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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, 2003
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. [ ]
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 a Series Preferred Stock (Series A Preferred Stock).
The Board of Directors designated a subclass of the common stock, Class B
Common Stock, by filing of Articles of Amendment to its Articles of
Incorporation on September 30, 1998. This Class B Common Stock has all of the
rights and privileges of Common Stock with the exception of voting rights. Of
the 2,000,000 shares of authorized Common Stock, 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 15, 2004 the aggregate number of the shares of the
Registrant's Common Stock outstanding was 1,068,588 (including 191,667 Class B
non-voting). There are 33,500 shares of Common Stock held in treasury stock at
March 15, 2004.
The Series A Preferred Stock consists of 500,000 authorized shares of stock
of which 136,842 shares are outstanding and 6,308 shares are held in treasury
stock as of March 15, 2004.
There are 75 pages in the Form 10-K.
FORM 10-K
United Bancshares, Inc.
Index
Item No. Page
PART I
1. Business............................................................ 3
2. Properties..........................................................12
3. Legal Proceedings...................................................13
4. Submission of Matters to a Vote of Security Holders.................13
PART II
5. Market for Registrant's Common Equity and
Related Stockholder Matters.......................................14
6. Selected Financial Data.............................................15
7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.........................................15
7A. Quantitative and Qualitative Disclosures about Market Risk..........35
8. Financial Statements and Supplementary Data.........................35
9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure..............................................35
9A. Controls and Procedures.............................................36
PART III
10. Directors and Executive Officers of Registrant......................36
11. Executive Compensation..............................................41
12. Security Ownership of Certain Beneficial Owners and Management......43
13. Certain Relationships and Related Transactions......................43
14. Principal Accounting Fees and Services..............................43
PART IV
15. Exhibits, Financial Statements Schedules and Reports on Form 8-K....44
UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF MARCH 15, 2004.
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 15, 2004, UBS and the Bank had a total of 49 employees.
3
United Bank of Philadelphia
United Bancshares, Inc. is an African American controlled and managed bank
holding company for United Bank of Philadelphia (the "Bank"), a commercial bank
chartered in 1992 by the Commonwealth of Pennsylvania, Department of Banking and
a member of the Federal Reserve System. The deposits held by the Bank are
insured by the Federal Deposit Insurance Corporation ("FDIC"). The Bank provides
full service community banking in Philadelphia neighborhoods that are rich in
diversity providing a market opportunity that includes men, women, families,
small business owners, skilled laborers, professionals and many more who value
home ownership and need banking services to help make their dreams come true.
The Bank conducts all its banking activities through its four offices
located as follows: (i) Center City Branch Two Penn Center, Philadelphia,
Pennsylvania; (ii) West Philadelphia Branch 38th and Lancaster Avenue,
Philadelphia, Pennsylvania, (iii) Mount Airy Branch 1620 Wadsworth Avenue,
Philadelphia, Pennsylvania; and (iv) Progress Plaza Branch 1015 North Broad
Street, Philadelphia, Pennsylvania. In 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, 2003,
the Bank had total deposits aggregating approximately $67.1 million and had
total net loans outstanding of approximately $46.7 million. Although the Bank's
primary service area for Community Reinvestment Act purposes is Philadelphia
County, it also services, generally, the Delaware Valley, which consists of
portions of Montgomery, Bucks, Chester, and Delaware Counties in Pennsylvania;
New Castle County in Delaware; and Camden, Burlington, and Gloucester Counties
in New Jersey.
The city of Philadelphia is comprised of 353 census tracts and, based on
2000 census data, 204 or 58% of these are designated as low to moderate-income
tracts while 105 or 30% are characterized both as low to moderate-income and
minority tracts. The Bank's primary service area consists of a population of
1,517,550, which includes a minority population of 752,309.
United Bank of Philadelphia, while state chartered as a commercial
bank, is uniquely structured to be a formidable player in providing retail
services to its urban communities, while maintaining and establishing a solid
portfolio of commercial relationships that include small businesses, churches
and corporations. The Bank will take full advantage of its CDFI (community
development financial institution) designation as established by the United
States Department of Treasury. While the Bank's certification period was
scheduled to end in January 2004, a recent review by the CDFI Fund has extended
the Bank's certification period to June 2005.
Among the greatest challenges facing inner city communities is their
lack of stability and transience. Outside organizations and institutions that
attempt to work within the community get frustrated and can leave at any time
because they have no vested stake in the neighborhood. It is very easy for an
organization without vested roots in the community to just pick up and leave,
thus fostering lack of institutional consistency. The Bank represents
consistency to these communities. The Bank takes its commitment to community
development quite seriously and recognizes that effective corporate and
institutional partnerships must be forged to truly make a difference. Bank
management recognizes the potential in these communities and knows that with the
right mix of financial services, growth will occur. The Bank will continue to
leverage its community know-how with the appropriate corporate and institutional
partners to ensure that we create economic profit by ensuring that comprehensive
products and services are available and accessible through service focused
delivery channels.
The Bank engages in the commercial banking business, serving the
banking needs of its customers with a particular focus on, and sensitivity to,
groups that have been traditionally under-served, including Blacks, Hispanics
and women. The Bank offers a wide range of deposit products, including checking
accounts, interest-bearing NOW accounts, money market accounts, certificates of
deposit, savings accounts and Individual Retirement Accounts.
4
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 15, 2004, the Bank's
maximum legal lending limit was approximately $859,000 per borrower. However,
the Bank's internal Loan Policy limits the Bank's lending to $500,000 per
borrower in order to diversify the loan portfolio. The Board of Directors of the
Bank maintains the ability to waive its internal lending limit upon
consideration of a loan. The Board of Directors has exercised this power with
respect to loans and participations on a number of occasions.
In the area of commercial loans, the Bank has flexibility to develop
loan arrangements targeted at a customer's objectives. Typically, these loans
are term loans or revolving credit arrangements with interest rate, collateral
and repayments terms, varying based upon the type of credit, and various factors
used to evaluate risk. The Bank participates in the government-sponsored Small
Business Administration ("SBA") lending program and when the Bank deems it
appropriate, obtains SBA guarantees for up to 90% of the loan amount. 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 participates in an automobile refinance
program that allows customers to reduce high interest rates paid on their
automobile loans down to more reasonable market rates. The Bank also offers
residential mortgage loans to its customers. Other services the Bank offers
include safe deposit boxes, travelers' checks, money orders, direct deposit of
payroll and Social Security checks, wire transfers and access to regional and
national automated teller networks.
The Bank will continue to focus on its niche businesses to include the
basic deposit and loan business, while developing relationships with several
corporate entities that have a commitment to community and economic development
in the urban sector. Strategic alliances and partnerships are key to the
economic strength of inner city neighborhoods. The Bank will seek to promptly
develop these strategic alliances/partnerships to help ensure that the
communities we serve have full access to financial products and services.
With strategic and focused strategies the Bank can realize fee income
with a select number of corporations. By developing the relationships
appropriately, a new niche for the Bank can be expanded to add to its core
earnings stream. These opportunities will include loan syndications, cash
management and lock box services, to name a few.
5
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.
Registrant will continue to be cognizant of the diversity in its market and
will continue to develop partnerships to leverage the Bank's capacity in its
niche market by skillfully targeting customers and building stakeholder
relationships.
Supervision and Regulation
Regulation of United Bancshares, Inc.
UBS, as a Pennsylvania business corporation, is subject to the
jurisdiction of the Securities and Exchange Commission (the "SEC") and certain
state securities commissions concerning matters relating to the offering and
sale of its securities. Accordingly, if UBS wishes to issue additional shares of
its Common Stock, for example, to raise capital or to grant stock options, UBS
must comply with the registration requirements of the Securities Act of 1933, as
amended, and any applicable states securities laws, or find an applicable
exemptions from registration.
