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EX-23.0 - UNITED BANCORP, INC. EXHIBIT 23 TO FORM 10-K - UNITED BANCORP INC /MI/unitedex23.htm
EX-24.0 - UNITED BANCORP, INC. EXHIBIT 24 TO FORM 10-K - UNITED BANCORP INC /MI/unitedex24.htm
EX-32.1 - UNITED BANCORP, INC. EXHIBIT 32.1 TO FORM 10-K - UNITED BANCORP INC /MI/unitedex321.htm
EX-31.2 - UNITED BANCORP, INC. EXHIBIT 31.2 TO FORM 10-K - UNITED BANCORP INC /MI/unitedex312.htm
EX-31.1 - UNITED BANCORP, INC. EXHIBIT 31.1 TO FORM 10-K - UNITED BANCORP INC /MI/unitedex311.htm
EX-99.2 - UNITED BANCORP, INC. EXHIBIT 99.2 TO FORM 10-K - UNITED BANCORP INC /MI/unitedex992.htm
EX-99.1 - UNITED BANCORP, INC. EXHIBIT 99.1 TO FORM 10-K - UNITED BANCORP INC /MI/unitedex991.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

þ             Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2012

Commission File #0-16640

United Bancorp, Inc.
(Exact name of registrant as specified in its charter)
Michigan
38-2606280
(State or other jurisdiction of incorporation or organization)
( I.R.S. Employer Identification No.)

2723 South State Street, Ann Arbor, MI 48104
(Address of principal executive offices)

Registrant's telephone number, including area code: (517) 423-8373

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  
Yes   o     No   þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  
Yes   o     No   þ

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 Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.  
Yes  þ     No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such file).
Yes þ  No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405) 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. þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.
Large Accelerated Filer o                                                                      Accelerated Filer                                        o
Non-Accelerated Filer o (do not check if a smaller reporting company)                                            Smaller reporting company þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes             o     No             þ

As of June 30, 2012, the aggregate market value of the common stock held by non-affiliates of the registrant was $41,811,000, based on a closing sale price of $3.40 as reported on the OTCQB market.

As of January 31, 2013, there were 12,705,983 outstanding shares of registrant's common stock, no par value.
 


DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant's definitive Proxy Statement in connection with the 2013 Annual Meeting of Shareholders are incorporated by reference into Part III of this report.

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and United Bancorp, Inc. Forward-looking statements are identifiable by words or phrases such as "outlook" or "strategy"; that an event or trend "may," "could," "should," "will," "is likely," or is "probable" or "projected" to occur or "continue" or "is scheduled" or "on track" or that the Company or its management "anticipates," "believes," "estimates," "plans," "forecasts," "intends," "predicts," or "expects" a particular result, or is "confident," "optimistic" or has an "opinion" that an event will occur, or other words or phrases such as "ongoing," "future," "evaluating," "alternatives,"  "potential," "effort," "tend" and variations of such words and similar expressions.  Such statements are based upon current beliefs and expectations and involve substantial risks and uncertainties which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These statements include, among others, statements related to evaluation of alternatives related to the Preferred Shares, plans for raising capital, asset and credit quality trends, future levels of marketing and advertising expense, deployment of liquidity and loan demand, future economic conditions, future investment opportunities, future levels of expenses associated with other real estate owned, real estate valuation, future recognition of income, future levels of non-performing loans, the rate of asset dispositions, future capital levels, future dividends, market growth potential, future growth and funding sources, future liquidity levels, future profitability levels, the effects on earnings of changes in interest rates and the future level of other revenue sources. All of the information concerning interest rate sensitivity is forward-looking. All statements referencing future time periods are forward-looking.

Management's determination of the provision and allowance for loan losses, the appropriate carrying value of intangible assets (including mortgage servicing rights and deferred tax assets) and the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary and the amount of any impairment) involves judgments that are inherently forward-looking. There can be no assurance that future loan losses will be limited to the amounts estimated or that other real estate owned can be sold for its carrying value or at all. Our ability to successfully implement new programs and initiatives, increase efficiencies, utilize our deferred tax asset, address regulatory issues, respond to declines in collateral values and credit quality, and improve profitability is not entirely within our control and is not assured. The future effect of changes in the financial and credit markets and the national and regional economy on the banking industry, generally, and on United Bancorp, Inc., specifically, are also inherently uncertain. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("risk factors") that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. United Bancorp, Inc. undertakes no obligation to update, clarify or revise forward-looking statements to reflect developments that occur or information obtained after the date of this report.

Risk factors include, but are not limited to, the risk factors described in "Item 1A - Risk Factors" of this report. These and other factors are representative of the risk factors that may emerge and could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.
Page 2


 

CROSS REFERENCE TABLE
 
 
Item No.
Description
Page
PART I
 
 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II
 
PART III
 
PART IV
 
 
 
 


PART I

ITEM 1                          BUSINESS

United Bancorp, Inc. (the "Company" or "United") is a Michigan corporation headquartered in Ann Arbor, Michigan and serves as the holding company for United Bank & Trust ("UBT" or "the Bank"), a Michigan-chartered bank organized over 115 years ago. The Company is a bank holding company registered with the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") under the Bank Holding Company Act of 1956, as amended (the "Bank Holding Company Act"). The Company has corporate power to engage in activities permitted to business corporations under the Michigan Business Corporation Act, subject to the limitations of the Bank Holding Company Act and regulations of the Federal Reserve System. In general, the Bank Holding Company Act and regulations restrict the Company with respect to its own activities and activities of any subsidiaries to the business of banking or other activities that are closely related to the business of banking. At December 31, 2012, the Company had total assets of approximately $907.7 million, total deposits of approximately $784.6 million, and total shareholders' equity of approximately $97.4 million. For more information about the Company's financial condition and results of operations, see the consolidated financial statements and related notes filed as part of this report.

The Company has four primary lines of business under one operating segment of commercial banking: banking services, residential mortgage, wealth management and structured finance. During the year ended December 31, 2012, our net interest income accounted for approximately 58.4% of our operating revenues and our noninterest income accounted for approximately 41.6% of our operating revenues. This compares to 63.6% and 36.4%, respectively, for 2011 and 65.6% and 34.4%, respectively, for 2010.

The Company was formed in 1985 to acquire all of the capital stock of UBT. The Company provides services through the Bank's system of seventeen banking offices, one trust office, one loan production office and twenty-one automated teller machines, located in Washtenaw, Lenawee, Livingston and Monroe Counties, Michigan. United's corporate headquarters are located in Ann Arbor, which is located in Washtenaw County, Michigan. The employment base of Washtenaw County is centered around health care, education and automotive high technology. Economic stability is provided to a great extent by the University of Michigan, which is a major employer and is not as economically sensitive to the fluctuations of the automotive industry. The services and public sectors account for a substantial percentage of total industry employment, in large part due to the University of Michigan and the University of Michigan Medical Center.

The Bank offers a full range of services to individuals, corporations, fiduciaries and other institutions. Banking services include checking accounts, NOW accounts, savings accounts, time deposit accounts, money market deposit accounts, safe deposit facilities and money transfers. Lending operations provide real estate loans, secured and unsecured business and personal loans, consumer installment loans, credit card and check-credit loans, home equity loans, accounts receivable and inventory financing, and construction financing. We offer our customers a full array of conventional residential mortgage products, including purchase, refinance and construction loans. The Bank offers a full complement of online services, including internet banking and bill payment.



The Bank maintains correspondent bank relationships with a small number of larger banks, which involve check clearing operations, securities safekeeping, transfer of funds, loan participation, purchase and sale of federal funds and other similar services.

Our mortgage group offers our customers a full array of conventional residential mortgage products, including purchase, refinance and construction loans. Due to our local decision making and fully-functional back office, we believe we have consistently been one of the most active originators of residential mortgage loans in our market area. Our mortgage group generated 33.3% of our noninterest income for the twelve months ended December 31, 2012.

Our Wealth Management group is a key focus of our growth and diversification strategy and offers a variety of investment services to individuals, corporations and governmental entities. The department provides trust services, financial planning services, investment services, custody services, pension paying agent services and acts as the personal representative for estates. These products help to diversify the Company's sources of income. The Bank offers nondeposit investment products through licensed representatives in its banking offices. Our Wealth Management group generated 24.4% of our noninterest income for the twelve months ended December 31, 2012.

Our structured finance group, United Structured Finance Company ("USFC"), offers simple, effective financing solutions to small businesses and commercial property owners, primarily by utilizing various government guaranteed loan programs and other off-balance sheet finance solutions through secondary market sources. The loans generated by USFC are typically sold on the secondary market, to the extent allowed by the applicable SBA programs. Gains on the sale of those loans are included in income from loan sales and servicing. USFC revenue provides additional diversity to the Company's income stream, and provides additional financing alternatives to clients of the Bank as well as non-bank clients. For the twelve months ended September 30, 2012 and 2011, United Structured Finance Company was the leading SBA lender in Lenawee, Washtenaw and Livingston Counties, combined. For 2012, USFC was the second-largest SBA 7A lender in Michigan, based on loan volume.

The Company's loan portfolio is not concentrated in any one industry. The Company has no foreign loans, assets or activities. No material part of the business of the Company is dependent upon a single customer or very few customers.

Supervision and Regulation

General

The Company and the Bank are extensively regulated and are subject to a comprehensive regulatory framework that imposes restrictions on their activities, minimum capital requirements, lending and deposit restrictions, and numerous other requirements. This system of regulation is primarily intended for the protection of depositors, federal deposit insurance funds and the banking system as a whole, rather than for the protection of shareholders and creditors. Many of these laws and regulations have undergone significant change in recent years and are likely to change in the future.



Future legislative or regulatory change, or changes in enforcement practices or court rulings, may have a significant and potentially adverse impact on the Company's operations and financial condition.

The Company

The Company is subject to supervision and regulation by the Federal Reserve System. Its activities are generally limited to owning or controlling banks and engaging in such other activities as the Federal Reserve System may determine to be closely related to banking. Prior approval of the Federal Reserve System, and in some cases various other government agencies, is required for the Company to acquire control of any additional bank holding companies, banks or other operating subsidiaries. The Company is subject to periodic examination by the Federal Reserve System, and is required to file with the Federal Reserve System periodic reports of its operations and such additional information as the Federal Reserve System may require.

The Company is a legal entity separate and distinct from the Bank. There are legal limitations on the extent to which the Bank may lend or otherwise supply funds to the Company. Payment of dividends to the Company by the Bank, the Company's principal source of funds, is subject to various state and federal regulatory limitations. Under the Michigan Banking Code of 1999, the Bank's ability to pay dividends to the Company is subject to the following restrictions:

 
·
A bank may not declare or pay a dividend if a bank's surplus would be less than 20% of its capital after payment of the dividend.
 
 
 
 
·
A bank may not declare a dividend except out of net income then on hand after deducting its losses and bad debts.
 
 
 
 
·
A bank may not declare or pay a dividend until cumulative dividends on preferred stock, if any, are paid in full.
 
 
 
 
·
A bank may not pay a dividend from capital or surplus.

Federal law generally prohibits a bank from making any capital distribution (including payment of a dividend) or paying any management fee to its parent company if the depository institution would thereafter be undercapitalized. The Federal Deposit Insurance Corporation ("FDIC") may prevent an insured bank from paying dividends if the bank is in default of payment of any assessment due to the FDIC. In addition, the FDIC may prohibit the payment of dividends by a bank if such payment is determined, by reason of the financial conditions of the bank, to be an unsafe and unsound banking practice. In addition, the Federal Reserve Bank of Chicago (the "Reserve Bank") has restricted the Company from declaration or payment of common stock dividends without prior written approval of the Reserve Bank. See "Board Resolution" below.
 
Additional information on restrictions on payment of dividends by the Company and the Bank may be found under Item 5 of this report and under Note 14 hereof, all of which information is incorporated here by reference.




Under Federal Reserve Board policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank. In addition, if the Michigan Office of Financial and Insurance Regulation ("OFIR") deems a Bank's capital to be impaired, OFIR may require the Bank to restore its capital by a special assessment on the Company as the Bank's only shareholder. If the Company fails to pay any assessment, the Company's directors would be required, under Michigan law, to sell the shares of the Bank's stock owned by the Company to the highest bidder at either a public or private auction and use the proceeds of the sale to restore the Bank's capital.

The Federal Reserve Board and the FDIC have established guidelines for risk-based capital by bank holding companies and banks. These guidelines establish a risk-adjusted ratio relating capital to risk-weighted assets and off-balance-sheet exposures. These capital guidelines primarily define the components of capital, categorize assets into different risk classes, and include certain off-balance-sheet items in the calculation of capital requirements.

The FDIC Improvement Act of 1991 established a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, federal banking regulators have established five capital categories – well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, in which all institutions are placed. The federal banking agencies have also specified by regulation the relevant capital levels for each of the categories.

Federal banking regulators are required to take specified mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Subject to a narrow exception, the banking regulator must generally appoint a receiver or conservator for an institution that is critically undercapitalized. An institution in any of the under-capitalized categories is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. An undercapitalized institution is also generally prohibited from paying any dividends, increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval.

Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and other restrictions on its business. In addition, such a bank would generally not receive regulatory approval of any application that requires the consideration of capital adequacy, such as a branch or merger application, unless the bank could demonstrate a reasonable plan to meet the capital requirement within a reasonable period of time. At December 31, 2012, the capital ratios of the Company and the Bank exceeded the regulatory guidelines for an institution to be categorized as "well-capitalized". Information in Note 17 of the Company's Notes to Consolidated Financial Statements provides additional information regarding the capital ratios of the Company and the Bank, and is incorporated here by reference.




The Bank

The Bank is chartered under Michigan law and is subject to regulation by OFIR. Michigan banking laws place restrictions on various aspects of banking, including permitted activities, loan interest rates, branching, payment of dividends, and capital and surplus requirements.

Substantially all of the deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund ("DIF") of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a matrix that takes into account a bank's capital level and supervisory rating. In addition, the Bank pays Financing Corporation ("FICO") assessments related to outstanding FICO bonds to the FDIC as collection agent. The FICO is a mixed-ownership government corporation established by the Competitive Equality Banking Act of 1987 whose sole purpose was to function as a financing vehicle for the now defunct Federal Savings and Loan Insurance Corporation. FICO assessments will continue in the future for the Bank.

The Bank is subject to a number of federal and state laws and regulations, which have a material impact on its business. These include, among others, minimum capital requirements, state usury laws, state laws relating to fiduciaries, the Truth in Lending Act, the Truth in Savings Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Expedited Funds Availability Act, the Community Reinvestment Act, the Real Estate Settlement Procedures Act, the USA PATRIOT Act, The Bank Secrecy Act, Office of Foreign Assets Control regulations, electronic funds transfer laws, redlining laws, predatory lending laws, antitrust laws, environmental laws, money laundering laws and privacy laws.  The instruments of monetary policy of authorities, such as the Federal Reserve System, may influence the growth and distribution of bank loans, investments and deposits, and may also affect interest rates on loans and deposits. These policies may have a significant effect on the operating results of banks.

Bank holding companies may acquire banks and other bank holding companies located in any state in the United States without regard to geographic restrictions or reciprocity requirements imposed by state banking law. Banks may also establish interstate branch networks through acquisitions of and mergers with other banks. The establishment of de novo interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed only if specifically authorized by state law.

