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Management's Discussion and Analysis 

 

In the following pages, management presents an analysis of United Bancorp, Inc.'s financial condition and results of operations as of and for the year ended December 31, 1996 as compared to prior years. This discussion is designed to provide shareholders with a more comprehensive review of the operating results and financial position than could be obtained from an examination of the financial statements alone. This analysis should be read in conjunction with the financial statements and related footnotes and the selected financial data included elsewhere in this report.

Financial Condition

Earning Assets - Loans

Competitive pricing, proactive officer calling programs, wide ranging product offerings which meet the communities needs and a willingness to seek growth where none is apparent have all combined to generate another year of significant loan growth for UBCP. With a well balanced portfolio, both in variety of product offerings and diversification of risk, the Banks optimistically view opportunities for continued growth and diversification. At year-end 1996, gross loans were $132,660,608 compared to $122,682,652 at year-end 1995, representing an increase of 8.13% over 1995 levels.

Installment loans, with emphasis placed on continued support of indirect automobile lending, were the largest category of total loans, totaling 34.0% of all loans at year-end 1996 compared to 35.1% at year-end 1995. This apparent decline is in fact attributable to significant growth in commercial and commercial real estate lending activities, thereby reducing the overall percentage in relation to the total. The indirect lending type of financing carries somewhat more risk than real estate lending, being offset to some extent by the potential for higher yields.

The targeted lending areas for both Banks encompass four metropolitan areas, potentially minimizing the risks inherent in changes in economic conditions in the communities where UBCP's eight banking centers are located. Of some concern, however, is the Wheeling-Pittsburgh Steel strike taking place since October of 1996 within the Martins Ferry market. With no apparent conclusion to the strike in sight as of the printing of this report,there remains an unknown element as to how far reaching the effects of this prolonged strike will be.Citizens-Martins Ferry has installment, mortgage and commercial loans to individuals and businesses associated with Wheeling-Pittsburgh Steel in amounts not considered concentrated or reliant upon a single large employer. Management believes the balance of the allowance for loan losses currently in place is sufficient to deal with losses associated with the strike.

Commercial real estate loans comprised 31.1% of total loan volume at year-end 1996 compared to 28.9% at year-end 1995 with efforts focused on developing and marketing loan product offerings tailored to the various needs recognized throughout the diverse markets serviced. The various types of commercial loans, as a mix of the total portfolio, continue to be diverse, with no material concentration in any one industry.Commercial loans were 9.4% and 8.8% of the total portfolio mix at year-end 1996 and 1995 with volumes expected to remain fairly constant throughout 1997.

Out of area loans occur mostly in the Columbus and Akron-Canton, Ohio areas. Lending beyond the local area has been for projects and borrowers with substantial net worth. The majority of these loans are secured by real estate holdings comprised of hotels, motels and churches located in various geographic locations minimizing potential risks associated with lending activities specific to a limited area.

Real estate mortgage loans were 25.5% of total loans at year-end 1996 compared to 27.1% at year-end 1995. Although the percentages indicate a decline in relation to total loans, actual volume increased slightly with a moderate decline in volume anticipated throughout 1997 as a result of UBCP's initiation of Secondary Market lending products by mid-year. Average loan volume represented 68.5% of average earning assets in 1996 compared to 64.7% in 1995. The allowance for loan losses represents that amount which management and the Board of Directors estimates is adequate to provide for inherent losses in its loan portfolio. The allowance balance and the annual provision charged to expense are reviewed by management and the Board of Directors monthly using a risk code model that considers borrowers past due experience, economic conditions and various other circumstances that are subject to change over time.

Earning Assets - Securities and Federal Funds

Sold

The securities portfolio is comprised of U.S. Treasury and other U.S. government agency obligations, tax-exempt obligations of state and political subdivisions and certain other investments.The Banks do not hold any collateralized mortgage- backed securities, other than those issued by U.S.government agencies or other derivative securities. The quality rating of obligations of state and political subdivisions within Ohio is no less than Aaa, Aa or A, with all out-of-state bonds rated at AAA. Board policy permits the purchase of certain non-rated bonds of local schools, townships and municipalities, based on their known levels of credit risk. Securities available for sale at December 31, 1996 increased by $955,761, or 3.5%, over December 31, 1995 totals. A portion of this growth was offset by a decrease of approximately $239,000 (before tax effect) in market value adjustments for year-end 1996 compared to an increase of approximately $706,000 (before tax effect) at year-end 1995 reported as required by Statement of Financial Accounting Standards ("SFAS") No. 115. This compares to a net increase in total volume at year-end 1995 of $453,332. The Banks used a portion of the proceeds from securities sales, calls and maturities to fund loan demand when deposit growth was insufficient to meet those needs. The remaining proceeds were reinvested in additional U.S. government agency obligations and State, County and Municipal Bonds. Average securities available for sale for 1996 totaled $25,631,000, or 13.8% of average earning assets. Average securities available for sale for 1995 totaled $14,871,000, representing 8.3% of average earning assets. Securities held to maturity at year-end 1996 increased a modest $431,547, or 1.5%, over year-end 1995 totals. Average securities held to maturity were $30,291,000, representing 16.5% of average earning assets for 1996. This compares to $46,991,000, or 26.1%, of average earning assets for 1995.

Short-term federal funds sold are used to manage interest rate sensitivity and to meet liquidity needs of the Banks. During 1996 these funds represented 1.3% of average earning assets. Federal funds in 1995 represented .8% of average earning assets.

