-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IBvp/f9z8OtS3tjwdzAONDrVhxv+OhLq9zDEqBMvNsKcNNxJD/hlih3od3Cs6VAg qrSCJ6sluLhXIYXeF3gq+A== 0000950152-06-002139.txt : 20060315 0000950152-06-002139.hdr.sgml : 20060315 20060315171216 ACCESSION NUMBER: 0000950152-06-002139 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 20051231 FILED AS OF DATE: 20060315 DATE AS OF CHANGE: 20060315 FILER: COMPANY DATA: COMPANY CONFORMED NAME: UNITED COMMUNITY FINANCIAL CORP CENTRAL INDEX KEY: 0000707886 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTIONS, NOT FEDERALLY CHARTERED [6036] IRS NUMBER: 341856319 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-24399 FILM NUMBER: 06689026 BUSINESS ADDRESS: STREET 1: 275 FEDERAL PLAZA WEST CITY: YOUNGSTOWN STATE: OH ZIP: 44503-1203 BUSINESS PHONE: 3307420500 10-K 1 l17997ae10vk.txt UNITED COMMUNITY FINANCIAL CORP. 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2005 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: 0-024399 UNITED COMMUNITY FINANCIAL CORP. -------------------------------- (Exact name of registrant as specified in its charter) Ohio 34-1856319 ------------------------------- ---------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 275 Federal Plaza West, Youngstown, Ohio 44503 ------------------------------------------------------------------ (Address of principal executive offices) (Zip Code) Registrant's telephone number: (330) 742-0500 Securities registered pursuant to Section 12(b) of the Act: None None ------------------ ------------------------------------------- (Title of Class) (Name of each exchange on which registered) Securities registered pursuant to Section 12(g) of the Act: Common shares, no par value per share --------------------------------------- (Title of Class) Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [X] No [ ] Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes [ ] No [X] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in a definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this 10K. [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.). Yes [ ] No [X] The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the last reported sale on June 30, 2005 was $333.0 million. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the registrant that such person is an affiliate of the registrant.) As of March 13, 2006, there were 31,092,963 of the Registrant's Common Shares outstanding. DOCUMENTS INCORPORATED BY REFERENCE Part II of Form 10-K - Portions of 2005 Annual Report to Shareholders Part III of Form 10-K - Portions of Proxy Statement for the 2006 Annual Meeting of Shareholders TABLE OF CONTENTS
Item Number Page - ------ ---- PART I 1. Description of Business General...................................................................................... 1 Discussion of Forward-Looking Statements..................................................... 2 Lending Activities........................................................................... 2 Investment Activities........................................................................ 11 Sources of Funds............................................................................. 13 Competition.................................................................................. 15 Employees.................................................................................... 16 Regulation................................................................................... 16 1A. Risk Factors.................................................................................... 17 1B. Unresolved Staff Comments....................................................................... 19 2. Properties...................................................................................... 19 3. Legal Proceedings............................................................................... 19 4. Submission of Matters to a Vote of Security Holders............................................. 19 PART II 5. Market for Registrant's Common Equity and Related Shareholder Matters........................... 19 6. Selected Financial Data......................................................................... 19 7. Management's Discussion and Analysis of Financial Condition and Results of Operations........... 19 7A. Quantitative and Qualitative Disclosures About Market Risk...................................... 19 8. Financial Statements and Supplemental Data...................................................... 19 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............ 20 9A. Controls and Procedures......................................................................... 20 9B. Other Information............................................................................... 20 PART III 10. Directors and Executive Officers of the Registrant.............................................. 20 11. Executive Compensation.......................................................................... 20 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters.. 20 13. Certain Relationships and Related Transactions.................................................. 21 14. Principal Accountant Fees and Services.......................................................... 21 PART IV 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K................................. 21 Signatures........................................................................................... 23 Exhibit Index........................................................................................ 24
PART I ITEM 1. DESCRIPTION OF BUSINESS GENERAL United Community Financial Corp. (United Community) was incorporated in the State of Ohio in February 1998 for the purpose of owning all of the outstanding capital stock of The Home Savings and Loan Company of Youngstown, Ohio (Home Savings) issued upon the conversion of Home Savings from a mutual savings association to a permanent capital stock savings association (Conversion). The Conversion was completed on July 8, 1998. On August 12, 1999, Butler Wick Corp. (Butler Wick) became a wholly-owned subsidiary of United Community. United Community's Internet site, http://www.ucfconline.com, contains a hyperlink to the Securities and Exchange Commission (SEC) where United Community's annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Section 16 Insider Reports and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge as soon as reasonably practicable after United Community has filed the report with the SEC. As a savings and loan holding company, United Community is subject to regulation, supervision and examination by the Office of Thrift Supervision (OTS), the Division of Financial Institutions of the Ohio Department of Commerce (Division) and the SEC. United Community's primary activity is holding the common shares of Home Savings and Butler Wick. Consequently, the following discussion focuses primarily on the business of Home Savings and Butler Wick. Home Savings was organized as a mutual savings association under Ohio law in 1889. During 2003, Home Savings changed its charter from a state-chartered savings and loan association to a state-chartered savings bank. Home Savings is subject to supervision and regulation by the Federal Deposit Insurance Corporation (FDIC) and the Division. Home Savings is a member of the Federal Home Loan Bank of Cincinnati (FHLB) and the deposits of Home Savings are insured up to applicable limits by the FDIC in the Savings Association Insurance Fund (SAIF). Home Savings conducts business from its main office located in Youngstown, Ohio, 37 full-service branches and six loan production offices located throughout northern Ohio and western Pennsylvania. The principal business of Home Savings is the origination of mortgage loans, including construction loans on residential and nonresidential real estate located in Home Savings' primary market area, which consists of Ashland, Columbiana, Cuyahoga, Erie, Geauga, Hancock, Huron, Lake, Mahoning, Montgomery, Richland, Sandusky, Seneca, Summit and Trumbull Counties in Ohio and Beaver County in Pennsylvania. In addition to real estate lending, Home Savings originates commercial loans and various types of consumer loans. For liquidity and interest rate risk management purposes, Home Savings invests in various financial instruments as discussed below under "Investment Activities." Funds for lending and other investment activities are obtained primarily from savings deposits, which are insured up to applicable limits by the FDIC, principal repayments of loans, borrowings from the FHLB and maturities of securities. Interest on loans and other investments is Home Savings' primary source of income. Home Savings' principal expense is interest paid on deposit accounts and other borrowings and salaries and benefits paid to employees. Operating results are dependent to a significant degree on the net interest income of Home Savings, which is the difference between interest earned on loans and other investments and interest paid on deposits and borrowed funds. Like most financial institutions, Home Savings' interest income and interest expense are affected significantly by general economic conditions and by the policies of various regulatory authorities. Butler Wick is the parent company for two wholly-owned subsidiaries: Butler Wick & Co., Inc. and Butler Wick Trust Company. Butler Wick conducts business from its main office located in Youngstown, Ohio and 20 offices located in northeastern Ohio, western Pennsylvania and Illinois. The principal business of Butler Wick is to sell common and preferred stocks, an array of government, corporate and municipal bonds, unit trusts, mutual funds, IRAs, money market accounts and certificates of deposit. Butler Wick also offers investments in a full line of life insurance and annuity products, personal and corporate financial planning, fiduciary services, estate planning, pension and profit sharing and precious metals. Butler Wick's primary source of income is commissions earned on trades initiated by customers and its primary expense is salaries and employee benefits. Commissions earned by Butler Wick, which are a component of non-interest income, may be affected by general economic conditions in its market area as well as policy changes by various regulatory agencies. 1 DISCUSSION OF FORWARD-LOOKING STATEMENTS When used in this Form 10-K the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project" or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties including changes in economic conditions in United Community's market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in Home Savings' market area, demand for investments in Butler Wick's market area and competition, that could cause actual results to differ materially from results presently anticipated or projected. United Community cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. United Community advises readers that the factors listed above could affect United Community's financial performance and could cause United Community's actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. United Community does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. LENDING ACTIVITIES GENERAL. Home Savings' principal lending activity is the origination of conventional real estate loans secured by real estate located in Home Savings' primary market area, including single family residences. Home Savings also originates loans secured by multifamily residences and nonresidential real estate, including construction projects. In addition to real estate lending, Home Savings originates commercial loans and various types of consumer loans, including home equity loans, education loans, loans secured by savings accounts, motor vehicles, boats and recreational vehicles and unsecured loans. 2 LOAN PORTFOLIO COMPOSITION. The following table presents certain information regarding the composition of United Community's loan portfolio at the dates indicated:
At December 31, 2005 2004 2003 2002 2001 ------------------- ------------------- ------------------- ------------------- ------------------- Percent Percent Percent Percent Percent of total of total of total of total of total Amount loans Amount loans Amount loans Amount loans Amount loans ---------- -------- ---------- -------- ---------- -------- ---------- -------- ---------- -------- (Dollars in thousands) Real estate loans: Permanent loans: One- to four-family residential $ 749,362 35.44% $ 690,413 37.68% $ 599,370 37.62% $ 884,950 59.13% $1,011,701 69.97% Multifamily residential 154,702 7.32 153,011 8.35 148,362 9.31 78,298 5.23 54,321 3.76 Non-residential 314,124 14.86 289,755 15.81 291,588 18.30 226,399 15.13 132,936 9.19 Land 14,979 0.71 14,701 0.80 14,147 0.89 5,812 0.39 10,368 0.72 ---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ Total permanent 1,233,167 58.33 1,147,880 62.64 1,053,467 66.12 1,195,459 79.88 1,209,326 83.64 Construction loans: One- to four-family residential 389,558 18.43 301,193 16.44 244,837 15.37 73,047 4.88 71,221 4.93 Multifamily and non-residential 66,788 3.16 47,230 2.58 27,586 1.73 27,625 1.85 23,344 1.61 ---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ Total construction 456,346 21.59 348,423 19.01 272,423 17.10 100,672 6.73 94,565 6.54 ---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ Total real estate loans 1,689,513 79.92 1,496,303 81.65 1,325,890 83.22 1,296,131 86.61 1,303,891 90.18 Consumer loans: Home equity 196,986 9.32 133,441 7.28 134,053 8.41 109,671 7.33 48,671 3.37 Auto 42,975 2.03 58,148 3.17 48,219 3.03 36,052 2.41 21,703 1.50 Marine 23,434 1.11 31,622 1.73 22,987 1.44 63 0.00 0 0.00 RV 48,108 2.27 27,330 1.49 15 0.00 25 0.00 0 0.00 Other (1) 12,012 .57 17,105 .94 13,488 .85 10,085 0.68 40,638 2.81 ---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ Total consumer 323,515 15.30 267,646 14.61 218,762 13.73 155,896 10.42 111,012 7.68 Commercial loans 100,977 4.78 68,523 3.74 48,570 3.05 44,470 2.97 30,906 2.14 ---------- ------ ---------- ------ ---------- ------ ---------- ------ ---------- ------ Total loans 2,114,005 100.00% 1,832,472 100.00% 1,593,222 100.00% 1,496,497 100.00% 1,445,809 100.00% ====== ====== ====== ====== ====== Less net items 16,572 16,496 16,728 18,284 19,138 ---------- ---------- ---------- ---------- ---------- Total loans, net $2,097,433 $1,815,976 $1,576,494 $1,478,213 $1,426,671 ========== ========== ========== ========== ==========
- --------------- (1) Consists primarily of overdraft protection loans and loans to individuals secured by demand accounts, deposits and other consumer assets. 3 LOAN MATURITY. The following table sets forth certain information as of December 31, 2005, regarding the dollar amount of construction loans and commercial loans maturing in Home Savings' portfolio based on their contractual terms to maturity. Demand loans and other loans having no stated schedule of repayments or no stated maturity are reported as due in one year or less. Mortgage loans originated by Home Savings generally include due-on-sale clauses that provide Home Savings with the contractual right to deem the loan immediately due and payable in the event the borrower transfers the ownership of the property without Home Savings' consent. The table does not include the effects of possible prepayments or scheduled repayments.
Principal repayments contractually due in the years ended December 31, --------------------------------------------------------- 2011 and 2006 2007-2010 thereafter Total --------- --------- ---------- --------- (Dollars in thousands) Construction loans: One- to four-family residential $ 304,165 $ 837 $ 84,556 $ 389,558 Multifamily and non-residential 12,988 13,823 39,977 66,788 --------- -------- -------- --------- 317,153 14,660 124,533 456,346 Commercial loans 53,237 41,836 5,904 100,977 --------- -------- -------- --------- Total $ 370,390 $ 56,496 $130,437 $ 557,323 ========= ======== ======== =========
The next table sets forth the dollar amount of all loans reported above as due after December 31, 2006, which have fixed or adjustable interest rates:
Due after December 31, 2006 --------------------------- (Dollars in thousands) Fixed rate $ 29,024 Adjustable rate 157,909 ---------- $ 186,933 ==========
LOANS SECURED BY ONE- TO FOUR-FAMILY REAL ESTATE. Home Savings originates conventional loans secured by first mortgages on one- to four-family residences located within Home Savings' primary market area. At December 31, 2005, Home Savings' one- to four-family residential real estate loans totaled approximately $749.4 million, or 35.4% of total loans. At December 31, 2005, $6.9 million, or 0.9%, of Home Savings' one- to four-family loans, were nonperforming. Home Savings currently offers fixed-rate mortgage loans and adjustable-rate mortgage loans (ARMs) for terms of up to 40 years. Although Home Savings' loan portfolio includes a significant amount of 30-year fixed-rate loans, since 200_ most fixed rate loans are originated for sale. The interest rate adjustment periods on ARMs are typically one, three or five years. The maximum interest rate adjustment on most of the ARMs is 2.0% on any adjustment date and a total of 6.0% over the life of the loan. The interest rate adjustments on three-year and five-year ARMs presently offered by Home Savings are indexed to the weekly average rate on the one-year U.S. Treasury securities. Rate adjustments are computed by adding a stated margin to the index. FDIC regulations and Ohio law limit the amount that Home Savings may lend in relationship to the appraised value of the real estate and improvements that secure the loan at the time of loan origination. In accordance with such regulations, Home Savings makes loans on one- to four-family residences of up to 97% of the value of the real estate and improvements (LTV). Home Savings typically requires private mortgage insurance on the portion of the principal amount of the loan that exceeds 85% of the appraised value of the property securing the loan. Under certain circumstances, Home Savings will offer 85% LTV loans without private mortgage insurance. Such loans involve a higher degree of risk because in the event of a borrower default, the value of the underlying collateral may not satisfy the principal and interest outstanding on the loan. To reduce this risk, Home Savings underwrites all such loans to Freddie Mac and Fannie Mae underwriting guidelines. At December 31, 2005, these loans totaled $113.2 million, $705,000 of which was nonperforming. 4 From time-to-time, Home Savings originates interest-only loans, but these loans are sold immediately after origination. Currently, no interest-only loans are contained in Home Savings portfolio. Home Savings issues loan origination commitments to qualified borrowers primarily for the purchase of single-family residential real estate. Such commitments have specified terms and conditions and are made for periods of up to 60 days, during which time the interest rate is locked in. LOANS SECURED BY MULTIFAMILY RESIDENCES. Home Savings originates loans secured by multifamily properties that contain more than four units. Multifamily loans are offered with adjustable rates of interest, which adjust according to a specified index, and typically have terms ranging from five to ten years and LTVs of up to 80%. Multifamily lending generally is considered to involve a higher degree of risk than one- to four-family residential lending because the borrower typically depends upon income generated by the project to cover operating expenses and debt service. The profitability of a project can be affected by economic conditions, government policies and other factors beyond the control of the borrower. Home Savings attempts to reduce the risk associated with multifamily lending by evaluating the creditworthiness of the borrower and the projected income from the project and by obtaining personal guaranties on loans made to corporations and partnerships. Home Savings requires borrowers to submit financial statements annually to enable management to monitor the loan and requires an assignment of rents from borrowers. At December 31, 2005, loans secured by multifamily properties totaled approximately $154.7 million, or 7.3% of total loans. The largest loan had a principal balance of $12.1 million and was performing according to its terms. There were approximately $725,000 in multifamily loans that were considered nonperforming at December 31, 2005. LOANS SECURED BY NONRESIDENTIAL REAL ESTATE. Home Savings originates loans secured by nonresidential real estate including shopping centers, office buildings, hotels and motels. Home Savings' nonresidential real estate loans have adjustable rates, terms of up to 25 years and, generally, LTVs of up to 75%. The majority of such properties are located within Home Savings' primary lending area. Nonresidential real estate lending generally is considered to involve a higher degree of risk than residential lending due to the relatively larger loan amounts and the effects of general economic conditions on the successful operation of income-producing properties. Home Savings has endeavored to reduce such risk by evaluating the credit history of the borrower, the location of the real estate, the financial condition of the borrower, the quality and characteristics of the income stream generated by the property and the appraisals supporting the property's valuation. At December 31, 2005, Home Savings' largest loan secured by nonresidential real estate had a balance of $11.2 million and was performing according to its terms. At December 31, 2005, approximately $314.1 million, or 14.9%, of Home Savings' total loans were secured by mortgages on nonresidential real estate, of which $5.6 million were considered nonperforming at December 31, 2005. LOANS SECURED BY VACANT LAND. Home Savings also originates a limited number of loans secured by vacant land for the construction of single-family houses. Home Savings' land loans generally are fixed-rate loans for terms up to five years and require a LTV of 75% or less. At December 31, 2005, approximately $15.0 million, or 0.71%, of Home Savings' total loans were land loans, a majority of which were loans to individuals intending to construct and occupy single-family residences on the properties. Nonperforming land loans totaled $3.7 million at December 31, 2005. CONSTRUCTION LOANS. Home Savings originates loans for the construction of one- to four-family residences, multifamily properties and nonresidential real estate projects. Residential construction loans are made to both owner-occupants and to builders on a speculative (unsold) basis. Construction loans to owner-occupants are structured as permanent loans with fixed or adjustable rates of interest and terms of up to 30 years. During the first year, while the residence is being constructed, the borrower is required to pay interest only. Construction loans for one- to four-family residences have LTVs of up to 95%, and construction loans for multifamily and nonresidential properties have LTVs of up to 80%, with the value of the land included as part of the owner's equity. At December 31, 2005, Home Savings had approximately $456.3 million, or 21.6% of its total loans, invested in construction loans, including $389.6 million in one- to four-family residential construction and approximately $66.8 million in multifamily and nonresidential construction loans. Approximately 87.5% of Home Savings' construction loans are made to 5 builders for homes for which the builder does not have a contract with a buyer. Home Savings, however, limits the number of outstanding loans to each builder on unsold homes under construction. Construction loans generally involve greater underwriting and default risks than loans secured by mortgages on existing properties because construction loans are more difficult to appraise and to monitor. Loan funds are advanced upon the security of the project under construction. In the event a default on a construction loan occurs and foreclosure follows, Home Savings must take control of the project and attempt either to arrange for completion of construction or dispose of the unfinished project. Nonperforming construction loans at December 31, 2005, totaled $1.2 million. CONSUMER LOANS. Home Savings originates various types of consumer loans, including home equity loans, vehicle loans, education loans, recreational vehicle loans, marine loans, overdraft protection loans, loans to individuals secured by demand accounts, deposits and other consumer assets and unsecured loans. Consumer loans are made at fixed and adjustable rates of interest and for varying terms based on the type of loan. At December 31, 2005, Home Savings had approximately $323.5 million, or 15.3% of its total loans, invested in consumer loans. Home Savings generally makes closed-end home equity loans in an amount which, when added to the prior indebtedness secured by the real estate, does not exceed 95% of the estimated value of the real estate. Home equity loans typically are secured by a second mortgage on the real estate. Home Savings frequently holds the first mortgage, although Home Savings will make home equity loans in cases where another lender holds the first mortgage. Home Savings also offers home equity loans with a line of credit feature. Home equity loans are made with adjustable and fixed rates of interest. Fixed-rate home equity loans have terms of ten years but can be called after five years. Rate adjustments on adjustable home equity loans are determined by adding a 1.25% margin to the current prime interest rate for loans on residences of up to 80% LTV or by adding a 1.50% margin to the current prime interest rate for loans on residences of up to 90% LTV to the one-year U.S. Treasury index. At December 31, 2005, approximately $197.0 million, or 60.9%, of Home Savings' consumer loan portfolio consisted of home equity loans. Consumer loans secured by a deposit or savings account are made for up to 100% of the principal balance of the account and generally have adjustable rates, which adjust based on the weekly average yield on U.S. Treasury securities plus a margin. For new automobiles, loans are originated for up to 110% of the MSRP value of the car with terms of up to 72 months, and, for used automobiles, loans are made for up to the National Automobile Dealers Association (N.A.D.A) retail value of the car model and a term of up to 66 months. Most automobile loans are originated indirectly by approved auto dealerships. At December 31, 2005, automobile loans totaled $43.0 million, or 13.3%, of Home Savings' consumer loan portfolio. Loans for recreational vehicles may be either originated or purchased by Home Savings. Recreational vehicle loans are originated for up to 85% of the selling price on new vehicles and 90% of the N.A.D.A retail value of used units with terms of up to 20 years. Loans are generally fixed for the first seven years and change to an adjustable rate loan for the remaining term. During 2005, Home Savings purchased a pool of recreational vehicle loans totaling $19.9 million. At December 31, 2005, recreational vehicle loans totaled $48.1 million, or 14.9%, of Home Savings' consumer loan portfolio. Nonperforming consumer loans at December 31, 2005, amounted to $2.7 million. COMMERCIAL LOANS. Home Savings makes commercial loans to businesses in its primary market area, including traditional lines of credit, revolving lines of credit, term loans and acquisition and development loans. The LTV ratios for commercial loans depend upon the nature of the underlying collateral, but generally commercial loans are made with LTVs of 50% to 90% and have adjustable interest rates. Lines of credit and revolving credits generally are priced on a floating rate basis, which is tied to the prime interest rate or U.S. Treasury bill rate. Term loans usually have adjustable rates, but can have fixed rates of interest, and have terms of one to five years. At December 31, 2005, Home Savings had approximately $101.0 million, or 4.8% of total loans, invested in commercial loans. The majority of these loans are secured by inventory, accounts receivable, machinery, investment property, vehicles or other assets of the borrower. Home Savings also originates unsecured commercial loans including lines of credit for periods of less than 12 months, short-term loans and, occasionally, term loans for periods of up to 36 months. These loans are underwritten based on the creditworthiness of the borrower and the guarantors, if any. Home Savings had $33.5 million in unsecured commercial loans as of December 31, 2005. 6 Commercial loans generally entail greater risk than real estate lending. The repayment of commercial loans typically is dependent on the income stream and successful operation of a business, which can be affected by economic conditions. The collateral for commercial loans, if any, often consists of rapidly depreciating assets. Nonperforming commercial loans at December 31, 2005, amounted to $3.6 million. LOAN SOLICITATION AND PROCESSING. The lending activities of Home Savings are subject to the written, non-discriminatory underwriting standards and loan origination procedures approved by Home Savings' Board of Directors (Board). Loan originations generally are obtained from existing customers and members of the local community and from referrals by real estate brokers, lawyers, accountants and current and former customers. Home Savings also advertises in the local print media, radio and television. Each of Home Savings' 37 offices and six loan production offices have loan personnel who can accept loan applications, which are then forwarded to Home Savings' Underwriting Department for processing and approval. In underwriting real estate loans, Home Savings typically obtains a credit report, verification of employment and other documentation concerning the creditworthiness of the borrower. An appraisal of the fair market value of the real estate that will be given as security for the loan is prepared by one of Home Savings' in-house licensed appraisers or an approved independent fee appraiser. For certain large nonresidential real estate loans, the appraisal is conducted by an outside fee appraiser whose report is reviewed by Home Savings' chief appraiser. Upon the completion of the appraisal and the receipt of information on the credit history of the borrower, the loan application is submitted for review to the appropriate persons. Commercial, residential and nonresidential real estate loans up to $1.0 million may be approved by an authorized executive officer. Loan requests of $1.0 million to $15.0 million require the approval of the Loan Committee. All loans of $15.0 million or more require approval by three executive officers and a majority of the Board. Borrowers are required to carry satisfactory fire and casualty insurance and flood insurance, if applicable, and to name Home Savings as an insured mortgagee. Home Savings generally obtains a title guarantee or title insurance on real estate loans. The procedure for approval of construction loans is the same as for permanent real estate loans, except that an appraiser evaluates the building plans, construction specifications and estimates of construction costs. Home Savings also evaluates the feasibility of the proposed construction project and the experience and record of the builder. Once approved, the construction loan is disbursed in installments based upon periodic inspections of construction progress. Consumer loans are underwritten on the basis of the borrower's credit history and an analysis of the borrower's income and expenses, ability to repay the loan and the value of the collateral, if any. LOAN ORIGINATIONS, PURCHASES AND SALES. Home Savings' residential loans generally are made on terms and conditions and documented to conform to the secondary market guidelines for sale to the Federal Home Loan Mortgage Company (FHLMC) and other institutional investors in the secondary market. Education loans are sold, once the borrower leaves school, to the Student Loan Marketing Association. Home Savings does not originate first mortgage loans insured by the Federal Housing Authority or guaranteed by the Veterans Administration, but it has purchased such loans as well as participation interests in such loans. Home Savings generally retains the servicing rights on the sale of loans originated in the geographic area surrounding its full service branches. Home Savings anticipates continued participation in the secondary mortgage loan market to maintain its desired risk profile. At December 31, 2005, Home Savings had $96.6 million of outstanding commitments to make loans and $142.5 million available to borrowers under consumer and commercial lines of credit. At December 31, 2005, Home Savings had $264.1 million in undisbursed funds related to construction loans in process. During 2003, Home Savings entered into an agreement to purchase one- to four-family construction loans from another institution. Loans purchased under this agreement earn a floating rate of interest, are guaranteed as to principal and interest by a third party and are for the purpose of constructing either pre-sold or market homes. At December 31, 2005, approximately $101.7 million was outstanding under this program. Home Savings anticipates continuing purchases of loans under this program in 2006. 7 LOANS TO ONE BORROWER LIMITS. Regulations generally limit the aggregate amount that Home Savings may lend to any one borrower to an amount equal to 15.0% of Home Savings' unimpaired capital and unimpaired surplus (Lending Limit Capital). A savings association may lend to one borrower an additional amount not to exceed 10.0% of Lending Limit Capital if the additional amount is fully secured by certain forms of "readily marketable collateral." Real estate is not considered "readily marketable collateral." In applying this limit, the regulations require that loans to certain related or affiliated borrowers be aggregated. Based on such limits, Home Savings could lend approximately $32.8 million to one borrower at December 31, 2005. The largest amount Home Savings had outstanding to one borrower at December 31, 2005, was $20.1 million, which consisted of nine loans secured primarily by mortgages on non-residential property. At December 31, 2005, these loans were performing in accordance with their terms. DELINQUENT LOANS, NONPERFORMING ASSETS AND CLASSIFIED ASSETS. Home Savings attempts to maintain a high level of asset quality through sound underwriting policies and aggressive collection practices. The following table reflects the amount of all loans in a delinquent status as of the dates indicated:
