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USBI > SEC Filings for USBI > Form 10-K on 28-Mar-2013All Recent SEC Filings

Show all filings for UNITED SECURITY BANCSHARES INC | Request a Trial to NEW EDGAR Online Pro

Form 10-K for UNITED SECURITY BANCSHARES INC


28-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.

Introduction and Overview

United Security Bancshares, Inc., a Delaware corporation ("Bancshares," "USBI" or the "Company"), is a bank holding company with its principal offices in Thomasville, Alabama. Bancshares operates one commercial banking subsidiary, First United Security Bank (the "Bank" or "FUSB"). At December 31, 2012, 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.

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-four 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 Bank provides a wide range of commercial banking services to small and medium-sized businesses, property managers, business executives, professionals and other individuals, while ALC's business is consumer oriented.

FUSB Reinsurance, Inc. ("FUSB Reinsurance"), an Arizona corporation and a 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, 2012, Bancshares had consolidated assets of $567.1 million, deposits of $489.0 million and shareholders' equity of $68.6 million. Total assets decreased by $54.7 million, or 8.8%, in 2012. Net income attributable to USBI increased from a loss of $(9.1) million in 2011 to income of $2.2 million in 2012. Net income attributable to USBI per share increased from a loss of $(1.51) in 2011 to income of $0.36 in 2012. These results are explained in more detail throughout this section.

Delivery of the best possible banking services to customers remains an overall operational focus of the Company. We recognize that attention to details and responsiveness to customers' desires are critical to customer satisfaction. The Company continues to employ current technology, both in its financial services and in the training of its 290.67 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 consolidated financial position, changes in financial position and results of operations of Bancshares and should be read in conjunction with the Audited Consolidated Financial Statements and Notes thereto included herein. The emphasis of this discussion is on the years 2012 and 2011. 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 on Form 10-K for the year ended December 31, 2012 (this "Annual Report"), other annual and periodic reports filed by Bancshares and its subsidiaries under the Securities Exchange Act of 1934, as amended, and any other written or oral statements made by or on behalf of Bancshares may include "forward-looking statements," within the meaning of the Private Securities Litigation Reform Act of 1995, that reflect Bancshares' 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:


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1. Possible changes in economic and business conditions that may affect the prevailing interest rates, the prevailing rates of inflation, 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;

4. The ability of Bancshares to achieve its expected operating results in the markets in which Bancshares operates and Bancshares' ability to expand into new markets and to maintain profit margins; and

5. Since 2008, the residential and commercial mortgage market in the United States has experienced a variety of difficult economic conditions that have adversely affected and may continue to adversely affect the performance and market value of our residential and commercial mortgage loans. Across the United States, delinquencies, foreclosures and losses with respect to residential and commercial mortgage loans generally increased from 2008 through 2012. In addition, from 2008 through 2012, prices and appraisal values declined. It is possible that values may remain stagnant or decline in the near term. An extended period of flat or declining values may result in increased delinquencies, losses on residential and commercial mortgage loans and reduced value of collateral that secure real estate loans. Bad economic conditions have also impacted consumer loan customers. High unemployment and a stagnant economy may continue to adversely effect the performance of our consumer loans.

In addition, Bancshares' business is subject to a number of general and market risks that would affect any forward-looking statements, including the risks discussed in Part I, Item 1A of this Annual Report.

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 Bancshares. Any such statements speak only as of the date such statements were made, and Bancshares undertakes no obligation to update or revise any forward-looking statements.

Critical Accounting Estimates

The preparation of the Company's consolidated 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 of America and general banking practices. These areas include accounting for the allowance for loan losses, other real estate owned and deferred income taxes.

Allowance for Loan Losses

The Company maintains the allowance for loan losses at a level deemed adequate by management to absorb probable 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:
(a) future economic conditions, (b) the financial condition and liquidity of certain loan customers and (c) 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. There can be no assurance that loan losses in future periods will not exceed the allowance for loan losses or that additions to the allowances will not be required.


