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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, 2005 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 _____ Not Applicable.
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 6, 2005
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 6, 2005.
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 6, 2005.
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FORM 10-Q
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Index
Item No. Page
PART I -- FINANCIAL INFORMATION
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 .......................................... 27
PART II -- OTHER INFORMATION
1. Legal Proceedings................................................. 28
2. Unregistered Sales of Equity Securities and Use of Proceeds....... 28
3. Defaults upon Senior Securities................................... 28
4 Submission of Matters to a Vote of Security Holders............... 28
5. Other Information................................................. 28
6. Exhibits ......................................................... 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 companies, 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
March 31, December 31,
2005 2004
---------- -----------
Assets
Cash and due from banks 3,524,226 4,317,645
Interest bearing deposits with banks 891,132 888,924
Federal funds sold 4,426,000 3,727,000
---------- ----------
Cash & cash equivalents 8,841,358 8,933,569
Investment securities:
Held-to-maturity, at amortized cost (fair value of $8,331,944 8,433,154 8,762,796
and $8,784,495 at March 31, 2005 and December 31, 2004, respectively)
Available-for-sale, at market value 4,422,645 4,797,549
Loans held for sale (market value of $1,437,274 at December 31, 2004) 0 1,412,554
Loans, net of unearned discount 48,429,850 45,680,014
Less: allowance for loan losses (643,593) (602,939)
---------- ----------
Net loans 47,786,257 45,077,075
Bank premises & equipment, net 1,087,129 1,074,855
Accrued interest receivable 346,686 328,354
Core deposit intangible 1,515,838 1,560,358
Prepaid expenses and other assets 519,862 353,789
---------- ----------
Total Assets 72,952,929 72,300,899
========== ===========
Liabilities & Shareholders' Equity
Demand deposits, non-interest bearing 13,887,626 13,439,567
Demand deposits, interest bearing 8,514,302 8,333,631
Savings deposits 17,482,232 17,591,981
Time deposits, $100,000 and over 13,643,200 13,641,202
Time deposits 10,298,924 10,165,837
---------- ----------
63,826,284 63,172,219
Accrued interest payable 92,037 78,196
Accrued expenses and other liabilities 242,406 239,156
---------- ----------
Total Liabilities 64,160,727 63,489,571
Shareholders' equity:
Preferred Stock, Series A, non-cum., 6%, $.01 par value, 1,368 1,368
500,000 shrs auth., 136,842 issued and 6,308 held in treasury
Common stock, $.01 par value; 2,000,000 shares authorized;
876,921 shares issued 8,769 8,769
Class B Non-voting common stock; 250,000 shares authorized; $0.01 par value;
191,667 shares issued and outstanding 1,917 1,917
Treasury Stock, 33,500 shares, at cost 0 0
Additional-paid-in-capital 14,749,852 14,749,852
Accumulated deficit (5,956,562) (5,968,140)
Net unrealized gain on available-for-sale securities (13,142) 17,562
---------- ----------
Total Shareholders' equity 8,792,202 8,811,328
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72,952,929 72,300,899
========== ==========
See Accompanying Notes
4
Consolidated Statements of Operations
(unaudited)
Three months ended Three months ended
March 31, March 31,
2005 2004
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Interest Income:
Interest and fees on loans $ 817,051 $ 747,046
Interest on investment securities 138,111 161,955
Interest on Federal Funds sold 25,789 9,963
Interest on time deposits with other banks 5,619 4,687
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Total interest income 986,570 923,651
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Interest Expense:
Interest on time deposits 90,073 75,446
Interest on demand deposits 10,552 13,981
Interest on savings deposits 14,640 15,899
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Total interest expense 115,265 105,325
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Net interest income 871,304 818,325
Provision for loan losses 40,000 (141,000)
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Net interest income less provision for
loan losses 831,304 959,325
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Noninterest income:
Customer service fees 169,637 225,599
ATM Fees 150,036 156,205
Gains on sales of investments 0 31,115
Gain on sale of loans 24,720 5,024
Loan Syndication fees 46,672 0
Other income 22,962 37,724
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Total noninterest income 414,027 455,667
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Non-interest expense
Salaries, wages, and employee benefits 467,418 537,231
Occupancy and equipment 258,891 307,103
Office operations and supplies 93,155 113,870
Marketing and public relations 6,534 12,026
Professional services 72,766 57,597
Data processing 109,369 141,423
Deposit insurance assessments 29,282 7,597
Other noninterest expense 196,336 220,139
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Total non-interest expense 1,233,752 1,396,987
Net income before income taxes 11,579 18,005
Provision for income taxes 0 0
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Net income $ 11,579 $ 18,005
========== ==========
