UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
Form 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30,1998
_________________________________
OR
[ ] 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 0-19214
____________________________________________
Union National Financial Corporation
________________________________________________________________
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2415179
___________________________________ _______________________
(State of Incorporation) (I.R.S. Employer ID No.)
101 East Main Street, P.O. Box 567, Mount Joy, PA 17552
____________________________________________________ ________
(Address of principal executive offices) Zip Code
(717) 653 - 1441
_________________________________________________________________
(Registrant's telephone number, including area code)
Not Applicable
_________________________________________________________________
(Former name, former address, & former fiscal year,
if changes since last report)
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 [ ]
______________
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all
documents and reports required to be filed by Section 12, 13, or
15 (d) of the Securities Exchange Act of 1934 subsequent to the
distribution of securities under a plan confirmed by a
court. Yes [ ] No[ ]
_________________
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the
issuer's classes of common stock, as of the latest practicable
date.
2,411,659 shares of $.25 (par) common stock were
_________________
outstanding as of November 04, 1998.
____________________
<PAGE>
UNION NATIONAL FINANCIAL CORPORATION
10Q INDEX Page
#
PART I - FINANCIAL INFORMATION:
_____________________
Item 1 - Financial Statements
- Consolidated Statements of Financial Condition 1
- Consolidated Statements of Income 2
- Consolidated Statements of Comprehensive Income 2
- Consolidated Statements of Cash Flows 3
- Notes to Consolidated Financial Statements 4
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations 5-17
Item 3 - Quantitative and Qualitative Disclosures About
Market Risk 15-16
PART II - OTHER INFORMATION 18
__________________
Item 1 - Legal Proceedings
Item 2 - Change in Securities
Item 3 - Defaults Upon Senior Securities
Item 4 - Submission of Matters to a Vote of Security Holders
Item 5 - Other Information
Item 6 - Exhibits and Reports on Form 8-K
Signature Page 19
Exhbit 27 - Financial Data Schedule 20
<PAGE>
<TABLE>
Union National Financial Corporation
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)
<CAPTION>
(In Thousands) 9/30/98 12/31/97
______________________
<S> <C> <C>
ASSETS
Cash and Due from Banks $5,817 $6,490
Federal Funds Sold 390 2,835
Investment Securities Held to Maturity
(Market Value - 1998-$22,381;1997-$18,943) 21,862 18,870
Investment Securities Available for Sale 47,331 45,867
Loans(Net of Unearned Income) 167,234 152,699
Less:Allowance for Loan Losses (1,750) (1,593)
______________________
Total Net Loans 165,484 151,106
Premises and Equipment - Net 5,165 5,415
Accrued Interest Receivable 1,642 1,446
Deferred Income Taxes 79 154
Investment in Limited Partnerships 891 941
Other Assets 201 119
______________________
TOTAL ASSETS $248,862 $233,243
======================
LIABILITIES
Deposits:
Noninterest-Bearing $19,391 $18,463
Interest-Bearing 173,387 161,672
______________________
Total Deposits 192,778 180,135
Short-Term Borrowing 314 900
Long-Term Debt 30,674 27,329
Accrued Interest Payable 1,164 1,008
Other Liabilities 421 115
_____________________
TOTAL LIABILITIES 225,351 209,487
STOCKHOLDERS' EQUITY
Common Stock (Par Value $.25) 626 627
Shares: Authorized - 20,000,000; Issued -
2,505,007 in 1998 (2,509,327 in 1997)
Outstanding - 2,413,154 in 1998 (2,487,175
in 1997)
Surplus 4,726 4,815
Retained Earnings 19,730 18,461
Unrealized gain on investment securities
available for sale, net of tax 463 295
Less: Treasury Stock - at cost
(91,853 shares in 1998 and 22,152 shares
in 1997) (2,034) (442)
______________________
TOTAL STOCKHOLDERS' EQUITY 23,511 23,756
______________________
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY $248,862 $233,243
======================
The accompanying notes are an integral part of the
consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
Union National Financial Corporation
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
<CAPTION>
Three Months Ended September 30,
___________________________________
(In Thousands, except Per Share Data) 1998 1997
___________________________________
<S> <C> <C>
INTEREST INCOME
Interest and Fees on Loans $3,590 $3,180
Investment Securities:
Taxable 642 671
Exempt from Federal Taxes 248 226
Deposits in Banks 0 1
Federal Funds Sold 61 33
_____________________
Total Interest Income 4,541 4,111
INTEREST EXPENSE
Deposits 1,810 1,649
Short-Term Borrowing 6 13
Long-Term Debt 412 266
_____________________
Total Interest Expense 2,228 1,928
_____________________
Net Interest Income 2,313 2,183
PROVISION for LOAN LOSSES 53 91
_____________________
Net Interest Income after Provision
for Loan Losses 2,260 2,092
OTHER OPERATING INCOME
Trust Income 34 30
Service Charges on Deposit Accounts 124 97
Other Service Charges, Commissions, Fees 124 114
Investment Securities Gains(Losses) 0 (2)
Other Income 13 5
_____________________
Total Other Operating Income 295 244
OTHER OPERATING EXPENSES
Salaries and Wages 820 715
Retirement Plan and Other Employee Benefits 162 203
Net Occupancy Expense 128 130
Furniture and Equipment Expense 103 99
FDIC Insurance Assessment 5 5
Other Operating Expenses 445 451
_____________________
Total Other Operating Expenses 1,663 1,603
_____________________
Income before Income Taxes 892 733
PROVISION for INCOME TAXES 185 147
_____________________
NET INCOME for PERIOD $707 $586
=====================
PER SHARE INFORMATION
Net Income for Period (Basic and Assuming
Dilution) $0.29 $0.23
Cash Dividends $0.110 $0.090
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME * (UNAUDITED)
Net income for Period $707 $586
Other Comprehensive Income, Net of Tax:
Unrealized Holding Gains/(Losses) on Investment
Securities Arising during Period 132 149
Reclassification adjustments for (gains) losses
included in Net Income 0 1
_____________________
Other Comprehensive Income (Loss) 132 150
_____________________
COMPREHENSIVE INCOME for PERIOD $839 $736
=====================
*This Statement is required by Statement No. 130, "Reporting
Comprehensive Income," as issued by the Financial Accounting
Standards Board. This Statement reflects net income as adjusted
for changes in stockholders' equity that result from changes in the
Corporation's unrealized gains and losses on its investment
securities available for sale. Changes in the interest rate
environment and other factors result in fluctuations in the value
of investment securities available for sale.
The accompanying notes are an integral part of the consolidated
financial statements.
