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 10, 2006, UBS and the Bank had a total of 34 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 August 2005, the Bank leased, and simultaneously subleased to a mortgage brokerage alliance, retail space on the bottom floor of its Center City Graham Building corporate office. The Bank placed one business development officer in this space with joint signage and an automated teller machine. This relationship allows the Bank to have presence in Center City Philadelphia without incurring additional occupancy expense. Through its locations, the Bank offers a broad range of commercial and consumer banking services. At December 31, 2005, the Bank had total deposits aggregating approximately $63.3 million and had total net loans outstanding of approximately $46.0 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.
Among the greatest challenges facing inner city communities is their lack of stability and transience. The Bank represents consistency to these communities. It 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 it creates economic profit by making comprehensive products and services 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 10, 2006, the Bank's maximum legal lending limit was approximately $1,122,000 per borrower. However, the Bank's internal Loan Policy limits the Bank's lending to $500,000 per borrower in order to diversify the credit risk in 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 regional mortgage brokerage 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.
In 2006, the Bank will introduce new products/strategies aimed at attracting a significant level of core deposits. These strategies include the introduction of a new "signature" savings account with a premium interest rate and remote deposit capture services. Coupled with internet banking, these products are designed to attract customers throughout the Philadelphia region without the additional cost of new brick and mortar. The Bank will work together with its Clergy Advisory Council, formed in May 2005, to roll these products out to churches and congregations in the Philadelphia region.
The Bank will continue to develop relationships with corporate entities in the region that have a commitment to community and economic development in the urban sector to ensure that the communities it serves have full access to financial products and services. Strategic alliances and partnerships are key to the economic strength of inner city neighborhoods.
Access to the Bank's Website and the United States Securities and Exchange Commission Website
Reports filed electronically by United Bancshares, Inc.'s 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 web site@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.
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 business development 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 has 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.
To help remain competitive and attract a significant level of new core customers, the Bank will introduce a premium rate signature savings account and new "Check 21" technology--remote deposit capture. This service will allow customers who are not located in close proximity to the Bank's branches to scan and transmit deposit information remotely versus physically depositing paper checks. Remote deposit capture will put the Bank on the cutting edge of technology in the financial services arena.
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 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 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 Bank is insured by the FDIC, which currently insures the Bank's deposits to a maximum of $100,000 per depositor. For this protection, each insured bank pays a semiannual statutory insurance assessment and is subject to certain rules and regulations of the FDIC. The amount of FDIC assessments paid by individual insured depository institutions, such as the Bank, is based on their relative risk as measured by regulatory capital ratios and certain other factors. Under this system, in establishing the insurance premium assessment for each bank, the FDIC will take into consideration the probability that the deposit insurance fund will incur a loss with respect to an institution, and will charge an institution with perceived higher inherent risks a higher insurance premium. The FDIC will also consider the different categories and concentrations of assets and liabilities of the institution, the revenue needs of the deposit insurance fund, and any other factors the FDIC deems relevant. A significant increase in the assessment rate or a special additional assessment with respect to insured deposits could have an adverse impact on the results of operations and capital levels of the Bank and/or UBS.
In February 2006, Congress passed the Federal Deposit Insurance Reform Act of 2005. This legislation will merge the Bank Insurance Fund and the Savings Association Insurance Fund into one fund, increase insurance coverage for retirement accounts to $250,000, adjust the maximum deposit insurance for inflation after March 31, 2010 and give the FDIC greater flexibility in setting insurance assessments.
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. In March of 2006 the Patriot Act, which was about to expire, was extended. The provisions in the Patriot Act concerning anti-terrorism were extended and provisions were added to the Patriot Act to curb certain of the criminal investigation powers that were in the original Patriot Act.
The Sarbanes-Oxley Act
The Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") stated goals 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 Sarbanes-Oxley Act and its implementing regulations 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
Section 404 ("SOX-404") of the Sarbanes-Oxley Act 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 postponed the effective date of SOX-404 for companies, such as UBS, with less than $75,000,000 in market capitalization until July 15, 2007.
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, 2007.
The rules and regulations, discussed above, which implement the Sarbanes-Oxley Act could have a significant economic impact on the compliance costs 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 one leverage capital ratio had fallen to 6.81%, below the 7% minimum capital ratio required by the Agreement. However, by February 2004, the tier one leverage ratio had improved to 7.29%. 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 improved to 9.49% at December 31, 2004. At December 31, 2005, the Bank's tier one leverage ratio increased to 9.47%.
With the stabilization of the Bank's capital position, management has turned its attention to increasing core profitability. A strategic plan has been adopted for 2006 that focuses on growth strategies for loans and deposits. These strategies include the introduction of "signature" deposit products with premium interest rates coupled with alternative service delivery channels including internet banking and remote deposit capture. In addition, the Bank has designated regional business development officers in the areas surrounding each of its three branches to solicit loan and deposit business. These strategies will allow the Bank to penetrate the marketplace without adding additional branches to its network. While expense reductions will continue to be sought, management believes that a greater impact will be realized with increased deposit levels and loan originations that result increased net interest income.
As a result of the actions referred to above, 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 1A
ITEM 1A - -RISK FACTORS
Below is a list of the significant risks that concern UBS, the Bank and the banking industry. The list may not be a complete listing and has not been prepared in a certain order.
Changes in the economy could have an adverse affect on the Bank and UBS - -----------------------------------------------------------------------
The strength of the U.S. economy and the local economy in which the Bank operates may be different than expected. The business and earnings of the Bank are directly affected by general conditions in the U.S. and in particular, economic conditions in the Philadelphia region. These conditions include legislative and regulatory changes, inflation, and changes in government and monetary and fiscal policies, all of which are beyond the Bank's control. A downturn in the economy could result in a decrease in products and service demand, an increase in loan delinquencies and increases in problem assets. Real estate pledged as collateral for loans made by the Bank may decline in value, reducing the value of assets and collateral associated with the Bank's existing loans. These factors could result in an increase in the provision for loan losses.
Future loan losses may exceed the Bank's allowance for loan losses - ------------------------------------------------------------------
The Bank is subject to credit risk, which is the risk of losing principal or interest due to borrowers' failure to repay loans in accordance with their terms. A downturn in the economy or the real estate market in Bank's market area or a rapid change in interest rates could have a negative effect on collateral values and borrowers' ability to repay. This deterioration in economic conditions could result in losses to UBS in excess of loan loss allowances. To the extent loans are not paid timely by borrowers, the loans are placed on non-accrual, thereby reducing interest income. To the extent loan charge-offs exceed the Bank's projections, increased amounts allocated to the provision for loan losses would reduce income.
