UNITED BANCSHARES INC/OH - Quarter Report: 2001 September (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(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, 2001

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.

          Yes          X          No

                    _ _ _ _ _ _        _ _ _ _ _ _

Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of November 9, 2001:   3,588,864.

This document contains 15 pages.

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PART I - FINANCIAL INFORMATION

ITEM 1

UNITED BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(Dollars in thousands)

2

UNITED BANCSHARES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Dollars in thousands, except per share data)

3

UNITED BANCSHARES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(Dollars in thousands)

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NOTES TO FINANCIAL STATEMENTS (Unaudited)

Note 1 - Consolidated Financial Statements

               The accompanying unaudited Condensed Consolidated Balance Sheets, Statements of Income, and Statements of Cash Flows of United Bancshares, Inc. and subsidiaries (the "Company") reflect all adjustments (which include normal recurring adjustments) necessary to present fairly such information for the periods and dates indicated. Since the condensed unaudited financial statements have been prepared in accordance with instructions to Form 10-Q, they do not contain all information and footnotes typically included in financial statements prepared in conformity with generally accepted accounting principles. Operating results for the three months and nine months ended September 30, 2001, are not necessarily indicative of the results that may be expected for the year ending December 31, 2001. 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, 2000.

              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.

              The accounting and reporting policies of the Company conform to generally accepted practices within the banking industry. The Company considers all of its principal activities to be banking related.

Note 2 - Acquisition of Delphos Citizens Bancorp

             Effective the close of business February 28, 2001, the Company entered into a reorganization with Delphos Citizens Bancorp (Delphos) that resulted in Delphos being acquired by the Company. As a result of the transaction, the Company paid cash of $8.6 million and issued 1,367,344 shares of its common stock in exchange for 100% of the outstanding common stock of Delphos.

             The transaction was accounted for using purchase accounting. Consequently, the assets and liabilities of Delphos as of February 28, 2001 were recorded at their estimated fair values. The total purchase price, including cash paid and the estimated fair value of the shares issued, approximated $22.3 million and resulted in a deferred credit (negative goodwill) of $3.9 million. Such deferred credit is currently being amortized to income using the straight-line method over a ten-year period.

             The accompanying Condensed Consolidated Statements of Income and Cash Flows include the operating results and cash flows of Delphos for the period subsequent to the acquisition.

Note 3 - New Accounting Pronouncement

               In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141, "Business Combinations", which addresses financial accounting and reporting for business combinations. Statement 141 stipulates that any unamortized deferred credit resulting from a business combination occurring before July 1, 2001 shall be written off and reported as a change in accounting principle. Consequently, as a result of the adoption of Statement 141, effective January 1, 2002, the Company will cease amortizing the deferred credit relating to the Delphos acquisition and will recognize an extraordinary gain of the unamortized balance.

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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 interest 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.

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        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 obligation, 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, The Bank of Leipsic, and Citizens' Bank of Delphos.

        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. Citizens' Bank of Delphos is a federally-chartered savings bank, subject to regulation, supervision, and examination by the FDIC and the Office of Thrift Supervision ("OTS"). This discussion and analysis should be read in conjunction with the 2000 audited consolidated financial statements, and footnotes thereto and the ratios, statistics, and discussions contained elsewhere in the Form 10-Q.

        On March 1, 2001, the Company completed the acquisition of Delphos Citizens Bancorp and its wholly-owned subsidiary, Citizens' Bank of Delphos (Citizens). That transaction was accounted for as a purchase and the financial position and results of operations of Citizens are consolidated within these financial statements for the period subsequent to the acquisition.

RESULTS OF OPERATIONS

Overview of the Income Statement

       Net income for the three months ended September 30, 2001, totaled $1,250,000, a 233.7% increase over 2000 results of $375,000. Net income for the nine months ended September 30, 2001, totaled $2,502,000, a 77.3% increase over 2000 results of $1,411,000. Earnings per diluted share were $0.33 for the three months ended September 30, 2001, as compared to $0.16 for the same period in 2000. Earnings per diluted shares were $0.71 for the nine months ended September 30, 2001, as compared to $0.59 for the same period in 2000.