<CAPTION>
Nine months ended September 30,
___________________________________
(In Thousands, except Per Share Data) 1998 1997
___________________________________
<S> <C> <C>
INTEREST INCOME
Interest and Fees on Loans $10,436 $9,151
Investment Securities:
Taxable 2,059 1,987
Exempt from Federal Taxes 725 637
Deposits in Banks 1 3
Federal Funds Sold 149 132
_____________________
Total Interest Income 13,370 11,910
INTEREST EXPENSE
Deposits 5,259 4,670
Short-Term Borrowing 18 78
Long-Term Debt 1,198 743
______________________
Total Interest Expense 6,475 5,491
______________________
Net Interest Income 6,895 6,419
PROVISION for LOAN LOSSES 282 203
______________________
Net Interest Income after Provision
for Loan Losses 6,613 6,216
OTHER OPERATING INCOME
Trust Income 101 90
Service Charges on Deposit Accounts 335 269
Other Service Charges, Commissions, Fees 347 279
Investment Securities Gains (Losses) (7) 2
Other Income 72 59
_____________________
Total Other Operating Income 848 699
OTHER OPERATING EXPENSES
Salaries and Wages 2,290 2,070
Retirement Plan and Other Employee Benefits 473 643
Net Occupancy Expense 408 436
Furniture and Equipment Expense 304 300
FDIC Insurance Assessment 16 15
Other Operating Expenses 1,402 1,299
_____________________
Total Other Operating Expenses 4,893 4,763
_____________________
Income before Income Taxes 2,568 2,152
PROVISION for INCOME TAXES 532 430
_____________________
NET INCOME for PERIOD $2,036 $1,722
=====================
PER SHARE INFORMATION
Net Income for Period $0.84 $0.69
Cash Dividends $0.315 $0.261
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME * (UNAUDITED)
Net income for Period $2,036 $1,722
Other Comprehensive Income, Net of Tax:
Unrealized Holding Gains/(Losses) on Investment
Securities Arising during Period 165 239
Reclassification adjustments for (gains) losses
included in Net Income 4 (1)
_____________________
Other Comprehensive Income (Loss) 169 238
_____________________
COMPREHENSIVE INCOME for PERIOD $2,205 $1,960
=====================
*This Statement is required by Statement No. 130, "Reporting
Comprehensive Income," as issued by the Financial Accounting
Standards Board. This Statement reflects net income as adjusted
for changes in stockholders' equity that result from changes in the
Corporation's unrealized gains and losses on its investment
securities available for sale. Changes in the interest rate
environment and other factors result in fluctuations in the value
of investment securities available for sale.
The accompanying notes are an integral part of the consolidated
financial statements.
</TABLE>
<PAGE>
<TABLE>
Union National Financial Corporation
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
<CAPTION>
Nine Months Ended September 30,
_________________________________
(In Thousands) 1998 1997
_________________________________
<S> <C> <C>
CASH FLOWS from OPERATING ACTIVITIES
Net Income $2,036 $1,722
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation and Amortization 355 382
Provision for Loan Losses 282 203
Investment Securities (Gains)/Losses 7 (2)
Provision for Deferred Income Taxes (12) 12
(Increase)/Decrease in Accrued
Interest Receivable (196) (131)
(Increase)/Decrease in Other Assets (57) (81)
Increase/(Decrease) in Other Liabilities 462 402
_____________________
Net Cash Provided by Operating Activities 2,877 2,507
CASH FLOWS from INVESTING ACTIVITIES
Net(Increase)/Decrease in Federal Funds Sold 2,445 4,790
Proceeds from Sales of
Available for Sale Securities 4,936 5,548
Proceeds from Maturities of
Available for Sale Securities 26,906 11,503
Proceeds from Maturities of
Held to Maturity Securities 681 2,332
Purchases of Available for Sale Securities (33,057) (19,561)
Purchases of Held to Maturity Securities (3,674) (3,815)
Loans Made to Customers, Net of
Principal Collected on Loans (14,659) (18,046)
Purchases of Property and Equipment (80) (92)
_____________________
Net Cash (Used in)Investing Activities (16,502) (17,341)
CASH FLOWS from FINANCING ACTIVITIES
Net Increase/(Decrease)in Demand Deposits
and Savings Accounts 4,641 3,292
Net Increase/(Decrease) in Certificates
of Deposits 8,002 4,062
Net Increase/(Decrease) in Short-Term
Borrowing (586) (1,804)
Proceeds from Issuance of Long-Term Debt 10,456 8,192
Payment on Long-Term Debt (7,111) 0
Acquisition of Treasury Stock (1,881) (229)
Issuance of Common Stock 198 136
Cash Dividends Paid (767) (653)
_____________________
Net Cash Provided by
Financing Activities 12,952 12,996
_____________________
Net Increase/(Decrease) in Cash
and Cash Equivalents (673) (1,838)
CASH and CASH EQUIVALENTS -
Beginning of Period 6,490 6,073
_____________________
CASH and CASH EQUIVALENTS - End of Period $5,817 $4,235
=====================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash Payments for:
Interest Paid to Depositors $5,101 $4,555
Interest Paid - Other 1,217 795
Income Taxes 507 462
SUPPLEMENTAL SCHEDULE OF NONCASH
INVESTING AND FINANCING ACTIVITIES
Retirement of Treasury Stock (13,000 shares
in 1998 and 12,000 shares in 1997) $288 $228
The accompanying notes are an integral part of the consolidated
financial statements.
</TABLE>
<PAGE>
Union National Financial Corporation
Mount Joy, Pennsylvania
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The information contained in this interim report is
unaudited and subject to year-end adjustment and audit.
However, in the opinion of management, the information
reflects all adjustments necessary to present fairly the
financial condition and results of operations for the latest
period. All such adjustments were of a normal, recurring
nature. All material intercompany transactions have been
eliminated in consolidation.
2. These statements should be read in conjunction with notes to
the financial statements contained in the 1997 Annual Report
to Stockholders.
3. Management considers the allowance for loan losses (reserve)
to be adequate at this time.
4. All per share computations include the retroactive effect of
stock dividends. The basic weighted average number of shares
of common stock outstanding used was apporximately 2,413,226
and 2,488,597 for the three month period ended September 30,
1998 and 1997, respectively, and 2,423,289 and 2,490,395 for
the nine month period ended September 30, 1998 and 1997,
respectively.
5. No shares of common stock are reserved for issuance in the
event of conversions or the exercise of warrants, options or
other rights, except as follows: 124,830 shares which are
reserved for issuance under the Corporation's 1988 and 1997
Stock Incentive Plans, 100,000 shares which are reserved for
issuance under the Corporation's 1997 Employee Stock
Purchase Plan, and 157,500 shares which are reserved for
issuance under the Corporation's Dividend Reinvestment and
Stock Purchase Plan. As of September 30, 1998, options to
purchase 4,830 shares have been granted under the
Corporation's Stock Incentive Plans. The exercise price
for such options is $23.27. No options have been exercised
as of September 30, 1998 under this plan. As of September 30,
1998, options to purchase 30,000 shares have been granted
under theCorporation's 1997 Employee Stock Purchase Plan. The
current exercise price for such options is $19.60. As of
September 30, 1998, 1,131 options have been exercised under
this plan. As of September 30, 1998, 20,319 shares have been
issued under the Corporation's Dividend Reinvestment and Stock
Purchase Plan.
