UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
UNITED BANCSHARES, INC.
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(Exact name of registrant as specified in its charter)
0-25976
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(Registrants' file number)
Pennsylvania 23-2802415
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(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
The Graham Building, 30 South 15th Street, Suite 1200,
Philadelphia, Pennsylvania 19102
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (215) 351-4600
Securities registered pursuant to Section 12(b)f of the Act: NONE
Securities registered pursuant to Section 12(g)f of the Act:
Common Stock, $.01 par value
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), 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 (ss.229.405 of this chapter) 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 registrant is an accelerated filer (as defined in
Rule 12b-2 of the Act). Yes [ ] No [X]
United Bancshares, Inc. (sometimes herein also referred to as the
"Company" or "UBS") has two classes of capital stock authorized - 2,000,000
shares of $.01 par value Common Stock and a Series Preferred Stock (Series A
Preferred Stock).
The Board of Directors designated a subclass of the common stock, Class B
Common Stock, by filing of Articles of Amendment to its Articles of
Incorporation on September 30, 1998. This Class B Common Stock has all of the
rights and privileges of Common Stock with the exception of voting rights. Of
the 2,000,000 shares of authorized Common Stock, 250,000 have been designated
Class B Common Stock. There is no market for the Common Stock. None of the
shares of the Registrant's stock was sold within 60 days of the filing of this
Form 10-K. As of March 17, 2005 the aggregate number of the shares of the
Registrant's Common Stock outstanding was 1,068,588 (including 191,667 Class B
non-voting). There are 33,500 shares of Common Stock held in treasury stock at
March 17, 2005.
The Series A Preferred Stock consists of 500,000 authorized shares of
stock of which 136,842 shares are outstanding and 6,308 shares are held in
treasury stock as of March 17, 2005.
There are 78 pages in the Form 10-K.
FORM 10-K
United Bancshares, Inc.
Index
Item No. Page
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PART I
1. Business........................................................... 3
2. Properties......................................................... 13
3. Legal Proceedings.................................................. 14
4. Submission of Matters to a Vote of Security Holders................ 14
PART II
5. Market for Registrant's Common Equity, Related Stockholder Matters. 15
6. Selected Financial Data............................................ 16
7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................. 16
7A. Quantitative and Qualitative Disclosures about Market Risk......... 37
8. Financial Statements and Supplementary Data........................ 37
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure............................................... 38
9A. Controls and Procedures............................................ 38
9B. Other Information.................................................. 38
PART III
10. Directors and Executive Officers of Registrant..................... 39
11. Executive Compensation............................................. 45
12. Security Ownership of Certain Beneficial Owners and Management..... 47
13. Certain Relationships and Related Transactions..................... 47
14. Principal Accounting Fees and Services............................. 47
PART IV
15. Exhibits and Financial Statements Schedules........................ 48
UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF MARCH 17, 2005.
2
PART I
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENT
Certain of the matters discussed in this document and the documents
incorporated by reference herein, including matters discussed under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" may constitute forward looking statements for the purposes of the
Securities Act of 1933, as amended and the Securities Exchange Act of 1934, as
amended, and may involve known and unknown risks, uncertainties and other
factors which may cause the actual results, performance or achievements of
United Bancshares, Inc. ("UBS") to be materially different from future results,
performance or achievements expressed or implied by such forward looking
statements. The words "expect," "anticipate," "intended," "plan," "believe,"
"seek," "estimate," and similar expressions are intended to identify such
forward-looking statements. UBS' actual results may differ materially from the
results anticipated by the forward-looking statements due to a variety of
factors, including without limitation: (a) the effects of future economic
conditions on UBS and its customers, including economic factors which affect
consumer confidence in the securities markets, wealth creation, investment and
consumer saving patterns; (b) UBS interest rate risk exposure and credit risk;
(c) changes in the securities markets with respect to the market values of
financial assets and the stability of particular securities markets; (d)
governmental monetary and fiscal policies, as well as legislation and regulatory
changes; (e) changes in interest rates on the level and composition of deposits,
loan demand, and the values of loan collateral and securities, as well as
interest-rate risks; (f) changes in accounting requirements or interpretations;
(g) the effects of competition from other commercial banks, thrifts, mortgage
companies, consumer finance companies, credit unions securities brokerage firms,
insurance company's, money-market and mutual funds and other financial
institutions operating in the UBS' trade market area and elsewhere including
institutions operating locally, regionally, nationally and internationally,
together with such competitors offering banking products and services by mail,
telephone, computer and the internet; (h) any extraordinary events (such as the
September 11, 2001 events), the war on terrorism and the U.S. Government's
response to those events or the U.S. Government becoming involved in a conflict
in a foreign country; (i) the failure of assumptions underlying the
establishment of reserves for loan losses and estimates in the value of
collateral, and various financial assets and liabilities and technological
changes being more difficult or expensive than anticipated; (j) UBS' success in
generating new business in its existing markets, as well as its success in
identifying and penetrating targeted markets and generating a profit in those
markets in a reasonable time; (k) UBS' timely development of competitive new
products and services in a changing environment and the acceptance of such
products and services by its customers; and (l) UBS' success in managing the
risks involved in the foregoing.
All written or oral forward-looking statements attributed to UBS are
expressly qualified in their entirety by use of the foregoing cautionary
statements. All forward-looking statements included in this Report are based
upon information presently available, and UBS assumes no obligation to update
any forward-looking statement.
ITEM 1 -- BUSINESS
United Bancshares, Inc.
United Bancshares, Inc. ("Registrant" or "UBS") is a holding company for
United Bank of Philadelphia (the "Bank"). UBS was incorporated under the laws of
the Commonwealth of Pennsylvania on April 8, 1993. The Registrant became the
Bank Holding Company of the Bank, pursuant to the Bank Holding Company Act of
1956, as amended, on October 14, 1994.
The Bank commenced operations on March 23, 1992. UBS provides banking
services through the Bank. The principal executive offices of UBS and the Bank
are located at The Graham Building, 30 S. 15th Street, Suite 1200, Philadelphia,
Pennsylvania 19102. The Registrant's telephone number is (215) 351-4600.
As of March 17, 2005, UBS and the Bank had a total of 39 employees.
3
United Bank of Philadelphia
United Bancshares, Inc. is an African American controlled and managed
bank holding company for United Bank of Philadelphia (the "Bank"), a commercial
bank chartered in 1992 by the Commonwealth of Pennsylvania, Department of
Banking and a member of the Federal Reserve System. The deposits held by the
Bank are insured by the Federal Deposit Insurance Corporation ("FDIC"). The Bank
provides full service community banking in Philadelphia neighborhoods that are
rich in diversity providing a market opportunity that includes men, women,
families, small business owners, skilled laborers, professionals and many more
who value home ownership and need banking services to help make their dreams
come true.
The Bank conducts all its banking activities through its three offices
located as follows: West Philadelphia Branch 38th and Lancaster Avenue,
Philadelphia, Pennsylvania, (iii) Mount Airy Branch 1620 Wadsworth Avenue,
Philadelphia, Pennsylvania; and (iv) Progress Plaza Branch 1015 North Broad
Street, Philadelphia, Pennsylvania. In July 2004, the Bank closed and
consolidated its Two Penn Center (Center City) branch with its Progress Plaza
Branch to create operating efficiencies. Through its locations, the Bank offers
a broad range of commercial and consumer banking services. At December 31, 2004,
the Bank had total deposits aggregating approximately $63.2 million and had
total net loans outstanding of approximately $46.5 million. Although the Bank's
primary service area for Community Reinvestment Act purposes is Philadelphia
County, it also services, generally, the Delaware Valley, which consists of
portions of Montgomery, Bucks, Chester, and Delaware Counties in Pennsylvania;
New Castle County in Delaware; and Camden, Burlington, and Gloucester Counties
in New Jersey.
The city of Philadelphia is comprised of 353 census tracts and, based on
2000 census data, 204 or 58% of these are designated as low to moderate-income
tracts while 105 or 30% are characterized both as low to moderate-income and
minority tracts. The Bank's primary service area consists of a population of
1,517,550, which includes a minority population of 752,309.
United Bank of Philadelphia, while state chartered as a commercial bank,
is uniquely structured to be a player in providing retail services to its urban
communities, while maintaining and establishing a solid portfolio of commercial
relationships that include small businesses, churches and corporations. The Bank
will leverage its CDFI (community development financial institution) designation
as established by the United States Department of Treasury to attract deposits
from entities seeking Community Reinvestment Act (the "CRA Act") credit as well
as grants and/or equity from the US Treasury CDFI Fund and other agencies of the
U.S. Government. While the Bank's certification period was scheduled to end in
January 2004, a recent review by the CDFI Fund has extended the Bank's
certification period to 2006.
Among the greatest challenges facing inner city communities is their lack
of stability and transience. Outside organizations and institutions that attempt
to work within the community get frustrated and can leave at any time because
they have no vested stake in the neighborhood. It is very easy for an
organization without vested roots in the community to just pick up and leave,
thus fostering lack of institutional consistency. The Bank represents
consistency to these communities. The Bank takes its commitment to community
development quite seriously and recognizes that effective corporate and
institutional partnerships must be forged to truly make a difference. Bank
management recognizes the potential in these communities and knows that with the
right mix of financial services, growth will occur. The Bank will continue to
leverage its community "know-how" with the appropriate corporate and
institutional partners to help ensure that we create economic profit by making
comprehensive products and services are available and accessible through service
focused delivery channels.
The Bank engages in the commercial banking business, serving the banking
needs of its customers with a particular focus on, and sensitivity to, groups
that have been traditionally under-served, including Blacks, Hispanics and
women. The Bank offers a wide range of deposit products, including checking
accounts, interest-bearing NOW accounts, money market accounts, certificates of
deposit, savings accounts and Individual Retirement Accounts.
4
The focus of the Bank's lending activities is on the origination of
commercial, consumer and residential loans. A broad range of credit products is
offered to the businesses and consumers in the Bank's service area, including
commercial loans, mortgage loans, student loans, home improvement loans, auto
loans, personal loans, and home equity loans. At March 17, 2005, the Bank's
maximum legal lending limit was approximately $1,132,000 per borrower. However,
the Bank's internal Loan Policy limits the Bank's lending to $500,000 per
borrower in order to diversify the loan portfolio. The Board of Directors of the
Bank maintains the ability to waive its internal lending limit upon
consideration of a loan. The Board of Directors has exercised this power with
respect to loans and participations on a number of occasions.
In the area of commercial loans, the Bank has flexibility to develop loan
arrangements targeted at a customer's objectives. Typically, these loans are
term loans or revolving credit arrangements with interest rate, collateral and
repayments terms, varying based upon the type of credit, and various factors
used to evaluate risk. The Bank participates in the government-sponsored Small
Business Administration ("SBA") lending program and when the Bank deems it
appropriate, obtains SBA guarantees for up to 90% of the loan amount. These
guarantees are intended to reduce the Bank's exposure to loss in its commercial
loan portfolio. Commercial loans are typically made on the basis of cash flow to
support repayment with secondary reliance placed on the underlying collateral.
The Bank's consumer loan program includes installment loans for home
improvement and the purchase of consumer goods and automobiles, student loans,
home equity and VISA secured and unsecured revolving lines of credit, and
checking overdraft protection. The Bank participates in an automobile refinance
program that allows customers to reduce high interest rates paid on their
automobile loans down to more reasonable market rates. The Bank also offers
residential mortgage loans to its customers through its strategic alliance with
a Fortune 500 mortgage company. Other services the Bank offers include safe
deposit boxes, travelers' checks, money orders, direct deposit of payroll and
Social Security checks, wire transfers and access to regional and national
automated teller networks.
The Bank will continue to focus on its niche businesses to include the
basic deposit and loan business, while developing relationships with several
corporate entities that have a commitment to community and economic development
in the urban sector. Strategic alliances and partnerships are key to the
economic strength of inner city neighborhoods. The Bank will continue to develop
these strategic alliances/partnerships to help ensure that the communities we
serve have full access to financial products and services.
With focused strategies the Bank can realize fee income with a select
number of corporations both locally and nationally. By developing the
relationships appropriately, a new niche for the Bank can be expanded to add to
its core earnings stream. To date, these opportunities have included loan
syndications for four (4) major U.S. Corporations for which the Bank receives
agent/arranger fees. The Bank will continue to cultivate these and other
relationships for additional fee income opportunities.
Access to the Bank's Website and the United States Securities and
Exchange Commission Website
Reports filed electronically by UBS with the Securities and Exchange
Commission including proxy statements, reports on Form 10-K, reports on Form
10-Q, and current event reports on Form 8-K, as well as any amendment of those
reports, and other information about UBS and the Bank are accessible at no cost
on the Bank's web site at www.unitedbankofphiladelphia.com under the
"shareholders corner" section. These files are also accessible on the
Commission's website at www.sec.gov.
5
Competition
There is substantial competition among financial institutions in the
Bank's service area. The Bank competes with local, regional and national
commercial banks, as well as savings banks and savings and loan associations.
Many of these banks and financial institutions have an amount of capital that
allows them to do more advertising and promotion and to provide a greater range
of services to customers including trust services and many "free" products and
services with bundled account relationships. To date, the Bank has attracted,
and believes it will continue to attract its customers from the deposit base of
such existing banks and financial institutions largely due to the Bank's mission
to service groups of people who have traditionally been under served and by its
devotion to personalized customer service. The Bank's strategy has been, and
will continue to be, to emphasize personalized services with special sensitivity
to the needs of Blacks, Hispanics and women and to offer competitive rates to
borrowers and depositors.
In order to compete, the Bank relies upon personal contacts by the
officers, directors and employees of the Bank to establish and maintain
relationships with Bank customers. The Bank focuses its efforts on the needs of
individuals and small and medium-sized businesses. In the event there are
customers whose loan demands exceed the Bank's lending limit, the Bank will seek
to arrange for such loans on a participation basis with other financial
institutions and intermediaries. The Bank will also assist those customers
requiring other services not offered by the Bank to obtain such services from
its correspondent banks.
UBS believes that a portion of the Bank's customer base is derived from
customers who were dissatisfied with the level of service provided at larger
financial institutions. Many of the national financial institutions that provide
financial services in Philadelphia are no longer headquartered in the region
resulting in a loss of connectivity with the community. The Bank plans to
further capitalize on this situation by implementing calling programs to offer
potential customers a personalized community-based approach to banking. The Bank
has sought, in the past, and intends to continue in the future, to hire customer
contact officers who have good relationships with desirable customers. These
personal relationships, provision of a high level of customer services, and
referrals from satisfied customers, form the basis of the Bank's competitive
approach, as opposed to advertising, rate competition or the development of
proprietary banking products, services or programs.
In the past, the principal competition for deposits and loans have been
other depository institutions. However, now the Bank also competes with other
financial intermediaries such as brokerage houses offering investment vehicles
to the general public. Other entities, both public and private, seeking to raise
capital through the issuance and sale of debt or equity securities are also
competitors with banks and savings and loan associations in the acquisition of
deposits.
In 2004, the Bank developed a strategic alliance with a group of minority
representatives from a Fortune 500 investment firm to provide a full array of
non-deposit products including investments, insurance and brokerage services.
The Bank intends to use this firm as an extension of its business development
staff to introduce and cross-sell all of its products and services including
loans and deposits.
UBS will continue to be cognizant of the diversity in its market and will
continue to develop partnerships to leverage the Bank's capacity in its niche
market by skillfully targeting customers and building stakeholder relationships.
Supervision and Regulation
Regulation of United Bancshares, Inc.
UBS, as a Pennsylvania business corporation, is subject to the
jurisdiction of the Securities and Exchange Commission (the "SEC") and certain
state securities commissions concerning matters relating to the offering and
sale of its securities. Accordingly, if UBS wishes to issue additional shares of
its Common Stock, for example, to raise capital or to grant stock options, UBS
must comply with the registration requirements of the Securities Act of 1933, as
amended, and any applicable states securities laws, or find an applicable
exemptions from such registration.
6
The Bank Holding Company Act
UBS, as a bank holding company, is subject to the Bank Holding Company
Act of 1956, as amended (the "BHC Act"), and supervision by the Federal Reserve
Board. The BCH Act limits the business of bank holding companies to banking,
managing or controlling banks, performing certain servicing activities for
subsidiaries and engaging in such other activities as the Federal Reserve Board
may determine to be closely related to banking. UBS is subject to the
supervision of and inspection by the Federal Reserve Board and required to file
with the Board an annual report and such additional information as the Board may
require pursuant to the BHC Act and its implementing regulations.
A bank holding company is prohibited from engaging in or acquiring direct
or indirect control of more than 5% of the voting shares of any company engaged
in non-banking activities, unless the Federal Reserve Board, by order or
regulation, has found such activities to be so closely related to banking or
managing or controlling banks, as to be a proper incident thereto. In making
this determination, the Board considers whether the performance of these
activities by a bank holding company would offer benefits to the public that
outweigh possible adverse effects.
The BHC Act requires UBS to secure the prior approval of the Federal
Reserve Board before it owns or controls, directly or indirectly, more than 5%
of the voting shares of any corporation, including another bank. In addition,
the BHC Act prohibits UBS from acquiring more than 5% of the voting shares of,
or an interest in, or all or substantially all of the assets of, any bank
located outside Pennsylvania, unless such an acquisition is specifically
authorized by the laws of the state in which such bank is located.
Subject to compliance with Pennsylvania law, and, as noted above,
compliance with the BHC Act, UBS is permitted to control a number of banks.
However, UBS is required under the BHC Act to obtain the prior approval of the
Federal Reserve Board before acquiring all or substantially all of the assets of
any bank, or acquiring ownership or control of any voting shares of any other
bank if, after such acquisition, UBS would control more than 5% of the voting
shares of such bank.
The BHC Act and the Federal Reserve Board's regulations prohibit a bank
holding company and its subsidiaries from engaging in certain tying arrangements
in connection with any extension of credit or services. The "anti-tying"
provisions prohibit a bank from extending credit, leasing, selling property or
furnishing any service to a customer on the condition that the customer obtain
additional credit or service from the bank, its bank holding company or any
other subsidiary of its bank holding company, or on the condition that the
customer not obtain other credit or services from a competitor of the bank, its
bank holding company or any subsidiary of its bank holding company.
The Bank, as a subsidiary of UBS, is subject to certain restrictions
imposed by the Federal Reserve Act, as amended, on any extensions of credit to
UBS or its subsidiaries, on investments in the stock or other securities UBS or
its subsidiaries, and on taking such stock or securities as collateral for
loans.
The Federal Reserve Act and Federal Reserve Board regulations also place
certain limitations and reporting requirements on extensions of credit by a bank
to principal shareholders of its parent holding company, among others, and to
related interests of such principal shareholders. In addition, that Act and
those regulations may affect the terms upon which any person who becomes a
principal shareholder of a holding company may obtain credit from banks with
which the subsidiary bank maintains a correspondent relationship.
Federal law also prohibits the acquisition of control by UBS of a bank
holding company, without prior notice to certain federal bank regulators.
Control is defined for this purpose as the power, directly or indirectly, to
direct the management or policies of the bank or bank holding company or to vote
25% or more of any class of voting securities of the bank holding company.
7
The Financial Services Act
The Financial Services Act (the "FSA Act"), sometimes referred to as the
Gramm-Leach-Bliley Act, repealed the provisions of the Glass-Steagall Act, which
prohibited commercial banks and securities firms from affiliating with each
other and engaging in each other's businesses. Thus, many of the barriers
prohibiting affiliations between commercial banks and securities firms have been
eliminated.
The FSA Act authorizes the establishment of "financial holding companies"
("FHC") to engage in new financial activities offering and banking, insurance,
securities and other financial products to consumers. Bank holding companies may
elect to become a FHC, if all of its subsidiary depository institutions are well
capitalized and well managed. See "Regulatory Action" and "Regulatory Matters"
below. If those requirements are met, a bank holding company may file a
certification to that effect with the Federal Reserve Board and declare that it
elects to become a FHC. After the certification and declaration are filed, the
FHC may engage either de novo or through an acquisition in any activity that has
been determined by the Federal Reserve Board to be financial in nature or
incidental to such financial activity.
Under the FSA Act the Bank, subject to various requirements, is permitted
to engage through "financial subsidiaries" in certain financial activities
permissible for affiliates of an FHC. However, to be able to engage in such
activities the Bank must be well capitalized and well managed and receive at
least a "satisfactory" rating in its most recent CRA Act examination. See "The
Community Reinvestment Act" below.
UBS cannot be certain of the future effect of the legislation and
regulations, described above, on its business, although there may be
consolidation among financial service institutions and increased competition for
UBS as well as an increase in the expense of regulatory compliance.
Regulation of the Bank
The Bank is subject to supervision, regulation and examination by the
Pennsylvania Department of Banking and the Federal Reserve Board because the
Bank is a member bank of the Federal Reserve System. The FDIC insures the Bank's
deposits and thus the Bank is subject to certain FDIC regulations. In addition,
the Bank is subject to a variety of local, state and federal laws that affect
its operation. Below are summarized those laws and regulations which a have
material impact on the operations and expenses of the Bank and thus UBS.
Branch Banking
The Pennsylvania Banking Code of 1965, as amended, the ("Banking Code"),
has been amended to harmonize Pennsylvania law with federal law to enable
Pennsylvania banking institutions, such as the Bank, to participate fully in
interstate banking and to remove obstacles to out of state banks engaging in
banking in Pennsylvania.
Federal Reserve Membership Regulations
Since the Bank is a member bank of the Federal Reserve System, the
Federal Reserve Board possesses the power to prohibit institutions regulated by
it, such as the Bank, from engaging in any activity that would be an unsafe and
unsound banking practice or violate the law. Moreover, the Board has: (i)
empowered the Federal Deposit Insurance Corporation (the "FDIC") to issue
cease-and-desist or civil money penalty orders against the Bank or its executive
officers, directors and/or principal shareholders based on violations of law or
unsafe and unsound banking practices; (ii) authorized the FDIC to remove
executive officers who have participated in such violations or unsound
practices; (iii) restricted lending by the Bank to its executive officers,
directors, principal shareholders or related interests thereof; (iv) restricted
management personnel of the Bank from serving as directors or in other
management positions with certain depository institutions whose assets exceed a
specified amount or which have an office within a specified geographic area.
Additionally, the Bank Control Act provides that no person may acquire control
of the Bank unless the Federal Reserve Board has been given 60-days prior
written notice and within that time has not disapproved of the acquisition or
extended the period for disapproval.
8
The Federal Deposit Insurance Corporation Act
The Federal Deposit Insurance Corporation Act (the "FDIC Act") includes
several provisions that have a direct material impact on the Bank. The most
significant of these provisions are discussed below.
To minimize losses to the deposit insurance funds, the FDIC Act has
established a format to monitor FDIC-insured institutions and to enable prompt
corrective action to be taken by the appropriate federal supervisory agency if
an institution begins to experience difficulty. The FDIC Act establishes five
"capital" categories. They are: (1) well capitalized, (2) adequately
capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5)
critically undercapitalized. The overall goal of these new capital measures is
to impose more scrutiny and operational restrictions on banks as they descend
the capital categories from well capitalized to critically undercapitalized.
Under current regulations, a "well-capitalized" institution would be one
that has at least a 10% total risk-based capital ratio, a 6% Tier I risk-based
capital ratio, a 5% Tier I leverage ratio, and is not subject to any written
order or final directive by its regulatory agency to meet and maintain a
specific capital level.
An "adequately capitalized" institution would be one that meets the
required minimum capital levels, but does not meet the definition of a
"well-capitalized" institution. The existing capital rules generally require
banks to maintain a Tier I Leverage Ratio of at least 4% and an 8% total
risk-based capital ratio. Since the risk-based capital requirement is to be in
the form of Tier I capital, this also will mean that a bank would need to
maintain at least 4% Tier I risk-based capital ratio. An institution must meet
each of the required minimum capital levels in order to be deemed "adequately
capitalized." The most recent notification dated March 3, 2005, from the Federal
Reserve authorities categorized the Bank as "adequately capitalized" under the
regulatory framework for prompt and corrective action. See "Regulatory Action"
and "Regulatory Matters" below.
An "undercapitalized" institution is one that fails to meet one or more
of the required minimum capital levels for an "adequately capitalized"
institution. Under the FDIC Act, an "undercapitalized" institution must file a
capital restoration plan and is automatically subject to restrictions on
dividends, management fees and asset growth. In addition, the institution is
prohibited from making acquisitions, opening new branches or engaging in new
lines of business without the prior approval of its primary federal regulator. A
number of other restrictions may be imposed.
The Community Reinvestment Act
The Bank is required, by the CRA Act and its implementing regulations,
to: (i) meet the credit needs of the community, including the low and
moderate-income neighborhoods, which it serves. The Bank's CRA Act record is
taken into account by the regulatory authorities in their evaluation of any
application made by the Bank for, among other things, approval of a branch or
other deposit facility, branch office relocation, a merger or an acquisition.
The CRA Act also requires the federal banking agencies to make public disclosure
of their evaluation of a bank's record of meeting the credit needs of its entire
community, including low and moderate-income neighborhoods. After its most
recent CRA Act examination the Bank was given an "outstanding" CRA Act rating."
