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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
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)f of the Act: NONE
Securities registered pursuant to Section 12(g)f of the Act:
Common Stock, $.01 par value
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the Registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [ X ] No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K (ss.229.405 of this chapter) is not contained herein, and will
not be contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ X ]
Indicate by check mark whether registrant is an accelerated filer (as defined in
Rule 12b-2 of the Act). Yes ___ No [ X ]
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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 17, 2003 the aggregate number of the shares of the Registrant's
Common Stock outstanding was 1,102,088 (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.
There are 210 pages in the Form 10-K.
FORM 10-K
United Bancshares, Inc.
Index
Item No. Page
PART I
1. Business............................................................ 3
2. Properties..........................................................10
3. Legal Proceedings...................................................11
4. Submission of Matters to a Vote of Security Holders.................11
PART II
5. Market for Registrant's Common Equity and
Related Stockholder Matters.......................................12
6. Selected Financial Data.............................................13
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................13
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......32
13. Certain Relationships and Related Transactions......................33
14. Controls and Procedures.............................................33
PART IV
15. Exhibits, Financial Statements Schedules and Reports on Form 8-K....34
UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF MARCH 17, 2003.
2
PART I
SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENT
Certain of the matters discussed in this document and the documents
incorporated by reference herein, including matters discussed under the caption
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" may constitute forward looking statements for the purposes of the
Securities Act of 1933, as amended and the Securities Exchange Act of 1934, as
amended, and may involve known and unknown risks, uncertainties and other
factors which may cause the actual results, performance or achievements of
United Bancshares, Inc ("UBS") to be materially different from future results,
performance or achievements expressed or implied by such forward looking
statements. The words "expect," "anticipate," "intended," "plan," "believe,"
"seek," "estimate," and similar expressions are intended to identify such
forward-looking statements. UBS' actual results may differ materially from the
results anticipated by the forward-looking statements due to a variety of
factors, including without limitation: (a) the effects of future economic
conditions on UBS and its customers including economic factors which affect
consumer confidence in the securities markets, wealth creation, investment and
consumer saving patterns; (b) UBS interest rate risk exposure and credit risk;
(c) changes in the securities markets with respect to the market values of
financial assets and the stability of particular securities markets; (d)
governmental monetary and fiscal policies, as well as legislation and regulatory
changes; (e) changes in interest rates on the level and composition of deposits,
loan demand, and the values of loan collateral and securities, as well as
interest-rate risks; (f) changes in accounting requirements or interpretations;
(g) the effects of competition from other commercial banks, thrifts, mortgage
companies, consumer finance companies, credit unions securities brokerage firms,
insurance company's, money-market and mutual funds and other financial
institutions operating in the UBS' trade market area and elsewhere including
institutions operating locally, regionally, nationally and internationally,
together with such competitors offering banking products and services by mail,
telephone, computer and the internet; (h) any extraordinary events (such as the
September 11, 2001 events and the U.S. Government's response to those events or
the U.S. Government becoming involved in a conflict in a foreign country; (i)
the failure of assumptions underlying the establishment of reserves for loan
losses and estimates in the value of collateral, and various financial assets
and liabilities and technological changes being more difficult or expensive than
anticipated; (j) UBS' success in generating new business in its existing
markets, as well as its success in identifying and penetrating targeted markets
and generating a profit in those markets in a reasonable time; (k) UBS' timely
development of competitive new products and services in a changing environment
and the acceptance of such products and services by customers; and (l) UBS'
success in managing the risks involved in the foregoing.
All written or oral forward-looking statements attributed to UBS are
expressly qualified in their entirety by use of the foregoing cautionary
statements. All forward-looking statements included in this Report are based
upon information presently available, and UBS assumes no obligation to update
any forward-looking statement.
ITEM 1 -- BUSINESS
United Bancshares, Inc.
United Bancshares, Inc. ("Registrant" or "UBS") is a holding company for
United Bank of Philadelphia (the "Bank"). UBS was incorporated under the laws of
the Commonwealth of Pennsylvania on April 8, 1993. The Registrant became the
Bank Holding Company of the Bank, pursuant to the Bank Holding Company Act of
1956, as amended, on October 14, 1994.
The Bank commenced operations on March 23, 1992. UBS provides banking
services through the Bank. The principal executive offices of UBS and the Bank
are located at 300 North Third Street, Philadelphia, Pennsylvania 19106. The
Registrant's telephone number is (215) 351-4600.
As of March 17, 2003, UBS and the Bank had a total of 51 employees.
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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, 2002,
the Bank had total deposits aggregating approximately $76.9 million and had
total net loans outstanding of approximately $43.5 million. Although the Bank's
primary service area for Community Reinvestment Act purposes is Philadelphia
County, it also services, generally, the Delaware Valley, which consists of
portions of Montgomery, Bucks, Chester, and Delaware Counties in Pennsylvania;
New Castle County in Delaware; and Camden, Burlington, and Gloucester Counties
in New Jersey.
The city of Philadelphia is comprised of 353 census tracts and, based on
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 17, 2003, the Bank's
maximum legal lending limit was approximately $1,007,000 per borrower. However,
the Bank's internal Loan Policy limits the Bank's lending to $500,000 per
borrower in order to diversify the loan portfolio. The Board of Directors of the
Bank maintains the ability to waive its internal lending limit upon
consideration of a loan. The Board of Directors has exercised this power with
respect to loans and participations on a number of occasions.
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. Other services the Bank offers include safe deposit boxes,
travelers' checks, money orders, direct deposit of payroll and Social Security
checks, wire transfers and access to regional and national automated teller
networks 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.
United Wealth Management Services ("UWMS"), a division of the Bank, was
introduced in September 2002, to provide a full array of non-deposit products
including investments, insurance and brokerage services through the Bank's
branch network. The Bank's partner in this venture is UVEST Investment Services.
UVEST is a registered broker/dealer that has been offering a wide range of
investment products and services since 1982. The Bank intends to use UWMS as a
vehicle to introduce and market all of its products and services including loans
and deposits.
Supervision and Regulation
Regulation of United Bancshares, Inc.
UBS, as a Pennsylvania business corporation, is subject to the jurisdiction
of the Securities and Exchange Commission (the "SEC") and certain state
securities commissions concerning matters relating to the offering and sale of
its securities. Accordingly, if UBS wishes to issue additional shares of its
Common Stock, for example, to raise capital or to grant stock options, UBS must
comply with the registration requirements of the Securities Act of 1933, as
amended, and any applicable states securities laws, or find an applicable
exemptions from registration.
The Bank Holding Company Act
UBS, as a bank holding company, is subject to the Bank Holding Company Act
of 1956, as amended (the "BHC Act"), and supervision by the Federal Reserve
Board. The BCH Act limits the business of bank holding companies to banking,
managing or controlling banks, performing certain servicing activities for
subsidiaries and engaging in such other activities as the Federal Reserve Board
may determine to be closely related to banking.
5
UBS is subject to the supervision of and inspection by the Federal Reserve Board
and required to file with the Board an annual report and such additional
information as the Board may require pursuant to the BHC Act and its
implementing regulations.
A bank holding company is prohibited from engaging in or acquiring direct
or indirect control of more than 5% of the voting shares of any company engaged
in non-banking activities, unless the Federal Reserve Board, by order or
regulation, has found such activities to be so closely related to banking or
managing or controlling banks, as to be a proper incident thereto. In making
this determination, the Board considers whether the performance of these
activities by a bank holding company would offer benefits to the public that
outweigh possible adverse effects.