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Other Real Estate Owned

Other real estate owned ("OREO") that consists of properties obtained through foreclosure or in satisfaction of loans is reported at the lower of cost or fair value, less estimated costs to sell at the date acquired, with any loss recognized as a charge-off through the allowance for loan losses. Additional OREO losses for subsequent valuation adjustments are determined on a specific property basis and are included as a component of other non-interest expense along with holding costs. Any gains or losses on disposal realized at the time of disposal are reflected in non-interest expense. Significant judgments and complex estimates are required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current is significantly shortened during periods of market volatility, as experienced during 2011 and 2012. As a result, the net proceeds realized from sales transactions could differ significantly from appraisals, comparable sales and other estimates used to determine the fair value of OREO.

Deferred Income Taxes

Management's determination of the realization of deferred tax assets 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 Company's subsidiaries will be able to generate sufficient operating earnings to realize the deferred tax benefits. As management periodically evaluates its ability to realize the deferred tax asset, subjective judgments are made that may impact the resulting provision for income tax.

Other Significant Accounting Policies

Other significant accounting policies, not involving the same level of measurable uncertainties as those discussed above, are nevertheless important to an understanding of the consolidated financial statements. Policies related to revenue recognition, investment securities, fair value measurements and long-lived assets require difficult judgments on complex matters that are often subject to multiple and recent changes in the authoritative guidance. Certain of these matters are among topics currently under re-examination by accounting standard setters and regulators. Specific conclusions have not been reached by these standard setters, and outcomes cannot be predicted with confidence. Also, see Note 2, "Summary of Significant Accounting Policies," in the "Notes to Consolidated Financial Statements" included in this Annual Report, as it discusses accounting policies that we have selected from acceptable alternatives.

Overview of 2012

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

For the year ended December 31, 2012, net income attributable to USBI was $2.2 million, compared with net loss attributable to USBI of $(9.1) million for the year ended December 31, 2011. Basic and diluted net income attributable to USBI per common share was $0.36 for the year ended December 31, 2012, compared with net loss attributable to USBI per common share of $(1.51) for 2011.

Other results for the year ended December 31, 2012 were as follows:

Total assets decreased 8.8% to $567.1 million since year-end 2011.

Deposits decreased 7.2% to $489.0 million, compared with $527.1 million at December 31, 2011.

Loans net of unearned interest and fees decreased 11.6% to $356.7 million, compared with $403.4 million at December 31, 2011.

At year-end 2012, our total risk-based capital was 17.05%, significantly above a number of financial institutions in our peer group and well above the minimum requirements of 10%, to achieve the highest regulatory rating of "well-capitalized."


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Our net interest income decreased 3.2% to $34.2 million in 2012, compared with $35.3 million in 2011. The decrease in net interest income was due primarily to a decline in interest-earning assets along with a decrease in the yield on earning assets. These decreases were somewhat offset by a decline in the cost of interest-bearing liabilities.

Provision for loan losses decreased to $4.3 million for the year ended December 31, 2012, or 1.2% annualized of average loans, compared with $18.8 million, or 4.6% annualized of average loans, for the year ended December 31, 2011.

Non-interest income decreased 36.2% to $5.6 million in 2012, compared with $8.7 million in 2011. Non-interest income in 2011 benefited from net gains on investment securities of $2.6 million, which declined to $1,000 in 2012.

Non-interest expense decreased 19.4% to $32.5 million in 2012, compared with $40.3 million in 2011. Impairment of goodwill was $4.1 million in 2011, with no impairment charged in 2012. Impairment of OREO decreased $2.8 million in 2012 compared to 2011.

Shareholders' equity totaled $68.6 million, with a corresponding book value of $11.40 per share, at December 31, 2012. Return on average assets in 2012 was 0.37%, and return on average shareholders' equity was 3.27%.

