ITEM 1 DESCRIPTION OF BUSINESS
(a) GENERAL DEVELOPMENT OF BUSINESS
United Bancorp, Inc. (Company) is a financial holding company headquartered in Martins Ferry, Ohio. The Company has two wholly owned subsidiary banks, The Citizens Savings Bank, Martins Ferry, Ohio (CITIZENS) and The Community Bank, Lancaster, Ohio (COMMUNITY), collectively "Banks". For additional information regarding the Company's business see "Narrative Description of Business".
(b) FINANCIAL INFORMATION ABOUT BUSINESS SEGMENTS
Refer to Note 1 of Notes to Consolidated Financial Statements set forth in Part II, Item 8 of this Report.
(c) EXECUTIVE OFFICERS OF THE REGISTRANT
Each individual has held the position noted during the past five years, except for the following:
Scott A. Everson served as Senior Vice President, Operations and Retail Banking of The Citizens Savings Bank from May 1999 to April 2002 and prior to that he served Assistant Vice President/Branch Manager Bridgeport Office from 1997 to May 1999. In addition, he is currently President and Chief Operating Office and a Director of The Citizens Savings Bank. He has held this position since April 2002.
Michael A. Lloyd served as Senior Vice President Management Information Systems from October 1999 to April 2002 of the Citizens Savings Bank and prior to that he served as Vice President Management Information Systems from April 1999 to October 1999. He served as Data Processing Manager from 1994 to April 1999 for The Citizens Savings Bank.
Each of these Executive Officers are serving at-will in their current positions. The Officers have held the positions for the following time periods: James W. Everson, 21 years, Alan M. Hooker, 5 years, Norman F. Assenza, Jr., 21 years, James A. Lodes, 8 years, and Randall M. Greenwood, 6 years.
(d) NARRATIVE DESCRIPTION OF BUSINESS
The Company is a financial holding company as defined under the Bank Holding Company Act of 1956, as amended (the "BHC Act"). The BHC Act regulates acquisitions by the Company of voting shares or assets of any bank or other company. The Company is subject to the reporting requirements of, and examination and regulation by, the Board of Governors of the Federal Reserve System, as well as reporting requirements under the Securities and Exchange Commission Act of 1934.
The Banks are located in northeastern, eastern, southeastern and south central Ohio and are engaged in the business of commercial and retail banking in Belmont, Harrison, Tuscarawas, Carroll, Athens, Hocking, and Fairfield counties and the surrounding localities. The Banks provide a broad range of banking and financial services, which include accepting demand, savings and time deposits and granting commercial, real estate and consumer loans. CITIZENS conducts its business through its main office in Martins Ferry, Ohio and nine branches located in Bridgeport, Colerain, Dellroy, Dover, Jewett, New Philadelphia, St. Clairsville, Sherrodsville, and Strasburg, Ohio. CITIZENS offers full service brokerage service with securities provided through UVEST(R) member NASD/SIPC. COMMUNITY conducts its business through its seven offices in Amesville, Glouster, Lancaster, and Nelsonsville, Ohio.
The markets in which the Banks' operate continue to be highly competitive. CITIZENS competes for loans and deposits with other retail commercial banks, savings and loan associations, finance companies, credit unions and other types of financial institutions within the Mid-Ohio valley geographic area along the eastern border of Ohio, extending into the northern panhandle of West Virginia and the Tuscarawas and Carroll County geographic areas of northeastern Ohio. COMMUNITY also encounters similar competition for loans and deposits throughout the Athens, Hocking, and Fairfield County geographic areas of central and southeastern Ohio.
The Company is regulated under the BHC Act, and is subject to the supervision and examination of the Board of Governors of the Federal Reserve System (the Federal Reserve Board). The BHC Act requires the prior approval of the Federal Reserve Board for a bank holding company to acquire or hold more than a 5% voting interest in any bank. The BHC Act allows interstate bank acquisitions anywhere in the country and interstate branching by acquisition and consolidation in those states that have not opted out by January 1, 1997.
Other than as described more thoroughly below with respect to activities that are "financial in nature," the Company is generally prohibited by the Act from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank or bank holding company and from engaging directly or indirectly in activities other than those of managing or controlling banks or furnishing services to its subsidiaries.
On November 12, 1999, the Gramm-Leach-Bliley Act (the "GLB Act") was enacted into law. The GLB Act made sweeping changes with respect to the permissible financial services, which various types of financial institutions may now provide. The Glass-Steagall Act, which had generally prevented banks from affiliation with securities and insurance firms, was repealed. Pursuant to the GLB Act, bank holding companies may elect to become a "financial holding company," provided that all of the depository institution subsidiaries of the bank holding company are "well capitalized" and "well managed" under applicable regulatory standards. As stated above, the Company has made such an election.
Under the GLB Act, a financial holding company may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. Activities that are "financial in nature" include securities underwriting, dealing and market-making, sponsoring mutual funds and investment companies, insurance underwriting and agency, merchant banking, and activities that the Federal Reserve Board has determined to be closely related to banking.
The Company's banking subsidiaries are also subject to limitations with respect to transactions with affiliates.
A substantial portion of the United Bancorp's cash revenues is derived from dividends paid by its subsidiary
bank. These dividends are subject to various legal and regulatory restrictions.
The Company's banking subsidiaries are subject to primary supervision, regulation and examination by the Ohio Department of Financial Institutions and the Federal Deposit Insurance Corporation (FDIC).
Federal regulators adopted risk-based capital guidelines and leverage standards for banks and holding companies. A discussion of the impact of risk-based capital guidelines and leverage standards is presented in Note 12 to the audited consolidated financial statements of United Bancorp, Inc., captioned "Regulatory Matters."
The Financial Reform, Recovery and Enforcement Act of 1989 (FIRREA) provides that a holding company's controlled insured depository institutions are liable for any loss incurred by the Federal Deposit Insurance Corporation in connection with the default of any FDIC-assisted transaction involving an affiliated insured bank or savings association.
Noncompliance with laws and regulations by financial holding companies and banks can lead to monetary penalties and/or an increased level of supervision or a combination of these two items. Management is not aware of any current instances of noncompliance with laws and regulations and does not anticipate any problems maintaining compliance on a prospective basis. Recent regulatory inspections and examinations of United Bancorp, Inc. and its subsidiary banks have not disclosed any significant instances of noncompliance.
The earnings and growth of United Bancorp are affected not only by general economic conditions, but also by the fiscal and monetary policies of the federal government and its agencies, particularly the Federal Reserve Board. The FRB's policies influence the amount of bank loans and deposits and the interest rates charged and paid thereon, and thus have an effect on earnings. The nature of future monetary policies and the effect of such policies on the future business and earnings of United Bancorp and its subsidiary banks cannot be predicted.
The Banks have no single customer or related group of customers whose banking activities, whether through deposits or lending, would have a material impact on the continued earnings capabilities if those activities were removed.
The Company itself, as a shell holding company, has no compensated employees. CITIZENS has 81 full time employees, with 19 of these serving in a management capacity and 35 part time employees. COMMUNITY has 32 full time employees, with 7 serving in a management capacity and 18 part time employees. The Company considers employee relations to be good at all subsidiary locations.
I DISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL
A-C Refer to Management's Discussion and Analysis "Average Balances, Net Interest Income and Yields Earned and Rates Paid"
II INVESTMENT PORTFOLIO
A Securities available for sale at year-end 2003 increased $11,746,000, or 9.1% over 2002, while securities held to maturity increased $2,669,000, or 20.6%. In our planning process, management's prediction for 2003 was for a steady to slightly rising interest rate environment. For the first half of 2003, management maintained an average of $9.2 million in fed funds sold. As the economy remained in a low-growth mode, management's posture on interest rates for the remainder of 2003 and heading into 2004 changed from one that interest rates may rise to a position that rates will go basically unchanged for the next twelve months. Therefore, by December 31, 2003, management had invested the Company's excess liquidity in investment securities and in loans.
The following table sets forth the carrying amount of securities at December 31, 2003, 2002 and 2001:
B Contractual maturities of securities at year-end 2003 were as follows:
C Refer to Note 2 of Notes to Consolidated Financial Statements.
D Excluding holdings of U.S. Agency, there were no investments in securities of any one issuer exceeding 10% of the Company's consolidated shareholders' equity at December 31, 2003.
III LOAN PORTFOLIO
A TYPES OF LOANS
The amounts of gross loans outstanding at December 31, 2003, 2002, 2001, 2000 and 1999 are shown in the following table according to types of loans:
Construction loans were not significant for the periods discussed.
B MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES
The following is a schedule of commercial and commercial real estate loans at December 31, 2003 maturing within the various time frames indicated:
The following is a schedule of fixed rate and variable rate commercial and commercial real estate loans at December 31, 2003 due to mature after one year:
Variable rate loans are those loans with floating or adjustable interest rates.
C RISK ELEMENTS
1. NONACCRUAL, PAST DUE, RESTRUCTURED AND IMPAIRED LOANS
The following schedule summarizes nonaccrual loans, accruing loans which are contractually 90 days or more past due, and impaired loans at December 31, 2003, 2002 and 2001:
(1) There were no restructured loans at any of the dates indicated above.
(2) Loans considered impaired under the provisions of SFAS No. 114 and interest recognized on a cash received basis were not considered material during any of the periods presented.
The additional amount of interest income that would have been recorded on nonaccrual loans, had they been current, totaled $907, $ 6,270 and $ 6,610 for the years ended December 31, 2003, 2002 and 2001
Interest income is not reported when full loan repayment is doubtful, typically when the loan is impaired or payments are past due over 90 days. Payments received on such loans are reported as principal reductions.
A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral.
1. POTENTIAL PROBLEM LOANS
The Company had no potential problem loans as of December 31, 2003 which have not been disclosed in Table C 1., but where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans into one of the problem loan categories.
3. FOREIGN OUTSTANDING
Not applicable.
4. LOAN CONCENTRATIONS
Refer to Note 11 of Notes to Consolidated Financial Statements.
D. OTHER INTEREST-BEARING ASSETS
Not applicable.
IV SUMMARY OF LOAN LOSS EXPERIENCE
For additional explanation of factors which influence management's judgment in determining amounts charged to expense, refer to "Management Discussion and Analysis" and Notes to Consolidated Financial Statements.
A ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
The following schedule presents an analysis of the allowance for loan losses, average loan data and related ratios for the years ended December 31, 2003, 2002, 2001, 2000, and 1999:
B ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
The following table allocates the allowance for possible loan losses at December 31, 2003, 2002, 2001, 2000 and 1999. Management adjusts the allowance periodically to account for changes in national trends and economic conditions in the Banks' service areas. The allowance has been allocated according to the amount deemed to be reasonably necessary to provide for the probability of losses being incurred within the following categories of loans at the dates indicated:
V DEPOSITS
A SCHEDULE OF AVERAGE DEPOSIT AMOUNTS AND RATES
(1)-(4) Refer to Management's Discussion and Analysis "Average Balances, Net Interest Income and Yields Earned and Rates Paid" in Part II, Item 7 of this Report.
