to the divestiture of the Company's western Illinois sales and service centers leading to the decreases experienced for salary and employee benefits, occupancy expense, marketing, supplies, telephone and other expense categories. Additionally, legal fees associated with the workout of problem credits have declined as asset quality continues to improve. Finally, management's continued efforts to contain costs have led to decreases in most all other expense categories. Applicable Income Taxes Income tax expense for the periods included benefits for tax-exempt income, tax-advantaged investments and general business tax credits offset by the effect of nondeductible expenses. The following table shows the Company's income before income taxes, as well as applicable income taxes and the effective tax rate for the three months ended March 31, 2005 and 2004. Three Months Ended March 31, ------------------------- 2005 2004 ---------- ---------- Income before income taxes $ 1,289 $ 996 Applicable income taxes 325 196 Effective tax rates 25.2% 19.7% The Company recorded an income tax expense of $325 and of $196 for the three months ended March 31, 2005 and 2004, respectively. Income tax expense for the periods included benefits for tax-exempt income, tax-advantaged investments and general business tax credits offset by the effect of nondeductible expenses. The Company's effective tax rate was lower than statutory rates due to several factors. First, the Company derives interest income from municipal securities and loans, which are exempt from federal tax and certain U. S. government agency securities, which are exempt from Illinois State tax. Second, the level of tax-exempt income has increased as a percentage of taxable income. Finally, the Company has reduced tax expense through various tax planning initiatives. 17. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- For the first quarter of 2005, the Company has less of its security portfolio invested in federally tax-exempt assets than in the same period in 2004. Thus, the amount of tax exempt interest earned on the portfolio in the first quarter of 2005 is lower than the same period of 2004. This change in mix in the security portfolio increased the amount of interest that is taxable leading to the higher effective tax rate experienced during the period. Preferred Stock Dividends The Company paid $52 in preferred stock dividends for the three months ended March 31, 2005 and 2004, respectively. Interest Rate Sensitivity Management The business of the Company and the composition of its balance sheet consist of investments in interest-earning assets (primarily loans and securities) which are primarily funded by interest-bearing liabilities (deposits and borrowings). All of the financial instruments of the Company are for other than trading purposes. Such financial instruments have varying levels of sensitivity to changes in market rates of interest. The operating income and net income of the Bank depends, to a substantial extent, on "rate differentials," i.e., the differences between the income the Bank receives from loans, securities, and other earning assets and the interest expense they pay to obtain deposits and other liabilities. These rates are highly sensitive to many factors that are beyond the control of the Bank, including general economic conditions and the policies of various governmental and regulatory authorities. The Company measures its overall interest rate sensitivity through a net interest income analysis. The net interest income analysis measures the change in net interest income in the event of hypothetical changes in interest rates. This analysis assesses the risk of changes in net interest income in the event of a sudden and sustained 100 to 200 basis point increase in market interest rates or a 100 basis point decrease in market rates. The interest rates scenarios are used for analytical purposes and do not necessarily represent management's view of future market movements. The tables below present the Company's projected changes in net interest income for the various rate shock levels at March 31, 2005 and December 31, 2004, respectively: March 31, 2005 ---------------------------------------------- Net Interest Income ---------------------------------------------- Amount Change Change ------ ------ ------ (Dollars in Thousands) +200 bp $ 22,204 $ 920 4.32% +100 bp 21,804 520 2.44 Base 21,284 -- -- -100 bp 20,353 (931) (4.37) Based upon the Company's model at March 31, 2005, the effect of an immediate 200 basis point increase in interest rates would increase the Company's net interest income by $920 or 4.32%. The effect of an immediate 100 basis point decrease in rates would decrease the Company's net interest income by $931 or 4.37%. For the March 31, 2005 reporting cycle, the Company has suppressed an immediate 200 basis point decrease in its Asset Liability model due to the abnormally low prevailing interest rate environment. 18. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- December 31, 2004 ---------------------------------------------- Net Interest Income ---------------------------------------------- Amount Change Change ------ ------ ------ (Dollars in Thousands) +200 bp $ 21,070 $ 996 4.96% +100 bp 20,635 560 2.79 Base 20,074 -- -- -100 bp 19,048 (1,026) (5.11) Based upon the Company's model at December 31, 2004, the effect of an immediate 200 basis point increase in interest rates would increase the Company's net interest income by $996 or 4.96%. The effect of an immediate 100 basis point decrease in rates would decrease the Company's net interest income by $(1,026) or (5.11%). For the December 31, 2004 reporting cycle, the Company has suppressed an immediate 200 basis point decrease in its Asset Liability model due to the abnormally low prevailing interest rate environment. Financial Condition General As of March 31, 2005, the Company had total assets of $661,424, total gross loans of $421,523, total deposits of $503,301 and total