Earnings per share-basic $0.01 $0.02
Earnings per share-diluted $0.01 $0.02
========== ==========
Weighted average number of shares 1,068,588 1,102,088
========== ==========
See Accompanying Notes
5
Consolidated Statements of Cash Flows
(unaudited)
Three Months ended Three Months ended
March 31, March 31,
2005 2004
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Cash flows from operating activities
Net income $ 11,579 $ 18,005
Adjustments to reconcile net income to net cash
used in operating activities:
Provision for loan losses 40,000 (141,000)
Gain on sale of investments 0 (31,115)
Gain on sale of loans (24,720) 0
Depreciation and amortization 141,607 141,701
(Increase) Decrease in accrued interest receivable and other assets (184,405) 86,010
Increase (Decrease) in accrued interest payable and other liabilities 17,091 (151,810)
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Net cash used in operating activities 1,152 75,209
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Cash flows from investing activities
Purchase of investments-Held-to-maturity 0 (750,000)
Proceeds from maturity & principal reductions of investments-Available-for-Sale 299,684 2,419,716
Proceeds from maturity & principal reductions of investments-Held-to-Maturity 327,168 317,893
Proceeds from sale of investments-Available-for-Sale 0 786,526
Net (increase) decrease in loans (2,709,182) 1,775,743
Proceeds from the sale of loans 1,437,273 0
Purchase of premises and equipment (102,370) (44,271)
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Net cash (used in) provided by investing activities (747,427) 4,505,606
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Cash flows from financing activities
Net increase (decrease) in deposits 654,064 (1,177,951)
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Net cash provided by (used in) financing activities 654,064 (1,177,951)
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(Decrease) Increase in cash and cash equivalents (92,211) 3,252,446
Cash and cash equivalents at beginning of period 8,933,569 6,692,946
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Cash and cash equivalents at end of period $8,841,358 $9,945,392
========== ==========
Supplemental disclosures of cash flow information
Cash paid during the period for interest 285,498 268,757
========== ==========
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, 2004 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, 2005 and December 31, 2004 and the consolidated results
of its operations for the three month periods ended March 31, 2005 and 2004, and
its consolidated cash flows for the three month periods ended March 31, 2005 and
2004.
2. Stock-based Compensation
At May 6, 2005, 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 Company had
applied the fair value recognition provisions of SFAS No. 123 to stock-based
employee compensation.
Three Months Ended
March 31,
2005 2004
------ ------
(in 000's)
Net income As reported $ 12 $ 18
Stock-based compensation
costs determined under fair
value method for all awards $ - $ -
----- -----
Pro forma $ 12 $ 18
Earnings per share (Basic) As reported $0.01 $0.02
Pro forma $0.01 $0.02
Earnings per share (Diluted) As reported $0.01 $0.02
Pro forma $0.01 $0.02
There were no options granted in 2005 and 2004.
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.
During the past five years, management has implemented re-capitalization
strategies and expense control measures to stabilize the Bank and position it
for growth. While re-capitalization and expense reductions have been achieved,
management believes that a greater impact will be realized with deposit growth
and increased loan originations that build the Bank's core earnings. Increased
deposits will increase the Bank's ability to fund and grow its earning assets
while an increased loan-to-deposit ratio will generally result in a higher net
interest margin on those assets. Thus, while continuing to control expenses,
management has placed more focus on the implementation of business development
strategies to achieve deposit and loan growth as a means to achieve core
profitability.
Business development strategies include the enhancement of the Bank's business
development team by adding appropriate skilled personnel and shifting focus of
other designated personnel to the development of new business. In addition, the
Bank has retained a public relations firm to assist in outreach to potential new
customers and to create a new "buzz" about the Bank. The goal is to engage in a
more aggressive marketing and advertising campaign to get the Bank back into the
marketplace and in the minds of existing and new customers. Full advantage will
be taken of the co-branding opportunities with the Bank's strategic alliances to
increase the Bank's consumer loan business including brochures, joint seminars,
and other business development opportunities. The Bank currently has alliances
with a Fortune 500 mortgage company and a Fortune 500 investment management
company.
8
During the quarter ended March 31, 2005, total deposits increased by $654
thousand, or 1.03%, and net loans (including loans held for sale) increased by
$1.3 million, or 2.79%. The focus of the Bank's lending activities is primarily
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
much marketing, the Bank has built a strong reputation as the "lender of choice"
for many religious organizations with this sector constituting 20% of the Bank's
commercial loan portfolio at March 31, 2005.
