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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PERSUANT TO SECTION 13 OR 15(d) OF
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2003
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________.
Commission file number: 0-28080
UNITED FINANCIAL CORP.
- --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
MINNESOTA 81-0507591
- --------------------------------------------------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
P.O. Box 2779, 120 First Avenue North, Great Falls, Montana 59403
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(406) 727-6106
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined by Rule 12b-2 of the Securities Exchange Act of 1934).
Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date:
Common Stock, no par value; 2,439,446 shares outstanding as of November 7, 2003
UNITED FINANCIAL CORP.
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
Consolidated Condensed Statements of Financial Condition at
September 30, 2003 (unaudited) and December 31, 2002 (audited) 1
Consolidated Condensed Statements of Income - Three and Nine
Months Ended September 30, 2003 and September 30, 2002
(unaudited) 2
Consolidated Condensed Statements of Cash Flows - Nine Months Ended
September 30, 2003 and September 30, 2002 (unaudited) 3
Notes to Consolidated Condensed Financial Statements (unaudited) 4
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 9
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 18
ITEM 4 CONTROLS AND PROCEDURES 19
PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS 20
ITEM 2 CHANGE IN SECURITIES AND USE OF PROCEEDS 20
ITEM 3 DEFAULTS UPON SENIOR SECURITIES 20
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS 20
ITEM 5 OTHER INFORMATION 20
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K 20
SIGNATURES 21
Page i
PART I - FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS.
UNITED FINANCIAL CORP.
CONSOLIDATED CONDENSED STATEMENTS OF FINANCIAL CONDITION
(Dollars in thousands, except per share data)
SEPTEMBER 30, DECEMBER 31,
------------- ------------
2003 2002
------------- ------------
ASSETS (UNAUDITED) (Audited)
Cash and cash equivalents $ 18,316 $ 17,992
Securities available-for-sale 39,393 43,526
Restricted stock, at cost 4,065 3,909
Loans held for sale 10,283 12,813
Loans receivable, net 222,166 211,350
Accrued interest receivable 2,430 2,167
Premises and equipment, net 6,952 6,684
Real estate and other personal property owned 716 586
Goodwill, net of accumulated amortization 1,422 3,429
Deferred income taxes, net 220 56
Other assets 1,046 985
Net assets from discontinued operations -- 74,483
-------- --------
$307,009 $377,980
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Demand, NOW and money market demand accounts $ 69,164 $ 62,454
Savings deposits 53,132 50,417
Time deposits 106,230 112,359
-------- --------
228,526 225,230
Federal Home Loan Bank advances 31,000 34,000
Securities sold under agreements to repurchase 8,824 12,787
Line of credit -- 700
Accrued interest payable 1,091 1,319
Advances from borrowers for taxes and insurance 283 104
Income taxes payable 141 295
Trust preferred securities 3,000 3,000
Other liabilities 1,872 1,142
Net liabilities from discontinued operations -- 65,977
-------- --------
274,737 344,554
MINORITY INTEREST -- 2,950
Stockholders' equity:
Preferred stock, no par value; authorized 2,000,000
shares; no shares issued and outstanding -- --
Common stock, no par value; authorized 8,000,000 shares;
2,441,810 and 2,439,225 shares issued and outstanding
at September 30, 2003 and December 31, 2002, 27,205 27,167
respectively
Retained earnings, substantially restricted 4,813 2,476
Accumulated other comprehensive income, net 254 833
-------- --------
32,272 30,476
-------- --------
$307,009 $377,980
======== ========
Equity/Assets 10.51% 8.06%
Book Value/Share $ 13.22 $ 12.49
See Notes to Consolidated Condensed Financial Statements
Page 1
UNITED FINANCIAL CORP.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
(In thousands, except per share data)
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
------- ------- ------- -------
INTEREST INCOME
Loans receivable $ 3,830 $ 4,066 $11,571 $12,331
Mortgage-backed securities 253 472 949 1,374
Other investment securities 96 161 341 632
Other interest earning assets 66 100 232 338
------- ------- ------- -------
Total interest income 4,245 4,799 13,093 14,675
INTEREST EXPENSE
Deposits 1,012 1,495 3,364 4,753
Other borrowings 405 622 1,281 2,186
------- ------- ------- -------
Total interest expense 1,417 2,117 4,645 6,939
------- ------- ------- -------
Net interest income 2,828 2,682 8,448 7,736
Provision for loan losses 128 425 703 845
------- ------- ------- -------
Net interest income after provision for loan losses 2,700 2,257 7,745 6,891
NON-INTEREST INCOME
Gain on sale of loans 1,484 1,086 4,425 2,456
Service charges and fees 378 262 899 740
Gain on sale of securities available-for-sale -- 1 18 1
Other income 46 43 130 135
------- ------- ------- -------
Total non-interest income 1,908 1,392 5,472 3,332
NON-INTEREST EXPENSE
Compensation and benefits 1,913 1,390 5,241 3,850
Occupancy and equipment expense 345 305 945 850
Data processing fees 181 148 528 439
Other expenses 720 727 1,913 1,942
------- ------- ------- -------
Total non-interest expense 3,159 2,570 8,627 7,081
------- ------- ------- -------
Income from continuing operations before
income taxes 1,449 1,079 4,590 3,142
Income taxes 438 413 1,621 1,184
------- ------- ------- -------
Income from continuing operations 1,011 666 2,969 1,958
DISCONTINUED OPERATIONS
Gain from operations of Valley Bancorp, Inc.
(including gain on disposition of $1.4
million in 2003) 1,418 100 1,586 287
Income taxes 695 -- 695 --
------- ------- ------- -------
Gain on discontinued operations 723 100 891 287
------- ------- ------- -------
Net income $ 1,734 $ 766 $ 3,860 $ 2,245
======= ======= ======= =======
PER SHARE INCOME FROM CONTINUING OPERATIONS
Basic earnings per share $ .41 $ .27 $ 1.22 $ .80
======= ======= ======= =======
Diluted earnings per share $ .40 $ .27 $ 1.18 $ .79
======= ======= ======= =======
PER SHARE GAIN ON DISCONTINUED OPERATIONS
Basic earnings per share $ .30 $ .04 $ .36 $ .12
======= ======= ======= =======
Diluted earnings per share $ .29 $ .04 $ .36 $ .12
======= ======= ======= =======
PER SHARE NET INCOME
Basic earnings per share $ .71 $ .31 $ 1.58 $ .92
======= ======= ======= =======
Diluted earnings per share $ .69 $ .31 $ 1.54 $ .91
======= ======= ======= =======
Dividends declared per share $ .27 $ .17 $ .62 $ .49
======= ======= ======= =======
Weighted average shares outstanding-basic 2,442 2,439 2,440 2,439
======= ======= ======= =======
Weighted average shares outstanding-diluted 2,525 2,462 2,503 2,459
======= ======= ======= =======
See Notes to Consolidated Condensed Financial Statements
Page 2
UNITED FINANCIAL CORP.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
----------------------------------
NINE MONTHS ENDED
----------------------------------
SEPTEMBER 30, September 30,
------------- ---------------
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net cash provided by (used in) operating activities $ 5,928 $ (4,839)
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in loans receivable (11,750) 6,300
Purchases of securities available-for-sale (21,207) (42,704)
Proceeds from maturities, pay downs and sales of securities
available-for-sale 24,557 49,571
Proceeds from sale of Valley Bancorp, Inc. stock 9,012 --
Purchases of premises and equipment (640) (1,495)
Proceeds from sale of premises and equipment 13 --
Proceeds from sale of real estate and other personal property
owned 84 214
Acquisition of real estate and other personal property owned -- (9)
-------- --------
Net cash provided by investing activities 69 11,877
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits 3,296 510
Proceeds from Federal Home Loan Bank advances 30,500 5,000
Payments on Federal Home Loan Bank advances (33,500) (15,500)
Payments on line of credit (700) --
Net increase (decrease) in securities sold under agreements to
repurchase (3,963) 456
Increase in advances from borrowers for taxes and
insurance 179 143
Dividends paid to stockholders (1,523) (1,198)
Proceeds from issuance of common stock 38 3
-------- --------
Net cash used in financing activities (5,673) (10,586)
-------- --------
Increase (decrease) in cash and cash equivalents 324 (3,548)
Cash and cash equivalents at beginning of year 17,992 19,445
-------- --------
Cash and cash equivalents at end of period $ 18,316 $ 15,897
======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURE
- ---------------------------------
Cash payments for interest $ 4,964 $ 7,356
Cash payments for income taxes $ 2,370 $ 1,221
NON CASH INVESTING AND FINANCING ACTIVITIES
- -------------------------------------------
Vehicle financed $ 28 $ --
Acquisition of other personal property in settlement of loans $ 231 $ 989
See Notes to Consolidated Condensed Financial Statements
Page 3
UNITED FINANCIAL CORP.
