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EX-32.2 - EXHIBIT 32.2 - UNITED BANCSHARES INC /PAex322.htm
EX-31.2 - EXHIBIT 31.2 - UNITED BANCSHARES INC /PAex312.htm
EX-31.1 - EXHIBIT 31.1 - UNITED BANCSHARES INC /PAex311.htm
EX-32.1 - EXHIBIT 32.1 - UNITED BANCSHARES INC /PAex321.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 SEPTEMBER 30, 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__
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. Yes_____ No_X__
 
 
 
1

 
 
 
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 November 6, 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 A 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 November 6, 2012.


 
2

 

 
 
 
Index
 
 
UNITED BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
Assets:
 
September 30, 2012
   
December 31, 2011
 
Cash and due from banks
  $ 2,469,242     $ 2,778,924  
Interest-bearing deposits with banks
    305,919       305,405  
Federal funds sold
    8,928,000       11,413,000  
   Cash and cash equivalents
    11,703,161       14,497,329  
                 
Investment securities:
               
Available-for-sale, at fair value
    1,087,754       1,280,874  
                 
 Held-to-maturity, at amortized cost (fair value of $13,073,977  and
    $17,738,368 at September 30, 2012 and December 31 2011,  respectively)
    12,398,742       17,209,295  
                 
Loans, net of unearned discount
    40,673,453       41,502,205  
Less allowance for loan losses
    (868,811 )     (867,019 )
   Net loans
    39,804,642       40,635,186  
 
Bank premises and equipment, net
    495,671       988,170  
Assets held for sale           356,758       -  
Accrued interest receivable
    325,189       342,029  
Other real estate owned
    1,177,092       1,284,390  
Intangible assets
    193,954       313,811  
Prepaid expenses and other assets
    388,233       465,838  
   Total assets
    67,931,196       77,016,922  
 
Liabilities and Shareholders’ Equity
               
 
Liabilities:
               
Demand deposits, noninterest-bearing
    15,447,155     $ 14,373,040  
Demand deposits, interest-bearing
    16,426,916       16,886,633  
Savings deposits
    14,167,210       14,688,985  
Time deposits, under $100,000
    7,428,258       7,768,057  
Time deposits, $100,000 and over
    9,752,863       17,583,743  
   Total deposits
    63,222,402       71,300,458  
 
Accrued interest payable
    26,537       58,361  
Accrued expenses and other liabilities
    304,530       397,187  
   Total liabilities
    63,553,469       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
    (10,421,772 )     (9,539,831 )
Accumulated other comprehensive income
    37,593       38,841  
   Total shareholders’ equity
    4,377,727       5,260,916  
   Total liabilities and shareholders’ equity
  $ 67,931,196     $ 77,016,922  

The accompanying notes are an integral part of these statements.
 
 

 
UNITED BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Unaudited)
   
Three Months ended
September 30, 2012
   
Three Months ended
September 30, 2011
   
Nine Months ended
September 30, 2012
   
Nine Months ended
September 30, 2011
 
Interest income:
                       
   Interest and fees on loans
    666,685     $ 654,573     $ 1,986,527       1,974,564  
   Interest on investment securities
    97,097       157,717       349,568       467,805  
   Interest on federal funds sold
    3,847       6,164       12,777       13,479  
   Interest on time deposits with other banks
    176       175       524       521  
      Total interest income
    767,805       818,629       2,349,396       2,456,369  
                                 
Interest expense:
                               
   Interest on time deposits
    18,110       37,208       66,242       115,751  
   Interest on demand deposits
    11,612       20,184       36,738       57,641  
   Interest on savings deposits
    1,760       2,680       5,317       9,571  
      Total interest expense
    31,482       60,072       108,297       182,963  
      Net interest income
    736,323       758,557       2,241,099       2,273,406  
Provision for loan losses
    61,000       30,000       121,000       100,000  
     Net interest income after provision for loan losses
    675,323       728,557       2,120,099       2,173,406  
                                 
Noninterest income:
                               
   Customer service fees
    103,435       93,319       296,326       286,654  
   ATM fee income
    77,545       88,535       238,316       265,314  
   Loan syndication fees
    -       -       80,000       80,000  
   Gain (loss) on sale of other real estate
    (5,968 )     -       (5,968 )     111,291  
   Gain on sale of loans
    69,163       -       69,163       -  
   Other income
    15,610       16,930       55,167       68,556  
      Total noninterest income
    259,785       198,784       733,004       811,815  
                                 
Noninterest expense:
                               
   Salaries, wages and employee benefits
    385,971       417,229       1,192,480       1,262,393  
   Occupancy and equipment
    261,700       273,563       802,297       821,232  
   Office operations and supplies
    81,453       76,585       231,576       229,167  
   Marketing and public relations
    5,186       14,323       28,675       72,748  
   Professional services
    104,666       56,405       256,198       199,187  
   Data processing
    114,602       117,964       352,603       368,394  
   Other real estate valuation allowance
    127,050       -       153,298       3,879  
   Loan and collection costs
    49,451       34,642       142,429       137,485  
   Deposit insurance assessments
    43,085       40,892       70,509       125,122  
   Other operating
    169,180       176,792       504,979       523,421  
      Total noninterest expense
    1,342,344       1,208,395       3,735,044       3,743,028  
      Net loss before income taxes
    (407,235 )     (281,054 )     (881,941 )     (757,807 )
Provision for income taxes
    -       -       -       -  
      Net loss
  $ (407,235 )   $ (281,054 )   $ (881,941 )   $ (757,807 )
Net loss per common share—basic  and diluted
  $ (0.38 )   $ (0.26 )   $ (0.83 )   $ (0.71 )
Weighted average number of common shares
    1,065,588       1,065,588       1,065,588       1,065,588  
Comprehensive Loss
                               
 Net Loss
  $ (407,235 )   $ (281,054 )   $ (881,941 )   $ (757,807 )
Unrealized losses on available for sale securities
    (884 )     (4,050 )     (1,248 )     (5,529 )
  Total comprehensive loss
  $ (408,119 )   $ (285,104 )   $ (883,189 )   $ (763,336 )
 
See Accompanying Notes to Consolidated Financial Statements which are an integral part of the unaudited consolidated financial statements.
 


