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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 JUNE 30, 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 August 6,
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 August 6, 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 August 6, 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........ 26
4. Controls and Procedures .......................................... 28
PART II
1. Legal Proceedings................................................. 29
2. Changes in Securities and Use of Proceeds......................... 29
3. Defaults upon Senior Securities................................... 29
4 Submission of Matters to a Vote of Security Holders............... 29
5. Other Information................................................. 29
6. Exhibits and Reports on Form 8-K.................................. 29
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
(Unaudited) (Audited)
June 30, December 31,
2004 2003
----------- -----------
Assets
Cash and due from banks 4,446,753 4,318,584
Interest bearing deposits with banks 878,925 874,362
Federal funds sold 4,139,000 1,500,000
----------- -----------
Cash & cash equivalents 9,464,678 6,692,946
Investment securities:
Held-to-maturity, at amortized cost
(fair market value of $6,811,916 and
$6,772,762 at June 30, 2004 and
December 31, 2003, respectively) 6,859,966 6,703,476
Available-for-sale, at market value 4,928,805 8,933,216
Loans, net of unearned discount 45,802,456 47,028,397
Less: allowance for loan losses (568,676) (338,574)
----------- -----------
Net loans 45,233,780 46,689,823
Bank premises & equipment, net 2,615,252 2,772,153
Accrued interest receivable 296,305 380,583
Core deposit intangible 1,649,397 1,738,436
Prepaid expenses and other assets 683,192 806,734
----------- -----------
Total Assets 71,731,375 74,717,367
=========== ===========
Liabilities & Shareholders' Equity
Demand deposits, non-interest bearing 16,563,240 16,112,983
Demand deposits, interest bearing 8,395,252 10,430,349
Savings deposits 18,657,371 19,309,126
Time deposits, $100,000 and over 9,955,563 10,349,830
Time deposits 10,602,023 10,914,535
----------- -----------
64,173,448 67,116,823
Accrued interest payable 67,888 77,775
Accrued expenses and other liabilities 86,780 287,875
----------- -----------
Total Liabilities 64,328,116 67,482,473
Shareholders' equity:
Preferred Stock, Series A, non-cum., 6%, $.01 par value, 1,432 1,432
500,000 shrs auth., 143,150 issued and outstanding,
6,308 shares held in treasury at June 30, 2004 and
December 31, 2003
Common stock, $.01 par value; 2,000,000 shares authorized;
1,068,588 shares issued and outstanding at June 30, 2004 10,686 10,686
and 1,068,588 at December 31, 2003, respectively.
Additional-paid-in-capital 14,749,789 14,749,789
Accumulated deficit (7,355,249) (7,614,662)
Net unrealized gain on available-for-sale securities (3,400) 87,649
----------- -----------
Total Shareholders' equity 7,403,258 7,234,894
----------- -----------
71,731,375 74,717,367
=========== ===========
The accompanying notes are an integral part of these statements.
4
Statement of Operations
(unaudited)
Quarter ended Quarter ended Six months ended Six months ended
June 30, June 30, June 30, June 30,
2004 2003 2004 2003
----------- ---------- ---------- ----------
Interest Income:
Interest and fees on loans $ 728,573 $ 732,451 $1,475,619 $1,456,167
Interest on investment securities 134,184 206,851 296,139 465,830
Interest on Federal Funds sold 15,223 43,579 25,186 65,328
Interest on time deposits with other banks 4,443 6,750 9,130 10,955
---------- ---------- ---------- ----------
Total interest income 882,423 989,631 1,806,074 1,998,280
Interest Expense:
Interest on time deposits 68,619 101,701 144,065 203,020
Interest on demand deposits 11,603 22,598 25,584 46,258
Interest on savings deposits 15,933 24,652 31,832 53,332
---------- ---------- ---------- ----------
Total interest expense 96,155 148,951 201,481 302,610
Net interest income 786,268 840,680 1,604,593 1,695,670
Provision for loan losses 111,000 60,000 (30,000) 120,000
---------- ---------- ---------- ----------
Net interest income less provision for loan losses 675,268 780,680 1,634,593 1,575,670
---------- ---------- ---------- ----------
Noninterest income:
Gain on sale of loans 1,275 0 6,299 0
Customer service fees 381,417 393,827 763,221 831,469
Realized gain (loss) on investments 0 0 31,115 0
Other income 505,155 15,874 542,879 40,402
---------- ---------- ---------- ----------
Total noninterest income 887,847 409,701 1,343,514 871,871
Non-interest expense
Salaries, wages, and employee benefits 488,800 544,135 1,026,031 1,127,279
Occupancy and equipment 307,629 318,558 614,732 607,503
Office operations and supplies 101,705 111,873 215,575 224,317
Marketing and public relations 15,294 29,377 27,320 43,718
Professional services 64,313 51,590 121,910 103,534
Data processing 134,450 159,627 275,873 316,586
Deposit insurance assessments 7,276 8,504 14,873 17,183
Other noninterest expense 202,241 201,056 422,380 387,282
---------- ---------- ---------- ----------
Total non-interest expense 1,321,708 1,424,720 2,718,694 2,827,402
---------- ---------- ---------- ----------
Net income (loss) $ 241,407 ($ 234,339) $ 259,413 ($ 379,861)
========== ========== ========== ==========
Earnings (loss) per share-basic $0.23 ($0.21) $0.24 ($0.34)
Earnings (loss) per share-diluted $0.23 ($0.21) $0.24 ($0.34)
========== ========== ========== ==========
Weighted average number of shares 1,068,588 1,101,628 1,068,588 1,101,628
========== ========== ========== ==========
The accompanying notes are an integral part of these statements.