6. As of January 1, 1998, the Corporation adopted Statement of
Financial Accounting Standards Statement No. 130, "Reporting
Comprehensive Income." Statement No. 130 establishes new
rules for the reporting and display of comprehensive income
and its components; however, the adoption of this Statement
had no impact on the Company's net income or stockholder's
equity. Statement No. 130 requires unrealized gains or losses
on available for sale securities, to be included in other
comprehensive income. Total comprehensive income was $839,000
for the quarter ended September 30, 1998, compared to $736,000
for the same period of 1997. Year to date total comprehensive
income was $2,205,000 for 1998, compared to $1,960,000 for
1997.
7. The results of operations for the nine month period ended
September 30, 1998 are not necessarily indicative of the
results to be expected for the full year.
8. Certain reclassifications have been made to the 1998
consolidated financial statements to conform with the
1997 presentation.
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following is management's discussion and analysis of the
significant changes in the results of operations, capital resources
and liquidity presented in its accompanying consolidated financial
statements for Union National Financial Corporation, a bank holding
company (the Corporation), and its wholly-owned subsidiary, Union
National Community Bank (the Bank). The Corporation's consolidated
financial condition and results of operations consist almost
entirely of the Bank's financial condition and results of
operations. Such financial condition and results of operations are
not intended to be indicative of future performance. This
discussion should be read in conjunction with the 1997 Annual
Report.
In addition to historical information, this 10-Q Report for the
nine months ended September 30, 1998 contains forward-looking
statements. The forward-looking statements contained herein are
subject to certain risks and uncertainties that could cause actual
results to differ materially from those projected in the
forward-looking statements. For example, risks and uncertainties
can arise with changes in: general economic conditions, including
their impact on capital expenditures; business conditions in the
financial services industry; the regulatory environment; rapidly
changing technology and competition with community, regional and
national financial institutions; new service and product offerings
by competitors; and price pressures. Readers are cautioned not to
place undue reliance on these forward-looking statements, which
reflect management's analysis only as of the date hereof. The
Corporation undertakes no obligation to publicly revise or update
these forward-looking statements to reflect events or circumstances
that arise after the date hereof. Readers should carefully review
the risk factors described in other documents the Corporation files
from time to time with the Securities and Exchange Commission,
including any Current Reports on Form 8-K filed by the Corporation.
Results of Operations
_____________________
Overview
Consolidated net income for the nine months ended September 30,
1998 was $2,036,000, an increase of 18.2%, as compared to the
consolidated net income of $1,722,000 for the same period in 1997.
Consolidated net income for the three months ended September 30,
1998 was $707,000, an increase of 20.6%, as compared to the
consolidated net income of $586,000 for the same period in 1997.
On a per share basis, net income for the nine months ended
September 30, 1998 was $.84, an increase of 21.7%, as compared to
$.69 for the same period in 1997. For the three months ended
September 30, 1998 and 1997, earnings per share amounted to $.29
and $.23, respectively, an increase of 26.1%.
Results of operations for the nine months ended September 30, 1998
as compared to the same period in 1997 were impacted by the
following items: (1) Net income increased due to a 17.4% increase
in average net loans, primarily residential and commercial
mortgages, which were funded by growth in deposits and by additions
to average borrowings; (2) net income increased due to a 21.3%
increase in other operating income; (3) net income decreased due to
the narrowing of the spread between the earnings rates on loans and
investments as compared to the interest rates paid on certificates
of deposit and long-term debt; (4) net income decreased due to a
2.7% increase in other operating expenses; and (5) net income
decreased due to an increase in the provision for loan losses. The
above items are quantified and discussed in further detail under
their respective sections below.
Net income as a percent of total average assets, also known as
return on average assets (ROAA), was 1.14% on an annualized basis
for the nine months ended September 30, 1998, as compared to 1.09%
for the same period in 1997. Net income as a percent
<PAGE>
of average stockholders' equity, also known as return on average
equity (ROAE), was 11.9% on an annualized basis for the nine months
ended September 30, 1998, as compared to 10.1% for the same period
in 1997. ROAE was positively impacted by the repurchase of 81,934
shares of outstanding common stock over the past eight months. See
the discussion under the section on Stockholder's Equity for
further details.
The growth in loans is considered a material favorable trend of the
Corporation which Management expects to continue for the remainder
of 1998. However with respect to deposits, Management expects the
growth in deposits for 1998 to be comparable to its historic growth
rates of deposits. Management has taken specific actions to enhance
the Bank's competitive position for core deposits. These actions
include a broad based sales training program for staff to enhance
the Bank's competitive position for loans, deposits and other
financial services in northwestern Lancaster County, Pennsylvania
(the Bank's Market Area). Other actions include the strategic
promotion of the Bank's retail offices in light of continued
consolidation of financial institutions in the Bank's Market Area
and the promotion of intermediate-term certificates of deposit. As
a result of the above described efforts, the Bank's certificate of
deposit portfolio under $100,000 increased by $7,900,000 and the
Bank's checking and savings deposits increased by $4,600,000 for
the nine months ended September 30, 1998. The funding for the loan
growth is further discussed under the section on Liquidity.
Management expects the loan growth that has occurred during the
first nine months to continue in 1998 for the following reasons:
(1) lending rates are at generally affordable rates for prospective
borrowers; (2) implementation of a broad based sales training
program for staff; (3) further product development and promotion of
the Bank's consumer and home equity lines of credit; (4) economic
stability of the Bank's Market Area as discussed later in this
section; and (5) continued population growth in the Bank's Market
Area.
It is anticipated that economic activity in the Bank's Market Area
during 1998 appears favorable due to the availability of generally
low lending rates and continued construction activity. The overall
effects of current and past economic conditions as well as other
factors can be seen by a mild lessening of certain borrowers'
financial strength. Management is monitoring these general and
specific trends closely. Their various effects are discussed later
under the section on Credit Risk and Loan Quality.
Net Interest Income
For analytical and discussion purposes, net interest income and
corresponding yields are presented on a taxable equivalent basis.
Net interest income for the nine months ended September 30, 1998
increased by $552,000, or 8.1%, over the same period in 1997.
Commercial, residential, and consumer average loan growth of
$23,068,000 and average investment security growth of $4,753,000
were funded by the growth in average deposits of $18,632,000 and by
the growth in average borrowings of $9,144,000. The additional
borrowings represented fixed-rate and variable-rate advances from
the Federal Home Loan Bank of Pittsburgh (FHLB). Average earning
assets increased in the amount of $28,146,000 in the aggregate over
the same period in 1997. The volume growth in earning assets and
interest-bearing liabilities increased net interest income by the
amount of $904,000.
The overall interest rate on the average total earning assets
decreased to 8.15% for the current period, as compared to 8.28% for
the same period of last year, due to the refinancing of higher
interest rate loans to lower interest rates. More significantly,
the overall interest rate on the average interest-bearing
liabilities increased to 4.44% for the current period, as compared
to 4.32% for the same period of last year, due to the change in the
mix of interest-bearing liabilities in the form of additional
long-term debt and additional funds in higher paying money market
accounts. The net effect of all interest rate fluctuations and
funding changes was to decrease net interest income in the amount
of $352,000 for the current period over the same period in 1997.