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. GENERAL
United Financial Corp. ("United") is a bank holding company
headquartered in Great Falls, Montana, with operations in 15 locations in 13
Montana communities. United's banking business in Montana is conducted through
its wholly-owned subsidiary, Heritage Bank. United's wholly-owned subsidiary,
United Financial-Montana Capital Trust I, was established in 2001 to issue and
administer $3.0 million of Capital Trust Pass-Through Securities. United had
assets of approximately $307.0 million, deposits of approximately $228.5 million
and stockholders' equity of approximately $32.3 million at September 30, 2003.
United owned approximately 65% of Valley Bancorp, Inc. ("Valley"), a
majority-owned subsidiary, at June 30, 2003. United completed the sale of Valley
to Marquette Financial Companies on July 31, 2003 (See Note 3 in Item I).
Heritage Bank is a state-chartered commercial bank with locations in
Billings, Bozeman, Chester, Fort Benton, Geraldine, Glendive, Great Falls (three
locations), Hamilton, Havre, Kalispell, Missoula, Libby and Shelby, Montana.
Heritage Bank is engaged in the community banking business of attracting
deposits from the general public through its branches and using those deposits,
together with other available funds, to originate commercial (including lease
financing), commercial real estate, residential, agricultural and consumer loans
primarily in its market areas in Montana. A majority of Heritage Bank's banking
business is conducted in the Great Falls area through its two full service
branches and one separate drive up location. Based on total assets, 52% of
United's assets are located at Heritage Bank's Great Falls locations. Heritage
Bank also invests in mortgage-backed securities, U.S. Treasury obligations,
other U.S. Government agency obligations and other interest-earning assets.
Heritage Bank also holds a 14% ownership interest in Bankers' Resource Center, a
computer data center.
Heritage Bank's financial condition and results of operations, and
therefore the financial condition and results of operations of United, are
dependent primarily on net interest income and fee income. Heritage Bank's
financial condition and results of operations are also significantly influenced
by local and national economic conditions, changes in market interest rates,
governmental policies, tax laws and the actions of various regulatory agencies.
United's principal offices are located at 120 First Avenue North, Great
Falls, Montana, and its telephone number is (406) 727-6106.
United makes available all periodic and current reports, free of
charge, on its website as soon as reasonably practicable after such material is
electronically filed with or furnished to the Securities and Exchange Commission
("SEC"). United's website address is www.ufcmontana.com. The contents of our
website are not incorporated into this report or into our other filings with the
SEC.
2. BASIS OF PRESENTATION
United's consolidated financial statements, included herein, have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("GAAP") for interim financial information and the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X of the Securities and
Exchange Commission. Accordingly, they do not include all of the information and
footnotes required by GAAP for complete financial statements. In the opinion of
management, the accompanying unaudited consolidated condensed financial
statements contain all adjustments (consisting only of normal recurring
adjustments) necessary for a fair presentation of the consolidated financial
condition, results of operations, and cash flows for the periods disclosed.
Operating results for the three and nine months ended September 30, 2003 are not
necessarily indicative of the results anticipated for the year ending December
31, 2003. For additional information, refer to the consolidated audited
financial statements and footnotes thereto included in United's Annual Report to
Shareholders and Annual Report on Form 10-K for the year ended December 31,
2002.
Page 4
3. DISPOSITION OF ASSETS
On July 31, 2003, United completed the sale of its majority-owned
subsidiary Valley, pursuant to a Merger Agreement dated May 22, 2003 (the
"Merger Agreement"), as a result of which Valley became a wholly-owned
subsidiary of Marquette Financial Companies ("Marquette"). At the time of the
sale, and taking into account stock options which were exercised immediately
prior to the closing, United owned approximately 62% of Valley's issued and
outstanding capital stock. As provided in the Merger Agreement, the net purchase
price paid by Marquette for all Valley capital stock outstanding was
approximately $14.6 million.
For accounting purposes, in our financial statements for 2002 as
reported in our Annual Report on Form 10-K for the year ended December 31, 2002,
we have presented consolidated financial statements with Valley as a
majority-owned subsidiary. Likewise, consolidated financial statements including
Valley were presented in our Form 10-Q for the quarter ended June 30, 2003.
The balance sheet as of September 30, 2003, as reported in this Form
10-Q, does not include any of the assets or liabilities of Valley, as the sale
was completed on July 31, 2003. The December 31, 2002 balance sheet, as reported
in this Form 10-Q, has been restated to report the previously consolidated
assets and liabilities of Valley as net assets and net liabilities from
discontinued operations.
The current and prior year income statements as reported in this Form
10-Q for the three and nine months ended September 30, 2003 and 2002, report the
results of operations of Valley in discontinued operations. The income from
discontinued operations presented also includes the gain on the sale of Valley
net of applicable income tax provisions.
For further information on this sale, see our Form 8-K dated August 15,
2003.
4. COMPREHENSIVE INCOME
United's only significant element of comprehensive income is unrealized
gains and losses on securities available-for-sale.