6
The Bank Holding Company Act
UBS, as a bank holding company, is subject to the Bank Holding Company
Act of 1956, as amended (the "BHC Act"), and supervision by the Federal Reserve
Board. The BCH Act limits the business of bank holding companies to banking,
managing or controlling banks, performing certain servicing activities for
subsidiaries and engaging in such other activities as the Federal Reserve Board
may determine to be closely related to banking. UBS is subject to the
supervision of and inspection by the Federal Reserve Board and required to file
with the Board an annual report and such additional information as the Board may
require pursuant to the BHC Act and its implementing regulations.
A bank holding company is prohibited from engaging in or acquiring direct
or indirect control of more than 5% of the voting shares of any company engaged
in non-banking activities, unless the Federal Reserve Board, by order or
regulation, has found such activities to be so closely related to banking or
managing or controlling banks, as to be a proper incident thereto. In making
this determination, the Board considers whether the performance of these
activities by a bank holding company would offer benefits to the public that
outweigh possible adverse effects.
The BHC Act requires UBS to secure the prior approval of the Federal
Reserve Board before it owns or controls, directly or indirectly, more than 5%
of the voting shares of any corporation, including another bank. In addition,
the BHC Act prohibits UBS from acquiring more than 5% of the voting shares of,
or an interest in, or all or substantially all of the assets of, any bank
located outside Pennsylvania, unless such an acquisition is specifically
authorized by the laws of the state in which such bank is located.
Subject to compliance with Pennsylvania law, and, as noted above,
compliance with the BHC Act, UBS is permitted to control a number of banks.
However, UBS is required under the BHC Act to obtain the prior approval of the
Federal Reserve Board before acquiring all or substantially all of the assets of
any bank, or acquiring ownership or control of any voting shares of any other
bank if, after such acquisition, UBS would control more than 5% of the voting
shares of such bank.
The BHC Act and the Federal Reserve Board's regulations prohibit a bank
holding company and its subsidiaries from engaging in certain tying arrangements
in connection with any extension of credit or services. The "anti-tying"
provisions prohibit a bank from extending credit, leasing, selling property or
furnishing any service to a customer on the condition that the customer obtain
additional credit or service from the bank, its bank holding company or any
other subsidiary of its bank holding company, or on the condition that the
customer not obtain other credit or services from a competitor of the bank, its
bank holding company or any subsidiary of its bank holding company.
The Bank, as a subsidiary of UBS, is subject to certain restrictions
imposed by the Federal Reserve Act, as amended, on any extensions of credit to
UBS or its subsidiaries, on investments in the stock or other securities UBS or
its subsidiaries, and on taking such stock or securities as collateral for
loans.
The Federal Reserve Act and Federal Reserve Board regulations also place
certain limitations and reporting requirements on extensions of credit by a bank
to principal shareholders of its parent holding company, among others, and to
related interests of such principal shareholders. In addition, that Act and
those regulations may affect the terms upon which any person who becomes a
principal shareholder of a holding company may obtain credit from banks with
which the subsidiary bank maintains a correspondent relationship.
Federal law also prohibits the acquisition of control by UBS of a bank
holding company, without prior notice to certain federal bank regulators.
Control is defined for this purpose as the power, directly or indirectly, to
direct the management or policies of the bank or bank holding company or to vote
25% or more of any class of voting securities of the bank holding company.
7
The Financial Services Act
The Financial Services Act (the "FSA Act"), sometimes referred to as the
Gramm-Leach-Bliley Act, repealed the provisions of the Glass-Steagall Act, which
prohibited commercial banks and securities firms from affiliating with each
other and engaging in each other's businesses. Thus, many of the barriers
prohibiting affiliations between commercial banks and securities firms have been
eliminated.
The FSA Act authorizes the establishment of "financial holding companies"
("FHC") to engage in new financial activities offering and banking, insurance,
securities and other financial products to consumers. Bank holding companies may
elect to become a FHC, if all of its subsidiary depository institutions are well
capitalized and well managed. See "Regulatory Action" and "Regulatory Matters"
below. If those requirements are met, a bank holding company may file a
certification to that effect with the Federal Reserve Board and declare that it
elects to become a FHC. After the certification and declaration are filed, the
FHC may engage either de novo or through an acquisition in any activity that has
been determined by the Federal Reserve Board to be financial in nature or
incidental to such financial activity.
Under the FSA Act the Bank, subject to various requirements, is permitted
to engage through "financial subsidiaries" in certain financial activities
permissible for affiliates of an FHC. However, to be able to engage in such
activities the Bank must be well capitalized and well managed and receive at
least a "satisfactory" rating in its most recent 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.
8
To minimize losses to the deposit insurance funds, the FDIC Act has
established a format to monitor FDIC-insured institutions and to enable prompt
corrective action to be taken by the appropriate federal supervisory agency if
an institution begins to experience difficulty. The FDIC Act establishes five
"capital" categories. They are: (1) well capitalized, (2) adequately
capitalized, (3) undercapitalized, (4) significantly undercapitalized, and (5)
critically undercapitalized. The overall goal of these new capital measures is
to impose more scrutiny and operational restrictions on banks as they descend
the capital categories from well capitalized to critically undercapitalized.
Under current regulations, a "well-capitalized" institution would be one
that has at least a 10% total risk-based capital ratio, a 6% Tier I risk-based
capital ratio, a 5% Tier I leverage ratio, and is not subject to any written
order or final directive by its regulatory agency to meet and maintain a
specific capital level.
An "adequately capitalized" institution would be one that meets the
required minimum capital levels, but does not meet the definition of a
"well-capitalized" institution. The existing capital rules generally require
banks to maintain a Tier I Leverage Ratio of at least 4% and an 8% total
risk-based capital ratio. Since the risk-based capital requirement to be in the
form of Tier I capital, this also will mean that a bank would need to maintain
at least 4% Tier I risk-based capital ratio. An institution must meet each of
the required minimum capital levels in order to be deemed "adequately
capitalized." The most recent notification dated March 11, 2004, from the
Federal Reserve authorities categorized the Bank as "adequately capitalized"
under the regulatory framework for prompt and corrective action. However, at
December 31, 2003, the Bank fell below the tier one leverage ratio of 7.00%
(6.81% at December 31, 2003) that is mandated in the Written Agreement with its
regulators. See "Regulatory Action" and "Regulatory Matters" below.
An "undercapitalized" institution is one that fails to meet one or more of
the required minimum capital levels for an "adequately capitalized" institution.
Under the FDIC Act, an "undercapitalized" institution must file a capital
restoration plan and is automatically subject to restrictions on dividends,
management fees and asset growth. In addition, the institution is prohibited
from making acquisitions, opening new branches or engaging in new lines of
business without the prior approval of its primary federal regulator. A number
of other restrictions may be imposed.
The Community Reinvestment Act
The Bank is required, by the CRA Act and its implementing regulations, to:
(i) meet the credit needs of the community, including the low and
moderate-income neighborhoods, which it serves. The Bank's CRA Act record is
taken into account by the regulatory authorities in their evaluation of any
application made by the Bank for, among other things, approval of a branch or
other deposit facility, branch office relocation, a merger or an acquisition.
The CRA Act also requires the federal banking agencies to make public disclosure
of their evaluation of a bank's record of meeting the credit needs of its entire
community, including low and moderate-income neighborhoods. After its most
recent CRA Act examination the Bank was given an "outstanding" CRA Act rating."
The Bank Secrecy Act
Under the Bank Secrecy Act ("BSA"), the Bank and other financial
institutions are required to report to the Internal Revenue Service currency
transactions, of more than $10,000 or multiple transactions of which the Bank
has knowledge exceed $10,000 in the aggregate. Civil and criminal penalties are
provided under the BSA for failure to file a required report, for failure to
supply information required by the BSA or for filing a false or fraudulent
report.