See Management's discussion below concerning the anticipated
<PAGE>
impact of these interest rate fluctuations to the results of
operations for the remainder of 1998.
In order to enhance the net interest income in future periods,
Management has entered into transactions that increase earning
assets funded by advances from the FHLB. The terms and amounts of
the transactions, when combined with the Bank's overall balance
sheet structure, maintain the Bank within its interest rate risk
policies. As of September 30, 1998, the Bank has received long-term
advances of $30,624,000 from its available credit of $77,189,000 at
the FHLB for purposes of funding loan demand and mortgage-backed
security purchases. The total advances have a current average
effective rate of 5.46% with maturities ranging from January 1999
to September 2008.
Commencing October 1998, the Federal Reserve Bank began loosening
the monetary supply causing the prime interest rate to decrease
from 8.50% to 8.00%. The immediate impact of the short-term
interest rate decreases was to decrease interest rates on loans and
deposits that adjust according to short-term rate indexes and to
decrease reinvestment rates on investment securities and renewing
certificates of deposit. In addition, the Bank's balances of
liabilities in the form of long-term debt and funds in money market
accounts that are paying higher interest rates have increased.
Consequently, for the remainder of 1998, Management currently
expects its net interest margin to further narrow as compared to
the same period of last year. In contrast, the growth in the
earning assets during 1997 and the first nine months of 1998 is
currently expected to increase the net interest margin for the
remaining months of 1998 over the same period of 1997. Although the
effective interest rate impact of expected cash flows on
investments and of renewing certificates of deposit can be
reasonably estimated at current interest rate levels, the yield
curve during the remainder of 1998, the options selected by
customers, and the future mix of the loan, investment and deposit
products in the Bank's portfolios may significantly change the
estimates used in the simulation models. Based on the Bank's
current model and estimates as of September 30, 1998, the factors
discussed above will have a net positive impact to the net interest
margin for the remaining months of 1998, as compared to the same
period in 1997. See discussions on Liquidity and Market Risk -
Interest Rate Risk.
Provision for Loan Losses
The provision for loan losses was $282,000 and $203,000 for the
nine months ended September 30, 1998 and 1997, respectively. Net
charge-offs for the nine months ended September 30, 1998 amounted
to $125,000 as compared to $50,000 for the same period in 1997. The
increase in the provision over the same period of last year is a
result of the additional net charge-offs and the significant loan
growth experienced during the first nine months of 1998. Future
adjustments to the allowance, and consequently, the provision for
loan losses, may be necessary if economic conditions or loan credit
quality differ substantially from the assumptions used in making
Management's evaluation of the level of the allowance for loan
losses as compared to the balance of outstanding loans.
Other Operating Income
Other operating income for the nine months ended September 30, 1998
was $848,000, representing an increase of $149,000, or 21.3%, over
the same period in 1997. Contributing to this increase were
additional earnings in ATM and card usage fees including ATM
surcharges ($40,000), additional earnings in insufficient funds
charges ($54,000), and additional earnings in debit card
interchange fee income ($31,000). The additional earnings in
insufficient funds charges is mainly a result of an increase in the
Bank's per item insufficient funds charge which was effective in
June 1998. The Bank also currently assesses a surcharge at its
ATMs; however, ATM surcharges, or the elimination thereof, may be
subject to future legislation.
Other Operating Expenses
The aggregate of noninterest expenses for the nine months ended
September 30, 1998
<PAGE>
increased by $130,000, or 2.7%, over the same period in 1997. This
noninterest expense increase is discussed below as it pertains to
the various expense categories.
Employee salaries and wages increased by $220,000, or 10.6%, over
the same period in 1997. This increase was essentially due to
annual merit and cost of living increases and planned staff
additions. New staff positions include a senior vice president to
lead retail banking operations, a retail office manager, an
accounting officer, and additional staff for our new telephone
customer service center. See the Other Matters section for
additional discussion of staff and management changes. Related
fringe benefits decreased by $170,000, or 26.4%, from the same
period in 1997. The decrease is essentially due to a reduction in
the Bank's discretionary contribution to the Bank's profit-sharing
plan.
Occupancy, furniture and equipment expenses for the nine months
ended September 30, 1998 decreased by $24,000, or 3.3%, from the
same period in 1997. This decrease was primarily due to a decrease
in other real estate expense from the same period in 1997.
Other operating expenses for the nine months ended September 30,
1998, increased by $103,000, or 7.9%, over the same period in 1997.
Contributing factors to the increase in other operating expenses as
compared to the same period in 1997 included the following: (1) an
increase in supplies expenses of $24,000; (2) an increase in
professional and consulting fees in the amount of $15,000; and (3)
an increase in ATM transaction and clearing costs in the amount of
$32,000. The increase in professional and consulting fees included
consulting fees for a broad based sales training program for staff,
consulting fees for an electronic data processing consultant to
perform a comprehensive review of current system capabilities and
alternatives, and legal costs for certain loan collection services
in connection with increased charge-offs and non-performing assets
in 1998.
Income Taxes
The Corporation's income tax expense increased by $102,000 for the
nine months ended September 30, 1998 to $532,000 from $430,000 for
the same period in 1997. The effective tax rate was 20.7% and 20.0%
for the nine months ended September 30, 1998 and 1997,
respectively. The increase in income tax expense and the effective
tax rate was due to the increase in corporate earnings before
income taxes. Currently, the effective tax rate of the Corporation
for the remaining months of 1998 is expected to approximate the
effective tax rate in 1997.
Year 2000 Issues
________________
The following section contains forward-looking statements which
involve risks and uncertainties. The actual impact on the
Corporation of the Year 2000 issue could materially differ from
that which is anticipated in the forward-looking statements as a
result of certain factors identified below.
The "Year 2000 Problem" (Y2K) arose because many existing computer
programs use only the last two digits to refer to a year.
Therefore, these computer programs do not properly recognize a year
that begins with "20" instead of the familiar "19". If not
corrected, many computer applications could fail or create
erroneous results by or at the year 2000. This could cause entire
system failures, miscalculations, and disruptions of normal
business operations including, among other things, a temporary
inability to process transactions, send statements, or engage in
similar day to day business activities. The extent of the
potential impact of the Year 2000 Problem is not yet known, and if
not timely corrected, it could affect the global economy.
The Bank is subject to the regulation and oversight of various
banking regulators, whose oversight included the provision of
specific timetables, programs and guidance regarding Year 2000
issues. Regulatory examination of the Bank's Year 2000 programs
are conducted on a quarterly basis and reports are submitted by the
Bank to the banking regulators on a periodic basis. In addition,
reports are currently provided
<PAGE>
on a monthly basis to the Corporation's Board of Directors.
Corporation's State of Readiness
Union National Financial Corporation is committed to ensuring that
the Corporation's daily operations suffer little or no impact from
the century date change. The Corporation has applied due diligence
throughout the Y2K process, following the guidelines contained in
the series of Federal Financial Institutions Examinations Council's
Interagency Guidelines. The guidelines identify the following
phases: awareness, assessment, renovation or remediation, testing
or validation and implementation.
