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UBFO > SEC Filings for UBFO > Form 10-Q on 12-Nov-2013All Recent SEC Filings

Show all filings for UNITED SECURITY BANCSHARES

Form 10-Q for UNITED SECURITY BANCSHARES


12-Nov-2013

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, 2012.

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 Business Oversight (formerly known as 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 Business Oversight in June 2009. The Order issued by the California Department of Business Oversight is similar to the written agreement with the Federal Reserve Bank of San Francisco. As of September 24, 2013, the Bank entered into a Memorandum of Understanding (the "MOU") with the California Department of Business Oversight. Effective October 15, 2013, the Order was officially terminated by the California Department of Business Oversight. The Board of Directors and management believe that the Company is in compliance with the terms of the MOU. (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, 2013 and 2012, totaling $5,427,000 for the three months ended September 30, 2013 as compared to $5,622,000 for the three months ended September 30, 2012, and $16,029,000 for the nine months ended September 30, 2013 as compared to $17,669,000 for the nine months ended September 30, 2012. The decrease


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in net interest income between 2012 and 2013 was primarily the result of a shift in the mix as well as a decline in the yield on interest-earning assets which outweighed the decrease in the Company's cost of funding between the two periods.

Average interest-earning assets increased approximately $27,650,000 between the nine month periods ended September 30, 2013 and 2012. Components of the $27,650,000 increase in average earning assets between 2012 and 2013 included a increase of $2,329,000 in loans and a $10,042,000 decrease in investment securities. More than offsetting these decreases between the comparative periods was an increase of $35,823,000 in overnight funds sold to the Federal Reserve Bank. During the past year, the Company's cost of interest-bearing liabilities have continued to decline, with the average cost of interest-bearing liabilities dropping from 0.62% during the nine months ended September 30, 2012, to 0.49% during the nine months ended September 30, 2013.

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
                                           9/30/13      12/31/12       9/30/12
Loans and Leases                           71.81%        74.20%        75.18%
Investment securities available for sale    4.99%         7.30%         7.19%
Interest-bearing deposits in other banks    0.28%         0.35%         0.38%
Interest-bearing deposits in FRB           22.92%        18.15%        17.25%
Total interest-earning assets              100.00%       100.00%       100.00%

NOW accounts                               15.42%        14.44%        14.53%
Money market accounts                      41.42%        37.39%        35.98%
Savings accounts                           12.37%        11.99%        11.95%
Time deposits                              27.71%        33.44%        35.00%
Other borrowings                            0.00%         0.00%         0.00%
Subordinated debentures                     3.08%         2.74%         2.54%
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 since 2012 and those trends continued into the third quarter of 2013. 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, increased 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 September 2012 to September 2013. Total nonperforming loans decreased during the nine months ended September 30, 2013, totaling $21,605,000 at September 30, 2013 compared to $23,142,000 reported at December 31, 2012.

As a result of a modest improvement in the economy, the Company has experienced improvement in the loan portfolio between 2012 and 2013. During the nine months ended September 30, 2013, the Company experienced increases in real estate construction development and real estate mortgage loans, but experienced decreases in commercial and industrial loans, compared to the same period ended September 30, 2012. Loans decreased $16,027,000 between December 31, 2012 and September 30, 2013, and increased $7,953,000 between September 30, 2012 and September 30, 2013. Commercial and industrial loans decreased $1,311,000 between December 31, 2012 and September 30, 2013 and decreased $53,432,000 between September 30, 2012 and September 30, 2013. Real estate mortgage loans increased $4,403,000 between December 31, 2012 and September 30, 2013, and $43,613,000 between September 30, 2012 and September 30, 2013. Agricultural loans decreased $11,189,000 between December 31, 2012 and September 30, 2013 and increased $2,102,000 between September 30, 2012 and September 30, 2013. 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 37.07%, 33.39%, and 33.17%, of the total loan portfolio at September 30, 2013, December 31, 2012, and September 30, 2012, 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


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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 $50,502,000 or 13.15% of the portfolio at September 30, 2013, $55,016,000, or 13.75% of the portfolio at December 31, 2012, and $24,201,000 or 6.44% of the portfolio at September 30, 2012. Loan participations purchased have decreased from $2,170,000 or 0.58% of the portfolio at September 30, 2012, to $33,000 or 0.01% of the portfolio at December 31, 2012, to $30,000 or less than 0.01% of the portfolio at September 30, 2013. Loan participations sold decreased from $12,645,000 or 3.36% of the portfolio at September 30, 2012, to $12,117,000 or 3.0% of the portfolio at December 31, 2012, to $9,786,000, or 2.5%, at September 30, 2013.

Although 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 decreased to 3.90% for the nine months ended September 30, 2013, when compared to 4.53% for the nine months ended September 30, 2012. 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 5.62% during the nine months ended September 30, 2013, as compared to 6.03% for the nine months ended September 30, 2012. The decrease in the Company's cost of funds over the past year has mitigated the impact of declining yields on earning assets. The Company's average cost of funds was 0.49% for the nine months ended September 30, 2013 as compared to 0.62% for the nine months ended September 30, 2012. Although the Company does not intend to increase its current level of brokered deposits, the levels of brokered deposits are expected to remain level at least in the short-term. The Company is currently only utilizing CDAR's reciprocal deposits as a concession to our customer. The $14,940,000 in brokered deposits at September 30, 2013 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 $3,038,000 reported for the nine months ended September 30, 2013 decreased $1,917,000 or 38.69% as compared to the nine months ended September 30, 2012. Noninterest income continues to be driven by customer service fees, which totaled $2,554,000 for the nine months ended September 30, 2013. However, the decrease in noninterest income between the nine months ended September 30, 2013 and September 30, 2012, was primarily the result of a $1,807,000 decrease in gain on sale of other investments and a decrease of $235,000 due to a loss on fair value of financial liability, partially offset by an decrease of $284,000 on impairment losses on investment securities.

