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EX-31.1 - EXHIBIT 31.1 - UNITED BANCSHARES INC /PAex311.htm
EX-10.1 - EXHIBIT 10.1 - UNITED BANCSHARES INC /PAex101.htm
EX-32.2 - EXHIBIT 32.2 - UNITED BANCSHARES INC /PAex322.htm
EX-32.1 - EXHIBIT 32.1 - UNITED BANCSHARES INC /PAex321.htm
EX-31.2 - EXHIBIT 31.2 - UNITED BANCSHARES INC /PAex312.htm



SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.
FORM 10-Q
 
(Mark One)
 
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2013 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 __X__ 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__
 
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:

 
1

 

 
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 August 1, 2013, 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 August 1, 2013.


 
2

 

 
 
 
Index
 


 
UNITED BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
Assets:
 
June 30,
 2013
   
December 31,
2012
 
Cash and due from banks
  $ 2,538,365     $ 2,363,166  
Interest-bearing deposits with banks
    306,431       306,033  
Federal funds sold
    6,432,000       7,567,000  
   Cash and cash equivalents
    9,276,796       10,236,199  
                 
Investment securities:
               
Available-for-sale, at fair value
    9,370,323       1,027,293  
Held-to-maturity, at amortized cost (fair value of $12,485,687
               
   at December 31, 2012)
    -       11,895,037  
                 
 Loans, net of unearned discounts and deferred fees
    41,853,357       41,501,555  
Less allowance for loan losses
    (778,556 )     (1,203,942 )
   Net loans
    41,074,801       40,297,613  
 
Bank premises and equipment, net
    653,731       562,729  
Accrued interest receivable
    277,108       309,971  
Other real estate owned
    526,537       775,407  
Intangible assets
    46,694       135,733  
Prepaid expenses and other assets
    372,899       375,524  
   Total assets
  $ 61,598,889     $ 65,615,506  
 
Liabilities and Shareholders’ Equity
               
 
Liabilities:
               
Demand deposits, noninterest-bearing
  $ 15,214,822     $ 14,324,970  
Demand deposits, interest-bearing
    13,002,758       15,526,344  
Savings deposits
    13,202,666       14,239,216  
Time deposits, under $100,000
    6,962,001       7,243,593  
Time deposits, $100,000 and over
    9,184,858       9,642,620  
   Total deposits
    57,567,105       60,976,743  
 
Accrued interest payable
    15,574       30,500  
Accrued expenses and other liabilities
    241,261       368,278  
   Total liabilities
    57,823,940       61,375,521  
                 
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
    (10,798,888 )     (10,556,078 )
Accumulated other comprehensive (loss) income
    (188,069 )     34,157  
   Total shareholders’ equity
    3,774,949       4,239,985  
   Total liabilities and shareholders’ equity
  $ 61,598,889     $ 65,615,506  

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
June 30, 2013
   
Three Months ended
June 30, 2012
   
Six
Months ended
June 30, 2013
   
Six
Months ended
June 30, 2012
 
Interest income:
                       
   Interest and fees on loans
  $ 630,275     $ 660,151     $ 1,258,451     $ 1,319,842  
   Interest on investment securities
    66,721       115,283       153,339       252,472  
   Interest on federal funds sold
    3,214       3,338       7,607       8,930  
   Interest on time deposits with other banks
    173       174       404       348  
      Total interest income
    700,383       778,946       1,419,801       1,581,592  
                                 
Interest expense:
                               
   Interest on time deposits
    12,326       19,899       27,534       48,131  
   Interest on demand deposits
    6,145       12,074       14,889       25,127  
   Interest on savings deposits
    1,678       1,755       3,412       3,558  
      Total interest expense
    20,149       33,728       45,835       76,816  
      Net interest income
    680,234       745,218       1,373,966       1,504,776  
(Credit)provision for loan losses
    (55,000 )     30,000       15,137       60,000  
                                 
     Net interest income after (credit)provision for loan losses
    735,234       715,218       1,358,829       1,444,776  
                                 
Noninterest income:
                               
   Customer service fees
    101,304       95,745       201,912       192,891  
   ATM fee income
    80,508       80,992       160,157       160,771  
   Gain on sale of investment securities
    378,248       -       378,248       -  
   Loan syndication fees
    88,300       80,000       88,300       80,000  
   Loss on sale of other real estate owned
    (13,484 )     -       (13,880 )     -  
   Other income
    19,187       22,243       34,805       39,557  
      Total noninterest income
    654,063       278,980       849,542       473,219  
                                 
Noninterest expense:
                               
   Salaries, wages and employee benefits
    371,532       392,971       748,996       806,508  
   Occupancy and equipment
    264,145       265,820       508,044       540,597  
   Office operations and supplies
    76,454       75,718       154,808       150,123  
   Marketing and public relations
    18,722       18,840       34,702       23,489  
   Professional services
    77,346       78,294       148,180       151,532  
   Data processing
    103,714       111,196       224,579       238,002  
   Other real estate expense
    124,039       66,948       167,544       57,534  
   Loan and collection costs
    38,906       33,013       58,808       61,693  
   Deposit insurance assessments
    37,654       26,209       74,652       27,424  
   Other operating
    180,808       162,085       330,868       335,798  
      Total noninterest expense
    1,293,320       1,231,094       2,451,181       2,392,700  
      Net income (loss) before income taxes
    95,977       (236,896 )     (242,810 )     (474,705 )
Provision for income taxes
    -       -       -       -  
      Net income (loss)
  $ 95,977     $ (236,896 )   $ (242,810 )   $ (474,705 )
Net income (loss) per common share—basic and diluted
  $ 0.09     $ (0.22 )   $ (0.23 )   $ (0.45 )
Weighted average number of common shares
    1,065,588       1,065,588       1,065,588       1,065,588  
Comprehensive loss:
                               
 Net income (loss)
  $ 95,977     $ (236,896 )   $ (242,810 )   $ (474,705 )
 Unrealized losses on available for sale securities
    (216,085 )     (723 )     (222,226 )     (364 )
  Total comprehensive loss
  $ (120,108 )   $ (237,619 )   $ (465,036 )   $ (475,069 )
 
The accompanying notes are an integral part of these statements.


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

   
2013
   
2012
 
             
Cash flows from operating activities:
           
Net loss
  $ (242,810 )   $ (474,705 )
   Adjustments to reconcile net loss to net cash
               
       used in operating activities:
               
        Provision for loan losses
    15,137       60,000  
        Loss on sale of other real estate
    13,880       -  
        Amortization of premiums on investments
    44,346       63,512  
        Amortization of core deposit intangible
    89,039       89,039  
        Depreciation on fixed assets
    73,650       114,259  
        Gain on sale of investment securities
    (378,248 )     -  
        Write-down of other real estate owned
    142,506       26,248  
        Increase in accrued interest receivable  and
               
          other assets
    35,488       11,184  
        Decrease in accrued interest payable and
               
          other liabilities
    (141,943 )     (105,496 )
          Net cash used in operating activities
    (348,955 )     (215,959 )
                 
Cash flows from investing activities:
               
        Purchase of held-to-maturity investment securities
    -       (3,249,311 )
        Purchase of available-for-sale investment securities
    (6,972,202 )     -  
        Proceeds from sale of available-for-sale investment securities
    7,731,841       -  
        Proceeds from maturity and principal reductions of
               
          available-for-sale investment securities
    2,904,044       117,594  
        Proceeds from maturity and principal reductions of
               
          held-to-maturity investment securities
    -       7,316,585  
        Proceeds from the sale of other real estate owned
    92,484       -  
        Net increase in loans
    (792,325 )     (1,418,792 )
        Purchase of bank premises and equipment
    (164,652 )     (16,135 )
Net cash provided by investing activities
    2,799,190       2,749,941  
 
               
Cash flows from financing activities:
               
        Net decrease in deposits
    (3,409,638 )     (8,971,562 )
        Net cash used in financing activities
    (3,409,638 )     (8,971,562 )
 
       Net decrease in cash and cash equivalents
    (959,403 )     (6,437,580 )
 
Cash and cash equivalents at beginning of period
    10,236,199       14,497,329  
 
Cash and cash equivalents at end of period
  $ 9,276,796     $ 8,059,749  
 
Supplemental disclosure of cash flow information:
               
        Cash paid during the period for interest
  $ 60,761     $ 111,552  
        Noncash transfer of investment securities from held-to-maturity to available-for sale
  $ 11,895,037     $ -  
        Noncash transfer of loans to other real estate owned
  $ -     $ 74,800  
 
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, 2012 when reviewing this Form 10-Q.  Quarterly results reported herein are not necessarily indicative of results to be expected for other quarters.

In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring adjustments) considered necessary to present fairly the Company's consolidated financial position as of June 30, 2013 and December 31, 2012 and the consolidated results of its operations and its cash flows for the three and six months ended June 30, 2013 and 2012.

Management’s Use of Estimates
The preparation of the financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) 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, the carrying value of other real estate owned, the determination of other than temporary impairment for securities and consideration of impairment of 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 any such litigation will have a material adverse effect on the financial condition or results of operations of the Company. However, the ultimate outcome of any such litigation, as with litigation generally, is inherently uncertain and it is possible that some litigation matters may be resolved adversely to the Company.



 Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses.  Loans that are determined to be uncollectible are charged against the allowance account, and subsequent recoveries, if any, are credited to the allowance.  When evaluating the adequacy of the allowance, an assessment of the loan portfolio will typically include changes in the composition and volume of the loan portfolio, overall portfolio quality and past loss experience, review of specific problem loans, current economic conditions which may affect borrowers’ ability to repay, and other factors which may warrant current recognition.  Such periodic assessments may, in management’s judgment, require the Bank to recognize additions or reductions to the allowance.

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

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 Income (Loss) Per Share
The calculation of net (loss) income per share follows:
   
Three Months Ended 
June 30, 2013
   
Three Months Ended
June 30, 2012
   
Six Months Ended 
June 30, 2013
   
Six Months Ended
June 30, 2012
 
Basic:
                       
Net income (loss) available to common shareholders
  $ 95,977     $ (236,896 )   $ (242,810 )   $ (474,705 )
Average common shares outstanding-basic
    1,068,588       1,068,588       1,068,588       1,068,588  
Net income (loss) per share-basic
  $ 0.09     $ (0.22 )   $ (0.23 )   $ (0.45 )
Diluted:
                               
Average common shares-diluted
    1,068,588       1,068,588       1,068,588       1,068,588  
Net income (loss) per share-diluted
  $ 0.09     $ (0.22 )   $ (0.23 )   $ (0.44 )

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 income (loss) per share calculations.


 
 3. Changes in Accumulated Other Comprehensive Income (Loss)

The following table presents the changes in other comprehensive income(loss):
 
(in 000’s)
 
Three Months ended
June 30, 2013
   
Six Months Ended
June 30, 2013
 
Beginning Balance
  $ 28     $ 34  
Other comprehensive loss before reclassifications-- Unrealized losses on available for sale securities
    (244 )     (256 )
Amounts reclassified from accumulated other comprehensive income to net income—Gain on sale of investment securities
        28           34  
Net current period other comprehensive loss
  $ (188 )   $ (188 )

4. New Authoritative Accounting Guidance

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’s adoption of this guidance in 2013 did not have an impact on its financial statements.
 
In February 2013, the FASB issued an update (ASU 2013-02 – Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income) which requires entities to disclose, for items reclassified out of accumulated other comprehensive income (“AOCI”) and into net income in their entirety, the effect of the reclassification on each affected net income line item and, for AOCI reclassification items that are not reclassified in their entirety into net income, a cross reference to other required U.S. GAAP disclosures. The guidance is effective for annual and interim reporting periods beginning after December 15, 2012; early adoption is allowed. The disclosures required by the adoption of this guidance in 2013 are included in Note 3 of the financial statements.
 
5.  Investment Securities

The following is a summary of the Company's investment portfolio as of June 30, 2013: 

(In 000’s)
 
June 30, 2013
 
         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
unrealized
   
Fair
 
   
Cost
   
Gains
   
losses
   
value
 
Available-for-sale:
                       
U.S. Government agency securities
  $ 4,097     $ -     $ (180 )   $ 3,917  
Government Sponsored Enterprises  residential mortgage-backed securities
    5,425       41       (142 )     5,324  
Investments in money market funds
    129       -       -       129  
    $ 9,651     $ 41     $ (322 )   $ 9,370  
       
   
December 31, 2012
 
           
Gross
   
Gross
         
   
Amortized
   
Unrealized
   
unrealized
   
Fair
 
   
Cost
   
Gains
   
losses
   
Value
 
Available-for-sale:
                               
Government Sponsored Enterprises         residential mortgage-backed securities
  $ 847     $ 51     $ -     $ 898  
Investments in money market funds
    129       -       -       129  
    $ 976     $ 51     $ -     $ 1,027  
                                 
Held-to-maturity:
                               
U.S. Government agency securities
  $ 3,605     $ 159     $ (4 )   $ 3,760  
Government Sponsored Enterprises residential mortgage-backed securities
    8,290       437       (1 )     8,726  
    $ 11,895     $ 596     $ (5 )   $ 12,486  

 
 
The amortized cost and fair value of debt securities classified as available-for-sale and held-to-maturity, by contractual maturity, as of June 30, 2013, 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
    4,097       3,917  
Government Sponsored Enterprises residential mortgage-backed securities
    5,425       5,324  
 Total debt securities
    9,522       9,241  
 Investments in money market funds
    129       129  
    $ 9,651       9,370  
 
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.
 
In May 2013, the Bank transferred its entire held to maturity portfolio to available for sale. This transfer was made to improve capital ratios and liquidity by allowing for the disposition of securities, if necessary. In May and June 2013, the Bank sold securities with a book value totaling approximately $7.4 million and recognized a gain of approximately $378,000.  Proceeds from the sale were reinvested in replacement securities.
 
The table below indicates the length of time individual securities have been in a continuous unrealized loss position at June 30, 2013:
   
Number
   
Less than 12 months
   
12 months or longer
   
Total
 
Description of
 
of
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
Securities
 
securities
   
Value
   
Losses
   
value
   
losses
   
value
   
losses
 
                                           
U.S. Government
                                         
     agency securities
    15     $ 3,917     $ (180 )   $ -     $ -     $ 3,917     $ (180 )
                                                         
Government Sponsored Enterprises
                                                       
     residential mortgage-backed securities
    18     $ 4,307       (142 )     -       -       4,307       (142 )
Total temporarily
                                                       
Impaired investment
                                                       
     securities
    33     $ 8,544     $ (322 )   $ -     $ -     $ 8,224     $ ( 322 )
 


 
The table below indicates the length of time individual securities have been in a continuous unrealized loss position at December 31, 2012:
   
Number
   
Less than 12 months
   
12 months or longer
   
Total
 
Description of
 
of
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
Securities
 
securities
   
Value
   
Losses
   
value
   
losses
   
value
   
losses
 
                                           
U.S. Government
                                         
     agency securities
    3     $ 746     $ (4 )   $ -     $ -     $ 746     $ (4 )
                                                         
Government Sponsored Enterprises
                                                       
     residential mortgage-backed securities
    2     $ 253     $ (1 )   $ -     $ -     $ 253     $ (1 )
Total temporarily
                                                       
Impaired investment
                                                       
     securities
    5     $ 999     $ (5 )   $ -     $ -     $ 999     $ (5 )
 
Government Sponsored Enterprises residential mortgage-backed securities. Unrealized losses on the Company’s investment in Government Sponsored Enterprises residential mortgage-backed securities were caused by market 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 market 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.
 
U.S. Government and Agency Securities. Unrealized losses on the Company's investments in direct obligations of U.S. government agencies were caused by market interest rate increases. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost bases of the investments. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired.
 
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.


6. Loans and Allowance for Loan Losses
 
The composition of the Bank’s loan portfolio is as follows:
(Dollars in thousands)
 
June 30,
2013
   
December 31,
2012
 
Commercial and industrial
  $ 2,992     $ 3,734  
Commercial real estate
    32,876       31,381  
Consumer real estate
    4,361       4,619  
Consumer loans other
    1,624       1,768  
           Total loans
  $ 41,853     $ 41,502  

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 rolling 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 period.  In addition, the average historical loss factor for commercial and industrial loans increased as a result of a $340,000 charge-off during the quarter. 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 Three months ended June 30, 2013  
   
Commercial and industrial
   
Commercial real estate
   
Consumer real estate
   
Consumer loans other
   
Total
 
Beginning balance
  $ 614     $ 275     $ 48     $ -     $ 937  
Provision (credit) for loan losses
    15       (65 )     (6 )     1       (55 )
                                         
Charge-offs
    (184 )     -       -       (4 )     (188 )
Recoveries
    1       78       2       3       84  
Net charge-offs
    (183 )     78       2       (1 )     (104 )
                                         
Ending balance
  $ 446     $ 288     $ 44     $ -     $ 778  
 
 

 
(in 000's)
For the Three Months ended June 30, 2012
   
Commercial and industrial
   
Commercial real estate
   
Consumer real estate
   
Consumer loans other
   
Total
 
Beginning balance
  $ 417     $ 412     $ 35     $ -     $ 864  
Provision for loan losses
    30       -               -       30  
                                         
Charge-offs
    -       -               -       -  
Recoveries
    -       2       10       -       12  
Net charge-offs
    -       2       10       -       12  
                                         
Ending balance
  $ 477     $ 414     $ 45     $ -     $ 906  
                                         
 

(in 000’s)
  For the Six months ended June 30, 2013
   
Commercial and industrial
   
Commercial real estate
   
Consumer real estate
   
Consumer loans other
   
Total
 
Beginning balance
  $ 891     $ 308     $ 5     $ -     $ 1,204  
Provision for loan losses
    77       (98 )     35       1       15  
                                         
Charge-offs
    (524 )     -       -       (4 )     (528 )
Recoveries
    2       78       4       3       87  
Net charge-offs
    (522 )     78       4       (1 )     (441 )
                                         
Ending balance
  $ 446     $ 288     $ 44       -     $ 778  
                                         
 

(in 000's)
  For the Six months ended June 30, 2012
   
Commercial and industrial
   
Commercial real estate
   
Consumer real estate
   
Consumer loans other
   
Total
 
Beginning balance
  $ 387     $ 412     $ 68     $ -     $ 867  
Provision for loan losses
    109       (50 )     -       1       60  
                                         
Charge-offs
    -       -       (38 )     (9 )     (47 )
Recoveries
    -       5       13       8       26  
Net charge-offs
    -       5       (21 )     (1 )     (21 )
                                         