Michigan banking laws do not significantly restrict interstate banking. The Michigan Banking Code of 1999 permits, in appropriate circumstances and with the approval of the OFIR, (1) acquisition of Michigan banks by FDIC-insured banks, savings banks or savings and loan associations located in other states, (2) sale by a Michigan bank of branches to an FDIC-insured bank, savings bank or savings and loan association located in a state in which a Michigan bank could purchase branches of the purchasing entity, (3) consolidation of Michigan banks and FDIC-insured banks, savings banks or savings and loan associations located in other states having laws permitting such consolidation, (4) establishment of branches in Michigan by FDIC-insured banks located in other states, the District of Columbia or U.S. territories or protectorates having laws permitting a Michigan bank to establish a branch in such jurisdiction, and (5) establishment by foreign banks of branches located in Michigan.  A Michigan bank holding company may acquire a non-Michigan bank and a non-Michigan bank holding company may acquire a Michigan bank.



Recent Developments

Exit from TARP Capital Purchase Program

The Company issued 20,600 shares of Fixed Rate Cumulative Perpetual Preferred Stock, Series A. Liquidation Preference Amount $1,000 per share ("Preferred Shares") to U.S. Treasury on January 16, 2009 as part of Treasury's Troubled Asset Relief Program Capital Purchase Program in a private placement exempt from the registration requirements of federal and state securities laws. On June 19, 2012, Treasury sold all 20,600 Preferred Shares in a modified dutch auction. The sale of the Preferred Shares did not result in any accounting entries on the books of the Company and did not change the Company's capital position. The Company incurred $299,000 of legal and accounting costs related to the sale of the Preferred Shares in the second quarter of 2012.

On July 18, 2012, the Company repurchased from Treasury for $38,000 a Warrant to purchase 311,492 shares of Company common stock. The Warrant was issued to Treasury in connection with the Company's participation in the TARP Capital Purchase Program.

As a result of these transactions, the Company no longer has any obligation to Treasury in connection with the TARP Capital Purchase Program and the Company is no longer subject to certain requirements of the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009, leaving the Company with greater flexibility to manage its business and affairs and eliminating the management time and expenses which were required to comply with these provisions.

Termination of Memorandum of Understanding

UBT previously entered into a Memorandum of Understanding with the FDIC and OFIR, which documented an understanding among the Bank, FDIC and OFIR relating to, among other things, the declaration and payment of dividends by the Bank to the Company and the maintenance of specified capital levels. On November 13, 2012, the Bank received a letter from FDIC and OFIR notifying the Bank that, as a result of an examination of the Bank as of June 30, 2012, FDIC and OFIR have terminated the Memorandum of Understanding with the Bank effective immediately.

The Board of Directors of the Bank continues to be committed to operation of the Bank in a safe and sound manner with a strong capital base. In connection with termination of the Memorandum of Understanding, the Board of Directors of the Bank has resolved that the Bank will maintain Tier 1 leverage ratio at a level equal to or exceeding 8.5% and that the Bank will not declare or pay any dividend to the Company unless the Board of Directors first determines that the Bank has produced stable earnings.

Board Resolution

At the direction of the Reserve Bank, on April 22, 2010, the Company's Board of Directors adopted a resolution requiring the Company to obtain written approval from the Reserve Bank prior to any of the following: (i) declaration or payment of common or preferred stock dividends; (ii) any increase in debt or issuance of trust preferred obligations; or (iii) the redemption of Company stock.



The Company has requested and received Reserve Bank approval to declare and pay as required, and has declared and paid, all accrued dividends on the Preferred Shares to the date of this report. On February 12, 2013, the Reserve Bank notified the Company that it is no longer required to obtain prior approval of future payments of dividends on the Preferred Shares.

Competition

The banking business in the Company's service area is highly competitive. In its markets, the Bank competes with a number of community banks and subsidiaries of large multi-state, multi-bank holding companies. In addition, the Bank faces competition from credit unions, savings associations, finance companies, loan production offices and other financial services companies. The principal methods of competition that we face are price (interest rates paid on deposits, interest rates charged on borrowings and fees charged for services) and service (convenience and quality of services rendered to customers).

The Company believes that the market perceives a competitive benefit to an independent, locally controlled commercial bank. Much of the Company's competition comes from affiliates of organizations controlled from outside the area.

Employees

On December 31, 2012, the Company and its subsidiary employed 255 full-time and 30 part-time employees. This compares to 244 full-time and 38 part-time employees at December 31, 2011.

Accounting Standards

Information regarding accounting standards adopted by the Company is included in Note 1 of the Company's Notes to Consolidated Financial Statements, and is incorporated here by reference.

Available Information

You can find more information about us at our website, located at www.ubat.com. Our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available as soon as reasonably practicable after such forms have been filed with or furnished to the Securities and Exchange Commission (the "SEC") free of charge on our website through a link to the SEC website.


SELECTED STATISTICAL INFORMATION

Additional statistical information describing our business appears in the following pages and in Management's Discussion and Analysis of Financial Condition and Results of Operations and in our consolidated financial statements and related notes contained in this report.




I DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIAL:

The information required by these sections is contained on Pages A-19 and A-20, and is incorporated here by reference.

II                  INVESTMENT PORTFOLIO

(A)            Book Value of Investment Securities

The book value of investment securities as of December 31, 2012, 2011 and 2010 are as follows, in thousands of dollars:


In thousands of dollars
 
2012
   
2011
   
2010
 
 U.S. Treasury and government agencies
 
$
187,815
   
$
152,064
   
$
99,785
 
 Obligations of states and political subdivisions
   
18,286
     
20,976
     
24,605
 
 Corporate, asset backed and other debt securities
   
-
     
126
     
126
 
 Equity securities
   
28
     
31
     
28
 
 Total Investment Securities
 
$
206,129
   
$
173,197
   
$
124,544
 


 (B)            Carrying Values and Yields of Investment Securities

The following table reflects the carrying values and yields of the Company's investment securities portfolio as of December 31, 2012. Average yields are based on amortized costs and the average yield on tax exempt securities of states and political subdivisions is adjusted to a taxable equivalent basis, assuming a 34% marginal tax rate.


In thousands of dollars where applicable
   
0 - 1
     
1 - 5
     
5 - 10
   
Over 10
     
Available For Sale
 
Year
   
Years
   
Years
   
Years
   
Total
 
U.S. Treasury and government agencies (1)
 
$
19,089
   
$
8,227
   
$
-
   
$
-
   
$
27,316
 
 Weighted average yield
   
1.31
%
   
1.25
%
   
0.00
%
   
0.00
%
   
1.29
%
U.S. agency mortgage-backed securities
   
-
     
160,499
     
-
     
-
   
$
160,499
 
 Weighted average yield
   
0.00
%
   
1.85
%
   
0.00
%
   
0.00
%
   
1.85
%
Obligations of states and political subdivisions
 
$
6,635
   
$
9,871
   
$
1,747
   
$
33
   
$
18,286
 
 Weighted average yield
   
6.22
%
   
5.49
%
   
5.90
%
   
6.65
%
   
5.80
%
Equity and other securities
 
$
28
   
$
-
   
$
-
   
$
-
   
$
28
 
 Weighted average yield
   
0.00
%
   
0.00
%
   
0.00
%
   
0.00
%
   
0.00
%
Total securities
 
$
25,752
   
$
178,597
   
$
1,747
   
$
33
   
$
206,129
 
 Weighted average yield
   
2.56
%
   
2.02
%
   
5.90
%
   
6.65
%
   
2.12
%
                                       
(1) Reflects the scheduled amortization and an estimate of future prepayments based on past and current experience of amortizing U.S. agency securities.

As of December 31, 2012, the Company's securities portfolio contains no concentrations by any single issuer of securities greater than 10% of shareholders' equity. As of December 31, 2012, the Company's securities portfolio contained no securities of issuers outside of the United States.



Additional information concerning the Company's securities portfolio is included under "Investment Securities" in the Company's Management's Discussion and Analysis of Financial Condition and Results of Operations and in Note 3 of the Company's Notes to Consolidated Financial Statements, and is incorporated here by reference.

III            LOAN PORTFOLIO

(A)            Types of Loans

The tables below show loans outstanding (net of unearned interest) at December 31, and the percentage makeup of the portfolios. All loans are domestic and contain no concentrations by industry or customer.


Balances (thousands of dollars)
 
2012
   
2011
   
2010
   
2009
   
2008
 
Personal
 
$
111,170
   
$
103,405
   
$
107,399
   
$
110,702
   
$
112,095
 
Business and commercial mortgage
   
336,772
     
335,133
     
354,340
     
392,495
     
410,911
 
Tax exempt
   
1,554
     
2,045
     
2,169
     
3,005
     
2,533
 
Residential mortgage
   
96,452
     
83,072
     
86,006
     
86,417
     
90,343
 
Construction & development
   
40,634
     
39,721
     
41,554
     
56,706
     
80,412
 
Deferred loan fees and costs
   
96
     
326
     
517
     
728
     
725
 
Total portfolio loans
 
$
586,678
   
$
563,702
   
$
591,985
   
$
650,053
   
$
697,019
 
 
Percent of total portfolio loans
                   
Personal
   
18.9
%
   
18.3
%
   
18.1
%
   
17.0
%
   
16.1
%
Business and commercial mortgage
   
57.5
%
   
59.5
%
   
59.9
%
   
60.4
%
   
58.9
%
Tax exempt
   
0.3
%
   
0.4
%
   
0.4
%
   
0.5
%
   
0.4
%
Residential mortgage
   
16.4
%
   
14.7
%
   
14.5
%
   
13.3
%
   
13.0
%
Construction & development
   
6.9
%
   
7.0
%
   
7.0
%
   
8.7
%
   
11.5
%
Deferred loan fees and costs
   
0.0
%
   
0.1
%
   
0.1
%
   
0.1
%
   
0.1
%
Total
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%


 (B)            Maturities and Sensitivities of Loans to Changes in Interest Rates

The following table presents the maturity of total loans outstanding, other than residential mortgages and personal loans, as of December 31, 2012, according to scheduled repayments of principal.


Thousands of dollars
 
0 - 1 Year
   
1 - 5 Years
   
After 5 Years
   
Total
 
 Business and commercial mortgage
Fixed rate
 
$
40,273
   
$
81,401
   
$
6,666
   
$
128,340
 
 
Variable rate
   
193,038
     
15,006
     
388
     
208,432
 
 Commercial construction & development
Fixed rate
 
$
1,317
   
$
3,102
   
$
-
   
$
4,419
 
 
Variable rate
   
18,302
     
3,372
     
2,418
     
24,092
 
 Tax exempt - fixed rate
Fixed rate
   
65
     
572
     
917
     
1,554
 
 Total
 
$
252,995
   
$
103,453
   
$
10,389
   
$
366,837
 
 Total fixed rate
 
$
41,655
   
$
85,075
   
$
7,583
   
$
134,313
 
 Total variable rate
 
$
211,340
   
$
18,378
   
$
2,806
   
$
232,524
 



(C)            Risk Elements
Nonaccrual, Past Due and Restructured Loans

Information regarding nonaccrual, past due and restructured loans is shown in the table below as of December 31, 2008 through 2012.


Nonperforming Assets, in thousands of dollars
 
2012
   
2011
   
2010
   
2009
   
2008
 
Nonaccrual loans
 
$
16,714
   
$
25,754
   
$
28,661
   
$
26,188
   
$
19,328
 
Accruing loans past due 90 days or more
   
37
     
31
     
583
     
5,474
     
1,504
 
Total nonperforming loans
 
$
16,751
   
$
25,785
   
$
29,244
   
$
31,662
   
$
20,832
 
   
 
                                 
 Accruing restructured loans
 
$
15,819
   
$
21,839
   
$
17,271
   
$
15,584
   
$
3,283
 


The following shows the effect on interest revenue of nonaccrual loans as of December 31, 2012, in thousands of dollars:
 
 
2012
 
Gross amount of interest that would have been recorded at original rate
 
$
735
 
Interest that was included in revenue
   
-
 
Net impact on interest revenue
 
$
735
 


Additional information concerning nonperforming loans, the Company's nonaccrual policy, and loan concentrations is provided under "Credit Quality" in the Company's Management's Discussion and Analysis of Financial Condition and Results of Operations, in Note 1 and Note 5  of the Company's Notes to Consolidated Financial Statements, and is incorporated here by reference.

At December 31, 2012, the Bank had one loan, other than those disclosed above, with a balance of $1.6 million, which cause management to have serious doubts as to the ability of the borrower to comply with the present loan repayment terms. This loan was included on the Bank's "watch list" and was classified as impaired; however, payments were current as of the date of this report.

(D)            Other Interest Bearing Assets

As of December 31, 2012, other than $3,409,000 in other real estate owned, there were no other interest bearing assets that would be required to be disclosed under Item III, Parts (C)(1) or (C)(2) of Industry Guide 3 if such assets were loans.

IV            SUMMARY OF LOAN LOSS EXPERIENCE

(A)            Changes in Allowance for Loan Losses

The table below summarizes changes in the allowance for loan losses for the years 2008 through 2012.


Thousands of dollars
 
2012
   
2011
   
2010
   
2009
   
2008
 
 Balance at beginning of period
 
$
20,633
   
$
25,163
   
$
20,020
   
$
18,312
   
$
12,306
 
 Charge-offs:
                                       
Business and commercial mortgage (1)
   
7,171
     
12,063
     
7,683
     
8,257
     
7,298
 
Construction and land development
   
1,108
     
2,908
     
5,919
     
14,379
     
-
 
Residential mortgage
   
901
     
1,387
     
1,820
     
229
     
450
 
Personal
   
707
     
2,006
     
1,907
     
1,503
     
1,024
 
 Total charge-offs
   
9,887
     
18,364
     
17,329
     
24,368
     
8,772
 
                                       
Recoveries:
                                       
Business and commercial mortgage (1)
   
2,220
     
1,111
     
424
     
185
     
98
 
Construction and land development
   
532
     
278
     
287
     
-
     
-
 
Residential mortgage
   
200
     
68
     
66
     
50
     
11
 
Personal
   
495
     
227
     
165
     
71
     
62
 
 Total recoveries
   
3,447
     
1,684
     
942
     
306
     
171
 
 Net charge-offs
   
6,440
     
16,680
     
16,387
     
24,062
     
8,601
 
 Net provision (2)
   
8,350
     
12,150
     
21,530
     
25,770
     
14,607
 
 Balance at end of period
 
$
22,543
   
$
20,633
   
$
25,163
   
$
20,020
   
$
18,312
 
 Ratio of net charge-offs to average loans
   
1.09
%
   
2.86
%
   
2.58
%
   
3.47
%
   
1.28
%
 Allowance as % of total portfolio loans
   
3.84
%
   
3.66
%
   
4.25
%
   
3.08
%
   
2.63
%
(1) 2008 figures include construction and development loans
 
(2) 2011 includes amounts related to change in allocation methodology
 


The allowance for loan losses is maintained at a level believed adequate by management to absorb losses inherent in the loan portfolio. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio, past loan loss experience, current economic conditions, volume, amount and composition of the loan portfolio, and other relevant factors. The provision charged to earnings was $8,350,000 in 2012, $12,150,000 in 2011, and $21,530,000 in 2010.


(B)            Allocation of Allowance for Loan Losses

The following table presents the portion of the allowance for loan losses applicable to each loan category as of December 31. A table showing the percent of loans in each category to total loans is included in Section III (A), above.