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED Three Months Ended
SEPTEMBER 30, 2003 September 30, 2002
------------------------------------------------------------
BEFORE TAX AFTER Before Tax After
TAX EXPENSE TAX Tax Expense Tax
------- ------- ------- ------- ------- -------
Net income $ 2,867 $ 1,133 $ 1,734 $ 1,270 $ 504 $ 766
Unrealized and realized
holding gains arising during
period 432 163 269 156 59 97
Less: reclassification adjustment
for gains included in net income (1) -- (1) 1 -- 1
------- ------- ------- ------- ------- -------
Net unrealized gains on
securities available for sale 431 163 268 155 59 96
Less: portion of unrealized gains
(loss) allocated to minority
interest 50 -- 50 (3) -- (3)
------- ------- ------- ------- ------- -------
Total comprehensive income $ 3,248 $ 1,296 $ 1,952 $ 1,428 $ 563 $ 865
======= ======= ======= ======= ======= =======
Page 5
NINE MONTHS ENDED Nine Months Ended
SEPTEMBER 30, 2003 September 30, 2002
------------------------------------------------------------
BEFORE TAX AFTER Before Tax After
TAX EXPENSE TAX Tax Expense Tax
------- ------- ------- ------- ------- -------
Net income $ 6,176 $ 2,316 $ 3,860 $ 3,687 $ 1,442 $ 2,245
Unrealized and realized
holding gains arising during
period 656 249 407 932 354 578
Less: reclassification adjustment
for gains included in net income 18 7 11 87 33 54
------- ------- ------- ------- ------- -------
Net unrealized gains on
securities available for sale 638 242 396 845 321 524
Less: portion of unrealized gains
allocated to minority interest 28 -- 28 43 -- 43
------- ------- ------- ------- ------- -------
Total comprehensive income $ 6,786 $ 2,558 $ 4,228 $ 4,489 $ 1,763 $ 2,726
======= ======= ======= ======= ======= =======
5. CASH EQUIVALENTS
For purposes of the consolidated condensed statements of cash flows,
United considers all cash, daily interest and non-interest bearing demand
deposits with banks with original maturities of three months or less to be cash
equivalents.
6. COMPUTATION OF EARNINGS PER SHARE
Basic earnings per share ("EPS") is computed by dividing net income by
the weighted average number of common shares outstanding for the period. Diluted
EPS is calculated by dividing net income by the weighted average number of
common shares used to compute basic EPS plus the incremental amount of potential
common stock determined by the treasury stock method. Potential common stock
includes the incremental shares under stock option plans.
THE FOLLOWING TABLE SETS FORTH THE COMPUTATION OF BASIC AND DILUTED
EARNINGS PER SHARE.
(IN THOUSANDS, EXCEPT PER SHARE THREE MONTHS ENDED NINE MONTHS ENDED
DATA) SEPTEMBER 30, SEPTEMBER 30,
---------------------- ------------------------
2003 2002 2003 2002
------- ------- ------- -------
Weighted average shares
outstanding during the period
on which basic earnings per
share is calculated 2,442 2,439 2,440 2,439
Add: incremental shares under
stock option plans 83 23 63 20
------- ------- ------- -------
Average outstanding shares on
which diluted earnings per
share is calculated 2,525 2,462 2,503 2,459
======= ======= ======= =======
Page 6
(IN THOUSANDS, EXCEPT PER SHARE THREE MONTHS ENDED NINE MONTHS ENDED
DATA) SEPTEMBER 30, SEPTEMBER 30,
---------------------- ------------------------
2003 2002 2003 2002
------- ------- ------- -------
INCOME FROM CONTINUING
OPERATIONS APPLICABLE TO
COMMON STOCKHOLDERS, BASIC $ 1,011 $ 666 $ 2,969 $ 1,958
Less: reduction of
proportionate share of Valley
net income assuming option
exercises - - (1) (2)
Net income applicable to
common stockholders,
diluted $ 1,011 $ 666 $ 2,968 $ 1,956
======= ======= ======= =======
Basic earnings per share $ .41 $ .27 $ 1.22 $ .80
======= ======= ======= =======
Diluted earnings per share $ .40 $ .27 $ 1.18 $ .79
======= ======= ======= =======
GAIN ON DISCONTINUED OPERATIONS
APPLICABLE TO COMMON
STOCKHOLDERS, BASIC $ 723 $ 100 $ 891 $ 287
Less: reduction of
proportionate share of Valley
net income assuming option
exercises - - (1) (2)
Net income applicable to
common stockholders,
diluted $ 723 $ 100 $ 890 $ 285
======= ======= ======= =======
Basic earnings per share $ .30 $ .04 $ .36 $ .12
======= ======= ======= =======
Diluted earnings per share $ .29 $ .04 $ .36 $ .12
======= ======= ======= =======
NET INCOME APPLICABLE TO COMMON
STOCKHOLDERS, BASIC $ 1,734 $ 766 $ 3,860 $ 2,245
Less: reduction of
proportionate share of Valley
net income assuming option
exercises - - (1) (2)
Net income applicable to
common stockholders,
diluted $ 1,734 $ 766 $ 3,859 $ 2,243
======= ======= ======= =======
Basic earnings per share $ .71 $ .31 $ 1.58 $ .92
======= ======= ======= =======
Diluted earnings per share $ .69 $ .31 $ 1.54 $ .91
======= ======= ======= =======
7. RELATED PARTIES
Central Financial Services, Inc. ("CFS") provides various management
services to United, including certain accounting and tax services, investment
consulting, personnel consulting, asset-liability management and regulatory
consulting. CFS is owned by United's former Chairman of the Board of Directors
and its current largest shareholder and has been providing similar services to
various banks and financial services organizations since December of 1988. CFS
fees billed to United were approximately $.3 million for each of the nine month
periods ended September 30, 2003 and 2002, respectively. The fees are billed by
CFS on an hourly basis for work performed by United's current Chairman and CEO,
its former Chairman, and four other employees. Neither the former Chairman or
the current Chairman and CEO of United receive direct compensation from United
for their services. Each is compensated for services as a director through
director's fees of $300 per month, and for services as an officer of United
through CFS. Through CFS, the former Chairman and current Chairman and CEO earn
annual
Page 7
salaries of $135,000 and $140,000, respectively. United's portion of those
salaries was approximately 53%, based upon CFS billings during those periods.
Banker's Resource Center ("BRC") provides data processing services for
Heritage Bank. Heritage Bank has a 14% ownership interest in BRC. The charges
for BRC's services were $.5 million and $.4 million for each of the nine months
ended September 30, 2003 and 2002, respectively.
8. DIVIDENDS DECLARED
On May 20, 2003, a 3 for 2 stock split effected as a 50% stock dividend
was approved by the Board of Directors of United, payable June 30, 2003 to
shareholders of record on June 23, 2003. As a result, all per share amounts from
time periods prior to this date have been restated to illustrate the effect of
the stock dividend. Any fractional shares were paid in cash.
On October 28, 2003, the Board of Directors of United declared a
quarterly cash dividend of $.27 per share, payable December 1, 2003, to
shareholders of record on November 17, 2003.
9. STOCK-BASED COMPENSATION
United has a stock-based employee compensation plan, which is a stock
option plan described more fully in footnotes included in United's Annual Report
to Shareholders and Annual Report on Form 10-K for the year ended December 31,
2002. United accounts for the plan under the recognition and measurement
principles of APB Opinion No. 25, "Accounting for Stock Issued to Employees, and
related Interpretations." No stock-based employee compensation cost is reflected
in net income, as all options granted under the plan have an exercise price at
or above 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
per share if United had applied the fair value recognition provisions of FASB
Statement No. 123, "Accounting for Stock-Based Compensation", to stock-based
employee compensation.