The Bank Secrecy Act
Under the Bank Secrecy Act ("BSA"), the Bank and other financial
institutions are required to report to the Internal Revenue Service currency
transactions, of more than $10,000 or multiple transactions of which the Bank
has knowledge exceed $10,000 in the aggregate. Civil and criminal penalties are
provided under the BSA for failure to file a required report, for failure to
supply information required by the BSA or for filing a false or fraudulent
report.
Privacy of Consumer Financial Information
The FSA Act also contains provisions designed to protect the privacy of
each consumer's financial information held in a financial institution. The
regulations (the "Regulations") issued pursuant to the FSA Act are designed to
prevent financial institutions, such as the Bank, from disclosing a consumer's
nonpublic personal information to third parties. However, financial institutions
can share a consumer customer's personal information or information about
business with affiliated companies.
9
The FSA Act Regulations permit financial institutions to disclose
nonpublic personal information to nonaffiliated third parties for marketing
purposes but financial institutions must provide a description of their privacy
policies to the consumers and give consumers an opportunity to opt-out of such
disclosure and prevent disclosure by the financial institution of the consumer's
nonpublic personal information to nonaffiliated third parties. These privacy
Regulations will affect how consumer information is transmitted through
diversified financial companies and conveyed to outside vendors.
Consumer Protection Rules - Sale of Insurance Products
In addition, as mandated by FSA Act, the bank regulators have published
consumer protection rules (the "Rules") which apply to the retail sales
practices, solicitation, advertising or offers of insurance products, including
annuities, by depository institutions such as the Bank.
The Rules provide that before the sale of insurance or annuity products
can be completed, disclosures must be made that such insurance products are not
deposits or other obligations of or guaranteed by the FDIC or any other agency
of the United States, the Bank or any affiliate and that insurance products,
including an annuities, may involve an investment risk, including a possible
loss of value.
The Rules also provide that the Bank may not condition an extension of
credit on the consumer's purchase of an insurance product or annuity from the
Bank or any affiliate or on the consumer's agreement not obtain or prohibit the
consumer from obtaining an insurance product or annuity from an unaffiliated
entity.
Finally the Rules also require formal acknowledgment by the consumer that
such disclosures have been received. In addition, to the extent practical, the
Bank must keep insurance and annuity sales activities physically separate from
the areas where retail sales are routinely accepted from the general public. The
Bank currently does not market insurance products.
The Patriot Act
The Patriot Act of 2001 which was enacted in the wake of the September
11, 2001 attacks, include provisions designed to combat international money
laundering and advance the U.S. government's war against terrorism. The Patriot
Act, and the regulations, which implement it, contains many obligations, which
must be satisfied by financial institutions, including the Bank, which involve
additional expenses for the Bank.
The Sarbanes-Oxley Act of 2002
On July 30, 2002 the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley
Act") became law. The stated goals of the Sarbanes-Oxley Act are to increase
corporate responsibility, provide enhanced penalties for accounting and auditing
improprieties by publicly traded companies and protect investors by improving
the accuracy and reliability of corporate disclosures made pursuant to the
securities law. The changes required by Sarbanes-Oxley Act and its implementing
regulations are intended to allow shareholders to monitor the performance of
companies and their directors more easily and effectively.
The Sarbanes-Oxley Act generally applies to all domestic companies, such
as UBS, that file periodic reports with the SEC under the Securities Exchange
Act of 1934, as amended (the "Exchange Act"). The Sarbanes-Oxley Act includes
very significant disclosure requirements and new corporate governance rules,
requires the SEC, the securities exchanges and the NASDAQ stock market to adapt
extensive additional disclosures, corporate governance provisions and other
related rules, as well as mandating that studies of certain significant issues
be made by the SEC and the US Comptroller General. Given the extensive number of
Sarbanes-Oxley Act rules and regulations to be finalized and implemented, the
final scope and impact of its requirements on UBS and the financial services
industry have yet to be determined.
10
The SOX Act addresses, among other matters, directors' audit committees;
certification of financial statements by the chief executive officer and chief
financial officer; forfeiture of bonuses and profits made by directors and
senior officers in the twelve (12) month period covered by restated financial
statements; a prohibition on insider trading during pension blackout periods;
disclosure of off-balance sheet transactions; a prohibition by companies, other
than federally insured financial institutions, on personal loans to their
directors and officers; expedited filing of reports concerning stock
transactions by directors and executive officers; formation of a public
accounting oversight board; auditor independence; and increased criminal
penalties for violation of certain the securities laws.
To implement the requirements of SOX Act and regulations, UBS' management
has instituted a series of actions to strengthen and improve UBS', corporate
governance practices. Included in those actions was the development of a system
designed to evaluate and monitor the continued effectiveness of the design and
operation of UBS' internal controls and procedures for financial reporting.
These series of actions by UBS' management improves UBS' and the Bank's
Audit Committees and Risk Management Committees of the Boards, and UBS' and
Bank's structures and processes which are intended to provide tools to
strengthen internal controls, communications and disclosure of necessary
information to those who must know and use it. UBS' system of internal controls
and procedures, which are in place, are designed to capture information from all
segments of its business. At UBS and the Bank, each key material element of
their operation is subject to oversight to help insure proper internal controls
and procedures, administration, risk management and delivery of critical
information disclosures to appropriate audit and financial officers, executive
management, Board committees and the Boards of directors. UBS' management
believes that the addition of these new controls and processes has brought with
it a broader and more in depth analysis to UBS' systems of controls and
procedures and corporate governance.
Compliance with Section 404 of the Sarbanes-Oxley Act of 2002
Section 404 ("SOX-404") of the Sarbanes-Oxley Act of 2002 requires that
UBS put internal controls for public financial reporting in place to gain
assurance that UBS properly presents its financial statements and related
footnotes, under generally accepted accounting principles of the United States
("GAAP"). The Commission has recently postponed the effective date of SOX-404
for companies, such as UBS, with less than $75,000,000 in market capitalization,
from December 31, 2005 until July 15, 2006.
As required by, SOX-404 UBS has undertaken a project to determine (1)
what internal controls for public financial reporting are in place and (2) what
additional internal controls needed to be implemented in order to gain assurance
that UBS properly presents its financial statements and related footnotes, under
GAAP. To accomplish this task UBS has devoted such staff to assist for UBS'
management in completing the project and thereby enabling the UBS' chief
executive officer and chief financial officer to certify, in a timely fashion,
whether or not there will be any significant deficiencies or material weaknesses
in the internal controls, established to assure that the UBS' financial
statements will be prepared under GAAP.
Upon completion of management's assessments of the adequacy of its
internal controls, its Independent Registered Public Accounting Firm, McGladrey
& Pullen, LLP ("McGladrey & Pullen"), will be required to audit management's
assessment of internal controls and issue an opinion stating whether (1)
management's assessment of the internal controls was fairly stated and (2)
whether UBS maintains effective internal control over financial reporting. Based
on UBS' management's assessment, the chief executive officer and chief financial
officer will then attest whether the UBS' internal control over financial
reporting is effective. McGladrey & Pullen will then issue a report stating
whether in their opinion management's assessment of the UBS' internal control
over financial reporting is fairly stated and that UBS maintains effective
internal control over financial reporting as of December 31, 2006.
The rules and regulations, discussed above, which implement the
Sarbanes-Oxley Act could have a significant economic impact on the compliance
cost of the UBS and all publicly held companies.
11
New Legislation and Regulations
The Fair and Accurate Credit Reporting Transactions Act
The Fair and Accurate Credit Reporting Transactions Act of 2003 (the
"Fact Act") became law on December 4, 2003. Among other things, the Fact Act
permanently extended the provisions of the Fair Credit Reporting Act (the "FCR
Act") that would have expired on January 1, 2004 and had prevented the states
from enforcing credit reporting laws that were more restrictive than the FCR Act
provisions.
Specifically, the Fact Act now permanently prohibits the states from
enforcing laws stricter than the Fact Act regulate that regulate: (1) the
prescreening of consumer reports, (2) the time within which credit bureaus must
respond to consumer disputes, (3) the duties of users of credit bureau
information, (4) the information contained in the credit reports, (5) the duties
of the information providers, and (6) the exchange of credit information between
affiliates.
In addition the Fact Act contains provisions concerning (i) how often
consumers may obtain free copies of their credit reports, (ii) the disclosure of
credit scores used for credit decisions, (iii) a consumers opt-out procedure for
exchange of credit information, that would otherwise be treated as a credit
report, among affiliates, (iv) the duty of lenders to notify consumers that
information contained in their credit reports resulted in their receiving credit
on less than the most favorable terms.
The Fact Act also contains provisions designed to reduce identity theft
and protect the confidentiality of a consumer's private medical information.
Future Legislation and Governmental Policies
From time to time various Federal and state legislation have been
proposed that could result in additional regulation of, and restrictions on, the
business of the Bank. As the enactment of the FSA Act and the Sarbanes-Oxley Act
confirm, from time to time, various proposals are enacted in the United States
Congress as well as Pennsylvania legislature and issued by various bank
regulatory authorities which alter the powers of, and place restrictions on,
different types of bank organizations.
As a consequence of the extensive regulation of commercial banking
activities in the United States, the Bank's business is particularly susceptible
to being affected by federal and state legislation and regulations that may
increase the costs of doing business. Bank management cannot anticipate the
changes in laws and regulations and their impact on the Bank's business,
financial position and reported results of operation.
Regulatory Action
In February 2000, as a result of a regulatory examination completed in
December 1999, the Bank entered into a Written Agreement ("the Agreement") with
its primary regulators with regard to, among other things, achievement of
agreed-upon capital levels, implementation of a viable earnings/strategic plan,
adequate funding of the allowance for loan losses, the completion of a
management review and succession plan, and improvement in internal controls. The
Agreement required the Bank to increase its capital ratio to 6.5% by June 30,
2000 and to 7% at all times thereafter. As of December 31, 2000, the Bank had
met the required ratios by implementing strategies that included: reducing
expenses, consolidating branches, and soliciting new and additional sources of
capital. Management continues to address all matters outlined in the Agreement.
At December 31, 2003, the Bank's Tier 1 leverage ratio had fallen to
6.81%, below the 7.00% minimum required by its Written Agreement with its
regulators (See Regulatory Matters below). However, as of December 31, 2004, the
Bank's tier one leverage capital ratio had improved to 9.49%. In 2004,
Management implemented capital improvement strategies including gains on sales
of Bank-owned real estate totaling more than $1.9 million. Management clearly
understands that additional capital is essential to achieve the Bank's strategic
plan of growth and core profitability. The Board and management continue to
aggressively explore strategies for the infusion of new capital into the
organization. The most productive way to increase capital is through sustained
core earnings.
12
A regulatory examination completed in February 2004 determined that the
Bank was not in compliance with certain other elements of the Agreement
including the implementation of a viable earnings/strategic plan and the timely
charge-off/funding of the allowance for loan losses. Management believes that it
has implemented corrective action where necessary including the adoption of an
achievable strategic plan. As a result, Management believes that the Bank is
"substantially" in compliance with the Agreement's terms and conditions. Failure
to comply could result in additional regulatory supervision and/or actions.
ITEM 2 -- PROPERTIES
Corporate Headquarters
United Bank of Philadelphia's corporate offices are located at The Graham
Building, 30 S. 15th Street, Suite 1200, Center City Philadelphia. In
conjunction with the sale of its corporate headquarters in July 2004, the Bank
entered a short-term lease for a portion of the building it previously occupied
at 300 North Third Street until January 31, 2005. On February 1, 2005 the Bank
began a 10-year lease for its new Center City headquarters location. The Graham
building is located in the heart of the Philadelphia business district, directly
across from City Hall. The Bank occupies approximately 10,000 square feet on the
12th Floor, including executive offices, operations, finance, human resource,
security and loss prevention functions. The average monthly lease rate over the
term of the lease is $15,170.
Mt. Airy Branch
The Bank operates a branch at 1620 Wadsworth Avenue, in the Mt. Airy
section of Philadelphia. This facility is located in a densely populated
residential neighborhood and in close proximity to small businesses/retail
stores. Management believes this branch has not reached its capacity and looks
forward to increased opportunities in all aspects of the Bank's niche
businesses. This facility, comprising a retail banking lobby, teller area,
offices, vault and storage space is currently leased at a monthly rental of
$3,730.
West Philadelphia Branch
In August 2003, the Bank purchased the branch location at 3750 Lancaster
Avenue for $287,500. From July 1996 to the time of purchase, this facility had
been leased. This branch is located in close proximity to two major universities
and hospitals. It is comprised of approximately 3,000 square feet. The main
floor houses teller and customer service areas, a drive-up teller facility and
automated teller machine. The basement provides storage for the facility.
Progress Plaza Branch
The Bank leases a branch facility located at 1015 North Broad Street,
Philadelphia, Pennsylvania. The Progress Plaza branch is a very active branch
with the largest number of customers seeking service on a daily basis. This
branch became the office of choice after the consolidation of the 28th & West
Girard location in 2000 and closure of its 2 Penn Center City location in July
2004. This area of North Philadelphia is an important area for the Bank and its
mission. The facility is comprised of a teller and customer service area, lobby
and vault. The aggregate monthly rental for this facility is $3,875 per month.
This lease expired in October 2003. The Bank had been notified by the landlord
that extensive improvements to the shopping plaza in which this branch is
located were planned for early 2004 but have since been placed on hold. The Bank
is currently leasing this facility on a month-to-month basis until final
renovation plans are determined by the landlord.
13
ITEM 3 -- LEGAL PROCEEDINGS
No material claims have been instituted or threatened by or against UBS
or the Bank other than in the ordinary course of business.
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A shareholders annual meeting of UBS was held on November 23, 2004.
Proxies for the annual meeting were solicited pursuant to Regulation 14A of the
Exchange Act and there were no solicitation in opposition to the management's
nominees as listed in the proxy statement and all such nominees were elected.
The matter voted upon at shareholders annual meeting of UBS were the
reelection of three (3) Class A directors to serve until the expiration of
their four (4) year terms and one (1) Class B and one (1) Class C director to
serve until the expiration of the balance of the terms of directors that
retired in 2003 and the ratification of the appointment of Grant Thornton LLP
as UBS' independent certified public accountants for the year 2004.
The votes cast at the meeting for the election of directors, for, against
or withheld, as well as a number of absentee and non-broker votes as to each
matter voted upon at the meeting, including a separate tabulation with respect
to each nominee for office is as follows:
-------------------------- --------------------------------
51.879% Shares Voted 452,999.67 of 873,192.32 Shares
-------------------------- --------------------------------
18.502% Accounts Voted 583 of 3,151 Accounts
-------------------------- --------------------------------
- -----------------------------------------------------------------------------
Question YES NO WITHHOLD/ABSTAIN
- -----------------------------------------------------------------------------
L. Armstead Edwards (CLASS A) 80.813% 0.00% 19.187%
366,082.67 0.00 86,917.00
- -----------------------------------------------------------------------------
Marionette Y. Wilson (CLASS A) 81.144% 0.00% 18.856%
367,582.67 0.00 85,417.00
- -----------------------------------------------------------------------------
Ernest L. Wright 81.089% 0.00% 18.911%
(CLASS A) 367,332.67 0.00 85,667.00
- -----------------------------------------------------------------------------
Ahsan M. Nasratullah 96.656% 0.00% 3.344%
(CLASS B) 437,849.67 0.00 15,150.00
- -----------------------------------------------------------------------------
Joseph T. Drennan 96.711% 0.00% 3.289%
(CLASS C) 438,099.67 0.00 14,900.00
- -----------------------------------------------------------------------------
Ratify Grant Thornton, LLP 96.943% 0.00% 3.002%
439,149.67 0.00 13,600.00
- -----------------------------------------------------------------------------
On December 16, 2004, UBS dismissed Grant Thornton, LLP as its independent
registered public accounting firm and retained McGladrey & Pullen, LLP
("McGladrey & Pullen"), Certified Public Accounts, as its new independent
registered public accounting firm on December 16, 2004 to audit UBS' financial
statements. The decision to change independent accountants was made by the Audit
Committee of UBS' Board of Directors, because of the costs savings, which will
be realized by appointing McGladrey & Pullen as its independent accountants to
audit UBS' financial statements. (Also see ITEM 9--CHANGES IN AND DISAGREEMENTS
WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE).
14
PART II
ITEM 5 -- MARKET FOR THE REGISTRANT'S COMMON EQUITY,
RELATED STOCKHOLDER MATTERS
Common Stock
The Common Stock is not traded on any national exchange or otherwise traded
in any recognizable market. There is no established public trading market for
UBS' common stock. Prior to December 31, 1993, the Bank conducted a limited
offering (the "Offering") pursuant to a registration exemption provided in
Section 3(a)(2) of the Securities Exchange Act of 1933. The price-per-share
during the Offering was $12.00. Prior to the Offering, the Bank conducted an
initial offering of the Common Stock (the "Initial Offering") at $10.00 per
share pursuant to the same registration exemption.
In June 2000 and December 2000, respectively, the Bank received $411,809
and $436,212 and issued 34,317 and 36,351 shares, respectively, as a result of
the purchase of UBS' common stock by members of the Bank's board of directors in
a limited offering at a price of $12.00 per share. This offering was exempt from
registration under the Act pursuant to the exemption in section 4(2) of the Act.
In May 2001 and December 2001, respectively, the Bank received $2,000 and
$9,596 and issued 167 and 800 shares, respectively, as a result of the purchase
of UBS common stock by two individuals in a limited offering at a price of
$12.00 per share. This offering was exempt from registration under the Act
pursuant to the exemption in section 4(2) of the Act.
In June 2002, the Bank received $20,400 and issued 1,700 shares as a result
of the purchase of UBS common stock by new members of the Bank's board of
directors in a limited offering at a price of $12.00 per share. This offering
was exempt from registration under the Act pursuant to the exemption in section
4(2) of the Act.
In June 2003, a shareholder of the Bank returned 33,500 shares of common
stock and 6,308 shares of preferred Series A stock. These shares were returned
for no consideration and were recorded as treasury stock by the Bank. No other
transactions with respect to UBS common stock occurred during 2003.
There were no capital stock transactions during 2004.
As of March 17, 2005 there were 3,149 shareholders of record of UBS' Voting
Common Stock and 2 shareholders of record of UBS' Class B Non-voting Common
Stock.
Dividend Restrictions
UBS has never declared or paid any cash or stock dividends. The
Pennsylvania Banking Code of 1965, as amended, provides that cash dividends may
be declared and paid only from accumulated net earnings and that, prior to the
declaration of any dividend, if the surplus of a bank is less than the amount of
its capital, the bank shall, until surplus is equal to such amount, transfer to
surplus an amount which is at least ten percent of the net earnings of the bank
for the period since the end of the last fiscal year or any shorter period since
the declaration of a dividend. If the surplus of a bank is less than 50% of the
amount of its capital, no dividend may be declared or paid by the Bank without
the prior approval of the Pennsylvania Department of Banking.
Under the Federal Reserve Act, if a bank has sustained losses equal to or
exceeding its undivided profits then on hand, no dividend shall be paid, and no
dividends can ever be paid in an amount greater than such bank's net profits
less losses and bad debts. Cash dividends must be approved by the Board if the
total of all cash dividends declared by a bank in any calendar year, including
the proposed cash dividend, exceeds the total of the Bank's net profits for that
year plus its retained net profits from the preceding two years less any
required transfers to surplus or to a fund for the retirement of preferred
stock. Under the Federal Reserve Act, the Federal Reserve Board has the power to
prohibit the payment of cash dividends by a bank if it determines that such a
payment would be an unsafe or unsound banking practice. As a result of these
laws and regulations, the Bank, and therefore UBS, whose only source of income
is dividends from the Bank, will be unable to pay any dividends while an
accumulated deficit exists. UBS does not anticipate that dividends will be paid
for the foreseeable future.
The FDIC generally prohibits all payments of dividends by a bank, which is
in default of any assessment to the FDIC. (See "Regulatory Action" below)
15
Securities Authorized for Issuance Under Equity Compensation Plans
The Company adopted a Stock Option Plan in 1998. Under this Plan, options
to acquire shares of common stock were granted to the former chief executive
officer. The Stock Option Plan provides for the granting of options at the fair
market value of the Company's common stock at the time the options are granted.
Each option granted under the Stock Option Plan may be exercised within a period
of ten years from the date of grant. However, no option may be exercised within
one year from the date of grant. In 1998, options to purchase 29,694 shares of
the Company's common stock at a price of $8.54 per share were awarded to the
former chief executive officer.
The information below has been derived from UBS' consolidated financial
statements.
ITEM 6 -- SELECTED FINANCIAL DATA
Selected Financial Data
Year ended December 31,
------------------------------------------------------------
(Dollars in thousands, except per share data) 2004 2003 2002 2001 2000
------------------------------------------------------------
Net interest income.............................. $ 3,280 $ 3,290 $ 3,726 $ 4,060 $ 5,415
Provision for loan losses........................ 45 565 175 335 565
Noninterest income............................... 3,655 1,891 2,327 2,443 3,197
Noninterest expense.............................. 5,243 5,732 6,095 7,038 8,801
Net income (loss)................................ 1,647 (1,115) (217) 870) (755)
Net income (loss) per share - basic.............. 1.54 (1.03) (0.20) (0.79) (0.72)
Net income per share - fully diluted............. 1.50 - - - -
Balance sheet totals:
Total assets................................. $ 72,301 $ 74,717 $86,044 $88,668 $93,533
Net loans.................................... 46,490 46,690 43,459 42,292 44,743
Investment securities........................ 13,560 15,637 21,518 25,806 35,014
Deposits..................................... 63,172 67,117 76,929 79,423 83,238
Shareholders' equity......................... 8,811 7,235 8,500 8,558 9,350
Ratios:
Tangible Equity to assets................. 9.89% 6.85% 7.45% 7.67% 7.74%
Return on assets.......................... 2.38% (1.38)% (0.25)% (0.95)% (0.63)%
Return on equity.......................... 26.96% (13.03)% (2.55)% (9.63)% (8.08)%
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Because UBS is a bank holding company for the Bank, the financial
statements in this report are prepared on a consolidated basis to include the
accounts of the Company and the Bank. The purpose of this discussion is to focus
on information about the Bank's financial condition and results of operations,
which is not otherwise apparent from the consolidated financial statements
included in this annual report. This discussion and analysis should be read in
conjunction with the financial statements presented elsewhere in this report.
Critical Accounting Policies
Allowance for Credit Losses
The Bank considers that the determination of the allowance for loan
losses involves a higher degree of judgment and complexity than its other
significant accounting policies. The balance in the allowance for loan losses is
determined based on management's review and evaluation of the loan portfolio in
relation to past loss experience, the size and composition of the portfolio,
current economic events and conditions, and other pertinent factors, including
management's assumptions as to future delinquencies, recoveries and losses. All
of these factors may be susceptible to significant change. To the extent actual
outcomes differ from management's estimates, additional provisions for loan
losses may be required that would adversely impact earnings in future periods.
Income Taxes
Under the liability method, deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax bases
of assets and liabilities. Deferred tax assets are subject to management's
judgment based upon available evidence that future realization is more likely
than not. For financial reporting purposes, a valuation allowance of 100% of the
deferred tax asset has been recognized to offset the deferred tax assets related
to cumulative temporary differences and tax loss carryforwards. If management
determines that the Bank may be able to realize all or part of the deferred tax
asset in the future, a credit to income tax expense may be required to increase
the recorded value of net deferred tax asset to the expected realizable amount.
16
Background Summary
History
The Bank entered a Written Agreement ("the Agreement") with the Federal
Reserve Bank in 2000 that had many ambitious timelines for the board and
management to meet. This Agreement became a motivator for the new management
team to dismantle a lack luster business model in order to keep the franchise
alive and relevant. This was a model that originally held great promise for it
was established to bring the "unbanked" into the mainstream of financial
services through affordable pricing and sensitive customer service. The
customers came and the numbers grew quickly and the franchise grew through the
acquisition of failed savings and loan branches. However, with this growth came
increased expenses through the assimilation of acquired branch locations,
people, products and the overall conversion expense.
The Bank had quickly strayed from its model of building a
customer-friendly and affordable franchise into a franchise of transforming
several branches of savings and loan customers into the Bank's commercial
platform. In 2000, the Bank was still faced with an enormous array of accounts
that had not yet been streamlined, thus curtailing the sales capacity of the
staff.
A major factor that needed to be addressed by the Bank was its capital
(tier one leverage ratio). When the Bank entered into the Agreement, the Bank's
tier one leverage ratio was slightly under 5%. Aggressive strategies were
developed and implemented by moving more expensive deposit relationships
(certificates of deposit and IRA's) off the Bank's balance sheet. These deposits
were sold for a gain and thus the Bank's total assets were reduced getting the
Bank closer to the 7% capital requirement. In 2004, management continued to
implement capitalization strategies including the sale of bank-owned real estate
for a $1.9 million gain. With this new capital, the Bank's is positioned for
growth.
A fundamental problem for the Bank's business model was its expense
profile. Major cuts were made including consolidating the branch network (from 8
offices to 4). Even with this reduction in branch offices, the Bank still
carried more branches than its peer group, which was generally two and no more
than three branches. Further reductions were made in 2004 with the
closure/consolidation of the Bank's Center City Philadelphia 2 Penn Center
office in conjunction with the expiration of a 10-year lease -- bringing the
number of full service branches down to three (3).
