-----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, Ky5qjN4pzg5AwnXfRrgHUHUiklDOyxnu+GqmcPcW8fUswyBHtRpuFW9eRDuXnum0 c2OwIQ4+EHQDymSA0xv2eg== 0000950159-03-000958.txt : 20031114 0000950159-03-000958.hdr.sgml : 20031114 20031114155119 ACCESSION NUMBER: 0000950159-03-000958 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20030930 FILED AS OF DATE: 20031114 FILER: COMPANY DATA: COMPANY CONFORMED NAME: UNITED BANCSHARES INC /PA CENTRAL INDEX KEY: 0000944792 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 232802415 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-25976 FILM NUMBER: 031004456 BUSINESS ADDRESS: STREET 1: 300 NORTH THIRD ST CITY: PHILADELPHIA STATE: PA ZIP: 19106 BUSINESS PHONE: 2158292265 MAIL ADDRESS: STREET 1: 2300 PACKARD BLDG STREET 2: 111 S 15TH ST CITY: PHILADELPHIA STATE: PA ZIP: 19102 10-Q 1 ub10q_3qtr.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. -------------- FORM 10-Q -------------- (Mark One) _X_ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003 OR ___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ TO _____________ UNITED BANCSHARES, INC. ---------------------- (Exact name of registrant as specified in its charter) 0-25976 ---------------------- Commission File Number Pennsylvania 23-2802415 ---------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 300 North 3rd Street, Philadelphia, PA 19106 -------------------------------------- ------------- (Address of principal executive office) (Zip Code) (215) 351-4600 ---------------- (Registrant's telephone number, including area code) N/A ---------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether 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 twelve months (or such shorter period that the registrant was required to filed such reports), and (2) has been subject to such filing requirements for the past 90 day. Yes _X_ No ____ Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12b2 of the Act) Yes_____ No___X___ Applicable only to issuers involved in bankruptcy proceedings during the preceding five years: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes _____ No _____ Applicable only to corporate issuers: Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. Registrant has two classes of capital stock authorized - 2,000,000 shares of $.01 par value Common Stock and 500,000 shares of Series A Preferred Stock. The Board of Directors designated a subclass of the common stock, designated Class B Common Stock, by filing of Articles of Amendment on September 30, 1998. This Class of stock has all of the rights and privileges of Common Stock with the exception of voting. Of the 2,000,000 shares of Common Stock authorized, 250,000 have been designated Class B Common Stock. As of November 3, 2003 1,067,082(including191,667 Class B Non voting) shares were issued and outstanding and 33,500 shares were held as Treasury Stock. The Board of Directors of United Bancshares, Inc. authorized 500,000 shares of one series of the Series A Preferred Stock of which 143,150 shares were outstanding and 6,308 shares were held as Treasury Stock as of November 3, 2003. FORM 10-Q Index Item No. Page ------- ---- PART I 1. Financial Statements.............................................. 3 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................ 9 3. Quantitative and Qualitative Disclosures about Market Risk......... 24 4. Controls and Procedures ........................................... 26 PART II 1. Legal Proceedings.................................................. 26 2. Restrictions on the Payment of Dividends........................... 26 3. Defaults upon Senior Securities.................................... 27 4. Submission of Matters to a Vote of Security Holders................ 27 5. Other Information.................................................. 27 6. Exhibits and Reports on Form 8K.................................... 22 2 Item 1. Financial Statements Consolidated Balance Sheets (unaudited)
Sept 30, December 31, 2003 2002 ---------- ------------ Assets Cash and due from banks 6,151,507 4,541,667 Interest bearing deposits with banks 872,081 865,421 Federal funds sold 4,701,000 10,122,000 ---------- ---------- Cash & cash equivalents 11,724,588 15,529,088 Investment securities: Held-to-maturity, at amortized cost, market value $5,776,783 5,704,238 7,183,403 Available-for-sale, at market value 8,870,850 14,334,360 Loans, net of unearned discount 47,041,527 44,133,190 Less: allowance for loan losses (750,543) (674,550) ---------- ---------- Net loans 46,290,984 43,458,640 Bank premises & equipment, net 2,814,874 2,612,608 Accrued interest receivable 488,459 555,006 Core deposit intangible 1,782,955 1,937,221 Prepaid expenses and other assets 431,962 433,793 ---------- ---------- Total Assets 78,108,910 86,044,119 ========== ========== Liabilities & Shareholders' Equity Demand deposits, non-interest bearing 16,008,043 20,453,455 Demand deposits, interest bearing 12,474,004 12,837,464 Savings deposits 19,530,720 20,494,208 Time deposits, $100,000 and over 10,595,554 10,882,722 Time deposits 11,188,837 12,261,455 ---------- ---------- Total Deposits 69,797,158 76,929,304 Accrued interest payable 102,875 156,219 Accrued expenses and other liabilities 482,563 458,455 ---------- ---------- Total Liabilities 70,382,596 77,543,978 Shareholders' equity: Preferred Stock, Series A, non-cum., 6%, $.01 par value, 500,000 shrs auth., 143,150 issued and outstanding 1,432 1,432 Common stock, $.01 par value; 2,000,000 shares authorized; 1,068,588 shares issued and outstanding at Sept 30, 2003 and 1,102,088 at December 31, 2002, respectively 10,686 11,021 Treasury Stock, 33,500 shares at September 30, 2003 0 0 Additional-paid-in-capital 14,749,789 14,749,454 Accumulated deficit (7,133,970) (6,499,197) Net unrealized gain on available-for-sale securities 98,377 237,432 ---------- ---------- Total Shareholders' equity 7,726,314 8,500,141 ---------- ---------- 78,108,910 86,044,119 ========== ==========
See Accompanying Notes 3 Consolidated Statements of Income (unaudited)
Quarter ended Quarter ended Nine months ended Nine months ended September 30, September 30, September 30, September 30, 2003 2002 2003 2002 ------------- ------------- ----------------- ----------------- Interest Income: Interest and fees on loans 737,618 757,472 2,193,785 2,223,101 Interest on investment securities 162,815 360,804 628,645 1,139,588 Interest on Federal Funds sold 19,391 35,489 84,719 133,080 Interest on time deposits with other banks 5,752 3,851 16,707 7,018 --------- --------- --------- ---------- Total interest income 925,576 1,157,616 2,923,856 3,502,787 Interest Expense: Interest on time deposits 88,185 144,824 291,205 521,661 Interest on demand deposits 21,046 30,642 67,304 85,669 Interest on savings deposits 19,180 32,307 72,512 98,232 --------- --------- --------- ---------- Total interest expense 128,411 207,773 431,021 705,562 Net interest income 797,165 949,843 2,492,835 2,797,225 Provision for loan losses 60,000 37,500 180,000 112,500 --------- --------- --------- ---------- Net interest income less provision for loan losses 737,165 912,343 2,312,835 2,684,725 --------- --------- --------- ---------- Noninterest income: Customer service fees 409,851 474,468 1,241,320 1,448,102 Realized gain (loss) on investments 675 0 675 25,789 Other income 51,560 285,178 91,962 361,569 --------- --------- --------- --------- Total noninterest income 462,086 759,646 1,333,957 1,835,460 Non-interest expense Salaries, wages, and employee benefits 543,555 582,855 1,670,834 1,825,677 Occupancy and equipment 327,362 308,294 934,865 1,011,439 Office operations and supplies 116,906 107,332 341,223 322,579 Marketing and public relations 31,875 18,111 75,593 44,975 Professional services 46,784 73,917 150,318 186,533 Data processing 169,532 157,114 486,118 463,702 Deposit insurance assessments 8,187 8,831 25,370 27,425 Other noninterest expense 208,558 230,758 597,243 732,663 --------- --------- --------- --------- Total non-interest expense 1,452,759 1,487,212 4,281,564 4,614,993 --------- --------- --------- --------- Net income (loss) ($253,508) $ 184,777 ($634,772) ($94,808) ========= ========= ========= ========= Earnings per share-basic ($0.23) $0.17 ($0.58) ($0.09) Earnings per share-diluted ($0.23) $0.17 ($0.58) ($0.09) ========= ========= ========= ========= Weighted average number of shares 1,090,141 1,100,582 1,090,141 1,100,582 ========= ========= ========= =========
See Accompanying Notes 4 Statement of Cash Flows (unaudited)
Nine Months ended Nine Months ended September September 2003 2002 ------------------ ----------------- Cash flows from operating activities: Net loss ($634,772) (94,808) Adjustments to reconcile net loss to net cash used in operating activities: Provision for loan losses 180,000 112,500 Gain on sale of fixed assets 0 (39,753) Depreciation and amortization 504,036 523,025 Decrease (increase) in accrued interest receivable and other assets 68,378 124,896 Increase (decrease) in accrued interest payable and other liabilites (29,235) (172,555) ---------- ---------- Net cash used in operating activities 88,407 453,305 Cash flows from investing activities: Purchase of investments-Available-for-Sale (2,032,133) (7,790,823) Purchase of investments-Held-to Maturity (2,012,482) (500,000) Proceeds from maturity & principal reductions of investments-Available-for-Sale 7,336,661 7,942,140 Proceeds from maturity & principal reductions of investments-Held-to-Maturity 3,481,120 3,415,715 Proceeds from sale of investments-Available-for-Sale 0 1,091,063 Net (increase) decrease in loans (3,012,344) (1,462,585) Purchase of premises and equipment (521,582) (162,205) Sale of premises and equipment 0 110,000 ---------- ---------- Net cash provided by investing activities 3,239,240 2,643,305 Cash flows from financing activities Net increase (decrease) in deposits (7,132,146) (1,810,900) Net proceeds from issuance of common stock 0 20,400 ---------- ---------- Net cash used in financing activities (7,132,146) (1,790,500) Increase in cash and cash equivalents (3,804,499) 1,306,110 Cash and cash equivalents at beginning of period 15,529,088 13,781,978 Cash and cash equivalents at end of period 11,724,589 15,088,088 ========== ========== Supplemental disclosures of cash flow information Cash paid during the period for interest 387,505 611,066 ========== ========== Write-down of cumulative effect of change in method of accounting for invesment securities -- --
See Accompanying Notes 5 NOTES TO FINANCIAL STATEMENTS 1. General United Bancshares, Inc. (the "Company") is a bank holding company registered under the Bank Holding Company Act of 1956. The Company's principal activity is the ownership and management of its wholly owned subsidiary, United Bank of Philadelphia (the "Bank"). During interim periods, the Company follows the accounting policies set forth in its Annual Report on Form 10-K filed with the Securities and Exchange Commission. Readers are encouraged to refer to the Company's Form 10-K for the fiscal year ended December 31, 2002 when reviewing this Form 10-Q. Quarterly results reported herein are not necessarily indicative of results to be expected for other quarters. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring adjustments) considered necessary to present fairly the Company's consolidated financial position as of September 30, 2003 and December 31, 2002 and the consolidated results of its operations for the nine month period ended September 30, 2003 and 2002, and its consolidated stockholders' equity for the nine month period ended September 30, 2003, and its consolidated cash flows for the nine month period ended September 30, 2003 and 2002. 2. Stock-based Compensation At September 30, 2003, the Bank had one stock-based employee compensation plan. The Bank accounts for that plan under the recognition and measurement principles of APB 25, "Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation costs is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table provides the disclosures required by SFAS No. 148 and illustrates the effect on net income and earnings per share if the Corporation had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation. (in 000's)
September 30, 2003 December 31, 2002 ------------------ ----------------- Net income (in thousands) As reported ($ 634) ($ 217) Stock-based compensation costs determined under fair value method for all awards $ - $ - -------- -------- Pro forma ($ 634) ($ 217) Earnings per share (Basic) As reported ($ 0.58) ($ 0.23) Pro forma ($ 0.58) ($ 0.23) Earnings per share (Diluted) As reported ($ 0.58) ($ 0.23) Pro forma ($ 0.58) ($ 0.23)
There were no options granted in 2003 and 2002. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Because the Company is a bank holding company for the Bank, the financial statements in this report are prepared on a consolidated basis to include the accounts of the Company and the Bank. The purpose of this discussion is to focus on information about the Bank's financial condition and results of operations, which is not otherwise apparent from the consolidated financial statements included in this quarterly report. This discussion and analysis should be read in conjunction with the financial statements presented elsewhere in this report. Critical Accounting Policies Allowance for Credit Losses The Bank considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The balance in the allowance for loan losses is determined based on management's review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions, and other pertinent factors, including management's assumptions as to future delinquencies, recoveries and losses. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management's estimates, additional provisions for loan losses may be required that would adversely impact earnings in future periods. Income Taxes Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities. Deferred tax assets are subject to management's judgment based upon available evidence that future realization is more likely than not. For financial reporting purposes, a valuation allowance of 100% of the deferred tax asset has been recognized to offset the deferred tax assets related to cumulative temporary differences and tax loss carryforwards. If management determines that the Bank may be able to realize all or part of the deferred tax asset in the future, a credit to income tax expense may be required to increase the recorded value of net deferred tax asset to the expected realizable amount. Selected Financial Data The following table sets forth selected financial data for the each of the following periods: (Thousands of dollars, except per share data) Quarter ended Quarter ended September 30, September 30, 2003 2002 ------------- ------------- Net interest income $ 797 $ 950 Provision for loan losses 60 37 Noninterest income 462 760 Noninterest expense 1,453 1,487 Net income (loss) (254) 185 Earnings (loss) per share-basic and diluted ($0.23) $0.17 7 September 30, December 31, 2003 2002 ------------- ------------- Balance sheet totals: Total assets $78,108 $86,044 Loans, net $46,290 $43,459 Investment securities $14,575 $21,518 Deposits $69,797 $76,929 Shareholders' equity $ 7,726 $ 8,500 Ratios Return on assets(1) (0.79)% (0.25)% Return on equity(1) (9.74)% (2.55)% Equity to assets ratio 7.41% 7.45% (1) Not annualized Financial Condition Sources and Uses of Funds The financial condition of the Bank can be evaluated in terms of trends in its sources and uses of funds. The comparison of average balances in the following table indicates how the Bank has managed these elements. Average funding sources increased approximately $3.3 million, or 4.42%, during the quarter ending September 30, 2003. Average funding uses decreased $4.1 million, or 5.48%, for the same quarter. Sources and Uses of Funds Trends
September 30, 2003 June 30, 2003 ------------------ ------------- (Thousands of Dollars, except percentages) Average Increase (Decrease) Average ------- ------------------- ------- Balance Amount % Balance ------- ------- ------- ------- Funding uses: Loans $47,969 $5,344 12.54 $42,625 Investment securities Held-to-maturity 5,927 (240) (3.89) 6,167 Available-for-sale 8,918 (1,801) (16.80) 10,719 Federal funds sold 7,667 (6,559) (46.11) 14,226 ------ ------- ------- Total uses $70,481 (3,256) $73,737 ======= ======= ======= Funding sources: Demand deposits Noninterest-bearing $17,046 (2,882) (14.46) $19,928 Interest-bearing 12,152 183 1.53 11,969 Savings deposits 20,138 (568) (2.74) 20,706 Time deposits 22,221 (878) (3.80) 23,099 ------- ------- ------- Total sources $71,557 (4,145) $75,702 ======= ======= =======