The BHC Act requires UBS to secure the prior approval of the Federal
Reserve Board before it owns or controls, directly or indirectly, more than 5%
of the voting shares of any corporation, including another bank. In addition,
the BHC Act prohibits UBS from acquiring more than 5% of the voting shares of,
or an interest in, or all or substantially all of the assets of, any bank
located outside Pennsylvania, unless such an acquisition is specifically
authorized by the laws of the state in which such bank is located.
Subject to compliance with Pennsylvania law, and, as noted above,
compliance with the BHC Act UBS is permitted to control a number of banks.
However, UBS is required under the BHC Act to obtain the prior approval of the
Federal Reserve Board before acquiring all or substantially all of the assets of
any bank, or acquiring ownership or control of any voting shares of any other
bank if, after such acquisition, UBS would control more than 5% of the voting
shares of such bank.
The BHC Act and the Federal Reserve Board's regulations prohibit a bank
holding company and its subsidiaries from engaging in certain tying arrangements
in connection with any extension of credit or services. The "anti-tying"
provisions prohibit a bank from extending credit, leasing, selling property or
furnishing any service to a customer on the condition that the customer obtain
additional credit or service from the bank, its bank holding company or any
other subsidiary of its bank holding company, or on the condition that the
customer not obtain other credit or services from a competitor of the bank, its
bank holding company or any subsidiary of its bank holding company.
The Bank, as a subsidiary of UBS, is subject to certain restrictions
imposed by the Federal Reserve Act, as amended, on any extensions of credit to
UBS or its subsidiaries, on investments in the stock or other securities UBS or
its subsidiaries, and on taking such stock or securities as collateral for
loans.
The Federal Reserve Act and Federal Reserve Board regulations also place
certain limitations and reporting requirements on extensions of credit by a bank
to principal shareholders of its parent holding company, among others, and to
related interests of such principal shareholders. In addition, that Act and
those regulations may affect the terms upon which any person who becomes a
principal shareholder of a holding company may obtain credit from banks with
which the subsidiary bank maintains a correspondent relationship.
Federal law also prohibits the acquisition of control by UBS of a bank
holding company, without prior notice to certain federal bank regulators.
Control is defined for this purpose as the power, directly or indirectly, to
direct the management or policies of the bank or bank holding company or to vote
25% or more of any class of voting securities of the bank holding company.
The Financial Services Act
The Financial Services Act (the "FSA Act"), sometimes referred to as the
Gramm-Leach-Bliley Act, repealed the provisions of the Glass-Steagall Act, which
prohibited commercial banks and securities firms from affiliating with each
other and engaging in each other's businesses. Thus, many of the barriers
prohibiting affiliations between commercial banks and securities firms have been
eliminated.
The FSA Act authorizes the establishment of "financial holding companies"
("FHC") to engagement in new financial activities offering and banking,
insurance, securities and other financial products to consumers. Bank holding
companies may elect to become a FHC, if all of its subsidiary depository
institutions are well capitalized and well managed. See Regulatory Action below.
If those requirements are met, a bank holding company may file a certification
6
to that effect with the Federal Reserve Board and declare that it elects to
become a FHC. After the certification and declaration are filed, the FHC may
engage either de novo or through an acquisition in any activity that has been
determined by the Federal Reserve Board to be financial in nature or incidental
to such financial activity.
Under the FSA Act the Bank, subject to various requirements, is permitted
to engage through "financial subsidiaries" in certain financial activities
permissible for affiliates of an FHC. However, to be able to engage in such
activities the Bank must be well capitalized and well managed and receive at
least a "satisfactory" rating in its most recent Community Reinvestment Act (the
"CRA Act") examination. See the Community Reinvestment Act below.
UBS cannot be certain of the future effect of the legislation and
regulations, described above, on its business, although there may be
consolidation among financial service institutions and increased competition for
UBS as well as an increase in the expense of regulatory compliance.
Regulation of the Bank
The Bank is subject to supervision, regulation and examination by the
Pennsylvania Department of Banking and the Federal Reserve Board because the
Bank is a member bank of the Federal Reserve System. The FDIC insures the Bank's
deposits and thus the Bank is subject to certain FDIC regulations. In addition,
the Bank is subject to a variety of local, state and federal laws that affect
its operation. Below are summarized those laws and regulations which a have
material impact on the operations and expenses of the Bank and thus UBS.
Branch Banking
The Pennsylvania Banking Code of 1965, as amended, the ("Banking Code"),
has been amended to harmonize Pennsylvania law with federal law to enable
Pennsylvania banking institutions, such as the Bank, to participate fully in
interstate banking and to remove obstacles to out of state banks engaging in
banking in Pennsylvania.
Federal Reserve Membership Regulations
Since the Bank is a member bank of the Federal Reserve System, the Federal
Reserve Board possesses the power to prohibit institutions regulated by it, such
as the Bank, from engaging in any activity that would be an unsafe and unsound
banking practice or violate the law. Moreover, the Board has: (i) empowered the
FDIC to issue cease-and-desist or civil money penalty orders against the Bank or
its executive officers, directors and/or principal shareholders based on
violations of law or unsafe and unsound banking practices; (ii) authorized the
FDIC to remove executive officers who have participated in such violations or
unsound practices; (iii) restricted lending by the Bank to its executive
officers, directors, principal shareholders or related interests thereof; (iv)
restricted management personnel of the Bank from serving as directors or in
other management positions with certain depository institutions whose assets
exceed a specified amount or which have an office within a specified geographic
area. Additionally, the Bank Control Act provides that no person may acquire
control of the Bank unless the Federal Reserve Board has been given 60-days
prior written notice and within that time has not disapproved of the acquisition
or extended the period for disapproval.
The Federal Deposit Insurance Corporation Act
The Federal Deposit Insurance Corporation Act (the "FDIC Act") includes
several provisions that have a direct material impact on the Bank. The most
significant of these provisions are discussed below.
To minimize losses to the deposit insurance funds, the FDIC Act has
established a format to monitor FDIC-insured institutions and to enable prompt
corrective action to be taken by the appropriate federal supervisory agency if
an institution begins to experience difficulty. The FDIC Act establishes five
"capital" categories. They are: (1) well capitalized, (2) adequately
capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5)
critically undercapitalized. The overall goal of these new capital measures is
to impose more scrutiny and operational restrictions on banks as they descend
the capital categories from well capitalized to critically undercapitalized.
Under current regulations, a "well-capitalized" institution would be one
that has at least a 10% total risk-based capital ratio, a 6% Tier I risk-based
capital ratio, a 5% Tier I leverage ratio, and is not subject to any written
order or final directive by its regulatory agency to meet and maintain a
specific capital level.
7
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 dated February 26, 2003, from the
Federal Reserve authorities categorized the Bank as "adequately capitalized"
under the regulatory framework for prompt and corrective action. See Regulatory
Action below.
An "undercapitalized" institution is one that fails to meet one or more of
the required minimum capital levels for an "adequately capitalized" institution.