UNITED BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30,

   
2012
   
2011
 
             
Cash flows from operating activities:
           
Net loss
  $ (881,941 )   $ (757,806 )
   Adjustments to reconcile net loss to net cash
               
       used in operating activities:
               
        Provision for loan losses
    121,000       100,000  
        Loss (gain) on sale of other real estate
    5,968       (111,291 )
        Gain on sale of loans
    (69,163 )     -  
        Amortization of premiums on investments
    90,818       43,250  
        Amortization of core deposit intangible
    133,559       133,559  
        Depreciation on fixed assets
    167,930       188,113  
        Write-down of other real estate owned
    153,298       1,306  
        Decrease in accrued interest receivable  and
               
          other assets
    80,745       146,762  
        Decrease in accrued interest payable and
               
          other liabilities
    (124,481 )     (94,262 )
          Net cash used in operating activities
    (322,267 )     (350,368 )
                 
Cash flows from investing activities:
               
        Purchase of held-to-maturity investment securities
    (4,860,337 )     (9,912,036 )
        Purchase of investments securities available-for-sale
    -       (264,403 )
        Proceeds from maturity and principal reductions of
               
          available-for-sale investment securities
    188,107       251,656  
        Proceeds from maturity and principal reductions of
               
          held-to-maturity investment securities
    9,583,837       7,643,619  
        Proceeds from the sale of other real estate owned
    22,832       844,238  
        Proceeds from sale of loans
    637,621       -  
        Net decrease in loans
    66,285       3,140,354  
        Purchase of bank premises and equipment
    (32,190 )     (88,161 )
Net cash provided by investing activities
    5,606,155       1,615,267  
 
               
Cash flows from financing activities:
               
        Net (decrease) increase in deposits
    (8,078,056 )     4,907,474  
        Net cash (used in) provided by financing activities
    (8,078,056 )     4,907,474  
 
       Net (decrease) increase in cash and cash equivalents
    (2,794,168 )     6,172,373  
 
Cash and cash equivalents at beginning of period
    14,497,329       8,696,111  
 
Cash and cash equivalents at end of period
  $ 11,703,161     $ 14,868,484  
 
Supplemental disclosure of cash flow information:
               
        Cash paid during the period for interest
  $ 140,121     $ 233,531  
        Noncash transfer of loans to other real estate owned
  $ 74,800     $ 602,100  
        Noncash transfer of bank premises to assets held for sale   $ 356,758     $ -  
 
The accompanying notes are an integral part of these statements.


 
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 September 30, 2012 and December 31, 2011 and the consolidated results of its operations and its cash flows for the three and nine months ended September 30, 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.
 
Assets Held For Sale
Assets are classified as held for sale if their carrying amount will be recovered principally through a sale transaction rather than through continuing use.  This condition is regarded as met only when the sale is highly probable and the asset is available for immediate sale in its present condition.  Management must be committed to the sale, which should be expected to qualify for recognition as a completed sale within one year from the date of classification.  Assets classified as held for sale are measured at the lower of their previous carrying amount and fair value less costs to sell.
 
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.

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.
 
 
 
 
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 September 30, 2012
Three Months Ended September 30, 2011
Nine Months Ended   September 30, 2012
Nine Months Ended September 30, 2011
Basic:
       
Net loss available to common shareholders
$(407,236)
$(281,056)
$(881,941)
$(757,804)
Average common shares outstanding-basic
1,065,588
1,065,588
1,065,588
1,065,588
Net loss per share-basic
$ (0.38)
$ (0.26)
$ (0.83)
$ (0.71)
Diluted:
       
Average common shares-diluted
1,065,588
1,065,588
1,065,588
1,065,588
Net loss per share-diluted
$ (0.38)
$ (0.26)
$ (0.83)
$ (0.71)
 
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 as reflected 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 presents comprehensive loss in a a separate statement.
 
 

 
In December 2011, the FASB issued an update (“ASU” No. 2011-12, Presentation of Comprehensive Income: Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05) which under ASU 2011-05 defers the effective date pertaining to reclassification adjustments out of other accumulated other comprehensive income (AOCI).  Concerns were raised that reclassifications of items out of AOCI would be costly for preparers and may add unnecessary complexity to financial statements. All other requirements in ASU 2011-05 are not affected by this Update. This amendment is effective for interim and annual periods beginning after December 15, 2011.
 
In December 2011, the FASB issued Accounting Standards Update ASU 2011-11: Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. The amendments in this Update require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. This Update affects all entities that have financial instruments and derivative instruments that are either (1) offset in accordance with either Section 210-20-45 or Section 815-10-45 or (2) subject to an enforceable master netting arrangement or similar agreement. The requirements amend the disclosure requirements on offsetting in Section 210-20-50. This information is intended to enable users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements on an entity’s financial position, including the effect or potential effect of rights of setoff associated with certain financial instruments and derivative instruments in the scope of this Update. The amendments are effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company is evaluating the impact of ASU 2011-11 on its consolidated financial statements.
 
4.  Investment Securities
The following is a summary of the Company's investment portfolio as of September 30, 2012: 
 
(In 000’s)
 
 
 
 
   
 
 
   
 
 
   
 
 
 
 
 
 
Amortized Cost
   
Gross unrealized gains
   
Gross unrealized losses
   
Fair Value
 
Available-for-sale:
                               
Government Sponsored Enterprises residential mortgage-backed securities
  $ 903     $ 56     $ -     $ 959  
Investments in money market funds
    129       -       -       129  
    $ 1,032     $ 56       -     $ 1,088  
Held-to-maturity:
                               
U.S. government agencies
  $ 3,355     $ 171     $ -     $ 3,526  
Government Sponsored Enterprises residential mortgage-backed securities
      9,044         505       (1 )       9,548  
 
  $ 12,399     $ 676     $ (1 )   $ 13,074  
 
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  
 
 
 
 
The amortized cost and fair value of debt securities classified as available-for-sale and held-to-maturity, by contractual maturity, as of September 30, 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
    903       959  
 Total debt securities
  $ 903     $ 959  
 Investments in money market funds
  $ 129     $ 129  
    $ 1,032     $ 1,088  
                                    Held-to-maturity
               
Due in one year
  $ -       -  
Due after one year through five years
    250       270  
Due after five years through ten years
    3,105       3,256  
Government Sponsored Enterprises residential mortgage-backed securities
    9,044       9,548  
    $ 12,399     $ 13,074  
 
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 September 30, 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:
                                   
Government Sponsored Enterprises residential mortgage-backed securities
  $ 255     $ (1 )   $ -     $ -     $ 255     $ (1 )
     Total
  $ 255     $ (1 )   $ -     $ -     $ 255     $ (1 )
 
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 )
 
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.
 
 
 
 
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.
 
5. Loans and 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 an eight-quarter historical charge-off rate to all pools of non-classified loans.
 
 
·  
Qualitative Factors Component – The loan portfolio is broken down 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 quarter ended September 30, 2012.  During the period, the average historical loss factors improved for commercial real estate loans, the most significant category, due to minimal charge-off activity.  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)
 
 
   
For the Nine months ended September 30, 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
    172       (56 )     -       5       121  
                                         
Charge-offs
    (56 )     -       (80 )     (16 )     (152 )
Recoveries
    -       8       14       11       33  
Net charge-offs
    (56 )     8       (66 )     (5 )     (119 )
                                         
Ending balance
  $ 503     $ 364     $ 2     $ -     $ 869  
                                         
 

(in 000's)
 
 
   
For the Nine months ended September 30, 2011
             
   
Commercial and industrial
   
Commercial real estate
   
Consumer real estate
   
Consumer loans other
   
Total
 
Beginning balance
  $ 301     $ 553     $ 52     $ 20     $ 926  
Provision for possible loan losses
    55       23       15       7       100  
                                         
Charge-offs
    (62 )     (148 )     -       (42 )     (252 )
Recoveries
    1       5       4       15       25  
Net charge-offs
    (61 )     (143 )     4       (27 )     (227 )
                                         