The Bank's reengineering and restructuring has resulted in a more
streamlined organization that provided the proper organizational platform to
become a more strategy-focused institution. Without compromising the segregation
of duties and internal controls, management was able to capitalize on the
strengths of its staff by combining functions while pushing for more enhanced
leadership throughout the organization which is essential to achieve
profitability, the Bank's primary goal. Also, with cross-training, the service
model in the branches was adjusted from an average eight(8) employees per
branch, down to five(5).
Management recognized that before it could introduce new strategies for
the Bank's core business, it had to ensure that the organization was running
well at every level. By compressing the organization and putting emphasis on
process improvements, management eliminated waste, and improved on operational
efficiencies, which has been validated through improved audits.
To compete in its marketplace, the Bank must have sound business
strategies that will yield results. The recent past has enabled management to
place more emphasis on strategy, with keen focus on a sound organization. While
there was a conscientious effort to dismantle the original business model,
management recognized the positive aspects of the model - consistent core
(versatile) staffing, low cost of funds, loyal customer base, and strong net
interest margins. These strengths can be built upon as a new, productive model
formulates and moves into action.
As was described earlier, the Bank is now well-capitalized and is much
more streamlined. The goal is to develop more earning assets to achieve
profitability. In addition, although many changes have been made through
consolidations and compressions, management will continue to seek opportunities
for the Bank to operate more efficiently and cost-effectively.
17
The Bank's Goals
The Bank is a much stronger institution as a result of the aggressive
steps taken to decrease expenses, compress the organization, and strengthen
internal controls. The ultimate challenge for the institution has been to keep
the franchise vibrant while enhancing the business model. Continuing to surround
these new strategies and opportunities is a regulatory restraint that is
unyielding until the Bank produces a steady stream of earnings.
The primary goal during 2004 was to infuse new capital to further
stabilize the franchise and position it for growth. Management accomplished this
re-capitalization with gains of $1.9 million on sales of bank-owned real estate.
This new capital can support the Bank's asset growth to $100 million. The true
stability of the Bank will occur with positive growth trends in loans and
deposits, month-by-month, quarter-by-quarter, yielding annual sustainable core
profits.
The Bank will continue to focus on its niche business lines to include
the basic deposit and loan business, while developing relationships with several
corporate entities that have a commitment to community and economic development
in the urban sector. Strategic alliances and partnerships are key to the
economic strength of inner city neighborhoods. The Bank has begun to develop
these strategic alliances/partnerships to help ensure that the communities it
serves have full access to financial products and services.
Efforts will continue to attract additional corporate partners to join
the Bank's minority credit syndication business line to generate fee income. The
Bank focuses on corporations that have a particular interest in impacting urban
communities in a sustainable way. United Bank of Philadelphia has been able to
leverage its strength in community development in its attainment of such dynamic
corporate clients. It has attracted four(4) such clients and has a goal of
adding two(2) additional relationships in 2005.
While the Bank will continue to provide a full array of commercial
products and services, enhanced emphasis will be placed on the production of
consumer products through the Bank's financial service centers (branches). Some
products will be marketed solely by the Bank while others will be offered
through strategic and marketing alliances. Some of the products and services
that will be emphasized include the following:
o Auto Loans--A relationship with a direct marketing company will
continue with mailings taking place at agreed upon times
throughout the year. The goal is to attract consumers who may not
bank with the Bank through this marketing effort and to cross sell
other products including the opening of a deposit account.
o Residential Mortgages--Through its marketing alliance with a
Fortune 500 mortgage company, the Bank's customers will have
access to a full array of affordable mortgage products with
special incentives. This marketing alliance will give the Bank
name recognition in the mortgage arena thereby setting the stage
for the Bank to, in the future, originate mortgages under its own
marquee.
o Home Equity Loans--This product will receive heightened attention
with the co-branded advertising in conjunction with a Fortune 500
mortgage company. All home equity inquiries, as a result of the
add campaign, will be referred to the Bank.
The Bank will continue to underwrite commercial transactions as well as
participate with other banks in the region. The commercial portfolio will be
built through traditional loans as outlined:
o Working capital lines of credit
o Term loans
o Demand loans
o Commercial real estate (construction and permanent)
Church loans and small business loans are deemed the "bread and butter"
of loans for the Bank. United Bank of Philadelphia is working in collaborative
relationships to enhance volume. Some of these relationships include Small
Business Development Centers, religious adjudicators and various local banks.
18
Management's focus will continue to be on relationship banking. The goal is
to engage in a more aggressive marketing and advertising campaign to get the
Bank back into the marketplace and in the minds of the customers. Full advantage
will be taken of the co-branding opportunities with the Bank's strategic
alliances to increase the Bank's consumer loan business including brochures,
joint seminars, and other business development opportunities.
Results of Operations
Summary
In 2004, the Company recorded net income of approximately $1,647,000 ($1.54
per share) compared to a net loss of approximately $1,115,000 for 2003 ($1.03
per share) and a net loss of $217,000 for 2002 ($0.20 per share). The financial
results for the year ended December 31, 2004 included non-recurring income of
$1.9 million from the gain on the sale of the Bank's corporate headquarters and
an adjacent parking lot. Without this gain, the Bank would have experienced a
net loss of approximately $250,000 from its core operations.
Revenue enhancement strategies have been employed to expand opportunities
for fee income through the expansion of its products and services including
corporate loan syndications where the Bank serves in the role of arranger and/or
administrative agent. During 2004, the Bank generated fees totaling $178,000
from this line of business compared to $85,000 in 2003 and $25,000 in 2002.
Further growth in this new core line of business is projected in 2005.
Management continued the implementation of strategies to reduce expenses
including the closure/consolidation of its Two Penn Center Center City branch
office. The cost of the lease was scheduled to double at expiration. As part of
the Bank's profit restoration plan, upon expiration of the lease in July 2004,
this branch was closed and consolidated with other branches in the network to
further reduce operating costs.
While expense reductions continue to be achieved, a greater impact will be
realized with deposit growth and increased loan originations that build the
Bank's core earnings. Increased deposits will increase the Bank's ability to
fund and grow its earning assets while an increased loan-to-deposit ratio will
generally result in a higher net interest margin on those assets. Thus, while
continuing to control expenses, management will place more focus on the
implementation of business development strategies to achieve deposit and loan
growth as a means to achieve core profitability.
A more detailed explanation for each component of earnings is included in
the sections below.
19
Table 1--Average Balances, Rates, and Interest Income and Expense Summary
December 31,
2004 2003 2002
----------------------- ----------------------- ------------------------
Average Yield/ Average Yield/ Average Yield/
(Dollars in thousands) balance Interest rate balance Interest rate balance Interest rate
----------------------- ----------------------- ------------------------
Assets:
Interest-earning assets:
Loans........................... $46,037 $3,009 6.54% $45,168 $2,913 6.45% $42,839 $3,006 7.02%
Investment securities
held-to-maturity.............. 7,273 308 4.23 6,479 273 4.21 10,155 626 6.16
Investment securities
available-for-sale............ 5,488 252 4.59 9,393 532 5.66 13,783 831 6.03
Interest bearing balances
with other banks.............. 880 30 3.41 869 21 2.99 -- -- --
Federal funds sold.............. 6,244 87 1.39 8,498 98 1.15 10,406 169 1.62
------- ------ ------- ------ ------- ------
Total interest-earning assets 65,922 3,685 5.59 70,407 3,837 5.45 77,183 4,632 6.00
Noninterest-earning assets:
Cash and due from banks......... 3,708 4,438 4,542
Premises and equipment, net..... 2,006 2,679 2,613
Other assets.................... 2,726 3,922 2,926
Less allowance for loan losses.. (542) (713) (674)
------- ------- -------
Total........................ $73,820 $80,728 $86,590
======= ======= =======
Liabilities and shareholders' equity:
Interest-bearing liabilities:
Demand deposits................. $ 9,315 $ 49 0.53% $11,924 $ 83 0.70% $12,882 114 0.89%
Savings deposits................ 18,693 62 0.33 20,241 89 0.44 21,931 129 0.59
Time deposits................... 21,559 295 1.37 21,565 375 1.74 23,712 663 2.79
------- ------ ------- ------ ------- ------
Total interest-bearing
liabilities................. 49,567 406 0.82 53,730 547 1.02 58,525 906 1.55
Noninterest-bearing liabilities:
Demand deposits................. 16,306 18,439 19,565
Other........................... 193 -- --
Shareholders' equity................ 7,754 8,559 8,500
------- ------- -------
Total........................ $73,820 $80,728 $86,590
======= ======= =======
Net interest earnings............... $3,280 $3,290 $3,726
Net yield on interest-earning assets 4.98% 4.67% 4.83%
For purposes of computing the average balance, loans are not reduced for
nonperforming loans.
Net Interest Income
Net interest income is an effective measure of how well management has
balanced the Bank's interest rate-sensitive assets and liabilities. Net interest
income, the difference between (a) interest and fees on interest-earning assets
and (b) interest paid on interest-bearing liabilities, is a significant
component of the Bank's earnings. Changes in net interest income result
primarily from increases or decreases in the average balances of
interest-earning assets, the availability of particular sources of funds and
changes in prevailing interest rates.
Net interest income was $3,280,000 in 2004, a decrease of $10,000, or
..31%, compared to 2003. Net interest income totaled $3,290,000 in 2003, a
decrease of $436,000, or 11.70%, compared to 2002.
20
Table 2--Rate-Volume Analysis of Changes in Net Interest Income
2004 compared to 2003 2003 compared to 2002
----------------------------- -----------------------------
Increase (decrease) due to Increase (decrease) due to
----------------------------- -----------------------------
(Dollars in thousands) Volume Rate Net Volume Rate Net
------- ------- ------- ------- ------- -------
Interest earned on:
Loans............................................... $ 57 $ 39 $ 96 $ 151 $(244) $ (93)
Investment securities held-to-maturity.............. 33 2 35 (167) (186) (353)
Investment securities available-for-sale............ (219) (61) (280) (161) (117) (278)
Interest-bearing deposits with other banks 5 4 9
Federal funds sold............................... 8 (19) (11) (22) (49) (71)
----- ----- ----- ----- ----- -----
Total interest-earning assets.................... (116) (35) (151) (199) (596) (795)
----- ----- ----- ----- ----- -----
Interest paid on:
Demand deposits..................................... (13) (21) (34) (6) (25) (31)
Savings deposits................................... ( 5) (22) (27) (7) (33) (40)
Time deposits....................................... ( 1) (78) (79) (37) (251) (288)
Total interest-bearing liabilities............... (19) (121) (140) (50) (309) (359)
----- ----- ----- ----- ----- -----
Net interest income.............................. $ (97) $ 86 $ (11) $(149) $(287) $(436)
====== ===== ===== ===== ===== =====
Changes in interest income or expense not arising solely as a result of volume
or rate variances are allocated to rate variances due to the interest
sensitivity of consolidated assets and liabilities.
In 2004, there was a decrease in net interest income of $97,000 due to
changes in volume and an increase of $86,000 due to changes in rate. In 2003,
there was a decrease in net interest income of $149,000 due to changes in volume
and a decrease of $287,000 due to changes in rate.
Average earning assets decreased from $71 million in 2003 to $66
million in 2004 and decreased from $77 million in 2002 to $71 million in 2003.
From February 2000 to July 2004, in an effort to manage its capital adequacy,
the Bank did not aggressively seek significant deposit growth. In 2004, gains on
asset sales were used to re-capitalize the Bank and support growth and
profitability strategies. With the increase in the Bank's capital, the Bank is
now positioned for deposit growth. Current capital levels allow for
approximately $25 million in deposit growth while remaining compliant with
mandatory capital requirements outlined in its Written Agreement with its
regulators (See Regulatory Matters below).
The net interest margin of the Bank was 4.98% in 2004, 4.67% in 2003,
and 4.83% in 2002. Management actively manages its exposure to interest rate
changes. The Bank's deposit base includes many low cost core checking and
savings deposits that are not sensitive to rate changes. Thus, although there
were a series of short-term rate increases (in aggregate 125 basis points) by
the Federal Reserve in 2004, the Bank's cost of funds did not increase at the
same pace while floating rate assets including loans, investments and Federal
Funds Sold did increase.
During 2004, the average federal funds yield was 1.39% compared to
1.15% in 2003 and 1.62% in 2002. During 2004, the average investment in federal
funds decreased by $2.2 million. The reduction was a result of a $3.9 million
decline in the Bank's total deposits. In conjunction with its profit restoration
plan, the Bank closed its Two Penn Center branch office located in Center City
Philadelphia in July 2004. The Bank experienced some attrition primarily related
to its savings passbook customers because of the closure of the branch. Because
passbook customers must physically enter the branch to complete transactions,
electronic banking alternatives including ATMs and e-banking could not be used
to help retain the savings account deposits.
The yield on the investment portfolio decreased 52 basis points to
4.39% in 2004 compared to 4.81% in 2003 and 6.09% in 2002. The reduction in
yield is primarily a result of calls of higher yielding agency securities as
well as floating rate mortgage-backed securities that have Treasury and LIBOR
indices that repriced in a lower interest rate environment.
21
The cost of interest-bearing liabilities declined to 0.82% in 2004
compared to 1.02% in 2003 and 1.55% in 2002. Consistent with market conditions
through mid-year 2004, the Bank reduced the rates it pays on many of its
interest-bearing products. Although short-term interest rates subsequently
increased in 2004, increases in rates on the Bank's core deposits did not change
at the same pace. When setting the pricing for its deposits, the Bank generally
uses the median rate paid by its competitors in the region. Because most of the
Bank's deposits are considered core, they were not sensitive to rising interest
rates and generally lag market changes.
Provision for Loan Losses
The provision for loan losses is based on management's estimate of the
amount needed to maintain an adequate allowance for loan losses. This estimate
is based on the review of the loan portfolio, the level of net credit losses,
past loan loss experience, the general economic outlook and other factors
management feels are appropriate.
The net provision for loan losses charged against earnings in 2004 was
$45,000 compared to $565,000 in 2003 and $175,000 in 2002. In February 2004, the
Bank recovered $265,000 related to one previously charged-off commercial loan.
Of this recovery, the Bank credited $165,000 back to operations and retained
$100,000 in the allowance for loan losses as required by the reserve analysis
performed by management. The Bank made provisions to the allowance totaling
$210,000 for the year ended December 31, 2004.
In 2003, the Bank made provisions for loan losses totaling $565,000.
This level of provision was required because of the charge off of $710,000 that
represented the non-Small Business Administration (SBA) guaranteed portion of a
loan to one borrower in the telecommunications industry. Severe financial
difficulties experienced by the borrower made the full collection of this loan
uncertain. Loans to this borrower totaled $1.3 million. The Bank has presented
this loan to the SBA for collection of the guaranteed portion of the loans that
total $569,000 that represents the Bank's balance on the loan. The SBA
documentation review as relates to this loan is currently underway. Although the
Bank has charged-off a portion of this loan, management will seek to maximize
its recovery through appropriate legal action.
The Bank continues to monitor its credit quality very closely by
working with borrowers in an effort to identify and control credit risk.
Systematic provisions are made to the allowance for loan losses to cover
potential losses related to the Bank's classified loans. Management believes the
level of the allowance for loan losses is adequate as of December 31, 2004.
Noninterest Income
Noninterest income increased $1,764,000 in 2004 compared to 2003 and
decreased $436,000 in 2003 compared to 2002. In connection with its 2004
re-capitalization plan, the Bank sold bank-owned real estate including a remote
bank-owned parking lot and its corporate headquarters building located at 300 N.
Third Street. The sale of these assets resulted in a gain of approximately $1.9
million in 2004. In addition, the Bank sold approximately $786,000 of its
available-for-sale portfolio for a gain of approximately $31,000.
The amount of the Bank's noninterest income also reflects the volume of
transactional and other accounts handled by the Bank and includes such fees and
charges as low balance account charges, overdrafts, account analysis, and other
customer service fees. Customer service fees decreased $202,000 in 2004 compared
to 2003 and decreased $275,000 in 2003 compared to 2002 primarily because of a
reduction in activity fees on deposits and lower surcharge income on the Bank's
ATM network.
There was a $3.9 million decline in the Bank's deposit levels that
resulted in less overdraft fees, activity service charges and low balance fees.
Also, in December 2003, to avoid the necessity to escheat the balances of
inactive customer accounts, the Bank made an extensive effort to contact
customers to re-activate their accounts. The Commonwealth of Pennsylvania
requires that accounts that are inactive for five years or more be closed and
escheated to the state. This resulted in a reduction in ongoing activity/dormant
account service charges in 2004.
22
During 2004, surcharge income on the Bank's ATM network declined by
$100,000, or 14.30%, compared to 2003. Some of the Bank's ATMs have experienced
a drop in volume as competitors placed machines in close proximity to existing
high volume ATMs of the Bank and several of the Bank's high volume ATM's were
replaced with those of competitors that paid significantly higher transactional
fees to site owners. Management continues to seek potentially high volume
locations to place machines.
Beginning in 2002, the Bank began developing a new core line of
business--serving as arranger/agent for loan syndications for four major
corporations throughout the country. In this capacity, the Bank syndicates
back-up lines/letters of credit with other minority banks throughout the country
for the corporations for which it receives agent fees. In 2004 these fees
totaled $178,000 compared to $86,000 in 2003 and $25,000 in 2002. These fees
will be received annually for the administration of the credit facilities.
Management plans to continue to develop this core line of business to generate
fee income to support the Bank's profitability goals.
Noninterest Expense
Noninterest expense decreased $489,000, or 8.52% in 2004 compared to
2003 and decreased $363,000, or 5.96%, in 2003 compared to 2002.
Salaries and benefits decreased $269,000, or 12.21%, in 2004 compared
to 2003 and decreased $140,000, or 5.98%, in 2003 compared to 2002. As part of
the Bank's continued implementation of its Profit Restoration Plan, there have
been strategic reductions in staff, job consolidations, and a reduction in
salaries for certain employees to lower the level of personnel expense. Also, in
conjunction with the closure of its Two Penn Center branch office in July 2004,
there was attrition and layoffs that resulted in staff reductions. Management
continues its review of its staff to ensure the Bank is operating with the most
efficient organizational structure.
Occupancy and equipment expense decreased approximately $122,000, or 9.97%,
in 2004 compared to 2003 and decreased $69,000, or 5.34%, during 2003 compared
to 2002. Management continued the implementation of strategies to reduce its
occupancy expense including the closure/consolidation of its Two Penn Center
City branch office. The cost of the lease was scheduled to double at expiration.
As part of the Bank's profit restoration plan, upon expiration of the lease in
July 2004, this branch was closed and consolidated with other branches in the
network to further reduce operating costs. In addition, there was a reduction in
depreciation expense related to the Two Penn Center branch office for which
leasehold-related improvements and furniture became fully depreciated.
Also, in August 2003, the Bank purchased its 38th and Lancaster Street
Branch as a measure to reduce its occupancy expense. This branch had been leased
on a "triple net" basis where the Bank bore all expenses related to the
facility. The annual savings on this transaction was approximately $20,000.
Data processing expenses are a result of the management decision to
outsource a majority of its data processing operations to third party
processors. Such expenses are reflective of the high level of accounts being
serviced for which the Bank is charged a per account charge by processors. The
Bank experiences a higher level of data processing expenses relative to its peer
group because of the nature of its deposit base -- low average balance and high
transaction volume. In addition, the Bank uses outside loan servicing companies
to service its mortgage, credit card, and student loan portfolios.
Data processing expenses decreased by $99,000, or 15.00%, in 2004
compared to 2003 and increased by $40,000, or 6.45%, during 2003 compared to
2002. The decline in 2004 is primarily the result of the
conversion/consolidation of the consumer loan account processing (previously
outsourced to EDS) with its core vendor, FISERV. This conversion resulted in a
monthly savings of approximately $6,000. The Bank continues to study methods by
which it may further reduce its data processing cost.
23
Marketing and public relations expense decreased by $31,000, or 27.21%
in 2004 compared to 2003 and increased by $31,000, or 37.32%, in 2003 compared
to 2002. In 2003, to further enhance its image and encourage business
development, the Bank began a re-branding campaign that included, among other
things, new brochures and in-branch signage. To reduce expenses in 2004, the
Bank began to utilize co-branded marketing materials with its strategic
alliances. To reach the goals and objectives of retaining its existing customers
and attracting new customers and partners management continues to review a
variety of strategies including the following:
Advertising
|_| Management will seek cost-effective ways to advertise the Bank's
products and services. Community-based newspapers and other forms
of advertising that include the church bulletins in targeted
churches will be utilized.
Public Relations
|_| The Bank will seek innovative ways to get its story out to the
public. It will participate on talk radio programs, and use a
variety of methods such as special events to make the Bank's name
more visible.
Marketing
|_| The Bank will retain professional services to assist management
in creating a "buzz" about the Bank.
Office operations and supplies expense decreased by $41,000, or 9.11%,
in 2004 compared to 2003 and increased by $20,000, or 4.53%, in 2003 compared to
2002. In conjunction with the closure/consolidation of the Bank's Two Penn
Center financial service center in July 2004, reductions were experienced in
this category of expense including supplies and other costs associated with
branch operations.
Professional services increased by $18,000, or 8.28%, in 2004 compared
to 2003 and decreased by $63,000, or 22.18%, in 2003 compared to 2002. The
increase in 2004 is primarily related to an increase in the use of consultants.
The Bank used external consultants to assist with disaster recovery testing and
penetration testing associated with its computer systems. In 2004, the Bank used
consultants for human resource-related matters including the development of a
new employee performance management system and compensation/contract review for
the Bank's two executive officers. Also, in October 2004, the Bank engaged two
business development consultants to assist with developing loans and deposits
for the Bank.
Federal deposit insurance premiums were $72,000 in 2004, $34,000 in
2003, and $36,000 in 2002. FDIC insurance premiums are applied to all financial
institutions based on a risk based premium assessment system. Under this system,
bank strength is based on three factors: 1) asset quality, 2) capital strength,
and 3) management. Premium assessments are then assigned based on the
institution's overall rating, with the stronger institutions paying lower rates.
The Bank's assessment was based on 1.96 basis points for BIF (Bank Insurance
Fund) assessable deposits and SAIF (Savings Insurance Fund) assessable deposits.
While the Bank is "adequately" capitalized, the increase during 2004, is a
result of the perceived risk associated with the Bank's operating losses.
All other expenses are reflective of the general cost to do business
and compete in the current regulatory environment and maintenance of adequate
insurance coverage.
24
FINANCIAL CONDITION
Sources and Uses of Funds
The Bank's financial condition can be evaluated in terms of trends in its
sources and uses of funds. The comparison of average balances in Table 3 below
indicates how the Bank has managed these elements. Average funding uses
decreased approximately $4.5 million, or 6.37%, in 2004 compared to a decrease
of $7.6 million, or 9.8%, in 2003.
Table 3--Sources and Use of Funds Trends
2004 2003 2002
------------------------------- ------------------------------- ---------
Increase Increase
Average (decrease) Average (decrease) Average
(Dollars in thousands) balance amount Percent balance amount Percent balance
--------- -------- ------- --------- -------- ------- ---------
Funding uses:
Loans ............................. $46,037 $ 869 1.92% $45,168 $ 2,329 5.44% $42,839
Investment securities..............
Held-to-maturity................. 7,273 794 12.25 6,479 (3,676) (36.20) 10,155
Available-for-sale............... 5,488 (3,905) (41.57) 9,393 (4,390) (25.55) 13,783
Interest-bearing balances
with other banks............... 880 11 1.27 869 9 1.03 860
Federal funds sold............... 6,244 (2,254) (26.52) 8,498 (1,908) (18.34) 10,406
------- ------- ------- ------- -------
Total uses................... $65,922 $(4,485) $70,407 $(7,636) $78,043
======= ======= ======= ======= =======
Funding sources:
Demand deposits:
Noninterest-bearing.............. $16,306 $(2,133) (11.57)% $18,439 $(1,126) (5.76)% $19,565
Interest-bearing................. 9,315 (2,609) (21.88) 11,924 (958) (7.44) 12,882
Savings deposits................... 18,693 (1,548) (7.65) 20,241 (1,690) (7.70) 21,931
Time deposits...................... 21,559 (6) (.03) 21,565 (2,147) (9.05) 23,712
------- ------- ------- ------- -------
Total sources................ $65,873 $(6,296) $72,169 $(5,921) $78,090
======= ======= ======= ======= =======
* Includes held-to-maturity and available-for-sale securities
Investment Securities and Other Short-Term Investments
The Bank's investment portfolio is classified as either
held-to-maturity or available-for-sale. Investments classified as
held-to-maturity are carried at amortized cost and are those securities the Bank
has both the intent and ability to hold to maturity. Investments classified as
available-for-sale are those investments the Bank intends to hold for an
indefinite amount of time, but not necessarily to maturity, and are carried at
fair value, with the unrealized holding gains and losses reported as a component
of shareholders' equity on the balance sheet.
Average investment securities and federal funds sold, in the aggregate,
decreased by $5.4 million, or 22.01%, in 2004, compared to a decrease of $9.9
million, or 29.04% in 2003 compared to 2002. The significant decline in
investable funds was a result of a $6.3 million reduction in average deposit
balances and a $869,000 increase in average loans during the year. To fund the
reduction in deposits and the increase in loans, the Bank used federal funds
sold as well as proceeds from called agency securities and paydowns on its
mortgage-backed securities.
