UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion provides additional information relating to the financial condition and results of operations of United Bancshares, Inc.
PERFORMANCE SUMMARY
Consolidated net income for United Bancshares, Inc. (the “Corporation”) and its wholly-owned subsidiary, The Union Bank Company (the “Bank”), was $2.9 million in 2009 compared to $4.4 million in 2008 and $4.6 million in 2007.
Net income in 2009 as compared to 2008 was unfavorably impacted by a $5.3 million increase in the provision for loan losses, and favorably impacted by a $1.1 million increase in net interest income, a $1.8 million increase in non-interest income, and an $855,000 decrease in the provision for federal income taxes. The increase in the provision for loan losses is more fully explained in the “Provision for Loan Losses and the Allowance for Loan Losses” section. The increase in net interest income is due to an improvement in the Corporation’s net interest margin from 3.64% in 2008 to 3.75% in 2009, as well as a slight increase in the level of average interest-earning assets in 2009 as compared to 2008. The increase in non-interest income is largely attributable to secondary market lending activities. The decrease in federal income taxes is reflective of the decrease in the Corporation&# 146;s income before federal income taxes.
The Corporation’s return on average assets was .47% in 2009, compared to .74% in 2008, and .83% in 2007. The Corporation’s return on average shareholders’ equity was 5.45% in 2009, 8.87% in 2008, and 9.69% in 2007. Basic net income per share was $0.84 in 2009, a decrease of $.44 per share from $1.28 in 2008. Basic net income per share was $1.28 in 2008, a decrease of $.02 per share from $1.30 in 2007. Changes in these amounts from year to year were generally reflective of changes in the level of net income.
The Corporation’s assets increased slightly to $616.4 million at December 31, 2009, compared to $616.1 million at December 31, 2008. Loans (including loans held for sale) decreased $10.6 million, or 2.6%, to $407.8 million at December 31, 2009, compared to $418.4 million at December 31, 2008. The decrease in loans resulted from continued soft loan demand in the Corporation’s market area, the selling of substantially all fixed rate mortgage loans originated in 2009, and $5.9 million of net loan charge-offs recognized in 2009. Deposits increased $4.9 million, or 1.1%, to $469.7 million at December 31, 2009, from $464.8 million at December 31, 2008. Shareholders' equity at December 31, 2009 was $54.3 million, a 7.2% increase compared to $50.7 million at December 31, 2008.
RESULTS OF OPERATIONS – 2009 Compared to 2008
Net Interest Income
Net interest income, which represents the revenue generated from interest-earning assets in excess of the interest cost of funding those assets, is the Corporation's principal source of income. Net interest income is influenced by market interest rate conditions and the volume and mix of interest-earning assets and interest-bearing liabilities. Many external factors affect net interest income and typically include the strength of client loan demand, client preference for individual deposit account products, competitors’ loan and deposit product offerings, the national and local economic climates, and Federal Reserve monetary policy.
4
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS – 2009 Compared to 2008 (CONTINUED)
Net Interest Income, Continued
Net interest income for 2009 was $20.6 million, an increase of $1.1 million (5.9%) from 2008. The increase in net interest income was primarily due to an overall increase in the Corporation’s net margin. The average yield on loans for 2009 decreased to 6.04% compared to 7.15% in 2008, and the average rate on interest-bearing liabilities decreased to 2.41% in 2009 from 3.12% in 2008. The net effect of these and other factors resulted in the net interest yield on average interest-earning assets, on a tax-equivalent basis, increasing in 2009 to 3.75% from 3.64% in 2008.
Provision for Loan Losses and the Allowance for Loan Losses
The Corporation’s loan policy provides guidelines for managing both credit risk and asset quality. The policy details acceptable lending practices, establishes loan-grading classifications, and prescribes the use of a loan review process. The Bank has a credit administration department that performs regular credit file reviews which facilitate the timely identification of problem or potential problem credits, ensure sound credit decisions, and assist in the determination of the allowance for loan losses. The Bank also engages an outside credit review firm to supplement the credit analysis function and to provide an independent assessment of the loan review process. The loan policy, loan review process, and credit analysis function facilitate management's evaluation of the credit risk inherent in the lending function.
As mentioned, ongoing reviews are performed to identify potential problem and nonperforming loans and also provide in-depth analysis with respect to the quarterly allowance for loan losses calculation. Part of this analysis involves accessing the need for specific reserves relative to impaired loans. This evaluation typically includes a review of the recent performance history of the credit, a comparison of the estimated collateral value in relation to the outstanding loan balance, the overall financial strength of the borrower, industry risks pertinent to the borrower, and competitive trends that may influence the borrower’s future financial performance. Loans are considered impaired when, based upon the most current information available, it appears probable that the borrower will not be able to make payments according to the contractual terms of the loan agreement. Impaired loans are recor ded at the observable market price of the loan, the fair value of the underlying collateral (if the loan is collateral dependent), or the present value of the expected future cash flows discounted at the loan's effective interest rate. Given that the Bank’s impaired loans are typically collateralized by real estate or other borrower assets, the fair value of individual impaired loans is most often based upon the underlying collateral value. Large groups of smaller balance homogenous loans are collectively evaluated for impairment.
To determine the allowance for loan losses, the Bank prepares a detailed analysis that focuses on delinquency trends, the status of nonperforming loans (i.e., impaired, nonaccrual, restructured, and past due 90 days or more), current and historical trends of charged-off loans within each loan category (i.e., commercial, real estate, and consumer), existing local and national economic conditions, and changes within the volume and mix in each loan category. Higher loss rates are applied in calculating the allowance for loan losses relating to potential problem loans. The loss rates are periodically evaluated considering historic loss rates in the respective potential problem loan categories (i.e., special mention, substandard, doubtful) and current trends.
5
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS – 2009 Compared to 2008 (CONTINUED)
Provision for Loan Losses and the Allowance for Loan Losses, Continued
Regular provisions are made in amounts sufficient to maintain the balance in the allowance for loan losses at a level considered by management to be adequate for losses within the portfolio. Even though management uses all available information to assess possible loan losses, future additions or reductions to the allowance may be required as changes occur in economic conditions and specific borrower circumstances. The regulatory agencies that periodically review the Bank’s allowance for loan losses may also require additions to the allowance or the charge-off of specific loans based upon the information available to them at the time of their examinations.
The allowance for loan losses at December 31, 2009 was $4.8 million, or 1.18% of total loans, compared to $3.2 million, or 0.76% of total loans at December 31, 2008. The change in the allowance for loan losses during 2009 included a $7.5 million provision for loan losses charged to operations and loan charge-offs, net of recoveries, of $5.9 million.
The provision for loan losses charged to operations is determined by management after considering the amount of net losses incurred as well as management’s estimation of losses inherent in the portfolio based on an evaluation of loan portfolio risk and current economic factors. The provision for loan losses of $7.5 million in 2009 compares to a provision of $2.2 million in 2008. The significant increase in the provision for loan losses in 2009, as compared to 2008, resulted from many factors, including an increase in the level of net loan charge-offs ($5.9 million in 2009 compared to $1.2 million in 2008) and an increase in the level of problem and potential problem loans. Net loan charge-offs in 2009 included $3.6 million relating to a commercial credit whose business operations ceased during the fourth quarter of 2009.
The Bank considers a loan to be impaired when it becomes probable that the Bank will be unable to collect under the contractual terms of the loan, based on current information and events. Impaired loans, principally consisting of commercial and commercial real estate credits, amounted to $13.2 million at December 31, 2009 compared to $5.6 million at December 31, 2008, an increase of $7.6 million. Impaired loans at December 31, 2009, included $8.2 million of loans with no specific reserves included in the allowance for loan losses and $5.0 million of loans with specific reserves of $1.2 million included in the Bank’s December 31, 2009 allowance for loan losses. Impaired loans at December 31, 2009 with no specific reserve, includes $3.5 million of loans which were charged down during 2009. The $5.6 million of impaired loans at December 31, 2008 included $5.4 million of loans with $1.1 million o f specific reserves included in the December 31, 2008 allowance for loan losses.
In addition to impaired loans, the Bank had other potential problem credits of $28.0 million at December 31, 2009 compared to $15.7 million at December 31, 2008, an increase of $12.3 million (78.3%). The Bank’s credit administration department continues to closely monitor these credits.
6
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS – 2009 Compared to 2008 (CONTINUED)
Non-Interest Income
Total non-interest income increased $1.8 million (68.0%) to $4.5 million in 2009 from $2.7 million in 2008. With the exception of securities gains and losses, most of the components of non-interest income are recurring, although certain components are more susceptible to change than others. Net securities gains increased slightly in 2009 to $129,000 compared to $49,000 in 2008.
Significant recurring components of non-interest income include service charges on deposit accounts, secondary market lending activities, and increases in the cash surrender value of life insurance. Service charges on deposit accounts decreased $184,000 (12.1%) to $1,331,000 in 2009 compared to $1,515,000 in 2008. This decrease appears to largely be attributable to changes in customer savings patterns.
The Bank has elected to sell in the secondary market substantially all fixed rate residential real estate loans originated, and typically retains the servicing rights relating to such loans. During 2009, the net gain on sale of loans was $1,376,000, including $612,000 of capitalized servicing rights. The net gain on sale of loans was $346,000 in 2008, including $147,000 of capitalized servicing rights. The significant increase in the net gain on sale of loans was attributable to the dramatic increase in loan sales activities between the two years with loan sales in 2009 amounting to $65.6 million compared to $16.0 million in 2008. Much of this activity occurred during the first and second quarters of 2009 and resulted from the significant decline in long-term mortgage interest rates that occurred during the latter part of the fourth quarter of 2008. Despite the significant loan sales activit y experienced during 2009, the Bank’s serviced portfolio remained relatively unchanged increasing only $2.6 million to $190.1 million at December 31, 2009, which is evidence of the significant impact borrower refinancing had on the 2009 loan sales activity.
The Bank reports its mortgage servicing rights using the fair value measurement method. As a result, the Corporation recognized a $195,000 increase in the fair value of mortgage servicing rights during 2009, compared to a $649,000 decrease in the fair value of mortgage servicing rights in 2008, a comparative $844,000 positive impact on income before income taxes. Prepayment assumptions are a key valuation input used in determining the fair value of mortgage servicing rights. While prepayment assumptions are constantly subject to change, such changes typically occur within a relatively small parameter from period to period. However, due to declines in the secondary market mortgage rates experienced during the fourth quarter of 2008, the prepayment assumptions used in determining the fair value of servicing at December 31, 2008 was 630 compared to 244 at December 31, 2007 which largely contributed to the significant decline in fair value of servicing experienced in 2008. As long-term mortgage rates stabilized in 2009, the prepayment assumptions returned to a more normal level of 300 at December 31, 2009.
7
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS – 2009 Compared to 2008 (CONTINUED)
Non-Interest Expenses
Total non-interest expenses amounted to $14,479,000 in 2009, compared to $14,463,000 in 2008, an increase of $16,000 (0.1%). Non-interest expenses for 2009 included a $1,077,000 increase in the Bank’s Federal Deposit Insurance Corporation (FDIC) expense. The Bank also experienced an increase in professional fees of $134,000 (24.3%) with much of the increase resulting from loan collection costs. Conversely, the Corporation experienced decreases in several non-interest expense categories during 2009 as compared to 2008, including OREO and other asset impairment costs ($340,000); ATM processing and other fees ($223,000); salaries, wages, and employee benefits ($197,000); dealer reserve ($98,000); advertising ($71,000); seminars and training ($66,000); and franchise tax ($48,000).
The significant increase in FDIC premium assessments was due to increased deposit premium rates as well as the FDIC Special Assessment ruling issued on May 22, 2009, which required all insured depository institutions to pay a special assessment equal to the lesser of 5 basis points on total assets less Tier 1 capital, or 10 basis points on total deposits. The decrease in salaries and wages was largely related to decreases in bonuses and other discretionary compensation. The significant components of other operating expenses are summarized in Note 12 to the consolidated financial statements.
Provision for Income Taxes
The provision for income taxes for 2009 was $156,000, an effective tax rate of 5.1%, compared to $1,011,000 in 2008, an effective rate of 18.6%. The significant decrease in the effective tax rate in 2009, as compared to 2008, primarily resulted from tax-exempt sources of income from securities and life insurance earnings comprising 82.6% of income before income taxes in 2009 compared to 44.3% in 2008. For the year ended December 31, 2009, the Corporation was subject to alternative minimum tax of $294,000. The Corporation can recover the resulting alternative minimum tax credits in the future to the extent regular tax exceeds the alternative minimum tax.
FINANCIAL POSITION – 2009 Compared to 2008
Securities
Management monitors the earnings performance and liquidity of the securities portfolio on a regular basis through Asset/Liability Committee (“ALCO”) meetings. As a result, all securities, except Federal Home Loan Bank of Cincinnati (FHLB) stock, have been designated as available-for-sale and may be sold if needed for liquidity, asset-liability management or other reasons. Such securities are reported at fair value, with any net unrealized gains or losses reported as a separate component of shareholders’ equity, net of related income taxes.
