UNITED BANCSHARES INC/OH - Quarter Report: 2003 September (Form 10-Q)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2003

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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)  Yes        No   X 

Indicate the number of shares outstanding of each of the issuer’s classes of Common Stock, as of October 31, 2003: 3,652,404

#

UNITED BANCSHARES, INC.

Table of Contents

Page

Part I – Financial Information

3

Item 1 – Financial Statements

3

Item 2 – Management’s Discussion and Analysis of Financial Condition

12

  and Results of Operations

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

17

Item 4 – Controls and Procedures

18

Part II – Other Information

18

PART 1 - FINANCIAL INFORMATION

ITEM 1

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)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

Note 1 – Consolidated Financial Statements

The consolidated financial statements 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 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, 2003, are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.  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, 2002.

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries.  Significant inter-company 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 – New Accounting Pronouncement

In June 2001, the Financial Accounting Standards Board issued Statement No. 141, “Business Combinations” (Statement 141), which addresses financial accounting and reporting for business combinations.  Under the provisions of Statement 141, any unamortized deferred credit resulting from a business combination occurring before July 1, 2001 shall be written-off and reported as the cumulative effect of a change in accounting principle.  Consequently, as a result of the adoption of Statement 141 effective January 1, 2002, the Company ceased amortizing the deferred credit relating to the Delphos acquisition and recognized as income from a change in accounting principle the unamortized deferred credit, amounting to $3,807,000.

Note 3 – Branch Acquisitions

In December 2002, the Company’s wholly-owned subsidiary, The Union Bank Company “Union”, entered into a purchase and assumption agreement to purchase certain assets and assume certain liabilities assigned to the branch offices of RFC Banking Company “RFCBC” in Pemberville and Gibsonburg, Ohio. The acquisition received approval from regulatory authorities, and was completed on March 28, 2003.  The acquisition was accounted for as a business combination since the Company acquired substantially all operating assets and liabilities of the branches and retained most of the branch employees.  Consequently, assets acquired and liabilities assumed in connection with the acquisition were recorded at fair value and included the following: Cash ($5,749,000), loans ($54,505,000), premises and equipment ($1,033,000), and deposits ($71,955,000).  Based on the negotiated purchase price, the transaction resulted in the recording of a deposit base premium of $1,778,000 and goodwill of $8,782,000.  The results of operations of the branches have been included for the period subsequent to the acquisition.

In accordance with Statement No. 142, “Goodwill and Other Intangible Assets”, issued by the Financial Accounting Standards Board, the goodwill arising from the RFCBC acquisition is not amortized but will be subject to an annual impairment test.  The deposit base premium is being amortized over a period of 7 years.

Note 4 – Merging of Bank Subsidiaries

On March 7, 2003, following the receipt of approval from the appropriate regulatory authorities, the Company collapsed the charters of Citizens Bank of Delphos and the Bank of Leipsic and merged them into the charter of The Union Bank Company.  Accordingly, the Company is now a one-bank holding company.  

Note 5 – Trust Preferred Securities Issuance

During the quarter ended March 31, 2003, the Company formed a wholly-owned subsidiary business trust, United (OH) Statutory Trust I “United Trust”.  Effective March 26, 2003, United Trust issued $10 million of trust preferred securities, which are guaranteed by the Company.  The trust used the proceeds from the issuance of their trust preferred securities to purchase subordinated deferrable interest debentures issued by the Company.  These debentures are United Trust’s only assets and the interest payments from the debentures and related income effects are not reflected in the Company’s consolidated financial statements since they are eliminated in consolidation.

The interest rate of the trust preferred securities and debentures is fixed at 6.40% for a five-year period through March 2008.  Thereafter, interest is at a floating rate adjustable quarterly and equal to 315 basis points over the 3-month LIBOR.  Interest is payable quarterly.  The Company has the right, subject to events in default, to defer payments of interest on the debentures by extending the interest payment period for a period not exceeding 20 consecutive quarterly periods.  The trust preferred securities are subject to mandatory redemption upon payment of the debentures.  The debentures mature on March 26, 2033, which date may be shortened to March 26, 2008, if certain conditions are met, as well as quarterly thereafter.

