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USBI > SEC Filings for USBI > Form 10-K on 21-Mar-2014All Recent SEC Filings

Show all filings for UNITED SECURITY BANCSHARES INC

Form 10-K for UNITED SECURITY BANCSHARES INC


21-Mar-2014

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 ("USBI"), is a bank holding company with its principal offices in Thomasville, Alabama. USBI operates one commercial banking subsidiary, First United Security Bank (the "Bank" or "FUSB"). As of December 31, 2013, 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-three 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.

Delivery of the best possible financial services to customers remains an overall operational focus of USBI and its subsidiaries (collectively, the "Company"). We recognize that attention to details and responsiveness to customers' desires are critical to customer satisfaction. The Company continues to upgrade 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 consolidated financial position, changes in financial position, results of operations and cash flows of the Company 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 2013 and 2012. 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

Statements contained in this Annual Report on Form 10-K that are not historical facts are forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). In addition, the Company, through its senior management, from time to time makes forward-looking statements concerning its expected future operations and performance and other developments. The words "estimate," "project," "intend," "anticipate," "expect," "believe" and similar expressions are indicative of forward-looking statements. Such forward-looking statements are necessarily estimates reflecting the Company's best judgment based upon current information and involve a number of risks and uncertainties, and various factors could cause results to differ materially from those contemplated by such forward-looking statements. Such factors could include those identified from time to time in USBI's Securities and Exchange Commission filings and other public announcements, including the factors described in this Annual Report on Form 10-K for the year ended December 31, 2013. Specifically, with respect to statements relating to loan demand, growth and earnings potential and the adequacy of the allowance for loan losses, these factors include, but are not limited to, the rate of growth (or lack thereof) in the economy, the relative


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strength and weakness in the consumer and commercial credit sectors and in the real estate markets and collateral values. Readers are cautioned not to place undue reliance on any forward-looking statements made by or on behalf of the Company. Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to revise forward-looking statements to reflect circumstances or events that occur after the dates the forward-looking statements are made, except as required by law.

In addition, the Company's business is subject to a number of general and market risks that would affect any forward-looking statements, including the risks discussed under Item 1A herein entitled "Risk Factors."

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 valuation of deferred tax assets.

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 at the balance sheet date. In determining the adequacy of the allowance for loan losses, management considers numerous factors, including, but not limited to, management's estimate of: (a) loan loss experience, (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.

Other Real Estate Owned

Other real estate owned ("OREO") consists of properties obtained through foreclosure or in satisfaction of loans, and is reported at the lower of cost or fair value, less estimated costs to sell at the date acquired, with any loss at the date of foreclosure 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 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 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 Tax Asset Valuation

A valuation allowance is recognized for a deferred tax asset if, based on the weight of available evidence, it is more likely than not that some portion or the entire deferred tax asset will not be realized. The ultimate realization of a deferred tax asset is dependent upon the generation of future taxable income during the periods in


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which the temporary differences that resulted in the deferred tax asset become deductible. Management's determination of the realization of deferred tax assets is based upon judgments regarding 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 USBI's subsidiaries will be able to generate sufficient operating earnings to realize the deferred tax assets recorded as of December 31, 2013. However, the amount of deferred tax asset considered realizable could be reduced if estimates of future taxable income are reduced.

Fair Value Measurements

A portion of the Company's assets and liabilities is carried at fair value, with changes in fair value recorded either in earnings or accumulated other comprehensive income (loss). These include securities available for sale and impaired loans. Additionally, other real estate and certain other assets acquired in foreclosure are reported at the lower of the recorded investment or fair value of the property, less estimated cost to sell. Fair value is generally defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. While management uses judgment when determining the price at which willing market participants would transact when there has been a significant decrease in the volume or level of activity for the asset or liability in relation to "normal" market activity, management's objective is to determine the point within the range of fair value estimates that is most representative of a sale to a third-party investor under current market conditions. The value to the Company if the asset or liability was held to maturity is not included in the fair value estimates.

A fair value measure should reflect the assumptions that market participants would use in pricing the asset or liability, including assumptions about the risk inherent in a particular valuation technique, the effect of a restriction on the sale or use of an asset and the risk of nonperformance. Fair value is measured based on a variety of inputs that the Company utilizes. Fair value may be based on quoted market prices for identical assets or liabilities traded in active markets (Level 1 valuations). If market prices are not available, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market are used (Level 2 valuations). Where observable market data is not available, the valuation is generated from model-based techniques that use significant assumptions not observable in the market, but observable based on Company-specific data (Level 3 valuations). These unobservable assumptions reflect the Company's own estimates for assumptions that market participants would use in pricing the asset or liability.

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 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 to our consolidated financial statements, as it discusses accounting policies that we have selected from acceptable alternatives.