Under the FDIC Act, an "undercapitalized" institution must file a capital
restoration plan and is automatically subject to restrictions on dividends,
management fees and asset growth. In addition, the institution is prohibited
from making acquisitions, opening new branches or engaging in new lines of
business without the prior approval of its primary federal regulator. A number
of other restrictions may be imposed.
The Community Reinvestment Act
The Bank is required, by the CRA Act and the implementing regulations, to:
(i) meet the credit needs of the community, including the low and
moderate-income neighborhoods, which it serves. The Bank's CRA Act record is
taken into account by the regulatory authorities in their evaluation of any
application made by the Bank for, among other things, approval of a branch or
other deposit facility, branch office relocation, a merger or an acquisition.
The CRA Act also requires the federal banking agencies to make public disclosure
of their evaluation of a bank's record of meeting the credit needs of its entire
community, including low and moderate-income neighborhoods. After its most
recent CRA Act examination the Bank was given an "outstanding" CRA Act rating."
The Bank Secrecy Act
Under the Bank Secrecy Act ("BSA"), the Bank and other financial
institutions are required to report to the Internal Revenue Service currency
transactions, of more than $10,000 or multiple transactions of which the Bank
has knowledge exceed $10,000 in the aggregate. Civil and criminal penalties are
provided under the BSA for failure to file a required report, for failure to
supply information required by the BSA or for filing a false or fraudulent
report.
Privacy of Consumer Financial Information
The FSA Act also contains provisions designed to protect the privacy of
each consumer's financial information held in a financial institution. The
regulations (the "Regulations") issued pursuant to the FSA Act are designed to
prevent financial institutions, such as the Bank, from disclosing a consumer's
nonpublic personal information to third parties. However, financial institutions
can share a consumer customer's personal information or information about
business with affiliated companies.
The FSA Act Regulations permit financial institutions to disclose nonpublic
personal information to nonaffiliated third parties for marketing purposes but
financial institutions must provide a description of their privacy policies to
the consumers and give consumers an opportunity to opt-out of such disclosure
and prevent disclosure by the financial institution of the consumer's nonpublic
personal information to nonaffiliated third parties. These privacy Regulations
will affect how consumer information is transmitted through diversified
financial companies and conveyed to outside vendors.
Consumer Protection Rules - Sale of Insurance Products
In addition, as mandated by FSA Act, the bank regulators have published
consumer protection rules (the "Rules") which apply to the retail sales
practices, solicitation, advertising or offers of insurance products, including
annuities, by depository institutions such as the Bank.
8
The Rules provide that before the sale of insurance or annuity products can
be completed, disclosures must be made that such insurance products are not
deposits or other obligations of or guaranteed by the FDIC or any other agency
of the United States, the Bank or any affiliate and that insurance products,
including an annuities, may involve an investment risk, including a possible
loss of value.
The Rules also provide that the Bank may not condition an extension of
credit on the consumer's purchase of an insurance product or annuity from the
Bank or any affiliate or on the consumer's agreement not obtain or prohibit the
consumer from obtaining an insurance product or annuity from an unaffiliated
entity.
Finally the Rules also require formal acknowledgment by the consumer that
such disclosures have been received. In addition, to the extent practical, the
Bank must keep insurance and annuity sales activities physically separate from
the areas where retail sales are routinely accepted from the general public. The
Bank currently does not market insurance products.
New Legislation and Regulations
The Patriot Act of 2001
The Patriot Act of 2001 which was enacted in the wake of the September 11,
2001 attacks, include provisions designed to combat international money
laundering and advance the U.S. government's war against terrorism. The Patriot
Act, and the regulations, which implement it, contains many obligations, which
must be satisfied by financial institutions, including the Bank, which involve
additional expenses for the Bank.
The Sarbanes-Oxley Act of 2002
On July 30, 2002 the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act")
became law. The stated goals of the Sarbanes-Oxley Act are to increase corporate
responsibility, provide enhanced penalties for accounting and auditing
improprieties by publicly traded companies and protect investors by improving
the accuracy and reliability of corporate disclosures made pursuant to the
securities law. The changes required by Sarbanes-Oxley Act and its implementing
regulations are intended to allow shareholders to monitor the performance of
companies and their directors more easily and effectively.
The Sarbanes-Oxley Act generally applies to all domestic companies, such as
UBS, that file periodic reports with the SEC under the Securities Exchange Act
of 1934, as amended. The Sarbanes-Oxley Act includes very significant disclosure
requirements and new corporate governance rules, requires the SEC, the
securities exchanges and the NASDAQ stock market to adapt extensive additional
disclosures, corporate governance provisions and other related rules, as well as
mandating that studies of certain significant issues be made by the SEC and the
US Comptroller General. Given the extensive number of Sarbanes-Oxley Act rules
and regulations to be finalized and implemented, the final scope and impact of
its requirements on UBS and the financial services industry have yet to be
determined.
The Sarbanes-Oxley Act addresses, among other matters, directors' audit
committees; certification of financial statements by the chief executive officer
and chief financial officer; forfeiture of bonuses and profits made by directors
and senior officers in the twelve month period covered by restated financial
statements; a prohibition on insider trading during pension blackout periods;
disclosure of off-balance sheet transactions; a prohibition by companies, other
than federally insured financial institutions, on personal loans to their
directors and officers; expedited filing of reports concerning stock
transactions by directors and executive officers; formation of a public
accounting oversight board; auditor independence; and increased criminal
penalties for violation of certain the securities laws.
To implement the requirements of Sarbanes-Oxley Act and regulations, UBS'
management has instituted a series of actions to strengthen and improve UBS',
corporate governance practices. Included in those actions was the development of
a system designed to evaluate and monitor the continued effectiveness of the
design and operation of UBS' internal controls and procedures for financial
reporting.
9
These series of actions by UBS' management improves UBS' and the Bank's
Audit Committees and Risk Management Committees of the Boards, and UBS' and
Bank's structures and processes which are intended to provide tools to
strengthen internal controls, communications and disclosure of necessary
information to those who must know and use it. UBS' system of internal controls
and procedures, which are in place, are designed to capture information from all
segments of its business. At UBS and the Bank, each key material element of
their operation is subject to oversight to help insure proper internal controls
and procedures, administration, risk management and delivery of critical
information disclosures to appropriate audit and financial officers, executive
management, Board committees and the Boards of directors. UBS' management
believes that the addition of these new controls and processes has brought with
it a broader and more in depth analysis to UBS' systems of controls and
procedures and corporate governance.
The rules and regulations, discussed above, which implement the
Sarbanes-Oxley Act could have a significant economic impact on the compliance
cost of the UBS and all publicly held companies.
Future Legislation and Governmental Policies
From time to time various Federal and state legislation have been proposed
that could result in additional regulation of, and restrictions on, the business
of the Bank. As the enactment of the FSA Act and the Sarbanes-Oxley Act confirm,
from time to time, various proposals are enacted in the United States Congress
as well as Pennsylvania legislature and issued by various bank regulatory
authorities which alter the powers of, and place restrictions on, different
types of bank organizations.
As a consequence of the extensive regulation of commercial banking
activities in the United States, the Bank's business is particularly susceptible
to being affected by federal and state legislation and regulations that may
increase the costs of doing business. Bank management cannot anticipate the
changes in laws and regulations and their impact on the Bank's business,
financial position and reported results of operation.
Regulatory Action
In February 2000, as a result of a regulatory examination completed in
December 1999, the Bank entered into a Written Agreement 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.
