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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
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FORM 10-Q
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(Mark One)
_X_ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004 OR
___ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________ TO
______________
UNITED BANCSHARES, INC.
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(Exact name of registrant as specified in its charter)
0-25976
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Commission File Number
Pennsylvania 23-2802415
- ------------------------------- ----------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
300 North 3rd Street, Philadelphia, PA 19106
- -------------------------------------- ----------------
(Address of principal executive office) (Zip Code)
(215) 351-4600
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(Registrant's telephone number, including area code)
N/A
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve months (or such shorter period that the registrant was
required to filed such reports), and (2) has been subject to such filing
requirements for the past 90 day. Yes _X_ No ____
Indicate by check mark whether registrant is an accelerated filer (as defined in
Rule 12b2 of the Act) Yes _____ No __X__
Applicable only to issuers involved in bankruptcy proceedings during the
preceding five years:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Sections 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes _____ No _____
Applicable only to corporate issuers:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
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. As of May 7, 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 May 7, 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 May 7, 2004.
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FORM 10-Q
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Index
Item No. Page
PART I
1. Financial Statements.............................................. 4
2. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 8
3. Quantitative and Qualitative Disclosures about Market Risk........ 25
4. Controls and Procedures .......................................... 26
PART II
1. Legal Proceedings................................................. 27
2. Changes in Securities and Use of Proceeds......................... 27
3. Defaults upon Senior Securities................................... 27
4 Submission of Matters to a Vote of Security Holders............... 28
5. Other Information................................................. 28
6. Exhibits and Reports on Form 8-K.................................. 28
2
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
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 or 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 war in Iraq) and the U.S. Government's
response to those events or the U.S. Government becoming involved in an
additional 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.
3
Item 1. Financial Statements
Consolidated Balance Sheets
March 31, December 31,
2004 2003
---------- -----------
(unaudited)
Assets
Cash and due from banks 3,923,748 4,318,584
Interest bearing deposits with banks 876,644 874,362
Federal funds sold 5,145,000 1,500,000
----------- -----------
Cash & cash equivalents 9,945,392 6,692,946
Investment securities:
Held-to-maturity, at amortized cost
(fair market value of $7,256,034 and
$6,772,762 at March 31, 2004 and
December 31, 2003, respectively 7,132,968 6,703,476
Available-for-sale, at market value 5,761,420 8,933,216
Loans, net of unearned discount 45,532,779 47,028,397
Less: allowance for loan losses (477,699) (338,574)
----------- -----------
Net loans 45,055,080 46,689,823
Bank premises & equipment, net 2,704,763 2,772,153
Accrued interest receivable 340,996 380,583
Core deposit intangible 1,693,916 1,738,436
Prepaid expenses and other assets 760,311 806,734
----------- -----------
Total Assets 73,394,846 74,717,367
=========== ===========
Liabilities & Shareholders' Equity
Demand deposits, non-interest bearing 16,498,645 16,112,983
Demand deposits, interest bearing 9,348,047 10,430,349
Savings deposits 19,286,183 19,309,126
Time deposits, $100,000 and over 10,047,330 10,349,830
Time deposits 10,758,667 10,914,535
----------- -----------
65,938,872 67,116,823
Accrued interest payable 85,657 77,775
Accrued expenses and other liabilities 128,184 287,875
----------- -----------
Total Liabilities 66,152,713 67,482,473
Shareholders' equity:
Preferred Stock, Series A, non-cum., 6%, $.01 par value, 1,432 1,368
500,000 shares auth., 143,150 issued and outstanding,
6,308 shares held in treasury at March 31, 2004 and
December 31, 2003
Common stock, $.01 par value; 2,000,000 shares authorized;
1,068,588 shares issued and outstanding at March 31, 2004 10,686 10,686
and December 31, 2003.
Treasury Stock, 33,500 shares at March 31, 2004 and
December 31, 2003 -- --
Additional-paid-in-capital 14,749,789 14,749,852
Accumulated deficit (7,596,659) (7,614,662)
Net unrealized gain on available-for-sale securities 76,885 87,649
----------- -----------
Total Shareholders' equity 7,242,133 7,234,893
----------- -----------
73,394,846 74,717,367
=========== ===========
See Accompanying Notes
4
Consolidated Statements of Income
(unaudited)
Three months ended Three months ended
March 31, March 31,
2004 2003
------------------ ------------------
Interest Income:
Interest and fees on loans 747,046 723,716
Interest on investment securities 161,955 258,979
Interest on Federal Funds sold 9,963 21,749
Interest on time deposits with other banks 4,687 4,205
---------- ----------
Total interest income 923,651 1,008,649
Interest Expense:
Interest on time deposits 75,446 101,319
Interest on demand deposits 13,981 23,660
Interest on savings deposits 15,899 28,680
---------- ----------
Total interest expense 105,325 153,659
Net interest income 818,325 854,990
Provision for loan losses (141,000) 60,000
---------- ----------
Net interest income less provision for loan losses 959,325 794,990
---------- ----------
Noninterest income:
Customer service fees 381,804 437,642
Gain on sale of investments 31,115 0
Gain on sale of loans 5,024 0
Other income 37,724 24,528
---------- ----------
Total noninterest income 455,667 462,170
Non-interest expense
Salaries, wages, and employee benefits 537,231 583,144
Occupancy and equipment 307,103 288,945
Office operations and supplies 113,870 112,444
Marketing and public relations 12,026 14,341
Professional services 57,597 51,945
Data processing 141,423 156,959
Deposit insurance assessments 7,597 8,679
Other noninterest expense 220,139 187,629
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Total non-interest expense 1,396,987 1,404,086
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Net income (loss) $ 18,005 $ (146,927)
========== ==========
Earnings per share-basic $0.02 ($0.13)
Earnings per share-diluted $0.02 ($0.13)
========== ==========
Weighted average number of shares 1,068,588 1,102,088
========== ==========
See Accompanying Notes
5
Statement of Cash Flows
(unaudited)
Three Months ended Three Months ended
March 31, March 31,
2004 2003
------------------ ------------------
Cash flows from operating activities
Net income (loss) $ 18,005 $(146,927)
Adjustments to reconcile net loss to net cash
used in operating activities:
Provision for loan losses (141,000) 60,000
Gain on sale of investments (31,115) 0
Depreciation and amortization 144,701 125,530
Increase in accrued interest receivable and
other assets 86,010 (183,319)
Decrease in accrued interest payable and
other liabilities (151,810) (82,057)
---------- ----------
Net cash used in operating activities (75,209) (226,773)
Cash flows from investing activities
Purchase of investments-Held-to-maturity (750,000) 0
Proceeds from maturity & principal reductions of
investments-Available-for-Sale 2,419,716 2,571,864
Proceeds from maturity & principal reductions of
investments-Held-to-Maturity 317,893 965,045
Proceeds from sale of investments-Available-for-Sale 786,526 0
Net decrease in loans 1,775,743 1,538,692
Purchase of premises and equipment (44,271) (98,946)
---------- ----------
Net cash provided by investing activities 4,505,606 4,976,654
Cash flows from financing activities
Net decrease in deposits (1,177,951) (2,164,105)
---------- ----------
Net cash used in financing activities (1,177,951) (2,164,105)
Increase in cash and cash equivalents 3,252,446 2,585,777
Cash and cash equivalents at beginning of period 6,692,946 15,529,088
Cash and cash equivalents at end of period 9,945,392 18,114,865
========== ==========
Supplemental disclosures of cash flow information
Cash paid during the period for interest 268,757 100,860
========== ==========
See Accompanying Notes
6
NOTES TO FINANCIAL STATEMENTS
1. General
United Bancshares, Inc. (the "Company") is a bank holding company registered
under the Bank Holding Company Act of 1956. The Company's principal activity is
the ownership and management of its wholly owned subsidiary, United Bank of
Philadelphia (the "Bank").