Thousands of dollars
 
2012
   
2011
   
2010
   
2009
   
2008
 
Business and commercial mortgage (1)
 
$
13,932
   
$
13,337
   
$
16,672
   
$
12,221
   
$
16,148
 
Construction and development loans
   
4,216
     
3,553
     
3,248
     
5,164
     
-
 
Residential mortgage
   
2,456
     
1,931
     
2,661
     
760
     
673
 
Personal
   
1,939
     
1,812
     
2,582
     
1,875
     
1,491
 
Total
 
$
22,543
   
$
20,633
   
$
25,163
   
$
20,020
   
$
18,312
 

As a percent of total
  2012    2011    2010    2009    2008 
Business and commercial mortgage (1)
   
61.8
%
   
64.6
%
   
66.3
%
   
61.0
%
   
88.2
%
Construction and development loans
   
18.7
%
   
17.2
%
   
12.9
%
   
25.8
%
   
0.0
%
Residential mortgage
   
10.9
%
   
9.4
%
   
10.6
%
   
3.8
%
   
3.7
%
Personal
   
8.6
%
   
8.8
%
   
10.3
%
   
9.4
%
   
8.1
%
Total
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
                                       
(1) 2008 figures include construction and development loans
 


Information regarding the Company's allocation methods used is provided in Note 5 of the Company's Notes to Consolidated Financial Statements, and is incorporated here by reference.

V            DEPOSITS

The information concerning average balances of deposits and the weighted-average rates paid thereon is included in the table titled "Yield Analysis of Consolidated Average Assets and Liabilities" contained in Management's Discussion and Analysis of Financial Condition and Results of Operations, and information regarding maturities of time deposits is provided in Note 8 of the Company's Notes to Consolidated Financial Statements, and is incorporated here by reference. At December 31, 2012, 2011 and 2010, there were no foreign deposits.

Outstanding time deposits in amounts of $100,000 or more as of December 31, 2012, 2011 and 2010 were scheduled to mature as shown below.


Thousands of dollars
 
As of December 31,
 
Time certificates of deposit $100,000 or more maturing:
 
2012
   
2011
   
2010
 
Within three months
 
$
17,400
   
$
14,466
   
$
16,344
 
Over three through six months
   
8,387
     
12,503
     
13,041
 
Over six through twelve months
   
18,635
     
23,815
     
16,619
 
Over twelve months
   
30,374
     
31,234
     
41,478
 
 Total
 
$
74,795
   
$
82,018
   
$
87,482
 


VI            RETURN ON EQUITY AND ASSETS

Various ratios required by this section and other ratios commonly used in analyzing bank holding company financial statements are included in Item 6, Selected Financial Data, and are incorporated here by reference.

VII            SHORT-TERM BORROWINGS

Information about the Company's short-term borrowings contained in Note 9 of the Company's Notes to Consolidated Financial Statements, and is incorporated here by reference. The Company is not required to disclose any additional information, as for all reporting periods there were no categories of short-term borrowings for which the average balance outstanding during the period was 30% or more of shareholders' equity at the end of the period.




ITEM 1A                          RISK FACTORS

Risks Related To Our Business

If our nonperforming assets increase, our earnings will be adversely affected.

At December 31, 2012, our nonperforming assets (which consist of non-accruing loans, loans 90 days or more past due, and other real estate owned) totaled $20.2 million, or 2.22% of total assets. At December 31, 2011 and December 31, 2010, our nonperforming assets were $29.5 million and $33.5 million, respectively, or 3.33% and 3.89% of total assets, respectively. Our nonperforming assets adversely affect our net income in various ways:

 
We do not record interest income on nonaccrual loans or other real estate owned.
 
 
 
 
We must provide for probable loan losses through a current period charge to the provision for loan losses.
 
 
 
 
Non-interest expense increases when we must write down the value of properties in our other real estate owned portfolio to reflect changing market values.
 
 
 
 
There are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance, and maintenance fees related to our other real estate owned.
 
 
 
 
The resolution of non-performing assets requires the active involvement of management, which can distract them from more profitable activity.

If additional borrowers become delinquent and do not pay their loans and we are unable to successfully manage our nonperforming assets, our losses and troubled assets could increase significantly, which could have a material adverse effect on our results of operations and financial condition.

The economic conditions in the State of Michigan could have a material adverse effect on our results of operations and financial condition.

Our success depends primarily on the general economic conditions in the State of Michigan and the specific local markets in which we operate. Unlike larger national or other regional banks that are more geographically diversified, we provide banking and financial services to customers primarily in the Lenawee, Livingston, Monroe and Washtenaw Counties, Michigan.

The local economic conditions in these areas have a significant impact on the demand for our products and services, as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities, financial, or credit markets or other factors could impact these local economic conditions and, in turn, have a material adverse effect on our results of operations and financial condition.




Difficult market conditions have adversely affected the financial services industry.

The capital and credit markets have been experiencing unprecedented volatility and disruption for an extended period of time. Dramatic declines in the housing market, falling home prices, increased foreclosures and unemployment have negatively impacted the credit performance of mortgage loans and construction and development loans, and resulted in significant write-downs of asset values by financial institutions. These write-downs have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions.

This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and commercial borrowers and lack of confidence in the financial markets has adversely affected our business, results of operations and financial condition. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience adverse effects, which may be material, on our ability to access capital and on our business, results of operations and financial condition.

We are subject to lending risk, which could materially adversely affect our results of operations and financial condition.

There are inherent risks associated with our lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where we operate. Increases in interest rates or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans, which could have a material adverse effect on our results of operations and financial condition. Competition for limited, high-quality lending opportunities and core deposits in an increasingly competitive marketplace may adversely affect our results of operations.

Business loans may expose us to greater financial and credit risk than other loans.

Our business loan portfolio, including commercial mortgages, was approximately $336.8 million at December 31, 2012, comprising approximately 57.4% of our loan portfolio. Business loans generally carry larger loan balances and can involve a greater degree of financial and credit risk than other loans.

Any significant failure to pay on time by our customers would hurt our earnings. The increased financial and credit risk associated with these types of loans are a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the size of loan balances, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans.




We have significant exposure to risks associated with commercial and residential real estate.

A substantial portion of our loan portfolio consists of commercial and residential real estate-related loans, including real estate development, construction and residential and commercial mortgage loans. As of December 31, 2012, we had approximately $239.6 million of commercial real estate loans outstanding, which represented approximately 40.8% of our loan portfolio. As of that same date, we had approximately $96.5 million in residential real estate loans outstanding, or approximately 16.4% of our loan portfolio, and approximately $40.6 million in construction and development loans outstanding, or approximately 6.9% of our loan portfolio. Consequently, real estate-related credit risks are a significant concern for us. The adverse consequences from real estate-related credit risks tend to be cyclical and are often driven by national economic developments that are not controllable or entirely foreseeable by us or our borrowers. General difficulties in our real estate markets have recently contributed to significant increases in our non-performing loans, charge-offs, and decreases in our income.

Our construction and development lending exposes us to significant risks and has resulted in a disproportionate amount of the increase in our provision for loan losses in recent periods.

Our construction and development loan portfolio includes residential and non-residential construction and development loans. Our residential construction and development portfolio consists mainly of loans for the construction, development, and improvement of residential lots, homes, and subdivisions. Our non-residential construction and development portfolio consists mainly of loans for the construction and development of office buildings and other non-residential commercial properties. This type of lending is generally considered to have more complex credit risks than traditional single-family residential lending because the principal is concentrated in a limited number of loans with repayment dependent on the successful completion and sale of the related real estate project. Consequently, these loans are often more sensitive to adverse conditions in the real estate market or the general economy than other real estate loans.

These loans are generally less predictable and more difficult to evaluate and monitor and collateral may be difficult to dispose of in a market decline. Additionally, we may experience significant construction loan losses because independent appraisers or project engineers inaccurately estimate the cost and value of construction loan projects.

Construction and development loans have contributed disproportionately to the increase in our provisions for loan losses in recent periods. As of December 31, 2012, we had approximately $40.6 million in construction and development loans outstanding, or approximately 6.9% of our loan portfolio. Approximately $8.2 million, or 24.0%, and $14.5 million, or 28.3%, at December 31, 2012 and 2011, respectively, of loans classified as impaired were attributable to construction and development loans. Further deterioration in our construction and development loan portfolio could result in additional increases in the provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.




Environmental liability associated with commercial lending could result in losses.

In the course of our business, we may acquire, through foreclosure, properties securing loans we have originated or purchased that are in default. Particularly in commercial real estate lending, there is a risk that hazardous substances could be discovered on these properties. In this event, we might be required to remove these substances from the affected properties at our sole cost and expense. The cost of this removal could substantially exceed the value of affected properties. We may not have adequate remedies against the prior owner or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have an adverse effect on our business, results of operations and financial condition.

Our allowance for loan losses may not be adequate to cover actual future losses.

We maintain an allowance for loan losses to cover probable incurred loan losses. Every loan we make carries a certain risk of non-repayment, and we make various assumptions and judgments about the collectibility of our loan portfolio including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with us.

The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. We cannot fully predict the amount or timing of losses or whether the loss allowance will be adequate in the future. If our assumptions prove to be incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to the allowance for loan losses. In addition, bank regulatory agencies periodically review the Company's allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different from those of management. Excessive loan losses and significant additions to our allowance for loan losses could have a material adverse impact on our financial condition and results of operations.

As of December 31, 2012 and 2011, our allowance for loan losses was $22.5 million and $20.6 million, respectively. As of the same dates, the ratio of our allowance for loan losses to total nonperforming loans was 134.6% and 80.0%, respectively. Nonperforming loans include nonaccrual loans and accruing loans past due 90 days or more and exclude accruing restructured loans. As of the same dates, total accruing restructured loans were $15.8 million and $21.8 million, respectively.

We operate in a highly competitive industry and market area, which may adversely affect our profitability.

We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources.



Such competitors primarily include a number of community banks, subsidiaries of large multi-state and multi-bank holding companies, credit unions, savings associations, finance companies and loan production offices.

The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking.

We compete with these institutions both in attracting deposits and in making loans. Price competition for loans might result in us originating fewer loans, or earning less on our loans, and price competition for deposits might result in a decrease in our total deposits or higher rates on our deposits. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Due to their size, many competitors may be able to achieve economies of scale and may offer a broader range of products and services as well as better pricing for those products and services than we can.

The Dodd-Frank Act enacted in 2010 may continue to adversely impact the Company's results of operations, financial condition or liquidity.
 
The Dodd-Frank Act was signed into law by President Obama on July 21, 2010. The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States, established the new federal Consumer Financial Protection Bureau (CFPB), and requires the CFPB and other federal agencies to implement many new and significant rules and regulations. The CFPB has issued significant new regulations that impact consumer mortgage lending and servicing. Those regulations will become effective in January 2014. In addition, the CFPB is drafting regulations that will change the disclosure requirements and forms used under the Truth in Lending Act and Real Estate Settlement and Procedures Act. Compliance with these new laws and regulations and other regulations under consideration by the CFPB will likely result in additional costs, which could be significant and could adversely impact the Corporation's results of operations, financial condition or liquidity.

Legislative or regulatory changes or actions, or significant litigation, could adversely impact us or the businesses in which we are engaged.

The financial services industry is extensively regulated. We are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of our operations. Laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance funds, and not to benefit our shareholders. The impact of changes to laws and regulations or other actions by regulatory agencies may negatively impact us or our ability to increase the value of our business. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution's allowance for loan losses. Future regulatory changes or accounting pronouncements may increase our regulatory capital requirements or adversely affect our regulatory capital levels.



Additionally, actions by regulatory agencies or significant litigation against us could require us to devote significant time and resources to defending our business and may lead to penalties that materially affect us and our shareholders.

We may face increasing pressure from historical purchasers of our residential mortgage loans to repurchase those loans or reimburse purchasers for losses related to those loans.

We generally sell the fixed rate long-term residential mortgage loans we originate on the secondary market and retain adjustable rate mortgage loans for our portfolios. In response to the financial crisis, purchasers of residential mortgage loans, such as government sponsored entities, are increasing their efforts to seek to require sellers of residential mortgage loans to either repurchase loans previously sold or reimburse purchasers for losses related to loans previously sold when losses are incurred on a loan previously sold due to actual or alleged failure to strictly conform to the purchaser's purchase criteria. As a result, we may face increasing pressure from historical purchasers of our residential mortgage loans to repurchase those loans or reimburse purchasers for losses related to those loans and we may face increasing expenses to defend against such claims. If we are required in the future to repurchase loans previously sold, reimburse purchasers for losses related to loans previously sold, or if we incur increasing expenses to defend against such claims, our financial condition and results of operations would be negatively affected.

We are subject to risks related to the prepayments of loans, which may negatively impact our business.

Generally, our customers may prepay the principal amount of their outstanding loans at any time. The speed at which prepayments occur, and the size of prepayments, are within customers' discretion. If customers prepay the principal amount of their loans, and we are unable to lend those funds to other borrowers or invest the funds at the same or higher interest rates, our interest income will be reduced. A significant reduction in interest income could have an adverse effect impact on our results of operations and financial condition.

Changes in interest rates may negatively affect our earnings and the value of our assets.

Our earnings and cash flows depend substantially upon our net interest income. Net interest income is the difference between interest income earned on interest-earnings assets, such as loans and investment securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are sensitive to many factors that are beyond our control, including general economic conditions, competition and policies of various governmental and regulatory agencies and, in particular, the policies of the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investment securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect: (i) our ability to originate loans and obtain deposits; (ii) the fair value of our financial assets and liabilities, including our securities portfolio; and (iii) the average duration of our interest-earning assets.



This also includes the risk that interest-earning assets may be more responsive to changes in interest rates than interest-bearing liabilities, or vice versa (repricing risk), the risk that the individual interest rates or rates indices underlying various interest-earning assets and interest-bearing liabilities may not change in the same degree over a given time period (basis risk), and the risk of changing interest rate relationships across the spectrum of interest-earning asset and interest-bearing liability maturities (yield curve risk), including a prolonged flat or inverted yield curve environment.  Any substantial, unexpected, prolonged change in market interest rates could have a material adverse affect on our financial condition and results of operations.

The global market crisis has triggered a series of cuts in interest rates. During 2010, 2011 and 2012, the Federal Open Market Committee kept the target federal funds between 0% and 0.25% and we expect the low interest rate environment to continue in 2013. The low interest rate environment has compressed our net interest spread, which has had an adverse impact on our revenue and results of operations.

We are subject to liquidity risk in our operations, which could adversely affect our ability to fund various obligations.

Liquidity risk is the possibility of being unable to meet obligations as they come due, capitalize on growth opportunities as they arise, or pay regular dividends because of an inability to liquidate assets or obtain adequate funding on a timely basis, at a reasonable cost and within acceptable risk tolerances. Liquidity is required to fund various obligations, including credit obligations to borrowers, mortgage originations, withdrawals by depositors, repayment of debt, dividends to shareholders, operating expenses and capital expenditures. Liquidity is derived primarily from retail deposit growth and retention, principal and interest payments on loans and investment securities, net cash provided from operations and access to other funding sources. Liquidity is essential to our business.

We must maintain sufficient funds to respond to the needs of depositors and borrowers. An inability to raise funds through deposits, borrowings, the sale or pledging as collateral of loans and other assets could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or regulatory action that limits or eliminates our access to alternate funding sources.

Our ability to borrow could also be impaired by factors that are nonspecific to us, such as severe disruption of the financial markets or negative expectations about the prospects for the financial services industry as a whole, as evidenced by recent turmoil in the domestic and worldwide credit markets.

The soundness of other financial institutions could adversely affect us.