Ending balance
  $ 295     $ 433     $ 71       -     $ 799  


(in 000's)
 
 
   
For the Three Months ended September 30, 2012
             
   
Commercial and industrial
   
Commercial real estate
   
Consumer real estate
   
Consumer loans other
   
Total
 
Beginning balance
  $ 496     $ 367     $ 43     $ -     $ 906  
Provision for possible loan losses
    63       (6 )     1       3       61  
                                         
Charge-offs
    (56 )     -       (43 )     (7 )     (106 )
Recoveries
    -       3       1       4       8  
Net charge-offs
    (56 )     3       (42 )     (3 )     (98 )
                                         
Ending balance
  $ 503     $ 364     $ 2     $ -     $ 869  
                                         
 

(in 000's)
 
 
   
For the Three Months ended September 30, 2011
             
   
Commercial and industrial
   
Commercial real estate
   
Consumer real estate
   
Consumer loans other
   
Total
 
Beginning balance
  $ 280     $ 432     $ 55     $ -     $ 767  
Provision for possible loan losses
    15       -       15       -       30  
                                         
Charge-offs
    -       -       -       (5 )     (5 )
Recoveries
    -       1       1       5       7  
Net charge-offs
    -       1       1       -       2  
                                         
Ending balance
  $ 295     $ 433     $ 71     $ -     $ 799  




(in 000's)
 
 
   
As of September 30, 2012
             
                               
    Commercial and industrial     Commercial real estate     Consumer real estate     Consumer loans other     Total  
Period-end amount allocated to:
 
 
                         
 Loans individually evaluated for impairment
  $ 503     $ -     $ -     $ -     $ 503  
 Loans collectively  evaluated for impairment
    -       364       2       -       366  
    $ 503     $ 364     $ 2     $ -     $ 869  
Loans, ending balance:
                                       
 Loans individually evaluated for impairment
  $ 626     $ 1,120     $ -     $ -     $ 1,746  
 Loans collectively  evaluated for impairment
    3,267       29,019       4,806       1,835       38,927  
Total
  $ 3,893     $ 30,139     $ 4,806     $ 1,835     $ 60,673  
                                         

(in 000's)
 
 
   
As of December 31, 2011
             
                               
    Commercial and industrial     Commercial real estate     Consumer real estate     Consumer loans other     Total  
Period-end amount allocated to:
 
 
                         
 Loans individually evaluated for impairment
  $ 308     $ -     $ -     $ -     $ 308  
 Loans collectively  evaluated for impairment
    79       412       68       -       559  
    $ 387     $ 412     $ 68     $ -     $ 867  
Loans, ending balance:
                                       
 Loans individually evaluated for impairment
  $ 592     $ 1,095     $ -     $ -     $ 1,687  
 Loans collectively  evaluated for impairment
    3,138       29,102       5,586       1,989       39,815  
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 September 30, 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
  $ 75     $ 340     $ 479     $ 894     $ 698     $ 1,592  
     SBA loans
    -       -       -       -       127       127  
     Asset-based
    -       -       99       99       2,075       2,174  
        Total Commercial and industrial
    75       340       578       993       2,900       3,893  
                                                 
Commercial real estate:
                                               
     Commercial mortgages
    131       -       732       863       13,552       14,415  
     SBA loans
    -       -       -       -       628       628  
     Construction
    -       -       -       -       2,530       2,530  
     Religious organizations
    806       -       387       1,193       11,373       12,566  
         Total Commercial real estate
    937       -       1,119       2,056       28,083       30,139  
                                                 
Consumer real estate:
                                               
     Home equity loans
    121       188       64       373       1,096       1,469  
     Home equity lines of credit
    -       -       -       -       26       26  
     1-4 family residential mortgages
    -       -       227       227       3,084       3,311  
         Total consumer real estate
    121       188       291       600       4,206       4,806  
                                                 
Total real estate
    1,058       188       1,410       2,656       32,289       34,945  
                                                 
Consumer and other:
                                               
     Consumer installment
    3       -       -       3       35       38  
     Student loans
    24       108       -       132       1,498       1,630  
     Other
    4       -       -       4       163       167  
         Total consumer and other
    31       108       -       139       1,696       1,835  
                                                 
         Total loans
  $ 1,164     $ 636     $ 1,988     $ 3,788     $ 36,885     $ 40,673  



An age analysis of past due loans, segregated by class of loans, as of December 31, 2011 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
  $ 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       13,901       14,677  
     SBA loans
    -       -       -       -       476       476  
     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.
·  
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.


 
The tables below detail the Bank’s loans by class according to their credit quality indictors discussed above.

Classified Loans by Class
                                         
(In 000's)
  September 30, 2012  
   
Good/
Excellent
   
Satisfactory
   
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Total
 
                                           
                                           
         
 
               
 
             
Commercial and industrial:
                                         
    Commercial
  $ 250     $ 87     $ 758     $ 19     $ 85     $ 393     $ 1,592  
    SBA loans
    -       30       -       48       49       -       127  
    Asset-based
    -       1,897       125       53       99       -       2,174  
      250       2,014       883       120       233       393       3,893  
Commercial real estate:
                                                       
    Commercial mortgages
    -       12,266       749       -       1,083       317       14,415  
     SBA Loans
    -       628       -       -       -       -       628  
    Construction
    -       1,899       -       -       631       -       2,530  
    Religious organizations
    -       8,746       3,269       164       387       -       12,566  
      -       23,539       4,018       164       2,101       317       30,139  
                                                         
Total commercial loans
  $ 250     $ 25,553     $ 4,901     $ 284     $ 2,334     $ 710     $ 34,032  
                                                         
 
    September 30, 2012
   
Residential Mortgage and Consumer Loans- Performing/Nonperforming
    Performing  
Nonperforming
   
Total
 
 
           
Consumer Real Estate:
           
     Home equity
  $ 1,405     $ 64     $ 1,469  
     Home equity line of credit
    26       -       26  
     1-4 family residential mortgages
    3,084       227       3,311  
      4,515       291       4,806  
                         
Consumer Other:
                       
     Consumer Installment
    38       -       38  
     Student loans
    1,630       -       1,630  
     Other
    167       -       167  
      1,835       -       1,835  
                         
Total  consumer loans
    6,350     $ 291     $ 6,641  
                         
Total loans
                      $                             40,673


 

(In 000's)
             
December 31, 2011
                   
   
Good/ Excellent
   
Satisfactory
   
Pass
   
Special Mention
   
Substandard
   
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 and 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 nine months ended September 30, 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.
 


 
Impaired loans as of September 30, 2012 are set forth in the following table.
 

(In 000's)
 
Unpaid Contractual
   
Recorded
Investment
   
Recorded
Investment
       
   
Principal
   
With No
   
With
   
Related
 
   
Balance
   
Allowance
   
Allowance
   
Allowance
 
                         
Commercial and industrial:
       
 
             
  Commercial
  $ 478     $ 23     $ 455     $ 355  
   SBA  loans
    49       -       49       49  
   Asset-based
    99       -       99       99  
     Total Commercial and industrial
    626       23       603       503  
                                 
Commercial real estate:
                               
   Commercial mortgages
    733       733       -       -  
   Religious Organizations
    387       387       -       -  
     Total Commercial real estate
    1,120       1,120       -       -  
                                 
         Total Loans
  $ 1,746     $ 1,143     $ 603     $ 503  

 
Impaired loans as of December 31, 2011 are set forth in the following table.
 