Changing interest rates could reduce the Bank's net interest margin, net - ------------------------------------------------------------------------ interest income, fee income and net income - ------------------------------------------
Interest and fees on loans and securities, net of interest paid on deposits and borrowings, are a large part of the Bank's net income. Interest rates are key drivers of the Bank's net interest margin and subject to many factors beyond the control of the Bank's management. As interest rates change, net interest income is affected. Rapidly changing interest rates in the future could result in interest expense increasing faster than interest income because of mismatches in financial instrument maturities and/or competitive pressures. Further, substantially higher interest rates generally reduce loan demand and may result in slower loan growth. Decreases or increases in interest rates could have a negative effect
on the spreads between the interest rates earned on assets and the rates of interest paid on liabilities, and therefore decrease net interest income.
Government regulation can result in limitations on operations - -------------------------------------------------------------
The Bank operates in a highly regulated environment and is subject to supervision and regulation by a number of governmental regulatory agencies. Regulations adopted by these agencies are generally intended to provide protection for depositors and customers rather than for the benefit of the shareholders, establish permissible activities for the Bank to engage in, maintenance of adequate capital levels, and other aspects of operations. The laws and regulations applicable to the banking industry could change at any time, and cannot predict the effect of these changes on the Bank's business and profitability. Increased regulation could increase the cost of compliance and adversely affect profitability. In addition, the Bank is currently operating under a regulatory agreement that requires the maintenance of minimum capital levels. Losses from operations may result in deterioration of the Bank's capital levels below required levels and could result in more severe regulatory action. (See "Regulatory Action" above)
The financial services industry is very competitive - ---------------------------------------------------
The Bank faces competition in attracting and retaining deposits, making loans, and providing other financial services such as trust and investment management services throughout the Bank's market area. The Bank's competitors include other community banks, larger banking institutions, trust companies and a wide range of other financial institutions such as credit unions, government-sponsored enterprises, mutual fund companies, insurance companies and other non-bank businesses. Many of these competitors have substantially greater resources than the Bank and are able to expend greater funds for advertising and marketing. If the Bank' is unable to compete effectively, the Bank will lose market share and income from deposits, loans, and other products may be reduced.
Inadequate liquidity - --------------------
The Bank may not be able to meet the cash flow requirements of its 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. While the Bank actively manages its liquidity position and is required to maintain minimum levels of liquid assets, rapid loan growth or unexpected deposit attrition may negatively impact the Bank's ability to meet its liquidity requirements.
Ability to attract and retain management and key personnel may affect future - ---------------------------------------------------------------------------- growth and earnings - -------------------
The Company's success will be influenced by its ability to attract and retain management experienced in banking and financial services and familiar with the communities in the Bank's market areas. The Bank's ability to retain executive officers, management team, and support staff is important to the successful implementation of the Bank's strategic plan. It is critical, as the Bank grows, to be able to attract and retain qualified staff with the appropriate level of experience and knowledge in community banking. The unexpected loss of services of key personnel, or the inability to recruit and retain qualified personnel in the future could have an adverse effect on the Bank's business, financial condition, and results of operations.
Additional, risk factors also include the following all of which may reduce - --------------------------------------------------------------------------- revenues and/or increase expenses and/or pull the Bank's management attention - ----------------------------------------------------------------------------- away from core banking operations which may ultimately reduce the Bank's net - ---------------------------------------------------------------------------- income - ------
>> New developments in the banking industry >> Variations in quarterly or annual operating results >> Revision of or the issuance of additional regulatory actions affecting UBS or the Bank >> Litigation involving UBS or the Bank >> Changes in accounting policies or procedures
Investments in UBS common shares involve risk. There is no trading market for UBS' common shares.
ITEM 1B
ITEM 1B - -UNRESOLVED STAFF COMMENTS
None.
ITEM 2
ITEM 2 -- PROPERTIES
Corporate Headquarters
In February 2005, United Bank of Philadelphia's corporate offices re-located to The Graham Building, 30 S. 15th Street, Suite 1200, Center City Philadelphia. 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.
In August 2005, the Bank assumed the remaining term from another financial institution of a lease for retail space on the ground level of the Graham Building. The Bank formed an alliance with a regional mortgage brokerage company and simultaneously subleased all except the lobby in which the automated teller machine (ATM) is located. The Bank occupies one desk in the space for the purpose of business development/cross-referrals. The lease expires in September 2009. The Bank's average aggregate gross monthly rental is $4,858 of which the tenant pays an average monthly rent of $3,358. In addition, the Bank pays $1,500 per month for the ATM lobby plus one third of common area maintenance.
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 $3,843.
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 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 has been notified by the landlord that extensive improvements to the shopping plaza in which this branch is located are planned for 2006. The Bank will be relocated within the shopping plaza in a space to be constructed by the Fall of 2006. It is currently leasing this facility on a month-to-month basis. However, a proposed new lease is currently under negotiation for the new location.
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 14, 2005. 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 matters voted upon at shareholders annual meeting of UBS were the reelection of one (1) Class B director to serve a four year term and the ratification of the appointment of McGladrey and Pullen LLP as UBS' independent registered 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:
- ------------------------------------------------ ------------------------------- 53.679% Shares Voted 468,716.99 of 873,192.32 Shares - ------------------------------------------------ ------------------------------- 14.898% Accounts Voted 469 of 3,148 Accounts - ------------------------------------------------ -------------------------------
- --------------------------------- ------------ ------- -------------------- Question YES NO WITHHOLD/ABSTAIN - --------------------------------- ------------ ------- -------------------- Ahsan M. Nasratullah 99.093% 0.00% 0.907% (CLASS B) 464,466.99 0.00 4,250.00 - --------------------------------- ------------ ------- -------------------- Ratify McGladrey and Pullen, LLP 99.208% 0.00% 0.642% 465,006.99 0.00 3,010.00 - --------------------------------- ------------ ------- --------------------
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.
There were no capital stock transactions during 2004 and 2005.
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.
As of March 10, 2006 there were 3,148 shareholders of record of UBS' voting Common Stock and two 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 the 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" above.)
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 net deferred tax asset has been recognized to offset the net 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 the 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. In 2002, management consolidated the Bank's product offerings to make them more customer/sales friendly.
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 its current capital position (9.47% tier one leverage at December 31, 2005), the Bank is positioned for growth.
Another fundamental problem for the Bank's business model was its expense profile. Major cuts were made including staff reductions and the consolidation the branch network (from 8 offices to 3). While there was a conscientious effort to dismantle the original business model, management recognized the positive aspects of the model - low cost of funds, loyal customer base, and strong net interest margins. These strengths can be built upon as a new, productive model is formulated and implemented.