Privacy of Consumer Financial Information
The FSA Act also contains provisions designed to protect the privacy of
each consumer's financial information held in a financial institution. The
regulations (the "Regulations") issued pursuant to the FSA Act are designed to
prevent financial institutions, such as the Bank, from disclosing a consumer's
nonpublic personal information to third parties. However, financial institutions
can share a consumer customer's personal information or information about
business with affiliated companies.
The FSA Act Regulations permit financial institutions to disclose nonpublic
personal information to nonaffiliated third parties for marketing purposes but
financial institutions must provide a description of their privacy policies to
the consumers and give consumers an opportunity to opt-out of such disclosure
and prevent disclosure by the financial institution of the consumer's nonpublic
personal information to nonaffiliated third parties. These privacy Regulations
will affect how consumer information is transmitted through diversified
financial companies and conveyed to outside vendors.
9
Consumer Protection Rules - Sale of Insurance Products
In addition, as mandated by FSA Act, the bank regulators have published
consumer protection rules (the "Rules") which apply to the retail sales
practices, solicitation, advertising or offers of insurance products, including
annuities, by depository institutions such as the Bank.
The Rules provide that before the sale of insurance or annuity products can
be completed, disclosures must be made that such insurance products are not
deposits or other obligations of or guaranteed by the FDIC or any other agency
of the United States, the Bank or any affiliate and that insurance products,
including an annuities, may involve an investment risk, including a possible
loss of value.
The Rules also provide that the Bank may not condition an extension of
credit on the consumer's purchase of an insurance product or annuity from the
Bank or any affiliate or on the consumer's agreement not obtain or prohibit the
consumer from obtaining an insurance product or annuity from an unaffiliated
entity.
Finally the Rules also require formal acknowledgment by the consumer that
such disclosures have been received. In addition, to the extent practical, the
Bank must keep insurance and annuity sales activities physically separate from
the areas where retail sales are routinely accepted from the general public. The
Bank currently does not market insurance products.
The Patriot Act
The Patriot Act of 2001 which was enacted in the wake of the September
11, 2001 attacks, include provisions designed to combat international money
laundering and advance the U.S. government's war against terrorism. The Patriot
Act, and the regulations, which implement it, contains many obligations, which
must be satisfied by financial institutions, including the Bank, which involve
additional expenses for the Bank.
The Sarbanes-Oxley Act of 2002
On July 30, 2002 the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley
Act") became law. The stated goals of the Sarbanes-Oxley Act are to increase
corporate responsibility, provide enhanced penalties for accounting and auditing
improprieties by publicly traded companies and protect investors by improving
the accuracy and reliability of corporate disclosures made pursuant to the
securities law. The changes required by Sarbanes-Oxley Act and its implementing
regulations are intended to allow shareholders to monitor the performance of
companies and their directors more easily and effectively.
The Sarbanes-Oxley Act generally applies to all domestic companies,
such as UBS, that file periodic reports with the SEC under the Securities
Exchange Act of 1934, as amended. The 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.
10
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.
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.
New Legislation and Regulations
The Fair and Accurate Credit Reporting Transactions Act
The Fair and Accurate Credit Reporting Transactions Act of 2003 (the "Fact
Act") became law on December 4, 2003. Among other things, the Fact Act
permanently extended the provisions of the Fair Credit Reporting Act (the FCR
Act") that would have expired on January 1, 2004 and had prevented the states
from enforcing credit reporting laws that were more restrictive than the FCR Act
provisions.
Specifically, the Fact Act now permanently prohibits the states from
enforcing laws stricter than the Fact Act regulate that regulate: (1) the
prescreening of consumer reports, (2) the time within which credit bureaus must
respond to consumer disputes, (3) the duties of users of credit bureau
information, (4) the information contained in the credit reports, (5) the duties
of the information providers, and (6) the exchange of credit information between
affiliates.
In addition the Fact Act contains provisions concerning (i) how often
consumers may obtain free copies of their credit reports, (ii) the disclosure of
credit scores used for credit decisions, (iii) a consumers opt-out procedure for
exchange of credit information, that would otherwise be treated as a credit
report, among affiliates, (iv) the duty of lenders to notify consumers that
information contained in their credit reports resulted in their receiving credit
on less than the most favorable terms."
The Fact Act also contains provisions designed to reduce identity theft and
protect the confidentiality of a consumer's private medical information.
Future Legislation and Governmental Policies
From time to time various Federal and state legislation have been proposed
that could result in additional regulation of, and restrictions on, the business
of the Bank. As the enactment of the FSA Act and the Sarbanes-Oxley Act confirm,
from time to time, various proposals are enacted in the United States Congress
as well as Pennsylvania legislature and issued by various bank regulatory
authorities which alter the powers of, and place restrictions on, different
types of bank organizations.
As a consequence of the extensive regulation of commercial banking
activities in the United States, the Bank's business is particularly susceptible
to being affected by federal and state legislation and regulations that may
increase the costs of doing business. Bank management cannot anticipate the
changes in laws and regulations and their impact on the Bank's business,
financial position and reported results of operation.
11
Regulatory Action
In February 2000, as a result of a regulatory examination completed in
December 1999, the Bank entered into a Written Agreement ("the Agreement") with
its primary regulators with regard to, among other things, achievement of
agreed-upon capital levels, implementation of a viable earnings/strategic plan,
adequate funding of the allowance for loan losses, the completion of a
management review and succession plan, and improvement in internal controls. The
Agreement requires the Bank to increase its capital ratio to 6.5% by June 30,
2000 and to 7% at all times thereafter. As of December 31, 2000, the Bank had
met the required ratios by implementing strategies that included: reducing
expenses, consolidating branches, and soliciting new and additional sources of
capital. Management continues to address all matters outlined in the Agreement.
As of December 31, 2003, the Bank's tier one leverage capital ratio fell to
6.81% , below the 7% minimum capital ratio required by the Agreement. However,
at February 29, 2004, the tier one leverage ratio had improved to 7.29% as a
result of a $265,000 recovery on a previously charged-off loan. Management
continues to review and revise its capital plan to address the development of
new equity. In addition, a profit restoration plan was developed and implemented
that includes expense reduction and profit enhancement strategies.
A regulatory examination completed in February 2004 determined that the
Bank was not in compliance certain other elements of the Agreement including the
implementation of a viable earnings/strategic plan and the timely
charge-off/funding of the allowance for loan losses. Management believes that it
has implemented corrective action where necessary including the adoption of an
achievable strategic plan for 2004 and the charge-off of all loans for which the
full collection appears unlikely. As a result, Management believes that the Bank
is "substantially" in compliance with the Agreement's terms and conditions.
Failure to comply could result in additional regulatory supervision and/or
actions.
ITEM 2 -- PROPERTIES
Corporate Headquarters
United Bank of Philadelphia's corporate offices are located at 300 N. Third
Street. The Bank has been at this location for the past four years in the area
of the City known as "Old City." This is an up and coming vibrant area filled
with art galleries, new development of condominiums, small businesses, and
restaurants. 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. As part of the Bank's profit
restoration plan, this property may be sold in 2004 to generate substantial
gains to re-capitalize the Bank. Management is in the process of evaluating
offers from potential buyers as well as reviewing alternate sites/expenses
related to the relocation of the corporate headquarters.
Mt. Airy Branch
The Bank operates a branch at 1620 Wadsworth Avenue, in the Mt. Airy
section of Philadelphia. During 2004, this office will undergo modest cosmetic
improvements. Management believes this branch has not reached its capacity and
looks forward to increased opportunities in all aspects of the Bank's niche
businesses. This facility, comprising a retail banking lobby, teller area,
offices, vault and storage space is currently leased at a monthly rental of
$3,517.