(In 000's)
 
Unpaid Contractual
   
Recorded Investment
   
Recorded Investment
       
   
Principal
   
With No
   
With
   
Related
 
   
Balance
   
Allowance
   
Allowance
   
Allowance
 
                         
Commercial and industrial:
       
 
             
     Commercial
  $ 491     $ 78     $ 413     $ 246  
     Asset-based
    101       -       101       62  
       Total Commercial and industrial
    592       78       514       308  
                                 
Commercial real estate:
                               
     Commercial mortgages
    677       677       -       -  
     SBA  Loans
    -       -       -       -  
     Religious Organizations
    407       407       -       -  
         Total Commercial real estate
    1,095       1,095       -       -  
                                 
         Total Loans
  $ 1,687     $ 1,173     $ 514     $ 308  




 
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. The following tables present additional information about impaired loans for the three and six months ended September 30, 2012 and 2011.

         
Nine Months Ended
         
Nine Months Ended
 
(In 000's)
 
 
   
September 30, 2012
   
 
   
September 30, 2011
 
   
Average
   
Interest recognized
   
Average
   
Interest recognized
 
   
Recorded
   
on impaired
   
Recorded
   
on impaired
 
   
Investment
   
loans
   
Investment
   
loans
 
                         
Commercial and industrial:
                       
     Commercial
  $ 503     $ 1     $ 479     $ -  
     SBA  loans
    -       2       18       -  
     Asset-based
    125       -       45       -  
        Total Commercial and industrial
    628       3       542       -  
                                 
Commercial real estate:
                               
     Commercial mortgages
    673       -       846       -  
     SBA  Loans
    -       -       58       -  
     Religious Organizations
    400       -       439       3  
         Total Commercial real estate
    1,073       -       1,343       3  
                                 
         Total Loans
  $ 1,701     $ 3     $ 1,885     $ 3  
                                 

         
Three Months Ended
         
Three Months Ended
 
(In 000's)
 
 
   
September 30, 2012
   
 
   
September 30, 2011
 
   
Average
   
Interest recognized
   
Average
   
Interest recognized
 
   
Recorded
   
on impaired
   
Recorded
   
on impaired
 
   
Investment
   
loans
   
Investment
   
loans
 
                         
Commercial and industrial:
                       
     Commercial
  $ 500     $ 1     $ 470     $ -  
     SBA  loans
    -       1       18       -  
     Asset-based
    120       -       40       -  
        Total Commercial and industrial
    620       2       528       -  
                                 
Commercial real estate:
                               
     Commercial mortgages
    670       -       835       -  
     SBA loans
    -       -       58       -  
     Religious Organizations
    390       -       436       -  
         Total Commercial real estate
    1,060       -       1,329       -  
                                 
         Total Loans
  $ 1,680     $ 2     $ 1,857     $ -  
                                 
 
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 September 30, 2012 and December 31, 2011.
 
 
 
 
6.  Other Real Estate Owned
 

Period-end other real estate owned was as follows:
             
(in 000's)
 
Nine Months Ended
   
Nine Months Ended
 
   
September 30, 2012
   
December 31, 2011
 
             
Beginning balance
  $ 1,284     $ 1,417  
Additions, transfers from loans
    75       602  
Sale of other real estate (book value)
    (28 )     (734 )
      1,331       1,285  
Less: write-downs
    (154 )     (1 )
Ending Balance
  $ 1,177     $ 1,284  
 
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.
 
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 balance sheets 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 September 30, 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
 
  $   959     $   -     $   959     $    -  
Money Market Funds
 
    129       129        -    
 -
 
 
     Total
  $ 1,088     $ 129     $ 959     $ -  
 

(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 $1,088,000 and $1,281,000 at September 30, 2012 and December 31, 2011, respectively.  Approximately 88% of the portfolio consisted of residential mortgage-backed securities, which had a fair value of $959,000 at September 30, 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 September 30, 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 September 30, 2012 and year ended December 31, 2011.
 
 
 
Fair Value on a Nonrecurring Basis
 
Certain assets are not measured at fair value on a recurring 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 balance sheet of condition by level within the hierarchy as of September 30, 2012 and December 31, 2011, for which a nonrecurring change in fair value has been recorded during the nine months ended September 30, 2012 and year ended 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 9 months ended
September 30, 2012
 
Impaired loans
 
  $ 100       -       -     $ 100     $ (195 )
Other real estate owned (“OREO”)
  $ 1,177       -       -     $ 1,177     $ (139 )
Assets held for sale        357       -       -       800       443  
 
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       -  
 
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 September 30, 2012 was approximately $503,000.  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.
 
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 fair value for nonperforming/impaired loans is determined by using discounted cashflow analysis or underlying collateral values, where applicable.
 
Assets held for sale:  The fair value is determined by using a current appraisal.
 
Accrued interest receivable:  The carrying amount of accrued interest receivable approximates fair value.
 
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.
 
The fair value of assets and liabilities are depicted below:
 
           September 30, 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
    $ 11,703     $ 11,703     $ 14,497     $ 14,497  
Available for sale securities
    (1 )     1,088       1,088       1,281       1,281  
Held to maturity securities
 
Level 2
      12,399       13,074       17,209       17,738  
Loans, net of allowance for loan losses
    (2 )     39,805       40,262       40,635       40,552  
Assets held for sale   Level 3       357       800       -       -  
Accrued interest receivable
 
Level 2
      325       325       342       342  
Liabilities:
                                       
Demand deposits
 
Level 2
      31,874       31,874       31,260       31,260  
Savings deposits
 
Level 2
      14,167       14,167       14,689       14,689  
Time deposits
 
Level 2
      17,181       17,544       25,352       25,401  
Accrued interest payable
 
Level 2
      27       27       58       58  
(1) Level 1 for money market funds; Level 2 for all other securities.
(2) Level 2 for non-impaired loans; Level 3 for impaired loans.



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 improved with 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;
A management assessment was completed in June 2012 in conjunction with the required management review and written management plan with benchmarks for recommended enhancements.
   
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 was received and approved by the Bank’s regulators.  Upon acceptance, the review commenced in May 2012 and was completed in June 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 plan was prepared and submitted to regulators for review together with a revised Strategic Plan in May 2012 following the completion of a regulatory review.
   
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 May 2012 following the completion of a regulatory review.
   
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 May 2012 following the completion of a regulatory review.
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 May 2012 following the completion of a regulatory review.
 
 
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 and submitted to regulators for review in April 2012.
   


 

Requirement
Status
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 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 and one inside director 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.
Quarterly reports were prepared and submitted in May 2012 and August 2012, as required.