The Bank's Goals
With the stabilization of the Bank's capital position and operating structure, the primary focus of management is to increase core profitability and build franchise/shareholder value. As a result of an internal assessment, the Bank will focus on the following goals to build value:
o Growing and diversifying the deposit mix
o Growing and diversifying the loan mix
o Growing and diversifying noninterest income
o Controlling expenses
o Enhancing the branch network and alternative delivery options
To accomplish these goals management will focus on the implementation of three (3) critical strategies as follows:
o Implementation of a Signature Savings Product--A new statement savings ----------------------------------------------- product will be introduced in 2006 that will have a constant premium interest rate (initial rate of 3.25%). The product will be rolled out via a targeted direct mail campaign, newspaper advertisements, and distribution in church bulletins. The Bank will work together with its Clergy Advisory Council to generate interest in the product and encourage congregants as well as churches to establish "Rainy Day Savings Funds" at the Bank. While the introduction of this product will result in an increased cost of funds, it allows for the creation of new core customers and the generation of significant deposits to fund loans and/or investments. This strategy is projected to generate increased net interest income that will result in increased core profitability for the Bank.
o Implementation of Remote Deposit Capture--New technology evolved from ------------------------------------------ the introduction of "Check 21" in October 2004. This new banking legislation allows for expedited clearing of check deposits through the use of images. The Bank is currently working with its core service provider to implement a remote deposit capture service delivery option in 2006. This new technology will allow customers near and far from the Bank's branch network to conveniently make deposits using a scanner. The initial target market for this product will be religious organizations to allow for expedited deposit processing and availability of tithes and offerings. Again, the Bank will utilize its Clergy Advisory Council to introduce this product. Remote deposit capture is projected to increase the level of core noninterest-bearing checking accounts.
o Hire Business Development Officers/Lenders--The Bank will seek to hire an experienced business development officer/lender to drive business to its branch network and build its loan portfolio. This person will "get the Bank's name out" as a critical player in Philadelphia's financial services arena. Substantial loan volume is projected to be generated by this individual. In addition, the Bank reallocated three (3) staff positions to become regional business development officers. These individuals will work to cultivate relationships in and around the areas surrounding the Bank's branches.
In addition, the Bank will continue to develop relationships with corporate entities in the region 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.
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 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 it mortgage brokerage 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.
o Home Equity Loans--This product will receive heightened attention with the co-branded advertising in conjunction with a the Bank's mortgage brokerage alliance. 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 continue to be the "bread and butter" of loans for the Bank. The Bank is working in collaborative relationships to enhance volume. Some of these relationships include Small Business Development Centers, religious adjudicators, the newly formed Clergy Advisory Council 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
In 2005, the Company recorded a net loss of approximately $269,000 ($0.25 per share) compared to net income of approximately $1,647,000 ($1.54 per share) in 2004 and a net loss of approximately $1,115,000 in 2003 ($1.03 per share). The financial results for 2005 were adversely impacted by increased provisions to allowance for loan losses totaling $558,000 compared to $45,000 in 2004. In addition, 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.
A detailed explanation for each component of earnings is included in the sections below.
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 totaled $3,571,000 in 2005, an increase of $291,000, or 8.87%, compared to 2004. Net interest income was $3,280,000 in 2004, a decrease of $11,000, or .31%, compared to 2003.
In 2005, there was an increase in net interest income of $54,000 due to changes in volume and an increase of $237,000 due to changes in rate. 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.
Average earning assets increased slightly to $66.4 million in 2005 from $65.9 million in 2004 and decreased from $71 million in 2003 to $66 million in 2004. With the sale of its corporate headquarters in July 2004, the Bank converted approximately $1.2 million in nonearning assets to liquid earning assets. 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 Action above).
The net interest margin of the Bank was 5.38% in 2005, 4.98% in 2004, and 4.67% in 2003. 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 175 basis points) by the Federal Reserve in 2005, 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 2005, the average federal funds yield was 3.29%, compared to 1.39% in 2004 and 1.15% in 2003. During 2005, the average investment in federal funds decreased by $762,000. The reduction was a result of a $1.8 million increase in average loan fundings.
The yield on the investment portfolio decreased 9 basis points to 4.30% in 2005 compared to 4.39% in 2004 and 4.81% in 2003. The reduction in yield is primarily a result of the purchase of short-term (average 2 year duration) agency securities in late September 2004 that were used as collateral for quasi-governmental deposit customers. These securities had an average yield of 4.00%. In addition, some of the Bank's floating rate mortgage-backed securities that had Treasury and LIBOR indices repriced in 2004 in a lower interest rate environment. The yield is projected to increase in 2006 as many of the floating rate securities repriced in late 2005 in a higher interest rate environment.
The cost of interest-bearing liabilities increased to 1.18% in 2005 compared to 0.82% in 2004 and 1.02% in 2003.
Consistent with market conditions through mid-year 2004, the Bank reduced the rates it paid on many of its interest-bearing products. Although short-term interest rates increased in 2005 by 175 basis points, 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. With the introduction of its new signature savings account in 2006 (minimum initial rate of 3.25%), the Bank is projecting an increase in its cost of funds to 1.98%. While increasing, this cost of funds remains below the Bank's peer group average cost of funds of 2.50%.
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 2005 was $558,000 compared to $45,000 in 2004 and $565,000 in 2003. The increase in the provision in 2005 was due to a review and analysis of the Bank's loan portfolio and an increase in the level of classified loans and charge-offs during the year. The Bank charged-off the un-guaranteed portion of three (3) Small Business Administration ("SBA") loans totaling $107,000. The un-guaranteed portion of the loans ranged between 10 and 25 percent of the outstanding loan balances. The Bank also charged-off the guaranteed portion of two (2) of these loans totaling $187,000 because of the unlikely collection from the SBA. In addition, the Bank charged-off forty-seven (47) loans totaling $368,000 related to an improperly administered mirco-loan fund in which it was a participant.
The Bank made net provisions to the allowance totaling $45,000 for the year ended December 31, 2004. The level of required provision was reduced by the recovery of $265,000 related to one previously charged-off commercial loan.
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-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. In 2003, loans to this borrower totaled $1.3 million. In 2005, the Bank collected the guaranteed portion of the loans that totaled $569,000.
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, 2005.
Noninterest Income
Noninterest income decreased $2,072,000 in 2005 compared to 2004 and increased $1,764,000 in 2004 compared to 2003. 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 non-recurring gain of approximately $1,874,000 million in 2004.
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. During 2005, customer service fees declined by $171,000, or 20.03%, compared to 2004. In 2005, there was a $1.6 million decline in the Bank's average noninterest bearing demand deposits 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 beginning in 2004.