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry.



As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral that we hold cannot be realized upon or is liquidated at prices insufficient to recover the full amount of the loan. We cannot assure you that any such losses would not materially and adversely affect our business, financial condition or results of operations.

Impairment of investment securities, other intangible assets, or deferred tax assets could require charges to earnings, which could result in a negative impact on our results of operations.

In assessing the impairment of investment securities, we consider the length of time and extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuers, whether the market decline was affected by macroeconomic conditions and whether we have the intent to sell the investment security or will be required to sell the investment security before its anticipated maturity.

Deferred tax assets are only recognized to the extent it is more likely than not they will be realized. Should our management determine it is not more likely than not that the deferred tax assets will be realized, a valuation allowance with a charge to earnings would be reflected in the period. At December 31, 2012, the Company's net deferred tax asset was $8.7 million, of which $3.8 million was disallowed for regulatory capital purposes. Based on the levels of taxable income in prior years, the significant improvement in operating results in 2012 compared to 2011 and 2010, and the Company's expectation of a return to sustained profitability in future years as a result of strong core earnings, management has determined that no valuation allowance was required at December 31, 2012. If the Company is required in the future to take a valuation allowance with respect to its deferred tax asset, its financial condition, results of operations and regulatory capital levels would be negatively affected.

An "ownership change" for purposes of Section 382 of the Internal Revenue Code may materially impair our ability to use our deferred tax assets.

Our ability to use our deferred tax assets to offset future taxable income will be limited if we experience an "ownership change" as defined in Section 382 of the Internal Revenue Code. In general, an ownership change will occur if there is a cumulative increase in our ownership by "5-percent shareholders" (as defined in the Code) that exceeds 50 percentage points over a rolling three-year period. A corporation that experiences an ownership change will generally be subject to an annual limitation on the use of its pre-ownership change deferred tax assets equal to the equity value of the corporation immediately before the ownership change, multiplied by the long-term tax-exempt rate.

In the event an "ownership change" was to occur, we could realize a permanent loss of a portion of our U.S. federal deferred tax assets and lose certain built-in losses that have not been recognized for tax purposes.



The amount of the permanent loss would depend on the size of the annual limitation (which is a function of our market capitalization at the time of an "ownership change" and the then prevailing long-term tax exempt rate) and the remaining carry forward period (U.S. federal net operating losses generally may be carried forward for a period of 20 years). The resulting loss could have a material adverse effect on our results of operations and financial condition and could also decrease the Bank's regulatory capital. We performed an evaluation of potential impairment at December 31, 2012, and determined that if an "ownership change" had occurred on December 31, 2012, we would have had no impairment of our net deferred tax asset.

If we are required to take a valuation allowance with respect to our mortgage servicing rights, our financial condition and results of operations would be negatively affected.

At December 31, 2012, our mortgage servicing rights had a book value of $6.4 million and a fair value of approximately $8.2 million. Because of the current interest rate environment and the increasing rate and speed of mortgage refinancings, it is possible that we may have to take a valuation allowance with respect to our mortgage servicing rights in the future. If we are required in the future to take a valuation allowance with respect to our mortgage servicing rights, our financial condition and results of operations would be negatively affected.

We may be required to pay additional insurance premiums to the FDIC, which could negatively impact earnings.

Recent insured institution failures, as well as deterioration in banking and economic conditions, have significantly increased FDIC loss provisions, resulting in a decline in the designated reserve ratio to historical lows. The reserve ratio may continue to decline over the next several years. In addition, the limit on FDIC coverage has been permanently increased to $250,000. These developments have caused our FDIC premiums to increase in recent periods.

Further, depending upon any future losses that the FDIC insurance fund may suffer, there can be no assurance that there will not be additional premium increases in order to replenish the fund. The FDIC may need to set a higher base rate schedule or impose special assessments due to future financial institution failures and updated failure and loss projections. Potentially higher FDIC assessment rates than those currently projected could have an adverse impact on our results of operations.

Expiration of the FDIC's Transaction Account Guarantee Program ("TAG") may result in a reduction of the Bank's deposit balances.

Temporary unlimited deposit insurance coverage for noninterest-bearing transaction accounts under the Dodd-Frank Act expired on December 31, 2012. TAG, which was originally part of the Temporary Liquidity Guarantee Program ("TLGP") of 2008, added unlimited insurance coverage to noninterest bearing accounts, regardless of balance. This temporary unlimited coverage was in addition to, and separate from, the general FDIC deposit insurance coverage of up to $250,000 available to depositors. Depending on the perceptions by depositors of the safety and soundness of banking institutions, the termination of the TAG program could result in deposit disintermediation in individual banks and in the banking industry as a whole.




We depend upon the accuracy and completeness of information about customers.

In deciding whether to extend credit to customers, we may rely on information provided to us by our customers, including financial statements and other financial information. We may also rely on representations of customers as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. Our financial condition and results of operations could be negatively impacted to the extent that we extend credit in reliance on financial statements that do not comply with generally accepted accounting principles or that are misleading or other information provided by customers that is false or misleading.

We hold general obligation municipal bonds in our investment securities portfolio. If one or more issuers of these bonds were to become insolvent and default on its obligations under the bonds, it could have a negative effect on our financial condition and results of operations.

Municipal bonds held by us totaled $18.3 million at December 31, 2012, and were issued by different municipalities. The municipal portfolio contains a small level of geographic risk, as approximately 1.5% of the investment portfolio is issued by political subdivisions located within Lenawee County, Michigan, 1.6% in Monroe County, Michigan and 2.0% in Washtenaw County, Michigan. If one or more of the issuers of these bonds were to become insolvent and default on their obligations under the bonds, it could have a negative effect on our financial condition and results of operations.

We may be a defendant in a variety of litigation and other actions, which may have a material adverse effect on our financial condition and results of operations.

We may be involved from time to time in a variety of litigation arising out of our business. Our insurance may not cover all claims that may be asserted against us, and any claims asserted against us, regardless of merit or eventual outcome, may harm our reputation or cause us to incur unexpected expenses, which could be material in amount. Should the ultimate expenses, judgments or settlements in any litigation exceed our insurance coverage, they could have a material adverse effect on our financial condition and results of operations. In addition, we may not be able to obtain appropriate types or levels of insurance in the future, nor may we be able to obtain adequate replacement policies with acceptable terms, if at all.

We may face risks related to future expansion and acquisitions or mergers, which include substantial acquisition costs, an inability to effectively integrate an acquired business into our operations, lower than anticipated profit levels and economic dilution to shareholders.

We may seek to acquire other financial institutions or parts of those institutions and may engage in de novo branch expansion in the future. We may incur substantial costs to expand. An expansion may not result in the levels of profits we anticipate. Integration efforts for any future mergers or acquisitions may not be successful, which could have a material adverse effect on our results of operations and financial condition. Also, we may issue equity securities, including our common stock and securities convertible into shares of our common stock, in connection with future acquisitions, which could cause ownership and economic dilution to our current shareholders.



Unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of computer systems or otherwise, or failure or interruption of the Company's communication or information systems, could severely harm the Company's business.

 
As part of the its business, the Corporation collects, processes and retains sensitive and confidential client and customer information on behalf of the Company and other third parties. Despite the security measures the Company has in place for its facilities and systems, and the security measures of its third party service providers, the Company may be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming and/or human errors or other similar events.

The Company relies heavily on communications and information systems to conduct its business. Any failure or interruption of these systems could result in failures or disruptions in the Company's customer relationship management, general ledger, deposit, loan and other systems. In addition, customers could lose access to their accounts and be unable to conduct financial transactions during a period of failure or interruption of these systems.  

Any security breach involving the misappropriation, loss or other unauthorized disclosure of confidential customer information, whether by the Company or by its vendors, or failure or interruption of the Company's communication or information systems, could severely damage the Company's reputation, expose it to risks of regulatory scrutiny, litigation and liability, disrupt the Company's operations, or result in a loss of customer business, the occurrence of any of which could have a material adverse effect on the Company's business.

We may not be able to effectively adapt to technological change, which could adversely affect our profitability.

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers, all of which could adversely affect our profitability.

Our controls and procedures may fail or be circumvented, which could have a material adverse effect on our business, results of operations and financial condition.

Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.



If we cannot raise additional capital when needed, our ability to further expand our operations through organic growth and acquisitions could be materially impaired.

We are required by federal and state regulatory authorities to maintain specified levels of capital to support our operations. We may need to raise additional capital to support our current level of assets or our growth. Our ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. We cannot assure that we will be able to raise additional capital in the future on terms acceptable to us or at all.

If we cannot raise additional capital when needed, our ability to maintain our current level of assets or to expand our operations through organic growth and acquisitions could be materially limited. Additional information on the capital requirements applicable to the Bank may be found under "Management's Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources" hereof, and is incorporated here by reference.

Loss of our Chief Executive Officer or other executive officers could adversely affect our business.

Our success is dependent upon the continued service and skills of our executive officers and senior management. If we lose the services of these key personnel, it could adversely affect our business because of their skills, years of industry experience and the difficulty of promptly finding qualified replacement personnel. The services of Robert K. Chapman, our President and Chief Executive Officer, would be particularly difficult to replace.

Risks Associated with Our Stock

The Preferred Shares restrict our ability to pay dividends to common shareholders, and could have other negative effects.

The Company issued Preferred Shares to Treasury on January 16, 2009 as part of Treasury's Troubled Asset Relief Program Capital Purchase Program in a private placement exempt from the registration requirements of federal and state securities laws. On June 19, 2012, the United States Department of the Treasury sold all 20,600 Preferred Shares in a modified dutch auction. The sale of the Preferred Shares did not result in any accounting entries on the books of the Company and did not change the Company's capital position. The Company incurred $299,000 of legal and accounting costs related to the sale of the Preferred Shares in the second quarter of 2012.

On July 18, 2012, the Company repurchased from Treasury for $38,000 a Warrant to purchase 311,492 shares of Company common stock. The Warrant was issued to Treasury in connection with the Company's participation in the TARP Capital Purchase Program.




As a result of these transactions, the Company no longer has any obligation to Treasury in connection with the TARP Capital Purchase Program and the Company is no longer subject to certain requirements of the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009, leaving the Company with greater flexibility to manage its business and affairs and eliminating the management time and expenses which were required to comply with these provisions.

The Preferred Shares require payment of cumulative dividends at a rate of 5% for the first five years and 9% thereafter. The payment of dividends on the Preferred Shares will reduce the amount of earnings available to pay dividends to common shareholders. This could negatively affect our ability to pay dividends on our common stock.

We are subject to restrictions on the payment of dividends to common shareholders and the repurchase of common stock. We may not pay any dividends on our common stock unless we are current on our dividend payments on the Preferred Shares.

If we fail to pay in full dividends on the Preferred Shares for six dividend periods, whether consecutive or not, the total number of positions on the Company's Board of Directors will increase by two and the holders of the Preferred Shares, acting as a class with any other shares of our preferred stock with parity voting rights to the Preferred Shares, would have the right to elect two directors to our board of directors. This right and the terms of such directors would end when we have paid in full all accrued and unpaid dividends for all past dividend periods. This right could reduce the level of influence existing common shareholders have in our management policies.

Unless we are able to redeem the preferred stock before January 16, 2014, the cost of this capital will increase on that date, from 5% (approximately $1,030,000 annually) to 9% (approximately $1,854,000 annually). Depending on our financial condition at the time, this increase in dividends on the preferred stock could have a negative effect on our capacity to pay common stock dividends.

Our ability to pay dividends is limited and we may be unable to pay future dividends.

We have suspended payment of dividends on our common stock in order to preserve capital. Our ability to pay dividends is limited by regulatory restrictions and the need to maintain sufficient consolidated capital. The ability of the Bank to pay dividends to the Company is limited by its obligations to maintain sufficient capital and by other general restrictions on dividends that are applicable to banks.

If the Company or the Bank does not satisfy these regulatory requirements, we would be unable to pay dividends on our common stock. Additional information on restrictions on payment of dividends by the Company and the Banks may be found in Item 1 of this report under "Supervision and Regulation," and in Note 14 of the Company's Notes to Consolidated Financial Statements, all of which information is incorporated here by reference.




The market price of our common stock can be volatile, which may make it more difficult to resell our common stock at a desired time and price.

Stock price volatility may make it more difficult for a shareholder to resell our common stock when a shareholder wants to and at prices a shareholder finds attractive or at all. Our stock price can fluctuate significantly in response to a variety of factors. General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of operating results.

Our common stock trading volume may not provide adequate liquidity for our shareholders.

Our common stock is quoted on the OTCQB. The average daily trading volume for our common stock is far less than larger financial institutions. Due to this relatively low trading volume, significant sales of our common stock, or the expectation of these sales, may place significant downward pressure on the market price of our common stock. No assurance can be given that an active trading market in our common stock will develop in the foreseeable future or can be maintained.

We may issue additional shares of our common stock in the future, which could dilute a shareholder's ownership of common stock.

Our articles of incorporation authorize our board of directors, without shareholder approval, to, among other things, issue additional shares of common or preferred stock. The issuance of any additional shares of common or preferred stock could be dilutive to a shareholder's ownership of our common stock. To the extent that we issue options or warrants to purchase common stock in the future and the options or warrants are exercised, our shareholders may experience further dilution. Holders of shares of our common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series and, therefore, shareholders may not be permitted to invest in future issuances of our common or preferred stock. We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. Accordingly, regulatory requirements and/or further deterioration in our asset quality may require us to sell common stock to raise capital under circumstances and at prices which result in substantial dilution.

We may issue debt and equity securities that are senior to our common stock as to distributions and in liquidation, which could negatively affect the value of our common stock.

In the future, we may increase our capital resources by entering into debt or debt-like financing or issuing debt or equity securities, which could include issuances of senior notes, subordinated notes, preferred stock or common stock. In the event of our liquidation, our lenders and holders of our debt or preferred securities would receive a distribution of our available assets before distributions to the holders of our common stock. Our decision to incur debt and issue securities in future offerings will depend on market conditions and other factors beyond our control. We cannot predict or estimate the amount, timing or nature of its future offerings and debt financings. Future offerings could reduce the value of shares of our common stock and dilute a shareholder's interest in us.



Our common stock is not insured by any governmental entity.

Our common stock is not a deposit account or other obligation of any bank and is not insured by the FDIC or any other governmental entity. Investment in our common stock is subject to risk, including possible loss of the entire investment.

Anti-takeover provisions could negatively impact our shareholders.

Our articles of incorporation and the laws of Michigan include provisions which are designed to provide our board of directors with time to consider whether a hostile takeover offer is in the best interests of us and our shareholders. These provisions could discourage potential acquisition proposals and could delay or prevent a change in control. The provisions also could diminish the opportunities for a holder of our common stock to participate in tender offers, including tender offers at a price above the then-current price for our common stock. These provisions could also prevent transactions in which our shareholders might otherwise receive a premium for their shares over then-current market prices, and may limit the ability of our shareholders to approve transactions that they may deem to be in their best interests.

If an entity holds as little as a 5% interest in our outstanding securities, that entity could, under certain circumstances, be subject to regulation as a "bank holding company."