8
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
FINANCIAL POSITION – 2009 Compared to 2008 (CONTINUED)
Securities, Continued
Securities, including FHLB stock, totaled $143.5 million at December 31, 2009 compared to $141.4 million at December 31, 2009, an increase of $2.1 million (1.5%). The amortized cost of the securities portfolio actually decreased $2.1 million due to sales and maturities of securities exceeding purchases in 2009. However, the Bank experienced net unrealized gains on securities of $4.2 million during 2009.
The Bank is required to maintain a certain level of FHLB stock based on outstanding borrowings from the FHLB. FHLB stock is considered a restricted security which is carried at cost and evaluated periodically for impairment. There were no purchases or sales of FHLB stock during 2009.
At December 31, 2009, net unrealized gains on available-for-sale securities, net of income taxes, amounted to $2.4 million compared to net unrealized losses on available for sale securities, net of income taxes, of $412,000 at December 31, 2008. At December 31, 2009, the Bank held 33 securities which were in a loss position with the fair value and gross unrealized losses of such securities amounting to $26.9 million and $464,000, respectively. Management has considered the current interest rate environment, typical volatilities in the bond market, and the Bank’s liquidity needs in the near term in concluding that the impairment on these securities is temporary.
Loans
At December 31, 2009, total loans (including loans held for sale) amounted to $407.9 million compared to $418.4 million at December 31, 2008, a decrease of $10.5 million (2.5%). Most categories within the loan portfolio decreased during 2009, with residential real estate loans decreasing $22.5 million (17.3%), agriculture loans decreasing $3.6 million (4.9%), and consumer loans decreasing $5.8 million (29.7%). Commercial loans increased $21.7 million (11.2%). The overall decrease in the loan portfolio is attributable to continued slow economic conditions experienced throughout the Corporation’s market area and tightening credit underwriting standards. The decrease in consumer loans is partially due to the continued residual effect of the Corporation’s decision to cease indirect automobile lending as of June 30, 2008.
Other Assets
During 2009, other real estate owned (OREO) increased $4.9 million to $5.2 million at December 31, 2009, compared to $250,000 at December 31, 2008. This increase was primarily attributable to a real estate development loan client who ceased operations during the fourth quarter of 2009. In December 2009, the Bank accepted from the customer deeds in lieu of foreclosure to various residential and non-residential real estate properties resulting in a $3.6 million transfer to OREO. During 2009, the Bank sold various properties from OREO and recognized a write-down on a property held in OREO at December 31, 2009, resulting in an overall loss on sale or write-down of OREO of $30,000.
9
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
FINANCIAL POSITION – 2009 Compared to 2008 (CONTINUED)
Other Assets, Continued
On September 29, 2009, the FDIC adopted a Notice of Proposed Rulemaking (NPR) mandating that insured depository institutions prepay their quarterly risk-based assessments to the FDIC for the fourth quarter of 2009 and for all of years 2010 through 2012 on December 30, 2009 when they pay their risk-based assessment for the third quarter of 2009. The assessments are expected to address the FDIC’s short-term liquidity needs. While the FDIC may use the prepaid premiums to pay resolution costs, the FDIC cannot immediately include the premiums in the calculation of the deposit insurance fund reserve. Under the plan, each depository institution would record the entire amount of its prepayment as an asset, and each depository would record an expense for its calculated regular quarterly assessment and a credit to the prepaid asset until the asset is exhausted. Accordingly, as of December 31, 2009, the Bank had prepaid FDIC assessments of $2.6 million to relating to years 2010 through 2012 and such amount was included in other assets.
Deposits
Total deposits at December 31, 2009 amounted to $469.7 million, an increase of $4.9 million (1.1%) compared with total deposits of $464.8 million at December 31, 2008. Of this increase, $4.0 million was related to non-interest bearing deposits. The change in deposits during 2009 also included a decrease of $20.0 million in brokered deposits. At December 31, 2009, brokered deposits amounted to $15.0 million, or 3.2% of total deposits.
Other Borrowings
The Bank also utilizes other borrowings as an alternative source of funding, as necessary, to support asset growth and periodic deposit shrinkage. Other borrowings, consisting of FHLB advances and customer repurchase agreements, amounted to $77.9 million at December 31, 2009, compared to $86.3 million at December 31, 2008, a decrease of $8.3 million (10.7%). This decrease in other borrowings included a $9.5 million decrease in FHLB borrowings and the maturity during 2009 of a $5.0 million security sold under agreement to repurchase that was outstanding at December 31, 2008, offset by a $6.2 million increase in customer repurchase agreements.
RESULTS OF OPERATIONS – 2008 Compared to 2007
Net interest income for 2008 was $19.4 million, an increase of $2.0 million (11.5%) from 2007. The increase in net interest income primarily resulted from a $1.6 million decrease in interest expense. The average yield on loans for 2008 decreased to 7.15% compared to 7.89% in 2007, and the average rate on interest-bearing liabilities decreased to 3.12% in 2008 from 3.77% in 2007. The net effect of these and other factors resulted in the net interest yield on average interest-earning assets, on a tax-equivalent basis, increasing slightly in 2008 to 3.64% from 3.61% in 2007.
10
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
RESULTS OF OPERATIONS – 2008 Compared to 2007 (CONTINUED)
The allowance for loan losses at December 31, 2008 was $3.2 million, or 0.76% of total loans, compared to $2.2 million, or 0.62% of total loans at December 31, 2007. The change in the allowance for loan losses during 2008 included a $2.2 million provision for loan losses charged to operations and loan charge-offs, net of recoveries, of $1.2 million.
The provision for loan losses of $2.2 million in 2008 compared to a provision of $625,000 in 2007. The increase in the provision for loan losses in 2008, as compared to 2007, resulted from many factors including an increase in the level of net loan charge-offs ($1.2 million in 2008 compared to $668,000 in 2007), loan portfolio growth, and an increase in the level of impaired loans during the year. Impaired loans and the amount of allowance for loan losses allocated to such loans amounted to $5.6 million and $1.1 million, respectively, at December 31, 2008, compared to $3.2 million and $367,000, respectively, at December 31, 2007.
Total non-interest income decreased $290,000 (9.8%) to $2.7 million in 2008 from $3.0 million in 2007. Significant non-recurring components of non-interest income include a gain from the sale of the Bank’s credit card portfolio of $355,000 in 2007, and security gains (losses) which had a positive impact of $275,000 on income before income taxes in 2008 with the Bank recognizing net securities gains of $49,000 in 2008 compared to net security losses of $226,000 in 2007. Service charges on deposit accounts increased $43,000 (2.9%) to $1,515,000 in 2008 compared to $1,472,000 in 2007.
The net gain on sale of residential real estate loans increased $16,000 to $346,000 in 2008 from $330,000 in 2007 due to increased loan origination volume. During 2008, the Bank sold $16.0 million of residential real estate loans compared to $14.6 million in 2007. The increased loan sales activity in 2008 resulted from lower interest rates, especially during the latter part of the year, which caused an increase in refinancing and mortgage loan origination activity. Net gain on sale of loans included $147,000 of capitalized servicing rights in 2008 and $153,000 of capitalized servicing rights in 2007.
In 2008, the Corporation recognized a $649,000 decrease in the fair value of mortgage servicing rights compared to a $364,000 decrease in 2007. Due to the declines in the secondary market mortgage rates experienced during the fourth quarter of 2008, the prepayment assumptions used to determine the fair value of servicing increased dramatically which caused a significant decrease in the fair value of the Bank’s servicing rights. Income from the increase in cash surrender value of life insurance increased $45,000 to $493,000 in 2008 from $448,000 in 2007.
Total non-interest expenses increased $445,000 (3.2%) to $14,463,000 in 2008. Included in non-interest expenses in 2008 was a $235,000 impairment loss relating to the Bank’s downtown Lima branch office. Salaries, wages and benefits increased $387,000 (5.3%) to $7,628,000 in 2008 from $7,241,000 in 2007. Occupancy expenses, which include costs relating to the operation and maintenance of buildings, furnishings, and equipment, decreased $78,000 (5.2%) to $1,430,000 in 2008, from $1,508,000 in 2007. Other operating expenses increased $137,000 (2.6%) to $5,405,000 in 2008 compared to $5,268,000 in 2007.
The provision for income taxes for 2008 was $1,011,000 (effective rate of 18.6%) compared to $1,161,000 (effective rate of 20.2%) in 2007. This decrease resulted from a $311,000 decrease in income before taxes.
11
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
FINANCIAL POSITION – 2008 Compared to 2007
Securities, including FHLB stock, totaled $141.4 million at December 31, 2008, representing a decrease of $1.2 million (0.8%) from the comparative total of $142.6 million at December 31, 2007. There were no purchases or sales of FHLB stock during 2008.
At December 31, 2008, net unrealized losses on available-for-sale securities, net of income taxes, amounted to $412,000. At December 31, 2008, the Bank held 76 securities which were in a loss position with the fair value and gross unrealized losses of such securities amounting to $43.4 million and $2.2 million, respectively. Management considered the current interest rate environment, typical volatilities in the bond market, and the Bank’s liquidity needs in the near term in concluding that the impairment on these securities was temporary.
At December 31, 2008, total loans (including loans held for sale) amounted to $418.4 million compared to $359.6 million December 31, 2007, an increase of $58.8 million (16.4%). Loans held for sale decreased to $242,000 at December 31, 2008 from $350,000 at December 31, 2007. Within the loan portfolio, residential real estate loans increased $19.6 million (17.8%), commercial loans increased $37.5 million (24.0%), and agriculture loans increased $8.4 million (12.7%), while consumer loans decreased $6.6 million (25.0%) during 2008. Most of the loan growth in 2008 was considered within the Corporation’s primary lending area, defined as being less than 100 miles from one of the Corporation’s banking centers. The decrease in consumer loans was partially due to the decision in late 2007 to limit indirect automobile lending.
Total deposits at December 31, 2008 amounted to $464.8 million, an increase of $71.6 million (18.2%) compared with total deposits of $393.2 million at December 31, 2007. Of this increase, $32.6 million was attributable to brokered time deposits and only $377,000 was related to non-interest bearing deposits.
Other borrowings, consisting of FHLB advances, securities sold under agreements to repurchase, and customer repurchase agreements, amounted to $86.3 million at December 31, 2008, compared to $91.9 million at December 31, 2007, a decrease of $5.6 million (6.1%).
LIQUIDITY
Liquidity relates primarily to the Corporation’s ability to fund loan demand, meet the withdrawal requirements of deposit customers, and provide for operating expenses. Assets used to satisfy these needs consist of cash and due from banks, federal funds sold, securities available-for-sale, and loans held for sale. A large portion of liquidity is provided by the ability to sell or pledge securities. Accordingly, the Corporation has designated all securities other than FHLB stock as available-for-sale. A secondary source of liquidity is provided by various lines of credit facilities available through correspondent banks and the Federal Reserve.
Another source of liquidity is represented by loans held for sale. Certain other loans within the Bank’s loan portfolio are also available to collateralize borrowings.
The consolidated statements of cash flows for the years presented provide an indication of the Corporation’s sources and uses of cash as well as an indication of the ability of the Corporation to maintain an adequate level of liquidity. A discussion of cash flows for 2009, 2008, and 2007 follows.
12
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
LIQUIDITY (CONTINUED)
The Corporation generated cash from operating activities of $5.6 million in 2009, $8.3 million in 2008, and $7.1 million in 2007.
Net cash flows from investing activities amounted to $1.7 million in 2009, $(60.9) million in 2008, and $4.9 million in 2007. The only significant investing cash flow activities in 2009 included $2.3 million of net cash inflows from securities proceeds (sales and maturities) net of purchases, and $710,000 to fund net loan growth. Investing cash outflows of $60.4 million in 2008 were used to fund loan growth. Other significant investing cash flow activities in 2008 included $1.7 million of net cash inflows from securities activity, and $2.5 million of premises and equipment purchases. Most of the 2008 premises and equipment additions were related to the re-construction of the Bank’s Ottawa branch office and the purchase and renovation of the Bank’s new Lima Shawnee branch office. Cash flows used for investing activities in 2007 included $26.8 million of loan portfolio growth offset by $31 .1 million in proceeds from the sales or maturities of available-for-sale securities, net of related purchases.
Net cash flows from financing activities amounted to $(5.5) million in 2009, $63.2 million in 2008, and $(9.2) million in 2007. Net cash used in financing activities in 2009 primarily resulted from an $8.3 million net reduction in other borrowings and the payment of $2.1 million ($.60 per share) of cash dividends, offset by customer deposit growth of $4.9 million. Deposit growth provided a $71.6 million financing funding source in 2008. Cash outflows from financing activities in 2008 included a $5.6 million net reduction in other borrowings, $775,000 for the purchase of 55,000 shares of stock under the Corporation’s stock buyback program, and the payment of $2.1 million ($.60 per share) of cash dividends. The use of cash flow for financing activities in 2007 primarily resulted from a $21.8 million net reduction in other borrowings, $1.3 million for the purchase of 86,500 shares of stock under the Corporation’s stock buyback program, and the payment of $2.0 million ($.56 per share) of cash dividends, offset by customer deposit growth of $15.8 million.
