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EX-31.1 - EXHIBIT 31.1 - UNITED BANCSHARES INC /PAex31-1.htm
EX-32.1 - EXHIBIT 32.1 - UNITED BANCSHARES INC /PAex32-1.htm
EX-32.2 - EXHIBIT 32.2 - UNITED BANCSHARES INC /PAex32-2.htm
EX-31.2 - EXHIBIT 31.2 - UNITED BANCSHARES INC /PAex31-2.htm
 

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
FORM 10-Q
 
(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, 2012 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.
 
(Exact name of registrant as specified in its charter)
 
0-25976
 
Commission File Number
Pennsylvania
 
23-2802415
(State or other jurisdiction of
 
(I.R.S. Employer
Incorporation or organization)
 
Identification No.)

30 S. 15th Street, Suite 1200, Philadelphia, PA
 
19102
(Address of principal executive office)
 
(Zip Code)
 
(215) 351-4600
 
(Registrant's telephone number, including area code)
 
N/A
 
(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 the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Registration S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).        Yes ____ No____
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one)
 
Large accelerated filer___
Accelerated filer___
Non-accelerated filer__
Smaller Reporting Company _X__
 
 
 
 
1

 
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange 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 500,000 shares of $0.01 par value Series A Preferred Stock.
 
The Board of Directors designated a subclass of the common stock, Class B Common Stock, by filing of Articles of Amendment to its Articles of Incorporation on September 30, 1998.  This Class B Common Stock has all of the rights and privileges of Common Stock with the exception of voting rights.  Of the 2,000,000 shares of authorized Common Stock, 250,000 have been designated Class B Common Stock.  There is no market for the Common Stock.  As of May 7, 2012, the aggregate number of the shares of the Registrant’s Common Stock issued was 1,068,588 (including 191,667 Class B non-voting).
 
The Series Preferred Stock consists of 500,000 authorized shares of stock of which 250,000 have been designated as Series A Preferred stock of which 136,842 shares are issued as of May 7, 2012.

 
 
 
 
 
 
 
 
2

 
 
 
FORM 10-Q
 

 

 
Index
Item No.
Page
 
PART I-FINANCIAL INFORMATION
       
1.
Financial Statements
 
2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
3.
Quantitative and Qualitative Disclosures about Market Risk
 
4.
Controls and Procedures
 
       
PART II-OTHER INFORMATION
       
1.
Legal Proceedings
 
1A.
Risk Factors
 
2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
3.
Defaults upon Senior Securities
 
4
Mine Safety Disclosures
 
5.
Other Information
 
6.
Exhibits
 
 

 

 
 
3

 

 
UNITED BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(unaudited)

 
Assets:
 
March 31, 2012
   
December 31, 2011
 
Cash and due from banks
  $ 2,131,797     $ 2,778,924  
Interest-bearing deposits with banks
    305,576       305,405  
Federal funds sold
    4,982,000       11,413,000  
   Cash and cash equivalents
    7,419,373       14,497,329  
                 
Investment securities:
               
Available-for-sale, at fair value
    1,223,420       1,280,874  
Held-to-maturity, at amortized cost (fair value of $17,096,544
               
   and $17,738,368 at March 31, 2012 and December 31 2011, respectively)
    16,615,631       17,209,295  
                 
Loans, net of unearned discount
    41,469,081       41,502,204  
Less allowance for loan losses
    (864,117 )     (867,019 )
   Net loans
    40,604,964       40,635,186  
 
Bank premises and equipment, net
    941,033       988,170  
Accrued interest receivable
    325,540       342,029  
Other real estate owned
    1,344,042       1,284,390  
Intangible assets
    269,292       313,811  
Prepaid expenses and other assets
    536,625       465,838  
   Total assets
    69,279,920       77,016,922  
 
Liabilities and Shareholders’ Equity
               
 
Liabilities:
               
Demand deposits, noninterest-bearing
  $ 14,173,913     $ 14,373,040  
Demand deposits, interest-bearing
    16,107,663       16,886,633  
Savings deposits
    14,496,088       14,688,985  
Time deposits, under $100,000
    7,616,251       7,768,057  
Time deposits, $100,000 and over
    11,533,939       17,583,743  
   Total deposits
    63,927,854       71,300,458  
 
Accrued interest payable
    48,101       58,361  
Accrued expenses and other liabilities
    280,499       397,187  
   Total liabilities
    64,256,454       71,756,006  
                 
Shareholders’ equity:
               
Series A preferred stock, noncumulative, 6%, $0.01 par value, 500,000 shares authorized; 136,842 issued and outstanding
    1,368       1,368  
Common stock, $0.01 par value; 2,000,000 shares authorized;
               
   876,921 issued and outstanding
    8,769       8,769  
Class B Non-voting common stock; 250,000 shares authorized; $0.01 par value;
               
   191,667 issued and outstanding
    1,917       1,917  
Additional paid-in-capital
    14,749,852       14,749,852  
Accumulated deficit
    (9,777,640 )     (9,539,831 )
Accumulated other comprehensive income
    39,200       38,841  
   Total shareholders’ equity
    5,023,466       5,260,916  
   Total liabilities and shareholders’ equity
  $ 69,279,920     $ 77,016,922  
 
The accompanying notes are an integral part of these statements.
 
 
 
 
4

 

 

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Unaudited)
Three Months Ended March 31,

   
2012
   
2011
 
Interest income:
           
   Interest and fees on loans
  $ 659,691     $ 668,281  
   Interest on investment securities
    137,189       153,231  
   Interest on federal funds sold
    5,592       3,244  
   Interest on time deposits with other banks
    174       174  
      Total interest income
    802,646       824,930  
                 
Interest expense:
               
   Interest on time deposits
    28,233       39,793  
   Interest on demand deposits
    13,053       17,710  
   Interest on savings deposits
    1,802       3,420  
      Total interest expense
    43,088       60,923  
      Net interest income
    759,558       764,007  
Provision for loan losses
    30,000       30,000  
                 
     Net interest income after provision for loan losses
    729,558       734,007  
                 
Noninterest income:
               
   Customer service fees
    97,146       97,285  
   ATM fee income
    79,779       86,174  
   Other income
    17,314       30,218  
      Total noninterest income
    194,239       213,677  
                 
Noninterest expense:
               
   Salaries, wages and employee benefits
    413,537       429,738  
   Occupancy and equipment
    274,777       270,145  
   Office operations and supplies
    74,405       77,356  
   Marketing and public relations
    4,649       22,792  
   Professional services
    73,238       70,731  
   Data processing
    126,806       126,017  
   Loan and collection cost
    19,266       47,572  
   Deposit insurance assessments
    1,215       42,138  
   Other operating
    173,713       168,153  
      Total noninterest expense
    1,161,606       1,254,642  
      Net loss before income taxes
    (237,809 )     (306,958 )
Provision for income taxes
    -       -  
      Net loss
  $ (237,809 )   $ (306,958 )
                 
Net loss per common share—basic  and diluted
  $ (0.22 )   $ (0.29 )
Weighted average number of common shares
    1,068,588       1,068,588  
Comprehensive Loss
               
 Net Loss
  $ (237,809 )   $ (306,958 )
 Unrealized gains (losses) on available for sale securities
    359       (2,290 )
  Total comprehensive loss
  $ (237,450 )   $ (309,248 )

See Accompanying Notes to Consolidated Financial Statements which are an integral part of the unaudited consolidated financial statements.
 
 
 
 
5

 
 

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended March 31,

   
2012
   
2011
 
             
Cash flows from operating activities:
           
Net loss
  $ (237,809 )   $ (306,958 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Provision for loan losses
    30,000       30,000  
Amortization of premiums on investments
    32,666       8,878  
Amortization of core deposit intangible
    44,520       44,520  
Depreciation on fixed assets
    58,606       63,018  
Write-down of other real estate owned
    15,148       3,879  
(Increase) decrease in accrued interest receivable and other assets
    (54,298 )     41,948  
Decrease in accrued interest payable and other liabilities
    (126,948 )     (86,374 )
Net cash used in operating activities
    (238,115 )     (201,089 )
                 
Cash flows from investing activities:
               
Purchase of held-to-maturity investment securities
    (3,249,311 )     (1,767,805 )
Proceeds from maturity and principal reductions of available-for-sale investment securities
    56,275       80,000  
Proceeds from maturity and principal reductions of held-to-maturity investment securities
    3,811,848       1,555,911  
Net (increase)  decrease in loans
    (74,579 )     2,860,144  
Purchase of bank premises and equipment
    (11,469 )     (25,190 )
Net cash provided by investing activities
    532,764       2,703,060  
                 
Cash flows from financing activities:
               
Net (decrease) increase in deposits
    (7,372,605 )     534,333  
Net cash (used in) provided by financing activities
    (7,372,605 )     534,333  
 
Net (decrease) increase in cash and cash equivalents
    (7,077,956 )     3,036,304  
 
Cash and cash equivalents at beginning of year
    14,497,329       8,696,111  
 
Cash and cash equivalents at end of year
    7,419,373     $ 11,732,415  
 
Supplemental disclosure of cash flow information:
               
Cash paid during the period for interest
  $ 53,348     $ 57,381  
Noncash transfer of loans to other real estate owned
  $ 74,800     $ 602,100  

 
The accompanying notes are an integral part of these statements.


 
6

 
 
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(unaudited)
 
1. Significant Accounting Policies
 
 
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, 2011 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, 2012 and December 31, 2011 and the consolidated results of its operations and its cash flows for the three months ended March 31, 2012 and 2011.

Management’s Use of Estimates
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.  Material estimates which are particularly susceptible to significant change in the near term relate to the fair value of investment securities, the determination of the allowance for loan losses, valuation allowance for deferred tax assets and consideration of impairment of other intangible assets.

Commitments
In the general course of business, there are various outstanding commitments to extend credit, such as letters of credit and un-advanced loan commitments, which are not reflected in the accompanying financial statements. Management does not anticipate any material losses as a result of these commitments.

Contingencies
The Company is from time to time a party to routine litigation in the normal course of its business. Management does not believe that the resolution of this litigation will have a material adverse effect on the financial condition or results of operations of the Company. However, the ultimate outcome of any such litigation, as with litigation generally, is inherently uncertain and it is possible that some litigation matters may be resolved adversely to the Company.
 
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses.  Loans that are determined to be uncollectible are charged against the allowance account, and subsequent recoveries, if any, are credited to the allowance.  When evaluating the adequacy of the allowance, an assessment of the loan portfolio will typically include changes in the composition and volume of the loan portfolio, overall portfolio quality and past loss experience, review of specific problem loans, current economic conditions which may affect borrowers’ ability to repay, and other factors which may warrant current recognition.  Such periodic assessments may, in management’s judgment, require the Bank to recognize additions or reductions to the allowance.

Various regulatory agencies periodically review the adequacy of the Bank’s allowance for loan losses as an integral part of their examination process.  Such agencies may require the Bank to recognize additions or reductions to the allowance based on their evaluation of information available to them at the time of their examination.  It is reasonably possible that the above factors may change significantly and, therefore, affects management’s determination of the allowance for loan losses in the near term.
 