Any entity, including a "group" composed of natural persons, owning or controlling with the power to vote 25% or more of our outstanding securities, or 5% or more if the holder otherwise exercises a "controlling influence" over us, may be subject to regulation as a "bank holding company" in accordance with the BHCA. In addition, (i) any bank holding company or foreign bank with a U.S. presence may be required to obtain the approval of the Federal Reserve Board under the BHCA to acquire or retain 5% or more of our outstanding securities and (ii) any person not otherwise defined as a company by the BHCA and its implementing regulations may be required to obtain the approval of the Federal Reserve Board under the Change in Bank Control Act of 1978, as amended, to acquire or retain 10% or more of our outstanding securities. Becoming a bank holding company imposes statutory and regulatory restrictions and obligations, such as providing managerial and financial strength for its bank subsidiaries. Regulation as a bank holding company could require the holder to divest all or a portion of the holder's investment in our securities or those nonbanking investments that may be deemed impermissible or incompatible with bank holding company status, such as a material investment in a company unrelated to banking.

ITEM 1B                          UNRESOLVED STAFF COMMENTS

None
 
 
ITEM 2                          PROPERTIES

The Company's executive offices are located in Ann Arbor, MI. The Company and the Bank operate twenty-one properties in Washtenaw, Lenawee, Livingston and Monroe Counties in Michigan. Seven of the properties are leased, and all others are owned. Seventeen properties include banking offices, and all but three of the banking offices offer drive-up banking services. All banking offices also offer ATM service.



In addition to banking offices, United operates one loan production office in Monroe, Michigan, and administrative and support facilities at the Hickman Financial Center, support and training facilities at the Downing Center, a Wealth Management office, and additional training facilities, all in Tecumseh.

ITEM 3                          LEGAL PROCEEDINGS

As of the date of this report, there are no material pending legal proceedings other than routine litigation incidental to the business of banking, to which the Company or its subsidiaries are a party or of which any of our properties are the subject. As of the date of this report, neither the Company nor its subsidiaries are involved in any proceedings to which any director, principal officer, affiliate thereof, or person who owns of record or beneficially more than five percent (5%) of the outstanding stock of the Company, or any associate of the foregoing, is a party or has a material interest adverse to the Company.

ITEM 4                          MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5 MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCK-HOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

MARKET FOR COMMON STOCK

The following table shows the high and low sale prices of common stock of the Company for each quarter of 2012 and 2011 as quoted on the OTCQB, under the symbol of "UBMI" and cash dividends declared for each quarter of 2012 and 2011. The quoted sale prices reflect inter-dealer prices without retail markup, markdown or commission and may not necessarily represent actual transactions, and do not include private transactions not involving brokers or dealers. The Company had 1,221 shareholders of record as of December 31, 2012.


 
2012
   
2011
 
 
Market Price
   
Cash Dividends
   
Market Price
   
Cash Dividends
 
  Quarter
 
High
   
Low
   
Declared
   
High
   
Low
   
Declared
 
  1st
 
$
3.45
   
$
2.49
   
$
-
   
$
4.05
   
$
3.35
   
$
-
 
  2nd
   
3.70
     
3.25
     
-
     
3.75
     
3.00
     
-
 
  3rd
   
4.20
     
3.26
     
-
     
3.50
     
2.90
     
-
 
  4th
   
4.65
     
3.91
     
-
     
2.80
     
2.20
     
-
 





Restrictions on the Company's ability to pay dividends and on the ability of the Bank to transfer funds to the Company are discussed in Note 14 of the consolidated financial statements included elsewhere in this report, under the headings "Supervision and Regulation" and "Recent Developments" in Item 1 of this report and the risk factor in Item 1A of this report entitled "The Preferred Shares restrict our ability to pay dividends to common shareholders, and could have other negative effects," which discussion is incorporated here by reference.

The following table provides information regarding equity compensation plans approved by shareholders as of December 31, 2012.


Plan Category
 
Number of Securities to be Issued upon Exercise of Outstanding Options, Warrants and Rights
   
Weighted-Average Exercise Price of Outstanding Options, Warrants and Rights
   
Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding
Securities Reflected
in Column (A)) (3)
 
 Equity compensation plans approved by shareholders
 
(A)
   
(B)
   
(C)
 
Stock Option Plans (1)
   
358,070
   
$
21.32
     
-
 
Stock Incentive Plan of 2010
   
214,045
     
3.33
     
263,330
 
Director Retainer Stock Plan (2)
   
119,539
   
NA
     
216,864
 
Senior Management Bonus Deferral Stock Plan (2)
   
4,568
   
NA
     
21,373
 
Total
   
696,222
     $
15.59
     
501,567
 
 
(1)
The Company's 2005 Stock Option Plan expired on January 1, 2010, and no additional options can be issued under the plan.
 
 
(2)
The number of shares credited to participants under the Director Retainer Stock and Senior Management Bonus Deferral Stock Plans is determined by dividing the amount of each deferral by the market price of stock at the date of that deferral.
 
 
(3)
The numbers of shares reflected in column (c) in the table above with respect to the Stock Incentive Plan of 2010, the Director Retainer Stock Plan and the Senior Management Bonus Deferral Stock Plan represent shares that may be issued other than upon the exercise of an option, warrant or right.

The Company has no equity compensation plans not approved by shareholders.

ITEM 6 SELECTED FINANCIAL DATA

The following table shows summarized historical consolidated financial data for the Company. The table is unaudited. The information in the table is derived from the Company's audited financial statements for 2008 through 2012. This information is only a summary. You should read it in conjunction with the consolidated financial statements, related notes, Management's Discussion and Analysis of Financial Condition and Results of Operations, and other information included in this report.


Thousands of dollars
                   
FINANCIAL CONDITION
 
2012
   
2011
   
2010
   
2009
   
2008
 
Assets
                   
Cash and demand balances in other banks
 
$
13,769
   
$
15,798
   
$
10,623
   
$
10,047
   
$
12,147
 
Federal funds sold and equivalents
   
56,843
     
91,794
     
95,599
     
115,542
     
6,325
 
Securities available for sale
   
206,129
     
173,197
     
124,544
     
92,146
     
82,101
 
Net loans
   
577,515
     
551,359
     
577,111
     
638,012
     
683,695
 
Other assets
   
53,485
     
52,861
     
53,833
     
53,581
     
48,125
 
Total Assets
 
$
907,741
   
$
885,009
   
$
861,710
   
$
909,328
   
$
832,393
 
                                       
Liabilities and Shareholders' Equity
                                       
Noninterest bearing deposits
 
$
165,430
   
$
139,346
   
$
113,206
   
$
99,893
   
$
89,487
 
Interest bearing deposits
   
619,213
     
625,510
     
620,792
     
682,908
     
620,062
 
Total deposits
   
784,643
     
764,856
     
733,998
     
782,801
     
709,549
 
Short term borrowings
   
-
     
-
     
1,234
     
-
     
-
 
Other borrowings
   
21,999
     
24,035
     
30,321
     
42,098
     
50,036
 
Other liabilities
   
3,702
     
2,344
     
3,453
     
3,562
     
3,357
 
Total Liabilities
   
810,344
     
791,235
     
769,006
     
828,461
     
762,942
 
Shareholders' Equity
   
97,397
     
93,774
     
92,704
     
80,867
     
69,451
 
Total Liabilities and Shareholders' Equity
 
$
907,741
   
$
885,009
   
$
861,710
   
$
909,328
   
$
832,393
 

 
RESULTS OF OPERATIONS
                   
Interest income
 
$
34,693
   
$
36,165
   
$
39,770
   
$
43,766
   
$
47,041
 
Interest expense
   
4,528
     
6,114
     
8,687
     
12,251
     
17,297
 
Net Interest Income
   
30,165
     
30,051
     
31,083
     
31,515
     
29,744
 
Provision for loan losses
   
8,350
     
12,150
     
21,530
     
25,770
     
14,607
 
Noninterest income
   
21,491
     
17,211
     
16,298
     
16,899
     
13,510
 
Goodwill impairment
   
-
     
-
     
-
     
3,469
     
-
 
Other noninterest expense
   
37,203
     
34,618
     
32,497
     
33,647
     
29,963
 
Income (loss) before federal income tax
   
6,103
     
494
     
(6,646
)
   
(14,472
)
   
(1,316
)
Federal income tax (benefit)
   
1,640
     
(423
)
   
(2,938
)
   
(5,639
)
   
(1,280
)
Net income (loss)
 
$
4,463
   
$
917
   
$
(3,708
)
 
$
(8,833
)
 
$
(36
)
 

KEY RATIOS
                   
Return on average assets
   
0.50
%
   
0.10
%
   
-0.42
%
   
-1.03
%
   
0.00
%
Return on average shareholders' equity
   
4.69
%
   
0.98
%
   
-4.66
%
   
-10.61
%
   
-0.05
%
Net interest margin
   
3.59
%
   
3.64
%
   
3.79
%
   
3.80
%
   
4.04
%
Basic and diluted earnings (loss) per share (1)
 
$
0.26
   
$
(0.02
)
 
$
(0.89
)
 
$
(1.93
)
 
$
(0.01
)
Cash dividends paid per common share
   
-
     
-
     
-
     
0.02
     
0.70
 
Dividend payout ratio
 
NA
   
NA
   
NA
   
NA
   
NA
 
Equity to assets ratio (2)
   
10.6
%
   
10.6
%
   
9.1
%
   
9.5
%
   
9.1
%
(1)
 
 
Earnings per share data is based on income available to common shareholders, divided by average common shares outstanding plus average contingently issuable shares.
(2) Average equity divided by average total assets



ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The information required by this item is contained on Pages A-1 through A-30, and is incorporated by reference here.

ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Supplementary financial information required by this item is contained in Note 20 of the Company's Notes to Consolidated Financial Statements, and is incorporated by reference here.

Our consolidated financial statements and related notes are contained on Pages A-31 through A-71 hereof, and are incorporated by reference here.


INDEX TO FINANCIAL STATEMENTS
Page No.
 
 
 
 
 
Consolidated Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 

ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A CONTROLS AND PROCEDURES

(a)
Our management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rule 13a-15(e) of the Securities Exchange Act of 1934 (the "Exchange Act"). Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report (the "Evaluation Date"), and have concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms.
 
(b)
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined under Rule 13a-15(f) of the Exchange Act. The Company's internal control over financial reporting system was designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company's assets that could have a material effect on the financial statements.
 
 
 
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
 
 
 
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company's internal control over financial reporting as of the Evaluation Date, and has concluded that, as of the Evaluation Date, the Company's internal control over financial reporting was effective. Management identified no material weakness in the Company's internal control over financial reporting as of the Evaluation Date. In making this evaluation, management used the criteria set forth by the Committee of Sponsoring Organizations of Treadway Commission in "Internal Control - Integrated Framework."
 
 
 
 
 
 
 
/s/ Robert K. Chapman
 
/s/ Randal J. Rabe
 
Robert K. Chapman
 
Randal J. Rabe
 
President and Chief Executive Officer
 
Executive Vice President and Chief Financial Officer
 
 
(c)
There has been no change in the Company's internal control over financial reporting that occurred during the fiscal quarter ended December 31, 2012 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

ITEM 9B OTHER INFORMATION

None.




PART III

ITEM 10 DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The Company has adopted a Code of Business Conduct and Ethics (the "Code") that applies to all co-workers, officers and directors of the Company and its subsidiaries. The Code is designed to deter wrongdoing and to promote:

Honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships;
 
 
Full, fair, accurate, timely and understandable disclosure in reports and documents that the Company files with, or submits to, the Commission and in other public communications made by the registrant;
 
 
Compliance with applicable governmental laws, rules and regulations;
 
 
Prompt internal reporting of violations of the Code to an appropriate person or persons identified in the Code; and
 
 
Accountability for adherence to the Code.

A copy of the Code is posted on our website at www.ubat.com.

The information required by this item, other than as set forth above, is contained under the heading "Board of Directors," "Executive Officers" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's definitive Proxy Statement in connection with its 2013 Annual Meeting of Shareholders and is incorporated here by reference

ITEM 11 EXECUTIVE COMPENSATION

The information required by this item is contained under the heading "Compensation of Directors and Executive Officers," "Compensation Committee Report" and "Compensation Committee Interlocks and Insider Participation" in the Company's definitive Proxy Statement in connection with its 2013 Annual Meeting of Shareholders and is incorporated here by reference.

ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
                      

The information required by this item is contained under the headings "Compensation of Directors and Executive Officers – Equity Compensation Plan Information," "Security Ownership of Certain Beneficial Owners," and "Security Ownership of Management," in the Company's definitive Proxy Statement in connection with its 2013 Annual Meeting of Shareholders and is incorporated here by reference.




ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this item is contained under the headings "Board of Directors," "Corporate Governance" and "Transactions with Related Persons" in the Company's definitive Proxy Statement in connection with its 2013 Annual Meeting of Shareholders and is incorporated here by reference.

ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item is contained under the heading "Relationship With Independent Public Accountants" in the Company's definitive Proxy Statement in connection with its 2013 Annual Meeting of Shareholders and is incorporated here by reference.

PART IV

ITEM 15 EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)
1.
The index to financial statements is included in Item 8, "Financial Statement and Supplementary Data," of this report, and is incorporated here by reference.
 
 
 
 
2.
Financial statement schedules are not applicable.
 
 
 
(b)
The exhibits filed in response to Item 601 of Regulation S-K are listed in the Exhibit Index, which is incorporated here by reference.
 
 
 
(c)
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted.

UNITED BANCORP, INC.
Management's Discussion and Analysis of
Financial Condition and Results of Operations
and
Consolidated Financial Statements

Table of Contents

 
 
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Financial Statements
 
 
 
 
 
 
 

Nature of Business

United Bancorp, Inc. (the "Company" or "United") is a Michigan bank holding company headquartered in Ann Arbor, Michigan. The Company, through its subsidiary bank, United Bank & Trust ("UBT" or the "Bank"), offers a full range of financial services through a system of seventeen banking offices located in Lenawee, Livingston, Monroe and Washtenaw Counties and one loan production office in Monroe County. The Bank's structured finance group conducts business under the name United Structured Finance Company ("USFC"). While the Company's chief decision makers monitor the revenue streams of the Company's various products and services, operations are managed and financial performance is evaluated on a company-wide basis. Accordingly, all of the Company's financial services operations are considered by management to be aggregated in one reportable operating segment – commercial banking.

Management's Discussion and Analysis of Financial Condition and Results of Operations

This discussion provides information about the consolidated financial condition and results of operations of the Company and the Bank.

Background

We are a Michigan corporation headquartered in Ann Arbor, Michigan and serve as the holding company for UBT, a Michigan-chartered bank organized over 115 years ago. We are registered as a bank holding company under the Bank Holding Company Act of 1956. At December 31, 2012, we had total assets of approximately $907.7 million, deposits of approximately $784.6 million, and total shareholders' equity of approximately $97.4 million. Our common stock is quoted on the OTCQB under the symbol "UBMI."

We have four primary lines of business under one operating segment of commercial banking: banking services, residential mortgage, wealth management and structured finance. Subject to our overall business strategy, each line of business is encouraged to be entrepreneurial in how it develops and implements its business. We believe that these four lines of business provide us with a diverse and strong core revenue stream that is unmatched by our community bank competitors and positions us well for future revenue growth and profitability. During the twelve month period ended December 31, 2012, our non-interest income equaled 41.6% of our operating revenues and for each of the last five years ended December 31, 2012 approximated 35.7% of our operating revenues. This diverse revenue stream has enabled us to recognize a pre-tax, pre-provision return on average assets of 1.62% for the twelve month period ended December 31, 2012. Our average pre-tax, pre-provision return on average assets over the last five years ended December 31, 2012 was approximately 1.61%. The presentation of pre-tax, pre-provision return on average assets is not consistent with, or intended to replace, presentation under generally accepted accounting principles. For additional information about our pre-tax, pre-provision income and pre-tax, pre-provision return on average assets, please see "Pre-tax, Pre-provision Income and Return on Average Assets" under "Results of Operations" below.

