UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006
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
incorporation or organization) Identification No.)
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 if the registrant is a well-known seasoned issuer, as
defined by Rule 405 of the Securities Act.
Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [X]
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. [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer.
Large Accelerated Filer [ ] Accelerated Filer [X] Non-Accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act.
Yes [ ] No [X]
As of June 30, 2006, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $107,109,000, based on a closing price of
$45.07 as reported on the OTC Bulletin Board.
As of January 31, 2007, there were 2,624,218 outstanding shares of registrant's
common stock, no par value.
Documents Incorporated By Reference:
Portions of the registrant's definitive 2007 Proxy Statement in connection with
the 2007 Annual Meeting of Shareholders are incorporated by reference into Part
III.
Page 1
CROSS REFERENCE TABLE
Page
ITEM NO. DESCRIPTION Numbers
- -------- ----------- -------
PART I
1. Business 3
I Selected Statistical Information 9
(A) Distribution of Assets, Liabilities and Shareholders'
Equity 9
(B) Interest Rates and Interest Differential 9
II Investment Portfolio 9
III Loan Portfolio 10
(A) Types of Loans 10
(B) Maturities and Sensitivities of Loans to Changes in
Interest Rates 11
(C) Risk Elements 11
(D) Other Interest Bearing Assets 11
IV Summary of Loan Loss Experience 12
(A) Changes in Allowance for Loan Losses 12
(B) Allocation of Allowance for Loan Losses 12
V Deposits 13
VI Return on Equity and Assets 13
VII Short-Term Borrowings 13
1A. Risk Factors 13
1B. Unresolved Staff Comments 16
2. Properties 16
3. Legal Proceedings 17
4. Submission of Matters to a Vote of Security Holders 17
PART II
5. Market for Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities 17
6. Selected Financial Data 19
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations 19
7A. Quantitative and Qualitative Disclosures About Market Risk 20
8. Financial Statements and Supplementary Data 20
9. Changes in and Disagreements With Accountants on Accounting &
Financial Disclosure 20
9A. Controls and Procedures 20
9B. Other Information 22
PART III
10. Directors, Executive Officers and Corporate Governance 22
11. Executive Compensation 23
12. Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters 23
13. Certain Relationships and Related Transactions and Director
Independence 23
14. Principal Accounting Fees and Services 23
PART IV
15. Exhibits and Financial Statement Schedules 23
Signatures 26
Power of Attorney 27
Exhibit Index 28
Page 2
PART I
ITEM 1 - BUSINESS
United Bancorp, Inc. (the "Company") was incorporated on May 31, 1985 as a
business corporation under the Michigan Business Corporation Act, pursuant to
the authorization and direction of the Directors of United Bank & Trust ("UBT").
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 of 1956, as amended (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. In general, the Bank Holding Company Act and regulations
restrict the Company with respect to its own activities and activities of any
subsidiaries to the business of banking or such other activities which are
closely related to the business of banking.
United Savings Bank opened in 1933 as a result of a merging of charters of
Lilley State Bank and Tecumseh State Savings Bank. United Savings Bank was
acquired by the Company on January 1, 1986. United Savings Bank changed its name
to United Bank & Trust on January 1, 1992, at the time it acquired Thompson
Savings Bank in Hudson. In November of 2000, the Company filed applications with
its regulators for permission to establish a second bank as a subsidiary of the
Company. United Bank & Trust - Washtenaw ("UBTW") opened for business on April
2, 2001, and is headquartered in Ann Arbor. UBTW operates with its own local
management and board of directors, and targets the Washtenaw County market for
its growth. In 2003, UBT sold its three Washtenaw County offices to UBTW.
UBT delivers financial services through a system of twelve banking offices and
one Trust office, plus fourteen automated teller machines, located in Lenawee
and Monroe Counties, Michigan. The business base of the area is primarily
agricultural and light manufacturing, with its manufacturing sector exhibiting
moderate dependence on the automotive and refrigeration and air conditioning
industries.
Banking services are delivered by UBTW through five banking offices and five
automated teller machines in Washtenaw County, Michigan. The employment base of
Washtenaw County is centered around health care, education and automotive high
technology. Economic stability is provided to a great extent by the University
of Michigan, which is a major employer and is not as economically sensitive to
the fluctuations of the automotive industry. The services and public sectors
account for a substantial percentage of total industry employment, in a large
part due to the University of Michigan and the University of Michigan Medical
Center.
The Company's subsidiary banks (the "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, credit card and check-credit loans,
home equity loans, accounts receivable and inventory financing, equipment lease
financing and construction financing.
The Banks maintain correspondent bank relationships with a small number of
larger banks, which involve check clearing operations, securities safekeeping,
transfer of funds, loan participation, and the purchase and sale of federal
funds and other similar services. UBTW also maintains a correspondent banking
relationship with UBT.
Page 3
The 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 derive income from the
sale of various insurance products to banking clients.
The following table shows comparative information concerning the Banks as of
December 31, 2006, in thousands of dollars:
Assets Loans Deposits
-------- -------- --------
United Bank & Trust $494,621 $366,400 $414,984
United Bank & Trust - Washtenaw 260,885 235,363 213,894
UBT operates a trust department, and provides trust services to UBTW on a
contract basis. The Wealth Management Group offers a variety of fiduciary
services to individuals, corporations and governmental entities, including
services as trustee for personal, pension, and employee benefit trusts. The
department provides trust services, financial planning services, investment
services, custody services, pension paying agent services and acts as the
personal representative for estates. These products help to diversify the
Company's sources of income.
Supervision and Regulation
General. The Company and the Banks are subject to extensive regulation under
federal and state laws. The regulatory framework is intended primarily for the
protection of depositors, federal deposit insurance funds and the banking system
as a whole and not for the protection of security holders.
Set forth below is a description of the significant elements of some of the laws
and regulations applicable to the Company and the Banks. The description is
qualified in its entirety by reference to the full text of the statutes,
regulations and policies that are described. Also, such statutes, regulations
and policies are continually under review by Congress and state legislatures and
federal and state regulatory agencies. A change in statutes, regulations or
regulatory policies applicable to the Company and the Banks could have a
material effect on the business of the Company and the Banks.
As a bank holding company within the meaning of the Bank Holding Company Act,
the Company is required to file quarterly and annual reports of its operations
and such additional information as the Federal Reserve Board may require and is
subject, along with its subsidiaries, to examination by the Federal Reserve
Board. The Federal Reserve Board is the primary regulator of the Company.
The Bank Holding Company Act requires every bank holding company to obtain prior
approval of the Federal Reserve Board before it may merge with or consolidate
into another bank holding company, acquire substantially all the assets of any
bank, or acquire ownership or control of any voting shares of any bank if after
such acquisition it would own or control, directly or indirectly, more than 5%
of the voting shares of such bank holding company or bank. The Federal Reserve
Board may not approve the acquisition by the Company of voting shares or
substantially all the assets of any bank located in any state other than
Michigan unless the laws of such other state specifically authorize such an
acquisition. The Bank Holding Company Act also prohibits a bank holding company,
with certain exceptions, from acquiring direct or indirect ownership or control
of more than 5% of the voting shares of any company which is not a bank and from
engaging in any business other than that of banking, managing and controlling
banks or furnishing services to banks and their subsidiaries. However, holding
companies may engage in, and may own shares of companies engaged in, certain
businesses found by the Federal Reserve Board to be so closely related to
banking or the management or control of banks as to be a proper incident
thereto.
Page 4
Under current regulations of the Federal Reserve Board, a holding company and
its nonbank subsidiaries are permitted, among other activities, to engage,
subject to certain specified limitations, in such banking related business
ventures as sales and consumer finance, equipment leasing, credit bureau
services and software operations, data processing and services transmission,
discount securities brokerage, insurance, mortgage banking and brokerage, sale
and leaseback and other forms of real estate banking. The Bank Holding Company
Act does not place territorial restrictions on the activities of nonbank
subsidiaries of bank holding companies. In addition, federal legislation
prohibits acquisition of "control" of a bank or bank holding company without
prior notice to certain federal bank regulators. "Control" in certain cases may
include the acquisition of as little as 10% of the outstanding shares of capital
stock.
In March of 2000, the Gramm-Leach-Bliley Act of 1999 (the "GLB Act") was
enacted. Under the GLB Act, new opportunities became available for bank holding
companies, banks and other depository institutions, insurance companies and
securities firms to enter into combinations that permit a single financial
services organization to offer customers a more complete array of financial
products and services. The GLB Act provided a new regulatory framework for
regulation through the "financial holding company," with the Federal Reserve
Board as the umbrella regulator. Functional regulation of the separately
regulated subsidiaries of a financial holding company are conducted by their
primary functional regulator. The Company became a financial holding company in
2000.
UBT and UBTW are Michigan banking corporations, and as such are subject to the
regulation of, and supervision and regular examination by, the Michigan Office
of Financial and Insurance Services ("OFIS") and the FDIC. OFIS is the primary
regulator of the Banks. Deposit accounts of the Banks are insured by the FDIC.
Requirements and restrictions under the laws of the United States and the State
of Michigan include the requirement that banks maintain reserves against certain
deposits, restrictions on the nature and amount of loans which may be made by a
bank and the interest that may be charged thereon, restrictions on the payment
of interest on certain deposits and restrictions relating to investments and
other activities of a bank.
Dividends. The Company is a legal entity, separate and distinct from the Banks.
While the Banks contract with the Company and pay for services provided, much of
the Company's revenue will be received in the form of dividends, if any, paid by
UBT and UBTW. Thus, the Company's ability to pay dividends to its shareholders
will be limited by statutory and regulatory restrictions on UBT and UBTW
concerning dividends. Michigan's banking laws restrict the payment of cash
dividends by a state bank by providing, subject to certain exceptions, that
dividends may be paid only out of net profits then on hand after deducting
therefrom its losses and bad debts and no dividends may be paid unless the bank
will have a surplus amounting to not less than twenty percent (20%) of its
capital after the payment of the dividend. Federal law generally prohibits a
bank from making any capital distribution (including payment of a dividend) or
paying any management fee to its parent company if the depository institution
would thereafter be undercapitalized.
The Federal Deposit Insurance Corporation ("FDIC") may prevent an insured bank
from paying dividends if the Bank is in default of payment of any assessment due
to the FDIC. In addition, the FDIC may prohibit the payment of dividends by a
bank, if such payment is determined, by reason of the financial conditions of
the bank, to be an unsafe and unsound banking practice.
Holding Company Support of Subsidiary Banks. Under Federal Reserve Board policy,
the Company is expected to act as a source of financial and managerial strength
to its Banks and to commit resources to support such subsidiaries. This support
of its subsidiary banks may be required at times when, absent such Federal
Reserve Board policy, the Company might not otherwise be inclined to provide it.
Page 5
In addition, any capital loans by a bank holding company to any of its
subsidiary banks are subordinate in right of payment to deposits and certain
other indebtedness of such subsidiary banks.
Liability of Commonly Controlled Depository Institutions. Under the Federal
Deposit Insurance Act, as amended ("FDIA"), FDIC-insured depository
institutions, such as any of the Banks, can be held liable for any loss incurred
by, or reasonably expected to be incurred by, the FDIC in connection with (i)
the "default" of a commonly controlled FDIC-insured depository institution, or
(ii) any assistance provided by the FDIC to any commonly controlled depository
institution in "danger of default." For these purposes, the term "default" is
defined generally as the appointment of a conservator or receiver and "in danger
of default" is defined generally as the existence of certain conditions
indicating that a default is likely to occur without federal regulatory
assistance.
Capital Adequacy and Prompt Corrective Action. The Federal Reserve Board and the
FDIC have established guidelines for risk-based capital by bank holding
companies and banks. These guidelines establish a risk adjusted ratio relating
capital to risk- weighted assets and off-balance-sheet exposures. These capital
guidelines primarily define the components of capital, categorize assets into
different risk classes, and include certain off-balance- sheet items in the
calculation of capital requirements. Generally, Tier 1 capital consists of
shareholders' equity less intangible assets and unrealized gain or loss on
securities available for sale, and Tier 2 capital consists of Tier 1 capital
plus qualifying loan loss reserves.
The FDIC Improvement Act of 1991 established a system of prompt corrective
action to resolve the problems of undercapitalized financial institutions. Under
this system, federal banking regulators have established five capital
categories, well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized, in which all
institutions are placed. The federal banking agencies have also specified by
regulation the relevant capital levels for each of the categories.
Federal banking regulators are required to take specified mandatory supervisory
actions and are authorized to take other discretionary actions with respect to
institutions in the three undercapitalized categories. The severity of the
action depends upon the capital category in which the institution is placed.
Generally, subject to a narrow exception, the banking regulator must appoint a
receiver or conservator for an institution that is critically undercapitalized.
An institution in any of the under-capitalized categories is required to submit
an acceptable capital restoration plan to its appropriate federal banking
agency. An undercapitalized institution is also generally prohibited from paying
any dividends, increasing its average total assets, making acquisitions,
establishing any branches or engaging in any new line of business, except under
an accepted capital restoration plan or with FDIC approval.
Failure to meet capital guidelines could subject a bank or bank holding company
to a variety of enforcement remedies, including issuance of a capital directive,
the termination of deposit insurance by the FDIC, a prohibition on accepting
brokered deposits, and other restrictions on its business. In addition, such a
bank would generally not receive regulatory approval of any application that
requires the consideration of capital adequacy, such as a branch or merger
application, unless the bank could demonstrate a reasonable plan to meet the
capital requirement within a reasonable period of time. The capital ratios of
the Company and the Banks exceed the regulatory guidelines for well capitalized
institutions. Information in Note 18 on Page A-40 hereof provides additional
information regarding the Company's capital ratios, and is incorporated herein
by reference.
Page 6
The federal regulatory authorities' risk-based capital guidelines are based upon
the 1988 capital accord of the Basel Committee on Banking Supervision (the
"BIS"). The BIS is a committee of central banks and bank supervisors/regulators
from the major industrialized countries that develops broad policy guidelines
for use by each country's supervisors in determining the supervisory policies
they apply. In 2004, the BIS published a new capital accord to replace its 1988
capital accord. The new capital accord would, among other things, set capital
requirements for operational risk and refine the existing capital requirements
for credit risk and market risk. Operational risk is defined to mean the risk of
direct or indirect loss resulting from inadequate or failed internal processes,
people and systems in connection with external events. The 1988 capital accord
does not include separate capital requirements for operational risk. The United
States federal regulatory authorities have released proposed rules to implement
the BIS's new capital accord, and comments are due in the first quarter of 2007.
The Company cannot predict the timing or final form of the United States rules
implementing the new capital accord and their impact on the Company. The new
capital requirements that may arise from the final rules could increase the
minimum capital requirements applicable to the Company and the Banks.
Affiliate Transactions. Banks are subject to restrictions imposed by federal law
on extensions of credit to, purchases of assets from, and certain other
transactions with affiliates and on investments in stock or other securities
issued by affiliates. Such restrictions prevent the Banks from making loans to
affiliates unless the loans are secured by collateral in specified amounts and
have terms at least as favorable to the Banks as the terms of comparable
transactions between the Banks and non-affiliates. Further, applicable federal
and state laws significantly restrict extensions of credit by the Banks to
directors, executive officers and principal stockholders and related interests
of such persons.
Deposit Insurance. Substantially all of the deposits of the Banks are insured up
to applicable limits by the Deposit Insurance Fund ("DIF") of the FDIC and are
subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes
a risk-based assessment system that imposes insurance premiums based upon a
matrix that takes into account a bank's capital level and supervisory rating.
Pursuant to the Federal Deposit Insurance Reform Act of 2005, the FDIC modified
its method of calculating FDIC insurance assessments effective November 2006,
and provided credits to certain banks for the calendar year 2007, to be applied
to future assessments. UBT has earned assessment credits, while UBTW has not,
since it is a relatively new institution. These changes will result in increased
FDIC insurance premiums for UBTW, while UBT will be able to offset all of its
FDIC assessments for 2007 and much of 2008 using credits it has earned. The
assessment methodology allows the FDIC to set its assessment rates in the future
in connection with declines in the insurance funds or increases in the amount of
insurance coverage. An increase in the assessment rate could have a material
adverse effect on the Company's earnings, depending on the amount of the
increase.
During 2006, the Banks paid $75,131 in Financing Corporation ("FICO")
assessments related to outstanding FICO bonds to the FDIC as collection agent.
The FICO is a mixed-ownership government corporation established by the
Competitive Equality Banking Act of 1987 whose sole purpose was to function as a
financing vehicle for the now defunct Federal Savings and Loan Insurance
Corporation. FICO assessments will continue in the future for both banks.
Depositor Preference. The FDIA provides that, in the event of the "liquidation
or other resolution" of an insured depository institution, the claims of
depositors of the institution, including the claims of the FDIC as a receiver,
will have priority over other general unsecured claims against the institution.
If an insured depository institution fails, insured and uninsured depositors,
along with the FDIC, will have priority in payment ahead of unsecured,
non-deposit creditors, including the parent bank holding company, with respect
to any extensions of credit they have made to such insured depository
institution.
