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UBMI > SEC Filings for UBMI > Form 10-Q on 26-Oct-2012All Recent SEC Filings

Show all filings for UNITED BANCORP INC /MI/

Form 10-Q for UNITED BANCORP INC /MI/


26-Oct-2012

Quarterly Report


Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations

This discussion provides information about the consolidated financial condition and results of operations for United Bancorp, Inc. (the "Company" or "United") and its subsidiary bank, United Bank & Trust ("UBT" or the "Bank"), for the three and nine month periods ended September 30, 2012 and 2011. The discussion should be reviewed in conjunction with the Company's consolidated financial statements and related notes.

Background

United is a Michigan corporation headquartered in Ann Arbor, Michigan and is the holding company for UBT, a Michigan-chartered bank organized over 115 years ago. We are registered as a bank holding company under the Bank Holding Company Act of 1956. At September 30, 2012, we had total assets of $898.6 million, deposits of $776.0 million, and total shareholders' equity of $96.8 million. Our common stock is quoted on the OTCQB under the symbol "UBMI."

We have four primary lines of business under one operating segment of commercial banking: banking services, residential mortgage, wealth management and structured finance. We believe that these four lines of business provide us with a diverse and strong core revenue stream. During the nine months ended September 30, 2012, our noninterest income equaled 40.6% of our combined net interest income and noninterest income. For each of the last five years ended December 31, 2011, noninterest income approximated 33.7% of our combined net interest income and noninterest income.

This diverse revenue stream has enabled us to recognize a pre-tax, pre-provision return on average assets of 1.74% for the three months and 1.61% for the nine months ended September 30, 2012. Pre-tax, pre-provision return on average assets is not consistent with, or intended to replace, presentation under generally accepted accounting principles. For additional information about our pre-tax, pre-provision income and return on average assets, please see "Pre-Tax, Pre-provision Income and Return on Average Assets" under "Results of Operations" below.

Our bank offers a full range of services to individuals, corporations, fiduciaries and other institutions. Banking services include checking accounts, NOW accounts, savings accounts, time deposit accounts, money market deposit accounts, safe deposit facilities and money transfers. Lending operations provide real estate loans, secured and unsecured business and personal loans, consumer installment loans, credit card and check-credit loans, home equity loans, accounts receivable and inventory financing, and construction financing.

Our mortgage group, United Mortgage Company, offers our customers a full array of conventional residential mortgage products, including purchase, refinance and construction loans.

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Due to our local decision making and fully-functional back office, we believe we have consistently been the most active originator of residential mortgage loans in our market area. Our mortgage group generated 36.5% of our noninterest income for the nine months ended September 30, 2012.

Our Wealth Management group is a key focus of our growth and diversification strategy and offers a variety of investment services to individuals, corporations and governmental entities. Our Wealth Management group generated 24.7% of our noninterest income for the nine months ended September 30, 2012.

Our structured finance group, United Structured Finance Company, offers simple, effective financing solutions to small businesses and commercial property owners, primarily by utilizing various government guaranteed loan programs and other off-balance sheet finance solutions through secondary market sources.

Other Developments

Memorandum of Understanding

On January 15, 2010, UBT entered into a Memorandum of Understanding with the Federal Deposit Insurance Corporation ("FDIC") and the Michigan Office of Financial and Insurance Regulation ("OFIR"). On January 11, 2011, we entered into a revised Memorandum of Understanding ("MOU") with substantially the same requirements as the MOU dated January 15, 2010. The MOU is not a "written agreement" for purposes of Section 8 of the Federal Deposit Insurance Act. The MOU documents an understanding among UBT, the FDIC and OFIR, that, among other things, (i) UBT will not declare or pay any dividend to the Company without the prior consent of the FDIC and OFIR; and (ii) UBT will have and maintain its Tier 1 capital ratio at a minimum of 9% for the duration of the MOU, and will maintain its ratio of total capital to risk-weighted assets at a minimum of 12% for the duration of the MOU. For additional information about the capital ratios of UBT, see the information under the heading "Capital Management" below, which information is incorporated here by reference.

Board Resolution

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

The Company has requested and received FRB approval to declare and pay as required, and has declared and paid, all accrued dividends on its 20,600 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A, Liquidation Preference Amount $1,000 per share (the "Preferred Shares") to the date of this report.

The Company is not required to seek prior approval of future payments of dividends on the Preferred Shares if certain conditions are met, including: (i) maintenance of a cash balance at the holding company of at least $3.3 million;
(ii) payment of dividends will not significantly impact

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the Bank's capital levels; and (iii) neither the Company nor the Bank experiences any significant change to its financial condition or regulatory classification or standing. If these conditions are satisfied, then we may pay dividends on the Preferred Shares without prior regulatory approval. Our cash balance at the holding company was $3.6 million at September 30, 2012.

