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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
UNITED BANCSHARES, INC.
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(Exact name of registrant as specified in its charter)
0-25976
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(Registrants' file number)
Pennsylvania 23-2802415
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(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
300 North Third Street, Philadelphia, Pennsylvania 19106
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (215) 351-4600
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01
par value
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Documents Incorporated by Reference: Part III -- Portions of Registrant's
definitive Proxy Statement for 2001 annual shareholders meeting, filed with the
Commission pursuant to Regulation 14A.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will
not be contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
1
FORM 10-K
Index
PART I
Item No. Page
1. Business........................................................ 3
2. Properties...................................................... 11
3. Legal Proceedings............................................... 12
4. Submission of Matters to a Vote of Security Holders............. 12
PART II
5. Market for Registrant's Common Equity and Related Stockholder
Matters......................................................... 12
6. Selected Financial Data......................................... 14
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations....................................... 14
7a Quantitative and Qualitative Disclosures about Market Risk...... 28
8. Financial Statements and Supplementary Data..................... 28
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure........................................ 28
PART III
10. Directors and Executive Officers of Registrant.................. 29
11. Executive Compensation.......................................... 30
12. Security Ownership of Certain Beneficial Owners and Management.. 30
13. Certain Relationships and Related Transactions.................. 30
PART IV
14. Exhibits, Financial Statements Schedules and Reports on Form 8-K 31
UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF MARCH 28, 2002.
2
United Bancshares, Inc. (sometimes herein also referred to as the "Company"
or "UBS") has two classes of capital stock authorized - 2,000,000 shares of $.01
par value Common Stock and Series Preferred Stock (Series A Preferred Stock).
The Board of Directors designated a subclass of the common stock, designated
Class B Common Stock, by filing of Articles of Amendment to its Articles of
Incorporation on September 30, 1998. This Class of stock has all of the rights
and privileges of Common Stock with the exception of voting rights. Of the
2,000,000 shares of Common Stock authorized, 250,000 have been designated Class
B Common Stock. There is no market for the Common Stock. None of the shares of
the Registrant's stock was sold within 60 days of the filing of this Form 10-K.
As of March 18, 2002 the aggregate number of the shares of the Registrant's
Common Stock outstanding was 1,100,388 (including 191,667 Class B Non voting).
The Board of Directors of United Bancshares, Inc. designated one series of
the Series Preferred Stock (the "Series A Preferred Stock"), 500,000 authorized
of which 143,150 shares were outstanding as of March 18, 2002.
The Exhibit index is on page 57. There are 57 pages in the Form 10-K.
PART I
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD LOOKING STATEMENT
Certain of the matters discussed in this document and the documents
incorporated by reference herein, including matters discussed under the captions
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" may constitute forward looking statements for the purposes of the
Securities Act of 1933, as amended and the Securities Exchange Act of 1934, as
amended, and may involve known and unknown risks, uncertainties and other
factors which may cause the actual results, performance or achievements of
United Bancshares, Inc (the "UBS") to be materially different from future
results, performance or achievements expressed or implied by such forward
looking statements. The words "expect," "anticipate," "intended," "plan,"
"believe," "seek," "estimate," and similar expressions are intended to identify
such forward-looking statements. UBS's actual results may differ materially from
the results anticipated by the forward-looking statements due to a variety of
factors, including without limitation: (a) the effects of future economic
conditions on the UBS and its customers; (b) governmental monetary and fiscal
policies, as well as legislation and regulatory changes; (c) the risks of
changes in interest rates on the level and composition of deposits, loan demand,
and the values of loan collateral and securities, as well as interest-rate
risks; (d) the effects of competition from other commercial banks, thrifts,
mortgage companies, consumer finance companies, credit unions securities
brokerage firms, insurance companies, money-market and mutual funds and other
financial institutions operating in the UBS's trade market area and elsewhere
including institutions operating locally, regionally, nationally and
internationally together with such competitors offering banking products and
services by mail, telephone, computer and the Internet; and (e) the failure of
assumptions underlying the establishment of reserves for loan losses and
estimates in the value of collateral, and various financial assets and
liabilities and technological changes being more difficult or expensive than
anticipated. All written or oral forward-looking statements attributable to UBS
are expressly qualified in their entirety by use of the foregoing cautionary
statements.
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 300 North Third Street, Philadelphia, Pennsylvania 19106. The
Registrant's telephone number is (215) 351-4600.
As of March 18, 2002, the UBS and the Bank had a total of 64 employees.
3
United Bank of Philadelphia
The Bank, an African-American controlled, state-chartered member bank of
the Federal Reserve System is regulated by both the Federal Reserve Board and
the Commonwealth of Pennsylvania Department of Banking (the "Department"). The
deposits held by the Bank are insured by the Federal Deposit Insurance
Corporation ("FDIC").
The Bank conducts all its banking activities through its four offices
located as follows: (i) Center City Branch Two Penn Center, Philadelphia,
Pennsylvania; (ii) West Philadelphia Branch 37th 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 January 2002, the Bank closed and
consolidated its 714 Market Street Branch with its branch located at Two Penn
Center to create operating efficiencies. Through its locations, the Bank offers
a broad range of commercial and consumer banking services. At December 31, 2001,
the Bank had total deposits aggregating approximately $79.4 million and had
total net loans outstanding of approximately $42.3 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
1990 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
1,577,815, which includes a minority population of 752,309.
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 18, 2002, the Bank's
maximum legal lending limit was approximately $984,000 per borrower. However,
the Bank's internal Loan Policy limits the Bank's lending to $500,000 per
borrower in order to diversify the loan portfolio. The Bank has established
relationships with correspondent banks to participate in loans that exceed the
Bank's internal policies or legal lending limits. 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.
The Bank also offers commercial and retail products. 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. This guaranty is 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 also offers residential mortgage loans
to its customers. In addition, the Bank offers 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 as well
as international and trust services through correspondent institutions.
4
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. 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 un-served and by its devotion to personalized customer
service. The Bank's strategy has been, and will continue to be, to emphasize
personalized services with special sensitivity to the needs of Blacks, Hispanics
and women and to offer competitive rates to borrowers and depositors.
In order to compete, the Bank relies upon personal contacts by the
officers, directors and employees of the Bank to establish and maintain
relationships with Bank customers. The Bank focuses its efforts on the needs of
individuals and small and medium-sized businesses. In the event there are
customers whose loan demands exceed the Bank's lending limit, the Bank will seek
to arrange for such loans on a participation basis with other financial
institutions and intermediaries. The Bank will also assist those customers
requiring other services not offered by the Bank to obtain such services from
its correspondent banks.
Registrant 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. While some of such customers have followed
officers of those institutions who were hired by the Bank, others were attracted
to the Bank by calling programs of its officers and referrals from other
customers. The Bank has sought, in the past, and intends to continue in the
future, to hire customer contact officers who have good relationships with
desirable customers. These personal relationships, provision of a high level of
customer services, and referrals from satisfied customers, form the basis of the
Bank's competitive approach, as opposed to advertising, rate competition or the
development of proprietary banking products, services or programs.
In the past, the principal competition for deposits and loans have been
other depository institutions. However, now the Bank also competes with other
financial intermediaries such as brokerage houses offering investment vehicles
to the general public. Other entities, both public and private, seeking to raise
capital through the issuance and sale of debt or equity securities are also
competitors with banks and savings and loan associations in the acquisition of
deposits.
Supervision and Regulation
The Holding Company, UBS, is registered under the Securities Exchange Act
of 1934, as amended, and is subject to the jurisdiction of the Securities and
Exchange Commission (the "SEC") and of state securities commissions for matters
relating to the offering and sale of its securities. Accordingly, if UBS wishes
to issue additional shares of its common stock, in order, for example, to raise
capital or to grant stock options, UBS will have to comply with the registration
requirements of the Securities Act of 1933, as amended and the applicable states
securities laws, or to qualify for exemption from registration.
UBS is subject to the provisions of the Bank Holding Company Act of 1956,
as amended (the "BHC Act"), and to supervision by the Federal Reserve Board. 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 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.