Page 7
Community Reinvestment Act. The Community Reinvestment Act of 1977 ("CRA")
requires depository institutions to assist in meeting the credit needs of their
market areas consistent with safe and sound banking practice. Under the CRA,
each depository institution is required to help meet the credit needs of its
market areas by, among other things, providing credit to low- and
moderate-income individuals and communities. Depository institutions are
periodically examined for compliance with the CRA and are assigned ratings. In
order for a financial holding company to commence any new activity permitted by
the Bank Holding Company Act, or to acquire any company engaged in any new
activity permitted by the Bank Holding Company Act, each insured depository
institution subsidiary of the financial holding company must have received a
rating of at least "satisfactory" in its most recent examination under the CRA.
Furthermore, banking regulators take into account CRA ratings when considering
approval of a proposed transaction.
Financial Privacy. In accordance with the GLB Act, federal banking regulators
adopted rules that limit the ability of banks and other financial institutions
to disclose non-public information about consumers to nonaffiliated third
parties. These limitations require disclosure of privacy policies to consumers
and, in some circumstances, allow consumers to prevent disclosure of certain
personal information to a nonaffiliated third party. The privacy provisions of
the GLB Act affect how consumer information is transmitted and conveyed to
outside vendors.
Anti-Money Laundering Initiatives and the USA Patriot Act. A major focus of
governmental policy on financing institutions in recent years has been aimed at
combating money laundering and terrorist financing. The USA PATRIOT Act of 2001
(the "USA Patriot Act") which was renewed in substantially the same form on
March 9, 2006, substantially broadened the scope of the United States and
anti-money laundering laws and regulations by imposing significant new
compliance and due diligence obligations, creating new crimes and penalties and
expanding the extra-territorial jurisdiction of the United States. The United
States Treasury Department has issued a number of regulations that apply various
requirements of the USA Patriot Act to financial institutions such as the Banks.
These regulations impose obligations on financial institutions to maintain
appropriate policies, procedures and controls to detect, prevent and report
money laundering and terrorist financing by verifying the identity of their
customers. Failure of a financial institution to maintain and implement adequate
programs to combat money laundering and terrorist financing, or to comply with
all of the relevant laws or regulations, could have serious legal and
reputational consequences for the institutions.
Legislative Initiatives. From time to time, various legislative and regulatory
initiatives are introduced in Congress and state legislatures, as well as by
regulatory agencies. such initiatives may include proposals to expand or
contract the powers of bank holding companies and depository institutions or
proposals to substantially change the financial institution regulatory system.
Such legislation could change banking statutes and the operating environment of
the Company in substantial and unpredictable ways. If enacted, such legislation
could increase or decrease the cost of doing business, limit or expand
permissible activities or affect the competitive balance among banks, savings
associations, credit unions, and other financial institutions. The Company
cannot predict whether any such legislation will be enacted, and, if enacted,
the effect that it, or any implementing regulations, would have on the financial
condition or results of operations of the Company. A change in statutes,
regulations or regulatory policies applicable to the Company or the Banks could
have a material effect on the business of the Company.
Consumer Protection Regulation. Other aspects of the lending and deposit
businesses of the Banks that are subject to federal and state regulation include
disclosure requirements with respect to interest, payment and other terms of
consumer and residential mortgage loans, disclosure of interest and fees and
other terms of, and the availability of, funds for withdrawal from consumer
deposit accounts,
Page 8
prohibiting certain forms of discrimination in credit transactions, and
imposing certain recordkeeping, reporting and disclosure requirements with
respect to residential mortgage loan applications.
Accounting Standards
Information regarding accounting standards adopted by the Company are discussed
beginning on Page A-26 hereof, and is incorporated herein by reference.
Competition
The banking business in the Company's service area is highly competitive. In
their markets, the Banks compete with a number of community banks and
subsidiaries of large multi-state, multi-bank holding companies. In addition,
the banks face competition from credit unions, savings associations, finance
companies, loan production offices and other financial services companies.
The Company believes that the market perceives a competitive benefit to an
independent, locally controlled commercial bank. Much of the Company's
competition comes from affiliates of organizations controlled from outside the
area. Against these competitors, the subsidiary banks continue to expand their
loan and deposit portfolios.
Employees
On December 31, 2006, the Company and its subsidiaries employed 202 full-time
and 42 part-time employees. This compares to 195 full-time and 39 part-time
employees at December 31, 2005.
Available Information
You can find more information about us at our website, located at www.ubat.com.
Our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current
Reports on Form 8-K, and any amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are
available as soon as reasonably practicable after such forms have been filed
with or furnished to the Securities and Exchange Commission (the "SEC") free of
charge on our website through a link to the SEC website.
I SELECTED STATISTICAL INFORMATION
(A) DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
(B) INTEREST RATES AND INTEREST DIFFERENTIAL:
The information required by these sections are contained on Pages A-3 through
A-9 hereof, and is incorporated herein by reference.
II INVESTMENT PORTFOLIO
(A) BOOK VALUE OF INVESTMENT SECURITIES
The table below reflects the book value of various categories of investment
securities of the Company at December 31:
In thousands of dollars 2006 2005
------- --------
U.S. Treasury and government agencies $52,209 $ 57,978
Obligations of states and political subdivisions 40,512 41,691
Equity and other securities 3,192 3,354
------- --------
Total Investment Securities $95,913 $103,023
Page 9
(B) CARRYING VALUES AND YIELDS OF INVESTMENT SECURITIES
The following table reflects the carrying values and yields of the Company's
securities portfolio for 2006. Average yields are based on amortized costs and
the average yield on tax exempt securities of states and political subdivisions
is adjusted to a taxable equivalent basis, assuming a 34% marginal tax rate.
Carrying Values and Yields of Investments
In thousands of dollars where applicable 0-1 1-5 5-10 Over 10
Available For Sale Year Years Years Years Total
------- ------- ------- ------- -------
U.S. Treasury and government agencies (1) $19,510 $18,870 $ -- $ -- $38,380
Weighted average yield 4.97% 4.73% -- -- 4.82%
Obligations of states and political subdivisions $11,891 $26,988 $13,801 $1,634 $54,314
Weighted average yield 3.75% 4.16% 3.99% 4.67% 4.00%
Equity and other securities (2) $ 3,117 $ -- $ -- $ -- $ 3,117
Weighted average yield 4.50% -- -- -- 4.50%
Total securities $34,518 $45,858 $13,801 $1,634 $95,811
Weighted average yield 4.51% 4.57% 3.99% 4.67% 4.46%
(1) Reflects the scheduled amortization and an estimate of future prepayments
based on past and current experience of amortizing U.S. agency securities.
(2) Reflects the scheduled amortization and an estimate of future prepayments
based on past and current experience of the issuer for various
collateralized mortgage obligations.
As of December 31, 2006, the Company's securities portfolio contains no
concentrations by issuer greater than 10% of shareholders' equity. Additional
information concerning the Company's securities portfolio is included on Page
A-9, and in Note 3 on Page A-30 hereof, and is incorporated herein by reference.
III LOAN PORTFOLIO
(A) TYPES OF LOANS
The tables below show loans outstanding (net of unearned interest) at December
31, and the percentage makeup of the portfolios. All loans are domestic and
contain no concentrations by industry or customer. Balances are stated in
thousands of dollars.
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
Personal $ 91,002 $ 81,571 $ 74,142 $ 70,301 $ 71,010
Business and commercial mortgage 327,928 320,188 278,838 256,778 212,611
Tax exempt 2,841 3,133 3,325 1,476 1,417
Residential mortgage (1) 85,636 67,246 76,228 85,156 110,985
Construction 94,356 85,974 64,365 33,109 34,503
-------- -------- -------- -------- --------
Total loans (1) $601,763 $558,112 $496,898 $446,820 $430,526
======== ======== ======== ======== ========
Personal 15.1% 14.6% 14.9% 15.7% 16.5%
Business and commercial mortgage 54.5% 57.4% 56.1% 57.5% 49.4%
Tax exempt 0.5% 0.6% 0.7% 0.3% 0.3%
Residential mortgage (1) 14.2% 12.0% 15.3% 19.1% 25.8%
Construction 15.7% 15.4% 13.0% 7.4% 8.0%
-------- -------- -------- -------- --------
Total loans (1) 100.0% 100.0% 100.0% 100.0% 100.0%
======== ======== ======== ======== ========
(1) Includes loans held for sale
Page 10
(B) MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES
The following table presents the maturity of total loans outstanding, other than
residential mortgages and personal loans, as of December 31, 2006, according to
scheduled repayments of principal. All figures are stated in thousands of
dollars.
0-1 1-5 After 5
Year Years Years Total
-------- -------- -------- --------
Business and commercial mortgage - fixed rate $ 39,222 $104,450 $14,024 $157,696
Business and commercial mortgage - variable rate 33,813 80,105 56,314 170,232
Tax exempt - fixed rate 217 2,518 106 2,841
Tax exempt - variable rate -- -- -- --
Construction -fixed rate 5,244 16,440 -- 21,684
Construction -variable rate 69,400 3,272 -- 72,672
-------- -------- ------- --------
Total fixed rate 44,683 123,408 14,130 182,221
Total variable rate 103,213 83,377 56,314 242,904
-------- -------- ------- --------
Total $147,896 $206,785 $70,444 $425,125
======== ======== ======= ========
(C) RISK ELEMENTS
Non-Accrual, Past Due and Restructured Loans
The following shows the effect on interest revenue of nonaccrual and troubled
debt restructured loans as of December 31, 2006, in thousands of dollars:
Gross amount of interest that would have been
recorded at original rate $327
Interest that was included in revenue --
----
Net impact on interest revenue $327
====
Additional information concerning nonperforming loans, the Company's nonaccrual
policy, and loan concentrations is provided on Pages A-10 through A-13, in Note
1 on Pages A-27 and A-28 and Notes 4 and 5 on Page A-32 hereof, and is
incorporated herein by reference
At December 31, 2006, the Banks had eight loans, other than those disclosed
above, for a total of $4,652,000 which would cause management to have serious
doubts as to the ability of the borrowers to comply with the present loan
repayment terms. These loans were included on the Banks' "watch lists" and were
classified as impaired; however, payments are current.
(D) OTHER INTEREST BEARING ASSETS
As of December 31, 2006, other than $1,063,000 in other real estate, there were
no other interest bearing assets that would be required to be disclosed under
Item III, Parts (C)(1) or (C)(2) of the Loan Portfolio listing if such assets
were loans.
Page 11
IV SUMMARY OF LOAN LOSS EXPERIENCE
(A) CHANGES IN ALLOWANCE FOR LOAN LOSSES
The table below summarizes changes in the allowance for loan losses for the
years 2002 through 2006, in thousands of dollars.
CHANGES IN ALLOWANCE FOR LOAN LOSSES
2006 2005 2004 2003 2002
------ ------ ------ ------ ------
Balance at beginning of period $6,361 $5,766 $5,497 $4,975 $4,571
Charge-offs:
Business and commercial mortgage 447 516 739 139 338
Residential mortgage 61 1 7 19 --
Personal 254 362 320 512 484
------ ------ ------ ------ ------
Total charge-offs 762 879 1,066 670 822
------ ------ ------ ------ ------
Recoveries:
Business and commercial mortgage 13 58 188 20 16
Residential mortgage 13 2 -- 3 --
Personal 101 82 99 100 105
------ ------ ------ ------ ------
Total recoveries 127 142 287 123 121
------ ------ ------ ------ ------
Net charge-offs 635 737 779 547 701
------ ------ ------ ------ ------
Additions charged to operations 2,123 1,332 1,048 1,069 1,105
Balance at end of period $7,849 $6,361 $5,766 $5,497 $4,975
====== ====== ====== ====== ======
Ratio of net charge-offs to average loans 0.11% 0.14% 0.17% 0.13% 0.13%
Allowance as percent of total loans 1.30% 1.14% 1.16% 1.23% 1.16%
The allowance for loan losses is maintained at a level believed adequate by
Management to absorb losses inherent 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 provision
charged to earnings was $2,123,000 in 2006, compared to $1,332,000 in 2005 and
$1,048,000 in 2004. The allowance is based on the analysis of the loan portfolio
and a four year historical average of net charge offs to average loans of 0.14%
of the portfolio.
(B) ALLOCATION OF ALLOWANCE FOR LOAN LOSSES
The following table presents the portion of the allowance for loan losses
applicable to each loan category in thousands of dollars, as of December 31. A
table showing the percent of loans in each category to total loans is included
in Section III (A), above.
2006 2005 2004 2003 2002
------ ------ ------ ------ ------
Business and commercial mortgage $6,911 $5,471 $5,036 $4,775 $3,950
Tax exempt -- -- -- -- --
Residential mortgage 24 14 20 37 15
Personal 889 777 710 685 571
Construction -- -- -- -- --
Unallocated 25 99 -- -- 439
------ ------ ------ ------ ------
Total $7,849 $6,361 $5,766 $5,497 $4,975
====== ====== ====== ====== ======
The allocation method used takes into account specific allocations for
identified credits and a four year historical loss average in determining the
allocation for the balance of the portfolio.
Page 12
V DEPOSITS
The information concerning average balances of deposits and the weighted-average
rates paid thereon, is included on Page A-5 and maturities of time deposits is
provided in Note 9 on Page A-33 hereof, and is incorporated herein by reference.
There were no foreign deposits. As of December 31, 2006, outstanding time
certificates of deposit in amounts of $100,000 or more were scheduled to mature
as shown below. All amounts are in thousands of dollars.
Time
Certificates
------------
Within three months $ 23,482
Over three through six months 20,739
Over six through twelve months 25,023
Over twelve months 33,248
--------
Total $102,492
========
VI RETURN ON EQUITY AND ASSETS
Various ratios required by this section and other ratios commonly used in
analyzing bank holding company financial statements are included on Page A-3 and
A-4 hereof, and are incorporated herein by reference.
VII SHORT-TERM BORROWINGS
Some of the information required by this section is contained in Note 10 on Page
A-33 hereof, and is incorporated herein by reference. No additional information
is required, as for all reporting periods, there were no categories of
short-term borrowings for which the average balance outstanding during the
period was 30% or more of shareholders' equity at the end of the period.
ITEM 1A - RISK FACTORS
An investment in the Company's common stock is subject to risks inherent to the
Company's business. The material risks and uncertainties that management
believes affect the Corporation are described below. Before making an investment
decision, you should carefully consider the risks and uncertainties described
below together with all of the other information included or incorporated by
reference in this report. The risks and uncertainties described below are not
the only ones facing the Company. Additional risks and uncertainties that
management is not aware of or focused on or that management currently deems
immaterial may also impair the Company's business operations. This report is
qualified in its entirety by these risk factors.
If any of the following risks actually occur, the Company's financial condition
and results of operations could be materially and adversely affected. If this
were to happen, the value of the Company's common stock could decline
significantly, and you could lose all or part of your investment.
RISKS RELATED TO THE COMPANY'S BUSINESS
The Company Is Subject To Interest Rate Risk
The Company's earnings and cash flows are largely dependent upon its net
interest income. Net interest income is the difference between interest income
earned on interest-earning assets such as loans and securities and interest
expense paid on interest-bearing liabilities such as deposits and borrowed
funds. Interest rates are highly sensitive to many factors that are beyond the
Company's control, including general economic conditions and policies of various
governmental and regulatory agencies and, in
Page 13
particular, the Federal Reserve Board. Changes in monetary policy, including
changes in interest rates, could influence not only the interest the Company
receives on loans and securities and the amount of interest it pays on deposits
and borrowings, but such changes could also affect (i) the Company's ability to
originate loans and obtain deposits, and (ii) the fair value of the Company's
financial assets and liabilities. If the interest rates paid on deposits and
other borrowings increase at a faster rate than the interest rates received on
loans and other investments, the Company's net interest income, and therefore
earnings, could be adversely affected. Earnings could also be adversely affected
if the interest rates received on loans and other investments fall more quickly
than the interest rates paid on deposits and other borrowings.
The Company Is Subject To Lending Risk
There are inherent risks associated with the Company's lending activities. These
risks include, among other things, the impact of changes in interest rates and
changes in the economic conditions in the markets where the Company operates.
Increases in interest rates and/or weakening economic conditions could adversely
impact the ability of borrowers to repay outstanding loans or the value of the
collateral securing these loans. The Company is also subject to various laws and
regulations that affect its lending activities. Failure to comply with
applicable laws and regulations could subject the Company to regulatory
enforcement action that could result in the assessment of significant civil
money penalties against the Company.
As of December 31, 2006, approximately 71% of the Company's loan portfolio
consisted of business and commercial mortgage and construction loans. Because
the Company's loan portfolio contains a significant number of business and
commercial and mortgage and personal construction loans with relatively large
balances, the deterioration of one or a few of these loans could cause a
significant increase in non- performing loans. An increase in non-performing
loans could result in a net loss of earnings from these loans, an increase in
the provision for possible loan losses and an increase in loan charge-offs, all
of which could have a material adverse effect on the Company's financial
condition and results of operations.