Center City Branch
The Bank operates a branch location at Two Penn Center, 15th Street and JFK
Boulevard, Philadelphia, Pennsylvania. Two Penn Center has been the Bank's main
office since the closure of the 714 Market Street location in January 2002. 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. As part of the Bank's profit restoration plan, upon
expiration of this lease in May 2004, this branch will be closed and
consolidated with other branches in the network to further reduce operating
costs.
12
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
In August 2003, the Bank purchased the branch location at 3750 Lancaster
Avenue for $287,500. From July 1996 to the time of purchase, this facility had
been leased. With the purchase of this facility, management looks forward to
capital improvements to be in line with the University City District's
environmental improvements along the Lancaster Avenue corridor. It is comprised
of approximately 3,000 square feet. The main floor houses teller and customer
service areas, a drive-up teller facility and automated teller machine. The
basement provides storage for the facility. The aggregate monthly rental was
$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 Progress Plaza branch is a very active branch
with the largest number of customers seeking service on a daily basis. This
branch became the office of choice after the consolidation of the 28th & West
Girard location in 2000. This area of North Philadelphia is an important area
for the Bank and its mission. The facility is comprised of a teller and customer
service area, lobby and vault. The aggregate monthly rental for this facility is
$3,875 per month. This lease expired in October 2003. The Bank had been notified
by the landlord that extensive improvements to the shopping plaza in which this
branch is located were planned for early 2004 but have since been placed on
hold. The Bank is currently leasing this facility on a month-to-month basis
until final renovation plans are determined by the landlord .
ITEM 3 -- 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.
13
PART II
ITEM 5 -- MARKET FOR THE REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS
Common Stock
As of March 15, 2004 there were 3,156 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.
In June 2003, a shareholder of the Bank returned 33,500 shares of common
stock and 6,308 shares of preferred Series A stock. These shares were returned
for no consideration and were recorded as treasury stock by the Bank. No other
transactions with respect to UBS common stock occurred during 2003.
Dividends
UBS has not, has never declared or paid any cash or stock dividends. The
Pennsylvania Banking Code of 1965, as amended, provides that cash dividends may
be declared and paid only from accumulated net earnings and that, prior to the
declaration of any dividend, if the surplus of a bank is less than the amount of
its capital, the bank shall, until surplus is equal to such amount, transfer to
surplus an amount which is at least ten percent of the net earnings of the bank
for the period since the end of the last fiscal year or any shorter period since
the declaration of a dividend. If the surplus of a bank is less than 50% of the
amount of its capital, no dividend may be declared or paid by the Bank without
the prior approval of the Pennsylvania Department of Banking.
Under the Federal Reserve Act, if a bank has sustained losses equal to or
exceeding its undivided profits then on hand, no dividend shall be paid, and no
dividends can ever be paid in an amount greater than such bank's net profits
less losses and bad debts. Cash dividends must be approved by the Board if the
total of all cash dividends declared by a bank in any calendar year, including
the proposed cash dividend, exceeds the total of the Bank's net profits for that
year plus its retained net profits from the preceding two years less any
required transfers to surplus or to a fund for the retirement of preferred
stock. Under the Federal Reserve Act, the Federal Reserve Board has the power to
prohibit the payment of cash dividends by a bank if it determines that such a
payment would be an unsafe or unsound banking practice. As a result of these
laws and regulations, the Bank, and therefore 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.
14
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) 2003 2002 2001 2000 1999
------------------------------------------------------------
Net interest income.............................. $ 3,290 $ 3,726 $ 4,060 $ 5,415 $ 5,264
Provision for loan losses........................ 565 175 335 565 1,007
Noninterest income............................... 1,891 2,327 2,443 3,197 2,226
Noninterest expense.............................. 5,732 6,095 7,038 8,801 7,714
Net income (loss)................................ (1,115) (217) (870) (755) (1,230)
Net income (loss) per share - basic.............. (1.03) (0.20) (0.79) (0.72) (1.24)
Balance sheet totals:
Total assets................................. $74,717 $86,044 $88,668 $93,533 $137,249
Net loans.................................... 46,690 43,459 42,292 44,743 59,444
Investment securities........................ 15,637 21,518 25,806 35,014 51,433
Deposits..................................... 67,117 76,929 79,423 83,238 124,766
Shareholders' equity......................... 7,235 8,500 8,558 9,350 9,027
Ratios:
Tangible Equity to assets................. 6.85 % 7.45 % 7.67 % 7.74 % 8.07 %
Return on assets.......................... (1.38)% (0.25)% (0.95)% (0.63)% (1.03)%
Return on equity.......................... (13.03)% (2.55)% (9.63)% (8.08)% (12.71)%
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Because UBS is a bank holding company for the Bank, the financial
statements in this report are prepared on a consolidated basis to include the
accounts of the Company and the Bank. The purpose of this discussion is to focus
on information about the Bank's financial condition and results of operations,
which is not otherwise apparent from the consolidated financial statements
included in this annual report. This discussion and analysis should be read in
conjunction with the financial statements presented elsewhere in this report.
Critical Accounting Policies
Allowance for Credit Losses
The Bank considers that the determination of the allowance for loan
losses involves a higher degree of judgment and complexity than its other
significant accounting policies. The balance in the allowance for loan losses is
determined based on management's review and evaluation of the loan portfolio in
relation to past loss experience, the size and composition of the portfolio,
current economic events and conditions, and other pertinent factors, including
management's assumptions as to future delinquencies, recoveries and losses. All
of these factors may be susceptible to significant change. To the extent actual
outcomes differ from management's estimates, additional provisions for loan
losses may be required that would adversely impact earnings in future periods.
Income Taxes
Under the liability method, deferred tax assets and liabilities are
determined based on the difference between the financial statement and tax bases
of assets and liabilities. Deferred tax assets are subject to management's
judgment based upon available evidence that future realization is more likely
than not. For financial reporting purposes, a valuation allowance of 100% of the
deferred tax asset has been recognized to offset the deferred tax assets related
to cumulative temporary differences and tax loss carryforwards. If management
determines that the Bank may be able to realize all or part of the deferred tax
asset in the future, a credit to income tax expense may be required to increase
the recorded value of net deferred tax asset to the expected realizable amount.
15
Background Summary
History
The Bank entered a Written Agreement ("the Agreement") with the Federal
Reserve Bank in 2000 that had many ambitious timelines for the board and
management to meet. This Agreement became a motivator for the new management
team to dismantle a lack luster business model in order to keep the franchise
alive and relevant. This was a model that originally held great promise for it
was established to bring the "unbanked" into the mainstream of financial
services through affordable pricing and sensitive customer service. The
customers came and the numbers grew quickly and the franchise grew through the
acquisition of failed savings and loan branches. However, with this growth came
increased expenses through the assimilation of acquired branch locations,
people, products and the overall conversion expense.
The Bank had quickly strayed from its model of building a
customer-friendly and affordable franchise into a franchise of transforming
several branches of savings and loan customers into the Bank's commercial
platform. In 2000, the Bank was still faced with an enormous array of accounts
that had not yet been streamlined, thus curtailing the sales capacity of the
staff. In addition, the Bank's pricing had not kept pace with the prevailing
rates in the local market. Thus, in early 2000 the Bank's pricing model was
enhanced to be more competitive while still affordable to its clients. This
shift gave the Bank a quick boost in revenue.
A major factor that needed to be addressed by the Bank was its capital
(tier one leverage ratio). With the onset of the Agreement, the Bank's tier one
leverage ratio was slightly under 5%. Aggressive strategies were developed and
implemented by moving more expensive deposit relationships (certificates of
deposit and IRA's) off the Bank's balance sheet. These deposits were sold for a
gain and thus the Bank's total assets were reduced getting the Bank closer to
the 7% capital requirement.