At December 31, ----------------------------------------------------------------------------- 2005 2004 ------------------------------------ ------------------------------------- Percent of Percent of net net Number Amount loans Number Amount loans ------ -------- ---------- ------ -------- ---------- (Dollars in thousands) Loans delinquent for: 30-59 days 295 $ 19,098 0.90% 258 $ 9,634 0.53% 60-89 days 81 14,193 0.67 73 4,464 0.24 90 days or over 220 24,391 1.15 221 19,225 1.05 --- -------- ---- --- -------- ---- Total delinquent loans 596 $ 57,682 2.72% 552 $ 33,323 1.82% === ======== ---- === ======== ====
Nonperforming assets include loans past due 90 days and on a nonaccrual status, loans past due 90 days and still accruing, loans less than 90 days past due and on a nonaccrual status, restructured loans, real estate acquired by foreclosure or by deed-in-lieu of foreclosure and repossessed assets. Once a loan becomes 90 days delinquent, it generally is placed on non-accrual status. Loans are reviewed through monthly reports to the Board and management and are placed on nonaccrual status when collection in full is considered doubtful by management. Interest accrued and unpaid at the time a loan is placed on nonaccrual status is charged against interest income. Subsequent cash payments generally are applied to interest income unless, in the opinion of management, the collection of principal and interest is doubtful. In those cases, subsequent cash payments are applied to principal. 8 The following table sets forth information with respect to Home Savings' nonperforming loans and other assets at the dates indicated:
At December 31, -------------------------------------------------------- 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- (Dollars in thousands) Nonperforming loans: Nonaccrual loans Real estate loans: One- to four-family residential $ 6,795 $ 6,511 $ 7,121 $ 7,567 $ 5,813 Multifamily and nonresidential 6,368 2,880 1,315 2,049 775 Construction (net of loans in process) and land 4,732 1,350 1,724 3,141 3,398 -------- -------- -------- -------- -------- Total real estate loans 17,895 10,741 10,160 12,757 9,986 Consumer 2,495 5,152 888 715 434 Commercial 3,889 4,960 1,933 952 469 -------- -------- -------- -------- -------- Total nonaccrual loans 24,279 20,853 12,981 14,424 10,889 Restructured loans 825 1,329 1,853 1,271 1,572 Past due 90 days and still accruing 563 377 1,300 - - -------- -------- -------- -------- -------- Total nonperforming loans 25,667 22,559 16,134 15,695 12,461 Real estate acquired through foreclosure and other repossessed assets 2,514 1,682 1,299 1,150 477 -------- -------- -------- -------- -------- Total nonperforming assets $ 28,181 $ 24,241 $ 17,433 $ 16,845 $ 12,938 ======== ======== ======== ======== ======== Nonperforming loans as a percent of loans, net 1.22% 1.24% 1.02% 1.06% 0.89% Nonperforming assets as a percent of total assets 1.11 1.06 0.84 0.85 0.67 Allowance for loan losses as a percent of nonperforming loans 61.26 70.38 93.66 96.20 92.13 Allowance for loan losses as a percent of loans, net 0.74 0.87 0.96 1.02 0.82
For 2005, approximately $2.6 million in additional interest income would have been recorded had nonaccrual and restructured loans been accruing pursuant to contractual terms. During 2005, interest collected on such loans and included in net income was approximately $561,000. Nonperforming assets increased approximately $3.9 million, or 16.3%, to $28.2 million at December 31, 2005, from $24.2 million at December 31, 2004. At December 31, 2005, total nonperforming loans accounted for 1.22% of net loans receivable, compared to 1.24% at December 31, 2004. Total nonperforming assets were 1.11% of total assets as of December 31, 2005 from 1.06% as of December 31, 2004. Real estate acquired in settlement of loans is classified separately on the balance sheet at the lower of cost or net realizable value as of the date of acquisition. At foreclosure, the loan is written down to the value of the underlying collateral by a charge to the allowance for loan losses, if necessary. Any subsequent write-downs are charged against operating expenses. Operating expenses of such properties, net of related income or loss on disposition, are included in other expenses. At December 31, 2005, the carrying value of real estate and other repossessed assets acquired in settlement of loans was $2.5 million and consisted of $1.7 million in single-family properties and $807,000 in boats and automobiles. In addition to the nonperforming loans identified above, other loans may be identified as having potential credit problems that result in those loans being classified by our internal loan review function. These potential problem loans, which have not exhibited the more severe weaknesses generally present in nonperforming loans, amounted to $15.5 million, net of applicable reserves, at December 31, 2005. ALLOWANCE FOR LOAN LOSSES. Management establishes the allowance for loan losses at a level it believes adequate to absorb probable losses incurred in the loan portfolio. Management bases its determination of the adequacy of the allowance upon estimates derived from an analysis of individual credits, prior and current loss experience, loan portfolio delinquency levels, overall growth in the loan portfolio and current economic conditions. Furthermore, in determining the level of the 9 allowance for loan loss, management reviews and evaluates on a monthly basis the necessity of a reserve for individual loans classified by management. The specifically allocated reserve for a classified loan is determined based on management's estimate of the borrower's ability to repay the loan given the availability of collateral, other sources of cash flow and legal options available to Home Savings. Once a review is completed, the need for a specific reserve is determined by the Home Savings Asset Review Committee and allocated to the loan. Other loans not reviewed specifically by management are evaluated as a homogeneous group of loans (single-family residential mortgage loans and all consumer credit except marine loans) using the historical charge-off experience ratio calculated by type of loan. The historical charge-off experience ratio factors into account the homogeneous nature of the loans, the geographical lending areas involved, regulatory examination findings, specific grading systems applied and any other known factors that may impact the ratios used. Specific reserves on individual loans and historical ratios are reviewed periodically and adjusted as necessary based on subsequent collections, loan upgrades or downgrades, nonperforming trends or actual principal charge-offs. When evaluating the adequacy of the allowance for loan losses, consideration is given to geographic concentration and the effect changing economic conditions have on Home Savings. These estimates are particularly susceptible to changes that could result in a material adjustment to results of operations. The provision for loan losses represents a charge against current earnings in order to maintain the allowance for loan losses at an appropriate level. The following table sets forth an analysis of Home Savings' allowance for loan losses for the periods indicated:
Year ended December 31, ------------------------------------------------------------ 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- (Dollars in thousands) Balance at beginning of period $ 15,877 $ 15,111 $ 15,099 $ 11,480 $ 6,553 Provision for loan losses 3,028 9,370 3,179 3,578 2,495 Charge-offs: Real estate (996) (1,016) (2,111) (347) (89) Consumer (2,848) (6,177) (650) (410) (283) Commercial (241) (1,867) (579) (1,210) (55) -------- -------- -------- -------- -------- Total charge-offs (4,085) (9,060) (3,340) (1,967) (427) -------- -------- -------- -------- -------- Recoveries: Real estate 53 325 94 71 13 Consumer 848 72 41 65 10 Commercial 2 59 38 3 9 -------- -------- -------- -------- -------- Total recoveries 903 456 173 139 32 -------- -------- -------- -------- -------- Net charge-offs (3,182) (8,604) (3,167) (1,828) (395) Acquisition of Industrial Savings - - - - 2,795 Acquisition of Potters Bank - - - 1,869 - -------- -------- -------- -------- -------- Balance at end of year $ 15,723 $ 15,877 $ 15,111 $ 15,099 $ 11,480 ======== ======== ======== ======== ======== Ratio of net charge-offs to average net loans (0.16)% (0.50)% (0.21)% (0.12)% (0.03)%
10 The following table sets forth the allocation of the allowance for loan losses by category. The allocations are based on management's assessment of the risk characteristics of each of the components of the total loan portfolio and are subject to change as and when the risk factors of each component change. The allocation is not indicative of either the specific amounts or the loan categories in which future charge-offs may be taken, nor should it be taken as an indicator of future loss trends. The allocation of the allowance to each category is not indicative necessarily of future loss in any particular category and does not restrict the use of the allowance to absorb losses in any category.
At December 31, ------------------------------------------------------------------------------------------------------------------ 2005 2004 2003 2002 2001 ---------------------- ---------------------- ---------------------- ---------------------- ---------------------- Percent of Percent of Percent of Percent of Percent of loans in each loans in each loans in each loans in each loans in each category category category category category Amount to total loans Amount to total loans Amount to total loans Amount to total loans Amount to total loans ------- -------------- ------- -------------- ------- -------------- ------- -------------- ------- -------------- (Dollars in thousands) Real estate loans $ 9,683 79.92% $10,559 81.65% $10,796 83.22% $11,017 86.61% $ 8,339 90.18% Consumer loans 3,378 15.30 3,615 14.61 2,670 13.73 1,947 10.42 975 7.68 Commercial loans 2,662 4.78 1,703 3.74 1,645 3.05 2,135 2.97 2,166 2.14 ------- ------ ------- ------ ------- ------ ------- ------ ------- ------ Total $15,723 100.00% $15,877 100.00% $15,111 100.00% $15,099 100.00% $11,480 100.00% ======= ====== ======= ====== ======= ====== ======= ====== ======= ======
INVESTMENT ACTIVITIES GENERAL. Investment securities are classified upon acquisition as available for sale, held to maturity or trading. Securities classified as available for sale are carried at estimated fair value with the unrealized holding gain or loss, net of taxes, reflected as a component of retained earnings. Securities classified as held to maturity are carried at amortized cost. Securities classified as trading are carried at estimated fair value with the unrealized holding gain or loss reflected as a component of income. United Community, Home Savings and Butler Wick recognize premiums and discounts in interest income over the period to maturity or call by the level yield method and realized gains or losses on the sale of debt securities based on the amortized cost of the specific securities sold. HOME SAVINGS INVESTMENT ACTIVITIES. Federal regulations and Ohio law permit Home Savings to invest in various types of marketable securities, including interest-bearing deposits in other financial institutions, federal funds, U.S. Treasury and agency obligations, mortgage-related securities, and certain other specified investments. The Board has adopted an investment policy that authorizes management to make investments in U.S. Treasury obligations, U.S. Federal agency and federally-sponsored corporation obligations, mortgage-related securities issued or sponsored by Federal National Mortgage Association (FNMA), FHLMC, Government National Mortgage Association (GNMA), as well as private issuers, investment-grade municipal obligations, creditworthy, unrated securities issued by municipalities in which an office of Home Savings is located, investment-grade corporate debt securities, investment-grade asset-backed securities, certificates of deposit that are fully-insured by the FDIC, bankers' acceptances, federal funds and money market funds. Home Savings' investment policy is designed primarily to provide and maintain liquidity within regulatory guidelines, to maintain a balance of high quality investments to minimize risk, and to maximize return without sacrificing liquidity and safety. Home Savings maintains a significant portfolio of mortgage-backed securities and collateralized mortgage obligations (CMOs) that are rated the highest credit quality by a nationally recognized rating agency. Both types of securities are issued by FNMA, GNMA and FHLMC. Mortgage-backed securities generally entitle Home Savings to receive a portion of the cash flows from an identified pool of mortgages. CMOs are a type of debt security issued by a special-purpose entity that aggregates pools of mortgages and mortgage-backed securities and creates different classes of securities with varying maturities and amortization schedules, as well as a residual interest, with each class possessing different risk characteristics. The cash flows from the underlying collateral generally are divided into tranches or classes that have descending priorities with respect to the distribution of principal and interest repayment of the underlying mortgages, as opposed to pass through mortgage-backed securities where cash flows are distributed pro rata to all security holders. In contrast to mortgage-backed securities from which cash flow is received (and hence, prepayment risk is shared) pro rata by all securities holders, the cash flow from the mortgages or mortgage-related securities underlying CMOs is paid in accordance with predetermined priority to investors holding various tranches of such securities or obligations. A particular tranche of CMOs may, therefore, carry prepayment risk that differs from that of both the underlying collateral and other tranches. Accordingly, CMOs attempt to moderate risks associated with conventional mortgage-backed securities resulting from unexpected prepayment activity. Home Savings is exposed to prepayment risk and reinvestment risk to the extent that actual prepayments will differ from those estimated in pricing the security, which may result in adjustments to the net yield on such securities. Mortgage-related securities enable Home Savings to generate positive interest rate spreads with minimal administrative expense and 11 reduce credit risk due to either guarantees provided by the issuer or the high credit rating of the issuer. Mortgage-related securities classified as available for sale also provide Home Savings with an additional source of liquid funds. BUTLER WICK INVESTMENT ACTIVITIES. Butler Wick holds securities through two subsidiaries, Butler Wick & Co., Inc. and Butler Wick Trust Company. Butler Wick & Co., Inc. invests in municipal securities and government agency securities for sale to clients. Butler Wick & Co., Inc.'s securities are carried at fair value with gains and losses recognized currently. Butler Wick & Co., Inc. does not make markets in equity securities. In order to qualify as a fiduciary in the State of Ohio, Butler Wick Trust Company deposited United States Government obligations having a principal value of $100,000 with the Federal Reserve Bank for the state. In addition to these deposits, Butler Wick Trust Company owns U.S. Government obligations. UNITED COMMUNITY INVESTMENT ACTIVITIES. Funds maintained by United Community for general corporate purposes, including possible acquisitions, primarily are invested in an account with Home Savings. United Community also owns a small portfolio of bank equities. 12 The following table presents the amortized cost, fair value and weighted average yield of securities at December 31, 2005 by maturity:
At December 31, 2005 -------------------------------------------------------------------------------- No stated After one year Five years through maturity One year or less through five years ten years ------------------ ------------------ ------------------ ------------------ Amortized Average Amortized Average Amortized Average Amortized Average cost yield cost yield cost yield cost yield --------- ------- --------- ------- --------- ------- --------- ------- (Dollars in thousands) Securities: U.S Government agencies and corporations $ - -% $ 24,147 2.71% $ 56,254 3.73% $ 9,891 5.23% States and political subdivisions - - 3 12.74 - - - - Mortgage-related securities - - 18 7.60 1,482 8.63 1,664 6.17 Other securities (a) 2,301 1.24 - - - - - - --------- --------- --------- --------- Total securities $ 2,301 1.24% $ 24.168 2.71% $ 57,736 3.86% $ 11,555 5.37% ========= ========= ========= =========
At December 31, 2005 -------------------------------------------------- After ten years Total ------------------- ----------------------------- Amortized Average Amortized Average Fair cost yield cost yield value --------- ------- --------- ------- -------- (Dollars in thousands) Securities: U.S. Government agencies and corporations $ - -% $ 90,292 3.62% $ 88,799 States and political subdivisions - - 3 12.87 3 Mortgage-related securities 109,028 4.52 112,192 4.60 110,106 Other securities (a) - - 2,301 1.24 2,962 --------- --------- -------- Total securities $ 109,028 4.52% $ 204,788 4.13% $201,870 ========= ========= ========
(a) Yield on equity securities only; mutual funds excluded SOURCES OF FUNDS GENERAL. Deposits traditionally have been the primary source of Home Savings' funds for use in lending and other investment activities. In addition to deposits, Home Savings derives funds from interest payments and principal repayments on loans and income on other earning assets. Loan payments are a relatively stable source of funds, while deposit inflows and outflows fluctuate in response to general interest rates and money market conditions. Home Savings also may borrow from the FHLB, as well as other suitable lenders, as a source of funds. DEPOSITS. Deposits are attracted principally from within Home Savings' primary market area through the offering of a selection of deposit instruments, including regular passbook savings accounts, demand deposits, individual retirement accounts (IRAs), checking accounts, money market accounts, and certificates of deposit. Interest rates paid, maturity terms, service fees, and withdrawal penalties for the various types of accounts are monitored weekly by management. Home Savings does not use brokers to attract deposits. The amount of deposits from outside Home Savings' primary market area is not significant. 13 The following table sets forth the dollar amount of deposits in the various types of accounts offered by Home Savings at the dates indicated:
At December 31, 2005 For the Year Ended December 31, 2005 ------------------------------------ ------------------------------------ Percent Weighted Percent Weighted of total average Average of average average Amount deposits rate balance deposits rate ---------- -------- -------- ---------- ---------- -------- (Dollars in thousands) Noninterest bearing demand $ 96,918 5.76% -% $ 89,483 5.64% -% Checking and money market accounts 258,998 15.40 1.76 269,652 17.00 1.20 Savings accounts 259,811 15.45 0.41 287,714 18.15 0.42 Certificates of deposit 1,066,117 63.39 3.88 938,957 59.21 3.57 ---------- ------ ---------- ------ Total deposits $1,681,844 100.00% 2.79% $1,585,806 100.00% 2.39 ========== ====== ========== ======
For the Year Ended December 31, 2004 For the Year Ended December 31, 2003 ------------------------------------ ------------------------------------ Percent Weighted Percent Weighted Average of average average Average of average average balance deposits rate balance deposits rate ----------- ---------- -------- --------- ---------- -------- (Dollars in thousands) Noninterest bearing demand $ 75,157 5.13% -% 61,273 4.17% -% Checking and money market accounts 302,936 20.67 0.79 308,816 21.01 1.01 Savings accounts 314,588 21.46 0.43 335,843 22.85 0.70 Certificates of deposit 773,019 52.74 3.18 763,704 51.97 3.33 ----------- ------ --------- ------ Total deposits $ 1,465,700 100.00% 1.93% 1,469,636 100.00% 2.10 =========== ====== ========= =======
The following table shows rate and maturity information for Home Savings' certificates of deposit at December 31, 2005:
Over Over Up to 1 year to 2 years to Rate one year 2 years 3 years Thereafter Total - ---------------------------------------- -------- --------- ---------- ---------- ---------- (Dollars in thousands) 2.00% or less $ 41,255 $ 3,486 $ 1,351 $ 2,757 $ 48,849 2.01% to 4.00% 285,693 92,718 58,424 15,475 452,310 4.01% to 6.00% 213,013 172,200 37,756 140,289 563,258 Greater than 6.00% 1,653 31 16 - 1,700 -------- --------- ---------- ---------- ---------- Total certificates of deposit $541,614 $ 268,435 $ 97,547 $ 158,521 $1,066,117 ======== ========= ========== ========== ========== Percent of total certificates of deposit 50.80% 25.18% 9.15% 14.87% 100.00%
At December 31, 2005, approximately $541.6 million of Home Savings' certificates of deposit mature within one year. Based on past experience and Home Savings' prevailing pricing strategies, management believes that a substantial percentage of such certificates will be renewed with Home Savings at maturity. If, however, Home Savings is unable to renew the maturing certificates for any reason, borrowings of up to $132.5 million are available from the FHLB. 14 The following table presents the amount of Home Savings' certificates of deposit of $100,000 or more by the time remaining until maturity at December 31, 2005:
Maturity Amount - -------------------------- ---------------------- (Dollars in thousands) Three months or less $ 35,900 Over 3 months to 6 months 34,033 Over 6 months to 12 months 40,200 Over 12 months 102,550 ---------- Total $ 212,683 ==========
Based on past experience, management believes that a substantial percentage of the above certificates will be renewed with Home Savings at maturity. The following table sets forth Home Savings' deposit account balance activity for the periods indicated:
Year ended December 31, --------------------------------- 2005 2004 ----------- ----------- (Dollars in thousands) Beginning balance $ 1,522,952 $ 1,423,698 Net increase (decrease) in deposits 122,020 71,060 ----------- ----------- Net deposits before interest credited 1,644,972 1,494,758 Interest credited 36,872 28,194 ----------- ----------- Ending balance $ 1,681,844 $ 1,522,952 =========== =========== Net increase (decrease) $ 158,892 $ 99,254 =========== =========== Percent increase (decrease) 10.43% 6.97%