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 $3,093,000 in the third quarter of 2001 compared to $2,018,000 for the same period of 2000. Net interest income was $8,515,000 for the first nine months of 2001 compared to $6,281,000 for the same period of 2000. As can be seen in the "Consolidated Average Balance Sheet and Analysis of Net Interest Income", this increase was tempered by the decrease in the yield on earning assets.

       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, 2001, the net interest margin (on a taxable equivalent basis) was 3.47% compared with 3.66% for the same period of 2000. For the nine months ended September 30, 2001, the net interest margin (on a taxable equivalent basis) was 3.47% compared with 3.96% for the same period of 2000. Most of this decrease was due to decreased interest income attributable to interest-earning assets.

       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.

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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 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. Another source of non-interest income is gain on sale of loans including capitalization of retained mortgage servicing rights, which amounted to $760,000 for the quarter ended September 30, 2001 compared to $33,000 for the comparable 2000 period. During the third quarter of 2001, approximately $45 million of fixed-rate mortgage loans originated by Citizens were sold to FHLMC in two separate sales. Gains and retained mortgage servicing rights of $460,000 were recognized from these sales and are part of the quarterly amounts cited above. Gains on sales of loans and retained mortgage servicing rights for the nine-month period ended September 30, 2001 were $1,047,000 compared to $93,000 for the comparable 2000 period. The significant increase in gain on sale of loans for the comparable nine-month periods resulted from the significant gains relating to the two large third quarter loan sales, as well as an increase in capitalized servicing rights and a $182,000 reduction in the valuation allowance for loans held for sale during the 2001 nine-month period.

       Since the fair value of net assets acquired in the Citizens transaction was in excess of the fair value of consideration paid, this gave rise to a deferred credit that is being amortized and recognized as income over a ten-year period. For the three-month and nine-month periods ended September 30, 2001 this amounted to $138,000 and $230,000, respectively.

Non-Interest Expense

       For the three-month period ended September 30, 2001, non-interest expenses totaled $2,419,000 compared to $1,727,000 for the equivalent period of 2000. Salaries and benefits represented $350,000 of this increase, primarily due to the staffing of the new Lima branch as well as a full quarter's expense for Citizens. Occupancy expense was higher by $39,000, also reflecting the costs of the two additional facilities. Data processing costs were higher by $60,000 due to additional volume. Professional fees increased to $120,000 from $49,000 largely due to costs related to issues raised incident to the Citizens transaction. While there are certain costs associated with opening a new branch and acquiring a new subsidiary, the Company anticipates that the higher level of expenses will continue since additional staff has been added to accommodate the additional volume of activity.

       For the nine-month period ended September 30, 2001, non-interest expenses totaled $6,925,000 compared to $4,931,000 for the comparable period of 2000. Salaries and benefits represented $1,095,000 of this increase, again primarily due to the staffing of the new Lima branch as well as the inclusion of Citizens for seven months of 2001. Occupancy expense was higher by $120,000, also reflecting the costs of the two additional facilities. Data processing costs were higher by $164,000 due to additional volume. Costs related to credit/debit cards increased to $262,000 from $156,000.

       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.

       For the third quarter of 2001, the Company's efficiency ratio was 54.7% compared to 70.4% for the same period of 2000. The efficiency ratio for 2001 was favorably impacted by the elements of non-interest income arising from an increase in gains on sales of loans including retained mortgage servicing rights recognized in the third quarter. For the nine-month period ended September 30, 2001, the Company's efficiency ratio was 63.1% compared to 65.3% for the same period of 2000.

Return on Assets

       For the quarter ended September 30, 2001, return on average assets ("ROA") was 1.29% compared to 0.60% for the same period of 2000. For the nine months ended September 30, 2001, return on average assets was 0.93% compared to 0.78% for the same period of 2000. The improvements in the 2001 periods as compared to 2000 were largely a result of gains on loan sales.

Return on Equity

       For the quarter ended September 30, 2001, return on average equity ("ROE") was 14.91% compared to 8.51% for the same period of 2000. For the nine months ended September 30, 2001, return on average equity was 10.87% compared to 10.71% for the same period of 2000.