Ending balance
  $ 496     $ 367     $ 43     $ -     $ 906  
                                         
 

(in 000's)
  June 30, 2013  
   
Commercial and industrial
   
Commercial real estate
   
Consumer real estate
   
Consumer loans other
   
Total
 
                               
Period-end amount allocated to:
 
 
                         
   
 
                         
 Loans indivdually evaluated for impairment
  $ 349     $ -     $ -     $ -     $ 349  
 Loans collectively  evaluated for impairment
    97       288       44       -       429  
    $ 446     $ 288     $ 44     $ -     $ 778  
                                         
Loans, ending balance:
                                       
 Loans individually evaluated for impairment
  $ 526     $ 1,291     $ -     $ -     $ 1,817  
 Loans collectively  evaluated for impairment
    2,466       31,585       4,361       1,624       40,036  
Total
  $ 2,992     $ 32,876     $ 4,361     $ 1,624     $ 41,853  
 
 

(in 000's)
  December 31, 2012  
   
Commercial and industrial
   
Commercial real estate
   
Consumer real estate
   
Consumer loans other
   
Total
 
                               
Period-end amount allocated to:
 
 
                         
   
 
                         
 Loans indivdually evaluated for impairment
  $ 843     $ -     $ -     $ -     $ 843  
 Loans collectively  evaluated for impairment
    48       308       5        -        361  
    $ 891     $ 308     $ 5     $ -     $ 1,204  
                                         
Loans, ending balance:
                                       
 Loans indivdually evaluated for impairment
  $ 1,021     $ 1,323     $ -     $ -     $ 2,344  
 Loans collectively  evaluated for impairment
    2,713       30,058       4,619       1,768       39,158  
Total
  $ 3,734     $ 31,381     $ 4,619     $ 1,768     $ 41,502  

Nonperforming and Nonaccrual and Past Due Loans
An age analysis of past due loans, segregated by class of loans, as of June 30, 2013 is as follows:
         
Accruing
                         
   
Loans
   
Loans 90 or
                         
(In 000's)
 
30-89 Days
   
More Days
         
Total Past
   
Current
       
   
Past Due
   
Past Due
   
Nonaccrual
   
Due Loans
   
Loans
   
Total Loans
 
Commercial and industrial:
                                   
     Commercial
  $ -     $ -     $ 477     $ 477     $ 487     $ 964  
     SBA loans
            -       -       -       117       117  
     Asset-based
    125       -       -       125       1,786       1,911  
        Total Commercial and industrial
    125       -       477       602       2,390       2,992  
                                                 
Commercial real estate:
                                               
     Commercial mortgages
    213       -       638       851       16,362       17,213  
     SBA loans
    -       -       -       -       607       607  
     Construction
    -       -       -       -       2,244       2,244  
     Religious organizations
    -       -       653       653       12,159       12,812  
         Total Commercial real estate
    213       -       1,291       1,504       31,372       32,876  
                                                 
Consumer real estate:
                                               
     Home equity loans
    358       -       123       481       885       1,366  
     Home equity lines of credit
    -       -       -       -       25       25  
     1-4 family residential mortgages
    54       -       242       296       2,674       2,970  
         Total consumer real estate
    412       -       365       777       3,584       4,361  
                                                 
Total real estate
    625       -       1,656       2,281       34,956       37,237  
                                                 
Consumer and other:
                                               
     Consumer installment
    -       -       -       -       23       23  
     Student loans
    103       132       -       235       1,221       1,456  
     Other
    2       -       -       2       143       145  
         Total consumer and other
    105       132       -       237       1,387       1,624  
                                                 
         Total loans
  $ 855     $ 132     $ 2,133     $ 3,120     $ 38,733     $ 41,853  
                                                 



An age analysis of past due loans, segregated by class of loans, as of December 31, 2012 is as follows:
         
Accruing
                         
   
Loans
   
Loans 90 or
                         
   
30-89 Days
   
More Days
         
Total Past
   
Current
       
(In 000's)
 
Past Due
   
Past Due
   
Nonaccrual
   
Due Loans
   
Loans
   
Total Loans
 
Commercial and industrial:
                                   
     Commercial
  $ 15     $ -     $ 873       888     $ 574     $ 1,462  
     SBA loans
    -       -       -       -       125       125  
     Asset-based
    83       -       99       182       1,965       2,147  
        Total Commercial and industrial
    98       -       972       1,070       2,664       3,734  
                                                 
Commercial real estate:
                                               
      Commercial mortgages
    306       -       649       955       13,765       14,720  
      SBA loans
    -       -       -       -       621       621  
     Construction
    -       -       -       -       3,398       3,398  
     Religious organizations
    -       -       674       674       11,968       12,642  
         Total Commercial real estate
    306       -       1,323       1,629       29,752       31,381  
                                                 
Consumer real estate:
                                               
     Home equity loans
    274       44       63       381       1,072       1,453  
     Home equity lines of credit
    -       26       -       26       -       26  
     1-4 family residential mortgages
    69       -       226       295       2,845       3,140  
         Total consumer real estate
    343       70       289       702       3,917       4,619  
                                                 
Total real estate
    649       70       1,612       2,331       33,669       36,000  
                                                 
Consumer and other:
                                               
     Consumer installment
    -       -       -       -       30       30  
     Student loans
    87       141       -       228       1,360       1,588  
     Other
    5       -       -       5       145       150  
         Total consumer and other
    92       141       -       233       1,535       1,768  
                                                 
         Total loans
  $ 839     $ 211     $ 2,584     $ 3,634     $ 37,867     $ 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.

(In 000's)
  Commercial Loans June 30, 2013  
   
Good/
Excellent
   
Satisfactory
   
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Total
 
                                           
                                           
         
 
                               
Commercial and industrial:
                                         
    Commercial
  $ 250     $ 9     $ 220     $ 8     $ 84     $ 393     $ 964  
    SBA loans
    -       25       -       43       49       -       117  
    Asset-based
    -       1,737       125       49       -       -       1,911  
      250       1,771       345       100       133       393       2,992  
Commercial real estate:
                                                       
    Commercial mortgages
    -       14,976       1,372       158       618       89       17,213  
     SBA Loans
    -       607       -       -       -       -       607  
    Construction
    -       2,244       -       -       -       -       2,244  
    Religious organizations
    -       9,201       2,328       -       1,283       -       12,812  
      -       27,028       3,700       158       1,901       89       32,876  
                                                         
Total commercial loans
  $ 250     $ 28,799     $ 4,045     $ 258     $ 2,034     $ 482     $ 35,868  
                                                         
 
    Residential Mortgage and Consumer Loans June 30, 2013
   
Performing
   
Nonperforming
   
Total
   
 
                   
Consumer Real Estate:
                   
     Home equity
  $ 1,243     $ 123     $ 1,366    
     Home equity line of credit
    25       -       25    
     1-4 family residential mortgages
    2,728       242       2,970    
      3,996       365       4,361    
                           
Consumer Other:
                         
     Consumer Installment
    23       -       23    
     Student loans
    1,456       -       1,456    
     Other
    145       -       145    
      1,624       -       1,624    
                           
Total  consumer loans
  $ 5,620     $ 365     $ 5,985    
                           
Total loans
                       
$      41,853



 

(In 000's)
  Commercial Loans, December 31, 2012  
   
Good/ Excellent
   
Satisfactory
   
Pass
   
Special Mention
   
Substandard
   
Doubtful
   
Total
 
 
                                         
Commercial and industrial:
                                         
    Commercial
  $ 250     $ 104     $ 15     $ 220     $ 480     $ 393     $ 1,462  
    SBA loans
    -       27       -       49       49       -       125  
    Asset-based
    -       1,869       125       54       99       -       2,147  
      250       2,000       140       323       628       393       3,734  
Commercial real estate:
                                                       
    Commercial mortgages
    -       12,678       1,322       -       403       317       14,721  
     SBA Loans
    -       621       -       -       -       -       621  
    Construction
    -       2,767       -       -       631       -       3,398  
    Religious organizations
    -       8,183       3,623       162       674       -       12,642  
      -       24,349       4,945       162       1,708       317       31,381  
                                                         
Total commercial loans
  $ 250     $ 26,249     $ 5,085     $ 485     $ 2,336     $ 710     $ 33,115  
                                                         
 
    Residential Mortgage and Consumer Loans December 31, 2012
   
 
   
   
Performing
   
Nonperforming
   
Total
   
 
                   
Consumer Real Estate:
                   
     Home equity
  $ 1,390     $ 63     $ 1,453    
     Home equity line of credit
    26       -       26    
     1-4 family residential mortgages
    2,914       226       3,140    
      4,330       289       4,619    
                           
Consumer Other:
                         
     Consumer Installment
    30       -       30    
     Student loans
    1,588       -       1,588    
     Other
    150       -       150    
      1,768       -       1,768    
                           
Total  consumer loans
  $ 6,098     $ 289     $ 6,387    
                           
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 three and six months ended June 30, 2013 and 2012, 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 June 30, 2013 are set forth in the following table.
 