The Company's Allowance For Possible Loan Losses May Be Insufficient
The Company maintains an allowance for possible loan losses, which is a reserve
established through a provision for possible loan losses charged to expense,
that represents management's best estimate of probable losses that may be
incurred within the existing portfolio of loans. The allowance, in the judgment
of management, is necessary to reserve for estimated loan losses and risks
inherent in the loan portfolio. The level of the allowance reflects management's
continuing evaluation of industry concentrations; specific credit risks; loan
loss experience; current loan portfolio quality; present economic, political and
regulatory conditions and unidentified losses inherent in the current loan
portfolio. The determination of the appropriate level of the allowance for
possible loan losses inherently involves a high degree of subjectivity and
requires the Company to make significant estimates of current credit risks and
future trends, all of which may undergo material changes. Changes in economic
conditions affecting borrowers, new information regarding existing loans,
identification of additional problem loans and other factors, both within and
outside of the Company's control, may require an increase in the allowance for
possible loan losses. In addition, bank regulatory agencies periodically review
the Company's allowance for loan losses and may require an increase in the
provision for possible loan losses or the recognition of further loan
charge-offs, based on judgments different than those of management. Any
increases in the allowance for possible loan losses will result in a decrease in
net income and, possibly, capital, and may have a material adverse effect on the
Company's financial condition and results of operations.
Page 14
The Company's Profitability Depends Significantly On Economic Conditions In The
State Of Michigan The Company's success depends primarily on the general
economic conditions of the State of Michigan and the specific local markets in
which the Company operates. Unlike larger national or other regional banks that
are more geographically diversified, the Company provides banking and financial
services to customers primarily in the Lenawee, Monroe and Washtenaw Counties,
Michigan. The local economic conditions in these areas have a significant impact
on the demand for the Company's products and services as well as the ability of
the Company's customers to repay loans, the value of the collateral securing
loans and the stability of the Company's deposit funding sources. A significant
decline in general economic conditions, caused by inflation, recession, acts of
terrorism, outbreak of hostilities or other international or domestic
occurrences, unemployment, changes in securities markets or other factors could
impact these local economic conditions and, in turn, have a material adverse
effect on the Company's financial condition and results of operations. See,
however, the disclosure under "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Background" on page A-2.
The Company Operates In A Highly Competitive Industry and Market Area
The Company faces substantial competition in all areas of its operations from a
variety of different competitors, many of which are larger and may have more
financial resources. Such competitors primarily include credit unions, savings
associations and various finance companies and loan production offices, in
addition to a number of community banks and subsidiaries of large multi-state
and multi-bank holding companies. The financial services industry could become
even more competitive as a result of legislative, regulatory and technological
changes and continued consolidation. Banks, securities firms and insurance
companies can merge under the umbrella of a financial holding company, which can
offer virtually any type of financial service, including banking, securities
underwriting, insurance (both agency and underwriting) and merchant banking.
Also, technology has lowered barriers to entry and made it possible for
non-banks to offer products and services traditionally provided by banks, such
as automatic transfer and automatic payment systems. Many of the Company's
competitors have fewer regulatory constraints and may have lower cost
structures. Additionally, due to their size, many competitors may be able to
achieve economies of scale and, as a result, may offer a broader range of
products and services as well as better pricing for those products and services
than the Company can.
The Company believes that the market perceives a competitive benefit to an
independent, locally controlled commercial bank. Much of the Company's
competition comes from affiliates of organizations controlled from outside the
area. Against these competitors, the subsidiary banks continue to expand their
loan and deposit portfolios.
The Company Is Subject To Extensive Government Regulation and Supervision
The Company and the Banks are subject to extensive federal and state regulation
and supervision as disclosed under "Item 1. Business - Supervision and
Regulation." Banking regulations are primarily intended to protect depositors'
funds, federal deposit insurance funds and the banking system as a whole, not
shareholders. These regulations affect the Company's lending practices, capital
structure, investment practices, dividend policy and growth, among other things.
Congress and federal regulatory agencies continually review banking laws,
regulations and policies for possible changes. Changes to statutes, regulations
or regulatory policies, including changes in interpretation or implementation of
statutes, regulations or policies, could affect the Company in substantial and
unpredictable ways.
The Company Continually Encounters Technological Change
The financial services industry is continually undergoing rapid technological
change with frequent introductions of new technology-driven products and
services. The effective use of technology increases
Page 15
efficiency and enables financial institutions to better serve customers and to
reduce costs. The Company's future success depends, in part, upon its ability to
address the needs of its customers by using technology to provide products and
services that will satisfy customer demands, as well as to create additional
efficiencies in the Company's operations. Many of the Company's competitors have
substantially greater resources to invest in technological improvements. The
Company may not be able to effectively implement new technology-driven products
and services or be successful in marketing these products and services to its
customers.
The Company's Stock Price Can Be Volatile
Stock price volatility may make it more difficult for you to resell your common
stock when you want to and at prices you find attractive. The Company's stock
price can fluctuate significantly in response to a variety of factors.
General market fluctuations, industry factors and general economic and political
conditions and events, such as economic slowdowns or recessions, interest rate
changes or credit loss trends, could also cause the Company's stock price to
decrease regardless of operating results. In addition, the trading volume in the
Company's common stock is significantly less than that of other larger financial
services companies. This can make the Company's stock price volatile as
significant sales of the Company's common stock, or the expectation of these
sales, could cause the Company's stock price to fall.
An Investment In The Company's Common Stock Is Not An Insured Deposit
The Company's common stock is not a bank deposit and, therefore, is not insured
against loss by the Federal Deposit Insurance Corporation (FDIC), any other
deposit insurance fund or by any other public or private entity. Investment in
the Company's common stock is inherently risky for the reasons described in this
"Risk Factors" section and elsewhere in this report and is subject to the same
market forces that affect the price of common stock in any company. As a result,
if you acquire the Company's common stock, you may lose some or all of your
investment.
The Company's Controls and Procedures May Fail or Be Circumvented
Management regularly reviews and updates the Company's internal controls,
disclosure controls and procedures, and corporate governance policies and
procedures. Any system of controls, however well designed and operated, is based
in part on certain assumptions and can provide only reasonable, not absolute,
assurances that the objectives of the system are met. Any failure or
circumvention of the Company's controls and procedures or failure to comply with
regulations related to controls and procedures could have a material adverse
effect on the Company's business, results of operations and financial condition.
ITEM 1B - UNRESOLVED STAFF COMMENTS
None.
ITEM 2 - PROPERTIES
The executive offices of the Company are located at the main office (Hickman
Financial Center) of United Bank & Trust, 205 East Chicago Boulevard, Tecumseh,
Michigan. UBT owns and occupies the
Page 16
entire two-story building, which was built in 1980. UBT operates three other
banking offices in the Tecumseh area, two in the city of Adrian, one each in the
cities of Hudson and Morenci, one in the village of Blissfield, and one each in
Clinton, Rollin and Raisin Townships, all in Lenawee County. In addition, the
bank operates one office in Dundee, Monroe County, Michigan. In 2005, the Bank
moved its Trust & Investment Group to a new leased facility in Tecumseh. The
bank owns all of the buildings except for the Trust facility, and leases the
land for one office in the city of Adrian. All offices other than the Hickman
Financial Center offer drive-up facilities. UBI owns and occupies a 12,000
square foot operations and training center in Tecumseh.
United Bank & Trust - Washtenaw operates one banking office in the City of Ann
Arbor and one office each in the city of Saline, the villages of Dexter and
Manchester, and Scio Township, Washtenaw County, Michigan. The bank owns the
Saline and Dexter buildings, leases the buildings for the Manchester and Scio
Township offices, and leases the land for the Dexter office. UBTW holds a
long-term lease on the facilities for its administrative and banking offices,
which it moved into in 2003. All offices offer ATM services, and all offices
other than Manchester offer drive-up facilities.
ITEM 3 - LEGAL PROCEEDINGS
On September 22, 2006, Annette Theisen and various entities controlled by her,
filed a complaint in Washtenaw Circuit Court against a number of defendants,
including UBTW and its President, Todd C. Clark. The complaint alleges that UBTW
and its President had a fiduciary duty and a duty of good faith to plaintiffs
and that UBTW and its President breached those duties in connection with secured
loans made to plaintiffs by, among other things, allegedly allowing plaintiffs
to make imprudent investments with such loans, causing transfers of, and
mortgages to be placed on, certain of plaintiffs' assets contrary to plaintiffs'
interests, not disclosing certain alleged conflicts of interest, and failing to
pay the premium on, and causing the cancellation of, Ms. Theisen's long-term
supplemental medical insurance policy. Plaintiffs seek damages of $6 million.
The Company is vigorously defending such claims.
The Company and its subsidiaries are not involved in any other material legal
proceedings. They are involved in ordinary routine litigation incident to its
business; however, no such proceedings are expected to result in any material
adverse effect on the operations or earnings of the Company. Neither the Company
nor it subsidiaries are involved in any proceedings to which any director,
principal officer, affiliate thereof, or person who owns of record or
beneficially more than five percent (5%) of the outstanding stock of the
Company, or any associate of the foregoing, is a party or has a material
interest adverse to the Company.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of 2006.
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
PRICE RANGE FOR COMMON STOCK
The following table shows the high and low selling prices of common stock of the
Company for each quarter of 2006 and 2005 as quoted on the OTC Bulletin Board,
under the symbol of UBMI. These prices do not reflect private trades not
involving brokers or dealers. Such over-the-counter market
Page 17
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions. The Company
had 1,341 shareholders of record as of December 31, 2006. The prices and
dividends per share have been adjusted to reflect stock dividends paid in 2006
and 2005.
2006 2005
--------------------------- ---------------------------
Market price Cash Market price Cash
--------------- dividends --------------- dividends
Quarter High Low declared High Low declared
- ------- ------ ------ --------- ------ ------ ---------
1st $58.62 $53.04 $ -- $62.58 $59.87 $0.317
2nd 56.05 42.77 0.352 63.81 59.87 0.333
3rd 47.10 43.73 0.370 64.76 59.05 0.352
4th 45.00 44.00 0.380 62.86 56.67 0.352
Banking laws and regulations restrict the amount the Banks can transfer to the
Company in the form of cash dividends and loans. Those restrictions are
discussed in Note 15 on Page A-36 hereof. As a result of a change in the timing
of declaration of cash dividends, only three cash dividends were declared in
2006, although four cash dividends were paid.
STOCK PERFORMANCE GRAPH
The following chart shows the yearly percentage change in the Company's
cumulative total shareholder return on its common stock. This increase is
compared in the chart to similar changes in the NASDAQ Bank Index and the
Standard & Poor's 500 Stock Index. All prices are adjusted for stock splits and
stock dividends. The graph assumes $100 invested on December 31, 2001. The total
return assumes reinvestment of dividends.
The NASDAQ Bank Index is a broad-based capitalization- weighted index of
domestic and foreign common stocks of banks that are traded on the NASDAQ
National Market System as well as the Small Cap Market. The Index contains
various types of NASDAQ listed banks and savings institutions and related
holding companies, establishments performing functions closely related to
banking, such as check cashing agencies, currency exchanges, safe deposit
companies and corporations for banking abroad. The index is made up of 532
institutions at December 31, 2006.
TOTAL SHAREHOLDER RETURN
CUMULATIVE YEARLY PERCENTAGE AT DECEMBER 31
(PERFORMANCE GRAPH)
2001 2002 2003 2004 2005 2006
----- ----- ----- ----- ----- -----
UBI 100.0 113.9 141.8 160.8 153.9 128.2
S&P 500 100.0 76.6 96.9 105.7 108.7 123.5
NASDAQ Bank Index 100.0 104.5 135.8 151.0 144.2 160.1
Page 18
ITEM 6 - SELECTED FINANCIAL DATA
The following tables present five years of financial data for the Company, for
the years ended December 31 (In thousands, except per share data).
FINANCIAL CONDITION 2006 2005 2004 2003 2002
- ------------------- -------- -------- -------- -------- --------
ASSETS
Cash and demand balances in other banks $ 17,606 $ 20,416 $ 18,188 $ 21,425 $ 16,719
Federal funds sold 3,770 -- -- -- 7,700
Securities available for sale 95,811 103,432 103,786 108,734 97,380
Net loans 593,914 551,751 491,132 441,323 425,551
Other assets 39,888 38,180 37,245 38,291 26,549
-------- -------- -------- -------- --------
Total Assets $750,989 $713,779 $650,351 $609,773 $573,899
======== ======== ======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Noninterest bearing deposits $ 81,373 $ 88,404 $ 85,598 $ 78,184 $ 71,976
Interest bearing certificates of deposit of
$100,000 or more 102,492 68,062 40,057 30,946 28,439
Other interest bearing deposits 444,137 434,186 404,223 393,453 371,135
-------- -------- -------- -------- --------
Total deposits 628,002 590,652 529,878 502,583 471,550
Short term borrowings 77 6,376 8,726 8,076 75
Other borrowings 40,945 42,228 42,847 35,375 41,867
Other liabilities 7,429 6,901 6,676 6,356 7,027
-------- -------- -------- -------- --------
Total Liabilities 676,453 646,157 588,127 552,390 520,519
Shareholders' Equity 74,536 67,622 62,224 57,383 53,380
-------- -------- -------- -------- --------
Total Liabilities and Shareholders' Equity $750,989 $713,779 $650,351 $609,773 $573,899
======== ======== ======== ======== ========
RESULTS OF OPERATIONS 2006 2005 2004 2003 2002
- --------------------- ------- ------- ------- ------- -------
Interest income $47,056 $38,649 $31,720 $30,835 $33,535
Interest expense 17,802 12,286 8,423 8,507 10,716
------- ------- ------- ------- -------
Net Interest Income 29,254 26,363 23,297 22,328 22,819
Provision for loan losses 2,123 1,332 1,048 1,069 1,105
Noninterest income 12,175 11,669 11,010 11,822 9,999
Noninterest expense 26,914 25,195 22,646 22,669 21,644
------- ------- ------- ------- -------
Income before Federal income tax 12,392 11,505 10,613 10,412 10,069
Federal income tax 3,420 3,181 2,960 3,024 2,934
------- ------- ------- ------- -------
Net Income $ 8,972 $ 8,324 $ 7,653 $ 7,388 $ 7,135
======= ======= ======= ======= =======
Basic earnings per share (1) (2) $ 3.38 $ 3.15 $ 2.92 $ 2.85 $ 2.76
Diluted earnings per share (1) (2) 3.38 3.13 2.90 2.83 2.75
Cash dividends paid per share (2) 1.45 1.36 1.24 1.14 1.10
(1) Earnings per share data is based on average shares outstanding plus average
contingently issuable shares.
(2) Adjusted to reflect the stock dividends paid in 2006, 2005, 2004, 2003 and
2002.
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-21
hereof, and is incorporated by reference herein.
Page 19
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is contained on pages A-13 through A-17
hereof, and is incorporated by reference herein.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Selected Quarterly Financial Data - The information required by this item is
contained on page A-3 hereof, and is incorporated by reference herein.
Other information required by this item is contained on pages A-22 through A-42
hereof, and is incorporated by reference herein.
INDEX TO FINANCIAL STATEMENTS
Page No.
----------
Report of Independent Registered Public Accounting Firm A-22
Consolidated Financial Statements
Consolidated Balance Sheets A-23
Consolidated Statements of Income A-24
Consolidated Statements of Cash Flow A-25
Consolidated Statements of Changes in Shareholders' Equity A-26
Notes to Consolidated Financial Statements A-27--A-42
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
ITEM 9A - CONTROLS AND PROCEDURES
(a) The term "disclosure controls and procedures" is defined in Rules 13a-15(e)
and 15d-15(e) of the Securities Exchange Act of 1934 (the "Exchange Act").
These rules refer to the controls and other procedures of a company that
are designed to ensure that information required to be disclosed by a
company in the reports that it files under the Exchange Act is recorded,
processed, summarized and reported, within required time periods. Our Chief
Executive Officer and Principal Financial Officer have evaluated the
effectiveness of our disclosure controls and procedures as of the end of
the period covered by this report (the "Evaluation Date"), and have
concluded that, as of the Evaluation Date, our disclosure controls and
procedures are effective in providing them with material information
relating to the Company known to others within the Company which is
required to be included in our periodic reports filed under the Exchange
Act.
(b) The management of the Company is responsible for establishing and
maintaining adequate internal control over financial reporting. The
Company's internal control system was designed to provide reasonable
assurance to the Company's management and Board of Directors regarding the
preparation and fair presentation of published financial statements.
All internal control systems, no matter how well designed, have inherent
limitations. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation.
Page 20
The Company's management assessed the effectiveness of the Company's
internal control over financial reporting as of December 31, 2006. In
making this assessment, it used the criteria set forth by the Committee of
Sponsoring Organizations of Treadway Commission (COSO) in "Internal Control
- Integrated Framework." Based on our assessment we believe that, as of
December 31, 2006, the Company's internal control over financial reporting
is effective based on those criteria.
The Company's independent auditors have issued an audit report on our
assessment of the Company's internal control over financial reporting. The
report immediately follows this report.