Overview of 2013

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, 2013, net income of the Company was $3.9 million, compared with $2.2 million for the year ended December 31, 2012. Basic and diluted net income per common share was $0.65 for the year ended December 31, 2013, compared with $0.36 for 2012.


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Other results for the Company as of and for the year ended December 31, 2013 were as follows:

Total assets increased 0.5% to $569.8 million, compared with $567.1 million as of December 31, 2012.

Deposits decreased 1.0% to $484.3 million, compared with $489.0 million as of December 31, 2012.

Loans net of unearned interest and fees decreased 13.0% to $310.3 million, compared with $356.7 million as of December 31, 2012.

As of December 31, 2013, the Company's total risk-based capital was 19.20%, significantly above a number of financial institutions in our peer group and well above the minimum requirement of 10%, to achieve the highest regulatory rating of "well-capitalized."

Net interest income decreased 10.1% to $30.7 million in 2013, compared with $34.2 million in 2012.

Provision for loan losses decreased to a credit of $0.6 million for the year ended December 31, 2013, compared with a charge of $4.3 million for the year ended December 31, 2012.

Non-interest income decreased 12.6% to $4.9 million in 2013, compared with $5.6 million in 2012.

Non-interest expense decreased 5.2% to $30.8 million in 2013, compared with $32.5 million in 2012. Impairment of OREO decreased $2.1 million in 2013, compared to 2012.

Shareholders' equity totaled $70.1 million, or book value of $11.63 per share, as of December 31, 2013, compared with $68.6 million, or book value of $11.40 per share, as of December 31, 2012.

Return on average assets in 2013 was 0.70%, compared with 0.37% in 2012, and return on average shareholders' equity was 5.68% in 2013, compared with 3.27% in 2012.

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

Results of Operations

Summary of Consolidated Operating Results for the Company



                                                              Year Ended December 31,
                                                               2013               2012
                                                               (Dollars in Thousands)
Interest Income                                            $     33,636         $  38,753
Interest Expense                                                  2,905             4,556

Net Interest Income                                              30,731            34,197
Provision (Reduction in Reserve) for Loan Losses                   (642 )           4,338

Net Interest Income After Provision (Reduction in
Reserve) for Loan Losses                                         31,373            29,859
Non-Interest Income                                               4,865             5,565
Non-Interest Expense                                             30,802            32,484

Income Before Income Taxes                                        5,436             2,940
Provision for Income Taxes                                        1,509               745

Net Income                                                 $      3,927         $   2,195

Net Interest Income and Margin

Net interest income measures 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 relatively stable during 2013, the yield on earning assets


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declined by 53 basis points, while the cost of interest-bearing liabilities declined by 29 basis points, as longer-term time deposits repriced at lower rates, decreasing net interest margin by 26 basis points, from 6.21% in 2012 to 5.95% in 2013. The table, "Yields Earned on Average Interest-Earning Assets and Rates Paid on Average Interest-Bearing Liabilities," summarizes the results of net interest income and net yield on earning-assets, comparing 2013 to 2012.

Net interest income decreased 10.1% to $30.7 million in 2013, compared to an increase of 3.2% in 2012. The decrease in net interest income in 2013 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 $5.1 million in 2013; $4.3 million was the result of decreased interest-earning assets, and $0.8 million was due to the 53 basis point decline in the yield on interest-earning assets. Interest expense declined $1.7 million in 2013; $0.6 million resulted from decreased interest-bearing liabilities, and $1.1 million was due to the 29 basis point decline in the cost of interest-bearing liabilities.

Overall, volume and yield changes in interest-earning assets and interest-bearing liabilities contributed to the decrease in net interest income during 2013. As to volume, the Company's average earning assets decreased $33.5 million during 2013, or 6.1%, while average interest-bearing liabilities decreased $40.7 million, or 8.8%. The Company's average loans declined by $48.6 million, or 12.9%, during 2013, and average investment securities increased by $12.2 million, or 7.1%. Average borrowings declined $2.7 million, average time deposits declined $44.4 million, average savings deposits increased $1.4 million, and average interest-bearing demand deposits increased $4.9 million.

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."

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 decreased to 81.8% in 2013, compared with 84.2% in 2012.

The Table, "Changes in Interest Earned and Interest Expense Resulting from Changes in Volume and Changes in Rates," summarizes the impact of changes in both the volume of interest-earning assets and interest-bearing liabilities, and the average rate earned or incurred on interest-earning assets and interest-bearing liabilities. As indicated by this table, the decrease in net interest income in 2013 is primarily attributable to decreases in the volume of interest-earning assets. One of the major challenges 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.


