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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K/A
AMENDMENT NO. 1
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
COMMISSION FILE #0-16640
UNITED BANCORP, INC.
(Exact name of registrant as specified in its charter)
MICHIGAN 38-2606280
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
205 E. CHICAGO BOULEVARD, TECUMSEH, MI 49286
(Address of principal executive offices, including Zip code)
Registrant's telephone number, including area code: (517) 423-8373
Securities registered pursuant to Section 12(b) of the Act: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, no par value
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer as defined
in Rule 12b-2 of the Act.
Yes [X] No [ ]
As of February 8, 2005, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $116,774,000 (common stock, no par value.)
As of February 8, 2005, there were 2,354,682 outstanding shares of registrant's
common stock, no par value.
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act.
Yes [ ] No [X]
Documents Incorporated By Reference:
Portions of the registrant's definitive 2005 Proxy Statement in connection with
the 2005 Annual Meeting of Shareholders are incorporated by reference into Part
III.
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Page 1
UNITED BANCORP, INC.
AMENDMENT NO. 1 TO THE ANNUAL REPORT OF FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004
EXPLANATORY NOTE
We are filing this Amendment No. 1 to our Annual Report on Form 10-K for the
fiscal year ended December 31, 2004, as filed with the U.S. Securities and
Exchange Commission on March 15, 2005 to directly include the information
required by Items 7, 7A and 8 and 9 of Part II and Item 15 of Part IV of Form
10-K.
This Amendment does not reflect events occurring after the original filing of
the Form 10-K and does not modify or update the disclosures therein in any way
other than as required to reflect the amendment as described above and set forth
below. According this Form 10-K/A should be read in conjunction with our other
filings made with the Securities and Exchange Commission subsequent to the
filing of the original Annual Report on Form 10-K, including any amendments to
those filings.
PART II
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this item is contained on pages A-2 through A-20
hereof, and is incorporated by reference herein.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is contained on pages A-14 through A-17
hereof, and is incorporated by reference herein.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is contained on pages A-22 through A-40
hereof, and is incorporated by reference herein.
INDEX TO FINANCIAL STATEMENTS PAGE NO.
- -------------------------------------------------------------- --------
Report of Independent Registered Public Accounting Firm A-21
Consolidated Financial Statements
Consolidated Balance Sheets A-22
Consolidated Statements of Income A-23
Consolidated Statements of Cash Flow A-24
Consolidated Statements of Changes in Shareholders' Equity A-25
Notes to Consolidated Financial Statements A-26 -- A-40
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
Page 2
PART IV
ITEM 15 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. The following documents are filed as a part of this report:
INDEX TO FINANCIAL STATEMENTS PAGE NO.
- --------------------------------------------------------------- --------
Report of Independent Registered Public Accounting Firm A-21
Consolidated Financial Statements
Consolidated Balance Sheets A-22
Consolidated Statements of Income A-23
Consolidated Statements of Cash Flow A-24
Consolidated Statements of Changes in Shareholders' Equity A-25
Notes to Consolidated Financial Statements A-26 -- A-40
2. Financial statement schedules are not applicable.
(b) Listing of Exhibits (numbered as in Item 601 of Regulation S-K):
Exhibit #
3(a) Restated Articles of Incorporation of United Bancorp, Inc., filed as
Exhibit (4)(a) to registrant's registration statement on Form S-8
(File Number 333-03305) dated May 8, 1996, and incorporated herein
by reference.
3(b) Bylaws of United Bancorp, Inc., filed as Exhibit (4)(b) to
registrant's registration statement on Form S-8 (File Number
333-03305) dated May 8, 1996, and incorporated herein by reference.
4(a) Restated Articles of Incorporation of United Bancorp, Inc., filed as
Exhibit (4)(a) to registrant's registration statement on Form S-8
(File Number 333-03305) dated May 8, 1996, and incorporated herein
by reference.
Exhibits (continued)
4(b) Bylaws of United Bancorp, Inc., filed as Exhibit (4)(b) to
registrant's registration statement on Form S-8 (File Number
333-03305) dated May 8, 1996, and incorporated herein by reference.
4(c) United Bancorp, Inc. Director Retainer Stock Plan, filed as Appendix
A to registrant's proxy statement dated March 25, 1996 (file number
0-16640) and incorporated herein by reference.
4(d) United Bancorp, Inc. Senior Management Bonus Deferral Stock Plan,
filed as Appendix B to registrant's proxy statement dated March 25,
1996 (file number 0-16640) and incorporated herein by reference.
4(e) United Bancorp, Inc. 1999 Stock Option Plan, filed as Appendix B to
the Company's proxy statement dated March 24, 2000 (file number
0-16640) and incorporated herein by reference.
4(f) United Bancorp, Inc. 2005 Stock Option Plan, filed as Appendix B to
the Company's proxy statement dated March 15, 2004 (file number
0-16640) and incorporated herein by reference.
Page 3
11 Statement re Computation of Per Share Earnings - this information is
incorporated by reference in Note 1 on Page A-28 and Note 19 on Page
A-38 hereof.
14 Registrant's Code of Business Conduct and Ethics as adopted December
9, 2003, filed as Exhibit 14 to registrant's Form 10-K filed on
March 15, 2005 and incorporated herein by reference.
21 Listing of Subsidiaries, filed as Exhibit 21 to registrant's
Form 10-K filed on March 15, 2005 and incorporated herein by
reference.
23 Consent of BKD LLP, Independent Registered Public Accounting Firm
24 Power of Attorney contained on the signature page of the Form 10-K
filed on March 15, 2005.
31.1 Certification of Principal Executive Officer
31.2 Certification of Principal Accounting Officer
32.1 Certification Pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(d) All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and therefore
have been omitted.
Page 4
UNITED BANCORP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
AND
CONSOLIDATED FINANCIAL STATEMENTS
TABLE OF CONTENTS
The Business of United Bancorp, Inc. A-1
Management's Discussion and Analysis of Financial Condition and
Results of Operations
Executive Summary A-3
Results of Operations A-3
Financial Condition A-9
Liquidity, Funds Management and Market Risk A-14
Capital Resources A-17
Contractual Obligations A-17
Prospective Accounting and Regulatory Changes A-18
Critical Accounting Policies A-19
Forward-Looking Statements A-20
Report of Independent Registered Public Accounting Firm A-21
Consolidated Financial Statements
Consolidated Balance Sheets A-22
Consolidated Statements of Income A-23
Consolidated Statements of Cash Flows A-24
Consolidated Statements of Changes in Shareholders' Equity A-25
Notes to Consolidated Financial Statements A-26
Page A-1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
This discussion provides information about the consolidated financial condition
and results of operations of United Bancorp, Inc. (the "Company") and its
subsidiary banks, United Bank & Trust ("UBT") and United Bank & Trust -
Washtenaw ("UBTW").
In accordance with Rule 14a-3 (c) of the Securities Exchange Act of 1934 (the
"Exchange Act"), the information contained in the narrative and tabular
information and in the consolidated financial statements and notes thereto is
provided solely for the information of shareholders and the Securities and
Exchange Commission (the "Commission"). Such information shall not be deemed to
be "soliciting material" or to be "filed" with the Commission or subject to
Regulation 14A under the Exchange Act (except as provided in Rule 14a-3) or to
the liabilities of Section 18 of the Exchange Act, unless, and only to the
extent that, it is expressly incorporated by reference into the Form 10-K of the
Company for its fiscal year ended December 31, 2004.
BACKGROUND
The Company is a financial holding company registered with the Board of
Governors of the Federal Reserve System (the "Federal Reserve Board") under the
Bank Holding Company Act. The Company has corporate power to engage in such
activities as permitted to business corporations under the Michigan Business
Corporation Act, subject to the limitations of the Bank Holding Company Act and
regulations of the Federal Reserve System. The Company's subsidiary banks offer
a full range of services to individuals, corporations, fiduciaries and other
institutions. Banking services include checking, NOW accounts, savings, time
deposit accounts, money market deposit accounts, safe deposit facilities and
money transfers. Lending operations provide real estate loans, secured and
unsecured business and personal loans, consumer installment loans, and
check-credit loans, home equity loans, accounts receivable and inventory
financing, equipment lease financing and construction financing.
The Company's Banks offer the sale of nondeposit investment products through
licensed representatives in their banking offices, and sell credit and life
insurance products. In addition, the Company and/or the Banks are co-owners of
Michigan Banker's Title Insurance Company of Mid-Michigan LLC and Michigan
Bankers Insurance Center, LLC, and derive income from the sale of various
insurance products to banking clients. UBT operates a trust department, and
provides trust services to UBTW on a contract basis. The Trust & Investment
Group offers a wide variety of fiduciary services to individuals, corporations
and governmental entities, including services as trustee for personal,
corporate, pension, profit sharing and other employee benefit trusts. The
department provides securities custody services as an agent, acts as the
personal representative for estates and as a fiscal, paying and escrow agent for
corporate customers and governmental entities, and provides trust services for
clients of the Banks. These products help to diversify the Company's sources of
income.
While unemployment in Michigan in recent months is generally higher than in many
areas of the U.S., the markets served by the Banks are only marginally impacted.
In particular, the Ann Arbor market has much lower unemployment levels than does
the rest of the State. While recent downturns in the economy have impacted some
small companies, in general the Banks have not felt the impact of this decline.
In addition, in part through the addition of its Ann Arbor subsidiary in 2001,
the Company continues to gain market share in its market areas.
Page A-2
EXECUTIVE SUMMARY
Net income of the Company for 2004 improved over 2003 as a result of increased
net interest income and reduced expenses, and in spite of declining noninterest
income. Net interest income increased while spread and net interest margin
declined, as balance sheet growth helped to offset declining margins.
Noninterest income was down from 2003, with substantially all of this decline
resulting from a significant reduction in income from the sale and servicing of
mortgage loans in the secondary market. At the same time, increases in most
other categories of noninterest income helped to offset much of this shortfall.
The Company's provision for loan loss and other expenses were virtually flat
from 2003.
The second half of 2004 was stronger than the first half of the year, as net
interest income continued its steady improvement quarter over quarter.
Noninterest income was relatively stable in the last three quarters of the year,
and expenses were consistent between quarters. The chart below shows the trends
of the major components of earnings for the four quarters of 2004.
in thousands of dollars, where appropriate 4th Qtr 3rd Qtr 2nd Qtr 1st Qtr
- ------------------------------------------ ------- ------- ------- -------
Net interest income before provision $ 6,031 $ 5,926 $ 5,676 $ 5,664
Provision for loan losses 253 229 304 262
Noninterest income 2,771 2,797 2,898 2,544
Noninterest expense 5,649 5,553 5,812 5,632
Federal income tax provision 816 839 707 598
Net income $ 2,084 $ 2,102 $ 1,751 $ 1,716
Return on average assets (a) 1.27% 1.30% 1.13% 1.12%
Return on average shareholders' equity (a) 13.38% 13.80% 11.83% 11.71%
======= ======= ======= =======
- ------------
(a) Annualized
RESULTS OF OPERATIONS
Earnings Summary and Key Ratios
Consolidated net income improved 3.6% over record levels achieved in 2003, with
growth at United Bank & Trust - Washtenaw contributed significantly to that
improvement. This percentage increase compares to an increase in 2003 of 3.5%
over 2002 levels. Shifts in the yield curve caused the Company's net interest
margin to tighten in spite of the asset-sensitive position of the balance sheet.
This tightening was offset by strong growth in loans and deposits, and net
interest income improved 4.3% over the prior year, following a decline in 2003
over 2002.
At the same time, noninterest income declined 6.9% from record levels achieved
in 2003, as income from the sale and servicing of residential real estate
mortgages in the secondary market declined. This reduction of income was offset
in part by increases in other areas, as the diversity of the Company's earnings
stream was evident. Expenses were down slightly from 2003, as was the provision
for loan loss. The end result was an improvement in net income, while return
ratios were not as strong as prior periods.
Page A-3
Return on average assets declined for the third year in a row, as the Company
had to work harder to make money with its assets. The same situation has
occurred with return on average equity, which declined in both 2003 and 2004. In
each case, the reduced return ratios were the result of asset and equity growth
that outpaced earnings growth. At the same time, book value per share and cash
dividends per share continue to provide improving returns to shareholders.
The chart below shows trends in these and other ratios. All figures are adjusted
to reflect stock dividends.
5 Year
Performance Ratios 2004 2003 2002 Average
- -------------------------------------- ------ ------ ------ -------
Return on average assets 1.21% 1.25% 1.28% 1.21%
Return on average shareholders' equity 12.72% 13.30% 14.02% 12.80%
Average equity to average total assets 9.5% 9.4% 9.2%
Dividend payout ratio 42.0% 39.9% 39.5%
Book value per share $26.42 $ 24.56 $22.89
Cash dividends per share $1.364 $ 1.261 $1.212
====== ======= ======
Book value per share is based on shares outstanding at December 31 of 2,355,097
for 2004, 2,336,211 for 2003 and 2,331,528 for 2002 as adjusted for stock
dividends. Dividends per share does not include contingently issuable shares,
and is based on average adjusted shares outstanding of 2,352,347 for 2004,
2,334,002 for 2003 and 2,327,187 for 2002, as adjusted for stock dividends.
Net Interest Income
United Bancorp, Inc. derives the greatest portion of its income from net
interest income. During the historically unique changes in interest rates during
2002, the Company benefited as its cost of funds decreased more quickly than did
its yield on earning assets. As interest rates declined in 2002 and 2003, the
Banks took the opportunity to lengthen the maturity of their liabilities, in
preparation for future increases in interest rates. This had the impact of
reducing net interest income in anticipation of rising rates in future periods.
While this strategy was basically sound, interest rates did not increase
consistently across the yield curve, and the rising rates in 2004 have not
improved net interest income as much as if the entire yield curve had shifted
up. This resulted in tightening of tax equivalent interest spread and net
interest margin, in spite of rising rates. However, continued growth of the
Company's balance sheet offset this tightening, and net interest income
increased 4.3% in 2004 over 2003, compared to a decline of 2.2% in the prior
year.
Yields on earning assets declined from 5.79% in 2003 to 5.57% in 2004, with the
greatest portion of that decline occurring in the loan portfolio. Cost of funds
also declined, but tax equivalent spread moved from 3.91% in 2003 to 3.82% in
2004. Net interest margin experienced a similar decline, dropping from 4.23% in
2003 to 4.12% in 2004.
