10QSB 1 d10qsb.txt FORM 10-QSB SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 _______________ FORM 10-QSB (Mark One) X QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE --- ACT OF 1934 For the quarterly period ended March 31, 2002 -------------- ___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ COMMISSION FILE NUMBER 1-5735 UNION FINANCIAL BANCSHARES, INC. ------------------------------- (Exact name of small business issuer as specified in its charter) Delaware 57-1001177 ------------------------------------------------------------------------------------------ (Jurisdiction of Incorporation) (I.R.S. Employer Identification No.) 203 West Main Street, Union, South Carolina 29379 ------------------------------------------- ---------- (Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (864) 429-1864 The Corporation had issued and outstanding 1,953,771 shares, $0.01 par value, common stock as of April 29, 2002. UNION FINANCIAL BANCSHARES, INC. INDEX
Part I. Financial Information Page --------------------- ---- Item 1. Consolidated Financial Statements (unaudited) Consolidated Balance Sheets as of March 31, 2002 and September 30, 2001 3 Consolidated Statements of Income for the three and six months ended March 31, 2002 and 2001 4 Consolidated Statements of Cash Flows for the six months ended March 31, 2002 and 2001 5 Consolidated Statements of Shareholders' Equity for the six months ended March 31, 2002 and 2001 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Part II. Other Information ----------------- Item 1. Legal Proceedings 18 Item 2. Changes in Securities 18 Item 3. Defaults Upon Senior Securities 18 Item 4. Submission of Matters to a Vote of Security Holders 18 Item 5. Other Information 19 Item 6. Exhibits and Reports on Form 8-K 19 Signatures 20
Item 1. Financial Statements UNION FINANCIAL BANCSHARES, INC. CONSOLIDATED BALANCE SHEETS March 31, 2002 (unaudited) and September 30, 2001
March 31, September 30, ASSETS 2002 2001 --------------------------------- (DOLLARS IN THOUSANDS) Cash $ 1,680 $ 914 Short term interest-bearing deposits 5,802 5,694 -------- -------- Total cash and cash equivalents 7,482 6,608 -------- -------- Investment and mortgage-backed securities: Held to maturity 18,326 11,315 Available for sale 89,103 77,802 -------- -------- Total investment and mortgage-backed securities 107,429 89,117 Loans , net 165,236 158,063 Office properties and equipment, net 6,884 7,204 Federal Home Loan Bank Stock, at cost 2,900 2,625 Accrued interest receivable 1,769 1,629 Mortgage servicing rights 654 842 Intangible assets 5,971 6,299 Cash surrender value of life insurance 4,595 4,465 Other assets 1,249 900 -------- -------- TOTAL ASSETS $304,169 $277,752 ======== ======== LIABILITIES Deposit accounts $199,386 $194,079 Advances from the Federal Home Loan Bank and other borrowings 54,500 46,007 Securities sold under agreements to repurchase 17,000 11,000 Corporate obligated floating rate capital securities 8,000 -- Accrued interest on deposits 411 404 Advances from borrowers for taxes and insurance 141 374 Other liabilities 67 1,512 -------- -------- TOTAL LIABILITIES 279,505 253,376 -------- -------- SHAREHOLDERS' EQUITY Serial preferred stock, no par value, authorized - 500,000 shares, issued and outstanding - None -- -- Common stock - $0.01 par value, authorized - 2,500,000 shares, issued and outstanding - 1,953,771 shares at 3/31/02 and 1,924,478 at 9/30/01 20 20 Additional paid-in capital 11,519 11,321 Accumulated other comprehensive loss (605) (182) Retained earnings, substantially restricted 13,730 13,217 -------- -------- TOTAL SHAREHOLDERS' EQUITY 24,664 24,376 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $304,169 $277,752 ======== ========
See notes to consolidated financial statements. 3 UNION FINANCIAL BANCSHARES, INC. CONSOLIDATED STATEMENTS OF INCOME Three and Six Months Ended March 31, 2002 (unaudited) and 2001 (unaudited)
Three Months Ended Six Months Ended March 31, March 31, March 31, March 31, 2002 2001 2002 2001 ------------------------------------------------------ (DOLLARS IN THOUSANDS) (DOLLARS IN THOUSANDS) Interest Income: Loans $ 3,157 $ 3,629 $ 6,325 $ 7,457 Deposits and federal funds sold 5 78 11 159 Mortgage-backed securities 1,082 651 2,031 1,341 Interest and dividends on investment securities 481 338 928 681 ---------- ---------- ---------- ---------- Total Interest Income 4,725 4,696 9,295 9,638 ---------- ---------- ---------- ---------- Interest Expense: Deposit accounts 1,466 2,292 3,242 4,546 Trust preferred corporate obligation 116 0 133 0 Advances from the FHLB and other borrowings 857 667 1,636 1,526 ---------- ---------- ---------- ---------- Total Interest Expense 2,439 2,959 5,011 6,072 ---------- ---------- ---------- ---------- Net Interest Income 2,286 1,737 4,284 3,566 Provision for loan losses 250 11 340 35 ---------- ---------- ---------- ---------- Net Interest Income After Provision for Loan Losses 2,036 1,726 3,944 3,531 ---------- ---------- ---------- ---------- Non Interest Income: Fees for financial services 368 188 700 449 Loan servicing fees (costs) (20) (10) (89) 16 Net loss on sale of investments (42) 0 (41) 3 Net gains on