stockholders' equity of $70,410. Total assets decreased by $8,122 or 1.21% from year-end 2004. Total gross loans increased by $2,248 or 0.5% from year-end 2004. Total deposits declined by $9,176 or 1.8% from year-end 2004. Nonperforming Assets The Company's financial statements are prepared on the accrual basis of accounting, including the recognition of interest income on its loan portfolio, unless a loan is placed on nonaccrual status. Loans are placed on nonaccrual status when there are serious doubts regarding the collectibility of all principal and interest due under the terms of the loans. Amounts received on nonaccrual loans generally are applied first to principal and then to interest after all principal has been collected. It is the policy of the Company not to renegotiate the terms of a loan because of a delinquent status. Rather, a loan is generally transferred to nonaccrual status if it is not in the process of collection and is delinquent in payment of either principal or interest beyond 90 days. Loans that are 90 days delinquent but are well secured and in the process of collection are not included in nonperforming assets. Other nonperforming assets consist of real estate acquired through loan foreclosures or other workout situations and other assets acquired through repossessions. The classification of a loan as nonaccrual does not necessarily indicate that the principal is uncollectible, in whole or in part. The Bank makes a determination as to collectibility on a case-by-case basis. The Bank considers both the adequacy of the collateral and the other resources of the borrower in determining the steps to be taken to collect nonaccrual loans. The final determination as to the steps taken is made based upon the specific facts of each situation. Alternatives that are typically considered to collect nonaccrual loans are foreclosure, collection under guarantees, loan restructuring, or judicial collection actions. Each of the Company's loans is assigned a rating based upon an internally developed grading system. A separate credit administration department also reviews grade assignments on an ongoing basis. Management continuously monitors nonperforming, impaired, and past due loans to prevent further deterioration of these loans. The Company has an independent loan review function which is separate from the lending function and is responsible for the review of new and existing loans. 19. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- The following table summarizes nonperforming assets and loans past due 90 days or more and still accruing for the previous five quarters.
2005 2004 --------- ------------------------------------------------ Mar 31, Dec 31, Sept 30, Jun 30, Mar 31 --------- --------- --------- --------- --------- Non-accrual loans $ 4,176 $ 3,649 $ 3,753 $ 5,293 $ 5,984 Loans 90 days past due and still accruing interest 846 553 771 502 1,170 --------- --------- --------- --------- --------- Total nonperforming loans 5,022 4,202 4,524 5,795 7,154 Other real estate owned 400 420 90 164 246 --------- --------- --------- --------- --------- Total nonperforming assets $ 5,422 $ 4,622 $ 4,614 $ 5,959 $ 7,400 ========= ========= ========= ========= ========= Nonperforming loans to total end of period loans 1.19% 1.00% 1.09% 1.28% 1.53% Nonperforming assets to total end of period loans 1.29 1.10 1.11 1.31 1.59 Nonperforming assets to total end of period assets 0.82 0.69 0.69 0.81 0.95
The level of nonperforming loans at March 31, 2005 increased to $5,022 versus the $4,202 that existed as of December 31, 2004 and decreased from $7,154 at March 31, 2004. The level of nonperforming loans to total end of period loans was 1.19% at March 31, 2005, as compared to 1.00% at December 31, 2004 and 1.53% at March 31, 2004. The reserve coverage ratio (allowance to nonperforming loans) was reported at 198.09% as of March 31, 2005 as compared to 231.60% as of December 31, 2004 and 138.13% as of March 31, 2004. Other Potential Problem Loans The Company has other potential problem loans that are currently performing, but where some concerns exist as to the ability of the borrower to comply with present loan repayment terms. If nonperforming loans are excluded, loans that management has classified as impaired totaled $6,524 at March 31, 2005 as compared to $4,114 at March 31, 2004 and $7,782 at December 31, 2004. The classification of these loans, however, does not imply that management expects losses on each of these loans, but believes that a higher level of scrutiny and close monitoring is prudent under the circumstances. Such classifications relate to specific concerns for each individual borrower and do not relate to any concentration risk common to all loans in this group. Allowance for Loan Losses At March 31, 2005, the allowance for loan losses was $9,948 or 2.36% of total loans as compared to $9,732 or 2.32% at December 31, 2004, and $9,882 or 2.12% at March 31, 2004. In originating loans, the Company recognizes that credit losses will be experienced and the risk of loss will vary with, among other things, general economic conditions; the type of loan being made; the creditworthiness of the borrower over the term of the loan; and, in the case of a collateralized loan, the quality of the collateral for such a loan. The allowance for loan losses represents the Company's estimate of the allowance necessary to provide for probable incurred losses in the loan portfolio. In making this determination, the Company analyzes the ultimate collectibility of the loans in its portfolio, incorporating feedback provided by internal loan staff, the independent loan review function, and information provided by examinations performed by regulatory agencies. The Company makes an ongoing evaluation as to the adequacy of the allowance for loan losses. On a quarterly basis, management reviews the adequacy of the allowance for loan losses. Commercial credits are graded by the loan officers and the Loan Review function validates the officers' grades. In the event that the loan 20. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- review function downgrades the loan, it is included in the allowance analysis at the lower grade. The grading system is in compliance with the regulatory classifications and the allowance is allocated to the loans based on the regulatory grading, except in instances where there are known differences (i.e., collateral value is nominal, etc.). To establish the appropriate level of the allowance, a sample of loans (including impaired and nonperforming loans) are reviewed and classified as to potential loss exposure. Based on an estimation computed pursuant to the requirements of Financial Accounting Standards Board ("FASB") Statement No. 5, "Accounting for Contingencies," and FASB Statements Nos. 114 and 118, "Accounting by Creditors for Impairment of a Loan," the analysis of the allowance for loan losses consists of three components: (i) specific credit allocation established for expected losses resulting from analysis developed through specific credit allocations on individual loans for which the recorded investment in the loan exceeds its fair value; (ii) general portfolio allocation based on historical loan loss experience for each loan category; and (iii) subjective reserves based on general economic conditions as well as specific economic factors in the markets in which the Company operates. The specific credit allocation component of the allowance for loan losses is based on a regular analysis of loans over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. The fair value of the loan is determined based on either the present value of expected future cash flows discounted at the loan's effective interest rate, the market price of the loan, or, if the loan is collateral dependent, the fair value of the underlying collateral less cost of sale. The general portfolio allocation component of the allowance for loan losses is determined statistically using a loss migration analysis that examines historical loan loss experience. The loss migration analysis is performed quarterly and loss factors are updated regularly based on actual experience. The general portfolio allocation element of the allowance for loan losses also includes consideration of the amounts necessary for concentrations and changes in portfolio mix and volume. The allowance for loan losses is based on estimates, and ultimate losses will vary from current estimates. These estimates are reviewed monthly, and as adjustments, either positive or negative, become necessary, a corresponding increase or decrease is made in the provision for loan losses. The composition of the loan portfolio has not significantly changed since year-end 2004. The methodology used to determine the adequacy of the allowance for loan losses is consistent with prior years, and there were no reallocations. Management remains watchful of credit quality issues and believes that issues within the portfolio are reflective of the challenging economic environment experienced over the past few years. Should the economic climate deteriorate from current levels, borrowers may experience difficulty, and the level of nonperforming loans, charge-offs and delinquencies could rise and require further increases in the provision. Liquidity The Company manages its liquidity position with the objective of maintaining sufficient funds to respond to the needs of depositors and borrowers and to take advantage of earnings enhancement opportunities. In addition to the normal inflow of funds from core-deposit growth together with repayments and maturities of loans and investments, the Company utilizes other short-term funding sources such as brokered time deposits, securities sold under agreements to repurchase, overnight federal funds purchased from correspondent banks and the acceptance of short-term deposits from public entities, and Federal Home Loan Bank advances. The Company monitors and manages its liquidity position on several bases, which vary depending upon the time period. As the time period is expanded, other data is factored in, including estimated loan funding 21. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- requirements, estimated loan payoffs, investment portfolio maturities or calls, and anticipated depository buildups or runoffs. The Company classifies all of its securities as available-for-sale, thereby maintaining significant liquidity. The Company's liquidity position is further enhanced by structuring its loan portfolio interest payments as monthly and by the significant representation of retail credit and residential mortgage loans in the Company's loan portfolio, resulting in a steady stream of loan repayments. In managing its investment portfolio, the Company provides for staggered maturities so that cash flows are provided as such investments mature. The Company's cash flows are comprised of three classifications: cash flows from operating activities, cash flows from investing activities, and cash flows from financing activities. Cash flows used in financing activities offset by those provided by operating activities and investing activities, resulted in a net decrease in cash and cash equivalents of $3,942 from December 31, 2004 to March 31, 2005. During the first three months of 2005, the Company experienced net cash outflows of ($7,548) in financing activities primarily due to a decrease in deposits. In contrast, net cash inflows were provided by $2,590 in operating activities due to proceeds from net loans sales and net income and $1,016 in investing activities largely due to the decrease in net loans and securities. Contractual Obligations, Commitments, Contingencies, and Off-Balance Sheet Financial Instruments The Company has entered into contractual obligations and commitments and off-balance sheet financial instruments. The following tables summarize the Company's contractual cash obligations and other commitments and off balance sheet instruments as of March 31, 2005.