(5)-(8) Not applicable.
B OTHER CATEGORIES
Not applicable.
C FOREIGN DEPOSITS
Not applicable.
D MATURITY ANALYSIS OF TIME DEPOSITS GREATER THAN $100,000.
The following schedule details the maturities of time certificates of deposit in amounts of $100,000 or more for the year ended December 31, 2003:
Refer to Note 5 of Notes to Consolidated Financial Statements for Additional Information.
E TIME DEPOSITS GREATER THAN $100,000 ISSUED BY FOREIGN OFFICES.
Not applicable.
VI RETURN ON EQUITY AND ASSETS
The ratio of net income to daily average total assets and average shareholders' equity, and certain other ratios, were as follows:
VII SHORT-TERM BORROWINGS
Information concerning securities sold under agreements to repurchase is summarized as follows:
Securities sold under agreements to repurchase are financing arrangements whereby the Company sells securities and agrees to repurchase the identical securities at the maturities of the agreements at specified prices.
Information concerning the cash management line of credit from the Federal Home Loan Bank of Cincinnati, Ohio is summarized as follows:
No other individual component of the borrowed funds total comprised more than 30% of shareholders' equity and accordingly are not disclosed in detail.
ITEM 2
ITEM 2 PROPERTIES
The Company owns and operates its Main Office in Martins Ferry, Ohio and the following offices;
Management believes the properties described above to be in good operating condition for the purpose for which it is used. The properties are unencumbered by any mortgage or security interest and is, in management's opinion, adequately insured.
ITEM 3
ITEM 3 LEGAL PROCEEDINGS
Refer to Note 1 of Notes to Consolidated Financial Statements set forth in Part II, Item 8 of this Report.
ITEM 4
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No motions were submitted to shareholders for a vote during the fourth quarter of 2003.
PART II
ITEM 5
ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Shareholder Information
United Bancorp, Inc.'s (the Company) common stock trades on The Nasdaq SmallCap Market tier of The Nasdaq Stock Market under the symbol UBCP, CUSIP #90991109. At year-end 2003, there were 3,752,105 shares outstanding, held among approximately 2,000 shareholders of record and in street name. The following table sets forth the quarterly high and low closing prices of the Company's common stock from January 1, 2003 to December 31, 2003 compared to the same periods in 2002 as reported by the NASDAQ. The price quotes have been adjusted for comparison purposes for the 10% stock dividend distributed on December 19, 2003 and the 5% dividend distributed on December 20, 2002. The price quotations presented should not necessarily be relied on in determining the value of the shareholders' investment. For information regarding dividend restrictions applicable to the Company and its subsidiaries, see Note 12, captioned "Regulatory Matters," under Item 8 of this report on Form 10-K.
INVESTOR RELATIONS: A copy of the Company's Annual Report on form 10-K as filed with the SEC, will be furnished free of charge upon written or Email request to: Randall M. Greenwood, CFO United Bancorp, Inc. 201 South 4th Street PO Box 10 Martins Ferry, OH 43935 or cfo@unitedbancorp.com
DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN: Shareholders may elect to reinvest their dividends in additional shares of United Bancorp, Inc.'s common stock through the Company's Dividend Reinvestment Plan. Shareholders may also invest optional cash payments of up to $5,000 per quarter in our common stock at market price. To arrange automatic purchase of shares with quarterly dividend proceeds, please contact: American Stock Transfer and Trust Company Attn: Dividend Reinvestment 6201 15th Avenue, 3rd Floor Brooklyn, NY 11219 1-800-278-4353
ANNUAL MEETING: The Annual Meeting of Shareholders will be held at 2:00 p.m., April 21, 2004 at the Corporate Offices in Martins Ferry, Ohio.
INTERNET: Please look us up at http//:www.unitedbancorp.com
INDEPENDENT AUDITORS: Grant Thornton LLP 625 Eden Park Drive Cincinnati, Ohio 45202 (513) 762-5000
CORPORATE OFFICES: The Citizens Savings Bank Building 201 South 4th Street Martins Ferry, Ohio 43935 (740) 633-0445 (740) 633-1448 (FAX)
TRANSFER AGENT AND REGISTRAR: For transfers and general correspondence, please contact: American Stock Transfer and Trust Company 6201 15th Avenue, 3rd Floor Brooklyn, NY 11219 1-800-937-5449
STOCK TRADING: Advest, Inc. 340 S. Hollywood Plaza Steubenville, Ohio 43952 1-800-761-8008 George Crim 800-761-8008
Stifel, Nicolaus & Company Inc. 655 Metro Place South Dublin, Ohio 43017 Steven Jefferis 877-875-9352
FTN Midwest Research 350 Madison Avenue 19th Floor New York, NY 10017 Bradley Dobin 866-268-6529
ANNUAL REPORT
ITEM 6
ITEM 6 SELECTED CONSOLIDATED FINANCIAL DATA
ITEM 7
ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In the following pages, management presents an analysis of United Bancorp, Inc.'s financial condition and results of operations as of and for the year ended December 31, 2003 as compared to prior years. This discussion is designed to provide shareholders with a more comprehensive review of the operating results and financial position than could be obtained from an examination of the financial statements alone. This analysis should be read in conjunction with the consolidated financial statements and related footnotes and the selected financial data included elsewhere in this report.
When used in this discussion or future filings by the Company with the Securities and Exchange Commission, or other public or shareholder communications, or in oral statements made with approval of an authorized executive officer, the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "believe," or similar expressions are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made, and to advise readers that various factors, including regional and national economic conditions, changes in levels of market interest rates, credit risks of lending activities and competitive and regulatory factors, could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from those anticipated or projected.
The Company is not aware of any trends, events or uncertainties that will have or are reasonably likely to have a material effect on its liquidity, capital resources or operations except as discussed herein. The Company is not aware of any current recommendations by regulatory authorities that would have such effect if implemented.
The Company does not undertake, and specifically disclaims, any obligation to publicly release any revisions that may be made to any forward-looking statements to reflect occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
The consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and follow general practices within the financial services industry. The application of these principles requires management to make certain estimates, assumptions and judgements that affect the amounts reported in the financial statements and footnotes. These estimates assumptions, and judgements are based on information available as of the date of the financial statements, and as this information changes, the financial statements could reflect different estimates, assumptions, and judgements.
The procedures for assessing the adequacy of the allowance for loan losses reflect our evaluations of credit risk after careful consideration of all information available to management. In developing this assessment, management must rely on estimates and exercise judgement regarding matters where the ultimate outcome is unknown such as economic factors, development affecting companies in specific industries and issues with respect to single borrowers. Depending on changes in circumstances, future assessments of credit risk may yield materially different results, which may require an increase or a decrease in the allowance for loan losses.
The allowance is regularly reviewed by management to determine whether the amount is considered adequate to absorb probable losses. This evaluation includes specific loss estimates on certain individually reviewed loans, statistical losses estimates for loan pools that are based on historical loss experience, and general loss estimates that are based on the size, quality and concentration characteristics of the various loan portfolios, adverse situations that may affect a borrower's ability to repay, and current economic and industry conditions. Also considered as part of that judgement is a review of the each bank's trend in delinquencies and loan losses, and economic factors.
The allowance for loan loss is maintained at a level believed adequate by management to absorb probable losses inherent in the loan portfolio. Management's evaluation of the adequacy of the allowance is an estimate based on management's current judgement about the credit quality of the loan portfolio. While the Company strives to reflect all know risk factors in its evaluation, judgement errors may occur.
FINANCIAL CONDITION
OVERVIEW
For a third straight year, the Company and its competitors faced an interest rate environment that continued at historically low levels. A weak economic environment in 2002 did not leave the economy on firm footing for a strong 2003. In 2003 the economy had to deal with the uncertainty of war. During the latter half of the year the economy showed mixed signs of improvement.
Notwithstanding the less than optimal economic environment, your Company reported record earnings for 2003. The Company posted a 15.6% increase in earnings per share and maintained our strong credit quality over the year. As would be expected, our customers wanted to "lock-in" their loan rates while the depository preferences were for shorter term certificates of deposits and liquid transaction accounts. With interest rates at a historical low, the Company did attract longer-term certificates of deposits at above market interest rates. Although in today's interest rate environment the rates were slightly higher than our competitors, management feels this is a prime opportunity to lock in retail based funding for terms over 60 months. The Company took advantage of the volatility in the bond market and realized approximately $344,000 in gains on the sale of available for sale securities in 2003.
TOTAL ASSETS (In Thousands)
[BAR CHART]
For the year ended December 31, 2003, the Company's total assets increased $23,811,900, or 6.6% over December 31, 2002 totals. Average total earning assets increased $28,222,000 or 8.8% over $319,789,000 for 2002.
EARNING ASSETS - LOANS
Gross loans totaled $198,609,000 at year-end 2003, representing a 5.7% increase from $187,888,000 at year-end 2002.
Average loans increased by $8,594,000, or 4.7% from 2002 to 2003.
Installment loans increased $4,414,000, or 9.8%, residential real estate loans decreased $299,000, or less than 1% and commercial real estate loans decreased $385,000 or less than 1% from December 31, 2002. Commercial loans increased $6,989,000 or 33.2% from December 31, 2002. As discussed previously, the overall slow down in the economy coupled with historical low interest rates caused management to be cautious in increasing longer term fixed-rate loans during this period of uncertainty. Similar to 2002 and 2001, consumers and businesses during the past year were extremely price and term sensitive and were looking for longer-term fixed-rate loans. Management priced our loan products competitively but not overly aggressive as they felt the economy would rebound over the next several years which then would most likely result in a higher interest rate environment. Based upon the Asset/Liability model utilized by the Company, management decided not to accept longer-term fixed interest rate risk at historical low levels.
Loan production for CITIZENS and COMMUNITY during 2003 yielded a growth in both Banks' loan portfolios. Lower interest rates in 2003, again caused the Company to struggle to maintain its loan portfolio. During the past three years the Company was in a posture of trying to maintain its current customer relationships. As interest rates leveled off in 2003, the amount of refinancing requests did slow down as compared to 2002 and 2001. As a result, the Company's loan portfolio ultimately grew by $10,721,000 or 5.7% in 2003.
