United Bancshares Inc: Form 10-Q for the period ended Jun 30, 2019

SELECTED FINANCIAL DATA

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

(a) Net income to average assets, net income to average tangible shareholders’ equity and net interest margin 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.

(c) Includes loans held for sale

(d) Goodwill and other intangibles for the June 30, 2019, as compared to the June 30, 2018, period includes the impact of the $3.4 million goodwill adjustment made in August 2018 as a result of a review of the accounting and tax implications of the September 2017 Benchmark Bancorp, Inc. transaction.

Introduction

United Bancshares, Inc. (the “Corporation”), 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 Corporation was incorporated and organized in 1985. The executive offices of the Corporation are located at 105 Progressive Drive, Columbus Grove, Ohio 45830. The Corporation is a one-bank holding company, as that term is defined by the Federal Reserve Board.

The Union Bank Company (the “Bank”), a wholly-owned subsidiary of the Corporation, is engaged in the business of commercial banking. The Bank is an Ohio state-chartered bank, which serves Allen, Delaware, Franklin, Hancock, Marion, Putnam, Sandusky, Van Wert and Wood counties in Ohio, with office locations in Bowling Green, Columbus Grove, Delaware, Delphos, Findlay, Gahanna, Gibsonburg, Kalida, Leipsic, Lima, Marion, Ottawa, Pemberville, Westerville and Worthington, Ohio.

The Bank offers a full range of commercial banking services, including checking accounts, savings and money market accounts, time certificates of deposit, automatic teller machines, commercial, consumer, agricultural, residential mortgage and home equity loans, credit card services, safe deposit box rentals, and other personalized banking services. The Bank has formed UBC Investments, Inc. (“UBC”) to hold and manage its securities portfolio. The operations of UBC are located in Wilmington, Delaware. The Bank has also formed UBC Property, Inc. to hold and manage certain other real estate owned.

When or if used in the Corporation’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 Corporation’s market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in the Corporation’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 Corporation 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 Corporation’s financial performance and could cause the Corporation’s actual results for future periods to differ materially from those anticipated or projected. The Corporation 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 Corporation is registered as a Securities Exchange Act of 1934 reporting company.

The following discussion and analysis of the consolidated financial statements of the Corporation is presented to provide insight into management’s assessment of the financial results.

RESULTS OF OPERATIONS

Overview of the Income Statement

For the quarter ended June 30, 2019, the Corporation reported net income of $2,285,000, or $0.70 basic earnings per share. This compares to the second quarter of 2018 net income of $2,200,000, or $0.67 basic earnings per share. The increase in operating results for the second quarter of 2019 as compared to the same period in 2018 was primarily attributable to an increase in non-interest income of $970,000, offset by a decrease in net interest income of $82,000 as well as increases in non-interest expenses of $693,000, provision for loan losses of $40,000 and provision for income taxes of $70,000.

Net income for the six months ended June 30, 2019 totaled $4,099,000 or $1.25 basic earnings per share compared to $3,999,000, or $1.22 basic earnings per share for the same period in 2018. Compared with the same period in 2018, net income increased $100,000, or 2.5%. This increase in operating results for the six month period ended June 30,2019 as compared to the six month period ended June 30, 2018 was primarily attributable to increases in net interest income of $323,000 and non-interest income of $1,230,000 offset by increases in non-interest expenses of $1,364,000, provision for loan loss of $50,000 and provision for income taxes of $39,000.

Net Interest Income

Net interest income is the amount by which 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 Corporation. 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 $7,245,000 for the second quarter of 2019, compared to $7,327,000 for the same period of 2018, a decrease of $82,000 (1.1%). Net interest income was $14,180,000 for the six months ended June 30, 2019 compared to $13,857,000 for the same period of 2018, an increase of $323,000 (2.3%).

The increase in net interest income for the six months ended June 30, 2019 was attributable to an increase in interest income of $2,005,000, including a $1,812,000 increase in interest income from loans and leases, offset by a $1,682,000 increase in interest expense. This increase in loan interest was attributable to average loan growth from June 2018 to June 2019 as well as higher rates. The average loan balance was $575.8 million for the second quarter 2019 compared to $523.9 million for the second quarter 2018. The increase in interest expense for the period was attributable to a $23.1 million increase in interest bearing deposits and higher deposit rates.

Net interest margin is calculated by dividing net interest income (adjusted to reflect tax-exempt interest income on a taxable equivalent basis) by average interest-earning assets. The resulting percentage serves as a measurement for the Corporation in comparing its results with those of past periods as well as those of peer institutions. For the quarter and six months ended June 30, 2019 the net interest margin (on a taxable equivalent basis) was 3.80% and 3.81%, respectively, compared with 4.19% and 4.02% for the same periods in 2018. Loans and leases comprised 75.0% of interest-earning assets at June 30, 2019 compared to 74.8% of interest-earning assets at June 30, 2018.

