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