sale of loans 0 84 0 193 ---------- ---------- ---------- ---------- Total Non Interest Income 306 262 570 661 ---------- ---------- ---------- ---------- Non Interest Expense: Compensation and employee benefits 732 728 1,400 1,465 Occupancy and equipment 377 278 769 611 Deposit insurance premiums 8 9 17 16 Professional services 89 66 157 85 Advertising/Public relations 24 19 88 93 Real estate operations 25 0 32 15 Deposit premium intangible 83 83 165 165 Goodwill amortization 82 82 163 163 Other 287 218 523 440 ---------- ---------- ---------- ---------- Total Non Interest Expense 1,707 1,483 3,314 3,053 ---------- ---------- ---------- ---------- Income Before Income Taxes 635 505 1,200 1,139 Income tax expense 163 178 300 404 ---------- ---------- ---------- ---------- Net Income $ 472 $ 327 $ 900 $ 735 ========== ========== ========== ========== Basic Net Income Per Common Share $ 0.24 $ 0.17 $ 0.46 $ 0.38 ========== ========== ========== ========== Diluted Net Income Per Common Share $ 0.23 $ 0.17 $ 0.45 $ 0.37 ========== ========== ========== ========== Weighted Average Number of Common Shares Outstanding Basic 1,951,990 1,916,765 1,939,310 1,915,044 Diluted 2,028,913 1,965,848 2,016,223 1,962,650
See notes to consolidated financial statements. 4 UNION FINANCIAL BANCSHARES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended March 31, 2002 (unaudited) and 2001 (unaudited)
Six Months Ended March 31, March 31, 2002 2001 ------------------------- (IN THOUSANDS) OPERATING ACTIVITIES: Net income $ 900 $ 735 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 340 35 Amortization of intangibles 328 414 Depreciation expense 450 392 Recognition of deferred income, net of costs (45) (52) Deferral of fee income, net of costs 153 64 Loans originated for sale 0 17,068 Sale of loans 0 (17,068) Gain on sale of loans 0 190 Changes in operating assets and liabilities: (Increase) in accrued interest receivable (140) (51) (Increase) in other assets (479) (925) Increase (decrease) in other liabilities (1,678) 726 Increase in accrued interest payable 7 63 -------- ------- Net cash provided by (used by) operating activities (164) 1,591 -------- ------- INVESTING ACTIVITIES: Purchase of investment and mortgage-backed securities: Held to maturity (8,000) 0 Available for sale (32,532) (1,133) Proceeds from sale of investment and mortgage- backed securities 10,909 1,735 Proceeds from maturity of investment and mortgage- backed securities: Available for sale 5,122 950 Principal repayments on mortgage-backed securities: Held to maturity 532 321 Available for sale 5,234 776 Net (increase) decrease in loans (7,621) 2,258 Net (increase) decrease in mortgage servicing rights 188 (376) Purchase of FHLB stock (275) 0 Redemption of FHLB stock 0 0 Purchase of office properties and equipment (130) (867) -------- ------- Net cash provided by (used by) investing activities ($26,573) $ 3,664 -------- ------- FINANCING ACTIVITIES: Proceeds from the dividend reinvestment plan 56 0 Dividends paid in cash ($0.20 per share -2002 and $0.20 per share - 2001) (387) (323) Proceeds from the exercise of stock options 142 0 Proceeds from term borrowings 14,493 (1,319) Proceeds from issuance of trust preferred corporate obligations 8,000 0 Increase in deposit accounts 5,307 4,966 -------- ------- Net cash provided by financing activities 27,611 3,324 -------- ------- NET DECREASE\INCREASE IN CASH AND CASH EQUIVALENTS 874 8,579 CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD 6,608 4,613 -------- ------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 7,482 $13,192 ======== ======= SUPPLEMENTAL DISCLOSURES: Cash paid for: Income taxes $ 1,566 $ 718 Interest 5,004 6,009 Non-cash transactions: Loans foreclosed $ 185 71
See notes to consolidated financial statements. 5 UNION FINANCIAL BANCSHARES, INC. CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY SIX MONTHS ENDED MARCH 31, 2002 AND 2001 (UNAUDITED)
Retained Accumulated Additional Earnings Other Total Common Stock Paid-in Substantially Comprehensive Shareholders' Shares Amount Capital Restricted Income Equity ------ ------ ------- ---------- ------ ------ (In Thousands, Except Share Data) BALANCE AT SEPTEMBER 30, 2000 1,911,005 $20 $11,314 $12,640 ($2,050) $21,924 Net income 735 735 Other comprehensive income Unrealized gains on securities: Equity reclassification 113 113 Unrealized holding gains arising during period 591 591 -------- ------- Comprehensive income 1,439 Equity reclassification (113) (113) Dividend reinvestment plan contributions 6,890 59 59 Cash dividend ($.20 per share) (382) (382) ---------------------------------------------------------------------------------- BALANCE AT MARCH 31, 2001 1,917,895 $20 $11,260 $12,993 ($1,346) $22,927 ================================================================================== BALANCE AT SEPTEMBER 30, 2001 1,924,478 $20 $11,321 $13,217 ($182) $24,376 Net income 900 900 Other comprehensive income Unrealized losses on securities: Unrealized holding losses arising during period (423) (423) -------- ------- Comprehensive income 477 Options exercised 23,605 142 142 Dividend reinvestment plan contributions 5,688 56 56 Cash dividend ($.20 per share) (387) (387) ---------------------------------------------------------------------------------- BALANCE AT MARCH 31, 2002 1,953,771 $20 $11,519 $13,730 ($605) $24,664 ==================================================================================