During interim periods, the Company follows the accounting policies set forth in
its Annual Report on Form 10-K filed with the Securities and Exchange
Commission. Readers are encouraged to refer to the Company's Form 10-K for the
fiscal year ended December 31, 2003 when reviewing this Form 10-Q. Quarterly
results reported herein are not necessarily indicative of results to be expected
for other quarters.
In the opinion of management, the accompanying unaudited consolidated financial
statements contain all adjustments (consisting of normal recurring adjustments)
considered necessary to present fairly the Company's consolidated financial
position as of March 31, 2004 and December 31, 2003 and the consolidated results
of its operations for the three month period ended March 31, 2004 and 2003, and
its consolidated cash flows for the three month period ended March 31,
2004 and 2003.
2. Stock-based Compensation
At March 31, 2004, the Bank had one stock-based employee compensation plan. The
Bank accounts for that plan under the recognition and measurement principles of
APB 25, "Accounting for Stock Issued to Employees, and related interpretations.
No stock-based employee compensation costs is reflected in net income, as all
options granted under the plan had an exercise price equal to the market value
of the underlying common stock on the date of grant.
The following table provides the disclosures required by SFAS No. 148 and
illustrates the effect on net income and earnings per share if the Corporation
had applied the fair value recognition provisions of SFAS No. 123 to stock-based
employee compensation.
(in 000's)
2004 2003
-------- -------
Net income (loss) As reported $ 18 $ (147)
Stock-based compensation
costs determined under fair
value method for all awards $ - $ -
------- -------
Pro forma $ 18 $ (147)
Earnings (loss) per share (Basic) As reported $0.02 ($0.13)
Pro forma $0.02 ($0.13)
Earnings (loss) per share (Diluted) As reported $0.02 ($0.13)
Pro forma $0.02 ($0.13)
There were no options granted in 2004 and 2003.
7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Because the Company is a bank holding company for the Bank, the financial
statements in this report are prepared on a consolidated basis to include the
accounts of the Company and the Bank. The purpose of this discussion is to focus
on information about the Bank's financial condition and results of operations,
which is not otherwise apparent from the consolidated financial statements
included in this quarterly report. This discussion and analysis should be read
in conjunction with the financial statements presented elsewhere in this report.
Executive Overview
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 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.
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. Without a lot of marketing initiative,
the Bank has built a strong reputation as the "lender of choice" for many
religious organizations with this sector constituting 23% of the Bank's
commercial loan portfolio at March 31, 2004.
The Bank's commercial loan pipeline continues to grow. At March 31, 2004, the
pipeline totaled $7 million, of which $3.5 million is projected to be funded in
the second quarter of 2004. In addition, other consumer loans including home
equity, automobile, student and credit card loans continue to be focused on for
growth in the portfolio to allow for risk diversification.
The Bank will focus on its niche business lines 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 has begun develop these strategic
alliances/partnerships to help ensure that the communities it serves have full
access to financial products and services.
8
Most recently, the Bank entered into a marketing relationship with a major
corporation for the purpose of increasing its residential mortgage loan
activity. The partner corporation will perform a comprehensive joint marketing
blitz and assign seasoned mortgage loan officers to the Bank's financial service
centers. This relationship is intended to generate fee income and create a
marketing "buzz" about the Bank and its homeownership programs. While first
mortgages will not be funded by the Bank, this relationship will allow the Bank
to cross sell other products including home equity loans, credit cards, and
wealth management services products.
At December 31, 2003, the Bank's Tier 1 leverage ratio had fallen below the
7.00% minimum required by its Written Agreement with its regulators (See
Regulatory Matters below). However, at March 31, 2004, primarily as a result of
a $265 thousand recovery on a previously charged-off loan, the Bank's Tier 1
leverage ratio was 7.15%, which is above the minimum requirement. Management
clearly understands that new capital is essential to achieve the Bank's
strategic plan of growth and core profitability. The Board and management
continue to aggressively explore 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.
Management accomplished the first phase of the Bank's re-capitalization
plan that included the sale of a remote bank-owned parking lot in April 2004.
This sale resulted in a net gain of $368 thousand which will be reflected in the
second quarter ending June 30, 2004. Further, an agreement of sale has been
entered into for the sale of the Bank's Corporate Headquarters Building located
at 300 N. Third Street. It is projected that the Bank could realize a gain of at
least $1.5 million on this transaction that is scheduled to close no later than
the third quarter of 2004. The gains on asset sales will be used to
re-capitalize the Bank and support growth and profitability strategies.
Simultaneous with these asset sale strategies to generate capital, management
continues its quest of raising external capital through the sale of the Bank's
common and/or preferred stock.