A bank holding company also is prohibited from engaging in or acquiring
direct or indirect control of more than 5% of the voting shares of any such
company engaged in non-banking activities unless the Federal Reserve Board, by
order or regulation, has found such activities to be closely related to banking
or managing or controlling banks as to be a proper incident thereto. In making
this determination, the Federal Reserve Board considers whether the performance
of these activities by a bank holding company would offer benefits to the public
that outweigh possible adverse effects.
5
As a bank holding company, UBS is required to file an annual report with
the Federal Reserve Board and any additional information that the Federal
Reserve Board may require pursuant to the BHC Act. The Federal Reserve Board may
also make examinations of the holding company and any or all of subsidiaries.
Further, under Section 106 of the 1970 amendments to the BHC Act and the Federal
Reserve Board's regulation, a bank holding company's subsidiaries are prohibited
from engaging in certain tying arrangements in connection with any extension of
credit or provision of credit of any property or services. The so called
"anti-tying" provisions state generally that a bank may not extend credit,
lease, sell property or furnish 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.
Subsidiary banks of a bank holding company are subject to certain
restrictions imposed by the Federal Reserve Act and by state banking laws on any
extensions of credit to the bank holding company or any of its subsidiaries, on
investments in the stock or other securities of the bank holding company and on
taking of such stock or securities as collateral for loans to any borrower.
A bank holding company located in Pennsylvania, another state, the District
of Columbia or a territory or possession of the United States may control one or
more banks, bank and trust companies, national banks, interstate banks and, with
the prior written approval of the Pennsylvania Department of Banking, may
acquire control of a bank and trust company or a national bank located in
Pennsylvania. A Pennsylvania-chartered institution may maintain branches in any
other state, the District of Columbia, or a territory or possession of the
United States upon the written approval of the Pennsylvania Department of
Banking.
Subject to satisfaction of the requirements of the Pennsylvania Banking
Code of 1965, as amended, the ("Code"), the Registrant is permitted to control
an unlimited number of banks. However, the Registrant would be required under
the BHC Act to obtain the prior approval of the Federal Reserve Board before it
could acquire all or substantially all of the assets of any bank, or acquiring
ownership or control of any voting shares of any bank other than the Bank, if,
after such acquisition, the registrant would own or control more than 5% of the
voting shares of such bank. The BHC Act has been amended by the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994 which authorizes bank
holding companies, subject to certain limitations and restrictions, to acquire
banks located in any state.
The Bank. The deposits of United Bank of Philadelphia are insured by the
FDIC. The Bank is subject to supervision, regulation and examination by the
Pennsylvania Department of Banking and by the FDIC. In addition, the Bank is
subject to a variety of local, state and federal laws that affect its operation.
In 1995, the Code was amended to harmonize Pennsylvania law with the
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 to enable
Pennsylvania institutions to participate fully in interstate banking and to
remove obstacles to the choice by banks from other states engaged in interstate
banking to select Pennsylvania as a head office location. Some of the more
salient features of the amendment are described below.
In addition, a banking institution existing under the laws of another
jurisdiction may establish a branch in Pennsylvania if the laws of the
jurisdiction in which it is located permit a Pennsylvania-chartered institution
or a national bank located in Pennsylvania to establish and maintain a branch in
such jurisdiction on substantially the same terms and conditions.
In 1995, the Pennsylvania General Assembly enacted the Economic Development
Agency, Fiduciary and Lender Environmental Liability Protection Act which, among
other things, provides protection to lenders from environmental liability and
remediation costs under the environmental laws for releases and contamination
caused by others. A lender who engages in activities involved in the routine
practices of commercial lending, including, but not limited to, the providing of
financial services, holding of security interests, workout practices,
foreclosure or the recovery of funds from the sale of property is not liable
under the environmental acts or common law equivalents to the Pennsylvania
Department of Environmental resources or to any other person by virtue of the
fact that the lender engages in such commercial lending practices. A lender,
however, will be liable if it, its employees or agents, directly cause an
immediate release or directly exacerbate a release of regulated substances on or
from the property, or knowingly and willfully compelled the borrower to commit
an action which caused such release or violation of an environmental act. The
Economic Development Agency, Fiduciary and Lender Environmental Liability
Protection Act, however, does not limit federal liability which still exists
under certain circumstances.
6
The Bank as a subsidiary bank of a holding company is subject to certain
restrictions imposed by the Federal Reserve Act, as amended, on any extensions
of credit to the bank holding company or its subsidiaries, on investments in the
stock or other securities of the bank holding company or its subsidiaries, and
on taking such stock or securities as collateral for loans. The Federal Reserve
Act, as amended, 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, such legislation
and 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 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 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 in violation of applicable law.
Moreover, the Federal Reserve Board may: (i) empower 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) authorize the FDIC to remove
executive officers who have participated in such violations or unsound
practices; (iii) restrict lending by the Bank to its executive officers,
directors, principal shareholders or related interests thereof; (iv) restrict
management personnel of a 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 the acquisition or extended the period for
disapproval.
In April 1995, the Bank's regulators revised the Community Reinvestment
Act ("CRA") with an emphasis on performance over process and documentation.
Under the revised rules, the five-point rating scale is still utilized by
examiners to assign a numerical score for a bank's performance in each of three
areas: lending, service and investment. Under the CRA, the Federal Reserve Board
is required to: (i) assess the records of all financial institutions regulated
by it to determine if these institutions are meeting the credit needs of the
community (including low-and moderate-income neighborhoods) which they serve,
and (ii) take this record into account in its evaluation of any application made
by any such institutions for, among other things, approval of a branch or other
deposit facility, office relocation, a merger or an acquisition of bank shares.
The CRA also requires the federal banking agencies to make public disclosures of
their evaluation of each bank's record of meeting the credit needs of its entire
community, including low and moderate income neighborhoods. This evaluation will
include a descriptive rate ("outstanding," "satisfactory," "needs to improve" or
"substantial noncompliance") and a statement describing the basis for the
rating. After its most recent examination of the Bank under CRA, the FDIC gave
the Bank a CRA rating of "outstanding".
Under the Bank Secrecy Act ("BSA"), banks and other financial institutions
are required to report to the Internal Revenue Service currency transactions of
more than $10,000 or multiple transactions in any one day of which the Bank is
aware that exceed $10,000 in the aggregate or other lesser amounts. 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.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
The Bank believes that further merger activity within Pennsylvania is likely
to occur in the future, resulting in increased concentration levels in banking
markets within Pennsylvania and other significant changes in the competitive
environment. The Riegle-Neal allows adequately capitalized and managed bank
holding companies to acquire banks in any state starting one year after
enactment (September 29, 1995). Another provision of the Riegle-Neal Act allows
interstate merger transactions beginning June 1, 1997. States are permitted,
however, to pass legislation providing for either earlier approval of mergers
with out-of-state banks, or "opting-out" of interstate mergers entirely.
7
Through interstate merger transactions, banks will be able to acquire branches
of out-of-state banks by converting their offices into branches of the resulting
bank. The Riegle-Neal Act provides that it will be the exclusive means for bank
holding companies to obtain interstate branches. Under the Riegle-Neal Act,
banks may establish and operate a "de novo branch" in any State that "opts-in"
to de novo branching. Foreign banks are allowed to operate branches, either de
novo or by merger. These branches can operate to the same extent that the
establishment and operation of such branches would be permitted if the foreign
bank were a national bank or state bank. All these changes are expected to
intensify competition in local, regional and national banking markets. The
Pennsylvania Banking Code has been amended to enable Pennsylvania institutions
to participate fully in interstate banking (see discussion above).
Federal Deposit Insurance Corporation Act of 1991
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDIC
Improvement Act") includes several provisions that have a direct impact on the
Bank. The most significant of these provisions are discussed below. In order to
minimize losses to the deposit insurance funds, the FDIC Improvement Act
establishes a format to monitor FDIC-insured institutions and to enable prompt
corrective action by the appropriate federal supervisory agency if an
institution begins to experience any difficulty. The FDIC Improvement 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 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.
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 Improvement 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.