/S/ Robert K. Chapman /S/ Dale L. Chadderdon
- ------------------------------------- ----------------------------------------
Robert K. Chapman Dale L. Chadderdon
President and Chief Executive Officer Executive Vice President and
Chief Financial Officer
(c) To the Shareholders of United Bancorp, Inc.:
We have audited management's assessment, included in the accompanying
Management's Report on Internal Control over Financial Reporting, that
United Bancorp, Inc. maintained effective internal control over financial
reporting as of December 31, 2006, based on criteria established in
Internal Control - Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). The Company's
management is responsible for maintaining effective control over financial
reporting and for its assessment of the effectiveness of internal control
over financial reporting. Our responsibility is to express an opinion on
management's assessment and an opinion on the effectiveness of the
Company's internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained
in all material respects. An audit includes obtaining an understanding of
internal control over financial reporting, evaluating management's
assessment, testing and evaluating the design and operating effectiveness
of internal control and performing such other procedures as we consider
necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed
to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes
in accordance with generally accepted accounting principals. A company's
internal control over financial reporting includes these policies and
procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted accounting
principals, and that receipts and expenditures of the company are being
made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention of
timely detection or unauthorized acquisition, use of disposition of the
company's assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatement. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions or that the
degree of compliance with the policies or procedures may deteriorate.
Page 21
In our opinion, management's assessment that United Bancorp, Inc.
maintained effective internal control over financial reporting as of
December 31, 2006, is fairly stated, in all material respects, based on
criteria established in Internal Control - Integrated Framework issued by
the Committee of Sponsoring Organizations of the Treadway Commission
(COSO). Also in our opinion, United Bancorp, Inc. maintained, in all
material respects, effective internal control over financial reporting as
of December 31, 2006, based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO).
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the consolidated
financial statements of United Bancorp, Inc. and our report dated March 16,
2007, expressed an unqualified opinion thereon.
/S/ BKD, LLP
----------------------------------------
BKD, LLP
Indianapolis, Indiana
March 16, 2007
(d) There has been no change in the Company's internal control over financial
reporting that occurred during the quarter ended December 31, 2006 that has
materially affected, or is reasonably likely to affect, the Company's
internal control over financial reporting.
ITEM 9B - OTHER INFORMATION
None
PART III
ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
On December 9, 2003, the Company adopted a code of ethics (the "Code") that
applies to all co-workers, officers and Directors of the Company and its
subsidiaries. The Code is designed to deter wrongdoing and to promote:
- Honest and ethical conduct, including the ethical handling of actual
or apparent conflicts of interest between personal and professional
relationships;
- Full, fair, accurate, timely and understandable disclosure in reports
and documents that the Company files with, or submits to, the
Commission and in other public communications made by the registrant;
- Compliance with applicable governmental laws, rules and regulations;
- Prompt internal reporting of violations of the Code to an appropriate
person or persons identified in the Code; and
- Accountability for adherence to the Code.
A copy of the Code is included in this report as Exhibit 14.
Page 22
The information required by this item, other than as set forth above, is
contained under the heading "Directors and Executive Officers, Committees and
Meetings of the Board of Directors" and "Beneficial Ownership Reporting
Compliance" in the Company's 2007 Proxy Statement and is incorporated herein by
reference.
ITEM 11 - EXECUTIVE COMPENSATION
The information required by this item is contained under the heading
"Compensation of Directors and Executive Officers" in the Company's 2007 Proxy
Statement and is incorporated herein by reference.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this item is contained under the heading "Equity
Compensation Plan Information", "Security Ownership of Certain Beneficial
Owners," and "Security Ownership of Management" and under the headings
"Compensation Committee Report" and "Compensation and Governance Interlocks and
Insider Particpation" in the Company's 2007 Proxy Statement and is incorporated
herein by reference.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
The information required by this item is contained under the headings "Directors
and Executive Officers" and "Directors, Executive Officers, Principal
Shareholders and their Related Interests - Transactions with the Banks" in the
Company's 2007 Proxy Statement and in Note 14 on Page A-36 hereof and is
incorporated herein by reference.
ITEM 14 - PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is contained under the heading
"Relationship With Independent Public Accountants" in the Company's 2007 Proxy
Statement and is incorporated herein by reference.
PART IV
ITEM 15 - EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) 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-22
Consolidated Financial Statements
Consolidated Balance Sheets A-23
Consolidated Statements of Income A-24
Consolidated Statements of Cash Flow A-25
Consolidated Statements of Changes in Shareholders' Equity A-26
Notes to Consolidated Financial Statements A-27--A-42
2. Financial statement schedules are not applicable.
Page 23
(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.
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.
10.1 Management Agreement effective January 1, 2006, between United
Bancorp, Inc. and David S. Hickman, filed as Exhibit C to the
Company's Form 8-K dated December 3, 2005 (file number 0-16640) and
incorporated herein by reference.
10.2 Employment Agreement effective January 1, 2007, between United
Bancorp, Inc. and Robert K. Chapman, filed as Exhibit 10.1 to the
Company's Form 8-K dated January 10, 2007 (file number 0-16640) and
incorporated herein by reference.
10.3 Employment Agreement effective January 1, 2007, between United
Bancorp, Inc. and Randal J. Rabe, filed as Exhibit 10.2 to the
Company's Form 8-K dated January 10, 2007 (file number 0-16640) and
incorporated herein by reference.
10.4 Employment Agreement effective January 1, 2007, between United
Bancorp, Inc. and Dale L. Chadderdon, filed as Exhibit 10.3 to the
Company's Form 8-K dated January 10, 2007 (file number 0-16640) and
incorporated herein by reference.
Page 24
Exhibits (continued)
10.5 Employment Agreement effective January 1, 2007, between United
Bancorp, Inc. and Todd C. Clark, filed as Exhibit 10.4 to the
Company's Form 8-K dated January 10, 2007 (file number 0-16640) and
incorporated herein by reference.
10.6 Employment Agreement effective January 1, 2007, between United
Bancorp, Inc. and Thomas C. Gannon, filed as Exhibit 10.5 to the
Company's Form 8-K dated January 10, 2007 (file number 0-16640) and
incorporated herein by reference.
10.7 Employment Agreement effective January 1, 2007, between United
Bancorp, Inc. and Jamice W. Guise, filed as Exhibit 10.6 to the
Company's Form 8-K dated January 10, 2007 (file number 0-16640) and
incorporated herein by reference.
10.8 Employment Agreement effective January 1, 2007, between United
Bancorp, Inc. and John A. Odenweller, filed as Exhibit 10.7 to the
Company's Form 8-K dated January 10, 2007 (file number 0-16640) and
incorporated herein by reference.
11 Statement re Computation of Per Share Earnings - this information is
incorporated by reference in Note 1 on Page A-29 and Note 19 on Page
A-39 hereof.
14 Registrant's Code of Business Conduct and Ethics as adopted December
9, 2003
21 Listing of Subsidiaries, filed herewith.
23 Consent of BKD LLP, Independent Accountants, filed herewith.
24 Power of Attorney contained on the signature pages of the 2007 Annual
Report on Form 10-K.
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
(c) 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 25
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 Background A-2
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-21
Report of Independent Registered Public Accounting Firm A-22
Consolidated Financial Statements
Consolidated Balance Sheets A-23
Consolidated Statements of Income A-24
Consolidated Statements of Cash Flows A-25
Consolidated Statements of Changes in Shareholders' Equity A-26
Notes to Consolidated Financial Statements A-27
NATURE OF BUSINESS
United Bancorp, Inc. (the "Company") is a Michigan Bank Holding Company
headquartered in Tecumseh, Michigan. The Company's subsidiary banks (the
"Banks") have local Boards of Directors and are locally managed. The Banks offer
a full range of financial services through a system of seventeen banking offices
located in Lenawee, Monroe and Washtenaw Counties. While the Company's chief
decision makers monitor the revenue streams of the various Company products and
services, operations are managed and financial performance is evaluated on a
Companywide basis. Accordingly, all of the Company's financial services
operations are considered by management to be aggregated in one reportable
operating segment.
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 the Company and its subsidiary banks, United Bank &
Trust ("UBT") and United Bank & Trust - Washtenaw ("UBTW").
BACKGROUND
The Company is a financial holding company registered with the Board of
Governors of the Federal Reserve System 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, electronic banking and bill payment,
and money transfers. Lending operations provide real estate loans, secured and
unsecured business and personal loans, consumer installment loans, check-credit
loans, home equity loans, accounts receivable and inventory financing, equipment
lease financing and construction financing.
The 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 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 Wealth Management Group offers a variety of fiduciary
services to individuals, corporations and governmental entities, including
services as trustee for personal, pension, and employee benefit trusts. The
department provides trust services, financial planning services, investment
services, custody services, pension paying agent services and acts as the
personal representative for estates. These products help to diversify the
Company's sources of income.
Unemployment for the State of Michigan at the end of December, 2006 was 7.1%,
which places it second-highest among the fifty states. The Lenawee County
unemployment rate of 7.2% is just above the State's level, while the Washtenaw
County unemployment rate of 4.4% is the lowest in the State. The Banks have
experienced some slowing of loan growth relating to current economic conditions.
On the other hand, while the Company's loan quality had experienced some
declines toward the end of 2005, loan quality improved during 2006 as the Banks
maintained a strong focus on loan quality. Management continues to keep an eye
on the quality of the loan portfolios and the softening economy while continuing
efforts to gain market share.
Page A-2
EXECUTIVE SUMMARY
United Bancorp, Inc. net income for 2006 was $648,000 above the level achieved
in 2005, as the Company reached record levels of earnings. This strong earnings
performance was driven primarily by an 11.0% improvement in net interest income
over 2005, in spite of the increasing cost of funding balance sheet growth.
Noninterest income for the year improved by 4.3% over the prior year, while
noninterest expenses increased by 6.8% as a result of continued growth of the
Banks. Earnings per share of $3.38 for 2006 was up from $3.15 per share for the
prior year. Return on average shareholders' equity for 2006 was 12.62%, compared
to 12.75% for 2005, and return on average assets for the year ended December 31,
2006 was 1.23%, compared to 1.21% for 2005.
Gross loans increased by $43.7 million over 2005, representing growth of 7.8%
for the year. Investment balances declined while fed funds sold increased, and
total assets grew by 5.2% in 2006 over 2005. This growth was funded by deposit
growth of 6.3%, or $37.4 million, as well as a net increase in capital of $6.9
million resulting primarily from net income for the year, net of cash dividends
paid.
2006 marked the first full year of the Company's operations with Robert K.
Chapman as Chief Executive Officer, following the retirement of David S. Hickman
at the end of 2005. During the year, the Company continued to strengthen its
management team. Gary D. Haapala joined the Company as head of Wealth
Management, and United added David Kersch as head of its mortgage business. In
the fourth quarter, UBTW opened its fifth banking office in Scio Township, and
expanded its office space at its Ann Arbor main office location.
RESULTS OF OPERATIONS
Earnings Summary and Key Ratios
Consolidated net income improved 7.8% over record levels achieved in 2005,
compared to an increase of 8.8% in 2005 over 2004. Both banks contributed to the
increase in earnings, and much of the earnings growth in 2006 was a result of
continued improvement in the Company's net interest income. This improvement
resulted both from balance sheet growth and improvement in asset yields in
excess of the cost of funding those assets. The Banks were able to maintain and
slightly improve their margin and spread in spite of economic conditions that
caused the yield curve to invert during the year, significantly increasing the
Company's cost of funds.
At the same time, noninterest income increased by 4.3% from the levels achieved
in 2005. Income from the sale and servicing of residential real estate mortgages
in the secondary market was down from 2005 levels and Trust fee income declined
slightly for the year. These reductions of income were more than offset by
increases in other areas, as the diversity of the Company's earnings stream
provided significant protection against declining income in any one area.
Expenses were up 6.8% from 2005, compared to an increase of 11.3% in 2005 over
2004.
Net income for the second half of the year is typically stronger than in the
first six months, and 2006 was no exception. Net interest income was strong
during the third and fourth quarters, while noninterest income remained
relatively flat and expenses declined slightly quarter over quarter. The chart
below shows the trends of the major components of earnings for the four quarters
of 2006.
Page A-3
in thousands of dollars, where appropriate 4th Qtr 3rd Qtr 2nd Qtr 1st Qtr
------- ------- ------- -------
Net interest income before provision $7,424 $7,428 $7,199 $7,203
Provision for loan losses 921 396 440 366
Noninterest income 3,110 3,123 3,051 2,891
Noninterest expense 6,598 6,742 6,791 6,782
Federal income tax provision 818 967 835 801
Net income $2,197 $2,446 $2,184 $2,145
Earnings per share (a) $0.828 $0.922 $0.824 $0.809
Return on average assets (b) 1.18% 1.32% 1.20% 1.21%
Return on average shareholders' equity (b) 11.85% 13.52% 12.48% 12.62%
(a) Basic earnings per share, adjusted for stock dividends paid
(b) Annualized
Return on average assets improved to 1.23% for 2006, up from 1.21% for 2005.
Return on average average shareholders' equity for 2006 was 12.62%, compared to
12.75% for 2005. At the same time, book value per share and cash dividends per
share continue to improve. The following chart shows trends in these and other
ratios. As a result of a change in the timing of declaration of cash dividends,
only three cash dividends were declared in 2006, although four cash dividends
were paid. To facilitate comparison to prior periods, the figure shown in the
table represent the dividends actually paid during the year. All figures are
adjusted to reflect stock dividends.
5 Year
Performance Ratios 2006 2005 2004 Average
- ------------------ ------ ------ ------ --------
Return on average assets 1.23% 1.21% 1.25% 1.24%
Return on average shareholders' equity 12.62% 12.75% 13.30% 13.08%
Average equity to average total assets 9.74% 9.46% 9.40%
Dividend payout ratio 42.5% 42.6% 39.9%
Book value per share $28.41 $25.83 $23.96
Cash dividends per share $1.455 $1.356 $1.237
Book value per share is based on shares outstanding at December 31 of 2,623,716
for 2006, 2,617,886 for 2005 and 2,596,494 for 2004 as adjusted for stock
dividends. Dividends per share does not include contingently issuable shares,
and is based on average adjusted shares outstanding of 2,623,469 for 2006,
2,614,068 for 2005 and 2,593,463 for 2004, as adjusted for stock dividends.
Net Interest Income
United Bancorp, Inc. derives the greatest portion of its income from net
interest income. During 2005 and much of 2006, rising short term interest rates
caused the yield curve to flatten and eventually to invert. In spite of the
challenges that the inverted curve presented, the Company managed to improve its
net interest income in 2006 over 2005, with growth in net interest income of
$2.891 million.
Interest income increased 21.8% in 2006 over 2005, for the same percentage
improvement as in 2005 over 2004. At the same time, interest expense increased
44.9% for 2006, compared to an increase of 45.9% in all of 2005. The net result
was an increase of 11.0% in net interest income for 2006 over 2005.
Tax-equivalent yields on earning assets improved to 7.05% for 2006, up from
6.18% for 2005, with the improvement occurring in both the investment and loan
portfolios. The Company's average cost of funds increased by 84 basis points,
and tax equivalent spread moved from 3.86% in 2005 to 3.88% in 2006. Net
interest margin experienced similar improvement, moving from 4.25% in 2005 to
4.42% in 2006. The next table provides insight into the various components of
net interest income, as well as the results of changes in balance sheet makeup
that have helped to keep the margin strong.