BORROWINGS. The FHLB system functions as a central reserve bank providing credit for its member institutions and certain other financial institutions. As a member in good standing of the FHLB, Home Savings is authorized to apply for advances, provided certain standards of creditworthiness have been met. Under current regulations, an association must meet certain qualifications to be eligible for FHLB advances. The extent to which an association is eligible for such advances will depend upon whether it meets the Qualified Thrift Lender (QTL) test. If an association meets the QTL test, the association will be eligible for 100% of the advances it would otherwise be eligible to receive. If an association does not meet the QTL test, the association will be eligible for such advances only to the extent it holds specified QTL test assets. At December 31, 2005, Home Savings was in compliance with the QTL test. Home Savings may borrow up to $608.6 million from the FHLB, and had $475.5 million in outstanding advances at December 31, 2005. Of the $475.5 million, a total of $35.0 million is callable, $25.0 million matured in February 2006 and $10.0 is callable quarterly and matures in February 2009. Butler Wick borrows on a secured basis to fund client receivables. Short-term bank loans bear interest at the federal funds rate plus 1% and are payable on demand. The loans are collateralized fully by marketable securities from both customers' margin accounts and securities owned by Butler Wick. Short-term borrowings also take the form of securities loaned to other broker/dealers. Short-term borrowings are available to Butler Wick to the extent of the loan value of the marketable securities. COMPETITION Home Savings faces competition for deposits and loans from other savings and loan associations, credit unions, banks and mortgage originators in Home Savings' primary market area. The primary factors in competition for deposits are customer service, convenience of office location and interest rates. Home Savings competes for loan originations primarily through the interest rates and loan fees it charges and through the efficiency and quality of service it provides to borrowers. 15 Competition is affected by, among other things, the general availability of lendable funds, general and local economic conditions, current interest rate levels and other factors, which are not readily predictable. Butler Wick offers retail brokerage, asset management, and trust services to clients primarily in northeastern Ohio and western Pennsylvania. In each of these businesses, Butler Wick competes with both regional and national firms. As a full service broker, Butler Wick competes based on personal service rather than price. Butler Wick Trust Company is the only such locally owned and managed financial services provider. EMPLOYEES At December 31, 2005, Home Savings and Butler Wick had 631 and 193 full-time equivalent employees, respectively. Home Savings and Butler Wick believe that relations with their employees are good. Home Savings offers health, life and disability benefits to all employees, a 401(k) plan and an employee stock ownership plan for its eligible employees. Butler Wick offers health, life and disability benefits to all employees, a 401(k) plan, a profit sharing plan and a retention plan for its eligible employees. REGULATION United Community is a unitary savings and loan holding company within the meaning of the Home Owners Loan Act, as amended (HOLA), and is subject to regulation, examination, and oversight by the OTS, although there generally are no restrictions on the activities of United Community unless the OTS determines that there is reasonable cause to believe that an activity constitutes a serious risk to the financial safety, soundness, or stability of Home Savings. Home Savings is subject to regulation, examination, and oversight by the Division and the FDIC, and it also is subject to certain provisions of the Federal Reserve Act. Butler Wick is subject to regulation, examination and oversight by the SEC and NASD and the Division. United Community, Home Savings and Butler Wick are also subject to the provisions of the Ohio Revised Code applicable to corporations generally, including laws that restrict takeover bids, tender offers and control-share acquisitions involving public companies which have significant ties to Ohio. The OTS, the FDIC, the Division, the SEC and the NASD each have various powers to initiate supervisory measures or formal enforcement actions if United Community or the subsidiary they regulate does not comply with applicable regulations. If the grounds provided by law exist, the FDIC or the Division may place Home Savings in conservatorship or receivership. Home Savings is also subject to regulatory oversight under various consumer protection and fair lending laws which govern, among other things, truth-in-lending disclosures, equal credit opportunity, fair credit reporting and community reinvestment. Failure to abide by federal laws and regulations governing community reinvestment could limit the ability of Home Savings to open a new branch or engage in a merger. Federal law prohibits Home Savings from making a capital distribution to anyone or paying management fees to any person having control of Home Savings if, after such distribution or payment, Home Savings would be undercapitalized. In addition, each company controlling an undercapitalized institution will comply with its capital restoration plan until the institution has been adequately capitalized on average during each of the four preceding calendar quarters and must provide adequate assurances of performance. Federal Reserve Board regulations currently require savings associations to maintain reserves of 3% of net transaction accounts (primarily checking accounts) up to $48.3 million (subject to an exemption of up to $7.8 million), and of 10% of net transaction accounts in excess of $48.3 million. At December 31, 2005, Home Savings was in compliance with its reserve requirements. Loans by Home Savings to executive officers, directors, and principal shareholders and their related interests must conform to the lending limit on loans to one borrower, and the total of such loans to executive officers, directors, principal shareholders, and their related interests cannot exceed specified limits. Most loans to directors, executive officers, and principal shareholders must be approved in advance by a majority of the "disinterested" members of the Board with any "interested" director not participating. All loans to directors, executive officers, and principal shareholders must be made on terms substantially the same as offered in comparable transactions with the general public or as offered to all employees in a company-wide benefit program, and loans to executive officers are subject to additional limitations. All other transactions between Home Savings and its affiliates must comply with Sections 23A and 23B of the Federal Reserve Act. United Community and Butler Wick are affiliates of Home Savings for this purpose. 16 Under federal law and regulations, no person, directly or indirectly, or acting in concert with others, may acquire control of Home Savings or United Community without 60 days' prior notice to the OTS. "Control" is generally defined as having more than 25% ownership or voting power; however, ownership or voting power of more than 10% may be deemed "control" if certain factors are in place. If the acquisition of control is by a company, the acquirer must obtain approval, rather than give notice, of the acquisition as a savings and loan holding company. In addition, a statutory limitation on the acquisition of control of an Ohio savings bank requires the written approval of the Division prior to the acquisition by any person or entity of a controlling interest in an Ohio association. Control exists, for purposes of Ohio law, when any person or entity which, either directly or indirectly, or acting in concert with one or more other persons or entities, owns, controls, holds with power to vote, or holds proxies representing, 15% or more of the voting shares or rights of an association, or controls in any manner the election or appointment of a majority of the directors. Ohio law also requires that certain acquisitions of voting securities that would result in the acquiring shareholder owning 20%, 33 1/3% or 50% of the outstanding voting securities of United Community must be approved in advance by the holders of at least a majority of the outstanding voting shares represented at a meeting at which a quorum is present and a majority of the portion of the outstanding voting shares represented at such a meeting, excluding the voting shares by the acquiring shareholder. Federal law generally prohibits a savings and loan holding company, such as United Community, from controlling any other savings association or savings and loan holding company, without prior approval of the OTS, or from acquiring or retaining more than 5% of the voting shares of a savings association or holding company thereof, which is not a subsidiary. Except with the prior approval of the OTS, no director or officer of a savings and loan holding company or person owning or controlling by proxy or otherwise more than 25% of such holding company's stock also may acquire control of any savings institution, other than a subsidiary institution, or any other savings and loan holding company. ITEM 1A. RISK FACTORS Like all financial companies, United Community's business and results of operations are subject to a number of risks, many of which are outside of our control. In addition to the other information in this report, readers should carefully consider that the following important factors, among others, could materially impact our business and future results of operations. Changes in interest rates could adversely affect our financial condition and results of operations. Our results of operations depend substantially on our net interest income, which is the difference between the interest earned on loans, securities and other interest-earning assets and the interest paid on deposits and other borrowings. These rates are highly sensitive to many factors beyond our control, including general economic conditions, inflation, recession, unemployment, money supply and the policies of various governmental and regulatory authorities. While we have taken measures intended to manage the risks of operating in a changing interest rate environment, there can be no assurance that these measures will be effective in avoiding undue interest rate risk. Increases in interest rates can affect the value of loans and other assets, including our ability to realize gains on the sale of assets. We originate loans for sale and for our portfolio. Increasing interest rates may reduce the origination of loans for sale and consequently the fee income we earn on such sales. Further, increasing interest rates may adversely affect the ability of borrowers to pay the principal or interest on loans and leases, resulting in an increase in nonperforming assets and a reduction of income recognized. In contrast, decreasing interest rates have the effect of causing clients to refinance mortgage loans faster than anticipated. This causes the value of assets related to the servicing rights on loans sold to be lower than originally anticipated. If this happens, we may need to write down our servicing assets faster, which would accelerate our expense and lower our earnings. Credit risks could adversely affect our results of operations. There are inherent risks associated with our lending activities, including credit risk, which is the risk that borrowers may not repay outstanding loans or the value of the collateral securing loans will decrease. We attempt to manage credit risk through a program of underwriting standards, the review of certain credit decisions and an on-going process of assessment of the quality of the credit already extended. However, conditions such as inflation, recession, unemployment, changes in 17 interest rates, money supply and other factors beyond our control may increase our credit risk. Such changes in the economy may have a negative impact on the ability of borrowers to repay their loans. Because we have a significant amount of real estate loans, decreases in real estate values could adversely affect the value of our collateral. In addition, a substantial portion of our loans are to individuals and businesses in Ohio. Consequently, any decline in the state's economy could have a materially adverse effect on our financial condition and results of operations. We operate in an extremely competitive market, and our business will suffer if we are unable to compete effectively. In our market area, we encounter significant competition from savings and loan associations, banks, credit unions, mortgage banking firms, securities brokerage firms, asset management firms and insurance companies. Many of our competitors have substantially greater resources and lending limits than we do and may offer services that we do not or cannot provide. Legislative or regulatory changes or actions could adversely impact the financial services industry. The financial services industry is extensively regulated. Federal and state banking laws and regulations are primarily intended for the protection of consumers, depositors and the deposit insurance funds, and are not necessarily intended to benefit our shareholders. Changes to laws and regulations or other actions by regulatory agencies may negatively impact us. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution's allowance for loan losses. The significant federal and state banking regulations that affect us are described in this 10-K under the heading "Regulation." Our ability to pay cash dividends is limited. We are dependent primarily upon the earnings of our operating subsidiaries for funds to pay dividends on our common shares. The payment of dividends by Home Savings is subject to certain regulatory restrictions. As a result, any payment of dividends in the future will be dependent, in large part, on our ability to satisfy these regulatory restrictions and Home Savings' earnings, capital requirements, financial condition and other factors. Although our financial earnings and financial condition have allowed us to declare and pay periodic cash dividends to our shareholders, there can be no assurance that dividend payments will continue or increase in the future. The preparation of financial statements requires management to make estimates about matters that are inherently uncertain. Management's accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods in order to ensure that they comply with generally accepted accounting principles and reflect management's judgment as to the most appropriate manner in which to record and report our financial condition and results of operations. Two of the most critical estimates are the level of the allowance of loan losses and the valuation of mortgage servicing rights. Due to the inherent nature of these estimates, we cannot provide absolute assurance that we will not significantly increase the allowance for loan losses, sustain loan losses that are significantly higher than the provided allowance, or recognize a significant provision for the impairment of mortgage servicing rights. We face risks with respect to future expansion. We may acquire other financial institutions in the future and we may engage in de novo branch expansion. We may also consider and enter into new lines of business or offer new products or services. We may incur substantial costs to expand, and we can give no assurance such expansion will result in the levels of profits we seek. Also, we may issue equity securities in connection with future acquisitions, which would dilute current shareholders' ownership interests. If we acquire other businesses, we may not be able to achieve fully the cost savings and synergies that we expect to result from any acquisition. In addition, because the markets in which we operate are highly competitive, we may lose customers or the customers of acquired entities as a result of an acquisition. We also may lose key personnel, either from the acquired entity or from United Community, as a result of an acquisition. 18 ITEM 1B. UNRESOLVED STAFF COMMENTS None. ITEM 2. PROPERTIES Home Savings owns it corporate headquarters building located in Youngstown, Ohio. Of Home Savings' 37 branch offices thirty are owned and the remaining offices are leased. Loan origination offices are leased under long-term lease agreements. Butler Wick leases its corporate headquarters located in Youngstown, Ohio under a long-term lease agreement. Its branch office locations and operations centers are also leased under long-term lease agreements. The information contained in Note 7 "Premises and Equipment" is incorporated herein by reference. ITEM 3. LEGAL PROCEEDINGS United Community and its subsidiaries are not parties to any other material litigation other than those arising in the normal course of business. While it is impossible to determine the ultimate resolution of these contingent matters, management believes any resulting liability would not have a material effect upon United Community's financial statements. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The information contained in the 2005 Annual Report to Shareholders of United Community (Annual Report) under the caption "Market Price and Dividends" is incorporated herein by reference and attached hereto as part of Exhibit 13. ITEM 6. SELECTED FINANCIAL DATA The information contained in the Annual Report under the caption "Selected Financial and Other Data" is incorporated herein by reference and attached hereto as part of Exhibit 13. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information contained in the Annual Report under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" is incorporated herein by reference and attached hereto as part of Exhibit 13. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information contained in the Annual Report under the caption "Asset and Liability Management and Market Risk" is incorporated herein by reference and attached hereto as part of Exhibit 13. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Consolidated Financial Statements appearing in the Annual Report and the report of Crowe Chizek and Company LLC dated February 1, 2006, are incorporated herein by reference and attached hereto as part of Exhibit 13. 19 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. ITEM 9A. CONTROLS AND PROCEDURES United Community's management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of December 31, 2005, an evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, management concluded that disclosure controls and procedures as of December 31, 2005 were effective in ensuring material information required to be disclosed in this Annual Report on Form 10-K was recorded, processed, summarized and reported on a timely basis. Additionally, there were no changes in the Company's internal control over financial reporting that occurred during the quarter ended December 31, 2005, that have materially affected, or are reasonably likely to affect, the Company's internal control over financial reporting. See "Management's Report on Internal Control Over Financial Reporting" contained in the 2005 Annual Report attached hereto as part of Exhibit 13. ITEM 9B. OTHER INFORMATION None PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information contained in the Proxy Statement for the 2006 Annual Meeting of Shareholders of United Community (Proxy Statement), to be filed with the Securities and Exchange Commission (Commission) on or about March 29, 2006, under the captions "Election of Directors," "Incumbent Directors," "Board Meeting and Compensation," "Executive Officers," "Section 16(a) Beneficial Ownership Reporting Compliance" and "Audit Committee Report" is incorporated herein by reference. United Community has adopted a code of ethics applicable to all officers, directors and employees that complies with SEC requirements. A copy of the code may be obtained upon written request to Patrick A. Kelly, Chief Financial Officer, United Community Financial Corp., 275 Federal Plaza West, Youngstown, Ohio 44503. ITEM 11. EXECUTIVE COMPENSATION The information contained in the Proxy Statement under the captions "Board Meetings, Committees and Compensation" and "Compensation of Executive Officers," is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS The information contained in the Proxy Statement under the caption "Ownership of UCFC Shares" is incorporated herein by reference. United Community maintains the United Community Financial Corp. 1999 Long-Term Incentive Plan ("Incentive Plan") and the United Community Financial Corp. Recognition and Retention Plan and Trust Agreement ("RRP") under which it may issue equity securities to its directors, officers and employees in exchange for goods or services. The Incentive Plan and the RRP were approved by United Community's shareholders at the 1999 Special Meeting of Shareholders. 20 The following table shows, as of December 31, 2005, the number of common shares issuable upon the exercise of outstanding stock options, the weighted average exercise price of those stock options, and the number of common shares remaining for future issuance under the Incentive Plan and the RRP, excluding shares issuable upon exercise of outstanding stock options. EQUITY COMPENSATION PLAN INFORMATION
(a) (b) (c) NUMBER OF SECURITIES REMAINING AVAILABLE FOR NUMBER OF SECURITIES FUTURE ISSUANCE UNDER TO BE ISSUED UPON WEIGHTED-AVERAGE EQUITY COMPENSATION PLANS EXERCISE OF EXERCISE PRICE OF (EXCLUDING SECURITIES PLAN CATEGORY OUTSTANDING OPTIONS OUTSTANDING OPTIONS REFLECTED IN COLUMN (a)) - ------------------------------ -------------------- ------------------- ------------------------- Equity compensation plans approved by security holders 2,217,216 $9.59 None
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information contained in the Proxy Statement under the caption "Compensation of Executive Officers --Certain Transactions" is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information contained in the Proxy Statement under the caption "Audit Fees" is incorporated herein by reference. PART IV ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (C) EXHIBITS 3.1 Articles of Incorporation 3.2 Amended Code of Regulations 10 Material Contracts 11 Statement Regarding Computation of Per Share Earnings 13 Portions of the 2005 Annual Report to Shareholders 20 Proxy Statement for 2006 Annual Meeting of Shareholders 21 Subsidiaries of Registrant 23 Crowe Chizek and Company LLC Consent 31.1 Section 302 Certification by Chief Executive Officer 21 31.2 Section 302 Certification by Chief Financial Officer 32 Certification of Financial Statements by Chief Executive Officer and Chief Financial Officer (a) FINANCIAL STATEMENT SCHEDULES. All schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. 22 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. UNITED COMMUNITY FINANCIAL CORP. /s/ Douglas M. McKay -------------------------------- Douglas M. McKay, President (Duly Authorized Representative) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated. /s/ Douglas M. McKay /s/ Richard M. Barrett - ---------------------------------------- -------------------------------- Douglas M. McKay, President and Director Richard M. Barrett, Director Date: March 15, 2006 Date: March 15, 2006 /s/ Richard J. Schiraldi /s/ David C. Sweet - ---------------------------------------- -------------------------------- Richard J. Schiraldi, Director David C. Sweet, Director Date: March 15, 2006 Date: March 15, 2006 /s/ Herbert F. Schuler, Sr. /s/ Patrick A. Kelly - ---------------------------------------- -------------------------------- Herbert F. Schuler, Sr., Director Patrick A. Kelly, Treasurer Date: March 15, 2006 (Principal Financial Officer) Date: March 15, 2006 /s/ Thomas J. Cavalier /s/ David G. Lodge - ---------------------------------------- -------------------------------- Thomas J. Cavalier, Director David G. Lodge, Director Date: March 15, 2006 Date: March 15, 2006 /s/ Eugenia C. Atkinson /s/ Clarence R. Smith, Jr - ---------------------------------------- -------------------------------- Eugenia C. Atkinson, Director Clarence R. Smith, Director Date: March 15, 2006 Date: March 15, 2006 23 INDEX TO EXHIBITS
Exhibit Number - -------------- 3.1 Articles of Incorporation Incorporated by reference to the Registration Statement on Form S-1 filed by United Community on March 13, 1998 (S-1) with the Securities and Exchange Commission (SEC), Exhibit 3.1 3.2 Amended Code of Regulations Incorporated by reference to the 1998 10-K filed by United Community on March 31, 1999 via Edgar, film number 99582343, Exhibit 3.2 10.1 The Home Savings and Loan Company of Youngstown, Ohio Incorporated by reference to the 2001 10-K filed by Employee Stock Ownership Plan United Community on March 29, 2002 via Edgar, film number 02593161, Exhibit 10.1 10.2 Employment Agreement between The Home Savings and Loan Incorporated by reference to the 2004 10-K/A filed by Company of Youngstown, Ohio and Douglas M. McKay, dated United Community on May 2, 2005 via Edgar, film number December 31, 2004. 04666159 (2004 10K/A), Exhibit 10.2 10.3 Employment Agreement between The Home Savings and Loan Incorporated by reference to the 2004 10-K/A, Exhibit Company of Youngstown, Ohio and Patrick W. Bevack, dated 10.3 December 31, 2004. 10.4 Employment Agreement between The Home Savings and Loan Incorporated by reference to the 2004 10-K/A, Exhibit Company of Youngstown, Ohio and Patrick A. Kelly, dated 10.4 December 31, 2004. 10.5 Employment Agreement between Butler Wick Corp. and Thomas Incorporated by reference to the 1999 10-K filed by J. Cavalier, dated August 12, 1999. United Community on March 29, 2000 via Edgar, film number 582478, Exhibit 10.5 10.6 Employment Agreement between The Home Savings and Loan Incorporated by reference to the 2004 10-K/A, Exhibit Company of Youngstown, Ohio and David G. Lodge, dated 10.6 December 31, 2004. 10.7 United Community 1999 Long -Term Incentive Plan Incorporated by reference to the Proxy Statement filed by United Community via Edgar on June 7, 1999, file number 9964170 (1999 Proxy), Exhibit 10.8 United Community Recognition and Retention Plan and Trust Incorporated by reference to the 1999 Proxy, Exhibit B Agreement 11 Statement Regarding Computation of Per Share Earnings Incorporated by reference to Note 21 to the Financial Statements included in the Annual Report in Exhibit 13. 13 Portions of the 2005 Annual Report to Shareholders 20 Proxy Statement for 2006 Annual Meeting of Shareholders Incorporated by reference to the Proxy Statement, to be filed with the Securities and Exchange Commission on or about March 29, 2006. 21 Subsidiaries of Registrant 23 Crowe Chizek and Company LLC Consent 31.1 Section 302 Certification by Chief Executive Officer 31.2 Section 302 Certification by Chief Financial Officer 32 Certification of Financial Statements by Chief Executive Officer and Chief Financial Officer
24 EX-13 2 l17997aexv13.txt EXHIBIT 13 . . . EXHIBIT 13 SELECTED FINANCIAL AND OTHER DATA Selected financial condition data:
At December 31, -------------------------------------------------------------- 2005 2004 2003 2002 2001 ---------- ---------- ---------- ---------- ---------- (Dollars in thousands) Total assets $2,528,850 $2,287,788 $2,073,833 $1,990,131 $1,944,780 Cash and cash equivalents 37,545 40,281 81,155 110,936 205,883 Securities: Trading, at fair value 10,812 32,316 15,600 5,060 8,352 Available for sale, at fair value 201,870 198,404 227,525 237,268 118,150 Held to maturity, at amortized cost -- -- -- -- 80,496 Loans held for sale 29,109 59,099 37,715 45,825 20,192 Loans, net 2,097,433 1,815,976 1,576,494 1,478,213 1,406,479 Federal Home Loan Bank stock, at cost 24,006 22,842 21,924 21,069 18,760 Cash surrender value of life insurance 22,260 21,406 20,496 -- -- Deposits 1,681,844 1,522,952 1,423,698 1,481,901 1,383,418 Borrowed funds 550,763 483,503 338,463 210,024 271,631 Total shareholders' equity 264,735 252,352 279,836 274,569 261,880
Summary of earnings:
Year ended December 31, ---------------------------------------------------- 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- (Dollars in thousands) Interest income $136,052 $113,441 $111,663 $125,960 $113,989 Interest expense 57,296 40,378 40,252 54,236 57,047 -------- -------- -------- -------- -------- Net interest income 78,756 73,063 71,411 71,724 56,942 Provision for loan losses 3,028 9,370 3,179 3,578 2,495 -------- -------- -------- -------- -------- Net interest income after provision for loan losses 75,728 63,693 68,232 68,146 54,447 Non-interest income 38,260 36,109 40,845 31,806 28,449 Non-interest expenses 78,881 72,834 73,572 68,359 57,708 -------- -------- -------- -------- -------- Income before income taxes 35,107 26,968 35,505 31,593 25,188 Income taxes 11,910 9,103 12,565 10,776 9,509 -------- -------- -------- -------- -------- Net income $ 23,197 $ 17,865 $ 22,940 $ 20,817 $ 15,679 -------- -------- -------- -------- --------
EX. 13-1 Selected financial ratios and other data:
At or for the year ended December 31, ---------------------------------------------------- 2005 2004 2003 2002 2001 -------- -------- -------- -------- -------- Performance ratios: Return on average assets (1) 0.96% 0.83% 1.15% 1.04% 0.97% Return on average shareholders' equity (2) 8.89 7.01 8.27 7.74 6.03 Interest rate spread (3) 3.15 3.34 3.51 3.36 2.95 Net interest margin (4) 3.47 3.60 3.81 3.79 3.66 Non-interest expense to average assets 3.27 3.37 3.70 3.74 3.56 Efficiency ratio (5) 67.00 65.87 65.29 64.52 66.34 Average interest earning assets to average interest bearing liabilities 112.41 113.16 114.24 114.98 119.23 Capital ratios: Average equity to average assets 10.83 11.78 13.95 13.48 16.04 Shareholders' equity to assets at year end 10.47 11.03 13.49 13.80 13.47 Tier 1 leverage ratio 8.36 8.36 8.22 8.05 9.07 Tier 1 risk-based capital ratio 10.08 9.92 9.64 11.64 13.88 Total risk-based capital ratio 10.86 10.79 10.56 12.61 14.70 Asset quality ratios: Nonperforming loans to loans, net (6) 1.22 1.24 1.02 1.06 0.89 Nonperforming assets to total assets at year end (7) 1.11 1.06 0.84 0.85 0.67 Allowance for loan losses as a percent of loans 0.74 0.87 0.96 1.02 0.82 Allowance for loan losses as a percent of nonperforming loans (6) 61.26 70.38 93.66 96.20 92.13 Number of: Loans 43,630 41,690 37,668 37,872 25,636 Deposits 183,565 173,997 169,920 173,528 164,753 Per share data: Basic earnings (8) $ 0.81 $ 0.61 $ 0.73 $ 0.65 $ 0.49 Diluted earnings (8) 0.80 0.60 0.72 0.65 0.48 Book value (9) 8.52 8.09 8.21 7.79 7.34 Dividend per share 0.33 0.30 0.30 0.30 0.30 Dividend payout ratio (10) 41.25% 50.00% 41.67% 46.15% 62.50%