Based on an ongoing assessment, the Corporation has determined that
it will be required to modify or replace portions of its software
so that its computer systems will properly use dates beyond
December 31, 1999. The Corporation presently believes that as a
result of modifications to existing software and hardware, the Year
2000 Problem can be mitigated. However, if such modifications are
not made, or are not completed on a timely basis, the Year 2000
Problem could have a material adverse impact on the operations of
the Corporation.
Management has initiated an enterprise-wide program to prepare the
Corporation's computer systems and applications for the Year 2000.
The Corporation has developed a comprehensive inventory of all
mainframe and PC based applications, third-party relationships,
environmental systems, proprietary programs and non-computer
related systems (such as postage meters and fax machines). This
assessment identified eleven mission-critical or related systems
which could have a significant impact on the Corporation due to the
effect of the century date change. As of September 30, 1998, the
Corporation has remedied ten of its eleven identified
mission-critical or related systems with the nonremediated system
expected to be compliant by March 31, 1999.
Currently, the Bank has communicated with and completed its Year
2000 credit risk assessment of over 70% of its material customers.
Material customers include significant commercial borrowers that
would pose a credit risk to the Bank and significant commercial
depositors that would pose a liquidity risk to the Bank, if they
are not Year 2000 compliant and their businesses are disrupted.
Remaining responses from material customers are being evaluated
accordingly and it is currently expected that this evaluation
process will be completed by the end of 1998.
The Corporation has initiated communications with all of its
significant vendors, suppliers and business partners to determine
the extent to which the Corporation is vulnerable to those
third-parties' failure to remedy their own Year 2000 Problems.
These include external suppliers, such as, wire transfer systems,
telephone systems, electric companies, and other utility companies
for continuation of service. These vendors' Year 2000 readiness
responses are currently being assessed as received as to their Year
2000 compliance status. In the event that any of the Corporation's
significant vendors, suppliers and business partners do not
successfully achieve Year 2000 compliance in a timely manner, the
Corporation's business or operations could be adversely affected.
If significant suppliers fail to meet Year 2000 operating
requirements, the Corporation intends to engage alternative
suppliers. Nevertheless, the Company does not believe that the cost
of addressing the Year 2000 issues will be a material event or
uncertainty that would cause reported financial information not to
be necessarily indicative of future operating results or financial
conditions, nor does it believe that the costs or the consequences
of incomplete or untimely resolution of its Year 2000 issues
represent a known material event or uncertainty that is reasonably
likely to affect its future financial results, or cause its
reported financial information not to be necessarily indicative of
future operating results or future financial condition.
Costs of Year 2000
The Corporation is utilizing both internal and external resources
to correct or modify, and test its systems for Year 2000
compliance. For the remaining months of
<PAGE>
1998 and 1999, the Corporation is currently expecting incremental
costs related to the Year 2000 problem to reduce results of
operations by $23,000 and, $14,000, net of income taxes,
respectively. The estimated Year 2000 project costs include the
costs associated with the impact of third-parties' Year 2000
issues, and are based on presently available information. The
total cost of the project is being funded through operating cash
flows. The Corporation does not expect the amounts required to be
expensed over the next 15 months to have a material effect on the
financial position or results of operations. However, if
compliance is not achieved in a timely manner by the Corporation or
any of its significant third-parties, be it a supplier of services
or customer, the Y2K issue could possibly have a material effect on
the Corporation's operations and financial position.
The cost of the projects and the date on which the Corporation
plans to complete both Year 2000 modifications and systems
conversions are based on management's best estimates, which were
derived utilizing numerous assumptions of future events including
the continued availability of certain resources, third-party
modification plans and other factors. However, there can be no
guarantee that these estimates will be achieved and actual results
could differ materially from those plans. Specific factors that
might cause such material differences include, but are not limited
to, the availability and cost of personnel trained in this area,
the ability to locate and correct all relevant computer codes, and
similar uncertainties.
Risks of Year 2000
At present, Management believes its progress in remedying the
Corporation's systems, programs, and applications and installing
Year 2000 compliant upgrades is on target. The Year 2000 computer
problem creates risk for the Corporation from unforseen problems in
its own computer systems and from third-party vendors who provide
the majority of mainframe and PC based computer applications.
Presently, the Corporation is testing its own remediated
mission-critical systems for Year 2000 compliance. Testing is
currently expected to be largely completed by December 31, 1998.
Failure of third-party systems relative to the Year 2000 issue
could have a material impact on the Corporation's ability to
conduct business.
Contingency Plans
The Corporation is currently developing a business resumption
contingency plan. This plan is for the possibility of the failure
of its systems at critical dates in the future. The business
resumption plan has a target completion date of June 30, 1999.
At present it is expected that mission-critical systems will
largely be remediated and tested for Year 2000 compliance by
December 31, 1998, thus the Corporation has not developed a
remediation contingency plan at this time. It is the Bank's intent
to mitigate the risks associated with a failure and to successfully
complete the implementation of its Year 2000 compliant
mission-critical systems. The Corporation will continue to monitor
the progress of remediation on the mission-critical systems and
will develop a remediation contingency plan in the future if such
a need should arise.
Other Matters
_____________
In furtherance of previous public announcements, William E. Eby
will retire as President/CEO on December 31, 1998 after 40 years
with the Bank and Mark D. Gainer will assume the position of
President/CEO. Mr. Eby will, however, continue to serve as a
member of the Board of Directors. Mr. Gainer has worked at the
Bank for the past 22 years, most recently as Senior Vice
President/Chief Operating Officer. The Board of Directors also
recently announced that Michael A. Frey has joined the Bank as
Senior Vice President and Clement M. Hoober, CPA has been promoted
to the position of Senior Vice President. Mr. Frey, who comes to
the Bank with 11 years of previous experience in the financial
services industry will be responsible for retail and commercial
banking. Mr. Hoober, who has been with the Bank for 10 years, will
have direct responsibility for financial services, operations, and
risk management.
<PAGE>
Further staff additions are expected during the remaining months of
1998 as the Bank plans to enhance its retail banking, marketing,
and lending efforts. These staff changes and additions will impact
results of operations for 1999 as compared to 1998 by a currently
estimated expense amount of $120,000, net of income taxes.
However, the Bank currently expects its enhanced retail banking,
marketing, and lending efforts to have a positive impact to its
results of operations for 1999.
Regulatory Activity
___________________
Recently, Pennsylvania enacted a law to permit State chartered
financial institutions to sell insurance. The Office of the
Comptroller of the Currency has issued guidelines for national
banks to sell insurance. The Bank is evaluating its options
regarding the sale of insurance.
Recently, the President signed a bill that would allow credit
unions to expand their membership eligibility rules. The banking
industry expects increased competition from credit unions as a
result of this bill's enactment.
Congress is currently considering legislative reform centered on
repealing the Glass-Steagall Act which prohibits commercial banks
from engaging in the securities industry. The holding company
structure, under such a proposal, would be regulated by the Federal
Reserve Board, and its subsidiaries would be supervised by the
applicable regulator based on their respective functions.