Page A-4
YIELD ANALYSIS OF CONSOLIDATED AVERAGE ASSETS AND LIABILITIES
2006 2005 2004
-------------------------- -------------------------- --------------------------
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 $ 6,968 $ 359 5.15% $ 5,762 $ 193 3.35% $ 3,906 $ 51 1.30%
Taxable securities 60,605 2,392 3.95% 70,375 2,032 2.89% 75,755 2,058 2.72%
Tax exempt securities (b) 35,824 2,069 5.77% 31,937 1,778 5.57% 28,981 1,680 5.80%
Taxable loans 571,705 42,771 7.48% 524,156 35,085 6.69% 469,749 28,426 6.05%
Tax exempt loans (b) 3,003 191 6.35% 3,259 207 6.37% 1,387 92 6.63%
-------- ------- -------- ------- -------- -------
Total interest
earning assets (b) 678,105 $47,781 7.05% 635,489 $39,297 6.18% 579,778 $32,306 5.57%
Cash and due from banks 18,792 19,024 21,052
Premises and equipment, net 13,534 10,913 14,232
Intangible assets 3,469 3,469 3,469
Other assets 23,271 26,795 20,278
Unrealized gain on securities available
for sale (371) (137) 570
Allowance for loan losses (6,822) (6,029) (5,698)
-------- -------- --------
Total Assets $729,978 $689,524 $633,681
======== ======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities
NOW accounts $105,396 $ 1,381 1.31% $122,904 $ 1,478 1.20% $115,140 $ 696 0.60%
Savings deposits 179,474 4,612 2.57% 176,582 2,805 1.59% 175,658 1,671 0.95%
CDs $100,000 and over 93,354 4,187 4.48% 59,047 2,030 3.44% 38,853 1,138 2.93%
Other int. bearing deposits 143,197 5,711 3.99% 124,399 3,971 3.19% 106,496 2,950 2.77%
-------- ------- -------- ------- -------- -------
Total int. bearing deposits 521,421 15,890 3.05% 482,932 10,285 2.13% 436,147 6,455 1.48%
Short term borrowings 1,032 62 5.97% 2,283 74 3.24% 2,447 38 1.55%
Other borrowings 40,064 1,850 4.62% 42,729 1,927 4.51% 42,343 1,930 4.56%
-------- ------- -------- ------- -------- -------
Total int. bearing liab. 562,517 17,802 3.16% 527,944 12,286 2.33% 480,937 8,423 1.75%
------- ------- -------
Nonint. bearing deposits 86,919 86,779 86,156
Other liabilities 9,445 9,539 6,398
Shareholders' equity 71,097 65,262 60,190
-------- -------- --------
Total Liabilities and Shareholders' Equity $729,978 $689,524 $633,681
======== ======== ========
Net interest income (b) 29,979 27,011 23,883
Tax-equivalent adjustment 725 648 586
------- ------- -------
Net interest income, GAAP basis $29,254 $26,363 $23,297
======= ======= =======
Net spread 3.88% 3.86% 3.82%
Net yield on interest earning assets (b) 4.42% 4.25% 4.12%
Ratio of interest earning assets to
interest bearing liabilities 1.21 1.20 1.21
(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 demonstrate the effect of volume and rate changes on net
interest income on a taxable equivalent basis for the past two years. The data
reflects the fact that the increase in the Company's net interest income during
2006 was a result of balance sheet growth, combined with changes in yields and
rate. For the year, the net increase in net interest income as a result of
changes in volume was slightly larger than the increase resulting from changes
in rate. This contrasts to the change from 2004 to 2005, when the largest
portion of the improvement resulted from growth.
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.
2006 compared to 2005 2005 compared to 2004
Increase (decrease) due to: Increase (decrease) due to:
--------------------------- ---------------------------
In thousands of dollars Volume Rate Net Volume Rate Net
------ ------ ------ ------ ------ ------
Interest earned on:
Federal funds sold $ 46 $ 120 $ 166 $ 33 $ 109 $ 142
Taxable securities (311) 671 360 (151) 126 (25)
Tax exempt securities 223 67 290 166 (68) 98
Taxable loans 3,346 4,340 7,686 3,475 3,184 6,659
Tax exempt loans (16) (1) (17) 119 (3) 116
------ ------ ------ ------ ------ ------
Total interest income $3,288 $5,197 $8,485 $3,642 $3,348 $6,990
Interest expense on:
NOW accounts $ (222) $ 125 $ (97) $ 50 $ 733 $ 783
Savings deposits 47 1,759 1,806 9 1,125 1,134
Interest bearing CDs of
100,000 or greater 1,415 742 2,157 668 224 892
Other int. bearing deposits 657 1,083 1,740 536 485 1,021
Short term borrowings (54) 42 (12) (3) 39 36
Other borrowings (122) 45 (77) 18 (21) (3)
------ ------ ------ ------ ------ ------
Total interest expense $1,721 $3,796 $5,517 $1,278 $2,585 $3,863
------ ------ ------ ------ ------ ------
Net change in net interest income $1,567 $1,401 $2,968 $2,364 $ 763 $3,127
Provision for Loan Losses
The Company's gross charge-offs within its loan portfolio declined in 2006,
following a similar decline in 2005 from 2004. At the same time, recoveries were
down from 2005 levels, and net charge-offs of $635,000 for 2006 were below 2005
net charge-offs of $737,000. The provision for 2006 increased from the prior two
years, exceeding the 2005 figure by 59.4%. 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 consistently has low to moderate levels of nonperforming loans, and
loan loss history continues to compare favorably to peers. The use of
third-party independent loan review 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 improved 4.3% in 2006 over 2005, compared to an
increase of 6.0% in 2005 over 2004. The following table summarizes changes in
noninterest income by category for 2006 and 2005, in thousands of dollars where
appropriate.
Change in Categories of Noninterest Income
2006 2005 Change 2004 Change
------- ------- ------- ------- ------
Service charges on deposit accounts $ 3,364 $ 3,017 11.5% $ 2,774 8.8%
Wealth Management fee income 3,769 3,874 -2.7% 3,754 3.2%
Gains (losses) on securities transactions 12 (1) -1300.0% (29) -96.6%
Income from loan sales and servicing 906 1,215 -25.4% 1,222 -0.6%
ATM, debit and credit card fee income 1,905 1,677 13.6% 1,469 14.2%
Sale of nondeposit investment products 993 798 24.4% 721 10.7%
Bank owned life insurance 408 398 2.5% 443 -10.2%
Other income 818 691 18.4% 656 5.3%
------- ------- ------- ------- -----
Total Noninterest Income $12,175 $11,669 4.3% $11,010 6.0%
======= ======= ======= ======= =====
Service charges on deposit accounts were up 11.5% in 2006 over 2005, compared to
an increase of 8.8% in 2005 and 5.8% in 2004. This compares to a growth in
total deposits of 6.3% during 2006, with short-term deposit products making up a
smaller portion of total deposits. Those categories of deposits generate fee
income, while certificates of deposit do not. 2006 marked the second full year
of the Banks' utilization of a High Performance Checking promotion as a method
of gathering deposits, and deposit service charges were restructured as a result
of this new program. No significant changes to service charge structure was
implemented in 2006.
The Wealth Management Group of UBT continues to provide a steady contribution to
the Company's income statement. However, Trust fee income declined 2.7% in 2006
compared to 2005. This compares to a 3.2% increase in 2005 over 2004. In 2006,
the department exited the 401k recordkeeping business, resulting in a reduction
of $235,000 in fee income and $25 million of assets under management. Assets
managed by the department at December 31, 2006 were $564.4 million, down from
$605.9 million at the end of 2005 and $616.9 million at the end of 2004.
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. Income from loan sales and servicing was down
25.4% in 2006 compared to 2005, following a decline of 0.6% in 2005. During
2006, the volume of loans sold on the secondary market declined substantially
from 2005 levels. This decline was a result of a number of factors, including
the fact that mortgage originations overall for the Company were down from 2005
levels.
During 2005, clients exhibited a preference for fixed rate loans as market rates
declined, resulting in a portion of those loans originated by the Banks being
sold in the secondary market. In addition, some of the mortgages previously held
on the balance sheets of the Banks were refinanced and sold in the secondary
market, providing additional servicing income. In 2006, the Banks experienced
the opposite effect, as fewer loans were sold on the secondary market and more
loans were added to the portfolios.
Page A-7
Late in 2006, the Company initiated significant restructuring of its mortgage
business, including the hiring of a seasoned mortgage professional as head of
the Company's mortgage department. Management anticipates that mortgage volume
should increase substantially in 2007 as a result of this change in leadership
and focus. As the Company is conservative in its approach to valuation of
mortgage servicing rights, no write-downs in mortgage servicing rights were
required in 2006, 2005 or 2004 as a result of impairment or other reasons.
ATM, debit and credit card fee income continues to provide a steady source of
noninterest income for the Company. The Banks operate nineteen 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 13.6% in
2006 over 2005, compared to an increase of 14.2% in 2005 over 2004.
Income from the sale of nondeposit investment products is derived from the sale
of investments and insurance products to clients, including credit and title
insurance policies, annuities, mutual funds and other investment vehicles. Sales
volume was particularly strong in 2006, and this category of income increased
24.4% in 2006 over 2005, compared to an increase of 10.7% in 2005 over 2004.
Income from bank-owned life insurance increased modestly in 2006, following a
decline in 2005. The improvement reflects increases in interest crediting rates
during the year, as the Banks made no change in the amount of their BOLI
holdings. Other noninterest income during the year consisted of income from
various fee-based banking services, such as sale of official checks, wire
transfer fees, safe deposit box income, sweep account and other fees. This
category of noninterest income improved 18.4% from 2005 to 2006, following an
increase of 5.3% from 2004 to 2005, with no one area contributing significantly
more than others to the improvement. Overall, total noninterest income increased
$506,000 from 2005 to 2006, following an increase of $659,000 from 2004 to 2005.
This continued improvement reflects the diversity of the Company's noninterest
income sources. Management anticipates continued improvement in the future as
the sources of noninterest income remain fluid.
Noninterest Expense
The following table summarizes changes in the Company's noninterest expense by
category for 2006 and 2005, in thousands of dollars where applicable.
Change in Categories of Noninterest Expense
2006 2005 Change 2004 Change
------- ------- ------ ------- ------
Salaries and employee benefits $15,037 $14,662 2.6% $13,502 8.6%
Occupancy and equipment expense 4,344 4,074 6.6% 4,019 1.4%
External data processing 1,537 1,283 19.8% 1,125 14.0%
Advertising and marketing 1,063 1,106 -3.9% 382 189.5%
Professional fees 891 251 255.0% 286 -12.2%
Director fees 447 384 16.4% 367 4.6%
Other expense 3,595 3,435 4.7% 2,965 15.9%
------- ------- ----- ------- -----
Total Noninterest Expense $26,914 $25,195 6.8% $22,646 11.3%
======= ======= ===== ======= =====
Total noninterest expenses were up 6.8% in 2006, compared to an increase of
11.3% in 2005 over 2004. The largest percentage increases for the year were in
occupancy and equipment expense, external data processing and Director fees. The
increase in external data processing resulted from a change in processing within
the Wealth Management group during the year, as back office processing functions
of the department were outsourced. This change in processing also resulted in
additional costs relating to the conversion. Occupancy and equipment expenses
reflect continued growth of the Banks, including
Page A-8
the addition of one new banking office and office space expansion in Ann Arbor
during the year. The increase in Director fees reflects a change in rates paid
in 2006 compared to 2005, as well as an increase in the number of meetings for
which Directors were paid.
Salaries and benefits are the organization's largest single area of expense.
During 2006, this category of expense increased 2.6% from 2005 levels, compared
to an increase of 8.6% in 2005. Benefits costs continue to be a large
contributor to personnel expense, while the amounts paid to co-workers for
profit sharing bonuses and 401(k) profit sharing contributions increased in 2006
as the Company exceeded its earnings targets and other objectives.
Occupancy and equipment expense increased 6.6% in 2006, compared to an increase
of 1.4% in 2005. This increase reflects the partial-year impact of three
expansion initiatives. In mid-2005, the Wealth Management Group moved into new
office space, and the full-year effect of those costs were experienced in 2006.
UBTW opened its fifth banking office in the fourth quarter of 2006 and expanded
the amount of occupied office space at its Ann Arbor main office, and a portion
of those expenses were in the 2006 income statement. There were no other
significant additions to the Company's technology or banking office
infrastructure in 2006.
Advertising and marketing expenses declined modestly in 2006, following a
increase of 189.5% in 2005. The increase in 2005 included costs of the High
Performance Checking program, along with the cost of increased marketing and
advertising presence in the communities served by the Banks, and those efforts
continued in 2006. Other expenses were up 4.7% over 2005, with no one category
contributing disproportionately to the increase in expenses.
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 2006 2005 2004
------- ------- -------
Income before tax $12,392 $11,505 $10,613
Federal income tax $ 3,420 $ 3,181 $ 2,960
Effective federal tax rate 27.6% 27.6% 27.9%
The Company's effective federal tax rate remained unchanged from 2006, following
a decline from 2004 to 2005. Income from bank owned life insurance and tax
credits from participation in low-income housing partnerships help to 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 tax-exempt 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 of
$7.6 million in the Company's securities portfolio during 2006. 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 all categories of securities declined in 2006, with the largest
decrease in U.S. agency investments.
Page A-9
Changes in the various categories of the Company's investment portfolio are
shown in the chart below.
Change in Categories of Securities Portfolio,
in thousands of dollars 2006 2005
------- -------
U.S. Treasury and agency securities $(5,312) $ 1,130
Mortgage backed agency securities (920) (7,665)
Obligations of states and political subdivisions (1,241) 6,118
Corporate, asset backed and other securities (148) 63
------- -------
Change in total securities $(7,621) $ (354)
======= =======
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, 2006 2005
----- -----
U.S. Treasury and agency securities 40.1% 42.2%
Mortgage backed agency securities 14.6% 14.4%
Obligations of states and political subdivisions 42.1% 40.2%
Corporate, asset backed and other securities 3.3% 3.2%
----- -----
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 26% 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 alternative minimum tax in the near future. The Banks'
investment in local municipal issues also reflects their commitment to the
development of the local area through support of its local political
subdivisions.
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. The chart below
summarizes unrealized gains and losses in each category of the portfolio at the
end of 2006 and 2005, in thousands of dollars.
Unrealized Gains and Losses in the
Investment Portfolio 2006 2005 Change
---- ----- ------
U.S. Treasury and agency securities $(54) $(403) $349
Mortgage backed agency securities (62) (176) 114
Obligations of states and political subdivisions 143 81 62
Corporate, asset backed and other securities 75 89 (14)
---- ----- ----
Total investment securities $102 $(409) $511
==== ===== ====
Loans
As full service lenders, the Banks offer a variety of loan products in their
markets. Loan growth was 7.8% in 2006, with much of that increase in personal
loans and residential mortgages. Business loan volume slowed during the year, in
part as a result of anticipated payoffs within the portfolio and a decline in
nonperforming loans. At the same time, expanded offerings of ARM products by the
Banks in 2006 have resulted in higher volume of ARM products for the year, which
are generally retained in the loan portfolios of the Banks
Page A-10
The chart below shows the percentage change in each category of the loan
portfolio for 2006 and 2005.
Percentage Change in Categories of Loan
Portfolio 2006 2005
---- -----
Personal 11.6% 10.0%
Business 2.4% 14.8%
Tax exempt -9.3% -5.8%
Residential mortgage 27.3% -11.8%
Construction 9.7% 33.6%
Total loans 7.8% 12.3%
==== =====
Personal loan balances grew 11.6% in 2006, following an increase of 10.0% in
2005 over 2004. Activity in 2006 was in all categories of personal loans, but
the largest growth was in home equity loans and personal 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, amounts outstanding in personal lines of credit and home
equity loans are included in this loan category.
The Banks generally sell their production of fixed-rate mortgages on the
secondary market, and retain shorter-term adjustable rate mortgages in their
portfolios. As a result, the mix of mortgage production for any given year will
have an impact on the amount of mortgages held in the portfolios of the Banks.
In 2005, a significant portion of mortgage production included refinancing of
existing portfolio loans into products that were sold on the secondary market.
In 2006, as a result of expanded ARM product offerings, a much larger portion of
the Company's mortgage production was in shorter term adjustable rate mortgages,
and much of this volume was retained on the balance sheets of the Banks. As a
result, Total dollars in the mortgage portfolio increased 27.3% in 2006 over
2005, following a decline of 11.8% in 2005.
Construction loan balances increased by 9.7% in 2006, following an increase of
33.6% in 2005. The rate of increase in construction loan volume declined
primarily as a result of a slowing 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.
Business loan growth slowed in 2006, following the strong growth experienced in
2005. Total loans outstanding to businesses increased 2.4% in 2006, compared to
growth of 14.8% in 2005. The slowing of loan growth in this category was
primarily the result of anticipated and unanticipated loan payoffs within the
portfolio. These payoffs reflect our efforts to maintain loan quality within the
portfolio, as well as increased competition within the Banks' markets.
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. In addition, the Banks purchase and sell participations in
business loans, in order to diversify their geographic risk. 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. Tax-exempt loan balances declined slightly in
2006 and 2005, following a large increase in 2004.
Page A-11
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 non- performing 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.
The chart below shows the amount of nonperforming assets by category at December
31 for each of the past five years.
Nonperforming Assets, in thousands of dollars 2006 2005 2004 2003 2002
------ ------ ------ ------ ------
Nonaccrual loans $5,427 $5,609 $3,709 $3,635 $1,583
Accruing loans past due 90 days or more 855 1,153 1,674 761 748
Troubled debt restructurings -- -- -- -- --
------ ------ ------ ------ ------
Total nonperforming loans 6,282 6,762 5,383 4,396 2,331
Other real estate 1,063 871 844 593 467
------ ------ ------ ------ ------
Total nonperforming assets $7,345 $7,633 $6,227 $4,989 $2,798
====== ====== ====== ====== ======
Percent of nonperforming loans to total loans 1.04% 1.21% 1.08% 0.98% 0.54%
====== ====== ====== ====== ======
Percent of nonperforming assets to total assets 0.98% 1.07% 0.96% 0.82% 0.49%
====== ====== ====== ====== ======
The Company experienced modest improvement in its total nonperforming assets
from year-end 2005 to 2006. Nonaccrual loans were down slightly, while
delinquent loans were at their lowest level since 2003. 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. Collection efforts
continue with all delinquent clients, to bring them back to performing status.
Holdings of other real estate was up from the end of 2005, and total
nonperforming loans as a percent of total loans moved from 1.21% at the end of
2005 to 1.04% at the end of 2006.