(1) Net income divided by average total assets. (2) Net income divided by average total equity. (3) Difference between weighted average yield on interest earning assets and weighted average cost of interest bearing liabilities. (4) Net interest income as a percentage of average interest earning assets. (5) Non-interest expense, excluding the amortization of core deposit intangible, divided by the sum of net interest income and non-interest income, excluding gains and losses on securities and other. (6) Nonperforming loans consist of loans ninety days past due, loans less then ninety days past due and not accruing and restructured loans. (7) Nonperforming assets consist of nonperforming loans and real estate acquired in settlement of loans and other repossessed assets. (8) Net income divided by average number of shares outstanding. (9) Shareholders' equity divided by number of shares outstanding. (10) Historical per share dividends declared and paid for the year divided by the diluted earnings per share for the year. EX. 13-2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL United Community Financial Corp. (United Community) was incorporated in the State of Ohio in February 1998 for the purpose of owning all of the outstanding capital stock of The Home Savings and Loan Company of Youngstown, Ohio (Home Savings) issued upon the conversion of Home Savings from a mutual savings association to a permanent capital stock savings association (Conversion). The Conversion was completed on July 8, 1998. On August 12, 1999, United Community acquired Butler Wick Corp. (Butler Wick), an investment brokerage/advisory firm. Home Savings conducts business from its main office located in Youngstown, Ohio, 37 full-service branches and six loan production offices located throughout Ohio and western Pennsylvania. The principal business of Home Savings is providing consumer and business banking services to its market area in Ohio and western Pennsylvania. Home Savings also originates loans secured by nonresidential real estate. In addition to real estate lending, Home Savings originates commercial loans and various types of consumer loans. For liquidity and interest rate risk management purposes, Home Savings invests in various financial instruments as discussed below. Funds for lending and other investment activities are obtained primarily from savings deposits, which are insured up to applicable limits by the FDIC, principal repayments of loans, borrowings from the Federal Home Loan Bank and maturities of securities. Interest on loans and other investments is Home Savings' primary source of income. Home Savings' principal expenses are interest paid on deposit accounts and other borrowings and salaries and benefits paid to employees. Operating results are dependent to a significant degree on the net interest income of Home Savings, which is the difference between interest earned on loans and other investments and interest paid on deposits and borrowed funds. Like most thrift institutions, Home Savings' interest income and interest expense are significantly affected by general economic conditions and by the policies of various regulatory authorities. Butler Wick is the parent company for two wholly-owned subsidiaries: Butler Wick & Co., Inc. and Butler Wick Trust Company. Butler Wick conducts business from its main office located in Youngstown, Ohio and 20 offices located in northeastern Ohio and western Pennsylvania. Butler Wick primarily sells common and preferred stocks, but also offers an array of government, corporate and municipal bonds, unit trusts, mutual funds, IRAs, money market accounts and certificates of deposit. Butler Wick also offers a full line of life insurance and annuity products, personal and corporate financial planning, estate planning, pension and profit sharing and investments in precious metals. The following discussion and analysis of the financial condition and results of operations of United Community and its subsidiaries should be read in conjunction with the consolidated financial statements, and the notes thereto, included in this Annual Report. FORWARD-LOOKING STATEMENTS Certain statements contained in this report that are not historical facts are forward looking statements that are subject to certain risks and uncertainties. When used herein, the terms "anticipate," "plan," "expect," "believe," and similar expressions as they relate to United Community or its management are intended to identify such forward looking statements. United Community's actual results, performance or achievements may differ materially from those expressed or implied in the forward-looking statements. Risks and uncertainties that could cause or contribute to such material differences include, but are not limited to, general economic conditions, the interest rate environment, competitive conditions in the financial services industry, changes in law, governmental policies and regulations and rapidly changing technology affecting financial services. CHANGES IN FINANCIAL CONDITION Total assets increased $241.1 million, or 10.5%, from $2.3 billion at December 31, 2004 to $2.5 billion at December 31, 2005. The net change in assets was a result of increases of $281.5 million, or 15.5%, in net loans, $3.5 million in available for sale securities, $3.0 million in premises and equipment and $2.6 million in accrued interest receivable. These increases were partially offset by decreases of $30.0 million in loans held for sale and $21.5 million in trading securities. Total liabilities increased $228.7 million, or 11.2%, primarily as a result of increases of $146.9 million in interest bearing deposits, $52.2 million in Federal Home Loan Bank advances, $15.1 million in repurchase agreements and other borrowings and $12.0 million in non-interest bearing deposits. United Community expects this growth trend to continue into 2006 as new locations are opened to better service customer needs. Net loans increased $281.5 million, or 15.5%, to $2.1 billion at December 31, 2005, compared to $1.8 billion at December 31, 2004. Much like the growth seen last year, the most significant increases were in the one- to four-family portfolio with a $58.9 million increase in permanent loans and an $88.4 million increase in one- to four-family construction loans. Other increases in the loan portfolio included a $55.9 million increase in consumer loans, a $32.5 million increase in commercial loans and a $24.4 million increase in non-residential real estate loans. During 2003, Home Savings entered into an agreement to purchase one- to four-family construction loans from another institution. Loans purchased under this agreement earn a floating rate of interest, are guaranteed as to principal and interest by a third party and may be for the purpose of constructing either pre-sold or speculative homes. Home Savings continued to purchase loans under this program in 2005 and had approximately $101.7 million outstanding at December 31, 2005. This represents an increase of $16.2 million over the outstanding balance of $85.5 million included in net loans as of December 31, 2004. Home Savings anticipates continued net growth in all loan categories, which may increase the risk of loan losses. Non-residential real estate lending generally is considered to involve a higher EX. 13-3 degree of risk than residential real estate lending due to the relatively larger loan amounts and the effects of general economic conditions on the successful operation of income-producing properties. Consumer lending also can involve a higher degree of risk than residential real estate lending as collateral for consumer loans can decline in value more quickly than real estate collateral. See Note 4 to the consolidated financial statements for additional information regarding the composition of net loans. Loans held for sale were $29.1 million at December 31, 2005 compared to $59.1 million at December 31, 2004. In the third quarter of 2004, Home Savings transferred $39.3 million in fixed rate, fixed term second mortgage loans originated by the bank from the portfolio to loans held for sale. These loans were transferred back to the portfolio in the first quarter of 2005 as management had decided not to sell these loans. United Community also continued to purchase residential mortgage loans from a number of correspondent lenders. Home Savings continues purchasing adjustable rate loans and selling long term fixed rate loans as a part of its strategic plan to manage interest rate risk. As interest rates rise, loan origination volumes generally decline, thus resulting in fewer loans available for sale. Trading securities decreased $21.5 million, or 66.5%, from December 31, 2004 to December 31, 2005. The reduction is a result of a decrease in Butler Wick's trading portfolio of $20.5 million. Additionally, trading securities held by United Community for the Butler Wick Retention Plan decreased as approximately 55% of the remaining plan assets were distributed in August 2005, as all participants are fully vested. Refer to note 16 of the consolidated financial statements for further discussion of the retention plan. Other assets increased $1.8 million during 2005. The increase is a result primarily of increases in receivables due from brokers/dealers at Butler Wick of $2.9 million and deferred mortgage servicing rights at Home Savings of $1.4 million. These increases were offset by decreases in deferred federal tax assets of $1.6 million, a low-income housing investment at Home Savings of $357,000 and a decrease in receivables for securities sold but not yet settled at United Community of $390,000. Funds not currently utilized for general corporate purposes are invested in overnight funds and securities. Cash and cash equivalents decreased $2.7 million, or 6.8%, to $37.5 million at December 31, 2005 compared to $40.3 million at December 31, 2004. The decrease is primarily a result of increased cash used for investments in securities partially offset by increased cash from normal operations. Available for sale securities increased $3.5 million during 2005 as a result of purchases of $80.3 million offset by paydowns and maturities of $51.1 million and sales of $20.9 million. The majority of United Community's available for sale portfolio is held by Home Savings. Home Savings has an investment in bank owned life insurance, which is insurance on the lives of certain employees where Home Savings is the beneficiary. Bank owned life insurance provides a long-term asset to offset long-term benefit obligations, while generating competitive investment yields. Home Savings recognized $910,000 as other non-interest income based on the cash value of the policies in 2004 and $854,000 in 2005. The increase in the cash value of the policies is tax exempt and any death benefit proceeds received by Home Savings are tax-free. Total deposits increased $158.9 million, or 10.4%, from $1.5 billion at December 31, 2004 to $1.7 billion at December 31, 2005, primarily as a result of an increase in certificates of deposit of $241.8 million. This change was offset by a decrease of $48.4 million in savings accounts and $44.1 million in checking deposits. During 2005, Home Savings emphasized growth in certificates of deposit in order to attract new customers. In addition, core deposit rates were kept at historically low levels that led to some migration into certificates of deposit. Management continually evaluates many variables when pricing deposits, including cash requirements, liquidity targets, asset acquisition, liability mix and interest rate risk. The increase in total deposits was used to partially fund the increase in net loans in 2005. Funds needed in excess of deposit growth are borrowed in the normal course of business. Home Savings has an established credit relationship with the Federal Home Loan Bank of Cincinnati under which the Bank can borrow up to $608.6 million. Of the total borrowing capacity at the Federal Home Loan Bank, Home Savings has outstanding advances of $475.5 million at December 31, 2005, which is an increase of $52.2 million compared to December 31, 2004. Their borrowings are collateralized primarily by one- to four-family residential mortgage loans. Repurchase agreements and other borrowings are also utilized by United Community. Repurchase agreements have increased $30.0 million as a result of Home Savings taking advantage of lower interest rates on this type of borrowing compared to Federal Home Loan Bank advances. Partially offsetting this increase was a decrease in the amount of other borrowings at Butler Wick. In 2004, Butler Wick had increased its borrowing position to fund the purchase of trading securities. These securities were sold in 2005 and the borrowing was repaid. United Community continually evaluates funding alternatives and may borrow additional funds in 2006 to satisfy funding requirements. Total shareholders' equity increased $12.4 million, or 4.9%, from December 31, 2004 to December 31, 2005. The increase was primarily due to net income of $23.2 million which was partially offset by dividends of $9.5 million paid to shareholders during the year, treasury stock purchases of $2.5 million, and a decrease in accumulated other comprehensive income of $2.9 million. Accumulated other comprehensive income decreased as a result of the change in market value of available for sale securities at December 31, 2005 compared to December 31, 2004. Book value per share and tangible book value per share were $8.52 and $7.37, respectively, as of December 31, 2005. Book value per share and tangible book value per share were $8.09 and $6.92, respectively, as of December 31, 2004. EX. 13-4 COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2005 AND DECEMBER 31, 2004 NET INCOME--Net income for the year ended December 31, 2005 was $23.2 million, compared to $17.9 million for the year ended December 31, 2004. This increase was due primarily to an increase of $22.6 million in interest income, a reduction in the provision for loan losses of $6.3 million and increased non-interest income of $2.2 million. These changes were partially offset by an increase in interest expense of $16.9 million, an increase in non-interest expense of $6.0 million and an increased provision for income taxes of $2.8 million. NET INTEREST INCOME--Net interest income for the year ended December 31, 2005, grew by $5.7 million, or 7.8%, over the year ended December 31, 2004. The change is due largely to an increase of $21.3 million in interest earned on loans, offset by increases in interest expense on deposits of $9.6 million and interest expense on Federal Home Loan Bank advances of $6.1 million. The increase of $21.3 million in interest earned on loans is due primarily to growth in the amount of outstanding loans, which accounted for additional interest earned of $15.5 million. The remaining $5.8 million of the total increase in interest earned on loans is a result of higher rates. United Community's net interest margin for 2005 was 3.47%, which represents a decrease of 13 basis points compared to 2004. Much of this compression resulted from the flattening of the yield curve and the narrowing of spreads. Management was pleased that the compression was so limited given the strong balance sheet growth in the current interest rate environment. Efforts to change the composition of the loan portfolio and deposit pricing throughout the year played an important role in management's efforts to counteract the effects of the flatter yield curve. PROVISION FOR LOAN LOSSES--A provision for loan losses is charged to operations to bring the total allowance for loan losses to a level considered by management to be adequate, based on management's evaluation of such factors as the delinquency status of loans, current economic conditions, the net realizable value of the underlying collateral, changes in the composition of the loan portfolio and prior loan loss experience. The provision for loan losses was $3.0 million in 2005 compared to a provision of $9.4 million in 2004, which included impairment charges aggregating $8.4 million in the third quarter of 2004 related to two loans made to a boat dealer and to a number of loans to purchasers of boats from that dealer. Similar reserves were not required in 2005. The allowance for loan losses totaled $15.7 million at December 31, 2005, which was 0.74% of net loans and 61.3% of nonperforming loans, compared to $15.9 million at December 31, 2004, which was 0.87% of net loans and 70.4% of nonperforming loans. The decline in the relationship of the allowance for loan losses to total loans and the decline in the allowance coverage ratio of nonperforming loans in 2005 is primarily a factor of the strong loan growth of $281.5 million discussed earlier and a change in the mix of impaired loans. Of the loan growth, $147.3 million occurred on one- to four-family real estate loans and construction loans. As a result of United Community's underwriting standards and stable real estate values in its market area historical losses on this segment of the loan portfolio have historically been low, mitigating the need for additional provisions for loan losses. With respect to impaired loans, at December 31, 2005, impaired loans totaled $17.7 million of which $4.6 million had specific valuation allowances of $667,000 allocated to them. In comparison, at December 31, 2004, impaired loans totaled $15.2 million of which $7.3 million had specific valuation allowances of $1.7 million allocated to them. At December 31, 2005, more of the loans classified as impaired were secured by real estate collateral with sufficient value to cover the outstanding loan balance. While general allowance allocations have increased, specific allowance allocations have decreased during the year. NON-INTEREST INCOME--Non-interest income increased $2.2 million, or 6.0%, to $38.3 million for the year ended December 31, 2005, from $36.1 million for the year ended December 31, 2004. The increase was due primarily to increases in brokerage commissions of $1.3 million due to increased brokerage activity at Butler Wick, service fees and other charges of $691,000 and other income of $753,000. These increases were offset by a lower gain realized on loans sold of $942,000. An increase in gains on available for sale securities was a result of an other-than-temporary charge of $1.4 million taken by Home Savings to write down a Fannie Mae security to its approximate market value in 2004. This security was sold in 2005, with no additional loss recognized. The change in income from trading securities was a result of larger losses recognized in Butler Wick's trading portfolio in 2004 versus 2005. In 2004, Butler Wick sustained losses aggregating $142,000 on a portfolio of $30.3 million compared to gains aggregating $165,000 on a portfolio of $9.8 million in 2005. Lower gains were recognized on the retention plan at Butler Wick during 2005 compared to 2004. Gains recognized on the retention plan in 2005 were $103,000 compared to $135,000 in 2004. Gains recognized on those assets will decline further as a result of the distribution in August 2005 of 55% of the plan assets to plan participants. Underwriting and investment banking fee income is derived from tax-advantaged bond offerings for school districts, health care facilities, municipalities and public agencies. Butler Wick brought fewer of these offerings to the market in 2005 compared to 2004, resulting in a decrease in revenues of $153,000, from $1.0 million to $876,000. NON-INTEREST EXPENSE--Non-interest expenses rose $6.1 million during the year ended December 31, 2005, compared to the same period in 2004, primarily as a result of employee compensation and benefits increasing $5.7 million. The increase is attributable to increased performance incentives as a result of record earnings, greater commission expenses, rising healthcare costs and increased personnel. Other expenses also increased consisting, in part, of legal and audit fees. These increases were offset partially by a decrease in advertising expense of $283,000. EX. 13-5 FEDERAL INCOME TAXES--During the year ended December 31, 2005, United Community recorded an $11.9 million provision for income taxes. This is an increase of $2.8 million over the year ended December 31, 2004 as a result of higher pretax income earned in 2005 compared to 2004. The effective tax rate at December 31, 2005 was 33.9% compared to 33.8% at December 31, 2004. COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2004 AND DECEMBER 31, 2003 NET INCOME-- Net income for the year ended December 31, 2004 was $17.9 million, compared to $22.9 million for the year ended December 31, 2003, primarily due to an increase of $6.2 million in the provision for loan losses and reduced non-interest income of $4.7 million, offset by an increase in net interest income of $1.7 million and reduced provision for income taxes of $3.5 million. NET INTEREST INCOME--Net interest income increased $1.7 million, or 2.3%, to $73.1 million in 2004 from $71.4 million for 2003. Total interest income increased $1.8 million while interest expense increased only slightly. The increase in total interest income was primarily due to increases in interest earned on loans at Home Savings of $3.8 million, interest earned on margin accounts at Butler Wick of $113,000 and interest earned on trading securities of $321,000. The average balance of net loans increased $231.6 million, driving the increase in interest earned on those assets. The increase in margin account interest was due to a higher yield earned on those assets of 88 basis points. The increase in trading securities was a result of an increase in the average balance of trading securities of $15.3 million in Butler Wick's portfolio. These increases were partially offset by a decrease in interest earned on available for sale securities of $1.8 million, due to a decrease in the average balance of available for sale securities of $62.9 million as a result of paydowns, maturities and sales of securities. Interest expense increased slightly because a decline in interest expense on deposits at Home Savings of $2.5 million was offset by an increase in interest expense on borrowed funds of $2.7 million. The decrease in interest expense on deposits was caused by a decrease in the average rate paid as well as a decrease in the average balance of interest bearing savings accounts of $21.3 million and a decrease in the average balance of checking and money market accounts of $5.9 million. Interest on borrowed funds increased primarily as a result of a $172.7 million increase in the average balance of borrowings. Borrowings increased, as noted above, to fund loan growth in excess of deposit growth at Home Savings as well as to purchase trading securities used to collateralize repurchase agreements at Butler Wick. PROVISION FOR LOAN LOSSES--Provisions for loan losses are charged to operations to bring the total allowance for loan losses to a level considered by management to be adequate, based on management's evaluation of such factors as the delinquency status of loans, current economic conditions, the net realizable value of the underlying collateral, changes in the composition of the loan portfolio and prior loan loss experience. The provision for loan losses was $9.4 million in 2004 compared to a provision of $3.2 million in 2003. The $6.2 million increase primarily was a result of impairment charges aggregating $8.4 million in the third quarter. These impairment charges relate to two loans made to a boat dealer and to a number of loans to purchasers of boats from that dealer. The charge was recorded after United Community learned that insufficient collateral secured these loans. Also, the mix of all loans in the portfolio in recent years has changed to include more construction, consumer, commercial and commercial real estate loans which involve a relatively higher level of credit risk. These factors all required a higher provision for loan losses than if the portfolio remained primarily comprised of one- to four-family mortgage loans. The allowance for loan losses totaled $15.9 million at December 31, 2004, which was 0.87% of net loans and 70.4% of nonperforming loans compared to $15.1 million at December 31, 2003, which was 0.96% of net loans and 93.7% of nonperforming loans. NON-INTEREST INCOME--Non-interest income decreased $4.7 million, or 11.6%, to $36.1 million for the year ended December 31, 2004, from $40.8 million for the year ended December 31, 2003. The change was due to decreases of $8.5 million in net gains recognized on the sale of loans, $831,000 in gains recognized on available for sale securities, $857,000 in gains recognized on trading securities and $499,000 in underwriting and investment banking income. During 2004, Home Savings sold $180.9 million in mortgage loans compared to sales of $536.6 million in 2003. A decline in one- to four-family residential loan origination volumes led to the reduced gain on related sales. As interest rates begin to rise, loan sales are expected to continue slowing into the foreseeable future. The decline in gains on available for sale securities was a result of an other-than-temporary charge of $1.4 million taken by Home Savings to write down a Fannie Mae security to its approximate market value. Home Savings incurred the charge because the market value of the stock declined significantly in the fourth quarter, following several negative announcements by Fannie Mae involving regulatory actions, earnings restatements and management turnover. Home Savings concluded that these events made the likelihood of future price appreciation less certain in the near term and would extend the time period for a recovery of United Community's investment cost beyond previous estimates. The change in income from trading securities was a result of larger losses recognized in Butler Wick's trading portfolio in 2004 compared to 2003. In 2004, Butler Wick sustained losses aggregating $142,000 on a portfolio of $30.3 million compared to $21,000 on a portfolio of $11.5 million in 2003. Also, lower gains were recognized on the retention plan at Butler Wick during 2004 compared to 2003. Gains recognized on the retention plan in 2004 were $135,000 compared to $872,000 in 2003. Underwriting and investment banking fee income is derived from tax-advantaged bond offerings for school districts, health care facilities, municipalities and public agencies. Butler Wick brought fewer of these offerings to the market in 2004 compared to 2003 resulting in a decrease in revenues of $499,000. A 40.5% increase in service fees and other charges in 2004 partially offset the aforementioned decreases in non-interest income. Service fees at Home Savings increased $2.7 million for the year ended December 31, 2004 compared to 2003 as a result of an increase in OverdraftHonor(TM) fees of $1.4 million, a decrease in deferred mortgage servicing rights amortization of $916,000 and a $341,000 increase in collection fee income. Service fees at Butler Wick increased $664,000, mostly due to an increase in trust fee income of $435,000 compared to 2003. Brokerage commissions also increased at Butler Wick for the year ending December 31, 2004 compared to the same period in 2003. EX. 13-6 Commissions are generated from the sale of equities, mutual funds and bonds to retail clients. Commissions increased $2.3 million over last year as a result of increased activity in 2004 compared to 2003. NON-INTEREST EXPENSE--Non-interest expense decreased $738,000 to $72.8 million for 2004, from $73.6 million in 2003. The primary reasons for the decrease were decreases in salaries and employee benefits of $437,000, a decrease in amortization expense related to the core deposit intangible of $414,000, a decrease in advertising expense of $379,000 and a decrease in equipment and data processing of $373,000. The primary reasons for the decrease in salaries and employee benefits include a reduction in the accrued expense related to the postretirement benefit plan of $1.5 million at Home Savings. Additional factors that contributed to the decrease include lower commissions and bonuses paid at Home Savings and a reduction in RRP expense as participants in that plan vested in August 2003. Offsetting the reduction in salary expense at Home Savings was an increase in salary expense at Butler Wick of $565,000 as a result of increased brokerage activity. The decrease in the amortization of the core deposit intangible resulting from the 2001 acquisition of Industrial Bancorp, Inc. and the 2002 acquisition of Potters' Financial Corporation is a result of amortization on a lower balance. The amount of amortization taken is greater in the first years of acquisition and decreases as the asset ages. Advertising expense declined in 2004 as a result of lower advertising expenses recognized at Home Savings of $336,000, partially as a result of fewer advertising campaigns, and $40,000 at Butler Wick. Equipment and data processing decreased as a result of lower depreciation expenses recognized at Home Savings in 2004 as compared to 2003. FEDERAL INCOME TAXES--Federal income taxes decreased $3.5 million, or 27.6%, in 2004 compared to 2003, primarily due to lower pretax income in 2004. The effective tax rate was 33.8% in 2004 and 35.4% in 2003. Refer to Note 13 to the consolidated financial statements for a further analysis of the effective tax rate. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The accounting and reporting policies of United Community are in accordance with accounting principles generally accepted within the United States of America and conform to general practices within the financial services industry. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the financial statements. Accordingly, as this information changes, the financial statements could reflect different estimates, assumptions and judgments. The most significant accounting policies followed by United Community are presented in Note 1 to the consolidated financial statements. Accounting and reporting policies for the allowance for loan losses, mortgage servicing rights and other-than-temporary impairment are deemed critical since they involve the use of estimates and require significant management judgments. Application of assumptions different than those used by management could result in material changes in United Community's financial position or results of operations. ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses is an amount that management believes will be adequate to absorb probable incurred losses in existing loans taking into consideration such factors as past loss experience, changes in the nature and volume of the portfolio, overall portfolio quality, loan concentrations, specific problem loans and current economic conditions that affect the borrower's ability to pay. Determination of the allowance inherently is subjective due to the aforementioned reasons. Loan losses are charged off against the allowance when management believes that the full collectability of the loan is unlikely. Recoveries of amounts previously charged off are credited to the allowance. The allowance is based on management's evaluation of homogeneous groups of loans (single-family residential mortgage loans and all consumer credit except marine loans) to which loss factors have been applied, as well as an evaluation of individual credits (multi-family, non-residential mortgage loans, marine loans and commercial loans) which are based on internal risk ratings, collateral and other unique characteristics of each loan. Management believes that it uses the best information available to determine the adequacy of the allowance for loan losses. However, future adjustments to the allowance may be necessary and the results of operations could be significantly and adversely affected if circumstances differ substantially from the assumptions used in making the determinations. MORTGAGE SERVICING RIGHTS. The cost of mortgage loans sold or securitized is allocated between the mortgage servicing rights and the mortgage loans based on the relative fair values of each. The fair value of the mortgage servicing rights is determined by using a discounted cash flow model, which estimates the present value of the future net cash flows of the servicing portfolio, about which management must make assumptions considering future expectations based on various factors, such as servicing costs, expected prepayment speeds and discount rates. Mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing income. Management periodically evaluates mortgage servicing rights for impairment by stratifying the loans by original maturity, interest rate and loan type. Impairment is measured by estimating the fair value of each pool, taking into consideration the estimated level of prepayments based upon current industry expectations. An impairment allowance is recorded for a pool when, and in an amount which, its fair value is less than its carrying value. The value of mortgage servicing rights is subject to prepayment risk. Future expected net cash flows from servicing a loan will not be realized if the loan pays off earlier than anticipated. Since most of these loans do not contain prepayment penalties, United Community receives no economic benefit if the loan pays off earlier than anticipated. EX. 13-7 OTHER-THAN-TEMPORARY IMPAIRMENT. Securities are written down to fair value when a decline in fair value is other-than-temporary. Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) United Community's intent and ability to hold the security for a period sufficient to allow for any anticipated recovery in fair value. Management must use its judgment based on information available in assessing the likelihood of recovery in value. EX. 13-8 YIELDS EARNED AND RATES PAID The following table sets forth certain information relating to United Community's average balance sheet and reflects the average yield on interest earning assets and the average cost of interest bearing liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average balances of interest earning assets or interest bearing liabilities, respectively, for the periods presented. Average balances are derived from daily balances. Nonaccruing loans have been included in the table as loans carrying a zero yield. Loan fees are included in interest income. The average balance for securities available for sale is computed using the carrying value and the average yield on securities available for sale has been computed using the historical amortized average balance.