The Bank's commercial loan pipeline remains active. At March 31, 2005, the
pipeline totaled $4 million, of which $2.9 million is projected to be closed in
the second quarter of 2005. In addition, other consumer loans including home
equity, automobile, student and credit card loans are targeted for growth in the
portfolio to allow for risk diversification.
The Bank will continue to focus on its niche business lines to include the basic
deposit and loan business, while developing relationships with corporate
entities that have a commitment to community and economic development in the
urban sector. Strategic alliances and partnerships are key to the economic
strength of inner city neighborhoods. The Bank will continue to develop these
strategic alliances/partnerships to help ensure that the communities it serves
have full access to financial products and services.
Management accomplished the re-capitalization of the Bank in 2004 with gains on
the sale of bank-owned assets. Although the Bank is now considered adequately
capitalized, management continues to seek capital through internal capital
generation (retained earnings) as well as external capital through the possible
future sale of the Bank's common/preferred stock. Additional capital will be
used to support growth in the Bank's balance sheet and fee income initiatives.
During the quarter ended March 31, 2005, net income from core operations was
approximately $12 thousand, or $.01 per share. Revenue enhancement strategies
have been employed to expand opportunities for fee income through the
implementation of products and services including corporate loan syndications
where the Bank serves in the role of arranger and/or administrative agent.
Consistent with 2004, the Bank manages four such arrangements with fee income
projected to exceed $175 thousand for 2005 of which approximately $47 thousand
was recognized in the quarter ended March 31, 2005. Efforts will continue to
attract additional corporate partners to join the Bank's minority credit
syndication business line to generate fee income.
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. 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, 2005 March 31, 2004
-------------- --------------
Net interest income $ 871 $ 818
Provision for loan losses 40 (141)
Noninterest income 414 456
Noninterest expense 1,234 1,397
Net income 12 18
Earnings per share-basic and diluted $0.01 $0.02
Balance sheet totals:
March 31, 2005 December 31, 2004
-------------- -----------------
Total assets $72,953 $72,301
Loans, net $47,786 $45,077
Investment securities $12,856 $13,560
Deposits $63,826 $63,172
Shareholders' equity $ 8,792 $ 8,811
Ratios
Return on assets 0.06% 0.10%
Return on equity 0.52% 1.04%
Tangible Equity to assets ratio 9.84% 7.15%
10
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 $84 thousand, or 1.31%, during the quarter ending March
31, 2005. Average funding uses decreased $1.6 million, or 2.46%, for the same
quarter.
Sources and Uses of Funds Trends
(Thousands of Dollars,
except percentages) March 31, 2005 December 31,2004
-------------- ----------------
Average Increase (Decrease) Average
Balance Amount % Balance
------- ------------------ ----- -------
Funding uses:
Loans $47,768 $1,597 3.46% $46,171
Investment securities
Held-to-maturity 8,628 1,355 18.63 7,273
Available-for-sale 4,306 (1,074) (19.96) 5,380
Federal funds sold 4,256 (3,517) (45.25) 7,773
------- -------- -------
Total uses $64,958 ($1,639) $66,597
======= ======== =======
Funding sources:
Demand deposits
Noninterest-bearing $13,603 ($ 947) (6.51%) $14,550
Interest-bearing 8,393 (922) (9.90) 9,315
Savings deposits 17,632 (1,061) (5.68) 18,693
Time deposits 23,649 2,090 9.69 21,559
------- ------ -------
Total sources $63,277 ($ 840) $64,117
======= ====== =======
Loans
Average loans increased $1.6 million, or 3.46%, during the quarter ended March
31, 2005. The Bank funded $4.1 million in commercial loans during the quarter.
The Bank's commercial loan pipeline continues to grow as a result of increased
business development efforts and loan participations with other financial
institutions.
At March 31, 2005, the commercial loan pipeline totaled $4 million of which $2.9
million is projected to be closed in the second quarter of 2005. 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.
While loan fundings increased during the quarter, the Bank sold $1.4 million of
its student loan portfolio in January 2005 to create liquidity to fund higher
yielding, less costly to service commercial loans. In addition, during the
quarter there were several unexpected payoffs of loans in which the Bank
participates with other financial institutions.
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. Approximately $1.3 million in commercial loan
participations were booked during the quarter ended March 31, 2005. Most of
these participations are secured by commercial real estate.
