UNITED BANCSHARES INC/OH - Quarter Report: 2000 September (Form 10-Q)

FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

(Mark One)

( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2000

or

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission file number 000-29283

UNITED BANCSHARES, INC.

(Exact name of Registrant as specified in its charter)

Ohio

(State or other jurisdiction of incorporation or organization)

100 S. High Street, Columbus Grove, Ohio

(Address of principal executive offices)

34-1516518

(I.R.S. Employer Identification Number)

45830

(Zip Code)

(419) 659-2141

(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of October 20, 2000: 2,247,328.

This document contains 19 pages.

PART I - FINANCIAL INFORMATION

ITEM 1

The following unaudited Condensed Consolidated Balance Sheets, Consolidated Statements of Income, Consolidated Statements of Shareholders' Equity, and Consolidated Statements of Cash Flows of United Bancshares, Inc. (the "Company") and subsidiaries, reflect all adjustments (which include normal recurring accruals) necessary to present fairly such information for the periods and dates indicated. Since the following condensed unaudited financial statements have been prepared in accordance with instructions to Form 10-Q, they do not contain all information and footnotes necessary for a fair presentation of financial position in conformity with generally accepted accounting principles. Operating results for the nine months ended September 30, 2000, are not necessarily indicative of the results that may be expected for the year ending December 31, 2000. Complete audited consolidated financial statements with footnotes thereto are included in the Company's Annual Report on Form 10-K for the year ended December 31, 1999.

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Significant intercompany accounts and transactions have been eliminated.

UNITED BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(Dollars in thousands)

UNITED BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Dollars in thousands, except per share data)

UNITED BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

NOTES TO FINANCIAL STATEMENTS (Unaudited)

Basis of Presentation

The accounting and reporting policies of United Bancshares, Inc. and Subsidiaries (the "Company") conform to generally accepted accounting principles and to general practices within the banking industry. The Company considers all of its principal activities to be banking related. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.

NOTES TO FINANCIAL STATEMENTS (Unaudited), (continued)

1. Acquisitions/New Branches

On February 1, 2000, the Company completed the acquisition of The Bank of Leipsic Company in an exchange of stock that was accounted for as a pooling of interests. As a result, the financial position and results of operations of The Bank of Leipsic Company are consolidated within the accompanying financial statements for all periods presented.

During the third quarter of 2000, an Affiliation Agreement was signed with Delphos Citizens Bancorp whereby Delphos Citizens Bancorp will merge with and into United Bancshares. The agreement is subject to approval by shareholders of both organizations as well as regulatory bodies. Form 8-K was filed during the quarter disclosing this proposed transaction.

In October 2000, the Company applied for a full-service branch to be located at 215 W. Market Street, Lima, Ohio. This branch will be located in a facility to be purchased in November 2000. The tentative opening date for the branch would be December 2000.

2. Accounting Standard Implemented in 2000

In June, 1998, the Financial Accounting Standards Board issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities", which establishes accounting and reporting standards for derivative instruments and hedging activities. Under Statement 133, derivatives are recognized on the balance sheet at fair value as an asset or liability. Changes in the fair value of derivatives is reported as a component of other comprehensive income or recognized as earnings through the income statement depending on the nature of the instrument. Statement 137 was issued in June 1999, and deferred the effectiveness of Statement 133 to all quarters of fiscal years beginning after June 15, 2000, with earlier adoption permitted. There was no impact on the Company's consolidated financial statements as a result of adopting Statement 133 during the third quarter of 2000 since the Company did not hold any derivative instruments or conduct hedging activities during the period.

Generally accepted accounting principles require an entity that sells loans with servicing rights retained to allocate the total cost of the loan to the mortgage servicing rights and the loans based on their relative values. The Company has not yet adopted the policy of allocating the value of servicing rights retained. However, in October 2000, the Company engaged a consultant to assist in the determination of the fair value of mortgage servicing rights and expects to record the fair value of mortgage servicing rights in the December 31, 2000 consolidated financial statements.

ITEM 2

MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS

OF OPERATIONS AND FINANCIAL CONDITION

SELECTED FINANCIAL DATA

The following data should be read in conjunction with the unaudited consolidated financial statements and the management discussion and analysis that follows:

(a) Net income to average assets, net income to average shareholders' equity, net interest margin, and efficiency ratio are presented on an annualized basis. Net interest margin is calculated using fully tax equivalent net interest

income as a percentage of average earning assets.

(b) Efficiency ratio is a ratio of non-interest expense as a percentage of fully tax equivalent net interest income plus non-interest income.

