Introduction

United Security Bancshares, Inc., a Delaware corporation ("United Security" or the "Company"), is a bank holding company with its principal offices in Thomasville, Alabama. United Security operates one commercial banking subsidiary, First United Security Bank (the "Bank"). At December 31, 2008, the Bank operated and served its customers through nineteen banking offices located in Brent, Bucksville, Butler, Calera, Centreville, Coffeeville, Columbiana, Fulton, Gilbertown, Grove Hill, Harpersville, Jackson, Thomasville, Tuscaloosa and Woodstock, Alabama, which are located in Clarke, Choctaw, Bibb, Shelby and Tuscaloosa Counties in Alabama.

The Bank owns all of the stock of Acceptance Loan Company, Inc. ("ALC"), an Alabama corporation. ALC is a finance company organized for the purpose of making and purchasing consumer loans. ALC operates twenty-two finance company offices located in Alabama and Southeast Mississippi. The headquarters of ALC is located in Jackson, Alabama. The Bank is the funding source for ALC.

The Company's sole business is banking; therefore, loans and investments are its principal sources of income. The Bank contributed approximately $5.4 million to consolidated net income in 2008, while ALC generated income of approximately $129,000. The Bank provides a wide range of commercial banking services to small and medium-sized businesses, real estate developers, property managers, business executives, professionals and other individuals.

FUSB Reinsurance, Inc. ("FUSB Reinsurance"), an Arizona corporation and wholly-owned subsidiary of the Bank, reinsures or "underwrites" credit life and credit accident and health insurance policies sold to the Bank's and ALC's consumer loan customers. FUSB Reinsurance is responsible for the first level of risk on these policies up to a specified maximum amount, and a primary third-party insurer retains the remaining risk. The third-party insurer is also responsible for performing most of the administrative functions of FUSB Reinsurance on a contract basis.

At December 31, 2008, United Security had consolidated assets of $668.0 million, deposits of $485.1 million and shareholders' equity of $78.7 million. Total assets increased by $8.1 million, or 1.2%, in 2008. Net income increased from $349,000 in 2007 to $5.4 million in 2008. Net income per share increased from $0.06 in 2007 to $0.89 in 2008.

Delivery of the best possible services to customers remains an overall operational focus of the Bank. We recognize that attention to details and responsiveness to customers' desires are critical to customer satisfaction. The Company continues to employ the most current technology, both in its financial services and in the training of its 286 full-time equivalent employees, to ensure customer satisfaction and convenience.

The following discussion and financial information are presented to aid in an understanding of the current financial position and results of operations of United Security and should be read in conjunction with the Audited Consolidated Financial Statements and Notes thereto included herein. The emphasis of this discussion will be on the years 2008, 2007 and 2006. All yields presented and discussed herein are based on the accrual basis and not on the tax-equivalent basis, unless otherwise indicated.

Forward-Looking Statements

This Annual Report, annual and periodic reports filed by United Security and its subsidiaries under the Securities and Exchange Act of 1934, as amended, and any other written or oral statements made by or on behalf of United Security, may include "forward-looking statements," within the meaning of the Private Securities Litigation Reform Act of 1995, that reflect United Security's current views with respect to future events and financial performance. Such forward-looking statements are based on general assumptions and are

subject to various risks, uncertainties and other factors that may cause actual results to differ materially from the views, beliefs and projections expressed in such statements. These risks, uncertainties and other factors include, but are not limited to:

1. Possible changes in economic and business conditions that may affect the prevailing interest rates, the prevailing rates of inflation, or the amount of growth, stagnation, or recession in the global, U.S., Alabama and Mississippi economies, the value of investments, the collectibility of loans and the ability to retain and grow deposits;

2. Possible changes in monetary and fiscal policies, laws and regulations, and other activities of governments, agencies and similar organizations;

3. Possible changes in regulation and laws affecting the financial services industry, such as banks, securities brokers and dealers, investment companies and finance companies, and attendant changes in patterns and effects of competition in the financial services industry; and

4. The ability of United Security to achieve its expected operating results including the continued growth of the markets in which United Security operates consistent with recent historical experience and United Security's ability to expand into new markets and to maintain profit margins.