Payments Due by Period ------------------------------------------------------------------- Within 1 After Contractual Obligations Year 1-3 Years 4-5 Years 5 Years Total ----------- ----------- ----------- ----------- ----------- Short-term debt $ 6,524 -- -- -- 6,524 Long-term debt -- $ 334 $ -- $ -- $ 334 FHLB Advances 14,800 16,000 18,300 8,000 57,100 ----------- ----------- ----------- ----------- ----------- Total contractual cash obligations $ 21,324 $ 16,334 $ 18,300 $ 8,000 $ 63,958 =========== =========== =========== =========== =========== Amount of Commitment Expiration per Period ------------------------------------------------------------------- Within 1 After Off-Balance Sheet Financial Instruments Year 1-3 Years 4-5 Years 5 Years Total ----------- ----------- ----------- ----------- ----------- Lines of credit $ 62,549 $ 4,837 $ 4,700 $ 12,872 $ 84,958 Standby letters of credit 6,569 1,039 -- -- 7,608 ----------- ----------- ----------- ----------- ----------- Total commercial commitments $ 69,118 $ 5,876 $ 4,700 $ 12,872 $ 92,566 =========== =========== =========== =========== ===========
22. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Capital Resources Stockholders' Equity The Company is committed to managing capital for maximum shareholder benefit and maintaining strong protection for depositors and creditors. Stockholders' equity at March 31, 2005 was $70,410, an increase of $163 or 0.2%, from December 31, 2004. The increase in stockholders' equity was largely the result of earnings for the first three months of 2005 less dividends paid to shareholders and a decrease in accumulated other comprehensive income. Average quarterly equity as a percentage of average quarterly assets was 10.61% at March 31, 2005, compared to 9.98% at December 31, 2004. Book value per common share equaled $17.27 at March 31, 2005 compared to $17.30 at December 31, 2004. Stock Repurchase On May 2, 2003, the Board of Directors approved a stock repurchase plan whereby the Company may repurchase from time to time up to 5% of its outstanding shares of common stock in the open market or in private transactions over an 18 month period. On September 23, 2004, the Board of Directors extended the Company's stock repurchase program through May 2, 2006. Under the terms of the plan, the Company is able to repurchase, from time to time, up to 5% of its outstanding shares of common stock in the open market or in private transactions. Purchases are dependent upon market conditions and the availability of shares. The extension of the repurchase program enables the Company to optimize its use of capital relative to other investment alternatives and benefits both the Company and the shareholders by enhancing earnings per share and return on equity. During the current quarter, 11,500 shares were repurchased at a weighted cost of $21.10 and to date, the Company has repurchased 30,000 shares at a weighted average cost of $19.57. Capital Measurements The Bank is expected to meet a minimum risk-based capital to risk-weighted assets ratio of 8%, of which at least one-half (or 4%) must be in the form of Tier 1 (core) capital. The remaining one-half (or 4%) may be in the form of Tier 1 (core) or Tier 2 (supplementary) capital. The amount of loan loss allowance that may be included in capital is limited to 1.25% of risk-weighted assets. The ratio of Tier 1 (core) and the combined amount of Tier 1 (core) and Tier 2 (supplementary) capital to risk-weighted assets for the Company was 13.1% and 14.3%, respectively, at March 31, 2005. The Company is currently, and expects to continue to be, in compliance with these guidelines. The following table sets forth an analysis of the Company's capital ratios:
December 31, Minimum Well March 31, -------------------- Capital Capitalized 2005 2004 2003 Ratios Ratios -------- -------- -------- -------- -------- Tier 1 risk-based capital $ 63,964 $ 63,347 $ 59,851 Tier 2 risk-based capital 6,111 6,067 7,790 -------- -------- -------- Total capital 70,075 69,414 67,641 Risk-weighted assets 488,852 485,325 556,729 Capital ratios Tier 1 risk-based capital 13.1% 13.0% 10.8% 4.00% 6.00% Tier 2 risk-based capital 14.3 14.3 12.2 8.00 10.00 Leverage ratio 9.8 9.5 7.7 4.00 5.00
23. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Impact of Inflation, Changing Prices, and Monetary Policies The financial statements and related financial data concerning the Company have been prepared in accordance with U.S. generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. The primary effect of inflation on the operations of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, changes in interest rates have a more significant effect on the performance of a financial institution than do the effects of changes in the general rate of inflation and changes in prices. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Interest rates are highly sensitive to many factors which are beyond the control of the Company, including the influence of domestic and foreign economic conditions and the monetary and fiscal policies of the United States government and federal agencies, particularly the Federal Reserve Board. Recent Regulatory and Accounting Developments SFAS 123R, "Accounting for Stock-Based Compensation, Revised," requires all public companies to record compensation cost for stock options provided to employees in return for employee service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employee service period, which is normally the vesting period of the options. The Securities and Exchange Commission in April 2005 amended the compliance dates for SFAS 123R from periods beginning after June 15, 2005 to the beginning of the next fiscal year. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted at such future date, as well as the vesting periods provided, and so cannot currently be predicted. There will be no significant effect on financial position as total equity will not change. Item 3. Quantitative and Qualitative Disclosures About Market Risk The information required by this Item 3 is incorporated by reference from the discussion on pages 18 and 19 of this Form 10-Q under the caption "Interest Rate Sensitivity Management" and the discussion immediately above under the caption "Impact of Inflation, Changing Prices, and Monetary Policies." Item 4. Controls and Procedures As of the end of the period covered by this report, the Company carried out an evaluation under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended). Based on this evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective in timely alerting them to material information relating to the Company required to be included in the Company's periodic filings with the Securities and Exchange Commission. It should be noted that in designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. The Company has designed its disclosure controls and procedures to reach a level of reasonable assurance of achieving the desired control objectives and, based on the evaluation described above, the Company's Chief 24. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (In Thousands, Except Per Share Data) -------------------------------------------------------------------------------- Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective at reaching that level of reasonable assurance. There was no change in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) during the Company's most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 25. PART II - OTHER INFORMATION Item 1. Legal Proceedings In the normal course of business the Company may be involved in various legal proceedings from time to time. The Company does not believe it is currently involved in any claim or action the ultimate disposition of which would have a material adverse effect on the Company's financial statements. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds The following table provides information about purchases of the Company's common stock by the Company during the quarter ended March 31, 2005.
=========================================================================================================== Total Number of Shares Purchased as Maximum Number of Part of Publicly Shares that May Yet Total Number of Average Price Paid Announced Plans or Be Purchased Under Period Shares Purchased per Share Programs the Plans or Programs =========================================================================================================== 01/01/05 - -- -- -- 181,510 01/31/05 =========================================================================================================== 02/01/05 - -- -- -- 181,510 02/28/05 =========================================================================================================== 03/01/05 - 11,500 $21.10 11,500 170,010 03/31/05 =========================================================================================================== Total 11,500 $21.10 11,500 170,010 ===========================================================================================================
(1) For the quarter ended March 31, 2005, the Company repurchased 11,500 shares at an average price per share of $21.10 of our common stock pursuant to the repurchase program that we announced on May 2, 2003 (the "Program"). (2) Our board of directors approved the repurchase by us of up to an aggregate of 5% of the outstanding shares of our common stock pursuant to the Program. The expiration date of this Program is May 2, 2006. Unless terminated earlier by resolution of our board of directors, the Program will expire on the earlier of such expiration date or when we have repurchased all shares authorized for repurchase under the Program. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None. 26. Item 5. Other Information The Company was notified by the Federal Reserve Bank of Chicago and the Illinois Department of Financial and Professional Regulation that the Joint Memorandum of Understanding effective December 17, 2002 previously disclosed in the Company's Form 10-Q Report as of September 30, 2002 has been terminated. In their inspection completed on August 16, 2004, they cited that improvements in the information technology department and management's continued willingness to correct deficiencies warranted the termination of the Memorandum. Item 6. Exhibits and Reports on Form 8-K Exhibits: 31.1 Certification of Dewey R. Yaeger, President and Principal Executive Officer, required by Rule 13a - 14(a). 31.2 Certification of Kurt R. Stevenson, Senior Vice President and Principal Financial and Accounting Officer required by Rule 13a - 14(a). 32.1(1) Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, from the Company's President and Principal Executive Officer. 32.2(1) Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, from the Company's Senior Vice President and Principal Financial and Accounting Officer. ---------------- (1) This certification is not "filed" for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended. 27. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. UNIONBANCORP, INC. Date: May 12, 2005 By: /s/ DEWEY R. YAEGER -------------------------------------- Dewey R. Yaeger President and Principal Executive Officer Date: May 12, 2005 By: /s/ KURT R. STEVENSON -------------------------------------- Kurt R. Stevenson Senior Vice President and Principal Financial and Accounting Officer 28.