 
 
 
7

 

 
The allowance consists of specific and general components. The specific component relates to loans that are classified as impaired.  For those loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.  The general component covers non-impaired loans and is based on historical charge-off experience, other qualitative factors, and adjustments made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.  The Bank does not allocate reserves for unfunded commitments to fund lines of credit.
 
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  The Bank will identify and assess loans that may be impaired through any of the following processes:
 
·  
During regularly scheduled meetings of the Asset Quality Committee
·  
During regular reviews of the delinquency report
·  
During the course of routine account servicing, annual review, or credit file update
·  
Upon receipt of verifiable evidence of a material reduction in the value of collateral to a level that creates a less than desirable LTV ratio
 
Impairment is measured on a loan by loan basis for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
 
Large groups of smaller, homogeneous loans, including consumer installment and home equity loans, 1-4 family residential mortgages, and student loans are evaluated collectively for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures.
 
Non-accrual and Past Due Loans.
Loans are considered past due if the required principal and interest payments have not been received 30 days as of the date such payments were due.  The Bank generally places a loan on non-accrual status when interest or principal is past due 90 days or more.  If it otherwise appears doubtful that the loan will be repaid, management may place the loan on nonaccrual status before the lapse of 90 days. Interest on loans past due 90 days or more ceases to accrue except for loans that are well collateralized and in the process of collection.  When a loan is placed on nonaccrual status, previously accrued and unpaid interest is reversed out of income.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Income Taxes
Under the liability method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax basis 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 net deferred tax asset has been recognized to offset the net deferred tax assets related to cumulative temporary differences and tax loss carryforwards.  If management determines that the Company may be able to realize all or part of the deferred tax asset in the future, an income tax benefit may be required to increase the recorded value of the net deferred tax asset to the expected realizable amount.
 
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that ultimately would be sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more-likely-than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. The evaluation of a tax position taken is considered by itself and not offset or aggregated with other positions. Tax positions that meet the more-likely-than not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.
 
 
 
 
8

 
 
 
Interest and penalties associated with unrecognized tax benefits, if any, would be recognized in income tax expense in the consolidated statements of operations.
 
2. Net Loss Per Share
The calculation of net loss income per share follows:

 
Three Months Ended
March 31, 2012
Three Months Ended
March 31, 2011
Basic:
   
Net loss available to common shareholders
($237,809)
($306,958)
Average common shares outstanding-basic
1,068,588
1,068,588
Net loss per share-basic
($0.22)
($0.29)
Diluted:
   
Average common shares-diluted
1,068,588
1,068,588
Net loss per share-diluted
($0.22)
($0.29)
 
The preferred stock is non cumulative and the Company is restricted from paying dividends.  Therefore, no effect of the preferred stock is included in the loss per share calculations.

3.New Authoritative Accounting Guidance
 In May 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance of the FASB and the International Accounting Standards Board (the “Boards”) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and International Financial Reporting Standards. The amendments to the Codification in ASU 2011-04 are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011.  The Company adopted ASU No. 2011-04 as of March 31, 2012 and included the new requirements in Note 7.
 
In June 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU amends the Codification to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments to the Codification in ASU 2011-05 do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  ASU 2011-05 should be applied retrospectively. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company adopted ASU 2011-05 during the quarter ended March 31, 2012 and presented comprehensive loss in a separate statement.
 
 
 
 
9

 
 
 
4.  Investment Securities
The following is a summary of the Company's investment portfolio as of March 31, 2012: 

(In 000’s)
 
 
 
Amortized Cost
   
 
Gross unrealized gains
   
 
Gross unrealized losses
   
 
 
Fair Value
 
Available-for-sale:
                       
Government Sponsored Enterprises residential mortgage-backed securities
  $ 1,036     $ 58     $  -     $ 1,094  
Investments in money market funds
    129       -       -       129  
    $ 1,165     $ 58       -     $ 1,223  
Held-to-maturity:
                               
U.S. government agencies
  $ 6,532     $ 131     $ (22 )   $ 6,641  
Government Sponsored Enterprises residential mortgage-backed securities
       10,084         376       (4 )       10,456  
 
  $ 16,616     $ 507     $ ( 26 )   $ 17,097  
 
The following is a summary of the Company's investment portfolio as of December 31, 2011: 
 

(In 000’s)
 
Amortized Cost
   
Gross unrealized gains
   
Gross unrealized losses
   
Fair Value
 
Available-for-sale:
                       
Government Sponsored Enterprises residential mortgage-backed securities
  $ 1,094     $ 58     $  -     $ 1,152  
Investments in money market funds
    129       -       -       129  
    $ 1,223     $ 58     $ -     $ 1,281  
Held-to-maturity:
                               
U.S. government agencies
  $ 7,531     $ 158     $ -     $ 7,689  
Government Sponsored Enterprises residential mortgage-backed securities
      9,678         373       (2 )       10,049  
    $ 17,209     $ 531     $ (2 )   $ 17,738  
 
 
 
 
10

 
 
 
The amortized cost and fair value of debt securities classified as available-for-sale and held-to-maturity, by contractual maturity, as of March 31, 2012, are as follows:
 
(In 000’s)
   
Amortized Cost
   
Fair Value
 
Available-for-Sale
     
Due in one year
  $ -     $ -  
Due after one year through five years
    -       -  
Due after five years through ten years
    -       -  
Government Sponsored Enterprises residential mortgage-backed securities
    1,036       1,094  
 Total debt securities
  $ 1,036     $ 1,094  
 Investments in money market funds
  $ 129     $ 129  
    $ 1,154     $ 1,223  
Held-to-maturity
               
Due in one year
  $ -       -  
Due after one year through five years
    6,332       6,442  
Due after five years through ten years
    200       199  
Government Sponsored Enterprises residential mortgage-backed securities
    10,084       10,456  
    $ 16,616     $ 17,097  
 
Expected maturities will differ from contractual maturities because the issuers of certain debt securities have the right to call or prepay their obligations without any penalties.
 
The table below indicates the length of time individual securities have been in a continuous unrealized loss position at March 31, 2012:
 
(in 000’s)
 
Less Than 12 Months
   
12 Months or Greater
   
Total
 
Description of Securities
 
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
Held-to-maturity:
                                   
U.S. government agencies
  $ 2,926     $ (22 )   $ -     $ -     $ 2,926     $ (22 )
Government Sponsored Enterprises residential mortgage-backed securities
    780     $ (4 )   $ -     $ -     $ 780     $ (4 )
     Total
  $ 3,706     $ (26 )   $ -     $ -     $ 3,706     $ (26 )
 
The table below indicates the length of time individual securities have been in a continuous unrealized loss position at December 31, 2011:
 
(in 000’s)
  Less Than 12 Months     12 Months or Greater     Total  
Description of Securities
 
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
   
Fair
Value
   
Unrealized
Losses
 
Held-to-maturity:
                                   
Government Sponsored Enterprises residential mortgage-backed securities
  $ 1,018     $ (2 )   $ -     $ -     $ 1,018     $ (2 )
     Total
  $ 1,018     $ (2 )   $ -     $ -     $ 1,018     $ (2 )
 
U.S. government agencies. Unrealized losses on the Company’s investments in direct obligations of U.S. government agencies were caused by interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at March 31, 2012.
 
Government Sponsored Enterprises residential mortgage-backed securities. Unrealized losses on the Company’s investment in federal agency mortgage-backed securities were caused by interest rate increases. The Company purchased those investments at a discount relative to their face amount, and the contractual cash flows of those investments are guaranteed by an agency of the U.S. government. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost basis of the Company’s investments. Because the decline in fair value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired at March 31, 2012.
 
 
 
11

 
 
 
The Company has a process in place to identify debt securities that could potentially have a credit impairment that is other than temporary.  This process involves monitoring late payments, pricing levels, downgrades by rating agencies, key financial ratios, financial statements, revenue forecasts and cash flow projections as indicators of credit issues.  On a quarterly basis, the Company reviews all securities to determine whether an other-than-temporary decline in value exists and whether losses should be recognized. The Company considers relevant facts and circumstances in evaluating whether a credit or interest rate-related impairment of a security is other than temporary. Relevant facts and circumstances considered include: (1) the extent and length of time the fair value has been below cost; (2) the reasons for the decline in value; (3) the financial position and access to capital of the issuer, including the current and future impact of any specific events and (4) for fixed maturity securities, the intent to sell a security or whether it is more likely than not the Company will be required to sell the security before the recovery of its amortized cost which, in some cases, may extend to maturity and for equity securities, the Company’s ability and intent to hold the security for a period of time that allows for the recovery in value.
 
 
 
 
 
 
 
 
12

 
 
5. Allowance for Loan Losses
The determination of the allowance for loan losses involves a higher degree of judgment and complexity than its other significant accounting policies. The allowance is the accumulation of three components that are calculated based on various independent methodologies that are based on management’s estimates.  The three components are as follows:
 
·  
Specific Loan Evaluation Component – Includes the specific evaluation of impaired loans.  
 
·  
Historical Charge-Off Component – Applies a twelve-quarter historical charge-off rate to all pools of non-classified loans.
 
·   
Qualitative Factors Component – The loan portfolio is segregated into multiple homogenous sub classifications, upon which multiple factors (such as delinquency trends, economic conditions, concentrations, growth/volume trends, and management/staff ability) are evaluated, resulting in an allowance amount for each of the sub classifications. The sum of these amounts comprises the Qualitative Factors Component.
 
All of these factors may be susceptible to significant change.   There were no changes in qualitative factors during the three months ended March 31, 2012.  During the period, the average 3-year net loss factors declined in each category with the exception of consumer loans for which the level of net charge-offs increased. 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.
 
The following table presents an analysis of the allowance for loan losses.
 