6 UNION FINANCIAL BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. Presentation of Consolidated Financial Statements ------------------------------------------------- The accompanying unaudited consolidated financial statements of Union Financial Bancshares, Inc. (the "Corporation") were prepared in accordance with instructions for Form 10-QSB and, therefore, do not include all disclosures necessary for a complete presentation of consolidated financial condition, results of operations, and cash flows in conformity with generally accepted accounting principles. However, all adjustments which are, in the opinion of management, necessary for the fair presentation of the interim consolidated financial statements have been included. All such adjustments are of a normal and recurring nature. The consolidated financial statements include the Corporation's wholly owned subsidiaries, Provident Community Bank (the "Bank"), a federally charted stock savings bank and Union Financial Statutory Trust I (the "Trust"), a statutory trust created under the laws of the state of Connecticut. The results of operations for the six months ended March 31, 2002 are not necessarily indicative of the results which may be expected for the entire fiscal year. The consolidated balance sheet as of September 30, 2001 has been derived from the Corporation's audited financial statements presented in the annual report to shareholders. Certain amounts in the prior year's financial statements have been reclassified to conform with current year classifications. Recently Issued Accounting Standards In July 2001, the SEC issued Staff Accounting Bulletin (SAB) No. 102 - Selected Loan Loss Allowance Methodology and Documentation Issues. This ----------------------------------------------------------------- staff accounting bulletin clearly defines the required development, documentation, and application of a systematic methodology for determining allowances for loan and lease losses in accordance with generally accepted accounting principles. The Corporation believes that it is in compliance with SAB 102. In September 2000, the Financial Accounting Standards Board (FASB) issued SFAS No. 140, Accounting for Transfers and Servicing of ----------------------------------------- Financial Assets and Extinguishment of Liabilities. This SFAS is a -------------------------------------------------- replacement of SFAS No. 125. The statement was effective for transfers and servicing of financial assets and extinguishment of debt occurring after March 31, 2001. The statement was effective for recognition and reclassification of collateral and for disclosures relating to securitizations for fiscal years ending after December 15, 2000. The adoption of the standard did not have a material impact on the Corporation. In June 2001, the FASB issued SFAS No. 141- Business Combinations. --------------------- This FASB addresses accounting and reporting for all business combinations and defines the purchase method as 7 the only acceptable method. This statement is effective for all business combinations initiated after June 30, 2001. In June 2001, the FASB issued SFAS No. 142 - Goodwill and Other ------------------ Intangible Assets. This SFAS addresses how goodwill and other ----------------- intangible assets should be accounted for at their acquisition (except for those acquired in a business combination) and after they have been initially recognized in the financial statements. The statement is effective for all fiscal years beginning after December 15, 2001. The Corporation is in the process of determining the effect of this SFAS on the financial position of the Corporation and plans to adopt it on October 1, 2002. Additional accounting standards that have been issued or proposed by the FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. 2. Income Per Share ---------------- Basic income per share amounts for the six months ended March 31, 2002 and 2001 were computed based on the weighted average number of common shares outstanding during the period. Diluted income per share adjusts for the dilutive effect of outstanding common stock options during the periods. 3. Assets Pledged -------------- Approximately $32,410,000 and $28,411,000 of debt securities at March 31, 2002 and September 30, 2001, respectively, were pledged by the Bank as collateral to secure deposits of the State of South Carolina, Laurens County and certain other liabilities. The Bank pledges as collateral for Federal Home Loan Bank advances the Bank's Federal Home Loan Bank stock and has entered into a blanket collateral agreement with the Federal Home Loan Bank whereby the Bank maintains, free of other encumbrances, qualifying mortgages (as defined) with unpaid principal balances equal to, when discounted at 75% of the unpaid principal balances, 100% of total advances. 