During 2005, surcharge income on the Bank's ATM network declined by $28,000, or 4.63%, compared to 2004.
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.
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 2005 these fees totaled $202,000 compared to $178,000 and $85,000 in 2004 and 2003, respectively. 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 $379,000, or 7.23%, in 2005 compared to 2004 and decreased $488,000, or 8.52% in 2004 compared to 2003.
Salaries and benefits decreased $105,000, or 5.42% in 2005 compared to 2004 and decreased $269,000, or 12.21%, in 2004 compared to 2003. As part of the Bank's continued effort to reduce/control expenses, there have been strategic reductions in staff and job consolidations. 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 staffing model to ensure the Bank is operating with the most efficient organizational structure.
Occupancy and equipment expense decreased approximately $108,000, or 9.79%, compared to 2004 and decreased $122,000, or 9.97%, in 2004 compared to 2003. Management continued the implementation of strategies to reduce its occupancy expense including the closure/consolidation of its Two Penn Center Center City branch office in 2004. 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. The Bank realized a full year expense benefit in 2005 related to the closure of this branch.
Also contributing to the reduction in occupancy expense was the sale of the Bank's corporate headquarters in July 2004. This building was sold to generate gains as part of the Bank's re-capitalization plan. The sale of the building resulted in a reduction in property taxes, insurance, repairs and maintenance, and depreciation expense on leasehold improvements associated with the building. In February 2005, the Bank began the lease of its new corporate headquarters on a 10,000 square foot floor of a full service high rise office building located in center city Philadelphia.
Office operations and supplies expense decreased by $67,000, or 16.18%, in 2005 compared to 2004 and decreased $41,000, or 9.11%, in 2004 compared to 2003. 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 security guards, supplies and other costs associated with branch operations.
Marketing and public relations expense increased by $18,000, or 21.5%, in 2005 compared to 2004 and decreased by $31,000, or 27.21% in 2004 compared to 2003. In April 2005, the Bank engaged a public relations firm to assist with re-acquainting the leaders in the Philadelphia region with the services of the Bank in effort to stimulate business development activity. Activities of this firm yielded in excess of $1 million in new deposit balances in 2005. Management will continue to seek cost-effective methods to sell its brand and products including the use of co-branded marketing materials with its strategic alliances and advertising in community-based newspapers and church bulletins.
Professional services increased by $26,000, or 11.06%, in 2005 compared to 2004 and increased $18,000, or 8.28%, in 2004 compared to 2003. The increase in 2005 is primarily related to the use of consultants to assist the Bank with the preparation of a five-year strategic plan. In addition, 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.
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 $155,000, or 27.61%, in 2005 compared to 2004 and decreased $99,000, or 15.00%, in 2004 compared to 2003. The reduction in 2005 is primarily a result of a decline in processing costs associated with the Bank's automated teller machine network because of fewer machines in service as well as a contract re-negotiation with its service provider. In addition, the Bank experienced a reduction the in monthly processing cost of its core processor, FISERV, as a result of the removal of closed deposit accounts from the account database as well as a line-by-line review of the invoice to identify other areas of savings.
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 including the consolidation of its mortgage loan service providers in 2006.
Federal deposit insurance premiums were $113,000 in 2005, $72,000 in 2004, and $34,000 in 2003. 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. By typical regulatory guidelines the Bank is considered "well" capitalized, however, because it is operating with a Written Agreement (Refer to "Regulatory Action" above), it is only considered to be "adequately" capitalized. The increase during 2005, 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 increased $493,000, or 0.75% in 2005 compared to 2004 and decreased approximately $4.5 million, or 6.37%, in 2004 compared to 2003.
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, decreased by $273,000, or 2.14%, in 2005 compared to 2004, and decreased $3.1 million, or 19.60%, in 2004 to 2003. The decrease in investments was primarily a result of paydowns in the Bank's mortgage-backed securities portfolio.
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 maturity of the portfolio is 3.25 years compared to 3.07 years in 2004. 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.
At December 31, 2005, approximately 48% 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, 2005 was 20.60% compared to 24.06% at December 31, 2004. This translates into 20.60% of the mortgage-backed pools repaying on an annual basis. This results in less monthly cash flow than was received in 2004.
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 current rising rate environment.
The above table sets forth the maturities of investment securities at December 31, 2005 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 $1,824,000, or 3.96%, in 2005 compared to 2004 and increased $869,000, or 1.92%, in 2004 compared to 2003. During 2005, the Bank funded $12 million in new commercial loans. However, growth in the loan portfolio was offset by payoffs of some large loan participations the Bank had with other financial institutions. In addition, the Bank's mortgage loan portfolio declined by $3.1 million as a result of customers with adjustable rate loans refinancing into fixed rate mortgages to avoid the negative impact of interest rate increases that occurred during the year.
The Bank has developed relationships with other financial institutions in the region with which it participates in loans as a strategy to grow its commercial loan portfolio. This strategy continues to be utilized while the Bank enhances it own business development capacity. Approximately $1.6 million in commercial loan participations were booked during 2005. Most of these participations were secured by commercial real estate.
To increase the level of loan originations management will add a business development officer/lender and retail sales manager to its staff in 2006. In addition, three (3) existing staff positions will be re-allocated to business development. Individuals in these positions will drive loan and deposit growth for the Bank.
The Bank's loan-to-deposit ratio at December 31, 2005 was 72.8%---slightly lower than 2004 at 73.6%. 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 decrease in this ratio is the result of a slightly larger deposit base.
As reflected in Table 5 below, the Bank's loan portfolio is heavily concentrated in commercial real estate loans that comprise approximately $25.8 million, or 55.60%, of total loans. Of the $12 million in 2005 of new commercial loan originations, $8.4 million were commercial real estate transactions, including $3.8 million in loans made to religious organizations. The Bank also continued to fund construction financing from prior year's loan originations. Continued payoffs resulted in a reduction of the residential mortgage loan component of the portfolio from $10.6 million at December 31, 2004 to $7.5 million at December 31, 2005.
In January 2005, the Bank sold $1,412,000 of its student loan portfolio and recorded a gain of $25,000. At December 31, 2004, these loans were recorded as held-for-sale. In December 2005, the Bank sold $363,000 of its student loan portfolio and recorded a gain of $6,000. These loans were sold to provide liquidity for the funding of higher yielding less costly to service commercial loans. Student loans are typically held in the consumer loan portfolio.
As reflected in Table 6 below, approximately 54.08% 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.
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.