A "critically undercapitalized" institution is one that has a tangible
equity (Tier I capital) ratio of 2% or less. In addition to the same
restrictions and prohibitions that apply to "undercapitalized" and
"significantly undercapitalized" institutions, any institution that becomes
"critically undercapitalized" is prohibited from taking the following actions
without the prior written approval of its primary federal supervisory agency:
engaging in any material transactions other than in the usual course of
business; extending credit for highly leveraged transactions; amending its
charter or bylaws; making any material changes in accounting methods; engaging
in certain transactions with affiliates; paying excessive compensation or
bonuses; and paying interest on liabilities exceeding the prevailing rates in
the institution's market area. In addition, a "critically undercapitalized"
institution is prohibited from paying interest or principal on its subordinated
debt and is subject to being placed in conservatorship or receivership if its
tangible equity capital level is not increased within certain mandated time
frames.
8
Financial Services Act of 1999
On March 11, 2000 the Financial Services Act of 1999 (the "FSA"),
sometimes referred to as the Gramm-Leach-Bliley Act, became effective.
The FSA repeals provisions of the Glass-Steagall Act, which had 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 amends the BHC Act to allow new "financial holding companies"
("FHC") to offer banking, insurance, securities and other financial products to
consumers. Specifically, the FSA amends Section 4 of the Act in order to provide
for a framework for the engagement in new financial activities. Bank holding
companies may elect to become a financial holding company if all its subsidiary
depository institutions are well capitalized and well managed. If these
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 is 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. Bank holding companies may engage in financial activities
without prior notice to the Federal Reserve Board if those activities qualify
under the new list in Section 4(k) of the BHC Act. However, notice must be given
to the Federal Reserve Board within 30 days after a FHC has commenced one or
more of the financial activities.
Under the FSA, a bank subject to various requirements is permitted to
engage through "financial subsidiaries" in certain financial activities
permissible for affiliates of FHC's. However, to be able to engage in such
activities the bank must continue to be well-capitalized and well-managed and
receive at least a "satisfactory" rating in its most recent Community
Reinvestment Act examination. UBS cannot be certain of the effect of the
foregoing recently enacted legislation on its business, although there is likely
to be consolidation among financial services institutions and increased
competition for UBS.
Privacy of Consumer Financial Information
The FSA also a contains a provision designed to protect the privacy of
each consumer's financial information in a financial institution. Pursuant to
the requirements of the FSA, the financial institution regulators (the
"regulators") have promulgated final regulations (the "regulations") intended to
better protect the privacy of a consumer's financial information maintained in
financial institutions.
The regulations are designed to prevent financial institutions, such as
the Bank, from disclosing a consumer's nonpublic personal information to third
parties that are not affiliated with the financial institution.
However, financial institutions can share a customer's personal
information or information about business with their affiliated companies. The
regulations also provide that financial institutions can disclose nonpublic
personal information to non-affiliated third parties for marketing purposes but
the financial institution must provide a description of its privacy policies to
the consumers and give the consumers an opportunity to opt-out of such
disclosure and, thus, prevent disclosure by the financial institution of the
consumer's nonpublic personal information to non-affiliated third parties.
The regulations, among other things, provide guidance concerning what are
"nonpublic personal information", "consumers", and "customers", as well as about
the required timing for notices to customers and the means by which customers
can exercise their right to opt out of disclosure of their personal information.
These privacy regulations will affect how consumer information is
transmitted through diversified financial companies and conveyed to outside
vendors. Although it is not possible at this time to assess the impact of the
privacy regulations on financial institutions or the Bank, the Bank does not
believe the privacy regulations will have a material adverse impact on its
operations in the near term. Nevertheless, the implementation of the privacy
regulations have and will continue to require significant effort by the staff
for the Bank and UBS.
9
Consumer Protection Rules - Sale of Insurance Products
In addition, as mandated by Section 305 of the FSA, the 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 and its
subsidiaries.
In very brief summary, the Rules provide that before the sale of insurance
or annuity products can be completed, disclosures must be made that state 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 its
affiliates. In the case of an insurance product, including an annuity, that
involves an investment risk, there is an investment risk involved with the
product, 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 its affiliates or on the consumer's agreement not obtain or prohibit the
consumer from obtaining an insurance product or annuity from an unaffiliated
entity.
The Rules also require formal acknowledgment from 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 Rules will
significantly affect the manner in which the Bank would market insurance
products, if the Bank does so in the future.
Impact of Governmental Policies and Future Legislation
As the enactment of the FSA confirms, from time to time, various proposals
are made in the United States Congress as well as Pennsylvania legislature and
by various bank regulatory authorities which would alter the powers of, and
place restrictions on, different types of bank organizations. Among current
proposals which could be significant to UBS or the Bank are the continued
liberalization of the restrictions on the acquisition of out-of-state banks by
bank holding companies, the expansion of the powers of banks and thrift
institutions, the liberalization of the restrictions upon the activities in
which bank holding companies may engage, the imposition of limitations on
interest rates and service charges, certain consumer legislation and the
requirement to provide certain basic banking services. It is impossible to
predict whether any of the proposals will be adopted and the impact, if any, of
such adoption on the business of UBS or the Bank.
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.
From time to time, various types of federal and state legislation have
been proposed that could result in additional regulation of, and restrictions
on, the business of the Bank. It cannot be predicted whether any such
legislation will be adopted or how such legislation would affect the business of
the Bank.
Regulatory Actions.
In February 2000, as a result of a regulatory examination completed in
December 1999, the Bank entered into a Written Agreement with its primary
regulators with regard to, among other things, achievement of agreed-upon
capital levels, implementation of a viable earnings/strategic plan, adequate
funding of the allowance for loan losses, the completion of a management review
and succession plan, and improvement in internal controls. See, Item 7,
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
Recent Regulatory Developments
By the end of 2001, in the wake of the events of September 11, 2001, the
banking regulators had published for comment or taken under consideration new
regulations concerning money laundering.
10
The federal budget for 2003 indicates a possible need for an increase in
bank deposit insurance coverage and in the premiums charged to banks for such
insurance and draft legislation has been introduced in the Congress with respect
to these matters. In March of 2002 the FDIC announced that an increase in
deposit insurance premiums was likely in the second half of 2002.
It is not now possible to assess the impact on the Bank of any of the
foregoing proposals.
ITEM 2 -- PROPERTIES
Corporate Headquarters
In August 1999, the Bank moved its corporate headquarters from the branch
facility at 714 Market Street to the building at 300 North Third Street,
Philadelphia, Pennsylvania. In October 2000, the Bank purchased the building
from a former officer in conjunction with the settlement of a legal matter for
approximately $1.4 million. Before its purchase, the Bank leased the building
from this officer under a 10-year non-cancelable capital lease. The facility
consists of 25,000 square feet including executive offices, operations, finance,
human resource, security and loss prevention functions. The Bank sublets
approximately 1400 square feet to the law firm of Tucci & Tannenbaum, P.C.;
2,500 square feet to the African American Interdenominational Ministries; and
650 square feet to Roland Jarvis, Esquire.
Market Street Branch
The Bank's Market Street Branch was located on the first floor of a
multi-tenant retail and commercial office building at 714 Market Street,
Philadelphia, Pennsylvania. The Bank occupied approximately 5,700 square feet of
space pursuant to a lease that expired on February 28, 2002. In conjunction the
expiration of the lease, the branch operations of this facility were
consolidated with the branch located at Two Penn Center in January 2002. The
aggregate monthly rent for this location was $14,023.
Mt. Airy Branch
The Bank operates a branch at 1620 Wadsworth Avenue, in the Mt. Airy section
of Philadelphia. This facility, comprising a retail banking lobby, teller area,
offices, vault and storage space is currently leased at a monthly rental of
$3,415.
Center City Branch
The Bank operates a branch location at Two Penn Center, 15th Street and JFK
Boulevard, Philadelphia, Pennsylvania. The Bank leases approximately 4,769
square feet at its Two Penn Center location. The space includes lobby, teller
area, customer service area, primary lending area and administrative offices, as
well as a vault. The aggregate monthly rent for this location is $13,115.
Frankford Branch
In 1995, the Bank purchased a branch facility at 4806 Frankford Avenue. In
September 2000, the Bank closed this facility. It is expected to be sold during
2002.
West Girard Branch
The Bank leases a facility located at 2836 West Girard Avenue. The branch
operations of this facility were discontinued in September 2000. An ATM machine
remained operational at this facility until the February 2002 when it was
relocated to 2820 West Girard. The aggregate monthly rental for the facility is
$500.