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 2,500 square feet to the African American Interdenominational
Ministries.
Market Street Branch (closed)
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 with
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.
10
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 $3,517.
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 and ATM Machine
In 1995, the Bank purchased a branch facility at 4806 Frankford Avenue. In
September 2000, the Bank closed this facility. In June 2002, the Bank sold this
facility. An ATM machine remains operational at this facility. The aggregate
monthly rental for the ATM Machine is $500.
West Girard Branch and ATM Machine
The Bank leased a facility located at 2820 West Girard Avenue. The branch
operations of this facility were discontinued in September 2000. An ATM machine
remained operational at this facility until February 2002 when it was relocated
to 2820 West Girard. The aggregate monthly rental for the ATM Machine at the new
location is $500.
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 $2,875 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 $3,875
per month. The Bank has been notified by the landlord that extensive
improvements to the shopping plaza in which this branch is located is planned
for early 2004. This will result in the temporary relocation of this facility to
a yet undetermined nearby location at the beginning of 2004.
ITEM 3 -- LEGAL PROCEEDINGS
No 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.
11
PART II
ITEM 5 -- MARKET FOR THE REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
Common Stock
As of March 17, 2003 there were 3,168 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.
In June 2000 and December 2000, respectively, the Bank received $411,809
and $436,212 and issued 34,317 and 36,351 shares, respectively, as a result of
the purchase of UBS common stock by members of the Bank's board of directors in
a limited offering at a price of $12.00 per share. This offering was exempt from
registration under the Act pursuant to the exemption in section 4(2) of the Act.
In May 2001 and December 2001, respectively, the Bank received $2,000 and
$9,596 and issued 167 and 800 shares, respectively, as a result of the purchase
of UBS common stock by two individuals in a limited offering at a price of
$12.00 per share. This offering was exempt from registration under the Act
pursuant to the exemption in section 4(2) of the Act.
In June 2002, the Bank received $20,400 and issued 1,700 shares as a result
of the purchase of UBS common stock by new members of the Bank's board of
directors in a limited offering at a price of $12.00 per share. This offering
was exempt from registration under the Act pursuant to the exemption in section
4(2) of the Act.
Dividends
UBS 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.
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.
12
The information below has been derived from UBS' consolidated financial
statements.
ITEM 6 -- SELECTED FINANCIAL DATA
Selected Financial Data
Year ended December 31,
------------------------------------------------------------
(Dollars in thousands, except per share data) 2002 2001 2000 1999 1998
------------------------------------------------------------
Net interest income.............................. $ 3,726 $ 4,060 $ 5,415 $ 5,264 $ 5,241
Provision for loan losses........................ 175 335 565 1,007 351
Noninterest income............................... 2,327 2,443 3,197 2,226 1,816
Noninterest expense.............................. 6,095 7,038 8,801 7,714 6,696
Net income (loss)................................ (217) (870) (755) (1,230) 10
Net income (loss) per share - basic (0.20) (0.79) (0.72) (1.24) 0.01
Balance sheet totals:
Total assets................................. $86,044 $ 88,668 $93,533 $137,249 $121,983
Net loans.................................... 43,459 42,292 44,743 59,444 57,271
Investment securities........................ 21,518 25,806 35,014 51,433 43,196
Deposits..................................... 76,929 79,423 83,238 124,766 109,063
Shareholders' equity......................... 8,500 8,558 9,350 9,027 8,904
Ratios:
Equity to assets.......................... 7.45% 7.67% 7.74% 8.07% 6.40%
Return on assets.......................... (0.25)% (0.95)% (0.63)% (1.03)% 0.01%
Return on equity.......................... (2.55)% (9.31)% (8.08)% (12.71)% 0.14%
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Because UBS is a bank holding company for the Bank, the financial
statements in this report are prepared on a consolidated basis to include the
accounts of the Company and the Bank. The purpose of this discussion is to focus
on information about the Bank's financial condition and results of operations,
which is not otherwise apparent from the consolidated financial statements
included in this annual report. This discussion and analysis should be read in
conjunction with the financial statements presented elsewhere in this report.
Results of Operations
Summary
The Company recorded a net loss of approximately $217,000 thousand for 2002
($0.20 per share) compared to a net loss of approximately $870,000 ($0.79 per
share) for 2001 and net loss of approximately $755,000 ($0.72 per share) in
2000. In 2002, the Bank was awarded a $198,000 grant from the U.S. Treasury
Department's Bank Enterprise Award (BEA) Fund which is included in other income
on the consolidated statement of operations. These funds are awarded to
financial institutions that demonstrate community development through loan and
deposit activity. The financial results for 2002 were also positively impacted
by the continued implementation of the Bank's profit restoration plan that
resulted in reductions in noninterest expenses of $943,000 compared to 2001.
Components of the plan included among other things staff
reductions/consolidations, salary reductions, reduction in branch operating
hours, elimination of director fees, and the reduction of other operating
expenses.
In addition, revenue enhancement strategies were employed to generate
expanded opportunities for fee income through the implementation of new products
and services including the debit card and wealth management services. The
marketing of consumer loan products including home equity, automobile, student,
and credit card loans, and; the installation of additional high volume automated
teller machines are also expected to contribute to increased revenues.
During 2002, while expense reductions were achieved, a greater impact is
expected to be realized with increased loan originations that build the Bank's
loan-to-deposit ratio. Increased loan volume will result in a higher net
interest margin and therefore increased revenues. Thus, while continuing to
control expenses, management will place more focus on the implementation of
business development strategies to increase the level of loans outstanding to
achieve profitability.
13
During 2003, to build momentum around business development and to generate
interest and enthusiasm in the marketplace, management will embark on a
re-branding campaign for the Bank. The campaign will focus on a re-introduction
of the Bank and emphasize its commitment to the community. This campaign will
include among other things, in-branch marketing of the Bank's products and
services, direct mail advertising/solicitation, and the use of newspaper and
television media . A major focus will be placed on the Bank's new division,
United Wealth Management Services, as a lead-in to cross-sell the Bank's other
products and services.
A more detailed explanation for each component of earnings is included in
the sections below.
Table 1--Average Balances, Rates, and Interest Income and Expense Summary
December 31,
2002 2001 2000
----------------------- ----------------------- ------------------------
Average Yield/ Average Yield/ Average Yield/
(Dollars in thousands) balance Interest rate balance Interest rate balance Interest rate
----------------------- ----------------------- ------------------------
Assets:
Interest-earning assets:
Loans........................... $ 42,839 $3,006 7.02% $ 45,828 $3,595 7.85% $ 55,262 $4,655 8.42%
Investment securities
held-to-maturity 10,155 626 6.16 14,669 987 6.73 28,659 1,875 6.54
Investment securities
available-for-sale 13,783 831 6.03 11,758 772 6.57 18,044 1,284 7.12
Federal funds sold.............. 10,406 169 1.62 7,726 282 3.65 5,518 339 6.15
------- ------ ------- ------ ------- ------
Total interest-earning assets 77,183 4,632 6.00 79,981 5,636 7.05 107,483 8,153 7.59
Noninterest-earning assets:
Cash and due from banks......... 4,542 4,801 5,339
Premises and equipment, net..... 2,613 3,214 3,671
Other assets.................... 2,926 4,028 4,494
Less allowance for loan losses.. (674) (576) (562)
-------- -------- --------
Total........................ $ 86,590 $ 91,448 $120,425
======== ======== ========
Liabilities and shareholders' equity:
Interest-bearing liabilities:
Demand deposits................. $ 12,882 114 0.89% $ 13,802 178 1.29% $ 19,851 602 3.03%
Savings deposits................ 21,931 129 0.59 24,480 317 1.29 30,776 497 1.61
Time deposits................... 23,712 662 2.79 24,089 1,081 4.49 28,531 1,387 4.86
Other borrowed funds............ - - - 1 - - 1,925 252 13.09
-------- ------ -------- ------ -------- ------
Total interest-bearing
liabilities 58,525 906 1.55 62,372 1,576 2.53 81,083 2,738 3.38
Noninterest-bearing liabilities:
Demand deposits................. 19,565 19,612 27,567
Other........................... - 431 3,233
Shareholders' equity................ 8,500 9,033 8,542
-------- ------ -------- ------ -------- ------
Total........................ $ 86,590 $ 91,448 $120,425
======== ======== ========
Net interest earnings............... $3,726 $4,060 $5,415
Net yield on interest-earning assets 4.83% 5.08% 5.04%
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.