Interest-bearing deposits comprised 89.3% of average interest-bearing liabilities for the three months ended June 30, 2019, compared to 90.1% for the same period in 2018.

Interest expense for the six months ended June 30, 2019 increased $1,681,000 (64.8%). The increase in interest expense was attributable to year over year average deposit growth of $43.2 million, as well as increased rates. The average deposit balance was $684.6 million for the second quarter of 2019 compared to $641.4 million for the second quarter 2018.

Provision for Loan and Lease Losses

The Corporation’s provision for loan and lease losses is determined based upon management’s calculation of the allowance for loan and lease losses and is reflective of management’s assessment of the quality of the portfolio and overall management of the inherent credit risk of the loan and lease portfolio. Changes in the provision for loan and lease losses are dependent, among other things, on loan and lease delinquencies, collateral position, portfolio risks and general economic conditions in the Corporation’s lending markets. A $250,000 provision for loan and lease losses was recognized during the six month period ended June 30, 2019 compared to a $200,000 provision during the six month period ended June 30, 2018. See “Allowance for Loan and Lease Losses” under Financial Condition for further discussion relating to the provision for loan and lease losses.

Non-Interest Income

The Corporation’s non-interest income is largely generated from activities related to the origination, servicing and gain on sales of fixed rate mortgage loans; customer deposit account fees; earnings on life insurance policies; income arising from sales of investment products to customers; and occasional security sale transactions. Income related to customer deposit accounts and life insurance policies provides a relatively steady flow of income while the other sources are more volume or transaction related and consequently can vary from quarter to quarter.

For the three month period ended June 30, 2019, non-interest income was $3,133,000, compared to $2,163,000 for the second quarter of 2018, a $970,000 (44.8%) increase, which was primarily attributable to increases in gain on sales of loans of $1,329,000 offset by a decrease in other non-interest income of $367,000. For the six month period ended June 30, 2019, non-interest income was $5,641,000, compared to $4,411,000 for same period in 2018, an increase of $1,230,000 (27.9%) which was primarily attributable to increases in gain on sales of loans of $1,668,000, offset by a decrease in gain on sales of securities of $6,000 as well as a decrease in other non-interest income of $432,000.

The significant increase in gain on sale of loans was attributable to the residential mortgage and governmental lending operations. Loan sales for the second quarter of 2019 approximated $57.3 million compared to $31.7 million for the second quarter of 2018, resulting in gains on sale of loans of $2,186,000 for the quarter ended June 30, 2019, compared to $857,000 for the second quarter of 2018, an increase of $1,329,000. For the six month period ended June 30, 2019 loan sales approximated $98.3 million compared to $64.8 million for the same period in 2018, resulting in gains on sale of loans of $3,624,000 for the six months ended June 30, 2019, compared to $1,956,000 for the six months ended June 30, 2018, an increase of $1,668,000.

The decrease in other operating income for the three and six month periods ended June 30, 2109 is largely attributable to the impact of changes in the fair value of mortgage servicing rights. During the three and six month periods ended June 30, 2019, the fair value of the mortgage servicing rights asset decreased $171,000 and $282,000, respectively, primarily due to an increase in prepayment speeds caused by a continued decrease in mortgage loan interest rates. This change is occurring throughout the mortgage banking industry and is not specific to the Bank's serviced loan portfolio. During the three month period ended June 30, 2018, the fair value of the servicing rights asset decreased $11,000 while during the six month period ended June 30, 2018, the fair value of the servicing rights asset increased $42,000 with a minimal change in the level of serviced loan portfolio.

Loss on sales of securities amounted to $8,000 for the quarter ended June 30, 2018. For the six months ended June 30, 2018 gain on sale of securities amounted to $6,000. There were no gains or losses for the quarter or six month period ended June 30, 2019.

Non-Interest Expenses

For the quarter ended June 30, 2019, non-interest expenses were $7,492,000, compared to $6,799,000 for the second quarter of 2018, a $693,000 (10.2%) increase. The quarter-over-quarter increases included salaries and benefits expense of $408,000 (10.4%), advertising and promotion of $21,000 (5.9%), legal fees of $48,000, loan fees of $123,000 and ATM processing expense of $48,000.

For the six month period ended June 30, 2019, non-interest expenses totaled $14,714,000, compared to $13,350,000 for the same period of 2018, an increase of $1,364,000 (10.2%) which was primarily attributable to increases in salaries and benefits expense of $808,000 (10.5%), data processing of $94,000 (14.8%), advertising and promotion of $39,000 (6.0%), legal fees of $151,000, loan fees of $153,000 and ATM processing expenses of $55,000.

