-----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, VeDK+idpTeeclgU+Lil/oxOLVkjGfuspOi9LT5waw5gbMgMSb4cmTtkBb0L+mpk3 RzxKxL116LXggg7qmo79+A== 0001010410-04-000002.txt : 20040330 0001010410-04-000002.hdr.sgml : 20040330 20040330171952 ACCESSION NUMBER: 0001010410-04-000002 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20031231 FILED AS OF DATE: 20040330 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-25976 FILM NUMBER: 04702573 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-K 1 ub_10k.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2003 UNITED BANCSHARES, INC. ------------------------------------------------------ (Exact name of registrant as specified in its charter) 0-25976 -------------------------- (Registrants' file number) Pennsylvania 23-2802415 ------------------------------- --------------------------- (State of other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 300 North Third Street, Philadelphia, Pennsylvania 19106 -------------------------------------------------- ---------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (215) 351-4600 Securities registered pursuant to Section 12(b)f of the Act: NONE Securities registered pursuant to Section 12(g)f of the Act: Common Stock, $.01 par value ---------------------------- (Title of Class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No ___ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ___ No [ X ] ================================================================================ United Bancshares, Inc. (sometimes herein also referred to as the "Company" or "UBS") has two classes of capital stock authorized - 2,000,000 shares of $.01 par value Common Stock and a Series Preferred Stock (Series A Preferred Stock). The Board of Directors designated a subclass of the common stock, Class B Common Stock, by filing of Articles of Amendment to its Articles of Incorporation on September 30, 1998. This Class B Common Stock has all of the rights and privileges of Common Stock with the exception of voting rights. Of the 2,000,000 shares of authorized Common Stock, 250,000 have been designated Class B Common Stock. There is no market for the Common Stock. None of the shares of the Registrant's stock was sold within 60 days of the filing of this Form 10-K. As of March 15, 2004 the aggregate number of the shares of the Registrant's Common Stock outstanding was 1,068,588 (including 191,667 Class B non-voting). There are 33,500 shares of Common Stock held in treasury stock at March 15, 2004. The Series A Preferred Stock consists of 500,000 authorized shares of stock of which 136,842 shares are outstanding and 6,308 shares are held in treasury stock as of March 15, 2004. There are 75 pages in the Form 10-K. FORM 10-K United Bancshares, Inc. Index Item No. Page PART I 1. Business............................................................ 3 2. Properties..........................................................12 3. Legal Proceedings...................................................13 4. Submission of Matters to a Vote of Security Holders.................13 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters.......................................14 6. Selected Financial Data.............................................15 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.........................................15 7A. Quantitative and Qualitative Disclosures about Market Risk..........35 8. Financial Statements and Supplementary Data.........................35 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..............................................35 9A. Controls and Procedures.............................................36 PART III 10. Directors and Executive Officers of Registrant......................36 11. Executive Compensation..............................................41 12. Security Ownership of Certain Beneficial Owners and Management......43 13. Certain Relationships and Related Transactions......................43 14. Principal Accounting Fees and Services..............................43 PART IV 15. Exhibits, Financial Statements Schedules and Reports on Form 8-K....44 UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF MARCH 15, 2004. 2 PART I SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENT Certain of the matters discussed in this document and the documents incorporated by reference herein, 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. 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 1 -- BUSINESS United Bancshares, Inc. United Bancshares, Inc. ("Registrant" or "UBS") is a holding company for United Bank of Philadelphia (the "Bank"). UBS was incorporated under the laws of the Commonwealth of Pennsylvania on April 8, 1993. The Registrant became the Bank Holding Company of the Bank, pursuant to the Bank Holding Company Act of 1956, as amended, on October 14, 1994. The Bank commenced operations on March 23, 1992. UBS provides banking services through the Bank. The principal executive offices of UBS and the Bank are located at 300 North Third Street, Philadelphia, Pennsylvania 19106. The Registrant's telephone number is (215) 351-4600. As of March 15, 2004, UBS and the Bank had a total of 49 employees. 3 United Bank of Philadelphia United Bancshares, Inc. is an African American controlled and managed bank holding company for United Bank of Philadelphia (the "Bank"), a commercial bank chartered in 1992 by the Commonwealth of Pennsylvania, Department of Banking and a member of the Federal Reserve System. The deposits held by the Bank are insured by the Federal Deposit Insurance Corporation ("FDIC"). The Bank provides full service community banking in Philadelphia neighborhoods that are rich in diversity providing a market opportunity that includes men, women, families, small business owners, skilled laborers, professionals and many more who value home ownership and need banking services to help make their dreams come true. The Bank conducts all its banking activities through its four offices located as follows: (i) Center City Branch Two Penn Center, Philadelphia, Pennsylvania; (ii) West Philadelphia Branch 38th and Lancaster Avenue, Philadelphia, Pennsylvania, (iii) Mount Airy Branch 1620 Wadsworth Avenue, Philadelphia, Pennsylvania; and (iv) Progress Plaza Branch 1015 North Broad Street, Philadelphia, Pennsylvania. In January 2002, the Bank closed and consolidated its 714 Market Street Branch with its branch located at Two Penn Center to create operating efficiencies. Through its locations, the Bank offers a broad range of commercial and consumer banking services. At December 31, 2003, the Bank had total deposits aggregating approximately $67.1 million and had total net loans outstanding of approximately $46.7 million. Although the Bank's primary service area for Community Reinvestment Act purposes is Philadelphia County, it also services, generally, the Delaware Valley, which consists of portions of Montgomery, Bucks, Chester, and Delaware Counties in Pennsylvania; New Castle County in Delaware; and Camden, Burlington, and Gloucester Counties in New Jersey. The city of Philadelphia is comprised of 353 census tracts and, based on 2000 census data, 204 or 58% of these are designated as low to moderate-income tracts while 105 or 30% are characterized both as low to moderate-income and minority tracts. The Bank's primary service area consists of a population of 1,517,550, which includes a minority population of 752,309. United Bank of Philadelphia, while state chartered as a commercial bank, is uniquely structured to be a formidable player in providing retail services to its urban communities, while maintaining and establishing a solid portfolio of commercial relationships that include small businesses, churches and corporations. The Bank will take full advantage of its CDFI (community development financial institution) designation as established by the United States Department of Treasury. While the Bank's certification period was scheduled to end in January 2004, a recent review by the CDFI Fund has extended the Bank's certification period to June 2005. Among the greatest challenges facing inner city communities is their lack of stability and transience. Outside organizations and institutions that attempt to work within the community get frustrated and can leave at any time because they have no vested stake in the neighborhood. It is very easy for an organization without vested roots in the community to just pick up and leave, thus fostering lack of institutional consistency. The Bank represents consistency to these communities. The Bank takes its commitment to community development quite seriously and recognizes that effective corporate and institutional partnerships must be forged to truly make a difference. Bank management recognizes the potential in these communities and knows that with the right mix of financial services, growth will occur. The Bank will continue to leverage its community know-how with the appropriate corporate and institutional partners to ensure that we create economic profit by ensuring that comprehensive products and services are available and accessible through service focused delivery channels. The Bank engages in the commercial banking business, serving the banking needs of its customers with a particular focus on, and sensitivity to, groups that have been traditionally under-served, including Blacks, Hispanics and women. The Bank offers a wide range of deposit products, including checking accounts, interest-bearing NOW accounts, money market accounts, certificates of deposit, savings accounts and Individual Retirement Accounts. 4 The focus of the Bank's lending activities is on the origination of commercial, consumer and residential loans. A broad range of credit products is offered to the businesses and consumers in the Bank's service area, including commercial loans, mortgage loans, student loans, home improvement loans, auto loans, personal loans, and home equity loans. At March 15, 2004, the Bank's maximum legal lending limit was approximately $859,000 per borrower. However, the Bank's internal Loan Policy limits the Bank's lending to $500,000 per borrower in order to diversify the loan portfolio. The Board of Directors of the Bank maintains the ability to waive its internal lending limit upon consideration of a loan. The Board of Directors has exercised this power with respect to loans and participations on a number of occasions. In the area of commercial loans, the Bank has flexibility to develop loan arrangements targeted at a customer's objectives. Typically, these loans are term loans or revolving credit arrangements with interest rate, collateral and repayments terms, varying based upon the type of credit, and various factors used to evaluate risk. The Bank participates in the government-sponsored Small Business Administration ("SBA") lending program and when the Bank deems it appropriate, obtains SBA guarantees for up to 90% of the loan amount. This guaranty is intended to reduce the Bank's exposure to loss in its commercial loan portfolio. Commercial loans are typically made on the basis of cash flow to support repayment with secondary reliance placed on the underlying collateral. The Bank's consumer loan program includes installment loans for home improvement and the purchase of consumer goods and automobiles, student loans, home equity and VISA secured and unsecured revolving lines of credit, and checking overdraft protection. The Bank participates in an automobile refinance program that allows customers to reduce high interest rates paid on their automobile loans down to more reasonable market rates. The Bank also offers residential mortgage loans to its customers. Other services the Bank offers include safe deposit boxes, travelers' checks, money orders, direct deposit of payroll and Social Security checks, wire transfers and access to regional and national automated teller networks. The Bank will continue to focus on its niche businesses to include the basic deposit and loan business, while developing relationships with several corporate entities that have a commitment to community and economic development in the urban sector. Strategic alliances and partnerships are key to the economic strength of inner city neighborhoods. The Bank will seek to promptly develop these strategic alliances/partnerships to help ensure that the communities we serve have full access to financial products and services. With strategic and focused strategies the Bank can realize fee income with a select number of corporations. By developing the relationships appropriately, a new niche for the Bank can be expanded to add to its core earnings stream. These opportunities will include loan syndications, cash management and lock box services, to name a few. 5 Competition There is substantial competition among financial institutions in the Bank's service area. The Bank competes with local, regional and national commercial banks, as well as savings banks and savings and loan associations. Many of these banks and financial institutions have an amount of capital that allows them to do more advertising and promotion and to provide a greater range of services to customers. To date, the Bank has attracted, and believes it will continue to attract its customers from the deposit base of such existing banks and financial institutions largely due to the Bank's mission to service groups of people who have traditionally been un-served and by its devotion to personalized customer service. The Bank's strategy has been, and will continue to be, to emphasize personalized services with special sensitivity to the needs of Blacks, Hispanics and women and to offer competitive rates to borrowers and depositors. In order to compete, the Bank relies upon personal contacts by the officers, directors and employees of the Bank to establish and maintain relationships with Bank customers. The Bank focuses its efforts on the needs of individuals and small and medium-sized businesses. In the event there are customers whose loan demands exceed the Bank's lending limit, the Bank will seek to arrange for such loans on a participation basis with other financial institutions and intermediaries. The Bank will also assist those customers requiring other services not offered by the Bank to obtain such services from its correspondent banks. Registrant believes that a portion of the Bank's customer base is derived from customers who were dissatisfied with the level of service provided at larger financial institutions. While some of such customers have followed officers of those institutions who were hired by the Bank, others were attracted to the Bank by calling programs of its officers and referrals from other customers. The Bank has sought, in the past, and intends to continue in the future, to hire customer contact officers who have good relationships with desirable customers. These personal relationships, provision of a high level of customer services, and referrals from satisfied customers, form the basis of the Bank's competitive approach, as opposed to advertising, rate competition or the development of proprietary banking products, services or programs. In the past, the principal competition for deposits and loans have been other depository institutions. However, now the Bank also competes with other financial intermediaries such as brokerage houses offering investment vehicles to the general public. Other entities, both public and private, seeking to raise capital through the issuance and sale of debt or equity securities are also competitors with banks and savings and loan associations in the acquisition of deposits. United Wealth Management Services ("UWMS"), a division of the Bank, was introduced in September 2002, to provide a full array of non-deposit products including investments, insurance and brokerage services through the Bank's branch network. The Bank's partner in this venture is UVEST Investment Services. UVEST is a registered broker/dealer that has been offering a wide range of investment products and services since 1982. The Bank intends to use UWMS as a vehicle to introduce and market all of its products and services including loans and deposits. Registrant will continue to be cognizant of the diversity in its market and will continue to develop partnerships to leverage the Bank's capacity in its niche market by skillfully targeting customers and building stakeholder relationships. Supervision and Regulation Regulation of United Bancshares, Inc. UBS, as a Pennsylvania business corporation, is subject to the jurisdiction of the Securities and Exchange Commission (the "SEC") and certain state securities commissions concerning matters relating to the offering and sale of its securities. Accordingly, if UBS wishes to issue additional shares of its Common Stock, for example, to raise capital or to grant stock options, UBS must comply with the registration requirements of the Securities Act of 1933, as amended, and any applicable states securities laws, or find an applicable exemptions from registration. 6 The Bank Holding Company Act UBS, as a bank holding company, is subject to the Bank Holding Company Act of 1956, as amended (the "BHC Act"), and supervision by the Federal Reserve Board. The BCH Act limits the business of bank holding companies to banking, managing or controlling banks, performing certain servicing activities for subsidiaries and engaging in such other activities as the Federal Reserve Board may determine to be closely related to banking. UBS is subject to the supervision of and inspection by the Federal Reserve Board and required to file with the Board an annual report and such additional information as the Board may require pursuant to the BHC Act and its implementing regulations. A bank holding company is prohibited from engaging in or acquiring direct or indirect control of more than 5% of the voting shares of any company engaged in non-banking activities, unless the Federal Reserve Board, by order or regulation, has found such activities to be so closely related to banking or managing or controlling banks, as to be a proper incident thereto. In making this determination, the Board considers whether the performance of these activities by a bank holding company would offer benefits to the public that outweigh possible adverse effects. The BHC Act requires UBS to secure the prior approval of the Federal Reserve Board before it owns or controls, directly or indirectly, more than 5% of the voting shares of any corporation, including another bank. In addition, the BHC Act prohibits UBS from acquiring more than 5% of the voting shares of, or an interest in, or all or substantially all of the assets of, any bank located outside Pennsylvania, unless such an acquisition is specifically authorized by the laws of the state in which such bank is located. Subject to compliance with Pennsylvania law, and, as noted above, compliance with the BHC Act, UBS is permitted to control a number of banks. However, UBS is required under the BHC Act to obtain the prior approval of the Federal Reserve Board before acquiring all or substantially all of the assets of any bank, or acquiring ownership or control of any voting shares of any other bank if, after such acquisition, UBS would control more than 5% of the voting shares of such bank. The BHC Act and the Federal Reserve Board's regulations prohibit a bank holding company and its subsidiaries from engaging in certain tying arrangements in connection with any extension of credit or services. The "anti-tying" provisions prohibit a bank from extending credit, leasing, selling property or furnishing any service to a customer on the condition that the customer obtain additional credit or service from the bank, its bank holding company or any other subsidiary of its bank holding company, or on the condition that the customer not obtain other credit or services from a competitor of the bank, its bank holding company or any subsidiary of its bank holding company. The Bank, as a subsidiary of UBS, is subject to certain restrictions imposed by the Federal Reserve Act, as amended, on any extensions of credit to UBS or its subsidiaries, on investments in the stock or other securities UBS or its subsidiaries, and on taking such stock or securities as collateral for loans. The Federal Reserve Act and Federal Reserve Board regulations also place certain limitations and reporting requirements on extensions of credit by a bank to principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, that Act and those regulations may affect the terms upon which any person who becomes a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship. Federal law also prohibits the acquisition of control by UBS of a bank holding company, without prior notice to certain federal bank regulators. Control is defined for this purpose as the power, directly or indirectly, to direct the management or policies of the bank or bank holding company or to vote 25% or more of any class of voting securities of the bank holding company. 7 The Financial Services Act The Financial Services Act (the "FSA Act"), sometimes referred to as the Gramm-Leach-Bliley Act, repealed the provisions of the Glass-Steagall Act, which prohibited commercial banks and securities firms from affiliating with each other and engaging in each other's businesses. Thus, many of the barriers prohibiting affiliations between commercial banks and securities firms have been eliminated. The FSA Act authorizes the establishment of "financial holding companies" ("FHC") to engage in new financial activities offering and banking, insurance, securities and other financial products to consumers. Bank holding companies may elect to become a FHC, if all of its subsidiary depository institutions are well capitalized and well managed. See "Regulatory Action" and "Regulatory Matters" below. If those requirements are met, a bank holding company may file a certification to that effect with the Federal Reserve Board and declare that it elects to become a FHC. After the certification and declaration are filed, the FHC may engage either de novo or through an acquisition in any activity that has been determined by the Federal Reserve Board to be financial in nature or incidental to such financial activity. Under the FSA Act the Bank, subject to various requirements, is permitted to engage through "financial subsidiaries" in certain financial activities permissible for affiliates of an FHC. However, to be able to engage in such activities the Bank must be well capitalized and well managed and receive at least a "satisfactory" rating in its most recent Community Reinvestment Act (the "CRA Act") examination. See "The Community Reinvestment Act" below. UBS cannot be certain of the future effect of the legislation and regulations, described above, on its business, although there may be consolidation among financial service institutions and increased competition for UBS as well as an increase in the expense of regulatory compliance. Regulation of the Bank The Bank is subject to supervision, regulation and examination by the Pennsylvania Department of Banking and the Federal Reserve Board because the Bank is a member bank of the Federal Reserve System. The FDIC insures the Bank's deposits and thus the Bank is subject to certain FDIC regulations. In addition, the Bank is subject to a variety of local, state and federal laws that affect its operation. Below are summarized those laws and regulations which a have material impact on the operations and expenses of the Bank and thus UBS. Branch Banking The Pennsylvania Banking Code of 1965, as amended, the ("Banking Code"), has been amended to harmonize Pennsylvania law with federal law to enable Pennsylvania banking institutions, such as the Bank, to participate fully in interstate banking and to remove obstacles to out of state banks engaging in banking in Pennsylvania. Federal Reserve Membership Regulations Since the Bank is a member bank of the Federal Reserve System, the Federal Reserve Board possesses the power to prohibit institutions regulated by it, such as the Bank, from engaging in any activity that would be an unsafe and unsound banking practice or violate the law. Moreover, the Board has: (i) empowered the FDIC to issue cease-and-desist or civil money penalty orders against the Bank or its executive officers, directors and/or principal shareholders based on violations of law or unsafe and unsound banking practices; (ii) authorized the FDIC to remove executive officers who have participated in such violations or unsound practices; (iii) restricted lending by the Bank to its executive officers, directors, principal shareholders or related interests thereof; (iv) restricted management personnel of the Bank from serving as directors or in other management positions with certain depository institutions whose assets exceed a specified amount or which have an office within a specified geographic area. Additionally, the Bank Control Act provides that no person may acquire control of the Bank unless the Federal Reserve Board has been given 60-days prior written notice and within that time has not disapproved of the acquisition or extended the period for disapproval. The Federal Deposit Insurance Corporation Act The Federal Deposit Insurance Corporation Act (the "FDIC Act") includes several provisions that have a direct material impact on the Bank. The most significant of these provisions are discussed below. 