10-Q 1 ubc1q02.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, 2002 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) Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange Title of Exchange Class which Registered -------------------------------------------------------------------------------- None None Securities registered pursuant to Section 12(g) of the Act: Common Stock ($1.00 par value) ------------------------------ (Title of Class) Preferred Purchase Rights ------------------------- (Title of Class) 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 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 14, 2002 ----------------------------- ----------------------------------- Common Stock, Par Value $1.00 3,979,056 ================================================================================ UnionBancorp, Inc. Form 10-Q Index Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements o Consolidated Balance Sheets.....................................1 o Consolidated Statements of Income and Comprehensive Income .....2 o Consolidated Statements of Cash Flows...........................3 o Notes to Unaudited Consolidated Financial Statements............4 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition..........................................10 PART II. OTHER INFORMATION Item 1. Legal Proceedings...................................................23 Item 2. Changes in Securities...............................................23 Item 3. Defaults Upon Senior Securities.....................................23 Item 4. Submission of Matters to a Vote of Security Holders.................23 Item 5. Other Information...................................................23 Item 6. Exhibits and Reports on Form 8-K....................................23 SIGNATURES...................................................................23 i
UNIONBANCORP, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED BALANCE SHEETS March 31, 2002 and December 31, 2001 (In Thousands, Except Share Data) ------------------------------------------------------------------------------------------------------------- March 31, December 31, 2002 2001 ----------- ----------- ASSETS Cash and cash equivalents $ 27,184 $ 26,699 Securities available-for-sale 193,225 186,282 Loans 490,144 504,968 Allowance for loan losses (6,387) (6,295) ----------- ----------- Net loans 483,757 498,673 Premises and equipment, net 13,629 12,451 Intangible assets, net 8,506 8,607 Mortgage servicing rights 2,390 2,102 Other assets 12,856 13,493 ----------- ----------- Total assets $ 741,547 $ 748,307 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits Non-interest-bearing $ 67,714 $ 73,138 Interest-bearing 548,159 539,006 ----------- ----------- Total deposits 615,873 612,144 Federal funds purchased and securities sold under agreements to repurchase 4,342 2,629 Advances from the Federal Home Loan Bank 39,950 52,750 Notes payable 9,275 9,275 Other liabilities 6,911 6,864 ----------- ----------- Total liabilities 676,351 683,662 ----------- ----------- Mandatory redeemable preferred stock, Series B, no par value; 1,092 shares authorized; 831 shares issued and outstanding 831 831 ----------- ----------- 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; 4,569,319 shares issued at March 31, 2002 and December 31, 2001 4,569 4,569 Surplus 21,841 21,841 Retained earnings 41,487 40,560 Accumulated other comprehensive income 1,148 1,536 Unearned compensation under stock option plans (56) (68) ----------- ----------- 69,489 68,938 Treasury stock, at cost; 590,263 shares (5,124) (5,124) ----------- ----------- Total stockholders' equity 64,365 63,814 ----------- ----------- Total liabilities and stockholders' equity $ 741,547 $ 748,307 =========== ===========
See Accompanying Notes to U naudited Financial Statements 1. UNIONBANCORP, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME Three Months Ended March 31, 2002 and 2001 (In Thousands, Except Share Data) -------------------------------------------------------------------------------- Three Months Ended March 31, ------------------------ 2002 2001 ---------- ---------- Interest income Loans $ 9,535 $ 11,254 Securities Taxable 1,712 2,349 Exempt from federal income taxes 439 504 Federal funds sold and other 44 65 ---------- ---------- Total interest income 11,730 14,172 Interest expense Deposits 4,796 7,400 Federal funds purchased and securities sold under agreements to repurchase 28 13 Advances from the Federal Home Loan Bank 592 744 Notes payable 96 206 ---------- ---------- Total interest expense 5,512 8,363 ---------- ---------- Net interest income 6,218 5,809 Provision for loan losses 519 309 ---------- ---------- Net interest income after provision for loan losses 5,699 5,500 Noninterest income Service charges 591 644 Merchant fee income 244 257 Trust income 180 172 Mortgage banking income 631 443 Insurance commissions and fees 544 671 Securities gains, net 243 82 Other income 570 543 ---------- ---------- 3,003 2,812 Noninterest expenses Salaries and employee benefits 3,884 3,166 Occupancy expense, net 453 479 Furniture and equipment expense 390 406 Supplies and printing 157 167 Telephone 225 188 Amortization of intangible assets 101 248 Other expenses 1,706 1,476 ---------- ---------- 6,916 6,130 ---------- ---------- Income before income taxes 1,786 2,182 Income taxes 517 647 ---------- ---------- Net income 1,269 1,535 Preferred stock dividends 64 65 ---------- ---------- Net income for common stockholders $ 1,205 $ 1,470 ========== ========== Basic earnings per share $ 0.30 $ 0.37 ========== ========== Diluted earnings per common share $ 0.30 $ 0.37 ========== ========== Comprehensive income $ 817 $ 2,892 ========== ========== See Accompanying Nots to Unaudited Financial Statements. 2.