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Yields Earned on Average Interest-Earning Assets and

Rates Paid on Average Interest-Bearing Liabilities



                                                                 Year Ended December 31,
                                                      2013                                     2012
                                        Average                    Yield/        Average                    Yield/
                                        Balance      Interest      Rate %        Balance      Interest      Rate %
                                                        (Dollars in Thousands, Except Percentages)
ASSETS
Interest-Earning Assets:
Loans (Note A)                         $ 328,085     $  30,394        9.26 %    $ 376,644     $  35,373        9.39 %
Taxable Investments                      170,309         2,682        1.57 %      157,457         2,801        1.78 %
Non-Taxable Investments                   14,089           549        3.90 %       14,716           575        3.91 %
Federal Funds Sold                         4,411            11        0.25 %        1,585             4        0.25 %

Total Interest-Earning Assets            516,894        33,636        6.51 %      550,402        38,753        7.04 %

Non-Interest-Earning Assets:
Other Assets                              44,937                                   48,595

Total                                  $ 561,831                                $ 598,997

LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-Bearing Liabilities:
Demand Deposits                        $ 126,442     $     606        0.48 %    $ 121,498     $     707        0.58 %
Savings Deposits                          69,243           162        0.23 %       67,803           223        0.33 %
Time Deposits                            224,070         2,116        0.94 %      268,496         3,503        1.30 %
Borrowings                                 2,876            21        0.73 %        5,573           123        2.21 %

Total Interest-Bearing Liabilities       422,631         2,905        0.69 %      463,370         4,556        0.98 %

Non-Interest-Bearing Liabilities:
Demand Deposits                           62,838                                   59,443
Other Liabilities                          7,270                                    9,127
Shareholders' Equity                      69,092                                   67,057

Total                                  $ 561,831                                $ 598,997

Net Interest Income (Note B)                         $  30,731                                $  34,197

Net Yield on Interest-Earning Assets                                  5.95 %                                   6.21 %

Note A -Forthe purpose of these computations, non-accruing loans are included in the average loan amounts outstanding. These loans amounted to $14.8 million and $22.7 million for 2013 and 2012, respectively. Note B -Loanfees of $3.6 million and $3.7 million for 2013 and 2012, 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 2013 versus 2012 and 2012 versus 2011.

                                            2013 Compared to 2012                     2012 Compared to 2011
                                             Increase (Decrease)                       Increase (Decrease)
                                              Due to Change In:                         Due to Change In:
                                                   Average                                   Average
                                      Volume         Rate          Net          Volume         Rate          Net
                                                                 (Dollars in Thousands)
Interest Earned On:
Loans                                $ (4,560 )    $   (419 )    $ (4,979 )    $ (2,717 )    $  1,026      $ (1,691 )
Taxable Investments                       229          (348 )        (119 )         435        (1,980 )      (1,545 )
Non-Taxable Investments                   (25 )          (1 )         (26 )        (347 )         (14 )        (361 )
Federal Funds                               7            -              7            -              4             4

Total Interest-Earning Assets          (4,349 )        (768 )      (5,117 )      (2,629 )        (964 )      (3,593 )

Interest Expense On:
Demand Deposits                            29          (130 )        (101 )          11          (318 )        (307 )
Savings Deposits                            5           (66 )         (61 )          82          (210 )        (128 )
Time Deposits                            (580 )        (807 )      (1,387 )        (330 )      (1,062 )      (1,392 )
Other Borrowings                          (60 )         (42 )        (102 )        (584 )         (51 )        (635 )

Total Interest-Bearing Liabilities       (606 )      (1,045 )      (1,651 )        (821 )      (1,641 )      (2,462 )

Increase (Decrease) in Net
Interest Income                      $ (3,743 )    $    277      $ (3,466 )    $ (1,808 )    $    677      $ (1,131 )

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 for loan losses. 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 in the portfolio. The provision for loan losses for the Company was a credit of $0.6 million and a charge of $4.3 million for the years ended December 31, 2013 and 2012, respectively. The reduction in provision expense resulted from significant recoveries experienced in 2013 related to certain loans that were previously charged off, coupled with an improvement in the credit quality and other inherent risks of the loan portfolio at December 31, 2013.

Net charge-offs for the Company totaled $9.2 million in 2013, compared with $7.3 million in 2012. Net charge-offs at the Bank were $6.6 million in 2013, compared to $4.2 million in 2012. The increase in net charge-offs from both a Company and Bank perspective resulted primarily from continued economic weakness in the markets in which the Bank operates, particularly with respect to the real estate market. The real estate market continues to adversely impact real estate values and the ability of borrowers to perform, particularly when performance is based on real estate sales. At ALC, net charge-offs totaled $2.6 million in 2013, a reduction from $3.1 million in 2012. This decrease resulted from management's ongoing efforts to shift ALC's loan portfolio to focus more heavily on consumer loans and less heavily on real estate related loans.

The ratio of the allowance for loan losses to loans, net of unearned income for . . .

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