Loans Average loans increased approximately $5.3 million, or 12.54%, during the quarter ended September 30, 2003. The increase is primarily the result of the purchase of approximately $4.8 million adjustable rate residential mortgage loans in late June 2003. This purchase was made to supplement the Bank's residential loan portfolio that had declined because of high refinancing activity as a result of the historically low interest rate environment. In addition, the Bank has equipped itself with resources (i.e. hiring an experienced mortgage loan officer, renewing its seller/servicer relationship with FannieMae, etc.) to become a competitive player in the mortgage loan origination market to reduce the level of payoffs and to generate a new source of fee income. 8 The Bank continues to cultivate relationships with other financial institutions in the region with which it participates in loans as a strategy to stabilize and grow its commercial loan portfolio. This strategy is utilized as a low cost means to build the Bank's pool of earning assets while it enhances its own business development capacity. During the quarter ended September 30, 2003, the Bank booked $1.4 million in new loan participations. Most of these participations are secured by commercial real estate. The Bank's loan-to-deposit ratio at September 30, 2003 was 67.40%, compared to 63.39% at June 30, 2003. The increase during the quarter is primarily a result of a smaller deposit base as well as commercial loan participations. The target loan-to-deposit ratio is 75%. This level would allow the Bank to optimize interest income on earning assets while maintaining adequate liquidity. Management will continue to implement loan growth strategies including the purchase of additional commercial loan participations and the origination of small business loans, mortgage loans and consumer loans including home equity, automobile, student and credit card loans. Because of the purchase of loan participations, the Bank's loan portfolio is heavily concentrated in commercial real estate loans that now comprise $13.0 million, or 27.7%, of total loans. Although paydowns continue, the purchase of $4.8 million adjustable rate residential mortgage loans in late June 2003 resulted in an increase in this component of the portfolio to $15.6 million, or 33.18% of the portfolio, at September 30, 2003. The following table shows the composition of the loan portfolio of the Bank by type of loan. (Thousands of Dollars) September 30, December 31, 2003 2002 ------------ ----------- Commercial and industrial $10,269 $10,855 Commercial real estate 13,035 11,898 Consumer loans 8,126 7,820 Residential mortgages 15,611 13,560 ------- ------- Total Loans $47,041 $44,133 ======= ======= Allowance for Loan Losses The allowance for loan losses reflects management's continuing evaluation of the loan portfolio, the diversification and size of the portfolio, and adequacy of collateral. The following factors are considered in determining the adequacy of the allowance for loan losses: levels and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volumes and terms of loans, effects of any changes in risk selection and underwriting standards, and other changes in lending policies, procedures and practices; experience, ability, and depth of lending management and relevant staff; national and local economic conditions; industry conditions; and effects of changes in credit concentrations. The following Table presents an analysis of the allowance for loan losses. 9 ANALYSIS OF ALLOWANCE FOR LOAN LOSSES (Dollars in thousands) Balance at January 1, 2003 $ 675 ----- Charge-offs: Commercial loans 89 Consumer loans 61 ----- Total charge-offs 150 ===== Recoveries 46 Net (charge-offs) recoveries (104) Additions charged to operations 180 ----- Balance at September 30, 2003 751 ===== The allowance for loan losses as a percentage of total loans was 1.60% at September 30, 2003 compared to 1.42% at June 30, 2003. The increase in this ratio is due to loan loss provisions of $60 thousand made during the quarter. The economy has been in recession for the last three years. Although, some sectors of the economy now seem poised for growth, economic instability persists. Because the impact on the borrowers may lag the current economic conditions, the Bank proactively monitors its credit quality while working with borrowers in an effort to identify and control credit risk. At September 30, 2003, the Bank's classified loans totaled $1.8 million, or 3.73% of total loans--relatively unchanged from the quarter ending June 30, 2003. Specific reserves totaling $669 thousand have been allocated to the Bank's classified loans. Approximately $357 thousand of this reserve is allocated to one loan for which full collectibility is uncertain. (Refer to Nonperforming and Nonaccrual Loans below for further discussion on this loan.) While management uses available information to recognize losses on loans, future additions may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments of information available to them at the time of the examination. Management believes the level of the allowance for loan losses is adequate as of September 30, 2003. Nonperforming and Nonaccrual Loans The Bank generally determines a loan to be "nonperforming" when interest or principal is past due 90 days or more. If it otherwise appears doubtful that the loan will be repaid, management may consider the loan to be "nonperforming" before the lapse of 90 days. The policy of the Bank is to charge-off unsecured loans after 90 days past due. Interest on "nonperforming" loans ceases to accrue except for loans that are well collateralized and in the process of collection. When a loan is placed on non-accrual, previously accrued and unpaid interest is generally reversed out of income unless adequate collateral from which to collect the principal of and interest on the loan appears to be available. At September 30, 2003, non-accrual loans were approximately $1.7 million--unchanged from June 30, 2003. A significant amount of the non-accrual loans primarily relate to one borrower with loans totaling $1.3 million (discussed below) that were placed on non-accrual in January 2003. Approximately $769 thousand of the Bank's non-accrual loans are guaranteed by the Small Business Administration. 10 The Bank has one borrower in the telecommunications industry with loans totaling approximately $1.3 million that is experiencing severe financial difficulty. Guarantees from the Small Business Administration (SBA) reduce the Bank's exposure to approximately $714 thousand. A specific reserve of $357 thousand has been allocated to this loan to cover potential losses. This loan has been modified to provide for a moratorium on principal payments until January 2004. The borrower is currently not in compliance with the modified terms of the agreement. Management is working with its legal counsel and the borrower to negotiate a new strategy that may include a new forbearance agreement and a lockbox agreement. Management continues to assess the likelihood of collection of this loan and the Bank's potential exposure. There is no other known information about possible credit problems other than those classified as nonaccrual that causes management to be uncertain as to the ability of any borrower to comply with present loan terms. The Bank grants commercial, residential and consumer loans to customers primarily located in Philadelphia County, Pennsylvania and surrounding counties in the Delaware Valley. From time to time, the Bank purchases loans from other financial institutions. These loans are generally located in the Northeast corridor of the United States. Although the Bank has a diversified loan portfolio, its debtors' ability to honor their contracts is influenced by the region's economy. At September 30, 2003, approximately 16% of the Bank's commercial loan portfolio was concentrated in loans made to religious organizations. From inception, the Bank has received support in the form of investments and deposits and has developed strong relationships with the Philadelphia region's religious community. Loans made to these organizations were primarily for expansion and repair of church facilities. Investment Securities and other short-term investments Investment securities, including Federal Funds Sold, decreased on average by $8.6 million, or 15.89%, during the quarter ended September 30, 2003. This decrease is due to the use of funds to purchase $4.8 million in residential mortgage loans in June 2003. In addition, the Bank had less investable funds resulting from a $4.1 million decline in deposits during the quarter because of a shift in deposits of a large quasi-local government entity. Whether these deposits will be replaced remains questionable. The Bank's current investment portfolio primarily consists of mortgage-backed pass-through agency securities, and other government-sponsored agency securities. The Bank does not invest in high-risk securities or complex structured notes. The yield on the portfolio is 4.93% at September 30, 2003 compared with 4.99% at June 30, 2003. The average duration of the portfolio is 2.10 years. In the current low interest rate environment, the duration of the investment portfolio is significantly shortened because of the level of fixed rate mortgage backed securities that comprised 40.7% of the total portfolio at September 30, 2003. Because customers are more likely to refinance in a low interest rate environment, the prepayment speed increases on this component of the portfolio. The constant one year prepayment rate (CPR) at September 30, 2003 was 47.71 that translates into 47.7% of the mortgage pool repaying on an annual basis. This results in more liquidity and a lower yield on the investment portfolio. 11 As a result of calls over the last two years, callable agencies now comprise only 20.3% of the investment portfolio. There were no called securities during the quarter ended September 30, 2003. The Bank will continue to take steps to reduce the impact of the level of optionality in the portfolio by identifying replacement loans or securities that diversify risk and provide some level of monthly cashflow to be reinvested in the future rising rate environments. The Bank has implemented a strategy to invest funds in hybrid mortgage-backed securities that are fixed for three to ten years and then become adjustable with the current market conditions. These securities have average current yields of at least 4.00% and estimated durations of 5 years with monthly cashflow. Deposits The Bank has a relatively stable core deposit base representing 85% of total deposits. During the quarter ended September 30, 2003, average deposits decreased $4.1 million, or 5.48%. This decline is primarily because the shift in deposits totaling $3 million of a large quasi-local government entity. Whether these deposits will be replaced remains questionable. In addition, during the quarter, the Bank returned $800 thousand in unauthorized brokered deposits. It is the Bank's policy not to accept brokered deposits as they do not represent core deposits and are often very rate sensitive. Significant deposit growth is not projected because of the Bank's mandatory capital requirements outlined in its Written Agreement with its regulators (See Regulatory Matters below). Therefore, aggressive deposit retention or new business development strategies have not been implemented. Other Borrowed Funds The Bank did not borrow funds during the quarter ended September 30, 2003. Generally, the level of other borrowed funds is dependent on many items such as loan growth, deposit growth, customer collateral/security requirements and interest rates paid for these funds. The Bank's liquidity has been enhanced by loan paydowns/payoffs and called investment securities--thereby, eliminating the need to borrow. Commitments and Lines of Credit The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit, which are conditional commitments issued by the Bank to guarantee the performance of an obligation of a customer to a third party. Both arrangements have credit risk essentially the same as that involved in extending loans, and are subject to the Bank's normal credit policies. Collateral may be obtained based on management's assessment of the customer. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instruments is represented by the contractual amount of those instruments. 12 The Bank's financial instrument commitments at September 30, 2003 are summarized below: Commitments to extend credit $ 11,382,000 Outstanding letter of credit $ 57,000 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Management believes the Bank has adequate liquidity to support the funding of unused commitments. Liquidity and Interest Rate Sensitivity Management The primary functions of asset/liability management are to assure adequate liquidity and maintain appropriate balance between interest-sensitive earning assets and interest-bearing liabilities. Liquidity management involves the ability to meet cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. The Bank is required to maintain minimum levels of liquid assets as defined by Federal Reserve Board (the "FRB")regulations. This requirement is evaluated in relation to the composition and stability of deposits; the degree and trend of reliance on short-term, volatile sources of funds, including any undue reliance on particular segments of money market or brokered deposits; any difficulty in obtaining funds; and the liquidity provided by securities and other assets. In addition, consideration is given to the nature, volume and anticipated use of commitments; the adequacy of liquidity and funding policies and practices, including the provision for alternate sources of funds; and the nature and trend of off-balance-sheet activities. As of September 30, 2003, management believes the Bank's liquidity is satisfactory and in compliance with the FRB regulations The Bank's principal sources of asset liquidity include investment securities consisting principally of U.S. Government and agency issues, particularly those of shorter maturities, and mortgage-backed securities with monthly repayments of principal and interest. Other types of assets such as federal funds sold, as well as maturing loans, are sources of liquidity. Approximately $10.1 million in loans are scheduled to mature within one year. 13 By policy, the Bank's minimum level of liquidity is 6.00% of total assets. At September 30, 2003, the Bank has total short-term liquidity, including cash and federal funds sold, of $11.7 million, or 15% of total assets. Additional liquidity of approximately $8.9 million is provided by the Bank's investment portfolio classified as available-for-sale. The Bank's overall liquidity continues to be enhanced by a significant level of core deposits which management has determined are less sensitive to interest rate movements. The Bank continues to avoid reliance on large denomination time deposits. However, the Bank has one $5 million deposit with a government agency that matures in December 2003. While this is a short-term renewal, based on discussions with the customer, management does not anticipate the removal of this deposit in the near future. The following is a summary of the remaining maturities of time deposits of $100,000 or more outstanding at September 30, 2003: (Thousands of dollars) 3 months or less $ 6,093 Over 3 through 12 months 3,896 Over 1 through three years 607 Over three years -- -- ------- Total $10,596 ======= Capital Resources Total shareholders' equity decreased approximately $335 thousand during the quarter ended September 30, 2003. The decrease in equity was primarily due to a net loss of $254 thousand during the quarter and an $80 thousand decrease in other comprehensive income (FAS 115 unrealized gains on available-for-sale securities) because of interest rate changes that reduced the value of the investment portfolio. FRB standards for measuring capital adequacy for U.S. Banking organizations requires that banks maintain capital based on "risk-adjusted" assets so that categories of assets with potentially higher risk will require more capital backing than assets with lower risk. In addition, banks are required to maintain capital to support, on a risk-adjusted basis, certain off-balance-sheet activities such as loan commitments. The FRB standards classify capital into two tiers, referred to as Tier 1 and Tier 2. Tier 1 consists of common shareholders' equity, non-cumulative and cumulative perpetual preferred stock, and minority interests less goodwill. Tier 2 capital consists of allowance for loan losses, hybrid capital instruments, term-subordinated debt, and intermediate-term preferred stock. Banks are required to meet a minimum ratio of 8% of qualifying capital to risk-adjusted total assets with at least 4% Tier 1 capital ratio and a Tier I Leverage ratio of at least 6%. Capital that qualifies as Tier 2 capital is limited to 100% of Tier 1 capital. 