MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

(a) Net income to average assets, net income to average 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) Excludes loans held for sale.

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Introduction

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 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.  

United Bancshares, Inc. (the “Corporation”), an Ohio corporation, is a bank holding Corporation 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 100 S. High Street, 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 (“Union”), a wholly-owned subsidiary of the Corporation, 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.

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 Corporation is registered as a Securities Exchange Act of 1934 reporting company.  

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RESULTS OF OPERATIONS

Overview of the Income Statement

For the quarter ended June 30, 2006, United Bancshares, Inc. reported net income of $1,243,000, or $0.34 basic earnings per share.  This compares to second quarter 2005 net income of $1,133,000, or $0.31 basic earnings per share.  Compared with the same period in 2005, second quarter 2006 net income increased $110,000 or 9.7%.  The increase in net income for the quarter was the result of an increase in non-interest income of $39,000 and decreases in the provision for income taxes of $40,000, provision for loan losses of $135,000 and non-interest expenses of $84,000, offset by a decrease of $188,000 in net interest income.   

Net income for the six months ended June 30, 2006, totaled $2,424,000, or $0.67 basic earnings per share compared to net income of $2,216,000, or $0.60 basic earnings per share for the same period in 2005.  The increase in net income for the six-month period was the result of an increase of $128,000 in non-interest income and decreases in the provision for loan losses of $185,000, non-interest expenses of $50,000 and the provision for income taxes of $91,000, offset by a decrease in net interest income of $246,000.

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 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 $4,397,000 for the second quarter of 2006 compared to $4,584,000 for the same period of 2005, a $188,000 decrease.  Net interest income was $8,783,000 for the first half of 2006 compared to $9,029,000 for the same period of 2005, a decrease of $246,000.    Although net interest margin was improved in 2006 compared to 2005, net interest income for the six-month period ended June 30, 2006 was reduced due to a decrease in average net interest-earning assets for the comparable period.  

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 Corporation in comparing its results with those of past periods as well as those of peer companies.  For the three and six month periods ended June 30, 2006, the net interest margin (on a tax equivalent basis) was 3.70%, compared with 3.62% and 3.59% for the same periods of 2005.  Management believes that this increase was primarily the result of changes in its interest rate pricing strategies and yield improvements as a result of the ongoing transfer of assets from the Corporation’s investment portfolio to the Corporation’s loan portfolio.

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

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economic conditions in the Corporation’s markets.  As a result of management’s analysis, a $40,000 provision for loan losses was made for the second quarter of 2006, and a $140,000 provision was made for the six months ended June 30, 2006, compared to provisions for loan losses of $175,000 for the three month and $325,000 for the six month periods ended June 30, 2005.  See “Allowance for Loan Losses” under Financial Condition for further discussion of the provision for loan losses.

Non-Interest Income

The Corporation’s non-interest income is largely generated from activities related to the origination and servicing of fixed rate mortgages, 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 volatile and can vary from quarter to quarter.  

Gain on sales of loans amounted to $78,000 for the quarter ended June 30, 2006 compared to $111,000 for the comparable 2005 period, a decrease of $33,000 (30.0%).  Such gains included capitalized servicing rights of $50,000 for each of the quarters, on $4.4 million and $5.9 million originated loan sales during the respective quarters.  The balance of the gain on sales of loans represented cash gains.  During the quarter ended June 30, 2005, the Corporation realized a $74,000 gain on the sale of securities (none for the quarter ended June 30, 2006).

Gain on sales of loans amounted to $141,000 for the six-month period ended June 30, 2006 compared to $195,000 for the comparable 2005 period, a decrease of $54,000 (27.7%).  Such gains included capitalized servicing rights of $95,000 and $107,000 on $9.0 million and $11.4 million originated loan sales during the respective periods. The balance of the gain on sales of loans represented cash gains.  Additionally, during the six-month period ended June 30, 2006, the Corporation realized a net loss on the sale of securities of $4,000, compared to a net gain of $120,000 for the same period in 2005.

Other non-interest income increased principally due to the increase in income from Bank Owned Life Insurance (“BOLI”), which was $122,000 and $231,000, respectively, for the quarter and six-month periods ended June 30, 2006, compared to $19,000 and $33,000, respectively, for the same periods in 2005.

Non-Interest Expenses

For the quarter ended June 30, 2006, non-interest expenses totaled $3,550,000 compared to $3,634,000 for the comparable period of 2005, a decrease of $84,000 (2.3%).  For the six-month period ended June 30, 2006, non-interest expenses totaled $7,105,000 compared to $7,155,000 for the comparable period of 2005, a decrease of $50,000 (0.7%).  