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 2005 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, 2006 2005
----- -----
Personal 15.1% 14.6%
Business 54.5% 57.4%
Tax exempt 0.5% 0.6%
Residential mortgage 14.2% 12.0%
Construction 15.7% 15.4%
----- -----
Total loans 100.0% 100.0%
===== =====
Loans to finance residential mortgages, including construction loans, make up
29.9% of the portfolio at year-end, compared to 27.4% at the end of 2005. This
increase is primarily reflected in increases in portfolio mortgages during the
year. 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, boats 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 63.6% 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 $37.4 million in 2006, or 6.3% for the year, compared
to deposit growth of 11.5% in 2005. While non-CD interest bearing deposit
products continue to be popular with clients, much of the deposit growth during
2006 was in certificates of deposit. 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.
While the Banks maintain a small amount of purchased or brokered deposits, they
do not support their growth through the use of those products. The Banks'
deposit rates are consistently competitive with other banks in its market area.
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 2006 and 2005.
Percentage Change in Deposits by Category 2006 2005
---- ----
Noninterest bearing deposits -8.0% 3.3%
Interest bearing deposits 8.8% 13.0%
Total deposits 6.3% 11.5%
==== ====
The chart below shows the percentage makeup of the deposit portfolio in 2006 and
2005.
Percentage Breakdown of Deposit Portfolio
as of December 31, 2006 2005
----- -----
Noninterest bearing deposits 13.0% 15.0%
Interest bearing deposits 87.0% 85.0%
----- -----
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. The Banks are
also 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
of Indianapolis ("FHLBI") and borrowings at the discount window of the Federal
Reserve Bank as additional short-term funding sources. Federal funds were used
during 2006 and 2005, and short term advances and discount window borrowings
were not utilized during either year.
Page A-13
The Company periodically finds it advantageous to utilize longer term borrowings
from the FHLBI. These long-term borrowings, as detailed in Note 11 of the Notes
to 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 2006, the Company's cash and cash equivalents increased as a result of
normal activities within the balance sheet and income statement. Throughout
2006, 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 net excess funds during 2006
were marginally higher than in 2005. The Company averaged net federal funds sold
of $5.9 million during 2006, compared to $3.5 million during 2005. These changes
were primarily a result of timing differences between loan, investment and
deposit growth.
Deposits grew $37.4 million in 2006, and FHLB advances declined by $1.3 million
as a result of maturities in excess of new borrowings. Net portfolio loans
increased by $42.2 million, and total investments declined by $7.6 million. All
of these changes contributed to the Company's increase 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
Page A-14
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 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,
2006, the Company would expect a maximum potential reduction in net interest
margin of less than 5% if market rates increased or decreased under an immediate
and sustained parallel shift of 200 basis points.
During 2006 and 2005, the Company decreased its usage of long term fixed rate
FHLB advances. In addition, the Company moved to a liability-sensitive position
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, 2006 and 2005.
FINANCIAL INSTRUMENTS AT DECEMBER 31, 2006
Principal Amount Maturing In:
------------------------------------------------ Fair
2007 2008 2009 2010 2011 Thereafter Total Value
-------- ------- ------- ------- ------- ---------- -------- --------
RATE-SENSITIVE ASSETS:
Fixed Rate:
Loans $ 63,826 $39,631 $35,830 $37,106 $36,879 $94,078 $307,350 $304,931
Average Rate 7.3% 7.2% 7.1% 7.0% 7.6% 6.2% 6.9%
Investments $ 33,725 $22,268 $ 5,016 $ 4,369 $ 3,806 $15,690 $ 84,874 $ 85,360
Average Rate 4.4% 4.8% 4.7% 5.1% 4.0% 4.1% 4.5%
Variable Rate:
Loans $112,291 $36,044 $26,096 $17,717 $15,729 $86,536 $294,413 $293,963
Average Rate 8.5% 7.8% 6.8% 5.8% 6.0% 8.6% 8.0%
Investments $ 1,945 $ 1,184 $ 988 $ 819 $ 359 $ 2,498 $ 7,793 $ 7,781
Average Rate 3.6% 4.0% 3.6% 3.6% 4.4% 4.0% 3.9%
Other interest
earning assets $ 6,812 $ 6,812 $ 6,812
Average interest rate 4.5% 4.5%
RATE-SENSITIVE LIABILITIES:
Noninterest bearing demand $81,373 $ 81,373 $ 81,373
Savings & interest
bearing demand $317,340 $317,340 $317,340
Average interest rate 2.4% 2.4%
Time deposits $160,766 $46,583 $19,501 $ 1,115 $ 1,269 $ 55 $229,289 $230,232
Average interest rate 4.6% 4.6% 4.4% 3.2% 5.0% 5.0% 4.6%
Fixed rate borrowings $21,339 $10,429 $ 6,000 $ 1,000 $ -- $ 2,177 $ 40,945 $ 40,656
Average interest rate 5.0% 4.1% 4.4% 4.0% 0.0% 5.3% 4.7%
Other interest bearing
liabilities $ 77 $ 77 $ 77
Average interest rate 0.5% 0.5%
Page A-15
FINANCIAL INSTRUMENTS AT DECEMBER 31, 2005
Principal Amount Maturing In:
------------------------------------------------ Fair
2006 2007 2008 2009 2010 Thereafter Total Value
-------- ------- ------- ------- ------- ---------- -------- --------
RATE-SENSITIVE ASSETS:
Fixed Rate:
Loans $ 40,937 $39,672 $37,069 $25,458 $35,175 $62,224 $240,535 $235,229
Average Rate 6.8% 7.1% 6.8% 6.8% 6.8% 5.8% 6.6%
Investments $ 57,273 $ 7,868 $ 4,205 $ 2,049 $ 3,465 $15,209 $ 90,069 $ 89,767
Average Rate 3.4% 3.3% 4.1% 3.6% 5.0% 4.0% 3.6%
Variable Rate:
Loans $134,500 $33,308 $24,722 $23,781 $18,228 $85,039 $319,578 $319,008
Average Rate 7.7% 7.1% 6.6% 6.0% 5.5% 7.7% 7.3%
Investments $ 5,434 $ 3,682 $ 773 $ 169 $ 129 $ 406 $ 10,593 $ 10,491
Average Rate 3.1% 3.3% 3.6% 3.9% 3.7% 4.2% 3.3%
Other interest
earning assets $ 3,176 $ 3,176 $ 3,176
Average interest rate 3.8% 3.8%
RATE-SENSITIVE LIABILITIES:
Noninterest bearing demand $88,396 $ 88,396 $ 88,396
Savings & interest bearing
demand $317,085 $317,085 $317,085
Average interest rate 1.7% 1.7%
Time deposits $119,896 $40,891 $14,899 $ 8,644 $ 803 $ 30 $185,163 $186,046
Average interest rate 3.6% 3.8% 3.9% 4.1% 3.0% 0.0% 3.7%
Fixed rate borrowings $ 8,021 $20,349 $ 8,940 $ 3,012 $ 1,013 $ 893 $ 42,228 $ 41,848
Average interest rate 4.2% 5.0% 3.9% 3.5% 4.0% 5.2% 4.5%
Other interest bearing
liabilities $ 6,376 $ 6,376 $ 6,376
Average interest rate 4.3% 4.3%
The Company's primary market risk exposure decreased from 2005 to 2006, based on
data supplied by its measurement systems. This market risk exposure is if rates
decline. 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, 2006. 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.
Page 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 $ 20,468 $ 23,183 $ 36,442 $14,173 $ 1,545 $ 95,811
Loans 214,688 72,557 253,618 45,594 15,306 601,763
-------- --------- -------- ------- -------- --------
Total earning assets $235,156 $95,740 $290,060 $59,767 $ 16,851 $697,574
Interest bearing deposits $322,584 $ 155,522 $ 68,468 $ 55 $ -- $546,629
Other borrowings 5,577 15,839 17,429 347 1,830 41,022
-------- --------- -------- ------- -------- --------
Total interest bearing
liabilities $328,161 $ 171,361 $ 85,897 $ 402 $ 1,830 $587,651
-------- --------- -------- ------- -------- --------
Net asset (liability)
interest sensitivity
exposure $(93,005) $ (75,621) $204,163 $59,365 $ 15,021 $109,923
Cumulative net asset
(liability) exposure $(93,005) $(168,626) $ 35,537 $94,902 $109,923
Cumulative ratio of asset
to liability exposure 0.72 0.66 1.06 1.16 1.19 to one
Cumulative exposure as a
percent of total assets -12.4% -22.5% 4.7% 12.6% 14.6%
CAPITAL RESOURCES
The common stock of the Company is traded on the Over The Counter Bulletin Board
("OTCBB") as UBMI. It is the policy of the Company to pay 30% to 45% of net
earnings as cash dividends to shareholders. The payout ratio for 2006 was 42.5%,
compared to 42.6% for 2005. Cash dividends per share have continued to
increased, providing steady return to shareholders. Book value of the Company's
stock increased from $25.83 at the end of 2005 to $28.41 at December 31, 2006.
Five percent stock dividends were paid to shareholders in 2006 and 2005.
The ratios of average equity to average assets of the Banks and the Company
increased in 2006 over 2005, 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 the Banks are considered to be
well-capitalized by the regulators.
The Company maintains short-term strategic plan and 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.
CONTRACTUAL OBLIGATIONS
The following table details the Company's known contractual obligations at
December 31, 2006, in thousands of dollars:
Payments due by period
--------------------------------------------------------
Less than More than
Contractual Obligations 1 year 1-3 years 3-5 years 5 years Total
--------- --------- --------- --------- --------
Long term debt (FHLB advances) $21,339 $16,429 $1,000 $2,177 $40,945
Operating lease arrangements 839 1,646 1,537 3,646 7,668
Purchase agreements -- -- -- -- --
------- ------- ------ ------ -------
Total $22,178 $18,075 $2,537 $5,823 $48,613
Page A-17
PROSPECTIVE ACCOUNTING AND REGULATORY CHANGES
In May 2005, the Financial Accounting Standards Board ("FASB") issued Statement
No. 154, "Accounting Changes and Error Corrections" ("SFAS No. 154"), a
replacement of APB Opinion No. 20, "Accounting Changes," and FASB Statement No.
3, "Reporting Accounting Changes in Interim Financial Statements." SFAS No. 154
requires retrospective application for voluntary changes in accounting
principles unless it is impracticable to do so. SFAS No. 154 was effective for
the Company beginning October 1, 2006. We have evaluated the requirements of
SFAS No. 154 and determined that it will not have a material effect on our
financial condition or results of operations.
In February 2006, FASB issued Statement No. 155. "Accounting for Certain Hybrid
Financial Instruments" ("SFAS No. 155"), which amends FASB Statement No. 133 and
140. This statement permits fair value remeasurement for any hybrid financial
instrument containing an embedded derivative that would otherwise require
bifurcation, and broadens a Qualified Special Purpose Entity's ("QSPE")
permitted holdings to include passive derivative financial instruments that
pertain to other derivative instruments. This statement is effective for the
Company for all financial instruments acquired, issued or subject to a
remeasurement event occurring on or after October 1, 2006. We have evaluated the
requirements of SFAS No. 155 and determined that it will not have a material
effect on our financial condition or results of operations.
In March 2006, FASB issued Statement of Financial Accounting Standards No. 156
("SFAS No. 156"), Accounting for Servicing of Financial Assets, an amendment of
FASB Statement No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishment of Liabilities, which requires that all separately
recognized servicing assets and servicing liabilities be initially measured at
fair value, if practicable and permits the entities to elect either the fair
value measurement with changes to fair value reflected in earnings or the
amortization and impairment requirements of Statement 140 for subsequent
measurement. The subsequent measurement of separately recognized servicing
assets and servicing liabilities at fair value eliminates the necessity for
entities that manage the risks inherent in servicing assets and servicing
liabilities with derivatives to qualify for hedge accounting treatment and
eliminates the characterization of declines in fair value as impairments or
direct write-downs. Statement No. 156 was effective for the Company beginning
October 1, 2006. We have evaluated the requirements of SFAS No. 156 and
determined that it will not have a material effect on our financial condition or
results of operations.
In June 2006, FASB issued Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes," an interpretation of SFAS No. 109, "Accounting for Income Taxes"
("Interpretation No. 48"). Interpretation No. 48 clarifies the accounting for
uncertainty in income taxes in financial statements and prescribes a recognition
threshold and measurement attribute for financial statement recognition and
measurement of a tax position taken or expected to be taken. It also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. Interpretation No. 48 was effective
for the Company beginning October 1, 2006. We have evaluated the requirements of
Interpretation No. 48 and determined that it will not have a material effect on
our financial condition or results of operations.
In September 2006, FASB issued SFAS No. 157, "Fair Value Measurements." SFAS No.
157 defines fair value, establishes a framework for measuring fair value in
generally accepted accounting standards, and expands disclosures about fair
value measurements. SFAS No. 157 is effective for financial statements issued
for fiscal years beginning after November 15 2007, and interim periods within
those fiscal years. We do not expect that the adoption of SFAS No. 157 will have
a material impact on our financial condition or results of operations.
Page A-18
Also in September 2006, the FASB Emerging Issues Task Force finalized Issue No.
06-5, Accounting for Purchases of Life Insurance - Determining the Amount That
Could Be Realized in Accordance with FASB Technical Bulletine No. 85-4
(Accounting for Purchases of Life Insurance). The issue requires that a
policyholder consider contractual terms of a life insurance policy in
determining the amount that could be realized under the insurance contract. It
also requires that if the contract provides for a greater surrender value if all
individual policies in a group are surrendered at the same time, that the
surrender value be determined based on the assumption that the policies will be
surrendered on an individual basis. Lastly, the issue discusses whether the cash
surrender value should be discounted when the policyholder is contractually
limited in its ability to surrender a policy. This issue is effective for fiscal
years beginning after December 15, 2006. The Company has not completed its
evaluation of the impact of adoption of this issue.
In September 2006, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 108, "Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements," which addresses how the effects of prior year uncorrected
misstatements should be considered when quantifying misstatements in current
year financial statements. SAB No. 108 will require registrants to quantify
misstatements using both the balance sheet and income-statement approaches and
to evaluate whether either approach results in the quantifying an error that is
material in light of relevant quantitative and qualitative factors. When the
effect of the initial adoption is determined to be material, SAB No. 108 allows
registrants to record that effect as a cumulative effect adjustment to beginning
retained earnings. The requirements were effective for the Company beginning
October 1, 2006. We have evaluated the requirements of SAB No. 108 and
determined that it will not have a material effect on our financial condition or
results of operations.
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.
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, 2006. 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
Page A-19
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 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
Page A-20
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 those discussed under "Risk Factors" in
Part I, Item 1A of the Company's Annual Report on Form 10-K for the year ended
December 31, 2006 and generally 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.
Page A-21
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
United Bancorp, Inc. and Subsidiaries
(BKD LLP 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, 2006 and 2005 and the related consolidated statements of
income, shareholders' equity and cash flows for each of the three years in the
period ended December 31, 2006. 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, 2006 and 2005 and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 2006 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, 2006 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 March 16, 2007 expressed unqualified opinions on management's
assessment and on the effectiveness of the Company's internal control over
financial reporting.