11
West Philadelphia Branch
On July 22, 1996, the Bank acquired a branch location at 3750 Lancaster
Avenue from PNC Bank. The facility 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. The aggregate monthly rental is $2,750 exclusive of taxes, insurance,
utilities and janitorial service.
Progress Plaza Branch
The Bank leases a branch facility located at 1015 North Broad Street,
Philadelphia, Pennsylvania. The facility comprises a teller and customer service
area, lobby and vault. The aggregate monthly rental for this facility is $3,656
per month.
ITEM 3 -- LEGAL PROCEEDINGS
None. All of the litigation involving the Bank listed in the Registrant's
10-Q Report for the period ending September 30, 2001 has been settled in a
manner satisfactory to the Bank.
NO OTHER MATERIAL CLAIMS HAVE BEEN INSTITUTED OR THREATENED BY OR AGAINST
REGISTRANT OR ITS AFFILIATES OTHER THAN IN THE ORDINARY COURSE OF BUSINESS.
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable. No matters were submitted to a vote of Registrant's
security holders since the Registrant's last periodic filing.
PART II
ITEM 5 -- MARKET FOR THE REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
Common Stock
As of March 18, 2002 there were 3,163 shareholders of record of UBS's Common
Stock.
The Common Stock is not traded on any national exchange or otherwise traded
in any recognizable market. 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 "Act"). 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.
Beginning April 24, 1995, Registrant commenced a private offering solely to
existing stockholders of 250,000 shares of its common stock and 750,000 warrants
to purchase a share of the common stock. 18,465 shares and 55,395 warrants have
been sold pursuant to this offering. Each unit, consisting of one share of
common stock and three warrants to purchase one share of common stock in each of
three subsequent years (total 3 shares), was issued at $12.00 per unit. The
warrant exercise price was $8.00 per share for the 1996 Warrant, was $9.00 per
share for the 1997 Warrant, and was $10.00 per share for the 1998 Warrant. The
units were offered pursuant to an exemption from registration contained in
section 4(2) and 3(a)(5) of the Act. No underwriters were used and no
commissions were paid as a result of this offering. The offering closed on
December 31, 1995. In December 1995, the Registrant sold 41,666 shares of
Registrant's common stock in an offering exempt from registration pursuant to
section 4(2) of the Act at a purchase price of $12.00 per share. This sale was
accomplished pursuant to a commitment to purchase these securities issued in
December 1994.
Beginning May 10, 1996, Registrant commenced a private offering solely to
existing stockholders of 250,000 shares of its common stock. 6,934 shares were
sold pursuant to this offering. The stock was offered pursuant to an exemption
from registration contained in 4(2) and 3(a)(5) of the Act. During 1996, the
Registrant received, $55,536 and issued 6,942 shares as a result of warrant
exercises by shareholders to purchase common stock at a price of $8.00 per
12
share. Beginning May 19, 1997, Registrant commenced an offering solely to
existing stockholders of 250,000 shares of its common stock, initially on a
pro-rata basis. 3,550 shares were sold pursuant to this offering. The stock was
offered pursuant to an exemption contained in 4(2) and 3(a)(5) of the Act.
During 1997, the Registrant received $34,710 and issued 3,856 shares as a result
of exercise of the 1997 warrants at $9.00 per share. During 1998, the Registrant
received $14,922 as a result of the exercise of the 1998 Warrants at $10.00 per
share and sold 6,492 shares of common stock as a result to its offering solely
to stockholders of record. This offering was exempt pursuant to an exemption
from registration contained in sections 4(2) and 3(a)(5) of the Act. As of March
31, 1999, there were no warrants outstanding to purchase common stock of the
Bank.
In June 2000 and December 2000, respectively, the Bank received $411,809 and
$436,212 and issued 34,317 and 36,351 shares, respectively, as a result of the
purchase of common stock by members of the Bank's board of directors in a
limited offering at a price of $12.00 per share. This offering was exempt from
registration under the Act pursuant to the exemption in section 4(2) of the Act.
In May 2001 and December 2001, respectively, the Bank received $2,000 and
$9,596 and issued 167 and 800 shares, respectively, as a result of the purchase
of common stock by two individuals in a limited offering at a price of $12.00
per share. This offering was exempt from registration under the Act pursuant to
the exemption in section 4(2) of the Act.
Class B Common Stock
On September 30, 1998, the Registrant filed Articles of Amendment to its
Articles of Incorporation with the Secretary of State of the Commonwealth of
Pennsylvania. The filing amended the Articles of Incorporation of the Registrant
to designate a sub-class of its Common Stock as Class B Common Stock. Pursuant
to the terms of the amendment, holders of the Class B Common Stock have all
rights of Common Stockholders, with the exception of voting rights.
Effective October 9, 1998, the Registrant sold 83,333 shares of its Class B
Common Stock to First Union Corporation ("First Union") for a purchase price of
$12 per share. The sale was exempt from registration requirements pursuant to
section 4(2) of the Act.
Effective February 8, 1999, the Registrant sold 83,333 shares of its Class B
Common Stock to First Union for a purchase price of $12 per share. The sale was
exempt from registration requirements pursuant to section 4(2) of the Act.
Effective September 23, 1999, Registrant sold 25,000 shares of its Class B
Common Stock to First Union Corporation at a purchase price of $12 per share.
The sale was exempt from registration pursuant to section 4(2) of the Act.
Effective December, 1999, the Registrant sold 5,000 shares of its Class B
Common Stock to an individual for a purchase price of $12 per share. The sale
was exempt from registration pursuant to section 4(2) of the Act.
Series A Preferred Stock
Registrant has engaged in the sale of Series A Preferred Stock which has the
characteristics identified in the UBS Articles of Incorporation incorporated by
reference as an Exhibit hereto pursuant to an exemption from registration
contained in Section 4(2) of the Act.
Dividends
The bank has not, during the three most recent fiscal periods declared or
paid any cash or stock dividends. The Pennsylvania Banking Code of 1965, as
amended, provides that cash dividends may be declared and paid only from
accumulated net earnings and that, prior to the declaration of any dividend, if
the surplus of a bank is less than the amount of its capital, the bank shall,
until surplus is equal to such amount, transfer to surplus an amount which is at
least ten percent of the net earnings of the bank for the period since the end
of the last fiscal year or any shorter period since the declaration of a
dividend. If the surplus of a bank is less than 50% of the amount of its
capital, no dividend may be declared or paid by the Bank without the prior
approval of the Pennsylvania Department of Banking.
13
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 the Registrant, whose only source
of income is dividends from the Bank, will be unable to pay any dividends while
an accumulated deficit exists. The Registrant does not anticipate that dividends
will be paid for the foreseeable future.
The Federal Deposit Insurance Act generally prohibits all payments of
dividends by a bank, which is in default of any assessment to the FDIC.
Because the Company 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.
ITEM 6 -- SELECTED FINANCIAL DATA
Selected Financial Data
Year ended December 31,
-------------------------------------------------------------------------
(Dollars in thousands, except per share data) 2001 2000 1999 1998 1997
- --------------------------------------------- ---- ---- ---- ---- ----
Net interest income ......................... $ 4,060 $ 5,415 $ 5,264 $ 5,241 $ 4,744
Provision for loan losses ................... 335 565 1,007 351 97
Noninterest income .......................... 2,443 3,197 2,226 1,816 1,517
Noninterest expense ......................... 7,038 8,801 7,714 6,696 5,983
Net income (loss) ........................... (870) (755) (1,230) 10 181
Net income (loss) per share - basic.......... (0.79) (0.72) (1.24) 0.01 0.22
Balance sheet totals:
Total assets ............................. $ 88,668 $ 93,533 $ 137,249 $ 121,983 $ 108,914
Net loans ................................ 42,292 44,743 59,444 57,271 73,694
Investment securities .................... 25,806 35,014 51,433 43,196 18,253
Deposits ................................. 79,423 83,238 124,766 109,063 99,427
Shareholders' equity ..................... 8,558 9,350 9,027 8,904 7,059
Ratios:
Equity to assets ....................... 7.67% 7.74% 8.07% 6.40% 6.61%
Return on assets ....................... (0.95)% (0.63)% (1.03)% 0.01% 0.18%
Return on equity ....................... (9.31)% (8.08)% (12.71)% 0.14% 2.69%
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
Summary
The Company recorded a net loss of approximately $870,000 for 2001 ($0.79 per
share) compared to a net loss of approximately $755,000 ($0.72 per share) for
2000 and net loss of approximately $1,230,000 ($1.24 per share) in 1999. During
2001, the Bank's financial results were negatively impacted by a 27% reduction
in the level of average earning assets, a declining interest rate environment
and a reduction in fees earned on deposits. In addition, 2000 included net gains
on the sales of assets and deposits in excess of $400,000, compared to net gains
of $160,000 in 2001. Thus, there was an improvement in the Bank's core operating
results. Expense reduction continued as a priority during 2001 with a resultant
decline in noninterest expense of 20% or $1.8 million. A more detailed
explanation for each component of earnings is included in the sections below.