11
The Bank's loan-to-deposit ratio at March 31, 2005 was 74.9%, up slightly from
73.6% at December 31, 2004 as a result of the loan origination activity
discussed above. The target loan-to-deposit ratio is 75%. This level allows the
Bank to optimize interest income on earning assets while maintaining adequate
liquidity. Although the Bank is very close to its target loan-to-deposit ratio,
deposit growth is projected for the remainder of 2005. To ensure that loans keep
pace with deposits and that this ratio is maintained, management will continue
to implement loan growth strategies including the participation in commercial
loans with other financial institutions.
While the Bank's target loan-to-deposit ratio is 75%, this ratio does not
represent a policy limit. The Bank has adequate liquidity to continue to fund
loan originations for the foreseeable future. If necessary, to create additional
liquidity, the Bank has the ability to sell a portion of its investment
portfolio or its lower yielding student loan portfolio.
The Bank's loan portfolio is heavily concentrated in commercial loans that
comprise $30.9 million, or 64%, of total loans at March 31, 2005 compared to
$28.2 million, or 60% of total loans. The increase in this concentration is a
result of the relatively high level of commercial loan activity that occurred
during the quarter compared to all other categories of loans that have remained
relatively consistent compared to December 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,
2005 2004
------- -------
Commercial and industrial $18,300 $15,217
Commercial real estate 12,590 13,070
Consumer loans 6,971 6,729
Residential mortgages 10,569 10,665
------- -------
Total Loans $48,430 $45,681
======= =======
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)
2005 2004
---- ----
Balance at January 1, $603 $339
Charge-offs:
Consumer loans (35) (31)
---- ----
Total charge-offs (35) (31)
Recoveries 36 311
Net (charge-offs) recoveries 1 280
Additions charged to operations 40 141
---- ----
Balance at March 31, $643 $478
==== ====
12
The allowance for loan losses as a percentage of total loans was 1.33% at March
31, 2005 compared to 1.28% at December 31, 2004. This level is somewhat higher
than the Bank's peer group average of 1.10% because of the relatively high level
of non-performing loans in the loan portfolio. (Refer to Nonperforming and
Nonaccrual Loans discussion below.) 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, 2005, the Bank's classified loans totaled $1.6 million, or 3.35%
of total loans. Specific reserves of $364 thousand have been allocated to these
loans. In addition, at March 31, 2005, approximately $888 thousand of the
classified loans are guaranteed by the Small Business Administration (SBA) 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, 2005.
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, 2005, non-accrual loans were approximately $1.6 million compared to
$1.4 million at December 31, 2004. The increase in non-accrual loans during the
quarter is a result of a group of micro loans that are administratively
delinquent. The Bank is currently working with the mirco loan fund administrator
to resolve the delinquent condition of these loans. 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 this loan to the SBA
for collection of the guaranteed portion of the loans that total $569 thousand
that represents the Bank's balance on the loans. The SBA documentation review as
relates to this loan is currently underway. Although the Bank has charged-off a
portion of this loan, management will seek to maximize its recovery through
appropriate legal action.
13
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, 2005, approximately 20% 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
$3.2 million, or 15.8%, during the quarter ended March 31, 2005. This decline is
due to a decrease in funds available for investment because of an $840 thousand
decline in average deposit balances (Refer to the discussion on Deposits below.)
as well as increased loan funding activity during the quarter.
The Bank's current investment portfolio primarily consists of mortgage-backed
pass-through agency securities (62.1%), and other government-sponsored agency
securities (37.9%). The Bank does not invest in high-risk securities or complex
structured notes. The yield on the portfolio was 4.37% at March 31, 2005
compared to 4.65% one year ago. The reduction in yield is primarily a result of
lower yielding short-term agency securities purchased in the latter part of 2004
to collateralize the deposits of a quasi-governmental agency. In addition, some
of the Bank's floating rate mortgage-backed securities that have Treasury and
LIBOR indices, repriced in 2004 in a lower interest rate environment.
The average duration of the portfolio at March 31, 2005 is 3.55 years compared
to 3.07 years at December 31, 2004. The extension of the duration during the
quarter ended March 31, 2005 resulted from noted improvement in the economy and
a corresponding rise in 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, declined from 24.06% at December 31, 2004 to
23.57% at March 31, 2005. This translates into only 23.57% of the mortgage pool
repaying on an annual basis compared to 24.06% at December 31, 2004 resulting in
a reduction of cashflow. 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.
14
Deposits
The Bank has a stable core deposit base representing 79% of total deposits.
While the Bank has $13.6 million in certificates of deposit with balances of
$100,000 or more, approximately $9 million, or 66%, of the these deposits are
with governmental or quasi-governmental entities that have a long history with
the Bank and are considered stable.