Year ended December 31, ------------------------------------------------------------------------------------------- 2005 2004 2003 ----------------------------- ----------------------------- ----------------------------- Average Interest Average Interest Average Interest outstanding earned/ Yield/ outstanding earned/ Yield/ outstanding earned/ Yield/ balance paid rate balance paid rate balance paid rate ----------- -------- ------ ----------- -------- ------ ----------- -------- ------ (Dollars in thousands) Interest earning assets: Net loans (1) $1,979,294 $123,749 6.25% $1,728,139 $102,453 5.93% $1,496,518 $ 98,646 6.59% Loans held for sale 33,845 1,651 4.88 30,814 1,449 4.70 41,418 1,950 4.71 Securities: Trading 29,777 943 3.17 29,221 736 2.52 13,887 415 2.99 Available for sale 186,404 7,227 3.88 200,069 7,022 3.51 262,967 8,851 3.37 Margin accounts 15,659 1,219 7.78 14,117 802 5.68 14,349 689 4.80 Federal Home Loan Bank stock 23,250 1,164 5.01 22,262 919 4.13 21,388 855 4.00 Other interest earning assets 3,867 99 2.56 4,958 60 1.21 21,415 257 1.20 ---------- -------- ------ ---------- -------- ------ ---------- -------- ------ Total interest earning assets $2,272,096 $136,052 5.98% $2,029,580 $113,441 5.59% $1,871,942 $111,663 5.97% Non-interest earning assets 136,728 132,972 116,685 ---------- ---------- ---------- Total assets $2,408,824 $2,162,552 $1,988,627 ========== ========== ========== Interest bearing liabilities: Deposits: Checking accounts $ 269,652 $ 3,231 1.20% $ 302,936 $ 2,386 0.79% $ 308,816 $ 3,112 1.01% Savings accounts 287,714 1,201 0.42 314,588 1,361 0.43 335,843 2,347 0.70 Certificates of deposit 938,957 33,488 3.57 773,019 24,614 3.18 763,704 25,441 3.33 Federal Home Loan Bank advances 460,205 17,364 3.77 351,800 11,254 3.20 199,633 8,841 4.43 Repurchase agreements and other 64,776 2,012 3.11 51,142 763 1.49 30,643 511 1.67 ---------- -------- ------ ---------- -------- ------ ---------- -------- ------ Total interest bearing liabilities $2,021,304 $ 57,296 2.83% $1,793,485 $ 40,378 2.25% $1,638,639 $ 40,252 2.46% ---------- -------- ------ ---------- -------- ------ ---------- -------- ------ Non-interest bearing liabilities 126,673 114,277 72,536 ---------- ---------- ---------- Total liabilities $2,147,977 $1,907,762 $1,711,175 Shareholders' equity 260,847 254,790 277,452 ---------- ---------- ---------- Total liabilities and equity $2,408,824 $2,162,552 $1,988,627 ========== ========== ========== Net interest income and interest rate spread $ 78,756 3.15% $ 73,063 3.34% $ 71,411 3.51% ======== ====== ======== ====== ======== ====== Net interest margin 3.47% 3.60% 3.81% ====== ====== ====== Average interest earning assets to average interest bearing liabilities 112.41% 113.16% 114.24% ====== ====== ======
(1) Nonaccrual loans are included in the average balance. EX. 13-9 The table below describes the extent to which changes in interest rates and changes in volume of interest earning assets and interest bearing liabilities have affected United Community's interest income and interest expense during the periods indicated. For each category of interest earning assets and interest bearing liabilities, information is provided on changes attributable to (i) changes in volume (change in volume multiplied by prior period rate), (ii) changes in rate (change in rate multiplied by prior period volume) and (iii) total changes in rate and volume. The combined effects of changes in both volume and rate, which cannot be separately identified, have been allocated in proportion to the changes due to volume and rate:
Year ended December 31, --------------------------------------------------------------- 2005 vs. 2004 2004 vs. 2003 ------------------------------ ------------------------------ Increase Increase (decrease) due to Total (decrease) due to Total ----------------- increase ----------------- increase Rate Volume (decrease) Rate Volume (decrease) ------ -------- ---------- ------- ------- ---------- (Dollars in thousands) Interest earning assets: Loans $5,815 $15,481 $ 21,296 $(7,071) $10,878 $ 3,807 Loans held for sale 56 146 202 (2) (499) (501) Securities: Trading 193 14 207 (53) 374 321 Available for sale 590 (385) 205 398 (2,227) (1,829) Margin accounts 322 95 417 124 (11) 113 Federal Home Loan Bank stock 203 42 245 28 36 64 Other interest earning assets 49 (10) 39 2 (199) (197) ------ ------- -------- ------- ------- ------- Total interest earning assets $7,228 $15,383 $ 22,611 $(6,574) $ 8,352 $ 1,778 ====== ======= ======== ======= ======= ======= Interest bearing liabilities: Checking accounts 1,071 (226) 845 (846) (140) (986) Savings accounts (47) (113) (160) (668) (58) (726) Certificates of deposit 3,183 5,691 8,874 (1,143) 316 (827) Federal Home Loan Bank advances 2,249 3,861 6,110 (1,383) 3,796 2,413 Repurchase agreements and other 1,002 247 1,249 (47) 299 252 ------ ------- -------- ------- ------- ------- Total interest bearing liabilities $7,458 $ 9,460 $ 16,918 $(4,087) $ 4,213 $ 126 ====== ======= ======== ======= ======= ======= Change in net interest income $ 5,693 $ 1,652 ======== =======
CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES AND OFF-BALANCE SHEET ARRANGEMENTS The following table presents, as of December 31, 2005, United Community's significant fixed and determinable contractual obligations by payment date. The payment amounts represent those amounts contractually due to the recipient and do not include any unamortized premiums or discounts or other similar carrying value adjustments. Further detail of the nature of each obligation is included in the referenced note to the consolidated financial statements.
Payments Due In ------------------------------------------------------------------------- Note One Year One to Three to Over Reference or Less Three Years Five Years Five Years Total --------- -------- ----------- ---------- ---------- ---------- (Dollars in thousands) Operating leases 7 $ 957 $ 1,527 $ 1,044 $ 507 $ 4,035 Deposits without a stated maturity 9 615,844 -- -- -- 615,844 Certificates of deposit 9 541,614 365,982 116,760 41,761 1,066,117 Federal Home Loan Bank advances 10 360,752 88,952 13,300 12,545 475,549 Repurchase agreements and other borrowings 11 38,614 36,600 -- -- 75,214
Discussion of loan commitments is included in Note 4 to the consolidated financial statements. In addition, United Community has commitments under benefit plans as described in Note 16 to the consolidated financial statements. ASSET AND LIABILITY MANAGEMENT AND MARKET RISK QUALITATIVE ASPECTS OF MARKET RISK. The principal market risk affecting United Community is interest rate risk. United Community is subject to interest rate risk to the extent that its interest earning assets reprice differently than its interest bearing liabilities. Interest rate risk is defined as the sensitivity of United Community's earnings and net asset values to changes in interest rates. As part of its efforts to monitor and manage the interest rate risk, the Board of Directors of Home Savings has adopted an interest rate risk policy that requires the Home Savings Board to review quarterly reports related to interest rate risk and annually set exposure limits for Home Savings as a guide to management in setting and implementing day to day operating strategies. EX. 13-10 QUANTITATIVE ASPECTS OF MARKET RISK. As part of its interest rate risk analysis, Home Savings uses the "net portfolio value" (NPV) methodology. Generally, NPV is the discounted present value of the difference between incoming cash flows on interest earning and other assets and outgoing cash flows on interest bearing and other liabilities. The application of the methodology attempts to quantify interest rate risk as the change in the NPV and net interest income that would result from various levels of theoretical basis point changes in market interest rates. Home Savings uses a NPV and earnings simulation model prepared internally as its primary method to identify and manage its interest rate risk profile. The model is based on actual cash flows and repricing characteristics for all financial instruments and incorporates market-based assumptions regarding the impact of changing interest rates on future volumes and the prepayment rate of applicable financial instruments. Assumptions based on the historical behavior of deposit rates and balances in relation to changes in interest rates also are incorporated into the model. These assumptions inherently are uncertain and, as a result, the model cannot measure precisely NPV or net interest income or precisely predict the impact of fluctuations in interest rates on net interest rate changes as well as changes in market conditions and management strategies. Presented below are analyses of Home Savings' interest rate risk as measured by changes in NPV and net interest income for instantaneous and sustained parallel shifts of 100 basis point increments in market interest rates. As noted, for the year ended December 31, 2005, the percentage changes fall within the policy limits set by the Board of Directors of Home Savings as the minimum NPV ratio and the maximum change in interest income the Home Savings Board deems advisable in the event of various changes in interest rates. Home Savings continues to monitor its interest rate exposure to declining rates. See the table below for Board adopted policy limits.
Year Ended December 31, 2005 --------------------------------------------------------------------------------- NPV as % of portfolio value of assets Next 12 months net interest income ----------------------------------------- ------------------------------------- (Dollars in thousands) Change in rates Internal policy Internal policy (Basis points) NPV Ratio limitations Change in % $ Change limitations % Change - --------------- --------- --------------- ----------- -------- --------------- -------- +300 11.90% 5.00% (1.35)% $ 322 (15.00)% 0.43% +200 12.45 6.00 (0.80) 390 (10.00) 0.52 +100 12.88 6.00 (0.36) (276) (5.00) (0.37) Static 13.24 7.00 -- -- -- -- (100) 13.08 6.00 (0.16) (649) (5.00) (0.87) (200) 12.38 6.00 (0.86) (3,638) (15.00) (4.89) (300) 10.98 5.00 (2.26) (10,678) (20.00) (14.37)
Year Ended December 31, 2004 --------------------------------------------------------------------------------- NPV as % of portfolio value of assets Next 12 months net interest income ----------------------------------------- ------------------------------------- (Dollars in thousands) Change in rates Internal policy Internal policy (Basis points) NPV Ratio limitations Change in % $ Change limitations % Change - --------------- --------- --------------- ----------- -------- --------------- -------- +300 13.75% 5.00% (0.41)% $ 3,028 (15.00)% 4.22% +200 14.09 6.00 (0.06) 2,318 (10.00) 3.23 +100 14.27 6.00 0.11 1,506 (5.00) 2.10 Static 14.16 7.00 -- -- -- -- (100) 13.22 6.00 (0.93) (3,856) (5.00) (5.37) (200) N/A N/A N/A N/A (15.00) N/A (300) N/A N/A N/A N/A (20.00) N/A
N/A - Due to a continuing low interest environment, it is not possible to calculate results for these scenarios. Due to changes in the composition of Home Savings' loan portfolio and with the prolonged period of low interest rates, Home Savings continues to be more sensitive to falling rates than rising rates. This increased sensitivity has occurred because a greater proportion of Home Savings' loans can reprice immediately and the prepayments on fixed-rate loans dramatically increase. In addition, the value of core deposits is diminished in a falling rate environment. As with any method of measuring interest rate risk, certain shortcomings are inherent in the NPV approach. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while EX. 13-11 interest rates on other types may lag behind changes in market rates. Further, in the event of a change in interest rates, expected rates of prepayment on loans and early withdrawal levels from certificates of deposit may deviate significantly from those assumed in making risk calculations. POTENTIAL IMPACT OF CHANGES IN INTEREST RATES. Home Savings' profitability depends to a large extent on its net interest income, which is the difference between interest income from loans and securities and interest expense on deposits and borrowings. Like most financial institutions, Home Savings' short-term interest income and interest expense are significantly affected by changes in market interest rates and other economic factors beyond its control. Accordingly, Home Savings' earnings could be adversely affected during a continued period of falling interest rates. LIQUIDITY AND CAPITAL United Community's liquidity, primarily represented by cash and cash equivalents, is a result of its operating, investing and financing activities. These activities are summarized below for the years ended December 31, 2005, 2004 and 2003.
Years ended December 31, --------------------------------- 2005 2004 2003 --------- --------- --------- (Dollars in thousands) Net income $ 23,197 $ 17,865 $ 22,940 Adjustments to reconcile net income to net cash from operating activities 92,222 10,230 20,152 --------- --------- --------- Net cash from operating activities 115,419 28,095 43,092 Net cash from investing activities (335,345) (264,802) (127,776) Net cash from financing activities 217,190 195,833 54,903 --------- --------- --------- Net change in cash and cash equivalents (2,736) (40,874) (29,781) Cash and cash equivalents at beginning of year 40,281 81,155 110,936 --------- --------- --------- Cash and cash equivalents at end of year $ 37,545 $ 40,281 $ 81,155 ========= ========= =========
The principal sources of funds for United Community are deposits, loan repayments, maturities of securities, borrowings from financial institutions and other funds provided by operations. Home Savings also has the ability to borrow from the Federal Home Loan Bank. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan prepayments are more influenced by interest rates, general economic conditions and competition. Investments in liquid assets maintained by United Community, Home Savings and Butler Wick are based upon management's assessment of (1) need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets and (4) objectives of the asset and liability management program. At December 31, 2005, approximately $541.6 million of Home Savings' certificates of deposit are expected to mature within one year. Based on past experience and Home Savings' prevailing pricing strategies, management believes that a substantial percentage of such certificates will be renewed with Home Savings at maturity, although there can be no assurance that this will occur. The Board of Directors has authorized an ongoing program to purchase United Community's common shares to be used for corporate purposes. These purchases can be made in the open market or in negotiated transactions from time to time, depending on market conditions. United Community acquired 232,400 common shares for $2.5 million, 3,797,000 common shares for $47.8 million, and 1,320,000 common shares for $12.4 million during the years ended December 31, 2005, 2004 and 2003. United Community has remaining authorization to repurchase 624,347 shares as of December 31, 2005, under the current repurchase program. The shares purchased in 2004 are primarily the result of a self-tender offer announced on January 26, 2004 and completed March 9, 2004. This offer was made in order to provide liquidity to United Community's shareholders and to deploy excess capital in an efficient, cost-effective manner. Home Savings is required by federal regulations to meet certain minimum capital requirements. Current capital requirements call for tangible capital of 1.5% of adjusted tangible assets, leverage, also known as core capital (which for Home Savings consists solely of tangible capital), of 4.0% of adjusted total assets and risk-based capital (which for Home Savings consists of leverage capital and the allowance for loan losses) of 8% of risk-weighted assets (assets are weighted at percentage levels ranging from 0% to 100% depending on their relative risk). EX. 13-12 The following table summarizes Home Savings' regulatory capital requirements and actual capital at December 31, 2005.
Current Excess of actual capital Applicable Actual capital minimum requirement over current requirement asset base ------------------ ------------------- ------------------------ ---------- Amount Percent Amount Percent Amount Percent Total -------- ------- -------- ------- -------- ------- ---------- (Dollars in thousands) Tangible capital $203,220 8.36% $ 36,449 1.50% $166,771 6.86% $2,429,909 Core capital 203,220 8.36 97,196 4.00 106,024 4.36 2,429,909 Risk-based capital 218,943 10.86 161,351 8.00 57,592 2.86 2,016,884
ACCOUNTING AND REPORTING DEVELOPMENTS A discussion of recently issued accounting pronouncements and their impact on United Community's consolidated financial statements is provided in Note 1 to the consolidated financial statements. MARKET PRICE AND DIVIDENDS There were 37,804,457 common shares of United Community stock issued and 31,092,963 shares outstanding and held by approximately 11,227 record holders as of February 28, 2006. United Community's common shares are traded on The Nasdaq Stock Market(R) under the symbol "UCFC". Quarterly stock prices and dividends declared are shown in the following table.
First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- 2005: High $ 11.53 $ 11.75 $ 11.75 $ 12.50 Low 10.00 10.05 10.53 10.28 Close 11.09 10.94 11.22 11.81 Dividends declared and paid 0.0825 0.0825 0.0825 0.0825
First Second Third Fourth Quarter Quarter Quarter Quarter ------- ------- ------- ------- 2004: High $13.24 $13.99 $13.10 $11.95 Low 11.15 11.10 10.43 10.57 Close 13.24 13.00 11.37 11.20 Dividends declared and paid 0.075 0.075 0.075 0.075
EX. 13-13 MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of United Community is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. United Community's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. United Community's internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of United Community; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of United Community are being made only in accordance with authorizations of management and directors of United Community; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of United Community's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of United Community's internal control over financial reporting as of December 31, 2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment and those criteria, management concluded that United Community maintained effective internal control over financial reporting as of December 31, 2005. United Community's independent registered public accounting firm has issued their report on management's assessment of United Community's internal control over financial reporting. That report follows under the heading, Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting. /S/ Douglas M. McKay /S/ Patrick A. Kelly - ------------------------------------- ---------------------------------------- Douglas M. McKay, Chief Executive Patrick A. Kelly, Chief Financial Officer Officer February 1, 2006 February 1, 2006 EX. 13-14 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING We have audited management's assessment, included in the accompanying Management's Report on Internal Control Over Financial Reporting, that United Community Financial Corp. maintained effective internal control over financial reporting as of December 31, 2005 based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. United Community Financial Corp. management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that United Community Financial Corp. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, United Community Financial Corp. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial condition of United Community Financial Corp. as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2005 and our report dated February 1, 2006 expressed an unqualified opinion on those consolidated financial statements. /S/ Crowe Chizek and Company LLC - ------------------------------------- Crowe Chizek and Company LLC Cleveland, Ohio February 1, 2006 EX. 13-15 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON FINANCIAL STATEMENTS To the Shareholders and Board of Directors United Community Financial Corp. Youngstown, Ohio We have audited the accompanying consolidated statements of financial condition of United Community Financial Corp. as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of United Community Financial Corp.'s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Community Financial Corp. as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of United Community Financial Corp.'s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 1, 2006 expressed an unqualified opinion thereon. /S/ Crowe Chizek and Company LLC - ------------------------------------- Crowe Chizek and Company LLC Cleveland, Ohio February 1, 2006 EX. 13-16 CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
December 31, ----------------------- 2005 2004 ---------- ---------- (In thousands) ASSETS Cash and deposits with banks $ 36,043 $ 36,886 Federal funds sold 1,502 3,395 ---------- ---------- Total cash and cash equivalents 37,545 40,281 ---------- ---------- Securities: Trading, at fair value 10,812 32,316 Available for sale, at fair value 201,870 198,404 Loans held for sale 29,109 59,099 Loans, net of allowance for loan losses of $15,723 and $15,877 2,097,433 1,815,976 Margin accounts 15,705 14,851 Federal Home Loan Bank stock, at cost 24,006 22,842 Premises and equipment, net 23,771 20,793 Accrued interest receivable 12,053 9,445 Real estate owned and other repossessed assets 2,514 1,682 Goodwill 33,593 33,593 Core deposit intangible 2,118 2,887 Cash surrender value of life insurance 22,260 21,406 Other assets 16,061 14,213 ---------- ---------- TOTAL ASSETS $2,528,850 $2,287,788 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Deposits: Non-interest bearing $ 96,918 $ 84,965 Interest bearing 1,584,926 1,437,987 ---------- ---------- Total deposits 1,681,844 1,522,952 Borrowed funds: Federal Home Loan Bank advances 475,549 423,355 Repurchase agreements and other 75,214 60,148 ---------- ---------- Total borrowed funds 550,763 483,503 Advance payments by borrowers for taxes and insurance 14,322 12,048 Accrued interest payable 2,622 1,089 Accrued expenses and other liabilities 14,564 15,844 ---------- ---------- TOTAL LIABILITIES 2,264,115 2,035,436 ---------- ---------- Commitments and contingent liabilities (Note 4 and Note 12) -- -- SHAREHOLDERS' EQUITY Preferred stock-no par value; 1,000,000 shares authorized and unissued -- -- Common stock--no par value; 499,000,000 shares authorized; 37,804,457 shares issued 143,896 142,337 Retained earnings 207,120 193,690 Accumulated other comprehensive income (loss) (1,845) 1,063 Unearned compensation (13,108) (14,930) Treasury stock, at cost, 2005 - 6,742,345 shares and 2004 - 6,602,477 shares (71,328) (69,808) ---------- ---------- TOTAL SHAREHOLDERS' EQUITY 264,735 252,352 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $2,528,850 $2,287,788 ========== ==========
See Notes to Consolidated Financial Statements. EX. 13-17 CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31, ------------------------------ 2005 2004 2003 -------- -------- -------- (In thousands, except per share data) INTEREST INCOME Loans $123,749 $102,453 $ 98,646 Loans held for sale 1,651 1,449 1,950 Securities: Trading 943 736 415 Available for sale 7,227 7,022 8,851 Margin accounts 1,219 802 689 Federal Home Loan Bank stock dividends 1,164 919 855 Other interest earning assets 99 60 257 -------- -------- -------- Total interest income 136,052 113,441 111,663 -------- -------- -------- INTEREST EXPENSE Deposits 37,920 28,361 30,900 Federal Home Loan Bank advances 17,364 11,254 8,841 Repurchase agreements and other 2,012 763 511 -------- -------- -------- Total interest expense 57,296 40,378 40,252 -------- -------- -------- Net interest income 78,756 73,063 71,411 Provision for loan losses 3,028 9,370 3,179 -------- -------- -------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 75,728 63,693 68,232 -------- -------- -------- NON-INTEREST INCOME Brokerage commissions 18,508 17,189 14,925 Service fees and other charges 12,471 11,780 8,382 Underwriting and investment banking 876 1,029 1,528 Net gains (losses): Securities available for sale 195 8 839 Trading securities 268 (7) 850 Loans sold 2,250 3,192 11,707 Other (22) (43) (105) Other income 3,714 2,961 2,719 -------- -------- -------- Total non-interest income 38,260 36,109 40,845 -------- -------- -------- NON-INTEREST EXPENSE Salaries and employee benefits 51,301 46,074 46,511 Occupancy 4,115 3,757 3,658 Equipment and data processing 9,067 9,086 9,459 Franchise tax 1,894 1,583 1,562 Advertising 1,570 1,853 2,232 Amortization of core deposit intangible 769 900 1,314 Other expenses 10,165 9,581 8,836 -------- -------- -------- Total non-interest expense 78,881 72,834 73,572 -------- -------- -------- INCOME BEFORE INCOME TAXES 35,107 26,968 35,505 INCOME TAXES 11,910 9,103 12,565 -------- -------- -------- NET INCOME $ 23,197 $ 17,865 $ 22,940 ======== ======== ======== EARNINGS PER SHARE Basic $ 0.81 $ 0.61 $ 0.73 Diluted $ 0.80 $ 0.60 $ 0.72 ======== ======== ========
See Notes to Consolidated Financial Statements. EX. 13-18 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated Other Shares Common Retained Comprehensive Unearned Treasury Outstanding Stock Earnings Income (Loss) Compensation Stock Total ----------- -------- -------- ------------- ------------ -------- -------- (In thousands, except per share data) BALANCE DECEMBER 31, 2002 35,245 $138,207 $172,080 $ 2,363 $(19,724) $(18,357) $274,569 Comprehensive income: Net income -- -- 22,940 -- -- -- 22,940 Change in net unrealized gain (loss) on securities, net of taxes of $745 -- -- -- (1,239) -- -- (1,239) -------- ------- -------- Comprehensive income -- -- 22,940 (1,239) -- -- 21,701 Issuance of common shares for RRP 2 23 -- -- (23) -- -- Amortization of restricted common stock compensation -- 280 -- -- 1,169 -- 1,449 Forfeiture of restricted common stock (1) (7) -- -- 4 -- (3) Shares allocated to ESOP participants -- 1,019 -- -- 1,822 -- 2,841 Purchase of treasury stock (1,320) -- -- -- -- (12,385) (12,385) Exercise of stock options 160 4 (96) -- -- 1,185 1,093 Dividends paid, $0.30 per share -- -- (9,429) -- -- -- (9,429) ------ -------- -------- ------- -------- -------- -------- BALANCE DECEMBER 31, 2003 34,086 139,526 185,495 1,124 (16,752) (29,557) 279,836 Comprehensive income: Net income -- -- 17,865 -- -- -- 17,865 Change in net unrealized gain (loss) on securities, net of taxes of $33 -- -- -- (61) -- -- (61) -------- ------- -------- Comprehensive income -- -- 17,865 (61) -- -- 17,804 Shares allocated to ESOP participants -- 1,682 -- -- 1,822 -- 3,504 Purchase of treasury stock (3,797) -- -- -- -- (47,814) (47,814) Exercise of stock options 913 1,129 (1,137) -- -- 7,563 7,555 Dividends paid, $0.30 per share -- -- (8,533) -- -- -- (8,533) ------ -------- -------- ------- -------- -------- -------- BALANCE DECEMBER 31, 2004 31,202 142,337 193,690 1,063 (14,930) (69,808) 252,352 Comprehensive income: Net income -- -- 23,197 -- -- -- 23,197 Change in net unrealized gain (loss) on securities, net of taxes of $1,565 -- -- -- (2,908) -- -- (2,908) -------- ------- -------- Comprehensive income -- -- 23,197 (2,908) -- -- 20,289 Shares allocated to ESOP participants -- 1,432 -- -- 1,822 -- 3,254 Purchase of treasury stock (233) -- -- -- -- (2,499) (2,499) Exercise of stock options 93 127 (305) -- -- 979 801 Dividends paid, $0.33 per share -- -- (9,462) -- -- -- (9,462) ------ -------- -------- ------- -------- -------- -------- BALANCE DECEMBER 31, 2005 31,062 $143,896 $207,120 $(1,845) $(13,108) $(71,328) $264,735 ====== ======== ======== ======= ======== ======== ========