(in 000's)
   As of March 31, 2012  
   
Commercial and industrial
   
Commercial real estate
   
Consumer real estate
   
Consumer loans other
   
Total
 
Beginning balance
  $ 387     $ 412     $ 68     $ -     $ 867  
Provision for possible loan losses
    30                             $ 30  
                                         
Charge-offs
    -       -       (38 )     (3 )     (41 )
Recoveries
    -       -       5       3       8  
Net charge-offs
    -       -       (33 )     -       (33 )
                                         
Ending balance
  $ 417     $ 412     $ 35     $ -     $ 864  
                                         
 
 
   For the three months ended March 31, 2011  
(in 000's)
 
 
         
 
   
 
 
   
Commercial and industrial
   
Commercial real estate
   
Residential mortgages
   
Consumer real estate
   
Consumer loans other
   
Total
 
Beginning balance
  $ 301     $ 553     $ 36     $ 36     $ -     $ 926  
Provision for possible loan losses
    -       23       -       -       7       30  
                                                 
Charge-offs
    (62 )     (148 )     -       -       (13 )     (223 )
Recoveries
    -       2       -       3       6       11  
Net charge-offs
    (62 )     (146 )     -       3       (7 )     (212 )
                                                 
Ending balance
  $ 239     $ 430     $ 36     $ 39     $ -     $ 744  
                                                 
 
 
 
13

 
 
 
 
 
 
 
                         
(in 000's)
   As of March 31, 2012  
   
Commercial and industrial
   
Commercial real estate
   
Consumer real estate
   
Consumer loans other
   
Total
 
Period-end amount allocated to:                                        
                                         
 Loans indivdually evaluated for impairment
  $ 304     $ -     $ -     $ -     $ 304  
 Loans collectively  evaluated for impairment
    113       412       35       -       560  
    $ 417     $ 412     $ 35     $ -     $ 864  
                                         
Loans, ending balance:
                                       
 Loans indivdually evaluated for impairment
  $ 586     $ 1,080     $ -     $ -     $ 1,666  
 Loans collectively  evaluated for impairment
    3,370       29,354       5,118       1,961       39,803  
Total
  $ 3,956     $ 30,434     $ 5,118     $ 1,961     $ 41,469  
 
 
 
 
 
                         
 
   As of December 31, 2011  
Period-end amount allocated to:
 
 
                         
   
 
                         
 Loans indivdually evaluated for impairment
  $ 308     $ -     $ -     $ -     $ 308  
 Loans collectively  evaluated for impairment
    79       412       68       -       559  
    $ 387     $ 412     $ 68     $ -     $ 867  
                                         
Loans, ending balance:
                                       
 Loans indivdually evaluated for impairment
  $ 586     $ 1,080     $ -     $ -     $ 1,666  
 Loans collectively  evaluated for impairment
    3,144       29,117       5,586       1,989       39,836  
Total
  $ 3,730     $ 30,197     $ 5,586     $ 1,989     $ 41,502  
 
Nonperforming and Nonaccrual and Past Due Loans
 
An age analysis of past due loans, segregated by class of loans, as of March 31, 2012 is as follows:

 
               
 
                   
(In 000's)
       
Accruing
                         
   
Loans
   
Loans 90 or
   
 
                   
   
30-89 Days
   
More Days
         
Total Past
   
Current
       
   
Past Due
   
Past Due
   
Nonaccrual
   
Due Loans
   
Loans
   
Total Loans
 
Commercial and industrial:
                                   
     Commercial
  $ 89     $ -     $ 485       574     $ 1,277     $ 1,851  
     SBA loans
    50       -       -       50       86       136  
     Asset-based
    56       -       101       157       1,812       1,969  
        Total Commercial and industrial
    195       -       586       781       3,175       3,956  
                                                 
Commercial real estate:
                                               
     Commercial mortgages
    128       -       673       801       14,520       15,321  
     SBA loans
    -       -       -       -       472       472  
     Construction
    -       -       -       -       1,173       1,173  
     Religious organizations
    -       -       407       407       13,061       13,468  
         Total Commercial real estate
    128       -       1,080       1,208       29,226       30,434  
                                                 
Consumer real estate:
                                               
     Home equity loans
    69       189       112       370       1,641       2,011  
     Home equity lines of credit
    -       -       -       -       46       46  
     1-4 family residential mortgages
    -       -       228       228       2,833       3,061  
         Total consumer real estate
    69       189       340       598       4,520       5,118  
                                                 
Total real estate
    197       189       1,420       1,806       33,746       35,552  
                                                 
Consumer and other:
                                               
     Consumer installment
    -       -       -       -       52       52  
     Student loans
    57       70       -       127       1,612       1,739  
     Other
    4       -       -       4       166       170  
         Total consumer and other
    61       70       -       131       1,830       1,961  
                                                 
         Total loans
  $ 453     $ 259     $ 2,006     $ 2,718     $ 38,751     $ 41,469  
                                                 
 
 
 
14

 
 

 
An age analysis of past due loans, segregated by class of loans, as of December 31, 2011 is as follows:

               
 
                   
(In 000's)
 
Loans
30-89 Days
Past Due
   
Accruing
Loans 90 or
More Days
Past Due
   
Nonaccrual
     
Total Past
Due Loans
   
Current
Loans
   
Total Loans
 
Commercial and industrial:
                                   
     Commercial
  $ 32     $ -     $ 491       523     $ 963     $ 1,486  
     SBA loans
    -       -       -       -       235       235  
     Asset-based
    -       -       101       101       1,908       2,009  
        Total Commercial and industrial
    32       -       592       624       3,106       3,730  
                                                 
Commercial real estate:
                                               
     Commercial mortgages
    99       -       677       776       13,900       14,676  
     SBA loans
    -       -       -       -       477       477  
     Construction
    -       -       -       -       1,391       1,391  
     Religious organizations
    559       173       418       1,150       12,503       13,653  
         Total Commercial real estate
    658       173       1,095       1,926       28,271       30,197  
                                                 
Consumer real estate:
                                               
     Home equity loans
    173       152       106       431       1,714       2,145  
     Home equity lines of credit
    -       -       38       38       47       85  
     1-4 family residential mortgages
    -       -       301       301       3,055       3,356  
         Total consumer real estate
    173       152       445       770       4,816       5,586  
                                                 
Total real estate
    831       325       1,540       2,696       33,087       35,783  
                                                 
Consumer and other:
                                               
     Consumer installment
    -       -       -       -       58       58  
     Student loans
    112       146       -       258       1,503       1,761  
     Other
    3       -       -       3       167       170  
         Total consumer and other
    115       146       -       261       1,728       1,989  
                                                 
         Total loans
  $ 978     $ 471     $ 2,132     $ 3,581     $ 37,921     $ 41,502  
                                                 
Loan Origination/Risk Management.  The Bank has lending policies and procedures in place to maximize loan income within an acceptable level of risk.  Management reviews and approves these policies and procedures on a regular basis.  A reporting system supplements the review process by providing management with periodic reports related to loan origination, asset quality, concentrations of credit, loan delinquencies and non-performing and emerging problem loans.  Diversification in the portfolio is a means of managing risk with fluctuations in economic conditions.
 
Credit Quality Indicators.  For commercial loans, management uses internally assigned risk ratings as the best indicator of credit quality.  Each loan’s internal risk weighting is assigned at origination and updated at least annually and more frequently if circumstances warrant a change in risk rating.  The Bank uses a 1 through 8 loan grading system that follows regulatory accepted definitions as follows:

·  
Risk ratings of “1” through “3” are used for loans that are performing and meet and are expected to continue to meet all of the terms and conditions set forth in the original loan documentation and are generally current on principal and interest payments.  Loans with these risk ratings are reflected as “Good/Excellent” and “Satisfactory” in the following table.
·  
Risk ratings of “4” are assigned to “Pass/Watch” loans which may require a higher degree of regular, careful attention.  Borrowers may be exhibiting weaker balance sheets and positive but inconsistent cash flow coverage. Borrowers in this classification generally exhibit a higher level of credit risk and are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Loans with this rating would not normally be acceptable as new credits unless they are adequately secured and/or carry substantial guarantors. Loans with this rating are reflected as “Pass” in the following table.
 
 
 
 
15

 
 
 
 
·  
Risk ratings of “5” are assigned to “Special Mention” loans that do not presently expose the Bank to a significant degree of risks, but have potential weaknesses/deficiencies deserving Management’s closer attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. No loss of principal or interest is envisioned.  Borrower is experiencing adverse operating trends, which potentially could impair debt, services capacity and may necessitate restructuring of credit.  Secondary sources of repayment are accessible and considered adequate to cover the Bank's exposure. However, a restructuring of the debt should result in repayment.  The asset is currently protected, but is potentially weak.  This category may include credits with inadequate loan agreements, control over the collateral or an unbalanced position in the balance sheet which has not reached a point where the liquidation is jeopardized but exceptions are considered material. These borrowers would have limited ability to obtain credit elsewhere.
·  
Risk ratings of “6” are assigned to “Substandard” loans which are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Assets must have a well-defined weakness. They are characterized by the distinct possibility that some loss is possible if the deficiencies are not corrected. The borrower’s recent performance indicated an inability to repay the debt, even if restructured. Primary source of repayment is gone or severely impaired and the Bank may have to rely upon the secondary source. Secondary sources of repayment (e.g., guarantors and collateral) should be adequate for a full recovery. Flaws in documentation may leave the bank in a subordinated or unsecured position when the collateral is needed for the repayment.
·  
Risk ratings of “7” are assigned to “Doubtful” loans which have all the weaknesses inherent in those classified “Substandard” with the added characteristic that the weakness makes the collection or liquidation in full, on the basis of current existing facts, conditions, and values, highly questionable and improbable.  The borrower's recent performance indicates an inability to repay the debt.  Recovery from secondary sources is uncertain.  The possibility of a loss is extremely high, but because of certain important and reasonably- specific pending factors, its classification as a loss is deferred.
·  
Risk rating of “8” are assigned to “Loss” loans which are considered non-collectible and do not warrant classification as active assets.  They are recommended for charge-off if attempts to recover will be long term in nature.  This classification does not mean that an asset has no recovery or salvage value, but rather, that it is not practical or desirable to defer writing off the loss, although a future recovery may be possible.  Loss should always be taken in the period in which they surface and are identified as non-collectible as a result there is no tabular presentation.
 
For consumer and residential mortgage loans, management uses performing versus nonperforming as the best indicator of credit quality.  Nonperforming loans consist of loans that are not accruing interest (nonaccrual loans) as a result of principal or interest being in default for a period of 90 days or more or when the ability to collect principal and interest according to contractual terms is in doubt.  These credit quality indicators are updated on an ongoing basis.  A loan is placed on nonaccrual status as soon as management believes there is doubt as to the ultimate ability to collect interest on a loan, but no later than 90 days past due.
 
 
 
 
 
 
16

 
 
 
The tables below detail the Bank’s loans by class according to their credit quality indictors discussed above.
 