Sources of Funds - Deposits

The Banks primary sources of funds are core deposits from retail and business customers. These core deposits include interest-bearing and non interest- bearing deposits, excluding certificates of deposit over $100,000. Total core deposits at year-end 1996 increased $2,628,895, or 1.7%, compared to year-end 1995. The largest segment of this increase was from certificates of deposits less than $100,000.

The Banks maintain a strong deposit base from public agencies, including local school districts, city and township municipalities, public works facilities and others which may tend to be more seasonal in nature resulting from the receipt and disbursement of state and federal grants. These entities maintain fairly static balances due to various funding and disbursement timeframes. These accounted for 4.72% and 4.50% of total deposits at year-end 1996 and 1995.

Financial Condition

Sources of Funds - Deposits

Certificates of deposit over $100,000 are not considered part of core deposits and as such are used as a tool to manage funds. These deposits tend to be more rate sensitive and as a result fluctuate in relation to the Banks' pricing strategies. At year- end 1996, certificates of deposit over $100,000 had increased $2,278,987, or 19.5%, over 1995 year-end totals. Such deposits represented only 8.1% and 7.0% total deposits at year-end 1996 and 1995.

Securities Sold Under Agreements to Repurchase and Other
Short-Term Borrowings

Other interest-bearing liabilities include securities sold under agreements to repurchase, sweep accounts, federal funds purchased, Treasury, Tax & Loan notes payable and Federal Home Loan Bank advances. At year-end 1996, securities sold under agreements to repurchase increased $4,173,572, or 93.4%, over 1995 year-end totals. While these totals are up considerably from 1995 levels, there were approximately $1,500,000 in repurchase agreements that had not been redeemed at year-end as has been the case in past years.

Asset/Liability Management

The Banks actively manage their asset and liability portfolios through the use of software applications specifically designed for the financial industry to monitor sources and uses of funds, the impact of varying future interest rate scenarios and changes in anticipated volume of activity in earning assets and interest bearing liability accounts. Actual monthly information is entered into the system model, providing instant key performance ratio analysis in relation to peer banks and Board approved budget levels. Additionally, variance analysis is accomplished detailing any areas of concern in relation to interest rate risk and significant volume changes. Several 'what if' models are run on the system, providing the projected end results on a monthly and year-to-date basis in relation to product pricing and expected yields on loans and investments.

A rate shock analysis is performed monthly to show the effects of a swing in interest rates of plus or minus 200 basis points to determine the risk exposure the Banks would be subjected to if these dramatic rate shifts did indeed occur. Financial institutions cannot arbitrarily establish growth targets in earnings and assets and implement pricing changes merely to achieve these goals without regard to possible future economic changes. Historical trends are also important factors in determining the most likely result of various pricing strategies and through the use of sophisticated asset/liability management models, these risks are highlighted and evaluated.

Market risk is the potential effect external forces have on the value of the Banks' assets, liabilities and off-balance sheet positions. This risk arises from movements in the local, regional and national markets. Interest rate risk is the threat to net interest income which may arise from repricing differences in the Banks' assets and liabilities. It is also the threat to net income arising from fluctuations in market values of financial instruments. No transaction in the financial industry is without risk. The Banks assess and manage market and interest rate risk through monthly Asset/Liability Committee (ALCO) meetings attended by Senior Management and the Executive

Committees of the Board of Directors.

Asset/liability management also includes GAP measurement which determines, over various time periods, interest earning assets and interest bearing liabilities which are due to reprice at current market rates. A financial institution will have a negative interest rate sensitivity GAP for a given period of time if the amount of its interest-bearing liabilities maturing or repricing within that period i greater than the total of the interest-earning assets maturing or repricing within the that same period. When interest rates increase, banks with a negative interest rate sensitivity GAP will be more likely to experience increases in the cost of their liabilities faster than the corresponding yields generated by their earning assets. Following the same concept, as interest rates decrease, the cost of funds for banks with a negative interest rate sensitivity GAP usually will decrease more rapidly than the yields on the earning assets. As a general rule of thumb, the same changes in interest rates will usually have the opposite effect on banks structured with a positive interest rate sensitivity GAP.

Interest rate sensitivity varies with various types of interest-earning assets and interest-bearing liabilities. Overnight federal funds on which the rates change daily and loans which are tied to variable indices differ markedly from long-term securities and fixed-rate loans. Time deposits over $100,000 and money market certificates are more interest sensitive than passbook savings accounts. The shorter-term interest rate sensitivities are critical to reasonable measurement of interest sensitivity GAP.

The Banks classify a portion of their interest- bearing demand deposit accounts and passbook savings accounts in the over one year category. Management has determined this assumption is reasonable based upon historical experience where these accounts do not materially react to changes in interest rates.

The following table presents the amounts of interest earning assets and interest bearing liabilities outstanding at December 31, 1996, which are scheduled to reprice or mature in each of the indicated time periods. Except as shown, the amount of assets and liabilities which reprice or mature during a particular period were calculated in relation to the actual contractual terms of the asset or liability. The table, however, does not necessarily indicate the impact of general interest rate changes on the Banks net interest income in part because the repricing of certain categories of assets and liabilities is subject to competition and other factors beyond the control of the Banks. Because of this limitation, certain assets and liabilities depicted as maturing or repricing within a specific period may in fact mature or reprice at other times and at different volumes..

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