(In 000's)
 
Unpaid Contractual
   
Recorded
Investment
   
Recorded
Investment
   
Total
       
   
Principal
   
With No
   
With
   
Recorded
   
Related
 
   
Balance
   
Allowance
   
Allowance
   
Investment
   
Allowance
 
                               
Commercial and industrial:
       
 
                   
  Commercial
  $ 477     $ 77     $ 400     $ 477     $ 300  
   SBA  loans
    49       -       49       49       49  
     Total commercial and industrial
    526       77       449       526       349  
                                         
Commercial real estate:
                                       
   Commercial mortgages
    638       638       -       638       -  
   Religious organizations
    653       653       -       653       -  
     Total commercial real estate
    1,291       1,291       -       1,291       -  
                                         
         Total loans
  $ 1,817     $ 1,368     $ 449     $ 1,817     $ 349  

 
Impaired loans as of December 31, 2012 are set forth in the following table.

(In 000's)
 
Unpaid Contractual
   
Recorded Investment
   
Recorded Investment
   
Total
       
   
Principal
   
With No
   
With
   
Recorded
   
Related
 
   
Balance
   
Allowance
   
Allowance
   
Investment
   
Allowance
 
                               
Commercial and industrial:
       
 
                   
     Commercial
  $ 873     $ 78     $ 795     $ 873     $ 695  
     SBA loans
    49       -       49       49       49  
     Asset-based
    99       -       99       99       99  
       Total commercial and industrial
    1,021       78       943       1,021       843  
                                         
Commercial real estate:
                                       
     Commercial mortgages
    649       649       -       649       -  
     Religious organizations
    674       674       -       674       -  
         Total commercial real estate
    1,323       1,323       -       1,323       -  
                                         
         Total loans
  $ 2,344     $ 1,401     $ 943     $ 2,344     $ 843  



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 June 30, 2013 and 2012.

    Three Months Ended     Three Months Ended  
(In 000's)
  June 30, 2013     June 30, 2012  
   
Average
   
Interest recognized
   
Average
   
Interest recognized
 
   
Recorded
   
on impaired
   
Recorded
   
on impaired
 
   
Investment
   
loans
   
Investment
   
loans
 
                         
Commercial and industrial:
                       
     Commercial
  $ 512     $ -     $ 482     $ -  
     SBA  loans
    49       -       17       1  
     Asset-based
    88       -       138       -  
        Total commercial and industrial
    649       -       637       1  
                                 
Commercial real estate:
                               
     Commercial mortgages
    639       -       666       -  
     SBA loans
    -       -       -       -  
     Religious organizations
    657       -       399       -  
         Total commercial real estate
    1,296       -       1,065       -  
                                 
         Total loans
  $ 1,945     $ -     $ 1,702     $ 1  
                                 
 

    Six Months Ended   Six Months Ended  
(In 000's)
  June 30, 2013   June 30, 2012  
   
Average
   
Interest recognized
   
Average
   
Interest recognized
 
   
Recorded
   
on impaired
   
Recorded
   
on impaired
 
   
Investment
   
loans
   
Investment
   
loans
 
                         
Commercial and industrial:
                       
     Commercial
  $ 626     $ -     $ 482     $ -  
     SBA  loans
    49       -       8       1  
     Asset-based
    99       -       119       -  
        Total commercial and industrial
    774       -       609       1  
                                 
Commercial real estate:
                               
     Commercial mortgages
    640       -       670       -  
     Religious organizations
    614       -       405       -  
         Total commercial real estate
    1,254       -       1,075       -  
                                 
         Total loans
  $ 2,028     $ -     $ 1,075     $ 1  
                                 



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 June 30, 2013 and December 31, 2012.
 
7. Other Real Estate Owned
 
Other real estate owned (“OREO”) consists of properties acquired as a result of deed in-lieu-of foreclosure and foreclosures. Properties or other assets are classified as OREO and are reported at the lower of carrying value or fair value, less estimated costs to sell. Costs relating to the development or improvement of assets are capitalized, and costs relating to holding the property are charged to expense.

Activity in other real estate owned for the periods was as follows:

(in 000's)
 
Three Months Ended
   
Three Months Ended
   
Six Months Ended
   
Six Months Ended
 
   
June 30, 2013
   
June 30, 2012
   
June 30, 2013
   
June 30, 2012
 
                         
Beginning balance
  $ 718     $ 1,344     $ 775     $ 1,284  
Additions, transfers from loans
    -       -       -       75  
Proceeds from sales
    (65 )     -       (92 )     -  
      653       1,344       683       1,359  
Less: write-downs and losses on sales
    (126 )     (11 )     (156 )     (26 )
Ending Balance
  $ 527     $ 1,333     $ 527     $ 1,333  
 
 
The following schedule reflects the components of other real estate owned:
 
(in 000's)
 
June 30,
2013
   
December 31,
2012
 
Commercial real estate
  $ 206     $ 206  
Residential real estate
    321       569  
     Total
  $ 527     $ 775  
 
The following table details the components of net expense of other real estate owned:
 
   
Three Months Ended
   
Three Months Ended
   
Six Months Ended
   
Six Months Ended
 
(in 000's)
 
June 30, 2013
   
June 30, 2012
   
June 30, 2013
   
June 30, 2012
 
Insurance
  $ 4     $ 10     $ 10     $ 17  
Professional fees
    -       -       -       3  
Real estate taxes
    5       33       11       36  
Utilities
    -       11       2       17  
Other
    2       2       2       2  
Transfer-in write-up
    -       -       -       (43 )
Impairment charges (net)
    113       11       143       26  
      Total
  $ 124     $ 67     $ 168     $ 58  
 
8.  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 June 30, 2013
   
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:
                       
U.S. Government agency securities
  $ 3,917     $  -     $ 3,917     $  -  
Government Sponsored Enterprises residential mortgage-backed securities
     5,324       -       5,324        -  
Money Market Funds
    129       129       -       -  
 
     Total
  $ 9,370     $ 129     $ 9,241     $ -  
 
(in 000’s)
       
Fair Value Measurements at Reporting Date Using:
 
   
Assets/Liabilities
Measured at Fair
Value at
December 31, 2012
   
Quoted
Prices in
Active
Markets for
Identical Assets
(Level 1)
   
Significant Other
Observable Inputs
(Level 2)
   
Significant
Unobservable Inputs
(Level 3)
 
Investment securities available-for-sale:
                       
Government Sponsored Enterprises residential mortgage-backed securities
  $ 898     $ -     $ 898     $ -  
Money Market Funds
    129       129       -       -  
 
     Total
  $ 1,027     $ 129     $ 898     $ -  
 
The fair value of the Bank’s AFS securities portfolio was approximately $9,370,000 and $1,027,000 at June 30, 2013, and December 31, 2012, respectively.  In May 2013, the Bank transferred its investment securities held-to-maturity to available-for-sale.  At June 30, 2013, approximately 57% of the portfolio consisted of residential mortgage-backed securities, which had a fair value of approximately $5,324,000.  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 June 30, 2013.  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 June 30, 2013 and year ended December 31, 2012.
 
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 consolidated balance sheet by level within the hierarchy as of June 30, 2013 and December 31, 2012, for which a nonrecurring change in fair value has been recorded during the six months ended June 30, 2013 and year ended December 31, 2012.

 
 Carrying Value at June 30, 2013:
(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
6 months ended
June 30,
2013
 
Impaired loans
  $ 1,468     $ -     $ -     $ 1,468     $ -  
Other real estate owned (“OREO”)
    527        -        -       527       (143 )

Carrying Value at December 31, 2012:
(in 000’s)
 
Total
   
Quoted Prices in
Active
markets for
Identical Assets
(Level 1)
   
Significant Other
Observable Inputs
(Level 2)
   
Significant
Unobservable Inputs
 (Level 3)
   
Total fair
value gain
(loss) during 12
months ended
December 31,
2012
 
Impaired Loans
  $ 1,501     $ -       -     $ 1,501     $ (843 )
Other real estate owned (“OREO”)
    775        -       -       775       (233 )
 
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 June 30, 2013 was approximately $ 349,000.  The valuation allowance for impaired loans at December 31, 2012 was approximately $843,000.
 
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.
 
 
 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:
     
    June 30, 2013 December 31, 2012
(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
$9,277
$9,277
$10,236
$10,236
Available for sale securities
(1)
9,370
9,370
1,027
1,027
Held to maturity securities
Level 2
-
-
11,895
12,486
Loans, net of allowance for loan losses
 (2)
41,075
41,786
40,298
40,325
Accrued interest receivable
Level 2
277
277
310
310
Liabilities:
         
Demand deposits
Level 2
28,218
28,218
29,851
29,851
Savings deposits
Level 2
13,202
13,202
14,239
14,239
Time deposits
Level 2
16,147
16,155
16,886
16,902
Accrued interest payable
Level 2
16
16
31
31
(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.

9. 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;
Profit and budget plans have been prepared and submitted to regulators as required annually.
 
 
 
Requirement
Status
Develop and implement a strategic plan for each year during which the orders are in effect, to be revised annually;
An annual comprehensive strategic plan was prepared and submitted to regulators as required.
   
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 as required annually.
   
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 as required.
   
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.
   
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   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 June 30, 2013 and December 31, 2012, the Bank’s tier one leverage capital ratio was 6.27% and 6.00%, respectively, and its total risk based capital ratio was 10.60% and 11.16%, respectively.  Although the Bank experienced losses, tier one leverage capital increased as a result of the decline in average assets.  The total risk based capital ratio decreased because of an increase in loans that carry a higher risk weight than cash or investments.  Management has developed and submitted a Capital Plan that focuses on the following:

 
1.
Core Profitability from Bank operations—Core profitability is essential to stop the erosion of capital.
 
2.
Sale of investment securities for a gain—approximately $7.5 million of the Bank’s investment portfolio were sold to generate a gain of approximately $378,000 during the quarter ended June 30, 2013.
 