A fundamental problem for the Bank's business model was its expense
profile. Major cuts have been made including consolidating the branch network
(from 8 offices to 4). Even with this reduction in branch offices, the Bank
still carried more branches than its peer group, which was generally two and no
more than three branches. This reduction yielded $600,000 to the overall expense
savings, which is an aggregate of approximately $3 million over the past four
years.
The Bank's reengineering and restructuring has resulted in a more
streamlined organization that provided the proper organizational platform to
become a more strategy-focused institution. Without compromising the segregation
of duties and internal controls, management was able to capitalize on the
strengths of its staff by combining functions while pushing for more enhanced
leadership throughout the organization which is essential to achieve
profitability, the Bank's primary goal.
Management recognized that before it could introduce new strategies for
the Bank's core business, it had to ensure that the organization was running
like a well-oiled machine at every level. By compressing the organization and
putting emphasis on process improvements, management eliminated waste, and
improved on operational efficiencies, which is validated through improved
audits.
To maintain relevance in its marketplace, the Bank must have sound
business strategies that will yield results. The recent past has enabled
management to place more emphasis on strategy, with keen focus on a sound
organization. While there was a conscientious effort to dismantle the original
business model, management recognized the positive aspects of the model -
consistent core (versatile) staffing, low cost of funds, loyal customer base,
and strong net interest margins. These strengths can be built upon as a new,
productive model formulates and moves into action.
As was described earlier, the Bank is much more streamlined and through
effective cost controls, expenses are manageable. The goal is to develop more
earning assets to achieve profitability. Although many changes have been made
through consolidations and compressions, there are still opportunities for the
Bank to operate more efficiently and cost-effectively.
16
The Bank's Goals
Although the Bank's bottom line has not yet achieved a profit, the Bank
is a much stronger institution as a result of the aggressive steps taken to
decrease expenses, compress the organization, and strengthen internal controls.
The ultimate challenge for the institution has been to keep the franchise
vibrant while enhancing the business model. Continuing to surround these new
strategies and opportunities is a regulatory restraint that is unyielding until
the Bank produces a steady stream of earnings and an infusion of equity.
In spite of these challenges, new relationships have been developed
that will have a positive impact on the Bank's performance. It is apparent that
lack of time is an enemy to the profit restoration plan. There is clear evidence
that the cycle is changing with a good pipeline of business and new corporate
relationships that are abounding All solid relationships require time to
cultivate and develop. However, management continues to move with gusto to
enhance current business lines while developing new fee income streams that are
sustainable.
Of course, the Bank's core consumer business is poised for growth
through the financial service centers. With an aggressive marketing plan and
strategic partners and alliances, the following products are projected to yield
profitable returns:
|_| Auto Loan Refinance Program
|_| Home Equity Loans
|_| Personal Loans (Secured and Unsecured)
|_| Overdraft Protection
|_| Residential Mortgages
|_| Student Loans
The Bank will continue to participate in commercial deals with regional
banks to foster fee income in the following areas:
|_| Working Capital Lines of Credit
|_| Term Loans
|_| Demand Loans
|_| Commercial Real Estate (Construction & Permanent Mortgages)
The Bank continues with its niche businesses that are specialized areas
whereby the Bank has a strong position. These businesses are considered to have
a significant profit potential, but are not necessarily basic to a community
bank or its corporate mission. Certain niche products may be appropriately
marketed outside of the geographic area defined in the Bank's mission; however,
the marketing strategies will be consistent with the Bank's objectives:
|_| Church Loans
|_| Priority Loan Program (Auto Refinance Program)
|_| Predatory Loan Program (Home Improvement/Refinance Loan Program)
|_| Small Business Loans (Emerging Markets)
|_| Credit Cards
The key for the Bank in achieving its external goals is to maximize its
strategic partnerships and to supplement its loan originations with additional
loan volume from partners that have a stake in the urban communities. In
addition, other sources for fee income will include the maximum utilization of
the Bank's ATM network in high volume locations (i.e. areas near public
transportation, shopping, and restaurants) that are out of the reach of the
Bank's branches to capitalize on additional fees. Some of the Bank's ATMs have
experienced a drop in volume as competitors placed machines in close proximity
to existing high volume ATMs of the Bank and several of the Bank's high volume
ATM's were replaced with those of competitors that paid significantly higher
transactional fees to site owners. Management continues the process of
identifying potentially high volume locations to place machines.
17
Results of Operations
Summary
The Company recorded a net loss of approximately $1,115,000 for 2003
($1.03 per share) compared to a net loss of $217,000 for 2002 ($0.20 per share)
compared to a net loss of approximately $870,000 ($0.79 per share) for 2001. In
2003, the Bank made provisions to its allowance for loan losses totaling
$565,000 primarily to cover the charge-off of $710,000 for the non-Small
Business Administration guaranteed portion of a loan to one customer totaling
approximately $1.3 million. A reserve of $357,000 had been provided for this
loan in previous years. The balance of this loan has been submitted to the SBA
for collection.
In addition, during 2003, the Bank's average earning assets declined
by $6.7 million resulting in a decrease in net interest income of $436,000. The
decline in earning assets was primarily related the reduction in deposit
balances of two deposit customers. These funds were required for the operating
needs of the customers.
During 2003, the Bank continued the implementation of its profit
restoration plan that resulted in a decline in noninterest expenses of $363,000
compared to 2002. Components of the plan include among other things staff
reductions/consolidations, salary reductions, reduction in branch operating
hours, continued elimination of director fees, and the reduction of other
operating expenses.
In 2002, the Bank was awarded a $198,000 grant from the U.S. Treasury
Department's Bank Enterprise Award (BEA) Fund that 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 Bank submitted its application to the BEA Fund in February
2004 for its 2003 loan activity. If selected, the Bank may receive a grant in
September 2004.
In addition, revenue enhancement strategies have been employed to
expand opportunities for fee income through the implementation of new products
and services including corporate loan syndications where the Bank serves in the
role of arranger and/or administrative agent. During 2003, the Bank generated
fees totaling $85,000 from this line of business. Further growth in this new
core line of business is projected in 2004.
While expense reductions continue to be achieved, a greaterimpact will 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.
18
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,
2003 2002 2001
----------------------- ----------------------- ------------------------
Average Yield/ Average Yield/ Average Yield/
(Dollars in thousands) balance Interest rate balance Interest rate balance Interest rate
----------------------- ----------------------- ------------------------
Assets:
Interest-earning assets:
Loans........................... $45,168 $2,913 6.45% $42,839 $3,006 7.02% $45,828 $3,595 7.85%
Investment securities
held-to-maturity 6,479 273 4.21 10,155 626 6.16 14,669 987 6.73
Investment securities
available-for-sale 10,262 553 5.38 13,783 831 6.03 11,758 772 6.57
Federal funds sold.............. 8,498 98 1.15 10,406 169 1.62 7,726 282 3.65
------- ------ ------- ------ ------- ------
Total interest-earning assets 70,407 3,837 5.45 77,183 4,632 6.00 79,981 5,636 7.05
Noninterest-earning assets:
Cash and due from banks......... 4,433 4,542 4,801
Premises and equipment, net..... 2,679 2,613 3,214
Other assets.................... 3,922 2,926 4,028
Less allowance for loan losses.. (713) (674) (576)
------- ------- ------
Total........................ $80,728 $86,590 $91,448
======= ======= =======
Liabilities and shareholders' equity:
Interest-bearing liabilities:
Demand deposits................. $11,924 $ 83 0.70% $12,882 114 0.89% $13,802 178 1.29%
Savings deposits................ 20,241 89 0.44 21,931 129 0.59 24,480 317 1.29
Time deposits................... 21,565 375 1.74 23,712 662 2.79 24,089 1,081 4.49
Other borrowed funds............ - - - - - - 1 - -
------- ------ ------- ------ ------- ------
Total interest-bearing
liabilities 53,730 547 1.02 58,525 906 1.55 62,372 1,576 2.53
Noninterest-bearing liabilities:
Demand deposits................. 18,439 19,565 19,612
Other........................... - - 431
Shareholders' equity................ 8,559 8,500 9,033
------- ------- -------
Total........................ $80,728 $91,448
======= ======= =======
Net interest earnings............... 3,290 $ 3,726 $ 4,060
Net yield on interest-earning assets 4.67% 4.83% 5.08%
For purposes of computing the average balance, loans are not reduced for
nonperforming loans.