5
Statements of Cash Flow
(unaudited)
Six Months ended Six Months ended
June 30, June 30,
2004 2003
---------- ----------
Cash flows from operating activities
Net income (loss) $ 259,413 ($ 379,861)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Provision for loan losses (30,000) 120,000
Gain on sale of investments (31,115) 0
Depreciation and amortization 284,125 326,751
Decrease (Increase) in accrued interest receivable and other assets 207,820 (55,933)
Decrease in accrued interest payable and other liabilities (210,982) (56,091)
---------- ----------
Net cash provided by (used in) operating activities 479,261 (45,134)
Cash flows from investing activities
Purchase of investments-Available-for-Sale 0 (1,500,647)
Purchase of investments-Held-to-maturity (1,000,000) (1,500,000)
Proceeds from maturity & principal reductions of investments-Available-for-Sale 3,184,287 5,679,631
Proceeds from maturity & principal reductions of investments-Held-to-Maturity 837,829 2,458,281
Proceeds from sale of investments-Available-for-Sale 786,526 0
Net (increase) decrease in loans 1,492,342 (3,857,561)
Purchase of premises and equipment (65,137) (237,674)
---------- ----------
Net cash provided by investing activities 5,235,846 1,042,029
Cash flows from financing activities
Net decrease in deposits (2,943,375) (1,397,760)
---------- ----------
Net cash used in financing activities (2,943,375) (1,397,760)
Increase in cash and cash equivalents 2,771,732 (400,865)
Cash and cash equivalents at beginning of period 6,692,946 15,529,088
Cash and cash equivalents at end of period 9,464,678 15,128,223
========== ==========
Supplemental disclosures of cash flow information
Cash paid during the period for interest 260,710 231,074
========== ==========
Write-down of cumulative effect of change in method
of accounting for investment securities
The accompanying notes are an integral part of these statements.
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 June 30, 2004 and December 31, 2003 and the consolidated results
of its operations for the six month period ended June 30, 2004 and 2003, and its
consolidated cash flows for the six month period ended June 30, 2004 and 2003.
2. Stock-based Compensation
At June 30, 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 thousands except per share data)
2004 2003
-------- -------
Net income (loss) As reported $ 259 ($380)
Stock-based compensation
costs determined under fair
value method for all awards $ - $ -
------ -----
Pro forma $ 259 ($380)
Earnings (loss) per share (Basic) As reported $0.24 ($0.34)
Pro forma $0.24 ($0.34)
Earnings (loss) per share (Diluted) As reported $0.24 ($0.34)
Pro forma $0.24 ($0.34)
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 24% of the Bank's
commercial loan portfolio at June 30, 2004.
The Bank's commercial loan pipeline continues to grow. At June 30, 2004, the
pipeline totaled $7.9 million, of which $3.1 million is projected to be funded
in the third 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 uses direct
mail campaigns to solicit much of its consumer loan business. A new marketing
campaign will be developed/implemented in the third quarter of 2004 to further
enhance the growth of this business.
The Bank will continue 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 to develop these
strategic alliances/partnerships to help ensure that the communities it serves
have full access to financial products and services.
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.