3.
External equity investments—An investment banker has been engaged to assist the Bank in developing a strategy and offering memorandum to generate external capital investment.

As a result of the above actions, management believes that the Bank has and will continue to attempt 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.




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

United Bancshares, Inc. (the "Company") is a bank holding company registered under the Bank Holding Company Act of 1956.  The Company's principal activity is the ownership and management of its wholly owned subsidiary, United Bank of Philadelphia (the "Bank").


Special Cautionary Notice Regarding Forward-looking Statements

Certain of the matters discussed in this document and the documents incorporated by reference herein, including matters discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” may constitute forward looking statements for the purposes of the Securities Act of 1933, as amended and the Securities Exchange Act of 1934, as amended, and may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of United Bancshares, Inc (“UBS”) to be materially different from future results, performance or achievements expressed or implied by such forward looking statements.  The words “expect,” “anticipate,” “intended,” “plan,” “believe,” “seek,” “estimate,” “may,” and similar expressions are intended to identify such forward-looking statements.  These forward looking statements include: (a) statements of goals, intentions and expectations; and (b) statements regarding business prospects, asset quality, credit risk, reserve adequacy and liquidity.  UBS’ actual results may differ materially from the results anticipated by the forward-looking statements due to a variety of factors, including without limitation: (a) the effects of future economic conditions on UBS and its customers, including economic factors which affect consumer confidence in the securities markets, wealth creation, investment and consumer saving patterns; (b) UBS interest rate risk exposure and credit risk; (c) changes in the securities markets with respect to the market values of financial assets and the stability of particular securities markets; (d) governmental monetary and fiscal policies, as well as legislation and regulatory changes; (e) changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral and securities, as well as interest-rate risks; (f) changes in accounting requirements or interpretations; (g) the effects of competition from other commercial banks, thrifts, mortgage companies, consumer finance companies, credit unions securities brokerage firms, insurance company’s, money-market and mutual funds and other financial institutions operating in the UBS’ trade market area and elsewhere including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the internet; (h) any extraordinary events (such as the September 11, 2001 events), the war on terrorism and the U.S. Government’s response to those events or the U.S. Government becoming involved in a conflict in a foreign country including the war in Iraq; (i) the failure of assumptions underlying the establishment of reserves for loan losses and estimates in the value of collateral, and various financial assets and liabilities and technological changes being more difficult or expensive than anticipated; (j) UBS’ success in generating new business in its existing markets, as well as its success in identifying and penetrating targeted markets and generating a profit in those markets in a reasonable time; (k) UBS’ timely development of competitive new products and services in a changing environment and the acceptance of such products and services by its customers; (l) the recent downgrade , and any future downgrades, in the credit rating of the United States Government and federal agencies; (m) changes in technology being more expensive or difficult than expected; (n) the ability of key third party providers to perform their obligations to UBS and; (o) the Bank and UBS’ success in managing the risks involved in the foregoing, and (m) failure to comply with the Consent Orders with the FDIC and the Pennsylvania Department of Banking.

All written or oral forward-looking statements attributed to 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 UBS assumes no obligation to update any forward-looking statement.
 


Overview
 
The Company reported net income of approximately $96,000 ($0.09 per common share) for the quarter ended June 30, 2013 compared to a net loss of approximately $237,000 ($0.22 per common share) for the same quarter in 2012. The Company reported a net loss of approximately $243,000 ($0.23 per common share) for the six months ended June 30, 2013 compared to a net loss of approximately $475,000 ($0.45 per common share) for the same period in 2012. The improvement compared to 2012 is primarily related to gains realized on the sale of investment securities.  Management remains committed to further 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 critical importance of establishing and maintaining capital levels to support the Bank’s risk profile and growth is understood.  As of June 30, 2013 and December 31, 2012, the Bank’s tier one leverage capital ratio was 6.27% and 6.00%, respectively, and its total risk based capital ratio was 10.60% and 11.16%, respectively.  Although the Bank experienced losses, the tier one leverage capital increased as a result of the decline in average assets.  The total risk based capital ratio decreased as a result of the Bank’s losses and also because of an increase in loans that carry a higher risk weight than cash or investments.  A concentrated effort is being made to stabilize and strengthen the Bank’s capital by the following:

 
·
Core Profitability from Bank operations—Core profitability is essential to stop the erosion of capital. .  Refer to the Earnings Enhancement discussion below.
 
·
Sale of investment securities for a gain—approximately $7.5 million of the Bank’s investment portfolio were sold to generate a gain of approximately $378,000 during the quarter ended June 30, 2013.
 
·
External equity investments—An investment banker has been engaged to assist the Bank in developing a strategy and offering memorandum to generate external capital investment.

 
Manage asset quality to minimize credit losses and reduce collection costs.  Asset quality trends improved during the quarter ended June 30, 2013 with a decrease in the level of delinquencies and classified loans. Also, several long-term commercial and industrial impaired loans were charged-off during the quarter after all collection efforts were exhausted.    While some progress has been made in the Bank’s underwriting and customer relationship management practices, additional efforts are necessary to ensure improvement in asset quality trends. Management will continue to proactively identify and manage emerging problem credits to minimize additions to its classified assets through its Asset Quality Committee discussions.

In conjunction with its regulatory orders, management has developed a Classified Asset Reduction Plan that is being utilized to reduce the level of non-performing assets. Forbearance, foreclosure and/or other appropriate collection methods will be used as necessary.  These activities will likely result in additional expenses, 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. Management recognizes the challenges it continues to face in achieving core profitability.  Although profitability was achieved for the quarter ended June 30, 2013 from a gain on the sale of investment securities, increased interest income on loans and gains on the sale of loans are targeted as the primary drivers of earnings enhancement.  Specifically, the Bank will seek to originate SBA loans for which the guaranteed portion will be sold in the secondary market for a gain.   Several SBA loans are in the pipeline with anticipated closings during the quarter ended September 30, 2013.

The Bank’s noninterest expense continues to be elevated.  The sale of a bank-owned branch in December 2012 resulted in reduced occupancy expense.  However, unlike other similar-sized community banks, the Bank continues to incur a higher level of professional service fees (audit and legal) because of its SEC filing requirements as a result of having in excess of 1,200 shareholders. In addition, increased valuation allowance on the Bank’s other real estate portfolio was required as a result of declining market values of the properties.  Further savings and efficiencies, where possible, including the following:

 

 
1.
Review and re-negotiation of significant contracts (i.e. data processing, credit card, EFT services, etc.)-The Bank’s EFT contract expires in August 2014.  Early termination/re-negotiation may be sought to achieve cost reduction.
 
2.
Sale and/or other disposition of other real estate properties to reduce carrying costs— The Bank is gradually reducing the level of other real estate.  Sales for the six months ended June 30, 2012 totaled approximately $105,000.

The amortization of the Bank’s core deposit intangible related to a premium paid for a branch acquisition will be complete in September 2013.  The completion of this amortization will reduce the Bank’s noninterest expense by $180,000 annually beginning in 2014.

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 2012 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
June 30,
2013
   
 
Quarter ended
June 30,
2012
   
Six months ended
June 30,
2013
   
Six months ended
June 30,
2012
 
Statement of operations information:
                       
Net interest income
  $ 680     $ 745     $ 1,374     $ 1,505  
(Credit)provision for loan losses
    (55 )     30       15       60  
Noninterest income
    654       279       850       473  
Noninterest expense
    1,293       1,232       2,451       2,393  
Net income (loss)
    96       (237 )     (243 )     (475 )
Net income (loss) per share-basic and diluted
    0.09       (0.22 )     (0.23 )     (0.45 )
                                 
Balance Sheet information:
 
June 30, 
2013
   
December 31, 
2012
                 
Total assets
  $ 61,599     $ 65,616                  
Loans, net
  $ 41,075     $ 40,298                  
Investment securities
  $ 9,370     $ 12,922                  
Deposits
  $ 57,567     $ 60,977                  
Shareholders' equity
  $ 3,775     $ 4,240                  
                                 
Ratios*:
 
Quarter ended
June 30,
2013
   
Quarter ended
June 30,
2012
                 
Return on assets
    0.23%       (1.30% )                
Return on equity
    3.82%       (19.72% )                
*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 $4,436,000, or 7.02% during the quarter ended June 30, 2013 compared to the quarter ended March 31, 2013. Average funding sources decreased approximately $3,706,000, or 6.02%, during the quarter ended June 30, 2013 compared to the quarter ended March 31, 2013.