The table below provides insight into the various components of net interest
income, as well as the results of changes in balance sheet makeup that have
impacted the margin.
Page A-4
YIELD ANALYSIS OF CONSOLIDATED AVERAGE ASSETS AND LIABILITIES
2004 2003 2002
-------------------------- ---------------------------- ---------------------------
Average Yield/ Average Yield/ Average Yield/
Dollars in Thousands Balance Interest Rate Balance Interest Rate Balance Interest Rate
ASSETS ------- -------- ------ -------- -------- ------ -------- -------- ------
Interest earning assets (a)
Federal funds sold $ 3,906 $ 51 1.30% $ 19,287 $ 214 1.11% $ 10,975 $ 175 1.60%
Taxable securities 75,755 2,058 2.72% 66,860 2,218 3.32% 64,210 2,789 4.34%
Tax exempt securities (b) 28,981 1,680 5.80% 30,672 1,791 5.84% 33,010 2,154 6.53%
Taxable loans 469,749 28,426 6.05% 424,719 27,138 6.39% 407,093 29,042 7.13%
Tax exempt loans (b) 1,387 92 6.63% 1,385 95 6.85% 1,649 125 7.55%
-------- ------- --------- ------- -------- -------
Total interest
earning assets (b) 579,778 $32,306 5.57% 542,923 $31,456 5.79% 516,937 $34,285 6.63%
Cash and due from banks 21,052 17,959 15,059
Premises and equipment, net 14,232 14,375 14,840
Intangible assets 3,469 3,469 3,469
Other assets 20,278 14,823 8,745
Unrealized gain on securities
available for sale 570 1,434 1,508
Allowance for loan losses (5,698) (5,256) (4,831)
-------- --------- --------
Total Assets $633,681 $ 589,727 $555,727
======== ========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities
NOW accounts $115,140 $ 696 0.60% $ 100,809 $ 633 0.63% $ 90,495 $ 848 0.94%
Savings deposits 175,658 1,671 0.95% 164,959 1,614 0.98% 143,735 2,016 1.40%
CDs $100,000 and over 38,853 1,138 2.93% 26,783 1,033 3.86% 29,886 1,394 4.66%
Other int. bearing deposits 106,496 2,950 2.77% 120,966 3,358 2.78% 138,379 4,722 3.41%
-------- ------- --------- ------- -------- -------
Total int. bearing deposits 436,147 6,455 1.48% 413,517 6,638 1.61% 402,495 8,980 2.23%
Short term borrowings 2,447 38 1.55% 138 1 0.62% 533 8 1.41%
Other borrowings 42,343 1,930 4.56% 38,265 1,869 4.88% 30,893 1,728 5.59%
-------- ------- --------- ------- -------- -------
Total int. bearing liab. 480,937 8,423 1.75% 451,920 8,508 1.88% 433,921 10,716 2.47%
------- ------- -------
Nonint. bearing deposits 86,156 75,511 64,699
Other liabilities 6,398 6,735 6,205
Shareholders' equity 60,190 55,561 50,902
-------- ------- ------
Total Liabilities and
Shareholders' Equity $633,681 $ 589,727 $555,727
======== ========= ========
Net interest income (b) $23,884 $22,948 $23,569
======= ======= =======
Net spread 3.82% 3.91% 4.16%
Net yield on interest earning assets (b) 4.12% 4.23% 4.56%
Ratio of interest earning assets to
interest bearing liabilities 1.21 1.20 1.19
(a) Non-accrual loans and overdrafts are included in the average balances of
loans.
(b) Fully tax-equivalent basis, net of nondeductible interest impact; 34% tax
rate.
Page A-5
The following tables support the fact that the increase in net interest income
during 2004 was a result of balance sheet growth, offset in part by changes in
yields and rate. For the year, the net increase in net interest income as a
result of changes in volume was 66% larger than the decline resulting from
changes in rate.
These tables demonstrate the effect of volume and rate changes on net interest
income on a taxable equivalent basis for the past two years. The change in
interest due to both rate and volume has been allocated to volume and rate
changes in proportion to the relationship of the absolute dollar amounts of the
change in each. Nonaccrual loans are included in total loans, and changes are
treated as volume variances.
2004 compared to 2003 2003 compared to 2002
Increase (decrease) due to: Increase (decrease) due to:
--------------------------------- ---------------------------------
Volume Rate Net Volume Rate Net
In thousands of dollars --------- --------- --------- --------- --------- ---------
Interest earned on:
Federal funds sold $ (194) $ 31 $ (163) $ 104 $ (65) $ 39
Taxable securities 272 (433) (161) 111 (681) (570)
Tax exempt securities (98) (12) (110) (146) (218) (364)
Taxable loans 2,776 (1,488) 1,288 1,219 (3,123) (1,904)
Tax exempt loans - (3) (3) (19) (11) (30)
-------- -------- -------- -------- -------- --------
Total interest income $ 2,756 $ (1,905) $ 851 $ 1,269 $ (4,098) $ (2,829)
Interest expense on:
NOW accounts $ 87 $ (24) $ 63 $ 88 $ (303) $ (215)
Savings deposits 103 (46) 57 268 (670) (402)
Interest bearing CDs of
100,000 or greater 393 (288) 105 (135) (226) (361)
Other int. bearing deposits (401) (6) (407) (550) (814) (1,364)
Short term borrowings 34 3 37 (4) (3) (7)
Other borrowings 191 (130) 61 378 (237) 141
-------- -------- -------- -------- -------- --------
Total interest expense $ 407 $ (491) $ (84) $ 45 $ (2,253) $ (2,208)
-------- -------- -------- -------- -------- --------
Net change in net
interest income $ 2,349 $ (1,414) $ 935 $ 1,224 $ (1,845) $ (621)
Provision for Loan Losses
The Company's charge-offs within its loan portfolio increased in 2004, following
a decline in 2003. At the same time, recoveries were up from 2003 levels. While
2004 net charge-offs of $779,000 were well above 2003 levels, they are slightly
ahead of 2002 figures, during a period of strong loan growth. The provision for
2004 was consistent with the prior two years, and was just below 2003 levels.
This provision provides for currently anticipated losses inherent in the current
portfolio, and Management continues to evaluate its allocation methodology to
assure that the Banks are adequately protected against these losses.
The Company has consistently low to moderate levels of nonperforming loans, and
loan loss history continues to compare favorably to peers. The use of an
independent loan review function for business loans and careful monitoring of
loans by Management allows the Banks to maintain a high level of quality in
their loan portfolios. These factors combine with the Company's level of
residential real estate loans to support an allowance as a percent of total
loans at a level that Management believes is appropriate for the risks in its
loan portfolio.
Page A-6
Noninterest Income
Total noninterest income declined 6.9% in 2004 over 2003. This follows increases
of 18.2% and 15.7% in 2003 and 2002, respectively. Substantially all of this
decline was a result of slowed activity in the sale of residential real estate
loans in the secondary market, and that decline will be discussed further. The
following table summarizes changes in noninterest income by category for 2004
and 2003, in thousands of dollars where appropriate.
Change in Categories of Noninterest Income
2004 2003 Change 2002 Change
-------- ------- ------- ------- ------
Service charges on deposit accounts $ 2,774 $ 2,623 5.8% $ 2,330 12.6%
Trust & Investment fee income 3,754 3,104 20.9% 2,888 7.5%
Gains (losses) on securities transactions (29) 105 -127.6% 15 600.0%
Loan sales and servicing 1,222 2,988 -59.1% 2,001 49.3%
ATM, debit and credit card fee income 1,469 1,442 1.9% 1,386 4.0%
Sales of nondeposit investment products 721 751 -4.0% 786 -4.5%
Bank owned life insurance 443 250 77.2% - 0.0%
Other income 656 559 17.4% 593 -5.7%
------- ------- ------ ------- -----
Total Noninterest Income $11,010 $11,822 -6.9% $ 9,999 18.2%
======= ======= ====== ======= =====
Service charges on deposit accounts were up 5.8% in 2004, compared to an
increase of 12.6% in 2003 and 8.4% in 2002 This is consistent with the fact that
total deposits grew 5.4% during 2004, with short-term deposit products making up
a larger portion of total deposits. Those categories of deposits generate fee
income, while certificates of deposit do not. No significant changes were made
in the Company's service charge structure during the year.
The Trust & Investment Group of UBT continues to provide a steady contribution
to the Company's income statement, as fee income improves with the growth of the
Department. 2004 was a particularly strong year, as fee income grew 20.9% over
the prior year. Continued improving conditions in the financial markets began to
be reflected in Trust fee income in 2003, and strong markets in 2004 combined
with excellent growth to provide the earnings improvement for the year. At
December 31, 2004, assets managed by the Department were $616.9 million,
compared to $579.7 million at the end of 2003 and $483.4 million at the end of
2002. The Trust department implemented a small fee increase late in 2004, which
provided minimal benefit to 2004 earnings. Future increases in Trust fee income
are dependent on the growth of the Department and the market value of assets
managed.
The Banks generally market their production of fixed rate long-term residential
mortgages in the secondary market, and retain adjustable rate mortgages for
their portfolios. The Company maintains a portfolio of sold residential real
estate mortgages, which it continues to service. This servicing provides ongoing
income for the life of the loans. During 2003, clients continued to exhibit a
preference for fixed rate loans as market rates declined, resulting in a greater
proportion of those loans originated by the Banks being sold in the secondary
market. This unprecedented activity in residential mortgages during 2003
resulted in record earnings from this source.
During 2004, this volume of residential mortgage origination and refinancing
slowed, resulting in a considerable reduction in fees from the sale of those
loans on the secondary market. Income from loan sales and servicing declined
59.1% in 2004 over 2003, following an increase of 49.3% in 2003 compared to
2002. As anticipated as a result of the slowdown in refinancing volume in 2004,
the Company experienced improved fee income as the write-off of unamortized
servicing rights declines with the slowing of the pace of refinancing within the
residential real estate mortgage portfolios. As the Company is conservative in
its approach to valuation of mortgage servicing rights, no write-downs in
Page A-7
mortgage servicing rights were required in 2004, 2003 or 2002 as a result of
impairment or other reasons.
Income from the sale of nondeposit investment products is derived from the sale
of investments and insurance products to clients, including credit, life and
title insurance policies, annuities, mutual funds and other investment vehicles.
This category of income continued its decline experienced in 2003, and reflects
slower sales volumes of annuities and mutual fund products. The Company has also
slowed its sales efforts in other insurance products, as a result of lower than
anticipated sales volumes.
ATM, debit and credit card fee income continues to provide a steady source of
noninterest income for the Company. The Banks operate seventeen ATMs throughout
their market areas, and Bank clients are active users of debit cards. The Banks
continue to receive ongoing fee income from credit card referrals and operation
of its credit card merchant business. Income from these areas was up slightly in
2004 over 2003, increasing 1.9%, compared to an increase of 4.0% from 2002 to
2003.
The increase in income from bank-owned life insurance in 2004 reflects a full
year of income on BOLI purchased in 2003. Other noninterest income during the
year consisted of income from various fee- based banking services, including
sale of official checks, wire transfer fees, safe deposit box income and other
fees. This category of noninterest income improved 17.4% from 2003 to 2004,
following a decline of 5.7% from 2002 to 2003, with no one area contributing
significantly more to the improvement. A portion of the decline in 2003 was
temporary, and resulted from the move of three banking offices from UBT to UBTW
during 2003. Fee income generated by clients of those three offices was down in
2003, as the Banks waived some fees in order to make the transition easier for
clients. Those fee levels returned to more normal levels in 2004.
Overall, total noninterest income declined $812,000 from 2003 to 2004, with a
reduction of $1.766 million in mortgage loan sales and servicing. This reflects
the diversity of the Company's noninterest income sources, and Management
anticipates continued improvement in the future as the sources of noninterest
income remain fluid.
Noninterest Expense
The following table summarizes changes in noninterest expense by category for
2004 and 2003, in thousands of dollars where appropriate.
Change in Categories of Noninterest Expense
2004 2003 Change 2002 Change
-------- -------- ------ -------- ------
Salaries and employee benefits $ 13,502 $ 13,672 -1.2% $ 12,647 8.1%
Occupancy and equipment expense, net 4,019 3,927 2.3% 3,764 4.3%
External data processing 1,125 1,208 -6.9% 1,161 4.0%
Advertising and marketing 382 360 6.1% 553 -34.9%
Other expense 3,618 3,502 3.3% 3,519 -0.5%
-------- -------- ---- -------- -----
Total Noninterest Expense $ 22,646 $ 22,669 -0.1% $ 21,644 4.7%
======== ======== ==== ======== =====
Total noninterest expenses were virtually flat in 2004, following growth of 4.7%
in 2003. At the same time, total assets increased 6.7% from the end of 2003 to
2004. This increase in expenses at a rate lower than asset growth reflects in
part the "growing into" overhead costs that resulted from the formation and
operation of United Bank & Trust-Washtenaw. The company continues to emphasize
cost controls, while continuing to make the expenditures necessary to remain
competitive.
Page A-8
Salaries and benefits are the organization's largest single area of expense.
During 2004, this category of expense declined 1.2% from 2003 levels, primarily
reflecting significant decline in commissions paid during the year, as a result
of the slowing of mortgage activity and the amounts paid to commissioned
mortgage originators. Benefits costs continue to be a large contributor to
personnel expense, but the amounts paid to co-workers for profit sharing bonuses
and 401(k) profit sharing contributions declined in 2004 as the Company fell
below its earnings targets.
Occupancy and equipment expense increased 2.3% in 2004, compared to an increase
of 4.3% in 2003 and 6.7% in 2002. This modest increase reflects the fact that
there were no significant additions to the Company's technology or office
infrastructure in 2004 other than those required to maintain strategic position.
Advertising and marketing expenses increased 6.1% in 2004, following a decline
of nearly $200,000 from 2002 to 2003. Other expenses were up 3.3% over 2003,
with no significant items contributing to the increase in expenses in this area.
Federal Income Tax
The following chart shows the effective federal tax rates of the Company for the
past three years, in thousands of dollars where applicable.
Effective Tax Rates 2004 2003 2002
- ------------------- -------- -------- --------
Income before tax $ 10,613 $ 10,412 $ 10,069
Federal income tax $ 2,960 $ 3,024 $ 2,934
Effective federal tax rate 27.9% 29.0% 29.1%
======== ======== ========
The Company's effective federal tax rate for 2004 declined slightly from 2003.