From time to time, various types of federal and state legislation
have been proposed that could result in additional regulation of,
and restrictions on, the business of the Corporation and the Bank.
It cannot be predicted whether such legislation will be adopted or,
if adopted, how such legislation would affect the business of the
Corporation and the Bank. As a consequence of the extensive
regulation of commercial banking activities in the United States,
the Corporation's and the Bank's business is particularly
susceptible to being affected by federal legislation and
regulations that may increase the cost of doing business. Except as
specifically described above, Management believes that the effect
of the provisions of the aforementioned legislation on the
liquidity, capital resources, and results of operations of the
Corporation will be immaterial. Management is not aware of any
other current specific recommendations by regulatory authorities or
proposed legislation, which if they were implemented, would have a
material adverse effect upon the liquidity, capital resources, or
results of operations, although the general cost of compliance with
numerous and multiple federal and state laws and regulations does
have, and in the future may have a negative impact on the
Corporation's results of operations.
Further, the business of the Corporation is also affected by the
state of the financial services industry in general. As a result of
legal and industry changes, Management predicts that the industry
will continue to experience an increase in consolidations and
mergers as the financial services industry strives for greater cost
efficiencies and market share. Management believes that such
consolidations and mergers may enhance its competitive position as
a community bank.
As the Year 2000 approaches, regulation of the Corporation and the
Bank with respect to completing Year 2000 modifications is likely
to increase. A brief discussion of the most recent federal banking
agency pronouncements that affect the Corporation and/or the Bank
follows.
In December 1997, the Federal Financial Institutions Examination
Council (FFIEC) issued an interagency statement. The statement
indicates that senior management and the board of directors should
be actively involved in managing the Corporation's and the Bank's
Year 2000 compliance efforts. The statement also recommended that
institutions obtain Year 2000 compliance certification from vendors
followed by comprehensive internal testing. In addition,
contingency plans should be developed for all vendors that service
mission critical applications, which are applications vital to the
successful continuance of a core business activity.
<PAGE>
The OCC issued an advisory indicating that Year 2000 preparedness
will be factored into reviews of de novo charters, conversions,
business combinations and establishment of federal branches and
agencies as well as hardware and software systems integrations
issues related to business combinations.
In addition, the OCC recently issued an advisory providing guidance
in key milestones and testing methods for institutions to use to
prepare their systems and applications for the Year 2000.
Institutions should develop and implement written testing
strategies and plan to test both internal and external systems. In
May 1998, the FFIEC issued two interagency statements with regards
to Year 2000 readiness. The first statement provided guidance for
institutions to design its Year 2000 contingency plan to mitigate
the risks associated with the institutions failure to become Year
2000 compliant or the failure of mission critical systems at
specific dates. The second statement provides suggestions for
developing a customer awareness program and identifies issues that
financial institutions should be prepared to discuss with
customers.
Changes in Accounting Standards
________________________________
In 1996, the Financial Accounting Standards Board issued Statement
No. 125 (SFAS No. 125), "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" and Statement
No. 127, an amendment to SFAS No. 125. All provisions of these
Statements have become effective for transfers and servicing of
financial assets and extinguishments of liabilities occurring after
December 31, 1997. The provisions are to be applied prospectively.
These Statements provide consistent standards for distinguishing
transfers of financial assets that are sales from transfers that
are secured borrowing. The accounting approach is called the
financial-components approach that focuses on control. Under that
approach, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when
control has been surrendered, and derecognizes liabilities when
extinguished. The Corporation has adopted the provisions of these
Statements when they became applicable. There has been no incidence
of coverage under SFAS No. 125 and No. 127 since adoption.
In September 1997, the Financial Accounting Standards Board issued
Statement No. 131, (SFAS No. 131), "Disclosures about Segments of
an Enterprise and Related Information." This Statement establishes
standards for the way that public business enterprises report
information about operating segments in annual financial statements
and requires that those enterprises report selected information
about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures
about products and services, geographic areas, and major customers.
The Statement has been adopted by the Corporation as of January 1,
1998 with interim comparative financial reporting effective in
1999. The impact of this Statement on the Corporation will be to
require additional disclosures about business segments in the
Corporation's annual financial statements for 1998 and interim
reports for 1999.
In February 1998, the Financial Accounting Standards Board issued
Statement No. 132, (SFAS No. 132), "Employers' Disclosures about
Pensions and Other Postretirement Benefits." This Statement revises
employers' disclosures about pension and other postretirement
benefit plans. It standardizes the disclosure requirements for
these plans to the extent practicable, requires additional
information on changes in the benefit obligation and fair values of
plan assets, and eliminates certain previously required
disclosures. This Statement has been adopted by the Corporation as
of January 1, 1998. The impact of this Statement on the Corporation
will be to require additional disclosures in the Corporation's
annual financial statements for 1998.
In June 1998, the Financial Accounting Standards Board issued
Statement No. 133, (SFAS No. 133), "Accounting for Derivative
Instruments and Hedging Activities." This Statement establishes
accounting and reporting standards for derivative instruments and
for hedging activities. In addition, the transition provisions of
this Statement
<PAGE>
allow the Corporation to reclassify held-to-maturity securities to
an available-for-sale classification. The Corporation does not
expect the provisions of this Statement to have a material effect
on the liquidity, results of operations, or capital resources of
the Corporation when it becomes effective in the first quarter of
2000.
In October 1998, the Financial Accounting Standards Board issued
Statement No. 134, (SFAS No. 134), "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held
for Sale by a Mortgage Banking Enterprise." There is no incidence
of coverage for the Corporation under this Statement.
Credit Risk and Loan Quality
____________________________
Other than as described herein, Management does not believe there
are any trends, events or uncertainties which are reasonably
expected to have a material impact on future results of operation,
liquidity or capital resources. Further, based on known
information, Management believes that the effects of current and
past economic conditions and other unfavorable specific business
conditions may result in the inability of loans amounting to
$1,748,000 to comply with their respective repayment terms. This
amount represents a decrease from the amount of $2,705,000 at
December 31, 1997, primarily due to three commercial loans becoming
non-performing assets during the year. In aggregate, these loans
are well secured, essentially with real estate, equipment and
vehicles. Management currently believes that potential losses on
these loans have already been provided for in the Allowance for
Loan Losses. The borrowers are of special mention since they have
shown a decline in financial strength and payment quality.
Management has increased its monitoring of the borrowers' financial
strength. In addition, Management currently estimates that an
immaterial amount of these loans will be classified as
nonperforming in the remaining months of 1998.
At September 30, 1998, total nonperforming assets amounted to
$1,300,000, or .8% of total net loans, from a level of $706,000, or
.5%, at December 31, 1997. Historically, the percentage of
nonperforming assets to total net loans as of December 31, for the
previous five year period was an average of .7%. The increase is
primarily a result of three additional nonperforming commercial
loans.