See Notes to Consolidated Financial Statements. EX. 13-19 CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31, --------------------------------- 2005 2004 2003 --------- --------- --------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 23,197 $ 17,865 $ 22,940 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 3,028 9,370 3,179 Net gains on loans (2,250) (3,192) (11,707) Net gains on other assets (173) 35 (734) Amortization of premiums and accretion of discounts 2,139 4,608 6,340 Depreciation and amortization 2,347 2,943 3,544 Federal Home Loan Bank stock dividends (1,164) (919) (855) (Increase) decrease in interest receivable (2,608) (1,002) 1,115 Increase (decrease) in interest payable 1,533 119 (156) Increase in prepaid and other assets (4,273) (5,869) (6,010) Increase (decrease) in other liabilities 412 (3,133) 4,195 Decrease (increase) in trading securities 21,504 (16,716) (10,540) Amortization of restricted stock compensation -- -- 1,446 (Increase) decrease in margin accounts (854) (463) 421 Net principal disbursed on loans held for sale (154,873) (155,664) (427,426) Proceeds from sale of loans held for sale 224,200 176,609 454,499 ESOP compensation 3,254 3,504 2,841 --------- --------- --------- Net cash from operating activities 115,419 28,095 43,092 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from principal repayments and maturities of: Securities available for sale 51,100 76,282 153,112 Proceeds from sale of: Securities available for sale 20,883 63,021 22,325 Loans -- -- 93,983 Commercial loan participations 1,500 43,156 9,443 Nonperforming loans 6,173 -- -- Premises and equipment 169 2 -- Real estate owned and other repossessed assets 3,999 1,932 1,820 Purchases of: Securities available for sale (80,301) (111,667) (170,458) Bank owned life insurance -- -- (20,000) Net principal disbursed on loans (46,836) (120,527) (2,606) Loans purchased (286,653) (213,802) (211,370) Purchases of premises and equipment (5,379) (3,199) (4,025) --------- --------- --------- Net cash from investing activities (335,345) (264,802) (127,776) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Net (decrease) increase in checking, savings and money market accounts (82,940) 17,174 17,935 Net increase (decrease) in certificates of deposit 241,883 82,219 (75,475) Net increase in advance payments by borrowers for taxes and insurance 2,274 1,327 4,725 Proceeds from Federal Home Loan Bank advances 122,345 50,000 25,500 Repayment of Federal Home Loan Bank advances (70,151) (19,257) (11,144) Net change in repurchase agreements and other 15,066 114,297 114,083 Dividends paid (9,462) (8,533) (9,429) Proceeds from exercise of stock options 674 6,420 941 Purchase of treasury stock (2,499) (47,814) (12,233) --------- --------- --------- Net cash from financing activities 217,190 195,833 54,903 --------- --------- --------- Decrease in cash and cash equivalents (2,736) (40,874) (29,781) Cash and cash equivalents, beginning of year 40,281 81,155 110,936 --------- --------- --------- Cash and cash equivalents, end of year $ 37,545 $ 40,281 $ 81,155 --------- --------- ---------
See Notes to Consolidated Financial Statements EX. 13-20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting policies of United Community Financial Corp. (United Community), a unitary savings and loan holding company, The Home Savings and Loan Company of Youngstown, Ohio (Home Savings), an Ohio chartered savings bank, and Butler Wick Corp. (Butler Wick), an investment brokerage firm registered with the Securities and Exchange Commission (SEC) and a member of the National Association of Securities Dealers (NASD) and the Chicago Stock Exchange, conform to accounting principles generally accepted in the United States of America and prevailing practices within the banking, thrift and brokerage industries. A summary of the more significant accounting policies follows. Nature of Operations United Community was incorporated under Ohio law in February 1998 by Home Savings in connection with the conversion of Home Savings from an Ohio mutual savings and loan association to an Ohio capital stock savings and loan association (Conversion). Upon consummation of the Conversion on July 8, 1998, United Community became the unitary savings and loan holding company for Home Savings. The business of Home Savings is providing consumer and business banking service to its market area in Ohio and western Pennsylvania. At the end of 2005, Home Savings was doing business through 37 full-service banking branches and 6 loan production offices. Loans and deposits are primarily generated from the areas where banking branches are located. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. There are no significant concentrations of loans to any one industry or customer. However, the customers' ability to repay their loans is dependent on the real estate and general economic conditions in the market area. Home Savings derives its income predominantly from interest on loans, securities, and to a lesser extent, non-interest income. Home Savings' principal expenses are interest paid on deposits, Federal Home Loan Bank advances, and normal operating costs. Consistent with internal reporting, Home Savings' operations are reported in one operating segment, which is banking services. On August 12, 1999, United Community acquired Butler Wick, the parent company for two wholly owned subsidiaries: Butler Wick & Co., Inc. and Butler Wick Trust Company. Butler Wick has 21 office locations providing a full range of investment alternatives for individuals, companies and not-for-profit organizations throughout Ohio and western Pennsylvania. Butler Wick's operations are reported in a separate operating segment, which is investment services. Basis of Presentation The consolidated financial statements include the accounts of United Community and its subsidiaries. All material inter-company transactions have been eliminated. Certain prior period data has been reclassified to conform to current period presentation. Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, fair value of financial instruments, fair value of servicing rights, carrying value of goodwill and core deposit intangible assets, and status of contingencies are particularly subject to change. Securities Securities are classified as available for sale or trading upon their acquisition. Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at estimated fair value with the unrealized holding gain or loss reported in other comprehensive income. Securities classified as trading are held principally for resale in the near term and are recorded at fair market value with any changes in fair value included in income. Quoted market prices are used to determine the fair value of trading securities. Restricted securities such as Federal Home Loan Bank stock are carried at cost. Interest income includes amortization of purchase premium or discount on debt securities. Premiums or discounts are amortized on the level-yield method without anticipating prepayments. Gains and losses on sales are recorded on the trade date and are based on the amortized cost of the individual security sold. Securities are written down to fair value when a decline in fair value is other-than-temporary. Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value. Loans Held for Sale Loans held for sale consist of residential mortgage loans originated for sale and other loans which have been identified for sale. These loans are carried on the books at the lower of cost or fair market value, determined in the aggregate. Loans Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the outstanding principal balance, net of deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. EX. 13-21 Interest income includes amortization of net deferred loan fees and costs over the loan term. Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well secured and in process of collection. Consumer loans are typically charged off no later than 180 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Nonaccrual loans are comprised principally of loans 90 days past due as well as certain loans which are less than 90 days past due, but where serious doubt exists as to the ability of the borrowers to comply with the repayment terms. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when future payments are reasonably assured. Allowance for Loan Losses The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectablilty of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required based on an analysis using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values, general economic conditions in the market area and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged-off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers pools of other loans and is based on historical loss experience adjusted for current factors. A loan is considered impaired when, based on current information and events, it is probable that United Community will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the facts and circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, United Community does not separately identify individual consumer or residential loans for impairment disclosures. Servicing Assets Servicing assets are recognized as separate assets when rights are acquired through purchase or sale of financial assets. For sales of mortgage loans, a portion of the cost of originating the loan is allocated to the servicing right based on relative fair value. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Capitalized servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant risk characteristics, such as original maturity, interest rate and loan type. Impairment is recognized through a valuation allowance for an individual tranche. If United Community later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as an increase to income. Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal, or a fixed amount per loan, and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income. Premises and Equipment Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation and amortization. Buildings and related components are depreciated and amortized using the straight-line method over the useful lives, generally ranging from 20 years to 40 years, (or term of the lease, if shorter) of the related assets. Furniture and fixtures are depreciated using the straight-line method with useful lives ranging from 3 to 7 years. Real Estate Owned and Other Repossessed Assets Real estate owned, including property acquired in settlement of foreclosed loans, is carried at the lower of cost or estimated fair value less estimated cost to sell after foreclosure, establishing a new cost basis. If fair value declines after acquisition, a valuation allowance is recorded through expense. Costs relating to the development and improvement of real estate owned are capitalized, whereas costs relating to holding and maintaining the property are charged to expense. Other repossessed assets are carried at the lower of cost or estimated fair value less estimated cost to sell after acquisition. EX. 13-22 Goodwill and Core Deposit Intangible Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. Core deposit intangible assets arose from whole bank acquisitions. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives, generally 15 to 20 years. Cash Surrender Value of Life Insurance Bank owned life insurance represents insurance on the lives of certain employees where Home Savings is the beneficiary. This life insurance provides a long-term asset to offset long-term benefit liabilities, while generating competitive investment yields. The life insurance is recorded at its cash surrender value, or the amount currently realizable. Increases in the Home Savings' policy cash value are tax exempt and death benefit proceeds received by Home Savings are tax-free. Income from these policies and changes in the cash surrender value are recorded in other income. Long-term Assets Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amounts may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value. Securitizations Some loans are transferred from time to time to a third party in exchange for ownership of a security based on those loans. Such transfers are recorded as a sale when control has been relinquished, with a gain or loss recorded on the sale. The gain or loss is calculated based on the cash received versus the carrying value of the assets transferred. If some interests, such as servicing assets and cash reserve accounts, are retained, the carrying value of all assets sold and retained is allocated to each asset based on fair value at sale date. Fair values are based on market quotes or on the present value of future expected cash flows using estimates of credit losses, prepayment rates, interest rates, and discount rates. Loan Fees Loan origination fees received for loans, net of direct origination costs, are deferred and amortized to interest income over the contractual lives of the loans using the level yield method. Fees received for loan commitments that are expected to be drawn, based on Home Savings' experience with similar commitments, are deferred and amortized over the lives of the loans using the level-yield method. Fees for other loan commitments are deferred and amortized over the loan commitment period on a straight-line basis. Unamortized deferred loan fees or costs related to loans paid off are included in income. Unamortized net fees or costs on loans sold are included in the basis of the loans in calculating gains and losses. Amortization of net deferred fees is discontinued for loans that are deemed to be nonperforming. Commissions and Service Fees Commissions are recognized when earned which is generally the settlement date of the security. Service fees are assessed to customer accounts on a regular basis. Trust fees are recognized in income on the accrual basis. Fees are assessed to customer accounts on a regularly scheduled basis and are generally based on the value of the assets under management. Stock Compensation Employee compensation expense under stock option plans is reported if options are granted below market price at grant date. Pro forma disclosures of net income and earnings per share are shown using the fair value method of FASB Statement No. 123, "Accounting for Stock-Based Compensation," to measure expense for options granted after 1994, using an option pricing model to estimate fair value. Employee compensation expense under stock options is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of FASB Statement No. 123.
2005 2004 2003 ------- ------- ------- (In thousands) Net income as reported $23,197 $17,865 $22,940 Deduct: Stock-based compensation expense determined under fair value method -- 1,855 2,165 ------- ------- ------- Pro forma net income $23,197 $16,010 $20,775 ------- ------- ------- Basic earnings per share as reported 0.81 0.61 0.73 Pro forma basic earnings per share 0.81 0.55 0.66 Diluted earnings per share as reported 0.80 0.60 0.72 Pro forma diluted earnings per share 0.80 0.54 0.65 ------- ------- -------
The pro forma effects are computed using option pricing models, using the following weighted-average assumptions as of grant date. EX. 13-23
2005 2004 2003 ---- ----- ----- Dividend yield N/A 2.27% 3.34% Expected stock price volatility N/A 22.73% 48.31% Risk-free interest rate N/A 3.18% 3.98% Expected option life (in years) N/A 7 10
Income Taxes Deferred income taxes, which result from temporary differences in the recognition of income and expense for financial statement and tax return purposes, are included in the calculation of income tax expense. The effect on deferred tax assets and liabilities of a change in income tax rates is recognized in income in the period that includes the enactment date. Deferred income tax assets and liabilities are recorded for differences between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to periods in which the differences are expected to affect taxable income. Valuation allowances are established, based on the weight of available evidence, when it is more likely than not that some portion or all of the deferred tax asset will not be realized. Income tax expense is the tax payable or refundable for the period adjusted for the change during the period in deferred tax assets and liabilities. Employee Stock Ownership Plan The cost of shares issued to the ESOP, but not yet allocated to participants, is shown as a reduction of shareholders' equity. Compensation expense is based on the market price of shares as they are committed to be released to participant accounts. Dividends on allocated ESOP shares reduce retained earnings; dividends on unearned ESOP shares reduce debt and accrued interest. Earnings Per Share Basic earnings per share (EPS) are based on the weighted average number of common shares outstanding during the year. Diluted EPS are based on the weighted average number of common shares and common share equivalents outstanding during the year. Unearned ESOP shares are not considered outstanding for this calculation. See further discussion at Note 21. Statements of Cash Flows For purposes of the statement of cash flows, United Community considers all highly liquid investments with a term of three months or less to be cash equivalents. Net cash flows are reported for loan and deposit transactions, trading securities, margin accounts, short-term borrowings and advance payments by borrowers for taxes and insurance. Loss Contingencies Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. See further discussion at Note 12. Fair Value of Financial Instruments Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 17. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. Comprehensive Income Comprehensive income consists of net income and unrealized gains and losses on securities available for sale, which are also recognized as separate components of equity. Commission Revenue and Expense Securities transactions and related commission revenue and expense are recorded on a settlement date basis, generally the third business day following the trade date. The effect on the financial statements of using the settlement date basis rather than trade date basis is not material. Execution, Settlement and Financing of Securities Transactions In the normal course of business, Butler Wick's activities involve the execution, settlement, and financing of various securities transactions. These activities may expose Butler Wick to risk in the event the customer is unable to fulfill its contractual obligations. Butler Wick maintains cash and margin accounts for its customers. Butler Wick's customer securities activities are transacted on either a cash or margin basis. In margin transactions, Butler Wick extends credit to its customers, subject to various regulatory and internal margin requirements, collateralized by cash and securities in customer's accounts. In connection with these activities, Butler Wick executes and clears customer transactions involving the sale of securities not yet purchased, all of which are transacted on a margin basis subject to regulations. Such transactions may expose Butler Wick to significant off-balance sheet risk in the event margin requirements are not sufficient to fully cover losses that customers may incur. In the event the customer fails to satisfy its obligations, Butler Wick may be required to purchase or sell financial instruments at prevailing market prices to fulfill the customer's obligations. Butler Wick seeks to control the risks associated with its customers' activities by requiring customers to maintain margin collateral in compliance with various regulatory and internal guidelines. Butler Wick monitors required margin levels daily and, pursuant to such guidelines, requires the customer to deposit additional collateral or to reduce security positions when necessary. EX. 13-24 Butler Wick's customer financing and securities settlement activities require Butler Wick to pledge customer securities as collateral in support of various secured financing sources such as bank loans and securities loaned. In the event the counterparty is unable to meet its contractual obligation to return customer securities pledged as collateral, Butler Wick may be exposed to the risk of acquiring the securities at prevailing market prices in order to satisfy its customer obligations. Butler Wick controls this risk by monitoring the market value of securities pledged on a daily basis and by requiring adjustments of collateral levels in the event of excess market exposure. In addition, Butler Wick establishes credit limits for such activities and monitors compliance on a daily basis. As a securities broker and dealer, all transactions purchased through margin accounts are collateralized. Butler Wick's exposure to credit risk associated with nonperformance in fulfilling contractual obligations pursuant to securities transactions can be directly impacted by volatile trading markets, which may impair the customer's ability to satisfy its obligations to Butler Wick. Off Balance Sheet Financial Instruments Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. New Accounting Standards Adoption of New Accounting Standards: On March 9, 2004, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) 105, "Application of Accounting Principles to Loan Commitments" stating that the fair value of loan commitments accounted for as a derivative instrument under FASB Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities," should not consider expected future cash flows related to servicing of the future loan. SAB 105 was effective for loan commitments accounted for as derivatives entered into after March 31, 2004. United Community adopted the provisions of SAB 105 as of April 1, 2004. The adoption of this standard did not have a material impact on United Community's financial position or results of operations. In November 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) 115-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." This FSP provides additional guidance on when an investment in a debt or equity security should be considered impaired and when that impairment should be considered other-than-temporary and recognized as a loss in earnings. Specifically, the guidance clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision not to sell has been made. The FSP also requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. See Note 3 for further discussion and the impact on United Community's financial position and results of operations. Newly Issued But Not Yet Effective Accounting Standards: Financial Accounting Standard (FAS) 123, Revised, requires companies to record compensation cost for stock options provided to employees in return for employment service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employment service period, which is normally the vesting period of the options. This will apply to awards granted or modified in fiscal years beginning in 2006. Compensation cost will also be recorded for prior option grants that vest after the date of adoption. The effect on results of operations will depend on the level of future option grants and the calculation of the fair value of the options granted at such future date, as well as the vesting periods provided, and so cannot currently be predicted. See Note 16 for further discussion of stock options. Operating Segments Internal financial information is primarily reported and aggregated in two lines of business, banking services and investment services. Dividend Restriction Banking regulations require maintaining certain capital levels and may limit the dividends paid by Home Savings and Butler Wick to the holding company or by the holding company to shareholders. These restrictions currently pose no practical limit on the ability of the bank or holding company to pay dividends at historical levels. See Note 15 for further discussion. Reclassifications Some items in the prior year financial statements were reclassified to conform to the current presentation. 2. CASH AND CASH EQUIVALENTS Federal Reserve Board regulations require depository institutions to maintain certain minimum reserve balances. These reserves, which consisted of vault cash at Home Savings, totaled approximately $11.7 million and $10.7 million at December 31, 2005 and 2004, respectively. At year end 2005 and 2004, cash of $16,000 has been segregated in a special reserve bank account for the benefit of customers of Butler Wick under Rule 15c3-3 of the Securities and Exchange Commission. EX. 13-25 3. SECURITIES The components of securities are as follows:
December 31, 2005 December 31, 2004 ---------------------------------- ---------------------------------- Gross Gross Gross Gross Fair Unrealized Unrealized Fair Unrealized Unrealized Available for Sale Value Gains Losses Value Gains Losses - ------------------ -------- ---------- ---------- -------- ---------- ---------- (In thousands) U.S. Treasury and agency securities $ 88,799 $ -- $(1,493) $ 88,317 $ 7 $(417) Tax exempt municipal obligation 3 -- -- 7 1 -- Equity securities 2,962 661 -- 7,169 1,459 -- Mortgage-related securities 110,106 73 (2,159) 102,911 869 (364) -------- ---- ------- -------- ------ ----- Total $201,870 $734 $(3,652) $198,404 $2,336 $(781) ======== ==== ======= ======== ====== =====
Debt securities available for sale by contractual maturity, repricing or expected call date are shown below:
December 31, 2005 ----------------- Fair Value ---------- (In thousands) Due in one year or less $ 23,815 Due after one year through five years 55,191 Due after five years through ten years 9,796 Mortgage-related securities 110,106 -------- Total $198,908 ========
Since equity securities do not have a contractual maturity, they are excluded from the table above. Proceeds, gross realized gains, losses and impairment charges of available for sale securities were as follows:
2005 2004 2003 ------- ------- ------- (In thousands) Proceeds $20,883 $63,021 $22,325 Gross gains 239 1,425 847 Gross losses 44 15 8 Impairment charges -- 1,402 --
Securities pledged for public funds deposits were approximately $24.6 million and $19.0 million at December 31, 2005 and 2004, respectively. See further discussion regarding pledged securities in Note 11. United Community's trading securities are carried at fair value and consist of the following:
2005 2004 ------- ------- (In thousands) Debt Securities: Obligations of U.S. government $ 2,531 $28,587 State and municipal obligations 7,061 1,657 Corporate bonds, debentures and notes 224 60 Mutual funds 996 2,012 ------- ------- Total trading securities $10,812 $32,316 ======= =======
EX. 13-26 Securities available for sale in a continuous unrealized loss position are as follows at December 31, 2005:
Less than 12 months 12 months or more Total ----------------------- ----------------------- ----------------------- Unrealized Unrealized Unrealized Fair value loss Fair value loss Fair value loss ---------- ---------- ---------- ---------- ---------- ---------- (In thousands) Description of securities: U.S. Treasury and agencies $ 35,128 $ (499) $53,671 $ (994) $ 88,799 $(1,493) Mortgage-related 86,993 (1,383) 19,887 (776) 106,880 (2,159) -------- ------- ------- ------- -------- ------- Total temporarily impaired securities $122,121 $(1,882) $73,558 $(1,770) $195,679 $(3,652) ======== ======= ======= ======= ======== =======
Securities available for sale in an unrealized loss position are as follows at December 31, 2004:
Less than 12 months 12 months or more Total ----------------------- ----------------------- ----------------------- Unrealized Unrealized Unrealized Fair value loss Fair value loss Fair value loss ---------- ---------- ---------- ---------- ---------- ---------- (In thousands) Description of securities: U.S. Treasury and agencies $79,091 $(417) $ -- $ -- $ 79,091 $(417) Mortgage-related 18,311 (216) 8,016 (148) 26,327 (364) ------- ----- ------ ----- -------- ----- Total temporarily impaired securities $97,402 $(633) $8,016 $(148) $105,418 $(781) ======= ===== ====== ===== ======== =====
All of the securities that are temporarily impaired at December 31, 2005, are impaired due to the current level of interest rates. All of these securities are debentures and continue to pay on schedule and management expects to receive all principal and interest owed on the securities. Home Savings owned $5.0 million par value of Fannie Mae preferred stock. During the fourth quarter of 2004, Home Savings recorded an other-than-temporary charge for the impairment of the Fannie Mae preferred stock, held in the available for sale portfolio, of $1.4 million, pretax. United Community recorded the charge because the market value of the stock had declined significantly in the fourth quarter, following several negative announcements by Fannie Mae involving regulatory actions, earnings restatements and management turnover. United Community concluded that these events made the likelihood of future price appreciation less certain in the near term and would extend the time period for a recovery of United Community's investment cost beyond previous estimates. The security was subsequently sold in 2005. 4. LOANS Portfolio loans consist of the following:
December 31, ----------------------- 2005 2004 ---------- ---------- (In thousands) Real Estate: One- to four-family residential $ 749,362 $ 690,413 Multi-family residential 154,702 153,011 Non-residential 314,124 289,755 Land 14,979 14,701 Construction: One- to four-family residential 389,558 301,193 Multi-family and non-residential 66,788 47,230 ---------- ---------- Total real estate 1,689,513 1,496,303 Consumer 323,515 267,646 Commercial 100,977 68,523 ---------- ---------- Total loans 2,114,005 1,832,472 ========== ========== Less: Allowance for loan losses 15,723 15,877 Deferred loan fees, net 849 619 ---------- ---------- Total 16,572 16,496 ---------- ---------- Loans, net $2,097,433 $1,815,976 ========== ==========
Loan commitments are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments extend over various periods of time with the majority of such commitments disbursed within a sixty-day period. Commitments generally have fixed expiration dates or other termination clauses, may require payment of a fee and may expire unused. Commitments to extend credit at fixed rates expose Home Savings to some degree of interest rate risk. Home Savings evaluates each customer's EX. 13-27 creditworthiness on a case-by-case basis. The type or amount of collateral obtained varies and is based on management's credit evaluation of the potential borrower. Home Savings normally has a number of outstanding commitments to extend credit.