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. The Bank currently has four such arrangements with fee
income projected to exceed $150 thousand for 2004.
As a result of the actions referred to above, management strongly believes that
the Bank is well positioned to achieve its 2004 strategic plan--to be a well
capitalized, profitable financial institution that is positioned for growth.
9
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.
No current income tax expense is recorded due to the partial utilization of the
Bank's net operating loss carryforward.
10
Selected Financial Data
The following table sets forth selected financial data for the each of the
following periods:
(Thousands of dollars, except per share data)
Quarter ended Quarter ended
March 31, March 31,
2004 2003
------------- -------------
Net interest income $ 818 $ 855
Provision for loan losses (141) 60
Noninterest income 456 462
Noninterest expense 1,397 1,404
Net income (loss) 18 (147)
Earnings (loss) per share-basic and diluted $0.02 ($0.13)
Balance sheet totals: March 31, December 31,
2004 2003
--------- ------------
Total assets $73,395 $74,717
Loans, net $45,055 $46,690
Investment securities $12,656 $15,637
Deposits $65,939 $67,117
Shareholders' equity $ 7,242 $ 7,235
Ratios
Return on assets(1) 0.10% (1.38)%
Return on equity(1) 1.04% (13.03)%
Tangible Equity to assets ratio 7.15% 6.85%
- ------------
(1) Not annualized for the quarter ended March 31, 2004.
Financial Condition
Sources and Uses of Funds
The financial condition of the Bank can be evaluated in terms of trends in its
sources and uses of funds. The comparison of average balances in the following
table indicates how the Bank has managed these elements. Average funding sources
decreased approximately $2.5 million, or 3.64%, during the quarter ending March
31, 2004. Average funding uses decreased $2.5 million, or 3.80%, for the same
quarter.
Sources and Uses of Funds Trends
(Thousands of Dollars, except percentages)
March 31, 2004 December 31,2003
--------------- ----------------
Average Increase (Decrease) Average
------- ------------------- -------
Balance Amount % Balance
------- ------ ------- -------
Funding uses:
Loans $45,809 $ (403) (0.87)% $46,212
Investment securities
Held-to-maturity 6,615 (332) (4.78) 6,947
Available-for-sale 7,553 (783) (9.39) 8,336
Federal funds sold 4,121 (1,012) (19.72) 5,133
------ ------- -------
Total uses $64,098 $(2,530) $66,628
======= ======= =======
Funding sources:
Demand deposits
Noninterest-bearing $16,158 $ (349) (2.11)% $16,507
Interest-bearing 9,581 (1,716) (15.19) 11,297
Savings deposits 19,475 (174) (0.89) 19,649
Time deposits 21,084 (268) (1.26) 21,352
------- ------- -------
Total sources $66,298 $(2,507) $68,805
======= ======= =======
11
Loans
Average loans declined approximately $403 thousand, or 0.87%, during the quarter
ended March 31, 2004. This decrease is primarily a result of continued payoffs
in the Bank's residential loan portfolio and one large loan pay-off in the
Bank's commercial loan portfolio. This loan totaled approximately $1 million and
represented participation in a construction line of credit with another
institution. In March 2004, the construction was completed and permanent
financing was obtained by the borrower. The Bank was not a participant in the
permanent financing.
However, the Bank's commercial loan pipeline continues to grow. At March 31,
2004, the pipeline totaled $7 million, of which $3.5 million is projected to be
funded in the second quarter of 2004. In addition, small business loans,
mortgage loans and other consumer loans including home equity, automobile,
student and credit card loans continue to be focused on for growth in the
portfolio to allow for risk diversification.
The Bank has cultivated 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 as a low
cost means to build the Bank's pool of earning assets while it enhances its own
business development capacity. Most of these participations are secured by
commercial real estate.
The Bank's loan-to-deposit ratio at March 31, 2004 was 68.3%, down slightly from
69.6% at December 31, 2003 as a result of the loan payoffs discussed above. The
target loan-to-deposit ratio is 75%. This level would allow the Bank to optimize
interest income on earning assets while maintaining adequate liquidity.
Management will continue to implement loan growth strategies including the
purchase of additional consumer loans (primarily home equity loans) and
participation in commercial loans with other financial institutions.
Because of the purchase of loan participations, the Bank's loan portfolio is
heavily concentrated in commercial loans (primarily commercial real estate) that
comprises $23 million, or 50.44%, of total loans. Continued payoffs in the
residential mortgage loan portfolio resulted in a reduction of this component of
the portfolio from $15.1 million at December 31, 2003 to $14.2 million at March
31, 2004. The following table shows the composition of the loan portfolio of the
Bank by type of loan.
(Thousands of Dollars)
March 31, December 31,
2004 2003
------- --------
Commercial loans $22,965 $23,223
Consumer loans 8,353 8,695
Residential mortgages 14,215 15,110
------- -------
Total Loans $45,533 $47,028
======= =======
Allowance for Loan Losses
The allowance for loan losses reflects management's continuing evaluation of the
loan portfolio, the diversification and size of the portfolio, and adequacy of
collateral. The following factors are considered in determining the adequacy of
the allowance for loan losses: levels and trends in delinquencies and impaired
loans; levels of and trends in charge-offs and recoveries; trends in volumes and
terms of loans, effects of any changes in risk selection and underwriting
standards, and other changes in lending policies, procedures and practices;
experience, ability, and depth of lending management and relevant staff;
national and local economic conditions; industry conditions; and effects of
changes in credit concentrations.
12
The following Table presents an analysis of the allowance for loan losses.
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
(Dollars in thousands)
Balance at January 1, 2004 $339
Charge-offs:
Consumer loans (31)
----
Total charge-offs (31)
====
Recoveries 311
Net (charge-offs) recoveries 280
----
Additions (charged to) credited back to operations 141
----
Balance at March 31, 2004 $478
====
The allowance for loan losses as a percentage of total loans was 1.05% at March
31, 2004 compared to 0.72% at December 31, 2003. During the quarter ended March
31, 2004, the Bank recovered $265 thousand related to one previously charged-off
commercial loan. Of this recovery, the Bank credited $165 thousand back to
operations and retained $100 thousand in the allowance for loan losses to
provide for potential future losses. In addition, during the quarter, the Bank
made provisions to the allowance totaling $24 thousand. The Bank continues to
proactively monitor its credit quality while working with borrowers in an effort
to identify and control credit risk.