Maintaining acceptable levels of non-interest expenses and operating efficiency are key performance indicators for the Corporation 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. For the quarter ended June 30, 2019, the Corporation’s efficiency ratio was 71.2%, compared to 70.6% for the same period of 2018. For the six months ended June 30, 2019, the Corporation's efficiency ratio was 72.9% compared to 71.7% for the same period of 2018.

Provision for Income Taxes

The provision for income taxes for the quarter ended June 30, 2019 was $451,000 (effective rate of 16.5%), compared to $381,000 (effective rate of 14.8%) for the comparable 2018 period. The provision for the six month period ended June 30, 2019 was $758,000 (effective rate of 15.6%) compared to $719,000 (effective rate of 15.2%) for the comparable 2018 period.

FINANCIAL CONDITION

Overview of Balance Sheet

Total assets amounted to $855.4 million at June 30, 2019, compared to $830.3 million at December 31, 2018, an increase of $25.1 million (3.0%). The increase in total assets was primarily the result of an increase of $3.9 million in cash and cash equivalents due to deposit growth, $10.6 million in net loans, $2.3 million in loans held for sale and $7.3 million in securities available-for-sale. Deposits during this same period increased $22.9 million (3.4%) while other borrowings decreased $6.2 million (7.9%).

Shareholders’ equity increased from $80.9 million at December 31, 2018 to $88.1 million at June 30, 2019. This increase was primarily the result of net income during the six month period ended June 30, 2019 of $4,099,000 and an increase in unrealized securities gains, net of tax of $3,721,000 offset by dividends paid of $850,000. The increase in unrealized securities gains during the six month period ended June 30, 2019, was the result of customary and expected changes in the bond market. Net unrealized gains and losses on securities are reported as accumulated other comprehensive income (loss) in the consolidated balance sheets.

Cash and Cash Equivalents

Cash and cash equivalents totaled $20.3 million at June 30, 2019 and $16.5 million at December 31, 2018, including interest-bearing deposits in other banks of $10.9 million at June 30, 2019 and $4.8 million at December 31, 2018. Management believes the current level of cash and cash equivalents is sufficient to meet the Corporation’s present liquidity and performance needs especially considering the availability of other funding sources, as described below. Total cash and cash equivalents fluctuate on a daily basis due to transactions in process and corresponding liquidity sources and uses. Management believes the Corporation’s liquidity needs in the near term will be satisfied by the current level 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 will mature within one year. These sources of funds should enable the Corporation to meet cash obligations and off-balance sheet commitments as they come due. In addition, the Corporation has access to various sources of additional borrowings by virtue of long-term assets that can be used as collateral for such borrowings.

Securities

Management monitors the earnings performance and liquidity of the securities portfolio on a regular basis through Asset/Liability Committee (ALCO) meetings. As a result, all securities, except FHLB stock, have been designated as available-for-sale and may be sold if needed for liquidity, asset-liability management or other reasons. Such securities are reported at fair value, with any net unrealized gains or losses reported as a separate component of shareholders’ equity, net of related incomes taxes.

The amortized cost and fair value of available-for-sale securities as of June 30, 2019 totaled $172.2 million and $174.7 million, respectively, resulting in net unrealized gain before tax of $2.5 million and a corresponding after-tax increase in shareholders’ equity of $2.0 million.

Loans and Leases

The Corporation’s primary lending areas are Northwestern, West Central, and Central Ohio. Gross loans and leases totaled $572.6 million at June 30, 2019, compared to $561.6 million at December 31, 2018, an increase of $11.0 million (2.0%).

There are also unrecognized financial instruments at June 30, 2019 and December 31, 2018 which relate to commitments to extend credit and letters of credit. The contract amount of such financial instruments approximated $135.6 million at June 30, 2019 and $147.5 million at December 31, 2018.

Allowance for Loan and Lease Losses

The following table presents a summary of activity in the allowance for loan and lease losses for the six month periods ended June 30, 2019 and 2018:

(in thousands)

The allowance for loan and lease losses as a percentage of gross loans and leases was .67% at June 30, 2019, .63% at December 31, 2018, and .59% at June 30, 2018.

Regular provisions are made in amounts sufficient to maintain the balance in the allowance for loan and lease losses at a level considered by management to be adequate for losses within the portfolio. Even though management uses all available information to assess possible loan and lease losses, future additions or reductions to the allowance may be required as changes occur in economic conditions and specific borrower circumstances. The regulatory agencies that periodically review the Corporation’s allowance for loan and lease losses may also require additions to the allowance or the charge-off of specific loans and leases based upon the information available to them at the time of their examinations.

Loans and leases on non-accrual status amounted to $1.1 million and $1.4 million at June 30, 2019 and December 31, 2018, respectively. Non-accrual loans and leases as a percentage of outstanding loans amounted to .19% at June 30, 2019 and .26% at December 31, 2018.