14
Net interest income in 2002 totaled $3.7 million, a decrease of $334,000,
or 8.22%, compared to 2001. Net interest income for 2001 totaled $4.1 million, a
decrease of $1.3 million or 25%, compared to 2000.
Table 2--Rate-Volume Analysis of Changes in Net Interest Income
2002 compared to 2001 2001 compared to 2000
----------------------------- -----------------------------
Increase (decrease) due to Increase (decrease) due to
----------------------------- -----------------------------
(Dollars in thousands) Volume Rate Net Volume Rate Net
------- ------- ------- ------- ------- -------
Interest earned on:
Loans............................................... $ (209) $ (380) $(589) $ (742) $(317) $(1,059)
Investment securities held-to-maturity.............. (277) (84) (361) (942) 55 (887)
Investment securities available-for-sale............ 122 (63) 59 (412) (100) (512)
Federal funds sold.................................. 44 (157) (113) 81 (138) (57)
----- ----- ----- ------- ----- -------
Total interest-earning assets.................... (320) (684) (1004) (2,015) (500) (2,515)
----- ----- ----- ------- ----- -------
Interest paid on:
Demand deposits..................................... (8) (55) (63) (78) (345) (423)
Savings deposits................................... (16) (172) (188) (83) (96) (179)
Time deposits....................................... (9) (410) (419) (200) (107) (307)
Other borrowed funds................................ - - - (252) - (252)
----- ----- ----- ------- ----- -------
Total interest-bearing liabilities............... (33) (637) (670) (613) (548) (1,161)
----- ----- ----- ------- ----- -------
Net interest income.............................. $ (287) $ (47) $(334) $(1,402) $ 48 $(1,354)
====== ====== ===== ======= ===== =======
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 2002, there was a decrease in net interest income of $334,000 due to
changes in volume but a decrease of $47,000 due to changes in rate. 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.
Average earning assets decreased from $80 million in 2001 to $77 million in
2002 and decreased from $107.5 million in 2000 to $80 million in 2001. 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 deposits. Beginning in
June 2000, the Bank sold higher yielding certificates of deposit to other
financial institutions, encouraged some large deposit account holders to remove
deposits, and consolidated three branches in its branch network. The Bank's core
deposit base was stable during 2002 and represented 84% of total deposits. Until
additional capital is raised, the Bank will not seek to significantly increase
its level of deposits.
The net interest margin of the Bank was 4.83% in 2002, 5.08% in 2001, 5.04%
in 2000. Management actively manages its exposure to interest rate changes.
While the prime rate decreased 400 basis points during 2001 and another 150
basis points in 2002, the Bank did not experience a similar decline in yield on
its earning assets. This is because much of the Bank's loan portfolio is fixed
rate in nature and not related to prime. In addition, 65% 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 2002, the average federal funds yield was 1.62% compared to 3.65% in
2001 and 6.15% in 2000. During 2002, the average investment in federal funds
increased by $2.7 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.
Alternate investment strategies were developed and continue to be implemented to
place liquid funds into longer-term securities including mortgage-backed (MBS)
and other agency securities to decrease the level of investment in low yielding
Federal Funds Sold.
15
The yield on the investment portfolio decreased 57 basis points to 6.09% in
2001 compared to 6.66% in 2002 compared to 6.76% in 2000. 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.
The cost of interest-bearing liabilities declined to 1.55% in 2002 compared
to 2.53% in 2001. Consistent with market conditions during 2002, the Bank
reduced the rates it pays on many of its interest-bearing products. 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 2002 was $175,000
compared to $335,000 in 2001 and $565,000 in 2000. Significant provisions were
made for the year ended December 31, 2001 for one commercial borrower that the
Bank added to its classified loans and provided a specific reserve of $357,000.
This borrower is in the telecommunications industry with loans totaling
approximately $1.3 million and is experiencing severe financial difficulty.
Guarantees from the Small Business Administration (SBA) reduce the Bank's
exposure to approximately $714 thousand. Management continues to work closely
with this borrower to develop a workout plan to minimize the risk of loss. These
loans have been modified to provide for a moratorium on principal payments until
January 2004. The borrower is in compliance with the modified terms.
During the current unstable economic environment, the Bank monitors its
credit quality very closely by working with borrowers in an effort to identify
and control credit risk. Systematic provisions are made to the allowance to
cover potential losses related to the Bank's classified loans. Management
believes the level of the allowance for loan losses is adequate as of December
31, 2002.
Noninterest Income
Noninterest income decreased $116,000 in 2002 compared to 2001 and
decreased $754,000 in 2001 compared to 2000.
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 $275,000 in
2002 compared to 2001 primarily because of a reduction in activity fees on
deposits and lower surcharge income on the Bank's ATM network. The Bank's lower
deposit levels in 2002 compared to 2001 result in less overdraft fees, activity
service charges and low balance fees.
Surcharges from the Bank's ATM network declined because of the 714 Market
Street branch closure in January 2002 and another ATM location lease expiration.
In addition, the Bank had two high-volume ATMs out of service for lengthy
periods during the year due to an accident and a relocation. Management
continues the process of identifying other potentially high volume locations.
The decline in customer service fees was partially offset by a $198,000
grant the Bank received from the U.S. Treasury Department's Bank Enterprise
Award (BEA) Fund. The Bank received this grant as a result of certificates of
deposit it placed with other Community Development Financial Institutions (CDFI)
throughout the country. (Note: United Bank of Philadelphia also has a CDFI
designation and periodically receives such deposits to support its community
development mission.)
Also, in 2002, the Bank syndicated a $60 million back-up line of credit
with other minority banks throughout the country for a major corporation for
which it received an agent fee. This fee will be received annually for the
administration of this line of credit.
During 2002, the Bank sold its former Frankford branch facility for a gain
of $48,000. In addition, the Bank sold approximately $1.1 million of its
available-for-sale portfolio for a gain of approximately $26,000.
16
During 2001, the Bank sold its former West Girard branch facility 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.
Noninterest Expense
Noninterest expense decreased $943,000, or 13.4% in 2002 compared to a
decrease of $1.8 million, or 20% in 2001 compared to 2000.