14 As indicated in the table below, the Company's and the Bank's risk-based capital ratios are above the minimum requirements. (Refer to Regulatory Matters below for Written Agreement requirements) Management continues the objective of increasing capital by offering additional stock (preferred and common) for sale to knowledgeable investors on a limited offering basis. However, the focus continues to be on increasing the rate of internal capital growth as a means of maintaining the required capital ratios. The Company and the Bank do not anticipate paying dividends in the near future. Company Company September 30, December 31, 2003 2002 ------- ------- Total Capital $ 7,726 $ 8,500 Less: Intangible Asset/Net unrealized gains (losses) on available for sale portfolio (1,900) (2,174) ------- ------- Tier 1 Capital 5,826 6,326 ------- ------- Tier 2 Capital 530 528 ------- ------- Total Qualifying Capital $ 6,356 $ 6,854 ======= ======= Risk Adjusted Total Assets (including off- Balance sheet exposures) $42,184 $42,104 Tier 1 Risk-Based Capital Ratio 13.81% 15.02% Tier 2 Risk-Based Capital Ratio 15.07% 16.28% Leverage Ratio 7.38% 7.46% Bank Bank September 30, December 31, 2003 2002 ------- ------- Total Capital $7,437 $8,211 Less: Intangible Asset/Net unrealized gains (losses) on available for sale portfolio (1,900) (2,174) ------- ------- Tier 1 Capital 5,537 6,037 ------- ------- Tier 2 Capital 530 528 ------- ------- Total Qualifying Capital $6,067 $ 6,565 ====== ======= Risk Adjusted Total Assets (including off- Balance sheet exposures) $42,184 $42,104 Tier 1 Risk-Based Capital Ratio 13.13% 14.34% Tier 2 Risk-Based Capital Ratio 14.38% 15.59% Leverage Ratio 7.01% 7.12% Results of Operations Summary The Bank had a net loss of approximately $254 thousand ($0.23 per common share) for the quarter ended September 30, 2003 compared to net income of $185 thousand ($0.17 per common share) for the quarter ended September 30, 2002. The financial results for the quarter ended September 30, 2002 were positively impacted by the award of a $198,000 grant from the U.S. Treasury Department's Bank Enterprise Award (BEA) Fund. These funds were awarded to financial institutions that demonstrate community development through loan and deposit activity. In addition, the financial results for 2003 were negatively impacted by the continued low interest rate environment and competitive market pressures that resulted in a decline in the Bank's net interest margin and noninterest income. 15 Revenue enhancement strategies continue to be implemented to generate expanded opportunities for fee income through the marketing of consumer loan products including residential mortgages, home equity, automobile, student, and credit card loans, and the installation of additional high volume automated teller machines (ATMs). However, A greater impact on profitability is expected to be realized with increased loan originations that build the Bank's loan-to-deposit ratio. Increased loan volume will result in a higher net interest margin and therefore increased revenues. To this end, management is focused on the implementation of business development strategies to increase the level of loans outstanding. Business development officers have been hired and a residential mortgage origination infrastructure has been put into place. In addition, to build momentum around business development and to generate interest and enthusiasm in the marketplace, management embarked on a re-branding campaign for the Bank. The campaign focuses on a re-introduction of the Bank and emphasizes its commitment to the community. This campaign includes among other things, in-branch marketing of the Bank's products and services and direct mail advertising/solicitation. A major emphasis has been placed on mortgage loan origination and the Bank's United Wealth Management Services Division, as a lead-in to cross-sell the Bank's other products and services. A more detailed explanation for each component of earnings is included in the sections below. Net Interest Income Net interest income is an effective measure of how well management has balanced the Bank's interest rate sensitive assets and liabilities. Net interest income, the difference between (a) interest and fees on interest earning assets and interest paid on interest-bearing liabilities, is a significant component of the earnings of the Bank. Changes in net interest income result primarily from increases or decreases in the average balances of interest earning assets, the availability of particular sources of funds and changes in prevailing interest rates. Net interest income declined $153 thousand, or 16.07% for the quarter ending September 30, 2003 compared to the quarter ending September 30, 2002. Much of this decline was experienced in the investment portfolio. The average balance of investment securities declined from $24.6 million at September 30, 2002 to $14.7 million at September 30, 2003, while the average yield decreased from 5.86% to 4.93% for the same period. During 2002, approximately $10.8 million higher yielding agency securities were called. In the current low interest rate environment, these funds were placed in lower yielding mortgage-backed securities or Federal Funds Sold. Strategies continue to be implemented to shift low yielding earning assets to higher yielding loan participations and investment securities including the purchase of hybrid adjustable rate securities with minimum yields of 4.00%. The Bank's cost of funds declined to .94% for the quarter ending September 30, 2003 compared to 1.43% for the same quarter in 2002. Consistent with current market conditions, the Bank reduced the rates it pays on many of its interest-bearing products. Because most of the Bank's deposits are considered core, they were not sensitive to declining rates. 16 The net interest margin of the Bank was 4.25% at September 30, 2003 compared to 4.63% at September 30, 2002. The decline is primarily related to calls of higher yielding investment securities over the last year. Management actively manages its exposure to interest rate changes. While the prime rate decreased 200 basis points over the last year, the Bank did not experience a similar decline in yield on its earning assets. This is because much of the Bank's loan portfolio is fixed rate in nature and not related to prime. In addition, 61% of the Bank's investment portfolio is fixed rate. These characteristics of the Bank's earning assets coupled with the Bank's significant level of core deposits resulted in less impact on the Bank's net interest margin during the declining rate environment. Provision for Loan Losses The provision is based on management's estimate of the amount needed to maintain an adequate allowance for loan losses. This estimate is based on the review of the loan portfolio, the level of net credit losses, past loan loss experience, the general economic outlook and other factors management feels are appropriate. The provision for loan losses charged against earnings for the quarter ending September 30, 2003 was $60 thousand compared to $37,500 for the same quarter in 2002. This increase in the provision was necessary because of an increase in classified loans for which specific reserves were provided. (Refer to Allowance for Loan Losses above for discussion on classified loans and specific reserves.) Management continues to closely monitor the portfolio for signs of weakness and will proactively make provisions to cover potential losses. During the current unstable economic environment, the Bank monitors its credit quality very closely by working with borrowers in an effort to identify and control credit risk. Systematic provisions are made to the allowance to cover potential losses related to the Bank's classified loans. Management believes the level of the allowance for loan losses is adequate as of September 30, 2003. Noninterest Income The amount of the Bank's noninterest income generally reflects the volume of the transactional and other accounts handled by the Bank and includes such fees and charges as low balance account charge, overdrafts, account analysis, and other customer service fees. Noninterest income for the quarter ended September 30, 2003 declined $298 thousand, or 39.17%, compared to the quarter ended September 30, 2002. The financial results for the quarter ended September 30, 2002 were positively impacted by the award of a $198,000 grant from the U.S. Treasury Department's Bank Enterprise Award (BEA) Fund. These funds were awarded to financial institutions that demonstrate community development through loan and deposit activity. Another large component of noninterest income, customer service fees, declined $65 thousand, or 13.62%, for the quarter ended September 30, 2003 compared to 2002. The decline was primarily because of a reduction in activity fees and dormancy fees on deposit accounts. More customers are avoiding service charges by keeping appropriate minimum balances. In addition, to avoid the necessity to escheat the balances of inactive customer accounts, the Bank made an extensive effort to contact these customers to re-activate their accounts. This resulted in a reduction in activity/dormant account service charges. 17 In addition, surcharge income on ATM's has declined. Some of the Bank's ATMs have experienced a drop in volume as competitors place machines in close proximity to existing high volume ATMs of the Bank. Management continues the process of identifying potentially high volume locations to place machines. Noninterest Expense Salaries and benefits expense decreased $39 thousand, or 6.74%, during the quarter ended September 30, 2003 compared to 2002. As part of its Profit Restoration Plan over the last year, the Bank made strategic reductions in staff, job consolidations, and reduced salaries for certain employees to lower the level of personnel expense. Management continues its review to ensure the Bank is operating with the most efficient organizational structure. Data processing expenses are a result of the management decision of the Bank to outsource a majority of its data processing operations to third party processors. Such expenses are reflective of the high level of accounts being serviced for which the Bank is charged a per account charge by processors. In addition, the Bank uses outside loan servicing companies to service its mortgage, credit card, installment and student loan portfolios. Data processing expenses increased approximately $12 thousand, or 7.90%, during the quarter ended September 30, 2003 compared to 2002. This increase is related to increased service activities provided by the Bank's new core data processor, FISERV. These services including statement rendering and research (imaging), were previously performed in-house. In November 2002, the Bank converted its core data processing to FISERV to achieve cost savings and create efficiencies to allow for further reductions in personnel expense. The Bank continues to study methods by which it may reduce its data processing costs, including but not limited to a consolidation of servicers and in-house loan servicing options. Occupancy expense increased approximately $19 thousand, or 6.19%, during the quarter ended September 30, 2003 compared to 2002. The increase is primarily attributable to the rising cost of utilities and other repairs and maintenance associated with the Bank's facilities. In August 2003, the Bank purchased its 38th and Lancaster Street Branch as a measure to reduce its occupancy expense. The projected annual savings on this transaction is $20,000. Professional services expense decreased approximately $27 thousand, or 36.71%, for the quarter ended September 30, 2003 compared to 2002. This decrease is primarily related to the final resolution of outstanding legal matters with W.T. Development and Monument Financial in 2002. In addition, the implementation of the Sarbanes Oxley Act in 2002 required increased legal involvement. 18 Office operations and supplies expense increased approximately $10 thousand, or 8.92%, for the quarter ended September 30, 2003 compared to 2002. The increase is primarily related to additional security cost. With the new emphasis on Homeland Security, the Bank heightened its security coverage. The review of more cost-effective security measures is currently underway. Marketing and Public Relations expense increased $13 thousand, or 76%, for the quarter ended September 30, 2003 compared to 2002. In 2003, the Bank began a re-branding campaign that included, among other things, new brochures and in-branch signage. Federal deposit insurance premiums decreased by close to $1 thousand, or 7.29%, for the quarter ended September 30, 2003 compared to 2002. FDIC insurance premiums are applied to all financial institutions based on a risk based premium assessment system. Under this system, bank strength is based on three factors: 1) asset quality, 2) capital strength, and 3) management. Premium assessments are then assigned based on the institution's overall rating, with the stronger institutions paying lower rates. The Bank's assessment was based on 1.96 basis points for BIF (Bank Insurance Fund) assessable deposits and SAIF (Savings Insurance Fund) assessable deposits. The decrease during 2003, is a result of a reduction in the Bank's level of deposits as well as improvement in the Bank's risk rating. All other expenses are reflective of the general cost to do business and compete in the current regulatory environment and maintenance of adequate insurance coverage. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148 "Accounting for Stock-Based Compensation--Transition and Disclosure" ("SFAS No. 148") in December 2002. SFAS No. 148 amends the disclosure and certain transition provisions of Statement of Financial Accounting Standards No. 123 "Accounting for Stock Based Compensation". The new disclosure provisions are effective for financial statements for fiscal years ending after December 15, 2002 and for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. Regulatory Matters In February 2000, as a result of a regulatory examination completed in December 1999, the Bank entered into a Written Agreement (herein sometimes referred to as the Agreement) with its primary regulators with regard to, among other things, achievement of agreed-upon capital levels, implementation of a viable earnings/strategic plan, adequate funding of the allowance for loan losses, the completion of a management review and succession plan, and improvement in internal controls. The Agreement requires the Bank to increase its capital ratio to 6.5% by June 30, 2000 and to 7% at all times thereafter. As of December 31, 2000, the Bank had met the required ratios by implementing strategies that included: reducing expenses, consolidating branches, and soliciting new and additional sources of capital. Management continues to address all matters outlined in the Agreement. Management believes that the Bank is "substantially" in compliance with the Agreement's terms and conditions. Failure to comply could result in additional regulatory supervision and/or actions. 19 At December 31, 2001, the Bank's tier one leverage capital ratio fell to 6.80%, below the 7% minimum capital ratio required by the Agreement. However, at December 31, 2002, the Tier I leverage ratio had improved to 7.12% as a result of the smaller average asset size of the Bank. At September 30, 2003, this ratio (currently 7.01%) continues to be above the required minimum due to the lower average asset size. Management continues to review and revise its capital plan to address the development of new equity--internal (retained earnings) and external (private limited sales of investment securities). Recent Accounting Pronouncements The Company adopted Statement of Financial Accounting Standard 149 (SFAS No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging Activities, on July 1, 2003. SFAS No. 149 clarifies and amends SFAS No. 133 for implementation issues raised by constituents or includes the conclusions reached by the FASB on certain FASB Staff Implementation Issues. Statement 149 also amends SFAS No. 133 to require a lender to account for loan commitments related to mortgage loans that will be held for sale as derivatives. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The Company periodically enters into commitments with its customers, which it intends to sell in the future. Management does not anticipate the adoption of SFAS No. 149 to have a material impact on the Company's financial position or results of operations. The FASB issued SFAS No.150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, on May 15, 2003. SFAS No. 150 changes the classification in the statement of financial position of certain common financial instruments from either equity or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in fair value or redemption amount, as applicable, in earnings. SFAS No. 150 is effective for public companies for financial instruments entered into or modified after May 31, 2003 and is effective at the beginning of the first interim period beginning after June 15, 2003. Management has not entered into any financial instruments that would qualify under SFAS No. 150. As a result, management does not anticipate the adoption of SFAS No. 150 to have a material impact on the Company's financial position or results of operations. The Company adopted FASB Interpretation ("FIN") 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others on January 1, 2003. FIN 45 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company has financial and performance letters of credit. Financial letters of credit require the Company to make payment if the customer's financial condition deteriorates, as defined in the agreements. Performance letters of credit require the Company to make payments if the customer fails to perform certain non-financial contractual obligation. The Company previously did not record a liability when guaranteeing obligations unless it became probable that the Company would have to perform under the guarantee. FIN 45 applies prospectively to guarantees the Company issues or modifies subsequent to December 31, 2002. At September 30, 2003, the Company was contingently liable on financial and performance standby letters of credit totaling $57,000, none of which were originated in the first six months of this year. The Company's commitments under standby letters of credit expire at various dates through June 2004. The Bank generally holds collateral and/or obtains personal guarantees supporting these commitments. In the event that the Bank is required to fulfill its contingent liability under a standby letter of credit, it could liquidate the collateral held, if any, and enforce the personal guarantee(s) held, if any, to recover all or a portion of the amount paid under the letter of credit. 20 In January 2003, the FASB issued FASB Interpretation 46 ("FIN 46"), Consolidation of Variable Interest Entities. FIN 46 clarifies the application of Accounting Research Bulletin 51, "Consolidated Financial Statements," for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest ("variable interest entities"). Variable interest entities within the scope of FIN 46 will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity's expected losses, receives a majority of its expected returns, or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The Company is in the process of determining what impact, if any, the adoption of the provisions of FIN 46 will have upon its financial condition or results of operations. The Company does not anticipate FIN 46 to have a material impact on its consolidated financial position and results of operations. In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or Certain Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with the evidence of deterioration of credit quality since origination acquired by completion of a transfer for which it is probable at acquisition, that the Company will be unable to collect all contractually required payments receivable. SOP 03-3 requires that the Company recognize the excess of all cash flows expected at acquisition over the investor's initial investment in the loan as interest income on a level-yield basis over the life of the loan as the accretable yield. The loan's contractual required payments receivable in excess of the amount of its cash flows excepted at acquisition (nonaccretable difference) should not be recognized as an adjustment to yield, a loss accrual or a valuation allowance for credit risk. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 31, 2004. Early adoption is permitted. Management is currently evaluating the provisions of SOP 03-3. Cautionary Notice Regarding Forward Looking Statements Certain of the matters discussed in this document including matters discussed under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" may constitute forward looking statements for the purposes of the Securities Act of 1933, as amended and the Securities Exchange Act of 1934, as amended, and may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of United Bancshares, Inc ("UBS") to be materially different from future results, performance or achievements expressed or implied by such forward looking statements. The words "expect," "anticipate," "intended," "plan," "believe," "seek," "estimate," and similar expressions are intended to identify such forward-looking statements. UBS' actual results may differ materially from the results anticipated by the forward-looking statements due to a variety of factors, including without limitation: (a) the effects of future economic conditions on UBS and its customers including economic factors which affect consumer confidence in the securities markets, wealth creation, investment and consumer saving patterns; (b) UBS interest rate risk exposure and credit risk; (c) changes in the securities markets with respect to the market values of financial assets and the stability of particular securities markets; (d) governmental monetary and fiscal policies, as well as legislation and regulatory changes; (e) changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral and securities, as well as interest-rate risks; (f) changes in accounting requirements or interpretations; (g) the effects of competition from other commercial banks, thrifts, mortgage companies, consumer finance companies, credit unions securities brokerage firms, insurance company's, money-market and mutual funds and other financial institutions operating in the UBS' trade market area and elsewhere including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the internet; (h) any extraordinary events (such as the September 11, 2001 events and the U.S. Government's response to those events or the U.S. Government becoming involved in a conflict in a foreign country; (i) the failure of assumptions underlying the establishment of reserves for loan losses and estimates in the value of collateral, and various financial assets and liabilities and technological changes being more difficult or expensive than anticipated; (j) UBS' success in generating new business in its existing markets, as well as its success in identifying and penetrating targeted markets and generating a profit in those markets in a reasonable time; (k) UBS' timely development of competitive new products and services in a changing environment and the acceptance of such products and services by customers; and (l) UBS' success in managing the risks involved in the foregoing. 21 All written or oral forward-looking statements attributed to UBS are expressly qualified in their entirety by use of the foregoing cautionary statements. All forward-looking statements included in this Report are based upon information presently available, and UBS assumes no obligation to update any forward-looking statement. Item 3. Quantitative and Qualitative Disclosures about Market Risk Interest rate sensitivity varies with different types of interest-earning assets and interest-bearing liabilities. Overnight federal funds on which rates change daily and loans which are tied to prime or other short term indices differ considerably from long-term investment securities and fixed-rate loans. Similarly, time deposits are much more interest sensitive than passbook savings accounts. The shorter-term interest rate sensitivities are key to measuring the interest sensitivity gap, or excess earning assets over interest-bearing liabilities. Management of interest sensitivity involves matching repricing dates of interest-earning assets with interest-bearing liabilities in a manner designed to optimize net interest income within the limits imposed by regulatory authorities, liquidity determinations and capital considerations. At September 30, 2003, a liability sensitive position is maintained on a cumulative basis through 1 year of 4.12% that is within the Bank's policy guidelines of +/- 15% on a cumulative 1-year basis. The current gap position is primarily due to the recent purchase of hybrid mortgage product that are fixed for three to seven years and then begin floating with Treasury yields or LIBOR. This position is somewhat mitigated by the significant level of core deposits which have very little rate sensitivity. Generally, because of the negative gap position of the Bank in shorter time frames, the Bank can anticipate that increases in market rates will have a negative impact on the net interest income, while decreases will have the opposite effect. While using the interest sensitivity gap analysis is a useful management tool as it considers the quantity of assets and liabilities subject to repricing in a given time period, it does not consider the relative sensitivity to market interest rate changes that are characteristic of various interest rate-sensitive assets and liabilities. Consequently, although the Bank currently has a negative gap position because of unequal sensitivity of these assets and liabilities, management believes this position will not materially impact earnings in a changing rate environment. For example, changes in the prime rate on variable commercial loans may not result in an equal change in the rate of money market deposits or short-term certificates of deposit. A simulation model is therefore used to estimate the impact of various changes, both upward and downward, in market interest rates and volumes of assets and liabilities on the net income of the Bank. This model produces an interest rate exposure report that forecast changes in the market value of portfolio equity under alternative interest rate environments. The market value of portfolio equity is defined as the present value of the Company's existing assets, liabilities and off-balance-sheet instruments. The calculated estimates of changes in market value of equity at September 30, 2003 are as follows: Market value of equity Changes in rate Market value of equity as a % of MV of Assets ------------------- ------------------------- ---------------------- (Dollars in thousands) +400 basis points $1,159 1.65% +300 basis points 2,450 3.40 +200 basis points 3,991 5.39 +100 basis points 5,262 6.94 Flat rate 6,617 8.52 -100 basis points 8,033 10.10 -200 basis points 9,465 11.62 -300 basis points 10,452 12.61 -400 basis points 11,359 13.48 22 The market value of equity may be impacted by the composition of the Bank's assets and liabilities. A shift in the level of variable versus fixed rate assets will create swings in the market value of equity. The Bank's market value of equity declines in a rising rate environment because of the high level of fixed rate loans the it has in its portfolio. The assumptions used in evaluating the vulnerability of the Company's earnings and capital to changes in interest rates are based on management's consideration of past experience, current position and anticipated future economic conditions. The interest sensitivity of the Company's assets and liabilities, as well as the estimated effect of changes in interest rates on the market value of portfolio equity, could vary substantially if different assumptions are used or actual experience differs from the assumptions on which the calculations were based. The Board of Directors of the Bank and management consider all of the relevant factors and conditions in the asset/liability planning process. Interest-rate exposure is not considered significant and is within the policy limits of the Bank at September 30, 2003. However, if significant interest rate risk arises, the Board of Directors and management may take (but are not limited to) one or all of the following steps to reposition the balance sheet as appropriate: 1. Limit jumbo certificates of deposit (CDs) and movement into money market deposit accounts and short-term CDs through pricing and other marketing strategies. 2. Purchase quality loan participations with appropriate interest rate/gap match for the balance sheet of the Bank. 3. Restructure the investment portfolio of the Bank. The Board of Directors has determined that active supervision of the interest-rate spread between yield on earnings assets and cost of funds will decrease the vulnerability of the Bank to interest-rate cycles. Item 4 Controls and Procedures As of the end of the period covered by this report, the Company carried out an evaluation under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer, Evelyn F. Smalls, and Chief Financial Officer, Brenda M. Hudson-Nelson, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 15(e). Based upon the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings. As of the date of this report, there have not been any significant changes in the Company's internal controls or in any other factors that could significantly affect those controls subsequent to the date of the evaluation. 23 PART II - OTHER INFORMATION Item 1. Legal Proceedings. No material claims have been instituted or threatened by or against Registrant or its affiliates other than in the ordinary course of business. Item 2. Restrictions on the Payment of Dividends. The holders of the Common Stock are entitled to such dividends as may be declared by the Board of Directors out of funds legally available therefore under the laws of the Commonwealth of Pennsylvania. Under the Pennsylvania Banking Code of 1965, funds available for cash dividend payments by a bank are restricted to accumulated net earnings and if the surplus of a bank is less than the amount of its capital, the bank shall, until surplus is equal to such amount, transfer to surplus an amount which is at least 10% of its net earnings for the period since the end of the last fiscal year or any shorter period since the declaration of a dividend. If the surplus of a bank is less than 50% of the amount of its capital, no dividend may be declared or paid by the bank without prior approval of the Secretary of Banking of the Commonwealth of Pennsylvania. Under the Federal Reserve Act, if a bank has sustained losses up to or exceeding its undivided profits, no dividend shall be paid, and no dividends can ever be paid in an amount greater than such bank's net profits less losses and bad debts. Cash dividends must be approved by the Federal Reserve Board if the total of all cash dividends declared by a bank in any calendar year, including the proposed cash dividend, exceeds the total of the bank's net profits for that year plus its retained net profits from the preceding two years, less any required transfers to surplus or to a fund for the retirement of preferred stock. Under the Federal Reserve Act, the Board has the power to prohibit the payment of cash dividends by a bank if it determines that such a payment would be an unsafe or unsound banking practice. The Federal Deposit Insurance Act generally prohibits all payments of dividends by a bank, which is in default of any assessment to the Federal Deposit Insurance Corporation. Item 3. Defaults Upon Senior Securities. (a) There has been no material default in the payment of principal, interest, a sinking or purchase fund installment, or any material default with respect to any indebtedness of the Registrant exceeding five percent of the total assets of the Registrant. (b) There have been no material arrearage or delinquencies as discussed in Item 3(a). Registrant has declared and issued a Series A Preferred Stock. No obligations pursuant to those securities have become due. 24 Item 4. Submission of Matters to a Vote of Security Holders. None Item 5. Other Information. None Item 6. Exhibits and Reports on Form 8-K a) Exhibits. Exhibit 31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 32.1 is the Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 32.2 is the Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. b) Reports on Form 8-K No Reports on Form 8-K were filed by the Company during the quarter ended September 30, 2003. 25 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. UNITED BANCSHARES, INC. Date: November 14, 2003 /s/ Evelyn F. Smalls --------------------------------- Evelyn F. Smalls President & CEO /s/ Brenda M. Hudson-Nelson --------------------------------- Brenda M. Hudson-Nelson EVP/Chief Financial Officer 26 EX-31 3 ex31_1.txt Exhibit 31.1 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Evelyn F. Smalls, Chief Executive Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of United Bancshares, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a 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 quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly 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-15 (e) and 15d-15 (e)) for the registrant and we 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 quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report are 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; and 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 28 5. The registrant's other certifying officer(s) 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 registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control 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/ Evelyn F. Smalls - ----------------------------- Evelyn F. Smalls Chief Executive Officer November 14, 2003 EX-31 4 ex31_2.txt Exhibit 31.2 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Brenda M. Hudson-Nelson, Chief Financial Officer, certify that: 1. I have reviewed this quarterly report on Form 10-Q of United Bancshares, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a 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 quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly 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 quarterly 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-15 (e) and 15d-15 (e)) for the registrant and we 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 quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report are 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; and 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 5. The registrant's other certifying officer(s) 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 registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies and material weaknesses in the design or operation of internal control 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/ Brenda M. Hudson-Nelson - ----------------------------- Brenda M. Hudson-Nelson Chief Financial Officer November 14, 2003 31 EX-32 5 ex32_1.