(IN THOUSANDS, EXCEPT PER SHARE DATA) THREE MONTHS ENDED NINE MONTHS ENDED
(UNAUDITED) SEPTEMBER 30, SEPTEMBER 30,
------------------- ------------------
2003 2002 2003 2002
-------- ------- ------- -------
Net income: As reported $ 1,734 $ 766 $ 3,860 $ 2,245
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (15) (20) (43) (61)
-------- ------- ------- -------
Pro forma net income $ 1,719 $ 746 $ 3,817 $ 2,184
======== ======= ======= =======
Earnings per share:
Basic - as reported $ .71 $ .31 1.58 .92
======== ======= ======= =======
Basic - pro forma $ .70 $ .30 1.56 .90
======== ======= ======= =======
Diluted - as reported $ .69 $ .31 1.54 .91
======== ======= ======= =======
Diluted - pro forma $ .68 $ .30 $ 1.52 $ .89
======== ======= ======= =======
10. CRITICAL ACCOUNTING POLICIES
United has identified its most critical accounting policy to be that
related to the allowance for loan losses. United's allowance for loan losses
methodology incorporates a variety of risk considerations in establishing an
allowance for loan losses that management believes is appropriate. Risk factors
include historical loss experience, delinquency and charge-off trends,
collateral values and an internal loan grading system adopted by Heritage Bank.
Other factors include the general economic environment in United's markets and,
in particular, the state of certain industries. Changes in any of the above
factors could have a significant affect on the calculation of the allowance for
loan losses in any given period.
At September 30, 2003, United had $1.4 million of recorded goodwill
which in accordance with its current accounting policies, is no longer amortized
to expense during the years ended December 31, 2003 and 2002, but rather is
reviewed annually by management for any impairment
Page 8
writedown. This accounting policy for goodwill is considered another critical
one for United because of the significant accounting estimates made by
management in assessing any potential impairment writedown. Such accounting
estimates can be significant due to the possibility that future events affecting
them may differ from management's current judgments.
11. SUBSEQUENT EVENT
On October 1, 2003, United announced the approval of a stock repurchase
plan of up to 150,000 shares, or up to $3.9 million. The shares may be purchased
from time to time, depending on market conditions, through any combination of
open market purchases, block transactions, or privately negotiated purchases.
The stock repurchase program will last for one year, unless rescinded earlier,
and will be funded using cash on hand. The shares covered by the stock
repurchase plan represent approximately 6.1% of United's outstanding shares. At
October 31, 2003, United had purchased 3,600 shares at an average price of
$23.98 per share.
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.
1. FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements.
Statements that are not historical or current facts, including statements about
beliefs and expectations, are forward-looking statements. Forward-looking
statements involve inherent risks and uncertainties, and important factors could
cause actual results to differ materially from those anticipated, including the
following factors, in addition to those contained in United's reports on file
with the SEC: (i) general economic or industry conditions could be less
favorable than expected, resulting in a deterioration in credit quality, a
change in the allowance for loan losses, or a reduced demand for United's
products and services; (ii) changes in the domestic interest rate environment
could reduce net interest income and could increase loan losses; (iii) changes
in the extensive laws, regulations and policies governing financial services
companies could alter United's business environment or affect operations; (iv)
the potential need to adapt to industry changes in information technology
systems, on which United is highly dependent, could present operational issues
or require significant capital spending; (v) competitive pressures could
intensify and affect United's profitability, including as a result of continued
industry consolidation, the increased availability of financial services from
non-banks, technological developments, or bank regulatory reform; (vi) the
impact of weather conditions in the geographic markets and business areas in
which United conducts it business; and (vii) capital investments in United's
businesses may not produce expected growth in earnings anticipated at the time
of the expenditure. Forward-looking statements speak only as of the date they
are made, and United undertakes no obligation to update them in light of new
information or future events.
Page 9
2. MATERIAL CHANGES IN FINANCIAL CONDITION. COMPARISON OF THE NINE MONTHS
ENDED SEPTEMBER 30, 2003 TO THE YEAR ENDED DECEMBER 31, 2002.
(In Thousands) SELECTED FINANCIAL CONDITION DATA
(Unaudited)
Valley
Bancorp
SEPT. 30, Dec. 31, $ Dec. 31,
2003 2002 Change 2002 Net Change
-------- -------- -------- -------- ----------
Cash and cash equivalents $ 18,316 $ 33,224 $(14,908) $ 15,232 $ 324
Securities available-for-sale 39,393 60,936 (21,543) 17,410 (4,133)
Restricted stock, at cost 4,065 4,327 (262) 418 156
Loans held for sale 10,283 13,648 (3,365) 834 (2,531)
Loans receivable, net 222,166 250,431 (28,265) 39,081 10,816
Premises and equipment, net 6,952 7,668 (716) 984 268
Real estate and other
personal property owned 716 586 130 -- 130
Goodwill, net 1,422 3,429 (2,007) -- (2,007)
All other assets 3,696 3,731 (35) 524 489
Total assets 307,009 377,980 (70,971) 74,483 3,512
Deposits 228,526 286,980 (58,454) 61,750 3,296
Federal Home Loan Bank
advances 31,000 38,000 (7,000) 4,000 (3,000)
Securities sold under
agreements to repurchase 8,824 12,787 (3,963) -- (3,963)
Line of credit -- 700 (700) -- (700)
Trust preferred securities 3,000 3,000 -- -- --
All other liabilities 3,387 3,087 300 226 74
Total liabilities 274,737 344,554 (69,817) 65,976 (3,841)
Stockholders' equity, net 32,272 30,476 1,796 -- 1,796
Total assets decreased $71.0 million to $307.0 million at September 30,
2003 from $378.0 million at December 31, 2002. Assets decreased $74.5 million as
a result of selling Valley (See Note 3 in Item I). The remaining increase in
assets of $3.5 million was primarily the result of a net increase in loans
receivable and loans held for sale of approximately $8.3 million, offset by a
decrease in securities available for sale of approximately $4.1 million and a
decrease in goodwill of $2.0 million due to the Valley sale. Other increases
totaling $1.3 million are detailed in the table above.
SECURITIES AVAILABLE-FOR-SALE - Securities available-for-sale decreased
$21.5 million to $39.4 million at September 30, 2003 from $60.9 million at
December 31, 2002. The Valley sale resulted in a decrease of $17.4 million in
securities available-for-sale. The remaining decrease of $4.1 million was the
result of $21.2 million of purchases, offset by $24.6 million of maturities and
calls, sales and principal repayments and a $.7 million decrease in unrealized
gains on securities.