Allowance for Loan Losses
_________________________
The allowance for loan losses is maintained at a level believed
adequate by Management to absorb estimated probable loan losses and
is formally reviewed by Management on a quarterly basis. The
allowance is increased by provisions charged to operating expense
and reduced by net charge-offs. Management's periodic evaluation of
the adequacy of the allowance is based on the Corporation's past
loan loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrower's ability to repay
(including the timing of future payments), the estimated value of
any underlying collateral, composition of the loan portfolio,
current economic conditions, and other relevant factors. While
Management uses available information to make such evaluations,
future adjustments to the allowance may be necessary if economic
conditions differ substantially from the assumptions used in making
the evaluation. In addition, various regulatory agencies, as an
integral part of their examination process, review the Bank's
Allowance for Loan Losses. Such agencies may require the Bank to
recognize additions to the allowance based on their judgement of
information available to them at the time of their examination.
<PAGE>
<TABLE>
SUPPORTING SCHEDULES
Schedule of Nonperforming Assets
________________________________
<CAPTION>
September 30, December 31,
(In Thousands) 1998 1997
_______________________________
<S> <C> <C>
Nonaccruing Loans $545 $94
Accrual Loans - 90 days or more
past due 774 612
Restructured Accrual Loans 0 0
Other Real Estate Owned 0 0
_______________________________
Total Nonperforming Assets $1,319 $706
===============================
Nonperforming Assets
as a % of Net Loans 0.8% 0.5%
===============================
Allowance for Loan Losses
as a % of Nonperforming Assets 133% 226%
===============================
</TABLE>
<TABLE>
Analysis of Allowance for Loan Losses
_____________________________________
<CAPTION>
Nine Months Ended September 30,
(In Thousands) 1998 1997
________________________________
<S> <C> <C>
Average Total Loans Outstanding
(Less Unearned Income) $160,551 $137,483
===============================
Allowance for Loan Losses,
Beginning of Period $1,593 $1,371
Loans Charged-off During Period 171 78
Recoveries of Loans Previously
Charged-off 46 28
_______________________________
Net Loans Charged-off 125 50
Addition to Provision for Loan Losses
Charged to Operations 282 203
_______________________________
Allowance for Loan Losses,
End of Period $1,750 $1,524
===============================
Ratio of Net Loans Charged-off to Average
Loans Outstanding (Annualized) 0.10% 0.05%
===============================
Ratio of Allowance for Loan Losses to
Net Loans at End of Period 1.05% 1.03%
===============================
</TABLE>
<PAGE>
The allowance for loan losses increased by $157,000 for the nine
months ended September 30, 1998, and the ratio of the allowance for
loan losses to net loans was 1.05% at September 30, 1998, as
compared to 1.04% at December 31, 1997. The increase in the
allowance for loan losses for the nine month period was due to an
increase in loans outstanding of $14,535,000 for the nine month
period. Management believes based on information currently
available that the current allowance for loan losses of $1,750,000
is adequate to meet potential loan losses. As of October 1998, a
review of selected portions of the Bank's commercial loan portfolio
was completed by an outside independent consultant. At the
conclusion of the review, the consultant did not recommend any
increase in the allowance for loan losses.
Liquidity
_________
The Corporation's objective is to maintain adequate liquidity to
fund needs at a reasonable cost and to provide contingency plans to
meet unanticipated funding needs or a loss of funding sources,
while minimizing interest rate risk. Adequate liquidity provides
resources for credit needs of borrowers, for depositor withdrawals,
and for funding Corporate operations. Sources of liquidity are as
follows: maturing investment securities, which include overnight
investments in federal funds sold; overnight correspondent bank
borrowing on various credit lines; payments on loans and
mortgage-backed securities; and a growing core deposit base,
primarily certificates of deposit. Management believes that its
core deposits are fairly stable even in periods of changing
interest rates. Liquidity management is governed by policies and
measured on a quarterly basis. These measurements indicate that
liquidity generally remains stable and that liquidity consistently
exceeds the Bank's minimum defined level. There are no known
trends, or any known demands, commitments, events, or uncertainties
that will result in, or that are reasonably likely to result in,
liquidity increasing or decreasing in any material way.
Membership in the FHLB provides the Bank with additional liquidity
alternatives such as short- or long-term funding on fixed- or
variable-rate terms. Available funding from the FHLB amounts to an
overnight borrowing capacity of up to $8,229,000 and a maximum
available funding capacity of up to $77,189,000. In order to
provide funding for the Bank's loans and investments, the Bank had
outstanding borrowing from the FHLB of $30,624,000 and $20,678,000
at September 30, 1998 and 1997, respectively.
Market Risk - Interest Rate Risk
________________________________
As a financial institution, the Corporation's primary component of
market risk is interest rate volatility. Fluctuations in interest
rates will ultimately impact the level of income and expense
recorded on a large portion of the Bank's assets and liabilities.
Virtually all of the Corporation's interest-sensitive assets and
liabilities are held by the Bank, and therefore, interest rate risk
management procedures are performed by the Bank. The nature of the
Bank's current operations is such that the Bank is not subject to
foreign currency exchange or commodity price risk. The Corporation
does not own any trading assets. The Corporation has not entered
into any hedging transactions such as interest rate floors, caps,
and swaps.
The objectives of interest rate risk management are to maintain or
increase net interest income over a broad range of market interest
rate movements. The Asset and Liability Management Committee is
responsible for managing interest rate risk using policies approved
by the Bank's Board of Directors. The Bank manages interest rate
risk by changing the mix or repricing characteristics of its
investment securities portfolio and borrowings from the FHLB and by
the promotion or development of specific loan and deposit products.
The Bank retains an outside consulting group to assist in
monitoring its interest rate risk using income simulation models on
a quarterly basis. The simulation model measures the sensitivity of
future net interest income to hypothetical changes in market
interest rates.
In an effort to assess market risk, the Bank utilizes a simulation
model to determine the effect of gradual increases or decreases in
market interest rates on net interest income and net income. The
aforementioned assumptions are revised based on defined scenarios
of assumed speed and direction changes of market interest rates.
These assumptions are inherently uncertain due to the timing,
magnitude and frequency of rate changes and changes in market
conditions as well as management strategies, among other factors.
Because it is difficult to accurately quantify into assumptions the
reaction of depositors and borrowers to market interest rate
changes, the actual net interest income and net income results may
differ from simulated results.
<PAGE>
The simulation model assumes a hypothetical gradual shift in market
interest rates over a twelve month period. This is based on a
review of historical changes in market interest rates and the level
and curve of current interest rates. The simulated results
represent the hypothetical effects to the Bank's net interest
income and net income. Projections for loan and deposit growth were
ignored in the simulation model. The simulation model includes all
of the Bank's earning assets and interest-bearing liabilities and
assumes a parallel and prorated shift in interest rates over a
twelve month period. As a result of the simulation model, it is
currently anticipated that a hypothetical two percent general rise
or decline in prevailing market interest rates over a one-year
period will have an immaterial impact to the Bank's net interest
income over the next twelve months. The computations do not
contemplate any actions Management or the Asset Liability
Management Committee could undertake in response to changes in
market conditions or market interest rates.