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

Summary of Consolidated Operating Results



                                                               Year Ended December 31,
                                                                2012               2011
                                                              (In Thousands of Dollars)
Interest Income                                            $       38,753        $  42,346
Interest Expense                                                    4,556            7,018

Net Interest Income                                                34,197           35,328
Provision for Loan Losses                                           4,338           18,802

Net Interest Income After Provision for Loan Losses                29,859           16,526
Non-Interest Income                                                 5,565            8,728
Non-Interest Expense                                               32,484           40,288

Income (Loss) Before Income Taxes                                   2,940          (15,034 )
Benefit From (Provision for) Income Taxes                             745           (5,958 )

Net Income (Loss)                                          $        2,195        $  (9,076 )

Less: Net Loss Attributable to Noncontrolling Interest                 -                (1 )

Net Income (Loss) Attributable to USBI                     $        2,195        $  (9,075 )

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. Although market rates were stable during 2012, the yield on earning assets declined by 35 basis points, while the cost of interest-earning liabilities declined by 46 basis points, as longer-term time deposits repriced at lower rates, improving the net interest margin by 4 basis points, from 6.17% in 2011 to 6.21% in 2012.


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Net interest income decreased 3.2% to $34.2 million in 2012, compared to an increase of 1.6% in 2011. The decrease in net interest income in 2012 was primarily due to a decline in interest-earning assets along with a decrease in the yield on earning assets. These decreases were somewhat offset by a decline in the cost of interest-bearing liabilities.

Interest income declined $3.6 million in 2012: $2.6 million was the result of decreased interest-earning assets, and $1.0 million was due to a 35 basis point decline in the yield on interest-earning assets. Interest expense declined $2.5 million in 2012: $0.8 million resulted from decreased interest-bearing liabilities, and $1.6 million was due to a 46 basis point decline in the cost of interest-bearing liabilities.

Overall, volume, rate and yield changes in interest-earning assets and interest-bearing liabilities contributed to the decrease in net interest income during 2012. As to volume, the Company's average earning assets decreased $22.6 million during 2012, or 3.9%, while average interest-bearing liabilities decreased $23.9 million, or 4.9%. The Company's average loans declined by $29.8 million, or 7.3%, during 2012, and average investment securities increased by $5.7 million, or 3.4%, for a net decrease in interest-earning assets of $22.6 million, or 3.9%. Average interest-bearing liabilities declined $23.9 million, or 4.9%. Average borrowings declined $18.7 million, average time deposits declined $19.4 million, average savings deposits increased $12.8 million and average interest-bearing demand deposits increased $1.3 million.

One of the major challenges that we face at the Bank and ALC is investing in quality interest earning assets. Average loans have declined over the last two years at the Bank and ALC. Difficult economic conditions and fierce competition among lenders for quality loans will continue to affect our ability to grow loans. Reducing non-performing assets and attracting and retaining quality loan customers at the bank and ALC remain the primary focus of management.

The Company'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 percentage of average earning assets. The interest margin improved slightly from 6.17% in 2011 to 6.21% in 2012.

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 that can be repriced to current market rates within a relatively short time. The Company'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 improved from 5.95% in 2011 to 6.06% in 2012. 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," decreased 4.9% in 2012, while the average rate of interest paid decreased from 1.4% in 2011 to 0.98% in 2012. Average interest-earning assets decreased 3.9% in 2012, while the average yield on earning assets decreased from 7.4% in 2011 to 7.0% in 2012.

The percentage of earning assets funded by interest-bearing liabilities also affects the Company's interest margin. The Company'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 Company's percentage of earning assets funded by interest-bearing liabilities has decreased slightly since


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2011. In 2012, 84.2% of the Company's average earning assets were funded by interest-bearing liabilities, compared with 85.1% in 2011.

Yields Earned on Average Interest-Earning Assets and

Rates Paid on Average Interest-Bearing Liabilities



                                                                       December 31,
                                                      2012                                     2011
                                        Average                    Yield/        Average                    Yield/
                                        Balance      Interest      Rate %        Balance      Interest      Rate %
                                                      (In Thousands of Dollars, Except Percentages)
ASSETS
Interest-Earning Assets:
Loans (Note A)                         $ 376,644     $  35,373        9.39 %    $ 406,436     $  37,064        9.12 %
Taxable Investments                      157,457         2,801        1.78 %      143,127         4,346        3.04 %
Non-Taxable Investments                   14,716           575        3.91 %       23,394           936        4.00 %
Federal Funds Sold                         1,585             4        0.25 %           -             -         0.00 %