ASSET LIABILITY MANAGEMENT
Closely related to liquidity management is the management of interest-earning assets and interest-bearing liabilities. The Corporation manages its rate sensitivity position to avoid wide swings in net interest margins and to minimize risk due to changes in interest rates.
The difference between a financial institution’s interest rate sensitive assets (assets that will mature or reprice within a specific time period) and interest rate sensitive liabilities (liabilities that will mature or reprice within the same time period) is commonly referred to as its “interest rate sensitivity gap” or, simply, its “gap”. An institution having more interest rate sensitive assets than interest rate sensitive liabilities within a given time interval is said to have a “positive gap”. This generally means that, when interest rates increase, an institution’s net interest income will increase and, when interest rates decrease, the institution’s net interest income will decrease. An institution having more interest rate sensitive liabilities than interest rate sensitive assets within a given time interval is said to have a “negative gap” . This generally means that, when interest rates increase, the institution’s net interest income will decrease and, when interest rates decrease, the institution’s net interest income will increase. The Corporation’s one year cumulative gap at December 31, 2009 is approximately 90% which means the Bank has more liabilities than it does assets re-pricing within one year.
13
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
EFFECTS OF INFLATION
The assets and liabilities of the Corporation are primarily monetary in nature and are more directly affected by fluctuations in interest rates than inflation. Movement in interest rates is a result of the perceived changes in inflation as well as monetary and fiscal policies. Interest rates and inflation do not necessarily move with the same velocity or within the same period; therefore, a direct relationship to the inflation rate cannot be shown. The financial information presented in the Corporation’s consolidated financial statements has been presented in accordance with generally accepted accounting principles, which require that the Corporation measure financial position and operating results primarily in terms of historical dollars.
SIGNIFICANT ACCOUNTING POLICIES
The Corporation’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the commercial banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements. These estimates, assumptions, and judgments are based upon the information available as of the date of the financial statements.
The Corporation’s most significant accounting policies are presented in Note 1 to the consolidated financial statements. These policies, along with other disclosures presented in the Notes to Consolidated Financial Statements and Management’s Discussion and Analysis, provide information about how significant assets and liabilities are valued in the financial statements and how those values are determined. Management has identified the determination of the allowance for loan losses, and the valuation of goodwill and mortgage servicing rights as the areas that require the most subjective and complex estimates, assumptions and judgments and, as such, could be the most subjective to revision as new information becomes available.
As previously noted, a detailed analysis to assess the adequacy of the allowance for loan losses is performed. This analysis encompasses a variety of factors including the potential loss exposure for individually reviewed loans, the historical loss experience for each loan category, the volume of non-performing loans, the volume of loans past due 30 days or more, a segmentation of each loan category by internally-assigned risk grades, an evaluation of current local and national economic conditions, any significant changes in the volume or mix of loans within each category, a review of the significant concentrations of credit, and any legal, competitive, or regulatory concerns.
Management considers the valuation of goodwill resulting from the 2003 Gibsonburg and Pemberville branch acquisitions through an annual impairment test which considers, among other things, the assets and equity of the Corporation as well as price multiples for sales transactions involving other local financial institutions. Management engaged an independent valuation specialist to perform a goodwill impairment evaluation as of September 30, 2009 which supported management’s assessment that no impairment adjustments to goodwill were warranted. To date, none of the goodwill evaluations have revealed the need for an impairment charge. Management does not believe that any significant conditions have changed relating to the goodwill assessment through December 31, 2009.
14
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Mortgage servicing rights are recognized when acquired through sale of mortgage loans and are reported at fair value. Changes in fair value are reported in net income for the period the changes occur. The Bank generally estimates fair value for servicing rights based on the present value of future expected cash flows, using management’s best estimates of the key assumptions – credit losses, prepayment speeds, servicing costs, and discount rates commensurate with the risks involved. The Bank has engaged an independent consultant to calculate the fair value of mortgage servicing rights on a quarterly basis. Management regularly reviews the calculation, including assumptions used in making the calculation and discusses with the consultant. Management also reconciles information used by the consultant, with respect to the Bank’s serviced portfolio, to the Bank’s accounting records. ;
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
A summary of new accounting standards adopted or subject to adoption in 2009, as well as newly-issued but not effective accounting standards at December 31, 2009, is presented in Note 2 to the consolidated financial statements. In addition, the Corporation adopted the provisions of FASB ASC 820-10, with respect to disclosure of fair value measurements for nonfinancial assets and liabilities as more fully disclosed in Note 20 to the consolidated financial statements.
OFF-BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS, AND CONTINGENT LIABILITIES AND COMMITMENTS
The following table summarizes loan commitments, including letters of credit, as of December 31, 2009:
| | | | | | | | | | |
| | | Amount of commitment to expire per period |
| | | Total Amount | | Less than 1 year | | 1 - 3 years | | 4 – 5 years | | Over 5 years |
| | | | | (Dollars in thousands) |
Type of commitment | | | | |
Commercial lines-of-credit | $ | 34,344 | $ | 32,974 | $ | 319 | $ | - | $ | 1,051 |
Real estate lines-of-credit | | 31,918 | | 1,612 | | 9,672 | | 4,682 | | 15,952 |
Consumer lines-of-credit | | 9 | | 9 | | - | | - | | - |
Letters of Credit | | 1,067 | | 1,067 | | | | | | |
Guarantees | | - | | - | | - | | - | | - |
| | | | | | | | | | | |
Total commitments | $ | 67,338 | $ | 35,662 | $ | 9,991 | $ | 4,682 | $ | 17,003 |
15
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
OFF-BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS, AND CONTINGENT LIABILITIES AND COMMITMENTS(CONTINUED)
As indicated in the preceding table, the Corporation had $67.3 million in total loan commitments at December 31, 2009, with $35.7 million of that amount expiring within one year. All lines-of-credit represent either fee-paid or legally binding loan commitments for the loan categories noted. Letters-of-credit are also included in the amounts noted in the table since the Corporation requires that each letter-of-credit be supported by a loan agreement. The commercial and consumer lines represent both unsecured and secured obligations. The real estate lines are secured by mortgages in residential and nonresidential property. Many of the commercial lines are due on a demand basis, and are established for seasonal operating purposes. It is anticipated that a significant portion of these lines will expire without being drawn upon.
The following table summarizes the Corporation’s contractual obligations as of December 31, 2009:
| | | | | | | | | | |
| | | Payments due by period |
| | | Total Amount | | Less than 1 year | | 1 - 3 years | | 4 – 5 years | | Over 5 years |
| | | | | (Dollars in thousands) |
Contractual obligations | | | | | | | | | | |
Long-term debt | $ | 76,450 | $ | 21,532 | $ | 27,055 | $ | 32 | $ | 27,831 |
Capital leases | | - | | - | | - | | - | | - |
Operating leases | | - | | - | | - | | - | | - |
Unconditional purchase obligations | | - | | - | | - | | - | | - |
Other long-term liabilities reflected under GAAP | | 317 | | 12 | | 31 | | 38 | | 236 |
| | | | | | | | | | | |
Total obligations | $ | 76,767 | $ | 21,544 | $ | 27,086 | $ | 70 | $ | 28,067 |
Long-term debt presented in the preceding table is comprised of $66.1 million in borrowings from the FHLB, and $10.3 million from the issuance of junior subordinated deferrable interest debentures.
FHLB borrowings include notes that require monthly interest payments, with principal on most issues due at maturity. The remaining FHLB issues require monthly principal payments as disclosed in Note 10 to the consolidated financial statements. FHLB borrowings include $54.6 million in advances with fixed interest rates and $11.5 million in advances with variable interest rates. While the variable rate obligations may be prepaid without penalty, certain of the fixed rate obligations have variable options, that stipulate a prepayment penalty if the note’s interest rate exceeds the current market rate for similar borrowings at the time of repayment. As a note matures, the Bank evaluates the liquidity and interest-rate circumstances at that point in time to determine whether to pay-off or renew the note. The evaluation process typically includes the strength of current and projected customer loan demand, the current federal funds sold or purchased position, projected cash flows from maturing securities, the current and projected market interest rate environment, local and national economic conditions, and customer demand for deposit product offerings. Fixed rate advances include $22.5 million in advances that can be put back at the option of the FHLB.
16
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
OFF-BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS, AND CONTINGENT LIABILITIES AND COMMITMENTS(CONTINUED)
The other long-term liabilities reflected under GAAP, as noted in the preceding table, represents the Bank’s agreement with its current Chairman of the Board of Directors to provide for retirement compensation benefits as more fully described in Note 15 of the consolidated financial statements. At December 31, 2009, the net present value of future deferred compensation payments amounted to $317,000. Such amount is included in other liabilities in the December 31, 2009 consolidated balance sheet.
As indicated in the table, the Corporation had no capital lease obligations as of December 31, 2009. The Corporation has certain operating lease obligations, including photocopying equipment, which is considered immaterial and not included in the preceding table. The Bank also has a non-qualified deferred compensation plan covering certain directors and officers, and has provided an estimated liability of $616,000 at December 31, 2009 for supplemental retirement benefits. Since substantially all participants under the plan are still active, it is not possible to determine the terms of the contractual obligations and, consequently, such liability is not included in the table.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The only significant market risk to which the Corporation is exposed is interest rate risk. The business of the Corporation and the composition of its balance sheet consist of investments in interest-earning assets (primarily loans and securities), which are funded by interest bearing liabilities (deposits and borrowings). These financial instruments have varying levels of sensitivity to changes in the market rates of interest, resulting in market risk. None of the Corporation’s financial instruments are held for trading purposes.
The Corporation manages interest rate risk regularly through its Asset Liability Committee. The Committee meets on a regular basis and reviews various asset and liability management information, including but not limited to, the bank’s liquidity positions, projected sources and uses of funds, interest rate risk positions and economic conditions.
The Corporation monitors its interest rate risk through a sensitivity analysis, whereby it measures potential changes in its future earnings and the fair values of its financial instruments that may result from one or more hypothetical changes in interest rates. This analysis is performed by estimating the expected cash flows of the Corporation’s financial instruments using interest rates in effect at year-end. For the fair value estimates, the cash flows are then discounted to year-end to arrive at an estimated present value of the Corporation’s financial instruments. Hypothetical changes in interest rates are then applied to the financial instruments, and the cash flows and fair values are again estimated using these hypothetical rates. For the net interest income estimates, the hypothetical rates are applied to the financial instruments based on the assumed cash flows. The Corpo ration applies these interest rate “shocks” to its financial instruments up and down 200 basis points.
17
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
The following table shows the Corporation’s estimated earnings sensitivity profile as of December 31, 2009:
| | |
Change in Interest Rates (basis points) |
Percentage Change in Net Interest Income |
Percentage Change in Net Income |
| | | |
+200 | -0.6% | -0.5% |
-200 | -4.5% | -13.0% |
Given a linear 200bp increase in the yield curve used in the simulation model, it is estimated that net interest income for the Corporation would decrease by 0.6% and net income would decrease by 0.5%. A 200bp decrease in interest rates would decrease net interest income by 4.5% and decrease net income by 13.0%. Management does not expect any significant adverse effect to net interest income in 2010 based on the composition of the portfolio and anticipated trends in rates.
OTHER INFORMATION
The global and U.S. economies are experiencing significantly reduced business activity as a result of, among other factors, disruptions in the financial system during the past year. Dramatic declines in the housing market, along with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.
Reflecting concern about the stability of the financial markets, many national and regional lenders have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions. The availability of credit, confidence in the financial sector, and level of volatility in the financial markets have been significantly adversely affected as a result. In recent months, volatility and disruption in the capital and credit markets have reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength.
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, the Emergency Economic Stabilization Act of 2008 (“EESA”) was signed into law on October 3, 2008. The EESA authorizes the U.S. Treasury Department (“Treasury”) to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. The EESA also provides a temporary increase in deposit insurance coverage from $100,000 to $250,000 per insured account until December 31, 2013.
18
UNITED BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS, CONTINUED
FORWARD-LOOKING STATEMENTS
This report includes certain forward-looking statements by the Corporation relating to such matters as anticipated operating results, prospects for new lines of business, technological developments, economic trends (including interest rates), and similar matters. The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements, and the purpose of this paragraph is to secure the use of the safe harbor provisions. While the Corporation believes that the assumptions underlying the forward looking statements contained herein and in other public documents are reasonable, any of the assumptions could prove to be inaccurate, and accordingly, actual results and experience could differ materially from the anticipated results or other expectations expressed by the Corporation in its forward-looking statements. Factors that could cause actual results or experience to differ from results discussed in the forward-looking statements include, but are not limited to: economic conditions, volatility and direction of market interest rates, governmental legislation and regulation, material unforeseen changes in the financial condition or results of operations of the Corporation’s customers, customer reaction to and unforeseen complications with respect to the integration of acquisition, product design initiative, and other risks identified, from time-to-time in the Corporation’s other public documents on file with the Securities and Exchange Commission.