The operating results for the three and six month periods included an adjustment to the provision for stock options based on the Corporation’s closing stock price as of June 30, 2006.  As a result of this adjustment, non-interest expenses were reduced $31,000 and $24,000, respectively, for the three and six-month periods ended June 30, 2006.   Non-interest expenses were reduced $9,000 and $84,000, respectively, for the three and six-month periods ended June 30, 2005.  Management believes that the Corporation’s non-interest expenses are acceptable, considering the increases in the costs of conducting business and the costs associated with various additional regulatory compliance, including compliance efforts regarding Section 404 of the Sarbanes-Oxley Act of 2002.  In addition to the Corporation’s ongoing commitment to the improvement of internal controls and the overall operational

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environment, the Corporation has and will continue to identify and implement cost saving strategies.  Such strategies have led to the containment or reduction of non-interest expenses for the three and six month periods ending June 30, 2006 compared to the same periods in 2005.

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, 2006, the Corporation’s efficiency ratio was 65.90% compared to 66.09% for the same period of 2005.  The Corporation’s efficiency ratio improved as a result of the aforementioned reduction in non-interest expenses and an increase in non-interest income offset by a reduction in net interest income.  For the six-month period ended June 30, 2006, the Corporation’s efficiency ratio was 66.03% compared to 66.10% for the same period of 2005.  The 2006 year-to-date improvement compared to 2005 was also the result of the aforementioned factors.  

Provision for Income Taxes

The provision for income taxes for the quarter ended June 30, 2006 was $306,000 or 19.8% of income before income taxes, compared to $346,000 or 23.4%, for the comparable 2005 period.  The provision for income taxes for the six-month period ended June 30, 2006 was $609,000, or 20.1% of income before income taxes, compared to $700,000, or 24.0%, for the comparable 2005 period.  The decrease in the effective tax rates was due to tax-exempt interest income and tax-exempt non-interest income associated with BOLI comprising a larger portion of pre-tax income for the 2006 periods.

Return on Assets

Return on average assets was 0.92% for the second quarter of 2006, compared to 0.82% for the comparable quarter of 2005.  Return on average assets for the six months ended June 30, 2006 was 0.90% compared to 0.80% for the same period in 2005.  Such increases reflect the increase in 2006 earnings as compared to 2005.

Return on Equity

Return on average shareholders’ equity for the second quarter of 2006 was 11.53% compared to 10.20% for the same period of 2005.  Return on average equity for the six months ended June 30, 2006 was 11.17% compared to 10.04% for the same period in 2005.  The Corporation and Union met all regulatory capital requirements and Union is considered “well capitalized” under regulatory and industry standards of risk-based capital.

FINANCIAL CONDITION

Overview of Balance Sheet

Total assets amounted to $540.9 million at June 30, 2006, compared to $536.2 million at December 31, 2005, an increase of $4.7 million, or .9%.  Loans at June 30, 2006, net of the allowance for loan losses, increased $13.3 million (4.3%) from December 31, 2005.  Securities available-for-sale decreased $9.7 million (5.3%) during this six-month period.  Deposits during

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this same period increased $4.8 million (1.3%).  Other borrowings increased $3.3 million (5.3%) during the six-month period.  

Shareholders’ equity decreased from $43.8 million at December 31, 2005 to $42.6 million at June 30, 2006.  This decrease was primarily the result of a $2.4 million, net of tax, increase in unrealized losses on securities, the repurchase of 24,350 common shares ($381,000) and the payment of dividends ($937,000), offset by net income ($2.4 million) and the sale of 4,086 treasury shares ($55,000) under the Corporation’s Employee Stock Purchase Plan.  The aforementioned increase in unrealized securities losses from December 31, 2005, was primarily the result of customary and expected changes in the bond market.  At the present, the Corporation has both the ability and intent to hold securities in a loss position until such time as market conditions change or the respective securities mature.  Consequently, such losses are considered to be temporary and have not been reflected in the Corporation’s earnings results.  The unrealized losses on securities is reported as accumulated other comprehensive loss in the consolidated balance sheets.  

Cash and Cash Equivalents

Cash and cash equivalents totaled $9.3 million at June 30, 2006 compared to $10.1 million at December 31, 2005 (December 31, 2005 includes Federal funds sold of $1.1 million).