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 September 30, 2012 and December 31, 2011, the Bank’s tier one leverage capital ratio was 6.06% and 6.27%, respectively, and its total risk based capital ratio was 11.20% and 12.41%, respectively. Although in excess of “well capitalized” levels, these ratios have declined as a result of losses and are below the levels required by the Orders. Management has developed and submitted a Capital Plan that focuses on curtailing losses to stop the erosion of capital and increase capital from internal strategies, including the following:

·  
Asset Reduction-- During 2012, the Bank’s deposits declined by more than $8 million. This reduction served to de-leverage the balance sheet while still maintaining adequate levels of liquidity.
 
·  
Gain on sale of real estate -- The Bank owns real estate that it is actively seeking to sell for a gain.  An agreement of sale is pending.  At a minimum, the gain is projected to be $600,000.
 

As a result of the above actions, 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.





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 the Company 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 the Company assumes no obligation to update any forward-looking statement.
 


Overview
 
The Company reported a net loss of approximately $407,000 ($0.38 per common share) for the quarter ended September 30, 2012 compared to a net loss of approximately $281,000 ($0.26 per common share) for the quarter ended September 30, 2011. The Company reported a net loss of approximately $882,000 ($0.83 per common share) for the nine months ended September 30, 2012 compared to a net loss of approximately $758,000 ($0.71 per common share) for the nine months ended September 30, 2011.  The results for 2012 include approximately $128,000 and $153,000 other real estate valuation allowance for the quarter and nine months ended September 30, 2012, respectively, as a result of declines in market value.  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 is understood.  Therefore, a concentrated effort will continue to be made to stabilize and strengthen the Bank’s capital through moderation of asset growth, 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.  In July 2012, the Bank applied for a grant totaling $279,000 from the CDFI Bank Enterprise Award Fund (“BEA”).  Although notification of award was initially expected by September 30, 2012, it was delayed by the CDFI Fund and is now projected to be announced by November 30, 2012.
 
Manage asset quality to minimize credit losses and reduce collection costs.  Asset quality trends waivered somewhat during the quarter ended September 30, 2012 with an increase in delinquencies and classified loans.  Management has intensified its collection efforts to combat further deterioration in credit quality.  In addition, the Classified Asset Reduction Plan it developed in conjunction with the Bank’s regulatory orders is being utilized in an attempt to improve asset quality trends.  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 restructured the Bank’s lending function by exiting consumer lending products and shifting its resources to focus on small business lending in order to reduce costs and increase efficiencies.  While management continues to grow its small business lending pipeline, competitive pressure from money center banks in the region has escalated that have resulted increased payoff activity.  Focused attention will be placed on SBA lending to mitigate credit risk, enhance interest income, and increase noninterest income from potential gains on the sale of the guaranteed portion of these loans.
 
Although some improvement has been made for the nine months ended September 30, 2012 compared to the same period in 2011, the Bank’s noninterest expense continues to be elevated as a result of significant cost related to its other real estate portfolio including valuation allowances for declines in market value and other carrying costs.  Also, unlike other similar-sized community banks, the Bank continues to incur a high level of professional service fees (consulting, audit and legal) to comply with the Consent orders and of its SEC filing requirements as a result of having in excess of 1,200 shareholders.  During 2012, management successfully reduced data processing cost by re-negotiating its core processing contract, however, further savings and efficiencies will be sought, where possible, including the following:

·  
Branch sale/closure in line with the Capital Plan to reduce occupancy expense
·  
Staff reductions. Review job functions and staffing levels to ensure the most efficient organizational structure
·  
Sale and/or other disposition of Other Real Estate properties to reduce carrying costs (may result in a temporary increase in expenses based on real estate market conditions)
·  
Review and revision of the Bank’s customer service fees to maximize income
 
 
 


 
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
September 30, 2012
   
 
 
Quarter ended
September 30, 2011
   
 
Nine months ended
September 30, 2012
   
 
Nine months ended
September 30, 2011
 
Statement of operations information:
                       
Net interest income
  $ 736     $ 819     $ 2,241     $ 2,273  
Provision for loan losses
    61       30       121       100  
Noninterest income
    260       199       733       812  
Noninterest expense
    1,342       1,208       3,735       3,743  
Net loss
    (407 )     (281 )     (882 )     (758 )
Net loss per share-basic and diluted
    (0.38 )     (0.26 )     (0.83 )     (0.71 )
                                 
Balance Sheet information:
 
September 30, 2012
   
December 31, 2011
                 
Total assets
  $ 67,931     $ 77,017                  
Loans, net
  $ 39,805     $ 40,635                  
Investment securities
  $ 13,486     $ 18,490                  
Deposits
  $ 63,222     $ 71,300                  
Shareholders' equity
  $ 4,378     $ 5,261                  
                                 
Ratios*:
 
Quarter ended
September 30, 2012
   
Quarter ended
September 30, 2011
                 
Return on assets
    (2.40 %)     (1.47 %)                
Return on equity
    (37.21 %)     (20.26 %)                
*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 $954,000, or 1.46% during the quarter ended September 30, 2012 compared to the quarter ended June 30, 2012. Average funding sources decreased approximately $931,000, or 1.44%, during the quarter ended September 30, 2012 compared to the quarter ended June 30, 2012.
 



 
 
Sources and Uses of Funds Trends
(Thousands of Dollars, except
percentages)
 
September 30, 2012
               
June 30, 2012
 
 
 
Average
   
Increase (Decrease)
   
Increase (Decrease)
   
Average
 
   
Balance
   
Amount
   
%
   
Balance
 
Funding uses:
                       
Loans
  $ 42,012     $ (343 )     (0.81 )%   $ 42,355  
Investment securities
                               
Held-to-maturity
    12,628       (2,397 )     (15.95 )     15,025  
Available-for-sale
    1,083       (59 )     (5.17 )     1,142  
Federal funds sold
    8,544       1,844       27.52       6,700  
Balances with other banks
    306       1       0.33       305  
Total  uses
  $ 64,573     $ (954 )     (1.46 )%   $ 65,527  
Funding sources:
                               
Demand deposits
                               
Noninterest-bearing
  $ 15,845     $ 523       3.41     $ 15,322  
Interest-bearing
    16,236       292       1.83       15,944  
Savings deposits
    14,152       (125 )     (0.88 )     14,277  
Time deposits
    17,320       (1,621 )     (8.56 )     18,941  
Total sources
  $ 63,553     $ (931 )     (1.44 )   $ 64,484  
 
Loans
Average loans decreased by approximately $343,000, or 0.81%, during the quarter ended September 30, 2012. While the Bank funded more than $1.6 million in loans during the quarter, commercial loan payoffs escalated as a result of increased market competition from money center banks in the region for quality performing loans as well as take-out financing on several construction loans and the sale of the guaranteed portion of an SBA loan.  In addition, the consumer portfolio continues to decline because of 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 made a strategic shift in its lending program in 2012 to phase out consumer lending, including home equity loans and lines of credit.