14
The allowance for loan losses as a percentage of total loans increased
from 1.24% in 2000 to 1.65% in 2001. This increase is attributable to loan loss
provisions related to one significant commercial loan as well as a reduction in
total loans outstanding.
Table 1--Average Balances, Rates, and Interest Income and Expense Summary
DECEMBER 31,
-----------------------------------------------------------------------------------------
2001 2000 1999
------------------------------ --------------------------- --------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
------------------------------ --------------------------- --------------------------
(Dollars in thousands)
Assets:
Interest-earning assets:
Loans .................................. $45,828 $3,595 7.84% $ 55,262 $ 4,655 8.42% $ 68,526 $5,589 8.16%
Investment securities held-to-maturity . 14,669 987 6.73 28,659 1,875 6.54 21,692 1,226 5.65
Investment securities available-for-sale 11,758 772 6.57 18,044 1,284 7.12 9,275 612 6.60
Federal funds sold ..................... 7,726 282 3.65 5,518 339 6.14 13,753 681 4.95
------- ------ -------- ------- -------- ------
Total interest-earning assets ........ 79,981 5,636 7.05 107,483 8,153 7.59 113,246 8,108 7.16
Noninterest-earning assets:
Cash and due from banks ................ 4,801 5,339 2,835
Premises and equipment, net ............ 3,214 3,671 1,880
Other assets ........................... 4,028 4,494 3,366
Less allowance for loan losses ......... (576) (562) (1,567)
------- -------- --------
Total ................................ $91,448 $120,425 $119,760
======= ======== ========
Liabilities and shareholders' equity:
Interest-bearing liabilities:
Demand deposits ........................ $13,802 178 1.29% $ 19,851 602 3.03% $ 19,892 569 2.86%
Savings deposits ....................... 24,480 317 1.29 30,776 497 1.61 26,744 440 1.65
Time deposits .......................... 24,089 1,081 4.49 28,531 1,387 4.86 35,020 1,695 4.84
Other borrowed funds ................... 1 -- -- 1,925 252 13.09 1,246 140 11.24
------- ------ -------- ------- -------- ------
Total interest-bearing liabilities ... 62,372 1,576 2.53 81,083 2,738 3.38 82,902 2,844 3.43
Noninterest-bearing liabilities:
Demand deposits ........................ 19,612 27,567 24,019
Other .................................. 431 3,233 3,177
Shareholders' equity ..................... 9,033 8,542 9,662
------- -------- --------
Total ................................. $91,448 $120,425 $119,760
======= ======== ========
Net interest earnings .................... $4,060 $5,415 $5,264
Net yield on interest-earning assets ..... 5.08% 5.04% 4.65%
- ----------
For purposes of computing the average balance, loans are not reduced for
nonperforming loans.
Net Interest Income
Net interest income is an effective measure of how well management has
balanced the Bank's interest rate-sensitive assets and liabilities. Net interest
income, the difference between (a) interest and fees on interest-earning assets
and (b) interest paid on interest-bearing liabilities, is a significant
component of the Bank's earnings. Changes in net interest income result
primarily from increases or decreases in the average balances of
interest-earning assets, the availability of particular sources of funds and
changes in prevailing interest rates.
15
Net interest income for 2001 totaled $4.1 million, a decrease of $1.3 million
or 25%, compared to 2000. Net interest income in 2000 totaled $5.4 million, an
increase of $151,000, or 2.86%, compared to 1999.
Table 2--Rate-Volume Analysis of Changes in Net Interest Income
2001 COMPARED TO 2000 2000 COMPARED TO 1999
------------------------------------- -------------------------------------
INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO
------------------------------------- -------------------------------------
(Dollars in thousands) VOLUME RATE NET VOLUME RATE NET
------------------------------------- -------------------------------------
Interest earned on:
Loans .................................. $ (742) $ (317) $(1,059) $ (673) $ (261) $ (934)
Investment securities held-to-maturity . (942) 55 (887) 646 3 649
Investment securities available-for-sale (412) (100) (512) 605 67 672
Federal funds sold ..................... 81 (138) (57) (450) 108 (342)
------- ------- ------- ------- ------- -------
Total interest-earning assets ........ (2,015) (500) (2,515) 128 (83) 45
------- ------- ------- ------- ------- -------
Interest paid on:
Demand deposits ........................ (78) (345) (423) (33) 66 33
Savings deposits ....................... (83) (96) (179) 109 (52) 57
Time deposits .......................... (200) (107) (307) (226) (82) (308)
Other borrowed funds ................... (252) -- (252) 68 44 112
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities ... (613) (548) (1,161) (82) (24) (106)
------- ------- ------- ------- ------- -------
Net interest income .................. $(1,402) $ 48 $(1,354) $ 210 $ (59) $ 151
======= ======= ======= ======= ======= =======
- ----------
Changes in interest income or expense not arising solely as a result of volume
or rate variances are allocated to rate variances due to the interest
sensitivity of consolidated assets and liabilities.
In 2001, there was a decrease in net interest income of $1.4 million due to
changes in volume but an increase of $48,000 due to changes in rate. In 2000,
there was an increase in net interest income of $210,000 due to changes in
volume but a decrease of $59,000 due to changes in rate.
Average earning assets decreased from $107.5 million in 2000 to $80 million
in 2001 and decreased from $113.2 million in 1999 to $107.5 million in 2000. The
1999 growth in earning assets was primarily attributed to the acquisition of
$31.5 million in deposits from First Union Corporation in September 1999. The
acquired deposits primarily consisted of core noninterest checking deposits and
savings deposits. However, to meet capital requirements mandated in its Written
Agreement with regulators (Refer to Regulatory Matters below) the Bank
implemented an asset reduction/capital improvement plan in 2000 that included
the reduction of non-First Union acquired deposits. Beginning in June 2000, the
Bank sold higher yielding certificates of deposit to other financial
institutions, encouraged some large deposit accountholders to remove deposits,
and consolidated three branches in its branch network.
The net interest margin of the Bank was 5.08% in 2001, 5.04% in 2000 and
4.65% in 1999. While the prime rate decreased 400 basis points during 2001, the
Bank did not experience a significant decline in yield on its loan portfolio.
This is because much of the Bank's loan portfolio is fixed rate in nature and
not related to prime. In addition, 82% of the Bank's investment portfolio is
fixed rate. These characteristics of the Bank's earning assets coupled with the
Bank's significant level of core deposits resulted in minimal impact to the
Bank's net interest margin during the declining rate environment.
During 2001, the average federal funds yield was 3.65% compared to 6.15% in
2000 and 4.95% in 1999. During 2001, the average investment in federal funds
increased by $2.2 million. Because of the declining rate environment, the Bank
experienced a high level of payoffs/paydowns in its loan portfolio as well as a
significant level of calls of its higher yielding government agency securities.
The yield on the investment portfolio decreased 10 basis points to 6.66% in
2001 compared to 6.76% in 2000 and 5.94% in 1999. As indicated above, the Bank
experienced a significant level of called agency securities that were
re-invested in a lower interest rate environment--thereby, reducing the yield on
the portfolio.
16
The cost of interest-bearing liabilities declined to 2.53% in 2001 compared
to 3.38% in 2000. Consistent with market conditions, during 2001, the Bank
reduced the rates it pays on many of its interest-bearing products by as much as
200 basis points. Because most of the Bank's deposits are considered core, they
were not sensitive to declining rates.