At March 31, 2004, the Bank's classified loans totaled $2.6 million, or 5.74%
of total loans. Specific reserves of $357 thousand have been allocated to these
loans. In addition, at March 31, 2004, approximately $1 million of the
classified loans are guaranteed by the Small Business Administration (SBA) and
$412 thousand are residential mortgage loans that have strong loan-to-values
that minimize the risk of loss.
While management uses available information to recognize losses on loans, future
additions may be necessary based on changes in economic conditions. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to recognize additions to the allowance based on their
judgments of information available to them at the time of the examination.
Management believes the level of the allowance for loan losses is adequate as of
March 31, 2004.
13
Nonperforming and Nonaccrual Loans
The Bank generally determines a loan to be "nonperforming" when interest or
principal is past due 90 days or more. If it otherwise appears doubtful that the
loan will be repaid, management may consider the loan to be "nonperforming"
before the lapse of 90 days. The policy of the Bank is to charge-off unsecured
loans after 90 days past due. Interest on "nonperforming" loans ceases to accrue
except for loans that are well collateralized and in the process of collection.
When a loan is placed on non-accrual, previously accrued and unpaid interest is
generally reversed out of income unless adequate collateral from which to
collect the principal of and interest on the loan appears to be available. At
March 31, 2004, non-accrual loans were approximately $1.4 million compared to
$1.6 million at December 31, 2003. Approximately $888 thousand of the Bank's
non-accrual loans were guaranteed by the SBA.
The Bank has one borrower in the telecommunications industry with loans totaling
approximately $1.3 million that experienced severe financial difficulty. As a
result, in December 2003, the Bank charged-off the non-SBA-guaranteed portion of
this credit totaling $710 thousand. The Bank has presented the remaining balance
totaling $568 thousand to the SBA for collection on its guarantee. Therefore, no
further loss is anticipated relative to this credit.
There is no other known information about possible credit problems other than
those classified as nonaccrual that causes management to be uncertain as to the
ability of any borrower to comply with present loan terms.
The Bank grants commercial, residential and consumer loans to customers
primarily located in Philadelphia County, Pennsylvania and surrounding counties
in the Delaware Valley. From time to time, the Bank purchases loans from other
financial institutions. These loans are generally located in the Northeast
corridor of the United States. Although the Bank has a diversified loan
portfolio, its debtors' ability to honor their contracts is influenced by the
region's economy.
At March 31, 2004, approximately 23% of the Bank's commercial loan portfolio was
concentrated in loans made to religious organizations. From inception, the Bank
has received support in the form of investments and deposits and has developed
strong relationships with the Philadelphia region's religious community. Loans
made to these organizations were primarily for expansion and repair of church
facilities.
Investment Securities and Other Short-term Investments
Investment securities, including Federal Funds Sold, decreased on average by
$2.1 million, or 10.42%, during the quarter ended March 31, 2004. This decline
is due to a decrease in funds available for investment because of an $800
thousand reduction in the balance of a significant account relationship in
December 2003. These funds were required by the customer to secure a credit
facility at another financial institution. In addition, Bank Enterprise
certificates of deposit placed at the Bank by other community development
financial institutions matured in March 2004. These certificates had a term of
three years and were non-renewable.
The Bank's current investment portfolio primarily consists of mortgage-backed
pass-through agency securities (78.6%), and other government-sponsored agency
securities (21.4%). The Bank does not invest in high-risk securities or complex
structured notes. The yield on the portfolio was 4.65% at March 31, 2004
compared with 5.45% one year ago. The reduction in yield is primarily a result
of called agency securities for which the replacement securities had
significantly lower yields. In addition, the Bank's floating rate
mortgage-backed securities that have Treasury and LIBOR indices, repriced in the
current lower interest rate environment.
14
The average duration of the portfolio at March 31, 2004 is 5.25 years compared
to 2.78 years at December 31, 2003. The extension of the duration during the
quarter ended March 31, 2004 resulted from noted improvement in the economy and
a corresponding rise in long term interest rates. Because a large percentage of
the Bank's portfolio includes mortgage-backed securities, the prepayment rate
slows as individuals are less likely to refinance mortgages in a rising rate
environment. In fact, the constant one year prepayment rate (CPR), prepayment
speed at which mortgage-backed securities pay, has declined from 42.93% at
December 31, 2003 to 39.80% at March 31, 2004. This translates into only 39.80%
of the mortgage pool repaying on an annual basis compared to 42.93% at December
31, 2003 resulting in a reduction of cashflow available to fund loans or to
reinvest. Management will continue to monitor and take appropriate action to
control its extension risk to ensure the appropriate level of funds are
available to meet liquidity needs. In 2003, a strategy was implemented 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. This strategy
should help to reduce the level of optionality/extension risk in the portfolio.
Approximately $1.8 million in securities were called during the quarter. The
average yield of called securities was 5.00%. Calls will likely diminish as the
economy continues to improve and interest rates rise.
Deposits
The Bank has a stable core deposit base representing 85% of total deposits.
During the quarter ended March 31, 2004, average deposits decreased $2.5
million, or 3.64%. As noted above in Investment Securities and Other Short-term
Investments, the Bank's deposit level declined because of an $800 thousand
reduction in the balance of a significant account relationship. These funds were
required by the customer to secure a credit facility at another financial
institution. In addition, Bank Enterprise certificates of deposit placed at the
Bank by other community development financial institutions matured in March
2004. These certificates had a term of three years and were non-renewable.
Only modest deposit growth is projected during 2004 because of the Bank's
mandatory capital requirements outlined in its Written Agreement with its
regulators (See Regulatory Matters below). Therefore, aggressive deposit
retention or new business development strategies will not be implemented until
capital levels are increased. (Please refer to the Capital Resources discussion
below for capital improvement strategies.)
Other Borrowed Funds
The Bank did not borrow funds during the quarter ended March 31, 2004.
Generally, the level of other borrowed funds is dependent on many items such as
loan growth, deposit growth, customer collateral/security requirements and
interest rates paid for these funds. The Bank's liquidity has been enhanced by
loan paydowns/payoffs and called investment securities--thereby, eliminating the
need to borrow.