Management adopted a business banking focus that incorporates strategies to increase the Bank’s small business 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.  In June 2012, the Bank originated one SBA loan totaling $750,000.  A gain of approximately $69,000 was recognized on the sale of the guaranteed portion of this loan in August 2012.  Focused and aggressive business development efforts targeting small businesses are being 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 will be 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 $30.1 million, or 74.1%, of total loans at September 30, 2012 of which approximately $15.5 million are owner occupied.  The Bank continues to have a strong niche in lending to religious organizations for which total loans at September 30, 2012 were approximately $12.6 million, or 42%, 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 net loans is as follows:



   
September 30,
   
December 31,
 
(In 000's)
 
2012
   
2011
 
             
             
Commercial and industrial:
           
     Commercial
  $ 1,592     $ 1,486  
     SBA loans
    127       235  
     Assets-based
    2,174       2,009  
        Total commercial and industrial
    3,893       3,730  
                 
Commercial real estate:
               
                 
     Commercial mortgages
    14,415       14,677  
     SBA loans
    628       476  
     Construction
    2,530       1,391  
     Religious organizations
    12,566       13,653  
         Total commercial real estate
    30,139       30,197  
                 
Consumer real estate:
               
     Home equity loans
    1,469       2,145  
     Home equity lines of credit
    26       85  
     1-4 family residential mortgages
    3,311       3,356  
         Total consumer real estate
    4,806       5,586  
                 
Total real estate
    34,945       35,783  
                 
Consumer and other:
               
     Consumer installment
    38       58  
     Student loans
    1,630       1,761  
     Other
    167       170  
         Total consumer and other
    1,835       1,989  
                 
         Loans, net
  $ 40,673     $ 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 Bank utilizes an eight rolling quarter historical loss factor as management believes this best represents the current trends and market conditions.  The allowance for loan losses as a percentage of total loans was 2.14% at September 30, 2012 and 2.09% at December 31, 2011.  During the nine months ended September 30, 2012, provisions for loan losses totaled $121,000.  Net charge-offs during the period totaled approximately $119,000 and were primarily related to several home equity loans for which there was insufficient equity to support repayment and one commercial and industrial loan for which related receivable collateral became impaired.

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 $1,746,000 at September 30, 2012 compared to $1,687,000 at December 31, 2011. The increase is related to one commercial and industrial loan totaling approximately $89,000 that was added during the period. The valuation allowance associated with impaired loans was approximately $503,000 and $308,000, at September 30, 2012 and December 31, 2011, respectively. The increase is primarily related to one loan for which the underlying collateral declined in value.  Management is aggressively working to reduce the level of classified and impaired loans. Forbearance, foreclosure and/or other appropriate collection methods will be used as necessary.

At September 30, 2012 and December 31, 2011, loans to religious organizations represented approximately $384,000 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 increased from 40.67% at December 31, 2011 to 43.71% at September 30, 2012 primarily as a result of additional provisions for loan losses.  Loans more than 90 days past due that are still in the process of collection for which the full payment of principal and interest can reasonably be expected are not considered nonperforming.  The following table sets forth information concerning nonperforming loans and nonperforming assets.

(In 000's)
 
September 30,
2012
   
December 31,
 2011
 
Commercial and industrial:
           
     Commercial
  $ 479     $ 491  
     SBA loans
    -       -  
     Asset-based
    99       101  
        Total Commercial and industrial
    578       491  
                 
Commercial real estate:
               
     Commercial mortgages
    732       677  
     SBA loans
    -       -  
     Religious organizations
    387       418  
         Total Commercial real estate
    1,119       1,095  
                 
Consumer real estate:
               
     Home equity loans
    64       106  
     Home equity lines of credit
    -       38  
     1-4 family residential mortgages
    227       301  
         Total consumer real estate
    291       445  
                 
Total real estate
    1,410       1,540  
                 
Consumer and other:
               
     Consumer installment
    -       -  
     Student loans
    -       -  
     Other
    -       -  
         Total consumer and other
    -       -  
                 
         Total nonperforming loans
  $ 1,988     $ 2,132  
         Other real estate owned
    1,177       1,284  
         Total nonperforming assets
  $ 3,165     $ 3,416  
                 
Nonperforming loans to total loans
    4.89 %     5.14 %
Nonperforming assets to total loans and other real estate owned
    7.56 %     7.98 %
Nonperforming assets to total assets
    4.66 %     4.44 %
                 
Allowance for loan losses as a percentage of:
               
     Total Loans
    2.14 %     2.09 %
     Total nonperforming loans
    43.61 %     40.67 %



 
The following table sets forth information related to loans past due 90 days or more and still accruing interest.
(In 000's)
 
September 30,
2012
   
December 31,
 2011
 
   
 
   
 
 
Commercial and industrial
  $ -     $ -  
   Commercial     340       -  
     Total commercial and industrial     340       -  
Commercial real estate:
               
     Religious organizations
    -       173  
         Total Commercial real estate
    -       173  
                 
Consumer real estate:
               
     Home equity loans
    188       152  
         Total consumer real estate
    188       152  
                 
Total real estate
    188       325  
                 
Consumer and other:
               
     Student loans
    108       146  
         Total consumer and other
    108       146  
                 
         Total
  $ 636     $ 471  
                 
 

Investment Securities and Other Short-term Investments
Average investment securities decreased by approximately $2,456,000, or 15.19%, during the quarter ended September 30, 2012. The decrease was primarily related to the calls of higher yielding securities in the current low interest rate environment.
 
The yield on the investment portfolio declined to 3.06% at September 30, 2012 compared to 3.36% at December 31, 2011 as a result of the call activity during the period.  The duration of the portfolio has extended to 3.2 years at September 30, 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 enterprises (GSE) mortgage-backed pass-through securities that serve to generate monthly cash flow.   The payments of principal and interest on these pools of GSE 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. During the quarter ended September 30, 2012, a strategic shift in portfolio allocation was made to allow up to 75% amortizing GSE mortgage-backed securities. 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 September 30, 2012, average deposits decreased approximately $931,000, or 1.44%, concentrated in the category of time deposits.  The publication of the Bank’s Consent Orders in 2012 negatively impacted the Bank’s existing depository relationships with governmental entities resulting in unplanned time deposit redemptions totaling $8 million during the six months ended June 30, 2012, $6 million. As a result, time deposits decreased on average by approximately $1,621,000, or 8.56%, during the quarter ended September 30, 2012. The Bank has approximately $6.0 million governmental or quasi-governmental certificate of deposit relationships remaining.  Management is proactively communicating with agency officials to avoid further reduction in account balances.  No significant reductions are anticipated.
 
There was an increase in average noninterest bearing demand deposits totaling approximately $523,000, or 3.41%, and an increase in average interest-bearing demand deposits totaling $292,000, or 1.83%, during the quarter primarily related to one significant depository relationship for which the balances increased in conjunction with contract funding it received.  These deposits are expected to fluctuate widely based on required payment activity related to projects completed by this customer.
 
 



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:
 
 
   
September 30,
2012
   
December 31,
2011
 
Commitments to extend credit
  $ 11,221,000     $ 9,163,000  
Standby letters of credit
    1,163,000       1,208,000  

The level of commitments at September 30, 2012 increased as a result of the approval of several construction loans/lines of credit including one significant SBA qualified loan totaling more than $2 million.  More than $4 million of the Bank’s the 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.