Salaries and benefits decreased $320,000, or 12.01% in 2002 compared to a
decrease of $411,000, or 13.4%, in 2001. In April 2002, as part of its Profit
Restoration Plan, the Bank made strategic reductions in staff, job
consolidations, and reduced salaries for certain employees to lower the level of
personnel expense. Management continues its review to ensure the Bank is
operating with the most efficient organizational structure.
Occupancy and equipment expense decreased approximately $316,000, or
19.62%, during 2002 compared to a decrease of approximately $181,000, or 10.1%,
during 2001. The decrease is primarily attributable to the closure/consolidation
of the Bank's 714 Market Street branch in January 2002. In addition, the Bank's
former West Girard branch was sold in June 2001 and the Bank's former Frankford
branch office was sold on June 8, 2002. The sale of these branches results in
occupancy expense savings. In addition, many of the fixed assets initially
acquired in 1992 when the Bank opened for business are now fully depreciated (10
year life). This results in a reduction in monthly depreciation expense.
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 $168,000, or 20.81%, during 2002 compared to a decrease of
$163,000 or 16.8%, during 2001. The decrease is primarily attributable to a
reduction in deposit levels for which the Bank pays an outside servicer to
process transactions and provide statement rendering. In addition, during 2002,
the Bank received a $75,000 credit from its core service provider to cover
projected cost savings that were lost due to delays in conversion of its core
processing system.
In November 2002, the Bank converted its core data processing to a new
vendor, FISERV. This conversion will reduce monthly data processing expense by
at least $7,500 and result in other efficiencies that may allow further
reductions in personnel expense. 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 loan servicing options and the
re-negotiation of existing contracts with servicers.
Marketing and public relations expense decreased by $27,000, or 24.39% in
2002 compared to a decrease of $49,000, or 31.1% in 2001. The Bank does not use
a significant amount of traditional marketing and advertising. Management seeks
to use innovative methods to market the Bank's products and services through its
corporate alliances and strong ties to the religious community to enhance its
visibility and expand channels of distribution for its products and services for
minimal cost.
Professional services increased by $51,000, or 21.92% in 2002. During 2002,
the Bank worked with outside attorneys to settle two outstanding legal matters.
In addition, the legal review and implementation of the Sarbanes-Oxley Act that
was enacted in 2002, resulted in increased legal fees.
Office operations and supplies expense decreased by $21,000, or 4.54%, in
2002. Savings were realized as a result of the closure/consolidation of the
Bank's 714 Market Street branch due to reductions in branch operating cost (i.e.
security guards, supplies, etc.). In addition, in conjunction with the Bank's
earnings enhancement / profit restoration plan, all other operating expenses are
tightly controlled.
Federal deposit insurance premiums were $36,000 in 2002 compared to
$150,000 in 2001 and $169,000 in 2000. FDIC insurance premiums are applied to
all financial institutions based on a risk based premium assessment system.
17
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 15 basis
points for BIF (Bank Insurance Fund) assessable deposits and SAIF (Savings
Insurance Fund) assessable deposits. The decrease during 2002 is a result of a
reduction in the Bank's level of deposits as well as improvement in the Bank's
risk rating.
All other expenses are reflective of the general cost to do business and
compete in the current regulatory environment and maintenance of adequate
insurance coverage.
FINANCIAL CONDITION
Sources and Uses of Funds
The Bank's financial condition can be evaluated in terms of trends in its
sources and uses of funds. The comparison of average balances in Table 3 below
indicates how the Bank has managed these elements. Average funding uses
decreased approximately $2.8 million, or 3.50% in 2002 compared to approximately
$27.5 million, or 25.6%, in 2001.
Table 3--Sources and Use of Funds Trends
2002 2001 2000
------------------------------- ------------------------------- ---------
Increase Increase
Average (decrease) Average (decrease) Average
(Dollars in thousands) balance amount Percent balance amount Percent balance
--------- -------- ------- --------- -------- ------- ---------
Funding uses:
Loans ............................. $42,839 $(2,989) (6.52)% $45,828 $ (9,434) (17.07)% $ 55,262
Investment securities
Held-to-maturity................. 10,155 (4,514) (30.77) 14,669 (13,990) (48.82) 28,659
Available-for-sale............... 13,783 2,025 17.22 11,758 (6,286) (34.84) 18,044
Federal funds sold............... 10,406 2,680 34.69 7,726 2,208 40.01 5,518
------- ------- ------- -------- --------
Total uses................... $77,183 $(2,798) $79,981 $(27,502) $107,483
======= ======= ======= ======== ========
Funding sources:
Demand deposits:
Noninterest-bearing.............. $19,565 $ (47) (0.09)% $19,612 $ (7,955) (28.86)% $ 27,567
Interest-bearing................. 12,882 (920) (6.67) 13,802 (6,049) (30.47) 19,851
Savings deposits................... 21,931 (2,549) (10.41) 24,480 (6,296) (20.46) 30,776
Time deposits...................... 23,712 (377) (1.57) 24,089 (4,442) (15.57) 28,531
Other borrowed funds............... - (1) (100.00) 1 (1,924) (99.95) 1,925
------- ------- ------- -------- --------
Total sources................ $78,090 $(3,894) $81,984 $(26,666) $108,650
======= ======= ======= ======== ========
*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,
increased by $191,000, or .56%, in 2002 compared to a decrease of $18 million,
or 34.6%, in 2001. The bulk of the increase was in the category of Federal Funds
Sold that increased on average by $2.7 million. During 2002, 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. These funds are temporarily
held in Federal Funds Sold until loans and/or investments can be originated or
purchased.
18
The Bank's current investment portfolio primarily consists of
mortgage-backed pass-through agency securities and other government-sponsored
agency securities. The Bank does not invest in high-risk securities or complex
structured notes As reflected in Table 4 below, the average duration of the
portfolio is 2.62 years. In the current low interest rate environment, the
duration of the investment portfolio is significantly shortened because of the
of callable government agency securities.- approximately 21.4%. Approximately
$10.8 million in securities were called during the year. The average yield of
called securities was 6.00%. Calls will likely continue as the rate environment
remains at historically low levels. The result is additional liquidity and a
reduction in yield on the portfolio.
Approximately 78.6% of the portfolio consist 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.
The Bank will continue to take steps to combat the impact of the high level
of optionality in the portfolio by identifying replacement loans or securities
that diversify risk and provide some level of monthly cashflow to be reinvested
in the future rising rate environments. In 2002, a strategy to invest $4 million
in variable rate mortgage-backed securities was implemented. These securities
have average current yields of approximately 4.00% and estimated durations of 4
years with monthly cashflow. These securities will adjust at various intervals
ranging from one to seven years.
Table 4--Analysis of Investment Securities
After one but After five but
Within one year within five years within ten years After ten years
--------------- ----------------- ---------------- ---------------
(Dollars in thousands) Amount Yield Amount Yield Amount Yield Amount Yield Total
------ ----- ------ ----- ------ ----- ------ ----- ------
Other government securities...... $ % $1,000 4.66% $3,862 5.90% $ % $ 4,862
Mutual funds..................... 106 1.35 106
Other investments................ 288 6.00 288
Mortgage-backed securities....... 16,262
----- ------ ------ ------ -------
Total securities................. $ 106 $1,000 $4,150 $21,518
Average maturity................. 2.62 years
The above table sets forth the maturities of investment securities at December
31, 2002 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 $3 million, or 6.52%, in 2002
compared to a decrease of $9.4 million, or 17.07%, in 2001. The Bank has
developed relationships with other financial institutions in the region with
which it participates in loans as a strategy to stabilize and grow its
commercial loan portfolio. This strategy continues to be utilized while the Bank
enhances it own business development capacity. Approximately $10 million in
commercial loan participations were booked during 2002. Most of these
participations were secured by commercial real estate.