19
UNITED BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2009, 2008 and 2007
| | | |
| | 2009 | 2008 | 2007 |
CASH FLOWS FROM OPERATING ACTIVITIES | | | |
Net income | $ 2,882,596 | $ 4,418,597 | $ 4,579,378 |
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Depreciation and amortization | 984,573 | 1,127,182 | 1,242,859 |
Credit for accrued compensation – stock options | - | (11,286) | (42,141) |
Deferred income taxes | (280,565) | (543,362) | (202,482) |
Provision for loan losses | 7,525,000 | 2,195,000 | 625,000 |
Gain on sale of loans | (1,375,729) | (346,267) | (329,584) |
Gain from sale of credit card portfolio | - | - | (355,366) |
Net securities losses (gains) | (129,493) | (49,055) | 226,416 |
Change in fair value of mortgage servicing rights | (195,101) | 649,091 | 363,943 |
Federal Home Loan Bank stock dividends | - | (190,700) | - |
Loss (gain) on sale or write-down of other real estate owned | 29,911 | 68,716 | (38,421) |
Increase in cash surrender value of life insurance | (512,152) | (493,051) | (447,691) |
Net accretion of security premiums and discounts | (21,986) | (9,578) | (20,658) |
Provision for deferred compensation | 107,371 | 144,988 | 66,450 |
Loss (gain) on disposal or write-down of premises and equipment and other assets | (2,472) | 275,925 | 70,512 |
Proceeds from sale of loans held-for-sale | 66,651,013 | 16,300,343 | 14,845,905 |
Originations of loans held-for-sale | (65,645,945) | (15,992,527) | (14,593,279) |
Decrease (increase) in other assets | (3,411,864) | 248,732 | 549,280 |
Increase (decrease) in other liabilities | (1,045,014) | 502,285 | 509,978 |
| | | | |
Net cash provided by operating activities | 5,560,143 | 8,295,033 | 7,050,099 |
| | | | |
CASH FLOWS FROM INVESTING ACTIVITIES | | | |
Proceeds from sales of available-for-sale securities | 3,228,921 | 1,565,930 | 15,303,741 |
Proceeds from maturities of available-for-sale securities, including paydowns on mortgage-backed securities | 29,800,007 | 28,149,767 | 17,791,602 |
Purchases of available-for-sale securities | (30,765,319) | (28,002,858) | (1,955,062) |
Proceeds from sale of credit card portfolio | - | - | 1,671,538 |
Net increase in loans | (710,284) | (60,379,189) | (26,280,256) |
Proceeds from sale of premises and equipment | 39,471 | 15,634 | 100,344 |
Proceeds from sale of other real estate owned | 168,650 | 179,299 | 241,421 |
Proceeds from sale of former branch | 187,240 | - | - |
Insurance proceeds from casualty loss | 145,000 | - | - |
Purchases of premises and equipment | (371,339) | (2,464,385) | (1,944,256) |
| | | | |
Net cash provided by (used in) investing activities | 1,722,347 | (60,935,802) | 4,929,072 |
24
UNITED BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2009, 2008 and 2007
| | | |
| | 2009 | 2008 | 2007 |
CASH FLOWS FROM FINANCING ACTIVITIES | | | |
Net increase in deposits | $ 4,876,840 | $ 71,588,401 | $ 15,773,370 |
Other borrowings: | | | |
Proceeds | 5,000,000 | 37,000,000 | 22,500,000 |
Repayments | (19,513,729) | (45,684,111) | (46,593,130) |
Change in customer repurchase agreements | 6,167,934 | 3,048,587 | 2,329,998 |
Purchase of common stock | - | (775,250) | (1,347,150) |
Proceeds from sale of treasury shares | 30,632 | 98,709 | 108,157 |
Payments of deferred compensation | (20,608) | (27,802) | (12,414) |
Cash dividends paid | (2,065,963) | (2,064,686) | (1,969,407) |
| | | | |
Net cash provided by (used in) financing activities | (5,524,894) | 63,183,848 | (9,210,576) |
| | | | |
NET INCREASE IN CASH AND CASH EQUIVALENTS | 1,757,596 | 10,543,079 | 2,768,595 |
| | | | |
CASH AND CASH EQUIVALENTS | | | |
At beginning of year | 25,622,293 | 15,079,214 | 12,310,619 |
| | | | |
At end of year | $ 27,379,889 | $ 25,622,293 | $ 15,079,214 |
| | | | |
SUPPLEMENTAL CASH FLOW DISCLOSURES | | | |
Cash paid during the year for: | | | |
Interest | $ 12,909,515 | $ 15,678,869 | $ 17,363,004 |
| | | | |
Federal income taxes | $ 1,500,000 | $ 1,655,000 | $ 1,000,000 |
| | | | |
Non-cash operating activity: Change in deferred income taxes on net unrealized loss on available-for-sale securities | $ (1,428,065) | $ (84,362) | $ (399,740) |
| | | | |
Cumulative effect of change in accounting principle – adjust mortgage servicing rights to fair value, net of deferred income taxes | $ - | $ - | $ 519,152 |
| | | | |
Non-cash investing activities: | | | |
Transfer of loans to other real | | | |
estate owned | $ 5,119,196 | $ 140,740 | $ 148,000 |
| | | | |
Transfer of premises classified as held for sale to other assets | $ - | $ 320,309 | $ - |
| | | | |
Change in net unrealized gain or loss on available-for-sale securities | $ 4,200,190 | $ 248,123 | $ 1,175,706 |
| | | | |
The accompanying notes are an integral part of the financial statements.
25
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
United Bancshares, Inc. (the “Corporation”) was incorporated in 1985 in the state of Ohio as a single-bank holding company for The Union Bank Company (the “Bank”). The Corporation subsequently acquired the Bank of Leipsic Company (“Leipsic”) in 2000 and Citizens Bank of Delphos (“Citizens”) in 2001. The Bank acquired the Gibsonburg and Pemberville, Ohio branch offices of RFC Banking Company in 2003. Effective February 1, 2007, the Bank formed a wholly-owned subsidiary, UBC Investments, Inc. (“UBC”) to hold and manage its securities portfolio. The operations of UBC are located in Wilmington, Delaware. Effective December 4, 2009, the Bank formed a wholly-owned subsidiary, UBC Property, Inc. to hold and manage its other real estate owned portfolio. The Corporation, through its wholly-owned subsidiary, the Bank, operates in one industr y segment, the commercial banking industry.
The Bank, organized in 1904 as an Ohio-chartered bank, is headquartered in Columbus Grove, Ohio, with branch offices in Bowling Green, Delphos, Gibsonburg, Kalida, Leipsic, Lima, Ottawa, and Pemberville Ohio.
The primary source of revenue of the Bank is providing loans to customers primarily located in Northwestern and West Central Ohio. Such customers are predominately small and middle-market businesses and individuals.
Significant accounting policies followed by the Corporation are presented below.
Use of Estimates in Preparing Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during each reporting period. Actual results could differ from those estimates. The estimates most susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of servicing assets and goodwill.
Principles of Consolidation
The consolidated financial statements include the accounts of the Corporation and Bank, including UBC. All significant intercompany balances and transactions have been eliminated in consolidation.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold which mature overnight or within four days.
Restrictions on Cash
The Bank was required to maintain cash on hand or on deposit with the Federal Reserve Bank in the amount of $358,000 at December 31, 2009 and $389,000 at December 31, 2008 to meet regulatory reserve and clearing requirements.
26
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Securities and Federal Home Loan Bank Stock
Securities are classified as available-for-sale and recorded at fair value, with unrealized gains and losses, net of applicable income taxes, excluded from income and reported as accumulated other comprehensive income (loss).
The cost of available-for-sale securities is adjusted for amortization of premiums and accretion of discounts to maturity. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in fair value of securities below their cost that are deemed to be other than temporary are reflected in income as realized losses. Gains and losses on the sale of securities are recorded on the trade date, using the specific identification method, and are included in non-interest income.
Investment in Federal Home Loan Bank of Cincinnati stock is classified as a restricted security, carried at cost, and evaluated for impairment.
Loans Held for Sale
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Estimated fair value is determined based on quoted market prices in the secondary market. Any net unrealized losses are recognized through a valuation allowance by charges to income.
Mortgage loans held for sale are sold with mortgage servicing rights retained or released by the Bank. The carrying value of mortgage loans sold with servicing rights retained is reduced by the cost allocated to the associated mortgage servicing rights. Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold.
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are generally stated at their outstanding principal amount adjusted for charge-offs and the allowance for loan losses. Interest is accrued as earned based upon the daily outstanding principal balance. Loan origination fees and certain direct obligation costs are capitalized and recognized as an adjustment of the yield of the related loan.
The accrual of interest on mortgage and commercial loans is generally discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Personal loans are typically charged-off no later than when they become 150 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income. Interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
27
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. Due to potential changes in conditions, it is at least reasonably possible that changes in estimates will occur in the near term and that such changes could be material to the amounts reported in the Corporation’s financial statements.
The allowance consists of specific, general and unallocated components. The specific component relates to impaired loans 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 classified loans (substandard or special mention) without specific reserves, as well as non-classified loans, and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
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. Impairment is measured on a loan by loan basis for commercial and construction 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 balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Bank does not separately identify individual consumer and residential loans for impairment disclosures.
28
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Other Real Estate Owned
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of cost or fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and fair value adjustments are included in other operating expenses.
Off-Balance Sheet Credit Related Financial Instruments
In the ordinary course of business, the Bank has entered into commitments to extend credit, including commitments under commercial letters of credit, and standby letters of credit. Such financial instruments are recorded when they are funded.
Loan Sales and Servicing
When the Bank sells mortgage loans it may retain the servicing rights that are initially measured at fair value. Gain or loss on the sale of loans depends in part on both the previous carrying value of the amount of the financial assets involved in the sale, allocated between assets sold and the interests that continue to be held based on their relative fair values at the date of the sale. The Bank generally estimates fair value for servicing rights based on the present value of future expected cash flows, using management’s best estimates of the key assumptions – credit losses, prepayment speeds, servicing costs, and discount rates commensurate with the risks involved.
Capitalized servicing rights are reported at fair value and changes in fair value are reported in net income for the period the change occurs.
Servicing fee income is recorded for servicing loans, based on a contractual percentage of the outstanding principal, and is reported as other operating income. Amortization of mortgage servicing rights is netted against loan servicing fee income.
Premises and Equipment
Premises and equipment is stated at cost, less accumulated depreciation. Upon the sale or disposition of the assets, the difference between the depreciated cost and proceeds is charged or credited to income. Depreciation is determined based on the estimated useful lives of the individual assets (typically 20 to 40 years for buildings and 3 to 10 years for equipment) and is computed using both accelerated and straight-line methods.
Premises and equipment is reviewed for impairment when events indicate the carrying amount may not be recoverable from future undiscounted cash flows. If impaired, premises and equipment is recorded at fair value and any corresponding write-downs are charged against current year earnings.
29
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Goodwill and Core Deposit Intangible Asset
Goodwill arising from the Gibsonburg and Pemberville branch acquisitions is not amortized, but is subject to an annual impairment test to determine if an impairment loss has occurred. The core deposit intangible asset, resulting from the Gibsonburg and Pemberville branch acquisitions, was determined to have a definite life and is being amortized on a straight-line basis over seven years through March 2010.
Supplemental Retirement Benefits
Annual provisions are made for the estimated liability for accumulated supplemental retirement benefits under agreements with certain officers and directors. These provisions are determined based on the terms of the agreements, as well as certain assumptions, including estimated service periods and discount rates.
Advertising Costs
All advertising costs are expensed as incurred.
Income Taxes
Deferred income taxes are provided on temporary differences between financial statement and income tax reporting. Temporary differences are differences between the amounts of assets and liabilities reported for financial statement purposes and their tax bases. Deferred tax assets are recognized for temporary differences that will be deductible in future years’ tax returns and for operating loss and tax credit carryforwards. Deferred tax assets are reduced by a valuation allowance if it is deemed more likely than not that some or all of the deferred tax assets will not be realized. Deferred tax liabilities are recognized for temporary differences that will be taxable in future years’ tax returns.
Benefits from tax positions taken or expected to be taken in a tax return are not recognized if the likelihood that the tax position would be sustained upon examination by a taxing authority is considered to be 50% or less. The Corporation has adopted the policy of classifying any interest and penalties resulting from the filing of its income tax returns in the provision for income taxes.
The Bank is not currently subject to state or local income taxes.
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Bank, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
30
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Per Share Data
Basic net income per share is computed based on the weighted average number of shares of common stock outstanding during each year. Diluted net income per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Corporation relate solely to outstanding stock options, and are determined using the treasury stock method.
The weighted average number of shares used for the years ended December 31, 2009, 2008 and 2007 were as follows:
| | | |
| | 2009 | 2008 | 2007 |
| | | | |
Basic | 3,443,093 | 3,447,536 | 3,527,093 |
| |
|
|
|
Diluted | 3,443,283 | 3,448,467 | 3,527,729 |
Dividends per share are based on the number of shares outstanding at the declaration date.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the consolidated balance sheet, such items, along with net income, are components of comprehensive income.
Rate Lock Commitments
Loan commitments related to the origination or acquisition of mortgage loans that will be held for sale are accounted for as derivative instruments. The Bank enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. Accordingly, such commitments, along with any related fees received from potential borrowers, are to be recorded at fair value as derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans. Fair value is based on fees currently charged to enter into similar agreements, and for fixed-rate commitments also considers the difference between current levels of interest rates and the committed rates. At December 31, 2009 and 2008, derivative assets and liabilities relatin g to rate lock commitments were not material to the consolidated financial statements.
