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UBFO > SEC Filings for UBFO > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for UNITED SECURITY BANCSHARES

Form 10-Q for UNITED SECURITY BANCSHARES


14-Nov-2012

Quarterly Report


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

Overview

Certain matters discussed or incorporated by reference in this Quarterly Report of Form 10-Q are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks and uncertainties include, but are not limited to, those described in Management's Discussion and Analysis of Financial Condition and Results of Operations. Such risks and uncertainties include, but are not limited to, the following factors: i) competitive pressures in the banking industry and changes in the regulatory environment; ii) exposure to changes in the interest rate environment and the resulting impact on the Company's interest rate sensitive assets and liabilities; iii) decline in the health of the economy nationally or regionally which could reduce the demand for loans or reduce the value of real estate collateral securing most of the Company's loans; iv) credit quality deterioration that could cause an increase in the provision for loan losses; v) Asset/Liability matching risks and liquidity risks; volatility and devaluation in the securities markets, vi) failure to comply with the regulatory agreements under which the Company is subject, vii) expected cost savings from recent acquisitions are not realized, and, viii) potential impairment of goodwill and other intangible assets. Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company. For additional information concerning risks and uncertainties related to the Company and its operations, please refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

United Security Bancshares (the "Company" or "Holding Company") is a California corporation incorporated during March of 2001 and is registered with the Board of Governors of the Federal Reserve System as a bank holding company under the Bank Holding Company Act of 1956, as amended. United Security Bank (the "Bank") is a wholly-owned bank subsidiary of the Company and was formed in 1987. References to the Company are references to United Security Bancshares (including the Bank). References to the Bank are to United Security Bank, while references to the Holding Company are to the parent-only, United Security Bancshares. The Company currently has eleven banking branches, which provide financial services in Fresno, Madera, Kern, and Santa Clara counties in the state of California.

Effective March 23, 2010, United Security Bancshares (the "Company") and its wholly owned subsidiary, United Security Bank (the "Bank"), entered into a formal written agreement (the "Agreement") with the Federal Reserve Bank of San Francisco. The Agreement was a result of a regulatory examination that was conducted by the Federal Reserve and the California Department of Financial Institutions in June 2009 and is intended to improve the overall condition of the Bank through, among other things, increased Board oversight; formal plans to monitor and improve processes related to asset quality, liquidity, funds management, capital, and earnings; and the prohibition of certain actions that might reduce capital, including the distribution of dividends or the repurchase of the Company's common stock. The Board of Directors and management believe that the Company is in compliance with the terms of the Agreement. (For more information on the Agreement see the "Regulatory Matters" section included in this Management's Discussion and Analysis of Financial Condition and Results of Operations.)

During May of 2010, the California Department of Financial Institutions issued a written order (the "Order") to the Bank as a result of a regulatory examination that was conducted by the Federal Reserve and the California Department of Financial Institutions in June 2009. The Order issued by the California Department of Financial Institutions is similar to the written agreement with the Federal Reserve Bank of San Francisco. The Board of Directors and management believe that the Company is in compliance with the terms of the Agreement. (For more information on the Agreement see the "Regulatory Matters" section included in this Management's Discussion and Analysis of Financial Condition and Results of Operations.)

Trends Affecting Results of Operations and Financial Position

The Company's overall operations are impacted by a number of factors, including not only interest rates and margin spreads, which impact the results of operations, but also the composition of the Company's balance sheet. One of the primary strategic goals of the Company is to maintain a mix of assets that will generate a reasonable rate of return without undue risk, and to finance those assets with a low-cost and stable source of funds. Liquidity and capital resources must also be considered in the planning process to mitigate risk and allow for growth. Net interest income before provision for credit losses has decreased between the three and nine months ended September 30, 2012 and 2011, totaling $5.6 million for the three months ended September 30, 2012 as compared to $6.2 million for the three months ended September 30, 2011, and $17.7 million for the nine months ended September 30, 2012 as compared to $18.7 million for the nine months ended September 30, 2011. The decrease in net interest income between 2012 and 2011 was primarily the result of declines in the volume of interest-earning assets which outweighed the decrease in the Company's cost of funding between the two periods.