5. During 2008 and thereafter, the residential mortgage market in the United States has experienced a variety of worsening economic conditions that may adversely affect the performance and market value of our residential construction and mortgage loans. Across the United States, delinquencies, foreclosures and losses with respect to residential construction and mortgage loans generally have increased during the last several months and may continue to increase. In addition, during 2008 and thereafter, housing prices and appraisal values in many states have declined or stopped appreciating. It is possible that housing values may remain stagnant or decline in the near term. An extended period of flat or declining housing values may result in increased delinquencies, losses on residential construction and mortgage loans and reduced value of collateral that secure loans.

In addition, United Security's business is subject to a number of general and market risks that would affect any forward-looking statements, including the risks discussed in Item 1A of United Security's Annual Report on Form 10-K for the year ended December 31, 2008.

The words "believe," "expect," "anticipate," "project" and similar expressions signify forward-looking statements. Readers are cautioned not to place undue reliance on any forward-looking statements made by or on behalf of United Security. Any such statements speak only as of the date such statements were made, and United Security undertakes no obligation to update or revise any forward-looking statements.

Irregularities at Acceptance Loan Company, Inc.

As a result of internal procedures of the Company, evidence was discovered during the second quarter of 2007 suggesting irregularities in certain loan transactions within ALC, a subsidiary of the Company. The irregularities were identified to be primarily related to four out of the twenty-five ALC branches and were largely related to (a) the making of improper or fraudulent loans,
(b) techniques used to conceal delinquent loans, (c) the improper or fraudulent handling of repossessed automobiles and (d) the inflation of appraisals on certain real estate collateral. The Company, under the direction of the Audit Committee, conducted an internal investigation relating to these irregularities with the assistance of outside legal counsel, as well as an outside forensic accounting firm.

As a result of the investigation, the results of operations for the year ended December 31, 2007 include a charge-off of loans and a write down of real estate collateral values relating to the irregularities of $12.5 million in ALC's loan and other real estate portfolio. These losses reduced the net income of the Company by $8.3 million, net of tax benefit, or $1.34 per basic and diluted share for the year ended December 31, 2007. The Company continues to vigorously pursue available avenues of recovery for these losses, including insurance and civil claims. In addition to these losses, the Company incurred a substantial amount of legal, accounting and associated

expenses relating to the investigation of these irregularities, which expenses are reflected in the Company's non-interest expense balance for the year ended December 31, 2007. The Company incurred additional legal and accounting expenses relating to the irregularities during 2008.

Critical Accounting Policies and Estimates

The preparation of the Company's financial statements requires management to make subjective judgments associated with estimates. These estimates are necessary to comply with accounting principles generally accepted in the United States and general banking practices. These areas include accounting for the allowance for loan losses, derivatives, deferred income taxes and supplemental compensation benefits agreements.

The Company maintains the allowance for loan losses at a level deemed adequate by management to absorb possible losses from loans in the portfolio. In determining the adequacy of the allowance for loan losses, management considers numerous factors, including, but not limited to, management's estimate of future economic conditions, the financial condition and liquidity of certain loan customers and collateral values of property securing certain loans. Because these factors and others involve the use of management's estimation and judgment, the allowance for loan losses is inherently subject to adjustment at future dates. Unfavorable changes in the factors used by management to determine the adequacy of the allowance, including increased loan delinquencies and subsequent charge-offs, or the availability of new information, could require additional provisions, in excess of normal provisions, to the allowance for loan losses in future periods.

Both fair-value and cash-flow hedges require assumptions related to the impact of changes in interest rates on the fair value of the derivative and the item being hedged. These assumptions are documented at inception to demonstrate effective hedging of the designated risk. If these assumptions do not accurately reflect future changes in the fair value, the Company may be required to discontinue the use of hedge accounting for a derivative. This change in accounting treatment could affect current period earnings.

Management's determination of the realization of a deferred tax asset is based upon management's judgment of various future events and uncertainties, including the timing and amount of future income earned by subsidiaries and the implementation of various tax planning strategies to maximize realization of the deferred tax asset. Management believes that the subsidiaries will be able to generate sufficient operating earnings to realize the deferred tax benefits. As management periodically evaluates the ability of the Bank to realize the deferred tax asset, subjective judgments are made that may impact the resulting provision for income tax.