During the quarter ended March 31, 2005, average deposits decreased $840
thousand, or 1.31%. Much of this decline was in the category of savings
deposits. In July 2004, the Bank closed its 2 Penn Center Office located in
Center City Philadelphia. The closure of this branch resulted in some savings
passbook account attrition during the third and fourth quarters of 2004. Because
passbook customers must physically enter the branch to complete transactions,
electronic banking alternatives including ATMs and e-banking could not be used
to help retain the savings account deposits.
With its 2004 re-capitalization, the Bank is positioned for deposit growth.
Current capital levels allow for approximately $25 million in deposit growth and
still remain compliant with mandatory capital requirements outlined in its
Written Agreement with its regulators (See Regulatory Matters below). New
business development strategies have been implemented that include leveraging
the strategic partnerships/alliances the Bank has developed to cross-sell its
products and services. In addition, the Bank will engage in a strategic
marketing/advertising campaign to generate new business including loans,
deposits and other fee-related services.
Other Borrowed Funds
The Bank did not borrow funds during the quarter ended March 31, 2005.
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.
15
The Bank's financial instrument commitments at March 31, 2005 are summarized
below:
Commitments to extend credit $13,284,000
There were no outstanding letters of credit at March 31, 2005.
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, 2005, 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 also sources of liquidity. Approximately $8.8
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, 2005, the Bank had total short-term liquidity, including cash and
federal funds sold, of $8.8 million, or 12.07% of total assets. Additional
liquidity of approximately $4.4 million is provided by the portion of the Bank's
investment portfolio classified as available-for-sale. However, a portion of
these securities is used as collateral for governmental/quasi-governmental
agencies and are therefore restricted from use to fund loans or other liquidity
requirements.
16
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 governmental agency that matures in June 2005 and a series of laddered
certificates of deposit (maturities ranging from 3 months to 12 months) totaling
$4 million from another quasi-governmental agency. While these are short-term
renewals, based on discussions with representatives of these agencies,
management does not anticipate the removal of these deposits 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, 2005:
(Thousands of dollars)
3 months or less $ 9,286
Over 3 through 12 months 4,204
Over 1 through three years 153
Over three years --
-------
Total $13,643
=======
Capital Resources
Total shareholders' equity decreased approximately $19 thousand during the
quarter ended March 31, 2005. The decrease in equity was primarily due to net
income of $12 thousand during the quarter offset by a $30 thousand decrease in
other comprehensive income (FAS 115 unrealized losses on available-for-sale
securities) because of interest rate changes that reduced the value of the
investment portfolio. The Board and management continue to explore strategies
for the infusion of new capital into the organization. The most productive way
to increase capital is through sustained core earnings. The Bank's plan projects
this occurrence in 2005.
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.
17
As indicated in the table below, the Company's risk-based capital ratios are
above the minimum requirements. Management continues the objective of raising
additional capital by offering additional stock (preferred and common) for sale
in a private offering as well as increasing the rate of internal capital growth
as a means of maintaining the required capital ratios. However, significant
asset growth and the need for additional provisions to the allowance for loan
losses could have an adverse effect on its capital ratios. The Company and the
Bank do not anticipate paying dividends in the near future.
Company Company
------- -------
March 31, December 31,
2005 2004
------- -------
Total Capital $ 8,791 $ 8,812
Less: Intangible Asset/Net
unrealized gains (losses) on
available for sale portfolio (1,503) (1,578)
------- -------
Tier 1 Capital 7,288 7,234
------- -------
Tier 2 Capital 562 544
------- -------
Total Qualifying Capital $ 7,850 $ 7,778
======= =======
Risk Adjusted Total Assets
(including off-Balance sheet exposures) $44,914 $43,436
Tier 1 Risk-Based Capital Ratio 16.23% 16.65%
Tier 2 Risk-Based Capital Ratio 17.48% 17.91%
Leverage Ratio 10.25% 9.89%
Bank Bank
------- -------
Total Capital $ 8,503 $ 8,524
Less: Intangible Asset/Net
unrealized gains (losses) on
available for sale portfolio (1,503) (1,578)
------- -------
Tier 1 Capital 7,000 6,946
------- -------
Tier 2 Capital 562 544
------- -------
Total Qualifying Capital $ 7,562 $ 7,490
======= =======
Risk Adjusted Total Assets
(including off-Balance sheet exposures) $44,914 $43,436
Tier 1 Risk-Based Capital Ratio 15.59% 15.99%
Tier 2 Risk-Based Capital Ratio 16.84% 17.24%
Leverage Ratio 9.84% 9.49%
Results of Operations
Summary
The Bank had net income of approximately $12 thousand ($0.01 per common share)
for the quarter ended March 31, 2005 compared to a net income of $18 thousand
($0.02 per common share) for the quarter ended March 31, 2004. The financial
results for the quarter ended March 31, 2004 included a $165 thousand recovery
(credit back to earnings) on a previously charged-off loan.