At December 31, 2005, nonaccrual loans totaled $683,000 compared to $1,366,000 at December 31, 2004. The decrease in 2005 is primarily related to the $569,000 collection of the SBA guaranteed portion of one problem loan and the charge-off of $294,000 related to three (3) other SBA guaranteed loans for which collection is uncertain. At December 31, 2005, $191,000 of the Bank's nonaccrual loans carried some level of guarantee from the SBA that provide credit enhancement to these loans.
The balance of impaired loans was $386,000 and $1,034,000 at of December 31, 2005 and 2004, 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 $113,000 and $259,000 at December 31, 2005 and 2004, respectively. In February 2006, the Bank reached a compromise agreement with the borrower on one real estate secured impaired loan totaling $127,000. The borrower has entered an agreement of sale for $185,000 on the underlying collateral property for which the Bank has received a deposit of $50,000. Full collection of principal balance is expected by April 1, 2006.
Interest income recognized on impaired loans in 2005 was $37,000. There was no interest recognized on impaired loans in 2004. 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, 2005, the Bank had $554,000 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, 2005, approximately 25% 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, 2005, 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 1.02% at December 31, 2005 compared to 1.28% at December 31, 2004. The decline in this ratio is a result of charge-offs and a reduction in the level of classified loans. In 2005, the Bank charged-off the un-guaranteed portion of three (3) SBA loans totaling $107,000. The Bank also charged-off the guaranteed portion of two (2) of these loans totaling $187,000 because of the unlikely collection from the SBA. In addition, the Bank charged-off forty-seven (47) loans totaling $368,000 related to an improperly administered mirco-loan fund in which it was a participant.
As a result of the charge-offs and the $569,000 collection from the SBA of the guaranteed portion of a problem loan, the level of classified loans significantly declined in 2005. At December 31, 2005, the Bank's classified loans totaled $694,000, or 1.50% of total loans, compared to $1.2 million, or 2.50%, of total loans at December 31, 2004. Approximately $191,000 of the Bank's classified loans are guaranteed by the SBA.
The Bank continues to proactively monitor its credit quality while working with borrowers in an effort to identify and control credit risk.
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 $1.6 million, or 2.41%, in 2005 compared to 2004 and declined $6.3 million, or 8.72%, in 2004 compared to 2003. One of the primary areas of decline was in demand deposit accounts that decreased on average by $1.6 million, or 10.05%, compared to 2004. This decrease was primarily related to one significant deposit relationship with a quasi-governmental organization that converted its deposit relationship from a noninterest bearing checking account to certificates of deposit for which there was a corresponding increase in the average balance.
The Bank also experienced a decline of $1.6 million, or 8.69%, in its average savings deposits during 2005. 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.
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 Action above).
The Bank is in the process of implementing business development strategies including a signature savings account and remote deposit capture to increase the level of core deposits. In addition, the Bank will leverage the strategic partnerships/alliances it has developed to cross-sell its products and services.
Table 10--Average Deposits by Class and Rate
Other Borrowed Funds
The Bank did not borrow funds during 2005. 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:
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, 2005, 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. At December 31, 2005, approximately $8.2 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..................................... $10,485 Over 3 through 6 months.............................. 2,520 Over 6 months through 1 year......................... - Over 1 through five years............................ Over five years...................................... - -------
Total................................................ $13,005 =======
The following table sets forth contractual obligation and other commitments representing required and potential cash outflows as of December 31, 2005:
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, 2005, 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, 2005, an asset sensitive position is maintained on a cumulative basis through one year of 5.50%. This level is within the Bank's policy guidelines of +/-15% on a cumulative one-year basis. 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 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, 2005 are as follows:
Net interest Percent of Changes in rate income risk
(Dollars in thousands)
+200 basis points $ 3,471 0.73% +100 basis points 3,463 0.49 Flat rate 3,446 -- -100 basis points 3,410 1.04 -200 basis points 3,345 2.93
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, 2005 are as follows:
MV of equity Changes in rate MV equity Risk change
(Dollars in thousands)
+200 basis points $ 6,479 (14.7)% +100 basis points 7,377 (7.9) Flat rate 8,205 - -100 basis points 8,853 4.8 -200 basis points 9,413 21.0
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 within the policy limits of the Bank at December 31, 2005. 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 decreased $320,000 in 2005 compared to 2004 and increased $1.6 million in 2004 compared to 2003. The decline in capital in 2005 is primarily attributable to the net loss of $269,000 for the year as well as a decline in other comprehensive income related to an increase in the unrealized loss on securities classified as available-for-sale.
The increase in 2004 was primarily related to gains realized on the sale of bank-owned real estate totaling $1.9 million. Aggressive steps were taken to infuse additional capital to ensure the continued viability and growth of the institution.
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. Management will seek to leverage capital down to industry levels through growth generated by its strategic initiatives--signature savings and remote deposit capture.
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 and operating 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
See "Regulatory Action" above for a description of and status of compliance with the regulatory Agreement under which the Bank is currently operating.
Recent Accounting Pronouncements
In May 2005, the Financial Accounting Standards Board ("FASB") issued Statement No. 154, ("SFAS No. 154") "Accounting Changes and Error Corrections - A Replacement of APB Opinion No. 20 and FASB Statement No. 3." This new standard replaces Accounting Principles Board ("APB") Opinion No. 20, "Accounting Changes", and FASB Statement No. 3, "Reporting Accounting Changes in Interim Financial Statements." Among other changes, SFAS No. 154 requires that a voluntary change in accounting principle be applied retrospectively with all prior period financial statements presented on the new accounting principle, unless it is impracticable to do so. SFAS No. 154 also provides that (1) a change in method of depreciating or amortizing a long-lived nonfinancial asset be accounted for as a change in estimate (prospectively) that was effected by a change in accounting principle, and (2) correction of errors in previously issued financial statements should be termed a "restatement. " The new standard is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. UBS does not anticipate this revision will have a material effect on its financial statements.
In December 2004, the FASB issued Statement No. 123 (Revised 2004) ("SFAS No. 123R") "Share-Based Payment," which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. SFAS No. 123R replaces SFAS No. 123, "Accounting for Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees." Share-based compensation arrangements include share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. SFAS No. 123R requires all share-based payments to employees be valued using a fair valued method on the date of grant and expensed based on that fair value over the applicable vesting period. SFAS No. 123R also amends SFAS No. 95 "Statement of Cash Flows," requiring the benefits of tax deductions in excess of recognized compensation cost be reported as financing instead of operating cash flows. The Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 107, ("SAB No. 107") which expresses the SEC's views regarding the interaction between SFAS No. 123R and certain SEC rules and regulations. Additionally, SAB No. 107 provides guidance related to share-based payment transactions for public companies. UBS will be required to apply SFAS No. 123R as January 1, 2006. UBS does not anticipate this revision will have a material effect on its financial statements.