Sources and Uses of Funds Trends
(Thousands of Dollars, except
percentages)
 
June 30, 2013
               
March 31, 2013
 
 
 
Average
   
Increase (Decrease)
   
Increase (Decrease)
   
Average
 
   
Balance
   
Amount
   
%
   
Balance
 
Funding uses:
                       
Loans
  $ 41,128     $ (404 )     (0.97 )%   $ 41,532  
    Investment Securities
    10,655       (2,148 )     (16.78 )     12,803  
Federal funds sold
    6,241       (2,272 )     (26.69 )     8,513  
Balances with other banks
    306       -       -       306  
Total  uses
  $ 58,718     $ (4,436 )     (7.02 )%   $ 63,154  
Funding sources:
                               
Demand deposits
                               
Noninterest-bearing
  $ 15,028     $ (426 )     (2.76 )%   $ 15,454  
Interest-bearing
    12,975       (2,286 )     (14.98 )     15,261  
Savings deposits
    13,635       (625 )     (4.38 )     14,260  
Time deposits
    16,253       (369 )     (2.22 )     16,622  
Total sources
  $ 57,891     $ (3,706 )     (6.02 )%   $ 61,597  

Loans
Average loans decreased by approximately $404,000, or 0.97%, during the quarter ended June 30, 2013. While the Bank funded more than $3.6 million loans during the quarter, a significant portion was originated at the end of the quarter. In addition, commercial loan payoffs totaled approximately $1.8 million during the quarter as a result of the conversion of several construction loans to permanent financing as well as increased market competition from money center banks in the region for quality performing loans.  The Bank’s consumer and residential mortgage loan portfolios continue to decline as a result of residential mortgages and home equity repayment activity as consumers refinance to take advantage of the continued low interest rate environment.  The Bank does not originate 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.

The Bank’s commercial loan pipeline continues to grow as a result of the adoption of a business banking focus, specifically targeting SBA loans.  This strategy is designed to generate fee income from sales of the guaranteed portion as well as build loan volume.  One SBA loan totaling approximately $1.3 million was originated during the quarter; however, it is a construction loan for which funding will occur over a nine month period. The guaranteed portion of this loan cannot be sold until it converts to a permanent mortgage.  Several other SBA loans are in the pipeline with anticipated closings during the quarter ended September 30, 2013. Loan participations may to 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 $32.9 million, or 78.6%, of total loans at June 30, 2013 of which approximately $16.8 million are owner occupied.  The Bank continues to have a strong niche in lending to religious organizations for which total loans at June 30, 2013 were approximately $12.8 million, or 39%, 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:



   
June 30,
   
December 31,
 
(In 000's)
 
2013
   
2012
 
             
             
Commercial and industrial:
           
     Commercial
  $ 964     $ 1,462  
     SBA loans
    117       125  
     Asset-based
    1,911       2,147  
        Total commercial and industrial
    2,992       3,734  
                 
Commercial real estate:
               
                 
     Commercial mortgages
    17,213       14,720  
     SBA loans
    607       621  
     Construction
    2,244       3,398  
     Religious organizations
    12,812       12,642  
         Total commercial real estate
    32,876       31,381  
                 
Consumer real estate:
               
     Home equity loans
    1,366       1,453  
     Home equity lines of credit
    25       26  
     1-4 family residential mortgages
    2,970       3,140  
         Total consumer real estate
    4,361       4,619  
                 
Total real estate
    37,237       36,000  
                 
Consumer and other:
               
     Consumer installment
    23       30  
     Student loans
    1,456       1,588  
     Other
    145       150  
         Total consumer and other
    1,624       1,768  
                 
         Loans, net
  $ 41,853     $ 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 1.87% at June 30, 2013 compared to 2.90% at December 31, 2012.  The reduction is related to the charge-off of three impaired loans totaling approximately $524,000 ($184,000 during the quarter ended June 30, 2013) for which specific reserves were previously allocated.  In June 2013, the Bank recovered approximately $75,000 related to one previously charged-off commercial real estate loan.

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 $1,817,000 at June 30, 2013 compared to $2,344,000 at December 31, 2012. The valuation allowance associated with impaired loans was approximately $349,000 and $843,000, at June 30, 2013 and December 31, 2012, respectively. The decrease in impaired loans and the related valuation allowance is attributable to the charge-off of three commercial and industrial loans.  Management continues to work to reduce the level of classified and impaired loans. Forbearance, foreclosure and/or other appropriate collection methods will be used as necessary.

At June 30, 2013 and December 31, 2012, loans to religious organizations represented approximately $653,000 and $674,000, 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 decreased from 46.59% at December 31, 2012 to 36.47% at June 30, 2013 primarily as a result of charge-off activity; however, approximately 77.63% of nonperforming loans are secured by real estate which serves to mitigate the risk of loss.   In addition, the level of nonperforming loans to total loans improved from 6.23% at December 31, 2013 to 5.10% at June 30, 2013.

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)
 
June 30,
2013
   
December 31,
2012
 
Commercial and industrial:
           
     Commercial
  $ 477     $ 873  
     Asset-based
    -       99  
        Total commercial and industrial
    477       972  
                 
Commercial real estate:
               
     Commercial mortgages
    638       649  
     Religious organizations
    653       674  
         Total commercial real estate
    1,291       1,323  
                 
Consumer real estate:
               
     Home equity loans
    123       63  
     1-4 family residential mortgages
    242       226  
         Total consumer real estate
    365       289  
                 
Total real estate
    1,656       1,612  
                 
                 
         Total nonperforming loans
  $ 2,133     $ 2,584  
         OREO
    527       775  
         Total nonperforming assets
    2,660     $ 3,359  
                 
Nonperforming loans to total loans
    5.10 %     6.23 %
Nonperforming assets to total loans and OREO
    6.28 %     8.12 %
Nonperforming assets to total assets
    4.32 %     5.10 %
                 
Allowance for loan losses as a percentage of:
               
     Total Loans
    1.87 %     2.90 %
     Total nonperforming loans
    36.47 %     46.59 %



The following table sets forth information related to loans past due 90 days or more and still accruing interest.

(In 000's)
 
June 30,
2013
   
December 31,
 2012
 
Consumer real estate:
           
     Home equity loans
  $ -     $ 70  
         Total consumer real estate
    -       70  
                 
Consumer and other:
               
     Student loans
    132       141  
         Total consumer and other
    132       141  
                 
         Total
  $ 132     $ 211  
                 
 
Investment Securities and Other Short-term Investments
Average investment securities decreased by approximately $2,148,000, or 16.78%, during the quarter ended June 30, 2013. The decrease was primarily related to the paydowns in mortgage-backed security portfolio and calls of higher yielding securities in the current low interest rate environment.  Called securities were not replaced because of the reduction in governmental deposits (City of Philadelphia) and related collateral requirement.
 
The yield on the investment portfolio declined to 2.56% at June 30, 2013 compared to 2.84% at December 31, 2012 as a result of an investment transaction that resulted in the sale of higher yielding bonds.  The duration of the portfolio has extended to 4.7 years at June 30, 2013 compared to 3.2 years at December 31, 2012 also as a result of the transaction that was executed during the quarter that included the purchase of replacement securities of 7-10 year callable agency securities as well as 15 and 20 year government sponsored enterprises (GSE) mortgage-backed pass-through securities.  The payments of principal and interest on these pools of GSE loans serve to provide monthly cashflow and 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.  Amortizing GSE mortgage-backed securities approximate 57% of the portfolio. 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 June 30, 2013, average deposits declined approximately $3,706,000, or 6.02%, concentrated in the category of interest-bearing demand deposits that declined approximately $2.3 million, or 14.98%.   At the end of March 2013, the City of Philadelphia closed a $2.3 million money market account for which funds had been earmarked for a construction project that resulted in a reduction in the average money market account balances for the quarter ended June 30, 2013.  In addition, the Bank has one depository relationship for which the balances declined in conjunction with contract funding it received related to a project that was completed in May 2013.  The decline in savings deposits by approximately $625,000, or 4.38%, is also attributable to the same customer that maintained reserve funds that were utilized at project completion.

In addition, certificates of deposit declined approximately $369,000, or 2.22%, as the result of the non-renewal of several corporate deposits for which higher rates were being sought.

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:
 
   
June 30,
2013
   
December 31,
2012
 
Commitments to extend credit
  $ 9,578,205     $ 9,484,000  
Standby letters of credit
    1,243,492       1,173,000  

The level of commitments at June 30, 2013 increased as a result of the approval of several construction loans/lines of credit.  More than $4 million of the Bank’s 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 June 30, 2013, the Bank had total short-term liquidity, including cash and federal funds sold, of approximately $9.3 million, or 15.06% of total assets, compared to $10.2 million, or 15.60%, at December 31, 2012. The closure of the City of Philadelphia deposit referenced above in Deposits is the primary reason for the reduction in liquidity.  Although reduced, liquidity levels remain strong and above policy limits.
 
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. In conjunction with the investment transaction executed in May, the Bank reclassified its entire portfolio to available-for-sale; thereby, increasing sources of liquidity.  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.

Other types of assets such as federal funds sold, as well as maturing loans, are also sources of liquidity.  Approximately $11.3 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 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 $750,000 in securities pledged that result in borrowing capacity of approximately $638,000. 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 June 30, 2013, a positive gap position is maintained on a cumulative basis through 1 year of 4.57% that is within the Bank’s policy guidelines of +/- 15% on a cumulative 1-year basis and represents a decline from the December 31, 2012 positive gap position of 11.62%. This decrease resulted from the reduction in Federal Funds Sold created by a decline in deposit balances.  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.  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 June 30, 2013, the change in the market value of equity in a +200 basis point interest rate change is -49.20%, in excess of the policy limit of 25%, and -76.30% in a +400 basis point interest rate change, in excess of the policy limit of -50%.  The exception to policy is created by the recent bond transaction for which longer term fixed rate bonds and mortgage-backed securities were purchased that decline in value when interest rates rise.  The analysis is prepared on a static basis however, because more than 50% of the portfolio includes amortizing securities, market risk should gradually decline as cashflows are reinvested in the current market.  Also, management will continue to mitigate this risk by originating more variable rate loans or structure short maturity balloon mortgages.  Although the economic value of equity is in excess of policy, interest-rate exposure is considered reasonable and manageable at June 30, 2013.