Net Interest Income
Net interest income is an effective measure of how well management has
balanced the Bank's interest rate-sensitive assets and liabilities. Net interest
income, the difference between (a) interest and fees on interest-earning assets
and (b) interest paid on interest-bearing liabilities, is a significant
component of the Bank's earnings. Changes in net interest income result
primarily from increases or decreases in the average balances of
interest-earning assets, the availability of particular sources of funds and
changes in prevailing interest rates.
Net interest income in 2003 totaled $3.3 million, a decrease of $436,000,
or 11.70%, compared to 2002. Net interest income for 2002 totaled $3.7 million,
a decrease of $334,000 or 8.23%, compared to 2001.
19
2003 compared to 2002 2002 compared to 2001
----------------------------- -----------------------------
Increase (decrease) due to Increase (decrease) due to
----------------------------- -----------------------------
(Dollars in thousands) Volume Rate Net Volume Rate Net
------- ------- ------- ------- ------- -------
Interest earned on:
Loans............................................... $ 151 $ (244) $ (93) $(209) $(380) $ (589)
Investment securities held-to-maturity.............. (167) (186) (353) (277) (84) (361)
Investment securities available-for-sale............ (161) (117) (278) 122 (63) 59
Federal funds sold.................................. (22) (49) (71) 44 (157) (113)
----- ----- ----- ----- ----- ------
Total interest-earning assets.................... (199) (596) (795) (320) (684) (1,004)
----- ----- ----- ----- ----- ------
Interest paid on:
Loans............................................... $ (209) $ (380) $(589) $(742) $(317) $(1,059)
Demand deposits..................................... (6) (25) (31) (8) (55) (63)
Savings deposits................................... (7) (33) (40) (16) (172) (188)
Time deposits....................................... (37) (251) (288) (9) (410) (419)
----- ----- ----- ----- ----- ------
Total interest-bearing liabilities............... (50) (309) (359) (33) (637) (670)
----- ----- ----- ----- ----- -------
Net interest income.............................. $ (149) $ (287) $(436) $(287) $ (47) $ (334)
====== ====== ===== ===== ===== =======
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 2003, there was a decrease in net interest income of $149,000 due to
changes in volume and a decrease of $287,000 due to changes in rate. In 2002,
there was a decrease in net interest income of $287,000 due to changes in volume
and a decrease of $47,000 due to changes in rate.
Average earning assets decreased from $77 million in 2002 to $70
million in 2003 and decreased from $80 million in 2000 to $77 million in 2002.
To meet capital requirements mandated in its Written Agreement with regulators
(Refer to "Regulatory Action" above and "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. During the three subsequent years, in effort to manage its
capital adequacy, the Bank has not aggressively sought significant deposit
growth. The Bank's core deposit base has remained relatively stable and
represents 85% 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 4.67% in 2003, 4.83% in 2002,
and 5.08% in 2001. Management actively manages its exposure to interest rate
changes. While the prime rate decreased more than 450 basis points over the last
three years, the Bank did not experience a similar decline in yield on its
earning assets. This is because only 29.65% of the Bank's loan portfolio
reprices or matures in less than one year. The structure for many of the
commercial loans of the Bank includes a five to seven year fixed rate with a
balloon. This type of structure minimizes the Bank's interest rate risk and
allows for repricing in five to seven years. In addition, except for a recently
purchased portfolio of home equity lines of credit that float with prime, much
of the Bank's consumer and mortgage portfolios have fixed interest rates. 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 2003, the average federal funds yield was 1.15% compared to
1.62% in 2002 and 3.65% in 2001. During 2003, the average investment in federal
funds decreased by $2 million. Alternate investment strategies were implemented
to place liquid funds into loans and longer-term securities including
mortgage-backed (MBS) to minimize the impact of the decline in the rate paid on
Federal Funds Sold.
The yield on the investment portfolio decreased 116 basis points to
4.93% in 2003 compared to 6.09% in 2002 and 6.66% in 2001. Over the last two
years, 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.
20
The cost of interest-bearing liabilities declined to 1.02% in 2003
compared to 1.55% in 2002. Consistent with market conditions during 2003, the
Bank reduced the rates it pays on many of its interest-bearing products. When
setting the pricing for its deposits, the Bank generally uses the median rate
paid by its competitors in the region. Because most of the Bank's deposits are
considered core, they were not sensitive to 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 2003 was
$565,000 compared to $175,000 in 2002 and $335,000 in 2001. In December 2003,
the Bank charged off $710,000 that represented the non-Small Business
Administration (SBA) guaranteed portion of a loan to one borrower in the
telecommunications industry. A specific reserve of $357,000 had previously been
established to cover potential losses. Severe financial difficulties experienced
by the borrower make the full collection of this loan uncertain. Loans to this
borrower totaled $1.3 million. The Bank has presented this loan to the SBA for
collection of the guaranteed portion of the loans that total $569,000 . Although
the Bank has charged-off a portion of this loan, management will seek to
maximize its recovery through appropriate legal action.
During the current uncertain 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, 2003.
Noninterest Income
Noninterest income decreased $436,000 in 2003 compared to 2002 and
decreased $116,000 in 2002 compared to 2001.
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 2003 compared to 2002 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 2003 compared to 2002 resulted in less overdraft
fees, activity service charges and low balance fees. In 2003, to avoid the
necessity to escheat the balances of inactive customer accounts (NOTE: The
Commonwealth of Pennsylvania requires that accounts that are inactive for five
years or more be closed and escheated to the state.), the Bank made an extensive
effort to contact customers to re-activate their accounts. This resulted in a
reduction in activity/dormant account service charges.
During 2003, surcharge income on the Bank's ATM network declined by
$121,000, or 14.76%, compared to 2002. Some of the Bank's ATMs have experienced
a drop in volume as competitors placed machines in close proximity to existing
high volume ATMs of the Bank and several of the Bank's high volume ATM's were
replaced with those of competitors that paid significantly higher transactional
fees to site owners. Management continues the process of identifying potentially
high volume locations to place machines.
In September 2002, the Bank received a $198,000 grant 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.) The Bank submitted its
application to the BEA Fund in February 2004 for its 2003 loan activity. If
selected, the Bank may receive a grant in September 2004.
21
During 2003, the Bank further developed a new core line of business--
serving as arranger/agent for loan syndications for major corporations
throughout the country. In 2003, the Bank was selected to syndicate three
significant back-up lines/letters of credit with other minority banks throughout
the country for major corporations for which it received agent fees totaling
$85,000. These fees will be received annually for the administration of the
credit facilities. In 2002, these fees totaled $25,000. Management plans to
continue to develop this core line of business to generate fee income to support
the Bank's profitability goals.
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.
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 $363,000, or 5.96%, in 2003 compared to
2002 and decreased $943,000, or 13.4%, in 2002 compared to 2001.