In November 2004, the Emerging Issues Task Force ("EITF") published Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." The Task Force discussed the meaning of other-than-temporary impairment and its application to certain investments carried at cost. The Task Force requested that the FASB staff consider other impairment models within U.S. Generally Accepted Accounting Principles ("GAAP") when developing its views. The Task Force also requested that the scope of the impairment issue be expanded to include equity investments and investments subject to FASB Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities," and that the issue be addressed by the Task Force as a separate EITF issue. At the EITF meeting, the Task Force reached a consensus on one issue that certain quantitative and qualitative disclosures should be required for securities accounted for under Statement 115 that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized. The APB ratified the consensus on that one issue at its November 25, 2004 meeting. In September 2004, the Financial Accounting Standards Board ("FASB") directed the FASB staff to issue two proposed FASB Staff Positions ("FSP"): Proposed FSP EITF Issue 03-1-a, which provides guidance for the application of paragraph 16 of EITF Issue 03-1 to debt securities that are
impaired because of interest rate and/or sector spread increases, and Proposed FSP EITF Issue 03-1-b, which delays the effective date of Issue 03-1 for debt securities that are impaired because of interest rate and/or sector spread increases. In June 2005, the FASB reached a decision whereby they declined to provide additional guidance on the meaning of other-than-temporary impairment. The Board directed the FASB staff to issue EITF 03-1a as final and to draft a new FSP that will replace EITF 03-01. The final FSP (retitled FAS 115-1, "The Meaning of Other-Than-Temporary Impairment and it Application to Certain Investments") is effective for reporting periods beginning after December 15, 2005. UBS does not anticipate this revision will have a material effect 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 33 of this Report, the Liquidity and Interest Rate Sensitivity Management provisions and pages 33 to 37 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 52 to 78 hereof.
ITEM 9
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There were no changes in or disagreements with accountants on accounting and financial disclosure during the year ended December 31, 2005.
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, 2005 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, 2005, 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
None.
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
*Please note that Mr. Drennan was elected as Treasurer of the Registrant and the Bank and serves as Chairman of the Audit Committees of those Board's of Directors beginning on November 14, 2005.
(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 and Financial Expert
The Audit/Compliance Committee of UBS' Board of Directors(1) comprised of Angela M. Huggins(3) (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 2005.
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 a "Financial Expert," as defined in the SEC's regulations.
The Compliance Committee is 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
The Audit/Compliance Committee of the Bank Board of Directors(1) comprised of Angela M. Huggins(3) (Chairman), Joseph T. Drennan(2), 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 2005.
In 2003, the Compliance Committee was combined with the Audit Committee and is comprised of the same members. On a quarterly basis, in addition to the audit matters outlined above, compliance matters are addressed to included the review of regulatory compliance matters, the Bank's compliance programs and the CRA Act activities.
(1)The Audit Committees of UBS and the Bank are operating standing committees established in accordance with Section 3(a)58(A) of the Exchange Act. (2)Mr. Drennan was elected as Treasurer of the Registrant and the Bank and serves as Chairman of the Audit Committees of those Board's of Directors beginning on November 14, 2005 (3)Angela M. Huggins retired from the Registrant's and Bank's Boards of Directors and their Audit Committee in November 2005 upon the expiration of her term.
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 2005 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 2005 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(4) (Vice Chairman)(1), Angela M. Huggins(3), 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 2005.
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(3) (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. 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 did not hold any meetings during 2005.
Meetings of UBS' Board and its Committees
The total number of meetings of UBS' Board of Directors that were held in 2005 was eleven (11). All of the incumbent directors, who were directors during 2005 (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 seventy-three percent (73%) and Steven Sanders(4) who attended fifty-five percent (55%) of all Board of Director and Executive Committee meetings.
(3)Angela M. Huggins retired from the Board of Directors in November 2005 upon the expiration of her term.
(4)Steve Sanders resigned from the Board of directors in January 2006 because of a change in his work schedule that precluded him from attending board 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(4) (Vice Chairman), Angela M. Huggins(3), 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 2005.
The Compensation Committee, comprised of Steven Sanders (Chairman)(1), L. Armstead Edwards, Angela M. Huggins(3) , 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 2005, the Compensation Committee did not hold any meetings as there were no changes in the contracts of the executive officers or other matters for discussion.
The Asset and Liability Management Committee comprised Bernard E. Anderson (Chairman), L. Armstead Edwards, Angela M. Huggins(3) , 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 2005, 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 2005.
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 2005 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 seventy-three percent (73%), and Steven Sanders(4) who attended fifty-five percent (55%) of all Board of Directors and Executive Committee meetings.
(3)Angela M. Huggins retired from the Board of Directors in November 2005 upon the expiration of her term. (4)Steve Sanders resigned from the Board of directors in January 2006 because of a change in his work schedule that precluded him from attending board 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 10, 2006:
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, 2005. 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 2005, the Compensation Committee did not hold any 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, 2005 (Ms. Smalls and Ms. Hudson-Nelson are hereinafter sometimes collectively referred to as the "Named Executive Officers").
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.
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 $8.54 per share were awarded to the former chief executive officer.
Equity Compensation Plan Table
ITEM 12
ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information known to UBS, as of March 10, 2006 (1), with respect to the only persons to UBS' knowledge, who may be beneficial owners of more than 5% of UBS' Common Stock.
The following table lists the beneficial ownership of shares of the UBS' Common Stock as of March 10, 2006 for each of the UBS' director, nominees and executive officers. The table also shows the total number of shares of Common Stock ownership by the director, nominees and executive officers of UBS as a group.
ITEM 13
ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Some of the directors and executive officers of the UBS and Bank and the entities with which they are associated were customers of and had banking transactions with the Bank in the ordinary course of its business during the year 2005. All loans and commitments to lend were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. In the opinion of Bank management, the transactions and loan commitments did not involve more than normal risk of collectively or present other unfavorable features.
ITEM 14
ITEM 14 - -PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table presents the fees for each of the last two fiscal years for the UBS' principal accountants by category:
2005 2004
Audit Fees..................................$ 86,703 $ 62,000 Audit-related fees.......................... - - Tax fees.................................... 8,304 - All other fees.............................. - - Total fees...............................$ 95,007 $ 62,000
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
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.