Page 10
A COMPARISON OF THE AMORTIZED COST AND ESTIMATED FAIR VALUE OF THE
CONSOLIDATED AVAILABLE-FOR-SALE INVESTMENT PORTFOLIO AT THE DATES INDICATED IS
AS FOLLOWS:
(IN THOUSANDS)
(UNAUDITED)
SEPTEMBER 30, 2003
-------------------------------------------------
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
U.S. GOVERNMENT AND FEDERAL
AGENCIES $ 4,500 $ 28 $ -- $ 4,528
MORTGAGE-BACKED SECURITIES 31,130 267 (119) 31,278
MUNICIPAL BONDS 1,824 65 -- 1,889
CORPORATE BONDS AND EQUITY
SECURITIES 1,526 172 -- 1,698
-------- -------- -------- --------
$ 38,980 $ 532 $ (119) $ 39,393
======== ======== ======== ========
December 31, 2002
-------------------------------------------------
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
--------- ---------- ---------- ---------
U.S. Government and federal
agencies $ 13,793 $ 238 $ -- $ 14,031
Mortgage-backed securities 42,195 1,060 -- 43,255
Municipal bonds 1,945 54 -- 1,999
Corporate bonds and equity
securities 1,526 125 -- 1,651
-------- -------- -------- --------
$ 59,459 $ 1,477 $ -- $ 60,936
======== ======== ======== ========
LOANS RECEIVABLE AND LOANS HELD FOR SALE - Net loans receivable
decreased $28.2 million to $222.2 million at September 30, 2003 from $250.4
million at December 31, 2002. Loans receivable decreased $39.1 million from the
Valley sale. The remaining increase in loans during the first nine months of
2003 was primarily in the commercial real estate loan category. Other loan
categories have remained fairly constant or decreased slightly as a result of a
weakened state and national economy and the resulting impact on loan demand.
United has also slowed its acquisition of participation loans from outside
Montana due to reduced interest rates and the concerns of a possible national
recession. The loan portfolio includes: real estate residential mortgages,
commercial and agricultural mortgages, agricultural and commercial non-mortgage
loans, consumer loans secured by real estate, and various consumer installment
loans. Heritage Bank also purchases and participates in commercial and lease
financing loans. Heritage Bank had $34.9 million and $36.7 million of
participation and purchased loans as of September 30, 2003 and 2002,
respectively.
During the nine months ended September 30, 2003, loans held for sale
decreased $3.4 million to $10.3 million at September 30, 2003 from approximately
$13.7 million at December 31, 2002, as secondary market sales outpaced loan
originations. A decrease of $.8 million was a result of the Valley sale.
Approximately $264.4 million of residential real estate loans were originated
for sale and $267.8 million of residential real estate loans were sold to the
secondary market during the nine month period ending September 30, 2003.
ALLOWANCE FOR LOAN LOSSES - The loan loss reserve increased $.1 million
to $3.7 million at September 30, 2003 as compared to $3.6 million at December
31, 2002. A decrease of $.5 million was the result of the Valley sale. The
remaining increase of $.6 million resulted from a loan loss provision of $.7
million for the nine months ended September 30, 2003, offset by loans in the
amount of $.1 million which were determined by United's management to be
uncollectible and subsequently charged-off. The loan loss reserve at September
30, 2003 is an amount which management believes is adequate given the relatively
low level of non-performing assets and management's assessment of loan risk. The
allowance for loan losses to total loans at September 30, 2003 was 1.64%.
Page 11
LOANS RECEIVABLE, NET OF UNAMORTIZED NET DEFERRED LOAN FEES, AT THE
DATES INDICATED ARE SUMMARIZED AS FOLLOWS:
(IN THOUSANDS)
(UNAUDITED)
SEPTEMBER 30, December 31,
2003 2002
----------- -----------
First mortgage loans and contracts secured
by real estate $ 76,935 $ 73,801
Commercial real estate loans 43,954 72,993
Commercial loans 52,917 59,428
Auto and other consumer loans 26,039 25,331
Second mortgage consumer loans 4,831 5,559
Agricultural loans 17,836 14,548
Tax exempt municipal loans 2,277 1,469
Savings account and other loans 1,071 875
----------- -----------
225,860 254,004
Less: Allowance for loan losses 3,694 3,573
----------- -----------
$ 222,166 $ 250,431
=========== ===========
A SUMMARY OF ACTIVITY IN THE ALLOWANCE FOR LOAN LOSSES FOR THE DATES
INDICATED ARE AS FOLLOWS:
(IN THOUSANDS) NINE MONTHS ENDED Year Ended
SEPTEMBER 30, 2003 December 31, 2002
------------------ -----------------
Balance, beginning of period $ 3,573 $ 3,503
Provision for loan losses 703 1,170
Losses charged off (130) (1,189)
Recoveries 8 89
Decrease from Valley sale (460) --
------------- -------------
Balance, end of period $ 3,694 $ 3,573
============= =============
NON-PERFORMING ASSETS - When a borrower fails to make a scheduled
payment on a loan and does not cure the delinquency within 15 days, United's
policy is to contact the borrower between the 15th and 30th day of delinquency
to establish a repayment schedule. If a loan is not current, or a realistic
repayment schedule is not being followed by the 90th day of delinquency, United
will generally proceed with legal action to foreclose the property after the
loan has been contractually delinquent for 90 days. Loans contractually past due
for 90 days are classified as non-performing. However, not all loans past due
for 90 days automatically result in the non-accrual of interest income. If a 90
day past due loan has adequate collateral, or is FHA insured or VA guaranteed,
leading to the conclusion that loss of principal and interest would likely not
be realized, then interest income will continue to be accrued.
Heritage Bank follows regulatory guidelines with respect to placing
loans on non-accrual status. When a loan is placed on non-accrual status, all
previously accrued and uncollected interest is reversed. At September 30, 2003,
Heritage Bank had non-accrual loans totaling $.5 million and loans totaling $.6
million past due for 90 days and still accruing interest. At December 31, 2002
by comparison, Heritage Bank's non-accrual loans totaled $.1 million and loans
past due for 90 days and still accruing totaled $.6 million.
Heritage Bank is required to review, classify and report to the Board
of Directors their assets on a regular basis and classify them as "substandard"
(the distinct possibility that some loss will be sustained), "doubtful" (high
likelihood of loss), or "loss" (uncollectible). Adequate valuation allowances
are required to be established for assets classified as substandard or doubtful
in accordance with generally accepted accounting principles. If an asset is
classified as a loss, the institution must either establish a specific valuation
allowance equal to the amount classified as loss or charge off such amount. At
September 30, 2003 and December 31, 2002, Heritage Bank had no assets classified
as losses. At both September 30, 2003 and December 31, 2002, Heritage Bank had
no assets classified as doubtful. At both September 30, 2003 and December 31,
2002, Heritage Bank had $.6 million of reported
Page 12
substandard assets. As a percent of total Heritage Bank assets, substandard
assets were approximately .21% at both September 30, 2003 and December 31, 2002.
At both September 30, 2003 and December 31, 2002, impaired loans were $.6
million. Impaired loans included those loans classified as either substandard or
doubtful. As a percentage of total Heritage Bank assets, impaired loans were
approximately .21% at both September 30, 2003 and December 31, 2002.
PREMISES AND EQUIPMENT - This category decreased $.7 million to $6.9
million at September 30, 2003 from $7.6 million at December 31, 2002. Premises
and equipment decreased $1.0 million from the Valley sale. The remaining $.3
million increase was an investment by Heritage Bank of approximately $.7 million
in fixed assets during the first nine months of 2003, primarily in connection
with the construction of the new Heritage Bank branch facility in Billings,
Montana. The purchases of premises and equipment were offset by approximately
$.4 million of depreciation.