The Bank's current investment portfolio primarily consists of
mortgage-backed pass-through agency securities and other government-sponsored
agency securities. The Bank does not invest in high-risk securities or complex
structured notes. As reflected in Table 4 below, the average duration of the
portfolio is 3.07 years in 2004 compared to 2.78 years in 2003. In the current
rising interest rate environment, the duration of the investment portfolio is
slightly extended because of the reduction in the prepayment speed on the Bank's
mortgage-backed security portfolio.
25
Approximately 64% of the portfolio consists of mortgage-backed pass-through
securities that have longer-term contractual maturities but are sometimes paid
off/down before maturity or have repricing characteristics that occur before
final maturity. The Bank has attempted to minimize the repayment risk (risk of
very fast or very slow repayment) associated with these types of securities by
investing primarily in a number of seasoned mortgage pools for which there is a
repayment history. This history better enables the Bank to project the repayment
speeds of these pools. In addition, the Bank has minimized the interest rate
risk associated with these mortgage-backed securities by investing in a variety
of pools, many of which have variable rates with indices that track closely with
the current interest rate environment. Because customers are less likely to
refinance in the current rising interest rate environment, the prepayment speed
decreased on this component of the portfolio. The constant one year prepayment
rate (CPR) at December 31, 2003 was 42.93% compared to 24.06% at December 31,
2004. This translates into only 24.06% of the mortgage-backed pools repaying on
an annual basis. This results in significantly less monthly cash flow than was
received in 2003.
The Bank will continue to take steps to control the level of optionality in
the portfolio by identifying replacement loans or securities that diversify risk
and provide some level of monthly cashflow to be reinvested in the projected
rising rate environments. The Bank's strategy is to invest funds in hybrid
mortgage-backed securities that are fixed for three to ten years and then become
adjustable with the current market conditions. These securities have average
current yields of at least 4.00% and estimated durations of 5 years with monthly
cashflow.
Table 4--Analysis of Investment Securities
After one but After five but
Within one year within five years within ten years After ten years
--------------- ----------------- ---------------- ---------------
(Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Total
------ ----- ------ ----- ------ ----- ------ ----- ------
Other government securities...... $ - - % $3,000 3.46% $1,750 4.09% $ - - % $ 4,750
Mutual funds and other........... - - - - 336
Mortgage-backed securities....... - - - - 8,474
----- ------ ------ ------ -------
Total securities................. $ - $3,000 $1,750 - $13,560
Average maturity................. 3.07 years
The above table sets forth the maturities of investment securities at December
31, 2004 and the weighted average yields of such securities (calculated on the
basis of the cost and effective yields weighted for the scheduled maturity of
each security).
Loans
Average loans increased approximately $869,000, or 1.92%, in 2004
compared to 2003 and increased $2.3 million, or 5.44%, in 2003 compared to 2002.
During 2004, the Bank funded $11.4 million in new commercial loans. However,
growth in the loan portfolio was stymied by payoffs of some large loan
participations the Bank had with other financial institutions. In addition, the
Bank's mortgage loan portfolio declined by $4.4 million as a result of customers
with adjustable rate loans refinancing into fixed rate mortgages to avoid the
negative impact of anticipated rate hikes.
The Bank has developed relationships with other financial institutions
in the region with which it participates in loans as a strategy to stabilize and
grow its commercial loan portfolio. This strategy continues to be utilized while
the Bank enhances it own business development capacity. Approximately $2.7
million in commercial loan participations were booked during 2004. Most of these
participations were secured by commercial real estate.
The Bank's commercial loan pipeline remains strong as a result of
focused business development efforts. At December 31, 2004, the pipeline totaled
$3.8 million. Management continues to seek cost effective methods of developing
business including the use of external commissioned strategic business
development partners to refer loan transactions. This strategy allows for
increased loan origination activity without adding fixed personnel expense. In
addition to commercial loans, mortgage loans and other consumer loans including
home equity, automobile, student and credit card loans will be sought for growth
in the portfolio to allow for risk diversification.
26
The Bank's loan-to-deposit ratio at December 31, 2004 was 73.6%, up
from 69.6% at December 31, 2003. The target loan-to-deposit ratio is 75%. This
level would allow the Bank to optimize interest income on earning assets while
maintaining adequate liquidity. The increase in this ratio is the result of an
increase in loans outstanding coupled with a smaller deposit base.
As reflected in Table 5 below, because of the purchase of loan
participations and a significant level of commercial loan originations in 2004,
the Bank's loan portfolio is heavily concentrated in commercial loans (primarily
commercial real estate) that comprises approximately $28 million, or 60%, of
total loans. Continued payoffs in the residential mortgage loan portfolio
resulted in a reduction of this component of the portfolio from $15.1 million at
December 31, 2003 to $10.6 million at December 31, 2004.
In January 2005, the Bank sold $1,412,000 of its seasoned student loan
portfolio and recorded a gain of $25,000. These loans were sold to provide
liquidity for the funding of higher yielding less costly to service commercial
loans. At December 31, 2004, these loans are recorded as held-for-sale.
As reflected in Table 6 below, approximately 41% of the Bank's loan
portfolio have scheduled maturities or reprice in five years or more. This
position is largely a result of the Bank's relatively high level of residential
mortgage loans and the typical five to seven year balloon structure of the
commercial real estate portfolio. While scheduled maturities and repricing
exceed five years, the actual duration of the portfolio may be much shorter
because of changes in market conditions and refinancing activity.
Table 5--Loans Outstanding, Net of Unearned Income
December 31,
(Dollars in thousands) 2004 2003 2002 2001 2000
------- ------- ------- ------- -------
Commercial and industrial................... $15,217 $11,361 $10,855 $11,054 $11,429
Commercial real estate...................... 13,070 11,862 11,898 5,504 652
Residential mortgages....................... 10,665 15,110 13,560 18,148 22,316
Consumer loans.............................. 6,729 8,695 7,820 8,294 10,908
------- ------- ------- ------- -------
- - - -
------- ------- ------- ------- -------
Total loans............................. $45,681 $47,028 $44,133 $43,000 $45,305
======= ======= ======= ======= =======
Table 6--Loan Maturities and Repricing
Within After one but After
(Dollars in thousands) one year within five years five years Total
------------ ----------------- ---------- -------
Commercial and industrial................... $ 7,537 $ 3,789 $ 3,891 $15,217
Commercial real estate...................... 1,575 3,968 7,527 13,070
Residential mortgages....................... 643 3,876 6,146 10,665
Consumer loans.............................. 3,290 1,581 1,857 6,729
------ ------ ------ ------
Total loans........................... 13,045 13,214 19,421 45,681
Loans maturing after one year with:
Fixed interest rates.................... $ 25,865
Variable interest rates................. 6,770
Nonperforming Loans
Table 7 reflects the Bank's nonperforming and restructured loans for
the last five years. The Bank generally determines a loan to be "nonperforming"
when interest or principal is past due 90 days or more. If it otherwise appears
doubtful that the loan will be repaid, management may consider the loan to be
nonperforming before the lapse of 90 days. The Bank's policy is to charge off
unsecured loans after 90 days past due. Interest on nonperforming loans ceases
to accrue except for loans that are well collateralized and in the process of
collection. When a loan is placed on nonaccrual, previously accrued and unpaid
interest is reversed out of income unless adequate collateral from which to
collect the principal of, and interest on, the loan appears to be available.
27
Table 7--Nonperforming Loans
(Dollars in thousands) 2004 2003 2002 2001 2000
------- ------- ------- ------- -------
Nonaccrual loans............................ $1,366 $1,588 $ 651 $ 412 $ 453
Interest income included in net income
for the year............................ 22 62 25 25 20
Interest income that would have been
recorded under original terms........... 143 120 49 29 28
Loans past due 90 days and still accruing... 65 560 797 526 34
Restructured loans.......................... 1,411 569 1,286 182 632
At December 31, 2004, nonaccrual loans totaled $1,366,000 compared to
$1,588,000 at December 31, 2003. The decrease in 2004 is primarily related to
the payoff of residential mortgage loans that were non-performing in 2003. The
remaining nonaccrual loans are concentrated in the commercial loan sector of the
loan portfolio. At December 31, 2004, $888,000 of the Bank's nonaccrual loans
carried some level of guarantee from the Small Business Administration ("SBA").
The underlying credit enhancement provided by the SBA minimizes the risk of loss
on these loans
The balance of impaired loans was $1,034,000 and $1,124,000 as of
December 31, 2004 and 2003, respectively. The Bank identifies a loan as impaired
when it is probable that interest and principal will not be collected according
to the contractual terms of the loan agreement. The allowance for loan loss
associated with these loans was $259,000 and $75,000 at December 31, 2004 and
2003, respectively.
At December 31, 2004, approximately $888,000 of the impaired loans have
SBA guarantees. There was no interest recognized on impaired loans in 2004.
Interest income recognized on impaired loans in 2003 was $69,000. The Bank
recognizes income on impaired loans under the cash basis when the loans are both
current and the collateral on the loan is sufficient to cover the outstanding
obligation to the Bank. If these factors do not exist, the Bank will not
recognize income on such loans.
From time to time, management will modify or restructure the terms of
certain loans to provide relief to borrowers. Restructured loans are those loans
whose terms have been modified because of deterioration in the financial
condition of a borrower to provide for a reduction of either interest or
principal, regardless of whether such loans are secured or unsecured and
regardless of whether such credits are guaranteed by the government or by
others. As of December 31, 2004, the Bank had approximately $1,411,000 in
restructured loans.
There is no known information about possible credit problems other than
those classified as nonaccrual or impaired that causes management to be
uncertain as to the ability of any borrower to comply with present loan terms.
The Bank grants commercial, residential, and consumer loans to
customers primarily located in Philadelphia County, Pennsylvania and surrounding
counties in the Delaware Valley. Although the Bank has a diversified loan
portfolio, its debtors' ability to honor their contracts is influenced by the
region's economy.
At December 31, 2004, approximately 18% of the commercial loan
portfolio of the Bank was concentrated in loans made to religious organizations.
From inception, the Bank has received support in the form of investments and
deposits and has developed strong relationships with the Philadelphia region's
religious community. Loans made to these organizations were primarily for
expansion and repair of church facilities. At December 31, 2004, none of these
loans were nonperforming.
Allowance for Loan Losses
The allowance for loan losses reflects management's continuing
evaluation of the loan portfolio, assessment of economic conditions, the
diversification and size of the portfolio, adequacy of collateral, past and
anticipated loss experience, and the amount and quality of nonperforming loans.
Table 8 below presents the allocation of loan losses by major category for the
past five years. The specific allocations in any particular category may prove
to be excessive or inadequate and consequently may be reallocated in the future
to reflect then current conditions.
28
The allowance for loan losses as a percentage of total loans was 1.28% at
December 31, 2004 compared to 0.72% at December 31, 2003. In 2004, the Bank
recovered $265,000 related to one previously charged-off commercial loan. Of
this recovery, the Bank credited $165,000 back to operations and retained
$100,000 in the allowance for loan losses. The Bank made provisions to the
allowance totaling $210,000 during the year ended December 31, 2004. The Bank
continues to proactively monitor its credit quality while working with borrowers
in an effort to identify and control credit risk.
At December 31, 2004, the Bank's classified loans totaled $1.2 million, or
2.50%, of total loans. Approximately, $888,000 of these loans have guarantees of
the SBA. In addition, specific reserves of $324,000 have been allocated to these
loans.
Table 8--Allocation of Allowance for Loan Losses
2004 2003 2002 2001 2000
------------------- ------------------- ------------------- ------------------- -------------------
Percent Percent Percent Percent Percent
of loans of loans of loans of loans of loans
in each in each in each in each in each
category to category to category to category to category to
Amount total loans Amount total loans Amount total loans Amount total loans Amount total loans
------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
Commercial and
industrial......... $ 424 32.31% $ 267 24.16% $ 565 24.60% $ 576 37.30% $ 383 25.23%
Commercial real
estate............. 49 27.75 -- 25.22 37 26.96 29 1.21 11 1.44
Residential mortgages 14 17.29 35 18.49 45 17.72 30 19.29 102 24.08
Consumer loans........ 110 22.65 37 32.13 28 30.72 73 42.20 66 49.25
Unallocated........... 6 -- -- -- -- -- -- -- -- --
----- ------ ----- ------ ----- ------ ----- ------ ----- ------
$ 603 100.00% $ 339 100.00% $ 675 100.00% $ 708 100.00% $ 562 100.00%
===== ====== ===== ====== ===== ====== ===== ====== ===== ======
Management believes that the allowance for loan losses is adequate.
While management uses available information to recognize losses on loans, future
additions may be necessary based on changes in economic conditions. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to recognize additions to the allowance based on their
judgments of information available to them at the time of the examination.
Table 9--Analysis of Allowance for Loan Losses
Year ended December 31,
-----------------------
(Dollars in thousands) 2004 2003 2002 2001 2000
------- ------- ------- -------- -------
Balance at January 1....................... $ 339 $ 675 $ 708 $ 562 $ 1,567
Charge-offs:
Commercial and industrial.............. (799) -- (61) (321)
Commercial real estate................. -- (100) -- (803)
Residential mortgages.................. -- - -- --
Consumer loans......................... (240) (174) (261) (261) (597)
------ ------ ------ ------ ------
(240) (973) (361) (322) (1,721)
------ ------ ------ ------ ------
Recoveries--commercial loans................ 265 -- -- -- --
Recoveries--consumer loans.................. 194 72 126 133 151
------ ------ ------ ------ ------
459 72 153 133 151
Net recoveries (charge-offs)............... 219 (901) (208) (189) (1,570)
Provisions charged to operations........... 45 565 175 335 565
------- ------ ------ ------ -------
Balance at December 31..................... $ 603 $ 339 $ 675 $ 708 $ 562
====== ====== ====== ====== =======
Ratio of net (recoveries) charge-offs to
average loans outstanding.............. (0.49%) 1.99% 0.49% 0.41% 2.84%
29
The amount charged to operations and the related balance in the
allowance for loan losses are based upon the periodic evaluations of the loan
portfolio by management. These evaluations consider several factors, including,
but not limited to, general economic conditions, loan portfolio composition,
prior loan loss experience, and management's estimate of future potential
losses.
Deposits
Average deposits declined approximately $6.3 million, or 8.72%, in 2004
compared to 2003, and declined $6 million, or 7.70%, in 2003 compared to 2002.
The primary area of decline was in demand deposit accounts that decreased on
average by $4.7 million, or 15.61%, compared to 2003. This decrease was
primarily related to one significant deposit relationship with a
quasi-governmental organization. However, the Bank subsequently received
deposits in the form of laddered certificates of deposit (maturities ranging
from 3 months to 12 months) totaling $3.6 million from the same organization.
The Bank also experienced a decline of $1.5 million, or 7.65%, in its
average savings deposits during 2004 In July 2004, the Bank closed its 2 Penn
Center Office located in Center City Philadelphia. The closure of this branch
resulted in some savings passbook account attrition. Because passbook customers
must physically enter the branch to complete transactions, electronic banking
alternatives including ATMs and e-banking could not be used to help retain the
savings account deposits.
Average certificates of deposit were relatively unchanged from 2003 to
2004. The Bank experienced the maturity of certificates of deposit related to a
Bank Enterprise (BEA) program of the U.S. Treasury Department where it received
deposits from other community development financial institutions. These
certificates had a term of three years and were non-renewable. However, the
laddered certificates of the quasi-governmental organization referred to above
offset these maturities.
With the increase in the Bank's capital from gains on asset sales, the
Bank is now positioned for deposit growth. Current capital levels allow for
approximately $25 million in deposit growth and still remain compliant with
mandatory capital requirements outlined in its Written Agreement with its
regulators (See Regulatory Matters below). New business development strategies
have been implemented that include the leveraging the strategic
partnerships/alliances the Bank has developed to cross-sell its products and
services. In addition, the Bank will engage in a strategic marketing/advertising
campaign to generate new business including loans, deposits and other
fee-related services.
Table 10--Average Deposits by Class and Rate
2004 2003 2002
----------------- ----------------- -----------------
(Dollars in thousands) Amount Rate Amount Rate Amount Rate
----------------- ----------------- -----------------
Noninterest-bearing demand deposits $16,306 -- % $18,439 -- % $19,565 -- %
Interest-bearing demand deposits 9,315 0.53 11,924 0.70 12,882 0.89
Savings deposits 18,695 0.33 20,241 0.44 21,931 0.59
Time deposits 21,559 1.37 21,565 1.74 23,712 2.7
Other Borrowed Funds
The Bank did not borrow funds during 2004. Generally, the level of
other borrowed funds is dependent on many items such as loan growth, deposit
growth, customer collateral/security requirements and interest rates paid for
these funds. The Bank's liquidity has been enhanced by loan paydowns/payoffs and
called investment securities -- thereby, reducing the need to borrow.
30
Off Balance Sheet Arrangements
The Bank is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and letters of
credit, which are conditional commitments issued by the Bank to guarantee the
performance of an obligation of a customer to a third party. Both arrangements
have credit risk essentially the same as that involved in extending loans and
are subject to the Bank's normal credit policies. Collateral may be obtained
based on management's assessment of the customer. The Bank's exposure to credit
loss in the event of nonperformance by the other party to the financial
instruments is represented by the contractual amount of those instruments.
Summaries of the Bank's financial instrument commitments are as follows:
2004 2003
------------ ------------
Commitments to extend credit..... $13,749,562 $ 8,152,988
Outstanding letters of credit.... -- 32,155
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract and
unused credit card lines. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. Commitments generally have fixed expiration
dates or other termination clauses and may require payment of a fee.
Liquidity and Interest Rate Sensitivity Management
The primary functions of asset/liability management are to assure
adequate liquidity and maintain appropriate balance between interest-sensitive
earning assets and interest-bearing liabilities. Liquidity management involves
the ability to meet cash flow requirements of customers who may be either
depositors wanting to withdraw funds or borrowers needing assurance that
sufficient funds will be available to meet their credit needs. Interest rate
sensitivity management seeks to avoid fluctuating net interest margins and
enhance consistent growth of net interest income through periods of changing
interest rates.
The Bank is required to maintain minimum levels of liquid assets as
defined by Federal Reserve Board ("FRB") regulations. This requirement is
evaluated in relation to the composition and stability of deposits; the degree
and trend of reliance on short-term, volatile sources of funds, including any
undue reliance on particular segments of the money market or brokered deposits;
any difficulty in obtaining funds; and the liquidity provided by securities and
other assets. In addition, consideration is given to the nature, volume and
anticipated use of commitments; the adequacy of liquidity and funding policies
and practices, including the provision for alternate sources of funds; and the
nature and trend of off-balance-sheet activities. As of December 31, 2004,
management believes the Bank's liquidity is satisfactory and in compliance with
FRB regulations.
The Bank's principal sources of asset liquidity include investment
securities consisting primarily of U.S. Government and agency issues,
particularly those of shorter maturities, and mortgage-backed securities with
monthly repayments of principal and interest. There are no securities maturing
in one year or less. However, other types of assets such as federal funds sold,
as well as maturing loans, are sources of liquidity. Approximately $13 million
in loans are scheduled to mature within one year.
The Bank's overall liquidity has been enhanced by a significant level
of core deposits which management has determined are less sensitive to interest
rate movements. The Bank has avoided reliance on large-denomination time
deposits as well as brokered deposits. Table 11 provides a breakdown of the
maturity of time deposits of $100,000 or more.
31
Table 11--Maturity of Time Deposits of $100,000 or More
(Dollars in thousands)
3 months or less................. $ 8,363
Over 3 through 6 months.......... 5,125
Over 6 months through 1 year..... --
Over 1 through five years........ 153
Over five years.................. --
-------
Total............................ $13,641
=======
The following table sets forth contractual obligation and other commitments
representing required and potential cash outflows as of December 31, 2004:
Table 12--Contractual Obligations and Other Commitments
Less than One to Four to After
(Dollars in thousands) Total one year three years five years five year
--------- --------- ----------- ---------- ---------
Certificates of Deposit....... $23,807 $22,100 $ 1,543 $ 65 $ 99
Rental Obligations ........... 2,080 183 676 177 1,044
------- ------- ------- ------ -------
Total .................... $25,887 $22,283 $ 2,219 $ 242 $ 1,143
======= ======= ======= ====== =======
In February 2005, the Bank entered into a 10-year lease for its new
corporate headquarters located at The Graham Building in Center City
Philadelphia. As reflected in Table 12 above, this transaction is included in
the Bank's long-term rental obligations.
Interest rate sensitivity varies with different types of interest-earning
assets and interest-bearing liabilities. Overnight federal funds on which rates
change daily and loans that are tied to prime or other short-term indices differ
considerably from long-term investment securities and fixed-rate loans.
Similarly, time deposits are much more interest-sensitive than passbook savings
accounts. The shorter-term interest rate sensitivities are key to measuring the
interest sensitivity gap or excess interest-earning assets over interest-bearing
liabilities. Management of interest sensitivity involves matching repricing
dates of interest-earning assets with interest-bearing liabilities in a manner
designed to optimize net interest income within the limits imposed by regulatory
authorities, liquidity determinations and capital considerations. Table 13 sets
forth the earliest repricing distribution of the Bank's interest-earning assets
and interest-bearing liabilities at December 31, 2004, the Bank's interest rate
sensitivity gap ratio (i.e., excess of interest rate-sensitive assets over
interest rate-sensitive liabilities, divided by total assets) and the Bank's
cumulative interest rate sensitivity gap ratio. For purposes of the table,
except for savings deposits, an asset or liability is considered rate-sensitive
within a specified period when it matures or could be repriced within such
period in accordance with its contractual terms. At December 31, 2004, an asset
sensitive position is maintained on a cumulative basis through one year of
0.50%. This level is within the Bank's policy guidelines of +/-15% on a
cumulative one-year basis. The current gap position is indicative of the Bank
being relatively neutrally positioned for any change in interest rates. Interest
rate risk is minimized by the Bank's high level of core deposits that have been
placed in shorter repricing intervals. Generally, because of the Bank's slightly
positive gap position in shorter time frames, the Bank can anticipate that
increases in market rates will have a positive impact on the net interest
income, while decreases will have the opposite effect.
For purposes of the gap analysis, such deposits (savings, MMA, NOW) which
do not have definitive maturity dates and do not readily react to changes in
interest rates have been placed in longer repricing intervals versus immediate
repricing time frames, making the analysis more reflective of the Bank's
historical experience.
32
Table 13--Interest Sensitivity Analysis
Interest rate sensitivity gaps as of December 31, 2004
------------------------------------------------------
Over
Over 1 year Over
3 months 3 through through 3 through Over
(Dollars in thousands) or less 12 months 3 years 5 years 5 years Cumulative
- ---------------------- -------- --------- ------- ------- ------- ----------
Interest-sensitive assets:
Interest-bearing deposits with banks. $ $ 889 $ $ $ $ 889
Investment securities................ 3,662 2,182 2,085 1,491 3800 13,221
Federal funds sold................... 3,727 3,727
Loans held-for-sale.................. 1,412 1,412
Loans................................ 15,350 8,164 7,191 4,322 10,654 45,077
------ ------ ----- ----- ------ -------
Total interest-sensitive assets.... 24,151 11,235 9,276 5,813 14,454 $64,929
------ ------ ----- ----- ------ =======
Cumulative totals.................. 24,151 35,386 44,662 50,475 64,929
------ ------ ------ ------ ------
Interest rate sensitivity gaps as of December 31, 2004
------------------------------------------------------
Over
Over 1 year Over
3 months 3 through through 3 through Over
(Dollars in thousands) or less 12 months 3 years 5 years 5 years Cumulative
- ---------------------- -------- --------- ------- ------- ------- ----------
Interest-sensitive liabilities:
Interest checking accounts........... 2,079 2,079 4,158
Savings accounts..................... 10,884 10,884 21,768
Certificates $100,000 or more....... 8,363 5,125 153 13,641
Certificates of less than $100,000 .. 3,353 5,259 1,163 391 10,166
------- ------- ------- ------- ------- -------
Total interest-sensitive liabilities $24,679 $10,384 $14,279 $ 391 $ -- $49,733
======= ======= ======= ======= ======= =======
Cumulative totals.................. $24,679 $35,063 $49,342 $49,733 $49,733
======= ======= ======= ======= =======
Interest sensitivity gap................. $ (528) $ 851 $(5,003) $ 5,422 $14,454
======= ======= ======= ======= =======
Cumulative gap........................... (528) 323 (4,680) 742 15,196
Cumulative gap/total earning assets...... 0.81% 0.50% 7.20% 1.14% 23.40%
Interest-sensitive assets to
interest-sensitive liabilities........ 0.98 1.01 0.65 14.87 --
- ----------
Core deposits such as checking and savings deposits have been placed in
repricing intervals based on historical trends and management's estimates.