This reduction was primarily a result of a full year of income in 2004 from
purchases of bank-owned life insurance at the Banks in mid-2003. In addition,
tax credits from participation in low-income housing partnerships has helped
reduce the Company's federal income taxes. Tax exempt income continues to be a
significant factor in the tax calculation for the Company, due to the percentage
of the investment portfolio carried in tax exempt municipal securities and
loans. The Banks intend to continue to invest in these assets as long as
liquidity, safety and tax equivalent yields make them an attractive alternative.
FINANCIAL CONDITION
Securities
Dollars of loan growth in excess of net deposit growth resulted in a decline in
the Company's securities portfolio during 2004. The makeup of the Company's
investment portfolio continues to evolve with the growth of the Company, and the
mix of the consolidated investment portfolio has continued to shift to meet
liquidity and interest rate risk needs. On a consolidated basis, investment in
tax exempt securities and corporate, asset backed and other securities declined,
while investments held in U.S. Treasury and agency securities and mortgage
backed agency securities have increased somewhat. The changes in the various
categories of the portfolio are shown in the chart below.
Change in Categories of Securities Portfolio, in thousands of dollars 2004 2003
- --------------------------------------------------------------------- -------- --------
U.S. Treasury and agency securities $ 1,762 $ 10,979
Mortgage backed agency securities 4,086 4,852
Obligations of states and political subdivisions (6,976) 4,425
Corporate, asset backed and other securities (3,820) (8,902)
-------- --------
Change in total securities $ (4,948) $ 11,354
======== ========
Page A-9
These changes are also reflected in the percentage makeup of the portfolio. The
following chart shows the percentage mix of the securities portfolio.
Percentage Makeup of Securities Portfolio at December 31, 2004 2003
- --------------------------------------------------------- ------ ------
U.S. Treasury and agency securities 41.0% 37.5%
Mortgage backed agency securities 21.7% 17.0%
Obligations of states and political subdivisions 34.2% 39.1%
Corporate, asset backed and other securities 3.1% 6.5%
----- -----
Total securities 100.0% 100.0%
===== =====
Investments in U.S. Treasury and agency securities are considered to possess low
credit risk. Obligations of U.S. government agency mortgage-backed securities
possess a somewhat higher interest rate risk due to certain prepayment risks.
The municipal portfolio contains a small amount of geographic risk, as
approximately 14% of that portfolio is issued by political subdivisions located
within Lenawee County, Michigan. The Company's portfolio contains no "high risk"
mortgage securities or structured notes.
The Company's current and projected tax position continues to make carrying
tax-exempt securities valuable to the Banks, and the Company does not anticipate
being subject to the alternative minimum tax in the near future. The investment
in local municipal issues also reflects the Company's commitment to the
development of the local area through support of its local political
subdivisions.
The chart below summarizes unrealized gains and losses in each category of the
portfolio at the end of 2004 and 2003, in thousands of dollars.
Unrealized Gains and Losses in the Investment Portfolio 2004 2003 Change
- ------------------------------------------------------- ------- ---- -------
U.S. Treasury and agency securities $ (268) $ 90 $ (358)
Mortgage backed agency securities (174) 43 (217)
Obligations of states and political subdivisions 509 640 (131)
Corporate, asset backed and other securities 84 107 (23)
------ ---- ------
Total investment securities $ 151 $880 $ (729)
====== ==== ======
Unrealized gains and losses within the investment portfolio are temporary, since
they are a result of market changes, rather than a reflection of credit quality.
Management has no specific intent to sell any securities, although the entire
investment portfolio is classified as available for sale.
Loans
The Company continues to be a significant provider of loans in its markets. As
full service lenders, the Banks offer a variety of loan products in their
markets. Loan growth exceeded 11% in 2004, as refinancing and sale of
residential portfolio mortgages slowed. At the same time, business and personal
loan volume continued to be strong. The chart below shows the percentage change
in each category of the loan portfolio for 2004 and 2003.
Percentage Change in Categories of Loan Portfolio 2004 2003
- ------------------------------------------------- ------ ------
Personal 5.5% -1.0%
Business 8.6% 20.8%
Tax exempt 125.3% 4.2%
Residential mortgage -10.5% -23.3%
Construction 94.4% -4.0%
Total loans 11.2% 3.8%
===== =====
Page A-10
The volume of mortgage loans generated during 2003 and 2002 reached record
levels. During this period, as a result of historically low interest rates
available in the market, most residential mortgage clients chose fixed rate
mortgage products. Since the Banks sell most of their fixed-rate mortgage loans
on the secondary market, this increase in mortgage origination volume was not
reflected on the Company's balance sheet. It was instead reflected in its
portfolio of loans sold with servicing retained, resulting in improved fee
income during the year.
That rate of reduction in the mortgage portfolio slowed in 2004, as rates began
to rise and refinancing into loans sold into the secondary market decreased. In
spite of that, the Company experienced a 10.5% reduction in portfolio
residential mortgages in 2004, compared to a decline of 23.3% in 2003.
Construction loan activity increased significantly in 2004, following a decline
in 2003. The percentage decline shown in the above table is as of December 31,
which is typically a slower time for construction loans in Michigan.
Construction loan volume reflects continued growth of the commercial mortgage
and residential housing activity in the Company's market area. Residential
construction loans will convert to residential mortgages to be retained in the
Banks' portfolios or to be sold in the secondary market, while commercial
construction loans will eventually be converted to commercial mortgages.
Personal loan balances grew in 2004, following a small decline in 2003, as
consumer finance activity at commercial banks slowed. Activity in 2004 was in
all categories of personal loans, but the largest growth was in home equity
loans and lines of credit. Personal loans on the Company's balance sheet include
direct and indirect loans for automobiles, boats and recreational vehicles, and
other items for personal use. In addition, personal lines of credit and home
equity loans are included in this loan category.
Business loans also experienced excellent growth during 2004, although at a
lower percentage increase than in 2003. Total loans outstanding to businesses
increased 8.6% in 2004, compared to growth of 20.8% in the prior year. This
growth in loans to commercial enterprises is derived from all of the markets the
Banks serve, including significant contributions from the Ann Arbor and Dexter
markets. Continued participation in tax exempt financing reflects continued
involvement in funding local community expansion at local municipalities and
school districts, reduced by normal amortizations of loan balances. Growth in
this category of loans in 2004 was up significantly from that experienced in
2003.
Credit Quality
The Company continues to maintain a high level of asset quality as a result of
actively monitoring delinquencies, nonperforming assets and potential problem
loans. The aggregate amount of nonperforming loans is presented in the table
below. For purposes of that summary, loans renewed on market terms existing at
the time of renewal are not considered troubled debt restructurings. The accrual
of interest income is discontinued when a loan becomes ninety days past due
unless it is both well secured and in the process of collection, or the
borrower's capacity to repay the loan and the collateral value appear
sufficient.
Page A-11
The chart below shows the amount of nonperforming assets by category for each of
the past five years.
Nonperforming Assets, in thousands of dollars 2004 2003 2002 2001 2000
- --------------------------------------------- ------- ------- ------- ------- ------
Nonaccrual loans $ 3,709 $ 3,635 $ 1,583 $ 1,084 $ 889
Accruing loans past due 90 days or more 1,674 761 748 1,104 408
Troubled debt restructurings - - - 130 132
------- ------- ------- ------- ------
Total nonperforming loans 5,383 4,396 2,331 2,318 1,429
Other real estate 844 593 467 179 544
------- ------- ------- ------- ------
Total nonperforming assets $ 6,227 $ 4,989 $ 2,798 $ 2,497 $1,973
======= ======= ======= ======= ======
Percent of nonperforming loans to total loans 1.08% 0.98% 0.54% 0.61% 0.42%
======= ======= ======= ======= ======
Percent of nonperforming assets to total assets 0.96% 0.82% 0.49% 0.48% 0.42%
======= ======= ======= ======= ======
The Company's percentage of nonperforming loans to total loans increased from
2003 to 2004, primarily reflecting an increase in loan delinquency and assets
held as other real estate. The increase in delinquent loans reflects the impact
of a slowing economy on a few local small business clients. Of the delinquency
amount shown, just under $600,000 reflects balances of one loan client that were
paid current immediately following the end of the year. Other balances within
that total include one business in the process of liquidation. That loan is
well-collateralized, and no loss is expected. Collection efforts continue with
all delinquent clients, to bring them back to performing status or to finish
liquidation. The allowance for loan losses provides adequate allocation for loan
losses that may result from shortfalls in these loans.. The balance of loans in
nonaccrual status was relatively unchanged from 2003 to 2004. Loans are
generally moved to nonaccrual status when ninety days or more past due or in
bankruptcy.
The amount listed in the previous table as other real estate reflects three
properties that were acquired through foreclosure or in lieu of foreclosure. All
are vacant and are for sale, and no significant loss on these properties is
anticipated. Total dollars in this category have increased from 2003 levels, but
remain relatively low as a percentage of assets.
Credit quality is dependent in part on the makeup of the loan portfolio. The
following chart shows the percentage makeup of the loan portfolio.
Percentage Makeup of Loan Portfolio at December 31, 2004 2003
- --------------------------------------------------- ------ ------
Personal 14.9% 15.7%
Business 56.1% 57.5%
Tax exempt 0.7% 0.3%
Residential mortgage 15.3% 19.1%
Construction 13.0% 7.4%
----- -----
Total loans 100.0% 100.0%
===== =====
Loans to finance residential mortgages, including construction loans, make up
28.3% of the portfolio at year-end, compared to 26.5% at the end of 2003. This
increase is primarily reflected in increases in commercial and residential
construction loans, most of which will remain on the balance sheet of the
Company, and some will be sold into the secondary market. Loans in this category
are well-secured and have had historically low levels of net losses.
Page A-12
The personal loan portfolio consists of direct and indirect installment, home
equity and unsecured revolving line of credit loans. Installment loans consist
primarily of loans for consumer durable goods, principally automobiles. Indirect
personal loans consist of loans for automobiles and manufactured housing, but
make up a small percent of the personal loans.
Business loans carry the largest balances per loan, and therefore, any single
loss would be proportionally larger than losses in other portfolios. Because of
this, the Banks use an independent loan review firm to assess the continued
quality of its business loan portfolio. This is in addition to the precautions
taken with credit quality in the other loan portfolios. Business loans consist
of approximately 59% of loans secured by nonfarm, nonresidential real estate.
There are no other significant concentrations in the business loan portfolio.
Further information concerning credit quality is contained in Note 6 of the
Notes to Consolidated Financial Statements.
Deposits
Deposit totals increased more than $27 million in 2004, or 5.4% for the year,
and total deposits increased 6.6% in 2003. Products such as money market deposit
accounts, Cash Management Checking and Cash Management Accounts continue to be
very popular with clients, aiding in continued deposit growth. Although clients
continue to evaluate alternatives to certificates of deposit in search of the
best yields on their funds, traditional banking products continue to be an
important part of the Company's product line.
The Banks do not support their growth through purchased or brokered deposits.
The Banks' deposit rates are consistently competitive with other banks in its
market area, including those new markets that the Company has entered in recent
periods. The majority of the Company's deposits are derived from core client
sources, relating to long term relationships with local personal, business and
public clients. The following chart shows the percentage change in deposits by
category for 2004 and 2003.
Percentage Change in Deposits by Category 2004 2003
- ----------------------------------------- ---- ----
Noninterest bearing deposits 9.5% 8.6%
Interest bearing deposits 4.7% 6.2%
Total deposits 5.4% 6.6%
=== ===
The chart below shows the percentage makeup of the deposit portfolio in 2004 and
2003.
Percentage Breakdown of Deposit Portfolio as of December 31, 2004 2003
- ------------------------------------------------------------ ----- -----
Noninterest bearing deposits 16.2% 15.6%
Interest bearing deposits 83.8% 84.4%
----- -----
Total deposits 100.0% 100.0%
===== =====
Cash Equivalents and Borrowed Funds
The Company maintains correspondent accounts with a number of other banks for
various purposes. In addition, cash sufficient to meet the operating needs of
its banking offices is maintained at its lowest practical levels. At times, the
Banks are participants in the federal funds market, either as borrowers or
sellers. Federal funds are generally borrowed or sold for one-day periods. The
Banks also have the ability to utilize short term advances from the Federal Home
Loan Bank ("FHLB") and borrowings at the discount window of the Federal Reserve
Bank as additional short-term funding sources. Federal funds were used during
2004 and 2003, and short term advances and discount window borrowings were not
utilized during either year.
The Company periodically finds it advantageous to utilize longer term borrowings
from the Federal Home Loan Bank of Indianapolis. These long-term borrowings, as
detailed in Note 11 of the Notes to
A-13
Consolidated Financial Statements, served to provide a balance to some of the
interest rate risk inherent in the Company's balance sheet. Additional
information regarding borrowed funds is found in the section below.
LIQUIDITY, FUNDS MANAGEMENT AND MARKET RISK
Liquidity
During 2004, the Company's cash and cash equivalents declined as a result of
normal activities within the balance sheet and income statement. Throughout
2004, the Company participated in the federal funds market; at times as a
provider of funds and at other times as a purchaser. Funding needs varied
throughout the year, and overall, the Company's excess funds during 2004 were
lower than in 2003. The Company averaged net federal funds sold of $1.535
million during 2004, compared to $19.287 million during 2003. These changes were
primarily a result of timing differences between loan, investment and deposit
growth.
Deposits increased by $27.3 million in 2004, and FHLB advances increased by $7.5
million. Net portfolio loans increased by $49.8 million, and total investments
declined by $4.9 million. All of these changes contributed to the Company's
reduction in excess funds.
The Banks monitor their liquidity position regularly, and are in compliance with
regulatory guidelines for liquidity. The cash flows of the Company are
relatively predictable. While loan and deposit cash flows are determined to a
large extent by the actions of its clients, the Company is able to control its
cash flows with regard to borrowings and investments. The Company has a number
of liquidity sources other than deposits, including federal funds and other
lines of credit with correspondent banks, securities available for sale, and
lines of credit with the FHLB. Information concerning available lines is
contained in Note 10 of the Notes to Consolidated Financial Statements.
