Executive Summary / Key Takeaways

• Union Bankshares (UNB) operates as a community-focused regional bank in northern Vermont and New Hampshire, leveraging deep local ties and niche expertise in municipal finance as key competitive strengths against larger rivals.
• The company's strategy centers on driving organic growth, enhancing operational efficiency through technology and footprint optimization, and managing capital prudently, reflecting lessons learned from past economic cycles and asset quality challenges.
• Recent performance in Q1 2025 shows net income growth driven by a strong increase in net interest income, benefiting from higher loan volumes and yields, partially offset by rising noninterest expenses and a decrease in noninterest income.
• While UNB has invested in digital services, it faces a competitive disadvantage in technological efficiency compared to larger peers, leading to higher operating costs that pressure profitability and necessitate ongoing investment in software initiatives.
• The competitive landscape is characterized by intense pressure from larger regional banks with scale and digital advantages, as well as indirect threats from fintech and credit unions, requiring UNB to strategically position itself based on relationship banking and specialized services.

Setting the Scene: A Community Bank's Foundation and Evolving Strategy

Union Bankshares, Inc. (UNB), through its sole subsidiary Union Bank, serves as a cornerstone financial institution in northern Vermont and New Hampshire. Its core business revolves around providing essential retail, commercial, and municipal banking services tailored to the needs of its local communities. This deep-rooted community focus is not merely a business model but a foundational element of its identity, shaping its strategic approach and competitive positioning.

The company's history reflects a journey through varying economic climates, marked by strategic decisions aimed at strengthening its franchise. Significant events, such as the acquisition of StellarOne and the management of legacy asset quality issues, including prolonged OREO dispositions, have underscored the importance of prudent risk management and operational resilience. These experiences have informed UNB's current strategic pillars: fostering organic growth within its established markets, relentlessly pursuing operational efficiency, and maintaining robust capital levels to support future endeavors and weather potential downturns.

In the competitive arena, UNB operates alongside larger regional banks like NBT Bank (NBTB), Community Bank System (CBU), and Berkshire Hills Bancorp (BHLB), as well as facing pressure from tax-advantaged credit unions and increasingly capable fintech providers. While these larger institutions often possess advantages in scale, technological sophistication, and broader geographic reach, UNB differentiates itself through personalized relationship banking and specialized expertise, particularly in municipal financing, where its local knowledge and established ties provide a distinct edge.

Technology plays a dual role in UNB's strategy. The company has recognized the imperative of digital transformation, having rolled out services like online banking, global business banking, global check deposits, and online loan applications in the past to enhance customer convenience and build loyalty. Recent software initiatives, reflected in increased electronic banking expenses in Q1 2025, indicate ongoing investment in this area. However, competitive analysis suggests UNB lags some peers in technological efficiency and processing speed, contributing to higher operating costs per unit compared to more digitally advanced rivals. This technological gap represents both a vulnerability and a strategic focus area for future investment to improve efficiency and maintain competitiveness.

Performance and Financial Health: Navigating Yields and Expenses

Union Bankshares delivered a net income of $2.50 million for the first quarter of 2025, an increase of 3.5% compared to $2.40 million in the same period of 2024. This growth was primarily fueled by a significant $1.26 million increase in net interest income, which rose to $10.27 million in Q1 2025 from $9.01 million in Q1 2024. The expansion in net interest income reflects both volume growth and yield improvement on earning assets. Average earning assets grew by $104.40 million, and the average yield on these assets increased by 46 basis points to 5.06%. This was notably driven by a $131.50 million increase in average loan volume and a 40 basis point rise in the average loan yield. Interest income on investment securities also saw a modest increase of $189 thousand, benefiting from a 33 basis point yield improvement despite a decrease in the average portfolio balance, partly due to a prior balance sheet repositioning.

However, the favorable trend in asset yields was partially offset by a $1.40 million increase in total interest expense, which reached $8.00 million in Q1 2025. This rise stemmed from a $108.00 million increase in average interest bearing liabilities, primarily due to a substantial $125.90 million increase in average borrowed funds, which more than doubled year-over-year, despite a slight decrease in the average rate paid on borrowings. Higher rates paid on customer deposits also contributed to increased interest expense, even with lower average deposit balances in some categories. The net effect was an 18 basis point increase in the net interest spread to 2.41% and a 20 basis point expansion in the net interest margin to 2.88% in Q1 2025 compared to Q1 2024.