8
In June 2004, the Bank entered into an alliance with American Family Life
Assurance Company (AFLAC), the world's largest supplemental insurance company.
This relationship will allow the Bank to offer its customers supplemental
insurance plans including dental, cancer, accidental, and others. The Bank will
earn commissions on the sale of these plans as well as use these products as a
means to attract customers for other cross-selling opportunities.
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 and June 30, 2004, the
Bank's Tier 1 leverage ratio was 7.15% and 7.59%, respectively, above the
minimum requirement. Management clearly understands that additional 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 is reflected in the quarter
ending June 30, 2004. The Bank completed the second phase of the plan in July
2004 with the sale of its corporate headquarters building located at 300 N.
Third Street. This sale resulted in a gain of $1.5 million that will be
reflected in the third quarter ending September 30, 2004. In conjunction with
this sale, the Bank entered a six month low cost lease for a portion of the
building while management completes its due diligence/analysis on potential new
headquarters locations.
The gains on asset sales are being 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. For the six months ended June
30, 2004, the Bank recorded approximately $100 thousand in fees related to these
syndications.
The Bank's 2004 profit restoration plan included the closure of its Two Penn
Center branch office located in Center City Philadelphia. Customers were
notified in June 2004 of the impending closure of this branch scheduled for July
9, 2004. Deposit retention strategies included the implementation of e-banking
in May 2004 that allow customers to perform electronic transactions on their
accounts via the internet. In addition, the Bank re-emphasized its extensive ATM
network of 28 machines and when appropriate increased customers' daily limits on
ATM transactions. While the Bank experienced some attrition related to its
savings passbook customers because of the physical nature of these accounts, the
overall attrition related to this branch closure was less than 2%. The projected
savings from this closure including personnel, occupancy and other operating
cost are estimated to be approximately $300 thousand annually.
9
In conjunction with the sale of its corporate headquarters (currently under a
short-term lease arrangement) and closure of its Two Penn Center branch office,
Management is pursuing a new Center City location for its corporate headquarters
to maintain its corporate relevance, increase market share and enhance its
corporate identity.
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.
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, Quarter ended Quarter ended
except per share data) ------------- -------------
June 30, 2004 June 30, 2003
------------- -------------
Net interest income 786 841
Provision for loan losses 111 60
Noninterest income 888 410
Noninterest expense 1,322 1,425
Net income (loss) 241 (234)
Earnings (loss) per share - basic and diluted
Balance sheet totals: June 30, 2004 December 31, 2003
------------- -----------------
Total assets 71,731 $74,717
Loans, net 45,234 $46,690
Investment securities 11,789 $15,637
Deposits 64,173 $67,117
Shareholders' equity 7,403 $ 7,235
Ratios
Return on assets(1) .34% (1.38)%
Return on equity 17.63% (13.03)%
Tangible Equity to assets ratio 7.59% 6.81%
(1) Not annualized for the quarter ended June 30, 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
increased approximately $126 thousand, or 0.19%, during the quarter ending June
30, 2004 compared to the prior quarter ended March 31, 2004. Average funding
uses decreased $412 thousand, or 0.64%, during the quarter.
Sources and Uses of Funds Trends
June 30, March 31,
(Thousands of Dollars, 2004 Increase 2004
except percentages) -------- (Decrease) ---------
Average -------- Average
Balance Amount % Balance
Funding uses: -------- ------- ----- -------
Loans $45,305 ($ 504) (1.10)% $45,809
Investment securities
Held-to-maturity 7,060 445 6.73 6,615
Available-for-sale 5,186 (2,367) (31.34) 7,553
Federal funds sold 6,135 2,014 48.87 4,121
------- ----- -------
Total uses $63,686 ($ 412) $64,098
======= ===== =======
Funding sources:
Demand deposits
Noninterest-bearing $16,998 $ 840 5.20% $16,158
Interest-bearing 9,378 (203) (2.12) 9,581
Savings deposits 19,179 (296) (1.52) 19,475
Time deposits 20,869 (215) (1.02) 21,084
------- ----- -------
Total sources $66,424 $ 126 $66,298
======= ===== =======
11
Loans
Average loans declined approximately $504 thousand, or 1.10%, during the quarter
ended June 30, 2004. This decrease is primarily a result of continued payoffs in
the Bank's residential loan portfolio where customers with adjustable rate loans
rushed to refinance into fixed rate mortgages to avoid the negative impact of
anticipated rate hikes later in 2004. The Bank has not aggressively sought to
retain or replace these loans because of the long-term interest rate/extension
risk associated with fixed rate loans in the projected rising rate environment.