Introduction

When or if used in the Company's Securities and Exchange Commission filings or other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases: "anticipate", "would be", "will allow", "intends to", "will likely result", "are expected to", "will continue", "is anticipated", "is estimated", "is projected", or similar expressions are intended to identify "forward looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Any such statements are subject to the risks and uncertainties that include but are not limited to: changes in economic conditions in the Company's market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Company's market area, and competition. All or some of these factors could cause actual results to differ materially from historical earnings and those presently anticipated or projected.

The Company cautions readers not to place undue reliance on any such forward looking statements, which speak only as of the date made, and advises readers that various factors including regional and national economic conditions, substantial changes in the levels of market interest rates, credit and other risks associated with lending and investing activities, and competitive and regulatory factors could affect the Company's financial performance and could cause the Company's actual results for future periods to differ materially from those anticipated or projected. The Company does not undertake, and specifically disclaims any obiligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements.

The following discussion and analysis of the consolidated financial statements of the Company is presented to provide insight into management's assessment of the financial results. The Company's subsidiaries are The Union Bank Company and The Bank of Leipsic.

The Company provides an array of financial products and services to its customers, including investments and insurance products, deposit products, loan products, credit and debit cards, cash management services, and safe deposit rental facilities. The Company provides services through traditional walk-in offices, automated teller machines, auto drive-in facilities, banking by phone and internet-based banking.

Both The Union Bank Company and The Bank of Leipsic are chartered by the state of Ohio and subject to regulation, supervision, and examination by the Federal Deposit Insurance Corporation ("FDIC") and the Ohio Division of Financial Institutions. This discussion and analysis should be read in conjunction with the prior year-end audited consolidated financial statements, and footnotes thereto and the ratios, statistics, and discussions contained elsewhere in the Form 10-Q.

On February 1, 2000, the Company completed the acquisition of The Bank of Leipsic. That transaction was accounted for as a pooling of interests and the financial positions and results of operations of The Bank of Leipsic are consolidated within these financial statements for all periods presented.

In connection with the acquisition of The Bank of Leipsic, certain shareholders dissented from voting in favor of the acquisition and requested that they be paid in cash for their shares. This transaction took place in the first quarter of 2000 with the acquired shares being reflected as Treasury Stock.

RESULTS OF OPERATIONS

Overview of the Income Statement

Net income for the three months ended September 30, 2000, totaled $375,000, a 35.0% decrease over 1999 results of $577,000. Net income for the nine months ended September 30, 2000, totaled $1,411,000, a 9.4% decrease over 1999 results of $1,557,000. Earnings per diluted share were $0.16 for the three months ended September 30, 2000, as compared to $0.24 for the same period in 1999. Earnings per diluted share were $0.59 for the nine months ended September 30, 2000 compared to $0.65 for the same period in 1999.

During the first nine months of 2000, the Company recognized $137,000 of expenses associated with the acquisition of The Bank of Leipsic. The majority of these expenses were legal fees related to comply with the various documents and filings required to effect the acquisition. At the same time, the Company recognized a reduction of expenses in the amount of $142,000 due to the market value impact on previously-issued Stock Appreciation Rights. The Company looks at these two amounts as nonrecurring in nature and basically offset one another.

Interest Income and Expense

Net interest income is the amount by which interest income from interest-earning assets exceeds interest incurred on interest-bearing liabilities. Interest-earning assets consist principally of loans and investment securities while interest-bearing liabilities include interest-bearing deposit accounts and borrowed funds. Net interest income remains the primary source of revenue for the Company. Changes in market interest rates, as well as changes in the mix and volume of interest-bearing assets and interest-bearing liabilities, impact net interest income.

Net interest income was $2,018,000 in the third quarter of 2000 compared to $2,058,000 for the same period of 1999. As can be seen in the "Consolidated Average Balance Sheet and Analysis of Net Interest Income", this decrease results from an increase in the rate paid on interest bearing liabilities which offsets the increase in the earning assets. Net interest income was $6,281,000 for the first nine months of 2000 compared to $5,947,000 for the same period of 1999. This increase is largely attributable to an increase in average loan balances that offsets a decrease in the net interest margin.

Net interest margin is calculated by dividing net interest income (adjusted to reflect tax-exempt municipal income on a taxable equivalent basis) by average interest-earning assets. The resultant percentage serves as a measurement for the Company in comparing its results with those of past periods as well as those of peer companies. For the three months ended September 30, 2000, the net interest margin (on a taxable equivalent basis) was 3.66% compared with 4.09% for the same period of 1999. Most of this decrease was due to interest expense attributable to interest-bearing liabilities. The rates on these liabilities have increased as a result of recent Federal Reserve action to increase rates and the resulting competitive pressures. Yields on loans are typically slower to respond to such market increases, causing a margin shrinkage. For the nine months ended September 30, 2000, the net interest margin (on a taxable equivalent basis) was 3.92% compared with 4.09% for the same period of 1999.