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. -------------- FORM 10-Q -------------- (Mark One) _X_ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003 OR ___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ TO _____________ UNITED BANCSHARES, INC. ---------------------- (Exact name of registrant as specified in its charter) 0-25976 ---------------------- Commission File Number Pennsylvania 23-2802415 ---------------------- ---------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 300 North 3rd Street, Philadelphia, PA 19106 -------------------------------------- ------------- (Address of principal executive office) (Zip Code) (215) 351-4600 ---------------- (Registrant's telephone number, including area code) N/A ---------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether 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 twelve months (or such shorter period that the registrant was required to filed such reports), and (2) has been subject to such filing requirements for the past 90 day. Yes _X_ No ____ Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12b2 of the Act) Yes_____ No___X___ Applicable only to issuers involved in bankruptcy proceedings during the preceding five years: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes _____ No _____ Applicable only to corporate issuers: Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. Registrant has two classes of capital stock authorized - 2,000,000 shares of $.01 par value Common Stock and 500,000 shares of Series A Preferred Stock. The Board of Directors designated a subclass of the common stock, designated Class B Common Stock, by filing of Articles of Amendment on September 30, 1998. This Class of stock has all of the rights and privileges of Common Stock with the exception of voting. Of the 2,000,000 shares of Common Stock authorized, 250,000 have been designated Class B Common Stock. As of November 3, 2003 1,067,082(including191,667 Class B Non voting) shares were issued and outstanding and 33,500 shares were held as Treasury Stock. The Board of Directors of United Bancshares, Inc. authorized 500,000 shares of one series of the Series A Preferred Stock of which 143,150 shares were outstanding and 6,308 shares were held as Treasury Stock as of November 3, 2003. FORM 10-Q Index Item No. Page ------- ---- PART I 1. Financial Statements.............................................. 3 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................ 9 3. Quantitative and Qualitative Disclosures about Market Risk......... 24 4. Controls and Procedures ........................................... 26 PART II 1. Legal Proceedings.................................................. 26 2. Working Capital Restrictions on the Payment of Dividends........... 26 3. Defaults upon Senior Securities.................................... 27 4. Submission of Matters to a Vote of Security Holders................ 27 5. Other Information.................................................. 27 6. Exhibits and Reports on Form 8K.................................... 22 2 Item 1. Financial Statements Consolidated Balance Sheets (unaudited)
Sept 30, December 31, 2003 2002 ---------- ------------ Assets Cash and due from banks 6,151,507 4,541,667 Interest bearing deposits with banks 872,081 865,421 Federal funds sold 4,701,000 10,122,000 ---------- ---------- Cash & cash equivalents 11,724,588 15,529,088 Investment securities: Held-to-maturity, at amortized cost, market value $5,776,783 5,704,238 7,183,403 Available-for-sale, at market value 8,870,850 14,334,360 Loans, net of unearned discount 47,041,527 44,133,190 Less: allowance for loan losses (750,543) (674,550) ---------- ---------- Net loans 46,290,984 43,458,640 Bank premises & equipment, net 2,814,874 2,612,608 Accrued interest receivable 488,459 555,006 Core deposit intangible 1,782,955 1,937,221 Prepaid expenses and other assets 431,962 433,793 ---------- ---------- Total Assets 78,108,910 86,044,119 ========== ========== Liabilities & Shareholders' Equity Demand deposits, non-interest bearing 16,008,043 20,453,455 Demand deposits, interest bearing 12,474,004 12,837,464 Savings deposits 19,530,720 20,494,208 Time deposits, $100,000 and over 10,595,554 10,882,722 Time deposits 11,188,837 12,261,455 ---------- ---------- Total Deposits 69,797,158 76,929,304 Accrued interest payable 102,875 156,219 Accrued expenses and other liabilities 482,563 458,455 ---------- ---------- Total Liabilities 70,382,596 77,543,978 Shareholders' equity: Preferred Stock, Series A, non-cum., 6%, $.01 par value, 500,000 shrs auth., 143,150 issued and outstanding 1,432 1,432 Common stock, $.01 par value; 2,000,000 shares authorized; 1,068,588 shares issued and outstanding at Sept 30, 2003 and 1,102,088 at December 31, 2002, respectively 10,686 11,021 Treasury Stock, 33,500 shares at September 30, 2003 0 0 Additional-paid-in-capital 14,749,789 14,749,454 Accumulated deficit (7,133,970) (6,499,197) Net unrealized gain on available-for-sale securities 98,377 237,432 ---------- ---------- Total Shareholders' equity 7,726,314 8,500,141 ---------- ---------- 78,108,910 86,044,119 ========== ==========
See Accompanying Notes 3 Consolidated Statements of Income (unaudited)
Quarter ended Quarter ended Nine months ended Nine months ended September 30, September 30, September 30, September 30, 2003 2002 2003 2002 ------------- ------------- ----------------- ----------------- Interest Income: Interest and fees on loans 737,618 757,472 2,193,785 2,223,101 Interest on investment securities 162,815 360,804 628,645 1,139,588 Interest on Federal Funds sold 19,391 35,489 84,719 133,080 Interest on time deposits with other banks 5,752 3,851 16,707 7,018 --------- --------- --------- ---------- Total interest income 925,576 1,157,616 2,923,856 3,502,787 Interest Expense: Interest on time deposits 88,185 144,824 291,205 521,661 Interest on demand deposits 21,046 30,642 67,304 85,669 Interest on savings deposits 19,180 32,307 72,512 98,232 --------- --------- --------- ---------- Total interest expense 128,411 207,773 431,021 705,562 Net interest income 797,165 949,843 2,492,835 2,797,225 Provision for loan losses 60,000 37,500 180,000 112,500 --------- --------- --------- ---------- Net interest income less provision for loan losses 737,165 912,343 2,312,835 2,684,725 --------- --------- --------- ---------- Noninterest income: Customer service fees 409,851 474,468 1,241,320 1,448,102 Realized gain (loss) on investments 675 0 675 25,789 Other income 51,560 285,178 91,962 361,569 --------- --------- --------- --------- Total noninterest income 462,086 759,646 1,333,957 1,835,460 Non-interest expense Salaries, wages, and employee benefits 543,555 582,855 1,670,834 1,825,677 Occupancy and equipment 327,362 308,294 934,865 1,011,439 Office operations and supplies 116,906 107,332 341,223 322,579 Marketing and public relations 31,875 18,111 75,593 44,975 Professional services 46,784 73,917 150,318 186,533 Data processing 169,532 157,114 486,118 463,702 Deposit insurance assessments 8,187 8,831 25,370 27,425 Other noninterest expense 208,558 230,758 597,243 732,663 --------- --------- --------- --------- Total non-interest expense 1,452,759 1,487,212 4,281,564 4,614,993 --------- --------- --------- --------- Net income (loss) ($253,508) $ 184,777 ($634,772) ($94,808) ========= ========= ========= ========= Earnings per share-basic ($0.23) $0.17 ($0.58) ($0.09) Earnings per share-diluted ($0.23) $0.17 ($0.58) ($0.09) ========= ========= ========= ========= Weighted average number of shares 1,090,141 1,100,582 1,090,141 1,100,582 ========= ========= ========= =========
See Accompanying Notes 4 Statement of Cash Flows (unaudited)
Nine Months ended Nine Months ended September September 2003 2002 ------------------ ----------------- Cash flows from operating activities: Net loss ($634,772) (94,808) Adjustments to reconcile net loss to net cash used in operating activities: Provision for loan losses 180,000 112,500 Gain on sale of fixed assets 0 (39,753) Depreciation and amortization 504,036 523,025 Decrease (increase) in accrued interest receivable and other assets 68,378 124,896 Increase (decrease) in accrued interest payable and other liabilites (29,235) (172,555) ---------- ---------- Net cash used in operating activities 88,407 453,305 Cash flows from investing activities: Purchase of investments-Available-for-Sale (2,032,133) (7,790,823) Purchase of investments-Held-to Maturity (2,012,482) (500,000) Proceeds from maturity & principal reductions of investments-Available-for-Sale 7,336,661 7,942,140 Proceeds from maturity & principal reductions of investments-Held-to-Maturity 3,481,120 3,415,715 Proceeds from sale of investments-Available-for-Sale 0 1,091,063 Net (increase) decrease in loans (3,012,344) (1,462,585) Purchase of premises and equipment (521,582) (162,205) Sale of premises and equipment 0 110,000 ---------- ---------- Net cash provided by investing activities 3,239,240 2,643,305 Cash flows from financing activities Net increase (decrease) in deposits (7,132,146) (1,810,900) Net proceeds from issuance of common stock 0 20,400 ---------- ---------- Net cash used in financing activities (7,132,146) (1,790,500) Increase in cash and cash equivalents (3,804,499) 1,306,110 Cash and cash equivalents at beginning of period 15,529,088 13,781,978 Cash and cash equivalents at end of period 11,724,589 15,088,088 ========== ========== Supplemental disclosures of cash flow information Cash paid during the period for interest 387,505 611,066 ========== ========== Write-down of cumulative effect of change in method of accounting for invesment securities
See Accompanying Notes 5 NOTES TO FINANCIAL STATEMENTS 1. General United Bancshares, Inc. (the "Company") is a bank holding company registered under the Bank Holding Company Act of 1956. The Company's principal activity is the ownership and management of its wholly owned subsidiary, United Bank of Philadelphia (the "Bank"). During interim periods, the Company follows the accounting policies set forth in its Annual Report on Form 10-K filed with the Securities and Exchange Commission. Readers are encouraged to refer to the Company's Form 10-K for the fiscal year ended December 31, 2002 when reviewing this Form 10-Q. Quarterly results reported herein are not necessarily indicative of results to be expected for other quarters. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring adjustments) considered necessary to present fairly the Company's consolidated financial position as of September 30, 2003 and December 31, 2002 and the consolidated results of its operations for the nine month period ended September 30, 2003 and 2002, and its consolidated stockholders' equity for the nine month period ended September 30, 2003, and its consolidated cash flows for the nine month period ended September 30, 2003 and 2002. 2. Stock-based Compensation At September 30, 2003, the Bank had one stock-based employee compensation plan. The Bank accounts for that plan under the recognition and measurement principles of APB 25, "Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation costs is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table provides the disclosures required by SFAS No. 148 and illustrates the effect on net income and earnings per share if the Corporation had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation. (in 000's)
September 30, 2003 December 31, 2002 ------------------ ----------------- Net income (in thousands) As reported ($ 634) ($ 217) Stock-based compensation costs determined under fair value method for all awards $ - $ - -------- -------- Pro forma ($ 634) ($ 217) Earnings per share (Basic) As reported ($ 0.58) ($ 0.23) Pro forma ($ 0.58) ($ 0.23) Earnings per share (Diluted) As reported ($ 0.58) ($ 0.23) Pro forma ($ 0.58) ($ 0.23)
There were no options granted in 2003 and 2002. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Because the Company is a bank holding company for the Bank, the financial statements in this report are prepared on a consolidated basis to include the accounts of the Company and the Bank. The purpose of this discussion is to focus on information about the Bank's financial condition and results of operations, which is not otherwise apparent from the consolidated financial statements included in this quarterly report. This discussion and analysis should be read in conjunction with the financial statements presented elsewhere in this report. Critical Accounting Policies Allowance for Credit Losses The Bank considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The balance in the allowance for loan losses is determined based on management's review and evaluation of the loan portfolio in relation to past loss experience, the size and composition of the portfolio, current economic events and conditions, and other pertinent factors, including management's assumptions as to future delinquencies, recoveries and losses. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management's estimates, additional provisions for loan losses may be required that would adversely impact earnings in future periods. Income Taxes Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities. Deferred tax assets are subject to management's judgment based upon available evidence that future realization is more likely than not. For financial reporting purposes, a valuation allowance of 100% of the deferred tax asset has been recognized to offset the deferred tax assets related to cumulative temporary differences and tax loss carryforwards. If management determines that the Bank may be able to realize all or part of the deferred tax asset in the future, a credit to income tax expense may be required to increase the recorded value of net deferred tax asset to the expected realizable amount. Selected Financial Data The following table sets forth selected financial data for the each of the following periods: (Thousands of dollars, except per share data) Quarter ended Quarter ended September 30, September 30, 2003 2002 ------------- ------------- Net interest income $ 797 $ 950 Provision for loan losses 60 37 Noninterest income 462 760 Noninterest expense 1,453 1,487 Net income (loss) (254) 185 Earnings (loss) per share-basic and diluted ($0.23) $0.17 7 September 30, December 31, 2003 2002 ------------- ------------- Balance sheet totals: Total assets $78,108 $86,044 Loans, net $46,290 $43,459 Investment securities $14,575 $21,518 Deposits $69,797 $76,929 Shareholders' equity $ 7,726 $ 8,500 Ratios Return on assets(1) (0.79)% (0.25)% Return on equity(1) (9.74)% (2.55)% Equity to assets ratio 7.41% 7.45% (1) Not annualized Financial Condition Sources and Uses of Funds The financial condition of the Bank can be evaluated in terms of trends in its sources and uses of funds. The comparison of average balances in the following table indicates how the Bank has managed these elements. Average funding sources increased approximately $3.3 million, or 4.42%, during the quarter ending September 30, 2003. Average funding uses decreased $4.1 million, or 5.48%, for the same quarter. Sources and Uses of Funds Trends
September 30, 2003 June 30, 2003 ------------------ ------------- (Thousands of Dollars, except percentages) Average Increase (Decrease) Average ------- ------------------- ------- Balance Amount % Balance ------- ------- ------- ------- Funding uses: Loans $47,969 $5,344 12.54 $42,625 Investment securities Held-to-maturity 5,927 (240) (3.89) 6,167 Available-for-sale 8,918 (1,801) (16.80) 10,719 Federal funds sold 7,667 (6,559) (46.11) 14,226 ------ ------- ------- Total uses $70,481 (3,256) $73,737 ======= ======= ======= Funding sources: Demand deposits Noninterest-bearing $17,046 (2,882) (14.46) $19,928 Interest-bearing 12,152 183 1.53 11,969 Savings deposits 20,138 (568) (2.74) 20,706 Time deposits 22,221 (878) (3.80) 23,099 ------- ------- ------- Total sources $71,557 (4,145) $75,702 ======= ======= =======