While using the interest sensitivity gap analysis is a useful management
tool as it considers the quantity of assets and liabilities subject to repricing
in a given time period, it does not consider the relative sensitivity to market
interest rate changes that are characteristic of various interest rate-sensitive
assets and liabilities. Consequently, even though the Bank currently has a
positive gap position because of unequal sensitivity of these assets and
liabilities, management believes this position will not materially impact
earnings in a changing rate environment. For example, changes in the prime rate
on variable commercial loans may not result in an equal change in the rate of
money market deposits or short-term certificates of deposit. A simulation model
is therefore used to estimate the impact of various changes, both upward and
downward, in market interest rates and volumes of assets and liabilities on the
net income of the Bank. The calculated estimates of net income or "earnings" at
risk at December 31, 2004 are as follows:
33
Net interest Percent of
Changes in rate income change
--------------- ------ ------
(Dollars in thousands)
+200 basis points $ 3,310 0.58%
+100 basis points 3,291 0.76
Flat rate 3,266 --
-100 basis points 3,223 1.32
-200 basis points 3,151 2.23
A simulation model is also used to estimate the impact of various changes,
both upward and downward, in market interest rates and volumes of assets and
liabilities on the economic value of the Bank. This model produces an interest
rate exposure report that measures the long-term rate risks in the balance sheet
by valuing the Bank's assets and liabilities at market. It simulates what amount
would be left over if the Bank liquidated its assets and liabilities. This is
otherwise known as "economic value" of the capital of the Bank. The calculated
estimates of economic value at risk at December 31, 2004 are as follows:
MV of equity as a %
Changes in rate MV equity of MV of assets
--------------- --------- ---------------
(Dollars in thousands)
+200 basis points $ 6,237 9.0%
+100 basis points 7,568 10.7
Flat rate 8,857 12.2
-100 basis points 9,832 13.3
-200 basis points 10,570 14.1
The market value of equity may be impacted by the composition of the
Bank's assets and liabilities. A shift in the level of variable versus fixed
rate assets will create swings in the market value of equity. The Bank's market
value of equity declines in a rising rate environment because of the high level
of fixed rate loans and investments it has in its portfolio that do not follow
market rate changes.
The assumptions used in evaluating the vulnerability of the Bank's
earnings and equity to changes in interest rates are based on management's
consideration of past experience, current position and anticipated future
economic conditions. The interest sensitivity of the Bank's assets and
liabilities, as well as the estimated effect of changes in interest rates on the
earnings and equity, could vary substantially if different assumptions are used
or actual experience differs from the assumptions on which the calculations were
based.
The Bank's Board of Directors and management consider all of the
relevant factors and conditions in the asset/liability planning process.
Interest rate exposure is not significant and is within the policy limits of the
Bank at December 31, 2004. However, if significant interest rate risk arises,
the Board of Directors and management may take, but are not limited to, one or
all of the following steps to reposition the balance sheet as appropriate:
1. Limit jumbo certificates of deposit and movement into money market
deposit accounts and short-term certificates of deposit through
pricing and other marketing strategies.
2. Purchase quality loan participations with appropriate interest
rate/gap match for the Bank's balance sheet.
3. Restructure the Bank's investment portfolio.
The Board of Directors has determined that active supervision of the
interest rate spread between yield on earning assets and cost of funds will
decrease the Bank's vulnerability to interest rate cycles.
34
Capital Resources
Total shareholders' equity increased $1.6 million in 2004 compared to
2003. The increase is primarily related to gains realized on the sale of
bank-owned real estate totaling $1.9 million.
The Bank's Capital Planning Committee, consisting of four outside
directors and the Bank's two executive officers, is charged to explore all
available options for capital infusion. The Board and management have a
heightened sensitivity to this area and recognize that the lack of proper
capital levels can threaten the viability and growth of the institution. In
2004, aggressive steps were taken to address this matter. The first step
included the sale of a remote bank-owned parking lot in April 2004. This sale
resulted in a net gain of $368,000. The second step included the sale of the
Bank's Corporate Headquarters Building located at 300 N. Third Street,
Philadelphia, PA. This sale was completed in July 2004 on which the Bank
realized a gain of $1.5 million.
While gains on asset sales were used to re-capitalize the Bank and
support growth and profitability strategies, The next phase of capital
generation will focus on retained earnings--attaining continuous profitability
from the Bank's core operations---loan and deposit growth.
The FRB standards for measuring capital adequacy for U.S. Banking
organizations require that banks maintain capital based on "risk-adjusted"
assets so that categories of assets with potentially higher risk will require
more capital backing than assets with lower risk. In addition, banks are
required to maintain capital to support, on a risk-adjusted basis, certain
off-balance-sheet activities such as loan commitments. The FRB standards
classify capital into two tiers, referred to as Tier I and Tier II. Tier I
consists of common shareholders' equity (excluding net unrealized holding gains
on available for sale securities), noncumulative and cumulative perpetual
preferred stock, and minority interests less goodwill and/or intangible assets).
Tier II capital consists of allowance for loan losses, hybrid capital
instruments, term subordinated debt, and intermediate-term preferred stock.
Banks are required to meet a minimum ratio of 8% of qualifying capital to
risk-adjusted total assets with at least 4% Tier I capital and a Tier I leverage
ratio of at least 6%. Capital that qualifies as Tier II capital is limited to
100% of Tier I capital.
As indicated in Table 14, the Company's risk-based capital ratios are
above the minimum requirements. Management continues the objective of raising
additional capital by offering additional stock (preferred and common) for sale
in a private offering as well as increasing the rate of internal capital growth
as a means of maintaining the required capital ratios. However, the Bank's
growth, operating losses and the need for additional provisions to the allowance
for loan losses may have an adverse effect on its capital ratios. UBS and the
Bank do not anticipate paying dividends in the near future.
Table 14--Capital Ratios
(Dollars in thousands) 2004 2003 2002
------- -------- -------
Total Capital ................................ $ 8,812 $ 7,235 $ 8,263
Less: Intangible Assets/Net unrealized
gains (losses) on available for sale ...... (1,578) (1,826) (1,937)
-------- -------- --------
Tier I capital ............................... 7,234 5,409 6,326
Tier II capital .............................. 544 339 528
-------- -------- --------
Total qualifying capital ..................... $ 7,778 $ 5,748 $ 6,854
======== ======== ========
Risk-adjusted total assets
(including off-balance-sheet exposures) .... $ 43,436 $ 44,971 $ 42,104
======== ======== ========
Tier I risk-based capital ratio .............. 16.65% 12.03% 15.02%
Total (Tier I and II) risk-based capital ratio 17.91% 12.78% 16.28%
Tier I leverage ratio ........................ 9.89% 7.19% 7.46%
35
Regulatory Matters
In February 2000, as a result of a regulatory examination completed in
December 1999, the Bank entered into a Written Agreement with its primary
regulators with regard to, among other things, achievement of agreed-upon
capital levels, implementation of a viable earnings/strategic plan, adequate
funding of the allowance for loan losses, the completion of a management review
and succession plan, and improvement in internal controls. The Agreement
required the Bank to increase its capital ratio to 6.5% by June 30, 2000 and to
7% at all times thereafter. As of December 31, 2000, the Bank had met the
required ratios by implementing strategies that included: reducing expenses,
consolidating branches, and soliciting new and additional sources of capital.
Management continues to address all matters outlined in the Agreement.
As of December 31, 2003, the Bank's tier one leverage capital ratio
fell to 6.81%, below the 7% minimum capital ratio required by the Agreement.
However, at February 29, 2004, the tier one leverage ratio had improved to 7.29%
as a result of a $265,000 recovery on a previously charged-off loan. At December
31, 2004, the Bank's tier one leverage ratio had further improved to 9.49% as a
result of the re-capitalization strategies that included gains on the sale of
Bank-owned real estate discussed above. Management continues to review and
revise its capital plan to address the development of new equity. The most
productive of which is to increase capital through sustained core earnings. The
Bank's plan projects this occurrence in 2005.
A regulatory examination completed in February 2004 determined that the
Bank was not in compliance certain other elements of the Agreement including the
implementation of a viable earnings/strategic plan and the timely
charge-off/funding of the allowance for loan losses. Management believes that it
has implemented corrective action where necessary including the adoption of an
achievable strategic plan for 2005. As a result, Management believes that the
Bank is "substantially" in compliance with the Agreement's terms and conditions.
Failure to comply could result in additional regulatory supervision and/or
actions. See also "Regulatory Action" above.
Recent Accounting Pronouncements
In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or
Certain Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with
the evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the
Company will be unable to collect all contractually required payments
receivable. SOP 03-3 requires that the Company recognize the excess of all cash
flows expected at acquisition over the investor's initial investment in the loan
as interest income on a level-yield basis over the life of the loan as the
accretable yield. The loan's contractual required payments receivable in excess
of the amount of its cash flows excepted at acquisition (nonaccretable
difference) should not be recognized as an adjustment to yield, a loss accrual
or a valuation allowance for credit risk. SOP 03-3 is effective for loans
acquired in fiscal years beginning after December 31, 2004. Early adoption is
permitted. The Company does not expect the adoption to have a material impact on
the consolidated financial statements, results of operations or liquidity.
The SEC recently released Staff Accounting Bulletin No.105, Application
of Accounting Principles to Loan Commitments. SAB 105 provides guidance about
the measurement of loan commitments recognized at fair value under FASB
Statement No. 133, Accounting for Derivative Instruments and Hedging Activities.
SAB 105 also requires companies to disclose their accounting policy for those
loan commitments including methods and assumptions used to estimate fair value
and associated hedging strategies. SAB 105 is effective for all loan commitments
accounted for as derivatives that are entered into after March 31, 2004. The
adoption of SAB 105 did not have a material effect on the Company's consolidated
financial statements.
In December 2004, the FASB issued SFAS No. 123 (Revised), "Share-Based
Payment" ("SFAS No. 123(R)"),establishing accounting standards for transactions
in which an entity exchanges its equity instruments for goods or services. SFAS
No. 123(R) also addresses transactions in which an entity incurs liabilities in
exchange for goods or services that are based on the fair value of the entity's
equity instruments. SFAS No. 123(R) covers a wide range of share-based
compensation arrangements including stock options, restricted stock plans,
performance-based stock awards, stock appreciation rights, and employee stock
purchase plans. SFAS No. 123(R) replaces existing requirements under SFAS No.
123, "Accounting for Stock-Based Compensation," and eliminates the ability to
account for share-based compensation transactions using APB Opinion No. 25. The
provisions for SFAS No. 123(R) are effective for the Company on July 1, 2005.
The Company is currently assessing the financial statement impact of adopting
SFAS No. 123(R).
36
In November 2003, the Emerging Issues Task Force (EITF) of the FASB
issued EITF Abstract 03-1, The Meaning of Other-Than-Temporary Impairment and
its Application to Certain Investments (EITF 03-1). The quantitative and
qualitative disclosure provisions of EITF 03-1 were effective for years ending
after December 15, 2003 and were included in the Company's 2003 Form 10-K. In
March 2004, the EITF issued a Consensus on Issue 03-1 requiring that the
provisions of EITF 03-1 be applied for reporting periods beginning after June
15, 2004 to investments accounted for under SFAS No. 115 and 124. EITF 03-1
establishes a three-step approach for determining whether an investment is
considered impaired, whether that impairment is other-than-temporary, and the
measurement of an impairment loss. In September 2004, the FASB issued a proposed
Staff Position, EITF Issue 03-1-a, Implementation Guidance for the Application
of Paragraph 16 of EITF 03-1 (EITF 03-1-a). EITF 03-1-a would provide
implementation guidance with respect to debt securities that are impaired solely
due to interest rates and/or sector spreads and analyzed for
other-than-temporary impairment under paragraph 16 of EITF 03-1. In September
2004, the FASB issued a Staff Position, EITF Issue 03-1-1, Effective Date of
Paragraphs 10-20 of EITF Issue No. 03-1 (EITF 03-1-1). FSP EITF Issue No.
03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, "The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain Investments"
delays the effective date of certain provisions of EITF Issue 03-1, including
steps two and three of the Issue's three-step approach for determining whether
an investment is other-than-temporarily impaired. However step one of that
approach must still be initially applied for impairment evaluations in reporting
periods beginning after June 15, 2004. The delay of the effective date for
paragraphs 10-20 of EITF Issue 03-1 will be superseded with the final issuance
of proposed FSP EITF Issue 03-1-a, Implementation Guidance for the Application
of Paragraph 16 of EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary
Impairment and Its Application to Certain Investments". The Company is in the
process of determining the impact that this EITF will have on its financial
statements.
ITEM 7A -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The financial information required by this Item 7A is incorporated by
reference to page 31 of this Report, the Liquidity and Interest Rate
Sensitivity Management provisions and pages 32 to 34 of this Report,
including Table 13 the Interest Sensitivity Analysis Table of this Report.
ITEM 8 -- FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Consolidated Financial Statements on pages 53 to 56 hereof.
37
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
Change in Accountants
On December 16, 2004, UBS dismissed Grant Thornton, LLP as its independent
registered public accounting firm and retained McGladrey & Pullen, Certified
Public Accounts, as its new independent registered public accounting firm on
December 16, 2004 to audit UBS' financial statements. The decision to change
independent accountants was made by the Audit Committee of UBS' Board of
Directors, because of the costs savings, which will be realized by appointing
McGladrey & Pullen as its independent accountants to audit UBS' financial
statements.
The independent registered public accounting firm report issued by
Grant Thornton, LLP on the financial statements of UBS for the two years ended
December 31, 2003 and 2002 did not contain an adverse opinion or a disclaimer of
opinion, nor were they modified as to uncertainty, audit scope or accounting
principles, except that its report on UBS' financial statements for the year
ended December 31, 2003, contained an explanatory paragraph indicating that
substantial doubt exists about UBS' ability to continue as a going concern.
The decision to change independent public accountants was made by the
Audit Committee of UBS' Board of Directors on December 16, 2004.
During each of the fiscal years ended December 31, 2002 and 2003 and
subsequent interim periods through December 16, 2004, there were no
disagreements between UBS and Grant Thornton, LLP on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure, which disagreement(s), if not resolved to the satisfaction of Grant
Thornton, LLP would have caused it to make reference to the subject matter of
the disagreement(s) in connection with its reports; and there were no
"reportable events" as that term is used in Item 304 (a)(1)(iv) of Regulation
S-K occurring within UBS two (2) most recent fiscal years and the subsequent
interim periods through December 16, 2004. UBS has provided Grant Thornton, LLP
with a copy of the foregoing disclosures and has requested that Grant Thornton,
LLP review such disclosures and furnish a letter addressed to the Securities and
Exchange Commission stating whether Grant Thornton, LLP agree with such
statements. A copy of Grant Thornton, LLP's letter response to such request is
attached hereto as Exhibit 16.
New Independent Accountants
UBS engaged McGladrey & Pullen as its new independent public accountants
to audit UBS' financial statements as of December 16, 2004, for the fiscal year
ended December 1, 2004 and until a new independent public accounting firm is
appointed by UBS' Board of Directors. During the fiscal years ended December 31,
2002 and 2003 and subsequent interim periods through December 16, 2004, neither
UBS or any one on UBS' behalf has consulted with McGladrey & Pullen regarding
(i) the application of accounting principles to a specific transaction, either
completed or proposed, or the type of audit opinion that might be rendered on
UBS' financial statement, or (ii) any matter that was either the subject of a
disagreement as that term is used in Item 304 (a)(1)(iv) of Regulation S-K and
the related instructions to Item 304 of Regulation S-K.
ITEM 9A--CONTROLS AND PROCEDURES
UBS carried out an evaluation, under the supervision and with the
participation of the UBS' management, including the UBS' Chief Executive
Officer, Evelyn F. Smalls and Chief Financial Officer, Brenda Hudson-Nelson, of
the effectiveness of the design and operation of the UBS' disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under
the Exchange Act), as of December 31, 2004 pursuant to Exchange Act Rule 13a-15.
Based upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that UBS' disclosure controls and procedures as of December
31, 2004, are effective and timely in alerting them to material information
relating to UBS (including its consolidated subsidiaries) required to be
included in UBS' periodic SEC filings.
During the last fiscal quarter, there have not been any significant
changes in UBS' internal control over financial reporting that have materially
affected or are reasonably likely to materially affect the UBS' internal control
over financial reporting.
ITEM 9B--OTHER INFORMATION
Not Applicable.
38
PART III
ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain biographical information. Other than as
indicated below, each of the persons named below has been employed in their
present principal occupation for the past five years.
(a) Directors of the Registrant and Bank
Principal occupation and Year first Term
Name Age other directorships became director will expire
- ---- --- ----------------------------- --------------- -----------
Bernard E. Anderson 66 Professor of Management/Economist 2002 2006
At the Wharton School,
Philadelphia, PA
David R. Bright 65 Retired, Executive Vice President
Meridian Bancorp 2002 2006
Philadelphia, PA
Chief Financial Officer
Joseph T. Drennan 59 Universal Capital Management, Inc. 2004 2008
Wilmington, DE
L. Armstead Edwards 63 Co-Chairman, 1993 2008
United Bancshares, Inc.
Owner and President,
Edwards Entertainment, Inc.
Philadelphia, Pennsylvania
Marionette Y. Wilson (Frazier) 60 Retired as Partner, 1996 2008
John Frazier, Inc.
Philadelphia, Pennsylvania
Angela M. Huggins 64 Treasurer, 1993 2005
United Bancshares, Inc.
Retired as Vice President
Real Estate Affairs
RMS Technologies, Inc.
39
Principal occupation and Year first Term
Name Age other directorships became director will expire
- ---- --- --------------------------- --------------- -----------
William B. Moore 62 Secretary,
United Bancshares, Inc.
Pastor, Tenth Memorial 1993 2007
Baptist Church
Philadelphia, Pennsylvania
Ashan M. Nasratul1ah 47 President,
JNA Capital, Inc.
Philadelphia, PA 2004 2005
Steven L. Sanders 44 President and Co-CEO,
MDL Capital 2002 2006
Evelyn F. Smalls 59 President and CEO of Registrant 2000 2007
and United Bank of Philadelphia
Ernest L. Wright 76 Founder, President and 1993 2008
CEO of Ernest L. Wright
Construction Company
Philadelphia, Pennsylvania
(b) Executive Officers of Registrant and Bank
Name Age Office
- ---- --- ------
Evelyn F. Smalls 59 President and Chief Executive Officer
Brenda M. Hudson-Nelson 43 Executive Vice President/Chief Financial Officer
L. Armstead Edwards 62 Chairman, Board of Directors
Steven L. Sanders 44 Vice Chairman, Board of Directors
William B. Moore 62 Secretary
Marionette Y. Frazier 60 Assistant Secretary
Angela M. Huggins 63 Treasurer
(c) Family Relationships.
There are no family relationships between any director, executive
officer or person nominated or chosen by the UBS or the Bank to become a
director or executive officer.
(d) Other
There have been no events under any bankruptcy act, no criminal
proceedings and no judgments or injunctions material to the evaluation of the
ability and integrity of any director or executive officer during the past five
years.
40
INFORMATION ABOUT THE AUDIT COMMITTEES
Information about the UBS' Audit/Compliance Committee
The Audit/Compliance Committee of UBS' Board of Directors(1) is
comprised of Angela M. Huggins (Chairman), Joseph T. Drennan(2), L. Armstead
Edwards, Marionette Y. Frazier and William B. Moore, meets when necessary at the
call of the Chairman. The Committee meets with the internal auditor to review
audit programs and the results of audits of specific areas, as well as other
regulatory compliance issues. In addition, the Committee meets with UBS'
independent certified public accountants to review the results of the annual
audit and other related matters. Each member of the Committee is "independent"
as defined in the applicable listing standards of the National Association of
Securities Dealers ("NASDAQ"). The Committee held four (4) meetings during 2004.
Each member of the Audit/Compliance Committee is independent and
financially literate as defined by NASDAQ. The Board of Directors of the Company
and the Bank have determined that Joseph T. Drennan is the "Financial Expert,"
as defined in the SEC's regulations.
In 2003, the Compliance Committee was combined with the Audit Committee
and is comprised of the same members. On a quarterly basis compliance matters
are addressed to included the review of regulatory compliance matters, the
Bank's compliance programs and the CRA Act activities.
Information about the Bank's Audit/Compliance Committee and Financial Expert
The Audit/Compliance Committee of the Bank Board of Directors(1)
comprised of Angela M. Huggins (Chairman), Joseph T. Drennan, L. Armstead
Edwards, William B. Moore, and Marionette Y. Frazier meets at least quarterly.
The Audit/Compliance Committee meets with the internal auditor to review audit
programs and the results of audits of specific areas, as well as other
regulatory compliance issues. In addition, the Audit/Compliance Committee meets
with the Bank's independent registered public accountants to review the results
of the annual audit and other related matters, with the internal auditor to
review audit programs and the results of audits of specific areas, as well as
other regulatory compliance issues. Each member of the Audit/Compliance
Committee is "independent" as defined in the applicable listing standards of the
NASDAQ. The Committee held four (4) meetings during 2004.
In 2003, the Compliance Committee was combined with the Audit Committee and
is comprised of the same members. On a quarterly basis compliance matters are
addressed to included the review of regulatory compliance matters, the Bank's
compliance programs and the CRA Act activities.
- ----------
(1) The Audit Committees of UBS and the Bank are operating standing committees
established in accordance with Section 3(a)58(A) of the Exchange Act.
(2) Please note that Mr. Drennan was elected to the Company's and the Bank's
Boards of Directors and the Audit Committees of those Board's of Directors
on March 24, 2004, and assumed his duties as a Financial Expert of the
Audit Committees of the Company's and the Bank's Boards of Directors Boards
on that date.
41
INFORMATION ABOUT THE COMMITTEES OF THE BOARDS
Under UBS' By-Laws, persons elected by the Board of Directors to fill a
vacancy on the Board serve as directors for the balance of the term of the
director who that person succeeds.
The Board of Directors of UBS and the Board of Directors of the Bank meet
on a monthly basis (except August). The Executive Committee of the Bank meets in
those months when the Board of Directors does not meet. The Executive Committees
of UBS and the Bank act in the stead of the Boards of Directors of UBS and the
Bank, respectively, and exercise the authority and powers of the Boards of
Directors at intervals between meetings of the Boards of Directors insofar as
may be permitted by law and have responsibility for the nomination of new
directors. The Asset and Liability Management Committee of the Bank's Board
meets for the purpose of managing and monitoring the Bank's exposure to interest
rate risks, market risk and liquidity risk. UBS' and the Bank's Audit/Compliance
Committees interface with UBS' and the Bank's independent registered public
accountants to review the results of the annual audit as well as regulatory
compliance matters. UBS' Board of Directors does not have a Compensation
Committee of the Board since it has no employees.
General Information About UBS' and Bank's Boards of Directors
UBS' Board of Directors meets when necessary and during 2004 held
eleven (11) meetings, including UBS' organization meeting. The Bank's Board of
Directors was scheduled to meet at least monthly, except in August. The total
number of meetings of the Bank's Board of Directors that were held in 2004 was
eleven (11).
Information About the Committees of UBS' Board of Directors
The Committees of UBS' Board of Directors are the Executive Committee
and the Audit Committee. The Executive Committee comprised of L. Armstead
Edwards (Chairman), Steven L. Sanders (Vice Chairman), Angela M. Huggins,
William B. Moore, Evelyn F. Smalls, and Marionette Y. Frazier meets, when
necessary, at the call of the Chairman, and to exercise the authority and powers
of UBS' Board of Directors at intervals between meetings of the Board of
Directors insofar as may be permitted by law. The Executive Committee held
eleven (11) meetings during 2004.
For information about UBS' and the Bank's Audit/Compliance Committees refer to
"INFORMATION ABOUT THE AUDIT COMMITTEES" above.
Information About UBS' Nominating Committee
The Nominating Committee, comprised of Angela M. Huggins (Chairman), L.
Armstead Edwards and Ernest L. Wright, meets at the call of the Chairman. The
Committee is responsible for considering and recommending future director
nominees to the Board of Directors of UBS and the Bank and the Committee will be
independent and meet the requirements for independence of NASDAQ. The Nominating
Committee a charter will be made available, without charge, upon written request
by the shareholders of UBS to the corporate secretary of UBS and the charter
will be attached to the Proxy Statement sent to the UBS shareholders in
connection with UBS' next Annual Meeting. The Committee held three (3) meetings
in 2004.
Meetings of UBS' Board and its Committees
The total number of meetings of UBS' Board of Directors that were held in
2004 was eleven (11). All of the incumbent directors, who were directors during
2004 (i) attended at least seventy-five percent (75%) of the total number of
meetings of the Board of Directors and (ii) all directors attended at least
seventy-five percent (75%) of the aggregate of the total number of meetings held
by all committees of the Board on which the director served except William B.
Moore, who attended sixty-seven percent (67%) of all Board of Director and
Executive Committee meetings.
42
Information About Committees of the Bank's Board of Directors
The Committees of the Bank's Board of Directors are the Executive, Asset
and Liability Management, the Audit/Compliance Committees, and the Loan
Committee.
The Executive Committee comprised of L. Armstead Edwards (Chairman), Steven
L. Sanders (Vice Chairman), Angela M. Huggins, William B. Moore, Evelyn F.
Smalls and Marionette Y. Frazier meets, when necessary, at the call of the
Chairman, to discuss and approve certain human resource matters including
compensation, to ratify and approve certain of the Bank's loans and to exercise
the authority and powers of the Bank's Board of Directors at intervals between
meetings of the Board of Directors insofar as may be permitted by law. The
Executive Committee held eleven (11) meetings during 2004.
The Compensation Committee, comprised of Steven Sanders (Chairman), L.
Armstead Edwards, Angela M. Huggins, William B. Moore, and Marionette Y. Wilson,
meets to discuss compensation matters. The Compensation Committee of the Bank
annually reviews and approves corporate goals and objectives relevant to CEO
compensation, evaluates the CEO's performance in light of those goals and
objectives and determines and approves the compensation and benefits to be paid
or provided to the Evelyn F. Smalls the President of UBS and Brenda M.