Increases in the commercial loan portfolio were offset by significant
levels of repayments in the Bank's residential mortgage loan portfolio as
consumers refinance existing loans or sell existing homes to purchase new homes
to take advantage of the current low interest rate environment. Because the Bank
is not a competitive player in the mortgage loan origination market, it does not
generate sufficient mortgage loan volume to cover these payoffs.
The Bank's loan-to-deposit ratio at December 31, 2002 was 56.5% up from
53.2% at December 31, 2001. The target loan-to-deposit ratio is 75%. This level
would allow the Bank to optimize interest income on earning assets while
maintaining adequate liquidity. Management will continue to implement loan
growth strategies including the purchase of additional commercial loan
participations and the origination of small business loans and consumer loans
including home equity, automobile, student and credit card loans.
19
As reflected in Table 5 below, during 2002, because of the purchase of loan
participations, commercial real estate loans increased by $6.4 million to 27% of
total loans. Conversely, the rapid repayments in the mortgage loan portfolio
resulted in a reduction of $4.6 million, or 25.3%--thereby creating a
significant shift in the composition of the overall loan portfolio.
As reflected in Table 6 below, approximately 55% of the Bank's loan
portfolio have scheduled maturities of five years or more. This position is
largely a result of the Bank's relatively high level of residential mortgage
loans. While scheduled maturities exceed five years, due to the high level of
refinancing in this portfolio, the actual duration of the portfolio may be much
shorter.
Table 5--Loans Outstanding, Net of Unearned Income
December 31,
------------------------------------------------------------------
(Dollars in thousands) 2002 2001 2000 1999 1998
------- ------- ------- ------- -------
Commercial and industrial................... $10,855 $11,054 $11,429 $13,664 $13,643
Commercial real estate...................... 11,898 5,504 652 1,288 1,518
Residential mortgages....................... 13,560 18,148 22,316 26,237 31,365
Consumer loans.............................. 7,820 8,294 10,908 19,822 11,424
------- ------- ------- ------- -------
Total loans............................. $44,133 $43,000 $45,305 $61,011 $57,950
======= ======= ======= ======= =======
Table 6--Loan Maturities and Interest Sensitivity
Within After one but After
(Dollars in thousands) one year within five years five years Total
------------ ----------------- ---------- -------
Commercial and industrial................... $ 7,622 $ 1,908 $ 1,325 $10,855
Commercial real estate...................... 1,520 2,028 8,350 11,898
Residential mortgages....................... 13,560 13,560
Consumer loans.............................. 522 5,027 2,271 7,820
------- ------- ------- -------
Total loans........................... 9,664 8,963 25,506 44,133
Loans maturing after one year with:
Fixed interest rates.................... $32,787
Variable interest rates................. 1,682
Nonperforming Loans
Table 7 reflects the Bank's nonperforming and restructured loans for the
last five years. The Bank generally determines a loan to be "nonperforming" when
interest or principal is past due 90 days or more. If it otherwise appears
doubtful that the loan will be repaid, management may consider the loan to be
nonperforming before the lapse of 90 days. The Bank's policy is to charge off
unsecured loans after 90 days past due. Interest on nonperforming loans ceases
to accrue except for loans that are well collateralized and in the process of
collection. When a loan is placed on nonaccrual, previously accrued and unpaid
interest is reversed out of income unless adequate collateral from which to
collect the principal of, and interest on, the loan appears to be available.
Table 7--Nonperforming Loans
(Dollars in thousands) 2002 2001 2000 1999 1998
------- ------- ------- ------- -------
Nonaccrual loans............................ $ 651 $ 412 $ 453 $2,027 $1,720
Interest income included in net income
for the year............................ 25 25 20 67 37
Interest income that would have been
recorded under original terms........... 49 29 28 113 189
Loans past due 90 days and still accruing... 797 526 34 53 125
Restructured loans.......................... 1,286 182 632 580 -
20
The balance of impaired loans was $ 1,951,000 and $412,000 as of December
31, 2002 and 2001, respectively. The Bank identifies a loan as impaired when it
is probable that interest and principal will not be collected according to the
contractual terms of the loan agreement. The impaired loan balance included
$651,000 and $412,000 of non-accrual loans at December 31, 2002 and 2001,
respectively. The allowance for loan loss associated with the $1,951,000 of
impaired loans was $402,000 at December 31, 2002. Interest income recognized on
impaired loans during 2002 and 2001 was $104,000 and $25,000, respectively. The
Bank recognizes income on impaired loans under the cash basis when the loans are
both current and the collateral on the loan is sufficient to cover the
outstanding obligation to the Bank. If these factors do not exist, the Bank will
not recognize income on such loans.
From time to time, management will modify or restructure the terms of
certain loans to provide relief to borrowers. Restructured loans are those loans
whose terms have been modified because of deterioration in the financial
condition of a borrower to provide for a reduction of either interest or
principal, regardless of whether such loans are secured or unsecured and
regardless of whether such credits are guaranteed by the government or by
others. As of December 31, 2002, the Bank had approximately $1.3 million in
restructured loans consisting primarily of three loans to one borrower in the
technology industry.
There is no known information about possible credit problems other than
those classified as nonaccrual or impaired that causes management to be
uncertain as to the ability of any borrower to comply with present loan terms.
The Bank grants commercial, residential, and consumer loans to customers
primarily located in Philadelphia County, Pennsylvania and surrounding counties
in the Delaware Valley. Although the Bank has a diversified loan portfolio, its
debtors' ability to honor their contracts is influenced by the region's economy.
At December 31, 2002, approximately 18.71% 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, 2002, none of these loans were
nonperforming.
During 2002, nonaccrual loans totaled $651,000, compared to $412,000 at
December 31, 2001. At December 31, 2002, approximately $66,000 of the total
nonaccrual loans was residential mortgages and $342,000 carried some level of
guarantee from the Small Business Administration. The underlying real estate
collateral and credit enhancement provided by the SBA minimizes the risk of
loss.
Allowance for Loan Losses
The allowance for loan losses reflects management's continuing evaluation
of the loan portfolio, assessment of economic conditions, the diversification
and size of the portfolio, adequacy of collateral, past and anticipated loss
experience, and the amount and quality of nonperforming loans. Table 8 below
presents the allocation of loan losses by major category for the past five
years. The specific allocations in any particular category may prove to be
excessive or inadequate and consequently may be reallocated in the future to
reflect then current conditions.
The allowance for loan losses as a percentage of total loans was 1.53% at
December 31, 2002 compared with 1.65% at December 31, 2001. During the past two
years, there has been an economic downturn and economic uncertainty continues.
Because the impact on the borrowers may lag the current economic conditions, the
Bank proactively monitors its credit quality while working with borrowers in an
effort to identify and control credit risk.