Average interest-earning assets decreased approximately $40.2 million between the nine month periods ended September 30, 2012 and September 30, 2011. Components of the $40.2 million decrease in average earning assets between 2011 and 2012 included a decrease of $38.5 million in loans and a $12.7 million decrease in investment securities. Offsetting these decreases between the nine-month comparative periods was an increase of $115 million in overnight funds sold to the Federal Reserve Bank. During the last year, the Company's cost of interest-bearing liabilities have continued to decline, with the average cost of interest-bearing liabilities dropping from .74% during the nine months ended September 30, 2011, to 0.62% during the nine months ended September 30, 2012.


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The following table summarizes the year-to-date averages of the components of interest-earning assets as a percentage of total interest-earning assets and the components of interest-bearing liabilities as a percentage of total interest-bearing liabilities:

                                               YTD Average       YTD Average       YTD Average
                                                 9/30/12          12/31/11           9/30/11
Loans and Leases                                      75.17 %           76.39 %           76.73 %
Investment securities available for sale               7.19 %            8.80 %            8.91 %
Interest-bearing deposits in other banks               0.38 %            0.43 %            0.43 %
Interest-bearing deposits in FRB                      17.26 %           14.38 %           13.93 %
Total interest-earning assets                        100.00 %          100.00 %          100.00 %

NOW accounts                                          14.52 %           11.80 %           11.61 %
Money market accounts                                 35.99 %           30.43 %           29.87 %
Savings accounts                                      11.95 %            9.67 %            9.40 %
Time deposits                                         35.00 %           40.21 %           40.38 %
Other borrowings                                       0.00 %            5.43 %            6.22 %
Subordinated debentures                                2.54 %            2.46 %            2.52 %
Total interest-bearing liabilities                   100.00 %          100.00 %          100.00 %

The residential real estate markets in the five county region from Merced to Kern showed signs of improvement during 2011 and those trends continued into the first three quarters of 2012. The severe declines in residential construction and home prices that began in 2008 continue to show signs of easing and reversing direction. The sustained period of double-digit price declines from 2008 - 2011 adversely impacted the Company's operations and increased the levels of nonperforming assets, expenses related to foreclosed properties, and decreased profit margins. As the Company continues its business development and expansion efforts throughout its market areas, a primary focus is reduction of nonperforming assets while providing customers options to work through this difficult economic period. Options include combinations of rate and term concessions, as well as forbearance agreements with borrowers. Median sales prices improved in the five county region from Merced to Kern between Sept 2011 to Sept 2012. Total nonperforming loans decreased during the nine months ended September 30, 2012, totaling $21.3 million at September 30, 2012 compared to $30.0 million reported at December 31, 2011.

As a result of the weak economy, the Company has experienced declines in the loan portfolio between 2011 and 2012. During the nine months ended September 30, 2012 and between September 30, 2011 and September 30, 2012, the Company experienced increases in real estate mortgage loans, but decreases were experienced in all other loan categories. In order from greatest to least, decreases over the past year have been experienced in commercial and industrial loans, real estate construction and development loans, and agricultural loans, as the Company has reduced its exposure to real estate markets which have been hard hit during the economic downturn. Loans decreased $32.6 million between December 31, 2011 and September 30, 2012, and decreased $41.3 million between September 30, 2011 and September 30, 2012. Commercial and industrial loans decreased $42.2 million between December 31, 2011 and September 30, 2012 and $43.7 million between September 30, 2011 and September 30, 2012. Real estate construction and development loans increased $15.9 million between December 31, 2011 and September 30, 2012, and $12.9 million between September 30, 2011 and September 30, 2012. Agricultural loans decreased $12.9 million between December 31, 2011 and September 30, 2012 and $13.7 million between September 30, 2011 and September 30, 2012. Commercial real estate loans (a component of real estate mortgage loans) have remained as a significant percentage of total loans over the past year, amounting to 33.2%, 29.1%, and 28.6%, of the total loan portfolio at September 30, 2012, December 31, 2011, and September 30, 2011, respectively. Residential mortgage loans are not generally a large part of the Company's loan portfolio, but some residential mortgage loans have been made over the past several years to facilitate take-out loans for construction borrowers when they were not able to obtain permanent financing elsewhere. These loans are generally 30-year amortizing loans with maturities of between three and five years. Residential mortgages totaled $24.2 million or 6.4% of the portfolio at September 30, 2012, $24.0 million, or 5.9% of the portfolio at December 31, 2011, and $25.0 million or 6.0% of the portfolio at September 30, 2011. Loan participations purchased have increased from $3.7 million or .9% of the portfolio at September 30, 2011, to $3.6 million or 0.9% of the portfolio at December 31, 2011, to $2.17 million or .5% of the portfolio at September 30, 2012. Loan participations sold decreased from $13.4 million or 3.2% of the portfolio at September 30, 2011, to $13.3 million or 3.3% of the portfolio at December 31, 2011, compared to $12.6 million, or 3.4%, at September 30, 2012.