Hudson-Nelson Executive Vice President and Chief financial Officer. Each member
of the Compensation Committee is independent as defined by NASDAQ. During 2004,
the Compensation Committee held three (3) meetings.
The Asset and Liability Management Committee comprised Bernard E.
Anderson (Chairman), L. Armstead Edwards, Angela M. Huggins, Evelyn F. Smalls
and Ernest L. Wright meets quarterly to review and manage the Bank's exposure to
interest rate risk, market risk and liquidity risk. During 2004, the Asset and
Liability Management Committee held three (3) meetings.
The Loan Committee, comprised of David R. Bright (Chairman), L. Armstead
Edwards, Ernest L. Wright, and Evelyn F. Smalls meets when necessary to review
and approve loans that are $200,000 and over and to discuss other related loan
matters. The Committee held 11 (eleven) meetings during 2004.
For information about UBS' and the Bank's Audit/Compliance Committees refer
to "INFORMATION ABOUT THE AUDIT COMMITTEES" above.
The Board of Directors of the Company and the Bank has determined that all
of its members are independent and meet the independence requirements of NASDAQ
except Evelyn F. Smalls. Because Ms. Smalls is the President and Chief Executive
Officer of the Company and the Bank she is not independent as defined by NASDAQ.
Meetings of Bank's Board and its Committees
The total number of meetings of the Bank's Board of Directors that were
held in 2004 was eleven (11). All incumbent directors (i) attended at least
seventy-five percent (75%) of the total number of meetings of the Board of
Directors, and (ii) attended at least seventy-five percent (75%) of the
aggregate of the total number of meetings held by all committees of the Board on
which the director served except William B. Moore, who attended sixty-seven
percent (67%) of all Board of Directors and Executive Committee meetings.
43
BOARDS OF DIRECTORS COMPENSATION
Directors Fees
The normal non-officer director fee paid by the Bank is Three Hundred
Fifty Dollars ($350) for attending each Board meeting and One Hundred
Seventy-five Dollars ($175) per quarter for attending the Board of Directors'
Committee meetings. Directors' fees are not paid to officer directors for
attending Bank Board of Directors or Committee meetings. UBS does not pay any
fees to any directors for attending UBS' Board of Directors or Committee
meetings. Effective April 1, 2002, the Board of Directors elected to waive all
fees for an indefinite period of time.
UBS'S AND BANK'S EXECUTIVE OFFICERS
The following table sets forth certain information with respect to the
current executive officers of UBS and Bank as of March 17, 2005:
UBS Stock
Name, Principal Occupation and Age as of Beneficially
Business Experience For Past 5 Years March 17, 2005 Office with the UBS and/or Bank Owned
- ------------------------------------- --------------- ------------------------------- -----
Evelyn F. Smalls (1)(2) 59 President and Chief Executive Officer 450
and Director of UBS and Bank
Brenda M. Hudson-Nelson (3) 43 Executive Vice President and 50
Chief Financial Officer of UBS and Bank
- ------------------
Footnote Information Concerning Executive Officers
(1) Ms. Smalls was elected as a director and was appointed as President and
Chief Executive Officer in June 2000. Prior to that, Ms. Smalls was Senior
Vice President of Human Resources and Compliance from October 1993 to May
2000.
(2) The President and Chief Executive Officer, currently Evelyn F. Smalls, acts
as Trustee of certain voting trust agreements (the "Voting Trusts")
pursuant to which Fahnstock, Inc. deposited 5,209 shares of Common Stock of
UBS.
(3) Ms. Hudson-Nelson was appointed Senior Vice President and Chief Financial
Officer in June 2000. Prior to that, Ms. Hudson-Nelson was Vice President
and Controller from January 1992 to May 2000. In May 2002, Ms.
Hudson-Nelson was promoted to Executive Vice President and Chief Financial
Officer.
CODE OF CONDUCT AND ETHICS
UBS and the Bank has adopted a Code of Business Conduct and Ethics (the
"Code") that applies to all its directors, employees and officers and including
its Chief Executive Officer and its Chief Financial Officer. The Code meets the
requirement of a code of ethics for the UBS' and the Bank's principal executive
officer and principal financial officer or persons performing similar functions
under Item 406 of the SEC's Regulation S-K. Any amendments to the Code, or any
waivers of the Code for directors or executive officers will be disclosed
promptly on a Form 8-K filed with the SEC or by any other means approved by the
SEC. The Code complies with requirements of Sarbanes-Oxley Act and the listing
standards of NASDAQ and UBS provides a copy of the Code to each director,
officer and employee."
UBS will provide, without charge, a copy of its Code of Business Conduct
and Ethics to any person who requests a copy of the Code. A copy of the Code may
be requested by writing to the President of UBS at United Bank of Philadelphia
at 30 S. 15th Street, Suite 1200, Philadelphia, PA 19102.
44
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires that UBS' directors and
executive officers file reports of their holdings of UBS' Common Stock with the
SEC. Based on UBS' records and other information available to UBS believes that
the SEC's Section 16(a) reporting requirements applicable to UBS' directors and
executive officers were complied with for UBS' fiscal year ended December 31,
2004. There were no reportable transactions during this period.
ITEM 11 -- EXECUTIVE COMPENSATION
The Compensation Committee, comprised of Steven Sanders (Chairman), L.
Armstead Edwards, Angela M. Huggins, William B. Moore, and Marionette Y. Wilson,
meets to discuss compensation matters. The Compensation Committee of the Bank
annually reviews and approves corporate goals and objectives relevant to CEO
compensation, evaluates the CEO's performance in light of those goals and
objectives and determines and approves the compensation and benefits to be paid
or provided to the Evelyn F. Smalls the President of UBS and Brenda M.
Hudson-Nelson Executive Vice President and Chief financial Officer. Each member
of the Compensation Committee is independent as defined by NASDAQ. During 2004,
the Compensation Committee held three (3) meetings.
The following information relates to all plan and non-plan compensation
awarded to, earned by, or paid to (i) Evelyn F. Smalls, the President and Chief
Executive Officer of the Bank, and (ii) Brenda M. Hudson-Nelson, Executive Vice
President and Chief Financial Officer of the Bank, the only persons who were
serving as executive officers of the Bank at December 31, 2004 (Ms. Smalls and
Ms. Hudson-Nelson are hereinafter sometimes collectively referred to as the
"Named Executive Officers").
(1) UBS' executives are not compensated for their services to UBS rather,
because the Bank is the principal subsidiary of UBS, they are compensated as
officers of the Bank.
Summary Compensation Table
The disclosure regarding the compensation of the Bank's executives includes
the following table that sets forth the compensation paid to the Named Executive
Officers during the last three fiscal years.
Annual Compensation(1)
----------------------
Stock All Other
Name and Principal Position During 2003 Year Salary Bonus Options Compensation(2)
- --------------------------------------- ---- ------ ------ ------- ---------------
($) (#) ($)
Evelyn F. Smalls 2004 $149,588 -- -- --
President and Chief Executive Officer 2003 $139,050 -- -- --
of UBS and the Bank 2002 $148,009 -- -- --
-- -- --
Brenda M. Hudson-Nelson 2004 $106,044 -- -- --
Executive Vice President and 2003 $ 97,850 -- -- --
Chief Financial Officer of UBS and the Bank 2002 $102,112 -- -- --
- ------------------
(1) Amounts are not included in the Bonus, Stock Option and All Other
Compensation columns of the table because no compensation of this nature
was paid by UBS or the Bank and the restricted stock awards and long term
incentive payouts columns are not included in the Compensation Table since
these benefits are not made available by UBS or the Bank.
(2) The SEC's compensation disclosure rules require the use, where applicable,
of a series of tables to describe various types of compensation paid to the
specified executive officers. The use of a specific table or column in a
table is not required by the SEC's rules if no compensation was paid or
awarded to the named executives. Only the tables or columns required to be
used by the SEC's rules, because of the compensation paid to the specified
executive officers, have been used in this report.
45
Executive Employment Agreements
The Bank entered into a new Employment Agreement with Evelyn F. Smalls in
November 2004 to continue to serve as the Bank's President and Chief Executive
Officer. The term of the Employment Agreement is three (3) years, unless
extended or terminated. The Employment Agreement provides for an annual base
salary of $160,000 that may be increased, but not decreased. Under her
Employment Agreement, Ms. Smalls has an opportunity to receive an annual cash
bonus based on performance targets specified in the Employment Agreement which
are based on the annual earnings of the Bank.
The Bank entered into a new Employment Agreement with Brenda M.
Hudson-Nelson in November 2004 to continue to serve as the Bank's Executive Vice
President and Chief Financial Officer. The term of the Employment Agreement is
three (3) years, unless extended or terminated. The Employment Agreement
provides for an annual base salary of $115,000 that may be increased, but not
decreased. Under her Employment Agreement, Ms. Hudson-Nelson has an opportunity
to receive an annual cash bonus based on performance targets specified in the
Employment Agreement which are based on the annual earnings of the Bank.
Equity Compensation Plan Information
The Company adopted a Stock Option Plan in 1998. Under this Plan,
options to acquire shares of common stock were granted to the former chief
executive officer. The Stock Option Plan provides for the granting of options at
the fair market value of the Company's common stock at the time the options are
granted. Each option granted under the Stock Option Plan may be exercised within
a period of ten years from the date of grant. However, no option may be
exercised within one year from the date of grant. In 1998, options to purchase
29,694 shares of the Company's common stock at a price of $8.54 per share were
awarded to the former chief executive officer.
Equity Compensation Plan Table
- ------------------------------
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------------
Plan Category Number of Securities Weighted average Number of securities
to be issued upon exercise price of remaining available
exercise of outstanding options, for future issuance
outstanding options, warrants, and rights under equity
warrants and rights compensation plans
(excluding securities
reflected in column (a))
- ------------------------------------------------------------------------------------------------------------------
Equity compensation plans 29,694 $8.54 70,306
approved by security holders
Equity compensation plans not -- -- --
approved by security holders
- ------------------------------------------------------------------------------------------------------------------
Total 29,694 $8.54 70,306
- ------------------------------------------------------------------------------------------------------------------
46
ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information known to UBS, as of
March 17, 2005(1), with respect to the only persons to UBS' knowledge, who may
be beneficial owners of more than 5% of UBS' Common Stock.
Percentage of
Amount and Nature of Outstanding
Beneficial Ownership Corporation
Name and Address of Corporation Common Stock
of Beneficial Owner Common Stock Owned
- ------------------- ------------ -----
Philadelphia Municipal 71,667 8.17%
Retirement System
2000 Two Penn Center
Philadelphia, Pennsylvania 19102
Wachovia Corporation (2) 50,000 5.70%
1 Wachovia Center
Charlotte, NC 28288
- ------------------
(1) As of March 17, 2005, there were 876,921 shares of UBS' voting Common Stock
outstanding.
(2) Wachovia Corporation owns 241,666 shares of UBS Common Stock of which
50,000 are voting shares.
ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Some of the directors and executive officers of the UBS and Bank and the
entities with which they are associated were customers of and had banking
transactions with the Bank in the ordinary course of its business during the
year 2003. All loans and commitments to lend were made on substantially the same
terms, including interest rates and collateral, as those prevailing at the time
for comparable transactions with other persons. In the opinion of Bank
management, the transactions and loan commitments did not involve more than
normal risk of collectively or present other unfavorable features.
ITEM 14--PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table presents the fees for each of the last two fiscal years
for the UBS' principal accountants by category:
2004 2003
--------- ---------
Audit Fees.................... $ 62,000 $ --
Audit-related fees............ -- --
Tax fees...................... -- --
All other fees................ -- --
--------- ---------
Total fees................. $ 62,000 $ --
========= =========
Refer to Item 9--Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure for further information.
The Audit Committee pre-approves all auditing services and permitted
non-audit services (including the fees and terms thereof) to be performed for
UBS by its independent auditor, subject to the minimus exceptions for non-audit
services described in Section 10A (i) (1) (B) of the Exchange Act which are
approved by the Committee prior to the completion of the audit. The Audit
Committee may form and delegate authority to subcommittees consisting of one or
more members when appropriate, including the authority to grant pre-approvals of
audit and permitted non-audit services, provided that decisions of such
subcommittee to grant pre-approvals shall be presented to the full Audit
Committee at its next scheduled meeting.
47
PART IV
ITEM 15 -- EXHIBITS AND FINANCIAL STATEMENTS SCHEDULES
The following documents are filed as part of this report of
United Bancshares, Inc.: Page
----
(a) 1. Financial Reports of United Bancshares, Inc.
Report of Independent Registered Public Accounting Firm ............ 51
Consolidated Balance Sheets at December 31, 2004 and 2003........... 53
Consolidated Statements of Operations for the three years ended
December 31, 2004................................................ 54
Consolidated Statements of Changes in Shareholders' Equity for the
three years ended December 31, 2004.............................. 55
Consolidated Statements of Cash Flows for the three years ended
December 31, 2004................................................ 56
Notes to Consolidated Financial Statements.......................... 57
2. Financial Statement Schedules
Financial Statement Schedules are omitted because the required
information is either not applicable, not required or is shown in
the respective financial statements or in the notes thereto.
4. The following Exhibits are filed herewith or incorporated by
reference as a part of this Annual Report:
Exhibit Number Item
-------------- ----
(3(i)) Articles of Incorporation (Incorporated by reference to
Registrant's 1998 Form 10-K).
(3(ii)) Bylaws (Incorporated by reference to Registrant's 1997
Form 10-K).
(9.1) Voting Trust Agreement with NationsBank
(Incorporated by reference to Registrant's 1997 Form 10-K).
(9.2) Voting Trust Agreement with Fahnstock
(Incorporated by reference to Registrant's 1997 Form 10-K).
(10) Material Contracts
a) Lease for corporate headquarters office located at The Graham
Building, 30 S. 15th Street, Suite 1200, Philadelphia, PA
b) Lease for branch office located at 1620 Wadsworth
Avenue (Incorporated by reference to Registrant's 2002 Form 10K)
c) Lease for branch office located at 3750 Lancaster
Avenue (Incorporated by reference to Registrant's 2002 Form 10K)
d) Lease for branch office located at 1015 North Broad
Street (Incorporated by reference to Registrant's 2002 Form 10K)
e) Evelyn F. Smalls' Employment Agreement, dated November 1, 2004
f) Brenda Hudson-Nelson's Employment Agreement, dated November 1,
2004
g) Long Term Incentive Compensation Plan (Incorporated by reference
to Registrant's 1992 Form 10)
48
(11) Statement of Computation of Earnings Per Share.
Included at Footnote 17 of the Financial Statements hereof.
(12) Statement of Computation of Ratios.
Included at Footnote 15 of the Financial Statements hereof.
c) Not applicable.
(14) Code Conduct and Ethics (attached hereto as Exhibit 14)
(16) Letter re Change of Accountant
(21) Subsidiaries of Registrant
Name State of Incorporation
---- ----------------------
United Bank of Philadelphia Pennsylvania
(31) Certification of the Annual Report
(31.1) Certification of the Chief Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
(31.2) Certification of the Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
(32) Certification Pursuant to issue of Section 1350
(A) 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 of the
Chief Executive Officer attached hereto as Exhibit 31.1.
(B) Exhibit 32.2
Certification Pursuant to 18 U.S.C. Section 1350, as adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of the
Chief Financial Officer attached hereto as Exhibit 31.2.
(99) Additional Exhibits
(A) Exhibit 99
Registrants Proxy Statement for its Annual Shareholders Meeting
held on November 23, 2004 is attached hereto as Exhibit 99(A).
49
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 BANCSHARES, INC. DATE
- ----------------------- ----
/s/ Evelyn F. Smalls
- ------------------------------------------------------------- April 14, 2005
Evelyn F. Smalls, President & CEO, Director
/s/ Brenda M. Hudson-Nelson
- ------------------------------------------------------------- April 14, 2005
Brenda M. Hudson-Nelson, EVP, CFO
/s/ L. Armstead Edwards
- ------------------------------------------------------------- April 14, 2005
L. Armstead Edwards, Chairman, Director
/s/ Steven L. Sanders
- ------------------------------------------------------------- April 14, 2005
Steven L. Sanders, Vice Chairman, Director
/s/ Marionette Y. Wilson (Frazier)
- ------------------------------------------------------------- April 14, 2005
Marionette Y. Wilson (Frazier), Assistant Secretary, Director
/s/ Angela M. Huggins
- ------------------------------------------------------------- April 14, 2005
Angela M. Huggins, Treasurer, Director
/s/ William B. Moore
- ------------------------------------------------------------- April 14, 2005
William B. Moore, Secretary, Director
/s/ Bernard E. Anderson
- ------------------------------------------------------------- April 14, 2005
Bernard E. Anderson, Director
/s/ David R. Bright
- ------------------------------------------------------------- April 14, 2005
David R. Bright, Director
/s/ Joseph T. Drennan
- ------------------------------------------------------------- April 14, 2005
Joseph T. Drennan, Director
/s/ Ashan M. Nasratullah
- ------------------------------------------------------------- April 14, 2005
Ashan M. Nasratullah, Director
/s/ Ernest L. Wright
- ------------------------------------------------------------- April 14, 2005
Ernest L. Wright, Director
50
McGladrey & Pullen, LLP
Certified Public Accountants
McGladrey & Pullen, LLP
One Valley Square, Ste. 250
512 Township Line Road
Blue Bell, PA 19422-2700
O 215-641-8600 F 215-641-8680
Report of Independent Registered Public Accounting Firm
To the Board of Directors
United Bancshares, Inc.
Philadelphia, Pennsylvania
We have audited the consolidated balance sheet of United Bancshares, Inc. and
Subsidiary (the "Company") as of December 31, 2004, and the related consolidated
statements of operations, changes in shareholders' equity and cash flows for the
year then ended. 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 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 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 audit provides 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 Bancshares,
Inc. and Subsidiary as of December 31, 2004, and the results of their operations
and their cash flows for the year then ended, in conformity with U.S. generally
accepted accounting principles.
/s/ McGladrey & Pullen, LLP
Blue Bell, Pennsylvania
March 29, 2005
McGladrey & Pullen, LLP is a member firm of RSM International
an affiliation of separate and independent legal entities.
51
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and Board of Directors
United Bancshares, Inc. and Subsidiary
We have audited the accompanying consolidated balance sheet of United
Bancshares, Inc. and Subsidiary as of December 31, 2003, and the related
consolidated statements of income, stockholders' equity, and cash flows for each
of the two years in the period ended December 31, 2003. 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of United Bancshares,
Inc. and Subsidiary as of December 31, 2003, and the consolidated results of
their operations and cash flows for the each of the two years in the period
ended December 31, 2003, in conformity with accounting principles generally
accepted in the United States of America.
The accompanying financial statements have been prepared assuming the Bank will
continue as a going concern. As discussed in Note 2 to the financial statements
the Bank entered into a written agreement (Agreement) with its primary
regulators dated February 23, 2000. As of December 31, 2003 the Bank was not in
compliance with certain requirements of the Agreement. Not meeting these
requirements, losses incurred in the current year and the results of a recent
regulatory examination, could expose the Bank to possible further regulatory
actions. As more fully discussed in Note 2, these matters raise substantial
doubt about the Bank's ability to continue as a going concern. The ability of
the Bank to continue as a going concern is dependent on many factors, including
achieving the required capital levels, earnings and fully complying with the
Agreement. Management's plans with respect to these matters are also described
in Note 2. The accompanying financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
Grant Thornton LLP
Philadelphia, Pennsylvania
January 22, 2004
52
United Bancshares, Inc. and Subsidiary
CONSOLIDATED BALANCE SHEETS
December 31,
Assets 2004 2003
------------- ------------
Cash and due from banks...................................................... $ 4,317,645 $ 4,318,584
Interest-bearing deposits with banks......................................... 888,924 874,362
Federal funds sold........................................................... 3,727,000 1,500,000
----------- ----------
Cash and cash equivalents.......................................... 8,933,569 6,692,946
Investment securities:
Available-for-sale, at fair market value................................. 4,797,549 8,933,216
Held-to-maturity, at amortized cost (fair market value of $8,784,495
and $6,703,476 in 2004 and 2003, respectively)........................ 8,762,796 6,703,476
Loans held-for-sale (market value of $1,437,274)............................ 1,412,554 --
Loans, net of unearned discount of $21,781 and $43,181 in 2004
and 2003, respectively................................................... 45,680,014 47,028,397
Less allowance for loan losses............................................... ( 602,939) 338,574)
------------ -----------
Net loans.......................................................... 45,077,075 46,689,823
Bank premises and equipment, net............................................. 1,074,855 2,772,153
Accrued interest receivable.................................................. 328,354 380,583
Intangible assets............................................................ 1,560,358 1,738,436
Prepaid expenses and other assets............................................ 353,789 806,734
----------- -----------
Total assets....................................................... $72,300,899 $74,717,367
=========== ===========
Liabilities and Shareholders' Equity
Liabilities:
Demand deposits, noninterest-bearing..................................... $13,439,567 $16,112,983
Demand deposits, interest-bearing........................................ 8,333,631 10,430,349
Savings deposits......................................................... 17,591,982 19,309,126
Time deposits, under $100,000............................................ 13,641,202 10,349,830
Time deposits, $100,000 and over......................................... 10,165,837 10,914,535
----------- -----------
Total deposits..................................................... 63,172,219 67,116,823
Accrued interest payable................................................. 78,196 77,775
Accrued expenses and other liabilities................................... 239,156 287,876
----------- -----------
Total liabilities.................................................. 63,489,571 67,482,474
----------- -----------
Commitments and Contingencies (Notes 6, 11, and 15)
Shareholders' equity:
Series A preferred stock, noncumulative, 6%, $0.01 par value,
500,000 shares authorized; 136,842 issued in 2004 and 2003,
respectively; 6,308 shares held in treasury at
December 31, 2004 and 2003............................................ 1,368 1,368
Common stock, $0.01 par value; 1,750,000 shares authorized;
876,921 issued at December 31, 2004 and 2003 ......................... 8,769 8,769
Class B Non-voting Common Stock; 250,000 shares authorized; $0.01 par value;
191,667 issued and outstanding at December 31, 2004 and 2003.......... 1,917 1,917
Treasury Stock, 33,500 shares at December 31, 2004 and 2003, at cost..... -- --
Additional paid-in-capital............................................... 14,749,852 14,749,852
Accumulated deficit...................................................... (5,968,140) (7,614,662)
Accumulated other comprehensive income .................................. 17,562 87,649
----------- -----------
Total shareholders' equity......................................... 8,811,328 7,234,893
----------- -----------
Total liabilities and shareholders' equity......................... $72,300,899 $74,717,367
=========== ===========
The accompanying notes are an integral part of these statements.
53
United Bancshares, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31,
2004 2003 2002
------------ ------------ ------------
Interest income:
Interest and fees on loans................................. $ 3,008,532 $ 2,912,547 $ 3,006,367
Interest on investment securities.......................... 560,255 805,655 1,446,072
Interest on federal funds sold............................. 86,935 97,599 169,071
Interest on time deposits with other banks................. 30,087 21,002 10,921
------------ ------------ ------------
Total interest income................................ 3,685,809 3,836,803 4,632,431
------------ ------------ ------------
Interest expense:
Interest on time deposits.................................. 294,863 374,297 662,493
Interest on demand deposits................................ 48,602 83,267 114,399
Interest on savings deposits............................... 62,464 89,020 129,227,
------------ ------------ ------------
Total interest expense............................... 405,929 546,584 906,119
------------ ------------ ------------
Net interest income.................................. 3,279,880 3,290,219 3,726,312
Provision for loan losses...................................... 45,000 565,000 175,000
------------ ------------ ------------
Net interest income after provision for loan losses.. 3,234,880 2,725,219 3,551,312
------------ ------------ ------------
Noninterest income:
Gain on sale of loans...................................... 6,299 57,061 -
Customer service fees...................................... 852,806 955,284 1,109,335
ATM Fee Income............................................. 597,965 697,724 818,503
Loan Syndication Fee Income................................ 178,802 86,000 25,000
Gain on sale of investments................................ 31,115 - 25,789
Gain on sale of fixed assets............................... 1,874,203 - 48,054
Other income............................................... 113,837 94,837 300,337
------------ ------------ ------------
Total noninterest income............................. 3,655,027 1,890,906 2,327,018
------------ ------------ ------------
Noninterest expense:
Salaries, wages and employee benefits...................... 1,935,421 2,204,583 2,344,746
Occupancy and equipment.................................... 1,102,627 1,224,719 1,293,803
Office operations and supplies............................. 411,920 453,202 433,557
Marketing and public relations............................. 82,652 113,552 82,692
Professional services...................................... 239,050 220,765 283,671
Data processing............................................ 562,655 661,939 639,854
Deposit insurance assessments.............................. 72,238 33,501 36,258
Other operating............................................ 836,822 819,329 980,332
------------ ------------ ------------
Total noninterest expense............................ 5,243,385 5,731,590 6,094,913
------------ ------------ ------------
Net income (loss).................................... $ 1,646,522 $ (1,115,465) $ (216,583)
============ ============ ============
Net income (loss) per common share--basic ..................... $ 1.54 $ (1.03) $ (0.20)
============ ============ ============
Net income per common share--diluted............................ $ 1.50 $ (1.03) $ (0.20)
============ ============ ============
Weighted average number of common shares....................... 1,068,588 1,084,694 1,101,247
============ ============ ============
The accompanying notes are an integral part of these statements.