(BKD, LLP)
BKD, LLP
Indianapolis, Indiana
March 16, 2007
Page A-22
CONSOLIDATED BALANCE SHEETS
United Bancorp, Inc. and Subsidiaries
December 31,
-------------------
In thousands of dollars 2006 2005
-------- --------
ASSETS
Cash and demand balances in other banks $ 17,606 $ 20,416
Federal funds sold 3,770 --
-------- --------
Total cash and cash equivalents 21,376 20,416
Securities available for sale 95,811 103,432
Loans held for sale 5,772 1,060
Portfolio loans 595,991 557,052
-------- --------
Total loans 601,763 558,112
Less allowance for loan losses 7,849 6,361
-------- --------
Net loans 593,914 551,751
Premises and equipment, net 13,215 12,998
Goodwill 3,469 3,469
Bank-owned life insurance 11,499 11,091
Accrued interest receivable and other assets 11,705 10,622
-------- --------
TOTAL ASSETS $750,989 $713,779
======== ========
LIABILITIES
Deposits
Noninterest bearing deposits $ 81,373 $ 88,404
Interest bearing deposits 546,629 502,248
-------- --------
Total deposits 628,002 590,652
Short term borrowings 77 6,376
Other borrowings 40,945 42,228
Accrued interest payable and other liabilities 7,429 6,901
-------- --------
TOTAL LIABILITIES 676,453 646,157
-------- --------
COMMITMENTS AND CONTINGENT LIABILITIES
SHAREHOLDERS' EQUITY
Common stock and paid in capital, no par value;
5,000,000 shares authorized, 2,623,716 shares
issued and outstanding in 2006 and 2,493,238
in 2005 71,075 63,186
Retained earnings 3,393 4,705
Accumulated other comprehensive income (loss), net of tax 68 (269)
-------- --------
TOTAL SHAREHOLDERS' EQUITY 74,536 67,622
-------- --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $750,989 $713,779
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
Page A-23
CONSOLIDATED STATEMENTS OF INCOME
United Bancorp, Inc. and Subsidiaries
For the years
ended December 31,
---------------------------
In thousands of dollars, except per share data 2006 2005 2004
------- ------- -------
INTEREST INCOME
Loans $42,900 $35,225 $28,488
Securities
Taxable 2,392 2,032 2,057
Tax exempt 1,405 1,199 1,124
Federal funds sold 359 193 51
------- ------- -------
Total interest income 47,056 38,649 31,720
------- ------- -------
INTEREST EXPENSE
Deposits 15,890 10,285 6,455
Short term borrowings 62 74 38
Other borrowings 1,850 1,927 1,930
------- ------- -------
Total interest expense 17,802 12,286 8,423
------- ------- -------
NET INTEREST INCOME 29,254 26,363 23,297
Provision for loan losses 2,123 1,332 1,048
------- ------- -------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 27,131 25,031 22,249
------- ------- -------
NONINTEREST INCOME
Service charges on deposit accounts 3,364 3,017 2,774
Wealth Management fee income 3,769 3,874 3,754
Gains (losses) on securities transactions 12 (1) (29)
Income from loan sales and servicing 906 1,215 1,222
ATM, debit and credit card fee income 1,905 1,677 1,469
Sale of nondeposit investment products 993 798 721
Income from bank-owned life insurance 408 398 443
Other income 818 691 656
------- ------- -------
Total noninterest income 12,175 11,669 11,010
------- ------- -------
NONINTEREST EXPENSE
Salaries and employee benefits 15,037 14,662 13,502
Occupancy and equipment expense 4,344 4,074 4,019
External data processing 1,537 1,283 1,125
Advertising and marketing 1,063 1,106 382
Professional fees 891 251 286
Director fees 447 384 367
Other expense 3,595 3,435 2,965
------- ------- -------
Total noninterest expense 26,914 25,195 22,646
------- ------- -------
INCOME BEFORE FEDERAL INCOME TAX 12,392 11,505 10,613
Federal income tax 3,420 3,181 2,960
------- ------- -------
NET INCOME $ 8,972 $ 8,324 $ 7,653
======= ======= =======
Basic earnings per share $ 3.38 $ 3.15 $ 2.92
Diluted earnings per share 3.38 3.13 2.90
======= ======= =======
The accompanying notes are an integral part of these consolidated financial
statements.
Page A-24
CONSOLIDATED STATEMENTS OF CASH FLOWS
United Bancorp, Inc. and Subsidiaries
For the years ended December 31,
--------------------------------
In thousands of dollars 2006 2005 2004
-------- -------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 8,972 $ 8,324 $ 7,653
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FROM
OPERATING ACTIVITIES
Depreciation and amortization 1,520 1,892 2,419
Provision for loan losses 2,123 1,332 1,048
(Gain) Loss on sale of loans (563) (940) (957)
Proceeds from sales of loans originated for sale 39,627 57,961 66,928
Loans originated for sale (43,776) (56,979) (66,983)
(Gain) Loss on securities transactions (12) 1 29
Deferred income taxes (503) 313 43
Increase in cash surrender value on bank owned life insurance (408) (398) (443)
Change in investment in limited partnership 107 234 86
Excess tax benefits from exercised stock options (28) (265) (188)
Change in accrued interest receivable and other assets (543) (898) 1,735
Change in accrued interest payable and other liabilities 1,650 204 329
-------- -------- --------
Total adjustments (806) 2,457 4,046
-------- -------- --------
Net cash from operating activities 8,166 10,781 11,699
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Securities available for sale
Purchases (40,177) (30,664) (50,113)
Sales 164 -- 4,626
Maturities and calls 42,711 20,688 41,737
Principal payments 5,439 9,423 7,255
Net increase in portfolio loans (40,353) (62,484) (51,328)
Net investment in bank owned life insurance -- -- --
Net premises and equipment expenditures (1,468) (1,126) (455)
-------- -------- --------
Net cash from investing activities (33,684) (64,163) (48,278)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in deposits 37,350 60,774 27,295
Net change in short term borrowings (6,299) (2,350) 650
Principal payments on other borrowings (8,033) (1,569) (528)
Proceeds from other borrowings 6,750 950 8,000
Proceeds from common stock transactions 499 987 880
Excess tax benefits from exercised stock options 28 265 188
Dividends paid (3,817) (3,447) (3,143)
-------- -------- --------
Net cash from financing activities 26,478 55,610 33,342
-------- -------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS 960 2,228 (3,237)
Cash and cash equivalents at beginning of year 20,416 18,188 21,425
-------- -------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 21,376 $ 20,416 $ 18,188
======== ======== ========
SUPPLEMENTAL DISCLOSURES:
Interest paid $ 17,186 $ 11,571 $ 8,373
Income tax paid 3,655 3,100 2,450
Loans transferred to other real estate 779 491 1,483
The accompanying notes are an integral part of these consolidated financial
statements.
Page A-25
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
United Bancorp, Inc. and Subsidiaries
For the years ended December 31, 2006, 2005, 2004
Common Retained
IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA Shares Stock (1) Earnings AOCI (2) Total
--------- --------- -------- -------- -------
Balance, January 1, 2004 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 of
reclass adjustments for realized gains
(losses) and related taxes (481) (481)
-------
Total comprehensive income 7,172
Cash dividends declared, $1.237 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
Net income, 2005 8,324 8,324
Other comprehensive income (loss):
Net change in unrealized gains (losses)
on securities available for sale, net of
reclass adjustments for realized gains
(losses) and related taxes (368) (368)
-------
Total comprehensive income 7,956
Cash dividends declared, $1.356 per share (3,545) (3,545)
Five percent stock dividend declared 118,681 7,952 (7,952) --
Common stock transactions 19,460 527 527
Tax effect of options exercised 265 265
Director and management deferred
stock plans 309 (114) 195
--------- ------- ------- ----- -------
Balance, December 31, 2005 2,493,238 $63,186 $ 4,705 $(269) $67,622
Net income, 2006 8,972 8,972
Other comprehensive income (loss):
Net change in unrealized gains (losses)
on securities available for sale, net of
reclass adjustments for realized gains
(losses) and related taxes 337 337
-------
Total comprehensive income 9,309
Cash dividends declared, $1.102 per share (2,894) (2,894)
Five percent stock dividend declared 124,972 7,280 (7,280) --
Common stock transactions 5,506 277 277
Tax effect of options exercised 28 28
Director and management deferred
stock plans 304 (110) 194
--------- ------- ------- ----- -------
Balance, December 31, 2006 2,623,716 $71,075 $ 3,393 $ 68 $74,536
========= ======= ======= ===== =======
(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-26
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-27
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, 2006 and 2005, other real estate owned
totaled $1,063,000 and $871,000, 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-28
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 2006, 2005 and 2004, 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.
In years prior to 2006, cash dividends were declared in the last month of the
quarter, payable the end of the month following quarter-end. Effective with the
first quarter of 2006, cash dividends are declared and are payable in the month
following the end of the quarter. As a result of this change in schedule, the
cash dividend declared in December of 2005 was paid in January, 2006, but no
dividends were declared in the first quarter of 2006. While this change in
procedure has not changed the number of dividends to be paid during the calendar
year, for 2006 the number of cash dividends declared during the calendar year
has been reduced by one.
STOCK BASED COMPENSATION
At December 31, 2006, the Company has a stock-based employee compensation plan,
which is described more fully in Note 16. Prior to 2006, the Company accounted
for this plan under the recognition and measurement principles of APB Opinion
No. 25, "Accounting for Stock Issued to Employees" and related Interpretations.
Accordingly, in 2005, no stock based employee compensation cost is reflected in
net income, as all options granted under this plan had an exercise price equal
to the market value of the underlying common stock at the grant date.
Effective January 1, 2006 the Company adopted the fair value recognition
provisions of Statement of Financial Accounting Standards (SFAS) No. 123R,
"Share Based Payment". The Company selected the modified prospective
application. Accordingly, after December 31, 2005 the Company began expensing
the fair value of stock options granted, modified, repurchased or cancelled.
The following table illustrates the effect on net income and earnings per share
if the company had applied the fair value provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation," to stock-based employee compensation
as of December 31, 2004.
In thousands of dollars, except per share data 2005 2004
------ ------
Net income, as reported $8,324 $7,653
Less: Total stock-based employee compensation cost
determined under the fair value based method,
net of taxes (128) (70)
------ ------
Pro forma net income $8,196 $7,583
Page A-29
2005 2004
----- -----
Earning per share:
Basic As reported $3.15 $2.92
Basic Pro forma 3.10 2.90
Diluted As reported 3.13 2.90
Diluted Pro forma 3.08 2.88
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 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 amount of reserve and clearing balances required at December 31, 2006
totaled approximately $245,000.
NOTE 3 - SECURITIES
The fair value of securities as of December 31, 2006 and 2005 are as follows, in
thousands of dollars:
SECURITIES AVAILABLE FOR SALE Fair Value Gains Losses
- ----------------------------- ---------- ----- ------
2006
U.S. Treasury and agency securities $ 38,380 $ 62 $(116)
Mortgage backed agency securities 13,945 19 (81)
Obligations of states and political subdivisions 40,369 374 (231)
Corporate, asset backed and other securities 3,117 75 --
-------- ---- -----
Total $ 95,811 $530 $(428)
======== ==== =====
2005
U.S. Treasury and agency securities $ 43,692 $ 6 $(409)
Mortgage backed agency securities 14,865 27 (203)
Obligations of states and political subdivisions 41,610 402 (321)
Corporate, asset backed and other securities 3,265 89 --
-------- ---- -----
Total $103,432 $524 $(933)
======== ==== =====
Page A-30
The Company's temporarily impaired investment securities as of December 31, 2006
and 2005 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
---------- ------ ---------- ------ ---------- ------
2006
U.S. Treasury and agency
securities $ 9,386 $ (28) $13,622 $ (87) $23,008 $(115)
Mortgage backed agency
securities 2,777 (28) 5,840 (53) 8,617 (81)
Obligations of states and
political subdivisions 3,874 (26) 17,836 (206) 21,710 (232)
------- ----- ------- ----- ------- -----
Total $16,037 $ (82) $37,298 $(346) $53,335 $(428)
======= ===== ======= ===== ======= =====
2005
U.S. Treasury and agency
securities $13,974 $ (97) $27,021 $(312) $40,995 $(409)
Mortgage backed agency
securities 1,847 (10) 10,188 (193) 12,035 (203)
Obligations of states and
political subdivisions 15,899 (238) 10,042 (83) 25,941 (321)
------- ----- ------- ----- ------- -----
Total $31,720 $(345) $47,251 $(588) $78,971 $(933)
======= ===== ======= ===== ======= =====
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 2006 2005 2004
---- ---- ------
Sales proceeds $164 $-- $4,626
Gross gains on sales -- -- --
Gross gains (losses) on calls 12 (1) (29)
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, 2006
Due in one year or less $31,398
Due after one year through five years 45,861
Due after five years through ten years 13,801
Due after ten years 1,634
Equity securities 3,117
-------
Total securities $95,811
=======
Securities carried at $15,122,000 and $15,090,000 as of December 31, 2006 and
2005 were pledged to secure deposits of public funds, funds borrowed, repurchase
agreements, and for other purposes as required by law.
Page A-31
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 2006 2005
-------- --------
Personal $ 91,002 $ 81,571
Business, including commercial mortgages 327,928 320,188
Tax exempt 2,841 3,133
Residential mortgage 79,864 66,186
Residential mortgages held for sale 5,772 1,060
Construction 94,356 85,974
-------- --------
Total loans $601,763 $558,112
======== ========
At December 31, 2006 and 2005, accruing loans delinquent 90 days or more totaled
$855,000 and $1,153,000. Non-accruing loans at December 31, 2006 and 2005 were
$5,427,000 and $5,609,000.
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 2006 2005 2004
------ ------ ------
Balance, January 1 $6,361 $5,766 $ 5,497
Loans charged off (762) (879) (1,066)
Recoveries credited to allowance 127 142 287
Provision charged to operations 2,123 1,332 1,048
------ ------ -------
Balance, December 31 $7,849 $6,361 $ 5,766
====== ====== =======
Information regarding impaired loans for the years ended December 31 follows:
In thousands of dollars 2006 2005 2004
------- ------ -------
Average investment in impaired loans $ 8,439 $8,295 $ 8,668
Interest income recognized on impaired loans 481 216 192
Interest income recognized on a cash basis 481 216 192
Balance of impaired loans at December 31 $10,219 $7,957 $10,045
Portion for which no allowance for loan
losses is allocated 2,101 2,394 2,668
Portion for which an allowance for loan
losses is allocated 8,118 5,563 7,377
Portion of allowance for loan losses
allocated to impaired loans 2,044 1,087 1,579
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 $230,066,000 and $237,221,000 at December 31, 2006
and 2005. The balance of loans serviced for others related to servicing rights
that have been capitalized was $225,629,000 and $235,512,000 at December 31,
2006 and 2005.
No valuation allowance was considered necessary at December 31, 2006 and 2005.
Unamortized cost of mortgage servicing rights included in accrued interest
receivable and other assets on the consolidated balance sheet, for the years
ended December 31 was as follows:
In thousands of dollars 2006 2005 2004
------ ------ ------
Balance, January 1 $1,645 $1,820 $1,832
Amount capitalized 131 171 377
Amount amortized (235) (346) (389)
------ ------ ------
Balance, December 31 $1,541 $1,645 $1,820
====== ====== ======
Page A-32
NOTE 7 - PREMISES AND EQUIPMENT
Depreciation expense was approximately $1,251,000 in 2006, $1,275,000 in 2005
and $1,344,000 in 2004. Premises and equipment as of December 31 consisted of
the following:
In thousands of dollars 2006 2005
-------- --------
Land $ 1,580 $ 1,580
Buildings and improvements 14,452 13,772
Furniture and equipment 13,076 12,339
-------- --------
Total cost 29,108 27,691
Less accumulated depreciation (15,893) (14,693)
-------- --------
Premises and equipment, net $ 13,215 $ 12,998
======== ========
The company has several noncancellable operating leases, primarily for banking
facilities, that expire over the next fifteen years. The leases generally
contain renewal options for periods ranging from one to five years. Rental
expense for these leases was $759,000, $710,000 and $630,000 for the years ended
December 31, 2006, 2005 and 2004, respectively.
Future minimum lease payments under operating leases are shown in the table
below:
In thousands of dollars
2007 $ 839
2008 832
2009 814
2010 771
2011 766
Thereafter 3,646
------
Total Minimum Lease Payments $7,668
======
NOTE 8 - GOODWILL
The Company follows the provisions of Statement of Financial Accounting
Standards No. 142 and Statement of Financial Accounting Standards No. 147 with
regard to accounting and financial reporting for goodwill and other intangible
assets. There was no impairment of goodwill in 2006, 2005 or 2004.
NOTE 9 - DEPOSITS
Information relating to maturities of time deposits as of December 31 is
summarized below:
In thousands of dollars 2006 2005
-------- --------
Within one year $160,815 $119,926
Between one and two years 46,583 40,891
Between two and three years 19,501 14,899
Between three and four years 1,116 8,644
Between four and five years 1,274 803
More than five years -- --
-------- --------
Total time deposits $229,289 $185,163
======== ========
Interest bearing time deposits in denominations of
$100,000 or more $102,492 $ 68,062
======== ========
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 $0 and $6.3 million of fed funds
purchased outstanding at December 31, 2006 and 2005.
Page A-33
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 2006 and
2005 totaled $77,000 and $76,000 and the daily average of such agreements
totaled $76,000 and $76,000. The balance outstanding at December 31, 2006 and
2005 was $77,000 and $76,000.
NOTE 11 - OTHER BORROWINGS
The Banks carried fixed rate, noncallable advances from the Federal Home Loan
Bank of Indianapolis totaling $40.9 million and $42.2 million at December 31,
2006 and 2005. As of December 31, 2006, the rates on the advances ranged from
2.69% to 6.18% with a weighted average rate of 4.67%. 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. If principal payments are paid
prior to maturity, advances are subject to a prepayment penalties.
Maturities and scheduled principal payments for other borrowings over the next
five years as of December 31 are shown below.
In thousands of dollars 2006
-------
Within one year $21,339
Between one and two years 10,429
Between two and three years 6,000
Between three and four years 1,000
Between four and five years --
More than five years 2,177
-------
Total $40,945
=======
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:
2006 2005
------------------ -----------------
Variable Fixed Variable Fixed
In thousands of dollars Rate Rate Rate Rate
-------- ------- -------- ------
Commitments to make loans $ 11,006 $13,760 $ 26,179 $7,580
Unused lines of credit 116,449 9,614 109,677 3,362
Standby letters of credit 12,882 -- 9,866 --
Page A-34
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, 2006, the rates for amounts in the fixed rate category ranged from
5.88% to 8.50%.