                                           
(In 000's)
  March 31, 2012  
   
Good/Excellent
   
Satisfactory
   
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Total
 
                                           
                                           
         
 
                               
Commercial and industrial:
                                     
    Commercial
  $ 379     $ 686     $ 273     $ 27     $ 260     $ 226     $ 1,851  
    SBA loans
    -       33       -       53       50       -       136  
    Asset-based
    -       1,628       125       115       101       -       1,969  
      379       2,347       398       195       411       226       3,956  
Commercial real estate:
                                                       
    Commercial mortgages
    -       13,173       779       -       1,369       -       15,321  
     SBA Loans
    -       468       -       -       4       -       472  
    Construction
    -       1,173       -       -       -       -       1,173  
    Religious organizations
    -       8,984       3,328       170       986       -       13,468  
      -       23,798       4,107       170       2,359       -       30,434  
                                                         
Total commercial loans
  $ 379     $ 26,145     $ 4,505     $ 365     $ 2,770     $ 226     $ 34,390  
                                                         
                                                         
 
       
    March 31, 2012  
   
Residential Mortgage & Consumer Loans- Performing/Nonperforming
 
   
Performing
         
Nonperforming
         
Total
 
                                       
Consumer Real Estate:
                                     
     Home equity
  $ 1,899             $ 112             $ 2,011            
     Home equity line of credit
    46               -               46            
     1-4 family residential mortgages
    2,833             $ 228               3,061            
      4,778               340               5,118            
                                                   
Consumer Other:
                                                 
     Consumer Installment
    52               -               52            
     Student loans
    1,739               -               1,739            
     Other
    170               -               170            
      1,961               -               1,961            
                                                   
Total  consumer loans
  $ 6,739             $ 340             $ 7,079            
                                                   
Total loans
                                                $41,469
                                                   

 
 
 
 

 
 
17

 
 
 
 
                                           
(In 000's)
       
December 31, 2011
                   
   
Good/Excellent
   
Satisfactory
   
Pass
   
Special Mention
   
Subtandard
   
Doubtful
   
Total
 
                                           
                                           
         
 
                               
Commercial and industrial:
   
 
                               
    Commercial
  $ 379     $ 586     $ -     $ 31     $ 264     $ 226     $ 1,486  
    SBA loans
    -       130       56       -       49       -       235  
    Asset-based
    -       1,847       61       -       101       -       2,009  
      379       2,563       117       31       414       226       3,730  
Commercial real estate:
                                                       
    Commercial mortgages
    -       13,118       151       -       1,408       -       14,677  
     SBA Loans
    -       471       -       -       5       -       476  
    Construction
    -       1,391       -       -       -       -       1,391  
    Religious organizations
    -       9,751       2,925       -       977       -       13,653  
      -       24,731       3,076       -       2,390               30,197  
                                                         
Total commercial loans
  $ 379     $ 27,294     $ 3,193     $ 31     $ 2,804     $ 226     $ 33,927  
                                                         
                                                         
             
December 31, 2011
             
     Residential Mortgage & Consumer Loans- Performing/Nonperforming            
   
Performing
            Nonperforming        
Total
                 
 
                                                       
Consumer Real Estate:
                                                       
     Home equity
  $ 2,039             $ 106             $ 2,145                  
     Home equity line of credit
    47               38               85                  
     1-4 family residential mortgages
    3,055               301               3,356                  
      5,141               445               5,586                  
                                                         
Consumer Other:
                                                       
     Consumer Installment
    58               -               58                  
     Student loans
    1,761               -               1,761                  
     Other
    170               -               170                  
      1,989               -               1,989                  
                                                         
Total  consumer loans
  $ 7,130             $ 445             $ 7,575                  
                                                         
Total loans
                                                  $ 41,502  
                                                         
 
 
 
Impaired Loans. The Bank identifies a loan as impaired when it is probable that interest and principal will not be collected according to the contractual terms of the loan agreement. The Bank recognizes interest income on impaired loans under the cash basis when the collateral on the loan is sufficient to cover the outstanding obligation to the Bank.   If these factors do not exist, the Bank will record interest payments on the cost recovery basis.
 
In accordance with guidance provided by ASC 310-10, Accounting by Creditors for Impairment of a Loan, management employs one of three methods to determine and measure impairment: the Present Value of Future Cash Flow Method; the Fair Value of Collateral Method; or the Observable Market Price of a Loan Method.  To perform an impairment analysis, the Company reviews a loan’s internally assigned grade, its outstanding balance, guarantors, collateral, strategy, and a current report of the action being implemented. Based on the nature of the specific loans, one of the impairment methods is chosen for the respective loan and any impairment is determined, based on criteria established in ASC 310-10.
 
The Company makes partial charge-offs of impaired loans when the impairment is deemed permanent and is considered a loss.  To date, these charge-offs have only included the unguaranteed portion of Small Business Administration (“SBA”) loans.  Specific reserves are allocated to cover “other-than-permanent” impairment for which the underlying collateral value may fluctuate with market conditions. During the quarters ended March 31, 2012 and 2011, there were no partial charge-offs of impaired loans.
 
Consumer real estate and other loans are not individually evaluated for impairment, but collectively evaluated, because they are pools of smaller balance homogeneous loans.
 
 
 
 
18

 
 
 
Impaired loans as of March 31, 2012 are set forth in the following table.
 
               
 
             
                               
(In 000's)
 
Unpaid
   
Recorded
   
Recorded
             
   
Contractual
   
Investment
   
Investment
   
Total
       
   
Principal
   
With No
   
With
   
Recorded
   
Related
 
   
Balance
   
Allowance
   
Allowance
   
Investment
   
Allowance
 
                               
Commercial and industrial:
       
 
                   
     Commercial
  $ 485     $ 76     $ 409     $ 485     $ 242  
     SBA  loans
    -       -       -       -       -  
     Asset-based
    -       -       -       -       -  
     Asset-based
    101       -       101       101       62  
        Total Commercial and industrial
    586       76       510       586       304  
                                         
Commercial real estate:
                                       
     Commercial mortgages
    673       673       -       673       -  
     SBA  Loans
    -       -       -       -       -  
     Construction
    -       -       -       -       -  
     Religious Organizations
    407       407       -       407       -  
         Total Commercial real estate
    1,080       1,080       -       1,080       -  
                                         
         Total Loans
  $ 1,666     $ 1,156     $ 510     $ 1,666     $ 304  
 
 
Impaired loans as of December 31, 2011 are set forth in the following table.
 
               
 
             
                               
(In 000's)
 
Unpaid
   
Recorded
   
Recorded
             
   
Contractual
   
Investment
   
Investment
   
Total
       
   
Principal
   
With No
   
With
   
Recorded
   
Related
 
   
Balance
   
Allowance
   
Allowance
   
Investment
   
Allowance
 
                               
Commercial and industrial:
       
 
                   
     Commercial
  $ 491     $ 78     $ 413     $ 491     $ 246  
     SBA  loans
    -       -       -       -       -  
     Asset-based
    101       -       101       101       62  
        Total Commercial and industrial
    592       78       514       592       308  
                                         
Commercial real estate:
                                       
     Commercial mortgages
    677       677       -       677       -  
     SBA  Loans
    -       -       -       -       -  
     Religious Organizations
    418       418       -       418       -  
         Total Commercial real estate
    1,095       1,095       -       1,095       -  
                                         
         Total Loans
  $ 1,687     $ 1,173     $ 514     $ 1,687     $ 308  
 
 
 
 
 
19

 

 
 
                         
   
Three Months
Ended
   
Three Months
Ended
 
(In 000's)
    March 31, 2012    
March 31, 2011
 
   
Average
   
Interest recognized
   
Average
   
Interest recognized
 
   
Recorded
   
on impaired
   
Recorded
   
on impaired
 
   
Investment
   
loans
   
Investment
   
loans
 
                         
Commercial and industrial:
                       
     Commercial
  $ 481     $ -     $ 483     $ -  
     SBA  loans
    -       -       -       -  
     Asset-based
    101       -       18       -  
        Total Commercial and industrial
    582       -       501       -  
                                 
Commercial real estate:
                               
     Commercial mortgages
    675       -       1,243       -  
     SBA  Loans
    -       -       58       -  
     Religious Organizations
    410       -       441       3  
         Total Commercial real estate
    1,085       -       1,742       3  
                                 
         Total Loans
  $ 1,667       -     $ 2,243     $ 3  
 
Troubled debt restructurings (“TDRs”).  TDRs occur when a creditor, for economic or legal reasons related to a debtor’s financial condition, grants a concession to the debtor that it would not otherwise consider, such as a below market interest rate, extending the maturity of a loan, or a combination of both. The Company made modifications to certain loans in its commercial loan portfolio that included the term out of lines of credit to begin the amortization of principal.  The terms of these loans do not include any financial concessions and are consistent with the current market.  Management reviews all loan modifications to determine whether the modification qualifies as a troubled debt restructuring (i.e. whether the creditor has been granted a concession or is experiencing financial difficulties).  Based on this review and evaluation, none of the modified loans met the criteria of a troubled debt restructuring.  Therefore, the Company had no troubled debt restructurings at March 31, 2012 and December 31, 2011.
 
6.  Other Real Estate Owned
 
Period-end other real estate owned was as follows:

(in 000’s)
Three Months Ended
 March 31, 2012
Year Ended
December 31, 2011
Three Months Ended
March 31, 2011
Beginning balance
$1,284
$ 1,417
$ 1,417
Additions, transfers from loans
75
602
602
Proceeds from sales
      -
(730)
-
 
1,359
1,289
2,019
Less: write-downs
(15)
(5)
(4)
Ending Balance
1,344
1,284
$2,015

 
7.  Fair Value
 
Fair Value Measurement
 
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the Fair Value Measurements and Disclosures topic of ASC 820, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
 
 
 
 
20

 
 
 
The fair value guidance in FASB ASC 820 provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions. In accordance with this guidance, the Company groups its assets and liabilities carried at fair value in three levels as follows:
 
Level 1
·  
Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2
·  
Quoted prices for similar assets or liabilities in active markets.
·  
Quoted prices for identical or similar assets or liabilities in markets that are not active.
·  
Inputs other than quoted prices that are observable, either directly or indirectly, for the term of the asset or liability (e.g., interest rates, yield curves, credit risks, prepayment speeds or volatilities) or “market corroborated inputs.”

Level 3
·  
Prices or valuation techniques that require inputs that are both unobservable (i.e., supported by little or no market activity) and that are significant to the fair value of the assets or liabilities.
·  
These assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
 
 
A financial instrument’s categorization within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement.
 
Fair Value on a Recurring Basis

Securities Available for Sale (“AFS”):  Where quoted prices are available in an active market, securities would be classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid government bonds and mutual funds. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow models. Level 2 securities include U.S. agency securities and mortgage backed agency securities.  In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy.
 
Assets on the consolidated statements of condition measured at fair value on a recurring basis are summarized below.

(in 000’s)
 
Fair Value Measurements at Reporting Date Using:
 
Assets Measured at
Fair Value at
March 31, 2012
Quoted Prices in Active Markets for Identical Assets (Level 1)
Significant Other Observable Inputs (Level 2)
Significant Unobservable Inputs (Level 3)
Investment securities available-for-sale:
       
Government Sponsored Enterprises residential mortgage-backed securities
$1,094
 
 
$ -
 
$1,094
 
$    -
 
Money Market Funds
129
129
         -
      -
         
     Total
$1,223
$129
$1,094
$    -
 

 
 
21

 

(in 000’s)
 
Fair Value Measurements at Reporting Date Using:
 
 
Assets/Liabilities Measured at Fair Value at
December 31, 2011
Quoted Prices in Active Markets for Identical Assets (Level 1)
Significant Other Observable Inputs (Level 2)
Significant Unobservable Inputs (Level 3)
Investment securities available-for-sale:
 
       
Government Sponsored Enterprises residential mortgage-backed securities
 
$1,152
$-
$1,152
-
Money Market Funds
 
129
129
-
-
     Total
$1,281
$129
$1,152
 
 
The fair value of the Bank’s AFS securities portfolio was approximately $1,223,000 and $1,281,000 at March 31, 2012 and December 31, 2011, respectively.  Over 90% of the portfolio consisted of residential mortgage-backed securities, which had a fair value of $1,094,000 at March 31, 2012.  All the residential mortgage-backed securities were issued or guaranteed by the Government National Mortgage Association (“GNMA”), the Federal National Mortgage Association (“FNMA”) or the Federal Home Loan Mortgage Corporation (“FHLMC”).  The underlying loans for these securities are residential mortgages that are geographically dispersed throughout the United States.  The majority of the AFS securities were classified as level 2 assets at March 31, 2012.  The valuation of AFS securities using Level 2 inputs was primarily determined using the market approach, which uses quoted prices for similar instruments and all relevant information.  There were no transfers between Level 1 and Level 2 assets during the period ended March 31, 2012 and year ended December 31, 2011.
 