The Company's installment lending portfolio increased by 9.8% from December 31, 2002 to December 31, 2003. These loans represented 24.9% of the total portfolio at year-end 2003 compared to 24.0% at year-end 2002. The targeted installment lending areas encompass the geographic areas serviced by the Banks, which are diverse, thereby reducing the risk to changes in economic conditions. Competition for installment loans principally came from the captive finance companies offering low to zero percent financing for extended terms. With a large share of the consumers being lured to the captive finance companies offering the promotional low interest rates, the remaining market share to compete for was vastly smaller. Management did not feel it was prudent, given the competition and low yields that were available, to aggressively price our installment loan product to capture this residual business.
Management countered the low interest rate competition through customer service enhancements by extending our customer service hours into the evening to provide our customers with the ability to arrange financing at their convenience. In addition, customers may access the Company's 24/7 Internet Bank and view rates and even inquire about financing. Customers merely have to e-mail their loan requests and a loan officer will provide a prompt response.
LOANS NET (In Thousands)
[BAR CHART]
The commercial and commercial real estate portfolio represented approximately 48.8% of the total loan portfolio at December 31, 2003 compared to 48.1% for December 31, 2002. The Company's commercial loan portfolio increased by $6,989,000, or 33.2%. However, the commercial real estate loan portfolio decreased $385,000. Management is pleased with the overall increase in the combined commercial and commercial real estate loan portfolios given the lower interest rate environment and sluggish economy. The Company was able to retain the majority of its corporate accounts during a time when the industry was experiencing a high rate of loan refinancing. To protect the Company's future net interest margin and mitigate its exposure to rising interest rates in future reporting periods, certain interest rate floors and wider repricing indices were established during 2001 and that structure was updated and carried forward into 2002 and 2003. This strategy may have caused a few of our price sensitive customers to seek alternative financing arrangements in the short term. However, in management's view, this will help preserve the Company's net interest margins should interest rates increase.
Residential real estate loans are comprised of 1, 3 and 5 year adjustable rate mortgages financed for 1-4 family units. The Company also offers fixed rate real estate loans through our Secondary Market Real Estate Mortgage Program. The fixed rate mortgages are serviced and originated by CITIZENS but are sold immediately in the secondary market. Therefore, we have mitigated our interest rate risk and our customers enjoy the convenience of working with a local bank and are able to obtain long-term fixed-rate financing for their home.
As mentioned, once these loans are originated they are immediately sold in what is referred to as the secondary market. Since the loans are immediately sold, without recourse, the Company does not assume any interest rate risk in this portfolio and does not have any loans held for sale. This arrangement is quite common in banks and without such an option our customers may look elsewhere for their home financing needs. As the overall interest rate environment remained at low levels, consumer preferences remained focused on fixed-rate loan products. Given the historical low interest rates in 2003 the Company's Secondary Market Program for the second year experienced a high volume of activity.
TOTAL AVERAGE EARNING ASSETS (In Thousands)
[BAR CHART]
For 2003 and 2002 the interest rate environment was favorable to the fixed-rate mortgage loan product and resulted in a high volume of customers refinancing. The Company recognized gains on the sale of secondary market loans of $286,832 in 2003 and $179,683 in 2002. Given the increased level of sales in the secondary market in 2003, the Company's residential real estate portfolio declined $299,000.
COMMUNITY continued their growth from the previous years, with an increase in loans of $7,261,000, or 13.7%. The increase this past year is due to the continued expansion of COMMUNITY into the Fairfield County market. COMMUNITY'S loan growth came in commercial and commercial real estate portfolio of $5,710,000 and the real estate portfolio of $3,112,000. This growth was offset by a decrease of $1,561,000 in the installment portfolio.
CITIZENS also experienced an increase in loans for 2003. Total loans increased $3,459,000, or 2.6% from December 31, 2002. The increase primarily came in the installment portfolio of $5,975,000 and commercial portfolio of $4,674,000. However, this increase was offset by decreases in the commercial real estate portfolio of $3,779,000 and the real estate portfolio of $3,410,000 for 2003.
The allowance for loan losses represents the amount which management and the Board of Directors estimates is adequate to provide for probable incurred losses in the loan portfolio. The allowance balance and the annual provision charged to expense are reviewed by management and the Board of Directors on a monthly basis. The allowance calculation is determined by utilizing a risk-grading model that considers borrowers' past due experience, economic conditions and various other circumstances that are subject to change over time. In general, the loan loss policy for installment loans requires a charge-off if the loan reaches 120-day delinquent status or if notice of bankruptcy is received. The Company follows lending policies, with established criteria for determining the repayment capacity of borrowers, requirements for down payments and current market appraisals or other valuations of collateral when loans are originated. Installment lending also utilizes credit scoring to help in the determination of credit quality and pricing.
The Company generally recognizes interest income on the accrual basis, except for certain loans which are placed on non-accrual status, when in the opinion of management, doubt exists as to collection on the loan. The Company's policy is to generally not allow loans greater than 90 days past due to accrue interest unless the loan is both well secured and in the process of collection. When a loan is placed on non-accrual status, interest income may be recognized as cash payment is received.
Management believes the current balance of the allowance for loan losses is sufficient to cover probable incurred losses. Net charge-offs to average loans for the year-ended 2003 was 0.35% compared to 0.29% for 2002. Refer to Provision for Loan Losses section for further discussion on the Company's credit quality.
EARNING ASSETS - SECURITIES AND FEDERAL FUNDS SOLD
The securities portfolio is comprised of U.S. Government and agency obligations, tax-exempt obligations of states and political subdivisions, mortgage-backed securities and certain other investments. The Company does not hold any collateralized mortgage-backed securities, other than those issued by U.S. Government agencies. The Company does not hold any derivative securities. The quality rating of most obligations of states and political subdivisions within Ohio is no less than Aaa, Aa, or A, with all out-of-state bonds rated at AAA. Board policy permits the purchase of certain non-rated bonds within Ohio of local schools, townships and municipalities, based on
known levels of credit risk.
Securities available for sale at year-end 2003 increased $11,746,000, or 9.1% over 2002, while securities held to maturity increased $2,669,000, or 20.6%.
In our planning process, management's prediction for 2003 was for a steady to slightly rising interest rate environment. For the first half of 2003, management maintained an average of $9.2 million in fed funds sold. As the economy continued to struggle, management's posture on interest rates for the remainder of 2003 and heading into 2004 changed from one that interest rates may rise to a position that rates will go basically unchanged for the next twelve months. Therefore, by December 31, 2003, management had invested the Company's excess liquidity in investment securities and in loans.
SOURCES OF FUNDS - DEPOSITS
The Company's primary source of funds is core deposits from retail and business customers. These core deposits include all categories of interest-bearing deposits, excluding certificates of deposit greater than $100,000. During 2003, core deposits increased $10,543,000, or 4.1%. Core deposit growth for CITIZENS and COMMUNITY was $5,832,000 and $4,711,000, respectively, for the year ended December 31, 2003. The Company continues to benefit from strong depository growth as a direct result of the expansion of COMMUNITY into Fairfield County (Lancaster). Over the past several years, COMMUNITY has developed several large depository customers. As of December 31, 2003, their eight largest depository customers accounted for approximately 31.0% of COMMUNITY'S certificate of deposits and approximately 91.0% of total certificates of deposits greater than $100,000. These customers also represent 19.0% of demand deposits at December 31, 2003. Total concentration of retail funding is approximately 27.0% of COMMUNITY'S total deposits at December 31, 2003. This concentration does pose additional liquidity and earnings risk for COMMUNITY. The earnings risks would be triggered if COMMUNITY would be placed in a position to sell assets below book value to meet current liquidity needs. This risk is mitigated with COMMUNITY'S capability to borrow wholesale funding from its correspondent banks. Management has an active asset/liability committee that monitors, among other items monthly liquidity needs on a 90 day time horizon.
NET INCOME (In Thousands)
[BAR CHART]
RETURN ON AVERAGE ASSETS
[BAR CHART]
On a consolidated level, this concentration of funding at COMMUNITY represents approximately 7.9% of total retail deposits at December 31, 2003.
The Company maintains strong deposit relationships with public agencies, including local school districts, city and township municipalities, public works facilities and others. These relationships may tend to be more seasonal in nature resulting from the receipt and disbursement of state and federal grants. These entities have maintained relatively stable balances with the Company due to various funding and disbursement time-frames.
Certificates of deposit greater than $100,000 are not considered part of core deposits and, as such, are used as a tool to balance funding needs. At year-end 2003, certificates of deposit greater than $100,000 decreased $6,219,000, or 14.5% over year-end 2002 totals. Certificates of deposits greater than $100,000 at both CITIZENS and COMMUNITY decreased by approximately 14% in 2003.
The attraction of and retention of core deposits continues to be a challenge to the Company and the overall banking industry. Alternative financial products are continuously being introduced by our competition whether through a traditional bank or brokerage services company.
However, during, the past three years, the Company observed a "flight to safety" effect for deposit products. As the economy weakened and the stock market declined, many consumers preferred to maintain liquidity in traditional bank product accounts.
SOURCES OF FUNDS - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND OTHER BORROWED FUNDS
Other interest-bearing liabilities include securities sold under agreements to repurchase, federal funds purchased, Treasury, Tax & Loan notes payable and Federal Home Loan Bank advances. Securities sold under agreements to repurchase decreased by $1,524,000. The average balance in securities sold under agreements to repurchase increased $199,000 from 2002 to 2003.
Advances from the Federal Home Loan Bank (FHLB) increased $14,637,000 from 2002 to 2003 and Federal funds purchased increased $7,659,000 for the same period. As previously discussed, in the second half of 2003, management invested the Company's excess liquidity and borrowed on its lines of credit at the FHLB to purchase investment securities and fund the loan portfolio.
OTHER ASSETS
The Company owns approximately $7.2 million in Bank Owned Life Insurance with the original investment occurring in 2002. Refer to Performance Overview 2003 to 2002, Noninterest Income section for further information.
PERFORMANCE OVERVIEW 2003 TO 2002
NET INCOME
The Company reported record earnings of $3,639,391 in 2003 compared to $3,220,163 in 2002. This earnings performance equates to a 0.97% Return on Average Assets ("ROA") and 11.40% Return on Average Equity ("ROE") for 2003 compared to 0.94% and 10.34% for 2002. Basic and Diluted Earnings per share ("EPS") were $1.04 and $1.03, respectively for 2003 compared to $0.90 for 2002. Per share amounts for all periods have been restated to reflect the 10% stock split in the from of a dividend distributed in December 2003 and the 5% stock dividend distributed in December 2002.
NET INTEREST INCOME
Net interest income, by definition, is the difference between interest income generated on interest-earning assets and the interest expense incurred on interest-bearing liabilities. Various factors contribute to changes in net interest income, including volumes, interest rates and the composition or mix of interest-earning assets in relation to interest-bearing liabilities. Net interest income increased $116,186, or 0.9% in 2003. The net interest margin decreased to 3.70% from 3.99%. Overall, the Company has seen both its earning assets and interest paying liabilities repricing downward given the low interest rate environment in 2003 as previously discussed.