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Even though market rates of interest are at historically low levels, the Company's disciplined deposit pricing efforts have helped maintain adequate margins, The Company's net interest margin increased to 4.53% for the nine months ended September 30, 2012, as compared to 4.45% for the nine months ended September 30, 2011. The net interest margin has also been impacted by a decline in loans, the Company's highest yielding asset, which has been partially offset by an increase in overnight investments with the Federal Reserve Bank, a much lower yielding asset. The Company has successfully sought to mitigate the low-interest rate environment with loan floors included in new and renewed loans when practical. Loans yielded 6.03% during the nine months ended September 30, 2012, as compared to 5.95% for the nine months ended September 30, 2011. The decrease in the Company's cost of funds over the past year and has mitigated the impact of declining yields on earning assets. The Company's average cost of funds was 0.62% for the nine months ended September 30, 2012 as compared to 0.74% for the nine months ended September 30, 2011. Although the Company does not intend to increase its current level of brokered deposits, and in fact as a result of the 2010 Agreement with the Federal Reserve Bank and Order with the California Department of Financial Institutions, continues to systematically reduce brokered deposit levels as they mature in the future, the $26.0 million in brokered deposits at September 30, 2012 continues to provide the Company with a low-cost source of deposits. The Company will continue to utilize these funding sources when required to maintain prudent liquidity levels, while seeking to increase core deposits when possible.

Total noninterest income of $5.6 million reported for the nine months ended September 30, 2012 increased $33,000 or 0.6% as compared to the nine months ended September 30, 2011. Noninterest income continues to be driven by customer service fees, which totaled $2.7 million for the nine months ended September 30, 2012, however the increase in noninterest income between the nine months ended September 30, 2012 and September 30, 2011, was primarily the result of increases of $1.8 million in the gain on sale of investments as well as the increase in the gain on sale of other real estate owned of $515,000, offset by a decrease of $2.1 million in gains recognized on the fair value of financial liabilities. The gain on sale of investments was related to the sale of income tax credits, the benefit of which was delayed due to the bank's sizeable net operating loss carry-forwards. The sale effectively saves the Bank $470,000 of amortization expense over each of the next 3 years, as well as generating the gain in 2012.

Noninterest expense decreased approximately $7.4 million or 33.1% between the nine months ended September 30, 2011 and September 30, 2012. Decreases experienced during the nine months ended September 30, 2012 were primarily the result of decreases in impairment loss on goodwill and on other real estate owned, as well as decreases in OREO expenses and professional fees.

Effective September 30, 2009 and beginning with the quarterly interest payment due October 1, 2009, the Company deferred interest payments on the Company's $15.0 million of junior subordinated debentures relating to its trust preferred securities. This was the result of regulatory restraints which have precluded the Bank from paying dividends to the Holding Company. The Agreement with the Federal Reserve Bank entered into during March 2010 specifically prohibits the Company and the Bank from making any payments on the junior subordinated debt without prior approval of the Federal Reserve Bank. The terms of the debentures and trust indentures allow for the Company to defer interest payments for up to 20 consecutive quarters without default or penalty. During the period that the interest deferrals are elected, the Company will continue to record interest expense associated with the debentures. Upon the expiration of the deferral period, all accrued and unpaid interest will be due and payable. Under the terms of the debenture, the Company is precluded from paying cash dividends to shareholders or repurchasing its stock during the deferral period.

The Company has not paid any cash dividends on its common stock since the second quarter of 2008 and does not expect to resume cash dividends on its common stock for the foreseeable future. Because the Company has elected to defer the quarterly payments of interest on its junior subordinated debentures issued in connection with the trust preferred securities as discussed above, the Company is prohibited under the subordinated debenture agreement from paying cash dividends on its common stock during the deferral period. In addition, pursuant to the Agreement entered into with the Federal Reserve Bank during March of 2010, the Company and the Bank are precluded from paying cash dividends without prior consent of the Federal Reserve Bank. On September 26, 2012, the Company's Board of Directors declared a one-percent (1%) quarterly stock dividend on the Company's outstanding common stock. The Company believes, given the current uncertainties in the economy and unprecedented declines in real estate valuations in our markets, it is prudent to retain capital in this environment, and better position the Company for future growth opportunities. Based upon the number of outstanding common shares on the record date of October 12, 2012, an additional 138,011 shares were issued to shareholders.