UNIONBANCORP, INC. AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS Three Months Ended March 31, 2002 and 2001 (In Thousands) -------------------------------------------------------------------------------------------------- Three Months Ended March 31, ------------------------ 2002 2001 ---------- ---------- Cash flows from operating activities Net income $ 1,269 $ 1,535 Adjustments to reconcile net income to net cash provided by operating activities Depreciation 324 318 Amortization of intangible assets 101 248 Amortization of unearned compensation under stock option plans 12 17 Amortization of bond premiums, net 397 35 Provision for loan losses 519 309 Securities gains, net (243) (82) Gain on sale of equipment -- (1) Loss on sale of real estate acquired in settlement of loans 13 51 Gain on sale of loans (612) (365) Proceeds from sales of loans held for sale 47,346 26,387 Origination of loans held for sale (45,099) (23,323) Change in assets and liabilities Decrease in other assets 785 1,126 Increase (decrease) in other liabilities 47 (1,026) ---------- ---------- Net cash provided by operating activities 4,859 5,229 Cash flows from investing activities Securities Available-for-sale Proceeds from maturities and paydowns 19,944 24,231 Proceeds from sales 9,268 -- Purchases (36,774) (33,109) Net increase (decrease) in loans 12,195 (1,071) Purchase of premises and equipment (1,502) (167) Proceeds from sale of real estate acquired in settlement of loans 196 227 Proceeds from sale of equipment -- 4 ---------- ---------- Net cash provided by (used in) investing activities 3,327 (9,885) Cash flows from financing activities Net increase (decrease) in deposits 3,729 (19,231) Net increase in federal funds purchased and securities sold under agreements to repurchase 1,713 4 Increase (decrease) in advances from the Federal Home Loan Bank (12,800) 12,000 Payments on notes payable -- (500) Dividends on common stock (279) (238) Dividends on preferred stock (64) (65) Proceeds from exercise of stock options -- 39 ---------- ---------- Net cash used in financing activities (7,701) (7,991) ---------- ---------- Net increase (decrease) in cash and cash equivalents 485 (12,647) Cash and cash equivalents Beginning of period 26,699 33,021 ---------- ---------- End of period $ 27,184 $ 20,374 ========== ==========
See Accompanying Notes to Unaudited Financial Statements 3. UNIONBANCORP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except 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 accounting principles generally accepted in the United States of America 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, 2001. The annualized results of operations during the three month period ended March 31, 2002 are not necessarily indicative of the results expected for the year ending December 31, 2002. Note 2. Earnings Per Share Basic earnings per share for the three months ended March 31, 2002 and 2001 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, 2002 and 2001 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, ------------------------ 2002 2001 ---------- ---------- Net income available to common shareholders $ 1,205 $ 1,470 Weighted average common shares outstanding 3,979 3,968 ---------- ---------- Basic Earnings Per Common Share $ 0.30 $ 0.37 ========== ========== Diluted Earnings Per Common Share Three Months Ended March 31, ------------------------ 2002 2001 ---------- ---------- Weighted average common shares outstanding 3,979 3,968 Add: dilutive effect of assumed exercised stock options 42 27 ---------- ---------- Weighted average common and dilutive Potential shares outstanding 4,021 3,995 ========== ========== Diluted Earnings Per Common Share $ 0.30 $ 0.37 ========== ========== There were approximately 70,550 and 115,550 options outstanding at March 31, 2002 and 2001, respectively, that were not included in the computation of diluted earnings per share because the options' exercise price was greater than the average market price of the common stock and were, therefore, antidilutive. 4. UNIONBANCORP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) -------------------------------------------------------------------------------- Note 3. Securities The Company's consolidated securities portfolio, which represented 26.5% of the Company's quarterly 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 with implied calls. Other securities consist of Federal Reserve stock, Federal Home Loan Bank stock, and SBA pooled securities. The Company's financial planning anticipates income streams generated by the securities portfolio are based on normal maturity and reinvestment. Securities classified as available-for-sale, carried at fair value, were $193,225 at March 31, 2002 compared to $186,282 at December 31, 2001. The Company does not have any securities classified as trading or held-to-maturity. The following table describes the amortized cost and fair value of securities available-for-sale at March 31, 2002 and December 31, 2001:
March 31, 2002 ----------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- --------- --------- --------- U.S. treasury $ 1,005 $ 24 $ -- $ 1,029 U.S. government agencies 56,727 395 (206) 56,916 States and political subdivisions 35,895 839 (67) 36,667 U.S. government mortgage-backed securities 76,728 831 (122) 77,437 Collateralized mortgage obligations and other asset backed securities 7,766 216 -- 7,982 Corporate bonds 986 -- -- 986 Other 12,229 16 (37) 12,208 --------- --------- --------- --------- $ 191,336 $ 2,321 $ (432) $ 193,225 ========= ========= ========= =========
December 31, 2001 ----------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- --------- --------- --------- U.S. treasury $ 1,006 $ 30 $ -- $ 1,036 U.S. government agencies 42,748 727 (75) 43,400 States and political subdivisions 36,592 829 (77) 37,344 U.S. government mortgage-backed securities 85,556 876 (154) 86,278 Collateralized mortgage obligations and other asset backed securities 12,021 345 -- 12,366 Other 5,858 -- -- 5,858 --------- --------- --------- --------- $ 183,781 $ 2,807 $ (306) $ 186,282 ========= ========= ========= =========