Average interest-earning assets increased $28,220,000, or 8.8% in 2003 while the associated weighted-average yield on these interest-earning assets decreased from 6.91% in 2002, to 5.95% for 2003.
Average interest-bearing liabilities increased $27,039,000 in 2003 over 2002. The average cost of funds decreased to 2.52% from 3.29% from the year ended December 31, 2002.
Refer to the sections on Asset and Liability Management and Sensitivity to Market Risks and Average Balances, Net Interest Income and Yields Earned and Rates Paid elsewhere for further discussion.
PROVISION FOR LOAN LOSSES
The provision for loan losses is an operating expense recorded to maintain the related balance sheet allowance for loan losses at an amount considered adequate to cover probable incurred losses in the loan portfolio. The total provision for loan losses was $540,000 in 2003 compared to $630,000 in 2002, a decrease of $90,000, or 14.3%. The decrease can be attributed to management's continued efforts to strengthen credit quality in the loan portfolio. Management reduced the provision in 2003 due to the continued improvement in credit quality statistics for the Company throughout 2002 and into 2003. Management considered such factors as lower past due percentages and modest loan growth. Net loans charged-off for 2003 were approximately $668,000 compared to $538,000 for 2002. Moreover, one borrower accounted for approximately 34% of the net charge-offs for 2003. Management is in the process of recovering this loan.
RETURN ON AVERAGE EQUITY
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The Company's total allowance for loan losses compared to nonaccrual loans is 354% at December 31, 2003, compared to 386% at December 31, 2002. The Company's non-performing loans to total loans was 0.40% at December 2003 compared to 0.41% at year-end 2002. These ratios measure the relative risk in the loan portfolio and coverage in the allowance for loan losses.
The allowance for loan losses as a percentage of loans decreased to 1.43% at year-end 2003, from 1.58% at year-end 2002. CITIZENS and COMMUNITY utilize a consistent reserve methodology with the detail reserve allocations specific to the individual loan portfolio.
NONINTEREST INCOME
Noninterest income is made up of bank-related fees and service charges, as well as other income-producing services. These include secondary market loan servicing fees, ATM/interchange income, internet bank fees, early redemption penalties for certificates of deposit, safe deposit box rental income, net gain or loss on sales of securities available for sale and loans, leased rental property, cash management services and other miscellaneous items. In addition, both CITIZENS and COMMUNITY invested in Bank Owned Life Insurance (BOLI) in 2002. The earnings from this investment are reflected in the Company's noninterest income. Total noninterest income for 2003 was $2,611,566, an increase of $552,393, or 26.8% over 2002 totals.
The increase in noninterest income in 2003 can be attributed to several factors. During mid-year 2002, CITIZENS and COMMUNITY invested approximately $6,707,000 in BOLI. This product offers an attractive tax deferred yield after mortality cost of approximately 7.0% and 7.9% for 2003 and 2002, respectively. For the year ended December 31, 2003 the additional income generated from the BOLI investment in 2003 over 2002 is approximately $154,000. Also explaining the growth in noninterest income in 2003 is the additional income of $24,000 related to gains on the sale of investment securities. Management's strategy in 2003 and 2002, took into consideration the relative volatility in the bond market. At times during the year management realized there was an opportunity to sell certain bonds in the portfolio when overall interest rates were depressed. The Company's secondary market mortgage program generated total income of $286,832 compared to $179,683 in 2002, an increase of $107,149. Service charges on deposit accounts increased $175,496, or 18.5% due to increased fees on transactional-based deposit accounts such as service charges, non-sufficient fund charges and daily overdraft charges.
TOTAL ALLOWANCE FOR LOAN LOSSES TO TOTAL LOANS
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DILUTED EARNINGS PER SHARE
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NONINTEREST EXPENSE
Noninterest expense for 2003 increased $426,775 or 4.3% over 2002.
Salaries and employee benefits increased $76,521, or 1.5% from 2002 to 2003. During 2003 management adjusted the staffing levels within the Company to control salary and benefit costs.
Occupancy and equipment increased $72,696 due to the mid year 2002 purchase of additional hardware and software for check imaging and processing and for an on-line loan and deposit origination system. Since the system was not installed until mid 2002, the Company did not record a full year of operating expenses with these two systems until 2003.
Franchise and other taxes increased $58,803 or 16.6% over 2002 mainly due to increases in franchise and state income taxes. The increase in franchise taxes resulted from an increase in the Company's capital base year over year.
Insurance expense increased $23,036 from 2002 to 2003. The Company renewed its Directors and Officers insurance for
a three-year period in 2002. The cost of this policy and other insurance has increased dramatically over the past several years.
Professional fees increased $51,698 or 16.4% for 2003 as compared to 2002. Professional fees increased due to additional costs relating to compliance with the Sarbanes-Oxley Act of 2002 requirements as well as other increased risk management costs.
Other expenses increased 7.9%, or $149,802. Overall there is not a single line item that contributes significantly to this increase.
PERFORMANCE OVERVIEW 2002 TO 2001
NET INCOME
The Company reported earnings of $3,220,163 in 2002 compared with $2,755,587 in 2001. This earnings performance equates to a 0.94% Return on Average Assets ("ROA") and 10.34% Return on Average Equity ("ROE") for 2002 compared to 0.82% and 9.13% for 2001. Basic and Diluted Earnings per share ("EPS") was $0.90 for 2002 compared to $0.76 for 2001. Per share amounts for all periods have been restated to reflect the 5% stock dividends distributed in December 2002 and 2001 as well as the 10% stock split in the form of a dividend distributed in 2003.
NET INTEREST INCOME
Net interest income, by definition, is the difference between interest income generated on interest-earning assets and the interest expense incurred on interest-bearing liabilities. Various factors contribute to changes in net interest income, including volumes, interest rates and the composition or mix of interest-earning assets in relation to interest-bearing liabilities. Net interest income increased $519,594, or 4.2% in 2002. The net interest margin increased to 3.99% from 3.87%. Overall, the Company has seen both its earning assets and interest paying liabilities repricing downward given the low interest rate environment in 2002.
NET CHARGEOFFS TO AVERAGE LOANS
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Average interest-earning assets increased $2,977,000 or 0.9% in 2002 while the associated weighted-average yield on these interest-earning assets decreased from 7.76% in 2001, to 6.91% for 2002.
Average interest-bearing liabilities increased $1,435,000 in 2002 over 2001. The average cost of funds decreased to 3.29% from 4.38% for the year ended December 31, 2001.
Refer to the sections on Asset and Liability Management and Sensitivity to Market Risks and Average Balances, Net Interest Income and Yields Earned and Rates Paid elsewhere for further discussion.
PROVISION FOR LOAN LOSSES
The provision for loan losses is an operating expense recorded to maintain the related balance sheet allowance for loan losses at an amount considered adequate to cover probable losses incurred in the normal course of lending. The total provision for loan losses was $630,000 in 2002 compared to $780,000 in 2001, a decrease of $150,000, or 19.2%. The decrease from 2001 of 19.2% in the provision for loan losses can be attributed to management's continued efforts to strengthen our credit quality in the loan portfolio. Management reduced the provision in 2002 due to the continued improvement in credit quality statistics. Management considered such factors as lower past due percentages, slower loan growth and a reduced level of net loans charged-off. Net loans charged-off for 2002 were approximately $538,000 compared to $691,000 for 2001. Considering the item just mentioned along with modest loan growth, the provision expense for 2002 was reduced.
The Company's total allowance for loan losses compared to non-performing loans is 386% at December 31, 2002, compared to 436% at December 31, 2001. The Company's non-performing loans to total loans was 0.41% at year-end 2002 and 2001. Both ratios measure in common size the relative risk and coverage in the allowance for loan losses.
The allowance for loan losses as a percentage of loans increased to 1.58% at year-end 2002, from 1.57% at year-end 2001. CITIZENS and COMMUNITY utilize a consistent reserve methodology with the detail reserve allocations specific to their individual loan portfolio.
NONINTEREST INCOME
Noninterest income is made up of bank-related fees and service charges, as well as other income-producing services. These include secondary market loan servicing fees, ATM/interchange income, internet bank fees, early redemption penalties for certificates of deposit, safe deposit box rental income, net gain or loss on sales of securities available for sale and loans, leased rental property, cash management services and other miscellaneous items. In addition, both CITIZENS and COMMUNITY invested in Bank Owned Life Insurance (BOLI) in 2002. The earnings from this investment are reflected in the Company's noninterest income. Total noninterest income for 2002 was $2,059,173, an increase of $453,127, or 28.2% over 2001 totals.
The increase in 2002 can be attributed to several factors. During 2002, CITIZENS and COMMUNITY invested approximately $6,707,000 in BOLI. This product offers an attractive tax deferred yield. For the year ended December 31, 2002 the pre-tax yield on this investment after mortality costs was approximately 5.3% or a tax equivalent yield of approximately 7.9%. The additional income generated from the BOLI investment in 2002 was $154,000. Also explaining the growth in noninterest income in 2002 is $320,485 related to gains on the sale of investment securities. Management's strategy in 2002, took into consideration the relative volatility in the bond market. At times the during the year management realized there was an opportunity to sell certain bonds in the portfolio when overall interest rates were depressed. Also contributing to the increase in noninterest income is the Company's secondary market mortgage program which generated total income of $179,683 compared to $135,124 in 2001, an increase of $44,559. Service charges on deposit accounts increased $42,135, or 4.7%. The Company recognized gains on other real estate property of $6,693 in 2002 and $44,794 in 2001.
NONINTEREST EXPENSE
Noninterest expense for 2002 increased $606,188, or 6.5% over 2001.
Salaries and employee benefits increased $572,617, or 12.5% from 2001 to 2002. Contributing to the increase is additional staffing associated with expansion activities and the rapidly escalating cost of health care.
Occupancy and equipment decreased $12,458 and other expense decreased $3,083 for the year.
An increase in stationery and office supplies of $47,000 is attributable to higher loan and depository related items. Included in this category are costs related to loan coupon books and depository customer checks.
Increased advertising of $25,000 was budgeted for 2002 for CITIZENS to celebrate its 100th year anniversary, which attributed to the increase in advertising expense of $31,727.
Professional services decreased approximately $60,151 mainly due to decreases in legal expenses. During 2001, CITIZENS and COMMUNITY incurred additional legal expenses in connection with the collection of several larger commercial credits.