Fair Value on a Nonrecurring Basis
 
Certain assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).  The following table presents the assets carried on the consolidated statements of condition by level within the hierarchy as of March 31, 2012 and December 31, 2011, for which a nonrecurring change in fair value has been recorded during the three months ended March 31, 2012 and year ended December 31, 2011.

 Carrying Value at March 31, 2012:
(in 000’s)
 
 
 
Total
Quoted Prices in Active markets for Identical Assets
(Level 1)
Significant Other Observable Inputs
(Level 2)
Significant Unobservable Inputs
(Level 3)
Total fair value gain (loss) during 3 months ended
March 31, 2012
Impaired loans
$817
-
-
$817
$ 4
Other real estate owned (“OREO”)
$75
-
-
$75
-

Carrying Value at December 31, 2011:
(in 000’s)
 
 
 
Total
Quoted Prices in Active markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
 (Level 3)
Total fair value gain (loss) during 12 months ended
December 31, 2010
Impaired Loans
$ 206
 -
-
$ 206
$(308)
Other real estate owned (“OREO”)
1,284
-
-
1,284
-

 
 
 
22

 
 
 
The measured impairment for collateral dependent of impaired loans is determined by the fair value of the collateral less estimated liquidation costs.  Collateral values for loans and OREO are determined by annual or more frequent appraisals if warranted by volatile market conditions, which may be discounted up to 10% based upon management’s review and the estimated cost of liquidation. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.  Adjustments are routinely made on the appraisal process by the appraisers for differences between the comparable sales and income data available.  Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. The valuation allowance for impaired loans is adjusted as necessary based on changes in the value of collateral as well as the cost of liquidation.  It is included in the allowance for loan losses in the consolidated statements of condition. The valuation allowance for impaired loans at March 31, 2012 was approximately $304,000.  The valuation allowance for impaired loans at December 31, 2011 was approximately $308,000.
 
Fair Value of Financial Instruments
 
FASB ASC Topic 825 requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.
 
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
 
Cash and cash equivalents: The carrying amounts reported in the statement of condition for cash and cash equivalents approximate those assets’ fair values.
 
Investment securities: Fair values for investment securities available-for-sale are as described above.  Investment securities held-to-maturity are based on quoted market prices, where available.  If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.  The carrying amount of accrued interest receivable approximates fair value.
 
Loans: The fair value of loans was estimated using a discounted cash flow analysis, which considered estimated pre­payments, amortizations, and non performance risk.  Prepayments and discount rates were based on current marketplace estimates and pricing.  Residential mortgage loans were discounted at the current effective yield, including fees, of conventional loans, adjusted for their maturities with a spread to the Treasury yield curve.  The carrying amount of accrued interest receivable approximates fair value. The fair value for nonperforming/impaired loans is determined by using discounted cashflow analysis or underlying collateral values, where applicable.
 
 Deposit liabilities: The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings, and certain types of money market accounts) are equal to the amounts payable on demand at the reporting date (e.g., their carrying amounts).  The carrying amounts for variable-rate, fixed-term money market accounts and certificates of deposit approximate the fair values at the reporting date.  Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation.  The Treasury yield curve was utilized for discounting cash flows as it approximates the average marketplace certificate of deposit rates across the relevant maturity spectrum.
 
Accrued interest payable:  The carrying amounts of accrued interest payable approximate fair value.
 
Commitments to extend credit: The carrying amounts for commitments to extend credit approximate fair value as such commitments are not substantially different from the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparts.  The carrying amount of accrued interest payable approximates fair market value.
 
 
 
 
23

 
 
 
The fair value of assets and liabilities are depicted below:

   
March 31, 2012
December 31, 2011
           
(in 000’s)
Level in
Carrying
Fair
Carrying
Fair
 
Value Hierarchy
Amount
Value
Amount
Value
(Dollars in thousands)
         
Assets:
         
Cash and cash equivalents
Level 1
$7,419
$7,419
$14,497
$14,497
Available for sale securities
Level 2
1,223
1,223
1,281
1,281
Held to maturity securities
Level 2
16,616
17,097
17,209
17,738
Loans, net of allowance for loan losses
   Level 2(1)
40,605
41,873
40,635
40,552
Accrued interest receivable
Level 2
326
326
342
342
Liabilities:
         
Demand deposits
Level 2
30,282
30,282
31,260
31,260
Savings deposits
Level 2
14,496
14,496
14,689
14,689
Time deposits
Level 2
19,150
19,149
25,352
25,401
Accrued interest payable
Level 2
48
48
58
58
(1) For non-impaired loans Level 2; for impaired loans Level 1

8. Regulatory
On January 31, 2012, the Bank entered into stipulations consenting to the issuance of Consent Orders with the Federal Deposit Insurance Corporation (“FDIC”) and the Pennsylvania Department of Banking (“Department”).  The material terms of the Consent Orders are identical.  The requirements and status of items included in the Consent Orders are as follows:

Requirement
Status
Increase participation of the Bank’s board of directors in the Bank’s affairs by having the board assume full responsibility for approving the Bank’s policies and objectives and for supervising the Bank’s management;
Board participation has been increased will full attendance at board and committee meetings.
   
Have and retain qualified management, and notify the FDIC and the Department of any changes in the Bank’s board of directors or senior executive officers;
There have been no changes in management; however, a management assessment will be performed in conjunction with the required management review and written management plan.
   
Retain a bank consultant acceptable to the FDIC and the Department to develop a written analysis and assessment of the Bank’s management needs and thereafter formulate a written management plan;
An engagement letter from a qualified consultant has been received and approved by the Bank’s regulators.  The review will commence in May 2012.
   
Formulate and implement written profit and budget plans for each year during which the orders are in effect;
A three year profit and budget plans were prepared and submitted to regulators for review together with the Bank’s Strategic Plan in April 2012.
   
Develop and implement a strategic plan for each year during which the orders are in effect, to be revised annually;
A comprehensive strategic plan was prepared and submitted to regulators for review in April 2012.
   
Develop a written capital plan detailing the manner in which the Bank will meet and maintain a ratio of Tier 1 capital to total assets (“leverage ratio”) of at least 8.5% and a ratio of qualifying total capital to risk-weighted assets (total risk-based capital ratio) of at least 12.5%, within a reasonable but unspecified time period;
A capital plan with quarterly benchmarks was prepared and submitted to regulators for review together with the Bank’s Strategic Plan in April 2012.
   
 
 
 
24

 
 
 
 
   
Formulate a written plan to reduce the Bank’s risk positions in each asset or loan in excess of $100,000 classified as “Doubtful” or “Substandard” at its regulatory examination;
A classified asset reduction plan with quarterly benchmarks measured against capital was prepared and submitted in April 2012.
Requirement
Status
Eliminate all assets classified as “Loss” at its current regulatory examination;
All assets classified as “Loss” have been eliminated.
   
Revise the Bank’s loan policy to establish and monitor procedures for adherence to the loan policy and to eliminate credit administration and underwriting deficiencies identified at its current regulatory examination;
The Bank’s loan policy has been revised to include enhanced monitoring procedures.  Revisions were submitted to regulators for review in April 2012.
   
Develop a comprehensive policy and methodology for determining the allowance for loan and lease losses;
The ALLL policy and methodology for determining the allowance for loan and lease losses were submitted to regulators for review in April 2012.
   
Develop an interest rate risk policy and procedures to identify, measure, monitor and control the nature and amount of interest rate risk the Bank takes;
The Bank’s interest rate risk policy and procedures were submitted to regulators for review in April 2012.
   
Revise its liquidity and funds management policy and update and review the policy annually;
The Bank’s liquidity policy and contingency plan were submitted to regulators for review in April 2012.
   
Refrain from accepting any brokered deposits;
The Bank did not accept brokered deposits.
   
Refrain from paying cash dividends without prior approval of the FDIC and the Department;
The Bank did not pay cash dividends.
   
Establish an oversight committee of the board of directors of the Bank with the responsibility to ensure the Bank’s compliance with the orders, and
An oversight committee consisting of three outside directors was established and meets periodically to ensure compliance with the orders.
   
Prepare and submit quarterly reports to the FDIC and the Department detailing the actions taken to secure compliance with the orders.
The first quarterly report will be prepared and submitted in May 2012.

The Orders will remain in effect until modified or terminated by the FDIC and the Department and do not restrict the Bank from transacting its normal banking business.  The Bank will continue to serve its customers in all areas including making loans, establishing lines of credit, accepting deposits and processing banking transactions.  Customer deposits remain fully insured to the highest limits set by the FDIC.  The FDIC and the Department did not impose or recommend any monetary penalties in connection with the Consent Orders.

 As of March 31, 2012 and December 31, 2011, the Bank’s tier one leverage capital ratio was 6.24% and 6.27%, respectively, and its total risk based capital ratio was 12.12% and 12.41%, respectively. These ratios are below the levels required by the Orders.  Management believes that the Bank has and will continue to comply with the terms and conditions of the Orders and will continue to operate as a going concern and an independent financial institution for the foreseeable future.
 
 
 
 
25

 

 

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

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").


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,” “may,” and similar expressions are intended to identify such forward-looking statements.  These forward looking statements include: (a) statements of goals, intentions and expectations; and (b) statements regarding business prospects, asset quality, credit risk, reserve adequacy and liquidity.  UBS’ actual results may differ materially from the results anticipated by the forward-looking statements due to a variety of factors, including without limitation: (a) the effects of future economic conditions on UBS and its customers, including economic factors which affect consumer confidence in the securities markets, wealth creation, investment and consumer saving patterns; (b) UBS interest rate risk exposure and credit risk; (c) changes in the securities markets with respect to the market values of financial assets and the stability of particular securities markets; (d) governmental monetary and fiscal policies, as well as legislation and regulatory changes; (e) changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral and securities, as well as interest-rate risks; (f) changes in accounting requirements or interpretations; (g) the effects of competition from other commercial banks, thrifts, mortgage companies, consumer finance companies, credit unions securities brokerage firms, insurance company’s, money-market and mutual funds and other financial institutions operating in the UBS’ trade market area and elsewhere including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the internet; (h) any extraordinary events (such as the September 11, 2001 events), the war on terrorism and the U.S. Government’s response to those events or the U.S. Government becoming involved in a conflict in a foreign country including the war in Iraq; (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 its customers; (l) the recent downgrade , and any future downgrades, in the credit rating of the United States Government and federal agencies; (m) changes in technology being more expensive or difficult than expected; (n) the ability of key third party providers to perform their obligations to UBS and; (o) the Bank and UBS’ success in managing the risks involved in the foregoing, and (m) failure to comply with the Consent Orders with the FDIC and the Pennsylvania Department of Banking.

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.
 