8 To minimize losses to the deposit insurance funds, the FDIC Act has established a format to monitor FDIC-insured institutions and to enable prompt corrective action to be taken by the appropriate federal supervisory agency if an institution begins to experience difficulty. The FDIC Act establishes five "capital" categories. They are: (1) well capitalized, (2) adequately capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5) critically undercapitalized. The overall goal of these new capital measures is to impose more scrutiny and operational restrictions on banks as they descend the capital categories from well capitalized to critically undercapitalized. Under current regulations, a "well-capitalized" institution would be one that has at least a 10% total risk-based capital ratio, a 6% Tier I risk-based capital ratio, a 5% Tier I leverage ratio, and is not subject to any written order or final directive by its regulatory agency to meet and maintain a specific capital level. An "adequately capitalized" institution would be one that meets the required minimum capital levels, but does not meet the definition of a "well-capitalized" institution. The existing capital rules generally require banks to maintain a Tier I Leverage Ratio of at least 4% and an 8% total risk-based capital ratio. Since the risk-based capital requirement to be in the form of Tier I capital, this also will mean that a bank would need to maintain at least 4% Tier I risk-based capital ratio. An institution must meet each of the required minimum capital levels in order to be deemed "adequately capitalized." The most recent notification dated March 11, 2004, from the Federal Reserve authorities categorized the Bank as "adequately capitalized" under the regulatory framework for prompt and corrective action. However, at December 31, 2003, the Bank fell below the tier one leverage ratio of 7.00% (6.81% at December 31, 2003) that is mandated in the Written Agreement with its regulators. See "Regulatory Action" and "Regulatory Matters" below. An "undercapitalized" institution is one that fails to meet one or more of the required minimum capital levels for an "adequately capitalized" institution. Under the FDIC Act, an "undercapitalized" institution must file a capital restoration plan and is automatically subject to restrictions on dividends, management fees and asset growth. In addition, the institution is prohibited from making acquisitions, opening new branches or engaging in new lines of business without the prior approval of its primary federal regulator. A number of other restrictions may be imposed. The Community Reinvestment Act The Bank is required, by the CRA Act and its implementing regulations, to: (i) meet the credit needs of the community, including the low and moderate-income neighborhoods, which it serves. The Bank's CRA Act record is taken into account by the regulatory authorities in their evaluation of any application made by the Bank for, among other things, approval of a branch or other deposit facility, branch office relocation, a merger or an acquisition. The CRA Act also requires the federal banking agencies to make public disclosure of their evaluation of a bank's record of meeting the credit needs of its entire community, including low and moderate-income neighborhoods. After its most recent CRA Act examination the Bank was given an "outstanding" CRA Act rating." The Bank Secrecy Act Under the Bank Secrecy Act ("BSA"), the Bank and other financial institutions are required to report to the Internal Revenue Service currency transactions, of more than $10,000 or multiple transactions of which the Bank has knowledge exceed $10,000 in the aggregate. Civil and criminal penalties are provided under the BSA for failure to file a required report, for failure to supply information required by the BSA or for filing a false or fraudulent report. Privacy of Consumer Financial Information The FSA Act also contains provisions designed to protect the privacy of each consumer's financial information held in a financial institution. The regulations (the "Regulations") issued pursuant to the FSA Act are designed to prevent financial institutions, such as the Bank, from disclosing a consumer's nonpublic personal information to third parties. However, financial institutions can share a consumer customer's personal information or information about business with affiliated companies. The FSA Act Regulations permit financial institutions to disclose nonpublic personal information to nonaffiliated third parties for marketing purposes but financial institutions must provide a description of their privacy policies to the consumers and give consumers an opportunity to opt-out of such disclosure and prevent disclosure by the financial institution of the consumer's nonpublic personal information to nonaffiliated third parties. These privacy Regulations will affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors. 9 Consumer Protection Rules - Sale of Insurance Products In addition, as mandated by FSA Act, the bank regulators have published consumer protection rules (the "Rules") which apply to the retail sales practices, solicitation, advertising or offers of insurance products, including annuities, by depository institutions such as the Bank. The Rules provide that before the sale of insurance or annuity products can be completed, disclosures must be made that such insurance products are not deposits or other obligations of or guaranteed by the FDIC or any other agency of the United States, the Bank or any affiliate and that insurance products, including an annuities, may involve an investment risk, including a possible loss of value. The Rules also provide that the Bank may not condition an extension of credit on the consumer's purchase of an insurance product or annuity from the Bank or any affiliate or on the consumer's agreement not obtain or prohibit the consumer from obtaining an insurance product or annuity from an unaffiliated entity. Finally the Rules also require formal acknowledgment by the consumer that such disclosures have been received. In addition, to the extent practical, the Bank must keep insurance and annuity sales activities physically separate from the areas where retail sales are routinely accepted from the general public. The Bank currently does not market insurance products. The Patriot Act The Patriot Act of 2001 which was enacted in the wake of the September 11, 2001 attacks, include provisions designed to combat international money laundering and advance the U.S. government's war against terrorism. The Patriot Act, and the regulations, which implement it, contains many obligations, which must be satisfied by financial institutions, including the Bank, which involve additional expenses for the Bank. The Sarbanes-Oxley Act of 2002 On July 30, 2002 the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") became law. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, provide enhanced penalties for accounting and auditing improprieties by publicly traded companies and protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities law. The changes required by Sarbanes-Oxley Act and its implementing regulations are intended to allow shareholders to monitor the performance of companies and their directors more easily and effectively. The Sarbanes-Oxley Act generally applies to all domestic companies, such as UBS, that file periodic reports with the SEC under the Securities Exchange Act of 1934, as amended. The Sarbanes-Oxley Act includes very significant disclosure requirements and new corporate governance rules, requires the SEC, the securities exchanges and the NASDAQ stock market to adapt extensive additional disclosures, corporate governance provisions and other related rules, as well as mandating that studies of certain significant issues be made by the SEC and the US Comptroller General. Given the extensive number of Sarbanes-Oxley Act rules and regulations to be finalized and implemented, the final scope and impact of its requirements on UBS and the financial services industry have yet to be determined. The Sarbanes-Oxley Act addresses, among other matters, directors' audit committees; certification of financial statements by the chief executive officer and chief financial officer; forfeiture of bonuses and profits made by directors and senior officers in the twelve month period covered by restated financial statements; a prohibition on insider trading during pension blackout periods; disclosure of off-balance sheet transactions; a prohibition by companies, other than federally insured financial institutions, on personal loans to their directors and officers; expedited filing of reports concerning stock transactions by directors and executive officers; formation of a public accounting oversight board; auditor independence; and increased criminal penalties for violation of certain the securities laws. 10 To implement the requirements of Sarbanes-Oxley Act and regulations, UBS' management has instituted a series of actions to strengthen and improve UBS', corporate governance practices. Included in those actions was the development of a system designed to evaluate and monitor the continued effectiveness of the design and operation of UBS' internal controls and procedures for financial reporting. These series of actions by UBS' management improves UBS' and the Bank's Audit Committees and Risk Management Committees of the Boards, and UBS' and Bank's structures and processes which are intended to provide tools to strengthen internal controls, communications and disclosure of necessary information to those who must know and use it. UBS' system of internal controls and procedures, which are in place, are designed to capture information from all segments of its business. At UBS and the Bank, each key material element of their operation is subject to oversight to help insure proper internal controls and procedures, administration, risk management and delivery of critical information disclosures to appropriate audit and financial officers, executive management, Board committees and the Boards of directors. UBS' management believes that the addition of these new controls and processes has brought with it a broader and more in depth analysis to UBS' systems of controls and procedures and corporate governance. The rules and regulations, discussed above, which implement the Sarbanes-Oxley Act could have a significant economic impact on the compliance cost of the UBS and all publicly held companies. New Legislation and Regulations The Fair and Accurate Credit Reporting Transactions Act The Fair and Accurate Credit Reporting Transactions Act of 2003 (the "Fact Act") became law on December 4, 2003. Among other things, the Fact Act permanently extended the provisions of the Fair Credit Reporting Act (the FCR Act") that would have expired on January 1, 2004 and had prevented the states from enforcing credit reporting laws that were more restrictive than the FCR Act provisions. Specifically, the Fact Act now permanently prohibits the states from enforcing laws stricter than the Fact Act regulate that regulate: (1) the prescreening of consumer reports, (2) the time within which credit bureaus must respond to consumer disputes, (3) the duties of users of credit bureau information, (4) the information contained in the credit reports, (5) the duties of the information providers, and (6) the exchange of credit information between affiliates. In addition the Fact Act contains provisions concerning (i) how often consumers may obtain free copies of their credit reports, (ii) the disclosure of credit scores used for credit decisions, (iii) a consumers opt-out procedure for exchange of credit information, that would otherwise be treated as a credit report, among affiliates, (iv) the duty of lenders to notify consumers that information contained in their credit reports resulted in their receiving credit on less than the most favorable terms." The Fact Act also contains provisions designed to reduce identity theft and protect the confidentiality of a consumer's private medical information. Future Legislation and Governmental Policies From time to time various Federal and state legislation have been proposed that could result in additional regulation of, and restrictions on, the business of the Bank. As the enactment of the FSA Act and the Sarbanes-Oxley Act confirm, from time to time, various proposals are enacted in the United States Congress as well as Pennsylvania legislature and issued by various bank regulatory authorities which alter the powers of, and place restrictions on, different types of bank organizations. As a consequence of the extensive regulation of commercial banking activities in the United States, the Bank's business is particularly susceptible to being affected by federal and state legislation and regulations that may increase the costs of doing business. Bank management cannot anticipate the changes in laws and regulations and their impact on the Bank's business, financial position and reported results of operation. 11 Regulatory Action In February 2000, as a result of a regulatory examination completed in December 1999, the Bank entered into a Written Agreement ("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. As of December 31, 2003, the Bank's tier one leverage capital ratio fell to 6.81% , below the 7% minimum capital ratio required by the Agreement. However, at February 29, 2004, the tier one leverage ratio had improved to 7.29% as a result of a $265,000 recovery on a previously charged-off loan. Management continues to review and revise its capital plan to address the development of new equity. In addition, a profit restoration plan was developed and implemented that includes expense reduction and profit enhancement strategies. A regulatory examination completed in February 2004 determined that the Bank was not in compliance certain other elements of the Agreement including the implementation of a viable earnings/strategic plan and the timely charge-off/funding of the allowance for loan losses. Management believes that it has implemented corrective action where necessary including the adoption of an achievable strategic plan for 2004 and the charge-off of all loans for which the full collection appears unlikely. As a result, 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. ITEM 2 -- PROPERTIES Corporate Headquarters United Bank of Philadelphia's corporate offices are located at 300 N. Third Street. The Bank has been at this location for the past four years in the area of the City known as "Old City." This is an up and coming vibrant area filled with art galleries, new development of condominiums, small businesses, and restaurants. The facility consists of 25,000 square feet including executive offices, operations, finance, human resource, security and loss prevention functions. The Bank sublets approximately 2,500 square feet to the African American Interdenominational Ministries. As part of the Bank's profit restoration plan, this property may be sold in 2004 to generate substantial gains to re-capitalize the Bank. Management is in the process of evaluating offers from potential buyers as well as reviewing alternate sites/expenses related to the relocation of the corporate headquarters. Mt. Airy Branch The Bank operates a branch at 1620 Wadsworth Avenue, in the Mt. Airy section of Philadelphia. During 2004, this office will undergo modest cosmetic improvements. Management believes this branch has not reached its capacity and looks forward to increased opportunities in all aspects of the Bank's niche businesses. This facility, comprising a retail banking lobby, teller area, offices, vault and storage space is currently leased at a monthly rental of $3,517. Center City Branch The Bank operates a branch location at Two Penn Center, 15th Street and JFK Boulevard, Philadelphia, Pennsylvania. Two Penn Center has been the Bank's main office since the closure of the 714 Market Street location in January 2002. The Bank leases approximately 4,769 square feet at its Two Penn Center location. The space includes lobby, teller area, customer service area, primary lending area and administrative offices, as well as a vault. The aggregate monthly rent for this location is $13,115. As part of the Bank's profit restoration plan, upon expiration of this lease in May 2004, this branch will be closed and consolidated with other branches in the network to further reduce operating costs. 12 Frankford Branch and ATM Machine In 1995, the Bank purchased a branch facility at 4806 Frankford Avenue. In September 2000, the Bank closed this facility. In June 2002, the Bank sold this facility. An ATM machine remains operational at this facility. The aggregate monthly rental for the ATM Machine is $500. West Girard Branch and ATM Machine The Bank leased a facility located at 2820 West Girard Avenue. The branch operations of this facility were discontinued in September 2000. An ATM machine remained operational at this facility until February 2002 when it was relocated to 2820 West Girard. The aggregate monthly rental for the ATM Machine at the new location is $500. West Philadelphia Branch In August 2003, the Bank purchased the branch location at 3750 Lancaster Avenue for $287,500. From July 1996 to the time of purchase, this facility had been leased. With the purchase of this facility, management looks forward to capital improvements to be in line with the University City District's environmental improvements along the Lancaster Avenue corridor. It is comprised of approximately 3,000 square feet. The main floor houses teller and customer service areas, a drive-up teller facility and automated teller machine. The basement provides storage for the facility. The aggregate monthly rental was $2,875 exclusive of taxes, insurance, utilities and janitorial service. Progress Plaza Branch The Bank leases a branch facility located at 1015 North Broad Street, Philadelphia, Pennsylvania. The Progress Plaza branch is a very active branch with the largest number of customers seeking service on a daily basis. This branch became the office of choice after the consolidation of the 28th & West Girard location in 2000. This area of North Philadelphia is an important area for the Bank and its mission. The facility is comprised of a teller and customer service area, lobby and vault. The aggregate monthly rental for this facility is $3,875 per month. This lease expired in October 2003. The Bank had been notified by the landlord that extensive improvements to the shopping plaza in which this branch is located were planned for early 2004 but have since been placed on hold. The Bank is currently leasing this facility on a month-to-month basis until final renovation plans are determined by the landlord . ITEM 3 -- 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 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable. No matters were submitted to a vote of Registrant's security holders since the Registrant's last periodic filing. 13 PART II ITEM 5 -- MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Common Stock As of March 15, 2004 there were 3,156 shareholders of record of UBS's Common Stock. The Common Stock is not traded on any national exchange or otherwise traded in any recognizable market. Prior to December 31, 1993, the Bank conducted a limited offering (the "Offering") pursuant to a registration exemption provided in Section 3(a)(2) of the Securities Exchange Act of 1933 (the "Act"). The price-per-share during the Offering was $12.00. Prior to the Offering, the Bank conducted an initial offering of the Common Stock (the "Initial Offering") at $10.00 per share pursuant to the same registration exemption. In June 2000 and December 2000, respectively, the Bank received $411,809 and $436,212 and issued 34,317 and 36,351 shares, respectively, as a result of the purchase of UBS common stock by members of the Bank's board of directors in a limited offering at a price of $12.00 per share. This offering was exempt from registration under the Act pursuant to the exemption in section 4(2) of the Act. In May 2001 and December 2001, respectively, the Bank received $2,000 and $9,596 and issued 167 and 800 shares, respectively, as a result of the purchase of UBS common stock by two individuals in a limited offering at a price of $12.00 per share. This offering was exempt from registration under the Act pursuant to the exemption in section 4(2) of the Act. In June 2002, the Bank received $20,400 and issued 1,700 shares as a result of the purchase of UBS common stock by new members of the Bank's board of directors in a limited offering at a price of $12.00 per share. This offering was exempt from registration under the Act pursuant to the exemption in section 4(2) of the Act. In June 2003, a shareholder of the Bank returned 33,500 shares of common stock and 6,308 shares of preferred Series A stock. These shares were returned for no consideration and were recorded as treasury stock by the Bank. No other transactions with respect to UBS common stock occurred during 2003. Dividends UBS has not, has never declared or paid any cash or stock dividends. The Pennsylvania Banking Code of 1965, as amended, provides that cash dividends may be declared and paid only from accumulated net earnings and that, prior to the declaration of any dividend, 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 ten percent of the net earnings of the bank 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 the prior approval of the Pennsylvania Department of Banking. Under the Federal Reserve Act, if a bank has sustained losses equal to or exceeding its undivided profits then on hand, 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 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 Federal Reserve 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. As a result of these laws and regulations, the Bank, and therefore the Registrant, whose only source of income is dividends from the Bank, will be unable to pay any dividends while an accumulated deficit exists. The Registrant does not anticipate that dividends will be paid for the foreseeable future. The Federal Deposit Insurance Act generally prohibits all payments of dividends by a bank, which is in default of any assessment to the FDIC. 14 The information below has been derived from UBS' consolidated financial statements. ITEM 6 -- SELECTED FINANCIAL DATA Selected Financial Data
Year ended December 31, ------------------------------------------------------------ (Dollars in thousands, except per share data) 2003 2002 2001 2000 1999 ------------------------------------------------------------ Net interest income.............................. $ 3,290 $ 3,726 $ 4,060 $ 5,415 $ 5,264 Provision for loan losses........................ 565 175 335 565 1,007 Noninterest income............................... 1,891 2,327 2,443 3,197 2,226 Noninterest expense.............................. 5,732 6,095 7,038 8,801 7,714 Net income (loss)................................ (1,115) (217) (870) (755) (1,230) Net income (loss) per share - basic.............. (1.03) (0.20) (0.79) (0.72) (1.24) Balance sheet totals: Total assets................................. $74,717 $86,044 $88,668 $93,533 $137,249 Net loans.................................... 46,690 43,459 42,292 44,743 59,444 Investment securities........................ 15,637 21,518 25,806 35,014 51,433 Deposits..................................... 67,117 76,929 79,423 83,238 124,766 Shareholders' equity......................... 7,235 8,500 8,558 9,350 9,027 Ratios: Tangible Equity to assets................. 6.85 % 7.45 % 7.67 % 7.74 % 8.07 % Return on assets.......................... (1.38)% (0.25)% (0.95)% (0.63)% (1.03)% Return on equity.......................... (13.03)% (2.55)% (9.63)% (8.08)% (12.71)%
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Because UBS 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 annual 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. 15 Background Summary History The Bank entered a Written Agreement ("the Agreement") with the Federal Reserve Bank in 2000 that had many ambitious timelines for the board and management to meet. This Agreement became a motivator for the new management team to dismantle a lack luster business model in order to keep the franchise alive and relevant. This was a model that originally held great promise for it was established to bring the "unbanked" into the mainstream of financial services through affordable pricing and sensitive customer service. The customers came and the numbers grew quickly and the franchise grew through the acquisition of failed savings and loan branches. However, with this growth came increased expenses through the assimilation of acquired branch locations, people, products and the overall conversion expense. The Bank had quickly strayed from its model of building a customer-friendly and affordable franchise into a franchise of transforming several branches of savings and loan customers into the Bank's commercial platform. In 2000, the Bank was still faced with an enormous array of accounts that had not yet been streamlined, thus curtailing the sales capacity of the staff. In addition, the Bank's pricing had not kept pace with the prevailing rates in the local market. Thus, in early 2000 the Bank's pricing model was enhanced to be more competitive while still affordable to its clients. This shift gave the Bank a quick boost in revenue. A major factor that needed to be addressed by the Bank was its capital (tier one leverage ratio). With the onset of the Agreement, the Bank's tier one leverage ratio was slightly under 5%. Aggressive strategies were developed and implemented by moving more expensive deposit relationships (certificates of deposit and IRA's) off the Bank's balance sheet. These deposits were sold for a gain and thus the Bank's total assets were reduced getting the Bank closer to the 7% capital requirement. A fundamental problem for the Bank's business model was its expense profile. Major cuts have been made including consolidating the branch network (from 8 offices to 4). Even with this reduction in branch offices, the Bank still carried more branches than its peer group, which was generally two and no more than three branches. This reduction yielded $600,000 to the overall expense savings, which is an aggregate of approximately $3 million over the past four years. The Bank's reengineering and restructuring has resulted in a more streamlined organization that provided the proper organizational platform to become a more strategy-focused institution. Without compromising the segregation of duties and internal controls, management was able to capitalize on the strengths of its staff by combining functions while pushing for more enhanced leadership throughout the organization which is essential to achieve profitability, the Bank's primary goal. Management recognized that before it could introduce new strategies for the Bank's core business, it had to ensure that the organization was running like a well-oiled machine at every level. By compressing the organization and putting emphasis on process improvements, management eliminated waste, and improved on operational efficiencies, which is validated through improved audits. To maintain relevance in its marketplace, the Bank must have sound business strategies that will yield results. The recent past has enabled management to place more emphasis on strategy, with keen focus on a sound organization. While there was a conscientious effort to dismantle the original business model, management recognized the positive aspects of the model - consistent core (versatile) staffing, low cost of funds, loyal customer base, and strong net interest margins. These strengths can be built upon as a new, productive model formulates and moves into action. As was described earlier, the Bank is much more streamlined and through effective cost controls, expenses are manageable. The goal is to develop more earning assets to achieve profitability. Although many changes have been made through consolidations and compressions, there are still opportunities for the Bank to operate more efficiently and cost-effectively. 16 The Bank's Goals Although the Bank's bottom line has not yet achieved a profit, the Bank is a much stronger institution as a result of the aggressive steps taken to decrease expenses, compress the organization, and strengthen internal controls. The ultimate challenge for the institution has been to keep the franchise vibrant while enhancing the business model. Continuing to surround these new strategies and opportunities is a regulatory restraint that is unyielding until the Bank produces a steady stream of earnings and an infusion of equity. In spite of these challenges, new relationships have been developed that will have a positive impact on the Bank's performance. It is apparent that lack of time is an enemy to the profit restoration plan. There is clear evidence that the cycle is changing with a good pipeline of business and new corporate relationships that are abounding All solid relationships require time to cultivate and develop. However, management continues to move with gusto to enhance current business lines while developing new fee income streams that are sustainable. Of course, the Bank's core consumer business is poised for growth through the financial service centers. With an aggressive marketing plan and strategic partners and alliances, the following products are projected to yield profitable returns: |_| Auto Loan Refinance Program |_| Home Equity Loans |_| Personal Loans (Secured and Unsecured) |_| Overdraft Protection |_| Residential Mortgages |_| Student Loans The Bank will continue to participate in commercial deals with regional banks to foster fee income in the following areas: |_| Working Capital Lines of Credit |_| Term Loans |_| Demand Loans |_| Commercial Real Estate (Construction & Permanent Mortgages) The Bank continues with its niche businesses that are specialized areas whereby the Bank has a strong position. These businesses are considered to have a significant profit potential, but are not necessarily basic to a community bank or its corporate mission. Certain niche products may be appropriately marketed outside of the geographic area defined in the Bank's mission; however, the marketing strategies will be consistent with the Bank's objectives: |_| Church Loans |_| Priority Loan Program (Auto Refinance Program) |_| Predatory Loan Program (Home Improvement/Refinance Loan Program) |_| Small Business Loans (Emerging Markets) |_| Credit Cards The key for the Bank in achieving its external goals is to maximize its strategic partnerships and to supplement its loan originations with additional loan volume from partners that have a stake in the urban communities. In addition, other sources for fee income will include the maximum utilization of the Bank's ATM network in high volume locations (i.e. areas near public transportation, shopping, and restaurants) that are out of the reach of the Bank's branches to capitalize on additional fees. Some of the Bank's ATMs have experienced a drop in volume as competitors placed machines in close proximity to existing high volume ATMs of the Bank and several of the Bank's high volume ATM's were replaced with those of competitors that paid significantly higher transactional fees to site owners. Management continues the process of identifying potentially high volume locations to place machines. 17 Results of Operations Summary The Company recorded a net loss of approximately $1,115,000 for 2003 ($1.03 per share) compared to a net loss of $217,000 for 2002 ($0.20 per share) compared to a net loss of approximately $870,000 ($0.79 per share) for 2001. In 2003, the Bank made provisions to its allowance for loan losses totaling $565,000 primarily to cover the charge-off of $710,000 for the non-Small Business Administration guaranteed portion of a loan to one customer totaling approximately $1.3 million. A reserve of $357,000 had been provided for this loan in previous years. The balance of this loan has been submitted to the SBA for collection. In addition, during 2003, the Bank's average earning assets declined by $6.7 million resulting in a decrease in net interest income of $436,000. The decline in earning assets was primarily related the reduction in deposit balances of two deposit customers. These funds were required for the operating needs of the customers. During 2003, the Bank continued the implementation of its profit restoration plan that resulted in a decline in noninterest expenses of $363,000 compared to 2002. Components of the plan include among other things staff reductions/consolidations, salary reductions, reduction in branch operating hours, continued elimination of director fees, and the reduction of other operating expenses. In 2002, the Bank was awarded a $198,000 grant from the U.S. Treasury Department's Bank Enterprise Award (BEA) Fund that is included in other income on the consolidated statement of operations. These funds are awarded to financial institutions that demonstrate community development through loan and deposit activity. The Bank submitted its application to the BEA Fund in February 2004 for its 2003 loan activity. If selected, the Bank may receive a grant in September 2004. In addition, revenue enhancement strategies have been employed to expand opportunities for fee income through the implementation of new products and services including corporate loan syndications where the Bank serves in the role of arranger and/or administrative agent. During 2003, the Bank generated fees totaling $85,000 from this line of business. Further growth in this new core line of business is projected in 2004. While expense reductions continue to be achieved, a greaterimpact will 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. Thus, while continuing to control expenses, management will place more focus on the implementation of business development strategies to increase the level of loans outstanding to achieve profitability. 18 A more detailed explanation for each component of earnings is included in the sections below. Table 1--Average Balances, Rates, and Interest Income and Expense Summary