Capital Resources
Total shareholders' equity decreased approximately $465,000 compared to December 31, 2012 as a result of the net loss of approximately $243,000 during the six months ended June 30, 2013 and other comprehensive loss of approximately $222,000 related to an unrealized loss on the securities classified as available-for-sale.  Because other comprehensive loss is not a component of Tier 1 capital, Tier 1 capital declined by approximately $166,000 during same period.
 
The critical importance of establishing and maintaining capital levels to support the Bank’s risk profile and growth is understood.  A concentrated effort will be made to stabilize and strengthen the Bank’s capital through the generation of core profitability from Bank operations and external investment.  The Bank will seek to raise $1,000,000 in equity investment from potential investors.
 
Federal and state banking laws impose on financial institutions such as USB and the Bank certain minimum requirements for capital adequacies.  The Company and the Bank are each generally required to maintain a minimum ratio of total capital to risk rated assets of 8%.  At least half of the total capital must be composed of “Tier I Capital” which is defined as common equity, retained earnings and qualified perpetual preferred stock, less certain intangibles.  The remainder may consist of “Tier II Capital” which is defined as specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock and a limited amount of loan loss allowance.  Also, federal banking regulatory agencies have established minimum leverage capital requirements for banking organizations.  Under these requirements, banking organizations must maintain a minimum of Tier I Capital to adjusted average quarterly assets equal to 3% to 5%, subject to bank regulatory evaluation of an organization’s overall safety and soundness.  Under the federal banking regulations, a financial institution would be deemed to “adequately capitalized” or better if it exceeds the minimum federal regulatory capital requirements.  A financial institution would be deemed “undercapitalized” if it fails to meet the minimum capital requirements and significantly undercapitalized if it has a total risk based capital ratio that is less than 6%, Tier I risk based capital ratio is less than 3%, or a leverage ratio that is less than 3% and “critically undercapitalized” if the institution has a ratio of tangible equity to total assets that is equal to less than 2%.  USB and the Bank are “well-capitalized” for regulatory capital purposes based upon the most recent notification under regulatory framework for prompt corrective action.
 
On January 31, 2012, the Bank entered into a Consent Order with its primary regulators that requires 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%.  At a minimum, the Capital Plan must include 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.
 
As indicated in table below, the Bank’s risk-based capital ratios are above the general minimum requirements but below those required by the Consent Orders.  Management has developed a Capital Plan that includes profitability and external investment to improve its capital ratios. The Company and the Bank do not anticipate paying dividends in the near future.
 
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
June 30, 2013
Amount
Ratio
Amount
Ratio
Amount
Ratio
Total capital to risk-weighted assets:
           
     Consolidated
$4,429
10.60%
$3,342
8.00%
N/A
 
     Bank
4,429
10.60%
3,342
8.00%
$4,178
10.00%
Tier I capital to risk-weighted assets:
           
     Consolidated
3,904
9.35%
1,671
4.00%
N/A
 
     Bank
3,904
9.35%
1,671
4.00%
$2,507
6.00%
Tier I capital to average assets:
           
     Consolidated
3,904
6.27%
2,491
4.00%
N/A
 
      Bank
3,904
6.27%
2,491
4.00%
$3,114
5.00%


(In 000’s)                                                  
   
Actual
 For capital
 Adequacy purposes 
To be well capitalized under
Prompt corrective actions provisions
December 31, 2012
Amount
Ratio
Amount
Ratio
Amount
Ratio
Total capital to risk-weighted assets:
           
     Consolidated
$4,584
11.16%
$3,287
8.00%
N/A
 
     Bank
 4,584
11.16%
3,287
8.00%
$4,109
10.00%
Tier I capital to risk-weighted assets:
           
     Consolidated
4,070
9.91%
1,644
4.00%
N/A
 
     Bank
4,070
9.91%
1,644
4.00%
$2,465
6.00%
Tier I capital to average assets:
           
     Consolidated
4,070
6.00%
2,715
4.00%
N/A
 
      Bank
4,070
6.00%
2,715
4.00%
$3,394
5.00%

Results of Operations

Summary
The Company reported net income of approximately $96,000 ($0.09 per common share) for the quarter ended June 30, 2013 compared to a net loss of approximately $237,000 ($0.22 per common share) for the same quarter in 2012. The Company reported a net loss of approximately $243,000 ($0.23 per common share) for the six months ended June 30, 2013 compared to a net loss of approximately $475,000 ($0.45 per common share) for the same period in 2012. 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
June 30, 2013
               
Three months ended
June 30, 2012
       
(in 000’s)
 
Average Balance
   
Interest
   
Yield/Rate
   
Average Balance
   
Interest
   
Yield/Rate
 
                                     
Assets:
                                   
Interest-earning assets:
                                   
     Loans
  $ 41,128     $ 630       6.13 %   $ 42,355     $ 660       6.23 %
     Investment securities
    10,655       67       2.52       16,167       115       2.85  
     Federal funds sold
    6,241       3       0.19       6,700       3       0.18  
     Interest bearing balances with other banks
    306       -       -       305       1       1.31  
        Total interest-earning assets
    58,330       700       4.80       65,527       779       4.76  
Interest-bearing liabilities
                                               
     Demand deposits
    12,975       6       0.18       15,944       12       0.30  
     Savings deposits
    13,635       2       0.06       14,277       2       0.06  
     Time deposits
    16,253       12       0.30       18,941       20       0.42  
          Total interest-bearing liabilities
    42,863       20       0.19       49,162       34       0.28  
Net interest income
          $ 680                     $ 745          
Net yield on interest-earning assets
                    4.66 %                     4.55 %
 
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.
 
         
Six months ended
June 30, 2013
               
Six months ended
June 30, 2012
       
(in 000’s)
 
Average Balance
   
Interest
   
Yield/Rate
   
Average Balance
   
Interest
   
Yield/Rate
 
                                     
Assets:
                                   
Interest-earning assets:
                                   
     Loans
  $ 41,329     $ 1,258       6.09 %   $ 41,939     $ 1,320       6.29 %
     Investment securities
    11,942       154       2.56       16,285       234       2.87  
     Federal funds sold
    7,371       8       0.22       8,913       9       0.20  
     Interest bearing balances with other banks
    306       -       -       305       1       0.66  
        Total interest-earning assets
    60,948       1,420       4.66       68,618       1,582       4.61  
Interest-bearing liabilities
                                               
     Demand deposits
    14,111       15       0.21       16,359       25       0.31  
     Savings deposits
    13,947       3       0.04       14,477       4       0.06  
     Time deposits
    16,437       28       0.34       21,660       48       0.44  
          Total interest-bearing liabilities
    44,495       46       0.21       52,496       77       0.29  
Net interest income
          $ 1,374                     $ 1,505          
Net yield on interest-earning assets
                    4.51 %                     4.39 %
 
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 $65,000, or 8.72%, for the quarter ended June 30, 2013 compared to the same quarter in 2012. Net interest income declined approximately $130,000, or 8.69%, for the six months ended June 30, 2013 compared to the same period in 2012. However, the net yield on interest-earning assets improved compared to 2012 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 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 June 30, 2013
compared to 2012
   
Three months ended June 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
  $ (19 )   $ (11 )   $ (30 )   $ 9     $ (1 )   $ 8  
Investment securities
    (36 )     (13 )     (49 )     (18 )     (23 )     (41 )
Interest-bearing deposits with other banks
    -       -       -       -       -       -  
    Federal funds sold
    (1 )     1       -       (2 )     1       (1 )
Total Interest-earning assets
    (56 )     (23 )     (79 )     (11 )     (23 )     (34 )
Interest paid on:
                                               
Demand deposits
    (2 )     (4 )     (6 )     2       (10 )     (8 )
Savings deposits
    -       -               -       (1 )     (1 )
Time deposits
    (3 )     (5 )     (8 )     (9 )     (10 )     (19 )
Total interest-bearing liabilities
    (5 )     (9 )     (14 )     (7 )     (21 )     (28 )
Net interest income
  $ (51 )   $ (14 )   $ (65 )   $ 18     $ (28 )   $ (6 )
 

   
Six months ended June 30, 2013
compared to 2012
   
Six months ended June 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
  $ (19 )   $ (42 )   $ (61 )   $ (23 )   $ 23     $ -  
Investment securities
    (87 )     (12 )     (99 )     1       (59 )     (56 )
Interest-bearing deposits with other banks
    -       -       -       -       -       -  
    Federal funds sold
    (2 )     1       (1 )     (1 )     3       2  
Total Interest-earning assets
    (108 )     (53 )     (161 )     (46 )     (10 )     (56 )
Interest paid on:
                                               
Demand deposits
    (3 )     (7 )     (10 )     5       (17 )     12  
Savings deposits
    -       (1 )     (1 )     -       (3 )     (3 )
Time deposits
    (9 )     (11 )     (20 )     (12 )     (19 )     (31 )
Total interest-bearing liabilities
    (12 )     (19 )     (31 )     (7 )     (39 )     (46 )
Net interest income
    (96 )     (34 )   $ (130 )   $ (39 )   $ 29     $ (10 )
 
For the quarter ended June 30, 2013 compared to the same period in 2012, there was a decrease in net interest income of approximately $51,000 due to changes in volume and a decrease of approximately $14,000 due to changes in rate. For the six months ended June 30, 2013 compared to the same period in 2012, there was a decrease in net interest income of approximately $96,000 due to changes in volume and a decrease of approximately $35,000 due to changes in rate.
 