15
Commitments and Lines of Credit
The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and letters of
credit, which are conditional commitments issued by the Bank to guarantee the
performance of an obligation of a customer to a third party. Both arrangements
have credit risk essentially the same as that involved in extending loans, and
are subject to the Bank's normal credit policies. Collateral may be obtained
based on management's assessment of the customer. The Bank's exposure to credit
loss in the event of nonperformance by the other party to the financial
instruments is represented by the contractual amount of those instruments.
The Bank's financial instrument commitments at March 31, 2004 are summarized
below:
Commitments to extend credit $15,087,000
There were no outstanding letters of credit at March 31, 2004.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Since many
of the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Management believes the Bank has adequate
liquidity to support the funding of unused commitments.
Liquidity and Interest Rate Sensitivity Management
The primary functions of asset/liability management are to assure adequate
liquidity and maintain appropriate balance between interest-sensitive earning
assets and interest-bearing liabilities. Liquidity management involves the
ability to meet cash flow requirements of customers who may be either depositors
wanting to withdraw funds or borrowers needing assurance that sufficient funds
will be available to meet their credit needs. Interest rate sensitivity
management seeks to avoid fluctuating net interest margins and to enhance
consistent growth of net interest income through periods of changing interest
rates.
The Bank is required to maintain minimum levels of liquid assets as defined by
Federal Reserve Board (the "FRB") regulations. This requirement is evaluated in
relation to the composition and stability of deposits; the degree and trend of
reliance on short-term, volatile sources of funds, including any undue reliance
on particular segments of 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. At March 31, 2004, management believes the
Bank's liquidity is satisfactory and in compliance with the FRB regulations.
16
The Bank's principal sources of asset liquidity include investment securities
consisting principally of U.S. Government and agency issues, particularly those
of shorter maturities, and mortgage-backed securities with monthly repayments of
principal and interest. Other types of assets such as federal funds sold, as
well as maturing loans, are sources of liquidity. Approximately $9.7 million in
loans are scheduled to mature within one year.
By policy, the Bank's minimum level of liquidity is 6.00% of total assets. At
March 31, 2004, the Bank has total short-term liquidity, including cash and
federal funds sold, of $9.9 million, or 13.6% of total assets. Additional
liquidity of approximately $5.5 million is provided by the Bank's investment
portfolio classified as available-for-sale.
The Bank's overall liquidity continues to be enhanced by a significant level of
core deposits which management has determined are less sensitive to interest
rate movements. The Bank continues to avoid reliance on large denomination time
deposits as well as brokered deposits. The Bank has one $5 million deposit with
a government agency that matures in June 2004. While this is a short-term
renewal, based on discussions with the customer, management does not anticipate
the removal of this deposit in the near future.
The following is a summary of the remaining maturities of time deposits of
$100,000 or more outstanding at March 31, 2004:
(Thousands of dollars)
3 months or less $ 5,100
Over 3 through 12 months 4,947
Over 1 through three years --
Over three years --
-------
Total $10,047
=======
Capital Resources
Total shareholders' equity increased approximately $7 thousand during the
quarter ended March 31, 2004. The increase in equity was primarily due to net
income of $18 thousand during the quarter offset by an $11 thousand decrease in
other comprehensive income (FAS 115 unrealized gains on available-for-sale
securities) because of interest rate changes that reduced the value of the
investment portfolio. The Board and management continue to aggressively explore
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.
17
The Bank's Capital Planning Committee, consisting of two outside directors and
the Bank's two executive officers, 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. The first step included the sale of a
remote bank-owned parking lot in April 2004. This sale resulted in a net gain of
$368,000. In addition, an agreement of sale has been entered into for the sale
of the Bank's Corporate Headquarters Building located at 300 N. Third Street. It
is projected that the Bank could realize a gain of at least $1.5MM on this
transaction that is scheduled to close no later than the third quarter of 2004.
Gains on asset sales will be used to re-capitalize the Bank and support growth
and profitability strategies.
FRB standards for measuring capital adequacy for U.S. Banking organizations
requires that banks maintain capital based on "risk-adjusted" assets so that
categories of assets with potentially higher risk will require more capital
backing than assets with lower risk. In addition, banks are required to maintain
capital to support, on a risk-adjusted basis, certain off-balance-sheet
activities such as loan commitments. The FRB standards classify capital into two
tiers, referred to as Tier 1 and Tier 2. Tier 1 consists of common shareholders'
equity, non-cumulative and cumulative perpetual preferred stock, and minority
interests less goodwill. Tier 2 capital consists of allowance for loan losses,
hybrid capital instruments, term-subordinated debt, and intermediate-term
preferred stock. Banks are required to meet a minimum ratio of 8% of qualifying
capital to risk-adjusted total assets with at least 4% Tier 1 capital and a Tier
I Leverage ratio of at least 6%. Capital that qualifies as Tier 2 capital is
limited to 100% of Tier 1 capital.
As indicated in the table below, the Company's and the Bank's risk-based capital
ratios are above the minimum requirements at March 31, 2004. However, as of
December 31, 2003, the Bank's tier one leverage capital ratio had fallen to
6.81%, below the 7% minimum capital ratio required by the Written Agreement.
However, at March 31, 2004,the tier one leverage ratio had improved to 7.15%
primarily as a result of a $265 thousand recovery on a previously charged-off
loan. (Refer to Regulatory Matters below for the Written Agreement
requirements). Management will employ the re-capitalization strategies outlined
above to ensure the capital ratio remains above the minimum requirements of the
Written Agreement and to support the growth initiatives of the Bank.