December 31, ------------------------------------------------------- 2005 2004 -------------------------- -------------------------- Fixed Rate Variable Rate Fixed Rate Variable Rate ---------- ------------- ---------- ------------- (In thousands) Commitments to make loans $40,290 $ 56,322 $33,688 $ 46,730 Undisbursed loans in process 36,059 228,054 27,002 257,641 Unused lines of credit 29,896 112,632 11,721 122,170
Terms of the commitments in both years extend up to six months, but are generally less than two months. The fixed rate loan commitments have interest rates ranging from 5.49% to 18% and maturities ranging from six months to 30 years. At December 31, 2005 and 2004, there were $19.1 million and $11.7 million, respectively, of outstanding standby letters of credit. These are issued to guarantee the performance of a customer to a third party. Standby letters of credit are generally contingent upon the failure of the customer to perform according to the terms of an underlying contract with the third party. Home Savings' business activity is principally with customers located in Ohio. Except for residential loans in Home Savings' market area, Home Savings has no other significant concentrations of credit risk. Allowance for Loan Losses Changes in the allowance for loan losses are as follows:
Year ended December 31, --------------------------- 2005 2004 2003 ------- ------- ------- (In thousands) Balance, beginning of year $15,877 $15,111 $15,099 Provision for loan losses 3,028 9,370 3,179 Amounts charged off (4,085) (9,060) (3,340) Recoveries 903 456 173 ------- ------- ------- Balance, end of year $15,723 $15,877 $15,111 ======= ======= =======
Nonaccrual loans were $24.3 million, $20.9 million and $13.0 million at December 31, 2005, 2004 and 2003. Restructured loans were $825,000, $1.3 million and $1.9 million at December 31, 2005, 2004 and 2003. Loans that are greater than ninety days past due and still accruing were $563,000 at December 31, 2005, $377,000 at December 31, 2004 and $1.3 million at December 31, 2003.
As of or for the year ended December 31, --------------------------- 2005 2004 2003 -------- ------- ------ (In thousands) Impaired loans on which no specific valuation allowance was provided $13,119 $ 7,898 $4,366 Impaired loans on which specific valuation allowance was provided 4,573 7,320 1,514 ------- ------- ------ Total impaired loans at year-end $17,692 $15,218 $5,880 ------- ------- ------ Specific valuation allowances on impaired loans at year-end 667 1,691 277 Average impaired loans during year 15,209 10,683 6,628 Interest income recognized on impaired loans during the year 386 134 145 Interest income received on impaired loans during the year 403 307 288 Interest income potential based on original contract terms of impaired loans 1,503 685 539 ======= ======= ======
Directors and officers of United Community, Home Savings and Butler Wick are customers of Home Savings in the ordinary course of business. The following describes loans to officers and/or directors of United Community, Home Savings and Butler Wick: (In thousands) Balance as of December 31, 2004 $ 2,161 New loans to officers and/or directors 1,046 Loan payments during 2005 (140) Reductions due to changes in officers and/or directors (1,039) ------- Balance as of December 31, 2005 $ 2,028 =======
EX. 13-28 5. MORTGAGE BANKING ACTIVITIES Mortgage loans serviced for others, which are not reported in United Community's assets, totaled $816.0 million and $667.0 million at December 31, 2005 and 2004. Activity for capitalized mortgage servicing rights, included in other assets, was as follows:
2005 2004 2003 ------- ------- ------- (In thousands) Balance, beginning of year $ 5,533 $ 5,557 $ 3,603 Originations 2,961 1,629 4,448 Amortized to expense (1,571) (1,653) (2,494) ------- ------- ------- Balance, end of year $ 6,923 $ 5,533 $ 5,557 ======= ======= =======
Activity in the valuation allowance for mortgage servicing rights was as follows:
2005 2004 2003 ---- ---- ----- (In thousands) Balance, beginning of year $-- $(76) $ -- Impairment charges -- -- (415) Recoveries -- 76 339 --- ---- ----- Balance, end of year $-- $ -- $ (76) === ==== =====
Key economic assumptions used in measuring the value of mortgage servicing rights at December 31, 2005 and 2004 were as follows:
2005 2004 ------- ------- Weighted average prepayment rate 278 PSA 281 PSA Weighted average life (in years) 5.11 5.41 Weighted average discount rate 8% 8%
Amounts held in custodial accounts for investors amounted to $7.4 million and $6.1 million at December 31, 2005 and 2004, respectively. Estimated amortization expense for each of the next five years is as follows: 2006 $1,334 2007 1,333 2008 1,327 2009 1,235 2010 872
6. SECURITIZATIONS Home Savings sold $90.4 million in residential mortgage loans in securitization transactions in 2003. The securities received in these transactions were immediately sold. Gains of $4.2 million were recorded on the sales. Home Savings retained servicing responsibilities for the loans, for which it receives servicing fees approximating 0.40% of the outstanding balance of the loans. There were no securitizations during 2005 or 2004. For the loans securitized in 2003, approximately $30.5 million of the loans had loan to value ratios greater than 80% and did not have sufficient mortgage insurance coverage on the delivery date. These loans were sold with recourse to Home Savings. This recourse obligation will terminate for each loan on June 30, 2006, provided that on that date, the applicable loan is not thirty days or more delinquent. If this criteria is not met, the recourse agreement on that loan will continue until such time as the loan becomes and remains current for a period of twelve consecutively scheduled monthly payments from the date of the last delinquency. Home Savings reduced the recorded gain from the securitizations by the fair value of the recourse obligation. As of December 31, 2005, approximately $425,000 of these loans were still covered by the recourse obligation. Home Savings also services loans from securitizations prior to 2003. Certain of these loans are covered by recourse or indemnification provisions specific to those sales. At December 31, 2005, approximately $181,000 in loans are covered by recourse agreements and approximately $8.9 million in loans are covered by an indemnification agreement. EX. 13-29 Cash flows from all securitizations of mortgage loans were as follows:
2005 2004 ------ ----- (In thousands) Securitization proceeds $ -- $ -- Servicing fees received 261 331
An analysis of the activity in securitizations serviced by Home Savings during 2005 and 2004 follows:
December 31, ------------------- 2005 2004 -------- -------- (In thousands) Balance at beginning of year: Principal balance of loans $ 87,413 $128,761 Amortized cost of servicing rights 626 1,005 Servicing rights as a % of principal 0.72% 0.78% New securitizations during the year: Principal balance of loans -- -- Fair value of servicing rights -- -- Servicing rights as a % of principal n/a n/a Principal payments received on loans securitized (18,597) (41,348) Balance at end of year: Principal balance of loans 68,816 87,413 Amortized cost of servicing rights 448 626 Servicing rights as a % of principal 0.65% 0.72% ======== ========
In the securitization transactions, Home Savings retained residual interests in the form of servicing assets. The servicing assets represent the allocated value of retained servicing rights on the loans securitized.
December 31, ------------------- 2005 2004 -------- -------- Other information at end of period: Weighted average rate of loans 6.65% 6.68% Weighted average maturity of loans in months 262 272 Principal balance of loans 30 days or more past due (in thousands) $ 1,289 $ 611 Fair value assumptions Discount rate 8.00% 8.00% Weighted average prepayment assumptions 290 PSA 295 PSA
The following table indicates how the fair value of the servicing rights might decline if the assumptions change unfavorably in two different magnitudes:
December 31, --------------- 2005 2004 ------ ------ (In thousands) Fair value at end of year $1,042 $1,078 Weighted average life (in months) 46 58 Projected fair value based on: Increase in PSA of 50 954 981 Increase in PSA of 100 881 901 ====== ======
The effect of adverse changes is hypothetical and should not be extrapolated to other changes, as the effects are not linear. EX. 13-30 7. PREMISES AND EQUIPMENT Premises and equipment consist of the following:
December 31, ----------------- Estimated life 2005 2004 -------------- ------- ------- (In thousands) Land $ 7,498 $ 6,924 Buildings up to 39 years 19,536 17,215 Leasehold improvements 10 years 1,461 1,421 Furniture and equipment 3-5 years 17,891 15,964 ------- ------- 46,386 41,524 Less: Accumulated depreciation and amortization 22,615 20,731 ------- ------- Total $23,771 $20,793 ======= =======
Rent expense was $1.4 million for 2005, $1.3 million for 2004 and $1.1 million for 2003. Rent commitments under noncancelable operating leases for offices were as follows, before considering renewal options that generally are present: (In thousands) 2006 $ 957 2007 798 2008 729 2009 521 2010 523 Thereafter 507 ------ Total $4,035 ======
8. GOODWILL AND INTANGIBLE ASSETS Goodwill Goodwill was $33.6 million at December 31, 2005, 2004, and 2003 and relates to acquisitions of The Industrial Savings and Loan Association in 2001 and Potter's Bank in 2002. Acquired Intangible Assets
As of December 31, ------------------------------------------------- 2005 2004 ----------------------- ----------------------- Gross Gross Carrying Accumulated Carrying Accumulated Amount Amortization Amount Amortization -------- ------------ -------- ------------ (In thousands) Amortized intangible assets: Core deposit intangibles $8,952 $6,834 $8,952 $6,065 ------ ------ ------ ------ Total $8,952 $6,834 $8,952 $6,065 ====== ====== ====== ====== Estimated amortization expense: For the year ended: December 31, 2006 $ 492 December 31, 2007 383 December 31, 2008 300 December 31, 2009 235 December 31, 2010 186
Aggregate amortization expense for the years ended December 31, 2005, 2004 and 2003, was $769,000, $900,000 and $1.3 million, respectively. EX. 13-31 9. DEPOSITS Deposits consist of the following:
December 31, ----------------------- 2005 2004 ---------- ---------- (In thousands) Checking accounts: Interest bearing $ 114,565 $ 158,682 Non-interest bearing 96,918 84,965 Savings accounts 259,811 308,187 Money market accounts 144,433 146,833 Certificates of deposit 1,066,117 824,285 ---------- ---------- Total deposits $1,681,844 $1,522,952 ========== ==========
Interest expense on deposits is summarized as follows:
Year Ended December 31, --------------------------- 2005 2004 2003 ------- ------- ------- (In thousands) Interest bearing demand deposits and money market accounts $ 3,231 $ 2,386 $ 3,113 Savings accounts 1,201 1,361 2,347 Certificates of deposit 33,488 24,614 25,440 ------- ------- ------- Total $37,920 $28,361 $30,900 ======= ======= =======
A summary of certificates of deposit by maturity follows:
December 31, 2005 ----------------- (In thousands) Within 12 months $ 541,614 12 months to 24 months 268,435 Over 24 months to 36 months 97,547 Over 36 months to 48 months 42,479 Over 48 months 116,042 ---------- Total $1,066,117 ==========
A summary of certificates of deposit with balances of $100,000 or more by maturity is as follows:
December 31, 2005 December 31, 2004 ----------------- ----------------- (In thousands) Three months or less $ 35,900 $ 14,957 Over three months to six months 34,033 17,954 Over six months to twelve months 40,200 33,132 Over twelve months 102,550 113,339 -------- -------- Total $212,683 $179,382 ======== ========
Deposits in excess of $100,000 are not federally insured. Home Savings did not have brokered deposits for the years ended December 31, 2005 and 2004. EX. 13-32 10. FEDERAL HOME LOAN BANK ADVANCES The following is a summary of Federal Home Loan Bank advances:
December 31, ------------------------------------------------- 2005 2004 ----------------------- ----------------------- (In thousands) Weighted Weighted Year of maturity Amount average rate Amount average rate ---------------- -------- ------------ -------- ------------ 2006 $360,752 4.21% $342,435 3.23% 2007 66,501 3.80 30,500 5.01 2008 22,451 3.69 21,500 3.69 2009 10,913 3.56 10,000 3.56 2010 2,387 3.54 1,500 3.54 Thereafter 12,545 3.86 17,420 3.86 -------- -------- Total Federal Home Loan Bank advances $475,549 $423,355 ======== ========
Home Savings has available credit, subject to collateral requirements, with the Federal Home Loan Bank of $608.6 million, of which $475.5 million is outstanding. Of the $475.5 million, a total of $35.0 million is callable. $25.0 million matures in February 2006 and $10.0 is callable quarterly and matures in February 2009. All advances must be secured by eligible collateral as specified by the Federal Home Loan Bank. Accordingly, United Community has a blanket pledge of its one- to four-family mortgages and multi-family loans as collateral for the advances outstanding at December 31, 2005. The required minimum ratio of collateral to advances is 135% for one- to four-family loans and 150% for multi-family loans. 11. SECURITIES SOLD UNDER AGREEMENT TO REPURCHASE AND OTHER BORROWINGS The following is a summary of securities sold under an agreement to repurchase and other borrowings:
December 31, ----------------------------------------------- 2005 2004 ---------------------- ---------------------- (In thousands) Weighted Weighted Amount average rate Amount average rate ------- ------------ ------- ------------ Securities sold under agreement to repurchase-term $45,520 3.73% $41,105 1.92% Other borrowings 29,694 3.20 19,043 1.91 ------- ---- ------- ---- Total repurchase agreements and other $75,214 3.52% $60,148 1.92% ======= ==== ======= ====
Securities sold under agreements to repurchase are secured primarily by mortgage-backed securities with a fair value of approximately $53.7 million at December 31, 2005 and $50.6 at December 31, 2004. Securities sold under agreements to repurchase are typically held by the brokerage firm in a wholesale transaction and by an independent third party when they are for retail customers. At maturity, the securities underlying the agreements are returned to United Community. Other borrowings consist primarily of lines of credit, payables to customers and payables to broker/dealers. United Community has a line of credit with a correspondent bank which has a stated maturity of September 2008. All other borrowings have no stated maturity. 12. LOSS CONTINGENCY United Community and its subsidiaries are not parties to any other material litigation other than those arising in the normal course of business. While it is impossible to determine the ultimate resolution of these contingent matters, management believes any resulting liability would not have a material effect upon United Community's financial statements. EX. 13-33 13. INCOME TAXES The provision for income taxes consists of the following components:
Year ended December 31, -------------------------- 2005 2004 2003 ------- ------ ------- (In thousands) Current $12,396 $9,914 $12,926 Deferred (486) (811) (361) ------- ------ ------- Total $11,910 $9,103 $12,565 ======= ====== =======
A reconciliation from tax at the statutory rate to the income tax provision is as follows:
Year ended December 31, ------------------------------------------------ 2005 2004 2003 -------------- -------------- -------------- Dollars Rate Dollars Rate Dollars Rate ------- ---- ------- ---- ------- ---- (In thousands) Tax at statutory rate $12,287 35.0% $9,439 35.0% $12,427 35.0% Increase (decrease) due to: Tax exempt income (78) (0.2) (78) (0.3) (137) (0.4) Life insurance (288) (0.8) (308) (1.1) (170) (0.5) State taxes (4) (0.0) (27) (0.1) (40) (0.1) Other (7) (0.0) 77 0.3 485 1.4 ------- ---- ------ ---- ------- ---- Income tax provision $11,910 34.0% $9,103 33.8% $12,565 35.4% ======= ==== ====== ==== ======= ====
Significant components of the deferred tax assets and liabilities are as follows:
December 31, ------------------ 2005 2004 ------- -------- (In thousands) Deferred tax assets: Loan loss reserves $ 5,503 $ 5,557 Postretirement benefits 1,428 1,372 Deferred loan fees 363 333 ESOP shares released 1,308 1,257 Compensation accruals 348 697 Unrealized loss on securities available for sale 993 -- Investment valuation -- 491 Interest on non-accrual loans 883 508 Other 716 342 ------- ------- Deferred tax assets 11,542 10,557 ------- ------- Deferred tax liabilities: Purchase accounting adjustments 622 1,373 Original issue discount -- 694 Federal Home Loan Bank stock dividends 5,855 5,448 Unrealized gain on securities available for sale -- 572 Mortgage servicing rights 2,423 1,937 Other 762 704 ------- ------- Deferred tax liabilities 9,662 10,728 ------- ------- Net deferred tax asset (liability) $ 1,880 $ (171) ======= =======
Retained earnings at December 31, 2005 include approximately $21.1 million for which no provision for federal income taxes has been made. This amount represents the tax bad debt reserve at December 31, 1987, which is the end of United Community's base year for purposes of calculating the bad debt deduction for tax purposes. If this portion of retained earnings is used in the future for any purpose other than to absorb bad debts, the amount used will be added to future taxable income. The unrecorded deferred tax liability on the above amount at December 31, 2005 was approximately $7.3 million. 14. SHAREHOLDERS' EQUITY Dividends United Community's source of funds for dividends to its shareholders are earnings on its investments and dividends from Home Savings and Butler Wick. During the year ended December 31, 2005, United Community paid regular dividends in the amount of $9.5 million. While EX. 13-34 Home Savings' primary regulator is the FDIC, the OTS has regulations that impose certain restrictions on payments of dividends to United Community. Home Savings must file an application with, and obtain approval from, the OTS (i) if the proposed distribution would cause total distributions for the calendar year to exceed net income for that year to date plus retained net income (as defined) for the preceding two years; (ii) if Home Savings would not be at least adequately capitalized following the capital distribution; (iii) if the proposed distribution would violate a prohibition contained in any applicable statute, regulation or agreement between Home Savings and the OTS or the FDIC, or any condition imposed on Home Savings in an OTS-approved application or notice. If Home Savings is not required to file an application, it must file a notice of the proposed capital distribution with the OTS. As of December 31, 2005, Home Savings had $38.6 million of retained earnings that could be distributed without requiring the prior approval of the OTS. Other Comprehensive Income Other comprehensive income included in the Consolidated Statements of Shareholders' Equity consists solely of unrealized gains and losses on available for sale securities. The change includes reclassification of gains or losses on sales of securities of $122,000, $540,000 and $837,000 for the years ended December 31, 2005, 2004 and 2003. Liquidation Account At the time of the Conversion, Home Savings established a liquidation account, totaling $141.4 million, which was equal to its regulatory capital as of the latest practicable date prior to the Conversion. In the event of a complete liquidation, each eligible depositor will be entitled to receive a distribution from the liquidation account in an amount proportionate to the current adjusted qualifying balances for the accounts then held. 15. REGULATORY CAPITAL REQUIREMENTS Home Savings is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on United Community. The regulations require Home Savings to meet specific capital adequacy guidelines and the regulatory framework for prompt corrective action that involve quantitative measures of Home Savings' assets, liabilities, and certain off balance sheet items as calculated under regulatory accounting practices. Home Savings' capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require Home Savings to maintain minimum amounts and ratios of Leverage (or Core) and Tangible capital (as defined in the regulations) to adjusted total assets (as defined) and of total capital (as defined) to risk-weighted assets (as defined). Actual and required capital amounts and ratios are presented below.