Loans Average loans increased approximately $5.3 million, or 12.54%, during the quarter ended September 30, 2003. The increase is primarily the result of the purchase of approximately $4.8 million adjustable rate residential mortgage loans in late June 2003. This purchase was made to supplement the Bank's residential loan portfolio that had declined because of high refinancing activity as a result of the historically low interest rate environment. In addition, the Bank has equipped itself with resources (i.e. hiring an experienced mortgage loan officer, renewing its seller/servicer relationship with FannieMae, etc.) to become a competitive player in the mortgage loan origination market to reduce the level of payoffs and to generate a new source of fee income. 8 The Bank continues to cultivate relationships with other financial institutions in the region with which it participates in loans as a strategy to stabilize and grow its commercial loan portfolio. This strategy is utilized as a low cost means to build the Bank's pool of earning assets while it enhances its own business development capacity. During the quarter ended September 30, 2003, the Bank booked $1.4 million in new loan participations. Most of these participations are secured by commercial real estate. The Bank's loan-to-deposit ratio at September 30, 2003 was 67.40%, compared to 63.39% at June 30, 2003. The increase during the quarter is primarily a result of a smaller deposit base as well as commercial loan participations. The target loan-to-deposit ratio is 75%. This level would allow the Bank to optimize interest income on earning assets while maintaining adequate liquidity. Management will continue to implement loan growth strategies including the purchase of additional commercial loan participations and the origination of small business loans, mortgage loans and consumer loans including home equity, automobile, student and credit card loans. Because of the purchase of loan participations, the Bank's loan portfolio is heavily concentrated in commercial real estate loans that now comprise $13.0 million, or 27.7%, of total loans. Although paydowns continue, the purchase of $4.8 million adjustable rate residential mortgage loans in late June 2003 resulted in an increase in this component of the portfolio to $15.6 million, or 33.18% of the portfolio, at September 30, 2003. The following table shows the composition of the loan portfolio of the Bank by type of loan. (Thousands of Dollars) September 30, December 31, 2003 2002 ------------ ----------- Commercial and industrial $10,269 $10,855 Commercial real estate 13,035 11,898 Consumer loans 8,126 7,820 Residential mortgages 15,611 13,560 ------- ------- Total Loans $47,041 $44,133 ======= ======= Allowance for Loan Losses The allowance for loan losses reflects management's continuing evaluation of the loan portfolio, the diversification and size of the portfolio, and adequacy of collateral. The following factors are considered in determining the adequacy of the allowance for loan losses: levels and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volumes and terms of loans, effects of any changes in risk selection and underwriting standards, and other changes in lending policies, procedures and practices; experience, ability, and depth of lending management and relevant staff; national and local economic conditions; industry conditions; and effects of changes in credit concentrations. The following Table presents an analysis of the allowance for loan losses. 9 ANALYSIS OF ALLOWANCE FOR LOAN LOSSES (Dollars in thousands) Balance at January 1, 2003 $ 675 ----- Charge-offs: Commercial loans 89 Consumer loans 61 ----- Total charge-offs 150 ===== Recoveries 46 Net (charge-offs) recoveries (104) Additions charged to operations 180 ----- Balance at September 30, 2003 751 ===== The allowance for loan losses as a percentage of total loans was 1.60% at September 30, 2003 compared to 1.42% at June 30, 2003. The increase in this ratio is due to loan loss provisions of $60 thousand made during the quarter. The economy has been in recession for the last three years. Although, some sectors of the economy now seem poised for growth, economic instability persists. Because the impact on the borrowers may lag the current economic conditions, the Bank proactively monitors its credit quality while working with borrowers in an effort to identify and control credit risk. At September 30, 2003, the Bank's classified loans totaled $1.8 million, or 3.73% of total loans--relatively unchanged from the quarter ending June 30, 2003. Specific reserves totaling $669 thousand have been allocated to the Bank's classified loans. Approximately $357 thousand of this reserve is allocated to one loan for which full collectibility is uncertain. (Refer to Nonperforming and Nonaccrual Loans below for further discussion on this loan.) While management uses available information to recognize losses on loans, future additions may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments of information available to them at the time of the examination. Management believes the level of the allowance for loan losses is adequate as of September 30, 2003. Nonperforming and Nonaccrual Loans The Bank generally determines a loan to be "nonperforming" when interest or principal is past due 90 days or more. If it otherwise appears doubtful that the loan will be repaid, management may consider the loan to be "nonperforming" before the lapse of 90 days. The policy of the Bank is to charge-off unsecured loans after 90 days past due. Interest on "nonperforming" loans ceases to accrue except for loans that are well collateralized and in the process of collection. When a loan is placed on non-accrual, previously accrued and unpaid interest is generally reversed out of income unless adequate collateral from which to collect the principal of and interest on the loan appears to be available. At September 30, 2003, non-accrual loans were approximately $1.7 million--unchanged from June 30, 2003. A significant amount of the non-accrual loans primarily relate to one borrower with loans totaling $1.3 million (discussed below) that were placed on non-accrual in January 2003. Approximately $769 thousand of the Bank's non-accrual loans are guaranteed by the Small Business Administration. 10 The Bank has one borrower in the telecommunications industry with loans totaling approximately $1.3 million that is experiencing severe financial difficulty. Guarantees from the Small Business Administration (SBA) reduce the Bank's exposure to approximately $714 thousand. A specific reserve of $357 thousand has been allocated to this loan to cover potential losses. This loan has been modified to provide for a moratorium on principal payments until January 2004. The borrower is currently not in compliance with the modified terms of the agreement. Management is working with its legal counsel and the borrower to negotiate a new strategy that may include a new forbearance agreement and a lockbox agreement. Management continues to assess the likelihood of collection of this loan and the Bank's potential exposure. There is no other known information about possible credit problems other than those classified as nonaccrual that causes management to be uncertain as to the ability of any borrower to comply with present loan terms. The Bank grants commercial, residential and consumer loans to customers primarily located in Philadelphia County, Pennsylvania and surrounding counties in the Delaware Valley. From time to time, the Bank purchases loans from other financial institutions. These loans are generally located in the Northeast corridor of the United States. Although the Bank has a diversified loan portfolio, its debtors' ability to honor their contracts is influenced by the region's economy. At September 30, 2003, approximately 16% of the Bank's commercial loan portfolio was concentrated in loans made to religious organizations. From inception, the Bank has received support in the form of investments and deposits and has developed strong relationships with the Philadelphia region's religious community. Loans made to these organizations were primarily for expansion and repair of church facilities. Investment Securities and other short-term investments Investment securities, including Federal Funds Sold, decreased on average by $8.6 million, or 15.89%, during the quarter ended September 30, 2003. This decrease is due to the use of funds to purchase $4.8 million in residential mortgage loans in June 2003. In addition, the Bank had less investable funds resulting from a $4.1 million decline in deposits during the quarter because of a shift in deposits of a large quasi-local government entity. Whether these deposits will be replaced remains questionable. The Bank's current investment portfolio primarily consists of mortgage-backed pass-through agency securities, and other government-sponsored agency securities. The Bank does not invest in high-risk securities or complex structured notes. The yield on the portfolio is 4.93% at September 30, 2003 compared with 4.99% at June 30, 2003. The average duration of the portfolio is 2.10 years. In the current low interest rate environment, the duration of the investment portfolio is significantly shortened because of the level of fixed rate mortgage backed securities that comprised 40.7% of the total portfolio at September 30, 2003. Because customers are more likely to refinance in a low interest rate environment, the prepayment speed increases on this component of the portfolio. The constant one year prepayment rate (CPR) at September 30, 2003 was 47.71 that translates into 47.7% of the mortgage pool repaying on an annual basis. This results in more liquidity and a lower yield on the investment portfolio. 11 As a result of calls over the last two years, callable agencies now comprise only 20.3% of the investment portfolio. There were no called securities during the quarter ended September 30, 2003. The Bank will continue to take steps to reduce the impact of the level of optionality in the portfolio by identifying replacement loans or securities that diversify risk and provide some level of monthly cashflow to be reinvested in the future rising rate environments. The Bank has implemented a strategy to invest funds in hybrid mortgage-backed securities that are fixed for three to ten years and then become adjustable with the current market conditions. These securities have average current yields of at least 4.00% and estimated durations of 5 years with monthly cashflow. Deposits The Bank has a relatively stable core deposit base representing 85% of total deposits. During the quarter ended September 30, 2003, average deposits decreased $4.1 million, or 5.48%. This decline is primarily because the shift in deposits totaling $3 million of a large quasi-local government entity. Whether these deposits will be replaced remains questionable. In addition, during the quarter, the Bank returned $800 thousand in unauthorized brokered deposits. It is the Bank's policy not to accept brokered deposits as they do not represent core deposits and are often very rate sensitive. Significant deposit growth is not projected because of the Bank's mandatory capital requirements outlined in its Written Agreement with its regulators (See Regulatory Matters below). Therefore, aggressive deposit retention or new business development strategies have not been implemented. Other Borrowed Funds The Bank did not borrow funds during the quarter ended September 30, 2003. Generally, the level of other borrowed funds is dependent on many items such as loan growth, deposit growth, customer collateral/security requirements and interest rates paid for these funds. The Bank's liquidity has been enhanced by loan paydowns/payoffs and called investment securities--thereby, eliminating the need to borrow. Commitments and Lines of Credit The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit, which are conditional commitments issued by the Bank to guarantee the performance of an obligation of a customer to a third party. Both arrangements have credit risk essentially the same as that involved in extending loans, and are subject to the Bank's normal credit policies. Collateral may be obtained based on management's assessment of the customer. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instruments is represented by the contractual amount of those instruments. 12 The Bank's financial instrument commitments at September 30, 2003 are summarized below: Commitments to extend credit $ 11,382,000 Outstanding letter of credit $ 57,000 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Management believes the Bank has adequate liquidity to support the funding of unused commitments. Liquidity and Interest Rate Sensitivity Management The primary functions of asset/liability management are to assure adequate liquidity and maintain appropriate balance between interest-sensitive earning assets and interest-bearing liabilities. Liquidity management involves the ability to meet cash flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. The Bank is required to maintain minimum levels of liquid assets as defined by Federal Reserve Board (the "FRB")regulations. This requirement is evaluated in relation to the composition and stability of deposits; the degree and trend of reliance on short-term, volatile sources of funds, including any undue reliance on particular segments of money market or brokered deposits; any difficulty in obtaining funds; and the liquidity provided by securities and other assets. In addition, consideration is given to the nature, volume and anticipated use of commitments; the adequacy of liquidity and funding policies and practices, including the provision for alternate sources of funds; and the nature and trend of off-balance-sheet activities. As of September 30, 2003, management believes the Bank's liquidity is satisfactory and in compliance with the FRB regulations The Bank's principal sources of asset liquidity include investment securities consisting principally of U.S. Government and agency issues, particularly those of shorter maturities, and mortgage-backed securities with monthly repayments of principal and interest. Other types of assets such as federal funds sold, as well as maturing loans, are sources of liquidity. Approximately $10.1 million in loans are scheduled to mature within one year. 13 By policy, the Bank's minimum level of liquidity is 6.00% of total assets. At September 30, 2003, the Bank has total short-term liquidity, including cash and federal funds sold, of $11.7 million, or 15% of total assets. Additional liquidity of approximately $8.9 million is provided by the Bank's investment portfolio classified as available-for-sale. The Bank's overall liquidity continues to be enhanced by a significant level of core deposits which management has determined are less sensitive to interest rate movements. The Bank continues to avoid reliance on large denomination time deposits. However, the Bank has one $5 million deposit with a government agency that matures in December 2003. While this is a short-term renewal, based on discussions with the customer, management does not anticipate the removal of this deposit in the near future. The following is a summary of the remaining maturities of time deposits of $100,000 or more outstanding at September 30, 2003: (Thousands of dollars) 3 months or less $ 6,093 Over 3 through 12 months 3,896 Over 1 through three years 607 Over three years -- -- ------- Total $10,596 ======= Capital Resources Total shareholders' equity decreased approximately $335 thousand during the quarter ended September 30, 2003. The decrease in equity was primarily due to a net loss of $254 thousand during the quarter and an $80 thousand decrease in other comprehensive income (FAS 115 unrealized gains on available-for-sale securities) because of interest rate changes that reduced the value of the investment portfolio. FRB standards for measuring capital adequacy for U.S. Banking organizations requires that banks maintain capital based on "risk-adjusted" assets so that categories of assets with potentially higher risk will require more capital backing than assets with lower risk. In addition, banks are required to maintain capital to support, on a risk-adjusted basis, certain off-balance-sheet activities such as loan commitments. The FRB standards classify capital into two tiers, referred to as Tier 1 and Tier 2. Tier 1 consists of common shareholders' equity, non-cumulative and cumulative perpetual preferred stock, and minority interests less goodwill. Tier 2 capital consists of allowance for loan losses, hybrid capital instruments, term-subordinated debt, and intermediate-term preferred stock. Banks are required to meet a minimum ratio of 8% of qualifying capital to risk-adjusted total assets with at least 4% Tier 1 capital ratio and a Tier I Leverage ratio of at least 6%. Capital that qualifies as Tier 2 capital is limited to 100% of Tier 1 capital. 