The trust preferred securities are reported as a liability but have been structured to qualify as Tier I capital for regulatory purposes.

ITEM 2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

SELECTED FINANCIAL DATA

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

For the Three

For the Nine

Months Ended

Months Ended

September 30,

September 30,

2003

2002

2003

2002

SIGNIFICANT RATIOS (Unaudited)

Net income to:

Average assets (a)

0.62%

0.87%

0.77%

0.68%

Average shareholders’ equity (a)

7.04%

9.20%

8.67%

7.23%

Net interest margin (a)

3.43%

3.53%

3.50%

3.47%

Efficiency ratio (a)(b)

75.04%

61.67%

70.05%

71.11%

Average shareholders’ equity to average assets

8.76%

9.52%

8.93%

9.48%

Loans to deposits (end of period)

76.55%

75.80%

76.55%

75.80%

Allowance for loan losses to loans (end of period)

1.05%

1.14%

1.05%

1.14%

Cash dividends to net income

53.88%

43.76%

44.20%

55.57%

PER SHARE DATA

Book value per share

$11.47

$11.29

$11.47

$11.29

(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.  For purposes of these calculations, as well as cash dividends to net income, net income excludes the impact of the change in accounting principle in 2002.

(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 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.  

United Bancshares, Inc. (the “Company”), an Ohio corporation, is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and is subject to regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”).  The Company was incorporated and organized in 1985.  The executive offices of the Company are located at 100 S. High Street, Columbus Grove, Ohio 45830.  Following the merger of the Company’s other two bank subsidiaries into The Union Bank Company (Columbus Grove, Ohio) in March 2003, the Company is now a one-bank holding company, as that term is defined by the Federal Reserve Board.

The Union Bank Company “Union” is engaged in the business of commercial banking.  Union is an Ohio state-chartered bank, which serves Allen, Putnam, Sandusky, Van Wert and Wood Counties, with office locations in Bowling Green, Columbus Grove, Delphos, Gibsonburg, Kalida, Leipsic, Lima, Ottawa, and Pemberville.

As described in Note 3 of the consolidated financial statements, the Company acquired branches from RFC Banking Company, effective March 28, 2003.  Since the acquisition was accounted for as a purchase, only the operations of the branches subsequent to March 28, 2003 are included in the Company’s consolidated financial information.

Union offers a full range of commercial banking services, including checking and NOW accounts, savings and money market accounts; time certificates of deposit; automatic teller machines; commercial, consumer, agricultural, residential mortgage loans and home equity loans; credit card services; safe deposit box rentals; and other personalized banking services.

The Company is registered as a Securities Exchange Act of 1934 (defined as Exchange Act later) reporting company.  

RESULTS OF OPERATIONS

Overview of the Income Statement

For the quarter ended September 30, 2003, the Company reported net income of $748,000 or $0.21 basic earnings per share. This compares to third quarter 2002 net income of $906,000, or $0.25 basic earnings per share.  Compared with the same period in 2002, third quarter 2003 net income decreased $158,000 or 17%.  The net income decline was the result of increases of $670,000 in non-interest expenses and $220,000 in the provision for loan losses, offset by increases in net interest income and non-interest income of $365,000 and $142,000, respectively and a $225,000 decrease in the provision for income taxes.

Factors affecting the increases in net interest income and non-interest expenses include a growing earning asset base and expanded operations as a result of the Company’s completion of the purchase of branches located in Pemberville, Gibsonburg and the Otterbein-Portage Valley Retirement Village from RFC Banking Company on March 28, 2003.  The increase in non-interest expenses also resulted from additional one time conversion costs associated with the purchase of the branches and the merger of the Company’s three bank charters into one.  

Net income for the nine months ended September 30, 2003, totaled $2,724,000, or $0.75 basic earnings per share compared to $2,137,000 or  $0.59 basic earnings per share for the same period in 2002 (excluding the impact of a change in accounting principle).  Net income for the nine months ended September 30, 2003 as compared to same period in 2002 was impacted by similar factors as stated above for the third quarter.