Fair Values Of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note 21. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
31
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Subsequent Events
Management evaluated subsequent events through the date the consolidated financial statements were issued. Events or transactions occurring after December 31, 2009, but prior to when the consolidated financial statements were issued, that provided additional evidence about conditions that existed at December 31, 2009, have been recognized in the financial statements for the year ended December 31, 2009. Events or transactions that provided evidence about conditions that did not exist at December 31, 2009 but arose before the financial statements were issued, have not been recognized in the consolidated financial statements for the year ended December 31, 2009.
NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS
In June 2009, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2009-01 (formerly FASB No. 168),The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles. The Accounting Standards Codification (ASC) is the single source of authoritative non-governmental U.S. Generally Accepted Accounting Principles (GAAP). The ASC does not change current GAAP, but is intended to simplify user access to all authoritative GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents are superseded and all other accounting literature not included in the Codification is considered nonauthoritative. The ASC was effective for financial statements issued for periods ending after September 15, 2009. The adoption of ASU No. 2009-01 did not h ave any impact on the consolidated results of operations or financial position of the Corporation as it only required changes to GAAP references in the financial statements.
ASC 815-10 expands disclosure requirements for derivative instruments and hedging activities and is intended to improve financial reporting transparency regarding derivative instruments and hedging activities. ASC 815-10 is effective for financial statements issued for fiscal years beginning after November 15, 2008. The adoption of the requirements of ASC 815-10 did not have a material impact on the Corporation’s consolidated financial statements.
ASC 320-10 amends existing guidance for determining whether impairment is other-than-temporary for debt securities. The ASC requires an entity to assess whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of these criteria is met, the entire difference between amortized cost and fair value is recognized in earnings. For securities that do not meet the aforementioned criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income. Additionally, the ASC expands and increases the frequency of existing disclosures about other-than-temporary impairments for debt and equity securities. The adoption of ASC 320-10 in 2009 had no im pact on the Corporation’s consolidated financial statements since the Bank had no securities considered to have other-than-temporary impairment.
32
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS (CONTINUED)
ASC 820-10-65 emphasizes that even if there has been a significant decrease in the volume and level of activity, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants. ASC 820-10-65 provides a number of factors to consider when evaluating whether there has been a significant decrease in the volume and level of activity for an asset or liability in relation to normal market activity. In addition, when transactions or quoted prices are not considered orderly, adjustments to those prices based on the weight of available information may be needed to determine the appropriate fair value. ASC 820-10-65 also requires increased disclosures. ASC 820-10-65 is effective for interim and annual re porting periods ending after June 15, 2009, and shall be applied prospectively. There was no impact on the consolidated financial statements of the Corporation as a result of the adoption of ASC 820-10-65 during the second quarter of 2009.
ASC 860-10 addresses accounting for transfers of financial assets. Among other requirements, the ASC removes the concept of a qualifying special-purpose entity and removes the exception from applying consolidation of variable interest entities to qualifying special-purpose entities. The objective is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. The Corporation is required to adopt ASC 860-10 effective January 1, 2010. Among other things, ASC 860-10 applies to any transfer of financial assets, which for the Corporation primarily relates to loan participations sold. The adoption is not expected to have a material impact on the Corporation’s consolidated financial statements.
NOTE 3 - SECURITIES
The amortized cost and fair value of securities as of December 31, 2009 and 2008 are as follows:
| | | | | |
| | 2009 | | 2008 |
| | Amortized cost | Fair value | | Amortized cost | Fair value |
Available-for-sale: | | | | | |
U.S. Government and agencies |
$ 3,993,013 |
$ 3,982,760 | |
$ - |
$ - |
Obligations of states and political subdivisions | 46,757,381 | 47,828,791 | |
47,296,096 |
46,522,557 |
Mortgage-backed | 83,758,593 | 86,270,563 | | 89,325,021 | 89,475,746 |
Other | 501,888 | 504,248 | | 501,888 | 499,999 |
| | | | | | |
Total | $135,010,875 | $138,586,362 | | $137,123,005 | $136,498,302 |
33
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SECURITIES (CONTINUED)
A summary of unrealized gains and losses on investment securities at December 31, 2009 and 2008 follows:
| | | | |
| | 2009 | 2008 |
| | Gross unrealized gains | Gross unrealized losses | Gross unrealized gains | Gross unrealized losses |
Available-for-sale: | | | | |
U.S. Government and agencies | $ - | $10,253 | $ - | $ - |
Obligations of states and political subdivisions |
1,280,274 | 208,864 | 330,224 | 1,103,763 |
Mortgage-backed | 2,756,975 | 245,005 | 1,282,487 | 1,131,762 |
Other | 2,360 | - | - | 1,889 |
| | | | | |
Total | $ 4,039,609 | $ 464,122 | $ 1,612,711 | $ 2,237,414 |
The amortized cost and fair value of securities at December 31, 2009, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| | |
| | Amortized cost | Fair value |
Due in one year or less | $ 1,359,479 | $ 1,392,893 |
Due after one year through five years | 6,761,785 | 7,081,058 |
Due after five years through ten years | 21,639,342 | 22,312,942 |
Due after ten years | 104,748,381 | 107,295,221 |
Other securities having no maturity date | 501,888 | 504,248 |
| | | |
Total | $135,010,875 | $138,586,362 |
Securities with a carrying value of approximately $77,579,000 at December 31, 2009 and $90,153,000 at December 31, 2008 were pledged to secure public deposits and for other purposes as required or permitted by law, including those described in Note 10.
The following table presents gross unrealized losses and fair value of debt securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2009 and 2008:
| | | | | | |
| | Securities in a continuous unrealized loss position |
| | Less than 12 months | 12 months or more |
Total |
2009 | Unrealized losses | Fair value | Unrealized Losses | Fair value | Unrealized losses | Fair value |
U.S. Government and agencies | $10,253 | $1,988,760 |
$ - |
$ - | $10,253 | $1,988,760 |
Obligations of states and political subdivisions | 69,987 | 7,810,566 | 138,877 | 3,159,180 | 208,864 |
10,969,746 |
Mortgage-backed | 74,689 | 8,053,841 | 170,316 | 5,914,022 | 245,005 | 13,967,863 |
| | | | | | | |
Total temporarily impaired securities | $154,929 | $17,853,167 | $309,193 | $9,073,202 | $464,122 | $26,926,369 |
34
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - SECURITIES (CONTINUED)
| | | | | | |
| | Securities in a continuous unrealized loss position |
| | Less than 12 months | 12 months or more |
Total |
2008 | Unrealized losses | Fair value | Unrealized Losses | Fair value | Unrealized losses | Fair value |
Obligations of states and political subdivisions | $1,080,385 | $22,266,312 | $ 23,378 | $ 364,622 | $1,103,763 | $22,630,934 |
Mortgage-backed | 712,045 | 14,482,783 | 419,717 | 6,331,491 | 1,131,762 | 20,814,274 |
| | | | | | | |
Total temporarily impaired securities | $1,792,430 | $36,749,095 | $ 443,095 | $6,696,113 | $2,235,525 | $43,445,208 |
There were 33 securities in an unrealized loss position at December 31, 2009, 12 of which were in a continuous unrealized loss position for twelve months or more. Management has considered industry analyst reports, whether downgrades by bond rating agencies have occurred, sector credit reports, issuer’s financial condition and volatility in the bond market in concluding that the unrealized losses as of December 31, 2009 were primarily the result of customary and expected fluctuations in the bond market. As a result, all security impairments as of December 31, 2009 are considered to be temporary.
Gross realized gains from sale of securities, including securities calls, amounted to $130,600 in 2009, $50,887 in 2008, and $181 in 2007, with the income tax provision applicable to such gains amounting to $44,404 in 2009, $17,301 in 2008, and $62 in 2007. Gross realized losses from sale of securities amounted to $1,107 in 2009, $1,832 in 2008, and $226,597 in 2007 with related income tax effect of $376 in 2009, $623 in 2008 and $77,043 in 2007.
NOTE 4 - LOANS
Loans at December 31, 2009 and 2008 consist of the following:
| | |
| | 2009 | 2008 |
| | | |
Residential real estate | $ 107,515,138 | $ 130,047,210 |
Commercial | 215,457,166 | 193,781,134 |
Agriculture | 71,027,689 | 74,651,951 |
Consumer | 13,814,930 | 19,663,075 |
| | | |
Total loans | $ 407,814,923 | $ 418,143,370 |
In March 2007, the Bank entered into an agreement to sell its credit card portfolio. Under the terms of the agreement, the buyer will service the credit card portfolio and provide the Bank's former credit card customers with credit cards branded with the Bank's name. Based on the proceeds received under the terms of the agreement, the Bank recognized a gain from sale of the credit card portfolio of $355,366 in 2007.
35
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS (CONTINUED)
Fixed rate loans approximated $70,088,000 at December 31, 2009 and $83,364,000 at December 31, 2008, including loans classified as held-for-sale. Certain commercial and agricultural loans are secured by real estate.
Impaired loans were as follows as of December 31, 2009 and 2008:
| | |
| | 2009 | 2008 |
| | | |
Loans with no allowance for loan losses allocated | $ 8,166,619 | $ 184,791 |
Loans with allowance for loan losses allocated | 5,009,477 | 5,403,077 |
| | | |
Total impaired loans | $ 13,176,096 | $ 5,587,868 |
| | | |
Amount of the allowance allocated to impaired loans | $ 1,228,814 | $ 1,054,518 |
The following is a summary of the activity in the allowance for loan losses of impaired loans, which is a part of the Bank’s overall allowance for loan losses summarized in Note 5, for the years ended December 31, 2009, 2008, and 2007:
| | | |
| | 2009 | 2008 | 2007 |
| | | | |
Balance at beginning of year | $ 1,054,518 | $ 366,500 | $ 286,093 |
Provision charged to operations | 5,640,681 | 1,281,943 | 195,151 |
Loans charged-off | (5,466,385) | (593,925) | (114,744) |
| | | |
Balance at end of year | $ 1,228,814 | $ 1,054,518 | $ 366,500 |
No additional funds are committed to be advanced in connection with impaired loans.
The average balance of impaired loans approximated $7,851,000 in 2009, $3,617,000 in 2008, and $2,649,000 in 2007. There was no interest income recognized by the Bank on impaired loans on an accrual or cash basis during 2009, 2008, and 2007.
Certain directors and executive officers, including their immediate families and companies in which they are principal owners, are loan customers of the Bank. Such loans are made in the ordinary course of business in accordance with the normal lending policies of the Bank, including the interest rate charged and collateralization. Such loans amounted to $3,353,452 and $3,988,374 at December 31, 2009 and 2008, respectively. The following is a summary of activity during 2009, 2008, and 2007 for such loans:
| | | |
| | 2009 | 2008 | 2007 |
| | | | |
Beginning of year | $ 3,988,374 | $ 3,657,288 | $ 3,835,612 |
Additions | 1,999,262 | 629,002 | 294,523 |
Repayments | (2,634,184) | (297,916) | (472,847) |
| | | | |
End of year | $ 3,353,452 | $ 3,988,374 | $ 3,657,288 |
Additions and repayments include loan renewals, as well as net borrowings and repayments under revolving lines-of-credit.
36
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - LOANS (CONTINUED)
Most of the Bank’s lending activities are with customers located in Northwestern and West Central Ohio. As of December 31, 2009 and 2008, the Bank’s loans from borrowers in the agriculture industry represent the single largest industry and amounted to $71,027,689 and $74,651,951, respectively. Agriculture loans are generally secured by property, equipment, livestock and crop income. Repayment is primarily expected from cash flow generated through the harvest and sale of crops; milk production for dairy products; or the breeding, development, and sale of livestock. Agriculture customers are subject to various risks and uncertainties which can adversely impact the cash flow generated from their operations, including weather conditions; milk production; health and stability of livestock; costs of key operating items such as fertilizer, fuel, seed, or animal feed; and market prices for crops , milk, and livestock. Credit losses arising from the Bank’s lending experience in the agriculture industry compare favorably with the Bank’s loss experience on their loan portfolio as a whole. Credit evaluation of agricultural lending is based on an evaluation of cash flow coverage of principal and interest payments and the adequacy of collateral received.
Loans on non-accrual of interest approximated $12,937,000 and $3,074,000 at December 31, 2009 and 2008, respectively. Loans past due 90 days or more and still accruing interest approximated $2,456,000 and $2,387,000 at December 31, 2009 and 2008, respectively.