The Bank managed its interest rate risk position for the nine
months ended September 30, 1998 by the following: (1) paying higher
rates on intermediate term certificates in order to manage the
average remaining term on certificates of deposit below $100,000;
(2) marketing its floating rate home equity line of credit
(outstanding balances increased by $2,508,000 for the period); (3)
additions to or by repositioning of its investment security
portfolio into floating, short- or long-term securities; (4)
utilization of seven- and ten-year balloon mortgages (outstanding
balances increased by $1,941,000 for the period); (5) increasing
its extensions of adjustable and floating rate loans for new or
refinanced commercial and agricultural loans (these outstanding
loans increased by $4,878,000 for the period); (6) managing and
expanding the Bank's core deposit base; and (7) additions to or
restructuring of adjustable- and fixed-rate advances from the FHLB.
The above strategies and actions impact interest rate risk and are
all included in the Bank's quarterly simulation models in order to
determine future asset and liability management strategies. See
related discussions in the section on Net Interest Income.
Stockholders' Equity
____________________
The Corporation maintains capital ratios that are well above the
minimum total capital levels required by federal regulatory
authorities including the risk-based capital guidelines. Other than
discussed herein, there are no material commitments for capital
expenditures. There are no known trends, events or uncertainties,
including regulatory matters that are expected to have a material
impact on the capital resources of the Corporation for the
remaining months of 1998, except as discussed below concerning the
Corporation's common stock repurchase plan. In addition, see
discussion on Regulatory Activity.
On February 5, 1998, the Corporation announced that the Board of
Directors had authorized and approved a plan to purchase up to
100,000 shares of the Corporation's outstanding common stock in
open market or privately negotiated transactions. The Board of
Directors believes that a redemption or repurchase of this type is
in the best interests of the Corporation and its stockholders as a
method to enhance long-term shareholder value. Currently, the
shares are to be held as treasury shares (issued, but not
outstanding shares). As of September 30, 1998, a total of 81,934
shares of common stock were repurchased under this plan at a cost
of $1,862,842. This amount was funded by dividends from the
Corporation's wholly-owned subsidiary, Union National Community
Bank. The Bank paid the dividends from its current cash flow and
available retained earnings. The Bank remains well capitalized and
meets all regulatory capital guidelines after payment of the
dividends as defined below.
The Bank has risk-based capital ratios exceeding the regulatory
requirement. The risk-based capital guidelines require banks to
maintain a minimum risk-based capital ratio of 8.0% at September
30, 1998, as compared to the Bank's current risk-based capital
ratio of 14.71%. The total risk-based capital ratio is computed by
dividing stockholders' equity plus the allowance for loan losses by
risk-adjusted assets. Risk-adjusted assets are determined by
assigning credit risk-weighing factors from 0% to 100% to various
categories of assets and off-balance-sheet financial instruments.
Banking regulations also require the Bank to maintain certain
minimum capital levels
<PAGE>
in relation to Bank assets. Failure to meet minimum capital
requirements could result in prompt corrective action by the
federal banking agencies. As of December 31, 1997, the Bank was
categorized as well capitalized under the regulatory framework for
prompt corrective action. There are no conditions or events since
that notification that Management believes have changed the Bank's
category. The Bank maintains the following leverage and risk-based
capital ratios:
<TABLE>
<CAPTION>
(In Thousands) September 30, December 31,
1998 1997
____________ _____________
<S> <C> <C>
Tier I - Total Stockholders' Equity $ 21,809 $ 22,358
Tier II - Allowance for Loan Losses 1,750 1,593
____________ _____________
Total Qualifying Capital $ 23,559 $ 23,951
============ =============
Risk-adjusted On-balance-sheet Assets $151,483 $137,256
Risk-adjusted Off-balance-sheet Exposure 8,692 8,352
____________ _____________
Total Risk-adjusted Assets $160,175 $145,608
============ =============
Ratios:
Tier I Capital Ratio - Actual 9.00% 9.95%
Minimum Required 4.00 4.00
To Be Well Capitalized under Prompt
Corrective Action Provisions 5.00 5.00
Risk-based Capital Ratio:
Tier I Captial Ratio - Actual 13.62% 15.35%
Minimum Required 4.00 4.00
To Be Well Capitalized under Prompt
Corrective Action Provisions 6.00 6.00
Total Capital Ratio - Actual 14.71% 16.45%
Minimum Required 8.00% 8.00%
To Be Well Capitalized under Prompt
Corrective Action Provisions 10.00 10.00
Total Risk-Based Capital in Excess of the
Minimum Regulatory Requirement $ 10,745 $ 12,302
============ =============
</TABLE>
<PAGE>
No shares of common stock are reserved for issuance in the event of
conversions or the exercise of warrants, options or other rights,
except as follows: 124,830 shares which are reserved for issuance
under the Corporation's 1988 and 1997 Stock Incentive Plans,
100,000 shares which are reserved for issuance under the
Corporation's 1997 Employee Stock Purchase Plan, and 157,500 shares
which are reserved for issuance under the Corporation's Dividend
Reinvestment and Stock Purchase Plan. As of September 30, 1998,
options to purchase 4,830 shares have been granted under the
Corporation's Stock Incentive Plans. The exercise price for such
options is $23.27. No options have been exercised as of September
30, 1998 under this plan. As of September 30, 1998, options to
purchase 30,000 shares have been granted under the Corporation's
1997 Employee Stock Purchase Plan. The current exercise price for
such options is $19.60. As of September 30, 1998, 1,131 options
have been exercised under this plan. As of September 30, 1998,
20,319 shares have been issued under the Corporation's Dividend
Reinvestment and Stock Purchase Plan.
<PAGE>
Part II - Other Information:
Item 1. Legal Proceedings
Management is not aware of any litigation that would have a
material adverse effect on the consolidated financial position of
the Corporation. There are no proceedings pending other than the
ordinary routine litigation incident to the business of the
Corporation and its subsidiary, Union National Community Bank. In
addition, no material proceedings are pending or are known to be
threatened or contemplated against the Corporation and the Bank by
government authorities.
Item 2. Changes in Securities - Nothing to report.
Item 3. Defaults Upon Senior Securities - Nothing to report.
Item 4. Submission of Matters to a Vote of Security Holders -
Nothing to report.
Item 5. Other Information - Nothing to report.
Item 6. Exhibits and Reports on Form 8-K:
(a) Exhibits - The following exhibit is being filed as
part of this Report: (see also Item 6(b)).
Exhibit No. 27 - Financial Data Schedule as of September
30, 1998.
(b) Reports on Form 8-K - Nothing to report.
<PAGE>
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.
Union National Financial Corporation
(Registrant)
By /s/ William E. Eby
___________________________
William E. Eby
President & CEO
(Principal Executive Officer)
Date: November 12, 1998
By /s/ Clement M. Hoober
__________________________
Clement M. Hoober
Chief Financial Officer
(Principal Financial and
Accounting Officer)
Date: November 12, 1998
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