However, the Bank's commercial loan pipeline continues to grow. At June 30,
2004, the pipeline totaled $7.9 million, of which $3.1 million is projected to
be funded in the third 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 June 30, 2004 was 70.49%, up slightly from
68.3% at March 31, 2004 because of the slight increase in loans and the decline
in deposit levels during the quarter. 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 approximately $25 million, or 54.44%, 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 and $12.7 million at June 30, 2004. The following
table shows the composition of the loan portfolio of the Bank by type of loan.
(Thousands of Dollars)
June 30, March 31, December 31,
2004 2004 2003
------- ------- -------
Commercial loans $24,936 $22,965 $23,223
Consumer loans 8,120 8,353 8,695
Residential mortgages 12,747 14,215 15,110
------ ------- -------
Total Loans $45,802 $45,533 $47,028
======= ======= =======
12
Allowance for Loan Losses
The allowance for loan losses reflects management's continuing evaluation of the
loan portfolio, the diversification and size of the portfolio, and adequacy of
collateral. The following factors are considered in determining the adequacy of
the allowance for loan losses: levels and trends in delinquencies and impaired
loans; levels of and trends in charge-offs and recoveries; trends in volumes and
terms of loans, effects of any changes in risk selection and underwriting
standards, and other changes in lending policies, procedures and practices;
experience, ability, and depth of lending management and relevant staff;
national and local economic conditions; industry conditions; and effects of
changes in credit concentrations. The following Table presents an analysis of
the allowance for loan losses.
ANALYSIS OF ALLOWANCE FOR LOAN LOSSES
(Dollars in thousands)
Balance at January 1, 2004 $339
Charge-offs:
Consumer loans (95)
----
Total charge-offs (95)
====
Recoveries 355
Net (charge-offs) recoveries 260
----
Additions (charged to) credited back to operations 30
----
Balance at June 30, 2004 $569
====
The allowance for loan losses as a percentage of total loans was 1.24% at June
30, 2004 compared to 1.05% at March 31, 2004. 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 ended June
30, 2004, the Bank made provisions to the allowance totaling $111 thousand. The
Bank continues to proactively monitor its credit quality while working with
borrowers in an effort to identify and control credit risk.
At June 30, 2004, the Bank's classified loans totaled $3.1 million, or 6.84% of
total loans. Specific reserves of $365 thousand have been allocated to these
loans. In addition, at June 30, 2004, approximately $888 thousand of the
classified loans are guaranteed by the Small Business Administration (SBA).
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
June 30, 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
June 30, 2004, non-accrual loans were approximately $1.1 million compared to
$1.4 million at March 31, 2004. 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 June 30, 2004, approximately 24% 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
Federal Funds Sold, increased on average by $2 million, or 48.87%, during the
quarter ended June 30, 2004. This increase is because of rapid payoffs in the
Bank's residential mortgage portfolio as well as called agency securities in the
Bank's investment portfolio.
The Bank's current investment portfolio primarily consists of mortgage-backed
pass-through agency securities (71.7%), and other government-sponsored agency
securities (28.3%). The Bank does not invest in high-risk securities or complex
structured notes. The yield on the portfolio was 4.54% at June 30, 2004 compared
with 4.99% 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 June 30, 2004 is 3.40 years compared to
2.78 years at December 31, 2003. The extension of the duration 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
31.19% at June 30, 2004. This translates into only 31.19% 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 that 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 will continue to be
used to help to reduce the level of optionality/extension risk in the portfolio.
Approximately $250 thousand 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 84.5% of total deposits.
During the quarter ended June 30, 2004, average deposits increased $126
thousand, or 0.19%. The primary area of increase was in noninterest-bearing
checking accounts that increased on average by $840 thousand. This increase was
primarily related to one significant deposit relationship with a
quasi-governmental organization. However, this increase was partially offset by
declines in other deposit categories including interest bearing checking
accounts, savings accounts, and time deposits.
In June 2004, the Bank notified customers of its intent to close its 2 Penn
Center Office located in Center City Philadelphia on July 9, 2004. The closure
of this branch resulted in some savings passbook account attrition. Because
passbook customers must physically enter the branch to complete transactions,
electronic banking alternatives including ATMs and e-banking could not be used.