3. 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 (Incorporated by reference to Registrant's 2004 Form 10-K)
b) Lease for branch office located at 1620 Wadsworth Avenue(Incorporated by reference to Registrant's 2002 Form 10-K)
c) Lease for branch office located at 3750 Lancaster Avenue(Incorporated by reference to Registrant's 2002 Form 10-K)
d) Lease for branch office located at 1015 North Broad Street(Incorporated by reference to Registrant's 2002 Form 10-K)
e) Evelyn F. Smalls' Employment Agreement, dated November 1, 2004, is attached hereto as Exhibit 10e.
f) Brenda Hudson-Nelson's Employment Agreement, dated November 1, 2004, is attached hereto as Exhibit 10f.
g) Long Term Incentive Compensation Plan (Incorporated by reference to Registrant's 1992 Form 10)
h) Lease for Retail office located at The Graham Building, 30 S. 15th Street, Philadelphia, PA, is attached hereto as Exhibit 10h.
i) Sublease for Retail office located at The Graham Building, 30 S. 15th Street, Philadelphia, PA, is attached hereto as Exhibit 10i.
(11) Statement of Computation of Earnings Per Share. Included at Note 16 of the Financial Statements hereof.
(12) Statement of Computation of Ratios. Included at Note 15 of the Financial Statements hereof. (14) Code of Conduct and Ethics (Incorporated by reference to Registrant's 2004 10-K)
(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 Sabanes-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 18U.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 99.1.
(B) Exhibit 32.2 Certification Pursuant to 18U.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 99.2.
(99)Additional Exhibits
(A) Exhibit 99 Registrants Proxy Statement for its Annual Shareholders Meeting held on November 14, 2005 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
UNITED BANCSHARES, INC. DATE
/s/ Evelyn F. Smalls _________________________________________ March 31, 2006 Evelyn F. Smalls, President & CEO, Director
/s/ Brenda M. Hudson-Nelson _________________________________________ March 31, 2006 Brenda M. Hudson-Nelson, EVP, CFO
/s/ L. Armstead Edwards ___________________________________ March 31, 2006 L. Armstead Edwards, Chairman, Director
/s/ Marionette Y. Wilson(Frazier) _________________________________________ March 31, 2006 Marionette Y. Wilson(Frazier), Assistant Secretary, Director
/s/ William B. Moore _________________________________________ March 31, 2006 William B. Moore, Secretary, Director
/s/ Bernard E. Anderson ________________________________________ March 31, 2006 Bernard E. Anderson, Director
/s/ David R. Bright ________________________________________ March 31, 2006 David R. Bright, Director
/s/ Joseph T. Drennan ________________________________________ March 31, 2006 Joseph T. Drennan, Treasurer, Director
/s/ Ashan M. Nasratullah _________________________________________ March 31, 2006 Ashan M. Nasratullah, Director
/s/ Ernest L. Wright _________________________________________ March 31, 2006 Ernest L. Wright, Director
Report of Independent Registered Public Accounting Firm
To the Board of Directors United Bancshares, Inc. Philadelphia, Pennsylvania
We have audited the consolidated balance sheets of United Bancshares, Inc. and Subsidiary (the "Company") as of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in shareholders' equity and cash flows for the years 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 audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Bancshares, Inc. and Subsidiary as of December 31, 2005 and 2004, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
/s/ McGladrey & Pullen, LLP
Blue Bell, Pennsylvania March 10, 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and Board of Directors United Bancshares, Inc. and Subsidiary
We have audited the accompanying consolidated statement of operations, changes in shareholders' equity, and cash flows of United Bancshares, Inc. and its Subsidiary, United Bank of Philadelphia ("Bank"), for the year 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 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 consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. 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 provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of United Bancshares, Inc. and Subsidiary as of 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 Company will continue as a going concern. As discussed in Note 2 to the December 31, 2003 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 Company's ability to continue as a going concern. The ability of the Company 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.
/s/ Grant Thornton LLP
Philadelphia, Pennsylvania February 27, 2004
UNITED BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31,
The accompanying notes are an integral part of these statements.
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005, 2004, and 2003
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. Changes in loans made to and deposits received from customers are reported on a net 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.
Securities classified as available for sale or held to maturity are considered to be impaired when a decline in the fair value is judged to be other-than temporary. The Bank evaluates the securities for the other-than-temporary impairment at least on a quarterly basis and more frequently when economic or market conditions warrant such evaluation. The Bank employs a systematic methodology that considers available evidence in evaluating potential impairment of its investments. In the event that the cost of an investment exceeds its fair value, the Bank evaluates, among other factors, the magnitude and duration of the decline in fair value; for equity and debt securities the financial health of and business outlook of the issuer; the performance of the underlying assets in interests in securitized assets; and the Bank's intent and ability to hold the investment. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in investment income and a new cost basis in the investment is established.
(Continued)
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
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.
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.
Loans Held-for-Sale
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.
Allowance for Loan Losses
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 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.
(Continued)
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
The allowance for loan losses is maintained at a level considered adequate to provide for potential losses in the 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.
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
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
SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, 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, 2005, 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, 2005, 2004, and 2003
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. The carrying amount of accrued interest receivable approximates fair market value.
(Continued)
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
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 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. The carrying amount of accrued interest receivable approximates fair market value.
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. The carrying amount of accrued interest payable approximates fair market value.
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, 2005, 2004, and 2003, respectively. The amortization of the intangible will be $178,078 for each of the next five years.
Intangible assets are reviewed for possible impairment when events or changed circumstances may affect the underlying basis of the net asset. Such reviews include an analysis of current results and take into consideration the discounted value of projected operating cash flows. The core deposit intangible was tested for impairment. No impairment has been recognized.
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, 2005, 2004, and 2003
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. Material estimates which are particularly susceptible to significant change in the near term relate to the market value of investment securities, the determination of the allowance for loan losses, valuation of other real estate, and consideration of impairment of other intangible assets.
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 2005 presentation.
Comprehensive Income
Comprehensive income includes net income as well as certain other items that result in a change to equity during the period. The components of other comprehensive income (loss) are as follows:
(Continued)
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
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. At December 31, 2003, the Bank's tier one leverage capital ratio had fallen to 6.81%, below the 7% minimum capital ratio required by the Agreement. However, by February 2004, the tier one leverage ratio had improved to 7.29%. 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 improved to 9.49% at December 31, 2004. At December 31, 2005, the Bank's tier one leverage ratio was 9.47%.
With the stabilization of the Bank's capital position, management has turned its attention to increasing profitability. A strategic plan has been adopted for 2006 that focuses on core growth strategies for loans and deposits. These strategies include the introduction of "signature" deposit products with attractive interest rates coupled with alternative delivery channels including internet banking and remote deposit capture. In addition, the Bank has designated regional business development officers in the regions surrounding each of its three branches to solicit loan and deposit business, These strategies allow the Bank to penetrate the market place without adding additional branches to the network. While expense reductions will continue to be sought, management believes that a greater impact will be realized with increased deposit levels and loan originations that result increased net interest income. As a result of all of the actions referred to above, Management believes that the Bank is substantially in compliance with the Agreement's terms and conditions. Management continues to address all matters outlined in the Agreement. Failure to comply could result in additional regulatory supervision and/or actions.