54
United Bancshares, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Years ended December 31, 2004, 2003 and 2002
Series A Accumulated Total Compre-
preferred stock Common stock Additional other share- hensive
---------------- ------------------ paid-in Accumulated comprehensive holders' income
Shares Amount Shares Amount capital deficit income (loss) equity (loss)
-------- ------ -------- -------- ----------- ------------ ------------ --------- ------
Balance at
December 31, 2001........ 143,150 $1,432 1,100,388 $11,004 $14,729,070 $(6,282,614) $ 98,819 $8,557,711
Proceeds from issuance
of common stock....... 1,700 17 20,383 20,400
Unrealized gains on
investment securities. 138,613 138,613 $ 138,613
Net loss.............. (216,583) (216,583) (216,583)
------- ------ --------- ------- ----------- ----------- --------- ---------- -----------
Total comprehensive
income (loss)............ $ (77,970)
===========
Balance at
December 31, 2002........ 143,150 1,432 1,102,088 11,021 14,749,453 (6,499,197) 237,432 8,500,141
Treasury Stock......... (6,408) (64) (33,500) (335) 399 --
Unrealized losses on
investment securities. (149,783) (149,783) $ (149,783)
Net loss.............. (1,115,465) (1,115,465) (1,115,465)
------- ------ --------- ------- ----------- ----------- ---------- ---------- -----------
Total comprehensive
income (loss)............ $(1,265,248)
===========
Balance at
December 31, 2003........ 136,842 1,368 1,068,588 10,686 14,749,852 (7,614,662) 87,649 7,234,893
======= ====== ========= ======= =========== ============ ========= ==========
Unrealized losses on
investment securities. (70,087) (70,087) $ (70,087)
Net income............. 1,646,522 1,646,522 1,646,522
------- ------ --------- ------- ----------- ----------- --------- ---------- -----------
Total comprehensive
income (loss).......... $ 1,576,435
===========
Balance at
December 31, 2004....... 136,842 $1,368 1,068,588 $ 10,686 $14,749,852 $(5,968,140) $ 17,562 $8,811,328
======= ====== ========= ======= =========== ============ ========= ==========
The accompanying notes are an integral part of these statements.
55
United Bancshares, Inc. and Subsidiary
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
------------------------
2004 2003 2002
------------ ------------ ------------
Cash flows from operating activities:
Net income (loss).......................................... $ 1,646,522 $ (1,115,465) $ (216,583)
Adjustments to reconcile net loss to net cash
(used in provided by operating activities:
Provision for loan losses............................... 45,000 565,000 175,000
Gain on sale of loans................................... (6,299) (57,061)
Gain on sale of fixed assets............................ (1,874,203) -- (48,054)
(Gain) loss on sale of investment securities............ (31,115) -- (25,789)
Depreciation and amortization........................... 610,440 688,247 673,361
(Increase) decrease in accrued interest receivable and
other assets................................................ 505,173 (198,518) 702,412
Decrease in accrued interest payable and
other liabilities...................................... (48,299) (249,024) (73,151)
----------- ------------- -----------
Net cash provided by (used in) operating activities.. 847,219 (366,821) 1,187,196
---------- ------------- ----------
Cash flows from investing activities:
Purchase of available-for-sale investments................. (496,421) (3,200,237) (10,792,294)
Purchase of held-to-maturity investments................... (3,986,354) (3,510,938) (2,247,096)
Proceeds from maturity and principal reductions of
available-for-sale investments.......................... 3,774,398 8,414,626 9,936,68501
Proceeds from maturity and principal reductions of
held-to-maturity investments............................ 1,917,765 3,967,709 6,568,297
Proceeds from sale of investments available-for-sale....... 786,526 -- 1,091,063
Proceeds from the sale of fixed assets..................... 3,283,536 -- --
Proceeds from sale of student loans........................ -- 3,054,429 --
Purchase of loans from other financial institutions........ -- (9,325,656) --
Net (increase) decrease in loans........................... 161,493 2,532,105 (1,341,919)
Purchase of premises and equipment......................... (102,935) (588,878) (182,004)
----------- ----------- -----------
Net cash used in investing activities................ 5,338,008 1,343,161 3,032,732
---------- ------------ ----------
Cash flows from financing activities:
Net decrease in deposits................................... (3,944,604) (9,812,482) (2,493,218)
Net proceeds from issuance of common stock................. -- -- 20,400
----------- ------------- -----------
Net cash used in financing activities................ (3,944,605) (9,812,482) (2,472,818)
----------- ----------- -----------
Net increase (decrease) in cash and cash equivalents. 2,240,623 (8,836,142) 1,747,110
---------- ----------- ----------
Cash and cash equivalents at beginning of year................. 6,692,946 15,529,088 13,781,978
----------- ---------- ----------
Cash and cash equivalents at end of year....................... $ 8,933,569 $ 6,692,946 $15,529,088
=========== =========== ===========
Supplemental disclosure of cash flow information:
Cash paid during the year for interest..................... $ 405,508 $ 468,141 $ 1,013,450
=========== =========== ===========
The accompanying notes are an integral part of these statements.
56
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2004, 2003, and 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of United
Bancshares, Inc. (the Company) and its wholly owned subsidiary, United Bank
of Philadelphia (the Bank). All significant intercompany transactions and
balances have been eliminated.
Statement of Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash
on hand, amounts due from banks, and federal funds sold on an overnight
basis.
Securities Held-to-Maturity
Bonds, notes, and debentures for which the Bank has both the positive intent
and ability to hold to maturity are classified as held-to-maturity and
carried at cost, adjusted for premiums and discounts that are recognized in
interest income using the interest method over the period to maturity.
Securities Available-for-Sale
Available-for-sale securities consist of bonds, notes and debentures, and
certain equity securities for which the Bank does not have positive intent
to hold to maturity. These securities are carried at fair value.
Unrealized holding gains and losses on securities classified as
available-for-sale are carried as a separate component of shareholders'
equity net of related income tax effects.
Gains and losses on the sale of available-for-sale securities are determined
by the specific identification method.
Premiums and discounts are recognized in interest income using the interest
method over the period to maturity.
The Bank adopted EITF 03-1, The Meaning of Other than Temporary Impairment
and Its Application to Certain Investments, as of December 31, 2003. EITF
03-1 includes certain disclosures regarding quantitative and qualitative
disclosures for investment securities accounted for under FAS 115,
Accounting for Certain Investments in Debt and Equity Securities, that are
impaired at the balance sheet date, but an other-than-temporary impairment
has not been recognized. The disclosures under EITF 03-1 are required for
financial statements for years ending after December 15, 2003 and are
included in these financial statements.
The cost of investment securities is adjusted for amortization of premiums
and accretion of discounts to maturity, or in the case of mortgage-backed
securities, over the estimated life of the security. Such amortization or
accretion is included in interest income from investments. Interest and
dividends are included in interest income from investments. Realized gains
and losses and declines in value judged to be other-than-temporary are
included in realized gains (losses) on investment securities. Factors
affecting the determination of whether an other-than-temporary impairment
has occurred include a downgrading of the security by a rating agency, a
significant deterioration in the financial condition of the issuer, or that
management would not have the intent and ability to hold a security for a
period of time sufficient to allow for any anticipated recovery in fair
value. The cost of securities sold is based on the specific-identification
method.
(Continued)
57
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
Loans
The Bank has both the positive intent and ability to hold the majority of
its loans to maturity. These loans are stated at the amount of unpaid
principal, reduced by net unearned discount and an allowance for loan
losses. Interest income on loans is recognized as earned based on
contractual interest rates applied to daily principal amounts outstanding
and accretion of discount. It is the Bank's policy to discontinue the
accrual of interest income when a default of principal or interest exists
for a period of 90 days except when, in management's judgment, the
collection of principal and interest is reasonably anticipated or adequate
collateral exists. Interest received on nonaccrual loans is either applied
against principal or reported as interest income according to management's
judgment as to collectibility of principal. When interest accruals are
discontinued, interest credited to income is reversed and the loan is
classified as nonperforming.
Unearned discount is amortized over the weighted average maturity of the
mortgage loan portfolio. Loan origination and commitment fees and certain
direct loan origination costs are deferred, and the net amount is amortized
as an adjustment of the related loan's yield. The Bank is amortizing these
amounts over the contractual life of the loan.
In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or Certain
Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with the
evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the
Company will be unable to collect all contractually required payments
receivable. SOP 03-3 requires that the Company recognize the excess of all
cash flows expected at acquisition over the investor's initial investment in
the loan as interest income on a level-yield basis over the life of the loan
as the accretable yield. The loan's contractual required payments receivable
in excess of the amount of its cash flows excepted at acquisition
(nonaccretable difference) should not be recognized as an adjustment to
yield, a loss accrual or a valuation allowance for credit risk. SOP 03-3 is
effective for loans acquired in fiscal years beginning after December 31,
2004. Early adoption is permitted. The Company does not expect adoption to
have a material impact on the Company's consolidated financial statements.
The Company adopted FASB Interpretation ("FIN") 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others on January 1, 2003. FIN 45 requires a guarantor
entity, at the inception of a guarantee covered by the measurement
provisions of the interpretation, to record a liability for the fair value
of the obligation undertaken in issuing the guarantee. From time to time the
Company has financial and performance letters of credit. Financial letters
of credit require the Company to make payment if the customer's financial
condition deteriorates, as defined in the agreements. Performance letters of
credit require the Company to make payments if the customer fails to perform
certain non-financial contractual obligation. The Company previously did not
record a liability when guaranteeing obligations unless it became probable
that the Company would have to perform under the guarantee. FIN 45 applies
prospectively to guarantees the Company issues or modifies subsequent to
December 31, 2002. At December 31, 2004, the Company had no outstanding
letters of credit for which it would be contingently liable.
(Continued)
58
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
The Securities and Exchange Commission (SEC) recently released Staff
Accounting Bulletin No.105, Application of Accounting Principles to Loan
Commitments. SAB 105 provides guidance about the measurement of loan
commitments recognized at fair value under FASB Statement No. 133,
Accounting for Derivative Instruments and Hedging Activities. SAB 105 also
requires companies to disclose their accounting policy for those loan
commitments including methods and assumptions used to estimate fair value
and associated hedging strategies. SAB 105 is effective for all loan
commitments accounted for as derivatives that are entered into after March
31, 2004. The adoption of SAB 105 did not have a material effect on the
Company's consolidated financial statements.
Loans Held-for-Sale
The Bank accounts for its transfers and servicing financial assets in
accordance with SFAS No. 140, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities. SFAS No. 140 revises
the standards for accounting for transfers of financial assets and
collateral. Transfers of financial assets, for which the Bank has
surrendered control, are accounted for as sales to the extent that
consideration other than beneficial interests in the transferred assets is
received in exchange. Retained interests in a sale of financial assets are
measured at the date of transfer by allocating the previous carrying amount
between the assets transferred and based on their relative estimated fair
values. The fair values of retained servicing rights and any other retained
interests are determined based on the present value of expected future cash
flows associated with those interests and by reference to market prices for
similar assets.
Loans held-for-sale are carried at the aggregate of lower of cost or market
value. The Bank had student loans held for sale totaling $1,412,554 as of
December 31, 2004.
For purchased loans, the discount remaining after the loan loss allocation
is being amortized over the remaining life of the purchased loans using the
interest method.
Allowance for Loan Losses
The Bank adopted Statement of Financial Accounting Standards (SFAS) No. 114,
"Accounting by Creditors for Impairment of a Loan," and SFAS No. 118,
"Accounting by Creditors for Impairment of a Loan Income Recognition and
Disclosures." Under SFAS No. 114, the allowance for loan losses related to
"impaired loans" is based on the discounted cash flows using the impaired
loans' initial effective interest rate as the discount rate, or the fair
value of the collateral for collateral-dependent loans. A loan is impaired
when it meets the criteria to be placed on nonaccrual status. Loans that are
evaluated for impairment pursuant to SFAS No. 114 are assessed on a
loan-by-loan basis and include only commercial nonaccrual loans. Large
groups of smaller, homogeneous loans, such as credit cards, student loans,
residential mortgages, and other student loans, are evaluated collectively
for impairment.
The allowance for loan losses is maintained at a level considered adequate
to provide for potential losses in the loan portfolio. The allowance is
increased by provisions charged to operating expenses and reduced by
charge-offs net of recoveries. Management's determination of the adequacy of
the allowance is based on continuous credit reviews of the loan portfolio,
consideration of the current economic conditions, review of specific problem
loans, and other relevant factors. This evaluation is subjective as it
requires material estimates, including the amounts and timing of future cash
flows expected to be received on impaired loans that may be susceptible to
significant change. However, actual losses on specific loans, which are
encompassed in the analysis, may vary from estimated losses. The allowance
is an accounting estimate subject to short-term changes based on the outcome
of periodic analysis.
(Continued)
59
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
Bank Premises and Equipment
Bank premises and equipment are stated at cost less accumulated
depreciation. Depreciation is computed on the straight-line method over the
estimated useful lives of the assets. Amortization of leasehold improvements
is computed over the shorter of the related lease term or the useful life of
the assets.
Income Taxes
The liability method is used in accounting for income taxes. Deferred tax
assets and liabilities are determined based on differences between financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse.
Earnings (Loss) Per Share
The Company follows the provisions of SFAS No. 128, which eliminates primary
and fully diluted earnings per share (EPS) and requires presentation of
basic and diluted EPS in conjunction with the disclosure of the methodology
used in computing such EPS. Basic EPS excludes dilution and is computed by
dividing income available to common shareholders by the weighted average
common shares outstanding during the period. Diluted EPS takes into account
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised and converted into common stock.
Stock-based Compensation
The Bank accounts for stock options under SFAS No. 123, Accounting for
Stock-Based Compensation, as amended by SFAS No. 148, which contains a fair
value-based method for valuing stock-based compensation that entities may
use, which measures compensation cost at the grant date based on the fair
value of the award. Compensation is then recognized over the service period,
which is usually the vesting period. Alternatively, SFAS No. 123 permits
entities to continue accounting for employee stock options and similar
equity instruments under Accounting Principles Board (APB) Opinion 25,
Accounting for Stock Issued to Employees. Entities that continue to account
for stock options using APB Opinion 25 are required to make pro forma
disclosures of net income and earnings per share, as if the fair value-based
method of accounting defined in SFAS No. 123 had been applied.
At December 31, 2004, the Company had one stock-based employee compensation
plan, which is more fully described in note 13. The Bank accounts for this
plan under the recognition and measurement principles of APB No. 25,
Accounting for Stock Issued to Employees, and related interpretations.
Stock-based employee compensation
(Continued)
60
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
costs are not reflected in net income, as all options granted under the
plans had an exercise price equal to the market value of the underlying
common stock on the date of grant.
The following table illustrates the effect on net income (loss) per share if
the Bank had applied the fair value recognition provisions of SFAS No. 123,
to stock-based employee compensation (in thousands, except per share
amounts).
Year ended December 31,
---------------------------------
(In thousands) 2004 2003 2002
-------- -------- --------
Net income (loss)
As reported....................................................... $ 1,647 $(1,115) (217)
Less: Stock-based compensation costs determined
under fair value-based method for all awards............... --
Pro forma......................................................... $ 1,647 $(1,115) (217)
Basic income (loss) per share
As reported....................................................... $ 1.54 $ (1.03) $(0.20)
Pro forma......................................................... $ 1.54 $ (1.03) $(0.20)
Diluted income (loss) per share
As reported....................................................... $ 1.50 $ (1.03) $(0.20)
Pro forma......................................................... $ 1.50 $ (1.03) $(0.20)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions used for grants in 1998: no dividends declared; expected
volatility of 20%; a risk-free interest rate of 4.7%, and expected life of
10 years.
Off-Balance-Sheet Financial Instruments
In the ordinary course of business, the Bank has entered into
off-balance-sheet financial instruments consisting of commitments to extend
credit and letters of credit. Such financial instruments are recorded in the
financial statements when they become payable.
Financial Instruments
The following methods and assumptions were used by the Bank in estimating
its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the balance
sheet for cash and cash equivalents approximate those assets' fair values.
Investment securities: Fair values for investment securities are based on
quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments.
Loans held-for-sale: Fair values are estimated using quoted rates based upon
secondary market sources for similar loans.
Loans: The fair value of loans was estimated using a discounted cash flow
analysis, which considered estimated
(Continued)
61
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
prepayments and amortizations. Prepayments and discount rates were based on
current marketplace estimates and pricing. Residential mortgage loans were
discounted at the current effective yield, including fees, of conventional
loans, adjusted for their maturities with a spread to the Treasury yield
curve.
Deposit liabilities: The fair values disclosed for demand deposits (e.g.,
interest and noninterest checking, passbook savings, and certain types of
money market accounts) are equal to the amounts payable on demand at the
reporting date (e.g., their carrying amounts). The carrying amounts for
variable-rate, fixed-term money market accounts and certificates of deposit
approximate the fair values at the reporting date. Fair values for
fixed-rate certificates of deposit are estimated using a discounted cash
flow calculation. The Treasury Yield Curve was utilized for discounting cash
flows as it approximates the average marketplace certificate of deposit
rates across the relevant maturity spectrum. Commitments to extend credit:
The carrying amounts for commitments to extend credit approximate fair value
as such commitments are not substantially different from the fees currently
charged to enter into similar agreements, taking into account the remaining
terms of the agreements and the present creditworthiness of the
counterparts.
Intangible Assets
On September 24, 1999, the Bank acquired four branches from First Union
Corporation with deposits totaling $31.5 million. As a result of the
acquisition, the Bank recorded a core deposit intangible of 2,449,488. The
core deposit intangible is being amortized over 14 years. Amortization
totaled $178,078 for each of the years ended December 31, 2004, 2003, and
2002, respectively. The amortization of the intangible will be $178,078 for
each of the next five years. The core deposit intangible was tested for
impairment. No impairment has been recognized.
On October 1, 2002, the Financial Accounting Standards Board (FASB) issued
SFAS No. 147, "Acquisitions of Certain Financial Institutions." SFAS No. 147
removes acquisitions of financial institutions from the scope of SFAS 72,
"Accounting for Certain Acquisitions of Banking or Thrift Institutions," and
requires that those transactions be accounted for in accordance with SFAS
No. 141, "Business Combinations and SFAS No. 142, "Goodwill and Intangible
Assets." SFAS No. 147 also requires that the acquisition of a
less-than-whole financial institution, such as a branch, be accounted for as
a business combination if the transferred assets and activities constitute a
business. In addition, SFAS No. 147 amends SFAS 144, "Accounting for the
Impairment of Disposal of Long-Lived Assets," to include within its scope
long-term customer relationship intangible assets of financial institutions
such as depositor-relationship intangible assets.
Foreclosed Real Estate
Real estate properties acquired through, or in lieu of, loan foreclosure are
to be sold and are initially recorded at fair value at the date of
foreclosure, establishing a new cost basis. After foreclosure, valuations
are periodically performed by management, and the real estate is carried at
the lower of carrying amount or fair value less the cost to sell. Revenue
and expenses from operations and changes in valuation allowance are charged
to operations. The historical average holding period for such properties is
24 months.
(Continued)
62
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
Management's Use of Estimates
The preparation of the financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
Segments
SFAS No. 131 establishes standards for the way public business enterprises
report information about operating segments in annual financial statements
and requires that those enterprises report selected information about
operating segments in subsequent interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. The statement
requires that a public business enterprise report financial and descriptive
information about its reportable operating segments. Operating segments are
components of an enterprise about which separate financial information is
available that is evaluated regularly by the chief operating decision-maker
in deciding how to allocate resources and assess performance. The statement
also requires that public enterprises report a measure of segment profit or
loss, certain specific revenue and expense items and segment assets. It also
requires that information be reported about revenues derived from the
enterprises' products or services, or about the countries in which the
enterprises earn revenues and hold assets, and about major customers,
regardless of whether that information is used in making operating
decisions.
The Company has one reportable segment, "Community Banking." All of the
Company's activities are interrelated, and each activity is dependent and
assessed based on how each of the activities of the Company supports the
other. For example, commercial lending is dependent upon the ability of the
Bank to fund itself with retail deposits and other borrowings and to manage
interest rate and credit risk. This situation is also similar for consumer
and residential mortgage lending. Accordingly, all significant operating
decisions are based upon analysis of the Company as one operating segment or
unit.
Reclassifications
Certain reclassifications have been made to the prior year's financial
statements to conform to the 2004 presentation.
Comprehensive Income
The Bank follows SFAS No. 130, which establishes standards for reporting
comprehensive income that includes net income as well as certain other
items that result in a change to equity during the period. These financial
statements reflect the provisions of SFAS No. 130. The income tax effects
allocated to comprehensive income (loss) are as follows:
(Continued)
63
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
December 31, 2004
-------------------------------------------
Before tax Tax benefit Net of tax
amount (expense) amount
------ --------- ------
Unrealized losses on securities
Unrealized holding losses arising during period $ (74,015) $ 24,776 $ (49,240)
Less: reclassification adjustment for gains
realized in net income 31,115 (10,267) 20,847
---------- -------- ---------
Other comprehensive income (loss), net $ (105,130) $ 35,043 $ (70,087)
========== ======== =========
December 31, 2003
--------------------------------------------
Before tax Tax benefit Net of tax
amount (expense) amount
------ --------- ------
Unrealized losses on securities
Unrealized holding losses arising during period $ (223,555) $ 73,772 $(149,783)
Less: reclassification adjustment for gains
realized in net income -- -- --
---------- -------- ---------
Other comprehensive income (loss), net $ (223,555) $ 73,772 $(149,783)
========== ======== =========
December 31, 2002
--------------------------------------------
Before tax Tax benefit Net of tax
amount (expense) amount
------ --------- ------
Unrealized gains on securities
Unrealized holding gains arising during period $ 232,674 $(76,782) $155,892
Less: reclassification adjustment for gains
realized in net income 25,789 (8,510) 17,279
---------- -------- --------
Other comprehensive income, net $ 206,885 $(68,272) $138,613
========== ======== ========
Variable Interest Entities
In January 2003, FASB issued FASB Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"). FIN 46 requires a variable interest
entity to be consolidated by a company if that company is subject to a
majority of the risk of loss from the variable interest entity's activities
or entitled to receive a majority of the risk of loss from the variable
interest entity's activities or entitled to receive a majority of the
entity's residual returns, or both. FIN 46 also requires disclosures about
variable interest entities that a company is not required to consolidate,
but it which it has a significant variable interest. Subsequent to the
issuance of FIN 46, the FASB issued a revised interpretation, FIN 46(R), the
provisions were required to be applied to certain variable interest entities
by March 31, 2004. The adoption of FIN 46 (R) did not have an impact on the
financial condition or results of operations of the Company.
64
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
2. REGULATORY AGREEMENT
In February 2000, as a result of a regulatory examination completed in
December 1999, the Bank entered into a Written Agreement (Agreement) with
its primary regulators with regard to, among other things, achievement of
agreed-upon capital levels, implementation of a viable earnings/strategic
plan, adequate funding of the allowance for loan losses, the completion of a
management review and succession plan, and improvement in internal controls.
The current Agreement requires the Bank to increase its capital ratio to
6.5% by June 30, 2000 and to 7% at all times thereafter. As of December 31,
2000, the Bank had met the required ratios by implementing strategies that
included: increasing profitability, consolidating branches, and soliciting
new and additional sources of capital. Management continues to address all
matters outlined in the Agreement. Failure to comply could result in
additional regulatory supervision and/or actions.
As of December 31, 2003, the Bank's tier one leverage capital ratio fell to
6.81%, below the 7% minimum capital ratio required by the Agreement.
However, at February 29, 2004, the tier one leverage ratio had improved to
7.29% primarily as a result of a $265,000 recovery on a previously
charged-off loan. Subsequently, as a result of a re-capitalization plan
including the sale of bank-owned real estate for a gain of $1.9 million, the
Bank's tier one leverage ratio further improved to 9.49%.
A regulatory examination completed in February 2004 determined that the
Bank was not in compliance with certain other elements of the Agreement
including the implementation of a viable earnings/strategic plan and the
timely charge-off/funding of the allowance for loan losses. Not meeting
these requirements in addition could expose the Bank to possible further
regulatory actions. In 2004, these matters raised substantial doubt about
the Bank's ability to continue as a going concern. Management believes that
it has implemented corrective action where necessary including the adoption
of an achievable strategic plan for 2005.
A profit restoration plan was developed and continues to be implemented. It
includes among other things staff reductions/consolidations, salary
reductions, reduction in branch operating hours, continued elimination of
director fees, and the reduction of other operating expenses. Also, as part
of the Bank's profit restoration plan, upon expiration of the lease in July
2004, the Bank's Two Penn Center was closed and consolidated with other
branches in the network to further reduce occupancy, personnel, and other
operating cost.
While expense reductions continue to be achieved, management believes that
a greater impact will be realized with increased deposit levels and loan
originations that build the Bank's loan-to-deposit ratio. It is anticipated
that increased loan volume will result in a higher net interest margin and
therefore increased revenues. Thus, while continuing to control expenses,
management will place more focus on the implementation of business
development strategies to increase the level of loans outstanding to
achieve profitability.