 

 
 
26

 
 
Overview
 
The Company reported a net loss of approximately $238,000 ($0.22 per common share) for the quarter ended March 31, 2012 compared to a net loss of approximately $307,000 ($0.29 per common share) for the quarter ended March 31, 2011.  The improvement is primarily related to a reduction in noninterest expense. Management is committed to improving the Company’s operating performance by implementing more effective strategies to achieve and sustain profitability, augment capital, and manage loan and other real estate portfolios. The following actions are crucial to enhancing the Company’s future financial performance:
 
Increase Capital.  The importance of establishing and maintaining capital levels to support the Bank’s risk profile and growth is understood.  Therefore, a concentrated effort will be made to stabilize and strengthen the Bank’s Capital through asset reduction, gains on the sale of real estate and core profitability from operations. In addition, management will continue to seek funding from available Community Development Financial Institution (“CDFI”) programs in the future to supplement capital and support growth.
 
Manage asset quality to minimize credit losses and reduce collection costs. Progress has been made in the Bank’s collection, underwriting, and customer relationship management practices. Evidence of these improvements can be seen in the reduction of the level of impaired/nonperforming loans. In conjunction with requirements of its Consent Orders, management developed a Classified Asset Reduction Plan. During 2012, this Plan will be utilized to achieve further progress in reducing the level of non-performing loans and non-performing assets. Forbearance, foreclosure and/or other appropriate collection methods will be used as necessary.  These activities will likely result in increased credit quality costs, including loan collection and other real estate related costs that will continue to affect reported earnings as the Bank diligently works to reduce the outstanding investment in these assets.
 
Earnings enhancement plan. In 2012, management will restructure the Bank’s lending function by gradually exiting consumer lending products and redeploy resources to focus on small business lending; therefore, re-introducing the Bank as a “Business Bank”. This shift into business banking is necessary to reduce costs and increase efficiencies in the lending process to maximize earnings.
 
Although improvement has been made compared to the same quarter in 2011, the Bank’s noninterest expense continues to be elevated as a result of core deposit intangible amortization expense and occupancy expense related to its three branch structure. Also, unlike other similar-sized community banks, the Bank continues to incur a high level of professional service fees (audit and legal) because of its SEC filing requirements as a result of having in excess of 1,200 shareholders. While there has been some improvement in noninterest expense, management will seek further savings and efficiencies, where possible, including the following:

·  
Staff reductions. Review job functions and staffing levels to ensure the most efficient organizational structure
·  
Review and re-negotiation of significant contracts (i.e. data processing, credit card, EFT services, etc.)
·  
Sale and/or other disposition of Other Real Estate properties to reduce carrying costs
·  
Review and revision of the Bank’s customer service fees to maximize income.
 
Another challenge to increased earnings is margin compression. Margin compression has been created by the reduction in loans outstanding as well as the continued low interest rate environment that has resulted in lower yields on loans, federal funds sold and investment securities. While management actively manages the rates paid on deposit products to “average” market rates in attempt to mitigate the effect of the reduction in yield on earning assets, deposit rates have generally “bottomed out”. Management will continue to focus on growing the Bank’s loan portfolio and reducing the level of nonaccrual loans to increase net interest income.
 
 

 
 
27

 
 
Significant Accounting Policies
The preparation of consolidated financial statements requires management to make estimates and assumptions that affect the reported amount of assets and liabilities as of the dates of the balance sheets and revenues and expenditures for the periods presented.  Therefore, actual results could differ from these estimates.
 
The Company 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.
 
The Company’s significant accounting policies are presented in Note 1 to the  Company’s audited consolidated financial statements filed as part of the 2011 Annual Report on Form 10-K and in the footnotes to the Company’s unaudited financial statements filed as part of this Form 10-Q.

 
Selected Financial Data
The following table sets forth selected financial data for each of the following periods:

 
(Thousands of dollars, except per share data)
 
 
Quarter ended
March 31, 2012
 
 
Quarter ended
March 31, 2011
Statement of operations information:
   
Net interest income
$760
$764
Provision for loan losses
30
30
Noninterest income
194
214
Noninterest expense
1,162
1,255
Net loss
(238)
(307)
Net loss per share-basic and diluted
(0.22)
(0.29)
     
Balance Sheet information:
March 31, 2012
December 31, 2011
Total assets
$69,280
$77,017
Loans, net
$40,605
$40,635
Investment securities
$17,839
$18,490
Deposits
$63,928
$71,300
Shareholders' equity
$5,023
$5,261
     
Ratios*:
Quarter ended
March 31, 2012
Quarter ended
March 31, 2011
Return on assets
(1.26%)
(1.65%)
Return on equity
(19.41%)
(20.95%)
*annualized

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 uses declined approximately $2,053,000, or 2.78% during the quarter ended March 31, 2012 compared to the quarter ended December 31, 2011. Average funding sources decreased approximately $2,214,000, or 3.06%, during the quarter ended March 31, 2012 compared to the quarter ended December 31, 2011.
 
 
 
 
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Sources and Uses of Funds Trends
(Thousands of Dollars, except percentages)

 
March 31, 2012
   
December 31, 2011
 
Average
Increase (Decrease)
Increase (Decrease)
Average
 
 Balance
Amount
%
 Balance
Funding uses:
       
Loans
$41,523
($511)
(1.22)%
$42,034
Investment securities
       
Held-to-maturity
17,544
(491)
(2.72)
18,035
Available-for-sale
1,209
(52)
(4.12)
1,261
Federal funds sold
11,126
(999)
(8.24)
12,125
Balances with other banks
305
-
-
305
Total  uses
$71,707
($2,053)
(2.78)%
$73,760
Funding sources:
       
Demand deposits
       
Noninterest-bearing
$14,396
($172)
(1.18)%
$14,568
Interest-bearing
16,773
(678)
(3.89)
17,451
Savings deposits
14,677
(57)
(0.39)
14,734
Time deposits
24,380
(1,307)
(5.09)
25,687
Total sources
$70,226
($2,214)
(3.06)%
$72,440


Loans
Average loans declined approximately $511,000, or 1.22%, during the quarter ended March 31, 2012. While the Bank funded more than $2.5 million in loans during the quarter, there were $1 million in commercial loan payoffs and a continued decline in the consumer portfolio created by residential mortgages and home equity repayment activity as consumers refinance to take advantage of the current low interest rate environment.  The Bank is not an originator of residential mortgage loans and has made a strategic shift in its lending program to phase out consumer lending, including home equity loans and lines of credit.  During 2012, management adopted a business banking focus that incorporates strategies to increase the Bank’s commercial lending activity in alliance with a third party SBA loan origination group.  This program is designed to generate fee income as well as build loan volume.  Focused and aggressive business development efforts targeting small businesses will be employed in effort to increase commercial and industrial lending activity (i.e. working capital, receivables, etc.) for which credit enhancements through the SBA or other loan guaranty programs may be available to mitigate credit risk.   In addition, loan participations are used to supplement the Bank’s lending activities.

The Bank’s loan portfolio continues to be concentrated in commercial real estate loans that comprise approximately $30.4 million, or 73.39%, of total loans at March 31, 2012 of which approximately $16.1 million are owner occupied.  The Bank continues to have a strong niche in lending to religious organizations for which total loans at March 31, 2012 were approximately $13.5 million, or 44.25%, of the commercial real estate portfolio.   Management closely monitors this concentration to proactively identify and manage credit risk in light of the current high level of unemployment that could impact the level of tithes and offerings that provide cash flow for repayment.  The composition of the loans is as follows:
 
 
 
 
29

 

 
 
   
March 31,
   
December 31,
 
(In 000's)
 
2012
   
2011
 
             
             
Commercial and industrial:
           
     Commercial
  $ 1,851     $ 1,486  
     SBA loans
    136       235  
     Assets-based
    1,969       2,009  
        Total commercial and industrial
    3,956       3,730  
                 
Commercial real estate:
               
                 
     Commercial mortgages
    15,321       14,676  
     SBA loans
    472       477  
     Construction
    1,173       1,391  
     Religious organizations
    13,468       13,653  
         Total commercial real estate
    30,434       30,197  
                 
Consumer real estate:
               
     Home equity loans
    2,011       2,145  
     Home equity lines of credit
    46       85  
     1-4 family residential mortgages
    3,061       3,356  
         Total consumer real estate
    5,118       5,586  
                 
Total real estate
    35,552       35,783  
                 
Consumer and other:
               
     Consumer installment
    52       58  
     Student loans
    1,739       1,761  
     Other
    170       170  
         Total consumer and other
    1,961       1,989  
                 
         Loans
  $ 41,469     $ 41,502  
                 
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. Provisions are made to the allowance for loan losses in accordance with a detailed periodic analysis.  This analysis includes specific reserves allocated to impaired loans based on underlying recovery values as well as a general reserve based on charge-off history and various qualitative factors including delinquency trends, loan terms, regulatory environment, economic conditions, concentrations of credit risk and other relevant data. The allowance for loan losses as a percentage of total loans was 2.08% at March 31, 2012 and 2.09% at December 31, 2011.  During the quarter ended March 31, 2012, provisions for loan losses totaled $30,000.  Net charge-offs during the period totaled approximately $33,000 and were primarily related to one home equity loan for which there was insufficient equity to support repayment.
 
 
 
 
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Loans deemed “impaired” are those for which borrowers are no longer able to pay in accordance with the terms of their loan agreements.  The Bank’s source of repayment is generally the net liquidation value of the underlying collateral.  Impaired loans totaled approximately $1,666,000 at March 31, 2012 compared to $1,687,000 at December 31, 2011.    The valuation allowance associated with impaired loans was approximately $304,000 and $308,000, at March 31, 2012 and December 31, 2011, respectively. In conjunction with its regulatory Orders, management developed a Classified Asset Reduction Plan. During 2012, this plan will be utilized to reduce the level of impaired and non-performing loans. Forbearance, foreclosure and/or other appropriate collection methods will be used as necessary.

At March 31, 2012 and December 31, 2011, loans to religious organizations represented approximately $407,000 and $418,000, respectively, of total impaired loans. Management continues to work closely with its attorneys and the leadership of these organizations in an attempt to develop suitable repayment plans to avoid foreclosure.  In general, loans to religious organizations are being monitored closely to proactively identify potential weaknesses in this area of high concentration.

Management uses all available information to recognize losses on loans; however, future additions may be necessary based on further deterioration in economic conditions and market conditions affecting underlying real estate collateral values.  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. Although management uses the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short-term change.

The percentage of allowance to nonperforming loans has improved from 40.67% at December 31, 2011 to 43.07% at March 31, 2012 primarily as a result of charge-off and foreclosure-related activity that reduced the level of impaired/nonperforming loans.  The following table sets forth information concerning nonperforming loans and nonperforming assets.