ASSET/LIABILITY MANAGEMENT AND SENSITIVITY TO MARKET RISKS
In the environment of changing business cycles, interest rate fluctuations and growing competition, it has become increasingly more difficult for banks to produce adequate earnings on a consistent basis. Although management can anticipate changes in interest rates, it is not possible to reliably predict
the magnitude of interest rates changes. As a result the Company has established a sound asset/liability management policy, which minimizes exposure to interest rate risk while maintaining an acceptable interest rate spread while insuring adequate liquidity.
The principal goal of asset/liability management - profit management - is accomplished by establishing decision processes and control procedures for all bank assets and liabilities. Thus, the full scope of asset/liability management encompasses the entire balance sheet of the Company. The broader principal components of asset/liability management include, but are not limited to liquidity planning, capital planning, gap management and spread management.
By definition, liquidity is measured by the Company's ability to raise cash at a reasonable cost or with a minimum amount of loss. Liquidity planning is necessary so the Company will be capable of funding all obligations to its customers at all times, from meeting their immediate cash withdrawal requirements to fulfilling their short-term credit needs.
Capital planning is an essential portion of asset/liability management, as capital is a limited bank resource, which, due to minimum capital requirements, can place possible restraints on bank growth. Capital planning refers to maintaining capital standards through effective growth management, dividend policies and asset/liability strategies.
Gap is defined as the dollar difference between rate sensitive assets and rate sensitive liabilities with respect to a specified time frame. A gap has three components - the asset component, the liability component, and the time component. Gap management involves the management of all three components.
Gap management is defined as those actions taken to measure and match rate sensitive assets to rate sensitive liabilities. A rate sensitive asset is any interest-earning asset, which can be repriced to a market rate in a given time frame. Similarly, a rate sensitive liability is any interest-bearing liability, which can have its interest rate changed to a market rate during the specified time period. Caps and collars may prevent certain loans and securities from adjusting to the market rate.
A negative gap is created when rate sensitive liabilities exceed rate sensitive assets and, conversely, a positive gap occurs when rate sensitive assets exceed rate sensitive liabilities. In most instances, a negative gap position will cause profits to decline in a rising interest rate environment and a positive gap will cause profits to decline in a falling interest rate environment. The Company's goal is to have acceptable profits under any interest rate environment. To avoid volatile profits as a result of interest rate fluctuations, the Company attempts to match interest rate sensitivities, while pricing both the asset and liability components to yield a sufficient interest rate spread so that profits will remain relatively consistent across interest rate cycles.
Management of the income statement is called spread management and is defined as managing investments, loans, and liabilities to achieve an acceptable spread between the Company's return on its earning assets and its cost of funds. Gap management without consideration of interest spread can cause unacceptable low profit margins while assuring that the level of profits is steady. Spread management without consideration of gap positions can cause acceptable profits in some interest rate environments and unacceptable profits in others. A sound asset/liability management program combines gap and spread management into a single cohesive system.
Management measures the Company's interest rate risk by computing estimated changes in net interest income and the net portfolio value ("NPV") of its cash flows from assets, liabilities and off-balance sheet items in the event of a range of assumed changes in market interest rates. The Banks' senior management and the Executive Committee of the Board of Directors, comprising the Asset/Liability Committee ("ALCO") review the exposure to interest rates at least quarterly. Exposure to interest rate risk is measured with the use of an interest rate sensitivity analysis to determine the change in NPV in the event of hypothetical changes in interest rates, while interest rate sensitivity gap analysis is used to determine the repricing characteristics of the assets and liabilities.
NPV represents the market value of portfolio equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items.
Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay rates, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Company may undertake in response to changes in interest rates. The NPV calculation is based on the net present value of discounted cash flows utilizing market prepayment assumptions and market rates of interest provided by surveys performed during each quarterly period, with adjustments made to reflect the shift in the Treasury yield curve between the survey date and quarter-end date. Certain short-
comings are inherent in this method of analysis presented in the computation of estimated NPV. Certain assets such as adjustable-rate loans have features that restrict changes in interest rates on a short-term basis and over the life of the asset. In addition, the portion of adjustable-rate loans in the Company's portfolio could decrease in future periods if market interest rates remain at or decrease below current levels due to refinancing activity. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate from those assumed in the table. Finally, the ability of many borrowers to repay their adjustable-rate debt may decrease in the case of an increase in interest rates.
The following tables present an analysis of the potential sensitivity of the Company's net present value of its financial instruments to sudden and sustained changes in the prevailing interest rates.
(Dollars in Thousands) Net Portfolio Value - December 31, 2003
Net Portfolio Value - December 31, 2002
The projected volatility of the net present value at both December 31, 2003 and 2002 fall within the general guidelines established by the Board of Directors. The NPV table shows that in a falling interest rate environment, the NPV would decrease between 7% and 8%. In management's view there is a low probability that interest rates would decrease another 100 to 200 basis points. In the upward change in interest rates the Company's NPV would decrease 9% with a 100 basis point interest rate increase. In a 200 basis point rate increase the Company's NPV would decrease 23%. This decrease is a result of the Company's available for sale securities portfolio that is invested in fixed-rate securities. As interest rates increase, the market value of the securities decrease. However, since the Company currently has the ability to hold these securities to their final maturity, it would not have to incur any losses.
AVERAGE BALANCES, NET INTEREST INCOME AND YIELDS EARNED AND RATES PAID
The following table provides information relating to average balance sheet information and reflects the average yield on interest-earning assets and the average cost of interest-bearing liabilities for the years ended December 31, 2003, 2002 and 2001. The yields and costs are calculated by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities.
The average balance of available for sale securities is computed using the carrying value of securities. Average balances are derived from daily average balances, which include nonaccruing loans in the loan portfolio, net of the allowance for loan losses. Interest income is on a historical basis without tax-equivalent adjustment.
- - For purposes of this schedule, nonaccrual loans are included in loans.
- - Net interest income is reported on an historical basis without tax-equivalent adjustment.
- - Fees collected on loans are included in interest on loans.
RATE/VOLUME ANALYSIS
The table below describes the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have affected interest income and expense during the periods indicated. For purposes of this table, changes in interest due to volume and rate were determined using the following methods:
- Volume variance results when the change in volume is multiplied by the previous year's rate.
- Rate variance results when the change in rate is multiplied by the previous year's volume.
- Rate/volume variance results when the change in volume is multiplied by the change in rate.
LIQUIDITY
Note: The rate/volume variance was allocated to volume variance and rate variance in proportion to the relationship of the absolute dollar amount of the change in each.
The following table is a summary of selected quarterly results of operations for the years ended December 31, 2003 and 2002.
CAPITAL RESOURCES
Internal capital growth, through the retention of earnings, is the primary means of maintaining capital adequacy for the Banks. The Company's shareholders' equity at year-end 2003 was $32,514,459 compared to $32,154,862 at year-end 2002, representing an increase of 1.1%. Equity totals include $248,591 in accumulated comprehensive losses, which is comprised solely of a net unrealized loss on securities available for sale, net of tax, at year-end 2003, compared to a $963,990 gain at year-end 2002. Total shareholders' equity in relation to total assets was 8.4% at December 31, 2003 and 8.9% at December 31, 2002.
The Company has established a Dividend Reinvestment Plan ("The Plan") for shareholders under which the Company's common stock will be purchased by The Plan for participants with automatically reinvested dividends. The Plan does not represent a change in the dividend policy or a guarantee of future dividends. Shareholders who do not wish to participate in The Plan will continue to receive cash dividends, as declared in the usual and customary manner.
In May 2001, the Company's shareholders approved an amendment to the Company's Articles of Incorporation to create a class of preferred shares with 2,000,000 authorized shares. This will enable the Company, at the option of the Board of Directors, to issue series of preferred shares in a manner calculated to take advantage of financing techniques which may provide a lower effective cost of capital to the Company. The amendment also provides greater flexibility to the Board of Directors in structuring the terms of equity securities that may be issued by the Company.
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DIVIDENDS PER SHARE
Liquidity relates primarily to the Company's ability to fund loan demand, meet deposit customers' withdrawal requirements and provide for operating expenses. Assets used to satisfy these needs consist of cash and due from banks, federal funds sold and securities available-for sale. These assets are commonly referred to as liquid assets. Liquid assets were $149 million at December 31, 2003 compared to $139 million at December 31, 2002. Management recognizes securities may need to be sold in the future to help fund loan demand and, accordingly, as of December 31, 2003, $140.8 million of the securities portfolio was classified as available for sale. Additionally the Company's residential real estate portfolio, can and has been readily, used to collateralize borrowings as an additional source of liquidity. Management believes its current liquidity level is sufficient to meet anticipated future growth.
The Cash Flows Statements for the periods presented provide an indication of the Company's sources and uses of cash as well as an indication of the ability of the Company to maintain an adequate level of liquidity. A discussion of the cash flow statements for 2003, 2002 and 2001 follows. The Company experienced a net increase in cash from operating activities in 2003, 2002 and 2001. Net cash from operating activities was a positive $4.2 million, $3.8 million and $3.6 million for the years ended December 31, 2003, 2002 and 2001, respectively. The adjustments to reconcile net income to net cash from operating activities consisted mainly of depreciation and amortization of premises and equipment and intangibles, gain on sales of loans, securities and other assets, the provision for loan losses, Federal Home Loan Bank stock dividends, net amortization of securities and net changes in other assets and liabilities.
NET CASH FROM INVESTING ACTIVITIES was $(28.3 million), $(31.4 million) and $(4.7 million) for the years ended December 31, 2003, 2002 and 2001, respectively. The changes in net cash from investing activities include loan growth, as well as normal maturities, security calls and reinvestments of securities and premises and equipment expenditures. In 2003, 2002 and 2001, the Company received $37.7 million, $47.9 million and $5.5 million, respectively, from sales of securities available for sale. Proceeds from securities, which matured or were called were $77.0 million, $83.9 million and $72.4 million in 2003, 2002 and 2001, respectively. As mentioned previously, the decrease in interest rates dramatically impacted the Company's cash flows from investing activities.
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EQUITY CAPITAL (In Thousands)
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BOOK VALUE PER SHARE
NET CASH FROM FINANCING ACTIVITIES was $22.2 million, $14.5 million and $13.8 million for the years ended December 31, 2003, 2002 and 2001, respectively. The net cash from financing activities in 2003 was primarily attributable to increases in short-term borrowings of $20.6 million. Also contributing to the net increase in cash from financing activities was growth in total deposits of $4.3 million, $16.8 million and $15.8 million in 2003, 2002 and 2001, respectively.
Management feels that it has the capital adequacy, profitability, and reputation to meet the current and projected needs of its customers.