Please refer to the "Consolidated Average Balance Sheet and Analysis of Net Interest Income" table included in this Form 10-Q for a quantitative analysis of the Company's net interest income.

Provision for Loan Losses

The provision for loan losses is based upon management's continuing evaluation of the adequacy of the allowance for loan losses and is reflective of the quality of management's assessment of the quality of the portfolio and overall management of the inherent credit risk. Any changes in the provision for loan losses will be dependent on loan delinquencies, portfolio risk, and general economic conditions in the Company's markets.

Non-Interest Income

The Company's non-interest income is largely generated from fees related to customer deposit accounts and income arising from sales of products such as investments to customers. The income related to deposit accounts provides a relatively steady flow of income while the other sources are more volume-related and can vary from quarter to quarter.

Non-Interest Expense

For the three-month period ended September 30, 2000, non-interest expenses totaled $1,727,000 compared to $1,478,000 for the equivalent period of 1999. Salaries and benefits represented $102,000 of this increase, primarily due to annual merit increases as well as several new positions. Data processing costs were higher by $40,000 due to the outsourced proof and transit function. Other real estate owned expense, relating to foreclosed property, was $40,000 higher in the third quarter of 2000 as compared to 1999. For the nine-month period ended September 30, 2000, non-interest expenses totaled $4,931,000 compared to $4,512,000 for the equivalent period of 1999. Salaries and benefits decreased from $2,360,000 in 1999 to $2,237,000 in 2000. The majority of this decrease is attributable to the adjustment made to state the current value of outstanding Stock Appreciation Rights in accordance with the decline in market value of the associated shares. To a lesser degree, attrition of employees accounted for some decline. Net occupancy expense increased from $449,000 in 1999 to $541,000 in 2000 largely as a result of the opening of an operations center to house the consolidated operations areas of the two subsidiaries. Data processing costs increased to $459,000 from $277,000. As previously mentioned, the cost of proof and transit is now reflected here since it is performed off-site. Previously, this labor-intensive cost would have been included in salaries and benefits. Other costs increased from $1,019,000 in the first nine months of 1999 to $1,261,000 in 2000. Causing most of this increase were the $137,000 of costs attributable to the merger with The Bank of Leipsic Company.

Maintaining acceptable levels of non-interest expense and operating efficiency are key performance indicators for the Company in its strategic initiatives. The financial services industry uses the efficiency ratio (total non-interest expense as a percentage of the aggregate of fully-tax equivalent net interest income and non-interest income) as a key indicator of performance. Any non-recurring items, whether income or expense, are not included in the calculation of the Company's efficiency ratio.

In the first nine months of 2000, the Company's efficiency ratio was 65.29% compared to 62.82% for the same period of 1999.

Return on Assets

For the quarter ended September 30, 2000, return on average assets ("ROA") was 0.60% compared to 1.02% for the same period of 1999. For the nine-month period ended September 30, 2000, return on average assets ("ROA") was 0.78% compared to 0.93% for the same period of 1999.

Return on Equity

For the quarter ended September 30, 2000, return on average equity ("ROE") was 8.34% compared to 12.62% for the same period of 1999. For the nine-month period ended September 30, 2000, return on average equity ("ROE") was 10.86% compared to 11.49% for the same period of 1999. A significant factor contributing to these year-to-year changes was the acquisition of treasury shares (causing a reduction in total shareholders' equity) at a cost of $914,000 near the end of the first quarter of 2000.

The Company and both of its subsidiaries are considered well-capitalized under regulatory and industry standards of risk-based capital.

FINANCIAL CONDITION

Overview of Balance Sheet

Loans at September 30, 2000, net of the allowance for loan losses, increased by $12 million from the balance at December 31, 1999. Investment securities have increased by $2 million during this nine-month period. Deposits during this same period have increased by $2 million. The remaining funding for the asset growth was provided by additional borrowings from the Federal Home Loan Bank of $13 million.

Shareholders' equity increased from $18.1million at December 31, 1999 to $18.4 million at September 30, 2000. This increase results from increases provided by net income for the nine-month period of $1,411,000 and a reduction in the unrealized loss on available-for-sale securities, net of income taxes, of $615,000. These increases were offset by the acquisition of treasury stock at a cost of $914,000, and cash dividends paid of $746,000.