Company Company
March 31, December 31,
2004 2003
-------- -----------
Total Capital $ 7,242 $ 7,235
Less: Intangible Asset/Net
unrealized gains (losses) on
available for sale portfolio (1,772) (1,826)
------- -------
Tier 1 Capital 5,470 5,409
------- -------
Tier 2 Capital 478 339
------- -------
Total Qualifying Capital $ 5,948 $ 5,748
======= =======
Risk Adjusted Total Assets
(including off-Balance sheet exposures) $43,206 $44,971
Tier 1 Risk-Based Capital Ratio 12.66% 12.03%
Tier 2 Risk-Based Capital Ratio 13.77% 12.78%
Leverage Ratio 7.54% 7.19%
18
Bank Bank
March 31, December 31,
2004 2003
-------- -----------
Total Capital $ 6,954 $ 6,957
Less: Intangible Asset/Net
unrealized gains (losses) on
available for sale portfolio (1,772) (1,826)
------- -------
Tier 1 Capital 5,182 5,131
------- -------
Tier 2 Capital 478 339
------- -------
Total Qualifying Capital $5,660 $ 5,470
======= =======
Risk Adjusted Total Assets
(including off-Balance sheet exposures) $43,206 $44,971
Tier 1 Risk-Based Capital Ratio 11.99% 11.39%
Tier 2 Risk-Based Capital Ratio 13.10% 12.14%
Leverage Ratio 7.15% 6.81%
Results of Operations
Summary
The Bank had net income of approximately $18 thousand ($0.02 per common share)
for the quarter ended March 31, 2004 compared to a net loss of $147 thousand
($0.13 per common share) for the quarter ended March 31, 2003. The financial
results for the quarter ended March 31, 2004 included a $165,000 recovery on a
previously charged-off loan. (NOTE: The actual recovery was $265,000 of which
$100,000 was retained in the allowance for loan losses to cover potential future
losses.)
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 July 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.
A more detailed explanation for each component of earnings is included in the
sections below.
19
Net Interest Income
Net interest income is an effective measure of how well management has balanced
the Bank's interest rate sensitive assets and liabilities. Net interest income,
the difference between (a) interest and fees on interest earning assets and
interest paid on interest-bearing liabilities, is a significant component of the
earnings of the Bank. Changes in net interest income result primarily from
increases or decreases in the average balances of interest earning assets, the
availability of particular sources of funds and changes in prevailing interest
rates.
Net interest income declined $37 thousand, or 4.29% for the quarter ending March
31, 2004 compared to the quarter ending March 31, 2003. Much of this decline was
experienced in the investment portfolio. The average balance of investment
securities declined from $19.8 million at March 31, 2003 to $14.2 million at
March 31, 2004, while the average yield decreased from 5.45% to 4.40% for the
same period. The reduction in yield is a result of calls of higher yielding
agency securities as well as the repricing of variable rate mortgage-backed
securities in the current low interest rate environment. Management continues
the goal of increasing the loan portfolio to achieve a 75% loan-to-deposit ratio
in order to maximize the Bank's net interest income.
The Bank's cost of funds declined to 0.65% for the quarter ending March 31, 2004
compared to 0.86% for the same quarter in 2003. Consistent with current market
conditions, the Bank reduced the rates it pays on many of its interest-bearing
products. Because most of the Bank's deposits are considered core, they were not
sensitive to declining rates.
The net interest margin of the Bank was 5.03% at March 31, 2004 compared to
4.72% at March 31, 2003. Management actively manages its exposure to interest
rate changes. The increase in margin is attributed to the reduction in the
Bank's cost of funds as well as a shift out of lower yielding federal funds sold
and student loans into higher yielding home equity loans in December 2003.
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 Bank credited back to earnings (negative provision or recovery) a net $141
thousand for the quarter ending March 31, 2004 compared to a $60 thousand
provision (charge against earnings) for the same quarter in 2003. The negative
provision reflects management's judgement of where the allowance has to be.
(i.e. the analysis drives the allowance which gets adjusted through the
provision.) The negative provision in 2004 was the result of a $265 thousand
recovery on a previously charged-off loan. Of this recovery, $100 thousand was
retained in the allowance for loan losses to cover potential future losses. In
addition, during the quarter ended March 2004, the Bank made provisions to the
allowance totaling $24 thousand. (Refer to Allowance for Loan Losses above for
discussion on classified loans and specific reserves.)
20
Management continues to closely monitor the portfolio for signs of weakness and
will proactively make provisions to cover potential losses. 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 March 31, 2004.
Noninterest Income
The amount of the Bank's noninterest income generally reflects the volume of the
transactional and other accounts handled by the Bank and includes such fees and
charges as low balance account charge, overdrafts, account analysis, and other
customer service fees. Noninterest income for the quarter ended March 31, 2004
declined $6,500, or 1.41%, compared to the quarter ended March 31, 2003. During
2004, the Bank recognized a non-recurring gain of approximately $31 thousand on
the sale of investment securities that helped to offset a $56 thousand (12.76%)
reduction in customer service fees.
The decline in customer service fees is the result 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 2004 compared to 2003 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. In February 2004, as the
result of a market study, the Bank increased some of its activity and low
balance service charges on deposit accounts. These increases began to positively
impact fee income in March 2004.
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.
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. The Bank was selected to syndicate four significant back-up
lines/letters of credit with other minority banks throughout the country for
major corporations for which agent fees for 2004 are projected to exceed $150
thousand compared to $85 thousand received in 2003. These fees will be received
annually for the administration of the credit facilities. During the quarter
ended March 31, 2004, the Bank began the syndication process for two new credit
facilities that are scheduled to close in the second quarter ending June 30,
2004. Management plans to continue to develop this core line of business to
generate fee income to support the Bank's profitability goals.
21
Noninterest Expense
Salaries and benefits decreased $46 thousand, or 7.87%, during the quarter ended
March 31, 2004 compared to 2003. As part of the Bank's continued implementation
of its Profit Restoration Plan, there have been strategic reductions in staff,
job consolidations, and a reduction in salaries for certain employees to lower
the level of personnel expense. Also, as the Bank prepares to close/consolidate
its Two Penn Center financial service center, it has allowed attrition to
accomplish necessary staff reductions to limit the number of possible layoffs.
Management continues its review to ensure the Bank is operating with the most
efficient organizational structure.
Data processing expenses are a result of the management decision of the Bank to
outsource a majority of its data processing operations to third party
processors. Such expenses are reflective of the high level of accounts being
serviced for which the Bank is charged a per account charge by processors. In
addition, the Bank uses outside loan servicing companies to service its
mortgage, credit card, and student loan portfolios. Data processing expenses
decreased approximately $16 thousand, or 9.90%, during the quarter ended March
31, 2004 compared to 2003. In December 2003, the Bank converted/consolidated its
consumer loan account processing (previously outsourced to EDS) with its core
vendor, FISERV. This conversion resulted in a monthly savings of approximately
$6 thousand. The Bank continues to study methods by which it may further reduce
its data processing cost.