4. Contingencies and Loan Commitments ---------------------------------- The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These instruments expose the Bank to credit risk in excess of the amount recognized on the balance sheet. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Total credit exposure at March 31, 2002 related to these items is summarized below: 8 Loan Commitments: Contract Amount ---------------- --------------- Approved loan commitments $ 1,167,000 Unadvanced portions of loans and credit lines 16,669,000 ------------ Total loan commitments $ 17,836,000 ============ Loan commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of credit is based on management's credit evaluation of the counter party. Collateral held is primarily residential and commercial property. Interest rates on loan commitments are a combination of fixed and variable. Commitments outstanding at March 31, 2002 consist of fixed and adjustable rate loans of approximately $17,836,000 at rates ranging from 6.5% to 7.5%. Commitments to originate loans generally expire within 30 to 60 days. Commitments to fund credit lines (principally variable rate, consumer lines secured by real estate and overdraft protection) totaled approximately $36,490,000 at March 31, 2002. Of these lines, the outstanding loan balances totaled approximately $19,821,000. The Bank also has commitments to fund warehouse lines of credit for various mortgage banking companies totaling $4,500,000, which had an outstanding balance at March 31, 2002 of approximately $85,000. 5. Corporation Obligated Floating Rate Capital Securities ------------------------------------------------------ On November 14, 2001, the Corporation sponsored the creation of the Trust. The Corporation is the owner of all of the common securities of the Trust. On December 18, 2001, the Trust issued $8.0 million in the form of floating rate capital securities through a pooled trust preferred securities offering. The proceeds from this issuance, along with the Corporation's $248,000 capital contribution for the Trust's common securities, were used to acquire $8.2 million aggregate principal amount of the Corporation's floating rate junior subordinated deferrable interest debentures due December 18, 2031 (the "Debentures"), which constitute the sole asset of the Trust. The interest rate on the Debentures and the capital securities is variable and adjustable quarterly at 3.60% over the three-month LIBOR, with an initial rate of 5.60%. A rate cap of 12.50% is effective through December 18, 2006. The Corporation has, through the Trust agreement establishing the Trust, the Guarantee Agreement, the notes and the related Indenture, taken together, fully irrevocably and unconditionally guaranteed all of the Trust's obligations under the capital securities. A summary of the Trust securities issued and outstanding follows: 9
Amount Outstanding at March 31, ---------------- Distribution Prepayment Payment Name 2002 2001 Rate Option Date Maturity Frequency --------------------------- --------- ---- -------- ---------------- ------------ -------------- Union Financial Statutory Trust I $8,000,000 -- 5.60% December 18, 2006 December 18, 2031 Quarterly
The stated maturity of the Debentures is December 18, 2031. In addition, the Debentures are subject to redemption at par at the option of the Corporation, subject to prior regulatory approval, in whole or in part on any interest payment date after December 18, 2006. The Debentures are also subject to redemption prior to December 18, 2006 at 107.5% of par after the occurrence of certain events that would either have a negative tax effect on the Trust or the Corporation or would result in the Trust being treated as an investment company that is required to be registered under the Investment Company Act of 1940. Upon repayment of the Debentures at their stated maturity or following their redemption, the Trust will use the proceeds of such repayment to redeem an equivalent amount of outstanding trust preferred securities and trust common securities. The Corporation has the right, at one or more times, to defer interest payments on the Debentures for up to twenty consecutive quarterly periods. All deferrals will end on an interest payment date and will not extend beyond December 18, 2031, the stated maturity date of the Debentures. If the Corporation defers interest payments on the Debentures, the Trust will also defer distributions on the capital securities. During any deferral period, each installment of interest that would otherwise have been due and payable will bear additional interest (to the extent payment of such interest would be legally enforceable) at the applicable distribution rate, compounded quarterly. 