Provision for Loan Losses
The provision 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 provision for loan losses charged against earnings in 2001 was $335,000
compared to $565,000 in 2000 and $1,007,003 in 1999. Significant provisions were
made for the year ended December 31, 2001 for one significant commercial loan
that the Bank added to its classified loans and provided a specific reserve of
$357,000. During the 2001 economic downturn, the Bank monitored its credit
quality very closely worked with borrowers in an effort to identify and control
credit risk. Management believes the level of the allowance for loan losses is
adequate as of December 31, 2001.
Noninterest Income
Noninterest income decreased $754,000 in 2001 compared to 2000 and increased
$971,000 in 2000 compared to 1999.
The amount of the Bank's noninterest income generally reflects the volume of
the transactional and other accounts handled by the Bank and includes such fees
and charges as low balance account charges, overdrafts, account analysis, and
other customer service fees. Customer service fees decreased $415,000 in 2001
compared to 2000. This decline was primarily due to a reduction in the average
level of non-interest bearing demand deposit accounts from $27.6 million in 2000
to $19.6 million in 2001. A lower level of demand deposit accounts results in
less overdraft fees, activity service charges and low balance fees.
During 2001, the Bank sold one of its closed branch facilities for a gain of
$78,000. In addition, the Bank sold approximately $3.5 million of its
available-for-sale portfolio for a gain of approximately $78,000.
To achieve capital ratios as set forth in its Written Agreement with
regulatory agencies (Refer to Regulatory Matters below), in June 2000 the Bank
sold approximately $6.6 million in certificates of deposit to other financial
institutions to reduce its asset size. These transactions resulted in a gain of
$253,000. During 2000, the Bank sold approximately $20 million of its investment
portfolio to fund the reduction in deposits as well as the asset size. The Bank
recorded a loss of $200,000 on these sales. In October 2000, the Bank sold one
of the branch facilities it acquired from First Union in 1999 for a gain of
approximately $329,000.
Noninterest Expense
Noninterest expense decreased $1.8 million to $7.0 million, or 20% in 2001
compared to an increase of $1.1 million, or 14.1% increase, in 2000 and $8.8
million compared to $7.7 million in 1999.
Salaries and benefits decreased $411,000, or 13.4% in 2001 compared to an
increase of $113,000, or 3.8%, in 2000. This decrease is primarily attributable
to attrition and strategic reductions in staff and job consolidations. The
closure/consolidation of three branches in September 2000 also contributed to
reductions in this expense.
Occupancy and equipment expense decreased approximately $181,000, or 10.1%,
during 2001 compared to an increase of approximately $353,000, or 24.5%, during
2000. The decrease during 2001 was primarily attributable to the conversion of
the lease of the Bank's corporate headquarters to a bank-owned facility.
Beginning in July 1999, the Bank leased 25,000 square feet at an average cost of
$14.14 per foot until September 2000. In accordance with Financial Accounting
Standards Board Statement No. 13, this lease was accounted for as a capital
lease in the amount of $1,483,000 as the present value of future minimum lease
payments exceeds 90% of the fair market value of the building. In October 2000,
the Bank purchased this facility for approximately $1.4 million. This
transaction is expected to save the Bank $1.6 million over the remaining 9-year
term of the lease it had in place and removes the capital lease obligation.
17
In addition, in conjunction with its acquisition of deposits from First Union
in September 1999, the Bank assumed the leases of four branches, two of which
were in close proximity to its existing branches. Due to more favorable
characteristics of these branches (i.e. visibility, drive-through, ATM's, etc.),
the Bank relocated its branch operations to the acquired facilities. The Bank
consolidated two of the acquired branches with its existing branch network and
closed its Frankford branch in September 2000. In October 2000, the Bank sold
one of the acquired facilities located in West Philadelphia for a gain of
approximately $329,000. In June 2001, the Bank sold its former West Girard
branch for a gain of $78,000. The Bank's Frankford branch has been listed with a
realtor and is expected to be sold shortly.
Data processing expenses are a result of the management decision of the Bank
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. In
addition, the Bank uses outside loan servicing companies to service its
mortgage, credit card, installment and student loan portfolios. Data processing
expenses decreased by $163,000, or 16.8%, during 2001 compared to an increase of
$108,000, or 12.5%, during 2000. This decline is primarily attributable to
strategic reductions in deposit levels during 2000 and 2001 to meet mandated
capital levels. The Bank continues to study methods by which it may reduce its
data processing costs, including but not limited to a consolidation of
servicers, in-house processing versus outsourcing, and the renegotiation of
existing contracts with servicers.
Marketing and public relations expense decreased by $49,000, or 31.1% in 2001
compared to a decrease of $146,000, or 47.9%, in 2000. In 2000, management
implemented an earnings enhancement plan that included a reduction of all
nonessential expenses including marketing. As the Bank was in an asset reduction
mode during 2000 and 2001, there were no new business initiatives that required
marketing.
Professional services decreased by $311,000, or 57.2% in 2001. During 2000,
the Bank paid fees to attorneys to handle loan related legal matters as well as
to negotiate the elements of its Written Agreement (Refer to Regulatory Matters
below) with Federal Regulators in February 2000. The Bank did not have
significant legal matters during 2001 nor did it use outside consultants to
handle operational matters.
Office operations and supplies expense decreased by $323,000, or 41.6%, in
2001. This decrease was primarily attributable to the closure/consolidation of
three branches in September 2000 which resulted in a full year of reductions in
branch operating costs (i.e. security guards, supplies, etc.) during 2001.
Federal deposit insurance premiums were $150,000 in 2001 compared to $169,000
in 2000 and $105,000 in 1999. 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. The decrease during 2001, is a result of a reduction in the Bank's
level of deposits.
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.
18
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
indicates how the Bank has managed these elements. Average funding uses
decreased approximately $27.5 million, or 25.6% in 2001 compared to
approximately $5.8 million, or 5.09%, in 2000.
Table 3--Sources and Use of Funds Trends
2001 2000 1999
--------------------------------- ---------------------------------- -------
INCREASE INCREASE
AVERAGE (DECREASE) AVERAGE (DECREASE) AVERAGE
BALANCE AMOUNT PERCENT BALANCE AMOUNT PERCENT BALANCE
------- ------ ------- ------- ------ ------- -------
(Dollars in thousands)
Funding uses:
Loans ............... $45,828 $ (9,434) (17.07)% $ 55,262 $(13,264) (19.36)% $ 68,526
Investment securities
Held-to-maturity .. 14,669 (13,990) (48.82) 28,659 6,967 32.12 21,692
Available-for-sale 11,758 (6,286) (34.84) 18,044 8,769 94.54 9,275
Federal funds sold 7,726 2,208 40.01 5,518 (8,235) (59.88) 13,753
------- -------- -------- -------- --------
Total uses ...... $79,981 $(27,502) $107,483 $ (5,763) $113,246
======= ======== ======== ======== ========
Funding sources:
Demand deposits:
Noninterest-bearing $19,612 $ (7,955) (28.86)% $ 27,567 $ 3,548 14.77% $ 24,019
Interest-bearing .. 13,802 (6,049) (30.47) 19,851 (41) (0.21) 19,892
Savings deposits .... 24,480 (6,296) (20.46) 30,776 4,032 15.08 26,744
Time deposits ....... 24,089 (4,442) (15.57) 28,531 (6,489) (18.53) 35,020
Other borrowed funds 1 (1,924) (99.95) 1,925 679 54.49 1,246
------- -------- -------- -------- --------
Total sources ... $81,984 $(26,666) $108,650 $ 1,729 $106,921
======= ======== ======== ======== ========
- ----------
*Includes held-to-maturity and available-for-sale securities
Investment Securities and Other Short-Term Investments
The Bank's investment portfolio is classified as either held-to-maturity or
available-for-sale. Investments classified as held-to-maturity are carried at
amortized cost and are those securities the Bank has both the intent and ability
to hold to maturity. Investments classified as available-for-sale are those
investments the Bank intends to hold for an indefinite amount of time, but not
necessarily to maturity, and are carried at fair value, with the unrealized
holding gains and losses reported as a component of shareholders' equity on the
balance sheet.