NOTE 5 - ALLOWANCE FOR LOAN LOSSES
The following represents a summary of the activity in the allowance for loan losses for the years ended December 31, 2009, 2008 and 2007:
| | | |
| | 2009 | 2008 | 2007 |
| | | | |
Balance at beginning of year | $ 3,198,130 | $ 2,232,708 | $ 2,275,486 |
Provision charged to operations | 7,525,000 | 2,195,000 | 625,000 |
Loans charged-off | (6,276,801) | (1,538,749) | (923,307) |
Recoveries of loans charged-off | 357,266 | 309,171 | 255,529 |
| | | | |
Total | $ 4,803,595 | $ 3,198,130 | $ 2,232,708 |
NOTE 6 - PREMISES AND EQUIPMENT
The following is a summary of premises and equipment at December 31, 2009 and 2008:
| | |
| | 2009 | 2008 |
| | | |
Land and improvements | $ 2,076,054 | $ 2,106,258 |
Buildings | 8,301,950 | 8,190,046 |
Equipment | 3,942,779 | 4,348,399 |
| | | |
| | 14,320,783 | 14,644,703 |
Less accumulated depreciation | 5,188,535 | 5,348,089 |
| | | |
Premises and equipment, net | $ 9,132,248 | $ 9,296,614 |
37
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - PREMISES AND EQUIPMENT (CONTINUED)
During 2008, the Bank opened a new branch office on the southwestern side of Lima and closed its downtown Lima branch office. As a result of closing the facility, the Bank recognized an impairment loss of $235,000 in 2008. The cost of the facility, net of the impairment loss, was included in other assets at December 31, 2008 since the facility was being held for sale. In January 2009, the Bank received $145,000 of insurance proceeds from water damage to the property and such amount was applied against the property’s net carrying value. The property was sold in December 2009, and the Bank received net proceeds of $187,240, resulting in a gain on sale of $5,576.
Depreciation expense amounted to $493,130 in 2009, $458,814 in 2008 and $546,157 in 2007.
NOTE 7 - PREPAID FDIC ASSESSMENTS
On September 29, 2009, the FDIC adopted a Notice of Proposed Rule making it mandatory that insured depository institutions prepay their quarterly risk-based assessments to the FDIC on December 30, 2009 for the fourth quarter of 2009 and for the years 2010 through 2012. As a result, the Bank had prepaid FDIC assessments amounting to $2,623,998 at December 31, 2009, representing assessments paid in 2009 for the years 2010 through 2012, and such amount is included in other assets in the accompanying 2009 consolidated balance sheet.
NOTE 8 - SERVICING
Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balance of mortgage loans serviced for others approximated $188,702,000 and $187,534,000 at December 31, 2009 and 2008, respectively.
Effective January 1, 2007, the Bank elected to record its mortgage servicing rights using the fair value measurement method and as a result recorded a cumulative effect adjustment to retained earnings of $519,152 representing the difference between fair value and carrying value of the mortgage servicing rights at January 1, 2007 of $786,594, net of deferred income taxes of $267,442. Mortgage servicing rights are included in other assets in the accompanying consolidated balance sheets.
Significant assumptions used in determining the fair value of servicing rights as of December 31, 2009 and 2008 include:
Prepayment assumptions:
Based on the PSA Standard Prepayment Model
Internal rate of return:
8% to 10%
Servicing costs:
$40 – $55 per loan, annually, increased at the rate
of $1 per 1% delinquency based on loan count
Inflation rate of servicing costs:
3%
38
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 – SERVICING (CONTINUED)
Following is a summary of mortgage servicing rights activity for the years ended December 31, 2009, 2008 and 2007:
| | | |
| | 2009 | 2008 | 2007 |
| | | | |
Fair value at beginning of year | $ 703,388 | $ 1,531,225 | $ 2,070,433 |
Capitalized servicing rights – new loan sales | 612,499 | 146,966 | 152,646 |
Disposals (amortization based on loan payments and payoffs) |
(237,463) |
(325,712) |
(327,911) |
Change in fair value | 195,101 | (649,091) | (363,943) |
| | | | |
Fair value at end of year | $ 1,273,525 | $ 703,388 | $ 1,531,225 |
The change in fair value of servicing rights for the year ended December 31, 2008 resulted from changes in external market conditions, including conditions that dramatically increased prepayment assumptions, which is a key valuation input used in determining the fair value of servicing. While prepayment assumptions are constantly changing, such changes are typically within a relatively small parameter from period to period. However, due to the declines in the secondary market mortgage rates experienced during the fourth quarter of 2008, the prepayment assumptions used in determining the fair value of servicing at December 31, 2008 was 630 compared to 300 at December 31, 2009 and 244 at December 31, 2007.
NOTE 9 - DEPOSITS
Time deposits at December 31, 2009 and 2008 include individual deposits of $100,000 or more approximating $41,111,000 and $71,931,000, respectively. Interest expense on time deposits of $100,000 or more approximated $1,282,000 for 2009, $2,202,000 for 2008, and $1,763,000 for 2007. Time deposits at December 31, 2009 and 2008 include brokered deposits approximating $14,990,000 and $34,990,000, respectively. Interest expense on brokered deposits approximated $1,019,000 in 2009, $1,142,000 in 2008 and $572,000 in 2007.
At December 31, 2009, time deposits approximated $277,351,000 and were scheduled to mature as follows: 2010, $152,217,000; 2011, $53,043,000; 2012, $57,488,000; 2013, $2,830,000; 2014, $10,961,000 and thereafter, $812,000.
39
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 – OTHER BORROWINGS
Other borrowings consists of the following at December 31, 2009 and 2008:
| | |
| | 2009 | 2008 |
Federal Home Loan Bank borrowings: | | |
Secured note, with interest at 3.25%, due March 6, 2009 | $ - | $ 4,000,000 |
Secured $2,500,000 term note with interest at 3.08%, with monthly principal and interest payments of $45,011, through May 1, 2009 | - | 223,331 |
Secured $2,500,000 term note with interest at 3.08%, with monthly principal and interest payments of $45,011, through May 1, 2009 | - | 223,331 |
Secured note, with interest at 1.34%, due July 3, 2009 | - | 5,000,000 |
Secured note, with interest at 1.30%, due December 4, 2009 | - | 5,000,000 |
Secured note, with interest at 1.95%, due June 4, 2010 | 5,000,000 | 5,000,000 |
Secured note, with interest at 6.55% due June 16, 2010 | 6,500,000 | 6,500,000 |
Secured note, with interest at 3.61%, due July 16, 2010 | 5,000,000 | 5,000,000 |
Secured note, with interest at 6.46%, due July 28, 2010 | 5,000,000 | 5,000,000 |
Secured note, with interest at 4.28%, due June 24, 2011 | 17,000,000 | 17,000,000 |
Secured note, with interest at 2.18%, due July 3, 2012 | 5,000,000 | - |
Secured note, with interest at 4.25% through February 28, 2008, thereafter putable back at the option of the holder, due August 28, 2012 | 5,000,000 | 5,000,000 |
Secured note, with interest at 4.20% through February 28, 2008, thereafter putable back at the option of the holder, due February 28, 2017 | 10,000,000 |
10,000,000 |
Secured note, with interest at 3.95% through September 11, 2008, thereafter putable back at the option of the holder, due September 11, 2017 | 7,500,000 | 7,500,000 |
Advances secured by individual residential mortgages under blanket agreement | 150,497 | 217,564 |
| | | |
Total Federal Home Loan Bank borrowings | 66,150,497 | 75,664,226 |
| | | |
Security sold under agreement to repurchase – | | |
4.01%, due October 13, 2009 | - | 5,000,000 |
| | | |
Customer repurchase agreements with an average | | |
outstanding rate of .68% at December 31, 2009 and 2008 | 11,756,091 | 5,588,157 |
| | | |
Total other borrowings | $ 77,906,588 | $ 86,252,383 |
40
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 – OTHER BORROWINGS (CONTINUED)
Federal Home Loan Bank borrowings are secured by Federal Home Loan Bank stock, securities with an aggregate carrying value approximating $19,229,000 and eligible mortgage loans approximating $107,075,000 at December 31, 2009. Interest on advances outstanding at December 31, 2009 secured by individual mortgages under blanket agreement ranged from 5.62% to 8.80%, with varying maturities through July 2019. At December 31, 2009, the Bank had $9,100,000 of borrowing availability under various line-of-credit agreements with the Federal Home Loan Bank and other financial institutions.
Securities sold under agreements to repurchase are secured by securities with an aggregate carrying value approximating $5,006,000 at December 31, 2008 (none at December 31, 2009). The Bank may be required to provide additional collateral based on the fair value of the underlying securities.
Future contractual maturities of other borrowings, excluding short-term customer repurchase agreements, are as follows at December 31, 2009: 2010, $21,532,056; 2011, $17,028,564; 2012, $10,026,882; 2013, $17,494; 2014, $14,312 and thereafter, $17,531,189.
NOTE 11 - JUNIOR SUBORDINATED DEFERRABLE INTEREST DEBENTURES
The Corporation has formed and invested $300,000 in a business trust, United (OH) Statutory Trust (United Trust) which is not consolidated by the Corporation. United Trust issued $10,000,000 of trust preferred securities, which are guaranteed by the Corporation, and are subject to mandatory redemption upon payment of the debentures. United Trust used the proceeds from the issuance of the trust preferred securities, as well as the Corporation’s capital investment, to purchase $10,300,000 of junior subordinated deferrable interest debentures issued by the Corporation. The debentures have a stated maturity date of March 26, 2033. As of March 26, 2008, and quarterly thereafter, the debentures may be shortened at the Corporation’s option. The interest rate of the debentures was fixed at 6.40% for a five-year period through March 26, 2008. Effective March 27, 2008, interest is at a floating rate adjustable quarterly and equal to 315 basis points over the 3-month LIBOR amounting to 3.52% at December 31, 2009 and 4.62% at December 31, 2008, with interest payable quarterly. The Corporation has the right, subject to events in default, to defer payments of interest on the debentures by extending the interest payment period for a period not exceeding 20 consecutive quarterly periods. Interest expense on the debentures amounted to $409,971 in 2009, $626,897 in 2008 and $640,000 in 2007, and is included in interest expense-borrowings in the accompanying consolidated statements of income.
Each issue of the trust preferred securities carries an interest rate identical to that of the related debenture. The securities have been structured to qualify as Tier I capital for regulatory purposes and the dividends paid on such are tax deductible. However, the securities cannot be used to constitute more than 25% of the Corporation’s Tier I capital inclusive of these securities under Federal Reserve Board guidelines.
41
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12 - OTHER OPERATING EXPENSES
Other operating expenses consisted of the following for the years ended December 31, 2009, 2008 and 2007:
| | | |
| | 2009 | 2008 | 2007 |
| | | | |
Data processing | $ 586,143 | $ 598,547 | $ 895,688 |
Professional fees | 683,860 | 550,374 | 486,477 |
Franchise tax | 522,909 | 570,468 | 561,434 |
Advertising | 339,246 | 410,406 | 381,524 |
ATM processing and other fees | 144,606 | 367,339 | 276,020 |
Amortization of core deposit intangible asset | 253,980 | 253,980 | 253,980 |
Postage | 192,138 | 186,894 | 182,108 |
Stationery and supplies | 123,899 | 140,208 | 156,104 |
Loss on disposal or write-down of premises and equipment | - | 275,925 | 70,512 |
FDIC assessment | 1,150,962 | 74,099 | 45,366 |
Loan closing fees | 154,230 | 152,330 | 141,635 |
Internet banking expense | 181,640 | 140,976 | 127,764 |
Other | 1,279,005 | 1,683,192 | 1,689,382 |
| | | | |
Total other operating expenses | $ 5,612,618 | $ 5,404,738 | $ 5,267,994 |
NOTE 13 - OTHER COMPREHENSIVE INCOME
The components of other comprehensive income and related tax effects are as follows for the years ended December 31, 2009, 2008 and 2007:
| | | |
| | 2009 | 2008 | 2007 |
Unrealized holding gains on | | | |
available-for-sale securities | $ 4,329,683 | $ 297,178 | $ 949,290 |
Reclassification adjustments for net securities | | | |
losses (gains) realized in income | (129,493) | (49,055) | 226,416 |
| | | | |
Net unrealized gains | 4,200,190 | 248,123 | 1,175,706 |
| | | | |
Tax effect | 1,428,065 | 84,362 | 399,740 |
| | | | |
Net-of-tax amount | $ 2,772,125 | $ 163,761 | $ 775,966 |
NOTE 14 - INCOME TAXES
The provision for income taxes for the years ended December 31, 2009, 2008 and 2007 consist of the following:
| | | |
| | 2009 | 2008 | 2007 |
| | | | |
Current | $ 436,565 | $ 1,554,362 | $ 1,363,482 |
Deferred | (280,565) | (543,362) | (202,482) |
| | | | |
Total provision for income taxes | $ 156,000 | $ 1,011,000 | $ 1,161,000 |
42
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - INCOME TAXES (CONTINUED)
The income tax provision attributable to income from operations differed from the amounts computed by applying the U.S. federal income tax rate of 34% to income before income taxes as a result of the following:
| | | |
| | 2009 | 2008 | 2007 |
| | | | |
Expected tax using statutory tax rate of 34% | $ 1,033,100 | $ 1,846,100 | $ 1,951,700 |
Increase (decrease) in tax resulting from: | | | |
Tax-exempt income on state and municipal | | | |
securities and political subdivision loans | (706,800) | (666,800) | (644,000) |
Interest expense associated with carrying | | | |
certain state and municipal securities | | | |
and political subdivision loans | 8,600 | 76,400 | 93,100 |
Increase in cash value of life insurance | | | |
policies | (174,100) | (167,600) | (152,200) |
Deductible dividends paid to United | | | |
Bancshares, Inc. ESOP | (61,700) | (54,500) | (47,400) |
Other, net | 56,900 | (22,600) | (40,200) |
| | | | |
Total provision for income taxes | $ 156,000 | $ 1,011,000 | $ 1,161,000 |
| |
|
|
|
The deferred income tax credit of $280,565 in 2009, $543,362 in 2008, and $202,482 in 2007 resulted from the tax effects of temporary differences. There was no impact for changes in tax laws and rates or changes in the valuation allowance for deferred tax assets.