December 31, 2003 2002 2001 ----------------------- ----------------------- ------------------------ Average Yield/ Average Yield/ Average Yield/ (Dollars in thousands) balance Interest rate balance Interest rate balance Interest rate ----------------------- ----------------------- ------------------------ Assets: Interest-earning assets: Loans........................... $45,168 $2,913 6.45% $42,839 $3,006 7.02% $45,828 $3,595 7.85% Investment securities held-to-maturity 6,479 273 4.21 10,155 626 6.16 14,669 987 6.73 Investment securities available-for-sale 10,262 553 5.38 13,783 831 6.03 11,758 772 6.57 Federal funds sold.............. 8,498 98 1.15 10,406 169 1.62 7,726 282 3.65 ------- ------ ------- ------ ------- ------ Total interest-earning assets 70,407 3,837 5.45 77,183 4,632 6.00 79,981 5,636 7.05 Noninterest-earning assets: Cash and due from banks......... 4,433 4,542 4,801 Premises and equipment, net..... 2,679 2,613 3,214 Other assets.................... 3,922 2,926 4,028 Less allowance for loan losses.. (713) (674) (576) ------- ------- ------ Total........................ $80,728 $86,590 $91,448 ======= ======= ======= Liabilities and shareholders' equity: Interest-bearing liabilities: Demand deposits................. $11,924 $ 83 0.70% $12,882 114 0.89% $13,802 178 1.29% Savings deposits................ 20,241 89 0.44 21,931 129 0.59 24,480 317 1.29 Time deposits................... 21,565 375 1.74 23,712 662 2.79 24,089 1,081 4.49 Other borrowed funds............ - - - - - - 1 - - ------- ------ ------- ------ ------- ------ Total interest-bearing liabilities 53,730 547 1.02 58,525 906 1.55 62,372 1,576 2.53 Noninterest-bearing liabilities: Demand deposits................. 18,439 19,565 19,612 Other........................... - - 431 Shareholders' equity................ 8,559 8,500 9,033 ------- ------- ------- Total........................ $80,728 $91,448 ======= ======= ======= Net interest earnings............... 3,290 $ 3,726 $ 4,060 Net yield on interest-earning assets 4.67% 4.83% 5.08%
For purposes of computing the average balance, loans are not reduced for nonperforming loans. 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 (b) interest paid on interest-bearing liabilities, is a significant component of the Bank's earnings. 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 in 2003 totaled $3.3 million, a decrease of $436,000, or 11.70%, compared to 2002. Net interest income for 2002 totaled $3.7 million, a decrease of $334,000 or 8.23%, compared to 2001. 19
2003 compared to 2002 2002 compared to 2001 ----------------------------- ----------------------------- Increase (decrease) due to Increase (decrease) due to ----------------------------- ----------------------------- (Dollars in thousands) Volume Rate Net Volume Rate Net ------- ------- ------- ------- ------- ------- Interest earned on: Loans............................................... $ 151 $ (244) $ (93) $(209) $(380) $ (589) Investment securities held-to-maturity.............. (167) (186) (353) (277) (84) (361) Investment securities available-for-sale............ (161) (117) (278) 122 (63) 59 Federal funds sold.................................. (22) (49) (71) 44 (157) (113) ----- ----- ----- ----- ----- ------ Total interest-earning assets.................... (199) (596) (795) (320) (684) (1,004) ----- ----- ----- ----- ----- ------ Interest paid on: Loans............................................... $ (209) $ (380) $(589) $(742) $(317) $(1,059) Demand deposits..................................... (6) (25) (31) (8) (55) (63) Savings deposits................................... (7) (33) (40) (16) (172) (188) Time deposits....................................... (37) (251) (288) (9) (410) (419) ----- ----- ----- ----- ----- ------ Total interest-bearing liabilities............... (50) (309) (359) (33) (637) (670) ----- ----- ----- ----- ----- ------- Net interest income.............................. $ (149) $ (287) $(436) $(287) $ (47) $ (334) ====== ====== ===== ===== ===== =======
Changes in interest income or expense not arising solely as a result of volume or rate variances are allocated to rate variances due to the interest sensitivity of consolidated assets and liabilities. In 2003, there was a decrease in net interest income of $149,000 due to changes in volume and a decrease of $287,000 due to changes in rate. In 2002, there was a decrease in net interest income of $287,000 due to changes in volume and a decrease of $47,000 due to changes in rate. Average earning assets decreased from $77 million in 2002 to $70 million in 2003 and decreased from $80 million in 2000 to $77 million in 2002. To meet capital requirements mandated in its Written Agreement with regulators (Refer to "Regulatory Action" above and "Regulatory Matters" below) the Bank implemented an asset reduction/capital improvement plan in 2000 that included the reduction of deposits. Beginning in June 2000, the Bank sold higher yielding certificates of deposit to other financial institutions, encouraged some large deposit account holders to remove deposits, and consolidated three branches in its branch network. During the three subsequent years, in effort to manage its capital adequacy, the Bank has not aggressively sought significant deposit growth. The Bank's core deposit base has remained relatively stable and represents 85% of total deposits. Until additional capital is raised, the Bank will not seek to significantly increase its level of deposits. The net interest margin of the Bank was 4.67% in 2003, 4.83% in 2002, and 5.08% in 2001. Management actively manages its exposure to interest rate changes. While the prime rate decreased more than 450 basis points over the last three years, the Bank did not experience a similar decline in yield on its earning assets. This is because only 29.65% of the Bank's loan portfolio reprices or matures in less than one year. The structure for many of the commercial loans of the Bank includes a five to seven year fixed rate with a balloon. This type of structure minimizes the Bank's interest rate risk and allows for repricing in five to seven years. In addition, except for a recently purchased portfolio of home equity lines of credit that float with prime, much of the Bank's consumer and mortgage portfolios have fixed interest rates. These characteristics of the Bank's earning assets coupled with the Bank's significant level of core deposits resulted in minimal impact to the Bank's net interest margin during the declining rate environment. During 2003, the average federal funds yield was 1.15% compared to 1.62% in 2002 and 3.65% in 2001. During 2003, the average investment in federal funds decreased by $2 million. Alternate investment strategies were implemented to place liquid funds into loans and longer-term securities including mortgage-backed (MBS) to minimize the impact of the decline in the rate paid on Federal Funds Sold. The yield on the investment portfolio decreased 116 basis points to 4.93% in 2003 compared to 6.09% in 2002 and 6.66% in 2001. Over the last two years, the Bank experienced a significant level of called agency securities that were re-invested in a lower interest rate environment--thereby, reducing the yield on the portfolio. 20 The cost of interest-bearing liabilities declined to 1.02% in 2003 compared to 1.55% in 2002. Consistent with market conditions during 2003, the Bank reduced the rates it pays on many of its interest-bearing products. When setting the pricing for its deposits, the Bank generally uses the median rate paid by its competitors in the region. Because most of the Bank's deposits are considered core, they were not sensitive to declining rates. 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 in 2003 was $565,000 compared to $175,000 in 2002 and $335,000 in 2001. In December 2003, the Bank charged off $710,000 that represented the non-Small Business Administration (SBA) guaranteed portion of a loan to one borrower in the telecommunications industry. A specific reserve of $357,000 had previously been established to cover potential losses. Severe financial difficulties experienced by the borrower make the full collection of this loan uncertain. Loans to this borrower totaled $1.3 million. The Bank has presented this loan to the SBA for collection of the guaranteed portion of the loans that total $569,000 . Although the Bank has charged-off a portion of this loan, management will seek to maximize its recovery through appropriate legal action. During the current uncertain 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 December 31, 2003. Noninterest Income Noninterest income decreased $436,000 in 2003 compared to 2002 and decreased $116,000 in 2002 compared to 2001. 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 charges, overdrafts, account analysis, and other customer service fees. Customer service fees decreased $275,000 in 2003 compared to 2002 primarily because of a reduction in activity fees on deposits and lower surcharge income on the Bank's ATM network. The Bank's lower deposit levels in 2003 compared to 2002 resulted in less overdraft fees, activity service charges and low balance fees. In 2003, to avoid the necessity to escheat the balances of inactive customer accounts (NOTE: The Commonwealth of Pennsylvania requires that accounts that are inactive for five years or more be closed and escheated to the state.), the Bank made an extensive effort to contact customers to re-activate their accounts. This resulted in a reduction in activity/dormant account service charges. During 2003, surcharge income on the Bank's ATM network declined by $121,000, or 14.76%, compared to 2002. Some of the Bank's ATMs have experienced a drop in volume as competitors placed machines in close proximity to existing high volume ATMs of the Bank and several of the Bank's high volume ATM's were replaced with those of competitors that paid significantly higher transactional fees to site owners. Management continues the process of identifying potentially high volume locations to place machines. In September 2002, the Bank received a $198,000 grant from the U.S. Treasury Department's Bank Enterprise Award (BEA) Fund. The Bank received this grant as a result of certificates of deposit it placed with other Community Development Financial Institutions (CDFI) throughout the country. (Note: United Bank of Philadelphia also has a CDFI designation and periodically receives such deposits to support its community development mission.) The Bank submitted its application to the BEA Fund in February 2004 for its 2003 loan activity. If selected, the Bank may receive a grant in September 2004. 21 During 2003, the Bank further developed a new core line of business-- serving as arranger/agent for loan syndications for major corporations throughout the country. In 2003, the Bank was selected to syndicate three significant back-up lines/letters of credit with other minority banks throughout the country for major corporations for which it received agent fees totaling $85,000. These fees will be received annually for the administration of the credit facilities. In 2002, these fees totaled $25,000. Management plans to continue to develop this core line of business to generate fee income to support the Bank's profitability goals. During 2002, the Bank sold its former Frankford branch facility for a gain of $48,000. In addition, the Bank sold approximately $1.1 million of its available-for-sale portfolio for a gain of approximately $26,000. During 2001, the Bank sold its former West Girard branch facility for a gain of $78,000. In addition, the Bank sold approximately $3.5 million of its available-for-sale portfolio for a gain of approximately $78,000. Noninterest Expense Noninterest expense decreased $363,000, or 5.96%, in 2003 compared to 2002 and decreased $943,000, or 13.4%, in 2002 compared to 2001. Salaries and benefits decreased $140,000, or 5.98% in 2003 compared to a decrease of $320,000, or 12.01%, in 2002. In April 2002, as part of its Profit Restoration Plan, 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. Occupancy and equipment expense decreased approximately $69,000, or 5.34%, during 2003 compared to a decrease of approximately $316,000, or 19.62%, during 2002. In August 2003, the Bank purchased its 38th and Lancaster Street Branch as a measure to reduce its occupancy expense. This branch had been leased on a "triple net" basis where the Bank bore all expenses related to the facility. The projected annual savings on this transaction is $20,000. Also, in conjunction with the expiration of the lease, the Bank's 714 Market Street branch was closed/consolidated with the Two Penn Center branch office in February 2002. Further, the Bank's former Frankford branch office was sold on June 8, 2002 resulting in a reduction in real estate taxes and property insurance. Finally, many of the fixed assets initially acquired in 1992 when the Bank opened for business are now fully depreciated (10-year life). This results in a reduction in monthly depreciation expense. Data processing expenses are a result of the management decision 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, and student loan portfolios. Data processing expenses increased by $40,000, or 6.45%, during 2003 compared to a decrease of $168,000 or 20.81%, during 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. In December 2003, the Bank converted/consolidated its consumer loan accounting process (previously outsourced to EDS) with its core vendor, FISERV. This conversion will reduce monthly processing cost by an estimated $6,000. Savings will begin to be realized in 2004. The Bank continues to study methods by which it may further reduce its data processing cost. Marketing and public relations expense increased by $31,000, or 37.32%, in 2003 compared to a decrease of $27,000, or 24.39% in 2002. In 2003, to further enhance its image and encourage business development, the Bank began a re-branding campaign that included, among other things, new brochures and in-branch signage. Management is firmly committed to enhancing the Bank's marketing and sales profile through effective communication and leadership. It knows that to remain competitive the Bank must develop better strategies for marketing and sales. Management is also committed to making the Bank's marketing drive the overall business planning process. Niche markets (church lending) have been identified and the Bank is committed to increasing this niche while adding others. 22 There are two basic things that need to be done in order to reach the Bank's goals and objectives-- attract new customers and partners and retain the existing customers and partners. In order to do this, management must look at a variety of strategies including the following: Advertising |_| Management will seek cost-effective ways to advertise the Bank's products and services. Community-based newspapers and other forms of advertising that include the church bulletins in targeted churches will be utilized. Public Relations |_| The Bank will seek innovative ways to get its story out to the public. It will participate on talk radio programs, and use a variety of methods such as special events to make the Bank's name more visible. Marketing |_| The Bank will retain professional services to assist management in creating a "buzz" about the Bank. Professional services decreased by $63,000, or 22.18%, in 2003 compared to an increase of $51,000, or 21.92%, in 2002. During 2002, the Bank worked with outside attorneys to settle two outstanding legal matters. In addition, the legal review and implementation of the Sarbanes-Oxley Act that was enacted in 2002, resulted in increased legal fees. There were no significant legal matters during 2003. Office operations and supplies expense increased by $20,000, or 4.53%, in 2003 compared to a decrease of $21,000, or 4.54%, in 2002. The increase in 2003 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. In addition, in conjunction with the Bank's earnings enhancement / profit restoration plan, all other operating expenses are tightly controlled. Federal deposit insurance premiums were $34,000 in 2003, $36,000 in 2002 and $150,000 in 2001. 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 15 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. 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. 23 FINANCIAL CONDITION Sources and Uses of Funds The Bank's financial condition can be evaluated in terms of trends in its sources and uses of funds. The comparison of average balances in Table 3 below indicates how the Bank has managed these elements. Average funding uses decreased approximately$6.8 million, or 8.78%, in 2003 compared to a decrease of $2.8 million, or 3.50%, in 2002. Table 3--Sources and Use of Funds Trends
2003 2002 2001 ------------------------------- ------------------------------- --------- Increase Increase Average (decrease) Average (decrease) Average (Dollars in thousands) balance amount Percent balance amount Percent balance --------- -------- ------- --------- -------- ------- --------- Funding uses: Loans ............................. $45,168 $ 2,329 5.44% $42,839 $(2,989) (6.52)% $45,828 Investment securities.............. Held-to-maturity................. 6,479 (3,676) (36.20) 10,155 (4,514) (30.77) 14,669 Available-for-sale............... 10,262 (3,521) (25.55) 13,783 2,025 17.22 11,758 Federal funds sold............... 8,498 (1,908) (18.34) 10,406 2,680 34.69 7,726 ------- ------- ------- ------- ------- Total uses................... $70,407 $(6,776) $77,183 $(2,798) $79,981 ======= ======= ======= ======= ======= Funding sources: Demand deposits: Noninterest-bearing.............. $18,439 $(1,126) (5.76)% $19,565 $ (47) (0.09)% $19,612 Interest-bearing................. 11,924 (958) (7.44) 12,882 (920) (6.67) 13,802 Savings deposits................... 20,241 (1,690) (7.70) 21,931 (2,549) (10.41) 24,480 Time deposits...................... 21,565 (2,147) (9.05) 23,712 (377) (1.57) 24,089 Other borrowed funds............... - - - - (1) (100.00) 1 ------- ------- ------- ------- ------- Total sources................ $72,169 $(5,921) $78,090 $(3,894) $81,984 ======= ======= ======= ======= =======
*Includes held-to-maturity and available-for-sale securities Investment Securities and Other Short-Term Investments The Bank's investment portfolio is classified as either held-to-maturity or available-for-sale. Investments classified as held-to-maturity are carried at amortized cost and are those securities the Bank has both the intent and ability to hold to maturity. Investments classified as available-for-sale are those investments the Bank intends to hold for an indefinite amount of time, but not necessarily to maturity, and are carried at fair value, with the unrealized holding gains and losses reported as a component of shareholders' equity on the balance sheet. Average investment securities and federal funds sold, in the aggregate, decreased by $9.1 million, or 26.5% in 2003 compared to an increase of $191,000, or .56%, in 2002 . The significant decline in the portfolio was caused by the high level of called agency securities as well as an increase in the prepayment speed on the Bank's mortgage-backed securities. In addition, excess liquidity previously held in Federal Funds Sold was re-deployed to higher yielding loans during 2003. 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. As reflected in Table 4 below, the average duration of the portfolio is 2.78 years. In the current low interest rate environment, the duration of the investment portfolio is shortened because of the of callable government agency securities and the increase in the prepayment speed on the Bank's mortgage-backed security portfolio. Approximately $4 million in securities were called during 2003. The average yield of called securities was 6.00%. Calls will likely diminish in 2004 as most of the higher yielding callable agency securities were called over the last two years. The average yield on the callable agency portfolio at December 31, 2003 was 4.43% and is closely aligned with current market pricing. 24 Approximately 70.2% of the portfolio consist of mortgage-backed pass-through securities that have longer-term contractual maturities but are sometimes paid off/down before maturity or have repricing characteristics that occur before final maturity. The Bank has attempted to minimize the repayment risk (risk of very fast or very slow repayment) associated with these types of securities by investing primarily in a number of seasoned mortgage pools for which there is a repayment history. This history better enables the Bank to project the repayment speeds of these pools. In addition, the Bank has minimized the interest rate risk associated with these mortgage-backed securities by investing in a variety of pools, many of which have variable rates with indices that track closely with the current interest rate environment. Because customers are more likely to refinance in the current low interest rate environment, the prepayment speed increased on this component of the portfolio. The constant one year prepayment rate (CPR) at December 31, 2003 was 42.93 that translates into 42.93% of the mortgage pool repaying on an annual basis. This results in more cashflow availability to fund loans or to reinvest in the projected increasing interest rate environment. The Bank will continue to take steps to control 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's strategy is 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. Table 4--Analysis of Investment Securities
After one but After five but Within one year within five years within ten years After ten years --------------- ----------------- ---------------- --------------- (Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Total ------ ----- ------ ----- ------ ----- ------ ----- ------ Other government securities...... $ - - % $1,250 3.92% $3,250 4.85% $ - - % $ 4,500 Mutual funds and other........... - - - - - - - - 395 Mortgage-backed securities....... - - - - - - - - 10,611 ----- ------ ------ ------ ------- Total securities................. $ - - $1,250 - $3,250 - $ - - $15,506 Average maturity................. 2.78 years
The above table sets forth the maturities of investment securities at December 31, 2003 and the weighted average yields of such securities (calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security). Loans Average loans increased approximately $2.3 million, or 5.44%, in 2003 compared to a decrease of approximately $3 million, or 6.52%, in 2002. The Bank has developed 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 continues to be utilized while the Bank enhances it own business development capacity. Approximately $3 million in commercial loan participations were booked during 2003. Most of these participations were secured by commercial real estate. In June 2003, the Bank purchased approximately $4.8 million adjustable rate residential mortgage loans. 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. Also, in December 2003, the Bank sold approximately $3 million in lower yielding student loans and purchased approximately $3.7 million in higher yielding variable rate Home Equity Lines of Credit. The Bank's loan-to-deposit ratio at December 31, 2003 was 69.6% up from 56.5% at December 31, 2002. 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. The increase in this ratio is the result of an increase in loans outstanding coupled with a smaller deposit base. Management will continue to implement loan growth strategies including the purchase of additional commercial loan participations and the origination of small business loans and consumer loans including home equity, automobile, student and credit card loans. 25 As reflected in Table 5 below, during 2003, because of the purchase of residential mortgage loans, this category increased by $1.5 million to 32% of total loans. As reflected in Table 6 below, approximately 40% of the Bank's loan portfolio have scheduled maturities or reprice in five years or more. This position is largely a result of the Bank's relatively high level of residential mortgage loans and the typical five to seven year balloon structure of the commercial real estate portfolio. While scheduled maturities and repricing exceed five years, the actual duration of the portfolio may be much shorter because of the rapid repayment speed of the Bank's residential mortgage loan portfolio. Table 5--Loans Outstanding, Net of Unearned Income