Cash and Cash Equivalents

Cash and cash equivalents totaled $9.6 million at September 30, 2000 compared to $8.8 million at December 31, 1999. Federal funds sold at December 31, 1999 were $2.3 million and $4.1 million at September 30, 2000.

Management believes the current balance of cash and cash equivalents adequately serves the Company's liquidity and performance needs. Total cash and cash equivalents fluctuate on a daily basis due to transactions in process and other liquidity needs. Management believes the liquidity needs of the Company are satisfied by the current balance of cash and cash equivalents, readily available access to traditional and non-traditional funding sources, and the portions of the investment and loan portfolios that mature within one year. These sources of funds should enable the Company to meet cash obligations and off-balance sheet commitments as they come due.

Investment Securities

At September 30, 2000, investment securities totaled $54.2 million, an increase of $2 million (3.8%) from December 31, 1999. All of the Company's investment securities are classified as available-for-sale. Management believes the available-for-sale classification provides flexibility for the Company in terms of selling securities as well as interest rate risk management opportunities. At September 30, 2000, the amortized cost of the Company's investment securities totaled $56.0 million, resulting in unrealized depreciation of $1.8 million and a corresponding after tax decrease in the Company's equity of $1.2 million.

Management monitors the earnings performance and liquidity of the investment portfolio on a regular basis through Asset/Liability Committee ("ALCO") meetings.

Loans

The Company's lending is primarily centered in northwestern and west central Ohio. These are principally retail lending markets, which include single-family residential and other consumer lending. A primary focus in these markets is the agribusiness industry.

Gross loans totaled $179.7 million at September 30, 2000, an increase of $12.4 million, or 7.4%, since December 31, 1999.

The following table details total outstanding loans at the specified dates:

Allowance for Loan Losses

The allowance for loan losses as a percentage of loans was 1.00% at September 30, 2000 and 1.00% at December 31, 1999.

The following table presents changes in the Company's allowance for loan losses for the nine months ended September 30, 2000, and 1999, respectively:

Nonperforming loans (those loans classified as nonaccrual, 90 days or more past due, and other real estate owned) as a percentage of outstanding loans were 1.66% at September 30, 2000, compared to 1.26% at December 31, 1999. Nonaccrual loans and those loans 90 days past due totaled $526,000 and $1,831,000, respectively, at September 30, 2000, compared to $743,000 and $1.367,000, respectively, at year-end 1999. Management believes the current level of nonperforming loans is better than peer group levels and is a reflection of the quality of the Company's loan portfolio.

At September 30, 2000, the Company had an insignificant amount of loans that were considered impaired. Management will continue to monitor the status of impaired loans, including performing and nonperforming loans, in order to determine the appropriate level of the allowance for loan losses.

The first nine months of 2000's provision for loan losses was higher in comparison to the same period of 1999 due to management's intention to increase the allowance at each separate subsidiary to a level at least equal to 1.00% of outstanding loans. Management continually monitors the loan portfolio to determine the adequacy of the allowance for loan losses and considers it to be adequate at September 30, 2000.

Funding Sources

The Company considers a number of alternatives, including but not limited to deposits, short-term borrowings, and long-term borrowings when evaluating funding sources. Traditional deposits continue to be the most significant source of funds for the Company, totaling $200.1 million, or 85.9% of the Company's funding sources at September 30, 2000.

Non-interest bearing deposits remain a smaller portion of the funding source for the Company than for most of its peers. These balances declined by $0.2 million at September 30, 2000 from the December 31, 1999 level. This decline is considered to be seasonal in nature and follows a trend of prior years.

Interest-bearings deposits were $184.8 million at September 30, 2000, compared to $182.5 million at December 31, 1999, an increase of 1.2%. Management considers this modest growth acceptable given the competitive pricing environment during the first nine months of 2000.

In addition to traditional deposits, the Company maintains both short-term and long-term borrowing capacity with the Federal Home Loan Bank. FHLB borrowings totaled $32.4 million at September 30, 2000, compared to $19.2 million at December 31, 1999. Long-term borrowings reprice after their initial fixed rate period (at the discretion of the FHLB), and the Company has the option to prepay any repriced advance without penalty, or allow the borrowing to reprice to a LIBOR based, variable product. Management plans to maintain access to long-term FHLB borrowings as an appropriate funding source.