 
 
 
 
31

 
 
(In 000's)
 
March 31, 2012
   
December 31, 2011
 
Commercial and industrial:
           
     Commercial
  $ 485     $ 491  
     SBA loans
    -       -  
     Asset-based
    101       101  
        Total Commercial and industrial
    586       592  
                 
Commercial real estate:
               
     Commercial mortgages
    673       677  
     SBA loans
    -       -  
     Religious organizations
    407       418  
         Total Commercial real estate
    1,080       1,095  
                 
Consumer real estate:
               
     Home equity loans
    112       106  
     Home equity lines of credit
    -       38  
     1-4 family residential mortgages
    228       301  
         Total consumer real estate
    340       445  
                 
Total real estate
    1,420       1,540  
                 
Consumer and other:
               
     Consumer installment
    -       -  
     Student loans
    -       -  
     Other
    -       -  
         Total consumer and other
    -       -  
                 
         Total nonperforming loans
  $ 2,006     $ 2,132  
         OREO
    1,344       1,284  
         Total nonperforming assets
  $ 3,350     $ 3,416  
                 
Past due 90 days or more and still accruing interest:
               
Commercial and industrial:
               
     Commercial
  $ -     $ -  
     SBA loans
    -       -  
     Asset-based
    -       -  
        Total Commercial and industrial
    -       -  
                 
Commercial real estate:
               
     Construction
    -          
     SBA loans
    -       -  
     Religious organizations
    -       173  
         Total Commercial real estate
    -       173  
                 
Consumer real estate:
               
     Home equity loans
    189       152  
         Total consumer real estate
    189       152  
                 
Total real estate
    189       325  
                 
Consumer and other:
               
     Student loans
    70       146  
     Other
    -       -  
         Total consumer and other
    70       146  
                 
                 
         Total
  $ 259     $ 471  
                 
Nonperforming loans to total loans
    4.83 %     5.14 %
Nonperforming assests to total loans and OREO
    7.82 %     7.98 %
Nonperforming assests to total assets
    4.83 %     4.44 %
                 
Allowance for loan losses as a percentage of:
               
     Total Loans
    2.08 %     2.09 %
     Total nonperforming loans
    43.07 %     40.67 %
                 
 
 
 
 
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Investment Securities and Other Short-term Investments
Average investment securities decreased by approximately $543,000, or 2.81%, during the quarter ended March 31, 2012. The decrease was primarily related to a decline in investable funds because of reduction in deposits. (Please refer to the Deposits section below.)
 
The yield on the investment portfolio declined to 3.17% at March 31, 2012 compared to 3.23% at December 31, 2011 as a result of the call of higher yielding agency securities during the period.  The duration of the portfolio has extended to 2.8 years at March 31, 2012 compared to 2.42 years at December 31, 2011 as a result of the purchase of callable agency securities with longer terms as well as amortizing 15 and 20 year government sponsored agency (GSA) mortgage-backed pass-through securities that serve to generate monthly cash flow.   The payments of principal and interest on these pools of GSA loans are guaranteed by these entities that bear the risk of default.  The Bank’s risk is prepayment risk when defaults accelerate the repayment activity.  These loans have longer-term con­tractual maturities but are sometimes paid off/down before maturity or have repricing characteristics that occur before final maturity. Management’s goal is to maintain a portfolio with a short duration to allow for adequate cash flow to fund loan origination activity and to manage interest rate risk.

Deposits
During the quarter ended March 31, 2012 average deposits decreased approximately $2,214,000, or 3.06%, concentrated in the category of time deposits.  The publicizing of the Bank’s Consent Orders in March 2012 negatively impacted the Bank’s existing depository relationships with governmental entities resulting in unplanned time deposit redemptions totaling $6 million. As a result, time deposits decreased on average by approximately $1,307,000, or 5.09%, during the quarter ended March 31, 2012. The Bank has approximately $8.0 million governmental or quasi-governmental depository relationships remaining.  Management is proactively communicating with agency officials to avoid further reduction in account balances.

There was also a decrease in average interest checking deposits of approximately $678,000, or 3.89%, during the quarter. The Bank has depository relationships with several not-for-profit and contractor-type customers that receive periodic payments on receivables for which fluctuations occur as funds are utilized for operations.

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. Commitments to extend credit fluctuate with the completion and conversion of construction lines of credit to permanent commercial mortgage loans and/or the closing of loans approved but not funded from one period to another.

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. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  Management believes the Bank has adequate liquidity to support the funding of unused commitments.  The Bank's financial instrument commitments are summarized below:

   
March 31,
2012
   
December 31,
2011
 
Commitments to extend credit
  $ 9,485,000     $ 9,162,000  
Standby letters of credit
    1,205,000       1,208,000  

The level of commitments at March 31, 2012 increased from approximately $10,370,000 to $10,690,000 as a result of an increase in approved but unfunded loans.  A significant portion of these outstanding commitments consist of unused lines of credit with Fortune 500 corporations for which the Bank leads and/or participates in syndications that are not expected to be drawn upon.
 
 
 
 
33

 
 

 
Liquidity
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.

By policy, the Bank’s minimum level of liquidity is 6.00% of total assets.  At March 31, 2012, the Bank had total short-term liquidity, including cash and federal funds sold, of approximately $7.4 million, or 10.71% of total assets, compared to $14.5 million, or 18.82%, at December 31, 2011. Time deposit redemptions totaling $6 million in March 2012 resulted in a reduction in liquidity during the quarter.
 
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. The portion of the Bank’s investment portfolio classified as available-for-sale could also provide liquidity. However, some of these securities are pledged as collateral for deposits of governmental/quasi-governmental agencies as well as the Discount Window at the Federal Reserve Bank.  Therefore, they are restricted from use to fund loans or to meet other liquidity requirements. The reduction in governmental deposits in March 2012 resulted in the release of approximately $6 million of pledged collateral.

Other types of assets such as federal funds sold, as well as maturing loans, are also sources of liquidity.  Approximately $12.8 million in loans are scheduled to mature within one year.
 
To ensure the ongoing adequacy of liquidity, the following contingency strategies will be utilized in order of priority, if necessary:
 
·  
Seek additional non-public deposits from existing private sector customers, specifically, members of the National Bankers Association (“NBA”) will be targeted as a source of deposits. Although not experiencing liquidity shortfalls, the Bank received approximately $2 million in deposits from these institutions in April 2012.
·  
Sell participations of existing commercial credits to other financial institutions in the region and/or NBA member banks based on pre-approved participation agreements.

The Bank’s contingent funding sources  include the Discount Window at the Federal Reserve Bank for which it currently has $1.75 million in securities pledged that result in borrowing capacity of $1.5 million. In light of the Bank’s regulatory Orders and “Troubled Bank” designation, liquidity will continue to be closely monitored and managed to minimize risk and ensure that adequate funds are available to meet daily customer requirements and loan demand.

Interest rate sensitivity
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 critical 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, 2012, a positive gap position is maintained on a cumulative basis through 1 year of 4.57% that is within the Bank’s policy guidelines of +/- 15% on a cumulative 1-year basis. This position makes the Bank’s net interest income more favorable in a rising interest rate environment.  The positive gap position decreased during the quarter as a result of the early redemption of $6 million in time deposits and related reduction in Federal Funds Sold. (Refer to Deposits above) Management will review and monitor the structure and rates on investment purchases, new loan originations and renewals to maintain a balanced interest rate risk profile.
 
 
 
 
34

 
 

 
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.  A simulation model is 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 forecasts 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.  At March 31, 2012, the change in the market value of equity in a +200 basis point interest rate change is -20.9%, within the Bank’s policy limit of 25% and -43.2 % in a +400 basis point interest rate change, within the policy limit of 50%.  Management will continue to mitigate this risk by originating more variable rate loans and purchasing variable rate MBS securities, when available.  Based on these models, interest-rate exposure is not considered significant and is within the policy limits of the Bank on all measures at March 31, 2012.

Capital Resources
Total shareholders' equity decreased approximately $237,000 compared to December 31, 2011 as a result of a net loss during the quarter ended March 31, 2012. On January 31, 2012, the Bank entered into Consent Orders with its primary regulators that required the development of a written capital plan ("Capital Plan") that details the manner in which the Bank will meet and maintain a Leverage Ratio of at least 8.50% and a Total Risk-Based Capital Ratio of at least 12.50% with specific benchmark Leverage Ratios and Total Risk-Based Capital Ratios to be met at each calendar quarter-end, until the required capital levels are achieved. Management developed and submitted a Capital Plan that focuses on curtailing losses to stop the erosion of capital and then increase capital from internal strategies before seeking external capital investment as follows:
 
·  
Asset Reduction--While not intentionally sought, in late March 2012, the Bank’s deposits declined by more than $6 million as a result of the early redemption of several governmental and quasi-governmental time deposits.  This decline served to de-leverage the Bank’s balance sheet while still maintaining adequate levels of liquidity. While there was no immediate impact on the Bank’s capital ratios, the improvement from this deposit reduction will be better reflected in the quarter ended June 30, 2012 as average assets will be lower for the quarter.
 
·  
Gains on sale of real estate -- The Bank owns real estate that it will seek to sell for a gain.
 
In addition, because the Bank is a CDFI, it has the ability to utilize programs of the U.S. Treasury’s CDFI Fund to supplement capital.  The Bank Enterprise Award (BEA) Program was created in 1994 to support FDIC-insured financial institutions, like the Bank, around the country that are dedicated to financing and supporting community and economic development activities. The BEA Program complements the community development activities of insured depository institutions (i.e., banks and thrifts) by providing financial incentives to expand investments in CDFIs and to increase lending, investment, and service activities within economically distressed communities. In 2011, the Bank applied for a BEA grant based on lending activity but did not qualify.  Management will continue to seek funding from available CDFI programs in the future to supplement capital and support growth, but will not include funding as part of its 2012 plan.
 
The Bank’s risk-based capital ratios are above the general minimum requirements but below those required by the Consent Orders.  The Company and the Bank’s actual capital amounts and ratios are as follows:
 
             
(in 000’s)
Actual
For capital
Adequacy purposes
To be well capitalized under
Prompt corrective actions provisions
March 31, 2012
Amount
Ratio
Amount
Ratio
Amount
Ratio
Total capital to risk-weighted assets:
           
     Consolidated
$5,263
12.12%
$3,474
8.00%
N/A
 
     Bank
5,263
12.12%
3,474
8.00%
$4,342
10.00%
Tier I capital to risk-weighted assets:
           
     Consolidated
4,715
10.86%
1,737
4.00%
N/A
 
     Bank
4,715
10.86%
1,737
4.00%
$2,605
6.00%
Tier I capital to average assets:
           
     Consolidated
4,715
6.24%
3,023
4.00%
N/A
 
      Bank
4,715
6.24%
3,023
4.00%
$3,778
5.00%


 
 
35

 

 
(in 000’s)
 
Actual
For capital
Adequacy purposes
To be well capitalized under
Prompt corrective actions provisions
December 31, 2011
Amount
Ratio
Amount
Ratio
Amount
Ratio
Total capital to risk-weighted assets:
           
Consolidated
$5,460
12.45%
$3,513
8.00%
N/A
 
Bank
 5,440
12.41%
3,507
8.00%
$4,384
10.00%
Tier I capital to risk-weighted assets:
           
Consolidated
4,908
11.20%
1,756
4.00%
N/A
 
Bank
4,888
11.15%
1,754
4.00%
$2,630
6.00%
Tier I capital to average assets:
           
Consolidated
4,908
6.29%
3,122
4.00%
N/A
 
Bank
4,888
6.27%
3,119
4.00%
$3,899
5.00%

Results of Operations

Summary
The Company reported a net loss of approximately $238,000 ($0.22 per common share) for the quarter ended March 31, 2012 compared to a net loss of approximately $307,000 ($0.29 per common share) for the quarter ended March 31, 2011.  The improvement is primarily related to a reduction in noninterest expense. A detailed explanation of each component of operations is included in the sections below.