December 31, (Dollars in thousands) 2003 2002 2001 2000 1999 ------- ------- ------- ------- ------- Commercial and industrial................... $11,361 $10,855 $11,054 $11,429 $13,664 Commercial real estate...................... 11,862 11,898 5,504 652 1,288 Residential mortgages....................... 15,110 13,560 18,148 22,316 26,237 Consumer loans.............................. 8,695 7,820 8,294 10,908 19,822 ------- ------- ------- ------- ------- Total loans............................. $47,028 $44,133 $43,000 $45,305 $61,011 ======= ======= ======= ======= =======
Table 6--Loan Maturities and Repricing
Within After one but After (Dollars in thousands) one year within five years five years Total ------------ ----------------- ---------- ------- Commercial and industrial................... $ 7,742 $ 2,759 $ 649 $11,150 Commercial real estate...................... 757 2,616 8,700 12,073 Residential mortgages....................... 360 7,031 7,719 15,110 Consumer loans.............................. 5,085 1,797 1,813 8,695 ------ ------ ------ ------ Total loans........................... 13,944 14,203 18,881 47,028 Loans maturing after one year with: Fixed interest rates.................... $21,767 Variable interest rates................. 11,317
Nonperforming Loans Table 7 reflects the Bank's nonperforming and restructured loans for the last five years. 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 Bank's policy 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 nonaccrual, previously accrued and unpaid interest is reversed out of income unless adequate collateral from which to collect the principal of, and interest on, the loan appears to be available. Table 7--Nonperforming Loans
(Dollars in thousands) 2003 2002 2001 2000 1999 ------- ------- ------- ------- ------- Nonaccrual loans............................ $1,588 $ 651 $ 412 $ 453 $2,027 Interest income included in net income for the year............................ 62 25 25 20 67 Interest income that would have been recorded under original terms........... 120 49 29 28 113 Loans past due 90 days and still accruing... 560 797 526 34 53 Restructured loans.......................... 569 1,286 182 632 580
26 At December 31, 2003, nonaccrual loans totaled $1,588,000, compared to $651,000 at December 31, 2002. The increase in nonaccrual loans is primarily in the commercial loan sector of the loan portfolio. At December 31, 2003, $897,000 of the Bank's nonaccrual loans carried some level of guarantee from the Small Business Administration ("SBA"). The underlying credit enhancement provided by the SBA minimizes the risk of loss on these loans. In addition, at December 31, 2003, approximately $415,000 of the total nonaccrual loans were residential mortgages. The strong loan-to-values associated with these loans reduce the risk of loss. Historically, the Bank has not experienced losses in its residential loan portfolio. The balance of impaired loans was $1,124,000 and $1,951,000 as of December 31, 2003 and 2002, respectively. The Bank identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. The allowance for loan loss associated with these loans was $75,000 and $402,000 at December 31, 2003 and 2002, respectively. The reduction in the allowance during 2003 resulted from the charge-off of $710,00 related to the un-guaranteed portion of a $1.3 million loan to one customer. The balance of this loan, $569,000 (guaranteed by the SBA) remains in the total of impaired loans. The Bank has submitted this loan for collection from the SBA. At December 31, 2003, approximately $897,000 (including the loan referenced above) of the impaired loans have SBA guarantees. Interest income recognized on impaired loans during 2003 and 2002 was $64,000 and $104,000, respectively. The Bank recognizes income on impaired loans under the cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Bank. If these factors do not exist, the Bank will not recognize income on such loans. From time to time, management will modify or restructure the terms of certain loans to provide relief to borrowers. Restructured loans are those loans whose terms have been modified because of deterioration in the financial condition of a borrower to provide for a reduction of either interest or principal, regardless of whether such loans are secured or unsecured and regardless of whether such credits are guaranteed by the government or by others. As of December 31, 2003, the Bank had approximately $569,000 in restructured loans. There is no known information about possible credit problems other than those classified as nonaccrual or impaired 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. Although the Bank has a diversified loan portfolio, its debtors' ability to honor their contracts is influenced by the region's economy. At December 31, 2003, approximately 20% of the commercial loan portfolio of the Bank 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. At December 31, 2003, none of these loans were nonperforming. Allowance for Loan Losses The allowance for loan losses reflects management's continuing evaluation of the loan portfolio, assessment of economic conditions, the diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount and quality of nonperforming loans. Table 8 below presents the allocation of loan losses by major category for the past five years. The specific allocations in any particular category may prove to be excessive or inadequate and consequently may be reallocated in the future to reflect then current conditions. 27 The allowance for loan losses as a percentage of total loans was 0.72% at December 31, 2003 compared with 1.53% at December 31, 2002. The decline in the allowance is a result of the charge-off of $710,000 of the non-SBA guaranteed portion of loans to one borrower for which full collectibility is uncertain. (Refer to Provision for Loan Losses above for further discussion on this loan.) At December 31, 2003, the Bank's classified loans totaled $1.2 million, or 2.60%, of total loans. Approximately, $897,000 of these loans have guarantees of the SBA. In addition, specific reserves of $178,000 have been allocated to these loans. Table 8--Allocation of Allowance for Loan Losses
2003 2002 2001 2000 1999 ------------------- ------------------- ------------------- ------------------- ------------------- Percent Percent Percent Percent Percent of loans of loans of loans of loans of loans in each in each in each in each in each category category to category to category to category to Amount total loans Amount total loans Amount total loans Amount total loans Amount total loans ------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ ----------- (Dollars in thousands) Commercial and industrial......... $ 267 31.51% $ 565 24.60% $ 576 37.30% $ 383 25.23% $ 263 22.40% Commercial real estate............. 1.22 37 26.96 29 1.21 11 1.44 877 2.11 Residential mortgages 35 24.57 45 17.72 30 19.29 102 24.08 144 43.00 Consumer loans........ 37 42.70 28 30.72 73 42.20 66 49.25 283 32.49 Unallocated.... - - - - - - - - 32 - ----- ------ ----- ------ ----- ------ ----- ------ ------ ------ $ 339 100.00% $ 675 100.00% $ 708 100.00% $ 562 100.00% $1,567 100.00% ===== ====== ===== ====== ===== ====== ===== ====== ====== ======
Management believes that the allowance for loan losses is adequate. 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. Table 9--Analysis of Allowance for Loan Losses
Year ended December 31, ------------------------------------------------------------------ (Dollars in thousands) 2003 2002 2001 2000 1999 ------- ------- ------- ------- ------- Balance at January 1....................... $ 675 $ 708 $ 562 $ 1,567 $ 679 Charge-offs: Commercial and industrial.............. (799) - (61) (321) (25) Commercial real estate................. - (100) - (803) - Residential mortgages.................. - - - - (47) Consumer loans......................... (174) (261) (261) (597) (315) ------ ------ ------ ------- ------ (973) (361) (322) (1,721) (387) ------ ------ ------ ------- ------ Recoveries--commercial loans................ - 27 - - - Recoveries--consumer loans.................. 72 126 133 151 268 ------ ------ ------- ------- ------ 72 153 133 151 268 Net charge-offs............................ (901) (208) (189) (1,570) (119) Provisions charged to operations........... 565 175 335 565 1,007 ------ ------ ------- ------- ------ Balance at December 31..................... $ 339 $ 675 $ 708 $ 562 $1,567 ====== ====== ====== ======= ====== Ratio of net charge-offs to average loans outstanding............................. 1.41% 0.49% 0.41% 2.84% 0.17%
28 The amount charged to operations and the related balance in the allowance for loan losses are based upon the periodic evaluations of the loan portfolio by management. These evaluations consider several factors, including, but not limited to, general economic conditions, loan portfolio composition, prior loan loss experience, and management's estimate of future potential losses. Deposits Average deposits declined approximately $6 million, or 7.70%, in 2003 compared to a decline of $3.9 million, or 4.71%, in 2002. This decline is primarily because of a reduction in deposits totaling $3 million of a large quasi-local government entity. Whether these deposits will be replaced remains uncertain. In addition, to avoid the necessity to escheat the balances of inactive customer accounts, the Bank made an extensive effort to contact customers to re-activate their accounts. This resulted in the closure of some accounts. At December 31, 2003, the Bank had $258,000 in dormant accounts that were escheated to the Commonwealth of Pennsylvania. Significant deposit growth is not projected because of the Bank's mandatory capital requirements outlined in its Written Agreement with its regulators (See "Regulatory Action" above and "Regulatory Matters" below). Therefore, aggressive deposit retention or new business development strategies have not been implemented. Table 10--Average Deposits by Class and Rate
2003 2002 2001 ------------------ ------------------ ------------------ (Dollars in thousands) Amount Rate Amount Rate Amount Rate ------------------ ------------------ ------------------ Noninterest-bearing demand deposits $18,439 - % $19,565 - % $19,612 - % Interest-bearing demand deposits 11,924 0.70 12,882 0.89 13,802 1.29 Savings deposits 20,241 0.44 21,931 0.59 24,480 1.30 Time deposits 21,565 1.74 23,712 2.79 24,089 4.49
Other Borrowed Funds The Bank did not borrow funds during 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, reducing the need to borrow. 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 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 ("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 the 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 December 31, 2003, management believes the Bank's liquidity is satisfactory and in compliance with FRB regulations. 29 The Bank's principal sources of asset liquidity include investment securities consisting primarily of U.S. Government and agency issues, particularly those of shorter maturities, and mortgage-backed securities with monthly repayments of principal and interest. There are no securities maturing in one year or less. However, other types of assets such as federal funds sold, as well as maturing loans, are sources of liquidity. Approximately $9.2 million in loans are scheduled to mature within one year. The Bank's overall liquidity has been enhanced by a significant level of core deposits which management has determined are less sensitive to interest rate movements. The Bank has avoided reliance on large-denomination time deposits as well as brokered deposits. Table 11 provides a breakdown of the maturity of time deposits of $100,000 or more. Table 11--Maturity of Time Deposits of $100,000 or More (Dollars in thousands) 3 months or less............................................ $ 200 Over 3 through 6 months..................................... 10,150 Over 6 months through 1 year................................ - Over 1 through five years................................... - Over five years............................................. - ------- Total....................................................... $10,350 ======= The following table sets forth contractual obligation and other commitments representing required and potential cash outflows as of December 31, 2003: Table 12--Contractual Obligations and Other Commitments
Less than One to Four to After (Dollars in thousands) Total one year three years five years five years -------- ---------- ----------- ---------- --------- Certificates of Deposit........ $ 21,264 $ 19,623 $ 1,495 $ 146 $ - Rental Obligations............. 393 134 210 49 - Letters of Credit.............. 57 57 - - - -------- -------- ------- ----- ----- Total loans........... $ 21,714 $ 19,814 $ 1,705 $ 195 $ - ======== ======== ======= ===== =====
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 that 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 interest-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. Table 13 sets forth the earliest repricing distribution of the Bank's interest-earning assets and interest-bearing liabilities at December 31, 2003, the Bank's interest rate sensitivity gap ratio (i.e., excess of interest rate-sensitive assets over interest rate-sensitive liabilities, divided by total assets) and the Bank's cumulative interest rate sensitivity gap ratio. For purposes of the table, except for savings deposits, an asset or liability is considered rate-sensitive within a specified period when it matures or could be repriced within such period in accordance with its contractual terms. At December 31, 2003, a liability sensitive position is maintained on a cumulative basis through one year of 6.83%. This level is within the Bank's policy guidelines of +/-15% on a cumulative one-year basis. The current gap position is due to the short maturity of the Bank's certificates of deposit. As indicated in Table 11 above, all of the Bank's certificates of $100,000 or more mature in six months or less and approximately $9.5 million of certificates of deposit less than $100,000 mature in less than one year. Interest rate risk is minimized by the Bank's high level of core deposits that have been placed in shorter repricing intervals. Generally, because of the Bank's negative gap position 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. 30 For purposes of the gap analysis, such deposits (savings, MMA, NOW) which do not have definitive maturity dates and do not readily react to changes in interest rates have been placed in longer repricing intervals versus immediate repricing time frames, making the analysis more reflective of the Bank's historical experience. Table 13--Interest Sensitivity Analysis
Interest rate sensitivity gaps as of December 31, 2003 -------------------------------------------------------------------------- Over Over 1 year Over 3 months 3 through through 3 through Over (Dollars in thousands) or less 12 months 3 years 5 years 5 years Cumulative -------- --------- --------- --------- --------- ---------- Interest-sensitive assets: Interest-bearing deposits with banks. $ $ 874 $ $ $ $ 874 Investment securities................ 7,739 531 409 1,094 5,470 15,243 Federal funds sold................... 1,500 1,500 Loans................................ 15,465 5,555 8,647 5,316 12,045 47,028 ------- ------- ------- ------- ------- ------- Total interest-sensitive assets.... 24,704 6,960 9,056 6,410 17,515 $64,645 ------- ------- ------- ------- ------- ------- Cumulative totals.................. 24,704 31,664 40,720 47,130 64,645 ------- ------- ------- ------- -------
Interest rate sensitivity gaps as of December 31, 2003 -------------------------------------------------------------------------- Over Over 1 year Over 3 months 3 through through 3 through Over (Dollars in thousands) or less 12 months 3 years 5 years 5 years Cumulative -------- --------- --------- --------- --------- ---------- Interest-sensitive liabilities: Interest checking accounts........... 5,737 4,694 10,431 Savings accounts..................... 10,620 8,689 19,309 Certificates $100,000 or more....... 638 8,735 1,384 157 10,914 Certificates of less than $100,000 .. 200 10,150 10,350 ------- ------- ------- ------- ------- ------- Total interest-sensitive liabilities $17,195 $ 18,885 $14,767 $ 157 $ - $51,004 ======= ======== ======= ======= ======= ======= Cumulative totals.................. $17,195 $ 36,080 $50,847 $51,004 $51,004 ======= ======== ======= ======= ======= Interest sensitivity gap................. $ 7,509 $(11,925) $(5,711) $ 6,253 $17,515 ======= ======== ======= ======= ======= Cumulative gap........................... 7,509 (4,416) (10,127) (3,874) 13,641 Cumulative gap/total earning assets...... 11.62% 6.83% 15.67% 5.99% 21.10% Interest-sensitive assets to interest-sensitive liabilities........ 1.44 0.37 0.61 40.83 -
Core deposits such as checking and savings deposits have been placed in repricing intervals based on historical trends and management's estimates. 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, even though the Bank currently has a positive 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. The calculated estimates of net income or "earnings" at risk at December 31, 2003 are as follows: 31 Net interest Percent of Changes in rate income change --------------- ----------- ---------- (Dollars in thousands) +200 basis points $ 3,235 1.02% +100 basis points 3,217 0.56 Flat rate 3,199 - -100 basis points 3,184 (0.47) -200 basis points 3,153 (1.44) A simulation model is also used to estimate the impact of various changes, both upward and downward, in market interest rates and volumes of assets and liabilities on the economic value of the Bank. This model produces an interest rate exposure report that measures the long-term rate risks in the balance sheet by valuing the Bank's assets and liabilities at market. It simulates what amount would be left over if the Bank liquidated its assets and liabilities. This is otherwise known as "economic value" of the capital of the Bank. The calculated estimates of economic value at risk at December 31, 2003 are as follows: MV of equity as a % Changes in rate MV equity of MV of assets --------------- ----------- ------------------- (Dollars in thousands) +200 basis points $ 4,230 5.96% +100 basis points 5,496 7.55 Flat rate 6,839 9.17 -100 basis points 8,237 10.77 -200 basis points 9,613 12.27 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 and investments it has in its portfolio that do not follow market rate changes. The assumptions used in evaluating the vulnerability of the Bank's earnings and equity 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 Bank's assets and liabilities, as well as the estimated effect of changes in interest rates on the earnings and equity, could vary substantially if different assumptions are used or actual experience differs from the assumptions on which the calculations were based. The Bank's Board of Directors and management consider all of the relevant factors and conditions in the asset/liability planning process. Interest rate exposure is not significant and is within the policy limits of the Bank at December 31, 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 and movement into money market deposit accounts and short-term certificates of deposit through pricing and other marketing strategies. 2. Purchase quality loan participations with appropriate interest rate/gap match for the Bank's balance sheet. 3. Restructure the Bank's investment portfolio. The Board of Directors has determined that active supervision of the interest rate spread between yield on earning assets and cost of funds will decrease the Bank's vulnerability to interest rate cycles. 32 Capital Resources Total shareholders' equity declined $1.3 million in 2003 compared to 2002. The decrease in 2003 is a result of the net loss of $1.1 million that resulted in an increase in the accumulated deficit and a decrease in other comprehensive income for the fair market value of available for sale investment securities, net of taxes. The FRB standards for measuring capital adequacy for U.S. Banking organizations require 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 I and Tier II. Tier I consists of common shareholders' equity (excluding net unrealized holding gains on available for sale securities), noncumulative and cumulative perpetual preferred stock, and minority interests less goodwill and/or intangible assets). Tier II 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 I capital and a Tier I leverage ratio of at least 6%. Capital that qualifies as Tier II capital is limited to 100% of Tier I capital. As indicated in Table 14, the Company's risk-based capital ratios are above the minimum requirements. Management continues the objective of raising additional capital by offering additional stock (preferred and common) for sale in a private offering as well as increasing the rate of internal capital growth as a means of maintaining the required capital ratios. However, the Bank's growth, continued losses and the additional provisions to the allowance for loan losses may have an adverse effect on its capital ratios. UBS and the Bank do not anticipate paying dividends in the near future. Table 14--Capital Ratios (Dollars in thousands) 2003 2002 2001 ------- ------- ------- Total Capital................................. $ 7,235 $ 8,263 $ 8,459 Less: Intangible Assets/Net unrealized gains (losses) on available for sale ............. (1,826) (1,937) (2,119) ------- ------- ------- Tier I capital................................ 5,409 6,326 6,340 Tier II capital............................... 339 528 510 ------- ------- ------- Total qualifying capital...................... $ 5,748 $ 6,854 $ 6,850 ======= ======= ======= Risk-adjusted total assets (including off-balance-sheet exposures).... $44,971 $42,104 $41,624 ======= ======= ======= Tier I risk-based capital ratio................ 12.03% 15.02% 15.23% Total (Tier I and II) risk-based capital ratio. 12.78% 16.28% 16.46% Tier I leverage ratio.......................... 7.19% 7.46% 7.12% The Board and management are aggressively exploring strategies for the infusion of new capital into the organization. The most productive way to increase capital is through sustained earnings. The Bank's plan projects this occurrence in 2004; however, external equity is essential for management to hit the ground running. A new Capital Planning Committee has been appointed that consists of two outside directors and the Bank's two executive officers. This Committee is charged to leave no stone unturned by exploring all available options for capital infusion as soon as possible. The Board and management have a heightened sensitivity to this area and recognize that the lack of proper capital levels coupled with the deterioration in earnings can threaten the viability of the institution. Aggressive steps are being taken to address both matters. One significant step being taken includes the possible sale of the Corporate Headquarters Building, 300 N. Third Street. It is anticipated that the Bank could realize a gain of at least $1.5MM on this transaction. 33 Regulatory Matters In February 2000, as a result of a regulatory examination completed in December 1999, the Bank entered into a Written 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. As of December 31, 2003, the Bank's tier one leverage capital ratio fell to 6.81% , below the 7% minimum capital ratio required by the Agreement. However, at February 29, 2004, the tier one leverage ratio had improved to 7.29% as a result of a $265,000 recovery on a previously charged-off loan. Management continues to review and revise its capital plan to address the development of new equity. In addition, a profit restoration plan was developed and implemented that includes expense reduction and profit enhancement strategies. A regulatory examination completed in February 2004 determined that the Bank was not in compliance certain other elements of the Agreement including the implementation of a viable earnings/strategic plan and the timely charge-off/funding of the allowance for loan losses. Management believes that it has implemented corrective action where necessary including the adoption of an achievable strategic plan for 2004 and the charge-off of all loans for which the full collection appears unlikely. As a result, 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. See also "Regulatory Action" above. Recent Accounting Pronouncements 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. The adoption of SFAS No. 149 did not 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 December 31, 2003, the Company was contingently liable on financial and performance standby letters of 34 credit totaling $57,000, none of which were originated 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. 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. The Bank adopted EITF 03-1, The Meaning of Other than Temporary Impairment and Its Application to Certain Investments, as of December 31, 2003. EITF 03-1 includes certain disclosures regarding quantitative and qualitative disclosures for investment securities accounted for under FAS 115, Accounting for Certain Investments in Debt and Equity Securities, that are impaired at the balance sheet date, but an other-than-temporary impairment has not been recognized. The disclosures under EITF 03-1 are required for financial statements for years ending after December 15, 2003 and are included in the financial statements. ITEM 7A -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The financial information required by this Item 7A is incorporated by reference to page 29 of this Report, the Liquidity and Interest Rate Sensitivity Management provisions and pages 29 to 32 of this Report, including Table 13 the Interest Sensitivity Analysis Table of this Report. ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Consolidated Financial Statements on pages 49 to 75 hereof. ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 35 ITEM 9A--CONTROLS AND PROCEDURES UBS carried out an evaluation, under the supervision and with the participation of the UBS' management, including the UBS' Chief Executive Officer, Evelyn F. Smalls and Chief Financial Officer, Brenda Hudson-Nelson, of the effectiveness of the design and operation of the UBS' disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of December 31, 2003 pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that UBS' disclosure controls and procedures as of December 31, 2003, are effective and timely in alerting them to material information relating to UBS (including its consolidated subsidiaries) required to be included in UBS' periodic SEC filings. As of the date of this Report, there have not been any significant changes in UBS' internal control over financial reporting that have materially affected or are reasonably likely to materially affect the UBS' internal control over financial reporting. PART III ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Directors of the Registrant and Bank
Principal occupation and Year first Term Name Age other directorships became director will expire - ---- --- --------------------------- --------------- ----------- Bernard E. Anderson 65 Professor of Management/Economist 2002 2006 At the Wharton School, Philadelphia, PA David R. Bright 64 Retired, Executive Vice President Meridian Bancorp 2002 2006 Philadelphia, PA Joseph T. Drennan 60 Mulberry Consulting Group 2004 2008 Ardmore, PA L. Armstead Edwards 62 Co-Chairman, 1993 2004 United Bancshares, Inc. Owner and President, P.A.Z., Inc. Philadelphia, Pennsylvania Marionette Y. Wilson(Frazier) 59 Retired as Partner, 1996 2004 John Frazier, Inc. Philadelphia, Pennsylvania Angela M. Huggins 62 Treasurer, 1993 2005 United Bancshares, Inc. Retired as Vice President Real Estate Affairs RMS Technologies, Inc.