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2009 and 2008 are presented below:
| | |
| | 2009 | 2008 |
Deferred tax assets: | | |
Unrealized loss on securities available-for-sale | $ - | $ 212,399 |
Allowance for loan losses | 1,671,200 | 1,125,200 |
Deferred compensation | 317,400 | 287,900 |
Alternative minimum tax credits | 293,700 | - |
Accrued expenses and other | 472,866 | 474,101 |
Total deferred tax assets | 2,755,166 | 2,099,600 |
Deferred tax liabilities: | | |
Unrealized gain on securities available-for-sale | 1,215,666 | - |
Federal Home Loan Bank stock dividends | 877,500 | 877,500 |
Capitalized mortgage servicing rights | 433,000 | 239,200 |
Depreciation and amortization | 1,187,500 | 770,700 |
Other | 43,000 | 66,200 |
Total deferred tax liabilities | 3,756,666 | 1,953,600 |
| | | |
Net deferred tax assets (liabilities) | $(1,001,500) | $ 146,000 |
43
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14 - INCOME TAXES (CONTINUED)
Net deferred tax assets (liabilities) at December 31, 2009 and 2008 are included in other assets (liabilities) in the consolidated balance sheets.
At December 31, 2009, the Corporation has available alternative minimum tax credit carryforwards of approximately $293,700 which may be utilized in the future to the extent computed regular tax exceeds the alternative minimum tax.
Management believes it is more likely than not that the benefit of deferred tax assets will be realized. Consequently, no valuation allowance for deferred tax assets is deemed necessary as of December 31, 2009 and 2008.
Unrecognized Tax Benefits
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
| |
Balance at January 1, 2009 | $154,200 |
Additions based on tax positions related to the current year | 48,800 |
Additions for tax positions of prior years | - |
Reductions for tax positions of prior years | - |
Reductions due to the statute of limitation | - |
Settlements | - |
| | |
Balance at December 31, 2009 | $ 203,000 |
The Corporation had unrecognized tax benefits of $203,000 and $154,200 at December 31, 2009 and 2008, respectively. Additions based on tax positions related to the current year amounted to $48,800 in 2009, $71,900 in 2008 and $82,300 in 2007. Such unrecognized tax benefits, if recognized, would favorably affect the effective income tax rate in future periods. The Corporation does not expect the total amount of unrecognized tax benefits to significantly change in the next twelve months.
The amount of accrued interest related to the Corporation’s uncertain tax positions was $8,100 at December 31, 2009 and $2,600 at December 31, 2008, respectively.
The Corporation and its subsidiaries are subject to U.S. federal income tax. The Corporation and its subsidiaries are no longer subject to examination by taxing authorities for years before 2006.
44
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 - EMPLOYEE AND DIRECTOR BENEFITS
The Corporation and Bank sponsor a salary deferral, defined contribution plan which provides for both profit sharing and employer matching contributions. The plan permits the investing in the Corporation’s stock subject to certain limitations. Participants who meet certain eligibility conditions are eligible to participate and defer a specified percentage of their eligible compensation subject to certain income tax law limitations. The Corporation and Bank make discretionary matching and profit sharing contributions, as approved annually by the Board of Directors, subject to certain income tax law limitations. Contribution expense for the plan amounted to $487,745, $491,502, and $465,329, in 2009, 2008, and 2007, respectively. At December 31, 2009, the Plan owned 317,441 shares of the Corporation’s common stock.
The Bank also sponsors nonqualified deferred compensation plans, covering certain directors and employees, which have been indirectly funded through the purchase of split-dollar life insurance policies. In connection with the policies, the Bank has provided an estimated liability for accumulated supplemental retirement benefits amounting to $616,307 at December 31, 2009 and $518,353 at December 31, 2008 which is included in other liabilities in the accompanying consolidated balance sheets. The Bank has also purchased split-dollar life insurance policies for investment purposes to fund other employee benefit plans. The combined cash values of these policies aggregated $11,851,036 and $11,358,947 at December 31, 2009 and 2008, respectively.
Under an employee stock purchase plan, eligible employees may defer a portion of their compensation and use the proceeds to purchase stock of the Corporation at a discount determined semi-annually by the Board of Directors as stipulated in the plan. The Corporation sold from treasury 2,103 shares in 2009, 7,258 shares in 2008, and 7,856 shares in 2007 under the plan.
The Bank has an agreement with Leipsic’s former President, who is the Corporation’s current Chairman of the Board of Directors, to provide for retirement compensation benefits. Such benefits are to be paid over a period of twenty years commencing upon retirement effective December 31, 2001. At December 31, 2009 and 2008, the net present value (based on the 12% discount rate in effect at the time of origination of the agreement) of future deferred compensation payments amounted to $317,235 and $328,426, respectively. Such amounts are included in other liabilities in the December 31, 2009 and 2008 consolidated balance sheets. A split-dollar life insurance policy has been purchased and is available to fund a portion of the future deferred compensation payments. The cash value of the policy amounted to $550,948 and $530,885 at December 31, 2009 and 2008, respectively.
The Chief Executive Officer and Chief Financial Officer of the Corporation have employment agreements which provide certain compensation and benefits as specified in the agreements. On January 14, 2010, the Corporation entered into a change of control agreement with the Chief Executive Officer which, among other things, provides for certain compensation and other benefits if a change of control exists as defined in the agreement. The agreement of the Chief Financial Officer provides for certain compensation and benefits should any triggering events occur, as specified in the agreement, including change of control or termination without cause.
45
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 - STOCK OPTIONS
The following summarizes stock options activity for the years ended December 31, 2009, 2008 and 2007:
| | | | | | | | |
| | 2009 | | 2008 | | 2007 |
| | Shares | Weighted average exercise price | | Shares | Weighted average exercise price | | Shares | Weighted average exercise price |
Outstanding at | | | | | | | | |
beginning of year | 5,146 | $9.66 | | 12,006 | $12.95 | | 12,006 | 12.95 |
Expired | - | - | | (6,860) | 15.42 | | - | - |
| | | | | | | | | |
Outstanding and | | | | | | | | |
exercisable | | | | | | | | |
at end of year | 5,146 | $ 9.66 | | 5,146 | $ 9.66 | | 12,006 | $ 12.95 |
Options outstanding at December 31, 2009 are all at an exercise price of $9.66 and expire May 5, 2010.
In connection with its acquisition in March 2001 of Citizens, the Corporation issued options to certain directors and a senior officer of Citizens under the terms of Citizens’ Amended and Restated Stock-Based Incentive Plan (the “Plan”). The Plan provides that options may be exercised through an “alternative option payment mechanism” referred to in the Plan as using “pyramiding transactions” where options are exercised, the shares gained through the exercise rate are tendered back to the Corporation as payment for a greater number of options, and the process is repeated as needed until all options are exercised. Ultimately, the holder of the option ends up with a lower number of shares than exercised but at essentially no cash outlay. All outstanding options could be exercised through the alternative payment method as of December 31, 2009 and 2008, but did not have any fair value.
NOTE 17 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is 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 are primarily loan commitments to extend credit and letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the consolidated balance sheets. The contract amount of these instruments reflects the extent of involvement the Bank has in these financial instruments.
The Bank’s exposure to credit loss in the event of the nonperformance by the other party to the financial instruments for loan commitments to extend credit and letters of credit is represented by the contractual amounts of these instruments. The Bank uses the same credit policies in making loan commitments as it does for on-balance sheet loans.
The following financial instruments whose contract amount represents credit risk were outstanding at December 31, 2009 and 2008:
| | | |
| | Contract amount |
| | 2009 | | 2008 |
| | | | |
Commitments to extend credit | $ 66,271,000 | | $ 85,792,000 |
| | | | |
Letters of credit | $ 1,067,000 | | $ 1,845,000 |
46
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK (CONTINUED)
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future cash requirements. The Bank evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Bank upon extension of credit is based on management’s credit evaluation of the customer. Collateral held varies but may include accounts receivable; inventory; property, plant, and equipment; and income-producing commercial properties.
Letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party and are reviewed for renewal at expiration. All letters of credit outstanding at December 31, 2009 expire in 2010. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Bank requires collateral supporting these commitments when deemed necessary.
NOTE 18 - REGULATORY MATTERS
The Corporation (on a consolidated basis) and Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Corporation’s and Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action pr ovisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Corporation and Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of December 31, 2009 and 2008, that the Corporation and Bank meet all capital adequacy requirements to which they are subject.
As of December 31, 2009, the most recent notification from federal and state banking agencies categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized”, an institution must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank’s category.
47
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 – REGULATORY MATTERS(CONTINUED)
The actual capital amounts and ratios of the Corporation and Bank as of December 31, 2009 and 2008 are presented in the following table:
Minimum to be
well capitalized
Minimum
under prompt
capital
corrective
Actual
requirement
action provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
(Dollars in Thousands)
As of December 31, 2009
Total Capital (to Risk-
Weighted Assets)
Consolidated
$
59,549
12.7%
$
37,546
> 8.0%
N/A
N/A
Bank
55,134
11.8%
37,436
> 8.0%
$
46,795
10.0%
Tier I Capital (to Risk-
Weighted Assets)
Consolidated
$
54,745
11.7%
$
18,773
> 4.0%
N/A
N/A
Bank
50,330
10.8%
18,718
> 4.0%
$
28,077
6.0%
Tier I Capital (to
Average Assets)
Consolidated
$
54,745
9.2%
$
23,848
> 4.0%
N/A
N/A
Bank
50,330
8.3%
24,194
> 4.0%
$
30,243
5.0%
As of December 31, 2008
Total Capital (to Risk-
Weighted Assets)
Consolidated
$
56,899
12.6%
$
36,249
> 8.0%
N/A
N/A
Bank
52,943
11.8%
36,175
> 8.0%
$
45,219
10.0%
Tier I Capital (to Risk-
Weighted Assets)
Consolidated
$
53,701
11.9%
$
18,125
> 4.0%
N/A
N/A
Bank
49,745
11.0%
18,088
> 4.0%
$
27,131
6.0%
Tier I Capital (to
Average Assets)
Consolidated
$
53,701
8.7%
$
24,576
> 4.0%
N/A
N/A
Bank
49,745
8.2%
24,326
> 4.0%
$
30,408
5.0%
On a parent company only basis, the Corporation’s primary source of funds is dividends paid by the Bank. The ability of the Bank to pay dividends is subject to limitations under various laws and regulations, and to prudent and sound banking principles. Generally, subject to certain minimum capital requirements, the Bank may declare dividends without the approval of the State of Ohio Division of Financial Institutions, unless the total dividends in a calendar year exceed the total of the Bank’s net profits for the year combined with its retained profits of the two preceding years.
The Board of Governors of the Federal Reserve System generally considers it to be an unsafe and unsound banking practice for a bank holding company to pay dividends except out of current operating income, although other factors such as overall capital adequacy and projected income may also be relevant in determining whether dividends should be paid.