10 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward Looking Statements -------------------------- Management's discussion and analysis of financial condition and results of operations and other portions of this Form 10-Q contain certain "forward-looking statements" concerning the future operations of the Corporation and the Bank. Management desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and is including this statement for the express purpose of availing the Corporation of the protections of such safe harbor with respect to all "forward-looking statements" contained in our 10-Q to describe future plans and strategies. Management's ability to predict results or the effect of future plans or strategies is inherently uncertain. Factors which could effect actual results include interest rate trends, the general economic climate in the Corporation's and the Bank's market area and the country as a whole, the ability of the Corporation and the Bank to control costs and expenses, competitive products and pricing, loan delinquency rates, and changes in federal and state regulation. These factors should be considered in evaluating the "forward-looking statements," and undue reliance should not be placed on such statements. Financial Condition ------------------- On November 14, 2001, the Corporation established the Trust as a business trust for the purpose of issuing trust preferred securities in a private placement conducted as part of a pooled offering sponsored by First Tennessee Capital Markets and Keefe Bruyette & Woods, Inc. On December 18, 2001, the Trust issued $8.0 million in trust preferred securities in the form of floating rate capital securities and issued approximately $248,000 of trust common securities to Union Financial. The Trust used the proceeds of these issuances to purchase $8.2 million of Union Financial's floating rate junior subordinated deferrable interest debentures due December 18, 2031 (the "Debentures"). The interest rate on the Debentures and the trust preferred securities is variable and adjustable quarterly at 3.60% over three-month LIBOR, with an initial rate of 5.60%. A rate cap of 12.50% is effective through December 18, 2006. The Debentures are the sole assets of the Trust and are subordinate to all of Union Financial's existing and future obligations for borrowed money, its obligations under letters of credit and certain derivative contracts, and any guarantees by Union Financial of any such obligations. The trust preferred securities generally rank equal to the trust common securities in priority of payment, but will rank prior to the trust common securities if and so long as Union Financial fails to make principal or interest payments on the Debentures. Concurrently with the issuance of the Debentures and the trust preferred and common securities, Union Financial issued a guarantee related to the trust securities for the benefit of the holders. The Debentures, the common securities issued by the Trust, and the related income effects are eliminated within Union Financial's financial statements. Union Financial's obligations under the Debentures, the related indenture, the trust agreement relating to the trust securities, and 11 the guarantee constitute a full and unconditional guarantee by Union Financial of the obligations of the Trust under the trust preferred securities. The stated maturity of the Debentures is December 18, 2031. In addition, the Debentures are subject to redemption at par at the option of Union Financial, subject to prior regulatory approval, in whole or in part on any interest payment date after December 18, 2006. The Debentures are also subject to redemption prior to December 18, 2006 at 107.5% of par after the occurrence of certain events that would either have a negative tax effect on the Trust or Union Financial or would result in the Trust being treated as an investment company that is required to be registered under the Investment Company Act of 1940. Upon repayment of the Debentures at their stated maturity or following their redemption, the Trust will use the proceeds of such repayment to redeem an equivalent amount of outstanding trust preferred securities and trust common securities. Union Financial intends to use the proceeds of the offering for general corporate purposes, to fund dividends to shareholders and for contributions to the capital of the Bank. Total assets of the Corporation increased $26,417,000 or 9.51%, to $304,169,000 at March 31, 2002 from $277,752,000 at September 30, 2001. Investments and mortgage-backed securities increased approximately $18,312,000, or 20.55%, from September 30, 2001 to March 31, 2002 due to the purchases of mortgage backed securities and municipal securities with the capital received through the trust preferred capital offering and borrowings. Loans increased $7,173,000, or 4.54%, to $165,236,000 at March 31, 2002. The Corporation continues to focus on consumer and commercial lending with reduced emphasis on residential mortgage loans. Consumer and commercial loans outstanding during this period increased $14,934,000 or 62.60% while outstanding residential mortgage loans decreased $10,492,000 or 8.49%. Deposits increased $5,307,000 or 2.73% to $199,386,000 at March 31, 2002. The increase was due primarily to growth in certificates of deposits as a result of ongoing promotions for longer term products. Borrowings from the Federal Home Loan Bank (FHLB) increased $8,493,000, or 18.46%, to $54,500,000 at March 31, 2002 from $46,007,000 at September 30, 2001. Securities sold under agreements to repurchase were $17,000,000 at March 31, 2002 compared to $11,000,000 at September 30, 2001. During this period, securities sold under agreement to repurchase provided a lower-cost funding alternative to Federal Home Loan Bank advances. The increases in borrowings from FHLB and securities sold under agreement to repurchase were utilized to fund additional growth for the Corporation. Other liabilities decreased $1,445,000, or 95.6%, to $67,000 at March 31, 2002 from $1,512,000 at September 30, 2001 due to the payment of state and federal income taxes. Shareholders' equity increased $288,000 or 1.18% to $24,664,000 at March 31, 2002 from $24,376,000 at September 30, 2001 due to net income year to date, offset by an increase in unrealized losses in securities available for sale and by the payment of $0.20 per share quarterly dividends. 