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 September 30, 2012, the Bank had total short-term liquidity, including cash and federal funds sold, of approximately $11.7 million, or 17.23% of total assets, compared to $14.5 million, or 18.82%, at December 31, 2011. Increased loan payoffs and called investment securities have served to increase liquidity.  Excess liquidity will be redeployed in the funding of approved but unfunded loan commitments.
 
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 2012 resulted in the release of approximately $8 million of pledged collateral.

Other types of assets such as federal funds sold, as well as maturing loans, are also sources of liquidity.  Approximately $9.9 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 non-public deposits from existing private sector customers; specifically, additional deposits from members of the National Bankers Association ("NBA") will be considered a potential source.
·  
Sell participations of existing commercial credits to other financial institutions in the region and/or NBA member banks based on 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 September 30, 2012, a positive gap position is maintained on a cumulative basis through 1 year of 13.21% that is within the Bank’s policy guidelines of +/- 15% on a cumulative 1-year basis and represents a slight increase from the June 30, 2012 positive gap position of 13.09%. This increase resulted from increased loan payoffs and called investment securities for which funds were placed in Federal Funds Sold.  This position makes the Bank’s net interest income more favorable in a rising interest rate environment. The most recent economic forecast suggests no further decline in rates but rather increases beginning in 2014. Therefore, management does not believe the interest rate risk associated with the Bank’s current position to be significant.  Management will continue review and monitor the structure and rates on investment purchases, new loan originations and renewals to manage the interest rate risk profile within acceptable limits.

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 September 30, 2012, the change in the market value of equity in a +200 basis point interest rate change is -6.2%, within the Bank’s policy limit of 25%, and -23.0 % 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 September 30, 2012.

Capital Resources
Total shareholders' equity decreased approximately $882,000 compared to December 31, 2011 as a result of the net loss during the nine months ended September 30, 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, including the generation of retained earnings and managing asset growth, before seeking external capital investment as follows:
 
·  
Asset Reduction--While not intentionally sought, during 2012, the Bank’s deposits declined by more than $8 million as a result of the early redemption of several governmental and quasi-governmental time deposits and other deposit account balance reductions.  This decline served to de-leverage the Bank’s balance sheet while still maintaining adequate levels of liquidity.
 
·  
Gains on sale of real estate  An agreement of sale for the Bank’s Lancaster Avenue branch is expected to be reached prior to year-end 2012 for which a gain of at least $600,000 is projected to be realized.
 
 
 
 
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 July 2012, the Bank applied for a BEA grant totaling approximately $279,000 based on its qualified lending activity.  Notification of award is now expected to be received by November 30, 2012.
 
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
 
September 30, 2012
 
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
Total capital to risk-weighted assets:
                                   
     Consolidated
  $ 4,673       11.19 %   $ 3,338       8.00 %     N/A    
 
 
     Bank
    4,673       11.19 %     3,338       8.00 %   $ 4,173       10.00 %
Tier I capital to risk-weighted assets:
                                               
     Consolidated
    4,147       9.93 %     1,669       4.00 %     N/A          
     Bank
    4,147       9.93 %     1,669       4.00 %   $ 2,504       6.00 %
Tier I capital to average assets:
                                               
     Consolidated
    4,147       6.06 %     2,738       4.00 %     N/A          
      Bank
    4,147       6.06 %     2,738       4.00 %   $ 3,422       5.00 %
 
                                                                                                       
   (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 $407,000 ($0.38 per common share) for the quarter ended September 30, 2012 compared to a net loss of approximately $281,000 ($0.26 per common share) for the same quarter in 2011.    September 30, 2012.   The Company reported a net loss of approximately $882,000 ($0.83 per common share) for the nine months ended September 30, 2012 compared to a net loss of approximately $758,000 ($0.71 per common share) for the same period in 2011. .  The results for 2012 include approximately a $128,000 and $153,000 other real estate valuation allowance for the quarter and nine months ended September 30, 2012, respectively as a result of a decline in market value.   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
September 30, 2012
               
Three months ended
September 30, 2011
       
(in 000’s)
 
Average Balance
   
Interest
   
Yield/Rate
   
Average Balance
   
Interest
   
Yield/Rate
 
                                     
Assets:
                                   
Interest-earning assets:
                                   
     Loans
  $ 42,012     $ 666       6.35 %   $ 41,569       655       6.30 %
     Investment securities-HTM
    12,628       89       2.82       18,446       147       3.19  
     Investments securities-AFS
    1,083       8       2.95       1,273       10       3.14  
     Federal funds sold
    8,544       4       0.19       12,438       6       0.19  
     Interest bearing balances with other banks
    306       1       1.31       305       1       1.31  
        Total interest-earning assets
    64,573       768       4.75       74,031       819       4.43  
Interest-bearing liabilities
                                               
     Demand deposits
    16,236       12       0.30       18,147       20       0.44  
     Savings deposits
    14,152       2       0.06       14,113       3       0.09  
     Time deposits
    17,320       18       0.42       26,171       37       0.57  
          Total interest-bearing liabilities
    47,708       32       0.26       58,431       60       0.41  
Net interest income
          $ 736                     $ 759          
Net yield on interest-earning assets
                    4.56 %                     4.02 %
 
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.
 
         
Nine months ended
September 30, 2012
               
Nine months ended
September 30, 2011
       
(in 000’s)
 
Average Balance
   
Interest
   
Yield/Rate
   
Average Balance
   
Interest
   
Yield/Rate
 
                                     
Assets:
                                   
Interest-earning assets:
                                   
     Loans
  $ 41,964     $ 1,986       6.31 %   $ 42,306     $ 1,974       6.22 %
     Investment securities-HTM
    15,057       323       2.86       16,943       438       3.45  
     Investments securities-AFS
    1,144       26       3.15       1,232       30       3.25  
     Federal funds sold
    8,789       13       0.20       10,565       13       0.16  
     Interest bearing balances with other banks
    305       1       0.44       305       1       0.44  
        Total interest-earning assets
    67,259       2,349       4.66       71,351       2,456       4.59  
Interest-bearing liabilities
                                               
     Demand deposits
    16,359       37       0.30       15,441       58       0.50  
     Savings deposits
    14,477       5       0.05       14,069       9       0.09  
     Time deposits
    21,660       66       0.41       26,130       116       0.59  
          Total interest-bearing liabilities
    52,496       108       0.27       55,640       183       0.44  
Net interest income
          $ 2,241                     $ 2,273          
Net yield on interest-earning assets
                    4.44 %                     4.15 %
 
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 $23,000, or 2.93%, for the quarter ended September 30, 2012 compared to the quarter ended September 30, 2011 and declined approximately $32,000, or 1.42%, for the nine months ended September 30, 2012 compared to the same period in 2011. However, the net yield on interest-earning assets improved compared to 2011 primarily as a result of a reduction in the cost of funds because of rate reductions made on the Bank’s deposit products to follow market conditions. Also, the early redemption of approximately $8 million in jumbo certificates of deposit in 2012 served to reduce the Bank’s cost of funds as well as the level of investment in lower yielding Federal Funds Sold; thereby, boosting the net yield.