The Company and the Bank have entered into supplemental compensation benefits agreements with the directors and certain executive officers. The measurement of the liability under the agreements includes estimates involving life expectancy, length of time before retirement and the expected returns on the Bank-owned life insurance policies used to fund the agreements. Should these estimates prove to be materially wrong, the cost of the agreements could change accordingly.

Overview of 2008

The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes and other schedules presented elsewhere in the report.

For the year ended December 31, 2008, net income rose to $5.4 million, compared with net income of $349,000 for the year ended December 31, 2007. Basic and diluted earnings per common share were $0.89 for the year ended December 31, 2008, compared with $0.06 for 2007. Our growth in net income benefited from a lower loan loss provision, growth in non-interest income and lower non-interest expenses compared with 2007.

Highlights for the year ended December 31, 2008 were:

• Total assets increased 1.2% to $668.0 million since the 2007 year-end.

• Deposits grew 1.4% to $485.1 million, compared with $478.6 million at December 31, 2007.

• At year-end 2008, our total risk-based capital was 17.49%, significantly above a number of financial institutions in our peer group and well above the minimum requirements of 10% to achieve the highest rating of 'well-capitalized.'

• Our net interest income decreased 13.1% to $35.2 million in 2008, compared with $40.5 million in 2007. The decrease in net interest income was due primarily to a decline in interest earned on loans related to lower volume and yields compared with 2007.

• Provision for loan losses declined to $8.9 million for the year ended December 31, 2008, or 2.1% annualized of average loans, compared with $21.2 million, or 4.7% annualized of average loans, for the year ended December 31, 2007. In 2007, approximately $12.5 million of the provision for loan losses was related to losses identified in the investigation of loan irregularities at ALC.

• Non-interest income rose 16.1% to $6.5 million in 2008, compared with $5.6 million in 2007. The increase in non-interest income resulted from higher service charges and fees on deposit accounts, credit life insurance commissions, letters of credit and commitment fees and all other fees and charges.

• Non-interest expense declined 2.1% to $25.3 million, compared with $25.8 million in 2007. We benefited from lower costs for salaries and benefits and lower occupancy costs compared with 2007 as a result of cost-saving measures and increased operational efficiency.

• Shareholders' equity totaled $78.7 million, or book value of $13.07 per share, at December 31, 2008. Return on average assets in 2008 was 0.80%, and return on average equity was 6.83%.

These items are discussed in further detail throughout this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section.

Summary of Operating Results



                                                            Year-Ended December 31,
                                                         2008        2007         2006
                                                           (In Thousands of Dollars)
 Interest Income                                       $  52,116   $ 59,983     $ 59,219
 Interest Expense                                         16,912     19,464       15,992

 Net Interest Income                                      35,204     40,519       43,227
 Provision for Loan Losses                                 8,901     21,152        3,726

 Net Interest Income After Provision for Loan Losses      26,303     19,367       39,501
 Non-Interest Income                                       6,463      5,566        5,621
 Non-Interest Expense                                     25,273     25,804       23,782

 Income (Loss) Before Income Taxes                         7,493       (871 )     21,340
 Provision for (Benefit from) Income Taxes                 2,123     (1,220 )      7,095

 Net Income                                            $   5,370   $    349     $ 14,245

Net Interest Income

Net interest income is an effective measurement of how well management has matched interest-earning assets and interest-bearing liabilities and is the Company's principal source of income. Fluctuations in interest rates materially affect net interest income. The Federal Reserve lowered the funds rate by 4.25% during 2008, which had a direct impact on the rates charged on loans. The yield on loans declined during 2008 faster than rates paid on deposits, which had an adverse impact on net interest income.

Net interest income declined 13.1% to $35.2 million in 2008, compared to a decline of 6.3% in 2007 and an increase of 5.8% in 2006. The decrease in net interest income in 2008 was due primarily to a 130 basis point decline in interest yields, a 0.10% decline in average earning assets to $600.6 million and a 3.6% increase in average interest bearing liabilities to $514.4 million, as compared to 2007.

The Company's loan portfolio declined by $28.1 million, or 6.4%, during 2008. However, investment securities increased during 2008 by $39.7 million, or 27.5%.