Funds Management and Market Risk
The composition of the Company's balance sheet consists of investments in
interest earning assets (loans and investment securities) that are funded by
interest bearing liabilities (deposits and borrowings). These financial
instruments have varying levels of sensitivity to changes in market interest
rates resulting in market risk.
Policies of the Company place strong emphasis on stabilizing net interest
margin, with the goal of providing a sustained level of satisfactory earnings.
The Funds Management, Investment and Loan policies provide direction for the
flow of funds necessary to supply the needs of depositors and borrowers.
Management of interest sensitive assets and liabilities is also necessary to
reduce interest rate risk during times of fluctuating interest rates.
Interest rate risk is the exposure of the Company's financial condition to
adverse movements in interest rates. It results from differences in the
maturities or timing of interest adjustments of the Company's assets,
liabilities and off-balance-sheet instruments; from changes in the slope of the
yield curve; from imperfect correlations in the adjustment of interest rates
earned and paid on different financial instruments with otherwise similar
repricing characteristics; and from interest rate related options embedded in
the Company's products such as prepayment and early withdrawal options.
A number of measures are used to monitor and manage interest rate risk,
including interest sensitivity and income simulation analyses. An interest
sensitivity model is the primary tool used to assess this risk, with
supplemental information supplied by an income simulation model. The simulation
model is used to estimate the effect that specific interest rate changes would
have on twelve months of pretax net
A-14
interest income assuming an immediate and sustained up or down parallel change
in interest rates of 200 basis points. Key assumptions in the models include
prepayment speeds on mortgage related assets; cash flows and maturities of
financial instruments; changes in market conditions, loan volumes and pricing;
and management's determination of core deposit sensitivity. These assumptions
are inherently uncertain and, as a result, the models cannot precisely estimate
net interest income or precisely predict the impact of higher or lower interest
rates on net interest income. Actual results will differ from simulated results
due to timing, magnitude, and frequency of interest rate changes and changes in
market conditions. Based on the results of the simulation model as of December
31, 2004, the Company would expect a maximum potential reduction in net interest
margin of less than 13% if market rates increased or decreased under an
immediate and sustained parallel shift of 200 basis points.
During 2004 and 2003, the Company increased its usage of long term fixed rate
FHLB advances in order to lock in its cost of funds at historically low rates.
In addition, the Company continued to be asset- sensitive in the twelve-month
timeframe based on internal interest sensitivity measures.
The following table provides information about the Company's financial
instruments used for purposes other than trading that are sensitive to changes
in interest rates. For loans, securities, and liabilities with contractual
maturities, the table presents principal cash flows and related weighted average
interest rates by the earlier of the contractual maturity or call dates as well
as market and historical experience of the impact of interest rate fluctuations
on the prepayment of mortgage-backed securities. Weighted average variable rates
are based on current rates and indexes. The Company currently has no market
sensitive instruments entered into for trading purposes and no off-balance-sheet
interest rate swaps or caps. The information is in thousands of dollars as of
December 31, 2004 and 2003.
FINANCIAL INSTRUMENTS AT DECEMBER 31, 2004
-----------------------------------------------------------------------------------------------------
Principal Amount Maturing In:
-------------------------------------------------------------- Fair
2005 2006 2007 2008 2009 Thereafter Total Value
---------- --------- --------- --------- --------- ---------- ---------- --------
RATE-SENSITIVE ASSETS:
Fixed Rate:
Loans $ 36,945 $ 30,137 $ 34,305 $ 38,045 $ 24,357 $ 43,304 $ 207,093 $209,926
Avg Int. Rate 6.6% 6.8% 7.0% 6.6% 6.7% 6.0% 6.6%
Investments $ 40,490 $ 26,461 $ 7,931 $ 2,868 $ 877 $ 7,784 $ 86,411 $ 86,684
Avg Int. Rate 2.9% 2.9% 3.3% 4.4% 4.4% 5.0% 3.2%
Variable Rate:
Loans $ 105,868 $ 44,543 $ 16,997 $ 15,553 $ 21,270 $ 85,574 $ 289,805 $289,940
Avg Int. Rate 5.8% 5.5% 5.1% 4.8% 5.0% 6.4% 5.8%
Investments $ 5,329 $ 4,018 $ 1,810 $ 1,001 $ 662 $ 1,288 $ 14,108 $ 13,984
Avg Int. Rate 3.0% 2.9% 3.2% 3.1% 3.1% 3.1% 3.0%
Other interest
earning assets $ 3,118 $ 3,118 $ 3,118
Average interest rate 3.7% 3.7%
RATE-SENSITIVE LIABILITIES:
Noninterest bearing demand $ 85,598 $ 85,598 $ 85,598
Savings & interest
bearing demand $ 314,143 $ 314,143 $314,143
Avg Int. Rate 1.1% 1.1%
Time deposits $ 55,272 $ 40,630 $ 23,169 $ 4,708 $ 6,358 $ - $ 130,137 $132,033
Avg Int. Rate 2.8% 3.4% 3.6% 3.4% 4.0% 0.0% 3.2%
Fixed rate borrowings $ 1,568 $ 8,011 $ 20,339 $ 8,929 $ 3,000 $ 1,000 $ 42,847 $ 43,336
Avg Int. Rate 3.8% 4.2% 5.0% 3.9% 2.9% 5.6% 4.4%
Other interest bearing
liabilities $ 8,726 $ 8,726 $ 8,726
Average interest rate 2.4% 2.4%
A-15
FINANCIAL INSTRUMENTS AT DECEMBER 31, 2003
-----------------------------------------------------------------------------------------------------
Principal Amount Maturing In:
-------------------------------------------------------------- Fair
2004 2005 2006 2007 2008 Thereafter Total Value
---------- --------- --------- --------- --------- ---------- ---------- --------
RATE-SENSITIVE ASSETS:
Fixed Rate:
Loans $ 38,649 $ 23,185 $ 33,551 $ 28,240 $ 39,843 $ 50,598 $ 214,066 $219,867
Avg Int. Rate 7.2% 7.2% 7.0% 7.3% 6.7% 6.5% 6.9%
Investments $ 56,858 $ 18,903 $ 8,560 $ 2,747 $ 3,068 $ 8,823 $ 98,959 $ 99,804
Avg Int. Rate 3.6% 2.9% 3.0% 3.2% 4.5% 4.9% 3.5%
Variable Rate:
Loans $ 78,593 $ 28,537 $ 23,385 $ 12,347 $ 13,961 $ 75,930 $ 232,753 $232,803
Avg Int. Rate 4.7% 4.5% 4.2% 4.0% 4.0% 6.5% 5.1%
Investments $ 3,556 $ 2,034 $ 752 $ 55 $ - $ - $ 6,397 $ 6,434
Avg Int. Rate 3.4% 3.6% 3.6% 5.1% 0.0% 0.0% 3.5%
Other interest
earning assets $ 2,496 $ 2,496 $ 2,496
Average interest rate 4.6% 4.6%
RATE-SENSITIVE LIABILITIES:
Noninterest bearing demand $ 78,184 $ 78,184 $ 78,184
Savings & interest
bearing demand $ 310,571 $ 310,571 $310,571
Avg Int. Rate 0.7% 0.7%
Time deposits $ 45,657 $ 25,753 $ 24,754 $ 14,680 $ 2,983 $ - $ 113,827 $117,921
Avg Int. Rate 2.6% 3.9% 3.8% 4.2% 3.3% 0.0% 3.4%
Fixed rate borrowings $ 529 $ 1,568 $ 8,011 $ 19,339 $ 5,928 $ - $ 35,375 $ 36,795
Avg Int. Rate 5.9% 4.0% 4.2% 5.1% 4.2% 0.0% 4.7%
Other interest bearing
liabilities $ 8,076 $ 8,076 $ 8,076
Average interest rate 1.2% 1.2%
The Company's primary market risk exposure increased from 2003 to 2004, based on
data supplied by its measurement systems. However, this market risk exposure is
if rates decline further, which seems unlikely in the current rate environment.
The Company's exposure to market risk is reviewed on a regular basis by the
Funds Management Committee. The policy objective is to manage the Company's
assets and liabilities to provide an optimum and consistent level of earnings
within the framework of acceptable risk standards.
The Funds Management Committee is also responsible for evaluating and
anticipating various risks other than interest rate risk. Those risks include
prepayment risk, credit risk and liquidity risk. The Committee is made up of
senior members of management, and continually monitors the makeup of interest
sensitive assets and liabilities to assure appropriate liquidity, maintain
interest margins and to protect earnings in the face of changing interest rates
and other economic factors.
The Funds Management policy provides for a level of interest sensitivity which,
Management believes, allows the Company to take advantage of opportunities
within the market relating to liquidity and interest rate risk, allowing
flexibility without subjecting the Company to undue exposure to risk. In
addition, other measures are used to evaluate and project the anticipated
results of Management's decisions.
The following table shows the rate sensitivity of earning assets and interest
bearing liabilities as of December 31, 2004. Loans and investments are
categorized using the earlier of their scheduled payment, call, or repricing
dates, where applicable. Savings, NOW and money market deposit accounts are
considered to be immediately repriceable. All other liabilities are reported by
their scheduled maturities, and no adjustments for possible prepayments are
included in the table.
A-16
INTEREST SENSITIVITY SUMMARY
--------------------------------------------------------------------------
Over 10
In thousands of dollars 0-3 Mo. 4-12 Mo. 1-5 Yrs 5-10 Yrs Years Total
- ------------------------------------------------ --------- --------- --------- --------- --------- ---------
Securities $ 26,965 $ 24,322 $ 44,565 $ 5,724 $ 2,210 $ 103,786
Loans 217,714 48,149 193,348 27,825 9,862 496,898
--------- --------- --------- --------- --------- ---------
Total earning assets $ 244,679 $ 72,471 $ 237,913 $ 33,549 $ 12,072 $ 600,684
Interest bearing deposits $ 333,687 $ 39,570 $ 71,023 $ - $ - $ 444,280
Other borrowings 8,726 1,568 40,279 1,000 - 51,573
--------- --------- --------- --------- --------- ---------
Total interest bearing liabilities $ 342,413 $ 41,138 $ 111,302 $ 1,000 $ - $ 495,853
--------- --------- --------- --------- --------- ---------
Net asset (liability) interest
sensitivity exposure $ (97,734) $ 31,333 $ 126,611 $ 32,549 $ 12,072 $ 104,831
Cumulative net asset (liability) exposure $ (97,734) $ (66,401) $ 60,210 $ 92,759 $ 104,831
Cumulative ratio of asset to liability exposure 0.71 0.83 1.12 1.19 1.21 to one
Cumulative exposure as a percent
of total assets -15.0% -10.2% 9.3% 14.3% 16.1%
========= ========= ========= ========= ========= =========
CAPITAL RESOURCES
It is the policy of the Company to pay 30% to 45% of net earnings as cash
dividends to shareholders. The payout ratio for 2004 was 42.0%, compared to
39.9% for 2003. Cash dividends have resulted in a dividend yield of
approximately 2.15% and 2.32% in 2004 and 2003, respectively. Five percent stock
dividends were paid to shareholders in 2004 and 2003. The stock of the Company
is traded locally over the counter, and demand consistently exceeds supply.
The ratios of average equity to average assets of the Banks and the Company
increased in 2004 over 2003, as average capital grew at a faster pace than did
average assets as a result of strong earnings. The Company's capital ratios
exceed the levels required by its regulators, and Management continues to
evaluate methods to optimize the high levels of equity of the Company. The table
in Note 18 of the Notes to Consolidated Financial Statements details the capital
ratios of the Company. The Company and UBT are considered to be well-capitalized
and UBTW was categorized as adequately capitalized by the regulators.
The Company maintains a five year plan, and utilizes a formal strategic planning
process. Management and the Board continue to monitor long term goals, which
include maintaining capital growth in relation to asset growth, and the
retention of a portion of earnings to fund growth while providing a reasonable
return to shareholders. Succession planning is in place for Management of the
Company, in order to assure a smooth transition upon the announced retirement of
Chairman and CEO David S. Hickman at the end of 2005.
CONTRACTUAL OBLIGATIONS
The following table details the Company's known contractual obligations at
December 31, 2004, in thousands of dollars:
Payments due by period
-------------------------------------------------------
Less than More than
Contractual Obligations Total 1 year 1-3 years 3-5 years 5 years
- -------------------------------- -------- --------- --------- --------- ---------
Long term debt (FHLB advances) $ 42,847 $ 1,568 $ 28,350 $ 11,929 $ 1,000
Capital lease obligations - - - - -
Operating lease arrangements 7,366 686 1,404 1,457 3,819
Purchase agreements - - - - -
-------- --------- --------- --------- ---------
Total $ 50,213 $ 2,254 $ 29,754 $ 13,386 $ 4,819
A-17
PROSPECTIVE ACCOUNTING AND REGULATORY CHANGES
In March 2004, the Emerging Issues Task Force (EITF) finalized and issued EITF
03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments (EITF 03-1). EITF 03-1 provides recognition and measurement
guidance regarding when impairments of equity and debt securities are considered
other-than-temporary requiring a charge to earnings, and also requires
additional annual disclosures for investments in unrealized loss positions. The
additional annual disclosure requirements were previously issued by the EITF in
November 2003 and were effective for the Company for the year ended December 31,
2003. In September 2004, the Financial Accounting Standards Board (FASB) issued
FASB Staff Position (FSP) EITF 03-1-1, which delays the recognition and
measurement provisions of EITF 03-1 pending the issuance of further
implementation guidance. We are currently evaluating the effect of the
recognition and measurement provisions of EITF 03-1. While our analysis is
pending the FASB's revisions to EITF 03-1, the Company currently believe the
adoption of EITF 03-1 will not result in a material impact on its results of
operations or financial condition.
On December 12, 2003, the American Institute of Certified Public Accountants
issued Statement of Position No. 03-3, Accounting for Certain Loans or Debt
Securities Acquired in a Transfer (SOP 03-3). SOP 03-3 requires acquired loans
with poor credit quality to be recorded at fair value and prohibits carrying
over or creation of valuation allowances in the initial accounting for the
loans. SOP 03-3 also limits the yield that may be accreted to income. SOP 03-3
applies to the purchase of an individual loan, a pool of loans, a group of
loans, and loans acquired in a business combination. SOP 03-3 is effective for
loans acquired in fiscal years beginning after December 31, 2004. SOP 03-3 is
not expected to have a material impact on the Company's results of operations or
financial condition.