36
Principal occupation and Year first Term Name Age other directorships became director will expire - ---- --- --------------------------- --------------- ----------- William B. Moore 61 Secretary, United Bancshares, Inc. Pastor, Tenth Memorial 1993 2007 Baptist Church Philadelphia, Pennsylvania Steven L. Sanders 43 President and Co-CEO, MDL Capital 2002 2006 Evelyn F. Smalls 58 President and CEO of Registrant 2000 2007 and United Bank of Philadelphia Ernest L. Wright 75 Founder, President and 1993 2004 CEO of Ernest L. Wright Construction Company Philadelphia, Pennsylvania
(b) Executive Officers of Registrant and Bank
Name Age Office - ---- --- ------ Evelyn F. Smalls 58 President and Chief Executive Officer Brenda M. Hudson-Nelson 42 Executive Vice President/Chief Financial Officer L. Armstead Edwards 62 Chairman, Board of Directors Steven L. Sanders 43 Vice Chairman, Board of Directors William B. Moore 61 Secretary Marionette Y. Frazier 59 Assistant Secretary Angela M. Huggins 62 Treasurer
(c) Family Relationships. There are no family relationships between any director, executive officer or person nominated or chosen by the UBS or the Bank to become a director or executive officer. (d) Other There have been no events under any bankruptcy act, no criminal proceedings and no judgments or injunctions material to the evaluation of the ability and integrity of any director or executive officer during the past five years. 37 INFORMATION ABOUT THE AUDIT COMMITTEES Information about the Company's Audit/Compliance Committee The Audit/Compliance Committee, comprised of Angela M. Huggins (Chairman), L. Armstead Edwards, James F. Bodine(retired-July 2003), Marionette Y. Frazier and William B. Moore, meets when necessary at the call of the Chairman. The Committee meets with the internal auditor to review audit programs and the results of audits of specific areas, as well as other regulatory compliance issues. In addition, the Committee meets with UBS' independent certified public accountants to review the results of the annual audit and other related matters. Each member of the Committee is "independent" as defined in the applicable listing standards of the National Association of Securities Dealers ("NASDAQ"). The Committee held ten (10 ) meetings during 2003. In 2003, the Compliance Committee was combined with the Audit Committee and is comprised of the same members. On a quarterly basis compliance matters are addressed to included the review of regulatory compliance matters, the Bank's compliance programs and the Community reinvestment Act( CRA) activities. Information about the Bank's Audit/Compliance Committee and Financial Expert The Audit/Compliance Committee comprised of Angela M. Huggins (Chairman), L. Armstead Edwards, James F. Bodine (retired-July 2003), William B. Moore, William C. Green and Marionette Y. Frazier meets at least quarterly. The Audit/Compliance Committee meets with the internal auditor to review audit programs and the results of audits of specific areas, as well as other regulatory compliance issues. In addition, the Audit/Compliance Committee meets with the Bank's independent certified public accountants to review the results of the annual audit and other related matters, with the internal auditor to review audit programs and the results of audits of specific areas, as well as other regulatory compliance issues. In addition, the Audit/Compliance Committee meets with the independent certified public accountants to review the results of the annual audit and other related matters. Each member of the Audit/Compliance Committee is "independent" as defined in the applicable listing standards of the National Association of Securities Dealers. The Committee held ten (10 ) meetings during 2003. In 2003, the Compliance Committee was combined with the Audit Committee and is comprised of the same members. On a quarterly basis compliance matters are addressed to included the review of regulatory compliance matters, the Bank's compliance programs and the Community reinvestment Act( CRA) activities. Each member of the Audit/Compliance Committee is independent and financially literate as defined by NASDAQ. The Board of Directors of the Company and the Bank have determined that Joseph T. Drennan(1) is the "Financial Expert," as defined in the SEC's regulations. - ------------- (1) Please note that Mr. Drennan was elected to the Company's and the Bank's Boards of Directors and the Audit Committees of those Board's of Directors on March 24, 2004, and assumed his duties as a Financial Expert of the Audit Committees the Company's and the Bank's Boards of Directors Boards on that date. 38 INFORMATION ABOUT THE COMMITTEES OF THE BOARDS Under UBS' By-Laws, persons elected by the Board of Directors to fill a vacancy on the Board serve as directors for the balance of the term of the director who that person succeeds. The Board of Directors of UBS and the Board of Directors of the Bank meet when necessary. The Executive Committee of the Bank meets in those months when the Board of Directors does not meet. The Executive Committees of UBS and the Bank act in the stead of the Boards of Directors of UBS and the Bank, respectively, and exercise the authority and powers of the Boards of Directors at intervals between meetings of the Boards of Directors insofar as may be permitted by law and have responsibility for the nomination of new directors. The Asset and Liability Management Committee of the Bank's Board meets for the purpose of managing and monitoring the Bank's exposure to interest rate risks, market risk and liquidity risk. UBS' and the Bank's Audit/Compliance Committees interface with UBS' and the Bank's independent certified public accountants to review the results of the annual audit as well as regulatory compliance matters. UBS' Board of Directors does not have a Compensation Committee of the Board since it has no employees, and does not have a Nominating Committee. General Information About UBS' and Bank's Boards of Directors UBS' Board of Directors meets when necessary and during 2003 held eleven (11) meetings, including UBS' organization meeting. The Bank's Board of Directors was scheduled to meet at least monthly, except in August. Information About the Committees of UBS' Board of Directors The Committees of UBS' Board of Directors are the Executive Committee and the Audit/Compliance Committee. The Executive Committee comprised of L. Armstead Edwards (Chairman), Steven L. Sanders(Vice Chairman), Angela M. Huggins, William B. Moore, Evelyn F. Smalls, and Marionette Y. Frazier meets, when necessary, at the call of the Chairman, and to exercise the authority and powers of UBS' Board of Directors at intervals between meetings of the Board of Directors insofar as may be permitted by law. The Executive Committee held eleven (11) meetings during 2003. For information about UBS' and the Bank's Audit/Compliance Committees refer to "INFORMATION ABOUT THE AUDIT COMMITTEES" above. Meetings of UBS' Board and its Committees The total number of meetings of UBS' Board of Directors, which were held in 2003 was eleven (11). All of the incumbent directors, who were directors during 2003 (i) attended at least seventy-five percent (75%) of the total number of meetings. Information About Committees of the Bank's Board of Directors The Committees of the Bank's Board of Directors are the Executive, Asset and Liability Management, the Audit/Compliance Committees, and the Loan Committee. The Executive Committee comprised of L. Armstead Edwards (Chairman), Steven L. Sanders (Vice Chairman), Angela M. Huggins, William B. Moore, Evelyn F. Smalls and Marionette Y. Frazier meets, when necessary, at the call of the Chairman, to discuss and approve certain human resource matters including compensation, to ratify and approve certain of the Bank's loans and to exercise the authority and powers of the Bank's Board of Directors at intervals between meetings of the Board of Directors insofar as may be permitted by law. The Executive Committee held eleven (11) meetings during 2003. The Bank's Board of Directors does not have a Compensation Committee but the Executive Committee performs that function. The Asset and Liability Management Committee comprised Bernard E. Anderson (Chairman), L. Armstead Edwards, Angela M. Huggins, Evelyn F. Smalls and Ernest L. Wright meets quarterly to review and manage the Bank's exposure to interest rate risk, market risk and liquidity risk. During 2003, the Asset and Liability Management Committee held four (4) meetings. The Loan Committee, comprised of David R. Bright (Chairman) L. Armstead Edwards, Ernest L. Wright, and Evelyn F. Smalls meets when necessary to review and approve loans that are $200,000 and over and to discuss other related loan matters. The Committee held 9 (nine) meetings during 2003. For information about UBS' and the Bank's Audit/Compliance Committees refer to "INFORMATION ABOUT THE AUDIT COMMITTEES" above. 39 Meetings of UBS' and the Bank's Board and its Committees The total number of meetings of the Bank's Board of Directors that were held in 2003 was eleven (11). All incumbent directors (i) attended at least seventy-five percent (75%) of the total number of meetings of the Board of Directors. BOARDS OF DIRECTORS COMPENSATION Directors Fees The normal non-officer director fee paid by the Bank is Three Hundred Fifty Dollars ($350) for attending each Board meeting and One Hundred Seventy-five Dollars ($175) per quarter for attending the Board of Directors' Committee meetings. Directors' fees are not paid to officer directors for attending Bank Board of Directors or Committee meetings. UBS does not pay any fees to any directors for attending UBS' Board of Directors or Committee meetings. Effective April 1, 2002, the Board of Directors elected to waive all fees for an indefinite period of time. UBS'S AND BANK'S EXECUTIVE OFFICERS The following table sets forth certain information with respect to the current executive officers of UBS and Bank as of March 15, 2004:
UBS Stock Name, Principal Occupation and Age as of Beneficially Business Experience For Past 5 Years March 15, 2004 Office with the UBS and/or Bank Owned ------------------------------------- -------------- ------------------------------- ------------ Evelyn F. Smalls(1)(2) 58 President and Chief Executive Officer and 450 Director of UBS and Bank Brenda M. Hudson-Nelson (3) 42 Executive Vice President and 50 Chief Financial Officer of UBS and Bank
- ------------------ Footnote Information Concerning Executive Officers (1) Ms. Smalls was elected as a director and was appointed as President and Chief Executive Officer in June 2000. Prior to that, Ms. Smalls was Senior Vice President of Human Resources and Compliance from October 1993 to May 2000. (2) The President and Chief Executive Officer, currently Evelyn F. Smalls, acts as Trustee of certain voting trust agreements (the "Voting Trusts") pursuant to which Fahnstock, Inc deposited 5,209 shares of Common Stock of UBS. (3) Ms. Hudson-Nelson was appointed Senior Vice President and Chief Financial Officer in June 2000. Prior to that, Ms. Hudson-Nelson was Vice President and Controller from January 1992 to May 2000. In May 2002, Ms. Hudson-Nelson was promoted to Executive Vice President and Chief Financial Officer. The Board of Directors of the Company and the Bank has determined that all of its members are independent and meet the independence requirements of THE NASDAQ Stock Market ("NASDAQ") except Evelyn F. Smalls. Because Ms. Smalls is the President and Chief Executive Officer of the Company and the Bank she is not independent as defined by NASDAQ. CODE OF ETHICS The Company and the Bank has adopted a Code of Business Conduct and Ethics (the "Code") that applies to all its directors, employees and officers and including its Chief Executive Officer and its Chief Financial Officer. The Code meets the requirement of a code of ethics for the Company's and the Bank's principal executive officer and principal financial officer or persons performing similar functions under Item 406 of the SEC's Regulation S-K. Any amendments to the Code, or any waivers of the Code for directors or executive officers will be disclosed promptly on a Form 8-K filed with the SEC or by any other means approved by the SEC. The Company will provice, without charge, a copy of its Code of Business Conduct and Ethics to any person who requests a copy of the Code. A copy of the Code may be requested by writing to the President of the Company at United Bank of Philadelphia at 300 North Third Street, Philadelphia, PA 19106-1101 40 SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934, as amended, requires that UBS' directors and executive officers file reports of their holdings of UBS' Common Stock with the Securities and Exchange Commission (the "Commission"). Based on UBS' records and other information available to UBS believes that the Commission's Section 16(a) reporting requirements applicable to UBS' directors and executive officers were complied with for UBS' fiscal year ended December 31, 2003. There were no reportable transactions during this period." ITEM 11 -- EXECUTIVE COMPENSATION The following information relates to all plan and non-plan compensation awarded to, earned by, or paid to (i) Evelyn F. Smalls, the President and Chief Executive Officer of the Bank , and (ii) Brenda M. Hudson-Nelson, Executive Vice President and Chief Financial Officer of the Bank, the only persons who were serving as executive officers of the Bank at December 31, 2003 (Ms. Smalls and Ms. Hudson-Nelson are hereinafter sometimes collectively referred to as the "Named Executive Officers"). (1) UBS' executives are not compensated for their services to UBS rather, because the Bank is the principal subsidiary of UBS, they are compensated as officers of the Bank. Summary Compensation Table The disclosure regarding the compensation of the Bank's executives includes the following table that sets forth the compensation paid to the Named Executive Officers during the last three fiscal years.
Annual Compensation(1) ---------------------- Stock All Other Name and Principal Position During 2002 Year Salary Bonus Options Compensation(2) - --------------------------------------- ---- ------ ------- ------- --------------- ($) (#) ($) Evelyn F. Smalls 2003 $139,050 -- -- -- President and Chief Executive Officer 2002 $148,009 -- -- -- of UBS and the Bank 2001 $141,000 -- -- -- Brenda M. Hudson-Nelson 2003 $ 97,850 -- -- -- Executive Vice President and Chief Financial 2002 $102,112 -- -- -- Officer of UBS and the Bank 2001 $100,900 -- -- --
- ------------------ (1) Amounts are not included in the Bonus, Stock Option and All Other Compensation columns of the table because no compensation of this nature was paid by UBS or the Bank and the restricted stock awards and long term incentive payouts columns are not included in the Compensation Table since these benefits are not made available by UBS or the Bank. (2) The Commission's compensation disclosure rules require the use, where applicable, of a series of tables to describe various types of compensation paid to the specified executive officers. The use of a specific table or column in a table is not required by the Commission's rules if no compensation was paid or awarded to the named executives. Only the tables or columns required to be used by the Commission's rules, because of the compensation paid to the specified executive officers, have been used in this Proxy Statement. 41 Executive Employment Agreements The Bank entered into an Employment Agreement with Evelyn F. Smalls dated June 12, 2000 to serve as the Bank's President and Chief Executive Officer. The initial term of the Employment Agreement is two (2) years, unless extended or terminated. In June 2002, the Employment Agreement was extended for two (2) years. The Employment Agreement provides for an annual base salary of $135,000 that may be increased, but not decreased. Under her Employment Agreement, Ms. Smalls has an opportunity to receive an annual initial cash bonus (the "Initial Cash Bonus") of 12% of her annual base salary and an annual additional cash bonus (the "Additional Cash Bonus") of 12% of her annual base salary in calendar years 2002 and 2003, based on performance targets specified in the Employment Agreement which are based on the annual earnings of the Bank. The Bank entered into an Employment Agreement with Brenda M. Hudson-Nelson dated June 12, 2000 to serve as the Bank's Senior Vice President and Chief Financial Officer. The initial term of the Employment Agreement is two (2) years, unless extended or terminated. In June 2002, the Employment Agreement was extended for two (2) years. The Employment Agreement provides for an annual base salary of $95,000 that may be increased, but not decreased. Under her Employment Agreement, Ms. Hudson-Nelson has an opportunity to receive an annual initial cash bonus (the "Initial Cash Bonus") of 12% of her annual base salary and an annual additional cash bonus (the "Additional Cash Bonus") of 12% of her annual base salary in calendar years 2000 and 2001, based on performance targets specified in the Employment Agreement which are based on the annual earnings of the Bank. Equity Compensation Plan Information The Company adopted a Stock Option Plan in 1998. Under this Plan, options to acquire shares of common stock were granted to the former chief executive officer. The Stock Option Plan provides for the granting of options at the fair market value of the Company's common stock at the time the options are granted. Each option granted under the Stock Option Plan may be exercised within a period of ten years from the date of grant. However, no option may be exercised within one year from the date of grant. In 1998, options to purchase 29,694 shares of the Company's common stock at a price of $8.54 per share were awarded to the former chief executive officer. Equity Compensation Plan Table
- -------------------------------------------------------------------------------------------------- (a) (b) (c) - -------------------------------------------------------------------------------------------------- Plan Category Number of Securities Weighted average Number of securities to be issued upon exercise price remaining available for exercise of of outstanding future issuance under equity outstanding options, options, warrants, compensation plans warrants and rights and rights (excluding securities reflected in column (a)) - -------------------------------------------------------------------------------------------------- Equity compensation plans 29,694 $8.54 70,306 approved by security holders - -------------------------------------------------------------------------------------------------- Equity compensation plans not - - - approved by security holders - -------------------------------------------------------------------------------------------------- Total 29,694 $8.54 70,306 ==================================================================================================
42 ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth certain information known to UBS, as of March 15, 2004 (1), with respect to the only persons to UBS' knowledge, who may be beneficial owners of more than 5% of UBS' Common Stock. Percentage of Amount and Nature of Outstanding Beneficial Ownership Corporation Name and Address of Corporation Common Stock of Beneficial Owner Common Stock Owned - ------------------------------------------------------------------------------- Philadelphia Municipal 71,667 8.67% Retirement System 2000 Two Penn Center Philadelphia, Pennsylvania 19102 Wachovia Corporation(2) 50,000 6.05% 1 Wachovia Center Charlotte, NC 28288 - ------------------ (1) As of March 15, 2004, there were 826,922 shares of UBS' voting Common Stock outstanding. (2) Wachovia Corporation owns 241,666 shares of UBS Common Stock of which 50,000 are voting shares. ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Some of the directors and executive officers of the UBS and Bank and the entities with which they are associated were customers of and had banking transactions with the Bank in the ordinary course of its business during the year 2003. All loans and commitments to lend were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. In the opinion of Bank management, the transactions and loan commitments did not involve more than normal risk of collectively or present other unfavorable features. ITEM 14 -- Principal Accountanting Fees and Services The following table presents the fees for each of the last two fiscal years for the principal accounts of UBS by category: 2003 2002 --------- -------- Audit Fees............................ $ 83,500 $ 73,500 Audit-related fees.................... 15,750 13,500 Tax fees.............................. 7,000 4,500 All other fees........................ - - -------- -------- Total fees......................... $106,250 $ 91,500 ======== ======== The Audit Committee pre-approves all auditing services and permitted non-audit services (including the fees and terms thereof) to be performed for UBS by its independent auditor, subject to the minimus exceptions for non-audit services described in Section 10A (I) (1) (B) of the Exchange Act which are approved by the Committee prior to the completion of the audit. The Audit Committee may form and delegate authority to subcommittees consisting of one or more members when appropriate, including the authority to grant pre-approvals of audit and permitted non-audit services, provided that decisions of such subcommittee to grant pre-approvals shall be presented to the full Audit Committee at its next scheduled meeting. 43 PART IV ITEM 15 -- EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K The following documents are filed as part of this report of United Bancshares, Inc.: (a) 1. Financial Reports of United Bancshares, Inc. Page -------------------------------------------- ---- Report of Independent Certified Public Accountants, March 15, 2004...51 Consolidated Balance Sheets at December 31, 2003 and 2002............52 Consolidated Statements of Operations for the three years ended December 31, 2003.................................................53 Consolidated Statements of Changes in Shareholders' Equity for the three years ended December 31, 2003..............................54 Consolidated Statements of Cash Flows for the three years ended December 31, 2003................................................55 Notes to Consolidated Financial Statements...........................56 2. Financial Statement Schedules Financial Statement Schedules are omitted because the required information is either not applicable, not required or is shown in the respective financial statements or in the notes thereto. 4. The following Exhibits are filed herewith or incorporated by reference as a part of this Annual Report: Exhibit Number Item -------------- ---- (3(i)) Articles of Incorporation (Incorporated by reference to Registrant's 1998 Form 10-K). (3(ii)) Bylaws (Incorporated by reference to Registrant's 1997 Form 10-K). (9.1) Voting Trust Agreement with NationsBank (Incorporated by reference to Registrant's 1997 Form 10-K). (9.2) Voting Trust Agreement with Fahnstock (Incorporated by reference to Registrant's 1997 Form 10-K). (10) Material Contracts a) Lease for branch office located at Two Penn Center (Incorporated by reference to Registrant's 2002 Form 10K) b) Lease for branch office located at 1620 Wadsworth Avenue (Incorporated by reference to Registrant's 2002 Form 10K) c) Lease for branch office located at 3750 Lancaster Avenue (Incorporated by reference to Registrant's 2002 Form 10K) d) Lease for branch office located at 1015 North Broad Street (Incorporated by reference to Registrant's 2002 Form 10K) e) Evelyn F. Smalls' Employment Agreement (Incorporated by reference to Registrant's 2002 Form 10K) f) Brenda Hudson-Nelson's Employment Agreement (Incorporated by reference to Registrant's 2002 Form 10K) 44 g) Brokerage Services Agreement (Dual Employee Program) by and between UVEST Financial Services Group, Inc. and the United Bank of Philadelphia, dated July 17, 2002 (Incorporated by reference to Registrant's 2002 Form 10K). h) Long Term Incentive Compensation Plan (Incorporated by reference to Registrant's 1992 Form 10) (11) Statement of Computation of Earnings Per Share. Included at Footnote 16 of the Financial Statements hereof. (12) Statement of Computation of Ratios. Included at Footnote 14 of the Financial Statements hereof. c) Not applicable. (13) Annual Report to Security Holders (14) Code of Ethics (21) Subsidiaries of Registrant Name State of Incorporation ---- ---------------------- United Bank of Philadelphia Pennsylvania (31) Certification of Annual Report (31.1) Certification of the Chief Executive Officer Pursuant to Section 302 of the Sabanes-Oxley Act of 2002. (31.2) Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (32) Certification Pursuant to issue of Section 1350 (A) Exhibit 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of the Chief Executive Officer. (B) 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 of the Chief Financial Officer. (99) Additional Exhibits (A) Exhibit 99 Registrants Proxy Statement for its Annual Shareholders Meeting held on July 25, 2003 is attached hereto as Exhibit 99(A). b) No reports on Form 8-K have been filed during the last quarter covered by this report. 45 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. UNITED BANCSHARES, INC. /s/ Evelyn F. Smalls ------------------------------------------- Evelyn F. Smalls, President & CEO, Director Date: March 30, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Corporation and in the capacities and on the date indicated. DATE ---- /s/ Evelyn F. Smalls March 30, 2004 - ------------------------------------------- Evelyn F. Smalls, President & CEO, Director /s/ Brenda M. Hudson-Nelson March 30, 2004 - ------------------------------------------ Brenda M. Hudson-Nelson, EVP, CFO /s/ L. Armstead Edwards March 30, 2004 - ------------------------------------------ L. Armstead Edwards, Chairman, Director /s/ Steven L. Sanders March 30, 2004 - ------------------------------------------ Steven L. Sanders, Vice Chairman, Director /s/ Marionette Y. Wilson(Frazier) March 30, 2004 - ------------------------------------------ Marionette Y. Wilson(Frazier), Assistant Secretary, Director /s/ Angela M. Huggins March 30, 2004 - ------------------------------------------ Angela M. Huggins, Treasurer, Director /s/ William B. Moore March 30, 2004 - ------------------------------------------ William B. Moore, Secretary, Director /s/ Bernard E. Anderson March 30, 2004 - ------------------------------------------ Bernard E. Anderson, Director /s/ David R. Bright March 30, 2004 - ------------------------------------------ David R. Bright, Director /s/ Joseph T. Drennan March 30, 2004 - ------------------------------------------ Joseph T. Drennan, Director /s/ Ernest L. Wright March 30, 2004 - ------------------------------------------ Ernest L. Wright, Director 46 Report of Independent Certified Public Accountants Shareholders and Board of Directors United Bancshares, Inc. and Subsidiary We have audited the accompanying consolidated balance sheets of United Bancshares, Inc. and Subsidiary as of December 31, 2003 and 2002, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of United Bancshares, Inc. and Subsidiary as of December 31, 2003 and 2002, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. The accompanying financial statements have been prepared assuming the Bank will continue as a going concern. As discussed in Note 2 to the financial statements the Bank entered into a written agreement (Agreement) with its primary regulators dated February 23, 2000. As of December 31, 2003 the Bank was not in compliance with certain requirements of the Agreement. Not meeting these requirements, losses incurred in the current year and the results of a recent regulatory examination, could expose the Bank to possible further regulatory actions. As more fully discussed in Note 2, these matters raise substantial doubt about the Bank's ability to continue as a going concern. The ability of the Bank to continue as a going concern is dependent on many factors, including achieving the required capital levels, earnings and fully complying with the Agreement. Management's plans with respect to these matters are also described in Note 2. The accompanying financial statements do not include any adjustments that might result from the outcome of this uncertainty. /s/ GRANT THORNTON LLP Philadelphia, Pennsylvania February 27, 2004 49 United Bancshares, Inc. and Subsidiary CONSOLIDATED BALANCE SHEETS December 31,