Shareholders' Equity

For the nine months ended September 30, 2000, the Company had net income of $1,411,000 and paid dividends of $746,000, resulting in a dividend payout ratio of 52.8% of net income. Management feels the overall equity level supports this payout ratio but feels that the ratio to net income will eventually drop to more traditional industry standards. The intention is to maintain the per share dividend while earnings increase which will more normalize the payout ratio.

At September 30, 2000, the adjustment for the net unrealized loss on available-for-sale securities, net of income taxes, totaled $1.8 million, a change of $690 thousand since December 31, 1999. Since all the investment securities in the Company's portfolio are classified as available-for-sale, both the investment and equity sections of the Company's balance sheet are sensitive to the changing market values of investments.

The Company has also complied with the standards of capital adequacy mandated by the banking industry. Bank regulators have established "risk-based" capital requirements designed to measure capital adequacy. Risk-based capital ratios reflect the relative risks of various assets banks hold in their portfolios. A weight category of either 0% (lowest risk assets), 20%, 50%, or 100% (highest risk assets) is assigned to each asset on the balance sheet and to certain off-balance sheet commitments.

At September 30, 2000, the risk-based capital ratios of the Company and each of the banking subsidiaries were above the minimum standard for a well-capitalized institution. The Company's risk-based capital ratio was 11.45%, compared to the 10% minimum standard for well-capitalized institutions. The Company's Tier 1 capital ratio of 10.53% also exceeded the 6% minimum standard for well-capitalized institutions. The leverage ratio at the end of the third quarter of 2000 was 7.12%, also above the minimum standard of 5% for well-capitalized institutions. The Company's capital ratios provide quantitative data demonstrating the strength and future opportunities for use of the Company's capital base. Management continues to evaluate risk-based capital ratios and the capital position of the Company and each of the banking subsidiaries as part of its strategic decision process.

Liquidity and Interest Rate Sensitivity

The objective of the Company's asset/liability management function is to maintain consistent growth in net interest income through management of the Company's balance sheet liquidity and interest rate exposure based on changes in economic conditions, interest rate levels, and customer preferences.

The Company manages interest rate risk to minimize the impact of fluctuating interest rates on earnings. The Company uses simulation techniques that attempt to measure the volatility of changes in the level of interest rates, basic banking interest rate spreads, the shape of the yield curve, and the impact of changing product growth patterns. The primary method of measuring the sensitivity of earnings of changing market interest rates is to simulate expected cash flows using varying assumed interest rates while also adjusting the timing and magnitude of non-contractual deposit repricing to more accurately reflect anticipated pricing behavior. These simulations include adjustments for the lag in prime loan repricing and the spread and volume elasticity of interest-bearing deposit accounts, regular savings, and money market deposit accounts.

The principal function of interest rate risk management is to maintain an appropriate relationship between those assets and liabilities that are sensitive to changing market interest rates. The Company closely monitors the sensitivity of its assets and liabilities on an ongoing basis and projects the effect of various interest rate changes on its net interest margin. Interest sensitive assets and liabilities are defined as those assets or liabilities that mature or reprice within a designated time-frame. The difference between rate sensitive assets and rate sensitive liabilities for a specified period of time is know as "gap".

Management believes the Company's current mix of assets and liabilities provides a reasonable level of risk related to significant fluctuations in net interest income and the resulting volatility of the Company's earning base. The Company's management reviews interest rate risk in relation to its effect on net interest income, net interest margin, and the volatility of the earnings base of the Company.

Effects of Inflation on Financial Statements

Substantially all of the Company's assets relate to banking and are monetary in nature. Therefore, they are not impacted by inflation to the same degree as companies in capital intensive industries in a replacement cost environment. During a period of rising prices, a net monetary asset position results in loss in purchasing power and conversely a net monetary liability position results in an increase in purchasing power. In the banking industry, typically monetary assets exceed monetary liabilities. Therefore, as prices have recently increased, financial institutions experienced a decline in the purchasing power of their net assets.

ITEM 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes in the Company's quantitative and qualitative market risks since December 31, 1999. The following table compares rate sensitive assets and liabilities as of September 30, 2000 to December 31, 1999.

UNITED BANCSHARES, INC.

CONSOLIDATED AVERAGE BALANCE SHEET AND ANALYSIS OF NET INTEREST INCOME

Interest income and yields presented on a fully tax-equivalent basis using a 34% tax rate.

PART II

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

EXHIBIT INDEX

UNITED BANCSHARES, INC. QUARTERLY REPORT ON FORM 10-Q

FOR PERIOD ENDED SEPTEMBER 30, 2000

EXHIBIT 11

UNITED BANCSHARES, INC. AND SUBSIDIARIES

Computation of Earnings Per Share