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 $3,660,000 for the third quarter of 2003 compared to $3,295,000 for the same period of 2002.  Net interest income was $11,016,000 for the nine-month period of 2003 compared to $9,301,000 for the same period of 2002.  

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 and nine months ended September 30, 2003, the net interest margin (on a taxable equivalent basis) was 3.43% and 3.50% compared with 3.53% and 3.47% for the same periods of 2002.

Provision for Loan Losses

The provision for loan losses is determined based upon management’s continuing calculation 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.  Changes in the provision for loan losses are dependent, among other things, on loan delinquencies, portfolio risk, and general economic conditions in the Company’s markets.  Although no provision for loan losses was determined to be necessary for the first six months of 2003, a $450,000 provision for loan losses was made for the third quarter of 2003, due to the deterioration of certain watch list credits, including one agricultural relationship.  The 2003 provision for loan losses compares to a provision for loan losses of $230,000 and $422,000, respectively, for the three and nine month periods ended September 30, 2002.  The overall loan portfolio had minimal changes in loan balance (excluding the impact of the RFCBC branch acquisitions), as well as the level and mix of problem and non-performing loans.

Non-Interest Income

The Company’s non-interest income is largely generated from activities related to the origination, servicing and gains on sale of fixed rate mortgages, gain on sales of security investments, customer deposit account fees, 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.  

Gain on sale of loans amounted to $697,000 for the quarter ended September 30, 2003 compared to $209,000 for the comparable 2002 period.  The quarterly gains included capitalized servicing rights of $356,000 and $162,000 on $37.2 and $20.0 million originated loan sales during the quarters ended September 30, 2003 and 2002, respectively. The balance of the gain on sale of loans represented cash gains resulting from reduced interest rates during 2003, and the resulting re-financing activity.  Additionally, during the three-month periods ending September 30, 2003 and 2002 the Company realized net gains on the sale of securities of $72,000 and $112,000, respectively.

Gain on sale of loans for the nine-month period ending September 30, 2003 amounted to $2,130,000 compared to $693,000 for the comparable 2002 period. The 2003 year to date gains include capitalized servicing rights of $856,000 and $510,000 on $105.0 and $59.5 million originated loan sales during the quarters ended September 30, 2003 and 2002, respectively.  The balance of the gain on sale of loans represented cash gains resulting from reduced interest rates during 2003, and the resulting re-financing activity.  Additionally, during the nine-month periods ending September 30, 2003 and 2002 the Company realized net gains on the sale of securities of $122,000 and $103,000, respectively.  The Company also recognized other income of $201,000 in the third quarter of 2003 from proceeds received as a result of one of the Company’s insurance carriers converting from a mutual insurance company to a stock insurance company.

Non-Interest Expenses

For the three-month period ended September 30, 2003, non-interest expenses totaled $3,340,000 compared to $2,670,000 for the comparable period of 2002.  The additional expenses were largely due to the RFC branch acquisition, as well as, the Company’s continued commitment to the improvement of internal controls and the overall operational environment.   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, 2003, non-interest expenses totaled $9,930,000 compared to $8,160,000 for the comparable period of 2002.  The additional expenses for the nine-month period were the result of similar factors as indicated above.

For the three and nine month periods of 2003, the Company’s efficiency ratio was 75.04% and 70.05% compared to 61.67% and 71.11% for the same periods of 2002.  Due to the aforementioned factors, there were increases in non-interest expenses for the three and nine month periods ending 2003 compared for the same periods in 2002.  However, the increases in expenses were partially offset by improvements in net interest and non-interest income.

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.  

Provision for Income Taxes

The provision for income taxes for the quarter ended September 30, 2003 was $144,000, or 16.1% of income before income taxes, compared to $369,000, or 28.9%, for the comparable 2002 period.  The provision for income taxes for the nine-month period ended September 30, 2003 was $885,000, or 24.5% of income before income taxes, compared to $756,000, or 26.1%, for the comparable 2002 period.  The decrease in the effective tax rates were due to tax-exempt interest comprising a larger portion of pre-tax income for the 2003 periods.