Management believes the current level of cash and cash equivalents is sufficient to meet the Corporation’s present 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 Corporation’s liquidity needs in the near term will be 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 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

At June 30, 2006, securities totaled $173.6 million, a decrease of $9.7 million from December 31, 2005.  All of the Corporation’s securities are classified as available-for-sale.  The decrease in available-for-sale securities was the result of management’s decision to take the portfolio’s cash flows and using those cash flows to fund loan growth instead of reinvesting them in the securities portfolio.   Management believes classifying securities as available-for-sale provides the Corporation flexibility and facilitates greater interest rate risk management opportunities.  At June 30, 2006, the amortized cost of the Corporation’s available-for-sale securities totaled $179.5 million, resulting in net unrealized losses of approximately $5.9 million and a corresponding after tax decrease in shareholders’ equity of $3.9 million.

Management monitors the earnings performance and liquidity of the investment portfolio on a regular basis through Asset/Liability Committee meetings.

Loans

The Corporation’s lending is primarily centered in northwestern and west central Ohio.  Gross loans (including loans held for sale) totaled $323.3 million at June 30, 2006 compared to $310.0 million at December 31, 2005, an increase of $13.3 million (4.3%).   The increase in loan

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balances was primarily the result of loan growth in agricultural real estate and participations in commercial real estate.

Allowance for Loan Losses

The allowance for loan losses as a percentage of loans (excluding loans held for sale) was 0.79% at June 30, 2006 compared to 0.82% at December 31, 2005.  The decrease in the allowance for loan losses, as a percent of total loans, is largely attributable to improvement in the credit quality of certain large classified credits.  Management believes the level of allowance is adequate given the composition of and risk inherent in the loan portfolio of Union.  Throughout 2006, 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 allowance for loan losses for the six months ended June 30, 2006 and 2005, respectively:

Loans on non-accrual status as a percentage of outstanding loans was 0.77% at June 30, 2006, compared to 0.76% at December 31, 2005.  Non-accrual loans totaled $2,495,000 and $2,060,000 at June 30, 2006 and December 31, 2005, respectively.  Management believes the current level of non-accrual loans is acceptable and is a reflection of the quality of Union’s loan portfolio as well as the adequacy of staffing levels devoted to monitoring and pursuing the collection of these credits.

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.  Traditional deposits continue to be the most significant source of funds for the Corporation, totaling $361.7 million, or 72.9% of the Corporation’s funding sources at June 30, 2006.

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 9.5% of total deposits at June 30, 2006.

In addition to traditional deposits, the Corporation maintains both short-term and long-term borrowing arrangements.  These borrowings consisted of FHLB borrowings totaling $64.9 million and $61.7 million at June 30, 2006 and December 31, 2005, respectively, and

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repurchase agreements totaling $59.2 million and $59.0 million at June 30, 2006 and December 31, 2005, respectively.  Management plans to maintain access to various borrowing alternatives as an appropriate funding source.

Shareholders’ Equity

For the six month period ended June 30, 2006, the Corporation had net income of $2,424,000 from traditional operations and dividends of $937,000, resulting in a dividend payout ratio of 38.66% of net income.  Management believes the overall equity level supports this payout ratio.  During the six month period ended June 30, 2006 and 2005, the Corporation transferred 4,086 and 6,253 shares, respectively of treasury stock to participants of the Corporation’s Employee Stock Purchase Plan. In addition, during the six month period ended June 30, 2006, the Corporation purchased 24,350 shares through its share repurchase program.

The increase in net unrealized loss on available-for-sale securities, net of income taxes, was $2.4 million for the six month period ended June 30, 2006.  Since all the securities in the Corporation’s portfolio are classified as available-for-sale, both the securities and equity sections of the consolidated balance sheet are sensitive to the changing market values of securities.  

The Corporation 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 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 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 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 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 reprice within a designated time frame.  The difference between rate sensitive assets and rate sensitive liabilities for a specified period of time is know as “gap”.

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Management believes the 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

Substantially all of the Corporation’s assets relate to banking and are monetary in nature.  Therefore, they are not impacted by inflation to the same degree as companies in capital-intensive industries in a replacement cost environment.  During a period of rising prices, a net monetary asset position results in loss in purchasing power and conversely a net monetary liability position results in an increase in purchasing power.  In the banking industry, typically monetary assets exceed monetary liabilities.  Therefore, as prices have recently increased, financial institutions experienced a decline in the purchasing power of their net assets.

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