Salaries and benefits decreased $140,000, or 5.98% in 2003 compared to
a decrease of $320,000, or 12.01%, in 2002. 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 $69,000, or
5.34%, during 2003 compared to a decrease of approximately $316,000, or 19.62%,
during 2002. In August 2003, the Bank purchased its 38th and Lancaster Street
Branch as a measure to reduce its occupancy expense. This branch had been leased
on a "triple net" basis where the Bank bore all expenses related to the
facility. The projected annual savings on this transaction is $20,000. Also, in
conjunction with the expiration of the lease, the Bank's 714 Market Street
branch was closed/consolidated with the Two Penn Center branch office in
February 2002. Further, the Bank's former Frankford branch office was sold on
June 8, 2002 resulting in a reduction in real estate taxes and property
insurance. Finally, 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 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, and student loan portfolios. Data processing expenses
increased by $40,000, or 6.45%, during 2003 compared to a decrease of $168,000
or 20.81%, during 2002. This increase is related to increased service activities
provided by the Bank's new core data processor, FISERV. These services including
statement rendering and research (imaging), were previously performed in-house.
In November 2002, the Bank converted its core data processing to FISERV to
achieve cost savings and create efficiencies to allow for further reductions in
personnel expense. In December 2003, the Bank converted/consolidated its
consumer loan accounting process (previously outsourced to EDS) with its core
vendor, FISERV. This conversion will reduce monthly processing cost by an
estimated $6,000. Savings will begin to be realized in 2004. The Bank continues
to study methods by which it may further reduce its data processing cost.
Marketing and public relations expense increased by $31,000, or 37.32%,
in 2003 compared to a decrease of $27,000, or 24.39% in 2002. In 2003, to
further enhance its image and encourage business development, the Bank began a
re-branding campaign that included, among other things, new brochures and
in-branch signage. Management is firmly committed to enhancing the Bank's
marketing and sales profile through effective communication and leadership. It
knows that to remain competitive the Bank must develop better strategies for
marketing and sales. Management is also committed to making the Bank's marketing
drive the overall business planning process. Niche markets (church lending) have
been identified and the Bank is committed to increasing this niche while adding
others.
22
There are two basic things that need to be done in order to reach the
Bank's goals and objectives-- attract new customers and partners and retain the
existing customers and partners. In order to do this, management must look at a
variety of strategies including the following:
Advertising
|_| Management will seek cost-effective ways to advertise the Bank's
products and services. Community-based newspapers and other forms
of advertising that include the church bulletins in targeted
churches will be utilized.
Public Relations
|_| The Bank will seek innovative ways to get its story out to the
public. It will participate on talk radio programs, and use a
variety of methods such as special events to make the Bank's name
more visible.
Marketing
|_| The Bank will retain professional services to assist management
in creating a "buzz" about the Bank.
Professional services decreased by $63,000, or 22.18%, in 2003 compared
to an increase of $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. There were no significant legal matters
during 2003.
Office operations and supplies expense increased by $20,000, or 4.53%,
in 2003 compared to a decrease of $21,000, or 4.54%, in 2002. The increase in
2003 is primarily related to additional security cost. With the new emphasis on
Homeland Security, the Bank heightened its security coverage. The review of more
cost-effective security measures is currently underway. 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 $34,000 in 2003, $36,000 in 2002
and $150,000 in 2001. FDIC insurance premiums are applied to all financial
institutions based on a risk based premium assessment system. Under this system,
bank strength is based on three factors: 1) asset quality, 2) capital strength,
and 3) management. Premium assessments are then assigned based on the
institution's overall rating, with the stronger institutions paying lower rates.
The Bank's assessment was based on 15 basis points for BIF (Bank Insurance Fund)
assessable deposits and SAIF (Savings Insurance Fund) assessable deposits. The
decrease during 2003 is a result of a reduction in the Bank's level of deposits.
All other expenses are reflective of the general cost to do business and
compete in the current regulatory environment and maintenance of adequate
insurance coverage.
23
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$6.8 million, or 8.78%, in 2003 compared to a decrease of
$2.8 million, or 3.50%, in 2002.
Table 3--Sources and Use of Funds Trends
2003 2002 2001
------------------------------- ------------------------------- ---------
Increase Increase
Average (decrease) Average (decrease) Average
(Dollars in thousands) balance amount Percent balance amount Percent balance
--------- -------- ------- --------- -------- ------- ---------
Funding uses:
Loans ............................. $45,168 $ 2,329 5.44% $42,839 $(2,989) (6.52)% $45,828
Investment securities..............
Held-to-maturity................. 6,479 (3,676) (36.20) 10,155 (4,514) (30.77) 14,669
Available-for-sale............... 10,262 (3,521) (25.55) 13,783 2,025 17.22 11,758
Federal funds sold............... 8,498 (1,908) (18.34) 10,406 2,680 34.69 7,726
------- ------- ------- ------- -------
Total uses................... $70,407 $(6,776) $77,183 $(2,798) $79,981
======= ======= ======= ======= =======
Funding sources:
Demand deposits:
Noninterest-bearing.............. $18,439 $(1,126) (5.76)% $19,565 $ (47) (0.09)% $19,612
Interest-bearing................. 11,924 (958) (7.44) 12,882 (920) (6.67) 13,802
Savings deposits................... 20,241 (1,690) (7.70) 21,931 (2,549) (10.41) 24,480
Time deposits...................... 21,565 (2,147) (9.05) 23,712 (377) (1.57) 24,089
Other borrowed funds............... - - - - (1) (100.00) 1
------- ------- ------- ------- -------
Total sources................ $72,169 $(5,921) $78,090 $(3,894) $81,984
======= ======= ======= ======= =======
*Includes held-to-maturity and available-for-sale securities
Investment Securities and Other Short-Term Investments
The Bank's investment portfolio is classified as either
held-to-maturity or available-for-sale. Investments classified as
held-to-maturity are carried at amortized cost and are those securities the Bank
has both the intent and ability to hold to maturity. Investments classified as
available-for-sale are those investments the Bank intends to hold for an
indefinite amount of time, but not necessarily to maturity, and are carried at
fair value, with the unrealized holding gains and losses reported as a component
of shareholders' equity on the balance sheet.
Average investment securities and federal funds sold, in the aggregate,
decreased by $9.1 million, or 26.5% in 2003 compared to an increase of $191,000,
or .56%, in 2002 . The significant decline in the portfolio was caused by the
high level of called agency securities as well as an increase in the prepayment
speed on the Bank's mortgage-backed securities. In addition, excess liquidity
previously held in Federal Funds Sold was re-deployed to higher yielding loans
during 2003.
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 2.78 years. In the current low interest rate environment, the
duration of the investment portfolio is shortened because of the of callable
government agency securities and the increase in the prepayment speed on the
Bank's mortgage-backed security portfolio. Approximately $4 million in
securities were called during 2003. The average yield of called securities was
6.00%. Calls will likely diminish in 2004 as most of the higher yielding
callable agency securities were called over the last two years. The average
yield on the callable agency portfolio at December 31, 2003 was 4.43% and is
closely aligned with current market pricing.
24
Approximately 70.2% 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. Because customers
are more likely to refinance in the current low interest rate environment, the
prepayment speed increased on this component of the portfolio. The constant one
year prepayment rate (CPR) at December 31, 2003 was 42.93 that translates into
42.93% of the mortgage pool repaying on an annual basis. This results in more
cashflow availability to fund loans or to reinvest in the projected increasing
interest rate environment.
The Bank will continue to take steps to control the level of optionality
in the portfolio by identifying replacement loans or securities that
diversify risk and provide some level of monthly cashflow to be reinvested in
the future rising rate environments. The Bank's strategy is to invest funds in
hybrid mortgage-backed securities that are fixed for three to ten years and then
become adjustable with the current market conditions. These securities have
average current yields of at least 4.00% and estimated durations of 5 years with
monthly cashflow.