 
Rate-Volume Analysis of Changes in Net Interest Income
 
   
Three months ended September 30, 2012 compared to 2011
   
Nine months ended September 30, 2012 compared to 2011
 
   
Increase (decrease) due to
   
Increase (decrease) due to
 
(Dollars in thousands)
 
Volume
   
Rate
   
Net
   
Volume
   
Rate
   
Net
 
Interest earned on:
                                   
Loans
  $ 7     $ 5     $ 12     $ (16 )   $ 28     $ 12  
Investment securities held-to-maturity
    (50 )     (9 )     (59 )     (52 )     (63 )     (115 )
Investment securities available-for-sale
    (1 )     (1 )     (2 )     (2 )     (1 )     (3 )
Interest-bearing deposits with other banks
    -       -       -       -       -       -  
    Federal funds sold
    (2 )     (- )     (2 )     (2 )     2       2  
Total Interest-earning assets
    (46 )     (5 )     (51 )     (72 )     (34 )     (106 )
Interest paid on:
                                               
Demand deposits
    (2 )     (6 )     (8 )     3       (24 )     (21 )
Savings deposits
    -       (1 )     (1 )     -       (4 )     (4 )
Time deposits
    (11 )     (8 )     (19 )     (18 )     (31 )     (49 )
Total interest-bearing liabilities
    (13 )     (15 )     (28 )     (15 )     (59 )     (74 )
Net interest income
  $ (33 )   $ 10     $ (23 )   $ (57 )   $ 25     $ (32 )
 
For the quarter ended September 30, 2012 compared to the same period in 2011, there was a decrease in net interest income of approximately $33,000 due to changes in volume and an increase of approximately $10,000 due to changes in rate.  For the nine months ended September 30, 2012 compared to the same period in 2011, there was a decrease in net interest income of approximately $57,000 due to changes in volume and an increase of approximately $25,000 due to changes in rate.
 
Average earning assets decreased compared to the same period in 2011; however, both the increase in the yield on loans as well as the reduction in lower yielding federal funds sold minimized the negative impact on the Bank’s net interest income.   Management’s focus continues to be on building loan volume to enhance net interest income.

Provision for Loan Losses
The provision for loan losses was $61,000 for the quarter ended September 30, 2012 compared to $30,000 for the same quarter in 2011. The provision for loan losses was $121,000 for the nine months ended September 30, 2012 compared to $100,000 for the same period in 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. (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 increased approximately $61,000, or 30.69%, for the quarter ended September 30, 2012 compared to the same quarter in 2011. The results for the quarter in 2012 include a net gain of approximately $69,000 on the sale of the guaranteed portion of a SBA loan. Noninterest income declined approximately $79,000, or 9.71%, for the nine months ended September 30, 2012 compared to the same period in 2011.    The results for 2011 include a non-recurring net gain on the sale of other real estate owned of approximately $111,000.

While customer service fees improved by approximately $10,000, or 10.84%, they were offset by a decline in ATM fees of approximately $11,000, or 12.41%, for the quarter ended September 30, 2012 compared to 2011.  ATM fees declined $27,000, or 10.18%, for the nine months ended September 30, 2012 compared to the same period in 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 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 is in the process of being implemented as ATM hardware upgrades are made to meet American Disabilities Act requirements during 2012.

Noninterest Expense
Salaries and benefits decreased approximately $31,000, or 7.49%, for the quarter ended September 30, 2012 compared to 2011 and declined approximately $70,000, or 5.54%, for the nine months ended September 30, 2012 compared to the same period in 2011.  The reduction resulted from the severance of several unproductive personnel in the lending/credit administration area of the Bank as well as 2012 branch staff attrition. In conjunction with a review required by the Consent Orders, management is reviewing the organizational structure to maximize efficiencies, increase utilization/productivity and increase business development activity.
 
 

 
Occupancy and equipment expense decreased approximately $12,000, or 4.34%, for the quarter ended September 30, 2012 compared to 2011 and decreased approximately $19,000, or 2.31%, for the nine months ended September 30, 2012 compared to the same period in 2011. The reduction is a result of lower depreciation expense related to fully depreciated equipment.

Marketing and public relations expense decreased approximately $9,000, or 63.80%, for the quarter ended September 30, 2012 compared to 2011 and decreased approximately $44,000, or 60.58%, for the nine months ended September 30, 2012 compared to the same period in 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 have been utilized to reduce expenses.

Professional services expense increased approximately $48,000, or 85.56%, for the quarter ended September 30, 2012 compared to 2011 and increased approximately $57,000, or 28.62%, for the nine months ended September 30, 2012 compared to the same period in 2011.  The increase is related to legal and consulting expenses incurred in conjunction with the Bank’s Consent Orders.
 
Data processing expenses decreased approximately $3,000, or 2.85%, for the quarter ended September 30, 2012 compared to 2011 and decreased approximately $16,000, or 4.29%, for the nine months ended September 30, 2012 compared to the same period in 2011.  In May 2012, management successfully negotiated a reduction in its core processing cost in conjunction with contract renewal.  Further reductions will be sought in processing costs associated with other vendors.
 
Federal deposit insurance assessments increased approximately $2,000, or 5.36%, for the quarter ended September 30, 2012 compared to 2011 but decreased approximately $55,000, or 43.65%, for the nine months ended September 30, 2012 compared to the same period in 2012.  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 will result in an annual increase of approximately $60,000.
 
During the quarter and nine months ended September 30, 2012, a valuation allowance of approximately $127,000 and $153,000, respectively, was recorded on the Bank’s other real estate portfolio because of market value declines.  Approximately, $123,000 of the valuation decline relates to one property for which the bank has entered an agreement of sale.  The valuation allowance for the nine months ended September 30, 2011 totaled approximately $4,000.
 
Loan and collection expenses increased approximately $15,000, or 42.75%, for the quarter ended September 30, 2012 compared to 2011 and increased approximately $5,000, or 3.60%, for the nine months ended September 30, 2012 compared to the same period in 2011. The increase is directly related to expenses associated with other real estate owned including insurance, taxes, utilities, and annual re-appraisal fees.
 
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.
 
 
 

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.
 
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.
 
 
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 September 30, 2012, the Bank’s tier one leverage capital ratio was 6.06% and its total risk based capital ratio was 11.19%.  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.
 
None
 
Item 5.  Other Information.
 
None


 
 
a)           Exhibits.
 
Exhibit 31.1 Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
Exhibit 31.2 Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
Exhibit 32.1 Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
Exhibit 32.2 Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


 
 
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:  November 14, 2012
/s/ Evelyn F. Smalls
 
Evelyn F. Smalls
 
President & Chief Executive Officer
   
   
Date: November 14, 2012
/s/ Brenda M. Hudson-Nelson
 
Brenda Hudson-Nelson
 
Executive Vice President/Chief Financial Officer


 

 
Index to Exhibits-FORM 10-Q
 

Exhibit 31.1
Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2
Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1
Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.2
Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 
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