Noninterest expense decreased approximately $1,152,000 or 8.04% between the nine months ended September 30, 2012 and September 30, 2013. The decrease experienced during the nine months ended September 30, 2013 were primarily the result of a decrease of $1,274,000 in the net operating cost on OREO and a decrease in amortization expenses.

Effective March 31, 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 24, 2013, 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 11, 2013, an additional 145,061 shares were issued to shareholders.


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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, 2013. Total assets increased approximately $12,854,000 during the nine months ended September 30, 2013, including a decrease of $6,807,000 in OREO, an increase of $40,215,000 in cash and cash equivalents, and an increase of $733,000 in investment securities. Total deposits increased $8,189,000, including an increase of $19,098,000 in noninterest-bearing deposits, partially offset by decreases of$2,726,000 in savings and NOW and money market accounts, and $8,183,000 in time deposits during the nine months ended September 30, 2013. Average loans comprised approximately 71.82% and 75.18% of overall average earning assets during the nine months ended September 30, 2013 and September 30, 2012, respectively.

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, 2013, but decreased $8,344,000 from a balance of $47,074,000 at December 31, 2012 to a balance of $38,730,000 at September 30, 2013. Nonaccrual loans totaling $11,925,000 at September 30, 2013, decreased $1,500,000 from the balance of $13,425,000 reported at December 31, 2012. 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. Impaired loans decreased $233,000 during the nine months ended September 30, 2013 with a balance of $21,698,000 at September 30, 2013. Other real estate owned through foreclosure decreased $6,807,000 between December 31, 2012 and September 30, 2013 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 7.25% at December 31, 2012 to 5.85% at September 30, 2013.

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.

(in thousands)                     September 30, 2013     December 31, 2012     September 30, 2012
Provision for credit losses
during period                     $           (1,120 )   $           1,019     $           1,010
Allowance as % of nonperforming
loans                                          48.84 %               50.92 %               52.43 %

Nonperforming loans as % total
loans                                           5.63 %                5.78 %                5.66 %
Restructured loans as % total
loans                                           3.47 %                4.19 %                4.46 %

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 comprise 56 loans totaling $13,340,000 at September 30, 2013, compared to 58 loans totaling $16,773,000 at December 31, 2012.

The Company recorded a negative provision of $1,120,000 to the allowance for credit losses during the nine months ended September 30, 2013 as compared to a provision of $1,010,000 for the nine months ended September 30, 2012. Net loan and lease charge-offs during the nine months ended September 30, 2013 totaled $112,000 as compared to $3,498,000 for the nine months ended September 30, 2012. The Company charged-off, or had partial charge-offs on, approximately 22 loans during the nine months ended September 30, 2013, as compared to 17 loans during the same period ended September 30, 2012, and 26 loans during year ended December 31, 2012. The annualized percentage charge-offs to average loans were 0.04% and 1.19% for the nine months ended September 30, 2013 and 2012, respectively, as compared to 0.74% for the year ended December 31, 2012.

Deposits increased by $8,189,000 during the nine months ended September 30, 2013, with increases experienced in non-interest bearing deposits, partially offset by a decrease in interest bearing deposits. The Company continues to maintain a low 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, compared to borrowing from FHLB or Federal Reserve Bank. Brokered deposits totaled $14,940,000 or 2.61% of total deposits at September 30, 2013, as


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compared to $17,984,000 or 3.19% of total deposits at December 31, 2012, and $25,995,000 or 4.72% of total deposits at September 30, 2012.

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 three months of 2013. With pricing at 3-month-LIBOR plus 129 basis points, the effective cost of the subordinated debt was 1.54% at September 30, 2013 as compared to 1.89% at December 31, 2012. Pursuant to fair value accounting guidance, the Company has recorded $519,000 in pretax fair value loss on its junior subordinated debt during the nine months ended September 30, 2013, bringing the total cumulative gain recorded on the debt to $5,768,000 at September 30, 2013.

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 have shown improvements but still remain depressed, compared with prior years.

Results of Operations

For the quarters ended September 30, 2013 and 2012, the Company reported net income of $1,852,000 or $0.13 per share ($0.13 diluted) and $1,366,000 or $0.09 per share ($0.09 diluted), respectively. On a year-to-date basis, the Company reported net income of $4,323,000 or $0.30 per share ($0.30 diluted) for the nine months ended September 30, 2013, as compared to $4,591,000 or $0.32 per share ($0.32 diluted) for the same period in 2012.

The Company's return on average assets was 0.90% for the nine months ended September 30, 2013 as compared to 0.99% for the nine months ended September 30, 2012 and was 1.14% for the quarter ended September 30, 2013, compared to 0.87% for the quarter ended September 30, 2012. The Bank's return on average equity was 8.10% for the nine months ended September 30, 2013 as compared to 9.43% for the nine months ended September 30, 2012 and was 10.14% for the quarter ended September 30, 2013, compared to 8.25% for the quarter ended September 30, 2012.

Net Interest Income

Net interest income before provision for credit losses totaled $16,029,000 for the nine months ended September 30, 2013, representing a decrease of $1,640,000, or 9.28%, when compared to the $17,669,000 reported for the same period of the previous year.

The Company's year-to-date net interest margin, as shown in Table 1, decreased to 3.90% at September 30, 2013 from 4.53% at September 30, 2012, a decrease of 63 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, 2013 and 2012 (the Prime rate averaged 3.25% during both periods), the decrease in the Company's yield on loans and investment securities, as well as a change in the earning asset mix to lower earning assets, negatively impacted the net margin between the two nine month periods.


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