Average earning assets decreased compared to the same period in 2012; however, 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
There was a credit for loan losses of $55,000 for the quarter ended June 30, 2013 compared to a provision of $30,000 for the same quarter in 2012.  The provision for loan losses was a provision of approximately $15,000 for the six months ended June 30, 2013 compared to a provision of $60,000 for the same period in 2012. 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. The credit during the quarter relates to the recovery of a previously charged-off loan that resulted in an increase in the allowance for loan losses. (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 $375,000, or 134.45%, for the quarter ended June 30, 2013 compared to the same quarter in 2012 and increased approximately $376,000, or 79.52%, for the six months ended June 30, 2013 compared to the period in 2012.  The increase is primarily related to a gain on the sale of investment securities.


 
During the quarter ended June 30, 2013, in conjunction with a bond transaction, the Bank sold securities with a book value totaling approximately $7.4 million, for which a gain of approximately $378,000 was recognized. Proceeds from the sale were reinvested in replacement securities.

Customer service fees improved by approximately $6,000, or 5.81%, for the quarter ended June 30, 2013 compared to 2012 and improved by approximately $9,000, or 4.68%, for the six months ended June 30, 2013 compared to the same period in 2012. The increase is primarily related to a higher level of overdraft fees for several commercial customers.

The Bank serves as agent in the syndication of several credit facilities for national companies.  Loan syndication fees increased by approximately $8,000, or 10.38%, during the quarter and six months ended June 30, 2013 compared to 2012.  This increase is a result of incentive compensation for growth in the Comcast facility from $24 million to $32.3 million.

Noninterest Expense
Salaries and benefits decreased approximately $21,000, or 5.46%, for the quarter ended June 30, 2013 compared to 2012 and decreased approximately $58,000, or 7.13%, for the six months ended June 30, 2013 compared to the same period in 2012.  The reduction resulted from the severance of several personnel in the lending/credit administration area of the Bank as well as 2012 branch staff attrition. However, a business development officer was hired in January 2013 to support the shift to business banking.   In 2013, as required by the Consent Orders, management plans to hire additional experienced personnel to support the Bank’s business development and credit administration function.

Occupancy and equipment expense decreased approximately $2,000, or 0.63%, for the quarter ended June 30, 2013 compared to 2012 and decreased approximately $33,000, or 6.02%, for the six months ended June 30, 2013 compared to the same period in 2012.   The reduction is a result of the sale of the Bank’s former 38th and Lancaster Avenue branch in December 2012 and lower depreciation expense related to fully depreciated equipment. During the quarter ended June 30, 2013, management renegotiated and extended the lease of the Bank’s corporate office located at the Graham Building and related retail space for the relocation of the former 38th and Lancaster branch.  The new lease has a term of 10 years and will result in an annual reduction in lease expense of approximately $11,000.

Marketing and public relations expense was relatively unchanged when compared to the same quarter in 2012 but increased approximately $11,000, or 47.74%, for the six months ended June 30, 2013 compared to the same period in 2012.  In 2013, the Company increased its business banking marketing to support the shift in strategy away from consumer banking.

Professional services expense decreased approximately $1,000, or 1.21%, for the quarter ended June 30, 2013 compared to 2012 and decreased approximately $3,000, or 2.21%, for the six months ended June 30, 2013 compared to the same period in 2012.   In 2012, the Bank incurred increased legal and consulting expenses in conjunction with its Consent Orders.
 
Data processing expenses decreased approximately $7,000, or 5.64%, for the quarter ended June 30, 2013 compared to 2012 and decreased approximately $13,000, or 6.73%, for the six months ended June 30, 2013 compared to the same period in 2012.  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 $11,000 for the quarter ended June 30, 2013 compared to 2012 and increased approximately $47,000 for the six months ended June 30, 2013 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 Consent Orders also resulted in an estimated increase of $60,000 in the annual insurance premiums.
 
Net other real estate expenses increased approximately $57,000, or 85.28%, for the quarter ended June 30, 2013 compared to 2012 and increased approximately $110,000, or 191.21%, for the six months ended June 30, 2013 compared to the same period in 2012.  The increase was the result of net write-downs of other real estate properties totaling approximately $113,000 and $143,000for the quarter and six months ended June 30, 2013, respectively.
 
Loan and collection expenses increased approximately $6,000, or 17.85%, for the quarter ended June 30, 2013 compared to 2012 and decreased approximately $3,000, or 4.68%, for the quarter ended June 30, 2013 compared to the same period in 2012. The increase during the quarter is related to re-appraisal cost associated with impaired loans while the year-to-date decrease is directly related to a reduction in the level of foreclosure activity compared to the same period.


 
Dividend Restrictions
The Company has never declared or paid any cash or stock dividends.  The Pennsylvania Banking Code of 1965, as amended, provides that cash dividends may be declared and paid only from accumulated net earnings and that, prior to the declaration of any dividend, if the surplus of a bank is less than the amount of its capital, the bank shall, until surplus is equal to such amount, transfer to surplus an amount which is at least ten percent (10%) of the net earnings of the bank for the period since the end of the last fiscal year or any shorter period since the declaration of a dividend.  If the surplus of a bank is less than fifty percent (50%) of the amount of its capital, no dividend may be declared or paid by the Bank without the prior approval of the Pennsylvania Department of Banking.
 
Under the Federal Reserve Act, the Federal Reserve Board has the power to prohibit the payment of cash dividends by a bank holding company if it determines that such a payment would be an unsafe or unsound practice or constitutes a serious risk to the financial soundness or stability of the subsidiary bank.  As a result of these laws and regulations, the Bank, and therefore the Company, whose only source of income is dividends from the Bank, will be unable to pay any dividends while an accumulated deficit exists.  The Company does not anticipate that dividends will be paid for the foreseeable future.
 
Item 3.  Quantitative and Qualitative Disclosures about Market Risk

Not applicable.
 
Item 4.  Controls and Procedures
 
As of June 30, 2013, 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 and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b), as adopted by the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (“Exchange Act”). The Company had previously reported that, as of December 31, 2012, it had identified material weaknesses in its internal control in connection with the identification and assessment of impaired loans and the valuation of certain other real estate owned as described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.  While the Company made progress in remediating the deficiencies in its internal controls over financial reporting relating to the weaknesses noted in its 2012 Annual Report, there was an insufficient period of time to determine whether those processes that were implemented were operating effectively as of June 30, 2013. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were not effective as of the end of the period covered by this report.

To address the material weaknesses, we have established the following policies:  (1) our current foreclosed real estate policy is to obtain annual valuations, through either appraisals or valuations on foreclosed properties in accordance with regulatory guidance.  We have revised our policy to require updated valuations, when necessary, based on information received when a foreclosed property is sold and require the prompt recording of any loss on the sale of foreclosed property.  When performing updates to valuations, we will use a discount to offset or adjust all valuations appropriately.  The valuation adjustments will be based on the age of the last valuation in the file and known market conditions, and (2) in addition to the existing third party external review and asset quality meetings, Management will enhance its review to a level of precision necessary to identify impaired loans and make any needed adjustments for loan losses.  Management believes that these changes will contribute significantly to the remediation of the material weaknesses in the financial controls that was in existence as of December 31, 2012. Additional changes will be implemented as determined necessary.
 
Although our remediation efforts are well underway and are expected to be completed in the near future, our material weaknesses will not be considered remediated until new internal controls are operational for a period of time and are tested, and management concludes that these controls are operating effectively.
 
The Company continually seeks to improve the effectiveness and efficiency of its internal control over financial reporting.  Except for remediation efforts to correct the weaknesses identified in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, there have been no changes to the Company’s internal control over financial reporting during the period ended June 30, 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


 
 
Item 1. Legal Proceedings.
 
The Bank is a defendant in certain claims and legal actions arising in the ordinary course of business.  In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial condition of the Company.
 
Item 1A. Risk Factors.
 
There have not been any material changes to the risk factors disclosed in the Company’s 2012 Annual Report on Form 10-K except as disclosed below.  The risk factors disclosed in the Company’s 2012 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 June 30, 2013, the Bank’s tier one leverage capital ratio was 6.27% and its total risk based capital ratio was 10.60%.  Refer to 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 10.1 Second Amendment to Lease, dated March 28, 2013, between 30 South 15th Associates L.P. and United Bank of Philadelphia.
 
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.
 

 
Signatures
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 

 
UNITED BANCSHARES, INC.

 

Date:  August 14, 2013
/s/ Evelyn F. Smalls
 
Evelyn F. Smalls
 
President & Chief Executive Officer
   
   
Date: August 14, 2013
/s/ Brenda M. Hudson-Nelson
 
Brenda Hudson-Nelson
 
Executive Vice President/Chief Financial Officer


 

 
Index to Exhibits-FORM 10-Q
 
Exhibit 10.1
Second Amendment to Lease, dated March 28, 2013, between 30 South 15th Associates L.P. and United Bank of Philadelphia.
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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