Also, revenue enhancement strategies have been employed to expand
opportunities for fee income through the implementation of new products and
services including corporate loan syndications where the Bank serves in the
role of arranger and/or administrative agent.
As a result of all of the actions referred to above, Management strongly
believes that the Bank is now "substantially" in compliance with the
Agreement's terms and conditions and will continue to operate as an
independent financial institution for the foreseeable future.
65
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
3. CASH AND DUE FROM BANK BALANCES
The Bank maintains various deposit accounts with other banks to meet normal
fund transaction requirements and to compensate other banks for certain
correspondent services. The withdrawal or usage restrictions of these
balances did not have a significant impact on the operations of the Bank as
of December 31, 2004.
4. INVESTMENTS
The amortized cost, gross unrealized holding gains and losses, and estimated
market value of the available-for-sale and held-to-maturity investment
securities by major security type at December 31, 2004 and 2003 are as
follows:
2004
-----------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Market
cost gains losses value
----------- -------- --------- -----------
Available-for-sale:
U.S. Government agency securities $ 250,000 $ -- $ (702) $ 249,298
Mortgage-backed securities ..... 4,183,980 54,149 (27,233) 4,210,896
----------- -------- --------- -----------
Total debt securities .......... 4,433,980 54,149 (27,935) 4,460,194
Investments in mutual funds .... 108,905 108,905
Other investments .............. 228,450 228,450
----------- -------- --------- -----------
$ 4,771,335 $ 54,149 $ (27,935) $ 4,797,549
=========== ======== ========= ===========
Held-to-maturity:
U.S. Government agency securities $ 4,499,892 $ 1,355 $ (30,030) $ 4,471,217
Mortgage-backed securities ..... 4,262,904 63,702 13,328 4,313,278
----------- -------- --------- -----------
$ 8,762,796 $ 65,057 $ (43,358) $ 8,784,495
=========== ======== ========= ===========
66
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
4. INVESTMENTS - Continued
2003
-----------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Market
cost gains losses value
----------- -------- --------- -----------
Available-for-sale:
U.S. Government agency securities $ 2,250,000 $ 5,705 $ $ 2,255,705
Mortgage-backed securities ..... 6,157,392 130,575 (5,459) 6,282,508
----------- ----------- --------- -----------
Total debt securities .......... 8,407,392 136,280 (5,459) 8,538,213
Investments in mutual funds .... 107,653 107,653
Other investments .............. 287,350 287,350
----------- ----------- --------- -----------
$ 8,802,395 $ 136,280 $ (5,459) $ 8,933,216
=========== =========== ========= ===========
Held-to-maturity:
U.S. Government agency securities $ 2,250,000 $ 7,907 $ (24,845) $ 2,233,062
Mortgage-backed securities ..... 4,453,476 93,147 (6,923) 4,539,700
----------- ----------- --------- -----------
$ 6,703,476 $ 101,054 $ (31,768) $ 6,772,762
=========== =========== ========= ===========
The table below indicates the length of time individual securities, both
held-to-maturity and available-for-sale, have been in a continuous unrealized
loss position at December 31, 2004 (in thousands):
Less than 12 months 12 months or longer Total
---------------------- ---------------------- ----------------------
Number
Description of of Fair Unrealized Fair Unrealized Fair Unrealized
Securities securities value losses value losses value losses
- ------------------- ------------ -------- ----------- -------- ----------- -------- ------------
U.S. Government
agency securities 10 $3,481 $ (19) 488 (12) $3,969 $(31)
Mortgage backed
securities 11 3,833 (35) 222 (5) 4,055 (40)
------- ------ ------ ------- ------- ------ ----
Total temporarily
impaired investment
securities 21 $7,314 $ (54) $ 710 $ (17) $ 8,024 $(71)
====== ====== ======= ======= ======= ======= ====
(Continued)
67
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
4. INVESTMENTS - Continued
The table below indicates the length of time individual securities, both
held-to-maturity and available-for-sale, have been in a continuous
unrealized loss position at December 31, 2003 (in thousands):
Less than 12 months 12 months or longer Total
---------------------- ---------------------- ----------------------
Number
Description of of Fair Unrealized Fair Unrealized Fair Unrealized
Securities securities value losses value losses value losses
- ------------------- ------------ -------- ----------- -------- ----------- -------- ------------
U.S. Government
agency securities 3 $1,475 ($25) -- -- $ 1,475 ($25)
Mortgage backed
securities 7 2,445 (12) -- -- 2,445 (12)
--------- ------ ----- ------- ------- ------ ----
Total temporarily
impaired investment
securities 10 $ 3,920 ($37) $ -- $ -- $ 3,920 ($37)
======== ======= ===== ======= ======== ======= ====
Management has considered factors regarding other than temporarily impaired
securities and determined that there are no securities that are impaired as
of December 31, 2004.
Maturities of investment securities classified as available-for-sale and
held-to-maturity at December 31, 2004 were as follows. Expected maturities
may differ from contractual maturities.
Amortized Market
cost value
----------- ----------
Available-for-sale:
Due after one month through three years .. $ -- $ --
Due after three year through five years .. 250,000 249,298
Due after five years through fifteen years -- --
Mortgage-backed securities ............... 4,183,980 4,210,896
---------- ----------
Total debt securities .................... 4,433,980 4,460,194
Investments in mutual funds .............. 108,905 108,905
Other investments ........................ 228,450 228,450
---------- ----------
$4,771,335 $4,797,549
========== ==========
Held-to-maturity:
Due in one month through three years ..... $ -- $ --
Due after three years through five years . 2,749,892 2,737,387
Due after five years through fifteen years 1,750,000 1,733,830
Mortgage-backed securities ............... 4,262,904 4,313,278
---------- ----------
$8,762,796 $8,784,495
========== ==========
(Continued)
68
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
4. INVESTMENTS - Continued
The Bank recorded a gain of $31,115 on the sale of investments during the
year ended December 31, 2004. No securities were sold during 2003. The Bank
recorded a gain of $25,789 on the sale of investments during the year ended
December 31, 2002.
As of December 31, 2004 and 2003, investment securities with a book value of
$11,459,636 and $7,451,203, were pledged as collateral to secure public
deposits and for other purposes required or permitted by law.
5. LOANS AND ALLOWANCE FOR LOAN LOSSES
The composition of the net loans is as follows:
2004 2003
------------ ------------
Commercial and industrial........ $ 15,217,162 $ 11,361,087
Commercial real estate........... 13,070,128 11,862,638
Residential mortgages............ 10,664,750 15,109,802
Consumer loans................... 6,727,974 8,694,870
------------ ------------
Total loans................... 45,680,014 47,028,397
Less allowance for loan losses... (602,939) (338,574)
------------ ------------
Net loans..................... $ 45,077,075 $ 46,689,823
============ ============
As of December 31, 2004, the Bank had student loans with a book value of
$1,412,554 that were held-for-sale.
As of December 31, 2004 and 2003, the Bank had loans to certain officers and
directors and their affiliated interests in aggregate dollar amounts of
$1,074,000 and $808,000, respectively. During 2004, there were $236,000 in
new loans to related parties and repayments amounted to $81,000. During 2003
there were no new loans to related parties and repayments amounted to
$65,000 and $249,000, respectively.
The balance of impaired loans was $1,034,000 and $1,124,000 as of December
31, 2004 and 2003, respectively. The Bank identifies a loan as impaired when
it is probable that interest and principal will not be collected according
to the contractual terms of the loan agreement. The entire balance of
impaired loans were in a non-accrual status at December 31, 2004 and 2003.
The allowance for loan loss associated with the impaired loans was $259,000
at December 31, 2004. A portion of impaired loans, $888,000, is guaranteed
by the SBA. No interest was recognized on impaired loans in 2004. Interest
income recognized on impaired loans during 2003 was $67,000. The Bank
recognizes income on impaired loans under the cash basis when the loans are
both current and the collateral on the loan is sufficient to cover the
outstanding obligation to the Bank. If these factors do not exist, the Bank
will not recognize income on such loans.
At December 31, 2004 and 2003, unamortized deferred fees and costs totaled
$139,296 and $107,676, respectively.
(Continued)
69
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
5. LOANS AND ALLOWANCE FOR LOAN LOSSES - Continued
Changes in the allowance for possible loan losses are as follows:
2004 2003 2002
---- ---- ----
Balance, beginning of year... $ 338,574 $ 674,550 $ 708,156
Provision.................... 45,000 565,000 175,000
Charge-offs.................. (239,757) (972,938) (361,656)
Recoveries................... 459,122 71,962 153,050
--------- --------- ---------
Balance, end of year......... $ 602,939 $ 338,574 $ 674,550
========= ========= =========
The Bank grants commercial, residential, and consumer loans to customers
primarily located in Philadelphia County, Pennsylvania and surrounding
counties in the Delaware Valley. Although the Bank has a diversified loan
portfolio, its debtors' ability to honor their contracts is influenced by
the region's economy. At December 31, 2004, approximately 18% of the Bank's
commercial loan portfolio was concentrated in loans made to religious
organizations.
6. BANK PREMISES AND EQUIPMENT
The major classes of bank premises and equipment and the total accumulated
depreciation are as follows:
Estimated
useful life 2004 2003
----------- ---- ----
Buildings and leasehold improvements... 10-15 years $ 1,355,086 $ 3,181,656
Furniture and equipment................ 3- 7 years 1,753,307 1,542,140
----------- -----------
3,108,393 4,723,796
Less accumulated depreciation.......... (2,033,538) (1,951,643)
----------- -----------
$ 1,074,855 $ 2,772,153
=========== ===========
The Bank leases other facilities and other equipment under non-cancelable
operating lease agreements. The amount of expense for operating leases for
the years ended December 31, 2004, 2003, and 2002 was $277,850, $329,878,
and $364,469.
Future minimum lease payments under operating leases are as follows:
Operating
Year ending December 31, leases
------------------------ ------
2005................................ $ 182,903
2006................................ 226,434
2007................................ 229,005
2008................................ 220,787
Thereafter.......................... 1,220,558
-----------
Total minimum lease payments........ $ 2,079,687
===========
70
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
7. DEPOSITS
At December 31, 2004, the scheduled maturities of time deposits
(certificates of deposit) are as follows (dollars in thousands):
2005......................... $ 22,100
2006......................... 920
2007......................... 396
2008......................... 227
Thereafter................... 164
---------
$ 23,807
=========
8. BORROWINGS
As of December 31, 2004, the Bank has two borrowing arrangements available
with financial institutions, collateralized by investment securities. One
arrangement is a fully secured Federal Funds line of credit with a
correspondent bank totaling $2 million, the second is a Master Repurchase
Agreement with another financial institution. Borrowings under these
agreements have interest rates that fluctuate based on market conditions. As
of December 31, 2004, the Bank had no borrowings outstanding.
9. CAPITAL STOCK
There were no capital stock transaction in 2004.
In June 2003, a shareholder of the Bank returned 33,500 shares of common
stock and 6,308 shares of preferred Series A stock. These shares were
returned for no consideration and were recorded as treasury stock by the
Bank.
In June 2002, the Bank received $20,400 and issued 1,700 shares as a result
of the purchase of common stock by members of the Bank's board of directors
in a limited offering at a price of $12.00 per share.
10. INCOME TAXES
At December 31, 2004, the Bank has net operating loss carryforwards of
approximately $4,130,000 for income tax purposes that begin to expire in
2008 through 2020.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amount used for income tax purposes. For
financial reporting purposes, a valuation allowance of $1,930,062 and
$2,352,209 as of December 31, 2004 and 2003, respectively, has been
recognized to offset the deferred tax assets related to the cumulative
temporary differences and the tax loss carryforwards. Significant components
of the Bank's deferred tax assets are as follows:
(Continued)
71
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
10. INCOME TAXES - Continued
2004 2003
---- ----
Deferred tax assets:
Provision for loan losses ....................... $ 72,243 $ (31,349)
Unrealized (gains) losses on investment securities (8,909) (43,172)
Depreciation ..................................... 436,223 369,277
Net operating loss carryforwards ................. 1,405,875 2,135,303
Other ...................................... 24,630 (77,850)
Valuation allowance for deferred tax assets ...... (1,930,062) (2,352,209)
----------- -----------
Net deferred tax assets ................ $ -- $ --
=========== ===========
2004 2003 2002
---- ---- ----
Effective rate reconciliation:
Tax at statutory rate ................... $ 559,817 $(379,258) $ (73,638)
Nondeductible expenses .................. 5,401 4,325 3,152
(Decrease) Increase in valuation allowance (422,447) 494,737 70,486
Other ................................... (142,771) (119,804) --
--------- --------- ---------
Total tax expense ................... $ -- $ -- $ --
========= ========= =========
11. FINANCIAL INSTRUMENT COMMITMENTS
The Bank is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and letters
of credit, which are conditional commitments issued by the Bank to guarantee
the performance of an obligation of a customer to a third party. Both
arrangements have credit risk essentially the same as that involved in
extending loans and are subject to the Bank's normal credit policies.
Collateral may be obtained based on management's assessment of the customer.
The Bank's exposure to credit loss in the event of nonperformance by the
other party to the financial instruments is represented by the contractual
amount of those instruments.
Summaries of the Bank's financial instrument commitments are as follows:
2004 2003
------------ ------------
Commitments to extend credit...... $13,749,562 $ 8,152,988
Outstanding letters of credit..... -- 32,155
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract and
unused credit card lines. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. Commitments generally have
fixed expiration dates or other termination clauses and may require payment
of a fee.
72
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
12. FAIR VALUES OF FINANCIAL INSTRUMENTS
Fair value information about financial instruments is required to be
disclosed, whether or not recognized in the balance sheet, where it is
practicable to estimate that value. In cases where quoted market prices are
not available, fair values are based on estimates using discounted cash
flows or other valuation techniques. Those techniques are significantly
affected by assumptions used, including the discount rate and estimates of
future cash flows. In that regard, the derived fair value estimates cannot
be substantiated by comparison to independent markets and, in many cases,
could not be realized in immediate settlement of the instrument. Certain
financial instruments and all nonfinancial instruments are exempt from
disclosure requirements. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Bank.
2004 2003
------------------------- -------------------------
Carrying Fair Carrying Fair
amount value amount value
---------- ---------- ----------- ----------
(Dollars in thousands)
Assets:
Cash and cash equivalents..................... $ 8,934 $ 8,934 $ 6,693 $ 6,693
Investment securities......................... 13,560 13,582 15,637 15,706
Loans held-for-sale........................... 1,412 1,437
Loans, net of allowance for loan losses....... 45,077 45,366 46,690 46,587
Liabilities:
Demand deposits............................... 21,773 21,773 26,543 26,543
Savings deposits.............................. 17,591 17,591 19,309 19,309
Time deposits................................. 23,807 23,807 21,264 21,264
13. EMPLOYEE COMPENSATION
In November 2004, the Bank renewed the employment agreements of its chief
executive officer and its chief financial officer covering such items as
salaries, bonuses and benefits for three years. These agreements provide for
guaranteed minimum annual compensation over the term of the contracts.
In 1998, the Company adopted a Stock Option Plan with the approval of its
shareholders. In accordance with the contractual terms with its former chief
executive officer, the Bank granted the right to acquire up to 4% of the
Bank's stock as of December 31, 1993 at $8.54 per share, which was the book
value at the date of grant. Under this Plan, options to acquire shares of
common stock were granted to the former chief executive officer. The Stock
Option Plan provides for the granting of options at the fair market value of
the Company's common stock at the time the options are granted. Each option
granted under the Stock Option Plan may be exercised within a period of ten
years from the date of grant. However, no option may be exercised within one
year from the date of grant. In 1998, options to purchase 29,694 shares of
the Company's common stock at a price of $8.54 per share were awarded, to
the former chief executive officer. Those options remain outstanding at
December 31, 2004. These options expire in 2008.
The Company made no stock-based compensation awards to any employee during
2004, 2003 and 2002.
73
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
14. CONSOLIDATED FINANCIAL INFORMATION--PARENT COMPANY ONLY
Condensed Balance Sheets
December 31,
------------
(Dollars in thousands) 2004 2003
--------- ---------
Assets:
Due from banks (subsidiary) .............. $ 289 $ 289
Investment in United Bank of Philadelphia 8,522 6,946
-------- --------
Total assets ......................... $ 8,811 $ 7,235
======== ========
Shareholders' equity:
Series A preferred stock ................. $ 1 $ 1
Common stock ............................. 11 11
Additional paid-in capital ............... 14,750 14,750
Accumulated deficit ...................... (5,968) (7,615)
Net unrealized holding gains on securities
available-for-sale ................... 17 88
-------- --------
Total shareholders' equity ........... $ 8,811 $ 7,235
======== ========
Condensed Statements of Operations
Years ended December 31,
-----------------------------
(Dollars in thousands) 2004 2003 2002
------- ------- ------
Equity in net income (loss) of subsidiary.... $ 1,646 $(1,115) $ (217)
------ ------- ------
Net income (loss)............................ $ 1,646 $(1,115) $ (217)
======= ======= ======
Condensed Statements of Cash Flows
Years ended December 31,
------------------------------------
(Dollars in thousands) 2004 2003 2002
------ ------ ------
Cash flows from operating activities:
Net income (loss) ........................... $ 1,646 $(1,115) $ (217)
Equity in net (income) loss of subsidiary ... (1,646) 1,115 217
------- ------- -------
Net cash provided by operating activities -- -- --
------- ------- -------
Cash flows from investing activities:
Investment in subsidiary ....................... -- -- (20)
------- ------- -------
Net cash used in investing activities .......... -- -- (20)
------- ------- -------
Cash flows from financing activities:
Issuance of common stock .................... -- -- 20
------- ------- -------
Net cash provided by financing activities -- -- 20
------- ------- -------
Net increase in cash and cash equivalents -- -- --
Cash and cash equivalents at beginning of year . 289 289 289
------- ------- -------
Cash and cash equivalents at end of year ....... $ 289 $ 289 $ 289
======= ======= =======
74
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
15. REGULATORY MATTERS
The Bank engages in the commercial banking business, with a particular focus
on serving Blacks, Hispanics and women, and is subject to substantial
competition from financial institutions in the Bank's service area. As a
bank holding company and a banking subsidiary, the Company and the Bank,
respectively, are subject to regulation by the Federal Reserve Board and the
Pennsylvania Department of Banking and are required to maintain capital
requirements established by those regulators. Prompt corrective actions may
be taken by those regulators against banks that do not meet minimum capital
requirements. Prompt corrective actions range from restriction or
prohibition of certain activities to the appointment of a receiver or
conservator of an institution's net assets. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that if undertaken, could have a direct
material effect on the Bank's financial statements. Under capital adequacy
guidelines that involve quantitative measures of the Bank's assets,
liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices, the Bank's 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 Bank to maintain minimum amounts and ratios (set forth in the
table below) of total Tier I capital (as defined in the regulations) for
capital adequacy purposes to risk-weighted assets (as defined).
The most recent notification dated March 3, 2005, from the Federal Reserve
Bank categorized the Bank as "adequately capitalized" under the regulatory
framework for prompt and corrective action. To be categorized as "well
capitalized," the Bank must maintain minimum total risk-based, Tier I
risk-based, and Tier I leverage ratios as set forth in the table below. The
Bank's growth and other operating factors such as the need for additional
provisions to the allowance for loans losses may have an adverse effect on
its capital ratios. (Also see Footnote 2. REGULATORY AGREEMENT)
(Continued)
75
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
15. REGULATORY MATTERS - Continued
The Bank's actual capital amounts and ratios are as follows:
To be well
capitalized under
For capital prompt corrective
Actual adequacy purposes action provisions
--------------------- -------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
--------- --------- --------- --------- --------- ---------
As of December 31, 2004:
Total capital to risk-weighted assets:
Consolidated...................... $ 7,778 17.91% $ 3,498 8.00% N/A
Bank.............................. 7,489 17.24 3,475 8.00 $ 4,344 10.00%
Tier I capital to risk-weighted assets:
Consolidated...................... 7,234 16.65 1,749 4.00 N/A
Bank.............................. 6,945 15.99 1,737 4.00 $ 2,606 6.00%
Tier I capital to average assets:
Consolidated...................... 7,234 9.89 2,938 4.00 N/A
Bank.............................. 6,945 9.49 2,926 4.00 $ 3,658 5.00%
As of December 31, 2003:
Total capital to risk-weighted assets:
Consolidated...................... $ 5,748 12.78% $ 3,621 8.00% N/A
Bank.............................. 5,459 12.14 3,598 8.00 $ 4,497 10.00%
Tier I capital to risk-weighted assets:
Consolidated...................... 5,409 12.03 1,810 4.00 N/A
Bank.............................. 5,120 11.39 1,799 4.00 $ 2,698 6.00%
Tier I capital to average assets:
Consolidated...................... 5,409 7.19 3,020 4.00 N/A
Bank.............................. 5,120 6.81 3,008 4.00 $ 3,760 5.00%
76
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
15. COMMITMENTS AND CONTINGENCIES
The Bank is a defendant in certain claims and legal actions arising in the
ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these matters
is not expected to have a material adverse effect on the consolidated
financial condition of the Company.
16. EARNINGS PER SHARE COMPUTATION
In accordance with SFAS No. 128, income (loss) per share is calculated
as follows:
Year ended December 31, 2004
---------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
----------- ------------- ------
Net income................................ $1,646,522
==========
Basic and fully diluted EPS
Income available to stockholders... $1,646,522 1,068,588 $ 1.54
========== ========= ======
Fully Diluted EPS
Income available to stockholders... $1,646,522 1,098,282 $ 1.50
========== ========= ======
Year ended December 31, 2003
-----------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
----------- ------------- ------
Net loss................................. $ 1,115,465)
===========
Basic and fully diluted EPS
Income available to stockholders.. $(1,115,465) 1,084,694 $ (1.03)
=========== ========= =======
Year ended December 31, 2002
-----------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
----------- ------------- ------
Net loss................................. $ (216,583)
==========
Basic EPS and fully diluted EPS
Income available to stockholders.. $ (216,583) 1,101,247 $ (0.20)
========== ========= =======
Options to purchase 29,694 shares of common stock were not included in the
computation of diluted EPS for the years ended December 31, 2003 and 2002
because the Company is in a loss position.
The Company's preferred stock is non-cumulative and the Bank is restricted
from paying dividends. Therefore, no effect of the preferred stock is
included in the earnings per share calculations.
77
United Bancshares, Inc. and Subsidiary
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2004, 2003, and 2002
17. SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
The following summarizes the consolidated results of operations during 2004
and 2003, on a quarterly basis, for United Bancshares, Inc. and Subsidiary:
(Dollars in thousands)
2004
----------------------------------------------
Fourth Third Second First
quarter quarter quarter quarter
------- ------- ------- -------
Interest income ................................ $ 933 $ 947 $ 882 $ 924
Interest expense ............................... 110 94 96 105
------- ------- ------- -------
Net interest income ......................... 823 853 786 818
Provisions for loan losses ..................... 39 36 111 (141)
------- ------- ------- -------
Net interest after provisions for loan losses 784 817 675 959
Non-interest income ............................ 403 1,908 888 456
Non-interest expense ........................... 1,288 1,237 1,322 1,397
------- ------- ------- -------
Net (loss) income ........................... $ (102) $ 1,489 $ 241 $ 18
======= ======= ======= =======
2003
----------------------------------------------
Fourth Third Second First
quarter quarter quarter quarter
------- ------- ------- -------
Interest income ................................ $ 913 $ 925 $ 990 $ 1,008
Interest expense ............................... 115 129 149 153
------- ------- ------- -------
Net interest income ......................... 798 796 841 855
Provisions for loan losses ..................... 385 60 60 60
------- ------- ------- -------
Net interest after provisions for loan losses 413 736 781 795
Non-interest income ............................ 557 462 409 462
Non-interest expense ........................... 1,451 1,453 1,422 1,404
------- ------- ------- -------
Net (loss) income ........................... $ (481) $ (255) $ (232) $ (147)
======= ======= ======= =======
78
NEW SECTION FOR EXHIBITS
Commission File No. 0-25976
SECURITIES AND EXCHANGE COMMISSION
- --------------------------------------------------------------------------------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Year Ended December 31, 2004
- --------------------------------------------------------------------------------
UNITED BANCSHARES, INC.
EXHIBITS
Exhibit 10(a) -- Lease for corporate headquarters office located at The Graham
Building, 30 S. 15th Street, Suite 1200, Philadelphia, PA
Exhibit 10(e) -- Evelyn F. Smalls' Employment Agreement, dated November 1, 2004
Exhibit 10(f) -- Brenda Hudson-Nelson's Employment Agreement, dated November 1,
2004
Exhibit 14 -- Code Conduct and Ethics
Exhibit 16 -- Letter re Change of Accountant
Exhibit 31.1 -- Certification of the Chief Executive Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 -- Certification of the Chief Financial Officer Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1(a) -- Certification Pursuant to 18 U.S.C. Section 1350, as adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of the Chief
Executive Officer attached hereto as Exhibit 31.1.
Exhibit 32.2(b) -- Certification Pursuant to 18 U.S.C. Section 1350, as adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 of the Chief
Financial Officer attached hereto as Exhibit 31.2.
Exhibit 99(a) -- Registrants Proxy Statement for its Annual Shareholders Meeting
held on November 23, 2004