Average investment securities and federal funds sold, in the aggregate,
decreased by $18 million, or 34.6%, in 2001 compared to an increase of $7.5
million, or 16.8%, in 2000. The decrease in the average balances during 2001 is
a result of the Bank's asset reduction/capital improvement plan that required
the sale of investment securities totaling approximately $20 million during the
latter half of 2000.
The Bank's 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, the assumed average maturity of the investment
portfolio was 3.34 years at year-end 2001. Approximately 64% of the portfolio
consists of mortgage-backed pass-through securities that have longer-term
contractual maturities but are sometimes paid off/down before maturity or have
repricing characteristics that occur before final maturity. The Bank has
attempted to minimize the repayment risk (risk of very fast or very slow
repayment) associated with these types of securities by investing primarily in a
number of seasoned mortgage pools for which there is a repayment history. This
history better enables the Bank to project the repayment speeds of these pools.
In addition, the Bank has minimized the interest rate risk associated with these
mortgage-backed securities by investing in a variety of pools, many of which
have variable rates with indices that track closely with the current interest
rate environment.
19
In a declining rate environment, the duration of the investment portfolio is
significantly shortened because of the high level of callable government agency
securities - approximately 34.2% at December 31, 2001. These higher yielding
securities are likely to be called as rates trend downward. During 2001,
approximately $19 million of these securities were called. The result was
additional liquidity and a reduction in yield on the portfolio. The Bank is
taking steps to combat the impact of the high level of optionality in the
portfolio by identifying replacement loans or securities that are fixed rate or
perform well when "shock" tested in a declining rate environments.
Table 4--Analysis of Investment Securities
WITHIN AFTER ONE BUT AFTER FIVE BUT AFTER
ONE YEAR WITHIN FIVE YEARS WITHIN TEN YEARS TEN YEARS
------------------ ------------------ ----------------- ----------------
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD TOTAL
------ ----- ------ ----- ------ ----- ------ ----- -----
(Dollars in thousands)
Other government securities $ -- -- % $ 2,604 6.00% $ 6,229 6.14% $ -- -- % $ 8,833
Mutual funds .............. 105 2.07 -- -- -- -- -- -- 105
Other investments ......... -- -- -- -- 287 6.00 -- -- 287
Mortgage-backed securities -- -- -- -- -- -- 16,581
------- ------- ------- ------ -------
Total securities .......... $ 105 $ 2,604 $ 6,516 $ -- $25,806
======= ======= ======= ====== =======
Average maturity..... 3.34 years
The above table sets forth the maturities of investment securities at December
31, 2001 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 decreased approximately $9.4 million, or 17.1%, in 2001
compared to a decrease of $13.3 million, or 19.4%, in 2000. Although the Bank
purchased a $22 million portfolio of seasoned automobile loans from NationsBank
in February 1999, over 90% of this portfolio had paid down by year-end of 2001.
The average life of this portfolio at the time of purchase was three years. The
Bank's mortgage loan portfolio continues to decline because of refinancings and
payoffs/paydowns for which there were no new originations to replace. During
2001, the Bank purchased $8.7 million in commercial loans from other financial
institutions in the region in effort to cover reductions in the portfolio while
it increased its capacity to originate loans. Management believes it is now
positioned to expand its business development efforts in the Philadelphia region
and has developed strategic plans to incorporate these initiatives.
Table 5--Loans Outstanding, Net of Unearned Income
DECEMBER 31,
---------------------------------------------------
(Dollars in thousands) 2001 2000 1999 1998 1997
------- ------- ------- ------- -------
Commercial and industrial $11,054 $11,429 $13,664 $13,643 $12,095
Commercial real estate .. 5,504 652 1,288 1,518 1,515
Residential mortgages ... 18,148 22,316 26,237 31,365 35,962
Consumer loans .......... 8,294 10,908 19,822 11,424 22,611
Loans held-for-sale ..... -- -- -- -- 1,979
------- ------- ------- ------- -------
Total loans .......... $43,000 $45,305 $61,011 $57,950 $74,162
======= ======= ======= ======= =======
20
Table 6--Loan Maturities and Interest Sensitivity
WITHIN AFTER ONE BUT AFTER
ONE YEAR WITHIN FIVE YEARS FIVE YEARS TOTAL
-------- ----------------- ---------- -----
(Dollars in thousands)
Commercial and industrial ......... $ 6,267 $ 904 $ 3,883 $11,054
Commercial real estate ............ -- 4,984 520 5,504
Residential mortgages ............. -- -- 18,148 18,148
Consumer loans .................... 613 5,928 1,753 8,294
------- ------- ------- -------
Total loans ................... $ 6,880 $11,816 $24,304 $43,000
======= ======= ======= =======
Loans maturing after one year with:
Fixed interest rates ........... $28,261
Variable interest rates ........ 7,859
Nonperforming Loans
Table 7 reflects the Bank's nonperforming 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.
The Bank had a One Million Dollar ($1,000,000) unsecured loan participation
in a $40.4 Million ($40,400,000) line of credit to KMART Corporation. The Bank
was repaid the One Million Dollar ($1,000,000) loan participation in full on
January 8, 2002. KMART Corporation filed for protection under Chapter 11 of the
federal bankruptcy laws on January 22, 2002 and such a filing by KMART
Corporation could expose the Bank to a future claim that the repayment to the
Bank of its loan participation was a preference payment. If the preference claim
is made and is successful, the Bank may be required to return the One Million
Dollar ($1,000,000) loan repayment and incur a loss in that amount to the extent
that the Bank can not obtain repayment of the loan participation from KMART
Corporation or as an unsecured creditor in the bankruptcy proceeding. As of
March 28, 2002, the Bank has not received any notification in regard to this
matter.
Table 7--Nonperforming Loans
(Dollars in thousands) 2001 2000 1999 1998 1997
- ---------------------- ---- ---- ---- ---- ----
Nonaccrual loans ........................ $ 412 $ 453 $2,027 $1,720 $1,179
Interest income included in net income
for the year ......................... 25 20 67 37 14
Interest income that would have been
recorded under original terms ........ 29 28 113 189 112
Loans past due 90 days and still accruing 526 34 53 125 306
There is no known information about possible credit problems other than those
classified as nonaccrual 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, 2001, approximately 22.8% 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, 2001, none of these loans were
nonperforming.
During 2001, nonaccrual loans totaled $412,000, compared to $453,000 at
December 31, 2000. At December 31, 2001, approximately $238,000 of the total
nonaccrual loans was residential mortgages. The underlying real estate
collateral associated with these loans minimizes the risk of loss. During 2001,
the Bank increased its collection efforts by designating a unit of the Bank
given specific responsibilities related to collections.
21
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 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.
Table 8--Allocation of Allowance for Loan Losses
2001 2000 1999 1998 1997
-------------------- -------------------- ------------------- ------------------- -------------------
PERCENT PERCENT PERCENT PERCENT PERCENT
OF LOANS OF LOANS OF LOANS OF LOANS OF LOANS
IN EACH IN EACH IN EACH IN EACH IN EACH
CATEGORY TO CATEGORY TO CATEGORY TO CATEGORY TO CATEGORY TO
AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS AMOUNT TOTAL LOANS
------ ----------- ------ ----------- ------ ----------- ------ ----------- ------ -----------
(Dollars in thousands)
Commercial and
industrial ........ $576 37.30% $383 25.23% $ 263 22.40% $272 23.55% $144 16.31%
Commercial real
estate ............ 29 1.21 11 1.44 877 2.11 132 2.62 13 2.04
Residential mortgages 30 19.29 102 24.08 144 43.00 55 54.12 180 48.49
Consumer loans ...... 73 42.20 66 49.25 283 32.49 188 19.71 97 33.16
Unallocated ......... -- -- -- -- -- -- 32 -- 34 --
---- ------ ---- ------ ------ ------ ---- ------ ---- ------
$708 100.00% $562 100.00% $1,567 100.00% $679 100.00% $468 100.00%
==== ====== ==== ====== ====== ====== ==== ====== ==== ======
Management believes that the allowance for loan losses is adequate. While
management uses available information to recognize losses on loans, future
additions may be necessary based on changes in economic conditions. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to recognize additions to the allowance based on their
judgments of information available to them at the time of the examination.