Assets 2003 2002 ------------ ------------ Cash and due from banks...................................................... $ 4,318,584 $ 4,541,667 Interest-bearing deposits with banks......................................... 874,362 865,421 Federal funds sold........................................................... 1,500,000 10,122,000 ----------- ----------- Cash and cash equivalents.......................................... 6,692,946 15,529,088 Investment securities: Available-for-sale, at fair market value................................. 8,933,216 14,334,360 Held-to-maturity, at amortized cost (fair market value of $6,772,762 and $7,442,870 in 2003 and 2002, respectively)........................ 6,703,476 7,183,403 Loans, net of unearned discount of $43,181 and $87,124 in 2003 and 2002, respectively................................................... 47,028,397 44,133,190 Less allowance for loan losses............................................... (338,574) (674,550) ----------- ----------- Net loans.......................................................... 46,689,823 43,458,640 Bank premises and equipment, net............................................. 2,772,153 2,612,608 Accrued interest receivable.................................................. 380,583 555,006 Intangible assets............................................................ 1,738,436 1,937,221 Prepaid expenses and other assets............................................ 806,734 433,793 ----------- ----------- Total assets....................................................... $74,717,367 $86,044,119 =========== =========== Liabilities and Shareholders' Equity Liabilities: Demand deposits, noninterest-bearing..................................... $16,112,983 $20,453,455 Demand deposits, interest-bearing........................................ 10,430,349 12,837,464 Savings deposits......................................................... 19,309,126 20,494,208 Time deposits, under $100,000............................................ 10,349,830 10,882,722 Time deposits, $100,000 and over......................................... 10,914,535 12,261,455 ----------- ----------- 67,116,823 76,929,304 Accrued interest payable................................................. 77,775 156,219 Accrued expenses and other liabilities................................... 287,876 458,455 ----------- ----------- Total liabilities.................................................. 67,482,474 77,543,978 ----------- ----------- Shareholders' equity: Series A preferred stock, noncumulative, 6%, $0.01 par value, 500,000 shares authorized; 136,842 issued and outstanding in 2003 and 2002, respectively; 6,308 shares held in treasury at December 31, 2003..................................................... 1,368 1,432 Common stock, $0.01 par value; 2,000,000 shares authorized; 1,068,588 and 1,102,088 issued and outstanding in 2003 and 2002, respectively.................................................... 10,686 11,021 Treasury Stock, 33,500 shares at December 31, 2003....................... - - Additional paid-in-capital............................................... 14,749,852 14,749,453 Accumulated deficit...................................................... (7,614,662) (6,499,197) Accumulated other comprehensive income .................................. 87,649 237,432 ----------- ----------- Total shareholders' equity......................................... 7,234,893 8,500,141 ----------- ----------- Total liabilities and shareholders' equity......................... $74,717,367 $86,044,119 =========== ===========
The accompanying notes are an integral part of these statements. 50 United Bancshares, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF OPERATIONS Year ended December 31,
2003 2002 2001 ------------ ------------ ------------ Interest income: Interest and fees on loans................................. $ 2,912,547 $ 3,006,367 $ 3,595,477 Interest on investment securities.......................... 805,655 1,446,072 1,750,549 Interest on federal funds sold............................. 97,599 169,071 281,540 Interest on time deposits with other banks................. 21,002 10,921 8,701 ----------- ---------- ---------- Total interest income................................ 3,836,803 4,632,431 5,636,267 ----------- ---------- ---------- Interest expense: Interest on time deposits.................................. 374,297 662,493 1,080,533 Interest on demand deposits................................ 83,267 114,399 178,059 Interest on savings deposits............................... 89,020 129,227 317,489 Interest on borrowed funds................................. - - 75 ----------- ---------- ---------- Total interest expense............................... 546,584 906,119 1,576,156 ----------- ---------- ---------- Net interest income.................................. 3,290,219 3,726,312 4,060,111 Provision for loan losses...................................... 565,000 175,000 335,000 ----------- ---------- ---------- Net interest income after provision for loan losses.. 2,725,219 3,551,312 3,725,111 ----------- ---------- ---------- Noninterest income: Gain on sale of loans...................................... 57,061 - - Customer service fees...................................... 1,653,008 1,927,838 2,202,489 Gain on sale of investments................................ - 25,789 78,456 Gain on sale of fixed assets............................... - 48,054 84,090 Other income............................................... 180,837 325,337 77,998 ----------- ---------- ---------- Total noninterest income............................. 1,890,906 2,327,018 2,443,033 ----------- ---------- ---------- Noninterest expense: Salaries, wages and employee benefits...................... 2,204,583 2,344,746 2,664,660 Occupancy and equipment.................................... 1,224,719 1,293,803 1,609,539 Office operations and supplies............................. 453,202 433,557 454,200 Marketing and public relations............................. 113,552 82,692 109,367 Professional services...................................... 220,765 283,671 232,662 Data processing............................................ 661,939 639,854 808,012 Deposit insurance assessments.............................. 33,501 36,258 150,042 Other operating............................................ 819,329 980,332 1,009,165 ----------- ---------- ---------- Total noninterest expense............................ 5,731,590 6,094,913 7,037,647 ----------- ---------- ---------- Net loss............................................. $(1,115,465) $ (216,583) $ (869,503) =========== ========== ========== Net loss per common share--basic and diluted.................... $ (1.03) $ (0.20) $ (0.79) =========== ========== ========== Weighted average number of common shares....................... 1,084,694 1,101,247 1,099,520 =========== ========== ==========
The accompanying notes are an integral part of these statements. 51 United Bancshares, Inc. and Subsidiary CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY Years ended December 31, 2003, 2002 and 2001
Series A Accumulated Total Compre- preferred stock Common stock Additional other share- hensive ---------------- ------------------ paid-in Accumulated comprehensive holders' income Shares Amount Shares Amount capital deficit income (loss) equity (loss) -------- ------ -------- -------- ----------- ------------ ------------ --------- ------ Balance at December 31, 2000........ 143,150 $1,432 1,099,421 $10,994 $14,717,484 $(5,413,111) $ 32,710 $9,349,509 Proceeds from issuance of common stock....... 967 10 11,586 11,596 Unrealized gains on investment securities. 66,109 66,109 $ 66,109 Net loss............... (869,503) (869,503) (869,503) ------- ------ --------- ------- ----------- ----------- ---------- ---------- ----------- Total comprehensive income (loss)............ $ (803,394) =========== Balance at December 31, 2001........ 143,150 1,432 1,100,388 11,004 14,729,070 (6,282,614) 98,819 8,557,711 Proceeds from issuance of common stock....... 1,700 17 20,383 20,400 Unrealized gains on investment securities. 138,613 138,613 138,613 Net loss.............. (216,583) (216,583) (216,583) ------- ------ --------- ------- ----------- ----------- ---------- ---------- ----------- Total comprehensive income (loss)............ $ (77,970) =========== Balance at December 31, 2002........ 143,150 1,432 1,102,088 11,021 14,749,453 (6,499,197) 237,432 8,500,141 Treasury Stock......... (6,408) (64) (33,500) (335) 399 - Unrealized losses on investment securities. (149,783) (149,783) (149,783) Net loss.............. (1,115,465) (1,115,465) (1,115,465) ------- ------ --------- ------- ----------- ----------- ---------- ---------- ----------- Total comprehensive income (loss)............ $(1,265,248) =========== Balance at December 31, 2003........ 36,842 $1,368 1,068,588 $10,686 $14,749,852 $(7,614,662) $ 87,649 $7,234,893 ======= ====== ========= ======= =========== ============ ========== ==========
The accompanying notes are an integral part of this statement. 52 United Bancshares, Inc. and Subsidiary CONSOLIDATED STATEMENTS OF CASH FLOWS Year ended December 31,
2003 2002 2001 ------------ ------------ ------------ Cash flows from operating activities: Net loss................................................... $ (1,115,485) $ (216,583) $ (869,503) Adjustments to reconcile net loss to net cash (used in)provided by operating activities: Provision for loan losses............................... 565,000 175,000 335,000 Gain on sale of loans................................... (57,061) - Gain on sale of fixed assets............................ - (48,054) (84,090) (Gain)loss on sale of investment securities............. - (25,789) (78,456) Depreciation and amortization........................... 688,247 673,361 772,742 (Increase) decrease in accrued interest receivable and other assets......................................... (198,518) 702,412 (35,995) Decrease in accrued interest payable and other liabilities.................................... (249,024) (73,151) (257,763) ------------ ------------ ------------ Net cash (used in) provided by operating activities.. (366,820) 1,187,196 (218,065) ------------ ------------ ------------ Cash flows from investing activities: Purchase of available-for-sale investments................. (3,200,237) (10,792,294) (14,859,870) Purchase of held-to-maturity investments................... (3,510,938) (2,247,096) (3,145,558) Proceeds from maturity and principal reductions of available-for-sale investments.......................... 8,414,626 9,936,685 8,674,401 Proceeds from maturity and principal reductions of held-to-maturity investments............................ 3,967,709 6,568,297 15,315,665 Proceeds from sale of investments available-for-sale....... - 1,091,063 3,487,208 Proceeds from sale of student loans........................ 3,054,429 - - Purchase of loans from other financial institutions........ (9,325,656) - - Net (increase)decrease in loans............................ 2,532,105 (1,341,919) 2,116,573 Purchase of premises and equipment......................... (588,878) (182,004) (78,265) ------------ ------------ ------------ Net cash used in investing activities................ 1,343,161 3,032,732 11,510,154 ------------ ------------ ------------ Cash flows from financing activities: Net decrease in deposits................................... (9,812,482) (2,493,218) (3,815,587) Net proceeds from issuance of common stock................. - 20,400 11,596 ------------ ------------ ------------ Net cash used in financing activities................ (9,812,482) (2,472,818) (3,803,991) ------------ ------------ ------------ Net (decrease) increase in cash and cash equivalents. (8,836,142) 1,747,110 7,488,098 ------------ ------------ ------------ Cash and cash equivalents at beginning of year................. 15,529,088 13,781,978 6,293,880 ------------ ------------ ------------ Cash and cash equivalents at end of year....................... $ 6,692,946 $ 15,529,088 $ 13,781,978 ============ ============ ============ Supplemental disclosure of cash flow information: Cash paid during the year for interest..................... $ 468,141 $ 1,013,450 $ 1,542,963 ============ ============ ============
The accompanying notes are an integral part of these statements. 53 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2003, 2002, and 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The consolidated financial statements include the accounts of United Bancshares, Inc. (the Company) and its wholly owned subsidiary, United Bank of Philadelphia (the Bank). All significant intercompany transactions and balances have been eliminated. Statement of Cash Flows For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold on an overnight basis. Securities Held-to-Maturity Bonds, notes, and debentures for which the Bank has both the positive intent and ability to hold to maturity are classified as held-to-maturity and carried at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity. Securities Available-for-Sale Available-for-sale securities consist of bonds, notes and debentures, and certain equity securities for which the Bank does not have positive intent to hold to maturity. These securities are carried at fair value. Unrealized holding gains and losses on securities classified as available-for-sale are carried as a separate component of shareholders' equity net of related income tax effects. Gains and losses on the sale of available-for-sale securities are determined by the specific identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. Derivative Note for Investment Securities The Bank adopted the provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133), as amended, as of January 1, 2001. The statement requires the Company to recognize all derivative instruments at fair value as either assets or liabilities. Financial derivatives are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship. The Bank does not have any derivative instruments at December 31, 2003, 2002 or 2001. The Bank adopted EITF 03-1, The Meaning of Other than Temporary Impairment and Its Application to Certain Investments, as of December 31, 2003. EITF 03-1 includes certain disclosures regarding quantitative and qualitative disclosures for investment securities accounted for under FAS 115, Accounting for Certain Investments in Debt and Equity Securities, that are impaired at the balance sheet date, but an other-than-temporary impairment has not been recognized. The disclosures under EITF 03-1 are required for financial statements for years ending after December 15, 2003 and are included in these financial statements. (Continued) 54 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued Loans The Bank has both the positive intent and ability to hold its loans to maturity. These loans are stated at the amount of unpaid principal, reduced by net unearned discount and an allowance for loan losses. Interest income on loans is recognized as earned based on contractual interest rates applied to daily principal amounts outstanding and accretion of discount. It is the Bank's policy to discontinue the accrual of interest income when a default of principal or interest exists for a period of 90 days except when, in management's judgment, the collection of principal and interest is reasonably anticipated or adequate collateral exists. Interest received on nonaccrual loans is either applied against principal or reported as interest income according to management's judgment as to collectibility of principal. When interest accruals are discontinued, interest credited to income is reversed and the loan is classified as nonperforming. Unearned discount is amortized over the weighted average maturity of the mortgage loan portfolio. Loan origination and commitment fees and certain direct loan origination costs are deferred, and the net amount is amortized as an adjustment of the related loan's yield. The Bank is amortizing these amounts over the contractual life of the loan. 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 December 31, 2003, the Company was contingently liable on financial and performance standby letters of credit totaling $57,000, none of which were originated 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. Loans Held-for-Sale 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. The Bank accounts for its transfers and servicing financial assets in accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 140 revises the standards for accounting for transfers of financial assets and collateral. Transfers of financial assets, for which the Bank has surrendered control, are accounted for as sales to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. Retained interests in a sale of financial assets are measured at the date of transfer by allocating the previous carrying amount between the assets transferred and based on their relative estimated fair values. The fair values of retained servicing rights and any other retained interests are determined based on the present value of expected future cash flows associated with those interests and by reference to market prices for similar assets. Loans held-for-sale are carried at the aggregate of lower of cost or market value. The Bank had no loans held for sale as of December 31, 2003. (Continued) 55 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued For purchased loans, the discount remaining after the loan loss allocation is being amortized over the remaining life of the purchased loans using the interest method. Allowance for Loan Losses The Bank adopted Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan," and SFAS No. 118, "Accounting by Creditors for Impairment of a Loan Income Recognition and Disclosures." Under SFAS No. 114, the allowance for loan losses related to "impaired loans" is based on the discounted cash flows using the impaired loans' initial effective interest rate as the discount rate, or the fair value of the collateral for collateral-dependent loans. A loan is impaired when it meets the criteria to be placed on nonaccrual status. Loans that are evaluated for impairment pursuant to SFAS No. 114 are assessed on a loan-by-loan basis and include only commercial nonaccrual loans. Large groups of smaller, homogeneous loans, such as credit cards, student loans, residential mortgages, and other student loans, are evaluated collectively for impairment. The allowance for loan losses is maintained at a level considered adequate to provide for potential losses in the loan portfolio. The allowance is increased by provisions charged to operating expenses and reduced by charge-offs net of recoveries. Management's determination of the adequacy of the allowance is based on continuous credit reviews of the loan portfolio, consideration of the current economic conditions, review of specific problem loans, and other relevant factors. This evaluation is subjective as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. However, actual losses on specific loans, which are encompassed in the analysis, may vary from estimated losses. Bank Premises and Equipment Bank premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of the assets. Amortization of leasehold improvements is computed over the shorter of the related lease term or the useful life of the assets. On January 1, 2002, the Company adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 retains the existing requirements to recognize and measure the impairment of long-lived assets to be held and used or to be disposed of by sale. However, SFAS No. 144 makes changes to the scope and certain measurement requirements of existing accounting guidance. SFAS No. 144 also changes the requirements relating to reporting the effects of a disposal or discontinuation of a segment of a business. The adoption of this statement did not have an impact o n the financial condition or results of operations of the Company. Income Taxes The liability method is used in accounting for income taxes. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. (Continued) 56 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued Earnings (Loss) Per Share The Company follows the provisions of SFAS No. 128, which eliminates primary and fully diluted earnings per share (EPS) and requires presentation of basic and diluted EPS in conjunction with the disclosure of the methodology used in computing such EPS. Basic EPS excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. Diluted EPS takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock. Stock-based Compensation The Bank accounts for stock options under SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, which contains a fair value-based method for valuing stock-based compensation that entities may use, which measures compensation cost at the grant date based on the fair value of the award. Compensation is then recognized over the service period, which is usually the vesting period. Alternatively, SFAS No. 123 permits entities to continue accounting for employee stock options and similar equity instruments under Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees. Entities that continue to account for stock options using APB Opinion 25 are required to make pro forma disclosures of net income and earnings per share, as if the fair value-based method of accounting defined in SFAS No. 123 had been applied. At December 31, 2003, the Company had one stock-based employee compensation plan, which is more fully described in note 12. The Bank account for this plan under the recognition and measurement principles of APB No. 25, Accounting for Stock Issued to Employees, and related interpretations. Stock-based employee compensation costs are not reflected in net income, as all options granted under the plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings (loss) per share if the Bank had applied the fair value recognition provisions of SFAS No. 123, to stock-based employee compensation (in thousands, except per share amounts). Year ended December 31, ----------------------- (In thousands) 2003 2002 --------- --------- Net loss As reported.................................. $(1,115) $ (217) Less: Stock-based compensation costs determined under fair value-based Method for all awards............... - - Pro forma.................................... $(1,115) $ (217) Basic and Diluted loss per share As reported.................................. $ (1.03) $ (0.20) Pro forma.................................... $ (1.03) $ (0.20) (Continued) 57 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 1998: no dividends declared; expected volatility of 20%; a risk-free interest rate of 4.7%, and expected life of 10 years. Off-Balance-Sheet Financial Instruments In the ordinary course of business, the Bank has entered into off-balance-sheet financial instruments consisting of commitments to extend credit and letters of credit. Such financial instruments are recorded in the financial statements when they become payable. Financial Instruments The following methods and assumptions were used by the Bank in estimating its fair value disclosures for financial instruments: Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values. Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. Loans held-for-sale: Fair values are estimated using quoted rates based upon secondary market sources for similar loans. Loans: The fair value of loans was estimated using a discounted cash flow analysis, which considered estimated prepayments and amortizations. Prepayments and discount rates were based on current marketplace estimates and pricing. Residential mortgage loans were discounted at the current effective yield, including fees, of conventional loans, adjusted for their maturities with a spread to the Treasury yield curve. Deposit liabilities: The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings, and certain types of money market accounts) are equal to the amounts payable on demand at the reporting date (e.g., their carrying amounts). The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate the fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation. The Treasury Yield Curve was utilized for discounting cash flows as it approximates the average marketplace certificate of deposit rates across the relevant maturity spectrum. (Continued) 58 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued Commitments to extend credit: The carrying amounts for commitments to extend credit approximate fair value as such commitments are not substantially different from the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparts. Intangible Assets On September 24, 1999, the Bank acquired four branches from First Union Corporation with deposits totaling $31.5 million. As a result of the acquisition, the Bank recorded a core deposit intangible of 2,449,488. The core deposit intangible is being amortized over 14 years. Amortization totaled $178,078, $178,078 and $178,078 for the year ended December 31, 2003, 2002, and 2001, respectively. The Bank tested the core deposit intangible for impairment. No impairment has been recognized. On October 1, 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 147, "Acquisitions of Certain Financial Institutions." SFAS No. 147 removes acquisitions of financial institutions from the scope of SFAS 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions," and requires that those transactions be accounted for in accordance with SFAS No. 141, "Business Combinations and SFAS No. 142, "Goodwill and Intangible Assets." SFAS No. 147 also requires that the acquisition of a less-than-whole financial institution, such as a branch, be accounted for as a business combination if the transferred assets and activities constitute a business. In addition, SFAS No. 147 amends SFAS 144, "Accounting for the Impairment of Disposal of Long-Lived Assets," to include within its scope long-term customer relationship intangible assets of financial institutions such as depositor-relationship intangible assets. Foreclosed Real Estate Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management, and the real estate is carried at the lower of carrying amount or fair value less the cost to sell. Revenue and expenses from operations and changes in valuation allowance are charged to operations. The historical average holding period for such properties is 24 months. Management's Use of Estimates The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. (Continued) 59 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued Segments SFAS No. 131 establishes standards for the way public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in subsequent interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers. The statement requires that a public business enterprise report financial and descriptive information about its reportable operating segments. Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and assess performance. The statement also requires that public enterprises report a measure of segment profit or loss, certain specific revenue and expense items and segment assets. It also requires that information be reported about revenues derived from the enterprises' products or services, or about the countries in which the enterprises earn revenues and hold assets, and about major customers, regardless of whether that information is used in making operating decisions. The Company has one reportable segment, "Community Banking." All of the Company's activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the other. For example, commercial lending is dependent upon the ability of the Bank to fund itself with retail deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential mortgage lending. Accordingly, all significant operating decisions are based upon analysis of the Company as one operating segment or unit. Reclassifications Certain reclassifications have been made to the prior year's financial statements to conform to the 2003 presentation. Comprehensive Income The Bank follows SFAS No. 130, which establishes new standards for reporting comprehensive income that includes net income as well as certain other items that result in a change to equity during the period. These financial statements have been reclassified to reflect the provisions of SFAS No. 130. The income tax effects allocated to comprehensive income (loss) are as follows: (Continued) 60 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
December 31, 2003 ------------------------------------------ Before tax Tax Net of tax amount benefit(expense) amount ---------- --------------- ---------- Unrealized losses on securities Unrealized holding losses arising during period.... $ (223,555) $ 73,772 $(149,783) Less: reclassification adjustment for gains realized in net income.......................... - - - ---------- ---------- --------- Other comprehensive income(loss), net................. $ (223,555) $ 73,772 $(149,783) ========== ========== =========
December 31, 2002 ------------------------------------------ Before tax Tax Net of tax amount benefit(expense) amount ---------- --------------- ---------- Unrealized gains on securities Unrealized holding losses arising during period $ 232,674 $ (76,782) $ 155,892 Less: reclassification adjustment for gains realized in net income 25,789 (8,510) 17,279 ---------- --------- --------- Other comprehensive income, net $ 206,885 $ (68,272) $ 138,613 ========== ========== =========
December 31, 2001 ------------------------------------------ Before tax Tax Net of tax amount benefit(expense) amount ---------- --------------- ---------- Unrealized gains on securities Unrealized holding gains arising during period $ 177,126 $ (58,451) $ 118,675 Less: reclassification adjustment for gains realized in net income 78,456 (25,890) 52,566 ---------- ---------- --------- Other comprehensive income, net $ 98,670 $ (32,561) $ 66,109 ========== ========== =========
New Accounting Pronouncements In January 2003, FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"). FIN 46 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns, or both. FIN 46 also requires disclosures about variable interest entities that a company is not required to consolidate, but it which it has a significant variable interest. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to existing entities in the first fiscal year or interim period beginning after June 15, 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. (Continued) 61 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 2. REGULATORY AGREEMENT In February 2000, as a result of a regulatory examination completed in December 1999, the Bank entered into a Written Agreement (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 required 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: increasing profitability, consolidating branches, and soliciting new and additional sources of capital. Management continues to address all matters outlined in the Agreement. Failure to comply could result in additional regulatory supervision and/or actions. As of December 31, 2003, the Bank's tier one leverage capital ratio fell to 6.81%, below the 7% minimum capital ratio required by the Agreement. However, at February 29, 2004, the tier one leverage ratio had improved to 7.29% as a result of a $265,000 recovery on a previously charged-off loan. Management continues to review and revise its capital plan to address the development of new equity. One significant element of the Bank's capital plan is the sale of bank-owned property including the corporate offices located at 300 North 3rd Street and its remote parking lot. Both are scheduled to be sold in 2004 to generate substantial gains to re-capitalize the Bank. A regulatory examination completed in February 2004 determined that the Bank was not in compliance certain other elements of the Agreement including the implementation of a viable earnings/strategic plan and the timely charge-off/funding of the allowance for loan losses. Management believes that it has implemented corrective action where necessary including the adoption of an achievable strategic plan for 2004 and the charge-off of all loans for which the full collection appears unlikely. A profit restoration plan was developed and continues to be implemented. It includes among other things staff reductions/consolidations, salary reductions, reduction in branch operating hours, continued elimination of director fees, and the reduction of other operating expenses. Also, as part of the Bank's profit restoration plan, upon expiration of the lease in May 2004, the Bank's Two Penn Center branch will be closed and consolidated with other branches in the network to further reduce occupancy, personnel, and other operating cost. While expense reductions continue to be achieved, a greater impact will 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. Thus, while continuing to control expenses, management will place more focus on the implementation of business development strategies to increase the level of loans outstanding to achieve profitability. Also, revenue enhancement strategies have been employed to expand opportunities for fee income through the implementation of new products and services including corporate loan syndications where the Bank serves in the role of arranger and/or administrative agent. As a result of all of the actions referred to above, Management strongly believes that the Bank is now "substantially" in compliance with the Agreement's terms and conditions and will continue to operate as an independent financial institution for the foreseeable future. (Continued) 62 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 3. CASH AND DUE FROM BANK BALANCES The Bank maintains various deposit accounts with other banks to meet normal fund transaction requirements and to compensate other banks for certain correspondent services. The withdrawal or usage restrictions of these balances did not have a significant impact on the operations of the Bank as of December 31, 2002. 4. INVESTMENTS The amortized cost, gross unrealized holding gains and losses, and estimated market value of the available-for-sale and held-to-maturity investment securities by major security type at December 31, 2003 and 2002 are as follows:
2003 ------------------------------------------------------------- Gross Gross Amortized unrealized unrealized Market cost gains losses value ----------- ---------- ---------- ----------- Available-for-sale: U.S. Government agency securities...... $ 2,250,000 $ 5,705 $ $ 2,255,705 Mortgage-backed securities............. 6,157,392 130,575 (5,459) 6,282,508 ----------- ---------- -------- ----------- Total debt securities.................. 8,407,392 136,280 (5,459) 8,538,213 Investments in mutual funds............ 107,653 107,653 Other investments...................... 287,350 287,350 ----------- --------- -------- ----------- $ 8,802,395 $ 136,280 $ (5,459) $ 8,933,216 =========== ========= ======== =========== Held-to-maturity: U.S. Government agency securities...... $ 2,250,000 $ 7,907 $(24,845) $ 2,233,062 Mortgage-backed securities............. 4,453,476 93,147 (6,923) 4,539,700 ----------- ---------- -------- ----------- $ 6,703,476 $ 101,054 $(31,768) $ 6,772,762 =========== ========= ======== ===========
(Continued) 63 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 4. INVESTMENTS - Continued
2002 ------------------------------------------------------------- Gross Gross Amortized unrealized unrealized Market cost gains losses value ----------- ---------- ---------- ----------- Available-for-sale: Other Government securities............ $ 4,299,596 $ 62,189 $ $ 4,361,785 Mortgage-backed securities............. 9,286,548 292,187 9,578,735 ----------- ---------- -------- ----------- Total debt securities.................. 13,586,144 354,376 13,940,520 Investments in mutual funds............ 106,490 106,490 Other investments...................... 287,350 287,350 ----------- ---------- -------- ----------- $13,979,984 $ 354,376 $ - $14,334,360 =========== ========== ======== ============ Held-to-maturity: Other Government securities............ $ 500,000 $ 8,985 $ $ 508,985 Mortgage-backed securities............. 6,683,403 250,482 6,933,885 ----------- ---------- -------- ----------- $ 7,183,403 $ 259,467 $ - $ 7,442,870 =========== ========== ======== ===========
The table below indicates the length of time individual securities, both held-to-maturity and available-for-sale, have been in a continuous unrealized loss position at December 31, 2003 (in thousands):
Less than 12 months 12 months or longer Total Number ---------------------- ----------------------- --------------------- Description of of Fair Unrealized Fair Unrealized Fair Unrealized Securities securities value losses value losses value losses ------------------- ------------ -------- ----------- -------- ---------- ------ ---------- U.S. Government agency securities 3 $1,475 $25 $ - $ - $1,475 $25 Mortgage-backed securities 7 2,445 12 - - 2,445 12 --- ------ --- --- ---- ------ --- Total temporarily impaired investment securities 10 $3,920 $37 $ - $ - $3,920 $37 === ====== === === ==== ====== ===
(Continued) 64 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 4. INVESTMENTS - Continued Management has considered factors regarding other than temporarily impaired securities and determined that there are no securities that are impaired as of December 31, 2003. Maturities of investment securities classified as available-for-sale and held-to-maturity at December 31, 2003 were as follows. Expected maturities may differ from contractual maturities.
Amortized Market cost value ----------- ----------- Available-for-sale: Due after one month through three years................................ $ - $ - Due after three year through five years................................ 1,250,000 1,250,000 Due after five years through fifteen years............................. 1,000,000 1,005,705 Mortgage-backed securities............................................. 6,157,392 6,282,508 ----------- ---------- Total debt securities.................................................. 8,407,392 8,538,213 Investments in mutual funds............................................ 107,653 107,653 Other investments...................................................... 287,350 287,350 ----------- ---------- $ 8,802,395 $ 8,933,216 =========== =========== Held-to-maturity: Due in one month through three years................................... $ $ Due after three years through five years............................... Due after five years through fifteen years............................. 2,250,000 2,233,062 Mortgage-backed securities............................................. 4,453,476 4,539,700 ----------- ----------- $ 6,703,476 $ 6,772,762 =========== ===========
(Continued) 65 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 4. INVESTMENTS - Continued The Bank recorded a gain of $25,789 on the sale of investments during the year ended December 31, 2002. The Bank recorded a gain of $78,456 on the sale of investments during the year ended December 31, 2001. As of December 31, 2003 and 2002, investment securities with a book value of $7,451,203 and $7,250,989, respectively, were pledged as collateral to secure public deposits and for other purposes required or permitted by law. 5. LOANS AND ALLOWANCE FOR LOAN LOSSES The composition of the net loans is as follows:
Assets 2003 2002 ------------ ------------ Commercial and industrial................................................. $ 11,361,087 $ 10,854,697 Commercial real estate.................................................... 11,862,638 11,897,622 Residential mortgages..................................................... 15,109,802 13,560,602 Consumer loans............................................................ 8,694,870 7,820,269 ------------ ----------- Total loans............................................................ 47,028,397 44,133,190 Less allowance for loan losses............................................ (338,574) (674,550) ------------ ------------ Net loans.............................................................. $ 46,689,823 $ 43,458,640 ============ ============
As of December 31, 2003 and 2002, the Bank had loans to certain officers and directors and their affiliated interests in aggregate dollar amounts of $808,000 and $839,000, respectively. During 2003 and 2002, there were no new loans to related parties and repayments amounted to $65,000 and $249,000, respectively. The balance of impaired loans was $1,124,000 and $1,951,000 as of December 31, 2003 and 2002, respectively. The Bank identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. The impaired loan balance included $1,124,000 and $651,000 of non-accrual loans at December 31, 2003 and 2002, respectively. The allowance for loan loss associated with the $1,124,000 of impaired loans was $75,000 at December 31, 2003. A portion of impaired loans, $897,000, is guaranteed by the SBA. Interest income recognized on impaired loans during 2003 and 2002 was $67,000 and $104,000, respectively. The Bank recognizes income on impaired loans under the cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Bank. If these factors do not exist, the Bank will not recognize income on such loans. At December 31, 2003 and 2002, unamortized deferred fees and costs totaled $107,676 and $108,670, respectively. (Continued) 66 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 5. LOANS AND ALLOWANCE FOR LOAN LOSSES - Continued Changes in the allowance for possible loan losses are as follows:
2003 2002 2001 ---------- ---------- ---------- Balance, beginning of year.............................. $ 674,550 $ 708,156 $ 562,174 Provision............................................... 565,000 175,000 335,000 Charge-offs............................................. (972,938) (361,656) (321,681) Recoveries.............................................. 71,962 153,050 132,663 ---------- ---------- ---------- Balance, end of year.................................... $ 338,574 $ 674,550 $ 708,156 ========== ========== ==========
The Bank grants commercial, residential, and consumer loans to customers primarily located in Philadelphia County, Pennsylvania and surrounding counties in the Delaware Valley. Although the Bank has a diversified loan portfolio, its debtors' ability to honor their contracts is influenced by the region's economy. At December 31, 2003, approximately 20% of the Bank's commercial loan portfolio was concentrated in loans made to religious organizations. 6. BANK PREMISES AND EQUIPMENT The major classes of bank premises and equipment and the total accumulated depreciation are as follows:
Estimated useful life 2003 2002 ----------- ----------- ----------- Buildings and leasehold improvements.................... 10-15 years $ 3,181,656 $ 2,870,558 Furniture and equipment................................. 3-7 years 1,542,140 1,411,250 ----------- ----------- 4,723,796 4,281,808 Less accumulated depreciation........................... (1,951,643) (1,669,200) ----------- ----------- $ 2,772,153 $ 2,612,608 =========== ===========
The Bank leases other facilities and other equipment under non-cancelable operating lease agreements. The amount of expense for operating leases for the years ended December 31, 2003, 2002, and 2001 was $329,878, $364,469 and $465,825. Future minimum lease payments under operating leases are as follows: Operating Year ending December 31, leases ------------------------ -------- 2004.................................................$ 134,110 2005................................................. 69,841 2006................................................. 71,184 2007................................................. 69,255 Thereafter........................................... 48,929 ---------- Total minimum lease payments.........................$ 393,319 ========== (Continued) 67 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 7. DEPOSITS At December 31, 2003, the scheduled maturities of time deposits (certificates of deposit) are as follows (dollars in thousands): 2004.................................................$ 19,623 2005................................................. 732 2006................................................. 752 2007................................................. 11 Thereafter........................................... 146 ---------- $ 21,264 8. BORROWINGS As of December 31, 2003, the Bank has outstanding two borrowing arrangements with financial institutions, collateralized by investment securities. One arrangement is a fully secured Federal Funds line of credit with a correspondent bank totaling $2 million, the second is a Master Repurchase Agreement with another financial institution. Borrowings under these agreements have interest rates that fluctuate based on market conditions. As of December 31, 2003, the Bank had no borrowings outstanding. 9. CAPITAL STOCK In June 2003, a shareholder of the Bank returned 33,500 shares of common stock and 6,308 shares of preferred Series A stock. These shares were returned for no consideration and were recorded as treasury stock by the Bank. In June 2002, the Bank received $20,400 and issued 1,700 shares as a result of the purchase of common stock by members of the Bank's board of directors in a limited offering at a price of $12.00 per share. In May 2001 and December 2001, respectively, the Bank received $2,000 and $9,596 and issued 167 and 800 shares, respectively, as a result of the purchase of common stock by two individuals in a limited offering at a price of $12.00 per share. 10. INCOME TAXES At December 31, 2003, the Bank has net operating loss carryforwards of approximately $6,228,000 for income tax purposes that begin to expire in 2008 through 2020. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. For financial reporting purposes, a valuation allowance of $2,352,209 and $1,783,520 as of December 31, 2003 and 2002, respectively, has been recognized to offset the deferred tax assets related to the cumulative temporary differences and the tax loss carryforwards. Significant components of the Bank's deferred tax assets are as follows: (Continued) 68 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 10. INCOME TAXES - Continued
2003 2002 ----------- ----------- Deferred tax assets: Provision for loan losses.............................................. $ (31,349) $ 105,778 Unrealized (gains) losses on investment securities..................... (43,172) (116,944) Depreciation........................................................... 369,277 308,844 Net operating loss carryforwards....................................... 2,135,303 1,592,020 Other.................................................................. 77,850) (106,178) Valuation allowance for deferred tax assets............................ (2,352,209) (1,783,520) ----------- ----------- Net deferred tax assets............................................ $ - $ - =========== ===========
2003 2002 2001 ------------ ----------- ----------- Effective rate reconciliation: Tax at statutory rate................................ $ (379,258) $ (73,638) $ (295,631) Nondeductible expenses............................... 4,325 3,152 2,416 Increase in valuation allowance...................... 494,737 70,486 174,938 Other................................................ (119,804) - 118,277 ----------- ----------- ----------- Total tax expense $ - $ - $ - =========== =========== ===========
11. FINANCIAL INSTRUMENT COMMITMENTS The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These 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. Summaries of the Bank's financial instrument commitments are as follows: 2003 2002 ----------- ----------- Commitments to extend credit.............. $ 8,152,988 $ 7,939,136 Outstanding letters of credit............. 32,155 57,155 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 and unused credit card lines. 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. (Continued) 69 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 12. FAIR VALUES OF FINANCIAL INSTRUMENTS Fair value information about financial instruments is required to be disclosed, whether or not recognized in the balance sheet, where it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using discounted cash flows or other valuation techniques. Those techniques are significantly affected by assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are exempt from disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Bank.