12 Liquidity --------- Liquidity is the ability to meet demand for loan disbursements, deposit withdrawals, repayment of debt, payment of interest on deposits and other operating expenses. The primary sources of liquidity are savings deposits, loan sales and repayments, borrowings, maturity of securities and interest payments. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit outflows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. The primary investing activities of the Corporation are the origination of residential one-to-four family mortgage loans and commercial and consumer loans, and the purchase of investment and mortgage-backed securities. These activities are funded primarily by principal and interest payments on loans and investment securities, deposit growth, securities sold under agreements to repurchase and the utilization of FHLB advances. During the six months ended March 31, 2002, the Corporation's loan originations totaled $53.9 million. At March 31, 2002, the Corporation's investment in investment and mortgage-backed securities totaled $107.4 million. Additionally, outstanding loan commitments (including commitments to fund credit lines) totaled $17.8 million at March 31, 2002. Management of the Corporation anticipates that it will have sufficient funds available to meet its current loan commitments. During the six months ended March 31, 2002, total deposits increased $5.3 million. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by the Corporation and its local competitors and other factors. The Corporation closely monitors its liquidity position on a daily basis. Certificates of deposit, which are scheduled to mature in one year or less from March 31, 2002, totaled $73.9 million. The Corporation relies primarily on competitive rates, customer service, and long-standing relationships with customers to retain deposits. From time to time, the Corporation will also offer competitive special products to its customers to increase retention and to attract new deposits. Based upon the Corporation's experience with deposit retention and current retention strategies, management believes that, although it is not possible to predict future terms and conditions upon renewal, a significant portion of such deposits will remain with the Corporation. If the Corporation requires funds beyond its ability to generate them internally, additional sources of funds are available through FHLB advances and securities sold under agreements to repurchase. At March 31, 2002, the Corporation had $54.5 million of FHLB borrowings and $17.0 million of securities sold under agreements to repurchase. Capital Resources ----------------- The capital requirement of the Bank consists of three components: (1) tangible capital, (2) core capital and (3) risk based capital. Tangible capital must equal or exceed 1.5% of 13 adjusted total assets. Core capital must be a minimum of 4% of adjusted total assets and risk based capital must be a minimum of 8% of risk weighted assets. As of March 31, 2002, the Bank's capital position, as calculated under regulatory guidelines, exceeds these minimum requirements as follows (dollars in thousands):
Requirement Actual Excess ------------------------------------------------------------------------------------------------------ Tangible capital $ 4,539 $24,224 $19,685 Tangible capital to adjusted total assets 1.50% 8.01% 6.51% Core capital $12,104 $24,224 $12,120 Core capital to adjusted total assets 4.00% 8.01% 4.01% Risk based capital $12,871 $25,613 $12,742 Risk based capital to risk weighted assets 8.00% 15.92% 7.92%
During the quarter ending December 31, 2001, the Corporation contributed $5 million to the capital of the Bank from the proceeds of the trust preferred capital securities completed on December 18, 2001. The reported capital requirements are based on information reported in the OTS March 31, 2002 quarterly thrift financial report. Results of operations for the six months ended March 31, 2002 and 2001 ---------------------------------------------------------------------- General ------- Net income increased $165,000, or 22.45%, to $900,000 for the six months ended March 31, 2002 as compared to the same period in 2001. An increase in net interest income was partially offset by an increase in the provision for loan losses, increases in non interest expense and reductions in non interest income. Non interest income decreased due to reduced mortgage loan service fees and lower gain on sale of