Return on Assets

Return on average assets was 0.62% for the third quarter of 2003, compared to 0.87% for the comparable quarter of 2002.  Return on average assets for the nine months ended September 30, 2003 was 0.77% compared to 0.68% for the same period in 2002, excluding the impact of the change in accounting principle.

Return on Equity

Return on average equity for the third quarter of 2003 was 7.04% compared to 9.20% for the same period of 2002.  Return on average equity for the nine months ended September 30, 2003 was 8.67% compared to 7.23% for the same period in 2002, excluding the impact of the change in accounting principle.  The Company’s bank subsidiary is considered well capitalized under regulatory and industry standards of risk-based capital.

FINANCIAL CONDITION

Overview of Balance Sheet

Loans at September 30, 2003, net of the allowance for loan losses, increased $46.2 million from December 31, 2002.  Securities available-for-sale increased $3.0 million during this nine-month period.  Deposits during this same period increased $52.5 million.  Federal Home Loan Bank borrowings increased $98,000 during the nine-month period and, as described in Note 5 to the consolidated financial statements, the Company issued $10 million of trust preferred securities during the first quarter of 2003.  As disclosed in Note 3 to the consolidated financial statements, the September 30, 2003 balance of loans and deposits was significantly impacted by the RFCBC branch acquisitions.  As of September 30, 2003, the acquired branches’ loans and deposits were  $50.0 and $63.4 million, respectively.

Shareholders’ equity increased from $41.0 million at December 31, 2002 to $41.9 million at September 30, 2003.  

Cash and Cash Equivalents

Cash and cash equivalents totaled $13.8 million at September 30, 2003 compared to $16.7 million at December 31, 2002, including Federal funds sold at September 30, 2003 of $4.0 million and $5.9 million at December 31, 2002.

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.  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.

Securities

At September 30, 2003, securities totaled $154.1 million, an increase of $3.0 million from December 31, 2002.  All of the Company’s 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, 2003, the amortized cost of the Company’s securities totaled $152.9 million, resulting in unrealized gains of $1.2 million and a corresponding after tax increase in the Company’s equity of $790,000.

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 (including loans held for sale) totaled $292.6 million at September 30, 2003 compared to $243.6 million at December 31, 2002, an increase of  $49.0 million.  Excluding the impact of the RFCBC branch acquisitions, gross loans decreased $5.5 million during the nine-month period.

Allowance for Loan Losses

The allowance for loan losses as a percentage of loans was 1.05% at September 30, 2003 compared to 1.15% at December 31, 2002.  As a result of the acquired branch loans the allowance for loan losses as a percentage of total loans has decreased.

Management believes the level of allowance is adequate given the composition of and risk inherent in the loan portfolio of the Company’s bank subsidiary.  Throughout 2003, management will continue to monitor the risk of credit loss associated with the loan portfolio, and will adjust the allowance accordingly.

The following table presents changes in the Company’s consolidated allowance for loan losses for the nine months ended September 30, 2003, and 2002, respectively:

(dollars in thousands)

2003

2002

Balance, beginning of period

$2,784

$2,592

Charge offs

(346)

(430)

Recoveries

131

86

Net charge offs

(215)

(344)

Provision for loan losses

450

422

Balance, end of period

$3,019

$2,670

====

====

Loans on non-accrual status as a percentage of outstanding loans were 0.39% at September 30, 2003, compared to 0.53% at December 31, 2002.  Non-accrual loans totaled $1,136,000 and $1,288,000 at September 30, 2003 and December 31, 2002, respectively.  Management believes the current level of non-accrual loans is acceptable 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.

Funding Sources

The Company considers a number of alternatives, including but not limited to deposits, as well as short-term and long-term borrowings when evaluating funding sources.  Traditional deposits continue to be the most significant source of funds for the Company, totaling $376.1 million, or 85.1% of the Company’s funding sources at September 30, 2003.

Non-interest bearing deposits remain a smaller portion of the funding source for the Company than for most of its peers.  These balances comprised 8.0% of total deposits at September 30, 2003.

In addition to traditional deposits, the Company maintains both short-term and long-term borrowing arrangements with the Federal Home Loan Bank.  FHLB borrowings totaled $56.0 million at September 30, 2003 and December 31, 2002.  Management plans to maintain access to long-term FHLB borrowings as an appropriate funding source.