Overall, volume, rate and yield changes in interest-earning assets and interest-bearing liabilities contributed to the decline in net interest income during 2008. The Company's average earning assets decreased $0.5 million during 2008, or 0.09%, while average interest-bearing liabilities increased $17.7 million, or 3.6%. Thus, growth of average interest-bearing liabilities outpaced growth in average earning assets by $17.2 million during 2008.

The Bank's ability to produce net interest income is measured by a ratio called the interest margin. The interest margin is net interest income as a percent of average earning assets. The interest margin was 5.9% in 2008, 6.7% in 2007 and 7.5% in 2006.

Interest margins are affected by several factors, one of which is the relationship of rate-sensitive earning assets to rate-sensitive interest-bearing liabilities. This factor determines the effect that fluctuating interest rates will have on net interest income. Rate-sensitive earning assets and interest-bearing liabilities are those which can be repriced to current market rates within a relatively short time. The Bank's objective in managing interest rate sensitivity is to achieve reasonable stability in the interest margin throughout interest rate cycles by maintaining the proper balance of rate-sensitive assets and interest-bearing liabilities. For further analysis and discussion of interest rate sensitivity, refer to the section entitled, "Liquidity and Interest Rate Sensitivity Management."

An additional factor that affects the interest margin is the interest rate spread. The interest rate spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities. This measurement is a more accurate reflection of the effect that market interest rate movements have on interest rate-sensitive assets and liabilities. The interest rate spread was 5.4% in 2008, 6.1% in 2007 and 6.8% in 2006. The average amount of interest-bearing liabilities as noted in the table, "Yields Earned on Average Interest-Earning Assets and Rates Paid on Average Interest-Bearing Liabilities," increased 3.6% in 2008, while the average rate of interest paid decreased from 3.9% in 2007 to 3.3% in 2008. Average interest-earning assets decreased 0.1% in 2008, while the average yield on earning assets decreased from 10.0% in 2007 to 8.7% in 2008.

The percentage of earning assets funded by interest-bearing liabilities also affects the Bank's interest margin. The Bank's earning assets are funded by interest-bearing liabilities, non-interest-bearing demand deposits and shareholders' equity. The net return on earning assets funded by non-interest-bearing demand deposits and shareholders' equity exceeds the net return on earning assets funded by interest-bearing liabilities. The Bank's percentage of earning assets funded by interest-bearing liabilities has increased slightly in recent years, reducing the Bank's interest margin. In 2008, 85.6% of the Bank's average earning assets were funded by interest-bearing liabilities compared with 82.6% in 2007 and 80.1% in 2006.

Yields Earned on Average Interest-Earning Assets and Rates Paid on Average
Interest-Bearing Liabilities



                                                                                   December 31,
                                                    2008                               2007                               2006
                                        Average                Yield/      Average                Yield/      Average                Yield/
                                        Balance    Interest    Rate %      Balance    Interest    Rate %      Balance    Interest    Rate %
                                                                  (In Thousands of Dollars, Except Percentages)
ASSETS
Interest-Earning Assets:
Loans (Note A)                         $ 414,321   $  43,281    10.45 %   $ 449,577   $  52,317    11.64 %   $ 444,094   $  52,630    11.85 %
Taxable Investments                      171,196       8,240     4.81 %     135,400       6,934     5.12 %     118,136       5,829     4.93 %
Non-Taxable Investments                   13,786         595     4.32 %      16,152         732     4.53 %      16,719         760     4.55 %
Federal Funds Sold                         1,256           0     0.00 %           2           0     0.00 %           0           0     0.00 %

Total Interest-Earning Assets            600,559      52,116     8.68 %     601,131      59,983     9.98 %     578,949      59,219    10.23 %

Non-Interest-Earning Assets:
Other Assets                              67,914                             59,741                             56,639

Total                                  $ 668,473                          $ 660,872                          $ 635,588

LIABILITIES AND SHAREHOLDERS EQUITY
Interest-Bearing Liabilities:
Demand Deposits                        $  89,926   $   1,211     1.35 %   $  75,873   $     631     0.83 %   $  78,396   $     642     0.82 %
Savings Deposits                          47,409         463     0.98 %      47,721         505     1.06 %      52,487         497     0.95 %
Time Deposits                            285,602      11,433     4.00 %     291,873      14,361     4.92 %     246,199      10,553     4.29 %
Borrowings                                91,418       3,805     4.16 %      81,188       3,967     4.89 %      86,825       4,300     4.95 %