In December, 2004, the FASB issued an amendment to SFAS 123 (SFAS 123R) which
eliminates the ability to account for share-based compensation transactions
using Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and generally requires that such transactions be accounted for using
a fair value-based method. SFAS 123R will be effective for the Company beginning
July 1, 2005. SFAS 123R applies to all awards granted after the required
effective date and to awards modified, repurchased, or cancelled after that
date. The cumulative effect of initially applying this Statement, if any, is
recognized as of the required effective date.
As of the required effective date, the Company will apply SFAS 123R using a
modified version of prospective application. Under that transition method,
compensation cost is recognized on or after the required effective date for the
portion of outstanding awards for which the requisite service has not yet been
rendered, based on the grant-date fair value of those awards calculated under
SFAS 123 for either recognition or pro forma disclosures. For periods before the
required effective date, a company may elect to apply a modified version of
retrospective application under which financial statements for prior periods are
adjusted on a basis consistent with the pro forma disclosures required for those
periods by SFAS 123.
Management is currently evaluating the effect of the recognition and measurement
provisions of SFAS 123R but we currently believe the adoption of SFAS 123R will
not result in a material impact on the Company's results of operations or
financial condition.
Management is not aware of any other trends, events or uncertainties that are
likely to have a material effect on the Company's liquidity, capital resources,
or operations. In addition, Management is not aware of any current
recommendations by regulatory authorities, other than those previously
discussed, which would have such an effect.
A-18
CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of the Company are in accordance with
accounting principles generally accepted in the United States and conform to
general practices within the banking industry. The Company's significant
accounting policies are described in detail in the notes to the Company's
consolidated financial statements for the year ended December 31, 2004. The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions. The
financial position and results of operations can be affected by these estimates
and assumptions and are integral to the understanding of reported results.
Critical accounting policies are those policies that management believes are the
most important to the portrayal of the Company's financial condition and
results, and they require management to make estimates that are difficult,
subjective, or complex.
Allowance for Credit Losses
The allowance for credit losses provides coverage for probable losses inherent
in the Company's loan portfolio. Management evaluates the adequacy of the
allowance for credit losses each quarter based on changes, if any, in
underwriting activities, the loan portfolio composition (including product mix
and geographic, industry or customer-specific concentrations), trends in loan
performance, regulatory guidance and economic factors. This evaluation is
inherently subjective, as it requires the use of significant management
estimates. Many factors can affect management's estimates of specific and
expected losses, including volatility of default probabilities, rating
migrations, loss severity and economic and political conditions. The allowance
is increased through provisions charged to operating earnings and reduced by net
charge-offs.
The Company determines the amount of the allowance based on relative risk
characteristics of the loan portfolio. The allowance recorded for commercial
loans is based on reviews of individual credit relationships and an analysis of
the migration of commercial loans and actual loss experience. The allowance
recorded for homogeneous consumer loans is based on an analysis of loan mix,
risk characteristics of the portfolio, fraud loss and bankruptcy experiences,
and historical losses, adjusted for current trends, for each homogeneous
category or group of loans. The allowance for credit losses relating to impaired
loans is based on the loan's observable market price, the collateral for certain
collateral-dependent loans, or the discounted cash flows using the loan's
effective interest rate.
Regardless of the extent of the Company's analysis of client performance,
portfolio trends or risk management processes, certain inherent but undetected
losses are probable within the loan portfolio. This is due to several factors
including inherent delays in obtaining information regarding a client's
financial condition or changes in their unique business conditions, the
judgmental nature of individual loan evaluations, collateral assessments and the
interpretation of economic trends. Volatility of economic or client-specific
conditions affecting the identification and estimation of losses for larger
non-homogeneous credits and the sensitivity of assumptions utilized to establish
allowances for homogenous groups of loans are among other factors. The Company
estimates a range of inherent losses related to the existence of these
exposures. The estimates are based upon the Company's evaluation of imprecision
risk associated with the commercial and consumer allowance levels and the
estimated impact of the current economic environment.
Mortgage Servicing Rights
Mortgage servicing rights ("MSRs") associated with loans originated and sold,
where servicing is retained, are capitalized and included in other intangible
assets in the consolidated balance sheet. The
A-19
value of the capitalized servicing rights represents the present value of the
future servicing fees arising from the right to service loans in the portfolio.
Critical accounting policies for MSRs relate to the initial valuation and
subsequent impairment tests. The methodology used to determine the valuation of
MSRs requires the development and use of a number of estimates, including
anticipated principal amortization and prepayments of that principal balance.
Events that may significantly affect the estimates used are changes in interest
rates, mortgage loan prepayment speeds and the payment performance of the
underlying loans. The carrying value of the MSRs is periodically reviewed for
impairment based on a determination of fair value. For purposes of measuring
impairment, the servicing rights are compared to a valuation prepared based on a
discounted cash flow methodology, utilizing current prepayment speeds and
discount rates. Impairment, if any, is recognized through a valuation allowance
and is recorded as amortization of intangible assets.
Goodwill and Other Intangibles
The Company records all assets and liabilities acquired in purchase
acquisitions, including goodwill and other intangibles, at fair value as
required by SFAS 141. Goodwill is subject, at a minimum, to annual tests for
impairment. Other intangible assets are amortized over their estimated useful
lives using straight-line and accelerated methods, and are subject to impairment
if events or circumstances indicate a possible inability to realize the carrying
amount. The initial goodwill and other intangibles recorded and subsequent
impairment analysis requires management to make subjective judgments concerning
estimates of how the acquired asset will perform in the future. Events and
factors that may significantly affect the estimates include, among others,
customer attrition, changes in revenue growth trends, specific industry
conditions and changes in competition.
FORWARD-LOOKING STATEMENTS
Statements contained in Management's Discussion and Analysis of Financial
Condition and Results of Operations include forward-looking statements that are
based on management's beliefs, assumptions, current expectations, estimates and
projections about the financial services industry, the economy, and about the
Company itself. Words such as "anticipate," "believe," "determine," "estimate,"
"expect," forecast, "intend," "is likely," "plan," "project," "opinion,"
variations of such terms, and similar expressions are intended to identify such
forward-looking statements. The presentations and discussions of the provision
and allowance for loan losses and determinations as to the need for other
allowances presented in this report are inherently forward-looking statements in
that they involve judgments and statements of belief as to the outcome of future
events.
These statements are not guarantees of future performance and involve certain
risks, uncertainties, and assumptions that are difficult to predict with regard
to timing, extent, likelihood, and degree of occurrence. Therefore, actual
results and outcomes may materially differ from what may be expressed or
forecasted in such forward-looking statements. Internal and external factors
that may cause such a difference include changes in interest rates and interest
rate relationships; demand for products and services; the degree of competition
by traditional and non-traditional competitors; changes in banking laws and
regulations; changes in tax laws; changes in prices, levies, and assessments;
the impact of technological advances; governmental and regulatory policy
changes; the outcomes of pending and future litigation and contingencies; trends
in customer behavior and customer ability to repay loans; software failure,
errors or miscalculations; and the vicissitudes of the national economy. The
Company undertakes no obligation to update, amend or clarify forward-looking
statements, whether as a result of new information, future events, or otherwise.
A-20
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
United Bancorp, Inc. and Subsidiaries
[BKD LOGO]
Shareholders and Board of Directors
United Bancorp, Inc.
Tecumseh, Michigan
We have audited the accompanying consolidated balance sheets of United Bancorp,
Inc. as of December 31, 2004 and 2003 and the related consolidated statements of
income, shareholders' equity and cash flows for each of the three years in the
period ended December 31, 2004. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of United Bancorp, Inc.
as of December 31, 2004 and 2003 and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2004 in
conformity with accounting principles generally accepted in the United States of
America.
We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of United Bancorp,
Inc. internal control over financial reporting as of December 31, 2004 based on
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our
report dated February 25, 2005 expressed unqualified opinions on management's
assessment and on the effectiveness of the Company's internal control over
financial reporting.
/s/ BKD, LLP
BKD, LLP
Indianapolis, Indiana
February 25, 2005
Page A-21
CONSOLIDATED BALANCE SHEETS
United Bancorp, Inc. and Subsidiaries
December 31,
-------------------------
In thousands of dollars 2004 2003
- ----------------------- -------- --------
ASSETS
Cash and demand balances in other banks $ 18,188 $ 21,425
Securities available for sale 103,786 108,734
Loans held for sale 1,102 90
Portfolio loans 495,796 446,730
-------- --------
Total loans 496,898 446,820
Less allowance for loan losses 5,766 5,497
-------- --------
Net loans 491,132 441,323
Premises and equipment, net 13,147 14,036
Goodwill 3,469 3,469
Bank-owned life insurance 10,694 10,250
Accrued interest receivable and other assets 9,935 10,536
-------- --------
TOTAL ASSETS $650,351 $609,773
======== ========
LIABILITIES
Deposits
Noninterest bearing deposits $ 85,598 $ 78,184
Interest bearing deposits 444,280 424,399
-------- --------
Total deposits 529,878 502,583
Short term borrowings 8,726 8,076
Other borrowings 42,847 35,375
Accrued interest payable and other liabilities 6,676 6,356
-------- --------
TOTAL LIABILITIES 588,127 552,390
-------- --------
COMMITMENTS AND CONTINGENT LIABILITIES
SHAREHOLDERS' EQUITY
Common stock and paid in capital, no par value; 5,000,000 shares authorized,
2,355,097 shares issued and outstanding in 2004 and 2,224,963 in 2003 54,133 45,809
Retained earnings 7,992 10,994
Accumulated other comprehensive income, net of tax 99 580
-------- --------
TOTAL SHAREHOLDERS' EQUITY 62,224 57,383
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $650,351 $609,773
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
Page A-22
CONSOLIDATED STATEMENTS OF INCOME
United Bancorp, Inc. and Subsidiaries
For the years ended December 31,
-----------------------------------
In thousands of dollars, except per share data 2004 2003 2002
- ---------------------------------------------- -------- -------- --------
INTEREST INCOME
Loans $ 28,488 $ 27,202 $ 29,126
Securities
Taxable 2,057 2,219 2,789
Tax exempt 1,124 1,200 1,445
Federal funds sold 51 214 175
-------- -------- --------
Total interest income 31,720 30,835 33,535
-------- -------- --------
INTEREST EXPENSE
Deposits 6,455 6,637 8,980
Short term borrowings 38 1 8
Other borrowings 1,930 1,869 1,728
-------- -------- --------
Total interest expense 8,423 8,507 10,716
-------- -------- --------
NET INTEREST INCOME 23,297 22,328 22,819
Provision for loan losses 1,048 1,069 1,105
-------- -------- --------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 22,249 21,259 21,714
-------- -------- --------
NONINTEREST INCOME
Service charges on deposit accounts 2,774 2,623 2,330
Trust & Investment fee income 3,754 3,104 2,888
Gains (losses) on securities transactions (29) 105 15
Loan sales and servicing 1,222 2,988 2,001
ATM, debit and credit card fee income 1,469 1,442 1,386
Sales of nondeposit investment products 721 751 786
Income from bank-owned life insurance 443 250 -
Other income 656 559 593
-------- -------- --------
Total noninterest income 11,010 11,822 9,999
-------- -------- --------
NONINTEREST EXPENSE
Salaries and employee benefits 13,502 13,672 12,647
Occupancy and equipment expense, net 4,019 3,927 3,764
External data processing 1,125 1,208 1,161
Advertising and marketing 382 360 553
Other expense 3,618 3,502 3,519
-------- -------- --------
Total noninterest expense 22,646 22,669 21,644
-------- -------- --------
INCOME BEFORE FEDERAL INCOME TAX 10,613 10,412 10,069
Federal income tax 2,960 3,024 2,934
-------- -------- --------
NET INCOME $ 7,653 $ 7,388 $ 7,135
======== ======== ========
Basic earnings per share $ 3.22 $ 3.14 $ 3.04
Diluted earnings per share 3.20 3.12 3.04
======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
Page A-23
CONSOLIDATED STATEMENTS OF CASH FLOWS
United Bancorp, Inc. and Subsidiaries
For the years ended December 31,
---------------------------------------
In thousands of dollars 2004 2003 2002
- ----------------------- --------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 7,653 $ 7,388 $ 7,135
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FROM
OPERATING ACTIVITIES
Depreciation and amortization 2,419 2,827 2,921
Provision for loan losses 1,048 1,069 1,105
(Gain) Loss on sale of loans (957) (3,318) (2,242)
Proceeds from sales of loans originated for sale 66,928 205,844 144,697
Loans originated for sale (66,983) (194,743) (143,642)
(Gain) Loss on securities transactions 29 (105) (15)
Gain on investment in bank owned life insurance (443) (250) -
(Gain) Loss on investment in limited partnership 86 (87) -
Change in accrued interest receivable and other assets 1,778 (475) (322)
Change in accrued interest payable and other liabilities 329 (355) 721
--------- --------- ---------
Total adjustments 4,234 10,407 3,223
--------- --------- ---------
Net cash from operating activities 11,887 17,795 10,358
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale
Purchases (50,113) (73,241) (49,266)
Sales 4,626 6,358 -
Maturities and calls 41,737 47,381 36,479
Principal payments 7,255 6,109 5,537
Net increase in portfolio loans (51,328) (24,895) (51,725)
Net investment in bank owned life insurance - (10,000) -
Net premises and equipment expenditures (455) (2,165) (559)
--------- --------- ---------
Net cash from investing activities (48,278) (50,453) (59,534)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 27,295 31,033 20,252
Net change in short term borrowings 650 8,001 (944)
Principal payments on other borrowings (528) (9,492) (2,342)
Proceeds from other borrowings 8,000 3,000 32,200
Proceeds from common stock transactions 880 262 363
Dividends paid (3,143) (3,140) (2,714)
--------- --------- ---------
Net cash from financing activities 33,154 29,664 46,815
--------- --------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS (3,237) (2,994) (2,361)
Cash and cash equivalents at beginning of year 21,425 24,419 26,780
--------- --------- ---------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 18,188 $ 21,425 $ 24,419
========= ========= =========
SUPPLEMENTAL DISCLOSURES:
Interest paid $ 8,373 $ 8,673 $ 10,887
Income tax paid 2,450 2,800 3,050
Loans transferred to other real estate 1,483 271 409
The accompanying notes are an integral part of these consolidated financial
statements.