The Corporation considers a loan or lease to be impaired when it becomes probable that the Corporation will be unable to collect under the contractual terms of the loan or lease, as the case may be, based on current information and events. The Corporation had impaired loans totaling $1,973,000 with $392,000 of specific reserves at June 30, 2019 and impaired loans of $372,000 with $128,000 of specific reserves as of December 31, 2018. The Corporation had $875,000 and $959,000, respectively, of impaired loans without specific reserves at June 30, 2019 and December 31, 2018.

The Corporation had other potential problem credits of $10.2 million at June 30, 2019 and $6.7 million at December 31, 2018. The Corporation’s credit administration department continues to closely monitor these credits.

The Corporation provides pooled reserves for potential problem loans and leases using loss rates calculated considering historic net loan charge-off experience, as well as other environmental and qualitative factors. The Corporation experienced $29,000 of loan charge-offs during the first six months of 2019 compared to loan charge-offs of $94,000 during the first six months of 2018 with most of the charge-offs coming from the commercial and residential real estate loan portfolios. The Corporation also provides general reserves for the remaining portion of its loan portfolio not considered to be problem or potential problem loans. These general reserves are also calculated considering, among other things, the historic net charge-off experience for the relative loan type.

Funding Sources

The Corporation considers a number of alternatives, including but not limited to, deposits, as well as short-term and long-term borrowings when evaluating funding sources. Deposits, including customer deposits, brokered certificates of deposit, and public funds deposits continue to be the most significant source of funds for the Corporation, totaling $689.2 million, or 89.8% of the Corporation’s outstanding funding sources at June 30, 2019. Total deposits increased $23.0 million during the three months ended June 30, 2019.

Non-interest bearing deposits remain a smaller portion of the funding source for the Corporation than for most of its peers. Non-interest bearing deposits comprised 16.7% of total deposits at June 30, 2019, compared to 17.3% at December 31, 2018.

In addition to traditional deposits, the Corporation maintains both short-term and long-term borrowing arrangements. Other borrowings consisted of FHLB borrowings totaling $50.0 million at June 30, 2019 and $54.2 million at December 31, 2018 as well as $9,250,000 and $9,750,000 of term borrowings from the United Bankers’ Bank (UBB) at June 30, 2019 and December 31, 2018, respectively. The Corporation also has outstanding junior subordinated deferrable interest debentures of $12,891,000 and $12,874,000 at June 30, 2019 and December 31, 2018, respectively. Management plans to maintain access to various borrowing alternatives as an appropriate funding source.

Regulatory Capital

The Corporation and Bank met all regulatory capital requirements as of June 30, 2019, and the Bank is considered “well capitalized” under regulatory and industry standards of risk-based capital.

Cash Flow from Operations

The Bank implemented a hedging program during the 2nd quarter of 2018. As part of this program, loans held for sale are now accumulated into larger blocks before being sold. Depending on the timing of the sales of these blocks, there could be a positive or negative impact to cash flow from operations. As of June 30, 2019, loans held for sale amounted to $10,003,000 compared to $7,705,000 as of December 31, 2018 resulting in a negative impact to cash flow from operations for the six month period ended June 30, 2019 of $2,298,000. Excluding the change in loans held for sale, cash flow from operations for the six months ended June 30, 2019 would have been a positive $3,936,000.

Liquidity and Interest Rate Sensitivity

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

The Corporation manages interest rate risk to minimize the impact of fluctuating interest rates on earnings. The Corporation 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 re-pricing to more accurately reflect anticipated pricing behavior. These simulations include adjustments for the lag in prime loan re-pricing 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 Corporation 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 re-price within a designated time frame.

Management believes the Corporation’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 Corporation’s earning base. The Corporation’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 Corporation.

Effects of Inflation on Financial Statements

All of the Corporation’s assets relate to commercial banking operations and are generally 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 of purchasing power and conversely a net monetary liability position results in an increase in purchasing power. In the commercial banking industry, monetary assets typically exceed monetary liabilities. The Corporation has not experienced a significant level of inflation or deflation during the six month period ended June 30, 2019. However, because of the depressed national real estate market and sluggish local economy, the Corporation has experienced declines in the value of collateral securing commercial and non-commercial real estate loans. Management continues to closely monitor these trends in calculating the Corporation’s allowance for loan and lease losses.

There have been no material changes in the quantitative and qualitative information about market risk from the information provided in the Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018.

Evaluation of 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 Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")); as of the end of the period covered by this Quarterly Report on Form 10-Q.

Based on that evaluation, the Corporation's management, including the Chief Executive Officer and Chief Financial Officer, concluded that the Corporation's disclosure controls and procedures were effective as of June 30, 2019.

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(f) under the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There have been no material changes in the discussion pertaining to risk factors that was provided in the Corporation’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018.