DEPOSITS - Deposits decreased $58.5 million to $228.5 million at
September 30, 2003 from $287.0 million at December 31, 2002. This decrease was
primarily the result of the Valley sale which resulted in a decrease in deposits
of $61.7 million.
(IN THOUSANDS)
(UNAUDITED)
SEPTEMBER 30, December 31,
2003 2002
---------- ----------
Demand accounts $ 38,800 17.0% $ 48,228 16.8%
Now and money market accounts 30,364 13.3 59,752 20.8
Savings accounts 53,131 23.2 50,980 17.8
Certificate of deposits 106,231 46.5 128,020 44.6
---------- ---------- ---------- ----------
$ 228,526 100.0% $ 286,980 100.0%
========== ========== ========== ==========
BORROWED FUNDS - FHLB advances decreased $7.0 million from $38.0
million at December 31, 2002 to $31.0 million at September 30, 2003. The Valley
sale resulted in a decrease of $4.0 million. The remaining decrease of $3.0
million was a net result of $30.5 million in advances and $33.5 million in
repayments. Securities sold under agreements to repurchase decreased $4.0
million to $8.8 million at September 30, 2003 from $12.8 million at December 31,
2002.
STOCKHOLDERS' EQUITY - Stockholders' equity increased $1.7 million to
$32.2 million at September 30, 2003 from $30.5 million at December 31, 2002.
This increase is due to $3.8 million of net income for the nine months ended
September 30, 2003 less cash dividends declared of $1.5 million, and a $.4
million decrease in unrealized gains net of tax effects, associated with
securities classified as available-for-sale being adjusted to market value. The
remaining decrease of $.2 million was from the Valley sale which resulted in the
elimination of $.2 million in unrealized gains on available-for-sale securities
of Valley, which had been recorded as a component of United's equity.
Page 13
3. MATERIAL CHANGES IN RESULTS OF OPERATIONS-COMPARISON OF THE THREE
MONTHS ENDED SEPTEMBER 30, 2003 AND SEPTEMBER 30, 2002.
(IN THOUSANDS) SELECTED INCOME STATEMENT DATA
(UNAUDITED) ------------------------------------------------
THREE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------
2003 2002 $ Change % Change
-------- -------- -------- --------
Interest income $ 4,245 $ 4,799 $ (554) (11.6)%
Interest expense 1,417 2,117 (700) (33.1)
-------- -------- -------- --------
Net interest income 2,828 2,682 146 5.4
Provision for losses on loans 128 425 (297) (70.0)
-------- -------- -------- --------
Net interest income after
provision for losses on loans 2,700 2,257 443 19.6
Non-interest income 1,908 1,392 516 37.0
Non-interest expense 3,159 2,570 589 22.9
-------- -------- -------- --------
Income from continuing operations
before income taxes 1,449 1,079 370 34.2
Income taxes 438 413 25 5.9
-------- -------- -------- --------
Income from continuing
operations 1,011 666 345 51.7
Gain on discontinued operations
(net of tax) 723 100 623 625.8
-------- -------- -------- --------
Net income $ 1,734 $ 766 $ 968 126.3%
======== ======== ======== ========
NET INCOME - United had net income of $1.7 million, or basic and
diluted earnings per share of $.71 and .69, respectively, for the three months
ended September 30, 2003. For the same period in 2002, United had net income of
$.8 million, or basic and diluted earnings per share of $.31.
NET INTEREST INCOME - Like most financial institutions, the most
significant component of United's earnings is net interest income, which is the
difference between the interest earned on interest-earning assets (loans,
investment securities, mortgage-backed securities and other interest-earning
assets), and the interest paid on deposits and borrowings. This amount, when
divided by average interest-earning assets, is referred to as the net interest
margin, expressed as a percentage. Net interest income and net interest margins
are affected by changes in interest rates, the volume and the mix of
interest-earning assets and interest-bearing liabilities, and the level of
non-performing assets. The difference between the yield on interest-earning
assets and the cost of interest-bearing liabilities expressed as a percentage is
referred to as the net interest-rate spread. Net interest income increased $.1
million from $2.7 million for the three months ended September 30, 2002 to $2.8
million for the three months ended September 30, 2003. Net interest margin
increased .30% from 3.56% for the three month period ended September 30, 2002 to
3.86% for the three month period ended September 30, 2003. Net interest spread
increased .34% from 3.40% for the three month period ended September 30, 2002 to
3.74% for the three month period ended September 30, 2003. Increased volume of
interest-earning assets, decreases in funding balances at FHLB and decreased
interest rates on consumer deposits resulted in an increase in both net interest
margin and net interest spread.
INTEREST INCOME - Interest income decreased $.6 million from $4.8
million for the three month period ended September 30, 2002 to $4.2 for the
three month period ended September 30, 2003. For the three month period ended
September 30, 2003, compared to the three month period ended September 30, 2002,
interest on loans receivable decreased $.3 million, and interest on
mortgage-backed securities, investments and interest on other interest-earning
assets decreased $.3 million.
INTEREST EXPENSE - Interest expense decreased $.7 million from $2.1
million for the three month period ended September 30, 2002 to $1.4 million for
the three month period ended September 30, 2003. Although the average balance of
deposits increased $10.3 million for the third quarter ended 2003 compared to
the same quarter in 2002, lower interest rates during the third quarter of 2003
allowed for a decrease in interest expense on deposits of $.5 million during the
third quarter of 2003 compared to the same quarter in 2002.
Page 14
For the three month period ended September 30, 2003, compared to the
three month period ended September 30, 2002, interest on other borrowings
decreased $.2 million. The average balance of other borrowings decreased $10.6
million for the quarter ended September 30, 2003 as compared to 2002. The
combination of the decrease in borrowings and lower interest rates on borrowed
funds in 2003 resulted in a $.2 million decrease in interest expense on other
borrowings in the third quarter of 2003 compared to the same period in 2002.
PROVISION FOR LOAN LOSSES - United provided $.1 million and $.4 million
for loan losses in the third quarters ended September 30, 2003 and 2002,
respectively. Asset quality at Heritage Bank has remained relatively strong.
Heritage Bank's past due and non-accrual loans totaled .46% and .38% of total
loans at September 30, 2003 and 2002, respectively.
The provision for loan losses is determined by management as the amount
to be added to the allowance for loan losses after net charge-offs have been
deducted to bring the allowance to a level which is considered adequate to
absorb losses inherent in the loan portfolio in accordance with GAAP. Future
additions to United's allowance for loan losses and any change in the related
ratio of the allowance for loan losses to non-performing assets are dependent
upon the performance and composition of United's loan portfolio, the economy,
inflation, changes in real estate values and interest rates and the view of the
regulatory authorities toward adequate reserve levels.
NON-INTEREST INCOME - In addition to net interest income, United
generates significant non-interest income from a range of retail banking
services, including mortgage banking activities and service charges for deposit
services. Non-interest income increased $.5 million from $1.4 million for the
three month period ended September 30, 2002 to $1.9 million for the three month
period ended September 30, 2003.
United's loan demand continued to be strong in the home lending market,
and particularly the refinancing market, during the three month period ended
September 30, 2003, as interest rates continued to be at levels which were
attractive to customers in the home lending market. Gain on sale of loans
increased $.4 million for the three month period ending September 30, 2003 to
$1.5 million from $1.1 million for the same period in 2002.