Page A-24
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
United Bancorp, Inc. and Subsidiaries
For the years ended December 31, 2004, 2003, 2002
IN THOUSANDS OF DOLLARS, Common Retained
EXCEPT PER SHARE DATA Shares Stock (1) Earnings AOCI (2) Total
- ------------------------ --------- -------- -------- ------- --------
Balance, January 1, 2002 2,009,242 $ 33,579 $ 13,843 $ 755 $ 48,177
Net income, 2002 7,135 7,135
Other comprehensive income:
Net change in unrealized gains (losses)
on securities available for sale, net 526 526
--------
Total comprehensive income 7,661
Cash dividends declared, $1.212 per share (2,821) (2,821)
Five percent stock dividend declared 100,462 5,124 (5,124) -
Common stock transactions 5,061 228 228
Director and management deferred
stock plans 191 (56) 135
--------- -------- -------- ------- --------
Balance, December 31, 2002 2,114,765 $ 39,122 $ 12,977 $ 1,281 $ 53,380
Net income, 2003 7,388 7,388
Other comprehensive income:
Net change in unrealized gains (losses)
on securities available for sale, net (701) (701)
--------
Total comprehensive income 6,687
Cash dividends declared, $1.261 per share (2,946) (2,946)
Five percent stock dividend declared 105,737 6,344 (6,344) -
Common stock transactions 4,461 46 46
Tax effect of options exercised 82 82
Director and management deferred
stock plans 215 (81) 134
--------- -------- -------- ------- --------
Balance, December 31, 2003 2,224,963 $ 45,809 $ 10,994 $ 580 $ 57,383
Net income, 2004 7,653 7,653
Other comprehensive income (loss):
Net change in unrealized gains (losses)
on securities available for sale, net (481) (481)
--------
Total comprehensive income 7,172
Cash dividends declared, $1.364 per share (3,211) (3,211)
Five percent stock dividend declared 111,776 7,321 (7,321) -
Common stock transactions 18,358 615 615
Tax effect of options exercised 188 188
Director and management deferred
stock plans 200 (123) 77
--------- -------- -------- ------- --------
Balance, December 31, 2004 2,355,097 $ 54,133 $ 7,992 $ 99 $ 62,224
========= ======== ======== ======= ========
(1) Includes Paid In Capital
(2) Accumulated Other Comprehensive Income (Loss), Net of Tax
The accompanying notes are an integral part of these consolidated financial
statements.
Page A-25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
United Bancorp, Inc. and Subsidiaries
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS AND BASIS OF PRESENTATION
The consolidated financial statements include the accounts of United Bancorp,
Inc. ("Company") and its wholly owned subsidiaries, United Bank & Trust and
United Bank & Trust - Washtenaw ("Banks"), after elimination of significant
intercompany transactions and accounts. The Company is engaged 100% in the
business of commercial and retail banking, including insurance, and trust and
investment services, with operations conducted through its offices located in
Lenawee, Washtenaw and Monroe Counties in southeastern Michigan. These counties
are the source of substantially all of the Company's deposit, loan, insurance
and trust activities.
USE OF ESTIMATES
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires Management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period as
well as affecting the disclosures provided. Actual results could differ from
those estimates. The allowance for loan losses and the fair values of financial
instruments are particularly subject to change.
SECURITIES
Securities available for sale consist of bonds and notes which might be sold
prior to maturity. Securities classified as available for sale are reported at
their fair values and the related net unrealized holding gain or loss is
reported in other comprehensive income. Other securities such as Federal Home
Loan Bank stock are carried at cost. Premiums and discounts on securities are
recognized in interest income using the interest method over the period to
maturity. Realized gains or losses are based upon the amortized cost of the
specific securities sold.
LOANS HELD FOR SALE
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or market value in the aggregate. Net unrealized
losses, if any, are recognized in a valuation allowance by charges to income.
LOANS
Loans that Management has the intent and ability to hold for the foreseeable
future or until maturity or payoff are reported at the principal balance
outstanding, net of deferred loan fees and costs and the allowance for loan
losses. Interest income is reported on the interest method and includes
amortization of net deferred loan fees and costs over the loan term. Loans are
placed on non-accrual status at ninety days or more past due and interest is
considered a loss, unless the loan is well-secured and in the process of
collection.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level believed adequate by
Management to absorb probable incurred credit losses in the loan portfolio.
Management's determination of the adequacy of the allowance is based on an
evaluation of the portfolio, past loan loss experience, current economic
conditions, volume, amount and composition of the loan portfolio, and other
factors. The allowance is
Page A-26
increased by provisions for loan losses charged to income. Loan losses are
charged against the allowance when Management believes the uncollectability of a
loan is confirmed. Subsequent recoveries, if any, are credited to the allowance.
Loan impairment is reported when full payment under the loan terms is not
expected. Impaired loans are carried at the present value of estimated future
cash flows using the loan's existing rate, or the fair value of collateral if
the loan is collateral dependent. A portion of the allowance for loan losses is
allocated to impaired loans if the value of such loans is deemed to be less than
the unpaid balance. If these allocations cause the allowance for loan losses to
require increase, such increase is reported as a component of the provision for
loan losses. Loans are evaluated for impairment when payments are delayed or
when the internal grading system indicates a substandard or doubtful
classification.
Impairment is evaluated in total for smaller-balance loans of similar nature
such as residential mortgage, consumer, home equity and second mortgage loans.
Commercial loans and mortgage loans secured by other properties are evaluated
individually for impairment. When credit analysis of borrower operating results
and financial condition indicates that underlying cash flows of the borrower's
business are not adequate to meet its debt service requirements, including the
Banks' loans to the borrower, the loan is evaluated for impairment. Often this
is associated with a delay or shortfall of payments of thirty days or more.
Loans are generally moved to nonaccrual status when ninety days or more past due
or in bankruptcy. These loans are often also considered impaired. Impaired
loans, or portions thereof, are charged off when deemed uncollectible. This
typically occurs when the loan is 120 or more days past due unless the loan is
both well-secured and in the process of collection.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost, less accumulated depreciation. The
provisions for depreciation are computed principally by the straight line
method, based on useful lives of ten to forty years for premises and three to
eight years for equipment.
OTHER REAL ESTATE OWNED
Other real estate consists of properties acquired through foreclosure or
acceptance of a deed in lieu of foreclosure and property acquired for possible
future expansion. Real estate properties acquired through, or in lieu of, loan
foreclosure are to be sold and are initially recorded at fair value, less
estimated selling costs, at the date of foreclosure establishing a new cost
basis. After foreclosure, valuations are periodically performed and the real
estate is carried at the lower of cost basis or fair value, less estimated
selling costs. The historical average holding period for such properties is less
than eighteen months. As of December 31, 2004 and 2003, other real estate owned
totaled $844,000 and $593,000, and is included in other assets on the
consolidated balance sheets.
GOODWILL
Goodwill is tested annually for impairment. If the implied fair value of
goodwill is lower than its carrying amount, a goodwill impairment is indicated
and goodwill is written down to its implied fair value. Subsequent increases in
goodwill value are not recognized in the financial statements.
SERVICING RIGHTS
Servicing rights are recognized as assets for the allocated value of retained
servicing on loans sold. Servicing rights are expensed in proportion to, and
over the period of, estimated net servicing revenues. Impairment is evaluated
based on the fair value of the rights, using groupings of the underlying loans
as to interest rates, remaining loan terms and prepayment characteristics. Any
impairment of a grouping is reported as a valuation allowance.
Page A-27
LONG-TERM ASSETS
Long-term assets are reviewed for impairment when events indicate their carrying
amount may not be recoverable from future undiscounted cash flows. If impaired,
the assets are written down to discounted amounts.
INCOME TAX
The Company records income tax expense based on the amount of taxes due on its
tax return plus deferred taxes computed based on the expected future tax
consequences of temporary differences between the carrying amounts and tax bases
of assets and liabilities, using enacted tax rates, adjusted for allowances made
for uncertainty regarding the realization of deferred tax assets.
EARNINGS PER SHARE
Amounts reported as earnings per share are based upon the weighted average
number of shares outstanding plus the weighted average number of contingently
issuable shares associated with the Directors' and Senior Management Group's
deferred stock plans. In 2004, 2003 and 2002, the Company paid five percent
stock dividends. Earnings per share, dividends per share and weighted average
shares have been restated to reflect the stock dividends.
STOCK BASED COMPENSATION
At December 31, 2004, the Company has a stock-based employee compensation plan,
which is described more fully in Note 16. The Company accounts for this plan
under the recognition and measurement principles of APB Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations. No
stock-based employee compensation cost is reflected in net income, as all
options granted under the plan had an exercise price equal to the market value
of the underlying common stock on the grant date. The following table
illustrates the effect on net income and earnings per share if the company had
applied the fair value provisions of FASB Statement No. 123, "Accounting for
Stock-Based Compensation," to stock-based employee compensation.
In thousands of dollars, except per share data 2004 2003 2002
- -------------------------------------------------------------- ----------- ----------- -----------
Net income, as reported $ 7,653 $ 7,388 $ 7,135
Less: Total stock-based employee compensation cost
determined under the fair value based method, net of taxes (70) (86) (96)
----------- ----------- -----------
Pro forma net income $ 7,583 $ 7,302 $ 7,039
Earning per share:
Basic As reported $ 3.22 $ 3.14 $ 3.04
Basic Pro forma 3.19 3.10 3.00
Diluted As reported 3.20 3.12 3.04
Diluted Pro forma 3.17 3.08 2.99
=========== =========== ===========
For purposes of the pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. Based on the
use of estimates and the subjective nature of the assumptions used, the
information presented above may not be representative of the pro forma impact in
future years.
STATEMENTS OF CASH FLOWS
For purposes of this Statement, cash and cash equivalents include cash on hand,
demand balances with banks, and federal funds sold. Federal funds are generally
sold for one day periods. The Company reports
Page A-28
net cash flows for client loan and deposit transactions, deposits made with
other financial institutions, and short term borrowings with an original
maturity of ninety days or less.
COMPREHENSIVE INCOME
Comprehensive income consists of net income and other comprehensive income
(loss). Other comprehensive income (loss) includes net unrealized gains and
losses on securities available for sale, net of tax, which are also recognized
as separate components of shareholders' equity.
INDUSTRY SEGMENT
The Company and its subsidiaries are primarily organized to operate in the
banking industry. Substantially all revenues and services are derived from
banking products and services in southeastern Michigan. While the Company's
chief decision makers monitor various products and services, operations are
managed and financial performance is evaluated on a Company-wide basis.
Accordingly, all of the Company's banking operations are considered by
Management to be aggregated in one business segment.
NOTE 2 - RESTRICTIONS ON CASH AND DEMAND BALANCES IN OTHER BANKS
The Banks are subject to average reserve and clearing balance requirements in
the form of cash on hand or balances due from the Federal Reserve Bank. These
reserve balances vary depending on the level of client deposits in the Banks.
The amounts of reserve and clearing balances required at December 31, 2004 and
2003 totaled approximately $25,000 and $25,000.
NOTE 3 - SECURITIES
The fair value of securities as of December 31, 2004 and 2003 are as follows, in
thousands of dollars:
SECURITIES AVAILABLE FOR SALE Fair Value Gains Losses
- ------------------------------------------------ ---------- -------- --------
2004
U.S. Treasury and agency securities $ 42,562 $ 9 $ (277)
Mortgage backed agency securities 22,530 103 (277)
Obligations of states and political subdivisions 35,492 586 (77)
Corporate, asset backed and other securities 3,202 84 -
-------- -------- --------
Total $103,786 $ 782 $ (631)
======== ======== ========
2003
U.S. Treasury and agency securities $ 40,800 $ 132 $ (42)
Mortgage backed agency securities 18,444 158 (115)
Obligations of states and political subdivisions 42,468 699 (59)
Corporate, asset backed and other securities 7,022 107 -
-------- -------- --------
Total $108,734 $ 1,096 $ (216)
======== ======== ========
The Company's temporarily impaired investment securities as of December 31, 2004
and 2003 are shown below.
Less than 12 Months 12 Months or Longer Total
----------------------- ---------------------- ---------------------
In thousands of dollars Fair Value Losses Fair Value Losses Fair Value Losses
- ------------------------- ---------- -------- ---------- -------- ---------- --------
2004
U.S. Treasury and agency
securities $ 33,638 $ (219) $ 4,837 $ (58) $ 38,475 $ (277)
Mortgage backed agency
securities 10,099 (154) 8,038 (123) 18,137 (277)
Obligations of states and
political subdivisions 7,938 (57) 4,178 (20) 12,116 (77)
-------- -------- -------- -------- -------- --------
Total $ 51,675 $ (430) $ 17,053 $ (201) $ 68,728 $ (631)
======== ======== ======== ======== ======== ========
Page A-29
Less than 12 Months 12 Months or Longer Total
---------------------- -------------------- ---------------------
In thousands of dollars Fair Value Losses Fair Value Losses Fair Value Losses
- ------------------------- ---------- -------- ---------- ------ ---------- -------
2003
U.S. Treasury and agency
securities $ 7,888 $ (42) $- $- $ 7,888 $ (42)
Mortgage backed agency
securities 13,372 (115) - - 13,372 (115)
Obligations of states and
political subdivisions 6,805 (59) - - 6,805 (59)
-------- -------- -- -- -------- -------
Total $ 28,065 $ (216) $- $- $ 28,065 $ (216)
======== ======== == == ======== =======
Unrealized losses within the investment portfolio are temporary, as they are a
result of market changes rather than a reflection of credit quality. Management
has no specific intent to sell any securities, although the entire investment
portfolio is classified as available for sale.
Sales activities for securities for the years indicated are shown in the
following table. All sales were of securities identified as available for sale.
In thousands of dollars 2004 2003 2002
- ----------------------------- ------- ------- ----
Sales proceeds $ 4,626 $ 6,358 $-
Gross gains on sales - 105 -
Gross gains (losses) on calls (29) - 15
The fair value of securities available for sale by contractual maturity are
shown below. Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties. Asset-backed securities are included in periods based
on their estimated lives.