At December 31, 2002, the Bank's classified loans totaled $2.7 million , or
6.1%, of total loans. Specific reserves of $608,000 have been allocated to these
loans. Approximately $357 thousand was allocated to one loan for which full
collectibility is uncertain. (Refer to Provision for Loan Losses above for
further discussion on this loan.)
21
Table 8--Allocation of Allowance for Loan Losses
2002 2001 2000 1999 1998
------------------- ------------------- ------------------- ------------------- -------------------
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 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.......... $ 565 24.60% $ 576 37.30% $ 383 25.23% $ 263 22.40% $ 272 23.55%
Commercial real
estate.............. 37 26.96 29 1.21 11 1.44 877 2.11 132 2.62
Residential mortgages. 45 17.72 30 19.29 102 24.08 144 43.00 55 54.12
Consumer loans........ 28 30.72 73 42.20 66 49.25 283 32.49 188 19.71
Unallocated........... - - - - - - - - 32 -
----- ------- ----- ------- ----- ------- ------ ------- ----- -------
$ 675 100.00% $ 708 100.00% $ 562 100.00% $1,567 100.00% $ 679 100.00%
===== ======= ===== ======= ===== ======= ====== ======= ===== =======
Management believes that the allowance for loan losses is adequate. While
management uses available information to recognize losses on loans, future
additions may be necessary based on changes in economic conditions. In addition,
various regulatory agencies, as an integral part of their examination process,
periodically review the Bank's allowance for loan losses. Such agencies may
require the Bank to recognize additions to the allowance based on their
judgments of information available to them at the time of the examination.
Table 9--Analysis of Allowance for Loan Losses
Year ended December 31,
------------------------------------------------------------------
(Dollars in thousands) 2002 2001 2000 1999 1998
------- ------- ------- ------- -------
Balance at January 1....................... $ 708 $ 562 $ 1,567 $ 679 $ 468
Charge-offs:
Commercial and industrial.............. (61) (321) (25) -
Commercial real estate................. (100) (803) - -
Residential mortgages.................. - (47) -
Consumer loans......................... (261) (261) (597) (315) (180)
------ ------ ------- ------- ------
(361) (322) (1,721) (387) (180)
------ ------ ------- ------- ------
Recoveries--commercial loans................ 27 - - - -
Recoveries--consumer loans.................. 126 133 151 268 41
------ ------ ------- ------- ------
153 133 151 268 41
Net charge-offs............................ (208) (189) (1,570) (119) (139)
Provisions charged to operations........... 175 335 565 1,007 350
------ ------ ------- ------- ------
Balance at December 31..................... $ 675 $ 708 $ 562 $ 1,567 $ 679
====== ====== ======= ======= ======
Ratio of net charge-offs to average loans
outstanding............................. 0.49% 0.41% 2.84% 0.17% 0.19%
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 $3.9 million, or 4.71%, in 2002
compared to a decline of $24.7 million, or 23.2%, in 2001. The decline is
primarily attributable to the maturity of certificates of deposits the Bank held
on deposit from a special deposit program of the Commonwealth of Pennsylvania.
This program was eliminated in 2002. Because of mandatory capital requirements
outlined in the Bank's Written Agreement with its regulators (See Regulatory
Matters below), aggressive deposit retention or new business development
strategies have not been implemented.
Table 10--Average Deposits by Class and Rate
2002 2001 2000
------------------ ------------------ ------------------
(Dollars in thousands) Amount Rate Amount Rate Amount Rate
------------------ ------------------ ------------------
Noninterest-bearing demand deposits $19,565 - % $19,612 - % $27,567 - %
Interest-bearing demand deposits 12,882 0.89 13,802 1.29 19,851 3.03
Savings deposits 21,931 0.59 24,480 1.30 30,776 1.61
Time deposits 23,712 2.79 24,089 4.49 28,531 4.86
Other Borrowed Funds
The Bank did not borrow funds during 2002. Generally, the level of other
borrowed funds is dependent on many items such as loan growth, deposit growth,
customer collateral/security requirements and interest rates paid for these
funds. The Bank's liquidity has been enhanced by loan paydowns/payoffs and
called investment securities--thereby, reducing the need to borrow.
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, 2002, 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 $9.2 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.......................... $ 7,754
Over 3 through 6 months................... 769
Over 6 months through 1 year.............. 1,114
Over 1 through five years................. 1,246
Over five years........................... -
-------
Total................................ $10,883
=======
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, 2002, 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, 2002, a slight
asset sensitive position is maintained on a cumulative basis through one year of
5.26%. 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, 2002
--------------------------------------------------------------------------
Over
Over 1 year Over
3 months 3 through through 3 through Over
(Dollars in thousands) or less 12 months 3 years 5 years 5 years Cumulative
-------- --------- --------- --------- --------- ----------
Interest-sensitive assets:
Interest-bearing deposits with banks. $ $ 865 $ $ $ $ 865
Investment securities................ 9,410 830 438 1,026 9,419 21,123
Federal funds sold................... 10,122 10,122
Loans................................ 14,630 4,939 5,764 4,046 14,754 44,133
------ ------ ----- ----- ------ ------
Total interest-sensitive assets.... 34,162 6,634 6,202 5,072 24,173 $76,243
------ ------ ----- ------ ------ =======
Cumulative totals.................. 34,162 40,796 46,998 52,070 76,243
------ ------ ------ ------ ------
Interest rate sensitivity gaps as of December 31, 2002
--------------------------------------------------------------------------
Over
Over 1 year Over
3 months 3 through through 3 through Over
(Dollars in thousands) or less 12 months 3 years 5 years 5 years Cumulative
-------- --------- --------- --------- --------- ----------
Interest-sensitive liabilities:
Interest checking accounts........... 2,927 2,927 5,854
Savings accounts..................... 13,739 13,739 27,478
Certificates less than $100,000...... 4,117 6,362 1,167 615 12,261
Certificates of $100,000 or more..... 6,332 3,306 1,245 10,883
Other borrowed funds................. - - - - -
------- ------- -------- ------- ------- -------
Total interest-sensitive liabilities $27,115 $ 9,668 $ 19,078 $ 615 $ - $56,476
======= ======= ======== ======= ======= =======
Cumulative totals.................. $27,115 $36,783 $ 55,861 $56,476 $56,476
======= ======= ======== ======= =======
Interest sensitivity gap................. $ 7,046 $(3,034) $(12,876) $ 4,457 $24,173
======= ======= ======== ======= =======
Cumulative gap........................... 7,046 4,012 (8,863) (4,406) 19,767
Cumulative gap/total earning assets...... 9.24% 5.26% 11.63% 5.78% 25.93%
Interest-sensitive assets to interest-sensitive
liabilities.......................... 1.26 1.11 0.84 0.92 1.35
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, 2002 are as follows:
25
Net interest Percent of
Changes in rate income change
--------------- ----------- ----------
(Dollars in thousands)
+200 basis points $ 3,835 2.43%
+100 basis points 3,790 1.23
Flat rate 3,744 -
-100 basis points 3,696 (1.28)
-200 basis points 3,638 (2.83)
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, 2002 are as follows:
Percent of
Changes in rate MV equity change
--------------- ----------- ----------
(Dollars in thousands)
+200 basis points $ 3,335 52.03%
+100 basis points 5,136 26.13
Flat rate 6,953 -
-100 basis points 8,836 27.08
-200 basis points 10,571 52.03
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 Bo