As of December 31, 2005 ------------------------------------------------------------- Minimum To Be Well Capitalized Capital Under Prompt Corrective Actual Requirements Action Provisions ---------------- ---------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio -------- ----- -------- ----- -------- ----- (In thousands) Total capital (to risk-weighted assets) $218,943 10.86% $161,351 8.00% $201,688 10.00% Tier 1 capital (to risk-weighted assets) 203,220 10.08 * * 121,013 6.00 Leverage (Tier 1) capital (to adjusted total assets) 203,220 8.36 97,196 4.00 121,495 5.00 Tangible capital (to adjusted total assets) 203,220 8.36 36,449 1.50 * *
As of December 31, 2004 ------------------------------------------------------------- Minimum To Be Well Capitalized Capital Under Prompt Corrective Actual Requirements Action Provisions ---------------- ---------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio -------- ----- -------- ----- -------- ----- (In thousands) Total capital (to risk-weighted assets) $196,145 10.79% $145,408 8.00% $181,761 10.00% Tier 1 capital (to risk-weighted assets) 180,268 9.92 * * 109,056 6.00 Leverage (Tier 1) capital (to adjusted total assets) 180,268 8.36 86,204 4.00 107,755 5.00 Tangible capital (to adjusted total assets) 180,268 8.36 32,326 1.50 * *
* Ratio is not required under regulations. As of December 31, 2005 and 2004, the FDIC and OTS, respectively categorized Home Savings as well capitalized under the regulatory framework for Prompt Corrective Action. There are no conditions or events since that notification that management believes has changed EX. 13-35 United Community or Home Savings' categorization. To be categorized as well capitalized, Home Savings must maintain minimum Leverage, Tier 1 and total capital ratios as set forth in the table above. Management believes, as of December 31, 2005, that Home Savings meets all capital requirements to which it is subject. Events beyond management's control, such as fluctuations in interest rates or a downturn in the economy in areas in which Home Savings' loans and securities are concentrated, could adversely affect future earnings, and consequently Home Savings' ability to meet its future capital requirements. Butler Wick is subject to regulatory capital requirements set forth by the Securities and Exchange Commission's Uniform Net Capital Rule. Butler Wick has elected to use the alternative method, permitted by rule, which requires Butler Wick to maintain minimum net capital, as defined, equal to the greater of $250,000 or 2% of aggregate debit balances arising from customer transactions, as defined. The Net Capital Rule also provides that equity capital may not be withdrawn or cash dividends paid if resulting net capital would be less than 5% of aggregate debits. At December 31, 2005, Butler Wick had net capital of $8.5 million, which was 48% of aggregate debit balances and $8.1 million in excess of required minimum net capital. 16. BENEFIT PLANS Postretirement Benefit Plans In addition to Home Savings' retirement plans, Home Savings sponsors a defined benefit health care plan that was curtailed in 2000 to provide postretirement medical benefits for employees who worked 20 years and attained a minimum age of 60 by September 1, 2000, while in service with Home Savings. The plan is unfunded and, as such, has no assets. Furthermore, the plan is contributory and contains minor cost-sharing features such as deductibles and coinsurance. In addition, postretirement life insurance coverage is provided for employees who were participants prior to December 10, 1976. The life insurance plan is non-contributory. Home Savings' policy is to pay premiums monthly, with no pre-funding. The benefit obligation was measured on December 31, 2005 and 2004. Information about changes in obligations of the benefit plan follows:
Year ended December 31, ----------------------- 2005 2004 ------- ------- (In thousands) CHANGE IN BENEFIT OBLIGATION: Benefit obligation at beginning of year $ 3,742 $ 3,932 Service cost 1 9 Interest cost 215 245 Actuarial (gain)/loss 471 (140) Benefits paid (271) (304) ------- ------- Benefit obligation at end of the year $ 4,158 $ 3,742 ------- ------- Funded status of the plan $(4,158) $(3,742) Unrecognized net (gain)/loss from past experience different from that assumed and effects of changes in assumptions 297 (173) Prior service cost not yet recognized in net periodic benefit cost (5) (6) ------- ------- Accrued benefit cost $(3,866) $(3,921) ------- -------
Components of net periodic benefit cost/(gain) are as follows:
Year Ended December 31, ----------------------- 2005 2004 2003 ---- ----- ----- (In thousands) Service cost $ 1 $ 9 $ 6 Interest cost 215 245 226 Expected return on plan assets -- -- -- Net amortization of prior service cost -- (1) (1) Recognized net actuarial gain -- -- (15) ----- ----- ----- Net periodic benefit cost/(gain) $ 216 $ 253 $ 216 ----- ----- ----- Assumptions used in the valuations were as follows: Weighted average discount rate 5.50% 5.75% 6.00% ----- ----- -----
The weighted-average annual assumed rate of increase in the per capita cost of coverage benefits (i.e., health care cost trend rate) used in the 2005 valuation was 11% and was assumed to decrease to 5.5% for the year 2012 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. A one-percentage point change in assumed health care cost trend rates would have the following effects as of December 31, 2005: EX. 13-36
1 Percentage 1 Percentage Point Increase Point Decrease -------------- -------------- (In thousands) Effect on total of service and interest cost components $ 21 $ (18) Effect on the postretirement benefit obligation 394 (345)
United Community anticipates contributions to the plan to fund benefits paid will aggregate $3.1 million over the next ten years as follows: 2006 $ 271,000 2007 278,000 2008 291,000 2009 301,000 2010 314,000 2011-2015 1,677,000 ---------- Total $3,132,000 ==========
401(k) Savings Plan Home Savings sponsors a defined contribution 401(k) savings plan, which covers substantially all employees. Under the provisions of the plan, Home Savings' matching contribution is discretionary and may be changed from year to year. For 2005, 2004 and 2003, Home Savings' match was 50% of pre-tax contributions, up to a maximum of 6% of the employees' base pay. Participants become 100% vested in Home Savings contributions upon completion of three years of service. For the years ended 2005, 2004 and 2003, the expense related to this plan was approximately $477,000, $458,000 and $433,000, respectively. Butler Wick also sponsors a defined contribution 401(k) savings plan, which covers substantially all employees. Under the provisions of the plan, Butler Wick's matching contribution is discretionary and may be changed from year to year. For 2005, 2004 and 2003, Butler Wick's match was 25% of pre-tax contributions, up to a maximum of 6% of the employees' base pay. Participants become 100% vested in Butler Wick contributions upon completion of six years of service. For the years ended 2005, 2004 and 2003, the expense related to this plan was approximately $168,000, $157,000 and $133,000, respectively. Employee Stock Ownership Plan In conjunction with the Conversion, United Community established an Employee Stock Ownership Plan (ESOP) for the benefit of the employees of United Community and Home Savings. All full-time employees who meet certain age and years of service criteria are eligible to participate in the ESOP. An ESOP is a tax-qualified retirement plan designed to invest primarily in the stock of United Community. The ESOP borrowed $26.8 million from United Community to purchase 2,677,250 shares in conjunction with the conversion. The term of the loan is 15 years and is being repaid primarily with contributions from Home Savings to the ESOP. Additionally, 1,598,810 shares were purchased with the return of capital distribution in 1999. The loan is collateralized by the shares of common stock held by the ESOP. As the note is repaid, shares are released from collateral based on the proportion of the payment in relation to total payments required to be made on the loan. The shares released from collateral are then allocated to participants on the basis of compensation as described in the plan. Compensation expense is determined by multiplying the average per share market price of United Community's stock during the period by the number of shares to be released. United Community recognized approximately $3.3 million, $3.5 million and $2.8 million in compensation expense for the years ended December 31, 2005, 2004 and 2003, respectively, related to the ESOP. Unallocated shares are considered neither outstanding shares for computation of basic earnings per share nor potentially dilutive securities for computation of diluted earnings per share. Dividends on unallocated ESOP shares are reflected as a reduction in the loan (and Home Savings' contribution is reduced accordingly). Shares released or committed to be released for allocation during the years ended December 31, 2005, 2004 and 2003 totaled 294,802; 294,802 and 294,802 and had a combined fair market value of $10.5 million. Shares remaining not released or committed to be released for allocation at December 31, 2005 totaled 2,121,358 and had a market value of approximately $25.1 million. Recognition and Retention Plan On July 12, 1999, shareholders approved United Community Financial Corp. Recognition and Retention Plan (RRP). The purpose of the plan is to reward and retain directors, officers and employees of United Community and Home Savings who are in key positions of responsibility by providing them with an ownership interest in United Community. Under the RRP, recipients are entitled to receive dividends and have voting rights on their respective shares, but are restricted from selling or transferring the shares prior to vesting. In August 1999, United Community awarded 1,342,334 common shares to eligible individuals. Approximately one-fifth of the number of shares awarded, or 268,638 shares, vested on the date of grant. The remaining 1,073,696 shares vested ratably on each of the first four anniversary dates of the plan. In August 2000, United Community awarded 46,291 common shares to eligible individuals. Approximately two-fifths of the number of shares awarded, or 18,517 shares, vested on the date of grant. The remaining 27,774 shares vested ratably on each of the first three anniversary dates of the plan. In August 2002, United Community awarded 69,677 common shares to eligible individuals. Approximately one-half of the shares awarded, or 34,839 shares, vested on the date of grant. The remaining 34,838 shares EX. 13-37 vested on the first anniversary date. In August 2003, United Community awarded 2,376 common shares to eligible individuals, all of which vested immediately upon grant. As of December 31, 2005 and 2004, there are no shares available for future grants. The aggregate fair market value of the unvested RRP shares is considered unearned compensation at the time of grant and is amortized over the vesting period. There was no compensation expense recognized in 2005 and 2004 as all shares granted had previously vested. Compensation expense recognized in 2003 related to the RRP was $1.2 million. Retention Plan In connection with the Butler Wick acquisition, United Community established and funded a $3.7 million retention plan into a Rabbi Trust. Participants in the retention plan became vested in their benefits after five years of service, subject to acceleration in the event of a change in control of United Community or Butler Wick. If a participant voluntarily leaves the employ of Butler Wick or a subsidiary, or is terminated for cause, before the expiration of the five-year vesting period, the participant will forfeit all funds in the plan. If a participant dies, becomes disabled or retires at or after age 65 and prior to the expiration of the five-year vesting period, the participant, or the participant's estate, will be entitled to receive the funds allocated to him or her under the plan, increased for any earnings or reduced for any loss on such funds, at the end of the five-year vesting period. Retention plan expense, including fair value adjustments related to the assets in the Rabbi Trust, was $145,000, $582,000 and $1.6 million for 2005, 2004 and 2003. Participants in the plan were permitted to select various mutual funds into which participants could direct their investments. Each participant was able to select up to four of these mutual funds in order to diversify his or her allocations, and was permitted to make changes in fund selections periodically. Participants were permitted to elect a lump sum distribution at vesting, or a distribution in equal annual installments over a period of time not to exceed five years. To the extent that the participant elected to be paid in installments, his or her account will continue to be credited with investment gains and debited with investment losses until his or her full investment is distributed from the plan. United Community accrued the deferred compensation obligation prorata over the vesting period through a charge to compensation expense. Plan assets are included in trading securities in United Community's financial statements and are recorded at fair value. Final vesting occurred on August 12, 2004 and approximately 56% of plan assets were distributed at that time. On August 12, 2005, approximately 55% of the remaining plan assets were distributed to remaining participants in the plan. Until the final distribution is made, United Community will continue to record income or expense as the market value of the remaining plan assets and corresponding liability to participants fluctuates. Plan assets amounted to $992,000 and $2.0 million at December 31, 2005 and 2004, respectively. Long-Term Incentive Plan On July 12, 1999, shareholders approved the United Community Financial Corp. Long-Term Incentive Plan (Incentive Plan). The purpose of the Incentive Plan is to promote and advance the interests of United Community and its shareholders by enabling United Community to attract, retain and reward directors, directors emeritus, managerial and other key employees of United Community, including Home Savings and Butler Wick, by facilitating their purchase of an ownership interest in United Community. The Incentive Plan provides for the grant of options, which may qualify as either incentive or nonqualified stock options. The incentive plan provides that option prices will not be less than the fair market value of the stock at the grant date. The maximum number of common shares that may be issued under the plan is 3,471,562, all of which have been granted prior to December 31, 2004. All of the options awarded became exercisable on the date of grant. The option period expires 10 years from the date of grant. A summary of activity in the plan is as follows:
As of December 31, ------------------------------------------------------------------ 2005 2004 2003 -------------------- -------------------- -------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price --------- -------- --------- -------- --------- -------- Outstanding at beginning of year 2,309,748 $9.49 2,468,622 $ 7.60 1,909,615 $7.01 Granted -- -- 754,403 12.73 742,654 8.97 Exercised (92,532) 7.28 (913,277) 7.03 (171,873) 7.08 Forfeited -- -- -- -- (11,774) 7.86 --------- ----- --------- ------ --------- ----- Outstanding at end of year 2,217,216 9.59 2,309,748 9.49 2,468,622 7.60 --------- ----- --------- ------ --------- ----- Options exercisable at year end 2,217,216 $9.59 2,309,748 $ 9.49 2,468,622 $7.60 --------- ----- --------- ------ --------- ----- Weighted-average fair value of options granted during year N/A $ 3.13 $3.65 ------ -----
Outstanding stock options have a weighted average remaining life of 6.99 years and may be exercised in the range of $6.66 to $12.73. Employee Stock Purchase Plan During 2005, United Community established an employee stock purchase plan (ESPP). Under this plan, United Community provides employees of Home Savings and Butler Wick the opportunity to purchase United Community Financial Corporation's common shares through payroll deduction. Participation in the plan is voluntary and payroll deductions are made on an after-tax basis. The maximum amount an employee can have deducted is nine hundred dollars per biweekly pay. Shares are purchased on the open market and EX. 13-38 administrative fees are paid by United Community. Expense related to this plan is a component of the Shareholder Dividend Reinvestment Plan and the expense recognized is considered immaterial. 17. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of financial instruments have been determined by United Community using available market information and appropriate valuation methodologies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that United Community could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Cash and cash equivalents, margin accounts, accrued interest receivable and payable and advance payments by borrowers for taxes and insurance--The carrying amounts as reported in the Statements of Financial Condition are a reasonable estimate of fair value due to their short-term nature. Securities--Fair values are based on quoted market prices, dealer quotes and prices obtained from independent pricing services. Loans held for sale--The fair value of loans held for sale is based on market quotes. Loans--The fair value is estimated by discounting the future cash flows using the current market rates for loans of similar maturities with adjustments for market and credit risks. Federal Home Loan Bank stock--The fair value is estimated to be the carrying value, which is par. All transactions in the capital stock of the Federal Home Loan Bank are executed at par. Deposits--The fair value of demand deposits, savings accounts and money market deposit accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using rates currently offered for deposits of similar remaining maturities. Borrowed funds--For short-term borrowings, fair value is estimated to be carrying value. The fair value of other borrowings is based on current rates for similar financing. Limitations--Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time United Community's entire holdings of a particular financial instrument. Because no market exists for a significant portion of United Community's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on and off balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. For example, a significant asset not considered a financial asset is premises and equipment. In addition, tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates. The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2005 and 2004, respectively. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. EX. 13-39
December 31, 2005 December 31, 2004 ------------------------- ----------------------- Carrying Fair Carrying Fair Value Value Value Value ----------- ----------- ---------- ---------- (In thousands) ASSETS: Cash and cash equivalents $ 37,545 $ 37,545 $ 40,281 $ 40,281 Securities: Trading 10,812 10,812 32,316 32,316 Available for sale 201,870 201,870 198,404 198,404 Loans held for sale 29,109 29,403 59,099 59,383 Loans, net 2,097,433 2,100,474 1,815,976 1,838,983 Margin accounts 15,705 15,705 14,851 14,851 Federal Home Loan Bank stock 24,006 24,006 22,842 22,842 Accrued interest receivable 12,053 12,053 9,445 9,445 LIABILITIES: Deposits: Checking, savings and money market accounts (615,726) (615,726) (698,667) (698,667) Certificates of deposit (1,066,117) (1,061,686) (824,285) (834,086) Federal Home Loan Bank advances (475,549) (472,012) (423,355) (425,135) Repurchase agreements and other (75,214) (75,263) (60,148) (60,265) Advance payments by borrowers for taxes and insurance (14,322) (14,322) (12,048) (12,048) Accrued interest payable (2,622) (2,622) (1,089) (1,089)
18. STATEMENT OF CASH FLOWS SUPPLEMENTAL DISCLOSURE Supplemental disclosures of cash flow information are summarized below:
Year Ended December 31, --------------------------- 2005 2004 2003 ------- ------- ------- (In thousands) Supplemental disclosures of cash flow information: Cash paid during the year for: Interest on deposits and borrowings, net of amounts capitalized $55,764 $40,259 $40,408 Interest capitalized on borrowings 42 19 21 Income taxes 9,615 12,938 14,570 Supplemental schedule of noncash activities: Loans transferred to held for sale 74,144 39,479 11,341 Loans transferred from held for sale 37,075 -- -- Transfers from loans to real estate owned 4,935 2,356 2,224
EX. 13-40 19. PARENT COMPANY FINANCIAL STATEMENTS CONDENSED STATEMENTS OF FINANCIAL CONDITION
December 31, ------------------- 2005 2004 -------- -------- (In thousands) ASSETS Cash and deposits with banks $ 479 $ 819 Federal funds sold and other 21 14 -------- -------- Total cash and cash equivalents 500 833 Securities: Trading 992 1,990 Available for sale 2,962 3,570 Note receivable inter-company 16,847 18,523 Investment in subsidiary-Home Savings 236,621 216,840 Investment in subsidiary-Butler Wick 15,174 16,764 Other assets 158 1,286 -------- -------- TOTAL ASSETS $273,254 $259,806 ======== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Repurchase agreements and other $ 6,600 $ 3,500 Accrued interest payable 51 3 Accrued expenses and other liabilities 1,868 3,951 -------- -------- Total liabilities 8,519 7,454 -------- -------- TOTAL SHAREHOLDERS' EQUITY 264,735 252,352 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $273,254 $259,806 ======== ========
CONDENSED STATEMENTS OF INCOME
Year ended December 31, --------------------------- 2005 2004 2003 ------- ------- ------- (In thousands) INCOME Cash dividends from subsidiary $ 7,000 $ -- $22,000 Interest income 1,530 1,680 1,871 Non-interest income 166 1,086 873 ------- ------- ------- Total income 8,696 2,766 24,744 EXPENSES Interest expense 406 14 -- Non-interest expenses 1,395 1,339 984 ------- ------- ------- Total expenses 1,801 1,353 984 ------- ------- ------- Income before income taxes 6,895 1,413 23,760 Income tax (benefit) expense (49) 558 692 ------- ------- ------- Income before equity in undistributed net earnings of subsidiaries 6,944 855 23,068 Equity in undistributed net earnings of subsidiaries 16,253 17,010 (128) ------- ------- ------- Net income $23,197 $17,865 $22,940 ======= ======= =======
EX. 13-41 CONDENSED STATEMENTS OF CASH FLOWS
Year ended December 31, ------------------------------ 2005 2004 2003 -------- -------- -------- (In thousands) CASH FLOWS FROM OPERATING ACTIVITIES Net Income $ 23,197 $ 17,865 $ 22,940 Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed earnings of the subsidiaries (16,253) (17,010) 128 Security gains (62) (948) -- Decrease (increase) in trading securities 998 2,081 (916) Decrease (increase) in interest receivable -- 1 10 Decrease (increase) in other assets 1,128 (751) (519) Increase in accrued interest payable 47 3 -- Decrease in other liabilities (1,948) (1,228) (1,764) -------- -------- -------- Net cash from operating activities 7,107 13 19,879 -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Proceeds from sale of: Securities available for sale 99 2,322 -- Purchases of: Securities available for sale (227) (105) (527) ESOP loan repayment 875 735 534 -------- -------- -------- Net cash from investing activities 747 2,952 7 -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Dividends paid (9,462) (8,533) (9,429) Net increase in borrowed funds 3,100 3,500 -- Purchase of treasury stock (2,499) (47,814) (12,233) Exercise of stock options 674 6,420 941 -------- -------- -------- Net cash from financing activities (8,187) (46,427) (20,721) -------- -------- -------- Decrease in cash and cash equivalents (333) (43,462) (835) Cash and cash equivalents, beginning of year 833 44,295 45,130 -------- -------- -------- Cash and cash equivalents, end of year $ 500 $ 833 $ 44,295 ======== ======== ========
20. SEGMENT INFORMATION United Community has two principal segments, banking and investment services. Banking provides consumer and corporate banking services. Investment services provide investment brokerage and a network of integrated financial services. The accounting policies of the segments are the same as those described in Note 1. Condensed statements of income and selected financial information by operating segment for the years ended December 31, 2005, 2004 and 2003 are as follows: EX. 13-42
Banking Investment Services Services Eliminations Total ---------- ---------- ------------ ---------- (In thousands) 2005 RESULTS OF OPERATIONS Total interest income $ 133,794 $ 2,258 -- $ 136,052 Total interest expense 56,357 939 -- 57,296 Provision for loan losses 3,028 -- -- 3,028 Net interest income after provision for loan losses 74,409 1,319 -- 75,728 Non-interest income 12,184 26,076 -- 38,260 Non-interest expense 53,413 25,468 -- 78,881 ---------- ------- ---- ---------- Income before income taxes 33,180 1,927 -- 35,107 Income taxes 11,234 676 -- 11,910 ---------- ------- ---- ---------- Net income $ 21,946 $ 1,251 -- $ 23,197 ========== ======= ==== ========== SELECTED FINANCIAL INFORMATION Total assets $2,488,771 $40,122 $(43) $2,528,850 Capital expenditures 5,029 320 -- 5,379 Depreciation and amortization 2,026 321 -- 2,347 ---------- ------- ---- ---------- 2004 RESULTS OF OPERATIONS Total interest income $ 111,822 $ 1,619 -- $ 113,441 Total interest expense 39,971 407 -- 40,378 Provision for loan losses 9,370 -- -- 9,370 Net interest income after provision for loan losses 62,481 1,212 -- 63,693 Non-interest income 11,629 24,480 -- 36,109 Non-interest expense 48,348 24,486 -- 72,834 ---------- ------- ---- ---------- Income before income taxes 25,762 1,206 -- 26,968 Income taxes 8,698 405 -- 9,103 ---------- ------- ---- ---------- Net income $ 17,064 $ 801 -- $ 17,865 ========== ======= ==== ========== SELECTED FINANCIAL INFORMATION Total assets $2,229,705 $58,089 $ (6) $2,287,788 Capital expenditures 2,928 271 -- 3,199 Depreciation and amortization 2,579 364 -- 2,943 ---------- ------- ---- ---------- 2003 RESULTS OF OPERATIONS Total interest income $ 110,510 $ 1,153 -- $ 111,663 Total interest expense 40,031 221 -- 40,252 Provision for loan losses 3,179 -- -- 3,179 Net interest income after provision for loan losses 67,300 932 -- 68,232 Non-interest income 18,795 22,050 -- 40,845 Non-interest expense 50,277 23,295 -- 73,572 ---------- ------- ---- ---------- Income (loss) before income taxes 35,818 (313) -- 35,505 Income taxes 12,675 (110) -- 12,565 ---------- ------- ---- ---------- Net income (loss) $ 23,143 $ (203) -- $ 22,940 ========== ======= ==== ========== SELECTED FINANCIAL INFORMATION Total assets $2,035,927 $37,958 $ (2) $2,073,883 Capital expenditures 3,714 311 -- 4,025 Depreciation and amortization 3,049 495 -- 3,544
EX. 13-43 21. EARNINGS PER SHARE Earnings per share are computed by dividing net income by the weighted average number of shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common shares determined for the basic computation plus the dilutive effect of potential common shares that could be issued under outstanding stock options. Stock options for 754,403 shares were anti-dilutive for the years ended December 31, 2005 and 2004. No stock options were anti-dilutive for the year ended December 31, 2003.
2005 2004 2003 ------- ------- ------- (In thousands, except per share data) BASIC EARNINGS PER SHARE: Net income applicable to common stock $23,197 $17,865 $22,940 Weighted average common shares outstanding 28,809 29,185 31,353 ------- ------- ------- Basic earnings per share $ 0.81 $ 0.61 $ 0.73 ------- ------- ------- DILUTED EARNINGS PER SHARE: Net income applicable to common stock $23,197 $17,865 $22,940 Weighted average common shares outstanding 28,809 29,185 31,353 Dilutive effect of stock options 330 420 431 ------- ------- ------- Weighted average common shares outstanding for dilutive computation 29,139 29,605 31,784 ------- ------- ------- Diluted earnings per share $ 0.80 $ 0.60 $ 0.72 ------- ------- -------
22. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The following table presents summarized quarterly data for each of the years indicated.
(Unaudited) ---------------------------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter Total ------- ------- ----------- ------- -------- (In thousands, except per share data) 2005: Total interest income $30,763 $32,853 $35,106 $37,330 $136,052 Total interest expense 12,011 13,518 15,044 16,723 57,296 ------- ------- ------- ------- -------- Net interest income 18,752 19,335 20,062 20,607 78,756 Provision for loan losses 633 418 702 1,275 3,028 Non-interest income 8,868 10,297 9,772 9,323 38,260 Non-interest expense 19,657 19,399 19,437 20,388 78,881 Income taxes 2,449 3,317 3,304 2,840 11,910 ------- ------- ------- ------- -------- Net income $ 4,881 $ 6,498 $ 6,391 $ 5,427 $ 23,197 ------- ------- ------- ------- -------- Earnings per share: Basic $ 0.17 $ 0.23 $ 0.22 $ 0.19 $ 0.81 Diluted 0.17 0.22 0.22 0.19 0.80
Non-interest expense increased between the third and fourth quarters largely due to an increase in employee compensation and benefits. The increase is attributable to increased performance incentives as a result of record earnings, greater commission expenses, rising healthcare costs and increased personnel. Other expenses also increased consisting, in part, of legal and audit fees. EX. 13-44
First Second Third Fourth Quarter Quarter Quarter Quarter Total ------- ------- ------- ------- -------- (In thousands, except per share data) 2004: Total interest income $27,075 $27,639 $28,986 $29,741 $113,441 Total interest expense 9,067 9,488 10,497 11,326 40,378 ------- ------- ------- ------- -------- Net interest income 18,008 18,151 18,489 18,415 73,063 Provision for loan losses 459 1,369 9,226 (1,684) 9,370 Non-interest income 10,331 8,666 8,678 8,434 36,109 Non-interest expense 19,514 17,770 17,718 17,832 72,834 Income taxes 2,893 2,676 29 3,505 9,103 ------- ------- ------- ------- -------- Net income $ 5,473 $ 5,002 $ 194 $ 7,196 $ 17,865 ------- ------- ------- ------- -------- Earnings per share: Basic $ 0.18 $ 0.17 $ 0.01 $ 0.25 $ 0.61 Diluted 0.18 0.17 0.01 0.24 0.60
The change in the provision for loan losses between the second and third quarter was primarily a result of United Community's determination that impairment charges were necessary in the third quarter on certain consumer loans having similar characteristics and loans to a commercial customer that relate to the aforementioned consumer loans. The increase in the provision for loan losses had a direct effect on pretax income, causing lower pretax income in the third quarter and, subsequently, lower income tax expense. The change between the second and third quarters was partially offset in the fourth quarter as management continued to evaluate the level of collateral securing delinquent one- to four-family residential mortgage loans. Additionally, specific reserves assigned to certain commercial loans were deemed to be no longer necessary because of improved credit quality and adequate collateral coverage. As a result, the provision for loan losses decreased, pretax income increased and the provision for income taxes increased. See Management's Discussion and Analysis as well as Note 4, "Loans" for more details on the provision for loan losses and Note 13, "Income Taxes" for more detail on the provision for income taxes. EX. 13-45 EX-21 3 l17997aexv21.txt EXHIBIT 21 . . . EXHIBIT 21 SUBSIDIARIES
Name State of Incorporation - ---- ---------------------- The Home Savings and Loan Company of Youngstown, Ohio Ohio Butler Wick Corp. Ohio
EX. 21-1 EX-23 4 l17997aexv23.txt EXHIBIT 23 EXHIBIT 23 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We consent to the incorporation by reference in the Registration Statements (No. 333-38028, No. 333-86015, and 333-100081) on Form S-8 of our reports dated February 1, 2006 with respect to the consolidated financial statements of United Community Financial Corp. and management's assessment of the effectiveness of internal control over financial reporting and the effectiveness of internal control over financial reporting, which reports appear in the Annual Report on Form 10-K of United Community Financial Corp. for the year ended December 31, 2005. /s/Crowe Chizek and Company LLC ------------------------------- Crowe Chizek and Company LLC Cleveland, Ohio March 15, 2006 EX. 23-1 EX-31.1 5 l17997aexv31w1.txt EXHIBIT 31.1 EXHIBIT 31.1 RULE 13a-15(e)/15d-15(e) CERTIFICATION I, Douglas M. McKay, certify that: 1) I have reviewed this annual report on Form 10-K of United Community Financial Corp. 2) Based on my knowledge, this annual report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) and internal control over financial reporting (as defined in Exchange Act Rules 13a 15(f) and 15d 15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5) The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Douglas M. McKay - -------------------- Douglas M. McKay Chief Executive Officer March 15, 2006 EX. 31.1-1 EX-31.2 6 l17997aexv31w2.txt EXHIBIT 31.2 EXHIBIT 31.2 RULE 13a-15(e)/15d-15(e) CERTIFICATION I, Patrick A. Kelly, certify that: 1) I have reviewed this annual report on Form 10-K of United Community Financial Corp. 2) Based on my knowledge, this annual report does not contain any untrue statement of material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3) Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4) The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) and internal control over financial reporting (as defined in Exchange Act Rules 13a 15(f) and 15d 15(f)) for the registrant and have: a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; c) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and d) disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5) The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing equivalent function): a) all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Patrick A. Kelly - -------------------- Patrick A. Kelly Chief Financial Officer March 15, 2006 EX. 31.2-1 EX-32 7 l17997aexv32.txt EXHIBIT 32 EXHIBIT 32 UNITED COMMUNITY FINANCIAL CORP. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of United Community Financial Corp. (the "Company") on Form 10-K for the year ended December 31, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), we certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. /s/ Douglas M. McKay /s/ Patrick A. Kelly - ----------------------- ----------------------- Douglas M. McKay Patrick A. Kelly Chief Executive Officer Chief Financial Officer March 15, 2006 March 15, 2006 A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. EX. 32-1 -----END PRIVACY-ENHANCED MESSAGE-----