Total Interest-Bearing Liabilities       514,355      16,912     3.29 %     496,655      19,464     3.92 %     463,907      15,992     3.45 %

Non-Interest-Bearing Liabilities:
Demand Deposits                           62,075                             64,472                             66,191
Other Liabilities                         13,372                             14,097                             16,722
Shareholders' Equity                      78,671                             85,648                             88,768

Total                                  $ 668,473                          $ 660,872                          $ 635,588

Net Interest Income (Note B)                       $  35,204                          $  40,519                          $  43,227

Net Yield on Interest-Earning Assets                             5.86 %                             6.74 %                             7.47 %

Note A - For the purpose of these computations, non-accruing loans are included in the average loan amounts outstanding. These loans amounted to $11,621,474, $5,555,400 and $6,858,270 for 2008, 2007 and 2006, respectively.

Note B - Loan fees of $3,317,709, $3,837,409 and $3,496,765 for 2008, 2007 and 2006, respectively, are included in interest income amounts above.

Changes in Interest Earned and Interest Expense Resulting from Changes in Volume and Changes in Rates

The following table sets forth the effect which varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates had on changes in net interest income for 2008 versus 2007, 2007 versus 2006 and 2006 versus 2005.

                                          2008 Compared to 2007                  2007 Compared to 2006               2006 Compared to 2005
                                           Increase (Decrease)                    Increase (Decrease)                 Increase (Decrease)
                                            Due to Change In:                      Due to Change In:                   Due to Change In:
                                                 Average                               Average                               Average
                                     Volume        Rate         Net        Volume        Rate         Net        Volume        Rate       Net
                                                                             (In Thousands of Dollars)
Interest Earned On:
Loans                               $ (4,103 )   $ (4,933 )   $ (9,036 )   $   650     $   (963 )   $   (313 )   $ 2,863     $  2,853   $ 5,716
Taxable Investments                    1,833         (527 )      1,306         852          252        1,104         138          797       935
Non-Taxable Investments                 (107 )        (30 )       (137 )       (26 )         (2 )        (28 )      (120 )          9      (111 )

Total Interest-Earning Assets         (2,377 )     (5,490 )     (7,867 )     1,476         (713 )        763       2,881        3,659     6,540

Interest Expense On:
Demand Deposits                          117          463          580         (21 )         10          (11 )       (15 )         19         4
Savings Deposits                          (3 )        (39 )        (42 )       (45 )         53            8         (45 )          3       (42 )
Time Deposits                           (309 )     (2,619 )     (2,928 )     1,958        1,850        3,808         909        2,659     3,568
Other Borrowings                         500         (662 )       (162 )      (279 )        (54 )       (333 )      (204 )        856       652

Total Interest-Bearing
Liabilities                              305       (2,857 )     (2,552 )     1,613        1,859        3,472         645        3,537     4,182

(Decrease) Increase in Net
Interest Income                     $ (2,682 )   $ (2,633 )   $ (5,315 )   $  (137 )   $ (2,572 )   $ (2,709 )   $ 2,236     $    122   $ 2,358

Provision for Loan Losses

The provision for loan losses is an expense used to establish the allowance for loan losses. Actual loan losses, net of recoveries, are charged directly to the allowance. The expense recorded each year is a reflection of actual net losses experienced during the year and management's judgment as to the adequacy of the allowance to absorb losses inherent to the portfolio. Charge-offs exceeded recoveries by $8.9 million during the year, and a provision of $8.9 million was expensed for loan losses in 2008, compared to $21.2 million in 2007 and $3.7 million in 2006. Net charge-offs at the Bank were $2.6 million for the year ending December 31, 2008 and $1.6 million for the year ending December 31, 2007. ALC had net charge-offs of $6.3 million for the year ending December 31, 2008, compared to $18.7 million for the year ending December 31, 2007. Net charge-offs as a percentage of average loans were 2.12%, 4.53%, 0.85% and 0.77% for the years ended December 31, 2008, 2007, 2006 and 2005, respectively.

The ratio of the allowance to loans net of unearned income at December 31, 2008 was 2.1%. For additional information regarding the Company's allowance for loan losses, see "Loans and Allowance for Loan Loss."

. . .