Net Interest Income
Net interest income is an effective measure of how well management has balanced the Bank’s interest rate-sensitive assets and liabilities.  Net interest income, the difference between (a) interest and fees on interest-earning assets and (b) interest paid on interest-bearing liabilities, is a significant component of the Bank’s earnings.  Changes in net interest income result primarily from increases or decreases in the average balances of interest-earning assets, the availability of particular sources of funds and changes in prevailing interest rates.

Average Balances, Rates, and Interest Income and Expense Summary
   
Three  months ended
March 31, 2012
   
Three  months ended
March 31, 2011
 
(in 000’s)
Average Balance
 
Interest
 
Yield/Rate
Average Balance
 
Interest
 
Yield/Rate
             
Assets:
           
Interest-earning assets:
           
Loans
$41,523
$660
6.36%
$43,579
$668
6.13%
Investment securities-HTM
17,544
128
2.92
15,406
141
3.66
Investments securities-AFS
1,209
9
2.98
1,243
12
3.86
Federal funds sold
11,126
5
0.18
8,861
3
0.14
Interest bearing balances with other banks
305
1
0.25
305
1
0.25
Total interest-earning assets
71,707
803
4.48
69,394
825
4.76
Interest-bearing liabilities
           
Demand deposits
16,773
13
0.31
13,681
18
0.53
Savings deposits
14,677
2
0.05
14,028
3
0.09
Time deposits
24,380
28
0.46
25,954
40
0.62
Total interest-bearing liabilities
55,830
43
0.31
53,663
61
0.45
Net interest earnings
 
$760
   
$764
 
Net yield on interest-earning assets
   
4.24%
   
4.40%
 
For purposes of computing the average balance, loans are not reduced for nonperforming loans.  Loan fee income is included in interest income on loans but is not considered material.
 
Net interest income declined approximately $4,000, or 0.58%, for the quarter ended March 31, 2012 compared to the quarter ended March 31, 2011. The net yield on interest-earning assets for the quarter ended March 31, 2012 declined to 4.24% from 4.40% for the same quarter in 2011. Although the yield on loans increased as a result of the transfer of several nonaccrual loans to OREO and the imposition of default interest rates for several borrowers for noncompliance with note requirements to provide annual financial statements, the overall yield on interest-bearing assets declined.  This decline was primarily the result of a reduction in yield on investment securities due to the call of higher yielding agency bonds that were replaced in the current low interest rate environment.
 
 
 
 
36

 
 
 
The cost of interest-bearing liabilities fell 14 basis points for the quarter ended March 31, 2012 compared to the same period in 2011 as a result of rate reductions made on the Bank’s deposit products to follow market conditions. However, deposit rates have relatively “bottomed-out”, leaving little room to make further downward adjustments.
 
For the quarter ended March 31, 2012 compared to the same period in 2011, there was a decrease in net interest income of approximately $60,000 due to changes in volume and an increase of approximately $56,000 due to changes in rate.
 
Rate-Volume Analysis of Changes in Net Interest Income
 

   
Three months ended March 31, 2012 compared to 2011
 
   
Increase (decrease) due to
 
(Dollars in thousands)
 
Volume
   
Rate
   
Net
 
Interest earned on:
                 
Loans
  $ (128 )   $ 120     $ (8 )
Investment securities held-to-maturity
    70       (83 )     (13 )
Investment securities available-for-sale
    (1 )     (2 )     (3 )
Interest-bearing deposits with other banks
    4       (4     -  
Federal funds sold
    4       (2 )     2  
Total Interest-earning assets
    (51 )     29       (22 )
Interest paid on:
                       
Demand deposits
    13       (18 )     (5 )
Savings deposits
    -       (1 )     (1 )
Time deposits
    (8 )     (4 )     (12 )
Total interest-bearing liabilities
    5       (23 )     (18 )
Net interest income
  $ (56 )   $ 52     $ (4 )
 
While average earning assets increased by approximately $2.3 million, both the decline in loan volume as well as the reduction in yield on the investment portfolio, did not allow for an increase in net interest income.   Management’s focus is on increasing loan origination activity to boost the net interest income.

Provision for Loan Losses
The provision for loan losses was $30,000 for both the three months ended March 31, 2012 and 2011. In general, provision requirements are based on credit losses inherent in the loan portfolio and the review and analysis of the loan portfolio in accordance with the Bank’s Allowance for Loan Loss policies and procedures.   Asset quality appears to have stabilized as the level of nonperforming/impaired loans has declined and delinquency trends have improved. (Refer to Allowance for Loan Losses above for discussion and analysis of credit quality.)

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 fees, overdrafts, account analysis, ATM fees and other customer service fees.  Noninterest income declined approximately $19,000, or 9.10%, for the quarter ended March 31, 2012 compared to the same quarter in 2011.   .

While customer service fees were relatively unchanged, ATM fees declined approximately $6,000, or 7.42%, for the quarter ended March 31, 2012 compared to 2011. The Bank’s ATM network continues to experience a reduction in volume because of ATM saturation in the marketplace by both financial and non-financial competitors.  Also, consistent with trends in the industry, ATM usage has declined as consumers continue to move to electronic payment methods utilizing debit and credit cards versus cash.   Methods to reduce cost and increase revenues associated with the ATM network continue to be evaluated including a more cost effective network communication system that will be implemented as ATM hardware upgrades are made to meet American Disabilities Act requirements during 2012.

Noninterest Expense
Salaries and benefits decreased approximately $16,000, or 3.77%, for the quarter ended March 31, 2012 compared to 2011 as a result of the severance of unproductive personnel in the lending/credit administration area of the Bank in April 2011. Management continues to review the organizational structure to maximize efficiencies, increase utilization/productivity and increase business development activity in conjunction with the Consent Orders and 2012 strategic plan.
 
 
 
 
37

 
 

 
Occupancy expense increased approximately $4,600, or 1.71%, for the quarter ended March 31, 2012 compared to 2011 as a result of rent escalations and an increase in common area maintenance expense related to leased facilities.

Office operations and supplies expense decreased approximately $3,000, or 3.81%, for the quarter ended March 31, 2012 compared to 2011.    There was a decrease in general office supplies expense as a result of the move to a less costly supplier and a concerted effort to reduce waste (i.e. using 2 sides of paper, only printing when necessary, etc.). Management continues to review all office operations expenses in effort to reduce expenses.

Marketing and public relations expense decreased approximately $18,000, or 79.60%, for the quarter ended March 31, 2012 compared to 2011.  In 2011, the Company began to push out its new branding message, “So Much More Than Banking” utilizing newspaper and magazine ads, bus depots, and other relevant marketing strategies.  In 2012, direct marketing was curtailed.  More direct outreach through office receptions and direct calling by business development staff will be utilized to reduce expenses.

Professional services expense increased approximately $2,500, or 3.54%, for the quarter ended March 31, 2012 compared to 2011.  The increase is related to legal expenses incurred in conjunction with the Bank’s Consent Orders.
 
Data processing expenses increased approximately $1,000, or 0.62%, for the quarter ended March 31, 2012 compared to 2011 as a result of an annual escalation in core processing fees.  The Bank experiences a higher level of data processing expenses relative to its peer group because of the nature of its deposit base--low average balance and high transaction volume.  In addition, the Bank uses outside loan servicing companies to service its mortgage, credit card, and student loan portfolios.  To better serve its customers, the Bank also has an extensive ATM network of twenty-four (24) machines for which it pays processing fees.  This network is larger than most banks in its peer group.  Management continues to seek reduction in its processing costs including contract re-negotiations/extensions and line item reviews.
 
Federal deposit insurance assessments decreased approximately $41,000, or 97.12%, for the quarter ended March 31, 2012 compared to 2011.  Assessments are based on many factors including the Bank’s deposit size and composition and its current regulatory ratings.   The FDIC assessment billing statements are provided one quarter in arrears and reflected a lower premium than recorded for the assessment period ending December 31, 2011.  The impact of the recent Consent Orders on the insurance premiums is not yet known.
 
Loan and collection expenses decreased approximately $28,000, or 59.50%, for the quarter ended March 31, 2012 compared to 2011. The decrease is directly related to a reduction in the level foreclosure and collection activity as asset quality trends appear to have stabilized.
 
Dividend Restrictions
The Company 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 (10%) 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 fifty percent (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, the Federal Reserve Board has the power to prohibit the payment of cash dividends by a bank holding company if it determines that such a payment would be an unsafe or unsound practice or constitutes a serious risk to the financial soundness or stability of the subsidiary bank.  As a result of these laws and regulations, the Bank, and therefore the Company, whose only source of income is dividends from the Bank, will be unable to pay any dividends while an accumulated deficit exists.  The Company does not anticipate that dividends will be paid for the foreseeable future.
 
Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Not applicable.
 
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 Securities and Exchange Commission filings.
 
 
 
38

 
 
 
As of the date of this report, there have not been any changes in the Company’s internal controls over financial reporting during the quarterly period covered by this report that have materially affected or are reasonably likely to materially affect its internal controls over financial reporting.
 
PART II - OTHER INFORMATION
 
Item 1. Legal Proceedings.
 
None.
 
Item 1A. Risk Factors.
 
There have not been any material changes to the risk factors disclosed in the Company’s 2011 Annual Report on Form 10-K except as disclosed below.  The risk factors disclosed in the Company’s 2011 Annual Report on Form 10-K are not the only risks that we face.  Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
 
Failure to Comply with the FDIC and Pennsylvania Department of Banking Consent Orders
 
The Bank has entered into Consent Orders with the FDIC and the Department which, among other provisions, require the Bank to increase its tier one leverage capital ratio to 8.5% and its total risk based capital ratio to 12.5%.  As of March 31, 2012, the Bank’s tier one leverage capital ratio was 6.24% and its total risk based capital ratio was 12.12%.  See the Regulatory Orders section.  The Bank’s failure to comply with the terms of the Consent Orders could result in additional regulatory supervision and/or actions.  The ability of the Bank to continue as a going concern is dependent on many factors, including achieving required capital levels, earnings and fully complying with the Consent Orders.  The Consent Orders raise substantial doubt about the Bank’s ability to continue as a going concern.
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 
 None
 

 
Item 3.  Defaults Upon Senior Securities.
 
None
 
 
Item 4. Mine Safety Disclosures.
 
Not applicable
 
 
Item 5.  Other Information.
 
None
 
 
 
 
39

 
 
 
Item 6. Exhibits.
 
a)           Exhibits.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
40

 
 
 
 
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 15, 2012
/s/ Evelyn F. Smalls
 
Evelyn F. Smalls
 
President & Chief Executive Officer
   
   
Date: May 15, 2012
/s/ Brenda M. Hudson-Nelson
 
Brenda Hudson-Nelson
 
Executive Vice President/Chief Financial Officer
 
 
 
 
 
 

 
 
41

 
 
Index to Exhibits-FORM 10-Q