NON-INTEREST EXPENSE - United's non-interest expense increased $.6
million during the three month period ending September 30, 2003 as compared to
the same period in 2002. This increase was principally due to the increased
personnel expenses associated with commissions to loan originators in United's
mortgage banking department.
GAIN ON DISCONTINUED OPERATIONS - As explained in Note 3 of Item 1
above, United completed the sale of its wholly-owned subsidiary, Valley, on July
31, 2003. The reported gain on discontinued operations of $.7 million includes
the gain on sale of Valley of $1.4 million and United's pro rata portion of
Valley's July 2003 net income of $8,635. The related provision for income taxes
on the gain of $.7 million was netted for a net gain on discontinued operations
of $.7 million.
Page 15
4. MATERIAL CHANGES IN RESULTS OF OPERATIONS-COMPARISON OF THE NINE MONTHS
ENDED SEPTEMBER 30, 2003 AND SEPTEMBER 30, 2002.
(IN THOUSANDS) SELECTED INCOME STATEMENT DATA
(UNAUDITED) ------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------
2003 2002 $ Change % Change
-------- -------- -------- --------
Interest income $ 13,093 14,675 $ (1,582) (10.8)%
Interest expense 4,645 6,939 (2,294) (33.1)
-------- -------- -------- --------
Net interest income 8,448 7,736 712 9.2
Provision for losses on loans 703 845 (142) (16.8)
-------- -------- -------- --------
Net interest income after
provision for losses on loans 7,745 6,891 854 12.4
Non-interest income 5,472 3,332 2,140 64.2
Non-interest expense 8,627 7,081 1,546 21.8
-------- -------- -------- --------
Income from continuing
operations before income taxes 4,590 3,142 1,448 46.1
Income taxes 1,621 1,184 437 36.9
-------- -------- -------- --------
Net income from continuing
operations 2,969 1,958 1,011 5.2
Gain on discontinued operations (net of tax) 891 287 604 210.4
-------- -------- -------- --------
Net income $ 3,860 $ 2,245 $ 1,615 71.9%
======== ======== ======== ========
NET INCOME - United had net income of $3.9 million, or basic and
diluted earnings per share of $1.58 and $1.54, respectively, for the nine months
ended September 30, 2003. For the same period in 2002, United had net income of
$2.2 million, or basic and diluted earnings per share of $.92 and $.91,
respectively.
NET INTEREST INCOME - Net interest income increased $.7 million from
$7.7 million for the nine months ended September 30, 2002 to $8.4 million for
the nine months ended September 30, 2002. Net interest margin increased .30% to
3.86% for the nine month period ended September 30, 2003 from 3.56% for the same
period last year. Net interest spread increased .34% to 3.74% for the nine month
period ended September 30, 2003 from 3.40% for the same period last year.
Although total interest income decreased $1.6 million, primarily as a result of
interest rate cuts by the Federal Reserve Bank which began in 2001, the decrease
in interest expense due to interest rate cuts was even greater, at $2.3 million,
resulting in a net increase in net interest income of $.7 million.
INTEREST INCOME - Interest income decreased $1.6 million from $14.7
million for the nine month period ended September 30, 2002 to $13.1 million for
the nine month period ended September 30, 2003. For the nine month period ended
September 30, 2003, compared to the nine month period ended September 30, 2002,
interest on loans receivable decreased $.8 million, and interest on
mortgage-backed securities, investments and interest on other interest-earning
assets decreased $.8 million.
INTEREST EXPENSE - Interest expense decreased $2.3 million from $6.9
million for the nine month period ended September 30, 2002 to $4.6 million for
the nine month period ended September 30, 2003. For the nine month period ended
September 30, 2003, compared to the nine month period ended September 30, 2002,
interest on deposits decreased $1.4 million. Although the average balances of
deposits increased $10.3 million for the nine month period ended September 30,
2003 compared to the same period in 2002, lower interest rates on customer
deposits during the third quarter of 2003 allowed for a decrease in interest
expense on deposits of $1.4 million for the nine month period ended September
30, 2003, compared to the same period in 2002. Average balances of other
borrowings decreased $10.6 million from September 30, 2002 to 2003. The
combination of the decrease in borrowings as well as lower interest rates in
2003, resulted in a $.9 million decrease in interest on other borrowings.
PROVISION FOR LOAN LOSSES - United provided $.7 million and $.8 million
for loan losses for the nine months ended September 30, 2003 and 2002,
respectively.
Page 16
NON-INTEREST INCOME - Non-interest income was $5.5 million for the nine
months ended September 30, 2003 compared to $3.3 million in 2002. This income
consisted primarily of a record $4.4 million gain on sale of loans in the first
nine months of 2003, an increase of $2.0 million or 80.2% over the same period
in 2002. Customer service charges represented $.9 million in income, up slightly
from 2002. The remaining $.2 million in income was comprised of loan servicing
fees and other income which remained consistent from 2002 to 2003.
NON-INTEREST EXPENSE - United's non-interest expense increased $1.5
million during the nine month period ending September 30, 2003 as compared to
the same period in 2002. This increase was principally due to increased
personnel expenses associated with commissions to loan originators in United's
mortgage banking department.
5. ASSET/LIABILITY MANAGEMENT
United's earnings depend to a large extent on the level of its "net
interest income." Net interest income depends upon the difference (referred to
as "interest rate spread") between the yield on United's loan and investment
portfolios and interest-earning cash balances ("interest-earning assets"), and
the rates paid on its deposits and borrowings ("interest-bearing liabilities").
Net interest income is further affected by the relative amounts of United's
interest-earning assets and interest-bearing liabilities. In recent years,
United's interest-earning assets have exceeded interest-bearing liabilities.
However, when interest-earning assets decrease as a result of non-accrual loans
and investments in non-interest earning assets, net interest income and interest
rate spread also decrease and any continued decrease in the level of
interest-earning assets would generally result in a negative impact on earnings.
One of the primary objectives of United's management has been to
restructure United's balance sheet to reduce its vulnerability to changes in
interest rates ("interest rate risk"). Commercial banking institutions can
suffer from a mismatch in the term to maturity of their assets and liabilities,
with mortgage loan assets tending to be of a much longer term than deposits, the
primary liabilities of commercial banking institutions. In periods of rising
interest rates, this mismatch can render commercial banking institutions
vulnerable to increases in costs of funds (deposits and borrowings) that can
outstrip increases in returns on longer-term fixed rate loans and investments,
resulting in a decrease in positive interest rate spread and lower earnings.
Several strategies have been employed by United to minimize the
mismatch of asset and liability maturities. For the past several years, Heritage
Bank has maintained a policy of selling the majority of newly-originated
long-term (15 to 30-year maturity) fixed-rate mortgage loans to the secondary
market. These loans are sold at their outstanding principal balance, which is
the prearranged contract purchase price, and therefore, no gain or loss is
realized at sale. The amount recognized on the income statement caption gain on
sale of loans represents fee income only. United promotes the origination and
retention of loans providing for periodic interest rate adjustments, shorter
terms to maturity or balloon provisions. United also emphasizes investment in
adjustable rate or shorter-term mortgage-backed securities and other
interest-earning investments. When maturities of loans increase, United offsets
the increased interest rate risk with matching funds and maturities with FHLB
borrowings.