mortgage loans as a result of the Corporation's phase out of its wholesale mortgage operation during the first quarter of fiscal year 2001. Interest Income --------------- Interest income decreased $343,000, or 3.56%, for the six months ended March 31, 2002 as compared to the same period in 2001. Interest income on loans decreased by 15.18%, or $1,132,000, to $6,325,000 for the six months ended March 31, 2002 from $7,457,000 for the six months ended March 31, 2001. The reduction in interest income on loans from the previous year was due primarily to declining interest rates along with higher net loan growth in prime-based commercial loans. Interest and dividends on investment and mortgage-backed securities increased $937,000, or 46.34%, for the six months ended March 31, 2002 to $2,959,000 from 14 $2,022,000 during the same period in 2001. The increase was due primarily to increased investments in mortgage-backed securities and municipal securities. Interest Expense ---------------- Interest expense decreased $1,061,000, or 17.47%, for the six months ended March 31, 2002 as compared to the six months ended March 31, 2001, due primarily to lower deposit rates from a declining interest rate environment. Interest expense on deposit accounts decreased $1,304,000, or 28.68%, to $3,242,000 for the six months ended March 31, 2002 from $4,546,000 during the same period in 2001. Interest expense on borrowings increased $110,000, or 7.21%, for the six months ended March 31, 2002 as compared to the same period in the previous year due to a higher level of borrowings that was utilized to fund growth, offset by lower interest rates during the period. The Corporation has also extended borrowing terms during this period to improve interest rate risk exposure. The Corporation also recorded $133,000 for the six months ended March 31, 2002 for interest expense on the trust preferred corporate obligation that was issued on December 18, 2001. Provision for Loan Loss ----------------------- During the six months ended March 31, 2002, the provision for loan losses was $340,000 as compared to $35,000 for the same period in the previous year. The increase in the provision reflects the implementation of a risk weighted loan loss reserve methodology that is intended to more closely track the level of risk of different types of loans. During this same period, non-accrual loans increased $60,000, or 7.55%, from $795,000 at September 30, 2001 to $855,000 at March 31, 2002. The increased provision also reflects the Corporation's continued movement from longer term, fixed rate residential mortgage loans to shorter term, floating rate consumer and commercial loans. Consumer and commercial loans carry higher risk weighted rates in the reserve calculation as compared to residential mortgage loans. Management believes the Bank's loan loss allowance is adequate to absorb future loan losses inherent in the portfolio. The Bank's loan loss allowance at March 31, 2002 was approximately .83% of the Bank's outstanding loan portfolio and 162.46% of non-performing loans compared to .78% of the Bank's outstanding loan portfolio and 69.75% of non-performing loans at March 31, 2001. The provision for loan loss calculation includes a segmentation of loan categories subdivided by residential mortgage, commercial and consumer loans. Each category is rated for all loans including performing groups. The weights assigned to each performing group is developed from previous loan loss experience and as the loss experience changes, the category weight is adjusted accordingly. In addition, as the loan categories increase and decrease in balance, the provision for loan loss calculation will adjust accordingly. 15 The following table sets forth information with respect to the Bank's non- performing assets at the dates indicated (dollars in thousands): March 31, 2002 September 30, 2001 -------------- ------------------ Non-accruing loans which are contractually past due 90 days or more: Real Estate: Residential $ 395 $ 626 Commercial 104 160 Consumer 356 9 ------- ------- Total $ 855 $ 795 ======= ======= Percentage of loans receivable, net 0.52% 0.50% ======= ======= Percentage of allowance for loan losses to total loans receivable, net 0.83% 0.67% ======= ======= Allowance for loan losses $ 1,389 $ 1,080 ======= ======= Real estate acquired through foreclosure and repossessed assets, net of allowances $ 185 $ 77 ======= ======= Non-accrual loans increased $60,000 to $855,000 for the period ending March 31, 2002 from $795,000 at September 30, 2001. The increase was due primarily to the increase in consumer loan non-accruals as a result of higher unemployment from plant layoffs and closings in the surrounding communities. The well collateralized loans are supported by mortgages, equipment, and automobiles that should reduce the risk of loss for the Corporation. Non Interest Income and Expense -------------------------------- Total non interest income decreased $91,000, or 13.77%, to $570,000 for the six months ended March 31, 2002 from $661,000 for the same period in the previous year. Fees from financial services increased $251,000, or 55.90%, to $700,000 for the six months ended