In December 2001, United Bank & Trust 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, 2006 and 2005, the total recorded investment
including the obligation to make additional future investments amounted to
$1,589,000 and $1,895,000 and was included in other assets. As of December 31,
2006 and 2005, the obligation of UBT to the limited partnership amounted to
$1,632,000 and $1,831,000 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.
On September 22, 2006, Annette Theisen and various entities controlled by her,
filed a complaint in Washtenaw Circuit Court against a number of defendants,
including UBTW and its President, Todd C. Clark. The complaint alleges that UBTW
and its President had a fiduciary duty and a duty of good faith to plaintiffs
and that UBTW and its President breached those duties in connection with secured
loans made to plaintiffs by, among other things, allegedly allowing plaintiffs
to make imprudent investments with such loans, causing transfers of, and
mortgages to be placed on, certain of plaintiffs' assets contrary to plaintiffs'
interests, not disclosing certain alleged conflicts of interest, and failing to
pay the premium on, and causing the cancellation of, Ms. Theisen's long-term
supplemental medical insurance policy. Plaintiffs seek damages of $6 million.
The Company is vigorously defending such claims.
NOTE 13 - FEDERAL INCOME TAX
Income tax expense consists of the following for the years ended December 31:
In thousands of dollars 2006 2005 2004
------ ------ ------
Current $3,923 $2,868 $2,917
Deferred (503) 313 43
------ ------ ------
Total income tax expense $3,420 $3,181 $2,960
====== ====== ======
The components of deferred tax assets and liabilities at December 31, are as
follows:
In thousands of dollars 2006 2005
------ ------
Deferred tax assets:
Allowance for loan losses $2,669 $2,163
Deferred compensation 592 592
Other 179 169
------ ------
Total deferred tax assets 3,440 2,924
====== ======
2006 2005
------- -------
Deferred tax liabilities:
Property and equipment (428) (383)
Mortgage servicing rights (524) (559)
Unrealized appreciation on securities available for sale (35) (49)
Other (1,269) (1,168)
------- -------
Total deferred tax liabilities (2,256) (2,159)
------- -------
Net deferred tax asset $ 1,184 $ 765
======= =======
No valuation allowance was considered necessary at December 31, 2006 and 2005.
Page A-35
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 2006 2005 2004
------ ------ ------
Income taxes at statutory rate of 34% $4,213 $3,912 $3,608
Non-taxable income, net of nondeductible interest expense (479) (427) (387)
Income on non-taxable bank owned life insurance (139) (135) (151)
Affordable housing credit (188) (184) (132)
Other 13 15 22
------ ------ ------
Total federal income tax $3,420 $3,181 $2,960
====== ====== ======
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, 2005 was
$46,065,000. During 2006, new and newly reportable loans to such related parties
amounted to $13,118,000 and repayments amounted to $21,332,000, resulting in a
balance at December 31, 2006 of $37,851,000. Related party deposits totaled
$14,577,000 and $13,062,000 at December 31, 2006 and 2005.
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, 2006, $21.1
million of retained earnings of the Banks were available for distribution to the
Company as dividends without prior regulatory approval. It is not the 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 100% of their compensation up to a maximum of $15,000 for 2006
and $14,000 for 2005 and 2004. 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 2006, 2005, and 2004 was $974,000,
$918,000 and $791,000.
The plan offers employees the option of purchasing Company stock with the match
portion of their 401(k) contribution. On that basis 2,193 shares in 2006, 2,356
shares in 2005 and 2,746 shares in 2004 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 ("Director 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.
Page A-36
SENIOR MANAGEMENT BONUS DEFERRAL STOCK PLAN
The Company maintains a deferred compensation plan designated as the Senior
Management Bonus Deferral Stock Plan ("Management 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 2005, Shareholders approved the Company's 2005 Stock Option Plan (the "2005
Plan"), which became effective January 1, 2005. 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 the market price at the time the
options are granted. The 2005 Plan replaced the 1999 Stock Option Plan ("the
1999 Plan"), under which no more options are to be granted.
The stock subject to the options are shares of authorized and unissued common
stock of the Company. As defined in the 2005 Plan, options representing no more
than 192,938 shares (adjusted for stock dividends declared) are to be made
available to the plan. 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 and the 2005
Plan during 2006, 2005 and 2004, adjusted for stock dividends:
2006 2005 2004
------------------------ ------------------------ ------------------------
Weighted Weighted Weighted
Average Average Average
Options Exercise Price Options Exercise Price Options Exercise Price
------- -------------- ------- -------------- ------- --------------
Balance, January 1 127,192 $51.92 111,326 $43.57 112,899 $39.38
Options granted 29,525 57.72 56,175 60.84 25,824 54.42
Options exercised (6,394) 42.98 (38,013) 40.59 (27,397) 36.51
Options forfeited (6,830) 58.62 (2,296) 53.05 -- --
------- ------ ------- ------ ------- ------
Balance, December 31 143,493 $53.19 127,192 $51.92 111,326 $43.57
======= ====== ======= ====== ======= ======
Options exercisable at
year-end 73,467 $47.79 45,624 $41.47 58,589 $38.44
Weighted average fair value of
options granted during the year $ 7.11 $ 6.47 $ 4.95
The following table provides information regarding stock options under the 2005
Plan at December 31, 2006:
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
- ------------------------ ----------- ----------------- -------------- ----------- --------------
$34.11 to $64.29 143,493 7.14 Years $53.19 73,467 $47.79
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:
2006 2005 2004
------- ------- -------
Dividend yield 2.45% 2.08% 2.15%
Expected life 5 years 5 years 5 years
Expected volatility 10.17% 8.67% 8.88%
Risk-free interest rate 4.36% 3.64% 3.05%
Page A-37
A summary of the status of the Company's nonvested shares as of December 31,
2006 and 2005, and changes during the years then ended, is presented below:
2006 2005
-------------------- --------------------
Weighted Weighted
Average Average
Options Fair Value Options Fair Value
------- ---------- ------- ----------
Balance, January 1 81,569 $5.76 52,738 $4.20
Options granted 29,525 7.05 56,175 6.42
Options vested (34,237) 5.27 (25,048) 4.04
Options forfeited (6,830) 6.41 (2,296) 4.85
------- ----- ------- -----
Balance, December 31 70,027 $6.48 81,569 $5.76
======= ===== ======= =====
The Company has recorded approximately $222,000 in compensation expense related
to vested stock options less estimated forfeitures for the twelve month period
ended December 31, 2006. As of December 31, 2006, unrecognized compensation
expense related to the stock options totaled $244,000 and is expected to be
recognized over 3 years. The total fair value of shares vested during the years
ended December 31, 2006, 2005 and 2004 was $180,000, $101,000 and $102,000,
respectively'.
At December 31, 2006, the aggregate intrinsic value of options outstanding
totaled $213,000. This value represents the difference between the Company's
closing stock price on the last day of trading for 2006 and the exercise price
multiplied by the number of in-the-money options assuming all option holders had
exercised their stock options on December 31, 2006.
The aggregate intrinsic value of stock options exercised during 2006 was
$79,000. Exercise of options during this same period resulted in cash receipts
of $60,000 and the Company recognized a tax benefit of approximately $28,000 on
the exercise of these options and has been recorded as an increase in equity.
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, 2006 2005
---------------------- ----------------------
Carrying Carrying
In thousands of dollars Value Fair Value Value Fair Value
--------- ---------- --------- ----------
Financial Assets
Cash and cash equivalents $ 21,376 $ 21,376 $ 20,416 $ 20,416
Securities available for sale 95,811 95,811 103,432 103,432
Net loans 593,914 591,045 551,751 547,876
Accrued interest receivable 4,523 4,523 3,521 3,521
Financial Liabilities
Total deposits $(628,002) $(628,945) $(590,652) $(592,810)
Short term borrowings (77) (77) (6,376) (6,376)
Other borrowings (40,945) (40,656) (42,228) (41,848)
Accrued interest payable 1,952 1,952 1,337 1,337
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:
Page A-38
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.
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 the Banks were categorized as well-capitalized at year end 2006
and 2005 by their regulators. Management is not aware of any conditions or
events that have occurred since year end that would change this classification.
The following table shows the Company's and the Banks' 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.
Page A-39
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, 2006
United Bancorp, Inc. (consolidated) 9.8% 11.6% 12.9%
United Bank & Trust 9.1% 12.0% 13.4%
United Bank & Trust - Washtenaw 9.5% 9.9% 11.1%
United Bancorp, Inc. consolidated equity $70,999 $70,999 $78,848
Regulatory requirement for minimum capital
adequacy (1) 29,199 24,497 48,994
------- ------- -------
Capital in excess of regulatory minimums 41,800 $46,502 $29,854
======= ======= =======
As of December 31, 2005
United Bancorp, Inc. (consolidated) 9.4% 11.1% 12.2%
United Bank & Trust 8.6% 11.4% 12.5%
United Bank & Trust - Washtenaw 9.1% 9.8% 10.8%
United Bancorp, Inc. consolidated equity $64,422 $64,422 $70,783
Regulatory requirement for minimum capital
adequacy (1) 27,581 23,133 46,267
------- ------- -------
Capital in excess of regulatory minimums 36,841 $41,289 $24,516
======= ======= =======
(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 2006 2005 2004
---------- ---------- ----------
Net income $ 8,972 $ 8,324 $ 7,653
Basic earnings per share:
Weighted average common shares outstanding 2,623,469 2,614,069 2,593,462
Weighted average contingently issuable shares 27,960 27,102 23,791
---------- ---------- ----------
2,651,429 2,641,171 2,617,253
Basic earnings per share $ 3.38 $ 3.15 $ 2.92
---------- ---------- ----------
Diluted earnings per share:
Weighted average common shares outstanding
from basic earnings per share 2,651,429 2,641,171 2,617,253
Dilutive effect of stock options -- 16,502 19,871
---------- ---------- ----------
2,651,429 2,657,673 2,637,124
Diluted earnings per share $ 3.38 $ 3.13 $ 2.90
Stock options for 100,196 and 1,000 shares of common stock were not considered
in computing diluted earnings per share for 2006 and 2005 because they were not
dilutive. No options were excluded from the computation in 2004, as all options
were dilutive.
Page A-40
NOTE 20 - OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related taxes were as follows:
In thousands of dollars 2006 2005 2004
---- ----- -----
Unrealized gains (losses) on securities available for sale $523 $(559) $(758)
Reclassification for realized amount included in income 12 (1) (29)
---- ----- -----
Other comprehensive income (loss), before tax effect 511 (558) (729)
Tax expense (benefit) 174 (190) (248)
---- ----- -----
Other comprehensive income (loss) $337 $(368) $(481)
==== ===== =====
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 2006 2005
------- -------
ASSETS
Cash and cash equivalents $ 715 $ 1,157
Investment in subsidiaries 72,012 65,333
Other assets 3,351 3,361
------- -------
TOTAL ASSETS $76,078 $69,851
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities $ 1,542 $ 2,229
Shareholders' equity 74,536 67,622
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $76,078 $69,851
======= =======
CONDENSED STATEMENTS OF INCOME
For the years
ended December 31,
--------------------------
In thousands of dollars 2006 2005 2004
------- ------- ------
INCOME
Dividends from subsidiaries $ 4,425 $ 6,775 $4,325
Other income 7,991 6,758 11
------- ------- ------
TOTAL INCOME 12,416 13,533 4,336
TOTAL NONINTEREST EXPENSE 8,418 7,125 231
------- ------- ------
Income before undistributed net income of subsidiaries
and income taxes 3,998 6,408 4,105
Income tax benefit (141) (121) (75)
------- ------- ------
Net income before undistributed net income of subsidiaries 4,139 6,529 4,180
Equity in undistributed (excess distributed) net income
of subsidiaries 4,833 1,795 3,473
------- ------- ------
NET INCOME 8,972 8,324 7,653
Net change in unrealized gains on securities available
for sale 337 (368) (481)
------- ------- ------
Other comprehensive income (loss) 337 (368) (481)
------- ------- ------
COMPREHENSIVE INCOME $ 9,309 $ 7,956 $7,172
======= ======= ======
Page A-41
CONDENSED STATEMENTS OF CASH FLOWS
For the years
ended December 31,
---------------------------
In thousands of dollars 2006 2005 2004
------- ------- -------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income $ 8,972 $ 8,324 $ 7,653
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
FROM OPERATING ACTIVITIES
(Undistributed) excess distributed net income of
subsidiaries (4,833) (1,795) (3,473)
Change in other assets (232) 2,571 (1,858)
Change in other liabilities 236 418 19
------- ------- -------
Total adjustments (4,829) 1,194 (5,312)
------- ------- -------
Net cash from operating activities 4,143 9,518 2,341
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of securities available for sale -- -- (181)
Investments in subsidiaries (1,500) (3,900) --
Net premises and equipment expenditures 233 (2,008) --
------- ------- -------
Net cash from investing activities (1,267) (5,908) (181)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from common stock transactions 499 987 880
Dividends paid (3,817) (3,447) (3,143)
------- ------- -------
Net cash from financing activities (3,318) (2,460) (2,263)
------- ------- -------
NET CHANGE IN CASH AND CASH EQUIVALENTS (442) 1,150 (103)
Cash and cash equivalents at beginning of year 1,157 7 110
------- ------- -------
CASH AND CASH EQUIVALENTS AT END OF YEAR $ 715 $ 1,157 $ 7
======= ======= =======
NOTE 22 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Quarterly financial information is summarized below.
Earnings
Net Per Share
In thousands of dollars, Interest Interest Net ---------------
except per share data Income Income Income Basic Diluted
-------- -------- ------ ----- -------
2006
First Quarter $11,031 $ 7,203 $2,145 $0.81 $0.81
Second Quarter 11,484 7,199 2,184 0.82 0.82
Third Quarter 12,167 7,428 2,446 0.92 0.92
Fourth Quarter 12,374 7,424 2,197 0.83 0.83
------- ------- ------ ----- -----
Full Year $47,056 $29,254 $8,972 $3.38 $3.38
======= ======= ====== ===== =====
2005
First Quarter $ 8,683 $ 6,145 $1,784 $0.68 $0.67
Second Quarter 9,401 6,524 1,957 0.74 0.74
Third Quarter 9,999 6,710 2,264 0.86 0.86
Fourth Quarter 10,566 6,984 2,319 0.87 0.86
------- ------- ------ ----- -----
Full Year $38,649 $26,363 $8,324 $3.15 $3.13
======= ======= ====== ===== =====
Page A-42
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/ Robert K. Chapman March 8, 2007
- ------------------------------------- Date
Robert K. Chapman, President and
Chief Executive Officer, Director
Page 26
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Robert K. Chapman and Dale L. Chadderdon, and each of
them, his true and lawful attorney(s)-in-fact and agent(s), with full power of
substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to sign any or all amendments to this report and to file
the same, with all exhibits and schedules thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting unto
said attorney(s)-in-fact and agent(s) full power and authority to do and perform
each and every act and thing requisite and necessary to be done, as fully to all
intents and purposes as he might or could do in person, hereby ratifying and
confirming all that said attorney(s)-in-fact and agent(s), or their
substitute(s), may lawfully do or cause to be done by virtue hereof.
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 March 14, 2007.
/S/ James D. Buhr /S/ David S. Hickman
- ------------------------------------- ----------------------------------------
James D. Buhr, Director David S. Hickman, Chairman of the Board
/S/ Joseph D. Butcko /S/ James C. Lawson
- ------------------------------------- ----------------------------------------
Joseph D. Butcko, Director James C. Lawson, Director
/S/ Robert K. Chapman /S/ Donald J. Martin
- ------------------------------------- ----------------------------------------
Robert K. Chapman (Principal Donald J. Martin, Director
Executive Officer) Director,
President and Chief Executive Officer
/S/ David E. Maxwell
----------------------------------------
/S/ George H. Cress David E. Maxwell, Director
- -------------------------------------
George H. Cress, Director
/S/ Kathryn M. Mohr
----------------------------------------
/S/ John H. Foss Kathryn M. Mohr, Director
- -------------------------------------
John H. Foss, Director
/S/ Dale L. Chadderdon
----------------------------------------
/S/ James G. Haeussler Dale L. Chadderdon (Principal Financial
- ------------------------------------- Officer) Executive Vice President &
James G. Haeussler, Director Chief Financial Officer
Page 27
EXHIBIT INDEX
Exhibit No. Description Page No.
- ----------- ----------- --------
Exhibit 11 Statement re Computation of Per Share Earnings - this
information is incorporated by reference in Note 1 on
Page A-29 and Note 19 on Page A-39 hereof.
Exhibit 14 Code of Ethics in accordance with Section 406 of the
Sarbanes-Oxley Act as amended. 29
Exhibit 21 Subsidiaries 32
Exhibit 23 Consent of Independent Registered Public Accounting
Firm 33
Exhibit 24 Power of Attorney contained on the signature pages of
the 2007 Annual Report on Form 10-K. 27
Exhibit 31.1 Certification of Principal Executive Officer 34
Exhibit 31.2 Certification of Principal Financial Officer 35
Exhibit 32.1 Certification pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002. 36
Page 28