Table 4--Analysis of Investment Securities
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...... $ - - % $1,250 3.92% $3,250 4.85% $ - - % $ 4,500
Mutual funds and other........... - - - - - - - - 395
Mortgage-backed securities....... - - - - - - - - 10,611
----- ------ ------ ------ -------
Total securities................. $ - - $1,250 - $3,250 - $ - - $15,506
Average maturity................. 2.78 years
The above table sets forth the maturities of investment securities at December
31, 2003 and the weighted average yields of such securities (calculated on the
basis of the cost and effective yields weighted for the scheduled maturity of
each security).
Loans
Average loans increased approximately $2.3 million, or 5.44%, in 2003
compared to a decrease of approximately $3 million, or 6.52%, in 2002. 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 $3 million in
commercial loan participations were booked during 2003. Most of these
participations were secured by commercial real estate.
In June 2003, the Bank purchased approximately $4.8 million adjustable
rate residential mortgage loans. This purchase was made to supplement the Bank's
residential loan portfolio that had declined because of high refinancing
activity as a result of the historically low interest rate environment. Also, in
December 2003, the Bank sold approximately $3 million in lower yielding student
loans and purchased approximately $3.7 million in higher yielding variable rate
Home Equity Lines of Credit.
The Bank's loan-to-deposit ratio at December 31, 2003 was 69.6% up from
56.5% at December 31, 2002. The target loan-to-deposit ratio is 75%. This level
would allow the Bank to optimize interest income on earning assets while
maintaining adequate liquidity. The increase in this ratio is the result of an
increase in loans outstanding coupled with a smaller deposit base. 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.
25
As reflected in Table 5 below, during 2003, because of the purchase of
residential mortgage loans, this category increased by $1.5 million to 32% of
total loans.
As reflected in Table 6 below, approximately 40% of the Bank's loan
portfolio have scheduled maturities or reprice in five years or more. This
position is largely a result of the Bank's relatively high level of residential
mortgage loans and the typical five to seven year balloon structure of the
commercial real estate portfolio. While scheduled maturities and repricing
exceed five years, the actual duration of the portfolio may be much shorter
because of the rapid repayment speed of the Bank's residential mortgage loan
portfolio.
Table 5--Loans Outstanding, Net of Unearned Income
December 31,
(Dollars in thousands) 2003 2002 2001 2000 1999
------- ------- ------- ------- -------
Commercial and industrial................... $11,361 $10,855 $11,054 $11,429 $13,664
Commercial real estate...................... 11,862 11,898 5,504 652 1,288
Residential mortgages....................... 15,110 13,560 18,148 22,316 26,237
Consumer loans.............................. 8,695 7,820 8,294 10,908 19,822
------- ------- ------- ------- -------
Total loans............................. $47,028 $44,133 $43,000 $45,305 $61,011
======= ======= ======= ======= =======
Table 6--Loan Maturities and Repricing
Within After one but After
(Dollars in thousands) one year within five years five years Total
------------ ----------------- ---------- -------
Commercial and industrial................... $ 7,742 $ 2,759 $ 649 $11,150
Commercial real estate...................... 757 2,616 8,700 12,073
Residential mortgages....................... 360 7,031 7,719 15,110
Consumer loans.............................. 5,085 1,797 1,813 8,695
------ ------ ------ ------
Total loans........................... 13,944 14,203 18,881 47,028
Loans maturing after one year with:
Fixed interest rates.................... $21,767
Variable interest rates................. 11,317
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) 2003 2002 2001 2000 1999
------- ------- ------- ------- -------
Nonaccrual loans............................ $1,588 $ 651 $ 412 $ 453 $2,027
Interest income included in net income
for the year............................ 62 25 25 20 67
Interest income that would have been
recorded under original terms........... 120 49 29 28 113
Loans past due 90 days and still accruing... 560 797 526 34 53
Restructured loans.......................... 569 1,286 182 632 580
26
At December 31, 2003, nonaccrual loans totaled $1,588,000, compared to
$651,000 at December 31, 2002. The increase in nonaccrual loans is primarily in
the commercial loan sector of the loan portfolio. At December 31, 2003, $897,000
of the Bank's nonaccrual loans carried some level of guarantee from the Small
Business Administration ("SBA"). The underlying credit enhancement provided by
the SBA minimizes the risk of loss on these loans. In addition, at December 31,
2003, approximately $415,000 of the total nonaccrual loans were residential
mortgages. The strong loan-to-values associated with these loans reduce the risk
of loss. Historically, the Bank has not experienced losses in its residential
loan portfolio.
The balance of impaired loans was $1,124,000 and $1,951,000 as of
December 31, 2003 and 2002, respectively. The Bank identifies a loan as impaired
when it is probable that interest and principal will not be collected according
to the contractual terms of the loan agreement. The allowance for loan loss
associated with these loans was $75,000 and $402,000 at December 31, 2003 and
2002, respectively. The reduction in the allowance during 2003 resulted from the
charge-off of $710,00 related to the un-guaranteed portion of a $1.3 million
loan to one customer. The balance of this loan, $569,000 (guaranteed by the SBA)
remains in the total of impaired loans. The Bank has submitted this loan for
collection from the SBA.
At December 31, 2003, approximately $897,000 (including the loan referenced
above) of the impaired loans have SBA guarantees. Interest income recognized on
impaired loans during 2003 and 2002 was $64,000 and $104,000, 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, 2003, the Bank had approximately $569,000 in
restructured loans.
There is no known information about possible credit problems other than
those classified as nonaccrual or impaired that causes management to be
uncertain as to the ability of any borrower to comply with present loan terms.
The Bank grants commercial, residential, and consumer loans to
customers primarily located in Philadelphia County, Pennsylvania and surrounding
counties in the Delaware Valley. Although the Bank has a diversified loan
portfolio, its debtors' ability to honor their contracts is influenced by the
region's economy.
At December 31, 2003, approximately 20% 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, 2003, none of these
loans were nonperforming.
Allowance for Loan Losses
The allowance for loan losses reflects management's continuing
evaluation of the loan portfolio, assessment of economic conditions, the
diversification and size of the portfolio, adequacy of collateral, past and
anticipated loss experience, and the amount and quality of nonperforming loans.
Table 8 below presents the allocation of loan losses by major category for the
past five years. The specific allocations in any particular category may prove
to be excessive or inadequate and consequently may be reallocated in the future
to reflect then current conditions.
27
The allowance for loan losses as a percentage of total loans was 0.72%
at December 31, 2003 compared with 1.53% at December 31, 2002. The decline in
the allowance is a result of the charge-off of $710,000 of the non-SBA
guaranteed portion of loans to one borrower for which full collectibility is
uncertain. (Refer to Provision for Loan Losses above for further discussion on
this loan.)
At December 31, 2003, the Bank's classified loans totaled $1.2 million,
or 2.60%, of total loans. Approximately, $897,000 of these loans have guarantees
of the SBA. In addition, specific reserves of $178,000 have been allocated to
these loans.
Table 8--Allocation of Allowance for Loan Losses
2003 2002 2001 2000 1999
------------------- ------------------- ------------------- ------------------- -------------------
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......... $ 267 31.51% $ 565 24.60% $ 576 37.30% $ 383 25.23% $ 263 22.40%
Commercial real
estate............. 1.22 37 26.96 29 1.21 11 1.44 877 2.11
Residential mortgages 35 24.57 45 17.72 30 19.29 102 24.08 144 43.00
Consumer loans........ 37 42.70 28 30.72 73 42.20 66 49.25 283 32.49
Unallocated.... - - - - - - - - 32 -
----- ------ ----- ------ ----- ------ ----- ------ ------ ------
$ 339 100.00% $ 675 100.00% $ 708 100.00% $ 562 100.00% $1,567 100.00%
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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,
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(Dollars in thousands) 2003 2002 2001 2000 1999