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, 2005.
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
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, 2005 and 2004 are as follows:
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
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, 2005 (in thousands):
Management does not believe any individual unrealized loss as of December 31, 2005 and 2004 represents other-than-temporary impairment. The unrealized losses on these securities are caused by the changes in general market interest rates. All securities with unrealized losses are reviewed by management at least quarterly to determine whether the unrealized losses are other-than-temporary. The Company believes it will collect all amounts contractually due on these securities as they are backed by the full faith and credit of the U.S. Government or are guaranteed by an agency of the U.S. Government. The Company has the ability and the intent to hold these securities until market price recovery or maturity.
(Continued)
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
4. INVESTMENTS - Continued
Maturities of investment securities classified as available-for-sale and held-to-maturity at December 31, 2005 were as follows. Expected maturities may differ from contractual maturities.
No securities were sold during 2005. The Bank recorded a gross gain of $31,115 on the sale of investments during the year ended December 31, 2004. No securities were sold during 2003.
As of December 31, 2005 and 2004, investment securities with a book value of $11,780,583 and $11,459,636, were pledged as collateral to secure public deposits and for other purposes required or permitted by law.
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
5. LOANS AND ALLOWANCE FOR LOAN LOSSES
The composition of the net loans is as follows:
As of December 31, 2004, the Bank had student loans with a book value of $1,412,554 that were held-for-sale.
At December 31, 2005 and 2004, unamortized deferred fees and costs totaled $127,714 and $139,296, respectively.
As of December 31, 2005 and 2004, the Bank had loans to certain officers and directors and their affiliated interests in aggregate dollar amounts of $856,473 and $1,074,000, respectively. During 2005, there were $125,000 in new loans to related parties and repayments amounted to $258,000. During 2004, there were $236,000 in new loans to related parties and repayments amounted to $81,000.
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 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.
Details on the Bank's non-performing loans are as follows:
(Continued)
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
5. LOANS AND ALLOWANCE FOR LOAN LOSSES - Continued
Changes in the allowance for possible loan losses are as follows:
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, 2005, approximately 25% 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, 2005, 2004, and 2003 was $340,638, $277,850, and $329,878.
Future minimum lease payments under operating leases are as follows:
Operating Year ending December 31, leases
2006................................................. $ 310,227
2007................................................. 316,808 2008................................................. 312,599 2009................................................. 266,389 2010................................................. 202,530 Thereafter........................................ 929,916 ----------
Total minimum lease payments......................... $ 2,338,469 ===========
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
6. BANK PREMISES AND EQUIPMENT-Continued
In August 2005, the Bank assumed the remaining term from another financial institution of a lease for retail space on the ground level of its corporate headquarters. The Bank formed an alliance with a regional mortgage brokerage company and simultaneously subleased all except the lobby in which the automated teller machine (ATM) is located. The lease expires in September 2009. The Bank's average aggregate gross monthly rental is $4,858 of which a tenant pays an average monthly rent of $3,358.
7. DEPOSITS
At December 31, 2005, the scheduled maturities of time deposits (certificates of deposit) are as follows (dollars in thousands):
2006............................... $ 21,296
2007............................... 647 2008............................... 307 2009............................... 90 2010............................... 253 Thereafter......................... 77 ---------- $ 22,670
8. BORROWINGS
As of December 31, 2005, 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, 2005 and 2004, the Bank had no borrowings outstanding.
9. CAPITAL STOCK
There were no capital stock transactions in 2005 and 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.
10. INCOME TAXES
At December 31, 2005, the Bank has net operating loss carryforwards of approximately $4,610,000 for income tax purposes that expire in 2008 through 2025.
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 $2,088,508 and $1,930,062 as of December 31, 2005 and 2004, 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, 2005, 2004, and 2003
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:
2005 2004 ------------ ------------
Commitments to extend credit............ $ 12,727,370 $ 13,749,562
Outstanding letters of credit........... 10,000 -
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, 2005, 2004, and 2003
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, 2005. These options expire in 2008.
The Company made no stock-based compensation awards to any employee during 2005, 2004, and 2003.
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
14. CONSOLIDATED FINANCIAL INFORMATION--PARENT COMPANY ONLY
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
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 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. By typical regulatory guidelines the Bank is considered "well" capitalized, however, because it is operating with a Written Agreement, it is only considered to be "adequately" capitalized. The Bank's growth and other operating factors may have an adverse effect on its capital ratios.(Also see Note 2. REGULATORY AGREEMENT)
(Continued)
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
15. REGULATORY MATTERS - Continued
Under the framework, the Bank's capital levels do not allow the Bank to accept brokered deposits without prior approval from regulators. Historically, the Bank has not accepted brokered deposits and management believes this restriction does not significantly limit the Bank's ability to attract deposits and maintain adequate liquidity.
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
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 are included in the computation of diluted EPS for the years ended December 31, 2004.
The preferred stock is non cumulative and the Company 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, 2005, 2004, and 2003
17. SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
The following summarizes the consolidated results of operations during 2005 and 2004, on a quarterly basis, for United Bancshares, Inc. and Subsidiary:
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
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:
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, 2005, 2004, and 2003
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, 2005. These options expire in 2008.
The Company made no stock-based compensation awards to any employee during 2005, 2004, and 2003.
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
14. CONSOLIDATED FINANCIAL INFORMATION--PARENT COMPANY ONLY
Condensed Balance Sheets
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
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 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. By typical regulatory guidelines the Bank is considered "well" capitalized, however, because it is operating with a Written Agreement, it is only considered to be "adequately" capitalized. The Bank's growth and other operating factors may have an adverse effect on its capital ratios.(Also see Note 2. REGULATORY AGREEMENT)
(Continued)
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
15. REGULATORY MATTERS - Continued
The Bank's actual capital amounts and ratios are as follows:
Under the framework, the Bank's capital levels do not allow the Bank to accept brokered deposits without prior approval from regulators. Historically, the Bank has not accepted brokered deposits and management believes this restriction does not significantly limit the Bank's ability to attract deposits and maintain adequate liquidity.
UNITED BANCSHARES, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
December 31, 2005, 2004, and 2003
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 are included in the computation of diluted EPS for the years ended December 31, 2004.
The preferred stock is non cumulative and the Company 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, 2005, 2004, and 2003
17. SUMMARY OF QUARTERLY RESULTS (UNAUDITED)
The following summarizes the consolidated results of operations during 2005 and 2004, on a quarterly basis, for United Bancshares, Inc. and Subsidiary:
(Dollars in thousands)