5. UNIONBANCORP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) -------------------------------------------------------------------------------- Note 4. Loans The Company offers a broad range of products, including granting agribusiness, commercial, residential, and installment loans, designed to meet the credit needs of its borrowers. The Company's loans are diversified by borrower and industry group. The following table describes the composition of loans by major categories outstanding at March 31, 2002 and December 31, 2001: March 31, 2002 December 31, 2001 ----------------------- ------------------------ $ % $ % ---------- ---------- ---------- ---------- Commercial $ 104,377 21.30% $ 107,382 21.27% Agricultural 34,775 7.09 40,563 8.03 Real estate: Commercial mortgages 155,739 31.77 150,878 29.88 Construction 20,823 4.25 23,676 4.69 Agricultural 33,596 6.85 34,611 6.85 1-4 family mortgages 89,685 18.30 94,368 18.69 Installment 48,797 9.96 50,961 10.09 Other 2,352 0.48 2,529 0.50 ---------- ---------- ---------- ---------- Total loans 490,144 100.00% 504,968 100.00% ========== ========== Allowance for loan losses (6,387) (6,295) ---------- ---------- Loans, net $ 483,757 $ 498,673 ========== ========== 6. UNIONBANCORP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except 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, 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 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, 2002 and 2001 are summarized below: Three Months Ended March 31, ------------------------ 2002 2001 -------- -------- Beginning balance $ 6,295 6,414 Charge-offs: Commercial 333 136 Real estate mortgages 132 50 Installment and other loans 118 63 -------- -------- Total charge-offs 583 249 -------- -------- Recoveries: Commercial 130 5 Real estate mortgages 6 -- Installment and other loans 20 12 -------- -------- Total recoveries 156 17 -------- -------- Net charge-offs 427 232 -------- -------- Provision for loan losses 519 309 -------- -------- Ending balance $ 6,387 $ 6,491 ======== ======== Period end total loans, net of unearned interest $490,144 $502,912 ======== ======== Average loans $498,912 $506,121 ======== ======== Ratio of net charge-offs to average loans 0.09% 0.05% Ratio of provision for loan losses to average loans 0.10 0.06 Ratio of allowance for loan losses to ending total loans 1.30 1.29 Ratio of allowance for loan losses to total nonperforming loans 72.63 67.74 Ratio of allowance at end of period to average loans 1.28 1.28 7. UNIONBANCORP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except 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 Company's operations are managed along two major operating segments: banking and other. Loans, investments, deposits, and mortgage banking provide the revenues in the banking segment. Insurance, brokerage, trust, asset management, data processing, and holding company services are categorized as other segments. All inter-segment services provided are charged at the same rates as those charged to unaffiliated customers. Such services are included in the revenues and net income of the respective segments and are eliminated to arrive at consolidated totals. The accounting policies used are the same as those described in the summary of significant accounting policies. Information reported for internal performance assessment is summarized below: Three Months Ended ------------------------------------- March 31, 2002 ------------------------------------- Banking Other Consolidated Segment Segments Totals -------- -------- -------- Net interest income (loss) $ 6,312 $ (94) $ 6,218 Other revenue 2,138 865 3,003 Other expense 5,187 1,729 6,916 Segment profit (loss) 2,744 (958) 1,786 Noncash items Depreciation 205 119 324 Provision for loan losses 519 -- 519 Goodwill and other intangibles 95 6 101 Segment assets 734,836 6,711 741,547 Three Months Ended ------------------------------------- March 31, 2001 ------------------------------------- Banking Other Consolidated Segment Segments Totals -------- -------- -------- Net interest income (loss) $ 5,995 $ (186) $ 5,809 Other revenue 1,818 994 2,812 Other expense 4,570 1,560 6,130 Segment profit (loss) 2,934 (752) 2,182 Noncash items Depreciation 195 123 318 Provision for loan losses 309 -- 309 Goodwill and other intangibles 209 39 248 Segment assets 745,534 7,090 752,624 8. UNIONBANCORP, INC. AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (In Thousands, Except Share Data) -------------------------------------------------------------------------------- Note 8. New Accounting Standards In 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which requires that goodwill no longer be amortized to earnings, but instead be reviewed for impairment. The amortization of goodwill ceases upon adoption of SFAS No. 142, which was adopted by the Company on January 1, 2002. At March 31, 2002, the Company has $7,597 of goodwill. Approximately $2,197 of the goodwill recorded by the Company is related to a branch acquisition. This goodwill will continue to be accounted for under SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions," (excluded from the scope from SFAS No. 142) and continue to be amortized to expense. The Company has not yet completed the first step of its impairment testing of goodwill to determine if goodwill is impaired. This is expected to be completed by the end of the second quarter. The impact of this standard on the periods ended March 31, 2002 and 2001 was as follows: Three Months Ended March 31, ------------------------ 2002 2001 ---------- ---------- Reported net income $ 1,269 $ 1,535 Add back: goodwill amortization -- 99 ---------- ---------- Adjusted net income $ 1,269 $ 1,634 ========== ========== Basic Earnings Per Common Share Three Months Ended March 31, ------------------------ 2002 2001 ---------- ---------- Reported net income $ 0.30 $ 0.37 Add back: goodwill amortization -- 0.02 ---------- ---------- Adjusted net income $ 0.30 $ 0.39 ========== ========== Diluted Earnings Per Common Share Three Months Ended March 31, ------------------------ 2002 2001 ---------- ---------- Reported net income $ 0.30 $ 0.37 Add back: goodwill amortization -- 0.02 ---------- ---------- Adjusted net income $ 0.30 $ 0.39 ========== ========== 9. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) -------------------------------------------------------------------------------- The following discussion provides an analysis of the Company's results of operations and financial condition of UnionBancorp, Inc. for the three months ended March 31, 2002 as compared to the same periods in 2001. Management's discussion and analysis should be read in conjunction with the consolidated financial statements and accompanying notes presented elsewhere in this report as well as the Company's 2001 Annual Report on Form 10-K. Annualized results of operations during the three month period ended March 31, 2002 are not necessarily indicative of results to be expected for the full year of 2002. 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 1993, as amended, and Section 21E of the Securities Exchange 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," or "project" 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. General UnionBancorp, Inc. (the "Company") 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 banking subsidiaries (the "Banks"), but also derives revenue from its nonbank subsidiary, UnionFinancial Services & Trust Company (the "Nonbank"). The Company provides a full range of services to individual and corporate customers located in the north central and west 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 and nonfinancial institutions providing financial services. Additionally, the Company and the Banks are subject to regulations of certain regulatory agencies and undergo periodic examinations by those regulatory agencies. 10. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) -------------------------------------------------------------------------------- Results of Operations Net Income. Net income equaled $1,269 or $0.30 per fully diluted share for the three months ended March 31, 2002. This compares with net income of $1,535 or $0.37 per fully diluted share for the same period in 2001 and represents decreases of 18.9% in per share earnings and 17.3% in net income. These results were impacted by increases in noninterest expense, incurred to support the growing levels of business activities and the provision for loan losses. Offsetting these factors was an increase in net interest income as a result of the decrease in cost of funds, gains on the sale of securities, and another strong quarter in the mortgage banking division in both volume and revenue generation. Return on average assets was 0.69% for the first quarter of 2002 compared to the 0.82% for the same period in 2001. Return on average stockholders' equity was 7.96% for the first quarter of 2002 compared to 10.18% for the same period in 2001. Return on average tangible equity capital equaled 9.19% for the three months ended March 31, 2002, compared to 12.69% for the same period in 2001. Net Interest Income. 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 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 was $6,468 for the first quarter ended March 31, 2002, compared with $6,094 earned during the same period in 2001. This represented an increase of $374 or 6.1%. The improvement in net interest income is attributable to the quarter-over-quarter reduction of interest expense paid on interest bearing liabilities totaling $2,851 exceeding the quarter-over-quarter reduction of interest income earned on interest-earning assets totaling $2,477. Also contributing to the increase in net interest income was average noninterest-bearing deposit growth of $3,560, or 5.3%, over the same period in 2001. The $2,477 change in interest income resulted from decreases of $240 associated with volume and $2,237 decline related to rate. The majority of the decrease in interest income was related to a 127 basis point decline in interest earned on average loans driven by the commercial loan portfolio. The $2,851 change in interest expense resulted from decreases of $369 associated with volume and $2,482 associated with rate. The majority of the decrease was attributable to a reduction in the rates paid on total interest-bearing liabilities located in expensive wholesale funding sources, including brokered deposits, which resulted in a 184 basis point decrease in the cost of total time deposits. This was a deliberate strategy aimed at reducing the Company's reliance on these higher-cost funding sources and to reduce interest rate risk. The net interest margin on a tax equivalent basis for the period increased 26 basis points to 3.77% as compared to the prior quarter's 3.51% and an increase from the 3.76% earned during the fourth quarter of 2001. The Company's net interest margin was positively impacted by the decline in short term interest 11. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) -------------------------------------------------------------------------------- rates, the steepening of the yield curve, and a greater concentration of noninterest bearing sources. Consequently, liabilities repriced downward at a faster pace than rates declined on earning-assets. This was offset by narrower loan spreads, due to competitive pressures, overall tightening of loan underwriting standards, slower than expected loan growth, and the cost of carrying a higher level of nonperforming loans. Specifically, yields on interest-earning assets decreased 133 basis points to 6.99% as compared to the prior year's quarter 8.32%. In contrast, rates paid on interest-bearing liabilities decreased 178 basis points to 3.69% as compared to the prior year's quarter 5.47%. 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 for the same period. 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. 12. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) --------------------------------------------------------------------------------
AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME For the Three Months Ended March 31, --------------------------------------------------------------- 2002 2001 ------------------------------ ------------------------------ 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 $ 1,299 $ 8 2.50% $ 1,611 $ 20 5.03% $ (3) $ (9) $ (12) Securities (1) Taxable 148,802 1,704 4.64 152,093 2,329 6.21 (49) (576) (625) Non-taxable (2) 35,571 665 7.58 40,567 763 7.63 (79) (19) (98) -------- -------- -------- -------- -------- -------- -------- -------- -------- Total securities (tax equivalent) 184,373 2,369 5.21 192,660 3,092 6.51 (128) (595) (723) -------- -------- -------- -------- -------- -------- -------- -------- -------- Federal funds sold 10,909 44 1.64 4,388 65 6.10 49 (70) (21) -------- -------- -------- -------- -------- -------- -------- -------- -------- Loans (3)(4) Commercial 142,872 2,561 7.27 151,134 3,449 9.26 (180) (708) (888) Real estate 304,085 5,751 7.67 299,067 6,413 8.70 106 (768) (662) Installment and other 51,955 1,247 9.73 55,920 1,418 10.28 (84) (87) (171) -------- -------- -------- -------- -------- -------- -------- -------- -------- Net loans (tax equivalent) 498,912 9,559 7.77 506,121 11,280 9.04 (158) (1,563) (1,721) -------- -------- -------- -------- -------- -------- -------- -------- -------- Total interest-earning assets 695,493 11,980 6.99 704,780 14,457 8.32 (240) (2,237) (2,477) -------- -------- -------- -------- -------- -------- -------- -------- -------- Noninterest-earning assets Cash and cash equivalents 18,584 19,679 Premises and equipment, net 12,777 11,818 Other assets 21,985 20,012 -------- -------- Total nonearning assets 53,346 51,509 -------- -------- Total assets $748,839 $756,289 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities NOW accounts $ 44,347 $ 129 1.18% $ 41,986 $ 251 2.42% $ 13 $ (135) $ (122) Money market accounts 62,577 312 2.02 49,605 430 3.52 95 (213) (118) Savings deposits 50,107 180 1.46 44,892 268 2.42 28 (116) (88) Time deposits 389,005 4,175 4.35 422,792 6,451 6.19 (482) (1,794) (2,276) Federal funds purchased and repurchase agreements 3,476 28 3.27 1,359 13 3.88 17 (2) 15 Advances from FHLB 47,314 592 5.07 48,975 744 6.16 (24) (128) (152) Notes payable 9,294 96 4.19 10,142 206 8.24 (16) (94) (110) -------- -------- -------- -------- -------- -------- -------- -------- -------- Total interest-bearing liabilities 606,120 5,512 3.69 619,751 8,363 5.47 (369) (2,482) (2,851) -------- -------- -------- -------- -------- -------- -------- -------- -------- Noninterest-bearing liabilities Noninterest-bearing deposits 70,549 66,989 Other liabilities 7,468 8,407 -------- -------- Total noninterest-bearing liabilities 78,017 75,396 -------- -------- Stockholders' equity 64,702 61,142 -------- -------- Total liabilities and stockholders' equity $748,839 $756,289 ======== ======== Net interest income (tax equivalent) $ 6,468 $ 6,094 $ 129 $ 245 $ 374 ======== ======== ======== ======== ======== Net interest income (tax equivalent) to total earning assets 3.77% 3.51% ======== ======== Interest-bearing liabilities to earning assets 87.15% 87.94% ======== ========
--------------------------------------------- (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. 13. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) -------------------------------------------------------------------------------- Provision for Loan Losses. The amount of the provision for loan losses is based on management's evaluations of the loan portfolio, with particular attention directed toward nonperforming 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, other nonperforming loans, other identified potential problem loans, historical loss experience, results of examinations by regulatory agencies, results of the independent internal asset quality review process, the market value of collateral, the estimate of discounted cash flows, the strength and availability of guaranties, concentrations of credits, and various other factors, including concentration of credit risk in various industries and current economic conditions. The provision for loan losses charged to operating expense for the first quarter of 2002 totaled $519, an increase of $210 over the $309 recorded during the same period a year ago. The provision for loan losses increased the allowance for loan losses in response to the gradual deterioration of various seasoned loans, nonperforming loans, net charge-offs and delinquencies, coupled with concerns over the economy's deteriorating economic impact, particularly in light of the unprecedented events on and subsequent to September 11. Net charge-offs for the first quarter of 2002 were $427 compared with $232 in 2000. Annualized net charge-offs increased to 0.09% of average loans for 2002 compared to 0.05% in the same period in 2001. The increase in net charge-offs was largely the result of several credits which were identified as requiring the status of watch list and specific allocation. These credits continued to deteriorate and were identified by management as non-bankable assets, and, subsequently, charged off. Along with other financial institutions, management remains watchful of credit quality issues and believes that current issues within the portfolio are reflective of a challenging economic environment and mirror problems faced by peers throughout the financial community. Should the economic climate continue to deteriorate, borrowers may experience difficulty, and the level of nonperforming loans, charge-offs, and delinquencies could rise and require further increases in the provision. Management continues to monitor the loan portfolio and take action to limit credit exposure. Noninterest Income. The following table summarizes the Company's noninterest income: Three Months Ended March 31, ------------------------ 2002 2001 ---------- ---------- Service charges $ 591 $ 644 Merchant fee income 244 257 Trust income 180 172 Mortgage banking income 631 443 Insurance commissions and fees 544 671 Securities gains, net 243 82 Other income 570 543 ---------- ---------- $ 3,003 $ 2,812 ========== ========== Noninterest income, which consists of a wide variety of fee-based revenues viewed as traditional banking services as well as revenues generated by the Company's insurance, brokerage, trust, asset management and data processing product lines, totaled $3,003 for the three months ended March 31, 2002, as 14. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) -------------------------------------------------------------------------------- compared to $2,812 for the same time frame in 2001. Exclusive of net securities gains, core noninterest income increased $30 or 1.1%. As a percentage of total income, (net interest income plus noninterest income), core noninterest income decreased to 31.7% versus 32.6% for the first quarter of 2001. The majority of the core increase was related to a $188 improvement in mortgage banking income. Mortgage banking income includes fees generated from underwriting, originating, and servicing, in addition to gains realized from the sale of these loans. This improvement was offset by lower than anticipated insurance fees and overdraft and nsf fees. The combined categories of merchant fee income, trust income, and other income remained relatively stable with only slight quarter-over-quarter changes. Noninterest Expense. The following table summarizes the Company's noninterest expense: Three Months Ended March 31, ------------------------ 2002 2001 ---------- ---------- Salaries and employee benefits $ 3,884 $ 3,166 Occupancy expense, net 453 479 Furniture and equipment expense 390 406 Supplies and printing 157 167 Telephone 225 188 Amortization of intangible assets 101 248 Other expenses 1,706 1,476 ---------- ---------- $ 6,916 $ 6,130 ========== ========== Noninterest expense, which is comprised primarily of compensation and employee benefits, occupancy and other operating expenses, totaled $6,916 for the three months ended March 31, 2002, as compared to $6,130 for the same timeframe in 2001. This represented an increase of $786 or 12.8%. The increase in noninterest expense on a quarter-over-quarter basis was attributable, in large part, to a substantial rise in salaries and benefits as we invested in our own future through the recruitment and retention of high-quality, seasoned industry professionals to fill existing vacancies, as well as new positions associated with the start up of our Yorkville office. In addition, a higher concentration of salary expenditures is also currently being realized by our mortgage banking division related to heightened levels of production due to the favorable interest rate environment. Also contributing were increases in telephone and other expenses due to the volume of real estate appraisals and other mortgage related expenses, debit card expense, and legal fees related to nonperforming loans. These increases were partially offset by a decrease in goodwill amortization due to the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets." The combined categories of occupancy expense, furniture and equipment expense, and supplies and printing remained relatively stable with only slight quarter-over-quarter changes. 15. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) -------------------------------------------------------------------------------- Applicable Income Taxes. The following table shows the Company's income before income taxes, as well as applicable income taxes and the effective tax rate for three months ended March 31, 2002 and 2001. Three Months Ended March 31, ------------------------ 2002 2001 ---------- ---------- Income before income taxes $ 1,786 $ 2,182 Applicable income taxes 517 647 Effective tax rates 28.9% 29.7% Tax expense for the quarterly periods included benefits for tax-exempt income, tax-advantaged investments and general business tax credits offset by the effect of nondeductible expenses. The Company recorded income tax expense of $517 and $647 for the quarters ended March 31, 2002 and 2001, respectively. Effective tax rates equaled 28.9% and 29.7% respectively, for such periods. The Company's effective tax rate was lower than statutory rates because 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. In addition, the Company has reduced tax expense through various tax planning initiatives. Preferred Stock Dividends. The Company paid $64 and $65 of preferred stock dividends for the quarters ended March 31, 2002 and 2001, respectively. Interest Rate Sensitivity Management The business of the Company and the composition of its balance sheet consists 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 Banks depend, to a substantial extent, on "rate differentials," i.e., the differences between the income the Banks receive 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 Banks, 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 or decrease in market interest rates. The tables below present the Company's projected changes in net interest income for the various rate shock levels at March 31, 2002 and December 31, 2001. 16. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) -------------------------------------------------------------------------------- March 31, 2002 ----------------------------------- Net Interest Income ----------------------------------- Amount Change Change ------ ------ ------ (Dollars in Thousands) +200 bp $26,707 $ 35 0.13% +100 bp 26,712 40 0.15 Base 26,672 -- -- -100 bp 26,780 108 0.40 -200 bp 26,440 (232) (0.87) Based upon the Company's model at March 31, 2002, the effect of an immediate 200 basis point increase in interest rates would increase the Company's net interest income by 0.13% or approximately $35. The effect of an immediate 200 basis point decrease in rates would decrease the Company's net interest income by 0.87% or approximately $232. However, the Company does not anticipate market interest rates decreasing an additional 200 basis points, so these results may not be achievable. December 31, 2001 ----------------------------------- Net Interest Income ----------------------------------- Amount Change Change ------ ------ ------ (Dollars in Thousands) +200 bp $28,134 $ 851 3.12% +100 bp 27,695 412 1.51 Base 27,283 -- -- -100 bp 26,900 (383) (1.40) -200 bp 26,095 (1,188) (4.35) Based upon the Company's model at December 31, 2001, the effect of an immediate 200 basis point increase in interest rates would increase the Company's net interest income by 3.12% or approximately $851. The effect of an immediate 200 basis point decrease in rates would decrease the Company's net interest income by 4.35% or approximately $1,188. Financial Condition General. As of March 31, 2002, the Company had total assets of $741,547, gross loans of $490,144, total deposits of $615,873, and total stockholders' equity of $64,365. Total assets decreased by $6,760 or 0.9% from year-end 2001. Total gross loans decreased by $14,824 or 2.9% from year-end 2001 and reflected tighter underwriting standards, an overall softening of loan demand, and normal paydowns. Total deposits increased by $3,729 or 0.6% from year-end 2001. 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 17. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) -------------------------------------------------------------------------------- of collection and is delinquent in payment of either principal or interest beyond 90 days. Loans which 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. Under Statement of Financial Accounting Standards No. 114 and No. 118, the Company defined loans that will be individually evaluated for impairment to include commercial loans and mortgages secured by commercial properties or five-plus family residences that are in nonaccrual status or were restructured. All other smaller balance homogeneous loans are evaluated for impairment in total. The classification of a loan as impaired or nonaccrual does not necessarily indicate that the principal is uncollectible, in whole or in part. The Banks make a determination as to collectibility on a case-by-case basis. The Banks consider both the adequacy of the collateral and the other resources of the borrower in determining the steps to be taken to collect impaired or 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 impaired or 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. Management is not aware of any material loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have been excluded from classification under nonperforming assets or impaired loans. Management has identified various loans which are now current, but where some concerns exist as to the ability of the borrower to comply with present loan repayment terms. These loans are not nonperforming, but management believes a higher level of scrutiny and specific allocations of the allowance are prudent under the circumstances. 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. Potential problem credits are monitored by the independent loan review function and are submitted for review to the loan committee and audit committee members. Despite a diversified loan portfolio, the Company experienced credit quality deterioration and saw a rise in the level of nonperforming loans during the first three months of the year. A weakening economy, among other factors, resulted in the level of nonperforming assets increasing to $11,038 versus the $10,761 that existed as of December 31, 2001. The level of nonperforming assets to total end of period assets was 1.49% at March 31, 2002, as compared to 1.44% at December 31, 2001. 18. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) -------------------------------------------------------------------------------- The following table summarizes nonperforming assets and loans past due 90 days or more and still accruing for the previous five quarters.
2002 2001 ---------- ------------------------------------------------- Mar 31, Dec 31, Sep 30, June 30, Mar 31, ---------- ---------- ---------- ---------- ---------- Nonaccrual and impaired loans not accruing $ 7,026 $ 7,259 $ 8,753 $ 8,237 $ 8,448 Impaired and other loans 90 days past due and still accruing interest 1,768 1,616 2,576 2,683 1,134 ---------- ---------- ---------- ---------- ---------- Total nonperforming loans 8,794 8,875 11,329 10,920 9,582 Other real estate owned 2,244 1,886 534 598 562 ---------- ---------- ---------- ---------- ---------- Total nonperforming assets $ 11,038 $ 10,761 $ 11,863 $ 11,518 $ 10,144 ========== ========== ========== ========== ========== Nonperforming loans to total end of period loans 1.79% 1.76% 2.24% 2.18% 1.91% Nonperforming assets to total end of period loans 2.25 2.13 2.34 2.30 2.02 Nonperforming assets to total end of period assets 1.49 1.44 1.56 1.55 1.35
Allowance for Loan Losses. At March 31, 2002, the allowance for loan losses totaled $6,387 or 1.30% of total loans as compared to $6,295 or 1.25% of total loans at December 31, 2001. In the fourth quarter of 2001, the Company increased the allowance by $2,890 due to the deterioration in overall credit quality and the impact of various identified credits. At March 31, 2002, there has been no significant change in the status of the various identified credits, but as indicated previously, overall non-performing assets have increased and net charge-offs have increased on a quarter-to-quarter comparison. 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 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 of each of the subsidiary banks meets to review the adequacy of the allowance for loan losses. Commercial credits are graded by the loan officers and the Independent Loan Review function validates the officers' grades. In the event that the Independent Loan 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. The analysis of the allowance for loan losses is comprised of three components: specific credit allocation, general portfolio allocation, and subjective determined allocation. The specific allocation includes a detailed review of the credit in accordance with SFAS 114 and 118 and an allocation is made based on 19. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) -------------------------------------------------------------------------------- this analysis. The general portfolio allocation consists of an assigned reserve percentage based on loans by major category. The subjective portion is determined based on the past five years of loan history and the Company's evaluation of qualitative factors including current economic conditions and trends in the portfolio, including delinquencies and impairments, as well as changes in the composition of the portfolio. Commitments to extend credit and standby letters of credit are reviewed to determine whether credit risk exists. 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 did not significantly change since year-end. The methodology used to determine the adequacy of the allowance for loan losses is consistent with prior years, and there were no reallocations. Along with other financial institutions, management remains watchful of credit quality issues and believes that current issues within the portfolio are reflective of a challenging economic environment and mirror problems faced by peers throughout the financial community, especially in light of the events of September 11, 2001. Should the economic climate continue to deteriorate, borrowers may experience difficulty, and the level of nonperforming loans, charge-offs, and delinquencies could rise and require further increases in the provision. Management continues to monitor the loan portfolio and take appropriate action to proactively limit credit exposure. 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 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 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 provided by operating and investing activities, offset by those used in financing activities, resulted in a net increase in cash and cash equivalents of $485 from December 31, 2001 to March 31, 2002. During the first three months of 2002, the Company experienced a net cash inflow of $4,859 from its operating activities primarily due to proceeds from sales of loans and net income and $3,327 net cash inflow in investing activities attributed to proceeds from maturities and paydowns of loans and securities. 20. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) -------------------------------------------------------------------------------- Financing activities, on the other hand, provided net cash outflows of $7,701 largely due to a decrease in Federal Home Bank advances partially offset by an increase in deposits. Capital Resources The Banks are 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 10.69% and 12.50%, respectively, at March 31, 2002. The Company is currently, and expects to continue to be, in compliance with these guidelines. The Board of Governors of the Federal Reserve System ("FRB") has announced a policy known as the "source of strength doctrine" that requires a bank holding company to serve as a source of financial and managerial strength for its subsidiary banks. The FRB has interpreted this requirement to require that a bank holding company, such as the Company, stand ready to use available resources to provide adequate capital funds to its subsidiary banks during periods of financial stress or adversity. The FRB has stated that it would generally view a failure to assist a troubled or failing subsidiary bank in these circumstances as an unsound or unsafe banking practice or a violation of the FRB's Regulation Y or both, justifying a cease and desist order or other enforcement action, particularly if appropriate resources are available to the bank holding company on a reasonable basis. The following table sets forth an analysis of the Company's capital ratios:
December 31, Minimum Well March 31, ---------------------- Capital Capitalized 2002 2001 2000 Ratios Ratios -------- -------- -------- -------- -------- Tier 1 risk-based capital $ 56,908 $ 55,911 $ 50,835 Tier 2 risk-based capital 7,218 7,126 7,245 Total capital 64,126 63,037 59,080 Risk-weighted assets 532,175 540,626 537,549 Capital ratios Tier 1 risk-based capital 10.69% 10.34% 9.64% 4.00% 6.00% Tier 2 risk-based capital 12.05 11.66 10.99 8.00 10.00 Leverage ratio 7.74 7.54 6.90 4.00 5.00
As of March 31, 2002, the Tier 2 risk-based capital was comprised of $6,387 in allowance for loan losses and $831 of Mandatory Redeemable Series B Preferred Stock. The Series A Preferred Stock is convertible into common stock, subject to certain adjustments intended to offset the amount of losses incurred by the Company upon the post-closing sale of certain securities acquired in conjunction with the 1996 acquisition of Prairie Bancorp, Inc. Impact of Inflation, Changing Prices, and Monetary Policies The financial statements and related financial data concerning the Company have been prepared in accordance with accounting principles generally accepted in the United States of America which require the measurement of financial position and 21. UNIONBANCORP, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION (In Thousands, Except Share Data) -------------------------------------------------------------------------------- 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 FRB. 22. PART II - OTHER INFORMATION Item 1. Legal Proceedings There are no material pending legal proceedings to which the Company or its subsidiaries is a party other than ordinary routine litigation incidental to their respective businesses. Item 2. Changes in Securities None. Item 3. Default Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K Exhibits: None. Reports on Form 8-K: None. 23. 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 on May 14, 2002. UNIONBANCORP, INC. By: /s/ CHARLES J. GRAKO -------------------------------------- Charles J. Grako President and Principal Executive Officer By: /s/ KURT R. STEVENSON -------------------------------------- Kurt R. Stevenson Vice President and Principal Financial and Accounting Officer 24.