Capital Management

In December, 2010, the Company closed its public offering of 7,583,800 shares of common stock. The net proceeds to the Company, after deducting underwriting discounts and commissions and offering expenses, were approximately $17.1 million. The Company has contributed $12.0 million of the net proceeds of the offering to the capital of the Bank to increase the Bank's capital and regulatory capital ratios. As a result of the additional capital, the Bank was in compliance with the capital requirements of its MOU with the FDIC and OFIR at December 31, 2010 and 2011, and September 30, 2012. At September 30, 2012 the Bank's Tier 1 capital ratio was 9.63%, and its ratio of total capital to risk-weighted assets was 15.61%. At September 30, 2012, the Bank was categorized as well-capitalized under applicable regulatory guidelines.

Exit from TARP Capital Purchase Program

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

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

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

Executive Summary

The Company's consolidated net income was $1.4 million in the third quarter of 2012 and $3.0 million for the nine months ended September 30, 2012, compared to losses of $2.1 million and $1.4 million, respectively, for the same periods of 2011. Net income per common share for the three and nine months ended September 30, 2012 was $0.09 and $0.17, respectively, up from losses of $0.19 and $0.18, respectively, for comparable periods of 2011. Return on average assets ("ROA") was 0.62% and 0.45%, respectively, for the third quarter and first nine months of 2012, compared to -0.95% and -0.21%, respectively, for the comparable periods of 2011. Return on average shareholders' equity ("ROE") was 5.79% and 4.26%, respectively, for the third quarter

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and first nine months of 2012, compared to -8.85% and -1.97%, respectively, for the same periods of 2011.

The Company's combined net interest income and noninterest income was up 13.0% in the third quarter and 9.8% in the first nine months of 2012 compared to the same periods of 2011. While some categories of noninterest income decreased in the third quarter and first nine months of 2012 compared to the same periods of 2011, large increases in income from loan sales and servicing offset the decreases. Total noninterest income for the quarter and nine month periods ended September 30, 2012 was up 30.7% and 24.0%, respectively, compared to the same periods of 2011.

United's noninterest expenses for the three and nine month periods ended September 30, 2012 also increased from the comparable periods of 2011, with the largest dollar increases in compensation expense. Several categories of noninterest expense declined in the third quarter of 2012 compared to the same period of 2011. Among those were external data processing, attorney, accounting and other professional fees, and expenses related to other real estate owned ("ORE") and other foreclosed properties. Total noninterest expenses were up 2.4% and 7.0%, respectively, in the third quarter and first nine months of 2012, compared to the same periods of 2011.

The Company's provision for loan losses for the third quarter and first nine months of 2012 was $2.0 million and $6.7 million, respectively, down from $6.0 million and $11.9 million, respectively, for the same periods of 2011. The reduced level of provision for losses is a direct result of United's improvement in its credit quality measures.

Total consolidated assets of the Company were $898.6 million at September 30, 2012, compared to $885.0 million at December 31, 2011 and $894.4 million at September 30, 2011. Total portfolio loans of $591.8 million increased by $28.1 million in the first nine months of 2012, and by $14.2 million since September 30, 2011. The Company generally sells its fixed rate long-term residential mortgages on the secondary market, and retains adjustable rate mortgages in its loan portfolio.

The Company's total portfolio loans have increased by $14.2 million, or 2.5%, since September 30, 2011, and the balance of loans serviced for others has increased by $99.7 million, or 13.9%, during the same time period. While the Company continues to hold elevated levels of investments, federal funds sold and cash equivalents in order to protect the balance sheet during this prolonged period of economic uncertainty, those balances have declined in recent quarters. United's balances in federal funds sold and other short-term investments were $52.0 million at September 30, 2012, compared to $91.8 million at December 31, 2011 and $99.4 million at September 30, 2011. Securities available for sale of $198.1 million at September 30, 2012 were up $24.8 million from December 31, 2011 levels and have increased by $33.1 million since September 30, 2011.

Total deposits of $776.0 million at September 30, 2012 were up $11.2 million from $764.9 million at December 31, 2011, with all of the growth in non-interest bearing deposit balances. The majority of the Bank's deposits are derived from core client sources, relating to long-term relationships with local individual, business and public clients. Public clients include local government and municipal bodies, hospitals, universities and other educational institutions. As a result of its strong core funding, the Company's cost of interest-bearing deposits was 0.59% and

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0.64% for the third quarter and first nine months of 2012, respectively, down from 0.81% and 0.86%, respectively, for the same periods of 2011.

The Company's ratio of allowance for loan losses to total loans was 3.80% and the ratio of allowance for loan losses to nonperforming loans was 108.0% at September 30, 2012, compared to 3.66% and 80.0%, respectively, at December 31, 2011 and 4.22% and 81.8%, respectively, at September 30, 2011. The Company's allowance for loan losses increased by $1.8 million from December 31, 2011 to September 30, 2012, as provision for loan losses expense has exceeded net charge-offs in each of the quarters of 2012. Net charge-offs have averaged approximately $1.6 million per quarter for 2012, representing the lowest level since the second quarter of 2008.