2003 2002 -------------------- ------------------- Carrying Fair Carrying Fair amount value amount value -------- ------- -------- ------- (Dollars in thousands) Assets: Cash and cash equivalents..................... $ 6,693 $ 6,693 $ 15,529 $ 15,529 Investment securities......................... 15,637 15,706 21,518 21,777 Loans, net of allowance for loan losses....... 46,690 46,587 43,459 41,942 Liabilities: Demand deposits............................... 26,543 26,543 33,291 33,291 Savings deposits.............................. 19,309 19,309 20,494 20,494 Time deposits................................. 21,264 21,264 23,144 23,144 Off-balance-sheet: Commitments to extend credit.................. 8,153 8,153 7,939 7,939 Outstanding letters of credit................. 32 32 57 57
13. EMPLOYEE COMPENSATION In June 2000, the Bank entered into two-year employment agreements with its chief executive officer and its chief financial officer covering such items as salaries, bonuses and benefits. The agreements expired in 2002 and were renewed for two more years. These agreements provide for guaranteed minimum annual compensation over the term of the contracts. The Company made no stock-based compensation awards to any employee during 2003, 2002 and 2001. In 1998, the Company adopted a Stock Option Plan with the approval of its shareholders. In accordance with the contractual terms with its former chief executive officer, the Bank granted the right to acquire up to 4% of the Bank's stock as of December 31, 1993 at $8.54 per share, which was the book value at the date of grant. Under this Plan, options to acquire shares of common stock were granted to the former chief executive officer. The Stock Option Plan provides for the granting of options at the fair market value of the Company's common stock at the time the options are granted. Each option granted under the Stock Option Plan may be exercised within a period of ten years from the date of grant. However, no option may be exercised within one year from the date of grant. In 1998, options to purchase 29,694 shares of the Company's common stock at a price of $8.54 per share were awarded, to the former chief executive officer. (Continued) 70 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 14. CONSOLIDATED FINANCIAL INFORMATION--PARENT COMPANY ONLY Condensed Balance Sheets December 31, --------------------- (Dollars in thousands) 2003 2002 -------- -------- Assets: Due from banks (subsidiary).................. $ 289 $ 289 Investment in United Bank of Philadelphia.... 6,946 8,211 -------- -------- Total assets............................. $ 7,235 $ 8,500 ======== ======== Shareholders' equity: Series A preferred stock..................... $ 1 $ 1 Common stock................................. 11 11 Additional paid-in capital................... 14,750 14,750 Accumulated deficit.......................... (7,615) (6,499) Net unrealized holding gains (losses) on securities available-for-sale...... 88 237 -------- -------- Total shareholders' equity........... $ 7,235 $ 8,500 ======== ======== Condensed Statements of Operations Year ended December 31, ----------------------------------- (Dollars in thousands) 2003 2002 2001 -------- -------- -------- Equity in net loss of subsidiary....... $ (1,115) $ (217) $ (870) -------- -------- -------- Net loss............................... $ (1,115) $ (217) $ (870) ======== ======== ======== Condensed Statements of Cash Flows Year ended December 31, ----------------------------------- (Dollars in thousands) 2003 2002 2001 -------- -------- -------- Cash flows from operating activities: Net loss............................ $ (1,115) $ (217) $ (870) Equity in net loss of subsidiary.... 1,115 217 870 -------- -------- -------- Net cash provided by operating activities............ - - - -------- -------- -------- Cash flows from investing activities: Investment in subsidiary.............. - (20) (12) -------- -------- -------- Net cash used in investing activities. - (20) (12) -------- -------- -------- Cash flows from financing activities: Issuance of preferred stock......... - - - Issuance of common stock............ - 20 12 -------- -------- -------- Net cash provided by financing activities........... - 20 12 -------- -------- -------- Net increase in cash and cash equivalents............... - - Cash and cash equivalents at beginning of year................ 289 289 289 -------- -------- -------- Cash and cash equivalents at end of year...................... $ 289 $ 289 $ 289 ======== ======== ======== (Continued) 71 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 15. REGULATORY MATTERS The Bank engages in the commercial banking business, with a particular focus on serving Blacks, Hispanics and women, and is subject to substantial competition from financial institutions in the Bank's service area. As a bank holding company and a banking subsidiary, the Company and the Bank, respectively, are subject to regulation by the Federal Reserve Board and the Pennsylvania Department of Banking and are required to maintain capital requirements established by those regulators. Prompt corrective actions may be taken by those regulators against banks that do not meet minimum capital requirements. Prompt corrective actions range from restriction or prohibition of certain activities to the appointment of a receiver or conservator of an institution's net assets. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices, the Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total Tier I capital (as defined in the regulations) for capital adequacy purposes to risk-weighted assets (as defined). (Continued) 72 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 15. REGULATORY MATTERS - Continued The most recent notification dated March 11, 2004, from the Federal Reserve Bank categorized the Bank as "adequately capitalized" under the regulatory framework for prompt and corrective action. To be categorized as "well capitalized," the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. The Bank's growth, continued losses and the additional provisions to the allowance for loans losses may have an adverse effect on its capital ratios. (Also see Footnote 2 -- Regulatory Agreement above.) The Bank's actual capital amounts and ratios are as follows:
To be well capitalized under For capital prompt corrective Actual adequacy purposes action provisions -------------------- -------------------- --------------------- Amount Ratio Amount Ratio Amount Ratio -------- ------- -------- ------- -------- ------- As of December 31, 2003: Total capital to risk-weighted assets: Consolidated........................ $ 5,748 12.78% $ 3,621 >8.00% N/A Bank................................ 5,459 12.14 3,598 8.00 $ 4,497 10.00% Tier I capital to risk-weighted assets: Consolidated........................ 5,409 12.03 1,810 4.00 N/A Bank................................ 5,120 11.39 1,799 4.00 $ 2,698 >6.00% Tier I capital to average assets: Consolidated........................ 5,409 7.19 3,020 4.00 N/A Bank................................ 5,120 6.81 3,008 4.00 $ 3,760 >5.00% As of December 31, 2002: Total capital to risk- weighted assets: Consolidated........................ $ 6,854 16.28% $ 3,391 >8.00% N/A N/A Bank................................ 6,565 15.59 3,368 8.00 $ 4,210 10.00% Tier I capital to risk-weighted assets: Consolidated........................ 6,326 15.02 1,696 4.00 N/A N/A Bank................................ 6,037 14.34 1,684 4.00 $ 2,526 >6.00% Tier I capital to average assets: Consolidated........................ 6,326 7.46 3,402 4.00 N/A N/A Bank................................ 6,037 7.12 3,390 4.00 $ 4,238 >5.00%
(Continued) 73 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 16. COMMITMENTS AND CONTINGENCIES The Bank is a defendant in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial condition of the Company. 17. EARNINGS PER SHARE COMPUTATION In accordance with SFAS No. 128, income (loss) per share is calculated as follows:
Year ended December 31, 2003 --------------------------------------------- Loss Shares Per share (numerator) (denominator) amount ----------- ------------- --------- Net loss......................................$ (1,115,465) ============ Basic EPS Income available to stockholders......... $ (1,115,465) 1,084,694 $ (1.03) ============ ========== ========
Year ended December 31, 2002 --------------------------------------------- Loss Shares Per share (numerator) (denominator) amount ----------- ------------- --------- Net loss..................................... $ (216,583) ============ Basic EPS Income available to stockholders......... $ (216,583) 1,101,247 $ (0.20) ============ ========== ========
Year ended December 31, 2001 --------------------------------------------- Loss Shares Per share (numerator) (denominator) amount ----------- ------------- --------- Net loss..................................... $ (869,503) ============ Basic loss per share Loss available to stockholders........... $ (869,503) 1,099,520 $ (0.79) ============ ========== ========
Options to purchase 29,694 shares of common stock were not included in the computation of diluted EPS for the years ended December 31, 2003, 2002 and 2001 because the Company is in a loss position. (Continued) 74 United Bancshares, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED December 31, 2003, 2002, and 2001 18. SUMMARY OF QUARTERLY RESULTS (UNAUDITED) The following summarizes the consolidated results of operations during 2003 and 2002, on a quarterly basis, for United Bancshares, Inc. and Subsidiary:
2003 (Dollars in thousands) ------------------------------------------------ Fourth Third Second First quarter quarter quarter quarter --------- -------- -------- -------- Interest income $ 913 $ 925 $ 990 $ 1,008 Interest expense 115 129 149 153 -------- -------- -------- -------- Net interest income 798 796 841 855 Provisions for loan losses 385 60 60 60 -------- -------- -------- -------- Net interest after provisions for loan losses 413 736 781 795 Non-interest income 557 462 409 462 Non-interest expense 1,451 1,453 1,422 1,404 -------- -------- -------- -------- Net (loss) income $ (481) $ (255) $ (232) $ (147) ======== ======== ======== ========
2002 (Dollars in thousands) ------------------------------------------------ Fourth Third Second First quarter quarter quarter quarter --------- -------- -------- -------- Interest income $ 1,131 $ 1,157 $ 1,169 $ 1,175 Interest expense 201 208 232 265 -------- -------- -------- -------- Net interest income 930 949 937 910 Provisions for loan losses 63 37 38 37 -------- -------- -------- -------- Net interest after provisions for loan losses 867 912 899 873 Non-interest income 492 760 544 531 Non-interest expense 1,482 1,487 1,508 1,618 -------- -------- -------- -------- Net (loss) income $ (123) $ 185 $ (65) $ (214) ======== ======== ======== ========
75 EX-14 3 exh14.txt EXHIBIT 14 UNITED BANCSHARES, INC. & UNITED BANK OF PHILADELPHIA CODE OF BUSINESS CONDUCT AND ETHICS Adopted by the Board of Directors on March 24, 2004 Introduction This Code of Business Conduct and Ethics (the "Code") of United Bancshares, Inc. (the "Company") and its wholly owned subsidiary, United Bank of Philadelphia (the "Bank"), covers a wide range of business practices and procedures. It does not cover every issue that may arise, but it sets out basic principles to guide all employees of the Company and the Bank, including our executive and senior financial officers. All of our employees must conduct themselves accordingly and seek to avoid even the appearance of improper behavior. The Code should also be provided to and followed by the Company's and the Bank's agents and representatives, including consultants. If a law conflicts with a policy in this Code, you must comply with the law. If you have any questions about these conflicts, you should ask your supervisor how to handle the situation. Those who violate the standards in this Code will be subject to disciplinary action, up to (and including) termination of employment. If you are in a situation that you believe may violate or lead to a violation of this Code, follow the guidelines described in Section 14 of this Code. 1. Compliance with Laws, Rules and Regulations Obeying the law, both in letter and in spirit, is the foundation on which the Company's and the Bank's ethical standards are built. All employees must respect and obey the laws of the cities, states and country in which we operate. Although not all employees are expected to know the details of these laws, it is important to know enough to determine when to seek advice from supervisors, managers or other appropriate personnel. If requested, the Company and the Bank will hold information and training sessions to promote compliance with laws, rules and regulations, including insider-trading laws. 2. Conflicts of Interest A "conflict of interest" exists when a person's private interest interferes in any way with the interests of the Company and the Bank. A conflict situation can arise when an employee, officer or director takes actions or has interests that may make it difficult to perform his or her work for the Company and the Bank objectively and effectively. Conflicts of interest may also arise when an employee, officer or director, or members of his or her family, receives improper personal benefits as a result of his or her position in the Company and the Bank. Loans to, or guarantees of obligations of, employees and their family members may also create conflicts of interest. It is almost always a conflict of interest for a Company and Bank employee to work simultaneously for a competitor, customer or supplier. You are not allowed to work for a competitor as a consultant or board member. The best policy is to avoid any direct or indirect business connection with our customers, suppliers or competitors, except on our behalf. Conflicts of interest are prohibited as a matter of Company and Bank policy, except under guidelines approved by the Board of Directors. Conflicts of interest may not always be clear-cut, so if you have a question, you should consult with higher levels of management. Any employee, officer or director who becomes aware of a conflict or potential conflict should bring it to the attention of a supervisor, manager or other appropriate personnel or consult the procedures described in Section 14 of this Code. 3. Insider Trading Employees who have access to confidential information are not permitted to use or share that information for stock trading purposes or for any other purpose except the conduct of our business. All non-public information about the Company and the Bank should be considered confidential information. To use non-public information for personal financial benefit or to "tip" others who might make an investment decision on the basis of this information is not only unethical but also illegal. In order to assist with compliance with laws against insider trading, the Company and the Bank have adopted a specific policy governing employees' trading in securities of the Bank. This policy has been distributed to every employee. If you have any questions, please contact President and CEO to discuss. 4. Corporate Opportunities Employees, officers and directors are prohibited from taking for themselves personally opportunities that are discovered through the use of corporate property, information or position without the consent of the Board of Directors. No employee may use corporate property, information, or position for improper personal gain, and no employee may compete with the Company and the Bank directly or indirectly. Employees, officers and directors owe a duty to the Company and the Bank to advance its legitimate interests when the opportunity to do so arises. 5. Competition and Fair Dealing We seek to outperform our competition fairly and honestly. Stealing proprietary information, possessing trade secret information that was obtained without the owner's consent, or inducing such disclosures by past or present employees of other companies is prohibited. Each employee should endeavor to respect the rights of and deal fairly with the Company's and the Bank's customers, suppliers, competitors and employees. No employee should take unfair advantage of anyone through manipulation, concealment, abuse of privileged information, misrepresentation of material facts, or any other intentional unfair-dealing practice. The purpose of business entertainment and gifts in a commercial setting is to create good will and sound working relationships, not to gain unfair advantage with customers. No gift or entertainment should ever be offered, given, provided or accepted by any Company and Bank employee, family member of an employee or agent unless it: (1) is not a cash gift, (2) is consistent with customary business practices, (3) is not excessive in value, (4) cannot be construed as a bribe or payoff, and (5) does not violate any laws or regulations. Please discuss with your supervisor any gifts or proposed gifts which you are not certain are appropriate. 6. Discrimination and Harassment The diversity of the Company's and Bank's employees is a tremendous asset. We are firmly committed to providing equal opportunity in all aspects of employment and will not tolerate any illegal discrimination or harassment of any kind. Examples include, but are not limited to, derogatory comments based on racial or ethnic characteristics and unwelcome sexual advances. 7. Health and Safety The Company and the Bank strive to provide each employee with a safe and healthy work environment. Each employee has responsibility for maintaining a safe and healthy workplace for all employees by following safety and health rules and practices and reporting accidents, injuries and unsafe equipment, practices or conditions. Violence and threatening behavior are not permitted. Employees should report to work in condition to perform their duties, free from the influence of illegal drugs or alcohol. The use of illegal drugs in the workplace will not be tolerated. 2 8. Record-Keeping The Company and the Bank require honest and accurate recording and reporting of information in order to make responsible business decisions. For example, only the true and actual number of hours worked should be reported. Many employees regularly use business expense accounts, which must be documented and recorded accurately. If you are not sure whether a certain expense is legitimate, ask your supervisor or your Chief Financial Officer. All of the Company's and the Bank's books, records, accounts and financial statements must be maintained in reasonable detail, must appropriately reflect the Company's and the Bank's transactions and must conform both to applicable legal requirements and to the Company's and the Bank's system of internal controls. Unrecorded or "off the books" funds or assets should not be maintained unless permitted by applicable law or regulation. Business records and communications often become public, and we should avoid exaggeration, derogatory remarks, guesswork or inappropriate characterizations of people and companies that can be misunderstood. This applies equally to e-mail, internal memos and formal reports. Records should always be retained or destroyed according to the Company's and the Bank's record retention policies. In accordance with those policies, in the event of litigation or governmental investigation please consult the highest level of management. 9. Confidentiality Employees must maintain the confidentiality of confidential information entrusted to them by the Company and the Bank or their customers, except when required by laws or regulations. Confidential information includes all non-public information that might be of use to competitors, or harmful to the Company and the Bank or their customers, if disclosed. It also includes information that suppliers and customers have entrusted to us. The obligation to preserve confidential information continues even after employment ends. 10. Protection and Proper Use of Company and Bank Assets All employees should endeavor to protect the Company's and Bank's assets and ensure their efficient use. Theft, carelessness and waste have a direct impact on the Company's and Bank's profitability. Any suspected incident of fraud or theft should be immediately reported for investigation. Company and Bank equipment should not be used for non-Company, non-Bank business, though incidental personal use may be permitted. The obligation of employees to protect the Company's and Bank's assets includes proprietary information. Proprietary information includes intellectual property such as trade secrets, patents, trademarks and copyrights, as well as business, marketing and service plans, engineering and manufacturing ideas, designs, databases, records, salary information and any unpublished financial data and reports. Unauthorized use or distribution of this information would violate Company and Bank policy. It could also be illegal and result in civil or even criminal penalties. 11. Payments to Government Personnel The U.S. Foreign Corrupt Practices Act prohibits giving anything of value, directly or indirectly, to officials of foreign governments or foreign political candidates in order to obtain or retain business. It is strictly prohibited to make illegal payments to government officials of any country. In addition, the U.S. government has a number of laws and regulations regarding business gratuities that may be accepted by U.S. government personnel. The promise, offer or delivery to an official or employee of the U.S. government of a gift, favor or other gratuity in violation of these rules would not only violate Company and Bank policy but could also be a criminal offense. State and local governments, as well as foreign governments, may have similar rules. 3 12. Waivers of the Code of Business Conduct and Ethics Any waiver of this Code for executive officers or directors maybe made only by the Board of Directors or the Audit Committee of the Board of Directors responsible for ethics oversight and will be promptly disclosed as required by law or stock exchange regulation. 13. Reporting any Illegal or Unethical Behavior Employees are encouraged to talk to supervisors, managers or other appropriate personnel about observed illegal or unethical behavior and when in doubt about the best course of action in a particular situation. It is the policy of the Company and the Bank not to allow retaliation for reports of misconduct by others made in good faith by employees. Employees are expected to cooperate in internal investigations of misconduct. Further, any employee may submit a good-faith concern regarding questionable accounting or auditing matters without fear of dismissal or retaliation of any kind. 14. Compliance Procedures We must all work to ensure prompt and consistent action against violations of this Code. However, in some situations it is difficult to know if a violation has occurred. Since we cannot anticipate every situation that will arise, it is important that we have a way to approach a new question or problem. These are the steps to keep in mind: o Make sure you have all the facts. In order to reach the right solutions, we must be as fully informed as possible. o Ask yourself: What specifically am I being asked to do? Does it seem unethical or improper? This will enable you o to focus on the specific question you are faced with, and the alternatives you have. Use your judgment and common sense; if something seems unethical or improper, it probably is. o Clarify your responsibility and role. In most situations, there is shared responsibility. Are your colleagues informed? It may help to get others involved and discuss the problem. o Discuss the problem with your supervisor. This is the basic guidance for all situations. In many cases, your o supervisor will be more knowledgeable about the question and will appreciate being brought into the decision-making process. Remember that it is your supervisor's responsibility to help solve problems. o Seek help from Company and Bank resources. In the rare case where it may not be appropriate to discuss an o issue with your supervisor, or where you do not feel comfortable approaching your supervisor with your question, discuss it with your supervisor superior. o You may report ethical violations in confidence and without fear of retaliation. If your situation requires that o your identity be kept secret, your anonymity will be protected. The Company and the Bank do not permit retaliation of any kind against employees for good faith reports of ethical violations. o Always ask first, act later: If you are unsure of what to do in any situation, seek guidance before you act. 15. Special Considerations for Chief Executive and Senior Financial Officers In addition to the foregoing provisions of this Code, the Chief Executive Officer and the Chief Financial Officer are subject to the following additional specific policies: o The Chief Executive Officer and the Chief Financial Officer are responsible for full, fair, accurate, timely and understandable disclosure in the periodic reports required to be filed by the Company and the Bank with the Securities and Exchange Commission. Accordingly, it is the responsibility of the Chief Executive Officer and the Chief Financial Officer promptly to bring to the attention of the Board any material information of which he or she may become aware that affects the disclosures made by the Company and the Bank in its public filings or otherwise assist the Board in fulfilling its responsibilities. 4 o The Chief Executive Officer and the Chief Financial Officer shall promptly bring to the attention of the Board of Directors and the Audit Committee any information he or she may have concerning (a) significant deficiencies in the design or operation of internal controls which could adversely affect the Company's and the Bank's ability to record, process, summarize and report financial data or (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's and the Bank's financial reporting, disclosures or internal controls. o The Chief Executive Officer and the Chief Financial Officer shall promptly bring to the attention of the Board of Directors and the Audit Committee any information he or she may have concerning any violation of this Code, including any actual or apparent conflicts of interest between personal and professional relationships, involving any management or other employees who have a significant role in the Company's and the Bank's financial reporting, disclosures or internal controls. o The Chief Executive Officer and the Chief Financial Officer shall promptly bring to the attention of the Board of Directors and the Audit Committee any information he or she may have concerning evidence of a material violation of the securities or other laws, rules or regulations applicable to the Company and the Bank and the operation of its business, by the Company and the Bank or any agent thereof, or of violation of this Code. o The Board of Directors shall determine, or designate appropriate persons to determine, appropriate actions to be taken in the event of violations of this Code by the Chief Executive Officer and the Chief Financial Officer of the Company and the Bank. Such actions shall be reasonably designed to deter wrongdoing and to promote accountability for adherence to this Code, and shall include written notices to the individual involved that the Board of Directors has determined that there has been a violation, censure by the Board of Directors, demotion or re-assignment of the individual involved, suspension with or without pay or benefits (as determined by the Board o of Directors) and termination of the individual's employment. In determining what action is appropriate in a particular case, the Board of Directors or such designee shall take into account all relevant information, including the nature and severity of the violation, whether the violation was a single occurrence or repeated occurrences, whether the violation appears to have been intentional or inadvertent, whether the individual in question had been advised prior to the violation as to the proper course of action and whether or not the individual in question had committed other violations in the past. * * * * * EX-31 4 exh31_1.txt CERTIFICATIONS I, Evelyn F. Smalls, Chief Executive Officer, certify that: 1. I have reviewed this annual report on Form 10-K of United Bancshares, Inc; 2. Based on my knowledge, this annual 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 annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual 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 annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures, and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and c) disclosed in this annual report, any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): 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. Date: March 30, 2004 /s/ Evelyn F. Smalls ----------------------------------------- Evelyn F. Smalls, Chief Executive Officer EX-31 5 exh31_2.txt CERTIFICATIONS I, Brenda Hudson-Nelson, Chief Financial Officer, certify that: 1. I have reviewed this annual report on Form 10-K of United Bancshares, Inc; 2. Based on my knowledge, this annual 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 annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual 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 annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures, and presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and c) disclosed in this annual report, any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): 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. Date: March 30, 2004 /s/ Brenda Hudson-Nelson ----------------------------------------- Brenda Hudson-Nelson, Chief Financial Officer EX-32 6 exh32a.txt EXHIBIT 32 (A) 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-K for the year ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Evelyn F. Smalls, Chief Executive 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/ Evelyn F. Smalls - ---------------------- Evelyn F. Smalls Chief Executive Officer March 30, 2004 EX-32 7 exh32b.txt EXHIBIT 32 (B) 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-K for the year ending December 31, 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 March 30, 2004 -----END PRIVACY-ENHANCED MESSAGE-----