Table 9--Analysis of Allowance for Loan Losses
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
(Dollars in thousands)
Balance at January 1 .................... $ 562 $ 1,567 $ 679 $ 468 $ 528
Charge-offs:
Commercial and industrial ............ (61) (321) (25) -- (66)
Commercial real estate ............... -- (803) -- -- --
Residential mortgages ................ -- -- (47) -- (9)
Consumer loans ....................... (261) (597) (315) (180) (160)
------- ------- ------- ------- -------
Total charge-offs .................. (322) (1,721) (387) (180) (235)
------- ------- ------- ------- -------
Recoveries--consumer loans .............. 133 151 268 41 78
------- ------- ------- ------- -------
Net charge-offs ......................... (189) (1,570) (119) (139) (157)
Provisions charged to operations ........ 335 565 1,007 350 97
------- ------- ------- ------- -------
Balance at December 31 .................. $ 708 $ 562 $ 1,567 $ 679 $ 468
======= ======= ======= ======= =======
Ratio of net charge-offs to average loans
outstanding .......................... 0.41% 2.84% 0.17% 0.19% 0.23%
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.
22
Deposits
Average deposits declined approximately $24.7 million, or 23.2%, in 2001
compared to growth of $1.05 million, or 1.0%, in 2000. To meet capital
requirements mandated in its Written Agreement with regulators (Refer to
Regulatory Matters below) the Bank implemented an asset reduction/capital
improvement plan in 2000 that included the reduction of non-First Union acquired
deposits. Beginning in June 2000, the Bank sold higher yielding certificates of
deposit to other financial institutions and encouraged some large deposit
accountholders to remove deposits to fund its asset reduction plan. In addition,
the Bank's September 2000 branch consolidation resulted in some deposit
attrition.
Table 10--Average Deposits by Class and Rate
2001 2000 1999
---------------------- ---------------------- --------------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
------ ---- ------ ---- ------ ----
(Dollars in thousands)
Noninterest-bearing demand deposits $ 19,612 -- % $ 27,567 -- % $ 24,019 -- %
Interest-bearing demand deposits .. 13,802 1.29 19,851 3.03 19,892 2.86
Savings deposits .................. 24,480 1.30 30,776 1.61 26,744 1.65
Time deposits ..................... 24,089 4.49 28,531 4.86 35,020 4.84
-------- -------- --------
$ 81,993 $106,725 $105,675
======== ======== ========
Other Borrowed Funds
The average balance for other borrowed funds declined $1.9 million, or 99.9%,
in 2001 compared to an increase of $679,000, or 54.5%, in 2000. During 2000,
borrowings were necessary to temporarily fund the Bank's asset reduction/capital
improvement plan until other assets were sold. 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. During 2001, the Bank's liquidity was enhanced by loan paydowns/payoffs
and called investment securities--thereby, reducing the need to borrow.
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, 2001, management believes
the Bank's liquidity is satisfactory and in compliance with FRB regulations.
The Bank's principal sources of asset liquidity include investment securities
consisting primarily of U.S. Government and agency issues, particularly those of
shorter maturities, and mortgage-backed securities with monthly repayments of
principal and interest. There are no securities maturing in one year or less.
However, other types of assets such as federal funds sold, as well as maturing
loans, are sources of liquidity. Approximately $6.9 million in loans are
scheduled to mature within one year.
23
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...................... $ 7,435
Over 3 through 6 months............... 4,407
Over 6 months through 1 year.......... 1,154
Over 1 through five years............. 800
Over five years....................... --
-------
Total................................. $13,796
=======
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 12 sets
forth the earliest repricing distribution of the Bank's interest-earning assets
and interest-bearing liabilities at December 31, 2001, 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, 2001, a slight
asset sensitive position is maintained on a cumulative basis through one year of
1.22%. This level is within the Bank's policy guidelines of +/-15% on a
cumulative one-year basis. The current gap position is relatively evenly matched
as a result of the number of loans either repricing or maturing in 12 months
closely matching certificate of deposit maturities. Interest rate risk is
minimized by the Bank's high level of core deposits that have been placed in
longer 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
increases 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.
24
Table 12--Interest Sensitivity Analysis
INTEREST RATE SENSITIVITY GAPS
AS OF DECEMBER 31, 2001
----------------------------------------------------------------------------------
OVER
OVER 1 YEAR OVER
3 MONTHS 3 THROUGH THROUGH 3 THROUGH OVER
OR LESS 12 MONTHS 3 YEARS 5 YEARS 5 YEARS CUMULATIVE
------- --------- ------- ------- ------- ----------
(Dollars in thousands)
Interest-sensitive assets:
Interest-bearing deposits with banks $ 257 $ -- $ -- $ -- $ -- $ 257
Investment securities .............. 9,265 1,295 897 2,257 11,700 25,414
Federal funds sold ................. 7,778 -- -- -- -- 7,778
Loans .............................. 13,418 5,024 6,546 3,753 14,259 43,000
------- ------ ------ ------ ------ -------
Total interest-sensitive assets ... 30,718 6,319 7,443 6,010 25,959 $76,449
------- ------ ------ ------ ------ =======
Cumulative totals ................. 30,718 37,037 44,480 50,490 76,449
------- ------ ------ ------ ------
INTEREST RATE SENSITIVITY GAPS
AS OF DECEMBER 31, 2001
----------------------------------------------------------------------------------
OVER
OVER 1 YEAR OVER
3 MONTHS 3 THROUGH THROUGH 3 THROUGH OVER
OR LESS 12 MONTHS 3 YEARS 5 YEARS 5 YEARS CUMULATIVE
------- --------- ------- ------- ------- ----------
(Dollars in thousands)
Interest-sensitive liabilities:
Interest checking accounts ..... 3,068 -- 3,749 -- -- $ 6,817
Savings accounts ............... 11,029 -- 17,995 -- -- 29,024
Certificates less than $100,000 3,560 5,934 1,343 494 -- 11,331
Certificates of $100,000 or more 7,435 5,561 800 -- -- 13,796
Other borrowed funds ........... -- -- -- -- --
-------- -------- -------- -------- -------- --------
Total interest-
sensitive liabilities ........ $ 25,092 $ 11,495 $ 23,887 $ 494 $ -- $ 60,968
======== ======== ======== ========= ======== ========
Cumulative totals ............. $ 25,092 $ 36,587 $ 60,474 $ 60,968 $ 60,968
======== ======== ======== ========= ========
Interest sensitivity gap .......... $ 5,626 $ (5,176) $(16,494) $ 5,516 $ 25,959
======== ======== ======== ========= ========
Cumulative gap .................... 5,626 450 (15,994) 44,974 15,481
Cumulative gap/
total earning assets ............ 18.31% 1.22% (35.96)% 89.08% 20.25%
Interest-sensitive assets to
interest-sensitive
liabilities .................... 1.22 .55 .31 12.17 --
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, 2001 are as follows:
25
NET INTEREST PERCENT OF
CHANGES IN RATE INCOME CHANGE
--------------- ------ ------
(Dollars in thousands)
+200 basis points $ -- -- %
+100 basis points -- --
Flat rate 3,500 --
-100 basis points (38) 1.08
-200 basis points (87) 2.47
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, 2001 are as follows:
PERCENT OF
CHANGES IN RATE MV EQUITY CHANGE
--------------- --------- ------
(Dollars in thousands)
+200 basis points $ 3,976 (34.06)%
+100 basis points 6,030 (25.60)
Flat rate 8,112 --
-100 basis points 10,241 26.24
-200 basis points 12,152 18.66
The assumptions used in evaluating the vulnerability of the Bank's earnings
and equity to changes in interest rates are based on management's consideration
of past experience, current position and anticipated future economic conditions.
The interest sensitivity of the Bank's assets and liabilities, as well as the
estimated effect of changes in interest rates on the earnings and equity, could
vary substantially if different assumptions are used or actual experience
differs from the assumptions on which the calculations were based.
The Bank's Board of Directors and management consider all of the relevant
factors and conditions in the asset/liability planning process. Interest rate
exposure is not significant and is within the policy limits of the Bank at
December 31, 2001. 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 declined $792,000 in 2001 compared to an increase
of approximately $322,000 in 2000. The decrease in 2001 is a result of the net
loss of $870,000 which resulted in an increase in the accumulated deficit offset
by an increase in other comprehensive income (fair market value of