For purposes of earnings per share calculations, the Company's weighted average shares outstanding and potentially dilutive shares used in the computation of earnings per share have been restated after giving retroactive effect to the 1% stock dividends to shareholders for all periods presented.

The Company has sought to maintain a strong, yet conservative balance sheet while continuing to reduce the level of nonperforming assets and improve liquidity during the nine months ended September 30, 2012. Total assets decreased approximately $17.7 million during the nine months ended September 30, 2012, including a decrease of $32.6 million in loans, an increase of $17.3 million in cash and cash equivalents, and a decrease of $3.6 million in OREO. Total deposits decreased $23.4 million, including decreases of $12.2 million in noninterest-bearing deposits and $34.1 million in time deposits during the nine months ended September 30, 2012 not offset by the increases in savings and NOW and money market accounts. The decrease in time deposits during the nine-month period was the result of Company's continued efforts to reduce the level of brokered time deposits. Average loans comprised approximately 75% of overall average earning assets during the nine months ended September 30, 2012 and September 30, 2011.


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Nonperforming assets, which are primarily related to the real estate loan and other real estate owned portfolio, remained high during the nine months ended September 30, 2012, but decreased $12.3 million from a balance of $57.0 million at December 31, 2011 to a balance of $44.8 million at September 30, 2012. Nonaccrual loans totaling $10.5 million at September 30, 2012, decreased $7.7 million from the balance of $18.1 million reported at December 31, 2011. In determining the adequacy of the underlying collateral related to these loans, management monitors trends within specific geographical areas, loan-to-value ratios, appraisals, and other credit issues related to the specific loans. Valuations on these loans and the underlying collateral continued to deteriorate during much of 2009, 2010, and 2011, resulting in increased charge-offs and levels of impaired loans. Impaired loans decreased $10.7 million during the nine months ended September 30, 2012 with a balance of $21.1 million at September 30, 2012. Other real estate owned through foreclosure decreased $3.6 million between December 31, 2011 and September 30, 2012 as a result of the sale of various properties. As a result of the related events, nonperforming assets as a percentage of total assets decreased from 13.96% at December 31, 2011 to 7.07% at September 30, 2012.

The following table summarizes various nonperforming components of the loan portfolio, the related allowance for loan and lease losses and provision for credit losses for the periods shown.

                                               September 30,       December 31,       September 30,
(in thousands)                                     2012                2011               2011
Provision for credit losses during period     $         1,010     $       13,602     $        12,497
Allowance as % of nonperforming loans                   52.43 %            45.52 %             42.55 %

Nonperforming loans as % total loans                     5.67 %             7.34 %              7.73 %
Restructured loans as % total loans                      4.31 %             4.74 %              4.78 %

Management continues to monitor economic conditions in the real estate market for signs of further deterioration or improvement which may impact the level of the allowance for loan losses required to cover identified losses in the loan portfolio. Greater focus has been placed on monitoring and reducing the level of problem assets, while working with borrowers to find more options, including loan restructures, to work through these difficult economic times. Restructured loans were comprised of 52 loans totaling $16.7 million at September 30, 2012, compared to 41 loans totaling $19.4 million at December 31, 2011.

Provisions made to the allowance for credit losses, totaled $1.0 million during the nine months ended September 30, 2012 as compared to $12.5 million for the nine months ended September 30, 2011. Net loan and lease charge-offs during the nine months ended September 30, 2012 totaled $3.5 million as compared to $15.1 million for the nine months ended September 30, 2011. The Company charged-off, or had partial charge-offs on, approximately 17 loans during the nine months ended September 30, 2012, compared to 48 loans during the nine months ended September 30, 2011, and 78 loans during year ended December 31, 2011. The annualized percentage charge-offs to average loans were 1.19% and 4.67% for the nine months ended September 30, 2012 and 2011, respectively, as compared to 3.9% for the year ended December 31, 2011.