In thousands of dollars Fair Value
- -------------------------------------- ----------
As of December 31, 2004
Due in one year or less $ 36,725
Due after one year through five years 55,647
Due after five years through ten years 6,086
Due after ten years 2,126
Equity securities 3,202
--------
Total securities $103,786
========
Securities carried at $18,493,000 and $16,283,000 as of December 31, 2004 and
2003 were pledged to secure deposits of public funds, funds borrowed, repurchase
agreements, and for other purposes as required by law.
NOTE 4 - LOANS
The table below shows total loans outstanding, including loans held for sale, at
December 31. All loans are domestic and contain no concentrations by industry or
client.
In thousands of dollars 2004 2003
- ---------------------------------------- -------- --------
Personal $ 74,142 $ 70,301
Business, including commercial mortgages 278,838 256,778
Tax exempt 3,325 1,476
Residential mortgage 75,126 85,066
Residential mortgages held for sale 1,102 90
Construction 64,365 33,109
-------- --------
Total loans $496,898 $446,820
======== ========
Page A-30
At December 31, 2004 and 2003, accruing loans delinquent 90 days or more totaled
$1,674,000 and $761,000. Non-accruing loans at December 31, 2004 and 2003 were
$3,709,000 and $3,635,000.
NOTE 5 - ALLOWANCE FOR LOAN LOSSES
An analysis of the allowance for loan losses for the years ended December 31
follows:
In thousands of dollars 2004 2003 2002
------- ------- -------
Balance, January 1 $ 5,497 $ 4,975 $ 4,571
Loans charged off (1,066) (670) (822)
Recoveries credited to allowance 287 123 121
Provision charged to operations 1,048 1,069 1,105
------- ------- -------
Balance, December 31 $ 5,766 $ 5,497 $ 4,975
======= ======= =======
Information regarding impaired loans for the years ended December 31 follows:
In thousands of dollars 2004 2003 2002
-------- ------- -------
Average investment in impaired loans $ 8,668 $ 4,283 $ 1,996
Interest income recognized on impaired loans 192 121 14
Interest income recognized on a cash basis 192 121 14
Balance of impaired loans at December 31 $ 10,045 $ 3,694 $ 1,896
Portion for which no allowance for loan losses is allocated 2,668 1,059 817
Portion for which an allowance for loan losses is allocated 7,377 2,635 1,079
Portion of allowance for loan losses allocated to impaired loans 1,579 782 136
======== ======= =======
NOTE 6 - LOAN SERVICING
Mortgage loans serviced for others are not included in the accompanying
consolidated financial statements. The unpaid principal balance of mortgage
loans serviced for others was $256,357,000 and $255,757,000 at December 31, 2004
and 2003. The balance of loans serviced for others related to servicing rights
that have been capitalized was $254,562,000 and $252,075,000 at December 31,
2004 and 2003.
No valuation allowance was considered necessary at December 31, 2004 and 2003.
Unamortized cost of mortgage servicing rights for the years ended December 31
was as follows:
In thousands of dollars 2004 2003 2002
------- ------- -------
Balance, January 1 $ 1,832 $ 1,352 $ 1,100
Amount capitalized 377 1,406 903
Amount amortized (389) (926) (651)
------- ------- -------
Balance, December 31 $ 1,820 $ 1,832 $ 1,352
======= ======= =======
NOTE 7 - PREMISES AND EQUIPMENT
Depreciation expense was approximately $1,344,000 in 2004, $1,430,000 in 2003
and $1,693,000 in 2002. Premises and equipment as of December 31 consisted of
the following:
In thousands of dollars 2004 2003
-------- --------
Land $ 1,579 $ 1,579
Buildings and improvements 13,615 13,622
Furniture and equipment 11,472 11,149
-------- --------
Total cost 26,666 26,350
Less accumulated depreciation (13,519) (12,314)
-------- --------
Premises and equipment, net $ 13,147 $ 14,036
======== ========
Page A-31
On August 31, 2001, United Bank & Trust - Washtenaw entered into a ten-year
lease agreement for its future main office premises. In 2003, that building was
occupied by the Bank, and average annual payments are approximately $571,000.
NOTE 8 - GOODWILL
During 2002, the Company changed its methods of accounting and financial
reporting for goodwill and other intangible assets by adopting the provisions of
Statement of Financial Accounting Standards No. 142 and Statement of Financial
Accounting Standards No. 147. There was no impairment of goodwill in 2004, 2003
or 2002.
NOTE 9 - DEPOSITS
Information relating to maturities of time deposits as of December 31 is
summarized below:
In thousands of dollars 2004 2003
--------- ---------
Within one year $ 55,272 $ 45,657
Between one and two years 40,630 25,753
Between two and three years 23,168 24,754
Between three and four years 4,708 14,680
Between four and five years 6,359 2,983
More than five years - -
--------- ---------
Total time deposits $ 130,137 $ 113,827
--------- ---------
Interest bearing time deposits in denominations of $100,000 or more $ 40,057 $ 30,946
========= =========
NOTE 10 - SHORT TERM BORROWINGS
The Company has several credit facilities in place for short term borrowing
which are used on occasion as a source of liquidity. These facilities consist of
borrowing authority totaling $45.9 million from correspondent banks to purchase
federal funds on a daily basis. There was $8.7 and $8.0 million of Fed Funds
purchased outstanding at December 31, 2004 and 2003.
The Banks may also enter into sales of securities under agreements to repurchase
(repurchase agreements). These agreements generally mature within one to 120
days from the transaction date. U.S. Treasury, agency and other securities
involved with the agreements are recorded as assets and are generally held in
safekeeping by correspondent banks. Repurchase agreements are offered
principally to certain clients as an investment alternative to deposit products.
The maximum amount of outstanding agreements at any month end during 2004 and
2003 totaled $76,000 and $76,000 and the daily average of such agreements
totaled $76,000 and $75,000. The balance outstanding at December 31, 2004 and
2003 was $76,000 and $76,000.
NOTE 11 - OTHER BORROWINGS
The Banks carried fixed rate, noncallable advances from the Federal Home Loan
Bank of Indianapolis totaling $42.8 million and $35.4 million at December 31,
2004 and 2003. As of December 31, 2004, the rates on the advances ranged from
2.96% to 6.18% with a weighted average rate of 4.45%. These advances are
primarily collateralized by residential mortgage loans under a blanket security
agreement. The unpaid principal balance of the loans pledged as collateral must
equal at least 145% of the funds advanced. Interest payments are made monthly,
with principal due annually and at maturity.
Page A-32
Maturities and scheduled principal payments for other borrowings over the next
five years as of December 31 are shown below.
In thousands of dollars 2004 2003
- ---------------------------- -------- --------
Within one year $ 1,568 $ 529
Between one and two years 8,011 1,568
Between two and three years 20,339 8,011
Between three and four years 8,929 19,339
Between four and five years 3,000 5,928
More than five years 1,000 -
-------- --------
Total $ 42,847 $ 35,375
======== ========
NOTE 12 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Banks are party to financial instruments with off-balance-sheet risk in the
normal course of business to meet financing needs of their clients. These
financial instruments include commitments to make loans, unused lines of credit,
and letters of credit. The Banks' exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for commitments to
extend credit is represented by the contractual amount of those instruments. The
Banks follow the same credit policy to make such commitments as is followed for
loans and investments recorded in the consolidated financial statements. The
Banks' commitments to extend credit are agreements at predetermined terms, as
long as the client continues to meet specified criteria, with fixed expiration
dates or termination clauses.
The following table shows the commitments to make loans and the unused lines of
credit available to clients at December 31:
2004 2003
---------------------- ----------------------
Variable Fixed Variable Fixed
In thousands of dollars Rate Rate Rate Rate
- ------------------------- -------- ------- -------- -------
Commitments to make loans $ 18,290 $ 5,200 $ 17,661 $ 6,812
Unused lines of credit 97,445 3,677 83,029 4,044
Standby letters of credit 7,964 - 4,175 -
======== ======= ======== =======
Commitments to make loans generally expire within thirty to ninety days, while
unused lines of credit expire at the maturity date of the individual loans. At
December 31, 2004, the rates for amounts in the fixed rate category ranged from
5.13% to 7.30%.
In December 2001, United Bank & Trust ("UBT") entered into a limited partnership
agreement to purchase tax credits awarded from the construction, ownership and
management of an affordable housing project and a residual interest in the real
estate. As of December 31, 2004 and 2003, the total recorded investment
including the obligation to make additional future investments amounted to
$2,208,000 and $2,371,000 and was included in other assets. As of December 31,
2004 and 2003, the obligation of UBT to the limited partnership amounted to
$1,908,000 and $1,985,000 which was reported in other liabilities. While UBT is
a 99% partner, the investment is accounted for on the equity method as UBT is a
limited partner and has no control over the operation and management of the
partnership or the affordable housing project.
Page A-33
NOTE 13 - FEDERAL INCOME TAX
Income tax expense consists of the following for the years ended December 31:
In thousands of dollars 2004 2003 2002
- ----------------------- ------- ------- -------
Current $ 2,917 $ 2,822 $ 3,096
Deferred 43 202 (162)
------- ------- -------
Total income tax expense $ 2,960 $ 3,024 $ 2,934
======= ======= =======
The components of deferred tax assets and liabilities at December 31, are as
follows:
In thousands of dollars 2004 2003
- ----------------------- ------- -------
Deferred tax assets:
Allowance for loan losses $ 1,851 $ 1,677
Deferred compensation 494 435
Other 140 205
------- -------
Total deferred tax assets 2,485 2,317
2004 2003
------- -------
Deferred tax liabilities:
Property and equipment (451) (574)
Mortgage servicing rights (619) (623)
Unrealized appreciation on securities available for sale (51) (299)
Other (912) (412)
------- -------
Total deferred tax liabilities (2,033) (1,908)
------- -------
Net deferred tax asset $ 452 $ 409
======= =======
No valuation allowance was considered necessary at December 31, 2004 and 2003.
A reconciliation between total federal income tax and the amount computed
through the use of the federal statutory tax rate for the years ended is as
follows:
In thousands of dollars 2004 2003 2002
- ----------------------- ------- ------- -------
Income taxes at statutory rate of 34% $ 3,608 $ 3,540 $ 3,424
Non-taxable income, net of nondeductible interest expense (387) (411) (499)
Income on non-taxable bank owned life insurance (151) (85) -
Affordable housing credit (132) (36) -
Other 22 16 9
------- ------- -------
Total federal income tax $ 2,960 $ 3,024 $ 2,934
======= ======= =======
NOTE 14 - RELATED PARTY TRANSACTIONS
Certain directors and executive officers of the Company and the Banks, including
their immediate families and companies in which they are principal owners, are
clients of the Banks. Loans to these parties did not, in the opinion of
Management, involve more than normal credit risk or present other unfavorable
features. The aggregate amount of these loans at December 31, 2003 was
$35,744,000. During 2004, new and newly reportable loans to such related parties
amounted to $19,392,000 and repayments amounted to $11,787,000, resulting in a
balance at December 31, 2004 of $43,349,000. Related party deposits totaled
$11,078,000 and $10,186,000 at December 31, 2004 and 2003.
NOTE 15 - RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS OR ADVANCES
Banking laws and regulations restrict the amount the Banks can transfer to the
Company in the form of cash dividends and loans. At December 31, 2004, $14.5
million of retained earnings of the Banks were available for distribution to the
Company as dividends without prior regulatory approval. It is not the
Page A-34
intent of Management to pay dividends in amounts which would reduce the capital
of the Banks to a level below that which is considered prudent by Management and
in accordance with the guidelines of regulatory authorities.
NOTE 16 - EMPLOYEE BENEFIT PLANS
EMPLOYEE SAVINGS PLAN
The Company maintains a 401(k) employee savings plan ("plan") which is available
to substantially all employees. Individual employees may make contributions to
the plan up to 25% of their compensation for 2004, 2003 and 2002. The Banks
offers discretionary matching of funds for a percentage of the employee
contribution, plus an amount based on Company earnings. The expense for the plan
for 2004, 2003 and 2002 was $791,000, $898,000 and $966,000.
The plan offers employees the option of purchasing Company stock with the match
portion of their 401(k) contribution. On that basis 2,615 shares in 2004, no
shares in 2003 and 3,293 shares in 2002 of United Bancorp, Inc. common stock
were issued to the 401(k) plan for the benefit of plan participants who so
elected Company stock for their match.
DIRECTOR RETAINER STOCK PLAN
The Company maintains a deferred compensation plan designated as the Director
Retainer Stock Plan. The plan provides eligible directors of the Company and the
Banks with a means of deferring payment of retainers and certain fees payable to
them for Board service. Under the Director Plan, any retainers or fees elected
to be deferred under the plan by an eligible director ultimately will be payable
in common stock at the time of payment.
SENIOR MANAGEMENT BONUS DEFERRAL STOCK PLAN
The Company maintains a deferred compensation plan designated as the Senior
Management Bonus Deferral Stock Plan. The Management Plan has essentially the
same purposes as the Director Plan discussed above and permits eligible
employees of the Company and its affiliates to elect cash bonus deferrals and,
after employment termination, to receive payouts in whole or in part in the form
of common stock on terms substantially similar to those of the Director Plan.