March 31, 2002 from $449,000 for the same period in the previous year. The increase was due primarily to the development of new fee income programs that were implemented during the first quarter of the 2002 fiscal year. Loan servicing fee costs for the six months ended March 31, 2002 were $89,000 compared to loan service fee income of $16,000 for the six months ended March 31, 2001. The decrease in loan servicing fee income was due to higher premium mortgage servicing rights amortization as a result of increased loan refinancing activity. Gain -16- on sale of loans was $0 for the six months ended March 31, 2002 compared to $193,000 for the same period in the previous year. The Corporation phased out its wholesale mortgage operation during the first quarter of fiscal year 2001 and no longer actively sells loans into the secondary market. Loss on sale of investments was $41,000 for the six months ended March 31, 2002 compared to a gain on sale of investments of $3,000 for the same period in the previous year. The loss on sale of investments for the current year was the result of the sale of investments with higher interest sensitivity and therefore the sale will improve interest rate exposure for the Corporation. For the six months ended March 31, 2002, total non interest expense increased $261,000, or 8.55%, to $3,314,000 from $3,053,000 for the same period in 2001. Compensation and employee benefits decreased $65,000, or 4.44%, to $1,400,000 for the six month period ended March 31, 2002 from $1,465,000 for the same period in 2001 due primarily to staff reductions resulting from the phase out of the wholesale mortgage operation that occurred during the first quarter of the previous fiscal year. Occupancy and equipment expense increased $158,000, or 25.86%, to $769,000 for the six months ended March 31, 2002 from $611,000 for the same period in 2001 due to higher depreciation and equipment expense as a result of a new branch opening in the fourth quarter of the previous fiscal year. Professional services expense increased $72,000, or 84.71%, to $157,000 for the six months ended March 31, 2002 from $85,000 for the same period in 2001 due to higher consultant and audit expenses. The Corporation currently uses consultants in the loan and credit administration areas for additional support. Real estate operations expense increased $17,000, or 113.33%, to $32,000 for the six months ended March 31, 2002 from $15,000 for the same period in 2001 due to higher disposition costs for loan foreclosures. Other expense increased $83,000, or 18.86%, to $523,000 for the six months ended March 31, 2002 from $440,000 for the same period in 2001 due primarily to higher items processing expense that resulted from new customer account features. The overall effective income tax rate for the Corporation was 25.00% for the six month period ended March 31, 2002 compared to 35.47% for the same period in 2001. The reduction was due to increased investments in government municipal securities with the municipal securities investments at March 31, 2002 at $15,394,000 compared to $1,765,000 at March 31, 2001. 17 PART II - OTHER INFORMATION Item 1. Legal Proceedings ----------------- The Corporation is involved in various claims and legal actions arising in the normal course of business. Management believes that these proceedings are immaterial to the Corporation's financial condition and results of operations. Item 2. Changes in Securities --------------------- The Corporation has the right, at one or more times, unless an event of default exists under the floating rate junior subordinated deferrable interest debentures due December 18, 2031 (the "Debentures"), to defer interest payments on the Debentures for up to 20 consecutive quarterly periods. During this time, the Corporation will be prohibited from declaring or paying cash dividends on its common stock. Item 3. Defaults upon Senior Securities ------------------------------- Not applicable. Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- The Annual Meeting of the Stockholders of the Corporation was held on January 30, 2002. The results of the vote on the matters presented at the meeting is as follows: 1) The following individuals were elected as directors, each for a three-year term by the following rate: Votes For Votes Withheld --------- -------------- Carl L. Mason 1,413,828 43,308 William M. Graham 1,429,349 27,787 John S. McMeekin 1,397,746 59,390 2) The appointment of Elliott Davis, LLC, as auditors or the Corporation for the fiscal year ending September 30, 2002 was ratified by the shareholders by the following vote: For 1,428,305 Against 23,306 Abstain 5,525 --------- ------- ----- 18 Item 5. Other Information ----------------- None Item 6. Exhibits and Reports on Form 8-K -------------------------------- Reports on Form 8-K ------------------- None 19 SIGNATURES ---------- In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. UNION FINANCIAL BANCSHARES, INC. -------------------------------- (Registrant) Date: 4-30-02 By: Dwight V. Neese ----------- --------------------- Dwight V. Neese, CEO Date: 4/30/02 By: Richard H. Flake ----------- --------------------- Richard H. Flake, CFO 20