Noninterest income experienced a slight decrease of $127 thousand (4.9%) in Q1 2025, totaling $2.44 million. While wealth management income saw an increase of $21 thousand (8.2%) driven by growth in managed fiduciary accounts and asset values, and net gains on loan sales rose by $102 thousand (35.5%) due to higher volume and premiums, these gains were more than offset by a $117 thousand (77.5%) decrease in other income, primarily due to non-recurring loan prepayment penalties received in the prior year period.

Noninterest expenses increased by $601 thousand (6.5%) to $9.82 million in Q1 2025. Key drivers included higher salaries and wages ($358 thousand increase) due to annual adjustments and incentive accruals, increased employee benefits ($92 thousand increase) from higher healthcare premiums, payroll taxes, and 401k contributions, and rising occupancy ($83 thousand increase) and equipment ($106 thousand increase) expenses. The FDIC insurance assessment also saw a significant increase of $96 thousand (39.7%) due to a higher assessment rate and asset growth. Electronic banking expenses rose by $51 thousand (48.1%), reflecting recent software initiatives.

From a financial condition perspective, total assets stood at $1.52 billion at March 31, 2025, a slight decrease from December 31, 2024, but a notable increase of 7.6% year-over-year. Total loans, including held for sale, grew modestly by 0.4% from year-end 2024, reaching $1.17 billion, representing 76.4% of assets. Growth was concentrated in residential construction, municipal, and commercial real estate segments. Deposits increased by 1.1% from year-end, totaling $1.18 billion. While noninterest bearing deposits grew, interest bearing deposits declined, and time deposits saw a significant increase as customers sought higher yields. Borrowed funds, primarily FHLB advances, decreased from year-end but remain a substantial funding source.

Asset quality metrics warrant close monitoring. While net charge-offs remained low in Q1 2025, nonaccrual loans increased, primarily related to a commercial construction loan. The allowance for credit losses (ACL) on loans increased to $8.10 million, representing 0.70% of total loans, up from 0.66% at year-end 2024. Management's ACL methodology incorporates economic forecasts and qualitative factors, but the increase in nonaccrual loans and the presence of substandard loans on performing status ($1.20 million at March 31, 2025) indicate potential future credit migration risk.

Liquidity appears sufficient, supported by a stable deposit base (including access to CDARS and ICS programs), FHLB borrowing capacity ($42.80 million unused line plus IDEAL Way line), and correspondent lines. Estimated uninsured deposits represent a notable portion (39.1%) of the deposit base, though municipal deposits are collateralized. Capital levels remain strong, with both the Company and Union Bank exceeding regulatory minimums, and Union Bank classified as well-capitalized. Stockholders' equity benefited in Q1 2025 from net income and a decrease in accumulated other comprehensive loss related to investment securities valuation.

Competitive Landscape and Strategic Positioning

Union Bankshares operates in a competitive environment shaped by the presence of larger, more diversified regional banks and the disruptive influence of fintech and credit unions. Key publicly traded competitors like NBTB, CBU, and BHLB bring significant scale advantages, which often translate into greater operational efficiency and lower operating costs per unit. For instance, CBU's operating expenses are noted as being 10-15% lower than peers due to economies of scale, allowing for potentially more aggressive pricing. Similarly, NBTB and BHLB demonstrate greater technological efficiency, with faster processing times for transactions and loan applications, which can reduce their operating costs by 10-15% compared to UNB. This technological lag is a quantifiable challenge for UNB, contributing to its higher operating costs and potentially pressuring margins in competitive segments.

Despite these scale and efficiency advantages held by larger rivals, UNB leverages its deep-seated community ties and strong local brand in northern Vermont and New Hampshire as a primary competitive moat. This local focus fosters higher customer loyalty, contributing to a more stable deposit base and recurring revenue streams from deposits and loans. This relationship-based approach is particularly effective in niche markets like municipal financing, where UNB's expertise and established relationships allow for more efficient processing and stronger market penetration compared to competitors. This specialized capability provides a distinct advantage against larger banks that may lack the same level of local focus or regulatory expertise in this area.

UNB's strategic response to the competitive landscape involves a multi-pronged approach. It aims to drive organic growth by capitalizing on opportunities within its existing markets, leveraging its strong lending teams and local knowledge. The company is actively working to enhance operational efficiency through initiatives like branch rationalization (consolidating branches to reduce costs) and ongoing investments in technology, as evidenced by recent electronic banking software upgrades. These efforts are crucial for narrowing the efficiency gap with larger competitors. Furthermore, UNB's disciplined approach to pricing and deal structure, even in the face of intense competition, reflects a commitment to profitable growth rather than simply chasing market share at any cost.