In addition, Bank Enterprise certificates of deposit placed at the Bank by other
community development financial institutions matured during the quarter. These
certificates had a term of three years and were non-renewable.
With the increase in the Bank's capital from recent gains on asset sales, the
Bank is now positioned for deposit growth. Current capital levels allow for
approximately $25 million in deposit growth to remain compliant with mandatory
capital requirements outlined in its Written Agreement with its regulators (See
Regulatory Matters below). However, the projected deposit growth for the
remainder of 2004 is $2 million. New business development strategies will be
implemented beginning in the third quarter of 2004.
15
Other Borrowed Funds
The Bank did not borrow funds during the quarter ended June 30, 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.
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 June 30, 2004 are summarized
below:
Commitments to extend credit $14,183,000
There were no outstanding letters of credit at June 30, 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. A significant portion of these commitments are
a result of minority bank syndications of credit facilities for large Fortune
500 companies. These credit facilities are generally unused and serve as back-up
lines to commercial paper. The Bank serves in the role as lead/arranger for four
(4) of these credits and participates in a number of other facilities where it
is not the lead.
Management believes the Bank has adequate liquidity to support the funding of
unused commitments.
16
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 June 30, 2004, management believes the
Bank's liquidity is satisfactory and in compliance with the FRB regulations
The Bank's principal sources of asset liquidity include investment securities
consisting principally of U.S. Government and agency issues, particularly those
of shorter maturities, and mortgage-backed securities with monthly repayments of
principal and interest. Other types of assets such as federal funds sold, as
well as maturing loans, are sources of liquidity. Approximately $8.5 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
June 30, 2004, the Bank has total short-term liquidity, including cash and
federal funds sold, of $9.5 million, or 13.2% of total assets. Additional
liquidity of approximately $4.9 million is provided by the Bank's investment
portfolio classified as available-for-sale.
The Bank's overall liquidity continues to be enhanced by a significant level of
core deposits which management has determined are less sensitive to interest
rate movements. The Bank continues to avoid reliance on large denomination time
deposits as well as brokered deposits. The Bank has one $5 million deposit with
a government agency that matures in December 2004. 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 June 30, 2004:
(Thousands of dollars)
3 months or less $2,866
Over 3 through 12 months 6,990
Over 1 through three years 100
Over three years --
------
Total $9,956
======
17
Capital Resources
Total shareholders' equity increased approximately $161 thousand during the
quarter ended June 30, 2004. The increase in equity was primarily due to net
income of $241 thousand during the quarter offset by an $80 thousand decrease in
other comprehensive income (FAS 115 unrealized gains on available-for-sale
securities) because of interest rate changes that reduced the value of the
investment portfolio.
The Bank's Capital Planning Committee, consisting of four 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 thousand. The second step included the sale of the Bank's Corporate
Headquarters Building located at 300 N. Third Street. This sale was completed in
July 2004 on which the Bank realized a gain of $1.5 million that will be
reflected in the third quarter of 2004. This sale resulted in a gain of $1.5
million that will be reflected in the third quarter ending September 30, 2004.
In conjunction with this sale, the Bank entered a six month low cost lease for a
portion of the building while management completes its due diligence/analysis on
potential new headquarters locations.
Gains on asset sales will be used to re-capitalize the Bank and support growth
and profitability strategies. The next phase of capital generation will focus on
retained earnings--attaining continuous core profitability from loan and deposit
growth.
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.
18
As indicated in the table below, the Company's and the Bank's risk-based capital
ratios were above the minimum requirements at June 30, 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. At
March 31, 2004 and June 30, 2004, the tier one leverage ratio had improved to
7.15% and 7.59%, respectively, primarily because of a $265 thousand recovery on
a previously charged-off loan and a $368 thousand gain on the sale of a remote
bank-owned parking lot. (Refer to Regulatory Matters below for the Written
Agreement requirements). With a focus on growth and core profitability,
management will work to ensure the capital ratio remains above the minimum
requirements of the Written Agreement.