Occupancy expense increased approximately $18 thousand, or 6.28%, during the
quarter ended March 31, 2004 compared to 2003. The increase is primarily
attributable to a significant rise in the cost of utilities during the Winter of
2003/2004. Management continues to implement strategies to reduce its occupancy
expense including the closure/consolidation of its Two Penn Center financial
service center located at 15th Street and JFK Boulevard, Philadelphia,
Pennsylvania. The cost of the lease was scheduled to double at expiration in
July 2004. As part of the Bank's profit restoration plan, upon expiration of
the lease, this branch will be closed and consolidated with other branches in
the network to further reduce operating costs.
Professional services expense increased approximately $6 thousand, or 10.88%,
for the quarter ended March 31, 2004 compared to 2003. This increase is
primarily related to increased audit-related cost with the implementation of the
Sarbanes-Oxley Act. In addition, the Bank outsourced human resource-related
projects including the implementation of a formal incentive compensation plan
for business development and a new performance evaluation system.
Office operations and supplies expense remained relatively constant from 2003 to
2004. However, in conjunction with the closure/consolidation of the Bank's Two
Penn Center financial service center, the Bank will experience reductions in
this category of expense including security guards and other costs associated
with branch operations.
22
FDIC insurance premiums decreased by $1 thousand, or 12.46%, for the quarter
ended March 31, 2004 compared to 2003. FDIC insurance premiums are applied to
all financial institutions based on a risk based premium assessment system.
Under this system, bank strength is based on three factors: 1) asset quality, 2)
capital strength, and 3) management. Premium assessments are then assigned based
on the institution's overall rating, with the stronger institutions paying lower
rates. The Bank's assessment was based on 1.96 basis points for BIF (Bank
Insurance Fund) assessable deposits and SAIF (Savings Insurance Fund) assessable
deposits. The decrease during 2004, 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.
Regulatory Matters
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 requires the Bank to maintain a minimum Tier 1 leverage capital ratio
of 7.00%. As of December 31, 2002, the Bank had met the required ratios by
continuing to implement 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. At
March 31, 2004, the Tier 1 leverage ratio had improved to 7.15% primarily as a
result of a $265 thousand recovery on a previously charged-off loan.
Management continues to review and revise its capital plan to address the
development of new equity. An initial step taken to re-capitalize the Bank
included the sale of a remote bank-owned parking lot in April 2004. This sale
resulted in a net gain of $368 thousand which will be reflected in the second
quarter ending June 30, 2004. In addition, an agreement of sale has been entered
into for the sale of the Bank's Corporate Headquarters Building located at 300
N. Third Street. It is projected that the Bank could realize a gain of at least
$1.5MM on this transaction that is scheduled to close no later than the third
quarter of 2004. Gains on asset sales will be used to help re-capitalize the
Bank and support growth and profitability strategies.
A regulatory examination completed in February 2004 determined that the Bank was
not in compliance with 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. Not meeting these
requirements in addition to losses incurred in the current year could expose the
Bank to possible further regulatory actions. Management believes that it has
implemented corrective action where necessary including the adoption of an
achievable strategic plan for 2004.
23
Recent Accounting Pronouncements
In March 2004, the Bank adopted 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. Subsequent to the issuance of FIN 46, the FASB issued a
revised interpretation, FIN 46(R), the provisions of which must be applied to
certain variable interest entities by March 31, 2004. The adoption of the
provisions of FIN 46 had no impact on the Company's financial condition or
results of operations.
In October 2003, the AICPA issued Statement of Accounting Position (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 SEC recently released Staff Accounting Bulletin No. 105, Application of
Accounting Principles to Loan Commitments. SAB 105 provides guidance about the
measurement of loan commitments recognized at fair value under FASB Statement
No. 133, Accounting for Derivative Instruments and Hedging Activities. SAB 105
also requires companies to disclose their accounting policy for those loan
commitments including methods and assumptions used to estimate fair value and
associated hedging strategies. SAB 105 is effective for all loan commitments
accounted for as derivatives that are entered into after March 31, 2004. The
adoption of SAB 105 is not expected to have a material effect on our
consolidated financial statements.
On March 31, 2004, the Financial Accounting Standards Board (FASB) issued a
proposed Statement, Share-Based Payment an Amendment of FASB Statements No. 123
and APB No. 95, that addresses the accounting for share-based payment
transactions in which an enterprise receives employee services in exchange for
(a) equity instruments of the enterprise or (b) liabilities that are based on
the fair value of the enterprise's equity instruments or that may be settled by
the issuance of such equity instruments. Under the FASB's proposal, all forms of
share-based payments to employees, including employee stock options, would be
treated the same as other forms of compensation by recognizing the related cost
in the income statement. The expense of the award would generally be measured at
fair value at the grant date. Current accounting guidance requires that the
expense relating to so-called fixed plan employee stock options only be
disclosed in the footnotes to the financial statements. The proposed Statement
would eliminate the ability to account for share-based compensation transactions
using APB Opinion No. 25, Accounting for Stock Issued to Employees. The Company
is currently evaluating this proposed statement and its effects on its results
of operations.
24
Item 3. Quantitative and Qualitative Disclosures about Market Risk
Interest rate sensitivity varies with different types of interest-earning assets
and interest-bearing liabilities. Overnight federal funds on which rates change
daily and loans which are tied to prime or other short term indices differ
considerably from long-term investment securities and fixed-rate loans.
Similarly, time deposits are much more interest sensitive than passbook savings
accounts. The shorter-term interest rate sensitivities are key to measuring the
interest sensitivity gap, or excess earning assets over interest-bearing
liabilities. Management of interest sensitivity involves matching repricing
dates of interest-earning assets with interest-bearing liabilities in a manner
designed to optimize net interest income within the limits imposed by regulatory
authorities, liquidity determinations and capital considerations.
At March 31, 2004, an asset sensitive position is maintained on a cumulative
basis through 1 year of 8.5% that is within the Bank's policy guidelines of +/-
15% on a cumulative 1-year basis. The current gap position is primarily due to
high level of funds in short-term investments (i.e. Federal Funds Sold) and the
level of variable rate loans and investment securities. Generally, because of
the positive gap position of the Bank in shorter time frames, the Bank can
anticipate that increases in market rates will have a positive impact on the net
interest income, while decreases will have the opposite effect.