The following table sets forth the Company's contractual obligations at December 31, 2003:
INFLATION
The majority of assets and liabilities of the Company are monetary in nature and therefore the Company differs greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. Inflation significantly affects noninterest expense, which tends to rise during periods of general inflation. Management believes the most significant impact on financial results is the Company's ability to react to changes in interest rates. Management seeks to maintain an essentially balanced position between interest sensitive assets and liabilities and actively manages the amount of securities available for sale in order to protect against the effects of wide interest rate fluctuations on net income and shareholders' equity.
ITEM 7A
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations, "Asset/Liability Management and Sensitivity to Market Risks" set forth in Part II, Item 7 of this report.
Report of Independent Certified Public Accountants
ITEM 8
ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders United Bancorp, Inc. Martins Ferry, Ohio
We have audited the accompanying consolidated statements of financial condition of United Bancorp, Inc. as of December 31, 2003 and 2002, and the related consolidated statements of earnings, comprehensive income, shareholders' equity and cash flows for each of the years in the three year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Bancorp, Inc. as of December 31, 2003 and 2002, and the results of its operations, comprehensive income and cash flows for each of the years in the three year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
/s/Grant Thornton LLP - --------------------- Grant Thornton LLP Cincinnati, Ohio January 9, 2004
Consolidated Statements of Financial Condition
The Accompanying Notes are an Integral Part of These Statements
Consolidated Statements of Earnings
The Accompanying Notes are an Integral Part of These Statements
Consolidated Statements of Comprehensive Income
The Accompanying Notes are an Integral Part of These Statements
Consolidated Statements of Shareholders' Equity
The Accompanying Notes are an Integral Part of These Statements
Consolidated Statements of Cash Flow
The Accompanying Notes are an Integral Part of These Statements
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION:
The consolidated financial statements include the accounts of United Bancorp, Inc. ("UNITED" or "the Company") and its wholly-owned subsidiaries, The Citizens Savings Bank of Martins Ferry, Ohio ("CITIZENS") and The Community Bank, Lancaster, Ohio ("COMMUNITY"), (collectively hereinafter "the Banks"). All intercompany transactions and balances have been eliminated in consolidation.
NATURE OF OPERATIONS/SEGMENTS:
The Company's revenues, operating income, and assets are almost exclusively derived from banking. Accordingly, all of the Company's banking operations are considered by management to be aggregated in one reportable operating segment. Customers are mainly located in Athens, Belmont, Carroll, Fairfield, Harrison, Hocking, and Tuscarawas Counties and the surrounding localities in northeastern, eastern and southeastern Ohio, and include a wide range of individuals, business and other organizations. CITIZENS conducts its business through its main office in Martins Ferry, Ohio and nine branches in Bridgeport, Colerain, Dellroy, Dover, Jewett, New Philadelphia, St. Clairsville, Sherrodsville, and Strasburg Ohio. COMMUNITY conducts its business through its seven offices in Amesville, Glouster, Lancaster, and Nelsonville, Ohio. The Company's primary deposit products are checking, savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, and installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets and real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. Real estate loans are secured by both residential and commercial real estate. Net interest income is affected by the relative amount of interest-earning assets and interest-bearing liabilities and the interest received or paid on these balances. The level of interest rates paid or received by the Company can be significantly influenced by a number of environmental factors, such as governmental monetary policy, that are outside of management's control.
USE OF ESTIMATES:
The financial information presented herein has been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and general accounting practices within the financial services industry. In preparing consolidated financial statements in accordance with U.S. GAAP, management is required to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and revenue and expenses during the reporting period. Actual results could differ from such estimates.
CASH FLOW REPORTING:
Cash and cash equivalents include cash and due from banks and federal funds sold. Net cash flows are reported for customer loan and deposit transactions, securities sold under agreements to repurchase and short-term borrowings with original maturities of 90 days or less.
SECURITIES:
The Company accounts for investment and mortgage-backed securities in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." SFAS No. 115 requires that investments be categorized as held-to-maturity, trading or available for sale. Investments and mortgage-backed securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Other securities such as Federal Home Loan Bank stock are carried at cost. Interest income includes amortization of purchase premiums and discounts. Realized gains and losses on sales and calls are based on the amortized cost of the security sold using the specific identification method. Securities are written down to fair value when a decline in fair value is deemed other than temporary.
LOANS:
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff, are reported at the principal balance outstanding, net of deferred loan fees and costs, and the allowance for loan losses. Loans held for sale are reported at the lower of cost or market, determined in the aggregate. Interest income is reported on the interest method and includes amortization of net deferred loan fees and costs over the loan term. Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in process of collection. Consumer loans are typically charged-off no later than 120 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not received for loans placed on nonaccrual are reversed against interest income. Interest received on such loans is accounted for on a cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LOAN SERVICING RIGHTS:
Loan servicing rights are recognized as assets for purchased rights and for the allocated value of retained servicing rights on loans sold. Servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights, using groupings of underlying loans with similar characteristics. Any impairment of a grouping is reported as a valuation allowance. At December 31, 2003 and 2002, the fair value and carrying value of the Company's mortgage servicing rights totaled approximately $156,870 and $168,264, respectively.
ALLOWANCE FOR LOAN LOSSES:
The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required based on past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. The Company accounts for impaired loans in accordance with SFAS No. 114, "Accounting for Creditors for Impairment of a Loan." SFAS 114 requires that impairment loans be measured based upon the present value of expected future cash flows discounted at the loan's effective interest rate or, as an alternative, at the loan's observable market price or fair value of the collateral. A loan is defined under SFAS No. 114 as impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. In applying the provisions of SFAS No. 114, the Company considers its investment in one-to-four family residential loans and consumer installment loans to be homogenous and therefore excluded from separate identification for evaluation of impairment. With respect to the Company's investment in nonresidential and multi-family residential real estate loans, and its evaluation of impairment thereof, such loans are generally collateral dependent and, as a result, are carried as a practical expedient at the lower of cost or fair market value.
Collateral dependent loans which are more than ninety days delinquent are considered to constitute more than a minimum delay in repayment and are evaluated for impairment under SFAS No. 114 at that time.
At December 31, 2003 and 2002, the amount of the Company's impaired loans was not material to the consolidated financial statements.
PREMISES AND EQUIPMENT:
Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Maintenance, repairs and minor improvements are expensed as incurred. Buildings and related components are depreciated using the straight-line method with useful lives ranging from 5 to 39 years. Furniture, fixtures and equipment are depreciated using the straight-line method with useful lives ranging from 3 to 5 years. An accelerated depreciation method is used for tax purposes. These assets are reviewed for impairment when events indicate the carrying amount may not be recoverable.
OTHER REAL ESTATE AND POSSESSIONS:
Assets acquired through or instead of loan foreclosure are initially recorded at the lower of the loan's unpaid principal balance (cost) or fair value when acquired. After acquisition, a valuation allowance reduces the reported amount to the lower of the initial cost or fair value less costs to sell. Expenses, gains and losses on disposition and changes in the valuation allowance are reported in other expenses as incurred.
BANK OWNED LIFE INSURANCE:
The Company has purchased life insurance policies on certain key executives. Company owned life insurance is recorded at its cash surrender value, or the amount that can be realized.
INTANGIBLE ASSETS:
Intangible assets consist of core deposits arising from branch acquisitions. Such assets were initially recorded at fair value and are being amortized over an eight-year life.
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE:
Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EMPLOYEE BENEFITS:
A defined benefit pension plan covers all employees who have completed 1,000 hours of service during an anniversary year, measured from their date of hire, who have attained age 21. The plan calls for benefits to be paid to eligible employees at retirement, based primarily upon years of service and compensation rates near retirement. Contributions to the plan reflect benefits attributed to employees' services to date, as well as services expected to be earned in the future. Plan assets consist of primarily common stock and debt instruments. Pension expense is the net of service and interest cost, return on plan assets, and amortization of gains and losses not immediately recognized.
The Company offers a 401(k) plan, which covers all employees who have attained the age of 21 and have completed one year of service. Eligible employees may contribute up to $12,000 in 2003 and employees who have attained the age of 50 years or older may contribute an additional $2,000 in 2003. The Company may make a discretionary matching contribution equal to a percentage of each participant's elective deferral not to exceed 6% of the participant's annual compensation. Employee contributions are always vested. Employer contributions become 100% vested after 3 years of service.
EARNINGS PER SHARE:
Basic earnings per common share is computed based upon the weighted-average number of common shares outstanding during the period. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under the Company's stock option plans. The computation are as follows:
Options to purchase 23,164 shares of common stock with a respective weighted-average exercise price of $14.99 were outstanding at December 31, 2003, 2002 and 2001, respectively, but were excluded from the computation of common share equivalents for those respective years because the exercise prices were greater than the average market prices of common shares. Weighted average common shares outstanding have been restated to give effect to share distributions made in each of the three years ended December 31, 2003, 2002 and 2001.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK OPTIONS
The Company maintains a nonqualified stock option plan for directors and officers. The exercise price for options granted under this plan is no less than 100% of the fair market value of the shares on the date of grant adjusted for stock dividends and stock splits.
The Company accounts for its stock option plan in accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," 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 companies to continue to account for stock options and similar equity investments under Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." Entities that continue to account for stock options using APB No. 25 are required to make pro forma disclosures of net earnings and earnings per share as is the fair value-based method of accounting defined is SFAS No. 123 had been applied.
The Company applies APB Opinion No. 25 and related Interpretations in accounting for it stock option plan. Accordingly, no compensation cost has been recognized for the plans. Had compensation cost for the Company's stock option plan been determined based on the fair value at the grant dates for awards under the plan consistent with the accounting method utilized in SFAS No. 123, the Company's net earnings and earnings per share would have been reported at the pro-forma amounts indicated in the table below.
All share and per share prices have been restated to reflect stock dividends distributed or declared prior to issuance of the financial statements. The fair value of each option grant has been estimated on the date of grant using the Black-Scholes options pricing model. No stock options were granted in 2003, 2002 or 2001. The options are first exercisable after November 21, 2004. Based on meeting portions of the established criteria, 16,766 became exercisable at December 31, 1998. All options become immediately exercisable upon retirement, death, and 9 1/2 years after issuance or in the event of a change in control of the Company.
A summary of the status of the Company's stock option plan as of December 31, 2003, 2002 and 2001 and changes for the years then ended is presented below:
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK OPTIONS (CONTINUED)
The following table summarizes information about stock options outstanding at December 31, 2003:
INCOME TAXES:
The Company accounts for federal income taxes pursuant to SFAS 109, "Accounting for Income Taxes." In accordance with SFAS No. 109, a deferred tax liability or deferred tax asset is computed by applying the current statutory tax rates to net taxable or deductible temporary differences between the tax basis of an asset or liability and its reported amount in the consolidated financial statements that will result in net taxable or deductible amounts in future periods. Deferred tax assets are recorded only to the extent that the amount of net deductible temporary differences or carryforward attributes may be utilized against current period earnings, carried back against prior years' earnings, offset against taxable temporary differences reversing in future periods, or utilized to the extent of management's estimate of future taxable income. A valuation allowance is provided for deferred tax assets to the extent that the value of net deductible temporary differences and carryforward attributes exceeds management's estimates of taxes payable on future taxable income. Deferred tax liabilities are provided on the total amount of net temporary differences taxable in the future.