Our Bank offers a full range of services to individuals, corporations, fiduciaries and other institutions. Banking services include checking accounts, NOW accounts, savings accounts, time deposit accounts, money market deposit accounts, safe deposit facilities and money transfers. Lending operations provide real estate loans, secured and unsecured business and personal loans, consumer installment loans, credit card and check-credit loans, home equity loans, accounts receivable and inventory financing, and construction financing. The Bank offers a full complement of online services, including internet banking and bill payment. In 2011, the Bank opened its first loan production office in neighboring Livingston County, Michigan. In 2012, that office was converted to a full-service banking office, and the Bank opened a new loan production office in the city of Monroe, Michigan.

Our mortgage group offers our customers a full array of conventional residential mortgage products, including purchase, refinance and construction loans. Due to our local decision making and fully-functional back office, we have consistently been one of the most active originators of mortgage loans in our market area.

United's mortgage group was the leading residential mortgage lender in Lenawee County, and had the second-highest volume in Washtenaw County for 2011.1 Information for 2012 is not yet available.

Our Wealth Management Group is a key focus of our growth and diversification strategy and offers a variety of investment services to individuals, corporations and governmental entities. Our Wealth Management Group generated 24.4% of our noninterest income for the twelve months ended December 31, 2012.

Our structured finance group, United Structured Finance Company, offers simple, effective financing solutions to small businesses and commercial property owners, primarily by utilizing various government guaranteed loan programs and other off-balance sheet finance solutions through secondary market sources. For the twelve months ended September 30, 2012 and 2011, USFC was the leading SBA lender in each of Lenawee, Washtenaw and Livingston Counties. For the twelve months ended September 30, 2012, USFC was the second largest SBA 7A lender in Michigan, based on loan volume.2

Economic Trends

Our primary market area is Washtenaw, Livingston, Lenawee, and Monroe Counties in Michigan, and generally encompasses the Ann Arbor metropolitan area, which we believe is our primary area for future organic growth.

Michigan had the fifth highest seasonally-adjusted unemployment rate in the United States for November 2012.3 The Michigan seasonally-adjusted unemployment rate of 8.9%4 for November 2012 improved from 9.3% at December 31, 2011.5 At the same time, October, 2012 local area unemployment rates were below year-ago levels in every metropolitan area in Michigan, and below September levels in every area except Detroit/Warren/Livonia.

The University of Michigan's Research Seminar for Quantitative Economics reports that they see modest pickup in the Michigan economy going into 2013 and continuing through 2014. Their estimate is that Michigan job growth will accelerate from its 0.5 percent pace over the last three quarters of 2012 to 1.2 percent at the beginning of 2013, holding near that level throughout most of the year before increasing its tempo to around 1.5 percent during 2014.6 Washtenaw County had the lowest unadjusted unemployment rate in the state at 4.3% for November 2012.7 Washtenaw County had a population of approximately 345,000 for 20108 and had a median household income of approximately $54,900 for 2009, which was the fourth highest in the state.9



1 SNL.com, Mortgage Origination Market Share by County for the State of Michigan for 2011
2 U.S. Small Business Administration, Detroit, Michigan office
3 U.S. Bureau of Labor Statistics, Local Area Unemployment Statistics, Unemployment Rates for November 2012.
4 Michigan Labor Market Information, Data Explorer – Unemployment Statistics, Statewide, Adjusted (Monthly Historical).
5 Id.
6 University of Michigan's Research Seminar for Quantitative Economics; http://www.michiganadvantage.org
7 Michigan Labor Market Information, Data Explorer – Unemployment Statistics, by County (November, 2012).
8 Michigan State Senate, Senate Fiscal Agency, Michigan Population by County.
9 Michigan Labor Market Information, Data Explorer – Income (2009 Annual).

The economic base of Washtenaw County has a substantial reliance on health care, education and automotive high technology. Economic stability is provided to a great extent by the University of Michigan, which is a major employer and is not as economically sensitive to the fluctuations of the automotive industry. The services and public sectors account for a substantial percentage of total employment, in large part due to the University of Michigan and the University of Michigan Medical Center.

Livingston County had an unadjusted unemployment rate of 7.6% for November 2012.10 The county had a population of approximately 181,000 for 201011 and had a median household income of approximately $68,500 for 2009, which was the highest in the state.12 Approximately 35 percent of the land in Livingston County is used for farming, and a large portion of the population works outside the county. Manufacturing in the county is dominated by auto-related sectors. 13

The economic base of Lenawee and Monroe Counties is primarily agricultural and light manufacturing, with their manufacturing sectors exhibiting moderate dependence on the automotive industry. Lenawee County had a population of approximately 100,000 for 201014 and a median household income of approximately $46,700 for 2009.15 Monroe County had a population of approximately 152,000 for 2010 16 and a median household income of approximately $53,200 for 2009.17 Lenawee County had an unadjusted unemployment rate of 7.6% for November 2012 18 and Monroe County had an unadjusted unemployment rate of 6.4% for that same month.19

Market Developments

Expiration of the FDIC's Transaction Account Guarantee Program ("TAG")

Temporary unlimited deposit insurance coverage for noninterest-bearing transaction accounts under the Dodd-Frank Act expired on December 31, 2012. TAG, which was originally part of the Temporary Liquidity Guarantee Program of 2008, added unlimited insurance coverage to noninterest bearing accounts, regardless of balance. This temporary unlimited coverage was in addition to, and separate from, the general FDIC deposit insurance coverage of up to $250,000 available to depositors. Depending on the perceptions by depositors of the safety and soundness of banking institutions, the termination of the TAG program could result in deposit disintermediation in individual banks and in the banking industry as a whole.


10 Michigan Labor Market Information, Data Explorer – Unemployment Statistics, by County (November 2012).
11 Michigan State Senate, Senate Fiscal Agency, Michigan Population by County.
12 Michigan Labor Market Information, Data Explorer – Income (2009 Annual).
13 Economic Development Council of Livingston County, Michigan www.livingstonedc.com.
14 U.S. Census Bureau, Population Finder (Lenawee County).
15 Michigan Labor Market Information, Data Explorer – Income (2009 Annual).
16 U.S. Census Bureau, Population Finder (Monroe County).
17 Michigan Labor Market Information, Data Explorer – Income (2009 Annual).
18 Michigan Labor Market Information, Data Explorer –Unemployment Statistics (November 2012).
19 Id.
Other Developments

Exit from TARP Capital Purchase Program

The Company issued Preferred Shares to U.S. Treasury on January 16, 2009 as part of Treasury's Troubled Asset Relief Program Capital Purchase Program in a private placement exempt from the registration requirements of federal and state securities laws. On June 19, 2012, Treasury sold all 20,600 Preferred Shares in a modified dutch auction. The sale of the Preferred Shares did not result in any accounting entries on the books of the Company and did not change the Company's capital position. The Company incurred $299,000 of legal and accounting costs related to the sale of the Preferred Shares in the second quarter of 2012.

On July 18, 2012, the Company repurchased from Treasury for $38,000 a Warrant to purchase 311,492 shares of Company common stock. The Warrant was issued to Treasury in connection with the Company's participation in the TARP Capital Purchase Program.

As a result of these transactions, the Company no longer has any obligation to Treasury in connection with the TARP Capital Purchase Program and the Company is no longer subject to certain requirements of the Emergency Economic Stabilization Act of 2008, as amended by the American Recovery and Reinvestment Act of 2009, leaving the Company with greater flexibility to manage its business and affairs and eliminating the management time and expenses which were required to comply with these provisions.

Termination of Memorandum of Understanding

UBT previously entered into a Memorandum of Understanding ("MOU") with the Federal Deposit Insurance Corporation ("FDIC") and the Michigan Office of Financial and Insurance Regulation ("OFIR") which documented an understanding among the Bank, FDIC and OFIR relating to, among other things, the declaration and payment of dividends by the Bank to the Company and the maintenance of specified capital levels. On November 13, 2012, the Bank received a letter from FDIC and OFIR notifying the Bank that, as a result of an examination of the Bank as of June 30, 2012, FDIC and OFIR have terminated the MOU with the Bank effective immediately.

The Board of Directors of the Bank continues to be committed to operation of the Bank in a safe and sound manner with a strong capital base. In connection with termination of the MOU, the Board of Directors of the Bank has resolved that the Bank will maintain Tier 1 leverage ratio at a level equal to or exceeding 8.5% and that the Bank will not declare or pay any dividend to the Company unless the Board of Directors first determines that the Bank has produced stable earnings. The Bank's Tier 1 leverage ratio was 9.59% at December 31, 2012, after payment of a $1.6 million dividend to the Company in the fourth quarter of 2012.

Board Resolution

At the direction of the Reserve Bank, on April 22, 2010, the Company's Board of Directors adopted a resolution requiring the Company to obtain written approval from the Reserve Bank prior to any of the following:



(i) declaration or payment of common or preferred stock dividends; (ii) any increase in debt or issuance of trust preferred obligations; or (iii) the redemption of Company stock.

The Company has requested and received Reserve Bank approval to declare and pay as required, and has declared and paid, all accrued dividends on its 20,600 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, Liquidation Preference Amount $1,000 per share (the "Preferred Shares") to the date of this report. On February 12, 2013, the Reserve Bank notified the Company that it is no longer required to obtain prior approval of future payments of dividends on the Preferred Shares.

Executive Summary

The Company's consolidated net income was $4.5 million for the twelve months ended December 31, 2012, improving from $917,000 for 2011. Reduced levels of loan loss provision and double-digit increases in the Company's noninterest income significantly contributed to the higher earnings levels achieved in 2012. The Company's return on average assets ("ROA") for the twelve month period ended December 31, 2012 was 0.50%, up from 0.10%, for the same period of 2011. Return on average shareholders' equity ("ROE") of 4.69% for the twelve months ended December 31, 2012 was up from 0.98% for 2011.

Net interest income for 2012 was 0.4% above 2011 levels, in spite of a 2.0% increase in average earning assets. Continued downward pressure on both short and long-term interest rates has contributed to the modest decline in the Company's net interest margin in 2012 compared to 2011. Net interest margin for the fourth quarter of 2012 declined from prior quarters primarily as a result of increasing prepayment speeds on the Bank's portfolio of mortgage-backed securities. While the current low rate environment has helped mortgage production, it has negatively impacted the yields on mortgage-backed securities.

Noninterest income improved by $4.3 million, or 24.9%, in 2012 as compared to 2011, following an increase of 5.6% in 2011 compared to 2010. United's double-digit increases in noninterest income were a significant driver of the Company's improved earnings in 2012. A significant portion of this growth in noninterest income resulted from increased loan originations, both of residential mortgages and SBA loans.

Total noninterest expenses were up 7.5% in 2012 compared to 2011, following an increase of 6.5% in 2011 compared to 2010. Several categories of noninterest expense declined in the twelve months ended December 31, 2012 compared to the same period of 2011. Among those were FDIC insurance premiums, external data processing expense and expenses related to other real estate owned ("ORE") and other foreclosed properties. At the same time, salaries and employee benefits, advertising and marketing expense and attorney and other professional fees each experienced increases in 2012 compared to 2011.

The Company's provision for loan losses of $8.4 million for the twelve months ended December 31, 2012 was down 31.3% from $12.2 million for the same period of 2011. This significantly reduced level of provision for loan losses was a result of continued significant improvement in the Company's credit quality metrics.

Total consolidated assets of the Company were $907.7 million at December 31, 2012, up 2.6% from $885.0 million at December 31, 2011. The Company's total portfolio loans have increased by $23.0 million, or 4.1%, since December 2011, reflecting United's entry into adjacent markets, combined with a moderate strengthening of the local economy.

The Company continues to hold elevated levels of investments, federal funds sold and cash equivalents in order to protect the balance sheet during this prolonged period of economic uncertainty. In 2012, the Company moved some of its liquidity from federal funds sold and cash equivalents into securities available for sale. United's balances in federal funds sold and cash equivalents were $56.8 million at December 31, 2012, compared to $91.8 million at December 31, 2011. Securities available for sale of $206.1 million at December 31, 2012 were up $32.9 million or 19.0% from December 31, 2011. The net change in federal funds sold and cash equivalents and securities available for sale was $2.0 million at December 31, 2012 compared to December 31, 2011.

Total deposits of $784.6 million at December 31, 2012 were up $19.8 million from $764.9 million at December 31, 2011, with all of the growth in non-interest bearing deposit balances. The majority of the Bank's deposits are derived from core client sources, relating to long-term relationships with local individual, business and public clients. Public clients include local government and municipal bodies, hospitals, universities and other educational institutions. As a result of its strong core funding, the Company's cost of interest-bearing deposits was 0.61% for 2012, down from 0.83% for 2011.

The Company's ongoing proactive efforts to resolve nonperforming loans have contributed to the Company's continued improvement in credit quality trends in 2012. Within the Company's loan portfolio, $16.8 million of loans were considered nonperforming at December 31, 2012, compared to $25.8 million at December 31, 2011. Total nonperforming loans as a percent of total portfolio loans improved from 4.57% at the end of 2011 to 2.86% at December 31, 2012. For purposes of this presentation, nonperforming loans consist of nonaccrual loans and accruing loans that are past due 90 days or more and exclude accruing restructured loans. Balances of accruing restructured loans at December 31, 2012 and 2011 were $15.8 million and $21.8 million, respectively.

The Company's ratio of allowance for loan losses to total loans at December 31, 2012 was 3.84%, and covered 134.6% of nonperforming loans, compared to 3.66%, and 80.0%, respectively, at December 31, 2011. The Company's allowance for loan losses increased by $1.9 million, or 9.3%, from December 31, 2011 to December 31, 2012. Net charge-offs of $6.4 million for 2012 were down 61.4% from the $16.7 million charged off in 2011.

Financial Condition

Investment Securities

Balances in the Company's securities portfolio increased in 2012 compared to 2011, generally reflecting a shift of liquidity from federal funds sold and equivalents. The makeup of the Company's investment portfolio evolves with the changing price and risk structure, and liquidity needs of the Company.
 

The table below reflects the carrying value of various categories of investment securities of the Company, along with the percentage composition of the portfolio by type as of the end of 2012 and 2011.


 
December 31, 2012
   
December 31, 2011
 
In thousands of dollars
 
Balance
   
% of total
   
Balance
   
% of total
 
 U.S. Treasury and agency securities
 
$
27,316
     
13.3
%
 
$
49,366
     
28.5
%
 Mortgage-backed agency securities
   
160,499
     
77.9
%
   
102,697
     
59.3
%
 Obligations of states and political subdivisions
   
18,286
     
8.9
%
   
20,977
     
12.1
%
 Corporate, asset backed and other securities
   
-
     
0.0
%
   
126
     
0.1
%
 Equity securities
   
28
     
0.0
%
   
31
     
0.0
%
 Total Investment Securities
 
$
206,129
     
100.0
%
 
$
173,197
     
100.0
%


Investments in U.S. Treasury and agency securities are considered to possess low credit risk. Obligations of U.S. government agency mortgage-backed securities possess a somewhat higher interest rate risk due to certain prepayment risks. The Company's portfolio contains no mortgage-backed securities or structured notes that the Company believes to be "high risk." The municipal portfolio contains a small level of geographic risk, as approximately 1.5% of the investment portfolio is issued by political subdivisions located within Lenawee County, Michigan, 2.0% in Washtenaw County, Michigan, and 1.6% in Monroe County, Michigan. The Bank's investment in local municipal issues reflects our commitment to the development of the local area through support of its local political subdivisions. The Company has no investments in securities of issuers outside of the United States.