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

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FINANCIAL CONDITION

Overview of Balance Sheet

       Loans at September 30, 2001, net of the allowance for loan losses, decreased by $63.2 million from the balance at December 31, 2000 combined with the loans acquired with the Citizens transaction. Investment securities have increased by $35.2 million during this nine-month period. Deposits during this same period have increased by $14.6 million combined with the Citizens acquisition. Federal Home Loan Bank borrowing were paid down by $31.2 million during the nine-month period. The major portion of these changes reflect the results of sales of fixed-rate mortgage loans and subsequent reinvestment of proceeds into investments securities as well as payment of Federal Home Loan Bank borrowings.

        Shareholders' equity increased from $19.0 million at December 31, 2000 to $34.6 million at September 30, 2001. This increase results primarily from the issuance of 1,367,344 shares to acquire Citizens.

Cash and Cash Equivalents

       Cash and cash equivalents totaled $30.9 million at September 30, 2001 compared to $13.9 million at December 31, 2000, including Federal funds sold at September 30, 2001 of $11.5 million and $7.7 million at December 31, 2000. Much of this increase is a result of the proceeds from the sale of Citizens' loans. Such funds will ultimately likely be invested in the securities portfolio.

       Management believes the current balance of cash and cash equivalents, after allowing for the probable investment cited in the above paragraph, 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. In addition, the Company has access to various sources of additional borrowings by virtue of long-term assets that can be used as collateral for such borrowings.

Investment Securities

       At September 30, 2001, investment securities totaled $89.0 million, an increase of $35.7 million from December 31, 2000. The majority of the increase has resulted from the reinvestment of proceeds from sales of fixed-rate mortgage loans. 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, 2001, the amortized cost of the Company's investment securities totaled $88.2 million, resulting in unrealized appreciation of $0.8 million and a corresponding after tax increase in the Company's equity of $0.5 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 $236.7 million at September 30, 2001 compared to $167.8 million at December 31, 2000 with $127 million of the increase resulting from the Citizens acquisition. The remaining net reduction represents the sales of fixed-rate mortgage loans through the secondary market.

Allowance for Loan Losses

       The allowance for loan losses as a percentage of loans was 1.13% at September 30, 2001 and 1.00% at December 31, 2000.

The following table presents changes in the Company's allowance for loan losses for the nine months ended September 30, 2001, and 2000, respectively:

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       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 0.99% at September 30, 2001, compared to 1.23% at December 31, 2000. Nonaccrual loans and those loans 90 days past due totaled $693,000 and $1,294,000, respectively, at September 30, 2001, compared to $360,000 and $1,359,000, respectively, at year-end 2000. The significant increase in amount of non-accrual loans results from one specific credit rather than an overall pattern. 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 as well as increased staffing levels devoted to monitoring and pursuing this area of credits.

       At September 30, 2001, 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 2001's provision for loan losses was lower in comparison to the same period of 2000 due to management's assessment that the allowance for loan losses was adequate in relation to the identified problem 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, 2001.

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 $305.5 million, or 91.1% of the Company's funding sources at September 30, 2001.

       Non-interest bearing deposits remain a smaller portion of the funding source for the Company than for most of its peers. These balances comprised only 6.1% of total deposits at September 30, 2001.

       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 $29.8 million at September 30, 2001 compared to $30.4 million at December 31, 2000. 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, 2001, the Company had net income of $2,502,000 and paid dividends of $1,036,000, resulting in a dividend payout ratio of 41.4% 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, 2001, the adjustment for the net unrealized income on available-for-sale securities, net of income taxes, totaled $513,000 compared to a net unrealized loss of $303,000 at December 31, 2000. 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.

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".

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       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. With the acquisition of Citizens, the Company has accepted additional levels of fixed-rate assets in the form of residential mortgages. Plans are underway to mitigate the risk associated with this acquisition and various options are being considered. The sale during the third quarter of approximately $45 million of fixed-rate mortgage loans originated by Citizens was primarily done to deal with this risk.

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.

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ITEM 3

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

       The Citizens transaction significantly changes the Company's market risk due to the nature of the lending policies previously followed by Citizens. The majority of their loans consist of fixed-rate residential mortgage loans. Management has made several changes to address this additional risk and is contemplating implementing additional changes to mitigate potential future risks.

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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.

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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, 2001

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EXHIBIT 11

UNITED BANCSHARES, INC. AND SUBSIDIARIES

Computation of Earnings Per Share

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