14 As indicated in the table below, the Company's and the Bank's risk-based capital ratios are above the minimum requirements. (Refer to Regulatory Matters below for Written Agreement requirements) Management continues the objective of increasing capital by offering additional stock (preferred and common) for sale to knowledgeable investors on a limited offering basis. However, the focus continues to be on increasing the rate of internal capital growth as a means of maintaining the required capital ratios. The Company and the Bank do not anticipate paying dividends in the near future. Company Company September 30, December 31, 2003 2002 ------- ------- Total Capital $ 7,726 $ 8,500 Less: Intangible Asset/Net unrealized gains (losses) on available for sale portfolio (1,900) (2,174) ------- ------- Tier 1 Capital 5,826 6,326 ------- ------- Tier 2 Capital 530 528 ------- ------- Total Qualifying Capital $ 6,356 $ 6,854 ======= ======= Risk Adjusted Total Assets (including off- Balance sheet exposures) $42,184 $42,104 Tier 1 Risk-Based Capital Ratio 13.81% 15.02% Tier 2 Risk-Based Capital Ratio 15.07% 16.28% Leverage Ratio 7.38% 7.46% Bank Bank September 30, December 31, 2003 2002 ------- ------- Total Capital $7,437 $8,211 Less: Intangible Asset/Net unrealized gains (losses) on available for sale portfolio (1,900) (2,174) ------- ------- Tier 1 Capital 5,537 6,037 ------- ------- Tier 2 Capital 530 528 ------- ------- Total Qualifying Capital $6,067 $ 6,565 ====== ======= Risk Adjusted Total Assets (including off- Balance sheet exposures) $42,184 $42,104 Tier 1 Risk-Based Capital Ratio 13.13% 14.34% Tier 2 Risk-Based Capital Ratio 14.38% 15.59% Leverage Ratio 7.01% 7.12% Results of Operations Summary The Bank had a net loss of approximately $254 thousand ($0.23 per common share) for the quarter ended September 30, 2003 compared to net income of $185 thousand ($0.17 per common share) for the quarter ended September 30, 2002. . The financial results for the quarter ended September 30, 2002 were positively impacted by the award of a $198,000 grant from the U.S. Treasury Department's Bank Enterprise Award (BEA) Fund. These funds were awarded to financial institutions that demonstrate community development through loan and deposit activity. In 2003, the Bank did not apply for this grant. In addition, the financial results for 2003 were negatively impacted by the continued low interest rate environment and competitive market pressures that resulted in a decline in the Bank's net interest margin and noninterest income. 15 Revenue enhancement strategies continue to be implemented to generate expanded opportunities for fee income through the marketing of consumer loan products including residential mortgages, home equity, automobile, student, and credit card loans, and the installation of additional high volume automated teller machines (ATMs). However, A greater impact on profitability is expected to be realized with increased loan originations that build the Bank's loan-to-deposit ratio. Increased loan volume will result in a higher net interest margin and therefore increased revenues. To this end, management is focused on the implementation of business development strategies to increase the level of loans outstanding. Business development officers have been hired and a residential mortgage origination infrastructure has been put into place. In addition, to build momentum around business development and to generate interest and enthusiasm in the marketplace, management embarked on a re-branding campaign for the Bank. The campaign focuses on a re-introduction of the Bank and emphasizes its commitment to the community. This campaign includes among other things, in-branch marketing of the Bank's products and services and direct mail advertising/solicitation. A major emphasis has been placed on mortgage loan origination and the Bank's United Wealth Management Services Division, as a lead-in to cross-sell the Bank's other products and services. A more detailed explanation for each component of earnings is included in the sections below. Net Interest Income Net interest income is an effective measure of how well management has balanced the Bank's interest rate sensitive assets and liabilities. Net interest income, the difference between (a) interest and fees on interest earning assets and interest paid on interest-bearing liabilities, is a significant component of the earnings of the Bank. Changes in net interest income result primarily from increases or decreases in the average balances of interest earning assets, the availability of particular sources of funds and changes in prevailing interest rates. Net interest income declined $153 thousand, or 16.07% for the quarter ending September 30, 2003 compared to the quarter ending September 30, 2002. Much of this decline was experienced in the investment portfolio. The average balance of investment securities declined from $24.6 million at September 30, 2002 to $14.7 million at September 30, 2003, while the average yield decreased from 5.86% to 4.93% for the same period. During 2002, approximately $10.8 million higher yielding agency securities were called. In the current low interest rate environment, these funds were placed in lower yielding mortgage-backed securities or Federal Funds Sold. Strategies continue to be implemented to shift low yielding earning assets to higher yielding loan participations and investment securities including the purchase of hybrid adjustable rate securities with minimum yields of 4.00%. The Bank's cost of funds declined to .94% for the quarter ending September 30, 2003 compared to 1.43% for the same quarter in 2002. Consistent with current market conditions, the Bank reduced the rates it pays on many of its interest-bearing products. Because most of the Bank's deposits are considered core, they were not sensitive to declining rates. 16 The net interest margin of the Bank was 4.25% at September 30, 2003 compared to 4.63% at September 30, 2002. The decline is primarily related to calls of higher yielding investment securities over the last year. Management actively manages its exposure to interest rate changes. While the prime rate decreased 200 basis points over the last year, the Bank did not experience a similar decline in yield on its earning assets. This is because much of the Bank's loan portfolio is fixed rate in nature and not related to prime. In addition, 61% of the Bank's investment portfolio is fixed rate. These characteristics of the Bank's earning assets coupled with the Bank's significant level of core deposits resulted in less impact on the Bank's net interest margin during the declining rate environment. Provision for Loan Losses The provision is based on management's estimate of the amount needed to maintain an adequate allowance for loan losses. This estimate is based on the review of the loan portfolio, the level of net credit losses, past loan loss experience, the general economic outlook and other factors management feels are appropriate. The provision for loan losses charged against earnings for the quarter ending September 30, 2003 was $60 thousand compared to $37,500 for the same quarter in 2002. This increase in the provision was necessary because of an increase in classified loans for which specific reserves were provided. (Refer to Allowance for Loan Losses above for discussion on classified loans and specific reserves.) Management continues to closely monitor the portfolio for signs of weakness and will proactively make provisions to cover potential losses. During the current unstable economic environment, the Bank monitors its credit quality very closely by working with borrowers in an effort to identify and control credit risk. Systematic provisions are made to the allowance to cover potential losses related to the Bank's classified loans. Management believes the level of the allowance for loan losses is adequate as of September 30, 2003. Noninterest Income The amount of the Bank's noninterest income generally reflects the volume of the transactional and other accounts handled by the Bank and includes such fees and charges as low balance account charge, overdrafts, account analysis, and other customer service fees. Noninterest income for the quarter ended September 30, 2003 declined $298 thousand, or 39.17%, compared to the quarter ended September 30, 2002. The financial results for the quarter ended September 30, 2002 were positively impacted by the award of a $198,000 grant from the U.S. Treasury Department's Bank Enterprise Award (BEA) Fund. These funds were awarded to financial institutions that demonstrate community development through loan and deposit activity. Another large component of noninterest income, customer service fees, declined $65 thousand, or 13.62%, for the quarter ended September 30, 2003 compared to 2002. The decline was primarily because of a reduction in activity fees and dormancy fees on deposit accounts. More customers are avoiding service charges by keeping appropriate minimum balances. In addition, to avoid the necessity to escheat the balances of inactive customer accounts, the Bank made an extensive effort to contact these customers to re-activate their accounts. This resulted in a reduction in activity/dormant account service charges. 17 In addition, surcharge income on ATM's has declined. Some of the Bank's ATMs have experienced a drop in volume as competitors place machines in close proximity to existing high volume ATMs of the Bank. Management continues the process of identifying potentially high volume locations to place machines. Noninterest Expense Salaries and benefits expense decreased $39 thousand, or 6.74%, during the quarter ended September 30, 2003 compared to 2002. As part of its Profit Restoration Plan over the last year, the Bank made strategic reductions in staff, job consolidations, and reduced salaries for certain employees to lower the level of personnel expense. Management continues its review to ensure the Bank is operating with the most efficient organizational structure. Data processing expenses are a result of the management decision of the Bank to outsource a majority of its data processing operations to third party processors. Such expenses are reflective of the high level of accounts being serviced for which the Bank is charged a per account charge by processors. In addition, the Bank uses outside loan servicing companies to service its mortgage, credit card, installment and student loan portfolios. Data processing expenses increased approximately $12 thousand, or 7.90%, during the quarter ended September 30, 2003 compared to 2002. This increase is related to increased service activities provided by the Bank's new core data processor, FISERV. These services including statement rendering and research (imaging), were previously performed in-house. In November 2002, the Bank converted its core data processing to FISERV to achieve cost savings and create efficiencies to allow for further reductions in personnel expense. The Bank continues to study methods by which it may reduce its data processing costs, including but not limited to a consolidation of servicers and in-house loan servicing options. Occupancy expense increased approximately $19 thousand, or 6.19%, during the quarter ended September 30, 2003 compared to 2002. The increase is primarily attributable to the rising cost of utilities and other repairs and maintenance associated with the Bank's facilities. In August 2003, the Bank purchased its 38th and Lancaster Street Branch as a measure to reduce its occupancy expense. The projected annual savings on this transaction is $20,000. Professional services expense decreased approximately $27 thousand, or 36.71%, for the quarter ended September 30, 2003 compared to 2002. This decrease is primarily related to the final resolution of outstanding legal matters with W.T. Development and Monument Financial in 2002. In addition, the implementation of the Sarbanes Oxley Act in 2002 required increased legal involvement. 18 Office operations and supplies expense increased approximately $10 thousand, or 8.92%, for the quarter ended September 30, 2003 compared to 2002 . The increase is primarily related to additional security cost. With the new emphasis on Homeland Security, the Bank heightened its security coverage. The review of more cost-effective security measures is currently underway. Marketing and Public Relations expense increased $13 thousand, or 76%, for the quarter ended September 30, 2003 compared to 2002. In 2003, the Bank began a re-branding campaign that included, among other things, new brochures and in-branch signage. Federal deposit insurance premiums decreased by close to $1 thousand, or 7.29%, for the quarter ended September 30, 2003 compared to 2002. FDIC insurance premiums are applied to all financial institutions based on a risk based premium assessment system. Under this system, bank strength is based on three factors: 1) asset quality, 2) capital strength, and 3) management. Premium assessments are then assigned based on the institution's overall rating, with the stronger institutions paying lower rates. The Bank's assessment was based on 1.96 basis points for BIF (Bank Insurance Fund) assessable deposits and SAIF (Savings Insurance Fund) assessable deposits. The decrease during 2003, is a result of a reduction in the Bank's level of deposits as well as improvement in the Bank's risk rating. All other expenses are reflective of the general cost to do business and compete in the current regulatory environment and maintenance of adequate insurance coverage. The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148 "Accounting for Stock-Based Compensation--Transition and Disclosure" ("SFAS No. 148") in December 2002. SFAS No. 148 amends the disclosure and certain transition provisions of Statement of Financial Accounting Standards No. 123 "Accounting for Stock Based Compensation". The new disclosure provisions are effective for financial statements for fiscal years ending after December 15, 2002 and for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. Regulatory Matters In February 2000, as a result of a regulatory examination completed in December 1999, the Bank entered into a Written Agreement (herein sometimes referred to as the Agreement) with its primary regulators with regard to, among other things, achievement of agreed-upon capital levels, implementation of a viable earnings/strategic plan, adequate funding of the allowance for loan losses, the completion of a management review and succession plan, and improvement in internal controls. The Agreement requires the Bank to increase its capital ratio to 6.5% by June 30, 2000 and to 7% at all times thereafter. As of December 31, 2000, the Bank had met the required ratios by implementing strategies that included: reducing expenses, consolidating branches, and soliciting new and additional sources of capital. Management continues to address all matters outlined in the Agreement. Management believes that the Bank is "substantially" in compliance with the Agreement's terms and conditions. Failure to comply could result in additional regulatory supervision and/or actions. 19 At December 31, 2001, the Bank's tier one leverage capital ratio fell to 6.80% , below the 7% minimum capital ratio required by the Agreement. However, at December 31, 2002, the Tier I leverage ratio had improved to 7.12% as a result of the smaller average asset size of the Bank. At September 30, 2003, this ratio (currently 7.01%) continues to be above the required minimum due to the lower average asset size. Management continues to review and revise its capital plan to address the development of new equity---internal (retained earnings) and external (private limited sales of investment securities). Recent Accounting Pronouncements The Company adopted Statement of Financial Accounting Standard 149 (SFAS No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging Activities, on July 1, 2003. SFAS No. 149 clarifies and amends SFAS No. 133 for implementation issues raised by constituents or includes the conclusions reached by the FASB on certain FASB Staff Implementation Issues. Statement 149 also amends SFAS No. 133 to require a lender to account for loan commitments related to mortgage loans that will be held for sale as derivatives. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The Company periodically enters into commitments with its customers, which it intends to sell in the future. Management does not anticipate the adoption of SFAS No. 149 to have a material impact on the Company's financial position or results of operations. The FASB issued SFAS No.150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, on May 15, 2003. SFAS No. 150 changes the classification in the statement of financial position of certain common financial instruments from either equity or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in fair value or redemption amount, as applicable, in earnings. SFAS No. 150 is effective for public companies for financial instruments entered into or modified after May 31, 2003 and is effective at the beginning of the first interim period beginning after June 15, 2003. Management has not entered into any financial instruments that would qualify under SFAS No. 150. As a result, management does not anticipate the adoption of SFAS No. 150 to have a material impact on the Company's financial position or results of operations. The Company adopted FASB Interpretation ("FIN") 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others on January 1, 2003. FIN 45 requires a guarantor entity, at the inception of a guarantee covered by the measurement provisions of the interpretation, to record a liability for the fair value of the obligation undertaken in issuing the guarantee. The Company has financial and performance letters of credit. Financial letters of credit require the Company to make payment if the customer's financial condition deteriorates, as defined in the agreements. Performance letters of credit require the Company to make payments if the customer fails to perform certain non-financial contractual obligation. The Company previously did not record a liability when guaranteeing obligations unless it became probable that the Company would have to perform under the guarantee. FIN 45 applies prospectively to guarantees the Company issues or modifies subsequent to December 31, 2002. At September 30, 2003, the Company was contingently liable on financial and performance standby letters of credit totaling $57,000, none of which were originated in the first six months of this year. The Company's commitments under standby letters of credit expire at various dates through June 2004. The Bank generally holds collateral and/or obtains personal guarantees supporting these commitments. In the event that the Bank is required to fulfill its contingent liability under a standby letter of credit, it could liquidate the collateral held, if any, and enforce the personal guarantee(s) held, if any, to recover all or a portion of the amount paid under the letter of credit. 20 In January 2003, the FASB issued FASB Interpretation 46 ("FIN 46"), Consolidation of Variable Interest Entities. FIN 46 clarifies the application of Accounting Research Bulletin 51, "Consolidated Financial Statements," for certain entities that do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest ("variable interest entities"). Variable interest entities within the scope of FIN 46 will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity's expected losses, receives a majority of its expected returns, or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. The Company is in the process of determining what impact, if any, the adoption of the provisions of FIN 46 will have upon its financial condition or results of operations. The Company does not anticipate FIN 46 to have a material impact on its consolidated financial position and results of operations. In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or Certain Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with the evidence of deterioration of credit quality since origination acquired by completion of a transfer for which it is probable at acquisition, that the Company will be unable to collect all contractually required payments receivable. SOP 03-3 requires that the Company recognize the excess of all cash flows expected at acquisition over the investor's initial investment in the loan as interest income on a level-yield basis over the life of the loan as the accretable yield. The loan's contractual required payments receivable in excess of the amount of its cash flows excepted at acquisition (nonaccretable difference) should not be recognized as an adjustment to yield, a loss accrual or a valuation allowance for credit risk. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 31, 2004. Early adoption is permitted. Management is currently evaluating the provisions of SOP 03-3. Cautionary Notice Regarding Forward Looking Statements Certain of the matters discussed in this document including matters discussed under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" may constitute forward looking statements for the purposes of the Securities Act of 1933, as amended and the Securities Exchange Act of 1934, as amended, and may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of United Bancshares, Inc ("UBS") to be materially different from future results, performance or achievements expressed or implied by such forward looking statements. The words "expect," "anticipate," "intended," "plan," "believe," "seek," "estimate," and similar expressions are intended to identify such forward-looking statements. UBS' actual results may differ materially from the results anticipated by the forward-looking statements due to a variety of factors, including without limitation: (a) the effects of future economic conditions on UBS and its customers including economic factors which affect consumer confidence in the securities markets, wealth creation, investment and consumer saving patterns; (b) UBS interest rate risk exposure and credit risk; (c) changes in the securities markets with respect to the market values of financial assets and the stability of particular securities markets; (d) governmental monetary and fiscal policies, as well as legislation and regulatory changes; (e) changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral and securities, as well as interest-rate risks; (f) changes in accounting requirements or interpretations; (g) the effects of competition from other commercial banks, thrifts, mortgage companies, consumer finance companies, credit unions securities brokerage firms, insurance company's, money-market and mutual funds and other financial institutions operating in the UBS' trade market area and elsewhere including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the internet; (h) any extraordinary events (such as the September 11, 2001 events and the U.S. Government's response to those events or the U.S. Government becoming involved in a conflict in a foreign country; (i) the failure of assumptions underlying the establishment of reserves for loan losses and estimates in the value of collateral, and various financial assets and liabilities and technological changes being more difficult or expensive than anticipated; (j) UBS' success in generating new business in its existing markets, as well as its success in identifying and penetrating targeted markets and generating a profit in those markets in a reasonable time; (k) UBS' timely development of competitive new products and services in a changing environment and the acceptance of such products and services by customers; and (l) UBS' success in managing the risks involved in the foregoing. 21 All written or oral forward-looking statements attributed to UBS are expressly qualified in their entirety by use of the foregoing cautionary statements. All forward-looking statements included in this Report are based upon information presently available, and UBS assumes no obligation to update any forward-looking statement. Item 3. Quantitative and Qualitative Disclosures about Market Risk Interest rate sensitivity varies with different types of interest-earning assets and interest-bearing liabilities. Overnight federal funds on which rates change daily and loans which are tied to prime or other short term indices differ considerably from long-term investment securities and fixed-rate loans. Similarly, time deposits are much more interest sensitive than passbook savings accounts. The shorter-term interest rate sensitivities are key to measuring the interest sensitivity gap, or excess earning assets over interest-bearing liabilities. Management of interest sensitivity involves matching repricing dates of interest-earning assets with interest-bearing liabilities in a manner designed to optimize net interest income within the limits imposed by regulatory authorities, liquidity determinations and capital considerations. At September 30, 2003, a liability sensitive position is maintained on a cumulative basis through 1 year of 4.12% that is within the Bank's policy guidelines of +/- 15% on a cumulative 1-year basis. The current gap position is primarily due to the recent purchase of hybrid mortgage product that are fixed for three to seven years and then begin floating with Treasury yields or LIBOR. This position is somewhat mitigated by the significant level of core deposits which have very little rate sensitivity. Generally, because of the negative gap position of the Bank in shorter time frames, the Bank can anticipate that increases in market rates will have a negative impact on the net interest income, while decreases will have the opposite effect. While using the interest sensitivity gap analysis is a useful management tool as it considers the quantity of assets and liabilities subject to repricing in a given time period, it does not consider the relative sensitivity to market interest rate changes that are characteristic of various interest rate-sensitive assets and liabilities. Consequently, although the Bank currently has a negative gap position because of unequal sensitivity of these assets and liabilities, management believes this position will not materially impact earnings in a changing rate environment. For example, changes in the prime rate on variable commercial loans may not result in an equal change in the rate of money market deposits or short-term certificates of deposit. A simulation model is therefore used to estimate the impact of various changes, both upward and downward, in market interest rates and volumes of assets and liabilities on the net income of the Bank. This model produces an interest rate exposure report that forecast changes in the market value of portfolio equity under alternative interest rate environments. The market value of portfolio equity is defined as the present value of the Company's existing assets, liabilities and off-balance-sheet instruments. The calculated estimates of changes in market value of equity at September 30, 2003 are as follows: Market value of equity Changes in rate Market value of equity as a % of MV of Assets ------------------- ------------------------- ---------------------- (Dollars in thousands) +400 basis points $1,159 1.65% +300 basis points 2,450 3.40 +200 basis points 3,991 5.39 +100 basis points 5,262 6.94 Flat rate 6,617 8.52 -100 basis points 8,033 10.10 -200 basis points 9,465 11.62 -300 basis points 10,452 12.61 -400 basis points 11,359 13.48 22 The market value of equity may be impacted by the composition of the Bank's assets and liabilities. A shift in the level of variable versus fixed rate assets will create swings in the market value of equity. The Bank's market value of equity declines in a rising rate environment because of the high level of fixed rate loans the it has in its portfolio. The assumptions used in evaluating the vulnerability of the Company's earnings and capital to changes in interest rates are based on management's consideration of past experience, current position and anticipated future economic conditions. The interest sensitivity of the Company's assets and liabilities, as well as the estimated effect of changes in interest rates on the market value of portfolio equity, could vary substantially if different assumptions are used or actual experience differs from the assumptions on which the calculations were based. The Board of Directors of the Bank and management consider all of the relevant factors and conditions in the asset/liability planning process. Interest-rate exposure is not considered significant and is within the policy limits of the Bank at September 30, 2003. However, if significant interest rate risk arises, the Board of Directors and management may take (but are not limited to) one or all of the following steps to reposition the balance sheet as appropriate: 1. Limit jumbo certificates of deposit (CDs) and movement into money market deposit accounts and short-term CDs through pricing and other marketing strategies. 2. Purchase quality loan participations with appropriate interest rate/gap match for the balance sheet of the Bank. 3. Restructure the investment portfolio of the Bank. The Board of Directors has determined that active supervision of the interest-rate spread between yield on earnings assets and cost of funds will decrease the vulnerability of the Bank to interest-rate cycles. Item 4 Controls and Procedures As of the end of the period covered by this report, the Company carried out an evaluation under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer, Evelyn F. Smalls, and Chief Financial Officer, Brenda M. Hudson-Nelson, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Exchange Act Rule 15(e). Based upon the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings. As of the date of this report, there have not been any significant changes in the Company's internal controls or in any other factors that could significantly affect those controls subsequent to the date of the evaluation. 23 PART II - OTHER INFORMATION Item 1. Legal Proceedings. No material claims have been instituted or threatened by or against Registrant or its affiliates other than in the ordinary course of business. Item 2. Restrictions on Payment of Dividends. The holders of the Common Stock are entitled to such dividends as may be declared by the Board of Directors out of funds legally available therefore under the laws of the Commonwealth of Pennsylvania. Under the Pennsylvania Banking Code of 1965, funds available for cash dividend payments by a bank are restricted to accumulated net earnings and if the surplus of a bank is less than the amount of its capital, the bank shall, until surplus is equal to such amount, transfer to surplus an amount which is at least 10% of its net earnings for the period since the end of the last fiscal year or any shorter period since the declaration of a dividend. If the surplus of a bank is less than 50% of the amount of its capital, no dividend may be declared or paid by the bank without prior approval of the Secretary of Banking of the Commonwealth of Pennsylvania. Under the Federal Reserve Act, if a bank has sustained losses up to or exceeding its undivided profits, no dividend shall be paid, and no dividends can ever be paid in an amount greater than such bank's net profits less losses and bad debts. Cash dividends must be approved by the Federal Reserve Board if the total of all cash dividends declared by a bank in any calendar year, including the proposed cash dividend, exceeds the total of the bank's net profits for that year plus its retained net profits from the preceding two years, less any required transfers to surplus or to a fund for the retirement of preferred stock. Under the Federal Reserve Act, the Board has the power to prohibit the payment of cash dividends by a bank if it determines that such a payment would be an unsafe or unsound banking practice. The Federal Deposit Insurance Act generally prohibits all payments of dividends by a bank, which is in default of any assessment to the Federal Deposit Insurance Corporation. Item 3. Defaults Upon Senior Securities. (a) There has been no material default in the payment of principal, interest, a sinking or purchase fund installment, or any material default with respect to any indebtedness of the Registrant exceeding five percent of the total assets of the Registrant. (b) There have been no material arrearage or delinquencies as discussed in Item 3(a). Registrant has declared and issued a Series A Preferred Stock. No obligations pursuant to those securities have become due. 24 Item 4. Submission of Matters to a Vote of Security Holders. None Item 5. Other Information. None Item 6. Exhibits and Reports on Form 8-K a) Exhibits. Exhibit 31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Exhibit 31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 32.1 is the Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Exhibit 32.2 is the Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. b) Reports on Form 8-K No Reports on Form 8-K were filed by the Company during the quarter ended September 30, 2003. 25 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. UNITED BANCSHARES, INC. Date: November 14, 2003 /s/ Evelyn F. Smalls --------------------------------- Evelyn F. Smalls President & CEO /s/ Brenda M. Hudson-Nelson --------------------------------- Brenda M. Hudson-Nelson EVP/Chief Financial Officer 26 EX-32 6 ex32_2.txt Exhibit 32.2 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 Quarterly Report of United Bancshares, Inc. (the "Company") on Form 10-Q for the period ending September 30, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Brenda M. Hudson-Nelson, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss.1350, as adopted pursuant to ss.906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge and belief: (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/ Brenda M. Hudson-Nelson - ----------------------------- Brenda M. Hudson-Nelson Chief Financial Officer November 14, 2003 -----END PRIVACY-ENHANCED MESSAGE-----