Company Company Company
-------- --------- ------------
June 30, March 31, December 31,
2004 2004 2003
-------- -------- --------
Total Capital $ 7,403 $ 7,242 $ 7,235
Less: Intangible Asset/Net
unrealized gains (losses) on
available for sale portfolio (1,646) (1,772) (1,826)
------- ------- -------
Tier 1 Capital 5,757 5,470 5,409
------- ------- -------
Tier 2 Capital 527 478 339
------- ------- -------
Total Qualifying Capital $ 6,284 $ 5,948 $ 5,748
======= ======= =======
Risk Adjusted Total Assets
(including off-Balance sheet exposures) $42,093 $43,206 $44,971
Tier 1 Risk-Based Capital Ratio 13.67% 12.66% 12.03%
Tier 2 Risk-Based Capital Ratio 14.93% 13.77% 12.78%
Leverage Ratio 7.99% 7.54% 7.19%
Bank Bank Bank
-------- --------- ------------
June 30, March 31, December 31,
2004 2004 2003
-------- -------- --------
Total Capital $ 7,115 $ 6,954 $ 6,957
Less: Intangible Asset/Net
unrealized gains (losses) on
available for sale portfolio (1,646) (1,771) (1,826)
------- ------- -------
Tier 1 Capital 5,469 5,182 5,131
------- ------- -------
Tier 2 Capital 527 478 339
------- ------- -------
Total Qualifying Capital $ 5,996 $ 5,660 $ 5,470
======= ======= =======
Risk Adjusted Total Assets
(including off-Balance sheet exposures) $42,093 $43,206 $44,971
Tier 1 Risk-Based Capital Ratio 12.99% 11.99% 11.39%
Tier 2 Risk-Based Capital Ratio 14.24% 13.10% 12.14%
Leverage Ratio 7.59% 7.15% 6.81%
19
Results of Operations
Summary
The Bank had net income of approximately $241 thousand ($0.23 per common share)
for the quarter ended June 30, 2004 compared to a net loss of $234 thousand
($0.21 per common share) for the quarter ended June 30, 2003. The financial
results for the quarter ended June 30, 2004 included a $368 thousand gain on the
sale of a remote parking facility owned by the Bank.
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 was closed and consolidated with other branches in the network to
further reduce occupancy, personnel, and other operating cost. The projected
annual savings from this action is $300 thousand.
While expense reductions continue to be achieved, a greater impact will be
realized with increased asset size (deposit growth) and loan originations that
build the Bank's loan-to-deposit ratio. Increased deposit and loan volume will
result in a higher net interest margin and therefore increased revenues. Thus,
while continuing to control expenses, management has placed more focus on the
implementation of business development strategies to increase the level of
deposits and loans outstanding to achieve profitability. Management plans to
leverage the Bank's strategic corporate alliances and channel its resources into
the delivery of competitive products and services. Cross-selling opportunities
will be sought that may begin with the introduction of other ancillary products
to include the following:
o The sale of supplementary insurance products through the Bank's new
alliance with American Family Life Assurance Company (AFLAC);
o Home mortgage products offered by GMAC mortgage representatives
working directly in the Bank's Financial Service Centers; and,
o Wealth management products and services offered through UVEST
Financial Services.
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.
20
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 $54 thousand, or 6.47% for the quarter ending June
30, 2004 compared to the quarter ending June 30, 2003. Much of this decline was
experienced in the investment portfolio. The average balance of investment
securities declined from $16.8 million at June 30, 2003 to $12.2 million at June
30, 2004, while the average yield decreased from 4.99% to 4.54% 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 has 2004 year-end goals
to increase deposits by a minimum of $2 million and to increase 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 0.59% for the quarter ending June 30, 2004
compared to 0.71% 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 4.88% at June 30, 2004 compared to 4.51%
at June 30, 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 made provisions totaling $111 thousand for the quarter ending June 30,
2004 compared to a $60 thousand provision for the same quarter in 2003. The
increase in the level of provisions is due to a review and analysis of the
Bank's loan portfolio and the increase in classified loans. Provisions were made
to the allowance to cover loans for which full collection is uncertain in
accordance with the Bank's Allowance for Loan Loss policies and procedures.
(Refer to Allowance for Loan Losses above for discussion on classified loans and
specific reserves.)
Management continues to closely monitor the portfolio for signs of weakness and
will proactively make provisions to cover potential losses. 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 June 30, 2004.
21
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 June 30, 2004
increased $478 thousand, or 116.71%, compared to the quarter ended June 30,
2003. In May 2004, the Bank recognized a non-recurring gain of $368 thousand on
the sale of a remote bank-owned parking facility located near its 300 North 3rd
Street Corporate headquarters building.
There was a decline of $12 thousand, or 3.15%, in customer service fees as a
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 addition, 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.