Management believes that the unrealized gains and losses within the investment portfolio are temporary, since they are a result of market changes, rather than a reflection of credit quality. Management has no specific intent to sell any securities, although the entire investment portfolio is classified as available for sale. The following chart summarizes net unrealized gains (losses) in each category of the portfolio at the end of 2012 and 2011.


In thousands of dollars
 
12/31/12
   
12/31/11
   
Change
 
 U.S. Treasury and agency securities
 
$
116
   
$
367
   
$
(251
)
 Mortgage-backed agency securities
   
1,670
     
842
     
828
 
 Obligations of states and political subdivisions
   
735
     
1,287
     
(552
)
 Equity securities
   
2
     
5
     
(3
)
 Total net unrealized gains
 
$
2,523
   
$
2,501
   
$
22
 


FHLB Stock

The Bank is a member of the Federal Home Loan Bank of Indianapolis ("FHLBI") and holds a $2.6 million investment in stock of the FHLBI. The investment is carried at par value, as there is not an active market for FHLBI stock. The FHLBI reported a profit of $107.8 million for the first nine months of 2012, and continues to pay dividends on its stock.20 The Company regularly reviews the credit quality of FHLBI stock for impairment, and determined that no impairment of FHLBI stock was necessary as of December 31, 2012.



20 Federal Home Loan Bank of Indianapolis, Form 10-Q Quarterly Report for the period ended September 30, 2012.

Portfolio Loans

Total portfolio loan balances at December 31, 2012 increased by $23.0 million, or 4.1%, from December 31, 2011. Personal loans on the Company's balance sheet included home equity lines of credit, direct and indirect loans for automobiles, boats, recreational vehicles and other items for personal use. Personal loan balances increased by $7.8 million, or 7.5%, in 2012, with substantially all of the increase in consumer installment loans. Business loan balances increased by $1.6 million, or 0.5%, over the twelve months ended December 31, 2012, compared to a 5.4% decrease in 2011. Growth of business loans in 2012 reflects a modest improvement in loan demand, net of write-downs, charge-offs and payoffs.

The Bank's loan portfolio includes $4.8 million of purchased participations in business loans originated by other institutions. These participations represent 0.8% of total portfolio loans, and these loans are primarily the result of participations purchased from other banks headquartered in Michigan.

The Bank generally sells its production of fixed-rate mortgages on the secondary market, and retains high credit quality mortgage loans that are not otherwise eligible to be sold on the secondary market and shorter-term adjustable rate mortgages in its portfolio. As a result, the mix of mortgage production for any given year will have an impact on the amount of mortgages held in the portfolio of the Bank. Improved economic conditions and a favorable interest rate environment contributed to stronger demand for residential real estate mortgages in 2012, and balances increased by $13.4 million, or 16.1%, in 2012 compared to 2011.

Outstanding balances of loans for construction and development have increased by $913,000 since December 31, 2011. The change in balances reflects an increase in the amount of individual construction loan volume, combined with a shift of some construction loans to permanent financing, and the payoff or charge-off of a number of construction and development loans. Residential construction loans generally convert to residential mortgages to be retained in the Bank's portfolio or to be sold in the secondary market, while commercial construction loans generally will be converted to commercial mortgages.

The following table shows the balances of each of the various categories of loans of the Company, along with the percentage of the total portfolio, as of the end of 2012 and 2011.


 
December 31, 2012
   
December 31, 2011
 
In thousands of dollars
 
Balance
   
% of Total
   
Balance
   
% of Total
 
Personal
 
$
111,170
     
18.9
%
 
$
103,405
     
18.3
%
Business, including commercial mortgages
   
336,772
     
57.5
%
   
335,133
     
59.5
%
Tax exempt
   
1,554
     
0.3
%
   
2,045
     
0.4
%
Residential mortgage
   
96,452
     
16.4
%
   
83,072
     
14.7
%
Construction and development
   
40,634
     
6.9
%
   
39,721
     
7.0
%
Deferred loan fees and costs
   
96
     
0.0
%
   
326
     
0.1
%
Total portfolio loans
 
$
586,678
     
100.0
%
 
$
563,702
     
100.0
%



Credit Quality

Nonperforming Assets. The Company actively monitors delinquencies, nonperforming assets and potential problem loans. The accrual of interest income is discontinued when a loan becomes ninety days past due unless the loan is both well secured and in the process of collection, or the borrower's capacity to repay the loan and the collateral value appears sufficient.

The chart below shows the amount of nonperforming assets by category at December 31, 2012 and 2011.


 
December 31,
   
Change
 
 Nonperforming Assets, in thousands of dollars
 
2012
   
2011
   
$
   
 
%
 
 Nonaccrual loans
 
$
16,714
   
$
25,754
   
$
(9,040
)
   
-35.1
%
 Accruing loans past due ninety days or more
   
37
     
31
     
6
     
19.4
%
 Total nonperforming loans
   
16,751
     
25,785
     
(9,034
)
   
-35.0
%
 Percent of nonperforming loans to total loans
   
2.86
%
   
4.57
%
   
-1.72
%
       
 Allowance coverage of nonperforming loans
   
134.6
%
   
80.0
%
   
54.6
%
       
                               
 Other assets owned
   
3,412
     
3,669
     
(257
)
   
-7.0
%
 Total nonperforming assets
 
$
20,163
   
$
29,454
   
$
(9,291
)
   
-31.5
%
 Percent of nonperforming assets to total assets
   
2.22
%
   
3.33
%
   
-1.11
%
       
                               
 Loans delinquent 30-89 days
 
$
3,007
   
$
6,468
   
$
(3,461
)
   
-53.5
%
                               
Accruing restructured loans
                               
Business, including commercial mortgages
 
$
7,643
   
$
10,404
   
$
(2,761
)
   
-26.5
%
Construction and development
   
4,738
     
8,186
     
(3,448
)
   
-42.1
%
Residential mortgage
   
3,267
     
3,078
     
189
     
6.1
%
Home Equity
   
171
     
171
     
-
     
0.0
%
Total accruing restructured loans
 
$
15,819
   
$
21,839
   
$
(6,020
)
   
-27.6
%


Interest payments received on impaired loans are recorded as interest income unless collection of the remaining recorded investment is doubtful, at which time payments received are recorded as reductions to principal. Subsequent payments on nonaccrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Nonaccrual loans are returned to accrual status when, in the judgment of management, the financial position of the borrower indicates there is no longer any reasonable doubt as to the timely collection of interest or principal. The Company requires a period of satisfactory performance of not less than six months before returning a nonaccrual loan to accrual status.

The Company has achieved significant improvement in its credit quality measures in recent periods. Total nonaccrual loans have decreased by $9.0 million, or 35.1%, since the end of 2011. The change in nonaccrual loans principally reflects the payoff or charge-off of some nonperforming loans, net of the migration of some loans to nonaccrual status. During the second half of 2012, the Bank received payoffs of five loans, each in excess of $1.0 million, with an aggregate payoff of $7.2 million.

Total nonperforming loans as a percent of total portfolio loans were 2.86% at December 31, 2012, down from 4.57% at December 31, 2011, while the allowance coverage of nonperforming loans increased from 80.0% at December 31, 2011 to 134.6% at December 31, 2012. Loan workout and collection efforts continue with all delinquent and nonaccrual loan clients, in an effort to bring them back to performing status.

Other assets owned includes other real estate owned and other repossessed assets, which may include automobiles, boats and other personal property. Holdings of other assets owned decreased by 7.0% since the end of 2011, as the Bank continued to sell assets while others have been added to its totals. At December 31, 2012, other real estate owned included 27 properties that were acquired through foreclosure or in lieu of foreclosure. The properties included 22 commercial properties, seven of which were the result of out-of-state loan participations, and five residential properties. All properties are for sale. Other repossessed assets at December 31, 2012 consisted of two automobiles.

The following table reflects the changes in other assets owned during 2012.


In thousands of dollars
 
Other Real Estate
   
Other Assets
   
Total
 
 Balance at January 1
 
$
3,657
   
$
12
   
$
3,669
 
 Additions
   
3,925
     
40
     
3,965
 
 Sold
   
(3,674
)
   
(49
)
   
(3,723
)
 Write-downs of book value
   
(499
)
   
-
     
(499
)
 Balance at December 31
 
$
3,409
   
$
3
   
$
3,412
 


Troubled Debt Restructurings. In the course of working with borrowers, the Bank may choose to restructure the contractual terms of certain loans. In this scenario, the Bank attempts to work out an alternative payment schedule with the borrower in order to optimize collectability of the loan. Any loans that are modified are reviewed by the Bank to identify if a troubled debt restructuring ("TDR") has occurred, which is when, for economic or legal reasons related to a borrower's financial difficulties, the Bank grants a concession to the borrower that it would not otherwise consider. Terms may be modified to fit the ability of the borrower to repay in line with its current financial status and the restructuring of the loan may include the transfer of assets from the borrower to satisfy the debt, a modification of loan terms, or a combination of the two. If such efforts by the Bank do not result in a satisfactory arrangement, the loan is referred to legal counsel, at which time foreclosure proceedings are initiated. At any time prior to a sale of the property at foreclosure, the Bank may terminate foreclosure proceedings if the borrower is able to work-out a satisfactory payment plan.

It is the Bank's policy to have any restructured loans that are on nonaccrual status prior to being restructured, remain on nonaccrual status until six months of satisfactory borrower performance, at which time management would consider its return to accrual status. The balance of nonaccrual restructured loans, which is included in nonaccrual loans, was $10.8 million at December 31, 2012 and $10.7 million at December 31, 2011. If a restructured loan is on accrual status prior to being restructured, it is reviewed to determine if the restructured loan should remain on accrual status. The balance of accruing restructured loans was $15.8 at December 31, 2012 and $21.8 million at December 31, 2011.

All TDRs are considered impaired by the Company. Loans that are considered TDRs are classified as performing unless they are on nonaccrual status or greater than 90 days delinquent as of the end of the most recent quarter. Under Company policy, a loan may be removed from TDR status when it is determined that the loan has performed according to its modified terms for a sustained period of repayment performance (generally not less than six months and not during the calendar year in which the restructuring took place), and the restructuring agreement specified an interest rate greater than or equal to an acceptable rate for a comparable new loan. On a quarterly basis, the Company individually reviews all TDR loans to determine if a loan meets these criteria. As of December 31, 2012, there were six commercial loans totaling $2.9 million that were proceeding through this six-month performance period and whose rate is not below current market rates.

Accruing restructured loans at December 31, 2012 are comprised of two categories of loans on which interest is being accrued under their restructured terms, and the loans are current or less than ninety days past due. The first category consists of commercial loans, primarily comprised of business loans that have been temporarily modified as interest-only loans, generally for a period of up to one year, without a sufficient corresponding increase in the interest rate.

Within this category are CLD loans that have been renewed as interest only, generally for a period of up to one year, to assist the borrower. The Bank does not generally forgive principal or interest on restructured loans. However, when a loan is restructured, principal is generally received on a delayed basis as compared to the original repayment schedule. CLD loans that are restructured are generally modified to require interest-only for a period of time. The Bank does not generally reduce interest rates on restructured commercial loans.

The second category included in accruing restructured loans consists of residential mortgage and home equity loans whose terms have been restructured at less than market terms and include rate modifications, extension of maturity, and forbearance. The Company has no personal loans other than the loans included in the table below that are classified as troubled debt restructurings.

The table below provides a breakdown of accruing restructured loans by type at December 31, 2012. The table also includes the average yield on restructured loans and the yield for the entire portfolio, for commercial loans and the residential mortgage and home equity line portfolio, for the fourth quarter of 2012.


 
December 31, 2012
   
Fourth Quarter
 
 Dollars in thousands
 
Number of Loans
   
Recorded Balance
   
Average Yield
   
Portfolio Yield
 
CLD Loans
   
6
   
$
4,738
         
Other Commercial Loans
   
18
     
7,643
         
Total Commercial Loans
   
24
     
12,381
     
5.15
%
   
5.25
%
                               
Residential Mortgage & Home Equity Loans
   
17
     
3,438
     
3.81
%
   
5.23
%
Total accruing restructured loans
   
41
   
$
15,819
                 



The Company performed its quarterly evaluation of the specific reserves on all of its loans previously identified as TDRs at December 31, 2012. All of the Company's accruing TDRs are performing in accordance with their modified terms and have demonstrated the necessary performance for the accrual of interest. The following table compares the recorded investment in accruing TDR loans and their specific reserve amount, as of December 31, 2012 and December 31, 2011.


In thousands of dollars
 
12/31/12
   
12/31/11
   
Change
 
 Balance of TDR Loans
 
$
15,819
   
$
21,839
   
$
(6,020
)
 Specific reserve on above loans
   
4,467
     
4,764
     
(297
)
 Percent
   
28.2
%
   
21.8
%
       


Impaired Loans. A loan is classified as impaired when it is probable that the Bank will be unable to collect all amounts due (including both interest and principal) according to the contractual terms of the loan agreement. Within the Bank's loan portfolio, $34.3 million of impaired loans have been identified as of December 31, 2012, down from $52.0 million at December 31, 2011. The specific allowance for impaired loans was $8.3 million at December 31, 2012, down from $9.0 million at December 31, 2011. The ultimate amount of the impairment and the potential losses to the Company may be substantially higher or lower than estimated, depending on the realizable value of the collateral. The level of provision for loan losses made in connection with impaired loans reflects the amount management believes to be necessary to maintain the allowance for loan losses at an adequate level, based upon the Bank's current analysis of losses inherent in its loan portfolios.

Business loans carry the largest balances per loan, and any single loss would be proportionally larger than losses in other portfolios. In addition to internal loan rating systems and active monitoring of loan trends, the Bank uses an independent loan review firm to assess the quality of its business loan portfolio. Interest payments received on impaired loans are recorded as interest income unless collection of the remaining recorded investment is doubtful, at which time payments received are recorded as reductions to principal.

CLD loans include residential and non-residential construction and land development loans. The residential CLD loan portfolio consists mainly of loans for the construction, development, and improvement of residential lots, homes, and subdivisions. The non-residential CLD loan portfolio consists mainly of loans for the construction and development of office buildings and other non-residential commercial properties.

This type of lending is generally considered to have more complex credit risks than traditional single-family residential lending because the principal is concentrated in a limited number of loans with repayment dependent on the successful completion and sales of the related real estate project. Consequently, these loans are often more sensitive to adverse conditions in the real estate market or the general economy than other real estate loans. These loans are generally less predictable and more difficult to evaluate and monitor and collateral may be difficult to dispose of in a market decline.


The Bank's portfolio of residential mortgages consists of loans to finance 1-4 family residences, second homes, vacation homes, and residential investment properties. The personal loan portfolio consists of direct and indirect installment, home equity and unsecured revolving line of credit loans. Installment loans consist primarily of home equity loans and loans for consumer durable goods, principally automobiles. Indirect personal loans, which make up a small percent of the personal loans, consist of loans for automobiles, boats and manufactured housing.