6. LIQUIDITY AND CAPITAL RESOURCES
United's primary sources of funds are deposits, FHLB borrowings,
repurchase agreements, proceeds from loan sales, and loan and mortgage-backed
securities repayments. While maturities and scheduled amortization of loans and
mortgage-backed securities are a predictable source of funds, deposit flows and
mortgage prepayments are greatly influenced by market interest rates, economic
conditions and competition. In a period of declining interest rates, mortgage
prepayments generally increase. As a result, these proceeds from mortgage
prepayments generally would be invested in lower yielding loans or other
investments which have the effect of reducing interest income. In a period of
rising interest rates, mortgage prepayments would generally decrease and the
proceeds from such prepayments generally would be invested in higher yielding
loans or investments which would have the effect of increasing interest income.
Page 17
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK - Market risk is the risk of loss in a financial instrument
arising from adverse changes in market rates/prices such as interest rates,
foreign currency exchange rates, commodity prices and equity prices. Since
United's earnings depend on its level of interest rate spread, its primary
market risk exposure is interest rate risk ("IRR").
INTEREST RATE RISK - United has established a formal IRR policy, and
Heritage Bank has an Asset/Liability Management Committee ("ALCO") and an
Investment Committee, which meet at least quarterly to review and report on
management's efforts to minimize IRR. Several asset/liability management
strategies have been employed by United to minimize its exposure to IRR. These
include selling most newly-originated long-term fixed-rate mortgages, promoting
the origination and retention of loans providing for periodic interest rate
adjustments, shorter terms to maturity or balloon provisions, and investing in
adjustable rate or shorter-term mortgage-backed securities and other
interest-earning investments.
The Asset/Liability Management Committee utilizes an institutional
funds management service detailed simulation model to quantify the estimated
exposure of net interest income ("NII") to sustained interest rate changes. The
model predicts the impact of changing interest rates on the interest income
received and interest expense paid on assets and liabilities. This sensitivity
analysis is compared to ALCO policy limits which specify a maximum tolerance
level for NII given a 200 basis point (bp) rise or decline in interest rates.
The following summarizes the sensitivity analysis for the Banks as of
June 30, 2003, the most recent information available. Management believes there
has been no material change in interest rate risk since June 30, 2003. For
additional information, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included herein in Item 2 and refer to the
Interest Rate Risk Management discussion included in United's Annual Report on
Form 10-K for the year ended December 31, 2002.
Estimated increase (decrease)
in net interest income: +200 bp -200 bp
------- -------
0-90 days $ 19,450 $ (110,721)
91-360 days (49,426) (223,815)
2 years (95,284) (546,788)
3 years (135,675) (875,228)
The preceding sensitivity analysis does not represent a forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions, including the
nature and timing of interest rate levels including yield curve shape,
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, reinvestment/replacement of assets and liability cash flows
and others. Sensitivity analysis does not reflect actions that United might take
in responding to or anticipating changes in interest rates.
INTEREST RATE SENSITIVITY OF THE ECONOMIC VALUE OF EQUITY - Mismatches
of interest rate repricing between assets and liabilities create interest rate
risk. Interest rate risk affects the market value of equity, also called the
economic value of equity ("EVE"). Measurement of the EVE is an attempt to
establish a methodology to gauge the potential for the reduction of future
earnings and stockholders' equity resulting from both lower net interest income
("NII") and lower EVE caused by changes in market interest rates. EVE is the
difference between United's depository portfolio value and its loans receivable
portfolio value. EVE thus provides a leading indicator of future potential
changes in both NII and stockholders' equity.
Page 18
Heritage Bank has established maximum percentage changes for EVE at
1.5% of total assets, given an 100 basis point change in interest rates. EVE, as
a percent to total assets was as follows:
Percent to Total Assets:
June 30, 2003 .51%
March 31, 2003 .58%
December 31, 2002 .85%
Heritage Bank periodically reviews and makes changes to established
limits for EVE changes due to mergers and other market factors.
The preceding sensitivity analysis does not represent a forecast and
should not be relied upon as being indicative of expected operation results.
These hypothetical estimates are based upon numerous assumptions, including the
nature and timing of interest rate levels including yield curve shape,
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, reinvestment/replacement of assets and liability cash flows
and others. The EVE analysis does not reflect actions that Heritage Bank might
take in responding to or anticipating changes in interest rates.
ITEM 4 CONTROLS AND PROCEDURES
United's Chief Executive Officer and Chief Financial Officer have
concluded, based on their evaluation as of the end of the period covered by this
report, that United's disclosure controls and procedures are adequately designed
to ensure that information required to be disclosed by United in the reports
that it files or submits under the Securities Exchange Act of 1934, as amended,
is recorded, processed, summarized and reported, within the time periods
specified in applicable rules and forms. There were no significant changes made
in United's internal controls or, to United's knowledge, in other factors that
could significantly affect these controls during the period covered by this
report.
Page 19
PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS.
Although not involved in any material pending litigation as of
September 30, 2003, United is a plaintiff in various legal proceedings arising
in the normal course of business. In the opinion of management, the disposition
of current litigation will not have a material effect on United's consolidated
financial position, results of operations, or liquidity.
ITEM 2 CHANGE IN SECURITIES AND USE OF PROCEEDS.
None
ITEM 3 DEFAULTS UPON SENIOR SECURITIES.
None
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS.
None
ITEM 5 OTHER INFORMATION.
NONE
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K.
A. Exhibits
3.1 Articles of Incorporation of United Financial Corp.,
as amended (incorporated by reference to Exhibit 3.1
of United's Annual Report on Form 10-K dated March
31, 1998).
3.2 Bylaws of United Financial Corp., as amended
(incorporated by reference to Exhibit 3.1 of United's
Annual Report on Form 10-K dated March 31, 1998).
31.1 Certification of chief executive officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of chief financial officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of principal executive officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of principal financial officer pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
B. Reports on Form 8-K
On May 22, 2003, we filed a press release and definitive agreement on
Form 8-K reporting under Items 5 and 7, relating to the signing of a
merger agreement involving the sale of stock in Valley Bancorp, Inc.
On July 30, 2003, we furnished our earnings release for the second
quarter ended June 30, 2003, on Form 8-K, reporting under Items 7, 9
and 12.
On August 1, 2003, we filed a press release on Form 8-K reporting under
Items 2, 7 and 9, relating to the completion of the sale of Valley
Bancorp, Inc. stock.
On August 15, 2003, we filed pro forma financial information related to
the sale of Valley Bancorp, Inc. stock on Form 8-K reporting under
Items 2 and 7.
Page 20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized:
United Financial Corp.
Date November 13, 2003 /s/ Kurt R. Weise
------------------------ ----------------------------
Kurt R. Weise
Chairman and Chief
Executive Officer
(Duly Authorized Officer and
Principal Executive Officer)
Date November 13, 2003 /s/ Paula J. Delaney
------------------------ ----------------------------
Paula J. Delaney
Chief Financial Officer
(Principal Financial and
Accounting Officer)
Page 21