The Bank has 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 June 30, 2004, the Bank completed the syndication process for two credit
facilities for which the fees received totaled $100 thousand. Management plans
to continue to develop this core line of business to generate fee income to
support the Bank's profitability goals.
Noninterest Expense
Salaries and benefits decreased $55 thousand, or 10.17%, during the quarter
ended June 30, 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 prepared to
close/consolidate its Two Penn Center financial service center, it allowed
attrition to accomplish necessary staff reductions to limit the number of
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 $25 thousand, or 15.77%, during the quarter ended June
30, 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.
22
Occupancy expense decreased approximately $11 thousand, or 3.43%, during the
quarter ended June 30, 2004 compared to 2003. The decrease is primarily
attributable to reduction in depreciation expense related to the Two Penn Center
branch office for which leasehold-related improvements became fully depreciated
during the quarter. Management continues to implement strategies to reduce its
occupancy expense including the closure/consolidation of its Two Penn Center
Center City branch office in July 2004. The cost of the lease was scheduled to
double at expiration. As part of the Bank's profit restoration plan, upon
expiration of the lease, this branch was closed and consolidated with other
branches in the network to further reduce operating costs.
Professional services expense increased approximately $13 thousand, or 24.66%,
for the quarter ended June 30, 2004 compared to 2003. This increase is primarily
related to increased audit-related cost with the implementation of the
Sarbanes-Oxley Act.
Office operations and supplies expense declined by $10 thousand, or 9.09%, for
the quarter ended June 30, 2004 compared to 2004. In conjunction with the
closure/consolidation of the Bank's Two Penn Center financial service center,
further reductions are projected in this category of expense including security
guards and other costs associated with branch operations.
FDIC insurance premiums decreased by $1 thousand, or 0.59%, for the quarter
ended June 30, 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 current Agreement
requires the Bank 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.
23
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. However, at
March 31, 2004 and June 30, 2004, the Bank's Tier 1 leverage ratio was 7.15% and
7.59%, respectively, above the minimum requirement. Management clearly
understands that additional 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 is reflected in the quarter
ending June 30, 2004. The Bank completed the second phase of the plan in July
2004 with the sale of its corporate headquarters building located at 300 N.
Third Street. This sale resulted in a gain of $1.5 million that will be
reflected in the third quarter ending September 30, 2004. The gains on asset
sales are being 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 Company's common and/or preferred stock.
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.
Restrictions on the Payment of Dividends
The Bank is the sole source of income with which to pay dividends to the
Company's shareholders. 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.
24
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.
Recent Accounting Pronouncements
In November 2003, the Emerging Issues Task Force (EITF) of the FASB issued EITF
Abstract 03-1, The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments (EITF 03-1). The quantitative and qualitative
disclosure provisions of EITF 03-1 were effective for years ending after
December 15, 2003 and were included in the Corporation's 2003 Form 10-K. In
March 2004, the EITF issued a Consensus on Issue 03-1 requiring that the
provisions of EITF 03-1 be applied for reporting periods beginning after June
15, 2004 to investments accounted for under SFAS No. 115 and 124. EITF 03-1
establishes a three-step approach for determining whether an investment is
considered impaired, whether that impairment is other-than-temporary, and the
measurement of an impairment loss. The Corporation is in the process of
determining the impact that this EITF will have on its financial statements.
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 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.
25
The Securities and Exchange Commission (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 the Company's 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.
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 June 30, 2004, an asset sensitive position is maintained on a cumulative
basis through 1 year of 6.11% 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.
26
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
June 30, 2004 are as follows:
Market value of Market value of equity
Changes in rate equity as a % of MV of Assets
------------------- --------------- -----------------------
(Dollars in thousands)
+300 basis points $2,413 5.10%
+200 basis points 4,525 6.60
+100 basis points 5,821 8.30
Flat rate 6,822 9.70
-100 basis points 8,878 11.0
-200 basis points 9,151 12.3
-300 basis points 9,952 13.1
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 June 30, 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.
27
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.
28
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.
None
Item 3. Defaults Upon Senior Securities.
None
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 June 30, 2004.
29
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: August 16, 2004 /s/ Evelyn Smalls
-----------------------------------
Evelyn Smalls
President & Chief Executive Officer
Date: August 16, 2004 /s/ Brenda M. Hudson-Nelson
-----------------------------------
Brenda Hudson-Nelson
Executive Vice President/
Chief Financial Officer
30
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 1 350, 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.
31