18
Management continues the implementation of a plan to restore core profitability
to the Bank. 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.
While expense reductions continue to be achieved, management believes that a
greater impact will be realized with increased loan originations that build the
Bank's loan-to-deposit ratio. Generally, increased loan volume results 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.
Average Balances, Rates, and Interest Income and Expense Summary
March 31, March 31,
2005 2004
----------------------------------- -----------------------------------
(Dollars in thousands) Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
------- -------- ---------- ------- -------- ----------
Assets:
Interest-earning assets:
Loans $47,768 $817 6.84% $45,809 $747 6.52%
Investment securities-HTM 8,628 98 4.55 6,615 82 4.96
Investments securities-AFS 4,306 40 3.72 7,553 80 4.24
Federal funds sold 4,256 26 2.42 4,121 10 0.97
Interest bearing balances with
other banks 889 6 2.53 889 5 2.11
------- --- ---- ------ --- ----
Total interest-earning assets 64,958 987 6.08 64,098 924 5.76
Noninterest-earning assets:
Cash and due from banks 3,724 3,490
Premises and equipment 1,070 2,755
Other assets 3,509 4,292
Less: allowance for loan losses (626) (415)
------- ------
Total 72,625 74,220
Liabilities and shareholders equity
Interest-bearing liabilities
Demand deposits 8,393 11 0.50 9,581 14 0.58
Savings deposits 17,632 15 0.33 19,475 16 0.33
Time deposits 23,649 90 1.52 21,084 75 1.43
------ --- ---- ------ --- ----
Total interest-bearing 49,674 116 0.93 50,140 105 0.84
liabilities
Noninterest-bearing liabilities
Demand deposits 13,603 16,158
Other 782 806
Shareholders equity 8,566 7,116
------- ------
Total 72,625 74,220
Net interest earnings $871 $818
Net yield on interest-earning assets 5.37% 5.11%
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 increased $53 thousand, or 6.47%, for the quarter ending
March 31, 2005 compared to the quarter ending March 31, 2004. The increase is
primarily attributed to an increase in average loans outstanding as well as a
200 basis point increase in the prime rate and federal funds sold rate since
June 2004. As a result, the yield on average earning assets increased from 5.76%
at March 31, 2004 to 6.08% at March 31, 2005.
Although the Bank's cost of funds increased to 0.93% for the quarter ending
March 31, 2005 from 0.84% for the same quarter in 2004, the cost of funds is
still considered low when compared to the Bank's peer group of 1.85%. The low
cost of funds is attributed to the Bank's core deposit base of checking and
savings accounts that are less sensitive to changes in interest rate. Typically,
the rates on these types of deposits lag market changes.
The net interest margin of the Bank was 5.37% at March 31, 2005 compared to
5.11% at March 31, 2004. Management actively manages its exposure to interest
rate changes. The increase in margin is attributed to the increase in prime, the
Bank's continued low cost of funds and an increase in average loan balances.
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 $40 thousand for the quarter ending March 31,
2005 compared to a negative provision (credit back to earnings) of $141 thousand
for the same quarter in 2004. The credit to earnings in 2004 was related to a
recovery of a previously charged-off loan. Provisions are based on management's
review and analysis of the Bank's loan portfolio and the level of classified
loans. There was no significant change in the level of classified loans during
the quarter. (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 March 31, 2005.
20
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, 2005
declined by $42 thousand, or 9.14%, compared to the quarter ended March 31,
2004.
Customer service fees declined by $56 thousand, or 24.81%, for the quarter
ending March 31, 2005, compared to 2004 as a result of less activity fees on
deposits. The Bank's lower average deposit levels in 2005 compared to 2004
resulted in less overdraft fees, activity service charges and low balance fees.
In addition, because that Bank escheated many of its dormant/inactive accounts
in 2003 and 2004 in accordance with the requirements of the Commonwealth of
Pennsylvania, there was a significant decline in activity/dormant account
service charges.
ATM fees declined by $6 thousand, or 3.95%, for the quarter ending March 31,
2005, compared to 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. In addition, one of the Bank's high volume machines was out of service
during the quarter because of a fire in the building in which it is located.
Management continues the process of identifying potentially high volume
locations to place machines.
The Bank serves 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 it recognized fees totaling $47 thousand during
the quarter ended March 2005. Fees for this service are projected to exceed $175
thousand for 2005. These fees will be received annually for the administration
of the credit facilities. Management plans to continue to develop this core line
of business to generate additional fee income to support the Bank's
profitability goals.