Within the Company's loan portfolio, $20.8 million of loans were considered nonperforming at September 30, 2012, compared to $25.8 million at December 31, 2011 and $29.8 million at September 30, 2011. Total nonperforming loans as a percent of total portfolio loans decreased from 4.57% at the end of 2011 and 5.16% at September 30, 2011 to 3.51% at September 30, 2012. For purposes of this presentation, nonperforming loans consist of nonaccrual loans and accruing loans that are past due 90 days or more, and exclude accruing restructured loans. Balances of accruing restructured loans at September 30, 2012, December 31, 2011 and September 30, 2011 were $16.3 million, $21.8 million and $21.4 million, respectively.

                              Financial Condition

Securities

Balances in the securities portfolio have increased in recent periods, generally
reflecting deposit growth in excess of loan growth. The makeup of the Company's
investment portfolio evolves with the changing price and risk structure, and
liquidity needs of the Company. The table below reflects the carrying value of
various categories of investment securities of the Company, along with the
percentage composition of the portfolio by type as of September 30, 2012 and
December 31, 2011.

                                                    September 30, 2012               December 31, 2011
In thousands of dollars                          Balance        % of total       Balance        % of total
U.S. Treasury and agency securities            $    25,339             12.8 %   $   49,366             28.5 %
Mortgage-backed agency securities                  153,180             77.3 %      102,697             59.3 %
Obligations of states and political
subdivisions                                        19,397              9.8 %       20,977             12.1 %
Corporate, asset backed, and other debt
securities                                             126              0.1 %          126              0.1 %
Equity securities                                       27              0.0 %           31              0.0 %
Total Investment Securities                    $   198,069            100.0 %   $  173,197            100.0 %

Investments in U.S. Treasury and agency securities are considered to possess low credit risk. Obligations of U.S. government agency mortgage-backed securities possess a somewhat higher interest rate risk due to certain prepayment risks. The municipal portfolio contains a small level of geographic risk, as approximately 1.5% of the investment portfolio is issued by political subdivisions located within Lenawee County, Michigan, 1.8% in Monroe County, Michigan, and 2.2% in Washtenaw County, Michigan. The Bank's investment in local municipal issues also reflects our commitment to the development of the local area through support of its local political subdivisions.

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Management believes that the unrealized losses within the investment portfolio are temporary, since they are a result of interest rate changes, rather than a reflection of credit quality. Management has no specific intent to sell any securities, although the entire investment portfolio is classified as available for sale. The following chart summarizes net unrealized gains in each category of the portfolio at September 30, 2012 and December 31, 2011.

Unrealized gains in thousands of dollars           9/30/12       12/31/11      Change
U.S. Treasury and agency securities                $    177     $      367     $  (190 )
Mortgage-backed agency securities                     2,592            842       1,750
Obligations of states and political subdivisions        803          1,287        (484 )
Equity securities                                         1              5          (4 )
Total Investment Securities                        $  3,573     $    2,501     $ 1,072

FHLB Stock

The Bank is a member of the Federal Home Loan Bank of Indianapolis ("FHLBI") and holds a $2.6 million investment in stock of the FHLBI. The investment is carried at par value, as there is not an active market for FHLBI stock. The FHLBI reported a profit of $33.2 million for the second quarter of 2012, and continues to pay dividends on its stock. 2 The Company regularly reviews the credit quality of FHLBI stock for impairment, and determined that no impairment of FHLBI stock was necessary as of September 30, 2012.

Loans

The following table shows the dollar and percent change in each category of
loans for the periods reported. All loans are domestic and contain no
significant concentrations by industry or client.

                                   This Quarter               Year to Date               Twelve-Month
In thousands of dollars        Change       Percent       Change       Percent       Change       Percent
Personal                      $  2,625           2.4 %   $  7,776           7.5 %   $  4,974           4.7 %
Business, including
commercial mortgages              (643 )        -0.2 %      8,601           2.6 %     (2,084 )        -0.6 %
Tax exempt                         (21 )        -1.2 %       (308 )       -15.1 %       (343 )       -16.5 %
Residential mortgage             3,367           4.0 %      3,739           4.5 %      5,077           6.2 %
Construction and
development                      9,480          24.5 %      8,415          21.2 %      6,658          16.1 %
Deferred loan fees and
costs                             (279 )       -57.2 %       (117 )       -35.9 %        (74 )       -26.1 %
Total portfolio loans         $ 14,529           2.5 %   $ 28,106           5.0 %   $ 14,208           2.5 %