STOCK OPTIONS
In 2000, Shareholders approved the Company's 1999 Stock Option Plan (the "1999
Plan"). The plan is a non-qualified stock option plan as defined under Internal
Revenue Service regulations. Under the plan, directors and management of the
Company and subsidiaries are given the right to purchase stock of the Company at
a stipulated price, adjusted for stock dividends, over a specific period of
time. The 1999 Plan is in effect until the end of 2004. In 2004, Shareholders
approved the Company's 2005 Stock Option Plan, which is effective January 1,
2005. The 1999 Plan was the only plan in effect during 2004.
The stock subject to the options are shares of authorized and unissued common
stock of the Company. As defined in the 1999 plan, options representing no more
than 144,426 shares (adjusted for stock dividends declared) are to be made
available to the plan. Options under this plan are granted to directors and
certain key members of management at the then-current market price at the time
the option is granted. The options have a three-year vesting period, and with
certain exceptions, expire at the end of ten years, or three years after
retirement. The following table summarizes option activity for the 1999 plan,
adjusted for stock dividends:
Page A-35
2004 2003 2002
------------------------- -------------------------- ---------------------------
Weighted Weighted Weighted
Average Average Average
Options Exercise Price Options Exercise Price Options Exercise Price
------- -------------- ------- -------------- ------- --------------
Balance, January 1 102,403 $ 43.41 88,003 $ 40.64 71,247 $ 39.38
Options granted 23,423 60.00 28,508 50.34 20,380 44.54
Options exercised (24,850) 40.25 (11,024) 38.31 (3,190) 38.05
Options forfeited - - (3,084) 46.42 (434) 37.61
------- ------- ------- ------- ------- -------
Balance, December 31 100,976 $ 48.04 102,403 $ 43.41 88,003 $ 40.64
======= ======= ======= ======= ======= =======
Options exercisable at year-end 53,142 $ 42.38 52,845 $ 39.94 33,664 $ 38.87
Weighted average fair value of
options granted during the year $ 5.46 $ 3.74 $ 4.28
======= ======= =======
The following table provides information regarding stock options under the plan
at December 31, 2004:
Options Outstanding Options Exercisable
------------------------------------------------------ -----------------------------
Weighted Weighted Weighted
Number Average Remaining Average Number Average
Range of Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- ------------------------ ----------- ----------------- -------------- ----------- --------------
$37.61 to $49.00 72,461 6.75 Years $ 43.58 51,637 $ 41.95
$49.01 to $60.00 28,515 8.93 Years 59.37 1,505 57.15
------- ------
Balance, December 31 100,976 7.37 Years $ 48.04 53,142 $ 42.38
======= ========== ======= ====== =======
The fair value of each option grant is estimated on the date of the grant using
the Black-Scholes option pricing model with the following weighted-average
assumptions:
2004 2003 2002
------ ------ ------
Dividend yield 2.15% 2.47% 2.68%
Expected life 5 years 5 years 5 years
Expected volatility 8.88% 7.55% 7.74%
Risk-free interest rate 3.05% 3.14% 4.22%
====== ====== ======
NOTE 17 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts and estimated fair value of principal financial assets and
liabilities were as follows:
As of December 31,
2004 2003
----------------------- ------------------------
Carrying Carrying
In thousands of dollars Value Fair Value Value Fair Value
- ----------------------- --------- ---------- ---------- ----------
Financial Assets
Cash and cash equivalents $ 18,188 $ 18,188 $ 21,425 $ 21,425
Securities available for sale 103,786 103,786 108,734 108,734
Net loans 491,132 494,100 441,323 447,172
Bank owned life insurance 10,694 10,694 10,250 10,250
Accrued interest receivable 2,777 2,777 2,624 2,624
Financial Liabilities
Total deposits $(529,878) $ (531,774) $ (502,583) $ (506,676)
Short term borrowings (8,726) (8,726) (8,076) (8,076)
Other borrowings (42,847) (43,336) (35,375) (36,795)
Accrued interest payable (622) (622) (571) (571)
========= ========== ========== ==========
Page A-36
Estimated fair values require subjective judgments and are approximate. The
above estimates of fair value are not necessarily representative of amounts that
could be realized in actual market transactions, nor of the underlying value of
the Company. Changes in the following methodologies and assumptions could
significantly affect the estimated fair value:
Cash and cash equivalents, accrued interest receivable and accrued interest
payable - Due to the short periods to maturity, the carrying amounts are
reasonable estimates of the fair values of these instruments at the
respective balance sheet dates.
Securities available for sale - Fair values for securities available for sale
are based on quoted market prices, if available. If quoted values are not
available, the estimated fair value is determined by using quoted market
prices for similar securities.
Net loans - The carrying amount is a reasonable estimate of fair value for
personal loans for which rates adjust quarterly or more frequently, and for
business and tax exempt loans which are prime related and for which rates
adjust immediately or quarterly. The fair value for residential mortgage
loans which are held for sale on the secondary market is the price offered by
the secondary market purchaser. The fair value of all other loans is
estimated by discounting future cash flows using current rates for loans with
similar characteristics and maturities. The allowance for loan losses is
considered to be a reasonable estimate of discount for credit quality
concerns.
Bank owned life insurance - The carrying value is a reasonable approximation
of fair value.
Total deposits - With the exception of certificates of deposit, the carrying
value is deemed to be the fair value due to the demand nature of the
deposits. The fair value of fixed maturity certificates of deposit is
estimated by discounting future cash flows using the current rates paid on
certificates of deposit with similar maturities.
Short term borrowings - The carrying value is a reasonable approximation of
fair value.
Other borrowings - The fair value is estimated by discounting future cash
flows using current rates on advances with similar maturities.
Off-balance-sheet financial instruments - Commitments to extend credit,
standby letters of credit and undisbursed loans are deemed to have no
material fair value as such commitments are generally fulfilled at current
market rates.
NOTE 18 - REGULATORY CAPITAL REQUIREMENTS
The Company and Banks are subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Company and the Banks must meet
specific capital guidelines that involve quantitative measures of assets,
liabilities, and certain off-balance-sheet items as calculated under regulatory
accounting practices. Capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings and
other factors. Quantitative measures established by regulation to ensure capital
adequacy require the Company and Banks to maintain minimum ratios of Total and
Tier I capital to risk-weighted assets, and of Tier I capital to average assets.
The Company and UBT were categorized as well-capitalized at year end 2004 and
2003 by their regulators. UBTW was categorized by its regulators as adequately
capitalized at year end 2004 and well-capitalized at year end 2003. Management
is not aware of any conditions or events that have
Page A-37
occurred since year end that would change this classification. The following
table shows the Company's and the Bank's capital ratios and the Company's
amounts compared to regulatory requirements at year end, and the amounts by
which the Company's capital, on a consolidated basis, exceeds regulatory
requirements. Dollars are shown in thousands of dollars where appropriate.
Tier I Capital to:
------------------------- Total Capital to
Average Risk Weighted Risk Weighted
Assets Assets Assets
------- ------------- ----------------
Regulatory Minimum for Capital Adequacy (1) 4.0% 4.0% 8.0%
Regulatory Minimum to be Well Capitalized (2) 5.0% 6.0% 10.0%
As of December 31, 2004
United Bancorp, Inc. (consolidated) 9.3% 11.5% 12.7%
United Bank & Trust 8.8% 12.1% 13.2%
United Bank & Trust - Washtenaw 8.2% 9.0% 10.0%
United Bancorp, Inc. consolidated equity $58,656 $58,656 $64,422
Regulatory requirement for minimum capital adequacy (1) 25,347 20,345 40,690
------- ------- -------
Capital in excess of regulatory minimums $33,309 $38,311 $23,732
======= ======= =======
As of December 31, 2003
United Bancorp, Inc. (consolidated) 9.1% 11.7% 12.8%
United Bank & Trust 8.6% 11.8% 13.1%
United Bank & Trust - Washtenaw 8.9% 10.8% 11.9%
United Bancorp, Inc. consolidated equity $53,151 $53,151 $58,591
Regulatory requirement for minimum capital adequacy (1) 23,589 18,239 36,478
------- ------- -------
Capital in excess of regulatory minimums $29,562 $34,912 $22,113
======= ======= =======
(1) Represents minimum required to be considered adequately capitalized under
Federal regulatory requirements.
(2) Represents minimum required to be considered well-capitalized under
Federal regulatory prompt corrective action provisions.
NOTE 19 - EARNINGS PER SHARE
A reconciliation of basic and diluted earnings per share follows:
In thousands of dollars, except per share data 2004 2003 2002
- -------------------------------------------------- ---------- ---------- ----------
Net income $ 7,653 $ 7,388 $ 7,135
Basic earnings per share:
Weighted average common shares outstanding 2,352,347 2,334,002 2,327,186
Weighted average contingently issuable shares 21,579 19,585 16,868
---------- ---------- ----------
2,373,926 2,353,587 2,344,054
Basic earnings per share $ 3.22 $ 3.14 $ 3.04
---------- ---------- ----------
Diluted earnings per share:
Weighted average common shares outstanding
from basic earnings per share 2,373,926 2,353,587 2,344,054
Dilutive effect of stock options 18,024 16,173 6,509
---------- ---------- ----------
2,391,950 2,369,760 2,350,563
Diluted earnings per share $ 3.20 $ 3.12 $ 3.04
========== ========== ==========
Stock options for 3,000 and 1,000 shares of common stock were not considered in
computing diluted earnings per share for 2003 and 2002 because they were not
dilutive. No options were excluded from the computation in 2004, as all options
were dilutive.
Page A-38
NOTE 20 - OTHER COMPREHENSIVE INCOME
Other comprehensive income components and related taxes were as follows:
In thousands of dollars 2004 2003 2002
------ ------ -----
Unrealized gains (losses) and on securities available for sale $ (758) $ (957) $ 812
Reclassification for realized amount included in income 29 (105) (15)
------ ------ -----
Other comprehensive income (loss) , before tax effect (729) (1,062) 797
Tax expense (benefit) (248) (361) 271
------ ------ -----
Other comprehensive income (loss) $ (481) $ (701) $ 526
====== ====== =====
NOTE 21 - PARENT COMPANY ONLY FINANCIAL INFORMATION
The condensed financial information for United Bancorp, Inc. is summarized
below.
CONDENSED BALANCE SHEETS December 31,
----------------------
In thousands of dollars 2004 2003
-------- --------
ASSETS
Cash and cash equivalents $ 7 $ 110
Investment in subsidiaries 60,011 57,036
Other assets 3,045 989
-------- --------
TOTAL ASSETS $ 63,063 $ 58,135
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities $ 839 $ 752
Shareholders' equity 62,224 57,383
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 63,063 $ 58,135
======== ========
CONDENSED STATEMENTS OF INCOME For the years ended December 31,
------------------------------------
In thousands of dollars 2004 2003 2002
------- -------- --------
INCOME
Dividends from subsidiaries $ 4,325 $ 10,283 $ 2,549
Other income 11 5 2
------- -------- --------
TOTAL INCOME 4,336 10,288 2,551
TOTAL NONINTEREST EXPENSE 231 215 123
------- -------- --------
Income before undistributed net income of subsidiaries
and income taxes 4,105 10,073 2,428
Income tax benefit (75) (71) (41)
------- -------- --------
Net income before undistributed net income of subsidiaries 4,180 10,144 2,469
Equity in undistributed (excess distributed) net income
of subsidiaries 3,473 (2,756) 4,666
------- -------- --------
NET INCOME 7,653 7,388 7,135
Net change in unrealized gains on securities available for sale (481) (701) 526
------- -------- --------
Other comprehensive income (loss) (481) (701) 526
------- -------- --------
COMPREHENSIVE INCOME $ 7,172 $ 6,687 $ 7,661
======= ======== ========
Page A-39
CONDENSED STATEMENTS OF CASH FLOWS For the years ended December 31,
------------------------------------
In thousands of dollars 2004 2003 2002
------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 7,653 $ 7,388 $ 7,135
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
FROM OPERATING ACTIVITIES
(Undistributed) excess distributed net income of subsidiaries (3,473) 2,756 (4,666)
Change in other assets (1,858) 272 (53)
Change in other liabilities 19 3 -
------- -------- --------
Total adjustments (5,312) 3,031 (4,719)
------- -------- --------
Net cash from operating activities 2,341 10,419 2,416
------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of securities available for sale (181) (40) (108)
Investments in subsidiaries - (7,500) -
------- -------- --------
Net cash from investing activities (181) (7,540) (108)
------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from common stock transactions 880 262 363
Dividends paid (3,143) (3,140) (2,714)
------- -------- --------
Net cash from financing activities (2,263) (2,878) (2,351)
------- -------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS (103) 1 (43)
Cash and cash equivalents at beginning of year 110 109 152
------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 7 $ 110 $ 109
======= ======== ========
NOTE 22 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly financial information is summarized below.
Earnings Per Share
In thousands of dollars, Interest Net Interest Net --------------------
except per share data Income Income Income Basic Diluted
- --------------------- -------- ------------ ------- ------ -------
2004
First Quarter $ 7,612 $ 5,664 $ 1,716 $ 0.72 $ 0.72
Second Quarter 7,654 5,676 1,751 0.74 0.73
Third Quarter 8,082 5,926 2,103 0.88 0.88
Fourth Quarter 8,372 6,031 2,083 0.88 0.87
-------- -------- ------- ------ -------
Full Year $ 31,720 $ 23,297 $ 7,653 $ 3.22 $ 3.20
2003
First Quarter $ 7,963 $ 5,631 $ 1,783 $ 0.76 $ 0.76
Second Quarter 7,750 5,553 1,702 0.72 0.72
Third Quarter 7,603 5,565 2,066 0.88 0.88
Fourth Quarter 7,519 5,579 1,837 0.78 0.76
-------- -------- ------- ------ -------
Full Year $ 30,835 $ 22,328 $ 7,388 $ 3.14 $ 3.12
======== ======== ======= ====== =======
Page A-40
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
United Bancorp, Inc.
/S/ David S. Hickman September 29, 2005
---------------------------------- Date
David S. Hickman, Chairman and
Chief Executive Officer, Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated, on September 26, 2005.
/s/ * /s/ *
- -------------------------------------- ----------------------------
James D. Buhr, Director Patricia M. Garcia, Director
/s/ * /s/ *
- -------------------------------------- ----------------------------
Joseph D. Butcko, Director James C. Lawson, Director
/s/ * /s/ *
- -------------------------------------- ----------------------------
Robert K. Chapman, Director, President Donald J. Martin, Director
/s/ * /s/ *
- -------------------------------------- ----------------------------
George H. Cress, Director David E. Maxwell, Director
/s/ * /s/ *
- -------------------------------------- ----------------------------
John H. Foss, Director Kathryn M. Mohr, Director
* /s/ Dale L. Chadderdon
--------------------------------------
Dale L. Chadderdon, Attorney in Fact
/s/ David S. Hickman /s/ Dale L. Chadderdon
- ------------------------------------------- ----------------------------
David S. Hickman (Principal Dale L. Chadderdon (Principal
Executive Officer) Director, Chairman Financial Officer) Executive
and Chief Executive Officer Vice President & Chief
Financial Officer
Page 5
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION PAGE NO.
- ------------ ------------------------------------------------------------------------ --------
Exhibit 23 Consent of Independent Registered Public Accounting Firm 7
Exhibit 31.1 Certification of Principal Executive Officer 8
Exhibit 31.2 Certification of Principal Financial Officer 9
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to 10
Section 906 of the Sarbanes-Oxley Act of 2002.
Page 6