Deferred income taxes results primarily from different methods of accounting for deferred loan origination fees and costs, Federal Home Loan Bank stock dividends, mortgage servicing rights, the loan loss allowance, amortization of intangibles, deferred compensation and pension expense. Additionally, a temporary difference is recognized for depreciation computed using accelerated methods for federal income tax purposes.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate fair values for financial instruments. The carrying amount is considered to approximate fair value for cash and cash equivalents, deposit liabilities subject to immediate withdrawal, short-term borrowings, loan servicing rights, FHLB stock, accrued interest receivable and payable and variable-rate loans that reprice at intervals of less than six months. Fair values of securities are based on quoted market prices or, if no quotes are available, on the rate and term of the security and on information about the issuer. For fixed-rate loans that reprice less frequently than each six months, time deposits and long-term debt, the fair value is estimated by a discounted cash flow analysis using current market rates for the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable. Fair value of loans held for sale is based on market estimates. The fair value of off-balance sheet items is based on the current fees or cost that would be charged to enter into or terminate such arrangements.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The estimated year-end fair values of financial instruments were:
ADVERTISING
Advertising costs are expensed as incurred.
EQUITY:
The Company has authorized 10,000,000 shares of $1.00 value common stock and 2,000,000 shares of preferred stock. Treasury stock is carried at cost. On November 18, 2003, a 10% stock split in the form of a dividend was approved for all shareholders of record on December 2, 2003 and distributed on December 19, 2003. On November 19, 2002, a 5% stock dividend was approved for all shareholders of record on December 2, 2002 and distributed on December 20, 2002. On November 20, 2001, a 5% stock dividend was approved for all shareholders of record on December 1, 2001 and distributed on December 20, 2001. All per share data has been retroactively adjusted for the stock dividends distributed in 2003, 2002 and 2001.
DIVIDEND RESTRICTION:
Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Banks to the Company or by the Company to shareholders. These regulations pose no practical limit on the ability of the Banks or Company to pay dividends at historical levels.
LOSS CONTINGENCIES:
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are any loss contingencies, the resolution of which will have an adverse effect on the financial statements.
RESTRICTIONS ON CASH:
Cash on hand or on deposit with the Federal Reserve Bank of $1,679,000 and $1,726,000 was required to meet the regulatory reserve and clearing requirements at December 31, 2003 and 2002. These balances do not earn interest.
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATIONS:
Certain prior year amounts have been reclassified to conform to the current presentation.
RECENT ACCOUNTING PRONOUNCEMENTS:
In November 2002, the ("FASB") issued FASB Interpretation No. 45, (FIN No. 45) "Guarantor's Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others." FIN No. 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 guarantee. The Company has financial 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. FIN No. 45 requires the Company to record an initial liability generally equal to the fees received for these letters of credit, when guaranteeing obligations unless it became probable that the Company would have to perform under the guarantee. FIN No. 45 applies prospectively to letters of credit the Company issues or modifies subsequent to December 31, 2002. The Company adopted FIN No. 45 on January 1, 2003, without material effect on its consolidated financial statements.
The Company defines the initial fair value of these letters of credit as the fee received from the customer. The maximum potential undiscounted amount of future payments of these letters of credit, as of December 31, 2003 are $640,200, of which all on a demand basis and of which all are reviewed and renewed on an annual basis. Amounts due under these letters of credit would be reduced by any proceeds that the Company would be able to obtain in liquidating the collateral for the loans, which varies depending on the customer.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities." 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 entity's residual returns, or both. FIN 46 also requires disclosures about variable interest entities that a company is not required to consolidate, but in which it has a significant variable interest. The consolidation requirements of FIN 46 apply immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to existing entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company has evaluated the impact of FIN 46 and has determined that the interpretation has no material effect on its financial statements.
In April 2003 the FASB issued SFAS No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" which clarifies certain implementation issues raised by constituents and amends SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," to include the conclusions reached by the FASB on certain FASB Staff Implementation Issues that, while inconsistent with Statement 133's conclusions, were considered by the Board to be preferable; amends SFAS No. 133's discussion of financial guarantee contracts and the application of the shortcut method to an interest-rate swap agreement that includes an embedded option and amends other pronouncements. The guidance in Statement 149 is effective for new contracts entered into or modified after June 30, 2003 and for hedging relationships designated after that date. Management adopted SFAS No. 149 effective July 1, 2003, as required, without a material effect on the Company's financial position or results of operations.
In May 2003, the FASB issued Statement of Financial Accounting Standards ("SFAS") No. 150, "Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity." SFAS No. 150 changes the classification in the statement of financial position of certain common financial instruments from either equity or mezzanine presentation to liabilities and requires an issuer of those financial statements to recognize changes in fair value or redemption amount, as applicable, in earnings. SFAS No. 150 requires the issuer to classify the following financial instruments as liabilities: mandatory redeemable preferred and common stocks; forward purchase contracts that obligate the issuer to repurchases shares of its stock by transferring assets; freestanding put options that may obligate the issuer to repurchase shares of its stock by transferring assets; freestanding financial instruments that require or permit the issuer to settle an obligation by issuing a variable number of its shares if, at inception, the monetary value of the obligation is based solely or predominately on any of the following: a fixed monetary amount known at inception; variations in something other than the issuer's shares; or variations inversely related to changes in the value of the issuer's shares. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and, with one exception, is effective at the beginning of the first interim period beginning after June 15, 2003. The Company has evaluated SFAS No. 150 and has determined that the Statement will have no adverse material effect on the Company's financial position or results of operations.
NOTE 2 - SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses and estimated fair values of securities available for sale at December 31 are summarized as follows:
The amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of securities held to maturity at December 31, are summarized as follows:
The fair value of debt securities and carrying amount, if different, at year-end 2003 by contractual maturity were as follows. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately.
NOTE 2 - SECURITIES (CONTINUED)
Sales of available for sale securities were as follows:
The table below indicates the length of time individual securities have been in a continuous unrealized loss position at December 31,
Management has the intent and ability to hold these securities for the foreseeable future, and the decline in the fair value is largely due to an increase in market interest rates. The fair value is expected to recover as the securities approach their respective maturity dates.
Securities with an amortized cost of $55,357,128 at December 31, 2003 and $49,715,952 at December 31, 2002 were pledged to secure public deposits, repurchase agreements and other liabilities as required or permitted by law. At year-end 2003 and 2002, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholders' equity.
NOTE 3 - LOANS
The composition of the loan portfolio at December 31, is as follows:
The Company has sold whole loans and participating interests in loans in the secondary market, retaining servicing on the loans sold. Loans sold and serviced for others totaled approximately $29.1 million and $27.0 million at December 31, 2003 and 2002, respectively.
NOTE 3 - LOANS (CONTINUED)
In the normal course of business, the Company has made loans to directors and officers, their immediate families, affiliated corporations, and other entities in which they own more than a 10% voting interest. In the opinion of management, such loans are consistent with sound banking practices and were originated within applicable regulatory lending limitations. Such loans are summarized below:
The activity in the allowance for loan losses was as follows:
Nonperforming loans were as follows at December 31:
As of December 31, 2003 and 2002 and for each of the three years in the period ended December 31, 2003 individually impaired loans were not material to the consolidated financial statements.
NOTE 4 - PREMISES AND EQUIPMENT
Premises and equipment is comprised of the following at December 31:
Depreciation expense was $895,889, $841,633, and $865,951 for the years 2003, 2002, and 2001 respectively. CITIZENS leases an in-store retail branch from a corporation in which a director of the Company holds an interest. The current five year lease provides for renewal options through 2012. Rental expense was $26,004 for the year ended December 31, 2003, $25,128 for the year ended December 31, 2002 and $22,500 for the year ended December 31, 2001.
NOTE 5 - TIME DEPOSITS
The scheduled maturities of time deposits as of December 31, 2003 were as follows:
NOTE 6 - INTANGIBLE ASSETS
Intangible assets at December 31, 2003 were as follows:
Amortization expense related to intangible assets totaled $18,000, $24,488, and $27,569 for the years ended December 31, 2003, 2002 and 2001.
Estimated amortization expense for each of the next four years:
NOTE 7 - BORROWED FUNDS
Securities sold under agreements to repurchase are financing arrangements whereby the Company sells securities and agrees to repurchase the identical securities at the maturities of the agreements at specified prices. Physical control is maintained for all securities sold under repurchase agreements. Information concerning securities sold under agreements to repurchase is summarized as follows:
Securities underlying these agreements at December 31, were as follows:
At December 31, advances from the Federal Home Loan Bank were as follows.
At December 31, 2003, required annual principal payments on Federal Home Loan Bank advances and lines of credit were as follows:
NOTE 7 - BORROWED FUNDS (CONTINUED)
Additionally, as members of the Federal Home Loan Bank system at year-end 2003, the Banks had the ability to obtain up to $32,738,740 based on securities pledged to the FHLB at December 31, 2003. At December 31, 2003, the Company and its Banks have $45,706,751 1-4 family residential real estate loans pledged as collateral for borrowings. Also at December 31, 2003, the Company and its Banks have cash management lines of credit with various correspondent banks (excluding FHLB cash management lines of credit) enabling further borrowings of up to $21.7 million.
NOTE 8 - BENEFIT PLANS
Information about the pension plan was as follows:
Pension expense includes the following:
NOTE 8 - BENEFIT PLANS (CONTINUED)
Weighted-average assumptions used to determine obligations at December 31,
Weighted-average assumptions used to determine net periodic benefit cost for the years ended December 31,
The Company's defined benefit plan's weighted-average asset allocation at December 31, 2003, and 2002 by asset category are as follows:
The plan's assets are invested in prototype investment strategy classified as a "balanced investment approach". This investment strategy permits the asset allocation to range between 40% to 60% for equities and fixed income investments. This model is further defined to permit the use of multiple equity mutual funds as deemed appropriate by the funds Investment Advisor. The types of mutual funds include but not limited to large, mid or small capitalization funds to international mutual funds. The fixed income investment model is categorized as a core model using a single mutual fund with both long and shorter-term focus. Depending on the needs of the plan benefits certain levels of liquidity in the plan will vary depending on scheduled benefit or lump sum distribution requirements. The remaining fund assets are subject to the previously mentioned investment guidelines. The actual rate of return on plan assets for 2003 was 4.25% for fixed income investments and 29.05% on equity investments. The actual rate of return and the expected long term rate of return using a balanced investment approach was used as the basis for the actuarial assumptions of 8% for the expected long term rate of return on assets.