Deposits decreased by $23.4 million during the nine months ended September 30, 2012, with decreases experienced in noninterest-bearing accounts and time deposits, more than offsetting the increases in savings and NOW and money market accounts during the first six months of 2012. Decreases in time deposits experienced during the nine months ended September 30, 2012 were primarily the result of decreases in brokered wholesale deposits, as the Company continues to reduce its reliance on brokered deposits and other wholesale funding sources, while maintaining sufficient liquidity.

Brokered deposits have provided the Company a relatively inexpensive funding source over the past several years totaling $26.0 million or 4.7% of total deposits at September 30, 2012, as compared to $40.9 million or 7.1% of total deposits at December 31, 2011, and $48.5 million or 8.6% of total deposits at September 30, 2011. Brokered deposits and other wholesale funding sources were used to some degree to fund loan growth in 2007 and 2008, but the current state of the economy and the financial condition of the Company have made it increasingly important to continue to develop core deposits and reduce the Company's dependence on brokered and other wholesale funding sources, including lines of credit with the Federal Reserve Bank and the FHLB. The Company continues its efforts to develop core deposit growth with employee training throughout the entire organization and a deposit-gathering program that incents employees to bring in new deposits from our local market area and establish more extensive relationships with our customers. As part of its liquidity position improvement plan resulting from the formal agreement with the Federal Reserve Bank issued in March 2010, the Company has reduced its reliance on brokered deposits in order to achieve levels more comparable with peers. The Company will seek to continue replacing maturing brokered deposits with core deposits, but may also control loan growth to help achieve that objective.


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The cost of the Company's subordinated debentures issued by USB Capital Trust II has remained low as market rates have remained low during the first nine months of 2012. With pricing at 3-month-LIBOR plus 129 basis points, the effective cost of the subordinated debt was 1.29% at September 30, 2012 as compared to 1.89% at December 31, 2011. Pursuant to fair value accounting guidance, the Company has recorded $171,000 in pretax fair value loss on its junior subordinated debt during the quarter ended September 30, 2012, bringing the total cumulative gain recorded on the debt to $6.8 million at September 30, 2012.

The Company continues to emphasize relationship banking and core deposit growth, and has focused greater attention on its market area of Fresno, Madera, and Kern Counties, as well as Campbell, in Santa Clara County. The San Joaquin Valley and other California markets continue to exhibit weak demand for construction lending and commercial lending from small and medium size businesses, as commercial and residential real estate markets remain depressed, compared with prior years.

Results of Operations

For the quarter ended September 30, 2012, the Company reported net income of $1.4 million or $0.10 per share ($0.10 diluted) as compared to a net loss of $1.5 million or ($0.10) per share (($0.10) diluted) for the quarter ended September 30, 2011. On a year to date basis, the Company reported net income of $4.6 million or $0.33 per share ($0.33 diluted) for the nine months ended September 30, 2012 as compared to a net loss of $7.5 million or ($.53) per basic and diluted shares for the nine months ended September 30, 2011. The increase in earnings between the quarters and nine months ended September 30, 2012 and 2011 are a result of decreases in interest expense and the provision for loan losses, and decreases in noninterest expense.

The Company's return on average assets was .99% for the nine months ended September 30, 2012 as compared to (1.50%) for the nine months ended September 30, 2011 and was 0.87% for the quarter ended September 30, 2012 compared to (2.98%) for the quarter ended September 30, 2011. The Bank's return on average equity was 9.82% for the nine months ended September 30, 2012 as compared to (13.68%) for the nine months ended September 30, 2011 and was 8.72% for the quarter ended September 30, 2012 compared to (29.58%) for the quarter ended September 30, 2011.

Net Interest Income

Net interest income before provision for credit losses totaled $17.7 million for the nine months ended September 30, 2012, representing a decrease of $1.1 million, or 5.7% when compared to the $18.7 million reported for the same nine months of the previous year.

The Company's year-to-date net interest margin, as shown in Table 1, increased to 4.53% at September 30, 2012 from 4.45% at September 30, 2011, an increase of 8 basis points (100 basis points = 1%) between the two periods. While average market rates of interest have remained level between the nine-month periods ended September 30, 2012 and 2011 (the Prime rate averaged 3.25% during both periods), the continued decrease in the Company's interest expenses positively impacted the net margin between the two nine-month periods.


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