Allowance for Loan Losses. The Company's allowance for loan losses increased by $1.9 million at December 31, 2012 as compared to December 31, 2011. The allowance for loan losses as a percent of total loans of 3.84% at December 31, 2012 was up from 3.66% at December 31, 2011. The allowance for loan losses is maintained at a level believed adequate by management to absorb probable incurred credit losses in the loan portfolio. Management's determination of the adequacy of the allowance for loan losses is based on an evaluation of the loan portfolio, past loan loss experience, current economic conditions, volume, amount, and composition of the loan portfolio, and other factors management believes to be relevant.

The table below provides a breakdown of ALLL, charge-offs and combined losses as of December 31, 2012 for impaired and non-impaired loans. Impaired loans are further split between accruing TDRs and other impaired loans.


                 
% of
 
 
Unpaid
       
Cumulative
       
Unpaid
 
 
Principal
       
Charge-
   
Combined
   
Principal
 
Dollars in thousands
 
Balance
   
ALLL
   
offs
   
Losses
   
Balance
 
Accruing TDRs
 
$
15,819
   
$
4,467
       
$
4,467
     
28.2
%
                                   
Other Impaired Loans
   
18,469
     
3,837
         
3,837
         
Cumulative Charge-offs
   
9,575
     
-
     
9,575
     
9,575
         
Total
   
28,044
     
3,837
     
9,575
     
13,412
     
47.8
%
                                       
Non-impaired loans
 
$
552,390
   
$
14,239
           
$
14,239
     
2.6
%


Further information concerning credit quality is contained in Note 5 of the Company's Notes to Consolidated Financial Statements, which information is incorporated here by reference.

Deposits

United internally funds its operations through a large, stable base of core deposits that provides cost-effective funding for its lending operations. The majority of deposits are derived from core client sources, relating to long term relationships with local individual, business and public clients. Public clients include local governments and municipal bodies, hospitals, universities and other educational institutions. At December 31, 2012 and 2011, core deposits accounted for 99.3% and 98.8%, respectively, of total deposits. For this presentation, core deposits consist of total deposits less national certificates of deposit and brokered deposits. Core deposits include deposits held through the Certificate of Deposit Account Registry Service® ("CDARS") as they represent deposits originated in the Bank's market area.

The table below shows the change in the various categories of the deposit portfolio for the reported periods.


 
2012 Change
   
2011 Change
 
 In thousands of dollars
 
Amount
   
Percent
   
Amount
   
Percent
 
Noninterest bearing deposits
 
$
26,084
     
18.7
%
 
$
26,140
     
23.1
%
Interest bearing deposits
   
(6,297
)
   
-1.0
%
   
4,718
     
0.8
%
Total deposits
 
$
19,787
     
2.6
%
 
$
30,858
     
4.2
%


Total deposits grew by $19.8 million, or 2.6%, in the twelve months ended December 31, 2012, compared to growth of $30.9 million, or 4.2%, in the twelve months ended December 31, 2011. The Bank's noninterest bearing deposits increased by 18.7% during 2012, while interest bearing deposits declined by 1.0%. As part of its capital ratio improvement initiatives, United generally did not replace maturing wholesale deposits in 2012 or 2011. The Bank utilizes purchased or brokered deposits for interest rate risk management purposes, but does not support its growth through the use of those products. In addition, the Bank participates in the CDARS program, which allows it to provide competitive CD products while maintaining FDIC insurance for clients with larger balances. The Bank's deposit rates are consistently competitive with other banks in its market areas. As a result of its strong core funding, the Company's cost of interest-bearing deposits was 0.61% for all of 2012, down from 0.83% for 2011.

Noninterest bearing deposits made up 21.1% of total deposits at December 31, 2012, compared to 18.2% at December 31, 2011. The table below shows the makeup of the Company's deposits at December 31, 2012 and 2011.


 
December 31, 2012
   
December 31, 2011
 
 In thousands of dollars
 
Balance
   
% of total
   
Balance
   
% of total
 
Noninterest bearing deposits
 
$
165,430
     
21.1
%
 
$
139,346
     
18.2
%
Interest bearing deposits
   
619,213
     
78.9
%
   
625,510
     
81.8
%
Total deposits
 
$
784,643
     
100.0
%
 
$
764,856
     
100.0
%


Cash Equivalents and Borrowed Funds

The Company maintains correspondent accounts with a number of other banks for various purposes. In addition, cash sufficient to meet the operating needs of its banking offices is maintained at its lowest practical levels. The Bank is also a participant in the federal funds market, either as a borrower or seller. Federal funds are generally borrowed or sold for one-day periods. The Bank maintains interest-bearing deposit accounts with the Federal Reserve Bank and the FHLBI, as alternatives to federal funds.

The Bank also has the ability to utilize short term advances from the FHLBI and borrowings at the discount window of the Federal Reserve Bank as additional short-term funding sources. Federal funds and equivalents were used during 2012 and 2011, while short term advances and discount window borrowings were not utilized during either year.

The Company periodically finds it advantageous to utilize longer-term borrowings from the FHLBI. These long-term borrowings, as detailed in Note 10 of the Company's Notes to Consolidated Financial Statements, serve to provide a balance to some of the interest rate risk inherent in the Company's balance sheet. Additional information regarding borrowed funds is found in the Liquidity section below.

Results of Operations

Earnings Summary and Key Ratios

Consolidated net income for the year ended December 31, 2012 was $4.5 million, or $0.26 per share of common stock, compared to $917,000, or $(0.02) per share of common stock (after accounting for preferred stock dividends), for 2011 and a loss of $3.7 million, or $(0.89) per common share, in 2010. Elevated levels of noninterest income and lower provision for loan losses in 2012 contributed to improved earnings levels and performance ratios compared to 2011 and 2010. Return on average assets ("ROA") was 0.50% for 2012, compared to 0.10% for 2011 and -0.42% for 2010. Return on average shareholders' equity ("ROE") was 4.69% for the full year of 2012, compared to 0.98% for 2011 and -4.66% for 2010.

Net interest income of $30.2 million for 2012 was 0.4% above the same period of 2011. These minimal changes resulted from relatively large reductions in both interest income and interest expense in 2012 compared to 2011. United's net interest margin was 3.59% for the twelve months ended December 31, 2012 and was down from 3.64% for 2011 and 3.79% for 2010.

Total noninterest income for the twelve months ended December 31, 2012 improved by $4.3 million, or 24.9%, in 2012 as compared to 2011. United's double-digit increases in noninterest income continued to be a significant driver of the Company's improved earnings. This growth in noninterest income resulted, in part, from increased loan originations, both of residential mortgages and SBA loans. Noninterest income represented 41.6% of the Company's total revenues in 2012, compared to 36.4% for 2011.

Total noninterest expense was up $2.6 million, or 7.5%, in 2012 compared to 2011. The largest dollar amount of increase for 2012 and 2011 was in salaries and employee benefits. Expenses relating to ORE properties, and attorney and other professional fees reflect costs related to the Company's credit quality concerns.

As a result of strong financial performance, the Company's combined net interest income and noninterest income was up 9.3% in 2012 compared to 2011, while the Company's noninterest expense increased by 7.5% in 2012 compared to 2011.The following table shows the trends of the major components of earnings and related ratios for the five most recent quarters.


 
2012
   
2011
 
 Dollars in thousands
 
4th Qtr
   
3rd Qtr
   
2nd Qtr
   
1st Qtr
   
4th Qtr
 
 Net interest income before provision
 
$
7,384
   
$
7,646
   
$
7,566
   
$
7,569
   
$
7,687
 
 Provision for loan losses
   
1,700
     
2,000
     
2,550
     
2,100
     
250
 
 Noninterest income
   
5,891
     
5,564
     
5,278
     
4,758
     
4,635
 
 Noninterest expense
   
9,586
     
9,300
     
9,148
     
9,169
     
8,815
 
 Federal income taxes
   
543
     
520
     
361
     
216
     
960
 
 Net income (loss)
 
$
1,446
   
$
1,390
   
$
785
   
$
842
   
$
2,297
 
 Basic and diluted earnings (loss) per share
 
$
0.09
   
$
0.09
   
$
0.04
   
$
0.04
   
$
0.16
 
 Return on average assets
   
0.64
%
   
0.62
%
   
0.36
%
   
0.38
%
   
1.03
%
 Return on average shareholders' equity
   
5.94
%
   
5.79
%
   
3.35
%
   
3.61
%
   
9.89
%
 Net interest margin
   
3.45
%
   
3.63
%
   
3.62
%
   
3.62
%
   
3.67
%
 Efficiency Ratio (tax equivalent basis)
   
71.7
%
   
69.9
%
   
70.7
%
   
73.8
%
   
70.9
%
 Tier 1 Leverage Ratio
   
10.2
%
   
10.1
%
   
9.9
%
   
9.8
%
   
9.9
%


Pre-tax, Pre-provision Income and Return on Average Assets

In an attempt to evaluate the trends of net interest income, noninterest income and noninterest expense, the Company calculates pre-tax, pre-provision income ("PTPP Income") and pre-tax, pre-provision return on average assets ("PTPP ROA"). PTPP Income adjusts net income by the amount of the Company's federal income tax (benefit) and provision for loan losses, which is excluded because its level is elevated and volatile in times of economic stress. PTPP ROA measures PTPP Income as a percent of average assets. While this information is not consistent with, or intended to replace, presentation under generally accepted accounting principles, it is presented here for comparison.

Management believes that PTPP Income and PTPP ROA are useful and consistent measures of the Company's earning capacity, as these financial measures enable investors and others to assess the Company's ability to generate capital to cover credit losses through a credit cycle, particularly in times of economic stress.

The Company's strong PTPP Income has been achieved through a substantial core funding base, which has resulted in a comparatively strong net interest margin, a diversity of noninterest income sources and expansion of our markets. The Company's PTPP ROA was 1.62% for 2012, compared to 1.44% and 1.70%, respectively, for 2011 and 2010. The reduction in PTPP ROA in 2011 compared to 2010 was in part a result of increases in noninterest expenses relating to collection and disposition of troubled assets, and the improvement in 2012 compared to 2011 resulted primarily as a result of the large increase in noninterest income from loan sales and servicing.

The table below shows the calculation and trend of PTPP Income and PTPP ROA for the twelve month periods ended December 31, 2012, 2011 and 2010.


 
Twelve Months Ended December 31,
 
Dollars in thousands
 
2012
   
2011
   
Change
   
2010
   
Change
 
Interest income
 
$
34,693
   
$
36,165
     
-4.1
%
 
$
39,770
     
-9.1
%
Interest expense
   
4,528
     
6,114
     
-25.9
%
   
8,687
     
-29.6
%
Net interest income
   
30,165
     
30,051
     
0.4
%
   
31,083
     
-3.3
%
Noninterest income
   
21,491
     
17,211
     
24.9
%
   
16,298
     
5.6
%
Noninterest expense
   
37,203
     
34,618
     
7.5
%
   
32,497
     
6.5
%
Pre-tax, pre-provision income
 
$
14,453
   
$
12,644
     
14.3
%
 
$
14,884
     
-15.0
%
Average assets
 
$
893,239
   
$
876,008
     
2.0
%
 
$
874,768
     
0.1
%
Pre-tax, pre-provision ROA
   
1.62
%
   
1.44
%
   
0.18
%
   
1.70
%
   
-0.26
%
Reconcilement to GAAP income:
                                       
Provision for loan losses
 
$
8,350
   
$
12,150
     
-31.3
%
 
$
21,530
     
-43.6
%
Income tax expense (benefit)
   
1,640
     
(423
)
 
NA
     
(2,938
)
 
NA
 
Net income (loss)
 
$
4,463
   
$
917
     
386.7
%
 
$
(3,708
)
 
NA
 


Net Interest Income

Declining interest rates over the past few years have significantly reduced the Company's yield on earning assets, but have also resulted in a reduction in its cost of funds. Interest income decreased 4.1% in 2012 compared to 2011, while interest expense decreased 25.9% for 2012 compared to 2014, resulting in an increase in net interest income of 0.4% for 2012 compared to 2011.

United's net interest margin was 3.59% for the twelve months ended December 31, 2012, compared to 3.64%, for 2011 and 3.79% for 2010. The Company's net interest margin has continued to trend downward year over year, as a result of a decline in loan balances and continued elevated levels of investments and short-term liquid assets, and in spite of a relatively large increase in non-interest bearing deposits. Net interest margin for the fourth quarter of 2012 declined from prior quarters primarily as a result of increasing prepayment speeds on the Bank's portfolio of mortgage-backed securities, further reducing the Company's net interest margin for the full year 2012. While the current low rate environment has helped residential mortgage loan production, it has negatively impacted the yields on mortgage-backed securities.

The Company has held historically high levels of liquidity since 2009, during this extended period of economic uncertainty. While the additional liquidity contributed to the Company's margin compression during that time period, a shift of a portion of its liquidity from federal funds sold and equivalents to investment securities in 2012 and 2011 has slowed United's decline in yields on earning assets. At the same time, the Bank has reduced its average balances of FHLB advances and higher-cost deposits during 2012 and 2011, and continues to fund its growth primarily with core deposits.

Tax-equivalent yields on earning assets declined from 4.37% for 2011 to 4.11% for 2012, for a reduction of 26 basis points. The Company's average cost of funds decreased by 24 basis points, and tax equivalent net interest margin declined from 3.64% for all of 2011 to 3.59% for 2012. The following table provides a summary of the various components of net interest income, and the results of changes in balance sheet makeup that have resulted in the changes in net interest spread and net interest margin for years ended December 31, 2012, 2011 and 2010.

Yield Analysis of Consolidated Average Assets and Liabilities
 
                                   
 Dollars in thousands
 
2012
   
2011
   
2010
 
 Assets
 
Average Balance
   
Interest (b)
   
Yield/ Rate
   
Average Balance
   
Interest (b)
   
Yield/ Rate
   
Average Balance
   
Interest (b)
   
Yield/ Rate
 
Interest earning assets (a)
                                   
Federal funds sold and equivalents
 
$
67,504
   
$
172
     
0.25
%
 
$
101,985
   
$
260
     
0.25
%
 
$
93,072
   
$
235
     
0.25
%
Taxable securities
   
173,350
     
2,390
     
1.38
%
   
127,448
     
2,731
     
2.14
%
   
79,088
     
2,136
     
2.69
%
Tax exempt securities (b)
   
19,570
     
992
     
5.87
%
   
22,276
     
1,147
     
5.15
%
   
27,805
     
1,455
     
5.69
%
Taxable loans (c)
   
589,578
     
31,390
     
5.32
%
   
581,283
     
32,292
     
5.56
%
   
632,319
     
36,279
     
5.74
%
Tax exempt loans (b)
   
1,760
     
120
     
6.84
%
   
2,105
     
174
     
8.28
%
   
2,359
     
194
     
8.23
%
Total interest earning assets (b)
   
851,762
   
$
35,064
     
4.11
%
   
835,097
   
$
36,604
     
4.37
%
   
834,643
   
$
40,299
     
4.83
%
Cash and due from banks
   
14,930
                     
13,742
                     
13,683
                 
Other nonearning assets
   
49,061
                     
52,475
                     
48,768
                 
Allowance for loan losses
   
(22,514
)
                   
(25,306
)
                   
(22,326
)
               
Total Assets
 
$
893,239
                   
$
876,008
                   
$
874,768
                 
                                                                       
Liabilities and Shareholders' Equity
                                                                       
Interest bearing liabilities
                                                                       
NOW and savings deposits
 
$
367,982
   
$
554
     
0.15
%
 
$
350,985
   
$
854
     
0.24
%
 
$
356,153
   
$
1,378
     
0.39
%
Other interest bearing deposits
   
246,293