Noninterest Expense
Salaries and benefits decreased $70 thousand, or 12.99%, during the quarter
ended March 31, 2005 compared to 2004. 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. In addition, in July 2004,
the Bank closed and consolidated the services of its Two Penn Center financial
service center with other branches in the network. This action resulted in
further staff reductions. 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 $32 thousand, or 22.67%, during the quarter ended March
31, 2005 compared to 2004. The reduction is primarily a result of a decline in
processing costs associated with the Bank's automated teller machine network
because of fewer machines in service as well as a contract re-negotiation with
its service provider. The Bank continues to study methods by which it may
further reduce its data processing cost.
21
Occupancy expense decreased approximately $48 thousand, or 15.7%, during the
quarter ended March 31, 2005 compared to 2004. The decrease is primarily
attributable to the closure/consolidation of the Two Penn Center financial
service center 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. All of the leasehold improvements and
furniture associated with this branch became fully depreciated at the time of
lease expiration in 2004.
Also contributing to the reduction in occupancy expense was the sale of the
Bank's corporate headquarters in July 2004. This building was sold to generate
gains as part of the Bank's re-capitalization plan. The sale of the building
resulted in a reduction in property taxes, insurance, repairs and maintenance,
and depreciation expense on leasehold improvements associated with the building.
In February 2005, the Bank began the lease of a 10,000 square foot floor of a
full service high rise office building located in center city Philadelphia.
Professional services expense increased approximately $15 thousand, or 26.34%,
for the quarter ended March 31, 2005 compared to 2004. This increase is
primarily related to increased audit-related cost associated with the Bank's
change in accounting firms in December 2004. To reference the former
accountant's opinion in the Bank's annual report 10K, the Bank had to pay fees
totaling $7,500. In addition, the Bank incurred legal fees associated with the
review of the lease of its new corporate headquarters.
Office operations and supplies expense decrease $21 thousand, or 18.19%, for the
quarter ended March 2005 compared to 2004. In conjunction with the
closure/consolidation of the Bank's Two Penn Center financial service center,
the Bank experienced reductions in this category of expense including security
guards and other costs associated with branch operations.
FDIC insurance premiums increased by $22 thousand, or 285.44%, for the quarter
ended March 31, 2005 compared to 2004. 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. While the Bank is well capitalized, the increase during 2005, is a
result of the perceived risk associated with the Bank's operating losses in
prior years.
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.
22
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.
At December 31, 2003, the Bank's tier one leverage capital ratio fell to 6.81%,
below the 7% minimum capital ratio required by the Agreement. However, during
2004 management implemented re-capitalization strategies including the sale of
bank-owned assets that generated gains of approximately $1.9 million. As a
result, at December 31, 2004, the Bank's tier one leverage ratio had improved to
9.49%. At March 31, 2005, the tier one leverage ratio had further improved to
9.84% as a result of a reduction in average assets and net income of $12
thousand for the quarter. Management continues to review and revise its capital
plan to address the development of new equity. The most productive of which is
to increase capital through sustained core earnings. The Bank's strategic plan
projects this occurrence in 2005.
At March 31, 2005, management believes that the Bank is "substantially" in
compliance with the Agreement's terms and conditions. Failure to comply could
result in additional regulatory supervision and/or actions.
Dividend Restrictions
UBS has never declared or paid any cash or stock dividends. The Pennsylvania
Banking Code of 1965, as amended, provides that cash dividends may be declared
and paid only from accumulated net earnings and that, prior to the declaration
of any dividend, if the surplus of a bank is less than the amount of its
capital, the bank shall, until surplus is equal to such amount, transfer to
surplus an amount which is at least ten percent of the net earnings of the bank
for the period since the end of the last fiscal year or any shorter period since
the declaration of a dividend. If the surplus of a bank is less than 50% of the
amount of its capital, no dividend may be declared or paid by the Bank without
the prior approval of the Pennsylvania Department of Banking.
Under the Federal Reserve Act, if a bank has sustained losses equal to or
exceeding its undivided profits then on hand, no dividend shall be paid, and no
dividends can ever be paid in an amount greater than such bank's net profits
less losses and bad debts. Cash dividends must be approved by the Board if the
total of all cash dividends declared by a bank in any calendar year, including
the proposed cash dividend, exceeds the total of the Bank's net profits for that
year plus its retained net profits from the preceding two years less any
required transfers to surplus or to a fund for the retirement of preferred
stock. Under the Federal Reserve Act, the Federal Reserve Board has the power to
prohibit the payment of cash dividends by a bank if it determines that such a
payment would be an unsafe or unsound banking practice. As a result of these
laws and regulations, the Bank, and therefore UBS, whose only source of income
is dividends from the Bank, will be unable to pay any dividends while an
accumulated deficit exists. UBS does not anticipate that dividends will be paid
for the foreseeable future.