Total Interest-Earning Assets            550,402        38,753        7.04 %      572,957        42,346        7.39 %

Non-Interest-Earning Assets:
Other Assets                              48,595                                   52,816

Total                                  $ 598,997                                $ 625,773

LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-Bearing Liabilities:
Demand Deposits                        $ 121,498     $     707        0.58 %    $ 120,166     $   1,014        0.84 %
Savings Deposits                          67,803           223        0.33 %       54,988           351        0.64 %
Time Deposits                            268,496         3,503        1.30 %      287,907         4,895        1.70 %
Borrowings                                 5,573           123        2.21 %       24,255           758        3.13 %

Total Interest-Bearing Liabilities       463,370         4,556        0.98 %      487,316         7,018        1.44 %

Non-Interest-Bearing Liabilities:
Demand Deposits                           59,443                                   59,142
Other Liabilities                          9,127                                    2,147
Shareholders' Equity                      67,057                                   77,168

Total                                  $ 598,997                                $ 625,773

Net Interest Income (Note B)                         $  34,197                                $  35,328

Net Yield on Interest-Earning Assets                                  6.21 %                                   6.17 %

Note A -For the purpose of these computations, non-accruing loans are included in the average loan amounts outstanding. These loans amounted to $22,667,706 and $21,728,886 for 2012 and 2011, respectively.
Note B -Loan fees of $3,711,430 and $3,430,230 for 2012 and 2011, respectively, are included in interest income amounts above.


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Changes in Interest Earned and Interest Expense Resulting from

Changes in Volume and Changes in Rates

The following table sets forth the effect that varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates had on changes in net interest income for 2012 versus 2011 and 2011 versus 2010.

                                            2012 Compared to 2011                     2011 Compared to 2010
                                             Increase (Decrease)                       Increase (Decrease)
                                              Due to Change In:                         Due to Change In:
                                                   Average                                   Average
                                      Volume         Rate          Net          Volume         Rate          Net
                                                               (In Thousands of Dollars)
Interest Earned On:
Loans                                $ (2,717 )    $  1,026      $ (1,691 )    $   (506 )    $   (516 )    $ (1,022 )
Taxable Investments                       435        (1,980 )      (1,545 )        (376 )      (1,137 )      (1,513 )
Non-Taxable Investments                  (347 )         (14 )        (361 )          82           (29 )          53
Federal Funds                              -              4             4            -             -             -

Total Interest-Earning Assets          (2,629 )        (964 )      (3,593 )        (800 )      (1,682 )      (2,482 )

Interest Expense On:
Demand Deposits                            11          (318 )        (307 )          42          (207 )        (165 )
Savings Deposits                           82          (210 )        (128 )          30           (27 )           3
Time Deposits                            (330 )      (1,062 )      (1,392 )         (90 )      (1,088 )      (1,178 )
Other Borrowings                         (584 )         (51 )        (635 )      (1,393 )        (322 )      (1,715 )

Total Interest-Bearing Liabilities       (821 )      (1,641 )      (2,462 )      (1,411 )      (1,644 )      (3,055 )

Increase (Decrease) in Net
Interest Income                      $ (1,808 )    $    677      $ (1,131 )    $    611      $    (38 )    $    573

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 $7.3 million in 2012, and a provision of $4.3 million was expensed for loan losses in 2012, compared to $18.8 million in 2011. The provision for 2012 and 2011 was 1.2% and 4.6% of average loans, respectively. The provisions in 2011 and 2012 were high due to charge-offs and impairments in the real estate development loan portfolio at the Bank. Net charge-offs at the Bank were $4.2 million for the year ending December 31, 2012, compared to $14.2 million for the year ending December 31, 2011. At the Bank, net charge-offs of commercial real estate decreased from $12.9 million in 2011 to $2.8 million in 2012. The severely depressed real estate market in the Bank's market area continues to adversely impact real estate values and the ability of borrowers to perform, particularly when performance is based on real estate sales. These conditions are the primary cause for the large amount of net charge-offs in 2011 compared to 2012. ALC had net charge-offs of $3.1 million for the year ending December 31, 2012, compared to $3.2 million for the year ending December 31, . . .

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