48
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - CONDENSED PARENT COMPANY FINANCIAL INFORMATION
A summary of condensed financial information of the parent company as of December 31, 2009 and 2008 and for each of the three years in the period ended December 31, 2009 is as follows:
| | |
Condensed Balance Sheets | 2009 | 2008 |
| | | |
Assets: | | |
Cash | $ 2,800,432 | $ 2,418,309 |
Investment in bank subsidiary | 60,163,521 | 57,003,816 |
Premises and equipment, net of accumulated depreciation | 420,504 | 446,126 |
Other assets, including income taxes receivable from bank | | |
subsidiary of $873,103 in 2009 and $799,870 in 2008 | 1,313,827 | 1,210,029 |
| | | |
Total assets | $ 64,698,284 | $ 61,078,280 |
| | | |
Liabilities: | | |
Accrued expenses | $ 119,179 | $ 118,565 |
Junior subordinated deferrable interest debentures | 10,300,000 | 10,300,000 |
| | | |
Total liabilities | 10,419,179 | 10,418,565 |
| | | |
Shareholders’ equity: | | |
Common stock | 3,760,557 | 3,760,557 |
Surplus | 14,659,661 | 14,659,661 |
Retained earnings | 38,343,134 | 37,528,026 |
Accumulated other comprehensive income (loss) | 2,359,821 | (412,304) |
Treasury stock, at cost | (4,844,068) | (4,876,225) |
| | | |
Total shareholders’ equity | 54,279,105 | 50,659,715 |
| | | |
Total liabilities and shareholders’ equity | $64,698,284 | $61,078,280 |
| | | |
Condensed Statements of Income | 2009 | 2008 | 2007 |
| | | | |
Income – including dividends from bank subsidiary | $ 3,006,657 | $ 3,000,000 | $ 3,016,595 |
Expenses – interest expense, professional fees and other expenses, net of federal income tax benefit |
(511,641) |
(642,937) |
(678,129) |
| | | | |
Income before equity in undistributed net income of bank subsidiary |
2,495,016 |
2,357,063 |
2,338,466 |
| | | | |
Equity in undistributed net income of bank subsidiaries |
387,580 |
2,061,534 |
2,240,912 |
| | | | |
Net income | $ 2,882,596 | $ 4,418,597 | $ 4,579,378 |
49
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19 - CONDENSED PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
| | | |
Condensed Statements of Cash Flows | 2009 | 2008 | 2007 |
| | | | |
Cash flows from operating activities: Net income |
$ 2,882,596 |
$ 4,418,597 |
$ 4,579,378 |
Adjustments to reconcile net income to net cash provided by operating activities: | | | |
Equity in undistributed net income of bank subsidiary |
(387,580) |
(2,061,534) |
(2,240,912) |
Provision (credit) for accrued compensation – stock options |
- |
(11,286) |
(42,141) |
Depreciation and amortization | 25,622 | 39,038 | 79,348 |
Decrease (increase) in other assets | (103,798) | (600,189) | 193,117 |
Increase (decrease) in accrued expenses | 614 | (36,436) | 32,847 |
| | | | |
Net cash provided by operating activities |
2,417,454 |
1,748,190 |
2,601,637 |
| | | | |
Cash flows from investing activity – proceeds | | | |
from sale of security | - | - | 51,121 |
| | | | |
Cash flows from financing activities: | | | |
Purchase of common stock | - | (775,250) | (1,347,150) |
Proceeds from sale of treasury shares | 30,632 | 98,709 | 108,157 |
Cash dividends paid | (2,065,963) | (2,064,686) | (1,969,407) |
| | | | |
Net cash used in financing activities | (2,035,331) | (2,741,227) | (3,208,400) |
| | | | |
Net increase (decrease) in cash | 382,123 | (993,037) | (555,642) |
| | | | |
Cash at beginning of the year | 2,418,309 | 3,411,346 | 3,966,988 |
| | | | |
Cash at end of the year | $ 2,800,432 | $ 2,418,309 | $ 3,411,346 |
During 2005, the Board of Directors approved a program whereby the Corporation purchases shares of its common stock in the open market. The decision to purchase shares, the number of shares to be purchased, and the price to be paid depends upon the availability of shares, prevailing market prices, and other possible considerations which may impact the advisability of purchasing shares. The Corporation purchased 55,000 shares in 2008 and 86,500 shares in 2007 (none in 2009) under the program.
NOTE 20 - FAIR VALUE MEASUREMENTS
Effective January 1, 2008, the Corporation adopted the provisions of SFAS No. 157, “Fair Value Measurements” which is codified in FASB ASC 820-10 (ASC 820-10). In accordance with FASB Staff Position (FSP) No. 157-2,Effective Date of FASB Statement No. 157, the Corporation delayed application of ASC 820-10 for any nonfinancial assets and nonfinancial liabilities until January 1, 2009. ASC 820-10 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.
50
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - FAIR VALUE MEASUREMENTS (CONTINUED)
ASC 820-10 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal ma rket that are independent, knowledgeable, and both able and willing to transact.
ASC 820-10 requires the use of valuation techniques that are consistent with the market approach, the income approach, and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable or unobservable. Observable inputs reflect the assumptions market participants would use in pric ing the asset or liability developed based on market data obtained from independent sources. Unobservable inputs reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, ASC 820-10 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
Level 1 –Unadjusted quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access at the measurement date.
Level 2 –Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include 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 for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3 – Unobservable inputs for the asset or liability for which there is little, if any, market activity at the measurement date. Unobservable inputs reflect the Corporation’s own assumptions about what market participants would use to price the asset or liability. The inputs are developed based on the best information available in the circumstances, which might include the Corporation’s own financial data such as internally developed pricing models, discounted cash flow methodologies, as well as instruments for which the fair value determination requires significant management judgment.
51
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - FAIR VALUE MEASUREMENTS (CONTINUED)
The following table summarizes financial assets (there were no financial liabilities) measured at fair value as of December 31, 2009 and 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
| | | | |
| | Level 1 | Level 2 | Level 3 | Total |
2009 | inputs | inputs | inputs | fair value |
| | | | | |
Recurring: | | | | |
Securities available-for-sale | $ - | $ 138,586,362 | $ - | $ 138,586,362 |
Mortgage servicing rights | - | - | 1,273,525 | 1,273,525 |
| | | | | |
Total recurring | $ - | $ 138,586,362 | $ 1,273,525 | $ 139,859,887 |
| | | | | |
Nonrecurring: | | | | |
Impaired loans | $ - | $ - | $11,947,282 | $ 11,947,282 |
Other real estate owned | - | - | 5,170,635 | 5,170,635 |
| | | | | |
Total nonrecurring | $ - | $ - | $17,117,917 | $ 17,117,917 |
| | | | |
2008 | | | | |
| | | | | |
Recurring: | | | | |
Securities available-for-sale | $ - | $ 136,498,302 | $ - | $ 136,498,302 |
Mortgage servicing rights | - | - | 703,388 | 703,388 |
| | | | | |
Total recurring | $ - | $ 136,498,302 | $ 703,388 | $ 137,201,690 |
| | | | | |
Nonrecurring: | | | | |
Impaired loans | $ - | $ - | $ 4,533,350 | $ 4,533,350 |
There were no financial instruments measured at fair value that moved to a lower level in the fair value hierarchy during 2009 and 2008 due to the lack of observable quotes in inactive markets for those instruments at December 31, 2009 and 2008.
The table below presents a reconciliation and income statement classification of gains and losses for mortgage servicing rights, which is measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2009 and 2008:
| | |
| | 2009 | 2008 |
| | | |
Balance at beginning of year | $ 703,388 | $ 1,531,225 |
Gains or losses, including realized and unrealized: | | |
Disposals – amortization based on loan payments and payoffs |
(237,463) |
(325,712) |
Purchases, issuances, and settlements | 612,499 | 146,966 |
Other changes in fair value | 195,101 | (649,091) |
| | |
Balance at end of year | $ 1,273,525 | $ 703,388 |
52
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - FAIR VALUE MEASUREMENTS (CONTINUED)
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, follows.
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Corporation’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Corporation’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Corporation’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
Securities Available-for-Sale
Where quoted prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would typically include government bonds and exchange traded equities. If quoted market prices are not available, then fair values are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Examples of such instruments, which would generally be classified within Level 2 of the valuation hierarchy, include corporate and municipal bonds, mortgage-backed securities, and asset-backed 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. The Corporation did not have any securities classified as Level 1 or Level 3 at December 31, 2009 and 2008.
Impaired Loans
The Corporation does not record impaired loans at fair value on a recurring basis. However, periodically, a loan is considered impaired and is reported at the fair value of the underlying collateral, less estimated costs to sell, if repayment is expected solely from the collateral. Collateral values are estimated using level 2 inputs, including recent appraisals and Level 3 inputs based on customized discounting criteria. Due to the significance of the level 3 inputs, impaired loans fair values have been classified as level 3.
Losses included in earnings before income taxes amounted to $5,640,681 in 2009 and $1,281,943 in 2008, relating to impaired loans, and such losses are included in the provision for loan losses. There were no gains or losses relating to securities available-for-sale included in earnings before income taxes that were attributable to changes in fair values of securities held at December 31, 2009 and 2008.
53
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20 - FAIR VALUE MEASUREMENTS (CONTINUED)
Other Real Estate Owned
The Corporation values other real estate owned at the estimated fair value of the underlying collateral less expected selling costs. Such values are estimated primarily using appraisals and reflect a market value approach. Due to the significance of the Level 3 inputs, other real estate owned has been classified as Level 3.
Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances, for example, when there is evidence of impairment. Financial assets and financial liabilities, excluding impaired loans and other real estate owned, measured at fair value on a nonrecurring basis were not significant at December 31, 2009.
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair values of recognized financial instruments at December 31, 2009 and 2008 are as follows:
| | | | | | | |
| | 2009 | | 2008 |
| | Carrying | | Estimated | | Carrying | | Estimated |
| | amount | | value | | amount | | value |
| | (dollars in thousands) |
FINANCIAL ASSETS | | | | | | | |
Cash and cash equivalents | $ 27,380 | | $ 27,380 | | $ 25,622 | | $ 25,622 |
Securities, including Federal | | | | | | | |
Home Loan Bank stock | 143,480 | | 143,480 | | 141,392 | | 141,392 |
Net loans, including loans | | | | | | | |
held for sale | 403,011 | | 430,072 | | 415,187 | | 439,018 |
Mortgage servicing rights | 1,274 | | 1,274 | | 703 | | 703 |
| | | | | | | | |
| | $ 575,145 | | $ 602,206 | | $ 582,904 | | $ 606,735 |
| | | | | | | | |
FINANCIAL LIABILITIES | | | | | | | |
Deposits | $469,668 | | $472,617 | | $464,792 | | $471,588 |
Other borrowings | 77,907 | | 80,649 | | 86,252 | | 90,617 |
Junior subordinated deferrable | | | | | | | |
interest debentures | 10,300 | | 8,776 | | 10,300 | | 6,232 |
Other liabilities | 4,251 | | 4,341 | | 4,060 | | 4,160 |
| | | | | | | | |
| | $ 562,126 | | $ 566,383 | | $ 565,404 | | $ 572,597 |
The above summary does not include accrued interest receivable and cash surrender value of life insurance which are also considered financial instruments. The estimated fair value of such items is considered to be their carrying amounts.
54
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
There are also unrecognized financial instruments at December 31, 2009 and 2008 which relate to commitments to extend credit and letters of credit. The contract amount of such financial instruments amounts to $67,338,000 at December 31, 2009 and $87,637,000 at December 31, 2008. Such amounts are also considered to be the estimated fair values.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments shown above:
Cash and cash equivalents:
Fair value is determined to be the carrying amount for these items (which include cash on hand, due from banks, and federal funds sold) because they represent cash or mature in 90 days or less and do not represent unanticipated credit concerns.
Securities:
The fair value of securities is determined based on quoted market prices of the individual securities or, if not available, estimated fair value was obtained by comparison to other known securities with similar risk and maturity characteristics. Such value does not consider possible tax ramifications or estimated transaction costs.
Loans:
Fair value for loans was estimated for portfolios of loans with similar financial characteristics. For adjustable rate loans, which re-price at least annually and generally possess low risk characteristics, the carrying amount is believed to be a reasonable estimate of fair value. For fixed rate loans the fair value is estimated based on a discounted cash flow analysis, considering weighted average rates and terms of the portfolio, adjusted for credit and interest rate risk inherent in the loans. Fair value for nonperforming loans is based on recent appraisals or estimated discounted cash flows.
Mortgage servicing rights:
The fair value for mortgage servicing rights is determined based on an analysis of the portfolio by an independent third party.
Deposit liabilities:
The fair value of core deposits, including demand deposits, savings accounts, and certain money market deposits, is the amount payable on demand. The fair value of fixed-maturity certificates of deposit is estimated using the rates offered at year end for deposits of similar remaining maturities. The estimated fair value does not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the marketplace.
55
UNITED BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21 - FAIR VALUE OF FINANCIAL INSTRUMENTS(CONTINUED)
Other financial instruments:
The fair value of commitments to extend credit and letters of credit is determined to be the contract amount, since these financial instruments generally represent commitments at existing rates. The fair value of other borrowings is determined based on a discounted cash flow analysis using current interest rates. The fair value of the junior subordinated deferrable interest debentures is determined based on quoted market prices of similar instruments. The fair value of other liabilities is generally considered to be carrying value except for the deferred compensation agreement described in Note 15. The fair value of the contract is determined based on a discounted cash flow analysis using a current interest rate for a similar instrument.
The fair value estimates of financial instruments are made at a specific point in time based on relevant market information. These estimates do not reflect any premium or discount that could result from offering for sale at one time the entire holdings of a particular financial instrument over the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Since no ready market exists for a significant portion of the financial instruments, fair value estimates are largely based on judgments after considering such factors as future expected credit losses, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect these estimates.
NOTE 22 - CONTINGENT LIABILITIES
In the normal course of business, the Corporation and its subsidiary may be involved in various legal actions, but in the opinion of management and legal counsel, the ultimate disposition of such matters is not expected to have a material adverse effect on the consolidated financial statements.
NOTE 23 - QUARTERLY FINANCIAL DATA (UNAUDITED)
The following represents a summary of selected unaudited quarterly financial data for 2009 and 2008:
Earnings
Net
Net
(loss) per
Interest
interest
income
common share
income
income
(loss)
Basic
Diluted
(Dollars in thousands, except per share data)
2009
First quarter
$
8,399
$
5,040
$
1,432
$
.42
$
.42
Second quarter
8,343
5,141
1,335
.39
.39
Third quarter
8,299
5,255
(777)
(.23)
(.23)
Fourth quarter
7,826
5,114
893
.26
.26
56