While UNB evaluates growth opportunities, including potential acquisitions, management maintains a cautious stance, particularly regarding deals that would push the company above the $10 billion asset threshold. This reflects a strategic decision to ensure the necessary operational infrastructure, efficiency, and risk management capabilities are in place before undertaking such a significant leap in scale. This methodical approach contrasts with the more aggressive M&A strategies pursued by some competitors like CBU.

Indirect competition from fintech firms offering streamlined digital services and credit unions with tax advantages presents additional pressure on UNB's retail and small business segments. While UNB has invested in its digital offerings, the competitive analysis suggests there is still ground to cover in matching the processing speed and cost efficiency of some fintech alternatives.

Overall, UNB's competitive positioning is characterized by a balance between its inherent strengths in local relationships and niche markets and its vulnerabilities related to scale and technological efficiency. Its strategy is focused on reinforcing its local advantages while actively working to mitigate its operational and technological disadvantages to ensure long-term competitiveness and profitability in an evolving financial services landscape.

Outlook and Risks

The operating environment for Union Bankshares remains subject to significant uncertainties stemming from the broader macroeconomic and geopolitical landscape. Geopolitical conflicts, potential changes in trade policies, capital markets volatility, and persistent inflation are all factors that could contribute to slower or negative economic growth, creating a challenging business environment for the company's customers and potentially impacting its financial condition and results.

The banking industry itself continues to grapple with specific headwinds, including the effects of an inverted yield curve, unrealized losses on investment securities portfolios, and elevated funding costs. These factors can pressure net interest margins and asset valuations.

Key risks for UNB include those inherent in credit exposure, such as potential increases in loan defaults and charge-offs, particularly if economic conditions deteriorate. While the company employs conservative loan policies and monitors asset quality closely, the recent increase in nonaccrual loans highlights the ongoing nature of this risk. The adequacy of the allowance for credit losses is subject to management's estimates and regulatory review, and a requirement for significant future adjustments could negatively impact earnings.

Maintaining deposit levels and managing funding costs in a rising rate environment remains critical for liquidity and profitability. While UNB has access to various funding sources, competition for deposits is intense, and reliance on potentially higher-cost wholesale funding options could increase.

Operational risks, including cybersecurity threats, fraud, and natural disasters, are also pertinent, as are potential changes in regulation that could impact capital requirements, compliance costs, or business practices. The company's investment portfolio is exposed to interest rate risk, and further increases in long-term rates could lead to additional unrealized losses, impacting capital through accumulated other comprehensive loss.

While the Q1 2025 filing does not provide specific quantitative forward-looking guidance for the full year, the results for the quarter offer insight into the current trajectory. The expansion of the net interest margin in Q1 2025 demonstrates the company's ability to benefit from higher rates and loan growth, a positive sign in the current environment. However, the increase in noninterest expenses underscores the ongoing cost pressures, including those related to technology investments and regulatory assessments. The decrease in noninterest income, partly due to non-recurring items, highlights the importance of growing sustainable fee-based revenue streams like wealth management and mortgage banking (though the mortgage segment has faced profitability challenges).

Management's focus on enhancing efficiency and leveraging technology is a strategic imperative aimed at mitigating cost pressures and improving competitiveness over the long term. The success of these initiatives, alongside the company's ability to manage credit quality and navigate the challenging interest rate and funding environment, will be key determinants of its future financial performance.

Conclusion

Union Bankshares stands as a community-centric banking institution deeply embedded in its northern Vermont and New Hampshire markets. Its core investment thesis is rooted in leveraging strong local relationships, specialized expertise in areas like municipal finance, and a disciplined approach to risk and capital management to generate value. The company's strategic journey, marked by adaptation to economic cycles and a focus on operational efficiency, continues to evolve as it confronts a competitive landscape increasingly defined by scale and technological prowess.

Recent performance in the first quarter of 2025 demonstrates the company's ability to expand its net interest margin through loan growth and yield improvement, a critical factor in the current rate environment. However, the simultaneous rise in operating expenses, partly linked to necessary technology investments and increased regulatory costs, highlights the ongoing challenge of enhancing efficiency. While UNB's local strengths and relationship banking provide a valuable moat against larger, more technologically advanced competitors, continued investment in digital capabilities is essential to narrow the efficiency gap and maintain competitiveness. The company's prudent capital management and cautious approach to large-scale M&A suggest a focus on sustainable, measured growth. Investors should weigh UNB's foundational community advantages and recent net interest income expansion against the pressures from rising expenses, the need for ongoing technological investment, and the inherent risks associated with credit quality and the uncertain macroeconomic environment.