During the first quarter of 2003, the Company issued $10 million in trust-preferred securities as described in Note 5 of the consolidated financial statements.  

Shareholders’ Equity

For the nine months ended September 30, 2003, the Company had net income of $2,724,000 from traditional operations.  The Company paid dividends of $1,204,000, resulting in a dividend payout ratio of 44.2% of net income.  During the first nine months of 2003, five employees exercised 22,191 share options at $4.86 per share. Management believes the overall equity level supports this payout ratio but feels that the ratio to net income will eventually decrease 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, 2003, the adjustment for the net unrealized gain on available-for-sale securities, net of income taxes, totaled $790,000.  Since all the 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”.

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

The most significant market risk to which the Company and its subsidiaries are exposed is interest rate risk.  The business of the Company and the composition of its balance sheet consist of investments in interest-earning assets (primarily loans and securities), which are funded by interest bearing liabilities (deposits and borrowings).  These financial instruments have varying levels of sensitivity to changes in the market rates of interest, resulting in market risk.  None of the Company’s financial instruments are held for trading purposes.

The Company manages interest rate risk regularly through the Asset/Liability Committee.  The Committee meets on a regular basis and reviews various asset and liability management information, including but not limited to liquidity positions, projected sources and uses of funds, interest rate risk positions and economic conditions.

The Company monitors its interest rate risk through a sensitivity analysis, whereby it measures potential changes in future earnings and the fair values of financial instruments that may result from one or more hypothetical changes in interest rates.  This analysis is performed by estimating the expected cash flows of financial instruments using interest rates in effect at year-end.  For the fair value estimates, cash flows are then discounted to year-end to arrive at an estimated present value of the Company’s financial instruments.  Hypothetical changes in interest rates are then applied to the financial instruments, and the cash flows and fair values are again estimated using these hypothetical rates.  For the net interest income estimates, the hypothetical rates are applied to the financial instruments based on the assumed cash flows.  

ITEM 4

CONTROLS AND PROCEDURES

With the participation of our management, including our chief executive officer and chief financial officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934 (the "Exchange Act"); as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, our chief executive officer and chief financial officer have concluded that such disclosure controls and procedures are effective as of the end of the period covered by this Quarterly Report on Form 10-Q to ensure that material information relating to United and its consolidated subsidiary is made known to them, particularly during the period for which our periodic reports, including this Quarterly Report on Form 10-Q, are being prepared.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

There were no significant changes during the period covered by this Quarterly Report on Form 10-Q in our internal control over financial reporting (as defined in Rules 13a-15 and 15d-15 of the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II

Item 1:  Legal Proceedings.

There are no pending legal proceedings to which the Company or its subsidiary are a party to or to which any of their property is subject except routine legal proceedings to which the Company or its subsidiary are a party incident to the banking business.  None of such proceedings are considered by the Company to be material.

Item 2:  Changes in Securities and Use of Proceeds.

None

Item 3:  Defaults upon Senior Securities.

None

Item 4:  Submission of Matters to a Vote of Security Holders

None

Item 5:  Other Information

(a) On July 10, 2003, a Form S-8 was filed to register the Company’s 2003 Employee Stock Purchase Plan.

Item 6:  Exhibits and Reports on Form 8-K.

(a)  Exhibits

Exhibit 31.1  Rule 13a-14(a)/15d-14(a) Certification of E. Eugene Lehman

Exhibit 31.2  Rule 13a-14(a)/15d-14(a) Certification of Brian D. Young

Exhibit 32    Section 1350 Certifications

(b)  Forms 8-K

Form 8-K was filed on July 23, 2003 announcing under Item 9 the Company’s second quarter 2003 net earnings.

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, 2003

Exhibit

Number

Description

Exhibit Location

31.1

Rule 13a-14(a)/15d-14(a) Certification of E. Eugene Lehman

Filed herewith

31.2

Rule 13a-14(a)/15d-14(a) Certification of Brian D. Young

Filed herewith

32

Section 1350 Certifications

Filed herewith