23
The FDIC generally prohibits all payments of dividends by a bank which is in
default of any assessment to the FDIC. (See "Regulatory Matters" above)
Recent Accounting Pronouncements
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. The Company does
not expect the adoption to have a material impact on the consolidated financial
statements, results of operations or liquidity.
In December 2004, the FASB issued SFAS No. 123 (Revised), "Shared-Based
Payment" ("SFAS No. 123(R)"), establishing accounting standards for transactions
in which an entity exchanges its equity instruments for goods or services. SFAS
No. 1234(R) also addresses transactions in which an entity incurs liabilities
in exchange for goods or services that ate based on the fair value of the
entity's equity instruments. SFAS No. 123(R) covers a wide range of share-based
compensation arrangements including stock options, restricted stock plans,
performance-based stock awards, stock appreciation rights, and employee stock
purchase plans. SFAS No. 123(R) replaces existing requirements under SFAS No.
123, "Accounting for Stock-Based Compensation," and eliminates the ability for
share-based compensation transactions using APB Opinion No. 25. The provision
for SFAS No. 123(R) are effective for the Company on July 1, 2005. The Company
is currently assessing the financial statement impact of adopting SFAS No.
123(R).
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 Company'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. In September 2004, the FASB issued a proposed Staff
Position, EITF Issue 03-1-a, Implementation Guidance for the Application of
Paragraph 16 of EITF 03-1 (EITF 03-1-a). EITF 03-1-a would provide
implementation guidance with respect to debt securities that are impaired solely
due to interest rates and/or sector spreads and analyzed for
other-than-temporary impairment under paragraph 16 of EITF 03-1.
24
In September 2004, the FASB issued a Staff Position, EITF Issue 03-1-1,
Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1 (EITF 03-1-1). FSP
EITF Issue No. 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No.
03-1, `The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments delays the effective date of certain provisions of EITF
Issue 03-1, including steps two and three of the Issue's three-step approach for
determining whether an investment is other-than-temporarily impaired. However
step one of that approach must still be initially applied for impairment
evaluations in reporting periods beginning after June 15, 2004. The delay of the
effective date for paragraphs 10-20 of EITF Issue 03-1 will be superseded with
the final issuance of proposed FSP EITF Issue 03-1-a, Implementation Guidance
for the Application of Paragraph 16 of EITF Issue No. 03-1, `'The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments. The
Company is in the process of determining the impact that this EITF will have on
its financial statements.
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, 2005, a liability sensitive position is maintained on a cumulative
basis through 1 year of 2.96% that is within the Bank's policy guidelines of +/-
15% on a cumulative 1-year basis. The current gap position is primarily due to
the level of short-term certificates of deposit maturing and repricing in one
year or less. A significant portion of these maturities relate to deposits with
governmental/quasi-governmental entities that mature in six months or less.
Generally, because of the negative gap position of the Bank in shorter time
frames, the Bank can anticipate that increases in market rates will have a
negative impact on the net interest income, while decreases will have the
opposite effect.
While using the interest sensitivity gap analysis is a useful management tool as
it considers the quantity of assets and liabilities subject to repricing in a
given time period, it does not consider the relative sensitivity to market
interest rate changes that are characteristic of various interest rate-sensitive
assets and liabilities. Consequently, although the Bank currently has a 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
25
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, 2005 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 $ 1,999 3.08%
+300 basis points 3,146 4.74
+200 basis points 4,431 6.51
+100 basis points 5,783 8.28
Flat rate 7,159 9.99
-100 basis points 8,246 11.27
-200 basis points 9,131 12.27
-300 basis points 9,948 13.15
-400 basis points 10,939 14.20
The market value of equity may be impacted by the composition of the Bank's
assets and liabilities. The declining market value of equity in a rising rate
environment is a result of the high level of fixed rate loans and investments
the Bank has on its balance sheet. Management will actively manage the level of
variable versus fixed rate assets in order to reduce the volatility 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.
26
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, 2005. 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.
27
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. Unregistered Sales of Equity 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
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.
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 13, 2005 /s/ Evelyn Smalls
------------------------------
Evelyn Smalls
President & Chief Executive Officer
Date: May 13, 2005 /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 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.
30