The Company's 401(k) matching percentage was 50% of the employees' first 6% of contributions for 2003, 2002 and 2001. The cash contribution and related expense included in salaries and employee benefits totaled $81,440 in 2003, $77,620 in 2002 and $73,350 in 2001.
NOTE 9 - INCOME TAXES
Income tax expense for the years ended December 31, was as follows:
The effective tax rate differs from the statutory federal income tax rate as follows:
Deferred tax assets and deferred tax liabilities are comprised of the following:
NOTE 10 - OFF-BALANCE SHEET ACTIVITIES
Some financial instruments, such as loan commitments, credit lines, letters of credit, and overdraft protection, are issued to meet customer-financing needs. These are agreements to provide credit or to support the credit of others, as long as conditions established in the contracts are met, and usually have expiration dates. Commitments may expire without being used. Off-balance sheet risk to credit loss exists up to the face amount of these instruments, although material losses are not anticipated. The same credit policies are used to make such commitments as are used for loans, including obtaining collateral at exercise of the commitment.
A summary of the notional or contractual amounts of financial instruments with off-balance sheet risk at December 31, is as follows:
At December 31, 2003, and included above, commitments to make fixed-rate loans at current market rates totaled $1,184,495 with the interest rates on those fixed-rate commitments ranging from 4.75% to 8.99%.
NOTE 11 - CONCENTRATIONS OF CREDIT RISK
The Banks grant commercial, commercial real estate, real estate and installment loans to customers mainly in Athens, Belmont, Carroll, Fairfield, Harrison, Hocking and Tuscarawas Counties and the surrounding localities. The Banks also grant commercial and commercial real estate loans in the Columbus, Ohio area. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, commercial real estate and residential real estate. At December 31, 2003, and 2002, total commercial and commercial real estate loans made up 48.8% and 48.0% respectively of the loan portfolio, with 10.0% and 15.6% of these loans secured by commercial real estate and business assets mainly in the Columbus, Ohio area. Installment loans account for 24.9% and 24.0% of the loan portfolio and are secured by consumer assets including automobiles, which account for 65.6% and 86.8%, respectively, of the installment loan portfolio. Real estate loans comprise 26.3% and 28.0% of the loan portfolio as of December 31, 2003 and 2002, respectively, and primarily include first mortgage loans on residential properties and home equity lines of credit. Included in cash and due from banks and federal funds sold as of December 31, 2003 and 2002, is $3,521,686 and $3,630,511 respectively on deposit with Bank One, NA, Detroit, Michigan.
NOTE 12 - REGULATORY MATTERS
The Company and Banks are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet various capital requirements can initiate regulatory action. Prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required. The Company and Banks at December 31, 2003 were categorized as well capitalized. Management is not aware of any conditions subsequent to that date which would change the Company's or the Banks' capital category.
NOTE 12 - REGULATORY MATTERS (CONTINUED)
At December 31, consolidated and Bank actual capital levels and minimum levels (dollars in thousands) were:
The Company's primary source of funds to pay dividends to shareholders is the dividends it receives from the Banks. The Banks are subject to certain restrictions on the amount of dividends that they may declare without prior regulatory approval. Generally, capital distributions are limited to undistributed net income for the current and prior two years. At December 31, 2003, $1,648,275 of retained earnings was available for dividend declaration without prior regulatory approval.
NOTE 13 - PARENT COMPANY CONDENSED FINANCIAL STATEMENTS
Following are condensed parent company financial statements:
Condensed Statements of Financial Condition December 31, 2003 and 2002
Condensed Statements of Income Years ended December 31, 2003, 2002 and 2001
NOTE 13 - PARENT COMPANY CONDENSED FINANCIAL STATEMENTS (CONTINUED)
Condensed Statements of Cash Flows Years ended December 31, 2003, 2002 and 2001
NOTE 14 - QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table summarizes the Company's quarterly results of operations for the years ended December 31, 2003 and 2002.
The earnings per share data have been adjusted to account for the 10% stock split in the form of a dividend paid in 2003 and the 5% share dividend paid in 2002.
ITEM 9
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
(a) On October 19, 2002, the Board of Directors of United Bancorp, Inc., upon the recommendation of its audit committee, dismissed Crowe, Chizek and Company LLP as the independent public accountant for the Company for all periods commencing on or after January 1, 2003. On October 19, 2002, the Audit Committee of the Company's Board of Directors, upon authority delegated to it by the Board of Directors, engaged the firm of Grant Thornton, LLP as the Corporation's new independent public accountant beginning with the 2003 year. Further discussion regarding this matter can be found in the Company's current report on Form 8-K filed with the Commission on November 26, 2002.
ITEM 9A
ITEM 9A CONTROLS AND PROCEDURES
The Company, under the supervision, and with the participation, of its management, including the Company's Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures as of December 31, 2003, pursuant to the requirements of Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of December 31, 2003, in timely alterting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings. There was no change in the Company's internal control over financial reporting that occurred during the Company's fiscal quarter ended December 31, 2003 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
PART III
ITEM 10
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item is incorporated by reference to the sections captioned "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" of pages 6 to 14 in the registrants' proxy statement for the 2004 Annual Meeting of Shareholders. Please see "Executive Officers" in Part I Item 1 of this report for information regarding registrant's executive officers. The Board of Directors has determined that Michael J. Arciello is an "Audit Committee Financial Expert" and "Independent" as defined under applicable SEC and NASDAQ rules.
The Company's Board of Directors has adopted a Code of Ethics that applies to its Principal Executive, Principal Financial, and Principal Accounting Officers. A copy of the Company's Code of Ethics is posted and can be viewed on the Company's internet web site at http://www.unitedbancorp.com/. In the event the Company amends or waives any provision of its Code of Ethics which applies to its Principal Executive, Principal Financial, or Principal Accounting Officers, and which relates to any element of the code of ethics definition set forth in Item 406(b) of Regulation S-K, the Company shall post a description of the nature of such amendment or waiver on its internet web site. With respect to a waiver of any relevant provision of the code of ethics, the Company shall also post the name of the person to whom the waiver was granted and the date of the waiver grant.
ITEM 11
ITEM 11 EXECUTIVE COMPENSATION
Information required by this item is incorporated by reference from the section captioned "Executive Compensation and Other Information" and "Compensation Committee Interlocks and Insider Participation in Compensation Decisions" pages 8 to 13 in the registrant's proxy statement for the 2004 Annual Meeting of Shareholders.
ITEM 12
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCK HOLDER MATTERS
Information required by this item is incorporated by reference to the section captioned "Ownership of Voting Shares" at pages 5 to 6 of the registrant's proxy statement for the 2004 Annual Meeting of Shareholders".
The following table is a disclosure of securities authorized for issuance under equity compensation plans
EQUITY COMPENSATION PLAN INFORMATION
ITEM 13
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Regulations of the Securities and Exchange Commission require the disclosure of any related party transactions with members of the Compensation Committee. During the past year, certain directors and officers, including members of the Compensation Committee, and one or more of their associates may have been customers of and had business transactions with one or more of the bank subsidiaries of United Bancorp, Inc. All loans included in such transactions were made in the ordinary course of business and on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other persons, and did not involve more than normal risk of collectability or present other unfavorable features. It is expected that similar transactions will occur in the future. In addition, The Citizens Savings Bank, a wholly-owned subsidiary of the Corporation, pursuant to the terms of a lease entered into on April 1, 1998, paid Riesbeck Food Markets, Inc. $25,128 in 2003, and over the five-year term of the lease, payments will total $130,000 as lease payments for space used in an in-store banking location at St. Clairsville, Ohio. Mr. Riesbeck, Chairman of the Compensation Committee, is an officer, director and shareholder of Riesbeck Food Markets, Inc. Management believes the lease between Riesbeck Food Markets, Inc. and the Corporation was made on an arms-length basis. Management employed a third party consulting firm that specializes in grocery store banking facilities to establish the terms of the lease.
ITEM 14
ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES
Information required by this item is incorporated by reference to the section captioned "Principal Accounting Firm Fees" at page 8 of the registrant's proxy statement for the 2004 Annual Meeting of Shareholders.
PART IV
ITEM 15
ITEM 15
(a) Financial Statements
(b) Reports on Form 8-K. No reports on Form 8-K were filed by the registrant during its fiscal quarter ended December 31, 2003.
(c) Exhibits
(1) Incorporated by reference to Appendix B to the registrant's Definitive Proxy Statement filed with the Securities and Exchange Commission on March 14, 2001. (2) Incorporated by reference to Appendix C to the registrant's Definitive Proxy Statement filed with the Securities and Exchange Commission on March 14, 2001. (3) Incorporated by reference to the registrant's 10-K filed with the Securities and Exchange Commission on March 27, 2003. (4) Incorporated by reference to Exhibit A to the registrant's Definitive Proxy Statement filed with the Securities and Exchange Commission in March 11, 1996.
UNITED BANCORP INC. 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.
(Registrant) United Bancorp, Inc.
By: /s/ James W. Everson March 29, 2004 -------------------------------------- James W. Everson, Chairman, President & CEO
Persuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
By: /s/ James W. Everson March 29, 2004 -------------------------------------- James W. Everson, Chairman, President & CEO
By: /s/ Randall M. Greenwood March 29, 2004 -------------------------------------- Randall M. Greenwood, Senior Vice President & CFO
By: /s/ Michael J. Arciello March 29, 2004 -------------------------------------- Michael J. Arciello
By: /s/ Terry A. McGhee March 29, 2004 -------------------------------------- Terry A. McGhee
By: /s/ John M. Hoopingarner March 29, 2004 -------------------------------------- John M. Hoopingarner
By: /s/ Richard L. Riesbeck March 29, 2004 -------------------------------------- Richard L. Riesbeck
By: /s/ L.E. Richardson, Jr. March 29, 2004 -------------------------------------- L.E. Richardson, Jr.
By: /s/ Matthew C. Thomas March 29, 2004 -------------------------------------- Matthew C. Thomas
EXHIBIT INDEX
(1) Incorporated by reference to Appendix B to the registrant's Definitive Proxy Statement filed with the Securities and Exchange Commission on March 14, 2001. (2) Incorporated by reference to Appendix C to the registrant's Definitive Proxy Statement filed with the Securities and Exchange Commission on March 14, 2001. (3) Incorporated by reference to the registrant's 10-K filed with the Securities and Exchange Commission on March 27, 2003. (4) Incorporated by reference to Exhibit A to the registrant's Definitive Proxy Statement filed with the Securities and Exchange Commission on March 11, 1996.