While using the interest sensitivity gap analysis is a useful management tool as
it considers the quantity of assets and liabilities subject to repricing in a
given time period, it does not consider the relative sensitivity to market
interest rate changes that are characteristic of various interest rate-sensitive
assets and liabilities. Consequently, although the Bank currently has a 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. This model produces an interest rate exposure report that forecast
changes in the market value of portfolio equity under alternative interest rate
environments. The market value of portfolio equity is defined as the present
value of the Company's existing assets, liabilities and off-balance-sheet
instruments. The calculated estimates of changes in market value of equity at
March 31, 2004 are as follows:
Market value of Market value of equity
Changes in rate equity as a % of MV of Assets
------------------- --------------- -----------------------
(Dollars in thousands)
+400 basis points 1,644 2.48%
+300 basis points 2,883 4.25
+200 basis points 4,167 5.98
+100 basis points 5,158 7.25
Flat rate 6,135 8.45
-100 basis points 6,622 8.97
-200 basis points 7,542 10.07
-300 basis points 8,156 10.73
-400 basis points 8,532 11.05
25
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 assumptions used in evaluating the vulnerability of the Company's earnings
and capital to changes in interest rates are based on management's consideration
of past experience, current position and anticipated future economic conditions.
The interest sensitivity of the Company's assets and liabilities, as well as the
estimated effect of changes in interest rates on the market value of portfolio
equity, could vary substantially if different assumptions are used or actual
experience differs from the assumptions on which the calculations were based.
The Board of Directors of the Bank and management consider all of the relevant
factors and conditions in the asset/liability planning process. Interest-rate
exposure is not considered significant and is within the policy limits of the
Bank at March 31, 2004. However, if significant interest rate risk arises, the
Board of Directors and management may take (but are not limited to) one or all
of the following steps to reposition the balance sheet as appropriate:
1. Limit jumbo certificates of deposit (CDs) and movement into money
market deposit accounts and short-term CDs through pricing and other
marketing strategies.
2. Purchase quality loan participations with appropriate interest rate/gap
match for the balance sheet of the Bank.
3. Restructure the investment portfolio of the Bank.
The Board of Directors has determined that active supervision of the
interest-rate spread between yield on earnings assets and cost of funds will
decrease the vulnerability of the Bank to interest-rate cycles.
Item 4. Controls and Procedures
As of the end of the period covered by the report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer, Evelyn F. Smalls,
and Chief Financial Officer, Brenda M. Hudson-Nelson, of the effectiveness of
the design and operation of the Company's disclosure controls and procedures
pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e). Based upon the
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Company's disclosure controls and procedures are effective in timely
alerting them to material information relating to the Company (including its
consolidated subsidiaries) required to be included in the Company's periodic SEC
filings.
As of the date of this report, there have not been any significant changes in
the Company's internal controls or in any other factors that could significantly
affect those controls subsequent to the date of the evaluation.
26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.
No material claims have been instituted or threatened by or against the Company
or its affiliates other than in the ordinary course of business.
Item 2. Changes in Securities and Use of Proceeds.
The holders of the Common Stock are entitled to such dividends as may be
declared by the Board of Directors out of funds legally available therefore
under the laws of the Commonwealth of Pennsylvania. Under the Pennsylvania
Banking Code of 1965, funds available for cash dividend payments by a bank are
restricted to accumulated net earnings and if the surplus of a bank is less than
the amount of its capital, the bank shall, until surplus is equal to such
amount, transfer to surplus an amount which is at least 10% of its net earnings
for the period since the end of the last fiscal year or any shorter period since
the declaration of a dividend. If the surplus of a bank is less than 50% of the
amount of its capital, no dividend may be declared or paid by the bank without
prior approval of the Secretary of Banking of the Commonwealth of Pennsylvania.
Under the Federal Reserve Act, if a bank has sustained losses up to or exceeding
its undivided profits, no dividend shall be paid, and no dividends can ever be
paid in an amount greater than such bank's net profits less losses and bad
debts. Cash dividends must be approved by the Federal Reserve Board if the total
of all cash dividends declared by a bank in any calendar year, including the
proposed cash dividend, exceeds the total of the bank's net profits for that
year plus its retained net profits from the preceding two years, less any
required transfers to surplus or to a fund for the retirement of preferred
stock. Under the Federal Reserve Act, the 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.
The Federal Deposit Insurance Act generally prohibits all payments of dividends
by a bank, which is in default of any assessment to the Federal Deposit
Insurance Corporation. The Written Agreement prohibits the Company and the Bank
from declaring or paying of dividends without the prior written approval of the
Philadelphia Federal Reserve Bank and the Directors of the Board of Governors
Division of Supervision and Regulation.
Item 3. Defaults Upon Senior Securities.
None
27
Item 4. Submission of Matters to a Vote of Security Holders.
None
Item 5. Other Information.
None
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits.
Exhibit 31.1 Certification of the Chief Executive Officer Pursuant to
Exchange Act Rule 13a-14(a) or Rule 15d-14(a)
Exhibit 31.2 Certification of the Chief Financial Officer Pursuant to
Exchange Act Rule 13a-14(a) or Rule 15d-14(a)
Exhibit 32.1 is the Certification of the Chief Executive Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2 is the Certification of the Chief Financial Officer
Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906
Of the Sarbanes-Oxley Act of 2002.
b) Reports on Form 8-K
No reports on Form 8-K were filed by the Company during the quarter
ended March 31, 2004.
28
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UNITED BANCSHARES, INC.
Date: May 17, 2004 /s/ Evelyn Smalls
------------------------------
Evelyn Smalls
President & Chief Executive Officer
Date: May 17, 2004 /s/ Brenda M. Hudson-Nelson
----------------------------------
Brenda Hudson-Nelson
Executive Vice President/Chief Financial Officer
29
Index to Exhibits
Exhibit 31.1 Certification of the Chief Executive Officer Pursuant to
Exchange Act Rule 13a-14(a) or Rule 15d-14(a)
Exhibit 31.2 Certification of the Chief Financial Officer Pursuant to
Exchange Act Rule 13a-14(a) or Rule 15d-14(a)
Exhibit 32.1 Certification of the Chief Executive Officer Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2 Certification of the Chief Financial Officer Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
30