Total portfolio loan balances increased by $28.1 million, or 5.0%, from December 31, 2011 and $14.2 million, or 2.5%, from September 30, 2011. Personal loans on the Company's balance sheet included home equity lines of credit, direct and indirect loans for automobiles, boats, recreational vehicles and other items for personal use. Personal loan balances increased by $2.6 million, or 2.4% in the third quarter of 2012, and grew by 4.7% in the twelve months ended September 30, 2012. Business loan balances decreased by $0.6 million, or 0.2%, in the third quarter of 2012, and $2.1 million, or 0.6%, over the twelve months ended September 30, 2012,


2 Federal Home Loan Bank of Indianapolis, Form 10-Q Quarterly Report for the period ended June 30, 2012.
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but have increased by $8.6 million since December 31, 2011. Growth of business loans in the first nine months of 2012 reflects a modest improvement in loan demand, net of write-downs, charge-offs and payoffs.

The Bank's loan portfolio includes $3.8 million of purchased participations in business loans originated by other institutions. These participations represent 0.6% of total loans. Of those participation loans, 91.6% of the outstanding balances are the result of participations purchased from other Michigan community banks.

The Bank generally sells its production of fixed-rate residential mortgages on the secondary market, and retains high credit quality residential mortgage loans that are not otherwise eligible to be sold on the secondary market and shorter-term adjustable rate residential mortgages in its portfolio. As a result, the mix of residential mortgage production for any given year will have an impact on the amount of residential mortgages held in the portfolio of the Bank. Portfolio balances of residential mortgages increased by 3.9% in the third quarter of 2012 and 6.2% in the twelve months ended September 30, 2012.

Outstanding balances of loans for construction and development have increased by $9.5 million in the third quarter of 2012 and $6.7 million since September 30, 2011. The increase in the third quarter of 2012 consisted of approximately $4.8 million of commercial construction (primarily owner-occupied) loans, and a similar amount of consumer residential construction loans. Over the twelve months ended September 30, 2012, nearly 75% of the increase in construction and development loans was in consumer residential construction loans. Residential construction loans generally convert to residential mortgages to be retained in the Bank's portfolio or to be sold in the secondary market, while commercial construction loans generally will be converted to commercial mortgages.

Credit Quality

The Bank's credit quality measures have continued to show improvement in recent quarters, and substantial improvement in credit quality measures occurred in the third quarter of 2012.

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

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The chart below shows the amount of nonperforming assets by category for the past five quarters.

In thousands of dollars                9/30/12      6/30/12      3/31/12      12/31/11      9/30/11
Nonaccrual loans                       $ 20,386     $ 25,634     $ 25,958     $  25,754     $ 29,392
Accruing loans past due 90 days or
more                                        406          242           13            31          386
Total nonperforming loans                20,792       25,876       25,971        25,785       29,778
Nonperforming loans % of total
portfolio loans                            3.51 %       4.48 %       4.51 %        4.57 %       5.16 %
Allowance coverage of nonperforming
loans                                     108.0 %       85.4 %       81.0 %        80.0 %       81.8 %

Other assets owned                        2,179        3,392        3,484         3,669        4,301
Total nonperforming assets             $ 22,971     $ 29,268     $ 29,455     $  29,454     $ 34,079
Nonperforming assets % of total
assets                                     2.56 %       3.31 %       3.22 %        3.33 %       3.81 %

Loans delinquent 30-89 days            $  2,807     $  2,070     $  3,729     $   6,468     $  3,613

Accruing restructured loans
Business, including commercial
mortgages                              $  7,819     $  8,641     $  9,137     $  10,404     $ 10,301
Construction and development              5,017        6,840        7,825         8,186        8,231
Residential mortgage                      3,276        3,284        3,293         3,078        2,569
Home Equity                                 171          171          171           171          300
Total accruing restructured loans      $ 16,283     $ 18,936     $ 20,426     $  21,839     $ 21,401

Total nonaccrual loans have decreased by $5.2 million since June 30, 2012, while accruing loans past due 90 days or more have increased by $164,000 for the same period. A significant portion of the decline in nonperforming assets in the third quarter of 2012 was the result of payoffs of three loans totaling $4.5 million that were carried on nonaccrual status.

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

Total nonperforming loans have declined by $5.0 million since December 31, 2011, and have declined by $9.0 million since September 30, 2011. Total nonperforming loans as a percent of total portfolio loans were 3.51% at September 30, 2012, down from 4.57% and 5.16% at December 31 and September 30, 2011, respectively, while the ratio of allowance for loan losses to nonperforming loans improved from 81.8% and 80.0%, respectively, at September 30 and December 31, 2011 to 108.0% at September 30, 2012. This represents the first time that the Company's ratio of allowance for loan losses to nonperforming loans has exceeded 100% since the second quarter of 2007. Loan workout and collection efforts continue with all delinquent clients, in an effort to bring them back to performing status.

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